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HomeMy WebLinkAbout2002-08-13; City Council; 16860; Annual Report of Investment PortfolioCITY OF CARLSBAD -AGENDA BILL iB# 16.860 m: ITG. 8 3 "02 ANNUAL REPORT OF INVESTMENT )EPT. TRS 1 PORTFOLIO I CITY MGR: ';fwt RECOMMENDED ACTION: Accept and file report. ITEM EXPLANATION: City Policy requires the City Treasurer to render an annual report of the City's investment portfolio. This report is for the fiscal year ended June 30, 2002 (FYOI-02). Assets in the investment portfolio totaled $389 million at the end of the fiscal year. The equity portion of the various funds at the amortized value of the total portfolio is summarized below: Fund equity balances are restricted for various purposes as listed above. This represents an increase of $23 million from the previous fiscal year. Cash and investments now comprise an estimated 52% of the total assets reported by the City and its agencies. It is estimated that the investment portfolio will increase to $410 million by the end of FYO2-03. For the last month of the fiscal year, the portfolio had a return of 4.85%. For the entire fiscal year, however, the portfolio averaged 5.28%. Cash interest income totaled $20.4 million in FYOI-02 of which approximately $3.2 million went to the General fund. For the next fiscal year (FYO2-03), it is expected that the average return for the portfolio will approximate 4.40%. EXHIBITS: 1. City Treasurer's Annual Report of Investment Portfolio for the fiscal year ended June 30.2002. CITY TREASURER ANNUAL REPORT OF INVESTMENT PORTFOLIO FOR THE FISCAL YEAR ENDED JUNE 30,2002 CASH MANAGEMENT AND INVESTMENT PROGRAM The City Treasurer is charged with the design of an effective cash management and investment program consistent with the California Government Code, the Carlsbad Municipal Code, and the Carlsbad Investment Policy. Among other activities, this includes arranging for banking services; forecasting all cash receipts and expenditures; investing all inactive cash; and reporting all investment activities. Accurate cash forecasts are the bases for optimizing interest revenues. This ranges from developing a cash budget for the fiscal year to the daily monitoring of individual deposits and checks as the bank enters them in the City's account. With on-line access to the bank's computer, the City Treasurer attempts to predict daily the account activity and its ending balance. Only sufficient cash is kept in the bank in order to cover uncollected funds and checks that are expected to clear the account that day. If it is beneficial to the City, compensating balances may be kept in the account to offset bank service charges. It is only after this detailed process that cash available for investment can be identified. Forecasts of interest rates for up to five years are then made to determine how far on the yield curve investments could or should be made. All inactive cash is then promptly invested to achieve the goals stipulated in the City's Investment Policy: safety of principal, sufficiency of liquidity, and maximum yield. A buy and hold investment policy is generally followed to ensure greater safety of principal. Through a staggering of investment maturity dates, the portfolio is designed to ensure liquidity and achieve an average market yield through the economic cycle. The investment portfolio is a pool of assets representing inactive cash from the various funds of the City and all of its agencies, including the City of Carlsbad, the Carlsbad Redevelopment Agency, and the Carlsbad Water District. Cash received into the pool is invested without regard to the agency and the fund from which it originated. Accounts are maintained, however, that identify the cash contributed and the interest earned by each agency and fund involved. This report summarizes and analyzes the activities of the investment portfolio for the fiscal year ended June 30, 2002 (FYOI-02). Amount of assets, yields achieved, and cash incomes are presented. To give perspective to these measurements, movements in market interest rates are provided, and 1 comparisons are made with the preceding four fiscal years. Finally, a statement is offered regarding the prospects for the fiscal year commencing July 1, 2002. FYOI -02 MARKET REVIEW Federal Funds Target Rate I Adjustments Made in FY 00-01 and FY01-02 II 4.00% 3.50% 3.00% 2~Sin.L i .. 