1. Life of an Act and How to Live with It Texas Public Funds Investment Act Local Government Code – Ch. 2256 1987 to the Present

2. Before 1987 Local governments – except home rule entities – were bank dependent Local governments – except home rule entities – were bank dependent Most used bank accounts and CDs Most used bank accounts and CDs Home rule cities could use the money markets – and did Home rule cities could use the money markets – and did The PFIA was created and passed initially in 1987 The PFIA was created and passed initially in 1987

3. Hanging with the Times Starts to provide opportunity Grows as the opportunities are recognized Grows as markets and access is identified Reacts as fears arise from market events Grows with greed in low rate periods And will continue to develop ……..

4. 1987 – The Basics Defined the entities Defined the entities Set collateral at 100% Set collateral at 100% Authorized specific investments Authorized specific investments CDs CDs US obligations including agencies/instrumentalities US obligations including agencies/instrumentalities Repurchase agreements Repurchase agreements Any bond guaranteed by Texas Any bond guaranteed by Texas Required an investment policy Required an investment policy Established the Prudent Person Rule as standard Established the Prudent Person Rule as standard

5. 1989 Pools were added through ILCA Pools were added through ILCA Pools were only generally defined and assumed to be constant dollar, money market equivalent Pools were only generally defined and assumed to be constant dollar, money market equivalent Reverse repurchase agreements added Reverse repurchase agreements added Commercial paper added Commercial paper added Bankers acceptances added Bankers acceptances added The Public Funds Collateral Act was created and passed The Public Funds Collateral Act was created and passed

6. 1991 Limits in money market funds were raised to specify use of authorized investment types only Limits in money market funds were raised to specify use of authorized investment types only Limits on which funds could be used in mutual funds were set Limits on which funds could be used in mutual funds were set Bond funds can never be put in mutual funds Bond funds can never be put in mutual funds Fear of loss of principal for bondholders Fear of loss of principal for bondholders

7. 1993 – Some Bad Timing Use of Collateralized Mortgage-backed Obligations (CMOs) were added Use of Collateralized Mortgage-backed Obligations (CMOs) were added Specific requirements were added for pools including disclosure of pertinent information through information statements, confirmations and monthly reports. Specific requirements were added for pools including disclosure of pertinent information through information statements, confirmations and monthly reports. Written strategies were now required with governing body approval Written strategies were now required with governing body approval Israeli Notes added Israeli Notes added

8. Greetings from.. California

9. 1995 – Burned by CA Prohibition added on certain MBS/CMOs Prohibition added on certain MBS/CMOs Reverse repurchase agreements were restricted by term and tied to the reverse term Reverse repurchase agreements were restricted by term and tied to the reverse term Training for investment officers was added Training for investment officers was added Policy certification requirement added Policy certification requirement added “imprudent investments” “imprudent investments” Added maximum maturities and WAM Added maximum maturities and WAM Investment officers had to be designated Investment officers had to be designated Written quarterly reports new required Written quarterly reports new required

10. 1995 – and Some Additions State agency training added State agency training added TX Higher Ed Coordinating Board to provide TX Higher Ed Coordinating Board to provide Prior authorized investments not required to be liquidated is authorization is removed Prior authorized investments not required to be liquidated is authorization is removed Pools must be rated no less than AAA Pools must be rated no less than AAA Municipalities with utilities authorized to hedge Municipalities with utilities authorized to hedge State purchase and delivery of securities State purchase and delivery of securities Loss of required rating requires prudent measures to liquidate Loss of required rating requires prudent measures to liquidate State Treasury was abolished and transferred to Comptroller State Treasury was abolished and transferred to Comptroller

11. 1997 Investment officer training extended to 10 hours within 12 months and every two years Investment officer training extended to 10 hours within 12 months and every two years Delivery versus payment added Delivery versus payment added Officer disclosure added Officer disclosure added List of brokers must be approved annually List of brokers must be approved annually

