Wednesday, November 28, 2007

Caisse under fire over commercial paper


Source: Reuters

MONTREAL — Quebec's public pension fund manager, Caisse de depot et placement, came under fire from opposition politicians Wednesday for taking what may be a multibillion-dollar stake in the troubled nonbank asset-backed commercial paper market.

Henri-Paul Rousseau, chief executive of the Caisse, Canada's largest pension fund, was scheduled to testify before the legislature's finance committee in Quebec City Wednesday afternoon on the extent of its holdings in the $35 billion market for so-called ABCP.

Before his testimony, however, Quebec's two main opposition parties demanded answers from the minority Liberal government on the Caisse's role in the frozen market for ABCP.

Mario Dumont, leader of the Action Democratique du Quebec, accused the government of washing its hands of the ABCP mess.

He criticized Quebec Finance Minister Monique Jerome-Forget for telling the legislature Wednesday that rating agency Standard and Poor's has lauded the government's policy of not intervening in the Caisse's management of investments.

“It's interesting that she cites Standard and Poor's. They said not to buy it -- commercial paper -- and the Caisse has $14 billion of it,” Dumont said.

Daryl Ching, head of Clarity Financial Strategy, which aims to educate corporations and professionals about the ABCP market, said there is plenty of interest in finding out exactly how much ABCP the Caisse holds.

“There have been guesses about their exposure of anywhere between $12 billion and $20 billion,” he said.

“If it's much higher than $13 billion, that'll be a shock to the market,” Ching added.

In Quebec City, Jerome-Forget told the legislature she had communicated with the governor of the Bank of Canada and Canadian Finance Minister Jim Flaherty on the matter, but Quebec would not intervene in the day-to-day management of the Caisse's portfolios.

“It's not that the Caisse has commercial paper, it's what is the quality of that commercial paper,” she said.

Gilles Taillon, finance critic for the ADQ, wanted to know if the Caisse's ABCP holdings could affect the solvency of some $27 billion of public employees' pension funds.

The Caisse, which manages Quebec's public pension and insurance funds, has $237 billion in assets under management.

It is widely believed to have been the biggest investor in that part of the ABCP market that is not run by the country's big banks.

That market faltered badly in August when investors balked at buying the securities because of fears that the assets backing the opaque instruments had hidden exposure to the default-ridden U.S. subprime mortgage market.

The Caisse led other key investors such as National Bank of Canada in signing the Montreal Accord, an agreement by those holding more than 80 per cent of the market to not trade the paper until a workout strategy could be put in place.

The deadline for that workout, which would seek to replace the paper with longer-term debt, is Dec. 14.

Wednesday, November 21, 2007

Will the Montreal Accord fly?


From Wednesday's Globe and Mail

Asked why it wrote down its asset-backed commercial paper by only 8 per cent, Groupe Desjardins told us, among other things, that it thinks the Montreal Accord restructuring effort will succeed.

National Bank, another signatory to the accord, gave its ABCP portfolio a 27-per-cent haircut, and hasn't said that it doubts the outcome of the accord.

You hope it works out for the sake of the investors holding the bag, but the odds don't look particularly good at the moment.

About three-quarters of the $33-billion of third-party ABCP sold to investors is of the synthetic variety, meaning, for example, that the conduits investors put money into are built from various kinds of interest-bearing securities and derivatives like credit default swaps. And almost 60 per cent of the total ABCP is leveraged, meaning through the use of derivatives, there are more assets in a conduit than investors put in money.

Here's the problem, according to people we spoke to: When the conduits entered into swap agreements, their counterparties - typically foreign banks - were essentially given first claim on the assets of the conduits in the event of a problem. If the value of the assets backing up their investment deteriorated, they could place a margin call forcing the conduit (or its sponsor) to add more collateral. Conduits would do this by tapping the capital markets for more money, which would have been possible in normal times. But of course now the markets are not functioning at all and the plan is to morph the commercial paper into 10-year notes with floating interest rates.

Under the circumstances it's a fine idea except for those pesky counterparty agreements in the leveraged conduits: They don't just go away for free.

The only logical trade would have been to ask the counterparties to drop the right to demand more collateral in exchange for not having to provide liquidity, but as it happens the liquidity agreements were so weak that there was effectively no risk of them ever being triggered. The banks weren't going to trade something that had very little risk to them for something that exposed them to great risk.

(The irony of course is that these banks win if credit quality drops but don't suffer if, as has happened, market liquidity dries up, even though the two problems can be closely related.)

With commercial paper, as mentioned, a margin call could be met by issuing more paper (in a normal market). But once converted to floating-rate notes, the situation becomes static: There's no easy way to raise more collateral. So the protection of that margin call disappears. Therefore, there doesn't appear to be any motivation for the foreign banks to play ball, and given that more than half the commercial paper is leveraged, it's hard to see the Montreal Accord succeeding. More...

Sunday, November 18, 2007

The black box explodes

From Saturday's Globe and Mail
November 16, 2007 at 9:47 PM EST

Shortly past 8 a.m. on an already sweltering August Monday, a small team
of financiers hurried down a flight of stairs in one of Montreal's most historic
office buildings to watch a modern disaster unfold.
The men, senior executives with National Bank Financial, were hurrying to a
cavernous room on the main floor of the beaux-arts Sun Life building where
more than 100 traders buy and sell billions of dollars of stocks, currencies
and debt instruments every day. Leading the group was Ricardo Pascoe, a
wiry, soft-spoken derivatives specialist who was named co-chief executive
officer of National Bank of Canada's securities arm a year earlier. At his side
was his top legal executive, Brian Davis.
Mr. Pascoe whisked the group past long lines of noisy trading desks to a
normally quiet corner where a half dozen men and women were feverishly
working the phones. The traders were seeking buyers for a Byzantine class
of short-term debt called asset-backed commercial paper. Known by the
clunky abbreviation ABCP, the paper had become a money market darling in
the past decade, accounting for more than 30 per cent of Canada's $360-
billion short-term debt market.
The 30-day and 60-day notes paid interest generated by bundles of mortgages,
car loans and other debts pooled in special vehicles called conduits or
trusts. These conduits were hard to understand, even by many lawyers and
bankers, but the lack of transparency never seemed to bother investors, who
snapped up the notes because they offered some of the highest interest
rates going, boasted the best credit ratings and were sold by the world's
leading banks. MORE...