ABCP agreement will try to stem liquidity crisis

Some of the country’s largest third-party providers of asset-backed commercial paper (ABCP) and their lenders reached an agreement Thursday that will attempt to stem a growing liquidity crisis in the ABCP market. The crisis has been a leading driver in the current Canadian market downturn.

Many of the key institutional lenders to third-party ABCP providers — including ABN AMRO, Barclays Capital, Caisse de dépôt et placement du Québec, Desjardins Group, Deutsche Bank, HSBC, PSP Investments, Merrill Lynch, National Bank and UBS — agreed to solutions that will attempt to slow the liquidity problems currently plaguing the ABCP market. DBRS, the country’s largest ABCP ratings provider, was also on hand.

Concerns about ABCPs, which are short-term debt obligations often used to refinance debt assets like mortgages, came to the forefront earlier this week when Coventree Inc., the largest third-party provider of ABCPs, said it didn’t have enough money to cover the price of its maturing ABCPs.

Usually, providers “roll over” their debt by issuing new ABCPs to cover the cost of the maturing ABCPs. Sub-prime and credit concerns have meant that the ABCP market has all but dried up, making it extremely difficult for providers to raise more capital.

Coventree appealed to some of its large institutional lenders for more funds to cover costs but was denied. The result has been a cascading climate of fear about ABCP defaults and risk in investments with exposure to them, such as money-market funds.

Thursday’s agreement seeks to protect ABCP providers from having to cover the cost of maturing debt obligations, while absolving their lenders of any obligation to have to provide excessive liquidity.

The key agreement, which is being proposed as a long-term solution is to convert all outstanding ABCPs into floating rate notes (FRNs). This means that the maturity of the debt obligations will be tied to the termination date of the underlying assets. Interest on the FRNs will be payable monthly or quarterly, as the case to match the fixed payment dates under the underlying assets.

This protects third-party ABCP providers from continually having to come up with liquidity to cover the maturing obligations.

“There will be a 60-day period. Signatories [ABCP providers] of the agreement have agreed that whatever asset-backed commercial paper they own they will roll over and won’t cash out, and in turn, the lenders to the third-party ABCP providers will not call margins,” says Mark Boutet, a spokesperson for the meeting.

Accordingly, ABCP providers have agreed to allow all existing liquidity arrangements and all outstanding liquidity calls to be revoked, absolving lenders of having to bail out the providers.

Boutet says the agreement is not a completely done deal. It’s going to require the note-holder approval of those currently holding ABCP from short-term and long-term investment vehicles. Boutet is confident that ABCP holders will approve the agreement, though, because it’s in everyone’s interest to see markets stabilized.

“[With this agreement] there are a significant number of investors willing to be patient and are encouraging other holders of the notes to be patient and honour the agreement so there can be stability to the market,” he says.

The agreement has already been met with open arms by Minister of Finance Jim Flaherty. “I welcome the positive actions of Canadian banks in support of asset-backed commercial paper vehicles that they sponsor,” he said in a statement. “I know that there are distinct pressures in the market for the non–bank-sponsored asset-based commercial paper vehicles. It is in the best interest of all involved that sponsors, liquidity providers (including large international banks) and investors (including those invested in large pension funds) engage constructively to pursue orderly market solutions to this liquidity situation.”

In addition to note-holder approval, legal and regulatory processes will need to be carried out by each individual provider before the ABCPs are converted to FRNs. The meeting’s participants expect that all necessary steps to give effect to this restructuring will be completed within 30 to 60 days.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com