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Home My WebLink About2004-09-21; City Council; 17789; Annual Report of Investment PortfolioP w U e e B a .. z 0 I- V - a - V z 3 0 V 4B# 17,789 UlTG. IEPT. TRS 912 1/04 TITLE: - CITY ATTY: ANNUAL REPORT OF INVESTMENT PORTFOLIO RECOMMENDED ACTION: Cash Balance by Fund: Genera I Special Revenue Debt Service Accept and file report. 72,180,281 32,167,195 4.148.274 ITEM EXPLANATION: Capital Projects Enterprise Internal Service Agency Funds Reconciling Adjustments Total Treasurer’s Investment Portfolio at Amortized Cost 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, 2004 (FY 03-04). 203,822,824 124,767,993 16,818,298 17,049,834 (20,856) 470,933,843 Assets in the investment portfolio totaled $472 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 $40 million from the previous fiscal year. Cash and investments comprise an estimated 48% of the total assets reported by the City and its agencies. It is estimated that the investment portfolio will increase to $520 million by the end of FYO4-05. For the last month of the fiscal year, the portfolio had a return of 3.46%. For the entire fiscal year, however, the portfolio averaged 3.43%. Cash interest income totaled $1 5.2 million in FYO3-04 of which approximately $1.8 million went to the General fund. For the next fiscal year (FYO4-05), it is expected that the average return for the portfolio will approximate 3.3%. EXHIBITS: I. City Treasurer’s Annual Report of Investment Portfolio for the fiscal year ended June 30,2004. City Treasurer’s Annual Report of Investments For Fiscal Year Ended June 30,2004 TABLE OF CONTENTS Paae Letter of Transmittal 1 Market Review FY03 -04 2 Portfolio Analysis 3 Preview FY04-05 8 Appendices: A: Risk Management and Disclosure B: Portfolio Activities for Year Ended June 30,2004 10 12 1635 Faraday Avenue, Carlsbad, CA 92008 Website: www.ci.car1sbad.ca.u~ Prepared by the Treasury Department a - City of Carlsbad August 2004 Honorable Mayor, City Council, City of Carlsbad 1635 Faraday Avenue Carlsbad, CA 92008-7314 And Citizens of the City of Carlsbad City Treasurer Letter of Transmittal 2003-2004 Annual Report of Investments I am pleased to present the Annual Report of Investments for the City of Carlsbad for the fiscal year ended June 30,2004 (FY 03-04). The report is intended to provide reliable information as a basis for reviewing portfolio performance and making management decisions. It also provides an archival reference. The City Treasurer is charged with the design of an effective cash management and investment program for the City of Carlsbad and all of its agencies. Among other activities, this includes arranging for banking services; forecasting all cash receipts and expenditures; investing all inactive cash; managing investment risk exposures; and reporting all investment activities. This report summarizes and analyzes the activities of the investment portfolio for FY 03-04. Total portfolio assets, asset allocations, yields achieved, cash incomes, risk exposures and cash flows are presented. To give perspectives to these measurements, movements in market interest rates are provided for the fiscal year ended June 30,2004. Comparisons are also made with the preceding fiscal years. Finally, a statement is offered regarding the prospects for the fiscal year 2004-2005 (FY 04-05) commencing July 1,2004. mes M. Stanton &y Treasurer 1635 Faraday Avenue Carlsbad, CA 92008-7314 (760) 602-2473 FAX (760) 602-8556 www.ci .carlsbad .ca. us CITY TREASURER ANNUAL REPORT OF INVESTMENT PORTFOLIO FOR THE FISCAL YEAR ENDED JUNE 30,2004 FYO3-04 MARKET REVIEW I Federal Funds Target Rate IN FY 02-03 and FY 03-04 I I 4.00% ~ 3.50% I 3.00% 2 ' 2.50% ' 1 2.00% + 1.75% 1 I 1 .OO% ' 1.50% I 1 .OO% 0.50% i c- 1.25% 1.25% p~-- I . -~ ~ -- r - ------ - __ ~ 0.00% - 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 federal funds rate are shown for the two fiscal years, FY 02-03 and FY 03-04. Over these two fiscal years the Federal Reserve decrease the federal funds rate twice from 1.75% to 1.25% on November 6, 2002, and from 1.25% to 1% on June 25, 2003. During the entire fiscal year ended on June 30, 2004, the federal funds rate was 1%. The federal funds rate was increase to 1.25% on June 30, 2004. Changes in short-term market interest rates are affected by