Collateralizing Your Deposits with
Municipal Letters of Credit
NYS GFOA 36th Annual Conference
March 27, 2015
©FEDERAL
2015 FEDERAL
HOMEBANK
LOANOF
BANK
NEW YORK • 101 PARK AVENUE • NEW YORK, NY 10178 • WWW.FHLBNY.COM
HOME LOAN
NEWOF
YORK
Today’s Agenda
» The Federal Home Loan Bank System
» Current Practices for Collateralizing New York State and
Local Municipal Deposits
» Inherent Problems with the Current Practice
» Letters of Credit (L/Cs)
» Uses for L/Cs
» New York State Law Regarding L/Cs
» Federal Home Loan Bank off New York’s (FHLBNY)
(
)
Municipal Letter of Credit (MULOC) Program
FEDERAL HOME LOAN BANK OF NEW YORK
2
The Federal Home Loan Bank System
FHLBNY SECOND DISTRICT
BOSTON
SEATTLE
DES MOINES
NEW YORK
NEW YORK
NEW JERSEY
PITTSBURGH
CHICAGO
SAN FRANCISCO
TOPEKA
CINCINNATI
ATLANTA
DALLAS
PUERTO RICO
U.S. VIRGIN ISLANDS
» Government Sponsored Enterprise (GSE) created by Congress in 1932 as a result of the Great Depression and its
effects on the housing market
» Primary business is extending credit to banks, thrifts, credit unions and insurance companies
» 12 Federal Home Loan Banks across the United States all registered with the SEC and regulated by the Federal
Housing Finance Agency (FHFA)
» Each Federal Home Loan Bank is an independent cooperative, owned by its members, who purchase stock in the
Federal Home Loan Bank
» The total membership as December 31,
31 2014 was 7,359
7 359 institutions
» The total Advances to members systemwide as of December 31, 2014 was $556 billion
FEDERAL HOME LOAN BANK OF NEW YORK
3
The Federal Home Loan Bank of New York
Our Mission:
To advance housing opportunity and local community
development by maximizing the capacity of community-based
member-lenders to serve their markets.
» 332 member institutions include commercial banks, thrifts, credit
unions, insurance companies, and community development
financial institutions (CDFI) in New York
York, New Jersey,
Jersey Puerto Rico,
Rico and
the U.S. Virgin Islands*
» $132.8 billion in assets*
» $97.2
$
billion dollars in advances *
» Triple-A counterparty credit rating
*As of 4Q2014
FEDERAL HOME LOAN BANK OF NEW YORK
4
Benefits of FHLBNY Membership
» Reliable low-cost funding source to help meet the liquidity needs of
our members
» Variety of types of advances with flexible terms to meet different
funding needs and to enhance interest rate risk management
» Triple-A-rated Letters of Credit to secure various obligations, such as
public-sector deposits
» Community Lending
g and Housing
g Grant Programs
g
to strengthen
g
communities
» Innovative mortgage purchase programs to improve our members’
competitive position
FEDERAL HOME LOAN BANK OF NEW YORK
5
State and Municipal Deposits of FHLBNY Members
2004–2014
$35
$25
Billions
Municipal De
eposit + Preferre
ed Deposits
$30
$20
$15
$10
$5
$0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Data through 4Q2014
Note: Analysis includes Citibank and HSBC Bank USA, NA
FEDERAL HOME LOAN BANK OF NEW YORK
6
Current Practices for Collateralizing NY State and
Local Municipal Deposits
» Eligible securities are pledged as collateral for municipal deposits
byy the depository
p
y bank
» Specific types of security collateral (typically Treasuries or Agency
securities) are often required by the municipality
» Pledged securities are held by a custodial bank or trust company
as agent of and custodian for the municipality
» The custodial bank is required to provide frequent and detailed
reports to the municipality on the collateral
» Default by the depository bank enables the municipality
to exercise its right to the pledged collateral
FEDERAL HOME LOAN BANK OF NEW YORK
7
Inherent Problems with the Current Practice
»
In case of default, it could prove difficult and time
consuming for the municipality to exercise its right to security
collateral
»
The reporting process is operationally inefficient for all parties
»
Collateralizing municipal deposits with security collateral can
be expensive for the depository bank - which the municipality
may “pay
pay for
for” in the form of lower deposit rates
»
Difficult for many banks to find enough eligible securities to
meet the demands of the municipalities
FEDERAL HOME LOAN BANK OF NEW YORK
8
Letters of Credit (L/Cs)
A credit instrument issued by a financial institution
promising/guaranteeing payment on behalf of its customer
to a beneficiary,
beneficiary normally to a third party but sometimes to
the bank’s customer, for a stated period of time and when
certain conditions are met, e.g. a promise to pay.
