INVESTMENT POLICIES: MAKE SURE THEY ARE SLY

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INVESTMENT POLICIES MAKE SURE THEY ARE SLY

• SEAN POLLAND
• TREASURY MANAGER
• ORANGE COUNTY COMPTROLLERS OFFICE

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Agenda

• Investment Policies
• Statutory Requirement
• Objectives
• Required Elements
• Other Recommendations
• Basic Fixed-Income Investments
• SBA
• Money market mutual funds
• Treasuries
• Federal agencies
• Non-negotiable CDs
• Bankers acceptances
• Commercial paper
• Asset-backed securities
• Municipal securities

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Orange County, Florida

• Territory of 1,000 square miles
• Population of 1.1 million
• Orlando is the principal city
• Annual revenues of 1.8 billion
• Expense budget of 2.1 billion
• Investment portfolio of 1.4 billion

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Orange County Portfolio
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Statutory Requirement

• Florida Statute 218.415
• Written investment plan
• No written investment policy
• Local Govt. Surplus Funds Trust Fund (SBA) or
  other authorized intergovernmental investment
  pool
• Money market mutual funds
• Time deposits or savings accounts in QPDs
• U.S. Treasury securities

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Investment Objectives

• Safety
• Liquidity
• Yield

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REQUIRED ELEMENTS

• Scope
• Performance measures
• Investment objectives (SLY)
• Prudence ethical standards
• Listing of authorized investments
• Portfolio composition
• Risk and diversification
• Maturity liquidity requirements
• Authorized investment institutions and dealers
• Third-party custodial agreements
• Master repurchase agreement
• (Offer and) bid requirement
• Internal controls
• Continuing education
• Reporting

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SCOPE

• Identify funds covered by the policy
• Examples Governmental funds, proprietary funds
  and agency funds
• Shall not apply to the following
• Pension funds
• Debt proceeds subject to other policies or
  indentures

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Performance Measures

• Benchmarks
• Specify in advance
• Appropriate for risk and return characteristics
  of the portfolio
• Examples
• SBA
• Treasuries
• Merrill Lynch 1-3 Year Treasury Index

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Prudence Ethical Standards
Statutory Requirement Prudent Person Rule
Investments should be made with judgment and
care, under circumstances then prevailing, which
persons of prudence, discretion, and intelligence
exercise in the management of their own affairs,
not for speculation, but for investment,
considering the probable safety of their capital
as well as the probable income to be derived from
the investment. Fiduciary Trend Prudent
Investor Rule Modern portfolio management
approach where investments are evaluated in the
context of the entire portfolio. Investment types
are typically not listed in the policy. The
driving determinant of investment suitability is
the purpose and needs of the portfolio.
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Listing of Authorized Investments

• List investments authorized by local government
• Approve by resolution
• SBA, money market funds, interest bearing time
  deposits in QPDs, Treasuries, federal agencies
  and closed-end management-type investment company
  comprised of Treasury and agency securities, as
  well as repos collateralized by Treasuries and
  agencies.
• Other investments can be authorized by law or
  local ordinance

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Portfolio Composition

• Limits
• Issues
• Issuers
• Maturities
• Guidelines for Investments
• Credit ratings
• Unique circumstances (e.g., tax-exempt issues)
• Collateral requirements

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Risk Diversification

• Investments should be diversified to control
  losses due to overconcentration in assets
• Diversification strategies must be reviewed
  periodically

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Maturity Liquidity Requirements

• Portfolio liquidity must be sufficient to pay
  obligations when due
• Maturities should be matched to known and
  anticipated cash needs
• Set maturity limits by fund class
• Current operating funds (e.g., 13 months)
• Noncurrent operating funds (e.g., five years)
• Bond reserves, construction funds, and other
  nonoperating funds (e.g., term to coincide with
  expected use but not to exceed ten years)

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Authorized Investment Institutions Dealers

