Allocation of Joint and Several Liability on Consolidated Obligations Among the Federal Home Loan Banks

FEDERAL HOUSING FINANCE BOARD

12 CFR Part 910

[No. 99-51]

RIN 3069-AA78

Allocation of Joint and Several Liability on Consolidated

Obligations Among the Federal Home Loan Banks

AGENCY: Federal Housing Finance Board.

ACTION: Final rule.

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

its rule governing the issuance of consolidated obligations, i.e.,

bonds, notes or debentures (COs) by the Finance Board pursuant to

section 11 of the Federal Home Loan Bank Act (Act), 12 U.S.C. 1431, to

establish a framework for the orderly allocation of joint and several

liability for the COs among the Federal Home Loan Banks (Banks). The

final rule adds new provisions to the Finance Board's regulations and

is intended to protect holders of COs to the greatest extent

practicable by providing a framework to ensure the continued timely

payment of all principal and interest on COs in the unlikely event of

the projected or actual inability of a Bank to meet its debt service

payment obligations.

DATES: This final rule is effective on November 12, 1999.

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

Economist, Office of Policy, Research and Analysis, by telephone at

(202) 408-2845 or by electronic mail at [email protected], or

Charlotte A. Reid, Special Counsel, Office of General Counsel, by

telephone at (202) 408-2510 or by electronic mail at [email protected], or

by regular mail at the Federal Housing Finance Board, 1777 F Street,

N.W., Washington, DC 20006.

SUPPLEMENTARY INFORMATION:

I. The Proposed Rule

On February 11, 1999, the Finance Board published for comment a

proposed rule to amend its Consolidated Bonds and Debentures Regulation

(CO Regulation), 12 CFR part 910, to outline a framework for the

orderly allocation of joint and several liability among the Banks on

COs issued by the Finance Board pursuant to section 11 of the Act, 12

U.S.C. 1431. 64 FR 6819 (Feb. 11, 1999). The sixty-day public comment

period closed on April 12, 1999. The Finance Board received thirteen

comment letters: twelve from Banks and one from a member institution.

The commenters, noting the stability and financial strength of the Bank

System, generally supported the goal of the proposed rule, but

expressed nearly uniform objection to the certification and reporting

requirements and requested other changes.

The Act provides plenary authority to the Finance Board in

connection with the issuance of COs, for which the Banks are jointly

and severally liable. Section 11 of the Act authorizes the Finance

Board to issue rules and regulations governing the issuance of COs. See

12 U.S.C. 1431(a). Pursuant to the authority set forth in section 11(b)

and (c) of the Act, the Finance Board may issue consolidated Bank

debentures or bonds which ``shall be the joint and several obligations

of all the Federal Home Loan Banks, and shall be secured and be issued

upon such terms and conditions as the [Finance] Board may prescribe.''

See id. at 1431(b) and (c). Moreover, section 11(d) of the Act provides

that the Finance Board shall have full power to require the Banks to

``deposit additional collateral or to make substitutions of collateral

or to adjust equities between the Federal Home Loan Banks.'' Id. at

1431(d). The Act makes clear that COs are not the obligations of and

are not guaranteed by the United States. See id. at 1435. The Banks

collectively are the sole obligors on COs. Finance Board regulations

governing the issuance of COs are set forth in 12 CFR parts 910 and

941.

[[Page 55126]]

Section 910.0(b) defines ``consolidated bonds'' to mean ``bonds or

notes issued on behalf of all Federal Home Loan Banks.'' For purposes

of this preamble, the terms CO(s), consolidated obligation(s), and

consolidated bonds are used interchangeably. In the final rule, the

term consolidated bond(s) is adopted for consistency with the existing

definitions in Sec. 910.0.

The Banks finance their operations principally with the proceeds

from COs issued by the Finance Board on their behalf. As of July 31,

1999, there were approximately $444.8 billion in COs outstanding. In

the history of the Bank System, no Bank has ever been delinquent or

defaulted on a principal or interest payment on any CO issued by the

Finance Board or the Federal Home Loan Bank Board (FHLBB), its

predecessor agency.

Neither the Finance Board nor the FHLBB adopted regulations to

establish the manner in which the joint and several liability of the

Banks would operate in the event of impending default or delinquency on

a CO. The Bank System remains financially healthy and strong, and no

such default or delinquency is expected. The holders of COs benefit

from the statutory joint and several liability of the Banks set forth

in section 11 of the Act. Prudence dictates, however, that the Finance

Board clarify how the joint and several financial responsibility for

the COs would be allocated among the Banks if a Bank were to experience

a payment problem.

