using the fundamentals - region one esc · 2019-04-01 · strategies must change – so adjust jan...
TRANSCRIPT
The Investment Decision
Where do I need money? A: cash flow What can I buy? A: authorized securities Am I diversified? A: policy
Where is the market? Where are the rates going? What has the best yield? A: relative value
Relative Value Analysis is = Comparative Shopping Yield is our common denominator to compare alternatives
Investments
Investments are not just longer term Every dollar every day is an investment
Investments are not locked in Basically all investments can be sold
Investments are designed to pay your bills Cash flow planning tells us where market swings become irrelevant once investment is made
Investments in place on a ladder creates earnings
Strategies
Dependent first off on your cash flow
Dependent on your risk tolerance
Dependent on your policy limits
Dependent on your economic view Will rates go up? When will it go up? How far will it go? What part of the curve will go up?
Disciplined InvestingEven Infrequent Investors Need It
Horizon investing Chose the time period
Month or quarter periods
Stay to your horizon
Consistently cover next disbursement Create liquidity buffer as you go
Create a ladder to pay upcoming liabilities
At Today’s RatesWhat do You Do?
You have $40mm in Texpool at 0.07%
You need $2,500,000 a month
You have a safekeeping account at bank
You have little time
Evaluating the Choices
Sector analysis assuming that similar sectors are similar which issuers are available, wanted
Spread analysis which maturity range is best which bond is best in that maturity
Yield curve analysis where are rates now where are rates going
Sector Analysis
Market sectors are the different types of securities Treasuries, agencies, CP, CD, pools
Sectors vary by risk and structure agencies and new agency issues commercial paper taxable municipals
Evaluating sectors requires information on that sector credit decisions and risks historical spread analysis
Spread Analysis Spread means difference
Difference in rate between securities or market sectors
Spreads are dynamic Anticipated spreads on credit Current spreads Historical spreads
Doing a spread analysis means comparing rates
You must check the rates at that maturity in various sectors
6
7
8
3mo 6mo 1yr 2yr
TreasAgyCP
Yield Curve Analysis
Yield curves depict the market conditions Shows the markets expectations and demands Tells a story Illustrates the best value Read in light of current conditions
Picking the best place on the curve Your portion of the curve is restricted by policy Your portion is restricted by risk tolerance and cash flow
Yield Curve Nuances
3.00
4.00
5.00
6.00
7.00
3 Mo 6 Mo 1 Yr 2 Yr 5 Yr 10 Yr 30 Yr
Steepness
Value
Pick-up
Cheap
Rich
Flat
Relative Value by Yield A core investment out 1.5 years…
T-Note 0.28 % FNMA 0.35 % FHLMC 0.33 % FHLB Call 0.40 % CD 0.95 %
What are your considerations ? How far do you feel safe going?
Strategies must change – so adjust
Jan 2001 – Jan 2002 Overnight rates move from 6.50% to 1.00% Need to lock-in rates as long as reasonable Going long was primary strategy
June 2004 – June 2005 Overnight rates move from 1.00% to 3.00% Need to move up with the rates Staying short was primary strategy
Sept 2008 – Sept 2009 Overnight rates move from 2.0% to 0% Need to lock in rates and look for alternatives Going long was primary strategy
Passive Management
Passivity No unnecessary action: liquid reliance Defensible and easy Will mirror the lowest rates available
Passive Conservative Based on facts: cash flow needs/core Conservative with liquid buffers Targets month-by-month needs Usually stays within one year horizon Occasionally given to fits of agony Increases portfolio yields
The Pie and the Portfolio
Liquid Sector Provides liquidity Alternatives
Bank demand deposits Local government pools Money market mutual funds Overnight repurchase agreements
Today’s strategy
Short-Term Match upcoming known expenditures Alternatives – in different scenarios
Securities (discount notes, CDs, some liquidity options)
The Pie and the Portfolio
Long-Term Ultimately matching known expenditures
becomes the short-term Usually 6 to 12 months Alternatives directed by market yields Today’s strategy
Core Reserves, no planned shorter term use Focus on rate movements and yield May call for different securities Today’s strategy
Two Views to the Structure
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
$9.0
Liquid20%
Short50%
Long 20%
Core10%
Liquidity
Liquidity funds must provide Funds availability Reasonable return Ease of use Reporting
Used for long term liquidity in rising rate environment Used for short-term liquidity facilitating choice of securities
Bank Liquidity Choices
A range of choices non-interest bearing checking interest bearing checking money market accounts sweeps
Dependent on risk/access
A New Alternative - ICSInsured Cash Sweep
Promontory Network (CDARS)
Fully insured deposits
Online monitoring
One monthly statement
ICS
Sweeps as an Investment
Account A
Account B
Account C
Daily Sweep
to MMMF
Make sure your policy includes MMMF as authorized investment
Excess amounts sweep each day not entire amount.
Liquidity Choices
Local Pools “Money Market Mutual Funds” (MMMF) Repurchase Agreements (larger entities) Bank Options
checking accounts, interest bearing accounts, money market accounts, Sweeps to money market funds
Risk and return variations on each choice
Liquidity Choices
Where would you put $2mm?
Alternatives: O/N Repo Rate 0.04 MMMF or $1 Pool Rate 0.04 Bank checking 0.01 Bank money market account 0.18 Bank sweep to MMMF 0.00
The 14 extra bps buys you $2,800 a year.
Commingled Investments
Local Government Pools
Money Market Mutual Funds Mutual Funds
All offer: Economy of scale Diversification Some extension with liquidity Reporting
Pools vs Funds
You are not “insured” in either
Pools require a resolution and certification Are not a security – they are a cooperative
Funds Need to be in your policy Do not require resolution or certification They are a registered security
Fund/Pool Types Constant dollar funds/pools
Strive to maintain $1 asset (share) value Money market equivalent – known as 2a-7 funds
Net asset value funds/pools Share value fluctuates on market price Mutual fund equivalents – potential loss of principal
1 2 3 4 5 6 7 8 9 10 11 12
ConstantNAV
Pools and Funds Provide It’s all about disclosure
Information statements Prospectus Full Information
Confirmations Transaction History
Reports Monthly History
All requirements built on SEC requirements for MMMF
Pools and Funds
Pools
Based on ILCA Require resolution by
Board Rated Unregulated All types
Money Market Funds
SEC registered No resolution required SEC oversight and
regulation Strict restrictions
based on liquidity only
What do these figures tell you?
