Boards of directors are required to exercise prudent fiscal management in maintaining the integrity of the reserve account. (Civ. Code § 5515.) HOA funds accepted or received by a managing agent (as defined in Civ. Code § 4158) must be deposited in accounts that protect the principal and covered by insurance provided by an agency of the federal government or a guaranty corporation. In no event may those HOA funds accepted or received by a managing agent be invested in stocks or high-risk investment options. (Civ. Code § 5380.)
Managing Agents. Managing agents who receive HOA funds must deposit them (i) into an escrow account with a bank, savings association, or credit union or into an account under the control of the association, (ii) into a trust fund account maintained by the managing agent in a bank, savings association, or credit union in this state. All funds deposited by the managing agent in the trust fund account shall be kept in this state in a financial institution insured by the federal government or is a guaranty corporation, and shall be maintained there until disbursed in accordance with written instructions from the association entitled to the funds. (Civ. Code § 5380(a).) The managing agent cannot commingle the funds of the association with the managing agent’s own money or with the money of others. (Civ. Code § 5380(d).)
Investment Strategy. Prudent investments of reserve monies should focus on the following parameters in their order of importance:
1. Safety. A board's primary goal should be the preservation of the association's reserves against loss. Sometimes an association's governing documents may limit investment opportunities by requiring that funds be kept in FDIC insured accounts. Following is a hierarchy of risk to the principal:
2. Liquidity. Liquidity refers to the ability to quickly convert investments into cash. If reserves are tied up on long-term investments, they will not be available in the event the association needs to (i) use funds for emergency repairs, (ii) borrow for short-term operating expenses or (iii) repair or replace large common area components that reach the end of their useful life earlier than expected. Accordingly, investing all of an association's reserves into a jumbo 3-year CD would not be prudent. A more prudent strategy is to invest in smaller CDs and stagger them to mature every six months.
3. Yield. Yield is the return received on an investment. Boards should seek a reasonable return on the association's reserve accounts but should never adopt a strategy that emphasizes return over preservation of capital (as occurred with Orange County in the 1990s and resulted in bankruptcy when the investments collapsed). Bank savings accounts may be too conservative due to their low rates of return. Using non-interest bearing accounts is viewed by some as mismanagement because the funds are not earning any income at all. The most common form of investment used by homeowner associations is the certificate of deposit.
Crime Insurance. As a further protection of the association's funds, the the association shall maintain crime insurance, employee dishonesty coverage, fidelity bond coverage, or their equivalent, for its directors, officers, and employees in an amount that is equal to or more than the combined amount of the reserves of the association and total assessments for three months. For more information, see Fidelity Bond - Crime Insurance.
Recommendation: Boards should consult with investment advisors familiar with Davis-Stirling requirements.
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