The final rule establishes a procedure to assure timely interest

and principal payments on all outstanding COs. The final rule will

provide that any Bank that participates in the proceeds of a CO

issuance, and that experiences or projects a payment problem, would be

required to apply its assets first toward the satisfaction of that

consolidated obligation. The final rule further specifies, as a

regulatory matter, that the Finance Board, pursuant to its authority to

ensure that the Banks operate in a safe and sound manner, remain

adequately capitalized and able to raise funds in the capital markets,

and to adjust the relative equities among the Banks in connection with

the issuance of COs, see 12 U.S.C. 1422a(a)(1), (3)(A), (3)(B)(iii) and

1431(d), has ultimate authority and discretion at any time to call on

any Bank to make any principal or interest payment on any CO. The

underlying purpose of the final rule is to emphasize the Finance

Board's intent that holders of COs not experience any interruption in

the flow of interest or principal payments.

II. Summary of Comments and Analysis of Changes Made in the Final

Rule.

A. Definitions--Sec. 910.0

1. Existing Definitions

The existing definitions in Part 910 are retained with only minor

revisions. For purposes of consistency with other regulations,

``Board'' has been redefined as ``Finance Board,'' a definition of

``Bank'' has been added, and the remaining definitions have been re-

designated accordingly. Additional definitions are addressed as

follows.

2. Participating Bank

The proposed rule would have amended Sec. 910.0 of the CO

regulation to add a new defined term: ``Participating Bank.'' The final

rule does not adopt that definition because it is not a necessary

component of the certification requirement as adopted in the final rule

and does not add to the requirement that each Bank must satisfy its

direct obligations.

3. Non-Performing Bank

The proposed rule added another defined term to Sec. 910.0: ``Non-

performing Bank.'' A majority of the commenters contended that the term

``Non-Performing Bank'' was too broad, had negative or pejorative

connotations, or could imply a default on the COs where none had

occurred. One commenter suggested the term should be changed to ``Non-

Compliant Bank'' to focus on the reporting and certification

requirements. The Finance Board agrees that a change in the terminology

is appropriate and has revised the term in the final rule to ``Non-

complying Bank.'' Also in response to comments, the Finance Board has

removed all references to ``net loss'' in the definition and in the

revisions to the reporting and certification requirements. See

discussion of Sec. 910.7(b), below. Furthermore, the definition was

revised to clarify that a Bank also may become a ``Non-complying Bank''

if it is required to file a notice pursuant to Sec. 910.7(b)(2).

4. Direct Obligation

The final rule defines ``direct obligation'' to mean a Bank's

obligation to repay principal and interest arising from its receipt of

all or a portion of the proceeds of an issuance of COs by the Finance

Board on behalf of one or more Banks. A direct obligation also includes

an obligation to pay CO principal or interest that has been assumed by

a Bank subsequent to the issuance of the consolidated bond, and any

obligation to make assistance payments to any other Bank, whether

pursuant to an agreement between two or more Banks or pursuant to a

Finance Board payment order. Additionally, consistent with

Sec. 910.7(e)(1), direct obligation also includes the obligation of an

assisted Bank to reimburse a Bank that pays the direct obligations of

the former Bank pursuant to an assistance agreement or by order of the

Finance Board. Thus, a direct obligation may arise: (1) as a result of

the receipt of proceeds from the issuance of a CO, or in a subsequent

assumption of a CO payment obligation; (2) by virtue of becoming

obligated to make assistance payments to another Bank, either pursuant

to a voluntary agreement between two or more Banks or pursuant to a

Finance Board payment order; or (3) pursuant to the obligation to

reimburse an assisting Bank for assistance payments made under an

assistance agreement or by order of the Finance Board, including

related costs and interest.

5. Other Definitional Requests

In response to several comments, references to consolidated

obligations have been changed throughout the final rule to reference

consolidated bonds in order to maintain consistency within part 910 and

to conform to existing definitions in Sec. 910.0.

Many commenters requested that certain definitions be added to the

rule. A majority of commenters requested that the rule define the term

``non-essential expenses'' to exclude normal operating expenses or

ordinary operational expenditures incurred in the regular course of

business such as salaries and benefits, office space and equipment

expenses. The Finance Board has adopted the recommendation by rewording

Sec. 910.7(c)(3) of the final rule to clarify that a Bank may continue

to pay normal operating expenses, including salaries, costs of office

space or equipment, or related expenses, but must refrain from

incurring any extraordinary expenses, thus obviating the need for

another defined term.

A number of commenters requested that the rule define, by

establishing a fixed standard, reasonable interest as it relates to

consolidated bond interest and principal payments made on behalf of a

non-complying Bank, so as to avoid unnecessary disputes between the

assisting and assisted Banks. The commenters who addressed the issue

suggested that the standard should be the Federal Funds rate plus an

amount, ranging from 50 to 300 basis points, sufficient to be punitive.

The Finance Board wishes to preserve for itself maximum discretion to

prescribe a reasonable interest rate based on the case presented.

Therefore, no definition

[[Page 55127]]

of reasonable interest rate is included in the final rule. Instead,

Sec. 910.7(d) of the final rule makes it clear that, on amounts paid by

one Bank to meet the principal and interest payment obligations of

another Bank, the interest rate on the reimbursement will be set by the

Finance Board in an order, or will be negotiated between the affected

Banks, in the case of an inter-Bank assistance agreement, subject to

the approval of the Finance Board.

