Public Funds Investment Act Workshop - PowerPoint Presentation

1. Public Funds Investment Act WorkshopESC Region 1JANUARY 2023Linda T. Patterson, CTPMeeder/Patterson group1

2. Today’s Strategy ?Utilizing a goldilocks economy2

3. What We Know Hawkish Fed continues its aggressive policy movesSlower but sure rate increases in 2023 perhaps to 5.1% overnightMonthly drawdown of balance sheet ($95 B) (60% Treas - 35% MBS) Economic and business cycles are challengingInflation is starting to moderateModerate but slow domestic growthHealthy payrolls see higher inflationSupply side price pressures less but …Decreased GDP anticipated in 2023Chances for recession are moderatingWe may see a soft landing3

4. A Very Hawkish Fed Central banks act in unison both up and slowingFed is not the only actor but the key oneBut poised for 25 bps hike in February Began the drawdown $9T portfolio (monthly $95B likely $35B Treasury & $35B MBS) The long-term result remains unclear investors jump on rate increase but back off on fears of slow economy A recession two years out could mean rates will drop again The dollar?4

5. Talk of Recession is Scary, but,Consider Economic CyclesExpansionPeakRecession or contractionsDepression, troughRecovery

6. Recession and RatesA recession slowdown forces the rates down usually very quickly6Grey areas are recessions

7. US Yield Curve7JanJan

8. YIELD CURVESMarket decisions i.e. prices generate a ‘yield curve’Long and short-term rates generally behave independentlyShort-term rates are primarily driven by Federal Reserve policy and the Federal Funds rate – but also market flowsLong-term rates are driven by longer run growth and inflation expectations – but also supplyYield curve is a reliable indicator of economic trends and potential future growthA “compilation of expectations” and expectations drive investors8

9. A Normal YIELD CURVELong-term rates higher than short-termProduces an upwardly sloping curveIndicates expectation of normal positive economic growthWe measure the ‘spread’ of the rates at certain key pointsProbably 90% of the time9

10. A STEEPENING OF THE YIELD CURVEIndicates expectation of economic expansion and growth or potentially higher inflation or Fed action to slow inflationThe ‘spread’ at certain points create the steepnessLong end flees their positions lowering prices10

11. A FLAT YIELD CURVEShort and Long ends are relatively the same indicating lower expectation of economic expansion and growthShort end ‘catches up’ due to Fed action as long end escapes positionsCould predict inverted curveLock in rates!11

12. AN INVERTED YIELD CURVEShort end outperforms the long end Long end has anticipated slow down12

13. Rising Rate StrategiesUsually, growth creates the rise in ratesBefore the rise one reduces maturities (reducing sensitivity to price change)Once it starts Ride it immediately Think about how long it will last Be ready to lock in13

14. Rising Rates Need diversification Buy and Hold cannot realize a loss though market may continue up dropping prices Chose your sectors by comparing all of them Shorter opportunities may then compound earnings Think how long the ‘up’ may last – it is different this time14

15. Key Issues for You to Watch

16. ROLE OF CENTRAL BANKSSovereign banks control the flow of liquidityCentral banks raise interest rates to keep inflation in check but keeping them too high for too long may result in recessionCentral banks lower rates to boost the economy but keeping them too low too long can cause stagflation and or deflationCentral banks provide liquidity to market sectorsCentral banks support the yield curve – quantitative easing

17. What Is The Fed Looking At and For? Dual mandate successPrice stabilityMaximum employmentUS Economic conditionsInternational conditionsImpact of policies17

18. What Does the Fed Do and Intend to Do?Raise rates to curb inflationRates may jump 50 bps in MayRate may rise to 2%Maintain high employmentStop the QE to stop the funds flowMaintain corporate credit facilitiesResume normal rep operations

19. So where does a district start?19

20. Cash Flow is Always FirstIdentifies when funds are neededProtects your liquidityImproves investment returnsEstablishes policy parametersMaximum maturityMaximum weighted average maturityRisk benchmarksPromotes safe maturity extensionsDefines your portfolio20

21. One Basic Evaluation Stay to the 80-20 % RuleLimit the categoriesLook at each month not by expenditureFind the net cash positionFill the gaps with maturitiesAdd year by year to get a solid average21

22. Building a Cash Flow Mo1Mo2Mo3Mo4Mo5Mo6REVENUES8,000,0009,000,0003,000,0002,000,0007,000,0005,000,000EXPENSES4,500,0005,000,0004,000,0005,500,0005,000,0006,000,000NET3,500,0004,000,000-1,000,000-3,500,0002,000,000-1,000,00022Look month-to-month focusing NET to invest to negative months.