• Specify which institutions can sell your entity
  securities
• Dealers
• Issuers
• Banks

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Third-Party Custodial Agreement

• Provide for suitable agreements for safekeeping
  assets
• Securities should be designated as assets of
  government entity
• Transactions only by authorized staff of
  government entity
• Delivery versus payment

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Master Repo Agreement

• Executed Master Repurchase Agreement
• Securities Industry and Financial Markets
  Association (SIFMA) standard agreement
• SIFMA agreement customized in annex
• Authorized issuers
• Eligible collateral
• Issuer credit rating
• Custodian of collateral
• Frequency of collateral valuation
• Conditions for liquidation of collateral

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(Offer ) Bid Requirement

• Determine maturity based on cash flow needs and
  market conditions
• If feasible and appropriate, procure competitive
  offers when purchasing/selling a security
• Accept offer that best matches needs in terms of
  objectives (SLY)
• Orange County Policy
• Three offers
• Offers undisclosed until best offer determined
  and awarded
• Exceptions must be approved by a member of
  Finance or Comptroller Administration

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Internal Controls

• Establish internal controls
• Reviewed by independent auditor as part of
  periodic financial audit
• Designed to prevent loss due to following
• Fraud
• Employee error
• Misrepresentation by third-parties
• Imprudent actions by employees

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Continuing Education

• Applies to all employees responsible for
  investment decisions
• 8 hours of continuing education annually
• Topics related to investment practices and
  products

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Reporting

• Annually or more frequently
• Report to legislative body
• Securities by class or type
• Book value
• Income earned
• Market value
• Available to public

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Other Recommendations

• Delegation of authority
• Due diligence review of investment pools and
  money markets
• Policy review and amendment
• Certification

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Delegation of Authority

• Official vested with responsibility for
  investment program
• Delegation to manager
• Expectations of manager
• Maintain internal controls
• Monitor internal controls and activities of staff

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Due Diligence Review of Investment Pools and
Money Markets

• Objectives
• Eligible investments
• Interest calculations and distributions
• Safeguarding securities
• Eligible investors
• Transaction size limits
• Statement schedule and portfolio listings
• Fee schedule
• Eligible for bond proceeds

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Policy Review and Amendment

• Periodic review
• Orange County
• Annual review
• Comptrollers Investment Committee
• Changes presented to Board of County
  Commissioners for adoption

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Certification

• Association of Public Treasurers of the United
  States and Canada
• Submit policy to refresh certification
  periodically

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Basic Fixed-Income Investments

• SBA
• Money market mutual funds
• Treasuries
• Federal agencies
• Non-negotiable CDs
• Bankers acceptances
• Commercial paper
• Asset-backed securities
• Municipal securities

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SBA Overview

• Objective to preserve capital and provide
  liquidity
• Evaluate relative to SP Rated GIP 30-Day Yield
  Index
• SEC Rule 2a-7 like
• Constant NAV
• Weighted-average maturity of 90 days or less
• Maximum maturity of 397 days on money market
  securities
• Government securities maximum maturity of 762 days

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SBA Investments

• First tier securities
• A1/P1 minimum
• Minimum long-term rating A- and A3 for SP and
  Moodys, respectively.
• Holdings on December 31st
• Treasuries 2
• Agencies 6
• Commercial Paper 48
• Floating Variable Rate Notes 44

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SBA Interest Calculation

• Monthly
• Sum individual accounts daily balances
• Divide by sum of total daily balances invested in
  SBA LGIP
• Multiply by pools total earnings
• Administrative expense
• (.00015/365) X days in month X (Avg. daily
  balance)

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SBA Calculation Example
State Board of Administration Sum of all daily
investments in SBA 130,000,000 Total Pool
earnings 6,900,000
Orange Countys Earnings (12,000,000/130,000,000)
X 6,900,000 636,923 Administrative
Expense (.00015/365) X 28 X (12,000,000/28)
4.93
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Money Market Mutual Funds