» An L/C substitutes the issuing bank’s credit for the credit of another party
» The issuing bank’s creditworthiness and credit rating is a critical factor for the
third party in the transaction
» Municipal L/C (MULOC): Used to collateralized city, state, court, municipal,
business development district and NYS community development program
deposits
» Refundable MULOC: Similar to the MULOC, but it is more flexible and is
used for fluctuating transactional deposit accounts (offers a potential
refund
f d off fees)
f
)
FEDERAL HOME LOAN BANK OF NEW YORK
9
FHLBNY MULOCs are Triple-A-Rated
What Does Triple-A-Rated Mean?
» AAA is the highest
g
rating
g and signifies
g
an extremelyy strong
g capacity
p
y to meet financial
commitments with minimal credit risk
» “... Aaa-rated is judged to be the best quality and carry the smallest degree of investment risk”
-Moody’s Investors Service
H
How
tto Become
B
TTriple-A
i l AR
Rated
t d
The information required by the rating agencies varies, but generally includes information regarding:
» Demographics
» Debt burden
» Economic base
» Finances
» Management structure
Ti l AR
Triple-A
Rating
ti
Gives
Gi
Us
U the
th Ability
Abilit to:
t
» Raise funds in the Capital Markets at a cost slightly higher than the U.S. Treasury
» The relatively low interest rates on FHLBNY debt enable the FHLBanks to provide advances, or loans
o members,
e be s, a
at a
all-in cos
costss that
a are
a e generally
ge e a y lower
o e than
a other
o e funding
u d g sources
sou ces
to
FEDERAL HOME LOAN BANK OF NEW YORK
10
Uses for L/Cs
Practically any type of financial transaction, including:
» Import/Export Transactions
» Lease Agreements
» Interest Rate Swaps
» Mortgage Revenue Bonds
» Community Development Bonds
» Construction Bonds
» Credit Enhancements for Community Investment Programs
» Low-Cost Housing
g
» Construction Funding
» Taxable Bond Issues
» Municipal and State Deposits
FEDERAL HOME LOAN BANK OF NEW YORK
11
Types of FHLBNY L/Cs
IRREVOCABLE
Cannot be cancelled before a specific
date without the agreement of all
parties involved.
STAND-BY
A contingent (future) obligation of the
issuing bank to make payment to the
designated beneficiary if its bank
customer fails to perform as called for
under the terms of the contract.
FEDERAL HOME LOAN BANK OF NEW YORK
Municipal Letter of Credit
((MULOC))
12
MULOCs – An Alternative Form of Collateral
» Municipal Letters of Credit (MULOCs) provide an attractive alternative
to using traditional security collateral
» MULOCs are operationally efficient for both the municipality and the
member bank – MULOCs eliminate the need to monitor security
collateral
» MULOCs are considered eligible collateral by the State of New York,
are widely accepted by municipalities, are operationally efficient
and provide an immediate payout in the event of default
» No cost to the municipality
» More cost efficient for member bank
FEDERAL HOME LOAN BANK OF NEW YORK
13
MULOCs - Eligible Under New York State Law
2001 New York Senate Bill No. 7160,
New York 225th Annual Legislative Session
O t b 2,
October
2 2002
General Municipal Law 10(3) (C) (ii) now provides as follows:
“In
In lieu of or in addition to the deposit of eligible securities
securities, the officers
making a deposit may, in the case of an irrevocable letter of credit
issued in favor of the local government by a Federal Home Loan
Bank, whose commercial paper and other unsecured short
short-term
term
debt obligations are rated in the highest rating category by at least
one nationally recognized statistical rating organization, accept such
letter of credit payable to such local government for the payment of
one hundred percent of the aggregate amount of public deposits
from such local officers agreed upon interest, if any.”
