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HomeMy WebLinkAboutCC 09-22-09 Item 05CITY OF 51. LADE LSII`IORT ` DREAM EXTREME REPORT TO CITY COUNCIL TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL FROM: ROBERT A. BRADY CITY MANAGER DATE: SEPTEMBER 22, 2009 SUBJECT: ANNUAL ADOPTION OF INVESTMENT POLICY Background Under Government Code Section 53646(a), the City's Investment Policy should be reviewed and adopted by City Council annually. Discussion Upon reviewing the investment policy and comparing it to the current Government Code, the City investment policy was determined to conform. The policy also has all required elements as outlined in the Model Investment Policy of the Municipal Treasurers' Association of the United States & Canada. No changes to the prior year investment policy are being proposed. Fiscal Impact No fiscal impact. Recommendation Approve the City's investment policy. Prepared by: James R. RileV~/ Acting Director /Administrative Services Approved by: Robert A. Bradyl(v City Manager CC September 22, 2009 Item No. 5 Page 1 of 28 September 2009 CITY OF LAKE ELSINORE INVESTMENT POLICY 1) POLICY 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 investment of the funds of the City of Lake Elsinore is directed to the goals of safety, liquidity and yield. The authority governing investments for municipal governments is set forth in the California Government Code (CDC), Sections 53601 through 53659. The primary objective of the investment policy of the City of Lake Elsinore is SAFETY OF PRINCIPAL. Investments shall be placed in those securities as outlined by type and maturity sector in this document. Effective cash flow management and resulting cash investment practices are recognized as essential to good fiscal management and control. The City's portfolio shall be designed and managed in a manner responsive to the public analysis and, as a result the balance between the various investments and maturities may change in order to give the City of Lake Elsinore the optimum combination of necessary liquidity and optimal yield based on cash flow projections. 2) SCOPE The investment policy applies to all financial assets of the City of Lake Elsinore as accounted for in the Comprehensive Annual Financial Report (CAFR). Policy statements outlined in this document focus on the City of Lake Elsinore's pooled funds, but will also apply to all other funds under the City Manager's span of control unless specifically exempted by statute or ordinance. This policy is applicable, but not limited, to all funds listed below: • General Fund • Special Revenue Fund • Debt Service Fund • Capital Project Fund • Enterprise Fund CC September 22, 2009 Item No. 5 Page 2 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY • Trust and Agency Funds • Any new fund created by the City Council unless specifically exempted. Bond proceeds and reserve funds under the direct administration of a third party trustee may have investments that may exceed the five-year policy period and are intended to coincide with liquidity needs. 3) PRUDENCE The standard to be used by investment officials shall be that of a "prudent person" and shall be applied in the context of managing all aspects of the overall portfolio. Investments shall be made with judgment and care, under circumstances then prevailing, which persons of prudence, direction, and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived. It is the City's full intent, at the time of purchase, to hold all investments until maturity to ensure the return of all invested principal dollars. However, it is realized that market prices of securities will vary depending on economic and interest rate conditions at any point in time. It is further recognized, that in a well-diversified investment portfolio, occasional measured losses are inevitable due to economic, bond market, or individual security credit analysis. These occasional losses must be considered within the context of the overall investment program objectives and the resultant long-term rate of return. The City Manager and other individuals assigned to manage the investment portfolio, acting within the intent and scope of the investment policy and other written procedures, an individual security's credit risk or market price changes, provided deviations from expectations are reported in a timely manner, and appropriate action is taken to control adverse developments. 4) OBJECTIVES As specified in CGC 53600.5, when investing, reinvesting, purchasing, acquiring, exchanging, selling, and managing public funds, the primary objectives, in priority order, of the investment activities shall be: A) Safety of Principal Safety of principal is the foremost objective of the City of Lake Elsinore. Each investment transaction shall seek to ensure that capital losses are avoided, whether form securities default, broker/dealer 2 CC September 22, 2009 Item No. 5 Page 3 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY default, or erosion of market value. The City shall seek to preserve principal by mitigating the two types of risk, credit risk and market risk. Credit Risk defined as the risk of loss due to failure of the issuer of a security, shall be mitigated by investing in investment-grade securities and by diversifying the investment portfolio so that the failure of any one issuer does not unduly harm the City's capital base and cash flow. Market Risk, defined as market value fluctuations due to overall changes in the general level of interest rates, shall be mitigated by limiting the average maturity of the City's investment portfolio to two years, the maximum maturity of any one security to five years, structuring the portfolio based on historic and current cash flow analysis eliminating the need to sell securities prior to maturity, and avoiding the purchase of long-term securities for the sole purpose of short-term speculation. 