12. 1999 Investment advisers added with contracts Investment advisers added with contracts Initial 2-year period then no limit Initial 2-year period then no limit Annual compliance audits added Annual compliance audits added GICs added GICs added Municipal utility section added for sale/distribution of gas/electricity allowing hedging for supplies Municipal utility section added for sale/distribution of gas/electricity allowing hedging for supplies

13. 2001 Water code directors excluded from some training requirements Water code directors excluded from some training requirements Letters of credit added as government obligation for PFCA Letters of credit added as government obligation for PFCA To cut bank costs on collateral To cut bank costs on collateral

14. 2003 Securities lending section added Securities lending section added New service push by banks for fees New service push by banks for fees Collateralized Collateralized Primary dealer or TX bank only Primary dealer or TX bank only Expansion of investment authority now requires state audit review Expansion of investment authority now requires state audit review [Obviously gutless.. As we will see] [Obviously gutless.. As we will see]

15. 2005 CD definition changes CD definition changes “domiciled” became “main office or branch in TX” “domiciled” became “main office or branch in TX” Codification induced – same requirement Codification induced – same requirement Added ability to use CDARS Added ability to use CDARS Entry bank must be in Texas Entry bank must be in Texas Reciprocity required Reciprocity required Safe spreading of CD funds Safe spreading of CD funds Decommissioning trust funds investment authority expanded to include Trust Code Decommissioning trust funds investment authority expanded to include Trust Code Gas or electricity utilities selling to public Gas or electricity utilities selling to public

16. 2007 Municipal hedging on coal and nuclear fuel expanded to commodity futures and related transportation costs Municipal hedging on coal and nuclear fuel expanded to commodity futures and related transportation costs

17. 2009 Municipalities with mineral rights leases and contracts expanded investment authority Municipalities with mineral rights leases and contracts expanded investment authority Barnett Shale and Eagle Ford impetus Barnett Shale and Eagle Ford impetus Includes oil, gas or other mineral rights Includes oil, gas or other mineral rights Establishes a Trustee authority Establishes a Trustee authority Funds must be separated Funds must be separated Investments can be made under Trust Code Investments can be made under Trust Code

18. 2011 – A Rush to Yield Proposed for 2011 Proposed for 2011 Corporate notes/bonds for CIP funds Corporate notes/bonds for CIP funds ISDs with >50,000 students only ISDs with >50,000 students only Born of low interest rates and g---d Born of low interest rates and g---d Investing in employee life insurance policy from employee (!!) Investing in employee life insurance policy from employee (!!) Your city as your beneficiary - yikes Your city as your beneficiary - yikes Remove change in market value from reporting Remove change in market value from reporting A requirement for 5% of every portfolio in Texas based corporations (!!) A requirement for 5% of every portfolio in Texas based corporations (!!) Could economic development be speaking here? Could economic development be speaking here?

19. 2011 Additional Proposals Policy must include procedures to monitor credit ratings and procedures to liquidate Policy must include procedures to monitor credit ratings and procedures to liquidate State agency training for officers tied to the biennium State agency training for officers tied to the biennium Local government training tied to fiscal years as starting point Local government training tied to fiscal years as starting point Authorized investment full faith and credit of FDIC Authorized investment full faith and credit of FDIC Pools can invest total funds in a money market fund Pools can invest total funds in a money market fund Pools must say how yield is calculated Pools must say how yield is calculated Pools must have financial statements available to users Pools must have financial statements available to users Pools report differences based on amount of funds invested Pools report differences based on amount of funds invested

20. What is the law supposed to do? Provide guidelines for safety Provide guidelines for safety Apply to all entities Apply to all entities Let local entity decide based on unique situations and conditions Let local entity decide based on unique situations and conditions Allow entities to set their own parameters Allow entities to set their own parameters WAM and maturities and authorized investments WAM and maturities and authorized investments Define guidelines on investments Define guidelines on investments Set limits for high credit quality and safety Set limits for high credit quality and safety Provide for flexibility (maturity) Provide for flexibility (maturity) To fulfill local needs To fulfill local needs Provide for control on extension risk (WAM) Provide for control on extension risk (WAM) To control volatility which represents risk To control volatility which represents risk

