Comprehensive Annual Financial Report Fiscal Year Ended June 30, 2013 BASIC FINANCIAL STATEMENTS - Notes To Financial Statements - Note 4 Cash Deposits and Investments

Notes to the Financial Statements

June 30, 2013

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, 2013, STIF had the following investments and maturities (amounts in thousands):

Short-Term Investment Fund (STIF)
Investment Maturities
(in years)
Amortized Less
Investment Type Cost Than 1 1-5
Federal Agency Securities $2,011,330 $1,988,865 $22,465
Bank Commercial Paper 325,000 325,000 -
US Gov. Guaranteed or Insured 50,156 50,156 -
Government Money Market Funds 205,737 205,737 -
Repurchase Agreements 100,000 100,000 -
Total Investments $2,692,223 $2,669,758 $22,465

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, 2013, the weighted average maturity of the STIF was 44 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, 2013, the amount of STIF's investments in variable-rate securities was $995 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, 2013, 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 $2,011,329 $- $2,011,329 $- $-
Bank Commercial Paper 325,000 - - 325,000 -
U.S. Government Guaranteed & Insured Securities 50,157 - 20,157 - 30,000
Government Money Market Funds 205,737 205,737 - - -
Repurchase Agreements 100,000 - - 100,000 -
Total Investments $2,692,223 $205,737 $2,031,486 $425,000 $30,000

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, 2013, 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 Farm Credit Bank $652,415
Federal Home Loan Bank $568,923
Fannie Mae $398,696
Freddie Mac $391,295
U.S. Bank $325,000
Morgan Stanley $205,737

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, 2013, $1,509,000 of the bank balance of STIF's deposits of $1,780,000 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $1,089,110
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 419,890
Total $1,509,000


Short-Term Plus Investment Fund (STIF Plus)
STIF Plus is a money market and short-term bond 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 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 are 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, 2013, STIF Plus had the following investments and maturities (amount in thousands):

Short-Term Plus Investment Fund
Investment
Maturities
(in years)
Fair Less
Investment Type Value Than 1
Asset Backed Securities $2,841 $2,841
Money Market Government Fund 1 1
Total Investments $2,842 $2,842

Interest Rate Risk
STIF Plus's policy for managing this risk is to perform, on a quarterly basis, an interest rate sensitivity analysis on the duration and the market value of the portfolio to determine the potential effect of a 200 basis point movement in interest rates. As of June 30, 2013, the weighted average maturity of STIF Plus was 43 days. In addition, STIF Plus is allowed to invest in floating-rate debt securities. For purposes of the fund's weighted average maturity calculation, variable-rate securities are calculated using their rate reset date. Because these securities reprise frequently to prevailing market rates, interest rate risk is substantially reduced. As of June 30, 2013, STIF Plus's investment in variable-rate securities was $2.8 million.

Credit Risk
The STIF Plus manages its credit risk by investing only in debt securities that fall within the highest short-term or long-term rating categories by nationally recognized rating organizations. As of June 30, 2013, STIF Plus's investments were rated by Standard and Poor's as follows (amounts in thousands):

Short-Term Plus Investment Fund
Quality Rating
Fair
Investment Type Value AAA A CCC D
Asset Backed Securities $2,841 $1,132 $867 $723 $119
Money Market Government Fund 1 - 1 - -
Total $2,842 $1,132 $868 $723 $119

Concentration of Credit Risk
STIF Plus's policy for managing this risk is to limit the amount it may invest in any single corporate entity or federal agency to 5 percent and 15 percent, respectively, at the time of purchase. As of June 30, 2013, STIF Plus' investments in any one issuer that represents more than 5 percent of total investments were as follows (amounts in thousands):

Fair
Investment Issuer Value
Argent Securities, Inc. $1,132
Granite Master Issuer Plc. $867
Indymac INBD Mortgage Loan Trust $407
Citigroup Mortgage Loan Trust $316

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.