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. 5) PERFORMANCE EVALUATION Investment performance is continually monitored and evaluated by the Director of Administrative Services. Investment performance statistics and activity reports are generated on a monthly basis for presentation to the City Manager, City Council and City Treasurer. 6) DELEGATION OF AUTHORITY Daily management responsibility of the investment program has been delegated to the Director of Administrative Services who shall establish procedures for the operation consistent with this investment policy. 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 this policy and the procedures established by the 3 CC September 22, 2009 Item No. 5 Page 4 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY Director of Administrative Services. The Director of Administrative Services shall be responsible for all transactions undertaken and shall establish a system of controls to regulate the activities of subordinate officials. Under the provisions of California Government Code 53600.3, the Director of Administrative Services is a trustee and a fiduciary subject to the prudent investor standard. 7) INVESTMENT PROCEDURES The Director of Administrative Services shall establish written investment procedures and guidelines for the operation of the investment program consistent with this policy. The procedures should include reference to: safekeeping, PSA 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. 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 safekeeping 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. 4 CC September 22, 2009 Item No. 5 Page 5 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY 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, marketable U.S. treasury bills, or other cash equivalent instruments such as money market mutual funds. 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. 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 The City Director of Administrative Services shall review and render monthly investment reports to the City Manager, City Council and City Treasurer. The report shall include the face amount of the cash investment, the classification of the investment, the name of the institution or entity, the rate of interest, the maturity date, the current market value, and accrued interest due for all securities. The report shall also detail all repurchase agreements and reverse repurchase positions and associated liabilities. The report will also include the source of the portfolio valuation. As specified in CGC 53646 (e), 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 report must also include a certification that (1) all investment actions executed since the last report have been made in full compliance with the investment policy, and (2) the City of Lake Elsinore will meet its expenditure obligations for the next six months as required by CGC 53646 (b) (2) and (3), respectively. The Director of Administrative Services shall maintain a complete and timely record of all investment transactions. 5 CC September 22, 2009 Item No. 5 Page 6 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY 13) QUALIFIED BROKER DEALERS The City shall transact business only with banks, saving and loans, and with brokers/dealers. For brokers/dealers of government securities and other investments, the standing with the California Department of Securities, the Securities and Exchange Commission, the National Association of Securities Dealers, or other applicable self-regulatory organizations. Before engaging in investment transactions with a broker/dealer, the Director of Administrative Services shall have received from said firm a signed certification form. This form shall attest that the individual responsible for the City of Lake Elsinore's account with that firm has reviewed the City of Lake Elsinore's investment policy, and that the firm understands the policy and intends to present investment recommendations and transactions to the City of Lake Elsinore that are appropriate under the terms and conditions of the investment policy. In addition, broker/dealers must supply the Director of Administrative Services the following: • Audited financial statements • Proof of National Association of Security Dealers certification • Proof of state registration • Complete broker/dealer questionnaire An annual review of the financial condition and registrations of qualified bidders will be conducted by the Director of Administrative Services. Exceptions will be made only upon written authorization of the City Council. 