HomeMy WebLinkAbout2007 11 26 Handed out by Ron McLemoreDate: November 29, 2007
This was provided to the City Commission
during the November 29, 2007 City Commission
Emergency Special Meeting.
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Ronald W. McLemore
City Manager
CITY OF WINTER SPRINGS, FLORIDA
1126 EAST STATE ROAD 434
WINTER SPRINGS, FLORIDA 32708-2799
Telephone (407) 327-5957 Facsimile (407) 327-6686
MEMORANDUM
TO:
FROM:
DATE:
SUBJ:
The Problem
Mayor & City Commission
Ron McLemore, City Manager
November 29, 2007
State Board of Administration
Confidence problem with the State Board of Administration (SBA) resulted in a run on assets
(panic).
Considerations
^ The SBA has halted all demands for withdrawals to investors until Tuesday to give
the SBA and the Cabinet time to work out a strategy to resolve confidence in the
Fund.
^ Much of the panic appears to be based upon what SBA characterizes as erroneous
information.
^ The City's Investment Policy provides for the investment of idle funds in the
following:
1. SBA Surplus Trust Fund, and
2. United States Government Securities
^ To date, the City has the following investments:
SBA $27,211,439
SBA 789,748*
Bank of New York 1,282,562*
Bank of America 2,439,706
Total 31,723,455
* Bond Reserves
^ This afternoon, the Executive Director of the SBA issued the attached advisory
setting out his interpretation of the issue and his recommendation for restoring
confidence in the Fund.
^ From a financial perspective, the Investment Fund is sound.
However, a perceived threat of unsoundness could and has caused a hedging on the
part of some large investors and a following run by other investors.
^ Devaluation
o It is impossible to determine the devaluation of assets at this time.
o However, it appears from what we know that the protection of assets is
manageable if SBA moves quickly to restore confidence.
Cit~perating Position
Although the City is heavily invested, thus heavily at risk, in the SBA due to the City's
conservative budget policies, it appears that we can continue to meet our cash needs from
operating revenues if we carefully manage our expenses.
Therefore, it is important that we not take any knee-jerk actions and cause any unnecessary
concerns among our employees or the community. Accordingly, we will be performing
additional cash flow studies to determine what strategies we need to put in place to maintain
operations and advise you accordingly.
City's Investment Position
For the time being, we have filed for withdrawal of funds from the SBA. We will monitor
this situation in the days ahead to determine the most appropriate withdrawal strategy.
For the time being, we obviously should avoid any further investments in SBA and focus our
investments in short term AAA government securities. We will continue to monitor the
situation with our investment advisors to determine the most appropriate investment
alternatives available to us and keep you advised.
EXECUTIVE DIRECTOR RECOMMENDS FINANCIAL PLAN TO PROTECT
THE LOCAL GOVERNMENT INVESTMENT POOL
NOVEMBER 28, 2007
Today Coleman Stipanovich the Executive Director of the State Board of Administration
announced that there will be a recommendation to the Board of Trustees to formally
adopt a plan to provide investors in the Local Government Investment Pool (Pool) with
assurance that the Pool will continue to provide safety of principal in the midst of an
unprecedented absence of market liquidity.
"It is important that every investor in the Pool has an accurate understanding of the facts
regarding our holdings, not misinformation" said Stipanovich. A November 28, 2007
article by Bloomberg News erroneously stated that: "The Florida pool's $900 million of
defaulted asset-backed commercial paper now amounts to almost 5 percent of its
holdings." In fact certain Pool investments have been downgraded below purchase credit
rating,,~uidelines but they have continued to pawprincipal and interest. The Pool has
collected approximately $64 million in principal and interest payments since August on
these downgraded investments.
At the December 4, 2007 meeting, the State Board of Administration Trustees consisting
of Governor Charlie Crist, Chief Financial Officer Alex Sink, and Attorney General Bill
McCollum, will consider the following recommendations to provide assurance to Pool
investors:
1. Credit protection for the Pool against the potential for default by
approximately $1.5 billion in securities from four issuers: Axon Financial,
KKR Atlantic, KKR Pacific, OTTIMO Funding and Countrywide. The
proposal would provide acost-effective backstop against the risk of any of
these securities fail to return par.
2. Commitment to obtain a AAA rating from Standard and Poor's on the Pool,
including adopting more conservative investment guidelines and establishing
an external Pool advisory council.
3. Continued restructuring of the Pool investments to become more liquid and
conservative. The Pool has not made any purchases of asset backed
commercial paper in November and expects the total asset backed exposure of
the Pool to be under 15 percent by the end of 2007. New risk controls with
respect to sector exposure will be adopted.
4. Building a larger reserve fund to protect the Pool against future episodes of
market illiquidity.
5. Improvements in the investment infrastructure supporting the Pool, including
daily pricing, performance measurement and risk analytics.
About the SBA:
The State Board of Administration of Florida (SBA) manages approximately $190 billion in assets,
including the $136 billion Florida Retirement System (FRS) Defined Benefit Plan. The FRS Defined
Benefit plan is the fifth largest public pension fund in the country. The FRS consists of approximately 1.1
million active participants and retirees. For additional information, please visit www.sballa.com.
###
r
A. When time constraints due to unusual circumstances preclude the use of the competitive bidding
process
B. When no active market exists for the issue being traded due to the age or depth of the issue
C. When a security is unique to a single dealer, for example, a private placement
D. When the transaction involves new issues or issues in the "when issued" market
Overnight sweep investments or repurchase agreements will not be bid, but may be placed with the City's
depository bank relating to the demand account for which the sweep investments or repurchase agreement
was purchased.
XII. AUTHORIZED INVESTMENTS AND PORTFOLIO COMPOSITION
Investments should be made subject to the cash flow needs and such cash flows are subject to revisions as
market conditions and as the City's needs change. However, when the invested funds are needed in whole
or in part for the purpose originally intended or for more optimal investments, the Finance Director or
management designee may sell the investment at the then-prevailing market price and place the proceeds
into the proper account at the City's custodian.
The following are the investment requirements and allocation limits on security types, issuers, and
maturities as established by the City. The Finance Director or management designee shall have the option
to further restrict investment percentages from time to time based on market conditions,. risk and
diversification investment strategies. The percentage allocations requirements for investment types and
issuers are calculated based on the original cost of each investment. Investments not listed in this policy
are prohibited.
