Copyright
Montana. Public Employees' Retirement Board.

Comprehensive annual financial report (Volume 2006) online

. (page 5 of 17)
Online LibraryMontana. Public Employees' Retirement BoardComprehensive annual financial report (Volume 2006) → online text (page 5 of 17)
Font size
QR-code for this ebook


buy or sell units on the first calendar day
of each month. MDEP security transac-
tions are recorded as of trade date rather
than settlement date. Because of this gen-
erally accepted practice, the MDEP port-
folio at June 30 may include receivables
from brokers for securities sold but not
delivered, and payables to brokers for se-
curities purchased but not received. Ad-
ministrative expenses incurred by the BOI
are charged daily to MDEP based on the
board's expenses applicable to MDEP.
The PERB portion of MDEP is 60.64 per-
cent. For Custodial Credit Risk as of June
30, 2006, all the MDEP securities were
registered in the nominee name for the
BOI and held in the possession of the
BOI's custodial bank, State Street Bank.
The BGI S&P 500 Equity Index Fund A,
S&P 400 MidCap Equity Index fund,
DFA Small Cap Subtrust. Goldman Sachs



and Western Asset (WAMCO) commin-
gled funds are registered in the name of
the Montana BOI. Concentration of
Credit Risk as of June 30, 2006 - there
were no single issuer investments that
exceeded 5% of the MDEP portfolio.

On October 1 1, 2002, the BOI received a
summons and complaint regarding the
bankruptcy of Owens-Coming. The com-
pany seeks a determination that the divi-
dend payments paid from October 1996
through July 2000 represent "fraudulent
transfers under Chapter 1 1 Bankruptcy
provisions and applicable state law, and
are, therefore, voidable". The complaint
states the BOI was the "recipient of divi-
dends in the amount of $357,099 for the
relevant period". The BOI has prepared a
response to the complaint. As of Septem-
ber 22, 2006, this matter is still pending.

In July 2005, the BOI agreed to lease a
Portfolio Order Management System
(POMS) from Bloomberg Financial Ser-
vices. This electronic securities trading
system reduces trading time and paper-
work, increases trading and accounting
accuracy, and provides certain controls
not previously available. Electronic trad-
ing began with the internally-managed
component of the MDEP in August 2005.
Implementation of electronic trading for
the STIP and the other fixed income port-
folios, as managed by the BOI staff, was
completed in fiscal year 2006.

RFBP portfolio includes corporate secu-
rities, foreign government bonds, U.S.
government direct-backed, U.S. govern-
ment indirect-backed and cash equiva-
lents. RFBP investments are presented at
fair value. Fair values are determined,
primarily, by reference to fair market
prices supplied to the BOI by its custodial



Montana PERB's Comprehensive Annual Financial Report



39



FINANCIAL SECTION



bank, State Street Bank. Premiums and
discounts are amortized/accreted using
the straight-line or scientific method to
the call, average life or maturity date of
the securities. Unit values are calculated
weekly and at month end, based on port-
folio pricing, to allow for participant
transactions to occur as determined by the
BOI's staff. The June 30, 2006 unit value
of $99.81 decreased from the June 30,
2005 unit value of $105.31. The yield on
longer term bonds increased during the
fiscal year, which has the effect of de-
creasing bond prices and the pool unit
value. The pension funds were rebalanced
in fiscal year 2006 to adjust the portfolios
toward the stated equity/fixed income al-
location. RFBP security transactions are
recorded as of the trade date rather than
the settlement date. Because of this gener-
ally accepted practice, the RFBP portfolio
at June 30 may include receivables from
brokers for securities sold, but not deliv-
ered, and payables to brokers for securi-
ties purchased, but not received. Accumu-
lated income is distributed monthly on the
first calendar day of the month. Realized
portfolio gains/losses are distributed at
least annually. Administrative expenses
incurred by the BOI are charged daily to
RFBP based on applicable BOI expenses.
Credit Risk is that the issuer of a fixed
income security may default in making
timely principal and interest payments.
RFBP fixed income investments are re-
quired to be rated an investment grade as
defined by Moody's or by S&P rating
services. Refer to the table at the top of
the next column. Obligations of the U.S.
government or obligations explicitly
guaranteed by the U.S. government are
not considered to have credit risk and do
not require disclosure of credit quality.
For Custodial Credit Risk as of June 30,
2006, all the investments were registered