the actions of the Federal Reserve. Market short-term rates were relatively steady until March 2004 when the market priced in the expected rate increase that occurred in June 2004. Changes in short-term market interest rates have a direct effect on portfolio ea rni ngs. Portfolio investments are limited to maturities of 5 years or less. SHORT-TERM INTEREST RATES U.S. Treasury Instruments Fiscal Year 2003 - 2004 2 I I --12/31/2003 .917 1.819 3.247 4.246 I- 7:~30/20~ 1.261 2.677 3.766 4.581 YIELD CURVE 7/0 1/03,12/3 1 /03,6/30/04 I The yield curve is a graphic 3 Mth 2 Yr 5 Yr 10 Yr 3Mth 2Yr 5Yr 10Yr I ~-07/01/2003 .846 1.300 2.409 3.513 ___ economy, if not a recession. At the beginning of FY 03-04 (July 1, 2003), the yield curve had a moderate upward slope, indicating a slight bias on the side of inflation. At the middle of FY 03-04 (December 31, 2003) the yield curve shifted upward reflecting higher market interest rates. The yield curve, however, maintained its upward slope. By the close of FY 03- 04, the yield curve again shifted upward with little change in the slope. On June 30, 2004, the yield curve was indicating a slight bias toward future higher long-term interest rates. PORTFOLIO ANAL YSIS 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 IN V E STM EN T PO RT F 0 L IO Dollar Amount of Assets (Fiscal Year End) FY96.97 FY97.98 FY91-99 FY99.00 FYOO.01 FYOI-02 FY02.03 FYO3-04 Total assets in the investment portfolio stood at $473 million at the end of the fiscal year, an increase of 10%. The $473 million is again a record amount for the po rtfol io. Commencing with FY 96-97, year-over- year percentage increases have been 32%, 26%, 19%, 8%, 13%, 6%, 11%, 10%. 3 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. At the end of FY 03-04, cash and investments managed by the City Treasurer represent 48% of all assets reported by the City and its agencies. CASHDNVESTMENTS RELATIVE TO TOTAL ASSETS OF CITY AND ITS AGENCIES* -1 ~~ ~ $1,000 - $900 $800 ~ p~~~ $700 - ~ FY96-97 Fxy7-98 FY98-99 FY99-00 FY00-01 FYO 1-02 FY02-03 FYO3-0Ap ~ _TotalAssets- IZICashllnvestmentr +% of Total Assets '\OUTEC romprrhenrlvc Annual Ftnlnclal Report NOW Total Assell ofClty and IU A~CIK.ICF ~b an euunatd imounc for kY03 04 SOURCE OF POOL ASSETS (Dollar Amounts in M illions) 6/30/03 6/3 0 /O 4 $ 58.5 ,--I S 28.3 $ 72.2 S S 16.8 4.1 <-ii;'--t Is 191.0 $ 17.0 WS203.8 $ 124.8 Total Assets - $430.6 M illion Total Assets - $470.9 M illion The portfolio is an investment pool that uses 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 10% from the previous fiscal year. The top three sources of portfolio assets are the Capital Projects fund ($203.8 million, 43% of the total), followed by the Enterprise fund ($124.8 million, 27% of the total), and the General fund ($72.2 million, 15% of the total). Together, these three funds account for 85% of portfolio assets. 4 ASSET ALLOCATION (Dollar Amounts in Millions) ~ ~- ___ Total $472,588,9131 L- -~ Total $430,806,504 1 __ -~ - ~~~ -~ ~ ' 'LAIF =Cash r C arporate m Federal Agencies ~ 6130103 613 Q 10 4 CASH LAIF LA'F $106.1 -~~-. ly $ 5.0 CASH -7A s 3.3 95.4 $109.3 ORATE RPORATE FEDERAL AGENCY Investments are made in financial instruments authorized by the City's Investment Policy and the California State Government Code. With the exception of bank deposits and deposits in the California state Local Agency Investment Fund (LAIF), all investments are in fixed-income instruments with known maturity dates. At the end of FY 03-04 (June 30, 2004), 56% of portfolio assets were invested in federal agencies, 23% in LAIF, and 20% in corporate notes. This allocation of assets was relatively unchanged from the previous fiscal year, reflecting the small changes in short-term market interest rates during FY 03-04. Within the asset category of federal agencies, investments in the Federal Home Loan Mortgage Corporation, the Federal Home Loan Bank, the Federal National Mortgage Association, and the Federal Farm Credit Bank, constituted 58%, 30%, 11% and 1% of the total, respectively. Federal agencies are creations of the U. S. Congress and include agencies and government- sponsored enterprises. PORWOLIOYIELDS With 6 Month T-Bill Yields EZl FW6-97 FY97-98 FY98-99 F(99-00 FnXI-01 FYOI-02 NO243 FY03-04 5.77 5.89 5.71 5.81 6.18 5.28 4.24 3.43 5.38 5.30 4.68 5.69 5.17 2.16 1.28 1.11 I' I The average return of the portfolio for FY 03-04 decreased to 3.43% from 4.24% the year before. The portfolio yield is heavily influenced by changes in short- term market interest rates since approximately 30% of total investments were required to mature within one year. The average interest rate for six- month U.S. Treasury Bills decreased to 1.11% from 1.28% the year previous. Investments previously made at higher interest rates were reinvested at the current lower interest rates. 