April 7 (Bloomberg) -- U.S. state and local borrowers from Denver to Atlanta, battered by rising interest costs from the collapse of the auction-rate bond market, now face higher fees to replace the debt.

Denver found only five banks willing to provide backing for new variable debt to replace $208 million of auction bonds, down from 30 five months ago, said Margaret Danuser, the city's debt administrator. The cost to line up a buyer of last resort in case such bonds, variable-rate demand obligations, go unsold when yields are reset jumped as much as fourfold to $400,000 on $100 million of securities a year, borrowers say.

``It's a lot of headaches,'' Danuser said. Denver's costs for a so-called liquidity facility on the new debt were double the fees on a similar agreement last year, she said. ``It's pretty telling of the tightness of the market.''

States, cities, hospitals and other municipal borrowers that sold $166 billion of auction-rate securities plan to replace at least $36.7 billion of the debt by May 23, according to data compiled by Bloomberg. The auction-rate market collapsed in February after investors shunned the securities and dealers that run the periodic bidding to set interest costs stopped committing their capital to prevent failures.

The extra costs for Denver are still lower than keeping bonds in the auction market, where interest costs rose to as high as 10 percent in February, from 3.5 percent in January.

``They were a lot higher than we ever anticipated,'' Danuser said. ``As we were getting up over 5 percent, it was apparent to us that we were paying more than we thought we needed to.''

Auction Yields Rise

Average rates on bonds with interest determined through bidding at dealer-run auctions every seven days rose to 5.67 percent April 2 from 3.63 percent in January. That compares with 1.89 percent on top-rated variable-rate demand bonds, whose rates are set by bankers, according to data from the Securities Industry and Financial Markets Association, or Sifma. The auction-rate index reached a record of 6.89 percent on Feb. 20.

When there aren't enough bids on auction debt, a ``failure'' results and rates are set at levels spelled out in bond documents. Investors who wanted to sell are left holding the bonds. When there isn't enough demand for variable-rate demand obligations at the time rates are reset, the provider of the backstop agreement buys debt that can't be immediately sold to other investors.

``The cost of liquidity facilities is so expensive now because those few who can provide them can charge huge premiums,'' Utah Treasurer Ed Alter said.

Fourfold Rise

The ability to forgo the added cost of so-called standby purchase agreements or letters of credit made auction securities popular among borrowers until the subprime-mortgage crisis sparked $232 billion in credit losses at banks worldwide. Dealers abandoned the market where they routinely bought unwanted securities to avoid failures.

Yields on weekly auction-rate securities averaged 0.1 percentage point less than variable-demand notes in the year through August, based on Sifma data.

When Children's Healthcare of Atlanta considered buying a liquidity facility for $200 million of variable-rate bonds, officials found the cost of a one-year commitment rose to as high as 0.4 percentage point from 0.1 percentage point, said Al Gasiorek, chief investment officer.

The Atlanta-based hospital network instead opted to act as its own backstop for debt to be sold April 15, putting its own cash at risk, Gasiorek said.

`Similar Maneuver'

``Because everybody is engaged in somewhat of a similar maneuver, the expense involved in various forms of liquidity has tripled or quadrupled,'' he said. ``The ability to secure five- or 10-year standby purchase agreements or letters of credit may not be available at all.''

Municipalities are also paying higher yields on fixed-rate bonds in their rush to escape the auction-rate market. Thirty- year tax-exempt bond yields rose to 4.88 percent, or 1.13 times the rate on the taxable Treasury, up from 0.96 times the federal benchmark Feb. 14, data compiled by Municipal Market Advisors and Bloomberg show.

Denver International Airport, the fifth-busiest, plans to exit the auction-rate market by May, refinancing its debt into three other forms: variable-rate notes, commercial paper and fixed bonds.

`Became Too Much'

Denver will sell $450 million of fixed-rate bonds April 10. Officials chose Goldman Sachs Group Inc. to manage its fixed- rate sale, one of the dealers that underwrote its auction debt.

``Our banks supported our auctions for as long as possible,'' Danuser said. ``It just became too much given all the other crises in the markets.''

New York City officials declined to disclose the cost of buying liquidity from banks including Bank of America Corp., Dexia SA and Bank of Nova Scotia used for a recent issue of $1.3 billion in variable-rate demand notes.

``It's highly competitive,'' said Regina Fleszar, head of investor relations for the city comptroller's office.

Ambac Financial Group Inc. said late last week it was creating a group to respond to the turmoil in the auction- and variable-rate markets, after scrutiny of credit ratings in the financial guarantor industry led investors to shun such debt.

To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net

Last Updated: April 7, 2008 10:19 EDT