1 Establishing the Municipal Bank of Los Angeles : A Conceptual Framework Br iefing paper prepared for Alliance for Community Transit – Los Angeles http://allianceforcommunitytransit.org Author: Karl Beit el kbeitel@earthlink.net Director, Municipal Finance Project Contents This briefing paper covers a broad range of issues, and serves as a guide to allow readers to focus on areas of particular inter est. It is r ecommended that the Executive Summary be read in full. Each subsequent section can be read independently of the rest of the document , based on the particular interest and concern of the reader Introduction /Executive Summary : The Municipal Bank of Los An geles (pp. 2 – 8 ) Section I: Operational Structure, Ca pitalization and Funding (pp. 8 – 26 ) Formation of a Public Depository Bank: A Multi - phase Process (pp.8 – 9 ) Operation al Structure (pp. 9 – 11 ) Capitalization (pp. 11 – 14 ) F unding t he MBLA (pp. 14 – 19 ) Becomin g the City’s Prim ary Depository (pp. 19 – 26 ) Section II. Parterships and Secondary Markets (pp. 26 – 31 ) Section III: New Option s for Affordable Housing (pp. 31 – 40 ) Appendix A: Assumptions Underlying Esti m at es of Affordable Housing Production (pp. 40 – 43 ) Appendix B: Outline of Steps to Establish a Municipal Bank and Commence Operations (pp. 43 – 45 ) 2 I ntroduction /Executive Summary : The Municipal Bank of Los Angeles A Municipal B ank is a publicly owned , legally independent corporate banking entity se t up by the City to mobilize and redirect public resources into investments in affordable housing, provision of below - market - rate loans to qualifying small business, and infrastructure financing . While a Municipal Bank of Los Angeles ( hereafter MBLA , or Mu nicipal Bank ) could be operated as a depository institution for households and small businesses, the model recommended here is a community partnership and wholesale investment bank. There are many benefits a Municipal Bank would provide to the City of Lo s Angeles and it’s residents. The Municipal Bank will make loans to support affordable housing development, in the form of both construction loans and long - term bond and mortgage loans for multi - unit housing developments. A Municipal Bank could, over time, be expanded to become a significant supplier of long - term affordable housing credit. A Municipal Bank could fund a property acquisition program that would acquire existing rental properties and place them into permanently affordable cooperative housing ar rangements and land trusts. The Municipal Bank could purchase municipal bonds to support targe ted infrastructure investments that meet the Bank’s environmental and economic equity objectives. The Bank will make loans to small businesses and microenterprise s located in lower - income, historically underinvested neighborhoods . In each case, the Bank can serve as sole originator, or convene loan participations in partnership with community banks and credit unions. The Bank could be scaled to become the City’s pu blic depository, and could potentially provide banking services to pension funds, public sector unions, and nonprofit organizations. The Bank could serve as a source of targeted lending for infrastructure projects and small business development. A Munici pal Bank could set up endu r ing partnerships with local credit unions and community banks through loan participations and equity commitments. These partnerships would significantly boost total lending for projects that further the Bank’s founding social goa ls and policy objectives – supporting residential affordability, environmental sustainability, and more socially equitable forms of economic development. The Bank could also endeavor to create new securitization platforms and secondary markets to tap the c apital markets, redirecting the vast financial resources of managed pension funds, mission - aligned philanthropic foundations, and socially responsible investment funds back into urgently needed local investments. Risks Need to Be Recognized and Managed Forming a Municipal Bank entails risks. Some of the primary types of risks that must be contemplated and managed are: • Credit risk: T o the extent that the City commits financial resources to capitalize and fund a Municipal Bank, the capital and funding co mmitments of the City become exposed, via the Bank, to the risk of losses in the event of a borrower’s default. 3 • Liquidity risk: T he City is exposed to liquidity risk if the City needs to access funds that have been lent to the Bank over a longer term and /or needs the Bank to redeem these liabilities at maturity, and the Bank has trouble finding other buyers of newly issued replacement securities. • Interest rate risk: B ecause the Bank will fund longer - term loans by issuing short er - term liabilities, if int erest rates rise the Bank could find itself forced to pay interest rates on debt securities and deposits that exceed the rates earned on the Bank’s loan s • Bond rating risk: F orming a Bank raises the specter of a downgrading of the City’s credit rating by the major rating agencies. While it is relatively straightforward to incorporate the Bank in a manner that shelters the City from any claims on its own assets beyond the funds committed to the Bank, the risks inherent in forming a Municipal Bank need to be recognized, and safeguards put in place to e nsure these risks are fully accounted for and rigorously managed. Credit risk can be managed provided the Bank has strict underwriting standards and safeguards in place, as well as mechanisms to prevent becom ing overexposed to cyclical instabilities in the real estate market. City deposits can be secured by holding collateral in the form of high - quality liquid securities (US Treasury notes and other government secu rities) and through Federal Home Loan Bank let ters of credit Liquidity risk can be managed by becoming a member of the Federal Home Loan Bank , which would allow the Bank access to Federal Home Loan Bank collateralized advances As part of contemplating the formation of a Municipal Bank, the City shou ld convene meetings with the credit rating agencies to determine how they are likely to assess the rating impacts of the City’s proposed capitalization and risk management standards. Risk m anagement is a technical topic. For this reason, I will not addre ss these issues at any length in this briefing paper, but defer more in - depth cons ideration to a subsequent briefing . For readers interested in additional discussion, please see The Municipal Bank: Compliance, Capitalization, Liquidity, and Risk http://rooseveltinstitute.org/municipal - bank - regulatory - compliance - capitalization - liquidity - and - risk/ Some General Characteristics The primary o bjective of this briefing paper is to outline a public banking model that is defined, at least in its initial stages, by two predominating characteristics. One , it is assumed the Municipal Bank’s depository functions are, at least initially, limited to pro viding banking services solely to the City. This restriction can be relaxed – there is no reason, provided the Municipal Bank can acquire a state banking charter, that the Bank could not provide depository services to other cities and counties, enterprise departments, and institutional depositors such as unions, nonprofit organization, pension funds, and foundations. 4 Second, the model outlined below assumes the City of Los Angeles and County of Los Angeles are willing to commit on the order of 3 – 4% of tot al General Fund portions currently under the fiduciary oversight of the Treasurers in the City ’s and County’s respective investment pools to provide low - interest, stable, long - term funding commitments to the Municipal Bank for its lending programs. Transfe rring funds from the investment pool to the Municipal Bank creates the major source of ongoing exposure of the City (and County). The risk exposures of the City and County investment pools can be managed provided the capital - to - risk weighted asset ratio of the Bank at all times exceeds the ratio at which the FDIC defines a commercial bank as “well capitalized ” 1 The Potential Benefits of a Public Bank are Multiple and Varied The primary advantage offered by a Municipal Bank is the creation of a dedicated , multi - purpose entity that combine s a multitude of capacities required to identify, underwrite, and originate low - cost, high - impact credit , enabling the City to pursue more socially beneficial and economic ally just forms of economic development. With a Mu nicipal Bank , the public sector could offer an alternative to the current regime of forced reliance on private investors and the private, for - profit housing market to try to capture limited affordability set - asides, and the all - to - often marginal community benefit agreements leveraged from City - supp o r ted private development initiatives. Moreover, a Municipal Bank can help ensure that future housing development linked to publicly funded transit investments do es not result in rampant and widespread displacemen t of residents of predominantly African American , Asian, and Latino working - class neighborhoods. Some of the key features of the MBLA and the scale and scope of its potential impact include : • Establishing a set of correspondence bank relations with partn er community banks to begin providing the City with limited depository services prior to receiving a state bank ing charter. Correspondence relationships will allow the City to shift to the MBLA various cash management, payment , and settlement functions, an d merchant banking services. Over time, as these correspondence relationships are developed, the MBLA will acquire the technical and logistical capacities to allow the City to shift all core depository and merchant banking functions to the Municipal Bank, which will thereafter serve as the City’s primary depository agent . Moving the City’s