Investors eye 5-7 point MAV note redemption arbitrage
Debtwire, April 19, 2013
by John Wilen
A plan by a group of US investors to collapse up to CAD 9.8bn (USD 9.6bn) in obscure Canadian asset-backed bonds — and cash in on big gains in the value of the underlying collateral — is in its final stages, according to three sources familiar with the plans.
The plan involves Master Asset Vehicle II notes created in 2009 as part of a Canadian government-sponsored bailout of the CAN 32bn portion of the country’s asset-backed commercial paper market that defaulted in 2007.
Two years ago, investors including King Street Capital noticed that the collateral underlying the notes — Canadian government Treasuries, Canadian bank commercial paper, Canadian agency mortgage securities, AAA rated ABS, CDS and a handful of CDO-squared holdings — was worth as much as 78 cents on the dollar, eight points more than where the notes themselves were trading. Investors holding more than CAN 1bn in the notes at that time hatched a plan to allow noteholders to access and sell that collateral and retire a corresponding portion of their MAV II note holdings. They hired Moelis & Co. to coordinate the effort.
While the notes have gained another 10 points in value since then — and are now trading in the CAN 88-89 price range — the value of the collateral has also risen, and is worth a low-to-mid-90s price, according to recent dealer offers and two of the sources familiar. A USD 3m piece of MAV II A-1 notes were offered as recently as Thursday, according to Debtwire ABS BWIC data.
The 5-7 point difference between the value of the collateral and that of the notes creates an easy arbitrage opportunity for investors who buy today — and a means of cashing out even bigger gains for investors who have held the notes for years. Many US hedge funds began purchasing the notes early in 2009 at prices closer to 20-30 cents on the dollar, according to two of the sources familiar.
Two-thirds of the MAV II noteholders approved the optional redemption plan last summer, in the process approving Moelis to represent the interests of all MAV II noteholders. All that is awaiting the plan’s execution is approval from the MAV vehicles’ Canadian bank counterparties, non-Canadian bank counterparties including Bank of America, Deutsche Bank and HSBC, the Canadian and Quebec governments, Blackrock, which administers the MAV vehicle, and the vehicle’s trustees.
While the plan could be approved during 2Q13, according to the first source familiar, the need for that many approvals could delay its execution until later in the year. The second two sources familiar declined to predict when it will be approved, saying only that Moelis is working with all involved parties on draft approval documentation.
Spokespeople for Moelis and King Street declined comment.
The MAV II notes were issued by one of three vehicles created to compensate Canadian ABCP investors who were stuck holding what were in many cases supposed to be overnight investments for two years after that market froze in 2007. When the notes were issued in January 2009, many of the holders — which included a wide variety of Canadian operating businesses and investors — quickly sold their MAV II notes for bargain prices.
The buyers were mostly US hedge funds, according to all three sources. The notes mature in December 2016.
The MAV II notes have risen steadily in value since then, in part because many of the riskier underlying CDS have matured, alleviating worries they would default and cause principal losses, according to the first source. DBRS upgraded the A-1 notes’ rating to AA from A last summer.
“A lot of the risk has come off these,” said Colin Kilgour, a partner at Kilgour Williams Group, a Toronto banking boutique that advises MAV note investors.
Of course, steady buying by US investors interested in redeeming the underlying collateral has also driven prices higher more recently. The notes are expected to hold their value, and perhaps even rise further in price, as long as the redemption plan appears to be moving forward, the first source said. If the plan is not approved, MAV II prices could fall.
According to one dealer’s offering sheet, the MAV II vehicles’ A-1 notes are trading at a 4.3% – 4.5% yield at current prices; its A-2s, priced in the CAN 84-85 range, trade at a 5.8% – 6% yield; its B notes trade at a 7.25% – 7.6% yield, and its C notes trade at a 6.1% – 6.9% yield.
The quarterly redemption process will require vertical slices of the underlying collateral to be sold, and corresponding retirements of vertical slices of MAV II notes. If investors holding 10% of the MAV II notes want to participate, 10% of each underlying asset will be sold off, and 10% of each class of MAV II bonds, from the A-1 to C notes, will be retired. The idea is to ensure that bonds held by investors who don’t participate will be backed by the same mix of collateral as the current MAV II notes.
The vertical slice requirement inserts a wrinkle into the plan, however. Noteholders looking to sell some of the underlying collateral must either own a corresponding amount of each the A-1, A-2, B and C class notes, or coordinate with other investors who do.
The first source familiar said he believes that some of the larger noteholders will coordinate with smaller investors to match up their holdings with those of other investors, ensuring that most investors who want to participate in the process can.