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HomeMy WebLinkAbout1997-05-13 City Council (4)BUDGET 1997-98 City of Palo Alto Summary Repor TO:HONORABLE CITY COUNCIL ATTENTION: FROM: FINANCE COMMITTEE CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES AGENDA DATE: SUBJECT:. MAY 13, 1997 CMR:234:97 PROPOSED CHANGES TO THE CITY’S POLICY INVESTMENT REOUEST The City of Palo Alto Statement of Investmem Policy requires review by Council annually, as part of the budget process. Staffis proposing changes to the currem policy for the 1997- 98 Budget. E AT Staff recommends that Council approve the following changes to the InvestmentPolicy: Revise the text to reflect newly enacted State legislation. Add several clarifications to the existing Policy to make it consistent with current investmem practices. Provide g!~ idelines for circumstances in which staff may place investments in excess of a five-year term, within the limit of 20 percent of the portfolio already permitted by existing policy. POLICY IMPLICATIONS This report does not recommend changes to existing City policies. P~ge 1 of 5 EXECUTIVE SUMMARY Annually~ during the budget process, staff submits the Investment Policy to Council for review and approval. Staff is proposing modifications to the Investment Policy to add language l~om recently enacted State laws to clarify the wording of existing policy, to make other wording modifications without changing current priorities, and to provide guidelines for placement of investments in excess of a five-year term. There is no fiscal impact from adopting the attached Investment Pblicy. ENVIRONMENTAL ASSESSMENT .. This is not a project for the purposes of the California Environmental Quality Act (CEQA); therefore, no environmental assessment is required. ATTACHMENTS 1)City of Palo Alto Long-Term Reserves 2)City of Palo Alto Investment Poliey PREPARED BY: Linda Craig, Senior Financial Analyst DEPARTMENT HEAD APPROVAL: Emily ~ardson CITY MANAGER APPROVAL: CC:n/a Page 2 of 5 City of Palo Alto City Manager’s Report PROPOSED CHANGES TO THE CITY’S INVESTMENT POLICY BACKGROUND Annually, during the budget process, staff submits the Investment Policy to Council for approval. The following are the proposed changes to the Investment Policy this year: Revise the text to reflect newly enacted State legislation. Add several clarifications to the existing Policy to make it consistent with current investment practices. 1)Clarify that investments held by the City’s safekeeping custodian will be in the name of the City of Palo Alto. 2)Make miscellaneous clarifications to the language in the policy. Provide guidelines for circumstances in which staff may place investments in excess of a five-year term, within the limit of 20 percent of the portfolio already permitted by existing policy. State law regarding local investments has changed since the investment policy was reviewed last year. ¯ SB 109, Chapter 749, effective January 1, 1997, expands the responsibility of persons authorized to make investments on behalf of the local agency by adding to the prudent investor standard the consideration of "the general economic conditions and anticipated needs of the agency." In addition, the law limits the delegation of authority to invest funds by the City Council "for a period of up to one year or earlier revocation." These provisions would not change current practice.s. Staff recommends the addition of language in the Investment Policy to reflect these new legislative requirements (pages 1 and 7). SB 864, Chapter 156, effective July 12, 1996, changes the limit on the.percentage of the portfolio allowed in mutual funds from 15 percent to a maximum of 20 percent, with the Page 3 o~ ~ provision that a maximum of 10 percent of the portfolio is permitted in any one mutual fund. Staff recommends changes to the Investment Policy to incorporate this new limit (page 5). The City’s Investment Policy states that City investments will be held by the city’s safekeeping custodian.. Staff is proposing amodification to this wording on page 5 to add the statement that.these securities are to be held "in the name of the City of Palo Alto." This does not change existing practice but. clarifies the fact that the City does have dear title and custody of its investments. The text of the policy on page 1, describing what action would be taken when there are increasing interest rates, is recommended to be deleted. Knowing when interest rates are increasing, or when they have peaked and are on the. decline, is simply not possible to predict. Current policy permits up to 20 percent of the portfolio to be placed in investments maturing in ¯more than five years. Investments are typically placed in securities with a three-year maturity length; the City portfolio’s average term is 2.16 years, as of May 1997, and staffhas not invested in any securities of a longer than five-year duration for several years. ’ Consequently, as of April 15, 1997, only .19 percent of the City’s portfolio is invested longer than five years. In the past few years, certain City reserves have been established for long-term planning. These include: the Calaveras Reserve in the Electric Utility, to accumulate funds to cover the "stranded costs" of outstanding Calaveras hydroelectric plant debt service .through the year 2024; the Retiree Health Benefit Trust Fund, to subsidize potential future extraordinary increases in the City health care obligation; and the Landfill Closure and Post Closure Care Liability account, most of which will "set aside" funds to monitor and maintain the City’s landfill for thirty years after it is projected to be closed in2013. The above reserves total aboutS55 million, or25 percent of the City’s investment portfolio as of June 30,. 