Cablegate: Unraveling Canada's Asset-Backed Commercial Credit Crunch

DE RUEHON #0430/01 2981844
P 251844Z OCT 07








E.O. 12958: N/A
SUBJECT: Unraveling Canada's Asset-Backed Commercial Credit Crunch

REF: Toronto 422

Sensitive But Unclassified -- protect accordingly.

1. (SBU) SUMMARY: By agreement among the players, the Canadian
non-bank asset-backed commercial paper (ABCP) market, which was
valued at C$40 billion in August, is frozen until December 14.
Canada's market for ABCP sold by non-bank dealers ground to a halt
in mid-August after Toronto-based Coventree Inc., and other ABCP
sponsors, failed to roll over their maturing ABCP debt because of
fears of exposure to bad credit in the U.S. sub-prime mortgage
market. ABCP holders have been left carrying billions of dollars of
commercial paper they cannot redeem. While a team of investors,
bankers and lawyers is working (with the approval of regulators and
the central bank) to thaw the non-bank ABCP market through
restructuring, market watchers fear the trouble could spill-over
into the C$80 billion Canadian bank-sponsored ABCP market (C$1 =
US$1.03). Further analysis of the ABCP market crisis may prompt
revisions to Canadian banking regulations to provide greater
protection for consumers. END SUMMARY.


2. (SBU) Between 2000 and August 2007 the Canadian ABCP market grew
faster than in other countries, doubling in size to C$120 billion.
Even before problems surfaced in August, the Canadian ABCP market
was disproportionately larger in the Canadian financial system than
the U.S. ABCP market in the U.S. system. Commercial paper is
short-term debt issued by banks or corporations. Asset-backed
commercial paper is debt in the form of mortgages, car loans, or
credit card receivables which has been repackaged and sold to
investors by a bank or another financial company.

3. (SBU) The commercial paper market ran into trouble around the
world when the U.S. sub-prime mortgage market plunged in the summer.
Investors, anxious about the Canadian ABCP's possible exposure to
sub-prime mortgage problems, stopped buying ABCP investment
instruments, leaving ABCP holders (or conduits) unable to make the
required interest payments to their investors. The conduits in turn
went to their banks for funding, but the banks refused to provide
it. The ABCP holders had understood that their maturing notes
carried liquidity guarantees, but certain foreign banks, including
ABN Amro, Barclays, Deutsche Bank, and HSBC, were less accommodating
than expected. In the U.S., financial institutions that had
provided liquidity guarantees did not have as much latitude to
withhold funds because those guarantees were broader than those that
were required in Canada.

4. (U) In what is known as the "Montreal Accord," on August 16
Canada's five largest banks -- Royal Bank of Canada,
Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, and
Canadian Imperial Bank of Commerce (CIBC), along with the somewhat
smaller National Bank of Canada -- pledged their support to the C$80
billion market for ABCP which they had sponsored (the so-called
"bank sponsored" ABCP). However, this left the smaller, remaining
C$40 billion market for "non-bank" ABCP still dysfunctional (NOTE:
The so-called "non-bank" market includes paper sponsored by
institutions which may be called "banks" but are not among Canada's
Big Five. END NOTE).

Immediate Fallout

5. (SBU) Toronto-based Coventree Inc. was Canada's largest non-bank
issuer of asset-backed commercial paper. The company's woes became
public in August when it could not find new buyers for several
billion dollars-worth of asset-backed loans that came due. Last
month, Coventree announced it was slashing 30% of its workforce
(about 25 jobs), and would close its Denver office in an effort to
cut costs to help weather the disruption of the ABCP market.
Coventree has also scaled down its office space in Toronto. The
workforce reduction, including severance, reportedly will cost the
company about C$1 million. Coventree reportedly holds an estimated
C$16 billion in outstanding debt and could face an after-tax loss of
about C$3.5 million if it is forced to write off its ABCP-conduit
loans. Coventree reportedly administers about C$7 billion worth of
frozen notes.

Bank Exposure

TORONTO 00000430 002 OF 003


6. (SBU) Canada's big banks appear to be buying up some of the ABCP
that they sponsored. Bank of Montreal (BMO), Canada's fourth
largest bank (market capitalization about C$33.2 billion) reportedly
has been one of the biggest players in Canada's bank-sponsored ABCP
market. Market analysts speculate that BMO may have bought back
billions of dollars worth of bank-sponsored ABCP since the August
market meltdown, as evidenced by BMO's balance sheet increasing by
C$22 billion (or 6%) in August. Approximately C$13 billion of the
increase was in debt securities, where analysts speculate the bank
repurchased some of its own bank-sponsored ABCP. Montreal-based
National Bank's (Canada's sixth largest bank, with a market
capitalization of C$9.6 billion) balance sheet also expanded
significantly in August. At that time, National Bank announced it
was buying back about C$2 billion in non-bank ABCP held in money
market mutual funds by National Bank and Toronto-based Altamira
Investment Services, which is owned by National Bank.

