Notes to the Financial Statements

June 30, 2016

Note 3 Cash Deposits and Investments

According to GASB Statement No. 40, "Deposit and Investment Risk Disclosures", the State is required 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, 2016, 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    1-5
Federal Agency Securities   $1,948,162   $1,938,162    $10,000
Bank Commercial Paper    399,747    399,747    -
US Government Guaranteed or Insured    29,000    29,000    -
Government Money Market Funds    190,532    190,532    -
Repurchase Agreements    450,000    450,000    -
Total Investments   $3,017,441   $3,007,441    $10,000

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, 2016, 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 25 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, 2016, the amount of STIF's investments in variable-rate securities was $885 million.

Credit Risk
The STIF's policy for managing credit risk is to purchase short-term, high-quality fixed income securities that fall within the highest short-term or long-term rating categories by nationally recognized rating organizations.

As of June 30, 2016, 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    AAAm    AA+/A-1+    A/A-1
Federal Agency Securities   $1,948,162    $- $1,948,162    $-
Bank Commercial Paper    399,747    -    399,747    -
U.S. Government Guaranteed & Insured Securities    29,000    -    29,000    -
Government Money Market Funds    190,532    190,532    -    -
Repurchase Agreements    450,000    -    200,000    250,000
Total Investments    $3,017,441    $190,532    $2,576,909    $250,000

Concentration of Credit Risk
STIF reduces its exposure to this risk by insuring that at least 75 percent of fund assets will be invested in securities rated "A-1+" or equivalent. In addition exposure to any single non-governmental issuer will not exceed 5 percent (at the time a security is purchased), exposure to any single money market mutual fund (rated AAAm) will not exceed 5 percent of fund assets and exposure to money market mutual funds in total will not exceed 10 percent. As of June 30, 2016, 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    $670,144
Federal Farm Credit Bank    $736,407
U.S. Bank    $225,000
Commercial Paper    $174,747
Freddie Mac    $244,578
Merryl Lynch    $250,000
Fannie Mae    $297,034
Western Asset    $190,532
RBC Capital Markets    $200,000

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, 2016, $1,779,500 of the bank balance of STIF's deposits of $1,880,000 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized    $957,025
Uninsured and collateral held by trust department of    
either the pledging bank or another bank not in the    
name of the State    822,475
Total    $1,779,500

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    $109,454    $661    $29,135,806
Other Investments    2,095    70,329    1,375,910
Total Investments-Current    $111,549    $70,990    $30,511,716

The CIFS measures and records its investments using fair value measurement guidelines. These guidelines have a three tired fair value hierarchy, as follows: Level 1: Quoted prices for identical investments in active market; Level 2: Observable inputs other than quoted market price; and, Level 3: Unobservable inputs.

As of June 30, 2016, the CIFS had the following recurring fair value measurements. (amounts in thousands):

      Fair Value Measurements    
Investments by Fair Value Level    Total    Level 1    Level 2    Level 3
         
Cash Equivalents    $77,377    $-    $77,377    $-
Asset Backed Securities    153,162    -    153,162    -
Government Securities    3,057,456    1,162,573    1,894,883    -
Government Agency Securities    645,771    -    645,771    -
Mortgage Backed Securities    402,029    -    402,029    -
Corporate Debt    3,046,436    -    2,954,600    91,836
Convertible Securities    53,747    -    53,747    -
Common Stock    13,540,539    13,540,539    -    -
Preferred Stock    87,632    78,400    9,232    -
Real Estate Investment Trust    385,415    324,390    61,025    -
Mutual Fund    703,637    171,221    -    532,416
Limited Partnerships    2,199    2,199    -    -
Total    $22,155,400    $15,279,322    $6,251,826    $624,252
        
Investments Measured at the Net Asset Value (NAV)      Unfunded    Redemption    Redemption
     Commitments    Frequency    Notice Period
Business Development Corporation    99,612    $45,103    Illiquid    N/A
Limited Liability Corporation    1,156    -    Illiquid    N/A
Trusts    530    -    Illiquid    N/A
Limited Partnerships    6,949,357    1,394,251    Illiquid    N/A
Total    7,050,655    $1,439,354       
Total Investments in Securities at Fair Value    $29,206,055          

  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.

