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By
Paul Peduto
Printable Version
Municipal deposits are an excellent source of low-cost funds for
many financial institutions. But there may be a hidden cost
that makes them less attractive than they appear. Most municipalities
require security on such deposits, either in the form of excess
deposit insurance or by accepting from the depository financial
institution investment securities, usually in the form of government
or agency securities.
Financial institutions may be giving up yield on assets if they
are keeping a portion of their securities portfolio mainly for
the purpose of securing these deposits. Can these investments be
better deployed as loans that provide a higher yield? We
think they can by using Federal Home Loan Bank of Boston (the Bank)
letters of credit instead of securities to secure the municipal
deposits.
A Federal Home Loan Bank of Boston letter of credit is an Aaa-rated
instrument in which the Bank promises to pay a third-party
beneficiary (in this case, the municipality) in case of default
by the maker (in this case, the member). Although the Bank
requires collateral for the letter of credit, the collateral can
be derived from the same menu of assets eligible to secure Bank
advances, including one- to four-family residential loans and higher-yielding
commercial real estate loans.
The cost of a Bank letter of credit is very reasonable at nine
basis points per year for a letter of $10 million or more; 12.5
basis points for $1 million to $10 million; and 25 basis points
for those under $1 million. The additional yield pickup for
moving to loans from securities should easily offset the cost of
the letter of credit.
Bank letters of credit are acceptable collateral in most municipalities
in New England. Because their face amount remains constant, there
is no need to update the amount pledged on a monthly basis, saving
both you and the municipality valuable time.
Please contact your relationship manager for further information
on this valuable financial instrument.
Paul M. Peduto is first vice president/sales and business
development at the Federal Home Loan Bank of Boston. |