1997. These reserves are detailed in Attachment 1. Staff believes it is these types of reserves that ought to be reviewed annually to identify how much potentially can be invested for longer than five years. Besides looking at available funding, staff would need to analyze the yields offered by longer-term securities at a given point in time, relative to their historical yields. Staff ¯ currently keeps a running five-year average history Of yields on five, and ten-year treasury securities. Staff would . only consider investing available funds in a five-year or greater term if the current yield offered for a five to ten-year security was attractive, in comparison to the five-year historical average yield. For example, a proposed investment should have a yield of at least the average yield that at least equals the yield on a comparable term Treasury bond’s average yield over the period of five years. CMR:234:97 .,~)age 4 of 5 Staff, therefore, proposes clarification to the investment policy to indicate that an analysis will be performed before investing in terms beyond five years, to assure that there are sufficient funds which the City plans, to be held for a .greater than five-year period. In addition, specific approval of the Director of Administrative Services will be required before placing any investment of greater than five year’s term (pages 2 and 6). As these longer-term investments are placed, staff will keep Council informed in the monthly and/or.quarterly investment status reports. Attachment City of Palo Alto Long Term Reserves ($ in thousands) Reserve Calaveras Reserve, Electric Fund Reserve to accumulate funds to cover the "stranded costs" of the Calaveras hydro plant debt service until 2024 Retiree Health Benefit Fund Trust fund to pay for health care costs in excess of 1 ½ percent of the City’s gross payroll costs in any fiscal year Landfill Closure and Post Closure :Care Liability, Refuse Fund ’ Mandated security for funds to monitor and maintain the City’s landfill for thirty years after closure in 2013. Projected Balance 6/30/1997 $41,640 $7,465 $6,647 Funds Available Year 5 $93,041 $8,707 $4,000 Funds Available ¯ Year 10 $84,500 $8,022 $5,350 Funds Available Over 10 Years $42,250 $3,284 $6,500 TOTAL $55,752 $105,748 $97,872 $52,034 ATTACHMENT 2 CITY OF PALO ALTO Statement of Investment Policy INTRODUCTION As a charter city, Palo Alto operates its pooled idle cash investments under the prudent investor rule and in conformance with California law. Investments are made with the judgment and care, under the circumstances then prevailing, . which investors with prudence, discretion, and intelligence would make, considering the safety of their capital as well as probable income: This affords the City a broad spectrum of investment opportunities, so long as the investment is deemed prudent ahd is allowable under current legislation of the State of California 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 su~cient 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~, 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 20 percent =of the portfolio may be in investments matudng 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 are the responsibility of the Administrative Services Department. The Administrative Services Department is under the control of the Director of Administrative Services, ~ 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, who is accountable to the Assistant Director of Administrative Services. The duties of the Manager, Investments, Debt and Projects, 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, Investments, Debt and Projects. The Senior Financial Analyst/Investments assists the Manager, Investments, Debt and Projects in the purchase and sale of securities. The Senior Financial Analyst also prepares the monthly report,. and " " ~_~,~ ~.~ 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., ~ Investments, Debt and Projects or Senior Financial Analyst/Investments 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 ¯The Manager, Investments, Debt and Projects, and the Senior Financial Analyst/Investments may also transfer no more than $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 wdtten authority of the Assistant Director of Administrative Services. ~S OF INVESTMENT Permitted investments are limited to the following: 2 3. 4. 5. 6. 7. 8. 9. Securities of the U.S: Government, or its agencies. This shall include Callable and Multi-step-up securities; provided that: o 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; Certificates of Deposit (or Time Deposits) (CD); Banker’s Acceptance Notes (BA); Short term Commercial Paper, i.e., maturing in 180 or fewer days; Local Agency Investment Fund (LAIF); Short-term Repurchase Agreements (REPO); City of Palo Alto Bonds; Money Market Deposit Accounts; and 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 upon 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: ¯Reverse repurchase agreements Derivatives, as defined in Appendix B ¯ Negotiable certificates of deposit Medium-term corporate notes Appendix B provides a more detailed description of each investment which is prohibited for City investment. M RI ~ Criteria for selecting investments are (in order of importance): 1.Safety 21 Liquidity, and 3.Yield Use of Brokers and Dealers The Administrative Services Dep,artment. maintains a list of acceptable brokers and dealers. 