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entitled 'Federal Housing Finance Agency: Oversight of the Federal
Home Loan Banks' Agricultural and Small Business Collateral Policies
Could Be Improved' which was released on August 11, 2010.
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Report to the Chairman, Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises, Committee on Financial Services,
House of Representatives:
United States Government Accountability Office:
GAO:
July 2010:
Federal Housing Finance Agency:
Oversight of the Federal Home Loan Banks' Agricultural and Small
Business Collateral Policies Could Be Improved:
GAO-10-792:
GAO Highlights:
Highlights of GAO-10-792, a report to the Chairman, Subcommittee on
Capital Markets, Insurance, and Government Sponsored Enterprises,
Committee on Financial Services, House of Representatives.
Why GAO Did This Study:
The Federal Home Loan Bank System is a government-sponsored enterprise
comprising 12 regionally-based Federal Home Loan Banks (FHLBank), the
primary mission of which is to support housing finance and community
and economic development. Each FHLBank makes loans (advances) to
member financial institutions in its district, such as banks, which
traditionally are secured by single-family mortgages. In 1999, the
Gramm-Leach-Bliley Act (GLBA) authorized FHLBanks to accept
alternative forms of collateral, such as agricultural and small
business loans, from small members. GAO was asked to assess (1)
factors that may limit the use of alternative collateral; and (2)
selected aspects of the Federal Housing Finance Agency’s, (FHFA)
related regulatory oversight practices.
GAO reviewed FHLBank policies and FHFA documentation; and interviewed
FHLBank and FHFA officials, and a nongeneralizable random sample of 30
small lenders likely to have significant levels of agricultural or
small business loans in their portfolios.
What GAO Found:
FHLBank and FHFA officials cited several factors to help explain why
alternative collateral represents about 1 percent of all collateral
that is used to secure advances. These factors include a potential
lack of interest by small lenders in pledging such collateral to
secure advances or the view that many such lenders have sufficient
levels of single-family mortgage collateral. Officials from two
FHLBanks said their institutions do not accept alternative collateral
at all, at least in part for these reasons. Further, FHLBank officials
said alternative collateral can be more difficult to evaluate than
single-family mortgages and, therefore, may present greater financial
risks. To mitigate these risks, the 10 FHLBanks that accept
alternative collateral generally apply higher discounts, or haircuts,
to it than any other form of collateral, which may limit its use (see
table). For example, an FHLBank with a haircut of 80 percent on
alternative collateral generally would allow a member to obtain an
advance worth 20 percent of the collateral’s value. While GAO’s
interviews with 30 small lenders likely to have significant
alternative collateral on their books found that they generally valued
their relationships with their local FHLBanks, officials from half
said the large haircuts on alternative collateral or other policies
limited the collateral’s appeal.
FHFA’s oversight of FHLBank alternative collateral policies and
practices has been limited. For example, FHFA guidance does not direct
its examiners to assess the FHLBanks’ alternative collateral policies.
As a result, the FHLBanks have wide discretion to either not accept
alternative collateral or apply relatively large haircuts to it. While
the FHLBanks may view these policies as necessary to mitigate
potential risks, 9 of the 12 FHLBanks did not provide documentation to
GAO to substantiate such policies. Further, the documentation provided
by three FHLBanks suggests that, in some cases, haircuts applied to
alternative collateral may be too large. Also, the majority of the
FHLBanks have not developed quantitative goals for products related to
agricultural and small business lending, such as alternative
collateral, as required by FHFA regulations. FHFA officials said that
alternative collateral has not been a focus of the agency’s oversight
efforts because it does not represent a significant safety and
soundness concern. However, in the absence of more proactive FHFA
oversight from a mission standpoint, the appropriateness of FHLBank
alternative collateral policies is not clear.
Table: Range of FHLBank Haircuts Applied to Various Collateral Types
FHLBank district: Ranges;
Alternative collateral haircuts: Small business: 40-80%;
Alternative collateral haircuts: Small farm: 40-80%;
Alternative collateral haircuts: Small agribusiness: 40-80%;
Single-family mortgages: 7-44%;
Commercial real estate mortgages: 40-67%.
Source: GAO analysis of FHLBank collateral policies.
[End of table]
What GAO Recommends:
FHFA should revise its examination guidelines to include periodic
analysis of alternative collateral, and enforce its regulation
pertaining to quantitative goals for products related to agricultural
and small business lending. FHFA agreed with these recommendations.
View [hyperlink, http://www.gao.gov/products/GAO-10-792] or key
components. For more information, contact William Shear at (202) 512-
8678 or shearw@gao.gov.
[End of section]
Contents:
Letter:
Background:
FHLBank and CFI Officials Cited Several Factors, Including Lack of
Interest and Risk-Management Policies, to Explain Minimal Use of
Alternative Collateral:
FHFA's Oversight of the FHLBanks' Alternative Collateral Policies and
Practices Has Been Limited:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Comments from the Federal Housing Finance Agency:
Appendix III: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Characteristics of CFI Members and Assets in the 12 FHLBanks,
as of December 31, 2009:
Table 2: Number and Total Assets of Agricultural CFIs by FHLBank
District, as of December 31, 2009:
Table 3: Number and Total Assets of Small Business CFIs by FHLBank
District, as of September 30, 2009:
Table 4: Percentage Haircut Requirements for the 10 FHLBanks That
Accept Alternative, Single-Family, and Commercial Real Estate
Collateral under a Blanket Lien Option:
Table 5: CFIs Reported Use of Alternative Collateral to Secure
Advances:
Table 6: Characteristics of GAO's Nongeneralizable, Random Sample of
30 CFIs:
Figure:
Figure 1: The 12 FHLBank Districts:
Abbreviations:
AHP: Affordable Housing Program:
CFI: Community Financial Institution:
CIP: Community Investment Program:
FDIC: Federal Deposit Insurance Corporation:
Federal Reserve: Board of Governors of the Federal Reserve System:
FHFA: Federal Housing Finance Agency:
FHFB: Federal Housing Finance Board:
FHLBank: Federal Home Loan Bank:
FHLBank System: Federal Home Loan Bank System:
FHLBank Act: Federal Home Loan Bank Act:
FIRREA: Financial Institutions Reform, Recovery, and Enforcement Act
of 1989:
GLBA: Gramm-Leach-Bliley Act of 1999:
GSE: Government-sponsored Enterprise:
HERA: Housing and Economic Recovery Act of 2008:
SBA: Small Business Administration:
[End of section]
United States Government Accountability Office: Washington, DC 20548:
July 20, 2010:
The Honorable Paul E. Kanjorski:
Chairman:
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises:
Committee on Financial Services:
House of Representatives:
Dear Mr. Chairman:
The Federal Home Loan Bank System (FHLBank System) is a government-
sponsored enterprise (GSE) that consists of 12 regionally based
Federal Home Loan Banks (FHLBank), the primary mission of which is to
support housing finance and community and economic development. To
carry out its mission, the FHLBank System issues debt in capital
markets, generally at relatively favorable rates due to its GSE
status, and each FHLBank makes loans (advances) to member financial
institutions, such as banks and thrifts, located in its district.
Traditionally, member institutions have secured advances by pledging
single-family mortgages or investment-grade securities as collateral
to their FHLBank. However, section 604 of title VI of the Gramm-Leach-
Bliley Act (GLBA), also known as the Federal Home Loan Bank System
Modernization Act of 1999, authorizes FHLBanks to accept alternative
collateral, such as small business and small farm loans, from small
members, known as Community Financial Institutions (CFI), which are
defined as having $1.029 billion or less in total assets.[Footnote 1]
In enacting the GLBA reforms, the goal was to help smaller banks or
thrifts, which may have limited single-family mortgages and other
traditional assets to pledge as collateral, gain greater access to the
liquidity offered by FHLBank advances.[Footnote 2] In so doing, the
GLBA reforms were supposed to help improve economic development credit
opportunities in rural areas and other underserved communities.
[Footnote 3]
GLBA's legislative history also contains language suggesting that the
FHLBanks and their former financial soundness and mission regulator,
the Federal Housing Finance Board (FHFB), should "prioritize" the
FHLBank System's economic development efforts through the use of
alternative collateral.[Footnote 4] FHFB regulations required each
FHLBank to develop strategic business plans that established
quantitative performance goals for products, which could include
alternative collateral, related to small business, small farm, and
small agribusiness lending.[Footnote 5] In 2008, as part of the
provisions of the Housing and Economic Recovery Act of 2008 (HERA),
FHFB was abolished and replaced by the Federal Housing Finance Agency
(FHFA), which assumed FHFB's financial soundness and mission oversight
responsibilities for the FHLBank System.
