GFOA Advisories identify specific policies and procedures necessary to minimize a governments exposure to potential loss in connection with its financial management activities. It is not to be interpreted as GFOA sanctioning the underlying activity that gives rise to the exposure.
Managers of government portfolios often enter into securities lending transactions as a way of increasing earnings on their investments. In securities lending transactions, entities transfer (loan) their securities to broker-dealers and other entities in exchange for collateral -- which may be cash, securities, or letters of credit and simultaneously agree to return the collateral for the same securities in the future. Income is generated when the government "lender" invests the cash received as collateral and the returns on the invested collateral exceed the "rebate" due to the borrowers of the securities. When securities or letters of credit are the collateral, the borrower typically will pay the lender a loan premium or fee for the securities loan.
The authoritative accounting and financial reporting guidance for securities lending transactions is found in the Governmental Accounting Standards Boards (GASB) Statement No. 28, Accounting and Financial Reporting for Securities Lending Transactions. GASB Statement No. 28 requires that government-lenders report an asset and a liability in connection with securities lending transactions when these transactions are collateralized with cash or with securities that may be pledged or sold without a default by the broker-dealer.
GFOA believes that assets, liabilities, income and expenses related to securities lending transactions should be reported in the financial statements in the manner that best reflects the true nature of these transactions, consistent with the provisions of GASB Statement No. 28. Specifically, the GFOA recommends the following presentation of securities lending transactions on the statement of position and the statement of activities:
- Cash received as collateral in connection with securities lending transactions should be reported separately from other cash and short-term investments. This treatment avoids creating the potentially misleading impression that a significant percentage of a portfolios total assets may not be fully invested.
- Securities lending income and related expenses (i.e., borrower rebates and management fees) should be reported together rather than divided between investment income and investment expense. For pension plans, income and expenses related to securities lending activities should be reported as a separate component of total net investment income, immediately following net income from all other types of investing activities on the statement of changes in plan net assets. An illustration of this approach for pension plans can be found in Exhibit 1, which accompanies this best practice.
Exhibit 1 - Alternative Presentation of Statement of Changes in Plan Net Assets
XYZ Retirement System
Statement of Changes
Year Ended June 30, 20XX
State contributions 137,555,388
Member purchase of service credit 726,527
State reimbursement of non-funded Benefits 9,907,505
Employer contributions service transfers 135,598
Total contributions 148,325,018
From investment activities
Net appreciation in fair value of investments 333,040,768
Dividends 44,711,334 '
Real estate operating income, net 4,605,881 Venture capital income 9,045,261 459,211,836 Investment activity expenses: Investment management fees (4,518,692) Investment consulting fees (150,000) Investment custodial fees (441,889) Total investment expenses (5,110,581) Net income from investing activities 454,101,255 From securities lending activities Securities lending income 10,047,888 Securities lending expenses: Borrower rebates (8,672,110) Management fees (399,472) Total securities lending activities expenses (9,071,582) Net Income from securities lending activities 976,306 Total net investment income 455,077,561 Miscellaneous income 9,152 Total additions 603,411,731 Deductions Benefits 126,168,796 Service transfer payments 30,327 Administrative expense 3,229,541 Legal settlement expense 23,148,000 Total deductions 152,576,664 Net increase 450,835,067 Beginning of year 2,794,632,453 End of year $ 3,245,467,520
This advisory was previously titled Presenting Securities Lending Transactions in Financial Statements.