St. LOUIS (ResourceInvestor.com) -- As the global credit crisis widens and deepens, troubles in the asset-backed commercial paper market are leaking into the mining sector thanks to questionable treasury activities by companies chasing higher yields on their cash piles.
Several Canadian miners with exposure to the asset-backed commercial paper (ABCP) market could get hit hard if banks and trusts prove unable to pay up despite the flood of liquidity and credit easing provided by central banks around the world. The latest - and one of the largest - firms to announce its exposure is Cameco Corp. [NYSE:CCJ; TSX:CCO], which said yesterday it has about C$120 million of its C$332 million “portfolio”, or nearly two fifths of the total, invested in the short-term notes.
In the Canadian market, the uranium company has C$13 million invested in asset-backed commercial paper held in two trusts: C$7.5 million in Apsley Trust, managed by Metcalf & Mansfield and C$5.5 million in Planet Trust, managed by Coventree Capital. Both matured on August 17, 2007, but neither counterparty has paid Cameco.
“These two investments are rated R-1 (high) by DBRS (Dominion Bond Rating Service), which is the highest possible rating for commercial paper,” Cameco said in a press release.
“However, the holders of these investments have advised they are unable to repay the funds owed to Cameco. We are investigating the implications of these events, which appear to be a result of the current lack of liquidity for asset-backed securities rather than the creditworthiness of the underlying assets. We expect it will take several months to clarify the situation and the best approach for Cameco to take.”
The irony of miners falling prey to derivatives is rich. The current commodities bull market has coincided with strident calls for companies not to hedge their revenue, especially in the gold and silver business. Indeed, the braggadocio of some executives was that their products were “not someone else’s liability”, and prophesied about a coming crash caused by the gold carry trade.
Now investors are faced with the fact of risk being purposefully introduced to what is normally a sacred domain on the balance sheet – cash and cash equivalents.
Very large corporations typically run sophisticated treasuries that treat cash as a portfolio management exercise. But in this case investors will be alarmed at small companies diverting financings into exotic securities in the hope of squeezing out a few more basis points of return.
Investors should be displeased that financings predicated on development or exploration needs have instead facilitated trading activities. To add insult to injury many of the culprits evidence an abandonment of old fashioned notions of portfolio diversity, never mind an aversion to risk. Notes to financial statements say precious little about the risk investors are exposed to when companies remove cash from the safety of a regular bank account to dabble in high octane derivatives.
Cameco also has $101 million invested in U.S. asset-backed commercial paper in seven different U.S. investment funds. These investments will mature between August 27 and September 18, 2007. Cameco expects the investments to be paid, but it says the company’s future plans will not be impacted if the payment is “disrupted.”
“The U.S. funds we are invested in have been making redemptions as scheduled, and none have experienced any defaults to date. While we expect that these U.S. investments will be repaid to Cameco as they reach maturity, there is uncertainty until the disruptions in the global credit markets are resolved. If repayment is disrupted, we do not expect this would impact our plans for the company going forward.”
Asset-Backed Commercial Paper
According to Investopedia.com, asset-backed commercial paper is “a short-term investment vehicle with a maturity that is typically between 90 and 180 days. The security itself is typically issued by a bank or other financial institution. The notes are backed by physical assets such as trade receivables and are generally used for short-term financing needs.
“A company or group of companies looking to enhance liquidity may sell receivables to a bank or other conduit, which, in turn, will issue them to its investors as commercial paper. The commercial paper is backed by the expected cash inflows from the receivables. As the receivables are collected, the originators are expected to pass the funds to the bank or conduit, which then passes these funds on to the note holders.”
But with the current credit crunch set off by the mayhem in American subprime mortgages, the commercial paper market is seizing up, leaving borrowers unable to pay their clients.
Investors are running from asset-backed commercial paper and turning toward safer government securities. This has resulted in soaring prices for U.S. Treasuries, whose yields move inversely to their face value.
According to media reports, more than half of the $1.1 trillion market for commercial paper comes due in the next 90 days. Hundreds of hedge funds and home-loan companies will have to sell $75 billion of debt if no new buyers are found.
Banks are struggling to regain investors’ trust. The National Bank of Canada is trying to reduce damage to its reputation by buying back $1.89 billion of its clients’ asset-backed commercial paper. It is likely the bank - which is offering to pay 100% for the paper in cash - will take a loss in the strategy. Of Canada’s six biggest banks, the National Bank of Canada is the most at risk in the market freeze, with much of its buyback coming from asset-backed commercial paper managed by Coventree and Quanto Financial Corp.’s Metcalfe & Mansfield.
Miners at Risk
In addition to Cameco, a number of mining and exploration companies disclosed their exposure to the asset-backed commercial paper market - much of which is sponsored by Coventree.
Coventree announced last week that due to the U.S. subprime mortgage credit crunch, it was unable to sell new asset-backed commercial paper in order to repay its maturing notes worth C$250 million. To date, Canadian miners have reported more than C$700 million at risk in the ABCP market.
Ivanhoe Mines [NYSE:IVN; TSX:IVN] has $66.5 million invested in Canadian asset-backed commercial paper - 34% of its $200 million worth of holdings. Coventree manages short-term notes worth $13.8 million that matured Aug. 14 but went unpaid.
First Quantum Minerals Ltd. [TSX:FM] has $10.5 million in asset-backed commercial paper under Coventree. Notes worth $7.5 million matured Aug. 14 and Aug. 15 but remain unpaid. A third note matures Aug. 23. The company has an additional $40.2 million in other asset-backed commercial paper.
Both New Gold Inc. [AMEX:NGD; TSX:NGD] and Redcorp Ventures [TSX:RDV] have around 40% of their holdings in Coventree notes, while Jura Energy Corp. [TSX:JEC] has C$14.9 million - 47% of its cash and investments - in short-term notes managed by Coventree and its associates.
Miramar Mining Corp. [AMEX:MNG; TSX:MAE] has C$37 million of its C$135 million in cash invested in Canadian short-term notes. Coventree sponsors C$11 million.
West Energy Ltd. [TSX:WTL] has C$29.97 million of its C$31.20 million worth of holdings invested in asset-backed commercial paper that have matured but remain unpaid.
Baffinland Iron Mines Corp. [TSX:BIM] has C$43.8 million of its $45.9 million worth of cash and investments in asset-backed commercial paper, C$33.9 million of which has matured but have not been repaid.
Northern Orion Resources [AMEX:NTO; TSX:NNO] has about $14 million in Canadian asset-backed commercial paper - 5.8% of its total holdings.
Barrick Gold Corp. [NYSE:ABX; TSX:HCX] said it has $65 million, or less than 3% of its total cash value of about $2.6 billion in Canadian asset-backed commercial paper.
Where to from here?
It is too early to say whether or not the mining money invested in ABCP is lost or safe. The market continues to discount further defaults despite efforts by central banks to lubricate the credit seizures. Everyone will be paying close attention to forthcoming redemption dates to see if loans can be repaid in full and on time. That means at least another 2-3 months of uncertainty, and it will weigh on affected stocks all the while.
More broadly, commodities, commodity stocks and commodity currencies are also likely to remain under pressure since “hot money” liquidation is expected to continue. Short-term investors and arbitrageurs have flooded into the sector in the last two years, and they will continue to exit if they cannot secure funding from regular sources.
We certainly won’t be surprised to hear investors asking companies for improved transparency in their disclosures about cash management. They will also likely be far more sceptical about participating in future financing requests - unless they get a guarantee that their pocketbooks won’t be leveraged to pay for over-priced condos in Miami.
