TD - Standing Proud, Standing Alone - But Why?

By: Ross Hendin, Hendin Consultants

The Globe and Mail contributes an important fact and insight in today's article on the ABCP issue: TD breaks ranks on frozen ABCP. It's an article worth reading.

Standing Proud, Standing Alone

Ed Clark, head of the TD Bank, has signaled that he is going to stand tall on the ABCP issue, and not expose his bank or shareholders to any ABCP risk. As he stood alone and didn't reap the benefits of the ABCP products when they were rolling well, he now stands alone as the one person who is not on the hook to run with the Crawford Committee's request for liquidity. I'm sure both his clients and his shareholders will breathe a sigh of relief. I'm also sure that the other heads of the banks, and the Committee, realize it means more investment and more risk than the other banks want to provide.

TD has been in the best position of all banks, but in saying that this can't be an easy time for any of them. I applaud Mr. Clark for making this choice and having the conviction to do it properly and from the outset while there must be a very strong lobby to have him change course. I can't help but wonder though if this decision has something to do with TD's international posture, even more than their domestic profile...

I still believe that most of the banks probably will sign on to support this accord. It's better to win friends in Ottawa and win the affection of clients than to save a few dollars for shareholders in the short term. Now that there is a potential financial incentive through a truce of lawsuits, what the Committee has offered banks really makes the Accord much more attractive. The banks now have strong legal, PR and financial incentives to risk the money and provide liquidity.
It makes me wonder just how high the risk to the banks really is if they won't sign onto this Accord even with all of these incentives... if the other bank's CEO's are keeping quiet because they know they are heading for litigation and they STILL aren't signing on the dotted line, the market should take note of that. The banks not signing on, combines with the lack of transparency in the Accord's progress, to signal something very bad. It makes me think that there are issues much bigger than the market expects that may come to light if the data room is opened and transparency is given. If that's the case, as I've said before, it's better to face the music now than keep the world in suspense.

Why?

Coming back to why TD would take this stand, the obvious answer is the one I am sure they will give to the market. But nobody has exposed or discussed the new, international element of the ABCP situation, and I think it's a critical insight into this TD decision and what the other banks may do in the days to come.

The world markets and savvy investors have been quietly following the story for months, but the world's major and most respected media are noticing this and giving their readers what they want - a close account of the situation in terms of trading the ABCP, and more and more the political fallout that is coming from the way the situation is being managed in terms of PR (everyone I know agrees that Mr. Crawford is doing nothing short of making miracles, and everyone agrees that if the Accord fails or not, he has done an outstanding job of trying to find the Win-Win situation). The situation is becoming increasingly radioactive by the day. With the world watching, everyone needs to be on their best behavior as they can't get away with what they could have otherwise.

TD has a number of companies outside of Canada that it needs to consider in all of this. TD Asset Management, TD Waterhouse, TD Ameritrade and TD Banknorth are probably the most important ones. There is a TD Waterhouse on High Holborn in London just a block away from an office I used to work in. With TD's global ambitions and the potential for disaster that they have seen and continue to see in the market, steering clear of ABCP may lose TD popularity at home with the other banks, but they no longer need to worry that their clients abroad will hear that they had anything to do with this. They must be concerned with their global image, not just their Canadian image, and that image will look much cleaner if they can take the high road on a looming political and financial disaster.

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.

Does a Second Solution Make Sense at this Point?

By: Daryl Ching, Clarity Financial Strategy

A key issue that everyone is asking about is whether the banks will backstop liquidity for ABCP investors. I commented on this topic in great length on my interview on BNN this morning. Click here to view the interview. Also, my colleague Ross Hendin has provided some insight into this situation on a blog on Friday, December 14. The general conclusion is that it will be very difficult to get the banks to agree to provide this liquidity and there is no certainty that it will be enough to address investor concerns.

