Financial Regulatory Forum

EXCLUSIVE: China fund plans $2 billion bet on U.S. “toxic” mortgages

By Reuters Staff
August 17, 2009

cic By George Chen, Asia Private Equity Correspondent

HONG KONG, Aug 17 (Reuters) – China’s $200 billion sovereign wealth fund, which lost big on its ill-timed 2007 Morgan Stanley and Blackstone bets, plans to invest up to $2 billion in U.S. mortgages as it eyes a property market rebound, two people with direct knowledge of the matter said Monday.

China Investment Corp plans to soon invest in U.S. taxpayer-subsidized investment funds that will acquire “toxic” mortgage-backed securities from the nation’s banks. CIC believes these assets are a safer bet than buying into the U.S. Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF), the people with direct knowledge said.

CIC is in talks with nine U.S. Treasury-designated Public-Private Investment Plan managers, the sources said.

They include: AllianceBernstein Holding, with sub-advisers Greenfield Partners LLC and Rialto Capital Management LLC; Angelo, Gordon & Co LP with GE Capital Real Estate, a unit of General Electric Co; BlackRock Inc; Invesco Ltd; Marathon Asset Management LP; Oaktree Capital Management LP; Trust Company of the West, a unit of Legg Mason; RLJ Western Asset Management LP, a venture formed by Legg’s Western Asset Management unit; and Wellington Management Co LLP.

CIC is expected to decide this month which of the nine PPIP managers will handle its investments in mortgage-backed securities under the PPIP plan, the sources said.

The fund is likely to select several, not all, of the firms, said the sources, who have direct knowledge of the matter, but asked not to be identified as the talks are confidential. CIC cannot invest directly in the PPIP.

CIC, BlackRock, Legg Mason and AllianceBernstein declined to comment. Officials from the other investment managers were not immediately available.

U.S. TREASURY APPROVES
Under the Public-Private Investment Plan launched earlier this year, the U.S. government plans to seed a number of investment funds with taxpayer money.

When combined with money from other investors, these private sector-managed funds are expected to soak up as much as $40 billion in soured, hard-to-sell securities clogging the balance sheets of banks.

CIC’s move comes after the United States and China ended their first annual Strategic and Economic Dialogue late last month. The two countries agreed to lead the global economy out of recession, with China seeking safer investments in the world’s leading economy.

“The Chinese government is always trying to seek a more ideal way to invest in U.S. assets rather than purely buying U.S. government bonds all the time,” said the source.

“Some might think $2 billion for a $200 billion sovereign fund is not big money, but it can be regarded as an innovative and positive option for Chinese investment,” the source added.

The U.S. Treasury has been informed the nine designated PPIP managers are in talks to receive CIC money, and supports bringing foreign investors such as CIC into the PPIP program, the sources said.

Early this year, some U.S. asset managers approached CIC to invest in their funds focused on mortgage securities sold into the market under the TALF, the sources said, but the Chinese declined given the uncertain outlook at the time for U.S. economic recovery.

They noted, however, that these TALF-focused funds performed well in the second quarter as global markets perked up following the long financial crisis triggered by the U.S. property market.

Compared with TALF, the PPIP program focuses on safer securities that have so-called “Triple-A” ratings by at least two credit-rating agencies and debts guaranteed by the U.S. Federal Deposit Insurance Corporation (FDIC), the sources explained.

“In this case, CIC feels safer to invest, and the safer it feels, the more confident it will naturally feel about its investments as well as in the prospects for the U.S. economy,” said one of the sources.

CIC, established by China’s Communist government in late 2007, is eager to participate in the PPIP as it expects the U.S. property market will recover gradually late this year, said the sources.

In June, Reuters reported Asia-Pacific sovereign wealth funds including CIC and Singapore’s Temasek, which have been rocked by soured bets on western financial companies, were diversifying into the riskier arena of distressed asset investments.

CIC’s $200 billion fund is part of China’s roughly $2 trillion of foreign exchange reserves. The majority of its reserves are in U.S. government bonds.

(Additional reporting by Ross Kerber in Boston, Chris Sanders and Joe Giannone in New York; Editing by Ian Geoghegan and Maureen Bavdek)

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