Life of an Act and How to Live with It

1. Life of an Actand How to Live with It Texas Public Funds Investment Act Local Government Code – Ch. 2256 1987 to the Present

2. Before 1987 • Local governments – except home rule entities – were bank dependent • Most used bank accounts and CDs • Home rule cities could use the money markets – and did • The PFIA was created and passed initially in 1987

3. Hanging with the Times Starts to provide opportunity Grows as the opportunities are recognized Reacts as fears arise from market events Grows as markets and access is identified Grows with greed in low rate periods And will continue to develop ……..

4. 1987 – The Basics • 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 • Established the Prudent Person Rule as standard

5. 1989 • 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 created and passed

6. 1991 • Limits in money market funds were raised to specify use of authorized investment types only • Limits on which funds could be used in mutual funds were set • Bond funds can never be put in mutual funds • Fear of loss of principal for bondholders

7. 1993 – Some Bad Timing • Use of Collateralized Mortgage-backed Obligations (CMOs) were added • Specific requirements were added for pools including disclosure of pertinent information through information statements, confirmations and monthly reports. • Written strategies were now required with governing body approval • Israeli Notes added

8. Greetings from.. California

9. 1995 – Burned by CA • Prohibition added on certain MBS/CMOs • Reverse repurchase agreements were restricted by term and tied to the reverse term • Training for investment officers was added • Policy certification requirement added • “imprudent investments” • Added maximum maturities and WAM • Investment officers had to be designated • Written quarterly reports new required

10. 1995 – and Some Additions • State agency training added • TX Higher Ed Coordinating Board to provide • Prior authorized investments not required to be liquidated is authorization is removed • Pools must be rated no less than AAA • Municipalities with utilities authorized to hedge • State purchase and delivery of securities • Loss of required rating requires prudent measures to liquidate • State Treasury was abolished and transferred to Comptroller

11. 1997 • Investment officer training extended to 10 hours within 12 months and every two years • Delivery versus payment added • Officer disclosure added • List of brokers must be approved annually

12. 1999 • Investment advisers added with contracts • Initial 2-year period then no limit • Annual compliance audits added • GICs added • Municipal utility section added for sale/distribution of gas/electricity allowing hedging for supplies

13. 2001 • Water code directors excluded from some training requirements • Letters of credit added as government obligation for PFCA • To cut bank costs on collateral

14. 2003 • Securities lending section added • New service push by banks for fees • Collateralized • Primary dealer or TX bank only • Expansion of investment authority now requires state audit review • [Obviously gutless.. As we will see]

15. 2005 • CD definition changes • “domiciled” became “main office or branch in TX” • Codification induced – same requirement • Added ability to use CDARS • Entry bank must be in Texas • Reciprocity required • Safe spreading of CD funds • Decommissioning trust funds investment authority expanded to include Trust Code • Gas or electricity utilities selling to public

16. 2007 • Municipal hedging on coal and nuclear fuel expanded to commodity futures and related transportation costs

17. 2009 • Municipalities with mineral rights leases and contracts expanded investment authority • Barnett Shale and Eagle Ford impetus • Includes oil, gas or other mineral rights • Establishes a Trustee authority • Funds must be separated • Investments can be made under Trust Code

18. 2011 – A Rush to Yield • Proposed for 2011 • Corporate notes/bonds for CIP funds • ISDs with >50,000 students only • Born of low interest rates and g---d • Investing in employee life insurance policy from employee (!!) • Your city as your beneficiary - yikes • Remove change in market value from reporting • A requirement for 5% of every portfolio in Texas based corporations (!!) • Could economic development be speaking here?

