R E A L. ecap the past. valuate the potential future. djust as needed. earn ACT 10 INVESTMENTS IN THE REAL WORLD

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1 2101 Oregon Pike Lancaster, PA Tel: (866) ACT 10 INVESTMENTS IN THE REAL WORLD PASBO 62 ND ANNUAL CONFERENCE AND EXHIBITS, PITTSBURGH March R E A L ecap the past valuate the potential future djust as needed earn 2 1

2 GOAL GOAL: To better Understand the impact of Act 10 of 2016 and how it Effects the permissible investment landscape for School Districts and other Local Government Entities Reviewing Permissible Investment Landscape Newly Permitted Investments per Act 10 of 2016 Importance of Managing Risk Recommended PSBA Investment Policy 3 Act 10 of 2016 broadens the scope of of the PA School Code by expanding ACT 10 the list OF of 2016 permissible investments available to municipal entities in the Commonwealth. This legislation does not supersede or preempt other investment powers of public corporations or municipal authorities as otherwise authorized by law. These new permissible investments would be available to any local government entity: County City Borough Township School District Or other municipality of the Commonwealth 4 2

3 Nationally Recognized Statistical Ratings Organization (NRSRO) NATIONALLY RECOGNIZED STATISTICAL RATINGS ORGANIZATION (NRSRO) a credit rating agency (CRA) that the U.S. Securities and Exchange Commission (SEC) permits other financial firms to use for certain regulatory purposes Standard & Poor s Moody s Investors Service Fitch Ratings Kroll Bond Rating Agency A.M. Best Company Dominion Bond Rating Service, Ltd. (DBRS) Japan Credit Rating Agency, Ltd. Egan-Jones Rating Company Morningstar, Inc. 5 Section Act 10 of 2016 Effective as of May 24, 2016 Direct obligations of the U.S. Government Obligations of U.S. Agencies & Instrumentalities (short term) Local Government Investment Pools (LGIPs) Municipal Debt PA Issuer (General Obligation) No Credit Rating Requirement Repurchase Agreements Shares of an Investment Co. (Money Market Funds) Pooled FDIC Insured CD Redeposit Program Debt obligation of any Federal Agency, Instrumentality, or GSE Bankers Acceptances (aka Bills of Exchange or Time Drafts ) Commercial Paper Banking Product FDIC Insured (Tax I.D.) Collateralized Negotiable CD s Credit Ratings Apply 6 3

4 Short-term Permissible Grades Moody's Permitted? S&P Permitted? Fitch Permitted? P-1 Yes A-1 Yes F1 Yes P-2 No A-2 No F2 No P-3 No A-3 No F3 No Long-term Permissible Grades Moody's Permitted? S&P Permitted? Fitch Permitted? Aaa Yes AAA Yes AAA Yes Aa Yes AA Yes AA Yes A Yes A Yes A Yes Baa No BBB No BBB No Ba No BB No* BB No *S&P definition of BB: "Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'C' the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions." History On June 13 th, 2008, Moody s Investor Services affirmed Lehman Brothers Holdings, Inc. Prime-1 (P-1) short term rating. Fitch Rating also gave Lehman a Top rating at that time. On September 15 th, 2008, Lehman Brothers filed for Bankruptcy protection and both Rating Agency s cut Lehman s credit rating to Junk. The lesson here is that increased yield and ratings should not be the only primary factors in one s decision to invest in these new vehicles. 7 Repurchase Agreements (MODIFIED BY ACT 10) Purchase of an allowed security with a promise to repurchase Obligations MUST be Rated at least A or equivalent by at least two nationally recognized statistical ratings organizations (NRSRO) Complex legal transaction Use with Care Benefits Enhanced Portfolio Diversification Liquid Management Risks Counterparty Default Risk Complicated to set-up and understand Yield Advantage Flexibility 8 4

5 Shares of an Investment Company (MODIFIED BY ACT 10) Investment Company MUST be registered under the Investment Company Act of Rated in the Highest Category by at least one nationally recognized rating agency The underlying investments of the company need to be permissible under State Law Section Act 10 of 2016 Benefits Enhanced Portfolio Diversification Additional Yield Risks Credit Risk - Potential for downgrade or default of an issuer or underlying investments Greater volatility in market pricing 9 Pooled FDIC Insured CD Redeposit Program (NOT NEW TO SCHOOLS) Savings or Demand deposits placed in a federally insured institution having a place of business in the Commonwealth This institution will then arrange for these funds to be redeposited in institutions that are FDIC members. Principal and interest must be covered by this insurance. Benefits Enhanced Portfolio Diversification Insured by FDIC up to $250,000 in each participating bank. Risks Risk of depositing above the FDIC insurance limit, if the public entity owns this product through multiple institutions or directly at one of the underlying banks. 10 5

