National Bank lets the cat out of the bag - standstill is still in effect

By: Daryl Ching, Clarity Financial Strategy

Nicole Mordant and Lynne Olver from Reuters published an article that confirms that the non-bank ABCP negotiations are still on track. Interestingly enough, the source did not come from the Crawford Committee but from National Bank. National Bank reported their Q1 results today announcing that their ABCP is stilled valued at $1.71 billion, which represents about a 25% write down. Bank CEO Louis Vachon repeated that he doesn't expect National to take further writedowns on the paper unless there is a severe U.S. recession or a disorderly liquidation of the ABCP conduits, neither of which he anticipates.

"We are getting much closer to execution and documentation and obviously that creates more complexity... But all parties are fully engaged and we are very confident that the process will reach a successful conclusion," said Ricardo Pascoe, Co-President and Co-Chief Executive of National Bank Financial. Mr. Pascoe also indicated that the standstill is still in effect and no margin calls have been made.

We applaud National Bank for speaking out and answering a very important question on investors’ minds. Is the restructuring still on track and is the standstill period still in effect? However, it would bring the market much comfort to hear this from Mr. Crawford’s Committee. We are hopeful that as the dust settles with BMO’s conduits, that the Crawford Committee will be forthcoming with their progress.

The Big Game of Chicken

By: Daryl Ching, Clarity Financial Strategy

I will be on the Business News Network at 2:45 PM EST to speak about the BMO CDO conduits - Sitka and Apex Trust. However, I will focus my blog today on the repercussions for the non-bank ABCP.

DBRS has downgraded Sitka and Apex Trust to the equivalent of CCC. They are technically in an event of default, because bank counterparties made margin calls, and to date all the parties failed to implement a restructure or post the required margin. BMO now has two days to remedy this situation or the bank counterparties will have the right to seize the assets in the trusts and proceed with a firesale. BMO faces a serious predicament. Should they post the required collateral (that will result in an additional $495MM in writedowns) or let them sink? I will discuss this decision on BNN.

Either decision they make begs the question about whether they are still going to stay committed to the margin facility for non-bank ABCP. Let’s just say for the sake of argument that BMO is more likely to bail out their own conduits than non-bank conduits and they decide to walk away from Mr. Crawford’s Committee. What then? Does CIBC pound their fist and say “Wait a minute! We’re in a dire situation too. Why should we have to participate then?” All of a sudden we may see this big game of chicken being played by the Big Banks. Nobody wants to see a $33 billion meltdown, and yet nobody wants to step up to the plate to be the saviour either.

Now let’s think back to December. On a conference call on Christmas Eve, Mr. Crawford mentioned a mystery banker that could step into the shoes of the Canadian banks if they did not step up. That mystery banker was identified to be JP Morgan, which some participants pointed out was a conflict of interest. However, fast forward the clock a couple months and the credit environment is significantly worse today than it was in December when the margin facility was first proposed. Is JP Morgan going to save the day or are they having second thoughts as well? This is likely causing the delay for Mr. Crawford’s press release.

Deafening Silence - What is happening behind those closed doors?

By: Daryl Ching, Ross Hendin

While the Crawford Committee has been quiet, participants in the market certainly have not been. The Facebook forum has had a high volume of comments. We have been inundated with numerous questions from ABCP noteholders and media about our thoughts on what is happening at this moment. The Clarity team has been thinking a lot over the last couple days about why there is a silence and what possibly could be happening with the Committee. While we have come up with a few thoughts that we are happy to share with you, we want to remind you that they are educated guesses at best, and these are conclusions being drawn with no input from the Crawford Committee.

Ross’s Perspective: So let’s start with why the silence?

It's no secret that the Committee has been doing whatever it can to keep its developments and actions as quiet as possible, while still trying to appear forthcoming and heroic. Every deadline the Committee has set so far has been for Friday at midnight, when nobody is around to celebrate their victories. They also had a media conference call last Christmas Eve at 12.30 PM - about the last time in the world anyone would want to hear about financial news. I have been saying for months that the point of their strategy has been to appear forthright but in reality be very secretive about their activities, and it could be that this week, we have seen their strategy be taken to another level of secrecy - total silence to the public.