14) AUTHROIZED INVESTMENTS Investment of City funds is governed by the California Government Code sections 53601 et seq. The California Government Code allows the City to invest in the following media: • Securities of the U.S. Government, or its government sponsored agencies • Small Business Administration loans • Certificates of deposit, placed with commercial banks and savings and loan companies • Negotiable certificates of deposit • Bankers acceptances • Commercial paper • Corporate notes and bonds, including medium term notes • Local Agency Investment Fund • Repurchase agreements • Reverse repurchase agreements • Passbook savings account demand deposits 6 CC September 22, 2009 Item No. 5 Page 7 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY • County Treasurer demand deposits • Asset-backed and mortgage-backed securities • Money market mutual funds Within the context of the limitations, the following investments are authorized, as further limited herein. Maximum Investment Type Authorization Limit % Maturity US Treasury Bond/Notes/Bills 0 to 100% 5 Years US Government Sponsored Agency Issues 0 to 100% 5 Years Banker's Acceptances 0 to 40% 180 Days Time Certificates of Deposit 0 to 25% 5 Years Negotiable Certificates of Deposit 0 to 30% 5 Years Commercial Paper 0 to 15% 270 Days Medium Term Corporate Notes 0 to 30% 5 Years Repurchase Agreements 0 to 100% 1 Year Reverse Repurchase Agreements 0 to 20% 92 Days Local Agency Investment Fund 0 to 100% N/A U.S. Treasury Bills - Issued weekly with maturity dates up to one year. They are issued and traded on a discount basis with interest figured on a 360-day basis, actual number of days. They are issued in amounts of $10,000 and up, in multiples of $5,000. They are a highly liquid security. U.S. Treasury Notes - Initially issued with two- to ten-year maturities. They are actively traded in a large secondary market and are very liquid. The Treasury may issue Note issues with a minimum of $1,000; however, the average minimum is $5,000. Federal Government Sponsored Agency Issues - Guaranteed directly or indirectly by the United States Government. All agency obligations qualify as legal investments and are acceptable as security for public deposits. They usually provide higher yields than regular Treasury issues with all of the same advantages. Examples include: • FICBs (Federal Intermediate Credit Bank Debentures) - Loans to lending institutions used to finance the short-term and intermediate needs of farmers, such as seasonal production. They are usually issued monthly in minimum denominations of $3,000 with a nine-month maturity. Interest is payable at maturity and is calculated on a 360-day, 30-day month basis. • FFCBs (Federal Farm Credit Bank) - Debt instruments used to finance the short and intermediate term needs of farmers and the national agricultural CC September 22, 2009 Item No. 5 Page 8 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY industry. They are issued monthly with three- and six-month maturities. The FFCB issues larger issues (one to ten year) on a periodic basis. These issues are highly liquid. • FLBs (Federal Land Bank Bonds) - Long-term mortgage credit provided to farmers by Federal Land Banks. These bonds are issued at irregular times for various maturities ranging from a few months to ten years. The minimum denomination is $1,000. They carry semi-annual coupons. Interest is calculated on a 360-day, 30-day month basis. • FHLBs (Federal Home Loan Bank Notes and Bonds) - Issued by the Federal Home Loan Bank System to help finance the housing industry. The notes and bonds provide liquidity and home mortgage credit to savings and loan associations, mutual savings banks, cooperative banks, insurance companies, and mortgage-lending institutions. They are issued irregularly for various maturities. The minimum denomination is $5,000. The notes are issued with maturities of less than one year and interest is paid at maturity. The bonds are issued with various maturities and carry semi-annual coupons. Interest is calculated on a 360-day, 30-day month basis. • FNMAs (Federal National Mortgage Association) - Used to assist the home mortgage market by purchasing mortgages insured by the Federal Housing Administration and the Farmers Home Administration, as well as those guaranteed by the Veterans Administration. They are issued about four times a year for maturities ranging from a few months to eight years. They are issued in minimum denominations of $10,000. They carry semi-annual coupons. Interest is computed on a 360-day, 30-day month basis. • FHLMCs (Federal Home Loan Mortgage Corporation) - A government- sponsored corporation established to develop the secondary market for conventional home mortgages. Mortgages are purchased solely from the Federal Home Loan Bank System member lending institutions whose deposits are insured by agencies of the United States Government. They are issued for various maturities and in minimum denominations of $10,000. Interest is paid semi-annually and is calculated on a 360-day, 30-day month basis. • Other federal agency issues are Small Business Administration notes (SBAs), Government National Mortgage Association notes (GNMAs), Tennessee Valley Authority notes (TVAs), and Student Loan Marketing Association notes (SALLIE-MAEs). As a matter of practice, the City does not invest in these issues as they do not suit our purposes as well as other investment opportunities available. 