UPDATE 2-Puerto Rico mulls changing auction-rate debt

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By Anastasija Johnson

NEW YORK, Feb 14 (Reuters) - Puerto Rico is considering restructuring approximately $600 million of its auction-rate debt after the market became the latest victim of the global credit crunch, officials said on Thursday.

The commonwealth will have to pay maximum 12 percent interest on $63 million of its debt after an auction of these securities failed on Tuesday, said Luis Alfaro-Martinez, financing director at Puerto Rico's Government Development Bank.

"We are already considering the alternatives," said the bank's president, Jorge Irizarry, adding that this debt could be restructured into fixed-rate bonds or variable-rate securities backed by letters of credit.

Irizarry and Alfaro-Martinez spoke to reporters after an industry luncheon.

Auction-rate debt are long-term securities with interest rates resetting periodically. An auction fails when not enough buyers emerge to purchase securities, forcing the issuer to pay a high penalty rate to bondholders until the yield resets lower or debt is redeemed.

Puerto Rico is among numerous municipal issuers that have been forced to pay stiff interest after their securities failed to attract new buyers this week and dealers did not want to commit their capital to the transactions.

Dealers traditionally provided liquidity to the $330 billion market but many started balking recently because their balance sheets are strained by subprime-related losses.

"It's a policy decision of banks. They don't have enough capital to give liquidity to these bonds," said Alfaro-Martinez.

Troubled bond insurers guarantee a large number of the auction-rate securities, and fears those insurers will lose their top credit ratings have contributed to market turmoil even though it is unlikely that issuers of these securities will default.

"Auction-rate is a retail product and they just go scared. I think it's credit reaction from the retail market," Irizarry said.

The Puerto Rico auction that failed was insured by CIFG and Goldman Sachs was the broker-dealer. Another auction on Wednesday of $50 million of bonds backed by FGIC cleared at a rate close to 11 percent, Alfaro-Martinez said. Lehman Brothers was the broker dealer on that deal.

FGIC on Wednesday became the first major bond insurer to lose its "AAA" rating from all three major rating agencies. For details, see [ID:nN14229473].

"The market is obviously in a very jittery state," Irizarry said. "We will get past that. We don't think it is going to happen in the next couple of weeks. We can handle (high-rates)for a prudent amount of time until we restructure that debt. We will be ready to do this very quickly."

Puerto-Rico's auction-rate exposure, while painful, is small compared to over $8 billion of fixed-rate general obligation debt that commonwealth has issued. The $600 million of outstanding auction-rate bond were sold by the commonwealth and its agencies. (Editing by Leslie Adler)