City Council
Staff Report
From: City Manager
Report Type: INFORMATION REPORTS
Lead Department: Administrative Services
Meeting Date: May 19, 2025
Report #:2501-4015
TITLE
Investment Activity Report for the Third Quarter, Fiscal Year 2025. CEQA Status – Not a Project.
RECOMMENDATION
This is an informational report and no City Council action is required.
EXECUTIVE SUMMARY
The City’s Investment Policy1 (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, 2025 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 and no significant notable activity or changes in value occurred in this reporting period. Two municipalities’ bond ratings have been downgraded below the City’s minimum Investment Policy guidelines, however, the likelihood of a loss of their investments is low so these investments are planned to be retained.
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 include details of the investment issuer, date of maturity, current market 1 City of Palo Alto website, Administrative Services Department, Money Management & Treasury:
https://www.cityofpaloalto.org/files/assets/public/v/1/administrative-services/investment-policies/adopted- investment-policy-1-39-asd.pdf
value, the book and face (par) value, and the weighted average maturity of each type of investment and of the entire portfolio.
The par value of the City’s portfolio is $656.6 million; in comparison, last quarter it was $637.2 million. The $19.4 million portfolio growth since the last quarter results from timing of cash flows, primarily seasonality and timing of major revenue receipts.
Property taxes and related receipts begin in the second quarter; for example, third quarter property related (taxes and assessments) receipts were $22.3 million. In addition, other major revenues such as sales, transient occupancy and utility user’s taxes historically trend higher in the third quarter.
The portfolio consists of $79.1 million in liquid accounts and $577.5 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 $247.1 million in investments maturing in less than two years, comprising 37.6% of the City’s investment portfolio. In addition, the Investment Policy allows up to 30% of the portfolio to be invested in securities with maturities beyond five years; actual at the end of the third quarter it is 26.1% of the portfolio.
The current market value of the portfolio is 96.3% of the book value. The market value of securities fluctuates, depending on how interest rates perform.
As interest rates decrease, the market value of the City’s portfolio will likely increase, and vice versa. There are inherent principal risks when actively buying and selling securities; reporting on market values a reporting requirement that informs staff of the portfolio’s overall position.
The market valuation is provided by U.S. Bank, the City’s safekeeping agent. The average life to maturity of the investment portfolio is 2.87 years compared to 2.95 years last quarter.
To minimize investment principal risk of loss due to lower market values, the City’s investment practice is to buy and hold investments to maturity. In 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.
Investments Activity During the Third Quarter
During the third quarter, $18.5 million securities with an average yield of 3.6% matured. During the same period, per the following Table 2, securities totaling $25.4 million with an average yield of 4.3% were purchased. The interest rates rose on new investments, the City’s portfolio’s average yield also rose. The City’s short-term money market and pool account increased by $12.4 million compared to the same quarter of the prior fiscal year. Staff continually monitors the City’s short-term cash flow needs and adjust liquid funds to meet them.
Per California Government Code Section 53607, the Administrative Services Department provides a monthly report of transactions (investments, reinvestment, sold, and exchanged securities) to Council via a separate report. Though not required by this code, included in this report are security maturities and cash movement activity in the City’s two liquid operating cash Table 1: Up to 1 Year 1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5 Years Portfolio Total * % of Portfolio U.S. Treasury 3.0$ 1.5$ -$ -$ -$ 4.5$ 0.7%U.S. Agency Bonds 64.6 17.5 2.2 12.9 103.0 200.2 30.5%U.S. Municipal/ State Bonds 30.8 57.1 30.3 58.0 67.3 243.5 37.1%Negotiable Certificates of Deposits (NCD) 9.2 6.7 5.7 8.4 0.8 30.8 4.7%U.S. Corporate Bonds 14.0 3.7 13.6 5.0 - 36.3 5.5%Supranational Organizations Bonds 26.5 12.5 1.0 22.2 - 62.2 9.5%Liquid Accounts (LAIF & Fidelity) 79.1 - - - - 79.1 12.0% Grand Total 227.2$ 99.0$ 52.8$ 106.5$ 171.1$ 656.6$ 100%% of Portfolio 34.6% 15.1% 8.0% 16.2% 26.1% 100.0%* $123.5 million or 18.9% are in investments that support Environmental, Social, and Governace (ESG) Activities(aka "Green", local banks, and Supranational Bonds) Investment Type
FY 2025 Q3 Maturities - Par Value (millions)
pool accounts (Local Agency Investment Fund and Fidelity accounts). Monthly and quarterly investment reports, along with the City’s Investment Policy, can be found on the City’s website2.
Availability of Funds 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.
Projections indicate that for the City’s cashflow, an overall decline in the portfolio of $37.1 million is expected over the coming six months due to routine business activities. This reflects expected receipts of $385.8 million and expenditures of $422.9 million over the next six months.
As of March 31, 2025, the City had $79.1 million deposited in the Local Agency Investment Fund (LAIF) and a money market account. In addition, investments totaling $73.1 million will mature between April 1, 2025 and September 30, 2025.
Compliance with City Investment Policy
During the third quarter, staff complied with all aspects of the Investment Policy. Attachment C lists the major restrictions in the City’s Investment Policy compared with the portfolio’s actual performance.
The City’s Investment Policy requires new such security purchases to be rated AA or better and “If securities owned by the City are downgraded by Moody’s, Fitch, or Standard & Poor’s to a level below AA or Aa2, it shall be the City’s policy to review the credit situation and make a determination as to whether to sell or retain such securities in the portfolio.” The Southern California wildfires (Palisades and Eaton fires), as reported in the prior quarter’s report, have resulted in rating downgrades of the Los Angeles Department of Water & Power 2 City of Palo Alto, Administrative Services, Financial Reporting, City Investment Reports and Policy:
www.cityofpaloalto.org/investmentreporting
Table 2:
Up to 1 Year 1 to 2 Years 2 to 3 Years 3 to 5 Years Over 5 Years Portfolio Total * % of Purchase U.S. Agency Bonds -$ -$ -$ $ - 8.1$ 8.1$ 31.9%U.S. Municipal/ State Bonds - - - - 7.0 7.0 27.6%Negotiable Certificates of Deposits (NCD) - - - - 0.3 0.3 1.2%U.S. Corporate Bonds - 1.9 1.0 1.2 - 4.1 16.1%Supranational Organizations Bonds - - - 5.9 - 5.9 23.2% Grand Total -$ 1.9$ 1.0$ 7.1$ 15.3$ 25.4$ 100%% of Purchase 0.0% 7.5% 3.9% 28.0% 60.2% 99.6%* $7.6 million or 30.1% are in investments that support Environmental, Social, and Governace (ESG) Activities(aka "Green", local banks, and Supranational Bonds) Investment Type
FY 2025 Q3 Security Purchases - Par Value (millions)
(LADWP) to “A” by Standard and Poor’s and Fitch to AA-. Moody’s still maintains its “Aa2” with a negative credit watch by all three rating firms meaning further rating downgrade(s) could occur.
The City’s investment portfolio has $1.9 million in LADWP bonds with a remaining maturity duration of 2.2 years. LADWP potential issues revolve around lack of water supply and working hydrants and possibility of fires starting by downed power lines. Based on staff’s analysis, the likelihood of a loss of these investments is low so these investments should be retained.
In April 2025, the City of Los Angeles rating was downgraded by S&P to AA- and is on a negative credit watch by the three rating agencies. The City’s portfolio contains $5.4 million of their General Obligation (GO) Bonds, six of their bonds in the City’s portfolio are only rated by S&P and one is rated only by Moody’s which has a rating of Aa2 with durations ranging from 1.6 years to
7.6 years. GO bonds debt service on these bonds are funded by restricted annual property tax assessment(s); risk of loss is low and these securities will be retained to maturity. The City’s portfolio does own other municipalities securities in the area whose ratings have not been impacted by this, but staff will actively monitor all these entities’ ratings and potential liability developments with the assistance of the City’s brokers.
In this report quarter, the City of Oakland’s S&P’s rating was downgraded to AA- with a negative credit watch. The City’s portfolio has $6.9 million in their GO Bonds only rated by S&P and $0.2 million in revenue bonds rated by both S&P and Moody’s. The five GO Bonds duration range from
3.8 years to 8.3 years while the one revenue bond duration is 0.7 years. The main reason for the revised ratings is the large current and projected deficit due to expenditure growth outpacing revenue growth, largely due to public safety spending increases. S&P acknowledges that Oakland’s management has implemented a plan to reduce operation expenditures, but they have concerns whether such actions are sufficient to address their structural imbalance. Based on the staff’s analysis, since they are mostly GO Bonds, the likelihood of a loss of these investments is low so these investments should be retained.
Investment Yields
Third quarter interest income, on an accrual basis, was $4.1 million. Compared to the prior year’s same quarter of $4.0 million, it is $0.1 million higher due to prudent long-term investments made in the last several years during the higher interest rate environment. As of March 31, 2025, the yield to maturity of the City’s portfolio was 2.65%; in the prior quarter it was 2.58%. In the third quarter, LAIF’s average yield was 4.34% while the average yield on the two-year and five-year Treasury bonds was approximately 4.15% and 4.25%, respectively. In comparison, in the prior quarter LAIF had higher 4.48% yield and the two-year and five-year Treasury bonds yields were at the same at 4.15% and lower at 4.13%.
The City’s portfolio yield is lower than the two-year and five-year Treasury bond due to the fluctuating but still high interest rates environment. It is expected that as the City’s investments mature in the next few years, funds will continue to be reinvested and will follow the economic patterns. Graph 2 shows the City’s yields and interest earnings for the past 23+ years.
City’s portfolio duration is 2.87 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. Then beginning July 31, 2024, they decreased the rate four times totaling 1.25%. In January and March 2025, the Federal Reserve kept interest rates unchanged. The primary goals of the Fed's monetary policy are to promote maximum employment, stable prices, and moderate long-term interest rates.
Following three consecutive rate reductions that began in September 2024, in March 2025 the FOMC held interest rate in the range of 4.25% to 4.50% for a third straight meeting. The Fed’s “wait-and-see” posture allows for time to assess impacts to inflation and growth from recent policy shifts under the new administration. Inflation remains elevated but has moderated over the past year and the economy is progressing at a steady pace with solid labor market conditions, according to the Chairman of the Federal Reserve. The latest FOMC outlook expects slower economic growth, higher inflation, and higher unemployment, with possible rate cuts in calendar year 2025.
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 #2404-2845 3. 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 3 City Council, June 17, 2024, https://portal.laserfiche.com/Portal/DocView.aspx?id=73964&repo=r-704298fc
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, 2025.
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 # 75534. Through March 31, 2025, principal investment contributions of $80.3 million made over time since May 2017, have increased to $96.1 million and the net return for one and five years has been 6.4% and 6.3% respectively. Since inception, $16.7 million net earnings have been realized with $0.9 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 the report is presented for informational purposes only with no action requested of the Council. 4 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
ATTACHMENTS
Attachment A: Consolidated Report of Cash Management
Attachment B: Investment Portfolio
Attachment C: Investment Portfolio Compliance
APPROVED BY:
Lauren Lai, Administrative Services Director