Friday, August 24, 2007

Banks' Exposure to Asset-Backed Commerical Papers

The Globe and Mail, Tavia Grant, 24 August 2007

Ewen Mackenzie has been trading securities for nearly three decades, half of that as head of his Thornhill, Ont., investment firm. And he's always been able to buy short-term government treasury bills — until Friday.

Like scores of other fixed-income investors, Mr. Mackenzie was looking to park money in one of the safest spots in Canada — government-backed bills. But when he called one of the Big Five banks Friday to place about $250,000 in 30-day and 90-day T-bills, he was told they weren't available.

The experience illustrates just how rattled investors are. Their aversion to the perceived risk of anything connected with non-bank asset-backed commercial paper (ABCP) means many are fleeing money market funds altogether for the haven of government-backed securities.

"I've been in this business for 28 years and I've never heard of anything like that before," said Mr. Mackenzie, who runs Ewen Mackenzie Investment Advisors Ltd. "I can only surmise that individual investors are bailing out of money market funds and buying Treasury bills and maybe they've bought them all up."

Treasury bills are sold at an auction every second Tuesday through the Bank of Canada. They're bought by investment dealers, who then typically resell them to retail investors.

Mr. Mackenzie wants the central bank to help soothe the liquidity problems by issuing more bills.

"If I'm getting a better rate than in the money market fund and it's got the guarantees of the government of Canada, it's a prudent thing to do. And now it would appear that that's been taken away from me," he said.

Fresh evidence of that came Friday when the Finance Department said the budget surplus for fiscal 2007-08 will be much higher than the $3-billion it had projected.

Canadian Treasury bill prices rose for a 14th-straight day, pushing the yield on a 90-day Government of Canada bill down 11 basis points Friday to a scant 3.80 per cent from 3.91 per cent Thursday. (A basis point is 1/100th of a percentage point.) Three weeks ago, the yield was 4.58 per cent, with the sudden drop indicative of the premium investors are willing to pay for debt backed by the Canadian government as they move into only the safest paper amid concerns about the safety of asset-backed commercial paper, which has been for years a substitute for scarce T-bills.

In the U.S., Treasury bill demand is easing after a surge last week and investors are showing confidence in asset backed commercial paper, signified by a shrinking spread between the yields on the two types of investments.

Appetite for T-bills surged in recent days after Coventree Inc. said it has been unable to find buyers for millions worth of ABCP. Fear that troubles in that segment could contaminate Canada's commercial paper market caused widening in spreads between commercial paper and one-month T-bills.

"To say that [T-bills] are scarce relative to what's out there is definitely true," said Mark Chandler, a fixed-income strategist at RBC Dominion Securities Inc.

That poses challenges for larger investors with a mandate to put their money into safe, low-risk vehicles.

Now, "concern about credit generally ... has the regular investors scrambling," he said.

"There's still a lot of confusion and until that confusion eases up a bit, I just don't see that part of the market improving that much," said Sheldon Dong, vice-president of fixed-income strategy at TD Waterhouse Group Inc.
The Globe and Mail, John Partridge, 24 August 2007

National Bank of Canada has fulfilled more than half of its pledge to buy back $1.85-billion in troubled short-term debt at the heart of a credit crunch in Canadian markets, a move that will make it the largest declared holder of the paper.

Bank spokesman Denis Dubé said Friday it has bought $999-million in so-called third-party, or non-bank, asset-backed commercial paper (ABCP) from eight of its mutual funds and an additional $88.6-million from six funds operated by its Altamira Investment Services Inc. unit.

National, the smallest of Canada's Big Six banks but the one with the largest exposure to this beleaguered and once obscure segment of the corporate debt market, said in a statement that this means it now has acquired all the ABCP from both its and Altamira's mutual funds.

This adds up to $1.08-billion in all, apparently leaving about $770-million of the $1.85-billion still to be dealt with.

In announcing its repurchase plan Monday – designed to protect its reputation and save its clients from losses – the bank said it also planned to buy ABCP bought by individual investors through it, its investment dealer and its discount brokerage arms on the same terms as the fund repurchases – 100 per cent of the clients' acquisition cost plus accrued interest.

It also pledged to buy back holdings of $2-million or less from corporate clients.

Meanwhile, Northwest Mutual Funds of Toronto joined National and a small list of other financial institutions that have decided to rescue their clients. The firm said in a statement that it will “assume” all the third-party ABCP held in its money-market fund. However, it provided no details and officials could not be reached for comment.

In other ABCP developments, the Ontario government has emerged as one of the largest holders of the paper yet known, but says the exposure is not material and will not impair its ability to meet its cash-flow needs.

The province currently owns a little over $700-million of ABCP, Ontario Ministry of Finance spokesman Scott Blodgett said Friday.

It also owns “less than $100-million” in ABCP sponsored by banks, Mr. Blodgett said.

In all, this adds up to less than 10 per cent of the province's $9-billion cash reserves, and as such, the government does not consider it material from a fiscal, financial or liquidity perspective.

“It won't have any impact on our surplus or our liquidity or ability to meet our cash flow needs,” Mr. Blodgett said.

By way of illustration, he said the province was able to sell out a $600-million issue of 10-year domestic bonds “within minutes” Thursday morning.

“We've certainly informed our bond underwriting syndicate. . .that out [ABCP] exposure is less than 10 per cent of our cash reserves and they have no further questions or concerns,” Mr. Blodgett added.

The government holds the ABCP investments through the Ontario Financing Authority, which manages provincial finances, he said.

By contrast, representatives for the New Brunswick, Nova Scotia, Newfoundland and Labrador and Manitoba governments, for example, said Friday morning that their treasuries have no exposure to ABCP.

ABPC is debt in the form of such things as mortgages, car loans and credit card receivables that banks or other third-party structured finance companies buy, repackage and sell to investors as short-term instruments for parking their cash at a profit.

However, in the fallout from the global credit crunch triggered by the U.S. sub-prime mortgage debacle, skittish investors have in the past two weeks largely stopped buying the third-party variety, and major banks have used a legal loophole to avoid having to honour agreements under which they are supposed to provide back-stop financing for the paper.

This has left several third-party finance companies in dire straits, most visibly Coventree Inc., a Toronto structured finance company. Its shares have plunged more than 80 per cent since it announced it could not find new buyers for hundreds of millions of dollars in asset-backed loans that had come due.

More small holders of the tarnished third-party paper disclosed their exposure Friday. They included Western Canadian Coal Corp. of Vancouver, which says it has $5-million tied up in the stuff, about 12 per cent of its current cash holdings, and Acceleware Corp. of Calgary, which said third-party ABCP accounts for $1.45-million of its $7.2-million in cash and cash equivalents.

Although it has refused to divulge its exposure, Quebec's massive pension fund, Caisse de dépôt et placement du Québec, is thought to be the largest holder of third-party paper in Canada, where the market for the stuff is currently estimated at about $35-billion.

The Caisse was the driving force behind a plan to salvage the market launched by a group of 10 financial institutions, the main plank of which is to convert the ABCP into longer-term notes. As of Thursday afternoon, the group had signed up companies that, it said, in total hold a little more than 77 per cent of the outstanding $35-billion.

