The state treasury earned $80.7 million in interest on its $4.5 billion investment portfolio in the fiscal year that ended June 30 -- a dip from $116.9 million in the previous fiscal year -- as interest rates declined, state Treasurer Dennis Milligan reported this week.
"We were able to navigate a changing investment environment, staffing changes and a global pandemic, all while maintaining a solid result for the state," Milligan told the state Board of Finance, chaired by Department of Finance and Administration Secretary Larry Walther.
Milligan, a Republican from Benton, said the finance department in June transferred $32 million of the treasury's interest earnings to the state's long-term reserve fund and $12.5 million to the budget stabilization fund.
The long-term reserve fund's current balance is $184.9 million, while the budget stabilization trust fund has $177.7 million, said Scott Hardin, a spokesman for the finance department.
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Fiscal 2020 is the first fiscal year in which the treasury's interest earnings have declined since Milligan took office in January 2015, according to his report to the Board of Finance.
The treasury's interest earnings had steadily increased from $22.3 million in fiscal 2015, in which Milligan was the treasurer for the last six months of that fiscal year, to $116.9 million in fiscal 2019. The previous high was $113.1 million in fiscal 2008, according to Milligan's office.
A year ago, the Board of Finance lowered its target rate of return for the treasury's investment portfolio from 2.5% in fiscal 2019 to 2% in fiscal 2020 at the recommendation of Walther, who said, "The market is changing."
The treasury's investment return in fiscal 2020 was 1.6%, said Milligan spokeswoman Stacy Peterson.
In the quarter that ended June 30, the treasury's interest earnings totaled $11.4 million -- the lowest amount since the earnings totaled $9.8 million in the second quarter of fiscal 2017 -- according to Milligan's report.
"Revenue from our investments in the fixed-income market had been on a downward trend prior to the covid pandemic due to an uneasy investment climate amid geo-political tensions worldwide," Milligan said. "Then covid hit. All of this created ... a 'perfect storm.' But even amid the upheaval of the market, my team was able to deliver results."
In the last quarter, the treasury's long-term investment portfolio earned $9.6 million and its short-term investment portfolio earned $1.7 million, according to Milligan's report.
The short-term portfolio's earnings are a reflection of the treasury's reactions to the covid-19 pandemic, Milligan said.
"When the virus hit the United States, we, along with staff at [the Department of Finance and Administration], made the prudent decision to liquidate our short-term holdings to ensure we had plenty of operating cash on hand for the state to continue functioning during what was an unpredictable time," he said.
"As our short-term holdings matured, we moved the money into several new money market funds and demand accounts in state banks, which were at lower interest rates in comparison to what we had been getting," Milligan said. "However, as the federal recovery packages started rolling out, banks became flooded with 'cheaper' cash and began expressing that they did not have a need for state money, nor would they be able to pay very much interest for it."
Regarding its long-term investment portfolio, Milligan said the treasury had been diversifying that portfolio throughout the year and, when possible, selling off the more heavily structured commercial-backed securities, and reinvesting in better-performing and better-structured securities as opportunities presented themselves.
"When interest rates drop as drastically as they did earlier this year, people take advantage of the opportunity to refinance their mortgages [and] when that happens -- and it did -- it affected earnings on our mortgage-backed securities, which as a reminder are backed by the federal government and make up over 40% of our total portfolio," he said.
With no interest rate increases on the horizon, Milligan said, he expects the interest earnings from the treasury's long-term investment portfolio to continue moving in a downward trend in the coming fiscal year.
"However, we continue to diversify and reinvest with safety as our top priority, and then yield," he said.
A year ago, two consultants hired by the treasurer's office told the finance board that the treasury issued between $600 million and $1.5 billion in commercial paper to two different single issues. The consultants recommended tighter investment restrictions that the board adopted.
The treasury's director of investments, Ed Garner, resigned effective Sept. 11, 2019, because he said it was time to pursue other financial opportunities, after Milligan declined to give him a pay raise in fiscal 2020. Garner is a former Republican state representative from Maumelle.
Garner's resignation came after Milligan hired a former investment analyst and strategist for Arizona's treasury, Martin Kelly, as the office's senior investment manager. Kelly started work on July 22, 2019, and then moved into a director-of-investment position.
In January, Milligan hired an investment portfolio manager in Illinois, Robert Romanik, to be the senior investment manager. He started work on Feb. 3.
Last month, Milligan's office announced that Kelly had unexpectedly died July 14. Peterson said Milligan's office hasn't started a search to fill Kelly's post yet.