Know how to read the facts about your pool(s).
Pools – Know what they are..Read the information statement
Most pools are constant dollar Texpool I and II Logic Class TASB – Liquidity TexStar
Some pools are mutual funds
Some are a hybrid
It’s your job to know Have accounts at more than one pool
Types of MMMF MMMF are regulated securities
maximum maturity 13 months Maximum WAM of 60 days
Types of MMMF Treasury
US Treasury Obligations & repo with treasuries Government
US treasuries and agencies & repo backed by treasuries and agencies Enhanced Government
Same as Government but including CP Prime
treasuries, agencies, CP, BA, or corporate to 5%, repo
New SEC Rules for MMMF
New regulations are directed towards safety, liquidity and stability
Minimum 10% in securities convertible to cash in 1 day Minimum 30% in securities convertible to cash in 1 week
Maximum WAM shortened to 60 days Maximum WAL of 120 days
weighted average life to reduce use of variables
Monthly reporting to SEC on shadow prices
Create procedures for stress tests
New Rules for MMMF
Repo collateralized with US Obligations or cash only
Ability to process at price not $1
Maximum 3% in second tier securities (higher risk securities) from 5%
Maximum of 5% in illiquid securities
Know Your Investor requirements added
Ability to suspend redemptions to prepare for liquidation
Proposed Money Market Rules
Sec has turned PRIME money funds into mutual funds Not strive to maintain $1 Fluctuate with market values (price) Can reflect principal loss
The ACT requires $1 NAV money market funds
What does your policy say? Money market mutual funds, excluding prime funds. Money market funds which strive to maintain a $1 NAV.
MMMF Considerations This is a registered security
add as authorized investment to your policy as direct or sweep Safety is that you own and not have pledged securities
Get and read the prospectus Check historical rates Check the expense fee Choose the type that fits you risk tolerance
It may add value to go directly to fund Usually will under-perform pools because of expenses/subsidy
Know the procedures
The Ubiquitous Repo Repurchase Agreements
Simultaneous “Buy-Sell” Transactions
Allows full liquidity at market rates Uses DVP and independent custody Margins (102%) monitored constantly Various types include overnight, open & term
“Flex” is designed for capital projects Established for the entire expenditure period Rate is fixed and normally above issue rate Flexibility on draws with xx/month Interest on semi-annual basis
SELL
BUY
Tri-Party Repo Transactions
Public Entity
with $$$
Primary dealer with securitiesAgreement to buy-sell
Third Party NYC Bank
$$
Securities
$
Cash Account
Securities
Account
Instructions
Safeguards for True Repos
Primary dealers only Banks are allowed under law but not competitive
Written Master Repurchase Agreement The Bond Market Association Master Repo Agreement
Independent Safekeeping Money center bank usually
DVP at all times! Mark-to-market daily Collateral Margins (102%) Designated Collateral
Danger: Repo Bank Sweeps
FDIC has no set procedure for liquidation
Losses have occurred Ownership is not clear Securities are segregated in bank’s name Securities remain in bank’s safekeeping account
Rates are slightly higher for a reason
Beyond Liquidity: Securities
Securities
Provide stability in rate changes
May add yield May not be liquid
Needed by all but smallest entities
Liquidity Options
Float, and lag, rates both up and down
Always provide short rate Assure liquidity
Needed by all entities
Investments Choices
US Treasuries US Agencies/ Commercial Paper
corporations, ABS Bankers Acceptances Certificates of Deposit Brokered CD Securities
Repurchase Agreements Money Market Mutual Funds Mutual Funds GICs Investment Pools State of Israel bonds Municipal Obligations [Letters of Credit]
Best Choices for Infrequent Investors
US Treasuries Treasury Bills and Notes Primarily discount securities
US Agencies/Instrumentalities FHLB, FNMA, FHLMC, FFCB Primarily discount structure
Certificates of Deposit FDIC and collateralized Depository FDIC Brokered (with controls)
Money Market Mutual Funds Local Government Investment Pools Other alternatives for today’s special situation
DEPOSITORYCertificates of Deposit
Depository agreements Bank relationship Any bank now allowed but primarily Texas Requires paperwork to create a deposit
Patriot (Terrorist) Act provisions Funds are left in the bank as a deposit
All MUST BE Insured by FDIC or collateralized Above $250,000 requires agreement and collateral Texas collateral rules protect you under PFCA Different collateral types are legal Controlled by PFIA and depository law (Local Gov’t Code Ch.105)
PFIA Language re CD2256.010
(a) Texas CD or CU Share Certificate Insured by FDIC or Nat’l CU Share Insurance Collateralized per PFCA including authorized mortgage backed
securities in PFIA Secured in any manner allowed by law
(b) Brokered CD Invest through Texas bank or Texas broker (on broker list) Fully insured by US or its instrumentality Includes CDARS spread program Limited to $250,000 per bank Broker can custody ---conflict with DVP
CD Confusion
Depository CD
Relationship with bank Paperwork involved Can exceed $250,000 Collateralize > $250,000 Only TEXAS Not on broker list
MERGER PROTECTION
Brokered CD
A registered security Straight buy/sell Can not exceed $250,000 No collateral allowed Any state Can be spread (CDARS) On broker list
NO MERGER PROTECTION
Brokered CDs (Added 2011)
Differentiate “Brokered” CD as securities in policy “Brokered certificate of deposit securities”
Often sold by brokers or banks Legal in Texas -------but only if FDIC insured
A Pool ?? Or??What does your policy say??
These are brokered CDs bought by a pool, not in City’s name and not in their policy.
