Terms and Conditions for Advances

FEDERAL HOUSING FINANCE BOARD

12 CFR Part 935

[No. 96-61]

Terms and Conditions for Advances

AGENCY: Federal Housing Finance Board.

ACTION: Final rule.

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SUMMARY: The Board of Directors of the Federal Housing Finance Board

(Finance Board) is adopting a final rule that amends its regulation on

terms and conditions for advances. The final rule requires a Federal

Home Loan Bank (FHLBank) that offers putable advances to provide

appropriate written disclosures and to offer replacement advance

funding in the event that the FHLBank terminates the putable advance

prior to its stated maturity date.

EFFECTIVE DATE: The final rule will become effective November 7, 1996.

FOR FURTHER INFORMATION CONTACT: Christine M. Freidel, Assistant

Director, Financial Management Division, Office of Policy, (202) 408-

2976, or, Janice A. Kaye, Attorney-Advisor, Office of General Counsel,

(202) 408-2505, Federal Housing Finance Board, 1777 F Street, N.W.,

Washington, D.C. 20006.

SUPPLEMENTARY INFORMATION:

I. Statutory and Regulatory Background

Under section 10 of the Federal Home Loan Bank Act (Bank Act), each

FHLBank has the authority to make secured advances \1\ to its members.

See 12 U.S.C. 1430. To ensure that the FHLBanks operate their advance

programs in a safe and sound manner, 12 U.S.C. 1422a(a)(3)(A), and

pursuant to its authority to supervise the FHLBanks and ensure that the

FHLBanks carry out their housing finance mission and remain adequately

capitalized and able to raise funds in the capital markets, id.

Sec. 1422a(a)(3)(B), the Finance Board promulgated a final rule

governing FHLBank advance programs in May 1993. See 58 FR 29456 (May

20, 1993), codified at 12 CFR part 935.

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\1\ For purposes of the Finance Board regulation governing

advances, 12 CFR part 935, an advance is a loan from a FHLBank that

is provided pursuant to a written agreement, supported by a note or

other written evidence of the borrower's obligation, and fully

secured by collateral in accordance with the Bank Act and Finance

Board regulations. See id. Sec. 935.1.

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Since that time, the FHLBanks have developed a new type of advance

product called a ``putable advance.'' A putable advance is one that a

FHLBank may, at its discretion, put back to a member for immediate

repayment prior to the maturity of the advance on dates specified in

the advances agreement. Putable advances present to a member borrower

the risk that a FHLBank will exercise the put option and terminate the

advance prior to its maturity date thereby placing the borrower at a

disadvantage. For example, if a FHLBank were to terminate a putable

advance prior to its maturity date in a rising interest rate

environment, any replacement advance funding offered to the member

might be extended at higher market interest rates. On the other hand,

since the member borrower is incurring the interest rate risk

associated with putable advance funding, a FHLBank is able to offer a

putable advance at an interest rate that can be significantly lower

than that available on a regular advance. FHLBank members have

expressed considerable interest in the lower cost funding available

through the use of putable advances.

The Finance Board's advances regulation does not address putable

advances, and the practices with respect to this type of advance

funding vary from FHLBank to FHLBank. To provide for uniformity and

consistency in practice among the FHLBanks that offer putable advances

and to reinforce the role of the FHLBanks as sources of liquidity for

member institutions, the Finance Board approved for publication a

proposed rule to amend its advances regulation to address specifically

the issuance of putable advances. The proposed rule was published in

the Federal Register on August 2, 1996, with a 30-day public comment

period that closed on September 3, 1996. See 61 FR 40364 (Aug. 2,

1996). The Finance Board received a total of four comments in response

to the notice of proposed rulemaking, two from FHLBanks and two from

industry trade associations. The commenters generally supported the

Finance Board's proposal. Specific comments are discussed in Sec. II of

the Supplementary Information.

II. Analysis of Public Comments and the Final Rule

The final rule adds a new subsection (d), putable advances, to

Sec. 935.6 of its advances regulation, which concerns the terms and

conditions for advances.

A. Disclosure

To ensure that members are fully apprised of the risks associated

with putable advance funding, Sec. 935.6(d)(1) requires a FHLBank that

provides a putable advance to a member to disclose in writing to such

member the risks associated with putable advance funding. Such risks

include the option risk described in Sec. I of the Supplementary

Information and the

[[Page 52687]]

potentially adverse impact on a member's liquidity if a FHLBank

terminates a putable advance prior to the stated maturity date.

A trade association commenter strongly supported the written

disclosure requirement and recommended that the disclosure contain

information regarding the interest rate environments in which a FHLBank

might exercise the put option. The Finance Board believes that the

disclosure required by the proposed rule already encompasses this type

of information. However, to provide further clarification, the final

rule states that the disclosure should include detail sufficient to

describe the type and nature of the risks associated with putable

advances.

