Wednesday, August 15, 2007

Banks & Asset-Backed Commercial Paper Market

RBC Capital Markets, 15 August 2007

• Vanishing liquidity in the structured finance market is now affecting the Canadian Asset Backed Commercial Paper market (ABCP). Concerns over transparency and credit quality of underlying assets have affected demand.

• Conduits with underlying assets in structured finance assets represent about $30 billion of the $120 billion Canadian ABCP market. The Big 6 banks do not appear to be heavily involved as sponsors nor as providers of backup lines of credit in that segment of the market, in which Coventree is the largest sponsor and foreign banks provide the majority of backup lines.

• A number of Canadian ABCP issuers have requested emergency funding from banks that provide backup lines of credit in case of market disruption. Many of these requests have been denied by banks. If banks do not provide liquidity to these conduits, their assets would have to be liquidated, probably at unattractive prices given the lack of liquidity for structured finance assets.

• DBRS believes that assets held by the troubled issuers "continue to perform in a manner that is consistent with the ratings that were originally assigned" but the market clearly does not care about, or does not believe, DBRS' assessment.

• If losses occur in the ABCP market, it would negatively impact the holdings of some money market funds. Canadian banks are the main sponsors of money market funds (73% of the $50.6 billion market). NA's asset management arm appears more exposed to non-bank conduits, with about $400 million in exposure to conduits that are facing liquidity issues. The other banks do not appear to have holdings that are as large.

• If bank-owned money market funds incur losses, the risk to shareholders is that the banks decide to reimburse unitholders for losses, similar to what MFC and IAG did when their clients faced losses in hedge funds.

• The broader ABCP market has seen renewals, albeit at higher spreads, as the market's ability to understand the underlying assets and confidence in sponsors (largely the Big 6 banks) is higher.

• If the entire ABCP market were to freeze up, which seems unlikely as we believe the Bank of Canada would intervene, we believe that the banks' capital positions and sources of liquidity are adequate enough to add $90 billion in assets to their balance sheets.
Financial Post, John Greenwood, 15 August 2007

With the debt markets sinking deeper into turmoil, a leading debt-rating agency is pointing its finger at the banks for helping to fuel the crisis by failing to follow through on deals made when times were good.

"When banks choose not to honour their obligations we have a situation like the one we have today," said Jireh Wong, a senior vice-president at DBRS. As a result, some major debt issuers could go into default "in a matter of days," Mr. Wong said.

Since the start of the week a string of issuers of securitized debt, including Coventree Inc., the biggest independent player in the Canadian securitization sector, have sought emergency funding from their banks after failing to find buyers for new debt. Asset-backed securities are backstopped by deals requiring banks to come forward with emergency funding in times of crisis.

But by the end of Tuesday, at least 16 of those independent players rated by DBRS had been turned down.

Mr. Wong said this is the first time since the securitized debt market began nearly two decades ago that players have been in such a situation.

Yesterday, Ironstone Trust joined the list of beleaguered issuers of securitized short-term debt after Canadian Imperial Bank of Commerce declined a request to provide back-up financing.

In a normal default, creditors move into the driver's seat, typically selling off the assets of the debtor. But some of the so-called conduits behind the troubled asset-backed commercial paper may prove too expensive to unwind, Mr. Wong said. "I don't know what would happen," he added.

Ripples from the U.S. sub-prime-mortgage crisis spread into Canada this week as liquidity all but disappeared in the commercial paper market. Troubles are worst for issuers of so-called asset-backed commercial paper -- or notes backed by bundles of obligations, including everything from credit-card debt to mortgages -- where more than a dozen issuers are facing default.

There is about $120-billion worth of asset-backed securities, accounting about one-third of Canada's vast commercial-paper market.

Since the start of the week officials from the Bank of Canada and the federal Ministry of Finance have been in contact with the big banks.

According to Mr. Wong and others familiar with the situation, the officials have been leaning on the bankers, trying to persuade them to help solve the problems in the credit market.

While some investors returned to the market yesterday, analysts are warning that the troubles in the market are far from over. So far, most of the concern is focused on asset-backed securities.

