Banks purge scrap paper from funds

In an effort to instill confidence in some of their mutual funds, National Bank and Desjardins Group have purchased all of the asset-backed commercial paper (ABCP) holdings from their subsidiary mutual funds.

The move comes on the heels of an agreement struck last week between issuers of third-party ABCP debt and their lenders allowing the conversion of ABCP into floating rate notes (FRNs) that would mature upon the termination of the underlying assets.

The debt instruments, which are short-term obligations to refinance debt assets like mortgages, have plagued the Canadian capital markets over the past few weeks because third-party issuers have been unable to come up with the capital to cover maturing issues.

In a healthy market, providers “roll over” their debt by issuing new ABCP to cover the cost of the maturing debt. Sub-prime and credit concerns have meant that it’s virtually impossible to sell new ABCP.

By turning the ABCP into FRNs, providers are able to defer paying back the face value of the maturing ABCP over the short-term. The problem is that most money market funds cannot hold commercial paper that has a term longer than one year.

David O’Leary, manager of fund analysis at Morningstar Canada, says the agreement means money market funds will be forced to sell their ABCP holdings in a hostile market.

“The latest national instrument states that the maturity of debt obligations in money market funds has to be under one year, so money market funds with ABCP exposure wouldn’t be able to take advantage of the FRNs that are more than a year,” he says.

National Bank and Desjardins have circumvented this problem by buying the ABCP for its full face value, plus accrued interest, in order to protect their funds from suffering the massive losses that would result from a forced ABCP sell-off in current market conditions.

For National Bank in particular, the move is a costly one. The bank said it will buy back more than $2 billion in ABCP from its mutual fund subsidiaries, which include National Bank Mutual Funds and Altamira Mutual Funds.

“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,” says Louis Vachon, CEO of National Bank. “We will continue to work for all participants — and with them — to protect the value of their investment in ABCP instruments and to find solutions to the current situation.”

Desjardins says that only a “small portion” of its fund holdings are in ABCP, but it wanted to “protect its members against the current uncertainty prevailing in the ABCP market.”

R elated Stories

ABCP agreement will try to stem liquidity crisis Market disruption language could hurt financials further

Both National Bank and Desjardins say the majority of the ABCP debt has been granted excellent credit ratings of R-1 (high) by the rating agency DBRS, which is the equivalent of a AAA rating for bonds.

O’Leary says the credit rating doesn’t factor much into the ABCP buyback but that it is an essential public relations move to safeguard the reputation of the funds. He expects other fund companies with significant ABCP exposure to follow suit.

“It’s really, really bad PR to have exposure to these things in your money market funds,” he says. “Out of that $2 billion that National Bank buys back, a lot will probably be fine, for all we know, but it’s better to get rid of the stuff entirely and take the risk away from their investors.”

BMO also attempted to reassure its money market fund investors about ABCP worries, announcing that it has no third-party ABCP exposure.

“None of the money market funds offered by each of BMO Mutual Funds and GGOF Guardian Group of Funds has exposure in their portfolios to asset-backed commercial paper issued by non–bank-sponsored conduits,” BMO said in a statement. “All asset-backed commercial paper owned in these Canadian money market funds is sponsored by the major Canadian banks and does not include any exposure to U.S. sub-prime, collateralized debt obligations and derivatives markets.”

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

(08/20/07)

Mark Noble