Collateral Eligible To Secure Federal Home Loan Bank Advances

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

its regulation governing eligible collateral for Federal Home Loan Bank

(FHLBank) advances to clarify that certain assets, including the

insured or guaranteed portions of federally-insured or guaranteed loans

and securities representing an equity interest in eligible collateral,

qualify as eligible collateral to secure FHLBank advances. The final

rule also amends the Finance Board's regulation on collateral

verification to eliminate certain ambiguities therein.

DATES: This final rule is effective on April 15, 1999.

FOR FURTHER INFORMATION CONTACT: Eric M. Raudenbush, Attorney-Advisor,

[[Page 16619]]

Office of General Counsel, (202) 408-2932, Federal Housing Finance

Board, 1777 F Street, NW., Washington, DC 20006, or by electronic mail

at [email protected].

SUPPLEMENTARY INFORMATION:

I. The Proposed Rule

On December 8, 1998, the Finance Board published for comment a

proposed rule to amend its Advances Regulation, 12 CFR part 935,

primarily in order to codify in the Regulation provisions governing

various collateral arrangements that have been the subject of

regulatory interpretations and requests for such interpretations from

the FHLBanks and their members. See 63 FR 67625 (Dec. 8, 1998). The

sixty day public comment period closed on February 8, 1999. The Finance

Board received a total of forty comments: eleven from FHLBanks,

seventeen from FHLBank members, five from trade associations, two from

members of Congress, and one each from an investment broker/dealer

serving FHLBank members, an accounting firm, a state governor and a

non-member corporate credit union. Only the non-member corporate credit

union opposed the rule generally.

Section 10(a) of the Federal Home Loan Bank Act (Bank Act)

enumerates four categories of collateral that are eligible to secure

FHLBank advances: (1) Current whole first mortgage loans on improved

residential property and securities representing a whole interest in

such mortgages; (2) securities that are issued, guaranteed, or insured

by the United States Government, or any agency thereof; (3) deposits of

a FHLBank; and (4) other real-estate related collateral in a total

amount not to exceed 30 percent of the borrowing member's capital. See

12 U.S.C. 1430(a). The Advances Regulation implements and clarifies the

statutory requirements of section 10 of the Bank Act that relate to the

security interests that a FHLBank must obtain and maintain when making

advances to member institutions. Among the issues that the Regulation

addresses are: the types and amounts of collateral that a FHLBank may

or must accept when making advances; the priority of FHLBank claims to

such collateral in relation to other creditors; and requirements

regarding the valuation and verification of the existence of pledged

collateral. See 12 CFR 935.9-12.

In response to numerous requests from both FHLBanks and their

members to clarify or interpret these collateral provisions in the

context of specific transactions, the Finance Board proposed to amend

Sec. 935.9 to make explicit in the Regulation that the FHLBanks may

accept as collateral to secure advances to members: (1) the insured or

guaranteed portions of federally-insured or guaranteed loans,

regardless of delinquency status; (2) securities representing an equity

interest in eligible collateral; and (3) eligible mortgage or

government securities collateral held by members' wholly-owned

investment subsidiaries, under the conditions set forth in the proposed

rule. In addition, the Finance Board proposed to amend Sec. 935.11(b)

of the Advances Regulation, governing collateral verification, to

eliminate an ambiguous reference therein to standards established by

the Auditing Standards Board of the American Institute of Certified

Public Accountants (AICPA).

II. Comments on the Proposed Rule and Analysis of Changes Made in

the Final Rule

A. Eligible Collateral Pledged by a Qualifying Investment Subsidiary

The proposed rule would have amended Sec. 935.1 of the Advances

Regulation to include a definition of the term ``Qualifying Investment

Subsidiary'' (QIS), which was to include business entities that: (1)

Are wholly owned by a member; (2) are operated solely as passive

investment vehicles on behalf of that member; and (3) hold only cash

equivalents and assets that are eligible collateral under

Secs. 935.9(a)(1) and (2) of the Advances Regulation. In turn, the

proposed rule would have created a new Sec. 935.9(b) under which the

FHLBanks would have been expressly permitted to accept pledges of

eligible collateral from a member's QIS to secure advances to that

member where the FHLBank was able to obtain and maintain a security

interest in the collateral pursuant to which its rights and privileges

were functionally equivalent to those that the FHLBank would possess if

the member were to pledge the collateral directly.

