Notes to the Financial Statements

June 30, 2014

Note 4 Cash Deposits and Investments

According to GASB Statement No. 40, "Deposit and Investment Risk Disclosures", the State needs to make certain disclosures about deposit and investment risks that have the potential to result in losses. Thus, the following deposit and investment risks are discussed in this note:

Interest Rate Risk - the risk that changes in interest rates will adversely affect the fair value of an investment.

Credit Risk - the risk that an issuer or other counterparty to an investment will not fulfill its obligations.

Concentration of Credit Risk - the risk of loss attributed to the magnitude of an investment in a single issuer.

Custodial Credit Risk (deposits) - the risk that, in the event of a bank failure, the State's deposits may not be recovered.

Foreign Currency Risk - the risk that changes in exchange rates will adversely affect the fair value of an investment or deposit.

Primary Government
The State Treasurer is the chief fiscal officer of State government and is responsible for the prudent management and investment of monies of State funds and agencies as well as monies of pension and other trust funds. The State Treasurer with the advice of the Investment Advisory Council, whose members include outside investment professionals and pension beneficiaries, establishes investment policies and guidelines. Currently, the State Treasurer manages one Short-Term Investment Fund, one Medium-Term Investment Fund, and twelve Combined Investment Funds.

Short-Term Investment Fund (STIF)
STIF is a money market investment pool in which the State, municipal entities, and political subdivisions of the State are eligible to invest. The State Treasurer is authorized to invest monies of STIF in United States government and agency obligations, certificates of deposit, commercial paper, corporate bonds, savings accounts, bankers' acceptances, repurchase agreements, and asset-backed securities. STIF's investments are reported at amortized cost (which approximates fair value) in the fund's statement of net position.

For financial reporting purposes, STIF is considered to be a mixed investment pool a pool having external and internal portions. The external portion of STIF (i.e. the portion that belongs to participants which are not part of the State's financial reporting entity) is reported as an investment trust fund (External Investment Pool fund) in the fiduciary fund financial statements. The internal portion of STIF (i.e., the portion that belongs to participants that are part of the State's financial reporting entity) is not reported in the accompanying financial statements. Instead, investments in the internal portion of STIF by participant funds are reported as cash equivalents in the government-wide and fund financial statements.

For disclosure purposes, certificates of deposit held by STIF are reported in this note as bank deposits, not as investments.

As of June 30, 2014, STIF had the following investments and maturities (amounts in thousands):

Short-Term Investment Fund
Investment Maturities
(in years)
Investment Type Amortized Less
Cost Than 1 1-5
Federal Agency Securities $1,591,460 $1,566,383 $25,077
Bank Commercial Paper 325,000 325,000 -
US Government Guaranteed or Insured 128,657 128,657 -
Government Money Market Funds 283,637 283,637 -
Repurchase Agreements 250,000 250,000 -
Total Investments $2,578,754 $2,553,677 $25,077

Interest Rate Risk
The STIF's policy for managing interest rate risk is to limit investment to a very short weighted average maturity, not to exceed 90 days, and to comply with Standard and Poor's requirement that the weighted average maturity not to exceed 60 days. As of June 30, 2014, the weighted average maturity of the STIF was 40 days. Additionally, STIF is allowed by policy to invest in floating-rate securities. However, investment in these securities having maturities greater than two years is limited to no more than 20 percent of the overall portfolio. For purposes of the fund's weighted average maturity calculation, variable-rate securities are calculated using their rate reset date. Because these securities reprice frequently to prevailing market rates, interest rate risk is substantially reduced. As of June 30, 2014, the amount of STIF's investments in variable-rate securities was $667 million.

Credit Risk
The STIF's policy for managing credit risk is to invest in debt securities that fall within the highest short-term or long-term rating categories by nationally recognized rating organizations.

