CMTA – Essentials Workshop

“Introduction to Investing in Municipal Bonds”September 28, 2010

Thomas Gardner, DPACity of Vista – Finance Director/Treasurer

Observation & Question

• Most municipality’s investment policies do not provide specifically for the use of municipal bonds in their portfolio.

• If in the policy, even fewer use them.

• Why not?

• Why are local agencies willing to sell bonds to investor they are unwilling to buy themselves?

Exploring the Issue: Overview

• Considering the Option– State Law & Other Barriers– Management Considerations– Investment risks

• The Differences to Consider– Due diligence– Evaluating a Purchase

• Future Discussions

Considering the Options –State law

• State law allows for:(a) Bonds issued by the local agency… (c) Registered state warrants or treasury

notes or bonds of this state…or by a department, board, agency, or authority of the state…

(d) Registered treasury notes or bonds of any of the other 49 United States in addition to California…

(e) Bonds, notes, warrants…any local agency within this state...

(Section 53601 of the State Government Code)

Considering the Options

• Do Muni’s violate Section 53600.5.?Primary Objective: Safeguard the principal

Secondary Objective: LiquidityThird Objective: “Return” on the funds under its control.

• NO, NO, and NO.

What Are Some of the Barriers?

• Not in current investment policies

• In policies, but no past experience

• Advisory Committee/management wants a “no risk” portfolio

• Return on investment is insufficient to offset risk.

Other Barriers - Return on Investment

• Historically the spread to agencies was not sufficient

• No incentive for tax exempt bonds

• Limited number of taxable notes.

• Brokers – trade other things

• Knowledge about Munis and their risk is limited.

Other Barriers - Risk Avoidance

• Liquidity Risk

• Interest Rate risk

• Credit Risk

• Reinvestment Risk

• “Political/publicity” Risk

- Greater

- Same

- Greater

- Less (no calls)

- Much Greater

Investment Risk: Harrisburg, Vallejo or California

Just $886 million of general obligation bonds in a $2.8 trillion municipal bond market this year have seen credit impairments, such as dipping into reserve funds or tapping bond insurance.

• Bond holders didn't get paid on $32 million of that total

Matt Fabian, Managing Director Municipal Market Advisors, Westport, Conn.

Implementing a Plan “for Municipals”

• Suitable risk tolerance– Willingness

• Consistent with management style

• Consistent with investment plan

• Consistent with a politically correct portfolio

Ben Finkelstein, Author“The Politics of Public Fund Investing”

Why not Municipals?

• They are not for everyone

• Portfolios have to be customized for the agency they are serving.

• Muni’s are a substitute for Corporate – not agencies

Changing Policies

“The key to change... is to let go of fear.” - Rosanne Cash

• “There is nothing wrong with change, if it is in the right direction.” - Winston Churchill

Focus On Risk Management

• “Walk on thick Ice”

• Approach changing policies/administration to create more risk control

Vista’s Example - Committee Concurrence

• Limits on size per investment/entity - $2 m.• Two rating agencies – “Underlying A or better”• Limited portion of portfolio @ 15%• Prior approval by City Manager• Enhanced due diligence & review

Differences to Consider - Brokers

• Working with Brokers– New policy review– Additional information for decisions

• Agency P.O.S• Disclosure• CAFR – reserves, liabilities etc• Insurance carrier & their rating• Recent Pricing• Rating analysis

• Use of Municipal Securities Rule Making Board - “emma.msrb”

Differences to Consider - Disappointments

• Research may lead to “no go”– Underlying contracts or revenue streams

may need more research than you have time for

– (Example: State revenue bond based on multiple RDA’s revenue stream)

– Call features may be more complicated ‘make whole calls’ require special calculations

Bumps in the Road

• Offers inconsistent with policy – Example: State bond that was actually a JPA– “negative outlook”, or single rating

• Problems with timely approvals– More lead time for approvals

• Complexity in the research– Know the agency you are buying– Underlying security– Insurances– Ratings

• Results in effort & lost opportunities

The Problem of Ratings - Singles

Not All Munis Are The Same

• Taxable• Non-taxable• General Obligation• Pension Obligation (1937 act)• Special Revenues

– Sewer– JPA– or Parking Structure

Benefits – Vista’s Use of MunicipalsMunicipal Bonds

Investment Type Face ValuePurchase Price

Lowest

Rating

Months Yield

% of Portfoli

oBroker/ Dealer

Long Beach Pension $ 1,855,000 103.66 AA+ 27 3.200% 1.35% Stone

Solano Co Pension $ 750,000 104.93 A1 27 3.000% 0.55% Stone

San Francisco Redev $ 1,450,000 105.30 A 26 2.900% 1.08% Stone

Port of Oakland $ 1,245,000 102.45 A 39 4.200% 0.90% Wedbush

Univ. of CA Revenue $ 1,000,000 107.73 AA 42 2.475% 0.76% Stone

LA Unified School $ 2,000,000 100.17 AA- 45 2.950% 1.43% Citigroup

Contra Costa Pension $ 2,000,000 104.00 AA- 49 3.653% 1.47% Stone

S.Coast Air Quality $ 2,275,000 108.55 A+ 34 2.500% 1.75% Stone

San Marcos Tax Alloc $ 600,000 104.69 A 34 3.200% 0.45% Stone

Fresno Co. Pension $ 2,000,000 94.95 A 60 5.446% 1.37% Citigroup

Total % of Portfolio 11.10%

Takeaway: Benefits

• Bullets– Fewer– Smaller

• Yield– Higher yield higher Risk (i.e.

parking)

• Political Support

Takeaway: Mitigate the Risks

• Select Quality - Know what you are buying

• Smaller Sizes

• Diversification

• Be Careful of Liquidity

• Alternative to “Corporates”

Takeaway: Don’t Use MUNI’s

• Staff is too small and organization is too risk averse

• Explaining why is now possible.

Continuing the Dialogue

• This has been an introduction• Would you like a more lengthy Discussion?• Potential topics for future:

– Changing the policies– Building a supporting team– Best Practices– Mitigating Risk– Evaluating the Agency