Federal Home Loan Bank Standby Letters of Credit

FEDERAL HOUSING FINANCE BOARD

12 CFR Part 938

[No. 98-17]

RIN 3069-AA61

Federal Home Loan Bank Standby Letters of Credit

AGENCY: Federal Housing Finance Board.

ACTION: Proposed Rule.

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SUMMARY: The Federal Housing Finance Board is proposing to codify its

existing policies on Federal Home Loan Bank (FHLBank) standby letters

of credit into the form of a regulation and to amend these policies to

allow for broader use of these products by FHLBank members and eligible

nonmember mortgagees. The proposed rule also would eliminate some of

the restrictions currently imposed on issuance of standby letters of

credit by FHLBanks that limit the usefulness of these products to

members and eligible nonmember mortgagees.

DATES: Comments are due on or before August 6, 1998.

ADDRESSES: Mail comments to Elaine L. Baker, Executive Secretary,

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

20006. Comments will be available for inspection at this address.

FOR FURTHER INFORMATION CONTACT: Diane E. Dorius, Associate Director,

Program Development, Office of Policy, (202) 408-2576; or Eric M.

Raudenbush, Attorney-Advisor, Office of General Counsel, (202) 408-

2932, Federal Housing Finance Board, 1777 F Street, N.W., Washington,

D.C. 20006.

SUPPLEMENTARY INFORMATION:

I. Background

The FHLBanks have been permitted to engage in standby letter of

credit (LOC) transactions since 1983, when the predecessor agency to

the Federal Housing Finance Board (Finance Board), the former Federal

Home Loan Bank Board (FHLBB), first adopted its Policy Guidelines for

Issuance of FHLBank Standby Letters of Credit (FHLBB Guidelines).

Underlying this policy was a 1983 FHLBB legal opinion which concluded

that FHLBank issuance of standby LOCs on behalf of members is

permissible under the FHLBanks' authority to make secured advances, set

forth in section 10 of the Bank Act, 12 U.S.C. 1430, because a FHLBank

standby LOC is the functional equivalent of an advance in that it

involves an extension of credit by the FHLBank to its member. Because

the FHLBB considered the authority to issue standby LOCs to derive from

the authority to make secured advances, the 1983 FHLBB Guidelines, and

the 1985 and 1989 revisions thereto, applied the statutory and

regulatory requirements pertaining to advances to standby LOC

transactions. The substance of the FHLBB Guidelines was maintained when

the Finance Board (created by the Financial Institutions Reform,

Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat.

412 (1989), to succeed the FHLBB as regulator of the FHLBanks) adopted

its first standby LOC policy in 1991.

FHLBank participation in standby LOC transactions currently is

governed by the Finance Board's Interim Policy Guidelines for FHLBank

Standby Letters of Credit (Interim Guidelines), which were adopted in

1993. The Interim Guidelines permit FHLBanks to issue or confirm

standby LOCs on behalf of members to facilitate: the purchase of, or

commitment to purchase mortgage loans; the collateralization of public

unit deposits; the collateralization of Internal Revenue Code (IRC)

Section 936 deposits (deposits made in Puerto Rican financial

institutions by corporations operating in Puerto Rico); interest rate

swaps and other transactions that assist a member's asset/liability

management; transactions that promote home financing, housing activity,

or members' involvement in commercial and economic development

activities that benefit low-and moderate-income families or activities

that are located in low-and moderate-income neighborhoods (community

development); and tax-exempt bonds or notes designed to promote housing

or the financing of community development. In addition, the Interim

Guidelines permit FHLBanks to issue LOCs on behalf of nonmember

mortgagees eligible to obtain advances under section 10b of the Bank

Act, 12 U.S.C. 1430b, for transactions that promote home financing,

housing activity, and community development.

Because the Finance Board retained the substance of the FHLBB

Guidelines and, by implication, the 1983 FHLBB legal analysis, the

Interim Guidelines continued to impose upon LOCs all of the regulatory

requirements and restrictions that apply to advances. For example, the

Interim Guidelines require that LOCs: be fully secured with collateral

eligible to secure advances under Sec. 935.9(a) of the Finance Board's

regulations, 12 CFR 935.9(a); be counted in the calculation of a

member's FHLBank stock-to-advances ratio; be issued only for housing

finance purposes if they have a term to maturity in excess of five

years, or are issued on behalf of non-qualified thrift lender (non-QTL)

members; and be included in the calculation of the limitation on

advances to non-QTL members set forth in Sec. 935.13 of the

regulations, id. Sec. 935.13, if issued on behalf of non-QTL members.

In addition, the Interim Guidelines limit LOCs and confirmations used

for purposes other than interest rate swap transactions to terms of ten

years or less and prohibit use of LOC confirmations solely to promote a

member's LOC program or to increase a member's profitability from this

fee-based service.

As part of an ongoing effort to determine both how FHLBank standby

LOCs might be made more useful to member institutions and nonmember

mortgagees and how to encourage greater use of LOCs in carrying out the

housing and community investment mission of the FHLBank System, the

Finance Board recently undertook a survey of the FHLBanks to determine

the uses of standby LOCs and the needs of the FHLBanks in issuing

standby

[[Page 25727]]

LOCs. The Finance Board also undertook a review of the legal bases on

which the FHLBanks' LOC authority has been, and could be, grounded. As

a result of these efforts, the Finance Board has concluded that FHLBank

authority to engage in standby LOC transactions is not limited to the

provisions addressed in the 1983 FHLBB legal opinion, but also may be

considered to be part of, and incidental to, the FHLBanks' deposit-

taking and payment processing powers set forth in section 11(e) of the

Bank Act. 12 U.S.C. 1431(e). If a FHLBank's involvement in a standby

LOC transaction is considered to be part of its payment processing

activity, however, FHLBank fees for LOCs may be subject to a private

sector adjustment factor under section 11(e)(2) of the Bank Act. 12

U.S.C. 1431(e)(2). The Finance Board specifically requests comment

regarding the consequences of this possibility.

