[Federal Register Volume 63, Number 229 (Monday, November 30, 1998)]
[Rules and Regulations]
[Pages 65693-65700]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31837]
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FEDERAL HOUSING FINANCE BOARD
12 CFR Parts 938 and 943
[No. 98-49]
RIN 3069-AA61
Federal Home Loan Bank Standby Letters of Credit
AGENCY: Federal Housing Finance Board.
ACTION: Final rule.
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SUMMARY: The Federal Housing Finance Board is codifying its existing
policy on Federal Home Loan Bank (FHLBank) standby letters of credit
(LOCs) in a regulation and amending the policy to allow for broader use
of standby LOCs by FHLBank members and eligible nonmember mortgagees.
This final rule also eliminates or modifies some of the restrictions
currently imposed on standby LOCs issued or confirmed by FHLBanks that
limit the usefulness of these products to members and eligible
nonmember mortgagees.
DATES: This final rule is effective on December 30, 1998.
FOR FURTHER INFORMATION CONTACT: Diane E. Dorius, Associate Director,
Program Development, Office of Policy, (202) 408-2576; or Eric M.
Raudenbush, Attorney-Advisor, Office of General Counsel, (202) 408-
2932, Federal Housing Finance Board, 1777 F Street, NW, Washington, DC
20006.
SUPPLEMENTARY INFORMATION:
I. Background
On May 8, 1998, the Federal Housing Finance Board (Finance Board)
published, and requested public comments on, a proposed rule to add to
its regulations a new part 938, governing the issuance and confirmation
of standby LOCs by FHLBanks. See 63 FR 25726 (May 8, 1998). The
rulemaking proposed to amend the Finance Board's existing policy on
FHLBank standby LOCs to provide the FHLBanks with greater flexibility
to respond to member needs for these products in a manner that would be
consistent with the FHLBank System's housing and community investment
mission, and to codify the amended policy into regulatory form.
The ninety day public comment period closed on August 6, 1998. The
Finance Board received a total of 24 comments: eleven from FHLBanks,
two from FHLBank Advisory Councils, eight from trade associations, and
one each from an executive agency of the U.S. Government, a FHLBank
member, and a private law firm. The FHLBanks that commented generally
supported the proposed rule. The executive agency, FHLBank member and
several trade associations opposed the rule.
The proposed rule established uniform standards for the issuance of
standby LOCs that addressed eligible purposes, collateral requirements,
nonmember use of LOCs, maturity limits, FHLBank capital stock, and
other policy requirements. The purpose of the proposal, and of the
final rule, is to provide the FHLBanks with greater flexibility and
discretion, consistent with safe and sound operation, than exist under
the Finance Board's current Interim Policy Guidelines for FHLBank
Standby LOCs (Interim Guidelines).
Specifically, the Finance Board proposed that the enumeration of
specific permissible uses for FHLBank LOCs that is set forth in the
Interim Guidelines be replaced with a provision authorizing the
FHLBanks to issue or confirm standby LOCs for any of four general
purposes: to assist members in facilitating residential housing
finance; to assist members in facilitating community lending (so-called
in the final rule, this was referred to as ``targeted economic
development'' in the proposed rule); to assist members with asset/
liability management; and to assist members with liquidity and other
funding.
The proposed rule permitted FHLBanks to issue and confirm standby
LOCs on behalf of nonmember borrowers for the same purposes as members
if such LOCs were secured by Federal Housing Administration (FHA)
insured loans or Government National Mortgage Association (GNMA)
securities backed by FHA loans. Under the proposed rule, FHLBanks could
issue or conform standby LOCs on behalf of nonmember borrowers that are
state housing finance agencies (SHFAs) for residential or economic
development lending that benefits individuals or families meeting the
income requirements in sections 142(d) or 143(f) of the Internal
Revenue Code, 12 U.S.C. 142(d), 143(f), if these LOCs were secured by
collateral with which an SHFA may secure advances under section 10B(b)
of the Federal Home Loan Bank Act (Bank Act). 12 U.S.C. 1430b(b).
Under the proposed rule, all LOCs were required to be fully
collateralized at the time of issuance by collateral eligible to secure
advances to members (or, as appropriate, nonmember mortgagees) and, in
the case of standby LOCs issued or confirmed on behalf of members for
housing or community lending purposes, also by certain other high-
quality collateral. Unlike the existing Interim Guidelines, the
proposed rule neither required nor permitted outstanding LOCs to be
taken into account in the computation of a member's advances-to-FHLBank
capital stock ratio.
Finally, the proposed rule required that: LOCs have a specific
expiration date or be for a definite term; LOC renewals be conditioned
upon the member/applicant meeting the FHLBank's credit criteria at the
time of renewal; and the FHLBank issuing an LOC would approve any
transfer of the LOC.
The final standby LOC regulation remains unchanged on most
substantive points from the rule as proposed, although the Finance
Board has made several amendments for purposes of clarity and in order
to make the regulation conform to the final Community Investment Cash
Advances (CICA) regulation, (published in the November 27, 1998 edition
of the Federal Register), to which the community lending provisions of
the rule are tied. These changes are described in detail below. Also
provided below are clarifications of certain issues that were raised in
the comment letters.
II. Statutory Basis for FHLBank Standby Letter of Credit Authority
Nine commenters explicitly addressed the statutory authority of
FHLBanks to issue and confirm LOCs pursuant to the terms set forth in
the proposed rule.
[[Page 65694]]
Three of these (two FHLBanks and one trade association) expressly
supported the view that, under the Bank Act, 12 U.S.C. 1421-49,
FHLBanks have such statutory authority. Six commenters (one FHLBank
member, the executive agency and four trade associations) questioned
the statutory bases underlying the proposed rule. Two of the trade
associations, in letters that were nearly identical, queried whether
the FHLBanks have statutory authority to issue standby LOCs under any
circumstances. The Finance Board has reviewed the legal reasoning
underlying the provisions of the proposed rule and has concluded that
there is ample authority under the Bank Act to permit the FHLBanks to
issue and confirm standby LOCs under the terms of the final rule.