• Safety depends on underlying assets
• Typically have constant NAV
• Very low default rates
• Excellent liquidity
• Provides alternative when SBA funds are not
  available

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Treasuries

• Treasury Bills 4 week, 3 6 month
• Cash Management Bills
• Treasury Notes Bonds 2, 3, 5, 10 30 years
• Treasury Inflation-Protected Securities (TIPS) -
  Typically 5 to 20 years

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Federal Agencies

• Government Sponsored Enterprises
• Fannie Mae
• Freddie Mac
• Federal Home Loan Banks
• Federal Farm Credit Bank
• Federally related institutions
• Ginnie Mae
• Tennessee Valley Authority

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Types of Agency Issues

• Discount notes
• Bullets
• Callables
• Mortgage pass throughs
• Collateralized mortgage obligations (CMOs)

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Agency Discount Notes

• Discount rate (1 - price)(360/days)
• Price 1 - discount rate(days/360)
• Purchase proceeds price x par value
• Example 20mm par, 5.09 discount yield for 148
  days
• Price 1 - .0509(148/360) .979074444
• Proceeds 20mm X .979074444 19,581,488.89
• Note Same discount formula applies to T-bills,
  commercial paper and bankers acceptances

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Agency Bullets

• Outstanding issues typically quoted by dealers as
  bond-equivalent yield (BEY) spread from a
  benchmark Treasury security
• BEY 2(1 yield on annual-pay bond).5 -1)
• Example BEY on 5 annual-pay bond
• 2(1 .05).5 -1) 4.94
• Make sure yield comparisons are made on an equal
  basis

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Valuing Callables
Source Bloomberg
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Mortgage Pass Throughs
Pool of Mortgages Loan 1 Loan 2 Loan 3 . . Loan
1,000
Monthly Cash Flow Interest Scheduled Principal
Payment Prepayments
Distribute cash flow on pro rata basis
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CMOs
Pool of Pass Throughs Loan 1 Loan 2 Loan
3 . . Loan 10,000
Monthly Cash Flow Interest Schedule Principal
Payment Prepayments
Distribute cash flow based on tranche structure
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Non-negotiable CDs

• Deposits must be secured in accordance with
  Chapter 280, Florida Statutes
• Qualified public depositories
• Pledge collateral
• Participating QPDs are contingently liable should
  the issuing bank fail
• Physical CD must be held in secured vault

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Bankers Acceptances

• Time draft drawn on bank
• Not bank obligation until accepted
• BA is created once stamped accepted
• Exporter/importer may discount BA and sell it to
  an investor
• If discounted, exporter/importer would remain
  secondarily liable should issuing bank default
• Two-name paper
• Maturities typically six months or less.
• Dwindling number of issuers

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Commercial Paper

• Short-term unsecured promissory note
• Maturities typically 270 days or less
• Purchase through dealer or directly from issuer
• Roll-over risk
• Issuers normally back program with a bank line of
  credit
• Emergence of asset-backed CP

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Asset-backed Securities

• Securities backed by credit card receivables,
  auto loans, home equity loans, manufactured
  housing loans, student loans etc.
• Credit enhancements
• Internal
• External
• Overcollateralization
• Senior/subordinated structure
• Passthrough (pro-rata) or pay through (tranches)

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Municipal Securities

• Tax-exempt debt
• Generally suitable for individuals in the highest
  tax bracket
• Governments may utilize for arbitrage compliance
• Taxable
• Limited issues
• Issued for financing that does not provide
  sufficient public benefit
• Sports stadiums
• Fund pension obligations
• Certain housing projects

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• Sean Polland, Treasury Manager
• Orange County Comptrollers Office
• 201 S. Rosalind Avenue, 4th Floor
• Orlando, Florida 32801
• Phone [phone]
• Fax [phone]
• E-mail sean.polland_at_occompt.com