Life of an ActLife of an Actand How to Live with Itand How to Live with It

Texas Public Funds Investment ActTexas Public Funds Investment ActLocal Government Code – Ch. 2256Local Government Code – Ch. 2256

1987 to the Present1987 to the Present

Before 1987Before 1987

Local governments – except home Local governments – except home rule entities – were bank dependentrule entities – were bank dependent

Most used bank accounts and CDsMost used bank accounts and CDs Home rule cities could use the Home rule cities could use the

money markets – and didmoney markets – and did The PFIA was created and passed The PFIA was created and passed

initially in 1987initially in 1987

Hanging with the TimesHanging with the Times

Starts to provide opportunity

Grows as the opportunities are recognized

Grows as markets and access is identified

Reacts as fears arise from market events

Grows with greed in low rate periods And will

continue to develop ……..

1987 – The Basics1987 – The Basics

Defined the entitiesDefined the entities Set collateral at 100%Set collateral at 100% Authorized specific investmentsAuthorized specific investments

CDsCDs US obligations including agencies/instrumentalitiesUS obligations including agencies/instrumentalities Repurchase agreementsRepurchase agreements Any bond guaranteed by TexasAny bond guaranteed by Texas

Required an Required an investment policyinvestment policy Established theEstablished the Prudent Person Rule Prudent Person Rule as as

standardstandard

19891989

PoolsPools were added through ILCA were added through ILCA Pools were only generally defined and Pools were only generally defined and

assumed to be constant dollar, money assumed to be constant dollar, money market equivalentmarket equivalent

ReverseReverse repurchase agreements added repurchase agreements added Commercial paperCommercial paper added added Bankers acceptancesBankers acceptances added added

The Public Funds The Public Funds Collateral ActCollateral Act was created was created and passedand passed

19911991

LimitsLimits in money market funds were in money market funds were raised to specify use of authorized raised to specify use of authorized investment types onlyinvestment types only

LimitsLimits on which funds could be used on which funds could be used in mutual funds were setin mutual funds were set Bond funds can never be put in mutual Bond funds can never be put in mutual

fundsfunds Fear of loss of principal for bondholdersFear of loss of principal for bondholders

1993 – Some Bad Timing1993 – Some Bad Timing Use of Collateralized Mortgage-backed Use of Collateralized Mortgage-backed

Obligations (Obligations (CMOsCMOs) were added) were added

Specific requirementsSpecific requirements were added for pools were added for pools including disclosure of pertinent information including disclosure of pertinent information through information statements, confirmations through information statements, confirmations and monthly reports.and monthly reports.

Written Written strategiesstrategies were now required with were now required with governing body approvalgoverning body approval

Israeli Notes addedIsraeli Notes added

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1995 – Burned by CA1995 – Burned by CA ProhibitionProhibition added on certain MBS/CMOs added on certain MBS/CMOs

Reverse repurchase agreements were Reverse repurchase agreements were restrictedrestricted by term and by term and tied to the reverse termtied to the reverse term

TrainingTraining for investment officers was added for investment officers was added

Policy Policy certificationcertification requirement added requirement added ““imprudent investments”imprudent investments”

Added Added maximummaximum maturities and WAM maturities and WAM

Investment officers had to be Investment officers had to be designateddesignated

Written quarterlyWritten quarterly reports new required reports new required

1995 – and Some Additions 1995 – and Some Additions State agency training addedState agency training added

TX Higher Ed Coordinating Board to provideTX Higher Ed Coordinating Board to provide

Prior authorized investments not required to be Prior authorized investments not required to be liquidatedliquidated is is authorization is removedauthorization is removed

Pools must be rated no less than Pools must be rated no less than AAAAAA

Municipalities with utilities authorized to Municipalities with utilities authorized to hedgehedge

State purchase and State purchase and deliverydelivery of securities of securities

Loss of required rating requires Loss of required rating requires prudent measuresprudent measures to liquidate to liquidate

State Treasury was abolished and transferred to ComptrollerState Treasury was abolished and transferred to Comptroller

19971997

Investment officer Investment officer training extendedtraining extended to 10 to 10 hours within 12 months and every two hours within 12 months and every two yearsyears

Delivery versus paymentDelivery versus payment added added

Officer Officer disclosuredisclosure added added

List of List of brokersbrokers must be approved annually must be approved annually

