Restrained Optimism and Frustration to the ABCP Deal

An agreement in principle was reached last week by the pan-Canadian investors committee tasked with creating a solution. Purdy Crawford, the chairman of the committee, is confident that the deal “will provide most holders of outstanding commercial paper with the opportunity to receive the full repayment of principal by holding restructured notes to maturity.”

Five of the six biggest Canadian banks have “indicated interest” in providing funding, and a sixth is “considering it,” Crawford said in a conference call last week. “Some of them have skin in the game,” he said of the banks. “I’m virtually certain they will participate.”

However, the sixth bank—Toronto-Dominion—isn’t very eager to participate. Its president and chief executive, Ed Clark, has said the bank “is willing to consider measures that support attempts to resolve liquidity issues” but it wouldn’t be in the best interest of shareholders “to assume incremental risk for activities in which we were not involved.”

At this stage, what Kilgour wants for investors is more information. “We’re being told we’re going to get new notes, but we don’t know what they are, so we don’t know how to value them.” With companies wrapping up their year end, there is a question mark on their balance sheets for these securities.

Brian Dayes, a principal with Mercer in Toronto, says investors and plan sponsors should anticipate a decline. “For the December year end you’re looking at a 10–15% valuation hit to the non-bank sponsored ABCP. To the extent that pension plans have exposure, they will see some loss on a marked-to-market basis.” However, most plans do not have a material allocation to cash, says Dayes, so this crisis should not be a widespread issue. “It’s more of an inconvenience in not having access to your capital for other purposes such as rebalancing.”

For a pension fund like the Caisse de dépôt et placement du Québec, who has $13.2 billion in ABCP, it’s a bit more than an inconvenience. But Daryl Ching, managing partner with Clarity Financial Strategy in Toronto, says the Caisse is in a more favourable position than plans that are less invested in ABCP. “I sympathize with the smaller note holders who don’t have a seat at the table and can’t really wait until the deal is finalized,” he says. “The Caisse is in a good position because they have a seat at the table and an incredible amount of voting power.” The Caisse has said publicly that it is very satisfied with the agreement and will continue to collaborate to put it in place.

The measures of the agreement are intended to provide liquidity for the restructured notes once the plan is complete. The investors committee expects an AAA rating for most of the restructured notes that, together with the full transparency of the underlying assets that support the notes, will help encourage trading.

Kilgour does not expect to see these securities freely traded for some time because “there is no real market yet.” Ching agrees that there will be a drag in time before they get sold as it will take months for buyers to the digest information and decide if it is a viable purchase. “Because of nature of assets—tainted and perceived to be distressed—sellers should manage their expectations, even with an AAA valuation, as they will experience a haircut.”

As the end of the ABCP crisis is now visible, industry insiders can reflect on the major lesson learned from the past months: due diligence and transparency. “People will be a lot more careful with what they buy and demand greater transparency,” says Dayes.

“Investors have learned a hard lesson,” adds Ching. “If they want to earn higher returns, they can’t just rely on a rating from an agency.”

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