TD Investment Advisor, Clark Carson, explains how to work with corporation Reserve Funds in accordance with the restrictions laid out in the Condominium Act, invest in higher yielding GICs & stepper GICs, & work alongside the Reserve Fund Study to ensure that funds are available as projects are targeted for completion.
In its recent quarterly “Monetary Policy Report”, released January 21, 2015, the Bank of Canada surprised investors by cutting its overnight interest rate to 0.75% from 1%- a level previously untouched since September 2010. This resulted in an immediate drop in interest rates earned on Guaranteed Investment Certificates (GICs) and led to lower yields on government bonds trading in the marketplace. Immediately, investors and borrowers alike began to ponder the implications of this latest move by our central bankers.
Corporations, non-profit organizations and individual investors alike were forced once more to look closely at their bank balances and investment statements to determine what action, if any, they could take to enhance the returns on their cash balances. Condominium corporation finance officers have witnessed a steady decline in interest rates over several years and those corporations that have historically maintained large Reserve Fund balances at banks and trust companies are yet again faced with the challenge of how they can do a better job investing on behalf of their fellow owners. These are some of the issues faced by those individuals responsible for ensuring that Reserve Fund balances are conservatively invested to meet the forecast capital requirements of the corporation.
When it comes to Reserve Fund investment options, the officers of a condominium corporation are required to adhere to strict requirements as outlined in the Condominium Act, 1998 (and subsequent amendments to the act that have broadened the options available to condo corporation investment professionals). Section 93 of the Act requires the establishment and maintenance of a Reserve Fund and makes it mandatory that the Reserve Fund be maintained in a segregated fund. Condominium unit holders must contribute monthly towards the Reserve Fund in the proportions which are set out in the condominium declaration to a minimum of 10% of the condo’s operating budget. Additionally, the condominium corporation must complete a Reserve Fund Study performed by qualified persons within a stipulated period of time to determine future capital cost requirements. Next, it is up to the officers of the condominium to develop a plan to ensure that the corporation’s Reserve Fund assets are sufficient to meet the anticipated Reserve Fund requirements. The professional Reserve Fund Study is referred to as the Notice of Future Funding (formally a Form 15). As well, the Condominium Act prohibits the use of Reserve Funds for anything other than major repairs and replacement of common elements and assets.
Assuming the Reserve Fund Study has been completed and the officers are comfortable with the adequacy of the fund within three years of the first Reserve Fund Study, the next major decision they will face, as cash balances begin to build, will be what to do with the Reserve Fund account. In the case of larger condominium corporations, Reserve Funds can grow to a significant size ($1 Million+) and the interest earned on the investments can be quite substantial.
The condo corporation will typically maintain one or more bank accounts designated as general accounts and at least one Reserve Fund account. These accounts can be maintained at a bank listed under Schedule I or II of the Bank Act (Canada): a trust corporation, a loan corporation, or a credit union authorized to receive money on deposit. The types of investments held within the Reserve Fund are considered “eligible securities” and this means a bond, debenture, guaranteed investment certificate, deposit receipt, deposit note, certificate of deposit, term deposit or similar instruments, provided that these instruments are:
a) Issued or guaranteed by the government of Canada or the government of any province of Canada, or
b) issued by an institution located in Ontario, insured by the Canada Deposit Insurance Corporation (CDIC) or the Deposit Insurance Corporation of Ontario (DICO), or Eligible securities can be held within a brokerage account provided it is a member of the Canadian Investment Dealers Association and is insured by the Canadian Investor Protection Fund.
c) A security of a prescribed class, 1998, (as prescribed by the regulations made under the Act).
Financial advisors with condominium investment experience should be aware of what constitutes an eligible security under the Act and could provide some options to condominium corporation officials to help to achieve higher yields on the Reserve Fund assets.
Before investing any part of the money in the corporation’s Reserve Fund accounts, the board shall develop an investment plan based on the anticipated cash requirements of the Reserve Fund as set out in the most recent Reserve Fund Study.
The board may invest all or part of the money in the Reserve Fund accounts in eligible securities if they are:
a) Registered in the name of the corporation; and
b) Held in a segregated account under the name of the corporation by a member of the Canadian Investment Dealers Association and insured by the Canadian Investor Protection Fund.
What are some Investment Options?
Given the current low interest rate environment, the corporation’s officers have somewhat limited options available to them at this time concerning how to best invest Reserve Fund balances. With typical bank and trust company deposit rates paying only 0.10% on credit balances in the $50,000 to $100,000 range, there may be some alternatives worth exploring. One option would be to construct a “fixed income ladder” made up of provincial and federal government bonds or GICs issued by eligible entities.
If the corporation does not currently need to keep 100% of the Reserve Funds in cash or near cash, there could be a benefit to staggering a number of equal weighted amounts (i.e. multiples of $50,000 to $100,000 over a three to five year time frame). Instead of simply earning say, 0.10% interest, the corporation could potentially earn anywhere from 1.5% on a one-year term to 2.50% for a five-year term, thereby achieving a higher overall “weighted average” investment yield. Another option could be to purchase “step-up” deposit notes, which offer a higher interest rate during each successive year of the investment- for example running over a three to five year total term. The benefit of the step-up note(s) would be to achieve a higher return than simply leaving the cash in short-term deposits. In the event that interest rates are higher when the first notes mature, the condo corporation could then reinvest at a higher rate of interest. The step-up notes would be issued by a major financial institution and would be guaranteed under CDIC Insurance.
The big question for conservative individuals and corporate investors alike over the past few years has been, when will interest rates reverse the downward trend we have witnessed over several years and actually start to rise again. By splitting the investment capital over a period of a few years, any potential capital requirements as outlined in the Reserve Fund Study can be matched by expected maturities within the “fixed income ladder” to ensure that the funds will be available when needed.
By working closely with your financial institution, those given the responsibility of better managing the condominium Reserve Fund balances can develop a customized investment program to meet the condominium’s anticipated capital requirements. This provides an excellent opportunity to make the Reserve Funds work harder for the unit holders than would be the case by simply leaving all funds on deposit and invested entirely in daily interest vehicles, or very short-term guaranteed investments, as no one can predict with certainty when the long awaited increase in interest rates will get under way.