HomeMy WebLinkAbout; ; 2005-2006 City Treasurer's Annual Report of Investments; 2006-06-30•a.ITYTR
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FiscalY was
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City Treasurer's
Annual Report of Investments
For Fiscal Year Ended June 30, 2006
TABLE OF CONTENTS
Page
Letter of Transmittal 1
Market Review FY05-06 2
Portfolio Analysis 3
Preview FY06-07 8
Appendices:
A: Risk Management and Disclosure 10
B: Portfolio Activities for Year Ended June 30,2006 12
1635 Faraday Avenue, Carlsbad, CA 92008
Website: www. ci. carlsbad. ca. us
Prepared by the Treasury Department
City of Carlsbad
Office of the Treasurer
October 2006
Honorable Mayor, City Council,
And Citizens of the City of Carlsbad
City of Carlsbad
1635 Faraday Avenue
Carlsbad,.CA 92008-7314
City Treasurer Letter of Transmittal
2005-2006 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, 2006 (FY 05-06). 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 05-06. 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, 2006. Comparisons are also made with the
preceding fiscal years. Finally, a statement is offered regarding the prospects for
the fiscal year 2006-2007 (FY 06-07) commencing July 1, 2006.
Harold (Mac)
City Treasurer
1635 Faraday Avenue • Carlsbad, CA 92008-7314 • (76O) 602-2473 • FAX (760) 6O2-8556
www.ci.carlsbad.ca.us
CITY TREASURER
ANNUAL REPORT OF INVESTMENT PORTFOLIO
FOR THE FISCAL YEAR ENDED JUNE 30, 2006
FYOS-Oe MARKET REVIEW
Federal Funds Target Rate
FY 05-06
5.50% -
5.00% -
4.50%
4.00% -
3.50% -
3 A ft O/
5.25%
5.00% f
4.75% |
4.50% f
4.25% j~
4.00% ";
3.75% *|
3.50% |
3.25%*|
Q^ 0%\0<* 0<J\a° <v\v° nfl^ tffi <S«P* o*)^ <$&
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. In fiscal
year 05-06 the Federal
Reserve increased the
federal funds rate eight more
times, each by 25 basis
points for a total of 200 basis
points. As a result, the
federal funds rate increased from 3.25% June 30, 2005 to 5.25% June 30, 2006.
SHORT-TERM INTEREST RATES
U.S. Treasury Instruments
Fiscal Year 2005 - 2006
I DA*-<->ant I
5.50
5.00 -
Changes in short-
term market interest
rates are usually
affected by the
actions of the Federal
Reserve. Six-month,
two year, and five
year market rates
increased over the
course of the fiscal
year. Longer-term
market rates rose
slightly, but were
otherwise relatively
unaffected by the
actions of the Federal
Reserve. The new
Fed Chairman, Ben Bernanke continued the rate increases that Greenspan initiated.
3.50
3.00
JUL AUG SEP OCT NOV DEC JAN FEE MAR APR MAY JUN
—•— Five Year—• - Two Year-*-6 Month
JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN
4.12 3.86 4.19 4.44 4.41 4.30 4.45 4.60 4.81 4.91 5.03 5.09
4.02 3.81 4.17 4.37 4.41 4.33 4.52 4.68 4.82 4.86 5.03 5.51
3.67 3.71 3.92 4.21 4.26 4.35 4.57 4.73 4.80 4.90 5.06 5.23
YIELD CURVE
7/01/05, 12/31/05, 6/30/06
[Market Rates I
6
5.5
S
4.5
43.5
3
2.S
2
1.5
1
3 M th 2 Yr
2 Yr
5 Yr 10 Yr
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 FY 05-06 (July 1, 2005), the yield curve was relatively flat. The flat
yield curve was indicating that the markets believed the economy was close to
equilibrium, with no discernible bias toward either inflation or recession. The Fed,
however, believed that inflation was still a problem and continued to raise the discount
rate. At the middle of FY 05-06 (December 31, 2005) the slope of the yield curve
began to invert. This meant that short term interest rates were higher than long term
interest rates. The markets believed the economy was slowing. As FY 05-06 ended,
the yield curve was still slightly inverted.
