By David Birkins

With the economy continuing to improve and the Fed starting to ratchet up short-term rates, 2004 could be the year when retail consumers begin to evaluate competing savings vehicles and their relative returns. At the same time, cash flows from bond portfolios could dry up just as loan demand strengthens, placing an additional strain on liquidity. Bottom line: it's clear that this area of risk management is only going to become more important in the coming years.

Forecasting liquidity is always a tricky enterprise. As such, an integral part of liquidity planning is having a comprehensive collateral-management program to enable members to tap into the borrowing capabilities available through the Federal Home Loan Bank of Boston. Assuring that adequate collateral is in place to support these borrowings is a critical part of the Bank's secured-lending process.

Qualified Collateral Our fundamental business is to provide members with advances and other credit products secured by various types of collateral. While the majority of members are familiar with pledging one- to four-family residential properties and various investment securities, many may not realize that other assets also constitute qualified collateral. For example, the Bank may consider other real estate-related collateral if members have pledged all other available qualified collateral. By adding these real estate-related loans to its qualified collateral, members with substantial holdings in this category can significantly increase their borrowing capacity with the Bank.

As use of this form of collateral has increased, the Bank's Collateral Department has streamlined the process to make it as efficient as possible for members. Prior to outlining the pledging process, there are several points members should consider:

• The assets must have a readily ascertainable value

• The Bank must be able to perfect a security interest in the asset

• The valuation for collateral purposes equates to the lesser of 50% of the market value, as determined by the Bank, or 50% of book value

• A "prioritization rule" is used to determine the member's eligibility to pledge these assets (see below for more detail on this process).

Guidelines for Pledging While the Bank's Products Policy fully describes the process for pledging these assets, the following guidelines are applicable.

General Consistent with the Bank's Products Policy, members must have pledged "all other available qualified collateral" prior to pledging other real estate-related collateral. This constitutes the Bank's collateral prioritization rule. All other available collateral consists primarily of one- to four-family residential properties, non-owner-occupied, one- to four-family and multifamily loans, and eligible investment securities. [Note: the Bank allows a member to retain 15 percent of unpledged securities to assets for liquidity and regulatory purposes, and still allows the member to pledge commercial real estate collateral to the Bank. The prioritization rule is not in effect with respect to securities collateral unless the member has in excess of 15 percent unpledged securities to assets.]

Loans cannot be accepted if they are classified as substandard or "high risk" by the member or its primary regulator. In addition, loans that have one or more payments over 45-days delinquent in the last 12 months are also not eligible. Loans on risky property types (for example, gas stations and other properties with potential environmental problems) are not typically considered eligible for collateral.

Other real estate-related collateral is subject to individual review and acceptance by the Bank. The review of the loan files will be performed on the member's premises. The loan reviews are conducted to ensure that the credit underwriting and supporting documentation for these loans meet the Bank's collateral-eligibility guidelines. If accepted, the Bank, at a minimum, will maintain these loans in listing status. If the member is in "delivery" status, the member must deliver the collateral to the Bank.

Listing of Loan Information The Bank has established a minimum number of loan-information fields that the member must provide the Bank in order to pledge these assets. Before scheduling an on-site collateral review, the member must provide the Bank with an Excel file (utilizing a template provided by the Bank) that lists all the loans that the member would like to have considered as qualified collateral. This file must be formatted according to the required fields of data in the Bank's collateral system.

On-Site Loan Review The collateral staff typically reviews a sample of these loans to determine the eligibility of other real estate-related collateral and if the loans can be accepted based on the sampling methodology. A member's underwriting practices are also reviewed during this process. If these practices are determined to be insufficient, the Bank may reduce the collateral valuation or require a review of the entire loan pledge.
Finally, property inspections are done on the loans from the sample reviewed. The inspections are either performed by the collateral staff or by a qualified third-party service provider that is retained by the Bank.

Acceptance of Collateral Based upon the results of the review, the Bank will assign a market value to the loans accepted as qualified collateral. Members are required to segregate and label as "Collateral for the Federal Home Loan Bank of Boston," all mortgage loans accepted and listed with the Bank.

Miscellaneous Once accepted, members are required to submit, on at least a quarterly basis, an unpaid balance update for all nonresidential commercial real estate loans pledged as qualified collateral with the Bank. Members may not use, commingle, encumber, or dispose of any mortgage collateral that has been specifically listed with the Bank, without the express written consent of the Bank. To remove a mortgage from listing status, the member must submit a "Request for Release" form to the Bank for approval. Please note that the Bank is not obligated to release mortgage collateral unless the member has sufficient collateral remaining (once the release has been processed) to cover its existing advances and extensions of credit.

Fees The Bank's Products Policy states that members "agree to permit Bank personnel to make periodic on-site verification of collateral pledged. All fees and costs incurred by the Bank in connection with its collateral requirements will be charged to the member." In accordance with this provision, members will be charged for all out-of-pocket expenses incurred by the Bank that are related to the on-site loan file review and the cost of the property inspections. After the initial on-site loan review, the Bank — within a 24-month period — will typically perform a follow-up review of loans accepted as qualified collateral to ensure continued compliance with the Bank's policies and procedures.

Conclusion Members who are contemplating enhancing their liquidity-risk-management program ahead of any potential liquidity crunch, or who may already be "tight" on other available collateral, can call their relationship manager to discuss any aspect of the process. For additional information on the Bank's collateral policy, please click on the Products Policy tab under the Products & Services banner on the Bank's Web site (www.fhlbboston.com).

David Birkins is the Bank's relationship manager for Connecticut, western and central Massashusetts, and parts of Rhode Island.