19991999

Investment Investment advisersadvisers added with contracts added with contracts Initial 2-year period then no limitInitial 2-year period then no limit

Annual Annual compliance auditscompliance audits added added

GICs addedGICs added

Municipal utilityMunicipal utility section added for section added for sale/distribution of gas/electricity allowing sale/distribution of gas/electricity allowing hedging for supplieshedging for supplies

20012001

Water code directors excluded from Water code directors excluded from some training requirementssome training requirements

Letters of creditLetters of credit added as added as government obligation for PFCAgovernment obligation for PFCA To cut bank costs on collateralTo cut bank costs on collateral

20032003

Securities lendingSecurities lending section added section added New service push by banks for feesNew service push by banks for fees CollateralizedCollateralized Primary dealer or TX bank onlyPrimary dealer or TX bank only

Expansion of investment authority Expansion of investment authority now requires state audit reviewnow requires state audit review [Obviously gutless.. As we will see][Obviously gutless.. As we will see]

20052005 CD definitionCD definition changes changes

““domiciled” became “main office or branch in TX”domiciled” became “main office or branch in TX” Codification induced – same requirementCodification induced – same requirement

Added ability to use Added ability to use CDARSCDARS Entry bank must be in TexasEntry bank must be in Texas Reciprocity requiredReciprocity required Safe spreading of CD fundsSafe spreading of CD funds

Decommissioning trust fundsDecommissioning trust funds investment investment authority expanded to include Trust Codeauthority expanded to include Trust Code Gas or electricity utilities selling to publicGas or electricity utilities selling to public

20072007

Municipal Municipal hedginghedging on coal and on coal and nuclear fuel expanded to commodity nuclear fuel expanded to commodity futures and related transportation futures and related transportation costscosts

20092009

Municipalities with Municipalities with mineral rightsmineral rights leases and contracts expanded leases and contracts expanded investment authorityinvestment authority Barnett Shale and Eagle Ford impetusBarnett Shale and Eagle Ford impetus Includes oil, gas or other mineral rightsIncludes oil, gas or other mineral rights Establishes a Trustee authorityEstablishes a Trustee authority Funds must be separated Funds must be separated Investments can be made under Trust Investments can be made under Trust

CodeCode

2011 – A Rush to Yield2011 – A Rush to Yield Proposed for 2011Proposed for 2011 Corporate notes/bonds for CIP funds Corporate notes/bonds for CIP funds

ISDs with >50,000 students onlyISDs with >50,000 students only Born of low interest rates and g---dBorn of low interest rates and g---d

Investing in employee life insurance policy Investing in employee life insurance policy from employee (!!)from employee (!!) Your city as your beneficiary - yikesYour city as your beneficiary - yikes

Remove change in market value from Remove change in market value from reportingreporting

A requirement for 5% of A requirement for 5% of everyevery portfolio in portfolio in Texas based corporations (!!)Texas based corporations (!!) Could economic development be speaking here?Could economic development be speaking here?

2011 Additional Proposals2011 Additional Proposals Policy must include procedures to monitor credit Policy must include procedures to monitor credit

ratings and procedures to liquidateratings and procedures to liquidate State agency training for officers tied to the State agency training for officers tied to the

bienniumbiennium Local government training tied to fiscal years as Local government training tied to fiscal years as

starting pointstarting point Authorized investment full faith and credit of FDICAuthorized investment full faith and credit of FDIC Pools can invest total funds in a money market fundPools can invest total funds in a money market fund Pools must say how yield is calculatedPools must say how yield is calculated Pools must have financial statements available to Pools must have financial statements available to

usersusers Pools report differences based on amount of funds Pools report differences based on amount of funds

investedinvested

What is the law supposed to do?What is the law supposed to do?

Provide guidelines for Provide guidelines for safetysafety

Apply to all entitiesApply to all entities Let local entity decide based on unique situations and Let local entity decide based on unique situations and

conditionsconditions Allow entities to set their own parametersAllow entities to set their own parameters WAM and maturities and authorized investmentsWAM and maturities and authorized investments

Define Define guidelinesguidelines on investments on investments Set limits for high credit quality and safetySet limits for high credit quality and safety

Provide for flexibility (maturity)Provide for flexibility (maturity) To fulfill local needsTo fulfill local needs

Provide for control on extension risk (WAM)Provide for control on extension risk (WAM) To control volatility which represents To control volatility which represents riskrisk

How should/must you comply?How should/must you comply?