As of June 30, 2014, STIF's investments were rated by Standard and Poor's as follows (amounts in thousands):

Short-Term Investment Fund
Quality Ratings
Amortized
Investment Type Cost AAA AA A Unrated
Federal Agency Securities $1,591,460 $- $1,591,460 $- $-
Bank Commercial Paper 325,000 - 325,000 - -
U.S. Government Guaranteed & Insured Securities 128,657 - 63,657 - 65,000
Government Money Market Funds 283,637 283,637 - - -
Repurchase Agreements 250,000 - - 250,000 -
Total Investments $2,578,754 $283,637 $1,980,117 $250,000 $65,000

Concentration of Credit Risk
STIF reduces its exposure to this risk by requiring that not more than 10 percent of its portfolio be invested in securities of any one issuer, except for overnight or two-business day repurchase agreements and U.S. government and agency securities. As of June 30, 2014, STIF's investments in any one issuer that represents more than 5 percent of total investments were as follows (amounts in thousands):

Amortized
Investment Issuer Cost
Federal Home Loan Bank $592,116
Federal Farm Credit Bank $530,002
U.S. Bank $325,000
Freddie Mac $265,907
Merrill Lynch $250,000
Fannie Mae $203,434
Morgan Stanley $150,000
Western Asset $133,637

Custodial Credit Risk-Bank Deposits-Nonnegotiable Certificate of Deposits (amounts in thousands):
The STIF follows policy parameters that limit deposits in any one entity to a maximum of ten percent of assets. Further, the certificate of deposits must be issued from commercial banks whose short-term debt is rated at least A-1 by Standard and Poor's and F-1 by Fitch and whose long-term debt is rated at least A and its issuer rating is at least "C", or backed by a letter of credit issued by a Federal Home Loan bank. As of June 30, 2014, $1,628,000 of the bank balance of STIF's deposits of $1,630,000 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $1,505,500
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 123,000
Total $1,628,500

Short-Term Plus Investment Fund (STIF Plus)
STIF Plus was a money market and short-term bond investment pool in which the State, municipal entities, and political subdivisions of the State were eligible to invest. The State Treasurer was authorized to invest monies of STIF Plus in U.S. government and agency obligations, certificates of deposit, commercial paper, corporate bonds, saving accounts, bankers' acceptance, repurchase agreements, asset-backed securities, and investment fund comprised of authorized securities. STIF Plus's investments were reported at fair value on the fund's statement of net position.

For financial reporting purposes, STIF Plus is considered to be an internal investment pool and is not reported in the accompanying financial statements. Instead, investments in STIF Plus by participant funds are reported as other investments in the government-wide and fund financial statements.

As of June 30, 2014, STIF Plus had no investments to disclose as the fund was closed May 14, 2014.

Combined Investment Funds (CIFS)
The CIFS are open-ended, unitized portfolios in which the State pension trust and permanent funds are eligible to invest. The State pension trust and permanent funds own the units of the CIFS. The State Treasurer is also authorized to invest monies of the CIFS in a broad range of fixed income and equity securities, as well as real estate properties, mortgages and private equity. CIFS' investments are reported at fair value in each fund's statement of net position.

For financial reporting purposes, the CIFS are considered to be internal investment pools and are not reported in the accompanying financial statements. Instead, investments in the CIFS by participant funds are reported as equity in the CIFS in the government-wide and fund financial statements.

Primary Government
Governmental Business-Type Fiduciary
Activities Activities Funds
Equity in the CIFS $109,464 $657 $29,317,810
Other Investments 3,605 123,965 921,639
Total Investments-Current $113,069 $124,622 $30,239,449

As of June 30, 2014, the CIFS had the following investments and maturities (amounts in thousands):

Combined Investment Funds
Investment Maturities (in Years)
Investment Type Fair Value Less Than 1 1 - 5 6 - 10 More Than 10
Cash Equivalents $622,637 $622,637 $- $- $-
Asset Backed Securities 170,453 3,043 161,333 3,762 2,315
Government Securities 2,798,228 96,911 1,291,865 786,626 622,826
Government Agency Securities 697,892 92,834 109,669 7,247 488,142
Mortgage Backed Securities 293,045 1,290 83,852 20,124 187,780
Corporate Debt 2,381,174 347,219 745,314 1,021,735 266,906
Convertible Debt 42,805 4,338 19,169 632 18,666
Total Debt Investments 7,006,234 $1,168,272 $2,411,202 $1,840,126 $1,586,635
Common Stock 14,970,113
Preferred Stock 136,459
Real Estate Investment Trust 310,123
Business Development Corporation 29,922
Mutual Fund 1,091,268
Limited Liability Corporation 1,156
Trusts 836
Limited Partnerships 5,936,222
Total Investments $29,482,333

Interest Rate Risk
CIFS' investment managers are given full discretion to manage their portion of CIFS' assets within their respective guidelines and constraints. The guidelines and constraints require each manager to maintain a diversified portfolio at all times. In addition, each core manager is required to maintain a target duration that is similar to its respective benchmark which is typically the Barclays Aggregate-an intermediate duration index.

