[Federal Register Volume 63, Number 124 (Monday, June 29, 1998)]
[Rules and Regulations]
[Pages 35117-35128]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-17163]
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FEDERAL HOUSING FINANCE BOARD
12 CFR Parts 933 and 935
[No. 98-15]
[RIN 3069-AA69]
Eligibility for Membership and Advances
AGENCY: Federal Housing Finance Board.
ACTION: Final rule.
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SUMMARY: The Federal Housing Finance Board (Finance Board) is amending
the definitions in its membership and advances regulations relating to
combination business or farm properties on which a residence is
located. For institutions with total assets of $500,000,000 or less,
the amendments eliminate the requirement that at least 50 percent of
the value of such properties be attributable to the residential portion
of the property, and require instead that the residence constitute an
integral part of the property. The amendments are intended to assist
smaller depository institutions, particularly those located in rural
areas, that have combination farm or business property loans in their
portfolios, to qualify for Federal Home Loan Bank (FHLBank) membership
and, once admitted, to provide the collateral necessary to obtain
FHLBank advances. For those institutions with assets in excess of
$500,000,000, the amendments retain the existing 50 percent of value
requirement. The amendments also allow loans that would satisfy the
statutory and regulatory requirements under the Community Investment
Program, or under the community investment cash advance provisions, of
the Federal Home Loan Bank Act (Bank Act), to qualify for membership
eligibility purposes.
DATES: Effective July 29, 1998.
FOR FURTHER INFORMATION CONTACT: Julie Paller, Senior Financial
Analyst, Office of Policy, (202) 408-2842; Neil R. Crowley, Associate
General Counsel, (202) 408-2990, Sharon B. Like, Senior Attorney-
Adviser, (202) 408-2930, Office of General Counsel; Federal Housing
Finance Board, 1777 F Street, N.W., Washington D.C. 20006.
SUPPLEMENTARY INFORMATION:
I. FHLBank System and Finance Board Roles and Responsibilities
Under the Bank Act, the Finance Board is responsible for the
supervision and regulation of the 12 FHLBanks. See 12 U.S.C. 1422a(a),
1422b(a)(1). Specifically, the Finance Board is responsible for
ensuring that the FHLBanks operate in a financially safe and sound
manner and carry out their housing finance and community investment
mission, and that they remain adequately capitalized and able to raise
funds in the capital markets. See id. section 1422a(a)(3). The Bank Act
also empowers the Finance Board to promulgate and enforce such
regulations and orders as are necessary from time to time to carry out
the provisions of the Bank Act, including regulations on FHLBank
membership eligibility and advances collateral requirements. See id.
section 1422b(a)(1).
II. Current 50 Percent Test For Loans Secured By Combination
Property Under the Membership and Advances Regulations
The regulations of the Finance Board allow certain types of
mortgage loans to be used in determining an institution's eligibility
to become a FHLBank member and its ability to borrow from the FHLBank,
after becoming a member. As described below, loans secured by
combination properties can be used for these purposes only if at least
50 percent of the total appraised value of the combined property is
attributable to the residential portion of the property (50 percent
test). See 12 CFR
[[Page 35118]]
933.1(n)(1)(iii), 935.1. For both purposes, that test is the same.
A. Membership Eligibility
Section 4(a) of the Bank Act establishes the eligibility criteria
for institutions to become members of the FHLBank System. See 12 U.S.C.
1424(a). Section 4(a)(2)(A) of the Bank Act requires, in part, that an
insured depository institution have ``at least 10 percent of its total
assets in residential mortgage loans'' in order to be eligible for
FHLBank membership (10 percent requirement). See id. section
1424(a)(2)(A) (emphasis added). The Bank Act does not define the term
``residential mortgage loan.'' The Finance Board's current membership
regulation defines ``residential mortgage loan'' to include, among
other things, a ``home mortgage loan.'' See 12 CFR 933.1(bb)(1). The
Bank Act defines a ``home mortgage loan'' as ``a loan made by a member
or a nonmember borrower upon the security of a home mortgage.'' See 12
U.S.C. 1422(5). The Bank Act defines a ``home mortgage'' generally as a
mortgage upon real estate ``upon which is located, or which comprises
or includes, one or more homes or other dwelling units, all of which
may be defined by the [Finance] Board.'' See id. section 1422(6). The
membership regulation implements these statutory provisions by defining
``home mortgage loan'' to include, in part, a loan secured by a first
lien on ``[c]ombination business or farm property where at least 50
percent of the total appraised value of the combined property is
attributable to the residential portion of the property.'' See 12 CFR
933.1(n)(1)(iii). The term ``combination business or farm property''
means ``real property for which the total appraised value is
attributable to residential, and business or farm uses.'' Id.
Sec. 933.1(i).
B. Eligible Collateral for Advances
Section 10(a) of the Bank Act authorizes a FHLBank to make secured
advances to its members and specifies the types of collateral that a
FHLBank may accept when originating or renewing an advance. See 12
U.S.C. 1430(a). Section 10(a)(1) of the Bank Act requires a FHLBank
making or renewing an advance to its members to obtain and maintain a
security interest in certain specified types of collateral, among which
are ``[f]ully disbursed, whole first mortgages on improved residential
property (not more than 90 days delinquent).'' See id. section
1430(a)(1) (emphasis added). The Bank Act does not define ``residential
property'' or ``improved residential property.'' The Finance Board's
current advances regulation defines ``improved residential real
property'' to mean ``residential real property excluding real property
to be improved, or in the process of being improved, by the
construction of dwelling units.'' 12 CFR 935.1. The advances regulation
defines ``residential real property'' to include, among other things,
``combination business or farm property, provided that at least 50
percent of the total appraised value of the combined property is
attributable to the residential portion of the property.'' See id. The
term ``combination business or farm property'' means ``real property
for which the total appraised value is attributable to the combination
of residential, and business or farm uses.'' Id.
Thus, in order for a combination farm or business loan to qualify
as a ``residential mortgage loan'' for purposes of satisfying the 10
percent requirement under the current membership regulation, or to
qualify for purposes of satisfying advance collateral requirements
under the current advances regulation, the combination farm or business
property securing the loan must meet the 50 percent test.
III. Proposed Rulemaking
A. Derivation and Description of Proposed Rule
In early 1997, the Finance Board was approached by representatives
of community depository institutions, particularly those located in
rural areas, who advised that they have a need for alternative funding
sources to meet credit demands in their communities, which they
believed the FHLBank System was well-suited to provide. As discussed in
the preamble to the proposed rule, they indicated that community
depository institutions, particularly those in rural areas, often are
essential to the housing finance activities and the broader economic
well being of the communities they serve. Such institutions have less
demand for conventional single family and multifamily mortgage credit
and their service areas often are characterized by low population
density and a low level of economic activity. In such circumstances,
those institutions have not been able to originate a substantial number
of residential first mortgage loans. Moreover, many loans originated by
rural banks are made on the security of family farms, which are in part
residential but which often do not meet the 50 percent test. They
stated that the 50 percent test thus hinders the ability of rural banks
to become FHLBank System members or to take full advantage, as FHLBank
members, of the opportunity to obtain advances and thereby serve the
credit needs of their communities.
In response to these concerns, the Finance Board had reason to
believe that the 50 percent test may operate to exclude some number of
residential properties beyond what was intended when the Finance Board
adopted the test. Accordingly, the Finance Board reviewed the relevant
statutory and regulatory provisions governing membership eligibility
and advances collateral and determined, as discussed in greater detail
below, that the statute affords sufficient latitude to address the
issues by making changes to the current regulations.
