CalPERS’ securities lending loss

CalPERS will continue its securities lending program following an annual review, despite significant pressure on its collateral pool, with income of $220 million generated for the year to March but unrealised losses on the internal collateral reinvestment of $854 million.

In a report to the board, the fund’s consultant, Wilshire said the significant unrealised loss in the collateral pool is likely to result in a total eventual loss to the fund of between $500 million and $1 billion.

This is due to the drop in prices on a lot of instruments purchased by CalPERS, with some securities defaulting or expected to default.

In an effort to limit any additional losses, the investment team has restricted all new investments to overnight securities, as they work out the damage to the collateral pool.

The internal staff annual review of the securities lending program confirmed the use of the program, a decision endorsed by Wilshire’s assessment.

In the past 12 months the fund held four auctions awarding more than $113 billion in assets to 11 borrowers, and in the past eight years CalPERS has auctioned off access to $835 billion in assets through 33 separate auctions, with cumulative net earnings of $1.4 billion.

Despite the failure, and merger, of several large counterparties over the past year, CalPERS has suffered no losses from defaults in any of its securities on loan.

According to Wilshire, CalPERS, like other lenders, requires over-collateralisation for all loans, and has simply kept the collateral, for no gain or loss, when a counterparty defaulted or declared bankruptcy. CalPERS had lent money to Lehman Brothers but incurred no losses on its default.

For the year to the end of March 2009, the average market value of securities on loan for the year was $33.5 billion, with annualised earnings of 23 bps. The large unrealised loss amount was due to CalPERS use of mark-to-market accounting on the valuation of the internal cash pool, which is not market convention on collateral reinvestment pools. The external portfolios use amortised cost pricing.

“This success reinforces the value of the auction platform and the demand in the marketplace to borrow CalPERS’ - the internal staff report said.