Auction troubles to boost liquidity costs for issuers

NEW YORK Feb 22 (Reuters) - Prices for standby purchase agreements and other liquidity products have already doubled or tripled in recent months and turmoil in the $330 billion auction-rate market may push them higher, issuers said on Friday.

Banks that provide these agreements, as well as letters or lines of credit, stand to gain as states, cities, hospitals and other issuers rush to restructure their auction-rate debt to avoid paying soaring interest rates.

Issuers are replacing their auction-rate securities with fixed-rate or variable-rate debt backed by a letter of credit or standby purchase agreements, boosting demand and prices for these products just as banks' credit capacity is shrinking.

"(Prices) on standby purchase agreements are upward of 30 basis points," said Marian Zucker, executive vice president at New York State's housing finance and mortgage agencies.

"Clearly that increase in cost is subject to increased demand for liquidity facilities as borrowers seek to exit the auction-rate market," she added.

Another New York issuer said strong credits now have to pay standby purchase agreement providers, usually banks, between 25 basis points to 50 basis points per $1 million of par value of their debt, or between $200,000 to $500,000 annually on a $100 million issue.

A year to six months ago, the annual cost was around 15 basis points, or $150,000 for $100 million of debt. Under these agreements, banks promise to buy variable-rate demand notes from investors if no other buyer emerges.

Letters of credit are even more expensive because banks not only promise to be the buyer of last resort but also to pay interest if an issuer defaults. By contrast, auction-rate securities do not have any liquidity facilities.

Auction-rate paper is long-term debt, but its rates are reset at set periods, from daily to 35 days or more. This type of borrowing was attractive because it enabled issuers to pay short-term rates -- which usually are much lower than long-term rates.

Many issuers had entered the now-troubled $330 billion auction rate market to avoid paying for liquidity facilities, said Paul Matus, director of tax-exempt investments at Smith Affiliated Capital in New York.

"The auction market evolved because people were trying to save money. It worked for a long time, but right now the easiest thing to do is to put on a letter of credit," Matus said.

Even though the costs for liquidity facilities have doubled or tripled, they are still better than the 15 percent or 20 percent interest rates that some issuers have had to pay when their auctions failed in recent weeks.

Hundreds of auctions collapsed since the end of January as traditional buyers and brokers abandoned the market, fearing losses on insured securities if bond insurers are downgraded.

Dealers, hurt by subprime mortgage losses, are trying to preserve cash and banks that provide liquidity facilities also have limited capacity.

"In general, we've been hearing that (due to) the scarcity of capacity on Wall Street it would be quite expensive to get a new line or a letter of credit. This is just a function of the market," said Colin MacNaught, Massachusett's assistant treasurer for debt management.

MacNaught said the state is in the process of replacing an existing line of credit and although it got a slightly lower fee than it had been charged on the existing one, most bids it received were significantly higher.

Last year, banks provided standby purchase agreements on $17.9 billion of municipal bonds, according to Thomson Financial. Dexia Group (DEXI.BR) was the largest player in the market, followed by Bank of New York (BK.N) and Depfa Bank.

Bank of America (BAC.N), JPMorgan Chase (JPM.N) and Wachovia Bank WNVIL.PK were the three largest providers of letters of credit in 2007, according to Thomson Financial. The total principal amount of letters of credit in 2007 was $20.4 billion.

Zucker said banks are allocating their capacity on the basis of existing relationships with issuers or to issuers that are willing to pay more. Higher prices are hurting all issuers, she added.

"The market for liquidity is one market. No matter why you need to access it, you are still going to the same banks," she said. (Additional reporting by Joan Gralla in New York; Editing by Dan Grebler)