Standby Letters of Credit – A Low-Cost, High-Reward Solution for Procuring Public Deposits

last updated on Wednesday, May 13, 2020 in Letters of Credit

It’s no secret that the Federal Home Loan Bank of Des Moines is best known for its Advance products, but did you know we have a lesser known product that is helping our members lower on-balance sheet liquidity costs and attract public funds? We’re talking about Standby Letters of Credit (SBLOCs). If you’d like a detailed explanation of SBLOCs we would highly recommend this whitepaper. SBLOC’s that are written in favor of public depositors serve as excellent substitutes for other means of satisfying collateralization requirements, including pledging of marketable securities.

Here are the most common cases in which our members and their public depositors frequently conclude that SBLOC’s are an optimal vehicle for satisfying collateralization requirements:

The Forgotten Security Call

Historically, a financial institution has collateralized a public unit deposit with a pledge of callable agency securities. A member subsequently receives notification that the callable bond will be called in five days, the next scheduled call date.

The SBLOC Solution

The member could replace part or all of its securities pledging program with a letter of credit program. Requiring far less monitoring, and eliminating the risks associated with a security being called. All the better for preserving a good relationship with a public depositor.

A Strategic Review of Liquidity Coverage and Income

In the wake of declining margins and a regulatory discussion, a financial institution's management team would like to review means of improving liquidity and income. An increasing portion of public unit deposits is being pledged via securities.

The SBLOC Solution

The member’s management team could examine the positive implications associated with using low-cost letters of credit. By substituting pledged securities with letters of credit they would be able to improve liquidity ratios while freeing up capital to deploy towards higher yielding loans.

Diminishing Securities Availability for Collateralization

A member is sustaining strong loan growth and has been decreasing its securities portfolio in order to fund a portion of that growth. An increasing percentage of the securities position has already been pledged to multiple public unit depositors.

The SBLOC Solution

Instead of allowing liquidity constraints to stunt further loan growth, the member could procure a letter of credit. This solution would allow them to continue funding loan growth by accessing funds previously pledged as securities. The member could then turn around and pledge the growing amount of loans, if eligible, as collateral with FHLB Des Moines.

Decreasing Securities Eligibility

A member has historically supported a portfolio with a high percentage of agency mortgage-backed and callable agency securities. Interest rates have dropped and many of these securities have paid down quickly or have been called. As an alternative investment option, the member would like to purchase municipal securities (which are not typically accepted by public units as a form of collateralization).

The SBLOC Solution

The member could pursue its purchase of municipal securities by deploying a letter of credit program for its public unit deposits. This solution would also allow them to avoid the risk of further securities being paid-down or called.

The above scenarios illustrate how SBLOCs could be used to help your institution strengthen public deposit relationships and strengthen your on-balance sheet liquidity. The mechanics of our Standby Letter of Credit program is thoroughly detailed in this whitepaper, or feel free to reach out directly to your Relationship Manager.

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