9.4.2 Investments Specific to Bond Funds
Certain types of investment securities have been designed specifically for the investment of bond funds. These allow for the investment of funds without market loss risk, simplify investment of trustee held funds, and/or limit the difficulty of complying with federal tax law yield restrictions.
TRUSTEE SWEEP ACCOUNTS – “Trustee sweep accounts” are money market funds managed by the bond trustee and limited to investments in federal securities. They contain little or no market risk and offer the public agency the assurance that funds will remain fully invested.
TREASURY SECURITIES – STATE AND LOCAL GOVERNMENT SERIES – The State and Local Government Series, (SLGS, pronounced “slugs”), are a special type of U.S. Treasury securities issued to enable state and local government issuers to comply with the yield restriction requirements of federal tax law. “Time Deposit” SLGS are fixed rate obligations maturing on a date specified by the public agency, bearing interest at a specified rate (commonly referred to as “SLGS rates”). “Demand Deposit” SLGS are redeemable on any date and bear interest at a rate that is adjusted daily. These SLGS are direct obligations of the U.S. Treasury and are unavailable from time to time, depending upon the status of the federal debt ceiling.
INVESTMENT AGREEMENTS – These investments, often referred to as guaranteed investment contracts or “GICs,” are another type of investment geared particularly to bond funds. GICs provide agencies the ability to invest bond funds in a way that conforms to specific liquidity, yield, and safety requirements. See Section 4.8.3.2, Guaranteed Investment Contracts. In most cases, the public agency or the bond trustee agrees to invest all funds held in a particular fund or account (e.g., the construction fund or the DSRF) with the investment agreement provider and the provider agrees to pay the agency or the trustee a fixed rate of interest on invested funds. Investments are generally not transferable (except to a successor trustee) and funds may not be withdrawn for the purpose of reinvestment.
Investment agreements assume different forms, depending upon the provider, the types of investments securing the funds, and any regulatory restrictions. An investment agreement may, for example, be structured as a time deposit with a bank, a series of repurchase agreements with a broker dealer, or a loan contract with a special purpose entity whose payment obligations are guaranteed by an insurance company. Investment agreements may allow for withdrawal whenever funds are needed for expenditure (a “full flex agreement”), or only at specified times, and may have different notice requirements for draws.
Investment agreements are generally obtained through a bidding process that specifies all material terms, with the contract awarded to the party satisfying the minimum bid requirements offering the highest interest rate. Because the public agency takes credit risk on the provider, investment agreements are generally entered into only with highly rated financial institutions. The provider’s repayment obligation is often required to be collateralized. Investment agreements are complex financial instruments. Public agencies are advised to engage a specialized investment consultant or financial advisor and bond counsel to assist in the bidding and negotiation of these agreements and ensure compliance with applicable “safe harbor” requirements.