by: Peter Santangelo, President at Wintrust Community Advantage

When I am attending Board meetings to discuss the associations finances I am asked consistently about the associations reserves.

Specifically do you think our reserves are adequate? Or how should we invest them?

I quickly respond do you have a reserve study? Most associations shy away from obtaining one because they do not want to spend the money to purchase one. However, a reserve study is an important tool for Boards that can help document and allocate what a reasonable amount is to have in reserves and also estimate how long a timeframe they have before the funds may be needed for the repair and replacement cost of the common elements of the property which the association is obligated to maintain. The Reserve study estimates the useful life and replacement cost of the common elements; however these repairs are not typically addressed until actually needed which may occur before or after the estimate of the study. This allows the association Board the option to extend the repair(s) if so desired. The reserve study may also bring to light necessary repairs that may have been neglected that can now be allocated into the reserve budget.   

The reserve study helps us work with the association in establishing a cash flow analysis chart on their reserve funds to determine an answer to their question. A cash flow analysis chart is a financial picture usually reflecting multiple years of activity showing how the association funds flow in and out of reserves. This reflects the ebb and flow of funds in the reserves also showing the estimated outflow for repair or replacement over multiple years which helps us determine if there is a shortfall during any one year in their reserve funds and can answer the question are my reserves adequate. Any shortfall during any one year would need to be addressed by asking can the repair be postponed or is it truly needed at the time designated. If the repair is needed an increase to the reserve contribution, special assessment, a loan or any combination of the three can be used to address the shortfall.

The cash flow chart will also assist in determining what excess funds the association will have in their reserve fund and when they will need the funds for

any estimated repair(s) and/or replacement of components of the association. Knowing this we can address the second question of how they should invest their reserve funds. We now can invest the associations excess funds based on when they will need to use them. The Association can have multiple investments with different maturity dates this is commonly known as “laddering”. Using a ladder approach can decrease interest rate risk and reinvestment risk. The association has a fiduciary responsibility and it is prudent for them to invest the reserves into an instrument that preserves the initial principal investment. So we recommend conservative investments like certificates of deposits (CD), U.S. Treasury funds (bills, notes or bonds) or brokered insured certificate of deposits depending on the amount being invested and maturity desired.  

I have heard some horror stories of Boards that have tried to maximize yield and ended up locking up their reserve funds in investments that tied up funds longer than expected and they were unable to break the investment when funds were needed. Or the cost to get out of the investment depleted the original principal investment. So it is extremely important for Boards to be prudent and fiscally responsibly when investing their reserve funds.

It is also important for an association to set a precedent for reserve investing. Creating a reserve fund investment policy can assist in guiding current board members and also provide continuity and direction for future boards. When drafting your reserve policy you should check your governing documents to see if you can invest in anything other than a basic safe vehicle that preserves your principal investment. A simple investment policy should be in the form of a resolution that is approved by the board encompassing some of the following items:

Purpose – statement of intent to establish procedural requirements and guidelines

Scope – will this discuss only reserve funds, short term reserves, long term reserves will operating funds be included?

Investment Objective – Preservation of principal, safety, liquidity, yield?

Delegation of Authority – suggest at least two officers to approve the transfer of funds or investment. Usually the Treasurer and President. Board should approve the investment.

Authorized Investments – list of what instruments each fund can be invested like FDIC insured certificates of deposits, FDIC insured money market accounts, etc…

Safekeeping and Custody – Who will be responsible for the safekeeping and review of the investments?

These are some key components of an investment policy which can be set forth with the guidance of your management company, banker or association attorney.  

All of these suggestions are not mandatory to follow however they do provide practical advice and direction for Board Members.