Bad Loans And Leverage Bruise Calpers
Tweet
Share
E-mail
As property values rose to atmospheric levels, California's largest pension fund, California Public Employees' Retirement System (Calpers), decided to buy a boatload of undeveloped land. Today, Calpers is one of the country's largest owners of undeveloped residential land.
As of June, the Wall Street Journal reported Calpers had $239 billion in assets, Calpers's portfolio was bigger than the government-run funds of Russia, South Korea, Dubai and Chile combined. It is is having one of its years since its founding it 1932 as it has lost almost a quarter of its assets since July 1, the start of the current fiscal year. In fact, Calpers is warning California's cities and schools that they may have to contribute more money to cover the retirement and other benefits the fund provides for 1.6 million state workers.
Recently, Calpers said it expects to report paper losses of 103% on its real estate investments in the fiscal year ended June 30. That's because Calpers invested not only its own money, it used everyone's favorite word, leverage, and invested billions of borrowed money that needs to be repaid even if the investment fails. In some deals, as much as 80% of the money invested by Calpers was borrowed.
Obviously, Calpers needs to raise cash so what it is being forced to do is liquidate its holdings in a troubled venture called LandSource. LandSource is selling land in possibly the worst market for land in our lifetimes. Calpers could possibly lose nearly $1 billion on LandSource.
Residential and commercial holdings total about one-tenth of the fund's overall $182.6 billion portfolio. Its real-estate portfolio fell 14.4% for the 12 months ended in September, underperforming its benchmark, which rose 5.3%. Calpers stresses that it's a long-term investor and can earn back the declines in the future, just as it erased declines suffered in the dot-com bust a few years ago.
Here is an example of a Calpers deal: It invested in three large parcels near Phoenix and last month Calpers effectively walked away from one of the three, after having invested $140 million. On one of the others, to start earning any return, Calpers's partner on the deal recently started selling ground water from the property.
Just one particularly bad year for investments can have serious consequences for California governments in the retirement system. Calpers recently estimated that if its declines for the current fiscal year are greater than 20%, it would trigger an increase of 2% to 5% of an employer's payroll.
In residential land deals, Calpers typically didn't used much borrowed money. But in 2005, the trustees sanctioned use of borrowed money in residential deals at an average rate of 60%.
Until last year, the Calpers strategy worked. Returns on housing investments were on average 16% from 2004 through 2006.
Not only did Calpers increase the leverage it employed on deals, it also got more aggressive on deals. For example, Calpers guaranteed $1.7 billion in debt across several deals. Typically, home-builders are the guarantors -- that is, they're responsible in the event of a default.
By Calpers being the guarantor, it was able to use its great reputation to obtain lower interest rates on loans. But, as many of the projects are now struggling, the guarantees mean Calpers has to deposit additional cash into projects from which it might otherwise just walked away.
In an effort to ensure these types of losses do not occur at Calpers again, it is changing its investment process. For the past year, Calpers now requires deals to be vetted three times -- by the internal investment committee, an independent fiduciary and, finally, by an outside consultant. Previously, much of the oversight came from Calpers' staff and consultants.
Calpers is also considering to reduce the maximum amount of leverage that can be used in housing deals, and cut back on loan guarantees.
As of June, the Wall Street Journal reported Calpers had $239 billion in assets, Calpers's portfolio was bigger than the government-run funds of Russia, South Korea, Dubai and Chile combined. It is is having one of its years since its founding it 1932 as it has lost almost a quarter of its assets since July 1, the start of the current fiscal year. In fact, Calpers is warning California's cities and schools that they may have to contribute more money to cover the retirement and other benefits the fund provides for 1.6 million state workers.
Recently, Calpers said it expects to report paper losses of 103% on its real estate investments in the fiscal year ended June 30. That's because Calpers invested not only its own money, it used everyone's favorite word, leverage, and invested billions of borrowed money that needs to be repaid even if the investment fails. In some deals, as much as 80% of the money invested by Calpers was borrowed.
Obviously, Calpers needs to raise cash so what it is being forced to do is liquidate its holdings in a troubled venture called LandSource. LandSource is selling land in possibly the worst market for land in our lifetimes. Calpers could possibly lose nearly $1 billion on LandSource.
Residential and commercial holdings total about one-tenth of the fund's overall $182.6 billion portfolio. Its real-estate portfolio fell 14.4% for the 12 months ended in September, underperforming its benchmark, which rose 5.3%. Calpers stresses that it's a long-term investor and can earn back the declines in the future, just as it erased declines suffered in the dot-com bust a few years ago.
Here is an example of a Calpers deal: It invested in three large parcels near Phoenix and last month Calpers effectively walked away from one of the three, after having invested $140 million. On one of the others, to start earning any return, Calpers's partner on the deal recently started selling ground water from the property.
Just one particularly bad year for investments can have serious consequences for California governments in the retirement system. Calpers recently estimated that if its declines for the current fiscal year are greater than 20%, it would trigger an increase of 2% to 5% of an employer's payroll.
In residential land deals, Calpers typically didn't used much borrowed money. But in 2005, the trustees sanctioned use of borrowed money in residential deals at an average rate of 60%.
Until last year, the Calpers strategy worked. Returns on housing investments were on average 16% from 2004 through 2006.
Not only did Calpers increase the leverage it employed on deals, it also got more aggressive on deals. For example, Calpers guaranteed $1.7 billion in debt across several deals. Typically, home-builders are the guarantors -- that is, they're responsible in the event of a default.
By Calpers being the guarantor, it was able to use its great reputation to obtain lower interest rates on loans. But, as many of the projects are now struggling, the guarantees mean Calpers has to deposit additional cash into projects from which it might otherwise just walked away.
In an effort to ensure these types of losses do not occur at Calpers again, it is changing its investment process. For the past year, Calpers now requires deals to be vetted three times -- by the internal investment committee, an independent fiduciary and, finally, by an outside consultant. Previously, much of the oversight came from Calpers' staff and consultants.
Calpers is also considering to reduce the maximum amount of leverage that can be used in housing deals, and cut back on loan guarantees.
You May Also Be Interested In
- Shopify board member resigns to join U.S. Department of Commerce
- Coty's chief people officer to resign in August
- Alarum Technologies responds to FBI investigation of subsidiary NetNut
Create E-mail Alert Related Categories
Corporate News, Insiders' BlogRelated Entities
Citi, CalPERSSign up for StreetInsider Free!
Receive full access to all new and archived articles, unlimited portfolio tracking, e-mail alerts, custom newswires and RSS feeds - and more!
