Monday, December 24, 2007

Agreement in Principle Complete by Purdy Crawford's Committee

By: Daryl Ching, Clarity Financial Strategy

The CNW Group published a press release from the Crawford Committee announcing a restructuring plan for ABCP. Below I will provide new pieces of information from the press release and my commentary below:

1) The restructuring of "substantially" all triggers to become more remote and transparent spread loss triggers.

Does the Committee anticipate that some mark-to-market triggers will remain or do they expect to restructure all the triggers?

2) The Committee plans to raise $14 billion for the margin facility in the event of collateral calls on CDO transactions. A group of institutional investors including La Caisse de Dépôt et Placement du Québec and Desjardins Financial Group have decided to provide their own capital to self-fund the margin facility in the amount of about $8 billion. The remaining $6 billion will be funded by a syndicate of banks and other institutions. This will create two distinct pools of notes from a legal, risk, economic and governance perspective.

Some institutions that have sufficient capital have elected to put up their own margin facilities to avoid paying fees. One question I have is whether these two classes of notes will reference two distinct pools or whether they will reference the same amalgamated pool that is parri passu from one another. If they have created two discrete pools with different assets, how is the committee ensuring that one group does not have a reference portfolio that is of better quality than the other?

3) The traditional non-synthetic assets will remain series specific and will not be pooled together into a jumbo fund. The US Sub-prime related assets will also remain series specific and will also not be pooled together into a jumbo fund.

This makes a lot of sense. The CDOs needed to be pooled together in order for the spread loss trigger to work. If the intention of the Committee is to reference a public credit default swap index that contains a wide basket of corporate names, the spread loss trigger only works if the underlying portfolio looks similar. By pooling the CDOs together, the underlying assets are becoming more diversified referencing a wider basket of credit default swaps and therefore further resembling a public index. However, this does not change the fact that certain trusts with CDOs that had low leverage and better quality credit could potentially be worse off with the amalgamation of all the assets.

There is no reason to pool the traditional assets together. Investors who bought trusts with better quality assets will be rewarded by bearing the same level of risk with the same underlying assets. This logic also applies to the US Sub-prime assets. As there are varying degrees of credit quality within this basket, investors continue to take on the risk of the underlying pool of assets they originally purchased.

4) The Committee has a 90% commitment for the margin facility. On the conference call, there was an indication that they have a foreign bank that is willing to provide the balance in the event that they are not able to raise enough money from the Canadian banks.

Although, we did not get a sense of how much each bank was stepping up, I am confident the Committee will come up with the required margin facility to warrant investment grade ratings on the notes.

5) The fees are expected to be in the range of 160 bps for participants to standby for the margin facility. In the event of a draw on the margin facility, the institutions providing the liquidity will rank senior to the rest of the noteholders.

It was mentioned on the conference call that to the extent there is excess cash, interest will be paid to the noteholders but it is uncertain what the rate will be at this time. I suspect that a significant portion of the yield will be used to pay for the margin facility. Although this fee seems high, we have to understand that this is a direct indication of the global liquidity crunch. Banks have liquidity problems of their own and are under the gun from the shareholders to minimize CDO and subprime exposure. They need to be compensated well to step in and provide a bail out to the frozen assets.

Overall, I remain confident that the restructure is moving in the right direction and will be successful with a secondary market opening as early as March 2008. However, to echo my previous comments, I continue to hope that the Committee will provide some liquidity relief to the small investors. Although I understand that this is an issue that is being tabled, it sounds to me like any liquidity that the Committee is successful in locking down will be used to fund the margin facility. Reading between the lines, I continue to believe that investors should expect that there will not be sufficient liquidity relief provided until the secondary market opens. Further to that, although it may be widely expected that most of the assets will yield par at maturity, investors selling the notes should still expect a haircut from potential buyers who deem the assets to be distressed and need to be compensated for various uncertainties. However, greater transparency will only help the situation.

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