[Federal Register Volume 74, Number 148 (Tuesday, August 4, 2009)]
[Notices]
[Pages 38618-38626]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-18545]


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FEDERAL HOUSING FINANCE AGENCY

[No. 2009-N-10]


Federal Home Loan Bank Collateral for Advances and Interagency 
Guidance on Nontraditional Mortgage Products

AGENCY: Federal Housing Finance Agency.

ACTION: Notice of study and recommendations and request for comment.

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SUMMARY: Section 1217 of the Housing and Economic Recovery Act of 2008 
(HERA) requires the Director of the Federal Housing Finance Agency 
(FHFA) to conduct a study on the extent to which loans and securities 
used as collateral to support Federal Home Loan Bank (FHLBank) advances 
are consistent with the interagency guidance on nontraditional mortgage 
products. The study must be submitted to the Committee on Banking, 
Housing and Urban Affairs of the Senate and the Committee on Financial 
Services of the House of Representatives no later than July 30, 2009, 
one year after the date of the HERA enactment. Further, the study (the 
HERA Section 1217 Study) must consider and recommend any additional 
regulations, guidance, advisory bulletins, or other administrative 
actions necessary to ensure that the FHLBanks are not supporting loans 
with predatory characteristics. Section 1217 of HERA also requires that 
the public have an opportunity to comment on any recommendations made 
as a result of the study. This Federal Register Notice is intended to 
inform the public about the HERA Section 1217 Study and provide the 
public with the requisite opportunity to comment.

DATES: Comments must be received on or before October 2, 2009.

ADDRESSES: You may submit your comments on the HERA Section 1217 Study, 
identified by a subject line of ``HERA Section 1217 Study,'' by any of 
the following methods:
     U.S. Mail, United Parcel Post, Federal Express, or Other 
Mail Service: The mailing address for comments is: Alfred M. Pollard, 
General Counsel, Attention: Comments/HERA Section 1217 Study, Federal 
Housing Finance Agency, Fourth Floor, 1700 G Street, NW., Washington, 
DC 20552.
     Hand Delivered/Courier: The hand delivery address is: 
Alfred M. Pollard, General Counsel, Attention: Comments/HERA Section 
1217 Study, Federal Housing Finance Agency, Fourth Floor, 1700 G 
Street, NW., Washington, DC 20552. The package should be logged at the 
Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m.
     E-mail: Comments to Alfred M. Pollard, General Counsel, 
may be sent by e-mail at [email protected]. Please include ``HERA 
Section 1217 Study'' in the subject line of the message.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments. If you submit your 
comment to the Federal eRulemaking Portal, please also send it by e-
mail to FHFA at [email protected] to ensure timely receipt by the 
agency. Please include ``HERA Section 1217 Study'' in the subject line 
of the message.

FOR FURTHER INFORMATION CONTACT: Louis M. Scalza, Associate Director, 
(202) 408-2953 or Linda L. Campbell, Senior Bank Examiner, (202) 408-
2586, Division of Federal Home Loan Bank Regulation; or Neil R. 
Crowley, Deputy General Counsel, Office of General Counsel, (202) 343-
1316, Federal Housing Finance Agency, 1625 Eye Street, NW., Washington, 
DC 20006. The telephone number for the Telecommunications Device for 
the Deaf is (800) 877-8339.

SUPPLEMENTARY INFORMATION: Section I of this Notice provides background 
on FHFA, the FHLBank System, and the collateral securing FHLBank 
advances. Section II summarizes the provisions of the interagency 
guidance and three Federal Housing Finance Board (FHFB) advisory 
bulletins relating to nontraditional, subprime, and anti-predatory 
lending. Section III describes the resources used to complete the HERA 
Section 1217 Study, including a collateral data survey that FHFA 
conducts annually, in-depth secured credit reviews performed during 
recent examinations, and a specific questionnaire related to the HERA 
Section 1217 issues that FHFA sent to the FHLBanks. Sections IV and V 
of this report present FHFA's analysis and conclusions from the HERA 
Section 1217 Study and Section VI requests comments on specific related 
questions.
    The HERA Section 1217 Study reports that FHLBanks' reliance on 
collateral described as nontraditional, subprime or Alt-A declined 
during 2008, accounting for about one-fifth of collateral securing 
advances as of December 31, 2008. Some portion of this collateral 
predates the issuance of the interagency guidance, but the FHLBanks 
need to manage and mitigate the risks associated with all of the 
collateral supporting advances.
    FHFA, through advisory bulletins issued by the prior regulator of 
the

[[Page 38619]]

FHLBanks, the FHFB, has issued explicit written guidance to the 
FHLBanks on anti-predatory, nontraditional, and subprime lending. The 
FHLBanks have adopted policies which address nontraditional and 
subprime collateral, although in-depth secured credit reviews found 
some weaknesses in those policies and practices. The FHLBanks' 
responses to an FHFA questionnaire indicate that they have adopted 
policies, procedures and practices that would require that loans and 
MBS used as collateral to support advances be consistent with the 
interagency guidance. FHFA will continue to assess the adequacy of the 
FHLBank's policies and procedures and monitor the FHLBank's remediation 
efforts. FHFA determines the appropriateness of issuing additional 
guidance based on examination results and its assessment of legislative 
developments.

