By Martin Z. Braun and Michael McDonald

Feb. 20 (Bloomberg) — Interest rates on $100 million of bonds issued by the Port Authority of New York and New Jersey were set at 8 percent in a weekly auction after surging to 20 percent on Feb. 12.

Rates had soared from 4.3 percent when too few buyers bid for the so-called auction-rate debt and Goldman Sachs Group Inc., which runs the auction, refused to put up its own capital to buy unwanted securities. That caused the yield to be set at a level predetermined in bond documents. Rates fell yesterday as the prospect of high yields enticed investors, according to data compiled by Bloomberg.

Rates in the more than $300 billion market for auction-rate debt are rising after banks including Citigroup Inc. and Goldman stopped bidding for the debt at periodic sales they oversee, prompting hundreds of so-called failures. Some investors, including OppenheimerFunds Inc., see an opportunity in the turmoil and are buying the bonds.

“Twenty percent was such an unusually high number,” said Judy Wesalo Temel, director of credit research at Samson Capital Advisors LLC, a fixed-income manager in New York. “I wouldn’t say that the whole market has calmed down or has even begun to function normally yet. It hasn’t.”

Yesterday, a Citigroup-run auction of $25 million of federally taxable debt issued by Vermont’s student loan agency failed, causing the rate to remain at 18 percent for the second week in a row. The debt paid 4.5 percent as recently as Feb. 11.

Port Authority Rates

The 8 percent rate on the federally taxable Port Authority debt is still above the range of 4 percent to 5.70 percent the agency paid until this month. Port Authority Treasurer Anne Marie Mulligan didn’t return a call for comment; Goldman spokesman Michael DuVally declined to comment.

Auction-rate bonds are long-term debt with interest rates that reset according to bids submitted through securities firms every seven, 28 or 35 days. When there aren’t enough bids, the auction fails and the rate is set at a level spelled out in bond documents. Investors who expected to sell the debt are left holding the securities.

Until the past two weeks, bankers who ran auctions prevented failures by purchasing bonds for their own account, though they weren’t required to do so. Investors grew wary of relying on bankers to support auctions as the investment firms reported more than $146 billion of losses and writedowns.

 Rising Average

 The average rate for seven-day municipal auction bonds rose to a record 6.59 percent on Feb. 13 from 4.03 percent the previous week, according to indexes compiled by the Securities Industry and Financial Markets Association.

Regulators allow dealers to bid when they choose, and to control auction information as long as they disclose that they might submit bids. Bankers don’t have to say how often they buy or how much, and aren’t required to make public the range of bids or when auctions fail.

Last week, New York Governor Eliot Spitzer cited the high rate on the Port Authority’s auction-rate bonds in testimony on bond insurers before a House subcommittee on Capital Markets, Insurance and Government. Insurers such as MBIA Inc. and Ambac Financial Group Inc. that back the debt are struggling to raise capital after taking more than $8 billion in writedowns related to mortgage-linked securities they guaranteed.

“The higher max rate stuff is starting to get some traction,” said Matt Dalton, chief executive officer of Belle Haven Investments, a money management firm based in Greenwich, Connecticut.

Massachusetts Tolls

 Drivers on the Massachusetts Turnpike may face higher tolls after the state was unable to sell auction-rate securities backed by a unit of Ambac, according to state officials. The turnpike is now trying to buy a letter of credit from State Street Bank and Trust Co. and KBC Group NV so it can sell variable-rate demand obligations by mid-March instead of auction-rate securities, an advisor for the Turnpike told the agency’s board yesterday.

“That is a very significant financial obligation, probably our biggest short-term problem,” Alan LeBovidge, the turnpike authority’s executive director, said at the state agency’s monthly board meeting yesterday.

Auction-Rate Proposal

 The Securities and Exchange Commission fined banks in a settlement over bid-rigging two years ago. The U.S. municipal bond market’s main regulator, the Municipal Securities Rulemaking Board, plans to propose rules requiring banks to disclose more, including the rate, bidding details and information about failures.

Auction-rate securities were introduced in the corporate market in 1984, when American Express Co. sold $300 million of auction preferred stock. The securities, devised by Ronald Gallatin, a retired managing director at Lehman Brothers Holdings Inc., then Shearson Lehman, were used by banks and other companies before auction difficulties prompted many companies to move away from them.

American Express retired its issue in 1991-1992, and in 1995 Lehman was fined $850,000 by the SEC for manipulating auctions conducted for American Express.

The first failed auction in the municipal market occurred in 1990 for bonds issued by the Pima County, Arizona, Industrial Development Authority for Tucson Electric Power Co., now a unit of UniSource Energy Corp., based in Tucson.

`Investor Protection’

 The Alexandria, Virginia-based municipal securities regulator said yesterday that it is reminding dealers of rules on disclosure to investors and on suitability requirements, which make dealers responsible for ensuring investors understand the securities they are buying.

