Thursday, January 31, 2008

National Bank: Did They Let The Cat Out Of The Bag?

By Ross Hendin, Hendin Consultants

Tara Perkins wrote this article in the Globe & Mail today, reporting that Mr. Vachon (National Bank CEO) feels the Committee is making progress, and that the restructure is basically a done deal with legal documents in the drafting phase.

She's quoted Mr. Vachon as saying: "That's where we are not; we're in the legal phase of the restructuring,"

Well, for those of us who aren't the majority noteholders, and who aren't being told anything at all (even as the deadline looms today at midnight) this certainly sounds like good news, even though it's not coming from the Committee itself.

I am sure I am joining the Clarity team and many of the noteholders and readers of the blog when I say that I certainly hope his insight is correct, and it's a matter of time before this is all dealt with and behind us.

I am also sure I speak for at least a few of us when I say that some reliable timelines, and updates from the Committee wouldn't go amiss - as many of the people involved have their lives balancing on expectations that deadlines will be met. I fear that some of the noteholders may not be able to take the strain of this limbo much longer, especially if they have (rightly or wrongly) promised creditors something based on the timeliness discussed.

I am very happy to hear - from the Committee or otherwise - that things sound like they are coming together. Will they actually come together and on time? We will have to wait another day and see...

Ross Hendin is CEO of Hendin Consultants, and is a Senior Advisor to the Canadian office of a leading multi-national PR firm. With strategic communication experience in more than 20 countries around the world, Ross specializes in litigation, financial and political strategic communication. He has worked in the ABCP niche since 2006. Hendin Consultants is in Toronto and London, UK, and is on the web at Email Ross at

Wednesday, January 30, 2008

Standstill agreement ends tomorrow

By: Daryl Ching, Clarity Financial Strategy

This morning I was on the Business News Network to provide some commentary on the ABCP restructure. Please click here to view the link. The standstill deadline or ceasefire ends at the stroke of midnight tomorrow, and we have not heard any news from Mr. Crawford’s Committee in the New Year. If they remain consistent, we will probably see a press release at around 12:30 AM on Friday morning.

DBRS issued a press release commenting on Leveraged Super Senior (“LSS”) transactions in light of the global market volatility. As a result of the unprecedented events in the global markets, DBRS has commenced a review of its mark-to-market (“MTM”) trigger methodologies for LSS transactions. Several LSS transactions have faced or are likely to face margin calls. On January 25, four conduits that are not part of the Montreal Accord, containing at least one LSS transaction with a MTM margin call were placed under review with developing implications. The reason why the trusts in the Montreal Accord are not being downgraded is because they have the benefit of the standstill agreement, in which no margin calls wil be made, which is set to expire January 31. Also, the restructure is moving towards spread-loss triggers, which makes the chance of a margin call more remote.

In the absence of the standstill agreement, a number of trusts would have already been required to post margin. In a normal credit environment, the margin requirement could have been met by: 1) issuing additional notes, 2) negotiating a revised margin call, 3) using other sources of liquidity. Unfortunately, the trusts within the Montreal Accord do not have access do any of these options and therefore the margin call would go unsatisfied, causing an event of default. This would then allow the swap counterparties to liquidate the assets in a distressed credit environment. “Considering the volatility and uncertainty in current credit markets, it is possible that a swap counterparty would not recover all of the costs associated with liquidating the collateral and unwinding the transaction at market value, thereby leaving Noteholders with very large losses on their notes.”

The press release ends with this paragraph; “Therefore, any Conduit that does not benefit from a standstill (as is the case with the Affected Trusts) or benefit from sponsors that either have or will restructure the MTM margin call regime, will most likely face immediate and substantial rating action.” Therefore, we are in a situation where the standstill agreement must be extended again and the notes must get restructured or noteholders may face substantial losses.

Based on the press releases back in December, a few things were expected to happen in January 2008. Crawford’s Committee anticipated that they would have a firm commitment for the $14 billion margin facility from the banks, an administrator and asset manager were to be selected and restructure proposals would be released for the current noteholders to vote on. Based on the silence from the committee, I have reason to believe that none of these have happened as of yet.

However, if history repeats itself, it is my opinion that Mr. Crawford’s Committee will be successful in achieving an extension of the standstill agreement. The process is too big to fail, and support can easily be obtained by the largest investors who are incented to wait out the process and hold the assets to maturity. However, considering the situation, I suspect that March 2008 is a very optimistic deadline for the completion of the restructure. Investors should manage their expectations as this restructure can take much longer than expected.

Tuesday, January 29, 2008

ABCP and the National Bank: Could the Chairman have been a champion?

By Ross Hendin, Hendin Consultants

Last week we learned through this Globe & Mail article that the National Bank of Canada had $7.8 million worth of ABCP bought back from 48 company insiders, including Louis Vachon, bank CEO - who held $2.54 million of it personally.

The article then made a of point of stating that while National Bank were the first to step up, and buy back the frozen paper from their clients (in what I thought was a terrific PR move), the buyback was limited to individual retail clients and corporate clients with total holdings of $2 million or less who are not considered accredited investors under regulations.