Following is a schedule which provides information about the interest rate risks associated with the CIF investments. The investments include short-term cash equivalents including certificate of deposits and collateral, long-term investments and restricted assets by maturity in years. (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    $77,377    $77,377    $-    $-    $-
Asset Backed Securities    153,162    9,211    118,312    15,124    10,515
Government Securities    3,057,456    118,521    1,186,623    695,703    1,056,609
Government Agency Securities    645,771    61,643    82,929    5,727    495,472
Mortgage Backed Securities    402,028    603    66,980    86,396    248,049
Corporate Debt    3,046,436    776,156    1,090,122    892,978    287,180
Convertible Debt    53,747    4,886    17,417    610    30,834
   $7,435,977    $1,048,397    $2,562,383    $1,696,538    $2,128,659

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, 2016, 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   $2,484,426    $-    $75,616    $1,477,893    $603,867    $271,129    $55,921    $-
Aa    573,991    3,000    2,677    393,378    -    11,075    163,861    -
A    672,191    -    1,737    327,573    -    13,273    329,608    -
Baa    691,470    -    -    352,658    -    7,046    330,976    790
Ba    631,841    -    -    182,505    -    -    441,749    7,587
B    805,211    -    -    50,949    -    -    742,406    11,856
Caa    296,878    -    -    29,969    -    -    260,061    6,848
Ca    11,476    -    -    -    -    -    11,476    -
C    1,592    -    -    -    -    -    1,592    -
Prime 1    374,671    -    2,786    -    -    -    371,885    -
Prime 2    10,394    -    -    -    -    -    10,394    -
Government fixed not rated    50,178    -    -    8,275    41,903    -    -    -
Non Government fixed not rated    234,256    -    -    234,256    -    -    -    -
Not Rated    597,402    74,377    70,346    -    -    99,506    326,507    26,666
   $7,435,977    $77,377    $153,162    $3,057,456    $645,770    $402,029    $3,046,436    $53,747

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, 2016, CIFS' foreign deposits and investments were as follows (amounts in thousands):

   Combined Investment Funds   
            Fixed Income Securities    Equities       
Foreign Currency    Total    Cash    Cash Equivalent Collateral    Government Securities    Corporate Debt    Asset Backed    Mortgage Backed    Common Stock    Preferred stock    Real Estate Investment Trust Fund
Argentine Peso    $49    $49    $-    $-    $-    $-    $-    $-    $-    $-
Australian Dollar    390,816    928    48    87,102    7,712   -  -    265,852    -    29,174
Brazilian Real    238,391    3,397    -    86,699    -    -    -    134,189    14,106    -
Canadian Dollar    113,770    527    -    25,029    -    -    -    85,815    -    2,399
Chilean Peso    4,367    43    -    152    -    -    -    4,172    -    -
Colombian Peso    34,735    5    -    32,147    2,387    -    -    196    -    -
Czech Koruna    793    1    -    -    -    -    -    792    -    -
Danish Krone    85,553    194    -    1,259    -    -    -    84,100    -    -
Egyptian Pound    3,813    294    -    -    -    -    -    3,519    -    -
Euro Currency    1,805,613    945    (5)    233,894   2,084  168    -   1,541,800    12,858    13,869
Hong Kong Dollar    558,798    1,385    -    -    -    -    -    551,404    -    6,009
Hungarian Forint    35,223    2    -    8,780    -    -    -    26,441    -    -
Iceland Krona    2    2    -    -    -    -    -    -    -    -
Indian Rupee    1,252    -    -    -    1,252    -    -    -    -    -
Indonesian Rupiah    110,265    77    -    50,760    2,587    -    -    56,841    -    -
Israeli Shekel    20,504    216    -    -    -    -    -    20,288    -    -
Japanese Yen    1,190,721    7,565    -    49,956    -    -    -    1,124,737    -    8,463
Malaysian Ringgit    83,394    30    -    65,236    -    -    -    18,128    -    -
Mexican Peso    194,423    2,018    -    142,149    3,598    -    -    43,813    -    2,845
New Turkish Lira    153,017    2    -    48,073    -    -    -    104,942    -    -
New Zealand Dollar    163,784    1,407    -    149,078   -  -   -    13,299    -    -
Nigerian Naira    181    11    -    -    -    -    -    170    -    -
Norwegian Krone    54,992    567    -    11,188    -    -    -    43,237    -    -
Peruvian Nouveau Sol    4,009    -    -    4,009    -    -    -    -    -    -
Philippine Peso    51,452    6    -    1,151    -    -    -    50,295    -    -
Polish Zloty    108,856    36    -    80,536    -    -    -    28,284    -    -
Pound Sterling    1,135,613   2,875   44    235,944    8,003    -    8,149    868,704    -    11,894
Romanian Leu    3,946    -    -    3,946    -    -    -    -    -    -
Russian Ruble    27,353    -    -    27,353    -    -    -    -    -    -
Singapore Dollar    85,880    534    -    8,241    -    -    -    71,780    -    5,325
South African Rand    180,585    914    -    81,865    -    -    -    97,195    -    611
South Korean Won    323,171    66    -    496    -    -    -    311,607    11,002    -
Sri Lanka Rupee    29    -    -    -    -    -    -    29    -    -
Swedish Krona    156,963    184    -    7,603    -    -    -    149,176    -    -
Swiss Franc    446,233    545    -    -    -    -    -    445,688    -    -
Thailand Baht    103,607    240    -    19,603    -    -    -    83,555    -    209
Uruguayan Peso    1,212    -    -    1,212    -    -    -    -    -    -
   $7,873,365   $25,065    $87    $1,463,461    $27,623    $168    $8,149    $6,230,048    $37,966    $80,798


