The pace of failure of auctions in the auction-rate securities market is quickening, and if it continues it could auger a higher London Interbank Offered Rate, according to an analysis by JPMorgan released yesterday.
"The auction-rate securities market is beginning to crack under pressure," W. Alexander Roever and Cie-Jai Brown said in a report.
At least four dealers presided over failed auctions during the past two weeks due to insufficient investor demand and lessened secondary market support, the report said. It's not clear how many auctions have failed, but some issuers have recently sought to convert bonds into other modes due to volatility in the auction-rate market. At least six auctions of tax-exempt, auction-rate securities failed in the past three weeks, Dow Jones Newswires recently reported.
"The direct cause of the failures has not been deteriorating credit quality," the report said. "Rather, we believe eroding market liquidity is the culprit."
The auction-rate mode offers investors liquidity, but a widespread failure of auctions could spook investors concerned that they could not sell the securities quickly.
"The investors who buy this paper are driven by liquidity - credit quality matters to them tremendously, don't get me wrong - but these are liquidity investors and so they count on being able to have access to their funds on a fairly short time frame," Roever said in an interview. "If the market's not functioning, if auctions are failing, that could limit their ability to get their money when they want it."
Roever said that widespread failures are not imminent, but are a possibility.
"It is a short-term market and the degree to which these securities become illiquid and the degree to which that their liquidity or price becomes impaired, that could become a problem for the banks that own them and for the brokers that trade them," he said. "Banks have been craving liquidity rather than having assets tied up in things like leveraged loans or [structured investment vehicles], or other sorts of securities."