The Finance Board also has determined that the authority of a

FHLBank to issue a standby LOC may be considered, in the alternative,

to be part of the FHLBanks' incidental authority to enter into

commitments to make advances. On the basis of this refined analysis,

the Finance Board has concluded that, although there may be safety and

soundness and other policy reasons for requiring certain restrictions,

it is unnecessary as a matter of law to subject FHLBank LOCs to all of

the statutory and regulatory restrictions and limitations that apply to

advances.

This rulemaking proposes to amend the Interim Guidelines to provide

the FHLBanks with greater flexibility to respond to member needs for

standby LOCs in a manner that ensures that FHLBanks' use of standby

LOCs is consistent with the FHLBank System's housing and community

investment mission and to codify these policies as a regulation.

Accordingly, these proposed standby LOC regulations permit FHLBank

members to request standby LOCs for a broader range of purposes and

remove many of the restrictions on FHLBank standby LOC issuance that

have limited the usefulness of such LOCs in the past.

The Finance Board requests comments on all aspects of the proposed

rule.

II. Analysis of the Proposed Rule

This rulemaking proposes to add to the Finance Board's regulations,

12 CFR chapter IX, a new part 938 to govern FHLBank Standby LOCs.

Definitions relevant to the proposed FHLBank Standby LOC regulation are

set forth in Sec. 938.1 of the proposed regulation. Because these

definitions have been drafted in order to implement substantive

provisions, they are discussed, as necessary, below in the context of

their use in the body of the regulation.

Section 938.2 of the proposed regulation governs FHLBank standby

LOCs issued or confirmed on behalf of member institutions. Paragraph

(a) authorizes FHLBanks to issue standby LOCs on behalf of members, and

to confirm standby LOCs issued by members, that conform to the

requirements of proposed part 938 and that are issued for the purposes

enumerated in paragraphs (a)(1) through (a)(4). The term ``standby

letter of credit,'' as defined in Sec. 938.1, is intended to include

those instruments that are commonly referred to as such; i.e., LOCs

that effectively guarantee the applicant's payment or performance in an

underlying transaction with the beneficiary. The term does not include

LOCs that are intended to serve as a short-term payment mechanism to

finance the movement of goods (commonly known as ``commercial'' LOCs).

The Finance Board considers ``direct pay'' LOCs, which are designed to

act as the primary mechanism for satisfying an applicant's payment

obligations over a period of time (for example, to make payments of

principal and interest on commercial paper and medium-term notes) to be

a form of standby LOC which FHLBanks would be authorized to issue under

the proposed regulation.

Under paragraph (a) of proposed Sec. 938.2, FHLBanks would be

authorized to issue or confirm standby LOCs for any of four broad

purposes: (1) To facilitate residential housing finance or other

housing activity; (2) to facilitate the financing of targeted economic

development projects; (3) to assist members with asset/liability

management; or (4) to provide members with liquidity or other funding.

This list of approved purposes would replace the more specific and

restrictive list set forth in the Interim Guidelines. By replacing the

specific list with the broader purposes set forth in paragraph (a) of

Sec. 938.2, the Finance Board intends to ensure that FHLBanks' use of

standby LOCs is consistent with the FHLBank System's housing and

community development mission and, at the same time, provide the

FHLBanks with greater flexibility to respond to member needs for such

credit. Under the proposed regulation, FHLBanks would determine,

subject to Finance Board review and oversight, whether particular

transactions fall within any of the above-described categories.

The term ``residential housing finance'' refers to the purchase or

funding of ``residential housing finance assets,'' or other activities

that support the development or construction of residential housing. As

defined in Sec. 935.1 of the Finance Board's regulations, the term

``residential housing finance assets'' includes: Loans secured by

residential real property; mortgage-backed securities; participations

in loans secured by residential real property; loans financed by CIP

advances (under the proposed Community Investment Cash Advance (CICA)

rule, discussed below, reference to CIP advances would be amended to

refer to loans or investments financed by advances made pursuant to a

CICA program); loans secured by manufactured housing; or any other

assets that the Finance Board determines to be residential housing

finance assets. The term ``residential housing finance,'' as defined in

Sec. 938.1 of the proposed regulation, also is intended to encompass

activities that are aimed toward providing residential housing for

individuals and families, but that do not fall within the existing

regulatory definition of ``residential housing finance assets,'' which

refers only to loans and securities backed by loans. For example, a

FHLBank would be permitted to issue a standby LOC to serve as a

performance bond to secure a builder's performance in a housing

construction project. Paragraph (a)(1) of Sec. 938.2 is intended to

provide the FHLBanks with the same scope of authority to issue and

confirm housing-related standby LOCs that currently exists under the

Interim Policy.

Economic development projects that would be eligible for support

through a FHLBank standby LOC would include commercial, manufacturing,

social service, public or community facility, and public or private

infrastructure projects or activities that benefit families with

incomes of 100 percent or less of area median income in urban areas,

115 percent or less of area median income in rural areas, or with an

income at or below a target level established by a FHLBank to address

unmet housing or economic development credit needs. Projects would be

deemed to benefit such families if: The project is located in a

neighborhood in which more than 50 percent of the families have incomes

at or below the targeted income level; the project is located in a

rural or urban Champion Community, a rural or urban Empowerment Zone,

or rural or urban Enterprise Community; the project is located in a

federally declared disaster area; the project involves property

[[Page 25728]]

eligible for a federal Brownfield Tax Credit; the project is located in

an area affected by a federal military base closing or realignment; the

project is located in an area identified as a designated community

under the Community Adjustment and Investment Program; the annual

salaries for at least 75 percent of the permanent full- and part-time

jobs, computed on a full-time equivalent basis, created or retained by

the project, other than construction jobs, are at or below the targeted

income level; the project qualifies as a small business; or more than

50 percent of the families who otherwise benefit from (other than

through employment) or are provided services by the project have

incomes at or below the targeted income level.

These provisions and the concepts underlying them were developed as

part of the Finance Board's proposed Community Investment Cash Advance

(CICA) program regulation, which has been published elsewhere in this

issue of the Federal Register. The proposed CICA Regulation would

establish a general framework under which the FHLBanks may establish

programs to provide advances to be used in support of financing for

housing and economic development activities that benefit income-

targeted families that may not benefit from advances made under the

FHLBanks' existing Affordable Housing Programs (AHP) and Community

Investment Programs (CIP).

Specifically, the proposed CICA Regulation would authorize each

FHLBank to establish: A Rural Development Advance (RDA) program to

provide advances to members and nonmember borrowers to finance economic

development projects in rural areas that benefit families with incomes

at or below 115 percent of the area median income; an Urban Development

Advance (UDA) program to provide advances to members and nonmember

borrowers to finance economic development projects in urban areas that

benefit families with incomes at or below 100 percent of the area

median income; and other CICA programs to provide financing for

economic development projects benefiting families with incomes at or

below a level established by the Bank to address unmet economic

development credit needs (defined as those for which financing is not

generally available, or is available at lower levels or under less

attractive terms). Regulation of the existing CIP would also be

subsumed within the CICA Regulation.

Under the Interim Guidelines, FHLBanks are permitted to issue

standby LOCs to support only those economic development activities that

benefit families earning less than 80 percent of area median income, or

that are located in a neighborhood in which 51 percent or more of the

households earn less than 80 percent of area median income, for which a

member could receive a CIP advance. Having determined that it may

authorize FHLBanks to issue standby LOCs to support a wider array of

activities than is currently permitted under the Interim Guidelines,

the Finance Board sought ways to permit FHLBanks to respond better to

member requests for LOC products while, at the same time, assuring that

FHLBanks' use of standby LOCs is consistent with the public policy

purposes of the FHLBank System. The inclusion of the CICA-related

targeted economic development provisions, which already had been

subject to much study and discussion in the process of developing the

proposed CICA Regulation, as one parameter for FHLBank LOC use appears

to meet both criteria by maximizing the ability of FHLBanks to benefit

areas with unmet economic development credit needs, as well as

furthering regulatory consistency.

A thorough discussion of the reasoning behind the Finance Board's

inclusion of particular substantive criteria in its conception of

targeted economic development may be found in the preamble to the

proposed CICA Regulation, published elsewhere in this issue of the

Federal Register. It is anticipated that, if and when the CICA and

Standby LOC Regulations are promulgated as final rules, the Standby LOC

Regulation will describe the economic activities that may be

appropriately supported by FHLBank LOCs merely by cross-referencing the

CICA Regulation, as opposed to including all of the CICA-related

definitions therein. Because the CICA Regulation thus far has been

published only as a proposed rule, the Finance Board found it

appropriate to restate those definitions in their entirety within the

proposed Standby LOC Regulation in order to make its scope more readily

apparent to the reader.

Under paragraph (a) of proposed Sec. 938.2, FHLBanks also would be

permitted to issue standby LOCs to assist members with their asset/

liability management and to provide members with liquidity or other

funding. Although the Interim Guidelines permit FHLBanks to issue

short-term LOCs to facilitate interest rate swaps and other

transactions that assist in asset/liability management, such LOCs would

no longer be limited to a term of five years or less, or limited only

to QTL members, under the proposed regulation. In addition, although

liquidity and other funding purposes are not mentioned expressly in the

Interim Guidelines, they have been included in the proposed regulation

to make clear that the FHLBanks may use their LOC authority to further

this central member-service function and to bring within the purview of

the regulation permissible standby LOC activities that might not be

easily traceable to a particular housing or economic development

purpose, such as securing public unit deposits and IRC Section 936

deposits.

Paragraph (b) of proposed Sec. 938.2 requires that FHLBank standby

LOCs made to members be secured at the time of issuance for the full

amount of the LOC by collateral described in paragraph (c) of that

section. This would continue the requirement of the Interim Guidelines

that LOCs be fully secured at the time of issuance, although, as

discussed below, members would be able to use a wider range of

collateral and would no longer need to pledge their FHLBank stock as

additional collateral for LOCs. Although the Finance Board has

concluded that, as a matter of law, the Bank Act does not necessarily

require that LOCs be collateralized fully at the time of issuance, it

has determined that such a requirement is advisable as a matter of safe

and sound banking practice. The Finance Board requests comments on

whether there are any circumstances under which the FHLBanks could

safely and soundly issue LOCs that are not fully collateralized.

Paragraph (c) describes the types of collateral that are eligible

to secure FHLBank standby LOCs issued on behalf of members. It provides

that all LOCs may be secured with collateral that is eligible to secure

FHLBank advances to members under Sec. 935.9(a) of the Finance Board's

regulations. 12 CFR 935.9(a). In addition, in order to facilitate the

use of LOCs to support housing and targeted economic development

activities and to permit greater access to LOCs by members that lack

sufficient Sec. 935.9(a)--eligible collateral, the proposed regulation

also would permit members to secure LOCs that are issued for the

purpose of facilitating residential housing finance or targeted

economic development activities with: (1) secured or federally-

guaranteed loans to small businesses (as defined by the Office of

Thrift Supervision); (2) investment-grade obligations of state or local

government agencies; and (3) ``other real estate-related collateral''

described in Sec. 935.9(a)(4) of the regulations in excess

[[Page 25729]]

of the ``30 percent of capital'' limitation set forth in paragraph

(a)(4)(iii) thereof.

