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FHLBank Atlanta Letters of Credit: Low-cost Payment Guarantees for Multiple Funding Needs

October 2012 - FHLBank Atlanta delivers a broad portfolio of products and services to help financial institutions build their lending businesses while supporting residential and commercial projects that create jobs and help strengthen local economies. An FHLBank Atlanta product that has recently grown in popularity is its letters of credit. Financial institutions are increasingly using letters of credit to support community-based real estate projects, bond issuances, and leases, as well as to collateralize Public Unit Deposits that exceed levels covered by FDIC insurance.

A key advantage of the letter of credit is that the financial institution can leverage FHLBank Atlanta’s high credit rating (AAA/AA+) to reduce financing costs and mitigate risk for the beneficiary.

The letter of credit provides added benefits to small- and medium-sized community banks as it allows them to compete for local business on a level playing field with larger, rated institutions.

FHLBank Atlanta issues Standby Letters of Credit that directly support the obligations of its shareholders and confirm certain undertakings of its shareholders under their own letters of credit (Confirming Letters of Credit). An FHLBank Atlanta Standby Letter of Credit is an independent guarantee of additional credit and collateral, issued by FHLBank Atlanta, to a third-party beneficiary on a shareholder’s behalf. A shareholder must have an underlying obligation to the beneficiary. Shareholders often use Standby Letters of Credit to support insurance premiums, leases, or charge card operations. However, the most common use of an FHLBank Atlanta Standby Letter of Credit is to secure Public Unit Deposits that exceed the level covered by the FDIC.

Public Unit Deposits

Financial institutions frequently pledge securities as collateral for Public Unit Deposits. The downside to this approach is that it ties up the financial institution’s assets in a relatively low-yielding investment. As an alternative, the financial institution can secure a letter of credit from FHLBank Atlanta to collateralize the Public Unit Deposit for a low annual fee (currently 9 basis points*). This arrangement frees up the financial institution’s assets for liquidity reporting purposes and to use for mortgage lending, which provides a higher yield.

The example below demonstrates the cost savings an FHLBank Atlanta Letter of Credit provides:

Before Using a Letter of Credit: Secure Public Unit Deposit with $5 million, 5-year agency security yielding 1.15% Income: $5 million x 1.15% = $57,500
After Using a Letter of Credit: Secure Public Unit Deposit with $5 million letter of credit at a cost of 9bps* and lend $5 million in 1-4 family mortgage loans yielding 3.75% Income: $5 million x (3.75%-.09%) = $183,000
Shareholder Benefit: $183,000-$57,500 = $125,500 $125,500 additional income from using FHLBank Atlanta Letter of Credit

*Annual fee subject to change. 

FHLBank Atlanta Confirming Letters of Credit

Confirming Letters of Credit issued by FHLBank Atlanta support a shareholder’s obligations with respect to the underlying letter of credit or credit transaction. The shareholder in turn pays the letter of credit fee; however, FHLBank Atlanta’s credit rating enhances the original letter of credit, reducing financing costs significantly.

Mechanics of Confirming Letter of Credit

Mechanics of Confirming Letter of Credit

FHLBank Atlanta shareholders also use Confirming Letters of Credit to support bond issuances. In many instances, a commercial project can be financed at a lower cost by issuing a bond with credit enhancement from an FHLBank Atlanta Letter of Credit compared with financing the project with a commercial loan.

For example, one Alabama shareholder worked with FHLBank Atlanta to secure a $25.2 million letter of credit to provide credit backing for a bond issuance for a development on the state’s Black Warrior River. The letter of credit helped support the construction of a $31 million LEED-certified office building, which was the initial phase of a larger downtown revitalization effort. The letter of credit contributed to the financial viability of the project by enabling the bonds to be issued at a favorable long-term interest rate.

Letter of Credit Growth

The number of FHLBank Atlanta shareholders using letters of credit has grown steadily over the past five years and the number of letters of credit issued tripled between 2007 and 2011. As of December 2011, 131 shareholders used letters of credit, totaling $17.4 billion in Public Unit Deposit letters of credit, and $4.1 billion in non-Public Unit Deposit letters of credits. 

As the need for alternative funding methods increases, FHLBank Atlanta Letters of Credit are a viable option for shareholders to use in their efforts to build local communities and strengthen the economy.

Letters of Credit Requirements

Some requirements do apply. A shareholder must have sufficient credit availability and collateral to cover 100 percent of the letter of credit amount for the entire term. Collateral requirements are the same as for advances, and shareholders can pledge loans or other eligible collateral to secure letters of credit. Other terms and conditions can be found in FHLBank Atlanta’s Member Products and Services Guide.

To learn more, call the FHLBank Atlanta Funding Desk at 1.800.536.9650, extension 8011.

© 2012 Federal Home Loan Bank of Atlanta, All Rights Reserved. 1475 Peachtree Street NE, Atlanta, GA 30309

The Federal Home Loan Bank of Atlanta is not a registered investment advisor. Nothing herein is an offer to sell
or a solicitation of an offer to buy any securities or derivative products. You should consult your own legal, financial, and accounting advisors before entering into any transaction.

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