The Optics Of Answers: Where are you going for your advice?

By: Ross Hendin, Hendin Consultants

In one of my first blog entries for Clarity, I pointed to the Canaccord / Scotia lawsuit, and said that as all the parties in this mess start to draw their lines in the sand, so too should they remember that PR - now more than ever - will play a critical role. Litigation communication is critical because without presenting your position and case properly, and without thinking through how your lawsuit will look, you risk your reputation and credibility.

I’ve had some positive feedback about this point, as many people want to seek the compensation they feel they deserve, but they want to do it in a way where they are positioned as “the good guys”. I have also had feedback from people who feel that while litigation PR is all very nice and good, it doesn’t solve the problem that the dealers who sold the notes (i.e. Canaccord and other banks) are the experts that the noteholders are sending their questions to. The noteholders, en masse, believe that the dealers are the right people to answer their technical questions and as such are working very hard to be in touch with them on their issues.

This is the ABCP equivalent of buying a car at a dealership, and going back to your salesperson when there is a problem with it. What would they tell you? “Nobody cares more about you than I do, and nobody wants to see you happier. The car isn’t made here; I know everything about the product but can’t tell you what’s wrong with it, and I can’t fix it. If you want it fixed you can take it to a place that specializes in fixing these things. Have a nice day and think of me when you need another car.”

Noteholders should remember that while the dealers are friends right now, things may change if the restructure doesn’t go according to plan. They may be the first people to get sued by the noteholders, who were told that the investments were short term and safe. The dealers may in turn sue the banks because they didn’t do their own diligence on the notes, and in so doing, will risk looking like they didn’t do homework before selling a product to their clients. Let’s be clear here, unless a dealer is giving the noteholders their money back, like National bank, they are in a difficult situation optically. They need to stay the friends of the noteholders now, knowing full well there could be litigation down the road, and knowing that while they have a strong knowledge of the notes, they aren’t the experts who built and stand behind the product.

Noteholders walked into a dealership, and bought a car they thought was a great bargain. The noteholders, and the dealers selling the product, didn’t look under the hood properly to check the mechanics. As a result, the salespeople are getting calls from customers with questions about engines, drivetrains and spark-plugs when their working knowledge really extends to horsepower, options, colors and lease rates.

Even though the dealers look like the logical place to seek advice now, they may not be. To me, it looks like Canaccord and other have showed the market that dealers may not be experts and may not know the product as well as the analysts that structured them.

ANNOUNCEMENT - Clarity Financial Strategy appoints John Sokic as Partner

TORONTO -- Clarity Financial Strategy (“CFS”) is pleased to announce that as a result of growing market interest in the ABCP restructure proposal that Mr. Crawford's Committee will be informing noteholders about later this month, John Sokic has joined CFS as a Partner in the firm’s ABCP Consulting arm.

With over seven years of structured finance experience at TD Securities and Coventree, John has forged an expert understanding of CDO transactions and other alternative asset classes. John has analyzed and structured deals worth over $8 billion, and is regarded in the industry as a leading analyst, deal-maker, negotiator and portfolio manager. John has directed analytical modeling, interfaced with banks and clients, and managed investment oversight functions in order to leverage investment opportunities.

In his current role with CFS, John will consult for clients affected by the ABCP situation. He will provide insight and assessment on the restructured notes.

John has a Bachelor of Commerce degree from the University of Toronto. He also holds the Chartered Financial Analyst (CFA) Designation.

Increasingly, noteholders, dealers and potential purchasers are looking to better understand the products and the implications of the restructure currently underway. While many noteholders turn to the banks that sold them the paper for a better understanding of the product, many are seeing the value of turning to specialists who were directly involved in structuring the assets. Further to that, CFS is independent and free of conflicts of interest.

DARYL CHING, Managing Partner: "ABCP experts and savvy noteholders know that the Crawford Committee is keeping things very quiet before their upcoming road show. With John joining the team, we are now more ready than ever to help noteholders make sense of the proposal and decide what's in their best interests."

DARYL CHING: "The ABCP market is very savvy. They know the product and now demand a very specialised skill-set to help them make an informed decision on the proposal. CFS intends to provide a supplementary opinion to corporations to help support their decisions. Their Board of Directors and shareholders will be pleased that they sought a second opinion before making such an important decision. John's expertise will give our clients the edge they need to make the right, independent decisions ahead of the curve."

