Industry Publications

Fall 2008

Adam Goldstein, VP & Director of Sales & Marketing

Collateralize Municipal Deposits with Letters of Credit issued by the Federal Home Loan Bank of New York

This article appeared in the:
New York State GFOA - New York GFOA Newsletter
Association of Towns of the State of New York - Talk of the Towns & Topics Publication
New York State Association of Counties - NYSAC News
IBANYS - Community Bank Notes

When depositing a significant amount of money into a financial institution, municipalities require their municipal deposits to be secured. Usually, a financial institution will post a number of its securities to collateralize the municipal deposit. While this is a sufficient form of collateral, it can be burdensome for both the municipality and its financial institution when a municipality needs to liquidate the security. With securities pledged as collateral, a default, albeit unlikely, will trigger a liquidation process. This process may hinder the promptness of the payout to the municipality, as the securities need to be sold in the open market. Fortunately, there is an alternate way to secure municipal deposits in a safe and legal manner that is operationally efficient for all parties, providing municipalities with a prompt payout for the full dollar amount of the deposit in the unlikely event of a draw. Now, under New York State law, commercial banks, and savings and loans or savings banks that are approved to have branches in New York State Banking Development Districts, may utilize a Federal Home Loan Bank (“HLB”) Letter of Credit (“L/C”) as eligible collateral. Listed below is a timeframe of important events affecting the HLB L/C, which has helped make it the widely accepted way to collateralize municipal deposits today.

  • October 2002:  New York - General Municipal Law § 10(3)(c) was amended to allow an HLB L/C to be accepted as collateral at 100% of a municipality’s public deposits, rather than the 140% required for other letters of credit
  • April 2004:  New York City begins to use the HLB’s L/C as collateral for city deposits
  • November 2004:  The HLB expanded the terms of the municipal L/C program from 2 weeks to 3 years to offer HLB members additional flexibility in the program
  • July 2005:  New York Law 2005, chap. 345, § 2, eff. July 26, 2005 amended State Finance Law § 105(2)(b) to clarify and ensure that irrevocable letters of credit issued by a Federal Home Loan Bank may be used as collateral for state deposits
  • March 2006:  Although the Banking Development District Program was created in 1998, it wasn’t until 2006 that the program took off. The numbers of BDDs began to increase, as did the use of HLB L/Cs to collateralize State and City funds
  • July 2006:  New York State Office of the State Comptroller released an opinion statement supporting HLB L/Cs

The HLB’s L/C is an undertaking guaranteeing payment on behalf of its customer (HLB’s member) to a beneficiary, (the municipality), for a stated period of time and under certain conditions.  The institution can use an L/C in lieu of securities as collateral.  The financial institution can obtain an L/C from a wholesale lender, such as the HLB.  The HLB can issue an L/C on behalf of its member bank, substituting the credit standing and capital market access of the HLB for that of its member.  On the day of the transaction, the municipality receives a one page L/C via fax, followed by the original by overnight mail.  In the unlikely event that the municipality’s bank defaults on its commitment, the municipality can submit the draw request to the HLB for prompt payment.

The HLB issues two types of L/Cs on behalf of its members to effectively collateralize municipal deposits:  an Irrevocable Standby L/C and an Irrevocable Direct Pay L/C.  The Irrevocable Standby L/C provides that the HLB will pay a draw request to the beneficiary, when the beneficiary certifies there has been non-performance with respect to an underlying transaction.  The Irrevocable Direct Pay L/C permits the beneficiary to look directly to the HLB for satisfaction of the member’s obligation.  Since the HLB’s L/Cs are legally accepted as eligible collateral, holding an “AAA” credit rating, both types of L/Cs are widely accepted.   

HLB L/Cs are recognized by both its members and municipalities as a very attractive way to collateralize municipal deposits.  Peter Gioffe, Vice President/Cashier of member lender Delaware National Bank of Delhi, New York, commented: “The utilization of HLB's Municipal Letters of Credit has allowed us to maintain the proper level of collateral on our municipal depositors with ease and efficiency.”  This method of collateralization can be more efficient because collateralizing with securities can be often costly for member institutions due to the operational expense of tracking and monitoring the security.  Municipalities especially find HLB L/Cs appealing because, unlike securities, the value of an L/C remains constant and does not change with market fluctuations.  Accepting L/Cs as collateral poses no additional cost to the municipal depositor, since the HLB member institution pays for the L/C. 

If you would like additional information on the HLB System, L/Cs, and the benefits they offer you, contact Adam Goldstein, Senior Vice President, Head of Sales and Marketing, at (212) 441-6703. 

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