In order to confirm whether the concerns raised by the community
institutions were well-founded, the Finance Board issued the proposed
rule, which would have eliminated the 50 percent test in both the
membership and advances regulations, and replaced it with a provision
permitting a loan to be eligible if it is secured by ``combination
business or farm property, on which is located a permanent structure
actually used as a residence, other than for temporary or seasonal
housing.'' See 62 FR 53251--53 (Oct. 14, 1997). The objective of the
proposal was to ease the burdens of the 50 percent test, within the
parameters of the statute. Doing so would allow more institutions with
combination family farm/residential loans or combination family
business/residential loans (such as loans secured by businesses where
the family owns and lives in a residential unit above the store) to be
eligible for FHLBank membership and borrowing from the FHLBanks. The
requirement that any eligible combination property must have a
permanent structure actually used as a residence was intended to ensure
that the property retained the requisite residential character required
by the statute, which was one reason why the Finance Board adopted the
50 percent test. The proposal was not intended to allow large
agribusiness or other large commercial loans to be used for membership
eligibility and advances collateral purposes.
In addition, the proposed rule defined ``residential mortgage
loan,'' for membership eligibility purposes, to include ``[l]oans that
finance properties or activities that, if made by a member, would
satisfy the statutory requirements for the Community Investment Program
[(CIP)] established under section 10(i) of the Bank Act, or the
regulatory requirements established for any community investment cash
advance program authorized by section 10(j)(10)
[[Page 35119]]
of the Bank Act.'' See 62 FR 53251--53; 12 U.S.C. 1430(i), (j)(10). The
intent of this proposed amendment was to allow such community
investment loans to be considered for purposes of eligibility for
membership, and to conform the membership regulation more closely to
the advances regulation, which already includes loans financed by
section 10(i) or section 10(j)(10) advances within the definition of
``residential housing finance assets.'' See 12 CFR 935.1.
B. General Discussion of Comments on Proposed Rule
The Finance Board received over 290 comment letters on the proposed
rule, which were split relatively evenly between those supporting and
those opposing the proposal. The commenters supporting the proposal
included five FHLBanks, FHLBank members, prospective members, banking
trade associations, and state finance departments. The overwhelming
majority of the letters supporting the proposal came from small
community banks and thrifts, predominantly in rural areas. The
remaining letters supporting the proposal followed closely a comment
letter submitted by a banking trade association.
All but one of the comment letters opposing the proposal were from
persons or entities associated with the Farm Credit System, a
nationwide network of federally chartered, borrower-owned cooperative
financial institutions and related service organizations specializing
in agricultural loans. The Farm Credit System institutions are major
competitors of commercial banks and other farm and rural housing
lenders within agricultural credit markets. See USDA Economic Research
Service Agricultural Economic Report Number 749, ``Credit in Rural
America'' (April 1997) at 42-43 (USDA Report). The trade association
for the Farm Credit System submitted a detailed comment letter opposing
the proposed rule. Nearly all of the remaining comment letters opposing
the proposed rule raised substantially the same issues, and many of
them were identical.
Commenters supporting the proposal confirmed the views expressed in
the proposed rule that there is a need for additional funding sources
in rural markets and that the proposal would further the FHLBank
System's housing finance mission by making available such funding for
combination farm/residential loans, which are important to rural
communities. Commenters confirmed that the 50 percent test is under-
inclusive, allowing only those combination loans secured by very small
farms to be used for membership eligibility and advances collateral
purposes. No commenter contended that the 50 percent test adequately
captures all of the family farms or businesses that make up combination
properties.
Commenters also stated that the 50 percent test may discriminate
against lower income individuals, who can afford only a modest
residence on their farm, in favor of more affluent persons, who can
place a more expensive residence on the same acreage. They contended
that the rule has the effect, in practice, of encouraging the FHLBanks
and their members to ignore the housing finance needs of the lower
income segments of their communities in favor of more wealthy
individuals, which is inconsistent with the FHLBanks' housing finance
mission. A banking trade association also emphasized that the 50
percent test may be unworkable in practice because even family farms
often are appraised based on their ability to generate income, using
the ``capitalization approach.'' Under that approach, the residential
portion rarely would be valued at a level approaching the 50 percent
test, notwithstanding that the residential portion of the property is
integral to the success of the farm on which it is located.
Representatives of the Farm Credit System contended, however, that
the proposal goes too far in the opposite direction and is apt to be
over-inclusive by allowing the use of loans secured by a combination
farm or business property with little or no residential value. They
argued that eliminating the 50 percent test is inconsistent with the
housing finance mission of the FHLBank System, that the test does not
hinder rural banks' ability to become FHLBank members, and that rural
banks do not have less demand for conventional single family and
multifamily mortgages. They also argued that the Finance Board failed
to consider the practical consequences and safety and soundness risks
of the proposal.
IV. Adoption of Revised Standard in the Final Rule
After considering the information received in the comment letters,
as well as its own resources, the Finance Board has decided to adopt
the final rule with one substantive change from the proposed rule, and
to limit the applicability of that change to community financial
institutions, which are defined as those of a certain asset size or
less. Each of those actions is intended to address concerns raised by
commenters about the possible overbreadth of the proposed rule. The
changes will apply to both the membership and advances collateral
provisions, and are intended to limit qualifying loans to combination
farm/residence and combination business/residence loans that have the
requisite residential nexus, and to exclude large agribusiness and
other large commercial loans, which do not. Specifically, the final
rule amends the definition of ``home mortgage loan'' in
Sec. 933.1(n)(1)(iii) of the membership regulation to include a loan
secured by ``combination business or farm property, on which is located
a permanent structure actually used as a residence (other than for
temporary or seasonal housing), where the residence constitutes an
integral part of the property.'' See Sec. 933.1(n)(1)(iii) (emphasis
added). That revision would apply only to ``community financial
institutions,'' which the final rule defines as institutions with
average total assets of $500,000,000 or less, based on the average of
total assets over the prior three years. For larger institutions, the
current 50 percent test would continue to apply. The definition of
``residential mortgage loan'' in Sec. 933.1(bb)(1) of the membership
regulation, because it already includes ``home mortgage loans,'' as
defined by these amendments, need not be specifically amended. See 12
CFR 933.1(bb)(1). The final rule amends the definition of ``residential
real property'' in Sec. 935.1 of the advances regulation in the same
manner. Thus, eligible collateral will include loans secured by
``combination business or farm property, on which is located a
permanent structure actually used as a residence (other than for
temporary or seasonal housing), where the residence constitutes an
integral part of the property.'' See Sec. 935.1 (emphasis added). As
with the membership provisions, this amendment would apply only for
institutions with average total assets of $500,000,000 or less over the
prior three years; larger institutions would remain subject to the 50
percent test.
V. Authority and Reasons for Changing the 50 Percent Test
A. Finance Board's General Statutory Authority
Congress has offered no guidance on how the Finance Board should
deal with combination properties. The Bank Act provides no definition
of ``residential mortgage loan,'' which is the operative term for
purposes of the 10 percent requirement, nor does it speak to what
combination properties may be encompassed by the term. See 12 U.S.C.
1424(a)(2)(A). The Bank Act does define a ``home mortgage loan'' as ``a
loan
[[Page 35120]]
made by a member or a nonmember borrower upon the security of a home
mortgage.'' See id. section 1422(5). The Bank Act also defines a ``home
mortgage'' generally as a mortgage upon real estate ``upon which is
located, or which comprises or includes, one or more homes or other
dwelling units, all of which may be defined by the [Finance] Board.''
See id. section 1422(6). The statute does not speak directly to the
issue of what constitutes a combination property for purposes of these
definitions, nor does the language used by Congress (``upon which is
located, or which comprises or includes'') suggest that the residential
portion of a combination property must meet any specified threshold in
order for a mortgage on such property to qualify as a ``home
mortgage.'' Indeed, the only statutory mandate, with respect to
eligibility for membership, is that the loan must be secured by real
estate on which there is located, or which comprises or includes, a
home or dwelling unit. See id. Moreover, the statute expressly
authorizes the Finance Board to define all of those terms.
Congress has offered no more guidance in the context of eligible
collateral for advances. Section 10(a) of the Bank Act authorizes each
FHLBank to make secured advances to its members upon collateral
sufficient, in the judgment of the FHLBank, to fully secure the
advances. See id. section 1430(a). The Bank Act sets forth the types of
collateral that may secure an advance, including ``[f]ully disbursed,
whole first mortgages on improved residential property (not more than
90 days delinquent).'' See id. section 1430(a)(1) (emphasis added).
