Thursday, December 13, 2007

ABCP Proposal to Offer Range of Losses - Commentary

By: Daryl Ching, Clarity Financial Strategy

Jacquie McNish and Boyd Erman wrote an article in the Globe and Mail today titled ABCP Proposal to Offer Range of Losses. The story reveals that recovery rates for the trusts range anywhere from about 50% for Apsley Trust to close to par for other higher quality trusts. While the Crawford Committee is still trying to win sufficient support to extend the standstill agreement until March 2008, they announced that they have Deutsche Bank AG on side, a party that is believed to be counterparty to half of the $25 billion of CDO transactions. The Committee revealed that although it has completed its assessment of the current value of the ABCP, it does not plan to release the information until the new year. The most interesting piece of news is that the plan calls for investors to swap their ABCP for two classes of notes that will be ranked senior or junior. Investors whose ABCP is backed by assets with higher market value will receive a higher portion of senior notes and those with harder hit assets will take more junior notes. The Committee has approached the banks to underwrite a market for these notes but they have not heard back from the banks.

While it appears the Committee is still struggling to get all parties to agree to an extension of the standstill period, getting Deutsche Bank AG on side is an important development. With the credit default swaps under water in today’s credit environment, the foreign banks who are swap counterparties to the CDO transactions can lay the hammer by making a margin call. In an environment where ABCP cannot be issued, this would result in an event of default and a firesale of the assets. It is relief to know that the Committee has Deutsche Bank’s support. I am confident that the Committee will round up the support required to continue the standstill period in order to continue the restructure into spring.

My interpretation of how the restructure will work is that the Committee will create a jumbo fund by amalgamating all the assets of all the trusts, with the exception of Skeena Trust that has been restructured separately. All the assets will be placed into two categories based on credit quality – senior and junior. The Committee will look at each trust and determine which assets belong in which category and assign notes accordingly to each investor. It is likely that the junior notes will be subordinate to the senior notes and take first losses.

This plan has its advantages and its disadvantages. Generally, investors will be better off, as all the assets will be pooled together to form greater diversification. However, this simplified approach also has its disadvantages and raises a lot of questions. Can we really separate all the assets into two categories? How will they be separated? Is a leveraged super senior corporate CDO that is levered five times in the same bucket as a CDO levered 40 times? Do all traditional securitization assets get thrown into senior? Does that mean that Canadian subprime mortgages are in the same bucket as a bank’s line of credits? What I am trying to get at here is that investors who bought very high quality trusts may receive more senior notes, but their assets may still be diluted with poorer quality assets. In the long run, some will be better off with this plan and others will be worse off.

I applaud Mr. Crawford’s committee for the progress made thus far. It appears they have had several successes including the restructure of Skeena Trust, the extension of the standstill period until now and a plan that may receive super majority support. Having said that, it would still be prudent for investors to fully understand the implications of this plan before signing on to the agreement. My opinion is that the assets cannot simply be sliced into two categories – good and bad. The complexities warrant more categories if we hope to have a more equitable outcome for all investors.

Finally, as the Committee has decided not to release any more information on the assets to facilitate a secondary market until the new year, I certainly hope that they provide some relief in the form of liquidity in the interim to investors who cannot wait until the spring to get some cash back.

Daryl Ching

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