Credit




Security Investment


Fair Value


Quality


Effective


Type (in thousands)


2006


Rating


Duration


Corporate Bonds








(Rated) $ 930,859


A


5.20


Corporate Bonds








(Unrated)


13,929


MR


3.81


Foreign Government








Bonds


4,850


BBB


5.83


U.S. Government








Direct-Backed


55,508


AAA


6.87


U.S. Government








Indirect-Backed


722,334


AAA


4.73


State Street








Repurchase Agrmt


448


AA-


NA


Short Term








Investment Pool
Total Fixed Income


109.117


NR


NA




Investments $ 1.837,045


AAz


105


Securities Lending








Collateral Investment








Pool !


i 84,097


NR


NA



in the nominee name for the BOI and held
in the possession of the BOI's custodial
bank. State Street Bank. The State Street
repurchase agreement was purchased in
the State of Montana BOI name. As of
June 30. 2006 the RFBP had Concentra-
tion of Credit Risk exposure to the Fed-
eral Home Loan Mortgage Corp of
5.50%. According to the RFBP Invest-
ment Policy, "with the exception of the
U.S. government indirect-backed securi-
ties, additional RFBP portfolio purchases
will not be made if the credit risk exceeds
2 percent of the portfolio at the time of
purchase". The RFBP investment policy
does not formally address Interest Rate
Risk. In accordance with GASB State-
ment No. 40, the BOI has selected the
effective duration method to disclose in-
terest rate risk. The table above displays
RFBP investments for the State of Mon-
tana. The PERB portion of RFBP is 50.74
percent. If a bond investment type is un-
rated, the quality type is indicated by NR
(not rated). Both the credit quality ratings



40



Molilalia PERB's Compreliensive Annual Financial Report



FINANCIAL SECTION



and duration have been calculated exclud-
ing cash equivalents. If duration has not
been calculated, duration is indicated by
NA (not applicable).

Corporate asset-backed securities are
based on cash flows from principal and
interest payments on underlying auto loan
receivables, credit card receivables and
other assets. These securities, while sensi-
tive to prepayments due to interest rate
changes, have less credit risk than securi-
ties not backed by pledged assets. The
RFBP portfolio holds REMICs (Real Es-
tate Mortgage Investment Conduits) total-
ing $387,052 in amortized cost as of June
30, 2006. These securities are based on
separate or combined cash flows from
principal and interest payments on under-
lying mortgages. The interest-only (lO)
are more sensitive to prepayments by
mortgagees resulting from interest rate
changes than other REMIC securities.
The 10 securities purchased in August
and September 1992 carry an amortized
cost of $3 as of June 30, 2006.

As of June 30, 2005, Delta Airlines Corp.
presented a higher credit risk to the BOI.
The RFBP holds $3 million par 10.0%
Delta Airlines Corp. bond maturing June
5, 2013, a $1,971 million par 10.0% Delta
Airlines Corp. bond maturing June 5,
2011 and a $6 million par 10.14% Delta
Airlines Corp. bond maturing August 14,
2012. Due to a weak credit outlook and
potential bankruptcy, the BOI stopped the
interest income accruals after the Decem-
ber 2004 and February 2005 pay dates.
Although the interest accruals were
stopped, the BOI received the interest due
in June 2005 and August 2005. The com-
bined book value of these securities was
$11 million as of June 30, 2005. Due to
the company's filing for Chapter 1 1 bank-



ruptcy protection on September 14, 2005,
the book values were reduced to $ 1 .5 mil-
lion, $985,500 and $3 million, respec-
tively. On March 20, 2006, the BOI sold
these securities and recorded a combined
gain of $892,680.