Among the other larger holders of the paper that have ‘fessed up so far are, Dundee Bank of Canada, at $400-million, air-traffic control system operator Nav Canada, with $368-million, the Greater Toronto Airports Authority, with $249-million and tour operator Transat A.T. Inc., with $154.5-million.
Reuters, Nicole Mordant, 23 August 2007

As the blame game starts after a credit crunch in a corner of Canada's asset-backed commercial paper market, it is emerging that several red flags were raised in the past year about these unique short-term debt investments.

In a June 2006 report, rating agency Standard & Poor's pointed out that Canada's ABCP market was one of a kind in its acceptance of products with "extremely limited-use liquidity support."

The phrase is prophetic, in hindsight. The market for ABCP issued by groups other than Canada's big banks froze up last week when issuers of the instruments turned to financial backers for emergency funding when they were unable to find takers for maturing paper as buyers took fright.

Those backers, mostly international banks operating in Canada, refused to throw issuers a lifeline, citing clauses in the ABCP agreements requiring them to step up only in the event of a "general market disruption" -- a loosely defined term and a situation that the banks said had not taken place.

"Conduits with this type of liquidity backup likely would not receive an investment-grade rating from Standard & Poor's," Toronto-based S&P primary credit analyst Maria Rabiasz and two other S&P analysts wrote in the 2006 report.

At the time, and still today, Toronto-based DBRS is the only rating group to rate Canadian non-bank ABCP, which are short-term debt instruments invested in assets such as mortgages and corporate credit.

DBRS handed most of this paper its top R-1 rating, a lure to investors who now want to know how many of these seemingly safe investments went sour. Players in the sector would have ended up in default, but for a bail-out drawn up late last week by 10 large market participants.

Rabiasz and her colleagues urged investors to request multiple rating opinions on the paper.

But S&P rival Moody's has also been concerned for some time about the lack of iron-clad funding backstops in non-bank ABCP contracts, Charles Gamm, vice-president and senior credit officer at ratings agency Moody's said.

"Moody's has always stated that this type of liquidity facility is not consistent with our highest short-term rating, which we call Prime-1," Gamm told Reuters.

The market for this specialized commercial paper is worth about C$35 billion ($33 billion). It grew rapidly in recent years as companies and money market funds looking for liquid investments with good returns for their cash piled in.

DBRS itself became concerned late last year, albeit not with the contract's liquidity clauses, but with the types of investments that some of the non-bank ABCP issuers were making, according to Canada's Globe and Mail newspaper.

That led the rating agency to firm up its ABCP investment criteria in January. DBRS also told the newspaper it has launched a review of the way it rates ABCP. The rating agency was not available for comment.

In May, Edward Devlin, Canadian portfolio manager at Pacific Investment Management Co. (Pimco), the world's largest bond manager, warned in an article of imprudent risk-taking in the ABCP market.

"In hindsight, this was not DBRS's finest hour," Devlin told Reuters.

But he is wary of blaming DBRS for the market freeze, which has resulted in several companies being unable to access their working capital because of a 60-day standstill clause in the bail-out plan.

"We at Pimco took the rating agencies' rating as just one opinion that we factor into our investment process... As an investor it is our fiduciary responsibility to do those things," he said.

But others said they depend heavily on agencies.

"It is not our core business, so we have to rely on some credible indicators and outside expertise," said Terence Chandler, president of the small mining company Redcorp Ventures Ltd. , which has C$90 million of its cash frozen in non-bank ABCP.

DBRS is not alone among rating agencies in drawing fire in recent weeks as cracks appear in credit markets around the world, sparked originally by rising defaults in the U.S. subprime mortgage market.

S&P, Moody's and Fitch have all come in for criticism and a U.S. senator has called for a review of rating agencies' role in giving strong ratings to risky subprime mortgage securities.
The Globe and Mail, Tara Perkins & John Partridge, 23 August 2007

HSBC Bank Canada has become the second bank to say it was telling clients to buy non-bank commercial paper based on the ratings it had received from DBRS Ltd.

"Like other financial institutions and intermediaries, HSBC Bank Canada and our subsidiaries have supplied bank and non-bank ABCP [asset-backed commercial paper] to customers based on ratings," spokeswoman Sharon Wilks said yesterday.

DBRS is the only credit rating agency that has been active in the Canadian non-bank ABCP market. Earlier this week, National Bank of Canada chief executive officer Louis Vachon said he believed his bank probably "focused a lot" on the solid ratings that DBRS had given these securities.

As a growing number of small resource firms disclose that they bought non-bank ABCP based on advice from HSBC Bank Canada, the Vancouver-based arm of Europe's biggest bank issued a statement yesterday saying that it recognizes the concern of its customers and will work with them during this "difficult time."

"This is a complex situation and it's going to take some time to work through," Ms. Wilks said.

The list of resource companies that say they bought non-bank ABCP based on advice from HSBC Bank Canada grew yesterday to include names such as Superior Mining International Corp., Silver Standard Resources Inc., Canada Energy Partners Inc., and Southern Arc Minerals Inc. Redcorp Ventures and First Quantum Minerals Ltd. are among the firms that have already said the same thing. All together, these small companies have more than $173-million invested in this area.

Vacation operator Transat A.T. Inc. also revealed yesterday that nearly half its cash is parked in this market. It says it made those investments based on advice from National Bank of Canada.

Executives at Montreal-based Transat sought to assure clients and investors that they still have sufficient funds on hand to keep the business operating.

The company said $154.5-million of its $340-million cash holdings are invested in 10 different ABCP trusts. But less than half of Transat's ABCP investments are in trusts managed by Coventree Inc.

"We would like to emphasize that we have enough cash to operate and that customer deposits are not at stake," Transat chief financial officer François Laurin said on a conference call.

The company will work hard to recover its money, but it's too soon to tell whether it will incur losses, executives said.

It will be some time before the Canadian companies who are holding non-bank ABCP find out what their investments are worth.

While some financial institutions are buying back the troubled paper from mutual funds and retail investors, corporate clients are largely being left to fend for themselves, people in the industry said.

"Nobody's having luck getting their money back," said the chairman of one Canadian firm that holds non-bank ABCP.

To protect its reputation, National is spending $1.85-billion to buy back non-bank ABCP, but the majority of that money will be used to buy it back from mutual funds that National Bank runs and from some individual investors.

As for corporate clients, National said it would buy non-bank ABCP from those who hold $2-million or less, and who are not accredited investors.

That means only very small companies qualify.

Transat's Mr. Laurin said yesterday that the tour operator is "in discussions with [National] about a lot of things."

Meanwhile, HSBC has not decided whether it will buy back non-bank ABCP from its corporate customers, Ms. Wilks said.

"We are working through, individually with customers, and just generally as an organization, how we're going to handle various situations."

While HSBC was recommending these products to its clients, it did not put them in its own mutual funds.

