Using the Fundamentals

1. Using the Fundamentals Linda T. Patterson Patterson & Associates linda@patterson.net

2. 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

3. 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?

4. A Major Change Factor • What is driving the rates and markets currently? • What factors will change outlooks? Public entities operate primarily in this area of the curve.

5. At Today’s RatesWhat do You Do? • $15mm are in Texpool • You need $500,000 a month • You have a safekeeping account at bank • You have little time

6. Strategy Exercise • Portfolio • Low $30mm • High $60mm • 100% liquid now • Need $2mm/month • Bond Funds • 25% of ptf. • Expected life 1yr. • Debt svc • Feb & Aug • $8mm/$4mm millions Cash Flow – Multiyear View

7. Today’s Questions/Considerations • Questions: • When do I first need money? • How should I use my Sept. allotment? • How will I use the tax money? • Can I invest the bond money better? • What is with this core? • Rates: • o/n 0.10% 3 mo 0.11% • 6 mo 0.30% 9 mo 0.30% • 12 mo 0.45% 18 mo 1.00%

8. A Strategy Forms… • Bond funds (approx. $7.2mm) • Leave $3.6 liquid • Invest $1.8 to 6 mos. and $1.8 to 9 mos. • Debt Svc • Invest $4mm to Feb (rest to come from taxes) • Invest $4mm to Aug to fulfill Aug payment • Operating Funds • Leave $24mm liquid to fund Sept. through Dec • $3mm remaining invested out to April (8 mos.)

9. Plan Execution • Target the beginning of each month • At maturity leave funds liquid for expenses • Without a s/k account • CDs from TX banks • CDARS • Money market accounts • With a s/k account • CDs from TX banks • Municipal debt in the 6 mo to 18 month area • Treasuries or agencies

10. 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

11. 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

12. 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

13. 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

14. Yield Curve 5/26/06 01/01/08 10/15/08 10/15/09 T-Bills T-Notes T-Bond

15. Yield Curve Nuances Cheap Steepness Flat Value Steep Rich Pick-up

16. 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?

17. Which do you do today? • Debt Service Strategizing • It is June 15th • Your Aug debt service payment is fully funded • The Feb payment is $3,000,000 • What are your options? Your plans?

18. Debt Service 2/15/14 • Pool will probably yield average 0.04% to 0.06% • Proceeds $ 750 for six months • Money market account at 0.35% • Proceeds $ 5,250 for six months • CD for 6 months should be 0.30% • Proceeds $ 4,500 for six months • Agency discount note at 0.15% • Proceeds $ 2,250 for six months

19. 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

20. 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

21. 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

22. 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

23. 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)

24. 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

25. Two Views to the Structure

26. Debt Service Cash Flow

27. 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

28. Bank Liquidity Choices • A range of choices • non-interest bearing checking • interest bearing checking • money market accounts • sweeps • Dependent on risk/access

29. Sweeps as an Investment Account A Excess amounts sweep each day not entire amount. Daily Sweep to MMMF Account B Account C Make sure your policy includes MMMF as authorized investment

30. 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

31. 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.

32. Commingled Investments • Local Government Pools • Money Market Mutual Funds • Mutual Funds • All offer: • Economy of scale • Diversification • Some extension with liquidity • Reporting

33. 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

34. What do these figures tell you? Know how to read the facts about your pool(s).

35. 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 Pools and Funds

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. Proposed Money Market Rules • SEC is out for comment now • Sec wants to turn PRIME money funds into mutual funds • Not strive to maintain $1 • Fluctuate with market values (price) • Can reflect principal loss • Are they for you? What does your policy say? • Money market mutual funds, excluding prime funds. • Money market funds which strive to maintain a $1 NAV.

43. 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

44. 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 BUY SELL

45. Tri-Party Repo Transactions Public Entity with $$$ Primary dealer with securities Agreement to buy-sell $ Instructions Third Party NYC Bank $$ Securities Account Cash Account Securities

46. 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

47. 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

48. Spread Money Market Accounts Through a BANK Through a BROKER

49. 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 Beyond Liquidity: Securities

50. 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] Investments Choices