Address you own local considerationsAddress you own local considerations Risk tolerance limits Risk tolerance limits Cash flow needsCash flow needs Build your own from a wide variety of Build your own from a wide variety of

choiceschoices

Establish set compliance schedule Establish set compliance schedule

Specific PFIA Specific PFIA RequirementsRequirements

Write a PolicyWrite a Policy (2256.005)(2256.005)

Emphasize safety and liquidityEmphasize safety and liquidity

Address diversification, yield, maturity & Address diversification, yield, maturity & capabilitycapability

List authorized investmentsList authorized investments

Set a maximum maturity and WAMSet a maximum maturity and WAM

Tell how prices are monitoredTell how prices are monitored

Require DVPRequire DVP

Review and Review and adoptadopt policy annually policy annually

PFIA RequirementsPFIA Requirements

2256.005d 2256.005d Write a Write a StrategyStrategy 2256.005e 2256.005e Review and Review and adoptadopt strategy annually strategy annually 2256.005f 2256.005f Designate an Designate an investment officerinvestment officer 2256.005i 2256.005i DiscloseDisclose personal/business personal/business

relationshipsrelationships 2256.005k 2256.005k Provide policy for written Provide policy for written certificationcertification 2256.005m 2256.005m Obtain annual management Obtain annual management auditaudit 2256.008 2256.008 Provide for Provide for trainingtraining 2256.023 2256.023 Report Report quarterly for Board approvalquarterly for Board approval

Other PFIA ItemsOther PFIA Items

.005 CDs bought orally and in writing.005 CDs bought orally and in writing .005 .005 Ethics considerationsEthics considerations .005 May specify unauthorized investments.005 May specify unauthorized investments .006 .006 PrudencePrudence is based on the whole portfolio is based on the whole portfolio .017 No need to liquidate if authorized at .017 No need to liquidate if authorized at

purchasepurchase .021 Prudence to liquidate at .021 Prudence to liquidate at loss of ratingloss of rating .025 Mineral rights funds (added in 2009).025 Mineral rights funds (added in 2009) .024 Chapter is sub-cumulative to other law.024 Chapter is sub-cumulative to other law

Who is Covered?Who is Covered?

Local entities and schoolsLocal entities and schools State agenciesState agencies Higher educationHigher education

Not:Not: Pension fundsPension funds Veterans Land Board fundsVeterans Land Board funds County registry fundsCounty registry funds Deferred compensation fundsDeferred compensation funds Securities donated to entities (except once Securities donated to entities (except once

liquidated)liquidated)

Number One in PriorityNumber One in Priority

Write an Write an Investment PolicyInvestment Policy Must be Must be adoptedadopted by governing body by governing body

annuallyannually Resolution must include Resolution must include changes changes made made

List the type of investments authorizedList the type of investments authorized Limit by maturity and perhaps qualityLimit by maturity and perhaps quality Such as: LGIP “constant dollar”Such as: LGIP “constant dollar”

Set a Set a maximum maturitymaximum maturity of of anyany security security Require delivery versus payment (Require delivery versus payment (DVPDVP) !!!) !!! (Allows for (Allows for allall transactions to be verbal) transactions to be verbal)

Governing Board DutiesGoverning Board Duties

Regardless of ‘investor’ they retain ultimate Regardless of ‘investor’ they retain ultimate fiduciary responsibilityfiduciary responsibility

Approve investment policy annuallyApprove investment policy annually Approve written strategy annuallyApprove written strategy annually Designate investment officersDesignate investment officers Review, revise, adopt broker/dealers list Review, revise, adopt broker/dealers list

annuallyannually Provide for training for officersProvide for training for officers

Approve training organizationsApprove training organizations Receive and review quarterly reportsReceive and review quarterly reports

Investment OfficersInvestment Officers

Must be designated by governing bodyMust be designated by governing body

Serves until removed or leaves entityServes until removed or leaves entity

Allowed to transfer, deposit, withdraw, Allowed to transfer, deposit, withdraw, and manageand manage Put language in resolution to avoid Put language in resolution to avoid

corporate resolutions later requiredcorporate resolutions later required

Investment Officers MustInvestment Officers Must Attend investment trainingAttend investment training