The only comments that have recently been drawn in public are from private individuals who want this dealt with transparently and quickly so that they can find some economic relief and value in the notes sooner rather than later. These people, who should never have held ABCP at all, are understandably irate at the process. The other thing that the spotlight is doing is forcing accountability for the Committee. With so many people doing their homework on what's really happening, and starting to see how the Committee itself may profit from this work, there is increasing speculation and pressure growing in a forum that really has little impact on the restructure itself or the parties involved.

So, I can imagine that for the Committee, and the vast majority of corporations and individuals that want to see this restructure happen, the best thing for Mr. Crawford to do is keep the story and the reporting out of the media and the public attention. With no reporting or interviews at all, the media will have nothing to report on, and with nothing to report on, the Committee can continue to operate in the darkness that they have been striving to find for months. Silence, in the scenario they find themselves in, really could be golden.

Daryl’s perspective – Three possible scenarios

The latest standstill agreement states that the standstill is in effect until March 15th, unless the banks do not sign up by Feb 22, in which case it expires on Feb 22. I am not sure whether to take the silence as the banks have signed up and the Crawford Committee does not feel the need to issue a press release until March 15 or the Committee is still having problems seeking a commitment from the banks on the margin facility.

Based on Ross’s comments, I believe the most likely scenario is that the Standstill period has been extended or is close to being extended but Crawford’s Committee has not made the progress that they would like. The Committee is fully aware that short of coming out with news that the Restructure Plan is fully complete (ready to vote on) with final terms and conditions and full commitment from the banks for the margin facility, any news will be met with great disappointment. The Committee is likely trying to prevent various parties from taking immediate legal action. Silence may be a better deterrent than a press release stating that they are still not quite there yet on the restructure.

The second scenario may be that JP Morgan has decided to move to a AA, A, or BBB rating for the CDO tranche. While a AAA rating would be ideal for noteholders planning to sell the notes in the secondary market, a lower rating would likely decrease the required size of the margin facility and probably relax the spread-loss trigger to a level more palatable for the bank counterparties, who would like to be able to make a margin call sooner rather than later. If this is the case, the Committee will need to switch gears and renegotiate the quantitative terms and conditions with the various parties.

Finally, the last scenario is the worst one. It could be possible that the Committee has simply not been successful getting all the parties to agree to the terms and conditions, and is unable to do so. Under this scenario, the Investor Committee will disband, the Standstill period will cease and investors will be left with the old notes they had originally purchased. This would lead to margin calls, more calls for liquidity from the banks, events of default, firesale of the assets and a hailstorm of litigation. Because there is so much at stake, we do not believe this to be a likely scenario.

BMO CDO Conduits under fire

By: Daryl Ching, Clarity Financial Strategy

On Tuesday, February 19, we posted a commentary on DBRS downgrading five trusts within the Montreal Accord for having US RMBS subprime exposure. It appears that it not just the non-bank conduits that are being impacted by the credit crunch. The latest news from DBRS is that Apex Trust and Sitka Trust have been placed under review with negative implications (BMO is the Securitization Agent to Apex and Financial Services Sub-Agent to Sitka).

Similar to the non-bank ABCP restructure, BMO is in the process of restructuring their CDO conduits, probably in a manner very similar to that of the Montreal Accord. DBRS quotes, “However, as of the date of this press release, no formal stand-still agreement has been agreed to. If a stand-still agreement is not agreed to quickly, or additional notes are not issued to satisfy the outstanding collateral calls on a timely basis, the Swap Counterparties that have demanded additional collateral may soon be able to seize the existing collateral thereby causing the Trusts to default.”

It appears that BMO is in a dire situation and must get a standstill agreement in place as soon as possible. They will then need to convince the bank counterparties to waive the mark-to-market triggers, if they want to prevent a firesale of the assets. This is an indication that is absolutely critical for the Crawford Committee to extend the Standstill Agreement and to complete the restructure in a timely manner with buy-in from all the bank counterparties, or we may see downgrades across the board on CDO transactions.

What can we expect for the standstill deadline today?

By: Daryl Ching, Clarity Financial Strategy

Today, I will be on the Business News Network at 4:45 PM EST to discuss status of the ABCP restructure. I anticipate that we will not have heard from Mr. Crawford's Committee by that time, but I will be providing insights on Caisse's financial statements, what some of the factors might be holding up the process, and what we can reasonably expect to hear. I will follow up with a full commentary after we receive the press release from the Committee.