JOHN SOKIC, Partner: "The current state of the market is such where even people with above-average knowledge of the product are left shaking their heads. They are smart, but the lack of information and time they will have to analyse the new products before voting on them is raising concerns. I am looking forward to working with CFS’s clients and helping them to make sense of the products they have."

Clarity Financial Strategy Inc. is a Toronto-based consulting firm founded by Daryl Ching. CFS is focused on providing insight and recommendations on the ABCP situation, is particularly outspoken in defence of noteholders in the ABCP restructure, and has clients both from Canada and abroad. For further enquiries please contact CFS Managing Director DARYL CHING (416) 505 7467 ###

Is the Canadian ABCP Market dead?

By: Daryl Ching, Clarity Financial Strategy

With the recent debacle, investor perception of all ABCP is probably equivalent to that of junk bonds. Corporate treasurers and CFOs who are receiving pressure from their boards or even worse, have lost their jobs may never return to the market to purchase these investments again.

Boyd Erman of the Globe and Mail recently published a blog, "What's left of Canada's ABCP market is holding up as U.S. meltdown continues?". Not including the $33 billion of frozen assets, there is still $80 billion of ABCP outstanding that continues to roll, down only 7% from its peak in August. As of December 19, the ABCP market in the US had plunged 36% from its peak. Most of the ABCP was issued by Structured Investment Vehicles (SIVs) that issued short-term commercial paper and purchased higher yielding long-term assets. We have learned that the SIVs in the US had massive exposure to the $1.3 billion US residential subprime market. As a result, US banks have bailed out their conduits by taking assets back on their balance sheet in a large way.

Canada is a very different story. Even the majority of the $33 billion of frozen assets are of good quality, but that is not the focus of this piece today. Due to the noise and loss of investor confidence created by the recent debacle, the bank ABCP conduits continue to trade at premiums today, roughly 50-60 bps higher that August. According to DBRS, while the non-bank ABCP conduits had 78.8% exposure to CDOs and 8.2% exposure to US subprime (there is overlap of 5.7% between these two asset classes), the $80 billion ABCP market that is generally sponsored by large banks has 3.4% exposure to CDOs and no exposure to US subprime assets at all.

For the first time in twenty years since the origination of the Canadian ABCP market, we are seeing some unprecedented events:

1) A market disruption actually happened, liquidity protocols and structures to the test that have only had theoretical constructs up to this point.

2) The first ABCP conduit was downgraded by DBRS – Apsley Trust.

3) More scrutiny from the government: The Bank of Canada and the federal government are getting involved influencing the ABCP restructure as well as calling for a national securities regulator. The Ontario Securities Commission is demanding more disclosure from the big banks for their ABCP conduits. The Canadian Securities Administrators announced that they are exercising more scrutiny on financial reporting of ABCP exposure.

4) ABCP conduits have moved from the traditional General Market Disruption liquidity protocol to Global Style Liquidity.

5) US rating agencies are coming north: RBC Capital Markets and Scotia Capital have announced that they have added a Moody’s rating to all their ABCP conduits. Deutsche Bank launched a new conduit, Okanagan Funding Trust, the first Canadian ABCP conduit to be rated by S&P.

Now back to my original question – will the ABCP market die? Quite simply put, the ABCP market is far too important as a funding source for corporations to fail. What we are seeing is massive correction in methodologies and pricing. Investors need to reevaluate the risk and return and decide if they ever want to return to this market. With more rating agencies providing an opinion, we may see new entrants. The Canadian Pension Plan Investment Board (CPPIB) recently announced that it has purchased $6 billion of bank ABCP.

When the dust settles, I believe we will see the following changes:

1) All ABCP conduits will have at least two ratings.

2) With the additional costs of rating agencies and the capital required for global style liquidity, corporations should expect their cost of funds for securitization facilities to rise, which ultimately will result in higher borrowing costs for consumers.

3) To fill the void of short-term ABCP, new types of products will be originated, possibly medium-term notes, asset-backed securities bonds or unrated securitization products.

4) Interest on ABCP will probably remain higher than the extremely low levels experienced prior to August.

5) We will probably not see any CDOs or structured products originated for quite some time and the ABCP market will be predominantly conservative traditional securitizations structures.

6) Most importantly, there will be more transparency and investors who purchase ABCP will need to figure out how to model these transactions to make themselves comfortable that they do in fact possess the risk characteristics that they are comfortable with.

How will the ABCP Restructuring affect Smaller Investors?