6 Pooled FDIC Insurance CD Deposit Program (NOT NEW TO SCHOOLS) Permissible per section of the PA School Code, but defined in Act 10 of The money is initially deposited and invested through a federally insured institution having a place of business in this Commonwealth Typically higher rate because covered by FDIC Insurance. No Cost of Collateral for institution Bank 1 <250,000 in principal and interest <$1,000,000 Deposit at an Institution <$250,000 kept at Institution Remaining Deposit are sent to other banks in amounts under $250,000 Bank 2 <250,000 in principal and interest Bank 3 <250,000 in principal and interest 11 Debt Obligations of ANY Federal Agency, Instrumentality, or GSE (MODIFIED BY ACT 10) Obligations MUST be Rated at least A or equivalent by at least two nationally recognized statistical ratings organizations (NRSRO) Federal Home Loan Bank (FHLB), Freddie Mac, Fannie Mae, Ginnie Mae, Federal Farm Credit Includes Short and NOW Long Term Investments Benefits Enhanced Portfolio Diversification Yield Advantage Risks These entities do not all have the direct backing of the United States Gov t (Default Risk) 12 6

7 Bankers Acceptances (aka Bills of Exchange, Time Drafts ) (NEW) Must not exceed 180 day maturity The accepting bank must be rated in the Top Short-term Category by at least two NRSROs. Benefits Enhanced Portfolio Diversification Additional Yield Risks Credit Risk - Potential for downgrade or default of an issuer Marginal yield pickup over agencies Few issuers in the marketplace 13 Commercial Paper (NEW) Must be issued by Corporations or Business Entities in Accordance with Federal and State Law Must not exceed 270 day maturity Must be rated in the Top Short-Term Category by at least two NRSROs Benefits Enhanced Portfolio Diversification Additional Yield Risks Credit Risk - Potential for downgrade or default of an issuer (i.e. Lehman Brothers) Greater volatility in market pricing 14 7

8 Negotiable CDs (NEW) - PSBA released an urgent Alert in reference to NCDs on June 10 th, 2016 Must be issued by a nationally or State-chartered bank, Savings & Loan, or a State-licensed branch of a foreign bank. Maturities of 1 year or less Must be rated in the Top short-term rating category by at least two NRSROs Maturities of 1 year to 3 years The senior debt obligations of the issuing institution or its parent must be Rates at least A or its equivalent by at least two NRSROs Benefits Enhanced Portfolio Diversification Additional Yield Risks Credit Risk (No Collateral)- Potential for downgrade or default of an issuer Marginally greater volatility in market pricing 15 Legal Alert on Negotiable Certificates of Deposit (NCDs) that PSBA thinks schools should be aware of they [NCDs] constitute a form of deposit of district funds otherwise subject to the collateralization requirements of Sections 621, 622 and 623 of the Public School Code. Thus, to the extent the amount of a negotiable CD of the uncollateralized kind currently available in the market exceeds $250,000 (the limit of FDIC deposit protection), it would be an impermissible investment in violation of the School Code, notwithstanding Act 10. This legislation does not supersede or preempt other investment powers of public corporations or municipal authorities as otherwise authorized by law. 16 8

9 As highlighted in PSBA s Policy News Network Volume III of 2016 issued in May, Act 10 of 2016 expanded the types of investments permissible for school districts, but in doing so also expanded potential exposure to financial risk. Accordingly, PSBA s revised policy guide for Policy 609, Investment of District Funds, emphasizes the need for extra caution with regard to Act 10 investments. PNN Volume III and the policy guide also flagged a potential legal obstacle for school districts with regard to one category of Act 10 investments negotiable certificates of deposit or other evidences of deposit. This alert is being provided to inform PSBA members and their solicitors that further legal review and analysis by highly experienced school finance attorneys has been shared with PSBA that confirms that the existing School Code requirements that deposits of district funds be secured by specified forms of collateral (to the extent not covered by FDIC insurance) continue to apply to the negotiable certificates of deposit or other evidences of deposit otherwise permitted by Act 10. This alert should not be understood as a criticism of negotiable CDs as an investment vehicle generally, nor as to their merit relative to other investments allowed by Act 10. Rather, the legal obstacle arises from the facts that these types of investments do not appear to currently exist in the marketplace in a collateralized form, and that they constitute a form of deposit of district funds otherwise subject to the collateralization requirements of Sections 621, 622 and 623 of the Public School Code. Thus, to the extent the amount of a negotiable CD of the uncollateralized kind currently available in the market exceeds $250,000 (the limit of FDIC deposit protection), it would be an impermissible investment in violation of the School Code, notwithstanding Act 10. Urgent Legal Alert on Act 10 Investments Act 10 makes clear that the investment authority it provides is to be in addition to any other investment powers provided by law for a public corporation (which is defined to include school districts), and that it does not supersede or preempt such powers. However, Act 10 did not amend the School Code, and its language does not otherwise state that it replaces safeguards in the School Code specific to deposits of school district funds. Therefore, unless and until this issue is resolved by corrective legislation, or there is a final judicial or other ruling having the force of law concluding that School Code requirements for collateralization of deposits do not apply to the negotiable certificates of deposit or other evidences of deposit otherwise permitted by Act 10, PSBA is compelled to caution members against including such investments in their districts portfolios. PSBA is revising the policy guide for Policy 609 accordingly, and the revised version will be transmitted to participants in PSBA s Policy News Network service next week. Watch for further details on this issue in next week s PNN. Contact: Stuart Knade Esq., General Counsel, x e=b5c1e6a18d 17 Modernizing Your Investment Policy Know what is in your Current Investment Policy Education and Understanding of each investment PSBA has issued a NEW Recommended Investment Policy Investment Policies can be stronger than State permissible statutes 18 9

