First Chicago Collateralizes State Cash with Surety Bonds

First Chicago Corp. may have found a partial solution to a perennial problem for banks: satisfying state and local governments that their deposits are safe.

The task has become a major headache as interest rates have come down. When yields were higher, banks did not mind holding U.S. Treasury securities as collateral, which state and local governments usually require. Now, however, clipping T-bill coupons does not generate enough return.

First National Bank of Chicago, the holding company's lead bank, won approval last week from Illinois to back the state's deposits with surety bonds. This way, the bank does not have to collateralize the deposits with U.S. securities.

Municipal Bond Insurer

The bank's partner in the arrangement is MBIA Corp., holding company for Municipal Bond Investors Assurance Corp., Armonk, N.Y. A major insurer of municipal bonds, MBIA in the second quarter alone sold credit enhancement policies on $8.6 billion of municipal issues.

To the extent governmental treasurers accept MBIA guarantees in lieu of U.S. securities as collateral, First National Bank can escape the burden of buying otherwise-unwanted U.S. issues that it, in turn, must capitalize, said William B. Nurre, a vice president in the bank's municipal division.

The volatility of government checking accounts makes this option valuable. Under traditional collateral arrangements, each dip or rise in account balances may force the bank to buy or sell U.S. securities.

These seesaw swings can disrupt a balance sheet.

At First National, for example, balances held in state and political-unit transaction accounts fell by 32% during the third quarter of 1990, soared 173% in the fourth quarter, and fell 49% in the first quarter of 1991, according to data from W.C. Ferguson & Co., Irving, Tex.

"Balances lift and fall like an elevator," said James E. Malling, an executive at MBIA.

Though portrayed as valuable, the surety arrangement won't have a major impact at First National. Ferguson & Co. said the bank's $141 million of transaction accounts from state and local governments comprised a scant 1.07% of total deposits at March 31.

And nationwide, U.S. banks at that date held $30.6 billion of such deposits, or about 1.15% of the total, according to Ferguson & Co. That suggests that the burden for treasurers, though widespread, is not crushing.

35 States Allow It

Mr. Malling of MBIA said 35 states have laws permitting their treasurers to accept surety bonds bought by banks holding state deposits. In fact, he said, this was standard practice several decades ago.

Still, it does not appear that state treasurers will stampede to endorse surety bonds. In Texas, for example, Assistant Deputy State Treasurer Linda Patterson expressed hesitance to exchange the liquidity and safety of U.S. government securities for "a private guarantee" as collateral.

And in this era when insurance companies themselves are having troubles, Ms. Patterson said, treasurers would have to monitor the credit ratings and performance of companies issuing surety bonds.

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