The Impact of Banking Regulations, Part 2
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Investment Alternatives Available for Michigan Public Entities
In the last issue of Footnotes, we outlined the 10 Steps to Investing Public Funds. Step 6 is to Determine Appropriate Investments. The goal of any investment program should be to invest your public dollars with an eye toward safety, liquidity and return, in that order. Consider expanding your investments by looking at all the safe options allowed by Michigan law. The following are eligible investments to consider:
Liquid investments – Liquid investments can be turned into cash immediately. These are checking, savings, sweep accounts, local government investment pools and money market mutual funds.
Deposit Accounts (checking, savings, sweep) – Your goals for these funds should be to ensure they are safe and to minimize bank fees. Of course, the great recession prompted government legislation providing enhanced safety options for government entities.
If you are in an interest-bearing demand deposit account, you currently have $250,000 of FDIC coverage per bank. Savings accounts, including CDs, have an additional $250,000 of FDIC coverage. Be sure to do your homework regarding the safety of your local financial institutions if your balances exceed this coverage.
In addition, on November 9, 2010, the FDIC issued a rule that provides for unlimited insurance coverage of noninterest-bearing transaction accounts. Beginning December 31, 2010, through December 31, 2012, all noninterest-bearing transaction accounts are fully insured, regardless of the balance of the account, at all FDIC-insured institutions. The unlimited insurance coverage is available to all depositors, including consumers, businesses and government entities. This unlimited insurance coverage is separate from, and in addition to, the insurance coverage provided on your other deposit accounts held at the bank.
A noninterest-bearing transaction account is a deposit account where interest is neither accrued nor paid; depositors are permitted to make an unlimited number of transfers and withdrawals; and the bank does not reserve the right to require advance notice of an intended withdrawal.
Please note that Money Market Deposit Accounts (MMDAs) and Negotiable Order of Withdrawal (NOW) accounts are not eligible for this unlimited insurance coverage, even if no interest is paid on the account.
Repo Sweep – These interest-bearing accounts sweep dollars “off balance sheet” at the end of every day then collateralize your money, generally with agency or treasury securities. This is a good alternative for your operating accounts as it protects your dollars over and above your FDIC coverage while earning interest.
Local Government Investment Pool (LGIP) – You may find it advantageous to participate one of several investment pools available to Michigan public entities. These funds are another safe alternative for your cash needs as they usually invest in treasuries, agencies and to a lesser extent highly rated commercial paper and can provide a market rate of return for your excess cash. These funds are highly liquid as you have access to them the same day you request them.
Money Market Mutual Funds – You may use these funds only if they utilize investments that are legal for Michigan public entities. You may purchase them through your local bank or broker. These funds can be used in a sweep arrangement with your bank.
Short-term investments – If you have core dollars that can be invested for longer periods, Michigan law allows a number of safe options. These include treasuries, agencies, commercial paper, CDs, CDARS and municipal securities. Of course, there are risks associated with investing in these types of securities, such as interest rate risk and maturity risk. In addition, most banks charge an early withdrawal fee for CDs and CDARS, so it is vital to completely understand your liquidity needs.
U.S. Treasury Securities – These securities are backed by the full faith and credit of the United States Treasury.
Agency Securities – These can be obligations of the United States or an agency or instrumentality of the United States such as Fannie Mae or Freddie Mac.
Commercial Paper – These are short-term obligations of corporations and must mature within 270 days of purchase and be within the two highest rating classifications by at least two rating services.
Municipal Securities – Schools can invest in obligations of the State of Michigan. All other government entities may invest in state obligations as well as obligations of any state political subdivisions. Obligations need to be rated at least investment grade (BBB/ Bbb or higher) by at least one rating agency.
Please note that Treasuries, Agencies, Commercial Paper and Municipal securities may be purchased through your local bank, broker or adviser.
Certificates of Deposit – State law requires the investing officer to invest in certificates of deposit only with financial institutions that are eligible depositories of public funds in the State of Michigan. Your local banks can provide a competitive interest rate for these types of deposits. It’s always a good idea to get quotes, but be mindful that you have only $250,000 of FDIC protection, so make sure you do your homework with respect to the ratings of the banks on your bid list.
One alternative to provide additional protection for these funds as interest rates rise is to ask for collateral from your banks.
Certificate of Deposit Account Registry Service (CDARS) – This investment alternative for local governments was added in 2008. Many banks in Michigan are members of the CDARS network, and this type of deposit allows you to invest in amounts greater than the FDIC-insured limits and still receive full FDIC protection.
Once you determine appropriate investments, continue with the remaining steps to investing public funds to make the process work for you on an ongoing basis.
Banks will continue to face regulatory challenges at the state and federal level, but by developing a sound investment and banking program, you can identify opportunities to safely increase your net interest earnings.
If you have questions or need help with complying with new banking regulations or determining effective investment processes and options, please contact us at footnotes@umbaugh.com.
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Information in this article was believed current as of the date of publication. As you know, changes occur frequently. The information presented is of a general educational nature. Before applying to your specific circumstances, please contact us at footnotes@umbaugh.com.