Rehypothecation of securities

Sara,

I have already had a brief discussion with Tana on some of the points below &
would appreciate your feedback and clarification on some specific issues.

We are currently looking at ability of Enron to rehypothecate securities
(principally T-bills) received as collateral.

Clearly the ability to rehypothecate securities that we hold can provide
significant benefits. The free up of funds that are being used to post cash
collateral to counterparties increases our B/S liquidity & reduces the total
cost of borrowing associated with posting cash.

We are reviewing the use rehypothecation of all securities posting for all
counterparties. Clement is in the process of executing a domestic custody
agreement with Chase Manhatten Bank which will facilitate rehypothecation.

More specifically we are looking at the ability to rehypothecate collateral
related to the most recent Mahonia pre-pay structure (very similar to Alberta
pre-pay).
The collateral arrangement within Mahonia provides for back to back transfer
of collateral right through the structure. This results in a net zero cash
position if all parties post cash. However if Enron receives securities (from
Chase) that we cannot reassign (to Mahonia - an SPE), the cash collateral
calls we are seeing are in the region of $600mm (approx. $42mm/yr in interest
expense to Enron).

In the past Chase have interchangeably used securities & cash. They are
currently posting cash, however they intend to post securities going forward
for this specific deal.

The most pressing issues going forward:
Does the existing Chase ISDA permit rehypothecation of securities. We are
looking at this. If it does not, then we will need to negotiate an amendment
to the credit support annex.
Accounting treatment - there are issues around the accounting treatment for
rehypothecation under the Mahonia transaction, principally relating to the
acceptability of the same securities posted by Chase being posted to Mahonia
SPE (Chase equity in SPE), thus linking all the swaps & potentially bringing
the pre-pay back on B/S.
We need to justify that we can rehypothecate Chase securities posted within
the structure. AA's key point is that linkage occurs as the securities posted
are most likely to be registered to Chase & these are then posted back to
Mahonia SPE with Chase equity.

Our case to support the use of Chase securities within the Mahonia pre-pay
structure relates to:
T-bills are highly liquid instruments & effectively cash equivalent
Securities posted by banks are typically registered to a street name ie a
brokerage house (ie not registered to Chase), if there is no physical
delivery. We are verifying that this is the case with the securities posted
by Chase.
Market standard contractual terms permit use of these posted securities

Re the last point, I have looked at our the standard ISDA credit support
annexe para. 6 © relating to Use of Posted Collateral, section (i). It
appears to say that regardless of a default occurring, the Secured Party
(Enron) has the right to "sell, pledge, rehypothecate, assign, invest, use,
commingle or otherwise dipose of, or otherwise use in its business any Posted
Collateral it holds............." Please confirm that that I have not
misinterpreted this or missed out relevant exclusions
- Cris, this standard ISDA language should further support our case to AA?.

In addition, I would like to clarify ownership & title to securities that are
rehypothecated in the event of default if a) Enron receives securities that
are then rehypothecated & Enron defaults b) the third party receiving
rehypothecated securities defaults

We are aiming to have the Domestic Custody Agreement executed within the next
10 days, & we would like to be in a position to assign securities posted to
us shortly thereafter for the Mahonia deal.

Outside of the Mahonia transaction, there is currently an additional $65mm
approx. in securities being posted to us by our counterparties. Going forward
we will:
Establish who are the counterparties where we have existing collateral
agreements that permit rehypotheaction of securities.
If we are receiving securities from CP where we are not permitted to
rehypothecate, we intend to amend the ISDA.

I would very much appreciate you response on use of posted collateral &
ownership & title to securities in the event of default.

Many thanks,

Soma