8 CC September 22, 2009 Item No. 5 Page 9 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY The City limits its investments to no more than 40% of its surplus funds in any one Federal Agency. Bankers Acceptances - Short-term credit arrangements to enable businesses to obtain funds to finance commercial transactions. They are time drafts drawn on a bank by an exporter or importer to obtain funds to pay for specific merchandise. By its acceptance, the bank becomes primarily liable for the payment of the draft at its maturity. An acceptance is a high-grade negotiable instrument. Bankers Acceptances can be purchased in various denominations for 30, 60, or 90 days, but no longer than -180 days. The interest is calculated on a 360-day discount basis similar to Treasury Bills. Local agencies may not invest more than 40% of their surplus funds in bankers acceptances or more than 10% of the agency's surplus funds in bankers acceptances of any one commercial bank. Certificates of Deposit - Time deposits of a bank or savings and loan. They are purchased in various denominations with maturities ranging from 30 to 360 days. The interest is calculated on a 360-day, actual-day month basis and is payable monthly. Negotiable Certificates of Deposit - Unsecured obligations of the financial institution, bank or savings and loan, bought at par value with the promise to pay face value plus accrued interest at maturity. They are high-grade negotiable instruments, paying a higher interest rate than regular certificates of deposit. The primary market issuance is in multiples of $1,000,000; the secondary market usually trades in denominations of $500,000, although smaller lots are occasionally available. As a matter of practice, only the ten largest U.S. banks where there is a secondary market established for continued liquidity are considered for investment. The City's total investment in negotiable certificates of deposit may not exceed 30% of surplus funds. Commercial Paper - Short-term unsecured promissory notes issued by a corporation to raise working capital. These negotiable instruments are purchased at a discount to par value or at par value with interest bearing. Local agencies are permitted by State law to invest in commercial paper of "prime" quality of the highest ranking or of the highest letter and numerical rating as provided by Moody's Investor's Service, Inc., and/or Standard and Poor's Corporation. Eligible paper is further limited to issuing corporations that are organized and operating within the United States and having total assets in excess of five hundred million dollars ($500,000,000) and having an "A" or higher rating for the issuer's debt other than commercial paper. Commercial Paper issued by an Issuer that has a rating of "A" on their debt other than commercial paper but are on credit watch for a possible downgrade by a nationally recognized rating agency shall not be considered for investment purposes. Purchases of eligible commercial paper may not exceed -270 days maturity nor represent more than 10% of the outstanding paper of an issuing corporation. Purchases of commercial paper may 9 CC September 22, 2009 Item No. 5 Page 10 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY not exceed 15 percent of the portfolio. An additional 15%, for a total of 30 percent of the portfolio, may be invested only if the dollar-weighted average of the entire investment in commercial paper does not exceed 31 days. "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. Medium Term Corporate Notes - Unsecured promissory notes issued by a corporation organized and operating in the United States. These are negotiable instruments and are traded in the secondary market. Medium term corporate notes can be defined as extended maturity commercial paper. Local agencies are restricted by the Government Code to investments in corporations rated in the top three note categories by Moody's Investors Service, Inc., and/or Standard and Poor's Corporation. For medium-term notes, eligible purchases consist of instruments that have a rating of "A" or better by both Moody's Investors Service, Inc., and Standard and Poor's Corporation. Corporate Notes issued by an issuer that has a rating of "A" but are on credit watch for a possible downgrade by a nationally recognized rating agency shall not be considered for investment purposes. If the security's credit rating falls below "A" by one of these agencies, then awareness is heightened and the security monitored closely to determine if credit risk has been significantly increased. If a security falls below "A" by both rating agencies, then the Director of Administrative Services will evaluate the need to sell the security prior to maturity. Further restrictions are a maximum term of five years to maturity and total investments in medium term corporate notes may not exceed 30% of the local agency's surplus funds. Repurchase Agreements - A repurchase agreement is a short-term investment transaction. Banks buy temporarily idle funds from a customer by selling U.S. Government or other securities with a contractual agreement to repurchase the same securities on a future date. Repurchase agreements are typically for one to ten days in maturity. The customer receives interest from the bank. The interest rate reflects both the prevailing demand for Federal funds and the maturity of the repurchase agreement. Some banks will execute repurchase agreements for a minimum of $100,000 to $500,000, but most banks have a minimum of $1,000,000. The term of a repurchase agreement may not exceed one year. The market value of securities that underlay a repurchase agreement shall be valued at 102 percent or greater of the funds borrowed against those securities and the value shall be adjusted no less than quarterly. Repurchase Agreements can only be executed with financial institutions or broker/dealers that have signed a Master Repurchase Agreement with the City. Reverse Repurchase Agreements - A reverse repurchase agreement is the opposite of a repurchase agreement. The City loans a security to a bank in exchange for cash. The City agrees to pay off the loan with interest on a future date. As this type of investment actually involves a loan arrangement, the City may 10 CC September 22, 2009 Item No. 5 Page 11 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY not invest more than 10% of its surplus funds in reverse repurchase agreements, and must always match its maturities to the reinvestment. Reverse repurchase agreements may be utilized only when either of the following conditions are met: 1. The security was owned or specifically committed to purchase, by the local agency, prior to December 31, 1994, and was sold using a reverse repurchase agreement on December 31, 1994. 