City Council
Staff Report
From: City Manager
Report Type: INFORMATION REPORTS
Lead Department: Administrative Services
Meeting Date: May 20, 2024
Report #:2402-2586
TITLE
Investment Activity Report for the Third Quarter, Fiscal Year 2024
RECOMMENDATION
This is an informational report and no City Council action is required.
EXECUTIVE SUMMARY
The City’s Investment Policy (Policy) requires that staff report to Council quarterly on the City’s portfolio composition and performance compared to the Council-adopted Policy; discuss overall compliance with the City’s Investment Policy; and provide recommendations, if any, for Policy changes. In addition, staff provides a detailed list of all securities and reports on the City’s ability to meet expenditure requirements over the next six months. This report is to inform Council of the City’s investment portfolio performance as of the third quarter ending March 31, 2024 and to disclose staff’s cash flow projections for the next six months. Staff expect that the City will have sufficient funds or liquidity to meet expenditure requirements for the next six months. The portfolio details, activities, and performance are discussed below, and additional information is provided in the attachments. During the third quarter staff complied with all aspects of the Investment Policy.
ANALYSIS
The City’s investment portfolio is summarized in Graph 1 and detailed in the Investments by Fund Report (Attachment B). The Investments by Fund Report groups the portfolio’s securities by investment type and includes details of the investment issuer, date of maturity, current market value, the book and face (par) value, and the weighted average maturity of each type of investment and of the entire portfolio.
Due to rounding, the above graph's percentage total is greater than 100 percent.
The par value of the City’s portfolio is $634.3 million; in comparison, last quarter it was $616.7 million. The $17.6 million portfolio growth since the last quarter results from timing of cash flows from the prepayment of the City’s Fiscal Year 2024 Unfunded Accrued Liability (UAL) pension cost for active employees to the Public Employers’ Retirement System (PERS) totaling $41.6 million, additional major revenue receipt due to seasonality timing, and one more pay period costs in the third quarter comparted to the second quarter. By prepaying PERS instead of making payments with each payroll period, the City expects savings of $1.4 million in pension costs; however, this savings will be partially offset by the loss of approximately $759 thousand in interest income in the City’s portfolio. The net citywide savings of prepaying the UAL cost is $641 thousand. The saving is a consequence of PERS’ potential ability to earn interest earlier and at a higher rate than the City’s portfolio could realize. Without this prepayment, an additional $11.6 million in UAL payment would have been made in the third quarter; this payment was made in first quarter’s prepayment. As far as additional major revenue receipt due to seasonality timing, property taxes and related receipts begin the second and third quarters and major revenues such as sales tax, transient occupancy and utility user’s taxes are historically higher in the third quarter.
The portfolio consists of $43.5 million in liquid accounts and $590.8 million in various investment types as detailed in the following Table 1. The Investment Policy requires that at least $50 million be maintained in securities maturing in less than two years. The portfolio includes $206.2 million in investments maturing in less than two years, comprising 32.5% of the City’s investment portfolio. In addition, the Investment Policy allows up to 30% of the portfolio to be invested in U . S . T r e a s u r y
1 . 1 %
U . S . A g e n c y
3 1 . 5 %
U . S .
M u n i c i p a l / S t a t e
4 0 . 0 %
N e g o t i a b l e C D
8 . 0 %
U . S . C o r p o r a t e
4 . 7 %
S u p r a n a t i o n a l
7 . 9 %
L i q u i d A c c t s .
6 . 9 %
G r a p h 1 : I n v e s t m e n t s b y T y p e - $ 6 3 4 . 3 M i l l i o n ( P a r V a l u e )
securities with maturities beyond five years; actual at the end of the third quarter is 29.3% of the portfolio.
The current market value of the portfolio is 93.7% of the book value. The market value of securities fluctuates, depending on how interest rates perform. When interest rates decrease, the market value of the securities in the City’s portfolio will likely increase; likewise, when interest rates increase, the market value of the securities will likely decrease. Understanding and showing market values is not only a reporting requirement, but essential to knowing the principal risks in actively buying and selling securities. It is important to note, however, that the City’s practice is to buy and hold investments to maturity, therefore changes in market price do not affect the City’s investment principal. The market valuation is provided by U.S. Bank, which is the City’s safekeeping agent. The average life to maturity of the investment portfolio is 3.38 years compared to 3.13 years last quarter.