The allocation limits and security types do not apply to the investment of debt proceeds. These
investments shall be governed by the debt covenant included in the debt instrument.
,.
A. The Florida Local Government Surplus Funds Trust Fund ("SBA"}
Investment Authorization
The Finance Director may invest in the SBA.
Portfolio Composition
A maximum of 100% of available funds may be invested in the SBA.
B. United States Government Securities
1. Purchase Authorization
City of Winter Springs Investment Policy page ~
Update on Sub-Prime Mortgage Meltdown and
State Board of Administration Investments
November 9, 2007
State Board of Administration of Florida
INVESTING FOR FLORIDA'S FUTURE
Table of Contents
I. Introduction ........................................................................................................................................... 3
II. Executive Summary ............................................................................................................................. 4
III. Recent Risk Monitoring Activities ..................................................................................................... 6
IV. Review of the Pension Plan ................................................................................................................ 8
V. SBA's Short-Term Portfolios ............................................................................................................ 11
Appendix: Third Quarter Florida Local Government Investment Pool Newsletter ............................... 16
2
I. Introduction
The State Board of Administration of Florida (SBA) is an investment management organization
responsible for managing $187.5 billion in governmental funds, including Florida's $138 billion
pension fund. Consistent with its fiduciary duties, the SBA continuously monitors its more than 300
investment portfolios. Operating under detailed investment policies and portfolio guidelines, the SBA
maintains highly diversified investment portfolios. As a result, the SBA is well-positioned to sustain a
disciplined long-term focus during periods of heightened financial market volatility and uncertainty.
The SBA's professional investment staff and external investment managers have exercised their
fiduciary duties to prudently steward trust assets during a number of historical periods of financial
stress. Further, they recognize that such periods will continue to occur due to the normal ebb and flow
of global economic and financial forces.
1. The 1980s experienced energy shortages, savings and loan crises, economic recession,
escalating inflation and double-digit interest rates;
2. In the 1990s, there was economic recession, 6% inflation, the Latin American debt crisis, the
Mexican Peso devaluation, East Asian devaluations and Russian debt defaults;
3. So far this decade, the hallmark events have been the bursting of the technology bubble, the
tragedies of September 11, and the current evolving sub-prime meltdown and contagion effects.
The collapse of the technology bubble was followed by one of the deepest and longest bear
markets since the Great Depression. Some are now concerned that the U.S. economy may be
entering a recession and bear market. Others are equally concerned that persistent strong U.S.
economic growth and a weak dollar will fuel inflation.
The SBA can take pride in the fact
that its investments have held up
well through periods of financial
crisis and economic downturns
(Chart 1). This report lays out our
current exposures and responses to
date dealing with the sub-prime
meltdown. Although past
performance is no guarantee of
future results, and the financial
environment may become even
more challenging, we believe the
SBA is positioned to deal with the
current financial stress at least as
well as we have with prior events.
We will continue to work toward
Chart l
1800%
1600%
1400% Cumulative Net Return on FRS
Pension Plan Assets
1200%
®SBA's Long-Term Return Objective
looo% (currently S.Ok plus inflation)
800% -Actuarial Return Assumption
(currently 7.75%)
600%
400%
200%
o%
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 OS 06 07
Fiscal Year Ending June 30
Cumulative Performance History
Fiscal Years 1976 Through 2007
preserving the Florida Retirement
System Pension Plan's status as having the highest funded ratio of large public pension plans in the
nation, as well as prudently managing all of our investment mandates.
3
II. Executive Summary
Investor anxiety about the sub-prime issue continues to reverberate through the financial markets. As
expected, we have been closely monitoring the SBA's assets for potential risks related to direct or
indirect sub-prime exposure and believe that the financial markets may remain challenging for some
time. We are pleased to report that the SBA's assets have continued to perform well in the face of
heightened market uncertainty.
In summary:
1. Diversification is one of the most important investment risk controls, and the SBA's portfolios are
highly diversified. In fact, the Florida Retirement System (FRS) Pension Plan Investment Policy
Statement approved by the Trustees in May 2007 both increased diversification and lowered the
level of absolute risk by about 13%.
2. On several occasions, the SBA has proactively reviewed funds under management for direct or
indirect exposures to sub-prime residential mortgages. Each review has indicated immaterial direct
exposure to sub-prime residential mortgages. We have nonetheless remained alert to managing
indirect or spillover effects from the sub-prime sector.
3. The vast majority of the SBA's assets are in actively managed strategies that prudently manage risk
while pursuing their return objectives. So far this fiscal year, the SBA has conducted about 230
meetings with public and private market active investment managers. A central topic in each of
these meetings was their management of the risks related to sub-prime mortgage loans and possible
contagion effects. Earlier this month, the SBA again reached out to its investment managers to
assess the potential for sub-prime spillover effects to negatively impact SBA assets.
4. In the aggregate, the SBA's portfolios are defensively positioned with respect to the primary risks
emanating from the sub-prime sector. Within the FRS Pension Plan, the domestic and foreign
equities asset classes are underweight the industries that could be most negatively impacted by sub-
prime contagion (e.g., homebuilding, banks, etc.). Similarly our fixed income investments are
emphasizing higher credit quality and, under Florida statutes, the SBA can only directly invest in
AAA-rated agency mortgage-backed securities (i.e., GNMA, FNMA and Freddie MAC). Our
short-term portfolios are also selectively lowering exposures to asset-backed commercial paper and
financial company securities in a prudent and orderly fashion.
5. Finally, the SBA's bond and money market investments have continued to maintain high overall
credit ratings. The only disappointment has been with isolated credit downgrades impacting several
short-term portfolios and accounting for about 4.7% of par value. However, we have participated in
restructuring negotiations with two asset-backed commercial paper issuers to ensure that collateral
is held in trust to pay principal and interest due the SBA's clients. 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 with an emphasis on safety and liquidity of principal.
