Inspection of FCA's Cash Management and Investment Practices

Published by the Farm Credit Administration, Office of Inspector General on 2000-09-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)




   . Cash Management
    Investment Practices


        September 28, 2000

 Farm Credit Administration                                     Ir,sp~ tor Gt no .11
                                                                     ",j  t Jr e
                                                                     1 A.      )2 OQC

September 27, 2000

The Honorable Michael M. Reyna
Chamnan and Chief Executive Officer
Farm Credit Administration
McLean, Virginia

Dear Mr. Reyna:

We have completed our inspection of the Farm Credit Administration's (FCA or Agency) Office
of Resources Management's Cash Management and Investment Practices. Our objective was to
evaluate the cash management and investment practices for funds garnered mainly by the
Agency assessment of Farm Credit System institutions.

Section 5.15 of the Farm Credit Act of 1971, as amended, limits the Agency's cash management
and investment practices but the Agency does have management discretion over them. The FCA
Board has adopted a policy for exercising this discretion. We found several areas that should be
improved, including collection and deposit practices, the process of making investment choices,
and compliance with Board policy. We also identified some potential improvements through our
benchmarking the cash management and investment practices of the Farm Credit System
Insurance Corporation.

We conducted this review in accordance with the Quality Standards for Inspections issued by the
President's Council on Integrity and Efficiency. We performed our fieldwork from May 2000 to
July 2000 at FCA headquarters in McLean, Virginia. An entrance conference was held on May
17, 2000 and an exit conference was held on September 6, 2000. The Office of Inspector
General and management have agreed on the actions to be taken to resolve all issues included in
this report.

Eldon W. Stoehr
Inspector General
                                    Table of Contents

Background                                                                        1

Objective, Scope, and Methodology                                                 .2

Findings and Agreed Upon Actions

      Collections received through the mail have not been deposited
        in a timely manner                                                        2

      There has been modest improvement in Agency investment practices
        but more is needed                                                        3

      Management is not complying with the Board's policy statement on
       Agency cash and liquidity management                                       .4

      FCSIC investment practices offer opportunities to improve FCA's practices   5
                                 FCA Office of Inspector General

                           AOO-07 Inspection of FCA's Cash Management

                                     and Investment Practices


The Farm Credit Administration (FCA or Agency) is an independent Federal financial regulatory
agency of the United States Government. It has regulatory, examination, and supervisory
responsibilities for the Farm Credit System (FCS or System) banks, associations, and related

The FCA is allowed under Section 5.15 (FCA's Operating Expenses Fund) of the Farm Credit
Act of 1971, as amended, (Act) to determine:

    •	 The cost of administering the Act for the subsequent fiscal year.
    •	 The amount of assessments required to pay administrative expenses, taking into
       consideration the funds already contained in the administrative expense account and
       needed to maintain a necessary reserve.
    •	 The amount of assessments that will be required to pay the costs of supervising and
       examining the Federal Agricultural Mortgage Corporation.

These funds have to be held in the Treasury of the United States (Treasury) in the FCA's
Administrative Expense Account.

The Agency has the following discretion over funds maintained by Treasury:

    •	 At the request of the FCA, the Treasury can invest and reinvest such amounts contained
       in the Administrative Expense Account that are in excess of the amounts necessary for
       current expenses of the FCA.
    •	 All income earned from such investments and reinvestments is deposited in the
       Administrative Expense Account.
    •	 Investments must be made in public debt securities with maturities in line with the needs
       of the Administrative Expense Account, and bearing interest at rates determined by the
       Treasury, taking into consideration current market yields on outstanding marketable
       obligations of the United States of comparable maturities.

