Tuesday, August 28, 2007

Is State Street Straight?

We won't tap dance around the issue like Senator Craig, but the bears are growling about the $28.81 billion in credit lines to four asset backed commercial paper conduits. Why the panic? Here's why.

State Street's (STT 61.16) $3 billion Limited Duration Bond Fund was down 37% in August. That scares people. Secondly, State Street has been pushing "leveraged funds" that are "market neutral"-Long 130%, short 30%. Nobody likes leverage today, and if it's market neutral, why bother. Is this just another quant product? State Street's net interest margin also increased from 1.2%, to 1.64%. How did they do this? From their SEC filings for the last quarter:

At June 30, 2007, our investment securities portfolio included a consistent percentage of floating-rate, asset-backed securities (36% of our average investment portfolio for the second quarter of 2007 compared to 37% a year earlier), a higher percentage of collateralized mortgage obligations (19% compared to 11%), and a lower percentage of direct obligations from U.S. Treasury and federal agencies (9% compared to 16%). We continue to invest conservatively in AAA and AA rated securities. AAA and AA rated securities comprised approximately 94% of our investment securities portfolio at June 30, 2007, with approximately 87% AAA rated.

Their floating rate asset-backed securities increased, they cut their Treasury or agency obligations to just 9%, and increased their CMO exposure by 80% to 19% of their $100 billion portfolio. This of course increased their net interest margin. It's also what got some banks in Europe in trouble. Throw in whispers of short selling stock loans tricks and you have a recipe for a takedown by the bears.


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