Title: Florida Holds $2.2 Billion of Debt Cut to Junk
Source: Bloomberg
URL Source: [None]
Published: Nov 14, 2007
Author: By William Selway and David Evans
Post Date: 2007-11-14 09:11:20 by DeaconBenjamin
Keywords: None
Views: 37
Comments: 4

Nov. 14 (Bloomberg) — The Florida agency that manages about $50 billion of short-term investments for the state, school districts and local governments holds $2.2 billion of debt cut to junk status.

The downgrades affect more than 4 percent of what the Florida State Board of Administration has purchased for the funds, according to a report by the agency’s director, Coleman Stipanovich, that will be delivered at a Cabinet meeting of Republican Governor Charlie Crist today. Some $3.6 billion, or 7.3 percent, of the securities may be downgraded by credit- rating companies, according to the document, provided to Bloomberg by the state board.

Florida rules require the state’s short-term investments to only be top-rated, liquid securities, so taxpayer funds aren’t placed at risk. The data from Florida shows how far the effects of the bursting of the housing bubble are being felt as complex investment vehicles once marketed as high-yielding safe havens are now backed by collateral shunned by investors.

“Investment of public money needs to be carefully conducted and thoroughly researched,” said Harvey Pitt, former chairman of the U.S. Securities and Exchange Commission. “This is not the place for seat-of-the-pants judgments. It requires a lot more than jumping on the latest investment du jour to improve your results.”

Florida isn’t the only government whose short-term investments have been affected by rising mortgage defaults in the U.S. and investors’ diminished appetite for the securities tied to them.

King County Woes

Last month, Fitch Ratings said Washington state’s King County, which includes the city of Seattle, may have its rating lowered on $1.5 billion of bonds because of its investments in debt being roiled by rising defaults on U.S. home mortgages.

Florida’s state funds were affected by bad investments in asset-backed commercial paper, short-term debt sold by financial institutions that is secured by collateral such as mortgage securities and credit-card receivables. As the value of that collateral dropped, investors were unwilling to reinvest their money when the short-term debt matured, creating a liquidity crisis for the financial institutions.

Florida’s short-term holdings include $400 million of Axon Financial Funding LLC debt, which was cut to junk status by Standard & Poor’s on Nov 9. The others rated below investment grade are $850 million of KKR Atlantic Funding Trust, which was cut to default by Fitch last month; $577 million of KKR Pacific Funding Trust debt, cut by Fitch to default last month; and $319 million of debt issued by Ottimo Funding Ltd., cut to default by S&P on Nov. 9.

Below-investment-grade, or junk, debt is rated lower than Baa3 by Moody’s Investors Service and below BBB- by S&P and Fitch.

No Client Losses

The Florida State Board of Administration said none of its clients have lost money and it has negotiated to recoup its investments. Even so, the board, known as the SBA, said it is decreasing its investments in asset-backed commercial paper by reinvesting elsewhere.

“No client of the SBA has ever lost money in a short-term portfolio, and we remain confident that our portfolios will continue to provide stable returns for clients,” the board said in the report.

The Florida agency manages $27.3 billion in a local government investment pool, as well as other short-term investment funds totaling about $50 billion.

“Client outflows have marginally increased given the heightened market uncertainty,” the report said.

Bank Run

Joseph Mason, a finance professor at Drexel University in Philadelphia, said that the nearly 1,000 school districts, cities and counties invested in the fund, now informed of its downgraded debt, will be tempted to pull money out.

“This sets up the danger for a run on the bank,” said Mason, a former economist at the U.S. Treasury Department.

Commercial money-market funds, established as a high- yielding alternative to savings accounts, have also invested securities battered by the U.S. subprime mortgage crisis. Money market funds with total assets of $300 billion have invested in securities related to mortgages extended to borrowers with poor — or non-existent — credit histories.

Bail Out

Bank of America Corp., Legg Mason Inc. and at least two other companies are propping up their money-market funds to cushion them against possible losses on debt issued by structured investment vehicles. Florida may not be in a position to bail out its funds, given how the construction slowdown is affecting its revenue and it has no income tax.

“The state’s in no position to bail out the fund,” said Mason. “Where are you going to make this up? It has to come from the taxpayers, or spending cuts, or a combination.”

State investment pools like Florida’s are exempt from the SEC’s rules and reporting requirements for money-market funds, which must follow federal rules and file regular reports with the agency. That’s a mistake, said Lynn Turner, former chief accountant for the SEC.

“I’m a big believer in eliminating the exemptions that state and local governments get for their investment funds,” Turner said. “I think they should have to comply with the same SEC rules. We’re seeing time and time again problems that exist in these unregulated funds.

“Lack of communication” sounds suspiciously like a euphemism for “refuse to pick up the phone and execute a trade at the quoted spread” — like the NASDAQ money makers in ‘87.

Pour it on, Jean-Claude.

Anyway, what I’m talking about is the spread between Libor — the London Interbank Offer Rate, which is the rate at which banks lend to each other — and the yields on Treasuries of the same maturity.

Normally, there’s just a small difference. For example, in February 3-month Treasuries yielded 5.03%, while 3-month Libor was 5.36%.

Right now, however, 3-month Treasuries are yielding only 3.18%, while 3-month Libor is 5.02%. That’s a big spread, suggesting that investors are very nervous about banks’ finances.

I know that Fed officials are watching Libor carefully. And it’s not reassuring them.

[…]

The spread gap is quite big!