Investment Portfolio Objectives

As stated in the City’s investment policy, the primary objectives of the City’s investment activities, in priority order, is safety, liquidity and yield. Consistent with this policy, the portfolio of securities is invested in U.S. Treasuries, U.S. Agencies, local government investment pools (LGIPs), commercial paper, and corporate debt subject to rating restrictions and concentration limits which are outlined in the City’s investment policy. The City-managed investment portfolio is administered to provide sufficient liquidity to meet all reasonably anticipated operating cash needs without selling securities prior to maturity. The portfolio controlled by PFM is actively managed which means that investments may be sold prior to maturity and reinvested in order to achieve the desired duration, yield or diversification of the portfolio.

Throughout 2022, stubbornly high inflation presented unevenly rising prices, a reduction in the purchasing power of many consumers and lowered the present value of bonds which negatively affected cash flows to investors. In the early months of 2022, the effects of the pandemic began to diminish as job gains were strong with low unemployment. Supply and demand imbalances persisted, the Russian invasion of Ukraine, higher energy prices and the reopening of the economy further contributed to higher inflation. This confirmed to the Fed that high inflation was here to stay and was not transitory. During the FOMC meeting in March, the target interest rates were increased by 25 basis points (bps) followed by an additional rate hike of 50 bps in May. The CPI index peaked at 9.1% in June, which was the highest level in 40 years. To stem inflation the Fed again raised the federal funds rate 75 bps this time during the June FOMC meeting, and began taking steps to shrink their balance sheet by reducing Treasury holdings. The consumer confidence index dropped significantly as high prices of food, gas and shelter effected the most vulnerable populations. The labor market continued to face labor shortages as the market remained robust in adding jobs in excess of estimates. The year ended with job gains, modest growth in spending and production, high food and energy costs and increased price pressures. Inflation in 2022 ended at 6.5%, with an unemployment rate at 3.5%. Shelter costs continue to rise but data from the private sector indicates that home prices and rent are on the decline. The federal funds rate increased from 0.25% at the beginning of 2022, ending at 4.50% in December after a total of seven rate hikes in attempt to cool inflation. The 2- and 5-year Treasury yields ended at 4.41% and 3.99% in December up from 0.73% and 1.26% respectively in 2021.

The City’s investment portfolio has increased by $43.2 million. The majority of the increase came from robust sales tax collections in 2022 and the issuance of bonds for capital projects. Due to labor shortages and supply delays, spending for the CIP projects was impacted as well contributing to the overall growth of the investment portfolio. The allocation between different sectors of market has not seen significant changes. The relative value has been seen in Treasuries and Municipal debt, hence the greater allocation to those sectors. During 2022 no securities were called before maturity due to rate increases.

The City’s combined investment portfolio posted $3.8 million in interest earnings, representing an increase of almost $800,000 more than the prior year. The yield on the portfolio managed by the City increased from 1.11% to 1.46%, an increase of 35 bps. The yield on the PFM managed portfolio fell slightly to 1.29% from 1.35%, a 6 bps decrease, due to some realized losses. PFM sold securities at a loss in order to reinvest the funds at a much higher rate, which would benefit the portfolio in the long run and offset the loss on the sale in the future years. The City’s investment portfolio turnover this year was about 19% compared to last year at 25%, which means almost a quarter of the portfolio was reinvested at higher rates than the investments that matured. Based on the maturity distribution chart, about 20% will be reinvested in 2023 again ideally at increasing rates. The volatility in the market makes it difficult to predict if the portfolio will yield higher interest earnings next year.

The City benchmarks its portfolio to the trailing 12 months (TTM) of a 2-year Treasury. The city’s portfolio matched its benchmarks in 2022. The duration of the city’s portfolio was 2.28 years compared to 2.33 in the prior year. In comparison to 2021, the duration of the PFM managed portfolio also shortened in 2022 from 2.48 to 2.33 years. Deliberate steps were taken to allocate some investments into shorter maturity buckets in anticipation of the rate increases over the next few years.

In 2021 the City investment committee reviewed and updated the investment policy. One of the bigger changes was lowering the credit rating requirements for corporate and municipal debt. The current credit quality by rating category is reflected in the graph. The graph is based on the S&P rating only. A small percentage of investments with BBB+ rating have A-rating with Moody’s and Fitch agencies, which is consistent with the investment policy requirements. As displayed in market indications from the portfolio characteristics table, the City continues to add A-rated investments. This contributed to a higher yield to maturity (YTM) at cost. The credit rating of all investments in the city’s portfolio is monitored and assessed on a monthly basis to ensure the safety of the investments.

From the credit rating perspective, over 91% of the City’s portfolio is invested in securities that are rated in the AAA and AA category. A little over 8.2% is allocated to A and BBB+ rated investments. The investment policy requires a minimum of A- rating from two credit rating agencies. The Credit Quality graph is based on the S&P rating only. The 0.20% of the securities that are rated BBB+ by S&P has at least A- rating from the other two agencies, Moody’s and Fitch. The allocation to A-rated securities has grown from 21 corporate names to 24 in the third quarter, a well-diversified bucket of investments.

Investment Management Focus - 2023

CREDIT QUALITY (S&P RATING)

• The market expectation is that the Fed will continue to raise the interest rates at their 2023 meetings until inflation decreases. The City will focus on slightly extending the portfolio duration by the end of the year to take advantage of the higher rates.

• The City will continue to utilize LGIPs for its excess cash. The yields in the LGIP pools are expected to rise along with the Fed interest rates. As of 12/31/2022 the yield on the LGIPs was 4.30%.

• Short-term corporate bonds are more attractive in 2023. The City will be selective in this sector but will look to re-invest few bonds as the current corporate bonds mature.

• The supply in the municipal bonds sector will slow down with the increasing interest rates. It may be more challenging to get a significant allocation to this sector. The city will continue to look for the appropriate opportunities.

• The Federal Agencies’ spreads have been lifting especially on the callable options. With the rising interest rates the risk of securities being called before maturity is lower. The City will look to increase its allocation to callable Agencies in the shorter maturity buckets while balancing it with the bullets (noncallable) on the longer end.