It mentions that "The board said the three executives who had their ABCP repurchased put the money into a trust account so they could work on the issue “without any appearance of conflict of interest.”" - I assume by saying appearance, it means they understand there is a conflict, but they just don't want it to look that way.

I'm following the ABCP story fairly closely, and I had no idea about these little points. It's one thing to have a CEO crusade for the little guy, and yet another when the public and shareholders discover that the CEO is benefiting from "doing the right thing". Now, should Mr. Vachon's holding ABCP personally count as a major negative? Based on this one article, I'd say so. Could this perception have been avoided? Absolutely.

The CEO and leader of the bank was as convinced about the investment's quality as any client would have been, and his demanding a resolution for everyone that the bank has dealt with was a good move on it's own. His reaction is a tricky balance, because some may say that showing the CEO held paper early would have eroded confidence in him as a finance expert, but I disagree totally. If the point of the meltdown is that nobody ever expected the paper to freeze, and the paper had the endorsement of the bank, I'd be more disappointed if the execs in the company steered clear of it than if they held it. Their holding it shows that they believed in the product just as their clients did, and as a spectator, says that they were at least acting in good faith as they sold the notes.

Let's take a moment and now reflect on the Scotiabank / Canaccord lawsuit, which alleges that the Scoita Capital execs were selling their notes even while telling their clients that the notes were safe. An act that, in retrospect, is much more disappointing than finding out that the CEO of National Bank bailed himself and many others out of a tough situation.

I'm more than willing to concede that given all we've learned from the Globe & Mail article, the National Bank of Canada could have been more forthright in their intentions and positions. From a Public Relations perspective, it would have been much more powerful to have their CEO expose his holdings in the paper, saying that he, like their clients, believed that this was safe and that he's going to do whatever he can to protect and save those who - like him - were caught in the fire. This may have undermined him as a financial clairvoyant, but would have made him human and would have shown the country that the bank stood behind what it sold. It would have also shown that the National Bank team “ were people too.”

The lessons to learn here:
1) The bank could have been more forthright, and could have won public support in being forthright.
2) The lack of transparency and the conflict of interest in how they dealt with the buy-back should enrage shareholders, but again, had the PR been done well, it would have boosted positive publicity and perhaps generated more revenue down the road.
3) Contrasting this situation to the Scotia one, it's easy to see where I'll be moving my investment portfolio - from the bank that sells me product they are dumping to a bank that buys the same products I do and then save themselves while saving their clients!

Ross Hendin is CEO of Hendin Consultants, and is a Senior Advisor to the Canadian office of a leading multi-national PR firm. With strategic communication experience in more than 20 countries around the world, Ross specializes in litigation, financial and political strategic communication. He has worked in the ABCP niche since 2006. Hendin Consultants is in Toronto and London, UK, and is on the web at Email Ross at

Friday, January 25, 2008

Whatever happened to Adam Smith’s concept of Laissez-Faire?

By: Daryl Ching, Clarity Financial Strategy

It’s funny how we preach one thing when times are good and completely flip when times are bad. As North Americans, we pride ourselves on an open market economy with minimal government intervention in our capital markets… until things get ugly.

Let’s start with Central Bank. My understanding is that the Central Bank’s role is to use monetary policy to control inflation – full stop. They are not responsible for avoiding recessions or boosting the capital markets. On Tuesday, the Feds did a surprise 75 bps rate cut. Bush and Paulson have announced a $150 billion stimulus package, are trying to push a 5-year subprime mortgage rate freeze and are now pressuring the US banks to bail out the monoline insurers.

Up here in Canada, I will say that the Bank of Canada looks more like they are playing the role of a Central Bank. We dropped a modest 25 bps, despite a 600 point drop in the TSX on Monday, and they are carefully watching core inflation. However, we saw the federal government apply pressure on the big banks to participate in a margin facility for the ABCP restructure, that they don’t want to be involved in.

Should we rewrite the economics textbooks to say that “Laissez-Faire” only works in good economic times? Let’s just say for the sake of argument that all the government intervention we are seeing is successful in preventing a deep recession. What message are we giving to the market participants? Don’t worry – the next time you underwrite junk product and create a bubble, we will bail you out again.

Intuition tells me that business cycles will never go away. We will see peaks and troughs. In order for the capital markets to improve, people need to feel the pain, and there is no better way to learn than to get snake bitten. Like the technology crash in 2000, people need to learn that what goes up, must come down. Double digit appreciation in the real estate market for six consecutive years is unsustainable. We then revamp ourselves, do more due diligence and purchase products that make sense.

As a believer in an open market economy, I think the best course of action in times like this is to let capital markets correct themselves. This will weed out the participants that have made poor decisions and reward those that resisted the temptation of taking on unnecessary risk. Only then can we really call ourselves a capitalist open market economy. Until then, let’s not pretend to be something that we’re not.

Wednesday, January 23, 2008

ABCP represents challange for accountants

By: Daryl Ching, Clarity Financial Strategy

Ken Mark, from the Bottom Line, a Lexis Nexis publication aimed at accounting and financial professionals, published a great article recapping the ABCP story. Click here to view the article. We have received numerous questions and interest in the ABCP situation from accountants. For the second consecutive quarter, auditors are still scratching their heads about how to value exposure to non-bank ABCP.

