2016 NASACT ANNUAL CONFERENCE

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State Treasurer s Office Dan Van Vooren Bank of America

1 2016 NASACT ANNUAL CONFERENCE Collateralization of Public Fund Deposits Current Issues and Developments Laura Glenn Georgia State Treasurer s Office Dan Van Vooren Bank of America Merrill Lynch Moderated by: Manju Ganeriwala Virginia State Treasurer

2 Collateralization of Public Fund Deposits Challenges facing financial institutions and public fund depositors 2

3 Collateralization of Public Fund Deposits Historically low interest rates and margins 3

4 Collateralization of Public Fund Deposits 4

5 Collateralization of Public Fund Deposits 5

6 Collateralization of Public Fund Deposits 6

7 Collateralization of Public Fund Deposits Regulatory changes and the impact on public fund depositors 7

8 Collateralization of Public Fund Deposits Dodd-Frank Act and Basel III Capital Minimum risk-based capital requirements Leverage Minimum capital limits regardless of risk Liquidity Liquidity buffers and stable funding 8

9 Collateralization of Public Fund Deposits Liquidity Coverage Ratio High Quality Liquid Assets LCR = > or = 100% Net Cash Outflows in 30 Days 9

10 Collateralization of Public Fund Deposits HQLA Haircuts and Limits Haircut Limit of HQLA Level 1: 0% No Limit Level2A: 15% 2A +2B < 40% Level 2B: 50% < 15% 10

11 Collateralization of Public Fund Deposits High Quality Liquid Assets (HQLA) Level 1: Cash, Fed Reserves, US Treasuries, etc. Level 2A: US GSEs, certain Sovereign securities Level 2B: Non-financial corporate debt, Publicly traded equities 11

12 Collateralization of Public Fund Deposits Net Cash Outflows Cumulative cash inflows capped at 75% of aggregate cash outflows Use highest daily cash outflow within 30 day stress period Deposit outflows determined by type Operational v Nonoperational deposits 12

13 Collateralization of Public Fund Deposits Assumed Deposit Cash Outflows Operating Accounts: 25% written agreement, 30 day notice to close stable average balance account designated operational primary purpose to obtain operational service must not incent depositor to keep excess balance Non-operating Accounts: 40% 13

14 Collateralization of Public Fund Deposits Impact of collateralized deposits depends on deposit type, operational versus non-operational, and type of collateral pledged 14

15 Collateralization of Public Fund Deposits Resulting Impact on Public Entities Reduced response to Requests for Proposals Reduced competition for deposits Mixed signals on municipal debt markets Reduced returns on deposits Need to expand investment options Need to re-visit collateral options Need to re-visit collateral requirements 15

16 Collateralization of Public Fund Deposits Possible Deposit Collateral Options Use of Federal Home Loan Bank Letter of Credit, Traditional and Adjustable Balance Non-HQLA Quick claims processing Cash, not securities delivered on claims Acceptable in most states 16

17 Collateralization of Public Fund Deposits Possible Deposit Collateral Options Pooled Collateral Programs May reduce total balance volatility Allows for more efficient collateral coverage Bank strength monitored at state level Simplified RFP process Single contact for collateral management and reporting 17

18 Collateralization of Public Fund Deposits 100% Bank of America Public Deposit Collateral Mix 90% 80% 70% 60% 50% Non-HQLA HQLA 40% 30% 20% 10% 0% 12/31/08-12/31/12-6/30/16-18

19 Collateralization of Public Fund Deposits Thank you 19

20 NASACT Annual Conference August 15, 2016 Laura Glenn, Portfolio Manager

21 Public Fund Deposits Collateralization: Dictated by State Code Haircuts vary from state to state Forms of collateral vary from state to state Pledging Pools not available in all states 21

22 Georgia State Code Deposit of securities in lieu of bond (a).in lieu of such a surety bond the state depository may deposit with the state treasurer to secure state funds on deposit in state depositories: (1) Bonds, bills, certificates of indebtedness, notes, or other direct obligations of the United States or of this state; (2) Bonds, bills, certificates of indebtedness, notes, or other obligations of the counties or municipalities of this state; (3) Bonds of any public authority created by the laws of this state, if the statute creating such authority provides that the bonds of the authority may be used for this purpose and the bonds have been duly validated as provided by law, and as to which there has been no default in payment, either of principal or interest; (4) Industrial revenue bonds or bonds of development authorities created by the laws of this state, which bonds have been duly validated as provided by law and as to which there has been no default in payment, either of principal or interest; or 22

23 Georgia State Code Section (cont.) (5) Bonds, bills, certificates of indebtedness, notes, or other obligations of a subsidiary corporation of the United States government, which are fully guaranteed by the United States government both as to principal and interest, or debt obligations issued by or securities guaranteed by the Federal Land Bank, the Federal Home Loan Bank, the Federal Intermediate Credit Bank, the Central Bank for Cooperatives, the Farm Credit Banks, the Federal Home Loan Mortgage Corporation, or the Federal National Mortgage Association. (b) The state treasurer may accept letters of credit issued by a Federal Home Loan Bank to secure state funds on deposit in state depositories. (c) The state treasurer shall also accept the guarantee or insurance of accounts of the Federal Deposit Insurance Corporation to secure state funds on deposit in state depositories, to the extent authorized by federal law governing the Federal Deposit Insurance Corporation. 23

24 State by State Maryland: Kentucky: All deposits have to be collateralized 100% by law Does not allow a collateral pool Allows FHLB Letter of Credit as a source of collateral Balances must be 100% collateralized Does not allow a collateral pool Allows FHLB Letter of Credit as a source of collateral Arkansas: Balances must be collateralized at 105% Accepts FHLB Letter of Credit as a source of collateral West Virginia: Balances must be collateralized at 102% Collateral Pool is not available Accepts FHLB Letter of Credit as a source of collateral Wyoming: Balances must be collateralized at 100% Collateral pool is not available Accepts FHLB Letter of Credit as a source of collateral 24

25 By State Arizona: Balances must be collateralized at 102% However, if FHLB Letter of Credit is utilized then accepted at 100% Tennessee: State Pool recently established Balances must be collateralized in excess of FDIC coverage Deposits outside of pool must be collateralized at 105% Missouri: Banks operating within voluntary pool must collateralize at 100% or 115% dependent upon the bank performance of 9 call report benchmarks Accepts FHLB Letter of Credit as a source of collateral Balances must be collateralized in excess of FDIC coverage Pooled option not available Collateral haircuts depend on collateral pledged ranges from 102% to 105% Accepts FHLB Letter of Credit as source of collateral South Carolina: Balances must be collateralized in excess of FDIC coverage Pledging pool available Collateralization depends on collateral type 100% for U.S. treasuries and up to 115% for certain types of mortgage-backed securities Accepts FHLB Letter of Credit as a source of collateral 25

26 Virginia: By State Collateralization program covers deposits of Virginia s state and local governments Balances must be collateralized in excess of FDIC coverage Two collateral methods Pool and Dedicated (outside of pool) Pledging pool - tiered collateral from 50% to 100% based on size of bank s public deposits Dedicated Collateral from 105% to 130% based on financial condition of bank Accept FHLB Letter of Credit as a source of collateral Accept mortgage back and municipal (in-state and out-of-state) securities with haircuts 26

27 SHOW ME THE MONEY!!! 27

28 Bank Compensation Earnings Credit Rate (ECR) is a daily calculation of interest paid on idle funds that reduce service charges ( Soft Money ) Current ECRs exceed rates available on overnight investments. Compensating balances are employed to offset analysis charges; excess balances are then swept into interest bearing accounts ( Hard Money ) Monitor bank ECRs and interest rates to determine the optimal mix of compensating balances and fee payments Earnings Allowance = Monthly Balance ECR Net Fees = Service Fees Earnings Allowance 28

29 Monitoring Bank Investments FDIC Insurance Collateral Type Value Reporting Verify Information Reported Frequency 29

30 Basel III Effects Basel III requirements has led to: Shortage of collateral to pledge to public depositors Increased cost of collateral to banks Fewer banks offering public depositors traditional deposit account services 30

31 Multibank Pledging Pool A Proposal to Align Depositors and Banks Needs Banks contingently liable for losses attributable to any individual participant

32 Multibank Pledging Pool Benefits to Public Depositors: Retain a level of collateralization Gain participating banks being held collectively accountable for the protection of public deposits Spreads risk among participating banks, in addition to depositor s bank, under the contingent liability agreement Compliance oversight and loss recovery by the Office of the State Treasurer Data from Georgia Bankers Association 32

33 Multibank Pledging Pool Benefits to Banks: Contingent liability structure could potentially result in lower percentage pledging requirements Frees a portion of the deposit to use for other purposes Provides LCR-covered banks the ability to comply with Basel III and continue to serve local and state public depositors Data from Georgia Bankers Association 33

34 Multibank Pledging Pool Public Depositors: Deposits with large banks will be monitored in a contingent liability statewide pool Collateralization percentage tiers set quarterly by Banking Commissioner based on the health of the bank Banks: Increased liability to cover losses caused by other institutions Increased reporting Increased transparency Data from Georgia Bankers Association 34

35 The State of Virginia Pooled Method

36 Collateralization of Public Deposits - Virginia Two choices: Pooled Method Dedicated Method Annual Election Period November 1 through December 1 for next calendar year 36

37 Virginia Pooled Method Liable for proportionate share of losses of uninsured and uncollateralized public deposits held by a pooled bank in default Tiered collateral requirements from 50% to 100% based on public deposit balances 100% collateralization of public deposits if ranked below average by bank rating service used Monthly reporting of public deposit balances Monthly reporting and pricing of collateral 37

38 Virginia Pooled Collateral Requirements Dollar Amount of Public Deposits above FDIC Required Collateral % < $50MM 50% $50MM to $250MM 75% > $250MM 100% 38

39 Virginia Pooled Method Collateral Calculation Public Deposits (net of FDIC) $500,000,000 Collateral Requirement Tier 1 (50% of $50 million) $ 25,000,000 Tier 2 (75% of $ 200 million) $150,000,000 Tier 3 (100% of excess balances) $250,000,000 Total $425,000,000 39

40 Virginia Dedicated Method Not liable for losses of public deposits held by other public depositories Can only look to collateral pledged by opt-out bank to cover losses of public deposits if that bank fails Collateral requirements based on financial strength of each banking institution using bank rating service Strength Collateral % Superior 105 Average 110 Below Average 120 Lowest Rating 130 Weekly reporting of public deposit balances Web-based reporting system with built-in edits Weekly pricing and reporting of securities 40

41 Virginia Dedicated Method Collateral Calculation Public Deposits (net of FDIC) $500,000,000 Collateral Requirement Bank rated 110% $550,000,000 41

42 Virginia Collateral Calculation by Bank Type Deposit Amount $500,000,000 Required Collateral Amount Dedicated Bank (105%) $525,000,000 Dedicated Bank (130%) $650,000,000 Pooled Bank $425,000,000 42

43 Virginia Statistics as of June 30, 2016 Total Public Deposits $8.8 billion (net of FDIC coverage) Total Market Value Collateral $9.8 billion Total Required Collateral $8.6 billion Percentage of Public Deposits held by the four largest Public Depositories 59% Total Qualified Public Depositories

44 Composition of Virginia Program - June Dedicated Banks Pooled Banks 44

45 Distribution of Virginia Deposits - June 2016 Total $8.8 Billion 30% 70% Dedicated Banks $6.2 Billion Pooled Banks $2.6 Billion 45

46 Composition of Pooled and Dedicated Banks - Virginia 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 30% 68% 70% 32% # of banks $ deposited Pooled Banks Dedicated Banks 46

Regulatory Practice Letter December 2013 RPL 13-20

Regulatory Practice Letter December 2013 RPL 13-20 Basel III Liquidity Coverage Ratio Proposal of U.S. Bank Regulators Executive Summary The Federal Reserve Board (Federal Reserve), the Office of the Comptroller