While the FHLBanks have been authorized to accept alternative
collateral for more than 10 years, its use has been minimal, according
to FHFA data. Specifically, FHFA data indicate that alternative
collateral secured about 1 percent of all FHLBank advances in 2008 and
that percentage has been fairly constant at 1 percent or less since
2001.[Footnote 6] In general, FHLBanks located in regions with
significant agriculturally based economies--such as the FHLBanks
located in Dallas, Des Moines, and Topeka--generally report higher
acceptance of alternative collateral than other FHLBank districts.
Several FHLBanks, including those in Atlanta, Cincinnati, and New
York, either have not sought regulatory approval to accept alternative
collateral or CFI members in their districts have not pledged such
collateral.[Footnote 7]
You requested that we review issues pertaining to the FHLBanks'
implementation of the GLBA collateral reforms. Specifically, this
report (1) discusses factors that may limit the use of alternative
collateral to secure FHLBank advances; and (2) assesses selected
aspects of FHFA's oversight of the FHLBanks' alternative collateral
policies and practices.
To address the first objective, we analyzed relevant sections of GLBA
and HERA, and FHLBank collateral policies and procedures, particularly
those pertaining to alternative collateral. While we were able to
review each FHLBank's collateral policies and procedures, the
confidentiality of such information limited what we could publicly
disclose in our report.[Footnote 8] We also conducted interviews with
officials from FHFA, the 12 FHLBanks, the Council of Federal Home Loan
Banks, and the Independent Community Bankers of America. Further, we
identified 796 CFI members, as of September 30, 2009, that either (1)
met criteria established by the FDIC defining them as significant
agricultural lenders or (2) met criteria established by the Small
Business Administration's (SBA) Office of Advocacy defining them as
significant small business lenders.[Footnote 9] We also identified
several CFIs that met the definition of both an agricultural and small
business lender. From these populations, we interviewed a
nongeneralizable, random sample of 30 CFI members.[Footnote 10]
Therefore, the sample consists of CFIs that might be expected to
encounter challenges in obtaining FHLBank advances by pledging
traditional forms of collateral. The sample also was designed to
ensure that it included the perspective of CFIs (1) located in FHLBank
districts that have high, some, or no use of alternative collateral;
and (2) are very small (that is, those with less than $100 million in
assets). The views expressed by the banks in our sample cannot be
generalized to the universe of CFIs. For the second objective, we
analyzed FHFA's regulations, examination policies and procedures, and
recent FHLBank examination results to understand the nature of rules
and information used by the agency to assess the FHLBanks' collateral
management efforts. We also reviewed GLBA, HERA, and Financial
Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA)
requirements, as well as the FHLBanks' strategic business and Targeted
Community Lending Plans and federal internal control standards.
Finally, we reviewed FDIC's asset valuation estimates for various loan
types in banks that recently failed or were on the verge of failure.
To assess the reliability of FDIC, FHFA, and SBA's Office of Advocacy
data, we (1) interviewed officials knowledgeable about the data; (2)
assessed the data for obvious outliers and missing information; (3)
checked a sample of the data against publicly available financial
information on banks and thrifts; and (4) reviewed independent
reports, and determined that the data were sufficiently reliable for
our purposes. Appendix I contains a detailed description of our scope
and methodology.
We conducted this performance audit from October 2009 to July 2010, in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Background:
The FHLBank System was established in 1932 and consists of 12 FHLBanks
(see figure 1). Member financial institutions, which typically are
commercial banks and thrifts (or savings and loans), cooperatively own
each of the 12 FHLBanks. To become a member of its local FHLBank, a
financial institution must maintain an investment in the capital stock
of the FHLBank in an amount sufficient to satisfy the minimum
investment required for that institution in accordance with the
FHLBank's capital plan.[Footnote 11] In addition to the ability to
obtain advances, other benefits of FHLBank membership for financial
institutions include earning dividends on their capital investments
and access to various products and services, such as letters of credit
and payment services. As of December 31, 2009, more than 8,000
financial institutions with approximately $13 trillion in assets were
members of the FHLBank System. The FHLBank System's total outstanding
advances stood at more than $631 billion.
Figure 1: The 12 FHLBank Districts:
[Refer to PDF for image: map of the U.S. indicating district
boundaries]
District 1: Boston;
District 2: New York;
District 3: Pittsburgh;
District 4: Atlanta;
District 5: Cincinnati;
District 6: Indianapolis;
District 7: Chicago;
District 8: Des Moines;
District 9: Dallas;
District 10: Topeka;
District 11: San Francisco;
District 12: Seattle.
Sources: FHFB data; Map Resources (map).
[End of figure]
As established by statute and FHFA regulations, the FHLBanks are
required to develop and implement collateral standards and other
policies to mitigate the risk that member institutions may default on
outstanding advances. To help do so, the FHLBanks generally apply a
blanket lien on all or specific categories of a member's assets to
secure the collateral underlying the advance. In general, a blanket
lien agreement is intended to fully protect the FHLBank by securing
its right to take and possibly sell any or all of a member's assets in
the event it fails or defaults on its outstanding advances. In limited
circumstances, FHLBanks may permit or require their members to pledge
collateral under (1) a listing (specific detail) lien agreement in
which the members are to report detailed information, such as the loan
amount, payments, maturity date, and interest rate for the loans
pledged as collateral; or (2) a delivery lien agreement, in which
members are required to deliver the collateral to the FHLBank or an
approved safekeeping facility.[Footnote 12] From a member's
perspective, the benefits of listing collateral in lieu of a blanket
lien agreement can include better pricing terms. Some FHLBanks may
require members to list or deliver collateral to better protect their
financial interests in instances in which a member is in danger of
failure or its financial condition begins to deteriorate.
FHLBanks also seek to manage risk and mitigate potential losses by
applying varying haircuts, or discounts, to collateral pledged to
secure advances. To illustrate: suppose that an FHLBank member sought
to pledge a single-family residential mortgage loan portfolio with a
value of $100 million to secure an advance from its district FHLBank.
If the FHLBank applied a haircut of 25 percent to such collateral, the
member would generally be able to secure advances of up to $75 million
subject to other risk-management policies the FHLBank may have
established.[Footnote 13] In general, the FHLBanks' haircut levels
tend to increase based on the perceived risks associated with the
collateral being pledged. As described in this report, single-family
mortgages and other forms of traditional collateral generally are
perceived as representing less risk than alternative forms of
collateral, such as agricultural and small business loans. Since
FHLBanks generally issue advances under blanket lien agreements, they
may calculate a member's total borrowing capacity by applying varying
haircuts to each form of eligible collateral on the member's books and
communicating this information to the member on a periodic basis.
In the event that a member institution fails, FHLBanks have a "first
lien" on its assets. That is, they have priority over all other
creditors, including FDIC, to obtain the collateral necessary to
protect against losses on their outstanding advances. In a typical
bank or thrift failure, FDIC pays off outstanding FHLBank advances in
full and takes possession of the collateral on the institution's books
to help offset its losses. According to the FHLBank Office of Finance,
in the 78-year history of the FHLBank System, no FHLBank has ever
suffered a credit loss on an advance.
The FHLBanks' haircuts and other risk management policies are intended
to mitigate potential losses; however, they also may limit some
members' interest in obtaining advances. For example, an FHLBank
member may perceive that the level of haircuts applied to the
collateral it pledges may unduly restrict the amount of financing it
would like to obtain through advances. Administrative and other costs
associated with obtaining advances also may factor into an FHLBank
member's decision making process. For example, FHLBank officials
conduct on-site inspections to assess members' collateral management
practices or require members to have such practices independently
audited. For some FHLBank members, the costs of such administrative
procedures may outweigh the potential benefits of obtaining advances,
particularly if they view the haircuts applied to the collateral as
unreasonable.
While the FHLBank System's primary mission over the years has been to
promote housing finance generally through its advance business, it is
also required by statute and regulation to meet other specific mission
requirements. For example, FIRREA authorizes both the Affordable
Housing Program (AHP) and the Community Investment Program (CIP) to
assist the FHLBanks' affordable housing mission.[Footnote 14] Under
AHP, each FHLBank is required to set aside 10 percent of its previous
year's earnings to fund interest rate subsidies on advances to members
engaged in lending for long-term, low-and moderate-income, owner-
occupied, and affordable rental housing at subsidized interest rates.
[Footnote 15] In using the advances, the FHLBank members are to give
priority to qualified projects, such as the purchase of homes for low-
or moderate-income families or to purchase or rehabilitate government-
owned housing. FIRREA also established CIP, which requires FHLBanks to
provide flexible advance terms for members to undertake community-
oriented mortgage lending. CIP advances may be made at the FHLBank's
cost of funds (for advances with similar maturities) plus the cost of
administrative fees. Moreover, FIRREA requires FHFB (now FHFA) to
establish standards of community investment or service for members of
FHLBanks to maintain continued access to long-term advances.[Footnote
16] These standards include the development of a Targeted Community
Lending Plan (which is designed to help the FHLBanks assess the credit
needs of the communities that they serve) and quantitative lending
goals that address identified credit needs and marketing opportunities
in each FHLBank's district.
