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Subprime Worries in Norway? There Are Now

The fallout from the credit crunch in the United States has made its way across the Atlantic Ocean and is impacting the coffers of eight small Norwegian communities, which since June may have lost up to half of their initial investment into a municipal tender-option bond trust. Hattfjelldal, which has a population of 1,562 people according to a 2004 census, invested 103 million Norwegian kroner, or roughly $18.9 million, into a Citigroup Alternative Investments off-shore focused TOB. Narvik, a community of fewer than 20,000 residents located north of the Arctic Circle, incurred enough losses through the same investment that it was planning to borrow money to pay municipal employees their December wages. Six other municipalities have come forth saying they were sold the same product and are facing similar losses. According to a Citigroup performance summary of TOB Capital Offshore obtained by The Bond Buyer, total returns in 2007 through September were negative 15.24%. August returns alone were negative 23.46%. The TOB was sold to the towns by Terra Securities ASA, an investment banking arm of Terra Gruppen. Terra Securities Wednesday filed for bankruptcy and had their license withdrawn by the Norwegian Financial Supervisory Authority, an equivalent to the Securities and Exchange Commission. “Terra Securities ASA has failed to provide information about significant risks in advance of the townships investments and has offered products to a target group that the products were not suited for,” the NFSA said in a statement when it withdrew the license. The bankruptcy voids Terra’s initial offer to repay four of the municipalities’ losses incurred after June 2007. Terra had made the repayment offer Tuesday with a statement saying it has discovered problems in the way the TOB was sold to the four towns. “Our internal investigations have discovered clear errors in the information given to the municipalities,” said Svein Erik Nordang, chief executive at Terra Securities, in a prepared statement. Terra did not return calls for comment. Payments to Hattfjelldal, Narvik, Rana, and Hemnes would have been $27.5 million plus $18 million of capital calls that were a result of losses during the period. Since June, the four towns have lost $45.5 million, which amounts to $990.16 for every man, woman, and child in each town. Total investments by the towns in the TOB have been reported as low as $96 million and up to as high as $850 million. Earlier in the week, Norwegian Finance Minister Kristin Halvorsen said at a press conference that the government would not act as safety net for municipal governments and did not plan on aiding them financially. In a statement to The Bond Buyer yesterday, Citigroup said that it “is concerned to read of the losses that investors have suffered on their investment. Losses on the investment are due to market conditions that have affected many investments around the globe, and the risks were fully disclosed to Terra Securities.” “Citi has announced that it will exercise its contractual rights to terminate the fund-linked notes that Citi sold to Terra in June 2007. Citi has the right to terminate because the market value of the transaction fell below certain trigger levels. The process of unwinding the transaction will include the mandatory early redemption of the notes and the sale of the underlying assets. The redemption proceeds of the notes will be paid to the trustee under the notes once the process for determining the final values of the assets is completed, and the trustee will then distribute them as provided in the notes.” This summer, the municipal market experienced a significant weakening and increased volatility during the first round of credit reassessment resulting from the defaults in the subprime mortgage market. Volatility peaked in August, when the yield scale for triple-A-rated general obligation bonds jumped 27 basis points from 4.51% on Aug. 13 to 4.78% on Aug. 24, according to Municipal Market Data. Earlier this week, the mayor of Hemnes provided evidence that Terra had given the municipality two prospectuses for the Citi investment, one in English and one translated into Norwegian. The Norwegian prospectus was claimed to be missing a portion of the prospectus titled “Significant Investment Consideration” that went on to detail the risk characteristics of Citi’s TOB. In a copy of the prospectus in English, the portion states “risks of the investment can include loss of all or a substantial portion of the investment due to leveraging, short selling, or other speculative investment practices.” It also notes a severe lack of liquidity for the product and that it does not expect one to develop. On this topic, Citi said that Terra Securities was advised by Citi that the product should be sold only to a similarly sophisticated counterparty. In agreements with Terra going back to 2006, the four municipalities bought into the Citi TOB with cash earned through energy sales from their hydroelectric plans. The investments would also be secured, in a contract with Terra, by the municipalities with future energy revenues. To make matters worse, the towns invested more in June this year, just as the municipal market began to falter. After the volatility of August, the communities were required to post extra capital to honor contracts made with Terra, or they would have had to lose their entire investments, according to the Norwegian newspaper Aftenposten, an English-language publication. “This is the first time that the tabloids are picking up what is normally just financial news,” said Jørn Jensen, of Jensen Asset Management LLC in Oslo. “So all of a sudden we get a human face to a complicated financial problem. Subprime impacts everyone, but this case is especially ugly after what came to light of Terra’s actions. On the bigger picture, though, this is only the beginning, and we will likely see more stories like this all over the world.” The Citigroup municipal investors TOB capital municipal portfolio is a sub-fund of Citigroup Alternative Investments. It is domiciled in Ireland. The investment strategy is that of a standard tender-option bond fund. It seeks to capture arbitrage by purchasing long-dated municipal debt, in this case between 20 and 40 years with a minimum rating of AA-minus or Aa3. It then sells short-term debt to money market funds. It is hedged on the London Interbank Offered Rate. The prospectus states that it aims to be leveraged between eight and 10 times. Eligible investments are municipal bonds, residual certificates of a TOB, or a forward-delivery municipal bond. The fund is managed by Craig Henick and Edward Sun. Jensen, who is also the former investment manager for fixed-income at KLP Asset Management, the largest life insurance and pension fund manager in Norway, said it is likely these towns did not even know the TOB was leveraged. He did express some shock, however, that the product came out of the U.S. municipal market. “It just goes to show you how far these problems reach and that no one is safe from subprime right now,” Jensen said. The prospectus is a typical one for tender option bonds, two TOB managers confirmed after reviewing the documents. The management fee is 2% per annum on capital and there is an incentive allocation. A minimum investment is $5 million. Of the other Norwegian municipalities, Rana invested the most in Citi’s TOB at $54.7 million. Four other municipalities are not part of the initial lawsuit and have yet to take action. Two of them are Helgesen, which invested $40 million, and Bremanger, which invested $31 million. The other two towns have not gone public yet, but the NFSA has confirmed that there are two more. All exchange rates used in this article are from Nov. 28.

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