Policy Language Authorizing Depository CDs
Fully insured or collateralized depository certificates of deposit of banks doing business in Texas, with a maximum maturity of ----- years guaranteed or insured by the Federal Deposit Insurance Corporation, or its successor, or collateralized in accordance with this Policy.
Collateralized CD will be created under a written collateral agreement.
Policy Language AuthorizingBrokered CDs
FDIC insured brokered certificate of deposit securitiesfrom banks in any US state, delivered versus payment to the City’s safekeeping
depository, not to exceed one year to maturity.
Before purchase the Investment Office must verify that the bank is FDIC insured on www.fdic.gov
Controls on Brokered CD
The investment officer must monitor On no less than a weekly basis Status and ownership of the issuing bank
based on FDIC information
If the bank has merged or been acquiredwhere other deposits exist Investment Officer shall immediately liquidate
any brokered CD which places the city above the FDIC insurance coverage
CD Accrual and Payments You purchase a CD:
Par $ 500,000.00 Principal $ 500,000.00 Interest rate 1.50 % Days-to-Maturity 180
Total Earnings = $ 3,750.00 Earning each day = $ 20.83 per day
($500,000 x 1.50%) / 360 x 180
Earnings are from accrued interest only Earnings belong on your monthly/quarterly reports Payments will differ (monthly, quarterly, at maturity) Check it!
Buying an FDIC CD FDIC coverage is permanent at $ 250,000
Decide on your needed maturity date
Phone several banks in Texas for the rate competition Ask for the maturity ranges (3 mo, 6 mo, 1 year) and compare Get all in APY (annual percentage yield) Clarify dates, agreement and certification requirements
Do not use a broker to place a depository CD
Chose the best rate and notify the banks Get instructions to send money Send money on settlement date
Buying A Collateralized CD
Decide on your needed maturity
You will need a collateral agreement Agree on terms and collateral needs Clarify certification
Phone several banks for the rates Get all in APY (annual percentage yield)
Chose the best rate and notify the banks Get instructions to send money Send money on settlement date
Buying a CDARS CD
Check for CDARS banks in Texas (CDARS.com) Currently up to $50 million at $10mm per week
Maturities set at 3,6, and 12 months normally They all settle on Thursdays
Phone or email several banks for the rates Get all in APY (annual percentage yield) Certification only from entrance bank
Chose the best rate and notify the banks Get instructions to send money and agreement for CDARS
Standard CDARS Deposit Placement Agreement Send money on settlement date
Certificate of Deposit Account Registry Service
CDARS Banks in Texas
Other CD Options
Virtual Banks doing business in Texas State Farm Insurance Ally Bank USAA Others?
Stay under FDIC insurance levels Must make investment directly
Check the Rates
Current rates survey (4/7/15):
Ally 1-year CD 1.05% State Farm MMA 0.25% State Farm 1 –year CD 0.10% State Farm 2-year CD 0.40%
Possible for 4a-4b corporations? Rates change normally on Tuesdays – all banks
Reduce Your Collateral Cost Collateral is expensive for banks – and you!
Additional FDIC assessments increase costs On time and demand deposits 10% to 15% possible
Certificate of Deposit Account Registry Service (CDARS) could reduce collateral on time deposits
Manage your collateral and balances Monitor the alternative rates – stay on top of them
CDARS: An Edge for Small Banks
No fee to customers CD rates are negotiated as normal Banks must be members
Promontory Inter-financial Network (700 banks)
Initial test transactions are used City receives consolidated report
Reciprocal or non-reciprocal
Sample CDARS CD
Account ID 1000088888 Product Name 52 week CD Interest Rate 2.350 % Account Balances $ 195,000 Effective Date 01/15/04 Maturity Date 01/14/05 YTD Interest accrued $ 2,291.25 Average Annual & Earned: 2.377 %
CD Issued by Bank X Balances and interest paid/accrued $ …………….
CD Issued by Bank Y Balances and interest paid/accrued $ …………….
Security Basics
Buying Securities At a discount At par At a premium
Reporting Securities Amortized value Book value Market value
The Money Markets
Loose collection of markets Creativity and innovation Structural variety requires knowledge
(embedded options, calls, strips, bullets, etc.) Book entry requires documentation DVP settlement is critical
Two Types of Securities You earn only from principal or interest
Money market = created only 1 year or less Here you earn solely from accretion of principal
US Government > T-Bills US Agencies > Discount Notes Local Government > BANs, TRANs Corporations > Commercial Paper
Fixed income = created only 1 year or more Her you can earn from principal and interest
US Government > Treasury Notes/Bond US Agencies > Agency Notes Local Government > Long-term Bonds Corporations > Corporate Notes
A Word on Security Earning
Earning come from only:
Principal The value of the principal increases
Interest A coupon accrued then pays on a schedule Rate accrues then pays on a fund/pool
Issuance Maturity
100(par)
Bought above par – moves to par
Amount above par is amortized – “expensed”
Bought below par – moves to par
Amount below par is accreted – “earns”
Premium
Discount
Expense
Income
A Word on Security Price
PAR means $100 or $1=$1 Buying at par means you pay the face value
DISCOUNT means below PAR Buying a discount means you pay less than face
PREMIUM means above PAR Buying at premium means you pay more than face
Discount Structures All securities with original maturities < 1 year
Treasury bills Agency discount notes Commercial paper
Quoted at a discount Often close to yield Ask to be quoted yield for comparison purposes
Discount vs. Price
Discount securities are often quoted as a discount Shorthand mechanism for price
Larger the discount = lower the price Know the convention but buy on yield Ask the broker to quote the yield for comparisons
T-Bill A 1.95 discount 99.5016667 price T-Bill B 1.65 discount 99.5783333 price
Discount Securities
Agency discount notes always sold below par Quoted at a discount not a price Only two key elements to know
Discount Listing
Maturity Mat Bid Asked Chg Ask YldDec 16 ‘xx 165 0.68 0.66 -0.03 0.75
Discount Securities Accrete (Gain) Value Over Life
Always bought at a price less than 100
Earn daily and only through accretion
Buying a $100,000 T-Note Price = $ 98,000 You own it 200 days until
maturity Discount/# of days 2,000/200 days= $ 10 / day 97
97.5
98
98.5
99
99.5
100
Purchase Maturity
What You Earn
You buy it at $ 98,000
it matures at $ 100,000
Buying at a “Discount”
Discount notes All securities under one
year at issue or auction T-Bills, CP, Discount notes
Notes at a discount Securities bought below face Book value increases daily in
a straight line
Earnings are difference discount to Par (face)
9293949596979899
100101
Purchase Maturity
Accretion
E
A
R
N
Daily Accretion
You purchased a T-Bill 8/6/12 about 0.11% yield:
Par $1,000,000.00 Principal $ 997,695.69 (book value day 1)
Discount $ 2,304.40 Days-to-Maturity 356
Daily Accretion $ 6.47 (2,304.40/356)
Earnings only from accretion
Ouch !