10 Items to Consider before Investing: 1. Define the Investment - What is the product being offered? 2. Does the investment have insurance or collateral? 3. What is the underlying Credit Rating of the Investment? 4. Is the Investment s rating on the Credit Watch List? 5. Does it fit within the LEA Investment Policy? 19 Recap: To better Understand the impact of Act 10 of 2016 and how it Effects the permissible investment landscape for School Districts and other Local Government Entities Reviewing Permissible Investment Landscape Newly Permitted Investments per Act 10 of 2016 Importance of Managing Risk Recommended PSBA Investment Policy 20 10

11 AN ACT Amending the act of July 25, 1973 (P.L.217, No.53), entitled "An act authorizing cities of the first class and second class to invest all funds received and deposited with the city treasurer in certain commercial paper under certain terms and conditions," amending the title of the act; and providing for investment of public corporation or authority funds. The General Assembly of the Commonwealth of Pennsylvania hereby enacts as follows: Section 1. The title of the act of July 25, 1973 (P.L.217, No.53), entitled "An act authorizing cities of the first class and second class to invest all funds received and deposited with the city treasurer in certain commercial paper under certain terms and conditions," is amended to read: AN ACT Authorizing cities of the first class and second class to invest all funds received and deposited with the city treasurer in certain commercial paper under certain terms and conditions; and providing for investment of public corporation or municipal authority funds. Section 1.1. The act is amended by adding a section to read: Section 1.1. (a) In addition to products otherwise authorized by law, a public corporation or municipal authority may invest and reinvest money of the public corporation or municipal authority in any of the following financial products: 21 (1) Obligations, participations or other instruments of any Federal agency, instrumentality or United States government-sponsored enterprise, including those issued or fully guaranteed as the principal and interest by Federal agencies, instrumentalities or United States government-sponsored enterprises, if the debt obligations are rated at least "A" or its equivalent by at least two nationally recognized statistical ratings organizations. (2) Repurchase agreements with respect to United States Treasury bills or obligations, participations or other instruments of or guaranteed by the United States or any Federal agency, instrumentality or United States government-sponsored enterprise. (3) Negotiable certificates of deposit or other evidences of deposit, with a remaining maturity of three years or less, issued by a nationally or State-chartered bank, a Federal or State savings and loan association or a State-licensed branch of a foreign bank. For obligations with a maturity of one year or less, the debt obligations of the issuing institution or its parent must be rated in the top short-term rating category by at least two nationally recognized statistical ratings organizations. For obligations with a maturity in excess of one year, the senior debt obligations of the issuing institution or its parent must be rated at least "A" or its equivalent by at least two nationally recognized statistical ratings organizations. (4) Bills of exchange or time drafts drawn on and accepted by a commercial bank, otherwise known as bankers' acceptances, if the bankers' acceptances do not exceed 180 days' maturity and the accepting bank is rated in the top short-term category by at least two nationally recognized statistical ratings organizations