Credit Risk
The CIFS minimizes exposure to this risk in accordance with a comprehensive investment policy statement, as developed by the Office of the Treasurer and the State's Investment Advisory Council, which provides policy guidelines for the CIFS and includes an asset allocation plan. The asset allocation plan's main objective is to maximize investment returns over the long term at an acceptable level of risk. As of June 30, 2014, CIFS' debt investments were rated by Moody's as follows (amounts in thousands):

Combined Investment Funds
Fair Value Cash Equivalents Asset Backed Securities Government Securities Government Agency Securities Mortgage Backed Securities Corporate Debt Convertible Debt
Aaa $2,684,822 $- $123,747 $1,735,227 $561,131 $178,448 $86,269 $-
Aa 250,385 - 1,836 104,590 - 17,502 126,457 -
A 443,438 - 2,656 242,773 703 9,191 188,115 -
Baa 770,166 - 118 411,738 - 2,302 353,527 2,481
Ba 342,105 - - 40,367 - 96 293,091 8,551
B 721,142 - - 36,379 - - 676,651 8,112
Caa 295,657 - - 56,503 - - 239,154 -
C 594 - - - - - 594 -
MIG 1,990 - - 1,990 - - - -
Prime 1 199,454 1,700 1,054 - - 1,400 195,300 -
Prime 2 15,097 15,097 - - - - - -
Withdrawn rating 59,385 - - - 172 - 59,213 -
Government fixed not rated 304,547 - - 168,661 135,886 - - -
Not Rated 917,451 605,840 41,042 - - 84,106 162,802 23,661
$7,006,233 $622,637 $170,453 $2,798,228 $697,892 $293,045 $2,381,173 $42,805

Foreign Currency Risk
The CIFS manage exposure to this risk by utilizing a strategic hedge ratio of 50 percent for the developed market portion of the International Stock Fund (a Combined Investment Fund). This strategic hedge ratio represents the neutral stance or desired long-term exposure to currency for the ISF. To implement this policy, currency specialists actively manage the currency portfolio as an overlay strategy to the equity investment managers. These specialists may manage the portfolio passively or actively depending on opportunities in the market place. While managers within the fixed income portion of the portfolio are allowed to invest in non-U.S. denominated securities, managers are required to limit that investment to a portion of their respective portfolios. As of June 30, 2014, CIFS' foreign deposits and investments were as follows (amounts in thousands):

Combined Investment Funds
Fixed Income Securities
Equities
Foreign Currency Total Cash Government Securities Corporate Debt Convertible Securities Asset Backed Common Stock Preferred stock Real Estate Investment Trust Fund
Argentine Peso $90 $90 $- $- $- $- $- $- $-
Australian Dollar 421,324 1,692 26,281 53,561 - - 321,855 - 17,935
Brazilian Real 251,662 1,825 56,209 1,339 - (26) 155,369 36,946 -
Canadian Dollar 75,368 1,275 - - - - 74,093 - -
Chilean Peso 763 74 - - - - 689 - -
China Yuan Renminbi 844 68 776 - - - - - -
Colombian Peso 27,942 - 20,213 7,729 - - - - -
Czech Koruna 15,454 90 - - - - 15,364 - -
Danish Krone 100,402 559 - 2,325 - - 97,518 - -
Egyptian Pound 4,618 (4) - - - - 4,622 - -
Euro Currency 2,082,175 7,421 71,857 19,087 548 574 1,928,202 41,910 12,576
Ghana Cedi 196 - - 196 - - - - -
Hong Hong Dollar 617,006 3,020 - - - 56 610,930 - 3,000
Hungarian Forint 40,028 131 7,774 - - - 32,123 - -
Iceland Krona 2 2 - - - - - - -
Indian Rupee 2,038 - 1,548 490 - - - - -
Indonesian Rupiah 95,945 312 36,070 4,358 - - 55,205 - -
Israeli Shekel 16,996 126 - - - - 16,870 - -
Japanese Yen 1,212,079 6,908 28,720 - - - 1,166,917 - 9,534
Kenyan Shilling 3 3 - - - - - - -
Malaysian Ringgit 84,430 123 46,487 - - - 37,820 - -
Mexican Peso 156,709 944 96,932 4,786 - (66) 51,955 - 2,158
New Taiwan Dollar (20) - - - - (20) - - -
New Turkish Lira 131,485 101 37,156 - - - 93,662 - 566
New Zealand Dollar 76,328 799 59,150 - - - 16,379 - -
Nigerian Naira 5,153 - 2,561 2,592 - - - - -
Norwegian Krone 84,769 1,051 13,365 - - - 70,353 - -
Peruvian Nouveau Sol 3,782 8 3,774 - - - - - -
Philippine Peso 54,375 7 2,431 - - - 51,937 - -
Polish Zloty 132,426 102 77,054 - - - 55,270 - -
Pound Sterling 1,219,775 4,487 16,010 1,761 - - 1,181,937 75 15,505
Romanian Leu 8,812 66 8,746 - - - - - -
Russian Ruble 37,585 470 28,636 8,479 - - - - -
Singapore Dollar 101,946 1,544 - - - - 94,799 - 5,603
South African Rand 125,377 288 31,965 837 - (103) 92,390 - -
South Korean Won 326,068 76 - - - (109) 319,408 6,693 -
Sri Lanka Rupee 45 - - - - - 45 - -
Swedish Krona 184,521 1,173 - - - - 183,348 - -
Swiss Franc 441,948 858 - - - 719 440,371 - -
Thailand Baht 103,792 24 13,982 - - - 89,715 - 71
Uruguayan Peso 3,875 - 3,875 - - - - - -
Vietnam Dong 755 - - 755 - - - - -

