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North Carolina Local Government Investment Association Winter Meeting – 2013 Investments 101 Presented by : Lee Carter Gary Porter PowerPoint PPT Presentation


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North Carolina Local Government Investment Association Winter Meeting – 2013 Investments 101 Presented by : Lee Carter Gary Porter Capital Management of the Carolinas, LLC. General Requirements (G.S. 159-30). Moneys may be deposited or invested Finance Officer manages investments

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North Carolina Local Government Investment Association Winter Meeting – 2013 Investments 101 Presented by : Lee Carter Gary Porter

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North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

North Carolina Local Government Investment Association

Winter Meeting – 2013

Investments 101

Presented by :

Lee Carter

Gary Porter

Capital Management of the Carolinas, LLC


General requirements g s 159 30

General Requirements (G.S. 159-30)

  • Moneys may be deposited or invested

    • Finance Officer manages investments

    • Subject to governing board restrictions

    • These are usually in investment policies

      • Types of securities allowed

      • Approvals for trades

      • Maturity limitations

      • Allowable concentrations

    • Managed so that cash is available when needed - liquidity


Basic guidelines

Basic Guidelines

  • Safety

  • Liquidity

  • Yield

  • Governments should evaluate:

    • Eligibility under G.S. 159-30(c)

    • Appropriateness

  • Request prospectus or other information before investing


Depository accounts

Depository Accounts

  • Board must designate official depositories

  • Insured or collateralized as required through G.S. 159-31(b)

  • Financial soundness of institution is the best safety mechanism

  • Deposit placement systems

    • Authorized in G.S. 159-30(b1)

    • CDARs, Finistar, etc.

    • Deposits in institutions up to insurance limits

    • Don’t use depository that a government utilizes directly

    • Out-of-state institutions – reciprocal flows

    • Financial soundness of depositories

    • LGC 203 reporting

    • Deposit broker must keep accurate records

    • “Funds in transit”


U s treasuries u s government guaranteed

U. S. Treasuries & U. S. Government Guaranteed

  • U.S. Treasuries

  • U.S. Government Guaranteed

    • GNMA

      • Prepayment risk

    • REFCORP (from S&L bailout)

    • FDIC-guaranteed corporate notes

    • Other securities possible

    • Must be specifically guaranteed as to principal and interest


Government agencies and instrumentalities

Government Agencies and Instrumentalities

  • Agency must be specifically listed in G.S. 159-30

  • “Direct” obligations only – not agency-guaranteed

  • Fannie Mae & Freddie Mac under U.S. conservatorship – form may change in 2013 or later

  • Best known issuers are Federal Home Loan Bank (FHLB), Federal Home Loan Mortgage Corp. (Freddie Mac), Fannie Mae


State and local obligations

State and Local Obligations

  • State of North Carolina and NC local governments and public authorities only

  • Bonds and notes only – not COPs

  • Notes being rolled into bonds eligible, not notes being rolled into COPs


Commercial paper

Commercial Paper

  • A1 / P1 / F1 only

  • No split ratings

  • “+” ratings for S&P

  • Term vs. overnight commercial paper


Bankers acceptances

Bankers Acceptances

  • No specific rating on security

  • Issuer must be either of the following:

    • Long-term rating is “AAA”

    • Bank or holding company headquartered in NC

  • No U.S. bank currently qualifies – only a few international banks are AAA-rated


Nccmt

NCCMT

  • SEC-registered funds (both cash and term portfolios)

  • AAA-rated (cash portfolio)

  • Investments limited to G.S. 159-30

  • Certified by LGC


Other investments

Other Investments

  • Stripped securities

  • Repurchase agreements

    • Third-party safekeeping

    • Collateral must be Treasuries or U.S. government guaranteed

    • Counterparty must be a primary dealer or bank

    • Marked to market daily (at least 100% of value)

  • Other mutual funds

    • Bond proceeds only – subject to arbitrage provisions

    • Fundamental investment limitations limited to G.S. 159-30

    • Ratings, arbitrage tracking – check with bond attorney

  • Other pools

    • STIF

    • Interlocal pools


Other investments not under g s 159 30 c

Other Investments (Not Under G.S. 159-30(c))

  • OPEB Trust Fund

  • LEO Separation Allowance Trust Fund

  • Special investment legislation


Not authorized

Not Authorized

  • Corporate notes

  • Brokered CDs

  • Foreign securities – only domestic subsidiaries are allowed

  • Bonds and notes from other states

  • Euro dollar CDs

  • “Retail” repos


Investment instruments

Investment Instruments

  • Select the Proper Investment Instruments–

    • Cash -Money in the bank, s/b an interest bearing account

    • NCCMT – Basis of your liquidity, AAA rated, state certified, money market fund, same day liquidity; Term Portfolio offers longer option w/ next-day liquidity

    • U.S. Treasuries – default risk free; Bills, issued at a discount, Notes and Bonds issued with coupons; does have interest rate risk

    • U.S. Agency Securities – discount notes (like T-bills), bullet coupon issues, callables, step-ups, floaters. Best known issuers are Federal Home Loan Bank (FHLB), Federal Home Loan Mortgage Corp. (FHLMC), Federal National Mortgage Assoc. (FNMA) and Government National Mortgage Assoc. (GNMA)


Investment instruments1

Investment Instruments

  • Certificates of Deposit and Other Deposits – Collateralized through pooling method, dedicated method or covered under FDIC insurance

  • Commercial Paper – unsecured promissory note of issuing corporation. Types are: Stand Alone, Letter of Credit, Asset Backed

  • Bankers’ Acceptances – used to finance foreign trade or working capital

  • Repurchase Agreements – need to use a tri-party repurchase agreement with an independent custodian

  • Flex Repo – repurchase agreements but flexible drawdown schedules


Investment instruments2

Investment Instruments

  • Agencies –

    • Discount Notes – Priced at a discount, resemble T-bills

      ($10,000 bond - $9,950 cost = $50 discount/interest)

    • Bullets – Issued with coupons, like notes and bonds, trade on a 30/360 day basis (bad days & good days)

    • Callables – Coupon issues with call options built-in. Option allows issuer to call issue at some point in the future.

      • Types of call options:

        • American Call – anytime after a specified lockout period (CC)

        • Bermuda Call – callable on interest payment dates (IPD)

          by predetermined schedule

        • European Call – callable one-time after a specified lockout

          (one-time call)


Investment instruments3

Investment Instruments

  • Step-Ups – Coupons step-up at preset times to higher levels, issues are usually callable on step-up dates.

    Ex. – Coupon starts at 1% and steps-up every 6 months to 1.25%, 1.50%, 1.75% respectively, final maturity is 2 years


Investment instruments4

Investment Instruments

  • Commercial Paper – Promissory notes issued by corporations and maturing in 270 days or less (no split ratings)

    • Stand Alone – Backed solely by the credit worthiness of the issuer

    • Letter-of-Credit – Security for purchaser is provided by a letter-of-credit provided by issuer’s bank that allows issuer to draw down funds to pay off maturities

    • Asset Backed (ABCP) – Security interest in some type of asset backing up the issue is the purchaser’s protection. Assets could be credit card receivables, trade receivables, etc…


Foundations of a solid investment program

Foundations of a Solid Investment Program

  • Safekeeping/Custody

    • Authorized Dealers & Financial Institutions – maintain a list

    • Internal Controls – need to have in place

    • Delivery vs. Payment (DVP) – to a 3rd party custodian in the unit’s name

    • Custodian - responsible for accurate record keeping and accounting of assets, timely delivery of securities, safekeeping of the assets and reporting to the client

  • Suitable and Authorized Investments

    • Investment types – what is allowed by law

    • Collateralization – which method (pooling or dedicated)

    • Repurchase Agreements – must comply with all provisions of state law


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

  • Safekeeping –

    • Signed Agreement

    • Transaction Deadline – usually between 10:00am and 12:00pm

    • Online access to account information

    • Services –

      • Safekeeping of assets

      • Receipt of income (interest)

      • Market value reporting

    • Compensation – usually included in banking services contract, may be a charge based on market value held


Foundations of a solid investment program1

Foundations of a Solid Investment Program

  • Investment Parameters

    • Diversification –

      • By issuer

      • By credit quality

      • By maturity –should have a stated maximum

    • Reporting

      • Methods – how often and what reported (individual securities, cost, market value, realized and unrealized gains and losses, weighted average maturity (WAM)

      • Performance Standards – appropriate benchmarks s/b established

      • Marking-to-Market – How often will market value or “fair value” be calculated GASB #31, at least annually at 6/30


Foundations of a solid investment program2

Broker

/Dealer

Executes Trades

Purchases or Sales

Local Unit

Issues Trade Confirms

Issues S/K Receipt

Local Unit S/K Agent

Dealer’s

S/K Agent

DTC

Settles Transaction

Issues S/K Receipt

Local FED

NY FED

Foundations of a Solid Investment Program

The Investment Process


Cash flow forecasting

Cash Flow Forecasting

  • Prepare a Cash Forecast – “The Holy Grail”

    • Cash Flow Projection - inflows and outflows of cash, use known amounts and estimates

      • Payroll, debt service, scheduled agency payments

      • Capital project estimates, departmental spending estimates

      • Maturities, tax receipts, state funds

    • Projection of Investable Balances - shows how the timing of cash flows and maturities affect investable balances


Cash flow forecasting1

Cash Flow Forecasting

  • Always have a liquidity pool for unforeseen expenditures.

    • Ex. – Commissioners buy land at their Tuesday night meeting, and by-the-way the closing is Friday.

  • GFOA recommends:

    • “continuously investing a portion of the portfolio in readily available funds, such as local government investment pools (LGIPs), money market funds, or overnight repurchase agreements to ensure that appropriate liquidity is maintained to meet ongoing operations.”

      - GFOA Recommended Practices


Investment instruments5

Investment Instruments

Default Risk Scale (Highest-to-Lowest)

Higher Degree Prime Commercial Paper A1/P1

of RiskCollateralized Bank CD’s

Bankers’ Acceptances

U.S. Treasury Repos (DVP)

U.S. Government Agencies

U.S. Government Guaranteed (GNMA)

Risk Free U.S. Treasury (Bills, Notes, Bonds)


Investment instruments6

Investment Instruments

Liquidity Scale (Highest-to-Lowest)

Most LiquidOvernight Repos

NCCMT

T-Bills

Other short-term Treasuries

Government Agencies

Bankers’ Acceptances

Commercial Paper

Long-term government bonds

Long-term U.S. Agency Bonds

Illiquid Certificates of Deposit


The investment process

The Investment Process

  • Identify unit’s objectives and constraints

  • Develop an investment policy

  • Develop administrative systems and internal controls

  • Prepare a cash forecast

  • Determine investment horizon

  • Establish an investment outlook and strategy

  • Analyze the yield curve

  • Select optimizing investments

  • Monitor markets and investment results

  • Report results

  • Adjust and rebalance the portfolio accordingly

    From Investing Public Funds, 2nd Edition, Girard Miller, GFOA


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

  • Establish an Investment/Economic Outlook

    • Most public investors are not trained economists

    • Most have an unwritten or implicit investment outlook

    • A formalized investment outlook may help improve communications and accountability

    • The outlook may include long-term, macroeconomic, cyclical and short-term expectations


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

  • Analyze the Yield Curve

    • Yield Curve – graphical representation of interest rate levels

    • What type of yield curve environment are you in?

      • Normal

      • Flat

      • Inverted

    • How do you think the yield curve will change in the future?


Bond math is not complicated

Bond Math is Not Complicated


Interest rates and bond prices

Interest Rates and Bond Prices

Bond Pricing

Bond prices move inversely to interest rates

Interest Rates goBond Prices go

Interest Rates go Bond Prices go

Need To Know This!

You will have a Fair Value Adjustment at Year-end


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

5.50% decline

5.50% decline

5.00+% decline


Where are we now

Where Are We Now?

Source: Investing Public Funds, 2nd Ed.


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

Standard Business Cycle and Interest Rate Tendencies (USA: 1940 – 1996)

Source: Investing Public Funds, 2nd Ed.


North carolina local government investment association winter meeting 2013 investments 101 presented by lee carter gary porter

  • Where are we on the business cycle?

    • Probably late trough phase

    • Looking for interest rates to increase in future

    • Rates are at historic lows so you won’t be “going out on a limb” with this prediction


Bond pricing

Bond Pricing

Bond purchased at par (price = 100%)

2 year maturity, - .25% coupon bond

Cost = Principal Amt. x Price ($1,000 x 100% = $1,000)

Interest rate moves to 1.0%

New Price = 98.519% New Market Value = $985.19FVA($14.81)

Interest rate moves to 2.0%

New Price = 96.585% New Market Value = $ 965.85FVA($34.15)

10 year maturity, - 1.50% coupon bond

Interest rate moves to 2.0%

New Price = 95.489% New Market Value = $954.89FVA($45.11)

Interest rate moves to 3.0%

New Price = 87.123% New Market Value = $871.23FVA($128.77)


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