A. Legal Determinations of the FHLBB Regarding FHLBank LOCs
Although the Bank Act does not expressly address LOCs, the FHLBanks
have been explicitly permitted to engage in standby LOC transactions
since 1983, when the predecessor agency to the Finance Board, the
former Federal Home Loan Bank Board (FHLBB), first adopted Policy
Guidelines for Issuance of FHLBank Standby Letters of Credit (FHLBB
Policy). Underlying the adoption of the FHLBB Policy was an opinion
rendered by the FHLBB General Counsel that, because a FHLBank standby
LOC is the functional equivalent of a loan between the FHLBank and its
member, FHLBanks have authority to issue standby LOCs as part of their
power to make advances under section 10 of the Bank Act, 12 U.S.C.
1430, provided that the member has the unconditional obligation to
reimburse the FHLBank for any payment made thereunder. As an
alternative, the FHLBB further concluded that the issuance by a FHLBank
of a standby LOC on behalf of a member and payment by the FHLBank of a
draft presented by the beneficiary thereunder is incidental to a
FHLBank's payment instrument processing authority under section
11(e)(2) of the Bank Act, 12 U.S.C. 1431(e)(2), so long as the
disbursement process under the LOC is directly linked to the member's
FHLBank demand deposit account. However, having relied on the section
10 advances authority as its primary rationale, the FHLBB imposed upon
each FHLBank standby LOC at the time of issuance all statutory
requirements that applied to outstanding advances, including
requirements as to capital stock ratio and purchase, purpose and
collateral. (The Finance Board later permitted FHLBanks to issue
standby LOCs on behalf of eligible nonmember mortgagees pursuant to the
FHLBanks' section 10b advances authority. See 12 U.S.C. 1430b.)
After numerous requests over a period of years from several
FHLBanks, the Finance Board undertook a comprehensive legal and policy
review of the Interim Guidelines in order to determine whether any of
these advances-related restrictions could be eliminated, so as to make
FHLBank LOCs more useful to their members and eligible nonmember
mortgagees. As a result of its legal review, the Finance Board's Office
of General Counsel (OGC) determined that, while the legal authority for
issuing LOCs articulated in the original FHLBB legal analysis remains
valid, it is not necessary to view a LOC as an outstanding advance at
the time the LOC is issued, nor is it necessary as a matter of law to
subject LOCs to all of the statutory restrictions and limitations that
apply to outstanding advances. OGC concluded that the authority to
engage in standby LOC transactions also arises from the FHLBanks'
authority to accept deposits and process payments under section 11(e)
of the Bank Act, 12 U.S.C. 1431(e), and from their incidental authority
to enter into commitments to make advances under sections 9, 10(a), and
11(a) of the Bank Act. Id. 1429, 1430(a), 1431(a).
B. FHLBank Deposit Taking and Payment Processing Authorities
Section 11(e)(1) of the Bank Act authorizes each FHLBank to accept
deposits from members, upon such terms and conditions as the Finance
Board shall prescribe. Id. 1431(e)(1). In addition, section 11(e)(2)(A)
authorizes the Finance Board to permit FHLBanks, among other things, to
be drawees of drafts drawn on members of any FHLBank and to have such
incidental powers as the Finance Board shall find necessary for the
exercise of such powers. Id. 1431(e)(2)(A).
A FHLBank that has issued a standby LOC on behalf of a member would
be the drawee of--that is, the financial institution directed to make
payment upon--any draft presented to it thereunder. Although the funds
paid by a FHLBank to a beneficiary pursuant to a LOC draft technically
are considered to be paid from the FHLBank's own funds, a LOC draft may
be regarded as being drawn on the member's deposit account at the
FHLBank where: (1) The FHLBank maintains an absolute right, either by
contract or operation of law, to offset the member's FHLBank deposit
account in the amount of the LOC draft; and (2) the member assumes an
absolute obligation to the FHLBank to have available in its account
sufficient funds to cover the amount of the LOC draft at the time of
the FHLBank's payment thereon. Because a primary purpose of a standby
LOC is to transfer the risk of default by the applicant from the
beneficiary to the issuer, it is consistent with the reality of a
standby LOC transaction to consider payment on a LOC draft to result in
a draw on a member/applicant's deposit account. These requirements have
been imposed upon FHLBank LOC transactions since they were first
permitted in 1983 and, in commercial practice, are common to standby
LOC transactions generally.
The plain language of section 11(e)(2) makes clear that the Finance
Board's powers to authorize FHLBank activity thereunder is to be
interpreted broadly, empowering the Finance Board both to implement
definitions of terms used therein and to permit the FHLBanks to engage
in such incidental activities as the Finance Board finds necessary for
the exercise of any authorities thereunder. See id. 1431(e)(2)(A). The
legislative history of section 11(e)(2) also stresses the broad range
of activities that may be authorized thereunder, explaining that ``it
is important that the [FHL]Banks have the ability to service the broad
and evolving financial service needs of members.'' H.R. Rep. No. 842,
96th Cong., 2nd Sess. 74 (1980). Given this expansive language, and
considering that section 11(e)(2) contains no limitation as to the
subject matter of the transaction of which the draft is a part, section
11(e)(2) permits the Finance Board to authorize FHLBanks to act as
drawee on drafts drawn on a member's FHLBank deposit account as part of
a standby LOC transaction.
Regardless of the purpose for which a standby LOC is issued, the
sole substantive undertaking by the issuer is to honor any conforming
draft that is presented by the beneficiary. All other apparent aspects
of a standby LOC transaction are merely by-products of this central
obligation. For example, while one might characterize the issuance of a
standby LOC as a guarantee of the applicant's obligation, or as a
lending of credit to the applicant, such characterizations are merely
means of describing the effect of the issuer's agreement to honor a
conforming draft presented by the beneficiary. In that, under section
11(e)(2) of the Bank Act, the Finance Board may authorize FHLBanks to
execute this central obligation by making payment on a conforming draft
presented by the beneficiary, the power to agree to undertake such an
obligation (by
[[Page 65695]]
contracting therefore with the member) and the power to undertake the
obligation (by issuing the standby LOC) are well within the FHLBanks'
incidental authority to engage in activities necessary to facilitate
the exercise of the FHLBanks' authority to make payment on the LOC
draft. Accordingly, under both the express terms and the incidental
powers clause of section 11(e)(2) of the Bank Act, the Finance Board is
authorized to permit FHLBanks to contract with members to issue standby
LOCs, to issue standby LOCs, and to honor conforming drafts presented
by a beneficiary pursuant to a standby LOC issued by a FHLBank.
