Thursday, December 11, 2008

Canadian ABCP restructuring will succeed: Analyst

From the National Post:

Despite rising turmoil in the credit markets, an RBC Capital Markets analyst has reiterated his belief that the proposed restructuring of Canada's seized-up asset backed commercial paper market will succeed.

In a note to clients this morning, Andre-Philippe Hardy said the restructuring of $32-billion of frozen ABCP will go ahead because all the parties have strong incentives to make it happen.

Mr. Hardy said not only noteholders but also dealers and firms that created the frozen notes would face significant losses if the workout falls apart.

"While the risk of failure will remain until all parties have signed on the bottom line, we continue to view a restructuring as the most likely outcome," he said.

Mr. Hardy singles out National Bank of Canada as one player with a lot on the line. National, which holds $2.2-billion of notes, has already written down the value of its investment by 34%.

He estimates that a failure of the so-called Montreal Accord would result in pre-tax losses of as much as $700-million for National, which would take its Tier 1 ratio down to 8.7%.

The market for ABCP not sponsored by the domestic banks froze up in August 2007 as a result of fallout from the subprime mortgage debacle. A group of market participants launched a plan to restructure the paper but 15 months later they have still not succeeded.

The wildcard in the restructuring is a group of foreign banks including Citigroup and Merrill Lynch who acted as counterparties to credit default swap transactions that underlie the ABCP. Their participation in the deal is critical but some observers worry that they may be too busy trying to survive the credit storm. Mr. Hardy disagrees. They have too much to lose to let the plan fail, he said.

But according to the Globe & Mail:

Conservative government is facing another call for financial help, this time to provide as much as $5-billion to $10-billion in federal backstops to salvage a frozen sector of the debt market and avoid a meltdown that could lead to massive losses for many Canadian investors.

The committee overseeing the restructuring of $32-billion of the seized-up short-term investments known as asset-backed commercial paper is asking for the aid after plunging markets this fall put a plan to fix the market at risk, according to two people familiar with the situation.

The paper has been frozen since August, 2007, when it was one of the first casualties of the economic crisis that has swept the globe.

The restructuring committee, led by Toronto lawyer Purdy Crawford, met yesterday with Finance Department officials to ask for help, with the exact amount of aid sought still undetermined. Under the plan being pitched, the government wouldn't have to write a cheque up front, but would potentially be called upon to cover losses if markets continue to tumble.

The request for federal help with fixing the asset-backed commercial paper mess is sure to be controversial, coming on the heels of similar requests from auto makers, forestry companies and banks.

"It's not the same as the car companies," said one person briefed on yesterday's talks. "There's no cheque. If you give $6-billion to the car companies you don't know if you'll see any of that back. Here all you have to do is stand by and say 'If there's losses, I'll cover a portion of it.' "

Ottawa would be called upon only in extremely dire circumstances. "It would have to be worse than the Depression," the person said.

At risk if the restructuring fails are the savings of hundreds of individual Canadians who bought the paper before the market froze, as well as potentially billions of dollars of losses for some major pension plans that invested in ABCP. Those include the Caisse de dépôt et placement du Québec and the Public Sector Pension Investment Board.

Still, the idea of federal aid for ABCP investors is already threatening to drive yet another economic-policy wedge between the Conservative government, which is signalling it would still rather stay on the sidelines, and the opposition Liberals, who criticized that stand.

The ABCP plan has been hung up for months waiting for the financial institutions whose backing is crucial to sign the final documents to complete the restructuring.

The problem is that markets have worsened more than expected by the players, which include major banks in Canada and around the globe that have already pledged billions in credit and concessions. That means the deal needs to be restructured and made stronger with the addition of more financial backing.

With financial institutions strapped for cash and unwilling or unable to contribute more, the committee has turned to the government.

The Harper government has so far maintained that the ABCP plan is a private-sector solution, and played a role mainly as an observer to the restructuring talks.

Finance Minister Jim Flaherty was initially resistant to the calls for help, sources said, in part because he was reluctant to back away from his public statements and speeches lauding Canada for solving the financial mess without public money.

In the wake of political turmoil in Ottawa and deepening woes in the economy, sources said, the government has been more open in recent weeks to requests for help.

"The Finance Department is much more engaged," said a second person familiar with the discussions.

Still, the official line from Mr. Flaherty's office yesterday was that the government is trying to avoid putting any cash at risk.

"From the beginning, the minister has said a market-led restructuring is a preferred course of action ... ," Chisholm Pothier, Mr. Flaherty's spokesman, reiterated yesterday.

By contrast, the Liberal Party, which has chastised the Harper Conservatives for a perceived unwillingness to spend and risk a deficit to help the economy, is on side with helping out.

"This transaction is important to protect Canadian savings and the solidity of our financial institutions," Scott Brison, the Liberal Party's industry critic, said. "The Harper government ought not let its laissez-faire ideological rigidity prevent a real solution."

Brian Hunter, an Alberta oil and gas engineer who has been among the most vocal of the individual ABCP investors, said "The government bailed out the Canadian banks. Do I think they should bail out the shareholders of the Canadian banks and not me? Of course not."


How we got into mess

Here's a very simplified version: ABCP instruments were essentially bundles of mortgages, car loans, derivatives and other assets that paid interest. They were packaged up and sold to investors as 30-day and 60-day notes. Buyers were enthusiastic because these products appeared safe and offered higher yields.

Why market was frozen

In the summer of 2007, it was revealed that about $32-billion in ABCP was tied to troubled U.S. housing loans. No one wanted to buy it any more. To ensure the trusts that issued the instruments didn't go into default, a group of big financial players called for a standstill while some kind of solution was found. The problem was with "non-bank" ABCP sponsored by entities that are not financial institutions.

The solution

In Canada, the plan, crafted by a committee led by Toronto lawyer Purdy Crawford, was to convert the short-term notes into long-term instruments, most maturing in nine years. Investors who hung on that long would likely get all their money back. Secondary trading would likely develop for those who had to sell sooner (although they would likely lose money.)

The problem now

The plan won court approval and the backing of investors and institutions earlier this year. But some players have been reluctant to sign on and hand over cash because of the meltdown of certain assets underlying some of the ABCP securities.

And after the market meltdown, banks and other financial players have shown reluctance to commit new capital to the ABCP rescue.

Now, the players would like the federal government to offer some guarantees to aid the restructuring process.

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