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. A broker or dealer will be removed from the list should there develop a history of problems (i.e., failure to deliver securities as promised, failure to honor transactions as quoted, or failure to provide reasonable 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. Safe_____~W - The primary objective shall be to safeguard the principal of the funds. O No more than 10 percent of the portfolio in collateralized CD’s of any institution. .. -An institution must be federally insured; and -Have been in operation for at least three years, with positive earnings for at least three of the past four quarters of operation; and o Report~equity in excess of 3 percent of assets; and - Report scheduled items not in excess of 2.5 per of assets. O 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 tho~e permitted types of investments. 4 O 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 -1~ ~ percent of ~ portfolio in Mutual Funds¯ NO more than 20 percent of portfolio in callable and Multi=step.=up agency securities. O All securities shall be delivered to the City’s safekeeping custodian, ~~ ith the exception of the following investments: ~ .... Certificates of deposit, which will be held by the City itself; Mutual funds ~ LAIF iLiggJ.d.i~ - 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 thenext 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 yeamare U.S. government securities, it is possible to maintain fairly accurate records on the market value of these securities and show the market value and 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 cash, and the loss (ifany) must be realized. As long as the City has planned 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. titan 2 years. o No more than 20 percent of the portfolio shall be in investments maturing in more than five years. .... , ¯ O O Any security purchased with a maturity greater than 10 years may pay principal; as well as interest, on a periodic basis. 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. Yi_j.i.i.i.i.i.i.ig~ - The third objective shall be to achieve a return on the funds. Yield, which, is defined as the return on an investment, will be the third criteria for investments, after safety and liquidity. 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 pdce on sale. This rule will not apply to new issues which are purchased at market no more than three (3) working days before pricing, LAIF, City of Palo Alto bonds, money-market accounts or mutual funds, which shall be evaluated separately. ~ REVIEW AND REPORTING I T Monthly, the Administrative Services Department will review performance in relation to the Council-adopted Policy. Monthly, the Department will report to the Council, in a manner approved by the Council, its performance in relation to this policy and explain any deviation from the policy and recommendations for changes, if any. "Quarterly, the Department will provide to the Council a detailed list of all securities, investments and moneys held by the City, and report on compliance with the City’s Investment Policy, and the ability to meet the expenditure requirements of the City for the next six months. Annually, the Administrative Services Department will present the Statement of Investment Policy to the City Council. The Council will review this policy annually as part of the Budget Process. All changes in policy must be approved by the Council prior to implementation. Amended 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 Adopted by City Council October 22, 1984. Monthly reporting effective January 1985. Amended and Adopted by City Council June 24, 1985. ¯ by City Council December 2, 1985. APPENDIX A EXPLANATION OF PERMITTED INVESTMENTS = 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), (C) 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 h!ghly unlikely that the government would let any agency default on its obligations. .Certificates of Deoosit. 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 maturity can be selected by the pumhaser. _Bankers’ Acce_otance. A Banker’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 vedfy 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 Paoer. 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 -2-79 ~ays 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. ReDurchase Aareements. 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 matu .ri~, the securities are repurchased and the funds repaid, plus interest. Usually, amounts are $500,000 or more, but some REPOS can be smaller. ~onev Market DeDJzsJLAc~J~ 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 are insured by the Federal Deposit Insurance Corporation or the Savings ASsociation Insurance Fund. ~ 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 ¯ 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 inclusive, of Section 53601 of the California Government Code, and with a~sets under management in excess of five hundred million dollars; and Co ¯ d= Invest solely in those securities and obligations authorized by Sections 53601 and 53635 of the California Government Code. VVhere 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-Steo-u.o_S.: 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 invested 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 onthe 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, illiquid 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 De.oosit 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. ! M_edium-Term Commercial Paoer or Co~ 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.