Tuesday, March 4, 2008

Clarity Financial Strategy still cautiously optimistic about successful restructure of ABCP

By: Daryl Ching, Clarity Financial Strategy

The more we read about the ABCP situation, the more signs we are receiving that this restructure may fall apart. As we had correctly pointed out on our blog on March 1, the Standstill Period is now being extended day to day, as the foreign banks do not wish to commit themselves any longer than that due to credit volatility. Purdy Crawford confirmed in an email to Brian Hunter’s Facebook group that investors should expect to sell their notes “at a significant discount to par.” A report from RBC's Mr. Andre-Philippe Hardy speculated that one of the foreign banks "has apparently become more nervous" and is no longer supporting the restructuring. If that is the case, "it could derail the restructuring," he said in a note last week. We have heard that BMO may be walking away from the table, in light of their current situation.

So where does that leave us? Is this Committee going to crumble? Are we going to see $33 billion of assets in fire sale? At Clarity Financial Strategy, we are still cautiously optimistic about a successful restructure, but before we go into our reasons, I want to reiterate the importance of the completion of this restructure.

An Event of Default and fire sale is an absolute disastrous scenario for all parties, maybe with the exception of lawyers. If this happens in today’s credit environment, we believe recovery value may be as low as zero for the synthetic CDOs, and we will all find ourselves in ABCP litigation for the next ten years. While I agree with Mr. Crawford that the restructured notes are likely to sell at a significant discount to par, I also believe that with a proper restructure with a margin facility, noteholders who hold the assets to maturity will receive close to par at maturity (with little interest).

So why are we still so optimistic about the restructuring? In December 2007, Mr. Crawford indicated that we had $12 billion of commitment for the margin facility, with a shortfall of $2 billion to be covered by the Canadian banks. In January 2008, Mr. Crawford mentioned that we had a commitment for 98% of the required amount, which would indicate about $13.72 billion. Now, we don’t know what the right number is, but let’s assume that we have $12 billion committed, without the participation of the Canadian banks. If Mr. Hardy is right and we may see one of the foreign banks walk away from the table, then let’s remove another billion and that leaves us with $11 billion committed.

As I have mentioned in previous blogs, nobody wants to see a meltdown. There is too much at stake, especially when considering that a fire sale could yield zero recovery. There are still a few possible outcomes to cover the required amount. Mr. Louis Vachon of National Bank has indicated that the Committee has alternative solutions, but would not go into what they were. Let’s do some thinking for ourselves: On a conference call in December, we learned that JP Morgan would top up the margin facility in the event that we had a shortfall if the Canadian banks did not participate. People have suggested that the credit market is much more volatile now and they may be reneging on their promise.

The one party with the most to lose is Caisse de Depot. With $12.6 billion of ABCP outstanding, Caisse cannot afford to see this restructure unwind. Caisse is currently participating in MAP 1 and has committed to post up to $8 billion for the margin facility. Will they not step in for another $3 billion to prevent the evaporation of $12.6 billion? Finally, I would not rule out the federal government. As an election might be right around the corner, they may be growing pressure for the government to step in and fund, despite their reluctance in the past. With the tragic stories coming from individuals on the Facebook page, who really should not have been sold ABCP in the first place and the possibility of a recession, those just might be enough factors to tip to government to feel the obligation to step in and top up the margin facility.

Finally, as I have also mentioned on a blog posted on February 27, the Crawford Committee has another option. The $14 billion margin facility is required to achieve a AAA rating. I am uncertain as to whether the rating agencies involved in the restructure have made any changes to their criteria for Leveraged Super Senior CDOs, but $11 billion of funding might get us to a lower rating. As Mr. Crawford has already indicated that the notes are expected to trade at a significant discount to par, does it really matter if they are AAA, AA, A or BBB? The important thing to do now is for the Committee to complete the restructure while we still have the bank counterparties at the table.

This arm twisting exercise of trying to force the Canadian banks has proved to be unproductive. However, it could be that if the Canadian banks do not participate in the margin facility, the foreign banks may feel that they are not obligated to do so as well. This may present complications for a successful outcome.

Crawford’s Committee should be shifting gears and the priority now needs to be getting a restructure completed as soon as possible in some form, not preserving the maximum value for noteholders. A fire sale would not only be detrimental for current noteholders but for the entire Canadian economy as well.

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