[Federal Register Volume 64, Number 65 (Tuesday, April 6, 1999)]
[Rules and Regulations]
[Pages 16618-16621]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-8356]



FEDERAL HOUSING FINANCE BOARD

12 CFR Part 935

[No. 99-20]
RIN 3069-AA77


Collateral Eligible To Secure Federal Home Loan Bank Advances

AGENCY: Federal Housing Finance Board.

ACTION: Final rule.

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SUMMARY: The Federal Housing Finance Board (Finance Board) is amending 
its regulation governing eligible collateral for Federal Home Loan Bank 
(FHLBank) advances to clarify that certain assets, including the 
insured or guaranteed portions of federally-insured or guaranteed loans 
and securities representing an equity interest in eligible collateral, 
qualify as eligible collateral to secure FHLBank advances. The final 
rule also amends the Finance Board's regulation on collateral 
verification to eliminate certain ambiguities therein.

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

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

[[Page 16619]]

Office of General Counsel, (202) 408-2932, Federal Housing Finance 
Board, 1777 F Street, NW., Washington, DC 20006, or by electronic mail 
at [email protected].

SUPPLEMENTARY INFORMATION:

I. The Proposed Rule

    On December 8, 1998, the Finance Board published for comment a 
proposed rule to amend its Advances Regulation, 12 CFR part 935, 
primarily in order to codify in the Regulation provisions governing 
various collateral arrangements that have been the subject of 
regulatory interpretations and requests for such interpretations from 
the FHLBanks and their members. See 63 FR 67625 (Dec. 8, 1998). The 
sixty day public comment period closed on February 8, 1999. The Finance 
Board received a total of forty comments: eleven from FHLBanks, 
seventeen from FHLBank members, five from trade associations, two from 
members of Congress, and one each from an investment broker/dealer 
serving FHLBank members, an accounting firm, a state governor and a 
non-member corporate credit union. Only the non-member corporate credit 
union opposed the rule generally.
    Section 10(a) of the Federal Home Loan Bank Act (Bank Act) 
enumerates four categories of collateral that are eligible to secure 
FHLBank advances: (1) Current whole first mortgage loans on improved 
residential property and securities representing a whole interest in 
such mortgages; (2) securities that are issued, guaranteed, or insured 
by the United States Government, or any agency thereof; (3) deposits of 
a FHLBank; and (4) other real-estate related collateral in a total 
amount not to exceed 30 percent of the borrowing member's capital. See 
12 U.S.C. 1430(a). The Advances Regulation implements and clarifies the 
statutory requirements of section 10 of the Bank Act that relate to the 
security interests that a FHLBank must obtain and maintain when making 
advances to member institutions. Among the issues that the Regulation 
addresses are: the types and amounts of collateral that a FHLBank may 
or must accept when making advances; the priority of FHLBank claims to 
such collateral in relation to other creditors; and requirements 
regarding the valuation and verification of the existence of pledged 
collateral. See 12 CFR 935.9-12.
    In response to numerous requests from both FHLBanks and their 
members to clarify or interpret these collateral provisions in the 
context of specific transactions, the Finance Board proposed to amend 
Sec. 935.9 to make explicit in the Regulation that the FHLBanks may 
accept as collateral to secure advances to members: (1) the insured or 
guaranteed portions of federally-insured or guaranteed loans, 
regardless of delinquency status; (2) securities representing an equity 
interest in eligible collateral; and (3) eligible mortgage or 
government securities collateral held by members' wholly-owned 
investment subsidiaries, under the conditions set forth in the proposed 
rule. In addition, the Finance Board proposed to amend Sec. 935.11(b) 
of the Advances Regulation, governing collateral verification, to 
eliminate an ambiguous reference therein to standards established by 
the Auditing Standards Board of the American Institute of Certified 
Public Accountants (AICPA).

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

A. Eligible Collateral Pledged by a Qualifying Investment Subsidiary

    The proposed rule would have amended Sec. 935.1 of the Advances 
Regulation to include a definition of the term ``Qualifying Investment 
Subsidiary'' (QIS), which was to include business entities that: (1) 
Are wholly owned by a member; (2) are operated solely as passive 
investment vehicles on behalf of that member; and (3) hold only cash 
equivalents and assets that are eligible collateral under 
Secs. 935.9(a)(1) and (2) of the Advances Regulation. In turn, the 
proposed rule would have created a new Sec. 935.9(b) under which the 
FHLBanks would have been expressly permitted to accept pledges of 
eligible collateral from a member's QIS to secure advances to that 
member where the FHLBank was able to obtain and maintain a security 
interest in the collateral pursuant to which its rights and privileges 
were functionally equivalent to those that the FHLBank would possess if 
the member were to pledge the collateral directly.
    These proposed provisions were intended primarily to address 
requests from FHLBanks to accept as security for advances to members 
eligible collateral held by Real Estate Investment Trust and state 
security corporation subsidiaries. However, a large number of 
commenters questioned the Finance Board's proposal to address only 
pledges of collateral from a narrow class of wholly-owned subsidiaries, 
while ignoring collateral arrangements with other types of affiliates 
that may be permissible under the Bank Act. In light of these comments, 
the Finance Board has decided to remove these QIS provisions from the 
text of the final rule pending further analysis of the issue. It is 
anticipated that, in the near future, the Finance Board will either 
finalize the QIS provisions separately in a modified form, or will 
issue a new proposed rule that addresses in a more comprehensive 
fashion pledges of collateral from members' affiliates.

B. Equity Interests in Eligible Collateral

    Section 935.9(a)(1)(iii) of the proposed rule expressly authorized 
FHLBanks to accept as collateral for advances to members any security 
the ownership of which represents an undivided equity interest in whole 
mortgages or mortgage-backed securities (MBS), all of which qualify as 
eligible collateral under Sec. 935.9(a)(1). Similarly, 
Sec. 935.9(a)(2)(ii) of the proposed rule expressly authorized FHLBanks 
to accept as collateral any security the ownership of which represents 
an undivided equity interest in underlying assets, all of which qualify 
as eligible government securities collateral under Sec. 935.9(a)(2). 
These provisions were intended to permit FHLBanks to accept as 
collateral shares of mutual funds and similar equity investments where 
the underlying assets of the fund comprise only eligible collateral.
    Seven commenters (two FHLBanks, two members, two trade associations 
and the investment broker/dealer) expressly supported, and no 
commenters expressly opposed, these provisions. However, the two 
FHLBanks opposed the proposed rule's requirement that the underlying 
assets of the fund consist only of eligible collateral. Noting that it 
is likely that, for liquidity purposes, such funds may hold a small 
percentage of assets that do not qualify as eligible collateral, one 
FHLBank suggested that the FHLBanks be authorized to accept shares of 
funds where at least 90 percent of the underlying assets are eligible 
collateral. The other FHLBank suggested that FHLBanks be permitted to 
lend against the pro-rata share of the underlying assets that do 
qualify as eligible collateral. In the final rule, the Finance Board 
has combined the material contained in proposed Secs. 935.9(a)(1)(iii) 
and (a)(2)(ii) into a new Sec. 935.9(a)(5), under which the FHLBanks 
are permitted to accept shares of mutual funds and similar investments 
that represent an undivided equity interest in underlying assets that 
qualify as eligible collateral under either Sec. 935.9(a)(1) or (a)(2). 
This change makes clear that FHLBanks may accept shares of funds that 
hold a combination of eligible mortgage assets and eligible government 
securities, in addition to

[[Page 16620]]

those that hold either one or the other type of eligible collateral. In 
addition, new Sec. 935.9(a)(5) makes clear that such funds may also 
hold cash or cash equivalents without losing their eligibility as 
collateral for advances. Because of the complexities of monitoring the 
fluctuating asset pools of mutual funds and similar investments, the 
Finance Board has determined that it will not, at this time, permit 
FHLBanks to accept under new Sec. 935.9(a)(5) shares of funds that hold 
any assets that are neither eligible collateral under Secs. 935.9(a)(1) 
or (a)(2), nor cash or cash equivalents. Depending on the mix of the 
underlying assets, however, shares of such funds may constitute 
eligible collateral under Sec. 935.9(a)(4).

C. Government Securities

    In the proposed rule, the Finance Board proposed to redesignate the 
existing text of Sec. 935.9(a)(2) of the Advances Regulation as 
Sec. 935.9(a)(2)(i)(A) and to add: a new paragraph (i)(B) to make clear 
that FHLBanks may accept, as eligible government securities collateral, 
mortgages or other loans, regardless of delinquency status, to the 
extent that the repayment of the principal and/or interest on such 
mortgages or loans is backed by the United States Government or any of 
its agencies; and a new paragraph (i)(C) to make clear that FHLBanks 
may also accept as eligible collateral securities that are backed by, 
or represent equity interests in, pools of loans or mortgages that are 
insured or guaranteed by the United States Government or its agencies 
(to the extent of such insurance or guarantee), even if the investment 
instrument itself is not so insured or guaranteed. Proposed 
Secs. 935.9(a)(2)(i)(B) and (C) have been redesignated in the final 
rule as Secs. 935.9(a)(2)(ii) and (iii), respectively.
    Nineteen commenters (nine members, four trade associations, three 
FHLBanks, two members of Congress and one state governor) expressly 
supported these changes and one commenter (the non-member corporate 
credit union) expressly opposed them. Several commenters noted 
specifically that, in the risk-based capital provisions of their 
respective regulations, the federal financial institution regulatory 
agencies recognize that individual loans that are insured or guaranteed 
by the United States Government possess risk equal to that of 
government-insured or guaranteed securities representing interests in 
pools of loans.
    A significant number of commenters requested that the Finance Board 
make clear in the preamble to the final rule that Sallie Mae student 
loans reinsured by the U.S. Department of Education (DOE) and 
certificates backed by pools of such loans will be considered to be 
eligible collateral pursuant to the new provisions. The Finance Board 
understands that, with respect to at least some Sallie Mae loans made 
under the Federal Family Education Loan Program (FFELP), the holder of 
the loan benefits directly only from the guarantee of a Guarantee 
Agency that is not part of the federal government. While a Guarantee 
Agency may have a legal right to be reimbursed by the DOE for a portion 
of guarantee payments made to holders of defaulted student loans, the 
holders of these loans do not, in most circumstances, have any right to 
reimbursement from the federal government. Without concluding that 
Sallie Mae loans may never be considered to be ``government 
securities,'' the Finance Board has determined that, where a member 
holding a loan is not the direct beneficiary of insurance or a 
guarantee payable by the United States or its agencies, such loans will 
not be considered to be eligible government securities collateral under 
section 10(a)(2) of the Bank Act. Accordingly, the text of final 
Sec. 935.9(a)(2)(ii) has been revised to reflect this requirement.
    Many commenters responded favorably to the statement in the 
preamble to the proposed rule that, pursuant to the new provisions, the 
guaranteed portions of small business loans guaranteed by the Small 
Business Administration (SBA) could be accepted as government 
securities collateral under Sec. 935.9(a)(2). Since the publication of 
the proposed rule, the Finance Board has learned that, under SBA 
regulations, holders of SBA guaranteed loans made under the SBA's 7(a) 
Program may not use the guaranteed portions of these loans as 
collateral for any borrowing without the prior written consent of the 
SBA, which will be granted only if certain conditions are met. See 13 
CFR 120.420. While the Finance Board continues to consider the 
guaranteed portions of SBA loans to be eligible collateral under 
Sec. 935.9(a)(2)(ii) of the final rule, it is the responsibility of the 
FHLBank and its borrowing member to ensure that these and any other 
statutory and regulatory requirements pertaining to the pledging of 
government-insured or guaranteed loans are met at the time such assets 
are taken as collateral. The Finance Board has no authority to 
interpret, waive, or enforce the regulations of other federal agencies 
and has not undertaken a comprehensive survey of statutory and 
regulatory requirements that may apply to government-insured or 
guaranteed loans that may be accepted as collateral under new 
Secs. 935.9(a)(2)(ii) and (iii).
    The one commenter that opposed the adoption of the new government 
securities provisions argued that, by permitting FHLBanks to accept, in 
addition to mortgages, ``other loans'' insured or guaranteed by the 
United States or its agencies, the Finance Board is permitting the 
FHLBanks to stray from their housing finance mission. In fact, section 
10(a)(2) of the Bank Act--which is the source of statutory authority 
for Sec. 935.9(a)(2) of the regulations--does not require that 
government securities be mortgage-related to be eligible as collateral 
for FHLBank advances. See 12 U.S.C. 1430(a)(2).

D. Collateral Verification

    Finally, in the proposed rule, the Finance Board proposed to amend 
Sec. 935.11(b) of the Advances Regulation, governing the verification 
of the existence of collateral, to remove therefrom a requirement that 
each FHLBank establish written collateral verification procedures 
containing standards similar to those established by the AICPA. Three 
commenters (two FHLBanks and one member) expressly supported the 
amendment. Two commenters (one member and the AICPA), while not 
objecting generally to revising Sec. 935.11(b), stated that any 
amendment should more clearly set forth objectively measurable 
expectations regarding collateral verification.
    The intent behind the proposed amendment is to direct the FHLBanks 
to maintain appropriate collateral verification standards and processes 
and to give the Finance Board examination staff the flexibility to 
assess the adequacy of specific standards and procedures adopted by 
each FHLBank. Although, in the course of such a review, examiners would 
normally look for consistency with generally accepted standards, such 
as those established by the AICPA, to mandate particular standards in 
the rule would eliminate the flexibility that the Finance Board has 
determined is necessary in carrying out these examinations. 
Accordingly, this amendment remains unchanged in the final rule.

III. Regulatory Flexibility Act

    The final rule applies only to the FHLBanks, which do not come 
within the meaning of ``small business,'' as defined in the Regulatory 
Flexibility Act (RFA). See 5 U.S.C. 601(6). Therefore, in

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accordance with section 605(b) of the RFA, 5 U.S.C. 605(b), the Finance 
Board hereby certifies that this proposed rule, if promulgated as a 
final rule, will not have a significant economic impact on a 
substantial number of small entities.

List of Subjects in 12 CFR Part 935

    Credit, Federal home loan banks, Reporting and recordkeeping 
requirements.
    Accordingly, the Finance Board amends 12 CFR part 935 as follows:

PART 935--ADVANCES

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

    Authority: 12 U.S.C. 1422a(a)(3), 1422b(a)(1), 1426, 1429, 1430, 
1430b and 1431.

Subpart A--Advances to Members

    2. Amend Sec. 935.1 by revising the definition of ``Mortgage-backed 
security'' to read as follows:


Sec. 935.1  Definitions.

* * * * *
    Mortgage-backed security means:
    (1) An equity security representing an ownership interest in:
    (i) Fully disbursed, whole first mortgage loans on improved 
residential real property; or
    (ii) Mortgage pass-through or participation securities which are 
themselves backed entirely by fully disbursed, whole first mortgage 
loans on improved residential real property; or
    (2) An obligation, bond, or other debt security backed entirely by 
the assets described in paragraph (1)(i) or (ii) of this definition.
* * * * *
    3. Amend Sec. 935.9 as follows:
    a. Add to the headings of paragraphs (b), (c) and (e) the word 
``advances'' preceding the word ``collateral'';
    b. Revise paragraph (a) as follows:


Sec. 935.9  Collateral.

    (a) Eligible security for advances. At the time of origination or 
renewal of an advance, each Bank shall obtain, and thereafter maintain, 
a security interest in collateral that meets the requirements of one or 
more of the following categories:
    (1) Mortgage loans and privately issued securities. (i) Fully 
disbursed, whole first mortgage loans on improved residential real 
property not more than 90 days delinquent; or
    (ii) Privately issued mortgage-backed securities, excluding the 
following:
    (A) Securities that represent a share of only the interest payments 
or only the principal payments from the underlying mortgage loans;
    (B) Securities that represent a subordinate interest in the cash 
flows from the underlying mortgage loans;
    (C) Securities that represent an interest in any residual payments 
from the underlying pool of mortgage loans; or
    (D) Such other high-risk securities as the Board in its discretion 
may determine.
    (2) Agency securities. Securities issued, insured or guaranteed by 
the United States Government, or any agency thereof, including without 
limitation:
    (i) Mortgage-backed securities, as defined in Sec. 935.1 of this 
part, issued or guaranteed by the Federal Home Loan Mortgage 
Corporation, the Federal National Mortgage Association, the Government 
National Mortgage Association, or any other agency of the United States 
Government;
    (ii) Mortgages or other loans, regardless of delinquency status, to 
the extent that the mortgage or loan is insured or guaranteed by the 
United States or any agency thereof, or otherwise is backed by the full 
faith and credit of the United States, and such insurance, guarantee or 
other backing is for the direct benefit of the holder of the mortgage 
or loan; and
    (iii) Securities backed by, or representing an equity interest in, 
mortgages or other loans referred to in paragraph (a)(2)(ii) of this 
section.
    (3) Deposits. Deposits in a Bank.
    (4) Other collateral. (i) Except as provided in paragraph 
(a)(4)(iii) of this section, other real estate-related collateral 
acceptable to the Bank if:
    (A) Such collateral has a readily ascertainable value; and
    (B) The Bank can perfect a security interest in such collateral.
    (ii) Eligible other real estate-related collateral may include, but 
is not limited to:
    (A) Privately issued mortgage-backed securities not otherwise 
eligible under paragraph (a)(1)(ii) of this section;
    (B) Second mortgage loans, including home equity loans;
    (C) Commercial real estate loans; and
    (D) Mortgage loan participations.
    (iii) A Bank shall not permit the aggregate amount of outstanding 
advances to any one member, secured by such other real estate-related 
collateral, to exceed 30 percent of such member's capital, as 
calculated according to GAAP, at the time the advance is issued or 
renewed.
    (5) Securities representing equity interests in eligible advances 
collateral. Any security the ownership of which represents an undivided 
equity interest in underlying assets, all of which qualify either as:
    (i) Eligible collateral under paragraphs (a)(1) or (2) of this 
section; or
    (ii) Cash or cash equivalents.
* * * * *
    4. Amend Sec. 935.11 by revising paragraph (b) to read as follows:


Sec. 935.11  Pledged collateral; verification.

* * * * *
    (b) Collateral verification. Each Bank shall establish written 
procedures and standards for verifying the existence of collateral 
securing the Bank's advances, and shall regularly verify the existence 
of the collateral securing its advances in accordance with such 
procedures and standards.

    Dated: March 19, 1999.

    By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairman.
[FR Doc. 99-8356 Filed 4-5-99; 8:45 am]
BILLING CODE 6725-01-P