5 7 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. It is an investment pool managed by the California State Treasurer. The LAlF investment pool is very liquid with average investments usually maturing in only six to seven months. City deposits in LAlF provide a desired measure of liquidity at attractive short-term rates, and typically comprise 15% to 25% of the total portfolio, depending on market interest 40 - 3.7 - 3.4 - 3.1 28 - 25 - 22 - 1.9 - 1.6 -1 1.3 -1 1.0 1 rates at the time. In many respects, City deposits in LAlF are comparable to having a checking account that earns interest similar to U. S Treasury instruments maturing in one to five years. "t -- w -% \ sc, ' r ' ' ' ' 7 " ' ' ' ' ' ' -' " r I ' I ' 1 ' 1 ' ' " " " " " " " " " " ~ " " " " " " " ' Compared to LAlF deposits, all other City investments will typically earn 40 basis points more. However, when market interest rates rise rapidly, earnings on LAlF deposits will briefly exceed the earnings on all other portfolio investments. On the other side, when market rates have either Rehxm onInvestrry=nts pmTFoLIoEx-LAIFandLAIF 6.7 6.4 6.1 5.8 5.5 5.2 4.9 been stable or have decreased rapidly, earnings on other investments can be anywhere from 30 basis points to 270 basis points (2.7%) greater than LAIF. LAlF turns over its investments in one-third the time and responds to changes in market interest rates much quicker than other investments in the portfolio. The effect of decreases in short- term rates is seen in the period December 2000 through June 2004. At the conclusion of FY 03-04 (June 30, 2004), earnings on investments other than LAlF exceeded earnings on LAlF deposits by approximately 267 basis points (2.67%). This spread will narrow or disappear as maturing investments are reinvested at lower market interest rates, or as short-term markets rates either stabilize or increase. 6 This graph shows the percent change in value of the portfolio over the last several years. Investments gain and lose value subsequent to purchase 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 caused by changes in market interest rates are normal and are expected. All investments are exposed to this interest rate risk. Historical Unrealized G ains/Losses as Percent of Am ortized Cost July 1996 -June 2004 4.00% 3.5 0 Yo 3.00% 2.5 0 Yo 2.00% 1.50% 1.00% 0.50% 0.00?40 -0.5 0 % -1.00% -1.50% -2.00% 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 interest rate risk identified in the City's Investment Policy. Unrealized gains decreased during FYO3-04 because of higher market interest rates, and because investments with high interest rates matured. 7 Cash income from portfolio investments represents an annuity stream of revenues from the Treasury. This annuity stream totaled $1 5.2 million, a decrease of approximately $3 000,000 from the previous fiscal year. This decrease in cash interest revenues was caused by the maturing of investments made earlier at higher interest rates. Of the total cash interest revenues earned by the portfolio in FY 03-04, over $1.8 million was credited to the General fund. Cash income is a function of ANNUITY STREAM FROM TREASURY (Cash Interest Revenue) For Fiscal Years Indicated $21.00 $18.00 $15.00 $12.00 $9.00 $6.00 %3.00 w.o.00 FY97-98 FY98-99 FY99-00 FY00-01 FYOI42 FY02-03 FY03-04 assets in the portfolio, the market interest rates at the time of the investments, and the interest payment schedules of the issues. FY 04-05 PREVIEW National and international economic forces are the primary influences on market interest rates. It is anticipated that domestic economic growth will continue and that the Federal Reserve will continue to raise the federal funds rate gradually in 25 basis points increments. Short-term market rates will increase faster than long term rates resulting in a