2.00% 1.50% - Federal funds rate is a key money market rate that correlates - with rates of other short-term credit arrangements. It is the interest rate that banks charge each other for overnight loans. The Federal Reserve sets the federal funds rate. To give a sense of the economic cycle, changes in the shown for the past two fiscal years, FYOO-01 and FYOI-02. The Federal Reserve decreased the federal funds rate by 275 basis points (2.75%) in the FYOO-01 (June 30, 2000 through June 30, 2001). An additional 200 (2.0%) basis points were reduced in FYOI-02 (June 30, 2001 through June 30, 2002). Over the last two fiscal years the federal funds rate was decreased a total of 475 basis points (4.75%). The last decrease occurred in December 2001. At the close of FYOI-02 (June 30, 2002) the federal funds rate stood at 1.75%. I federal funds rate are Changes in short-term market interest rates predict actions by the Federal Reserve. Thus, the decreases in short- term market rates through October were in anticipation of the last reduction in the federal funds rate that occurred in December 2001. In November, the market interest rates of two-year and five-year instruments started to increase but the six-month stayed relatively 1 SHORT-TERM INTEREST RATES U.S. Treasury Instruments Fiscal Year 2001 - 2002 1.00 4 JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN e same. This caused the yield curve to steepen. 2 3 YIELD CURVE I 7/01/01, 12/31/01, 06/30/02 1 3.651 4.238 4.949 5.410 3Mth 2Yr 5Yr 10Yr 1.720 3.022 4.300 5.049 1.700 2.826 4.003 4.780 The yield curve is a graphic presentation of the difference between short-term and longer-term interest rates of U.S. Treasury instruments on a given day. Financial analysts use it to assess the market's expectation of recession or inflation. The normal shape of the yield curve has a moderately upward slope, with short-term rates lower than longer-term rates. If the upward slope steepens, the financial markets believe inflation may occur. An inverted yield curve is when short-term market rates are greater than longer-term market rates. An inverted curve indicates that the financial markets expect a slower economy, if not a recession. At the beginning of FYOI-02 (July 1, 2001), the yield curve had a moderate upward slope, indicating a slight bias on the side of inflation. At the middle of FYOI-02 (December 31, 2001), however, the yield curve became much steeper. This was caused primarily by lower short-term market interest rates. By the close of FYOI-02, the steeper slope of the yield curve was essentially unchanged from the middle of the fiscal year. On June 30, 2002, the yield curve was indicating that inflation was a growing possibility. 3 Y PORTFOLIO ANALYSIS INVESTMENT PORTFOLIO Dollar Amount of Assets (Fiscal Year End) $400.0 $350.0 $300.0 $250.0 $200.0 $150.0 $100.0 $50.0 so.0 I FY95-96 FY96-97 FY97-98 FV98-99 FY99-00 FYOO-01 FYO1-02 Total assets in the investment portfolio stood at $389.5 million at the end of the fiscal year, an increase of 6%. The $389.5 million is again a record amount for the portfolio. With the exception of FYOO- 01, the total value of the portfolio has been increasing at a decreasing rate. Commencing with FY96- 97. vear-over-vear percentage increases have been 32%, 26%, 19%, 8%, 13%, and 6%. ," ~~~~, The City publishes a Comprehensive Annual Financial Report (CAFR) at the end of each fiscal year. Among other information, this report presents a balance sheet showing the total assets owned by the City and all its agencies. The cash and investments managed by the City Treasurer represent 52% of all assets reported by the City and its agencies. It should be noted that infrastructure assets CASHDNVESTMENTS RELATIVE TO TOTAL ASSETS OF CITY AND ITS AGENCIES* $8 0 0 Millions 1,,8 , 100% 80% 60% 40% 20% 0 7. such as streets, streetlights, sidewalks, curbs, gutters, trees, and medians are not reported in the CAFR. This will change, however. An accounting rule- making body called the Government Accounting Standards Board (GASB) has issued a statement requiring that all infrastructure assets be reported as part of total assets owned. This accounting change is being implemented incrementally. Its full effect will be reflected in the CAFR dated June 30, 2006. Until that time, it is expected that cash and investments will gradually comprise a lower percentage of total assets owned. 4 5 I SOURCE OF POOL ASSETS (Dollar Amounts in Millions) I 6130101 6 /3 0 10 2 $ 61.8 $ 78.2 $ 25.8 $ 147.0 s 144.0 I Total Assets - $366.8 Million Total Assets - S389.5 Million The portfolio is an investment pool that uses for investments the inactive cash from the various funds of all City agencies, including the City, the Water District, and the Redevelopment Agency. Total portfolio assets increased by 6% from the previous fiscal year. The majority of portfolio assets come from the Capital Projects fund ($144.0 million, 37% of the total), followed by the Enterprise fund ($114.0 million, 29% of the total), and the General fund ($78.2 million, 20% of the total). Of these three funds, portfolio assets from the General fund experienced the largest percentage increase (27%) from the previous fiscal year. Portfolio assets from the Enterprise fund increased 5%, while portfolio assets from the Capital Projects fund decreased 2%. I I The average return of the PORTFOLIO YIELDS * portfolio for FYOI-02 decreased to 5.28% from 6.18% the vear With 6 Month T-Bill Yields before. The portfolio yielh is 7. 