UPDATE 1-Biggest ever demand by dealers at Fed's TSLF auction

(Adds context, analyst comment)

NEW YORK, July 24 (Reuters) - Primary dealers flocked to the Federal Reserve’s 28-day, $25 billion Term Securities Lending Facility auction on Thursday, showing the biggest demand since this program was introduced in March to provide Treasuries in exchange for riskier collateral.

“This data suggests a greater dependence on the Fed,” said Ward McCarthy, managing director with Stone & McCarthy Research Associates, in Princeton, New Jersey.

Primary dealers submitted $51.72 billion of bids for the $25 billion of Treasuries offered at the auction in exchange for riskier Schedule 1 collateral, generating a bid-to-cover ratio -- an indication of demand -- of 2.07, the highest ever and well above the 0.85 bid-to-cover at a similar auction of the same size earlier this month.

“These auction results suggest that there must be some type of disinclination to do term repo, with some type of dislocation in the term repo market, and that there are some holders of mortgage securities out there who are looking for ways to finance them,” McCarthy said.

The TSLF facility is one of several programs the Fed has brought in during recent months as lifelines to the cash-strapped financial sector.

With the recent rebound in prices of riskier fixed income securities after the government's July 13 announcement of a support plan for Fannie Mae FNM.N and Freddie Mac FRE.N, some dealers may be seizing advantage of a moment to park mortgage securities with the Fed at attractive levels, analysts said.

“You use the Fed as a shoulder to get through this time period,” said George Goncalves, chief Treasury/TIPS and agency strategist with Morgan Stanley in New York.

“It is partly due to the uncertainties going on in the mortgage market and with GSEs and not knowing exactly how things are going to unfold,” Goncalves said.

The TSLF enables dealers to temporarily lodge riskier securities they have on their books with the central bank, converting these into Treasuries which can be exchanged for cash in the U.S. repurchase market, to help shore up balance sheets that have been depleted by the credit crisis.

But some analysts viewed Thursday’s auction results as a sign that non government bond markets were recovering somewhat.

"Spread products have done better in the wake of the government plan to help Fannie/Freddie; with positions built up, those positions need to be financed," said Lou Crandall, chief economist at Wrightson ICAP, in Jersey City, New Jersey. "So this is a positive sign," said Crandall. (For more details clickhere) (Reporting by John Parry, Tamawa Kadoya and Chris Reese; Editing by James Dalgleish)