ABCP is debt in the form of such things as mortgages, car loans and credit card receivables that banks or other "third party" structured finance companies buy, repackage and sell to investors as short-term instruments for parking their cash at a profit.

In the fallout from the global credit crunch triggered by the U.S. subprime mortgage debacle, skittish investors largely stopped buying the third-party variety last week, and major banks have taken the position that conditions under which they contracted to provide backstop financing for the paper have not been met.

This has left several third-party finance companies in dire straits, most visibly Coventree, which announced it could not find new buyers for hundreds of millions of dollars in asset-backed loans that had come due.

Earlier yesterday, Industrial Alliance Insurance and Financial Services Inc. of Quebec City said it will buy back all $70-million in third-party ABCP held in its money market mutual funds at 100 per cent of the purchase price plus accrued interest, the same terms National is offering.

Meanwhile, NAV Canada and Dundee Bank of Canada each disclosed yesterday that they hold close to $400-million of non-bank ABCP.
Scotia Capital, 21 August 2007

National Bank Moves Rapidly to Protect Franchise

• National Bank announced that it plans to acquire $2.0 billion in asset-back commercial paper (ABCP), including about $150 million in bank administered conduits, held in mutual funds as well as held by retail clients.

• This very quick action reflects NA's active participation in the "Framework Agreement" and is very supportive to their customers and investors. The $2 billion will be going on NA's balance sheet and if underlying credit remains solid and interest rates do not increase we would expect the bank to suffer no material financial loss on this transaction. The $2 billion figure includes money market funds, fixed income funds and other pooled funds of its subsidiaries.

National Bank to Make Funds Whole

• NA has agreed to purchase the asset-backed commercial paper at cost thus keeping the holders whole. The $2 billion in assets represents $2 billion in risk-weighted assets which will reduce the bank's Tier 1 capital ratio by 36 bp.

• NA stated it will take the following measures in its press release on August 20, 2007:

o "Holders of Mutual and Pooled Funds: National Bank will agree to acquire all ABCP currently held in the National Bank and Altamira public mutual funds and in the pooled funds used by Natcan in its discretionary management (except for two alternative funds) and by National Bank Trust in its private investment management at 100% of the acquisition cost of such ABCP to these funds plus accrued interest. Payment to the funds will be made in cash and used to purchase securities such as Canadian treasury bills or other similar high quality liquid government bonds.

o Individual Investors: National Bank will agree to acquire ABCP purchased through the Bank, National Bank Financial or National Bank Direct Brokerage and held in their accounts by individual retail clients of such entities at 100% of their acquisition cost plus accrued interest. Payment will be made in Bearer Deposit Notes or in National Bank Banker's Acceptances.

o Corporations: National Bank will also agree to acquire ABCP purchased through the Bank, National Bank Financial or National Bank Direct Brokerage by other clients who have total holdings of Cdn. $2 million or less in ABCP in their accounts at such entities and who do not qualify as accredited investors under securities regulations, at 100% of the acquisition cost of such ABCP plus accrued interest. Payment will be made in Bearer Deposit Notes or in National Bank Banker's Acceptances."

Market Heavily Discounting NA ABCP Exposure

• NA will have to make a decision in Q4 whether there is any impairment on the $2 billion of ABCP and whether or not to take a provision although assets are currently rated R-1 by DBRS with DBRS stating that asset quality remains solid.

• NA's exposure of $1.85 billion to non-bank administered conduits includes securitization sponsors Coventree, Quantos and Newshore with conduits including Rocket, Comet, Aurora, Gemini, Planet, Slate, Apollo, Apsley, Whitehall and Devonshire.

• In terms of potential write-downs or provisions, a 10% provision on the $1.85 billion of non-bank administered ABCP would represent $185 million pre-tax ($120 million after-tax or $0.75 per share). We believe the market is currently discounting approximately $1 billion, which, in our opinion is excessive.

Major Banks - No Exposure to Non-Bank ABCP

• The remaining 5 major Canadian banks issued press releases (RY and TD on August 16, 2007, followed by BMO, BNS and CM on August 20, 2007) stating that their Canadian money market funds have no exposure to asset-backed commercial paper administered by non-bank sponsored conduits. The commercial paper held in money market funds is sponsored by the major Canadian banks. In addition, the banks stated that money market funds do not have any exposure to U.S. sub-prime, collateralized debt obligations or derivatives markets. BMO also stated that it has not experienced above average redemption activity in its funds.

Banker's Acceptances Spreads Blow Out

• The nervousness in the market about liquidity and the ABCP crisis is reflected in the Banker's Acceptance - T-Bill spread that has moved out 68 bp in the past 8 days to 72 bp, the highest level since the Asia Crisis in Sept/Oct 1998.


• We recently upgraded NA to a 2-Sector Perform from a 3-Sector Underperform based on share price weakness and substantial P/E discount of 19%.
Bloomberg, Doug Alexander and Frederic Tomesco, 21 August 2007

Bank of Montreal, Canadian Imperial Bank of Commerce and Canada's four other biggest banks agreed to work together to ensure that the C$120 billion ($113 billion) market for asset-backed commercial paper continues to ``perform satisfactorily.''

The banks' chief executive officers held discussions today, and reiterated their commitment to provide ``liquidity'' for their commercial paper when it comes due, according to a joint statement. The Bank of Canada said the move was a ``positive step.''

``This might very well be to placate their mutual-fund holders,'' Genuity Capital Markets analyst Mario Mendonca said in an interview.

The statement may indicate the banks are facing redemptions from their commercial paper funds, and are trying to reassure investors that they'll prop up money markets, he said. National Bank of Canada yesterday offered to buy back C$2 billion in commercial paper from clients.

The market for commercial paper used to buy assets from mortgages to car loans has seized up as fallout from the subprime mortgage crisis in the U.S. spreads. In Canada, a group of 10 banks and pension funds last week agreed to convert about C$35 billion in commercial paper into longer-term notes after non-bank firms such as Coventree Inc. failed to roll over debt.

``Ultimately the objective is stability in the market, so the banks needed to address the concerns investors have,'' said Huston Loke, head of global structured finance at DBRS, a Toronto-based rating company.

Some Canadian lenders including Royal Bank of Canada and National Bank have said they haven't had problems rolling over their own asset-backed commercial paper. National Bank said yesterday it had redemptions of about 5 percent from its money- market funds.

``The paper is definitely rolling over,'' Loke said. ``Obviously the spreads are wider than everyone would like.''

Banks manage about two-thirds of the C$120 billion market for asset-backed commercial paper in Canada, with the rest run by firms like Coventree.

``The commitment by Canada's major bank CEOs to work together to support the performance and liquidity of the market for bank-sponsored asset-backed commercial paper is a further positive step to help re-establish well functioning money markets,'' the Ottawa-based central bank said in statement today on its Web site.

The bank CEOs held a conference call this morning, Royal Bank spokeswoman Beja Rodeck said in an interview.

In a separate statement, CIBC said it will support its own commercial paper trusts: Crisp Trust, Franchise Trusts I and II, Macro Trust, Safe Trust, Smart Trust and Sound Trust. And Industrial Alliance Insurance and Financial Services Inc., a Quebec City-based insurer, said today it offered to buy back C$77 million in non-bank commercial paper.

