INVESTING SCHOOL FUNDS

Public Funds Investment Act Workshop

Region 1 – Edinburg

October 2013

The Dynamic Act

Initially separated investment from banking

It has responded over the years to: public entity efforts

new market opportunities

financial and investment crises

banks desires

mineral rights funds and hedging needs

brokers looking for income

PFIA Changes Mirror Markets

1980’s Banking and investments were split apart

1990’s Markets accommodative and investors taking

risks

1994 Major crash in Orange County

1995 Major adjustments to law/controls

2000’s Banks go for service not investment and mineral

rights gain strength

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)

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

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

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

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 reports required

Mutual funds added

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

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

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

2005 – 2009 Responding to Specific Needs

2005 CDARS added with a Texas bank and reciprocity for banks required Decommissioning trust funds investment authority expanded to include

Trust Code For entities with gas or electricity utilities selling to public

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

investments Includes oil, gas or other mineral rights Establishes a Trustee authority Funds must be separated Investments can be made under Trust Code

2011

Procedures to monitor credit rating must be in policy

Training years now defined as fiscal years

FDIC/FICA insured obligations FICA and CDs and interest bearing accounts

Can invest in FDIC insured CDs outside TX

Conflict within the Act adds danger

CDs from a broker in TX allows broker to custody BUT Act requires you require DVP which this is not

Repurchase Agreements can be collateralized with cash

ISDs with over 50,000 average attendance can buy AA- corporate bonds Gov’t Code 1371 definition based on Ed Code 42.005

Pools may not invest in corporate bonds

2011 Changes for Pools

Pools can now invest 100% in money market funds

Pools must say how yield is calculated in monthly reports

Constant dollar pools must report yield under SEC regulations

Pools’ websites must:

Include disclosures (information statement)

Make audited annual financials available

Must define breakpoints creating rate differentials

2013 Legislative Change

Public Funds Collateral Act Amendment

Custodian need not send trust receipts to public entity

Custodian has choice of recipient Trust receipts to public entity or to bank with directions to

forward

Public entity can request current collateral list

YOU need to tell your bank/custodian that you want reports monthly from the custodian

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

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

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 guidelines on 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

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

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

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 disclose personal/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

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

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

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

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

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

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?

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

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)

Adapting to Change

Competitive process will keep you on top of the market

Periodic review of policies and procedures will keep policy dynamic

Training will keep you up-to-date

Expecting change allows you to adapt

Today’s Major Change Factor

• Interest rates control you and your strategies

• Know what you can control

• Know the rates generally

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

3mo 6mo 1yr 2yr 3yr 5yr 10yr 30yr

Sep-13

Aug-13

Jun-13

Dec-12

Sep-12

Jun-12

Public entities operate primarily in this area of the curve.

A Major Change Factor

• What is driving the rates and markets

currently?

• What factors will change outlooks?

0.00

0.50

1.00

3mo 6mo 1yr 2yr 3yr

Sep-13

Aug-13

May-13

Sep-12

Jun-12

Mar-12

Public entities operate primarily in this area of the curve.

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

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

Cash Flow Analysis What?

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

Cash Flow Analysis Why?

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

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

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

Horizon Yield

Overnite 2.0 %

1 month 2.1 %

2 months 2.2 %

3 months 2.3 %

4 months 2.4 %

5 months 2.5 %

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

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

Major Category History Revenues Jan Feb Mar Apr May Jun Jul

Taxes 8,500,000 7,000,000 3,500,000 750,000 1,000,000 2,000,000 1,000,000

State $$ 250,000 200,000 200,000 200,000 250,000 300,000 300,000

Svc Fees 150,000 150,000 250,000 275,000 400,000 400,000 400,000

Utility 2,000,000 350,000 433,000 400,500 600,000 700,000 750,000

Total 10,900,000 7,700,000 4,383,000 1,625,500 2,250,000 3,400,000 2,450,000

Expenses

Salaries 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000

Contracts 300,000 300,000 350,000 450,000 645,000 875,000 750,000

Capital 300,000 200,000 400,000 500,000 400,000 450,000 500,000

Debt Svc 2,000,000

Total 2,600,000 2,500,000 4,750,000 2,950,000 3,045,000 3,325,000 3,250,000

Net Cash 8,300,000 5,200,000 -367,000 -1,324,500 -795,000 75,000 -800,000

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

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

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

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.

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.

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.

Either route gets you to…

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

1 2 3 4 5 6 7 8 9 10 11 12

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

Core

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

Information for Maximum Maturity

0

20

40

60

80

Entity A has no core – starting and ending the cycle at zero

They can not invest longer than one year = maximum maturity 1 yr

Entity B has a core so they can invest longer

Possibly B could create a maximum maturity of 2 years

You must understand what the core is made up and if might change

core 0

20

40

60

80

core ?

A. B.

Cash Flowing Capital Projects

A recurring problem: obtaining information

A large nonrecurring expenditure A unique cash flows for some entities

Work with departments for expenditure plans before $$ arrives

Bond document may have draft plan

Get regular updates from departments and engineers to modify plans

Some projects are repetitive and history of old funds shows pattern

Explaining the importance of cash flow helps generate support Impact of additional earnings Verify arbitrage impacts

CIP Trends

0

200

400

600

800

1 2 3 4 5 6 7 8 9

0

200

400

600

800

1 2 3 4 5 6 7 8 9

Use multiple historical issues

of the same type fund

streets

water mains

land acquisition

Trend often appear over the

time frame of the total project

Use for projections on the

same type projects in the

future

Streets - 2007

Streets - 2009

0

200

400

600

800

1 2 3 4 5 6 7 8 9

Streets Projection 2005 Street Composite – New Funds

Cash Flow Investing

We focus on a monthly expenditure need

Eliminate the need to invest to each liability

Meet the monthly need with one early investment

Place the maturity before the first known liability

Use liquid options or short investments to target each liability in month

Reduces cost of safekeeping but still increases portfolio effectiveness

Translating the Information into Action

S M T W TH F S 1 2 3 4 5 6 7

8 9 10 11 12 13 14

15 16 17 18 19 20 21

22 23 24 25 26 27 28

Payroll

$1mm

Payroll

$1mm

Payables $250,000

Payables

$250,000

Payables

$250,000

Payables

$250,000

Entity needs $3 million a month for A/P and payroll costs.

