Montreal ABCP meeting: What it means for client investments

The standstill period for the Montreal Accord on non-bank asset-backed commercial paper expires on Friday. The industry is expecting an announcement on how more than $30 billion in outstanding ABCP will be restructured. The decision will have little direct impact on retail investors, but there could be some spillover that will affect money market funds.

In August most of the country’s largest third-party providers of ABCP and their lenders came to an agreement to postpone the maturity of their ABCP holdings, which are short-term debt obligations often used to refinance debt assets like mortgages. Exposure to the U.S. sub-prime market in some of the underlying assets of this paper virtually wiped out any demand on the market.

On Friday, this postponement ended, and it is expected a committee representing what has become known as the Montreal Accord will announce what will happen to the paper.

Colin Kilgour, president of Connor, Clark & Lunn Wholesale Finance, expects that the Montreal meeting will result in a further standstill of ABCP for another three months while holders convert them to longer-term floating rate notes with a maturity attached to the termination date of the underlying assets.

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“There is a discussion of converting the ABCP to floating rate notes, where each note holder will get two notes, one senior note and one junior note that together will reflect the par value of the securities,” he says. “The more senior note, which is the higher-quality piece, will only reflect the current market value of the client’s holdings, which may well be less than 100 cents on the dollar.”

The problem, Kilgour points out, is the Montreal committee is not expected to announce what the market valuations will be. DBRS has determined the creditworthiness of the majority of ABCP, but since no one wants to purchase the assets at their face value for fear of defaults in the underlying assets, their value is essentially unknown. American investment banking giant JPMorgan has been tasked with determining the value.

“My understanding is that we will not be getting valuations when they make an announcement today, which is really disappointing. JPMorgan has the valuations and has shared them with certain investors but not with the broader investor community. For instance, the Caisse [de Dépôt et Placement du Québec] and those in the Montreal committee would have seen the valuations. Investors who are not on the Montreal committee would not have seen them,” he says.

Most of the mutual funds that had third-party ABCP in their holdings were able to remove them or sell them to their parent companies. For money market funds, though, this is a big problem because it leaves in flux what was one of the key sources of yield available to them.

The rise of ABCP was directly related to a low-interest-rate environment. They were a conservative investment alternative to lower-yield treasuries and corporate bonds. Kilgour says money market funds really don’t have any alternatives available to them to duplicate that yield without increasing their risk profile.

Without ABCP, money market funds have their yields reduced to what many retail investors can get from high-interest savings accounts for a fraction of the cost.

“Money market funds have definitely been seeing a reduction in assets over the last three or four years. I think the advent of high-interest savings accounts that pay a quarter point trailer to advisors is a big part of the explanation,” says fund industry analyst Dan Hallett, president of Dan Hallett and Associates.

One of the industry’s top providers of high-interest savings accounts was Dundee Bank, which derived its interest payments partly through ABCP. But unlike most money market funds, Hallett says high-interest savings accounts are generally guaranteed by the Canadian Deposit Insurance Corporation. Also unlike money market funds, investors can find safer forms of higher yield from their lending operations.

“What some of the banks can do is offer a competitive yield based on spread — as long as they can turn enough of a spread and they are relatively lean, which many of these virtual banks are,” says Hallett. “This gives them a bit of a higher-yield investment to source from the lending side, so they are not necessarily reliant on commercial paper.”

Investors should also keep an eye on the different camps that emerge from Montreal, Kilgour says. If the ABCP is converted into the floating rate notes, he expects, institutional investors will approach their ABCP holdings in three different ways.

He expects that the larger institutional investors will hold on to their ABCP until maturity, in seven to 10 years, because the underlying creditworthiness is still considered relatively sound, despite tightening credit conditions and an increase in defaults.

He expects smaller ABCP holders, with less than $100 million in assets, to try to sell their holdings as soon as their value is determined or sue those from whom they bought the ABCP.

“They invested in it as an equivalent-to-cash investment and want their cash, which they have been waiting for four months. Some of those guys will find hedge funds to sell their ABCP to and will take a haircut on it when they do,” he says. “There’s a third camp that will see the valuations that are 50-, 60- or 70-cent valuations on the dollar, and they’ll say, ‘you know what, it’s worth it to me to sue someone.'”

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

(12/14/07)

Mark Noble