21. How should/must you comply? Address you own local considerations Address you own local considerations Risk tolerance limits Risk tolerance limits Cash flow needs Cash flow needs Build your own from a wide variety of choices Build your own from a wide variety of choices Establish set compliance schedule Establish set compliance schedule

22. Specific PFIA Requirements Write a Policy (2256.005) Write a Policy (2256.005) Emphasize safety and liquidity Address diversification, yield, maturity & capability List authorized investments Set a maximum maturity and WAM Tell how prices are monitored Require DVP Review and adopt policy annually Review and adopt policy annually

23. PFIA Requirements 2256.005d Write a Strategy 2256.005d Write a Strategy 2256.005e Review and adopt strategy annually 2256.005e Review and adopt strategy annually 2256.005f Designate an investment officer 2256.005f Designate an investment officer 2256.005i Disclose personal/business relationships 2256.005i Disclose personal/business relationships 2256.005k Provide policy for written certification 2256.005k Provide policy for written certification 2256.005m Obtain annual management audit 2256.005m Obtain annual management audit 2256.008 Provide for training 2256.008 Provide for training 2256.023 Report quarterly for Board approval 2256.023 Report quarterly for Board approval

24. Other PFIA Items.005 CDs bought orally and in writing.005 CDs bought orally and in writing.005 Ethics considerations.005 Ethics considerations.005 May specify unauthorized investments.005 May specify unauthorized investments.006 Prudence is based on the whole portfolio.006 Prudence is based on the whole portfolio.017 No need to liquidate if authorized at purchase.017 No need to liquidate if authorized at purchase.021 Prudence to liquidate at loss of rating.021 Prudence to liquidate at loss of rating.025 Mineral rights funds (added in 2009).025 Mineral rights funds (added in 2009).024 Chapter is sub-cumulative to other law.024 Chapter is sub-cumulative to other law

25. Who is Covered? Local entities and schools Local entities and schools State agencies State agencies Higher education Higher education Not: Not: Pension funds Pension funds Veterans Land Board funds Veterans Land Board funds County registry funds County registry funds Deferred compensation funds Deferred compensation funds Securities donated to entities (except once liquidated) Securities donated to entities (except once liquidated)

26. Number One in Priority Write an Investment Policy Write an Investment Policy Must be adopted by governing body annually Must be adopted by governing body annually Resolution must include changes made Resolution must include changes made List the type of investments authorized List the type of investments authorized Limit by maturity and perhaps quality Limit by maturity and perhaps quality Such as: LGIP “constant dollar” Such as: LGIP “constant dollar” Set a maximum maturity of any security Set a maximum maturity of any security Require delivery versus payment (DVP) !!! Require delivery versus payment (DVP) !!! (Allows for all transactions to be verbal) (Allows for all transactions to be verbal)

27. Governing Board Duties Regardless of ‘investor’ they retain ultimate fiduciary responsibility Regardless of ‘investor’ they retain ultimate fiduciary responsibility Approve investment policy annually Approve investment policy annually Approve written strategy annually Approve written strategy annually Designate investment officers Designate investment officers Review, revise, adopt broker/dealers list annually Review, revise, adopt broker/dealers list annually Provide for training for officers Provide for training for officers Approve training organizations Approve training organizations Receive and review quarterly reports Receive and review quarterly reports

28. Investment Officers Must be designated by governing body Must be designated by governing body Serves until removed or leaves entity Serves until removed or leaves entity Allowed to transfer, deposit, withdraw, and manage Allowed to transfer, deposit, withdraw, and manage Put language in resolution to avoid corporate resolutions later required Put language in resolution to avoid corporate resolutions later required

29. Investment Officers Must Attend investment training Attend investment training 10 hours within 12 months of obtaining responsibilities 10 hours within 12 months of obtaining responsibilities 10 hours every two years 10 hours every two years By organization approved by governing body By organization approved by governing body Treasurer, or CFO if not Treasurer, and investment officer Treasurer, or CFO if not Treasurer, and investment officer Board Treasurer assumed to require training Board Treasurer assumed to require training Organizations report attendance to Comptroller Organizations report attendance to Comptroller Exercise prudence Exercise prudence Disclose potential conflict relationships Disclose potential conflict relationships By blood or marriage By blood or marriage Disclose to governing body and TX Ethics Commission Disclose to governing body and TX Ethics Commission Provide policy for certification to anyone attempting to sell Provide policy for certification to anyone attempting to sell offering to engage in an investment transaction offering to engage in an investment transaction

30. Investment Officers Must Only transact with entities which have provided policy certification Only transact with entities which have provided policy certification Broker/dealers, banks and pools Broker/dealers, banks and pools Must perform an annual compliance audit and audit management controls Must perform an annual compliance audit and audit management controls Compliance with Act and your Policy Compliance with Act and your Policy State agencies perform only bi-annually State agencies perform only bi-annually If invested in other than CDs and pools If invested in other than CDs and pools Must have auditor review quarterly reports Must have auditor review quarterly reports

31. Investment Officers Must On loss of a required rating On loss of a required rating Take ‘prudent measures’ to liquidate Take ‘prudent measures’ to liquidate In accordance with your policy In accordance with your policy Primarily refers to commercial paper, BA, pools and municipal notes/bonds Primarily refers to commercial paper, BA, pools and municipal notes/bonds On newly ‘unauthorized’ security On newly ‘unauthorized’ security No need to liquidate if authorized at time of purchase No need to liquidate if authorized at time of purchase Prudence is still your guideline Prudence is still your guideline

32. Investment Officers Must Provide for quarterly reporting Provide for quarterly reporting Requires Officer knows accounting rules Requires Officer knows accounting rules Describing in detail the positions Describing in detail the positions Book and market values are required Book and market values are required Trying to show volatility (change in market) Trying to show volatility (change in market) Full earnings (interest accrues + amortization) Full earnings (interest accrues + amortization) Give summary information (diversification) Give summary information (diversification) Must be signed by IO as in compliance Must be signed by IO as in compliance With policy and the Act With policy and the Act

33. Broker/Dealers Must Review you policy Review you policy Complete a policy certification Complete a policy certification Not a guarantee or safeguard Not a guarantee or safeguard Don’t fool yourself the responsibility is yours! Don’t fool yourself the responsibility is yours!

34. Investment Committees Only mentioned once in Act Only mentioned once in Act Can approve broker/dealer list annually Can approve broker/dealer list annually As opposed to governing body passage As opposed to governing body passage

35. Security Specifics All must be delivered DVP All must be delivered DVP NO broker safekeeping NO broker safekeeping No broker advisors No broker advisors Know the players Know the players An entity can ‘un-authorize’ securities in policy An entity can ‘un-authorize’ securities in policy

36. Act’s Unauthorized Securities All unauthorized are mortgage backed securities All unauthorized are mortgage backed securities These are not the debentures of an agency These are not the debentures of an agency Interest Only MBS – IO – pay only interest and no principal Interest Only MBS – IO – pay only interest and no principal Principal Only MBS – PO – pay only principal and no interest Principal Only MBS – PO – pay only principal and no interest CMOS with stated maturities over 10 years CMOS with stated maturities over 10 years Inverse Floaters – float inversely on index Inverse Floaters – float inversely on index Easy way to eliminate danger is in authorized list Easy way to eliminate danger is in authorized list Obligations of US, its agencies and instrumentalities excluding mortgage backed securities Obligations of US, its agencies and instrumentalities excluding mortgage backed securities

37. US Obligations Treasury Bills, Notes and the ‘Bond’ Treasury Bills, Notes and the ‘Bond’ Agencies and Instrumentalities Agencies and Instrumentalities GSE – government sponsored enterprises GSE – government sponsored enterprises A note on FNMA and FHLMC A note on FNMA and FHLMC Under conservatorship until 1/1/14 Under conservatorship until 1/1/14 Currently full faith and credit of US Currently full faith and credit of US Other obligations insured full faith & credit Other obligations insured full faith & credit Basically GNMA Basically GNMA

38. US Obligations Set your maximum maturity Set your maximum maturity These extend to 30 years by definition These extend to 30 years by definition

39. Certificates of Deposit MUST BE in Texas MUST BE in Texas Can not be “brokered” or “securitized” CDs Can not be “brokered” or “securitized” CDs Must be collateralized above FDIC coverage Must be collateralized above FDIC coverage May be CDARS (cdars.com) May be CDARS (cdars.com) initiatlly placed in TX bank initiatlly placed in TX bank Protects from merger and acquisition dangers of undercollateralization/insurance Protects from merger and acquisition dangers of undercollateralization/insurance Don’t have to be but you need to bid competitively!! Don’t have to be but you need to bid competitively!!

40. Repurchase Agreements Must have: Must have: Defined termination date Defined termination date Collateral defined by Act Collateral defined by Act An independent custodian An independent custodian A primary dealer or TX bank as counterparty A primary dealer or TX bank as counterparty A Bond Market Association Master Agreement A Bond Market Association Master Agreement Securities Lending – a form of Repo Securities Lending – a form of Repo TX Bank or primary TX Bank or primary Specific reinvestment options Specific reinvestment options Same pledging and custody requirements Same pledging and custody requirements Agreement can only be one year in duration Agreement can only be one year in duration

41. Money Market Alternatives Commercial Paper Commercial Paper Must be: Must be: A1/P1 by two NRSRO A1/P1 by two NRSRO or one rating and an irrevocable LOC or one rating and an irrevocable LOC Law states 270 days but you should use 90! Banker Acceptances Banker Acceptances Must be: Must be: Able to liquidate at maturity Able to liquidate at maturity Same credit requirements Same credit requirements Law states 270 days but you should use 90 or 180 days

42. Money Market Mutual Funds Must be: Must be: Registered with and regulated by SEC Registered with and regulated by SEC which includes all Act requirements which includes all Act requirements Will always have a net asset value of $1 Will always have a net asset value of $1 Note: Require rating in Policy for GASB Note: Require rating in Policy for GASB

43. Mutual Funds Must: Must: Only have ACT authorized investments Only have ACT authorized investments Registered and regulated by SEC Registered and regulated by SEC Average WAM less than 2 years Average WAM less than 2 years Be AAA rated Be AAA rated Not authorized for any bond funds Not authorized for any bond funds Note: these represent a real potential for loss of principal Note: these represent a real potential for loss of principal

44. Pools Built on Interlocal Cooperation Act Built on Interlocal Cooperation Act Requires governing body action to join cooperative Requires governing body action to join cooperative Has specific reporting requirement built on MMMFs Has specific reporting requirement built on MMMFs Must basically have a Policy available to all Must basically have a Policy available to all Must report all transactions and balances Must report all transactions and balances Must establish a ½ cent collar on $1 pools Must establish a ½ cent collar on $1 pools Need not be constant dollar Need not be constant dollar Investment Officer must understand their pool Investment Officer must understand their pool

45. Special: Higher Education Sponsored cash management and investment pools (Common Fund) Sponsored cash management and investment pools (Common Fund) Bank issued negotiable certificates of deposit Bank issued negotiable certificates of deposit with banks rated at least 1 or A1/P1 with banks rated at least 1 or A1/P1 Corporate bonds Corporate bonds Investment grade (two highest ratings) Investment grade (two highest ratings) Primarily for foundation use Primarily for foundation use