CNW Group has also released an interesting article “Canada's CAs call for clear disclosure of ABCP holdings”. What investors thought were high quality, cash equivalent investments are being restructured into long-term holdings with no clear indication of time to maturity or valuation. Crawford’s Committee holds the information and JP Morgan has completed its valuation of the assets. However, for reasons of their own, they have decided not to release this information to the public.

Accountants have been asking me how to value the non-bank ABCP. At this point, the simple answer is that they can’t, at least not in a meaningful way. We have seen corporate write-downs ranging from 5% to 40%. The only public trade that has taken place was by Westaim and we know they sold their ABCP for 70% of book value with some upside. While this trade sets a precedent, it does not set a market value for all instruments. The value of the ABCP will depend heavily on which trusts were purchased.

JP Morgan’s valuation will be very useful information, as it will provide some colour as to the anticipated recovery value on the assets if they are held to maturity. However, for companies looking to sell their restructured notes, there is great uncertainty about what the secondary market will look like. As the restructure is scheduled to close by the end of March 2008, it may take potential buyers a couple of months to digest the information in order to make meaningful bids. Therefore, we many see any trading until May 2008.

Unfortunately, in this vacuum of information, companies having to report their results are left in the dark, just as much as their shareholders. Substantial financial decisions and budgeting activities will continue to be put on hold until they receive more clarity from the Crawford Committee as to what these assets are truly worth. In the mean time, shareholders will need to settle with vague disclosures about ABCP holdings and a best guess at valuation, which may or may not reflect true value.

Tuesday, January 22, 2008

Turbulent times put rating agencies to the test

By: Daryl Ching, Clarity Financial Strategy

Yesterday, the TSX saw the largest one-day drop since the September 11 attacks. The TSX has dropped over 1,500 points over the last week, with a minor recovery today after the Fed’s surprise announcement of a 75 basis points rate cut. Stock markets all over the world have experienced extremely volatility as fears of a US recession are looming. Several corporate entities have fallen victim to the global credit crunch. Quebecor World announced yesterday that it will be filing for creditor protection. Credit insurers like ACA are hanging on by a thread.

Clarity Financial Strategy recently published a white paper to explain the spread-loss trigger in the ABCP restructure proposal. The largest component of the ABCP is directly linked to corporate credit defaults swaps, which make bets on corporate defaults. Mr. Crawford’s Committee has the challenge of setting a trigger so that the chance of a draw on the margin facility will be extremely remote. The probability of a draw is directly linked to corporate credit performance.

The rating agencies will be put to the test with the ABCP restructure. Have they sized the spread-loss trigger at a level that can withstand today’s current credit environment? Is the margin facility large enough to cover the potential defaults? JP Morgan as advisor is currently faced with a very difficult task. They need to size the spread-loss trigger large enough that a chance of draw is a remote, but at the same time, keep the bank counterparties happy that they are sufficiently protected. The bank counterparties that sold the CDOs prefer a smaller trigger so that they can draw on the margin facility to protect themselves against corporate defaults in the event that the markets experience greater volatility.

Friday, January 18, 2008

No News Can't Be Good News: A Commentary

By: Ross Hendin, Hendin Consultants

The many readers of the blog may have noticed something important in the last week or so... or maybe they didn't know, and that's even more important: the coverage of Crawford Committee developments has slowed down totally. Is it because you, the noteholders and industry-insiders have lost interest? Is it because the media has decided that there are better things to cover? Is it perhaps that the global credit-crunch is just hogging precious news real estate?

No. It's because the Crawford Committee hasn't released any news, and is probably also not commenting on developments happening in the country that noteholders want answers to. They can tell that avoiding the media doesn't mean the story will run with a line somewhere that says "Mr. Crawford was not available for comment and / or didn't take our call". Quite the contrary. Our reporters do a very good job of reporting on fact, and not rumor. The downside for the public and the noteholders is that with so little information about the Committee's actions actually seeing the light of day, all that the public have are rumors and speculation about what will happen.

I've said it before, and I'll say it again now that we are seeing another clear indication that there is no clear indication - the communication strategy being employed here is being done very carefully, and is working very well. When was the last time you saw "good news" released on Christmas Eve at 12.30 PM as opposed to at 9 am when there was a chance for reporters to make deadline on one of the slower days of the year?

It was discovered not two days later that the bank assessing the assets and setting the spread for the notes is also the mystery bank set to fund if no other banks come to the table. I wonder if other banks are even going to be able to see the assets they for which they would provide the margin facility.

The diligence with which the Committee keeps critical information away from the noteholders, let alone the public, is truly disappointing in a country with a rule of law.

Let's compare the news on Christmas to another, slightly more high-profile case where the same thing happened:

This article in the Telegraph gives an account of a famous Russian energy company expropriation case. This case is seen by some to be the definitive turning point in post-modern Soviet history - the point where authoritarianism started to return to Russia. As this recent article alludes to, the Russia propaganda machine is known in PR circles to be among the most effective in the world, and the Kremlin joins with state owned energy major Gazprom in spending in excess of $11 million USD in the next three years on foreign Public Relations alone.