Security “Notes” Any security is longer than one year when issued or
auctioned is a note Notes move to maturity over time An old 30 year could now be a 1 year note
All notes have a coupon which is ‘fixed’ at issuance * *With a few exceptions The rate is based on the then current rates
The coupon earns = accrues interest
The principal can earn or can be an expense
Notes Bought at a Premium
Buying above par ($1=$1)
Daily amortization is an expense
Premium of $20,000 for 180 days
= $111.11/day
99
99.5
100
100.5
101
101.5
102
Purchase Maturity
Amortization
e x p e n s e
Prices and YieldsMove Inversely
% $
A 5% coupon at par (100)
Coupon = 5% Yield = 5%
Prices and Yields
If Rates Go UP
%
$
A 5% coupon is not worth as much if rates go up so price goes down
Coupon = 5 % Yield = 6 %
Prices and Yields
If Rates Go DOWN
%
$
A 5% coupon is worth more if rates go down so price goes up
Coupon = 5 % Yield = 4 %
Discount or Premium?
T-Note 5% Note - yield of 3.22% A premium or discount ?
T-Note 5% Note - yield of 6.75% A premium or discount ?
US Treasury Obligations
Various types T-Bills, T-Notes, TIPS, Strips Securities are auctioned regularly If you buy at auction then get auction yield Securities then move to the secondary market
Explicit guarantee Based on taxing ability of the US
The ‘certainty’ security Strict guidelines control the auctions and forms
Treasury Bills
Markets hate uncertainty so it loves its certainty and stability Auctions are scheduled with $$ announced
Maturities of 1 year or less No coupon Trade at discount to par 3- & 6-month auctioned every Monday* 4-week auctioned every Tuesday* Settlement & maturities on Thursdays*
Cash Management Bills – one month
*Unless a holiday, then next business day
Buying A Treasury Bill
$100,000 T-Bill maturing 5/27/XX Settling 6/5/xx at 1.11 Discount
The discount price translates into a discount from par
Par $ 100,000.00 Price 94.83322 Principal $ 94,833.22 Discount $ 5,166.78 Yield 1.38 %
Notes
Notes are created starting at 2 years
Notes carry a coupon The coupon is normally ‘fixed’ A few securities coupons change on schedules A coupon accrues for the owner as long as owned When you buy a note you also buy the accrued interest
Notes can be bought at/above/below par
US Treasury Notes
The NO-SURPRISES security
Semi-annual fixed coupons fixed at time of issuance (auction)
Mature on the 15th or last day of month “Currents” (on-the-runs)= most recently auctioned Interest is actual days/actual days of year basis Price quoted as % of par (99,100,101) Usually quoted as YTM
Issuance Maturity
100(par)
Note bought at Premium
Note bought at Discount
Coupon coupon coupon coupon
A note will have coupon accrual during its life in
Addition to possible accretion and amortization.
Buying a Treasury Note
Semi-annual coupons Sold at par, discount or premium Price is percent of face Quoted in 32nds Still only two things to attend to: maturity and yield
T-Note Listing
Rate Maturity Bid Asked Chg Ask Yld1 3/4 Aug xx 97:26 97:28 -3 1.41
Strips
Only Treasury strips are authorized by PFIA
All coupons have been stripped away Only the principal is purchased No payment until maturity Straight line accretion
Creates a long-term discount note Good for targeting specific dates in future Usually start at 5-10 year maturities
Other Treasury Structures
Callables Treasury has a right to call them
Strips (US Government securities) Separate Trading of Registered Interest& Principal zero coupon, wireable, like a long T-Bill
TIPS (a NEGATIVE yield TIPS in 10/10!!) inflation adjusted
Where to find the Treasuries:On the Yield Curve
5
6
7
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr
T-Bills T-Notes T-Bond
A ‘normal’ yield curve
Treasury Rates Abound
US Agencies
Short term agencies Called ‘discount notes’ Some are regularly ‘issued’ and some as needed Non-standard dates created to fill investor needs
Longer term agencies Called ‘debentures’ or agencies Some are set maturities – many are not Different structures created to fit investor or market
US Agencies
Treasuries give markets standardization
Agencies offer more to get your business
Advantages All ‘good day’ maturities Flexible maturity date choices Flexible structures More yield to take ‘risk’ of lower credit
The investor’s advantage in lower credit
Federal Agencies
Agencies most often in the marketplace
FHLB Federal Home Loan Bank
FHLMC in “conservatorship” “Freddie Mac” Home Loan Mortgage Corp
FFCB “Farm Credit” Farm Credit Bank
FNMA in “conservatorship” “Fannie Mae” National Mortgage Assoc.
