The Federal Home Loan Bank of San Francisco -- a government-sponsored enterprise with superior credit quality -- is considering selling a $200 million tax-exempt letter of credit, a move that would substantially increase the bank's presence in the municipal market.
"One large customer has asked us for an availability for [about $200 million]," said Gary L. Curley, senior vice president of financial services at the Federal Home Loan Bank of San Francisco. "There has been some upturn in business recently."
Analysts said the planned enhancement is the harbinger of a new market sector -- tax-exempts with the "implied" backing of the federal government. In addition to the Federal Home Loan Bankers, two government-sponsored enterprises -- College Construction Loan Insurance Association and Student Loan Marketing Association -- have guaranteed municipal bonds.
Some of the drastic changes in the regulatory environment for banks have resulted in more institutions joining the home loan bank system, according to Karen Hill, senior investment officer at PNC Financial Group. "Membership has speeded up," Ms. Hill said. "You probably will see more of these deals in the future."
The San Francisco bank's housing deal, proposed for early 1992, would be the intitution's fourth tax-exempt letter of credit. The bank's first such deal was in last August, and the largest to date is a $10.6 million offering by Los Angeles sold in September. Its total municipal exposure is $22.33 million.
Letters of credit are widely used by the home loan banks, but until this year, activity was almost exclusively in the taxable commercial paper market. Ms. Hill said the 12 home loan banks issued letters of credit for $3.5 million to $4 billion annually for the past four years.
Analysts noted that tax-exempts guaranteed by the banks trade very strongly, in some cases matching Treasury prices. As a result, a strange security is evolving: A triple-A rated issue that trades on a par with debt from "natural" triple-A municipalities, yet its underlying credit quality could be very low.
"The [Los Angeles] pricing was in line with any other natural triple-A and certainly better than the other insurance companies," said Will Browne, municipal credit analyst with Philadelphia-based PNC Financial Group. "We feel good about the GSE itself, too. A lot of strength comes from the implied backing, but at the same time we feel there's enough resources there to pay" without tapping the federal government.
"Our bonds have been trading very tight to Treasuries," Mr. Curley said. "But that's not surprising to us. Quite honestly, we don't have any interest in following these things."
"Generally speaking, we are very highly regarded by the marketplace and by the rating agencies as the only GSE that could get a triple-A on its financial condition," he added. "And our prices are very attractive; it's probably extremely cost-effective to use our letter of credit."
Very attractive is an understatement. Mr. Curley said the bank charges a uniform 15-basis-point fee, regardless of credit quality, size, or sophistication. Other letter-of-credit banks place enormous emphasis on credit quality, charging more than 50 basis points for weak A-rated credits, and, in fact, steer clear of housing deals altogether.
The San Francisco bank has a AAA rating from Standard & Poor's Corp.
Lisa Pent, assistant vice president at Fuji Bank Ltd., the number one letter-of-credit provider, said the current tax-exempt housing market has so many risks, from developer-based risk to low-income payor mix, the banks are shying away from the sector. As such, the home loan bank is guaranteeing issues that "slipped through the cracks in the past" and does not present a competitive threat, she said.
"We're not worried about them taking business away from us," Ms. Pent said. "There's definitely a need to do" multifamily housing deals. "If they figured out a way, great."
Until now, Connie Lee has been the most visible GSE in the municipal market. The bond insurer sold its first and only primary municipal bond insurance policy in late October.
Connie Lee's insurance activities are being closely watched by the municipal bond insurers, who are concerned about the GSE's possible head-to-head competition over educational borrowings. The firm is negotiating to back its second deal, slated to be a $15 million borrowing by the Massachusetts Health and Education Financing Authority.
And Sallie Mae has dabbled in the municipal markets. In 1989, the GSE, which owns 35% of Connie Lee, provided a letter of credit for a $43 million student loan borrowing by the Virginia Education Loan Authority.
Despite the creeping increase in letters of credit from GSEs, Richard Ciccarone, director of fixed income research at Kemper Securities Group, suggested the political downside to infringing on thriving private markets are too great for letter of credit banks to be worried.
"I don't expect these things to overtake the credit enhancement market," Mr. Ciccarone said. "There's an interest by the GSEs not to usurp the private sector; from a political standpoint, you'll find reluctance to increase market share substantially."
Mr. Curley of the San Francisco home loan bank said the institution's letters are "strictly" confined to housing issues. Whatever volume the bank does going forward, he stressed, will be driven by the demand from its member banks. The bank also is working with investment bankers, Mr. Curley said, "to show them what we can do."