The Investment Policy states “Should the ratio of the market value of the portfolio to the book value of the portfolio fall below 95%, the Administrative Services Department will report this to the City Council within a reasonable time frame and evaluate whether there is any risk of holding any of the securities to maturity.” In the prior seven quarters the market value fell below 95%; ranging from 89% to 94% during these periods. The market rate this third quarter is 93.7% of book value. Interest rates on new investments have fluctuated so the expectation is the market value of the portfolio is expected to stay in the current range in the coming quarters. To minimize risk of loss for investment principal due to lower market values, the City’s investment practice is to buy and hold investments to maturity; in the instances where there is a need to sell securities for contingency cash flow planning, the City’s practice is to sell securities that are at or above the market value.
Table 1: Up to 1 Year 1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5 Years Portfolio Total * % of Portfolio U.S. Treasury 2.5$ 3.0$ 1.5$ -$ -$ 7.0$ 1.1%U.S. Agency Bonds 10.4 64.6 16.5 10.2 98.4 200.1 31.5%U.S. Municipal/ State Bonds 21.8 32.8 57.7 55.0 86.4 253.7 40.0%Negotiable Certificates of Deposits (NCD) 15.4 10.2 8.5 15.2 1.2 50.5 8.0%U.S. Corporate Bonds 4.0 14.0 1.7 9.8 - 29.5 4.7%Supranational Organizations Bonds 1.0 26.5 12.5 10.0 - 50.0 7.9%Liquid Accounts (LAIF & Fidelity) 43.5 - - - - 43.5 6.9% Grand Total 98.6$ 151.1$ 98.4$ 100.2$ 186.0$ 634.3$ 100% % of Portfolio 15.5% 23.8% 15.5% 15.8% 29.3% 100.0%* $115.2 million or 18.2% are in investments that support Environmental, Social, and Governace (ESG) Activities(aka "Green", local banks, and Supranational Bonds) Investment Type
FY 2024 Q3 Maturities - Par Value (millions)
Investments Made During the Third Quarter
During the third quarter, $14.4 million of securities with an average yield of 3.9% matured.
During the same period, per the following Table 2, securities totaling $60.3 million with an average yield of 4.9% were purchased. As expected, as interest rates rose on new investments, the City’s portfolio’s average yield has begun to gradually rise. In the prior two fiscal years or during the height of the COVID-19 economic closures, the portfolio’s interest rate had steadily declined. The City’s short-term money market and pool account decreased by $28.4 million compared to the second quarter of Fiscal Year 2024. Staff continually monitors the City’s short- term cash flow needs and adjusts liquid funds to meet them. The decrease is attributable to investment of excess cash in authorized securities per the Investment Policy and the normal timing of net cash activities.
Availability of Funds for the Next Six Months
Normally, the flow of revenues from the City’s utility billings and General Fund sources is enough to provide funds for ongoing expenditures in those respective funds. Projections indicate that for the City’s cashflow, an overall decline in the portfolio of $40.3 million is expected over the coming six months due to routine business activities. This reflects expected receipts of $344.5 million and expenditures of $384.8 million over the next six months.
The expected decline in the portfolio is attributable to pre-paying a portion of the Fiscal Year 2025 Public Employers’ Retirement System’s (PERS) employer contribution of $47.2 million, representing the City’s unfunded accrued liability (UAL) lump-sum prepayment for FY 2025. By prepaying PERS instead of making payments with each payroll period, the City is expected to save $1.6 million in pension expense; the savings will be offset by the loss of approximately $1 million in interest income in the City’s investment portfolio. This results in net citywide savings of $0.6 million because PERS has the ability to earn interest earlier and at a higher rate than the City could realize.