As of June 30, 2013, the amount of equity in the CIFS reported in the financial statements was as follows (amounts in thousands):

Primary Government
Governmental Business-Type Fiduciary
Activities Activities Funds
Equity in the CIFS $102,712 $649 $25,837,449
Other Investments 7,414 56,065 866,233
Total Investments-Current $110,126 $56,714 $26,703,682

As of June 30, 2013, 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 $1,497,963 $1,152,548 $24,359 $45,982 $275,074
Asset Backed Securities 142,566 6,689 111,630 20,580 3,667
Government Securities 2,686,838 182,297 1,165,019 715,711 623,811
Government Agency Securities 577,237 2,829 45,462 17,370 511,576
Mortgage Backed Securities 205,486 - 33,848 10,270 161,368
Corporate Debt 1,942,072 87,411 594,454 1,006,861 253,346
Convertible Debt 41,827 957 12,449 5,812 22,609
Mutual Fund 519,845 - - - 519,845
Total Debt Investments 7,613,834 $1,432,731 $1,987,221 $1,822,586 $2,371,296
Common Stock 12,871,698
Preferred Stock 92,692
Real Estate Investment Trust 287,650
Mutual Fund 405,729
Limited Liability Corporation 1,033
Trusts 946
Limited Partnerships 4,638,923
Total Investments $25,912,505

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, 2013, 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 Mutual Fund
Aaa $1,131,891 $- $75,882 $233,974 $552,435 $114,878 $154,722 $- $-
Aa 204,506 - 5,749 81,755 - 14,187 102,815 - -
A 339,688 - 6,464 143,820 - 9,750 179,654 - -
Baa 834,480 - 424 460,031 - 870 371,330 1,825 -
Ba 305,406 - - 45,974 - - 252,640 6,792 -
B 611,467 - - 64,025 - - 542,331 5,111 -
Caa 188,526 - - 2,004 - - 186,522 - -
Ca 7,350 - - - - - 7,350 - -
MIG 8,771 - - 8,771 - - - - -
Prime 1 209,502 205,000 4,502 - - - - -
Government fixed not rated 1,671,286 - - 1,646,485 24,801 - - - -
Not Rated 2,100,961 1,292,963 49,546 - - 65,800 144,709 28,098 519,845
$7,613,834 $1,497,963 $142,567 $2,686,839 $577,236 $205,485 $1,942,073 $41,826 $519,845

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, 2013, 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
Mutual
Funds
Corporate
Debt
Convertible
Securities
Asset Backed Common Stock Preferred
Stock
Real Estate
Investment
Trust
Argentine Peso $286 $286 $- $- $- $- $- $- $- $- $-
Australian Dollar 381,317 2,963 - 20,495 - 61,674 - - 275,040 - 21,145
Brazilian Real 241,752 520 - 73,731 - 7,067 - - 124,351 36,083 -
Canadian Dollar 64,463 420 - - - - - - 64,043 - -
Chilean Peso 1,992 1,478 - 514 - - - - - - -
China Yuan Renminbi 835 47 - 788 - - - - - - -
Colombian Peso 17,595 - - 10,500 - 7,095 - - - - -
Czech Koruna 10,364 - - - - - - - 10,364 - -
Danish Krone 58,297 131 - - - 2,435 - - 55,731 - -
Egyptian Pound 6,200 107 - - - - - - 6,093 - -
Euro Currency 1,671,003 5,115 4 99,502 - 39,754 528 1,121 1,480,090 35,471 9,418
Ghana Cedi 338 - - - - 338 - - - - -
Hong Hong Dollar 566,451 873 - - - - - - 562,963 - 2,615
Hungarian Fornit 29,994 3 - 15,515 - - - - 14,476 - -
Iceland Krona 2 2 - - - - - - - - -
Indian Rupee (856) - - - - 1,807 - (2,663) - - -
Indonesian Rupiah 116,864 - - 25,155 - 6,443 - - 85,266 - -
Israeli Shekel 11,578 392 - - - - - - 11,186 - -
Japanese Yen 1,170,201 4,349 - 29,020 - - - - 1,127,916 - 8,916
Kenyan Shilling 64 - - - - - - - 64 - -
Malaysian Ringgit 105,543 237 - 42,435 - - - - 62,871 - -
Mexican Peso 119,941 112 - 65,637 - 1,641 - - 47,275 - 5,276
Moroccan Dirham 125 - - - - - - - 125 - -
New Romanian Leu 2,817 23 - 2,794 - - - - - - -
New Russian Rubel 54,776 805 - 40,343 - 13,628 - - - - -
New Taiwan Dollar (15) 6 - - - - - (21) - - -
New Zealand Dollar 66,384 361 - 51,330 - 3,293 - - 11,400 - -
Nigerian Naira 7,509 256 - 1,683 - 5,458 - - 112 - -
Norwegian Krone 52,225 477 - - - - - - 51,748 - -
Peruvian Nouveau Sol 3,727 - - 3,727 - - - - - - -
Philippine Peso 53,025 77 - - - - - - 52,948 - -
Polish Zloty 101,370 805 - 65,640 - - - - 34,925 - -
Pound Sterling 1,093,838 4,299 - 280 444 2,583 - - 1,078,887 - 7,345
Singapore Dollar 102,898 643 - - - - - - 97,051 - 5,204
South African Rand 110,181 1,046 - 38,483 - 649 - (103) 70,106 - -
South Korean Won 278,939 274 - - - - - (49) 275,024 3,690 -
Sri Lanka Rupee 2,910 - - - - 2,910 - - - - -
Swedish Krona 158,194 39 - - - - - - 158,155 - -
Swiss Franc 386,277 846 - - - - - - 385,431 - -
Thailand Baht 156,361 259 - 25,976 86 - - - 130,040 - -
Turkish Lira 121,534 2 - 40,846 - 141 - - 80,545 - -
Ukraine Hryvna 1,063 - - - - 1,063 - - - - -
Uruguayan Peso 7,742 - - 7,742 - - - - - - -
Vietnam Dong 2,635 - - - - 2,635 - - - - -
$7,338,739 $27,253 $4 $662,136 $530 $160,614 $528 $(1,715) $6,354,226 $75,244 $59,919