12 (5) Commercial paper issued by corporations or other business entities organized in accordance with Federal or State law, with a maturity not to exceed 270 days, if the issuing corporation or business entity is rated in the top short-term category by at least two nationally recognized statistical ratings organizations. (6) Shares of an investment company registered under the Investment Company Act of 1940 (54 Stat. 789, 15 U.S.C. 80a-1 et seq.) whose shares are registered under the Securities Act of 1933 (48 Stat. 74, 15 U.S.C. 77a et seq.), if all of the following conditions are met: (i) The investments of the company are the authorized investments under this subsection. (ii) The investment company is managed in accordance with 17 CFR 270.2a-7 (relating to money market funds). (iii) The investment company is rated in the highest category by a nationally recognized rating agency. (7) Savings or demand deposits placed in accordance with the following conditions: (i) The money is initially deposited and invested through a federally insured institution having a place of business in this Commonwealth, which is selected by the public corporation or municipal authority. (ii) The selected institution arranges for the redeposit of the money in savings or demand deposits in one or more financial institutions insured by the Federal Deposit Insurance Corporation, for the account of the public corporation or municipal authority. (iii) The full amount of principal and any accrued interest of each such deposit is insured by the Federal Deposit Insurance Corporation. (iv) On the same date that the money is redeposited pursuant to paragraph (ii), the selected institution receives an amount of deposits from customers of other financial institutions equal to or greater than the amount of money initially invested through the selected institution by the public corporation or municipal authority. 23 (b) Nothing in subsection (a) shall be construed to supersede or preempt other investment powers of public corporations or municipal authorities as authorized by law c) (1) Each local government investment trust or local government investment pool that invests funds as provided for under this section shall file with the Department of Community and Economic Development, within 120 days of completion of its fiscal year, an annual investment report for the previous fiscal year. The report shall be made available to the public, upon request, during normal business hours. Nothing may prohibit the posting of the report on the Internet. (2) The report shall provide all of the following: (i) A listing of each investment authorized by this section that was purchased during the fiscal year. (ii) For each investment purchased, the listing must show the issuer, date of purchase, maturity date, par amount, cost, yield to maturity at the time of purchase, broker/dealer from which the investment was purchased, if applicable, any separately stated fees related to the purchase of the investment and the name of the party receiving the fee 24 12

13 (d) As used in this section, the following words and phrases shall have the meanings given to them in this subsection unless the context clearly indicates otherwise: "Local government investment trust" or "local government investment pool" shall mean a trust or pool offered by the State Treasurer or multiple public corporations or municipal authorities, governed by a board of directors or board of trustees for the exclusive benefit of the participating public corporations or municipal authorities. "Public corporation" shall have the same meaning as given to it in section 1 of the act of May 16, 1929 (P.L.1773, No.581),entitled, "An act to supplement an act approved the twentieth day of April, one thousand eight hundred and seventy-four (Pamphlet Laws, sixty-five), entitled 'An act to regulate the manner of increasing the indebtedness of municipalities; to provide for the redemption of the same; and to impose penalties for illegal increase thereof,' by authorizing the sale of property purchased by a public corporation out of funds provided by increase of indebtedness of such corporation; and providing for the disposition of the funds realized from such sale." Section 2. This act shall take effect in 60 days. APPROVED--The 25th day of March, A.D TOM WOLF 25 Act 10 of 2016 Executive Summary Security New? Benefits Risks Debt obligation of any Federal Agency, Instrumentality, or GSE Now permissible for longer terms Enhanced Portfolio Diversification Yield Advantage The entities do not have the direct backing of the United States (Default risk) Repurchase Agreements Enhanced Portfolio Diversification Liquid Management Yield Advantage Flexibility Counterparty Default Risk Complicated to set-up and understand Negotiable Certificate of Deposits PSBA Alert Bankers Acceptances Enhanced Portfolio Diversification Additional Yield Enhanced Portfolio Diversification Additional Yield Credit Risk No Collateral Marginally greater volatility in market pricing Credit Risk potential for downgrade Marginal yield pickup over agencies Few issuers in marketplace 26 13

14 Act 10 of 2016 Executive Summary (cont.) Security New? Benefits Risks Commercial Paper Enhanced Portfolio Diversification Additional Yield Credit Risk potential for downgrade Greater volatility in market pricing Shares of an Investment Company Modified to also include Act 10 Securities Enhanced Portfolio Diversification Additional Yield Credit Risk Potential for Downgrade Greater volatility in market pricing Pooled FDIC Insured CD Redeposit Program Enhanced Portfolio Diversification Insured by FDIC up to $250,000 in each participating bank Risk of depositing above the FDIC insurance limit if the public entity owns this product through multiple institutions or directly at one of the underlying banks. This does not purport to be a complete statement of all material facts relating to securities mentioned. The information contained, while not guaranteed as to accuracy or completeness, has been obtained from sources, which we believe to be reliable. Opinions expressed herein are subject to change without notice. This notice shall not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any state in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities law of any such state. Please refer to the PSDLAF Information Statement for any questions at 14