Bear Stearns arb selling $100 mln munis: traders

By Anastasija Johnson

NEW YORK (Reuters) - Bear Stearns' BSC.N arbitrage program was offering over $100 million of municipal bonds for sale on Friday and there were other sizable sellers, traders said.

Bear Stearns arb, which had not been seen in the muni bond market for some time, was selling on a day when the Federal Reserve Bank of New York and JPMorgan Chase & Co. (JPM.N) agreed to provide emergency financing for the investment bank after its cash position deteriorated sharply.

Traders said they did not know why the Bear Stearns program was selling. The offering was not very large. A Bear Stearns spokesman could not be reached immediately for comment.

Arbitrage players and hedge funds have been selling billions of dollars of municipal bonds in recent weeks because their leveraged trades went awry as the value of their assets plummeted just when their financing costs shot up.

"I have not seen them for a while" with a bid wanted list, a trader in Chicago said of Bear. "But that doesn't mean they have not sold bonds."

Arbitrage players, known as tender option bond programs, and hedge funds use leverage to profit from the difference between short-term and long-term municipal yields.

The market value of municipal bonds Bear Stearns held in its arbitrage net of offsetting positions was $3.77 billion at the end of November, according to its annual report.

Municipal bonds, which finance public projects such as schools and roads, plummeted in February amid fears that insurers that guarantee interest payments are no longer creditworthy.

The sell-off triggered margin calls and a number of hedge funds had to unwind their positions. Citigroup (C.N) on Tuesday said it would commit $1 billion to shore up six leveraged municipal hedge funds after they were hammered by losses.

Reuters also reported on Tuesday that Blue River Asset Management's main municipal bond fund is liquidating, according to sources familiar with the situation.

Market participants were also worried that banks will start selling municipal bonds because mortgage-related losses reduce their need for tax-free income that state and local government debt provides.

Traders said municipal bonds were lagging a rally in Treasuries on Friday because of arb selling. Municipal bond underperformance also means hedges used by leveraged players are not working.

BEAR LIST

Bear Stearns' bid-wanted list included $21.5 million of Upper Occoquan, Virginia, bonds due in 2020 with a 5.15 percent coupon, and $12.5 million of Illinois general obligation bonds due in 2016 with a 5.375 percent coupon, a trader in New York said. The settlement date for the bonds was March 25.

The trader in Chicago said he bought a small block of municipal bonds from the list, but added he was very careful about trading with Bear Stearns because of concerns about the counterparty risk that Bear Stearns will not be able to meet its obligations.