TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL
FROM: DENNIS McLEAN, DIRECTOR OF FINANCE AND INFORMATION TECHNOLOGY
DATE: DECEMBER 6, 2005
SUBJECT: REVISED CITY INVESTMENT STRATEGY
It is recommended that the City allocate approximately 60% (or approximately $8.23 million or 30.8% of the total investment portfolio for fiscal year 2005-2006) of the remaining monies in the total investment portfolio to short-term securities as follows:
50% 3-Month Treasury Bills (Mature in December)
50% 6-Month Treasury Bills (Mature in April)
It is further recommended that the City invest the residual 40% (or approximately $5.5 million or 20.5% of the total investment portfolio for fiscal year 2005-2006) of the total investment portfolio in U.S. Government-backed securities as follows:
66% 1-Year Over-the-Counter (OTC) Treasuries
Attachment:
Exhibit A – Fieldman, Rolapp Financial Services Memorandum
MEMORANDUM
To: Dennis McLean, Finance Director
From: Michelle Durgy, Senior Associate
cc: Kathryn Downs; Gary Gyves; Jim Fabian
Re: Cash Flow Analysis and Investment Recommendation
Date: November 15, 2005
Pursuant to the City’s request, Fieldman, Rolapp Financial Services has been engaged to propose an investment strategy for the City of Rancho Palos Verdes based on the City’s investment policies coupled with the City’s current and projected cash flow needs. The City’s Finance and Information Technology Staff has requested that a passive investment strategy be utilized. It is recommended that the following investment strategy be implemented for the City’s total excess cash, which for the purposes of this recommendation is defined as total investment portfolio.
PORTFOLIO RECOMMENDATION
- Liquid Securities
- Short-term Securities
- Long-term Securities
It is recommended that the City keep an amount equivalent to the projected total general fund expenditures for the current fiscal year in a stable, highly liquid, investment vehicle. According to the Adopted Budget for fiscal year 2005-2006, the amount of total general fund expenditures equates to approximately $13.1 million or approximately 48.7% of the City’s total investment portfolio. Options include money market funds, money market savings accounts and the State’s Local Agency Investment Fund (LAIF). LAIF is the preferred option due to the high degree of safety, liquidity and yield it offers.
It is recommended that the City allocate approximately $8.23 million (or 30.8% of the total investment portfolio for fiscal year 2005-2006) to short-term securities. Short-term securities, as stated in the City’s Investment Policies for fiscal year 2005-2006, include Certificates of Deposit (FDIC-insured), Repurchase Agreements (no longer than seven days), and Treasury bills (days, four weeks, 13 weeks, and 26 weeks). Provided that Treasury Bills have the highest degree of safety and market liquidity, it is suggested that the City allocate the monies accordingly:
50% $4.11 million 3-Month Treasury Bills (mature in December)
50% $4.11 million 6-Month Treasury Bills (mature in April)
It is further recommended that the City invest approximately $5.5 million (or 20.5% of the total investment portfolio for fiscal year 2005-2006) of the total investment portfolio in U.S. Government-backed securities. The precise allocation is recommended as follows:
66% $3.63 million 1-Year Over-the-Counter (OTC) Treasuries
34% $1.87 million 2-Year GNMA (Ginnie Mae) Note
DATA ANALYSIS AND METHODOLOGY
In order to make proper investment selection and allocation percentages, it is necessary to determine the liquidity needs of the portfolio. A portfolio’s liquidity needs can best be assessed through matching cash flows to maturities. This recommendation was based on the results of a series of cash flow analyses utilizing annual and monthly data reports. In the first step, historical data on recurring cash flow streams was reviewed. Secondly, cash flow projections were analyzed as documented in the City’s 2005 Five-Year Financial Model. Interruptions (non-recurring events, such as inflows from insurance proceeds or outflows from land purchases) in cash flows were evaluated.
Discussions with the staff members of the City’s Finance and Information Technology Department revealed that the annual budget for the City’s Capital Improvement Program ranged between $4-6 million from 1998-2003. The current Capital Improvement Fund budget for fiscal year 2005-2006 is about $10 million, including projects carried over from the previous fiscal year. Based upon these discussions, it is also noted that there is a significant amount of uncertainty regarding the possibility of future emergency repairs and a substantial likelihood for the City’s general fund expenditures to rise dramatically over the next five years.