46. Special: Municipal Utility Electric utility or sales of natural gas Electric utility or sales of natural gas Hedging contracts for supplies or reserves Hedging contracts for supplies or reserves Fuel oil, natural gas,coal, nuclear fuel, elctric futures/options Fuel oil, natural gas,coal, nuclear fuel, elctric futures/options Including transportation costs Including transportation costs

47. Special: Mineral Rights Funds from a lease or contract Funds from a lease or contract Must be separately reported and invested Must be separately reported and invested Must be estbalished as a Trustee Must be estbalished as a Trustee Can use Trust Code (basically anything!) Can use Trust Code (basically anything!)

48. Special: Decommissioning Trusts Nuclear Regulatory Commission Trusts Nuclear Regulatory Commission Trusts Regardless if public funds by PFIA definition Regardless if public funds by PFIA definition Basically uses Trust Code Basically uses Trust Code Most cities use long treasuries or mutual funds Most cities use long treasuries or mutual funds

49. Special: Housing Authority Bonds Mortgage pass throughs certificates Mortgage pass throughs certificates Individual mortgage loans Individual mortgage loans

50. Compliance with the PFCA Public Funds Collateral Act Public Funds Collateral Act Prevails over all other laws Prevails over all other laws Public funds over FDIC limits must be collateralized Public funds over FDIC limits must be collateralized Amount = principal plus accrued interest Amount = principal plus accrued interest Requires 100% collateralization Requires 100% collateralization School districts require 110% on MBS only School districts require 110% on MBS only

51. PFCA Requirements Entity shall inform bank of $$ changes in deposits Entity shall inform bank of $$ changes in deposits Entity must have a collateral policy Entity must have a collateral policy Put it inside your investment policy as section Put it inside your investment policy as section Designate what you will accept as collateral Designate what you will accept as collateral Provide for substitution Provide for substitution Methodology used for valuing securities Methodology used for valuing securities Collateral Agreement must: Collateral Agreement must: Conditions for possession (safekeeping by bailee) Conditions for possession (safekeeping by bailee) Ownership provisions – on and off events of default Ownership provisions – on and off events of default Subsitution rights Subsitution rights Events of default actions Events of default actions

52. PFCA Custodian must be approved by the entity Custodian must be approved by the entity Custodian Custodian Your bailee – pay attention Your bailee – pay attention State or national bank, TTSTC, capital stock >$5 million, FHLB State or national bank, TTSTC, capital stock >$5 million, FHLB Custodian must: Custodian must: Immediately identify securities on their books Immediately identify securities on their books Promptly deliver a “trust receipt” to entity Promptly deliver a “trust receipt” to entity Keep separate and accurate books Keep separate and accurate books File a collateral report with Comptroller (Comptroller’s manner) File a collateral report with Comptroller (Comptroller’s manner) SHOULD send you a collateral report monthly! SHOULD send you a collateral report monthly!

53. PFCA Collateral Pooling estbalished in 2009 Collateral Pooling estbalished in 2009 Voluntary basis for bank and entity Voluntary basis for bank and entity Probably will not be implemented Probably will not be implemented

54. So what do I do?? Analyze your cash needs and decide risk tolerances Analyze your cash needs and decide risk tolerances Chose securities you understand Chose securities you understand Chose and designate investment officer(s) by resolution Chose and designate investment officer(s) by resolution Write your investment policy and strategy Write your investment policy and strategy Get Council approval of policy and strategy Get Council approval of policy and strategy Use one resolution Use one resolution Set up brokers/banks/pools Set up brokers/banks/pools Council action required on pools only Council action required on pools only Have officer(s) disclose relationships, if applicable Have officer(s) disclose relationships, if applicable

55. It only hurts for a short time.. The foundation is critical The foundation is critical The Acts are there to assist and guide The Acts are there to assist and guide Linda T. Patterson Patterson & Associates Austin, TX linda@patterson.net