23. Now Use It as an InvestorFocus on balances required to pay expensesUse historical needs to set investment requirementsKeep a small liquidity buffer (ex: 1-month noremal expenditures)Ongoing use builds the traditional informationYou can create the basic cash flow in your headHow much is your payroll each month?How much is your accounts payable each month?When are your debt service payments? How much?23

24. This District needs $3 million each month but only needs one investmentSMTWTHFS1234567891011121314151617181920212223242526272824Payroll $1mmPayroll $1mmPayables $250,000Payables$250,000Payables$250,000Payables$250,000

25. Using the Information – I&S25An overview of the cash flow needs allows the investor to look ahead.The flow in Jan. alone covers the February payment.The net balances of each other month can be invested 11, 9, 8 and 6 months.

26. A General Fund Sample26We use the excess balances not needed for the next month and extend.Three excess balances result in 3-month investments.The cash flow knowledge allows Sept. to be extended to 8-month investment.

27. Everyone has a CORE PortfolioMeasuring and Using the CoreA core is money you have not touched for an extended period allows you to extend the portfolioIf you have no core you have a maximum maturity of one year or lessYour WAM should fit the cycles of your cash flowYour WAM will set a benchmark to compare risk27coreWhat is the apparent maximum maturity and WAM of each of these?

28. Strategies are a must on capital projectsOften a large nonrecurring expenditure unique cash flow like projects can show trendsPreliminary work with departments Set expenditure plan before funds arriveBond documents contain basic plansExplain to generate support Impact of additional earningsArbitrage impacts28Slow start setting contractsBuilding takes placeBuilding slowsFunds live on…..

29. Your PortfolioCash $10,000,000Securities $0Total Portfolio $10,000,000Your SecuritiesWeighted Average Maturity 1 dayWeighted Average Yield 0.20 %Estimated Annual Interest Income $20,000 Your Maturity DistributionYour Asset AllocationUsing the Cash Flow29Your Current Portfolio May be Very LiquidYield and Interest Income information is annualized. All yield information is shown gross of any advisory and custody fees and is based on yield to maturity at cost. Past performance is not a guarantee of future results.

30. Your PortfolioCash $10,000,000Securities $Total Portfolio $10,000,000Your SecuritiesWeighted Average Maturity 9 monthsWeighted Average Yield 1.20 %Estimated Annual Interest Income $120,000 Your Maturity DistributionAsset AllocationUsing (Strategizing) from Your Cash Flow 30

31. LegalCompliance31

32. What is PFIA Designed to Do?Provide guidelines for safetyHighest credit quality limitsRequires controls (maximum maturity, maximum WAM, DVP)Provide for flexibility to match individual needsAllow flexibility for entities to set their own parametersAllow for adjustments to internal and external changeApply to all entities regardless of sizeYou tailor it to your situation and needs32

33. PFIA Policy Specific Requirements Write and adopt a policy annually which must: (2256.005)Must be adopted by resolutionThe resolution must show any changes made Be writtenPrimarily emphasize safety and liquidityState the maximum stated maturity authorizedAddress diversification, yield, maturity & capability of officersList your authorized investmentsInclude a procedure to monitor credit rating changes Set a maximum weighted average maturity (WAM)Method to monitor market pricesRequire delivery versus payment (DVP)Policy may ‘un-authorize’ any type investment33