Investors are getting educated and speaking out... on Facebook

By: Daryl Ching, Clarity Financial Strategy

Jim Middlemiss of the Financial Post published an interesting article "Engineer rallies ABCP investors on Facebook". Brian Hunter, who goes under the alias of "Windyfield" is an avid reader of the Clarity blog and has posted several insightful comments throughout some of our entries. Mr. Hunter has created a Facebook page to rally support for the smaller investors. His site includes letters to and from Purdy Crawford and Mark Carney.

Based on comments we have received from people like Brian Hunter, it appears not only are ABCP investors getting fed up with the restructure process and speaking out, but they are getting very educated on the topic. It is apparent through Mr. Hunter's comments, that he has done much research on the situation and has an intricate understanding of how all the various parties were involved with ABCP. His website is rallying support and has up to 10 users at this point.

DBRS Downgrades ABCP Trusts and Changes Rating Methodology

By: John Sokic, Clarity Financial Strategy

On February 15th, DBRS announced a downgrade of Planet, Ironstone, Aurora, Aria an Apsley trusts, mainly due to their subprime exposure within CDO transactions. (www.dbrs.com). All of these trusts are covered by the standstill agreement and restructuring efforts of the Crawford committee.

Also on the 15th, DBRS said it has changed its methodology for rating CDOs that reside within Canadian conduits. Specifically, they are looking to reduce their reliance on US-based rating agencies. Normally, DBRS would simply use ratings by US agencies on the underlying RMBS within CDOs, then plug them into a model to come up with AAA-level enhancement for the CDO.

Now, instead of coming up with ratings of their own, DBRS has decided to notch US ratings when they are on negative watch. The notching is fairly punitive, which DBRS calls conservative. In relation to Crawford's restructure, the assets in question all fall into the 'ineligible asset' group, also known as the subprime bucket. I have to say I am not sure where DBRS is adding value here. When I first read the headline relating to a change in their methodology, I assumed they would actually 'fess up’ and begin rating the underlying RMBS themselves. Instead, they are offering a prediction of where the other agencies will place their ratings in the future - only in Canada.

These actions make the outlook fairly bleak for that 3rd bucket of assets. The downgrades for Ironstone and Apsley are so low that they are below investment grade (R-4 or BB (high)). The others are not as bad but it would appear to mean that the notes emerging from the tranche will not have investment grade ratings and that they will have an even more difficult time trading in a secondary market.

Can Mr. Crawford’s Committee stop legal chaos?

By: Daryl Ching, Clarity Financial Strategy

What is taking the big banks so long to commit to the margin facility? Why don’t they just sign on so we can get this restructure done? Before I answer this question, let’s not forget the Big 5 banks may have been involved in the non-bank ABCP market in several forms: liquidity provider, bank dealer, swap counterparty, trustees, structuring and underwriting.

Now let’s look at the potential chain of law suits. The two precedent law suits that have already been launched are by investors suing their “brokers” who sold them the paper. In one case, one of the “brokers” turned around sued the bank dealer who sold them the paper. What can potentially happen is the bank dealer will turn around and sue the conduit sponsor for giving them improper information. The conduit sponsor will turn around and sue the bank counterparties that sold them product. The bank counterparties may turn around and sue the banks for not providing liquidity. Somewhere in that line, one of the parties sues the rating agency for giving the assets the top rating.

The point I am trying to make here is that there is a way you can assign blame to virtually any party that was involved in the non-bank ABCP market. The banks see this potential hailstorm of law suits that can keep litigation going for years. To address this, Mr. Crawford’s Committee is attempting to avoid this legal chaos by asking the noteholders to sign a release that waives their right to sue all the parties named in the Montreal Accord.

Several questions have been asked of me by investors. “If I do not sign on the accord, can my right to sue really be waived for me if there is a supermajority approval? What if there was negligence from the dealer who sold me the paper? What if they misrepresented risks?” Unfortunately, not having a legal background and not having seen the final restructure proposal, I do not have the answers to these questions. However, talking to lawyers, opinions vary, which leads me to believe that this legal release will be subject to various interpretations from different lawyers. If you are a lawyer reading this, and have a comment, please feel free to post directly to this blog or send me an email.