10 hours within 12 months of obtaining responsibilities10 hours within 12 months of obtaining responsibilities 10 hours every two years10 hours every two years By organization approved by governing bodyBy organization approved by governing body TreasurerTreasurer, or CFO if not Treasurer, , or CFO if not Treasurer, andand investment officer investment officer Board Treasurer assumed to require trainingBoard Treasurer assumed to require training Organizations report attendance to ComptrollerOrganizations report attendance to Comptroller

Exercise prudenceExercise prudence

Disclose potential conflict relationshipsDisclose potential conflict relationships By blood or marriageBy blood or marriage Disclose to governing body and TX Ethics CommissionDisclose to governing body and TX Ethics Commission

Provide policy for certification to anyone attempting to sell Provide policy for certification to anyone attempting to sell offering to engage in an investment transactionoffering to engage in an investment transaction

Investment Officers MustInvestment Officers Must Only transact with entities which have Only transact with entities which have

provided policy certificationprovided policy certification Broker/dealers, banks and poolsBroker/dealers, banks and pools

Must perform an annual compliance audit Must perform an annual compliance audit and audit management controlsand audit management controls Compliance with Act and your PolicyCompliance with Act and your Policy State agencies perform only bi-annuallyState agencies perform only bi-annually

If invested in other than CDs and poolsIf invested in other than CDs and pools Must have auditor review quarterly reportsMust have auditor review quarterly reports

Investment Officers MustInvestment Officers Must

On loss of a required ratingOn loss of a required rating Take ‘prudent measures’ to liquidateTake ‘prudent measures’ to liquidate In accordance with your policyIn accordance with your policy Primarily refers to commercial paper, BA, pools Primarily refers to commercial paper, BA, pools

and municipal notes/bondsand municipal notes/bonds

On newly ‘unauthorized’ securityOn newly ‘unauthorized’ security No need to liquidate if authorized at time of No need to liquidate if authorized at time of

purchasepurchase Prudence is still your guidelinePrudence is still your guideline

Investment Officers MustInvestment Officers Must Provide for Provide for quarterly quarterly reportingreporting

Requires Officer knows accounting rulesRequires Officer knows accounting rules

Describing in detail the positionsDescribing in detail the positions Book Book and and marketmarket values are required values are required Trying to show volatility (change in market)Trying to show volatility (change in market) Full earnings (interest accrues + amortization)Full earnings (interest accrues + amortization) Give summary information (diversification)Give summary information (diversification)

Must be signed by IO as in complianceMust be signed by IO as in compliance With policy and the ActWith policy and the Act

Broker/Dealers MustBroker/Dealers Must

Review you policyReview you policy

Complete a policy certificationComplete a policy certification

Not a guarantee or safeguardNot a guarantee or safeguard Don’t fool yourself the responsibility is Don’t fool yourself the responsibility is

yours!yours!

Investment CommitteesInvestment Committees

Only mentioned once in ActOnly mentioned once in Act

Can approve broker/dealer list Can approve broker/dealer list annuallyannually As opposed to governing body passageAs opposed to governing body passage

Security SpecificsSecurity Specifics

All must be delivered DVPAll must be delivered DVP NO broker safekeepingNO broker safekeeping No No brokerbroker advisors advisors Know the playersKnow the players

An entity can ‘un-authorize’ An entity can ‘un-authorize’ securities in policysecurities in policy

Act’s Unauthorized SecuritiesAct’s Unauthorized Securities All unauthorized are All unauthorized are mortgage backedmortgage backed

securitiessecurities These are not the debentures of an agencyThese are not the debentures of an agency Interest OnlyInterest Only MBS MBS – IO – pay only interest and no – IO – pay only interest and no

principalprincipal Principal Only MBS – PO – pay only principal and no Principal Only MBS – PO – pay only principal and no

interestinterest CMOS with stated maturities over 10 yearsCMOS with stated maturities over 10 years Inverse Floaters – float inversely on indexInverse Floaters – float inversely on index

Easy way to eliminate danger is in authorized Easy way to eliminate danger is in authorized listlist Obligations of US, its agencies and instrumentalities Obligations of US, its agencies and instrumentalities

excluding mortgage backed securitiesexcluding mortgage backed securities

US ObligationsUS Obligations

Treasury Bills, Notes and the ‘Bond’Treasury Bills, Notes and the ‘Bond’ Agencies and InstrumentalitiesAgencies and Instrumentalities

