Illinois to lend securities in state's portfolio

By Steven R. Strahler

Crain's Chicago Business, Chicago, IL

Published Monday, January 7, 2008

(Crain’s) — The state of Illinois hopes to reap up to $1 million annually by lending out securities in its investment portfolio — a practice already under way in 32 other states.

Dresdner Kleinwort, the investment banking unit of Dresdner Bank A.G., won a three-year, competitively bid contract to administer the program, according to the state treasurer’s office.

Under the plan, the treasurer’s office gets cash from borrowers in exchange for U.S. Treasury and government agency securities it lends from its portfolio. The cash proceeds are then reinvested in overnight repurchase agreements.

Dresdner bears the default risk and gets a cut of the proceeds, while the state enjoys two sources of income — one from the borrowers and another from the cash it invests.

Borrowers are typically hedge funds and other institutional investors that use securities to cover short sales or to meet requirements of other transactions in a timely fashion.

The $1 million expected to be generated annually would amount to about a 0.1% return on the treasurer’s office’s $1-billion investment pool. That’s a very narrow spread but still attractive because of Dresdner Kleinwort’s indemnification against losses.

“Quite frankly, it’s astonishing to me that the state of Illinois has not done this before,” says state Treasurer Alexi Giannoulias.

Pension industry consultant Marquette Associates Inc., which advises Mr. Giannoulias’ office, said an attempt a couple of years ago under a previous administration stalled for lack of a default guarantee from J. P. Morgan Chase & Co., which had been chosen to be administrator.

“For the incremental amount of return . . . the perceived risk early on didn’t make sense from the state’s point of view,” says Marquette Managing Director Pat Krolak. J. P. Morgan Chase didn’t comment immediately.

Dresdner Kleinwort won the most recent bid after it alone guaranteed a minimum level of portfolio lending and offered the most favorable spreads and split in proceeds, according to Ed Buckles, deputy treasurer and chief fiscal officer.

Last year the College Illinois prepaid tuition program administered by the Illinois Student Assistance Commission opted to pursue securities lending and picked U.S. Bank to administer the program. In the first five months, it has generated about $200,000, according to College Illinois Director Randy Erford.

“As a good fiduciary, why wouldn’t you do it?” he says.