FUNDAMENTALS OF PUBLIC FUNDS INVESTING SESSION 5 | CASH FLOW AND CASH FLOW FORECASTING Carlos Oblites Senior Portfolio Strategist January 26, 2021 SESSION OVERVIEW • Management of a public agency’s cash requirements, • Balancing revenues (taxes and fees) with monthly obligations, periodic debt-service payments, and other recurring or non-recurring cash demands. • Practice for preparing and implementing a cash flow forecast • Using budgetary and statistical forecast to make investment decisions 2 Determining Cash Available 3 How Much $40 $35 Liquidity is $35 Enough? $30 $25 Do your investments $25 meet cash needs? $20 $20 $19 $16 Millions $15 $10 $10 $10 $8 $5 $5 $1 $0 Overnight 1 Day - 1 Year 1-2 Years 2-3 Years 3-5 Years Investments Cash Outflows This is shown as an example for illustrative purposes only. Please refer to important disclosures at the end of this presentation. 4 How Much $40 $35 Liquidity is $35 Enough? $30 $25 Are your investments $25 optimized for return? $20 $20 $19 $16 Millions $15 $10 $10 $10 $8 $5 $5 $1 $0 Overnight 1 Day - 1 Year 1-2 Years 2-3 Years 3-5 Years Investments Cash Outflows This is shown as an example for illustrative purposes only. Please refer to important disclosures at the end of this presentation. 5 How Much Delayed Payments Liquidity is Enough? Cost of Insufficient Additional Borrowing Costs Liquidity: Additional Transaction Costs Negative Internal and External Headlines 6 How Much Liquidity is Enough? Lost Investment Income Cost of Excess Liquidity: Bad Press Lost Opportunities 7 How Much Liquidity is Am I meeting my Code-mandated goal of Enough? safety and liquidity? Most Crucial Questions: Will I have the cash available when I need it? Am I earning as much as I could? 8 Select Fixed-Income Benchmark Total Returns By Duration As of September 30, 2020 The Cost of Too 10 YR Additional Much Liquidity Cumulative Value Index Duration Annualized Value Over of $100 Million Return LAIF Local Agency Investment Fund 0.46 Years 0.85% $108,825,144 N/A ICE BAML 1 YR Treasury Note 0.99 Years 0.931% $109,709,885 $884,741 Index ICE BAML 1-3 YR Treasury Index 1.90 Years 1.278% $113,540,595 $4,715,451 ICE BAML 1-5 YR Treasury Index 2.65 Years 1.718% $118,570,902 $9,745,758 ICE BAML 3-5 YR Treasury Index 3.86 Years 2.381% $126,530,048 $15,861,071 Source: Bloomberg, ICE BAML Indices and LAIF. Data as of September 30, 2020. Performance for ICE BAML indices based on a $100 million portfolio, relative to LAIF. Performance shown is hypothetical and not based on an actual client's account. LAIF returns include an administrative fee charged to investors by the California State Treasurer. LAIF duration estimated based on average maturity in days, as of September 30, 2020 divided by 365 9 days. Past performance is not a guarantee of future results. Please see disclosures at the end of this presentation for further details. Why a Cash Flow Analysis? “The analysis is intended to measure and assess the government’s ability to meet its needs, to negate the need for any short-term borrowing or liquidation of long-term investments before maturity, and to identify any idle funds, and the duration of that idle period, to determine whether those funds could be invested over that time frame. Cash flow analysis is therefore an essential tool for informed management decision making.” - GFOA Best Practice: “Cash Flow Analysis” Source: GFOA 10 What is a Cash Flow Analysis? Projection of Projection of It considers anticipated It considers all anticipated cash timing of cash funds receipts receipts and disbursements disbursements 11 What a Cash Flow Analysis Is NOT! “Cash” is the operative word in “Cash Flow Forecasting” It is not accruals or Only cash is spendable budgeted funds or investable! 12 $40 Ensuring $35 Liquidity $30 $25 $25 $25 $20 $19 $19 $16 $16 Ensuring maturing cash Millions $15 $10 $10 and reserves are $10 $8 $8 available when needed by matching investments $5 to cash outflows $0 Overnight 1 Day - 1 Year 1-2 Years 2-3 Years 3-5 Years Investments Cash Outflows This is shown as an example for illustrative purposes only. Please refer to important disclosures at the end of this presentation. 13 Sample Local Government Balances Ensuring 5 Year Period Liquidity 6 5 Total balances trend higher or lower 4 Balances fluctuate through the 3 Liquid Balances year $ millions$ 2 The “liquid” balances are for Core/Reserve Balances meeting cash needs 1 The “core” balances are 0 available for longer- duration investing Month This is shown as an example for illustrative purposes only. Please refer to the important disclosures at the end of this presentation. 