Unforeseen Risk

by Richard K. Brawn, CCGA, MPA | August 21, 2008

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Frank Barbera’s Market Wrap up of August 19, 2008 was an excellent warning of what I also feel is to come.  I want to offer up a small example that may help some folks understand why this credit problem is far from over.  

Canadian investors are probably more attuned to what is happening with Company Creditors Arrangement Act of Canada (CCAA) law application to Asset Backed Commercial Paper (ABCP) than are we Americans.  Ivanhoe Mines purchased ABCP from Coventry Capital. The paper had a triple A rating and assurance of liquidity. However, the liquidity of the Asset Backed Commercial Paper dried up and the notes could no longer be liquidated. An Ontario Superior Court has ruled on a restructuring plan for $32 billion worth of frozen non-bank asset-backed commercial paper that includes the paper purchased by Ivanhoe Mines. The ruling has now been reaffirmed by the Ontario Court of Appeal. The ruling allows certain classes of (individuals) purchasers to have their holding bought back from them, but not others. Institutional investors objected to the special treatment and to blanket protection against civil suits granted to the banks and brokers who sold the ABCP.  Under the ruling, the institutional investors would receive notes based upon the pooling of the ABCP and due sometime in the future. The court perspective is somewhat eye-opening.

Here are a few lines from the Globe and Mail of Canada:   (BOYD ERMAN, August 19, 2008)

The Ontario Court of Appeal wrote: “The CCAA is a sketch, an outline, a supporting framework for the resolution of corporate insolvencies in the public interest,” the unanimous decision states. “Parliament wisely avoided attempting to anticipate the myriad of business deals that could evolve from the fertile and creative minds of negotiators restructuring their financial affairs.

“It left the shape and details of those deals to be worked out within the framework of the comprehensive and flexible concepts of a ‘compromise' and ‘arrangement.' I see no reason why a release in favour of a third party, negotiated as part of a package between a debtor and creditor and reasonably relating to the proposed restructuring cannot fall within that framework.”

“In insolvency restructuring proceedings almost everyone loses something,” Monday's decision said.

“Here, the debtor corporations being restructured represent the issuers of more than $32-billion in non-bank sponsored ABCP notes. The proposed compromise and arrangement affects that entire segment of the ABCP market and the financial markets as a whole. In that respect, [Justice Campbell] was correct in adverting to the importance of the restructuring to the resolution of the ABCP liquidity crisis and to the need to restore confidence in the financial system in Canada.

“He (lower court judge, Justice Campbell) was required to consider and balance the interests of all note holders, not just the interests of [those who launched the appeal], whose notes represent only about 3 per cent of that total. That is what he did.”

The Ontario Court of Appeals ruling conflicts with an earlier Quebec Court of Appeals ruling. So, Ivanhoe is appealing to the Canadian Supreme Court. At issue is whether or not under CCAA a court can grant blanket protection to the advisors and sellers of ABCP when they agree to participate in the reorganization plan.

In the US, the agreements between the New York District Attorney and similar entities that marketed US ABCP follow a very similar line.

It leaves unanswered the question of where the money to re-liquefy the ABCP will come from. It increasingly looks like any prospective investor in ABCP must be prepared to accept long term illiquid notes, with the note holder ownership rights to the collateral compromised by court rulings/DA agreements. What this tells me is that the credit crisis is far, far from over.

 

Copyright © 2008 Richard K. Brawn
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Richard K. Brawn, CCGA, MPA | Petaluma, CA USA | Email
California Certified General Appraiser (CCGA) | Master Public Administration (MPA)

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