The User's Perspective

May 2006

Deposits and Investments: New Information in the Notes

            A government’s cash deposits and investments can be quite significant relative to its other assets and a source of substantial income. In fact, governments may be working harder than ever to increase the return on these resources in an attempt to alleviate the growing financial pressures of rising costs, stagnant revenues, and an inhospitable environment for revenue increases. But the investment of a government’s available cash to generate more resources comes with a variety of risks—risks that the payoffs will not be what a government expects, and even that some or all of a government’s investment could be lost.

            A body of accounting and reporting standards has developed around deposits and investments in order to the give the public information about the risks that accompany them. A variety of people interested in government finance are concerned with investments—a loss of investment value or income could affect a government’s ability to pay its bills or repay its long-term debt and could raise the specter of budget cuts or tax increases.

            The issuance of GASB Statement No. 40, Deposit and Investment Risk Disclosures, was the culmination of a thorough review of the existing standards for providing note disclosures about a government’s deposits and investments. This article describes the impact that this Statement will have on prior disclosures and the new information that will result from its implementation.

Disclosures Required before Statement 40

            Governments are generally required to present their investments at fair value in the financial statements and to report changes in their fair value as investment income. The fair value of an investment essentially is an estimate of what the market believes to be the current value of the net income it will provide in the future. Certain investments, such as money market investments, are reported at amortized cost—the original cost of the investment, plus a portion of associated discounts or premiums (which are spread over the life of the asset).

            Because the fair value (or amortized cost) of the investments is typically aggregated into one or two numbers in the financial statements, the standards require it to be disaggregated in the notes by type of investment—for instance, U.S. Treasuries, stocks, corporate bonds, and so on. (However, the new standard clarifies that all securities from an individual issuer are not the same and that disclosures by type should take different risks into account.)

            The notes should also include descriptive information about the investments, including:

  • The types of investments that the government is legally or contractually allowed to purchase, if there were any violations of those legal or contractual provisions, and actions the government took to address the violations
  • If fair value amounts are based on anything other than quoted market prices, a government discloses its methodology and assumptions for estimating fair value.

If a government has investments in an external investment pool, it discloses:

  • The regulatory oversight, if any, for a pool that is not registered with the Securities and Exchange Commission and whether there is a difference between the fair value of the investments and the value of the government’s shares in the pool
  • Whether involvement in the external investment pool is involuntary (for example, state law might require that if a government invests, it do so through a specific pool)
  • The methods and assumptions made to estimate fair value if a government cannot obtain from the pool the information needed to determine fair value.

            In the past, governments disclosed the degree to which their deposits and investments were exposed to custodial credit risk—the possibility that a government will not be able to recover its deposits, investments, or collateral from the bank or the other party it is dealing with. The deposits were divided among three categories of increasing credit risk:

  • Category 1—deposits that are insured (such as by the Federal Deposit Insurance Corporation—FDIC—or a state insurance fund) or that are collateralized with securities that are held by the government itself or by its agent in the government’s name
  • Category 2—deposits that are collateralized with securities that are held by the bank’s trust department or by an agent in the government’s name
  • Category 3—deposits that are not collateralized, or that are collateralized with securities held by the bank or by the bank’s trust department or agent, but not in the government’s name.

            The fair value (or amortized cost) of investments was similarly divided among three categories:

  • Category 1—investments that are insured or registered in the name of the government or securities that are held by the government itself or by its agent in the government’s name
  • Category 2—investments that are neither insured nor registered, with securities that are held by the trust department of the other party to the investment or by an agent in the government’s name
  • Category 3— investments that are neither insured nor registered, with securities that are held by the other party or its trust department or agent but not in the government’s name.

A typical custodial credit risk disclosure for a government’s investments might have looked like the following:

Figure 1. Pre-Statement 40 Custodial Credit Risk Disclosure



            Specific additional disclosures are required for a government’s repurchase agreements, reverse repurchase agreements, and securities lending transactions. These disclosures are still required for those transactions and agreements, and the new requirements in Statement 40 apply to them as well.