34. PFIA Strategy Specific Requirement34

35. PFIA Investment OfficersGoverning Body Designates Investment Officer(s) by rule, order ordinance or resolution (2256.005)Governing body may choose anyone as IOIO is responsible for investment consistent with policyA contracted adviser/entity can also be an IOEffective until rescinded or terminated from employmentIO must follow Prudent Person RuleCouncil must provide for the training of officersNo person can deposit, withdraw, transfer or manager unless authorized by lawCouncil has the option to chose officers (no necessary set position)Regional Planning Commission can only serve Commission as IOThe governing body retains ultimate fiduciary responsibility by statute 35

36. Investment Officer EthicsIO must be a local and designated (and ‘Treasurer’ if there is one)Must disclose personal/business relationships by officerRefers to personal business relationshipsIO must file a statement disclosing the relationshipIf IO relationship is within two levels of blood or marriage andIf IO owns >10% of voting stock/shares or >$5,000 in fair market value of firmIf IO received >10% of IO’s prior year income from the firmIf IO received >$2,500 in investments in prior year for his personal accountIf these limits are met then file with the Texas Ethics Commission Specific income limits are set but full disclosure is safer/easier36

37. PFIA Officer Training37

38. PFIA Required Standard of CareInvestments shall be made in accordance with the StandardInvestments are governed in order of priority by:Preservation and safety of principalLiquidityyieldDetermination of prudence takes into consideration:Investment of all funds – not a single investmentWhether the investment was consistent with the policy38

39. PFIA Standard of CarePrudent Person Standard Investments shall be made with judgment and care under circumstances then prevailing that persons of prudence, discretion and intelligence exercise in the management of their own affairs not for speculation but for investment considering probable safety as well as probable income.Addresses the cyclical nature of investingPeriodic required reviews/reports address changes39

40. Actions Required by the ActAnnuallyGoverning body adoption of policy and strategyAdoption of broker listQuarterlyQuarterly reporting presented to governing boardOne-time actionsDesignation of investment officersApproved training sources40

41. Ratings Requirements of the Act41

42. Procedures Requirements of the Act42

43. Authorization Requirements of the ActSecurities that become “unauthorized” by law or policyNeed not be liquidatedReinvestment must be as provided by policySecurities that lose their required ratingEntity must take prudent steps to liquidateMust be liquidated but no specific time period43

44. Monitoring Required by Act44

45. Special Specific Investment AuthoritySchools Districts are authorized to buy corporate notes if:It is rated no less that “AA-”It is not convertible to stock and is securedThe District has an average of over 50,000 studentsHedging is authorized for cities in several instances if:It complies with CFTCIt is segregated and accounted for separatelyIt is an “eligible entity” and uses for “eligible projects”45

46. PFIA Quarterly Reporting describe the investment position of the entity in detailbe prepared jointly by investment officersbe signed by each investment officerBe presented to governing body and chief executive quarterly On a timely basis within a reasonable time (usually 45 days is reasonable)contain summary informationBeginning and ending market valueFully accrued interest (net earnings)detail each position by book/market, maturity date, fundstate compliance with Policy and PFIA46

47. Audits Required by the ActExternal auditorIf you invest in other than CD and poolsAuditor must review the quarterly reportsInternal Compliance auditCompliance to your policyCompliance to the PFIA47

48. PFIA Governing Body Duties The Board retains ultimate fiduciary responsibility by law designates the investment officers reviews and approves policy annually reviews and adopts strategy annually receives quarterly reports approves broker/dealer list annually approves training sources can designate an Investment Committees (optional)48

49. PFIA Investment Officers’ DutiesInvestment officers Must disclose any personal blood/money conflicts Must prepare and sign quarterly reports Must attend to training every 2 years Must comply with the Policy Must suggest and monitor broker/dealers and certification Must monitor credit ratings Must advise the Council/Board Must do or arrange for an annual compliance review Must provide for documented competitive transactions49

50. Counter-party Duties50

51. PFIA Broker RequirementsBroker/DealersGoverning body must annually review, revise and adopt list of authorized broker/dealersList is for broker/dealers only not banksCan be approved by governing body designated investment committeeBroker/Dealer policy certification is no longer requiredBest practice is to send the policy to any broker/dealer51

