How a Dublin Firm Roils Money Market

Euro credit crisis was triggered by Hype Real Estate's subsidary bank, Delpfa, which garantee moeny market liquidity for muni issuers. The cuase of Delpha could be traced to Lehman's demise. The collapse of Lehman let the floodgate open.... The woes of a small Dublin-based financial firm called Depfa Bank PLC are rapidly spreading around the globe, in a chain reaction that highlights the destructive force of the mutinous debt markets. In a matter of days, the situation at Depfa, a unit of German commercial lender Hypo Real Estate Holding AG, has gone from bad to worse. That's because banks that had provided cheap loans to Depfa have stopped lending to it. The crisis has dragged some of Europe's largest banks and Germany's government into a €50 billion ($67.6 billion) bailout of Hypo. Now, Depfa's troubles are spilling into the U.S. municipal debt market, where Depfa potentially is on the hook to backstop, or buy back, billions of dollars of debt used to fund various projects and towns. Borrowers that could suffer as a result are a low-income housing program in Colorado, and the financier of a six-lane bridge across Vancouver's Fraser River. As central bankers and governments around the world scramble to unclog short-term lending markets, Depfa's troubles demonstrate how little time they have, and how far-reaching the repercussions of failure can be. Around the world, the clock is ticking as other banks and companies face deadlines to pay off hundreds of billions of dollars in short term debts, with uncertain prospects for borrowing the money they'll need to do so. They banks will either need to renew the debt or find a way to pay them off. On Tuesday, the Federal Reserve, in an unprecedented step, said it would set up a fund to buy IOUs known as commercial paper, which banks and companies issue to borrow money for everyday needs such as paying their employees and buying supplies. But while the move could ease tensions in short-term lending markets, banks and companies still face a mountain of debt coming due. European banks alone have some €533 billion of debt maturing between now and March, according to a recent report by Keefe, Bruyette & Woods. The shuttered credit markets means that much of that would be impossible to re-fund today. Debt that could be raised is at a much higher cost. Hypo Real Estate, eager to expand beyond its commercial real-estate business, agreed in July 2007 to buy Depfa to tap the Dublin bank's public-finance expertise. For a fee, Depfa agrees to be what the municipal market calls a "liquidity provider." That means it guarantees it will act as a buyer of last resort for money market funds. It will buy the short-term debt of a municipal issuer from funds if the funds no longer want it or become obliged to unload it. Money-market funds operate under strict rules regarding the ratings its investments must carry and their ability to sell their holdings. Depfa's current predicament can be traced to Sept. 15, the day U.S. securities firm Lehman Brothers Holdings Inc. filed for bankruptcy protection. Lehman's default spilled into the supposedly safe U.S. money-market funds that had bought Lehman's commercial paper, triggering an exodus of investors from both the funds and the commercial-paper market. At the same time, banks halted their lending to one another amid fears that more financial institutions would fail. Depfa relied heavily on short-term lending markets to borrow the money it needed to do business: As of June 30, Depfa had borrowed €54 billion in the short-term lending markets, 22% of its total borrowings. Within days of Lehman's default, Depfa and Hypo decided that it would have to turn to the German government and financial institutions for a bailout, which it eventually secured. But as credit ratings agencies slash Depfa's ratings, the debt that the bank guarantees is also getting hit with credit warnings. That has cascaded to mean ratings cuts of dozens of municipal bonds for which Depfa acts as a buyer of last resort. The changes have hit projects and financings in the U.S. and Canada, where Depfa has helped raise and serve as a back-stop for debt issues. The Depfa downgrade is a particular threat to bonds called variable rate demand bonds. The debt allows a municipality or an entity to raise money for long periods, but at lower rates typically associated with short-term bonds. Dealers resell the bonds' daily and weekly, which adjusts their interest rates. It's not clear exactly how much of the nearly $500 billion short-term variable rate demand bond market Depfa backstops, but on Tuesday, there were $3.7 billion in Depfa backed bonds up for sale by dealers, with few takers, says one money market fund manager. Money-market funds, another corner of the debt markets badly hit, had bought the bonds because they were able to unload them at any time to a buyer of last resort. Depfa's problems gave them a new scare because of the concern that banks such as Depfa might not be strong enough to take back the bonds. For the Colorado Housing & Finance Authority, at least $113 million of its short-term debt has cost 10% weekly for several weeks. The authority, created in 1973 to provide loans to low- and moderate-income home buyers, gets more than half of its funding from the short-term debt markets. It will likely have to "greatly reduce" the amount it can lend to Colorado residents this year based on its high cost of funding, says Tom Hemmings, chief financial officer. "We want to try to go through this in an orderly manner and not jump to conclusions," says Mr. Hemmings. Depfa's problems also hit the debt that is backing the Golden Ears Bridge project in Vancouver, British Columbia. Moody's Investors Service last week placed on review for downgrade Golden Crossing Finance Inc.'s debt due to Depfa's downgrade. The six-lane bridge. which will connect some of the industrial activity on the north side of the Fraser River in Vancouver to the highways that lead to the U.S. border, is about 80% completed, says Ian McLeod, spokesman for the bridge's construction team.