As of June 30, 2006, Northwest Airlines
Inc. presented a higher credit risk to the
BOI. The RFBP held a $5.7 million par
4.64% Northwest Airlines Inc. real estate
backed bond maturing July 7, 2010. The
4.64% bond maturing July 7, 2010 is se-
cured by Northwest Airlines Inc.'s corpo-
rate headquarters' building and land. As
of June 30, 2005 the RFBP held a $9.9
million par 6.81% Northwest Airlines Inc.
bond maturing February 1, 2020 and a
$7.8 million par 7.935% Northwest Air-
lines Inc. MBIA Insurance Corp. insured
bond maturing April 1, 2019. The com-
bined book value of these securities was
$17.2 million as of June 30, 2005. On
September 14, 2005, the company filed
for Chapter 1 1 bankruptcy protection.
Due to this action, the BOI stopped the
interest income accruals for the 6.81%
bond maturing February 1 , 2020 after the
August 2005 pay date. This issue was
sold on September 20, 2005 generating a
loss of $642,183. The sale included ac-
crued interest from August 1, 2005 to
September 20, 2005. Since the 7.935%
bond maturing April 1, 2019 is insured by
MBIA Insurance Corp. to support the
payment of any interest due and out-
standing principal balance, the BOI did
not stop the interest income accrual or
reduce book value. On January II, 2006
Northwest Airlines Inc. called the 7.935%
bond maturing April 1, 2019 at par and
included accrued interest from October 1,
2005 to January 11, 2006. The BOI re-
corded a gain of $132,710 on this transac-
tion.



Montana PERB's Comprehensive Annual Financial Report



41



FINANCIAL SECTION



As of June 30, 2006, Burlington Indus-
tries, Inc. presented legal and higher
credit risks to the BOl. The BOI owns a
Burlington Industries, Inc., $6 million
par, 7.25% bond maturing September 15,

2005. In September 2000, the company
announced a reduction of stockholders'
equity. Due to an increasing senior bank
line and declining credit trend, the bond
ratings for this issue were downgraded, in
May 2001, by the Moody's and Standard
& Poor's rating agencies. During fiscal
year 2001, the book value of Burlington
Industries Inc. was reduced from the Au-
gust 31, 2000 book value of $5.6 million
to $2.4 million. Due to the company's
filing for Chapter 1 1 bankruptcy protec-
tion on November 11, 2001, the book
value was reduced to $1.2 million. In Oc-
tober 2003, Burlington Industries, Inc.
received court approval to sell its assets.
Under the company's recovery plan, the
BOI received $1.5 million in August 2004
for its unsecured claim. This transaction
reduced the book value to $0 and gener-
ated a gain of S254.961. In February 2005
and May 2005, the BOI received an addi-
tional $208,771 and $194,247 respec-
tively for this unsecured claim. In May

2006, the BOI received an additional pay-
ment of $158,278. The BOI is expected to
receive the final distribution in September
2006.

The BOI received a summons and com-
plaint, dated September 3. 2002, regard-
ing the sale of a Pennzoil Quaker State,
$5 million par, 6.75% corporate bond ma-
turing April 1, 2009. Deutsche Bank Se-
curities claims a "breach of contract" for
the March 25, 2002 sale of the bond at a
price of $94,669 plus accrued interest.
Deutsche Bank Securities seeks damages
of $538,632 for the additional costs in-
curred to acquire the bond from third par-



ties, plus any statutory interest, costs and
expenses. On October 1, 2002, Shell Oil
Company acquired Pennzoil and subse-
quently announced a public tender of
Pennzoil Quaker State debt. The BOI ten-
dered the Pennzoil Quaker State holdings
on October 8, 2002 at a price of
$1 13.099. The tender was accepted with a
settlement date of November 1, 2002. On
November 4, 2002, the BOI received $5.7
million in principal and interest plus
$150,000 as a consent fee. As of June 30,
2006, this matter is still pending.