2. The security: a) to be sold has been owned and fully paid for a minimum of 30 days prior to sale; and b) total of all reverse repurchase agreements owned does not exceed 10 percent of the base value of the portfolio; and c) agreement does not exceed a term of 92 days, unless the agreement includes a written codicil guaranteeing a minimum earning or spread for the entire period between the sale of a security using a reverse repurchase agreement and the final maturity date of the same security. LAIF (Local Agency Investment Fund) - A special fund in the State Treasury which local agencies may use to deposit funds for investment. There is no minimum investment period and the minimum transaction is $5,000, in multiples of $1,000 above that, with a maximum balance of $40,000,000 for any agency. The City is restricted to a maximum of fifteen transactions per month. It offers high liquidity because deposits can be converted to cash in 24 hours and no interest is lost. All interest is distributed to those agencies participating on a proportionate share basis determined by the amounts deposited and the length of time they are deposited. Interest is paid quarterly. The State retains an amount for reasonable costs of making the investments, not to exceed one-quarter of one percent of the earnings. California Government Code §16429.3 states, in part: "money placed with the State Treasurer for deposit in the Local Agency Investment Fund by cities, counties, or special districts shall not be subject to impoundment or seizure by any state official or state agency." Prohibited Investments Under the provisions of CGC 53601.6 and 53631.5, the City of Lake Elsinore shall not invest any funds covered by this investment policy in inverse floaters, range notes, interest-only strips derived from mortgage pools, or any investment that my result in a zero interest accrual if held to maturity. Investment of Bond Proceeds When investing proceeds from the issuance of bonds, the City of Lake Elsinore will follow this Investment Policy when determining allowable 11 CC September 22, 2009 Item No. 5 Page 12 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY investments. Should the trust agreement of a particular bond issue be more or less restrictive than the City's policy on permitted investments, then the trust agreement will take precedence. 15) COLLATERAL REQUIREMENTS Collateral is required for investments in certificates of deposit, repurchase agreements, and reverse repurchase agreements. All certificates of deposit must be collateralized by U.S. Treasury Obligations. Collateral must be held by a third party trustee and valued on a monthly basis. In order to reduce market risk, the collateral level will be set at the maximum allowed by state and federal law. 16) DERIVATIVE INVESTMENTS Derivative investments have value "derived" from a benchmark or index. That benchmark can be almost any financial measure from interest rates to commodity and stock prices. Investing in any derivative investment is prohibited. 17) LEGISLATIVE CHANGES Any State of California legislative action that further restricts allowable maturities, investment type or percentage allocations will be incorporated into the City of Lake Elsinore's investment policy and superseded any and all applicable language. 18) 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. 19) LIMITING MARKET VALUE EROSION The longer the maturity of securities, the greater their market price volatility. Therefore, it is the general policy of the City to limit the potential effects from erosion in market values by adhering to the following guidelines: All immediate and anticipated liquidity requirements will be addressed prior to purchasing all investments. Maturity dates for long-term investments will coincide with significant cash flow requirements where possible, to assist with short-term cash requirements at maturity. All long-term securities will be purchased with the intent to hold all investments to maturity under then prevailing economic conditions. However, economic or 12 CC September 22, 2009 Item No. 5 Page 13 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY market conditions may change, making it the City's best interest to sell or trade a security prior to maturity. 20) PORTFOLIO MANAGEMENT ACTIVITY The investment program shall seek to augment returns consistent with the intent of this policy, identified risk limitations, and prudent investment principals. These objectives will be achieved by use of the following strategy. Utilize the expert investment professionals of the State (Local Agency Investment Fund). 21) 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. The current policy of utilizing State Local Agency Investment Funds will continue to be the primary investment instrument of the City. 22) GLOSSARY Because this policy is to be available to the public as well as the governing body, it is important that a glossary of related terminology be part of the policy. 