“The notice was put out to remind dealers of their investor protection obligation under MSRB rules,” Executive Director Lynnette Hotchkiss, said in an interview with Bloomberg Television. The board makes the rules for the $2.6 trillion market of debt sold by states and municipalities.

Also yesterday the U.S. Internal Revenue Service said it plans to issue new rules making it easier for local governments to convert high-rate auction bonds to lower-cost debt.

The changes wouldn’t be such a significant modification that it would amount to a re-issuance of the bonds, the IRS said. Many auction securities were sold with the option of converting them to variable-rate demand bonds or to debt with a fixed rate.

If the conversion was considered a re-issuance in the eyes of the tax authorities, it might result in “various negative consequences to a bond issuer,” including lower limits on interest earned from investment of bond proceeds, termination of interest-rate swaps or public approval requirements for some kinds of bonds, the IRS notice said.

By Jason Kelly and Pierre Paulden

Feb. 20 (Bloomberg) — KKR Financial Holdings LLC, Kohlberg Kravis Roberts & Co.’s only publicly traded fixed-income fund, delayed repaying debt a second time in six months after failing to find buyers for commercial paper backed by mortgages.

Lenders to the fund agreed to the delay as KKR Financial seeks to restructure, the San Francisco-based company said yesterday in a regulatory filing. KKR Financial, whose stock has fallen 50 percent in the past year, didn’t say how much debt is affected.

The announcement rekindled concerns that the decline in the market for short-term asset-backed debt, which totaled $1.2 trillion in August, will accelerate after a rebound early last month. Assets fell to $796 billion in the week ended Feb. 13, the third weekly drop. Standard & Poor’s downgraded ratings on notes issued by KKR Pacific Funding Trust last week, citing uncertain pricing on the AAA rated securities that support them.

“The picture is getting worse and worse,” said Felix Freund, who helps manage the equivalent of $14.7 billion of fixed-income securities at Frankfurt-based Union Investment GmbH. KKR Financial’s second repayment extension “shows there is still a lot of levered investments in the credit market that we can’t see.”

About half the debt will be due by March 3 instead of Feb. 15, with the rest owed on March 25, according to the filing.

The talks come less than six months after the fund received a $230 million cash infusion from investors following losses on residential mortgages in the wake of the U.S. subprime crisis. The fund, led by Chief Executive Officer Saturnino Fanlo, raised a further $270 million in a rights offering with some of New York-based KKR’s own partners buying shares in it, which had $19 billion of assets at the end of December.

Repricing `Driver’

The deferral drove investors to seek the security of government debt, sending 10-year Japanese bonds to the biggest gain in two weeks while perceived corporate risk in Asia and Europe soared. Contracts on Europe’s Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings increased 26.5 basis points to 611.5 today, according to Deutsche Bank AG. A basis point is 0.01 percentage point.

“The driver behind the current repricing is KKR Financial Holdings delaying repayment of CP for the second time,” analysts led by Mark Harmer, head of credit research at ING Groep NV, said in a note to clients today.

KKR Financial fell 30 cents, or 2.1 percent, to $14.23 at 11:44 a.m. in New York Stock Exchange composite trading. Zoe Watt, a spokeswoman for KKR in London, declined to comment.

IPO

Kohlberg Kravis Roberts, the New York-based investment firm run by Henry Kravis and George Roberts, raised $800 million in KKR Financial’s initial public offering in June 2005, selling the shares for $24 apiece. The fund raised money by selling commercial paper to invest in mortgages. It sold almost half of its mortgage loans in August as prices on bonds linked to U.S. home loans started to drop, leaving it with about $5.3 billion of mortgages.

Both Kravis and Roberts sit on KKR Financial’s six-member investment committee, alongside KKR Partner Scott Nuttall, KKR Financial’s Fanlo and Chief Operating Officer David Netjes.

Kravis and Roberts started the firm with Jerome Kohlberg, their colleague from Bear Stearns Cos., in 1976. Kohlberg left in 1987 and started his own buyout group, Kohlberg & Co. LLC. The private-equity business owns more than 42 companies with more than $180 billion of annual revenue and about 800,000 workers around the world. The firm’s investments range from Alliance Boots Ltd. in the U.K. to Texas power producer TXU Corp., now known as Energy Future Holdings Corp.

Cash Injection

KKR put $38.3 million in October into the two commercial- paper funds run by KKR Financial. The KKR Atlantic Funding Trust and KKR Pacific Funding Trust, once $5 billion conduits rated A- 1+, the top level, were downgraded by ratings company Standard & Poor’s to A-2 and A-1 in October. KKR Pacific was cut again to A-3, the lowest investment-grade for short-term debt in February.

