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HomeMy WebLinkAboutAgenda Item No.8CITY OF LADE LSIIYOI�E - � ?1V DREAM EXTREME REPORT TO CITY COUNCIL TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL FROM: GRANT M. YATES CITY MANAGER DATE: DECEMBER 11, 2012 SUBJECT: ANNUAL ADOPTION OF INVESTMENT POLICY Recommendation Approve the City's investment policy. Background Under Government Code Section 53646(a), the City's Investment Policy should be reviewed and adopted by City Council annually. Discussion The investment policy is reviewed annually by the City's investment advisor, PFM Asset Management LLC (PFM) and the City Treasurer. The recommendations made by PFM have been incorporated in this year's investment policy. A copy of the memorandum from PFM noting their evaluation and recommendations is included with this report. The City Treasurer has reviewed and finds no objection to the revised Investment Policy that conforms well within that allowed by the California Government Code. Also, this is an Investment Policy, before revision, that has been reviewed and found in conformance with California Government Code by the City's independent auditor. The policy also has all required elements as outlined in the Model Investment Policy of the Municipal Treasurers' Association of the United States & Canada. Fiscal Impact No fiscal impact. Prepared by: James R. Riley Director of Adn Services Approved by: Grant M. Yates City Manager AGENDA ITEM NO. 8 Page] of 24 Page 2 of 24 December 2012 CITY OF LAKE ELSINORE INVESTMENT POLICY 1) INTRODUCTION The purpose of this document is to set out policies and procedures that enhance opportunities for a prudent and systematic investment policy and to organize and formalize investment - related activities. The investment policies and practices of the City of Lake Elsinore (the "City ") are, in every case, subject to and limited by applicable provisions of state law and to prudent money management principles. All funds will be invested in accordance with the City's Investment Policy, and applicable provisions of Chapter 4 of Part 1 o Division 2 of Title 5 of the California Government Code (Section 53600 et seq.). 2) SCOPE The investment policy applies to all financial assets, except bond proceeds and retirement funds, accounted for in the City of Lake Elsinore Comprehensive Annual Financial Report (CAFR) and any new fund created by the City Council, unless specifically exempted. The investment of bond proceeds will be governed by the provisions of relevant bond documents. 3) OBJECTIVES The primary objectives, in priority order, of the City's investment activities shall be: A) Safety of Principal Safety of principal is the foremost objectiveof the City. Investments of the City shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. The City shall seek to preserve principal by mitigating two types of risk: credit risk and interest rate risk. 1. Credit Risk The City will minimize credit risk, which is the risk of loss due to the failure of the security issuer or backer, by: Page 3 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY • Limiting investments to the types of securities listed in the authorized Investments section of this Investment Policy. • Diversifying the investment portfolio so that the impact of potential losses from any one type of security or from any one individual issuer will be minimized. 2. Interest Rate Risk: The City will minimize interest rate risk, which is the risk that the market value of securities in the portfolio will fall due to changes in market interest rates, by: • Structuring the investment portfolio with marketable securities so that securities can be liquidated to meet cash flow needs or structuring the portfolio to mature to meet cash requirements for ongoing operations. B) Liquidity Historical cash flow trends are compared to current cash flow requirements on an ongoing basis in an effort to ensure that the City's investment portfolio will remain sufficiently liquid to enable the City to meet all reasonably anticipated operating requirements. C) Yield The investment portfolio shall be designed with the objective of attaining a market rate of return throughout budgetary and economic cycles, taking into account the investment risk constraints and the cash flow characteristics of the portfolio. 4)PRUDENCE In managing its investment program, the City will observe the 'Prudent Investor" standard as stated in Government Code Section 53600.3, applied in the context of managing an overall portfolio. Investments will be made with care, skill, prudence and diligence, taking into account the prevailing circumstances, including, but not limited to general economic conditions, the anticipated needs of the City and other relevant factors that a prudent person acting in a fiduciary capacity and familiar with those matters would use in the stewardship of funds of a like character and purpose. This standard of prudence shall be applied in the context of managing an overall portfolio. Investment officers acting in accordance with written procedures and the investment policy and exercising due diligence shall be relieved of personal responsibility for an individual security's credit risk or market price changes provided deviations from expectations are reported in a timely fashion and appropriate action is take to control adverse developments. 2 Page 4 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY 5) PERFORMANCE EVALUATION Investment performance is to be continually monitored and evaluated by the Director of Administrative Services. The City's primary portfolio performance will be measured against a total return index with securities with similar attributes and similar average maturity, e.g., the Merrill Lynch 1 -5 Year U.S. Treasury Index. 