Derivatives
As of June 30, 2014, the CIFS held the following derivative Investments (amounts in thousands):

Derivative Investments Fair Value
Asset Backed Securities $169,679
Mortgage Backed Securities 198,073
Collateralized Mortgage Obligations 94,946
TBA's 135,752
Interest Only Securities 1,478
Adjustable Rate Securities 289,678
Total $889,606

The CIFS invest in derivative investments for trading purposes and to enhance investment returns. The credit exposure resulting from these investments is limited to their fair value at year end.

The CIFS also invest in foreign currency contracts. Contracts to buy are used to acquire exposure to foreign currencies, while contracts to sell are used to hedge the CIFS' investments against currency fluctuations. Losses may arise from changes in the value of the foreign currency or failure of the counterparties to perform under the contracts' terms. As of June 30, 2014, the fair value of contracts to buy and contracts to sell was $3.5 billion and $3.6 billion, respectively.

Custodial Credit Risk-Bank Deposits
The CIFS minimize this risk by maintaining certain restrictions set forth in the Investment Policy Statement. The CIFS use a Liquidity Account which is a cash management pool investing in highly liquid money market securities. As of June 30, 2014, the CIFS had deposits with a bank balance of $51.4 million which was uninsured and uncollateralized.

Complete financial information about the STIF, STIF Plus, and the CIFS can be obtained from financial statements issued by the Office of the State Treasurer.

Other Investments
As of June 30, 2014, the State had other investments and maturities as follows (amounts in thousands):

Other Investments
Investment Maturities (in years)
Fair Less More
Investment Type Value Than 1 1-5 6-10 Than 10
State Bonds $24,525 $- $8,310 $16,215 $-
U.S. Government and Agency Securities 404,920 157,219 20,585 225,033 2,083
Guaranteed Investment Contracts 157,196 - 47,300 37,803 72,093
Money Market Funds 8,605 8,605 - - -
Total Debt Investments 595,246 $165,824 $76,195 $279,051 $74,176
Endowment Pool 12,114
Limited Partnership 150
Total Investments $607,510

Credit Risk
As of June 30, 2014, other debt investments were rated by Standard and Poor's as follows (amounts in thousands):

Other Investments
Fair
Investment Type Value AA A Unrated
State Bonds $24,525 $24,525 $- $-
U.S. Government and Agency Securities 260,877 260,877 - -
Guaranteed Investment Contracts 157,196 37,157 120,039 -
Money Market Funds 8,605 - - 8,605
Total $451,203 $322,559 $120,039 $8,605

Custodial Credit Risk-Bank Deposits (amounts in thousands):
The State maintains its deposits at qualified financial institutions located in the state to reduce its exposure to this risk. These institutions are required to maintain, segregated from its other assets, eligible collateral in an amount equal to 10 percent, 25 percent, 100 percent, or 120 percent of its public deposits. The collateral is held in the custody of the trust department of either the pledging bank or another bank in the name of the pledging bank. As of June 30, 2014, $887,537 of the bank balance of the Primary Government of $891,058 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $43,190
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 844,347
Total $887,537