Interest income earned by the Agency on the balance of these funds may be used to reduce the
total assessment imposed on FCS institutions. FCA earned $870,000 in interest income on fiscal
year 1999 investments that averaged $14.4 million. The Agency's new accounting system has
not been able to provide information about the average uninvested balance nor average yield for
the investment portfolio since its implementation in late 1998. We used information from the
Fiscal Resources Division (FRD) quarterly cash flow and investment analysis in arriving at our

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                                     FCA Office of Inspector General

                               AOO-07 Inspection of FCA's Cash Management

                                         and Investment Practices


The objective of this inspection was to evaluate the Agency's cash management and investment
practices. To meet this objective we: 1) analyzed FCA's cash flow for the past two years to
identify opportunities to improve the collection and/or payment of funds; 2) reviewed FCA's
investment transactions to evaluate whether the invested portion of available funds and the yields
of specific investments produced the best available earnings for the Agency; 3) compared
investment practices to the Board's policy to conclude whether the Board's expectations are
being met; and 4) benchmarked the Agency's investrrient practices and perfonnance against
those of the Fann Credit System Insurance Corporation (FCSIC).


Collections received through the mail have not been deposited in a timely manner.

FRD has not made timely deposits of collections received by mail. Even though the majority of
FCS institutions pay their assessments electronically, the Agency still physically handles a
significant number of checks each quarter because 59 institutions, or 33 percent of all FCS
institutions, continue to send in their payments by mail. Depositing practices for these mailed
payments were not always in accordance with Agency policy. This increased the potential for
loss of the deposits themselves.

FRD's written procedures require deposits to be made at least twice a week or whenever
collections on hand exceed $1,000. According to FRD management, the infonnal FRD policy is
for deposits to be made at least once a week or whenever collections reach $5,000. We found
that actual practices do not confonn to either FRD written procedures or management's less
stringent unwritten expectations; i.e., as checks over $5,000 were not deposited for several days
and deposits were not always made weekly. Review of deposit records for December and March

    •      three checks totaling $59,000 were deposited six days after their receipt,
    •      four checks totaling $30,000 were deposited four days after receipt,

    •      one check for $24,000 was deposited five days after receipt,

    •      one check for $5,000 was deposited 13 days after receipt, and

    •      one check for $1,100 was deposited 10 days after receipt.

Timely depositing has recently been added to the responsible employee's perfonnance plan in an
attempt to improve the division's perfonnance in this area.

Electronic payment of assessments by FCS institutions makes those collections immediately
available for investment and eliminates the administrative processing of collections received
through the mail. While the Agency has previously requested nonparticipating FCS institutions

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                                  FCA Office of Inspector General

                            AOO-07 Inspection of FCA's Cash Management

                                      and Investment Practices

to change to electronic payment, as stated above about one third continue to pay by the
traditional mailed check method. The Agency should redouble its efforts to persuade all
institutions to pay electronically.

Agreed Upon Actions

1.	 FRD management will strengthen internal controls to ensure timely deposit ofpayments
    and conformance with establishedprocedures.

2.	 FRD management will update office procedures establishing accountabilities for making

3.	 FRD management will continue efforts to convert the FCS institutions to making
    assessment payments electronically.

There has been modest improvement in Agency investment practices but more is needed.

FCA's current strategy is to place the bulk of its investments in overnight funds with only a small
portion of the portfolio (15-20%) placed in instruments with longer maturities. The portion of
the portfolio with longer maturities includes instruments with maturities from six months to two
years and they are "laddered" to mature at six-month intervals. Individual investments are
limited by FRD practice to instruments that mature within two years. The Agency has slowly
increased the proportion of longer maturities within the portfolio, subsequent to a September
1996 Office of Inspector General audit. Prior to that audit, all investments had maturities of less
than 30 days. The practice of investing primarily in overnight instruments assumes an inverted
yield curve environment; i.e., when higher interest rates are paid on short term investments than
long term investments. Inverted yield curves are abnormal and usually are of a short duration.

Unwavering adherence to the practices described above, without considering current market
conditions, has caused the Agency to pass up significant interest income opportunities when
higher yields were available on investments with longer maturities. In December 1997 the
Agency rolled over a $543,000 investment into a one-year instrument when a two percent
premium was available on a two-year instrument. The Agency forfeited $23,000 in interest
earnings by that action and that loss was compounded by the fact that the one-year investment
matured and was reinvested in a falling interest environment. Investing in two-year maturities is
well within the parameters of the Board's cash and liquidity management policy.