Government Agencies
Non-standard, semi-annual coupons Varying middle dates
Agency Listing
Rate Maturity Bid Asked Yield
0.75 4-xx 92:20 92:24 1.88
Callable Securities Issuers
Agencies, corporations, public entities
Callable is two securities1. Issuer sells fixed income security to investor
Value = present value of stream of cash flows2. Investor sells option to call to issuer
Value = probability of being exercised based upon current yield curve, a rate of volatility, and time to exercise date
Lock-out period Call protection; initial period during which issuer can’t call bonds
Callable Structures Various structures – 3/1; 5/2; 10/3 “2YNC6 Berm”
European – one-time call Bermuda – “Discrete call”, callable only on interest payment
dates American – “Continuous call”, callable anytime with specified #
of days notice
Step-up callables Fixed coupon to next call date At call date, bonds either called or coupon “steps
up”/increases to structured higher coupon Can have multi-step ups Not the same as floating rate notes
Valuation of Callable Securities
Priced at spread to Treasuries
Yield to Worst (YTW) Which is lesser: Yield to Maturity or Yield to Call
Option Adjusted Spread (OAS) Creates synthetic “bullet” Compare spread from OAS analysis to historical spread for non-
callable securities from same market sector
Structured or Floating-Rate Notes
“Floaters” reset rates periodically
Index
Spreads
Reset Periods
Day Count Periods
Payment Periods
Maturity
Valuation difficulties (accounting variations)
Agencies Come in 2 Varieties
Agencies issue debentures to get funds to buy mortgages
Agency Notes debentures of the agency backed by the credit of the agency Issued like regular discount notes and notes
Mortgage Backed Agencies Created by pools of and backed by home mortgages affected by interest rates and mortgage pay-downs
Some More Securities
Additional types of securities Not used by most public entities
They are legal if in your policy You might want specificity in definitions
Chose your policy securities carefully
Bond Mutual Funds Structure is key – not liquid securities
Moves on market prices – not a straight accrual Must have a maximum WAM of 2 years Not permitted for bond funds because of risk Not much reason to use – especially now
Potential of principal loss in rising rates
Check the fee Use no-load funds total expense ratio
Know the earnings history
Read the prospectus Size Goals and policy restraints
Bond Funds
Must be treasury and agency Bond Proceeds are prohibited by law!! Too much risk of principal loss. Maximum WAM of 2 years
What would that make the maximum maturity??
Short term bond mutual funds Only safe when rates are falling Rising rates may limit your liquidity or lose principal
Look for Morningstar Four Stars **** Watch for rates to turn Watch and check for liquidity terms Reporting will be different Restrict the amount used – primarily for reserves
Corporate Bonds
Only for Higher Education and ISD >50,000
Credit required AA- but higher may be safer
Monitoring required
Mortgage Backed Securities
Built from pools of home mortgages “Pass-through” securities Passes through P&I from homeowner
Stated maturity and expected maturity
Performance of pool dependent on mortgage payments Dependent upon interest rates
Subjective pricing
Basic Mortgage Backed Security (‘MBS’)
Homeowner gets Company sells Agency pools
Mortgage the mortgage like mortgages
As homeowner pays P&I monthly Payments flow
through agency investor
to investor
It all hinges on the homeowner.
Derivative Mortgage Backed
Created for investors clamoring for yield
Pool of mortgages is divided Collateralized Mortgage Obligations (CMO) Each piece (tranche) is structured differently
CMO differ in risk TAC, PAC, Jump-Z, Inverses
CMO
Collateralized mortgage obligations Noble laureates puzzle over some of this math
Pools of mortgages split into pieces
Each piece is structured differently Some carry more risk (and therefore yield)
Certain CMO are unauthorized in TX
Municipal Obligations
Current value over other securities
Taxable and non-taxable issuers In any US state Rated A or above (you may want higher!)
Various structures
Credit and liquidity issues
Arbitrage safe haven
Commercial Paper
Unsecured promissory note of a corporation Corporation is borrowing short term funds Using the low rates of the short term market Often used by municipalities then rolled to longer term debt
Credit Considerations Dual rating is better market-wise Law allows single rating with LOC
Cautions: Stay to known names Consider the situation (like European bank debt!) Stay short and high quality Available out 270 days Stay within 90 days – set your policy as such
Sample CP Policy Language
Commercial paper rated A1/P1 or equivalent by two nationally recognized rating agencies with a maturity not longer than 90 days.
Could stipulate domestic CP only
Asset Backed Commercial Paper
Know what backed the securities
Based on underlying securities or assets Not based on credit of the company
Originally backed by receivables Short-term debt used to finance long term risk
High concentrations threaten funds/pools Florida, Montana, Washington State
Bankers Acceptances Bankers Acceptances
International trade primarily Defined as 270 maximum
Restrict to 90-120 days in policy Illiquid Measure spread vs CP Credit issues Foreign versus domestic?
Israeli Bonds
Issued, assumed or guaranteed by the State of Israel Assumed backing by US Currently 1.20% on 2-year
Denominated in US dollars Longer term Illiquid
Limited-Use Securities GIC
Guaranteed Investment Contracts Basically insurance contracts
Specialized funds [IRS Code Sec 501(f)] Institutions of Higher Education
Municipal utilities Distributing electricity or natural gas Hedging contracts Decommissioning Trust Fund
Mineral Rights Funds Alternate uses for mineral right (gas) funds Barnett Shale impetus
Securities Lending
Authorized after 9/1/03
Reverse repo without buy/sell
Banks and some primaries
50% of income to entity (10-15 bps)
Collateralized
Treasuries (primarily) and agencies only
Larger portfolio use
primarily:
must have
securities to lend
Requires a strategy
Securities Lending Must be at least 100% collateralized with
treasuries, agencies and munis letters of credit from bank rated not less than A commercial paper, mutual funds, or pools
Must allow for termination at any time Collateral must be
pledged to public entity and held in its name deposited at time of the loan
Loan must be with primary or bank in Texas Contract may not be for term longer than 1 year
Can extend
Special Use PFIA Securities
Guaranteed Investment Contracts (GICs) Primarily housing authorities Detailed restrictions on use & collateral
Nuclear De-commissioning funds Long life requires differentiation
Higher Education variations Corporate notes, equities, stock mutual funds NOT for school districts
Securities in General Current Issues Round lot purchases may be better prices Odd lot purchases to buy and hold
Watch for credit warnings and esoteric structures
When it sounds too good to be true…..
BUT… When in Doubt - Don’t!