Royal Bank shares rose 92 cents, or 1.7 percent, to C$54.32 at 4:16 p.m. on the Toronto Stock Exchange, leading the gains among Canada's six-biggest banks. The S&P/TSX Banks Index rose 1.5 percent.

Asset-backed commercial paper is corporate debt that matures within a year and is backed by assets such as mortgages or commercial loans.
Financial Post, John Greenwood, 21 August 2007

Hit by a wave of redemptions by spooked investors, National Bank Financial took evasive action yesterday, announcing it will buy back $2-billion of troubled asset-backed commercial paper held by its mutual funds and clients.

The market for asset-backed commercial paper, a widely held form of commercial debt, ran aground last week as investors grew concerned about exposure to U.S. subprime mortgages. So far, most of the worry is focused on asset-backed commercial paper (ABCP) issued by nonbank firms, a $35-billion sector owned by entities ranging from mutual funds to mining companies. That market is now all but dried up, with issuers unable to sell at any price.

National Bank said most of its exposure to ABCP is through funds such as its Altamira subsidiary. Denis Dube, a spokesman for the bank, said the board of directors made the decision to take the hit on Sunday after a chaotic week during which frightened investors withdrew $100-million from National's money-market mutual funds, or about 5% of the total.

"We view this as very much a move to preserve the bank's reputation with investors," said Mario Mendonca, an analyst at Genuity Capital Markets. "They did this to cover themselves."

Louis Vachon, National's chief executive, said buying back the investment was "the right thing to do, for all stakeholders."

Commercial paper is a popular investment with companies and individuals looking to park their money for short periods of time. In recent days a string of companies have disclosed exposure to ABCP. National Bank and the Caisse de depot et placement du Quebec, Canada's largest pension fund manager, are believed to be the biggest holders.

National's announcement comes four days after a group of 10 major financial institutions unveiled a plan to calm the troubled market. The group, which includes National and the Caisse de depot, said they will convert the ABCP that can't find buyers into longer-term debt, thereby removing or at least postponing the threat of default by some issuers.

The plan's backers are hoping that by transferring the troubled investments to another market and extending payment deadlines, the value may be restored. But critics charge that the bail-out still leaves investors on the hook for risk that they never agreed to accept in the first place. The troubles in the commercial-paper market first emerged early last week after Coventree Inc., a leading independent player in asset-backed paper, was unable to roll over some of its debt.

Coventree and other issuers typically have deals with big banks that require them to come to the rescue with additional financing in the event of a market collapse. But when Coventree called on its bankers for emergency funding last week, its pleas were declined. That prompted DBRS, the only rating agency that covers the sector in Canada, to issue a series of default warnings. Since then the market for has been all but dry.

Asset-backed commercial paper is backed by bundles of credit obligations ranging from car loans to credit-card debt to, in some cases, U.S. subprime mortgages. Much of it is packaged with "enhancements," including guarantees by financial players to kick in funding if something goes wrong with the market or with underlying cash flows. Partly on the strength of those arrangements, DBRS gave many Canadian ABCP issues top ratings.

The troubles are exacerbated by the lack of clarity as to exactly what kind of debt investors are exposed to with top-rated issues not requiring a prospectus. That means investors have limited knowledge of what they are buying.

The market crisis now unfolding "is something nobody ever thought would happen," said one industry insider. He said it was always assumed that a default was considered a highly remote possibility.
The Globe and Mail, Tara Perkins & Sinclair Stewart, 21 August 2007

National Bank of Canada says it relied on Dominion Bond Rating Service's stamp of approval when it put substantial mutual fund assets into a now-troubled corner of the commercial paper market, and it's not the only investor holding these securities.

Canada's sixth-biggest bank is buying nearly $2-billion worth of so-called non-bank asset-backed commercial paper (ABCP) from its money market funds, individual investors and corporations in a move designed to protect its reputation.

Money market funds are typically perceived as bastions of safety by average investors. But National Bank's money market funds had up to 40 per cent of their assets invested in non-bank-administered ABCP that is now experiencing a liquidity crisis.

Asset-backed commercial paper is short-term debt that's backed up by packages of loans, ranging from credit card receivables to car loans to mortgages. It generally rolls over every day.

Last week, the Caisse de dépôt et placement du Québec led a group of major financial institutions in the creation of an agreement, dubbed the "Montreal proposal," to shore up the market for non-bank ABCP.

But it's too early to know what these securities will eventually be worth.

"Whatever our decisions were, the consequences should not be borne by our clients," National Bank chief executive officer Louis Vachon said on a conference call yesterday.

Having assumed the role of CEO earlier this summer, he found himself defending National Bank's reputation, as it was the only big Canadian bank to put money market fund assets into these securities.

Mr. Vachon said he believes National probably "focused a lot" on the solid ratings that the securities received from DBRS.

"Given that we were still within the investment management policies that we had, we ended up with a fair amount of weighting of these securities in our funds," Mr. Vachon said.

DBRS did not comment yesterday.

Last week, DBRS managing director Jerry Marriott said that "any rating agency should be able to stand up for itself and give its rationale for why it took a particular rating decision." He said DBRS has been "very responsible in terms of not only giving ratings on this paper initially, but also confirming that rating and being clear about the basis of our confirmation of that rating throughout this time of uncertainty."

While lessons will be learned, Mr. Vachon said to "keep in mind the market is obviously a lot more aware of the risk of these securities over the last few weeks, but you just go back three or four weeks ago, the market was still functioning properly."

He also noted that National is holding about $2-billion of the estimated $35-billion market in Canada, and said he would like to know where the other $33-billion is being held.

A flurry of mining companies have stated that they are holding millions of dollars in third-party ABCP. Some of them have said they got into the market on the advice of HSBC Bank Canada, which has declined to comment.

Ernst & Young, which is working with the financial institutions that signed the Montreal proposal, is trying to find out who owns the rest, Mr. Vachon said.

The five biggest Canadian banks issued statements yesterday to say their mutual funds do not hold non-bank ABCP. The non-bank market is a small part of the Canadian ABCP market that includes companies such as Coventree Inc. A larger part of the market is administered by the banks.

Desjardins Group said it will buy non-bank ABCP out of its money market funds. Its exposure is about $100-million, a spokesman said.

Some big banks said they kept largely away from the non-bank ABCP market because the underlying assets are opaque, and it's hard to determine what they are worth.

All of the big five banks are providing liquidity to their own sponsored conduits - vehicles set up to package and sell ABCPs - and that market is functioning smoothly, a source said.

"I think non-bank conduits are done. It's over. And it will never happen again," said the source, who is a senior executive at one of the big banks. They added that it was large international banks that helped it to flourish.

Mr. Vachon said National's board and senior management decided to buy back the $2-billion in commercial paper because they were concerned that clients would be worried about the quality of their investments.