Finger-Pointing Ensues

7. (SBU) According to market analysts, the narrowness of the
Canadian definition of "market disruption" caused the problems in
the Canadian market. The narrow definition enabled liquidity
suppliers, such as banks, to avoid fully backing their ABCP except
in the most extreme circumstances. Foreign financial institutions
like Barclays and Deutsche Bank comprised 90% of the
non-bank-sponsored Canadian ABCP market. These foreign banks
reportedly exploited the opportunity to make large profits at low
risk in the Canadian ABCP market -- earning fees by nominally
guaranteeing liquidity without ever having to formally set aside
assets or capital to actually supply the liquidity.

Investor Committee Sorting out the ABCP Mess

8. (SBU) The August 16 Montreal Accord was originally signed by the
major financial players owning, financing, and issuing non-bank
ABCP. These players agreed to a 60-day freeze of activity in the
market so that a solution to convert short-term paper into
longer-term notes could be worked out.

9. (U) As part of the August 16 "Montreal Accord," a pan-Canadian
investors committee was formed to restructure the ABCP market. On
October 15 the committee extended a 60-day market standstill to
December 14 in order to complete their market restructuring
proposals. Just before the October 15 extension, negotiators
convinced half a dozen non-bank sponsors and trustees of Canadian
ABCP, including Coventree, to join the Montreal Accord, giving
participating banks short-term protection against sponsors
triggering loans or liquidity agreements that back ABCP.

10. (SBU) Under the agreed freeze, key holders of the affected
financial instruments cannot demand access to their capital for at
least 60 days. Original backers of the accord included: ABN AMRO
Bank, Barclays, Quebec's Caisse de dptt et placement du Qubec
(manages public pension plans in Quebec, and is the largest Canadian
investor in non-bank ABCP), Quebec-based Desjardins Group, Deutsche
Bank, HSBC, Ottawa-based PSP Investments (invests and manages
Canadian public sector pension plans), Merrill Lynch, and National
Bank. Third party conduits affected by the Accord include: Apollo
Trust, Apsley Trust, Aria Trust, Aurora Trust, Comet Trust,
Devonshire Trust, Encore Trust, Gemini Trust, Ironstone Trust,
MMAI-I Trust, Newshore Canadian Trust, Opus Trust, Planet Trust,
Rocket Trust, Selkirk Funding Trust, Silverstone Trust, Skeena
Capital Trust, SLATE Trust, Structured Asset Trust, Structured
Investment Trust III, Symphony Trust, and Whitehall Trust.

One Third-Party Conduit Fixed

11. (SBU) C$2.1 billion Skeena Capital Trust, a conduit sponsored by
Toronto-based Dundee Wealth Management, was the first ABCP conduit
to be "fixed" by the investors committee. The committee promised
October 16 that by the end of October, Skeena holders will receive
their return on capital, plus interest, minus an undisclosed
restructuring cost. As part of the plan, Bank of Nova Scotia and
Dundee Wealth will take newly issued notes, backed by Skeena's
assets. The 21 other conduits remain frozen until December. During

TORONTO 00000430 003 OF 003

the restructuring period, market watchers are worried that hedge
funds and other speculators could take advantage of the complex and
illiquid situation by trying to reap profits from short-selling the
assets underlying the ABCP trusts.

Risky Investment

12. (SBU) In October, superintendent of Canada's federal Office of
the Superintendent of Financial Institutions (OSFI) Julie Dickson
defended her office, which had been criticized in connection with
the Canadian asset-backed commercial paper (ABCP) credit crisis.
Dickson blamed investors for buying ABCP based on only one credit
rating agency - Toronto-based DBRS Ltd. Elsewhere, including in the
U.S., investors require at least two ratings. Other international
credit rating agencies refused to rate Canadian ABCP because the
Canadian interpretation of "market disruption" (which would formally
require ABCP-backers to provide liquidity) was narrower and only
applied if the ABCP market totally dissolved. Institute for
International Finance (IIF) director Philip Suttle reportedly blamed
Canadian banks and regulators, as well as market participants and
the industry as a whole, for the Canadian ABCP market troubles this

13. (SBU) On October 17, DBRS said that 75% of the third-party ABCP
market is backed by complicated financial structures known as
collateralized debt obligations (CDOs), while only about 23% of the
market is backed by "traditional" assets like mortgages and auto
loans. C$1.8 billion (7%) of the CDOs relate to U.S residential
mortgage-backed securities (RMBS) assets, many of which were
downgraded by Moody's earlier this month.

14. (SBU) COMMENT: In mid-October, outgoing Bank of Canada Governor
David Dodge, in Washington for World Bank and IMF meetings, told the
IIF that credit market problems should be solved by "natural market
forces" rather than regulatory intervention. He argued that
investors should demand greater rates of return in exchange for
"opaque" products. The result, he said, would be issuers producing
more transparent products, not unlike the ingredients provided on
consumer packaged goods. Incoming Governor Mark Carney, who takes
over from Dodge in February 2008, has identified the credit crunch
affecting the ABCP market as one of his first orders of business.
Further analysis of the ABCP market crisis may prompt revisions to
Canadian banking regulations to provide greater protection for
consumers. END COMMENT.


© Scoop Media

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