19. 2011 Additional Proposals • Policy must include procedures to monitor credit ratings and procedures to liquidate • State agency training for officers tied to the biennium • Local government training tied to fiscal years as starting point • Authorized investment full faith and credit of FDIC • Pools can invest total funds in a money market fund • Pools must say how yield is calculated • Pools must have financial statements available to users • Pools report differences based on amount of funds invested

20. What is the law supposed to do? • Provide guidelines for safety • Apply to all entities • Let local entity decide based on unique situations and conditions • Allow entities to set their own parameters • WAM and maturities and authorized investments • Define guidelines on investments • Set limits for high credit quality and safety • Provide for flexibility (maturity) • To fulfill local needs • Provide for control on extension risk (WAM) • To control volatility which represents risk

21. How should/must you comply? • Address you own local considerations • Risk tolerance limits • Cash flow needs • Build your own from a wide variety of choices • Establish set compliance schedule

22. Specific PFIA Requirements • Write a Policy(2256.005) Emphasize safety and liquidity Address diversification, yield, maturity & capability List authorized investments Set a maximum maturity and WAM Tell how prices are monitored Require DVP Review and adopt policy annually

23. PFIA Requirements • 2256.005d Write a Strategy • 2256.005e Review and adopt strategy annually • 2256.005f Designate an investment officer • 2256.005i Disclosepersonal/business relationships • 2256.005k Provide policy for written certification • 2256.005m Obtain annual management audit • 2256.008 Provide for training • 2256.023 Report quarterly for Board approval

24. Other PFIA Items • .005 CDs bought orally and in writing • .005 Ethics considerations • .005 May specify unauthorized investments • .006 Prudence is based on the whole portfolio • .017 No need to liquidate if authorized at purchase • .021 Prudence to liquidate at loss of rating • .025 Mineral rights funds (added in 2009) • .024 Chapter is sub-cumulative to other law

25. Who is Covered? • Local entities and schools • State agencies • Higher education • Not: • Pension funds • Veterans Land Board funds • County registry funds • Deferred compensation funds • Securities donated to entities (except once liquidated)

26. Number One in Priority • Write an Investment Policy • Must be adopted by governing body annually • Resolution must include changes made • List the type of investments authorized • Limit by maturity and perhaps quality • Such as: LGIP “constant dollar” • Set a maximum maturity of any security • Require delivery versus payment (DVP) !!! • (Allows for all transactions to be verbal)

27. Governing Board Duties • Regardless of ‘investor’ they retain ultimate fiduciary responsibility • Approve investment policy annually • Approve written strategy annually • Designate investment officers • Review, revise, adopt broker/dealers list annually • Provide for training for officers • Approve training organizations • Receive and review quarterly reports

28. Investment Officers • Must be designated by governing body • Serves until removed or leaves entity • Allowed to transfer, deposit, withdraw, and manage • Put language in resolution to avoid corporate resolutions later required

29. Investment Officers Must • Attend investment training • 10 hours within 12 months of obtaining responsibilities • 10 hours every two years • By organization approved by governing body • Treasurer, or CFO if not Treasurer, and investment officer • Board Treasurer assumed to require training • Organizations report attendance to Comptroller • Exercise prudence • Disclose potential conflict relationships • By blood or marriage • Disclose to governing body and TX Ethics Commission • Provide policy for certification to anyone attempting to sell • offering to engage in an investment transaction

30. Investment Officers Must • Only transact with entities which have provided policy certification • Broker/dealers, banks and pools • Must perform an annual compliance audit and audit management controls • Compliance with Act and your Policy • State agencies perform only bi-annually • If invested in other than CDs and pools • Must have auditor review quarterly reports

31. Investment Officers Must • On loss of a required rating • Take ‘prudent measures’ to liquidate • In accordance with your policy • Primarily refers to commercial paper, BA, pools and municipal notes/bonds • On newly ‘unauthorized’ security • No need to liquidate if authorized at time of purchase • Prudence is still your guideline

32. Investment Officers Must • Provide for quarterly reporting • Requires Officer knows accounting rules • Describing in detail the positions • Book and market values are required • Trying to show volatility (change in market) • Full earnings (interest accrues + amortization) • Give summary information (diversification) • Must be signed by IO as in compliance • With policy and the Act

33. Broker/Dealers Must • Review you policy • Complete a policy certification • Not a guarantee or safeguard • Don’t fool yourself the responsibility is yours!

