County could lose millions because of credit downgrade

The nation's subprime-mortgage crisis has slammed into the halls of local government.

Financial managers told the Metropolitan King County Council on Tuesday that credit-rating agencies have downgraded two investments that hold more than $100 million in local taxpayers' money.

Under a worst-case scenario, King County could lose up to $8 million on just one investment.

County officials have halted purchases of mortgage-backed "commercial paper" investments while an independent reviewer studies whether other investments are at risk.

And to prevent rating agencies from downgrading the $4.1 billion King County Investment Pool, financial managers last week pulled a troubled $53 million investment out of the pool — meaning the county will bear any losses on that investment by itself.

Commercial paper, a type of corporate IOU, comprises almost one-fourth of the pool, which invests the cash of county agencies and 100 other jurisdictions, including all school, fire, water and sewer districts in the county, the Public Facilities District and Sound Transit.

Investment-pool managers, who seek to invest in secure, short-term interest-bearing securities, were shocked by the sudden downgrading of two investments that had been highly rated.

"We have stepped in very quickly to protect our investments and the county investment pool," said Ken Guy, county director of finance and business operations.

The county's Executive Finance Committee last week removed a commercial-paper fund, Mainsail II, from the investment pool last week after Standard & Poor's downgraded its credit rating below investment grade — in part because too much was in sub-prime mortgages. The fund's assets — prime and subprime mortgages — are scheduled to be sold this month by a trustee bank "at distressed prices," Standard & Poor's reported.

King County financial managers are working with other creditors to try to delay the sale of Mainsail assets, in hopes that the market for mortgage-backed securities will improve and the county can recoup its entire investment.

"It's not a fire sale, it doesn't have to be a fire sale," said county Budget Director Bob Cowan. "Let's let the markets calm down. We have a high degree of confidence we'll get our money back."

The worst-case scenario is that the county will receive "85 cents on the dollar" — or an $8 million loss — Guy said.

Because King County had only a 40 percent stake in Mainsail before removing it from the investment pool, the county's risk would have been only $3.2 million if the county had left the investment in the pool.

The county investment pool also holds $50 million of mortgage-backed securities issued by Cheyne Financial, which has been downgraded by Standard & Poor's, but not to the point of jeopardizing the pool's financial rating. Cheyne is also selling assets to pay creditors.

Bob Ferguson, the only County Council member on the finance committee, cast the only vote against pulling the entire Mainsail investment out of the county pool — a move he said leaves the county "on the hook for the entire amount, which I felt was too significant."

Ferguson and Councilmember Larry Phillips said they were concerned that the county has set a precedent for bailing out when an investment goes bad. "It's troubling and perhaps alarming that we're in this situation," Phillips said.

Guy said Mainsail's financial troubles were "such an aberration" in the county's investing history "that we believed we could take this one-time action to preserve the pool's integrity while we weather the storm over the next several months."

Guy said the finance committee wanted to preserve Standard & Poor's attractive AAAf rating of the investment pool so its participants won't be tempted to invest their money elsewhere.

The pool generates $3 million a year in management fees, which go into the county's general fund.

"That's an important source of revenue for the county," Guy said. "It's important for us to maintain the confidence of our investment-pool participants."

Aside from commercial paper, 39 percent of the pool's other holdings are repurchase agreements, in which the county pool buys U.S. Treasury securities from banks and sells them back in exchange for interest payments. The pool also invests in federal-agency obligations and certificates of deposit.

In the arcane alphabet of investing, the Mainsail and Cheyne investments are "SIVs lite" — or structured investment vehicles whose underlying assets are less diverse than those of other SIVs.

Keith Ervin: 206-464-2105 or kervin@seattletimes.com