Since it began in the late 1980s, the securitization market in Canada has taken off, powered mostly by the big banks, which account for about 70% of the market. The remainder is controlled by firms such as Coventree, which has a portfolio of $16-billion of asset-backed funds.

One reason for the sudden nervousness about the securities is that in many cases the holders don't know what kinds of debt they have. Given the surprises in the U.S. subprime market, investors are panicking and they don't want to own asset-backed commercial paper any more.

However some of the biggest investors in the market are the banks. Analysts say that gives them a major incentive to try to keep the market healthy by continuing to buy and by providing emergency funding when called on.

Sumit Malhotra, an analyst at Merrill Lynch, predicted the banks will likely "move to bolster liquidity in the market" since allowing the market to fail would be like shooting themselves in the foot.

Whatever happens, when the dust finally clears there are bound to be a lot of accusations about what caused the meltdown.

Laurence Booth, a professor at the University of Toronto's Rotman School of Management, says the rating agencies that gave opinions on asset backed securities must take at least some of the blame. "Credit rating is what makes [these products] work," he said in an interview earlier this week.

Many asset backed securities garnered top ratings even though they were exposed to less than good quality loans because they contained enhancements to make them more appealing. "There's billions and billions of sub-prime loans that got repackaged," Mr. Booth said.
Bloomberg, Sean B. Pasternak and Frederic Tomesco, 15 August 2007

Coventree Inc. shares surged after the Canadian financial-services company said it found buyers for C$600 million ($558 million) of asset-backed commercial paper, indicating a funding freeze may be lifting.

Canada's biggest non-bank issuer of asset-backed commercial paper said last night it rolled over C$600 million of maturing debt, after failing to sell about C$950 million the previous day. The announcement sent shares of subprime mortgage firms higher, including San Diego-based Accredited Home Lenders Holding Co. and Xceed Mortgage Corp. in Toronto.

``We've been active in buying. It's an opportunity to selectively pick away at some of these attractive offerings,'' said Walter Posiewko, who oversees about C$13 billion in money-market assets at RBC Asset Management in Toronto. He declined to say if he bought any Coventree funds.

Investors had refused to buy the debt amid a global credit crunch, forcing as many as 17 commercial paper funds in Canada with assets of C$27 billion to seek emergency financing from banks.

Still, Coventree wasn't able to roll over all its maturing debt yesterday, extending maturities on C$60 million and requesting funding from lenders for another C$60 million. At least 16 funds sought emergency funding for a second day after failing to refinance all their notes, said rating company DBRS today in a statement.

Ironstone Trust, another fund seeking financing after it failed to roll over debt, said in a statement today that Canadian Imperial Bank of Commerce declined to provide funding.

Metcalfe & Mansfield Capital Corp., whose owners include National Bank of Canada and Deutsche Bank AG, said that three of its funds were unable to refinance maturing notes yesterday. Deutsche Bank and Barclays Bank Plc didn't provide financing for a second day, Metcalfe & Mansfield said in a statement posted on its Web site.

``I don't think we are out of the woods yet,'' said Posiewko. ``It's going to be a protracted situation that is going to take some time to resolve.''

Funds such as Coventree sell commercial paper with maturities of one to two months, backed by assets such as mortgage loans, car loans, credit cards and other revenue sources. Buyers in the C$120 billion market include pension funds and money-market mutual funds.

The struggle to refinance the securities dragged other bank stocks in Canada lower the past three days, on concern they may be forced to finance these funds or may have trouble rolling over their own commercial paper. Bank of Montreal is the biggest seller of asset-backed commercial paper, followed by Canadian Imperial Bank of Commerce and Coventree, according to DBRS.

Craig Armitage, an outside spokesman for Coventree, didn't return a phone call seeking comment.

``We're likely to see continued strains on the system as companies in a similar situation as Coventree struggle to fund ongoing financing,'' said Andrew Pyle, an investment adviser at Scotia McLeod, a unit of Bank of Nova Scotia. ``Canadian banks have taken a hit more on psychological grounds than on direct exposure to that market.''

Royal Bank of Canada and Bank of Montreal said they aren't ``significant'' providers of emergency funding for non-bank commercial paper sellers.

Royal Bank, the country's largest lender by assets, reported on its Web site yesterday that of its C$34.3 billion in ``backstop'' financing, 90 percent is for bank-administered commercial paper funds.