Portfolio Reporting To show risk
Volatility risk (change in market value)
To provide accounting/archiving Detail for holdings and summary for information
To illustrate compliance Compliance with policy parameters (SLDY)
To judge performance Yield Benchmark comparison
Accounting and Reporting Concepts
Two types of securities Discount securities Fixed income securities (with a coupon)
Two values Market value = price of you sell it – changes daily Book value = your value net of amortization – changes daily
Three computations Interest accrual (coupons) Accretion (earnings) Amortization (expense)
What Did I Earn?
Earnings = accrual plus (net amortization + accrued)
Amortization from notes bought above par decreases earnings
Accretion from notes bought below par increases earnings
Accounting for the Portfolio
Buying securities At par = $1 for $1 face (price of 100) at par Below par = below $1 or 100 at a discount Above par = above $1 or 100 at a premium All affect the principal only
Accounting for securities The book value at maturity must equal face value (100) Straight line amortization/accretion
Earnings from securities are from: Earning from the changes in principal (premium/discount) Earning from interest accrued in a coupon (accrued interest)
Market Value Changes Daily
Market value is quoted as principal only
Market value equals: Current price x face value 101.22 x $100,000 = $101,220 98.3 x $100,000 = $ 98,300
Certificates of Deposit always priced at 100 Market will always equal face amount 100 x $100,000 = $100,000
Fair Market Value
When do I report it?
What is change in market value?
Pricing
Require an independent source
Gains and Losses realized and unrealized
Structured securities can be tricky Calls, step-ups, floaters, indexed, TIPS, pools
Mortgage backed securities need more particularly subjective/judgmental pricing Prepayment speed assumptions, PSA rates
Small issue pricing comparables
Earnings
Earnings = amortization + accrued
Note – bought at a premium1. Monthly amortization = daily amort. * # days plus2. Coupon earnings = coupon rate * face/12
Note – bought at a discount1. Monthly accretion = daily accretion * # days plus2. Coupon earnings = coupon rate * face/12
What did I earn?
Income equals:
Total Accrued + Net Amortization
Investment Earnings recognizes coupon flow (accrued) recognizes original price of security (principal)
Accrual basis does not include cash coupons
Reporting Issues
Accuracy Timeliness Compliance Risk Identification Pricing Value Representation Formats
Information
A Cardinal Reporting Rule Weighting the Information
Recognizes the impact of Dollar value Maturity Yield
$ 10,000 CD 100 days $ 500,000 CD 10 days = 12 day WAM
Weighted Average Maturity
This measure is useful in determining the degree of market or interest rate risk.
The longer the WAM, the more exposure to the market and more potential for capital gains and loses. More risk.
Portfolio managers typically shorten or lengthen average maturities depending on their interest rate outlook. If rates are expected to drop we ------- ? If rates are expected to rise we -------- ?
Calculating Weighted Average MaturityMultiply book value by days remaining to maturity
Divide Sum by total book value of portfolio
Current Book Value
Remaining Days to Maturity
Book x Days
6,568,777 14 91,962,878
3,211,222 48 154,138,656
5,999,158 300 1,799,747,400
1,425,177 540 769,595,580
1,920,575 270 518,555,250
19,124,909 3,333,999,764
3,333,999,764/19,124,909 Equals WAM =
174.3 days
Weighted Average Yield
The weighted average yield will accurately describe the performance of a buy-and-hold portfolio.
Weighted yield is a measure against your benchmark.
This measure does not consider market value impact. This measure reflects the price at which you bought the securities.
Calculating Weighted Average Yield
Multiply book value by purchase yieldDivide Sum by total book value of portfolio
Book Value Purchase Yield Book x Yield
6,568,777 2.25 147,797
3,211,222 2.10 67,435
5,999,158 1.99 119,383
1,425,177 2.75 39,192
1,920,575 3.20 61,458
19,124,909 435,265
435,265 / 19,124,909 Equals WAY =
2.27 %
To Commingle or Not to …..Interest Distribution
How to effectively distribute interest to various funds Replaces separate portfolios May help your overall yield Distributed on a pro rata basis by percent of fund
Accuracy Ease Timeliness
Distributing Interest Total interest to be distributed = $10,000
Fund/ Avg* % of InterestProject Bal Total Received
Fund A $ 150,000 50.49 % $ 5,049.00Fund B $ 40,000 13.40 % $ 1,340.00Fund C $ 101,500 34.43 % $ 3,443.00Fund D $ 5,000 1.68 % $ 168.00
$ 296,500 $10,000.00
*Use either month-end balance or average balance
Specific Report Requirements
Compliance statement and signature “Report was prepared in compliance with the Act and our policy”
Detail Information Each investment position (including bank accounts) with
maturity date Book and market values of each position at end of period Portfolio/fund investment belongs to
Summary Information Beginning and ending market value of portfolio Earnings for the period Market sector summaries
Report Mirror Policy Parameters Key report parameters reflect your policy
Maximum maturity limitations Maximum average maturity limitations Diversification goals and limits Performance benchmarks Philosophy (Strategy) on the portfolio Volatility (change in market value)
not required by PFIA as of 2011
Reports should reflect risk tolerances
Looking in Reports for Risk
Liquidity risk
Extension risk
Volatility risk
Credit risk
Diversification
Detail Description Elements
Description of the holding Type (T-Bill, T-Note, FNMA, CD Bank XX, etc.) Par (face amount) Coupon rate Purchase yield Purchase date )settlement not trade date) Maturity Date (and call date if applicable)
Book value – amortized value of the security Market value – price it could be sold for today
Earnings for the period Accrued + Net Accretion/Amortization
Inventory Report Sample Inventory ReportAs of xx-xx-xx
Purchase Beginning Beginning Ending Ending Mo.Date Security Coupon Maturity Yield Book Market Book Market Earnings
Treasuries
4-5-xx T-Bill 0% 1-16-xx 4.22% 101,486 102,100 102,570 102,100 1,0845-10-xx T-Bill 0% 2-22-xx 4.35% 251,488 252,980 251,999 253,005 5112-4-xx T-Bill 0% 5-15-xx 4.52% 190,025 194,020 192,005 192,401 1,9807-9-xx T-Note 5% 8-15-xx 4.75% 354,898 355,390 354,300 366,980 860
Agencies 11-20-xx FNDN 0% 3-7-xx 4.41% 107,642 107,666 107,999 107,000 357
7-3-xx FHLB 5% 6-4-xx 5.25% 104,567 104,750 104,850 106,010 1,766
CDs 3-5-xx BankOne 4% 3-5-xx 4.00% 98,000 98,000 98,327 98,327 3277-8-xx BankTwo 3% 1-8-xx 3.00% 95,454 95,454 95,691 95,691 237
Pools
xx-xx-xx Pool #1 0% xx-xx-xx 4.37% 120,123 102,123 120,999 120,999 876
TOTALS 1,423,683 1,412,483 1,428,740 1,442,513 7,998
Diversification by Sector
0
10
20
30
40
50
60
70
TreasAgencyCDPool
By Market Sector
Shows diversification
Illustrates Risks Too short Too long Barbelled
Diversification by Maturity
0
5
10
15
20
25
30
35
O/n0-3 mo3-6 mo6-9 mo9-12 mo
By maturity breakdown Shows coverage of liabilities
Funds concentration on near-by liabilities Plus use of longer opportunities
Pool/Fund Reporting Pools and Funds price and value
designed to show risk to investor
Constant dollar (money market equivalents) Price is always $1 Days-to-maturity is always 1 day
Mutual fund equivalents Price is the net asset value or share price that day Days to maturity is the WAM of the underlying portfolio
Benchmarks
Purpose Risk or performance?
