UBS muni bond exit may spike public borrowing costs

CHICAGO (Reuters) - UBS Securities' plan to exit the municipal bond business could result in higher borrowing costs for cities and states as competition for underwriting business thins, market participants said on Tuesday.

Grappling with a subprime mortgage crisis that has hit its bottom line, UBS (UBSN.VX) on Tuesday said it would sell or close down its municipal operation as it cuts 5,500 jobs to trim costs. The company also said it was in the preliminary stages of a possible sale of the muni operations.

UBS ranked third behind Citigroup (C.N) and Lehman Brothers LEH.N as book running manager for municipal bonds in the first quarter of 2008, according to Thomson Financial. It served as senior manager on 89 issues with a par amount totaling more than $7.5 billion.

A UBS spokeswoman declined to give the number of jobs in its muni operations or the number that will be cut.

The municipal securities group "is a successful business with leading capital markets and sales teams and broad relationships, but is a business we believe will be highly valuable to another owner," UBS said in a statement.

"Select municipal trading desks" will be moved into the company's wealth management area to provide clients with muni inventory from the secondary market, UBS said.

No details on possible buyers for the muni operation were available, the UBS spokeswoman said.

Muni issuers, such as cities, states, schools and hospitals, may also end up paying more to sell their debt in the wake of fewer investment banks.

"The No. 4, 5 and 6 in the business are probably not too upset because margins will increase. And if UBS is not around to underwrite a deal, they will be able to charge more on a deal," said Tim McGregor, director of municipal fixed income at Northern Trust in Chicago.

Remaining top underwriters also will be stretched to deal with new muni bond issuance, especially as they have been hard-pressed this spring to keep up with extra bond sales from issuers restructuring their auction-rate bonds.

The extra work load has squeezed out some traditional muni offerings, such as ones that raise money for capital projects or ones that are sold competitively, McGregor said.

"Minus somebody like UBS, this process will take even longer to accomplish," McGregor said.

Muni traders reported no heavy selling of munis out of UBS on Tuesday.

UBS is not the first muni underwriter to be hit by the subprime mortgage crisis.

Last month, liquidity troubles at Bear Stearns & Co. BSC.N led to its pending acquisition by JPMorgan Chase & Co. JPN.N. Bear Stearns ranked seventh among municipal senior managers in the first quarter, with JPMorgan ranking sixth.

The impact of UBS quitting the muni business more closely resembles Salomon Brothers' decision to exit this area in 1987 because both were much more dominant underwriters than Bear Stearns, said Evan Rourke, a muni strategist with M.D. Sass. "And in both cases there was no clear successor to take on their business," he said.

In contrast, Bear Stearns' book of business will be handled by JPMorgan, he noted.

Some traders fretted about how smoothly UBS would handle its pipeline of deals. But a Colorado public borrower on Tuesday said UBS AG turned in the best performance this year in underwriting a "BBB" health-care deal, underscoring how much the bank's muni underwriting prowess will be missed.

Corinne Johnson, a spokeswoman for the Colorado Health Facilities Authority, said the $51 million debt sale "probably did 20 basis points better" than any other offering of similarly rated health-care debt done this year.

The authority's financial adviser "thought UBS did a phenomenal job," she added.

The California Treasurer's Office, which has used UBS as senior manager on three bond issues since the beginning of 2007, will be losing an advocate, according to Tom Dresslar, a treasury spokesman.

"Among our underwriter pool members, UBS was one of the most helpful in supporting our initiative to boost retail sales," Dresslar said. "They also backed our campaign to reform how rating agencies grade municipal bonds."

(Reporting by Karen Pierog; Additional reporting by Joan Gralla and Anastasija Johnson in New York; Editing by Leslie Adler)