B. Replacement Funding

To preclude the possibility that putable advance funding might

cause liquidity problems for members, Sec. 935.6(d)(2) of the proposed

rule would have required a FHLBank that terminates a putable advance

prior to its maturity date to offer replacement funding to the member

at the market rate for the remaining term to maturity of the putable

advance. To provide maximum utility to FHLBank members and flexibility

to both members and the FHLBanks, one FHLBank commenter suggested that

the term to maturity of the replacement funding should be determined

through negotiations between the FHLBank and the member. The other

FHLBank commenter suggested that, in order to provide FHLBank members

with some protection from interest rate changes, a member should be

permitted to elect at the time of origination of the putable advance

whether replacement funding will be priced at the market rate or a

predetermined rate negotiated between the FHLBank and the member. The

Finance Board has decided to incorporate these suggestions into the

final rule.

Section 935.6(d)(2) of the final rule requires a FHLBank that

terminates a putable advance prior to its maturity date to offer

replacement funding to the member. Paragraph (d)(2)(i) provides that at

the option of the member, the term to maturity of replacement funding

may be either the remaining term to maturity of the putable advance or

a term to maturity agreed upon between the FHLBank and the member.

Paragraph (d)(2)(ii) provides that at the option of the member,

replacement funding may be priced at either the market rate or a

predetermined rate agreed upon between the FHLBank and the member.

Although the final rule requires a FHLBank to offer replacement

funding, it does not obligate the member to accept the offer.

In the notice of proposed rulemaking, the Finance Board stated that

the FHLBanks should consider replacement funding to be a conversion of

the outstanding advance rather than a new extension of credit. To

ensure that there is no conflict between the putable advances provision

and Sec. 935.5 of the Finance Board's advances regulation, 12 CFR

935.5, which establishes limitations on access to FHLBank advances, a

FHLBank commenter suggested clarifying the final rule. The Finance

Board agrees with this suggestion and has added a new paragraph to the

final rule, Sec. 936.5(d)(2)(iii), providing that, for purposes of part

935, replacement funding is the conversion of an outstanding advance,

not the renewal of an existing advance or the extension of a new

advance.

A trade association commenter supported the development of new

advance products that help FHLBank members to meet their liquidity and

credit needs. The commenter recommended that, in addition to putable

advances, the FHLBanks should offer ``callable advances'' that would be

callable at the option of the FHLBank member. A FHLBank would factor

the cost of the call provision into the coupon, much as it includes the

cost of the put in the price of a putable advance, rather than through

a prepayment penalty. All of the FHLBanks currently offer callable

advances and all but two factor the full cost of the option into the

advance coupon.

C. Definition of ``Putable Advance''

The Finance Board adopted the definition of the term ``putable

advance'' in Sec. 935.6(d)(3) of the proposed rule without change. For

purposes of Sec. 935.6(d), the term ``putable advance'' means an

advance that a FHLBank may, at its discretion, terminate and require

the member to repay prior to the stated maturity date of the advance.

III. Regulatory Flexibility Act

Under the Regulatory Flexibility Act (RFA), 5 U.S.C. 601, et seq.,

the FHLBanks are not ``small entities.'' Id. section 601(6). Since this

final rule contains only technical revisions to an existing rule that

applies only to the FHLBanks, it does not impose any additional

regulatory requirements on small entities. Thus, in accordance with the

provisions of the RFA, the Board of Directors of the Finance Board

hereby certifies that this final rule will not have a significant

economic impact on a substantial number of small entities. Id. section

605(b).

List of Subjects in 12 CFR Part 935

Credit, Federal home loan banks.

Accordingly, the Board of Directors of the Finance Board hereby

amends part 935, chapter IX, title 12, Code of Federal Regulations, as

follows:

PART 935--ADVANCES

1. The authority citation for part 935 continues to read as

follows:

Authority: 12 U.S.C. 1422b(a)(1), 1426, 1429, 1430, 1430(b), and

1431.

2. In Sec. 935.6, paragraph (d) is added to read as follows:

Sec. 935.6 Terms and conditions for advances.

* * * * *

(d) Putable advances. (1) Disclosure. A Bank that offers a putable

advance to a member shall disclose in writing to such member the type

and nature of the risks associated with putable advance funding. The

disclosure should include detail sufficient to describe such risks.

(2) Replacement funding. If a Bank terminates a putable advance

prior to the stated maturity date of such advance, the Bank shall offer

to provide replacement funding to the member.

(i) Term to maturity. At the option of the member, a Bank shall

offer replacement funding:

(A) For the remaining term to maturity of the putable advance; or

(B) For a term to maturity agreed upon between the Bank and the

member.

(ii) Interest rate. At the option of the member, a Bank shall price

replacement funding:

(A) At the market rate of interest; or

(B) At a predetermined rate of interest agreed upon between the

Bank and the member.

(iii) Conversion. For purposes of this part, replacement funding

shall be considered the conversion of an outstanding advance, and shall

not be considered the renewal of an existing advance or the extension

of a new advance.

(3) Definition. For purposes of this paragraph (d), the term

putable advance means an advance that a Bank may, at its discretion,

terminate and require the member to repay prior to the stated maturity

date of the advance.

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

Bruce A. Morrison,

Chairperson.

[FR Doc. 96-25695 Filed 10-7-96; 8:45 am]

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