These proposed provisions were intended primarily to address

requests from FHLBanks to accept as security for advances to members

eligible collateral held by Real Estate Investment Trust and state

security corporation subsidiaries. However, a large number of

commenters questioned the Finance Board's proposal to address only

pledges of collateral from a narrow class of wholly-owned subsidiaries,

while ignoring collateral arrangements with other types of affiliates

that may be permissible under the Bank Act. In light of these comments,

the Finance Board has decided to remove these QIS provisions from the

text of the final rule pending further analysis of the issue. It is

anticipated that, in the near future, the Finance Board will either

finalize the QIS provisions separately in a modified form, or will

issue a new proposed rule that addresses in a more comprehensive

fashion pledges of collateral from members' affiliates.

B. Equity Interests in Eligible Collateral

Section 935.9(a)(1)(iii) of the proposed rule expressly authorized

FHLBanks to accept as collateral for advances to members any security

the ownership of which represents an undivided equity interest in whole

mortgages or mortgage-backed securities (MBS), all of which qualify as

eligible collateral under Sec. 935.9(a)(1). Similarly,

Sec. 935.9(a)(2)(ii) of the proposed rule expressly authorized FHLBanks

to accept as collateral any security the ownership of which represents

an undivided equity interest in underlying assets, all of which qualify

as eligible government securities collateral under Sec. 935.9(a)(2).

These provisions were intended to permit FHLBanks to accept as

collateral shares of mutual funds and similar equity investments where

the underlying assets of the fund comprise only eligible collateral.

Seven commenters (two FHLBanks, two members, two trade associations

and the investment broker/dealer) expressly supported, and no

commenters expressly opposed, these provisions. However, the two

FHLBanks opposed the proposed rule's requirement that the underlying

assets of the fund consist only of eligible collateral. Noting that it

is likely that, for liquidity purposes, such funds may hold a small

percentage of assets that do not qualify as eligible collateral, one

FHLBank suggested that the FHLBanks be authorized to accept shares of

funds where at least 90 percent of the underlying assets are eligible

collateral. The other FHLBank suggested that FHLBanks be permitted to

lend against the pro-rata share of the underlying assets that do

qualify as eligible collateral. In the final rule, the Finance Board

has combined the material contained in proposed Secs. 935.9(a)(1)(iii)

and (a)(2)(ii) into a new Sec. 935.9(a)(5), under which the FHLBanks

are permitted to accept shares of mutual funds and similar investments

that represent an undivided equity interest in underlying assets that

qualify as eligible collateral under either Sec. 935.9(a)(1) or (a)(2).

This change makes clear that FHLBanks may accept shares of funds that

hold a combination of eligible mortgage assets and eligible government

securities, in addition to

[[Page 16620]]

those that hold either one or the other type of eligible collateral. In

addition, new Sec. 935.9(a)(5) makes clear that such funds may also

hold cash or cash equivalents without losing their eligibility as

collateral for advances. Because of the complexities of monitoring the

fluctuating asset pools of mutual funds and similar investments, the

Finance Board has determined that it will not, at this time, permit

FHLBanks to accept under new Sec. 935.9(a)(5) shares of funds that hold

any assets that are neither eligible collateral under Secs. 935.9(a)(1)

or (a)(2), nor cash or cash equivalents. Depending on the mix of the

underlying assets, however, shares of such funds may constitute

eligible collateral under Sec. 935.9(a)(4).

C. Government Securities

In the proposed rule, the Finance Board proposed to redesignate the

existing text of Sec. 935.9(a)(2) of the Advances Regulation as

Sec. 935.9(a)(2)(i)(A) and to add: a new paragraph (i)(B) to make clear

that FHLBanks may accept, as eligible government securities collateral,

mortgages or other loans, regardless of delinquency status, to the

extent that the repayment of the principal and/or interest on such

mortgages or loans is backed by the United States Government or any of

its agencies; and a new paragraph (i)(C) to make clear that FHLBanks

may also accept as eligible collateral securities that are backed by,

or represent equity interests in, pools of loans or mortgages that are

insured or guaranteed by the United States Government or its agencies

(to the extent of such insurance or guarantee), even if the investment

instrument itself is not so insured or guaranteed. Proposed

Secs. 935.9(a)(2)(i)(B) and (C) have been redesignated in the final

rule as Secs. 935.9(a)(2)(ii) and (iii), respectively.

