Converting the short-term paper into long-term floating rate notes is a tremendous undertaking, says Michael Feldman in Financial Post

August 22, 2007

Lawyers are working out the details of what has been dubbed the Montréal Proposal, a 60-day standstill agreement reached on August 16 by ten—mostly foreign—banks, and led by the Caisse de dépôt et placement du Québec.

This meltdown in the asset-backed commercial paper (ABCP) market converts about $40 billion of third-party ABCP—believed to be about one-third of the $120 billion Canadian market—into floating rate notes. The rest lies in the Big Five bank channel. The Montréal Proposal calls for the task to be completed within 30 to 60 days, which is a tight timeframe given the complexity of the products involved.

“It is going to be a lot of work converting all the short-term paper into long-term floating rate notes,” says Michael Feldman. “You can't wave a magic wand and have it done. All the underlying assets are supposed to be renegotiated, so there's lots of work to do on that front. They're in effect two-way instruments. They are considered to be an asset, but also have a liability side to them. There's very big time pressures to get it done in 60 days."

Observers say that lawyers will be walking a legal tightrope as they pore over the documentation and attempt to keep the various parties on side. Things could get interesting if a major player doesn't want to cooperate, or if distressed debt buyers come in and create a secondary market. They would have different interests than the players currently at the table, and could cause a disruption in the plans.

Another threat is what happens if the credit markets continue to deteriorate during the standstill agreement period and there are more downgrades. That would normally trigger certain rights and benefits for some of the players at the table under their trust agreements. The challenge is how to arrive at a deal without someone losing a benefit or someone gaining an unjust right. It will be extremely complicated and likely very fluid.

The way asset-backed securities work is that financiers pull together different types of debt and slice and dice it to create a new product in the form of a trust (not to be confused with income trusts). Usually the assets involve things like credit card debts, auto loans, first mortgages or trade receivables. Those are considered to be stable assets; taking a mix of them lowers the risk of holding only one asset class. They can, however, involve more risky leverage. Some might also contain more esoteric assets, such as derivatives, collateralized debt obligations and instruments such as interest rate swaps, making them more complex and changing the risk associated with them.

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