core deposits and cash management accounts to the MBLA would provide about $100 million in annual funding to support loans that meet the MBLA’s social and economic object ives. 1 There are additional provision s, such as liquidity coverage ratios, that, while not binding on the Municipal Bank due the Bank’s mode st size, should nevertheless be satisfied to e nsure the Bank is fully insulated against funding runoffs in the event of a systemic banking crisis. Moreover, as I show below, the Bank can , in principle, be constructed in a manner that e nsures public deposit s are “ over - collateralized. ” The Municipal Bank can also seek letters of credit from the FHLB to provide additional liquidity guarantees to longer - term lending commitments funded through the reallocation of investment pool assets 5 • At the City level, the main source of support for the Bank’s lending programs will be provided by reallocating up to 3 – 5 % of the approximately $ 4. 9 billion General Fund share of monies currently under the Treasurer’s fiduciary management to finance lending for affordable housing and targeted infrastructure investments • At the County level, the County of Los Angeles Treasurer and Tax Collector oversee the county investment pool , which current ly has $34.9 billion in total fu nds under management . Real locating a small portion of these funds – for instance, as little as 1% of total funds current under Treasury management – to purchase liabilities and make placements into funding accounts offered by the Municipal Bank could provide funding for upward s of $349 million in new loans and investments. • Under modest capitalization and funding assumptions – for instance, a shift of the City’s core banking deposits and reallocation of funds from the City and County investment pool to finance the MBLA lending prog rams – the Bank could be managing a loan portfolio of upwards of $1 billion in total assets within 10 years after commencing initial operations. • Additional funds could be raised by selling medium - term notes and other short - to medium - term securities to e ntities such as pension funds, mission - aligned foundations, and socially responsible investors (SRIs) . A reasonable target for total funds procured through these channels is likely to be on th e order of $15 0 million within 10 years of commencing operations , and could be higher depending of the size and depth of these funding networks. • The MBLA can cultivate a network of secondary market participants amongst pension funds, mission - aligned foundation s , and SRIs that would purchase securities backed by under lying pools of loans the MBLA and its partner entities (credit unions and community banks) would originate. This is a potentially very high - impact strategy for funding the MBLA loans and investments, as loans could be transformed back into reserves to supp ort the issu anc e of additional credit. These arrangements would allow the MBLA to finance a far larger volume of loans than it could if the majority of new loans were held to maturity on the MBLA’s own balance sheet. • Precedents already exist for these ty pes of arrangements – t he Economic Financial Initiative fund operated by the New York City Employee Retirement System has authorized the allocation of up to 2% of total funds under management to provide financing to underserved businesses and neighborhoods , an example of the type of funding arrangement s that could be administered . The pension funds connected to the City and County of Los Angeles could set up similar types of commitments, and use the MBLA as the conduit to redirect these dedicated funds into local investments that meet the City’s affordable housing and community development targets. 6 • To enhance the impact of loans issued through its own balance sheet, the Municipal Bank will enter into partnerships with credit unions and community banks throu gh loan participations and syndication arrangements. Participations will allow the loans issued by the Bank through its own balance sheet to be amplified at ratios from 50 % to 500%, depending on the nature of such arrangements and the number of loan partic ipants. Assuming a 1:1 participation ratio, for instance, means that each dollar committed by the MBLA ends up supporting $2 in new lending for affordable housing and targeted community economic development. • Funding arrangements made possible through the MBLA would allow the City to leverage current federal, state, and local funds that support affordable housing to finance the production of a potentially far large r number of total affordable housing units. To realize the full funding potential of the MBLA in relation to affordable housing development, it will be necessary to develop mixed - income housing projects consisting of both “market rate” and “below market rate” units that are developed and built by nonprofit and public sector developers wil l ing to f ully forgo profits. As shown below, lending programs that could be established and managed by the MBLA would allow existing affordable housing funding sources (the City of LA Affordable Housing Trust Fund, Low - Income Housing Tax Credit , and conduit financi ng) to be leveraged to support an increase on the order of 300% o r greater th a n the total production levels possible under present funding arrangements. • In addition, the MBLA could provide flexible terms and term extensions on lines of credit and 1 - to 3 - year loans to affordable housing developers to acquire existing properties, with an emphasis on working - class neighborhoods with a high proportion of people of color that are experiencing, or likely to experience, gentrification and involuntary displaceme nt. The MBLA could also provide long - term multi - unit mortgage financing, allowing the City and nonprofits to acquire thousands of units of existing housing that would be permanently removed from the for - profit segment of the local housing market. The Ci ty Has a Variety of Options to Capitalize and Fund a Municipal Bank There are several local and public sector sources that can be used to capitalize the Municipal Bank of Los Angeles, all of which are discussed in detail in the sections that follow. First , the City Council has the authority to authorize the withdrawal of a portion of unrestricted surplus monies held in the City investment pool. Second, additional sources of initial capital can be provided through a series of limited, annual line - item appro priations from the General Fund. Third, shares can be sold to other public sector entit i es and other local governments. The MBLA will fund its loans through a variety of pub lic and private sources: 7 • Surplus funds held in the City investment pool can be lent to the MBLA on a short - term basis , with funds available for withdrawal on one - day notice without penalty • The Municipal Bank can establish Supplemental Reserve Accounts that will receive fund ing from public and private entities in the form of low - inte rest loans that will reach maturity in 1 to 5 years. • The Municipal Bank can sell medium - term notes (liabilities that allow the Bank to borrow funds for a 1 - to 5 - year duration) to the City and County Treasurer’s pool, provided the MBLA has a credit rating of “A” or higher from a Nationally Recognized Securities Rating Organization (NRSRO) as required by California Government Code Title 5, Chapter 4, Article 1, Section 53601 • The Municipal Bank can sell medium - term notes to any private entity, such as pens ion funds, foundations, and socially responsible investment funds (SRIs), subject only to the Bank’s own discretion regarding funding needs and these parties’ willingness to purchase the Bank’s liabilities If the MBLA acquires a state banking license, the Bank can fund its loans and investments by receiving and managing government and institutional bank deposits. Particular benefits will be concentrated in the areas of affordable housing and economic development initiatives in low - income neighborhoods As shown in the second section of this report, a M unicipal B ank could very significant ly increase the production of housing affordable to households earning between 60% and 80% of Area Median Income. This includes both new development and acquisition of ex isting rental properties in neighborhoods threatened by involuntary displacement. However, because the Bank is a credit - granting institution, reali zing the Bank’s potential impact will require the City and nonprofit developers to contemplate certain change s in how the City subsidizes affordable housing development. T his issue is discussed in more detail in Section III of this report. Small business lending and funding for targeted community economic development initiatives is another area in which the Ban k could have a major impact. This includes small business loans that will prioritize economically viable minority - and women - owned businesses, as well as small and medium - size business es that pay living wages and offer their employees meaningful training a nd career advancement opportunities. In addition, the Bank can be a source of social venture capital funding to provide seed money for small - scale initiatives; financing for non - exploitative microenterprise s ; and funding for worker cooperatives and other c ooperative social enterprises. A Municipal Bank Will Enhance I ts Impact Through a Set of Supportive Networks and Joint Funding Arrangements 8 To have maximal impact, the MBLA will cultivate a system of mutually supportive relationships with existing financ ial institutions such as credit unions, community banks, and Community Development Financial Institutions (CDFIs). In addition, the MBLA will undertake and establish a new set of secondary market s for loans the Bank and its partners will originate. This wi ll allow the MBLA to underwrite and then sell loans to institutions such as pension funds, philanthropic foundations, and