4
Chart 2
SBA Assets Under Management
As of September 30, 2007 - $ Billions
,.;,
$138.4 FRS Pension t~ ~ 1, 38.4 FRS Pension Plan _~
,. Crl ~«, c I
r $27.3 Local Government Investment Poot
$5.1 Citizens Property Insurance
~~ $4.1 FRS Investment Plan
$3.9 Hurricane Catastrophe Finance Corp. i
$2.4 Lawton Chiles Endowment Fund
^ $2.3 Debt Service
$1.3 Florida Hurricane Catastrophe Fund
$2.7 Other 27 individual mandates/trusts
(
Total Assets Under Management:
$187.5 billion
Chart 3
SBA Assets Under Management by Investment Vehicle - As of September 30, 2007
(11 (21 131 (41 (51 161 PI
SBA Investment Pools Separately Total Assets Share of
LGIP CAMP-MM CAMP-FI CAMP-DE Managed Assetr Under Management Total
Portfolios With Separately Managed Assets
1. FRS Pension Plan - - - - 138,438,587,159 138,438,587,159 73.82%
2. Citizens Property Insurance 5,078,712,671 5,078,712,671 2.71%
3. Florida Hurricane Catastrophe Finance Corp. - 5 - - 3,879,635,419 3,879,635,424 2.07%
4. FRS Investment Plan - - - - 4,080,089,767 4,080,089,767 2.18%
5. Lawton Chiles Endowment Fund - 28,799,014 327,711,550 243,747,465 1,790,702,710 2,390,960,738 1.27%
6. Debt Service - - - - 2,332,029,048 2,332,029,048 1.24%
7. Florida Hurricane C ""~'
8. Department of the
Funds
- - 1,343,508,468 1,343,508,468 0.72%
- - 1,270,271,723 1,271,371,557 0.68%
256,517,436 314,769,034 0.17%
- - 285,098,868 285,098,868 0.15%
- - 150,419,251 209,477,818 0.11%
- - 185,629,943 188,644,287 0.10%
14. Florida College Investment Plan - - - - 26,543,744 26,543,744 0.014%
15. Torrey Pines institute for Molecular Studies Fund - 13,922,371 - - 10,984,092 24,906,463 0.013%
16. McKnight Doctoral Fellowship Program - 1,591,799 - 1,067,686 230,956 2,890,441 0.002%
17. Gas Tax Trust Fund ~ - _ _ _
18. Bond Proceeds Trust Fund' - 0 0.00%
- - - - 0 0.00%
19. Local Government Investment Pool 27,268,602,440 - - - - 27,268,602,440 14.54%
20. Police and Firefighters' Premium Tax Trust Fund - 86,335,725 - - - 86,335,725 0.05%
21. FSU Research Foundation - - 39,085,116 43,410,890 - 82,496,006 0.04%
22. SBA Administrative Fund - 11,275,577 28,943,143 - - 40,218,720 0.02%
23. PEORP Administrative Fund - 27,872,652 - - - 27,872,652 0.015%
24. Insurance Capital Build-up Program - 18,733,784 - - - 18,733,784 0.010%
25. SRI International Fund ;` - 13,982,455 - - - 13,982,455 0.007%
26. Florida Prepaid College Foundation - 9,251,634 - - - 9,251,634 0.005%
27. Pinellas Suncoast Transit Authority - - 6,101,926 - - 6,101,925 0.003%
28. Florida Division of Blind Services - 41,865 925,253 1,597,367 - 2,564,486 0.001%
29. Arbitrage Compliance Trust Fund - 2,072,299 - - - 2,072,299 0.001%
30.FIa. Endowment for Vocational Rehabilitation - 2,119,859 - - - 2,119,859 0.001%
31. Bond Fee Trust Fund - 1,840,415 - - - 1,840,415 0.001%
32. Fta. College Investment Plan Admin. Expense - 555,570 - - - 555,570 0.0003%
33. Fla. Prepaid College Fund Administrative Expense - 439,864 - - _
439,864 0.0002%
34. Investment Fraud Restoration Financing Corp. - 27,668 - - - 27,668 0.00001%
35. Inland Protection Financing Corporation - 1,440 - - - 1,440 0.000001%
Total Assets Under Management $27,268,602,440 $ 341,068,547 $ 402,766,987 $ 289,823,408 $ 159,242,433,865 $ 187,544,695,247
'The fund balance is periodically zero due to cash flows. --
' Individual accounts are not shown. As of September 30, 2007 there were 2,168 individual accounts in the LGIP
5
III. Recent Risk Monitoring Activities
The SBA regularly utilizes consultants, investment risk models, credit analysis and other analytics to
review the risk exposures in funds under its stewardship. This analysis is essential to prudently
managing the funds and overseeing external fiduciary investment managers that exercise discretion
over the SBA's assets. Just within the FRS Pension Plan, there are about 140 portfolios (i.e., 80 public
market investment portfolios and 60 private equity and real estate funds).
The vast majority of the SBA's assets are in actively managed strategies where experienced investment
managers construct diversified portfolios by prudently managing risk factors in pursuit of their return
objectives. Chart 4 illustrates the SBA's reliance on active management strategies for the FRS Pension
Plan. The SBA regularly interacts with its investment managers to review their performance,
investment process, organizational factors and market views regarding risks and opportunities. Since
June 30, 2007, staff has conducted about 230 meetings with managers (not including unscheduled
calls, etc.). A central topic in these meetings was their actual and planned management of the risks
related to sub-prime mortgage loans and possible contagion effects.
Chart 4
i
29.8%
Domestic Equities
+ Foreign Equities
^ Fixed Income
High Yield
Real Estate
Private Equity
Strategic Invest.
^ Cash Equivalents
4 0%
w} ~ ':
Passive 37.4%
FRS Pension Plan Asset Deployment
As of August 31, 2007
,_
60.0%~ "
11.8%
50.0%
12.3%
40.0% ~(
ii
30.0% ~'
_
i
_
20.0%~~
I
ii 6.2%
10.0%-~
~I 3.2%
`` ~ 0.8%
Active 62.6%
Additionally, the SBA has engaged in several focused reviews of potential direct or indirect sub-prime
exposures. In late July, the SBA reviewed its portfolios for exposure to equity tranches of
collateralized debt obligations (CDO) based on sub-prime mortgages. No such exposure was identified.
In early to mid August, the SBA reviewed exposure to CDOs backed by sub-prime mortgages. At that
time:
1. Exposure to CDOs backed by sub-prime mortgages across the SBA's investment mandates was
limited to a collective trust managed by a third-party fiduciary and was immaterial. The SBA had
6
less than $3 million of a CDO backed by sub-prime mortgage exposure in a Defined Contribution
Plan institutional money market fund.
