Notes to the Financial Statements

June 30, 2015

Note 3 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 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, 2015, STIF had the following investments and maturities (amounts in thousands):

Short-Term Investment Fund
Investment
Maturities
(in years)
Amortized Less
Investment Type Cost Than 1
Federal Agency Securities $1,476,285 $1,476,285
Bank Commercial Paper 350,000 350,000
US Government Guaranteed or Insured 65,295 65,295
Government Money Market Funds 501,170 501,170
Repurchase Agreements 500,000 500,000
Total Investments $2,892,750 $2,892,750

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, 2015, the weighted average maturity of the STIF was 37 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, 2015, the amount of STIF's investments in variable-rate securities was $568 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, 2015, 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
Federal Agency Securities $ 1,476,285 $ - $ 1,476,285 $-
Bank Commercial Paper 350,000 - 350,000 -
U.S. Government Guaranteed & Insured Securities 65,295 - 65,295 -
Government Money Market Funds 501,170 501,170 - -
Repurchase Agreements 500,000 - 250,000 250,000
Total Investments $ 2,892,750 $ 501,170 $ 2,141,580 $ 250,000

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, 2015, 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 $ 673,629
Federal Farm Credit Bank $ 457,890
U.S. Bank $ 350,000
Freddie Mac $ 151,386
Merryl Lynch $ 250,000
Fannie Mae $ 193,379
Morgan Stanley $ 250,001
Western Asset $ 251,169
RBC Capital Markets $ 250,000

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, 2015, $2,065,000 of the bank balance of STIF's deposits of $2,140,000 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $ 1,202,063
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 862,475
Total $ 2,064,538

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 external 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 $ 110,069 $ 652 $ 29,541,256
Other Investments 2,826 68,570 1,004,995
Total Investments-Current $ 112,895 $ 69,222 $ 30,546,251

As of June 30, 2015, 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 $ 198,784 $ 198,784 $ - $ - $ -
Asset Backed Securities 191,411 3,902 161,552 15,533 10,424
Government Securities 2,746,047 149,878 1,086,902 617,616 891,651
Government Agency Securities 725,993 122,431 56,503 6,194 540,865
Mortgage Backed Securities 377,930 10,098 61,452 73,195 233,185
Corporate Debt 3,068,331 803,147 998,896 1,005,421 260,867
Convertible Debt 34,542 1,644 13,963 - 18,935
Total Debt Investments 7,343,038 $ 1,289,884 $ 2,379,268 $ 1,717,959 $ 1,955,927
Common Stock 14,406,676
Preferred Stock 124,880
Real Estate Investment Trust 309,747
Business Development Corporation 80,600
Mutual Fund 820,291
Limited Liability Corporation 1,157
Trusts 583
Limited Partnerships 6,668,284
Total Investments $ 29,755,256

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, 2015, 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 $ 2,235,451 $ 100 $138,598 $ 1,269,100 $ 534,650 $ 233,191 $ 59,812 $ -
Aa 492,201 7,500 2,886 334,515 - 14,683 132,617 -
A 641,373 - 1,486 327,413 - 11,067 301,407 -
Baa 799,566 - 109 454,248 - 11,211 333,202 796
Ba 520,267 - - 82,170 - - 428,750 9,347
B 840,172 - - 36,043 - - 788,159 15,970
Caa 261,361 - - 40,775 - - 220,586 -
Ca 12,769 - - 3,527 - - 9,242 -
C 940 - - - - - 940 -
Prime 1 493,856 - 2,672 - - 4,798 486,386 -
Prime 2 30,391 - - - - - 30,391 -
Government fixed not rated 202,429 - - 191,343 - - -
Non Government fixed not rated 187,170 - 187,170 - - - -
Not Rated 625,092 191,184 45,660 - - 102,980 276,839 8,429
$ 7,343,038 $ 198,784 $191,411 $ 2,746,047 $ 725,993 $ 377,930 $ 3,068,331 $ 34,542

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, 2015, CIFS' foreign deposits and investments were as follows (amounts in thousands):

 