52. PFIA Policy Certification RequirementThe certificate effectively states:Organization has implemented control procedures except where:Policy requires an interpretation of subjective investment standardsPolicy relates to funds not invested through the organizationThe certificate must be received before any transaction takes placePolicy certification must be acceptable to both parties – not set by PFIANothing relieves entity of responsibility to monitor investmentsPools now have standard certificates – use them52

53. Create your checklist for Compliance53

54. Next, Of Course, A Policy54

55. Policy Musts55

56. PFIA Specific Requirements Write and adopt a policy annually which must: (2256.005)Must be adopted by resolutionThe resolution must show any changes made Be writtenPrimarily emphasize safety and liquidityState the maximum stated maturity authorizedAddress diversification, yield, maturity & capability of officersList your authorized investmentsInclude a procedure to monitor credit rating changes Set a maximum weighted average maturity (WAM)Method to monitor market pricesRequire delivery versus payment (DVP)Policy may ‘un-authorize’ any type investment56

57. The LOCAL Standard Authority Approved Investments Safety Management – Prudent Person Liquidity and Maturity Diversification Monitoring market prices Monitoring rating changes Fund strategies Safekeeping and Custody Broker/Dealers Soliciting bids for CDs Interest Rate Risk Internal Controls [Collateral] Reporting Annual Review Annual Audit57

58. Possible Local Policy Additions58

59. Needed – A Collateral Policy59

60. Internal Controls Separation of authorityAvoidance of collusionClear delegation of authority – including the BoardWritten confirmation of telephone all transactions Safekeeping control collateral and owned securities Security proceduresDVP – Delivery versus Payment Cash flow analysis as basis for decisionsCompetitive bidding on all transactions Monitoring FDIC coverage60

61. StrategiesDependent on your cash flowDependent on your risk toleranceDependent on your policy limitsRequire some analysisPartially dependent on your economic viewWill rates go up?When will it go up?How far will it go?

62. Public Funds are 90% Buy and HoldAssures funds availability and requires minimum timeWorks well with a laddered portfolioEffective when used in conjunction with a formal cash flow.Keeps transaction costs down Proven to outperform “active management” on a total cost basis.

63. Now Set a Macro Strategy63

64. What is a Macro Strategy?Sets the stage for an overall view of portfolioSets your weighted average maturity (WAM)Can set your maximum WAM for entire portfolioIt must describe how you intend to obtain: Objective of investments: what actions and controlsSuitability of instruments: all high credit quality Safety of Principal: high credit quality and safekeepingLiquidity: laddering and adding a liquidity bufferMarketability of investments: all with secondary marketsDiversification: competition and moves with the marketsYield: competition, extensions to meet cash flows64

65. Sample Strategy for aShort Conservative Portfolio 65

66. Sample Strategy for aShort Conservative Pro-active Portfolio The primary objective is to invest in accordance with cash flow needs to produce a market yield. All securities will be of the highest credit quality to manage risk. The portfolio will be structured as a ladder to match known liabilities and providing for a reasonable liquidity buffer for unexpected needs.The portfolio will be diversified to avoid market and credit risk. The maximum weighted average maturity will be one year.66

67. We Require Different StrategiesStrategies are dependent on the use of the fundsWhat would the ‘strategy’ be for these?Max maturity, max WAM, portfolio structure??? Securities?Debt Service Fund?Operating Fund?Bond Proceeds?

68. Common Macro Strategies100% Cash (pools, bank deposits, money markets) - opportunity costLadderMatching known liabilities with a liquidity bufferBarbellSplit maturities add capture yield – liquidity risk possibilityCould be used in a commingled portfolio effectivelyAll should be Buy and Hold Most governments will not trade actively but buy to liability and hold to maturityActive Management uses market knowledge and captures opportunities

69. Full Liquidity All funds held in fully liquid cash instruments bank deposits, local government investment pools, money market funds This strategy is beneficial when:Interest rates are rising quicklyThe yield curve is flat or invertedNo clear understanding of cash flow Disadvantages:Very low yieldsLacks diversification by market sectorLeft at mercy of rates if the market shifts directions and yields drop

70. The Laddered PortfolioIn a laddered portfolio securities are positioned to match liabilities so maturities occur in regular intervals to provide a known stream of cash. The laddered portfolio may, or may not, correspond with expected future expenditures. Regardless of interest rates move, you will be reinvesting at the prevailing market yield.