I. Background

A. Federal Housing Finance Agency

    Effective July 30, 2008, HERA, Public Law 110-289, 122 Stat. 2654 
(2008), transferred the supervisory and oversight responsibilities of 
the Office of Federal Housing Enterprise Oversight (OFHEO) over the 
Federal National Mortgage Association (Fannie Mae) and the Federal Home 
Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), 
and the oversight responsibilities of the FHFB over the FHLBanks and 
the Office of Finance (which acts as the FHLBanks' fiscal agent) to 
FHFA, a new independent agency of the Federal Government. FHFA is 
responsible for ensuring that the Enterprises and the FHLBanks operate 
in a safe and sound manner, maintain adequate capital and internal 
controls, foster liquid, efficient, competitive and resilient national 
housing finance markets, and carry out their public policy missions 
through authorized activities. See Sec.  1102, Public Law 110-289, 122 
Stat. 2663-64. The Enterprises and the FHLBanks continue to operate 
under regulations promulgated by OFHEO and the FHFB until FHFA issues 
its own regulations. See id. at Sec. Sec.  1302, 1312, 122 Stat. 2795, 
2798. The Division of Federal Home Loan Bank Regulation is the 
principal organizational unit within FHFA responsible for supervision 
of the FHLBanks.

B. The FHLBank System

    The twelve FHLBanks are instrumentalities of the United States 
organized under the Federal Home Loan Bank Act (Bank Act). See 12 
U.S.C. 1423, 1432(a). The FHLBanks are cooperatives; only members of an 
FHLBank may own the capital stock of an FHLBank and only members or 
certain eligible housing associates (such as state housing finance 
agencies) may obtain access to the products provided by an FHLBank. See 
12 U.S.C. 1426, 1430(a), 1430b. Each FHLBank is managed by its own 
board of directors and serves the public by enhancing the availability 
of residential mortgage and community lending credit through its member 
institutions. See 12 U.S.C. 1427. Any eligible institution 
(principally, federally-insured depository institutions or state-
regulated insurance companies) may become a member of an FHLBank by 
satisfying certain criteria and by purchasing a specified amount of the 
FHLBank's capital stock. See 12 U.S.C. 1424, 1426; 12 CFR part 931.
    As government sponsored enterprises (GSEs), the FHLBanks are 
normally able to borrow funds in the capital markets on terms more 
favorable than could be obtained by most private entities. Until 
recently, the FHLBank System could borrow funds at a modest spread over 
the rates on U.S. Treasury securities of comparable maturity, across a 
wide range of maturities. In 2008, market conditions contributed to 
substantially wider spreads between FHLBank consolidated obligations 
and U.S. Treasuries, particularly at longer maturities. Although the 
wider spreads may have contributed to a decline in advances that began 
in the fourth quarter of 2008, the FHLBanks continue to serve as a 
source of liquidity to their members.
    The FHLBanks pass along their GSE funding advantage to their 
members--and ultimately to consumers--by providing advances (secured 
loans) and other financial services at rates that would not otherwise 
be available to their members. Some of the FHLBanks also have Acquired 
Member Asset (AMA) programs whereby they acquire fixed-rate, single-
family mortgage loans from participating member institutions.
    The FHLBanks raise funds in the capital markets by issuing 
consolidated obligations consisting of bonds and discount notes. 
Consolidated obligations are issued by the Office of Finance on behalf 
of the twelve FHLBanks and are the principal source of funding not only 
for FHLBank advances, but also for AMA programs, and investments. 
Although an FHLBank is primarily liable for the portion of the 
consolidated obligations corresponding to the proceeds received by that 
FHLBank, each FHLBank is also jointly and severally liable with the 
other eleven FHLBanks for the payment of principal of, and interest on, 
all consolidated obligations. See 12 U.S.C. 1431; 12 CFR 966.9.

C. Collateral Securing FHLBank Advances

    The United States Government established the Federal Home Loan Bank 
System in 1932 to stimulate mortgage finance by providing liquidity 
from the FHLBanks to its member financial institutions. Members, 
generally financial institutions, increase liquidity by obtaining 
advances from the FHLBanks. Those advances are secured by eligible 
collateral, typically government securities, residential mortgages, or 
other real estate related collateral (e.g., commercial real estate 
loans, home equity lines of credit and second mortgage loans). Total 
advances at the end of June 2009 were $721 billion, down from a peak 
exceeding $1 trillion in October 2008.
    All advances are collateralized, which protects the FHLBank should 
the member default. The FHLBanks secure member advances in several 
ways: a blanket lien on all or specific categories of a member's 
assets, a lien on specific member assets for which the member provides 
a listing of collateral characteristics to the FHLBank, a lien on 
assets that a member delivers to the FHLBank, or some combination 
thereof. The level of collateralization depends on the level of risk 
associated with the collateral. To date, the FHLBanks have never 
incurred a credit loss on an advance.
    A member may pledge only the following types of collateral for an 
advance: (a) Fully disbursed, whole first mortgages on improved 
residential property not more than 90 days delinquent; (b) securities 
issued, insured, or guaranteed by the U.S. Government or any agency 
thereof; (c) cash or deposits of an FHLBank; (d) other real estate 
related collateral acceptable to the FHLBank, provided the value of 
such collateral is readily ascertainable and the FHLBank can perfect 
its interest in the collateral; and (e) for institutions that qualify 
as ``community financial institutions'' (CFIs), secured loans for small 
business, agriculture, or community development activities, or 
securities representing a whole interest in such secured loans. See 12 
U.S.C. 1430(a)(3) as amended. Whole first mortgage loans on residential 
real property represent the largest source of member-provided 
collateral to the System. As of December 31, 2008, whole residential 
mortgage loans pledged as collateral for advances

[[Page 38620]]

were $859 billion or 59.7 percent of the total collateral securing 
advances.

