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Thursday, September 27, 2007 8:43 PM

Global Credit Crisis Canadian Style

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An ABCP Asset Backed Commercial Paper Crisis is Brewing in Canada.

"It's a made-in-Canada problem," said Claude Lamoureux, head of Ontario Teachers' Pension Plan. Many people in the market "didn't know or didn't ask questions" because they were making more profits than elsewhere, he added.

The Canadian ABCP market attracted a flood of foreign financial institutions such as Barclays Bank and Deutsche Bank, who exploited the gaps in the Canadian ABCP rules to make big profits at lower risk to themselves, sources said.

By June this year, Canada's ABCP market was about 10% of the size of the market in the United States, although the overall U.S. financial system is proportionately far larger than Canada's.

When concerns surfaced in August about the underlying assets in ABCP -- many of which have included troubled mortgage loans in the U.S. -- some owners of ABCP were caught off guard. Owners of ABCP were under the belief that they could convert it to cash or another similar product at the end of 30 or 60 days but instead were left holding the product.

Canadian investment bank Coventree Capital Inc. became one of the first major victims of the global credit crunch when it was unable to trade the ABCP it was holding because of the general seizing up of credit markets around the world.

Following Coventree's collapse, Canadian non-bank owners of $40-billion of troubled asset-backed commercial paper -- pension funds and corporate treasury departments -- were forced into an unprecedented joining-of-forces known as the Montreal Accord to try to salvage their holdings.
One of the big players in the crisis is Caisse, the Québec pension plan. GlobeAndMail is reporting ABCP credit crisis spells big trouble for Caisse.
Controversy comes by way of reports that the Caisse holds between $13-billion and $20-billion of the $35-billion in now illiquid non-bank asset-backed commercial paper (ABCP) gathering mould in Canadian accounts.

The Caisse has total assets under management of close to $240-billion, but its reporting requirements do not cover all of that amount. What's more, if a viable secondary market emerges for the converted paper, the Caisse could conceivably have a good chunk of the investments off its books by year-end. That may not protect the Caisse from taking a hit, but trading losses on investments bought and sold during the calendar year don't show up on the annual statement.
Rescue Plan on the Ropes

An agreement between some of the players to convert short term debt to long term debt as the solution to the crisis is now on the ropes as a Stalemate threatens the Montreal rescue plan.
With the deadline for an agreement less than a month away, hopes of success for a plan to rescue about $40-billion of illiquid asset-backed commercial paper are growing steadily dimmer, sources say.

Under the so-called Montreal proposal, the frozen commercial paper would be converted into longer-term floating-rate notes, thereby providing holders with a way to get their money back. But now the major banks and investors behind the plan are finding their progress slowed and even blocked by hurdles they never imagined when the plan was launched in August.

The Montreal proposal was launched on Aug. 16, three days after the non-bank sponsored ABCP market was hit by contagion from the subprime mortgage crisis in the United States, triggering a string of default warnings from issuers.

The plan was spearheaded by pension giant Caisse de depot et placement du Quebec supported by nine other banks and financial institutions that participated in the market. That group was later joined by a committee of investors chaired by Osler, Hoskin & Harcourt lawyer Purdy Crawford that will oversee the restructuring.

The trouble is, everyone is serving a different agenda.

"The question becomes, will everyone play along," said Mario Mendonca, an analyst at Genuity Capital Markets. "But that's a hard one to answer. We are in uncharted territory. [The proposal backers] are making this up as they go along."

Meanwhile, uncertainty over the future of the frozen $40-billion ABCP is spilling over into the rest of the credit market in Canada, driving down demand and forcing companies to cancel projects because of the soaring costs of funding.
A workout at this stage appears to be a pipe dream.
The legal complexities facing Purdy Crawford and the committee that has been struck to solve the crisis is daunting. It's folly to think it can be done in 60 days.

Workouts like Stelco and Air Canada involved a single corporate empire. The third-party ABCP workout resembles a Cecil B. DeMille film, with a cast of thousands. One lawyer notes there could be as many as 40 trust structures alone, each of which has a weighty trust indenture that must be reviewed, and assets that must be dissected before anyone knows their legal options.

Toss into the mix those who issued the paper, those who created the investment conduits, those who provided liquidity, the SWOP providers, and dozens of companies holding suspect notes and it makes a highly volatile situation. And the information void: After almost 60 days, most noteholders don't know what they're holding.

The committee has to figure out how to turn short-term notes into mid-or long-term floating rate notes and do it with little pain. But many lawyers say it's likely someone will have to take a haircut and the question is:Who will it be?

Don't look to corporate Canada to bear that burden. Most have retained counsel and some of them are getting pretty itchy at the trigger. They didn't buy long-term paper and they have financial obligations of their own. Some have raised capital to build mines and expand operations. They likely signed contracts with suppliers who will shortly be demanding payment to start projects and will sue for breach of contract.

The problem is that the noteholders are subject to the trust indentures, preventing lawsuits. Hence, handcuffed. Far worse, it's trustees who control the litigation process under the trust indentures. Right now they're laying very low. Moreover, if a trustee were to launch some type of enforcement action, it would trigger defaults of the derivative assets in the paper and then it's a nuclear bomb scenario.

Where are the mining companies, the paper companies and the mineral companies that were sold this stuff ? They're not at the table. Makes you wonder who is being set up to take the haircut?
Canadian Credit Crisis in a nutshell
  • $40-billion in ABCP is frozen.
  • The Québec Pension Plan (Caisse) and the Ontario Teachers' Pension Plan are on the hook as are 40 other trustholders, mining companies, paper companies, etc all of which thought they were buying short term easily marketable notes.
  • What they were really buying was toxic waste from troubled mortgage loans in the U.S.
  • A workout plan called the Montreal Accord was originated by Caisse. The proposed solution was to convert short term debt to long term debt some of which stretches out all the way to 2015, just to break even.
  • While this may suit the needs of Caisse, some companies need money now to fund mine operations and the like. Those companies do not want their money tied up for years.
  • "Most noteholders [still] don't know what they're holding."
  • Uncertainty over the frozen $40-billion ABCP is spilling over into the rest of the credit market in Canada, driving down demand and forcing companies to cancel projects because of the soaring costs of funding.
Mike Shedlock / Mish

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