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HomeMy WebLinkAboutIR 7873 INFORMAL REPORT TO CITY COUNCIL MEMBERS No. 7873 G�pRTE Q To the Mayor and Members of the City Council November 1, 1994 excs Subject: SECURITIES LENDING PROGRAM Securities lending is a fee-generating program for the City in which a primary dealer borrows the City's investment securities for use in its own investment activities. In return, the primary securities dealer gives the City one of its own securities of greater value as collateral and pays the City a monthly fee. A third-party custodial bank safekeeps all securities. Primary Dealers The City will only work with eligible primary broker dealers. Primaries are the largest Wall Street investment banks which report to the Federal Reserve Bank of New York and are required to maintain large capital positions and "make markets" for U. S. Treasury securities. These firms have high credit quality and large portfolios of securities. By only dealing with these large, well-capitalized firms, the City adds an extra level of confidence to its Securities Lending Program. How It Works The City establishes a custodial account at a third-party bank and then delivers its securities to the bank. The primary dealer delivers collateral securities to this account equal to 102 percent of the market value of the City's portfolio. The separate custodial account insures that all securities offered as collateral are the property of the City. The higher market value provides an extra measure of safety. The primary dealer uses the borrowed securities in a number of ways. With these high quality securities, the primary dealer can borrow money cheaply which it can then use to finance its own positions or to invest short-term in a higher yielding investment. It can also use the securities to cover short sales. Short sales occur when a trader sells a security before he owns it. He thinks the price is going down, and he can buy the security more cheaply, thus making a profit. By having ready access to a bond through security lending, a firm can insulate itself from the risk of short selling. The borrowed bond can also be used to correct "fails." Fails are the result of a "domino effect." When the City buys a bond from a primary dealer, the primary dealer often is buying it from another institution, which is buying it from someone else, etc. Any breakdown in deliveries in this chain causes "fails" down the line. If a primary dealer has access to bonds through security lending, it can avoid some fails and any associated costs. ViVt Wall mx. ISSUED BY THE CITY MANAGER FORT WORTH,TEXAS INFORMAL REPORT TO CITY COUNCIL MEMBERS No. 7873 pATE& A a. To the Mayor and Members of the City Council November 1j, 1994 Page 2 of 2 X Subject: 1873 SECURITIES LENDING PROGRAM The City always retains full ownership of securities borrowed by the primary dealer. All interest payments come to the City. The City can sell the bond at any time, and the primary dealer will return it. The custodian bank prices the City's bonds daily to make sure sufficient,collateral is kept in its account. Reports of activity are regularly sent to the City for monitoring purposes. Since the account is in the City's name, all collateral securities kept in it are the property of the City. In the very unlikely event the primary dealer is unable to deliver any borrowed bonds, the collateral becomes the property of the City. Since the collateral meets specific guidelines of the City as to credit quality and liquidity, the City is assured of being able to sell these securities should it have to buy back any borrowed bonds. History of the Program The City had a limited "bonds borrowed" program from 1987 to 1989. The City would lend individual bonds to eligible primary dealers for varying fees. Beginning in 1989, the City entered into annual contracts with a single firm. This firm accepted the entire City portfolio and paid a fixed monthly fee. Over the past six years, the program has generated $1,200,761 for the City, $232,135 in FY 1994. All fees are recorded in the General Fund. The securities lending contracts expiring on November 11, 1994, are with Morgan Stanley and Bank of New York as custodian. Staff has contacted Morgan Stanley and four other primary dealers to ascertain their interest in the Securities Lending Program. Based upon the responses received, staff recommends renewing the contracts with Morgan Stanley and Bank of New York as custodian. Staff will bring forward a M&C for Council approval on November 8, 1994 CAS (2. Bob Terrell City Manager HFICIAL RECORD CITY SECRETARY' FL WORTH, TEX, ISSUED BY THE CITY MANAGER FORT WORTH, TEXAS