June 30,1996
(Amounts in thousands unless otherwise stated)
In this note, the State's deposits and investments are classified in categories of "custodial credit risk". This is the risk that the State will not be able (a) to recover deposits if the depository bank fails or (b) to recover the value of investments or collateral securities that are in the custody of an outside party if the counterparty to the investment or deposit transaction fails. Classification in category 1 means that the exposure of deposits or investments to potential custodial credit risk is low. The level of potential custodial credit risk is higher for those deposits or investments classified in category 2, and highest for those in category 3.
Cash Deposits
At June 30, 1996, the carrying amount of the State's deposits was $(151,376) for the Primary Government and
$92,076 for the Component Units. The corresponding bank balance for such deposits was $36,537 for the Primary
Government and $93,058 for the Component Units. Of the bank balance for the Primary Government, $3,956 was
insured by the Federal Deposit Insurance Corporation (Category 1), $3,421was collateralized (Category 3), and
$29,160 was uninsured and uncollateralized (Category 3). Of the bank balance for the Component Units, $4,386 was
insured by the Federal Deposit Insurance Corporation (Category 1), $2,041 was collateralized (Category 3), and
$86,631 was uninsured and uncollateralized (Category 3).
Collateralized deposits are deposits protected by State statute. Under this statute, any bank holding public deposits must at all times maintain, segregated from its other assets, eligible collateral in an amount equal at least to a certain percentage (that is, 10, 25, 100, or 120) of its public deposits. The applicable percentage is determined based on the bank's risk-based capital ratio - a measure of the bank's financial condition. The collateral is kept in the custody of the trust department of either the pledging bank or another bank in the name of the pledging bank.
Investments
According to State statutes, the State Treasurer is responsible for investing monies of State funds and agencies as well
as monies of pension and other trust funds. All investments made by the State Treasurer adhere to strict guidelines on
prudence, corporate governance, social responsibility and affirmative action. Investment guidelines are established by
the State Treasurer with the advice of the Investment Advisory Council. Over the past years, the State Treasurer has
created one short-term investment fund and eight combined investment funds (including one international investment
fund).
The short-term investment fund is a money market investment pool which is available for investment to the State, municipal entities, and political subdivisions of the State. The State Treasurer is authorized to invest monies of the short-term investment fund in United States government and agency obligations, United States postal service obligations, certificates of deposit, commercial paper, corporate bonds, saving accounts, bankers' acceptances, repurchase agreements, reverse repurchase agreements, asset-backed securities, and student loans. Investments in this fund are carried at amortized cost and are included in the investments schedule (primary government).
The combined investment funds are open-end, unitized portfolios which are available for investment to the State pension and other trust funds. The State Treasurer is also authorized to invest monies of the combined investment funds in common stock, commercial equity real estate, foreign companies stocks and bonds, commercial and residential mortgages, foreign governments obligations, mortgage-backed securities, and venture capital partnerships. There is a restriction that not more than 55% of the investments held by the pension and other trust funds can consist of common stock. Investments in these funds are carried at market value and are included in the investments schedule (primary government).
For financial reporting purposes, the short-term investment fund and the combined investment funds are not included in the combined financial statements. Instead, each fund type's investment in these funds is reported as "cash equivalents" or as "equity in combined investment funds" in the combined balance sheet. Complete financial information about the short-term investment fund and the combined investment funds can be obtained from financial statements issued by the State Treasurer.
Certain State agencies and component units are also authorized to invest in investment contracts and state and municipal bonds.
The combined investment funds account for the purchase and sale of investments using "trade date" accounting. This means that investments are increased or decreased on the date the purchase or sales order is made although the investments are not received or delivered until a later date (settlement date). As of year end, investments under unsettled purchases are disclosed as State investments but are not categorized under categories of custodial credit risk because the investments are still in the hands of the dealers. Investments held by the State under unsettled sales are not disclosed as State investments. However, these investments are disclosed separately because they are still subject to custodial credit risk that could result in losses prior to settlement.
The schedules on the following page disclose the carrying amount and market value of the State's investments in total and by investment type as of June 30, 1996. Further, the carrying amount of these investments is classified in three categories of custodial credit risk. Category 1 includes investments that are insured or registered or for which the securities are held by the State or its agent in the State's name. Category 2 includes uninsured and unregistered investments for which the securities are held by the counterparty s trust department or agent in the State s name. Category 3 includes uninsured and unregistered investments for which the securities are held by the counterparty, or by its trust department or agent but not in the State's name.
