G ASB N O. 40— NEW DISCLOSURES FOR CASH AND INVESTMENTS

1. GASB NO. 40—NEW DISCLOSURES FOR CASH AND INVESTMENTS CONRAD ANDASSOCIATES, L.L.P. April 20, 2005

2. GASB STATEMENT NO. 40 • Required for years ending June 30, 2005

3. GASB STATEMENT NO. 40 • Addresses disclosures relating to the following risks: • Interest rate risk • Credit risk • Concentration of credit risk • Custodial credit risk • Applicable to both pooled investments as well as investments held by bond trustee

4. GASB STATEMENT NO. 40 • Example cash and investments note • Best way to understand impact of GASB 40 • Tailored for typical medium sized California entity • Incorporates existing investment disclosure requirements plus those required by GASB 40

5. New Cash and Investments Note • Begins with two tables: • Reconciliation to financial statements • Breakdown between: • Investments • Deposits in financial institutions • Cash on hand (petty cash, etc.)

7. New Cash and Investments Note • Briefly summarizes Entity policies relating to GASB 40 risks • Policy includes state laws (11) • Policy includes requirements established by governing board (10) • Policy excludes administrative practices (10) • If has no policy for a GASB 40 risk, must statethat fact

10. Interest Rate Risk • Interest rate risk—the risk that changes in interest rates demanded by the market will adversely affect the fair value of an investment

11. Interest Rate Risk • Must use one of five methods: • Segmented time distribution • Specific identification • Weighted average maturity • Duration • Simulation model

12. Interest Rate Risk • Should match how that entity manages interest rate risk • Entity should provide to auditors a schedule that provides the information required for the note • Can use more than one method for different portions of the portfolio • Can change from year to year (must disclose) (33)

13. GASB STATEMENT NO. 40 • All GASB 40 disclosures must be broken down at least by investment type (1) • For GASB 40 purposes, LAIF is a singleinvestment (3) • Don’t have to “look through” LAIF to give disclosures for the various investment types contained in LAIF (3) • How group investments will vary from entity to entity • Investments with strongly dissimilar risks should not be grouped together

14. Interest Rate Risk • Assumptions regarding interest rate risk can be made (15) • Assumptions must be disclosed (15) • For example: whether or not a security will be called on the call date, assumptions about the interest rate used in the disclosure, etc. (15)

15. Segmented Time Distribution • Segmented time distribution—dollar amounts are grouped together in tabular form with separate columns for various ranges of maturities • Generally longer maturity investments have a greater sensitivity to interest rate fluctuations • The weighted average maturity of the LAIF portfolio or a mutual fund portfolio dictates what column LAIF or the mutual fund goes in • Ability to withdraw funds on demand is irrelevant

18. Weighted Average Maturity • Weighted average maturity—calculates average maturity in years or months by investment type (weighed for the dollar amount of individual investments in that investment type).

20. Specific Identification • Specific identification—each investment is listed individually in the note in order to display amount, maturity, and any call options.

22. Simulation Model • Simulation model—calculates effect on investment fair values for hypothetical (negative) changes in interest rates. • If this is not being used during the year to monitor interest rate risk in your portfolio, you probably should not use this method for the cash and investment note.

24. Duration • Duration—calculates in years or months the time to elapse for a group of investments to become due and payable (weighted for the present value of investment cash flows). • If this is not being used during the year to monitor interest rate risk in your portfolio, you probably should not use this method for the cash and investment note.