Investment matures on 2nd and is available for rest of month.

Cash Flow Structure Creates the Portfolio

Maturity Date Amount

Liquid (now to 6 mos.) $3,000,000

6 months $ 500,000

7 months $ 500,000

8 months $ 500,000

9 months $ 500,000

10 months $ 500,000

11 months $ 500,000

12 months $ 500,000

14 months $1,000,000

18 months $1,000,000

24 months $1,000,000

$9,500,000

Summary

Cash flow analysis should be straightforward

Undue maintenance needs will render it cumbersome and un-usable

Cash flow must be done to set policy controls

Cash flow should result in information not statistics

Cash flow will pay for itself in good investing decisions

Maintenance is minimal Perhaps one-half hour every quarter

Cash Flow Questions

A continuing money balance is a ______ .

Cash flow sets my ________ and ______ .

What level of analysis is most productive?

The key action is to _____ .

Multi-year averaging eliminates _____________ .

Step 2: Identify Risks

Risks occur in every investment

Risks occur within the custody area

Risks occur with counter-parties

Identify your risk tolerance level

Risk

Exists in all securities and all markets

You can not avoid risk

You can manage risk

Risk can be used to your advantage

Measured risk will increase yield

Use credit ratings and limitations for control

The Oink Factor

The animals in any marketplace The bull, the bear and the pig

Beware the pig in you A pig keeps his head in the earnings trough and ignores the

circumstances prevailing

The pig goes only for yield

Primary pig controls Maximum maturity limitations

Weighted average maturity limits

Controlled leverage

“Market” Risks

Who is this “market” anyway?

You are the market

Encompasses all investors

Their actions and expectations control actions

Built on investors expectations

General ‘Market’ Risk

Market risk is based on the market price

Diversifying reduces your exposure

Money will flow from one sector to another for safety or yield

High credit quality reduces exposure High quality retains its value (i.e. UD $ as reserve currency)

In fixed income markets When prices go up – rates go down So, a bull market has rates dropping

Credit Risk

Credit risk is the risk of issuer failure Inability to pay interest or principal

Authorized investments normally face little credit risk Most statutes require AAA ratings or equivalents Limit the maturity to further manage risk

Recognize the media loves a scare – don’t react without cause Do your homework on why prices are moving Talk to several sources and reason it through

Measure and control the inherent risk in securities Create diversification limits

Use CP but restrict to dual ratings and stay under 90 days

Understand issuers restraints and strengths For example: FHLMC and FNMA conservatorship raises credit

Measure and monitor bank credit Monitor bank credit on ongoing basis Use independent bank ratings agencies (Veribanc, Prudent Man) Monitor collateral market value

How to Manage Credit Risk

Restrict the portfolio to the highest rating

Diversify Set % of portfolio limits for riskier securities

Limit maximum maturities

Monitor credit ratings regularly

Watch market news Watch for major sector moves or news

Require dual ratings Two views are better than one

Utilize credit rating agencies Understand when they are being political too!

Understand the rating definitions

Credit (Default) Risk

Low Risk Higher Risk

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Procedures for Downgrades

Have a procedure for down-grades including: Disclosure to supervisor or governing board

Consider the conditions of the downgrade

Consider your maturity on the security

Immediate sales often do not make sense

Understand what the ratings mean Investment grade goes to BBB- at S&P

Investment grade goes to BBB at Fitch

Investment grade goes to Baa at Moody’s

Monitoring Ratings

Create a control in policy or procedure for downgrades Authorized investments requiring credit rating (such as CP) need to be

monitored constantly

Create your process based on your risk tolerance: The Investment Officer shall monitor, on no less than a monthly basis, the

credit rating on investments in the portfolio requiring a rating based upon information from a nationally recognized rating agency.

THEN EITHER:

If any security falls below the minimum rating required by Policy, the Investment Officer shall notify the ------- of the loss of rating, conditions affecting the rating and possible loss of principal with liquidation options available within two days.

OR: If any security falls below the minimum rating required by Policy, the

Investment Officer shall immediately sell the security, if possible, regardless of a loss of principal.

Know Your Ratings

S&P Moody’s Fitch

Extremely strong capacity – very

low expectation of default AAA Aaa aaa

Very high credit & strong capacity-

low default expectation AA Aa aa

Somewhat susceptible to adverse

conditions – low default risk A A a

Adequate capacity but subject to

adverse conditions BBB Baa bbb

Lowest investment grade BBB- Ba b

Many pools and funds are not rated on these but on ‘volatility’ ratings such as V-1.

Money market instruments (like CP) have similar levels but different ratings (A1/P1).

Liquidity Risk

Liquidity Risk The risk of not having cash when needed

The inability to sell security when needed for cash

Liquidity is reduced with longer maturities

Liquidity is reduced in smaller issues

Some agency paper is sold in small issues and you could own the whole issue – no problem if you can hold to maturity

Public funds’ biggest perceived risk

Danger that it forces many to stay TOO liquid

Liquidity Risk

Cash Illiquid

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Overn

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Long

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Degree of Liquidity

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The Lure of Lazy Liquidity

It is December 2010,

Pools yield 0.16%

6 month CD yields 0.60% ( FDIC 0.85%)

1 year CD yields 0.75% (FDIC 0.85%)

In 6 months $1mm=

Pool = $800 in 6 months

6 Mo CD = $3,000 - $4,250

You just had a $3,450 opportunity loss

Managing Liquidity Risk

Don’t be liquidity dependent

Being totally liquid puts you at the lowest rates

Do your cash flow and invest to it

Stick with the program

Create a liquidity buffer

Be practical and prepare for the unexpected

Use liquid investments

High credit quality always increases liquidity

Watch the size of the issues

On agencies the small issues will not be as liquid

Price and Volatility

Market Risk The risk that market prices will fall Lower prices threatens liquidity

Can you take a loss by policy?

Risk that if sold you recognize a loss of principal “Unrealized” loss versus “realized” loss

Volatility Risk (VIX = the risk index)

The risk of significant changes in market prices Higher the volatility = higher risk

Volatility increases with longer maturities, low credit and structured securities

Market Risk

Low Risk Higher Risk

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Bank C

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Managing Market & Volatility Risk

To manage these inter-related risks:

Invest to your cash flow needs in the short-end

Purchase high credit quality

Establish maximum maturities suitable to sector

Ex: keep commercial paper under 90 days

Maintain a shorter weighted average maturity

Minimize embedded options

diversify

Event Risk Event Risk

An unforeseen change that affects markets.

Moves markets especially with uncertainty

Event risk is everywhere Lehman, AIG, Stanford, Madoff

Europe

Health care

Weather impacts on commodities

Auto industry

Afghanistan

Political change

Sovereign and local deficits/defaults

Managing Event Risk

Diversification is the key

Not all eggs in one basket

Diversify banks, pools, funds, market sectors

Prepare for the worst

Imagine the worst and have a plan for it

Extension Risk

Extension Risk Risk that securities lengthen in maturity unexpectedly

Primarily found in mortgage backed securities When mortgage rates rise people do not refinance

When people don’t refinance the pay-down horizon extends

Callables can have a short-term extension risk Only if you buy it assuming a call

Always assume your risk is holding to maturity

Reporting must reflect stated maturity to show total risk

Managing Extension Risk

Use mortgage-backed securities only in suitable long portfolios Portfolios always have to be able to hold to maturity

Diversify among market sectors

Report WAM based on stated maturity Maximum risk is if it goes to maturity

Amortize callables to the call Reflects the risk of the call for amortization cost

Reinvestment Risk

Re-Investment Risk Risk that reinvestment will be at lower rates

Primarily in callable securities when they are called as rates fall

Reinvestment of proceeds will be at lower rates

Do not assume a call If not called will it affect your liquidity?

You will be rewarded for the callable risk Using risk to your advantage

Managing Reinvestment Risk

Diversify and use some callables

Consider call risk to add yield

Insure initial yield covers reinvestment risk

Amortize to call

Creates a par bond which is more valuable

If it is called there is not a principal loss

Managing Collateral Risk

FDIC and collateral issues

Bank Collateral Securities pledged to repay a debt

Deposits protected by FDIC and collateral

Covered by Public Funds Collateral Act (Local Government Code, Chapter 2257)

Manage the risk by answering: What is acceptable collateral to me?

Is there enough of it?

Is the collateral mine – can I prove it?

Who is Covered by FDIC Insurance

Based on Tax Identification Number within the entire holding company of the bank

Based on Type of Account FDIC defines only two types of accounts

Non-interest bearing accounts have $250,000 Interest earning accounts are combined for $250,000

Based on Location of city and bank If the bank’s HQ is in your same state

then both type accounts receive FDIC insurance If the bank’s HQ is not in your state

all accounts types together receive only $250,000

FDIC Coverage Only “public units” can have collateral pledged

“Public unit” is a FDIC definition not a state definition Must created under express authority of law Must have some function of government delegated Must execute exclusive control of its funds for exclusive use

Special cases of public “corporations” 4a and 4b corporations Water supply corporations

Dependent on several factors 12 C.F.R. Part 330.15

FDIC Insurance

Exception accounts

“Testamentary Accounts” (I&S accounts)

Funds set aside to discharge a debt

Applies to the debt holders

Coverage is $250,000 for each bond holder

FDIC Coverage

Search on: public unit insurance

Is your collateral report coming from the custodian?

If not how secure is it?

Using a Rating Service

Bank Rating Services:

-Best

-Highline

--Veribanc

Rating services rate ‘CAMELS’

Capital

Assets

Management

Equity

Liquidity

Systems

Managing Collateral Risk

Define the authorized collateral (in policy and RFP) Obligations of the US Government, its agencies and

instrumentalities, including mortgage backed securities with CMOs passing the bank test

Monitored and maintained by the bank at all times.

Choose and understand your options within law Surety bonds

Treasury Notes and Bills

US Agencies

Rated Municipals

Letters of Credit

Custodian Duties

In any event of default

Take control of collateral

Hold the collateral under your instructions

Sell the collateral if applicable

Paying your 100% portion

Return excess to bank

The Fed as Custodian

Perhaps the best custodian

Standard Pledgee Agreement Form is used

The Fed will not sign a collateral agreement

Supplements the Collateral Agreement

Reference the Circular 7 in your agreement

Fed will ask for authority to use e-mail to contact you

Recent Circular 7 Change Notification

Little impact but a good lesson The pledgee is responsible

Contract must require bank to monitor and maintain colalteral levels

Treatment of principal Principal will be held in non-interest bearing account until the earliest of:

New securities are substituted Principal is released by Pledgee (public entity) Principal collected by pledgee on event of default

Treatment of MBS (amortizing book-entry security)

Principal will be held in non-interest bearing account until the earliest of same three conditions

Treatment of interest Interest goes to the Pledgor (bank) unless written notification of event of default

Federal Reserve as custodian

Circular 7 Pledgee Agreement

Authorizing

use of

e-mail for

contact

purposes

Surety Bonds

Surety bonds are insurance policies

Verify:

Company (and its strength)

Recipient (is it the District?)

Terms (tie it to the contract)

Letters of Credit

Initiated for State CD business

LOC normally issued by FHLB

backed by pledged unrestricted securities or bank credit

Created to replace collateral and PFCA

Collateral Pooling

Final Rules Published 10/10

Voluntary – bank and public entity

Not applied to counties or higher education

Exclusion of higher ed. not in 2257

Collateral Pooling Why It Doesn’t Work in Texas

Comptroller controls the contract

Comptroller holds the collateral

Comptroller has set collateral unacceptable to banks

Entity bears more responsibility:

for low level of collateral overall

Entity must report big changes in balances

For monitoring bank reporting on balances

Repurchase Agreement “Collateral”

Differentiating collateral types in your policy

Collateral is a mis-nomer

This must be a buy-sell transaction

The entity owns the securities

The same requirements apply Define the authorized collateral types

Establish the required margin (102%)

Establish 3rd party safekeeping

Managing Risk

Custody and Safekeeping Risk Risk to your proof of ownership

Proving your ownership

Risk of a custodian restricting access

Key safety points Independence Reporting to you directly Custodian should verify authorized collateral and margin

Applies to:

collateral pledged to you (custody) securities you own (safekeeping)

Custodians

Custodian has fiduciary responsibilities Usually you agree to/approve a custodian

Safekeeping agents simply hold securities Usually you chose custodian

Key factors for both: Independence on trades or pledgor

Custodians and agents should report directly to you

What is a Safekeeping Account?

Not a “bank account” for funds In your entity’s name Totally electronic

Places assets in care of an agent

Used to hold YOUR owned securities

‘Street-name’ safekeeping

Generic ‘nominee’ name to ease transactions/transfers Client is actual owner – nominee holds title

Fees are required

Hard-dollar: Usually not charged through account analysis

Typical Safekeeping Costs

Clearing FRB DTC

Safekeeping

FRB or DTC Par or cusip

Income Distribution Coupons paid Maturities calls

How are they charged?

Why is it important to know?

When do you use this information?

How can you reduce the fees?

Safekeeping Services

Safekeeping need not be at banking services bank Banking services bank is convenient Other banks may be needed or less expensive A second bank requires ongoing transfers and an account

Agreements Depository Agreement covers safekeeping services Includes a collateral agreement if funds are over FDIC Master Agreements are for banking services Safekeeping agreements for safekeeping only

Will probably involve collateral as funds move through account

Controlling Portfolio Risks

Risk of over extension Set a maximum weighted average maturity Set a maximum maturity

Always use competitive transactions

Only way to assure ‘market’ price

Always use delivery versus payment (DVP)

Always diversify to spread risk

Always report on a timely basis with info not just detail

Show asset allocations by maturity and market sector

Non-Market Risks Counterparty risk

Broker background checks FINRA registration Independent safekeeping outside brokerage

Banking risks

Reconciliation within 30 days Verify availability of funds Continuously monitor cost of services with account analysis

Employee risk Separation of duties Oversight and cross training Cash controls like numbered receipts, safes, assigned tills

Technology’s Risks

Employee controls Pin numbers and separation

Limited access to cash and programs

Sole use PC for bank transactions

Bank fraud controls Filters/blocks on ACH

Payee positive pay

Step 3: Set Strategy

Macro strategy

Policy statement from passivity or proactivity

Includes setting WAM and maximum maturity

Requires annual review

Must be flexible enough to adjust to market and internal conditions

Market Strategy

Changes daily and requires market information

How do I achieve Safety?

Document all transactions Use competitive transactions Recognize changes in your and the markets’ situation Learn about the various securities/opportunities Use independent counter-parties Delivery versus Payment (DVP) Settlement Review and report regularly Establish controls and procedures Review contracts

establish equality review for practicality

Establish Collateral Independent safekeeping and reporting

Diversify

How do I achieve Liquidity?

Create and understand your cash flow

Invest to known liabilities

Providing liquidity at appropriate time

Always have a small cash buffer for emergencies

Buy high quality securities

High quality assures a secondary market

How do I achieve Diversification?

Create competition in every transaction Never rely on one institution or broker

Do not allow a broker to do competitive bidding for you

Diversification by type of security Knowledge of the securities

Use securities that make sense for the period

Diversification maturity Create a ladder to meet your liabilities

How do I achieve Yield? Invest to your cash flow needs

Knowing your securities and use appropriate ones

Assure there is always competition

Use time and attention for the portfolio

Know your alternatives and compare them

Use the alternatives available

Commonalities SAFETY LIQUIDITY DIVERSIFICATION YIELD

cash flow cash flow cash flow cash flow

information information information Information

controls controls controls

diversification diversification diversification diversification

documentation

contracts

competition competition competition

documentation

procedures procedures

credit quality credit quality

PFIA Required Strategy

A strategy should be written

And preferably adopted by governing body

Set strategy by portfolio(s)

Or one commingled portfolio

Including in the policy ties the two closely

Should describe how you achieve:

Objective of investments

Suitability of instruments

Safety

Liquidity

Diversification

Yield

Sample Strategy for a Short, Passive Portfolio

The [City] maintains one commingled portfolio for investment purposes which incorporates the specific needs and unique characteristics of the funds grouped represented in the portfolio. Income is distributed to each specific fund based on its participation in the portfolio.

The primary objective is liquidity and reasonable yield. Authorized securities or the pool used will be of the highest credit quality. When not matched to a liability it will be short term and liquid. The portfolio will be diversified to avoid market and credit risk. Diversification requirements can be met through a pool. Maximum WAM is 120 days.

Typical General Fund Strategy

The investment strategy has as it primary objective the assurance that anticipated liabilities are matched and

adequate liquidity provided for unanticipated liabilities. A second objective is to minimize volatility by purchasing high credit quality, short and intermediate

term maturities in a laddered structure and permitting some extension for additional yield.

Sample Debt Service Strategy

The investment strategy for debt service funds shall have as its primary objective the assurance of available

funds adequate to fund debt service obligations on a timely basis. Successive debt service dates will be fully funded before any extension of investments are made.

Successive funding is critical

Too often these funds are kept liquid losing yield

Benefits of Commingling

Think through the portfolio structure

Radically different fund types need a separate policy

Separate portfolios

Require separate accounting

May cause liquidity problems

Can reduce yield by requiring liquidity balances

Commingled portfolios

Can still address unique needs of funds

Smaller liquidity needs may allow more extensions

Reporting is simpler

Addressing More ‘Action’

Pro-active portfolios may change their ladders

Addressing sales and swaps

Securities may be sold before they mature if market conditions present an opportunity to benefit…

The investment officer will continuously monitor market conditions…

Addressing loss

A loss may be taken on a swap of securities if the loss is regained within a three-month horizon on the trade. No realized loss may be taken on a straight sale of a security.

Step 4: Policy Development

Your first line of defense

Single most important element in your program

Pollicies are working dynamic documents

Must be reviewed and adopted annually by Board

Policies show prudence and pro-active management to

Rating agencies, capital markets and citizens

Policy Objectives

Policies combine legal and procedural elements Be concise and clear

Policy is not a manual

Create flexibility with limits for changing conditions Allows you to react to cash flows and markets

Create controls

Creates authorizations and responsibilities Who is authorized to do what?

What must each entity do and when?

Policies are Built on Fundamentals

Not a boilerplate document – tailor to your needs

Cash flow

Sets maximum maturity

Sets maximum weighted average maturity

Sets benchmarks

Risk tolerance identification

Chooses the authorized securities

Sets internal controls

Initial Key Questions Portfolio structure

Commingling all funds or separation by type of funds?

Accounting and Reporting Needs

Separate entities and funds and responsibilities

Scope of authority

Designation of authority by governing body

Training needs and budgets

Brokers and critical competition

Governing body interpretation of risk

What performance do they expect?

Does risk and conservative action mean the same to them??

Steps to Writing the Policy

Internal review

Cash flow

Resources available (tech and personnel)

Accounting needs

Market information systems

Banking arrangements and contracts

Safekeeping

Supervision and oversight

Legal and statutory review

Be aware of different type entities

Being legal doesn’t mean it’s reasonable

Beware of special interests in the law

Input to the Policy

Legal

References for controlling statues/ordinances

Governing body

Prioritizing in their reviews

Internal staff

Accounting staff

Policy: Statement Section

Establish policy as The Policy

Establish as sole policy and reference

Reference procedures but do not include

Establish the strategy approach

Passive or pro-active but always conservative

Establish goals and intent

Protect principal

Provide for reasonable liquidity

Utilize and preserve diversity

Attain reasonable yield

TEA LOCAL

Investment Authority

Approved Instruments

Objectives Safety, Liquidity, Diversity

Monitoring market prices

Monitoring credit changes

Funds/Strategies Operating funds

Agency Funds

Debt Service Funds

Capital Projects

Safekeeping and Custody

Broker/Dealers

Soliciting CDs

Interest rate risk

Internal Controls

Legal and Local Policies

Possible Additions to Local

Scope

Annual review

Investment officers

Standard of Care

Collateral

Broker Requirements

If not policy inclusion – procedural control

Opening Policy Statement

Administration handled as the highest public trust

Receipt of market yield is secondary to safety

All actions in compliance with the laws

Limits are set to provide for diversity and liquidity

Goal is pro-active conservative management

Sample Policy Statement

It is the policy of [x] that the administration of its funds and the investment of those funds shall be handled as its highest public trust.

Investments shall provide for maximum security of principal.

Policy limits and diversification of the portfolio are primary and daily cash flow needs.

The receipt of a market yield will be secondary to the requirements for safety and liquidity.

All investments will be made in full compliance with state statutes, bond ordinances and applicable IRS requirements.

Policy: Legal References

State law

Reference PFIA and specific cites

Use Web link to assure timely update

Local ordinances: check the old ones!

IRS Provisions for bond arbitrage

Bond funds should reference arbitrage needs

Policy: Scope Section Scope

This Policy applies to all financial assets Policies usually except pension funds specifically

Definitive list of funds or reference to CAFR Materially or legally different funds may need a separate policy

Decommissioning funds or economic development entities Escrow funds Responsibility for investment of difference funds can vary

One portfolio can be used Commingled funds still recognize differences G/L accounting keeps funds separate Use sub-funds in the portfolio if necessary

Different bond issues Caution on arbitrage requirements

Policy: Objectives

Do more than just state the objectives

Safety, liquidity, diversification and yield

Define objectives at macro level

Tie the investments to the cash flow

Sets the tone for active-passive choice

If safety is your goal

Tight limits, extreme credit limits, etc.

If safety with yield is your goal

Wider security choices and longer terms

Yield versus Rate of Return

Beware of the specificity of the terms

Connotes intent to market participants/brokers

Yield

Buy-and-hold, not a trading portfolio, conservative

“Yield” based on purchase price and remains to maturity

Rate of Return

Market driven, active management, often indexed

“market return” based on the market price as it changes over time

Policy: Assigning Responsibilities

Clarification for each involved party

Concise listing aides comprehension

Summary in one place avoids confusion

Statutory and policy requirements outlined

Designating responsibilities

Governing body

Investment officers

Investment committee

Auditors

Advisers

Sample Responsibilities

The Investment Officer

The [--position----] is designated as the Investment Officer and is responsible for all investment decisions and activities.

The Officer will receive training…

The officer will develop procedures and controls…

The officer will not be personally liable if the policy and procedures are followed.

The officer will prepare monthly and quarterly reports…

The officer will disclose any conflicts…

Sample Responsibilities

Governing body

Retains ultimate fiduciary responsibility for investment of funds…

Will review and adopt the policy annually…

Will receive monthly and quarterly reports…

Will designate investment officers by resolution…

Will provide for officer training…

Will approve broker/dealers at least annually…

Auditors

Will review quarterly reports

Policy: Ethics and Disclosure

Ethics and Conflicts of Interest Standards and Disclosure

Officers will refrain from personal business that would conflict with proper and impartial execution of their duties. All personal and business relationships with entities doing business with the City will be disclosed.

Policy: Authorized Investments

Limit specifically by investment type

Require legal changes require local governing body re-adoption

Set a maximum maturity by type

Set credit requirements

Need not include all legally authorized types

Tailor the list to your entity’s needs

Sample Language

Define the security

Obligations of the US Government, its agencies and instrumentalities, excluding mortgage backed securities, with a stated maturity not to exceed ---- years.

“Stated” maturities are critical in callables, etc.

A1/P1 or equivalent rated commercial paper, rated by two nationally recognized rating agencies not to exceed 90 days to stated maturity.

Set your maximum maturity to recognize market risk

With CP the market risks increases measurably after 90 days

The Special Case for CDs

Special case of the CD

Policy must differentiate types because of risk

Depository certificates of deposit

Relationship with a bank

Usually restricted to the state

FDIC and collateral protection

Brokered/negotiated certificates of deposit

A security which trades on secondary market (cusip)

Needs additional monitoring requirements added to policy

No extended FDIC coverage on merger requires extra precautions

Depository CD

Limitations will differ with state statutes

May be afforded collateral

Define collateral requirements in policy section

On merger or acquisition if bank FDIC will be extended

Coverage will extend to first maturity date

Sample:

Insured or collateralized CD of banks doing business in the state and collateralized in accordance with this policy, not to exceed ---- years.

Brokered CDs This is a security traded like any security

Can be written outside States Often pushed as safe held by broker – contradicts DVP

No collateral is available

Stay under FDIC coverage

On merger or acquisition there is no extension of FDIC coverage Must be monitored weekly (Friday am)

FDIC insured brokered certificates of deposit securities from a bank

in any US state, delivered versus payment to the [City] safekeeping agent, not to exceed one year to maturity. Before purchase, the Investment Officer must verify the FDIC status of the bank on fdic.gov (bankfind) to assure that the bank is FDIC insured.

Brokered CDs need special

attention – mergers and acquisitions can leave you over-

the-limit.

Not the same

as YOU being in two banks that merge or acquired.

Internal Control for Brokered CDs

FDIC handles these two types of CDs differently Protect yourself FDIC provides NO reprieve for mergers and acquisitions

The Investment Officer, or Investment Adviser, shall monitor, on no less

than a weekly basis, the status and ownership of all banks issuing brokered CDs owned by the [City] 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, or Adviser, shall immediately liquidate any brokered CD which places the [City] above the FDIC insurance level.

Are bank accounts authorized?

You make an investment decision with funds in a bank

Should it be an authorized investment for clarity?

Account for low rate environments when a large % may be needed

Account for funds left in the ECR as an investment

Define for use accounts in all state banks

FDIC insured or collateralized interest bearing accounts in any bank in the state, collateralized in accordance with this Policy

Security Diversification Tables An optional control to assure diversification

Security Max % of Ptf.

Treasuries 80 % Agencies/Instrum 70 % Depository CD 25 %

% by bank 10 % CP 20 %

% by issuer 10 % Constant $ Pools 100 %

% of pool 10 % MMMF 40 % Bank Accounts 60 %

These are ‘maximums’ not designations. Allow for changing conditions.

Policy: Internal Controls Section

Internal controls define and assign Responsibility for creating controls

Responsibility for auditing controls

The Investment Officer will create and maintain internal procedures to control fraud, collusion, errors,…

Monitoring Ratings

Authorized investments requiring credit rating (such as CP) need to be monitored

Add to the policy a process and/or action for monitoring the ratings

Two alternatives based on your risk tolerance: The Investment Officer shall monitor, on no less than a weekly basis, the credit

rating on investments in the portfolio requiring a rating based upon information from a nationally recognized rating agency…..

If any security falls below the minimum rating required by Policy, the Investment Officer shall notify the ------- of the loss of rating, conditions affecting the rating and possible loss of principal with liquidation options available within two days.

If any security falls below the minimum rating required by Policy, the Investment Officer shall immediately sell the security, if possible, regardless of a loss of principal.

Policy: Safekeeping

Its criticality merits its own policy section

Total control requires independent safekeeping

Require receipts to be matched and maintained

Securities owned by the [entity] will be safe-kept at the banking services depository or an approved custodian and all securities will be settled delivery versus payment (DVP) to assure proof of ownership. The safekeeping bank will not be used as a broker in order to guarantee DVP settlement.

Policy: Bank Collateral Section

Collateral is pledged – you do not own it

Dictate what can be pledged Your list can restrict legally authorized securities

Dictate margin requirements Industry standard is 102% but states vary considerably

Remember value is market value not par

Dictate independent custody

Dictate reporting requirements Require that custodian – not bank – sends report direct to your entity

Policy: Owned Collateral Section

Repo collateral is owned by the entity

Require the ‘Bond Market Master Repurchase Agreement’

Dictate what will be authorized collateral

You set the requirements

Dictate the margin

Agreement and industry standard is 102%

Dictate independent custody

Policy: Counterparty Section

Counterparties include brokers, banks and pools

Requirements are set because they are selling you a transaction

Covering any body which is selling a transactions

Broker/dealers, banks, pools

Establish qualifications

Establish monitoring

Establish a reasonable number of counterparties

Dependent on your time and need

Policy: Adoption

Investment Policy and Strategy Adoption

Adoption assures that the governing body is on board

Annual adoption by resolution is required

The Policy and strategy shall be reviewed and adopted no less than annually by the [City Council]. A written resolution approving that review and noting any changes to the Policy or strategy will be recorded by the Council.

Step 5: Procedures and Controls

Procedures support the Policy

Controls are needed to manage risk

Keep them short and practical

Key areas:

Collateral and safekeeping

Trading procedures and counter-parties

Settlement by delivery versus payment

Reporting Procedures

Investment reporting is about performance

Statutes may address reporting – you must address it

Set the standards and requirements

Timing – monthly and/or quarterly

Amortization and accruals required

Pricing by independent entity/service

Especially subjective MBS pricing

Use of a benchmark for risk measurement

Reporting Procedures/Controls

Detail information Detail on each position/investment

Beginning and ending book and market Description, par, maturity, yield, and book and market value

Earnings (accruals plus net amortization)

Summary information Sum of book and market values plus realized gain/loss Total earnings for portfolio Change in market value (to measure volatility) Overall weighted average maturity (WAM)

Performance reporting

Benchmark performance for the period Overall portfolio yield for the period

Counterparty Control Investment officers must monitor the counter-parties

Annual review of registrations

State and FINRA registrations

CRD annual check for any actions taken against the firm/individual

FINRA.org – ‘Broker Check’

Annual review of their usefulness

How many times have they given the best price level

Annual review of financials

Not really necessary because of DVP – no true risk represented

Critical if you allow broker safekeeping (high risk)

Broker/Dealer Controls

Limit the number of broker/dealers for efficiency Minimum activity or a small portfolio rarely need more than 3 Always have three to assure competition More active portfolios in different markets may need 5-7 Don’t let brokers take up your whole day

Certification requirement?

Texas requires counter-parties to read and certify review of the policy

Good control that the counter-party knows your guidelines

Broker/Dealer Requirements

Gather and maintain background information only firm information contact broker information delivery instructions public client references Annual audited financials (if required) Certification of policy

Differentiate between secondary and primary brokers

Non-Primary Brokers

Identify market sector involvement Must sync with your needs

FINRA Broker Check

Finra.org

Self regulatory

Annual check

CRD# or name

Depositories Controls Designation of depository optional

Banking is a key element of investing

By depository law must be competitively bid at least every five years Primary banking services depository

Recognize right to use other depositories for investments

Incorporate right to go outside ETJ

Entity reserves the right to designate a primary banking services depository outside its ETJ.

Satisfies legal requirement for a resolution to so state.

Investing: Part of Cash Management

Invoicing and

Collection Debt Issuance

Cashiering Disbursements

Investments Safekeeping Banking

Various

components of

the cash

management

process.

Are the controls in place for each? Name three for each.

Step 6: Structure a Portfolio

Built on your cash flow

Built around your risk tolerance

Built on alternative securities

Dependent on market and internal conditions

Structures: laddering or otherwise

Rate anticipation ideas

Structuring a Portfolio requires an Economic View

In today’s Economic Landscape what is Going On ?