An analysis of the City’s monthly cash flow was performed over the period from July 2004 through June 2005. Specifically, an analysis in the difference in debits and credits per month yielded a range of $2.35 million positive balance to $2.45 million negative balance. The range here equates to fluctuation of nearly $5 million with the highest monthly debit at $4.3 million. The highest negative cash flow months were January, May and October, respectively.
All data was analyzed on a present value basis. To maintain consistency with City reports, discount rates were not used and forecasting methods were not employed.
DISCUSSION
- Risk Management
In accordance with the California Government Code, the City shall invest its monies with a priority for safety, liquidity and yield in that order. To invest with the highest degree of safety, the City must minimize its exposure to risk. The recommendation above considers these risks and allocates accordingly. The following is an outline of some of the investment risks to which the City’s investments may be exposed and how the recommendation minimizes them.
By following the recommendation, the City’s investments are staggered along the yield curve at various points, which equate to different interest rates. Having investments mature at different times allows the City to realize a blended yield or average yield while minimizing its exposure to interest rate risk.
The City’s exposure to call risk is minimized in all cases except Certificates of Deposit (CDs). This provision does not designate an investment term for these securities. For this reason, the recommendation does not allocate monies to CDs.
The City can minimize its exposure to credit risk by limiting investments to AAA-rated money market accounts, State-managed funds (LAIF), U.S. Government-backed securities, and FDIC-insured deposits. However, provided that the FDIC coverage is limited to $100,000 per depositor, per bank, it is highly recommended that investments in money markets and CDs be restricted to the FDIC coverage limits.
Like interest rate risk, by allocating amounts at different points along the yield curve, no more than 7% of the total investment portfolio would be exposed to inflation risk for more than two years.
There is a substantial market for U.S. Treasury and Agency securities. By investing the long-term portion of the total investment portfolio in mostly Treasury securities, the recommended allocation ensures that the City will be able to sell the securities, if the need arises.
- Allocation and Investment Selection
As a result, it is recommended that the City keep an amount equivalent to the projected total general fund expenditures for the current fiscal year in a stable, highly liquid investment vehicle. The approximate percentage to be allocated to the liquid securities component of the investment portfolio can be determined by dividing the City’s projected general fund expenditures for the current fiscal year by the City’s total fund balance for the current fiscal year. According to the Adopted Budget for fiscal year 2005-2006, the amount of total general fund expenditures equates to approximately $13.1 million or approximately 48.7% of the total investment portfolio. Options include money market funds, money market savings accounts and the State’s Local Agency Investment Fund (LAIF). LAIF is the preferred option due to the high degree of safety, liquidity and yield it offers.
Moreover, cash flow analyses of fiscal year 2004-2005 data showed the highest debits for the City occurred in the months of January, May and October. The prevalence of these debits revealed a likelihood for future high debits to recur in the same period. Provided that Treasury Bills offer the highest degree of safety and market liquidity as requisite for this segment of the portfolio, it is recommended that the City allocate this equally to Treasury Bills maturing in December and April of each year. Using data from the Adopted Budget for fiscal year 2005-2006, the allocation would be as follows:
50% $4.13 million 3-Month Treasury Bills (mature in December)
50% $4.13 million 6-Month Treasury Bills (mature in April)
Given the propensity for a higher degree of risk associated with investments in FDIC-insured instruments, specifically Certificates of Deposit, it is not recommended that the City invest in these instruments at this time.
Based on the City’s propensity for non-recurring debts coupled with a range of monthly debits greater than 10% of the total investment portfolio, it is recommended that the City invest approximately $5.5 million (or 20.5% of the total investment portfolio). The precise allocation is recommended as follows:
66% $3.63 million 1-Year Over-the-Counter (OTC) Treasuries
34% $1.87 million 2-Year GNMA (Ginnie Mae) Note
The recommended allocation is no less than 66% in Over-the-Counter (OTC) Treasuries (with a one-year maturity) and no more than 34% in two-year notes issued by the GNMA/Ginnie Mae. Although securities issued by GNMA are backed by the full faith and credit of the U.S. Government, the recent events surrounding other non-guaranteed Federal agencies suggest that the exposure to GNMA securities also be limited.
OTHER CONSIDERATIONS
After a period of one year after full implementation of the investment recommendation, the City may choose to review its investment policies. Some possible amendments include: