Standby letters of credit are available to members for a variety of purposes. They carry a Aaa/AA+ rating and offer an off-balance sheet accounting treatment for the following:
Collateralization
of Public Unit Deposits (PUD):
LOCs can be used when a member institution's public unit deposit exceeds the amount of insurance coverage provided by the FDIC or to certify that the public depositor is adequately secured. Examples include collateralization of state deposits, county deposits, school deposits, etc.
Credit Enhancement:
LOCs can serve to provide a Aaa/AA+ rating to the issuance
of debt in the form of certain taxable and tax-exempt
bonds.
Housing Related:
LOCs can facilitate the purchase, sale, or origination
of housing related mortgage loans. They may also be
used in housing construction where the LOC functions
as a performance bond.
Available Maturities:
LOCs may be issued with maturities to 10 years and may
be renewed at the FHLB Chicago 's discretion.
Community Investment:
LOCs are also available for community investment related
transactions at a lower cost. Community Investment LOCs
require a Community Investment Program application.
Pricing:
The pricing schedule for letters of credit is shown
below.
Letters of Credit are subject to the FHLB Chicago 's normal collateral requirements.
| |
Regular |
CIP |
Collateralization of
Public Unit
Deposits |
12.5 bps., $125 minimum fee |
8 bps., $125 minimum fee |
| Credit Enhancement |
25 bps. + $125 minimum fee +
legal fees |
8 bps. + $125 minimum fee + legal
fees |
| All Others |
25 bps + costs, $125 minimum
fee + legal fees |
|
In all cases, the member shall pay for any attorneys' fees, accountants' fees, or
other out of pocket expenses associated with LOCs and drafts thereunder. Normally,
there are no legal fees associated with PUDs.
Interest
Rate Swaps
An interest rate swap is a contractual agreement between two parties to exchange cash payments based upon agreed indices, payment intervals, and notional amount.
There is no exchange of principal, and the counterparty risk becomes very
important. The Aaa/AA+ rating offered by The Federal Home Loan Bank of Chicago reduces counterparty risk significantly.
Typically, swaps are used to convert a fixed rate instrument to a floating rate,
or vice versa. Swaps may be structured with maturities of six months to 10 years,
assigned forward starting dates and allowed to amortize. Additionally, put or
call options can be embedded in the swap.
Interest
Rate Caps
An interest rate cap provides protection against future increases in interest rates. In a standard cap transaction, a buyer makes an up-front payment and
receives protection against a rise in a specified floating rate index, such as
LIBOR, above a preset strike level, for a set amount and maturity. If the
floating rate exceeds the strike rate at the beginning of any payment period,
the buyer receives the difference between the market and the strike rate, times
the notional amount for that payment period.
Typically, caps are purchased to reduce floating rate debt exposure, while
benefiting from low or falling rates. Caps are sold to generate premium income.
Caps are highly flexible products that may be structured with maturities of three
months to 10 years, assigned forward starting dates and allowed to amortize.
Interest
Rate Floors
An interest rate floor provides protection against future decreases in interest rates. In a standard floor transaction, a buyer makes an up-front payment and
receives protection against a drop in a specified floating rate index, such as
LIBOR, below the preset strike level, for a set amount and maturity. If the
floating rate is below the strike rate at the beginning of any payment period,
the buyer receives the difference between the strike and the market rate, times
the notional amount for that payment period.
Typically, floors are purchased to reduce floating rate asset exposure, while
benefiting from high or rising rates. Floors are sold to generate premium income.
Floors are highly flexible products that may be structured with maturities of
three months to 10 years, assigned forward starting dates and allowed to amortize.
Counterparty Risk
Off-balance sheet derivative products are legal contracts between two parties.
If the counterparty cannot meet the contract obligations, the member is faced
with a default that could be very costly to their bottom line. The best way to
protect that from happening is to use the FHLB Chicago as counterparty.
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