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Caisse de dépôt takes $5.7-billion hit

The Canadian Press

Montreal — The troubled Caisse de dépôt et placement du Québec, still reeling from a disastrous 2008, failed to find its footing the first half of this year, as risky commercial real estate loans and private equity investments led to more than $5-billion in writedowns at the provincial pension fund manager.

The Caisse took the unprecedented move of announcing interim financial results Tuesday – indicating that an overall writedown of $5.7-billion on real estate and other investments completely wiped out gains on stocks in the first half of the year – in part to quell growing rumours about trouble in its property portfolio.

The Caisse, which manages the assets of 25 provincial funds including the Quebec Pension Plan, was stung by criticism last fall that it was too secretive, when it continuously rejected calls to reveal the extent of the damage it suffered as a result of October's stock market meltdown.

Tuesday, the fund manager's new chief executive officer Michael Sabia signalled that the era of secrecy has passed, as he unveiled as major retrenchment at the real estate unit and an unwinding of the risky property investment strategies pursued under his predecessor, Henri-Paul Rousseau.

Those strategies bet on so-called mezzanine loans, essentially second and third mortgages on U.S. office buildings, on the assumption that commercial property values would continue to rise. The loans were riskier than conventional, secured mortgages, but carried much higher interest rates and produced strong returns for several years.

The Caisse was badly bruised in 2008 by its oversized position in currency and futures contracts and third-party asset-backed commercial paper holdings, posting a $40-billion loss last year, equal to a return of minus 25 per cent.

The ABCP exposure caused a further writedown of $400-million in the first six months of this year, the Caisse said Tuesday. Private equity and infrastructure investments caused a $1.3-billion hit, with most of that coming from its troubled investment in British Airports Authority (BAA).

But the majority of the Caisse's pain so far this year stems from real estate, which accounted for 71 per cent of its writedowns. And the first-half real estate losses are on top of the negative 22-per-cent return the property portfolio yielded in 2008.

The writedowns this year erased the 5-per-cent return that the Caisse had earned on other investments to June 30, leaving it with “neutral” overall performance, Mr. Sabia said. “No one here thinks that neutral returns is what we should be aiming for,” he told reporters on a conference call. “There's a lot of work to do in repositioning the Caisse and changing our strategies, and we're going to continue to do that.”

Mr. Sabia has shaken up the real estate group's management team, and the pension fund will stop investing in the higher-risk mezzanine loans and other forms of subordinate real estate loans.

The Caisse will also fold its Cadim division, which invests in multiresidential properties and hotels, into its office building subsidiary.

The rush into riskier commercial real estate lending intensified under Mr. Rousseau and his lieutenant Richard Guay, reflecting a risk management strategy that placed enormous faith in the protection offered by asset allocation. The theory was that the Caisse could hold riskier assets in many different categories without danger, since not all asset classes would collapse at the same time.

The market meltdown last fall put the lie to that idea. And by this spring, it was clear that commercial real estate was becoming the next asset class to crater. Earlier this year, the Caisse was forced to buy a New York office building on which it held low-ranking mortgage of $130-million (U.S.) after the building's owner, Macklowe Properties, went into default. Had it not bought the building for a nominal sum of $100,000, the property would have gone into foreclosure and the Caisse would have had to realize a loss on the entire value of its mortgage.

Another sign of trouble in the real estate unit emerged last month when the head of Cadim, the Caisse division responsible for the property mortgages, suddenly left the pension fund manager. No reason was given for Richard Dansereau's departure at the time.

Mr. Sabia said the Caisse still has strong real estate subsidiaries. “When I look at Ivanhoe Cambridge and SITQ, the quality of the operations, the size of these companies in the global framework of the real estate business over all, these are major, major companies that perform at a very high level with respect to operations.”

The restructuring will help the real estate businesses weather the challenges in the U.S. real estate market, he said.

The Caisse's writedowns are paper losses based on mark-to-market accounting rules, which require the plan to ratchet down the value of its assets to what they would fetch in the market today. Mr. Sabia said he expects the market for hard-to-sell assets to remain difficult, given continuing weakness in the global economy.

The Caisse is the country's largest pension fund manager. Deborah Allan, a spokeswoman for Ontario Teachers' Pension Plan, declined to comment on Mr. Sabia's decision to boost transparency at the Caisse but said “we do not have any plans to report more frequently than annually.”

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