MTIP portfolio includes equities with six
externally managed funds at June 30,
2006: Schroder Investment Management
NA, Nomura Asset Management, Bar-
clays Global Investors (BGI) Equity In-
dex Fund Europe, Barclays Global Inves-
tors (BGI) Passive Pacific Index Strategy,
Dimensional Fund Advisors (DFA) Inter-
national Small Co., and State Street
EAFE ISPIFF. In November 2005. the
BOI approved the securitization of MTIP
cash by investing in an international eq-
uity derivative, the State Street EAFE
(Europe, Asia, Far East) International
Stock Perfomiance Index Futures Fund
(ISPIFF). MTIP cash was previously in-
vested in the domestic SPIFF. In Decem-
ber 2005, the BOI terminated Pyrford In-
ternational, the European external man-
ager. The BOI transferred $1.2 million
Pyrford International units held by MTIP
at a gain of $39.5 million to the BGI Re-
structure account. Closure of the BGI Re-
structure account to the BGI MSCI
Europe Index Fund resulted in additional
gains of $1.5 million. Because transac-
tions are recorded as of the trade date
rather than settlement date, the MTIP
portfolio may include receivables from
brokers for securities sold, but not deliv-
ered, and payables to brokers for securi-



42



Montana PERB s Comprehensive Annual Financial Report



FINANCIAL SECTION



MTIP Cash bv Currency 1






Fair Value


Cash (in thousands)


$


2006


Australian Dollar


68


Hong Kong Dollar




699


Japanese Yen




1,317


South Korean Won




24


Malaysian Ringgit




9


Philippine Peso




3


-Singapore Dollar




1,367


New Taiwan Dollar
Total Cash $"

MTIP Investment bv Secur


168


3,655


tv Tvoe


Security Investment Type




Fair Value


(in thousands)


'$'


2006


BGI MSCI Europe Index


768,769


BGI MSCI Pacific Index




65,943


BGI Cash and Money Market




-


DFA International Small Co.




93,071


State Stree EAFE ISPIFF




30,496


Schroder Investment Mgmt




139,113


Nomura Asset Management

Total Investments
Securities Lending Collateral


s"


143,656


1,241.048




Investment Pool


A


31,331



ered, and payables to brokers for securi-
ties purchased, but not received. Invest-
ments are presented at current U.S. dollar
value after conversion from foreign cur-
rency by the custodial bank. State Street
Bank and Trust. Unit values are calcu-
lated weekly and once a month at the
close of the last business day of the
month, based upon the fair value of the
MTIP equity holdings, other assets and
liabilhies. Based on the BOI Investment
Officer's decision, participants are al-
lowed to buy or sell units on the first
business day of each month. Realized
gains/losses from the sale of securities
and related foreign exchange transactions
are retained by each fund. MTIP income
is distributed at least monthly to the re-



tirement funds, net of external manager
fees and administrative expenses, on the
first business day of the following month.
For Custodial Credit Risk as of June 30,
2006, all MTIP securities were registered
in the nominee name for the Montana
BOI and held in the possession of the
BOI's custodial bank. State Street Bank.
The BGI MSCI Europe and Pacific Index
and the DFA Small Company Portfolio
are registered in the name of the Montana
BOI. Foreign Currency Risk is the risk
that changes in exchange rates will ad-
versely affect the fair value of an invest-
ment. The MTIP has significant invest-
ments in 1 1 foreign countries. Future eco-
nomic and political developments in these
countries could adversely affect the li-
quidity or value or both of the securities
in which MTIP is invested. The table to
the left discloses the investments by cur-
rency and investment type in U.S. dollars.
The PERB portion of MTIP is 50.77 per-
cent.