The key subject I would like to touch on today is where do we go from here? By no means am I disappointed by the progress that has been made by Crawford's Committee. This is a very difficult restructure and I think we have come a long way. I am however, disappointed by the continued lack of transparency and the unwillingness of the Committee to consider a second option. At this point the Committee owes it to the investors to be more forthcoming. Based on my conversations with various investors, I have concluded that they continue to lack the understanding required to make an informed decision. More education and disclosure is warranted at this moment.

As I have previously mentioned I am extremely sympathetic for the smaller investors who are in dire need of liquidity and have had their business operations negatively impacted by the wait. To put things in perspective, these investors had to report to their board of directors and shareholders in August that they have had their ABCP locked up, but are hopeful for a solution by October. In October, they returned to these meetings stating that progress was being made on a restructure and a solution was imminent in December. Once again, they have to report that another extension has been made, and terms and conditions will be available by January with a completed restructure by March. Further to that, we have received no firm commitment from the big banks to provide backstop liquidity.

While the larger investors that represent the super majority generally have the balance sheet to wait out the restructure, there are many in a position that cannot wait any longer. Crawford Committee's press release does not provide enough information for the investors to make meaningful decisions at this point. This brings me back to the idea of a second solution - an open market. While the big banks that are facing liquidity issues of their own are reluctant to take on any more ABCP exposure, there may be other financial institutions in a better situation that might be more willing.

Rather than constraining the market to several parties, opening up the Data Room will bring more participants to the table. This includes potential buyers of ABCP who are willing wait out the restructure and financial institutions who are willing to provide loans to backstop ABCP.

By no means am I suggesting that the Committee should halt the restructure process. There are certainly investors that have the financial backing to wait this process through and they should continue to work with the Committee. However, there are certainly investors that can't and they deserve a second option. I believe the Committee has a responsibility to provide liquidity today, and that is by providing more transparency and information to the public, so investors have the choice to sell their assets or seek loans from other financial institutions if they choose to do so.

Crawford Committee Extends Standstill Period - Commentary

By: Daryl Ching, Clarity Financial Stratetgy

Crawford's Committee put out a press release this morning at 12:45 AM calling it, "Pan-Canadian Investors Committee Announces Framework for Restructuring of Third-Party ABCP" on Canadian Business Online. Some new information has been presented. I will present the information followed by my commentary.

1) A syndication of a margin funding facility is being put together.

This means the Committee will not be able to waive all mark to market triggers for CDO transactions and will require a facility to post collateral if margin calls are made. An obvious question here is who is in the syndicate group?

2) The standstill period has been extended to January 31, 2008, with a plan to reclose the restructuring by March 14, 2008.

This means the Committee was unsuccessful negotiating an extension to March 2008 as they had hoped. The Committee has 47 days left to get all parties to agree to the terms and conditions of the restructure. It is obvious that various parties are growing impatient and may lay the hammer as early as January 31, causing an event of default and law suits.

3) There will be distinct restructuring solutions for three different types of assets: "(i) ABCP which is supported solely by traditional, unleveraged assets (approx. $3 billion), (ii) ABCP which is supported by leveraged assets, unleveraged synthetic assets or a combination of leveraged and unleveraged assets (approx. $27 billion) and (iii) ABCP which is supported primarily by U.S. subprime assets (approx. $3 billion)."

This is not enough information for investors to make an informed decision about whether this deal makes sense for them or not. I expect to see more information on the jumbo fund and how the assets would be split between senior and junior class notes.

4) In some cases mark-to-market triggers will be replaced by more remote spread loss triggers. However, in cases where mark-to-market triggers cannot be waived, a credit facility will be put in place to post collateral on margin calls.

Investors will need to assess whether the credit facility is large enough to cover the potential risk of margin calls given today's volatile credit envirnoment.

5) The restructured notes will come out with an investment grade rating.

6) The Committee will make a further announcement following agreement on difinitive terms sheet with all key stakeholders. An information package will be circulated to holders of ABCP following such an agreement.

Will we see another announcement prior to all parties agreeing to the terms?

