Light in the Tunnel

Commercial-Paper-Trading Canada’s asset-backed commercial paper (ABCP) market got an unexpected Christmas present yesterday. Investors finally agreed, in principle to a restructuring, offering hope that the beleaguered market will “soon” get back on its feet.

The surprise announcement is light at the end of the tunnel for ABCP investors, non-bank lenders, and mortgage shoppers alike.  If it works out, the restructuring could partly defuse Canada’s liquidity crisis which has kept mortgage rates abnormally high for months.

The ABCP market has been closed for trading since August when subprime fears sent investors running for the hills.  The worry was that subprime assets would significantly devalue ABCP paper–even though we now know that only 9% of ABCP was subprime linked.  After missing two deadlines, observers were starting to wonder if this fiasco would ever be resolved.

The restructuring is expected to close by March 2008, but ABCP investors will need to wait a lot longer to get their money back.  They’ll receive newly-minted notes in lieu of their old investments, and probably have to hold these notes until maturity (7 years on average) if they want to protect their principle.

Investors reportedly won’t get any interest for holding the new notes which implies a 30% opportunity cost right off the bat.  On the other hand, if they sell now they’ll only get a fraction of their principle.  Most of the new paper should be AAA-rated which will help boost confidence in the new market.

A news conference is scheduled for today and should lay out the remaining details.

Asset-backed commercial paper (ABCP), is a short-term debt instrument secured by a pool of assets like mortgages, accounts receivable, car loans, and credit-card receivables.

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Side Bar: Despite this good news, Conventree, the biggest former sponsor of ABCP, appears to be toast.  According to the Financial Post, Coventree said its business is no longer viable and there will be no further investment in it.

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