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.

National Bank Execs Under Fire For Being Right?

By Ross Hendin, Hendin Consultants

Saturday's The Gazette published this article covering the attack that National Bank CEO Mr. Louis Vachon and his executives are receiving because they "bought back $2.1 billion of paper from individual and corporate clients and its mutual funds after the ABCP market froze last summer".

When accused of the fact that he used shareholder money to save select people from the exposure to the ABCP, he replied:

"Shares of the bank have been more volatile than some of our competitors', and I take responsibility for that. But do I regret the decisions we took? No. I suspect hell will freeze over before I change my mind on that. The perception is that people in senior positions in the bank always do things for the short term. What we did in August was not for the short term. We took a hit. We knew it would be a difficult thing in the short term. But it was absolutely the right thing to do for the long term."

From a PR perspective, I have to say that a situation where shareholders are taking action against a CEO for protecting their brand is rare and unwise. No executive should be chastised this publicly for trying to protect the bank’s more vulnerable clients, or showing the bank stood behind the product it sold.

To put this in another context, imagine that you heard that a few bottles of children's vitamins were poisoned at a manufacturing plant in China, and that this poison affected some of the brands that you use. Hearing about the poisoning, only one company does a recall of the product in question from the shelves (let's say that's Centrum for arguments sake). The other companies sit quietly while the manufacturing authorities investigate the situation. The head of Centrum then gets up and says that not only have his customers been wronged through a product with the Centrum name, but he is a Centrum user too and has been using the same products that his customers have. To make sure the customers know they can trust Centrum, he's going to do a recall of the product outstanding to the groups that need refunds the most.

And then that CEO, who is also a user of the company’s products, is trying to defend the brand and protect clients and is chastised for his actions.

CEOs of corporations today need to be champions of their brands, and need to defend them and keep the trust of their clients. It's paramount to any success in business.

The message that National Bank shareholders are sending to the market is that anyone who tries to buy back ABCP - or more fundamentally tries to stand behind their product and the integrity of the paper - will be reprimanded. What does this say about the perceived integrity of the notes? What will happen when no other bank CEO will want to do the right thing and be criticized for it? And probably most importantly, will shareholder actions against the executive actually cost the bank more than the buyback would have been in terms of bad publicity, last of consumer confidence, and potential legal action?

At a critical time in the restructure, with BMO about to let 2 conduits meltdown, questions arising about who will fund the margin facility, who will provide liquidity to noteholders in need, etc.; Mr. Vachon's critics could not have picked a worse time to challenge what he and I agree is the right decision.

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.

National Bank: Did They Let The Cat Out Of The Bag?

By Ross Hendin, Hendin Consultants

Tara Perkins wrote this article in the Globe & Mail today, reporting that Mr. Vachon (National Bank CEO) feels the Committee is making progress, and that the restructure is basically a done deal with legal documents in the drafting phase.

She's quoted Mr. Vachon as saying: "That's where we are not; we're in the legal phase of the restructuring,"

Well, for those of us who aren't the majority noteholders, and who aren't being told anything at all (even as the deadline looms today at midnight) this certainly sounds like good news, even though it's not coming from the Committee itself.

I am sure I am joining the Clarity team and many of the noteholders and readers of the blog when I say that I certainly hope his insight is correct, and it's a matter of time before this is all dealt with and behind us.

I am also sure I speak for at least a few of us when I say that some reliable timelines, and updates from the Committee wouldn't go amiss - as many of the people involved have their lives balancing on expectations that deadlines will be met. I fear that some of the noteholders may not be able to take the strain of this limbo much longer, especially if they have (rightly or wrongly) promised creditors something based on the timeliness discussed.

I am very happy to hear - from the Committee or otherwise - that things sound like they are coming together. Will they actually come together and on time? We will have to wait another day and see...