6) DELEGATION OF AUTHORITY In accordance with the City Council Policy of the City of Lake Elsinore and under authority granted by the City Council, the City Treasurer's function and responsibility for investing the unexpended cash in the City Treasury has been designated to the City Manager. The responsibility for conducting the City's investment program has been delegated to the Director of Administrative Services, who shall establish written procedures for the operation of the investment program consistent with this investment policy. Such procedures shall include explicit delegation of authority to persons responsible for all investment activities. No person may engage in an investment transaction except as provided under the terms of the policy and the procedures established by the Director of Administrative Services. Portfolio management and transactions may be delegated to an independent investment advisor registered with the SEC. 7) INVESTMENT PROCEDURES The Director of Administrative Services shall establish written investment procedures and a system of controls to regulate the operation of the investment program and the activities of subordinate officials consistent with this policy. The procedures should include reference to: safekeeping, repurchase agreements, wire transfer agreements, banking service contracts and collateral /depository agreements. Such procedures shall include explicit delegation of authority to persons responsible for investment transactions. No person may engage in an investment transaction except as provided under the terms of the policy and the procedures established by the Director of Administrative Services. i Page 5 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY 8) ETHICS AND CONFLICTS OF INTEREST Officers and employees involved in the investment process shall refrain from personal business activity that conflicts with proper executions of the investment program, or impairs their ability to make impartial investment decisions. Additionally, the City Officials are required to annually file applicable financial disclosures as required by the Fair Political Practices Commission (FPPC). 9) SAFEKEEPING AND CUSTODY To protect against fraud or embezzlement of losses caused by collapse of an individual securities dealer, all securities owned by the City shall be held in safe keeping by a third party bank / trust department. All security transactions entered into by the City of Lake Elsinore shall be conducted on delivery- versus - payment (DVP) basis. All securities purchased or acquired shall be delivered to the City of Lake Elsinore by book entry, physical delivery, or by third part custodial agreement as required by CGC 53601. Securities held custody of the City shall be independently audited on an annual basis to verify investment holdings. All exceptions to this safekeeping policy must be approved by the City Manager in written form and included in monthly reporting to the City Council. 10) DIVERSIFICATION The City of Lake Elsinore will diversify its investments by security type and institution. It is the policy of the City of Lake Elsinore to diversify its investment portfolio. Assets shall be diversified to eliminate the risk of loss resulting from over concentration of assets in a specific maturity, a specific issuer, or a specific class of securities. Diversification strategies shall be determined and revised periodically. In establishing specific diversification strategies, the following general policies and constraints shall apply: (a) Maturities selected shall provide for stability of income and liquidity. (b) Disbursement and payroll dates shall be covered through maturity investments and marketable securities. 11) INTERNAL CONTROL The investment portfolio and all related transactions are reviewed and balanced to appropriate general ledger accounts by the Finance Staff on a monthly basis. CI Page 6 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY An independent analysis by an external auditor shall be conducted annually to review internal control, account activity, and compliance with policies and procedures and reported to City Council. 12) REPORTING Each month the Director of Administrative Services shall submit to City Council, the City Manager, and the City Treasurer a monthly report of investment transactions. The report shall also include a detailed security report. If all funds are placed in LAIF, FDIC- insured accounts, and /or in a county investment pool, the foregoing report elements may be replaced by copies of the latest statements from such institutions. The Director of Administrative Services shall maintain a complete and timely record of all investment transactions. Additionally, every quarter the Director of Administrative Services shall render to the City Manager, City Council andthe City Treasurer a quarterly investment report, which shall include, at a minimum, the following information for each individual investment: • Type of investment instrument (i.e., Treasury bill, medium term note); • Issuer name (i.e., General Electric Credit Corporation); • Purchase date (trade and settlement date); • Maturity date; • Par value; • Purchase price; • Current market value and the source of the valuation; Overall portfolio yield based on cost. The quarterly report also shall (a) state compliance of the portfolio to the statement of investment policy, or manner in which the portfolio is not in compliance; (b) include a description of any of the City's funds, investments, or programs that are under the management of contracted parties, including lending programs; and (c) include