2. Internally managed short-term portfolios had invested in CDOs backed by various types of high
grade assets, including bank liquidity enhancements. An exposure analysis revealed that none of
these CDOs were directly backed by sub-prime mortgage loans.
a. As of August 22, 2007, the SBA had roughly $1.5 billion invested in CDOs in the FRS Pension
Plan (i.e., Defined Benefit), Local Government Investment Pool, and trusts for separate account
clients.
b. The CDOs had the highest short-term credit ratings from Moody's, S&P etc.
c. The CDOs were very short-term in nature and all but one matured in September. Currently, the
SBA has only one CDO (rated A-1+/Aaa/AAA), with a par value of $80 million, maturing in
Apri12008.
By August 22, all internally managed short-term and long-term fixed income portfolios had been
reviewed, and they did not have any sub-prime exposure. SBA continued to evaluate other potential
indirect sub-prime exposure across all externally managed investment portfolios. Areas of focus were:
1. Asset-backed Commercial Paper.
2. Asset-backed Securities, including those backed by home equity loans.
3. Corporate debt issued by sub-prime mortgage originators.
The cumulative review indicated:
1. The only exposure to sub-prime loans through these three categories of instruments was in the
Defined Contribution Plan, and this exposure was less than 0.5% of total plan assets and almost
entirely through AAA-rated floating rate securities (i.e., with credit enhancements). As of early
November, these exposures had declined to less than 0.4% of plan assets.
2. The SBA had exposure to Al/Pl-rated Asset-backed Commercial Paper that was backed by high
grade collateral. As of late August, most of these investments had been recently affirmed by the
rating agencies. However, two were on credit watch by the rating agencies because of liquidity
concerns. The SBA believed the investments remained sound from a credit quality perspective and
was in active negotiations with other senior note holders and the administrator to extend the
maturity of the investments until the liquidity crisis subsided and the markets normalized. Section
V provides a detailed update on these exposures.
On August 23, the SBA's internal Senior Investment Group and consultants from Ennis, Knupp +
Associates and Wilshire Associates formally discussed the following agenda items:
1. Impact of recent market volatility on asset class performance and portfolio management;
2. Material sectors/instruments that are receiving particular focus from the asset class and/or
portfolio managers due to perceptions of heightened risk; and
3. Tactics being used to manage, mitigate, avoid, or exploit the recent market volatility and
changes in relative valuations.
Since that meeting, the SBA has continued to work with its investment managers to monitor the risk
exposures. The managers were recently surveyed regarding exposures to specific sub-industries and
companies sensitive to the sub-prime contagion, particularly focusing on:
7
1. How the account is positioned to manage, mitigate or avoid the recent market volatility and
changes in relative valuations created by the evolving sub-prime-related turbulence and
potential contagion effects; and
2. The firm's view of the materiality and likelihood of additional contagion effects impacting the
performance of the broader financial markets or financial system.
IV. Review of the Pension Plan
The Florida Retirement System Pension Plan Trust Fund has assets of approximately $138 billion
broadly diversified across the asset classes shown in Chart 5. The Fund's asset allocation is the most
important determinant of both short-term and long-term investment returns and risk. Of note, the
Investment Policy Statement approved in May 2007 lowered the level of risk in the portfolio by about
13%. This was accomplished by increasing the Fund's allocation to bond-type assets and lowering the
allocation to equity-type assets (i.e., 78%/22% to 69%/31%, representing a 9% shift). Diversification
within equities was also improved by increasing the allocation to foreign equities and adding small cap
foreign equities exposure.
Diversification is further enhanced because asset classes closely track broad market indexes: e.g.,
3,000 securities in domestic equities, 10,400 securities in investment grade and high yield bonds, 5,400
securities in foreign equities, 2,500 securities in global equities etc. Finally, diversification is enforced
within a portfolio context by guidelines limiting certain concentrations/exposures; e.g., single
position issuer limits, industry/sector limits, etc.
Chart 5
FRS Pension Plan Asset Allocation
As of November 6, 2007
Strategic Invest., 4.49% Cash Equivalents, 0.67%
Private Equity, 3.22%-~
High Yield, 7.33%
Real Estate, 6.27%
~`+t «...
i
Domestic Equities, 38.67%
8
Despite lowering the Fund's overall risk level this past summer, the Fund is still expected to provide
long-term average returns of 5% per year in excess of inflation. However, the advantage of less total
fund risk is a lower probability o£
• Disappointing investment performance;
• Higher employer contributions; and
• Deterioration of the current surplus.
In the aggregate, the FRS Pension Plan is defensively positioned with respect to the primary risks
emanating from the sub-prime sector. The equities asset classes, constituting about 63% of the Fund,
are underweight the industries that could be most negatively impacted by spillover from the sub-prime
problems. Staff and investment managers identified 32 sub-industries within the consumer
discretionary, financials, industrials and materials sectors and measured the active managers'
cumulative positions relative to the neutral market weightings.' Chart 6 shows a material defensive
posture in the three main groupings of public market equity investments in the Fund.
Chart 6
FRS Exposure to Sub-Prime Sensitive Sectors Relative to Market
0
in
N
1.0%
d
O.O% ~~ N ,3 O p ~~$
~ O N O ~ ya:.
W 3E O ~ ~ o O h
i
- _ _ _ _ N - - - - - j _ - - - - 1~tT.
i t
i O ~,
~ ~
2.0%' ~ ~ ae ~
-3.0%J
- -
-4,09y~ ~ Domestic Equities
a'e Global Equities a
-5.0% ' [„ ^ Foreign Equities
--------------_--a-__._----------__.._ ..
0
ae
-6.0%J
J.0%
Consumer Financials Industrials Materials Total
Discretionary
Actively Managed Holdings Above (Below) Market Weights
For Sectorslndicated
~ The sub-industries were: Consumer Electronics, Home Furnishings, Home Improvement Retail, Homebuilding, Home
Furnishing Retail, Household Appliances, Specialized Consumer Services, Asset Management & Custody Banks,
Consumer Finance, Diversified Banks, Diversified REITs, Industrial REITs, Investment Banking & Brokerage, Mortgage
REITs, Multi-Line Insurance, Multi-Sector Holdings, Office REITs, Other Diversified Financial Services, Property &
Casualty Insurance, Real Estate Management & Development, Regional Banks, Residential REITs, Retail REITs,
Specialized Finance, Specialized REITs, Thrifts & Mortgage Finance, Building Products, Construction & Engineering,
Construction & Farm Machinery & Heavy Trucks, Electrical Components & Equipment, Construction Materials, Forest
Products.