GSE – government sponsored enterprisesGSE – government sponsored enterprises A note on FNMA and FHLMCA note on FNMA and FHLMC

Under conservatorship until 1/1/14Under conservatorship until 1/1/14 Currently full faith and credit of USCurrently full faith and credit of US

Other obligations insured full faith & Other obligations insured full faith & creditcredit Basically GNMABasically GNMA

US ObligationsUS Obligations

Set your maximum maturitySet your maximum maturity These extend to 30 years by definitionThese extend to 30 years by definition

Certificates of DepositCertificates of Deposit MUST BE in TexasMUST BE in Texas Can not be “brokered” or “securitized” CDsCan not be “brokered” or “securitized” CDs

Must be collateralized above FDIC coverageMust be collateralized above FDIC coverage

May be CDARS (cdars.com) May be CDARS (cdars.com) initiatlly placed in TX bankinitiatlly placed in TX bank Protects from merger and acquisition dangers of Protects from merger and acquisition dangers of

undercollateralization/insuranceundercollateralization/insurance

Don’t have to be but you need to bid Don’t have to be but you need to bid competitively!!competitively!!

Repurchase AgreementsRepurchase Agreements Must have:Must have:

Defined termination dateDefined termination date Collateral defined by ActCollateral defined by Act An independent custodianAn independent custodian A primary dealer or TX bank as counterpartyA primary dealer or TX bank as counterparty A Bond Market Association Master AgreementA Bond Market Association Master Agreement

Securities Lending – a form of RepoSecurities Lending – a form of Repo TX Bank or primaryTX Bank or primary Specific reinvestment optionsSpecific reinvestment options Same pledging and custody requirementsSame pledging and custody requirements Agreement can only be one year in durationAgreement can only be one year in duration

Money Market AlternativesMoney Market Alternatives

Commercial PaperCommercial Paper Must be: Must be:

A1/P1 by two NRSRO A1/P1 by two NRSRO or one rating and an irrevocable LOCor one rating and an irrevocable LOC Law states 270 days but you should use 90!

Banker AcceptancesBanker Acceptances Must be:Must be:

Able to liquidate at maturityAble to liquidate at maturity Same credit requirementsSame credit requirements Law states 270 days but you should use 90 or 180

days

Money Market Mutual FundsMoney Market Mutual Funds

Must be:Must be: Registered with and regulated by SEC Registered with and regulated by SEC

which includes all Act requirementswhich includes all Act requirements

Will always have a net asset value of Will always have a net asset value of $1$1

Note: Require rating in Policy for Note: Require rating in Policy for GASBGASB

Mutual FundsMutual Funds

Must:Must: Only have ACT authorized investmentsOnly have ACT authorized investments Registered and regulated by SECRegistered and regulated by SEC Average WAM less than 2 yearsAverage WAM less than 2 years Be AAA ratedBe AAA rated

Not authorized for any bond fundsNot authorized for any bond funds

Note: these represent a real potential for Note: these represent a real potential for loss of principalloss of principal

PoolsPools Built on Interlocal Cooperation ActBuilt on Interlocal Cooperation Act

Requires governing body action to join cooperativeRequires governing body action to join cooperative Has specific reporting requirement built on MMMFsHas specific reporting requirement built on MMMFs Must basically have a Policy available to allMust basically have a Policy available to all Must report all transactions and balancesMust report all transactions and balances Must establish a ½ cent collar on $1 poolsMust establish a ½ cent collar on $1 pools

Need Need notnot be constant dollar be constant dollar

Investment Officer Investment Officer mustmust understand their pool understand their pool

Special: Higher EducationSpecial: Higher Education

Sponsored cash management and Sponsored cash management and investment pools (Common Fund)investment pools (Common Fund)

Bank issued Bank issued negotiable certificates of negotiable certificates of depositdeposit with banks rated at least 1 or A1/P1with banks rated at least 1 or A1/P1

Corporate bonds Corporate bonds Investment grade (two highest ratings)Investment grade (two highest ratings) Primarily for foundation usePrimarily for foundation use