Derivatives
As of June 30, 2016, the CIFS held the following derivative investments (amounts in thousands):

Derivative Investments    Fair Value
Adjustable Rate Securities    $581,229
Asset Backed Securities    153,799
Mortgage Backed Securities    303,821
Collateralized Mortgage Obligations    98,208
TBA's    41,236
Interest Only Securities    423
Options    1,281
Total    $1,179,997

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, 2016, the fair value of contracts to buy and contracts to sell was $11.9 billion and $11.9 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, 2016, the CIFS had deposits with a bank balance of $40.1 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
The University of Connecticut measures and records its investments using fair value measurement guidelines. These guidelines have a three tired fair value hierarchy, as follows: Level 1; Quoted prices for identical investments in active market; Level 2: Observable inputs other than quoted market price; and, Level 3: Unobservable inputs. As of June 30, 2016, UConn had the following recurring fair value measurements. (amounts in thousands):

Fair Value Measurements
Investments by Fair Value Level    Total    Level 1    Level 2    Level 3
 
Cash Equivalents    $1,926    $1,926    $-    $-
Fixed Income Securities    913    913    -    -
Equity Securities    8,129    7,376    753    -
Partnerships    3    -    -    3
Total   $10,971    $10,215    $753    $3
Investments Measured at the Net Asset Value (NAV)      Unfunded    Redemption    Redemption
Commitments    Frequency    Notice Period
Private Capital Partnerships    $1,655    $215    N/A    N/A
Private Real Estate Partnerships    329    41    N/A    N/A
Natural Resource Partnerships    566    67    N/A    N/A
Long/Short Equities    1    -    N/A    N/A
Relative Value    832    -    N/A    N/A
Total    3,383    $323       
Total Investments in Securities at Fair Value    $14,354  

As of June 30, 2016, 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    $17,629    $-    $5,269    $12,360    $-
U.S. Government and Agency Securities    112,662    55,352    6,450    50,366    494
Guaranteed Investment Contracts    130,472    -    40,712    34,882    54,878
Money Market Funds    31,261    31,261    -    -    -
Total Debt Investments    292,024   $86,613   $52,431   7,608   $55,372
Endowment Pool    12,593      
Corporate Stock    1,758      
Limited Partnership    3      
Total Investments   $306,378      

Credit Risk
As of June 30, 2016, other debt investments were rated by Standard and Poors as follows (amounts in thousands):

Other Investments 
   Fair          
Investment Type   Value    AA    A    Unrated
State Bonds    $17,629    $17,629    $-    $-
U.S. Government and Agency Securities    62,447    62,447    -    -
Guaranteed Investment Contracts    130,472    34,882    95,590    -
Money Market Funds    31,261    -    -    31,261
Total   $241,809    $114,958    $95,590    $31,261

Connecticut State Universities reported $50 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, 2016, $438,282 of the bank balance of the Primary Government of $441,570 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $38,456
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 399,826
Total $438,282

Component Units
The Connecticut Housing Finance Authority (CHFA) and the Connecticut Lottery Corporation (CLC) reported the following investments and maturities as of December 31, 2015 and June 30,2016, 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    $743    $-    $-    $743    $-
GNMA & FNMA Program Assets    846,159    -    -    -    846,159
Mortgage Backed Securities    768    -    -    125    643
Money Market    15,624    15,624          
Municipal Bonds    42,750    213    1,258    1,655    39,624
STIF    448,707    448,707    -    -    -
Structured Securities    450    -    -    -    450
U.S. Government Agency Securities    892    -    -    -    892
Total Debt Investments    1,356,093    $464,544    $1,258    $2,523    $887,768
Annuity Contracts    130,333             
Total Investments    $1,486,426             

The CHFA and the CLC own 91.2 percent and 8.8 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 December 31, 2015 as follows (amounts in thousands):

   Component Units             
   Fair       Quality Ratings   
Investment Type   Value    AAA    CCC    D    Unrated
Collateralized Mortgage Obligations    $743    $-    $743    $-    $-
Municipal Bonds    42,750      -    -   42,750
Money Market    15,624             15,624
STIF    448,707    448,707          -
Structured Securities    450    -    -    450    -
Total    $508,274   $448,707    $743   $450   $58,374

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, 2015, 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 fair value of the collateral held and the fair value of securities on loan were $2,590.9 million and $2,512.6 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 49.46 days and an average weighted maturity of 57.77 days.