Retail investors hold key to Canadian ABCP restructuring

A vote on the Montreal Accord, the proposal to restructure C$33 billion (US$32.7 billion) of distressed non-bank Canadian asset-backed commercial paper (ABCP), is due on April 25. But with all votes counted as equal, satisfying the demands of approximately 1,800 retail investors is critical for the plan to succeed.

On August 12 last year, 22 Canadian non-bank ABCP conduits were no longer able to meet payment obligations due to the drying up of liquidity that hit global financial markets in the second half of 2007. The conduits were unable to issue additional securities, while requests to draw on liquidity lines were refused.

The conduits in question were sponsored by National Bank Financial – the brokerage arm of the National Bank of Canada - Coventree, Dundee Securities, Nereus Financial, Newshore Capital, Quanto Financial and Securitus Capital.

Several major foreign institutions provided the liquidity facilities, including ABN Amro, Bank of America, Citi, Deutsche Bank, HSBC, Merrill Lynch and the Royal Bank of Scotland.

To prevent a fire sale of assets in a distressed market, the sponsors and liquidity providers got together with 15 institutional and large corporate investors (collectively known as the Pan Canadian Investors' Committee) in an attempt to re-establish normal market conditions under the Montreal Accord. JP Morgan was brought in as financial adviser.

Essentially, the accord provided for a standstill agreement, meaning parties agreed not to trade, trigger default provisions or exercise security rights over the affected ABCP while a restructuring plan was being devised.

In late December, the investors' committee reached agreement in principal for the restructuring of 20 conduits, the outstanding principal of which totalled C$32 billion. Of the two other conduits, one – the C$2.1 billion Skeena Capital Trust – was successfully restructured in December. The fate of the other, called Devonshire Trust, will rest on a separate initiative to the Montreal Accord.

The JP Morgan-devised scheme for the 20 conduits involves the conversion of short-term paper into term notes with maturities ranging from five to nine years – matching the maturity of the underlying assets.

The notes will be separated into three tranches according to the type of assets. The first tranche, totalling C$3 billion, will be backed by ‘ineligible’ assets, including distressed subprime mortgages and home equity loans. The second series – also C$3 billion in size – will be collateralised by stable, traditional securitised products such as auto loans and trade receivables. The third tranche, to be split into two series totalling C$26 billion, will be backed by collateralised debt obligations and traditional assets.

Early indications suggest the first tranche will be rated below investment grade – if at all – while the second and third tranches will be rated at the AA level. Additionally, market triggers will be modified into more remote spread loss triggers. Further support for the notes will come via a C$14 billion margin facility, funded by large investors and banks, to provide extra collateral in the event of margin calls.

Current valuations of the underlying assets reveal the logic behind the plan. According to JP Morgan, collateralised debt obligations featuring leveraged super-senior swaps – which account for C$17.2 billion – are worth 30% of their face value. Meanwhile, RBC Capital Markets values the C$3 billion of paper backed by subprime and home equity loans at 20% of their original value.

Assuming the market environment improves in the long run, the restructured notes are a more favourable option than unwinding the conduits, say analysts.

“With the exception of the subprime-linked notes, the assets held by the conduits are fundamentally still of a high quality. However, in a fire sale scenario prices are unlikely to reflect credit quality,” said Priya Sha, London-based structured credit analyst at Dresdner Kleinwort. “By restructuring the short-dated ABCP into longer-term notes, investors will most likely be able to recover more value, closer to par, in the long run.”

On March 17, the investors' committee launched a filing in the Superior Court of Ontario under the Companies Creditors Arrangement Act to replace the standstill agreement. Again, this means the respective parties waive their claims over the assets until the investors – including 1,800 approximately retail buyers – vote on the restructuring on April 25.

Despite the consequences of liquidating the assets, getting the green light for the plan is by no means certain. Approval is dependent on a yes vote from investors holding more than 66.7% of the outstanding principal, but also from the majority of noteholders, with all votes counted as equal.

And the retail investors, who own between C$300 million and $330 million of the assets according to various estimates, are not happy with the proposal as it stands. Many individuals claim they bought what they thought were safe AAA products on the advice of brokers and had no idea these had any links to derivatives. This is entirely plausible given that Canadian conduits are not required to send out prospectuses with details on assets being bought.

Brian Hunter, a Calgary-based investor with C$658,000 tied up in the distressed ABCP, has established a Facebook group to represent the interests of the disgruntled retail investors.

“A significant proportion of investors are over 65,” he claims. “The irony of course is that the most risk-averse people that have put their money in these vehicles have been the worst hit by recent events.”

While recognising that a liquidation of assets would benefit no-one (except possibly hedge funds looking for opportunities), and trying to sue through the courts would be expensive and time consuming, Hunter says the retail investors are standing firm.

“The only way for the institutions to get this to pass is to get the individuals on side. The only way they’ll be able to do that is to give them all their money back plus interest and that is what I think will happen,” adds Hunter.

It took months of internal wrangling to force banks and investors to commit funds to the C$14 billion margin facility. The same institutions have been hesitant to dip further into their own pockets to resolve the retail investor issue. But with the April 25 deadline looming ever closer, it seems they have little choice.

Daryl Ching, Toronto-based managing partner of Clarity Financial Strategy, which is providing advisory services to corporate investors on the restructuring, says a no vote would have disastrous consequences.

“In the event of conduit unwinding, recoveries would be extremely low. A fair assumption to make would be that the average recovery across the board might be as low as 10 cents on the dollar,” says Ching. “That means $30 billion would be lost, people’s pensions would get hit, some of the smaller companies who invested may go bankrupt – the consequences of a huge ripple effect would be substantial.”