7) The Globe and Mail indicated in a recent article that the big banks have agreed to put up $500 million a piece.

This is good news. Although the smaller investors do not represent a super majority of ABCP holders, there is absolutely nothing more vital right now than providing emergency funding to those participants who are cash strapped and have had their business operations impaired since August. How much of the $2.5 billion from the Big Banks will be used for the credit facility and how much will be provide the emergency liqudity funding for the small investors? How will this money be prioritized and allocated to the investors? Will this be enough to carry the investors through to March 2008?

It appears that great progress is being made by the Committee. Having the big banks step up and provide liquidity is a big success and provides some of the backup required to make this restructure a success. This press release looks and feels like the release back on October 15 when the Committee came out and said that great progress was being made and people should wait a couple more months for a solution. While I am confident that progress is being made and we are further down the road today than back in October, we are now at a critical point, four months after the market disruption where more information needs to become available for investors to make informed decisions about the restructure. Investors will no longer settle for the lack of transparency in the process that has been apparent to date. I expect Crawford's Committee is working through the weekend to come up with more information and I certainly hope that information becomes available as early as next week. I also hope to see more frequent updates on progress as we move forward.

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.

Is There a Future For ABCP?

By: Daryl Ching, Clarity Financial Strategy

I spoke on BNN this morning to give an update on the Crawford Committee deadline. Click here to watch the interview. Further to my comments I wanted to add more commentary.

The outcome of the non-bank ABCP restructure for the $35 billion of frozen assets will have a significant impact on the ABCP market going forward. Despite the fact that this represents only one quarter of the total ABCP market in Canada, if investors take losses, they may shy away from the ABCP investments altogether. The news that we are hearing is that progress is being made by the Crawford Committee with the restructure of Skeena Trust, the jumbo fund with senior and junior notes and a positive outlook on getting the standstill period extended to March 2008.

While this is good news for the large ABCP investors who can wait out the restructure, this does not help the smaller investors who are cash strapped and cannot wait any longer for the restructure. The smaller investors have expressed frustration, not having a seat at the table through the negotiation process. The money they expected to get paid in August has hindered their ability to continue normal business operations, they feel they have been left in the dark with little transparency on progress and they find it tough to sell their assets, as information on the assets is not being released to the public. In my mind, despite representing the minority, there is nothing more imperative than providing some liquidity relief to small investors who cannot wait out the restructure any longer. I certainly hope that since Crawford's Committee has decided not to release the information to facilitate a secondary market, that they have a plan in their proposal to provide some form of liquidity to the smaller investors who are in dire need, and I hope this becomes available immediately. I also hope to see more transparency and more frequent updates from the Committee going forward.

So the big question is will the ABCP market collapse? My response is that the ABCP market is too important to fail for many reasons. The ABCP market is approximately $120 billion in Canada, which represents the largest portion of the non-government short-term money. There is more ABCP outstanding than Banker's Acceptances and corporate commercial paper combined. While I can point out that ABCP represents a neat alternative investment for a higher pickup in yield than GICs, it is more important to note that many large companies across the country rely on securitization is a key source of funding. The Big 3 auto companies, credit card companies, mortgage companies and others rely on ABCP as their largest source of capital. If the ABCP market went away, you would have many large companies scrambling to find a new source of funding that will likely come less efficiently and at a higher cost, passing on higher prices and interest rates to consumers.

There is no question that market participants have made mistakes in this industry, and we are paying dearly for them. However, this is an opportunity for us to learn from our mistakes and make it right. There are two fundamental changes that must occur to revive the industry: 1) Market participants must increase transparency and make a concerted effort to educate the investors and 2) Investors must do their homework. If investors want a pick up on yield on their investments, they cannot rely solely on the rating agencies and they should only be considered opinions. It will be up to the investors to seek the required expertise, establish their own criteria for how they get comfortable with the assets and set up a platform to do monthly due diligence and analysis.