26. Credit Risk • Credit risk—the risk that the issuer will not fulfill its obligation to the holder of the investment • Disclose any state laws or policy requirements associated with this risk • If none, so state. • Usually stated as a minimum rating

27. Credit Risk • In addition to disclosing requirement, must disclose rating as of end of year • Not required for direct investment in U.S. Treasury securities • Required for all other investments • Required for mutual funds composed of U.S. Treasury securities (26) • Required for federal agency securities (FNMA, etc.) (21)

28. Credit Risk • Required for bankers acceptances (24) • Not required for repurchase agreements if the securities underlying the repurchase agreement is a U.S. Treasury security (24) • Required for guaranteed investment contracts

29. Credit Risk • Must disclose rating for that specific instrument, not general rating for issuer • Required for external investment pools (LAIF, etc.) • If an investment does not have a rating, not required to get one. Just must disclose that it is unrated. [Required for all but U.S. Treasuries.] (22)

30. Credit Risk • Only end of year rating is required (8) • Generally, subsequent declines in ratings do not need to be disclosed • However, subsequent period event disclosure rules require disclosure of any known fair value declines that are significant to the total portfolio (25)

32. Concentration of Credit Risk • Concentration of credit risk—risk of loss attributed to magnitude of an entity’s investment in a single issuer • Must disclose by issuer and amount investments in any one issuer that represents 5% or more of total investments for that Entity or for a reporting unit (paragraph 11) • Not required for external investment pools (LAIF), mutual funds, or U.S. Treasuries (paragraph 11)

34. Concentration of Credit Risk • Reporting unit (paragraph 5): • Total governmental activities • Total business type activities • Individual major funds • Nonmajor funds in the aggregate • Fiduciary fund types

35. GASB STATEMENT NO. 40 • Whenever any GASB 40 risk is significantly greater for any reporting unit above than it is for the portfolio as a whole, that fact must be disclosed in the notes to the financial statements (paragraph 5).

37. Custodial Credit Risk • Custodial credit risk—risks relating to how an investment is being held by the custodian • Only have to disclose amounts held in category three • The other two categories don’t even have to be mentioned • Generally category three will be described without labeling it category three.

38. Custodial Credit Risk • For deposits, this generally means uncollateralized deposits in excess of federally insured amounts

39. Custodial Credit Risk • For investments, generally this will mean securities held by the broker-dealer used to buy the securities (or the broker-dealer’s safekeeping department), even if held in the Entity’s name, or • Held by the broker-dealer’s agent or trustdepartment but not in the Entity’s name.

42. Foreign Currency Risk • Foreign currency risk—risk that changes in foreign exchange rates will adversely affect the fair value of an investment • Only applies to investments that are denominated in foreign currencies. • Can be satisfied by listing the specific investments showing amount, maturity, and identification of the foreign currency

43. Highly Sensitive Investments • Highly sensitive investments—investments whose sensitivity to interest rate fluctuations is not addressed by the method used for disclosing interest rate risk (55) • Give dollar amount and summarize the characteristics that make them highly sensitive (16) • Characteristics can be grouped together in ranges

44. Highly Sensitive Investments • Fixed rate securities (bullets) are sensitive to interest rate fluctuations • But generally that sensitivity is already reflected in the five disclosure methods

45. Highly Sensitive Investments • Examples of highly sensitive investments: • Floors, caps, and collars—when the underlying benchmark rate reaches certain levels, the rate becomes fixed, increasing its sensitivity to market rate fluctuations (58) • Coupon multipliers—small changes in interest rates are amplified by the multiplier

46. Highly Sensitive Investments • Stripped interest payments—subject to prepayment risk which truncates the expected cash flows thereby diminishing the investment’s fair value (50) • Mortgage backed securities (FNMA, etc.)—highly sensitive to prepayments resulting from refinancings when interest rates decline (47)

47. Highly Sensitive Investments • Range notes– the interest rate jumps to a different rate when the benchmark index (e.g., 30 Treasury) falls within a prescribed range (e.g., 4.75% to 5.25%) (48) • Step up features—on certain dates issuer can call. If not called, rate is adjusted to a new rate specified at inception (not necessarily a market-adjusted rate) (48)

48. Highly Sensitive Investments • Generally, simple variable rate securities are not highly sensitive to interest rate fluctuations, because their interest rates are continuously adjusted to a measure of market interest, keeping its fair value close to par (38) • Because it is only exposed to interest rate risk until the next reset date, the reset date can be used to measure maturity (disclose this assumption if used) (38)