The Russian Purocracy (equivalent of our DA / Crown Attorney) announced a decision to continue the unlawful detention of Mikhail Khodorkovsky (the CEO of Yukos, the energy company at the centre of the expropriation) on December 23, 2003, on the assumption that it was close enough to Christmas nobody would care about the detainment, but at the same time not wanting to look too shameless about the timing.

I really hope that the Committee can wake up to the reality that the public and the media are watching this, and that a more open approach is a more elegant and public-friendly way of accomplishing what I am sure is a hard enough task as it is.

Thursday, January 17, 2008

ABCP Exit Strategy

By: John Sokic, Clarity Financial Strategy

Today Merrill Lynch announces an $11.5 B write-down. Yesterday, it was Citibank's turn with an $18 B loss. Major Banks and brokers are seeking overseas capital to shore up their balance sheets. Bond insurance companies are hanging on for dear life. The cause for all of these problems appears to be the leverage in the system created by structured financial products.

For example, SIV products in the US are flatlining at the moment. The Financial Times published an article, "SIV's don't rollover, they die". As they fully unwind, a large glut of CDO and subprime product will flood the market. SIV triggers require a forced sale but who will purchase their assets? So many former participants have been burned or 'snake bit' already. The effect is so widespread that only 'virgin' players and their capital will be stepping up to the plate. I see this happening very slowly over time.

The world of rating CDOs is changing. The Financial Times released another article, "Brace yourselves: S&P adjusts risk models". Rating agencies are changing parts of their methodology such as their loss curve assumptions. Too little, too late of course. However, something must be done. Rating agency credibility has taken the biggest hit in their histories. It is clear that many people were wrong in the way they chose to analyze these CDO deals. So we have to completely change our views. Going forward, only those that understand where things went wrong and come up with a totally new way of analyzing these transactions will succeed in this market going forward.

CDO issuance has grind to a halt. The market for structured products has become a distressed one. However, there is no precedent in financial history for a distressed market this large. In Canada, we have a relatively conservative financial profile with very little of these problems. Our structured finance market never really developed to any kind of scale.

We did, however, create a large market for ABCP. The non-bank variety heavily reference US assets. So we do share in their pain. For those embroiled in the situation, what is the best course of action? What is our exit strategy?

The exit will be much more difficult to achieve than most parties currently believe. Given the situation in the US, how do investors in Canadian ABCP expect to find buyers for their holdings? According to the restructure proposal issued late in December by the Crawford commitee, roughly half of investors in the large CDO pool are going to self-fund for margin calls. To self-fund, investors would have to have a very high credit rating or capital base. Agencies would not allow a weak link for the new restructured notes, such as a small, unrated company that promises to pony up for margin calls.

Self-funding implies a certain commitment to hold the restructured notes to maturity. There appears to be no plan to unload the notes as soon as a secondary market opens up. These investors have that luxury. What about the typical corporate treasurer, responsible for funding the operations of his or her company?

Whether we like it or not, the structured finance world is front and centre for everyone involved in the finance industry (and well beyond). Many participants find themselves buried beneath a mountain of distressed, complex assets with acronyms they have never heard of. Education is the key. Only with knowledge of the situation, of the product spectrum and our local Canadian manifestation, will participants have the tools needed to dig their way out.

Wednesday, January 16, 2008

Clarity Financial Strategy publishes white paper on spread-loss triggers

By: Daryl Ching, John Sokic, Clarity Financial Strategy

Please click here to view the white paper.

Mr. Crawford’s Committee issued a press release on December 23, 2007, outlining high level information on the Canadian ABCP restructure and the implications of that restructure on Leveraged Super Senior (“LSS”) CDOs. The Committee proposed to amalgamate all the CDOs into a jumbo fund and introduced the concept of spread-loss triggers, moving away from mark-to-market (“MTM”) triggers. But what does this really mean and what are the implications for investors?

Being in contact with numerous investors, it is apparent to us that this is a concept that has not been well understood. It is our mandate to provide education to investors so that they are making informed decisions. To facilitate a better understanding, we are providing an explanation for one of many key elements in the ABCP restructure proposal and how this directly impacts current noteholders when the restructure is complete.

Friday, January 11, 2008

Eerie silence into mid-January

By: Daryl Ching, Clarity Financial Strategy

We are 20 days away from the standstill period deadline and there has still been no confirmation from the big banks to step up for the margin facility. One can only assume that this negotiation is as difficult as we had suspected back in December. It is very difficult to determine to what extent each bank was involved in the frozen ABCP market. Banks could have participated in several ways: provide liquidity, provide hedging for traditional securitization deals, selling ABCP and acting as counterparties for CDO transactions. With TD Bank clearly announcing their reluctance to participate due to their non-involvement in the market, this has opened up a can of worms as the banks start pointing the finger at the negotiation table, arguing about who is more responsible.