Ross Hendin is CEO of Hendin Consultants, and is a Senior Advisor to the Canadian office of a leading multi-national PR firm. With strategic communication experience in more than 20 countries around the world, Ross specializes in litigation, financial and political strategic communication. He has worked in the ABCP niche since 2006. Hendin Consultants is in Toronto and London, UK, and is on the web at www.hendinconsultants.com. Email Ross at ross@hendinconsultants.com.

ABCP and the National Bank: Could the Chairman have been a champion?

By Ross Hendin, Hendin Consultants

Last week we learned through this Globe & Mail article that the National Bank of Canada had $7.8 million worth of ABCP bought back from 48 company insiders, including Louis Vachon, bank CEO - who held $2.54 million of it personally.

The article then made a of point of stating that while National Bank were the first to step up, and buy back the frozen paper from their clients (in what I thought was a terrific PR move), the buyback was limited to individual retail clients and corporate clients with total holdings of $2 million or less who are not considered accredited investors under regulations.

It mentions that "The board said the three executives who had their ABCP repurchased put the money into a trust account so they could work on the issue “without any appearance of conflict of interest.”" - I assume by saying appearance, it means they understand there is a conflict, but they just don't want it to look that way.

I'm following the ABCP story fairly closely, and I had no idea about these little points. It's one thing to have a CEO crusade for the little guy, and yet another when the public and shareholders discover that the CEO is benefiting from "doing the right thing". Now, should Mr. Vachon's holding ABCP personally count as a major negative? Based on this one article, I'd say so. Could this perception have been avoided? Absolutely.

The CEO and leader of the bank was as convinced about the investment's quality as any client would have been, and his demanding a resolution for everyone that the bank has dealt with was a good move on it's own. His reaction is a tricky balance, because some may say that showing the CEO held paper early would have eroded confidence in him as a finance expert, but I disagree totally. If the point of the meltdown is that nobody ever expected the paper to freeze, and the paper had the endorsement of the bank, I'd be more disappointed if the execs in the company steered clear of it than if they held it. Their holding it shows that they believed in the product just as their clients did, and as a spectator, says that they were at least acting in good faith as they sold the notes.

Let's take a moment and now reflect on the Scotiabank / Canaccord lawsuit, which alleges that the Scoita Capital execs were selling their notes even while telling their clients that the notes were safe. An act that, in retrospect, is much more disappointing than finding out that the CEO of National Bank bailed himself and many others out of a tough situation.

I'm more than willing to concede that given all we've learned from the Globe & Mail article, the National Bank of Canada could have been more forthright in their intentions and positions. From a Public Relations perspective, it would have been much more powerful to have their CEO expose his holdings in the paper, saying that he, like their clients, believed that this was safe and that he's going to do whatever he can to protect and save those who - like him - were caught in the fire. This may have undermined him as a financial clairvoyant, but would have made him human and would have shown the country that the bank stood behind what it sold. It would have also shown that the National Bank team “ were people too.”

The lessons to learn here:
1) The bank could have been more forthright, and could have won public support in being forthright.
2) The lack of transparency and the conflict of interest in how they dealt with the buy-back should enrage shareholders, but again, had the PR been done well, it would have boosted positive publicity and perhaps generated more revenue down the road.
3) Contrasting this situation to the Scotia one, it's easy to see where I'll be moving my investment portfolio - from the bank that sells me product they are dumping to a bank that buys the same products I do and then save themselves while saving their clients!

Ross Hendin is CEO of Hendin Consultants, and is a Senior Advisor to the Canadian office of a leading multi-national PR firm. With strategic communication experience in more than 20 countries around the world, Ross specializes in litigation, financial and political strategic communication. He has worked in the ABCP niche since 2006. Hendin Consultants is in Toronto and London, UK, and is on the web at http://www.rsmediacorp.com/. Email Ross at mailto:rhendin@rsmediacorp.com.

