A governmental entity in Pennsylvania may deposit its moneys in a financial institution only if the financial institution pledges collateral for the deposit to the extent the deposit exceeds the FDIC insurance limits. This requirement applies to any public deposits, including, for example, deposits in a checking or savings account and certificates of deposit.
The most common way for financial institutions in Pennsylvania to satisfy this requirement is under the statute commonly referred to as Act 72 (72 Pa.Stat.Ann. § 3836-1 et seq.) The Pennsylvania Legislature enacted Act 72 in 1971, and amended it in 2000, to enable financial institutions to pledge collateral on a pooled basis to secure public deposits in excess of the FDIC insurance limits.
Rather than having to pledge a separate amount of collateral in a separate pledge account for each public depositor, which would be time consuming and expensive, the financial institution can set up one collateral account under Act 72 to secure all of its public depositors. If the financial institution should fail, the public depositors are secured proportionally by the collateral.
Act 72 is not a perfect statute. It has some weaknesses, particularly from the depositor's point of view. These weaknesses can be addressed through an agreement between the depositor and the financial institution.
Here are some areas of concern with respect to Act 72 pledges:
The collateral is valued under Act 72 at face value, not market value. Of course, the face value of a security has no direct relationship to its market value. A financial institution could legally pledge collateral with a face value much higher than its market value. If the institution goes under, the public depositors will only get a portion of their deposits back. Public depositors should require financial institutions to use market value.
A broad range of securities may be pledged as collateral. The permissible securities are listed in United States Treasury Circular No. 92 (as of November 1, 1971). Typically, financial institutions will pledge U.S. Government and federal agency securities which are generally secure and capable of valuation. But the list of eligible collateral under Treasury Circular No. 92 is quite broad and includes municipal bonds and corporate securities which can be illiquid and hard to value. Public depositors should require that only federal securities be pledged.
Although Act 72 requires the collateral value to be constantly maintained, there may be financial institutions which do not undertake frequent valuations. Public depositors should receive confirmation that the collateral is being marked to market frequently – daily or weekly valuation is good; valuation less frequently than monthly is probably not a good arrangement for the depositors.
Public depositors need to know who holds the collateral. Under Act 72, the custodian of the collateral may be the financial institution's own trust department or it may be another Pennsylvania financial institution. The public depositor should make sure it is comfortable with the custody arrangement. Obviously, an independent, third party custodian is the safest structure. If the financial institution is serving as its own custodian, the public depositor should check that the collateral is being held in a separate Act 72 account in the financial institution's trust department.
Many public depositors never check the collateral in the financial institution's Act 72 account. Act 72 permits the public body to request periodic reports from the depositary and the custodian on the status of the public deposits and the collateral. Every public depositor should request such reports on a monthly basis.
Act 72 provides that a financial institution "may pledge assets to secure public deposits on a pooled basis." It does not discuss perfection of the pledge.
The federal savings and loan bailout statute enacted after the savings and loan crisis of the 1980's (known as the Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended) (FIRREA) provides in 12 U.S.C. § 1823(e) that a collateral pledge agreement will not be valid against the FDIC if it does not meet three specific requirements.
The three FIRREA requirements are: (a) the agreement is in writing; (b) the pledge is approved by the board of directors or loan committee of the financial institution, and such approval is reflected in the minutes; and (c) the approval is kept continuously as an official record of the financial institutions.
Given this federal statute, it is crucial for the depositor to have a written agreement with the financial institution regarding the deposits secured by the Act 72 collateral. The written agreement can address the issues described above, such as marking the collateral to market, the type of securities that may be pledged as collateral, the frequency of valuation, the identity of the custodian, and the frequency of reports.
If a financial institution is interested in obtaining public deposits, it should prepare a form of agreement that includes the protections for depositors described above. A fair agreement will encourage governments to deposit their public funds with that financial institution.