socially responsible investment fund s , converting illiquid loans into cash that can be used to support the funding of additional loans that meet the Bank’s found ing goals and objectives. This point is fundamental to envisioning how a Municipal Bank would operate. Convening and organizing a set of complementary funding and lending networks will allow the Bank to significantly increase i t s impact on the trajectory of the r egion’s economic development , through linking the large capital pools controlled by more progressive and socially conscious sectors of the institutional investor networks with local circuits of housing investment and equ ity - based economic development. Briefing Paper Outline This briefing paper is organized as follows : I t lays out the steps that must be taken to establish a municipally owned bank, and various pathways through which the City can contemplate the B ank’s in corporation and establishment as a viable, ongoing concern. This is followed by a brief outline of the operational and divisional structure of the p roposed Bank. I t then discuss es capitalization and funding in more depth and gives an overview of partnershi ps with local lender s as well as ways the Bank could set up and operate secondary markets for loans the Bank will originate. Given the concern in Los Angeles to address the City’s housing crisis, the briefing then present s an analysis of the potential impa ct a Bank could have on funding higher levels of affordable housing production, and the changes that would need to take place to realize the full potential of funding affordable housing through the conduit of a Municipal Bank. Section I: Capitalization a nd Funding Formation of a Public Depository Bank: A Multi - phase Process This report recommends conceptualizing the formation the municipal bank as a multi - phase process. The first phase will involve incorporating a new publicly owned financial instituti on that will perform certain bank - like functions : issuing liabilities, using the proceeds to finance loans, and potentially coordinating cash manag e ment, settlement, and payment clearing functions on behalf of the City. This option allows the City to immed iately begin to establish many of the core funding and lending operations , as well as the supporting set of complementary relationships with local credit unions, other banks, and non - public providers of funding (pension funds, foundations, socially respons ible mutual funds) that will support loan origination. The framewo rk outlined below allows the MBLA to be constituted in a manner that lays the foundation for ramp - up into a full - fledged depository institution. Significant 9 uncertainty currently exists as to whether the CA Department of Business Oversight will require the MBLA to qualify for FDIC deposit insurance as a precondition for a warding a state banking charter. It is necessary to create a framework that can institute many of the basic funding struc tures and lending programs (see below) that lay the foundation for acquiring a state bankin g charter, assuming no change in state law. At the same time , the basic model is essentially identical to the nature of the institution that would be established if the Municipal Bank were incorporated , from its inception , as a state - chartered depository institution. The major distinction has to do with the ability of the Municipal Bank to be the agent that will actually hold deposits on behalf of the City. This pap er also outline s a novel approach through which the Municipal Bank begin s to assume responsibility for many of the City’s core banking operations without needing to acquire a state banking charter. This option allows the City to begin to scale up an instit ution that can provide a broad range of core depository functions, and fund a range of lending programs , while remaining exempt from state laws that, as currently written, would constraint the ability of a state - chartered Municipal Bank to serve as the Cit y’s primary public depository. Operational Structure The MBLA would be divided into two broad operational divisions. The Lending Division would oversee the Bank’s underwriting and loan organization, monitor assessment of participation loans, and operate the Bank’s securitization p latform. The Payments and Liquidity Division will oversee cash management functions, including e nsuring that the Bank can at all times make payment of all maturing liabilities (medium - term notes) and meet demands for cash withdr awal. Lending Division Lending Department : O versees lending operations; manages credit risk, assessment of participation programs and secondary capital injections, quality controls , and underwriting provisions; monitors the balance sheet and performanc e of the Bank’s partner organizations Secondary Markets Program : O perates and manages the Bank’s securitization platform in partnership with participating credit unions and community banks; maintains and