In a blog that I posted on January 2, I pointed to several articles written by the Star, National Post and Globe and Mail that identified the “mystery banker” backing the margin facility. During Mr. Crawford's conference call on December 24, he announced that a foreign bank would be willing to step in with approximately $2 billion to top up the required amount for the margin facility in the event that we have a shortfall from the Canadian banks. At that time, the Committee refused to identify the banker. The bank was later identified to be JP Morgan by the press. Furthermore, the Committee was criticized for the potential conflict of interest, as JP Morgan is the financial advisor negotiating the size and the fee of the margin facility and the only party with access to the data.

Mark Boutet, a spokesperson for the Committee responded by saying, “If there is one, JP Morgan has committed to look the world over to find financing for this and to deliver the market for it.” As it is January 11, and we still have not received a commitment from the big banks, I certainly they hope that the Committee has fulfilled their promise and reached out to other global institutions that may be less exposed to CDOs. I also hope that they are providing sufficient data to these institutions to help them get comfortable with the risks of the margin facility. The deadline is fast approaching and we are running out of time.

Thursday, January 10, 2008

Rating agencies swinging the job axe

By: Daryl Ching, Clarity Financial Strategy

John Greenwood from the National Post, published an article about DBRS closing their European offices. DBRS eliminated about 70 positions, which represents about one quarter of the entire workforce and includes individuals from their Frankfurt, Paris and London offices. The article also points out that Moody's eliminated 275 people last year out of a total workforce of about 4,000 and Standard and Poors will be looking to reduce its workforce by about 3% this year.

The rating agencies have been hit hard by the global credit crunch, as investors had relied on their ratings to make purchases of structured product. Their credibility has come into question. People have pointed the finger at DBRS for their unique General Market Disruption liquidity protocols and their CDO methodology that permitted mark-to-market triggers. S&P and Moody's will need to explain why they stamped AAA on numerous US subprime mortgage transactions, of which many have been downgraded and are facing liquidation and losses today.

Many people have asked me if I think the rating agencies will survive. I think it really depends on how they respond to the current situation. As for DBRS, in response to the events in August, they have changed their liquidity criteria to Global Style Liquidity, which is more resilient that the previous type. DBRS's use of market-to-market triggers for CDO transactions has also been called into question as the underlying credit default swaps are generally under water. The indication we have received from Mr. Crawford's Committee is that we are moving away from mark-to-market triggers with the CDOs and replacing them with spread-loss triggers. The outcome of the restructure proposal will be a true test to determine if rating agencies are continuing to use their current methodologies or if they have revised them in light of the current situation. S&P and Moody's will need to explain how they got comfortable stamping the highest rating on US subprime transactions.

Investors will be demanding some answers. My advice for the rating agencies is for them to come forward, take responsibility for errors in their criteria, explain how they happened, and address what steps they will be taking to prevent them from happening going forward. Rating agencies play a vital role in the capital markets, but every step must be taken to restore investor confidence at this point. Whether the rating agencies survive or not will depend on their actions over the next few months.

Wednesday, January 9, 2008

The Optics Of Answers: Where are you going for your advice?

By: Ross Hendin, Hendin Consultants

In one of my first blog entries for Clarity, I pointed to the Canaccord / Scotia lawsuit, and said that as all the parties in this mess start to draw their lines in the sand, so too should they remember that PR - now more than ever - will play a critical role. Litigation communication is critical because without presenting your position and case properly, and without thinking through how your lawsuit will look, you risk your reputation and credibility.

I’ve had some positive feedback about this point, as many people want to seek the compensation they feel they deserve, but they want to do it in a way where they are positioned as “the good guys”. I have also had feedback from people who feel that while litigation PR is all very nice and good, it doesn’t solve the problem that the dealers who sold the notes (i.e. Canaccord and other banks) are the experts that the noteholders are sending their questions to. The noteholders, en masse, believe that the dealers are the right people to answer their technical questions and as such are working very hard to be in touch with them on their issues.

This is the ABCP equivalent of buying a car at a dealership, and going back to your salesperson when there is a problem with it. What would they tell you? “Nobody cares more about you than I do, and nobody wants to see you happier. The car isn’t made here; I know everything about the product but can’t tell you what’s wrong with it, and I can’t fix it. If you want it fixed you can take it to a place that specializes in fixing these things. Have a nice day and think of me when you need another car.”

Noteholders should remember that while the dealers are friends right now, things may change if the restructure doesn’t go according to plan. They may be the first people to get sued by the noteholders, who were told that the investments were short term and safe. The dealers may in turn sue the banks because they didn’t do their own diligence on the notes, and in so doing, will risk looking like they didn’t do homework before selling a product to their clients. Let’s be clear here, unless a dealer is giving the noteholders their money back, like National bank, they are in a difficult situation optically. They need to stay the friends of the noteholders now, knowing full well there could be litigation down the road, and knowing that while they have a strong knowledge of the notes, they aren’t the experts who built and stand behind the product.

Noteholders walked into a dealership, and bought a car they thought was a great bargain. The noteholders, and the dealers selling the product, didn’t look under the hood properly to check the mechanics. As a result, the salespeople are getting calls from customers with questions about engines, drivetrains and spark-plugs when their working knowledge really extends to horsepower, options, colors and lease rates.

Even though the dealers look like the logical place to seek advice now, they may not be. To me, it looks like Canaccord and other have showed the market that dealers may not be experts and may not know the product as well as the analysts that structured them.