4- short-term market interest rates . . . . . . . . I - __.. -.- ..__ heavily influenced by changes in since approximately 35% of total 3- investments were required to 2- mature within one vear. The 63 5- .._ .__.. I, FYBB-97 FY97-98 FY98-99 FY89-00 FYOO-01 FYO1-02 average interest rate or six- month US. Treasury Bills ~9.597 ww.98 ~98.99 Fywno woo-n1 FyuI-ul 5.77 5.89 5.71 5.81 6.18 5.28 decreased to 2.1 6% from 5.1 7% "T-BIII 5.38 5.30 4.68 5.69 5.17 2.16 the year previous, a relatively .FhSaI".ar*r.rags. Moreover, the 2.16% is the precipitous decrease. lowest average for six-month T-Bills in the past six years. 5 Return on investments is shown in two categories: (1) LAlF deposits and (2) all other investments. LAlF is an acronym for Local Agency Investment Fund. LAlF is an investment pool managed by the California State Treasurer. The LAlF investment pool is very liquid with average investments maturing in six to seven months. City deposits in LAlF provide a desired measure of liquidity at attractive short-term rates, and typically comprise 5% to 15% of the total portfolio, depending on market interest rates at the time. In many respects, City deposits in LA1 F are comparable to having a checking account that earns interest similar to U. S Treasury instruments maturing in one to five years. Return on Investments PORTFOLIO EX-LAIF VS. LAIF 8.8 JULY 1998 -JUNE 2002 6.5 11.2 5,s 5.6 5.3 5.0 I ,,j 1.7 \ 2.9 1.2 2.8 Jun-ell i Dac-Oll Jun-99 D.s.OO lun-OD D.c.00 Jun.01 D.c.03 Jun.02 Jun 98 Dn~98 Jun 99 DCI 99 Jun 00 Dee 00 Jun 01 Dee 01 JunO2 5.94 5.19 5.66 5.80 6.12 6.21 6.16 5.89 5.61 5.61 5.41 5.10 5.50 6.19 6.53 5.34 3.53 2.76 Compared to LAlF deposits, other City investments have typically earned 20 to 50 basis points more. When market interest rates rise or fall rapidly, however, as was the case in FY99-00 and FYOO-01, the difference between earnings on LAlF deposits and earnings on all other investments will widen. LAlF deposits will earn more when there is a rapid increase in short-term market interest rates. The reverse is true when market interest rates fall rapidly. LAlF turns over its investments in one-third the time and responds to changes in market interest rates much quicker. The effect of rapid and significant decreases in short-term rates is seen in the period December 2000 through June 2002. At the conclusion of FYOI-02 (June 30, 2002), earnings on investments other than LAlF exceeded earnings on LAlF deposits by approximately 280 basis points (2.8%), an unprecedented amount. This spread will narrow as maturing investments are reinvested at lower market interest rates, or as short-term markets rates Increase. 6 7 Historical Unrealized Gains/Losses as Percent of Amortized Cost July 1996 - June 2002 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 0.50% 1.00% -0.50% 0.00% -1.00% -2.00% -1.50% L This graph shows the percent change in value of the portfolio over the last several years. Investments gain and lose value after they are made because of changes in market interest rates. When market interest rates decrease, investments made earlier at higher rates will gain value. The reverse is true when market interest rates increase. Accountants refer to these changes in value as unrealized gains and unrealized losses; newspapers report them as paper gains and paper losses. Changes in value cause by changes in market interest rates are normal and are expected. Since an objective of the City's Investment Policy is to achieve an average market rate of return over the economic cycle, the portfolio is expected to experience over time unrealized gains and losses that are approximately equal to each other. The graph indicates that the portfolio is achieving this objective. Tracking and measuring unrealized gains and losses could also reveal any presence of high-risk investments in the portfolio. The changes in asset values shown in the graph indicate that portfolio investments are within the acceptable risk identified in the City's Investment Policy. The rapid decreases in market interest rates in the last fiscal year caused earnings of the City's portfolio to decrease from 5.98% on June 30, 2001 to 4.85% on June 30, 2002. These same lower market rates, however, caused investments that had been made earlier at higher rates to gain value. 