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In the 1980s, the financial services industry shifted from using the asset side of the balance sheet to using the liability side to manage liquidity. In an earlier era, it was standard practice for bank treasury departments to hold treasuries or other readily saleable securities to cover unpredictable swings in cash flows.  

In discussions of liability-side liquidity management, a commonly heard phrase in the financial industry today is “just in time inventory” — a term originally used by industrial companies to describe maintaining minimal inventory to reduce stocking and reorder costs.  

In the financial industry, the term refers to the need to have enough inventory, or borrowing room, from the Federal Home Loan Bank of Boston (considered the most stable funding source) to cover an unanticipated funding need.

While an industrial company seeks to reduce its inventory to “just in time” levels to reduce costs, a financial company’s goal is to increase its inventory to “just in time” levels to reduce costs from potential liquidity disruption.

Many members refer to unused borrowing capacity based on collateral pledged at FHLB Boston as their collateral “cushion,” which is expressed as a strict dollar limit or percentage of liabilities or assets.

Many members are operating perilously close to their desired cushion and could benefit from adding collateral other than the one- to four-family mortgages. A good choice to expand their collateral cushion might be other real estate-related collateral (ORERC), which includes HELOCs and commercial real estate.  

Adding collateral provides a member with adequate borrowing capacity when FHLB Boston borrowing rates or product structure are preferable to an alternate retail or wholesale funding source. In today’s flat-yield-curve and competitive loan- and deposit-pricing environment, members need to eek out every possible basis point of value.

Maintaining a larger cushion also reduces the risk that a member might sustain if one- to four-family loans unexpectedly prepaid or were inadvertently classified incorrectly, causing borrowing to exceed collateral. 

Expanding "Other" Collateral
The process for expanding collateral beyond one- to four-family, owner-occupied residential loans is fairly straightforward.*  What follows is a brief overview of the steps involved in expanding collateral through use of loan types other than one- to four-family owner-occupied properties. This category includes HELOCs, commercial real estate, multifamily housing, and non-owner occupied one- to four-family residential loans.

*Note: For this analysis, we assume members are already using, or are unwilling to use, investment securities to expand collateral.

Step 1 — Need Analysis – Volume and Timing:  Member establishes the amount of the liquidity cushion desired and the day it needs to be in place. The member strives to bring its cushion to the desired level based on liquidity outlook and volatility of funding. Time requirement: one hour or less

FHLB Boston’s collateral review manager (CRM) schedules members for review and works with them to determine which portfolio to review. The CRM determines what a member’s need is likely to be — whether it is large and immediate, small and immediate, or a specific amount over a certain period of time. The CRM will give scheduling priority to members who urgently need to borrow or are concerned about falling below their cushion.

If a member already has sufficient borrowing capacity (based on one- to four-family loans) to meet any potential borrowing need in the next year, it is usually unnecessary to expand its collateral position.     

Step 2 — Selection of Portfolios for Review:  Member contacts the CRM to discuss conclusions drawn from step 1. The CRM works with the member to determine a customized and streamlined approach to get the additional borrowing capacity in place as soon as possible. The customized approach focuses on each member’s particular loan mix, immediate borrowing and liquidity needs, and possible constraints (for example, systems or staffing concerns) to determine which collateral will be most effective based on the objectives established in Step 1. Time Requirement: 15 minutes to one hour

Overall, the member’s objective is to select the loan portfolio or combination of portfolios from FHLB Boston’s qualifying loan types that best meet its volume and time objective, is likely to meet FHLB Boston’s criteria, and minimizes administration of monitoring and maintaining the collateral source.

For example, if a member needs a quick addition of a small amount of collateral, selection of a few large dollar commercial loans that meet FHLB Boston standards often does the trick. On the other hand, if the member needs a larger addition, then the HELOCs portfolio — with or without some large commercials — may be a good selection. Alternatively, if the member has an ample portfolio of multifamilies or nonowners it might consider listing those property types before those in the “other real estate” category. The decision is tailored to the member’s portfolio types and needs.

One nice advantage of HELOCs relative to commercial real estate is that they allow use of a statistical sample for the fallout percentage (nonqualifying loans) for the entire portfolio, then use that sample as new loans replace maturing ones or are added to the pledged portfolio.   

Step 3 — Complete Loan Information Template:  Member completes an information sheet in Excel format, commonly referred to as a template, that contains fields describing pertinent loan information. Once completed, the template is submitted to the CRM. The fields requested will vary from portfolio to portfolio. Time requirement: One day to one month

Step 4 — Collateral Department Review of Template:  The Collateral Department reviews the submission for completeness and to ensure it meets FHLB Boston specifications for the collateral type. Time requirement: One day to one week

Step 5 — Collateral Department Onsite Review of Loan Files:  The member and the CRM schedule an onsite collateral review. The FHLB Boston collateral review staff visits the member’s office to review credit and legal files, payment histories, and other pertinent information regarding pledged collateral. In the case of commercial real estate, all files must be reviewed. For HELOCs, a sample of loans are generally tested. Upon completion of the field review, FHLB Boston will determine the fallout rate or collateral-adjustment factor. Time requirement: One day to one week

Step 6 — Posting to Member’s Borrowing Capacity: FHLB Boston adds the qualifying loans to the member’s collateral position. After the relevant haircut, the collateral for borrowing capacity is determined. Time requirement: One day to two weeks

Step 7 — Subsequent Credit Reviews:  Subsequent credit reviews will be performed within two years of the initial field review.

The entire process from Step 1 (Needs Analysis) to Step 6 (Posting to Member’s Borrowing Capacity) can take anywhere from five days to eight weeks, depending on volume and resources.
           
In summary, we hope this article has demystified the process for expanding loan collateral beyond one- to four-family owner-occupied loans. In today’s difficult funding environment, having sufficient collateral may help a member’s earnings and interest-rate-risk management by providing flexibility to borrow from FHLB Boston when it offers a preferable rate or product. Having adequate available collateral also reduces the nontolerable risk that occurs if one- to four-family collateral were to unexpectedly fall below borrowing levels.  

For more information about FHLB Boston products and services, please contact your relationship manager.