Monday, January 7, 2008

ANNOUNCEMENT - Clarity Financial Strategy appoints John Sokic as Partner

TORONTO -- Clarity Financial Strategy (“CFS”) is pleased to announce that as a result of growing market interest in the ABCP restructure proposal that Mr. Crawford's Committee will be informing noteholders about later this month, John Sokic has joined CFS as a Partner in the firm’s ABCP Consulting arm.

With over seven years of structured finance experience at TD Securities and Coventree, John has forged an expert understanding of CDO transactions and other alternative asset classes. John has analyzed and structured deals worth over $8 billion, and is regarded in the industry as a leading analyst, deal-maker, negotiator and portfolio manager. John has directed analytical modeling, interfaced with banks and clients, and managed investment oversight functions in order to leverage investment opportunities.

In his current role with CFS, John will consult for clients affected by the ABCP situation. He will provide insight and assessment on the restructured notes.

John has a Bachelor of Commerce degree from the University of Toronto. He also holds the Chartered Financial Analyst (CFA) Designation.

Increasingly, noteholders, dealers and potential purchasers are looking to better understand the products and the implications of the restructure currently underway. While many noteholders turn to the banks that sold them the paper for a better understanding of the product, many are seeing the value of turning to specialists who were directly involved in structuring the assets. Further to that, CFS is independent and free of conflicts of interest.

DARYL CHING, Managing Partner: "ABCP experts and savvy noteholders know that the Crawford Committee is keeping things very quiet before their upcoming road show. With John joining the team, we are now more ready than ever to help noteholders make sense of the proposal and decide what's in their best interests."

DARYL CHING: "The ABCP market is very savvy. They know the product and now demand a very specialised skill-set to help them make an informed decision on the proposal. CFS intends to provide a supplementary opinion to corporations to help support their decisions. Their Board of Directors and shareholders will be pleased that they sought a second opinion before making such an important decision. John's expertise will give our clients the edge they need to make the right, independent decisions ahead of the curve."

JOHN SOKIC, Partner: "The current state of the market is such where even people with above-average knowledge of the product are left shaking their heads. They are smart, but the lack of information and time they will have to analyse the new products before voting on them is raising concerns. I am looking forward to working with CFS’s clients and helping them to make sense of the products they have."

Clarity Financial Strategy Inc. is a Toronto-based consulting firm founded by Daryl Ching. CFS is focused on providing insight and recommendations on the ABCP situation, is particularly outspoken in defence of noteholders in the ABCP restructure, and has clients both from Canada and abroad. For further enquiries please contact CFS Managing Director DARYL CHING (416) 505 7467 ###

Is the Canadian ABCP Market dead?

By: Daryl Ching, Clarity Financial Strategy

With the recent debacle, investor perception of all ABCP is probably equivalent to that of junk bonds. Corporate treasurers and CFOs who are receiving pressure from their boards or even worse, have lost their jobs may never return to the market to purchase these investments again.

Boyd Erman of the Globe and Mail recently published a blog, "What's left of Canada's ABCP market is holding up as U.S. meltdown continues?". Not including the $33 billion of frozen assets, there is still $80 billion of ABCP outstanding that continues to roll, down only 7% from its peak in August. As of December 19, the ABCP market in the US had plunged 36% from its peak. Most of the ABCP was issued by Structured Investment Vehicles (SIVs) that issued short-term commercial paper and purchased higher yielding long-term assets. We have learned that the SIVs in the US had massive exposure to the $1.3 billion US residential subprime market. As a result, US banks have bailed out their conduits by taking assets back on their balance sheet in a large way.

Canada is a very different story. Even the majority of the $33 billion of frozen assets are of good quality, but that is not the focus of this piece today. Due to the noise and loss of investor confidence created by the recent debacle, the bank ABCP conduits continue to trade at premiums today, roughly 50-60 bps higher that August. According to DBRS, while the non-bank ABCP conduits had 78.8% exposure to CDOs and 8.2% exposure to US subprime (there is overlap of 5.7% between these two asset classes), the $80 billion ABCP market that is generally sponsored by large banks has 3.4% exposure to CDOs and no exposure to US subprime assets at all.

For the first time in twenty years since the origination of the Canadian ABCP market, we are seeing some unprecedented events:

1) A market disruption actually happened, liquidity protocols and structures to the test that have only had theoretical constructs up to this point.

2) The first ABCP conduit was downgraded by DBRS – Apsley Trust.

3) More scrutiny from the government: The Bank of Canada and the federal government are getting involved influencing the ABCP restructure as well as calling for a national securities regulator. The Ontario Securities Commission is demanding more disclosure from the big banks for their ABCP conduits. The Canadian Securities Administrators announced that they are exercising more scrutiny on financial reporting of ABCP exposure.

4) ABCP conduits have moved from the traditional General Market Disruption liquidity protocol to Global Style Liquidity.

5) US rating agencies are coming north: RBC Capital Markets and Scotia Capital have announced that they have added a Moody’s rating to all their ABCP conduits. Deutsche Bank launched a new conduit, Okanagan Funding Trust, the first Canadian ABCP conduit to be rated by S&P.