Is there a need for further regulation? I don't think more regulation is answer to our problems in this case. I think investors will get smarter, demand more information and do their analysis. Industry participants will realize that they need to provide more transparency. With the work required to analyze the assets, this may mean that we see less investors, but they will become more sophisticated. On August 13, the market disruption was caused by panic from investors who did not understand the assets and found out the they had exposure to subprime. It should be noted that there is good quality and bad quality subprime assets. The earlier vintages of subprime had no teaser rates, minimum down payments, respectable credit scores from the borrowers and low delinquency and default rates. Mortgage underwriting became more aggressive in 2005 and 2006 with the low teaser rates and no down payments. If investors were sophisticated and understood this, there would not have been a mass exodus on the entire non-bank ABCP market and investors would have continued to roll the trusts that had good quality assets.

As an indiviudal who has invested so many years in this industry, I feel a personal responsibility to help revive the securitization market. I will do whatever I can to push for more transparency from conduit sponsors and provide education to participants who need to get up the curve. I believe this will level the playing field, where all participants in the market will receive consistent information and there will no longer be any investors at a disadvantage.

Daryl Ching

ABCP Proposal to Offer Range of Losses - Commentary

By: Daryl Ching, Clarity Financial Strategy

Jacquie McNish and Boyd Erman wrote an article in the Globe and Mail today titled ABCP Proposal to Offer Range of Losses. The story reveals that recovery rates for the trusts range anywhere from about 50% for Apsley Trust to close to par for other higher quality trusts. While the Crawford Committee is still trying to win sufficient support to extend the standstill agreement until March 2008, they announced that they have Deutsche Bank AG on side, a party that is believed to be counterparty to half of the $25 billion of CDO transactions. The Committee revealed that although it has completed its assessment of the current value of the ABCP, it does not plan to release the information until the new year. The most interesting piece of news is that the plan calls for investors to swap their ABCP for two classes of notes that will be ranked senior or junior. Investors whose ABCP is backed by assets with higher market value will receive a higher portion of senior notes and those with harder hit assets will take more junior notes. The Committee has approached the banks to underwrite a market for these notes but they have not heard back from the banks.

While it appears the Committee is still struggling to get all parties to agree to an extension of the standstill period, getting Deutsche Bank AG on side is an important development. With the credit default swaps under water in today’s credit environment, the foreign banks who are swap counterparties to the CDO transactions can lay the hammer by making a margin call. In an environment where ABCP cannot be issued, this would result in an event of default and a firesale of the assets. It is relief to know that the Committee has Deutsche Bank’s support. I am confident that the Committee will round up the support required to continue the standstill period in order to continue the restructure into spring.

My interpretation of how the restructure will work is that the Committee will create a jumbo fund by amalgamating all the assets of all the trusts, with the exception of Skeena Trust that has been restructured separately. All the assets will be placed into two categories based on credit quality – senior and junior. The Committee will look at each trust and determine which assets belong in which category and assign notes accordingly to each investor. It is likely that the junior notes will be subordinate to the senior notes and take first losses.

This plan has its advantages and its disadvantages. Generally, investors will be better off, as all the assets will be pooled together to form greater diversification. However, this simplified approach also has its disadvantages and raises a lot of questions. Can we really separate all the assets into two categories? How will they be separated? Is a leveraged super senior corporate CDO that is levered five times in the same bucket as a CDO levered 40 times? Do all traditional securitization assets get thrown into senior? Does that mean that Canadian subprime mortgages are in the same bucket as a bank’s line of credits? What I am trying to get at here is that investors who bought very high quality trusts may receive more senior notes, but their assets may still be diluted with poorer quality assets. In the long run, some will be better off with this plan and others will be worse off.

I applaud Mr. Crawford’s committee for the progress made thus far. It appears they have had several successes including the restructure of Skeena Trust, the extension of the standstill period until now and a plan that may receive super majority support. Having said that, it would still be prudent for investors to fully understand the implications of this plan before signing on to the agreement. My opinion is that the assets cannot simply be sliced into two categories – good and bad. The complexities warrant more categories if we hope to have a more equitable outcome for all investors.