a statement denoting the ability of the City to meet its expenditure requirements for the next six months, or provide an explanation as to why sufficient money shall, or may, not be available. i7 Page 7 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY 13) AUTHORIZED FINANCIAL DEALERS AND INSTITUTIONS The Director of Administrative Services will maintain a list of financial institutions authorized to provide investment services. In addition, a list will also be maintained of approved security broker /dealers selected by credit worthiness with at least five years of operation. The Director of Administrative Services will review the financial condition and registrations of qualified bidders annually. All financial institutions and broker /dealers who desire to become qualified for investment transactions must supply the following as appropriate: • Audited financial statements demonstrating compliance with state and federal capital adequacy guidelines to be submitted annually • Proof of National Association of Security Dealers (NASD) certification (not applicable to Certificate ofDeposit counterparties) • Proof of state registration • Complete broker /dealer questionnaire (not applicable to Certificate of Deposit counterparties) • Certification of having read and understood and agreeing to comply with the City's Investment Policy prior to commencing trading • Evidence of adequate insurance coverage An annual review of the financial condition and registrations of qualified bidders will be conducted by the Director of Administrative Services. The City may also use broker /dealers approved and evaluated by an SEC registered investment advisor acting in a fiduciary capacity for the City. The City is required to obtain at least 3 competing bids from different broker /dealers for every purchase or sale of a security. 14) AUTHORIZED INVESTMENTS Investment of City funds is governed by the California Government Code sections 53601 et seq. Unless otherwise specified in this section,no investment shall be made in any security, other than a security underlying a repurchase or reverse repurchase agreement as authorized by this section, that at the time of the investment has a term remaining to maturity in excess of five years. The Director of Administrative Services, or designee, is authorized to purchase the following investment instruments: A. U.S. Treasury ,notes, bonds ,bills, or other certificates of indebtedness or those for which the full faith and credit of the United States are pledged for the payment of principal and interest. R Page 8 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY B. Federal agency or United States government- sponsored enterprise obligations, participation, or other instruments, including those issued by or fully guaranteed as to principal and interest by federal agencies or United States government- sponsored enterprises including debt guaranteed under the FDIC's Temporary Liquidity Guarantee Program, which is backed by the full faith and credit of the U.S .Government'. No more than 40% of the City's portfolio may be invested in any one federal agency. C. Obligations of the State of California or any local agency within the state, including bonds payable solely out of revenues from a revenue producing property owned, controlled or operated by the state or any local agency or by a department, board, agency or authority of the state or any local agency, provided that such obligations are rated in one of the top three rating categories by a NRSRO and are general obligation bonds or essential service bonds secured with revenue from a water, sewer, power, or electric system. D. Registered treasury notes or bonds of any of the other 49 United States in addition to California, including bonds payable solely out of the revenues from a revenue - producing property owned, controlled, or operated by a state or by a department, board, agency, or authority of any of the other 49 United States, in addition to California, provided that such obligations are rated in one of the top three rating categories by a NRSRO and are general obligation bonds or essential service bonds secured with revenue from a water, sewer, power, or electric system. E. Repurchase Agreements. Repurchase agreements are to be used solely as short-term investments not to exceed 30 days. The City may enter into repurchase agreements with primary government securities dealers rated "A" or better by two nationally recognized rating services. Counterparties should also have (i) a short-term credit rating in the highest category by a nationally recognized statistical rating organization ( NRSRO); (ii) minimum assets and capital size of $25 billion in assets and $350 million in capital; (iii) five years of acceptable audited financial results; and (iv) a strong reputation among market participants. The following collateral restrictions will be observed: Only U.S. Treasury securities or Federal Agency securities will be acceptable collateral. All securities underlying repurchase agreements must be delivered to the City's custodian bank versus payment or be handled under a properly executed tri -party repurchase agreement. The total market value of all collateral for each repurchase agreement must equal or exceed 102% of the total dollar value of the money invested by the City for the term of the 1 The details of the FDIC guarantee are provided in the FDIC's regulations, 12 CFR Part 370, and at the FDIC's website http: / /www.fdie.gov /regulations /resource /'rLGP. 7 Page 9 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY investment. For any repurchase agreement with a term of more than one day, the value of the underlying securities must be