Illinois to Finally Begin Securities Lending Program
Investment strategy expected to generate millions for state
January 7, 2008
The State of Illinois is introducing securities lending as a new, low-risk investment strategy designed to boost the yield on the state’s portfolio, conservatively, by as much as $1 million annually, State Treasurer Alexi Giannoulias said today.
The Treasurer’s Office recently awarded a three-year, competitively bid contract to Dresdner Bank AG, through its Dresdner Kleinwort investment banking division, which will administer the state’s securities lending program.
Securities lending is an effective way to generate new income for the state’s general portfolio by making short-term loans of otherwise idle U.S. Treasury and Agency securities in the state’s investment portfolio.
“The Treasurer’s Office is constantly looking for creative and responsible ways to bring new revenue to the state, especially during these tough budget years,” Giannoulias said. “Securities lending is a common and safe way for state treasurers and other public institutions to improve portfolio returns without risking taxpayer dollars.
“Securities lending will bring millions of dollars to Illinois just by utilizing its idle investments,” Giannoulias added. “It’s astonishing the state has not leveraged its portfolio in the past to include such a great revenue-generating strategy. But times have changed and this administration now has the expertise and capability to initiate these opportunities.”
Securities lending is currently used by a number of institutional investors, including state treasurers and private and public pension funds in 32 states, according to the National Association of State Treasurers. In the Midwest, Indiana, Michigan, Missouri, and Ohio currently use securities lending as a means of generating additional incremental revenue.
In neighboring Iowa, the $20 billion Iowa Public Employees Retirement System and the $2.5 billion state operating fund have been lending their securities since 2002. The securities lending program at IPERS has generated $16.4 million in total earnings the past three fiscal years, while the state operating fund has gained about $2.5 million in the same time period.
The Commonwealth of Virginia generated about $3.2 million in revenue in the first 12 months it contracted with Dresdner Bank for securities lending, said Virginia’s Director of Investment and Cash Management John Small. Virginia had been using its custodian for this service previously, but then moved to Dresdner, a non-custodial (“third-party”) agent, increasing revenues significantly.
“If securities lending is done properly and with adequate monitoring, there certainly is a potential for additional revenue,” Small said.
For the past three fiscal years, Dresdner has administered securities lending for the State of Maryland’s general fund and state lottery. Just in November, with an average of $4 billion in securities on loan, the state generated $416,283, said Mary Christine Jackman, Maryland’s director of investments.
“This investment strategy added additional income to the state for securities we already held. Dresdner put them to work doubly,” Jackman said.
Under the new securities lending strategy, Illinois will lend state-owned securities to approved counterparties on a fully collateralized basis. At the Treasurer’s direction, Dresdner will then reinvest the cash collateral in high-quality overnight repurchase agreements and rebate a portion of the investment yield to the borrower when the securities are returned.
The state’s profits are derived from the excess yield after rebating some of the investment yield to the borrower. In terms of safety, the state deals only with a select list of highly creditworthy counterparties that use standardized industry contracts and well established practices.
Loans are made on an overnight basis, so the state can recall securities on one day’s notice if it should need to sell a security, and loans are also marked to market each day to ensure that adequate collateral is always in place. Lastly, Dresdner Bank, one the world’s largest non-custodial securities lending agents, will provide contractual indemnification against counterparty risk, according to the contractual agreement,
“Securities lending provides the market with short-term, temporary liquidity that will benefit the state by generating an increase in the overall monthly portfolio yield through incremental revenues without undertaking additional high risk and potential risky exposure,” Giannoulias said. “Because Dresdner is protecting us against losses, the worst we can do is break even.”
Dresdner Kleinwort is the investment banking division of Dresdner Bank AG and a member of the Allianz Group. Operating from offices in New York, London and Frankfurt, Dresdner is one of the leading providers of non-custody (i.e., “third-party”) securities lending services. Dresdner will officially begin providing services for Illinois beginning in early January.
“Securities lending is a time tested practice of providing asset pools a relatively safe way of generating additional income,” said investment expert Brian Wrubel, managing director of Marquette Associates, Inc., in Chicago, which helped advise the Treasurer’s Office. “In today’s fixed income market environment it is important to make sure you are doing all the little things right, every dollar counts.”
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