Conversely in January 2000, a $1 million investment was made with a two-year maturity that
yielded only .25 percent premium over the overnight funds rate. This produced only a $5,000
increase in earnings but committed a large amount over the two years in an environment of
increasing interest rates. FRD staff indicates that there is no criteria for deciding between
overnight funds and longer term investments nor are interest rate forecasts considered in

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                                 FCA Office of Inspector General

                           AOO-07 Inspection of FCA's Cash Management

                                     and Investment Practices

investment decisions. FRD's assertion that liquidity is the overriding investment objective is
contradicted by this transaction.

There are no back-up procedures for many investment functions; particularly, alternative
investment instructions did not exist to communicate the information required for investment of
overnight funds during a recent power outage. As a consequence, the Agency lost $2,100 in
interest income because that transaction could not be executed.

Current investment practices limit the investment portfolio to instruments with no more than a
two-year maturity even though the Board policy allows up to 50% of the portfolio to be in
instruments with maturities longer than two years. Current practice precludes the Agency from
taking advantage of occasional "sweet spots" in the yield curve to generate more interest income.
Recent historical data indicates that an additional half percent could be added to the average
investment yield by extending maturities an additional one to three years. This would increase
investment income $5,000 annually for each $1 million investment and, based on the historical
investment balances, annual interest income for the entire portfolio would increase by
approximately $70,000.

Agreed Upon Actions

4.	 FRD management will develop backup processes to ensure the timely and effective
    investment ofAgency funds.

5.	 Adjust the Agency investment strategy to appropriately balance market conditions and
    cash flow requirements in all investment decisions for the entire investment portfolio.

6.	 As cash flow needs permit, lengthen the maturity ofthe investment portfolio when
    compelling market opportunities exist beyond the selfimposed two-year time horizon.

Management is not complying with the Board's policy statement on Agency cash and
liquidity management.

Agency cash and liquidity management requirements are established in FCA Board Policy
Statement Number 66. However, some aspects of this policy statement have not been followed,
mainly on the reporting requirement that says: "Quarterly, the COO shall report to the FCA
Board on the liquidity position of the Agency and the composition of the investment portfolio."
The quarterly reporting was discontinued with the advent of the Agency's new accounting
system in late 1998, which could not provide quarterly reporting for the Agency's liquidity
position and the composition of the investment portfolio. Since then, FRD has been following an
FRD developed draft policy statement, which calls for reporting to the Board periodically on the
liquidity position and composition of the investment portfolio.

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                                  FCA Office of Inspector General

                            AOO-07 Inspection of FCA's Cash Management

                                      and Investment Practices

Agreed Upon Action

7.	 FRD management will propose an update to the Board's Policy Statement on Cash and
    Liquidity Management for the Board's approvaL

FCSIC investment practices offer opportunities to improve FCA's practices.

Our benchmarking of FCSIC's investment practices and performance confirmed that the FCA
has shadowed certain positive aspects of the FCSIC. During the past two years the FCA has
been following a strategy of increasing its "barbell approach" (overweighing the invested amount
at each end of their investment time horizon) for investing its excess reserves. This has been
done by increasing the amounts invested in overnight funds (since December of 1998) and
increasing the amount of investments with maturities in the six-month to two-year time frame.
The increased use of overnight funds was consistent with FCSIC's approach. These actions
highlighted a shortening of the overall maturity level of the portfolio by using overnight funds to
take advantage of the" inverted yield curve that existed. However, the following FCSIC
investment practices offer opportunities to improve FCA's investment function:

    •	 All investment decisions are adjusted for market conditions.

    •	 Redundant systems are in place to ensure investments are always made.

    •	 FCSIC focuses on yield rather than strict adherence to strategy and therefore takes
       advantage of pricing opportunities in the yield curve.

    •	 FCSIC uses an investment committee for investment decisions.

FCSIC's investment performance suggests that adoption of the above items would also benefit
the Agency's overall investment function. If the size of the Agency's investment portfolio
makes some of these aspects impractical, the Agency could consult FCSIC on such issues.

Agreed Upon Action

8.	 FRD will utilize FCSIC as a source ofinvestment advice for the Agency's investment
    decisions andpractices.

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