9
Similarly, the Fund's bond investments have a higher credit quality than the general market (Charts 7
and 8). These bond portfolios have a market weight to securitized assets but, under current Florida
statutes, the SBA can only directly invest in AAA-rated agency mortgage-backed securities (i.e.,
GNMA, FNMA and Freddie MAC). The presence of Caa-rated bonds in the high yield asset class
primarily represents split-rated bonds (84%), and none of the holdings are related to the 32 sub-
industries identified above.
Chart 7
Chart 8
FRS Pension Plan Fixed Income Assets
By Credit Quality
As of September 30, 2007
?~
4 82.6%
J
~ a1.7% ~,
Aaa
5.9% i i ~ i
i i i i
4.7~ i i i
' ~ i ~ ~.
Aa t
i i i '~ ~ _ i
i Lehman Aggregate Index i i
'
i i I i
I ~
4.6% ~, i ~a FRS Portfolio
Baa ~'
I
~
'~ 0.2%
~
a.o%
Other ~ ~~ ~ ~ ~
~ ~ ~ ~
~~
,
~-~
0.0% 10.0% ~~-~f ! --f
20.0% 30.0% 40.0% 50.0% 60.0% 70.0% ~
~
80.0% 90.0%
5,.s%
10
Importantly, Chart 9 illustrates that FRS Pension Plan performance has not been materially impacted
by the recent sub-prime problems and contagion. Through September 2007, Fund performance net of
fees exceeds the market benchmark for 1-year and longer measurement periods. For 1-month and 3-
month periods, private market investments account for the vast majority of underperformance versus
the benchmark (largely due to lags in updating property and partnership valuations heading into
calendar year-end).
Chart 9
Periods Ending September 30, 2007
8.00%
~ ~~ ~~ ~
~,
10 years T53%
~
i
14.68%~
i
5 ears ~ -
Y - '°: 14.65%
i
- 13.74% ~ '
3 ears
Y 13.36% i
`
~,k 16.45%'~
,
12 months 16.22% i
2.44% i i i i i
2.73%
i
3 months
3.04~q i i ~ i i
3121 i i
% i i i i
1 month '
~ ~ ~ ~
i ~ i
~-~ _..-f- -- f i
i i i
T~
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%
are annualized for all periods 12 months or greater ~ Managed Return
V. SBA's Short-Term Portfolios
We are pleased to report that none of the SBA's short-term portfolios (i.e., money market pools) have
any direct exposure to sub-prime residential mortgages. However, in August, investor anxiety about
the sub-prime issue spilled over into the commercial paper market. For many years, the SBA has
purchased commercial paper with high short-term credit ratings (i.e., rated A-1/P-1 or better by
Standard & Poor's and Moody's), particularly asset-backed commercial paper.
Over the last 20 years, asset-backed commercial paper has grown to constitute more than 50% of the
commercial paper market. A large number of A-l+/P-1 rated commercial paper programs have been
collateralized by portfolios of AAA-rated private mortgage-backed and other securities. This collateral
is held in trust to protect investors in the event the commercial paper issuer defaults (hence the term
asset-backed commercial paper or "ABCP"). However, these ABCP programs came under duress
because of falling collateral prices and many investors' unwillingness to refinance the ABCP as it
matured. Chart 10 illustrates the sharp rise in ABCP yields as issuers reacted to difficulty in finding
investors.
11
The root cause of the market illiquidity was that AAA-rated residential mortgage-backed securities
issued by private entities experienced a sharp drop in demand in August, because many of these
entities were also originators of sub-prime and non-conforming residential mortgages. The mortgages
supporting these AAA-rated securities typically had low delinquencies, low loan to value ratios, and
high FICO scores (i.e., credit worthiness scores), but the sudden and wholesale lack of investor
demand caused some prices to plummet by 5% to 10%. As a point of context, such AAA-rated
residential mortgage-backed securities would typically price within a range of +/- 0.50% of par.
Chart 10
Money Market Rates Since June 2007
6.50
6.25-
6.00
v
a
} 5.75-
c
a
u
a 5.50
v
a
N
~ 5.25
c
c
5.00
4.75
4.50
US Direct Issuer CP (First Tier)
®US Dealer CP (A2/P2)
^ Asset Backed CP (First Tier)
^ Fed Funds
®LIBOR
iui~s
11 /6
Overall, the SBA's short-term portfolios have maintained high credit ratings. The principal
disappointment has been with downgrades of Countrywide Financial securities and several asset-
backed commercial paper positions. Chart 11 illustrates the overall credit quality of a composite of all
the SBA's short-term portfolios, including the amount and percentage of investments that post-
purchase are now below our original stringent credit quality purchase requirements, as well as those on
negative credit watch.
Additionally, we have participated in restructuring negotiations with two asset-backed commercial
paper issuers to ensure that collateral is held in trust to pay principal and interest due the SBA's clients.
The SBA continues to collect principal and interest on these restructured investments and has not
experienced any loss.
12
Chart 11
Through recent months, we have continued to work diligently to ensure that all of the short-term
portfolios appropriately balanced risk and return. Charts 12 and 13 demonstrate that, over various
periods, the two largest short-term portfolios under the SBA's direction have delivered investment
returns that track industry money market benchmarks. While financial markets are likely to remain
challenging in the near future, we remain confident that these portfolios will continue to provide stable
returns for participants, with an emphasis on safety and liquidity of principal.
