Trader's Corner: Letters of Credit

Relationship Manager Mona Tavss sits down with Member Financial Services Associate Director John “JJ” Jaravata to explore how members can maximize use of the Bank’s Letters of Credit to fortify balance sheets and reduce risk.

Photo of JJ JaravataQ: Welcome back, JJ! Thank you for visiting with Bank Notes once again. The last time we discussed the Bank’s Letters of Credit product, you talked about how they are used for Public Unit Deposits (PUDs). Can you remind our readers how PUD’s benefit from our LCs?

A: Hi Mona; Thank you for inviting me back. I appreciate the opportunity to talk LCs with you again! Our LCs can be used to solve several complex challenges, including when a member has a lack of suitable, highly liquid collateral or when a member is in need of support for new or expanded business activities, such as liability or asset generation. 

Still, the most popular use of LCs by our member financial institutions is to secure PUDs under various state and local agency deposit programs, both within the Bank’s district of Arizona, California, and Nevada, and in certain other states. For FHLBank San Francisco members already accepting PUDs, a LC can be a more attractive form of collateral for both our member and their depositor customer. For members not already offering PUDs, the LC might be considered an ideal form of collateral for taking advantage of this desirable source of funding and as a vehicle for community investment.
               
Photo of Mona TavssQ:  So, in short, in lieu of securities our letters of credit can be an inexpensive solution to collateralize PUDs? 

A:  Yes, that is correct. LCs can fortify collateral, improve liquidity, and help reduce risk.

Q: How do LCs help fortify collateral, improve liquidity and manage risk?

A: There are many great benefits from using our LCs, including:

  • Improved liquidity: For regulatory purposes, once securities are pledged, they cannot be factored into liquidity ratios. It makes sense to pledge less-liquid whole loans to FHLBank San Francisco to support the issuance of a LC to preserve your securities portfolio for liquidity purposes.
  • Reduced interest rate risk: A low-interest rate environment has made holding securities less attractive.
  • Reduced operation risk: Managing portfolios of securities as collateral demands significant operational and reporting activities that are not necessary with LCs.

Q: Got it! What are some other ways LCs can be used for PUDs and beyond?

A:    Additional member benefits from LCs for PUDs include:

  • Modest issuance fee of $100
  • Low annual maintenance fee of 10 basis points or minimum annual fee of $500.
  • Documentation is simple
  • Online application and same day issuance for most transactions, if requested before 12:00 pm Pacific Time

In addition to using LCs for PUDs, LCs offer a number of features such as:

  • No cost to the beneficiary
  • No minimum size. The LC amount can be tailored to the member’s needs.
  • Original amount can be modified, and terms adjusted, with approval of beneficiary
  • The Bank’s Aaa rating by Moody’s and AA+ by Standard & Poor’s insures to the beneficiary

Q: Can you remind me for what purposes the Bank is currently authorized to issue LCs?

A: Great question! The Bank is currently authorized to issue LCs to:

  • Facilitate residential housing finance
  • Facilitate community lending*
  • Assist asset/liability management, and
  • Support liquidity by collateralizing deposits 

*Community lending means providing financing for economic development projects for targeted beneficiaries, and, for community financial institutions, the purchase or funding of small business farm, or agri-business loans.

Q. What are the benefits of a FHLBank San Francisco LC for Bond Issuances?

A: The Bank has been issuing two types of LCs to credit enhance bonds:

  1. Promote Home Financing or Housing Activity: This type of LC is issued to credit enhance taxable private bonds issued by a developer LLC or other formed entity for a project. This is currently the most popular bond LC we have been issuing.  
  2. Tax Exempt Bonds – Housing: This type of LC is issued to credit enhance tax-exempt state or municipal bonds for housing. 

Q. Thanks, JJ. To clarify, LCs are a solution that FHLBank San Francisco offers to enhance our members' credit, in this instance, with a bond issuance. This is attractive to members (and buyers of bonds) because of FHLBank San Francisco's credit ratings, correct?

A. That's right, Mona. One of the main benefit of a FHLBank San Francisco LC for bond issuances is that they are backed by the Bank's Moody's (Aaa) and Standard & Poor's (AA+) credit ratings.

These are just some of the solutions we offer. Members should contact their Relationship Manager or the Member Services Desk at (415) 616-2500 with questions about any of these products. Members can also learn more about the Bank's credit products on our public website

Member Services Team

Graphic of the Bank's Traders executive team including Ira Chin, Kush Patel, Stanley Yeung, and JJ Jaravata