Frozen funds are not a ‘significant budget issue’

Maine has a proven track record of putting the resources of the state to work for taxpayers.

Last year, the state treasurer’s office earned $34 million by investing state revenues not immediately needed to pay bills. We earned nearly $64 million for the two years that ended in June. Our earnings for the first four months of this fiscal year, from July 1 through Oct. 31, have exceeded $12 million.

These gains have been the result of a closely controlled and conservative cash management approach that at all times has complied with Maine’s restrictive investment rules. Of the many thousands of investments made, we know of only one that has failed to pay on time.

On Aug. 8, in conformity with our guidelines and upon the suggestion of a long-standing financial advisor from Merrill Lynch, the state treasury invested about $20 million in a Delaware-based company named Mainsail II. We made that investment decision using the same Treasury investment process that has worked without exception for many years, perhaps even decades.

The investment represented a sliver (about 3 percent) of the available cash pool and carried the highest credit ratings from credit-watchers Moody’s (A-1+) and Standard & Poor’s (A-1). This was in no way a subprime investment. We invested for the short period of 23 days. Public funds in Connecticut, Florida and a number of other states are also known to have invested in Mainsail.

Twelve days after Maine made this investment, Aug. 20, Mainsail’s balance sheet was stress-tested by its governing trustee (the Bank of New York) and found to have exceeded its authorized liability-to-asset ratio. The trustee immediately froze the company’s business and the company’s credit rating went from super-high quality to junk bond status overnight. It was a sudden and severe credit rating downgrade, apparently unprecedented in U.S. markets.

Its underlying assets, however, continued to be rated as triple-A and double-A quality by the credit rating agencies. These also were far from subprime assets. On Aug. 31, the date of maturation, Mainsail failed to timely pay its debt to the state of Maine.

Mainsail appears to have been a victim of the subprime crisis even though it was neither a subprime investor nor a subprime company. As investors last August became afraid of all asset backed commercial paper and many backed out of the market, Mainsail was not able to refresh its capital base. Without new capital, it failed its assets-to-liabilities ratio test with the Bank of New York.

Without access to its assets, Mainsail was unable to timely pay its debt to Maine. It now seems accurate to say that the Mainsail situation is the result of last summer’s subprime investment concerns, but the situation developed despite the high quality ratings applied to both the company and its underlying assets.

While Maine is owed the money, it has not been lost, and I am confident the state will recoup the investment, so long as we do not succumb to panic selling.

Barclays Capital of England was reported as proposing a buyout program which would have fully repaid all commercial paper debtors in Mainsail, including Maine. That buyout option eventually failed, but other investors have now stepped in to purchase individual Mainsail holdings. They have asked about buying Maine’s position.

It would be a mistake to succumb to a fire-sale mentality, however. Indeed, the unlikely worst-case scenario, as described by the public funds manager for King County in Washington state, is for repayment of no less than 85 percent of initial investments. This would mean Maine would still have a $9 million net earnings gain for the first four months of the year.

The only impact on state finances from non-performance of the Mainsail investment is a slightly reduced revenue expectation from cash pool earnings, and that reduction has already been included in new revenue estimates recently given to the Legislature. The projections will bump up again, once we are paid. This is not a significant budget issue for the state.

We now know that Mainsail’s non-performance developed despite our tight investment guidelines, its top-notch credit ratings and the suggestion of a long-standing and previously reliable investment advisor. Now, Maine’s short-term cash pool assets have been mostly moved into lower-yielding, but fully collateralized, bank investments while we wait for stability in the nation’s credit markets and renewed confidence in the commercial paper credit rating system.

We are also taking a hard look at why our investment advisor, Merrill Lynch, suggested the Mainsail purchase.

Maine has a history of earnings success built upon a conservative and safe investment strategy. By acting prudently, the state treasurer’s office has brought millions of new dollars into the state, which has helped reduce the burden on taxpayers and support important government services.

We will work to continue our long track record of putting taxpayer dollars to work for the betterment of the state.

David Lemoine is treasurer for the state of Maine. E-mail him at [email protected].