Chart 12
FRS Pension Plan -Cash Holdings Performance
Periods Ending September 30, 2007
^Managed Return
are annualized for all periods 12 months or greater Benchmark Return
13
Chart 13
Florida Local Government Investment Pool
Annualized Returns through September 30, 2007
4.05%
10 Years 3.99%
4~ ___ _ . _"~.._~.__. ,_. _ ~.~..~ .~ 4.01%
3.19%
S Years - 3.07%
-.._ , 3.14%
4.38%
3 Years 4.29%
f 4.36%
5.56%
112 Months 5.46%
5.51%
1.40%
3 Months 1.34% ^ participants Return - ~!
_ __,~~.~~ -~~ 1.37% S£xP US AAA & AA Rated GIP Atl 30 Day Gross Index
0.47% ' iMoneyNet First Tier Institutional Money Market Funds Gross Index
__
1 Month 0.43%
~ 0.45%
~ _ _ i
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
Returns less than 1 year are not annualized. for periods prior to 1998, S8P gross index was calculated by 58A assuming an average fee of 30
basis points using the published S&P US AAA & AA Rated GIP All 30 Day Net Yield series from Bloomberg. Methodology available upon request.
Nonetheless, within our short-term portfolios, we are decreasing investments in asset-backed
commercial paper and financial company securities in a prudent and orderly fashion. Early this month,
the SBA strategically began to reinvest asset-backed commercial paper maturities in other highly rated
instruments:
1. We intend to enhance the liquidity in the SBA's short-term portfolios because client outflows have
marginally increased given heightened market uncertainty.
2. Sentiment in the money markets has been improving with two Federal Reserve interest rate cuts
and injections of liquidity, but the overall environment remains somewhat unsettled with persistent
anxiety regarding commercial paper credit downgrades and worries about U.S. and European
commercial and investment bank sub-prime write-offs.
The SBA has also communicated a detailed update on the status of the short-term portfolios to clients.
The latest quarterly Florida Local Government Investment Pool Newsletter is in the Appendix.
Downgraded Positions
Table 1 lists the current holdings that have been downgraded below the initial purchase guidelines for
the various short-term portfolios.
KKR Pacific and KKR Atlantic (sponsored by KKR Financial Holdings) and OTTIMO (sponsored
by Aladdin Capital Management) are ABCP that extended their maturities but chose to negotiate
with the ABCP investors to achieve a mutually agreeable liquidation plan for the collateral. Our
negotiations with KKR, alongside other senior note holders, have been completed and the interests
of the ABCP investors have been protected accordingly (i.e., a capital injection by KKR, an
interest rate premium, and new maturities in February/March 2008 including an option to
control the collateral at that point). The collateral supporting the Ottimo ABCP has been placed in
a liquidating trust for the benefit of note holders.
14
Axon Financial is a Structured Investment Vehicle (SIV) and has just begun enforcement actions.
At this point, the collateral is sufficient to pay all senior note holder maturities. The SBA has two
other SIV positions (i.e., Rathgar) that have not suffered any negative rating actions.
There are nine Countrywide holdings of relatively small size that are primarily floating rate notes.
Despite the company's setbacks and future challenges in a slow housing market, the SBA
continues to expect the investments to mature as scheduled.
Chart 14: Holdings Downgraded Below the Initial Purchase Guidelines
Maturity Date SEtP Moodys Fitch Par Value Status
Axon Financial Funding LLC 04/25/2008 A-2 * NP C * $400,000,000 Restructuring
KKR Atlantic Funding Trust .03/18/2008 A-2 * NP D $849,917,483: Restructured
KKR Pacific Funding Trust 03/18/2008 A-1 * NP NR $577,338,339 Restructured
OTTIMO Funding Ltd 03/19/2008 C * NP NR $318,859,251 Restructured
Countrywide Financial Corp Various BBB+ * Baa3 * BBB+ $134,570,000 Expect to Mature
Countrywide Home Loans 12/19/2007 BBB+ * Baa3 * BBB+ $1,450,000 :Expect to Mature
Total $2,282,135,073
Note: * indicates holding is on negative credit watch
15
This quarterly newsletter is expanded to ad-
dress the sub-prime residential mortgage
market meltdown that has created an un-
precedented event in the financial markets.
While financial markets may remain challeng-
ing in the near future, we remain confident
that the Florida Local Government Surplus
Funds Investment Pool ("Pool") will continue
to provide stable returns for participants with
an emphasis on safety and liquidity of princi-
pal.
We are pleased to report that the Pool does
not have any direct exposure to sub-prime
residential mortgages. However, in August,
investor anxiety about the sub-prime issue
spilled over into the commercial paper mar-
ket. For many years, the Pool has purchased
commercial paper with high short-term credit
ratings (i.e., rated A-1/P-1 or better by Stan-
dard & Poor's and Moody's), including asset-
backed commercial paper with the highest
ratings of A-1+/P-1.
Overall, the Pool's investments have main-
tained high credit ratings. The only disap-
pointment has been with isolated credit down-
grades accounting for 3.4% of the par value
of the Pool. Chart 1 illustrates the Pool's over-
all credit quality and identifies the specific
securities that have been downgraded below
the original purchase requirements. More-
over, we have participated in restructuring
negotiations with two asset-backed commer-
cial paper issuers to make certain that collat-
eral is held in trust to pay principal and inter-
est due the Pool.
Throughout the quarter, we continued to work
diligently to appropriately balance risk and
return. Chart 2 demonstrates that over the
short-term and long-term the Pool has deliv-
ered investment returns that track industry
money market benchmarks.
As always, we welcome any questions. Also,
please visit the Pool website for updated in-
formation on yields, performance, investment
guidelines, holdings and financial statements.
Chart 1: Florida Local Government Investment Pool
Credit Ratings of Holdings as of October 31, 2007
raded F3elow
se Guidelines
3.4
23.2 %
Note: Per S&P convention, A-I commercial paper with 7 or less days to
maturity is included in the A-I+ category.
Holdings Downgraded Bclow Purchase Guidelines
Issuer S&P Moody's Fitch Par Value
Axon Financial A-2 NP F3 * $175,000,000
Funding
KKR Atlantic * NP D $17Q,079,9g9
Fdg Trust LN
KKR Pacific A-I* NP $362,333,143
Fdg Trust LN
Ovimo Pdg LN C* NP $179,935,112
Percent of 3.4%
Poa('s Par
* On negative cre dit watch
Chart 2: Florida Local Government Investment Pool
Annualized Returns through September 30, 2007
10 Years
5 Years
3 Years
12 Months
1.ao%
3 Months 1.37%
_ _ 1.34
(1.47%
l Month ~ 045ru
043%
5.56%
5.51 %
x.46%
Returns less than 1 year arc not annualized. For periods prior to 1998, S&P
gross index was calculated by SBA assuming an average fee of 30 basis
points using the published S&P US AAA & AA Rated GIP All 30 Day Net
Yield scrics from Bloomberg. Methodology available upon rcqucst.