Derivatives
As of June 30, 2013, the CIFS held the following derivative
Investments (amounts in thousands):

Derivative Investments Fair Value
Asset Backed Securities $142,566
Mortgage Backed Securities 65,664
Collateralized Mortgage Obligations 139,780
TBA's 115,909
Interest Only Securities 1,050
Options 14
Adjustable Rate Securities 658,512
Total $1,123,495


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, 2013, the fair value of contracts to buy and contracts to sell was $6,144.6 million and $6,125.9 million, 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, 2013, the CIFS had deposits with a bank balance of $42.3 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, 2013, 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 $27,986 $- $1,596 $26,390 $-
U.S. Government and Agency Securities 315,495 83,144 32,837 197,431 2,083
Guaranteed Investment Contracts 225,526 - 52,823 90,837 81,866
Money Market Funds 8,270 8,270 - - -
Total Debt Investments 577,277 $91,414 $87,256 $314,658 $83,949
Endowment Pool 10,464
Limited Partnership 150
Total Investments $587,891

Credit Risk
As of June 30, 2013, 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 $27,986 $27,986 $- $-
U.S. Government and Agency Securities 246,190 246,190 - -
Guaranteed Investment Contracts 225,526 38,315 187,211 -
Money Market Funds 8,270 - - 8,270
Total $507,972 $312,491 $187,211 $8,270

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, 2013, $555,039 of the bank balance of the Primary Government of $559,449 was exposed to custodial credit risk as follows:

Uninsured and uncollateralized $31,555
Uninsured and collateral held by trust department of either the pledging bank or another bank not in the name of the State 523,484
Total $555,039

Component Units
The Connecticut Housing Finance Authority (CHFA) and the Connecticut Lottery Corporation (CLC) reported the following investments and maturities as of 12-31-12 and
6-30-13, 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 $1,011 $- $- $- $1,011
Fidelity Funds 7,589 7,589 - - -
GNMA Program Assets 668,013 - - - 668,013
Mortgage Backed Securities 1,342 14 46 126 1,156
Municipal Bonds 14,739 - - - 14,739
U.S. Government Agency Securities 958 - - - 958
Structured Securities 566 - - - 566
Fidelity Tax Exempt Fund 5,484 5,484 - - -
Total Debt Investments 699,702 $13,087 $46 $126 $686,443
Annuity Contracts 147,032
Total Investments $846,734

The CHFA and the CLC own 82.6 percent and 17.4 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 12-31-12 as follows (amounts in thousands):

Component Units
Fair Quality Ratings
Investment Type Value CCC D Unrated
Collateralized Mortgage Obligations $1,011 $1,011 $- $-
Fidelity Tax Exempt Fund 5,484 - - 5,484
Municipal Bonds 14,739 - - 14,739
Structured Securities 566 - 566 -
Total $21,800 $1,011 $566 $20,223

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, 2012, 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 $2,716.3 million and $2,634.3 million, respectively.

Under normal circumstances, the average duration of collateral investments is managed so that it will not exceed (a) 120 days or (b) the average duration of the loans by more than 45 days. If any of these limits is exceeded for any 3-day period, the Trustee shall take certain actions. At year end, the average duration of the collateral investments was 15.07 days; the average duration of the loans was unknown, although it is assumed to remain at 1 day.