Friday, December 14, 2007

Is There a Future For ABCP?

By: Daryl Ching, Clarity Financial Strategy

I spoke on BNN this morning to give an update on the Crawford Committee deadline. Click here to watch the interview. Further to my comments I wanted to add more commentary.

The outcome of the non-bank ABCP restructure for the $35 billion of frozen assets will have a significant impact on the ABCP market going forward. Despite the fact that this represents only one quarter of the total ABCP market in Canada, if investors take losses, they may shy away from the ABCP investments altogether. The news that we are hearing is that progress is being made by the Crawford Committee with the restructure of Skeena Trust, the jumbo fund with senior and junior notes and a positive outlook on getting the standstill period extended to March 2008.

While this is good news for the large ABCP investors who can wait out the restructure, this does not help the smaller investors who are cash strapped and cannot wait any longer for the restructure. The smaller investors have expressed frustration, not having a seat at the table through the negotiation process. The money they expected to get paid in August has hindered their ability to continue normal business operations, they feel they have been left in the dark with little transparency on progress and they find it tough to sell their assets, as information on the assets is not being released to the public. In my mind, despite representing the minority, there is nothing more imperative than providing some liquidity relief to small investors who cannot wait out the restructure any longer. I certainly hope that since Crawford's Committee has decided not to release the information to facilitate a secondary market, that they have a plan in their proposal to provide some form of liquidity to the smaller investors who are in dire need, and I hope this becomes available immediately. I also hope to see more transparency and more frequent updates from the Committee going forward.

So the big question is will the ABCP market collapse? My response is that the ABCP market is too important to fail for many reasons. The ABCP market is approximately $120 billion in Canada, which represents the largest portion of the non-government short-term money. There is more ABCP outstanding than Banker's Acceptances and corporate commercial paper combined. While I can point out that ABCP represents a neat alternative investment for a higher pickup in yield than GICs, it is more important to note that many large companies across the country rely on securitization is a key source of funding. The Big 3 auto companies, credit card companies, mortgage companies and others rely on ABCP as their largest source of capital. If the ABCP market went away, you would have many large companies scrambling to find a new source of funding that will likely come less efficiently and at a higher cost, passing on higher prices and interest rates to consumers.

There is no question that market participants have made mistakes in this industry, and we are paying dearly for them. However, this is an opportunity for us to learn from our mistakes and make it right. There are two fundamental changes that must occur to revive the industry: 1) Market participants must increase transparency and make a concerted effort to educate the investors and 2) Investors must do their homework. If investors want a pick up on yield on their investments, they cannot rely solely on the rating agencies and they should only be considered opinions. It will be up to the investors to seek the required expertise, establish their own criteria for how they get comfortable with the assets and set up a platform to do monthly due diligence and analysis.

Is there a need for further regulation? I don't think more regulation is answer to our problems in this case. I think investors will get smarter, demand more information and do their analysis. Industry participants will realize that they need to provide more transparency. With the work required to analyze the assets, this may mean that we see less investors, but they will become more sophisticated. On August 13, the market disruption was caused by panic from investors who did not understand the assets and found out the they had exposure to subprime. It should be noted that there is good quality and bad quality subprime assets. The earlier vintages of subprime had no teaser rates, minimum down payments, respectable credit scores from the borrowers and low delinquency and default rates. Mortgage underwriting became more aggressive in 2005 and 2006 with the low teaser rates and no down payments. If investors were sophisticated and understood this, there would not have been a mass exodus on the entire non-bank ABCP market and investors would have continued to roll the trusts that had good quality assets.

As an indiviudal who has invested so many years in this industry, I feel a personal responsibility to help revive the securitization market. I will do whatever I can to push for more transparency from conduit sponsors and provide education to participants who need to get up the curve. I believe this will level the playing field, where all participants in the market will receive consistent information and there will no longer be any investors at a disadvantage.

Daryl Ching

No comments: