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HomeMy WebLinkAbout1998-05-05 City CouncilBUDGET ’98- ’99 City of Palo Alto ,City Manager’s Report TO:HONORABLE CITY COUNCIL ATTENTION: FINANCE COMMITTEE FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES DATE:MAY 5, 1998 CMR:222:98 SUBJECT:PROPOSED CHANGES TO THE CITY’S INVESTMENT POLICY RECOMMENDATION The City of Palo Alto Statement of Investment Policy requires review by Council as part of the annual budget process. Staff recommends that Council approve the following changes to the Investment Policy: A.Increase the amount of the portfolio that can be invested in investments maturing in more than five years from 20 to 30 percent. Clarify the definition of brokers and dealers to be firms or businesses selling investments, and that the agents of those brokers and dealer~ must have a minimum of one year of experience in selling investments. C.Language changes to clarify the Investment Policy text. BACKGROUND During the annual budget process, staff submits the Investment Policy to Council for review and approval. During the past year, there have been no changes in State law that would require revision to the City’s current Investment Policy. For 1998-99, however, staff is proposing changes that: reflect the nature and goals of specific City reserves; clarify the definition of brokers and dealers and the minimum experience the City requires from its traders; and clarify the Policy text so it reads more clearly. CMR:222:98 Page 1 of 3 DISCUSSION Staff is proposing to increase the percentage of the portfolio that can be invested in instruments greater than five years from 20 to 30 percent. Reserves such as the Calaveras Reserve, the Retiree Health Benefit Trust Fund, and the Landfill Closure and Post Closure Care .Liability account have been created to deal with long-term issues that will impact the City over the next two decades. As of March 31, 1998, these reserves totaled approximately $65 million, or 26 percent of the City’s Investment Portfolio. In addition, the Calaveras Reserve is anticipated to increase to $93 million by the year 2001. It is appropriate to link the size and horizons of these reserves with the age to maturity of investments in the portfolio (the current average age to maturity of investments in the City’s portfolio is two years). Since investments of longer duration typically have higher yields, these types of reserves provide an opportunity to increase the portfolio’s yield through longer-term investments. As interest rates begin to rise, staff would pursue longer-term investments. It is important to note that since the City holds its investments to maturity, investing more funds beyond five years holds no risk other than the foregone opportunity of potential increases in interest rates. The current Policy does not define dealers and brokers and whether they are firms or individuals who work for those firms. Policy changes are recommended that more clearly define brokers and dealers as businesses. While current Policy provides guidelines on the minimum qualifications for brokers and dealers, such as a minimum of three years experience operating with California municipalities, it does not specify minimum requirements for individual traders or agents with whom the City does business. It is recommended that the policy be changed to require that agents or traders have a minimum of one year of expertise operating with California municipalities, in addition to the three-year requirement for.the firm itself..This will provide additional protections to the City. Finally, staff has edited policy text to make it read more fluidly. These recommended language changes do not change current investment priorities or practices. RESOURCE IMPACT There is no resource impact from adopting the attached Investment Policy. POLICY IMPLICATIONS This report does not recommend changes to existing City policies. ENVIRONMENTAL ASSESSMENT This is not a project for the purposes of the Califomia Environmental Quality Act (CEQA); therefore, no environmental assessment is required. ATTACHMENT ~ Proposed City of Palo Alto Statement of Investment Policy for 1998-99 CMR:222:98 Page 2 of 3 PREPARED BY: Joe Saccio, Senior Financial Analyst APPROVED BY: CITY MANAGER APPROVAL: CC: n/a Mehssa Cavallo Acting Director~dministr~w-e~S ervices ,iJ1 ne Flemihg ~.~ ty Manager CITY OF PALO ALTO Proposed Statement of Investment Policy for 1998-1999 INTRODUCTION As a charter city, Palo Alto operates its pooled idle cash investments under the prudent investor rule and in conformance with California law..This investment, policy shallon!y apply to investments of idle cash made for.the purposes of.realizing ~interest earnings. j dg "--’--"-- -: ..........."---Investments are made with the u ment and care, ~,,,~,~, ,,,~ ~.,,,.,~,,,,ot=,,~,~o ,,,~,, n~d3 Gf the """"¯ ~,,x, which investors with prudence, discretion, and intelligence would make, considering the safety of their capital as well as probable income; and lunder_the circumstances then prevailing, including but not limitedto,-.the general economic conditions and anticipated needs of the City. This affords the City a broad spectrum of investment opportunities, so long as the investment is deemed prudent and is allowable under ~ ,~u,o,=,,~,,, ~,, ,,,~ State of California law and the charter of the City of Palo Alto. Palo Alto strives to maintain the level of investment of all idle funds as near 100 percent as possible, through daily and projected cash flow determinations. Investments are made so that maturities match or precede cash needs of the City. PHILOSOPHY The basic premise underlying Palo Alto’s investment philosophy is to ensure that sufficient money is always available to meet current expenditures. The City is able to take advantage of the relatively large reserve balances maintained by its utilities and other funds, which allow it to take advantage of the general tendency of the market to provide a higher return for longer-term investments (known as liquidity preference). Up to -29 30 percent of the portfolio may be in investments maturing in more than five years. Consequently, in the long run, the City should average a higher total return than most cities without such reserves to invest. The City’s practice is to buy securities and to hold them to their date of maturity rather than to trade or sell securities prior to maturity date for the sake of improving yield. If securities are purchased and held to their maturity date, then any changes in market value of those securities during their life will have no effect on their principal value at maturity. Under a buy and hold philosophy, the City is able to protect its invested principal. The economy, the money markets, and various financial institutions (such as the Federal Reserve System) are monitored carefully to assess the probable course of interest rates. AUTHORIZED INVESTMENT PERSONNEL Idle cash management and investment transactions Administrative Services Department. are the responsibility of the The Administrative Services Department is under the control of the Director of Administrative Services, as treasurer, who is accountable to the City Manager. The Department is composed of Administration, Accounting, Investments, Revenue Collections, Budget, Purchasing, Real Estate, and Information Technology, as set forth in Sections 2.08.150 of the Palo Alto Municipal Code. The Investment function is under the supervision of the Manager, Investments, Debt and Projects (Manager), who is accountable to the Assistant Director of Administrative Services. The duties of the Manager, ~,’~;’~t,,"~nt~,,.,~,,, =,,,~, ,,.,j~,,,o, include managing the City’s portfolio of treasury investments, remaining accountable for the City’s treasury balance, developing and monitoring the City’s cash flow model and developing long-term revenue and financing strategies and forecasts. A Senior Financial Analyst/Investments reports to the Manager,,,,,~o,,,,~,,,o,’ ..... "-^-’- ,.,~,,"^’-" =,,,,---’ Fzrojeets. The Senior Financial Analyst/Investments (Ana!ySt)~assists the Manager; ,,,,~o,,,,~,,,o, ,-,~,, =,,,, , ,,.,j~,.,,o in the purchase and sale of securities. The-Se~dof ~ Analyst also prepares the m~,nth’,y qua~er!y report, and records daily all investment transactions as to the type of investment, amount, yield, and maturity. Cash flow projections are prepared as needed. The Assistant Director of Administrative Services, or designee, is authorized to make all investment transactions allowed by the Statement of Investment Policy. He or she may authorize the Manager ’ ¯ ¯ "-’-" ---’ " ¯ ~’--.’-- ~" ’ ¯ " Rrtve~zme~t~ orAna!yst to enter into investments within clearly specified parameters. In all circumstances approval from the Director of Administrative Services is required before selling securities from the City’s portfolio or before placing an investment withgreater than five years’ term. The Manager, =,’;;’~st,,’~,’~t3, ,-,A,., __.,=,~,, =,,,, ,~;~j~ct~, ~,;’",,, t~ the-Analyst_ .. may also transfer no more than a total of $5 million a day from the City’s general account to any one financial institution, without the prior approval of the Assistant Director of Administrative Services. No other person has authority to make investment transactions without the written authority of the Assistant Director of Administrative Services. 2 TYPES OF INVESTMENT Permitted investments are limited to the following: 1.Securities of the U.S. Government, or its agencies. This shall include Callable and Multi-step-up securities, provided that: -the potential call dates are known at the time of purchase; -the interest rates at which they "step-up" are known at the time of purchase; and -the entire face value of the security is redeemed at the call date; 2.Certificates of Deposit (or Time Deposits) (CD); 3.Banker’s Acceptance Notes (BA); 4.Short-term Commercial Paper, i.e., maturing in 180 or fewer days; 5.Local Agency Investment Fund (LAIF); 6.Short-term Repurchase Agreements (REPO); 7.City of Palo Alto Bonds; 8.Money Market Deposit Accounts; and 9.Mutual Funds which are limited essentially to the above investments and further defined in note 9 of Appendix A. Appendix A provides a more detailed description of each investment vehicle and its security and liquidity features. Most of the City’s short-term investments will be in securities which pay principal up6n maturity, while long-term investments may be in securities which periodically repay principal, as well as interest. Most of the City’s investments will be at a fixed rate. However, some of the investments may be at a variable rate, so long as that rate changes on specified dates in pre-determined increments. Prohibited Investments: includes all investments not specified above, and in particular: 2. 3. 4. Reverse repurchase agreements Derivatives, as defined in Appendix B Negotiable certificates of deposit Medium-term corporate notes 3 Appendix B provides a more detailed description of each investment which is prohibited for City investment. INVESTMENT CRITERIA Criteria for selecting investments are (in order of importance): 1.Safety 2.Liquidity, and 3.Yield Use of Brokers and Dealers The Administrative Services Department maintains a list of acceptable brokers and dealers. A broker or dealer is defined as a firm or business, Any broker or dealer must have at least three years experience operating with California municipalities, maintain an inventory of trading securities of at least $10 million, and be approved by the Assistant Administrative Services Director before being added to the City’s list of approved brokers and dealers. In addition, individual.tradersor__agents rePresenting abroker or-dealer-must have a minimum of one year of expedence-operating~With California municipalities. A broker or dealer will be removed from the list should there develop a history of problems ~., to include: failure to deliver securities as promised, failure to honor transactions as quoted, or failure to provide reasonable oraCcurate information). Specific Investment Strategy Depending upon the City’s financial situation and conditions in the money markets, the investment strategy will change to achieve the appropriate balance of safety, liquidity and yield. Safety O -The primary objective shall be to safeguard the principal of the funds. No more than 10 percent of the portfolio in collateralized CD’s of any institution. -An institution must be federally insured; and - Have been ir~ operation for at least three years, with positive earnings for at least three of the past four quarters of operation; and -Report equity in excess of 3 percent of assets; and - Report scheduled items not in excess of 2.5 per of assets. 4 O No more than 30 percent of the portfolio in Banker’s Acceptance Notes, not to exceed 270 days maturity -No more than $5 million with any one institution. No more than 15 percent of the portfolio in commercial paper, not to exceed 180 days maturity. -No more than $3 million with any one institution. Limit investments exclusively to those permitted types of investments. No more than 10 percent of the portfolio in Farm Credit Securities. No more than 2 percent of the portfolio in the Guaranteed Portion of Small Business Administration Notes. O O No more than 20 percent of the portfolio in Mutual Funds., with no more than 10 percent of the portfolio in any one Mutual Fund. No more than 20 percent of portfolio in callable and Multi-step-up agency securities. All securities shall be delivered to the City’s safekeeping custodian, and held in the name of the City of Palo Alto,~with the exception of the following investments: Certificates of deposit, which will be held by the City itself; City shares in pooled investment funds, under contract; Mutual funds LAIF Li~.uidity - The secondary objective shall be to meet the liquidity needs of the City. The City’s ability to fund its current cash transactions is assured by appropriate cash flow planning, scheduling the maturity of investments at times when funds are required, and maintaining sufficient liquid funds to support unexpected cash requirements. In this regard, staff reports on a quarterly basis on the availability of funds to meet the expenditure requirement of the next six months. Usually, the longer term the investment the larger degree of interest rate risk. If interest rates increase, it is likely that the long-term investments would decrease in value. This is primarily a factor for securities which have maturities in excess of two years. Since almost all of the investments held by the City of Palo Alto with maturities in excess of two years are U.S. government securities, it is possible to maintain fairly accurate records on the market value of these securities ando,,~,,,-" .... "",,,~ .... ,,,=,,,~,"-" "’-",=,,,~’- and the potential loss to interest rate risk. This risk is a part of all long-term investment portfolios and does not become an important factor unless there is a need for-the to sell a security for cash, and the loss (if any) must be realized. As long as the City hae-pte~! plans for its cash flow needs, and is able to hold securities to maturity, fluctuations in the market value of the investment during the time it is held will have no effect on receiving the full face value of the investment’s principal at maturity. The following are liquidity constraints: o Liquidity enough to meet one month’s cash needs. o At least $50 million maturing in less than 2 years. O No more than -29 30 percent of the portfolio shall be in investments maturing in more than five years. Investments placed beyond a five-year term shall be supported by: cash flow projections indicating a plan to hold the funds for an extended period of time; and historical yield information that indicates available longer term yields are attractive, relative to historical yields. O Any security purchased with a maturity greater than 10 years may pay principal, as well as interest, on a periodic basis. O Should the ratio of the market value of the portfolio to the cost basis of the portfolio fall below 95 percent, the Administrative Services Department will report this fact to .the City Council within a reasonable time frame and evaluate whether there is any risk of holding any of the securities to maturity. O Commitments to purchase securities newly introduced on the market shall be made no more than three (3) working days before pricing. Yield - The third objective shall be to achieve a return on the funds. After safety and liquidity, yield, which is defined as the return on an investment, will be the third criteria for investments, -"~- ;;ty ----=,L~, ~=~ ’:--’’:’~:~" Whenever possible, the City will obtain three or more bids on the purchase or sale of comparable securities and take the higher yield on purchase or higher price on sale. This rule will not apply to new issues which are purchased at market no more than three (3) working days before pricing, as~we!i as LAIF, City of Palo Alto bonds, money market accounts of= and mutual funds, all of which shall be evaluated separately. POLICY REVIEW AND REPORTING ON INVESTMENTS Monthly, the Administrative Services Department will review performance in relation to the Council-adopted Policy. Quarterly, the Department will report to the-Council on: ~ " its performance in r-e!atio~ comparison to this policy, explain any de~iatie~ variances from the policy, af~d provideany recommendations for policy changes, if--arty and discuss overall compliance~with the City’s Investment Policy. IF, ~" ....."-’~ ......,,,~ u~,,,,,~,,y ,~,,~,,, In addition, the Department will provide t~ the-Council with a detailed list of all securities, investments and monies held by the City, ...." .......="- ""^ """"- ’ ....."-~-’ "~’;^’"City’s ability~.~,,,,F,,=,,~.~ ,,,,,, ,,,~ ,.,,,y = ,,,,~o,,,,~,,,, ~,,,,.y, and report on the to meet the expenditure requirements of-the-~eFfoP over the next six months. Annually, the Administrative Services Department will present the a Proposed Statement of Investment Policy, to include the delegation of investment authority, to the City Council for review during the annual budget process. Th~ " ..... """;" .... ; .... "’-;- --" ......... ’"" ""-- ~"’"-^" P,~,~.~oo All proposed changes in policy must be approved by the Council prior to implementation. Adopted by City Council October 22, 1984. Monthly reporting effective January 1985. Amended and Adopted by City Council June 24, 1985. Amended by City Council December 2, 1985. Amended by City Council June 23, 1986. Amended by City Council June 22, 1987. Amended by City Council August 8, 1988 Amended by City Council November 28, 1988. Amended by City Council June.26, 1989. Amended by City Council May 14, 1990. Amended by City Council June 24, 1991. Amended by City Council June 22, 1992. Amended by City Council June 23, 1993. Amended by City Council November 18, 1993. Amended by City Council June 20, 1994. Amended by City Council June 19, 1995. Amended by City Council June 24, 1996 Amended by City Council June 23, 1997 Amended by City Council January 26, 1998 Amended by City Council June __, 1998 APPENDIX A EXPLANATION OF PERMITTED INVESTMENTS o U.S. Government Agency Securities. U.S. Government Agency Obligations include the securities of the Federal National Mortgage Association (FNMA), Federal Land Banks (FLB), Federal Intermediate Credit Banks (FICB), banks for cooperatives, Federal Home Loan Banks (FHLB), Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Student Loan Marketing Association (SLMA), Small Business Administration (SBA), Federal Farm Credit (FFC) and Tennessee Valley Authority (TVA). Federal Agency securities are debt obligations that essentially result from lending programs of the Government. Federal agency securities differ from other types of securities, as well as among themselves. Their characteristics depend on the issuing agency. It is possible to distinguish three types of issues: (A) participation certificates (pooled securities), (B) Certificates of interest (pooled loans), © notes, bonds, and debentures. The securities of a few agencies are explicitly backed by the full faith and credit of the U.S. Government. All issues, however, have de facto backing from the federal government, and it is highly unlikely that the government would let any agency default on its obligations. Certificates of Deposit. A certificate of deposit (CD) is a receipt for funds deposited in a bank, savings bank, or savings and loan association for a specified period of time at a specified rate of interest. Denominations are $100,000 and up. The first $100,000 of a certificate of deposit is guaranteed by the Federal Deposit Insurance Corporation (FDIC), if the deposit is with a bank or savings bank, or the Savings Association Insurance Fund (SAIF), if the deposit is with a savings and loan. CDS with a face value in excess of $100,000 can be collateralized by U.S. Government Agency and Treasury Department securities or first mortgage loans. Government securities must be at least 110 percent of the face value of the CD collateralized in excess of the first $100,000. The value of first mortgages must be at least 150 percent of the face value of the CD balance insured in excess of the first $100,000. Generally, CDS are issued for more than 30 days and the matudty can be selected by the purchaser. Bankers’ Acceptance. A Banke¢s acceptance (BA) is a negotiable time draft or bill of exchange drawn on and accepted by a commercial bank. Acceptance of the draft irrevocably obligates the bank to pay the bearer the face amount of the draft at maturity. BAs are usually created to finance the import and .export of goods, the shipment of goods within the United States and storage of readily marketable staple commodities. In over 70 years of usage in the United States, there has been no known instance of principal loss to any investor in BAs. In addition to the guarantee by the accepting bank, the transaction is identified with a specific commodity. Warehouse receipts verify that the pledged commodities exist, and, by definition, these commodities are readily marketable. The sale of the underlying goods generates the necessary funds to liquidate the indebtedness. BAs enjoy marketability since the Federal Reserve Bank is authorized to buy and sell prime BAs with maturities of up to nine months. The Federal Reserve Bank enters into repurchase agreements in the normal course of open market operations with BA dealers. BAs are sold at a discount from par. An acceptance is tied to a specific loan transaction; therefore, the amount and maturity of the acceptance is fixed. Commercial Paper. Commercial paper notes are unsecured promissory notes of industrial corporations, utilities, and bank holding companies. Interest is discounted from par and calculated using actual number of days on a 360-day year. The notes are in bearer form, with maturities from one to 180 days selected by the purchaser, and denominations generally start at $100,000. There is a small secondary market for commercial paper notes and an investor may sell a note prior to maturity. Commercial paper notes are backed by unused lines of credit from major banks. Some issuer’s notes are insured, while some are backed by irrevocable letters of credit from major banks. State law limits a City to investments in United States corporations having assets in excess of five hundred million dollars with an "A" or higher rating for the issuer’s debentures. Cities may not invest more than 30 percent of idle cash in commercial paper. Local Agency Investment Fund Demand Deposit. The Local Agency Investment Fund (LAIF) was established by the State to enable treasurers to place funds in a pool for investments. The City is limited to an investment of the amount allowed by LAIF (currently $20 million). LAIF has been particularly beneficial to those jurisdictions with small portfolios. Palo Alto uses this fund for short-term investment, liquidity, and yield. Repurchase Agreements. A Repurchase Agreement (REPOS) is not a security, but a contractual arrangement between a financial institution or dealer and an investor. The agreement normally can run for one