Selection with yield versus rate of return Comparability Sector recognition Comparable treasury versus index
Always compare same periods
Benchmarks Measure Risk and Performance
Sample Benchmarks
Comparable Treasury Yields 3-Mo, 6-Mo, 1 Yr
Fed Funds Pools or S&P’s LGIP Index GFOA “Public Investor” Benchmarks Government Bond Indexes
Summaries Tell the Story
Beginning Book Value 10,100,000 Beginning Market Value 10,400,000 Beginning WAM 240 days
Ending Book Value 10,150,000 Ending Market Value 10,500,000 Change in market value 100,000 Earnings for Period 4,160 Ending WAM 280 days
Period Average Yield 2.40 % Period Average Benchmark Yield 2.10 %
If you are more than 0.75% from your benchmark you should know why!
Annual GASB Reporting
GASB focus is on risk
Displays fiduciary responsibility and public trust
Annual risk disclosure Collateral risk Safekeeping risk Volatility risk Credit risk
Government Accounting Standards Board
GASB 31
Fair Market Evaluation Designed to show change in market value Annual reporting only Entry is made and reversed Too much volatility equals volatility risk
Discloses risk created by change of market price
Only used for securities > one year only
GASB 40
Disclosure is aimed at:
Credit risk including credit quality from rating agencies
Interest rate risk disclosure including WAMs and specific derivatives
Interest rate sensitivity Primarily on structured notes
Foreign exchange (currency) risk
Texas PFIA Makes GASB 40 Reporting Easy
All areas are covered by policy and approved by governing body
Reporting Credit Exposures: All Agencies are AAA Credit ratings critical on CP, BA, Corporates Procedure to monitor credit in policies
Reporting Interest Rate Exposures: % Callables or other structured notes
Requires listing of callable and structured notes only
Reporting Interest Rate Exposures: Maximum Maturity Weighted Average Maturity Benchmarks
So what do I do – about reporting
Recognize amortized book value Recognize accretion and amortization
Get independent pricing source
Report monthly if possible – quarterly required Holdings report for detail Management reports/information for summary view
Use benchmarks
How Do I Buy a Security?
Security Transactions Banks
Can sell depository CD or be a broker Broker/Dealers
Can sell securities of different types
Advice and Management Investment Advisers Find, competitively bid and purchase for you Can not sell anything Act as your investment officer
Buying A Security
Set the time horizon and amount Get competitive bids/offers Award the winner Inform the losers Write the trade ticket
Access to the Market
Brokers/dealers access the markets Market distribution process A broker puts buyer and seller together A dealer sells securities from an inventory
US Treasury US Agencies
Corporate entities
-Primary dealer structure
--Selling groups
-- banks and investment bankers
Purchases and Sales
Settlement Cash (same day) Regular (next day)
Bid (sale) vs. Offer (buy)
Independent safekeeping
Settlement
Parties involved: YOU Broker Banks
Timing is critical
Documents are critical
Settlement Require delivery versus payment (DVP)
It is the law No broker safekeeping
Send every broker your delivery instructions Get the instructions from your bank Instructions are your ABA number and account
Document by trade ticket and confirmation Clearing confirmation shows security arrived Safekeeping receipt shows bank is holding the security
ABA 11-12345611for account of ------ District
?
Delivery and Settlement Language
Federal Reserve’s FedWire DTC (Depository Trust Corporation) PTC (Participatory Trust)
Delivery versus Payment Free Delivery
DK (“Don’t know” the trade)
Bankers
Bankers selling a traditional depository CD
Banks acting as a broker
If your bank holds your securities they can not be your broker Does not perfect DVP
Banks are not advisers Still need multiple brokers for competition
New factors for depository CD: Terrorism Act documentation Collateralized versus FDIC funds
Bank CD Trade Settlement
Getting yields from multiple banks Check for details
Day count, coupon pay dates, good maturity
Get Policy Certification
If not FDIC, need Depository Collateral Agreement
Terrorism documentation takes time
Broker or Dealer
Broker No inventory Transaction based FINRA Regulation Capitalization Retail -Institutional
Dealer Maintains inventory FINRA Regulation
Primary Dealer Reports to NY Fed Capital monitored Open market trading
for NY Fed Liquidity provider FINRA
Primary Dealer List www.ny.frb.org
Broker/Dealer vs. Adviser
Broker/Dealers sell a security
Advisers SEC registered as advisers
Must have a CRD #
Can not charge on a transaction/security Portfolio perspective Only an adviser can do competitives for you
Advisers
SEC registered under 1940 Act
A ‘money manager’ who advises and can not sell a security
Discretionary vs non-discretionary management public is always non-discretionary because of cash flows
A ‘broker’ can not be an adviser A broker can not do your competitive bidding
Where is Your Protection
What danger do you really have?????