Now let’s go back to my question about what is taking the banks so long to sign on to the accord. In order for Mr. Crawford to convince the various parties to make concessions to the Accord, all the parties want immunity from litigation. My best guess is that this is the sticking point that is preventing the big banks from signing on. They want to be assured that the legal release will protect them but how will they really know? They can probably only receiving an opinion from a lawyer at best. How will the courts rule if investors decide to launch law suits anyway, despite signing this release, or even worse, having this release enforced on them by a majority vote?

The other question I have been asked is “What is my interest going to be on the new notes?” Most investors know they were receiving a return greater than BA’s prior to the market freeze. The yield on most of these assets is high enough to cover the interest to investors, liquidity fees, bank dealer fees, conduit sponsor program fees, trustee fees, swap fees, etc. However, for the investors that are expecting to receive a yield commensurate to when they first bought the notes, please consider the following: the expenses for the restructure will include Mr. Crawford Committee’s fees, JP Morgan’s advisor fee, two rating agency fees, margin facility fees (currently 160 bps to standby), legal fees, trustee fees, and others. What will be left after all this paid out? Your interest. I am not saying that there will be no interest on the restructured notes, but there will be a vast amount of fees that will need to be paid to parties working on the restructure before investors even see a dime.

Rating agencies under fire

By: Daryl Ching, Clarity Financial Strategy

The rating agencies have been in the spotlight since the market freeze in August and have taken action to appease the public. Boyd Erman published an article in the Globe and Mail called “Regulators may clamp down on rating agencies”. The International Organization of Securities Commissions (IOSCO) may toughen the code of conduct for credit rating agencies by requiring more disclosure of rating processes, prohibiting the practice of consulting on the design of securities and requiring more research into the assets underlying complex securities.

S&P recently announced 27 separate measures to change the way they operate addressing enhancing governance, strengthening analytics, increasing transparency and educating the public. As an example, to address the conflict of interest, S&P proposes to rotate analysts so they don’t get unhealthily close to the issuers who pay for their own ratings. Moody’s has proposed to move from a letter grade system to a numerical system for structured finance. DBRS is currently reviewing the Leveraged Super Senior CDO methodology and has made a shift to requiring Global Style Liquidity for ABCP conduits.

It is worth noting another criticism of the rating agencies – an over reliance on quantitative financial models. We hear stories about the rating agencies hiring PHDs in math and physics to develop sophisticated models for the various asset classes. In the traditional securitization world, the rating agencies get comfortable with “stress testing models”. When evaluating a basket of mortgages, they will make assumptions such as an increase in losses, an adjustment in prepayment rate, a drop in real estate values, etc. Provided there is sufficient credit enhancement to protect against these stresses, the structure passes as AAA. For the Leveraged Super Senior CDOs, a key component that is stressed is correlation. As long as there was sufficient diversification among industries, geography, etc., these models would pass the test.

While the quantitative models have merit, what is missing is more emphasis on the practical approach. If mortgages are being granted to individuals in the US with low teaser rates who cannot afford them, it may not be enough to stress losses four times or to rely on a model. With the LSS CDOs, in a severe credit crunch such as the one experienced recently, correlation for defaults can easily be come 1 across all industries. Some transactions relied on hedging with credit insurers that are rated AAA. When these insurers are insuring debt at a multiple of their capital base, it is worth taking a step back and saying, perhaps this insurance is not worth a AAA rating.

The rating agencies like to rely on models because it automates processes and makes the ratings easier to do. Especially, in some cash CDO transactions that reference a hundred RMBS bonds, it would an onerous process to review the underwriting practices of every mortgage servicer. However, we have learned that this practical approach of looking at all the qualitative factors in a transaction is absolutely essential.

We certainly hope that JP Morgan and the rating agencies picked to rate the restructured notes in the Montreal Accord will apply this practical approach. It is no longer sufficient for the rating agencies to rely on old methodologies to rate structured finance products going forward.

Canaccord Writes Down ABCP, But What About The NoteHolder Clients?