reviewed on an on- going basis according to market conditions. Market value must also be calculated each time there is a substitution of collateral. Since the market value of the underlying securities is subject to daily market fluctuations, the investments in repurchase agreements shall be in compliance if the value of the underlying securities is brought back up to 102% no later than the next business day. The City or its trustee shall have a perfected first security interest under the Uniform Commercial Code in all securities subject to repurchase agreement. The City shall have properly executed a Master Repurchase Agreement with each counter party with which it enters into repurchase agreements. F. Bills of exchange or time drafts drawn on and accepted by a commercial bank and brokered to investors in the secondary market, otherwise known as bankers' acceptances. Purchases of bankers' acceptances may not exceed 180 days' maturity, or 40% of the City's surplus money that may be invested. However, no more than 30 %of the City's surplus funds may be invested in the bankers' acceptances of any one commercial bank. Eligible bankers' acceptances are restricted to issuing financial institutions with short -term paper rated in the highest category by one NRSRO. G. Commercial paper of "prime" quality of the highest ranking or of the highest letter and number rating as provided for by a NRSRO. The entity that issues the commercial paper shall meet all of the following conditions in either paragraph (1) or paragraph (2) below: 1. The entity meets the following criteria: (A) is organized and operating in the United States as a general corporation. (B) has total assets in excess of five hundred million dollars ($500,000,000). (C) has debt other than commercial paper, if any, that is rated "A" or higher by a NRSRO. 2. The entity meets the following criteria: (a) is organized within the United States as a special purpose corporation, trust, or limited liability company. (b) Has program wide credit enhancements including, but not limited to, over collateral ization, letters of credit, or surety bond. (c) Has commercial paper that is rated "A -1" or higher, or the equivalent, by a NRSRO. Page 10 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY The City may invest no more than 15% of its portfolio in eligible commercial paper with a maximum maturity of 270 days. The City may invest an additional 10% of its portfolio in eligible commercial paper provided the dollar- weighted average of the aggregate investment in commercial paper does not exceed 31 days Notwithstanding anything herein to the contrary the City may invest no more than 25 %of its portfolio in eligible commercial paper, and the City may purchase no more than 10% of the outstanding commercial paper of any single issuer. H. Medium term notes with a maximum remaining maturity of five years or less issued by corporations organized and operating within the United States or by depository institutions licensed by the United States or any state and operating within the United States. Notes eligible for investment under this subsection must be rated in one of the top three rating categories by a NRSRO and shall not be on credit watch for a potential downgrade by a NRSRO. Purchases of medium term notes may not exceed 30% of the City's portfolio. I. FDIC - insured or fully collateralized time certificates of deposit in financial institutions located in California, including U.S. branches of foreign banks licensed to do business in California. Any amounts invested in excess of the FDIC insured deposit limit must be collateralized in accordance with California Government Code Section 53561. J. Negotiable certificates of deposit issued by a nationally or state - chartered bank, a savings association or a federal association (as defined by Section 5102 of the Financial Code), a state or federal credit union, or by a state - licensed branch of a foreign bank. Securities eligible for investment under this subdivision shall be rated with the highest letter and number rating by a NRSRO for short-term ratings and in the second highest category for longer -term ratings. Purchases of negotiable certificates of deposit may not exceed 30% of the City's portfolio. K. State of California's Local Agency Investment Fund (LAIF). Investment in LAIF may not exceed $50 million. 1. The LAIF portfolio should be reviewed periodically. L. California Asset Management Program (CAMP). 2 Dollar- weighted average maturity is defined as the sum of the amount of each outstanding commercial paper investment multiplied by the number of days to maturity, divided by the total amount of outstanding commercial paper. 9 Page 11 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY M. Shares of beneficial interest issued by diversified management companies that are money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (15U.S.C.Sec.80a -1, et seq.). The purchase price of shares shall not exceed 20 percent of the investment portfolio of the City. To be eligible for investment pursuant to this subdivision these companies shall either: 1. Attain the highest ranking letter or numerical rating provided by not less than two of the three largest NRSRO or 2. Have an investment advisor registered or exempt from registration with the Securities and Exchange Commission with not less than five years experience managing money market mutual funds and with assets under management in excess of $500,000,000. N. Insured savings account or money market account. To be eligible to receive local agency deposits, a financial institution must have received a minimum overall satisfactory rating for meeting the credit needs of California Communities