Peer Experience and References Credit Lines Capital Adequacy
A standard not a guarantee Government Security Dealer Act 1986 (structure) Government Securities Act 1993 (standards)
SIPC INSURANCE ONLY APPLIES FOR BROKER HELD SECURITIES – DO NOT ASK FOR OR DEMAND SIPC
FINRA (Financial Institutions Regulatory Authority) Self regulatory body
FINRA finra.org
Selecting a Broker
Determined by portfolio needs Local versus non-local Primary versus secondary Banks How many brokers? What due diligence?
NEVER use broker safekeeping Your policy and the law say DVP settlement move securities to your depository bank
Certification in Texas 2256.005(k)
This is not a guarantee – it affords little or no protection
Policy must be given to any person offering to engage in an investment transaction Brokers and bankers (including pools and advisers)
“execute a written instrument in a form acceptable to the investing entity…and the business organization substantially to the effect that” Firm has received and reviewed the policy Firm has established controls to sell only approved securities
Nothing relieves the entity from responsibility for monitoring for policy compliance
Some brokers view of certification…
POLICY CERTIFICATION FORM as required by Texas Government Code 2256.005(k)
________________ (the “Entity”) ________________ (the “Firm”)
I AM A BROKER. I HAVE PERUSED THE POLICY. I WILL TRY KINDA, SORTA, MAYBE, PERHAPS ATTEMPT TO NOT SELL YOU
ANY OF THE FUNKY, *&$^%% SECURITIES MY DESK OFFERS.
Firm: _______________________________________
Signature _______________________________________
Annual Broker/Dealer List
PFIA requires an annual adoption of list Investment committees can adopt list Any firm on list must have provided certification
List is for broker/dealers only Banks may change as CD rates are found Pools are already authorized by Board action
May list banks and pools for information
Documents for Your Broker
Before Selection Questionnaire Investment Policy Certification
After Selection CAFR Trading Authorization Your delivery instructions Tax identification number No account application (safekeeping agreement)
Broker Dealer Questionnaires Differentiate between brokers and primary brokers
All brokers: firm information contact broker information delivery instructions public client references
Non-Primary Brokers: market sector involvement
Basic Questionnaire Info
Name of Firm: __________________ CRD #___________________Address: ___________________________________________________ Primary Representative on account: ___________________________________Telephone: ________________ Fax: _______________________________
E-Mail: ______________________________________________Broker CRD# ___________________________Backup representative or trading assistant: ______________________________Telephone: ___________________________________________ E-mail: ___________________________________________Branch Manager: ___________________________________________Telephone: ______________________________________ Fax: ____________________________________________ E-Mail: ____________________________________________
QuestionnaireIs the firm designated as a Primary Dealer by the Federal Reserve? __________________Is the firm registered with the tx State Securities Board? __________________________Is the firm and representative registered with FINRA? ___________________________How long has the designated representative been an institutional fixed income broker at this firm? ____________________In total? _____________________
In what market sectors does the account representative specialize? Treasuries ? _________ Agencies? _________ MBS? _________
Delivery instructions: ___________________________________________________
All transactions will be completed delivery versus payment.
Non-Primary Information
FINRA Registration and CRD Report State Securities Registration Market Involvement Public Sector Involvement References
Audited Financial Statements provided annually
So what do I do…?
Finding brokers to use Peer group ideas and references Use at least 3 – bank/broker
Use at least one primary and all institutional brokers Feel comfortable with the person
It’s a telephone market – no need to meet
Establishing a relationship Talk about your policy and limits Get basic information
Backup person and numbers Delivery instructions
Send your policy and certifications Modified certifications
And then what…?
Making an investment Set your time horizon
Set the maximum maturity date
Tell the brokers what you need/want “I need the best rate not past xx/xx/xx in an agency or
treasury”
Wait for them to do the research They will bring back alternatives for you to chose from
Make the decision Inform them all what you bought (the “cover”) Feedback is important
And then…….?
You chose on date and yield Do not go past your due date if it is set Chose the highest yield (true or gov’t yield)
Settling the security The broker has your delivery instructions Tell your bank it is coming (trade ticket) Broker will send the bond to the bank
Investment Steps
Set your maximum date (your time horizon)
Set your maximum money to invest
Have a general idea of where rates are
Look at value in all markets available
Look at them all !
Check the alternatives authorized for you:
CD 3.01 % T-Bill 3.85 % FNMA disco 4.01 % FNMA note 4.00 % FHLMC note 4.07 % SLMA note 4.09 % TVA note 4.12 %
What are your considerations?
The Buying Decision
Determine the maximum maturity (time horizon) Do not go beyond that maturity Request offers short of or on that date
Offers will differ in maturity and type Are they all authorized? Do they fit diversification? Do I know what they are?
Chose the best yield
Active StrategiesExpand on the Same Basics
Advantages Improved yields
Utilize market opportunities
Techniques yield curve analysis (rate anticipation) riding the curve spread and sector analysis market timing swaps
Larger Entities
Some “core” cash Fund types provide additional opportunity Annual review required Rewards and responsibilities
One or more constant dollar pools Bank sweep accounts Flex for large bond funds Ladder of securities matching liabilities
Steps in Developing a Market View
1. Perspective on world and geo-political situation
2. View of business environment
3. Market and economic conditions Yield curve movement Relative value
4. Your unique situation
So what do I do – about all this
Do your cash flow Write your policy Choose at least two brokers and qualify them Create a short term ladder
Out to 4-6 months Create a longer term ladder
if rates are favorable to go further If not move extra funds to the “high” point in rates
Do competitive bidding Do delivery versus payment Get started!
Be careful – Get started –Good luck!
Linda T. PattersonPatterson & Associates
Austin, [email protected]