| Carrying Amount | ||||
|---|---|---|---|---|
| Investment Type | Category 1 | Category 2 | Total | Market Value |
| Common Stock | $ 7,712,380 | $ 29,084 | $ 7,741,464 | $ 7,742,286 |
| U.S. Government & Agency Securities | 1,438,142 | - | 1,438,142 | 1,441,052 |
| Corporate Debt | 2,365,113 | - | 2,365,113 | 2,364,971 |
| Banker's Acceptances | 190,544 | - | 190,544 | 192,058 |
| Commercial Paper | 362,346 | 28,163 | 390,509 | 390,378 |
| Convertible Securities | 196,908 | - | 196,908 | 196,908 |
| Mortgage-Backed Securities | 145,960 | - | 145,960 | 145,960 |
| Preferred Stock | 76,513 | - | 76,513 | 76,513 |
| Repurchase Agreements | 659,780 | 45,000 | 704,780 | 707,277 |
| Bank Notes | 183,896 | - | 183,896 | 183,616 |
| Certificates of Deposit - Negotiables | 388,848 | - | 388,848 | 388,751 |
| Collateralized Investment Agreements | 137,919 | 55,845 | 193,764 | 194,238 |
| State and Municipal Obligations | 308,074 | - | 308,074 | 281,829 |
| Asset Backed Securities | 284,964 | - | 284,964 | 284,979 |
| Cash Equivalents | 60,706 | - | 60,706 | 60,706 |
| Other | 10,794 | - | 10,794 | 10,792 |
| $14,522,887 | $158,092 | 14,680,979 | 14,662,314 | |
| Investments not categorized because they are not evidenced by securities that exist in physical or book entry form: | ||||
| Real Estate (Trusts, Limited Partnerships and Annuities) | 768,122 | 768,122 | ||
| Commercial Mortgages Trust Funds | 124,943 | 124,943 | ||
| Deferred Compensation Plan Mutual Investments | 411,870 | 411,870 | ||
| Limited Partnerships | 441,888 | 441,888 | ||
| Tax Exempt Proceeds Fund | 138,544 | 138,544 | ||
| Guaranteed Investment Contracts | 267,488 | 267,488 | ||
| Other | 3,181 | 5,143 | ||
| Investments held by broker-dealers under unsettled purchases (various securities) | 514,934 | 514,934 | ||
| Total Investments | 17,351,949 | 17,335,246 | ||
The pension trust funds own approximately 82 percent of the investments that are in category 1.
As of year-end, the State held securities with a market value of $226,174 under unsettled sales. These securities would have been classified under Category 1 of custodial credit risk if they were included in the investments schedule.
| INVESTMENTS - COMPONENT UNITS | |||||
|---|---|---|---|---|---|
| Carrying Amount | |||||
| Investment Type | Category 1 | Category 2 | Category 3 | Total | Market Value |
| U.S. Government & Agency Securities | $ - | $ 747,072 | $ 23,284 | $ 770,356 | $ 764,084 |
| Common Stock | 11,821 | - | - | 11,821 | 11,821 |
| Repurchase Agreements | - | 243,419 | - | 243,419 | 243,419 |
| Collateralized Investment Agreements | - | - | 14,270 | 14,270 | 14,270 |
| Product Development and Marketing In | 12,633 | - | - | 12,633 | 12,633 |
| Other | 1,626 | 14,365 | 660 | 16,651 | 16,651 |
| 26,080 | 1,004,856 | 38,214 | 1,069,150 | 1,062,878 | |
| Investments not categorized because they are not evidenced by securities that exist in physical or book entry form: | |||||
| Guaranteed Investment Contracts | 266,023 | 266,055 | |||
| Fidelity Funds | 48,903 | 48,903 | |||
| Open Mutual Funds | 57,257 | 57,257 | |||
| Other | 4,077 | 4,077 | |||
| Total Investments | $1,445,410 | $1,439,170 | |||
CHFA owns 84% of the investments that are in Category 2.
Derivatives GASB Technical Bulletin Number 94-1 defines derivatives as contracts whose value depends on, or derives from, the value of an underlying asset, reference rate, or index. According to this definition, the following State's investments or contracts are considered to be derivatives:
The State invests in derivatives in order to increase earnings on investments or to hedge against fluctuations in the value of foreign currencies (as in the case of foreign exchange contracts).
CMO's are bonds which are issued by a special purpose trust and which are collateralized by an underlying pool of mortgage loans. The bonds pay interest at fixed or variable rates and have stated maturity dates. Interest payments on the bonds are made in accordance with the trust indentures and amounts received from borrowers in excess of interest payments and expenses are used to amortize the principal on the bonds in order of their stated maturity. Because mortgage prepayments are largely dependent on market interest rates, the ultimate maturity of the bonds is unpredictable and is sensitive to changes in interest rates, but is generally prior to the stated maturity date. As of June 30, 1996 the State held CMOs valued at $114.7 million.
Interest-only strips are a specialized type of CMOs. The cash flow on these investments is derived from the interest payments on the underlying mortgages. Therefore, these investments are very sensitive to changes in interest rates, which may encourage or discourage the prepayment of the underlying mortgages. For example, if interest rates decline, the underlying mortgages will be prepaid, thereby, reducing the cash flows from interest payments, and the value of these investments will decline. Because of the volatility of these investments, the State sold its remaining holding of these investments during the year.
The common stock represents an investment in an underlying derivative consisting of a subordinated "residual interest" in a securitized portfolio of commercial mortgage loans (the CMO residual). These loans were sold by the State to the corporate issuer who, in turn, issued bonds collateralized by the loans. The residual interest represents the difference between the principal of the underlying mortgage loans and the outstanding principal of the bonds. The underlying loans pay a fixed interest rate while the bonds pay a variable interest rate. The State is subject to the market risk that if the interest rate on the bonds increases, more of the cash flows generated by the loans will go to the bondholders, thereby, reducing the amount available to the State, and the value of the investment will decline. At June 30, 1996, the CMO residual had an estimated fair value value of $86.6 million, and the weighted average yield on the underlying loans was 10.75% while the variable rate on the bonds was 5.47%.
Foreign exchange contracts are used to facilitate transactions in foreign securities and to manage the funds' currency exposure. Contracts to buy are used to acquire exposure to foreign currencies, while contracts to sell are used to hedge the funds' investments against currency fluctuations. Losses may arise from changes in the value of foreign currencies or failure of the counterparties to perform under the contracts' terms.
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