Component Units
The Connecticut Housing Finance Authority (CHFA) and the Connecticut Lottery Corporation (CLC) reported the following investments and maturities as of 12-31-13 and
6-30-14, respectively (amounts in thousands):

Major Component Units
Investment Maturities (in years)
Fair Less More
Investment Type Value Than 1 1-5 6-10 Than 10
Collateralized Mortgage Obligations $1,014 $- $- $- $1,014
Fidelity Funds 6,623 6,623 - - -
GNMA & FNMA Program Assets 553,480 - - - 553,480
Mortgage Backed Securities 1,026 1 - 132 893
Municipal Bonds 41,603 191 1,127 1,483 38,802
U.S. Government Agency Securities 825 - - - 825
Structured Securities 626 - - - 626
Fidelity Tax Exempt Fund 4,599 4,599 - - -
Total Debt Investments 609,796 $11,414 $1,127 $1,615 $595,640
Annuity Contracts 139,248
Total Investments $749,044

The CHFA and the CLC own 81.4 percent and 18.6 percent of the above investments, respectively. GNMA Program Assets represent securitized home mortgage loans of CHFA which are guaranteed by the Government National Mortgage Association. Annuity contracts are the only investment held by the CLC, which are not subject to investment risks discussed next.

Interest Rate Risk
CHFA

Exposure to declines in fair value is substantially limited to GNMA Program Assets. The Authority's investment policy requires diversification of its investment portfolio to eliminate the risk of loss resulting from, among other things, an over-concentration of assets in a specific maturity. This policy also requires the Authority to attempt to match its investments with anticipated cash flows requirements and to seek diversification by staggering maturities in such a way that avoids undue concentration of assets in a specific maturity sector.

Credit Risk
CHFA
The Authority's investments are limited by State statutes to United States Government obligations, including its agencies or instrumentalities, investments guaranteed by the state, investments in the state's STIF, and other obligations which are legal investments for savings banks in the state. The Fidelity Funds are fully collateralized by obligations issued by the United States Government or its agencies. Mortgage Backed Securities are fully collateralized by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association, and Collateralized Mortgage Obligations are fully collateralized by the United States Department of Housing and Urban Development mortgage pools.

CHFA's investments were rated as of 12-31-13 as follows (amounts in thousands):

Component Units
Fair Quality Ratings
Investment Type Value CCC D Unrated
Collateralized Mortgage Obligations $1,014 $1,014 $- $-
Fidelity Tax Exempt Fund 4,599 - - 4,599
Municipal Bonds 41,603 - - 41,603
Structured Securities 626 - 626 -
Total $47,842 $1,014 $626 $46,202

Concentration of Credit Risk
CHFA
The Authority's investment policy requires diversification of its investment portfolio to eliminate the risk of loss resulting from, among other things, an over-concentration of assets with a specific issuer. As of December 31, 2013, the Authority had no investments in any one issuer that represents 5 percent or more of total investments, other than investments guaranteed by the U.S. Government (GNMA Program Assets), and investments in the State's STIF.

Security Lending Transactions
Certain of the Combined Investment Funds are permitted by State statute to engage in security lending transactions to provide incremental returns to the funds. The funds' master custodian is authorized to lend available securities to authorized broker-dealers and banks subject to a formal loan agreement.

During the year, the master custodian lent certain securities and received cash or other collateral as indicated on the Securities Lending Authorization Agreement. The master custodian did not have the ability to pledge or sell collateral securities received absent a borrower default. Borrowers were required to deliver collateral for each loan equal to at least 100 percent of the market value of the loaned securities.

According to the Agreement, the master custodian has an obligation to indemnify the funds in the event any borrower failed to return the loaned securities or pay distributions thereon. There were no such failures during the fiscal year that resulted in a declaration and notice of Default of the Borrower. During the fiscal year, the funds and the borrowers maintained the right to terminate all securities lending transactions upon notice. The cash collateral received on each loan was invested in an individual account known as the State of Connecticut Collateral Investment Trust. At year end, the funds had no credit exposure to borrowers because the value of the collateral held and the market value of securities on loan were $2,019.2 million and $1,952.3 million, respectively.

Under normal circumstances, the average duration of collateral investments is managed so that it will not exceed 60 days. At year end, the average duration of the collateral investments was 7.58 days and an average weighted maturity of 15.85 days.