National Bank said that as of July 31 it had reduced by half, to C$750 million, the amount of emergency money available for its own asset-backed funds. The Montreal-based bank said in an e-mailed statement today it doesn't finance non-bank trusts.

Bank shares erased earlier gains. Royal Bank shares fell 11 cents to C$51.89 and Bank of Montreal fell 2 cents to C$61.25. Canadian Imperial fell 35 cents to C$87.
The Globe and Mail, Tara Perkins & Boyd Erman, 15 August 2007

Royal Bank of Canada took the unusual step last night of trying to calm worries over its exposure to the troubled commercial paper market, as the country's biggest bank and others were under pressure from players in the struggling industry for a bailout.

RBC wanted to make clear that it had little exposure to the part of the commercial paper market that is not administered by the banks. To make that point, it went to the trouble of issuing a clarification to its annual report.

The bank was one of a number of Bay Street players seeking to calm the market as financial stocks took a beating over disruptions in the market for commercial paper.

With skittish investors punishing uncertainty, statements such as one from Firm Capital Mortgage Investment Trust, which issued a press release to say it "is not involved in the subprime mortgage investment marketplace and has no exposure to the securitization market," were common yesterday.

The latest wave of worries began after Coventree Capital Group Inc. revealed on Monday that it couldn't find investors for hundreds of millions of dollars in asset-backed loans that had come due. That quickly hit the bank stocks, as the market tried to determine who provided liquidity to Coventree and how far into the commercial paper market the problem had spread.

Commercial paper is short-term debt issued by banks or corporations. Under an asset-backed commercial paper (ABCP) program, debt in the form of mortgages, car loans or credit card debt is packaged up and sold to investors either by a bank or another finance company.

Traders say there is still a functioning market for asset-backed commercial paper issued by trusts run by the country's big banks, but that there is very little demand for paper sold by trusts run by smaller companies such as Coventree. The bank-administered ABCP market is worth about $100-billion, while the non-bank market is about $30-billion. As a result, the funds haven't been able to roll over their paper, and are now forced to ask banks such as Deutsche Bank AG for loans, but the banks have been balking.

"I think the independents are going to go away. I don't know if they're going to survive this," said a source close to the industry. "They don't have the deep pockets - that's why they've been defaulting."

There is now a push behind the scenes to have Canada's biggest financial institutions bail out struggling players in the asset-backed commercial paper market.

The Caisse de dépôt et placement du Québec, one of the biggest buyers of ABCP, called a meeting Friday in Montreal to ask all the big Canadian banks to pump liquidity into the market to rescue smaller players, sources said. Then Monday morning, the Caisse abandoned the market and stopped buying asset-backed commercial paper issued by trusts run by non-bank companies, sources said.

While some banks are interested in the idea of a bailout, betting that the problem is a short-term liquidity issue rather than a long-term problem with the underlying assets in funds, the about-face at the Caisse has many bank officials confused, sources said, and is making it difficult to pull together any concerted effort.

"We do not comment on daily activities," a spokeswoman for the Caisse said yesterday.

RBC spokeswoman Katherine Gay said yesterday that "RBC and its programs are all getting funded." Transactions in the bank-administered market are getting done, she said.

RBC had $34.3-billion in backstop liquidity facilities at the end of October. That means it had set up agreements to provide liquidity financing to conduits, under certain conditions, if they had problems. The point it wanted to make is that more than 90 per cent of that amount was for RBC-administered conduits.

"Our participation in the non-bank administered ABCP market is nominal," Ms. Gay said.

Late yesterday, a Bank of Montreal spokesman said: "We are an insignificant provider of liquidity backup lines to third-party-administered asset-backed commercial paper issuers in Canada."

BMO stock had been suffering since late Monday. In a note to clients, BMO Nesbitt Burns analyst Ian de Verteuil said bank stocks have been roiled by concerns regarding commercial paper used by asset-backed conduits, and the market has clearly been speculating that BMO was tied up with Coventree.

"At this stage, we are unclear if this is the case," Mr. de Verteuil wrote. But, "in the event that BMO is obligated to provide liquidity to Coventree, we believe that BMO can easily handle this situation."