C. FHLBanks' Incidental Power To Enter Commitments To Make Advances
While the Finance Board has concluded that section 11(e) provides
sufficient independent authority to permit a FHLBank to engage in a
standby LOC transaction, it has not rejected the FHLBB's position that
such activity is also authorized as part of the FHLBanks' statutory
advances powers. However, the Finance Board has concluded that, in
applying the statutory advances provisions to a standby LOC
transaction, a standby LOC is characterized more logically as a form of
advance commitment than as an outstanding advance. Section 9 of the
Bank Act authorizes any FHLBank member to apply in writing for
advances. See 12 U.S.C. 1429. In turn, section 10(a) authorizes each
FHLBank to extend to members advances that are fully secured at the
time of origination or renewal by a security interest in one or more of
the types of eligible collateral that are listed in that section. See
id. 1430(a). In addition to these express powers, section 11(a) of the
Bank Act authorizes the FHLBanks to do all things necessary for
carrying out the provisions of the Bank Act and ``all things incident
thereto.'' See id. 1431(a).
D. Legal Authority for Nonmember LOCs
Because the power to enter into a contractual commitment to extend
an advance is convenient and useful in connection with the FHLBanks'
express authority to make advances and to accept applications for
advances, such power is incidental to both of these express
authorities. A standby LOC is a form of advance commitment in that both
may: (1) Involve the FHLBank entering into an obligation, intended to
benefit its member, to disburse funds at some future date; (2) require
reimbursement by the member in the event that the commitment to fund is
exercised; and (3) result in an advance. The proposed regulation
further tied standby LOC authority to the FHLBanks' power to enter into
advance commitments by authorizing the FHLBanks to issue standby LOCs
only when: (1) the member has assumed an unconditional obligation to
reimburse the FHLBank for any amounts paid to the beneficiary pursuant
to a LOC draft; and (2) prior to agreeing to issue a standby LOC, the
FHLBank performs the same type of credit analysis of the member that
would occur before entering into a traditional commitment. Accordingly,
the FHLBanks' incidental power to enter into commitments to make
advances provides an alternative source of authority for the FHLBanks
to engage in standby LOC transactions.
Because the FHLBanks' express deposit taking and payment processing
authorities set forth in section 11(e) of the Bank Act apply only to
dealings with members and those eligible to make application to become
members, the power of the FHLBanks to issue standby LOCs on behalf of
nonmember mortgagees arises only from the FHLBanks' authority, detailed
in section 10b of the Bank Act, 12 U.S.C. 1430b, to make and to commit
to make advances to nonmember mortgagees. Because the Finance Board
cannot authorize the FHLBanks, as part of this payment processing
power, to be a drawee on a draft drawn on the deposit account of a
nonmember, the provisions of the proposed rule authorizing FHLBanks to
issue standby LOCs on behalf of nonmembers is grounded entirely in the
FHLBanks' powers to make advances to nonmember mortgagees and to enter
into commitments to make such advances.
III. Comments on Proposed Rule and Analysis of Changes Made in
Final Rule
A. Definitions
Section 938.1 of both the proposed and final rules set forth the
definitions of terms used in part 938. One of the purposes for which
FHLBank members, and certain nonmembers, may issue standby LOCs under
both the proposed and final rules is to assist members in facilitating
the financing of community lending eligible for any of the FHLBanks'
CICA programs under part 970 of the Finance Board's regulations.
Because, at the time that the proposed LOC rule was published, the CICA
regulation had not been codified as a final rule, the Finance Board
included definitions of all CICA-related terms explicitly in the
proposed LOC rule for purposes of clarity. However, because the Finance
Board has now promulgated a final CICA rule, the Finance Board has
removed most of the CICA-related definitions from the final LOC rule
and has merely cross-referenced the CICA regulation, where appropriate.
The one remaining CICA-related term that is set forth in Sec. 938.1
is ``community lending,'' which is intended to refer to non-housing
activities addressed in the CICA regulation. In the proposed LOC rule,
these activities were referred to as ``economic development projects
that would benefit families with incomes at or below a targeted income
level'' (the individual terms in this phrase were each defined
separately in the proposed rule). This terminology has been changed in
the final LOC rule so that it remains consistent with that used in the
CICA regulation. Aside from the elimination of the CICA-related
definitions and the substitution of the term ``community lending,''
Sec. 938.1 remains unchanged in the final rule.
B. Purposes for Which a FHLBank May Issue or Confirm a Standby LOC
Sections 938.2 and 938.3 of the proposed and final rules govern
FHLBank issuance and confirmation of standby LOCs on behalf of members
and eligible nonmembers, respectively. Sections 938.2(a) (1)-(4) set
forth the four general purposes for which a FHLBank may issue or
confirm a standby LOC on behalf of a member, while Secs. 938.3(a) (1)-
(4) enumerate the same four general purposes with respect to standby
LOCs issued or confirmed on behalf of eligible nonmember mortgagees
that are not SHFAs. In the final rule, both Sec. 938.2(a)(2) and
Sec. 938.3(a)(2) have been amended to refer to community lending that
is eligible for any of the FHLBanks' CICA programs under part 970 of
the regulations, as opposed to ``economic development projects that
benefit families with incomes at or below a targeted income level.''
This was done in order to make clear the connection between the LOC and
CICA regulations, to eliminate the need to address in the LOC
regulation terms of art that are defined in detail in the CICA
regulation and, as explained above, to conform to the terminology used
in the final CICA rule.
Although this amended wording was not intended to result in a
substantive change, changes made to the community lending (i.e., non-
housing) provisions of the CICA regulation in the final CICA rule have
resulted in a slightly altered scope for both Secs. 938.2(a)(2) and
938.3(a)(2) in the final standby LOC rule. These changes, as well as
comments received regarding the scope of what is now termed ``community
lending,'' are addressed in detail in the preamble to the final CICA
rule.
[[Page 65696]]
Four commenters (the executive agency and three trade associations)
criticized the enumerated purposes for which FHLBanks would be
permitted to issue or confirm standby LOCs. All four commenters
expressed concern that the breadth of the proposed purposes would allow
the FHLBanks to finance, with government subsidized funds, a wide array
of economic activities and other transactions that may have little or
no relation to the FHLBank System's mission. All four also stated that
the Finance Board had failed to show that expanding the FHLBanks'
authority to issue LOCs is necessary to overcome a market failure and
that the regulation appeared to allow the FHLBanks to intrude into
private markets for credit enhancements by unfairly taking advantage of
their funding subsidy to supplant, rather than supplement, the role of
private sector financial services providers. Two of the trade
associations and the executive agency also stated that FHLBank LOCs
will serve merely as a substitute for advances.
