officer Investment Technical Assistance to School Districts
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10 Key Steps For Managing School District Investments: | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | Glossary |

1. Comply with state and federal laws.

State and federal laws set the rules within which all school districts are expected to operate when investing public funds. It is important for every district to know, understand and comply with these laws. If experts in these laws are not available within the district, expertise should be obtained to advise and direct the district on these important issues. Investment training is also available and required for school district investment officers. The Public Funds Investment Act (the "Act"), codified at Chapter 2256 of the Texas Government Code identifies the basic requirements for training, written investment policies and authorized investments. A full text of the Public Funds Investment Act is available at: http://www.capitol.state.tx.us/statutes/go/go225600toc.html

Training
Section 2256.008 of the Government Code requires the treasurer or chief financial officer and the investment officer of a school district to attend initial investment training within 12 months of assuming duties, and to attend recurring investment training at least once every two years.

Written Investment Policies
Section 2256.005 of the Government Code requires school districts to annually adopt written local investment policies. Among other things, the local investment policy must be written, primarily emphasizing the safety of principal and liquidity and address investment diversification, yield, maturity and the quality and capability of investment management. Investment policies are discussed in greater detail in Step 2: Establish Sound Policies, of this document.

Authorized Investments
The Public Funds Investment Act outlines the eight types of authorized investments that can be used by all school districts:

  • Obligations of, or guaranteed by governmental entities;
  • Certificates of deposit and share certificates;
  • Repurchase agreements;
  • Banker’s acceptances;
  • Commercial paper;
  • Mutual funds;
  • Guaranteed investment contracts; and
  • Investment pools

These authorized investments are described in Sections 2256.009 through 2256.016 of the Government Code. The types of authorized investments are briefly described below, but the descriptions here do not represent legal interpretations and should not be used as a substitute for the statute. Please consult your attorney or registered investment management firm for any questions as to whether a particular investment is authorized.

A. Obligations of, or guaranteed by governmental entities: Government Code §2256.009

This category of authorized investments includes obligations, including letters of credit, of the United States or its agencies and instrumentalities such as treasury bills (T-Bills), as well as direct obligations of the state of Texas or its agencies and instrumentalities such as municipal bonds.

Obligations of states, agencies, counties, cities and other political subdivisions of any state are authorized as long as a nationally recognized investment rating firm such as Moody’s Investor Service or Standard & Poor’s Index (S&P’s) rates the investment not less than "A" or its equivalent. A rating represents the formal evaluation of a security’s credit quality and ability to honor financial commitments. An "A-rating" indicates that the security issuer has a strong capacity to meet financial obligations.

Also included in this category are collateralized mortgage obligations (CMOs), which are derivative mortgage-backed securities, created from pools of home mortgage loans. A few classes of CMOs are considered legal investments in Texas, but most of the structures available do not meet the legal definition outlined in the Public Funds Investment Act. Section 2256.009(b) of the Government Code describes unauthorized CMOs, such as those that have a stated final maturity date of greater than 10 years.

Finally, this category includes bonds issued, assumed or guaranteed by the State of Israel. Israeli bonds are securities issued by the State of Israel to help build and strengthen the nation’s economy and infrastructure. While these bonds are not actively traded and as a result, are less liquid than Federal agency securities, they are available in the United States through the Development Corporation for Israel, a New York corporation and a registered National Association of Securities Dealers (NASD) broker/dealer. Israeli bonds are backed by the full faith and credit of the Government of Israel, which has maintained a perfect record of repayment of interest and principal since the first bond was issued almost 50 years ago. Israeli Bonds are rated "investment grade" by both Moody's (A2) and Standard & Poor's (A-).

B. Certificates of Deposit and Share Certificates: Government Code §2256.010

A certificate of deposit (CD) is a time deposit issued by a bank that pays interest periodically or at a specific maturity date, as shown on the certificate. The bank issues a certificate indicating that a specific dollar amount has been deposited with that bank for a fixed period of time at a predetermined interest rate. Large denomination CDs are typically negotiable; they can be sold or exchanged. There is normally a penalty for early withdrawal of a CD.