Changes in the Information Previously Reported

            As the GASB reviewed the existing standards, it noted a number of changes since they were originally enacted. Professional standards had been raised considerably. New oversight and regulation had resulted from changes in federal law, including the enactment of the Government Securities Act of 1986 and the repeal of the Glass–Steagall Act by the Financial Modernization Act of 1999. In addition, the GASB’s research found that there had been no recent losses in investments and deposits in Categories 1 and 2.

            Consequently, although most prior disclosure requirements were retained, the GASB decided that the only category exposed to custodial credit risk was Category 3. Statement 40 changed the disclosure requirement to an exception basis—governments disclose custodial credit risk only if they have:

    • Deposits that are not insured and not collateralized, or that are collateralized with securities that are held by the bank or the bank’s trust department or agent, but not in the government’s name
    • Investments that are not insured and are held by the other party or its trust department or agent, but not in the government’s name.

The GASB also concluded that investments in mutual funds and external investment pools are not exposed to custodial credit risk and, therefore, do not have to be included in this disclosure.

New Information

            Statement 40 also addressed four other types of risk that are common to investments—overall credit risk, concentration of credit risk, foreign currency risk, and interest rate risk. In addition to describing the extent to which their investments are exposed to these risks, governments are now required to briefly describe their formally adopted policy for dealing with each of them when they are present—or to state that they do not have such a policy. This should help the reader to understand a government’s tolerance for risk or, conversely, the lengths to which it will go to minimize or avoid risk.

            Overall credit risk is the chance that an issuer of an investment will not fulfill its obligations; governments will disclose overall credit risk by reporting the credit quality ratings of their investments as determined by the rating agencies. In general, a high credit quality rating suggests that the risk that an investment will not pay off is relatively low. (Obligations of or guaranteed by the U.S. government are not considered to be exposed to overall credit risk and, therefore, are not included in this disclosure.)

            A government’s potential losses from credit risk are heightened if a significant portion of its resources are invested with a single issuer. If that issuer did not make good on its obligation to the government, the impact could be potentially damaging. Therefore, governments will report their concentration of credit risk by disclosing, by amount and issuer, investments in any single issuer that represent more than 5 percent of the total investments in the column they are reported in. (Governments do not have to disclose concentrations in investments of or guaranteed by the U.S. government or investments in mutual funds, external investment pools, or other pooled investments.)

            Foreign currency risk is the chance that changes in exchange rates will adversely affect the fair value of a government’s investments and deposits. Governments will disclose the amounts, in U.S. dollars, of deposits and investments exposed to foreign currency risk, organized by currency denomination and investment type.

            The possibility that changes in interest rates will reduce the fair value of a government’s investments is called interest rate risk. In general, the longer the period until an investment matures, the greater the negative impact that changes in interest rates can have on fair value. Governments may use one of five prescribed methods for reporting interest rate risk (they should choose a method based on how they actually manage interest rate risk), disclosing any assumptions that were required.

            A government with few investments might use specific identification to individually list each of the investments and their maturity dates. A segmented time distribution shows the total fair value of investments maturing during a given period. For instance, the illustrative disclosure in Figure 2 divides fair value into four periods—less than six months, six months to one year, one to five years, and more than five years.

Figure 2. Sample Interest Rate Risk Disclosure


              Alternatively, a government could disclose the weighted average maturity of each type of investment. Weighted average maturity is calculated by multiplying each individual investment’s fair value by the amount of time until maturity (in years or months), then adding the individual calculations and dividing them by total fair value for the investment type. This produces an average maturity that takes into account the size of individual investments relative to the total.

            Duration is another approach to calculating aggregate measures of the time to maturity. Duration essentially calculates weighted average maturities for each of the payments made until the investment’s maturity, rather than an average of the fair values. Duration is an indicator of volatility—the higher the duration, the greater the potential loss of fair value as interest rates rise. Finally, governments may use a simulation model to estimate the impact that potential changes in interest rates would have on fair value. For example, the disclosure might show estimated fair values if interest rates were to rise 1, 2, or 3 percentage points.

            As a group, these new disclosures should considerably assist the public in assessing the level of risk to which a government’s deposits and investments are exposed. This information could be valuable when evaluating a government’s financial health, the likelihood that it will have the resources it needs to meet its obligations in the future or to make debt service payments, or the amount of resources that will be available to fund a government’s budget. Such information also can inform discussions of what investment policies and objectives are appropriate for a particular government and how much risk is acceptable.