71. The Barbell PortfolioA barbell maintains some of the portfolio in liquid deposits then invests a portion in longer, higher yielding securities (usually 18 to 36 months)Disadvantages:Rates will impact the portfolio directly and immediately. If rates fall longer end will support shorter.If rates rise liquidity has to cover all needs because long end will be at unrealized loss.

72. Your PortfolioCash $10,000,000Securities $70,000,000Total Portfolio $80,000,000,Your SecuritiesWeighted Average Maturity 9 monthsWeighted Average Yield 1.65%Estimated Annual Interest Income $1,320,000 Your Maturity DistributionYour Asset AllocationBut with a Plan – Add Flexibility and Earnings72With possible changesYield and Interest Income information is annualized. All yield information is shown gross of any advisory and custody fees and is based on yield to maturity at cost. Past performance is not a guarantee of future results.Review and change, if necessary, quarterly

73. Commingling StrategyThink through the portfolio structureRadically different fund types need a separate policySeparate portfolios Require separate accountingMay cause liquidity problemsCan reduce yield by requiring liquidity balancesCommingled portfoliosCan still address unique needs of fundsSmaller liquidity needs may allow more extensionsReporting is simpler

74. Banking Changes Bank regulations Liquidity ratiosLeverage ratiosStable net asset accountsThese directly affect districts74

75. Translation for Public EntitiesBanks will try to reduce collateralUse of letters of credit instead of securitiesBanks will add fees to address regulatory burdenBalance based feesBanks trade investment for serviceService not depository75

76. Why Letters of CreditCost differential for banksSecurities cost about 10-12 bps. and a LOC 5 bps.What is a LOC? How do I use it?FHLB is a banker’s bank owned by the member banksCredit backing comes from the member banksTime requirements for amount changes can be critical76

77. Balance-Based Fee77

78. Sweep Accounts78Money Market FundSweeps usually have higher interest rates than bank, andEliminate balance-based fees

79. Your Decision Hinges on RatesDo you use compensating balances?If so, compare your ECR to outside optionsA 0.40% ECR on $10 million balance will generate $3,333/monthIf rates outside give you 0.70% the same balance generates $ 5,833 / moInvest the funds outside pay $3,333 directly and keep $ 2,500/mo ($30,004/yr)79

80. How You Pay for Bank Services Depends on the RatesThe method hinges on investment rates Compensating balance basisTraditional for public entitiesYou leave money in bank which earns $$ and pays the billYou never see the charge – it looks “free”The cost is the use of your money and its potential earningsFee BasisYou pay the fees for the service by debit to the account

81. The Rates Say It AllComp BalanceFee BasisFee BasisECR0.40 %0.40 %0.40 %Bal. Required$ 5,000,0000000ECR Earnings$ 1,6670000Sweep %001.75 %1.75 %Sweep Amount00$ 5,000,000$ 1,500,000Sweep Earnings00$ 7,292$ 2,188Pool %2.20 %2.20 %2.20 %Pool Amount0000$ 3,500,000Pool Earnings0000$ 6,416Net to Bank (fee)$ 1,667$ 1,667$ 1,667Net to You00$ 5,625$ 8,604Net Annual Earnings00$ 67,500$ 103,24881

82. Then Add in a Balance Based Fee Fee…Comp BalanceFee BasisFee BasisECR0.40 %0.40 %0.40 %Bal. Required$ 5,000,0000000ECR Earnings$ 1,6670000Balance Based fee$50000Sweep %001.75 %1.75 %Sweep Amount00$ 5,000,000$ 1,500,000Sweep Earnings00$ 7,292$ 2,188Pool %2.20 %2.20 %2.20 %Pool Amount0000$ 3,500,000Pool Earnings0000$ 6,416Net to Bank (fee)$ 2,167$ 1,667$ 1,667Net to You00$ 5,625$ 8,604Net Annual Earnings00$ 67,500$ 103,24882