Nineteen commenters (nine members, four trade associations, three

FHLBanks, two members of Congress and one state governor) expressly

supported these changes and one commenter (the non-member corporate

credit union) expressly opposed them. Several commenters noted

specifically that, in the risk-based capital provisions of their

respective regulations, the federal financial institution regulatory

agencies recognize that individual loans that are insured or guaranteed

by the United States Government possess risk equal to that of

government-insured or guaranteed securities representing interests in

pools of loans.

A significant number of commenters requested that the Finance Board

make clear in the preamble to the final rule that Sallie Mae student

loans reinsured by the U.S. Department of Education (DOE) and

certificates backed by pools of such loans will be considered to be

eligible collateral pursuant to the new provisions. The Finance Board

understands that, with respect to at least some Sallie Mae loans made

under the Federal Family Education Loan Program (FFELP), the holder of

the loan benefits directly only from the guarantee of a Guarantee

Agency that is not part of the federal government. While a Guarantee

Agency may have a legal right to be reimbursed by the DOE for a portion

of guarantee payments made to holders of defaulted student loans, the

holders of these loans do not, in most circumstances, have any right to

reimbursement from the federal government. Without concluding that

Sallie Mae loans may never be considered to be ``government

securities,'' the Finance Board has determined that, where a member

holding a loan is not the direct beneficiary of insurance or a

guarantee payable by the United States or its agencies, such loans will

not be considered to be eligible government securities collateral under

section 10(a)(2) of the Bank Act. Accordingly, the text of final

Sec. 935.9(a)(2)(ii) has been revised to reflect this requirement.

Many commenters responded favorably to the statement in the

preamble to the proposed rule that, pursuant to the new provisions, the

guaranteed portions of small business loans guaranteed by the Small

Business Administration (SBA) could be accepted as government

securities collateral under Sec. 935.9(a)(2). Since the publication of

the proposed rule, the Finance Board has learned that, under SBA

regulations, holders of SBA guaranteed loans made under the SBA's 7(a)

Program may not use the guaranteed portions of these loans as

collateral for any borrowing without the prior written consent of the

SBA, which will be granted only if certain conditions are met. See 13

CFR 120.420. While the Finance Board continues to consider the

guaranteed portions of SBA loans to be eligible collateral under

Sec. 935.9(a)(2)(ii) of the final rule, it is the responsibility of the

FHLBank and its borrowing member to ensure that these and any other

statutory and regulatory requirements pertaining to the pledging of

government-insured or guaranteed loans are met at the time such assets

are taken as collateral. The Finance Board has no authority to

interpret, waive, or enforce the regulations of other federal agencies

and has not undertaken a comprehensive survey of statutory and

regulatory requirements that may apply to government-insured or

guaranteed loans that may be accepted as collateral under new

Secs. 935.9(a)(2)(ii) and (iii).

The one commenter that opposed the adoption of the new government

securities provisions argued that, by permitting FHLBanks to accept, in

addition to mortgages, ``other loans'' insured or guaranteed by the

United States or its agencies, the Finance Board is permitting the

FHLBanks to stray from their housing finance mission. In fact, section

10(a)(2) of the Bank Act--which is the source of statutory authority

for Sec. 935.9(a)(2) of the regulations--does not require that

government securities be mortgage-related to be eligible as collateral

for FHLBank advances. See 12 U.S.C. 1430(a)(2).

D. Collateral Verification

Finally, in the proposed rule, the Finance Board proposed to amend

Sec. 935.11(b) of the Advances Regulation, governing the verification

of the existence of collateral, to remove therefrom a requirement that

each FHLBank establish written collateral verification procedures

containing standards similar to those established by the AICPA. Three

commenters (two FHLBanks and one member) expressly supported the

amendment. Two commenters (one member and the AICPA), while not

objecting generally to revising Sec. 935.11(b), stated that any

amendment should more clearly set forth objectively measurable

expectations regarding collateral verification.

The intent behind the proposed amendment is to direct the FHLBanks

to maintain appropriate collateral verification standards and processes

and to give the Finance Board examination staff the flexibility to

assess the adequacy of specific standards and procedures adopted by

each FHLBank. Although, in the course of such a review, examiners would

normally look for consistency with generally accepted standards, such

as those established by the AICPA, to mandate particular standards in

the rule would eliminate the flexibility that the Finance Board has

determined is necessary in carrying out these examinations.

Accordingly, this amendment remains unchanged in the final rule.

III. Regulatory Flexibility Act

The final 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

[[Page 16621]]

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 935

Credit, Federal home loan banks, Reporting and recordkeeping

requirements.