FEDERAL HOME LOAN BANK OF NEW YORK
14
MULOC Process
Municipality
Guarantees payment on
member’s behalf
Contract
MULOC
FHLBNY
Member
FEDERAL HOME LOAN BANK OF NEW YORK
Request that an L/C is issued
on their behalf
FHLBNY
15
Benefits of the FHLBNY MULOC
Benefits to Municipality
Benefits to Members
» Safety of a triple
triple-A-rated
A rated L/C
» Alternate form of collateral
» No cost to municipality
» Ability to pledge securities
elsewhere
» Easy to use
» Operationally efficient
» Immediate payment to a
municipal beneficiary if drawn
upon
» Approved
pp
byy the state of
New York
» Increase earnings of investment
portfolio
» Eliminates the need to match
securities and monitor calls
» Decrease operational expense
» Low cost
Please visit www.fhlbny.com/lc for more information
FEDERAL HOME LOAN BANK OF NEW YORK
16
Growth of MULOC Program
MULOC Commitments Issued
$100
60
$ Amount Issued
# of Members
$90
50
$80
Billions
40
$60
$50
30
$40
Numb
ber of Members
$70
20
$30
$20
10
$10
$0
0
2008
2009
2010
2011
2012
2013
2014
2015YTD
Data through 2/28/2015
FEDERAL HOME LOAN BANK OF NEW YORK
17
How Does a Municipality Request a FHLBNY MULOC?
» Only members of the FHLBNY can request a MULOC, so you must
work with your depository bank
» Ask your bank if they are a member of the FHLBNY. With 332 FHLBNY
members, it’s a good chance that your current bank is a member
» The FHLBNY is available for joint meetings to further discuss the
MULOC program
» Call or e-mail me at ((212)) 441-6838 or Thomas.Settino@fhlbny.com
FEDERAL HOME LOAN BANK OF NEW YORK
18
Municipal Education
» Spread the awareness of MULOCs
» Advertisements in municipal trade publications
» Breakfast / lunch seminars for discussion
FEDERAL HOME LOAN BANK OF NEW YORK
19
Advancing Housing and Community Growth
Thomas Settino
Vice President,
President Director
Sales and Business Development
(212) 441-6838
thomas.settino@fhlbny.com
The information provided by the Federal Home Loan Bank of New York (FHLBNY) in this communications is set forth for informational purposes only. The
information should not be construed as an opinion, recommendation or solicitation regarding the use of any financial strategy and/or the purchase or sale
of any financial instrument. All customers are advised to conduct their own independent due diligence before making any financial decisions. Please note
that the past performance of any HLB service or product should not be viewed as a guarantee of future results. Also, the information presented here and/or
the services or products provided by the FHLBNY may change at any time without notice.
101
FEDERAL HOME LOAN BANK
OFPARK
NEWAVENUE
YORK • NEW YORK, NY 10178 • WWW.FHLBNY.COM
Protecting Public Funds
FDIC Insurance Coverage in 2015
Collateral Considerations & Alternatives
NYS GFOA 2015 Annual Conference
Jim McGlynn, PCB
Four Factors…
• Legality –NYS GML Sec. 10 &11
• Safety – FDIC, business partners, collateral quality
• Liquidity – meet cash flow needs
• Yield – rate
You must understand the risks and potential rewards associated with the investment options being considered.
Historical 6-Month CD Rates - Daily Chart
FDIC Insurance Coverage
• Up to $250,000 for the combined
amount of all time and savings accounts
(including NOW accounts) and
• Up to $250,000 for all demand deposit
accounts (interest-bearing and noninterest-bearing).
FDIC Insurance Example
8 accounts with a local bank.
3 accounts are NIBTA with balances of $1,250,000 and
5 accounts are time and savings accounts with balances of $5,000,000.
How much FDIC coverage does the Treasurer have and what is the excess over FDIC?
Amount
Amount
Total of Transaction
Acct’s
$1,250,000
Total of Time &
Savings Acct’s
$5,000,000
2012 FDIC Coverage
Unlimited
FDIC Coverage
$250,000
Amount in excess of
FDIC coverage
$0
Amount in excess of
FDIC coverage
$4,750,000
2013 FDIC Coverage
$250,000
FDIC Coverage
$250,000
Amount to be secured
by collateral
$1,000,000
Amount to be secured
by collateral
$4,750,000
Reciprocal Public Deposits
Signed into Law July 2012
Allows New York public agencies to invest their funds using insured reciprocal deposits. Investments must initially be made at or through a bank located in or authorized to do business in the state of New York.