FHFA has safety and soundness and mission oversight for the FHLBank
System and Fannie Mae and Freddie Mac.[Footnote 17] For example, FHFA
is responsible for ensuring that the FHLBanks establish appropriate
collateral management policies and practices to mitigate the risks
associated with their advance business. From a mission standpoint,
FHFA also is responsible for ensuring that the FHLBanks are in
compliance with statutes and regulations pertaining to the AHP and CIP
programs. While GLBA does not establish specific requirements for
alternative collateral, its legislative history suggests that the
FHLBanks and FHFB, and by extension FHFA, should prioritize the
FHLBank System's economic development activities through the use of
alternative collateral. To carry out its responsibilities, FHFA may
issue regulations, establish capital standards, and conduct on-site
safety and soundness or mission-related examinations. FHFA also may
take enforcement actions, such as issuing cease and desist orders, and
may place an FHLBank, Fannie Mae, or Freddie Mac into conservatorship
or receivership if they become undercapitalized or critically
undercapitalized.[Footnote 18]
FHLBank and CFI Officials Cited Several Factors, Including Lack of
Interest and Risk-Management Policies, to Explain Minimal Use of
Alternative Collateral:
Officials from the 12 FHLBanks cited several factors to help explain
the minimal use of alternative collateral to secure advances in the
FHLBank System. These factors include a potential lack of interest
among many CFI members; the view that many CFIs belong to the FHLBank
System primarily to have access to letters of credit and other
products or to obtain a backup source of liquidity; and that many CFIs
may have sufficient holdings of traditional collateral to secure
advances. Moreover, due to the potential risks associated with
alternative collateral, the 10 FHLBanks that accept it have
established risk-management strategies to mitigate potential losses,
which also may limit its use. In particular, the FHLBanks generally
have applied higher haircuts to alternative collateral than to any
other type of collateral used to secure advances. Officials from many
of the 30 CFIs we interviewed said that they valued their
relationships with their local FHLBanks and the products and services
provided. However, officials from half of these CFIs expressed
concerns about the level of the haircuts applied to alternative
collateral or other FHLBank risk-management strategies. In some cases,
they said the haircuts or policies limited their willingness to pledge
such collateral to obtain advances.
FHLBank Officials Generally Attributed the Minimal Use of Alternative
Collateral to Limited Demand among Many CFI Members and Ready
Availability of Traditional Collateral:
According to representatives from the 12 FHLBanks, they have ongoing
member outreach programs that are intended, in part, to address
members' credit and collateral needs and the various products
available to them. The FHLBank officials said that outreach activities
can include telephone calls or visits to members to discuss the
availability of alternative collateral and its potential use by CFI
members. Some FHLBanks also have annual meetings, online product
tutorials, and electronic bulletins that provide information about
alternative collateral.
While officials from the 12 FHLBanks said they had outreach programs
in place, some officials cited the significant differences in the
membership characteristics across the FHLBank System as affecting the
use of alternative collateral (see table 1). For example, CFIs
represent more than 80 percent of the membership and about 30 percent
of the assets of the FHLBanks in Dallas and Topeka, and many of these
CFI members focus on agricultural lending due to its prominence in the
regional economies. While CFI assets represented a relatively small
proportion, or 13 percent, of the total assets of members in the Des
Moines FHLBank district, officials said that alternative collateral
was of significant interest to their members due to the prominence of
agricultural-related businesses in the district. In contrast, CFI
assets represented a relatively small portion, or less than 10
percent, of all membership assets in the FHLBank districts of Atlanta
and New York, neither of which have submitted new business activity
notices to FHFA requesting approval to accept alternative collateral;
and the FHLBank of Cincinnati reported no alternative collateral
activity at year-end 2008. Officials from these three FHLBanks said
that their memberships had not expressed an interest in pledging
alternative collateral. Similarly, although CFI membership and assets
also were relatively significant in the Chicago FHLBank district,
officials said that their membership had not expressed much interest
in using alternative collateral to secure advances. One FHLBank
official noted that, given the cooperative nature of the FHLBank
System, membership interest often drove the decision to make certain
products and services available.
Table 1: Characteristics of CFI Members and Assets in the 12 FHLBanks,
as of December 31, 2009:
Dollars in millions:
FHLBank district: Atlanta;
Total CFI members: 946;
Total members: 1,194;
Percentage of CFI members: 79%;
Total CFI assets: $259,916;
Total member assets: $3,455,365;
Percentage of CFI assets: 8%.
FHLBank district: Boston;
Total CFI members: 252;
Total members: 462;
Percentage of CFI members: 55%;
Total CFI assets: $94,176;
Total member assets: $692,444;
Percentage of CFI assets: 14%.
FHLBank district: Chicago;
Total CFI members: 695;
Total members: 790;
Percentage of CFI members: 88%;
Total CFI assets: $148,981;
Total member assets: $499,675;
Percentage of CFI assets: 30%.
FHLBank district: Cincinnati;
Total CFI members: 563;
Total members: 735;
Percentage of CFI members: 77%;
Total CFI assets: $19,168;
Total member assets: $872,869;
Percentage of CFI assets: 14%.
FHLBank district: Dallas[A];
Total CFI members: 776;
Total members: 922;
Percentage of CFI members: 84%;
Total CFI assets: $83,467;
Total member assets: $601,072;
Percentage of CFI assets: 31%.
FHLBank district: Des Moines[A];
Total CFI members: 1,078;
Total members: 1,226;
Percentage of CFI members: 88%;
Total CFI assets: $81,984;
Total member assets: $1,455,698;
Percentage of CFI assets: 13%.
FHLBank district: Indianapolis;
Total CFI members: 254;
Total members: 417;
Percentage of CFI members: 61%;
Total CFI assets: $57,894;
Total member assets: $450,396;
Percentage of CFI assets: 13%.
FHLBank district: New York;
Total CFI members: 208;
Total members: 331;
Percentage of CFI members: 63%;
Total CFI assets: $68,860;
Total member assets: $1,581,211;
Percentage of CFI assets: 4%.
FHLBank district: Pittsburgh;
Total CFI members: 245;
Total members: 316;
Percentage of CFI members: 78%;
Total CFI assets: $73,689;
Total member assets: $984,503;
Percentage of CFI assets: 7%.
FHLBank district: San Francisco;
Total CFI members: 254;
Total members: 406;
Percentage of CFI members: 63%;
Total CFI assets: $69,810;
Total member assets: $1,785,012;
Percentage of CFI assets: 4%.
FHLBank district: Seattle;
Total CFI members: 244;
Total members: 384;
Percentage of CFI members: 64%;
Total CFI assets: $66,775;
Total member assets: $388,666;
Percentage of CFI assets: 17%.
FHLBank district: Topeka[A];
Total CFI members: 756;
Total members: 873;
Percentage of CFI members: 87%;
Total CFI assets: $122,190;
Total member assets: $444,338;
Percentage of CFI assets: 27%.
FHLBank district: FHLBank System total;
Total CFI members: 6,271;
Total members: 8,056;
Percentage of CFI members: 78%;
Total CFI assets: $1,446,910;
Total member assets: $13,211,249;
Percentage of CFI assets: 11%.
Source: GAO analysis of FHFA data.
[A] Indicates FHLBanks whose officials said that alternative
collateral was significant to their membership.
[End of table]
Officials from several FHLBanks also said that CFIs often do not take
out advances from their local FHLBank and, therefore, have no reason
to use alternative collateral. Rather than taking out advances,
several FHLBank officials said many CFIs derive other benefits from
their membership, particularly letters of credit, and other services.
The officials added that CFIs also may belong to the FHLBank System to
have a backup source of liquidity in case other sources, including
customer deposits or the federal funds market become unavailable or
prohibitively expensive.[Footnote 19]
According to some FHLBank officials, many CFIs may have sufficient
traditional collateral, such as single-family mortgages and investment-
grade securities, to secure advances. Officials at the FHLBanks of
Boston, Cincinnati, and Pittsburgh said that they reported no or low
levels of alternative collateral securing advances at year-end 2008,
in part, because their members had sufficient levels of other eligible
collateral. Atlanta and New York FHLBank officials said that they
conducted regular analyses to determine whether any banks in their
membership were collaterally constrained and, therefore would need
alternative collateral to obtain an advance. Officials at these banks
said since 2000, their annual analyses have determined that
alternative collateral was not needed among their membership.