B. Joint and Several Liability--Sec. 910.7

The proposed rule added a new Sec. 910.7 to the CO Regulation to

establish a framework for the orderly allocation of joint and several

liability on the COs among the Banks.

1. General Requirements--Sec. 910.7(a)

The proposed rule at Sec. 910.7(a) would have stated the joint and

several liability of the Banks and the duty of the Banks to give

priority to consolidated bond payments.

One commenter objected to the premise of proposed Sec. 910.7(a)(2),

that each Bank must ensure the CO payment obligations of all other

Banks, and suggested that the final rule provide that each Bank be

responsible only for its own payment obligations. Because the Finance

Board believes that the essence of joint and several liability is that

each Bank is ultimately liable for the repayment of any CO, no change

to this provision has been adopted in the final rule, other than the

addition of a new subsection (3), which states that the provisions

shall not restrict, limit, or otherwise diminish the joint and several

liability of all of the Banks on all of the consolidated bonds.

Several commenters questioned how other creditors of the Banks,

such as swap counterparties, would be affected by proposed

Sec. 910.7(a)(2), and noted that the proposed rule would appear to give

CO holders payment priority over other creditors of the Bank,

regardless of the legal priorities among those parties. The Finance

Board is not attempting to create regulatory creditor priorities that

would not already exist under law. Therefore, the final rule has been

revised to address this concern by eliminating reference to ``any other

creditor not entitled by law or contract to priority over or parity

with the holder of consolidated obligations.'' A provision was also

added in Sec. 910.7(g) to clarify that payments made by a Bank to

satisfy the direct obligations of another Bank shall be made for the

sole purpose of discharging the joint and several liability of the

Banks on the consolidated bonds, not for the benefit of other

creditors.

2. Certification and Reporting--Sec. 910.7(b)

Section 910.7(b) of the proposed rule would have required each Bank

President to certify for the upcoming quarter that the Bank will not

suffer a net loss, will remain in compliance with reserve and liquidity

requirements, as well as with the Finance Board's Financial Management

Policy (FMP), and will be capable of making full and timely payment of

all its direct obligations when due. The proposed rule also would have

required each Bank immediately to report to the Finance Board any

projected loss, debt service deficiency or liquidity/reserves

deficiency.

The comments expressed a number of objections to Sec. 910.7(b) as

proposed: (1) the impossibility of certification as to future events;

(2) misplaced reliance on net loss as an indicator of a Bank's ability

to meet its direct obligations; (3) the lack of a specific causal nexus

between potential non-compliance with liquidity requirements and a

Bank's ability to meet its direct obligations; and (4) each Bank should

be required only to certify that it will have the ability in the

upcoming quarter to meet its direct obligations.

a. Certification as to Future Events. The commenters stated that it

would be impossible to certify as to future events given the potential

variables that affect financial statements, and were concerned that

forward-looking certifications might subject a Bank to liability if

events played out other than as predicted. Commenters also objected to

the certification requirement on the basis that a certification, which

generally involves confirmation of known facts as of a certain date,

would be a factual impossibility because factors beyond the control of

a Bank could preclude the Bank from being able to state with certainty

three months in advance that no change in circumstances would occur.

One commenter suggested that the lack of certainty as to future

projections could be dealt with either by revising the required

representation to assert that ``the President has no knowledge of any

facts that would materially affect the accuracy of the certification,''

or requiring, based on information known to the Bank, reasonable

assurance that the Bank will remain in compliance and be capable of

fulfilling CO payments in the upcoming quarter.

Another commenter favored requiring that Bank management provide a

negative assurance stating that, as of the date of the quarterly

certification, Bank management has no actual knowledge of material

facts that through the next quarter could foreseeably prevent the Bank

from making full and timely payment of interest and principal on the

COs due and payable in the upcoming quarter. To improve on the

reporting requirement, the commenter urged that the Banks be allowed to

rely on the unqualified opinion provided annually by a Bank's

independent certified accountant and eliminate the management

certification.

Concerned commenters noted that if certifications are given and

subsequent unanticipated events adversely affect the accuracy of the

statements or the ability of a Bank to make full and timely direct

obligation payments when due, the result could be causes of action

against the Bank and the Finance Board for false certifications.

While the Finance Board does not believe that a negative assurance

or a reasonable assurance statement would accomplish the same goal as

the certification and reporting requirements, the Finance Board does

believe that many of the other concerns raised by the commenters have

merit. The final rule addresses these concerns by modifying the

certification requirement to reflect that the certification should be

based on known information, current facts and financial information,

which the Finance Board expects will follow reasonable investigation.

b. Net Loss. Many commenters objected to being required to certify

that a Bank would not sustain a net loss in the upcoming quarter on the

grounds that net loss is an inappropriate measure for determining

ability to meet CO payment obligations. Several Bank commenters called

for the term to be eliminated from the rule, or defined if the

certification and reporting requirements were to be retained in the

final rule. One commenter stated that net income and net loss are

accounting concepts that bear virtually no relation to cash flow, which

is the primary factor affecting a Bank's ability to make payments.