Table 2:
Up to 1 Year 1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5 Years Portfolio Total * % of Purchase U.S. Treasury -$ -$ -$ -$ -$ -$ 0.0%U.S. Agency Bonds - - - 0.6 7.5 8.1 13.4%U.S. Municipal/ State Bonds 0.4 1.8 0.4 1.6 28.6 32.8 54.4%Negotiable Certificates of Deposits (NCD) 0.7 1.7 3.2 5.3 - 10.9 18.1%U.S. Corporate Bonds 1.0 - - 2.0 - 3.0 5.0%Supranational Organizations Bonds - - 1.0 4.5 - 5.5 9.1% Grand Total 2.1$ 3.5$ 4.6$ 14.0$ 36.1$ 60.3$ 100%% of Purchase 3.5% 5.8% 7.6% 23.2% 59.9% 100.0% * $10 million or 16.5% are in investments that support Environmental, Social, and Governace (ESG) Activities(aka "Green", local banks, and Supranational Bonds) Investment Type
FY 2024 Q3 Security Purchases - Par Value (millions)
As of March 31, 2024, the City had $43.5 million deposited in the Local Agency Investment Fund (LAIF) and a money market account that could be withdrawn on a daily basis. In addition, investments totaling $32.9 million will mature between April 1, 2024 and September 31, 2024.
Based on the above, staff expect that the City will have sufficient funds or liquidity to meet expenditure requirements for the next six months.
Compliance with City Investment Policy
During the third quarter, staff complied with all aspects of the Investment Policy. Attachment C lists the major restrictions in the City’s Investment Policy compared with the portfolio’s actual performance.
Investment Yields
Interest income on an accrual basis, for the General Fund, for the third quarter was $4.0 million; compared to the prior year’s third quarter of $3.1 million or $0.9 million higher than the prior year’s quarter due to higher yield investment environment and higher General Fund cash balance. As of March 31, 2024, the yield to maturity of the City’s portfolio was 2.52%; in the prior quarter it was 2.39%. In the third quarter, LAIF’s average yield was 4.12% while the average yield on the two-year and five-year Treasury bonds was approximately 4.48% and 4.12%, respectively.
In comparison, in the prior quarter LAIF had 3.81% yield and the two-year and five-year Treasury bonds yields were higher at 4.80% and lower at 4.42%.
Historically, the City’s portfolio yield has outperformed the two-year and five-year Treasury bond rates and did so again several years ago; this is an expected occurrence during economic downturns. However, during economic recovery periods, interest rates rise, and the City’s portfolio yield is expected to be lower, which is the current financial environment. As the City’s laddered portfolio investments mature in the next year or two, funds will continue to be reinvested and trends will follow the economic patterns. Graph 2 shows the City’s yields and interest earnings for the past 21+ years.
City’s portfolio duration is 3.38 years.
Yield Trends
The Federal Open Market Committee (FOMC), since March 2020, has raised the federal funds rate 11 times totaling 5.25% with the first occurring on March 16, 2022. Prior to this the rate was near zero. This was to mitigate the persistent elevated inflation rate from the peak of 9.1% in June to 3.4% in December 2023, slightly higher than the prior month with a 2% target.
With the FOMC not raising the rate in the last five meetings, the expectation is they are done with further rate increases. The FOMC states “Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.” The expectation is inflation will decline in the long-term but will fluctuate up and down in the short-term.
The following tables show the U.S. inflation and unemployment rates and the U.S. Gross Domestic Product (GDP) past and recent trends.
5 . 8 8 %
5 . 0 0 %
4 . 1 7 %
4 . 5 4 %
C i t y o f P a l o A l t o
2 . 7 1 %
1 . 8 0 %
1 . 9 3 % 1 . 6 6 %
2 . 5 2 %
3 . 6 5 %
1 . 4 1 %
0 . 8 1 %
0 . 2 5 %
2 Y r . T r e a s u r y
4 . 3 9 %
4 . 4 8 %
4 . 4 3 %
4 . 3 9 %
4 . 9 8 %
1 . 1 0 %
5 - Y r . T r e a s u r y
2 . 8 8 %
2 . 4 7 %
0 . 2 7 %
3 . 2 3 %
4 . 0 0 %
4 . 1 2 %
1 . 4 4 %
5 . 2 5 %
0 . 2 3 %
L A I F
1 . 2 9 %
2 . 6 3 %
4 . 1 2 %
$ 0 . 0
$ 0 . 5
$ 1 . 0
$ 1 . 5
$ 2 . 0
$ 2 . 5
$ 3 . 0
$ 3 . 5
$ 4 . 0
$ 4 . 5
$ 5 . 0
0 . 0 %
0 . 5 %
1 . 0 %
1 . 5 %
2 . 0 %
2 . 5 %
3 . 0 %
3 . 5 %
4 . 0 %
4 . 5 %
5 . 0 %
5 . 5 %
6 . 0 %
I n t . E a r n i n g s ( M i l l i o n s )
Y i e l d s
F i s c a l Y e a r Q u a r t e r s
G r a p h 2 : Y i e l d s a n d I n t e r e s t E a r n i n g s Graph 3: U.S. Inflation Rate
The annual inflation rate in the United States went up to 3.5% in March 2024, the highest since September, compared to 3.2% in February.
Graph 4: U.S. Unemployment Rate
The unemployment rate in the United States dipped to 3.8% in March 2024 from the previous month's two-year high of 3.9%.
Graph 5: U.S. Gross Domestic Product (GDP) Annual Growth Rate The Gross Domestic Product (GDP) in the United States expanded 3% in the first quarter of 2024, slightly below 3.1% in the last three months of 2023.
Funds Held by the City or Managed Under Contract
Attachment A is a consolidated report of all City investment funds, including those not held directly in the investment portfolio. These include cash in the City’s regular bank account with US Bank and Wells Fargo. A description of the City’s banking relationships can be found in City Council Staff Report ID # 7858 i and ID # 11402 ii. The bond proceeds, reserves, and debt service payments being held by the City’s fiscal agents are subject to the requirements of the underlying debt indenture. The trustees for the bond funds are U.S. Bank and California Asset Management Program (CAMP). Bond funds with U.S. Bank are invested in federal agency and money market mutual funds that consist exclusively of U.S. Treasury securities. Bond funds in CAMP are invested in banker’s acceptance notes, certificates of deposit, commercial paper, federal agency securities, and repurchase agreements. The most recent data on funds held by the fiscal agent is as of March 31, 2024.
In January 2017, the City established a Section 115 Irrevocable Trust (Public Agencies Post- Employment Benefits Trust) administered by Public Agency Retirement Services (PARS). This fund is governed by the City’s Retiree Benefit Policy as opposed to the Investment Policy; however, it is discussed in this report to present the full picture of the City’s investments. It is the City’s intent to prefund pension costs and began to address the Net Pension Liabilities (NPL) as calculated by Governmental Accounting Standards Board Pronouncement No. 68 (GASB 68). The
Section 115 Trust offered by PARS has five portfolios from which to choose in making investments of City funds. In February 2023, the City Council revised the City’s portfolio selection from “Moderately Conservative” to “Moderate”, shifting from the second most conservative to third.
Additional information on the establishment of this trust can be found in City Council Staff Report ID # 7553 iii. Through March 31, 2024, principal investment contributions of $61 million made over time since May 2017, has increased to $71.5 million or by $10.5 million and the net return for one and five years has been 14.2% and 5.1% respectively. Since inception, $11.2 million net earnings have been realized with $0.66 million in administrative expenses.
FISCAL/RESOURCE IMPACT
This is an information report.
STAKEHOLDER ENGAGEMENT
Staff works internally and with external parties (U.S. Bank’s custodial, U.S. Bank’s bonds, Wells Fargo and U.S. Bank’s banking, California Asset Management Program (CAMP), and Public Agency Retirement Services (PARS)) statements to prepare this report.
ENVIRONMENTAL REVIEW
This Council informational report is not a project under California Environmental Quality Act (CEQA) as defined in CEQA Guidelines, section 15378, because it has no potential for resulting in either a direct or reasonably foreseeable indirect physical change in the environment.
ATTACHMENTS
Attachment A: Consolidated Report of Cash Management
Attachment B: Investment Portfolio
Attachment C: Investment Portfolio Compliance
Attachment D: Investment Activities in the Report Period APPROVED BY:
Lauren Lai, Director of Administrative Services
i City Council, April 11, 2017, under “Additional Information”, CMR 7858:
https://www.cityofpaloalto.org/files/assets/public/agendas-minutes-reports/reports/city-manager-reports- cmrs/year-archive/2017/7858.pdf
ii City Council, September 21, 2020 Item #2, CMR 11402:
https://www.cityofpaloalto.org/files/assets/public/agendas-minutes-reports/reports/city-manager-reports- cmrs/year-archive/2020-2/id-11402.pdf
iii City Council, January 23, 2017 Item #5, CMR 7553:
https://www.cityofpaloalto.org/files/assets/public/agendas-minutes-reports/reports/city-manager-reports- cmrs/year-archive/2017/7553.pdf