in its most recent evaluation. Credit criteria and sectors and issuers percentages for investments listed in this section will be determined at the time the security is purchased. A decline in the overall investment balances that causes the percent to any investment above its maximum policy limit will not be considered out of compliance. The City may from time to time be invested in a security whose rating is downgraded. In the event a rating drops below the minimum allowed rating category for that given investment type, the Director of Administrative Services shall notify the City Manager, the City Treasurer, and City Council and recommend a plan of action. Notwithstanding anything herein to the contrary, with the exception of the U.S. Treasury, federal agency institutions, and government sponsored enterprises no more than 5% of the City's portfolio may be invested in securities issued by any one corporate, financial, or municipal issuer. 15) PROHIBITED INVESTMENTS Any security type or structure not specifically approved by this policy is hereby specifically prohibited. Security types which are thereby prohibited include, but are not limited to, inverse floaters, derivatives, range notes, interest only strips that are derived from a pool of mortgages, or in any investment that could result in zero interest accrual if held to maturity. 16) LEGISLATIVE CHANGES Any State of California legislative action that further restricts allow able maturities, investment type or percentage allocations will be deemed to be incorporated into the City of Lake Elsinore's investment policy and will supersede any and all applicable language. fill: Page 12 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY 17) INTEREST EARNINGS All moneys earned and collected from investments authorized in this policy shall be allocated quarterly to various fund accounts based on the cash balance in each fund as a percentage of the entire pooled portfolio. 18) POLICY REVIEW The City of Lake Elsinore's investment policy shall be adopted by the City Council on an annual basis. This investment policy shall be reviewed at least annually to insure its consistency with the overall objectives of preservation of principal, liquidity and yield, and its relevance to current law and financial and economic trends. Any amendments to the policy shall be forwarded to the City Council for approval. 11 Page 13 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY Glossary Arbitrage: Transactions by which securities are bought and sold in different markets at the same time for the sake of the profit arising from a yield difference in the two markets. Bankers Acceptance: A draft or bill or exchange accepted by a bank or trust company. The accepting institution, as well as the issuer, guarantees payment of the bill. Comprehensive Annual Financial Report (CAFR):The official annual report for the City of Lake Elsinore. It includes five combined statements for each individual fund and account group prepared in conformity with GAAP. It also includes supporting schedules necessary to demonstrate compliance with finance - related legal and contractual provisions, extensive introductory material, and a detailed Statistical Section. Bond Proceeds:The money paid to the issuer by the purchaser or underwriter of a new issue of municipal securities. These monies are used to finance the project or purpose for which the securities were issued and to pay certain costs of issuance as may be provided in the bond contract. Broker: Someone who brings buyers and sellers together and is compensated for his /her service. Certificate of Deposit (CD): A time deposit with a specific maturity evidenced by a certificate. Large - denomination CD's are typically negotiable. Collateral ization: Process by which a borrower pledges securities, property, or other deposits for the purpose of securing the repayment of a loan and /or security. Commercial Paper: An unsecured short -term promissory note issued by corporations, with maturities ranging from 2 to 270 days. 12 County Pooled Investment Funds: The aggregate of all funds from public agencies placed in the custody of the County Treasurer or Chief Finance Officer for investment and reinvestment. Coupon: The annual rate of interest that a bond's issuer promises to pay the bondholder on the bond's face value; a certificate attached to a bond evidencing interest due on a payment date. Custodian: A bank or other financial institution that keeps custody of stock certificates and other assets. Dealer: Someone who acts as a principal in all transactions, including buying and selling from his /her own account. Debenture: A bond secured only by the general credit of the issuer. DefeasedBond Issues:lssues that have sufficient money to retire outstanding debt when due so that the agency is released from the contracts and covenants in the bond document. Page 14 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY Delivery versus Payment: There are two methods of delivery of securities: delivery versus payment and delivery versus receipt. Delivery versus payment is delivery of securities with an exchange of money for the securities. Delivery versus receipt is delivery of securities with an exchange of a signed receipt for the securities. Derivative: Securities that are based on, or derived from, some underlying asset, reference date, or index. Discount: The difference between the cost price of a security and its maturity when quoted at lower than face value. A security selling below original offering price shortly after sale also is considered to be at a discount. Diversification: Dividing investment funds among a variety of securities offering independent