Major Market Forces - Now

How will these affect the market generally?

Federal Reserve tapering and QE plans A Yellen Fed - focusing on mortgage rates

Employment

Inflation

Global rates

Housing

Step 7: Reporting

Aides your monitoring

Detail on all aspects of portfolio

Summary is critical to spot trends and risk

Measuring risk is a primary functions

Too long?

Too short?

Not diversified?

Reflective of policy objectives?

Banking Impacts Your Treasury

A key element of Treasury Timely receipt of funds Safety of funds Investment alternatives

Structure of accounts

Type and use of accounts

Services

Fraud services and cost efficiencies

Collateral safety

Depository Law

Local Government Code Chapter 105

For cities and school districts

Banks, CU or savings associations

Resolution for ETJ banks required (105.011b2)

Notice required (21 days from deadline)

Allows for more than one depository (105.015)

Term limit of 5 years (105.017)

Deposit of funds in 60 days

Collateral portions superceded by PFCA (Govt Code 2257)

Special Depositories

Local Government Code Chapter 131

In case of a bank failure or business suspension or

regulatory take-over

Local government can name special depository

Special depository is to pay entity all funds due within

three years

TEA Process The TEA process involves either a Bid or RFP. What are the benefits of each?

TEA Contract

Required form.

Ties to RFP/Bid.

Two years plus two year extension.

Key choice of collateral.

Paying for Banking

It all goes back to the cost

It all depends on interest rates

Fee Basis Paying the service fees directly in cash

Compensating Balance Providing a balance which earns interest that then pays the fees

The earnings credit rate (ECR) is used to earn the interest

Compensating Balance

The balance is maintained and earns interest

The interest rate is the ECR

Earnings Credit Rate Applies only to the required balance

The interest is used to pay the fees Fees = (comp balance x ECR)/12

Currently 100% FDIC insured Generates a FDIC fee (varies 0.10-0.13%) Until January 1, 2013 – extension status unknown

Calculating a ‘Comp Balance’

Daily Ledger Balances

- Federal Reserve Requirement (10%)

- Average Daily Float

Average Collected Balance

x Earnings Credit Rate (1.25%) (annualized)

Net Monthly Earnings

Account Analysis Your Invoice

Lists each service used

States cost of each service

States amount of service used in period

Calculates fee basis of service

Calculates compensating balance for service

Based on a reduced ‘earnings credit rate’ (ECR)

Totals all fees

Computes excess/(deficit)

District earned $4,078 but needed only $ 2,569

Left $1,509 behind

Volume * price = Fee or Balance Required

BASED ON FEES SET BY CONTRACT

Mo. Contract Total

Service Description Vol Fee Cost

Master Account Maintenance Fee 8.0000 0.00

Subsidiary Account Maintenance 8.0000 0.00

Money Market Account Maintenance Fee 8.0000 0.00

0.00

Investment Sweep Maintenance 50.0000 0.00

Dr/Cr Sweep Transaction Fee 0.0000 0.00

ZBA Account - Subsidiary 8.0000 0.00

0.00

Checks/Debits Posted 0.0500 0.00

Branch Credits Posted - Electronic 0.1000 0.00

Automated Services - Balance & Detail

Acct Balance Report 0.00

Online Access Maintenance Fee 5.0000 0.00

Online Access Subscription Fee 5.0000 0.00

Previous day Reporting 10.0000 0.00

Previous Day Dr/Cr Items 10.0000 35,210.00

Image Capture Per Item 0.0300 0.00

Image Retention Per Item 0.0200 0.00

Branch Deposits

Commercial Account Maintenance 20.0000 0.00

Branch Credits Posted 0.5000 0.00

Branch Immediate Verification 0.1000 0.00

TOTAL FEES AT CURRENT MONTH VOLUMES

From the

monthly account analysis, input

the volumes for

each service.

Match the total

fees in the spread sheet to

the account analysis.

If they do not

match then a fee is wrong.

Check it!

A critical

monthly responsibility

Create a monthly CHECKLIST for your analysis fees.

ECR Rates Matter

Pool rates are about 0.10%-0.15%

ECR rates are 0.55%-0.70%

Impact on balance and FDIC pass-through

Should comp balance be on your investment report?

Fee $ 1,500 $ 1,500

ECR 0.20% 0.70%

Balance Req. $ 9,000,000 $ 2,500,000

FDIC Fee $ 9,000 $ 2,500

The 3% Threshold

Fed Funds Below 3% Above 3%

ECR 0.07% 2.00%

Fees/Earn. $ 1,500 $ 1,500

Bal. Required

$ 2,500,000 $ 900,000

Outside % 0.15% 4.00%

Outside Earn $ 312 $ 3,000 Above 3%

ECR will be half Fed

Funds

Evaluating Banks

Services Basic versus enhanced services

Does the bank keep up with technology?

Fees Transition or retention incentives?

Adjust for bundled services

Compare apples to apples

Earnings Look at ECR, interest bearing, MMA and sweeps

Carry-Over Management

Managed by you monthly

Insist on quarterly/semi-annual carry-over

Adjust your balances monthly before close

Managed by an automatic sweep

Sweep excess funds to a money market fund or account

Have the sweep set at either:

Compensating balance amount

Zero

The Value of a “Carry-over”

Daily ledger $ 550,000

- Federal Reserve $ 66,000-

-Daily Float $ 35,000-

Average Collected $ 449,000

x ECR 3.25%/12

Earnings on ECR $ 1,216

Fees $ 1,000

Excess Paid $ 216

Excess earnings are retained by the bank - with

“carry-over there is no settlement monthly

The Value of a “Carry-over”

Daily ledger $ 396,384

- Federal Reserve $ 66,000-

-Daily Float $ 35,000-

Average Collected $ 295,384

x ECR 3.25%/12

Earnings from ECR $ 1,000

Fees to be Paid $ 800

Deficit $ 200-

With a carry-over to the next month balance is

reduced and a deficit balances prior month excess.