The terms of investing in both programs were first changed Oct. 15, S&P said, with KKR agreeing to inject cash into the funds and lengthening the maturities to Feb. 15 for half of each program’s extendible notes and March 13 for the other half.

KKR Financial booked a third-quarter loss of $261.5 million, hurt by a $250 million writedown for the notes. The fund had $1.04 billion of cash available at the end of 2007, according to its earnings report.

The company received $500 million in August from investors including Farallon Capital Management LLC and Morgan Stanley. The fund also raised $270 million in a rights offering in September, with almost a fifth of the shares on sale bought by Kohlberg Kravis Roberts partners.

By Neil Unmack

 Feb. 20 (Bloomberg) — Standard Chartered Plc abandoned a plan to bail out its $7.15 billion Whistlejacket Capital Ltd. structured investment vehicle, the largest bank-run SIV to collapse because of “continuing deterioration” in markets.

Whistlejacket will become the sixth SIV to default unless it makes a payment tomorrow when a three-day grace period ends, according to Standard & Poor’s. SIVs with more than $20 billion of total assets are in default, including funds managed by New York-based Ceres Capital Partners LLC and Cheyne Capital Management (UK) LLP in London.

HSBC Holdings Plc and Citigroup Inc. led banks bailing out their SIVs, funds that use short-term borrowing to buy higher- yielding assets, after the collapse of U.S. subprime mortgages caused investors to shun debt securities that couldn’t be valued. SIV assets have shrunk by $100 billion from $400 billion since August, according to Moody’s Investors Service.

“It seems Standard Chartered is the only bank sponsor not willing to stand behind its SIV, in the way that HSBC or Citigroup have done,” said Harpreet Parhar, a London-based credit analyst at Calyon in London. “There is a reputational risk there.”

Standard Chartered, the U.K.’s sixth-biggest bank by market value, fell 30 pence to 1558 pence at the close of trading.

Freezing Payments

Whistlejacket, based in the U.K. Channel Islands, appointed receivers after the asset value of bonds owned by its most- junior creditors fell below 50 percent, requiring it to wind down.

Deloitte & Touche LLP froze Whistlejacket’s debt payments on Feb. 15 after London-based Standard Chartered told the receiver the SIV may not be able to repay future debts, according to Neville Kahn, a receiver at Deloitte.

Deloitte was working with Standard Chartered this week on the bank’s proposal to buy assets from the SIV, Kahn said.

“We worked doggedly to find a solution for Whistlejacket,” said Tim Baxter, a London-based spokesman for Standard Chartered. “In making our final decision we were conscious of all the various stakeholders – the SIV’s investors, our shareholders and our customers.”

Whistlejacket has reduced holdings by more than 50 percent from $18.2 billion in August after it sold assets to repay maturing debt, including short-term commercial paper, Standard Chartered said last month. The SIV still has $6.9 billion of senior debt outstanding as of Feb. 11, according to S&P.

The market for asset-backed commercial paper, IOUs secured by home and consumer loans, shrank $6.2 billion to $796 billion last week, according to the Federal Reserve. Record defaults on U.S. subprime mortgages prompted investors to shun short-term debt backed by assets, cutting off funding for SIVs.

‘No Fire Sale’

SIVs typically invest in asset-backed securities and bonds sold by banks and insurance companies with high credit ratings.

Whistlejacket invested about 44 percent of its assets in financial company debt, according to Moody’s Investors Service. About 20 percent is in mortgage-backed bonds and 10 percent in collateralized debt obligations, notes that pool other securities.

Standard Chartered blamed the “impracticality of completing any proposal within the confines of the receivership” for withdrawing its refinancing plan, in a statement today. The bank also cited the “continuing deterioration in the market.”

Deloitte is considering ways to refinance the SIV or letting the assets pay down, and is in discussions with a number of financial companies, Deloitte’s Kahn said in interview today.

“There is no need for a fire sale of assets,” he said.

SuperSIV

The threat of fire sales by SIVs further roiling credit markets prompted U.S. Treasury Secretary Henry Paulson to start talks on setting up an $80 billion bailout fund last year. Citigroup, Bank of America Corp. and JPMorgan Chase & Co. abandoned the so-called SuperSIV after banks began rescuing their own funds, led by London-based HSBC.

Citigroup in New York, the largest SIV sponsor, said December it would provide financing for its seven funds, taking on their assets and liabilities. Bank of Montreal yesterday proposed to provide up to $12.7 billion of financing for its SIVs, Links Finance and Parkland Finance.

Standard Chartered first proposed to finance its SIVs Jan. 31, but abandon the plan after the companies’ asset prices fell, forcing it to appoint receivers. The bank made two further proposals to the receiver last week.

Whistlejacket sold some assets to investors in its junior- ranking bonds in return for repaying their debt in deals known as vertical slices.