FHLBInsider

By James B. Eibel, CFA, assistant vice president and manager of financial strategies.

The millennium bug is coming to town. Be honest, are you hoarding canned goods in your backyard? Are you secretly building a survivalist camp in northern Michigan? Maybe you think it’s all a bunch of foolishness, and are amused by the concerns of others. Regardless of whether you believe January 1, 2000, will be Armageddon, a non-event, or somewhere in between, your institution should adhere to the Boy Scout motto, "Always be prepared."

The Y2K event subjects financial institutions to both operational and financial risks. Operational risks such as computer failure and inadequate vault cash have been well documented by the media. Issues such as liquidity risk have received less attention but are equally important. Skillful use of Federal Home Loan Bank of Indianapolis (FHLBI) membership can assist in managing the liquidity risk posed by Y2K. This article lists several steps that every member of the FHLBI should consider taking.

Draft a contingency funding plan that includes FHLBI advances. Given the liquidity risk posed by Y2K, regulators have placed special emphasis on contingency funding plans. Every financial institution should have a current contingency funding plan for managing a liquidity crisis. The plan should contain the policies and procedures for using back-up sources of liquidity, such as the FHLBI, correspondent banks, and the Federal Reserve discount window.

As a review, the FHLBI is a $23.5 billion, AAA-rated institution. As part of the $440 billion Home Loan Bank System, the FHLBI has a tremendous presence in the capital markets. The System has recently surpassed the US Treasury in volume of debt issuance. FHLBI membership can enable a small community-based institution to access the global capital market with the same clout as a mega bank.

Your FHLBI membership represents a first-line defense against a liquidity crisis. However, it is not a silver bullet for Y2K. In case of a major liquidity crisis, institutions could be forced to use a variety of funding sources, including the last resort of the Federal Reserve.

Make sure all borrowing documents are complete and up-to-date. It’s nice to know the gun is loaded before you need to pull the trigger. Before an institution can borrow from the FHLBI, all borrowing agreements must be up-to-date. The last thing your institution needs during a liquidity crisis is a paperwork headache. If you haven’t used FHLBI advances recently, call the credit department at (800) 442-2568 or your marketing representative to conduct a quick document check-up. Ask if all borrowing documents are ready in case you need funds in a hurry. This simple exercise should give your institution added peace of mind.

Pledge all eligible assets to maximize available borrowing capacity. FHLBI members should post enough collateral to meet their projected Y2K liquidity needs. To speed the borrowing process, all collateral agreements and pledges should be current and complete. Most members operate under either a blanket collateral agreement ("blanket") or they specifically identify the collateral to be pledged ("specific").

The blanket status is popular due to its ease of use. Members must fill out a one-page collateral report every quarter and have their independent auditor provide an annual unqualified opinion that the collateral level has been maintained. Once the quarterly report has been received, a member is permitted to borrow up to $1 for every $1.60 of unencumbered collateral.

Specific collateral status typically produces the maximum borrowing capacity for FHLBI members. Under the agreement, mortgage loans or securities are specifically identified as collateral. For mortgage loan collateral, a member may borrow $1 for every $1.25 of eligible market value, and must provide monthly reports on the collateral
and an annual unqualified independent auditor’s opinion. For security collateral (treasuries, agencies, or mortgage-backeds), a member may borrow $1 for every $1.10 of market value and must safekeep the securities with the FHLBI.

Increase your borrowing resolution to reflect Y2K liquidity needs. Each FHLBI member’s board must adopt a borrowing resolution setting a limit on total advances. The resolution does not represent a commitment, but only the authorization to borrow. The level of this self-imposed borrowing constraint should be reflected in the contingency funding plan.

Given the uncertainty posed by Y2K, FHLBI members should seriously consider increasing their borrowing resolutions. One strategy would be to increase the resolution to the maximum borrowing level based on collateral status. This would remove an unnecessary constraint to FHLBI advance access during an emergency.

Begin extending liability maturities past January 1, 2000. Institutions with borrowings maturing during 1999 should consider longer maturities and fixed rate borrowings. If large deposit outflows occur on a systemic basis during the fourth quarter, both the availability and the rate of fed funds and other short-term borrowings will be affected by increased demand. By lengthening both the maturity and repricing of borrowings until after January 1, 2000, institutions can avoid the risk of being a buyer of short-term funds in a sellers' market.

If you have never borrowed from the FHLBI, conduct a Y2K test borrowing. The suggestion to conduct a Y2K test borrowing may sound self-serving, but it can pay big dividends. First time borrowers must be underwritten by the credit department before funds can be advanced. It generally takes at least 24 hours to receive funding the first time. Institutions with a recent borrowing history generally do not require any special review and are able to receive funding faster. If the Y2K panic results in a liquidity crisis, quick access to FHLBI funding could be very important. In addition to a faster borrowing cycle, a successful test borrowing should provide both you and your board with peace of mind that the system works. Documentation of a successful Y2K test borrowing could also help to validate your contingency funding plan with the regulators. Why not test your backup liquidity sources just like other systems for Y2K readiness? All that is required to conduct a test borrowing is a small, short-term advance. The small cost of the transaction could be far outweighed by its benefits.

This article has been presented for educational purposes only.  The FHLBI is not a financial or investment advisor.   It is solely the reader's responsibility to evaluate the risk and merits of any funding strategy or business proposal.

Copyright 1999, Federal Home Loan Bank of Indianapolis