Our analysis of FHFA, FDIC, and SBA's Office of Advocacy data found
that while most CFIs may have sufficient traditional sources of
collateral to secure advances, a considerable minority of CFIs with
significant holdings of alternative collateral on their books may face
challenges in doing so. For example, we identified 480 CFIs with $47.3
billion in assets, as of December 31, 2009, that met the FDIC's
definition of an agricultural bank (see table 2). The FHLBanks of Des
Moines and Topeka had the most agricultural CFI members and the CFIs
in these two districts had the greatest amount of total assets for
such lenders.
Table 2: Number and Total Assets of Agricultural CFIs by FHLBank
District, as of December 31, 2009:
Dollars in millions:
FHLBank district: Atlanta;
Number of agricultural CFIs: 0;
Number of all CFIs: 946;
Agricultural CFIs as a percentage of all CFIs: 0.00%;
Agricultural CFI assets: $0;
All CFI assets: $259,916;
Agricultural CFI assets as a percentage of all CFI assets: 0.00%.
FHLBank district: Boston;
Number of agricultural CFIs: 0;
Number of all CFIs: 252;
Agricultural CFIs as a percentage of all CFIs: 0.00;
Agricultural CFI assets: $0;
All CFI assets: $94,176;
Agricultural CFI assets as a percentage of all CFI assets: 0.00.
FHLBank district: Chicago;
Number of agricultural CFIs: 29;
Number of all CFIs: 695;
Agricultural CFIs as a percentage of all CFIs: 4.17%;
Agricultural CFI assets: $2,934;
All CFI assets: $148,981;
Agricultural CFI assets as a percentage of all CFI assets: 1.97%.
FHLBank district: Cincinnati;
Number of agricultural CFIs: 0;
Number of all CFIs: 563;
Agricultural CFIs as a percentage of all CFIs: 0.00;
Agricultural CFI assets: $0;
All CFI assets: $119,169;
Agricultural CFI assets as a percentage of all CFI assets: 0.00.
FHLBank district: Dallas;
Number of agricultural CFIs: 39;
Number of all CFIs: 776;
Agricultural CFIs as a percentage of all CFIs: 5.03%;
Agricultural CFI assets: $3,380;
All CFI assets: $183,467;
Agricultural CFI assets as a percentage of all CFI assets: 1.84%.
FHLBank district: Des Moines;
Number of agricultural CFIs: 213;
Number of all CFIs: 1,078;
Agricultural CFIs as a percentage of all CFIs: 19.76%;
Agricultural CFI assets: $23,373;
All CFI assets: $181,984;
Agricultural CFI assets as a percentage of all CFI assets: 12.84%.
FHLBank district: Indianapolis;
Number of agricultural CFIs: 1;
Number of all CFIs: 254;
Agricultural CFIs as a percentage of all CFIs: 0.39%;
Agricultural CFI assets: $48;
All CFI assets: $57,893;
Agricultural CFI assets as a percentage of all CFI assets: 0.08%.
FHLBank district: New York;
Number of agricultural CFIs: 0;
Number of all CFIs: 208;
Agricultural CFIs as a percentage of all CFIs: 0.00;
Agricultural CFI assets: $0;
All CFI assets: $68,860;
Agricultural CFI assets as a percentage of all CFI assets: 0.00.
FHLBank district: Pittsburgh;
Number of agricultural CFIs: 0;
Number of all CFIs: 245;
Agricultural CFIs as a percentage of all CFIs: 0.00;
Agricultural CFI assets: $0;
All CFI assets: $73,689;
Agricultural CFI assets as a percentage of all CFI assets: 0.00.
FHLBank district: San Francisco;
Number of agricultural CFIs: 0;
Number of all CFIs: 254;
Agricultural CFIs as a percentage of all CFIs: 0.00;
Agricultural CFI assets: $0;
All CFI assets: $69,810;
Agricultural CFI assets as a percentage of all CFI assets: 0.00.
FHLBank district: Seattle;
Number of agricultural CFIs: 11;
Number of all CFIs: 244;
Agricultural CFIs as a percentage of all CFIs: 4.51%;
Agricultural CFI assets: $741;
All CFI assets: $66,775;
Agricultural CFI assets as a percentage of all CFI assets: 1.11%.
FHLBank district: Topeka;
Number of agricultural CFIs: 187;
Number of all CFIs: 756;
Agricultural CFIs as a percentage of all CFIs: 24.74%;
Agricultural CFI assets: $16,858;
All CFI assets: $122,190;
Agricultural CFI assets as a percentage of all CFI assets: 13.80%.
FHLBank district: FHLBank System total;
Number of agricultural CFIs: 480;
Number of all CFIs: 6,271;
Agricultural CFIs as a percentage of all CFIs: 7.65%;
Agricultural CFI assets: $47,334;
All CFI assets: $1,446,910;
Agricultural CFI assets as a percentage of all CFI assets: 3.27%.
Source: GAO analysis of FHFA, FDIC, and SBA's Office of Advocacy data.
[End of table]
Using SBA's Office of Advocacy data we also found 326 CFIs with $102.3
billion in assets, as of September 30, 2009, that were identified as
the largest small business lenders (see table 3).[Footnote 20] The
number and assets of small business CFIs appeared to be more evenly
distributed across the FHLBank System than agricultural CFIs. We
interviewed a limited sample of 30 representatives from these
agricultural and small business CFIs and discuss their perspectives on
FHLBank alternative collateral policies and practices later in this
report.
Table 3: Number and Total Assets of Small Business CFIs by FHLBank
District, as of September 30, 2009:
Dollars in millions:
FHLBank district: Atlanta;
Number of small business CFIs: 51;
Number of all CFIs: 948;
Small business CFIs as a percentage of all CFIs: 5.38%;
Small business CFI assets: $18,214;
All CFI assets: $247,370;
Small business CFI assets as a percentage of all CFI assets: 7.36%.
FHLBank district: Boston;
Number of small business CFIs: 13;
Number of all CFIs: 247;
Small business CFIs as a percentage of all CFIs: 5.26%;
Small business CFI assets: $6,961;
All CFI assets: $89,078;
Small business CFI assets as a percentage of all CFI assets: 7.81%.
FHLBank district: Chicago;
Number of small business CFIs: 19;
Number of all CFIs: 702;
Small business CFIs as a percentage of all CFIs: 2.71%;
Small business CFI assets: $4,913;
All CFI assets: $144,137;
Small business CFI assets as a percentage of all CFI assets: 3.41%.
FHLBank district: Cincinnati;
Number of small business CFIs: 28;
Number of all CFIs: 564;
Small business CFIs as a percentage of all CFIs: 4.96%;
Small business CFI assets: $8,247;
All CFI assets: $116,593;
Small business CFI assets as a percentage of all CFI assets: 7.07%.
FHLBank district: Dallas;
Number of small business CFIs: 39;
Number of all CFIs: 778;
Small business CFIs as a percentage of all CFIs: 5.01%;
Small business CFI assets: $10,790;
All CFI assets: $172,949;
Small business CFI assets as a percentage of all CFI assets: 6.24%.
FHLBank district: Des Moines;
Number of small business CFIs: 44;
Number of all CFIs: 1,082;
Small business CFIs as a percentage of all CFIs: 4.07%;
Small business CFI assets: $12,638;
All CFI assets: $174,460;
Small business CFI assets as a percentage of all CFI assets: 7.24%.
FHLBank district: Indianapolis;
Number of small business CFIs: 17;
Number of all CFIs: 259;
Small business CFIs as a percentage of all CFIs: 6.56%;
Small business CFI assets: v3,877;
All CFI assets: $58,161;
Small business CFI assets as a percentage of all CFI assets: 6.67%.
FHLBank district: New York;
Number of small business CFIs: 20;
Number of all CFIs: 203;
Small business CFIs as a percentage of all CFIs: 9.85%;
Small business CFI assets: $9,126;
All CFI assets: $63,950;
Small business CFI assets as a percentage of all CFI assets: 14.27%.
FHLBank district: Pittsburgh;
Number of small business CFIs: 15;
Number of all CFIs: 242;
Small business CFIs as a percentage of all CFIs: 6.20%;
Small business CFI assets: $5,679;
All CFI assets: $66,820;
Small business CFI assets as a percentage of all CFI assets: 8.50%.
FHLBank district: San Francisco;
Number of small business CFIs: 16;
Number of all CFIs: 260;
Small business CFIs as a percentage of all CFIs: 6.15%;
Small business CFI assets: $5,585;
All CFI assets: $69,042;
Small business CFI assets as a percentage of all CFI assets: 8.09%.
FHLBank district: Seattle;
Number of small business CFIs: 25;
Number of all CFIs: 238;
Small business CFIs as a percentage of all CFIs: 10.50%;
Small business CFI assets: $9,610;
All CFI assets: $63,879;
Small business CFI assets as a percentage of all CFI assets: 15.04%.