CDs are authorized if they have been issued by a state or national bank or savings bank or a state or federal credit union located in Texas and that are either:

  • Guaranteed or insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Share Insurance Fund;
  • Secured by obligations of or guaranteed by governmental entities described in section 2256.009(a) of the Public Funds Investment Act, but excluding those mortgage backed securities of the nature described by Section 2256.009(b) of the Act; or
  • Secured in any other manner and amount provided by law for deposits of the investing entity.

C. Repurchase Agreements: Government Code §2256.011

A repurchase agreement, commonly referred to as a "repo," is an investment agreement involving the purchase of a security with a simultaneous agreement by the seller to buy back or repurchase that security at a specified price and date. Repurchase agreements may be used to earn interest income on idle cash at or near the federal funds market rate. A holder of securities sells them to an investor with a repurchase agreement. The buyer is in effect lending the seller money for the period of the agreement. The terms of the repurchase agreement are structured to compensate the buyer for the use of the cash.

Fully collateralized repurchase agreements are authorized investments if they have a defined termination date and are secured by obligations of the United States, its agencies or instrumentalities. The Public Funds Investment Act also requires that the securities being purchased by the school district be pledged to the district, be held in the district’s name and be deposited at the time the investment is made. In addition, the repurchase agreement must be placed through a primary government securities dealer or financial institution doing business in Texas. Although not identified in the Public Funds Investment Act, a repurchase agreement should be executed under a Master Repurchase Agreement, which is a written contract that covers all repurchase transactions between two parties and that establishes each party’s rights in these transactions. Such an agreement will often specify, among other things, the right of the buyer or lender to liquidate the underlying securities in the event of default by the seller or borrower.

On the flip side, a reverse repurchase agreement, commonly referred to as a "reverse repo," is an agreement under which an investor sells securities to a broker/dealer/bank and agrees to buy the securities back at a pre-determined price on a pre-determined date. Essentially, this is a form of "securities lending," whereby an investor receives cash from the broker/dealer/bank and agrees to pay the money back, along with a set rate of interest after a certain period of time. In theory, if the investor can reinvest the cash at a higher interest rate than what they are paying to the broker/dealer/bank, the investor can make money. But this can also backfire if the interest rate earned on the cash falls below the amount the investor is having to pay to the broker/dealer/bank. The term of any reverse security repurchase agreement may not exceed 90 days after the date the reverse security repurchase agreement is delivered, according to Section 2256.011 (c).

D. Banker’s Acceptances: Government Code §2256.012

A banker’s acceptance is a money market instrument that is used to finance import or export transactions. Banker’s acceptances are essentially checks issued by a bank with a promise to pay the face or principal amount on a stipulated maturity date. Among other things, any banker’s acceptance purchased by a public entity must have a stated maturity of 270 days or less, must be accepted by a bank organized and existing under federal or state law, and the short term obligations of the bank must be rated not less than A1/P1. "A1" is the highest short-term rating category assigned by Standard & Poor’s, while "P1" is the highest short-term rating category for Moody’s Investor Service.

E. Commercial Paper: Government Code §2256.013

Commercial paper is defined as unsecured short-term obligations with maturities ranging from one to 270 days issued by banks, corporations, and other borrowers to investors with large temporary cash positions. This type of investment is usually issued at a discount and carries a zero coupon. This means that the investor is not paid interest in increments over the life of the investment, but instead the security is sold for an amount less than the face value of the security. When the security reaches maturity, the investor is paid face value. For example, an investor buys a $100 security at a discount for $60. No interest is paid to the investor until the security matures, but if the investor holds the security to maturity, they are paid $100. Therefore, the investor has earned $40 in interest over the life of the investment.

State law requires that commercial paper carry a minimum credit rating of A1 or P1 as assigned by at least two national credit rating agencies or as assigned by one national credit rating agency while being fully secured by a letter of credit issued by a bank.

F. Mutual Funds: Government Code §2256.014

No-load mutual funds and no-load money market mutual funds are both authorized investments, but each of them is different, as are the requirements and restrictions for each. A no-load fund is a mutual fund offered by an investment company that does not include a sales charge (or "load") on the purchase of shares in the fund. The Public Funds Investment Act provides that school districts can only buy no-load funds.

Mutual funds are a professionally managed portfolio of investments owned by a large number of individual investors. All of the shareholders participate in the gains or losses of the fund. The value of a share is calculated based on the market value of the portfolio. This value will fluctuate, depending upon the level of risk the mutual fund assumes. Some mutual funds specialize in high-tech stocks, while others invest in more conservative and less volatile securities. But, the higher the risk, typically the higher the rate of return on the investment.

