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Letters of credit (LOCs) issued by the Federal Home Loan Bank of Boston support a wide range of business activity. Our standby and confirming LOCs issued to members (and eligible non-members) can be used to facilitate residential housing finance and community lending, assist with asset/liability management, or to provide liquidity or other funding. An LOC issued by FHLB Boston provides the backing of a triple-A-rated institution that ensures wide acceptance for multiple purposes including:
- Securing public unit — or municipal — deposits;
- Credit support for tax-exempt bonds and taxable bonds;
- Performance guaranty in lieu of a construction performance bond;
- Collateral for obligations arising pursuant to an interest-rate swap, interest-rate exchange, or other such comparable agreement; and
- Credit support for other financial obligations.
FHLB Boston LOCs are most commonly used to secure municipal deposits and to provide credit support for tax-exempt bonds.
Securing Municipal Deposits
You value the deposit business provided by your municipal clients, but the required pledging of collateral can be onerous and costly. You need an alternative that is efficient and flexible yet still provides your clients with the security they demand. Because of our strong credit position, many municipalities will accept an FHLB Boston LOC in lieu of pledging securities for municipal deposits. The LOC guarantees that FHLB Boston will pay the municipal depositor, upon demand, if you default on the deposit. This efficient, low-cost option allows you to retain securities for liquidity and other purposes. It also allows the municipality immediate access to its funds without having to first liquidate securities, which are normally pledged to them. We offer an easy application process and flexible terms and conditions.
To secure municipal deposits, the member applies to FHLB Boston for the LOC. The member is the applicant, while the municipality is the beneficiary; FHLB Boston issues the LOC on behalf of the applicant, in favor of the beneficiary. The LOC must have an expiry date and can only be cancelled with the municipality’s consent. To enforce the LOC in the event of default, the municipality must present a statement to FHLB Boston certifying that the member has failed to redeem its deposits as per the terms of the LOC. Should the municipality submit such a statement to FHLB Boston, the LOC would guarantee payment to the municipality as long as the statement meets the terms of the LOC. FHLB Boston honors the obligation of the member bank to redeem deposits to the municipality. An advance is then created against the member’s account. Municipalities and local governments may determine that they will accept a LOC issued by FHLB Boston as collateral for their deposits because the LOC constitutes “satisfactory security.” Based on FHLB Boston’s triple-A rating, this determination should be easy for a treasurer or collector to make.
Treasurers often view the FHLB Boston LOC as having advantages over traditional securities collateral. Specifically, in the unlikely event of your default, the municipality need only present documentation in accordance with the terms of the LOC to FHLB Boston to receive full payment and thereby avoid the delays involved with an attachment and liquidation of securities. The LOC relieves the municipality of having to seek recovery of your securities in the event of default and instead places that burden on FHLB Boston, which can seek to recover only after it has paid the municipality for your debt.
Refundable Balance LOC
As an addition to the Fixed Balance LOC product used to collateralize public unit deposits, the Bank has created the Refundable Balance Letter of Credit to meet member needs for a flexible, cost-effective LOC that would account for balance fluctuations in public unit deposit accounts.
Many members keep public unit deposits in transactional accounts, which could fluctuate. Since municipalities require their deposits to be fully collateralized at all times, members would over-collateralize their deposits by requesting a Fixed Balance LOC for the estimated maximum account balance, leaving the member exposed to overpayment if the actual balance never reached this high point.
Now, members can request a Refundable Balance LOC equal to the estimated highest balance in the public unit deposit account for terms of one month or greater. If the actual high-balance in the account remains below the face amount of the Refundable Balance LOC throughout its duration, a portion of the fee is eligible for a refund to the member when the LOC matures. Therefore, the Refundable Balance LOC not only provides added flexibility when bidding on municipal deposits, it also offers a safer way to collateralize these deposits along with the potential for a refund.
For example, assume a member opens a deposit account for a local municipality. Based on the municipality’s high-balance estimate, the member requests that the Bank issue a $5 million, one-year Refundable Balance LOC. The up-front fee that the member pays to the Bank to issue the LOC is $7,500 ($5 million times 15 basis points for one year). If during the one-year term, the municipality’s highest deposit balance was only $4 million, the member — upon their request — would receive a refund of $1,400 ($1 million times 15 basis points for one year less a $100 administrative fee for processing the refund).
Providing Credit Support for Tax-Exempt Bonds
Construction companies and development businesses often partner with state housing and development agencies to issue tax-exempt bonds that fund public initiatives ranging from housing developments to community development projects. When your loan customer in the construction or development business is involved in this type of initiative, you may be asked to issue a LOC to “guaranty” principal and interest payments to the bondholders. The bondholders require that your institution have a certain rating, but your institution may not have a rating. In such instances, the bondholders may still accept a LOC from your institution, but it must have a “wrap” by a triple-A bank. A confirming LOC from FHLB Boston can satisfy that requirement. Of course, the same arrangement can work for taxable bonds. With this arrangement, you, the member, will issue your own LOC to the benefit of the bondholders. You promise to pay the bondholders in the event the “borrower” (bond issuer) defaults on its obligation to pay principal and interest to the bondholders. FHLB Boston will then issue a confirming LOC, also to the benefit of the bondholders, that promises to pay the bondholders if your institution defaults on its LOC.
To determine whether a bond fits the requirement of facilitating residential housing finance, other housing activity, or community lending, please contact your relationship manager.
Collateral and Capital Requirements
A LOC issued by FHLB Boston must be collateralized, but you may use any form of collateral that is acceptable for advances, including one- to four-family loans, which you may already have pledged to FHLB Boston. There is also a requirement to purchase FHLB Boston capital stock, but at only half the amount required for advances, or 2.25 percent.
Pricing
Pricing is based on the term of the letter of credit, and a minimum fee may be charged. A processing fee will be charged for confirming letters of credit issued in support of bond transactions. See the letter of credit pricing schedule.
Forms and Applications
LOC application and other related forms
Sample Documents
External resources
For more information on using FHLB Boston letters of credit, please consult your relationship manager. |
