INVESTING SCHOOL FUNDS
Public Funds Investment Act Workshop
Region 1 –Edinburg
July 2014
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

State Treasury was abolished and transferred to Comptroller
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






2001



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
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

CD definition changes


Added ability to use CDARS



“domiciled” became “main office or branch in TX”
Entry bank must be in Texas
Reciprocity for banks required
Decommissioning trust funds investment authority
expanded to include Trust Code

For entities with gas or electricity utilities selling to public
Responding to Public Needs

2007


Municipal hedging on coal and nuclear fuel expanded to
commodity futures and related transportation costs
2009

Municipalities with mineral rights leases and contracts expanded
investment authority




Includes oil, gas or other mineral rights
Establishes a Trustee authority
Funds must be separated
Investments can be made under Trust Code
Key Changes in 2011
Affecting You

Policies must include procedures to monitor credit rating
changes in investments [2256.021]

Training years now defined as fiscal years

FDIC/FICA insured obligations [2256.0009(a)(4)]



[2256.008(a)(2)]
FICA and CDs and interest bearing accounts
Can invest in FDIC insured CDs outside TX [2256.010(C)]
Conflict within the Act adds danger


CDs from a broker in TX allows broker to custody [2256.010(b)]
BUT Act requires you require DVP which this is not
2011 Changes for Pools

Can now invest 100% in money market funds

Must say how yield is calculated in monthly reports


MMMF pools must report yield in accordance with the SEC
regulations
The pool’s website must:
 Include disclosures (information statement)
 Make audited annual financials available
 Must define breakpoints creating rate differentials
2011 Changes Reporting

Investment quarterly reporting:


Need not be in accordance with GAAP
Need not state the beginning book and market of individual
assets/investments BUT still need to give summary market
values at beginning and end of period
PFCA 2013


No change to PFIA
PFCA Change
 Releases custodian from having to send trust receipts to
public entity


Trust receipts to public entity or to bank with directions to
forward
Struck the term “promptly” to same business day

Public entity can request current collateral list

YOU need to tell your bank/custodian that you want reports
monthly from the custodian

Include in Policy and bank RFP
Lessons from History



Not all the changes made affect you
Not all the changes are necessarily good
for you
The devil is in the details
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



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


Includes pools, banks, investment advisors as well as broker/dealers
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



No need to liquidate if authorized at purchase


Does not constitute an authorized security with lower rating
Policy must include procedure for monitoring credit rating and
possible liquidation
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


Liquidity



Avoiding risk of over-concentration
Yield


Assuring that funds are available
Covering known and unexpected expenses
Diversification


Preservation of capital
Making all the funds work
How do we achieve the objectives?
Change

Market conditions change constantly






Internal situations change





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
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



Firm Foundation


Your objectives
Economic realities
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
4.50
4.00
3.50
Sep-13
Aug-13
Jun-13
Dec-12
Sep-12
Jun-12
3.00
2.50
2.00
1.50
1.00
0.50
0.00
3mo
6mo
1yr
2yr
3yr
5yr
10yr
Public entities operate primarily in this area of the curve.
30yr
A Major Change Factor
•
•
1.00
What is driving the rates and markets
currently?
What factors will change outlooks?
Sep-13
Aug-13
May-13
Sep-12
Jun-12
Mar-12
0.50
0.00
3mo
6mo
1yr
2yr
3yr
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


Study of how and when money flows



Capture revenues & expenditures for analysis over time
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




Traditional approach details




Present viable information for decision-making
Develop parameters for portfolio structure
Limiting liquidity risk
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



Capture historical data before analysis



Continue use of 80-20% rule or
add categories
Total revenues minus total expenses
Multiple years will highlight and smooth aberrations
End result is same cash balance data
Major Category History
Revenues
Taxes
Jan
Feb
Mar
Apr
May
Jun
Jul
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
2,000,000
350,000
433,000
400,500
600,000
700,000
750,000
10,900,000
7,700,000
4,383,000
1,625,500
2,250,000
3,400,000
2,450,000
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
Utility
Total
Expenses
Salaries
Debt Svc
Total
Net Cash
2,000,000
2,600,000
2,500,000
4,750,000
2,950,000
3,045,000
3,325,000
3,250,000
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



80% of revenues come from 20% of revenue sources


Payroll and fringes probably account for 80%
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



You can create the basic cash flow now – a base line




Eliminating the need for years of data
Data farming too often an excuse not to act
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…
10,000,000
9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
4,000,000
3,000,000
2,000,000
Core
1,000,000
0
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
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
A.
B.
80
80
60
60
40
40
20
20
core ?
0

They can not invest longer than one year = maximum maturity 1 yr
Entity B has a core so they can invest longer


core
Entity A has no core – starting and ending the cycle at zero


0
Possibly B could create a maximum maturity of 2 years
You must understand what the core is made up and if might change
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
Use multiple historical issues
of the same type fund
streets
water mains
land acquisition
Streets - 2007
800
600
400
200
0
1
3
4
5
6
7
8
9
6
7
8
9
Streets - 2009
800
600
400
200
0
Trend often appear over the
time frame of the total project
2
1
2
3
4
5
Street
Streets
Composite
Projection
– New
2005
Funds
Use for projections on the
same type projects in the
future
800
600
400
200
0
1
2
3
4
5
6
7
8
9
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
Entity needs $3 million a month for A/P and payroll costs.
Investment matures on 2nd and is available for rest of month.
S
1
M
2
T
3
W
4
TH
9
10
11
S
5
6
12
13
14
19
20Payroll
21
Payables
$250,000
8
F
Payroll
$1mm
7
Payables
$250,000
15
16
17
18Payables
$1mm
$250,000
22
23
24
25
Payables
$250,000
26
27
28
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
“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


High credit quality reduces exposure


Money will flow from one sector to another for safety or yield
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


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



Inability to pay interest or principal
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


Understand issuers restraints and strengths


Use CP but restrict to dual ratings and stay under 90 days
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




Limit maximum maturities
Monitor credit ratings regularly
Watch market news


Two views are better than one
Utilize credit rating agencies


Watch for major sector moves or news
Require dual ratings


Set % of portfolio limits for riskier securities
Understand when they are being political too!
Understand the rating definitions
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
AAA
Aaa
aaa
Very high credit & strong capacitylow 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
Extremely strong capacity – very
low expectation of default
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
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


Do your cash flow and invest to it


Be practical and prepare for the unexpected
Use liquid investments


Stick with the program
Create a liquidity buffer


Being totally liquid puts you at the lowest rates
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


Risk that if sold you recognize a loss of principal


Can you take a loss by policy?
“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
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



Do not assume a call


when they are called as rates fall
Reinvestment of proceeds will be at lower rates
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


Based on Type of Account


within the entire holding company of the bank
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
Rating services rate ‘CAMELS’
Capital
Assets
Management
Equity
Liquidity
Systems
Bank Rating Services:
-Best
-Highline
--Veribanc
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:




Treatment of MBS (amortizing book-entry security)


New securities are substituted
Principal is released by Pledgee (public entity)
Principal collected by pledgee on event of default
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


Safekeeping agents simply hold securities


Usually you agree to/approve a custodian
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



Places assets in care of an agent


Used to hold YOUR owned securities
‘Street-name’ safekeeping



In your entity’s name
Totally electronic
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



Safekeeping



FRB
DTC
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




Banking risks




Broker background checks
FINRA registration
Independent safekeeping outside brokerage
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 Collateral


establish equality
review for practicality
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



Diversification by type of security



Never rely on one institution or broker
Do not allow a broker to do competitive bidding for
you
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
diversification
diversification
competition
competition
controls
diversification
diversification
documentation
contracts
competition
documentation
procedures
credit quality
procedures
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.
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









Safekeeping and Custody
Broker/Dealers
Soliciting CDs
Interest rate risk
Internal Controls
Operating funds
Agency Funds
Debt Service Funds
Capital Projects
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: Scope Section

Scope



Definitive list of funds or reference to CAFR


This Policy applies to all financial assets
Policies usually except pension funds specifically
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 overthe-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







Treasuries
Agencies/Instrum
Depository CD
% by bank
CP
% by issuer
Constant $ Pools
% of pool
MMMF
Bank Accounts
Max % of Ptf.
80 %
70 %
25 %
10 %
20 %
10 %
100 %
10 %
40 %
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
Control and Procedural Areas









Signatories
Custodians
Ethics
Investment decisions
Investment procedures
Accounting and reporting
Wires
Documentation
Strategy
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
Cashiering
Investments
Debt Issuance
Various
components of
the cash
management
process.
Safekeeping
Disbursements
Banking
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 ?
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




Structure of accounts


Type and use of accounts
Services


Timely receipt of funds
Safety of funds
Investment alternatives
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



The interest is used to pay the fees


Earnings Credit Rate
Applies only to the required balance
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
Create a monthly CHECKLIST for your analysis fees.
BASED ON FEES SET BY CONTRACT
Mo.
From the
monthly account
analysis, input
the volumes for
each service.
Match the total
fees in the
spread sheet to
the account
analysis.
Service Description
Vol
Contract
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
If they do not
match then a fee
is wrong.
Total
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
20.0000
0.00
Branch Credits Posted
0.5000
0.00
Branch Immediate Verification
0.1000
0.00
Branch Deposits
Check it!
Commercial Account Maintenance
TOTAL FEES AT CURRENT MONTH VOLUMES
A critical
monthly
responsibility
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%
$ 9,000,000
$ 2,500,000
$ 9,000
$ 2,500
Balance Req.
FDIC Fee
The 3% Threshold
Fed Funds
Below 3%
Above 3%
0.07%
2.00%
$ 1,500
$ 1,500
$ 2,500,000
$ 900,000
Outside %
0.15%
4.00%
Outside Earn
$ 312
$ 3,000
ECR
Fees/Earn.
Bal.
Required
Above 3%
ECR will be
half Fed
Funds
Evaluating Banks

Services



Fees




Basic versus enhanced services
Does the bank keep up with technology?
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
- Federal Reserve
-Daily Float
Average Collected
x ECR
$ 550,000
$
66,000$
35,000$ 449,000
3.25%/12
Earnings on ECR
Fees
Excess Paid
$
$
$
1,216
1,000
216
Excess earnings are retained by the bank - with
“carry-over there is no settlement monthly
The Value of a “Carry-over”








Daily ledger
- Federal Reserve
-Daily Float
Average Collected
x ECR
$ 396,384
$ 66,000$ 35,000$ 295,384
3.25%/12
Earnings from ECR
Fees to be Paid
Deficit
$
$
$
1,000
800
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
Electronic Processing
Source: Wells Fargo
E-Box

Electronic receivables

Consolidating receivables

Collection of invoices electronically

Combines online bill payments to single stream
Truncated Checks


Key to eliminating paper documents
Replaces checks with digital images



“substitute checks”
IRD (image replacement documents)
xx
Your Tools for Expediting

Physical Minimization




Electronic Maximization








Moving away from documents
Capturing documents electronically
Minimizing physical handling
Imaging
Wires
ACH
Sweeps
Remote Deposit
Payment/receivable processing
Smart safes
Monetary Rewards


Availability schedules and policies
Staff time
Sweeps
Account A
Money Market
Fund
Account B
Master Account
O/Nite Sweep
Account C
Account D
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
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Collects payments from third-party
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bill pay services and PC banking
Captured prior to posting to DDA
Captures vendor info and addenda
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Consolidates in ACH receiver system
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Sent to you for direct application to A/R
E-Commerce and E-Funding
E-Payables and E-Receivables
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Converting paper to electronic transactions
EDI: Not a technology – a change in process
 Electronic data interchange
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Extending bank operations
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Major cost-savings developments
Purchasing Cards
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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
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Termination and revocation
Controlled Disbursement
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Outdated? Use of alternatives limit use
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Sweeps eliminate usefulness
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Cost is lower to sweep
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Using remote bank to clear checks
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Cash management purposes - not delay
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Elimination with electronic capture
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Additional costs make it less than worthwhile
Merchant Card Processing
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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
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Merchant Service Providers
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Payment Company Fees
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Can be banks or other providers
Differ by type “merchant”
Merchant Service Provider Fees
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Set $ fee and % fee
Dependent on your size/volume of payments
Remember Investing
is Risk Management!
Linda Patterson
Patterson & Associates
linda@patterson.net