Now back to my original question – will the ABCP market die? Quite simply put, the ABCP market is far too important as a funding source for corporations to fail. What we are seeing is massive correction in methodologies and pricing. Investors need to reevaluate the risk and return and decide if they ever want to return to this market. With more rating agencies providing an opinion, we may see new entrants. The Canadian Pension Plan Investment Board (CPPIB) recently announced that it has purchased $6 billion of bank ABCP.

When the dust settles, I believe we will see the following changes:

1) All ABCP conduits will have at least two ratings.

2) With the additional costs of rating agencies and the capital required for global style liquidity, corporations should expect their cost of funds for securitization facilities to rise, which ultimately will result in higher borrowing costs for consumers.

3) To fill the void of short-term ABCP, new types of products will be originated, possibly medium-term notes, asset-backed securities bonds or unrated securitization products.

4) Interest on ABCP will probably remain higher than the extremely low levels experienced prior to August.

5) We will probably not see any CDOs or structured products originated for quite some time and the ABCP market will be predominantly conservative traditional securitizations structures.

6) Most importantly, there will be more transparency and investors who purchase ABCP will need to figure out how to model these transactions to make themselves comfortable that they do in fact possess the risk characteristics that they are comfortable with.

Friday, January 4, 2008

How will the ABCP Restructuring affect Smaller Investors?

By: John Sokic, Clarity Financial Strategy

The Crawford Committee should be applauded for their efforts in preventing a fire sale of the assets within the ABCP trusts in Canada. While the traditional receivable tranche and subprime tranche will remain straight forward with investors holding on to the same assets as they had originally purchased, the amalgamation of the synthetic CDOs raises some concerns. Instead of investors receiving some discounted value of their original investment, many will be scratching their heads now, wondering what it is they are left with after the restructuring.

Mark-to-Market triggers on the CDO deals were the single largest hurdle to a successful restructure. In order to morph these triggers into something that would work going forward, much has been sacrificed in the way of simplicity and liquidity. Ostensibly, this is the opposite of the committee’s objective.

Pooling the CDOs together creates what is known in the industry as a CDO squared. We now have a giant CDO that references a pool of other CDOs. We have replaced some of the leverage that resided in mark to market risk with internal or credit risk that every investor will now share. So, we have a strange and unprecedented instrument emerging here that neither current nor prospective investors will be able to easily handle. Hence we face more complexity, less transparency, and ultimately, even less liquidity.

Less liquidity? How can that have happened? Well, it is in the interest of the largest investors. These holders have the ability to place the assets on their long-term books to hold until maturity. The Crawford committee has stated they expect that, should investors hold until maturity, they will receive as close to par as possible. How many small investors could actually wait for maturity? It seems this solution works to the benefit of large investors and to the detriment of smaller ones.

As a result of the additional complexity, prospective buyers of the new notes will take more time to digest this information and may ultimately demand a deeper discount upon purchase. Potential buyers that were planning to hedge the risk will have a more difficult time doing so. It seems likely that smaller investors will be in a bleak position when the secondary market for the restructured notes eventually opens up. Were I in their position, I would be doing everything I can to understand these assets and get prepared to negotiate for the highest possible price for my holdings. Prior to January 31 when the proposals are expected be sent out for a vote, it is in the best interest for current investors to seek a second opinion and perform their own valuation before deciding to sign on.

Thursday, January 3, 2008

Issues for investors to keep in mind as the deadline approaches

By: Daryl Ching, Clarity Financial Strategy

As we move closer and closer to the standstill deadline of January 31, there are some important outstanding issues that all participants need to keep in mind.

1) How are we going to address administration? Currently all the conduit sponsors continue to administer their own assets - this includes wire payments, collecting from traditional receivable clients, investing collateral, resetting swaps, monitoring events of termination, and the list goes on. Essentially, these are necessary functions to keep the cash flowing in and out of the system, and to maximize recovery value on the assets. Can it be expected that all the non-bank sponsors will stay solvent for 7-10 years just to perform this function? Coventree recently announced in a press release that they will be closing their Capital Markets business unit and that there can be no assurance that Coventree's revenue will continue to be sufficient to cover the costs of continuing to support the restructuring efforts.

From an administration perspective, the economics really only make sense for one party to take over the entire $33 billion portfolio. As Coventree currently administers the majority of the assets, they would be the most practical choice, as it would be the most seamless transition. The other alternatives would include selecting another non-bank conduit sponsor or appointing a completely new administrator. The administrator will be paid a fee, likely in the range of 5 to 10 bps to perform this function. However, it is an important aspect of the restructure and we need to understand how this will be addressed by the Committee.

2) Bush's plan to freeze subprime mortgage rates for five years will have a direct impact on the subprime assets and an indirect impact on all other assets. While this plan has been met with a great deal of criticism, it might actually be of benefit for the ABCP noteholders. To the extent this plan actually delays defaults, noteholders with shorter term assets will stand to benefit. ABCP noteholders in all tranches should be watching this plan closely, as defaults in the subprime sector will also have an impact on corporate risk.

