ty of principal because of the large debt service
exposure that occurs at maturity of the notes; for
these reasons, the guidelines presented here for
investing operating funds take on more importance
for such issuers, and investment practices that veer
from them could be cause for rating concern.
Nonoperating funds, such as endowments and pen-
sion funds, can be invested long-term while ensur-
ing that assets and liabilities are maturity matched.
The following guidelines are suggested for investing
general operating funds. Operating funds, as defined
by Standard & Poor’s, are those needed to pay recur-
ring expenses, such as payroll, maintenance, debt
service, and other expenses needed to provide normal
essential services during the fiscal year. Issuers that
deviate from these guidelines will be examined indi-
vidually to determine the effect, if any, their invest-
ment practices have on their credit ratings.‘Prudent Practice’
Standard & Poor’s general operating fund invest-
ment guidelines are based on what it considers “nor-
mal, prudent” investment practices with regard to
maturity and liquidity, leverage, and credit quality.
Average maturity and liquidity
The weighted average maturity of the operating
fund, as well as the maturity of individual securities
in the fund, should be limited to one year, or as
needed for the issuer’s normal disbursement patterns.
Operating funds should be invested in liquid
securities to meet withdrawals related to operating
expenses, debt service, note payments, and so forth.
Principal protection and liquidity are typically the
primary goals of an operating fund and investment
return a secondary goal. If the operating funds are
invested in county or state investment pools, the
weighted average maturity of the county or state
pool should typically be one year or less.
Leverage
Borrowing through reverse repurchase agreements
and other types of leveraged investments is typically
limited and reflective of the risk profile of the
issuer. If reverse repos are used for enhancing yield
on the portfolio, the money borrowed should be
invested in securities of a high credit quality and
match the term of the reverse repos. Issuers that use
reverse repos need to have the sophistication and
skills in place to hedge collateral call and interest
rate risks associated with reverse repos.
Credit quality
An entity’s operating fund investments should meet
the minimum credit quality standards permitted by
statute, or its own investment policy. Investments
can include deposits in local financial institutionsthat are FDIC-insured, commercial paper issued by
investment-grade corporations and financial institu-
tions, bankers’ acceptances, and treasury or govern-
ment agency securities.Derivatives
For the purposes of these guidelines, derivative
investments can be described as those whose yield or
market value does not follow the normal swings of
interest rates. They include, but are not limited to,
such items as structured notes issued by agencies and
corporations, “inverse floaters,” leveraged variable-
rate debt, and interest-only or principal-only CMOs.
These securities are volatile and can result in
dramatically different market values if liquidated
before maturity. Significant investment positions in
risky derivatives could be viewed negatively,
depending on the proportion of derivatives to
total investments and the liquidity needs of the
issuer. These derivatives are extremely sensitive to
interest rate changes and are highly susceptible to
liquidity risks.Pools And Mutual Funds
The same guidelines regarding average maturity and
liquidity, leverage, credit quality, and derivatives
should be adopted for operating fund investments in
externally managed investment pools. Exceptions can
be made depending on the amount of nonoperating
and surplus funds invested in the pool. In addition to
reviewing the pool investments, the historical and
projected cash flows of the pool will be examined.
While we do not require investment funds to be
rated by Standard & Poor’s in order to evaluate an
issuer’s credit quality, a public rating on the invest-
ment fund provides transparency as well as the ini-
tial and ongoing information that is asked for as
part of an investment review.Review And Oversight
Issuers should be aware of statutory investment
requirements and may want to supplement statuto-
ry guidelines with a written investment policy tai-
lored to that entity’s situation. The policies should
address credit quality, maturity, market valuation
frequency, leverage, and derivative-type invest-
ments. Officials should be aware of such policies,
and periodic reporting of compliance and perform-
ance should be in place. As part of Standard &
Poor’s analysis, we may request a discussion of the
investment practices and how they follow written
or otherwise adopted policies.
In general, the longer the maturity or duration of
permitted investments—and the less liquid the secu-
rities—the more frequent the need for “mark to
market” valuations of operating fund investments.Cross Sector Criteria50 Standard & Poor’s Public Finance Criteria 2007