Annual reports do suggest BMO is one of the larger players in the ABCP business, with about twice the relative exposure of other banks, he added.

The Ontario Securities Commission yesterday reminded companies involved in the commercial paper market of their obligation to disclose material changes to the public.

Meanwhile, Canada's banking regulator said yesterday it is watching developments in the commercial paper market.
The Globe and Mail, Andrew Willis, 15 August 2007

Canada's $125-billion commercial paper market was in turmoil yesterday as foreign banks refused to provide emergency funding to smaller financial companies, while larger players insisted they have more than enough capital to weather any crisis.

A brushfire broke out Monday when Coventree Capital Group Inc. failed to find buyers for $950-million of its commercial paper - short-term debt backed by assets such as mortgages, auto loans and credit card debt. The Toronto-based company then tried to refinance most of this debt by asking a number of banks to make emergency loans, in much the same way a cash-strapped homeowner might tap a personal line of credit.

Several foreign lenders balked yesterday at backstopping Coventree, which has $17-billion of commercial paper outstanding, and fanned the flames by also refusing to lend to other funds that offer asset-backed commercial paper. The firestorm reflects a global credit crunch that started with a meltdown in the U.S. subprime mortgage market and spread to other types of debt.

In a release that may help calm markets, Coventree said last night it was able to sell $600-million in commercial paper, but was unable to find buyers for $60-million of its debt.

Foreign banks are refusing to provide the loans needed to retire commercial paper because they view Canada's credit market as functioning relatively normally. The banks say their contracts with Coventree and its peers only require emergency lending when debt markets shut down completely.

"This is a big deal in a little corner of the market, but it's not a systemic problem. Big players are having no problem rolling over their commercial paper," said an executive at one foreign bank that refused to fund several small Canadian players in asset-backed securities. He said: "Investors aren't refusing to buy commercial paper. They're just refusing to buy commercial paper from certain issuers."

Coventree said several lenders refused to step up Monday when the company asked for $700-million in loans to refinance its commercial paper. The company forced investors to continue holding another $250-million of paper that was scheduled to be redeemed on Monday. Coventree, which has $16-billion in asset-backed funds outstanding, did not name the banks. Coventree's stock dropped steeply for the second straight day, falling 72 per cent before being halted on the Toronto Stock Exchange.

Deutsche Bank refused to supply emergency funding to a unit of the $1.5-billion Global Diversified Investment Grade Income Trust, which sells commercial paper backed by mortgages and asset-backed securities and is administered by National Bank Financial.

Deutsche Bank and Barclays Bank PLC balked at funding commercial paper programs at two asset-backed funds issued by Montreal-based Quanto Financial Corp., which has sold $5.75-billion of securities. The snub came despite the fact that Deutsche Bank is part owner of Quanto. Paris-based Société Générale did lend Quanto the money it requested to support a third fund.

Sources say HSBC Bank Canada, Merrill Lynch & Co. Inc. and Royal Bank of Scotland are among the other institutions that balked at the prospect of bailing out small Canadian players in the asset-based market.

In a worst-case scenario, the foreign banks' refusal to lend could trigger defaults on billions of dollars worth of commercial paper, much of which is held by money market mutual funds. Dominion Bond Rating Service said yesterday that 17 separate asset-backed funds have asked for emergency loans. DBRS also said in a report: "Failure to receive funding in a timely manner ... may result in an event of default under the Issuers trust indenture after applicable grace periods have expired."

However, a financial crisis seems unlikely. Coventree and the other asset-backed fund companies were in talks with lenders yesterday aimed at finding new sources of funding; one source said Coventree may be forced to sell itself to a larger financial company.

The Bank of Canada and all the major Canadian banks, which are the biggest players in the asset-backed security market, are working on loan packages and can find buyers for commercial paper issued by their own asset-backed programs.

The six big banks have a total of $125.2-billion committed to backstopping asset-backed commercial paper, according to a report by BMO Nesbitt Burns. "While banks may have to provide liquidity lines, the assets that they would take onto their books remain good quality," said a report yesterday from Ian de Verteuill at BMO Nesbitt Burns. "We continue to remind investors that Canadian banks have extremely strong capital ratios."