FHLBank district: Topeka;
Number of small business CFIs: 39;
Number of all CFIs: 758;
Small business CFIs as a percentage of all CFIs: 5.15%;
Small business CFI assets: $6,644;
All CFI assets: $118,760;
Small business CFI assets as a percentage of all CFI assets: 5.59%.
FHLBank district: FHLBank System total;
Number of small business CFIs: 326;
Number of all CFIs: 6,281;
Small business CFIs as a percentage of all CFIs: 5.19%;
Small business CFI assets: $102,284;
All CFI assets: $1,385,199;
Small business CFI assets as a percentage of all CFI assets: 7.38%.
Source: GAO analysis of FHFA and SBA's Office of Advocacy data.
[End of table]
FHLBank Policies That Focus On Potential Risks May Also Limit the Use
of Alternative Collateral:
FHFA and some FHLBank officials said that alternative collateral
generally has been viewed as representing greater risks than single-
family mortgages and investment-grade securities. For example, FHFA
officials said that it could be difficult to establish a value for
agricultural and small business loans because they generally have not
been actively traded in secondary markets. In the absence of secondary
markets, alternative collateral may be relatively illiquid, which
means an FHLBank might face difficulties in selling such underlying
collateral if a CFI failed or defaulted on its advance.[Footnote 21]
As described earlier, FDIC generally pays the FHLBank the principal
balance of the outstanding advances of failed members and takes
possession of the underlying collateral. However, FDIC may not always
follow this procedure in future bank failures and the possibility of a
CFI defaulting on a loan or failing would put the FHLBank at a risk of
losses, as it might be unable to sell the alternative collateral in a
timely manner.[Footnote 22] In contrast, FHLBanks generally can more
easily estimate values for traditional collateral because mortgages
often are pooled into securities and actively traded on secondary
markets. In the event a member failed or defaulted on its outstanding
advances, the FHLBanks generally would be able to sell the underlying
collateral that secured the mortgages or securities.
In a previous report, we commented on the challenges associated with
establishing values for small business loans as compared with single-
family mortgage loans.[Footnote 23] Unlike mortgage lending, small
business loans exhibit greater heterogeneity and more complexity. For
example, although mortgage lending has become more complicated in
recent years, the type of financing that prospective homebuyers seek
remains fairly standardized (two general categories--fixed-or variable-
rate loans) and the collateral securing mortgages, generally single-
family residences, is relatively easy to understand and market. In
contrast, the types of financing that small businesses typically seek
can range from revolving lines of credit to term loans, and the
collateral pledged against such loans also may vary widely in risk and
marketability (from relatively secure real estate to less secure
inventory).
The 10 FHLBanks that accept alternative collateral have adopted risk-
management policies intended to mitigate the perceived risks of such
collateral, but which also may limit its appeal to CFIs. These
FHLBanks generally apply higher haircuts to alternative collateral
than to any other type of collateral that may be used to secure
advances. As shown in table 4, the haircuts, or range of haircuts,
that the FHLBanks apply to alternative collateral generally have been
higher than for traditional forms of collateral, such as single-family
mortgages or commercial real estate loans. The maximum haircut applied
by an FHLBank to alternative collateral is 80 percent under a blanket
lien policy, which generally means that the member could take out an
advance of up to 20 percent of the value of such collateral, whereas
the maximum haircut applied to commercial real estate collateral is 67
percent. Over the years, commercial real estate has been viewed as a
potentially risky type of asset that has resulted in significant bank
losses and numerous bank failures.[Footnote 24]
Table 4: Percentage Haircut Requirements for the 10 FHLBanks That
Accept Alternative, Single-Family, and Commercial Real Estate
Collateral under a Blanket Lien Option[A]:
FHLBank district: Bank A;
Alternative collateral haircuts: Small business: 40;
Alternative collateral haircuts: Small farm: 50;
Alternative collateral haircuts: Small agribusiness: 50;
Single-family: 17;
Commercial real estate: 40 or 60.
FHLBank district: Bank B;
Alternative collateral haircuts: Small business: 50[C];
Alternative collateral haircuts: Small farm: 50[C];
Alternative collateral haircuts: Small agribusiness: 50[C];
Single-family: 25;
Commercial real estate: 67[C].
FHLBank district: Bank C[B];
Alternative collateral haircuts: Small business: 67-80;
Alternative collateral haircuts: Small farm: 67-80;
Alternative collateral haircuts: Small agribusiness: 67-80;
Single-family: 20-43;
Commercial real estate: 46-58.
FHLBank district: Bank D[B];
Alternative collateral haircuts: Small business: 40;
Alternative collateral haircuts: Small farm: 60;
Alternative collateral haircuts: Small agribusiness: 60;
Single-family: 25;
Commercial real estate: 40.
FHLBank district: Bank E[B];
Alternative collateral haircuts: Small business: 67;
Alternative collateral haircuts: Small farm: 50;
Alternative collateral haircuts: Small agribusiness: [D];
Single-family: 31;
Commercial real estate: 50.
FHLBank district: Bank F[B];
Alternative collateral haircuts: Small business: 55-65;
Alternative collateral haircuts: Small farm: 55-65;
Alternative collateral haircuts: Small agribusiness: 55-65;
Single-family: 31-40;
Commercial real estate: 45-55.
FHLBank district: Bank G;
Alternative collateral haircuts: Small business: 50;
Alternative collateral haircuts: Small farm: 50;
Alternative collateral haircuts: Small agribusiness: 50;
Single-family: 25;
Commercial real estate: 50.
FHLBank district: Bank H[B];
Alternative collateral haircuts: Small business: 50-76;
Alternative collateral haircuts: Small farm: [D];
Alternative collateral haircuts: Small agribusiness: 50-76;
Single-family: 15-44;
Commercial real estate: 46-57.
FHLBank district: Bank I[B];
Alternative collateral haircuts: Small business: 75;
Alternative collateral haircuts: Small farm: 75;
Alternative collateral haircuts: Small agribusiness: 75;
Single-family: 36-41;
Commercial real estate: 48-53.
FHLBank district: Bank J[B];
Alternative collateral haircuts: Small business: 50-51;
Alternative collateral haircuts: Small farm: 35;
Alternative collateral haircuts: Small agribusiness: 50;
Single-family: 7-30;
Commercial real estate: 51.
FHLBank district: Total haircut range;
Alternative collateral haircuts: Small business: 40-80;
Alternative collateral haircuts: Small farm: 40-80;
Alternative collateral haircuts: Small agribusiness: 40-80;
Single-family: 7-44;
Commercial real estate: 40-67.
Source: GAO analysis of FHLBank collateral policies.
[A] The FHLBanks use different methods to reflect the percentage
haircut requirement on collateral. We have converted their different
measures to one consistent standard for purposes of comparison.
[B] Indicates FHLBanks whose haircuts for alternative collateral are
generally higher than for single family and commercial real estate
collateral:
[C] Data reflect haircuts under a specific or listed lien agreement
because the FHLBank does not accept these collateral types under a
blanket lien.
[D] The FHLBank does not accept the loan type as collateral.
[End of table]
The haircuts that the FHLBanks apply to alternative collateral can
vary significantly. For example, the haircut on small business loans
ranges from 40 to 80 percent. In contrast, two FHLBanks apply a
uniform 50 percent haircut to all three types of alternative
collateral (see table 4). We discuss the extent to which the FHLBanks
have an analytical basis for the haircuts applied to alternative
collateral later in this report.
Some FHLBanks also maintain other collateral policies designed to
mitigate the perceived risks associated with alternative collateral.
For example, the FHLBanks have established borrowing capacity limits
to further minimize the risks associated with making advances and
generally apply them to all members. However, some FHLBanks have
established more stringent borrowing limits for members pledging
alternative collateral. For example, in addition to applying haircuts
of more than 50 percent, one FHLBank limits the amount of alternative
collateral that a member may pledge to 20 percent of the member's
total assets. One FHLBank sets the limit at 10 percent, in addition to
its 50 percent haircut. In contrast, most other FHLBanks' policies set
borrowing capacity rates from 30 to 55 percent for members.
CFIs Generally Valued Their Relations With FHLBanks, but Half Raised
Concerns about Haircuts on Alternative Collateral or Other FHLBank
Risk-Management Policies:
While many CFIs may have significant traditional collateral resources
to pledge to secure advances, we conducted interviews with 30 CFIs
that could be constrained in their ability to obtain FHLBank advances
due to their significant involvement in agricultural or small business
lending. Most of the CFIs in our sample said that they valued the
products and services they received from their local FHLBank.[Footnote
25] Officials from many of the CFIs said that FHLBank membership
provided their institutions with access to a stable and relatively low-
cost source of liquidity or provided access to a key source of backup
liquidity, among other things. Officials from several CFIs that have
significant concentrations in agricultural loans said that their
ability to pledge such loans as collateral helped them to obtain
advances and thereby expand their lending activities, because the
advances generally allowed CFIs to provide borrowers with long-term
financing on favorable terms.