34. Investment Committees • Only mentioned once in Act • Can approve broker/dealer list annually • As opposed to governing body passage

35. Security Specifics • All must be delivered DVP • NO broker safekeeping • No broker advisors • Know the players • An entity can ‘un-authorize’ securities in policy

36. Act’s Unauthorized Securities • All unauthorized are mortgage backed securities • These are not the debentures of an agency • Interest OnlyMBS – IO – pay only interest and no principal • Principal Only MBS – PO – pay only principal and no interest • CMOS with stated maturities over 10 years • Inverse Floaters – float inversely on index • Easy way to eliminate danger is in authorized list • Obligations of US, its agencies and instrumentalities excluding mortgage backed securities

37. US Obligations • Treasury Bills, Notes and the ‘Bond’ • Agencies and Instrumentalities • GSE – government sponsored enterprises • A note on FNMA and FHLMC • Under conservatorship until 1/1/14 • Currently full faith and credit of US • Other obligations insured full faith & credit • Basically GNMA

38. US Obligations • Set your maximum maturity • These extend to 30 years by definition

39. Certificates of Deposit • MUST BE in Texas • Can not be “brokered” or “securitized” CDs • Must be collateralized above FDIC coverage • May be CDARS (cdars.com) • initiatlly placed in TX bank • Protects from merger and acquisition dangers of undercollateralization/insurance • Don’t have to be but you need to bid competitively!!

40. Repurchase Agreements • Must have: • Defined termination date • Collateral defined by Act • An independent custodian • A primary dealer or TX bank as counterparty • A Bond Market Association Master Agreement • Securities Lending – a form of Repo • TX Bank or primary • Specific reinvestment options • Same pledging and custody requirements • Agreement can only be one year in duration

41. Money Market Alternatives • Commercial Paper • Must be: • A1/P1 by two NRSRO • or one rating and an irrevocable LOC • Law states 270 days but you should use 90! • Banker Acceptances • Must be: • Able to liquidate at maturity • Same credit requirements • Law states 270 days but you should use 90 or 180 days

42. Money Market Mutual Funds • Must be: • Registered with and regulated by SEC • which includes all Act requirements • Will always have a net asset value of $1 • Note: Require rating in Policy for GASB

43. Mutual Funds • Must: • Only have ACT authorized investments • Registered and regulated by SEC • Average WAM less than 2 years • Be AAA rated • Not authorized for any bond funds • Note: these represent a real potential for loss of principal

44. Pools • Built on Interlocal Cooperation Act • Requires governing body action to join cooperative • Has specific reporting requirement built on MMMFs • Must basically have a Policy available to all • Must report all transactions and balances • Must establish a ½ cent collar on $1 pools • Need not be constant dollar • Investment Officer must understand their pool

45. Special: Higher Education • Sponsored cash management and investment pools (Common Fund) • Bank issued negotiable certificates of deposit • with banks rated at least 1 or A1/P1 • Corporate bonds • Investment grade (two highest ratings) • Primarily for foundation use

46. Special: Municipal Utility • Electric utility or sales of natural gas • Hedging contracts for supplies or reserves • Fuel oil, natural gas,coal, nuclear fuel, elctric futures/options • Including transportation costs

47. Special: Mineral Rights • Funds from a lease or contract • Must be separately reported and invested • Must be estbalished as a Trustee • Can use Trust Code (basically anything!)

48. Special: Decommissioning Trusts • Nuclear Regulatory Commission Trusts • Regardless if public funds by PFIA definition • Basically uses Trust Code • Most cities use long treasuries or mutual funds

49. Special: Housing Authority Bonds • Mortgage pass throughs certificates • Individual mortgage loans

50. Compliance with the PFCA • Public Funds Collateral Act • Prevails over all other laws • Public funds over FDIC limits must be collateralized • Amount = principal plus accrued interest • Requires 100% collateralization • School districts require 110% on MBS only