BRADENTON, Fla. - Florida's Citizens Property Insurance Corp. told its financial adviser yesterday to work on a plan to defease $4.75 billion of taxable auction-rate securities following its first failed auction.

Citizens at previous auctions recently bought back about 20% of its outstanding auction-rate paper to help prevent a failed auction and to limit demands for higher interest rates by investors increasingly wary of securities wrapped by bond insurers facing potential rating downgrades, said Sharon Binnun, Citizens chief financial officer, after a conference call meeting yesterday of the corporation's finance and investment committee.

But the highly unstable market finally resulted in the state-run insurer's first failed auction on Wednesday, resulting in a reset at the penalty rate of 15%. Four other auctions were successful but interest rates were between 10% and 12%, rates significantly higher from when the securities were first purchased.

Citizens sold the debt, carrying insurance from various bond insurers, in recent years to have cash reserves available to pay claims if necessary in the event of a hurricane. It issued taxable securities so it could freely invest the proceeds in the meantime and avoid federal tax restrictions imposed on investing of tax-exempt bond proceeds.

But since the auction-rate market meltdown began, monthly carrying costs on the debt have grown significantly. The auction rates have increased dramatically, from a weighted average of the London Interbank Offered Rate minus 11 basis points in January 2007 to a weighted average of Libor plus 99 basis points in January 2008, said an analysis.

Committee member Earl Horton said yesterday that the rate has now risen from Libor plus 99 basis points to plus 1,000 basis points. "I think this imposes a greater sense of urgency to get an alternative [to auction rate securities] in place," he said.

Because interest rates on the debt have risen faster than the income on investments, Citizens has seen negative arbitrage soar to about $30 million a month, Citizens financial adviser, John Forneywith Raymond James & AssociatesInc., said yesterday during the conference call.

In a memo Feb. 8, Forney recommended taking out $1 billion to $2 billion of the agency's auction-rate securities in response to problems developing the market. However, yesterday Forney said that because of recent events Citizens should take out all of the auction-rate securities.

Market distress, Forney said, has accelerated not only because of insurance downgrades but because some broker-dealers have issued statements saying they would not backstop auctions, which caused an average 100 basis point increase that has "now multiplied several times in the last few days so the increase in interest rates is significant."

Citizens used a variety of broker-dealers to underwrite the debt, including Citi and Bear, Stearns & Co., according to Thomson Financial.

"Right now the cost of the current instruments is way beyond what we can tolerate," said Citizens board member Allan Katz, who also sits on the finance committee. "We need to move as quickly as we can."

Forney recommended a four-point plan to replace the securities with other instruments designed to provide as much liquidity as possible should Citizens need funds to pay claims.

The plan includes negotiating the extension of an existing $1 billion bank line of credit Citizens has now through a group of banks led by Citiand JPMorgan. Then Citizens would solicit another consortium of banks to provide an additional $1 billion line of credit.

Citizens could issue $1 billion of variable-rate demand notes insured by triple-A rated Financial Security Assurance. The memo indicated FSA's parent, DexiaSA, said it would be the liquidity provider only if FSA was the insurer.

Forney recommended Citizens also explore issuing $2 billion to $3 billion of a short-term fixed-rate product.

The Finance and Investment Committee yesterday ordered work to begin on the new plan to raise liquidity and defease the auction-rate securities, which could take several months. A report will be presented at Citizens' full Board of Governors meeting next Thursday. q

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