[Federal Register Volume 63, Number 89 (Friday, May 8, 1998)]
[Proposed Rules]
[Pages 25726-25733]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-11948]
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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