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The ABCs of asset-backed commercial paper


Monday, April 07, 2008

What is ABCP?

Asset-backed commercial paper is 30-day and 60-day notes designed to pay investors interest generated by bundles of mortgages, car loans, derivatives and other assets pooled in special vehicles called conduits or trusts.

Why did ABCP become popular with investors?

ABCP offered good returns at a time when central banks were slashing interest rates. The investment was also highly rated and sold by some of the world's biggest banks. Last year, ABCP accounted for 30 per cent of Canada's $360-billion short-term debt market.

Who holds frozen ABCP?

About 1,400 clients of Canaccord Capital Inc. collectively hold $269-million of the frozen commercial paper in their accounts. There are also hundreds of other individual investors who bought the paper from other sellers, bringing the total to at least 1,800 holders. The rest is held by companies, Crown corporations, pension funds, institutional investors and banks.

Why is Canada's ABCP frozen?

The ABCP sector was swept up by the crisis in U.S. subprime mortgages in August. That's when it was revealed that an unknown amount of ABCP was tied to dodgy U.S. housing loans. Buyers disappeared and the market froze. To stop the trusts that issued the paper from going into default and being liquidated, a group of major financial players, led by the Caisse de dépôt et placement du Québec, called for a standstill in the market to avoid a meltdown and seek a solution. As it turned out, a relatively small portion of the paper was tied to the U.S. subprime mortgage market.

What are they waiting for?

Toronto lawyer Purdy Crawford and his committee have crafted a plan to exchange the short-term notes for ones that mature in as much as nine years. But a majority of investors must approve the plan at a vote that's currently scheduled for April 25. That is why Mr. Crawford is holding meetings with investors in major cities.

Will investors get their money back?

Under the restructuring plan, investors who hold the notes until they mature – up to nine years – will receive much, if not all, of their money back. Many investors say they can't wait that long, and the committee hopes an over-the-counter market will develop so investors can trade their shares soon after the plan is in place. However, investors who have to sell in the short term will almost certainly lose money.

What is the frozen paper's market value?

There have been no recent disclosed trades in the paper, so nobody is sure.

Notes that are backed by bad U.S. mortgages will be worth less than those backed by solid assets. An RBC Dominion Securities analyst recently said the overall market has lost about 40 per cent of its value. However, if the restructuring fails, many of the assets will be seized by creditors and sold at depressed prices, leaving little or nothing for investors who own the paper.

Determining exactly how much of their money investors in this paper will recoup is somewhat more complicated. That's because the restructuring plan for the market involves dividing it up into three types of new investments that will each have different values, because some will be riskier than others, and each investor will get a different mix of the new paper depending on what types of frozen paper they held.

Who's paying for the Crawford committee and its work?

Investors. It will cost between $80-million and $100-million to pay the lawyers, financial advisers, the court-appointed monitor and the rating agency.

What are the legal releases?

If the committee's plan is put in place, all of the major players in the ABCP market – from banks to brokers to credit-rating agencies and the Crawford committee – will receive releases that will protect them from lawsuits.

Do the releases mean investors won't be able to sue?

Yes. If the plan passes, investors will not be able to sue essentially any party for any damages they might have suffered relating to ABCP.

What if an investor votes against the plan, but the plan passes?

They still lose their right to sue.

Who gets to vote on the plan?

Any investor that held affected ABCP as of Feb. 29, 2008, who registers by April 22. Investors who might have bought affected paper since Feb. 29 need to be assigned the right to vote by the investor who sold them the paper.

What has happened to the interest that's been building up in the ABCP sector since August?

The assets behind the paper have continued to generate money. Different commercial paper programs had different rules, for instance about whether certain fees and expenses get paid before interest to note holders. The committee is tallying up the interest in each commercial paper series to determine what, if any, interest investors will receive.

When might investors get their new notes?

If the plan is approved at the investors' vote on April 25, and then sanctioned by the court, the committee expects it could distribute the new notes on May 23.

What happens if the plan is voted down?

The committee says that if the plan is voted down, the standstill agreements that are keeping the market frozen could expire and investors could cause a liquidation. If the trusts go into default, “it is reasonable to conclude that note holders would suffer very significant if not total losses on their holdings of affected ABCP,” the committee says.

What percentage approval does the vote need to pass?

The plan must be approved by the majority of investors who vote, and they must collectively hold at least two-thirds of the total dollar value of the affected paper. Big investors that collectively hold more than $21-billion have already said they'll vote in favour of the plan, making the second test a near certainty. But each investor gets one vote no matter how much paper they hold, and so the first test will be swayed by the votes of the more than 1,800 small individual investors who are holding ABCP. They can vote by mail before the day of the actual vote, which will be held in Toronto, and retain the right to change their minds.

If investors approve the plan in the vote, will it automatically pass?

No. The committee has put the affected commercial paper trusts into a court-supervised restructuring process in an Ontario court, and the judge overseeing that process must sanction the plan following the vote. Investors who are unhappy with the plan will have a chance to try to convince the judge that it should not proceed.

© The Globe and Mail

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