One commenter suggested that the rule should provide that prior to

allocating loss to all Banks, the Finance Board should look to the

other participating Banks for payment of principal and interest where

another participating Bank is unable to make the payments for which it

is responsible. Some of the Banks expressed a desire that the reporting

periods be specified in the rule.

Several commenters argued that the various periodic financial

condition reports already required to be filed by

[[Page 55128]]

the Banks with the Finance Board \1\ provide sufficient notice to the

Finance Board of any potential difficulty a Bank might experience in

meeting its debt obligations, and that the certification and reporting

requirements would be unnecessarily duplicative and burdensome.

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\1\ See, e.g., 12 CFR 934.7 (balance sheets and income statement

projects); 12 CFR 934.17 (support for dividend requests); 12 CFR

937.2 (information for Bank System quarterly and annual reports).

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The Finance Board agrees with many of the observations in the

comments, and has addressed commenters' objections by eliminating the

requirement that each Bank must certify that it will not sustain a net

loss in the upcoming quarter.

c. Lack of Causal Nexus Between Liquidity and Ability to Pay Direct

Obligations. Many comments focused on what factors actually affect a

Bank's ability to meet its obligations and noted that non-compliance

with liquidity requirements is not tantamount to an inability to make

such payments.

One commenter, calling the liquidity requirements outmoded, stated

that compliance with the liquidity requirements is not an accurate

reflection of the Bank's ability to meet its payment obligations. The

commenter said that factors that would more likely cause a negative

impact on a Bank's ability to service its debt would be an inability to

access the capital markets to replace maturing or called debt, and that

the certification requirement is inconsistent with real world balance

sheet management.

The Finance Board does not agree with the comment that compliance

with the statutory and regulatory liquidity requirements does not bear

any financial relationship to a Bank's ability to meet its direct

obligations and has adopted this requirement in the final rule without

change. The comment is premised on the assumption that the Banks can

raise funds in the capital markets at will. However, since the Banks at

times may face inhospitable conditions in the capital markets during

which they might be unable to raise large amounts of money in very

short time periods, the Finance Board believes it is advisable for the

Banks to maintain sufficient, highly liquid assets to meet member

demands. Because the Banks are required to maintain compliance with

statutory and regulatory liquidity requirements at all times, no

additional burden should be imposed by the requirement in the final

rule that a Bank certify to that compliance.

d. Certification Only to Direct Obligations. The commenters

requested that the proposed rule be clarified to require a Bank to

certify only that it will remain capable of making full and timely

payment of its share of all principal and interest payments on COs. The

Finance Board concurs in these comments and has clarified the final

rule to state that each Bank must certify that it will remain capable

of making full and timely payment of all of its current obligations,

including direct obligations. Direct obligations would also include the

obligation to reimburse an assisting Bank for the payment of the

assisted Bank's direct obligations, as provided for in Sec. 910.7(e)(1)

of the final rule.

e. The Reporting Requirement. The proposed rule called for each

Bank to report immediately to the Finance Board if: (1) the Bank was

unable to provide the required certification; (2) subsequent to

providing the certification, the Bank projected that it would incur a

net loss, fail to comply with liquidity requirements or would be unable

to satisfy its payment obligations on consolidated bonds; (3) the Bank

actually missed a consolidated bond payment, incurred a net loss or

failed to comply with liquidity requirements. The commenters offered

criticisms nearly identical to those for the certification requirement.

Additionally, some commenters recommended that the rule specify the

reporting period.

In response to the comments, the final rule eliminates the

requirement to file a report in favor of a notice requirement. Section

910.7(b)(2) of the final rule requires a Bank to submit immediate

written notice to the Finance Board if the Bank is or is expected to be

unable to provide the certification when due as required by

Sec. 910.7(b)(1), or, if at any time, a Bank projects that it will not

meet its liquidity requirements, direct obligations or other current

obligations. Notice is also required if the Bank actually fails to meet

its liquidity requirements or direct obligations. Such notice also is

required if a Bank is in negotiations to enter or enters into an

assistance agreement with another Bank for the payment of its direct

obligations or other current obligations. Similarly, if a Bank

experiences a temporary interruption in its payment operations due to

an external event, which is not necessarily related to the financial

condition of the Bank such as a natural disaster or power failure, the

Bank must notify the Finance Board. A notice required by

Sec. 910.7(b)(2) may be provided by a senior officer of the Bank having

knowledge of its financial condition and authorized by the Bank to sign

the notice.