Accordingly, the Finance Board amends 12 CFR part 935 as follows:

PART 935--ADVANCES

1. The authority citation for part 935 is revised to read as

follows:

Authority: 12 U.S.C. 1422a(a)(3), 1422b(a)(1), 1426, 1429, 1430,

1430b and 1431.

Subpart A--Advances to Members

2. Amend Sec. 935.1 by revising the definition of ``Mortgage-backed

security'' to read as follows:

Sec. 935.1 Definitions.

* * * * *

Mortgage-backed security means:

(1) An equity security representing an ownership interest in:

(i) Fully disbursed, whole first mortgage loans on improved

residential real property; or

(ii) Mortgage pass-through or participation securities which are

themselves backed entirely by fully disbursed, whole first mortgage

loans on improved residential real property; or

(2) An obligation, bond, or other debt security backed entirely by

the assets described in paragraph (1)(i) or (ii) of this definition.

* * * * *

3. Amend Sec. 935.9 as follows:

a. Add to the headings of paragraphs (b), (c) and (e) the word

``advances'' preceding the word ``collateral'';

b. Revise paragraph (a) as follows:

Sec. 935.9 Collateral.

(a) Eligible security for advances. At the time of origination or

renewal of an advance, each Bank shall obtain, and thereafter maintain,

a security interest in collateral that meets the requirements of one or

more of the following categories:

(1) Mortgage loans and privately issued securities. (i) Fully

disbursed, whole first mortgage loans on improved residential real

property not more than 90 days delinquent; or

(ii) Privately issued mortgage-backed securities, excluding the

following:

(A) Securities that represent a share of only the interest payments

or only the principal payments from the underlying mortgage loans;

(B) Securities that represent a subordinate interest in the cash

flows from the underlying mortgage loans;

(C) Securities that represent an interest in any residual payments

from the underlying pool of mortgage loans; or

(D) Such other high-risk securities as the Board in its discretion

may determine.

(2) Agency securities. Securities issued, insured or guaranteed by

the United States Government, or any agency thereof, including without

limitation:

(i) Mortgage-backed securities, as defined in Sec. 935.1 of this

part, issued or guaranteed by the Federal Home Loan Mortgage

Corporation, the Federal National Mortgage Association, the Government

National Mortgage Association, or any other agency of the United States

Government;

(ii) Mortgages or other loans, regardless of delinquency status, to

the extent that the mortgage or loan is insured or guaranteed by the

United States or any agency thereof, or otherwise is backed by the full

faith and credit of the United States, and such insurance, guarantee or

other backing is for the direct benefit of the holder of the mortgage

or loan; and

(iii) Securities backed by, or representing an equity interest in,

mortgages or other loans referred to in paragraph (a)(2)(ii) of this

section.

(3) Deposits. Deposits in a Bank.

(4) Other collateral. (i) Except as provided in paragraph

(a)(4)(iii) of this section, other real estate-related collateral

acceptable to the Bank if:

(A) Such collateral has a readily ascertainable value; and

(B) The Bank can perfect a security interest in such collateral.

(ii) Eligible other real estate-related collateral may include, but

is not limited to:

(A) Privately issued mortgage-backed securities not otherwise

eligible under paragraph (a)(1)(ii) of this section;

(B) Second mortgage loans, including home equity loans;

(C) Commercial real estate loans; and

(D) Mortgage loan participations.

(iii) A Bank shall not permit the aggregate amount of outstanding

advances to any one member, secured by such other real estate-related

collateral, to exceed 30 percent of such member's capital, as

calculated according to GAAP, at the time the advance is issued or

renewed.

(5) Securities representing equity interests in eligible advances

collateral. Any security the ownership of which represents an undivided

equity interest in underlying assets, all of which qualify either as:

(i) Eligible collateral under paragraphs (a)(1) or (2) of this

section; or

(ii) Cash or cash equivalents.

* * * * *

4. Amend Sec. 935.11 by revising paragraph (b) to read as follows:

Sec. 935.11 Pledged collateral; verification.

* * * * *

(b) Collateral verification. Each Bank shall establish written

procedures and standards for verifying the existence of collateral

securing the Bank's advances, and shall regularly verify the existence

of the collateral securing its advances in accordance with such

procedures and standards.

Dated: March 19, 1999.

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

Bruce A. Morrison,

Chairman.

[FR Doc. 99-8356 Filed 4-5-99; 8:45 am]

BILLING CODE 6725-01-P