        Combined Investment Funds             
 Fixed Income Securities   Equities         
 Cash   Real Estate 
 Equivalent   Government   Corporate   Asset   Mortgage   Common   Preferred   Investement  
Foreign Currency  Total   Cash   Collateral   Securities   Debt   Backed   Backed   Stock   Stock   Trust Fund 
Argentine Peso  $                    81  $               81  $               -    $              -    $                 -    $            -    $                 -    $               -    $               -    $                -  
Australian Dollar               410,838                 999                 113          89,266              13,020                -                       -            288,175                   -              19,265
Brazilian Real               279,997              2,492                   -          111,328                1,437                -                       -            128,965
Canadian Dollar                 84,910                 145                   43          15,550                     -                  -                       -              66,765                   -                2,407
Chilean Peso                   2,761                   -                     -              1,660                     -                  -                       -                1,101                   -                     -  
Colombian Peso                 31,645                   42                   -            26,266                4,684                -                       -                   653                   -                     -  
Croatian Kuna                        86                   -                     -                    -                       -                  -                       -                     86                   -                     -  
Czech Koruna                   4,158                   74                   -                    -                       -                  -                       -                4,084                   -                     -  
Danish Krone                 88,349                 686                   -              1,241                     -                  -                       -              86,422                   -                     -  
Egyptian Pound                   6,662                 207                   -                    -                       -                  -                       -                6,455                   -                     -  
Euro Currecny            1,964,783            (1,610)                   -          189,222                6,257            (535)                     -         1,727,992            29,649            13,808
Hong Kong Dollar               633,515              1,576                   -                    -                       -                  -                       -            627,957                   -                3,982
Hungarian Forint                 24,324                   -                     -              6,341                     -                  -                       -              17,983                   -                     -  
Iceland Krona                          2                     2                   -                    -                       -                  -                       -                     -                     -                     -  
Indian Rupee                   3,300                   -                     -              1,612                1,688                -                       -                     -                     -                     -  
Indonesian Rupiah                 96,094                   20                   -            42,289                6,442                -                       -              47,343                   -                     -  
Israeli Shekel                 17,565                 404                   -                    -                       -                  -                       -              17,161                   -                     -  
Japanese Yen            1,339,030              4,395                   -            58,669                     -                  -                       -         1,270,735                   -                5,231
Malaysian Ringgit                 84,282                 451                   -            63,042                     -                  -                       -              20,789                   -                     -  
Mexican Peso               198,235              1,980                   -          159,361                4,268                -                       -              29,454                   -                3,172
Moroccan Dirham                        62                   -                     -                    -                       -                  -                       -                     62                   -                     -  
New Turkish Lira               201,272                   11                   -            41,199                     -                  -                       -            159,454                   -                   608
New Zealand Dollar               110,084                 929                   -            96,223                     -                  -                       -              12,932                   -                     -  
Nigerian Naira                   2,698                   -                     -              2,698                     -                  -                       -                     -                     -                     -  
Norwegian Krone                 60,802              1,325                   -            14,124                     -                  -                       -              45,353                   -                     -  
Peruvian Nouveau Sol                   1,864                   -                     -              1,864                     -                  -                       -                     -                     -                     -  
Philippine Peso                 65,375                   17                   -              3,444                     -                  -                       -              61,914                   -                     -  
Polish Zloty               105,748                   81                   -            65,666                     -                  -                       -              40,001                   -                     -  
Pound Sterling            1,387,031              1,764                 223        200,831              11,298                -                  5,805       1,151,938                   -              15,172
Romanian Leu                   6,293                   -                     -              6,293                     -                  -                       -                     -                     -                     -  
Russian Ruble                 26,939                   -                     -            26,610                   329                -                       -                     -                     -                     -  
Singapore Dollar                 91,253              1,344                   -                    -                       -                  -                       -              83,945                   -                5,964
South African Rand               179,454                     8                   -            80,084                     -                  -                       -              99,362                   -                     -  
South Korean Won               299,880                 148                   -                    -                       -                  -                       -            289,596            10,136                   -  
Sri Lanka Rupee                        78                   -                     -                    -                       -                  -                       -                     78                   -                     -  
Swedish Krona               183,098                 942                   -              6,746                     -                  -                       -            175,410                   -                     -  
Swiss Franc               452,525               (554)                   -                    -                       -                  -                       -            453,079                   -                     -  
Thailand Baht               114,855                 236                   -            13,615                     -                  -                       -            101,004                   -                     -  
Uganda Shilling                   2,159                   -                     -              2,159                     -                  -                       -                     -                     -                     -  
Uruguayan Peso                   3,357                   -                     -              3,357                     -                  -                       -                     -                     -                     -  
 $        8,565,444  $        18,195  $             379  $ 1,330,760  $          49,423  $        (535)  $            5,805  $   7,016,248  $        75,560  $        69,609