MPEP portfolio includes venture capital,
leveraged buyout, mezzanine, distressed
debt, special situation and secondary in-
vestments. The MPEP was established in
April 2002 to allow retirement funds the
opportunity to participate in the venture
capital and leveraged buyout markets and
other private equity investments via a di-
versified pool. Given the complexity and
specialization of private equity invest-
ment, the BOI contracts with eleven pri-
vate equity managers. The private equity
managers include Adams Street Partners
(formerly Brinson Partners); Kohlberg,
Kravis, Roberts and Company (KKR);
Welsh Carson Anderson and Stowe;
Madison Dearborn Partners; Lexington
Partners; Oaktree Capital Management;
ArcLight Energy Partners; Oak Hill Capi-
tal Partners; ILL Partners, Inc.; Odyssey



Montana PERB's Comprehensive Annual Financial Report



43



FINANCIAL SECTION



Investment Partners and Carlyle Partners.
Investments are presented at fair value
and because no recognized market exists
for private equity investment, the invest-
ments, on valuation date, are stated at the
fair value reported in the most recent ex-
ternal managers' valuation reports. The
pool portfolio is priced quarterly. Unit
values are calculated at month end and
participant transactions will most likely
occur on a quarterly basis. Based on the
BOI Investment Officer's decision, par-
ticipants are allowed to buy, reinvest or
sell units on the first business day of each
month. Administrative expenses incurred
by the BOI are charged daily to the
MPEP based on the BOI's expenses ap-
plicable to MPEP. For Custodial Credit
Risk as of June 30, 2006, all MPEP in-
vestments were recorded in the name of
the Montana BOI. The State Street Bank
and Trust repurchase agreement for
$447,174, as of June 30, 2005 was pur-
chased in the Montana BOI's name. This
repurchase agreement was collateralized
at $458,263 by a AAA rated Federal
Home Loan Mortgage Corporation note
maturing February 15, 2006. Foreign
Currency Risk includes several MPEP
investments that represent limited part-
nership investments in various foreign
countries. Per GASB Statement No. 40,
no foreign currency risk disclosure is re-
quired for these limited partnership in-
vestments. Private equity investments are
recognized as investments with a higher
degree of risk with a higher return poten-
tial. Specific Risk associated with MPEP
is portfolio diversification achieved
through multiple partnership relationships
and investments diversified by time, fi-
nancing stage, industry sector, investment
size and geographical region. Private eq-
uity investments typically have a low cor-
relation relative to other investment asset



classes and contribute to the reduction of
portfolio risk. The PERB portion of
MPEP is 61.25 percent.

In October 2004, the BOI committed $25
million to Inter Mountain Private Equity
Partners, LP, a regional venture capital
"fund of funds" with Credit Suisse First
Boston (CSFB), as the General Partner.
This commitment was contingent upon
CSFB raising an additional $15 million
from other investors in the region. De-
spite best efforts, the Fund dissolved May
2006 and the Board's commitment was
withdrawn. For a private equity commit-
ment the BOI on August 24, 2006 funded
the initial capital call in Carlyle Venture
Fund III of $4.4 million which included
investment and management fees. In July
2006, the staff committed $25 million to
JC Flowers Sidecare Fun II. a buyout
fund focused on the global financial ser-
vices industry. On August 14, 2006, the
board made the initial investment of $1.8
million. In July 2006, the staff committed
$30 million to First Reserve Corp Fund
XI, a buyout fund focused on the energy
industry. In August 2006, the staff com-
mitted $35 million to Lehman Brothers
Co-Investment Fund I and $30 million to
CCMP Capital Investors Fund II. Both
managers invest in mid-market buyout
funds.

MTRP was approved by BOI on April
26, 2006, to permit the state's retirement
systems to participate in a diversified real
estate portfolio. The BOI approved the
original MTRP May 1998, to allow retire-
ment and endowment funds the opportu-
nity to participate in the Real Estate In-
vestment Trust (REIT) equity market via
a diversified pool. The original was cre-
ated on July 1, 1998 by a spin-off of the
REIT stock investments held in the Mon-