Under the Interim Guidelines, LOCs may be secured only by

collateral that is eligible to secure advances, regardless of the

purpose for which the LOC is issued. Such collateral includes Small

Business Administration--(SBA) guaranteed securities. However because

most small business loans are not SBA-guaranteed, the proposed

regulation, by permitting all secured or federally-guaranteed small

business loans to be used as collateral for LOCs, could encourage

members to provide financing for smaller or start-up businesses that

often have a more difficult time accessing credit than well-established

or larger enterprises. Expanded use of small business loans as

collateral will support the FHLBanks' mission of providing support for

targeted economic development lending--the targeted universe in this

case being small commercial and business entities, including small

farms. Commercial bank members and Community Development Financial

Institution (CDFI) members, in particular, may have substantial amounts

of such loans available to use as collateral.

Under the proposed regulation, an additional source of collateral

for LOCs would be state and municipal bonds rated investment grade by a

nationally-recognized rating agency (such as bonds rated BBB or better

by Moody's or Bbb or better by Standard & Poor's). Under the Interim

Guidelines, FHLBanks may accept real estate-related state and municipal

housing bonds as collateral for LOCs only as part of the limited basket

of other real estate-related collateral. See 12 CFR 935.9(a)(4)(iii).

Expanding eligible collateral for LOCs to include investment grade

state or municipal bonds could benefit members who hold such

investments and who have insufficient advances-eligible collateral.

Because there is an established secondary market for these bonds, they

can be easily valued and, if necessary, liquidated by a FHLBank.

The proposed regulation also permits members to secure LOCs issued

for housing finance or targeted economic development purposes with

other real estate-related collateral in excess of the ``30 percent of

capital'' limitation set forth in Sec. 935.9(a)(4)(iii) of the Advances

Regulation. 12 CFR 935.9(a)(4)(iii). If so permitted, members that have

substantial amounts of such collateral, such as commercial banks, could

expand their use of FHLBank LOCs. For example, members specializing in

community development lending could pledge, without limit, loans

secured by community facilities, such as day care centers and health

clinics and lenders in rural areas could pledge more of their farm

loans.

The proposed regulation would permit each FHLBank to establish

limits on the use of these additional types of collateral. FHLBanks

accepting such collateral would be expected to include, as part of

their standby LOC policies required under Sec. 938.5(a)(1), policies

and procedures for valuing and securing such collateral that are

consistent with safe and sound banking practice. The Finance Board

believes that any additional risks that might arise from the use of

these additional types of collateral should be adequately managed in

accordance with the collateral provisions of the Advances Regulation

that are referenced in proposed Sec. 938.5(d). Among other things, the

Advances Regulation requires the FHLBanks to establish written

procedures for determining the value of collateral, and to follow those

procedures in ascertaining the value of a particular asset offered as

collateral. See 12 CFR 935.12. The Advances 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. Id.

The Finance Board expects that if proposed part 938 is adopted as a

final rule, each FHLBank will review its collateral valuation

procedures, and will amend them as necessary to reflect the

availability of these additional types of collateral to secure standby

LOCs, before accepting such collateral. 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. Such

appraisal should take into account the security of the loan itself, as

well as any additional risks inherent in such collateral and each

FHLBank's own ability to evaluate those risks. The Finance Board

specifically requests comment on whether there are other assets that

should be considered as eligible collateral for LOCs and whether the

Finance Board should establish limits on these additional types of

collateral based upon the assets that secure the loans themselves.

Section 938.3 of the proposed regulation governs FHLBank standby

LOCs issued or confirmed on behalf of customers that have been

certified as eligible nonmember mortgagees pursuant to Sec. 935.22(b)

of the Finance Board's regulations. 12 CFR 935.22(b). Paragraph (a) of

proposed Sec. 938.3 would authorize FHLBanks to issue or confirm on

behalf of nonmember mortgagees standby LOCs that are fully secured by

Federal Housing Administration-(FHA) insured loans or Government

National Mortgage Association (GNMA) securities backed by FHA-insured

loans, for the same broad purposes for which FHLBanks may issue or

confirm LOCs on behalf of member institutions. In addition, paragraph

(b) of proposed Sec. 938.3 would authorize FHLBanks to issue or

confirm, on behalf of nonmember mortgagees that have qualified as state

housing finance agencies (SHFAs) by meeting the requirements of

Sec. 935.22(d) of the regulations, 12 CFR 935.22(d), standby LOCs that

are fully secured by collateral eligible under Sec. 935.9(a) of the

regulations, id. 935.9(a), to secure advances. Standby LOCs secured by

such collateral would be required to facilitate residential or

commercial lending that benefits individuals or families meeting the

income requirements in section 142(d) or 143(f) of the IRC.

Proposed Sec. 938.3 would continue the general policy of the

Interim Guidelines by requiring that FHLBank LOCs issued on behalf of

nonmember mortgagees be subject to the same limitations and

restrictions that apply to advances made to nonmembers under section

10b of the Bank Act, 12 U.S.C. 1430b, and Sec. 935.24 of the

regulations, 12 CFR 935.24. In its legal review of the sources of

statutory authority for issuance of LOCs by FHLBanks, the Finance Board

determined that, unlike LOCs issued on behalf of members, the issuance

of LOCs on behalf of nonmembers could not be considered to fall within

the FHLBanks' payment processing authority, which expressly applies

only to FHLBank dealings with members and financial institutions

eligible to apply for FHLBank membership. See 12 U.S.C. 1431(e)(2).

Thus, the Finance Board believes that FHLBanks should issue LOCs to a

nonmember mortgagee only under the same conditions that would apply if

the FHLBank were to enter into an advance commitment with that

nonmember. Because the type of collateral that a FHLBank may accept to

secure advances to nonmembers is linked, by statute, to the purpose of

the advance, the purpose for which a LOC is issued on behalf of a

nonmember also must govern the type of collateral that the FHLBank may

accept to secure the LOC.

