Public unit deposits (PUDs) play a critical role in the financial landscape. While public unit entities require that their public funds are safely managed, PUDs can offer financial institutions a diversified source of liquidity. Financial institutions are typically required to collateralize PUD amounts that exceed Federal Deposit Insurance Corporation (FDIC) and National Credit Union Insurance Fund limits with certain eligible assets, and often use securities such as U.S. Treasuries or agency securities. However, pledging securities to support PUDs can restrict a financial institution’s liquidity and require increased administrative oversight.
To address these challenges, the Federal Home Loan Bank of San Francisco (FHLBank San Francisco) offers a letter of credit product as an alternative form of collateral for PUDs.
This article highlights the multiple benefits of FHLBank San Francisco letters of credit, demonstrating how this product can enhance liquidity and improve operational efficiencies for member institutions.
Financial institutions often use eligible securities to secure PUDs, a process that can present several inefficiencies:
Liquidity Constraints: Pledged securities are often high-quality assets that otherwise could be a source of liquidity and be deployed for lending or other higher-yielding investments.
Market Volatility Risks: Changes in the value of pledged securities can impact a financial institution’s ability to meet collateralization requirements, necessitating frequent adjustments to account for market value fluctuations, maturing securities, deposit changes, etc.
Administrative Burden: Most PUD programs require frequent, even daily, monitoring and reporting for the pledged securities, which combined with tracking securities maturities and possible substitutions can create significant operational overhead.
Letters of credit issued by FHLBank San Francisco present a strategic alternative for securing PUDs, offering key advantages over securities collateral.
Partnering with FHLBank San Francisco has provided our bank with a more efficient and flexible approach to collateralizing public unit deposits. The transition to a letter of credit has simplified our operations while maintaining the security and confidence that our public depositors require. This change not only reduces administrative burdens but also enhances our ability to manage liquidity effectively.
Adam Markarian
Chief Financial Officer of Nevada Bank & Trust
Enhanced Liquidity and Capital Optimization
Using a FHLBank San Francisco letter of credit to secure PUDs can free up securities that would otherwise be encumbered as collateral, allowing member institutions to enhance their liquidity ratio, or redeploy those freed up securities into higher-yielding opportunities such as mortgage loans. This improved asset utilization can lead to better liquidity ratios or increased net interest income.
To illustrate this, FHLBank San Francisco separated member institutions who had PUDs as of 2024 year-end into two groups: those that collateralized PUDs with FHLBank San Francisco letters of credit and those that continued with pledged securities. The comparison revealed a meaningful difference in the Total Loans/Total Assets ratio between these two groups.
The group of member institutions that utilized FHLBank San Francisco letters of credit had a higher median value of Total Loans/Total Assets ratio, as they were able to redeploy previously encumbered securities into higher-yielding securities or loans. The figure below illustrates the distribution of the ratio across both groups, demonstrating a clear financial advantage for institutions leveraging FHLBank San Francisco letters of credit, by better optimizing asset deployment.
Improved Depositor Confidence and Market Risk Mitigation
FHLBank San Francisco letters of credit meet collateralization requirements for many PUDs, providing a reliable and efficient alternative to securities collateral. Since these letters of credit are irrevocable commitments and are backed by FHLBank San Francisco’s Aaa/AA+ credit rating, they can enhance public unit depositor confidence while reducing a member institution’s exposure to market volatility.
Operational Efficiency
Managing securities collateral can involve continuous monitoring, substitution, and reporting. FHLBank San Francisco letters of credit can simplify this process by providing a straightforward, single-issuance instrument that reduces administrative overhead and compliance complexity. As long as members have pledged sufficient collateral to FHLBank San Francisco to support the letter of credit and a Letter of Credit Reimbursement Agreement in place, members can apply for PUD letters of credits easily through the Member Portal, allowing for timely implementation.
Quick and Reliable Depositor Access to PUDs
In the event of a member institution’s default, a public unit depositor, as the beneficiary of a FHLBank San Francisco letter of credit, is ensured timely access to the amount of their deposits. Having access to a letter of credit backed by FHLBank San Francisco, therefore, can enhance the attractiveness of a member institution as a potential depository for public unit entities.
A notable example of the benefits of FHLBank San Francisco letters of credit comes from Nevada Bank & Trust. They requested a letter of credit to secure PUDs from depositors like school districts, county hospitals and other healthcare facilities, county power/utility companies, local city and county government, county conservation, and chambers of commerce.
These deposits are typically well over the FDIC-insured amounts, requiring collateralization to secure the amount in excess. Securities are often used as collateral, but securing collateralization for deposits of additional funds could take a day or two to pledge, meaning the customer would have to wait a day or two to move funds.
In addition, the Nevada State Treasurer requires daily reporting on securities collateralizing PUDs. Market value of securities can change frequently, adding to the administrative burden of using securities as collateral. The state also accepts irrevocable letters of credit to collateralize PUDs, and as a member of FHLBank San Francisco, Nevada Bank & Trust has access to cost-effective and efficient letter of credit issuance.
By providing greater flexibility and the online, streamlined issuance process for PUD letters of credit, it is easier for FHLBank San Francisco members to support increased balances from public entities. With a letter of credit as collateral, Nevada Bank & Trust has the ability to receive the public funds the same day, making it easier to work with their public customers and the State of Nevada.
Adam Markarian, Chief Financial Officer of Nevada Bank & Trust added, “Partnering with FHLBank San Francisco has provided our bank with a more efficient and flexible approach to collateralizing public unit deposits. The transition to a letter of credit has simplified our operations while maintaining the security and confidence that our public depositors require. This change not only reduces administrative burdens but also enhances our ability to manage liquidity effectively.”
Their collateral is now centralized with FHLBank San Francisco, giving them ready access to funds through advance and letter of credit structures and flexibility to manage liquidity efficiently.
The FHLBank San Francisco letter of credit provides an effective alternative to securities collateralization of PUDs. By improving liquidity and operational efficiencies, FHLBank San Francisco letters of credit empower member institutions to optimize asset allocation while continuing to serve public unit entities effectively.
For more information on how FHLBank San Francisco letters of credit can benefit your institution, please contact your Relationship Manager or the Member Services Desk at (415) 616-2500.
FHLBank San Francisco makes a portion of its net income available through grants to finance the purchase, construction, or rehabilitation of housing for low- or moderate- income households in member communities. Utilizing FHLBank San Francisco products to collateralize PUDs could result in more financing available for housing needs in your communities.
FHLBank San Francisco makes no representations or warranties about the accuracy or suitability of any information in this article. This article or the information presented is not intended to constitute legal, accounting, investment, tax, or financial advice or the rendering of legal, accounting, tax, consulting, or other professional services of any kind. Your institution should consult with its accountants, counsel, tax, financial representatives and advisors, consultants, and/or other advisors regarding the extent to which the information presented in this article may be useful to it and with respect to any legal, tax, business, and/or financial matters or questions. This article does not constitute an offer to extend credit or an investment solicitation to buy or sell any security.
Your institution should exercise its independent capability, and that of its advisors, to evaluate the merits and the financial risks associated with the use of any FHLBank San Francisco products and should not rely on analysis or communication from FHLBank San Francisco, including anything in this article. The decision to use any FHLBank San Francisco products remains solely your institution's responsibility.