By: John Sokic, Clarity Financial Strategy

The Crawford Committee should be applauded for their efforts in preventing a fire sale of the assets within the ABCP trusts in Canada. While the traditional receivable tranche and subprime tranche will remain straight forward with investors holding on to the same assets as they had originally purchased, the amalgamation of the synthetic CDOs raises some concerns. Instead of investors receiving some discounted value of their original investment, many will be scratching their heads now, wondering what it is they are left with after the restructuring.

Mark-to-Market triggers on the CDO deals were the single largest hurdle to a successful restructure. In order to morph these triggers into something that would work going forward, much has been sacrificed in the way of simplicity and liquidity. Ostensibly, this is the opposite of the committee’s objective.

Pooling the CDOs together creates what is known in the industry as a CDO squared. We now have a giant CDO that references a pool of other CDOs. We have replaced some of the leverage that resided in mark to market risk with internal or credit risk that every investor will now share. So, we have a strange and unprecedented instrument emerging here that neither current nor prospective investors will be able to easily handle. Hence we face more complexity, less transparency, and ultimately, even less liquidity.

Less liquidity? How can that have happened? Well, it is in the interest of the largest investors. These holders have the ability to place the assets on their long-term books to hold until maturity. The Crawford committee has stated they expect that, should investors hold until maturity, they will receive as close to par as possible. How many small investors could actually wait for maturity? It seems this solution works to the benefit of large investors and to the detriment of smaller ones.

As a result of the additional complexity, prospective buyers of the new notes will take more time to digest this information and may ultimately demand a deeper discount upon purchase. Potential buyers that were planning to hedge the risk will have a more difficult time doing so. It seems likely that smaller investors will be in a bleak position when the secondary market for the restructured notes eventually opens up. Were I in their position, I would be doing everything I can to understand these assets and get prepared to negotiate for the highest possible price for my holdings. Prior to January 31 when the proposals are expected be sent out for a vote, it is in the best interest for current investors to seek a second opinion and perform their own valuation before deciding to sign on.

Issues for investors to keep in mind as the deadline approaches

By: Daryl Ching, Clarity Financial Strategy

As we move closer and closer to the standstill deadline of January 31, there are some important outstanding issues that all participants need to keep in mind.

1) How are we going to address administration? Currently all the conduit sponsors continue to administer their own assets - this includes wire payments, collecting from traditional receivable clients, investing collateral, resetting swaps, monitoring events of termination, and the list goes on. Essentially, these are necessary functions to keep the cash flowing in and out of the system, and to maximize recovery value on the assets. Can it be expected that all the non-bank sponsors will stay solvent for 7-10 years just to perform this function? Coventree recently announced in a press release that they will be closing their Capital Markets business unit and that there can be no assurance that Coventree's revenue will continue to be sufficient to cover the costs of continuing to support the restructuring efforts.

From an administration perspective, the economics really only make sense for one party to take over the entire $33 billion portfolio. As Coventree currently administers the majority of the assets, they would be the most practical choice, as it would be the most seamless transition. The other alternatives would include selecting another non-bank conduit sponsor or appointing a completely new administrator. The administrator will be paid a fee, likely in the range of 5 to 10 bps to perform this function. However, it is an important aspect of the restructure and we need to understand how this will be addressed by the Committee.

2) Bush's plan to freeze subprime mortgage rates for five years will have a direct impact on the subprime assets and an indirect impact on all other assets. While this plan has been met with a great deal of criticism, it might actually be of benefit for the ABCP noteholders. To the extent this plan actually delays defaults, noteholders with shorter term assets will stand to benefit. ABCP noteholders in all tranches should be watching this plan closely, as defaults in the subprime sector will also have an impact on corporate risk.

3) In a recent press release, Strategem Capital announced it will take another writedown of its asset-backed commercial paper holdings and warns it may not be able to make distributions if a new March restructuring deadline isn't met. Strategem Capital has been conservative writing down the ABCP 40% and potentially increasing that writedown to 45%.

I get the impression from conversations with various investors and press releases that investors expect to receive all their money back on March 2008. Let's keep in mind that when the restructure is complete and prospectus-like disclosure becomes available, it will still take time for potential buyers to digest all the information, run their analysis and make a bid - potentially months. If they choose to hire experts in the industry to provide clarity, this time can be cut much shorter. However, potential sellers of the new notes need to keep a couple of things in mind: they should not expect to sell as soon as the restructure is complete unless they are willing to take a deeper discount and the secondary market may price the new notes below JP Morgan's valuations. From a buyer perspective, the assets have been tainted as distressed assets, and the market perception will likely be that buyers need to earn a premium to purchase these notes, even if they are investment grade.