Section 938.4 of the proposed regulation governs the obligation of

both members and nonmember mortgagees on whose behalf an FHLBank issues

a LOC to reimburse the FHLBank for any funds drawn by the beneficiary

under

[[Page 25730]]

the LOC. Paragraph (a) of proposed Sec. 938.4 requires that, as part of

the agreement pursuant to which a LOC is to be issued, a member or

nonmember assume an unconditional obligation to reimburse the FHLBank

fully for any amounts drawn by the beneficiary under the LOC by having

available in its FHLBank deposit or transaction account on the day of

the FHLBank's payment to the beneficiary sufficient funds to cover such

payment. The requirement that an applicant assume an unconditional

obligation to reimburse the FHLBank continues the policy of the Interim

Guidelines and is consistent with the provisions of Article 5 of the

Uniform Commercial Code (UCC), as revised in 1995, which provide that

an issuer that has honored a presentation made by a beneficiary under a

LOC is entitled to be reimbursed by the applicant in immediately

available funds not later than the date of its payment of funds. See

UCC 5-108(i) (1995).

In order to facilitate reimbursement of a FHLBank, to emphasize the

applicant's responsibility to cover the amount of any draw under a LOC,

to tie the FHLBanks' LOC activities more closely to their payment

processing authority (in the case of LOCs issued on behalf of members)

and for purposes of regulatory consistency, paragraph (a)(1) of

Sec. 938.4 requires that reimbursement by an applicant be accomplished

through its FHLBank deposit account (if the applicant is a member) or

transaction account (if the applicant is a nonmember, see 12 CFR

935.24).

Paragraph (b) of proposed Sec. 938.4 requires FHLBanks to take

prompt action to recover the funds due if an applicant fails to have

available in its FHLBank deposit or transaction account on the day of a

draw under a LOC sufficient funds to cover the draw. Despite this

requirement, paragraph (b) of proposed Sec. 938.4 authorizes an issuing

FHLBank, at the request of a member or nonmember, but in its own

discretion, to finance an applicant's repayment of a LOC draw by making

an advance to the applicant. Of course, such an advance could be made

only if the applicant is, at that time, willing and able to comply with

the advances requirements of section 10 (if the applicant is a member)

or section 10b (if the applicant is a nonmember) of the Bank Act, 12

U.S.C. 1430, 1430b, and part 935 of the Finance Board's regulations, 12

CFR part 935. For purposes of complying with the regulatory advance

requirements, the ``purpose'' of an advance made to a member or

nonmember under the conditions of proposed Sec. 938.4(c) would be

determined using the same standards that apply to any other type of

advance. See 12 CFR 935.13 & .14.

Section 938.5 of the proposed regulation sets forth certain

miscellaneous provisions that would apply to all LOCs issued on behalf

of members and nonmembers. paragraph (a)(1) of proposed Sec. 938.5

requires that all LOCs issued on behalf of members or nonmembers be

issued only pursuant to a written LOC policy established by the FHLBank

to govern its standby LOC programs. Such a policy would be required to:

(1) implement all statutory and regulatory provisions that apply to

standby FHLBank LOCs; (2) to set forth underlying criteria to apply to

the issuance or renewal of standby LOCs that is consistent with the

criteria that must be applied to the underwriting of advances; and (3)

set forth criteria regarding the pricing of standby LOCs, including any

special criteria that could apply to LOCs issued to facilitate the

financing of targeted economic development projects.

It is intended that paragraph (a)(1)(ii) of proposed Sec. 938.5,

regarding the application of underwriting criteria under the FHLBank's

LOC policy at the time of the issuance or renewal of a LOC, apply also

in cases where a LOC contains a provision stating that the LOC will

automatically renew unless the FHLBank notifies the beneficiary of its

intent not to renew the LOC. Such provisions must be carefully

monitored so that the FHLBank can control its risk exposure. The

renewal of any LOC pursuant to such a provision should be approved in

the same manner as a renewal of a LOC that does not contain this

provision. However, because an issued LOC cannot be canceled without

agreement from the beneficiary, FHLBanks are encouraged to issue LOCs

only for a limited term, with the potential for renewal if the account

party remains creditworthy. This would give the FHLBanks an opportunity

to reassess periodically their exposure on long-term transactions.

As a matter of safety and soundness regulation, paragraph (a)(2) of

proposed Sec. 938.5 would continue the policy of the Interim Guidelines

by requiring that all LOCs issued by a FHLBank either contain a

specific expiration date, or be for a specified term. This is

consistent with Comptroller of the Currency and the OTS regulations on

LOCs, which specifically require that LOCs issued by national banks and

savings associations, as a matter of sound banking practice, be limited

in duration or terminable periodically or at will upon notice or

payment to the beneficiary. See 12 CFR 7.1016(b)(1)(iii) and

560.120(b)(1)(iii).

Similarly, paragraph (a)(3) of proposed Sec. 938.5 would continue

the policy of the Interim Guidelines by requiring that the transfer of

a FHLBank LOC be approved in advance by the issuing FHLBank. A transfer

of a letter of credit occurs when the beneficiary transfers to a

another party its right to draw under the LOC. Requiring approval by a

FHLBank would ensure that a LOC could not be transferred without the

FHLBank's knowledge.

Finally, paragraph (b) of proposed Sec. 938.5 would apply to

FHLBank LOCs issued on behalf of members and nonmembers certain

provisions set forth in the Finance Board's Advances Regulation, 12 CFR

part 935, including provisions regarding the FHLBank's right to require

additional collateral or to limit the type of collateral that it will

accept, and matters of collateral verification, safekeeping and

valuation.

