06-7848. Examination Rating System for the Federal Home Loan Banks and the Office of Finance

AGENCY:

Federal Housing Finance Board.

ACTION:

Notice with request for comments.

SUMMARY:

The Federal Housing Finance Board (Finance Board) is requesting comments on a proposed examination rating system to be known as the Federal Home Loan Bank Rating System (Rating System).

DATES:

The Finance Board will accept comments in writing on or before October 23, 2006.

Comments: Submit comments to the Finance Board only once, using any one of the following methods:

E-mail: [e-mail].

Fax: [phone].

Mail/Hand Delivery: Federal Housing Finance Board, 1625 Eye Street, NW., Washington, DC 20006, Attention: Public Comments.

Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by e-mail to the Finance Board at [e-mail] to ensure timely receipt by the agency. Include the following information in the subject line of your submission: Federal Housing Finance Board. Notice: Examination Rating System for the Federal Home Loan Banks and the Office of Finance. Docket Number 2006-N-05.

We will post all public comments we receive without change, including any personal information you provide, such as your name and address, on the Finance Board Web site at http://www.fhfb.gov/​Default.aspx?​Page=​93&​Top=​93.

FOR FURTHER INFORMATION CONTACT:

Anthony Cornyn, Associate Director, Supervision and Examination, Office of Supervision, [e-mail] or 202-408-2522, or Kari Walter, Associate Director, Supervisory and Regulatory Policy, Office of Supervision, [e-mail] or 202-408-2829. You can send regular mail to the Federal Housing Finance Board, 1625 Eye Street, NW., Washington, DC 20006.

SUPPLEMENTARY INFORMATION:

I. Background

The Federal Home Loan Bank Act (12 U.S.C. 1421 et seq.) provides that the primary duty of the Finance Board is to ensure that the Federal Home Loan Banks (Banks) operate in a financially safe and sound manner. To the extent consistent with the safety and soundness charge, the other statutory duties of the Finance Board are to: (1) Supervise the Banks; (2) ensure that the Banks carry out their housing finance mission; and (3) ensure that the Banks remain adequately capitalized and able to raise funds in the capital markets. See 12 U.S.C. 1422a(a)(3).

The Banks are privately capitalized, government-sponsored enterprises that provide wholesale credit to members and housing associates for use in mortgage lending and related activities. The Banks have a statutory mandate to promote housing and community investment finance. See 12 U.S.C. 1430(g), (i), and (j); 1430b. The Banks provide long-term, flexible financing to more than 8,100 member financial institutions around the country.

In addition to supervising the Banks, the Finance Board has regulatory authority and supervisory oversight responsibility for the Office of Finance (OF), which is a joint office of the Banks that issues consolidated obligations in the public capital markets on behalf of the Banks. See 12 U.S.C. 1422b(b)(2); 12 CFR part 985. The Banks fund themselves principally by issuing consolidated obligations, which are the joint and several obligations of all 12 Banks' and consist of bonds (original maturity of 1 year or longer) and discount notes (original maturity of less than 1 year). Although consolidated obligations are not guaranteed or insured by the federal government, the Banks' status as government sponsored enterprises enables them to raise funds at rates slightly above comparable obligations issued by the Department of the Treasury.

To carry out its mission of ensuring that the Banks and the OF are safe and sound so the Banks can serve as a reliable source of liquidity and funding for the nation's housing finance and community investment needs, the Finance Board has one major program area: supervision of the Banks. See 12 U.S.C. 1440 (requiring the Finance Board to perform annual examinations of the Banks). Staff monitors the performance, condition, and risk profile of each Bank through on-site examinations and other supervisory activities. Examinations are the cornerstone of the Finance Board's safety and soundness supervisory program. In order to execute an effective risk-based supervisory program that promptly identifies and addresses current and emerging risks to the Banks, the Office of Supervision plans to implement the risk rating system discussed below for use beginning in calendar year 2007.

II. The Proposed Federal Home Loan Bank Rating System

The Finance Board is requesting comments on a proposed examination rating system to be known as the Federal Home Loan Bank Rating System. The proposed Rating System is attached as an Exhibit to this Notice.

In 2005, the Office of Supervision began to provide an overall conclusion—Satisfactory, Fair, Marginal, or Unsatisfactory—as part of its Report of Examination. The proposed Rating System, which is the next step in communicating exam results to the Banks, is a risk-focused system under which each Bank and the OF would be assigned a composite rating based on an evaluation of various aspects of their operations. The composite rating of each Bank would be based on an evaluation and rating of 5 key components: Corporate governance, market risk, credit risk, operational risk, and financial condition and performance. The composite rating of the OF would be based primarily on an evaluation of 2 components: corporate governance and operational risk.

Under the Rating System, we would take administration of a Bank's affordable housing and community investment activities into account in assigning component ratings for corporate governance and operational risk. Given the importance of affordable housing and community investment activities to the mission of the Bank System, the Office of Supervision may consider the need for a separate rating system or a separate ratings component to evaluate and rate the affordable housing and community investment programs of each Bank after gaining experience with the proposed Rating System.

The Rating System is intended to serve 2 purposes. First, it is designed to reflect in a comprehensive, systematic, and consistent fashion the overall condition and performance of an institution, taking into consideration all significant financial, operational, and compliance factors addressed in the Finance Board's examination. Second, the Rating System is meant to further enhance communication and transparency between the Office of Supervision and each Bank and the OF regarding the results of the examination process. The ratings for individual Banks and the OF would not be made public or released to other Banks, but would be supplied to the individual Banks and the OF on a confidential basis as part of the examination and supervisory process.

Under the Rating System, each of the 5 components would be assigned a numeric rating from “1” to “4.” A “1” rating indicates the lowest degree of supervisory concern, while a “4” rating indicates the highest degree of supervisory concern. The composite rating of each Bank and the OF also would be rated on a scale of “1” to “4” based on the ratings of the underlying components. The composite rating would be based on the component ratings but it would not be a simple arithmetic average of the component ratings. Instead, the relative importance of each component would be determined on a case-by-case basis within the parameters established by this rating framework. As proposed, an examiner would take a Bank's performance in administering its affordable housing and community investment activities into consideration in assigning a composite rating to the Bank. More specifically, a Bank's performance in administrating it affordable housing and community investment activities would be given special consideration in the corporate governance and operational risk components of the Rating System.

The Rating System would become operative when issued by the Office of Supervision, which is anticipated to occur before year end 2006 for implementation in 2007.

III. Request for Comments

The Finance Board requests comment on all aspects of the proposed Rating System. In addition, the Finance Board invites specific comments on the following questions:

1. Does the proposed Rating System capture the essential components of an institution's performance and condition that are relevant to assigning a composite rating to a Bank and the OF? If not, what additional or different components should be considered?

2. Do the factors to be considered under each of the 5 components (corporate governance, market risk, credit risk, operational risk, and financial condition and performance) address the factors that should be considered in assessing each of the components? If not, what additional or different factors should be considered?

Dated: September 13, 2006.

By the Federal Housing Finance Board.

John P. Kennedy,

General Counsel.