83. Different Rates ControlMove to Fee Basis if rates outside betterPay the bank and keep the earningsWatch out for the “free services” and balance feeUse investment options through the bankSweeps take money out of bankEliminates regulatory feeDoes not require bank to hold collateralUse investment options outside the bankPools are just as liquid – transfer in as needed83

84. 84District earned $4,078 but needed only $ 2,569You can use ‘carry-over’ to cure this – it’s in your RFPThe All-importantAccount AnalysisYour invoice for service

85. Carry-Over ManagementManaged by you monthlyInsist on quarterly/semi-annual carry-overAdjust your balances monthly before closeManaged by an automatic sweepSweep excess funds to a money market fund or accountHave the sweep set at either:Compensating balance amountZero 85

86. Control the Banking RelationshipUse the FDIC relationshipStructure accounts to your advantageAlways keep checking the fees and earnings rates86

87. Use FDIC Coverage to your AdvantageBased on type of account – a change in definitionsAll time and savings accounts = $250,000Includes NOW and money market accountsAll demand accounts = $250,000Includes interest bearing and non-interest bearingBased on location of bank If the bank is outside the state all deposited are lumped togetherThis has changed from ‘headquarters”87

88. Banking Safety: Founded on FIRREA“Financial Institutions Resource, Recovery and Enforcement Act”Regulation used by FDIC in bank closuresKey components must be followedRequirements:depository/collateral agreement be in writingagreement be approved by resolution of the Bank Board or Bank Loan Committeeresolution must be in ‘official’ bank recordsmust not contain a list of specific securities pledged88

89. IntraFi as a ‘Sweep’Intrafi is the renamed Insured Cash SweepBanks may ‘present’ ICS as a sweep, but:ICS is a money market account with withdrawal limitsIt does not give daily liquidityThis is a savings account option - not a sweep89

90. Monthly Collateral ReportsInvestment officer’s responsibility to reviewThe value you are watching is market valueNew bank move to money center banks add inquiryAdds inquiry and daily pricing for your control90

91. Collateral ControlFDIC insurance cover by tax id and type of accountCollateral is pledged not ownedSet the margin at 102% (110%) to protect from price volatilityEstablish independent custodyRequire independent monthly reporting PFCA requires you request the monthly report91

92. What about Substitute CollateralMany banks are changing to Bank of New York as custodianMore efficient for banks in transfersPossible lower costs for banksNon-approval of substitution may be requestedBeneficial move for daily inquiry access to market value92

93. Repo Sweep CautionRepo Sweeps pose a unique risk – don’t use themSegregation of assets not a buy-sell transactionCollateral is segregated not bought and soldAs a sweep, repo must be established as buy-sellFDIC sweep construction by bank could cause lossIf agreement doesn’t say ‘buy-sell’ do not use it93

94. Monitor Your BankKnow your depository Understand the collateral terms and agreementCheck collateral report monthly from custodianTake action if necessary94

95. Managing Risk95

96. Credit RiskThe risk of value loss due to issuer default or delays on payment of interest or principal on a timely basisMinimized by:Buying high credit quality securitiesMonitoring credit ratingDiversifying between issuersUsing investments and deposits that are collateralized Pre-qualifying the financial institutions and intermediaries96

97. Liquidity RiskThe risk that the entity will need the money before the investment's maturity date restricting access to money. Cured by taking a loss or paying a penalty (on a CD)Minimized by:Accurate cash flow projectingLaddering maturitiesMaintaining a small liquidity buffer for unanticipated needs97

98. Collateral RiskThe risk of insufficient collateral to compensate the entity if a bank fails. The risk that ownership of collateral is not perfected or not available. Minimized by:Requiring a minimum of 102% (110% MBS) market value on the pledged collateralEnsuring confirmation of the pledged collateral Ensuring security collateral is of PFIA authorized qualityMonitoring the collateral at least monthly Now daily is available with some banks98