Bank Focus #1: Safety & Fraud

Same old issues: safety and service Collateral and margins FDIC coverage Bank credit Delivery versus payment settlement Independent transactions and parties

New approaches Electronic processing Payee positive pay Courier options Pooling of collateral Security sign-ons (PINS and secure-cards) Online investment access

Positive Pay

A requirement for safety

Relieves liability for fraudulent checks received Add payee positive pay for double fraud protection

City sends bank the check register

Data base of valid checks screens all checks received Check number and amount standard New developments on payee and signatures

City gets option to review and approve

Without positive pay City retains liability

Stored Value Cards

Originally for payroll alternative (“pay card”)

Creates a debit card for employees

Internal Payroll Processed as direct deposit

Funds go to the card

Point of sale, bank or ATM use

Stops liability for lost checks

Cuts cost of checks

$0.06 versus $0.03

Reconciliation (ARP)

Serial Sort physical checks returned in order Phasing out with Check 21

Partial Reconciliation

paid check report

Full Reconciliation matches issued and paid outstanding items, voids & cancels

Deposit Reconciliation

Location identification

Combining with Positive Pay

Price savings Staff time savings

Mobile Access

Smart phone applications

Retrieve balance and transaction detail

Positive pay exceptions

Event messaging

Usually no cost

Security considerations

Bank Focus #2: Expediting funds

Move funds and documents

as expeditiously and efficiently as possible

Use technology to minimize cost

Use technology to increase access to funds

for longer earning period

Use physical and electronic services

May require changing internal processes

Truncated Checks

Key to eliminating paper documents

Replaces checks with digital images

“substitute checks”

IRD (image replacement documents)

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Your Tools for Expediting

Physical Minimization Moving away from documents Capturing documents electronically Minimizing physical handling

Electronic Maximization Imaging Wires ACH Sweeps Remote Deposit Payment/receivable processing Smart safes

Monetary Rewards

Availability schedules and policies Staff time

Sweeps

Account A

Account B

Account C

Account D

Master Account

Money Market Fund

O/Nite Sweep

Sweeps expedite funds plus allow you to automatically drill down to a comp balance or to zero balance

Remote Check Acceptance

On-site scanning of checks received

Transmission of scanned image: check and coupons Customization of fields Imaged and archived information

Scan and send from cashier or back office

Savings Float savings on deposit speed Courier (or staff transit) savings Liability savings Extended deposit times (9:00pm)

Remote Deposit

New delivery system Minimal internal disruption

Usually less costly clearing

Process Your cashiers total checks

Cashiers scan checks

Checks retained (7 days) then shredded

Transmit to bank

Same day deposit and clearing

Clearing reported on next day reports

Smart Safes

Available through banks or courier services

Deposit directly into smart safe

Sealed bags created

Deposit slip created on-site

Electronic transmission to courier

Courier periodic pick-up

Daily credit

RCK – Represented Check

Transforming NSF consumer checks to ACH

NSF checks are not represented next day

NSF checks converted to ACH

ACH direct debits are processed on a specific

date

Increased collections benefit

Image Lockboxes

Image lockbox consolidates

High volume, low dollar payments (retail lockbox)

Utility payments or tax payments

Low volume, high dollar payments (wholesale lockbox)

Image lockboxes truncate and speed receipts

Checks received at unique post office box

Box cleared up to 8 times a day

Processing 24/6

All transactions are imaged

Images/Records sent to you electronically

Records post directly to general ledger

Vaults and Deposits

Vault services are expensive Reduce through internal planning

Check rolling and strapping alternatives/discounts

Online vault provide for coin/currency orders

Deposit location tracking groups info, aides recon

Analyze your own coin/currency flows and ‘orders’

Service List Alerts

Research and confirmations

Signature control

Creation versus retrieval

Intra-day versus prior day

Maintenance charges

Module charges

Fax and phone charges

Deposit corrections

Standard versus optional reports

File versus detail transmissions

Tech Drives Future Services ACH key to many services

Banks move to service providers

Consolidation of transactions

Consolidating Payments E-Payables

Then

Invoice preparation and mailing

Manual sorts, opening and extracting

Manual batching and balancing

Armored car delivery

Check clearing availability

Now

Generate payables file for ACH/wire/print/mail service

Receive a file of bills paid

Virtual Payables

Single Use Accounts (SUA)

Non-plastic card electronic payment (virtual card)

Expiration date control

Can increase rebate potential

Supplier receives payment immediately – payor pays on statement date

Steps Checks Virtual Card

1 Receive invoice Receive invoice

2 Approve invoice Approve invoice

3 Cut check Generate single use account online

4 Mail check to vendor Email payment info to vendor

5 Vendor cashes check Vendor swipes virtual card online

6 Manual reconciliation Automatic reconciliation

Check Outsourcing

Industry cost to print check = $5-12

Print to mail services: bank prints and mails at bulk rate

Send file of checks to bank

Instead of to the printer in-house

Bank prints checks with your logo/specs

Bank utilizes sort for postage discount

Eventually move to ACH payments

E-checks

Electronic checks

Electronic version if paper check

Check payor provides

ABA routing #

Account number

Name on account

E-Receivables

Tied to an image lockbox

Scan the check and the document at bank site

Checks and documents imaged and captured

Combines with all receivables

Transmitted to your g/l with detail

Info archived at bank

ACH e-Lockbox

Collects payments from third-party

bill pay services and PC banking

Captured prior to posting to DDA

Captures vendor info and addenda

Consolidates in ACH receiver system

Sent to you for direct application to A/R

E-Commerce and E-Funding

E-Payables and E-Receivables

Converting paper to electronic transactions

EDI: Not a technology – a change in process

Electronic data interchange

Extending bank operations

Major cost-savings developments

Purchasing Cards

Limits purchases on SCI product types

Limits use by day or week

Agreement issues

Liability for unauthorized use

Billing disputes and chargebacks

Credit limits

Proprietary information

Arbitration

Termination and revocation

Controlled Disbursement

Outdated? Use of alternatives limit use

Sweeps eliminate usefulness

Cost is lower to sweep

Using remote bank to clear checks

Cash management purposes - not delay

Elimination with electronic capture

Additional costs make it less than worthwhile

Merchant Card Processing

Processing Visa, MC, Discover

Access to funds

Key element is PCI Compliance

Compare to State Contract

Training

Information

Credit and debit cards

Merchant Services Fees

Merchant Service Providers Can be banks or other providers

Payment Company Fees Differ by type “merchant”

Merchant Service Provider Fees Set $ fee and % fee

Dependent on your size/volume of payments

Remember Investing is Risk Management!

Linda Patterson

Patterson & Associates

linda@patterson.net