Yet another reason for transparency - JP Morgan identifed as mystery banker

By: Daryl Ching, Clarity Financial Strategy

For those of you who just got back from holidays and are catching up on the ABCP story, there was an interesting development last week. During Mr. Crawford's conference call on December 24, he announced that a foreign bank would be willing to step in with approximately $2 billion to top up the required amount for the margin facility in the event that we have a shortfall from the Canadian banks. At that time, the Committee refused to identify the banker. The Financial Times named this mystery banker as JP Morgan in an article written by Bernard Simon on December 26. (Click on links to view articles) The Star, National Post and the Globe and Mail were able to confirm this and wrote articles on this topic last week as well.

For those of you who are interested in the commentary on the restructure proposal released on December 23, feel free to watch my interview on BNN last week or visit my previous blog entry for a recap.

With the lack of transparency from the Committee, all measures should be taken to avoid any conflict of interest. JP Morgan, the sole financial advisor with access to the Data Room is in the best position to negotiate the best deal for the investors. When negotiating credit facilities, rating agencies and bank counterparties will always ask for as much credit enhancement as they can get, as more credit enhancement only improves the quality of the rating and the credit position of the bank counterparties. The role of the financial advisor is to act as an intermediary, and structure a transaction that addresses these concerns with a reasonable amount of credit enhancement, that also takes into account the needs of the investors. While a larger margin facility provides more protection, this also results in higher fees, which ultimately results in greater costs to the investors. If JP Morgan stands to earn $32 million / year ($2 billion at 160 bps) on the margin facility, this begs the question about whether there should be more scrutiny in this process.

The Committee indicated on a conference call that with the new spread loss triggers, the chance of a draw on the margin facility will be very remote. If that is the case, 160 bps is a very lucrative standby fee. For clarification, this is only a standby fee. If a margin call is made and the facility actually gets drawn, I anticipate the drawn fee will be based on the Prime Rate, but the Committee has not disclosed this rate as of yet. To put things into perspective, General Market Disruption liquidity facilities, which were considered remote risk, in a functioning ABCP market were previously priced between 10-15 bps. I believe the high spread is a result of two factors: 1) Not enough transparency - for the same reason that we are not seeing bids from potential buyers of ABCP for more than 50 or 60 cents to the dollar, banks are being asked to participate in the margin facility with very little information, 2) The Committee has asked parties to participate that are reluctant to do so, because they are already overexposed to ABCP, have liquidity problems of their own and have a gun to their heads from shareholders not to take any more, like the big banks in Canada. I suspect that opening up the Data Room would bring more financial institutions to the table, if they have the ability to assess for themselves, the risk on the margin facility, especially if JP Morgan has already made themselves comfortable to step in.

Other than JP Morgan, are there any other parties at the table that can determine if $14 billion is a reasonable amount for a margin facility or if 160 bps is fair? Unfortunately, with the exception of the financial advisor, I have reason to believe that the participants in the industry who have the skills to assess this do not have access to the Data Room. JP Morgan holds all the cards in this negotiation process and no second opinion will be offered. Furthermore, by the time, we all have access to the data, terms and conditions will likely have been finalized by the Committee by approval of the super majority of the trusts. Let's not forget that some of the large institutional investors like La Caisse de Dépôt et Placement du Québec and Desjardins Financial Group have a considerable amount of voting power with their holdings, are self-funding the margin facility and do not even need to worry about the margin facility fee.

This is the reality and I have come to accept the fact that negotiations will continue to take place in a vacuum. I have also come to the realization that super majority approval for most of the trusts can be can be reached by a small concentration of investors. Therefore, JP Morgan has a fundamental responsibility to remain in a position where a conflict will never come into question with a role as important as the sole financial advisor, especially with closed door negotiations. The next step is for the Committee to be more forthcoming with information in order to welcome other institutions to the table. This may even result in lower fees than 160 bps. While we would all like to see a deal get done, I would still like to see a properly negotiated transaction with sufficient credit enhancement to protect the bank counterparties, but at the same time, creating the best value for the investors, by minimizing the costs, which will minimize their losses. Unfortunately, we will not know how well the deal is structured until the data comes out. For now, we have to rely on what we are being told by the Committee, which is not very much.