US embassy cable - 07TORONTO430

Unraveling Canada's Asset-Backed Commercial Credit Crunch

Identifier: 07TORONTO430
Wikileaks: View 07TORONTO430 at
Origin: Consulate Toronto
Created: 2007-10-25 18:44:00
Redacted: This cable was not redacted by Wikileaks.
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. 

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