Will the Big Banks Step Up Liquidity? - Pre Announcement

Will the banks come through for the Committee, or their shareholders?
By: Ross Hendin, Hendin Consultants

The banks are caught between a rock and a hard place, and it’s one minute to midnight. The issue really focuses now on politics and nothing more. Will the banks bend to the muscle of the Bank of Canada and the Committee, or will they learn a lesson from Jean Coutu and National Bank and protect their shareholders by leaving both their clients and the Bank of Canada to face a potentially massive disaster?

Reasons why the banks would come through for the Committee and provide liquidity would be to repay the favor of the Bank of Canada stepping in with a cash infusion months ago, and to bail out the clients they sold the notes to (just as National Bank did with their clients). This, from an optics and political perspective is the best choice for the banks: its great PR, it pays back favors to the political heavyweights that it needs favors from in time to come, and it allows the banks to position themselves as heroes and then hope that people don’t remember they are a large part of the reason the market is in this situation in the first place.

The main reason why the banks wouldn’t come through for the Committee and provide liquidity is their accountability to their shareholders. Just as Jean Coutu has publicly chastised National Bank for bailing out their clients, so too to CEO’s of the big banks need to justify why they put further funds on the line to try and save the Committee’s structured rescue. At best, shareholders will see this as a needless risk that worked out well, but at worst it puts substantial funds into needless risk – a surefire way to make sure you go from the top of the heap never working on Bay St. again.

This has to be one of the hardest weeks in all of the CEO’s lives, as there is no right answer here. What’s better: paying a favor to the powers that be, or avoiding risk for shareholders and shielding from further exposure to dangerous assets? Either way, a powerful lobby is going to have your job and your reputation at the top of their hit list.

As in so many other places in the world, I’d imagine that CEO’s would be speaking to their spouses, confidants, lawyers and their PR people about this. If I were advising on the right course of action, I would do what’s right for the bank’s clients over anyone else. Canadian’s today have more choice than ever in their retail and commercial needs – HSBC, ING etc. are all going to be able to take advantage of massive fallouts between clients and their “trusted” institutions. Shareholders will see their stocks rebound and then some if the CEO’s are perceived to be concerned about their client’s needs. If they put shareholders first, the negative public sentiment may take a long time to forget. Look at the Exxon Valdeez or the McLibel suit, and compare it to the JetBlue groundings and BP calling themselves “beyond petroleum”.

The best move for a CEO is to put their client’s first, and themselves second. It’s the best way to make sure they maximize PR for the bank and make the Bank of Canada and Mr. Crawford look like heroes – all things that will help make the frown on shareholder faces turn upside down faster.

A CEO that puts their shareholder’s needs today above their client’s needs risks lowering shareholder value tomorrow. The CEO that puts good PR and saving the minority note-holders above the needs of the shareholder today, will see both groups much happier tomorrow.

Caisse under fire over commercial paper

ROBERT MELNBARDIS

Source: Reuters

November 28, 2007 at 1:00 PM EST

MONTREAL — Quebec's public pension fund manager, Caisse de depot et placement, came under fire from opposition politicians Wednesday for taking what may be a multibillion-dollar stake in the troubled nonbank asset-backed commercial paper market.

Henri-Paul Rousseau, chief executive of the Caisse, Canada's largest pension fund, was scheduled to testify before the legislature's finance committee in Quebec City Wednesday afternoon on the extent of its holdings in the $35 billion market for so-called ABCP.

Before his testimony, however, Quebec's two main opposition parties demanded answers from the minority Liberal government on the Caisse's role in the frozen market for ABCP.

Mario Dumont, leader of the Action Democratique du Quebec, accused the government of washing its hands of the ABCP mess.

He criticized Quebec Finance Minister Monique Jerome-Forget for telling the legislature Wednesday that rating agency Standard and Poor's has lauded the government's policy of not intervening in the Caisse's management of investments.

“It's interesting that she cites Standard and Poor's. They said not to buy it -- commercial paper -- and the Caisse has $14 billion of it,” Dumont said.