Finally, Sec. 910.7(b)(3) of the proposed rule provided that the

Finance Board could require a Bank to file a report, accompanied by a

consolidated obligation payment plan, if the Finance Board had reason

to believe the Bank was about to default on an obligation or cease to

be compliance with the statutory or regulatory liquidity requirements.

This provision has not been adopted as part of the final rule because

the Finance Board believes it would be redundant in light of the

revisions to the certification, notice and payment plan provisions.

3. Consolidated Obligation Payment Plan--Sec. 910.7(c)

Proposed Sec. 910.7(c) would have required any Bank projecting or

experiencing an inability to service its current COs to submit a

consolidated obligation payment plan to the Finance Board and to

refrain from incurring non-essential operating expenses, declaring or

paying dividends, or redeeming any stock, until its CO payment plan is

approved by the Finance Board and its consolidated obligation payment

obligations were satisfied.

One commenter recommended that Sec. 910.7(c) be modified to require

only that the plan address the methods a Bank would undertake ``to make

full and timely payment of its share of all principal and interest

consolidated obligation payments in which the [Federal Home Loan] Bank

is a participating Bank.'' The final rule clarifies that a Bank must

file a consolidated bond payment plan outlining the methods to be used

to meet its current obligations, including direct obligations. The

comment that the payment of non-essential expenses should contain an

exception for ``ordinary operational expenditures incurred by a Bank in

its regular course of business,'' has also been adopted in

Sec. 910.7(c)(3) of the final rule.

One commenter proposed that the final rule should make provision

for the Finance Board to accept or request modifications on a

consolidated bond payment plan within a certain timeframe, and for

automatic approval of the payment plan if the Finance Board fails to

act by a date certain. Another commenter opposed the restrictions set

forth in proposed Sec. 910.7(c)(3) on payment of dividends or

redemption of stock as being draconian. The commenter argued that the

Finance Board should impose such sanctions only after it has reviewed

the specific situation. The final rule is designed to allow the Finance

Board to analyze any proffered payment plan independently and in the

circumstances presented. A

[[Page 55129]]

fixed timeframe for automatic approval would not further the purpose of

the rule which is to afford the Finance Board a rational regulatory

process for the necessary deliberation of all relevant factors.

Additionally, the restrictions as to payment of dividend or stock

redemption are intended to preserve assets that may be needed to ensure

that the Bank will be able to continue to operate and make full and

timely CO payments. For these reasons, this provision of the final rule

has been adopted as proposed.

Other commenters urged the Finance Board to build flexibility into

the rule to allow Banks to develop recovery plans or participate in

fully-secured inter-Bank loans that would provide for orderly recovery

short of liquidation, depending on the severity of the Bank's financial

condition. The Finance Board has adopted certain modifications to the

rule and believes that as revised the final rule provides sufficient

flexibility in how the consolidated bond payment plans would be

structured, and makes sufficient provision for payment assistance

agreements to be reached between Banks. Inter-Bank consolidated bond

payment assistance agreements are subject to Finance Board approval.

Under the final rule, a Bank must notify the Finance Board when it

commences negotiations for such an assistance agreement with one or

more other Banks, and may not implement an assistance agreement prior

to Finance Board approval. Thus, the final rule clearly affords

oversight authority to the Finance Board to evaluate any given

situation individually and determine what remedial steps are

appropriate or required.

The final rule requires a Bank to file a consolidated bond payment

plan for Finance Board approval if the Bank fails to provide the

certification required in paragraph (b)(1), is required to provide the

notice required in paragraph (b)(2), or if the Finance Board determines

that the Bank will cease to be in compliance with the liquidity

requirements or will be unable to meet its current obligations,

including its direct obligations. The final rule requires that the

consolidated bond payment plan specify the measures the Bank will

undertake to meet its current obligations, including its direct

obligations. The final rule permits a non-complying Bank to continue to

incur and pay normal operating expenses in the regular course of

business, but requires such a Bank to refrain from incurring any

extraordinary expenses, declaring or paying dividends or redeeming

capital stock until the Finance Board has approved the plan and the

Bank's direct obligations have been met.

The Finance Board would have authority under the final rule to take

into consideration any capital requirements mandated by statute or

regulation, and make provision for the Banks to redeem capital and pay

dividends in accordance with the applicable provisions of the Act. The

Finance Board may waive or amend the consolidated bond payment plan

requirements as necessary to accommodate future legislative changes to

the capital structure of the Bank System. A separate, specific

reservation of authority to do so is unnecessary.

4. Finance Board Payment Orders--Sec. 910.7(d)

Under proposed Sec. 910.7(d), in the remote event that a Bank would

be unable, due to actual or projected cash flow or balance sheet

deficiencies, to service its direct obligations, the Finance Board

could have ordered one or more other Banks to make such payments. The

non-complying Bank would have been liable to the assisting Banks for

reimbursement. The Finance Board would look to the assets of the non-

complying Bank for reimbursement of such payments.