higher but flatter yield curve. The federal funds rate on June 30, 2005 will increase to 2.0% from the current 1.25%. Approximately $38 million of investments with fixed maturity dates will mature in FY 04- 05. An additional $50 million may be called. Proceeds from these investments will be reinvested at market rates lower than the maturing or called investments. Yields on our LAlF investments are expected to be higher. At the end of FY 03-04 (June 30, 2004), LAlF investments had a yield of 1.44%, and all other investments had a yield of 4.11%. LAlF investment yield will increase to 2.0% while yields on investments other than LAlF will decrease to 3.70%. Throughout the fiscal year ending June 30, 2004 the total portfolio averaged 3.43%. During fiscal year July 1, 2004 to June 30, 2005 (FY 04-05), the total portfolio is projected to have an average yield of approximately 3.30%. Total assets in the investment portfolio stood at approximately $473 million at the end of FY 03-04. This is expected to increase to approximately $520 million by the end of FY 04-05. Assessed property values are forecasted to increase by about 10.1%, while sales tax revenues and transient occupancy tax (TOT) revenues are expected to 8 increase by 5.3% and 4.8%, respectively. Additionally, interest revenue earned from portfolio investments in FY 04-05 should approximate $18 million. Underlying all of these projections is the State’s continuing fiscal problems and how they might impact the City’s revenues. Will the state choose to cut spending or will it try to find other sources of revenues for itself? APPENDICES TO ANNUAL REPORT OF INVESTMENT PORTFOLIO APPENDIXA: RISK MANAGEMENT AND DISCLOSURE All investments are exposed to risk of some type. The objective of risk management is to identify the risks involved and establish acceptable levels of risks that are consistent with the City’s investment objectives. Risk management includes managing, monitoring, and reporting the various risks to which portfolio investments are exposed. Portfolio investments are exposed to the following types of risks: A. Credit risk. a. Custodial credit risk. a) Investments. b) Deposits. b. Default credit risk. c. Concentration credit risk. B. Interest rate risk. As of June 30, 2004, the portfolio had the following investments and cash in its internal investment pool. Investment U. S. agencies Corporate Notes LAlF Sweep accounts Cash accounts Total Disclosures Market Value Maturities Market Value Gain July 2004 - June 2009 $262,387,262 $ (2,065,840) July 2004 - Aug 2007 96,572,415 3,008,468 109,639,596 -- 1,300,016 -- 1,977,181 -- $471,876?470 $ 942,628 Custodial Credit Risk (Investments). The City uses a third party custody and safekeeping service for its investment securities. The Union Bank of California (UBC) is under contract to provide these custodial services. Custodial credit risk is the risk that the City will not be able to recover the value of its investments in the event of a UBC failure. All City investments held in custody and safekeeping by UBC are held in the 10 name of the City and are segregated from securities owned by the bank. This is the lowest level of custodial credit risk exposure. Custodial Credit Risk (Deposits). The City maintains cash accounts at Wells Fargo Bank (WFB) and UBC. At the conclusion of each business day, balances in these accounts are “swept” into overnight investments. These overnight investments are in either U. S. government securities (guaranteed) or in U. S. agency securities (government sponsored). The California Code and the City’s Investment Policy authorize both of these types of investments. A small amount of cash is not swept from the WFB checking accounts to cover checks that may be presented for payment. Amounts up to $100,000 are FDIC insured. Default Credit Risk. Default credit risk is the risk that the issuer of the security does not pay either the interest or the principal when due. The debts of most U. S. agencies are not backed by the full faith and credit of the federal government; however, because the agencies are U. S. Government-sponsored, they carry AAA credit ratings. The default credit risk of these investments is minimal. California state code limits investments in medium-term corporate notes to the top three credit ratings (AAA, AA, and A). It is the