13 CC September 22, 2009 Item No. 5 Page 14 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY Agency: Federal agency securities and /or Government-sponsored enterprises. Bankers' Acceptance (BA): A draft or bill or exchange accepted by a bank or trust company. The accepting institution guarantees payment of the bill, as well as the issuer. Broker: A broker brings buyers and sellers together for a commission. California Local Government Debt: Is bonds, notes, warrants, or other evidences of indebtedness of any local agency within California. California local government debt is a permitted investment under the California Government Code. The Government Code does not specify minimum credit ratings for local government debt in which local agencies may invest. The Authority does not invest in these securities. Certificate of Deposit (CD): A time deposit with a specific maturity evidenced by a certificate. Large- denomination CD's are typically negotiable. Collateral: Securities, evidence of deposit of other property which a borrower pledges to secure repayment of a loan. Also refers to securities pledged by a bank to secure deposits of public monies. Comprehensive Annual Financial Report (CAFR): The official annual report for the City of Lake Elsinore. It includes five combine statements for each individual fund and account group Glossary 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. Coupon: (a) The annual rate of interest that a bond's issuer promises to pay the bondholder on the bond's face value. (b) A certificate attached to a bond evidencing interest due on a payment date. DEALER: A dealer, as opposed to a broker, acts as a principal in all transactions, buying and selling for his own account. Debenture: A bond secured only by the general credit of the issuer. 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. Derivatives: (1) Financial instruments whose return profile is linked to, or derived from, the movement of one or more underlying index or security, and may include a leveraging factor, or (2) financial contracts based upon notional amounts whose value is derived from an underlying index or security (interest rates, foreign exchange rates, equities or commodities). Discount: The difference between the cost price of a security and its maturity 14 CC September 22, 2009 Item No. 5 Page 15 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY 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. Federal Credit Agencies: Agencies of the Federal government set up to supply credit to various classes of institutions and individuals, e.g., S&L's, small business firms, students, farmers, farm cooperatives, and exporters. Federal Deposit Insurance Corporation (FDIC): A federal agency that insures bank deposits, currently up to $100,000 per deposit. Federal Funds Rate: The rate of interest at which Fed funds are traded. This rate is currently pegged by the Federal Reserve through open-market operations. Federal Home Loan Banks (FHLB): Government sponsored wholesale banks (currently 12 regional banks) which lend funds and provide correspondent banking services to member commercial banks, thrift institutions, credit unions and insurance companies. The mission of the FHLB is to liquefy the housing related assets of its members who must purchase stock in their district Bank. Federal National Mortgage Association (FNMA): FNMA, like GNMA was chartered under the Federal National Mortgage Association Act in 1938. FNMA is a federal corporation working under the auspices of the Department of Housing and Urban 15 Development (HUD). It is the largest single provider of residential mortgage funds in the United States. Fannie Mae, as the corporation is called, is a private stockholder-owned corporation. The corporation's purchases include a variety of adjustable mortgages and second loans, in addition to fixed-rate mortgages. FNMA's securities are also highly liquid and are widely accepted. FNMA assumes and guarantees that all security holders will receive timely payment of principal and interest. 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. Government National Mortgage Association (GNMA or Ginnie Mae): Securities influencing the volume of bank credit guaranteed by GNMA and issued by mortgage bankers, commercial banks, savings and loan associations, and other institutions. Security holder is protected by full faith and credit of the U.S. Government. CC September 22, 2009 Item No. 5 Page 16 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY Ginnie Mae securities are backed by the FHA, VA or FmHA mortgages. The term "pass-throughs" is often used to describe Ginnie Maes. Issuer: Any corporation, government unit or financial institution which borrows money through the sale of securities. Liquidity: A liquid asset is one that can be converted easily and rapidly into cash without a substantial loss of value. In the money market, a security is said to be liquid if the spread between bid and asked prices is narrow and reasonable size can be done at those quotes. 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 of one 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 the State Treasurer for investment and reinvestment. Market Value: The price at which a security is trading and could presumably be purchased or sold. Master Repurchase Agreement: A written contract covering all future transactions between the parties to 16 repurchase - reverse repurchase agreements that establishes each party's rights in the transactions. A master agreement will often specify, among other things, the right of the buyer-lender to liquidate the underlying securities in the event of default by the seller-borrower. Maturity: The date upon which the principal or stated value of an investment becomes due and payable. 