Money market mutual funds are a specific type of mutual fund that invests only in money market instruments (i.e., short-term debt instruments such as Treasury bills, commercial paper, bankers’ acceptances, repurchase agreements and federal funds) as defined and registered with the Securities and Exchange Commission. There are three types of money market mutual funds: (1) Treasury, (2) governmental and (3) prime. Prime money market mutual funds are permitted to invest in commercial paper and other non-government securities. Money market mutual funds are designed to provide both safety and liquidity.

To be an authorized investment, both no-load money market mutual funds and no-load mutual funds must be registered with the Securities and Exchange Commission. Section 2256.014(a) outlines the requirements for money market mutual funds, while section 2256.014(b) outlines the requirements for other types of mutual funds. In addition, because other mutual funds are more risky than money market mutual funds, there are more restrictions applicable to the other types of mutual funds. For example, a school district cannot invest in the aggregate more than 15 percent of its monthly average fund balance in mutual funds described in Section 2256.014(b). Furthermore, a district cannot invest any of its bond proceeds, reserves and funds held for debt service in mutual funds described in Section 2256.014(b).

Moreover, a school district’s investment in any one mutual fund, including money market mutual funds, cannot exceed 10 percent of that mutual fund’s total assets.

G. Guaranteed Investment Contracts: Government Code §2256.015

A guaranteed investment contract is a fixed rate, fixed maturity contract similar to a bond. . However, unlike a bond, a guaranteed investment contract is always valued at par (face) value. This occurs because the company issuing the guaranteed investment contract, usually an insurance company, guarantees the investment by agreeing to pay the difference between the market value and book value for the issue if the investor decides to sell it. A guaranteed investment contract may be structured in a manner similar to a flexible repurchase agreement, whereby the investor is able to draw down the balance upon written request throughout the life of the contract.

For a guaranteed investment contract to qualify as an authorized investment, the district’s school board must specifically authorize guaranteed investment contracts as an eligible investment, must receive at least three bids, must purchase the highest yielding guaranteed investment contract for which a qualifying bid is received, the price of the guaranteed investment contract must take into account the reasonably expected drawdown schedule for the bond proceeds to be invested and the provider must certify the administrative costs reasonably expected to be paid to third parties in connection with the guaranteed investment contract. In addition, a guaranteed investment contract must have a defined termination date, be secured by obligations of the United States or its agencies and instrumentalities in an amount equal to the amount of bond proceeds invested, and be pledged to the school district and deposited with the district or with a third party selected by the district.

Bond proceeds, other than bond proceeds representing reserves and funds maintained for debt service purposes, may not be invested in a guaranteed investment contract with a term of longer than five years from the date of issuance of the bonds, according to Section 2256.015 (b).

H. Investment Pools: Government Code §2256.016

A local government investment pool is a professionally managed pool of funds composed of cash deposits from a governmental group of entities such as cities, counties, school districts and local governments. In Texas, the ability to pool assets was created under the Local Government Cooperation Act. The investment pool manager purchases a portfolio of securities with the deposits and each pool participant owns a pro rata share in the portfolio. The most common structure is similar to a money market fund in which withdrawals can be made daily. Normally the pool investment managers seek to maintain a "constant dollar," meaning that the principal is not expected to be subject to loss of value.

A public funds investment pool must be continuously rated no lower than AAA or AAA-m or at an equivalent rating by at least one nationally recognized rating service, or be rated no lower than investment grade by at least one nationally recognized rating service with a weighted average maturity no greater than 90 days, according to Section 2256.019.

A school district may invest its funds in an eligible investment pool if the school board authorizes by resolution such an investment in the particular pool. The investment pool is required to furnish the school district’s investment officer an information statement (prospectus), transaction confirmations and monthly reports containing information specified in section 2256.016. The investment pool must also have an advisory board as required and invest in authorized investments.

Unauthorized Investments
There are specific mortgage-backed securities – collateralized mortgage obligations (CMOs), sometimes referred to as derivatives, which are NOT authorized under state law and the district may "unauthorize" any security it desires. The unauthorized securities include:

  • Interest Only (IO) CMOs – whose payments represent only interest on the outstanding principal of the underlying mortgage-backed security.
  • Principal Only (PO) CMOs – whose payments represent only principal from the underlying mortgage-backed security.
  • Collateralized mortgage obligations with a stated final maturity date of greater than 10 years.
  • Inverse CMOs (Inverses) whose interest rate is determined by an index that adjusts opposite to changes in a market index.

In addition, other unauthorized investments include investments that do not meet the criteria listed in the Act and investments that fail to meet the specific criteria for authorized investments laid out in sections 2256.009 through 2256.16 of the Government Code. Finally, unauthorized investments include any investment that the board of trustees in its investment policy specifies as not suitable for the district .

Other Restrictions
In addition to restricting school district investments to specific authorized securities, the Act sets other investment requirements for school districts, to include:

  • An investment that requires a minimum rating under the Act does not qualify as an authorized investment during the period the investment does not have the minimum rating. The district must take all prudent measures that are consistent with its investment policy to liquidate an investment that does not have the minimum rating, according to Section 2256.021.

There are also other restrictions on soliciting bids for investments defined in the Texas Education Code. For example:

  • Contracts for Investment of Debt Service Funds. A school district may enter into a contract with a term not to exceed seven years to purchase investments with the proceeds of taxes for the purpose of paying debt service on bonds issued by the district. Before entering into such a contract, the district must solicit and receive bids from at least three separate providers. The contract may provide only for the purchase of obligations of the United States or its agencies or instrumentalities, according to Section 45.112 of the Education Code.

  • Interest-bearing time deposits or bonds or other obligations of the United States in which proceeds of bonds or certificates of indebtedness are invested must be of a type that cannot be cashed, sold, or redeemed for an amount less than the sum deposited or invested by the district, according to Section 45.102(b) of the Education Code.

  • Investment of Gifts, Devices and Bequests. Section 45.107 of the Education Code authorizes a district to invest any gifts, devices or bequests in accordance with the terms of the gift, device or bequest and under the guidelines of Section 113.056 of the Property Code.

  • School district depository banks must be selected through competitive bidding pursuant to the requirements of Subchapter G of Chapter 45 of the Education Code, according to Sections 45.201 – 45.209 of the Education Code.

It is a good practice and imperative that all investments are competitively procured. In addition, districts may bid certificates of deposit electronically, according to Section 2256.005(c) (3) of the Government Code.

Additional Resources:

Below is a list of additional resources you may find helpful. Information in the documents and URLs listed below are not endorsed by this agency, but only provided as resource material. For more information on these resources, consult the bibliography.

Legal Basis for School District Investing
(Texas Education Agency and University of North Texas)
Overview of the Public Funds Investment Act. It also cites the portions of the Texas Education Code related to investing.

Public Funds Investment Act Compliance Guide
(University of North Texas)
A questionnaire to determine if an entity (school district) is in compliance with the Public Funds Investment Act.

Types of Investments
(Comptroller of Public Accounts, Treasury Operations)
A list of the various types of allowed and disallowed investments, the advantages and disadvantages of different types of allowed investments and the associated risks.

Investment Controls
(University of North Texas)
Elements of investment controls, the purpose of the school district investment policy, the role of ethics and disclosure in controlling risk, relationships with investment providers and reporting requirements.

IRS Bidding Rules for Flexible Repurchase Agreements
(First Southwest Asset Management)
Internal Revenue Service bidding rules for flexible repurchase agreements.

The Basics of Arbitrage Compliance
(First Southwest Asset Management)
An overview of compliance with arbitrage requirements.

Accounting for Investments
(Texas Education Agency)
Procedures for accounting for investments that are allowed under the Public Funds Investment Act.

Public Funds Investment Act:
http://www.capitol.state.tx.us/statutes/go/go225600toc.html

Texas Education Code:
http://www.capitol.state.tx.us/statutes/edtoc.html

State and Local Government Series Securities:
http://www.publicdebt.treas.gov/spe/spe.htm

IMPORTANT NOTICE: The information in this document is presented solely as technical assistance and as a resource available to school districts. The information does not serve as a substitute for legal advice nor replace the independent judgement of a district's governing body concerning its investments. A district should consult its attorney or other appropriate counsel such as its investment adviser to resolve questions about its investment transactions.