City’s policy, however, to limit investments to the top two credit ratings (AAA and AA). As of June 30, 2004, approximately 49% of the investments in medium-term corporate notes had credit ratings below the AA limit set by the City’s Investment Policy. All of these investments were made when the credit ratings were either AAA or AA. California state code and the City’s Investment Policy allows the City Treasurer to determine the course of action to correct exceptions to the Policy. It is the intent of the City Treasurer to hold these investments in the portfolio until maturity unless events indicate they should be sold. The default credit risk for corporate notes with a credit rating of single A is lower than U. S. federal agencies or LAIF, but is considered by the City Treasurer to be within acceptable limits for purposes of holding to maturity. A credit rating of single A is within State code requirements. The Local Agency Investment Fund (LAIF) is an investment pool managed by the California State Treasurer. Its investments are short-term and follow the investment requirements of the State. As of June 30, 2004, the average maturity of the LAlF investments was 220 days. The State Treasurer does not contract for a credit rating to be assessed. California state code section 16429.3 specifically excludes LAlF deposits from being transferred, loaned, impounded or seized by any state agency or official. The State Treasurer has made a public written statement saying that he would oppose any attempt to change this section of the State code. The default credit risk of LAlF is minimal. Concentration Credit Risk. Concentration credit risk is the heightened risk of potential loss when investments are concentrated in one issuer. The California state code does not identify a specific percentage that indicates when concentration risk is present for any one issuer. The state code does, however, require that total investments in medium-term corporate notes of all issuers not exceed 30% of the 11 portfolio. As if June 30, 2004, approximately 20% of the City’s total portfolio investments were in medium-term corporate notes. For concentration of investments in any one issuer, the City’s Investment Policy requires that no more than 5% of investments in corporate notes be in any one issuer. There is no similar requirement in either the state code or the City’s Investment Policy for U. S. agencies. As of June 30, 2004, no investments in any one corporate issuer exceeded 5% of total portfolio investments. Interest Rate Risk. Interest rate risk is the risk that investments will lose market value because of increases in market interest rates. A rise in market interest rates will cause the market value of investments made earlier at lower interest rates to lose value. The reverse will cause a gain in market value. As of June 30, 2004, the portfolio had a .2% gain in market value. The City’s investment policy has adopted two means of limiting its exposure to market value losses caused by rising market interest rates: (1) Limiting total portfolio investments to a maximum modified duration of 2.2, and (2) requiring maturing investments within one year be equal to an amount that is not less than the current operating budget ($143,000,000). As of June 30, 2004, the modified duration of the portfolio was 2.06, within the required maximum of 2.2. Investments maturing within one year were $152,000,000, exceeding the required minimum of $143,000,000. The City’s exposure to interest rate risk is within acceptable limits. APPENDIX B: PORTFOLIO ACTIVITIES FOR FISCAL YEAR ENDED JUNE 30,2004 The City’s portfolio balance increased 10% from $430.8 million to $472.6 million in fiscal year 2003-04. The increase of $42 million does little to show the volume of cash that flows in and out of the portfolio in the course of one fiscal year. The following table illustrates that the City Treasurer managed during fiscal year 2003-04 over two billion dollars of cash inflows and cash oufflows prompting investment decisions. Cash inflows: Bond Maturities Bond Calls Bond Sales LAIF Withdrawals Sweep Interest Income Bond Purchases LAIF Investments Sweep Investments Cash Investment (net) Total $ 34,505,000 143,477,000 100,738,000 736,603,000 15,231,000 21 7,207,000 104,272,000 733,478,000 1,436,000 $2?086,947?000 --- 12