0.00% L00% 2.00% 3.00% 4.00% 5.00%
^ Participant Retum
iMoneyNet First Tier Institutional Money Market Funds Gross Index
6F S&P US AAA & AA Rated GIP All 30 Day Gross Index
6.00 % 7.00
STATE BOARD OF ADMINISTRATION
3
Recent Market Environment
Despite a growing U.S. economy, the
sub-prime crisis deepened this summer
with hedge fund failures and rating
agency downgrades of sub-prime secu-
rities. The credit markets extrapolated
risks, and otherwise unrelated securities
were severely impacted. Commercial
banks drastically lowered their lending
in the inter-bank loan market because of
worries that other banks had not fully
disclosed their sub-prime exposure.
This was reflected in a sharp increase in
the cost of lending as 1-month LIBOR
peaked at 5.82% or 57 basis points over
the Federal Funds target of 5.25%. This
spread had been 3 to 7 basis points
since the beginning of 2007 (Chart 3).
Additionally, AAA-rated residential mort-
gage-backed securities issued by pri-
vate label entities experienced a sharp
drop in demand, because many of these
entities were also originators of sub-
prime and non-conforming residential
mortgages. The mortgages supporting
these AAA-rated securities typically had
low delinquencies, low loan to value
ratios, and high FICO scores, but the
sudden and wholesale lack of investor
demand caused some prices to plum-
met by 5% to 10%. As a point of con-
text, such AAA-rated residential mort-
gage-backed securities would typically
price within a range of +/- 0.50% of par.
Over the last 20 years, asset-backed
commercial paper has grown to consti-
tute more than 50% of the commercial
paper market. A large number of A-1+/
P-1 rated commercial paper programs
are collateralized by portfolios of AAA-
rated private mortgage-backed and
other securities. This collateral is held in
trust to protect investors in the event the
commercial paper issuer defaults
(hence the term asset-backed commer-
cial paper or "ABCP"). However, these
ABCP programs came under duress
because of falling collateral prices and
many investors' unwillingness to refi-
nance the ABCP as it matured.
Overnight rates for ABCP jumped from
5.3% to 7.0% and a small number of
extendable ABCP programs decided to
utilize their extension option for the first
time in the 12-year history of the struc-
tu re.
In August, the Federal Reserve and
European Central Bank added the most
liquidity to the global banking system
since the period immediately following
the September 11, 2001 tragedies. On
September 18, 2007, the Federal Re-
serve cut the overnight Federal Funds
rate by 50 basis points, citing an at-
tempt to: "forestall some of the adverse
effects on the broader economy that
might otherwise arise from the disrup-
tions in financial markets." The Federal
Reserve cut rates by another 25 basis
points on October 31, 2007.
In recent weeks, the inter-bank loan
market and commercial paper market
have shown signs of improvement.
Whereas many investors were avoiding
all ABCP (regardless of the credit fun-
damentals), with clear support from the
Federal Reserve and the ebbing of
"headline risk," an increasing number of
investors are investing in ABCP and
private label residential mortgage-
backed securities. While yields on these
securities and in the inter-bank loan
market still reflect historically high risk
premiums, they have continued to im-
prove.
Status of Pool's ABCP Commercial
Paper Investments
The SBA maintains a list of 150 to 200
approved commercial paper programs.
Out of an approved list of approximately
50 extendable ABCP programs on
July 31, 2007, the Pool owned extend-
able ABCP issued by seven programs
that recently chose to extend maturities.
All seven were collateralized by Prime
and Alt-A mortgages; the latter mort-
gages have high FICO scores and low
loan to value ratios, but non-standard
documentation. We have reviewed the
underlying collateral and it continues to
pay as expected, but the seven ABCP
programs have employed various re-
sponses to the credit crunch:
Most issuers chose to close their
programs in an orderly fashion by
selling the collateral and covering
any shortfalls with additional cash
infusions, as needed. Examples
include programs sponsored by
Countrywide, Thornburg Mortgage,
Luminent Mortgage Capital and
American Home Mortgage.
Two programs sponsored by RAMS
Home Loans also extended and are
paying enhanced coupons. Of note,
Westpac Banking Corp. has an-
nounced that they are purchasing
the RAMS franchise and plan to
commit $1.5 billion to the $6 billion
ABCP program.
KKR Pacific and KKR Atlantic
(sponsored by KKR Financial Hold-
ings) and Ottimo (sponsored by
Aladdin Capital Management) ex-
tended their maturities, but chose to
negotiate with the ABCP investors
to achieve a mutually agreeable
liquidation plan for the collateral.
Our negotiations with KKR, along-
side other senior note holders, have
been completed and the interests of
the ABCP investors have been pro-
tected accordingly (i.e., a capital
injection by KKR, an interest rate
premium, and new maturities in
February/March 2008 -including an
option to control the collateral at
that point). Restructuring discus-
sions relating to commercial paper
issued by Ottimo has not been final-
ized.
(Continued nn page 3)
STATE BOARD OF ADMINISTRATION
Local Gove
Status of Pool's CDO and SIV In-
vestments
In addition to the turbulence surround-
ing ABCP, market analysts have also
expressed concern regarding Collater-
alized Debt Obligations ("CDO") and
Structured Investment Vehicles ("SIV").
The Pool has selectively purchased
commercial paper issued by these ve-
hicles where they had the highest pos-
sible credit ratings (i.e., rated A-1+/P-
1) and there were sufficient credit en-
hancements. As of July 31, 2007, the
Pool had investments in securities is-
sued by 28 CDOs and SIVs. Of the 28
issuers, positions with only 2 have not
matured. Table 1 shows the active po-
sitions. One of the 2 active positions
(Axon) was recently downgraded by
Fitch and Moody's (see Chart 1).
Pool's Current Investment Profile
The Pool's participant yield at the end
of the quarter (5.77%) was noticeably
higher than LIBOR, but will decline
materially by the end of November
2007 due to resets on floating rate in-
vestments. Heading into the quarter,
the Pool had been holding short-term
securities and avoided longer dated
fixed coupon investments. Most of our
$16 billion floating coupon security po-
sitions, with the coupon reset based on
1- and 3-month LIBOR, participated in
the extraordinary rise in LIBOR yields.
