INVESTING SCHOOL FUNDS Public Funds Investment Act Workshop

1. INVESTING SCHOOL FUNDSPublic Funds Investment Act Workshop Region 1 –Edinburg July 2014

2. 1987: Separating Banking and Investing • Local governments – except home rule entities – were bank dependent • Before most entities were restricted to bank accounts and CDs • The PFIA was created and passed initially in 1987 • Defined the entities • Set collateral at 100% • Authorized specific investments • CDs • US obligations including agencies/instrumentalities • Repurchase agreements • Any bond guaranteed by Texas • Required an investment policy(no details)

3. 1989:Pools Created to Aide Small Entities • Pools were added through ILCA • Pools were only generally defined and assumed to be constant dollar, money market equivalent • Reverse repurchase agreements added • Commercial paper added • Bankers acceptances added • The Public Funds Collateral Act was passed

4. 1991 and 1993:Entities Start Feeling Their Oats • 1991 • Money market funds limited to specified authorized investment types added • 1993 • Specific “Collateralized Mortgage-backed Obligations” (CMOs) were added (as rates were falling) • Pools required to disclose information statement and provide confirmations and monthly reports • Written strategies now required with governing body approval

5. 1994: Orange County • Local Government Investment Pool in CA • Guaranteed liquidity • But, bought long mortgage backed securities • Risked the liquidity • And, Leveraged securities 5 to 6 times • Board never questioned high rates

6. 1995 – Reaction to Orange County • Prohibition added for certain MBS/CMOs • Reverse repurchase agreements restricted by term and tied to the reverse term (leverage) • Training for investment officers added • Broker certification requirement added • “imprudent investments” original language • Added maximum maturities and WAM • Designation of investment officers added • Written quarterly reportsrequired • Mutual funds added

7. 1995 – Major Reactions • State agency training added • TX Higher Ed Coordinating Board to provide • Prior authorized investments not required to be liquidated • Pools must be rated no less than AAA or equivalent • Municipalities with utilities authorized to hedge • State purchase and delivery of securities regulations • Loss of required rating requires prudent liquidation • State Treasury was abolished and transferred to Comptroller

8. 1997 – More Controls • Investment officer training extended • to 10 hours within 12 months and every two years • Delivery versus payment added as requirement and required in policy • Officer ethics disclosure added • Broker list creation and approval added

9. Expansion Years • 1999 • Investment advisers added • Annual compliance audits added • Israeli bonds added • GICs added • Municipal utility section added for sale/distribution of gas/electricity allowing hedging for supplies • 2001 • Water code directors training reduced • Letters of credit added as collateral in PFCA • 2003 • Securities lending section added • Expansion of investment authority now requires state audit review

10. 2005 • CD definition changes • “domiciled” became “main office or branch in TX” • Added ability to use CDARS • Entry bank must be in Texas • Reciprocity for banks required • Decommissioning trust funds investment authority expanded to include Trust Code • For entities with gas or electricity utilities selling to public

11. Responding to Public Needs • 2007 • Municipal hedging on coal and nuclear fuel expanded to commodity futures and related transportation costs • 2009 • Municipalities with mineral rights leases and contracts expanded investment authority • Includes oil, gas or other mineral rights • Establishes a Trustee authority • Funds must be separated • Investments can be made under Trust Code

12. Key Changes in 2011 Affecting You • Policies must include procedures to monitor credit rating changes in investments [2256.021] • Training years now defined as fiscal years [2256.008(a)(2)] • FDIC/FICA insured obligations [2256.0009(a)(4)] • FICA and CDs and interest bearing accounts • Can invest in FDIC insured CDs outside TX[2256.010(C)] • Conflict within the Act adds danger • CDs from a broker in TX allows broker to custody [2256.010(b)] • BUT Act requires you require DVP which this is not

13. 2011 Changes for Pools • Can now invest 100% in money market funds • Must say how yield is calculated in monthly reports • MMMF pools must report yield in accordance with the SEC regulations • The pool’s website must: • Include disclosures (information statement) • Make audited annual financials available • Must define breakpoints creating rate differentials

14. 2011 Changes Reporting • Investment quarterly reporting: • Need not be in accordance with GAAP • Need not state the beginning book and market of individual assets/investments BUT still need to give summary market values at beginning and end of period

15. PFCA 2013 • No change to PFIA • PFCA Change • Releases custodian from having to send trust receipts to public entity • Trust receipts to public entity or to bank with directions to forward • Struck the term “promptly” to same business day • Public entity can request current collateral list • YOU need to tell your bank/custodian that you want reports monthly from the custodian • Include in Policy and bank RFP