expands network of mission - aligned socially respo nsible mutual funds, public pension funds, and philanthropic foundations that provide a secondary market for loans originated by the Bank and its affiliates. Payments and Liquidity Division Risk Control and Liquidity Management Department : M anages the f unding (liability) side of the Bank’s balance sheet; e nsures the liquidity of deposits; monitors and manages rollover and refunding risks ; interacts extensively with the Office of Finance and the Federal Home Loan Bank to coordinate and execute letters of cr edit program and FHLB 10 advances; m anage s payment clearing and settlements through the MBLA network of correspondence relations. Technology Department Manages IT needs, logistical operations, maintenance of software programs , and compliance with indust ry technolog y standards Community Outreach, Marketing, Public Outreach and Education Division Does publicity, outreach, marketing of Ban k ’s lending programs; convenes regular community forums; manages press relations; conducts outreach to community con stituencies Research Department Conducts regular, ongoing review of existing market conditions; analy ze s various trends in vacancy rates in both residential and commercial real estate markets ; review s local economic conditions such as employment, rate of growth of key local economic sectors, property prices; analy zes financial variables and financial market conditions S ome of this work may be conducted in partnership with the Treasurer’s Office and the staff of the City’s Chief Economist. General Adm inistrative Support (1 – 2 full - time employees) Provid es general administrative support for internal audits and reviews, person ne l matters, general office matters , communications, and internal procedure and document review. Table 1 provides an estimate of non - interest operational costs over the first six years of operation. Estimates are based on the average costs for US banks with between $100 million and $1 b illion of total assets, adjusted for the fact that the proposed MBLA will not provide retail serv ices, but rather will function as a “ wholesale ” lender and engage in extensive participation loans. The MBLA is here also assumed to only offer depository services to the City. These factors significantly reduce estimated costs. 11 Capitalization As of 3/31/2018, the investment pool of the City of Los Angeles had $9 55 billion in funds under the fiduciary oversight and management of the Office of Finance. Of this total, approximately $4.9 billion represents the General Fund share – i.e., monies placed i nto the pool that represent surpluses appropriated but not needed for immediate use in conducting the City’s ongoing daily operational expenditure. 2 The remaining balance of approximately $4.7 billion represents surpluses received from other local enterpri se departments and agencies that hold surplus funds in the investment pool. The Office of Finance manages and invests these funds in a blended manner, as opposed to operating separate short - term investment accounts for each participa ting member . As of 5 /31 /2018, the amount of $ 3.772 billion was in the “core portfolio , ” or short - term investments with an average maturity of 108 days, and the remaind er of $6. 801 billion was in the “reserve portfolio” with an average weighted maturity of 2.8 years. As seen in F igure 1 , the total amount of funds under management by the Office of Finance has grown by almost 80% over the last eight years, due to the accumulation of ongoing financial surpluses linked to unspent appropriations in the General Fund, the reinvestment of earnings on investments, and increased placements of surplus funds made by the City enterprise departments. 2 As of May 31, 2018, th e amount of funds in the Investment Pool had risen to $10.57 billion Table 1: Cost of Operation Estimates Year of Operation 1 (2020) 2 (2021) 3 (2022) 4 (2023) 5 (2024) 6 (2025) Expense category Salary executive management (CEO, CFO) $700,000 $700,000 $700,000 $700,000 $700,000 $700,000 Salary staff (27 FTE employees) $1,500,000 $3,543,750 $3,543,750 $4,219,375 $4,556,250 $4,556,250 Amortization $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 Rent, other occupancy-related costs $1,200,000 $1,200,000 $1,200,000 $1,200,000 $1,200,000 $1,200,000 Other $2,000,000 $2,000,000 $2,500,000 $2,750,000 $3,000,000 $3,000,000 Total annual operational costs $5,500,000 $7,543,750 $8,043,750 $8,969,375 $9,556,250 $9,556,250 (Estimates make no adjustments for COLAs or Producers Price Index) 12 Funds are invested according the terms set out in Section 53631 (a) - (p) of the California Government Code for the ongoing operations of local government and enterprise departments. The majority of the funds are invested in US Treasury notes and US government bonds of up to five years in duration, as well as commercial paper and various debt securities issued by major corporations with high - quali ty investment - grade ratings. Of the General Fund portion of the pool, some percentage of these funds will have various restrictions and assignments, and hence for accounting purposes are designated “restricted” or “assigned , ” and are not generally regarded as being available for immediate appropriation. The balance is available for use without restriction, subject only to City Council authorization. This portion was reported to be $493.8 million as of 6/30/2016, and $453.8 million as of 6/30/2017. Because t hese funds are available for appropriation, they represent a core source of any initial MBLA capitalization. The initial public sector capitalization of the MBLA can occur in two ways. The first is that the City Council may authorize the withdrawal of fu nds from the investment pool to be placed into a dedicated capitalization fund. These monies may be held under the custodial care of the Treasurer until the Bank begins official operation. At this point, the funds are used to purchase shares – common Tier I equity that will be issued by the MBLA and sold to the City. The funds so procured will be invested in short - term US Treasury notes. To get to meaningful scale, the City will need to commit on the order of $100 million to $120 million in funding over a five - year period – we should note, however, that as indic a ted above, this well below the total amount of funds available for appropriation. $0 $2 $4 $6 $8 $10 $12 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Office of Finance, Monthly Investment Reports Figure 1: Total Funds in Investment Pool (in billions), as of June 30 for each fiscal year 13 There are two sources of local funds that could be made available for the initial phased - in capitalization. The fir st is an authorization by the City Council to appropriate monies current held in the City investment pool under the fiduciary care of the Office of Finance. The legal basis and rationale for such an appropriation is laid out in full in the accompanying Are nt Fox memo. 3 The second local source is a series of annual appropriations out of the City’s G eneral F und, with fu nds utilized to provide the MBLA with additional core Tier I capital. For instance , an initial appropriation of $30 million from the investm ent p ool could be supplemented by General Fund appropriations . In the mock - up example below, I assume that total allocations from both sources are such that $100 million has been committed by the end of the sixth year. Given that the MBLA will run at a def icit over its first couple of years in operation, this level of funding appropriation should allow the Bank to become fully operational between years four and five at approximately $100 million in total capitalization. In addition, the MBLA can sell e quity participations to other local governments, public enterprise funds, the MBLA’s network of affiliated local lending institutions (credit unions and CDFIs), and private investors such a s mission - aligned philanthropic foundations. All funds committed by the City are Tier I capital, and hence represent permanent capital. Additional capitalization achieved through selling various equity participations will generally be structured as Tier II capital ; exceptions will be made for participants willing to accep t the risk associated with Tier I equity. The City will retain, at all times, ownership of over 50% of all core Tier I capital, and hence will exercise majority controlling interest in the MBLA. All City funds used for purpose s of capitalization would me et the criteria of Tier I core capital as defined by the FDIC. It is strongly recommended that the Bank maintain a ratio of Tier I capital to total risk - weighted assets of around 10%. This is above the ratio set by the FDIC of 8% at which bank is defined a s “well capitalized ” It is recommended that the MBLA manage its lending portfolio to meet or exceed this ratio in order to mitigate 3 The Arent Fox memo prepared for the San Francisco Public Banking Coalition specifically address es the formation of the public bank in San Francisco, but has many conclusions that are re levant to Los Angeles, given that both municipalities are subject to California state law. See accompanying Arent Fox, pp. 16 – 19 in particular Table 2: Proposed Capitalization Sources and Schedule Year of Operation 1 (2020) 2 (2021) 3 (2022) 4 (2023) 5 (2024) 6 (2025) Council-authorized appropriation from Investment Pool $30,000,000 General Fund annual appropriation $20,000,000 $20,000,000 $20,000,000 $10,000,000 Supplemental Tier II issue (pension funds, foundation, other governments $1,500,000 $2,000,000 $2,500,000 $2,500,000 Total Tier I Capital $46,070,000 $71,985,856 $96,320,764 $107,798,386 $104,637,056 $98,725,519 14 risk and place limits on rapid and potentially high - risk expansion of the Bank’s loan portfolio. In addition, the City ca n at any time in the future utilize year - end unrestricted surplus fund balances to make additional capital infusions into the Municipal Bank, as opposed to placing these monies into the investment pool. Decisions as to how to allocate surplus fund balances are discretionary in nature, and will be determined through the annual fiscal deliberations of the Council. Funding the MBLA Subsequent to incorporation and capitalization, the Bank must fund its loan portfolio. This section presents several mechanism s through which funds currently under fiduciary management of the Office of Finance can be reallocated while maintaining provisions to e nsure the safety of funds held in the investment pool. 1 ) Once the MBLA is established, but prior to becoming a full - f ledged depository bank, the City can begin to transfer funds currently held on deposit with the City’s current public depositories into accounts set up at the MBLA. The loans would have deposit - like characteristics, as they could be withdraw n in full on on e - day notice without penalty. This should be seen as a transitional phase that would lay the basis for the MBLA to eventually assume the role of the City’s primary depository institution (see below) . These accounts could, over time, be scaled to allow the MBLA to carry out payroll - type functions and the handling of other core fin ancial transactions of the City. Although the account balances of the City held at the MBLA have deposit - like characteristics, they are not technically deposits. Rather, they woul d be defined as loans made by the City to allow the MBLA to carry out its functions as a public instrumentality. The reason these accounts would not be deemed deposits despite one - day withdrawal without penalty is that, in the first stage of formation, if the MBLA only accepts “deposits” from the City and does not offer this type of account to any other entity, the MBLA would not meet the legal or regulatory definition of a depository banking entity. Hence, these funds, despite near deposit - like liquidity, would not result in the MBLA being defined as a bank by either the CA Department of Business or the FDIC. It follows that these funds would not be subject to the collateralization requirements set out in CA Government Code Sections 53630 - 53686. The fact that the relation of the City and the MBLA would not be subject to the requirements of CA Government Code does not imply that the City’s money should not be subject to the full protections intended by Sec 53630 - 53686. Hence, safeguards similar to those req uired by state code will need to be established to secure the funds committed by the City. Accordingly, the MBLA will need to secure agreements with the FHLB to provide letters of credit up to the full amou nt of the funds held at the MBLA. 15 All funds held by the Bank on a short - term basis will be collateralized in a manner similar to the mechanisms described in the section on collateralizing the City’s deposits , outlined in detail below under the heading Meeting Collateral Requirements 2 ) The City Counc il may authorize the establishment of a Supplemental Reserve Account overseen by the Office of Finance. A Supplemental Reserve Account (SRA) would be a separate account that exists outside the Investment Pool and would provide a separate option for inves ting the City’s surplus monies. The SRA would be structured to allow the City to authorize a transfer of funds out of the investment pool. The legal basis for the SRA is similar to that of the short - term loans described above, namely that the City Council has the authority to request a withdrawal of funds from the investment pool. The primary difference from the previously discussed loan program is that these funds would be transferred from the investment pool to MBLA over a longer period, as the SRA would have terms of 1 to 5 year s . At the expiration of this term , these funds would be returned to the investment pool . I t is understood, however, that barring unforeseen financial contingencies, funds in these accounts will be rolled over at maturity , and thus could be regarded, from the vantage point of the Municipal Bank, as a stable, long - term liability The advantage of using a Supplement Reserve Account as a funding mechanism is that these funds, because they would be a Council authorized time - dated trans fer of funds out of the investment pool , would not be subject to the provisions of California Government Code 53601 (a) - ( p). This allows the City to proving financing without the Bank having to be rated by a Nationally Recognized Statistical Rati ng Organiz ation ( NRSRO ) . Given the difficulties of achieving such a rating in the initial years of operation, a n SRA provides the means through which the City can use the resources of the investment pool to fund the Bank ’ s lending programs. To facilitate this tran sfer, the MBLA would open a designated account to receive monies transferred by the Treasurer up to the maxim um authorized amount. It is recommended that the amount that can be transferred