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...
