Report to: General Committee Report
Date:
SUBJECT: Town of
PREPARED BY: Mark Visser, Manager, Financial Strategy & Investments
RECOMMENDATION:
1) THAT the report dated
2) AND THAT a Capital Gains Reserve be established and funded though surpluses in the Capital Gains account.
3) AND THAT staff be authorized and directed to do all things necessary to give effect to this resolution.
EXECUTIVE SUMMARY:
N/A
PURPOSE:
The Town of
BACKGROUND:
The Town currently has an average
investment portfolio of $400 million. Of
this amount, $80 million is related to Development Charge investments. Any interest from these investments goes
straight to the Development Charge Reserves. The remaining $320 million balance
is comprised of $120 million of interest bearing reserves and reserve funds and
$200 million which is considered as the Town’s general portfolio. This $200 million figure is an average
balance that fluctuates between $100 million and $300 million throughout the
year (the major sources of this balance are non-interest bearing reserves,
unspent capital, and Region and School Board taxes collected and yet to be
dispersed). Annual Investment Interest
budgets are set based on the general portfolio balance.
OPTIONS/ DISCUSSION:
Interest Allocation
The Town invests in both short-term (money market) and long-term (bond market) investments. At the moment, the average ratio is approximately 60% long term. Since the long term investments are held over multiple years, the rate of return on the bond portion of the portfolio does not fluctuate significantly year over year. Over the past 3-4 years, the average bond market yield (exclusive of capital gains) has been approximately 4.4%. Conversely, the money market portion of the portfolio fluctuates significantly. In 2007, money market rates were close to 5%. Currently, they are around 0.5%.
Because of the large swing in portfolio balances throughout the year (due to the timing of the collection and disbursement of taxes), there will always need to be a significant portion of the Town’s funds invested in the money market.
The Town’s practice has been to allocate money market rates to the interest bearing reserves and apply bond interest to the general portfolio. The reasons for this are 1) over the long term, bond rates generally outperform money market rates, therefore the Town is able to achieve higher rates of return in its general portfolio and thereby reducing the immediate need for tax increases; 2) bond market rates are more stable which allows for smoother budgeting; and 3) reserves and reserve funds can more easily absorb these money market rate fluctuations as the requirements for these funds are longer term in nature.
The attached policy looks to maintain the Town’s current practice of allocating money market interest (typically around prime less 1.75%) to interest bearing reserves and reserve funds. The only change to the current practice is to charge reserves with negative balances at a rate of prime (which is more reflective of the rate for borrowing). The only reserves that are currently, or projected to be, in a negative balance are the Development Fee and Building Reserves.
Capital Gains Reserve
The Town currently budgets $200,000 a year for Capital Gains (based on average gains from 2006-2008). 2009 year-to-date capital gains are over $900,000, contributing $700,000+ to the year end surplus. Historically these surpluses are simply amalgamated into the Town’s year-end operating surplus/deficit. A Council resolution from March 2005 dictates that “year-end operating surpluses, if any, be used first to top-up the Corporate Rate Stabilization Reserve…and secondly to replenish the expenditures in the Environmental Land Acquisition Reserve Fund, and finally transferred to the Life Cycle Replacement and Capital Reserve Fund”.
The attached policy seeks to give staff flexibility in taking investment income surpluses (or a portion thereof) and transferring to a special Capital Gains Reserve. The purpose of this would be to provide a method of applying surpluses earned in one year to a subsequent year’s budget. It allows for smoother budgeting, as well as promoting the best buy/sell decisions for the Town since the impact to future year’s budgets can be managed better.
For example, a 5-year $1.0 million, 6% coupon bond purchased at par earns the Town $60,000/year in interest ($300,000 over a 5 year period). If the Town can sell that same bond for $1.1 million and reinvest the $1.1 million at 4%, the Town earns $44,000/year plus the $100,000 in capital gains for a total of $320,000 over 5 years. This is the best decision for the Town to make but has the following effect on interest income revenues:
|
Current |
2009 |
2010 |
2011 |
2012 |
2013 |
TOTAL |
|
Buy and Hold (A) |
$60 K |
$60 K |
$60 K |
$60 K |
$60 K |
$300 K |
|
Sell and Reinvest (B) |
$144 K |
$44 K |
$44 K |
$44 K |
$44 K |
$320 K |
|
Difference
(D) |
$84 K |
($16 K) |
($16 K) |
($16 K) |
($16 K) |
$20 K |
|
Budget (B) |
$44 K |
$44 K |
$44 K |
$44 K |
By being able to take a portion of the $100,000 of capital gains in 2009 and transferring $20,000 to each of following years, it can help offset the reduction in income in years 2010-2013 which allows for higher annual Investment Interest budgets each year (by $20,000 per year in this example)
|
Proposed |
2009 |
2010 |
2011 |
2012 |
2013 |
TOTAL |
|
Buy and Hold (A) |
$60 K |
$60 K |
$60 K |
$60 K |
$60 K |
$300 K |
|
Sell and Reinvest (B) |
$144 K |
$44 K |
$44 K |
$44 K |
$44 K |
$320 K |
|
Transfer to/from
Reserve (C) |
($80 K) |
$20 K |
$20 K |
$20 K |
$20 K |
$0 K |
|
Difference
(D) |
$4 K |
$4 K |
$4 K |
$4 K |
$4 K |
$20 K |
|
$64 K |
$64 K |
$64 K |
$64 K |
FINANCIAL TEMPLATE
There is no long term financial impact to this policy as it simply outlines the methods of allocating interest. As outlined above, it will have an impact on budget setting in future years.
ALIGNMENT WITH STRATEGIC PRIORITIES:
Not applicable
DEPARTMENTS CONSULTED AND AFFECTED:
Not applicable
RECOMMENDED
BY: ________________________ ________________________
Barb Cribbett, Andy Taylor, Commissioner
Treasurer of Corporate Services
ATTACHMENTS:
Attachment 1 – Town of
Attachment 1
TOWN OF
OBJECTIVE
The objective of this policy is to provide a framework with regards to the recording and allocation methods of the Town’s Investment Interest income (including bonds, money market, interest earned on bank balances, etc).
INTEREST ALLOCATION
This section outlines the methods for allocating interest to various Town Reserves and Reserve Funds.
Development Charges Reserves
The Development Charge Reserves have its own segregated investment pool. The interest generated from these investments is fully allocated to the Development Charge Reserves on a monthly basis.
Interest Bearing Reserves and Reserve
Funds
There are no specific investments made on behalf of reserve and reserve funds. Interest is calculated and allocated monthly. The amount of interest is determined by applying the average money market rate earned by the Town in a given month to the previous month’s ending reserve balance. Any reserves or reserve funds with negative balances will be charged at a rate of prime.
Varley Trust
Through a past agreement with the Varley Trust, interest is calculated and allocated monthly by applying the average bond market rate (exclusive of capital gains) earned by the Town in a given month to the previous month’s ending reserve balance.
General Portfolio
The remaining interest not allocated to the above reserves and trusts is deemed to be the interest earned on the general portfolio.
CAPITAL GAINS RESERVE
The Treasurer has the authority to transfer year-end surpluses in the Capital Gains account to a Capital Gains Reserve.
The Capital Gains reserve can only be drawn upon in the following situations:
1) Funds are required to make up for a current year budget deficit in the Investment Interest or Capital Gains accounts
2) Funds are required to set the Investment Interest budget for the following year budget