[Federal Register Volume 66, Number 153 (Wednesday, August 8, 2001)]
[Proposed Rules]
[Pages 41474-41483]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-19851]


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FEDERAL HOUSING FINANCE BOARD

12 CFR Parts 930 and 932

[No. 2001-16]
RIN 3069-AB11


Unsecured Credit Limits for Federal Home Loan Banks

AGENCY: Federal Housing Finance Board.

ACTION: Proposed rule.

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SUMMARY: The Federal Housing Finance Board (Finance Board) is proposing 
to amend the unsecured credit provision of its rules, which was adopted 
as part of its capital rule on December 20, 2000 and governs the amount 
of unsecured credit that a Federal Home Loan Bank (FHLBank) can extend 
to a particular counterparty. The limits adopted in December were 
generally stricter than the limits under which the FHLBanks operated 
with the Finance Board's Financial Management Policy (FMP). The 
proposed amendments would set the amount of unsecured credit that an 
FHLBank can extend to a government-sponsored enterprise (GSE) at the 
level allowed under the FMP, adjust the limits for sales of overnight 
federal funds and the limits for unsecured credit that can be extended 
to groups of affiliated counterparties. They also would clarify how an 
FHLBank should calculate its credit exposures from on- and off-balance 
sheet items and derivative contracts and make other technical or 
clarifying changes to the unsecured credit provision. On March 7, 2001, 
the Finance Board published for comment in the Federal Register some of 
these proposed changes. Based in part on the comments received on that 
proposal, the Finance Board believes that broader changes to the rule 
than initially envisioned may be appropriate and is thereby proposing 
new amendments to the rule.

DATES: The Finance Board will consider written comments on the proposed 
rulemaking that are received on or before September 7, 2001.

ADDRESSES: Send comments to: Elaine L. Baker, Secretary to the Board, 
by electronic mail at [email protected], or by regular mail at the 
Federal Housing Finance Board, 1777 F Street, NW., Washington, DC 
20006. Comments will be available for inspection at this address.

FOR FURTHER INFORMATION CONTACT: James L. Bothwell, Managing Director, 
(202) 408-2821; Scott L. Smith, Acting Director, (202) 408-2991; or 
Julie Paller, Senior Financial Analyst, (202) 408-2842, Office of 
Policy, Research and Analysis; or Thomas E. Joseph, Senior Attorney-
Advisor, (202) 408-2512, Office of General Counsel, Federal Housing 
Finance Board, 1777 F Street, NW., Washington, DC 20006.

SUPPLEMENTARY INFORMATION:

I. Introduction

    On December 20, 2000, in accordance with the Gramm-Leach-Bliley 
Act, Pub. L. No. 106-102, 133 Stat. 1338 (November 12, 1999) (GLB Act), 
the

[[Page 41475]]

Finance Board adopted a final rule to implement the new capital 
structure that the GLB Act established for the FHLBanks. 66 FR 8262 
(January 30, 2001). As part of the final capital rule, the Finance 
Board adopted new limits on the permitted amounts of an FHLBank's 
unsecured credit exposures to a single counterparty or a group of 
affiliated counterparties. Id. at 8318-19. See also 12 CFR 932.9. These 
new limits represent a revision and codification of the unsecured 
credit guidelines of Section VI of the FMP, Finance Board Res. No. 96-
45 (July 3, 1996), as amended by Finance Board Res. No. 96-90 (December 
6, 1996), Finance Board Res. No. 97-05 (January 14, 1997), and Finance 
Board Res. No. 97-86 (December 17, 1997), which will remain in effect 
until the earlier of October 1, 2001 or when the new limits currently 
being proposed are adopted as a final rule and take effect. See Finance 
Board Res. No. 2001-11 (June 5, 2001).
    On March 7, 2001, the Finance Board published a proposed rule 
requesting comment on potential amendments to certain sections of the 
unsecured credit requirements. Specifically, the Finance Board 
requested comment on adjusting the limit on a Bank's unsecured 
extensions of credit to a GSE, including supporting analysis concerning 
the appropriate level for the new limit; and on excluding from the 
unsecured credit limits sales of federal funds with a maturity of one 
day or less, or federal funds sold under a continuing contract. These 
changes were proposed after FHLBanks indicated that, given the 
magnitude of the reduction in the allowable credit exposure to a GSE 
under Sec. 932.9, they would experience difficulty in developing new 
investment strategies to conform to the new limits.
    In conjunction with the Finance Board's approval of the proposed 
rule, the Finance Board also adopted a resolution waiving FHLBank 
compliance with the unsecured credit limits of Sec. 932.9 and, because 
they are related to the unsecured credit limits, the liquidity 
requirements of Sec. 932.8 of the Finance Board's rules, until July 2, 
2001. See Finance Board Res. No. 2001-04 (February 28, 2001). The 
resolution also stipulated that the unsecured credit guidelines of 
Section VI of the FMP would remain in effect until the new effective 
date for Secs. 932.8 and 932.9 of July 2, 2001. On June 5, 2001, the 
Finance Board adopted another resolution further delaying the 
implementation of Secs. 932.8 and 932.9 until the earlier of October 1, 
2001 or the completion of the current rulemaking process amending 
Sec. 932.9, again subject to the FHLBanks' continuing compliance with 
Section VI of the FMP.\1\ See Finance Board Res. No. 2001-11 (June 5, 
2001). This further delay was intended to provide additional time for 
consideration of the issues that were raised in the comments on the 
proposed rule, as well as to consider other possible amendments to the 
unsecured credit limits.
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    \1\ The unsecured credit guidelines contained in Sec. 932.9 of 
the Finance Board's rules are intended to replace Section VI of the 
VMP upon becoming effective, and delaying the implementation of 
Sec. 932.9 requires that the FMP guidelines remain in place.
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    The Finance Board is now proposing amendments to the unsecured 
credit limits that address issues beyond those that were discussed in 
the proposed rule. Many of these issues were identified as a result of 
comments received on the proposed rule. Because the amendments now 
being proposed are more far-reaching, albeit rather technical in 
nature, than those previously proposed, the Finance Board believes it 
appropriate to solicit comments on them. Thus, the Finance Board is re-
proposing amendments to its rule concerning unsecured credit limits for 
a 30-day comment period.

II. Discussion of the Comments Received

    The Finance Board received nine comment letters on its proposal to 
amend the unsecured credit limits set forth in Sec. 932.9 of its 
regulations. Eight of the comments were from FHLBanks, and the ninth 
was from the Council of Federal Home Loan Banks (Council). In addition 
to commenting on the proposed changes to the GSE credit limits, the 
letters also responded to the Finance Board's request for comments on 
excluding sales of federal funds with a maturity of one day or less or 
subject to a continuing contract \2\ (together, ``overnight federal 
funds'') from the unsecured credit limits, as well as raising issues 
that had not been addressed by the proposal. The Finance Board 
carefully considered all of the comments received in drafting its new 
proposal, and discusses the most important comments below.
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    \2\ Sales of federal funds subject to a continuing contract are 
overnight federal funds loans that are automatically renewed each 
day unless terminated by either the lender or the borrower. See 
Marvin Goodfriend and William Whelpley, Federal Funds in Instruments 
of the Money Market 10 (Federal Reserve Bank of Richmond 1998) 
(available at www.rich.frb.org/pubs/instruments).
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    Credit Limits for GSEs. In its proposed rule, the Finance Board 
indicated that it intended to raise the unsecured credit limits 
applicable to GSEs. Eight of the nine commenters supported raising the 
limits on unsecured extensions of credit to GSEs, and most, though not 
all of these commenters, indicated a specific limit that should be 
adopted. Five of the commenters urged the Finance Board to raise the 
limit to 100 percent of the lesser of the GSE's or an FHLBank's total 
capital, which is the equivalent of the current limit in the FMP.\3\ 
One commenter contended that a limit equal to 50 percent of an 
FHLBank's total capital would be sufficient. Another commenter 
recommended that a provision be added to make a GSE subject to the same 
unsecured credit limits that would apply to a non-GSE counterparty if 
the GSE's long-term debt were downgraded to less than the highest 
investment grade by any Nationally Recognized Statistical Rating 
Organization (NRSRO). These commenters noted that GSEs were highly-
rated by NRSROs and viewed as better credit risks by the markets than 
even the highest rated non-GSE counterparties. They also argued that 
extensions of unsecured credit to GSEs provided a more liquid 
investment than most other investments available to the FHLBanks.
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    \3\ Under Section VI of the FMP, unsecured extension of credit 
to a GSE may not exceed an FHL Bank's capital. Because the total 
capital of the Federal National Mortgage Association (FannieMae) and 
the Federal Home Loan Mortgage Corporation (Freddie Mac), the two 
major GSEs to which the FHLBanks extend unsecured credit, is larger 
than that of any single FHLBank, the limit proposed by commenters on 
unsecured credit to GSEs as applied to these two entities, and thus, 
as applied to almost all of the FHLBanks' lending to GSEs, would 
equal an FHLBank's total capital.
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    The Finance Board generally agrees with these commenters' 
observations and, as discussed more fully in the next section, is 
proposing to change the limits on unsecured extensions of credit to a 
GSE to the lesser of the FHLBank's total capital or the GSE's total 
capital. However, because the Finance Board's support for the proposed 
higher GSE limit is based in large part on the fact that GSEs have 
historically been viewed in debt markets more favorably than even the 
highest-rated corporate debt issuers, the Finance Board is also 
proposing to adopt the commenter's suggestion that the preferential 
unsecured credit limit for GSEs automatically ceases to apply if any 
NRSRO rates a GSE's senior unsecured obligations, or downgrades such 
obligations to a rating, less than the highest investment grade or if 
any NRSRO places a GSE on a credit watch for a potential downgrade. 
This provision would help ensure that the preferential unsecured credit 
limit would not be applied to any GSE undergoing obvious financial 
difficulties.

[[Page 41476]]

    A commenter also suggested that the Finance Board make explicit 
that the unsecured credit limits applied to GSEs by Sec. 932.9 also 
applied to unsecured extensions of credit from one FHLBank to another. 
The FMP currently excludes unsecured extensions of credit from one 
FHLBank to another from its credit limits. This exclusion was adopted 
in recognition of a long-standing business practice of inter-FHLBank 
lending. In adopting current Sec. 932.9 of its regulations, the Finance 
Board did not incorporate the FMP's exclusion for inter-FHLBank 
extensions of unsecured credit, but it also did not explicitly address 
whether that exclusion was being removed. However, the Finance Board 
believes that inter-FHLBank lending does not raise any safety and 
soundness concerns and that the practice can be supervised without 
establishing specific limits. Thus, the Finance Board does not find a 
strong reason to disrupt a long-standing FHLBank practice, and is 
proposing to incorporate the FMP's exclusion for inter-FHLBank 
unsecured extensions of credit into the rule.
    One commenter did not comment directly on the GSE limits but 
instead urged the Finance Board to adopt a different approach to 
setting the unsecured credit limits. Specifically, the commenter 
recommended that the limits be based on the lesser of some percentage 
of the FHLBank's capital or the counterparty's assets, and include an 
FHLBank System-wide limit on exposures at each credit rating level 
stated as a percentage of the counterparty's assets. Further, the 
commenter believed that each FHLBank should be allocated a pro rata 
share of this System-wide limit, and should be allowed to trade unused 
portions of that share with the other FHLBanks, subject to an overall 
limit on an FHLBank's unsecured credit exposure based upon a percentage 
of the FHLBank's capital.
    The Finance Board believes that the approach suggested by this 
commenter would be very complex to implement and monitor. Furthermore, 
the general approach underlying the current and proposed versions of 
Sec. 932.9 addresses the Finance Board's concerns with the potential 
concentration of unsecured credit with a limited number of 
counterparties, see 66 FR at 8302, but remains relatively 
straightforward to implement. Therefore, the Finance Board is not 
convinced that it need amend its basic approach to calculating the 
unsecured credit limits.
    Overnight Federal Funds Transactions. In the SUPPLEMENTARY 
INFORMATION section of the proposed rule, the Finance Board also 
requested comment as to whether it should exclude sales of overnight 
federal funds from the unsecured credit limit, as do other federal 
banking regulators. 66 FR at 13689. Seven commenters urged the Finance 
Board to exclude sales of overnight federal funds. Of these commenters, 
one also suggested that in the alternative, the Finance Board could 
adopt more lenient limits for these transactions. These commenters 
generally believed that excluding overnight federal funds transactions 
from the unsecured credit limits added relatively little risk to the 
FHLBank System and allowed the FHLBanks to undertake larger 
transactions with a group of known, highly-creditworthy counterparties. 
Another commenter urged the Finance Board to exclude only overnight 
federal funds transactions with GSEs. The final commenter did not 
support excluding specific types of transactions from the unsecured 
credit limits, indicating that the primary means for prudent risk 
diversification was the adoption of appropriate counterparty and 
concentration limits for each FHLBank and for the FHLBank System as a 
whole.
    The Finance Board carefully considered these comments. The 
FHLBanks' sales of overnight federal funds, however, currently are 
included in the amount of unsecured credit that is subject to the FMP 
limits. In adopting the unsecured credit limits set forth in 
Sec. 932.9, the Finance Board intended to implement stronger safeguards 
against undue concentrations of unsecured credit in individual or 
affiliated counterparties. Exempting all overnight federal funds 
transactions from these new unsecured credit limits would represent a 
significant loosening of current practices and would be inconsistent 
with the goal of implementing more rigorous limits.
    The Finance Board has also considered the fact that other federal 
bank regulators exclude overnight federal funds transactions from their 
credit limits. See 12 CFR part 32 (Office of the Comptroller of the 
Currency (OCC)) and 12 CFR 560.93 (Office of Thrift Supervision (OTS)). 
However, the Finance Board also recognizes that commercial depository 
institutions and the FHLBanks have different incentives to lend in the 
federal funds markets. The FHLBanks can benefit from the funding 
advantage afforded by their GSE-status to borrow in the consolidated 
obligation (CO) market and then profitably lend those funds in the 
federal funds market. Commercial depository institutions, on the other 
hand, do not enjoy the same funding advantage as GSEs and generally 
lend excess reserves that are on-hand in order to earn interest on such 
reserves. Because of the GSE funding advantage, adopting the same 
exclusion for overnight federal funds transactions as applies to 
commercial depository institutions would provide the FHLBanks with an 
incentive, not available to commercial institutions, to borrow in the 
CO market and expand their lending in the federal funds market. This 
type of arbitrage activity could create safety and soundness concerns 
if significant concentrations of unsecured credit were created because 
of unchecked, short-term lending to a limited number of counterparties.
    The Finance Board, therefore, is not proposing to exclude sales of 
overnight federal funds from the unsecured credit limits, but is 
proposing more lenient limits for these transactions. The Finance Board 
believes that the proposed limits, which are described in more detail 
below, will provide the FHLBanks sufficient leeway to prudently invest 
funds to meet both their liquidity needs and to counter cyclical 
fluctuations in their business but still limit incentives to create 
undue concentrations of credit in a few counterparties.
    Treatment of Affiliated Counterparties. The Finance Board did not 
propose amending, nor did it solicit comments on, the aggregate 
unsecured credit limits imposed on groups of affiliated counterparties 
by Sec. 932.9(b) of its rules.\4\ Nevertheless, three commenters 
objected to this provision. In general, the commenters believed that 
the unsecured credit limits on affiliated counterparties severely 
restricted the FHLBanks' lending to large, creditworthy financial 
groups. They also contended that affiliated institutions that were 
separately chartered, capitalized and regulated should be treated as 
separate counterparties subject only to individual unsecured credit 
limits. Two of the commenters argued that it was particularly 
appropriate to treat regulated financial institutions as separate 
counterparties because the rules governing these entities mitigate the 
risks of cross-defaults. One commenter stated that the

[[Page 41477]]

OCC applied fairly restrictive tests to determine when a commercial 
bank must deem affiliated institutions to be a single institution for 
the purpose of applying the combined general limit on credit, with the 
result that aggregation was only infrequently required, see 12 CFR 
32.5(a), and that the Finance Board should adopt a similar approach. 
This commenter also stated that special, bankruptcy-remote subsidiaries 
should not be considered affiliates for the purposes of applying the 
unsecured credit limitations.
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    \4\ Under Sec. 932.9(b), the aggregate amount of unsecured 
credit that an FHL Bank may extend to a group of affiliated 
counterparties can not exceed the product of the maximum capital 
exposure limit applicable to the counterparty with the highest NRSRO 
credit rating multiplied by the lesser of the sum of total capital 
of all the affiliated counterparties or the total capital of the FHL 
Bank. See 12 CFR 932.9(b). In addition, an FHLBank's extensions of 
unsecured credit to each counterparty within a group of affiliated 
counterparties can not exceed the unsecured credit limit applicable 
to a particular counterparty.
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    The Finance Board has considered these comments but continues to 
believe that conservative, aggregate limits on the unsecured extensions 
of credit to affiliated counterparties are needed to prevent undue 
concentrations of credit in a limited number of counterparties at both 
the FHLBank level and the FHLBank System level. See 66 FR at 8302. 
Concentrations of credit in affiliated counterparties raise safety and 
soundness concerns because the financial difficulties or default of one 
party significantly raises the potential that affiliated entities will 
experience a deteriorating credit situation or default. These spillover 
effects would raise the potential for loss at an FHLBank if it had a 
significant unsecured credit exposure to a group of affiliated entities 
of which one or more were experiencing severe financial difficulties.
    Moreover, other federal banking regulators recognize the safety and 
soundness problems raised by excessive concentrations of credit in 
affiliated entities and limit extensions of credit to groups of 
affiliated counterparties. The OCC's rules restrict a commercial bank's 
aggregate extensions of secured and unsecured credit to a corporate 
group to an amount not to exceed 50 percent of the bank's capital and 
surplus.\5\ See 12 CFR 32.5(d). The OTS, which has generally adopted 
the OCC's regulations on credit limits, albeit subject to certain 
specific changes, would also apply this limit. See 12 CFR 560.93(c). 
Applying credit exposure limits to groups of affiliated counterparties 
is also consistent with principles for sound management of credit risk 
as articulated by the Basel Committee on Banking Supervision (Basel 
Committee). See, Basel Committee, ``Principles for the Management of 
Credit Risk'' 10 (September 2000) (``An important element of credit 
risk management is the establishment of exposure limits on single 
counterparties and groups of connected counterparties.'')
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    \5\ This requirement is distinct from the OCC regulation cited 
by the commenter, 12 CFR 32.5(a), that governs when a commercial 
bank must deem affiliated persons to be a single person for the 
purposes of applying the combined general limit.
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    Further, depository institutions are not necessarily immune from 
spill-over effects caused by the default of one of their affiliated 
institutions. For example, by law, depository institutions that are 
insured by the Federal Deposit Insurance Corporation (FDIC) may be held 
liable for the losses (or anticipated losses) to the FDIC caused by the 
default of affiliated, FDIC-insured institutions. See 12 U.S.C. 1815(e) 
and 12 CFR 308.165. More importantly, it would be inconsistent with the 
Finance Board's conservative approach to credit limits to assume that a 
default by one affiliated counterparty could not have a negative effect 
on other entities in that group. The Finance Board is persuaded, 
however, that the limit on an FHLBank's unsecured credit exposure to a 
group of affiliated counterparties adopted in Sec. 932.9(b) may be too 
restrictive and, therefore, as discussed more fully below, is proposing 
a new limit equal to 30 percent of the FHLBank's total capital.
    Application of Part 980. In the SUPPLEMENTARY INFORMATION section 
of the March proposing release, the Finance Board noted that:

[b]efore a [FHL]Bank may extend unsecured credit to any counterparty 
(or affiliated counterparties) to which a [FHL]Bank could not 
previously lend because the credit rating restrictions or maturity 
limitations in the FMP, the [FHL]Bank must obtain the Finance 
Board's approval for the lending activity as a new business activity 
pursuant to 12 CFR part 980.

66 FR at 13688. Five commenters objected to this application of the 
Finance Board's part 980 regulations. In general, the commenters 
believed that other Finance Board regulations, including the 
restrictions in Sec. 932.9, adequately addressed the risks created by 
the FHLBanks' unsecured lending and that expansion of unsecured lending 
activities did not involve risks not previously undertaken or managed 
by the FHLBanks, as required by the part 980 regulations. Some 
commenters also noted that it was unclear how the part 980 requirements 
would be applied to unsecured lending activities.
    The purpose of the part 980 regulations is to provide the Finance 
Board with prior notice that an FHLBank is undertaking an activity that 
among other things involves a risk not previously and regularly managed 
by the FHLBank so that the Finance Board may disapprove, examine, or 
restrict such activity as necessary on a case-by-case basis. See 65 FR 
44414, 44420 (July 18, 2000) (discussing part 980 regulations). Prior 
notice, therefore, provides the Finance Board with a needed opportunity 
to verify that the new activity will be executed in a safe and sound 
manner, regardless of whether the activity in question is authorized or 
otherwise addressed by other provisions in the Finance Board's 
regulations. Id.
    In this respect, as investment and lending restrictions imposed by 
the FMP are lifted, the FHLBanks will be able to take on exposures to 
different types of counterparties and for much longer maturities than 
was allowed under the FMP. Such authority could allow an FHLBank to 
develop new investment strategies that would alter its risk profile and 
involve new risks for the FHLBank. The Finance Board continues to 
believe, therefore, that approval under the part 980 regulations is 
proper before the FHLBanks undertake significant lending or investing 
activities that were not permitted under the FMP.
    Given the comments received on this matter, however, the Finance 
Board wishes to clarify when a notice filing under part 980 may be 
required for new unsecured lending activities. The FHLBanks will not be 
required to provide notice under part 980 each time they intend to lend 
to a new counterparty, or to purchase a new class of debt instrument or 
to take on a credit exposure that would have been prohibited under the 
FMP, if such activity involves only marginal changes in the FHLBank's 
investment portfolio.\6\ However, should an FHLBank adopt strategies 
that would require it to take on, or should the FHLBank begin to take 
on, more significant unsecured credit exposures to classes of 
counterparties to which lending was previously prohibited by the FMP or 
for maturities not allowed under the FMP, the Finance Board would 
expect the FHLBank to file a new business activity notice covering the 
change to the FHLBank's lending or investing strategy.
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    \6\ Such activity would have to be authorized by and comply with 
applicable Finance Board regulations.
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    Other Issues. Five commenters requested that the Finance Board add 
a provision to Sec. 932.9 to grandfather any investments that were made 
before the effective date of Sec. 932.9 and conformed with the 
controlling FMP provisions whether or not these positions conformed to 
Sec. 932.9. In general, a regulation does not have retroactive effect, 
and as the Finance Board previously stated, there is nothing in 
Sec. 932.9 to suggest that an FHLBank must unwind positions that do not 
conform to the new limits provided that the credit

[[Page 41478]]

was extended in accordance with the FMP before the effective date of 
the new rule. 66 FR at 13688. The Finance Board does not believe that 
additional changes need to be made to the rule to make this point any 
more explicit. Furthermore, the FHLBanks should have sufficient time to 
adjust overnight extensions of unsecured credit, including sales of 
federal funds subject to a continuing contract, so as to be in 
compliance with the new limits on these transactions on the effective 
date of the rule.
    Two commenters asked the Finance Board to delay the effective date 
of Sec. 932.9 until after the capital plans have been approved and 
implemented. The safety and soundness concerns, however, raised by 
undue concentrations of credit in a limited number of counterparties 
are not related to the implementation of the FHLBanks' new capital 
structures required by the GLB Act. While the Finance Board has been 
willing to delay the effective date of Sec. 932.9 to assure that the 
rule can be implemented with the least disruption possible, it still 
believes that its concerns with concentrations of credit should be 
addressed in as timely a fashion as possible. Therefore, it would not 
be prudent to delay the effective date of Sec. 932.9 until the 
FHLBanks' capital plans are implemented.
    One commenter noted that sections of the FMP, other than the 
section controlling unsecured extensions of credit, impose counterparty 
and maturity limitations on the FHLBanks' lending activities, and the 
commenter specifically requested that the Finance Board rescind certain 
investment restrictions set forth in Section II.B of the FMP. In this 
respect, the Finance Board's investment regulation states that 
investments authorized thereunder are subject to among other things, 
the FMP. See 12 CFR 956.2. In adopting the investment regulation, the 
Finance Board addressed the continued applicability of the FMP's 
investment restrictions. See 65 FR 43969, 43980 (July 17, 2000). The 
Finance Board sees no reason to reconsider this issue as part of this 
rulemaking.

III. Proposed Changes to the Rule

    Change in GSE Limit. As already noted, the Finance Board agrees 
with commenters on the amendments proposed in March 2001 that the 
reduction of the unsecured limits for GSEs that would be implemented 
under Sec. 932.9 could be disruptive to the FHLBanks investment 
strategies and programs, and that, historically, GSEs have been viewed 
more favorably by debt markets than even the highest-rated corporate 
debt issuers. In addition, the Finance Board believes that the limit 
contained in the FMP does not raise any safety and soundness concerns. 
Thus, the Finance Board is now proposing a limit on unsecured credit 
exposure to GSEs of 100 percent of the lesser of FHLBank capital or the 
counterparty's capital.
    In addition, proposed Sec. 932.9(c)(2) would treat GSEs like other 
private counterparties in the event any NRSRO assigns a credit rating 
to, or downgrades the credit rating of, any long-term, senior unsecured 
debt obligation issued by a GSE to below the highest investment grade, 
or places the GSE on a credit watch for a potential downgrade. In this 
case, the FHLBank would be required to calculate the maximum amount of 
its unsecured extensions of credit to that GSE in accordance with 
paragraph (a)(1) of the proposed rule.
    Further, proposed Sec. 932.9(c)(3) would incorporate the FMP 
exclusion for inter-FHLBank credit exposure, as discussed above. Under 
this proposal, extensions of credit to another FHLBank would still be 
subject to the reporting requirements of Sec. 932.9, which have been 
redesignated as paragraph (e) in the proposed rule.
    Overnight Fed Funds. In the proposed rule, the Finance Board 
requested comments on whether it should exclude from the unsecured 
credit limits, the sale of federal funds with a maturity of one day or 
less, or federal funds sold under a continuing contract, given that 
other commercial bank regulators have adopted such an exclusion from 
the limits they impose on regulated institutions. As already discussed, 
the Finance Board sees merit in commenters' arguments supporting such 
an exclusion, but believes that because the FHLBanks could potentially 
have very large positions in overnight federal funds transactions, not 
retaining some limit on exposure from these federal funds transactions 
could raise safety and soundness concerns. Thus, the Finance Board is 
proposing to retain a limit on sales of federal funds with a maturity 
of one day or less and sales of federal funds subject to a continuing 
contract, but increase the limit applicable to a counterparty on such 
sales. Specifically, the proposal would require an FHLBank always to 
meet two limits. The first limit, the term limit set forth in proposed 
Sec. 932.9(a)(1), would apply to all unsecured extensions of credit 
except overnight federal funds transactions, and the second limit, the 
overall limit set forth in proposed 932.9(a)(2), would be twice the 
term limit, and would apply to all unsecured extensions of credit 
including overnight federal funds transactions.
    Under proposed Sec. 932.9(a)(1), an FHLBank would not include sales 
of federal funds with a maturity of one day or less and sales of 
federal funds subject to a continuing contract in its calculation of 
unsecured extensions of credit to a specific counterparty. Such 
overnight federal funds transactions would therefore not be subject to 
the term limit on unsecured extensions of credit that would be imposed 
under this proposed provision. However, under proposed 
Sec. 932.9(a)(2), an FHLBank would add into its calculation of total 
extensions of unsecured credit all sales of federal funds with a 
maturity of one day or less and sales of federal funds subject to a 
continuing contract with the counterparty. The resulting total amount 
of unsecured credit including these overnight sales of federal funds 
could not exceed an overall limit equal to twice the term limit.
    For example, if a counterparty's applicable credit rating was 
determined to be the highest investment grade category, the term limit 
that would apply under proposed Sec. 932.9(a)(1) would equal 15 percent 
of the lesser of the FHLBank's total capital, or the counterparty's 
Tier 1 capital, or if Tier 1 capital is not available, total capital 
(as defined by the counterparty's principal regulator) or some similar 
comparable measure identified by the FHLBank. The overall limit under 
proposed Sec. 932.9(a)(2) would apply when sales of overnight federal 
funds are added into the total extensions of unsecured credit to the 
counterparty. The overall limit would equal 30 percent of the lesser of 
the FHLBank's total capital or the counterparty's applicable capital 
measurement but, because the term limit would also apply, an FHLBank's 
extensions of unsecured extensions of credit, other than overnight 
federal funds transactions, could not exceed 15 percent of the 
FHLBank's total capital or the counterparty's applicable capital 
measurement.
    In addition, the Finance Board is proposing to define ``sales of 
federal funds subject to a continuing contract'' as an overnight 
federal funds loan that is automatically renewed each day unless 
terminated by either the lender or the borrower. This definition is 
consistent with the generally understood meaning of the term. See 
Goodfriend and Whelpley, n.2, supra.
    Maximum capital exposure limits. The Finance Board is proposing to 
change the maximum capital exposure limits listed in Table 4. The 
Finance Board is also proposing to simplify the FHLBanks' monitoring of 
a

[[Page 41479]]

counterparty's credit rating by changing the rule to require that the 
applicable maximum exposure limit in Table 4 be determined based on a 
counterparty's long-term credit rating, and that a short-term credit 
rating be used only if the counterparty has a short-term, but no long-
term, rating from an NRSRO. These changes are discussed in more detail 
below.
    The general approach adopted in Sec. 932.9, however, of imposing 
more restrictive maximum capital exposure limits on lower-rated, and 
therefore potentially riskier, counterparties is not altered by the 
proposed rule amendments. This general approach is consistent with 
principles for sound management of credit risk articulated by the Basel 
Committee on Banking Supervision (Basel Committee), which has stated 
that:

[a]n important element of credit risk management is the 
establishment of exposure limits on single counterparties and groups 
of connected counterparties. Such limits are frequently based in 
part on internal risk rating assigned to the borrower with 
counterparties assigned better risk ratings having potentially 
higher exposure limits.

Basel Committee, ``Principles for the Management of Credit Risk'' 10-11 
(September 2000). It is also consistent with the approach adopted in 
Sec. 932.4 of the Finance Board's rules with regard to the credit risk 
percentage requirements, which are used to calculate the risk-based 
capital charges for credit risk and which vary with the potential risk 
of an asset, as evidenced by the asset's applicable NRSRO long-term 
credit rating.
    As proposed, the applicable maximum capital exposure limit for a 
counterparty rated at the highest investment grade by an NRSRO would 
remain 15 percent. This level is broadly consistent with federal 
lending limits pertaining to commercial banks as set forth by statute 
and regulation, although the fifteen-percent limit for commercial banks 
remains the same regardless of the credit rating of the borrower. See 
12 U.S.C. 84, and 12 CFR part 32. The proposed maximum capital exposure 
limits corresponding to credit ratings below the highest investment 
grade, however, are calibrated to the 15 percent maximum capital 
exposure limit based upon the ratio of the average credit risk 
percentage requirement (over all maturity bucket groupings) for the 
highest investment grade to the average credit risk percentage 
requirement for each investment grade.\7\ The logic of this approach is 
that as credit risk, as captured in the credit risk percentage 
requirements, increases, the unsecured credit limit proportionately 
decreases. Further, because the credit risk percentage requirements 
were derived from actual corporate bond default data, the relative 
differences among the proposed maximum capital exposure limits more 
closely reflect historic credit loss experiences than do the 
differences among the current maximum capital exposure limits set forth 
in Sec. 932.9. See 66 FR 8287-88 (explaining the derivation of the 
credit risk percentage requirements in Table 1.3).
---------------------------------------------------------------------------

    \7\ The credit risk percentage requirements are set forth in 
Sec. 932.4, Table 1.3 of Part 932 of the Finance Board rules. 12 CFR 
932.4.
---------------------------------------------------------------------------

    To perform the required calculation, the Finance Board first 
averaged the credit risk percentage requirements for each credit rating 
category across all maturity buckets provided in Table 1.3. The average 
credit risk percentage requirement corresponding to the highest 
investment grade was then divided by the average credit risk percentage 
requirement corresponding to each of the other investment grades. The 
result of this calculation for each investment grade, and for the 
highest below-investment grade rating category, was then multiplied by 
15 percent--the maximum capital exposure limit corresponding to the 
highest investment grade--and the product was rounded to the nearest 
whole percentage point. The result of the calculation, as rounded, for 
each investment grade equals the proposed maximum capital exposure 
limit with the result of the calculation for the highest below-
investment grade rating category being used to set the proposed maximum 
capital exposure limit for the category, ``Below Investment Grade or 
Other,'' in Table 4.
    Section 932.9(a)(3) of the proposed rule also would require an 
FHLBank to determine the maximum capital exposure limit applicable to a 
counterparty based primarily on the counterparty's long-term credit 
rating. Under this proposed change, a short-term credit rating would be 
used only in the rare circumstance that an NRSRO has provided a short-
term credit rating for a counterparty but has not provided a long-term 
rating for that counterparty. Further, the Finance Board is proposing 
that where a short-term credit rating is used, the highest short-term 
investment grade rating would correspond to the maximum capital 
exposure limit assigned to the third highest long-term investment grade 
rating in proposed Table 4 (i.e., nine percent), and the second and 
third highest short-term investment grade ratings would correspond to 
the maximum capital exposure limit assigned to the fourth highest long-
term investment grade rating in proposed Table 4 (i.e., 3 percent).
    The proposed approach for determining the applicable maximum 
capital exposure limit is the same as the approach already adopted in 
Sec. 932.4 of the Finance Board's capital rule for determining the 
credit risk percentage requirement applicable to a particular asset. 
See 12 CFR 932.4(e)(2)(ii)(C). Reliance on long-term NRSRO credit 
ratings as an approximation of credit risk is also consistent with the 
approach for assigning risk weightings for assets suggested by the 
Basel Committee under its standardized approach in the proposed New 
Basel Capital Accord. See Basel Committee, ``Overview of the New Basel 
Capital Accord'' 13-14 (January 2001) and Basel Committee, ``A New 
Capital Adequacy Framework'' 26-36 (June 1999).
    Moreover, the Finance Board believes that the proposed use of long-
term credit ratings to determine the maximum capital exposure limit 
would more accurately reflect the relative default risks among 
counterparties. Based on Moody's default data from 1970 to 2000, 
counterparties that are rated in the highest short-term investment 
grade or third highest long-term investment grade categories have a 
significantly higher 30-day maximum default rate than those rated in 
the highest or second highest investment grade long-term credit 
rating.\8\ Similarly,

[[Page 41480]]

counterparties rated in the second highest short-term investment grade 
and the fourth highest long-term investment grade category have the 
same 30-day maximum default rate of 0.32 percent. These differences 
indicate that use of the short-term ratings alone to set the unsecured 
credit limitations may not reflect the true rates of default among 
counterparties, and that despite having the same short-term credit 
ratings, counterparties with a lower long-term credit rating may 
display a significantly higher maximum 30-day default rate. Thus, use 
of long-term ratings as a basis for determining the applicable maximum 
capital exposure limit would assure that a more restrictive unsecured 
credit limit is imposed on counterparties with the higher default rate, 
even when applied to short-term credit exposures.
---------------------------------------------------------------------------

    \8\ Generally, NRSROs use three short-term credit ratings that 
are considered investment grade. Counterparties with different long-
term ratings may be grouped in the same short-term credit rating 
category, however. For example, in rating short-term commercial 
paper, Moody's assigns the highest category, however. For example, 
in rating short-term commercial paper, Moody's assigns the highest 
short-term investment grade credit rating to issuers that would have 
long-term credit ratings ranging from the highest investment grade 
to the third highest investment grade and assigns the second highest 
short-term investment grade rating to issuers that would have long-
term credit ratings of either the third highest investment grade or 
the fourth highest investment grade. See ``Commercial Paper Defaults 
and Rating Transitions,'' 1972-2000, Moody's Investors Service 
(October 2000); ``Moody's Credit Opinions: Financial Institutions,'' 
Moody's Investors Service (December 1999). The lowest short-term 
investment grade rating is assigned solely to issuers that also have 
the fourth highest long-term investment grade credit rating. Id. A 
comparison of U.S. financial institutions' short-term ratings by 
Moody's also shows that the highest short-term investment grade 
credit rating is more commonly associated with the third highest 
long-term investment grade credit rating than with the highest or 
second highest long-term investment grade credit ratings. See 
``Moody's Credit Opinions: Financial Institutions,'' Moody's 
Investors Service (March 2000). The maximum 30-day default rate for 
commercial paper rated at the highest short-term investment grade 
(i.e., P-1), based on Moody's data for the period 1972-2000, is 0.08 
percent. However, the maximum 30 day default rate for the third 
highest long-term rating (i.e., A) is 0.24%, but is zero percent for 
the highest (i.e., AAA) or second highest (i.e., AA) long-term 
rating.
---------------------------------------------------------------------------

    Relying primarily on long-term credit ratings to determine the 
applicable maximum capital exposure limit also would simplify the 
FHLBanks' monitoring of counterparties credit ratings. Currently, 
Sec. 932.9 requires that the maximum capital exposure limit 
corresponding to the higher of a counterparty's short-term or long-term 
credit rating be used to calculate the total unsecured credit limit for 
the counterparty, while the lower of the two ratings be used to 
calculate the limit applicable to any unsecured credit with a maturity 
corresponding to the ratings. See 12 CFR 932.9(a)(3)(iii). To implement 
the rule, the FHLBanks, therefore, would be required to track the long- 
and short-term credit ratings assigned to each counterparty by each 
NRSRO. The proposed rule change would allow the FHLBanks to monitor a 
counterparty's long-term credit ratings only, except in rare 
circumstances.
    The proposed rule still would allow the use of short-term ratings 
to determine the maximum capital exposure limit when an NRSRO has not 
provided a long-term rating to a counterparty. For this purpose, 
however, the proposed rule, in effect, deems the highest short-term 
investment grade credit rating to be the equivalent of the third 
highest long-term investment grade credit rating and the second and 
third highest short-term investment grade ratings to be the equivalent 
of the fourth highest long-term investment grade rating.
    This approach is consistent with the approach adopted in Sec. 932.4 
for determining the credit risk percentage requirement where an NRSRO 
has assigned a short-term rating to an asset but not a long-term 
rating. See 12 CFR 932.4(e)(2)(ii)(C). See also 66 FR 8291-92 
(discussing reason for adopting 12 CFR 932.4(e)(2)(ii)(C)). This 
treatment of the short-term investment grade credit ratings also 
reflects the fact that, as discussed above, a counterparty with the 
highest short term credit rating would be rated in at least the third 
highest long-term investment grade category, and a counterparty 
receiving the second or third highest short-term investment grade 
ratings would be rated in at least the fourth highest long-term 
investment grade category. See note 8, supra. Deeming a short-term 
rating to be equivalent to the lowest potential long-term investment 
grade credit rating that a counterparty could have is also consistent 
with the conservative approach proposed by the Finance Board for 
setting unsecured credit limits.
    Affiliated counterparties. As already discussed, the Finance Board 
has considered comments received on this provision and has decided to 
propose an amendment to the affiliated counterparty limit. Under 
proposed Sec. 932.9(b), the aggregate limit on the extension of 
unsecured credit to a group of affiliated counterparties would equal 30 
percent of the FHLBank's total capital. In calculating the amounts of 
unsecured credit extended to a group of affiliated counterparties, the 
proposed rule would require an FHLBank to include the amounts of sales 
of overnight federal funds to those affiliated counterparties. The 
proposed rule also makes clear that unsecured credit limitations on 
individual counterparties continue to apply to each counterparty within 
a group of affiliated counterparties.
    The proposed aggregate limit on extensions of credit to affiliated 
counterparties would provide the FHLBanks with more flexibility to 
extend somewhat larger amounts of unsecured credit to large financial 
groups than does the current aggregate limit in Sec. 932.9. Given 
historic FHLBank lending patterns and the FHLBank's current 
counterparties that would benefit from this additional lending 
flexibility, the Finance Board does not believe that the proposed 
change in the aggregate limit, if adopted, would result in a build-up 
of unsecured credit exposures of questionable quality. Furthermore, the 
Finance Board believes that the proposed aggregate limit on lending to 
affiliated counterparties remains sufficiently restrictive, especially 
when coupled with the proposed individual counterparty limits, to keep 
unsecured credit exposure concentrations to affiliated counterparties 
from raising safety and soundness concerns.
    The Finance Board also is proposing to amend the definition of 
affiliated counterparty in Sec. 930.1 to read as follows:

    Affiliated counterparty means a counterparty of a Bank that 
controls, is controlled by or is under common control with another 
counterparty of the Bank. For the purposes of this definition only, 
direct or indirect ownership (including beneficial ownership) of 
more than 50 percent of the voting securities or voting interests of 
an entity constitutes control.

The proposed definition would generally raise the threshold for control 
from ownership (either direct or indirect) of 25 percent of the voting 
securities or voting interests of an entity to ownership (either direct 
or indirect) to 50 percent of the voting securities or voting interests 
of an entity. This change, however would not significantly alter the 
number or groupings of counterparties that would be covered by the 
proposed affiliated counterparty limitations because traditionally most 
groups of affiliated counterparties to which the FHLBanks have lent 
have consisted of groups of wholly-owned, or nearly wholly-owned, 
subsidiaries of a parent corporation. Furthermore, the proposed 
definition is more consistent with the meaning of corporate group, as 
that phrase is used in OCC's rules limiting extensions of credit, see 
12 CFR 32.5(d), than is the current definition of affiliated 
counterparty in Sec. 930.1 of the Finance Board rules. The Finance 
Board also believes that the proposed definition is more easily 
understood than the current definition.
    Addition of Transition Provision for Downgrades. The proposed rule 
contains transition provisions for FHLBanks that have extended 
unsecured credit to counterparties that are downgraded or placed on 
credit watch. Proposed Sec. 932.9(d) provides that in the event a lower 
maximum credit limit is imposed on a counterparty because an NRSRO has 
downgraded the credit rating applicable to a counterparty or has placed 
a counterparty on a credit watch for a potential downgrade, an FHLBank 
is not required to unwind or liquidate any transaction or position that 
was entered into prior to the date of the downgrade or the placement on 
credit watch so long as the transaction or position complied with the 
limits at the time it was entered. However, any new unsecured 
extensions of credit to the counterparty would have to comply with the 
new lower maximum exposure limit. A similar transition provision is

[[Page 41481]]

contained in the FMP. Because an FHLBank might have to accept less than 
the remaining balance on a debt if it were required to liquidate or 
unwind a position within a particular timeframe, especially if the 
counterparty in question were undergoing financial stress, the Finance 
Board believes that it is appropriate to maintain such a provision in 
the unsecured credit regulation.
    In addition, the proposed rule makes clear that a renewal of an 
existing unsecured extension of credit, including any decision not to 
terminate a sale of federal funds subject to a continuing contract, 
would be considered a new extension of unsecured credit.
    Addition of provision for calculating extensions of credit. Neither 
the final capital rule nor the proposed rule published on March 7, 2001 
contained specific requirements for how to measure unsecured extensions 
of credit. Proposed Sec. 932.9(f) would now specify how the FHLBanks 
would measure unsecured extensions of credit. Consistent with the 
requirements of the FMP, the proposed rule would require the amount of 
unsecured credit exposure arising from on-balance sheet transactions be 
equal to the sum of the book value of the item plus net payments due 
the Bank. For off-balance sheet and derivative transactions, the 
Finance Board is proposing that the measurement conform to the 
measurement under Sec. 932.4 for the purpose of calculating the 
required credit risk-based capital charge. Thus, the proposed rule 
specifies that unsecured credit exposures arising from off-balance 
sheet and derivatives transactions be measured in accordance with 
Secs. 932.4(f) and 932.4(g) or Sec. 932.4(h) of the Finance Board's 
regulations, respectively.
    Other technical changes. The reporting requirements now contained 
in Sec. 932.9(c) of the Finance Board rules are found in paragraph (e) 
of the proposed rule, but have not been altered in substance. 
Similarly, the provisions concerning the FHLBanks' determination of a 
counterparty's applicable credit ratings have been redesignated as 
Sec. 932.9(a)(4) in the proposed rule, and would be substantively 
altered only to remove the provision that required an FHLBank to use 
different maximum capital exposure limits for short-and long-term 
unsecured extensions of credit, because that provision would not 
conform to the proposed approach for determining these limits, as 
discussed above.
    The Finance Board also is proposing to change the wording in 
Sec. 932.9 so that derivative contracts are identified as items 
distinct from on-or off-balance sheet items. The wording change is 
being proposed because of changes required by Statement of Financial 
Accounting Standards (SFAS) No. 133, Accounting for Derivative 
Instruments and Hedging Activities, and would conform the wording of 
Sec. 932.9 to changes made to other provisions of part 932 when the 
Finance Board adopted the final capital rule. See 66 FR at 8281 
(discussing reference to derivative contracts in final capital rule). 
This proposed change would not affect the substance of how derivatives 
contracts would be treated under the proposed rule.
    The Finance Board also is proposing to add new paragraph (g) to 
Sec. 932.9 to make clear that obligations of, or guaranteed by, the 
United States would not be subject to any of the requirements of 
Sec. 932.9 (including the reporting requirements that are contained in 
proposed Sec. 932.9(e)). This exclusion is contained in the FMP 
limitations on unsecured credit but was not included in Sec. 932.9 when 
the rule was adopted. The Finance Board, however, has stated that 
Sec. 932.9 does not apply to obligations backed by the full faith and 
credit of the United States, see 66 FR at 13688, and the proposed 
change would merely codify this position.

IV. Regulatory Flexibility Act

    The final rule would apply only to the FHLBanks, which do not come 
within the meaning of small entities 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 effect on a substantial 
number of small entities.

V. Paperwork Reduction Act

    The proposed rule does not contain any collections of information 
pursuant to the Paperwork Reduction Act of 1995. See 44 U.S.C. 3501 et 
seq. Therefore, the Finance Board has not submitted any information to 
the Office of Management and Budget for review.

Lists of Subjects in 12 CFR Parts 930 and 932

    Capital, Credit, Federal home loan banks, Investments, Reporting 
and recordkeeping requirements.

    Accordingly, the Federal Housing Finance Board proposes to amend 
title 12, chapter IX, Code of Federal Regulations as follows:

PART 930--DEFINITIONS APPLYING TO RISK MANAGEMENT AND CAPITAL 
REGULATIONS

    1. The authority citation for part 930 continues to read as 
follows:

    Authority: 12 U.S.C. 1422a(a)(3), 1422b(a), 1426, 1440, 1443, 
1446.

    2. In Sec. 930.1 revise the definition of Affiliated counterparty, 
and add, in correct alphabetical order the definition for Sales of 
federal funds subject to a continuing contract, to read as follows:


Sec. 930.1  Definitions.

* * * * *
    Affiliated counterparty means a counterparty of a Bank that 
controls, is controlled by or is under common control with another 
counterparty of the Bank. For the purposes of this definition only, 
direct or indirect ownership (including beneficial ownership) of more 
than 50 percent of the voting securities or voting interests of an 
entity constitutes control.
* * * * *
    Sales of federal funds subject to a continuing contract means an 
overnight federal funds loan that is automatically renewed each day 
unless terminated by either the lender or the borrower.
* * * * *

PART 932--FEDERAL HOME LOAN BANK CAPITAL REQUIREMENTS

    3. The authority citation for part 932 continues to read as 
follows:

    Authority: 12 U.S.C. 1422a(a)(3), 1422b(a), 1426, 1440, 1443, 
1446.

    4. Revise Sec. 932.9, to read as follows:


Sec. 932.9  Limits on unsecured extensions of credit to one 
counterparty or affiliated counterparties; reporting requirements for 
total extensions of credit to one counterparty or affiliated 
counterparties.

    (a) Unsecured extensions of credit to a single counterparty. A Bank 
shall not extend unsecured credit to any single counterparty (other 
than a GSE) in an amount that would exceed the limits of this 
paragraph. A Bank shall not extend unsecured credit to a GSE in an 
amount that would exceed the limits set forth in paragraph (c) of this 
section.
    (1) Term limits. All unsecured extensions of credit by a Bank to a 
single counterparty that arise from the Bank's on-and off-balance sheet 
and derivative transactions (but excluding the amount of sales of 
federal funds with a maturity of one day or less and sales of federal 
funds subject to a continuing contract) shall not exceed the product of 
the maximum capital exposure limit applicable to such counterparty, as 
determined in

[[Page 41482]]

accordance with paragraph (a)(3) and Table 4 of this part, multiplied 
by the lesser of:
    (i) The Bank's total capital; or
    (ii) The counterparty's Tier 1 capital, or if Tier 1capital is not 
available, total capital (as defined by the counterparty's principal 
regulator) or some similar comparable measure identified by the Bank.
    (2) Overall limits including sales of overnight federal funds. All 
unsecured extensions of credit by a Bank to a single counterparty that 
arise from the Bank's on-and off-balance sheet and derivative 
transactions, including the amounts of sales of federal funds with a 
maturity of one day or less and sales of federal funds subject to a 
continuing contract, shall not exceed twice the limit calculated 
pursuant to paragraph (a)(1) of this section.
    (3) Bank determination of applicable maximum capital exposure 
limits. (i) Except as set forth in paragraph (a)(3)(ii) of this 
section, the applicable maximum capital exposure limits for specific 
counterparties are assigned to each counterparty based upon the long-
term credit rating of the counterparty, as determined in accordance 
with paragraph (a)(4) of this section, and are provided in the 
following Table 4 of this part:

 Table 4.--Maximum Limits on Unsecured Extensions of Credit to a Single
      Counterparty by Counterparty Long-Term Credit Rating Category
------------------------------------------------------------------------
                                                               Maximum
                                                               capital
      Long-term credit rating of counterparty category         exposure
                                                              limit  (in
                                                               percent)
------------------------------------------------------------------------
Highest Investment Grade...................................           15
Second Highest Investment Grade............................           14
Third Highest Investment Grade.............................            9
Fourth Highest Investment Grade............................            3
Below Investment Grade or Other............................            1
------------------------------------------------------------------------

    (ii) If a counterparty does not have a long-term credit rating but 
has received a short-term credit rating from an NRSRO, the maximum 
capital exposure limit applicable to that counterparty shall be based 
upon the short-term credit rating, as determined in accordance with 
paragraph (a)(4) of this section, as follows:
    (A) The highest short-term investment grade credit rating shall 
correspond to the maximum capital exposure limit provided in Table 4 of 
this part for the third highest long-term investment grade rating;
    (B) The second highest short-term investment grade rating shall 
correspond to the maximum capital exposure limit provided in Table 4 of 
this part for the fourth highest long-term investment grade rating; and
    (C) The third highest short-term investment grade rating shall 
correspond to the maximum capital exposure limit provided in Table 4 of 
this part for the fourth highest long-term investment grade rating.
    (4) Bank determination of applicable credit ratings. The following 
criteria shall be applied to determine a counterparty's credit rating:
    (i) The counterparty's most recent credit rating from a given NRSRO 
shall be considered;
    (ii) If only one NRSRO has rated the counterparty, that NRSRO's 
rating shall be used. If a counterparty has received credit ratings 
from more than one NRSRO, the lowest credit rating from among those 
NRSROs shall be used;
    (iii) Where a credit rating has a modifier, the credit rating is 
deemed to be the credit rating without the modifier;
    (iv) If a counterparty is placed on a credit watch for a potential 
downgrade by an NRSRO, the credit rating from that NRSRO at the next 
lower grade shall be used; and
    (v) If a counterparty is not rated by an NRSRO, the Bank shall 
determine the applicable credit rating by using credit rating standards 
available from an NRSRO or other similar standards.
    (b) Unsecured extensions of credit to affiliated counterparties. 
(1) In general. The total amount of unsecured extensions of credit by a 
Bank to a group of affiliated counterparties that arise from the Bank's 
on-and off-balance sheet and derivative transactions, including sales 
of federal funds with a maturity of one day or less and sales of 
federal funds subject to a continuing contract, shall not exceed thirty 
percent of the Bank's total capital.
    (2) Relation to individual limits. The aggregate limits calculated 
under this paragraph shall apply in addition to the limits on 
extensions of unsecured credit to a single counterparty imposed by 
paragraph (a) of this section.
    (c) Special limits for GSEs. (1) In general. Unsecured extensions 
of credit by a Bank to a GSE that arise from the Bank's on-and off-
balance sheet and derivative transactions, including any sales of 
federal funds with a maturity of one day or less and sales of federal 
funds subject to a continuing contract, shall not exceed the lesser of:
    (i) The Bank's total capital; or
    (ii) The GSE's total capital (as defined by the GSE's principal 
regulator) or some similar comparable measure identified by the Bank.
    (2) Limits applying to a GSE after a downgrade. If any NRSRO 
assigns a credit rating to any senior unsecured obligation issued (or 
to be issued) by a GSE that is below the highest investment grade or 
downgrades, or places on a credit watch for a potential downgrade of, 
the credit rating on any senior unsecured obligation issued by a GSE to 
below the highest investment grade, the special limits on unsecured 
extensions of credit under paragraph (c)(1) of this section shall cease 
to apply, and instead, the Bank shall calculate the maximum amount of 
its unsecured extensions of credit to that GSE in accordance with 
paragraphs (a)(1) and (a)(2) of this section.
    (3) Extensions of unsecured credit to other Banks. The limits of 
this section do not apply to unsecured credit extended by one Bank to 
another Bank.
    (d) Extensions of unsecured credit after downgrade or placement on 
credit watch. If an NRSRO downgrades the credit rating applicable to 
any counterparty or places any counterparty on a credit watch for a 
potential downgrade, a Bank need not unwind or liquidate any existing 
transaction or position with that counterparty that complied with the 
limits of this section at the time it was entered. In such a case, 
however, a Bank may extend any additional unsecured credit to such a 
counterparty only in compliance with the limitations that are 
calculated using the lower maximum exposure limits. For the purposes of 
this section, the renewal of an existing unsecured extension of credit, 
including any decision not to terminate any sales of federal funds 
subject to a continuing contract, shall be considered an additional 
extension of unsecured credit that can be undertaken only in accordance 
with the lower limit.
    (e) Reporting requirements. (1) Total unsecured extensions of 
credit. Each Bank shall report monthly to the Finance Board the amount 
of the Bank's total unsecured extensions of credit arising from on-and 
off-balance sheet and derivative transactions to any single 
counterparty or group of affiliated counterparties that exceeds 5 
percent of:
    (i) The Bank's total capital; or
    (ii) The counterparty's, or affiliated counterparties' combined, 
Tier 1 capital, or if Tier 1 capital is not available, total capital 
(as defined by each counterparty's principal regulator) or some similar 
comparable measure identified by the Bank.

[[Page 41483]]

    (2) Total secured and unsecured extensions of credit. Each Bank 
shall report monthly to the Finance Board the amount of the Bank's 
total secured and unsecured extensions of credit arising from on-and 
off-balance sheet and derivative transactions to any single 
counterparty or group of affiliated counterparties that exceeds 5 
percent of the Bank's total assets.
    (f) Measurement of unsecured extensions of credit. For purposes of 
this section, unsecured extensions of credit will be measured as 
follows:
    (1) For on-balance sheet transactions, an amount equal to sum of 
the book value of the item plus net payments due the Bank;
    (2) For off-balance sheet transactions, an amount equal to the 
credit equivalent amount of such item, calculated in accordance with 
Sec. 932.4(f) of this part; and
    (3) For derivative transactions, an amount equal to the sum of the 
current credit exposure and the potential future exposure for the 
derivative contract, where the current credit exposure and potential 
future credit exposure are calculated in accordance with Secs. 932.4(g) 
or 932.4(h) of this part, as applicable.
    (g) Obligations of the United States. Obligations of, or guaranteed 
by, the United States are not subject to the requirements of this 
section.

    Dated: August 1, 2001.
    By the Board of Directors of the Federal Housing Finance Board.
J. Timothy O'Neill,
Chairman.
[FR Doc. 01-19851 Filed 8-7-01; 8:45 am]
BILLING CODE 6725-01-P