Guest Commentary: Diane Urquhart Analyzes PSP Investments' 2008 Results

This blog has given me the opportunity to meet and talk with some very interesting people. One of those is Diane Urquhart who I already favorably alluded to in my very first blog entry on the ABCP's of Pension Governance.

Diane Urquhart is an independent financial analyst and former senior securities industry executive who appeared before the Parliamentary finance committee’s hearings into Canada’s frozen non-bank ABCP.

was one of six witnesses to address the committee and appeared on behalf of a group of retail customers of non-bank ABCP (she also appeared with the support of the National Pensioners and Senior Citizens Federation).

Diane brought to my attention that PSP Investments' 2008 Annual Report failed to highlight significant losses in credit default swaps (click on image above taken from page 60 of the 2008 Annual Report). She went over the financial statements very carefully and shared these comments with me and she allowed me to post them on my blog.

I thank her for this contribution and I hope my readers will take the time to read her comments below. (You can find most of her articles on by clicking here.)

From Diane Urquhart (added emphasis is mine):

PSP Investments has just released its 2008 Annual Report, which has for the first time disclosed the PSP Investments' exposure to Non Bank ABCP at $1,972 million and a writedown taken of -$450 million. PSP Investments is the third largest owner of Non Bank ABCP, behind the Caisse at $12,600 million and the National Bank at $2,250 million. It is inexcusable for a public sector pension plan to have delayed its public disclosure of its exposure to Non Bank ABCP until now. PSP Investments and the Caisse were members of the Montreal Accord and the Pan Canadian Committee, which formulated the ABCP CCAA Restructuring Plan, which is awaiting a decision before the Appeal Court of Ontario.

PSP Investments also owns Collateralized Debt Obligations (CDOs) with a notional exposure of $1.4 billion, where it has taken a writedown of approximately $470 million.

In addition, PSP Investments has marked-to-market losses of -$510 million on $1,351 million notional amount of credit default swaps they have written. Credit default swaps are like insurance contracts since PSP Investments has agreed to pay the credit default damages on reference credit portfolios described in contracts with bank or other financial institution counterparties. These are direct credit default swap contract losses, which are similar to the indirect credit default swap contract losses within the Non Bank ABCP trusts owned by PSP Investments.

In total, the distressed credit losses of the PSP Investments are -$1,430 million, as accounted for in its 2008 Annual Report. The total exposure to the three types of distressed credit is $4,723 million or 12% of the $38,925 million of total pension assets. This level of exposure to high risk credit is far too high for a pension fund, whose fiduciary duty is to ensure assets are invested prudently to fund the defined pension benefits of the Federal public service, RCMP and Canadian Forces.

I would say that the Non Bank ABCP accounting valuation of $1,522 million is far too high, making the unrealized loss of -$450 million far too low. Based on my work as financial advisor to the Ad Hoc ABCP Retail Owners Committee, I would say the likely trading value of the Non Bank ABCP will be $889 million, making the marked-to market loss at about -$1,083 million. The CDO's are likely accounted for at an artificially high valuation as well, but this is not something I can professionally substantiate, since unlike the Non Bank ABCP, there is no public information on the CDO's that PSP Investments owns. The credit default swap contract losses are more visible in the secondary market, so this estimated loss of -$510 may be accurate, compared to the other two types of distressed debt owned.

In fiscal year 2008, the PSP Investment's rate of return was -0.3%, which is 1.5 percentage points below the Policy Benchmark rate of return of 1.2%. The Policy Benchmark methodology is not disclosed. Readers should note that two other non-publicly traded assets classes, real estate and private equity, made strong 2008 contributions of $952 million and $375 million respectively, which offset the writedowns in the distressed credit categories.

The Non Bank ABCP owned by PSP Investments has been the subject of considerable allegations of negligence, and possible fraud, by the banks, securities dealers and DBRS in motions submitted to the Ontario Superior Court of Justice and subsequent appellant filings. This week, Rick Waugh, CEO of Scotiabank and Co-Chairman of the Institute of International Finance Committee on Market Best Practices, admits that banks have made mistakes in structured credit products and that widespread changes in international bank industry practices are in order. PSP Investments makes no admissions about its mistakes in due diligence or undue concentration in structured credit securities. There is no evidence in the 2008 Annual Report that anyone at the PSP Investments has borne any consequences for these mistakes.

My research report, "Another Made-in-Canada Defective Investment Product - ABCP, dated December 17, 2007 can be found at the following web address.

Diane Urquhart
Independent Financial Analyst

***Important Update from Diane Urquhart*** (
added emphasis is mine)

July 24, 2008

I spoke this morning with John Valentini, CFO, and Anne-Marie Laurendeau, Director of Communications and Government Relations,
of PSP Investments. I would like you to place the following follow-up on your website.

John Valentini, CFO of PSP Investments, has advised me that the Collateralized Debt Obligation (CDO) notional amount of $1,400M and 2008 writedown of -$470M is included in the Table of Derivative Financial Instruments found in Note 3(b) of the financial statements under the category of Credit Derivatives Swaps, which shows a notional amount of $1,351M and a fair market value loss of -$510M.

He admits that the terminology of CDO and credit derivatives swaps is not clear in the 2008 Annual Report. John Valentini says that the securities owned that are referred to in the text as CDO's receive premiums and not interest revenue and are considered by PSP Investments to be credit derivatives and not fixed income securities.

As an analyst, I consider the term CDO to apply to different tranches of debt funding a conduit owning securitized assets or synthetic assets associated with credit default swap contracts. The fact that premiums are received and not interest revenue suggests that PSP Investments has written and owns $1,351M of notional amount in credit default swaps, and that these might better have been referred to in the text of the annual report as credit default swaps rather than CDO's.

Perhaps, PSP Investments found the term Collateralized Debt Obligations to be more palatable and simpler to understand for its pension beneficiaries and the general public, but in mind it was the wrong technical term to apply.

The -$510M fair value loss in the Table of Derivative Financial Instruments is a balance sheet fiscal yearend amount, whereas the -$470 million loss in the text is the unrealized loss occurring during the 2008 fiscal year and is part of the income statement. The difference between the -$510M balance sheet fair value loss and the income statement -$470M loss is due to the purchase and sale of positions during the fiscal year giving rise to net losses in the year and long term positions held at the yearend that have accrued fair value loss in the prior year.

My bottom line conclusion from this follow-up discussion with John Valentini is that there are just two classes of distressed credit at the PSP Investments, $1,972M of Non Bank ABCP and $1,351M of written credit default swaps.

The total distressed credit exposure is $3,323M or 8.5% of the $38,925 of total pension assets. The total writedowns on the two distressed credit classes is -$920M or -2.4% impact on the fiscal year performance.

I continue to conclude that there is an unacceptably high concentration of high risk credit securities owned by the PSP Investments, and that these credit securities did not pay a sufficient risk premium at the time of purchase to warrant the risk involved.

Diane Urquhart
Independent Analyst
Mississauga, Ontario
Telephone: (905) 822-7618
Cell: (416) 505-4832