returns. Government Accounting Standards Board (GASB): A standard - setting body, associated with the Financial Accounting Foundation, which prescribes standard accounting practices for governmental units. Fannie Mae: Trade name for the Federal National Mortgage Association (FNMA), a United States sponsored corporation. Federal Deposit Insurance Corporation (FDIC): Insurance provided to customers of a subscribing bank that guarantees deposits to a set limit (currently $250,000) per account. Federal Funds Rate:The rate of interest at which Fed funds are traded. This rate is currently pegged by the fib? Federal Reserve through open- market operations. Federal Open Market Committee (FOMC): Consists of seven members of the Federal Reserve Board and five of the twelve Federal Reserve and Presidents. The President of the New York Federal Reserve Bank is a permanent member, while the other Presidents serve on a rotating basis. The Committee periodically meets to set Federal Reserve guidelines regarding purchases and sales of Government Securities in the open market as a means of influencing the volume of bank credit and money. Federal Reserve System: The central bank of the United States created by Congress and consisting of a seven member Board of Governors in Washington, D.C., 12 regional banks and about 5,700 commercial banks that are members of the system. Freddie Mac: Trade name for the Federal Home Loan Mortgage Corporation (FHLMC), a United States sponsored corporation. Ginnie Mae: Trade name for the Government National Mortgage Association (GNMA), a direct obligation bearing the full faith and credit of the United States Government. Interest Rate: The annual yield earned on an investment, expressed as a percentage. Issuer: Any corporation, government unit or financial institution which borrows money through the sale of securities. Page 15 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY Liquidity: Refers to the ability to rapidly convert an investment into cash. Local Agency Investment Fund (LAIF): A special fund in the State Treasury which local agencies may use to deposit funds for investment. All interest is distributed to those agencies participating on a proportionate share determined by the amounts deposited and the length of time they are deposited. Interest is paid quarterly via direct deposit to the LAIF account. The State keeps an amount for reasonable costs of making the investments, not to exceed one - quarter ofone per cent of the earnings. Local Government Investment Pool (LGIP): The aggregate of all funds from political subdivisions that are placed in the custody of theState Treasurer for investment and reinvestment. Market Risk: Defined as market value fluctuations due to overall changes in the general level of interest rates. Adverse fluctuation possibilities shall be mitigated by limiting the maximum maturity of any one security to five years, structuring the portfolio based on historic and current cash flow analysis, and eliminating the need to sell securities for the sole purpose of short- term speculation mitigates market risk. Market Value: The price at which a security is trading and could presumably be purchased or sold. Maturity: The date the principal or stated value of an investment becomes due and payable. Medium -Term Notes: Instruments issued by corporations organized and 14 operating within the depository institutior United States or any United States or by is licensed by the state and operating within the United States. Member: Refers to a governmental entity which is a signatory to the Joint Powers Agreement establishing the California Joint Powers Insurance Authority. Money Market: The market in which short -term debt instruments (bills, commercial paper, bankers' acceptances, etc.) are issued and traded. Negotiable: Term used to designate a security, the title to which is transferable by delivery. Offer: The price asked by a seller of securities. (When you are buying securities, you ask for an offer). See Asked and Bid. Open Market Operations: Purchases and sales of government and certain other securities in the open market by the New York Federal Reserve Bank as directed by the FOMC in order to influence the volume of money and credit in the economy. Purchases inject reserves into the bank system and stimulate growth of money and credit; sales have the opposite effect. Open market operations are the Federal Reserve's most important and most flexible monetary policy tool. Portfolio: Collection of securities held by an investor. Primary Dealer: A group of government securities dealers who submit daily reports of market activity Page 16 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY and positions and monthly financial statements to the Federal Reserve Bank of New York and are subject to its informal oversight. Primary dealers included Securities and Exchange Commission (SEC) — registered securities broker - dealers, banks, and a few unregulated firms. Principal: Describes the original cost of a security.lt represents the amount of capital or money which the investor pays for the investment. Purchase Date: The date in which a security is purchased for settlement on that or a later date. Qualified Public Depositories: A financial institution which does not claim exemption from the payment of any sales or compensating use or ad valorem taxes under the laws of this state, which has segregated for the benefit of the commission eligible collateral having a value of not less than its maximum liability and which has been approved by the Public Deposit Protection Commission to hold public deposits. Rate of Return:The yield obtainable on a security based on its purchase price or its current