'AAAm' Local Government Investment Pools

The 'AAAm' local government investment pool (LGIP) trends report shows metrics of U.S.-domiciled LGIPs that seek to maintain principal value ($1.00) and limit exposure to principal losses due to credit risk, as defined in S&P Global Ratings' principal stability fund ratings (PSFR) criteria. The LGIPs featured in this report all conform to our PSFR criteria, as shown in the affirmation of our 'AAAm' ratings during 2022. In our rating analysis, we place emphasis on the net asset value (NAV) per share, 'A-1+' credit quality, weighted average maturity to reset (WAM-R), weighted average maturity to final (WAM-F), net asset trends, and the underlying composition of LGIPs.

LGIPs are present in many U.S. states where, generally, the state treasurer oversees a pooled investment vehicle that operates in a similar way to a money market fund. Typically a cost-effective investment option, LGIPs allow municipalities and public entities to combine their idle cash and operating balances to obtain economies of scale, through a diversified range of investments, to earn an incremental rate of return. Unlike money market funds registered with the SEC (U.S. Securities and Exchange Commission), LGIPs are not regulated by the SEC and therefore not subject to SEC rule 2a-7. However, LGIPs typically benefit from the purview of state statutes, which provide guidelines on LGIPs' investment policy and objective, as well as from the standards and guidance of the Governmental Accounting Standards Board, where standard 79 allows the use of amortized cost to value an LGIP's portfolio assets.

Our LGIP metrics demonstrate the investment practices of 'AAAm' rated LGIPs and those conforming to our PSFR criteria. If an individual LGIP's metrics are below our benchmarks, this may indicate a more conservative approach to investment, while metrics well above our benchmarks may signal a more aggressive approach, albeit still within the range for a 'AAAm' PSFR.

Market Comment

U.S LGIPs' asset levels reached historical highs in the first quarter of 2023, accentuating the benefits of this investment product.   LGIPs with assets collectively exceeding $320 billion follow a prime or government strategy and are rated under our PSFR criteria. Asset flows generally follow cyclical patterns related to funding activities and tax receipts. Over the first quarter of 2023, rated LGIPs following a government strategy (government LGIPs) saw assets increase by 17.8%, while asset growth for rated prime LGIPs was 12.4%. Generally speaking, strong asset growth can be attributed to improving tax receipts and competitive returns over money market funds and bank deposits. In addition, LGIPs absorbed monies from participants receiving federal stimulus funds, a factor that has contributed to recent years' asset growth.

Chart 1

LGIP returns continued to rise in Q1 2023, making the funds more compelling in a rising interest rate environment.  Following several interest rate hikes by the U.S. Federal Reserve Bank (the Fed) during 2022, LGIP seven-day yields broke through the 4% barrier for the first time since the global financial crisis (see table 1). Following the 25 basis-point hike in March, government and prime LGIP seven-day yields continued to rise through the first quarter of 2023, inching closer to 5%. LGIPs now provide a rate of return that can compete with interest on bank deposits.

Table 1

Managers continued to mitigate price volatility with conservative management, providing a consistent NAV per share.  The NAV per share averaged 0.99972 in the first quarter of 2023, about 22 basis points higher than our lowest NAV threshold of 0.9975 for 'AAAm' PSFRs (see chart 2). We previously observed a decline in LGIP NAVs following the 75-basis-point hike in June, but they remain within the 'AAAm' threshold. Notably though, managers have followed a prudent investment focus, navigating the rapid interest rate moves with measures to reduce portfolio hazards and improve liquidity.

Chart 2

The Fed's interest rate policy steps remain at the forefront when it comes to formulating investment strategy. Recently, volatility in the banking sector and uncertainty regarding the debt ceiling have seen a continuation of high credit quality positioning and a moderate increase in weekly maturing assets. This was especially the case for government-focused LGIPs, which (on average) had 70% of their assets maturing weekly in March 2023, the highest recorded in the last two years. Prime LGIPs have been consistent, with 45% weekly liquidity, an improvement since the rate hikes.

Chart 3

Weighted average maturities, key indicators to interest rate risk, remained conservative in the first quarter of 2023.  The marked decline in 2022 (see table 2 and chart 4) can be attributed to fluctuations in global market conditions caused by geopolitical uncertainty, with the resulting dramatic rise in inflation prompting aggressive actions from the Fed. A further extension of weighted average maturities (WAMs) is likely following the expected rate hike. However, WAMs are unlikely to extend to pre-rate-hike levels due to economic uncertainty.

Table 2

Chart 4

Chart 5

In looking at 2023 and recognizing the nature of the underlying instruments in LGIP portfolios--generally high credit quality ('A-1' or higher; see table 3 and chart 6) government, agency, and bank investments--we cite some of the key takeaways from recent reports: "Singing The (Banking) Blues: Navigating The Current Volatility In The Banking Industry," March 27, 2023, on spglobal.com, and "Economic Outlook U.S. Q2 2023: Still Resilient, Downside Risks Rise," March 27, 2023, published on RatingsDirect.

• S&P Global's economists now expect full-year U.S. GDP growth at 0.7%, in contrast to the November 2022 forecast of a contraction of 0.1% in 2023.
• The collapse of Silicon Valley Bank in the first quarter, following a flight of deposits, led to a reassessment of market liquidity and attempts to manage contagion risks across the banking industry.
• Inflation likely peaked in the third quarter of 2022 and is expected to remain higher than historical levels on continued supply-chain disruptions in certain sectors.
• The federal funds rate is expected to peak at 5.00%-5.15% by May, but as prices begin to stabilize, the first interest rate cut could occur by mid-2024.

Table 3

Chart 6

Chart 7

Chart 8

Table 4

Related Research

• Credit Conditions North America Q2 2023: Coalescing Stresses, March 28, 2023
• Economic Outlook U.S. Q2 2023: Still Resilient, Downside Risks Rise, March 27, 2023
• Signing The (Banking) Blues: Navigating The Current Volatility In The Banking Industry, March 27, 2023
• Rapidly Rising Rates Are Putting Some Money Market Funds At Risk, July 22, 2022