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.

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