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. Mutual Funds: Referred to in the Government Code, Section 53601(k) as "shares of beneficial interest issued by diversified management companies." The Mutual Fund must be restricted by its by-laws to the same investments as the local agency by the Government Code. These investments are Treasury issues, Federal Agency issues, State of California and City (within California) debt obligations, Bankers Acceptances, Commercial Paper, Certificates of Deposit, Negotiable Certificates of Deposit, Repurchase Agreements, Reverse Repurchase Agreements, and Medium Term Corporate Notes. The quality rating and percentage restrictions in each investment category applicable to the local agency also apply to the Mutual Fund. CC September 22, 2009 Item No. 5 Page 17 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY 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 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. It represents the amount of capital or money which the investor pays for the investment. Prudent Person Rule: An investment standard. In some states the law requires that a fiduciary, such as a 17 trustee, may invest money only in a list of securities selected by the custody state - the so-called legal list. In other states the trustee may invest in a security if it is one which would be bought by a prudent person of discretion and intelligence who is seeking a reasonable income and preservation of capital. 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 (RP or Repo): A holder of securities sells these securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. The security "buyer" in effect lends the "seller" money for the period of the agreement, and the terms of the agreement are structured to compensate him for this. Dealers use RP extensively to finance their positions. Exception: When the Fed is said to be doing RP, it is lending money, that is, increasing bank services. Safekeeping: A service to customers rendered by banks for a fee whereby securities and valuables of all types and CC September 22, 2009 Item No. 5 Page 18 of 28 CITY OF LAKE ELSINORE INVESTMENT POLICY 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, SLMA, 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: A non-interest bearing discount security issued by the U.S. Treasury to finance the national debt. Most bills are issued to mature in three months, six months, or one year. 18 Treasury Notes: Medium-term coupon- bearing U.S. Treasury securities issued as direct obligations of the U.S. 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. 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 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. CC September 22, 2009 Item No. 5 Page 19 of 28 CITY OF LAKE ELSINORE INVESTMENT PROCEDURES, GUIDELINES AND STRATEGY PROCEDURES AND GUIDELINES - Procedures and guidelines are established to direct and control activities in such a manner that previously established goals are achieved and policies are followed. 1. Investment Selection. Every investment transaction must be authorized by City Council and reviewed by the Director of Administrative Services. The Director of Administrative Services reviews how much of the cash balance is available for investment as determined by the Finance Manager or Senior Accountant and selects the area of the yield curve that most closely matches the required maturity date. A review of some of the flowing sources should be made to determine whether the investments should be placed to match projected expenditures or shorter, or to take advantage of current and expected interest rate environments: a) Wall Street Journal or similar daily business publication. b) Input from approved broker/dealers. c) Input from depository banks. d) Publications on general trends of economic statistics. e) Input from data services (Telerate, Bloomberg, Reuters, etc.) 2. Pooled Cash. Whenever practical, local agency cash is consolidated into one bank account and invested on a pooled concept basis. Interest earnings are allocated quarterly according to month-end cash and investment balances for each fund. 3. Competitive Bids. Purchase and sales of securities are made on the basis of competitive offers and bids when practical. 4. Cash Forecast. The cash flow for the City is analyzed with the receipt of revenues and maturity of investments scheduled so that adequate cash will be available to meet disbursement requirements. 5. Liquidity. The marketability of a security is considered at the time of purchase, as the security may have to be sold at a later date to meet unanticipated cash demands. 19 CC September 22, 2009 Item No. 5 Page 20 of 28 INVESTMENT PROCEDURES, GUIDELINES AND STRATEGY (Continued) 6. Diversification. The portfolio should consist of a mix of various types of securities, issuers, and maturities. 