Again, with regard to what is encompassed by ``residential property''
or ``improved residential property,'' Congress has opted to remain
silent and has not defined the terms. Thus, with respect to the use of
whole first mortgages as collateral for advances, the only statutory
mandate is that they attach to real property that previously has been
improved by the construction of a residence. See id.
In considering the comments and determining the terms of the final
rule, the Finance Board has been mindful of the requirement that it is
bound ultimately by the ``unambiguously expressed intent of Congress.''
See Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.,
467 U.S. 837, 842-43 (1984) (Chevron); Independent Banks Association of
America, and American Bankers Association v. Farm Credit
Administration, Civil Action No. 97-00695 (Memorandum Opinion) (Nov.
24, 1997) at 8 (IBAA). As noted previously, Congress has opted not to
define ``residential mortgage loan'' and ``improved residential
property,'' which are the operative terms in the Bank Act underlying
these amendments to the membership and advances regulations. Moreover,
the only terms that Congress has defined, ``home mortgage'' and ``home
mortgage loan,'' are not implicated in the statutory provisions here at
issue. Even if they were, Congress has defined them in such a way that
does not address combination properties, and Congress has expressly
authorized the Finance Board to define the terms of the definitions.
Because there is nothing in the plain language of the Bank Act that
mandates that the residential portion of combination properties
constitute a specified percentage of the property's total appraised
value, the Finance Board, in the exercise of its informed discretion,
must interpret ``residential mortgage loan'' and ``improved residential
property'' for this purpose and must do so in a manner that is
``permissible'' in light of the statute's structure and purpose. See
Chevron, 467 U.S. at 843-45; IBAA at 8.
B. Reasons for Changing the 50 Percent Test
1. Bank Act and Legislative History Do Not Provide Particular Direction
Just as there is nothing in the plain language of the Bank Act that
suggests how to define ``residential mortgage loan'' and ``improved
residential property,'' there is nothing in the legislative history of
the Bank Act that indicates an intent of Congress about how to define
these terms, both of which were adopted by the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA), Pub. Law 101-
73, 108 Stat. 183 (August 9, 1989). See FIRREA, Secs. 704(a), 714(a).
FIRREA added the 10 percent ``residential mortgage loans'' requirement
to section 4 of the Bank Act. See FIRREA, Sec. 704(a). The Conference
Report accompanying FIRREA states that, in order to qualify for
membership in a FHLBank, insured depository institutions ``must have at
least 10 percent of their assets in residential mortgage loans,
including 1-4 family, multifamily and funded residential construction
loans, to qualify for membership.'' See Joint Explanatory Statement of
the Committee of Conference, H.R. Conf. Rep. 101-222, 101st Cong., 1st
Sess. at 424 (1989) (FIRREA Conference Report). That statement is not
particularly helpful because the use of the term ``including''
indicates that it is at best a non-exclusive illustrative list of some
types of loans that Congress viewed as qualifying as ``residential
mortgage loans.''
The legislative history also indicates that the 10 percent
requirement was the product of a legislative compromise. The Senate
bill would have required a commercial bank to meet the Qualified Thrift
Lender (QTL) test, as revised by the Senate bill, in order to be
eligible for FHLBank membership. The QTL test, both before and after
FIRREA, required a savings association to maintain a certain percentage
of its assets in ``qualified thrift investments'' (QTIs), which FIRREA
defined in some detail. The FIRREA Conference Report describes QTIs as
``housing finance and related activities.'' See id. at 407. The House
bill would not have required commercial banks to meet any quantitative
assets test to be eligible for FHLBank membership. In conference, the
agreed upon compromise was to replace the Senate's QTL threshold test
with the 10 percent residential mortgage loans requirement.
The understanding of the Congress in reaching this compromise is
not evident from the legislative history. What is evident from the
statutes, however, is that Congress chose diametrically opposed
approaches for dealing with the concepts of QTIs and ``residential
mortgage loans'' or ``improved residential property,'' respectively.
Congress took great care to define by statute the categories of assets
that could be considered to be QTIs. See FIRREA, Sec. 303(a). Moreover,
Congress quite clearly expressed its intent that the QTI categories
established by statute were not to be modified, stating that the QTI
assets ``are specifically defined so as to prevent the inclusion of
other assets by regulatory interpretation.'' See FIRREA Conference
Report at 407. In contrast, Congress did not define what may be
included in ``residential mortgage loans'' for purposes of the 10
percent requirement, nor did it include any comparable language in the
FIRREA Conference Report. If any inference can be drawn from this
meager legislative history, it is that Congress must have intended to
leave the implementation of these terms to the informed judgment of the
Finance Board. Had it intended otherwise, it could have defined the
terms by statute or unequivocally expressed its intent as to how the
provisions are to be applied, both of which it did, in the same law,
for the QTL test.
Regarding eligible collateral for advances, prior to FIRREA each
FHLBank was authorized to make
[[Page 35121]]
secured advances to its members upon such security as the Federal Home
Loan Bank Board (FHLBB) may prescribe. See 12 U.S.C. 1430(a) (1989).
FIRREA amended section 10(a) to establish specific categories of
eligible collateral that a FHLBank may accept as security for advances
to members. See FIRREA, Sec. 714(a). Section 10(a)(1) eligible
collateral includes ``fully disbursed, whole first mortgages on
improved residential property (not more than 90 days delinquent). See
12 U.S.C. 1430(a)(1) (emphasis added). The FIRREA Conference Report
refers to the eligible collateral as ``low risk assets'' and describes
the section 10(a)(1) collateral generally as ``current first
residential mortgage loans.'' See FIRREA Conference Report at 427. The
FIRREA Conference Report does not further define ``improved residential
property'' or ``residential mortgage loans'' for advances collateral
purposes. For the reasons described for membership purposes, it appears
as well that Congress intended to allow the Finance Board to further
define these terms.
2. The 50 Percent Test Is Purely a Regulatory Creation That Can Be
Changed for Good Reason
The 50 percent test was purely a regulatory creation of the Finance
Board, adopted on the assumption that requiring at least half of the
value of the combination property to be attributable to a residence
would ensure that such properties possess the residential nexus
required by the statute and still meet the housing finance needs of
rural and other communities. In retrospect, it appears that the
decision to rely on the 50 percent test in all cases was unduly
restrictive, because properties not meeting the test still might
possess substantial residential characteristics that could be
recognized for membership and advances collateral purposes, consistent
with the statute. After considering the comments in favor of the
proposal, the Finance Board is persuaded that the 50 percent test is
not operating in practice to serve the purposes intended. Indeed, it
appears more likely that the test operates in some cases to frustrate
the mission of the FHLBank System by excluding important elements of
both rural and urban housing finance markets. The Finance Board is
particularly concerned about comments indicating that the test
discriminates against lower income persons, effectively precluding
current and prospective FHLBank members from using FHLBank services to
address the housing finance needs of that segment of the population.
As a general matter, an agency is free to change its interpretation
of its statute so long as its actions are rational, reasonable, not
arbitrary and capricious, involve no clear error of judgment, and a
satisfactory explanation for its actions is included in the record.
See, e.g., 5 U.S.C. 706(2)(A); Motor Vehicle Mfrs. Ass'n of United
States, Inc. v. State Farm Mutual Auto. Ins. Co., 463 U.S. 29, 41-43
(1983); Camp v. Pitts, 411 U.S. 138, 142 (1973) (per curiam); IBAA, at
8-9. This test is ``not particularly demanding,'' even when the agency
action consists of a change in a long-standing regulatory position on a
particular issue. See, e.g., Republican Nat. Committee v. Federal
Election Com'n., 76 F.3d 400, 407 (D.C. Cir. 1996), cert. denied, 117
S.Ct. 682 (1997); IBAA at 9. In fact, an agency is charged with the
responsibility of continually evaluating the appropriateness of its
regulatory policy, even regulatory policy already adopted. See Chevron,
467 U.S. at 863-64; IBAA at 9.
3. Specific Reasons for Changing the 50 Percent Test
Commenters supporting the proposal confirmed that it would further
the FHLBank System's housing finance mission by making available a
needed source of funding for combination farm/residential loans, which
are important to rural communities. Commenters also confirmed that the
50 percent test is under-inclusive, allowing only those combination
loans secured by very small farms to be used for membership eligibility
and advances collateral purposes. No commenter contended that the 50
percent test precisely captures all of the family farms or businesses
that make up combination properties having a sufficient residential
nexus. The Finance Board is of the view that the 50 percent test is
unnecessarily severe in excluding bona fide residences simply because
the non-residential portion may have a greater value than the
residential portion.
One difficulty in relying exclusively on an objective test, such as
the 50 percent test, is that it is apt to be over-or under-inclusive
because of geographic variations. Another difficulty with the 50
percent test is that it may discriminate against lower income
individuals, who can afford only a modest residence on their farm, in
favor of more affluent persons, who can place a more expensive
residence on the same acreage. One commenter raised precisely that
issue, providing examples of the value of certain types of residences
in relation to given acreage of farmland. A rule that encourages the
FHLBanks and their members to ignore the housing finance needs of the
lower income segments of their communities in favor of more wealthy
individuals is not consistent with carrying out the housing finance and
community investment mission of the FHLBanks, which relates to all
segments of the market.
Farm Credit System commenters contended, however, that the proposal
to eliminate the 50 percent test without providing a substitute
standard went too far in the opposite direction and is apt to be over-
inclusive by allowing the use of loans secured by a combination
business or farm property, even if the property were to possess only
the barest of residential characteristics. The Finance Board believes
that there may be merit in that argument, at least on the point that
the proposed rule might be construed by some as allowing properties
with only the slightest residential component to be included as
residential property. The proposal was not intended to be applied in
the manner suggested by the commenters. Nor was it intended to allow a
FHLBank to characterize large agribusiness and other large commercial
loans as residential loans. Instead, it was intended to make the
definitions recognize and conform to the practical realities of the
residential housing finance markets in rural communities. The Finance
Board agrees that the final rule should incorporate some further
standard that more clearly expresses the Finance Board's intention to
preclude the use of loans having only minimal residential
characteristics.
Therefore, the Finance Board is revising the definitions of ``home
mortgage loan'' and ``residential real property'' in the final rule to
include a standard that would limit qualifying loans to combination
farm/residence and combination business/residence loans with a
sufficient residential nexus. The final rule also limits the
application of the revised definition to institutions with assets of
$500,000,000 or less. By narrowing the substance of the definition and
by limiting its applicability, the Finance Board intends to target the
benefits of the rule change more precisely on the housing finance and
community investment mission of the FHLBank System, and to exclude the
types of large agribusiness and other large commercial loans that were
of concern to some commenters. Specifically, the final rule amends the
definition of ``home mortgage loan'' in Sec. 933.1(n)(1)(iii) of the
membership regulation to include a loan secured by ``combination
business or farm property, on which is located a permanent structure
actually used as a residence
[[Page 35122]]
(other than for temporary or seasonal housing), where the residence
constitutes an integral part of the property.'' See
Sec. 933.1(n)(1)(iii) (emphasis added). The amended rule would apply
only to institutions with average total assets of $500,000,000 or less,
determined over a three-year period; for larger institutions, the
current 50 percent test would remain in effect. The definition of
``residential mortgage loan'' in Sec. 933.1(bb)(1) of the membership
regulation includes the term ``home mortgage loans,'' as defined in
Sec. 933.1(n)(1)(iii), and therefore, need not be specifically amended
in order to include these revisions. See 12 CFR 933.1(bb)(1). The final
rule amends the definition of ``residential real property'' in
Sec. 935.1 of the advances regulation in a similar manner. See
Sec. 935.1.
The intent of the Finance Board in adding the ``integral''
requirement is to create a standard that will include only those
combination properties where the residence is inextricably linked to
the non-residential portion, such as in what is commonly understood as
a family farm or a family business with a residence ``above the
store.'' What constitutes such a property will vary from region to
region across the country; what constitutes a family farm in the
western states, for example, might well be larger in size than what
constitutes a family farm in New England, although the residential
portion of each property may be of comparable size. The Finance Board
believes adding the ``integral'' requirement will allow additional
latitude for the FHLBanks by providing for the inclusion of loans
secured by property containing a residence whose value cannot be
inconsequential in relation to the overall value of the property, while
excluding the types of large agribusiness and other large commercial
loans that concerned the commenters.
By adopting a more subjective standard, the Finance Board intends
to allow the FHLBanks, which are in a better position to know what
constitutes a family farm or business within their districts, to
determine for themselves which combination properties include a
residence that is so inextricably linked to the remainder of the
property as to be integral to the property as a whole. That is a
particularly fact-specific determination. For example, the ``integral''
standard would not necessarily preclude non-contiguous farm parcels
that secure the same loan, so long as, in the judgment of the FHLBank,
all of the parcels satisfy the ``integral'' standard. Clearly, a
parcel's proximity to the residence is apt to be a principal
consideration in determining whether the two properties are
``inextricably linked'' for these purposes. In any event, these would
be matters for the FHLBank to address. Likewise, the FHLBank must
determine how much documentation shall be provided by prospective and
current members in order to show that particular loans and their
collateral satisfy the standard. The Finance Board expects to review
the FHLBanks' implementation of the standard as part of the annual
examination process and will monitor compliance with this provision.
Limiting the applicability of the revised definitions to
institutions with assets of $500,000,000 or less would further address
the concerns of some commenters that the proposed rule could be
manipulated to allow very large commercial and large agribusiness loans
to be considered as ``residential'' simply by including a residence on
the underlying property. The Finance Board never intended the proposed
rule to encompass purely commercial or business loans, and has
incorporated the ``integral'' standard into the final rule in order to
ensure that any combination loan used for membership or collateral
purposes would have the requisite residential nexus. Nonetheless, the
Finance Board also believes that the inclusion of an additional
safeguard against the concerns expressed by the commenters would be
consistent with its goals and with the Bank Act.
One means of lessening the likelihood that an institution could
mischaracterize large commercial or large agribusiness loans as
``residential'' is to limit the maximum size of the loans that may
qualify under the ``integral'' standard. That result may be achieved
indirectly by limiting the size of the institutions that may take
advantage of the amended rule, because the maximum dollar amount of
loans that a depository institution may make is tied to its capital
levels, which in turn are a function of its size. As a general matter,
depository institutions are barred from extending credit to any one
borrower in an amount exceeding 15 percent of their capital and
surplus. 12 U.S.C. 84(a)(1). That lending limit applies to the
aggregate amount of all loans made to a single ``borrower,'' which term
may encompass other related persons and entities. See 12 CFR 32.5.
Although the dollar amount of the lending limit will vary from
institution to institution, the approximate cap for institutions with
assets of $500,000,000 or less should be sufficiently small to preclude
the type of large commercial and large agribusiness loans cited by the
commenters. For example, a depository institution must maintain minimum
total capital equal to 8 percent of its ``risk-weighted assets.'' Id.
Part 3, App. A, Sec. 4(b). Using that as a proxy for actual capital,
and assuming a 100 percent risk-weighting (which in practice is
unlikely to be the case), an institution with assets of $500,000,000
might have capital of approximately $40,000,000, with a lending limit
of approximately $6,000,000. An institution with $100,000,000 in assets
might have a lending limit of approximately $1,200,000. Those limits
would apply to the total amount of all loans made to a single borrower,
and thus would encompass both residential loans of the type permitted
under these amendments, as well as any commercial or personal loans.
Moreover, as a matter of sound banking practice, depository
institutions do not generally lend to the full amount permitted under
their lending limit, so the Finance Board anticipates that the dollar
amounts of loans made are apt to be considerably smaller than these
rough estimates. The Finance Board believes that effectively placing
the qualifying loans within the lending limits of members and
prospective members should help ensure that the loan amounts, and hence
their purposes, are more likely to be for bona fide residential
combination properties and not for large commercial or large
agribusiness loans.
4. Other Alternatives Considered
In attempting to reconcile the competing interests of commenters,
the Finance Board considered various other options for defining
qualifying ``residential mortgage loans'' and ``residential real
property.'' As discussed further below, in the Finance Board's view,
none of these alternatives would satisfactorily achieve the goal of
including true combination family farm and business loans, both of
which have the residential nexus required by the Bank Act, while
excluding large agribusiness and other large commercial loans, which do
not.
For example, the Finance Board considered adopting a specific
percentage test other than the 50 percent test. Such a test would
ensure that the property securing the loan has a greater residential
component than under the proposal, while continuing to qualify more
loans that now fail the 50 percent test. However, such a test would
establish a national standard that likely would remain under-inclusive,
that could not reflect differences in local real estate values, and
would continue to exclude from membership and borrowing any rural
institutions with combination farm or business loans that
[[Page 35123]]
could not meet the reduced percentage test, regardless of whether the
underlying properties included bona fide residences. For example, as a
commenter pointed out, even such a modified test likely would exclude
family ranches in areas where the land is very valuable relative to the
residence. The test also would create operational difficulties where
the existing appraisals held by the members originating the loan do not
separate the value of the residence from the value of the entire
property.
The Finance Board also considered adopting a specific acreage limit
or dollar limit as a proxy for identifying a family farm or business,
i.e., the combined farm property securing the loan could not exceed a
specific acreage limit, or the combination farm or business loan could
not exceed a specific dollar amount. If the acreage limit or dollar
limit were set low enough, the standard likely would qualify small
combination family farm or business loans, while excluding large
agricultural and other business loans. However, as pointed out by a
commenter, such limits once again would establish national standards
that cannot reflect differences in local business operations and real
estate values. The acreage size limit likely would be under-inclusive,
excluding some large-acreage farms that would be considered to be
family farms in certain locales, such as ranching areas. The dollar
limit likely would have the same problem, effectively requiring the
establishment of a nationwide standard that would not necessarily
reflect local market differences. In addition, an acreage limit or
dollar limit, by itself, would not necessarily guarantee an adequate
residential nexus, which the statute requires.
One FHLBank commenter suggested that the Finance Board adopt an
employee-based or ownership-based standard as a surrogate for small
combination family farm and business loans. Such an approach would
limit a qualifying farm or business obtaining the loan to no more than
a specific number of full-time equivalent employees. The commenter
suggested using 100 employees as an appropriate level. The commenter
also proposed limiting a farm or business corporation obtaining the
loan to no more than a specific number of shareholders, such as 10
shareholders. Such standards likely would encompass many of the type of
loans intended by the Finance Board, while excluding large agricultural
and other large business loans. However, again, this approach would
establish a national standard that would not work in all locales. It
also would be very difficult for the Finance Board to ascertain how
many employees or shareholders are typical for a family farm or
business throughout the country, and then craft a regulation based on
that information. In addition, an employee or shareholder test, by
itself, would not necessarily guarantee an adequate residential nexus,
which the statute requires.
Another option considered was to require that the combination farm
or business property securing the loan be owner-occupied. Such a
standard would exclude loans secured by large farms with only a
caretaker's residence located on the property. However, a commenter
indicated that this standard would be under-inclusive because it would
exclude a significant number of combination family farm or business
loans where a family member lives in the residence on the property but
the residence is owned in the name of another family member or a
family-owned corporation. Defining ownership also could create problems
in implementation of the standard, and possible conflicts with state
laws.
Another option presented was to limit the farm or business
obtaining the loan to family partnerships or proprietorships, i.e., not
corporations, on the theory that this would serve as a surrogate for
small combination family farm and business loans. However, as a
commenter pointed out, such a standard also would be under-inclusive
because it would eliminate many small family farms that are
incorporated for tax or other reasons.
The Finance Board also considered an option supported by a FHLBank
commenter to establish a ``materiality'' standard for the residential
portion of the combination property, with each FHLBank adopting its own
criteria for determining ``materiality'' based on local conditions.
Such a standard could be an independent requirement or combined with a
reduced percentage test. The standard would ensure that the property
securing the loan has a ``material'' residential component, and would
reflect differences in local combination farm or business properties,
which a national standard cannot do, thereby qualifying more
combination farm or business loans held by rural institutions that
might otherwise fail the 50 percent test or a reduced percentage test.
However, the term ``material'' is a term of art in other areas of the
law, such as the federal securities laws, and its use here might prompt
unintended and undue reliance on a standard established under a body of
law unrelated to the FHLBanks.
C. Comments on Finance Board's Authority to Change the 50 Percent Test
1. Mission and Goals of the FHLBank System
The Farm Credit System commenters contended that the proposed rule
would be inconsistent with the housing finance mission of the FHLBank
System, principally because it would have allowed the use of loans for
membership and collateral purposes that are not predominantly
residential in nature. As described previously, the final rule requires
not only that any eligible combination property must include a bona
fide permanent residence, but that the residential component of the
property must be ``integral'' to, or inextricably linked with, the
overall parcel.
The Finance Board believes that the ``integral'' standard will
ensure that any loan secured by such combination property will have the
necessary residential nexus required by the Bank Act, and thus will be
consistent with the FHLBanks' housing finance mission. The ``integral''
standard may well allow the use of some loans secured by combination
properties even if the value of the residential portion of the property
does not predominate, but the Bank Act clearly permits that
possibility, for reasons discussed previously. Moreover, the housing
finance mission of the FHLBanks includes a community investment
component, and the final rule is consistent with that aspect of the
mission as well. In 1989, the Congress mandated that each FHLBank must
establish a Community Investment Program (CIP); Congress also expressly
permitted the FHLBanks to establish additional community investment
cash advance programs (Section 10(j)(10) programs). See 12 U.S.C.
1430(i), (j)(10).
Under the CIP, ``community-oriented mortgage lending'' includes
loans to finance commercial and economic development activities that
benefit low-and moderate-income families or activities that are located
in low- and moderate-income neighborhoods. Id. at 1430(j)(2). The
Finance Board previously has determined that such targeted commercial
and economic development lending constitutes ``residential housing
finance,'' for purposes of allowing long-term CIP advances. See CIP
Policy Statement, Board Resolution No. 92-533 (July 17, 1992); 12 CFR
935.1, 935.14(b)(2). The section 10(j)(10) provisions do not specify
any targeting requirements, which suggests that Congress contemplated
that Section 10(j)(10) programs need not have the same targeting or
other eligibility
[[Page 35124]]
requirements as are required under the CIP.
It is possible under these provisions for a FHLBank to fund
targeted commercial or economic development that has no ``residential''
component, at least in the sense contemplated by the Farm Credit System
commenters. Yet, the Finance Board has determined that such funding
would be part of the FHLBank's housing finance mission, as described
above. It would be anomalous to find that a targeted loan for wholly
commercial or economic development purposes is so clearly within the
mission of the FHLBanks, but that a combination loan, even if similarly
targeted, would somehow be beyond the housing finance mission because
it may be in part related to a commercial business or farm property.
The Finance Board believes that some number of rural and urban
combination properties will necessarily be located in low-and moderate-
income neighborhoods. Further, limiting the size of the institutions
eligible to use the revised standard, and thereby limiting the size of
the combination loans to be made by these institutions, is itself a
method of targeting the use of this standard to the communities and
uses most in need of the relief. To accept the reasoning of the Farm
Credit System commenters and conclude otherwise would require the
Finance Board to ignore the community investment aspect of the housing
finance mission, which it is not prepared to do. In the view of the
Finance Board, the final rule is consistent with both the historical
concept of residential housing finance, as well as the more broadly
defined concept incorporated by Congress into the Bank Act in 1989.
2. ``Rational'' Basis for Changing Prior Agency Statutory
Interpretation
Some of the commenters opposing the proposed rule contended that
the proposal should be withdrawn as inconsistent with the Finance
Board's prior interpretations of the statutory provisions, suggesting
that the Finance Board has ignored those interpretations and is obliged
to adhere to them. The commenters noted, for example, that in the
original rulemaking when the 50 percent test for advances collateral
purposes was adopted, the Finance Board rejected a commenter's
suggestion to set the limit at 10 percent, explaining that the higher
percentage better reflected the FHLBanks' focus on housing finance. See
58 FR 29456, 29462 (May 20, 1993). Opposing commenters now question the
authority of the Finance Board to take what they believe is a
conflicting position.
The Finance Board by no means has ignored its prior positions and
interpretations relating to the 50 percent test. To the contrary, the
Finance Board has carefully and thoroughly considered its past
approaches to this issue, all of the comments and suggestions received
in response to the proposed rule, and various alternative approaches.
The Finance Board has elected now to adopt an approach that is
consistent with its prior intentions yet, at the same time, better
accomplishes its intentions, is more flexible and allows for more
subjective analysis in lieu of rigid adherence to a fixed percentage
test.
As previously noted, an agency is free to change its interpretation
of its statute so long as its actions are rational, reasonable, not
arbitrary and capricious, involve no clear error of judgment, and a
satisfactory explanation for its actions is included within the record.
See, e.g., 5 U.S.C. 706(2)(A); Motor Vehicle Mfrs. Ass'n, 463 U.S. at
41-43; Camp, 411 U.S. at 142; IBAA, at 8-9.
Nothing in the Bank Act or in the Administrative Procedure Act
alters the agency's authority in this regard. In fact, deference is
given to the administering agency's construction of an ambiguous
statute if it is ``permissible'' or ``reasonable'' in light of the
statute's overall structure and goals. Chevron, 467 U.S. at 843-45.
Deference to the Finance Board's policy judgments is particularly
appropriate given its expertise and the broad discretion Congress has
conferred upon it. The Finance Board regulates in an area--the
financial services context where courts have customarily deferred to
evolving administrative interpretations of statutory language as a
means of accommodating changes in the market place and customers'
service needs. See, e.g., Clarke v. Securities Industry Ass'n, 479 U.S.
388, 403-09 (1987); Board of Governors of Federal Reserve System v.
Investment Company Institute, 450 U.S. 46, 56-58, 68 (1981). A notable
example of such deference is IBAA v. Clarke, where the court, deferring
to a statutory construction by a federal banking regulatory agency that
recognized ``the realities of banking in the nineties'' and that ``the
financial industry is complex and changing,'' concluded that ``[t]his
kind of regulatory and competitive environment is especially suited to
the expert judgment of regulators accustomed to dealing with the
industry day to day.'' 917 F.2d 1126, 1129 (8th Cir. 1990). Thus, it is
firmly established that the Finance Board is entitled to deference as
the agency charged with administering the Bank Act. See Rust v.
Sullivan, 500 U.S. 173, 184, 186-187 (1991).
Change in statutory interpretation is not a problem ``since the
whole point of Chevron is to leave the discretion provided by the
ambiguities of a statute with the implementing agency.'' Smiley v.
Citibank (South Dakota), N.A., 116 S.Ct. 1730, 1734 (1996). As the U.S.
Supreme Court emphasized in Chevron, ``an initial agency interpretation
is not instantly carved in stone. On the contrary, the agency, to
engage in informed rulemaking, must consider varying interpretations
and the wisdom of its policy on a continuing basis.'' 467 U.S. at 863-
64. That is what the Finance Board is doing through this rulemaking.
3. Ability of Rural Banks to Become FHLBank Members; Need for FHLBank
Credit
Some commenters argued that the Finance Board offered no reasoned
explanation or empirical data to support its departure from prior
practice. The Farm Credit System trade association argued that the 50
percent test should be retained because it does not hinder rural banks'
ability to become FHLBank members, and rural banks do not have less
demand for conventional single family and multifamily mortgages.
As an initial matter, there is nothing that requires the Finance
Board to conduct empirical studies as a prerequisite to conducting a
rulemaking proceeding. Indeed, there are any number of issues on which
an agency may regulate, such as interpretations of a statute, where
empirical analysis would have little relevance or benefit. An empirical
study of rural credit and housing markets might better inform the
Finance Board about certain aspects of those markets. It would be of no
use, however, in determining what minimum residential characteristics
are required by Congress in order for loans on combination properties
to be eligible for membership and advances collateral purposes, which
is the issue addressed by this rule.
That said, in adopting this final rule, the Finance Board has
considered studies prepared by other parties as sources of information
about the need for alternative funding sources for rural banks and the
state of rural credit markets. See USDA Report; ``Second Annual
Community Bank Competitiveness Study,'' ABA/ABA Banking Journal (Feb.
1998); Farm Credit Situation Survey Report 1997 (American Bankers
Association 1997). The Finance Board also has taken into consideration
its initial discussions with industry representatives about the
shortcomings of the 50 percent test, as well as the comments supporting
the proposal, which confirm the need for
[[Page 35125]]
alternative funding sources for rural banks and the likelihood that the
proposal would address that need. The Finance Board does not believe
that it is required to undertake further independent empirical research
of the rural credit and housing markets in order to exercise its
rulemaking authority.
The Farm Credit System trade association cited to a statement in
the USDA Report that, ``[n]ationwide, rural-headquartered commercial
banks are as likely to be members of the [FHLBank System] as are other
banks'' to support its views. See USDA Report at 48 n.19. However, the
commenter also acknowledged in a footnote that, ``[n]otwithstanding
this conclusion, the [USDA] Report noted that `rural access' to FHLBank
membership was of `some concern' in three isolated markets.'' What the
commenter characterizes as three ``isolated markets'' are in fact three
FHLBank districts--Des Moines, Dallas and Topeka--which encompass 14
states. Moreover, the USDA Report indicates that there are a total of
900 ineligible rural banks in these districts. See id. The purpose of
the Finance Board's rule is to assist some of these 900 rural banks in
joining and borrowing from the FHLBank System, as well as to assist
current members in increasing their borrowing capacity. Two of the
FHLBanks cited in the USDA Report, Des Moines and Topeka, submitted
comment letters strongly supporting the proposal. The Des Moines letter
stated that eliminating the current 50 percent test will enable over
600 of the FHLBank's current small community bank members with assets
under $100 million to fully use FHLBank funding. In addition, the
FHLBank estimated that the expansion of the membership eligibility
criteria to include these combination loans will enable approximately
700 more financial institutions to join the Des Moines FHLBank. (The
USDA Report estimated 322 ineligible rural banks in the Des Moines
district, see id.; therefore, it is assumed that the estimate of 700
ineligible institutions provided by the Des Moines FHLBank covers non-
rural as well as rural institutions.)
In addition, the USDA Report states that there are concerns about
whether rural offices of large urban banks effectively serve their
rural customers. See id. at 63. The USDA Report also states that rural
FHLBank members are larger and hold a greater ratio of mortgage-related
assets than other rural banks that are not FHLBank members. See id. at
48 n.19. This suggests that smaller banks and their rural customers may
be underserved at present and that increased FHLBank access by small
rural banks is needed. Notwithstanding the arguments of the Farm Credit
System commenters, it appears that the information in the USDA Report
actually supports the Finance Board's view that the 50 percent test
operates in practice to hinder the ability of rural banks to become
FHLBank members.
In addition, in a subsequent comment letter the Farm Credit System
trade association suggested that it is concerned with commercial bank
competition in the agricultural markets and indicated that there are
already two government sponsored enterprises (GSEs) serving the credit
needs of agriculture--the Farm Credit System and the Federal
Agricultural Mortgage Corporation (Farmer Mac). As previously stated,
many family farm/residential loans, while not meeting the 50 percent
test, have a sufficient residential nexus to ensure consistency with
the FHLBank System's housing finance and community investment mission.
Because it is within the missions of the Farm Credit System and Farmer
Mac, as well as the FHLBank System, to support the rural housing
markets, there is clearly some overlap in the markets served by
different GSEs. Such overlap can result in competition among GSEs.
The primary benefit afforded to GSEs is the ability to borrow at
rates only slightly higher than Treasury borrowing rates. The Farm
Credit System, Farmer Mac and the FHLBanks all receive this benefit by
virtue of their GSE status. In return for this benefit, GSEs have a
responsibility to fulfill a public policy mission. One of the ways that
GSEs fulfill their mission is by passing along their funding advantage
to the end user. The FHLBank System's housing finance and community
investment mission requires the FHLBanks to provide funds to financial
institutions in all markets, including rural markets that also may
receive some assistance from one or more other GSEs. To the extent that
other GSEs also provide government subsidized assistance to certain
rural markets, the revisions to the FHLBanks' membership and collateral
provisions do not result in an introduction of a new subsidy to these
markets, but rather provide another source of government-subsidized
funding. In fact, competition among GSEs can be viewed as a positive
development because it helps ensure that government subsidies flow to
the end user and not to the GSE's managers and shareholders.
The Farm Credit System trade association also argued that its
analysis of the likely membership effects of the proposed rule does not
suggest that rural banks would uniquely benefit from elimination of the
50 percent test. The commenter indicated that, based on its own
analysis of the loan portfolios of non-metropolitan and metropolitan
banks, membership eligibility for non-metropolitan banks would increase
approximately 10.5 percent, while membership eligibility for
metropolitan banks would similarly increase by more than 8 percent.
Although the proposed rule was issued in response to concerns
raised by rural banks, and is intended specifically to assist rural
banks in accessing the FHLBank System, the Finance Board did not intend
that such benefits accrue solely to rural banks. These amendments apply
as well to combination properties involving a non-farm business and a
residence, and it is anticipated that loans secured by such properties
located in urban areas also will be used by members and prospective
members as a result of this rule. The mission of the FHLBank System
includes the provision of funds to financial institutions located in
all areas of the country, and to the extent the rule assists non-rural,
as well as rural, banks, it is entirely consistent with the FHLBank
System's mission.
The Farm Credit System trade association also claimed that
statements made in support of the proposed rule contradict and must be
reconciled with past Finance Board statements to Congress.
Specifically, the Finance Board has stated that ``[e]ligible [other
real estate related] collateral for [FHLBank] System advances is
already very broad,'' and ``[t]here is no evidence that advance demand
is constrained by a lack of eligible collateral.'' See Finance Board
Report on the Structure and Role of the Federal Home Loan Bank System
at 167 (March 19, 1993).
The advantages of expanding the scope of that category of eligible
collateral were not considered to be significant at that time. See id.
However, as acknowledged by the commenter, the Finance Board separately
recommended that Congress permit the FHLBanks to accept a broader range
of collateral to secure advances in order to carry out the FHLBank
System's mission as defined by the Finance Board. See id. In addition,
as explained in the proposed rule, since adoption of the 50 percent
test, the Finance Board has received new information from members and
nonmembers of the FHLBank System indicating that the 50 percent test
has proven to be under-inclusive and, consequently, is constraining
advance demand in certain markets. This was confirmed by a significant
number of commenters, many of whom contend
[[Page 35126]]
that eliminating the 50 percent test would further the FHLBank System's
housing finance mission by making available a needed source of funding
for combination farm/residential loans.
4. Practical Consequences of Changing the 50 Percent Test
The Farm Credit System trade association also argued that the
Finance Board failed to consider the practical consequences of the
proposal. For instance, the commenter stated that the proposed rule did
not indicate how, with a substantial increase of eligible collateral,
the Finance Board would reconcile the credit demand in rural markets
with the potential impact on credit supply. The commenter estimated
that more than $18 billion in loans held by non-metropolitan banks
could be newly pledged as collateral for FHLBank advances. The
commenter argued that such an analysis is one essential predicate to
deciding whether the proposed rule is appropriately tailored to the
Finance Board's statutory housing mission.
The most likely practical consequences resulting from the final
rule are that some number of rural institutions will become eligible to
become members of the FHLBank System, will do so, and will borrow from
their FHLBank to finance residential housing within their communities.
Obviously, if the rule has the desired effect, there should be some
corresponding increase in the aggregate amount of advances outstanding,
which currently total approximately $208 billion System-wide. The
Finance Board has no reason to believe that an additional $18 billion
of collateral, assuming for the sake of argument that $18 billion is an
accurate figure, will overwhelm the credit markets. For one thing, some
portion of that amount will be owned by institutions that choose not to
become members, and some will be owned by members who will not borrow
to their full potential. Additionally, the FHLBanks all have credit
policies that establish discounts for various types of collateral.
Given the circumstances and the prudent underwriting by the FHLBanks,
the Finance Board would expect that any FHLBank accepting newly-
authorized loans on combination properties would significantly discount
those loans pledged as collateral. This discounting, or
overcollateralization, would further diminish the amount of credit that
the newly-authorized collateral could support. Moreover, the insured
depository institutions that presumably would be borrowing against this
collateral are regulated by other agencies, which require the
institutions they regulate to limit asset growth to what is prudent.
See 12 CFR Part 30, App. A, Sec. II.F. The Finance Board believes that
those operational and regulatory checks will preclude any undue
consequences in the rural credit markets as a result of this rule.
5. Safety and Soundness Risks of Changing the 50 Percent Test
The Farm Credit System trade association also stated that the
Finance Board did not indicate how it will address the fact that a
mortgage on a combination property may be less liquid and marketable
than a conventional home mortgage. The commenter stated that a safety
and soundness issue may arise where a prospective member lender lacks
the necessary understanding of the agricultural lending process, which
may result in compromised underwriting practices and poor credit
decisions in pursuing loans on newly eligible combination properties,
increasing the likelihood of loan losses incurred by the FHLBanks.
In fact, the proposed rule discussed at length the fact that any
additional risks that might arise if such mortgage loans are used as
collateral for advances should be adequately managed in accordance with
the current provisions of the advances regulation and FHLBank credit
policies. The FHLBanks already accept combination loans, and have
expertise in underwriting advances secured by such loans. The final
rule, like the current advances regulation, does not mandate that the
FHLBanks accept combination farm or business loans as collateral for
advances. It merely includes such loans in the category of loans
eligible to be accepted by a FHLBank to secure advances.
The FHLBanks already are permitted to accept as collateral for
advances to members ``other real estate related collateral'' (provided
aggregate outstanding advances secured by such collateral do not exceed
30 percent of the member's capital). See 12 U.S.C. 1430(a)(4); 12 CFR
935.9(a)(4). Included in this category of permissible collateral are
loans on farms and other agricultural property, commercial mortgage
loans, construction loans, land development loans, and second mortgage
loans including home equity loans. See 12 CFR 935.9(a)(4)(ii). The
FHLBanks also may accept multifamily loans as eligible collateral,
without being subject to the 30 percent member capital limit. See 12
U.S.C. 1430(a)(1); 12 CFR 935.9(a)(1)(i). With respect to each of those
types of collateral, the FHLBanks already manage the credit, liquidity,
and marketability risks cited by the commenter, as well as other risks,
associated with non-one-to-four family residential mortgage collateral.
There is no evidence that these revisions will subject the FHLBanks to
underwriting tasks that are beyond their ability to manage.
The Finance Board requires that the FHLBanks have such underwriting
expertise and credit policies before accepting such loans as
collateral. Specifically, the advances regulation requires, among other
things, that the FHLBanks establish written procedures for determining
the value of collateral securing advances, and that the FHLBanks follow
those procedures in ascertaining the value of particular assets offered
as collateral. See 12 CFR 935.12. The regulation also permits the
FHLBanks 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. See id.
Rural lending often requires collateral valuation practices that
may differ significantly from those typically employed in lending on
the security of one-to-four family homes. The Finance Board expects
each FHLBank to review its collateral valuation procedures, and amend
them as necessary to reflect the changes made in the final rule, before
accepting as collateral any newly authorized combination properties.
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 rural 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 review
or re-valuation for various types of collateral. Moreover, the loan
quality and underwriting practices of the individual members are
reviewed regularly by the
[[Page 35127]]
primary banking regulators through periodic examinations.
In short, the above-described FHLBank practices, regulatory
requirements, and Finance Board examination oversight, do not encourage
FHLBank members to approve unsafe or unsound loans that could be
pledged to the FHLBanks to secure advances.
In addition, increasing access to the FHLBank System would provide
current and prospective members with enhanced risk management options.
The USDA Report states that access to funds from GSEs, such as the
FHLBanks, enhances liquidity and can improve profitability and risk
management of depository financial intermediaries, including commercial
banks, credit unions, and thrifts. See USDA Report at 97. Risk
management is enhanced because GSE funds are available with longer
maturities than are usually available on deposits at commercial banks.
See id. at 98. Advances can be used to control interest rate risk by
allowing member banks to match the funding to the maturity, payment
structure, prepayment options, and other features of the loans they
make. See id.
The Finance Board specifically requested comment on whether
elimination of the 50 percent test might expose the FHLBanks to any
undue risk of loss should a FHLBank need to liquidate the combination
mortgage loans it holds as collateral for an advance. See 62 FR 53252.
Many commenters stated that the proposal would not present safety or
soundness risks for the FHLBanks because, as discussed above, the
FHLBanks do not lend against the full value of collateral, but rather
apply discounts depending on the riskiness of the collateral and the
difficulties in valuing it. Commenters also pointed out that the
FHLBanks obtain appraisals of collateral from members, and can require
additional collateral if necessary.
In addition, commenters noted that combination loans at rural banks
are solidly performing and generally exceed the loan quality of the
rest of the banking industry, with 1996 net charge-offs on average
loans at rural banks at 0.32 percent, while net charge-offs for banks
overall were 0.61 percent. One FHLBank commenter noted that the
experience of lenders in Iowa during the 1980s ``agricultural crisis''
was that, while there was a substantial decline in value of both one-
to-four family properties in rural areas and combination farm/residence
properties, the decline was not greater for the combination properties
than it was for those that were solely residential. In fact, the
combination properties were more likely to be sold since there remained
buyers interested in the agricultural portion of the land. Based on
this experience, the commenter did not believe that combination
property is more volatile than solely residential property located in
rural areas. The commenter stated that it planned to hire additional
experienced personnel to ensure that, through proper due diligence, its
practices are prudent and will not expose the FHLBank to undue risks of
loss.
Accordingly, the Finance Board believes that through due diligence,
overcollateralization, and prudent credit and collateral risk
management procedures and practices, the FHLBanks can adequately
prevent undue risk of loss on advances secured by combination loans.
Therefore, the Finance Board does not believe that there are undue
safety and soundness risks that would suggest that the Finance Board
lacks the ``rational'' basis for changing the 50 percent test in the
final rule.
VI. Definition of ``Residential Mortgage Loan'' in
Sec. 933.1(bb)(8) of the Final Rule
Consistent with the proposed rule, ``residential mortgage loan'' is
defined in Sec. 933.1(bb)(8) of the final rule to include, for
membership eligibility purposes, loans that finance properties or
activities that, if made by a member, would satisfy the statutory
requirements for the CIP established under section 10(i) of the Bank
Act, or the regulatory requirements established for any community
investment cash advance program authorized by section 10(j)(10) of the
Bank Act. See 12 U.S.C. 1430(i), (j)(10).
The intent of this amendment is to allow such community investment
loans to be considered for purposes of eligibility for membership, and
to conform the membership regulation more closely to the advances
regulation, which already includes loans financed by section 10(i) or
section 10(j)(10) advances within the definition of ``residential
housing finance assets.'' See 12 CFR 935.1. A banking trade association
specifically supported the proposed definition.
VII. Regulatory Flexibility Act
The final rule does not impose any additional reporting,
recordkeeping, or compliance requirements on prospective or current
FHLBank members. Although the Finance Board anticipates that the final
rule will be of benefit primarily to small depository institutions, it
will not have a disproportionate impact on small entities. Therefore,
in accordance with the Regulatory Flexibility Act, the Finance Board
hereby certifies that this final rule will not have a significant
economic impact on a substantial number of small entities. 5 U.S.C.
605(b).
VIII. Paperwork Reduction Act
The final rule does not contain any collections of information, as
defined by the Paperwork Reduction Act of 1995. See 44 U.S.C. 3501 et
seq. Consequently, the Finance Board has not submitted any information
to the Office of Management and Budget for review.
List of Subjects
12 CFR Part 933
Federal home loan banks, Reporting and recordkeeping requirements.
12 CFR Part 935
Credit, Federal home loan banks, Reporting and recordkeeping
requirements.
Accordingly, the Federal Housing Finance Board hereby amends title
12, chapter IX, parts 933 and 935 of the Code of Federal Regulations as
follows:
PART 933-MEMBERS OF THE BANKS
1. The authority citation for part 933 continues to read as
follows:
Authority: 12 U.S.C. 1422, 1422a, 1422b, 1423, 1424, 1426, 1430,
1442.
2. Amend Sec. 933.1 by revising paragraph (n)(1)(iii), removing
``or'' at the end of paragraph (bb)(6)(iii), removing the period at the
end of paragraph (bb)(7) and adding ``; or'' in its place, and adding
paragraph (bb)(8) to read as follows:
Sec. 933.1 Definitions.
* * * * *
(n) Home mortgage loan * * *
(1) * * *
(iii) Combination business or farm property where at least 50
percent of the total appraised value of the combined property is
attributable to the residential portion of the property or, in the case
of any community financial institution, combination business or farm
property, on which is located a permanent structure actually used as a
residence (other than for temporary or seasonal housing), where the
residence constitutes an integral part of the property. For purposes of
this subparagraph, the term ``community financial institution'' means
an institution that has average total assets of $500,000,000 or less,
based on an average of total assets over the three preceding years. The
Board shall adjust the limit annually based on the annual
[[Page 35128]]
increase, if any, in the Consumer Price Index for all urban consumers,
as published by the Department of Labor; or
* * * * *
(bb) Residential mortgage loan * * *
(8) Loans that finance properties or activities that, if made by a
member, would satisfy the statutory requirements for the Community
Investment Program established under section 10(i) of the Act, or the
regulatory requirements established for any community investment cash
advance program authorized by section 10(j)(10) of the Act.
* * * * *
PART 935--ADVANCES
1. The authority citation for part 935 continues to read as
follows:
Authority: 12 U.S.C. 1422a(a)(3), 1422b(a)(1), 1426, 1429, 1430,
1430b, 1431.
2. Amend Sec. 935.1 by revising paragraph (1)(v) in the definition
of ``Residential real property'' to read as follows:
Sec. 935.1 Definitions.
* * * * *
Residential real property * * *
(1) * * *
(v) Combination business or farm property where at least 50 percent
of the total appraised value of the combined property is attributable
to the residential portion of the property or, in the case of any
community financial institution, combination business or farm property,
on which is located a permanent structure actually used as a residence
(other than for temporary or seasonal housing), where the residence
constitutes an integral part of the property. For purposes of this
subparagraph, the term ``community financial institution'' means an
institution that has average total assets of $500,000,000 or less,
based on an average of total assets over the three preceding years. The
Board shall adjust the limit annually based on the annual increase, if
any, in the Consumer Price Index for all urban consumers, as published
by the Department of Labor.
* * * * *
Dated: April 14, 1998.
By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairperson.
[FR Doc. 98-17163 Filed 6-26-98; 8:45 am]
BILLING CODE 6725-01-P