99. Collateral Risk Can be Minimized99

100. Managing Collateral RiskDefine the authorized collateral in policy (and RFP) for any bank investment“Obligations of the US Government, its agencies and instrumentalities, including mortgage backed securities and CMO passing the bank test”Require monitoring by bankRequire monthly reportsThe options by law include:Surety bonds Treasury notes and billsUS AgenciesMunicipals rated A or betterLetters of Credit100

101. Needed – A Collateral Policy101

102. Banking Safety: Founded on FIRREA“Financial Institutions Resource, Recovery and Enforcement Act”Regulation used by FDIC in bank closuresKey components must be followedRequirements:depository/collateral agreement be in writingagreement be approved by resolution of the Bank Board or Bank Loan Committeeresolution must be in ‘official’ bank recordsmust not contain a list of specific securities pledged102

103. Other CustodiansMany banks are moving to money center banks Bank of New York as custodianProcess remains the sameSafeguards remain the sameContractually controlledCollateral management control groups in banksRight of approval of substitution may be waivedShould offer you online access to monitor assetsPricing may be more frequent103

104. Market RisksMarket RiskThe risk that market prices will fall Lower prices threatens liquidity If you can not sell at a lossIf sold you might recognize a loss of principal If not sold it is an “unrealized” loss and no threatVolatility Risk (the “Fear Index”)The risk of significant changes in market prices Higher volatility = higher riskVolatility increases with longer maturities, low credit and structured securities104

105. Managing Event RiskIs the risk when markets move in unexpected directionsAn unforeseen event can cause markets to turn quickly Markets move especially with uncertaintyMinimized by:DiversificationRemembering that you are a buy and hold portfolio You are matching liabilities that do not changeYour events risks are internal more often than not105

106. Security Structure Risk 106

107. Technology’s RisksEmployee controlsPin numbers and separationLimited access to applicationsStand alone computer accessPCI controlBank fraud controlsFilters/blocks on ACH Payee positive pay107

108. Safekeeping and Custody RiskCustody RiskAccompanied by high fiduciary responsibility Custody of pledged securities Risk to proof of the pledgeRisk to control of the pledgeSafekeeping RiskLower fiduciary responsibilitySafekeeping of securities you ownRisk to your proof of ownership Proving your ownership108

109. Securities must be ‘settled’then ‘safekept’ (or custodied)This is an institution holding securities owned by you not collateral.109ISD buys a Broker sells security the securityThe TradeISD approves Broker sends to Bank safekeepstrade and funds bank DVP the securityTells bankBroker sends security to bankIf it does not agree in all details it is DK’d (Don’t Know)

110. Safekeeping Bank Accounts110Depository BankRelationshipInterest Bearing Money Market Account Account Safekeeping AccountSafekeeping is tied directly to an accountSafekeeping accounts are not regular bank accounts but must be tied to a demand deposit account (DDA) so that money that buys a security can only flow back to the same account.These accounts are in the securities clearing section of the bank and assigned by name.

111. 111Sample Safekeeping FeesOn-usNot On-US

112. Key Custody and Safekeeping FactorsCustodian/safekeeper must be independentCustodian/safekeeper should report to you directlyCustodian will verify authorized collateral and marginCustodians may mark-to-marketSafekeeper will not be responsible past your requestYou chose your safekeeping agentYou approve your custodian112

113. Opportunity Cost RiskThe funds the investor lost because the best rates were not taken.The difference between current investment return and alternative investment offering a higher return. An example would be purchasing safer US T-Bill yielding 0.3% instead of commercial paper yielding 1.0%0.7% difference in yield is the opportunity costOn $1mm that’s $7,000/year!Minimized by DiversificationMonitoring market sectors for the best ratesBuying short when rates rise – longer when rates fall113

114. Non-Market RisksCounterparty riskCheck for FINRA registration (FINRA.org, broker check)Require independent safekeeping outside brokerageBanking risksReconcile within 30 daysVerify availability of fundsMonitor cost of services and account structure with account analysisEmployee riskSeparation of dutiesOversight and cross trainingCash controls like numbered receipts, safes, assigned tills114