Daryl Ching, head of Clarity Financial Strategy, which aims to educate corporations and professionals about the ABCP market, said there is plenty of interest in finding out exactly how much ABCP the Caisse holds.

“There have been guesses about their exposure of anywhere between $12 billion and $20 billion,” he said.

“If it's much higher than $13 billion, that'll be a shock to the market,” Ching added.

In Quebec City, Jerome-Forget told the legislature she had communicated with the governor of the Bank of Canada and Canadian Finance Minister Jim Flaherty on the matter, but Quebec would not intervene in the day-to-day management of the Caisse's portfolios.

“It's not that the Caisse has commercial paper, it's what is the quality of that commercial paper,” she said.

Gilles Taillon, finance critic for the ADQ, wanted to know if the Caisse's ABCP holdings could affect the solvency of some $27 billion of public employees' pension funds.

The Caisse, which manages Quebec's public pension and insurance funds, has $237 billion in assets under management.

It is widely believed to have been the biggest investor in that part of the ABCP market that is not run by the country's big banks.

That market faltered badly in August when investors balked at buying the securities because of fears that the assets backing the opaque instruments had hidden exposure to the default-ridden U.S. subprime mortgage market.

The Caisse led other key investors such as National Bank of Canada in signing the Montreal Accord, an agreement by those holding more than 80 per cent of the market to not trade the paper until a workout strategy could be put in place.

The deadline for that workout, which would seek to replace the paper with longer-term debt, is Dec. 14.

www.clarityfinancialstrategy.com

Will the Montreal Accord fly?

FABRICE TAYLOR

From Wednesday's Globe and Mail

November 21, 2007 at 6:22 AM EST

Asked why it wrote down its asset-backed commercial paper by only 8 per cent, Groupe Desjardins told us, among other things, that it thinks the Montreal Accord restructuring effort will succeed.

National Bank, another signatory to the accord, gave its ABCP portfolio a 27-per-cent haircut, and hasn't said that it doubts the outcome of the accord.

You hope it works out for the sake of the investors holding the bag, but the odds don't look particularly good at the moment.

About three-quarters of the $33-billion of third-party ABCP sold to investors is of the synthetic variety, meaning, for example, that the conduits investors put money into are built from various kinds of interest-bearing securities and derivatives like credit default swaps. And almost 60 per cent of the total ABCP is leveraged, meaning through the use of derivatives, there are more assets in a conduit than investors put in money.

Here's the problem, according to people we spoke to: When the conduits entered into swap agreements, their counterparties - typically foreign banks - were essentially given first claim on the assets of the conduits in the event of a problem. If the value of the assets backing up their investment deteriorated, they could place a margin call forcing the conduit (or its sponsor) to add more collateral. Conduits would do this by tapping the capital markets for more money, which would have been possible in normal times. But of course now the markets are not functioning at all and the plan is to morph the commercial paper into 10-year notes with floating interest rates.

Under the circumstances it's a fine idea except for those pesky counterparty agreements in the leveraged conduits: They don't just go away for free.

The only logical trade would have been to ask the counterparties to drop the right to demand more collateral in exchange for not having to provide liquidity, but as it happens the liquidity agreements were so weak that there was effectively no risk of them ever being triggered. The banks weren't going to trade something that had very little risk to them for something that exposed them to great risk.

(The irony of course is that these banks win if credit quality drops but don't suffer if, as has happened, market liquidity dries up, even though the two problems can be closely related.)

With commercial paper, as mentioned, a margin call could be met by issuing more paper (in a normal market). But once converted to floating-rate notes, the situation becomes static: There's no easy way to raise more collateral. So the protection of that margin call disappears. Therefore, there doesn't appear to be any motivation for the foreign banks to play ball, and given that more than half the commercial paper is leveraged, it's hard to see the Montreal Accord succeeding. More...

http://www.clarityfinancialstrategy.com