PORTFOLIO ANALYSIS
INVESTMENT PORTFOLIO
Dollar Amount of Assets (Fiscal Year End)
$550.0
$500.0
$450.0
$400.0
$350.0
$300.0
$250.0
$200.0
$150.0
$100.0
$510.0
FY97-98 FY98-99 FY99-00 FYOO-01 FY01-02 FY02-03 FY03-04 FY04-05 FY05-06
Total assets in the
investment portfolio
stood at $517 million at
the end of the fiscal
year, an increase of
1%. The $517 million
is again a record
amount for the
portfolio. Commencing
with FY 97-98, year-
over-year percentage
increases have been
26%, 19%, 8%, 13%,
6%, 11%, 10%, 8%,'
and 1%.
PORTFOLIO ASSETS RELATIVE TO
TOTAL ASSETS OF CITY AND ITS AGENCIES*
$1,300
$1
FY98-99 FY99-00 FYOO-01 FY01-02 FY02-03 FY03-04 FY04-05 FY05-06
:Total Assets 3 Portfolio Assets % of Total Assets
•Source: Comprehensive Annual Financial Repon. Note: Total Assets of City and Its Agencies is an amount for FY05-06.
The City publishes a
Comprehensive Annual
Financial Report (CAFR) at
the end of each fiscal year.
Among other information,
CAFR presents a balance
sheet showing the total
assets owned by the City and
all its agencies. At the end
of FY 05-06, cash and
investments managed by the
City Treasurer represent
43% of all assets reported by
the City and its agencies.
SOURCE OF POOL ASSETS
(Dollar Amounts in Millions)
6/3O/05
$35.1
6/3O/O6
34'6
217.0
$229.6
$ 26.
$123.5
Total Assets - $510.8 Million
$
13^J^Total Assets - $515.9 Million
o Generald Capital Projects• Agency Fundsa Other
I Special RevenueI EnterpriseI Internal Service
The portfolio is an internal 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 1 % from the previous fiscal year. The top
three sources of portfolio assets are the Capital Projects fund ($229.6 million, 45% of
the total), followed by the Enterprise fund ($131.5 million, 25% of the total), and the
General fund ($67.8 million, 13% of the total). Together, these three funds account for
83% of total portfolio assets.
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.
ASSET ALLOCATION
(Dollar Amounts in Millions)
6/30/05 6/30/06
LAIF
$63
CORP PARE
$9.80
FEDERAL
AGENCY
$359.
ORPORATE
CORPORATE
$52.5
FEDERAL
GENCY
$438.2
At the end of FY 05-06
(June 30, 2006), 85%
of portfolio assets were
invested in federal
agencies, 10% in
corporate notes, 3% in
LAIF, and 2% in cash.
The allocation of assets
to federal agencies
increased, while the
allocation to corporate
notes and LAIF both
decreased from the
previous fiscal year.
This reflected the
continued decrease in
interest rate spreads
for corporate notes
relative to U. S. Treasuries and the increase in short term interest rates relative to LAIF.
Within the asset category of federal agencies, investments in the Federal Home Loan
Bank, the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association, and the Federal Farm Credit Bank, constituted 40%, 35.4%, 23.4% and
1.2% of the total, respectively. Federal agencies are creations of the U. S. Congress
and include agencies and government-sponsored enterprises.
Total $512,009,997 Total $516,852,810
a LAIF
D Corporate
• Cash
• Federal Agencies
PORTFOLIO YIELDS
With 6 Month T-Bill Yields
7
6
5
4
3
2
1
FY96- FY97- FY98- FY99- FYOO- FY01- FY02- FY03- FY04- FY05-
97 98 99 00 01 02 03 04 05 06
FY96-97 FY-)7-V8 FY98-99 FY9->-ll(l FVOO-Ul KYOI-02 l'Y02-l)3 FYU3-04 FYD4-05 FYU5-06
5.77 5.89 5.71 5.81 6.18 5.28 4.24 3.43 3.55 3.98
5.38 5.30 4.68 5.69 5.17 2.16 1.28 111 2.59 4.45
'A- - .
