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HomeMy WebLinkAbout2016-01-12; City Council; 22182; Annual Report of Investment Portfolio for Year Ended June 30, 2015Annual Report of Investment Portfolio FYE 6/30/15 January 12, 2016 Page2 ENVIRONMENTAL IMPACT: Pursuant to Public Resources Code section 21065, this action does not constitute a "project" within the meaning of CEQA in that it has no potential to cause either a direct physical change in the environment, or a reasonably foreseeable indirect physical change in the environment, and therefore does not require environmental review. EXHIBITS: 1. City Treasurer's Annual Report of Investment Portfolio for the fiscal year ended June 30, 2015. emerging economies. Vietnam and Indonesia have exhibited considerable success in securing new manufacturing relationships. US manufacturers, in some situations, have begun relocating labor-intensive manufacturing operations back into Mexico. Labor rates are competitive with China and the logistical support and pipeline is easier to manage. Quantitative Easing (QE) programs were launched last year and continue in both the European Central Bank and Japan. These prolonged efforts to maintain essentially a zero percent interest rate environment have so far yielded minimal results. The most immediate effect to date is an increase in equity valuations in most stock markets. Emerging markets have been impacted by declining commodity prices. This is a result of many emerging market's dependency on the extraction of raw materials. Inflation is well contained with few exceptions such as Brazil and Argentina. Overall growth is very modest with Euro zone GDP growth projected to be 0-1 percent. In comparison, the US GDP growth rate is currently between 1-2 percent, the slowest recovery on record since World War II. U.S. Economy As we close our June 30, 2015 fiscal year end, we have been tracking the FOMC (Federal Open Market Committee) meeting minutes and statements from former and current Federal Reserve Governors, including Chairperson Janet Yellen. QE was projected to end in October of last year. However, what followed was an endless stream of references to the fragile recovery in our economy and a hesitance to act until the Leading Economic Indicators reported a more favorable environment to do so. Our US dollar has strengthened during this period and would strengthen further should a decision to act be implemented. This has both good and bad elements; for exporting companies, it makes their products more expensive in international markets, and for consumers, it reduces the price of imported products. Overall, the US economy is expanding, however, weakness in the industrial sector and business capital investments are creating a slow growth environment. Recent estimates suggest that there is more than $2 trillion of cash held in foreign subsidiaries of US companies. The US is one of only two countries that taxes profits earned in foreign subsidiaries a second time (after they have already paid foreign taxes) when these earnings are repatriated to the US . With a US corporate tax rate of 35 percent, this is a barrier to corporations bringing these profits back for redeployment into new business investment. A number of presidential candidates have proposed ideas that would reduce this tax penalty freeing up additional significant new capital for investment. The housing market is an area of our economy that can produce significant benefits as the dollars spent are multiplied a number of times as they work their way through our economy. Multi-family (apartments) continue to show strength meeting the demand for rental inventory. Single-family residences are coming online at a far slower pace than historical recovery levels. Pricing in many markets across the US have returned nearing previous market highs and in some cases surpassing them. Inflation remains muted. For a second time within a six year period, individuals receiving Social Security benefits will not receive an increase for 2016 based upon the previous year Consumer Price Index. 8 At the end of FY 14-15 , LAIF investments had a yield of 0.29 percent, and all other investments had a yield of 1.31 percent. Revenues on all investments will remain flat or decrease due to the low interest rate environment. On June 30, 2015 the yield of the total portfolio averaged 1.09 percent. Total assets in the investment portfolio stood at $700.6 million as measured on a cost basis at the close ofFY 14-15. 9 13 > APPENDICES TO ANNUAL REPORT OF INVESTMENT PORTFOLIO APPENDIX A: 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, measuring, 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 C. Event Risk As ofJune 30, 2014, the portfolio had the following investments and cash in its internal investment pool. Market Value Investment Maturities Market Value Gain (Loss) U.S. agencies July 2015 -June 2020 $398,488,000 $ 457,000 Corporate Notes Sept 2015 -Feb 2020 156,924,000 366,000 Certif. of Deposit July 2015 -June 2020 14,293 ,000 0 LAIF 125,097,000 47,000 Sweep accounts 3,160,000 Cash accounts 1,003,000 Total $698,965,000 $ 870 ,000 10 Itt. Disclosures Custodial Credit Risk (Investments). The city uses a third party custody and safekeeping service for its investment securities. The Mitsubishi UFJ Financial Group Union Bank, N.A. (MUFGUB) 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 MUFGUB are held in the 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 MUFGUB. At the conclusion of each business day, balances in these ~ccounts are "swept" into overnight investments. These overnight investments are pooled and collateralized with either U.S. government securities or U.S. agency securities. The California Code authorizes this type of investment. 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 $250,000 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 AA credit ratings. The default credit risk ofthese investments is minimal. Unless otherwise exempted, California state code limits investments 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, 2015, two investments in corporate notes had a credit rating below the AA limit. These investments were made when the credit ratings were either AAA or AA. California state code and the city's Investment Policy allow 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 a sale should be made. The default credit risk for corporate notes with a credit rating of single A is higher than U.S. Treasuries, federal agencies or LAIF, but is considered by the City Treasurer to be within acceptable limits for purposes of holding to maturity. 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 30,2015, the average maturity of the LAIF investments was 226 days. The State Treasurer is not required to contract for a credit rating to be assessed for LAIF. California state code section 16429.3 excludes LAIF deposits from being transferred, loaned, impounded or seized by any state agency or official. 11 /5 . 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 percent of the portfolio. As of June 30, 2015, approximately 22.7 percent 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 percent 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, 2015, no investments in any one corporate issuer exceeded 5 percent 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, 2015 , the portfolio had a negative 0.30 percent loss in market value based on cost. The city's Investment Policy has adopted two means oflimiting 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 2/3 of the current operating budget ($227,142,000). As of June 30, 2015 , the modified duration of the portfolio was 1.997, within the required maximum of 2.2. Investments maturing within one year were $221 ,027,000, exceeding the required minimum of $151 ,429,000. The city's exposure to interest rate risk is within acceptable limits. Event Risk. Event risks include the chance that something unexpected will impede the ability of an issuer of a security to meet its obligations. These types of risks are usually short in duration, but can impair the city's ability to communicate with or use banking services. Such an event could cause a delay in collecting securities which have matured. Security risks are also within this category. 12 lb. APPENDIX 8: PORTFOLIO ACTIVITIES FOR FISCAL YEAR ENDED JUNE 30, 2015 The city's portfolio balance increased 5.6 percent from $663 .3 million to $700.6 million based on cost in fiscal year 2014-15. The increase of $3 7.3 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 over two billion dollars of cash inflows and cash outflows which prompted investment decisions during fiscal year 2014-15. Cash Flows: Bond Maturities Bond Calls LAIF Withdrawals Sweep Withdrawals Interest Income Bond Purchases LAIF Investments Sweep Investments Cash Investments (net) Total $ 60,065,000 161 ,425,000 217,541 ,000 901 ,127,000 7,865,000 257,323,000 217,348,000 901 ,442,000 (195,000) $2.723.941.000 13 11.