There exists no statutory provision that limits the FHLBanks to
providing to their members and eligible nonmembers only those products
or services for which there has been a failure of the market. Moreover,
the FHLBanks have been issuing LOCs on behalf of members since 1983,
and on behalf of nonmember mortgagees since 1993, and such issuance has
not resulted in a diversion of attention or funds from the FHLBanks'
advances programs. Although a FHLBank LOC technically could be
structured so as to serve as a substitute for an advance, there are
many instances where it is more logical to provide a LOC to support a
particular transaction than an advance. For example, a LOC may be
issued to support the issuance of bonds, to guarantee a member's
performance in a swap transaction, or to secure public unit deposits.
The use of an advance to support any of these transactions would be
both cumbersome and not in keeping with modern business practices. The
Finance Board's decision to permit FHLBanks to issue or confirm LOCs
for such purposes, and for asset/liability management and liquidity
purposes generally, is in keeping with Congress's expressed desire to
allow the FHLBanks to service the broad and evolving financial service
needs of their members. See H.R. Rep. No. 842, 96th Cong., 2nd Sess. 74
(1980); 108 Cong. Rec. H4994 (daily ed. Aug. 3, 1989) (statement of
Rep. Garcia).
The only truly new use that has been authorized for FHLBank LOCs
under the proposed and final rules is for CICA-defined community
lending activities, which clearly is consistent with the System's
housing and community lending mission, and is expressly mentioned in
the Bank Act as an authorized use of advances. See 12 U.S.C.
1430(j)(10). Even this authorization is not a wholesale departure from
past practice, as the FHLBanks have been permitted since 1993 to issue
LOCs to support targeted economic development activities under their
Community Investment Programs. In addition, by permitting only mission-
related LOCs to be secured by collateral that would not be eligible to
secure advances (discussed more thoroughly below), the Finance Board is
encouraging the FHLBanks to concentrate on providing LOCs to support
mission-related activities.
C. Collateral for Standby LOCs
1. Full Collateralization
Sections 938.2(b) and 938.3(b) of the proposed rule, addressing
collateralization of member and nonmember LOCs, respectively, required
that all LOCs be fully collateralized at the time of issuance. The
Finance Board specifically requested comment on: (1) Whether there are
any circumstances under which the FHLBanks could safely and soundly
issue LOCs that are not fully collateralized; and (2) whether there are
other assets, in addition to those enumerated in the proposed rule,
that should be considered as eligible collateral for LOCs and whether
the Finance Board should establish limits on these additional types of
collateral. Three FHLBanks supported continuing to require full
collateralization of LOCs and stated that they were unaware of any
circumstance where less than full collateralization would be
appropriate or prudent. These FHLBanks also stated that they believed
the expanded types of collateral provided sufficient flexibility to
members and that maintenance of the AAA rating of each FHLBank and the
FHLBank System as a whole far outweighed any possible perceived benefit
to permitting issuance of less than fully secured LOCs.
Three FHLBanks supported giving the FHLBanks the authority to issue
LOCs that are not fully collateralized. One FHLBank stated that
commercial banks issue unsecured LOCs based on their credit
underwriting and their assessment of the business relationship with the
applicant and that FHLBanks similarly should be permitted to use their
business judgment in determining the assets it will accept as
collateral. Another FHLBank recommended that the FHLBanks be permitted
to take into account the probability of actual loss on a LOC in
determining the level of collateralization necessary.
Sections 938.2(b) and 938.3(b) of the final rule continue to
require that LOCs issued or confirmed on behalf of members or
nonmembers, respectively, be fully collateralized at the time of
issuance or confirmation. Requiring that LOCs be fully collateralized
at the time of issuance provides protection from credit risk and
ensures that a FHLBank is not involved in underwriting the transaction
that is supported by the LOC.
2. Collateral Eligible To Secure FHLBank Standby LOCs for Members
Section 938.2(c) of the proposed rule authorized a FHLBank, at its
discretion, to accept from members as collateral for LOCs for housing
and community lending purposes, in addition to the section 10(a)
collateral required for advances: secured or federally guaranteed loans
to small businesses; investment-grade obligations of state or local
government agencies; and ``other real estate-related'' collateral in
excess of the ``30 percent of capital'' limitation applicable to such
collateral used for advances, see 12 CFR 935.9(a)(4). Sections
938.2(c)(1) and (2) have been amended in the final rule to make clear
that standby LOCs that are confirmed on behalf of a member, as well as
those that are issued on behalf of a member, must be secured by assets
that fall within the enumerated categories of eligible collateral. The
words ``or confirmed'' had been omitted inadvertently from both
sections in the proposed rule.
In addition, the last sentence of paragraph (c)(1) has been amended
to eliminate reference to ``outstanding advances,'' so as not to imply
that an FHLBank standby LOC is, or must otherwise be treated as, an
outstanding advance. The first sentence of Sec. 938.2(c)(1) permits the
FHLBanks to accept as collateral for standby LOCs any collateral that
is eligible to secure advances under Sec. 935.9(a) of the regulations.
Under Sec. 935.9(a)(4) of the regulations, and as required by section
10(a)(4) of the Bank Act, 12 U.S.C. 1430(a)(4), a FHLBank may not
accept as collateral for advances so-called ``other real estate related
collateral'' in an amount exceeding 30 percent of the borrowing
member's capital. See 12 U.S.C. 1430(a)(4), 12 CFR 935.9(a)(4). As
discussed above, the Finance Board has concluded that statutory
requirements pertaining to FHLBank advances need not be applied to LOCs
at the time of issuance. Therefore, as a legal matter, the Finance
Board may permit the FHLBanks to accept ``other real estate
[[Page 65697]]
related collateral'' as security for standby LOCs without regard to the
statutory ``30 percent of capital'' limitation that applies to
advances, to the extent that the acceptance of such collateral is
consistent with the safe and sound operation of the FHLBanks.
However, as a matter of regulatory policy, the Finance Board is
permitting FHLBanks to accept ``other real estate-related collateral''
in excess of the ``30 percent of capital'' limitation only where the
LOC being secured is issued or confirmed for one of the mission-related
purposes enumerated in Sec. Sec. 938.2(a)(1) and (2). This policy is
expressed in negative terms in the second sentence of Sec. 938.2(c)(1),
which qualifies the presumption that LOCs must be secured by collateral
that is eligible to secure advances by stating that only those LOCs
that are issued or confirmed for the non-mission-related purposes
enumerated in Sec. Sec. 938.2(a)(3) and (4) are subject to the ``30
percent of capital limitation.'' In other words, Sec. 938.2(c)(1)
requires that the combined amount of advances and outstanding standby
LOCs issued or confirmed for purposes enumerated in
Sec. Sec. 938.2(a)(3) and (4) that are secured by ``other real estate-
related collateral'' may not exceed 30 percent of a member's capital.
The intent behind the second sentence of Sec. 938.2(c)(1) is to permit
FHLBanks to accept without limitation as security for mission-related
standby LOCs--that is, those issued or confirmed to assist members in
facilitating residential housing finance or community lending--``other
real estate related collateral'' referred to in Sec. 935.9(a)(4) of the
regulations.
Seven commenters (five FHLBanks and two trade associations)
supported the expanded types of eligible collateral identified in the
proposed rule. One commenter noted in particular that residential
acquisition, development and construction loans that otherwise would be
subject to the ``30 percent of capital'' limitation applied to ``other
real estate related collateral'' have proven to be profitable and
performed quite well. In addition, requiring the FHLBanks to establish
policies and procedures for valuing and securing this collateral could
allay any safety and soundness concerns. Five commenters (four FHLBanks
and one advisory council) supported leaving the eligible collateral to
the discretion of the FHLBank. Three commenters (the executive agency
and two trade associations) opposed expanding the categories of
eligible collateral for LOCs.
In the final rule, the Finance Board has retained the collateral
requirements that were included in the proposed rule. Because the Bank
Act does not specify the types of collateral that may be used to secure
LOCs, the Finance Board has the discretion to specify the eligible
types of collateral, consistent with the safe and sound operation of
the FHLBanks, and even to authorize the FHLBanks themselves to
determine the appropriate types of collateral. The proposed rule
identified additional types of collateral that may be used only to
finance activities that are clearly linked to the FHLBanks' mission of
supporting housing and community lending. Accordingly, the Finance
Board's determination to allow FHLBanks to accept such collateral is
clearly tied to a beneficial public policy goal. In addition, the
expanded types of collateral (secured or federally guaranteed loans to
small businesses, investment-grade obligations of state or local
government agencies and ``other real estate-related'' collateral in
excess of the 30 percent of capital limitation) build upon the
experience the FHLBanks currently have in valuing and securing such
collateral.
The FHLBanks already are permitted to accept ``other real-estate
related collateral'' to secure LOCs and advances (within the ``30
percent of capital'' limitation). Thus, the FHLBanks already manage the
credit, liquidity and marketability risks, as well as other risks,
associated with these types of collateral. There is no evidence that
permitting the FHLBanks to accept these types of collateral for LOCs in
excess of that which is allowed for advances will subject the FHLBanks
to underwriting tasks that are beyond their ability to manage.
With regard to the FHLBanks' acceptance of small business loans as
collateral, the Finance Board requires that the FHLBanks have
underwriting expertise and credit policies in place before accepting
such loans as collateral. Specifically, Sec. 935.5 of the Finance
Board's advances regulation, 12 CFR 935.5, requires that the FHLBanks
establish written procedures for determining the value of collateral
and to follow these procedures in ascertaining the value of particular
assets used as collateral. This requirement has been applied to LOC
transactions in Sec. 938.5(a)(1)(ii) of the proposed and final rules.
Under Sec. 935.12 of the regulations, which has also been made to apply
to LOCs under Sec. 938.5(b)(2) of the proposed and final rules, the
FHLBanks also are permitted to require a member to support the
valuation of any collateral with an appraisal or other investigation of
the collateral as the FHLBank deems necessary.
The Finance Board is requiring each FHLBank to review its
collateral procedures, and amend them as necessary to reflect the
changes made in the final rule before accepting any newly authorized
assets as collateral for LOCs. The Finance Board also expects that the
FHLBanks, as a matter of practice, will conduct careful review and, if
necessary, require an appraisal of such collateral, taking into account
the additional risks inherent in small business lending and each
FHLBank's own capability to evaluate those risks. In addition, the
FHLBanks generally require that members pledge additional collateral if
the value of their original collateral declines.
Finally, as the regulator of the FHLBanks, the Finance Board's
primary responsibility is to ensure that the FHLBanks operate in a
financially safe and sound manner. See 12 U.S.C. 1422a(a)(3)(A). The
Finance Board's oversight of the FHLBanks includes annual on-site
examinations and regular off-site review of FHLBank operations.
Emphasis is placed on areas of FHLBank operation that could potentially
expose the FHLBank and the FHLBank System to risk. As part of the
examination process, the Finance Board reviews and evaluates the
FHLBanks' management of collateral. Examiners review valuation
methodology, discounts applied to collateral, and frequency of re-
valuation for various types of collateral. In short, the above-
described FHLBank practices, regulatory requirements, and Finance Board
examination oversight, all serve to ensure that the safety and
soundness of the FHLBanks would not be compromised by authorizing the
expanded collateral options in the final rule.
3. Collateral Securing Nonmember Standby LOCs
Under Sec. 938.3 of the proposed rule, nonmember borrowers were
permitted to secure LOCs with the same types of collateral that they
may use to secure advances. Under proposed Sec. 938.3(a), nonmember
borrowers (including SHFAs) were permitted to use FHA-insured loans or
GNMA securities backed by FHA-insured loans as collateral for LOCs used
for any of the same four purposes permitted for LOCs on behalf of
members. Under Sec. 938.2(b), a SHFA may secure LOCs with collateral
eligible to secure advances under section 10(a) of the Bank Act, 12
U.S.C. 1430(a), provided the LOCs are used to facilitate residential or
commercial lending that benefits individuals or families meeting the
income requirements in section 142(d) or 143(f) of the Internal Revenue
Code.
[[Page 65698]]
See 26 U.S.C. 142(d), 143(f). Both of these provisions remain unchanged
in the final rule.
Noting that the proposed rule would permit members to use
investment grade debt securities of a SHFA as eligible collateral for
LOCs, one commenter (a private law firm) recommended that nonmember
SHFAs be permitted to obtain LOCs backed only by an investment-grade
general obligation of the SHFA, where the obligation is secured by a
statutory lien on the SHFA's unencumbered assets. The commenter stated
that the ability to combine collateral types (the SHFA's investment
grade obligation and the statutory lien, and the option of the mortgage
being financed) may be the only way to provide economical tax-exempt
financing for housing and economic development projects. While this
suggestion has logical merit, as explained above, the Finance Board has
concluded that, as a matter of law, LOCs may be issued or confirmed on
behalf of nonmembers only under the same conditions that apply to
nonmember advances. See 12 U.S.C. 1430b, 12 CFR 935.24. Therefore,
under the Bank Act, the Finance Board may not authorize a nonmember
SHFA to offer as collateral its general obligation, even under the
conditions recommended by this commenter.
D. Additional Provisions Applying to FHLBank Standby LOCs
1. Special Pricing Provisions in FHLBank Standby LOC Policies
In the final rule, Sec. 938.5(a)(1)(iii), regarding pricing
criteria that must be set forth in each FHLBank's standby LOC policy,
has been amended to cross-reference the codified CICA regulation,
thereby eliminating the need to use and define in the LOC regulation
terms of art that are explained thoroughly in the CICA regulation.
2. Cost of Capital Adjustment Factor
In the proposed rule, the Finance Board requested comments on
whether FHLBank fees for LOCs may be subject to a cost of capital
adjustment factor under section 11(e)(2) of the Bank Act, 12 U.S.C.
1431(e)(2), given that the FHLBanks' power to make payments upon
standby LOCs arises partially from the FHLBanks' payment processing
powers. Five commenters (three FHLBanks, one advisory council and one
trade association) opposed applying the adjustment factor to LOC fees.
Section 11(e)(2)(B) of the Bank Act requires FHLBanks to make
charges for payment processing services provided under section
11(e)(2), including the payment of drafts, in a manner consistent with
the criteria established for pricing of Federal Reserve Bank payment
processing under section 11A(c) of the Federal Reserve Act. 12 U.S.C.
248a(c). This statutory requirement has been implemented through part
943 of the Finance Board's regulations. 12 CFR part 943. Specifically,
the pricing of services is addressed in Sec. 943.6(b), which requires
that the FHLBanks apply a cost of capital adjustment factor to their
payment processing charges in order to take into account all direct and
indirect costs of such services and the imputed rate of return that
would have been earned and the taxes that would have been paid if the
FHLBanks were wholly private corporations. See id. 943.6(b).
Accordingly, the Finance Board has concluded that, for any draw
made by a beneficiary under a standby LOC, the applicant must be
charged a processing fee calculated in accordance with the requirements
of Sec. 943.6(b) of the Finance Board's regulations. In the final rule,
Sec. 938.5(a)(1) has been amended to add a new paragraph (iv) requiring
that each FHLBank's standby LOC policy require such a charge. This
requirement does not extend to fees, periodic or otherwise, charged to
a customer to issue, confirm, or renew a standby LOC.
In addition, in the final rule, the Finance Board has amended
Sec. 943.6(c) of its regulations to exempt fees collected for draws
upon a LOC from the publication requirement set forth therein. The Bank
Act does not require that FHLBank payment processing fees be published
in the Federal Register.
3. Members' FHLBank Capital Stock
Section 938.5(b)(2) has been amended in the final rule to make
clear that the provisions regarding advances collateral that are set
forth in Sec. Sec. 935.9(d) and 935.10 of the Finance Board's
regulations apply also to collateral pledged to secure a FHLBank LOC.
Section 935.9(d) of the regulations provides that each FHLBank shall
have a lien upon the stock of its members for all indebtedness of the
member to the FHLBank. The cross-reference to this section that has
been added to Sec. 938.5(b)(2) of the final rule is intended to make
clear that each FHLBank shall have a lien upon its member's FHLBank
stock for any indebtedness that may result from a draw upon a LOC
issued or confirmed by the FHLBank on behalf of that member. This
reference is intended only to require a lien on FHLBank stock that the
member already owns and should not be read as requiring or permitting a
FHLBank to include standby LOCs in the calculation of its members'
capital stock-to-advances leverage ratio. Stock purchase would be
required only if and when an LOC is drawn and the FHLBank and its
member agree to fund any resulting overdraft of the member's deposit
account with an advance.
Seven commenters (five FHLBanks, one advisory council and one trade
association) supported this provision. One FHLBank noted that the
elimination of the stock purchase requirement contained in the current
policy would improve the FHLBank's leverage position and make the
program more attractive to shareholders. Four commenters (one FHLBank
and three trade associations) believed LOCs, like advances, should be
subjected to a stock purchase requirement. One FHLBank noted that this
minimizes risk to the FHLBank if the LOC must be drawn upon. One of the
trade associations stated that the proposal could exacerbate the risks
to which the FHLBanks would be exposed by permitting them to deduct
LOCs from their capital calculation and from their reported balances of
outstanding advances, permitting a dangerous leveraging of FHLBank
balance sheets which would be undetectable to the Finance Board and
outside analysts. The other two trade associations stated that unlike
commercial banks or other private financial service providers, the
FHLBanks operate without an adequate cushion of permanent stock. Most
members are free to redeem their stock and give up their membership,
and in times of financial difficulty, the Finance Board is unlikely to
be able to prevent these members from fleeing the FHLBank System.
Further, they believed that the FHLBanks would issue or confirm a much
higher volume of LOCs if they are free from requirements to reserve
capital to protect taxpayers from the consequences of any mistakes.
The Finance Board's decision not to require that LOCs be included
in a member's advances-to-capital stock ratio calculation will not
undermine the safety and soundness of the FHLBank System. Under the
capital requirements of the FHLBanks specified in the Bank Act, members
must purchase capital in their FHLBank equal to the greater of 1
percent of their residential mortgage assets, 0.3 percent of total
assets, or 5 percent of their outstanding advance balances. See 12
U.S.C. 1426. These statutory capital requirements, together with the
Finance Board's regulation limiting the FHLBank System's debt to 20
times capital, assure that the FHLBanks have capital-to-asset ratios
which approximates the 5 percent ratio for well-capitalized depository
[[Page 65699]]
institutions and is about twice the 2.5 percent capital-to-asset
requirements for Fannie Mae and Freddie Mac.
On a risk-adjusted basis, the FHLBanks are even better capitalized
than the raw numbers would indicate. To be considered well-capitalized,
depository institutions must have total risk-based capital of 10
percent and, as of year-end 1997, insured depository institutions held
12.65 percent risk-based capital on average. By comparison, the
FHLBanks held over 22 percent risk-based capital at year-end 1997. As
of year-end 1997, advances outstanding to members totaled $202.2
billion and LOCs outstanding totaled $2.9 billion. Even if, as a result
of the changes in policy implemented by this final rule, the total
amount of LOCs outstanding increased, FHLBanks would remain well-
capitalized.
Because a LOC must be fully collateralized at time of issuance, a
FHLBank would have secured sufficient collateral to reimburse the
FHLBank for any draw, minimizing the financial risk to the FHLBank. In
fact, unlike commercial financial institutions, the FHLBanks generally
have required members to secure LOCs with collateral in excess of the
value of the LOC. Because the regulation clarifies that the contingent
liability of an LOC is covered by section 10(c) of the Bank Act that
provides a FHLBank shall have a lien upon the stock of a member as
further collateral security for all indebtedness of the member to the
FHLBank, the FHLBank's position would be further secured. In addition,
Sec. 938.5(a)(1)(ii) provides that a member or nonmember requesting an
LOC is subject to the same underwriting criteria that applies to the
making of advances. It is anticipated that FHLBanks will use this
information to minimize their exposure to credit risk. Therefore,
eliminating the requirement that LOCs be supported by the purchase of
capital stock does not present any safety and soundness concerns.
4. Priority Lien on Member Collateral
The cross-reference to Sec. 935.10 that has been added to
Sec. 938.5(b) is intended to make clear that the statutory priority
lien that applies to any security interest granted by a member, or an
affiliate of a member, to a FHLBank, see 12 U.S.C. 1430(f), applies to
security interests in collateral pledged to secure standby LOCs.
IV. Regulatory Flexibility Act
The final rule applies only to the FHLBanks, which do not come
within the meaning of ``small business,'' as defined in the Regulatory
Flexibility Act (RFA). See 5 U.S.C. 601(6). Therefore, in accordance
with section 605(b) of the RFA, 5 U.S.C. 605(b), the Finance Board
hereby certifies that this final rule will not have a significant
economic impact on a substantial number of small entities.
List of Subjects
12 CFR Part 938
Federal home loan banks, Credit, Letters of credit, Community
development and housing.
12 CFR Part 943
Federal home loan banks, Checks, Price controls, Reporting and
recordkeeping requirements.
Accordingly, the Finance Board hereby amends chapter IX, title 12,
Code of Federal Regulations, as follows:
1. Add part 938 to read as follows:
PART 938--STANDBY LETTERS OF CREDIT
Sec.
938.1 Definitions.
938.2 Standby letters of credit on behalf of members.
938.3 Standby letters of credit on behalf of nonmember mortgagees.
938.4 Obligation to Bank under all standby letters of credit.
938.5 Additional provisions applying to all standby letters of
credit.
Authority: 12 U.S.C. 1422b, 1429, 1430, 1430b, 1431.
Sec. 938.1 Definitions.
As used in this part:
Act means the Federal Home Loan Bank Act, as amended (12 U.S.C.
1421-49).
Applicant means a person or entity at whose request or for whose
account a standby letter of credit is issued.
Bank means a Federal Home Loan Bank established under the authority
of the Act.
Beneficiary means a person or entity who, under the terms of a
standby letter of credit, is entitled to have its complying
presentation honored.
Community Lending has the meaning set forth in Sec. 970.4 of this
chapter.
Confirm means to undertake, at the request or with the consent of
the issuer, to honor a presentation under a standby letter of credit
issued by a member or nonmember mortgagee.
Document means a draft or other demand, document of title,
investment security, certificate, invoice, or other record, statement,
or representation of fact, law, right, or opinion that is presented
under the terms of a standby letter of credit.
Finance Board means the agency established by the Act as the
Federal Housing Finance Board.
Issuer means a person or entity that issues a standby letter of
credit.
Member means an institution that has been approved for membership
in a Bank and has purchased capital stock in the Bank in accordance
with Sec. Sec. 933.20 and 933.24 of this chapter.
Nonmember mortgagee means an entity certified as a nonmember
mortgagee pursuant to Sec. 935.22(b) of this chapter.
Nonmember SHFA means a nonmember mortgagee that is a ``state
housing finance agency,'' as that term is defined in Sec. 935.1 of this
chapter, and that has met the requirements of Sec. 935.22(d) of this
chapter.
Presentation means delivery of a document to an issuer, or an
entity that has undertaken a confirmation at the request or with the
consent of the issuer, for the giving of value under a standby letter
of credit.
Residential housing finance means:
(1) The purchase or funding of ``residential housing finance
assets,'' as that term is defined in Sec. 935.1 of this chapter; or
(2) Other activities that support the development or construction
of residential housing.
Small business means a ``small business concern,'' as that term is
defined by section 3(a) of the Small Business Act (15 U.S.C. 632(a))
and implemented by the Small Business Administration at 13 CFR part
121, or any successor provisions.
Standby letter of credit means a definite undertaking by an issuer
on behalf of an applicant that represents an obligation to the
beneficiary, pursuant to a complying presentation: to repay money
borrowed by, advanced to, or for the account of the applicant; to make
payment on account of any indebtedness undertaken by the applicant; or
to make payment on account of any default by the applicant in the
performance of an obligation. The term standby letter of credit does
not include a commercial letter of credit, or any short-term self-
liquidating instrument used to finance the movement of goods.
Sec. 938.2 Standby letters of credit on behalf of members.
(a) Authority and purposes. Each Bank is authorized to issue or
confirm on behalf of members standby letters of credit that comply with
the requirements of this part, for any of the following purposes:
(1) To assist members in facilitating residential housing finance;
(2) To assist members in facilitating community lending that is
eligible for
[[Page 65700]]
any of the Banks' CICA programs under part 970 of this chapter;
(3) To assist members with asset/liability management; or
(4) To provide members with liquidity or other funding.
(b) Fully secured. A Bank, at the time it issues or confirms a
standby letter of credit on behalf of a member, shall obtain and
maintain a security interest in collateral that is sufficient to secure
fully the member's unconditional obligation described in
Sec. 938.4(a)(2) of this part, and that complies with the requirements
set forth in paragraph (c) of this section.
(c) Eligible collateral. (1) Any standby letter of credit issued or
confirmed on behalf of a member may be secured by collateral that is
eligible to secure advances under Sec. 935.9(a) of this chapter. Only
standby letters of credit issued for the purposes described in
paragraphs (a)(3) or (a)(4) of this section shall be counted in making
the calculation required under Sec. 935.9(a)(4)(iii).
(2) A standby letter of credit issued or confirmed on behalf of a
member for a purpose described in paragraph (a)(1) or (a)(2) of this
section may, in addition to the collateral described in paragraph
(c)(1) of this section, be secured by:
(i) Secured or federally-guaranteed loans to small businesses or
securities representing interests in such loans; or
(ii) Obligations of state or local government units or agencies,
rated as investment grade by a nationally-recognized rating agency.
Sec. 938.3 Standby letters of credit on behalf of nonmember
mortgagees.
(a) Nonmember mortgagees. Each Bank is authorized to issue or
confirm on behalf of nonmember mortgagees standby letters of credit
that are fully secured by collateral described in
Sec. Sec. 935.24(b)(1)(i) or (ii) of this chapter, and that otherwise
comply with the requirements of this part, for any of the following
purposes:
(1) To assist nonmember mortgagees in facilitating residential
housing finance;
(2) To assist nonmember mortgagees in facilitating community
lending that is eligible for any of the Banks' CICA programs under part
970 of this chapter;
(3) To assist nonmember mortgagees with asset/liability management;
or
(4) To provide nonmember mortgagees with liquidity or other
funding.
(b) Nonmember SHFAs. Each Bank is authorized to issue or confirm on
behalf of nonmember SHFAs standby letters of credit that are fully
secured by collateral described in Sec. 935.24(b)(2)(i)(A), (B) or (C)
of this chapter, and that otherwise comply with the requirements of
this part, for the purpose of facilitating residential or commercial
mortgage lending that benefits individuals or families meeting the
income requirements in section 142(d) or 143(f) of the Internal Revenue
Code (26 U.S.C. 142(d) or 143(f)).
Sec. 938.4 Obligation to Bank under all standby letters of credit.
(a) Obligation to reimburse. A Bank may issue or confirm a standby
letter of credit only on behalf of a member or nonmember mortgagee that
has:
(1) Established with the Bank a cash account pursuant to
Sec. Sec. 934.5, 935.24(b)(2)(i)(B) or 935.24(d) of this chapter; and
(2) Assumed an unconditional obligation to reimburse the Bank for
value given by the Bank to the beneficiary under the terms of the
standby letter of credit by depositing immediately available funds into
the account described in paragraph (a)(1) of this section not later
than the date of the Bank's payment of funds to the beneficiary.
(b) Prompt action to recover funds. If a member or nonmember
mortgagee fails to fulfill the obligation described in paragraph (a)(2)
of this section, the Bank shall take action promptly to recover the
funds that such member or nonmember mortgagee is obligated to repay.
(c) Obligation financed by advance. Notwithstanding the obligations
and duties of the Bank and its member or nonmember mortgagee under
paragraphs (a) and (b) of this section, the Bank may, at its
discretion, permit such member or nonmember mortgagee to finance
repayment of the obligation described in paragraph (a)(2) of this
section by receiving an advance that complies with sections 10 or 10b
of the Act and part 935 of this chapter.
Sec. 938.5 Additional provisions applying to all standby letters of
credit.
(a) Written policy; other requirements. Each standby letter of
credit issued or confirmed by a Bank shall:
(1) Be issued or confirmed only in compliance with a written
policy, developed and implemented by the Bank to govern its standby
letter of credit programs, that:
(i) Is consistent with the provisions of the Act and this part;
(ii) Sets forth credit underwriting criteria, consistent with the
provisions of Sec. 935.5 of this chapter, to be applied in evaluating
applications for standby letters of credit and renewals thereof;
(iii) Sets forth criteria regarding the pricing of standby letters
of credit, including any special pricing provisions for letters of
credit that facilitate the financing of projects that are eligible for
any of the Banks' CICA programs under part 970 of this chapter; and
(iv) Provides that, for any draw made by a beneficiary under a
standby letter of credit, the applicant will be charged a processing
fee calculated in accordance with the requirements of Sec. 943.6(b) of
this chapter;
(2) Contain a specific expiration date, or be for a specific term;
and
(3) Require approval in advance by the Bank of any transfer of the
standby letter of credit from the original beneficiary to another
person or entity;
(b) Additional collateral provisions. (1) A Bank may take such
steps as it deems necessary to protect its secured position on standby
letters of credit, including requiring additional collateral, whether
or not such additional collateral conforms to the requirements of
Sec. Sec. 938.2 or 938.3 of this part.
(2) Collateral pledged by a member or nonmember mortgagee to secure
a letter of credit issued or confirmed on its behalf by a Bank shall be
subject to the provisions of Secs. 935.9(b), 935.9(d), 935.9(e),
935.10, 935.11 and 935.12 of this chapter.
PART 943--COLLECTION, SETTLEMENT, AND PROCESSING OF PAYMENT
INSTRUMENTS
2. The authority citation for part 943 continues to read as
follows:
Authority: 12 U.S.C. 1430, 1431.
3. Amend Sec. 943.6 by revising paragraph (c) to read as follows:
Sec. 943.6 Pricing of services.
* * * * *
(c) Review and publication. The Finance Board shall from time to
time and at least annually review the cost of capital adjustment factor
and review prices for services authorized in this part for compliance
with the principles set forth in paragraphs (a) and (b) of this
section. All prices for Bank services authorized in this part will be
published annually in the Federal Register, except those for fees
charged to an applicant for draws made by a beneficiary under a standby
letter of credit.
Dated: October 28, 1998.
By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairman.
[FR Doc. 98-31837 Filed 11-27-98; 8:45 am]
BILLING CODE 6725-01-P