To some degree, the results from our interviews with officials from
the 30 CFIs were consistent with rationales offered by FHLBank and
FHFA officials about the minimal use of alternative collateral in the
FHLBank System. Officials from 15 of the 30 CFIs we interviewed said
that they had pledged alternative collateral to help secure FHLBank
advances and officials from all but one of these reported having
advances outstanding (see table 5). Officials from the other 15 CFIs
said they had not used alternative collateral to secure an advance
because, for example, they generally had sufficient traditional
collateral to secure advances or sufficient levels of other sources of
liquidity, such as customer deposits, to finance their lending
activities (see table 5). As discussed previously, FHLBank officials
have stated that readily available traditional collateral is one
reason that many CFIs have not pledged alternative collateral to
obtain advances.
Table 5: CFIs Reported Use of Alternative Collateral to Secure
Advances:
Reported alternative collateral usage: Used;
Reported currently having outstanding advances: 14;
Did not report currently having outstanding advances: 1;
No response: 0;
Total: 15.
Reported alternative collateral usage: Not used;
Reported currently having outstanding advances: 9;
Did not report currently having outstanding advances: 5;
No response: 1;
Total: 15.
Reported alternative collateral usage: Total;
Reported currently having outstanding advances: 23;
Did not report currently having outstanding advances: 6;
No response: 1;
Total: 30.
Source: GAO.
[End of table]
However, officials from 15 of the 30 CFIs we interviewed expressed
concern about the haircuts applied to alternative collateral or other
FHLBank policies that may limit its appeal and use. Of these 15 CFIs,
officials from 11 specifically expressed concern about the level of
haircuts. These officials, some of whom had not yet pledged
alternative collateral to secure an advance, said that their local
FHLBank's large haircuts were a factor in their banks' decision not to
pledge alternative collateral. Some of the officials also said that
their local FHLBank's haircuts were not consistent with historical
losses on small business, small farm, or small agribusiness loans.
[Footnote 26]
Officials from 4 of the 15 CFIs expressed concern about other FHLBank
policies unrelated to haircuts, which included limitations on the
types of alternative collateral accepted by some FHLBanks and limits
on borrowing that some FHLBanks apply to alternative collateral.
[Footnote 27] For example, an official from an agricultural CFI with
$56 million in total assets said that its local FHLBank has a policy
that limits the amount of an advance a CFI member could obtain using
alternative collateral to 10 percent of total assets. The official
characterized the policy as highly restrictive, particularly for a
small agricultural lender. The FHLBank to which this lender belongs
permits non-CFI members using traditional collateral to secure an
advance to borrow up to 35 percent of their total assets.
FHFA's Oversight of the FHLBanks' Alternative Collateral Policies and
Practices Has Been Limited:
While FHFB held a conference in 2005 on the use of alternative
collateral which may have focused the FHLBanks' attention on the
issue, regulatory oversight of the FHLBanks' policies and practices
for such collateral, from a mission standpoint, has been limited.
[Footnote 28] For example, FHFA examiners have not been routinely
directed to assess the FHLBanks' analytical basis for the haircuts on
alternative collateral, although they are directed to do so for
traditional forms of collateral. In the absence of regulatory
oversight, the FHLBanks have exercised wide discretion in establishing
policies and practices pertaining to alternative collateral over the
years. Although the FHLBanks may view these policies and practices as
necessary to protect their financial soundness, our review also
indicates that many FHLBanks have not substantiated through
documentation the analytical basis for such policies, including
establishing the haircut levels. Available FHLBank documentation
suggests that some haircuts applied to alternative collateral may need
to be lowered and others raised. Moreover, a majority of the FHLBanks
have not established quantitative performance goals for products,
related to agricultural and small business lending in their strategic
business plans, which could include alternative collateral, as
required by agency regulations. Additionally, the FHLBanks are not
required to identify and address agricultural and small business
financing needs in their communities, including potential uses for
alternative collateral, through a process of market analysis and
consultations with stakeholders as they are required to do by FHFA
regulations for their Targeted Community Development Plans, which
agency officials said largely pertain to the AHP and CIP programs.
FHFA officials said they have not focused oversight efforts on
alternative collateral policies and practices because its minimal use
within the FHLBank System does not represent a safety and soundness
concern. But, without more proactive oversight by FHFA from a mission
standpoint, the appropriateness of FHLBank alternative collateral
policies may not be clear.
FHFA Examinations Do Not Include Reviews of the FHLBanks' Analytical
Basis for Their Alternative Collateral Policies and Practices:
While FHFA examination guidance does not require reviews of FHLBank
alternative collateral policies and practices, it does include
procedures related to general collateral management policies and
practices. For example, examiners are expected to assess whether each
FHLBank has addressed appropriate levels of collateralization,
including valuation and collateral haircuts. According to FHFA
officials, at every examination an examiner will review documentation
of the FHLBanks' general collateral valuation and haircut analyses,
and any available underlying financial models.
Our review of FHFB and FHFA examinations of each of the 12 FHLBanks
over the past three examination cycles confirmed that examiners did
not address the FHLBanks' alternative collateral management policies
and practices.[Footnote 29] However, consistent with the examination
guidance, the examinations did include analysis of the FHLBanks'
general collateral policies and practices. For example, FHFA examiners
noted that one FHLBank did not regularly review its collateral
haircuts and that the current haircuts had not been validated by well-
documented analyses. Examiners also found that another FHLBank
disregarded the results of a collateral valuation model to establish
haircuts for certain members without sufficient analysis to support
the decision. FHFA officials we contacted said that due to mounting
concerns about the FHLBanks' safety and soundness in 2009, the agency
conducted a focused review of the FHLBanks' collateral management
practices, including valuation and haircut methodologies. They also
noted that they have been monitoring the FHLBanks' progress in
responding to examiners' recommendations to improve documentation of
their general collateral haircut policies.
FHFA guidance also includes procedures for assessing the FHLBanks'
compliance with other mission-related programs. Specifically, the
examination guidance includes procedures for assessing the FHLBanks'
implementation of the AHP and the CIP programs. As established by FHFA
guidance, examiners should assess the effectiveness of these programs
at each FHLBank and whether program operations were consistent with
the laws and policies that govern them. For example, the examination
guidance indicates that examiners should evaluate the reasonableness
of fees associated with these programs, whether the FHLBank has met
its established community lending goals, and the extent to which the
projects funded by the programs benefited eligible targeted businesses
or households. Our review found that the examinations generally
included sections that assessed the FHLBanks' implementation of AHP
and CIP programs.
FHFA officials cited several reasons why the agency's examination
procedures and practices did not specifically address alternative
collateral. First, they said that the use of alternative collateral
was minimal and did not represent a significant safety and soundness
concern. Because single-family mortgages, investment-grade securities,
and commercial real estate loans represent the vast majority of member
assets that are pledged to secure advances, FHFA officials said that
they have focused their examination resources on them. They wanted to
ensure that the FHLBanks have established adequate policies and
procedures for managing such collateral, including the analytical
basis for the haircuts applied to it, and the mitigation of potential
losses. Furthermore, FHFA officials said important differences between
alternative collateral and other mission-related programs, such as the
AHP program, explained the differences in the agency's oversight
approaches. They said that FIRREA establishes specific requirements
for how the AHP program is to be funded and implemented. For example,
the statute establishes the level of annual contribution from each
FHLBank to fund their AHP programs as well as minimum requirements for
the FHLBanks' mandated AHP implementation plans. In contrast, FHFA
officials said GLBA only authorizes the FHLBanks to accept alternative
collateral to secure advances, and does not establish specific
requirements for operating the program that could be assessed through
examinations.
In the Absence of FHFA Examination Oversight, FHLBanks Have Wide
Discretion to Establish Haircuts and Other Policies for Alternative
Collateral, but Documentation to Support These Policies Is Limited:
While FHFA may prioritize FHLBank safety and soundness concerns and
the structure of the AHP and CIP programs may facilitate their
oversight from a mission standpoint, FHFA's, as well as FHFB's,
limited oversight of alternative collateral may have limited its
appeal within the FHLBank System. By not implementing examination
procedures that are consistent with its general approaches to
monitoring FHLBank collateral practices, FHFA has provided the
FHLBanks with wide discretion in adopting policies and practices for
alternative collateral. Although the FHLBanks may have adopted
policies that they believe are necessary to protect their financial
interests while complying with their missions, our work indicates that
the analytical bases for these generally have not been fully
documented.
Although federal internal control standards established that key
decisions need to be documented, one of the two FHLBanks that has not
accepted alternative collateral provided a documented basis for its
policy.[Footnote 30] Further, of the 10 FHLBanks that accept
alternative collateral, 3 provided documentation of the basis of the
haircuts that they applied to such collateral. Analysis from 2
FHLBanks suggested that their haircuts for all types of alternative
collateral were too high and 1 FHLBank subsequently revised the
haircuts downward by an average of about 11 percentage points. The
other FHLBank's analysis suggested that the haircuts it applied to
agricultural collateral might be too high, while the haircuts for
small business collateral might be too low. Of the 7 FHLBanks that did
not provide any documentation of their alternative collateral
haircuts, officials from 3 said they have not documented such analysis
and the other 4 did not respond to our requests. An official from 1 of
the FHLBanks that has not established documentation for its
alternative haircuts said they had been set at a level to be
"conservative." As discussed previously, FHFA guidance directs
examiners to assess the analytical basis for the haircuts applied to
other forms of collateral.
We also analyzed FDIC data on the estimated losses on various loan
categories in banks that failed or were on the verge of failure
between January 2009 and February 2010, which raises some questions
and reinforces the need for further analysis of the risks associated
with alternative collateral. Prior to a bank's failure, FDIC
contractors conduct on-site reviews to assess the value (defined as
the estimated market value of the loans as a percentage of the
outstanding balances) of the assets held by the bank to calculate how
much the failure will cost the Deposit Insurance Fund.[Footnote 31]
According to FDIC officials, estimates are made on the value of the
loans of such banks, including single-family residential loans,
residential and nonresidential construction loans, consumer loans,
business loans, and agricultural loans. According to the FDIC data,
the estimated value of agricultural loans was higher than the value of
any other type of loan reviewed. Our discussions with several
agricultural CFIs and reviews of some regulatory and independent
reports also suggest that the U.S. agricultural economy has performed
somewhat better than the broader economy in recent years, which may
explain why such collateral recently may have outperformed other types
of loans as suggested by FDIC data.[Footnote 32] Furthermore, while
the commercial and industrial loans category (which includes small
business loans) had a lower estimated value than the agricultural,
consumer, and single-family mortgage loan categories, according to the
FDIC's asset valuation estimates, it had a higher estimated value than
the nonresidential and residential construction loan categories.
[Footnote 33]
However, important limitations apply to any analysis of these FDIC
data. First, because the data only cover recent bank failures or near
failures, they do not provide a historical basis to assess the
relative risk of the various loan types. Many banks have failed
recently primarily due to substantial losses on residential mortgages
and commercial real estate loans, of which each has experienced
significant price declines.[Footnote 34] Second, the analysis does not
control for any other factors that may be related to FDIC's asset
valuation estimates, such as the characteristics of the loans made by
the banks. Nevertheless, these data raise questions about the
FHLBanks' analytical basis for the haircuts that are currently applied
to alternative collateral as well as the need for FHFA to routinely
review the basis for these policies from a mission standpoint to help
ensure that they are not unduly limiting the use of such collateral to
secure advances.
FHFA Has Not Enforced or Amended Regulations That Could Focus the
FHLBanks' Attention on Agricultural and Small Business Lending,
Including the Use of Alternative Collateral:
In 2000, FHFB issued regulations, which remain in effect today, that
require each FHLBank's board of directors to adopt a strategic
business plan that describes how the business activities of the
FHLBank will achieve its mission. As part of the strategic business
plan, FHLBanks must establish quantitative performance goals for
products related to multifamily housing, small business, small farm,
and small agribusiness lending. Such products could include advances
to CFIs that are secured by alternative collateral. As part of its
mission oversight responsibilities, FHFA is responsible for ensuring
that the FHLBanks comply with these annual goal requirements in
establishing their plans.
Our review indicates that the strategic business plans of five
FHLBanks do not include such goals. While the remaining seven FHLBanks
have established goals for alternative collateral lending, three have
set goals at zero. The four FHLBank strategic business plans that
include the required goals establish annual benchmarks for the number
or dollar amount of advances made to members for the purpose of
lending to small businesses, small farms, and small agribusinesses.
FHFA officials said that lending goals for alternative collateral are
not part of its planned review of FHLBanks' 2010 strategic business
plans. In the absence of vigorous oversight and enforcement by FHFA,
many FHLBanks may continue to place a low priority on requirements
that they establish quantitative annual goals for products related to
agricultural and small business lending, which could include advances
secured by alternative collateral.
According to FHFA officials, the regulation pertaining to the AHP and
CIP programs requires the FHLBanks to develop annual Targeted
Community Lending Plans to address identified credit needs and market
opportunities for targeted community lending in their districts.
[Footnote 35] To develop these plans, FHLBanks are to consult with
members, economic development organizations, and others, and establish
quantitative community lending goals. FHLBanks also must conduct
market research to ascertain their district's economic development
needs and opportunities. The regulator then uses the Targeted
Community Lending Plans to help determine the extent to which FHLBanks
have achieved their mission to provide community and economic
development opportunities in their districts.
Although FHFA's regulation that requires the establishment of Targeted
Community Lending Plans may provide a means for the FHLBanks to
identify lending and economic development needs within their
communities and respond accordingly, it does not specifically require
the FHLBanks to analyze small business and agricultural lending needs
or opportunities for the use of alternative collateral. According to
FHFA officials, this is because the regulation pertains specifically
to the AHP and CIP programs. Given that FHFA does not require the
FHLBanks to include an assessment of opportunities to use alternative
collateral to support small business and agricultural lending in their
Targeted Community Lending Plans, such plans generally have not
addressed such issues. One FHLBank's Targeted Community Lending Plan--
that of the FHLBank of Indianapolis--did discuss issues pertaining to
agricultural and small business lending. Specifically, the plan for
2010 stated that the Bank intends to increase its small business,
small farm, or small agribusiness lending by 5 percent in the next
year.
While FHFA officials told us that the regulation that requires the
FHLBanks to develop Targeted Community Lending Plans does not pertain
to alternative collateral, we note that the general process involved
in creating the plans is potentially beneficial in that it calls on
the FHLBanks to review relevant information and consult with
stakeholders in their communities to identify and address relevant
lending needs. A similar process--through revisions to FHFA's
regulations pertaining to Targeted Community Lending Plans, or
strategic business plans, or other measures as appropriate--that would
require the FHLBanks to assess agricultural and small business lending
needs as well as opportunities to use alternative collateral, could
better focus their attention on potential opportunities and strategies
to enhance such financing.
Conclusions:
GLBA's inclusion of new types of collateral for CFIs indicates that
these types of available collateral should be taken in account when
formulating strategies for the FHLBanks' economic development efforts.
However, the regulators' limited oversight of FHLBank alternative
collateral policies and practices over the years has provided the
FHLBanks with wide discretion to establish risk-management policies,
which although viewed as necessary to protect against potential losses
may involve an off-setting trade-off. That is, they may unduly limit
the appeal and use of alternative collateral.
We have identified several areas of concern. In many cases the
FHLBanks have not substantiated and documented their reasons for not
accepting alternative collateral or applying relatively high haircuts
to it. Available FHLBank documentation suggests that some alternative
collateral haircuts may be too high; limited FDIC asset valuation
estimates indicate that the risks associated with alternative
collateral can vary over time; and 15 of the 30 CFI representatives we
interviewed expressed concerns about haircuts applied to such
collateral and other risk-management practices, some of whom said such
policies and practices limited their willingness to use alternative
collateral. In addition, because FHFA has not leveraged its existing
examination procedures to include an assessment of the FHLBanks'
alternative collateral policies, the appropriateness of such policies
may not be clear. Furthermore, FHFA has not ensured that all FHLBanks
establish quantitative goals for products related to agricultural and
small business lending, which could include alternative collateral, in
their strategic business plans as required by the agency's
regulations. Finally, FHFA has not taken steps, such as revising its
regulations pertaining to Targeted Community Development Plans, or
strategic business plans, or other measures as may be appropriate, to
follow a process whereby they conduct market analysis and consult with
a range of stakeholders in their communities to identify and address
agricultural and small business financing needs, including the use of
alternative collateral. We recognize that FHFA has critical
responsibilities to help ensure that the FHLBanks' operate in a safe
and sound manner, and has not focused on alternative collateral
because it was not deemed a risk to safety and soundness.
Nevertheless, the agency also has an obligation to take reasonable
steps to help ensure that the FHLBank System is achieving the missions
for which it was established, including economic development through
the use of alternative collateral.
Recommendations for Executive Action:
We recommend that the Acting Director of FHFA take the following
actions to help ensure that the FHLBanks' economic development mission-
related activities include the appropriate use of alternative
collateral, as provided for in GLBA.
* Revise FHFA examination guidance to include requirements that its
examiners periodically assess the FHLBanks' alternative collateral
policies and practices, similar to the manner in which other forms of
collateral, such as single-family mortgages, are assessed.
