Affordable Housing Institute : US

Last fall, with a very Canadian minimum of fuss, our neighbors from the Great White North pulled off a deft exercise in recapitalization and the triumph of shared interests, in what they all call the Montreal Accord.  To quote the Financial Times:

 

Under an August 16 deal, known as the Montreal Accord, a group of issuers, investors and banks agreed to a moratorium on claims pending a restructuring of the market.

 

Though its title suggests a Ludlum thriller, it was in fact a clever, swift, cartel-like resolution of a problem common to all the banks and now besetting the globe: a sudden freeze in the ability to resell asset-backed commercial paper. 

 

Only one man can stop the global crisis …

 

I stumbled over this in, of all places, Sun City, South Africa, when I was sharing an International Union of Housing Finance panel with Andy Asselin of Canada Mortgage and Housing Corporation, who described it.  Here, as I understand it based on the few articles I could readily access (all errors are mine!) are the essential ideas:

 

1.  Resale freeze.  The major Canadian banks collectively owned a super-majority of interests in pools of sliced-and-diced asset-backed commercial paper (”ABCP”).  The individual ABCP asset values were being pummeled by the same mark-to-distressed-sale-comparable problem afflicting US assets. 

 

Want … to … resell … my … position

 

Since August, 20 highly leveraged trusts, or conduits, have been frozen in Canada when issuers were unable to roll over maturing paper as a result of turmoil in the US subprime market, investors’ diminished appetite for risk and the failure of emergency ABCP liquidity provisions unique to the country.

 

2.  Pooling of assets.  Recognizing that the ABCP resale freeze would not end anywhere near soon enough to stabilize their balance sheets before the next critical reporting period, the major banks elected to place all these individual assets (each, a “Contribution”) into an enormous resolution pool (the “Pool”).

 

Hold your nose and contribute your assets!

 

The main proposal under the restructuring plan is to convert ABCP held in the conduits into floating-rate notes with longer maturities of between five and eight years.

 

3.  Issuance of new paper.  The Pool would issue standard new instruments (”New Paper”) whose maturities would match those of the underlying ABCP assets, and which would the consideration given to the participating banks for contributing their ABCP.

 

Just add financial toner – make sure you have enough red link!

 

4.  Agreed valuation algorithm.  Since each participating bank’s contributed asset set would be different – a little different or a lot different – the parties had to agree on a common means of valuing them all.  So they got together (perhaps facilitated by independent valuation experts), and collectively hammered out a valuation algorithm (the “Measuring Tool”) that everybody accepted would be applied to all Contributions.

 

Are those writedowns in metric?

 

The securities will be divided into three groups, according to the quality of their underlying assets.

 

Note that each participating group could run the draft Measuring Tool in real time on its own pool, thus always having a private assessment of its own Contributions’ value.

 

5.  Equitable valuation of all Contributions.  After agreeing on the Measuring Tool, the parties then submitted their ABCP to a qualified independent valuation expert (the “Wizard”) for a binding assessment.  The Wizard put each contribution into the Measuring Tool and issued its report.

 

All results guaranteed!

 

6.  Simultaneous mutual exchange.  On an agreed date, everyone contributed their assets into the Pool and received shares in exchange.

 

I’ll swap my rags for yours

 

Purdy Crawford, the committee’s chairman, said that failure to approve the restructuring would bring investors “back to where they are now”.

 

That everybody played was important.  As Reuters put it:

 

TORONTO, March 17 /PRNewswire-FirstCall/ – TD Bank Financial Group (TDBFG) today confirmed that, following a specific request, the Bank will provide financial support to the agreement commonly known as the Montreal Accord aiding in the restructuring of the non-bank sponsored asset-backed commercial paper (ABCP) market. TD’s financial participation will not be material to the Bank, reflecting the fact TD did not have exposure to the non-bank ABCP

market.

 

Come on, TD Bank, come on boy!

 

“In light of continued challenges facing financial markets, TD was asked to play a role and we’ve agreed on the basis that both the government and the Montreal Accord Committee indicated our participation is critical to the overall success of the restructuring process. We have always said that we would be part of a solution if our participation was needed to resolve this issue and did not involve significant risks to our shareholders and customers,” said Ed Clark, President and CEO, TDBFG.  “The Pan-Canadian Committee’s ability to reach an agreement is a positive step forward in contributing to a solution that brings stability to this market issue.”

 

The power of the group – it’s the same force that makes lending to savings co-operative members safer, because the group can coerce compliance.

 

7.  Agreement to hold until runoff.  Canada’s banking regulator agreed that the banks could hold the paper until it ran off.

 

Mr Crawford said that while the deal might mean “some diminution” in value, “the restructuring gives investors a reasonable expectation of receiving the full par value over time”.

 

8.  Collateral backstopping with sovereign credit.  As we’ve seen in the US, with banking on value and putting the GSEs into conservatorship to back their paper, sovereign credit is the rock in a crisis.  And the pension fund was just sitting there!

 

The agreement includes a C$14bn credit facility to provide extra collateral in the event of margin calls as the value of the trusts’ assets declines. The margin call funding facility will be provided by foreign and Canadian banks, and large ABCP investors, notably the Caisse de depot et placement du Quebec, the province’s public pension plan.

 

9.  Regulator’s benediction.  The regulators also agreed, based in part on new collateral posted, to value the paper based on what Paulson/ Bernanke would call “mark to maturity” or “mark to model.”

 

I’m giving it my blessing

 

Most of the affected notes are expected to receive triple-A credit ratings, helping to make them more liquid.

 

Clever, eh?  It depended on three preconditions:

 

1.  Concentration.  All the paper was concentrated in a few big banks.

 

About 11 foreign institutions were active ABCP dealers and asset providers. They sold packages of credit default swaps to the conduits, giving them the right to make margin calls.

 

We’ve concentrated all the risk

 

2.  Mutual trust.  The banks, being all domestic to Canada, were comfortable working with one another.

 

More than a dozen banks and dealers [in] in Canada’s asset-backed commercial paper (ABCP) market, [participated] in a restructuring plan covering C$33bn ($33.6bn) of the distressed securities.

 

3.  Regulatory help.  The regulator played ball (in a good way).

 

Of course, that was Canada, and our situation is different.  There are plenty of barriers to doing this broadly in the US:

 

What, you don’t think Washington would play ball?

 

1.  The US is a different ecosystem.

 

The restructuring is a step towards improving liquidity in global credit markets. But it will not be easy to replicate in places where markets operate under different rules. Many US money market funds are barred from converting short-term paper into medium-term notes, for example.

 

2.  US asset pools are much more complex and heterogeneous.

 

3.  US structured assets are often more remote (derivatives or slices of derivatives) from the properties themselves.

 

4.  US structured assets have much less concentration.  They’re spread around the globe, with vast amounts held by foreigners.

 

One could, however, imagine doing it more narrowly – e.g. by asset class (such as multi), geography (particular areas), or even by institution (e.g. those taking TARP money).

 

Nine steps to success, right?

 

Nonetheless, some lawsuits have already been launched by investors claiming that they were misled about the creditworthiness of the securities.

 

Just one eensy-weensy loose end:

 

Don’t pull that

 

[Continued tomorrow in Part 2.]

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