16. Lessons from History • Not all the changes made affect you • Not all the changes are necessarily good for you • The devil is in the details

17. What is public investing? • Managing risk • Putting money to work. • Creating a performing asset • Building a portfolio to serve the entity • Utilizing markets and products for entity benefit • Adding yield but not risk to the portfolio • Assuring cash efficiency and security • including banking arrangements

18. A Public Investor • Special fiduciary duties for public funds: • market and internal entity knowledge • to understand risk • to be conservative • to be pro-active and curious • effective communication skills

19. What is PFIA Designed to Do? • Provide guidelines for safety • Apply to all entities • Allow entities to set their own parameters • WAM and maturities and authorized investments • Define guidelineson investments to direct high credit quality • Provide for flexibility (maturity) • Provide for control on extension risk (WAM) • Allow entities to adjust to changes internally and externally

20. Standard of Care • Prudent Person Rule • Investment shall be made with judgment and care, under prevailing conditions, that a person of prudence, discretion, and intelligence would exercise in the management of the person’s own affairs, not for speculation but for investment considering the probable safety and probable income to be derived. • Essentially I am more concerned with the return of my money than the return on my money • A key point is “circumstances then prevailing” because conditions change • internally and in the market

21. PFIA Specific Requirements(Call it “Audit Risk”) • Write a Policy which:(2256.005) • Emphasizes safety and liquidity • Addresses diversification, yield, maturity & capability • Lists authorized investments • Includes procedure to monitor credit rating changes • Set a maximum maturity and WAM • Tell how market prices are monitored • Require delivery versus payment (DVP) • Review and adopt policy annually

22. PFIA Specific Requirements • Entity must write a strategy • Council must review and adopt the strategy annually • Council must designate investment officer(s) • Designate by resolution • Effective until rescinded or terminated from employment • Council must provide for the training of officers • Council has the option to chose officers (no necessary set position) • Officers must disclosepersonal/business relationships • Refers to personal business relationships • 2nd degree of affinity or consanguinity (blood or marriage) • Specific income limits are set but full disclosure is safer/easier • Disclosure to TX Ethics Commission and governing body

23. Investment Officers • Must be designated by resolution • Officers or employees of entity • Contracted investing entity can be officers • Effective until rescinded or terminated • Regional Planning Commission officer can only serve RPC

24. Training Specifics • Required training • Required within 12 months of appointment or position • Required every two succeeding fiscal years • Training sources must be approved by governing board or investment committee • Required training for • (a) treasurer, • (b) CFO (if Treasurer is not CFO) and • (c) all designated investment officers

25. PFIA Specific Requirements • Provide policy for written certification • To all firms wishing to sell a transaction must provide certificate • Includes pools, banks, investment advisors as well as broker/dealers • Provides for the review – it is not a guarantee • Counter-parties • All counterparties must certify to the Policy • A list of broker/dealers must be approved annually by Council • Or a Council designated Investment Committee • Audits • Annually obtain or complete an annual management audit • Assuring compliance with the Policy and the PFIA • Audit by independent auditor may be required • if invested in more than CDs and pools

26. PFIA Specific Requirements • Reporting • Must be prepared jointly by investment officers • Must be signed by each Investment officer • Must be submitted to Board quarterly • On a timely basis • Must contain detail and summary information • Must conform to PFIA report requirements • Must state compliance with Policy and PFIA

27. PFIA Specific Items • CDs may be bought orally • Prudence is based on the whole portfolio • Prudence to liquidate at loss of rating • Does not constitute an authorized security with lower rating • Policy must include procedure for monitoring credit rating and possible liquidation • No need to liquidate if authorized at purchase • Discuss and decide the reasonable action to take • Chapter is sub-cumulative to other law • Some Water District variations have been created

28. Basic Public Objectives • Safety of principal • Preservation of capital • Liquidity • Assuring that funds are available • Covering known and unexpected expenses • Diversification • Avoiding risk of over-concentration • Yield • Making all the funds work • How do we achieve the objectives?