Derivatives
As of June 30, 2015, the CIFS held the following derivative investments (amounts in thousands):

Derivative Investments Fair Value
Adjustable Rate Securities $ 505,870
Asset Backed Securities 191,498
Mortgage Backed Securities 277,288
Collateralized Mortgage Obligations 100,623
TBA's 190,181
Interest Only Securities 740
Options (306)
Total $ 1,265,894

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, 2015, the fair value of contracts to buy and contracts to sell was $8.4 billion and $8.3 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, 2015, the CIFS had deposits with a bank balance of $31.0 million which was uninsured and uncollateralized.

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

Other Investments
As of June 30, 2015, 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 $ 21,080 $ - $ 6,780 $ 14,300 $ -
U.S. Government and Agency Securities 350,209 101,380 10,929 236,776 1,124
Guaranteed Investment Contracts 147,829 11,735 29,830 47,930 58,334
Money Market Funds 8,301 8,301 - - -
Total Debt Investments 527,419 $ 121,416 $ 47,539 $ 299,006 $ 59,458
Endowment Pool 11,611
Corporate Stock 2,850
Limited Partnership 150
Total Investments $ 542,030

Credit Risk
As of June 30, 2015, other debt investments were rated by Standard and Poor's as follows (amounts in thousands):

Other Investments
Fair Quality Ratings
Investment Type Value AA A Unrated
State Bonds $ 21,080 $ 21,080 $ - $ -
U.S. Government and Agency Securities 261,116 261,116 - -
Guaranteed Investment Contracts 147,829 35,952 111,877 -
Money Market Funds 8,301 - - 8,301
Total $ 438,326 $ 318,148 $ 111,877 $ 8,301

Connecticut State Universities reported $89 million as U.S. Government Securities, these securities have no credit risk therefore, these securities are not included in the above table.

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, 2015, $660,444 of the bank balance of the Primary Government of $664,623 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $ 55,181
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 605,263
Total $ 660,444

Component Units
The Connecticut Housing Finance Authority (CHFA) and the Connecticut Lottery Corporation (CLC) reported the following investments and maturities as of 12-31-14 and 6-30-15, 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 $ 863 $ - $ - $ 863 $ -
Fidelity Funds 6,114 6,114 -   -
GNMA & FNMA Program Assets 621,231 - - - 621,231
Mortgage Backed Securities 878 - - 150 728
Municipal Bonds 42,164 201 1,191 1,567 39,205
U.S. Government Agency Securities 928 - - - 928
Structured Securities 690 - - - 690
Fidelity Tax Exempt Fund 3,333 3,333 - - 3,333
Total Debt Investments 676,201 $ 9,648 $ 1,191 $ 2,580 $ 662,782
Annuity Contracts 130,354
Total Investments $ 806,555

The CHFA and the CLC own 83.8 percent and 16.2 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 12-31-14 as follows (amounts in thousands):

Component Units
Fair Quality Ratings
Investment Type Value CCC D Unrated
Collateralized Mortgage Obligations $ 863 $ 863 $ - $ -
Fidelity Tax Exempt Fund 3,333 - - 3,333
Municipal Bonds 42,164 - - 42,164
Structured Securities 690 - 690 -
Total $ 47,050 $ 863 $ 690 $ 45,497

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, 2014, 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 and FNMA 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' Agent is authorized to lend available securities to authorized broker-dealers and banks subject to a formal loan agreement.

During the year, the Agent lent certain securities and received cash or other collateral as indicated on the Securities Lending Authorization Agreement. The Agent 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 102 percent of the market value of the domestic loaned securities or 105 percent of the market value of foreign loaned securities.

According to the Agreement, the Agent 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 or 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 $1,866.8 million and $1,826.0 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 23.22 days and an average weighted maturity of 44.83 days.