Section 910.7(d)(1) of the final rule makes clear that the Board of

Directors of the Finance Board, in its discretion and notwithstanding

any other provision in the rule, may at any time order any Bank to make

any payment on any consolidated bond. The final rule in

Sec. 910.7(d)(2) establishes unequivocally that to the extent a Bank

makes an assistance payment, whether by agreement or by order of the

Board of Directors of the Finance Board, the assisting Bank is entitled

to reimbursement of the assistance, including costs and interest. The

rate of interest for the reimbursement for payments made to assist a

non-complying Bank in making its payment obligations will be set by the

Board. Additionally, the final rule clarifies that where an agreement

is reached between an assisting Bank and a non-complying Bank (or one

whose payment capabilities were temporarily impaired by payment system

disruptions outside the control of the Bank) the negotiated rate will

be subject to the approval of the Finance Board. As discussed

previously herein, the Finance Board disagrees with the recommendations

from commenters that the rate of interest on reimbursement payments

should be set in the regulation at the Federal Funds rate plus 50 to

300 basis points or at an amount high enough to reflect the serious

nature of a potential default and act as a deterrent. In the Finance

Board's view, the interest rate is a necessary business component to

compensate the assisting Bank for its expenses and assistance. The

Finance Board has chosen to reserve to itself the authority to set a

reasonable interest rate or to approve the terms, including an interest

rate, of negotiated assistance agreements.

5. Adjustment of Equities--Sec. 910.7(e)

Under proposed Sec. 910.7(e), the reallocation of the payment

obligations among the other Banks would have been based on the pro rata

participation of each Bank in all COs outstanding as of the most recent

month end for which the Finance Board has data. The reallocation (as

opposed to payments that may be ordered by the Finance Board) would

have occurred only after the non-complying Bank had applied all of its

assets to service all of its direct consolidated obligations.

Several commenters expressed concern that the requirement in

proposed Sec. 910.7(e)(1), that a defaulting Bank shall apply its

assets to fulfill its consolidated obligations payment obligations,

could require a Bank to sell assets classified as ``held to maturity''

under ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES,

Statement of Financial Accounting Standards No. 115 (Fin. Accounting

Standards Bd. 1993) and thereby require the Bank to mark-to-market its

entire portfolio and further worsen the Bank's financial position.

One commenter asked for clarification of whether all of a Bank's

assets would have to be applied to the payment of COs before such

assets could be used to pay expenses as provided in proposed

Secs. 910.7(a)(2) and (c). Another commenter suggested that the

solution to that interpretation would be to construe the phrase ``apply

its assets'' to mean that a Bank may be required to apply interest

earned on its assets, and any cash received upon maturity of assets to

payment of consolidated obligations, after payment of all necessary

expenses, then there should be minimal adverse ramifications to the

Banks.

The final rule clarifies that a non-complying Bank shall apply all

of its assets to pay its direct obligations, including amounts owed to

reimburse any Bank that has provided assistance in meeting the non-

complying Bank's direct obligations, whether under an assistance

agreement or by order of the Finance Board.

A Bank that provides assistance to another Bank whose operations

temporarily are impaired by a natural

[[Page 55130]]

disaster or power failure will have a similar right to reimbursement.

Finally, Sec. 910.7(e)(3) provides that where the Finance Board

determines that a Bank is a non-complying Bank, then the Finance Board

may allocate the non-complying Bank's outstanding direct obligation

liability among the remaining Banks on a pro rata basis in proportion

to each Bank's participation in all COs as of the end of the most

recent month for which the Finance Board has data. In Sec. 910.7(e)(1)

of the final rule, a non-complying Bank is presumed to have

insufficient assets to continue to operate as usual and make full and

timely CO payments. The finding of asset insufficiency in paragraph (e)

differs from the situation contemplated by Sec. 910.7(c)(3) of the

final rule. In the latter section, the final rule assumes that the non-

complying Bank will continue to operate as usual, albeit under the

terms of a payment plan approved by the Finance Board. A non-complying

Bank is thus expressly authorized to continue to incur and pay ordinary

operating expenses.

The final rule thus contemplates that the Finance Board will have

to intervene to ensure that a non-complying Bank's CO payments are

fully and timely made and that its assets are appropriately applied to

outstanding consolidated bond obligations and other obligations as

provided in the final rule. The Act specifically provides the authority

for the Finance Board to do so, see 12 U.S.C. 1431(d), and the final

rule provides a regulatory framework for the Finance Board to evaluate

the overall situation and implement a rational payment solution.

Section 910.7(f) of the final rule expressly reserves to the Finance

Board the authority to adjust the equities of the Banks in a manner

different from the manner scripted in Sec. 910.7(e) to ensure the

safety and soundness of one or more of the Banks.

