Patriots Get Sacked by Muni Bond Liquidity Crunch

Even the New England Patriots have been tripped up by the suddenly treacherous municipal bond auction-rate market, as the team was forced to pay a 20 percent interest rate until it switched to more frequent auctions, according to a market source.

The interest rate the football team pays on Tuesday was reset to 13.76 percent because it switched to auctioning its debt every 7 days from a 28 day cycle, according to the source, who requested anonymity after providing the details late Tuesday.

A Patriots official had no immediate comment on Wednesday.

The team's latest interest rate was still high but about one-third less than the penalty rate the team had to pay last week on its $71 million of taxable debt when dealers en masse stopped supporting auctions.

Corporations and wealthy individuals, the main market for this type of long-term debt whose interest rates float or are reset periodically by auction, were spooked by the billion-dollar losses facing the U.S. bond insurers that guaranteed this paper.

New York Insurance Superintendent Eric Dinallo has been trying to help the insurers raise more capital to shore up the "AAA" credit ratings the insurance business demands.

But his task grew more complicated on Wednesday after Ohio's attorney general said he might sue on behalf of state funds that invested in auction rate securities.

Dealers stopped buying auction-rate debt that failed at auction in order to preserve their cash for other uses, and this was the only way to get the issuers to understand the market was indeed imperiled, market sources said.

"A lot of investment banks had been saying to the issuers, 'You guys need to call and redo these securities, and very few if any were listening,"' one of the experts said. "When all of a sudden you're paying 20 percent, you're listening."

The Patriot's decision to switch to more frequent auctions was just one of the ways issuers are dealing with the way the $330 billion market for auction rate securities has seized up.

Other issuers are considering switching to fixed-rate paper or variable rate demand notes. For example, $611 million of debt sold for the Indianapolis Colts' new stadium will either be switched to variable rate demand notes or a fixed-rate mode, according to the agency that sold the debt for the team.

Variable rate demand notes cost issuers more than auction rate debt because they buy letters of credit or standby purchase agreements. Letters of credit boost the credit, while standby purchase agreements oblige the dealers who sell those contracts to take the debt back if no one else wants it.

The auction-rate market is dominated by municipal issuers such as states, counties, cities, and authorities which have sold around $250 billion of this debt. Since the first municipal auction rate debt failed at auction in late January, hedge funds and highly sophisticated individuals have swarmed to the market, eager to capture the uncommonly high yields.

Their buying tamed the high rates seen last week, and now investors are jockeying to bid high enough to get the paper but not too high. "You bid too cheap and you get left out," explained one of the market sources.

For muni securities, "The market's sweet spot now is 8 to 10 percent," another market source said. "There are auctions clearing, but they are clearing at double the rate they cleared prior to (the failures)," he said. This type of debt might have commanded 4.0 percent rates or so until the market froze.