44



Montana PERB's Comprehensive Annual Financial Report



FINANCIAL SECTION



tana Stock Pool (MTCP). On March 1,
2001, BOI approved liquidation of the
MTRP and all REIT securities were sold.
As of June 30, 2001, all accounts related
to the original Montana Real Estate Pool
reported a zero balance. Investments are
presented at fair value. The MTRP will
invest with external real estate managers
with both open-end and closed-end
pooled funds. The MTRP, as an internal
investment pool, invests its excess cash in
the BOI's STIP. The pension funds sold
STIP shares totaling $30 million to fund
the MTRP on June 1. 2006. Each pension
fund participant was issued units in the
new pool at an initial unit value of $100.
Unit values are calculated on the close of
the last business day of the month. Based
on the investment officer's decision, par-
ticipants may buy or sell units on the first
business day of each month. MTRP will
not participate in security lending because
of the characteristics of the portfolio. At
June 30. 2006. no securities were on loan
for the MTRP. Credit Risk: STIP, as an
external investment pool, has not been
rated by a Nationally Recognized Statisti-
cal Rating Organizations (NRSRO). The
six NRSRO 's include Standard and Poors
(S&P), Moody's, Duff and Phelps, Fitch,
IBCA and Thompson's Bank Watch. The
Custodial Credit Risk as of June 30, 2006
for the MTRP investment in STIP was
recorded in the name of the BOI. The
Concentration of Credit Risk as of June
30, 2006 is MTRP's single investment of
the Montana's STIP. Interest Rate Risk
according to GASB Statement No. 40,
"interest rate disclosure are not required
for pooled investments if the pool is a 2a-
7-like pool". This is the case for the
MTRP. Specific Risks associated with
MTRP are achieved through multiple
manager relationships and investments
diversified by time, real estate type, real



estate size, and geographical region. As
of September 22, 2006 BOI has made
commitments, but not yet funded, the fol-
lowing real estate managers: AG Core
Plus Realty Fund II, Apollo Real Estate
Finance Corp., ABR Chesapeake III, and
TA Associates Realty Fund VIII. The
PERB portion of MTRP, which only is
applicable to PERS, is 15.1 percent.

All Other Funds (AGF) Investments are

owned by various State of Montana agen-
cies and managed on their behalf by the
BOI. The portfolio for the pension plans
include real estate, mortgages and other
equity. Fair values are determined, pri-
marily, by reference to market prices sup-
plied to the BOI by its custodial bank,
State Street Bank and Trust. The real es-
tate investments and residential and mul-
tifamily mortgages are valued based on a
discounted cash flow. The mortgages re-
ceivable funded by the retirement systems
consist of residential mortgages. As of
June 30, 2006, there were no uncollect-
ible account balances for mortgages. Real
estate investments held, in part, for the
PERS include buildings at 100 North
Park Avenue in Helena, MT; in 2004 a
building constructed at 2273 Boot Hill
Court in Bozeman, MT; a building at
2401 Colonial Drive in Helena, MT; and
property located on California Street in
Helena, MT. The BOI also holds the
building located at 1712 Ninth Avenue in
Helena, MT for the sole benefit of the
PERS. Credit Risk as of June 30, 2006 the
PERB did not hold fixed income invest-
ments in the AOF financial statements.
The U.S. government securities are guar-
anteed directly or indirectly by the U.S.
government and are not considered to
have credit risk and do not require disclo-
sure of credit quality. For Montana mort-
gages, there is a lien on the real estate



Montana PERB' s Comprehensive Annual Financial Report



45



FINANCIAL SECTION



property. In the event of default, the prop-
erty can be sold. Custodial Credit Risk as
of June 30, 2006 has all other equity, real
estate, and mortgage investments regis-
tered in the name of the Montana BOI.
Concentration of Credit Risk is not ad-
dressed in the investment policy state-
ments. The single issuer for residential
mortgages would be the residential bor-
rower and there are no single issuers that
have a principal balance in excess of 5
percent. Interest Rate Risk is not formally


1 2 3 5 7 8 9 10 11 12 13 14 15 16 17

Online LibraryMontana. Public Employees' Retirement BoardComprehensive annual financial report (Volume 2006) → online text (page 5 of 17)