Local Government Deposits $1,000,000 in Participating Bank
Third Party Processor
$800,000
$1,000,000
Bank of Deposit
$200,000
$200,000
Local Government
$200,000
$200,000
$200,000
Financial Institution D
Financial Institution A
Financial Institution B
Financial Institution C
A Sample Provider – Promontory (CDARS)
• Created by former Comptroller of the Currency to create a level playing field with banks “too large to fail”.
• Can provide F.D.I.C. coverage up to $80 million dollars
• Only uses banks that are highly‐rated for safety & soundness
• All receipts, tax filings and written communications are provided through your local depository bank
• Ends the task of splitting investments among numerous banks to achieve the F.D.I.C. coverage
PROS & CONS
PROS:
• An accepted alternative to deposit collateralization
• May provide higher investment rates
• Assures safety of municipal deposits with Federal Government backing
CONS:
• Only investible once weekly*
• Cannot break CDs early*
• Rates may not be higher
* Overnights also available
The Bottom Line is…
• Consider using Reciprocal Public Deposits when they bring you higher investment rates
• Amend your investment policy to include such alternatives as Reciprocal Public Deposits and Letters of Credit to secure your deposits
• Recognize that some banks may not offer additional securities as deposit collateral since collateral securities are finite
Local Governments Investing in Debt of Other NYS Local Governments
• Investment Alternative is Gaining Popularity
• Must Fall Within Governments Investment Policy
• Requires OSC Approval
• Short term RANs & TANs only
• Negotiated Rate
• May be Counted as “Shared Service Savings”
Investing in Local Gov’t. Debt
• Although there is no credit rating requirement, government unit should have an Investment Grade rating
• Recommend only investing with local municipalities with whom you are comfortable • Be aware of the extended preparation period required due to required OSC approval
Repurchase Agreements
• Technically not a deposit, but a sale/resale of securities
• Not F.D.I.C. insured
• Requires a third party custodian
• Short‐term (overnight) investments usually offer documentation AFTER the transaction
• WARNING: municipal losses with these instruments initiated the 3rd‐party custodian movement
General Municipal Law (GML)
• Section 10 requires the designation of one or more “banks” or “trust companies” for deposit of public funds and for the securing of public deposits not covered by FDIC. • Section 11 allows for certain temporary investment of moneys not required for immediate expenditure. • Section 39 requires the adoption, by resolution, of an investment policy. • Articles 3‐A and 5‐G govern generally the temporary investment of moneys by more than one municipal corporation pursuant to a municipal cooperation agreement.
Credit Worthiness of Financial Institutions
FACTORS TO CONSIDER:
• Financial information from the bank
 Municipalities should require the depository financial institution(s) to provide a copy of their annual reports.
 A financial institution’s strength include its Capital Ratio, Return on Assets (ROA), and Return on Equity (ROE).
•
Oversight or regulatory constraints on the institution
•
Creditworthiness of institution (As reported by an independent rating agency)
 recommended you use an independent bank agency rating report. A commonly utilized resource for bank information is Bauer Financial (www.bauerfinancial.com).  You can access a list of rating agencies from www.FDIC.gov. Most of these reports are inexpensive to obtain.
 Other potential financial information can be found on your bank’s website, usually under investor relations or via search engines.
Credit Worthiness of Financial Institutions (cont.)
•
Reputation of institution
•
Local government’s familiarity with the institution.
Local governments may request their depositaries to provide their most recent Consolidated Report of Condition (call report), or may find copies of those reports on the Web at https://cdr.ffiec.gov/public/. Call reports contain financial information on bank and trust company revenues, expenses, and balance sheet positions. Collateral Options
Pledge of Eligible Securities ‐ Eligible securities pledged to secure local government deposits and investments must have an aggregate market value at least equal to the total amount of excess public deposits and investments under the control of the chief fiscal officer or other officers authorized to make deposits and investments.
A pledge of a pro‐rata portion of a pool of eligible securities – a pool of securities having in aggregate a market value at least equal to the total amount of the public deposits and investments.
