December 2, 2007 / 3:47 PM / in 10 years

Sorting out the commercial paper mess

MONTREAL (Reuters) - The liquidity crisis in Canada’s seized-up market for nonbank asset-backed commercial paper may weigh on the country’s financial markets for some time as key players try to sort out the mess.

The C$33 billion ($33 billion) ABCP market has been frozen since mid-August as a blue chip group of investors and banks tries to craft a workout under a standstill pact dubbed the Montreal Accord.

Hoping to avoid a wholesale liquidation of ABCP assets, Banks and corporate holders have already taken some C$1.2 billion in writedowns on the opaquely structured paper that is backed by bundles of mortgage, credit-card and other payments.

Stephen Jarislowsky, the octogenarian billionaire and pre-eminent Canadian investment counselor, steered clear of ABCP. He left it, rather, to the market “alligators” to gobble up what was supposed to be triple-A short-term investment.

“It’s all part of the greed and performance measurement syndrome in this country,” Jarislowsky told Reuters.

“They thought that it was perfect, solid, sound paper, but how they cane to that conclusion I will never understand.”

Jarislowsky said investors relied too heavily on debt rating agencies rather than doing their own investigation into exactly what had been bundled into the complex ABCP products being shopped around.

Analysts figure more writedowns may land with a thud in already jittery markets before and after the December 14 deadline for the Montreal Accord workout, especially once the lawsuits start flying.

Consider National Bank of Canada NA.TO, which was tipped into its first quarterly loss in 15 years on a C$575 million writedown representing 25 percent of its ABCP holdings.

That portfolio remains the “dark cloud” hanging over National Bank’s earnings, said Michael Goldberg, an analyst at Desjardins Securities.

“Although a disruptive liquidation of the assets has so far been avoided, it seems highly unlikely that a painless restructuring will be achieved,” Goldberg wrote in a research note.

That, he said, means National’s clients could face real losses, not just non-cash writedowns.

“If clients hold as much as National, their losses and National’s litigation risk could equal the markdown it has already taken.”

CAISSE LIFTS THE VEIL

National Bank Chief Executive Louis Vachon said the bank favored the conservative end of its range when taking the writedown.

“Ultimately, the mystery will be solved as we go through the restructuring process,” he told analysts.

The 800-pound gorilla in the room, public pension fund manager Caisse de depot et placement du Quebec, lifted part of the veil on the mystery when it acknowledged it held C$13.2 billion of ABCP exposure, including about C$1 billion of assets linked to the imploding U.S. subprime mortgage market.

Henri-Paul Rousseau, the Caisse’s physically imposing chief executive, noted during a grilling in Quebec’s legislature that talks among signatories to the Montreal Accord were complicated because each reserved the right to sue international and domestic banks over the whole debacle.

“To say that is was a very complicated situation is an understatement,” Rousseau told the legislators.

Indeed, and an embarrassing one for the Caisse, which, sometimes prodded by its Quebec political bosses and driven by an appetite for rich returns, has shown considerable brawn in the capital markets and corporate boardrooms.

Managing C$143 billion of net assets and custodian of the province’s public pension and insurance fund assets, the Caisse has long been Canada’s most powerful investor.

Rousseau admitted the Caisse could write off C$500 million of its C$1 billion of U.S. subprime assets, but he refused to be pinned down on the other C$12.2 billion of ABCP on the books.

Meantime, the Montreal Accord group will work feverishly toward a remedy that would replace the frozen ABCP assets with longer-term debt.

Jarislowsky, who is not involved in the process, thinks it will all hinge on the quality of the underlying collateral.

“Unless there is a market for it, it will have enormously impaired the banking sector,” he said.

($1=$1 Canadian)

Reporting by Robert Melnbardis, additional reporting by Lynne Olver in Toronto; Editing by Rob Wilson

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