Several commenters suggested that the final rule permit inter-Bank

loans to assist in meeting payment obligations, upon terms and

conditions negotiated between the Banks, which would obviate the need

for the Finance Board to order a Bank to cover the CO payments of

another Bank. Another commenter argued in favor of a system providing

for the resources of all co-participating Banks to be tapped before the

assets of a non-participating Bank are applied to cover the liability

of a Bank. The Finance Board believes this could create disincentives

for the Banks to enter into CO issuances as co-participants and has not

incorporated this comment into the final rule. In addition, the final

rule provides for inter-Bank loans and will require that the assisted

Bank file notice pursuant to Sec. 910.7(b) and thus trigger the

provisions for CO payment plans and Finance Board review.

6. Reservation of Rights--Sec. 910.7(f)

Under proposed Sec. 910.7(f), the Finance Board reserved its

authority to take supervisory, enforcement or other action against any

Bank pursuant to the Act to ensure that the Banks are operated in a

safe and sound manner. The final rule adopts this and expressly

preserves the Finance Board's authority to adjust the equities between

the Banks in any manner different from that set forth in this rule.

7. No Rights Created--Sec. 910.7(g)

Several commenters suggested that the proposed rule be revised

expressly to provide that the certification and reporting requirements

of the rule do not create any rights in any third party and that non-

compliance with the provisions of the rule would not constitute a

default under the COs. The Finance Board has adopted this suggestion by

including a new Sec. 910.7(g) in the final rule. The final rule

provides that nothing in the section shall be deemed to create any

rights in any third party, payments made by a Bank on the direct

obligations of another Bank are made solely to discharge the joint and

several obligation of the Banks on the consolidated bonds, and

complying with or failing to comply with the provisions of this section

shall not be deemed to be an event of default under any consolidated

bond.

III. Regulatory Flexibility Act

The final rule applies only to the Banks, which do not come within

the meaning of ``small entities,'' 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 final rule will not have significant

economic impact on a substantial number of small entities.

IV. Paperwork Reduction Act

The final rule does not contain any collections of information

pursuant to the Paperwork Reduction Act of 1995. See 44 U.S.C. 350, et

seq. Consequently, the Finance Board has not submitted any information

to the Office of Management and Budget for review.

List of Subjects in 12 CFR Part 910

Consolidated bonds and debentures, Banks, Securities.

For the reasons stated in the preamble, the Finance Board amends 12

CFR part 910 as follows:

PART 910--CONSOLIDATED BONDS AND DEBENTURES

1. Revise the authority citation for part 910 to read as follows:

Authority: 12 U.S.C. 1422a, 1422b and 1431.

2. Amend Sec. 910.0 by:

A. Revising paragraph (a).

B. Redesignating paragraphs (b) through (d) as paragraphs (c)

through (e), respectively.

C. Adding a new paragraph (b).

D. Revising newly designated paragraph (c).

E. Adding paragraphs (f) and (g).

The additions and revisions read as follows:

Sec. 910.0 Definitions.

(a) Finance Board means the Federal Housing Finance Board.

(b) Bank means Federal Home Loan Bank.

(c) Consolidated bond means any bond or note issued on behalf of

one or more Banks by the Finance Board pursuant to section 11(c) of the

Federal Home Loan Bank Act, as amended (the Act) (12 U.S.C. 1431(c)).

* * * * *

(f) Direct Obligation means an obligation of a Bank to make any

principal or interest payment due on a consolidated bond, whether such

obligation arises from:

(1) The Bank's receipt of sale proceeds from the issuance of that

consolidated bond or the assumption of the obligation in a voluntary

transaction subsequent to the issuance of the bond;

(2) An obligation to make an assistance payment to any other Bank,

whether made pursuant to an agreement between one or more Banks or

pursuant to a Finance Board payment order; or

(3) An assistance payment reimbursement obligation.

(g) Non-complying Bank means any Bank that fails to certify,

pursuant to Sec. 910.7(b)(1) of this part, that it is able to pay all

of its current obligations, including direct obligations, in full when

due; that fails to make consolidated bond payments in full when due;

that is required to file a notice pursuant to Sec. 910.7(b)(2) or a

consolidated bond payment plan pursuant to Sec. 910.7(c); or that is

determined by the Finance Board to require assistance in meeting its

direct obligations on consolidated bonds.

3. Add Sec. 910.7 to read as follows:

Sec. 910.7 Joint and several liability

(a) In general. (1) Each and every Bank, individually and

collectively, has an obligation to make full and timely payment of all

principal and interest on consolidated bonds when due.

[[Page 55131]]

(2) Each and every Bank, individually and collectively, shall

ensure that the timely payment of principal and interest on all

consolidated bonds is given priority over, and is paid in full in

advance of, any payment to or redemption of shares from any

shareholder.

(3) The provisions of this section shall not limit, restrict or

otherwise diminish, in any manner, the joint and several liability of

all of the Banks on all of the consolidated bonds issued by the Finance

Board pursuant to section 11(c) of the Act.