II. HERA Section 1217 Study Regulatory Guidance

    HERA Section 1217, which mandated this study, specifically refers 
to interagency guidance on nontraditional mortgage products. This 
section provides a summary of the interagency guidance on 
nontraditional mortgage products along with the related statement on 
subprime residential mortgage lending. It then summarizes the advisory 
bulletins issued by the FHFB to apply the principles of the interagency 
guidance to the supervision of the FHLBanks, as well as an advisory 
bulletin on anti-predatory lending.\1\
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    \1\ Advisory bulletins provide guidance to the FHLBanks 
regarding particular supervisory issues. Although an advisory 
bulletin does not have the force of a regulation or an order, it is 
integrated into the examination programs. Advisory bulletins are 
effective upon issuance and remain in effect until rescinded.
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A. Interagency Guidance

    The term ``interagency guidance'' is not specifically defined in 
the HERA legislation. For purposes of this report, FHFA uses the term 
``interagency guidance'' to mean the guidance issued jointly by five 
federal financial institution regulatory agencies--the Office of the 
Comptroller of the Currency, the Board of Governors of the Federal 
Reserve System, the Federal Deposit Insurance Corporation, the Office 
of Thrift Supervision, and the National Credit Union Administration--
concerning nontraditional mortgage products and subprime lending.\2\ 
The principal interagency guidance on nontraditional and subprime 
residential mortgage loans can be summarized as follows.
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    \2\ Although HERA specifically refers to the interagency 
guidance on nontraditional mortgage products, the FHFA believes that 
the issue of subprime mortgage lending is closely related. 
Therefore, the FHFA has expanded the scope of the study to include 
subprime lending.
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Interagency Guidance on Nontraditional Mortgage Product Risks (2006)
    The federal financial institution regulatory agencies issued the 
Interagency Guidance on Nontraditional Mortgage Product Risks on 
October 4, 2006. This notice instructs financial institutions on how to 
offer nontraditional mortgage products in a safe and sound manner and 
in a way that clearly discloses the benefits and risks to borrowers. 
The guidance focuses on nontraditional residential mortgage products 
that permit borrowers to defer payment of principal or interest, 
including interest-only residential mortgage loans, payment option 
adjustable-rate residential mortgage loans, and negative amortization 
residential mortgage loans. It also covers other higher-risk practices 
often associated with nontraditional residential mortgage loans, such 
as simultaneous second-lien residential mortgage loans, variable 
interest rates with below-market introductory rates, and the use of 
reduced documentation in the evaluation of an applicant's 
creditworthiness. The guidance establishes that financial institutions 
should recognize and mitigate the risks inherent in these products by 
ensuring that loan terms and underwriting standards are clearly 
disclosed and consistent with prudent lending practices, including 
credible consideration of a borrower's repayment capacity.
Statement on Subprime Mortgage Lending (2007)
    The federal financial institution regulatory agencies subsequently 
issued the Statement on Subprime Mortgage Lending on July 10, 2007. The 
Statement addresses issues relating to certain adjustable-rate mortgage 
products that can cause the borrower's monthly payment to increase 
significantly and potentially become unaffordable. The Statement 
establishes prudent safety and soundness and consumer protection 
standards that should be followed to ensure that consumers, especially 
subprime borrowers, obtain loans they can afford to repay and receive 
information that adequately describes product features. These standards 
include qualifying the borrower using a fully-indexed interest rate 
(i.e., the interest rate after any lower, introductory interest rate in 
the early period of a loan) and a fully-amortizing repayment schedule. 
The standards also convey the regulators' expectation that stated 
income and reduced documentation should be accepted by the lender only 
if there are documented mitigating factors that clearly minimize the 
need for verification of a borrower's repayment capacity. The Statement 
reiterates that institutions should develop strong control systems to 
monitor compliance with risk management and consumer protection 
policies and practices, including clear disclosures to customers and 
limits on prepayment penalties.

B. FHFB Guidance

    FHFA--like its predecessor agencies the Federal Housing Finance 
Board and the Office of Federal Housing Enterprise Oversight--is 
mindful of the potential risk to the FHLBanks and the impact on the 
public if the FHLBanks were to provide liquidity to support predatory 
loans or inappropriately underwritten nontraditional and subprime 
residential mortgage loans. Accepting such loans as collateral for 
advances could pose a safety and soundness risk to the FHLBanks and 
would also be inconsistent with the overarching housing finance mission 
of the FHLBanks.
    As a result of concerns about predatory lending, in 2005 the former 
FHFB issued an advisory bulletin to the FHLBanks requiring each FHLBank 
to establish and communicate to its member institutions its anti-
predatory lending policies. The FHLBanks were required to establish 
those policies to avoid accepting loans with predatory characteristics 
as collateral for advances. In 2007 and 2008, the FHFB also issued 
advisory bulletins on nontraditional and subprime residential mortgage 
loans as a complement to the interagency guidance. The FHFB guidance 
established that any nontraditional or subprime mortgage loans 
originated or acquired by the member after July 10, 2007 could serve as 
eligible collateral only if those loans were underwritten consistent 
with the interagency guidance. The 2007 and 2008 guidance expanded the 
reach of the interagency guidance by establishing that the standards in 
the interagency guidance would apply not just to loans purchased by the 
FHLBanks, but also to whole loans collateralizing advances and to loans 
underlying MBS that serve as collateral for advances or that the 
FHLBanks purchase as investment securities. Further, the FHFB 
instructed the FHLBanks to apply the interagency standards to loans and 
MBS accepted as collateral from FHLBank member institutions that were 
not otherwise directly subject to the interagency guidance, e.g., 
insurance companies. The following provides a summary of the three 
advisory bulletins.
Advisory Bulletin 2005-AB-08
    In August of 2005, the FHFB issued Advisory Bulletin 2005-AB-08, 
Guidance on FHLBank Anti-Predatory Lending Policies. This Bulletin 
establishes that each FHLBank must have in place comprehensive anti-
predatory lending policies to govern the purchases of residential 
mortgage loans and the level of advances that can be made to its 
members. Although the advisory bulletin acknowledged that there is no 
single definition of predatory lending in federal, state, and local 
laws and regulations, it noted that over the preceding several years, 
federal, state, and local jurisdictions had adopted anti-