29. Change • Market conditions change constantly • Know the “circumstances then prevailing” • The best weapon is information • Do not single-source information • Have a reasonable process for downgrades • Ongoing disclosure to governing boards will help • Internal situations change • Changes in tenured individuals • Board proclivities for risk change • New or different types of funds may change (bond $$) • Weather events may influence need for liquidity • Legislation changes

30. Use the Act and Your Policy to Address Change • Fundamentals • Your objectives • Economic realities • Firm Foundation • Controls and plans • Flexibility • Policy guidelines which allow change • Securities not usually used (state and municipal debt and CU) • New liquidity alternatives • Extension alternatives (step-ups)

31. Adapting to Change • Competitive process will keep you on top of the market • Periodic review of policies and procedures will keep policy dynamic • Trainingwill keep you up-to-date • Expecting change allows you to adapt

32. Today’s Major Change Factor • Interest rates control you and your strategies • Know what you can control • Know the rates generally Public entities operate primarily in this area of the curve.

33. A Major Change Factor • What is driving the rates and markets currently? • What factors will change outlooks? Public entities operate primarily in this area of the curve.

34. Investment Process/Cycle • The process is cycle to verify circumstances then prevailing have not changed • The process exists for all types of investing • The process requires ongoing systematic review

35. Step 1: Cash Flow • Identifies when you need money to pay bills • Protects your liquidity • Improves investment returns • Establishes parameters for policy guidelines • Maximum maturity • Maximum weighted average maturity • Risk benchmark • Promotes safe maturity extensions • Defines your portfolio

36. Cash Flow AnalysisWhat? • Study of how cash moves through an entity • Capture revenues & expenditures for analysis over time • Study of how and when money flows • Problem periods • Opportunities • Basis for cash projections

37. Cash Flow AnalysisWhy? • Protects your liquidity • Improves investment returns • Establishes parameters for policy guidelines • Maximum maturity • Maximum weighted average maturity • Risk benchmark • Promotes safe maturity extensions • Cash is the gas that makes an entity go • Cash flow analysis makes the portfolio go Defines your portfolio

38. Cash Flow Sets Time Horizons • Knowing cash flows/horizons allows you to act pro-actively • Provides comfort that necessary funds are available • Allows some extension by recognizing future flows • Yield is not the end-game but an added benefit • Defines the portions of your portfolio • And from that the strategy for each

39. Debt Service Time Horizons • A $2mm debt payment is scheduled out 6 months • $400,000 is paid in each month to meet debt service • Staying liquid over the 6 months earns $14,000 • Investing each successive month at rates shown earns $16,333

40. Two Approaches • Both approaches have same goal • Present viable information for decision-making • Develop parameters for portfolio structure • Limiting liquidity risk • Traditional approach details • Define all variables • Build on extensive historical data • Extensive analytics for forecasting • Expense Orientation approach simplifies • Limit the elements being analyzed • Designed to get going faster

41. Traditional Cash Flow • Capture more detailed information • Continue use of 80-20% rule or • add categories • Capture historical data before analysis • Total revenues minus total expenses • Multiple years will highlight and smooth aberrations • End result is same cash balance data

42. Major Category History

43. Multi-year History Smoothes • Layering each year’s history allows an average • Building off history allows you to compute monthly % • Historical % used on new budget creates a forecast • Tie the summary sheet to detail sheets per year • Layering sheets allows for research on aberrations

44. The 80-20 Rule • Regardless of approach • Capturing every detail can be overwhelming in detail • Can be difficult to maintain • 80% of expenses come from 20% of expense categories • Payroll and fringes probably account for 80% • 80% of revenues come from 20% of revenue sources • Taxes, state payments or fees probably account for 80% • Capture the key elements • Summarize remaining “other” amounts and focus

45. Let’s Flow • A key to cash flow analysis is to START • Eliminating the need for years of data • Data farming too often an excuse not to act • You can create the basic cash flow now – a base line • How much is your payroll each month? • How much is your accounts payable each month? • When are your debt service payments? How much? • Add a ‘liquidity buffer’ for the unexpected

46. A Debt Service Example This entity has two debt service payments: February and August. Funds for debt service flow in from tax payments first 6 months. Balances build in these front months. Keeping funds liquid leaves them at the lowest possible rate. We need to make these funds work.

47. Using the Information An 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.

48. A General Fund Sample We 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.

49. Either route gets you to… Core • A view to the balances of cash throughout the year • The net cash shows the peaks and valleys on balances • Normally there is a minimum balance across the year • On this graph the entity has historically never gone less than $2,000,000. - this is our ‘core’ • Cores can be invested longer knowing that there is little chance of using that cash

50. Maturity and WAM • The Investment Policy and its controls are often based on cash flow • The maximum maturity (flexibility) • allows the entity to extend and reflects a core and longer time horizon • The weighted average maturity (control) • controls for over-extension