Proposed part 938 would not include many of the restrictions on

FHLBank standby LOC transactions that currently are imposed by the

Interim Guidelines. The Interim Guidelines require a member to purchase

FHLBank stock when a FHLBank issues a LOC, which is an off-balance

sheet item, on behalf of that member. This causes a decrease in the

FHLBank's leverage because the FHLBank's outstanding stock is increased

without a corresponding increase in on-balance sheet assets. Under

proposed part 938, FHLBanks would no longer be required to include LOCs

in the computation of a member's advances/FHLBank capital stock ratio,

because the Finance Board no longer considers LOCs to be the legal

equivalent of outstanding advances. Eliminating this requirement would

remove the deleveraging effect of the current policy and would make

FHLBank standby LOCs more attractive to members.

By applying uniform requirements to standby LOCs issued on behalf

of any member, without regard to the QTL status of the member, proposed

part 938 would not require that standby LOCs issued on behalf of non-

QTL members be issued only for housing finance purposes, as is the case

under the Interim Guidelines. In addition, proposed part 938 would not

require that standby LOCs issued on behalf of non-QTL members be

included with total FHLBank System advances and advances to non-QTL

members for purposes of monitoring compliance with the FHLBank System's

statutory 30 percent limit on advances to non-QTL members. See 12

U.S.C. 1430(e)(2). Again, the Finance Board has determined that these

restrictions are not required by law because the Finance

[[Page 25731]]

Board no longer considers LOCs to be the legal equivalent of

outstanding advances.

Removing these restrictions on standby LOCs issued on behalf of

non-QTL members, many of which are actively involved in financing

housing and economic development transactions, would expand the

opportunities for FHLBanks to issue standby LOCs to support such

housing and economic development activities. In addition, removal of

these restrictions would enhance the ability of FHLBanks to assist non-

QTL members with their liquidity needs.

The Interim Guidelines limit the use of standby LOCs with tax-

exempt bonds to those issues designed to promote housing or commercial

and economic development that benefits low-and moderate-income families

or that is located in low-and moderate-income neighborhoods. Under IRC

section 149, 26 U.S.C. 149, it is unclear whether tax-exempt bonds

financing economic development would lose their tax-exempt status if

supported by a FHLBank standby LOC. The Finance Board currently is

working with Congress to resolve this issue legislatively. In the

meantime, the Finance Board considers this issue to be a matter for the

Internal Revenue Service to determine and, therefore, has not specified

in the proposed regulation the types of tax-exempt bonds for which a

FHLBank standby LOC may be issued.

The Interim Guidelines provide that FHLBank LOC confirmations may

not be used solely to support a member's own LOC program or to increase

a member's profitability. LOC confirmations serve essentially the same

purpose, and incur for a FHLBank the same contingent liability, as the

issuance of a LOC. A member's access to a FHLBank's LOC confirmation

presumably would make a member's LOC more acceptable to a beneficiary

and would help to increase a member's profitability. Because all of the

products and services offered by a FHLBank to its members are designed

to assist members improve their liquidity, to offer additional

financing options to its customers, and consequently increase its

income, the current restriction on confirmations appears to conflict

with these goals. Therefore, this restriction has not been included in

proposed part 938.

The Interim Guidelines limit the term of a FHLBank standby LOC

issued on behalf of a QTL member to 5 years for non-housing finance

purposes and 10 years for housing finance purposes, but impose no limit

for issues that support a member's performance in interest rate swap

transactions. The Interim Guidelines limit the term of a FHLBank

standby LOC issued on behalf of a non-QTL member to 10 years or less

for housing finance. In contrast, FHLBanks may offer advances with

maturities of any length consistent with the safe and sound operation

of the FHLBank. See 12 CFR 935.6(a).

Expanding the terms for LOCs would benefit low-income housing tax

credit transactions that often require a 15-year letter of credit. In

addition, a longer term would permit LOCs to be used with industrial

development and other bonds used to fund local economic development

that typically have terms longer than 10 years. Because standby LOCs

posses no more credit risk than an advance, there appears to be no

reason to limit the maturity of a LOC as long as a FHLBank has

established controls that ensure the safe and sound operation of the

FHLBank. Therefore, the proposed regulation imposes no term limitations

on FHLBank standby LOCs.

Proposed part 938 would not require that outstanding FHLBank LOCs

be reflected on the books of the FHLBank as contingent liabilities, as

is required under the Interim Guidelines, because this is already

required under General Accepted Accounting Principles (GAAP), which the

FHLBanks must follow. Finally, the requirement of the Interim

Guidelines that FHLBanks must submit monthly LOC reports has not been

included in the proposed regulation because this is already subsumed

within the current general requirement that FHLBanks report monthly to

the Finance Board on all FHLBank activities. See 12 CFR 934.7(e).

III. Regulatory Flexibility Act

The proposed rule applies only to the FHLBanks, which do not come

within the meaning of ``small business,'' as defined in the Regulatory

Flexibility Act (RFA). See 5 U.S.C. 601(6). Therefore, in accordance

with section 605(b) of the RFA, 5 U.S.C. 605(b), the Finance Board

hereby certifies that this proposed rule, if promulgated as a final

rule, will not have a significant economic impact on a substantial

number of small entities.

List of Subjects in 12 CFR Part 938

Community development, Credit, Federal home loan banks, Housing,

Mortgages.

Accordingly, the Finance Board hereby proposes to amend chapter IX,

title 12, Code of Federal Regulations, to add a new part 938 to read as

follows:

PART 938--STANDBY LETTERS OF CREDIT

Sec.

938.1 Definitions.

938.2 Standby letters of credit on behalf of members.

938.3 Standby letters of credit on behalf of nonmember mortgagees.

938.4 Obligation to Bank under all standby letters of credit.

938.5 Additional provisions applying to all standby letters of

credit.

Authority: 12 U.S.C. 1422b, 1429, 1430, 1430b, 1431.

Sec. 938.1 Definitions.

As used in this part:

Act means the Federal Home Loan Bank Act, as amended (12 U.S.C.

1421-49).