7. Purchasing an Investment Establish with whom the City of Lake Elsinore is going to transact business. This should be accomplished through the use of a questionnaire, which helps provide the following evaluation: a) Financial condition, strength and capability to fulfill commitments. b) Overall reputation with other dealers and investors. C) Regulatory status of the broker/dealer (providers). d) Background and expertise of the individual representative. The following must be determined prior to contacting the providers: a) Settlement - cash, regular (next day), corporate (3 business days) or when-issued of a new issue. b) Amount - either par value or total dollars to be invested. c) Type of security to be purchased, or type to be excluded. d) Targeted maturity, or maturity range. e) Time limit to show offering - 5 minutes, 15 minutes, etc. Before concluding the transaction, the Director of Administrative Services should validate the following: a) The security selected for purchase meets all criteria, including portfolio diversification, collateral izatio n (if appropriate) and maturity. If the security has any imbedded options such as call provisions or coupon adjustments, these should also be reviewed. b) Yield calculations should be verified. c) Total purchase cost (including accrued interest) does not exceed funds available for investment. d) Advise the successful provider that their offering has been selected for purchase. e) After confirmation of the purchase, as a courtesy, notify the other broker/dealers that you have placed the investment. Best price may be disclosed, if you choose. 20 CC September 22, 2009 Item No. 5 Page 21 of 28 INVESTMENT PROCEDURES, GUIDELINES AND STRATEGY (Continued) After consummation of the transaction, and prior to settlement date, the Director of Administrative Services and the provider should exchange and review the following information to ensure prompt and uninterrupted settlement: a) Name of third-party safekeeping agent. b) ABA number of safekeeping agent. c) Safekeeping account number. d) Reconfirm amount of transaction. e) Reconfirm settlement date. f) Acquire CUSIP number of security, if applicable. Evaluate Certificates of Deposit a) Certificates of Deposit shall be evaluated in terms of FDIC coverage. For deposits in excess of the insured maximum of $100,000, approved collateral at full market value shall be required. (California Government Code Section 53652 and/or 53651(m) and 53651.2(a) M. b) Negotiable Certificates of Deposit shall be evaluated in terms of the credit worthiness of the issuer, as these deposits are uninsured and uncollateralized promissory notes. 9. Settlement & Follow-through The Director of Administrative Services should forward to the safekeeping agent a report of the investment transaction. The report may be verbal, but a written form should be sent and acknowledged. When applicable, the following should be verified: a) Provision of receipt of disbursement of funds. b) Internal transfer or wiring of funds. c) Validation of written "safekeeping receipt" d) Notification of discrepancy prior to acceptance or rejection of the transaction. e) Immediate notification if a fail has occurred: by provider if they are responsible, by safekeeping agent if they are responsible. 10. Safekeepina: All transactions will be handled on a Delivery Verses Payment (DVP) using a third party safekeeping custodian. 21 CC September 22, 2009 Item No. 5 Page 22 of 28 11. Repurchase agreements wire transfer agreements, banking service contracts and collateral/depository agreements: All investing agreements will be reviewed by the City Attorney, managed by the Director of Administrative Services, and executed by the City Manager. STRATEGY - Strategy refers to the ability to manage financial resources in the most advantageous manner. Economic Forecasts. Economic Forecasts are obtained periodically from economists and financial experts through bankers and brokers to assist the Director of Administrative Services with the formulation of an investment strategy for the local agency. Implementing Investment Strategy. Investment transactions are executed which conform to anticipated interest rate trends and the current investment strategy plan. 3. Preserve Portfolio Value. Field standards are developed in order to maintain earnings near the market and to preserve the value of the portfolio. 22 CC September 22, 2009 Item No. 5 Page 23 of 28 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 set up. 23 CC September 22, 2009 Item No. 5 Page 24 of 28 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. 24 CC September 22, 2009 Item No. 5 Page 25 of 28 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. 25 CC September 22, 2009 Item No. 5 Page 26 of 28 CITY OF LAKE ELSINORE SEGREGATION OF RESPONSIBILITIES OF THE TREASURY FUNCTIONS Function Responsibility Formal Investment Policy should be: Prepared By: Approved By: 2. Investment Plan with specific investments in mind Director of Administrative Services City Council City Council 3. Investment Transactions for execution of Investment Plan should be approved by 4. Execution of investment transactions 5. 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 confirma- tion to City's records Director of Administrative Services Finance Manager or Senior Accountant Finance Manager or Senior Accountant (but reviewed by Director) Finance Manager or Senior Accountant (but reviewed by Director) Account Specialist Director of Administrative Services 7. Safeguarding of Assets and Records: Reconciliation of City's records to the accounting records Finance Manager or Senior Accountant Reconciliation of City's records to bank statements and safekeeping records Finance Manager or Senior Accountant (but reviewed by Director) 26 CC September 22, 2009 Item No. 5 Page 27 of 28 CITY OF LAKE ELSINORE SEGREGATION OF RESPONSIBILITIES OF THE TREASURY FUNCTIONS (Continued) Function _ Responsibility 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 Independent Auditors 27 CC September 22, 2009 Item No. 5 Page 28 of 28