[[Page 38621]]

predatory lending measures to combat abusive practices in the mortgage 
market.
    The 2005 advisory bulletin requires that the FHLBanks' policies 
preclude purchasing residential mortgage loans or accepting as eligible 
collateral for advances loans that violate applicable federal, state, 
or local anti-predatory lending laws. The FHLBanks' anti-predatory 
lending policies must also, at a minimum, address: residential mortgage 
loans subject to the Home Ownership and Equity Protection Act (HOEPA), 
prepaid single-premium credit life or similar insurance, prepayment 
penalties beyond the early years of the loan, and mandatory 
arbitration. In addition, the FHLBanks must require each member to 
certify that it is aware of the FHLBanks' anti-predatory lending 
policies and will comply with those policies in the sale of residential 
mortgage loans to the FHLBank or when obtaining advances from the 
FHLBank. Each FHLBank must also develop written procedures and 
standards for verifying member compliance with its anti-predatory 
lending mortgage purchase and advance policies, paying particular 
attention to any loans that are otherwise not subject to review by a 
federal financial institution supervisory agency. Finally, each FHLBank 
must have agreements in place with its members to provide for 
replacement or indemnity for any loan or collateral that is found to be 
in noncompliance with the FHLBanks' policies. See http://www.fhfb.gov/webfiles/4201/2005-AB-08.pdf.
Advisory Bulletin 2007-AB-01
    Issued in April 2007, Advisory Bulletin 2007-AB-01, Nontraditional 
and Subprime Residential Mortgage Loans, requires the FHLBanks to 
implement policies and risk management practices that establish risk 
limits for, and mitigation of, credit exposure on nontraditional and 
subprime mortgage loans. The advisory bulletin requires that an 
FHLBank's policies and procedures must address how the FHLBank 
measures, monitors and controls risks arising from exposures to 
nontraditional and subprime mortgage loans. The advisory bulletin 
further requires that an FHLBank's policies must be discussed with and 
approved by its board of directors and must identify the attributes of 
nontraditional and subprime residential mortgage loans that have the 
potential for increased risk. The policies should establish limits and 
require regular monitoring of exposure to nontraditional and subprime 
residential mortgage loans, including limits and acceptable adjustments 
to collateral coverage requirements or ``haircuts.'' The procedures for 
monitoring collateral securing advances should allow an FHLBank to 
identify the volume of nontraditional and subprime residential mortgage 
loans pledged to secure advances. Finally, the collateral review 
procedures should also include assessments and testing of member 
underwriting and monitoring of nontraditional and subprime loans and 
address the acceptance of MBS with nontraditional and subprime 
collateral. See http://www.fhfb.gov/webfiles/6372/2007-AB-01.pdf.
Advisory Bulletin 2008-AB-02
    Issued in July 2008, Advisory Bulletin 2008-AB-02, Application of 
Guidance on Nontraditional and Subprime Residential Mortgage Loans to 
Specific FHLBank Assets, provides written guidance regarding 
residential mortgage loans purchased under the FHLBank's Acquired 
Member Assets programs, investments in private-label MBS, and 
collateral securing advances. The advisory bulletin states that 
residential mortgage loans that were originated or acquired by the 
member after July 10, 2007 may be included in calculating the amount of 
advances that can be made to a member only if those loans were 
underwritten consistent with all aspects of the interagency guidance. 
The guidance in the advisory bulletin applies to whole mortgage loans 
and to the residential mortgage loans that underlie private-label MBS 
used as collateral for advances.
    Further, the advisory bulletin requires the FHLBanks to take the 
quality control steps necessary to ensure compliance with the 2006 and 
2007 interagency guidance on nontraditional and subprime mortgage 
loans. Those quality controls include requiring the adoption of 
business practices including, but not limited to: conducting due 
diligence on the mortgages or assets it acquires or collateralizes 
itself, relying on an independent third party to assess compliance, or 
relying on certifications, representations or warranties provided by 
the member. The FHLBanks may rely on representations and warranties and 
third-party assurances only if the FHLBank has a credible plan to test 
and verify their dependability. See http://www.fhfb.gov/webfiles/6906/2008-AB-02.pdf.
Coverage and Applicability of FHFB Guidance
    According to Advisory Bulletin 2008-AB-02, in order to be eligible 
collateral for advances, nontraditional and subprime residential 
mortgage loans originated or acquired by a member after July 10, 2007--
and such loans backing private-label MBS issued after that date--must 
conform to the interagency guidance. By adopting the effective date of 
the interagency guidance,\3\ the FHFB chose not to apply the advance 
collateral guidance retroactively. To have done so might have reduced 
access to liquidity and potentially added to the financial stress of 
some FHLBank member institutions at a time of increasing uncertainty in 
financial and housing markets.
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    \3\ Statement on Subprime Mortgage Lending, 72 FR 37569 (July 
10, 2007).
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Recap of the Three FHFB Advisory Bulletins

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                   FHFB advisory bulletins                        2005-AB-08       2007-AB-01       2008-AB-02
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Anti-predatory lending policies and procedures...............               X
    Home Ownership and Equity Protection Act.................               X
    Single-premium credit life or similar insurance..........               X
    Prepayment penalties beyond the early loan years.........               X
    Mandatory arbitration....................................               X
Nontraditional and subprime mortgage loan risk management....  ...............               X
    Mitigation of nontraditional and subprime credit exposure  ...............               X
    Nontraditional and subprime collateral limitations.......  ...............               X
Compliance with interagency guidance on nontraditional and     ...............  ...............               X
 subprime mortgage lending...................................
    Whole loans securing advances............................  ...............  ...............               X
    MBS with underlying applicable loans securing advances...  ...............  ...............               X
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[[Page 38622]]

III. HERA Section 1217 Study Resources

    For purposes of the HERA Section 1217 Study, FHFA primarily relied 
on three resources: a collateral data survey that FHFA conducts 
annually, in-depth secured credit reviews performed during recent 
examinations, and a questionnaire related to the HERA Section 1217 
issues that FHFA sent to the FHLBanks. This section describes each of 
these information resources.

A. Collateral Data Survey

    Each year FHFA surveys the FHLBanks and prepares a report on the 
levels and trends in collateral securing advances by type and FHLBank. 
The collateral data survey collects information on the minimum levels 
of collateral required by the FHLBanks' policies to secure outstanding 
advances. The survey focuses on the minimum levels of collateral 
required by FHLBank policies because most FHLBanks file a blanket lien 
on the assets of most of their borrowing members. The volume of 
collateral under blanket lien, however, is generally not the most 
meaningful indicator of collateral protection because it does not 
indicate the quality or liquidity of the collateral. In general, the 
FHLBanks that utilize a blanket lien establish a ``collateral 
hierarchy'' in which they first consider the highest quality and most 
liquid collateral when calculating collateral coverage before they look 
to other types of collateral. Thus, for the collateral data survey, the 
FHLBanks report the collateral that they would rely upon first to cover 
any repayment shortfall resulting from member default on an outstanding 
advance. The FHLBanks report in the collateral data survey the levels 
of collateral that consists of subprime and nontraditional residential 
mortgage loans, and Alt-A and subprime private-label MBS.\4\ The 
FHLBanks may use estimates for subprime and nontraditional mortgage 
loan amounts when the actual data are not available for all members, 
such as members to which an FHLBank lends by using a blanket lien on 
the members' assets.
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    \4\ An industry standard definition of Alt-A does not exist. 
Alt-A MBS have traditionally been considered to be those backed by 
mortgage loans to borrowers with prime credit scores but with 
features that included, for example, low or no borrower income or 
asset verification. Subprime private-label MBS are those backed by 
residential mortgage loans to subprime borrowers. Since there is no 
industry standard for a credit score threshold under which a 
borrower is considered subprime, the FHLBanks may use different 
credit score thresholds in reporting subprime residential mortgage 
loans in the survey.
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B. Secured Credit Reviews

    FHFA evaluates the policies, procedures and practices of each 
FHLBank as part of its examination and supervision program. FHFA 
regulates the FHLBanks and does not, in the normal course of an 
examination, examine the individual loans or MBS pledged by the 
FHLBanks' member institutions.\5\ During examinations of the FHLBanks, 
FHFA evaluates the FHLBanks' collateral policies, how the FHLBank 
manages and secures its collateral positions, and the measures the 
FHLBank takes to protect itself from risk. The FHLBanks are required to 
have appropriate controls in place to protect their financial safety 
and soundness, to adhere to regulatory guidance, and to carry out their 
housing finance mission.
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    \5\ The FHFA only evaluates or examines the collateral under 
compelling circumstances such as might be presented by large member 
institutions experiencing known financial stress.
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    In recognition of the rapid and serious deterioration in the 
residential mortgage market, as part of its examination process, FHFA 
conducted in-depth secured credit reviews in 2008-2009, which focused 
on the advances and collateral policies and practices of the FHLBanks. 
FHFA examiners commenced the in-depth reviews with FHLBank examinations 
opening the second quarter of 2008, prior to the passage of HERA. The 
review process was designed to closely evaluate whether the FHLBanks 
have taken appropriate steps to control and value collateral, secure 
advances, and plan for the potential for member failures. The review 
work program covered collateral risk management in seven areas: 
collateral control, haircut and valuation methodologies, risk limits, 
member failure plans, member monitoring, insurance company members, and 
nontraditional and subprime mortgage loan products. The last of the in-
depth secured credit reviews was completed in the second quarter of 
2009.

C. HERA Section 1217 Questionnaire

    To complement the existing information on FHLBank collateral and in 
response to Section 1217 of HERA, FHFA's Division of Federal Home Loan 
Bank Regulation developed the HERA Section 1217 Questionnaire and 
delivered it to the FHLBanks in March 2009. The Section 1217 
questionnaire was used to obtain consistent information regarding the 
FHLBanks' policies, procedures, and practices on nontraditional and 
subprime residential mortgage loans acceptable as collateral for 
advances, either directly or through MBS that are backed by such loans. 
The questionnaire also requested information on anti-predatory lending 
policies, procedures, and practices. The questionnaire focused on 
whether the loans and securities used as collateral to support FHLBank 
advances are consistent with the requirements of the advisory bulletins 
and the interagency guidance on nontraditional and subprime mortgage 
products and anti-predatory lending. The questionnaire was also 
designed to complement the in-depth secured credit reviews, 
particularly to gauge the extent to which the FHLBanks are addressing 
concerns raised in the secured credit reviews regarding the acceptance 
of nontraditional and subprime residential mortgage loans as collateral 
for advances.

IV. HERA Section 1217 Study Results

    This section presents an analysis of the information obtained for 
the HERA Section 1217 Study through the collateral data survey, the 
secured credit reviews, and the follow-up questionnaire to the 
FHLBanks. The analysis focuses on the extent to which loans and 
securities used as collateral supporting FHLBank advances are 
consistent with the interagency guidance on nontraditional and subprime 
mortgage products.

A. FHLBank Collateral

    The tables below summarize information from the collateral surveys 
for year-ends 2007 and 2008 showing the types and amounts of collateral 
upon which the FHLBanks rely to secure advances. As of December 31, 
2007, the par value of FHLBank advances outstanding totaled $867 
billion and the FHLBanks reported that the collateral on which they 
were relying to secure those advances totaled $1.3 trillion. As of 
December 31, 2008, the par value of FHLBank advances outstanding 
increased to $900 billion, secured by collateral totaling $1.4 
trillion.

[[Page 38623]]

[GRAPHIC] [TIFF OMITTED] TN04AU09.114

    From 2007 to 2008, whole loan collateral declined from $890 billion 
to $859 billion, a decrease of $31 billion or 8 percentage points, yet 
whole loans continue to comprise the majority of the collateral 
securing advances at the FHLBanks. During this period, MBS and other 
real estate related collateral grew as a component of total collateral 
securing advances.

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                                                       2007                            2008
                 Collateral type                   collateral ($     2007 (%)      collateral ($     2008 (%)
                                                     billions)                       billions)
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Whole Loans.....................................            $890            67.7            $859            59.7
Mortgage-backed Securities......................             195            14.8             218            15.1
Other Securities................................               6             0.5              17             1.2
Other Real Estate Related Collateral............             213            16.2             329            22.8
Community Financial Institutions................              10             0.8              17             1.2
                                                 ---------------------------------------------------------------
    Total Collateral............................           1,314           100.0           1,440           100.0
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    The collateral surveys for year-ends 2007 and 2008 show 
nontraditional and subprime residential mortgage loans declined as a 
proportion of the collateral on which the FHLBanks rely to secure 
advances. As of December 31, 2007, nontraditional and subprime 
residential mortgage loans represented $410 billion or 31.2 percent of 
total advance collateral of $1.3 trillion. Subprime MBS and Alt-A MBS 
accounted for 3.3 percent of reported collateral. As of December 31, 
2008, nontraditional and subprime residential mortgage loans 
represented $267 billion or 18.5 percent of total advance collateral of 
$1.4 trillion, a decline of 12.7 percentage points from 2007. 
Additionally, subprime MBS and Alt-A MBS represented 2.0 percent of 
reported collateral, a decline of 1.3 percentage points from the 
previous year-end.\6\ Based on the totals reported, the FHLBanks relied 
on higher levels of nontraditional mortgage loan collateral than 
subprime mortgage loan collateral and higher levels of Alt-A MBS 
collateral than subprime MBS collateral.
---------------------------------------------------------------------------

    \6\ Percentages from the table may not sum to the exact figures 
reported in the text due to rounding.

----------------------------------------------------------------------------------------------------------------
                                                       2007                            2008
                 Collateral type                  collateral  ($     2007  (%)    collateral  ($     2008  (%)
                                                     billions)                       billions)
----------------------------------------------------------------------------------------------------------------
Subprime Mortgage Loans.........................             $80             6.1             $56             3.9
Nontraditional Mortgage Loans...................             297            22.6             186            12.9
Mortgage Loans that are both Subprime and                     34             2.6              24             1.7
 Nontraditional.................................
Private-label Subprime MBS......................               2             0.2              10             0.7
Private-label Alt-A MBS.........................              41             3.1              19             1.3
                                                 ---------------------------------------------------------------
    Subtotal: Subprime/Nontraditional/Alt-A.....             454            34.6             295            20.5
                                                 ---------------------------------------------------------------
Other Collateral................................             860            65.4           1,145            79.5
                                                 ---------------------------------------------------------------
        Total Collateral........................           1,314           100.0           1,440           100.0
----------------------------------------------------------------------------------------------------------------

    As of December 31, 2008, collateral described as nontraditional, 
subprime or Alt-A accounted for about one-fifth of the collateral 
securing advances at FHLBanks. This number is best understood as an 
approximation, given the varying definitions of these terms in the 
financial industry in recent years. For example, purchasers of private-
label

[[Page 38624]]

MBS, including FHLBank member institutions, relied on rating agency 
characterization of the securities at the time of issuance. However, 
these designations might not capture all the variation in underlying 
loans within a given security nor would they reflect any subsequent 
deterioration in the quality of the underlying collateral.
    Some portion of collateral described as nontraditional, subprime or 
Alt-A was originated or purchased prior to July 10, 2007, and 
therefore, under the guidance in FHFB's advisory bulletins, is not 
required to conform to the interagency guidance. The collateral survey 
does not contain information sufficient to allow FHFA to determine how 
much of the collateral would be subject to the interagency guidance. 
However, the FHFB guidance does require the FHLBanks to have policies 
in place to ensure that subprime and nontraditional loans that were 
originated or acquired by the FHLBank member subsequent to the issuance 
of the interagency guidance and certain effective dates in the FHFB 
advisory bulletins may not be pledged as collateral for advances if 
they do not conform to the guidance.

B. FHLBank Policies and Procedures Regarding Nontraditional and 
Subprime Collateral--Findings From the Secured Credit Reviews

    As part of its examination process, FHFA conducted in-depth reviews 
of the FHLBanks' policies and procedures regarding secured credit. One 
part of FHFA's in-depth reviews of secured credit focused directly on 
subprime lending and nontraditional loan products. Other aspects of the 
secured credit reviews that are relevant for this study included 
collateral control, member monitoring, and haircut and valuation 
methodologies.
    Although the reviews found that the FHLBanks had policies regarding 
the acceptance of subprime and nontraditional loans as collateral for 
advances, examiners questioned, in some cases, the appropriateness of 
the policies and implementing procedures and practices. In addition, a 
number of FHLBanks had difficulty determining their exposure to 
nontraditional and subprime residential mortgage loan collateral used 
to support FHLBank advances. Examiners identified weaknesses in 
FHLBanks' assessments and testing of member underwriting and monitoring 
of nontraditional and subprime loans, haircuts and discounts for 
nontraditional and subprime collateral, risk limits on the acceptance 
of these types of collateral, and board reporting of exposures to the 
collateral. Specifically, examiners noted the following:
     Five FHLBanks did not require an assessment of member 
underwriting of nontraditional or subprime loans to ensure consistency 
with interagency guidance as part of their onsite collateral review 
procedures. Of the remaining FHLBanks, three did not consistently 
document their review of member underwriting of nontraditional or 
subprime loans.
     Three FHLBanks lacked analytical support or validation for 
haircuts used for subprime and nontraditional mortgage products. Two 
FHLBanks did not have differentiated haircuts for conventional mortgage 
loan collateral and nontraditional and subprime mortgage loan 
collateral.
     Four FHLBanks did not have risk limits on the volume of 
nontraditional and subprime mortgage loan collateral that members may 
pledge to support FHLBank advances.
     Three FHLBanks did not regularly report exposures of 
nontraditional and subprime collateral to their boards of directors.
    FHFA examination staff communicated these weaknesses and 
expectations for corrective action to executive management and the 
boards of directors of the individual FHLBanks. Each FHLBank receiving 
regulatory criticisms of its policies committed to correct the 
weaknesses, and the examination staff has begun evaluating the 
FHLBanks' corrective actions through follow-up visitations and 
examinations. FHLBanks that have not adequately addressed the 
weaknesses identified during the secured credit reviews will be subject 
to a commensurately stricter supervisory response. Unsatisfactory 
remediation of adverse examination findings would be a factor that FHFA 
considers when determining whether formal supervisory enforcement 
actions would be warranted in the future.

C. Responses to the HERA Section 1217 Questionnaire

    The Section 1217 Questionnaire complements and in some cases 
updates the information from the in-depth secured credit reviews. The 
responses provide the FHLBanks' perspectives on a consistent set of 
questions. During on-site examinations, FHFA will review documents and 
independently evaluate the FHLBanks' policies, procedures and 
practices. FHFA will draw final conclusions about the FHLBanks' 
progress in addressing criticisms from the secured credit reviews and 
in adhering to the advisory bulletins related to the interagency 
guidance after completion of the next annual examinations of the 
FHLBanks.
1. Do the FHLBanks have policies that exclude from eligible collateral 
for advances residential mortgage loans and MBS backed by such loans 
that do not conform to the interagency guidance?
    Nine of the twelve FHLBanks have board-approved policies to exclude 
from eligible collateral for advances nontraditional and subprime 
residential mortgage loans originated or acquired by the member after 
July 10, 2007 that do not conform to the interagency guidance, as well 
as private-label MBS issued after July 10, 2007, with underlying 
nontraditional or subprime residential mortgage loans that do not 
conform to the interagency guidance. The other three FHLBanks have 
adopted policies addressing, but not specifically excluding, the 
acceptance of applicable nontraditional and subprime residential 
mortgage loans or private-label MBS used as collateral for advances.
2. Do the FHLBanks require members to certify that residential mortgage 
loans used to calculate eligible collateral comply with the interagency 
guidance and obtain and provide to the FHLBank certifications from 
securities issuers that loans underlying private-label MBS serving as 
collateral conform to the interagency guidance?
    All of the FHLBanks' policies require members to certify that the 
nontraditional and subprime residential mortgage loans used to 
calculate eligible collateral comply with the interagency guidance. One 
FHLBank, however, requires the certification regarding subprime 
residential mortgage loans only from members with established subprime 
lending programs.\7\ Nine FHLBanks require that members pledging 
private-label MBS certify or deliver to the FHLBank enforceable 
representations and warranties from the issuer or other credible 
evidence indicating that the loans backing the MBS comply with the 
interagency guidance. The remaining FHLBanks do not accept as eligible 
collateral for advances private-label MBS issued after July 10, 2007 
that is collateralized by nontraditional and subprime residential 
mortgage loans.
---------------------------------------------------------------------------

    \7\ FHFA established that for purposes of determining collateral 
eligibility the interagency guidance should apply regardless of 
whether a member has a subprime lending program. FHFA is addressing 
this matter with the FHLBank.

---------------------------------------------------------------------------

[[Page 38625]]

3. Do the FHLBanks evaluate, test, and validate member and issuer 
certifications?
    To evaluate and test member certifications regarding the 
conformance of nontraditional and subprime residential mortgage loan 
collateral to the interagency guidance, the FHLBanks review members' 
underwriting policies, verify loan documentation on-site at members, or 
review members' internal or external examination reports.\8\ Regarding 
validation of certifications from securities issuers that loans 
underlying private-label MBS originated after July 10, 2007 conform to 
the interagency guidance, the FHLBanks commonly responded that although 
they adopted policies to require such certifications, members have not 
been able to obtain and provide them. Therefore, as a practical matter, 
the FHLBanks have not accepted private-label MBS originated after July 
10, 2007 as collateral for advances.
---------------------------------------------------------------------------

    \8\ The results of the secured credit reviews indicate that the 
quality of the FHLBanks' evaluations of member underwriting and 
certifications is uneven. FHFA examination staff is addressing 
identified issues with the FHLBanks.
---------------------------------------------------------------------------

4. Do the FHLBanks have in place policies and procedures that preclude 
the acceptance of residential mortgage loans with predatory 
characteristics as collateral for advances?
    All FHLBanks have anti-predatory lending policies or procedures 
that preclude acceptance as eligible collateral for advances 
residential mortgage loans that violate applicable federal, state, or 
local predatory lending laws and other similar credit-related consumer 
protection laws. In addition, each of the FHLBanks specifically 
excludes from eligible collateral loans which: have an annual 
percentage rate or charge points or fees which exceed the thresholds 
established by HOEPA; include requirements for prepaid, single-premium 
credit life insurance; include a fee or charge for prepayment beyond 
the early years of a loan; or require mandatory arbitration to resolve 
disputes. Seven of the FHLBanks define ``early years'' for permissible 
prepayments as a period of five years. Five FHLBanks qualify their 
collateral ineligibility standard related to mandatory arbitration as a 
loan requiring mandatory arbitration that is prohibited by any 
applicable anti-predatory lending laws. One FHLBank qualifies its 
collateral ineligibility standard related to prepayment penalties as a 
loan including prepayment fees beyond the early years of the loan to 
the extent prohibited or limited by any applicable anti-predatory 
lending laws. The FHLBanks perform procedures to evaluate and test 
member underwriting of collateral that are similar to those outlined 
above for nontraditional and subprime residential mortgage loans.

V. Conclusions and Recommendations

    Approximately one-fifth of the collateral supporting FHLBank 
advances consists of subprime or nontraditional loans or Alt-A or 
subprime private-label MBS. Although a significant share of the loans 
or MBS in these categories may have been originated or issued prior to 
July 10, 2007, and thus not technically subject to the interagency 
guidance, the FHLBanks still need to manage and mitigate the risks 
associated with all of the collateral underlying advances. Going 
forward, the FHLBanks will need to ensure that the collateral 
supporting advances remains consistent with safety and soundness as 
well as the overarching housing finance mission of the FHLBanks.
    Although all FHLBanks had policies addressing nontraditional and 
subprime collateral, findings from the in-depth secured credit reviews 
revealed some weaknesses in policies and practices, particularly in 
regard to the management of the risks of this type of collateral. The 
FHLBanks' responses to the HERA Section 1217 Questionnaire indicate 
that they have adopted policies, procedures, and practices that would 
require that the loans and MBS used as collateral to support advances 
be consistent with the interagency guidance. The next cycle of 
examinations will evaluate whether weaknesses that examiners previously 
identified in the FHLBanks' policies and practices for subprime and 
nontraditional residential mortgage loans have been corrected and 
verify their responses to the HERA Section 1217 Questionnaire regarding 
application of the principles of the interagency guidance to the 
acceptance of collateral used to support advances. Through its 
supervisory programs, FHFA will continue to assess the adequacy of the 
FHLBank's policies and procedures, determine weaknesses or 
deficiencies, and monitor the FHLBanks' remediation efforts.
    The advisory bulletins issued by FHFB on the subjects of 
nontraditional and subprime mortgage loans and predatory lending 
between 2005 and 2008 provide explicit guidance for the FHLBanks. 
Adoption of the policies and practices expected by the guidance has 
received and will continue to receive focused attention through 
supervisory programs and particularly as part of FHFA's examinations of 
the FHLBanks. FHFA uses the information obtained through its 
supervisory program of examinations, targeted reviews and surveys, and 
off-site monitoring to develop appropriate guidance to facilitate the 
FHLBanks' mission of providing liquidity to its members. For example, 
FHFA's Division of Federal Home Loan Bank Regulation has recently 
prepared guidance for examiners to address questions that the FHLBanks 
have asked when developing policies and procedures to implement the 
guidance contained in the advisory bulletins.
    FHFA intends to reevaluate whether additional guidance or rules are 
necessary for the FHLBanks regarding anti-predatory lending or the 
acceptance of nontraditional or subprime residential mortgages as 
collateral for advances after the completion of the next cycle of 
examinations, which will determine if the FHLBanks have appropriately 
addressed attendant weaknesses identified by the in-depth secured 
credit reviews that began in 2008. At a minimum, FHFA expects to 
clarify one point made in Advisory Bulletin 2008-AB-02. The advisory 
bulletin states that residential mortgage loans underlying private-
label MBS issued after July 10, 2007, must conform to the interagency 
guidance, but it is silent about MBS issued before that date that a 
member may acquire after that date. FHFA intends to clarify that MBS 
purchased by a member after July 10, 2007, is also subject to the 
guidance contained in Advisory Bulletin 2008-AB-02.
    Since the passage of HERA, there have been several legislative 
developments addressing mortgage lending reform. FHFA is following 
these developments and intends to update its regulations and guidance, 
as appropriate, as issues surface in the legislative discussion. FHFA 
especially notes the provision in the Mortgage Reform and Anti-
Predatory Lending Act recently passed by the House of Representatives 
that adopts a borrower's ability to repay as a minimum standard defined 
in the law; comments are invited on a question related to the concept 
of a borrower's ability to repay in the request for comments below.

VI. Request for Comments

    FHFA welcomes comments on all aspects of the HERA Section 1217 
Study presented in this Notice. FHFA invites comments on the following 
questions, in particular:
     Should FHFA replace its existing guidance on 
nontraditional, subprime,

[[Page 38626]]

or anti-predatory lending with formal regulatory standards?
     Does any guidance contained in Advisory Bulletins 2005-AB-
08, 2007-AB-01, and 2008-AB-02 need additional emphasis or 
clarification?
     Should FHFA explicitly address other mortgage loan 
features as a control against predatory lending, or is it sufficient 
that Advisory Bulletin 2008-AB-02 requires an FHLBank to only accept 
residential mortgage loans (and such loans backing private-label MBS) 
as eligible collateral for advances when they conform to the 
interagency guidance? Some loan features that may be associated with 
either high risk or potentially predatory loans are addressed in the 
Federal Reserve Board's Amendments to Regulation Z (Truth in Lending) 
which will go into effect later in 2009 and 2010. For ``higher-priced 
mortgages,'' the amended regulation addresses a borrower's ability to 
repay the loan, prepayment penalties, income verification, and escrow 
accounts.
     Should FHFA seek any additional statutory authority to 
support its ability to prohibit an FHLBank from accepting loans with 
predatory characteristics as collateral for advances?
     As the federal financial institution regulatory agencies, 
such as through the Federal Financial Institutions Examination Council, 
look to modify or enhance guidance with respect to nontraditional or 
subprime mortgage products, should FHFA be formally and directly 
involved?
    Copies of all comments will be posted without change, including any 
personal information you provide, such as your name and address, on the 
FHFA internet web site at http://www.fhfa.gov. In addition, copies of 
all comments received will be available for examination by the public 
on business days between the hours of 10 a.m. and 3 p.m., at the 
Federal Housing Finance Agency, Fourth Floor, 1700 G Street, NW., 
Washington, DC 20552. To make an appointment to inspect comments, 
please call the Office of General Counsel at (202) 414-3751.

     Dated: July 29, 2009.
James B. Lockhart III,
Director, Federal Housing Finance Agency.
[FR Doc. E9-18545 Filed 8-3-09; 8:45 am]
BILLING CODE 8070-01-P