An eligible surety bond – must be executed by an insurance company authorized to do business in New York State, the claims paying ability of which is rated in the highest rating category by at least two nationally recognized statistical rating organizations. The bond must be payable to the local government as security for the payment of 100% of the aggregate amount of public deposits and investments from the local government and agreed‐upon interest, if any.
An eligible letter of credit – for the payment of 140% of the aggregate amount of public deposits and investments from the local government and agreed‐upon interest, if any.
An irrevocable letter of credit issued by certain federal home loan banks – issued by a federal home loan bank whose commercial paper and other unsecured short‐term debt obligation are rated in the highest category by at least one nationally recognized statistical rating organization, for the payment of 100% of the aggregate amount of public deposits and investments from the local government and agreed‐upon interest, if any.
Eligible Securities
i) Obligations issued by the United States of America, an agency thereof or a United States government sponsored corporation or obligations fully insured or guaranteed as to the payment of principal and interest by the United States of America, an agency thereof or a United States government sponsored corporation.
(ii) Obligations issued or fully guaranteed by the International Bank for Reconstruction and Development, the Inter‐American Development Bank, the Asian Development Bank, and the African Development Bank.
(iii) Obligations partially insured or guaranteed by any agency of the United States of America, at a proportion of the market value of the obligation that represents the amount of the insurance or guaranty.
(iv) Obligations issued or fully insured or guaranteed by this state, obligations issued by a municipal corporation, school district or district corporation of this state or obligations of any public benefit corporation which under a specific state statute may be accepted as security for deposit of public monies.
(v) Obligations issued by states (other than this state) of the United States rated in one of the three highest rating categories by at least one nationally recognized statistical rating organization.
vi) Obligations of Puerto Rico rated in one of the three highest rating categories by at least one nationally recognized statistical rating organization.
(vii) Obligations of counties, cities and other governmental entities of another state having the power to levy taxes that are backed by the full faith and credit of such governmental entity and rated in one of the three highest rating categories by at least one nationally recognized statistical rating organization.
(viii) Obligations of domestic corporations rated in one of the two highest rating categories by at least one nationally recognized statistical rating organization.
(ix) Any mortgage related securities, as defined in the Securities Exchange Act of 1934, as amended, which may be purchased by
banks under the limitations established by federal bank regulatory agencies.
(x) Commercial paper and bankers' acceptances issued by a bank (other than the bank with which the money is being deposited or invested) rated in the highest short‐term category by at least one nationally recognized statistical rating organization and having maturities of not longer than sixty days from the date they are pledged.
(xi) Zero‐coupon obligations of the United States government marketed as "Treasury STRIPS".
Investment Policy
• Adopt and update a written investment policy
– Annual review/approval by board
– Compliant with GML
• Local Government Investment Policy must address:
– Standards for Qualifications of business partners such as creditworthiness, institutional experience and depth, capitalization, size.
– Collateral Agreements executed and on file, and procedures for monitoring, controlling and retaining collateral.
– Standards for acceptable Investments and Collateral.
– Permitted types of authorized investments, and diversification by type of investment and firms with whom you are dealing.
• See GFOA Sample Investment Policy
Closing Tips
• Know the financial institutions with whom you are dealing, including their safety & soundness rating
• Keep up‐to‐date on F.D.I.C. and collateral coverage of your deposits, including alternatives
• Keep your investment policy up‐to‐date, including new collateral alternatives
• Understand all investment vehicles before using them for investments
• Make sure you stay within the law & OSC guidelines
References
•
New York State General Municipal Law. Section 10 (Deposits of Public Money)
•
New York State General Municipal Law. Section 11 (Temporary Investments)
•
Office of the New York State Comptroller.
Local Government Management Guide: Investing & Protecting Public Funds. Jan. 2011
•
FDIC – www.fdic.gov/edie/fdic_info
•
GFOA ‐ A Best Practices Guide to Cash Management in New York State
(2nd Edition) 2007
QUESTIONS?
If any of your questions that were not answered, please
feel free to contact the GFOA or today’s presenter:

Jim McGlynn, VP, Pioneer Commercial Bank
21 2nd St., Troy, NY 12180
PH#518-687-5119 fax518-273-7801 mcglynnj@pioneerbanking.com
THANK YOU!