Applicant means a person or entity at whose request or for whose

account a standby letter of credit is issued.

Bank means a Federal Home Loan Bank established under the authority

of the Act.

Beneficiary means a person or entity who, under the terms of a

standby letter of credit, is entitled to have its complying

presentation honored.

Benefit. An economic development project is deemed to benefit

families with incomes at or below a targeted income level if:

(1) The project is located in a neighborhood in which more than 50

percent of the families have incomes at or below the targeted income

level;

(2) The project is located in a rural Champion Community, or a

rural Empowerment Zone or rural Enterprise Community, as designated by

the Secretary of Agriculture (in the case of projects located in rural

areas);

(3) The project is located in an urban Champion Community, or an

urban Empowerment Zone or urban Enterprise Community, as designated by

the Secretary of HUD (in the case of projects located in urban areas);

(4) The project is located in a federally declared disaster area;

(5) The project involves property eligible for a federal Brownfield

Tax Credit authorized by 26 U.S.C. 198;

(6) The project is located in an area impacted by a federal

military base closing or realignment;

(7) The project is located in an area identified as a designated

community under the Community Adjustment and Investment Program;

(8) The annual salaries for at least 75 percent of the permanent

full-and part-time jobs, computed on a full-time equivalent basis,

created or retained by the project, other than construction jobs, are

at or below the targeted income level;

(9) The project qualifies as a small business; or

[[Page 25732]]

(10) More than 50 percent of the families who otherwise benefit

from (other than through employment) or are provided services by the

project have incomes at or below the targeted income level.

Champion Community means a community which developed a strategic

plan and applied for designation by either the Secretary of Housing and

Urban Development or the Secretary of Agriculture as an Empowerment

Zone or Enterprise Community, but was designated a Champion Community.

Confirm means to undertake, at the request or with the consent of

the issuer, to honor a presentation under a standby letter of credit

issued by a member or nonmember mortgagee.

Document means a draft or other demand, document of title,

investment security, certificate, invoice, or other record, statement,

or representation of fact, law, right, or opinion that is presented

under the terms of a standby letter of credit.

Economic development projects means:

(1) Commercial, manufacturing, social service, and public facility

projects and activities; and

(2) The construction or rehabilitation of public or private

infrastructure, such as roads, utilities, and sewers.

Family means one or more persons living in the same dwelling unit.

Finance Board means the agency established by the Act as the

Federal Housing Finance Board.

Issuer means a person or entity that issues a standby letter of

credit.

Median income for the area means one or more of the following, as

determined by the Bank:

(1) The median income for the area, as published annually by the

Department of Housing and Urban Development;

(2) The applicable median family income, as determined under 26

U.S.C. 143(f) (Mortgage Revenue Bonds) and published by a State agency

or instrumentality;

(3) The median income for the area, as published by the United

States Department of Agriculture; or

(4) The median income for any definable geographic area, as

published by a federal, state, or local government entity for purposes

of that entity's housing programs, and approved by the Board of

Directors of the Finance Board, at the request of a Bank, for use under

the Bank's Community Investment Cash Advance (CICA) programs, as

provided for in part 970 of this chapter.

Member means an institution that has been approved for membership

in a Bank and has purchased capital stock in the Bank in accordance

with Sec. Sec. 933.20 and 933.24 of this chapter.

Metropolitan statistical area means a ``metropolitan statistical

area,'' as that term is defined by the U.S. Bureau of the Census.

Neighborhood means:

(1) A census tract or block numbering area;

(2) A unit of general local government with a population of 25,000

or less;

(3) A rural county;

(4) A trust or restricted Indian land, Native Hawaiian Home Land,

or Alaskan Native Village; or

(5) A geographic location designated in comprehensive plans,

ordinance, or other local documents as a neighborhood, village, or

similar geographic designation that is within the boundary of but does

not encompass the entire area of a unit of general local government.

Nonmember mortgagee means an entity certified as a nonmember

mortgagee pursuant to Sec. 935.22(b) of this chapter.

Nonmember SHFA means a nonmember mortgagee that is a ``state

housing finance agency,'' as that term is defined in Sec. 935.1 of this

chapter, and that has met the requirements of Sec. 935.22(d) of this

chapter.

Presentation means delivery of a document to an issuer, or an

entity that has undertaken a confirmation at the request or with the

consent of the issuer, for the giving of value under a standby letter

of credit.

Residential housing finance means:

(1) The purchase or funding of ``residential housing finance

assets,'' as that term is defined in Sec. 935.1 of this chapter; or

(2) Other activities that support the development or construction

of residential housing.

Rural area means:

(1) A unit of general local government or an unincorporated place

outside a metropolitan statistical area that has a population of less

than 30,000; or

(2) A trust or restricted Indian land, Native Hawaiian Home Land,

or Alaskan Native Village.

Small business means a ``small business concern,'' as that term is

defined by section 3(a) of the Small Business Act (15 U.S.C. 632(a))

and implemented by the Small Business Administration at 13 CFR part

121, or any successor provisions.

Standby letter of credit means a definite undertaking by an issuer

on behalf of an applicant that represents an obligation to the

beneficiary, pursuant to a complying presentation, to repay money

borrowed by, advanced to, or for the account of the applicant; to make

payment on account of any indebtedness undertaken by the applicant; or

to make payment on account of any default by the applicant in the

performance of an obligation. The term standby letter of credit does

not include a commercial letter of credit, or any short-term self-

liquidating instrument used to finance the movement of goods.

Targeted income level means:

(1) For projects or activities that benefit primarily individuals

or families residing in an urban area, 100 percent of the median income

for the area;

(2) For projects or activities that benefit primarily individuals

or families residing in a rural area, 115 percent of the median income

for the area; or

(3) An income level that is based on a percentage of median income

established by the Bank to address unmet community investment credit

needs.