By: Ross Hendin, Hendin Consultants

Since the Canaccord / Scotia lawsuit emerged a few months ago, I have been keeping an eye on it. (I encourage all readers of the blog to revisit this entry, and look at the comments to it – they’re worth reading). With the exception of the potential hailstorm of lawsuits against rating agencies, and of course what happens with the Yukon government (who have used over 30% of their budget surplus to buy ABCP in violation of their investment rules), some of the Canaccord suits may be the only litigation to survive the Crawford Committee legal ceasefire that is a part of the restructure (To the best of my knowledge, the Committee's ceasefire will not include negligence on the part of resellers, but I stand to be corrected). However, unlike the rating agencies, the Canaccord suits could be very easily untangled if Canaccord wished to make things easier for their clients.

From a PR perspective, Canaccord seems to be handling their clients as if they were financial terrorists - they will not negotiate with them, perhaps under fear that once they do, every client that they have ever treated improperly will come after them looking for compensation and a settlement. A clear message that Canaccord doesn't settle out of court means that people will think twice about taking them on, because taking them on means a number of years and probably more money on legal fees than the suit is worth.

In the Globe & Mail article, Canaccord Clipped By ABCP Writedown, Roma Luciw and Boyd Erman quote Canaccord COO Mark Maybank as saying: "Some of the [client complaints] have more validity than others and they will get addressed in the normal course of business."

It's not often that somebody who's in a client-centered business comes out and discredits their clients by saying that their suing the company in one of the most high-profile finance debacles in Canadian history has no validity. Considering Canaccord is suing Scotia Capital for a portion of damages because Scotia recommended the ABCP and Canaccord didn't do its own diligence, it's hypocritical of Canaccord to turn around and dismiss the litigation as invalid.

It's also not often to hear a company exec say that they will deal with customer complaints in the normal order of business. What is the normal order of business? To some of us, it's to make sure the customer is always right and happy. For others, the normal course of business is years of litigation.

The article also says Canaccord has gone public with news that there are now 24 clients who have "filed complaints" about ABCP holdings, which is up from 13 in the last quarter.

While we are obviously past the point where Canaccord will not do what National Bank did, and buy back the ABCP from their clients, litigation is still not the only way to untangle this for the 24 clients now seeking some assistance. This is a potential disaster for Canaccord, in terms of optics. They think that they are sending a message not to sue them, but in reality the message I am seeing is that I shouldn't do business with Canaccord in the first place.

Is TD Bank's decision not to participate good or bad? - Two Perspectives

By: Daryl Ching, Ross Hendin

On Monday, Mr. Crawford’s Committee issued a press release and hosted a conference call stating that they had an agreement in principle with four of the Big 5 banks, subject to conditions. I suspect a key condition will be an opinion that the banks have full immunity from potential investor lawsuits. One of the conditions for the restructure is that the various parties involved are released from any liabilities that result from losses on the notes.

Back in December, the Bank of Canada pressured the Big 5 to facilitate the ABCP restructure by contributing to the margin facility. TD Bank issued a response immediately declaring that they had not been involved in the non-bank ABCP market and therefore did not feel the obligation to participate. This opened up a can of worms, as a simple “everyone put up $500 million” would have been a simple solution. Now the exercise turned into “Let’s figure out how involved you were in the non-bank ABCP market and allocate your contribution from that.” To date, there has been no confirmation of the commitment amount from each bank, and a resolution has only been reached in principle, subject to conditions.

Daryl's Opinion

To my surprise, TD Bank is not participating in the margin facility. I thought this was one of those PR exercises where they pound their fist to let the world know that they were not involved in the non-bank ABCP market. I thought they would then come to the table with a nominal amount (less than the other banks) and say “See, we’re supporting the Canadian market. This is all goodwill.” In principle, I think this is the right move standing behind your convictions. However, in today’s current political environment of back scratching, TD Bank’s decision will have ramifications.

Undoubtedly, the Big 5 continue to prosper in Canada because they are protected by the government. The Bank of Canada further supports the big banks through different means such as overnight lending, which we saw a lot of starting in August when the market turmoil started. David Dodge flew to Toronto to meet with all the bank CEOs and asked them to participate in the margin facility to help out the Canadian market. By refusing, TD Bank has slapped Dodge in the face. The next time TD Bank needs a favour from the Bank of Canada, they may not be so willing to help out.