The average return of the
portfolio for FY 05-06
increased to 3.98% from
3.55% the year before. The
portfolio yield is heavily
influenced by changes in short-
term market interest rates
since approximately 22% of
total investments were required
to mature within one year. The
average interest rate for six-
month U.S. Treasury Bills
increased to 4.45% from
2.59% the previous year.
Return on investments is shown in two categories: (1) LAIF deposits and (2) all other
investments. LAIF is an acronym for Local Agency Investment Fund. It is an investment
pool managed by the California State Treasurer. The LAIF investment pool is very
liquid with average investments usually maturing in six to seven months. City deposits
in LAIF provide a desired measure of liquidity at attractive short-term rates, and typically
comprise 5% to 10% of the
total portfolio, depending on
market interest rates at the
time. In many respects, City
deposits in LAIF 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 and LAIF
JULY 1998 - JUNE 2006
6.76.4
B.8
S.S5.24.9a4.03.73.43.12.82.52.21.9
1.0
Jun- Dec Jun- Dec Jun- Dec Jun- Dec Jun- Dec Jun- Dec Jun- Dec Jun- Dec Jun-
98 99 00 01 02 03 04 OS 05
Jun 02 Dec 02 Jun 03 Dec 03 Jim 04 Dec 04 Jun OS Dec 05 Jun 06
Compared to LAIF deposits,
all other City investments will
typically earn 40 basis points
more. However, when
market interest rates rise
rapidly, as they have over the
past two years, earnings on
LAIF deposits will briefly
exceed the earnings on all other portfolio investments. On the other side, when market
rates have either been stable or have decreased rapidly, earnings on other investments
will typically earn 40 to 100 basis points (1%) greater than LAIF. LAIF 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. Reacting to short-term interest
rates in FY05-06, returns on LAIF investments increased significantly while returns on
other portfolio investments increased slightly. Beginning in May of FY05-06 the return
on LAIF deposits exceeded the return on all other portfolio investments. As interest
rates decrease during FY06-07, we will see returns on investment correct to a normal
pattern.
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. The gain/loss is not
recognized until the investment is sold. Changes in value caused by changes in market
interest rates are normal and are expected.
Historical Unrealized Gains/Losses
as Percent of Amortized Cost
July 1996-June 2006
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50%
-1.00%
-1.50%
-2.00%
-2.50%
-3.00%
With a buy and hold policy, an objective of the City's Investment Policy is to achieve an
average market rate of return over the economic cycle. The success in achieving this
objective can be approximated with having unrealized gains and losses that are
relatively equal over time. 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.
The total portfolio had an unrealized loss in FY 05-06. This unrealized loss occurred as
investments with high interest rates matured and were reinvested in lower market rates.
It is likely that this trend will reverse in FY06-07 as investments with lower interest rates
mature.
Cash income from portfolio
investments represents an
annuity stream of revenues
from the Treasury. This
annuity stream totaled
$17.8 million, an increase
of approximately $2.1
million dollars from the
previous fiscal year. Of the
total cash interest revenues
earned by the portfolio in
FY 05-06, over $2.28
million was credited to the
General fund. Cash
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.
ANNUITY STREAM FROM TREASURY
(Cash Interest Revenue)
For Fiscal Years Indicated
$21
$0.00
FY97- FY98- FV99- FYOO- FY01- FV02- FVB3- FVD4- FW5-
98 99 00 01 02 03 04 05 06
FY 06-07 PREVIEW
National and international economic forces are the primary influences on market
interest rates. It is anticipated that domestic economic growth will decline slightly. This
will prevent the Federal Reserve from raising the federal funds rate. It is widely
anticipated that the Federal Reserve will decrease the fed funds rate 50 to 75 basis
points during the first quarter of 2007. Short-term market rates will decrease faster than
long term rates resulting in a lower, closer to normal, yield curve. On June 30, 2006
the federal funds rate increased from 5.00% to 5.25%.
