Questions Persist as FHLBs Push Plan

The Federal Home Loan Banks want municipal issuers to take advantage of a provision in a new housing law that allows the banks to guarantee tax-exempt debt beyond housing deals, but some muni market participants still have questions about how this new program will work.

"What types of loans will they guarantee?" asked one bond attorney who has received numerous inquiries from issuers about the letters of credit. "How does the process work? What will be required to establish it is a safe and sound loan? And if someone wants to investigate a guaranty, who do they contact?"

To answer these questions and notify issuers in need of credit enhancement of the new opportunity, the FHLBs have launched information campaigns to tell both muni market participants and their member lender banks about the new program.

"We have been talking to bond counsel to get the word out. We're talking to state and local government agencies that we have relationships with to make sure everyone's aware of this," said Dana Yealy, general counsel for the Federal Home Loan Bank of Pittsburgh, which was in the process of issuing its first new letter of credit last week.

The 12 Federal Home Loan Banks are also currently educating their 8,100 member lender banks about the new ability, he added.

"We're basically doing a road show for our members, to educate them on this new opportunity for them," he said.

The Pittsburgh bank is bringing experts from the rating agencies and others to the member banks "to help the financial institutions who primarily weren't in the business before," he said.

Reggie O'Shields, deputy general counsel for the Federal Home Loan Bank of Atlanta, said many of the details will come down to what each member lender bank is capable of doing for issuers.

"The normal way we provide a guaranty, so to speak, is a letter of credit ... usually in the form of a confirming letter of credit that wraps around a letter of credit from a member [bank]," he said.

Under the new program, an issuer will be expected to go to a member bank for the original letter of credit, which the appropriate FHLB will then back with its own confirming LOC. As a result, the FHLB will not insure the specific deal directly, but rather will guarantee continued payments to investors if the member bank fails.

The issuer will then be able to obtain the FHLB rating for its muni bond transaction. Ten of the 12 FHLBs currently carry a triple-A rating, with Seattle and Chicago carrying ratings of double-A-plus and double-A, respectively from Standard & Poor's. Moody's Investors Service rates them all triple-A.

While issuers will reap the benefits of the FHLBs' high ratings, the federal banks will avoid much of the risk.

"The bondholder is going to see the Federal Home Loan Bank [rating], but the economics and the underlying reality is that it's the community bank lender that takes the predominant amount of the risk," Yealy said. "They take the risk of the project's default."

The FHLBs, which previously could only back taxable or tax-exempt housing deals, received the increased ability to provide credit enhancement to all types of new tax-exempt issues as a provision in the massive omnibus housing relief bill enacted into law by President on July 31.

Under the new law, the banks can only provide letters of credit to bonds issued after the law was enacted, meaning if an issuer wants the letter of credit for an existing bond issue, it would only be able to obtain one through a refunding.

The FHLB provisions in the law also contains a "safety and soundness" condition, which basically states that the FHLBs cannot lower their credit standards from where they were in April - when the legislation was written - in order to issue more letters of credit to riskier borrowers. However, since the FHLBs only provide "wrapping" letters of credit, they will not be assessing the risk of specific deals or borrowers, but rather will focus on the member bank and its credit.

"From our perspective, we shouldn't lower the requirements below what is appropriate," Yealy said. "Now, whether or not the [FHLB credit standards] in April were too high or too low, it's in the statute, so it is what it is."

Meanwhile, muni market members are in the process of digesting the new law, and determining if there are any tax issues that need clarification from the Internal Revenue Service and Treasury Department.

"We've got tax and bond counsel and underwriters, and they're going to noodle on this," said Charles Samuels, a partner at Mintz Levin Cohn Ferris Glovsky & Popeo PC here, to determine "what type of guidance needs to come from the IRS."

Samuels serves as counsel to the National Association of Health and Educational Facilities Finance Authorities, which was a strong advocate for the FHLB legislation. Samuels noted that he is not aware at this point of any tax areas of the legislation that might require IRS guidance.

While it is not known at this time if the IRS will need to weigh in on the new law, the FHLBs are hoping that significant use of the program will show Congress the program plays a viable and much-needed role in the market.

The current law allows the banks to provide letters of credit on these deals until the end of 2010. However, the institutions and their supporters are hoping that high activity will convince Congress to reauthorize the program beyond that expiration date.

"We want to see a lot of activity, so we can show Congress that it's been a useful," Samuels said.

"I've been in this system for almost two and a half decades, and this is one of those times where you can't believe the excitement, because there is a real [need] in the market," Yealy said. "This is potentially a really great solution for a lot of those issuers, so there's a lot of energy about being able to move forward quickly but prudently to empower community banks, the guys who are really on the streets throughout the country, who see every one of these projects."

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