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.

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