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ABCP restructuring: Razzle-dazzle

Thomas Watson

May 12, 2008

Canaccord Capital can’t seem to do the right thing these days — even when it tries.

Less than a week after the embattled Vancouver investment firm received kudos for offering to buy back toxic investments sold under questionable conditions to retail and business clients last year, it was under fire for misleading the market over the state of its balance sheet.

Thanks to global fears over U.S. sub-prime mortgage assets, at least 1,800 average Canadians were caught holding potentially worthless debt instruments last August, when the supposedly liquid $32-billion market for so-called non-bank asset-backed commercial paper (ABCP) turned to ice.

The individuals in question collectively invested hundreds of millions of dollars, expecting to earn a relatively decent rate of return on short-term and highly liquid financial products that were frequently compared to GICs. Canaccord was not the only seller of ABCP to retail buyers, but it was the largest, and it has been repeatedly accused of misrepresenting the risks associated with the paper.

In one e-mail obtained by Canadian Business, a Canaccord investment adviser told a conservative client that ABCP notes were “fully secured. So no worries.” When defending itself last September, the firm said it relied on the high credit rating given to the ABCP and insisted it had no legal obligation to reimburse anyone. When hit with an investor lawsuit in December, Canaccord alleged Scotia Capital aggressively pushed the paper on the brokerage while failing to warn it of the risks involved.

Nevertheless, on April 9, Canaccord announced a relief program that will see it pay $138 million to buy back ABCP at 100% on the dollar (plus interest) from clients with $1 million or less invested in the toxic paper. The program is contingent on approval of a market restructuring (slated at press time to be put to a vote on April 25) developed under the Companies’ Creditors Arrangement Act, which aims to turn ABCP into long-term bonds. If the CCAA plan is approved, investors should get a considerable portion of their money back over a 10-year period — or when stability returns to the market. If the restructuring fails, retail and corporate holders, along with pension funds and ABCP brokers like Canaccord, could lose everything invested.

Earlier this year, retail investors attacked the CCAA efforts when details were outlined by Bay Street lawyer Purdy Crawford, the restructuring committee chairman, during a cross-country roadshow. But Canaccord’s move to appease retail investors, which has now been matched by Credential Securities Inc., greatly increased the odds for creditor approval.

Canaccord’s larger note holders, along with corporate clients of National Bank and other ABCP dealers, are now angrier than ever since they have more money at stake than retail players. But this camp lacks the voting strength held by the smaller investors who successfully joined forces to fight for their money using the Facebook social network. The bigger ABCP holders still hope to delay the vote and want the court to empower them to block any deal they don’t support as a separate class of investors. But retail investors, including about 97% of Canaccord’s clients, are now expected to sign away the right to sue ABCP dealers and sponsors by supporting the restructuring plan. And that helps explain why Canaccord’s stock surged almost 10% after the program was made public.

On April 14, however, Canaccord announced a new $60-million share issue. And that bought-deal financing surprised the Street since Canaccord said it did not need additional capital when announcing the ABCP relief program — despite the $54.2-million pretax hit that it will take as a result of the client bailout.

Canaccord did not return requests for comment. But when the share issue was announced, the company’s chief operating officer, Mark Maybank, told the media “no large contradiction” existed between the two events, noting Canaccord was simply raising capital for “balance sheet repair.” That’s not how Merrill Lynch analyst Sumit Malhotra sees it. While excess capital can be a prudent thing to have in difficult times, he told clients in a research note, the financing “will clearly be an unpleasant surprise for investors” who, just days earlier, bought shares after being told Canaccord “does not need to secure any financing to continue to operate our business” and that the firm remains “very well capitalized for all operating levels of business.”

As a result of the increase in share count, Merrill Lynch reduced its earnings per share estimates for Canaccord in 2009 and 2010 by 10%. That, of course, is nothing like the haircut ABCP investors will take if restructuring efforts fail.

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