The New York State Housing Finance Agency this week plans to convert $173.3 million of auction-rate bonds into variable-rate demand obligations. The conversion will be the second this year for the authority, which is considering a third conversion next month to get bonds out of the volatile auction-rate market.

The bonds were sold in 2005 with a 33-year maturity to finance the construction of a 36-story, 407 unit multifamily housing development at 55 West 25th Street in Manhattan. Fannie Mae provided credit enhancement on the bonds and will provide liquidity for them when they convert.

The project was a joint venture between TFJ Estates LLC and Rosekey Associates LLC. Hawkins Delafield & Wood LLP is bond counsel on the conversion this week. UBS Securities is the remarketing agent.

HFA executive vice president for housing programs and policy Marian Zucker said that the agency has both reached out to its clients and been contacted by them as interest rates spiked on auction-rate bonds in the fall.

"We've called the broker dealers when this first started happening at the end of last year to say 'hey what's going on,' " Zucker said. "We've reached out to the clients, also, and said 'you really ought to think about getting out of this market.' "

Last month's conversion and the conversion planned for this week were relatively straightforward, she said.

"Because these transactions had a precommitment [from Fannie Mae] for liquidity it was a very easy change to make," Zucker said. Even though their credit enhancement hasn't been downgraded or put on watch, as some others have, they still saw interest rates rise along with the rest of the market.

"The issue here is the dislocation in auction-rate market," she said. "We've seen in these transactions rates in excess of 6%."

If last month's conversion is any guide, the strategy works. According to Bloomberg data, the conversion of $176.8 million of bonds used to finance the construction of an 125 West 31st didn't just blunt the spikes in interest rates, it beat them down.

In August, before the bond insurance turmoil and volatility in the auction-rate market began, bonds for 125 West 31st Street reset at 3.87%. Rates jumped 58 basis points in September to 4.45% and by December they had reached 6.25%, a 238 basis point increase compared to August. After the conversion to VRDO, interest rates, which are reset by the remarketing agent, plummeted. First to 3.1% in January and by last week they were down to 1.55%. Zucker declined to provide details on the possible third conversion.

Since 2003, New York issuers have marketed $12.57 billion of bonds in auction-rate mode, according to Thomson Financial data. By contrast, in 2008, no New York issuer has sold new debt in auction-rate mode.

Moody's Investors Service managing director for public finance John Nelson said that he's seen an uptick in the number of people calling and telling the rating agency that they are considering a conversion from auction rate or have already begun the process of converting to a different debt structure.

"These things take a lot of time to do," Nelson said. "You're not going to see a lot of them right away but there's a lot of activity going on."

Speaking generally about auction-rate market, Joseph Fichera, chief executive officer of the financial advisory firm Saber Partners, LLC, said the market a "mess."

"The complication is not the conversion of the auction rates, it is the conversion of auction rates with insurance," he said. "Even if you provide a liquidity facility, the insurance is still there and underwriters are saying that even though you may have a letter of credit behind it or some other liquidity, the investors will not buy it because it still has insurance. They are shunning anything with insurance even if you added additional liquidity." e_SRitq

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