3) In a recent press release, Strategem Capital announced it will take another writedown of its asset-backed commercial paper holdings and warns it may not be able to make distributions if a new March restructuring deadline isn't met. Strategem Capital has been conservative writing down the ABCP 40% and potentially increasing that writedown to 45%.

I get the impression from conversations with various investors and press releases that investors expect to receive all their money back on March 2008. Let's keep in mind that when the restructure is complete and prospectus-like disclosure becomes available, it will still take time for potential buyers to digest all the information, run their analysis and make a bid - potentially months. If they choose to hire experts in the industry to provide clarity, this time can be cut much shorter. However, potential sellers of the new notes need to keep a couple of things in mind: they should not expect to sell as soon as the restructure is complete unless they are willing to take a deeper discount and the secondary market may price the new notes below JP Morgan's valuations. From a buyer perspective, the assets have been tainted as distressed assets, and the market perception will likely be that buyers need to earn a premium to purchase these notes, even if they are investment grade.

Wednesday, January 2, 2008

Yet another reason for transparency - JP Morgan identifed as mystery banker

By: Daryl Ching, Clarity Financial Strategy

For those of you who just got back from holidays and are catching up on the ABCP story, there was an interesting development last week. During Mr. Crawford's conference call on December 24, he announced that a foreign bank would be willing to step in with approximately $2 billion to top up the required amount for the margin facility in the event that we have a shortfall from the Canadian banks. At that time, the Committee refused to identify the banker. The Financial Times named this mystery banker as JP Morgan in an article written by Bernard Simon on December 26. (Click on links to view articles) The Star, National Post and the Globe and Mail were able to confirm this and wrote articles on this topic last week as well.

For those of you who are interested in the commentary on the restructure proposal released on December 23, feel free to watch my interview on BNN last week or visit my previous blog entry for a recap.

With the lack of transparency from the Committee, all measures should be taken to avoid any conflict of interest. JP Morgan, the sole financial advisor with access to the Data Room is in the best position to negotiate the best deal for the investors. When negotiating credit facilities, rating agencies and bank counterparties will always ask for as much credit enhancement as they can get, as more credit enhancement only improves the quality of the rating and the credit position of the bank counterparties. The role of the financial advisor is to act as an intermediary, and structure a transaction that addresses these concerns with a reasonable amount of credit enhancement, that also takes into account the needs of the investors. While a larger margin facility provides more protection, this also results in higher fees, which ultimately results in greater costs to the investors. If JP Morgan stands to earn $32 million / year ($2 billion at 160 bps) on the margin facility, this begs the question about whether there should be more scrutiny in this process.

The Committee indicated on a conference call that with the new spread loss triggers, the chance of a draw on the margin facility will be very remote. If that is the case, 160 bps is a very lucrative standby fee. For clarification, this is only a standby fee. If a margin call is made and the facility actually gets drawn, I anticipate the drawn fee will be based on the Prime Rate, but the Committee has not disclosed this rate as of yet. To put things into perspective, General Market Disruption liquidity facilities, which were considered remote risk, in a functioning ABCP market were previously priced between 10-15 bps. I believe the high spread is a result of two factors: 1) Not enough transparency - for the same reason that we are not seeing bids from potential buyers of ABCP for more than 50 or 60 cents to the dollar, banks are being asked to participate in the margin facility with very little information, 2) The Committee has asked parties to participate that are reluctant to do so, because they are already overexposed to ABCP, have liquidity problems of their own and have a gun to their heads from shareholders not to take any more, like the big banks in Canada. I suspect that opening up the Data Room would bring more financial institutions to the table, if they have the ability to assess for themselves, the risk on the margin facility, especially if JP Morgan has already made themselves comfortable to step in.

Other than JP Morgan, are there any other parties at the table that can determine if $14 billion is a reasonable amount for a margin facility or if 160 bps is fair? Unfortunately, with the exception of the financial advisor, I have reason to believe that the participants in the industry who have the skills to assess this do not have access to the Data Room. JP Morgan holds all the cards in this negotiation process and no second opinion will be offered. Furthermore, by the time, we all have access to the data, terms and conditions will likely have been finalized by the Committee by approval of the super majority of the trusts. Let's not forget that some of the large institutional investors like La Caisse de Dépôt et Placement du Québec and Desjardins Financial Group have a considerable amount of voting power with their holdings, are self-funding the margin facility and do not even need to worry about the margin facility fee.

This is the reality and I have come to accept the fact that negotiations will continue to take place in a vacuum. I have also come to the realization that super majority approval for most of the trusts can be can be reached by a small concentration of investors. Therefore, JP Morgan has a fundamental responsibility to remain in a position where a conflict will never come into question with a role as important as the sole financial advisor, especially with closed door negotiations. The next step is for the Committee to be more forthcoming with information in order to welcome other institutions to the table. This may even result in lower fees than 160 bps. While we would all like to see a deal get done, I would still like to see a properly negotiated transaction with sufficient credit enhancement to protect the bank counterparties, but at the same time, creating the best value for the investors, by minimizing the costs, which will minimize their losses. Unfortunately, we will not know how well the deal is structured until the data comes out. For now, we have to rely on what we are being told by the Committee, which is not very much.