Let’s also think about all the parties involved. The other four banks now have to put up more money for the margin facility due to TD’s reluctance to participate. I am certain that virtually all the investors currently holding the paper and waiting out the restructure have some form of relationship with TD, even if it is just a checking account. The other foreign bank counterparties that have all contributed to the facility will be disappointed with the decision. The general public in Canada who is watching this carefully and does not want to see a meltdown will remember that TD Bank did not step up to help out with the greatest financial crisis in Canada when all the other banks did. The only party that is happy with this decision is TD Bank’s shareholders, but it is a very near-sighted happiness. Is it really in the best interest of the shareholders in the long-term that TD Bank has now created negative will with all the external constituents that they do business with? Would a contribution of $100 million to the margin facility really have hurt the bank that much?

I am a guest student in the GettingItDone™ course at the Rotman School of Management. In class I learned that Peter Drucker said "the purpose of a business is to create and keep a customer". Shareholders provide a financial means for corporations to achieve their objectives, but without the client, there is no reason for a business to exist. As a general rule of thumb, I have always believed that corporations can only prosper if they put their clients first.

Another perspective from Ross:

But to look at this from another perspective, yes, another $100 million would have hurt the bank because we are not just talking about this facility. We are talking about the opportunity cost of not participating in the ABCP market for the years when times were good. TD has always said that they did not want to take profits from this market for a number of reasons, and they have missed out on untold millions for their shareholders as a result of the decision. It turns out that they were ultimately right in predicting the meltdown, and as such, why should they have to pay a penalty for abstaining from making money when everyone else participated and profited? That’s not a very free-market approach to problem solving.

And from a PR perspective, I have to say that only time will tell if their move is going to be taken positively or not. While I can see that TD’s not playing ball won’t please the Bank of Canada or the other banks, the reality is that for better or worse, TD is in the inner-circle and is a keystone in the Canadian financial scene. They can’t just be kicked out of the circle, and they don’t have to worry about ramifications that are too strong or bias, because after all, we are living in a place with a rule of law. In Canada, we are supposed to be free of Government entities penalizing companies when they have broken no laws, and so the Bank of Canada may not have any legal way to penalize TD for making this decision.

The TD bank has already paid a very high cost for abstaining from investing in ABCP, and aside from taking a tough stance politically they are not doing anything wrong by staying away from the restructure. They are in bed with the Bank of Canada for better or worse, and in time, this issue and this decision will be behind them. All that will remain is Mr. Clark’s (TD CEO) reputation of being a tough fighter for his convictions and his shareholders.

Mr. Crawford hosts press briefing on ABCP restructuring plan

By: Daryl Ching, Clarity Financial Strategy

Today, Mr. Crawford’s Committee held a conference call to provide an update on the ABCP restructure. The standstill agreement has been extended to February 22, and the restructure is still scheduled to be completed in March 2008. While the noteholders of Devonshire had previously elected not to participate in the Montreal Accord, they will now be considered for the standstill agreement. Bank of Montreal, CIBC, Royal Bank, Scotiabank have each agreed in principle, subject to the satisfaction of certain conditions, to participate in the margin facility. The Committee has appointed BlackRock to be Administrator and Asset Manager. The Committee expects to provide a restructure plan for investors to vote on by the end of February.

The press asked a series of questions to which most received indirect responses. There was no comment on the dollar amount committed by the banks or the conditions for them signing on. The committee has still not finalized the index that will be used for the spread-loss trigger. When asked who had seen the data at this time, Mr. Crawford commented “mainly JP Morgan” and the Committee went on to describe the process of the how the data will be released to investors in the future. When asked about TD Bank’s lack of involvement, Mr. Crawford responded with “No comment. They have been cooperative.”

However, there were a few issues that were clarified. While the Crawford Committee had promised a “liquidity tranche” to provide relief to the investors in the interim back in November, it has been confirmed that this will not be available before the conclusion of the restructure. Liquidity will only be offered at the close of the restructure, whether it is in the form of bonds to be traded in the secondary market or lending from financial institutions.

It was also clarified that if the Committee is successful in securing 66 2/3 majority, the terms and conditions of the restructure will be binding on all parties involved. In this scenario all the investors will have the benefit of the restructured notes and waive their right to sue the parties involved. This may be the answer to a very interesting question that I had. If the restructure proposal is being voted on at the end of February and you need to give everyone at least 30 days to review the proposal and vote, how does the committee still expect to complete the restructure in March? Is it because the Committee will achieve supermajority approval before the proposal is sent out for wide distribution to investors?