(b) Certification and reporting. (1) Before the end of each

calendar quarter, and before declaring or paying any dividend for that

quarter, the President of each Bank shall certify in writing to the

Finance Board that, based on known current facts and financial

information, the Bank will remain in compliance with the liquidity

requirements set forth in section 11(g) of the Act (12 U.S.C. 1431(g)),

and the Finance Board's Financial Management Policy (as the same may be

amended, modified or replaced), and will remain capable of making full

and timely payment of all of its current obligations, including direct

obligations, coming due during the next quarter.

(2) A Bank shall immediately provide written notice to the Finance

Board if at any time:

(i) The Bank is unable to provide the certification required in

paragraph (b)(1) of this section;

(ii) The Bank projects at any time that it will fail to comply with

statutory or regulatory liquidity requirements, or will be unable to

timely and fully meet all of its current obligations, including direct

obligations, due during the quarter;

(iii) The Bank actually fails to comply with statutory or

regulatory liquidity requirements or to timely and fully meet all of

its current obligations, including direct obligations, due during the

quarter; or

(iv) The Bank negotiates to enter or enters into an agreement with

one or more other Banks to obtain financial assistance from such

Bank(s) to meet its current obligations, including direct obligations,

due during the quarter; the notice of which shall be accompanied by a

copy of the agreement, which shall be subject to the approval of the

Finance Board.

(c) Consolidated bond payment plans. (1) A Bank promptly shall file

a consolidated bond payment plan for Finance Board approval:

(i) If it becomes a non-complying Bank as a result of failing to

provide the certification required in paragraph (b)(1) of this section;

(ii) If it becomes a non-complying Bank as a result of being

required to provide the notice required pursuant to paragraph (b)(2) of

this section, except in the event that a failure to make a principal or

interest payment on a consolidated bond when due was caused solely by a

temporary interruption in the Bank's debt servicing operations

resulting from an external event such as a natural disaster or a power

failure; or

(iii) If the Finance Board determines that a Bank will cease to be

in compliance with the statutory or regulatory liquidity requirements,

or will lack the capacity to timely and fully meet all of its current

obligations, including direct obligations, due during the quarter.

(2) A consolidated bond payment plan shall specify the measures the

non-complying Bank will undertake to make full and timely payments of

all of its current obligations, including direct obligations, due

during the applicable quarter.

(3) A non-complying Bank may continue to incur and pay normal

operating expenses incurred in the regular course of business

(including salaries, benefits, or costs of office space, equipment and

related expenses), but shall not incur or pay any extraordinary

expenses, or declare, or pay dividends, or redeem any capital stock,

until such time as the Finance Board has approved the Bank's

consolidated bond payment plan or inter-Bank assistance agreement, or

ordered another remedy, and all of the non-complying Bank's direct

obligations have been paid.

(d) Finance Board Payment Orders; Obligation to Reimburse. (1) The

Board of Directors of the Finance Board, in its discretion and

notwithstanding any other provision in this section, may at any time

order any Bank to make any principal or interest payment due on any

consolidated obligation.

(2) To the extent that a Bank makes any payment on any consolidated

obligation on behalf of another Bank, the paying Bank shall be entitled

to reimbursement from the non-complying Bank, which shall have a

corresponding obligation to reimburse the Bank providing assistance, to

the extent of such payment and other associated costs (including

interest to be determined by the Finance Board).

(e) Adjustment of equities. (1) Any non-complying Bank shall apply

its assets to fulfill its direct obligations.

(2) If a Bank is required to meet, or otherwise meets, the direct

obligations of another Bank due to a temporary interruption in the

latter Bank's debt servicing operations (e.g., in the event of a

natural disaster or power failure), the assisting Bank shall have the

same right to reimbursement as set forth in paragraph (e)(1) of this

section.

(3) If the Finance Board determines that the assets of a non-

complying Bank are insufficient to satisfy all of its direct

obligations as set forth in paragraph (e)(1) of this section, then the

Finance Board may allocate the outstanding liability among the

remaining Banks on a pro rata basis in proportion to each Bank's

participation in all consolidated obligations outstanding as of the end

of the most recent month for which the Finance Board has data.

(f) Reservation of authority. Nothing in this section shall affect

the Finance Board's authority to adjust the equities between the Banks

in any manner different than the manner described in this section, or

to take such enforcement or other action against any Bank pursuant to

the Finance Board's authority under the Act or otherwise to supervise

the Banks and ensure that they are operated in a safe and sound manner.

(g) No rights created. (1) Nothing in this section shall create or

be deemed to create any rights in any third party.

(2) Payments made by a Bank toward the direct obligations of

another Bank are made for the sole purpose of discharging the joint and

several liability of the Banks on the consolidated bonds.

(3) Compliance, or the failure to comply, with any provision in

this section shall not be deemed a default under the terms and

conditions of the consolidated bonds.

Dated: October 4, 1999.

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

Bruce A. Morrison,

Chairman.

[FR Doc. 99-26283 Filed 10-8-99; 8:45 am]

BILLING CODE 6725-01-P