[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