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David J. Cholst
Partner
cholst@chapman.com
(312) 845-3862
Presented by: Matthew Eisel, CFA
Senior Managing Consultant
eiselm@pfm.com
(717) 232-2723
PFM Asset Management LLC
One Keystone Plaza, Suite 300
North Front & Market Streets
Harrisburg, PA 17101-2044
www.pfm.com
111 West Monroe Street
Chicago, IL 60603-4080
www.chapman.com
Demand Deposit SLGS Investment
May 17, 2011
Chapman and Cutler LLP | PFM Asset Management LLC 2
Table of Contents
I. Overview
II. SLGS Regulations – Required Certifications
III. Pricing, Liquidity, and Potential Uses
Chapman and Cutler LLP | PFM Asset Management LLC 4
Definition
Demand Deposit SLGS
One-day certificates of indebtedness that are automatically rolled over each day until redemption is requested (31 CFR §344.7)
Pay interest at a variable rate (reset weekly) (31 CFR §344.7(a))
Exempt from both yield restriction and rebate (Treas. Reg. §1.150-1(b)(2))
Chapman and Cutler LLP | PFM Asset Management LLC 5
History
1972
SLGS Program initiated
1996
Regulations eliminated both the $35mm limit and advance refunding prohibition
1969
Legislation restricted the yield of investments for tax-exempt bond proceeds
1986 Demand Deposit SLGS introduced
Suggested as part of the 1986 Tax Act in response to a Congressional Mandate to make the SLGS Program more flexible
Designed to be an investment vehicle for avoiding the need for arbitrage rebate computations
Prohibited for advance refundings
1989
Limited to bond issues of $35mm or less
Chapman and Cutler LLP | PFM Asset Management LLC 6
Monthly SLGS Statistics
From: https://www.treasurydirect.gov/govt/reports/slgs/slgs_mnthlyslgsstat.htm
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Demand Deposit SLGS Outstanding
1/31/1
996
1/31/1
997
1/31/1
998
1/31/1
999
1/31/2
000
1/31/2
001
1/31/2
002
1/31/2
003
1/31/2
004
1/31/2
005
1/31/2
006
1/31/2
007
1/31/2
008
1/31/2
009
1/31/2
010
1/31/2
011$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$3
$517
$1,211
$5,365
(mill
ion
s)
Chapman and Cutler LLP | PFM Asset Management LLC 8
Tax Regulatory Treatment
For purposes of arbitrage, treated as tax-exempt bonds (Treas. Reg. §1.150-1(b))
Excluded from rebate and yield restriction computations (Code Section 148(b)(3)(A)
Treatment for other Code Sections unclear (e.g. Section 149(g))
Treasury Regulations § 1.149(d)-1(b)(3) provide special rules for “mixed escrows” (may apply to Demand Deposit SLGS)
Chapman and Cutler LLP | PFM Asset Management LLC 9
Demand Deposit vs. Time Deposit SLGS
Demand Deposit Time Deposit
Purchase Increment
May be purchased to the penny (same for redemptions)
Must be purchased in whole dollar amounts
Redemption Time
Depending on size, may be redeemed in 1 or 3 business days
Redemptions in 14 days
Redemption Value
Redeemable at par plus accrued interest
Uses market value redemption formula
RateVariable rate instruments typically reset weekly
Fixed and reset daily
31 CFR 344.7, 8, 9 31 CFR 344.4, 5, 6
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SLGS Regulations - Required Certifications
1. Eligible Sources of Funds (31 CFR 344.1)
2. Certifications (31 CFR 344.2(e))
3. Impermissible Practices (31 CFR 344.2(f))
4. Subscription (31 CFR 344.8)
Chapman and Cutler LLP | PFM Asset Management LLC 12
1. Eligible Source of Funds (31 CFR 344.1)
Eligible sources are the same as for Time Deposit SLGS and include:
Gross proceeds of a tax-exempt bond issue (or reasonably expected to become gross proceeds)
Former gross proceeds
Amounts held in a commingled fund with gross proceeds
Proceeds of a taxable issue that refunds or is refunded by a tax-exempt issue
Other amounts subject to §148 yield restriction limitations (BAB proceeds that are not excepted)
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2. Certifications
Certifications are similar to Time Deposit SLGS (though not as comprehensive) and include:
– Agency Certification (31 CFR 344.2(e)(1))
– Purchased with early liquidation proceeds• Yield means what it means for arbitrage (§ 1.148-5) – not applicable
– No certification required on redemption (31 CFR 344.2(e)(2)(ii))
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3. Impermissible Practices (31 CFR 344.2(f))
Generally the same as for Time Deposit SLGS (except for redemptions)
No “cost-free” option
Limitation on yield of purchased SLGS