14 What Are You Hoping to Accomplish? Ensure sufficient liquidity for 6-12 Identify short-term cash 1 months of disbursements 3 deficits Warn of impending budget 2 Improve earnings: 4 problems • Match sources and uses of cash • Invest core funds in longer duration investments for higher return potential • Manage liquidity and market risks 15 Annual Cash Flow Forecasts Determines Covers anything Estimates cash available Provides a useful from this fiscal monthly cash for investments monthly overview year to the next position for next of more than for investment out to possibly 3 12 months 30 days decision-making years 16 How Do I Create Project a net change It? Project cumulative balance of cash Use monthly revenue 3 position and invested and expenditures 2 securities projections 4 Start with the beginning Develop a balance of cash and 5 schedule of investments 1 current investments and coupon payments 17 Start by Identifying Revenues and Expenditures Major Revenues Major Expenditures Property taxes Payroll and benefits Sales and use taxes Operating expenses User fees Debt service Capital projects Shared revenues (spending schedules) Non-recurring revenues Non-recurring (financing) Other Other 18 Historical data from general ledger Sources of Information Current year budget Capital project spending projections Historical data from bank, pool investments Schedule of maturities and coupon payments 19 The Budgetary Approach 20 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Please refer to disclosures at the end of this presentation. The Statistical Approach $300 Sample Balances Analysis Amount available for longer-term Minimum needed to cover outflows $250 $200 Excess Liquidity $150 Millions $100 Actual portfolio of Securities $50 $0 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Please refer to disclosures at the end of this presentation. 21 The Statistical Approach Sample Balances Analysis with Forecast $350 Forecast Balances Historical Balances $300 Minimum needed to cover outflows $250 $200 Millions $150 $100 Forecast amount available for longer- term investments $50 $0 Sep-17 Mar-18 Sep-18 Mar-19 Sep-19 Mar-20 Sep-20 Mar-21 Sep-21 Mar-22 Sep-22 Mar-23 Sep-23 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Please refer to disclosures at the end of this presentation. 22 Challenges to Developing Forecasts Physical Inter-departmental Systems Political Structure Communications Limitations of Locations Elected Other departments not computer systems of people officials understanding for historical data agendas importance of or data information management 23 Review and Compare actual results vs. forecast results Maintain Cash Make sure to identify reasons for variances Flow Forecast Adjust assumptions if warranted Follow up with department heads on capital project slippage Update your model and retain documentation for future reference 24 Cash Flow Needs How Do I Invest 1 It? California Government Code and your You must take into investment Policy account: 2 Investment objectives 3 Current Market Conditions 4 25 In Summary: Check in with all your Safety and Determine how resources: Reduce liquidity are much is needed • Revenues and expenditures unnecessary historical and to date more important liquid liquidity • Debt payments than return • Everchanging CIP schedules 26 Now What Do You Do With It? 27 Meet Your Code- Mandated Protect Objectives Principal Your Investment Program Optimize Provide earnings liquidity to while cover both providing ongoing and safety and unexpected liquidity cash needs 28 Constraining portfolio duration relative to a Meet Your Code- Portfolio benchmark Mandated Duration Objectives Based on cash flow Strategic allocations to key sectors, with value-based rotation analysis, California Sector Government Code, and the Allocation Investment policy, these decisions must be made: Positioning securities along the yield curve to Term capture value across maturities Structure Selecting undervalued bonds offering the greatest potential for risk-adjusted return Security Selection 29 Structuring Your Total Portfolio Funds Liquidity Funds Core Funds § Local Government Investment Pool § Target generally to a higher duration (LGIP) to enhance the potential to increase earnings § Matching maturities to known expenditures • Invest in securities allowed by Code: • Money market instruments o U.S. Treasury Securities o Agency Discount Notes o U.S. Agency Securities o Commercial Paper o High-Grade Credit o Certificates of Deposit This is shown as an example for illustrative purposes only. Please refer to the important disclosures at the end of this presentation. 30 Matching Cash Flows Maturity $20 $20 Structure $20 $18 $16 $14 $12 $10 $10 $10 $10 $10 $8 $8 $8 Millions $6 $5 $5 $4 $2 $0 Overnight 1 Day - 1 Year 1-2 Years 2-3 Years 3-5 Years Investments Cash Outflows This is shown as an example for illustrative purposes only.