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.

No comments: