[Federal Register Volume 64, Number 65 (Tuesday, April 6, 1999)]
[Proposed Rules]
[Pages 16792-16795]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-8358]



  Federal Register / Vol. 64, No. 65 / Tuesday, April 6, 1999 / 
Proposed Rules  

[[Page 16792]]



FEDERAL HOUSING FINANCE BOARD

12 CFR Parts 933, 934, 935

[No. 99-22]
RIN 3069-AA85


Mandatory Excess Capital Stock Redemption; Prohibited Stock 
Dividends

AGENCY: Federal Housing Finance Board.

ACTION: Advance notice of proposed rulemaking (ANPRM).

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SUMMARY: The Federal Housing Finance Board (Finance Board) is 
requesting public comment on how, by what means, and to what extent 
prohibiting or limiting the ability of the Federal Home Loan Banks 
(Banks) to pay stock dividends to members would assist the Finance 
Board in achieving the goal of reducing excess capital stock in the 
Bank System. Similarly, the Finance Board is requesting comment on 
whether the Banks should be required to unilaterally redeem members' 
excess Bank capital stock to help achieve the goal of reducing excess 
capital stock in the Bank System.

DATES: Comments must be received in writing on or before May 6, 1999.

ADDRESSES: Comments should be mailed to: Elaine L. Baker, Secretary to 
the Board, Federal Housing Finance Board, 1777 F Street, NW, 
Washington, DC 20006. Comments will be available for public inspection 
at this address.

FOR FURTHER INFORMATION CONTACT: Joseph A. McKenzie, Deputy Chief 
Economist, (202) 408-2845, Office of Policy, Research and Analysis; or 
Sharon B. Like, Senior Attorney-Advisor, (202) 408-2930, or Jane S. 
Converse, Senior Attorney-Advisor, (202) 408-2976, Office of General 
Counsel, Federal Housing Finance Board, 1777 F Street, NW, Washington, 
DC 20006.

SUPPLEMENTARY INFORMATION:

I. Statutory and Regulatory Background

A. The Banks' Housing Finance and Community Investment Mission

    The Federal Home Loan Bank System (Bank System) is comprised of 12 
District Banks that are federally chartered and managed by boards of 
directors that set policies pursuant to regulations established by the 
Finance Board. As government-sponsored enterprises (GSEs), the Banks 
act as intermediaries in the capital markets, raising funds on 
favorable terms and passing the proceeds on to member institutions in 
the form of advances (loans).
    Under section 10(a) of the Federal Home Loan Bank Act (Bank Act) 
and part 935 of the Finance Board's regulations, the Banks have broad 
authority to make advances in support of housing finance, which 
includes community investment finance. See 12 U.S.C. 1430 (a), (i), 
(j); 12 CFR part 935. The Banks also are required to offer two 
programs, the Affordable Housing Program (AHP) and the Community 
Investment Program (CIP), to provide subsidized or at-cost advances, 
respectively, in support of unmet housing finance or economic 
development credit needs. See 12 U.S.C. 1430 (i), (j); 12 CFR parts 
960, 970. In addition, section 10(j)(10) of the Bank Act, as 
implemented by a recently issued Finance Board regulation, authorizes 
the Banks to establish Community Investment Cash Advance (CICA) 
Programs for community lending, defined as providing financing for 
economic development projects for targeted beneficiaries. See 12 U.S.C. 
1430(j)(10); 63 FR 65536 (Nov. 27, 1998).
    The Bank Act provides that the Finance Board's primary duty is to 
ensure that the Banks operate in a financially safe and sound manner. 
See id. section 1422a(a)(3)(A). The Bank Act further provides that, to 
the extent consistent with this primary duty, the Finance Board also is 
responsible for supervising the Banks, ensuring that the Banks carry 
out their housing finance mission, and ensuring that the Banks remain 
adequately capitalized and able to raise funds in the capital markets. 
See id. section 1422a(a)(3)(B).

B. Statutory and Regulatory Minimum Capital Stock, Redemption and 
Dividend Provisions

    Under the Bank Act and implementing Finance Board regulations, a 
member's required minimum capital stock investment in its Bank is the 
greater of: (1) 1 percent of the member's aggregate unpaid loan 
principal (defined as the member's home mortgage loans, home purchase 
contracts, and similar obligations) but not less than $500; (2) 0.3 
percent of the member's total assets; or (3) 5 percent of total 
advances outstanding to the member. In the case of members that are not 
``qualified thrift lenders'' (QTLs), the third option is computed as 5 
percent of total advances outstanding to the member divided by the 
member's ``actual thrift investment percentage'' (as defined in 12 
U.S.C. 1467a(m)). See 12 U.S.C. 1426(b)(1), (2), (4); 1430(c), (e)(1), 
(3); 12 CFR 933.20(a).
    Section 6(b)(1) further provides that the Bank shall annually 
adjust, at such time and in such manner as the Finance Board may by 
regulations or otherwise prescribe, the amount of capital stock held by 
each member so that such member shall have invested its minimum capital 
stock requirement. See id. section 1426(b)(1); 12 CFR 933.22(b)(1). 
Section 6(b)(1) also provides that if the Bank finds that the 
investment of any member in capital stock is greater than that required 
under section 6(b), the Bank may, unless prohibited by the Finance 
Board, in its discretion and upon application of the member, retire the 
capital stock of such member in excess of the amount so required. See 
id. section 1426(b)(1); 12 CFR 933.22(b)(2).
    Section 16(a) of the Bank Act provides, among other things, that 
dividends may be paid by the Banks with the approval of the Finance 
Board. See 12 U.S.C. 1436(a). Section 6(g) of the Bank Act provides 
that all stock of any Bank shall share in dividend distributions 
without preference. See id. section 1426(g). Section 934.17 of the 
Finance Board's regulations on the operations of the Banks implements 
these provisions by providing, among other things, that dividends may 
be paid by the Banks in cash or in the form of stock. See 12 CFR 932.3; 
63 FR 65683, 65687 (Nov. 30, 1998) (redesignating Sec. 932.3 as 
Sec. 934.17).
    Section 935.15(b) of the Finance Board's Advances Regulation 
provides that ``[a] Bank, after providing 15 calendar days advance 
written notice to a member, may unilaterally redeem that amount of the 
member's Bank stock that exceeds'' the member's minimum statutory and 
regulatory capital stock requirements. See 12 CFR 935.15(b). Section 
935.15(b) further provides that the Bank shall have discretion to 
determine the timing of such unilateral redemption, provided that the 
Bank's redemption policy is consistent with the requirement in section 
7(j) of the Bank Act that the affairs of the Bank shall be administered 
fairly and impartially and without discrimination in favor of or 
against member borrowers, see 12 U.S.C. section 1427(j).
    The Bank Act and Sec. 935.15(b) of the Advances regulation are 
silent on whether a Bank, in administering its mandatory redemption 
policy, may impose on or accept from a member a fee in lieu of 
redeeming the member's excess Bank capital stock.

[[Page 16793]]

II. Interim Final Rule Prohibiting Fee In Lieu of Mandatory Excess 
Capital Stock Redemption--Sec. 935.15(b)

A. Proposed Fee In Lieu of Mandatory Excess Capital Stock Redemption

    A Bank has adopted a policy, effective March 31, 1999, pursuant to 
which the Bank generally will redeem that amount of each member's 
capital stock exceeding 115 percent of the member's minimum statutory 
capital stock requirement, with an option, if lawful and appropriate, 
for the member to pay a fee to the Bank in lieu of such redemption. The 
Bank has requested confirmation from the Finance Board that the 
proposed fee would be authorized under the Bank Act and Finance Board 
regulations.
    As noted above, the Bank Act and Sec. 935.15(b) of the Finance 
Board's Advances regulation are silent on whether a Bank may impose on 
or accept from a member a fee in lieu of redeeming the member's excess 
Bank capital stock. Even though the Bank Act is susceptible to an 
interpretation that the payment of such fees would be authorized under 
law, the Finance Board has determined that allowing the payment of such 
fees would detract from the agency's ongoing efforts and initiatives to 
ensure that the Banks carry out their housing finance and community 
investment mission, as discussed below. Therefore, simultaneously with 
this ANPRM, the Finance Board has adopted a separate interim final 
rule, published elsewhere in this issue of the Federal Register, that 
prohibits the payment of such fees. Although the interim final rule is 
effective on the date of publication in the Federal Register, the 
Finance Board is requesting comment on all aspects of that rule during 
a 30-day comment period.
    According to the Bank, the purpose of the Bank's proposed 
redemption policy is to enhance the Bank's competitiveness vis a vis 
other Banks by increasing its earnings per share and therefore its 
dividend rate. The Bank forecasts that mandatory redemption of surplus 
capital stock or payment of the fee in lieu of redemption would add 
approximately 12 basis points to the Bank's quarterly dividend. The 
Bank has a number of large members owned by holding companies that also 
have subsidiaries located in other Bank districts. The Bank is 
concerned that these members may discontinue borrowing from the Bank 
and that their affiliates will become members and borrow from these 
other Banks because those Banks pay higher dividend rates than the 
Bank.
    Under the Bank's proposed policy, the Bank would unilaterally 
redeem ``surplus'' capital stock (defined by the Bank as capital stock 
in excess of 115 percent of minimum capital stock requirements but not 
less than $100,000) held by all members, unless the member pays a fee 
to the Bank, on a monthly basis, to continue holding its surplus 
capital stock. The 115 percent threshold was adopted to allow 
membership flexibility for future borrowings from the Bank and absorb 
the stock dividends. The $100,000 minimum was adopted in order to 
reduce the operational impact of the redemption policy on smaller 
members. The Bank states that the fee, which is 1.65 percent of the 
value of a member's surplus capital stock, was designed to make the 
Bank financially indifferent to a member's decision to continue to hold 
surplus capital stock. The fee income paid to the Bank would act as an 
offset to the dividend dilution caused by those members holding surplus 
capital stock.
    As of August 31, 1998, the Bank had excess capital stock of $554 
million, or 14 percent of its total capital of $3.9 billion. The Bank's 
total ``surplus'' capital stock, as of August 31, 1998, was $312 
million. One mandatory thrift member held 70 percent of the Bank's 
total surplus capital stock as of that date. The Bank has excess 
capital stock, in part, because it pays members quarterly stock 
dividends rather than cash dividends. The Bank has indicated that 
paying a stock dividend rather than a cash dividend provides tax 
benefits for its members, and the Bank intends to continue paying stock 
dividends for this reason.

B. The Banks Are Significantly Overcapitalized

    By many standards, the 12 Banks are significantly overcapitalized. 
As of December 31, 1998, the 12 Banks had total capital stock of $22.8 
billion, with $2.8 billion, or 12.6 percent, of this amount 
constituting capital stock in excess of the Banks' statutory minimum 
capital stock requirements. On a risk-adjusted basis (using the current 
risk-based standards applicable to federally regulated depositories), 
the total capital is estimated at 22 percent of the Banks' total 
assets, a level far above that of large commercial banks and other 
housing GSEs.\1\ The highest percentage of excess capital stock to 
total capital stock at a Bank was 30.1 percent, and the lowest was 1.2 
percent.
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    \1\ A depository institution generally is deemed to be ``well-
capitalized'' if it has a total risk-based capital rtio of 10 
percent or greater, a Tier 1 risk-based capital ratio of 6 percent 
or greater, and a leverage ratio of 5 percent or greater. See 12 CFR 
6.4(b)(1), 208.33(b)(1), 325.103(b)(1), 565.4(b)(1). The minimum 
capital requirement for the other housing GSEs--the Federal National 
Mortgage Association and the Federal Home Loan Mortgage 
Corporation--generally is 2.5 percent of on-balance sheet assets 
plus .45 percent of off-balance sheet obligations. See 12 U.S.C. 
4612(a).
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    Even without excess capital stock in the Bank System, i.e., capital 
stock at only the statutorily required minimum stock levels, the Banks 
would be significantly overcapitalized. A redemption of all excess 
capital stock in the Bank System would reduce the Banks' risk-based 
capital ratio to approximately 19.2 percent.
    Members have excess capital stock holdings, in part, because they 
receive stock dividends from the Banks. Currently, five Banks pay stock 
dividends, and seven Banks pay cash dividends. The Internal Revenue 
Service has ruled that the issuance of stock dividends by the Banks is 
not taxable income for members. See IRS Rev. Rul. 90-98, November 26, 
1990, 1990-48-I.R.B.4, 26 CFR 1.305-2. However, cash dividends and 
redemptions of stock received as dividends generally are taxable income 
to members. See 26 U.S.C. 301(c), 302(a). Because of the deferred tax 
liability associated with stock dividends, many members may have 
allowed their stock dividends to accumulate rather than request 
redemption of their stock, as is their option under the Bank Act. See 
12 U.S.C. 1426(b)(1). The members' holdings of excess capital stock are 
concentrated, with the largest holder of excess capital stock having 9 
percent of the Bank System's total excess capital stock. The top five 
holders of excess capital stock represent 19 percent of the Bank 
System's total excess capital stock.
    Excess capital stock holdings also arise where members' total 
assets, home mortgage loans or outstanding advances have decreased 
since their last capital stock purchases, or where members have changed 
to QTL status, thereby reducing their advances-based capital stock 
requirement. Members may continue to hold some excess stock in order to 
minimize the transaction costs associated with capital stock purchases 
that would be required if the member's levels of total assets, home 
mortgage loans or outstanding advances fluctuate.

C. The Banks' Arbitrage Activities With Non-Core Mission Assets Detract 
From the Mission of the Banks To Promote Housing Finance and Community 
Investment

    The Banks pay dividends on all capital stock, including excess 
capital

[[Page 16794]]

stock. Since the average Bank System dividend rate of 6.64 percent 
exceeds the rate of return a Bank can earn by investing members' 
capital in core mission assets, a Bank must leverage its excess capital 
stock to pay dividends. The leveraging cannot involve advances, since 
they are already capitalized by required capital stock. Thus, the Banks 
must leverage excess capital stock by investing in non-core mission 
assets in order to generate sufficient earnings to pay a uniform 
dividend on all capital stock, including the excess capital stock.
    There is a strong correlation between the amount of excess capital 
stock at a Bank and the level of that Bank's non-core mission assets. 
In demonstrating the correlation between excess capital stock and non-
mission-related assets, the Finance Board looked at the concept of 
``core mission assets,'' defined as Bank advances, which include AHP 
advances and subsidies, CIP advances, community lending advances, 
Mortgage Partnership Finance assets, and other assets generated for the 
Banks by members and nonmember borrowers. Core mission assets do not 
include mortgage-backed securities (MBS) and money market instruments, 
which are not generated for the Banks by members or nonmember borrowers 
and their purchase by the Banks does not materially facilitate housing 
and community lending by members or nonmember borrowers. As 
demonstrated in the following table, the Banks with the highest levels 
of excess capital stock also have the lowest ratios of core mission 
assets to consolidated obligations:

                                  Excess Capital Stock and Core Mission Assets
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                                                   Core mission
                                                     assets to                    Excess capital
                      Bank                         consolidated     Descending    stock to total       Rank
                                                    obligations        rank        capital stock
                                                        (%)                             (%)
----------------------------------------------------------------------------------------------------------------
A...............................................            86.5               1            10.4               7
B...............................................            85.1               2             1.0               1
C...............................................            81.8               3            10.2               6
D...............................................            81.3               4             4.2               2
E...............................................            80.7               5             3.0               3
F...............................................            79.7               6             7.8               4
G...............................................            70.5               7             9.3               5
H...............................................            69.4               8            17.1              10
I...............................................            65.4               9            26.8              11
J...............................................            63.8              10            15.2               8
K...............................................            59.9              11            30.1              12
L...............................................            58.6              12            16.2               9
Bank System.....................................            75.8  ..............            12.6  ..............
----------------------------------------------------------------------------------------------------------------

    Approximately 75.8 percent of total Bank System consolidated 
obligations are invested in core mission assets.
    The four Banks with the highest ratios of core mission assets to 
consolidated obligations had ratios of excess capital stock to total 
capital stock of 10.4 percent, 1.2 percent, 10.4 percent, and 4.2 
percent. The five Banks with the lowest ratios of core mission assets 
to consolidated obligations had the highest ratios of excess capital 
stock to total capital stock. Of these five, three pay stock dividends, 
and one pays the highest dividend in the Bank System. At present, core 
mission assets are no more than 86.5 percent of consolidated 
obligations at any Bank.
    The Finance Board believes that the Banks' arbitrage activities for 
the purpose of generating sufficient earnings to pay adequate dividends 
on excess capital stock detract from the mission of the Banks to 
promote housing finance and community investment, by encouraging 
activities not related to the Banks' mission and thereby detracting 
from the financial incentive to engage in mission-related activity. 
While the Banks' interest in paying a reasonable dividend to members is 
a legitimate business consideration, and it is appropriate to redeem 
excess capital stock to assist in this purpose, allowing members to pay 
a fee in lieu of such mandatory redemption would perpetuate excess 
capital stock at the Banks and the Banks' continued need to invest in 
non-core mission assets to pay dividends on such excess stock.

D. Amendment of Advances Regulation To Prohibit Payment of Fee In Lieu 
of Mandatory Excess Capital Stock Redemption--Sec. 935.15(b)

    For the reasons discussed above, the interim final rule adopted by 
the Finance Board and published elsewhere in this issue of the Federal 
Register amends Sec. 935.15(b) of the Finance Board's Advances 
regulation to prohibit the Banks from imposing on or accepting from a 
member a fee in lieu of mandatory redemption of the member's excess 
capital stock.

III. Issues for Consideration

Reducing Levels of Excess Capital Stock By Prohibiting Payment of Stock 
Dividends and Requiring Unilateral Redemption of Excess Capital Stock--
Secs. 934.17, 935.15(b)

    The Finance Board believes that the Banks' levels of excess capital 
stock should be significantly reduced. As discussed above, the Banks 
are substantially overcapitalized and, thus, reduction in the amount of 
their excess capital would not adversely affect the safety and 
soundness of the Banks. The statutory minimum capital stock 
requirements guarantee that a Bank's capital stock will grow as the 
scope of its operations increases.
    As discussed above, excess capital stock requires the Banks to 
generate earnings, through investments in non-core mission assets, in 
order to pay dividends on such stock, which is not needed to capitalize 
advances and other core mission assets. The Banks' arbitrage activities 
for this purpose detract from the mission of the Banks to promote 
housing finance and community investment, by encouraging activities not 
related to the Banks' mission and thereby detracting from the financial 
incentive to engage in mission-related activity. A reduction in the 
amount of excess capital stock would reduce the amount of capital stock 
on which dividends must be paid, thereby reducing the level of 
arbitrage activities conducted in order to generate earnings to pay 
dividends on such capital stock.
    One cause of the Banks' excess capital stock levels is the payment 
by some Banks of stock dividends rather than

[[Page 16795]]

cash dividends to members. Prohibiting the Banks from paying stock 
dividends would help reduce excess capital stock levels in the Bank 
System and the consequent arbitrage activities.
    Another way to reduce excess capital stock in the Bank System and 
thereby reduce arbitrage activities in non-core mission assets by the 
Banks, would be to require the Banks to unilaterally redeem members' 
excess capital stock. In the past year, five Banks unilaterally 
redeemed their excess capital stock expressly for the purpose of 
reducing the amount of their money market investments.
    The Finance Board recognizes that payment of stock dividends has 
Federal tax advantages to members over payment of cash dividends, and 
that excess capital stock redemptions incur Federal tax liabilities for 
members. However, the private financial advantage to members from 
minimizing their taxes through the payment of stock dividends, while 
having no safety and soundness implications for the Banks, ultimately 
detracts from the Banks' housing finance and community investment 
mission and serves no other legitimate business purpose for the Banks.
    Accordingly, the Finance Board is requesting comment on how, by 
what means, and to what extent prohibiting or limiting the Banks' 
ability to pay stock dividends to members would assist the Finance 
Board in achieving the goal of reducing excess capital stock in the 
Bank System. See 12 CFR 934.17. Similarly, the Finance Board is 
requesting comment on whether the Banks should be required to 
unilaterally redeem members' excess Bank capital stock to help achieve 
the goal of reducing excess capital stock in the Bank System. See id. 
Sec. 935.15(b). The Finance Board specifically requests comment on 
whether a member should be allowed to maintain some amount of excess 
capital stock, e.g., 10 percent of its total minimum capital stock 
requirement, in anticipation of fluctuations in its assets or 
outstanding advances that may affect its minimum capital stock 
requirement. The Finance Board also requests comment on what the timing 
of unilateral redemptions should be, e.g., no less frequently than 
quarterly, semi-annually, or annually at the time of the Banks' 
adjustments of the members' minimum capital stock requirements? The 
Finance Board also requests comment on whether the currently required 
15 days' notice to members before redemption should be retained or 
modified. In addition, the Finance Board requests comment on whether 
Sec. 933.23 of the Finance Board's membership regulation, which permits 
members to purchase excess capital stock if approved by the Bank, 
should be removed or modified. See id. Sec. 933.23.
    In the alternative, the Finance Board requests comment on whether 
the Banks should be permitted to hold excess capital stock, but be 
prohibited from paying dividends on such stock, as a way to reduce the 
Banks' arbitrage activities with non-core mission assets. The Finance 
Board also requests comment on whether and to what extent excess 
capital stock holdings could be allowed so long as they are not being 
leveraged in the consolidated obligations market. In addition, the 
Finance Board requests comment on whether excess capital stock holdings 
should be permitted for a limited period of time, such as up to six 
months, where the member indicates that it intends to increase its 
advance borrowings during that time period.
    Comments received in response to this ANPRM will be reviewed and 
considered by the Finance Board in preparation for further action in 
connection with the issues discussed in this ANPRM.

    Dated: March 19, 1999.

    By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairman.
[FR Doc. 99-8358 Filed 4-5-99; 8:45 am]
BILLING CODE 6725-01-P