Special: Municipal UtilitySpecial: Municipal Utility

Electric utility or sales of natural gasElectric utility or sales of natural gas

Hedging contracts for supplies or Hedging contracts for supplies or reservesreserves

Fuel oil, natural gas,coal, nuclear Fuel oil, natural gas,coal, nuclear fuel, elctric futures/options fuel, elctric futures/options Including transportation costsIncluding transportation costs

Special: Mineral RightsSpecial: Mineral Rights

Funds from a lease or contractFunds from a lease or contract

Must be separately reported and Must be separately reported and investedinvested

Must be estbalished as a Trustee Must be estbalished as a Trustee

Can use Trust Code (basically anything!)Can use Trust Code (basically anything!)

Special: Decommissioning TrustsSpecial: Decommissioning Trusts

Nuclear Regulatory Commission TrustsNuclear Regulatory Commission Trusts

Regardless if public funds by PFIA Regardless if public funds by PFIA definitiondefinition

Basically uses Trust CodeBasically uses Trust Code Most cities use long treasuries or mutual Most cities use long treasuries or mutual

funds funds

Special: Housing Authority BondsSpecial: Housing Authority Bonds

Mortgage pass throughs certificatesMortgage pass throughs certificates Individual mortgage loansIndividual mortgage loans

Compliance with the PFCompliance with the PFCCAA

Public Funds Collateral ActPublic Funds Collateral Act

Prevails over all other lawsPrevails over all other laws

Public funds over FDIC limits must be Public funds over FDIC limits must be collateralized collateralized

Amount = principal Amount = principal plusplus accrued interest accrued interest Requires 100% collateralizationRequires 100% collateralization School districts require 110% on MBS onlySchool districts require 110% on MBS only

PFCA RequirementsPFCA Requirements Entity shall inform bank of $$ Entity shall inform bank of $$ changeschanges in deposits in deposits

Entity Entity mustmust have a have a collateral policycollateral policy Put it inside your investment policy as sectionPut it inside your investment policy as section Designate what you will accept as collateralDesignate what you will accept as collateral Provide for substitutionProvide for substitution Methodology used for valuing securitiesMethodology used for valuing securities

Collateral AgreementCollateral Agreement must: must: Conditions for possession (safekeeping by bailee)Conditions for possession (safekeeping by bailee) Ownership provisions – on and off events of defaultOwnership provisions – on and off events of default Subsitution rightsSubsitution rights Events of default actionsEvents of default actions

PFCAPFCA Custodian must be approved by the entityCustodian must be approved by the entity

CustodianCustodian Your bailee – pay attentionYour bailee – pay attention State or national bank, TTSTC, capital stock >$5 million, State or national bank, TTSTC, capital stock >$5 million,

FHLBFHLB

Custodian must:Custodian must: Immediately identify securities on their booksImmediately identify securities on their books Promptly deliver a “trust receipt” to entityPromptly deliver a “trust receipt” to entity Keep separate and accurate booksKeep separate and accurate books File a collateral report with Comptroller (Comptroller’s File a collateral report with Comptroller (Comptroller’s

manner)manner) SHOULD send you a collateral report monthly!SHOULD send you a collateral report monthly!

PFCAPFCA

Collateral Pooling estbalished in 2009Collateral Pooling estbalished in 2009

Voluntary basis for bank and entityVoluntary basis for bank and entity

Probably will not be implemented Probably will not be implemented

So what do I do??So what do I do?? Analyze your cash needs and decide risk tolerancesAnalyze your cash needs and decide risk tolerances

Chose securities you understandChose securities you understand

Chose and designate investment officer(s) by resolutionChose and designate investment officer(s) by resolution

Write your investment policy and strategyWrite your investment policy and strategy

Get Council approval of policy and strategyGet Council approval of policy and strategy Use one resolutionUse one resolution

Set up brokers/banks/poolsSet up brokers/banks/pools Council action required on pools onlyCouncil action required on pools only

Have officer(s) disclose relationships,Have officer(s) disclose relationships, if if applicableapplicable

It only hurts for a short time..It only hurts for a short time..

The foundation is critical The foundation is critical

The Acts are there to assist and The Acts are there to assist and guideguide

Linda T. PattersonLinda T. Patterson

Patterson & AssociatesPatterson & Associates

Austin, TXAustin, TX

linda@patterson.netlinda@patterson.net