Thursday, February 14, 2008

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.

1 comment:

windyfield said...

My understanding from my Canaccord IA is that if a noteholder refuses to sign the legal waiver they will be left with the worthless paper that coventree et al sold and NOT be given the new note. In other words you can sue but you will be taking 100% of the risk forward for the 10+ years it will take to sue them.

I notice that you neglected to mention a couple of the players that have the most responsibility in creating the circumstance, precipitating the occurrence and finally allowing the ABCP to freeze while they could have prevented it. The Finance department of the Government of Canada has major responsibility here. Section B-5 of the OSFI guidelines was the flaw that created this situation, the Banks and DBRS used this when writing the paper and as S&P and Moody suspected it was a problem. The Caisse precipitated the situation by trying to test the liquidity providers by selling a big volume of this stuff in August. They had to know that there would be no market. Finally the Bank of Canada could have called this a general market disruption since it really was. The BOC went beyond their mandate and took Bank ABCP at the overnight window from August 15 to Sept 7. If they hadn't done this some Banks probably would have gone the way of Northern Rock. So final responsibility rests with Bank of Canada for preferentially saving the 'Bank' ABCP and allowing the 'non-bank' ABCP (which is really bank in disguise)to fail and its noteholders to suffer the current problem. As for what the interest rate will be, I will be surprised if anything is left for the smaller investors. I'm sure the banks will figure out how to still get paid as trustees and Blackrock will take a cut and the senior investors like the caisse will take their 160 BP's
(and be almost held whole in the process). Not a pretty picture for the folks holding this crap that cant provide their own margin. Notes will start trading at less than 50 cents on the dollar and Purdy and friends on the "Vendors" Committee will congratulate themselves on a job well done. Saved the big guys (who are just money managers anyway and have no personal risk or interest)and left the individual noteholders with a huge haircut mark to market. Sure it might be worth near face value in 7 or so years but it will trade at a big discount if it trades at all. There will be no market for this kind of paper ever.