or more days. The investor puts up funds for a certain number of days at a stated yield. In return, the investor takes title to a given block of securities as collateral. At maturity, the securities are repurchased and the funds repaid, plus interest. Usually, amounts are $500,000 or more, but some REPOS can be smaller. Money Market Deposit Accounts. Money Market Deposit Accounts are market- sensitive bank accounts, which are available to depositors at any time, without penalty. The interest rate is generally comparable to rates on money market mutual funds, though any individual bank’s rate may be higher or lower. These accounts 2 o are insured by the Federal Deposit Insurance Corporation or the Savings Association Insurance Fund. Mutual Funds. Mutual funds are shares of beneficial interest issued by diversified management companies, as defined by section 23701 M of the Revenue and Taxation Code. To be eligible for investment, these funds must: Attain the highest ranking in the highest letter and numerical rating provided by not less than two of the three largest nationally recognized rating services; or o bo Have an investment advisor registered with the Securities and Exchange Commission with not less than five years experience investing in the securities and obligations, as authorized by subdivisions (a) to (n), inclusive, of Section 53601 of the California Government Code, and with assets under management in excess of five hundred million dollars; and Co do Invest solely in those securities and obligations authorized by Sections 53601 and 53635 of the California Government Code. Where the Investment Policy of the City of Palo Alto may be more restrictive than the State Code, the Policy authorizes investments in mutual funds which shall have minimal investment in securities otherwise restricted by the City’s Policy. Minimal investment is defined as less than 5 percent of the mutual fund portfolio; and The purchase price of shares of beneficial interest purchased shall not include any commission that these companies may charge. Callable Securities and Multi-Step-ups: Callable securities are defined as fixed interest rate government agency securities, that give the issuing agency the option of returning the invested funds at a specific point in time to the purchaser. Multi- step-ups are government agency securities in which the interest rate increases ("steps-up") at preset intervals, and which also have a callable option that allows the issuing agency to return the ihvested funds at a preset interval. Callable and multi- step-ups are permitted, provided that: -the potential call dates are known at the time of purchase; - the interest rates at which they "step-up" are known at the time of purchase; - the entire face value of the security is redeemed at the call date; APPENDIX B EXPLANATION OF PROHIBITED INVESTMENTS Reverse Repurchase Agreements: A Reverse Repurchase Agreement (Reverse REPO) is a contractual agreement by the investor (e.g. local agency) to post a security it owns as collateral, and a bank or dealer temporarily exchanges cash for this collateral, for a specific period of time, at an agreed-upon interest rate. During the period of the agreement, the local agency may use this cash for any purpose. At maturity, the securities are repurchased from the bank or dealer, plus interest. California law contains a number of restrictions on the use of Reverse REPOS by local agencies. Derivatives: A derivative is a financial instrument created from, or whose value depends on (is derived from), the value of one or more underlying assets or indices. The term "derivative" refers to instruments or features, such as collateralized mortgage obligations, forwards, futures, currency and interest rate swaps, options, caps and floors. Except for those callable and multi-step-up securities as described under "Permitted Investments," derivatives are prohibited. Certain derivative products have characteristics which could include high price volatility, liquid markets, products that are not market-tested, products that are highly leveraged, products requiring a high degree of sophistication to manage, and products that are difficult to value. According to California law, a local agency shall not invest any funds in inverse floaters, range notes, or interest-only strips that are derived from a pool of mortgages. Negotiable Certificates of Deposit Negotiable Certificates of Deposit (NCDs) are usually supported only by the strength of the issuing institution, but can be sold at any time and; thus, provide liquidity. Medium-Term Commercial Paper or Corporate Notes: Medium-term notes are unsecured corporate notes ranging from nine months to a maximum of five years maturity. Commercial paper with a term of six to nine months is not a permitted investment for local agencies in California.