"There were two scenarios that we absolutely wanted to avoid," he said. "One was to suspend redemptions of any of our money market products. And, second, facing a hypothetical situation whereby we would have to inform our money market investors that they were taking losses on an investment they'd make on money markets with National Bank."

Redemptions in the funds had hit 5 per cent in the past week or so, Mr. Vachon said.

This weekend, The Globe and Mail and a number of Quebec newspapers reported that National's money market funds had assets invested in the non-bank ABCP market.

About 90 per cent of the $2-billion worth of paper it's buying back was in mutual funds and other vehicles where National had discretionary investment responsibility for the assets, he said.

The bank is also buying $150-million in bank-sponsored ABCP.

National's decision to buy back ABCP from some individual and corporate clients who bought it from the bank is causing a headache for the other large banks, who are now getting calls from clients asking whether they will do the same, said sources at two of the banks.

National executives said that up to 10 per cent of the non-bank ABCP market is invested in U.S. subprime mortgages.

Exposure to non-bank, or third-party, asset-backed commercial paper:

National Bank $1.85-billion
New Gold $152-million
Desjardins Group $100-million
Barrick Gold U$65-million
Baffinland Iron $43.8-million
Petrolifera $37.7-million
Miramar Mining $37-million
Westaim $19.7-million
Jura Energy $14.9-million
Ivanhoe Mines $13.8-million
The Globe and Mail, 20 August 2007

National Bank of Canada is defending its dramatic decision to protect retail, mutual fund and some other clients from losses by repurchasing about $2-billion in troubled asset-backed commercial paper (ABCP), and warning investors not to rush to judgment about the size of its presence in this market.

“The amounts are large, I'll grant you that,” chief executive officer Louis Vachon said of National's exposure during a conference call with analysts Monday after it pledged to buy all the ABCP held by these clients for 100 per cent of the clients' original purchase price plus accrued interest, in a move that also is designed to protect the bank's reputation. “However, before reaching any conclusions on our relative weight in these things versus some of our other competitors on the street, we should probably wait and see where the rest [is].

“We've accounted today for $2-billion of the $35-billion. . . I think it would be fair to find out where the other $33-billion is being held.”

The short-term paper, sold as a good place to park cash at a premium return, has run into a major liquidity crisis in the current global credit squeeze, especially a variety sold by so-called third-party, or non-bank issuers, which currently accounts for about $35-billion of the approximately $120-billion Canadian ABCP market.

National Bank is moving to protect its retail and mutual fund clients, and its reputation, from potential losses on so-called third-party asset-backed commercial paper.

As well, challenged by one analyst about the potentially costly precedent National is setting by bailing out its clients this way, Mr. Vachon said the bank decided the alternative would be worse – even though it had no legal obligation to take action.

“We were much more worried about the other precedent we would have created in the event that we would have had to suspend redemptions on our money market funds and/or there may have been losses [for retail investors] associated with our money market funds,” he said.

“So, we are taking pretty drastic measures, [but] our sense is that it's the right thing to do to protect the franchise – and well see.”

Mr. Vachon said it is too soon to tell what financial impact the measures will have on National's financial results and that selling third-party ABCP was not a major business for the bank.

“Now, with the benefit of hindsight, clearly we'll take the next few months to find out what we could or should have done a little differently in terms of managing these assets,” he added.

The Globe and Mail reported Saturday that National, the smallest of Canada's Big Six domestic banks, is the only one of them to have loaded up its money market funds with the third-party variety.

Analyst Ohad Lederer at Veritas Investment Research in Toronto warned in a report to clients Friday that there is a “significant risk” that the National money market funds in question “will incur losses unwinding their holdings” and, in the worst case, might have to suspend redemptions.

“Should this happen, National's reputation will be seriously damaged,” Mr. Lederer wrote, who has a “sell” recommendation on the bank's shares.

In an interview following the conference call Monday, he said National had no choice but to take action. “It's kind of like they were forced into doing the right thing,” he said. “It's good for the retail investor.”

However, the bank is taking the $2-billion in ABCP on to its own balance sheet, and this means it will have to set aside capital to cover the additional assets. “That's capital that can't be used for other things, such as [share] buy-backs,” Mr. Lederer said.

Desjardins Group, which also has some ABCP in several funds, also issued a statement Monday saying that it “will take charge of” all this paper “in order to protect its members against the current uncertainty prevailing in the. . . market.”

Meanwhile, Bank of Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce all issued nearly identical statements saying that their money market mutual funds do not contain any third-party asset-backed paper in money market funds and do not have any exposure to U.S. subprime, collateralized debt obligations and derivatives markets.

National's action Monday comes four days after it and nine other financial institutions — none of them other Big Six banks — announced a rescue plan for the battered third-party ABCP market involving the conversion of this short-term debt into longer-term instruments and other measures, including a standstill agreement.

The group issued another statement Monday saying investors who want to participate in the plan should contact accounting firm Ernst & Young, which the group has hired to co-ordinate the effort, to confirm that they support the standstill. “By doing so, [they] are simply committing to continue to roll their paper during the 60 day standstill period and not to take any action that would precipitate a default in any of these trusts,” the group said.

National said it will buy all the ABCP currently held in its and Altamira's public mutual funds, pooled funds used by subsidiaries Natcan (excluding two hedge funds) and National Bank Trust in their discretionary and private investment management activities. Payment will be in cash that will be used to buy “high-quality liquid government bonds,” including treasury bills, it said.

“As a result, our clients can be reassured that the funds will not hold any ABCP until we are convinced of the quality and liquidity of the paper, whether or not it is issued by a major bank,” National said.

Meanwhile, individual investors who bought ABCP through the bank or its brokerage arms, will be paid in bearer deposit notes or banker's acceptances, the bank said.

National added that it also will buy back holdings of up to $2-million in ABCP from corporate clients which “do not qualify as accredited investors under securities regulations,” also paying bearer deposit notes or banker's acceptances.

“Thanks to the bank's good financial position, we have the opportunity to voluntarily take these extraordinary measures to maintain the relationship of confidence that we have with our clients,” Mr. Vachon said in a statement.

National said that as a result of these actions it expects to buy a total of about $2-billion in asset-backed paper from its clients, including about $150-million issued by bank-sponsored conduits.

Asset-backed commercial paper is created when banks or other companies take long-term assets such as mortgages, auto leases and credit card receivables, repackage them as short-term debt and sell them to investors, through special purpose trusts, or conduits.

Third-party ABCP is created by non-bank financial companies, the largest in Canada being Coventree Inc. in Toronto.

Coventree became the epicentre of the crisis in the market last week — and saw its stock market value shredded — when it disclosed it could not find buyers for large chunks of this paper when it came due and that banks that had committed to providing it with loans to back-stop its operations were refusing to do so.

It said it plans to assess the value of the acquired paper, as well as other contingencies related to its exposure to the current quarter.

National Bank's shares gyrated up and down and up again on news of the rescue plan. At about 2.20 p.m. EDT, they were back in the black at $54.87, up 7 cents, on the Toronto Stock Exchange, having fallen as $53.75.
The Globe and Mail, Tara Perkins, 18 August 2007

A number of National Bank of Canada's money market mutual funds contain a troubled type of commercial paper that could expose them to potential losses.