7 ANNUITY STREAM FROM TREASURY Cash income from I portfolio investments represents an annuity stream from the Treasury. This annuity stream totaled $20.4 million, an increase of $500,000 from the previous fiscal year. Of the total cash earned by the portfolio in FYOI-02, over $3.2 million was credited to the General fund. Cash (Cash In1 For Fiscal Yea] (Mllhooll $21.00 7 come) -s Indicated $18.00 $15.00 $12.00 $9.00 $6.00 $3.00 $0.00 17.02 $12.16 FY97-98 FY98-99 FY99-00 FY00-01 FYO1-02 I income is a function of assets in the portfolio, the market interest rates at the time of the investments, and the interest payment schedules of the issues. FYO2-03 PREVIEW National and international economic forces, as well as domestic political considerations, influence market interest rates. On the international level, the dollar has become weaker relative to the European Common Market euro and the Japanese yen. Additionally, there remains considerable unused productive capacity in those countries. A weaker dollar will reduce investments in dollar denominated stocks and bonds. A weaker dollar will also tend to reduce imports and increase exports. Considerable domestic demand, however, will continue to be met by low-priced imports, subduing inflationary pressures. On the national scene, retail sales, consumption, and the stock market are leading indicators of future Federal Reserve action regarding interest rates. Retail sales and business activity continue to be strong. Declines in the stock market are mostly attributed to loss of investor confidence in published corporate financial reports, and anticipated changes in accounting rules that will reduce reported earnings. In a report to Congress on July 16, 2002, Alan Greenspan was positive on the economy. He said that inflation continues to be tame, that productivity remains “remarkably strong”, and that there were few signs of upward pressures. On the other hand, demand for durable goods decreased 3.8%. Additionally, misleading 8 corporate financial reports have caused the prices of stocks to plummet, causing investment money to move from stocks to bonds. As a result, bonds have increased in value and market interest rates have decreased significantly. A survey of financial analysts in May 2002 indicated a consensus that the Federal Reserve will increase interest rates in September 2002. At this writing (July 2002), it appears that the economy will not improve as rapidly as thought previously. Moreover, the effects of 9/11 events, the loss of investor confidence in audited financial reports, and the uncertainty of expensing stock options will keep market interest rates and the stock market lower for a longer period. It is more likely that the Federal Reserve will leave interest rates untouched until at least mid 2003. The yield curve should remain steep through FYO2-03. Total assets in the investment portfolio stood at approximately $389 million at the end of FYOI-02. This should increase to approximately $410 million by the end of FYO2-03. Assessed property values are forecasted to increase by about 14%, while sales tax revenues and transient occupancy tax (TOT) revenues are expected to increase by 7.3% and 7.0%, respectively. Additionally, interest revenue earned from portfolio investments in FYOI-02 should approximate $21 million. (The forecasted increases in sales tax and TOT revenues are not as robust as they may appear. The actual sales tax and TOT revenues in the previous fiscal year, FYOI-02, were lower than expected because of the events on 9/11 .) With the start of the new fiscal year on July 1. 2002, the required minimum amount of investments maturing within one year increased from $136 million to $140 million. This conforms to the City’s Investment Policy requiring investments maturing within one year to be no less than the approved operating budget. This requirement will cause a slight increase in short-term investments. Approximately $44 million of investments with fixed maturity dates will mature in FYO2-03. An additional $77 million may be called. Proceeds from these investments will be reinvested at market rates that will most likely be lower. Additional cash received into the portfolio will also be invested at slightly lower rates, but yields on our LAlF investments are expected to be relatively unchanged to slightly higher. At the end of FYO1-02 (June 30, 2002). LAlF investments had a yield of 2.8%, and all other investments had a yield of 5.6%. At the end of FYOI-02 the total portfolio had a yield of 4.85%. Throughout FYOI-02, the total portfolio averaged 5.28%. The yield on LAlF investments in FYO2-03 will essentially be the same, but the yield on all other investments will decrease. 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