market price. This may be the amortized yield to maturity on a bond the current income return. Repurchase Agreement (Repo): Contractual arrangements between a financial institution or dealer and an investor. The investor puts up their funds for a certain number of days at a stated yield. In return, they take title to a given blockof securities as collateral. At maturity, the securities are repurchased 15 and the funds are repaid with interest. Safekeeping: A service to customers rendered by banks for a fee whereby securities and valuables of all types and descriptions are held in the bank's vaults for protection. Secondary Market: A market made for the purchase and sale of outstanding issues following the initial distribution. Securities & Exchange Commission: Agency created by Congress to protect investors in securities transactions by administering securities legislation. SEC Rule 15C3 -1: See Uniform Net Capital Rule. Structured Notes: Notes issued by Government Sponsored Enterprises (FHLB, FNMA, etc.) and Corporations which have imbedded options (e.g., call features, step -up coupons, floating rate coupons, derivative -based returns) into their debt structure. Their market performance is impacted by the fluctuation of interest rates, the volatility of the imbedded options and shifts in the shape of the yield curve. Treasury Bills: United States Treasury Bills which are short term, direct obligations of the United States Government issued with original maturities of 13 weeks, 26 weeks and 52 weeks; sold in minimum amounts of $10,000 in multiples of $5,000 above the minimum. Issued in book entry form only. T -bills are sold on a discount basis. Treasury Notes: Medium -term coupon - bearing U.S. Treasury securities issued as direct obligations of the U.S. Page 17 of 24 CITY OF LAKE ELSINORE INVESTMENT POLICY Government and having initial maturities from two to ten years. Uniform Net Capital Rule: Securities and Exchange Commission requirement that member firms as well as nonmember broker - dealers in securities maintain a maximum ratio of indebtedness to liquid capital of 15 to 1; also called net capital rule and net capital ratio. Indebtedness covers all money owed to a firm, including margin loans and commitments to purchase securities, one reason new public issues are spread among member of underwriting syndicates. Liquid capital includes cash and assets easily converted into cash. United States Government Agencies: Instruments issued by various United States Government Agencies most of which are secured only by the credit worthiness of the particular agency. Yield: The rate of annual income return on an investment, expressed as a percentage. (a) Income Yield is obtained by dividing the current dollar income by the current market price for W -1 the security. (b) Net Yield or Yield to Maturity is the current income yield minus any premium above par or plus any discount from par in purchase price, with the adjustment spread over the period from the date of purchase to the date of maturity of the bond Page 18 of 24 CITY OF LAKE ELSINORE INVESTMENT PROCEDURES INTERNAL CONTROL - GUIDELINES OBJECTIVES OF INTERNAL CONTROL Internal control is the plan of organization and all the related systems established by the management's objective of ensuring, as far as practicable: • The orderly and efficient conduct of its business, including adherence to management policies. The safeguarding of assets. • The prevention or detection of errors and fraud. • The accuracy and completeness of the accounting records. • The timely preparation of reliable financial information. LIMITATIONS OF INTERNAL CONTROL No internal control system, however elaborate, can by itself guarantee the achievement of management's objectives. Internal control can provide only reasonable assurance that the objectives are met, because of its inherent limitations, including: • Management's usual requirement that a control be cost - effective. • The direction of most controls at recurring, rather than unusual, types of transactions. • Human error due to misunderstanding, carelessness, fatigue, or distraction. • Potential for collusion that circumvents controls dependent on the segregation of functions. Potential for a person responsible for exercising control abusing that responsibility; a responsible staff member could be in a position to override controls which management has setup. 17 Page 19 of 24 CITY OF LAKE ELSINORE INVESTMENT PROCEDURES INTERNAL CONTROL - GUIDELINES (Continued) ELEMENTS OF INTERNAL CONTROL Elements of a system of internal control are the means by which an organization can satisfy the objectives of internal control. These elements are: ORGANIZATION Specific responsibility for the performance of duties should be assigned and lines of authority and reporting clearly identified and understood. 2. PERSONNEL Personnel should have capabilities commensurate with their responsibilities. Personnel selection and training policies together with the quality and quantity of supervision are thus important. 3. SEGREGATION OF FUNCTIONS Segregation of incompatible functions reduces the risk that a person is in a position both to perpetrate and conceal errors or fraud in the normal course of duty. If two parts of a transaction are handled by different people, collusion is necessary to conceal errors or fraud. In particular, the functions that should be considered when evaluating segregation of functions are authorization, execution, recording, custody of assets, and performing reconciliations. 