National, the country's sixth-largest bank, is the only big bank to have holdings of this type in its money market funds, said Christian Charest, associate editor of Morningstar Canada, which rates mutual funds.

Groupe Desjardins has two money market funds with minimal amounts of exposure, he added.

National Bank declined to comment yesterday. Desjardins could not be reached for comment.

The $40-billion third-party asset-backed commercial paper (ABCP) market fell into disarray recently after liquidity dried up.

On Thursday, a group of 10 financial institutions, including National Bank, announced a preliminary bailout plan for the market. It would see the short-term paper converted into longer-term instruments, with maturities of up to 10 years.

Some fund industry players have complained that money market funds can only hold debt that matures within a year, meaning they might be forced to sell and take a loss.

Five of National Bank's funds are loaded with third-party ABCP issued by conduits that are experiencing a problems with liquidity, Veritas Investment Research analyst Ohad Lederer wrote in a note to clients yesterday. He questioned whether National is the next BNP Paribas.

Paribas, France's biggest bank, sent markets tumbling last week after it said it was freezing three mutual funds, halting withdrawals on billions of dollars of assets.

Mr. Lederer said National Bank told him it believes that if the bailout goes through, National's money market funds will be able to hold the notes and not be forced to sell at a potential loss.

Mr. Lederer estimates that, as of March 31, the five National Bank funds with exposure held between 16.9 and 46.2 per cent of their net assets in commercial paper issued by conduits having liquidity problems.

Mr. Charest said, as of July 31, the five funds had between 8.44 and 42.34 per cent of their holdings exposed to trusts that were on a list of more than 20 trusts and issuers placed under review by Dominion Bond Rating Services this week.
The Globe and Mail, 17 August 2007

Last week, French bank BNP Paribas SA suspended three asset-backed securities funds, saying it could not value them accurately as the liquidity crisis was in full swing around the globe.

Now, Veritas Investment Research is asking if National Bank of Canada is the next Paribas?

Analyst Ohad Lederer points out that National has loaded five of its money market mutual funds with asset-backed commercial paper (ABCP) issued by non-bank conduits that are currently experiencing a lack of liquidity.

“We believe there is a significant risk that these funds will incur losses unwinding their holdings and, in a worst case scenario, the funds may have to suspend redemptions. Should this happen, National’s reputation will be seriously damaged,” he warns, advising investors to “sell” shares of National.

The stock is trading at $53.87, down 43 cents, on the TSX Friday and down from a recent high of $63.64 on July 24.

Mr. Lederer figures National’s Corporate Cash Management Fund, which is benchmarked against 91-day T-bills, holds an estimated $350-million of commercial paper issued by non-bank conduits that are now on Dominion Bond Rating Services’ watch list. That represents an “astonishing” 46 per cent of the fund’s net assets, he adds.
Financial Post, Barry Critchley, 17 August 2007

Seasoned pros have seen it before. Novices in the business now have a new relationship -- one that explains the recent flurry of releases from the chartered banks providing further details of their exposure to the asset-backed commercial-paper sector -- to work on.

"It's all to do with the stock price. They will give more disclosure when they see the stocks melting down," said one observer, adding that after being beaten up for the past few days, most of them rallied yesterday when the banks told the world more about their exposure to the sector.

"It was in their best interests to give some information," said a market participant who contends the rest of the banks learned from the experience of Canadian Imperial Bank of Commerce, which earlier this week detailed its exposure to the U.S. subprime market. Even though the exposure was more than what many expected, the stock rallied. "The banks got a nice lesson in disclosure," added the participant, who says that without the disclosure [from the banks yesterday] the banks would have continued to trade lower. "If investors weren't taking their stocks down, we wouldn't have heard anything more."

Indeed, prior the flurry of information, the market was in the dark. The banks didn't provide this information in their annual reports. Instead, they referred to overall numbers --numbers that included exposure to their own conduits and to third-party conduits. "Their disclosure [until yesterday] was bad until they realized they were going to get hit," said one observer, who still believes the banks haven't told the full story. "They still don't want to provide the nitty-gritty but it's better than nothing."

Among individual banks that commented yesterday, Bank of Nova Scotia said it has $10.9-billion of exposure, of which 73% represents committed liquidity for Scotiabank Canadian sponsored conduits. It has a 3% exposure (or about $300-million) to non-Scotiabank sponsored Canadian conduits. For its part, Bank of Montreal said it "is an insignificant provider of liquidity backup lines to third party administered asset-backed commercial paper issuers in Canada." Toronto-Dominion Bank, which didn't provide any overall numbers, said it didn't have any exposure to non-bank issuers of ABCP. CIBC, which also didn't provide numbers on exposure, said its "direct holdings in the third-party asset backed commercial paper market are not significant." Earlier in the week, Royal Bank of Canada said "over 90%" of its $34.3-billion in backstop liquidity facilities "was committed for RBC-administered commercial paper conduits."

And what's more, a number of the banks reported that their own conduits -- where they are aware of the individual assets that are included -- are preforming satisfactorily.
Financial Post, Paul Vieira, 17 August 2007

Finance Minister Jim Flaherty's statement Thursday to calm investors about Canada's economy amid plunging markets was more a "subtle hint" to the major chartered banks to do their part to ensure the turmoil over a credit crunch does not snowball into a full-blown crisis.

If it was designed as such, the banks got the message. Hours after the Minister's statement was made public, the five major chartered banks -- Royal Bank of Canada, Bank of Montreal, Toronto-Dominion Bank, Bank of Nova Scotia and Canadian Imperial Bank of Commerce -- said in notices they would do their part to make funds available to market participants who find themselves in a liquidity squeeze.

Mr. Flaherty, in his statement, tried to reassure investors about the global credit crunch -- perhaps exacerbated in Canada by concerns in the market dealing with asset-backed commercial paper.

The Minister said he was pleased with an accord struck yesterday, involving a consortium of lenders and investors, to convert asset-backed commercial paper into longer-term notes in an effort to ease liquidity concerns. But he urged players on Bay Street to go further in bringing calm to markets.

"Clearly, there are stresses in some corners of the Canadian money markets. ? [And] I know that there are distinct pressures in the market for the non-bank-sponsored asset-based commercial paper vehicles," Mr. Flaherty said.

"It is in the best interest of all involved that sponsors, liquidity providers (including large international banks) and investors (including large pension funds) engage constructively to pursue orderly market solutions to this liquidity situation," he said in the statement, released after lunchtime when the Toronto benchmark stock index was at its biggest loss of the day.

One market watcher said he believes Mr. Flaherty's words were aimed directly at the big Canadian banks.

"He's basically telling them that everyone ought to co-operate. And I would say it is a subtle hint," said Laurence Booth, a professor at the University of Toronto's Rotman School of Management and an expert in structured finance. "He's suggesting to the banks that they can't operate in their own narrow interests and refuse to honour their commitments."

A string of issuers of securitized debt have sought added funds from chartered banks after failing to find buyers for new paper. But some banks, most notably CIBC, had declined to provide backstop financing -- even though financing agreements between lenders and debt issuers generally provide for emergency funds in times of liquidity shortages, Mr. Booth said.

Later yesterday afternoon, though, the banks appeared to heed Mr. Flaherty's call for credit. Four banks issued statements, in which they pledged their support to find an "orderly solution" in the non-bank commercial paper market

Curiously, stocks on Bay Street recovered in the hours after Mr. Flaherty's statement. Between roughly 12:45 p.m., when the statement was released, and 4 p.m., the Toronto benchmark index went from a 560-point loss to a drop of 200 points.

Mr. Flaherty's statement also went to great lengths to assure Canadians that the fundamentals underlying the domestic economy remained "strong," and that the financial system was "well capitalized."

Nevertheless, he said he was in "close contact" with the Bank of Canada regarding global cash crunches -- stoked largely by a meltdown in the U.S. subprimemortgage market -- and Finance department officials would continue to closely monitor developments.

As part of efforts to stabilize markets, the Bank of Canada yesterday injected an additional $370-million into the financial system through agreements to purchase and resale securities. The central bank this week took the unusual step of extending the list of securities it would accept as collateral on short-term financing arrangements.
The Globe and Mail, John Partridge & Tara Perkins, 16 August 2007

The funding crisis in a key part of Canada's debt market may be over.

A group of 10 major financial players, including Quebec's giant provincial pension fund, said Thursday that, at a meeting in Montreal, they have reached an agreement to bail out the battered $40-billion market for so-called third-party asset-backed commercial paper (ABCP).

In a statement issued at 8.40 a.m. (EDT), the group said its members hold at least two-thirds of this ABCP, and that they are “confident” other market participants will sign on to the agreement.

The key elements of the rescue plan are to convert this short-term debt, which is sold through special-purpose trusts, into longer-term instruments, while also slapping a temporary moratorium on both investors trying to get their money out of the trusts and on issuers seeking financial injections from their lenders to keep the paper afloat.

The third-party ABCP market has been hammered by a sudden, rapid exodus of investors and a refusal by many banks and other lenders to honour agreements to provide such injections.

The third-party segment accounts for about one-third of the total ABCP market, while the other two-thirds is dominated by bank-sponsored trusts.

“Obviously the objective here is to bring some stability to the market, and we're encouraging every holder of this type of commercial paper to roll it over and take part in the standstill period so we can restructure the trusts,” Mark Boutet, a spokesman for the group, said when reached in Montreal.

Besides the Caisse de dépôt et placement du Québec, which is believed to have spearheaded the push for a solution, the 10-member group includes: ABN Amro, Barclays Capital, Desjardins Group, Deutsche Bank, Merrill Lynch, National Bank of Canada and UBS, along with PSP Investments, the investment arm of the federal Public Service Pension Investment Board, the pension plan for the federal public service, the armed forces and the RCMP.

The federal Finance Department was heavily involved in brokering the deal, sources in Ottawa said.

Finance Minister Jim Flaherty applauded both the rescue plan and the “positive actions” of Canadian banks in support of the ABCP vehicles they sponsor and exhorting all market players to pull together to try to stabilize the market.

“I know that there are distinct pressures in the market for the non-bank sponsored asset-based commercial paper vehicles,” Mr. Flaherty said in a statement issued at midday.

“It is in the best interest of all involved that sponsors, liquidity providers (including large international banks) and investors (including large pension funds) engage constructively to pursue orderly market solutions to this liquidity situation.”

Later in the afternoon, the Bank of Canada also voiced support.

“The agreement announced this morning by major investors and liquidity providers to pursue an orderly restructuring of the Canadian market for structured finance asset-backed commercial paper (third party ABCp) provides an opportunity for parties to work through the many complex issues related to the market for asset-backed commercial paper,” the central bank said in a statement.

“The Bank also welcomes the confirmation by Canada's major chartered banks that they are supporting their own bank-sponsored asset-backed commercial paper programs.”

The commercial paper crunch is part of the worldwide fallout from the implosion of the U.S. subprime (read “high risk”) residential mortgage market.

The group's statement came as the Bank of Canada injected another $370-million in temporary short-term credit into the financial system in its latest bid to help loosen the credit squeeze.

Among the most important terms of the pact announced Thursday morning are that all outstanding third-party ABCP will be converted into term, floating-rate notes that will mature no earlier than the underlying assets and on which interest will be payable monthly or quarterly to match the fixed payment dates on those underlying assets.

“Existing liquidity facilities will therefore not be necessary and will be cancelled and all outstanding liquidity calls will be revoked,” the group said.

As well, margin agreements on the ABCP will be “revised to create renewed stability, thereby reducing the likelihood of near-term margin calls.”

In the short term, meanwhile, the group's members have agreed to continue to roll over the paper they hold for the next 60 days and will “encourage” other holders who have not yet signed up to do the same.

As well, they will not pursue any margin calls during this standstill period against any of the so-called conduits, which have repackaged the ABCP into special-purpose trusts they have then sold to investors. The conduits, in turn, will drop requests for liquidity they have already made and not make additional calls for 150 days after the standstill expires.

The conversion of the trusts to notes is designed to turn short-term instruments into longer term instruments, Mr. Boutet said, while the standstill will provide time for investors to approve the conversion, he said.

However, persuading investors to do this could be a tough proposition, judging by complaints about the rescue package levelled by Ken Anderson, who manages both the Canadian and U.S. money market funds for Fidelity Investments.

"What is really disheartening is that there was a meeting just yesterday with some of the largest underwriters of these securities and they've come to in their minds a great solution, they're going to take these extendible securities and turn them out into three- and five-year portion of the curve," Mr. Anderson said during a conference call Thursday. "We have one-year guidelines. We cannot invest out past one year. So, I'm not sure what type of solution this is.

“I think the holders of these securities will be forced to sell and most likely take some losses in their funds."

By contrast, one of the trusts affected by the crisis welcomed the news of the rescue package, calling it “important.”

The trustee for Global Diversified Investment Grade Income Trust II, which holds credit default swap agreements against various mortgage- and asset-backed securities and other instruments, said that the deal “could resolve the current inability” of its counterparty Silverstone Trust to renew or replace maturing short-term debt.

News of the rescue plan did nothing to stop another stock market plunge, which saw the S&P/TSX composite index drop dramatically.

Dominion Bond Rating Service said the agreement “reduces the liquidity risk, while exposing the investor to the same amount of credit risk that the investor held prior to the exchange.”

It added in a statement that it has placed about 90 individual asset-backed commercial paper trusts “under review” following the announcement.

News of the rescue plan could be especially sweet for structured finance firm Coventree Inc. of Toronto, the largest player in this market, whose troubles have become the epicentre of the crisis and whose stock market value has been shredded since the crisis began.

Coventree has been most visibly hurt by the commercial paper crunch and, despite news of the rescue package, its shares fell again Wednesday, as markets plunged.

Coventree operates nine conduits, special-purpose trusts that hold such long-term assets as mortgages, auto leases and credit card receivables that the firm buys from their originators, and then repackages and sells to investors as short-term debt.

Before the lenders group made its announcement Thursday, Coventree issued a statement saying it had been unable to find buyers for any ABCP that came due Wednesday, and has now requested a total of $1.6-billion in liquidity from its lenders, but that most are balking at providing funds.

The rescue plan also could benefit CFI Leasing Ltd. of Toronto, the latest player in the ABCP market to disclose it has run into trouble. It said Thursday morning that CFI Trust, which it manages, has been unable to roll over $82-million in asset-backed commercial paper and has therefore extended the term.

Quebec's Caisse is the biggest buyer of the asset-backed paper in which entities like Coventree and CFI Trust operate. The Globe and Mail reported Thursday that the giant Quebec pension fund has been pushing Canadian and international banks to provide liquidity to bail out the seized-up ABCP market.

In a report issued Wednesday, Merrill Lynch Canada Inc. economist and strategist David Wolf hypothesized that confidence could quickly return to the ABCP market if there were an agreement among participants or banks demonstrated they were broadly willing to provide backstop financing.

“Crisis over, Canadian ABCP starts rolling again at higher market-clearing spreads, and we wait for the credit crunch mole to pop back up in another market and another country.”

Without such a development, Mr. Wolf said, Coventree and other third-party sponsors' trusts could quickly begin defaulting.

Given the deteriorating global credit backdrop, he said, creditors would likely have an incentive to act quickly, likely leading to the forced sale of underlying assets. “This could end up being the tug on the Canadian string that further unravels the global credit ball of yarn, as these assets are both pressured and marked for the world to see,” Mr. Wolf warned.
Bloomberg, Doug Alexander and Frederic Tomesco, 16 August 2007

ABN Amro Holding NV, Deutsche Bank AG and eight other banks and money managers agreed to convert asset- backed commercial paper in Canada into longer-term notes to ease a credit crunch in the C$40 billion ($37 billion) market.

The group of lenders and investors, which also includes the Caisse de Depot et Placement du Quebec and Merrill Lynch & Co., signed an agreement in Montreal today, according to a statement.

The accord may lift a money-market freeze in Canada sparked by the meltdown in the U.S. subprime mortgage market. Commercial paper trusts in Canada have been unable to sell debt coming due this week, and banks such as Deutsche and Barclays Plc have declined to provide emergency funding.

``This is a bad precedent, it's a form of bailout,'' said Hans Black, chairman and chief investment officer at Interinvest Consulting Corp. in Montreal, which manages about $2.8 billion and doesn't own commercial paper. ``This is going to calm the markets down, but only temporarily.''

Under the agreement, the commercial paper funds will be converted to floating-rate notes with maturities linked to the underlying assets, such as mortgages and corporate loans. Commercial paper in Canada typically matures in one to three months.

``It creates bigger problems down the road,'' Black said. ``This is floating-rate paper that is being issued, so somebody is going to have to get paid at some point.''

The pension funds, which include the Caisse de Depot et Placement du Quebec, also agreed to roll over maturing commercial paper for 60 days while the restructuring is carried out. These funds will also encourage other investors to roll over debt as it matures. The agreement is supported by two-thirds of the holders of this type of commercial paper, the group said.

Caisse, the largest pension fund manager in Canada, is among the largest holders of asset-backed commercial paper and called the group together to reach an agreement. The Montreal-based fund manager owned about C$1.69 billion of the debt at year end. The Caisse declined to say how much it still owns.

As part of the agreement, the banks won't seize assets as collateral during the period, and commercial paper issuers won't seek emergency financing from banks for 210 days, the statement said. The banks have refused funding for some trusts this week, arguing the freeze wasn't a ``market disruption'' that would force them to provide financing.

The agreement was also signed by Desjardins Group, HSBC Holdings Plc, The Public Sector Pension Investment Board, National Bank of Canada, Barclays Plc and UBS AG. DBRS, a Toronto-based rating company, was present for the discussions.

``It will resolve the liquidity crisis facing these conduits and the risk that they will default,'' Desjardins Securities analyst Michael Goldberg said in a note. ``We view this as a positive development overall for capital markets because it should reduce concerns about this issue spreading.''

Canadian Finance Minister Jim Flaherty said he welcomed the agreement and encouraged banks to pursue further ``market solutions,'' according to a statement today.

Royal Bank of Canada, the country's largest bank, Canadian Imperial Bank of Commerce, Toronto-Dominion Bank and Bank of Montreal said in separate statements that they support the agreement.

``We are supportive of attempts to resolve issues, even if we are not directly involved, and would encourage other financial institutions to do the same,'' said Toronto-Dominion Chief Executive Officer Ed Clark in a statement.

About 23 commercial paper trusts will be supported, with assets of C$35 billion. These include at least seven run by Coventree Inc., Canada's biggest issuer of non-bank asset-backed commercial paper, and three run by Metcalfe & Mansfield Capital Corp., whose owners include Deutsche Bank and National Bank. Other trusts include Selkirk Funding Trust, Devonshire Trust, Foundation Trust and Skeena Capital Trust.

Coventree's units have been struggling to refinance debt as the subprime crisis spills over into Canada's C$120 billion asset-backed commercial paper market, about a third of which is run by non-commercial bank firms such as Coventree.

Coventree is ``supportive'' of the proposal to ``stabilize'' the market and hasn't issued funding requests on its paper that matured today, the Toronto-based company said in a statement. Earlier today Coventree said it was seeking an additional C$790 million of emergency funds from banks after failing to sell any notes yesterday.

Its shares rose 10 cents, or 2.6 percent, to C$4 at 3:26 p.m. trading on the Toronto Stock Exchange, and have declined 69 percent in five days. Canadian banks shares also rose, led by Bank of Montreal and Toronto-Dominion.

The agreement could offer relief for firms such as Redcorp Ventures Ltd., a Vancouver-based mining company whose repayments of C$102.2 million from investments in Coventree funds have been delayed.

``It's still a little murky right now, but obviously there's a lot of people working on this issue to resolve it,'' Redcorp President Terence Chandler said in an interview. ``We're hopeful that that means we'll have a resolution in our particular case as soon as possible.''

Redcorp told investors today it didn't receive repayments from Coventree, driving the stock down as much as 64 percent in Toronto.

``It's sheer worry and panic,'' said Denis Durand, a senior partner at Montreal fund manager Jarislowsky Fraser Ltd., which oversees the equivalent of $58.7 billion. ``Everyone in Canada thought a few weeks ago that the subprime mortgage problem was something limited to the U.S.''

Canadian banks account for about two-thirds of the asset- backed commercial paper market, led by Bank of Montreal and CIBC, according to DBRS. These banks have said this week they haven't had trouble rolling over their commercial paper, and that they aren't ``significant'' suppliers of emergency funds for these non-bank trusts. Foreign banks such as Barclays are the most active in that area.

``We believe this is good news for the Canadian banks, as it reduces the likelihood that they will have provided back-stop liquidity support'' to these trusts, CIBC World Markets analyst Darko Mihelic said in a note.