Approximately $124 million of investments with fixed maturity dates will mature in FY
06-07. An additional $205 million may be called, however, only a small percentage will
actually be called. Available proceeds from these investments will be reinvested at
market rates slightly higher than the maturing investments and slightly lower than the
called investments. Yields on our LAIF investments are expected to decrease as
interest rates decline.
At the end of FY 05-06 (June 30, 2006), LAIF investments had a yield of 4.53%, and all
other investments had a yield of 4.0%. A 4.0% yield approximates the historic average.
LAIF investment yield will likely increase to 4.7% through December 2006 and then
decrease to 4.1% by the end of the FY06-07 (June 30, 2007). Yields by fiscal year end
8
on investments other than LAIF will likely remain steady due to the maturing of lower
yielding investments.
Throughout the fiscal year ending June 30, 2006 the yield of the total portfolio averaged
3.98%. During fiscal year ending June 30, 2007, the total portfolio is projected to have
an average yield of approximately 4.35%.
Total assets in the investment portfolio stood at approximately $517 million at the end
of FY 05-06. This is expected to decrease (due to appropriated but as yet unspent
construction-in-process expenditures) to approximately $510 million by the end of FY
06-07. Interest revenue earned from portfolio investments in FY 06-07 should
approximate $19 million. Property tax revenues are projected to increase by 14%.
Sales tax and transient occupancy tax (TOT) revenues are expected to increase by 9%
and 6% respectively.
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 of June 30, 2006, the portfolio had the following investments and cash in its internal
investment pool.
Investment
U. S. agencies
Maturities
July 2006-June 2011
Corporate Notes July 2006 - April 2011
Certif. of Deposit July 2006 - March 2007
LAIF
Sweep accounts
Cash accounts
Total
Disclosures
Market Value
$430,699,680
50,495,284
488,000
16,476,055
8,598,075
566.534
$507.323.628
Market Value
Gain (Loss)
$(7,913,077)
599,966
(29,945)
$ (7.343.056)
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
10
failure. All City investments held in custody and safekeeping by UBC 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 UBC. At the conclusion of each business day, balances in these
accounts 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 $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, 2006, approximately 21% 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
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 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, 2006, the average maturity of the LAIF
investments was 142 days. The State Treasurer does not contract for a credit rating to
be assessed for LAIF. California state code section 16429.3 specifically excludes LAIF
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
LAIF 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 of June 30, 2006, approximately 9% 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, 2006, 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, 2006, the portfolio had a
1.2% loss 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 2/3 of the
current operating budget ($158,000,000). As of June 30, 2006, the modified duration of
the portfolio was 2.022, within the required maximum of 2.2. Investments maturing
within one year were $124,227,000, exceeding the required minimum of $106,000,000.
The City's exposure to interest rate risk is within acceptable limits.
Event Risk. Event risk is 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. The city is currently taking action to minimize event risk.
APPENDIX B: PORTFOLIO ACTIVITIES FOR FISCAL YEAR ENDED JUNE 30, 2006
The City's portfolio balance increased 1% from $512.0 million to $516.9 million in fiscal
year 2005-06. The increase of $4.9 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 2005-06 over two billion
dollars of cash inflows and cash outflows prompting investment decisions.
Cash Flows:
Bond Maturities $ 95,105,000
Bond Calls 8,000,000
Bond Sales
LAIF Withdrawals 178,768,000
Sweep Withdrawals 714,887,000
Interest Income 17,845,000
Bond Purchases 158,099,000
12
LAIF Investments 131,870,000
Sweep Investments 712,354,000
Cash Investments (net) (340.000)
Total $2.016.588.000
13