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4. Subscription
Information needed to enter subscription into SLGSafe: (31 CFR 344.8(b))
− Issue date
− Principal amount
− Issuer name and TIN
− Title of officer authorized to purchase (and redeem) SLGS
− Description of tax-exempt bond issue
Time requirements (31 CFR 344.8(a))
− Subscription due At least 5 business days prior to the issue date for issues consisting of
$10 million or less At least 7 days prior to the issue date for issues greater than $10
million
− No more than 60 days in advance
Chapman and Cutler LLP | PFM Asset Management LLC 17
Pricing
Tax-exempt and variable rate Priced off of 3-month Treasury Bill (“T-Bill”)
– typically yields 75% of the T-Bill yield Rate usually refreshed each Tuesday, the day after new T-Bill auction Demand Deposit SLGS rate may be higher than one- or two-month Time Deposit
SLGS rate
4/20
/201
0
5/11
/201
0
6/1/
2010
6/22
/201
0
7/13
/201
0
8/3/
2010
8/24
/201
0
9/14
/201
0
10/5
/201
0
10/2
6/20
10
11/1
6/20
10
12/7
/201
0
12/2
8/20
10
1/18
/201
1
2/8/
2011
3/1/
2011
3/22
/201
1
4/12
/201
10.00%0.02%0.04%0.06%0.08%0.10%0.12%0.14%0.16%0.18%
Demand Deposit SLGS vs. 1-Month Time Deposit SLGS
DD SLGS 1-mo TD SLGS
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Pricing Considerations
Usually don’t know rate when subscription is placed – Subject to weekly reset (makes market calls a bit more difficult)
Preserve optionality – Outperform if Fed increases target rate (“reinvestment risk” not a big concern)
4/20/2010 5/21/2010 6/21/2010 7/22/2010 8/22/2010 9/22/2010 10/23/2010 11/23/2010 12/24/2010 1/24/2011 2/24/2011 3/27/20110.00%
0.05%
0.10%
0.15%
0.20%
0.25%
Demand Deposit SLGS vs. 6-Month T-Bill
DD SLGS 6-mo T-bill
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Comparison to Money Market Funds
Demand Deposit SLGS may provide higher yield than Treasury-only money market funds
4/20/2010 5/21/2010 6/21/2010 7/22/2010 8/22/2010 9/22/2010 10/23/2010 11/23/2010 12/24/2010 1/24/2011 2/24/2011 3/27/20110.00%
0.02%
0.04%
0.06%
0.08%
0.10%
0.12%
0.14%
Demand Deposit SLGS vs. Money Market Fund (Treasury-Only)
DD SLGS Goldman Sachs Financial Square Funds - Government Series
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Comparisons to Other Investment Alternatives
Cash (not invested)
No return FDIC insurance? Considered imputed earnings for
tax law purposes (Treas. Reg. §1.148-5)
Demand Deposit SLGS Securities
Liquidity resembles money market fund for draws less than $10 million May yield slightly higher than money market funds Backed by full faith and credit of U.S. (31 CFR 344) Potential SLGS window closure is problematic Redemptions in 1 or 3 business days depending on size (31 CFR 344.9(a))
Money Market Funds
Returns currently near 0% Typically AAA-rated May not provide defeasance security
(may lose value because of market risk)
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Other Considerations
Cash flows uncertain, so generally need to “gross fund” fixed liabilities because rate could go to 0%
Need to set up procedure for redemptions; do not automatically redeem or “mature”– Exhibit to escrow deposit agreement showing subscription and redemption dates
Risk of SLGS window closing– When window closes, Demand Deposit SLGS are rolled over into special 90 day
certificates of indebtedness – Certificates of indebtedness can often be redeemed early
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Common Uses of Demand Deposit SLGS
Escrows May allow for an
escrow that yields above the bond yield
Especially useful for current refundings and float periods
Debt Service Funds Could be useful if
not considered a “bona fide debt service fund” – arbitrage a concern
Project Funds With strict permitted
investments language
Good liquidity and potential to earn positive arbitrage if yield curve is flat or inverted
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Unique Considerations and Investment Strategies
Useful for periods of less than 30 days when you want to earn interest – Better alternative to 0% SLGS in 15 to 29 day window unless yield restriction
concerns exist– Less costly and administratively simple alternative to purchasing open market
Treasuries
Use in funds subject to rebate or yield restriction in high interest rate environment – retainable earnings in excess of arbitrage yield
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