Local government bodies in the Australian state of New South Wales have been forbidden from making new CDO investments and other structured credit products until December 2009.

According a review initiated by the New South Wales treasurer, local councils face losses of around A$200 million ($184 million) from CDOs that were hit by the global credit crisis. Some municipal councils have been identified as holding in excess of 45% of their total investments in CDOs.

The review also found that the market value of the investments held by these councils are currently worth A$5.37 billion, dipping by A$320 million of the book value. It represents a 5.6% decline in total investments and a 15.2% decrease for the longer-term funds. But to date, only A$2 million of CDO securities losses have actually been realized. This loss comes from a council selling its holding of the Federation CDO.

The main criticism of the investment strategy of these councils has been the poor risk /return trade-off. According to figures from the review, in one instance, the upside return was capped at a couple of per cent over the risk-free rate but the downside risk exposure has been recorded at 85% of the capital investment. However, though the unrealized losses are significant, they are not expected to pose a threat to the financial viability of the New South Wales government sector, the review said.

As a result, New South Wales is looking to implement more prohibitive standards that will protect the interest of ratepayers. “[It’s] clearly a setback for structured credit markets given that Australian councils, from New South Wales and Western Australia in particular, have been significant investors in synthetic CDOs in recent years,” Royal Bank of Scotland structured credit analysts said.


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