Finally, as the Committee has decided not to release any more information on the assets to facilitate a secondary market until the new year, I certainly hope that they provide some relief in the form of liquidity in the interim to investors who cannot wait until the spring to get some cash back.

Daryl Ching

Skeena Fix Not So Easy, After All - commentary

By: Daryl Ching, Clarity Financial Strategy

Boyd Erman of the Globe and Mail published an article about the progress of the ABCP restructuring. He indicated that Skeena Trust, a trust sponsored by Edenbrook Hill Capital and Dundee Securities Corp., which the public widely believed would be restructured in short order with full recovery on principal and accrued interest, could still lose two cents to the dollar. It is being restructured into a 9-year bond issued by White Knight Investment Trust. Skeena Trust is comprised of six leveraged super senior CDO transactions, some of which have been levered over 40 times. The Globe indicates that the haircut is due to further deterioration in the credit markets and the "banks squabbled over which would absorb losses and take on risks as part of the conversion of the trust's derivative assets to more stable contracts."

This is an indication that the market is not willing to pay par for exposure to CDOs. With respect to leveraged super senior transactions that reference credit default swaps, it can easily be assumed that the reference portfolio of corporate names is worth less today in our current credit environment than it was when these transactions were first originated. This sets a precendent for all other trusts with leveraged super senior CDOs.

Despite the deterioration in the credit market, the CDO transactions would have been fine with a functioning ABCP market. Many of these CDO transactions have "mark to market triggers", in which investors would have to post collateral if there was deterioration in the value of the credit default swaps. Like putting up more cash for a margin call when you buy stocks, investors would have simply issued more commercial paper and posted cash. The only impact this would have had on investors would have been a compression in yield due to a lower leverage factor, similar to the fact that you would receive a lower return on your stocks. However, in today's credit environment where ABCP cannot be issued, investors would have to find other ways to post collateral if a margin call is made. This would result in additional exposure to the assets, and this environment, investors are reluctant to take on any more exposure than they have to. Like the stock market, if investors are unable to post collateral on a margin call, the foreign banks have the right to sell the credit default swaps in the open market, make themselves whole and return whatever is left to the investors.

It is interesting to note that White Knight Investment Trust is not subject to any collateral calls by the banks. The banks that provided backup liquidity to Skeena Trust include Bank of Nova Scotia, ABN Amro Bank NV and HSBC Holdings PLC. However, there are only two swap counterparties in relation to the transactions. While the swap counterparties would likely be willing to waive margin calls if they themselves were investors, they would not be incented to waive margin calls for other investors involved without some form of compensation. It can be assumed that a haircut of the accrued interest and some principal (2 cents to the dollar) was required in order to negotiate the waiver of the margin call. However, it is great news that the margin calls have been successfully waived and the investors no longer need to worry about posting collateral for a mark to market trigger. Despite the loss of two cents in principal, I commend Mr. Crawford's committee for the successful restructure of Skeena Trust.

It is also interesting to note that the ABCP will be converted into new bonds issued by "White Knight Investment Trust" and will be rated AAA by Standard and Poor's and DBRS. This gives us a new piece of information about the restructure. It seems likely that the restructured notes will come in the form of a bond offering with at least two ratings. This should not come as a surprise, as investors will take more comfort in a second opinion from another rating agency. ABCP trusts in the US and Europe have at least two ratings. I anticipate we will start seeing at least two ratings on all ABCP trusts going forward, as one of the structural changes to the securitization industry in Canada.

This news confirms that the ABCP restructure continues to remain a great challenge for the Crawford Committee. It is also unfortunate that a precedent has been set that it will very difficult to obtain par on the new bond offerings. It is now more important than ever, that buyers and sellers seek the expertise required to get comfortable with the valuation of the assets before making any decisions to trade. However, there is light at the end of the tunnel, and hopefully this sets a precedent more successful restructures to come.

Daryl Ching