115. Risk, Return and Strategy Belong TogetherYour strategy and opportunities will depend on:Your resources and risk toleranceYour cash flowThe time you spendYou are basically a BUY AND HOLD portfolioControls can help minimize risks You more on cash flow than economic or geo-political conditions115

116. Key Controls and Limits116

117. You Need Investment Controls117

118. Types of Controls and Limits118

119. Procedures and ControlsPFIA mandated controlsWrite and annually adopt a policy and strategyDesignate investment officers and train themSet your objectivesChoose your securities Report in a timely quarterly mannerPFCA controlsDevelop a collateral policySet parameters for collateral119

120. Why Expand with Procedures120

121. Procedures can Define Securities More ConciselyAuthorized InvestmentsAuthorized investments include only the followingSet the maximum maturity for each security type at time of purchaseSet credit criteriaSet additional requirements by typeExample:Authorized investment under this Policy shall be limited to the instruments listed below and as further defined by the PFIA.Obligations of the US, its agencies and instrumentalities, excluding MBS and CMOs, with a stated final maturity less than 2 yearsFully collateralized or insured CDs of banks doing business in TX…collateralized in accordance with the district collateral policyFDIC insured CDs from any state All security transactions will be made on a competitive basis.121

122. Procedure for Monitoring Certain SecuritiesEven more important than credit ratingsDifference created by FDIC coverage limited to $250,000No reprieve for mergers and acquisitionsThe Investment Officer shall monitor, on no less than a weekly basis, the status and ownership of all banks issuing brokered CDs owned based upon information from the FDIC. If any bank has been acquired or merged with another bank in which brokered CDs are owned, the Investment Officer shall immediately liquidate any brokered CD which exceeds the FDIC insurance level. 122

123. Procedure for Monitoring CreditMonitoring credit on securities requiring ratingCommercial paperBankers AcceptancesState and Local government bonds(Corporate bonds – only for higher education)PoolsPolicy must have a procedure to monitor ratingsAct: “an investment that requires a minimum rating…does not qualify during period without minimum rating…take all prudent measures to liquidate…”123

124. Monitoring Credit with Your Analysis OptionThe Officer shall monitor on a monthly basis, the credit rating on all authorized investments requiring a rating based on independent information from a nationally recognized rating agency. If the security falls below the minimum rating, the Officer will notify------ of the loss of rating, conditions affecting the rating and possible loss of principal along with liquidation alternatives available for action within two weeks of the loss of rating.124

125. Monitoring Credit on Automatic PilotThe Officer, or adviser, shall monitor on a monthly basis, the credit rating on all authorized investments requiring a rating based on independent information from a nationally recognized rating agency. If the security falls below the minimum rating, the Investment Officer shall immediately solicit bids for and sell the security, if possible, regardless of loss of principal.125

126. Procedure for Banking Controls126

127. Bank Rating Services127

128. Using a Bank Rating Agency 128

129. Safekeeping ControlSafekeepingMust be delivery versus paymentRequires independent safekeeping away from the tradeNo broker safekeepingSecurities owned by the District will be safe-kept at its banking services depository and all security transactions will be made delivery versus payment. Safekeeping bank will not be used as a broker.129

130. Key Investment Employee Controls 130

131. Controls for Technology131

132. Meeting Your Objectives132

133. /How do I achieve Safety?

134. How do I achieve Liquidity?134

135. How do I achieve Diversification? Create competition in every transactionNever rely on one institution or brokerDo not allow a broker to do competitive bidding for youDiversify by type of securityKnowledge of the alternative securitiesUse securities that make sense for the periodDiversification maturityCreate a ladder to meet your liabilities135

136. How do I achieve Yield?Invest to your cash flow needsReduce lower yielding balances at bankKnow the securities and use appropriate onesAssure there is always competitionKnow, compare and use your alternativesMonitor bank costs and structures136

137. You Made It ! See You Tomorrow!Linda Patterson512-230-1336Meeder Investment/Patterson Grouplpatterson@patterson-mpf.com137

138. Relax – we’re done…for today…138