Credit Crisis with a Canadian Twist

The scope of the credit crisis in Canada is only, and thankfully, the “mini me” version of the subprime disaster in the U.S. Yet, we have still managed to pull off our own flavor of the meltdown. Canadian lenders did not issue too many foolish mortgages and did not lower the bar for homeownership too much. However, Canadian investors, mostly institutional, did go gaga for the asset- backed commercial paper (ABCP). And if that paper was not issued by Canada’s major banks, it hit a six-foot brick wall in August.

As is customary, now everyone is looking for someone to blame for millions, if not billions, in lost dollars. It seems investors have found one — the only credit-rating agency in Canada that even wanted to rate non-bank sponsored ABCPs — DBRS Limited.

I suppose DBRS is as good a scapegoat as any. However, what investors out for blood have trouble admitting is their part of the blame. As already mentioned, DBRS was the only credit-rating agency that agreed to rate ABCPs not issued by major banks. The reason why were covenants littered with loopholes that made these issues highly risky investments. One such loophole was that ABCP’s financial backers did not have to pay a dime in an emergency, unless the entire worldwide ABCP market literally dissolved. In creditors’ lingo, this is known as “Canadian-style (il)liquidity.”

Typically, institutional investors dumping billions of dollars in debt securities consult at least two credit-rating agencies. At this point, I can only offer one explanation why Canadian investors relied on only one credit-rating agency — complete and utter recklessness in greed. As a result, in August, Canada’s ABCP market, estimated at $40.0 billion, was left out in the cold. Not a single bank wanted to bail out cash-strapped issuers and investors.

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This resulted in many good companies with investment departments dabbling in the ABCP market having some tough explaining to do. For example, an airline company that I really like, Transat A.T. Inc., invested almost half of its operating cash flow into ABCPs. When the smelly stuff hit the fan in August, the company had to disclose its exposure in the risky sector, which resulted in the stock price hitting 52-week lows in a matter of days. Thankfully, Transat is a quality company, its working capital was never impacted, and the stock recovered. But, I’m sure there are plenty of other greedy “victims” out there who cannot say the same.

In DBRS’ defense, the Office of the Superintendent of Financial Institutions (OSFI) said that market disruption clauses for similar commercial paper are common and internationally accepted. OSFI also said that 90% of emergency funding was not supposed to come from Canada’s big banks, but rather from foreign banks. By the time the Canadian ABCP market needed emergency funds, those foreign banks most likely couldn’t help themselves, let alone others.

Canada’s credit market crisis resembles the story about Pandora’s Box; only curiosity didn’t open it, but greed. And, I’m afraid there is nothing left at the bottom of the box — certainly not hope. The Bank of Canada has slightly increased the money supply, but nowhere near the levels released in the U.S. As far as our interest rates go, we can only dream of the half-a-percentage-point cuts enjoyed south of the border. New investors have scattered, and those caught up in the game are not likely to be rolling-over their existing investments. The way it looks to me, the ABCP market in Canada is disappearing — and, all things considered, I wish it good riddance.