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Frequently Asked Questions - Council investments

CDO stands for Collateralised Debt Obligation. They are a newer type of investment with a potentially higher return than traditional government bonds. A CDO investment is available to individuals, organisations and companies.

The CDO is a product which is exposed to corporate debt. A typical CDO will be exposed to a portfolio of 100 corporate names. A CDO is built to withstand a number of defaults before it incurs any capital loss.

A default occurs when a company which is included in the 100 corporate names is unable to repay its debt obligations and files for bankruptcy. Should more defaults occur than the amount able to be sustained by the CDO product, the principal amount invested is placed at risk.

The rating of a CDO is determined by the quality of the corporate names within the portfolio.

Investments must be in accordance with  the Minister for Local Government investment order.

Byron Shire Council’s investments conform to the following:

  • Council’s Investment Policy
  • Section 625 of the Local Government Act 1993 (as amended)
  • the Minister's Investment Order which existed at the time of the investment
  • clause 212 of the Local Government (General) Regulations 2005
  • Third Party Investment requirements of the Department Local Government Circular 06-70.

None of Council’s CDO investments had a rating lower than AA at the time the capital was invested.  Therefore they were rated highly at the time of investment.

The current economic crisis is a global event and like many individuals and companies, Byron Shire Council’s investment portfolio has been exposed to credit products that are below the original amount invested.

As an individual, you may have found you have been affected by the recession in the following manner

  • A drop in the value of your home
  • A drop in your share portfolio investments
  • A drop in the current value of your superannuation fund.

Within the current economic crisis, the number of corporate (company) defaults is significantly higher than normal.

As corporate companies default, the protection of the CDO is reduced. This results in the remaining CDOs having a reduced capacity for further defaults and consequently they have a current valuation significantly lower than the original investment. These investments are deemed more likely to incur a capital loss.

Yes, we do.

Council began investing in CDOs in 2002 and we have already had five CDOs with a combined value of $7m mature fully from December 2007 to December 2008. They were a proven and safe investment.

Until recently Byron Shire Council had five CDO investments. All were recently "stress tested" by Council's independent investment advisor Denison Financial Advisory Pty Ltd.

The Sceptre CDO investment did not pass the test and consequently sold for a return of 18.2 cents in the dollar.  This is approximately $365,000 out of the original $2 million investment.

The challenge faced was when to sell a "non-performing" investment and this had to be balanced against maximising a sell price. This is not easy in during a global financial crisis.

The alternative was to sit on the Sceptre investment and risk a high probability of the investment defaulting and zero return.

At this stage, Council does not intend to sell the remaining CDOs however they are being monitored closely and this may change due to financial market movements.

From 2010 until 2011.

The market still has time to improve before the CDOs mature and therefore result in an improved capital investment return.

However, there is a risk that the investments will not reach their maturity date and that Council will not receive a return on the capital investment. Council is currently waiting on independent financial advice on the likelihood of this scenario

Council currently has approximately $50 million invested in numerous investment streams.

$3.5 million is invested in CDOs. That is, approximately 7% is currently invested in CDOs.

There are no guarantees with CDOs. Council's investment advisors have stress tested all CDOs and have recommended that we hold the rest until maturity

Byron Shire Council has a duty to regularly review investments with the aim of ensuring an optimum return. 

Council's financial advisor continually monitors the investments and provides a monthly report to Council.

Council resolved last year to appoint an Internal Auditor to help provide independent assurance over the internal and risk management framework of the Council. This position was filled in March 2009.

An Internal Audit Committee has been formed and held its first meeting on 25 March 2009.

At this meeting the Committee recommended to:

  1. place on exhibition a revised Draft Investment Policy
  2. appoint an independent investment advisor for three months and
  3. distribute proportionately any losses that may occur from Council investments.

In attendance were representatives from Council's external auditors, Thomas Noble & Russell and Denison Financial Advisory. At this meeting, Denison's presented information on a range of strategies to deal with under performing investments.

As a result of the Internal Audit Committee meeting, Council resolved the following on 9 April 2009:

09-181 Resolved that the revised Draft Investment Policy (#838120) be placed on exhibition for a period of 28 days.

09-182 Resolved that an independent investment advisor be appointed for a three month period.

09-183 Resolved that Management request its Investment Advisor to calculate:

  1. the current realisable Market value /bid of the Mica and Sceptre Products.
  2. the current probability that the subordinated component of Mica/Sceptre products will be consumed.
  3. the probability that the product will proceed to maturity without loss.
  4. the probability that coupon payments where applicable will be made, the quantum of these coupons and comparisons to current bid price, and that management continue to work with the financial advisor with a view to determining a decision framework.

09-184 Resolved that a strategy for Council's Investments portfolio be developed by staff and the financial advisor, and that the strategy be reported to Council for consideration.

09-185 Resolved that Council participate in a joint initiative with other Northern Rivers Councils for the engagement of a financial advisor on a permanent basis.

09-186 Resolved that the budget line items for interest received on section 94 contributions and internal reserves be reduced to reflect the loss of revenue from capital protected investment products.

09-187 Resolved that should any capital losses be sustained from investments, that the loss be distributed proportionately based on the total value of the respective funds held.

09-188 Resolved that should Council lose ownership / management of any portion of its business, the value of the investments to be transferred from Council will include proportionate decrease based on the current difference between the principal value and the current value of Council investments at the time of transfer.

In October 2008 Council was also given a public presentation by the ANZ on its financial status. During this session, Council took questions from the floor and consequently advertised that the audio recording was available to the public.

No capital works programs or community services have been postponed, cancelled or affected by Byron Shire Council's current investment approach.

Byron Shire Council's independent investment advisor, Denison Financial Advisory Pty Ltd, completed a report on Council's Investment Portfolio and Strategy.