4. AUTHORIZATION All transactions should be authorized by an appropriate responsible individual. The responsibilities and limits of authorization should be clearly delineated. The individual or group authorizing a specific transaction or granting general authority for transactions should be in a position commensurate with the nature and significance of the transactions. Delegation of authority to authorize transactions should be handled very carefully. 5. CONTROLS OVER AN ACCOUNTING SYSTEM Controls over an accounting system include the procedures, both manual and computerized, carried out independently to ascertain that transactions are complete, valid, authorized, and properly recorded. IN Page 20 of 24 CITY OF LAKE ELSINORE CASH CONTROLS PROCEDURES PERFORMED BY EXTERNAL AUDITORS WITH RESPECT TO CASH RECEIPTS A. City procedures and controls are reviewed. Some of the system strengths are: 1. Receipts are controlled upon receipt by proper registration devices. 2. Receipts are reconciled on a daily basis. 3. Amounts are deposited intact. 4. Bank reconciliations are reviewed. 5. Prompt posting of cash receipt entries in books. 6. Proper approval required for write -offs of customer accounts. 7. Checks are restrictively endorsed upon receipt or when run through cash register. 8. Adequate physical security over cash. 19 Individuals that handle cash do not post to customer account records or process billing statements. 10. Adequate supervision of Finance Department operations. B. Significant revenues are confirmed directly with payer and compared with City books to make sure amounts are recorded properly. C. Cash balances are substantiated by confirming all account balances recorded in books. Bank reconciliations are reviewed for propriety and recalculated by the auditor. All significant reconciling items on bank reconciliations are verified as valid reconciling items by proving to subsequent bank statements. 19 Page 21 of 24 CITY OF LAKE ELSINORE SEGREGATION OF RESPONSIBILITIES OF THE TREASURY FUNCTIONS Function 1 2. 3. 13 5. Formal Investment Policy should be: *Prepared By: *Approved By: Develop Investment Strategy Investment Strategy should be approved by Execution of investment transactions Timely recording of investment transactions: Recording of investment transactions in the City's records Recording of investment transactions in the accounting records 6. Verification of investment, i.e., match broker confirmation to City's r�,.,,,a� 7. Safeguarding of Assets and Records: Reconciliation of City's records to the accounting records Reconciliation of City's records to bank statements and safekeeping records 20 .. Director of Administrative Services City Council Registered Investment Advisor Director of Administrative Services Registered Investment Advisor Finance Manager or Accounting Supervisor (but reviewed by Director) Finance Manager or Accounting Supervisor (but reviewed by Director) Account Specialist Director of Administrative Services Finance Manager or Accounting Supervisor Finance Manager or Accounting Supervisor (but reviewed by Director) Page 22 of 24 CITY OF LAKE ELSINORE SEGREGATION OF RESPONSIBILITIES OF THE TREASURY FUNCTIONS (Continued) • • 71]I� 8. Safeguarding of Assets and Records (continued): Annual review of (a) financial institution's financial condition, (b)safety, liquidity, and potential yields of investment instruments. Director of Administrative Services 9. No less than an annual review of investment portfolio as prepared by Director of Administrative Services 21 Independent Auditors Page 23 of 24 r gg The PFM Group Pubic Flna ri co, .1 ? ii &(jBR:Br ? ±, inc PF M Asst` telex ?ayearneH ?t. t1C PH,l Advlstli s 2375 E. Camelback Road 602 -387 -5187 Suite 5118 Fax 602 - 387 -4279 Phoenix, AZ w .pfm.com 85016 November 5, 2012 Memorandum To: James Riley, CPA, Director of Administrative Services Allen Baldwin, City Treasurer The City of Lake Elsinore From: Monique Spyke, Senior Managing Consultant PFM Ansel Management LLC Re: Investment Policy Recommendations We have completed our annual review of the City's Investment Policy (the "Policy "). The City's Policy is comprehensive and in comphance with all applicable California Government Code (the "Code ") statutes regulating the investment of public funds. However, we have two recommendations; one to further protect the City's assets in this time of economic uncertainty, and one to remove an uncommon investment sector from the Policy. Section 14— Authorized Investments Issuer Allocation – The Policy does not currently specify a maximum portfolio issuer allocation for municipal obligations, medium -term notes, or negotiable certificates of deposits. In order to provide adequate diversification throughout the portfolio, we recommend adding a 5% issuer allocation restriction to the policy. Adding this restriction will ensure that the City's funds are distributed across a wide number of issuers. Reverse Repurchase Agreements –The City's Policy currently permits the use of reverse repurchase agreements. Reverse repurchase agreements are another form of securities lending. We do not usually recommend securities lending arrangements to due to the related counterparty risk and collateral risks described below. Counterparty risk – The risk that the Borrower (a third party) will not be able to return the loaned securities to the lender (the local agency). • Collateral risk – Investments made with the cash proceeds of a loan may not be a legal investment and may be encumbered or liened by a party other than the lender (the local agency). In the case of a default, ownership of investments made with cash collateral, if pooled through an investment vehicle, may become complicated. Accordingly, we recommend removing reverse repurchase agreements from the Policy. Please let us know if you have any questions about our recommendations Page 24 of 24