Urban area means a unit of general local government or an

unincorporated place that is:

(1) Within a metropolitan statistical area; or

(2) Outside a metropolitan statistical area and has a population of

more than 30,000.

Sec. 938.2 Standby letters of credit on behalf of members.

(a) Authority and purposes. Each Bank is authorized to issue or

confirm on behalf of members standby letters of credit that comply with

the requirements of this part, for any of the following purposes:

(1) To assist members in facilitating residential housing finance;

(2) To assist members in facilitating the financing of economic

development projects that benefit families with incomes at or below a

targeted income level;

(3) To assist members with asset/liability management; or

(4) To provide members with liquidity or other funding.

(b) Fully secured. A Bank, at the time it issues or confirms a

standby letter of credit on behalf of a member, shall obtain and

maintain a security interest in collateral that is sufficient to secure

fully the member's unconditional obligation described Sec. 938.4(a)(2),

and that complies with the requirements set forth in paragraph (c) of

this section.

(c) Eligible collateral. (1) Any standby letter of credit issued on

behalf of a member may be secured by collateral that is eligible to

secure advances under Sec. 935.9(a) of this chapter. In making the

calculation required under Sec. 935.9(a)(4)(iii) of this chapter, only

standby letters of credit issued for the

[[Page 25733]]

purposes described in paragraphs (a)(3) or (a)(4) of this section shall

be counted as ``outstanding advances.''

(2) A standby letter of credit issued on behalf of a member for a

purpose described in paragraphs (a)(1) or (a)(2) of this section may,

in addition to the collateral described in paragraph (c)(1) of this

section, be secured by:

(i) Secured or federally-guaranteed loans to small businesses or

securities representing interests in such loans; or

(ii) Obligations of state or local government units or agencies,

rated as investment grade by a nationally-recognized rating agency.

Sec. 938.3 Standby letters of credit on behalf of nonmember

mortgagees.

(a) Nonmember mortgagees. Each Bank is authorized to issue or

confirm on behalf of nonmember mortgagees standby letters of credit

that are fully secured by collateral described in Secs. 935.24(b)(1)(i)

or (ii) of this chapter, and that otherwise comply with the

requirements of this part, for any of the following purposes:

(1) to assist nonmember mortgagees in facilitating residential

housing finance;

(2) To assist nonmember mortgagees in facilitating the financing of

economic development projects that benefit families with incomes at or

below a targeted income level;

(3) To assist nonmember mortgagees with asset/liability management;

or

(4) To provide nonmember mortgagees with liquidity or other

funding.

(b) Nonmember SHFAs. Each Bank is authorized to issue or confirm on

behalf of nonmember SHFAs standby letters of credit that are fully

secured by collateral described in Secs. 935.24(b)(2)(i)(A), (B) or (C)

of this chapter, and that otherwise comply with the requirements of

this part, for the purpose of facilitating residential or commercial

mortgage lending that benefits individuals or families meeting the

income requirements in section 142(d) or 143(f) of the Internal Revenue

Code (26 U.S.C. 142(d) or 143(f)).

Sec. 938.4 Obligation to Bank under all standby letters of credit.

(a) Obligation to reimburse. A Bank may issue or confirm a standby

letter of credit only on behalf of a member or nonmember mortgagee that

has:

(1) Established with the Bank a cash account pursuant to

Secs. 934.5, 935.24(b)(2)(i)(B) or 935.24(d) of this chapter; and

(2) Assumed an unconditional obligation to reimburse the Bank for

value given by the Bank to the beneficiary under the terms of the

standby letter of credit by depositing immediately available funds into

the account described in paragraph (a)(1) of this section not later

than the date of the Bank's payment of funds to the beneficiary.

(b) Prompt action to recover funds. If a member or nonmember

mortgagee fails to fulfill the obligation described in paragraph (a)(2)

of this section, the Bank shall take action promptly to recover the

funds that such member or nonmember mortgagee is obligated to repay.

(c) Obligation financed by advance. Notwithstanding the obligations

and duties of the Bank and its member or nonmember mortgagee under

paragraphs (a) and (b) of this section, the Bank may, at its

discretion, permit such member or nonmember mortgagee to finance

repayment of the obligation described in paragraph (a)(2) of this

section by receiving an advance that complies with sections 10 or 10b

of the Act and part 935 of this chapter.

Sec. 938.5 Additional provisions applying to all standby letters of

credit.

(a) Written policy; other requirements. Each standby letter of

credit issued or confirmed by a Bank shall:

(1) Be issued or confirmed only in compliance with a written

policy, developed and implemented by the Bank to govern its standby

letter of credit programs, that:

(i) Is consistent with the provisions of the Act and this part;

(ii) Sets forth credit underwriting criteria, consistent with the

provisions of Sec. 935.5 of this chapter, to be applied in evaluating

applications for standby letters of credit and renewals thereof; and

(iii) Sets forth criteria regarding the pricing of standby letters

of credit, including any special pricing provisions for letters of

credit that facilitate the financing of economic development projects

that benefit families with incomes at or below a targeted income level;

(2) Contain a specific expiration date, or be for a specific term;

and

(3) Require approval in advance by the Bank of any transfer of the

standby letter of credit from the original beneficiary to another

person or entity.

(b) Additional collateral provisions. (1) A Bank may take such

steps as it deems necessary to protect its secured position on standby

letters of credit, including requiring additional collateral, whether

or not such additional collateral conforms to the requirements of

Secs. 938.2 or 938.3.

(2) Collateral pledged by a member or nonmember mortgagee to secure

a letter of credit issued or confirmed on its behalf by a Bank shall be

subject to the provisions of Secs. 935.9(b), 935.9(e), 935.11 and

935.12 of this chapter.

Dated: April 22, 1998.

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

Bruce A. Morrison,

Chairman.

[FR Doc. 98-11948 Filed 5-7-98; 8:45 am]

BILLING CODE 6725-01-P