Monday, December 10, 2007

What is this ABCP Worth?

By: Daryl Ching, Clarity Financial Strategy

December 14 will mark the end of the standstill period where investors have agreed not to force a default, conduit sponsors have agreed not to issue liquidity notices, foreign banks have agreed not to make margin calls on corporate CDOs and various parties have agreed not to launch what can be a hailstorm of lawsuits.

The ABCP restructure is extremely complex, involving many parties with conflicting interests. The parties include the Big 5 Banks, other Canadian financial institutions and non-bank securitization providers, a group of large foreign banks, investors ranging from small mining companies in BC to the largest pensions funds in Quebec, and more recently, the Office of the Superintendent of Financial Institutions and the Bank of Canada. To give an idea of just how many interests each group has, consider that just the banks were involved with the following: sale of commercial paper (distribution), liquidity provider, CDO underwriter, conduit sponsor and investor. The odds are stacked against Mr. Crawford’s committee.

On November 22, Mr. Crawford’s Pan Canadian Committee released the first comment on the restructure in months in a Financial Post article. The Committee disclosed two new pieces of information:

- The Committee is creating a liquidity tranche for investors in need; and
- The restructuring is scheduled to be completed by March 2008.

As a consultant, the two most questions I get most rfrequently asked are: 1) What are these assets worth? and 2) Who is to blame for the debacle? Today I will tackle Question 1.

In order to answer the $35 billion question of "What are these assets worth?", we must answer this question with some more questions. Below are some of the key questions that should be asked of Purdy Crawford's Committee and the answers will have a material impact on the recovery value on the assets:

- The most difficult part of the restructure will be to address the margin calls that can be made by the foreign banks for corporate CDOs in an environment, where new ABCP cannot be issued. If investors are unable to post collateral for a margin call, this will result in an event of default and a firesale of the assets. How will the Committee prevent this from happening? There is speculation that either the triggers will be widened to a level where they are less likely to be triggered or the foreign banks will agree to waive them altogether. However, this leaves the foreign banks greater exposed to corporate credit market. It is not likely they will agree to these new terms without some form of compensation. That form of compensation is likely to come from the investors. For this reason, it can be assumed the investors will not receive par for their investments in leveraged super senior CDOs, as the value of the credit default swaps are generally lower in today's credit crunch environment, compared to when the transactions were first originated.

- Who will be providing the “liquidity tranche” and how will this work? The government? Banks? Who is willing to take on additional exposure to the ABCP? Will this be available on December 14 or March 2008? This might give investors immediate temporary relief.

- How bad will the US subprime market get? As of October 2007, the default rate (90 days past due) was at 16% on the US$1.3 trillion subprime mortgage market. Will Bush's plan to freeze subprime mortgage rates for five years be successful? This may have an impact on the 7% of US subprime assets embedded in the ABCP.

- At what rate will investors be compensated for the standstill period?

- What type of return can investors expect on the new longer term notes?

- Will the restructure come in a form of bonds, issued with a prospectus much like the asset backed securities term transactions or will they be privately traded?

- Who will be the administrator of the newly structured notes? Can the role of administration be passed on seamlessly without any interruptions? Any interruption in administration (investment of collateral, collecting on receivables from traditional clients, etc.) can lead to deterioration in recovery value.

- When will the Data Room be open to the public to facilitate secondary trading? The sonner this happens, the sooner we will some bids from potential buyers.

- Can all investors wait until March 2008 for the restructure to complete? Are we confident the restructure will complete by March 2008?

- Will the standstill period be extended until March 2008? Can the Committee get all parties who have been waiting patiently since August to waive their rights again for an additional three months?

- Most importantly, can the Committee successfully convince all parties to play ball, or will one significant stakeholder lay the hammer and not agree to the terms and conditions beyond December 14?

It should be apparent that the valuation of the assets is a very difficult question to answer. This is why we have seen write-offs on ABCP all over the map between 5% to 40%. For the parties trying to sell ABCP, it is important to remember that in an open market economy, the assets are only worth what buyers will pay for them. While the affirmation of AAA ratings by DBRS gives some investors comfort, it is not enough to solicit meaningful bids from buyers. We must all do our part to urge greater transparency and flow of information in the market. Not only wil this give the market a better idea of the value of the assets, but we will actually begin to see some meaningful bids from secondary buyers.

Daryl Ching
Clarity Financial Strategy

No comments: