Proposed Changes to the Financial Management Policy of the Federal Home Loan Bank System

SUMMARY: The Federal Housing Finance Board (Finance Board) is proposing

to amend its policy statement entitled ``Financial Management Policy of

the Federal Home Loan Bank System'' (FMP). The proposed amendments to

the FMP are being made in conjunction and conformance with proposed

regulatory changes to the Finance Board's regulations regarding the

Office of Finance (OF), described in detail in a Proposed Rule

published elsewhere in this issue of the Federal Register. The proposed

regulatory changes would reorganize the OF, a joint office of the

Federal Home Loan Banks (Bank or Banks), and broaden its duties,

functions and responsibilities in two key respects: (1) the OF would

perform consolidated obligation (CO) issuance functions, including

preparation of combined financial reports, for the Banks; and (2) the

OF would serve as a vehicle for the Banks to carry out joint activities

in a way that promotes operating efficiency and effectiveness in

achieving the mission of the Banks.

DATES: The Finance Board will accept comments on the proposed changes

to the FMP in writing on or before March 6, 2000.

ADDRESSES: Send comments to Elaine L. Baker, Secretary to the Board, by

electronic mail at [email protected], or by regular mail at the Federal

Housing Finance Board, 1777 F Street, N.W., Washington, D.C. 20006.

Comments will be available for public inspection at this address.

FOR FURTHER INFORMATION CONTACT: Joseph A. McKenzie, Deputy Chief

Economist, Office of Policy, Research and Analysis, 202/408-2845,

[email protected]; Charlotte A. Reid, Special Counsel, Office of

General Counsel, 202/408-2510, [email protected]; or Eric E. Berg, Senior

Attorney, Office of General Counsel, 202/408-2589, [email protected].

Staff also can be reached by regular mail at the Federal Housing

Finance Board, 1777 F Street, N.W., Washington, D.C. 20006.

SUPPLEMENTARY INFORMATION:

I. Background

The FMP evolved from a series of policies and guidelines initially

adopted by the former Federal Home Loan Bank Board (FHLBB), predecessor

agency to the Finance Board, in the 1970s and revised a number of times

thereafter. The Finance Board adopted the FMP in 1991, consolidating

into one document the previously separate policies on funds management,

hedging, and interest-rate swaps, and adding new guidelines on the

management of unsecured credit and interest-rate risks. See 62 FR 13146

(Mar. 19, 1997).

The FMP generally provides a framework within which the Banks may

implement their financial management strategies in a prudent and

responsible manner. Specifically, the FMP identifies the types of

investments the Banks may purchase pursuant to their statutory

investment authority and includes a series of guidelines relating to

the funding and hedging practices of the Banks and the management of

their credit, interest-rate, and liquidity risks. The FMP also

establishes liquidity requirements in addition to those required by

statute. See FMP secs. III-IV.

II. Analysis of the FMP amendments

Pursuant to section 11 of the Federal Home Loan Bank Act, 12 U.S.C.

1431, and the proposed changes to 12 CFR parts 900, 910 and 941

described in detail in a Proposed Rule published elsewhere in this

issue of the Federal Register, the Finance Board and the Banks have

authority to issue through the OF consolidated obligations (COs), i.e.,

bonds, notes, or debentures on which the Banks are jointly and

severally liable. Under the FMP, a Bank is authorized to participate in

the proceeds from COs, so long as entering into such transactions will

not cause the Bank's total COs and unsecured senior liabilities to

exceed 20 times its capital. See FMP sec. IV.C.

The FMP also authorizes a Bank to participate in certain types of

standard and non-standard debt issues. See id. Specifically, the FMP

requires a Bank participating in non-standard debt issues to enter into

a contemporaneous hedging arrangement that passes the interest-rate or

basis risk through to the hedge counterparty unless the Bank is able to

document that the debt will be used to fund mirror-image assets in an

amount equal to the debt, offset or reduce interest-rate or basis risk

in the Bank's portfolio, or otherwise assist the Bank in achieving its

interest-rate or basis risk management objectives. If a Bank

participates in debt denominated in a currency other than U.S. dollars,

it is required to hedge the currency exchange risk. See id. at sec.

IV.C.3.

The proposed FMP amendments would delete existing section IV,

``Funding Guidelines,'' and replace it with a new section IV titled

``Minimum Total Capital and Hedging Requirements.'' The new section

would read as follows:

Minimum Total Capital and Hedging Requirements.

A. Leverage limit. Each Bank shall have and maintain at all

times total capital in an amount equal to at least 4.76 percent of

the Bank's total assets. For purposes of this section, total capital

is the sum of a Bank's retained earnings and total paid-in capital

stock outstanding, less the Bank's unrealized net losses on

available-for-sale securities.

B. Prohibition on foreign currency or commodity positions. A

Bank shall not take a position in any commodity or foreign currency.

If a Bank participates in consolidated obligations denominated in a

currency other than U.S. dollars or linked to equity or commodity

prices, it must hedge the currency, equity, and commodity risks.

The proposed FMP amendments would eliminate the Funding Guidelines,

with one exception, as unnecessary in light of the proposed

comprehensive regulatory amendments published elsewhere in this issue

of the Federal Register. The one exception concerns the leverage limit.

Currently, Finance Board regulations (12 CFR 910.1(b)) and the FMP

provide that, on a Bank System-wide and Bank-by-Bank basis,

respectively, liabilities cannot exceed 20 times paid-in capital stock,

retained earnings, and reserves. As discussed in detail in the proposed

rulemaking, the Finance Board is proposing to remove the System-wide

liability-based leverage limit from Finance Board regulations as

unnecessary, and is here proposing to replace the current Bank-by-Bank

liability-based leverage limit in the FMP with a minimum total capital

requirement that would, in effect, recast the leverage limit as a

percentage of assets, that is, that a Bank's total assets cannot exceed

21 times its capital, or inversely, capital must be at least 4.76

percent of assets. The Bank System had an average capital-to-assets

ratio of 5.1 percent at September 30, 1999.

Neither the elimination of the Bank System-wide leverage limit from

the Finance Board regulations, nor the proposed revision to the Bank-

by-Bank leverage limit contained in the FMP, would have any practical

effect on the Bank System or its bondholders. The Finance Board, as the

regulator of the Banks, would continue to monitor each Bank for

compliance with the individual leverage limit included in

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the FMP. The current FMP prohibits a Bank from participating in COs if

such transactions would cause the Bank's liabilities to exceed 20 times

the Bank's total capital. The proposed revision to the FMP would

establish an equivalent leverage standard stated as a percentage of

assets that would require each Bank to maintain capital of at least

4.76 percent of its total assets. Imposition of the 4.76 percent

standard on each Bank will ensure that the Bank System itself stays

within the leverage limit, rendering retention of a Bank System-wide

leverage limit unnecessary. Further, the Finance Board notes that with

the recent passage of Title VI of the Gramm-Leach-Bliley Act, the

Federal Home Loan Bank System Modernization Act of 1999, Pub. L. 106-

102, 113 Stat. 1338 (Nov. 12, 1999), the Banks will be subject to

statutory leverage limits and risk-based capital requirements. When

implemented in regulations, the new risk-based capital regime will

provide an additional safeguard to the Bank System and its bondholders

by requiring Banks to hold capital in proportion to the risks they

assume.

The changes reflected in proposed section IV.B of the FMP do not

draw the distinction between standard and non-standard debt issues

contained in the current FMP. Instead, the changes require the Banks to

hedge some types of debt issues previously defined as non-standard. The

types of debt issues that must be hedged under the proposed amendments

to the FMP are those linked to equity or commodity prices or those

denominated in foreign currencies.

The Finance Board also is taking this opportunity to propose a

change in the FMP unrelated to the issuance of debt or the OF

reorganization. Section VII of the FMP contains guidelines for the

Banks on the management of interest-rate risk. The Finance Board uses

duration of equity as its primary measure of interest-rate risk. The

current FMP gives the Banks an option on how to calculate their

duration of equity. The option deals with the inclusion or exclusion of

the cash flows associated with the Bank's Affordable Housing Program

(AHP) and Resolution Funding Corporation (REFCorp) obligations. Since

1995, each Bank has to contribute a minimum of 10 percent of its annual

income (net of its REFCorp obligation) for the AHP, with a Bank System-

wide minimum of $100 million. See 12 U.S.C. 1430(j)(5)(C). In addition,

the Banks, in the aggregate, formerly were required annually to

contribute $300 million towards the Bank System's REFCorp obligation.

Id. 1441b(f)(2)(c) (superseded).

The Gramm-Leach-Bliley Act changed the REFCorp obligation for years

2000 and beyond from a fixed annual payment of $300 million to the

payment of 20 percent of the Banks' net earnings (net of AHP and

operating expenses), with the payment period extended or shortened as

necessary to ensure full payment of the present value of the

obligation. Since the AHP has not been a fixed dollar obligation since

1994 and the REFCorp obligation will no longer be a fixed dollar

amount, the Finance Board proposes to prohibit the Banks from managing

their assets and liabilities as if these items are fixed dollar

obligations. Instead, under the revised FMP, a Bank would treat these

obligations as typical variable expenses (like operating expenses) for

purposes of asset-liability management. Because the Banks' AHP and

REFCorp obligations are variable expenses, the Finance Board believes

that it would not be appropriate for the Banks to include AHP and

REFCorp-related cash flows in their duration of equity calculations.

The Finance Board originally proposed this change to the FMP in 1997.

See 62 FR 13146 (Mar. 19, 1997). The proposed language would read as

follows:

Each Bank is required to report its cash flows and calculate its

duration and market value of equity without projected cash flows

which represent the Bank's share of the System's REFCorp and AHP

obligations.

The Finance Board is expressly proposing this language again as even

more appropriate in light of the Gramm-Leach-Bliley Act change to the

REFCorp payment methodology.

The Finance Board will accept comments on the proposed FMP

amendments for the same 60-day comment period as the proposed

regulatory amendments to parts 900, 910, and 941.

By the Board of Directors of the Federal Housing Finance Board.

Dated: December 14, 1999.

Bruce A. Morrison,

Chairman.

[FR Doc. 00-36 Filed 1-3-00; 8:45 am]

BILLING CODE 6725-01-P