March 28 (Bloomberg) -- Auction-rate bond failures rose to about 71 percent this week, leading borrowers from Dallas and Fort Worth's airport to Ascension Health in Missouri to refinance the debt and avoid paying penalty interest rates.

The number of auctions that failed to draw enough buyers to a market that also includes debt of student lenders and closed- end mutual funds increased from 69 percent last week, according to data compiled by Bloomberg. Rates are set through a bidding process managed by banks typically every seven, 28 or 35 days.

States and municipalities are fleeing the auction-rate market after it began collapsing about seven weeks ago as investors balked at buying the securities on concern about the creditworthiness of bond insurers guaranteeing the debt. Dealers stopped purchasing the unwanted debt, and the average rate for weekly municipal auction bonds rose to 6.56 percent on March 19, from 3.63 percent on Jan. 16, based on the latest public data from the Securities Industry and Financial Markets Association.

``The auction-rate market is just going to keep getting worse,'' said Michael Phemister, the vice president of finance at Dallas-Fort Worth International Airport, the world's third busiest airport by takeoffs and landings.

The airport, known as DFW and owned by the two cities, converted $337 million of auction debt into bonds with fixed rates as high as 6.25 percent that will be paid through at least November 2009. Some of the penalty rates on the auction bonds were poised to go higher, after one insurer lost an investment- grade rating, Phemister said.

`Right Thing'

``We felt restructuring was the right thing to do,'' in part, to free investors from auctions that would likely continue to fail, Phemister said. Would-be sellers can't get their money when auctions fail.

The auction-rate securities market originally attracted borrowers by offering financing for 20 years or more at variable costs determined through periodic bidding. They were sold to some investors as money market equivalents.

Citigroup Inc., Deutsche Bank AG, Morgan Stanley and Merrill Lynch & Co. have been named in separate lawsuits by customers who claim they were misled about the risks of auction- rate securities.

While not obligated to do so, underwriters from UBS AG to Goldman Sachs Group Inc. and Citigroup often bid for their own accounts when too many people wanted to sell and there weren't enough buyers at auction. That prevented the auctions from failing and kept interest costs down. From the creation of the securities in 1984 through 2007, there were less than 50 recorded failures, according to Moody's Investors Service.

Hundreds of Failures

Auction failures have numbered in the hundreds each day since Feb. 13, and 60 percent or more of public auctions have been unsuccessful, based on data compiled by Bloomberg from auction agents Deutsche Bank AG, Wilmington Trust Corp., Bank of New York Mellon Corp. and Wells Fargo & Co. Out of 2,865 auctions this week, 2,023 failed.

``The ARS that have the higher rates are rapidly being bonded out into longer maturities to lessen the pain for the issuers,'' Tom Spalding, senior investment officer at Nuveen Investments in Chicago, said in an e-mail, using the abbreviation for auction-rate securities.

Municipal borrowers are pulling more than $21 billion of bonds out of auction rates by May 1, according to official notices compiled by Bloomberg.

Closed-end funds' preferred shares and student-loan debt made up about $148 billion of the $331 billion auction-rate market as of year-end 2007, according to a Feb. 13 Bank of America Corp. report. A greater proportion of their auctions are failing because many of their penalty rates are tied to a formula based on the London interbank offered rate or other money-market benchmarks that limit the increase.

Long Wait

Smaller, less frequent borrowers and those on the losing end of interest-rate swaps attached to their auction-rate deals might take much longer to get out, said Matt Fabian, managing director at the research firm Municipal Market Advisors. Issuers used the swaps to hedge interest-rate risk.

``It might be a year or two before some of these are unwound,'' Fabian said. ``It's definitely consuming more cash'' for some issuers.

Dallas-Fort Worth airport, or DFW, converted debt this week that will continue carrying guarantees from MBIA Insurance Corp. and XL Capital Assurance Inc. MBIA's AAA rating remains under review for a possible downgrade at Fitch Ratings; XL Capital Assurance was cut to BB, or below investment grade, from A.

Airport Refinancing

The airport will pay 6.125 percent on $56 million of 10- year bonds insured by XL Capital Assurance through late next year, when it has the option to buy back the debt at face value. It had faced a possible penalty rate of 2.75 times one-month Libor, or about 7.45 percent, on those obligations.

``Anyone who buys this bond knows there is a high probability we will refund in 18 months,'' Phemister said. ``It gives us some flexibility.''

Also this week, Kansas City, Missouri-based Ascension Health planned to start converting all of its tax-exempt auction debt through the sale of $326 million in fixed-rate bonds. The largest U.S. nonprofit health system's refinancing continues next week and will remove insurance from the debt, while maintaining interest-rate swap agreements.

To contact the reporters on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net; Darrell Preston in Dallas at dpreston@bloomberg.net.

Last Updated: March 28, 2008 10:16 EDT