The unanticipated dislocation of LIBOR
from the Federal Funds rate explains
the majority of the recent increase in
the Pool's yield (Chart 3). Additionally,
in late August and early September,
we selectively purchased ABCP that
had full liquidity support, typically from
an AA-rated counterparty, at yields
exceeding 6%. Over $5 billion of these
ABCP securities were purchased and,
as of October 25, 2007, they had a
weighted average maturity of 45 days.
Thus, the near-term maturity of these
recent purchases will also depress the
Pool's yield through the end of the cal-
endar year.
No one can consistently predict the
future course of financial markets and
residential mortgage default rates, but
credit markets are showing some signs
of gradually recovering. During the
worst of the market turbulence, 1-
month LIBOR traded 20 to 40 basis
points over the Federal Funds rate.
That spread is now lower at 7 basis
points, although still elevated relative
to the historical average. Similarly, 1-
month ABCP yields traded as high as
50 to 60 basis points over 1-month
LIBOR, but that spread has trended
down to about 10 basis points.
Table 1
We encourage you to contact us if you
have any questions or concerns. We
also want to remind you to visit the
Pool website for updated information
on yields, performance, investment
guidelines, holdings and financial
statements.
Harrier Financial Funding* ~ Axon Financial Funding
Bought Date 05/25/2007 08/03/2007 ~ 07/27/2007
Cusip 41365WAQ5
Last Applicable Credit Rating** A-1+ / P-1
Coupon Rate (%)
41365 WAU6 05462NAD
A-1+ / P-1 I A-2/ NP / F3
5.34 4.92
5.32
Maturity Date 02/15/2008
Current Par Value $250,000,000
Type
04/25/2008 I 04/25/2008
$190,000,000 ~ $175,000,000
SIV SIV
SIV
Percent of Pool's Par Value 0.96% 0.73% 0.67%
* RATHGAR CAPITAL US CORP
"Credit rating applicable at time of maturity or current rating
Chart 3: Recent 30-Day Money Market Yields Since June 2007
6.50
6.25
6.00
~ 5,75
s~
S.SU
~9
Z 5.25
5.00
4.75
4.50
^~, ^\~" ^\,y^~ ^~,p ~b ~~^~ ~,yp ~,yn 9\^~ q\~p q\~~ q\,ya ,p\~ ,p~ ,p\`5 ,p\titi ,pie
-US Direct Issuer (:P (First Tier) -+-US Dealer CP (A2/P2) ~Asse[ Ifacked CP (First Tier) -Fed Funds ~L.IRORI
-
SOURCE: Bloomberg
STATE BOARD OF ADMINISTRATION
S Local Government Investment Pool N E W S L ETT E R
State Board of Administration
1801 Hermitage Blvd.
Tallahassee, FL 32308
_~ Local Government Investment Pool NEWSLETTER
For Previous Four t~uarters
Novemb
y Decemb
CIPANTS
rently consist
counts main
ernment oarti
veu
'll@sbafla.coi
The investment pool closed with the amortized cost on investments on September 30, 2007
of $27,146,340,795. The portfolio's average days to maturity were 34 and the security distri-
bution was as follows
^-•----• °-.•..°•--- ~~.~_.~. ~ _~.~.....
._~_., ^913N0~. .nci~nin~_ n31Z~m~ ~~~z,mc
Commercial Pa er -Discounted 29.45% 8.81 % 16.43% 26.08%
Li uidit Notes -Discounted 6.41 % 36.19% 33.78% 21.60%
Commercial Pa er -Interest Bearin 0% 0% 0% 0.31%
Cor orate Variable Rate Extendable 17.35% 19.50% 15.53% 12.38%
Certificate of De osit Variable Rate Extendable 0.70% 1.59% 0% 0%
Cor orate Variable Rate 16.11% 1.83% 0.91% 0.88%
Commercial Pa er Floatin Rate 2.39% 3.32% 5.54% 7.96%
Commercial Pa er Variable Rate 14.23% 18.49% 15.61 % 14.33_%
Certificate of De osit Floatin Rate 0% 0.23% 0.22% 0.22%
Certificate of De osit Variable Rate 7.28% 7.45% 7.70% 5.06%
Bank Note Variable Rate 0.18% 0.16% 0.15% 0.16%
Li uidit Notes Variable Rate 4.98% 2.11% 2.29% 2.64%
USA enc Discount Notes 0% 0% 0% 2.96%
USA enc Callable 0% 0% 0% 0.78%
USA enc Callable Ste ed 0% 0% 0% 1.25%
USA enc Variable Rate Callable 0.92% 0.32% 0.62% 1.38%
US Treasu Bills 0% 0% 0.61 % 0%
US Treasu Notes 0% 0% 0.61% 2.03%
Totals: 100% 100% 100% 100%
3
UPCOMING POOL HOLIDAYS
Veterans Day November 12, 2007
Thanksgiving November 22, 2007
-- -Day atter November'Z`d,°'LUU%
Christmas Day December 25, 2007
POOL PARTICIPANTS RTI
The pool currently consists of 2,168 un
individual accounts maintained by ac
995 local government participants. 1ov
-~ CONTACT IN FORMATION ONTACT !I
Susan Crosw ell ;usan Crosu
susan.croswe ll@sbafla.com isan.croswE
( 850) 488-731 1 >50) 488-73
FAX FAX
( 850) 413-123 4 3% ~ (850) 413-12.
J /o
~ocumE 1) Statements, transaction history and the Input Document form are found on our website under the Documents tab. n er the D
2) You may call in "future dated" transactions to the Pool line at 850-488-7311.
3) You should always get a confirmation number when entering a transaction on the website.
~itli tree 4) Local Governments which may be investing bond proceeds in our investment pool should consult with their bond ~It v
>sues s, counsel regarding arbitrage regulations. Guidance should be obtained with regard to compliance issues surrounding .e i_=
their regulations.
OF ~ i+ll`'TR ISSUE DATE :10/31/2007 ts~ttr ,-~~,slw tc:!'~I t ~,;t;% STATE BOARD OF ADMINISTRATION RC