Specifically, FHFA should revise its guidance to ensure that examiners
periodically assess the FHLBanks' analytical basis for either (1) not
accepting alternative collateral, or (2) establishing their haircuts
and other risk-management policies for such collateral.
* Enforce regulatory requirements that the FHLBanks' strategic
business plans include quantitative performance goals for products
related to agricultural and small business financing, including the
use of alternative collateral as appropriate.
* Consider requiring the FHLBanks, through a process of market
analysis and consultations with stakeholders, to periodically identify
and address agricultural and small business financing needs in their
communities, including the use of alternative collateral. Such
requirements could be established through revisions to FHFA's
regulations for Targeted Community Development Plans or strategic
business plans or through other measures as deemed appropriate.
Agency Comments and Our Evaluation:
We provided a draft of this report to FHFA for its review and comment.
We received written comments from FHFA's Acting Director, which are
reprinted in appendix II. In its comments, FHFA expressed certain
reservations about the analysis in the draft as discussed below, but
agreed to implement our recommendations. Specifically, FHFA stated
that the agency would (1) review each FHLBank's policies and
practices, starting with the 2011 annual supervisory examination
cycle, to assure that they can substantiate their collateral practices
and are meeting their CFI members' liquidity needs; (2) issue an
Advisory Bulletin to the FHLBanks that provides supervisory guidance
on how to include goals for alternative collateral in the preparation
of FHLBank strategic business plans beginning in 2011, and review
those plans to ensure they include such goals; and (3) direct the
FHLBanks to document their outreach and alternative collateral needs
assessment efforts in their strategic business plans, and instruct
examiners to monitor the FHLBanks' efforts in these areas as part of
the agency's ongoing supervisory review. FHFA also provided technical
comments, which we incorporated as appropriate.
In commenting on the draft report, FHFA said that it has no evidence
that any CFI member is collaterally constrained and unable to access
advances as a result of the FHLBanks' collateral risk management
practices. FHFA also said that it has no evidence that any issues
discussed in the draft report have resulted in or contributed to a
lack of liquidity for small farm, agriculture, and small business
lending. In addition, FHFA noted that in many cases, CFI members
obtain sufficient liquidity by pledging real estate-related collateral
and, therefore, CFI members' ability to obtain an advance is not
limited by the type of collateral they have. While our draft report
noted that most CFIs may not be collaterally constrained, we
identified nearly 800 CFIs, constituting about 13 percent of all CFIs,
that may face challenges in obtaining an advance using traditional
collateral because they have substantial amounts of small business and
agricultural collateral on their books. Further, we interviewed a
nongeneralizable sample of 30 of these CFIs and found that half of
them expressed concerns with FHLBank haircuts and other policies
related to alternative collateral. Several CFIs said that the haircuts
applied to alternative collateral were a factor in their decision not
to pledge alternative collateral to secure an advance. In agreeing to
implement the recommendations, FHFA will have the information
necessary to help assess the extent to which CFIs may face challenges
in obtaining financing as well as the appropriateness of FHLBank
alternative collateral policies and practices.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to other interested congressional committees and to the Acting
Director of the Federal Housing Finance Agency. In addition, the
report will be available at no charge on GAO's Web site at [hyperlink,
http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made major contributions
to this report are listed in appendix III.
Signed by:
William B. Shear:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The objectives of this report were to (1) discuss factors that may
limit the use of alternative collateral to secure Federal Home Loan
Bank (FHLBank) advances; and (2) assess selected aspects of the
Federal Housing Finance Agency's (FHFA) oversight of the FHLBanks'
alternative collateral policies and practices.
To address the first objective, we reviewed relevant sections of the
Gramm-Leach-Bliley Act of 1999, the Housing and Economic Recovery Act
of 2008, and FHLBank collateral policies and procedures, particularly
those pertaining to alternative collateral. While we were able to
review each FHLBank's collateral policies and procedures, the
confidentiality of such information limited what we could publicly
disclose in our report. Specifically, because the collateral haircut
policies of some of the FHLBanks generally are considered to be
proprietary, we were unable to specify the policies of individual
FHLBanks. Where appropriate, we used an alphabetic system when
discussing FHLBank collateral policies and limited discussion of
details to ensure the protection of the FHLBanks' identities. We also
conducted interviews with representatives from FHFA, the regulator of
the FHLBank System; the 12 FHLBanks; the Council of Federal Home Loan
Banks; the Independent Community Bankers of America; and obtained
information from a nongeneralizable, random sample of 30 Community
Financial Institutions (CFI).
To develop the nongeneralizable, stratified random sample of 30 CFIs,
we first identified the population of CFIs that may have limited
sources of traditional collateral to secure FHLBank advances. To
identify CFIs that may have relatively large volumes of agriculturally
related loans on their books, we used the Federal Deposit Insurance
Corporation's (FDIC) definition of an agricultural bank; that is, a
bank having 25 percent or more of its loans associated with
agricultural lending. FHFA provided a list of 6,281 CFI members as of
September 30, 2009--of which 470 met FDIC's definition of an
agricultural bank, meaning that they held at least 25 percent of their
assets in agricultural loans. (We note that the report includes
updated data on agricultural banks as of year-end 2009.) To identify
CFIs that may have relatively large volumes of small business loans on
their books, we used information from the Small Business
Administration's (SBA) Office of Advocacy.[Footnote 36] Specifically,
because there is no similar threshold to define a small business
lender, we used the SBA's Office of Advocacy's determination of the
top 10 percent of small business lenders in each state to determine
the small business sample population. We then matched and merged this
list of institutions, by institution name, with FHFA's list of CFI
members. The resulting list included 326 small business CFIs and their
total assets for each FHLBank district. The final sample population of
agricultural and small business CFIs totaled 796. From this final
sample population, we identified 10 lenders that met the definition of
both an agricultural and small business CFI. We sampled this dual-
status CFI population separately because of its potential to provide a
unique perspective on alternative collateral in the FHLBank System.
Our sample was stratified to ensure that it included the perspective
of CFIs located in FHLBank districts that had (1) high, some, or no
use of alternative collateral, as of year-end 2008; and, (2) banks
that are very small, meaning less than $100 million in total assets.
We defined an FHLBank as having had a "high" acceptance of alternative
collateral if it accepted more than $500 million in alternative
collateral in 2008; "some" acceptance if it accepted from $1 to $500
million in alternative collateral in 2008; and "no" acceptance if it
accepted no alternative collateral ($0) in 2008. We then over sampled
within each stratum to accommodate refusals to participate and
randomly selected a nongeneralizable sample of 30 CFIs (see table 6).
Table 6: Characteristics of GAO's Nongeneralizable, Random Sample of
30 CFIs:
FHLBank district: Atlanta;
Level of acceptance of alternative collateral: None;
Small business CFI: 2;
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: Boston[A];
Level of acceptance of alternative collateral: Some;
Small business CFI: [Empty];
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: Chicago;
Level of acceptance of alternative collateral: Some;
Small business CFI: 2;
Agricultural CFI: 5;
Dual-status CFI: [Empty].
FHLBank district: Cincinnati;
Level of acceptance of alternative collateral: None;
Small business CFI: 1;
Agricultural CFI: 1;
Dual-status CFI: [Empty].
FHLBank district: Dallas;
Level of acceptance of alternative collateral: High;
Small business CFI: 1;
Agricultural CFI: [Empty];
Dual-status CFI: 1.
FHLBank district: Des Moines;
Level of acceptance of alternative collateral: High;
Small business CFI: 1;
Agricultural CFI: 4;
Dual-status CFI: 1.
FHLBank district: Indianapolis;
Level of acceptance of alternative collateral: Some;
Small business CFI: 1;
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: New York[A];
Level of acceptance of alternative collateral: None;
Small business CFI: [Empty];
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: Pittsburgh;
Level of acceptance of alternative collateral: None;
Small business CFI: 2;
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: San Francisco;
Level of acceptance of alternative collateral: High;
Small business CFI: 1;
Agricultural CFI: [Empty];
Dual-status CFI: [Empty].
FHLBank district: Seattle;
Level of acceptance of alternative collateral: Some;
Small business CFI: 2;
Agricultural CFI: 2;
Dual-status CFI: [Empty].
FHLBank district: Topeka;
Level of acceptance of alternative collateral: High;
Small business CFI: 1;
Agricultural CFI: 1;
Dual-status CFI: 1.
FHLBank district: Total;
Level of acceptance of alternative collateral: [Empty];
Small business CFI: 14;
Agricultural CFI: 13;
Dual-status CFI: 3.
Source: GAO.
[A] While our sample included CFIs from the Boston and New York
FHLBank districts, no CFIs from these districts agreed to participate
in our interviews.
[End of table]
To obtain information from the CFIs in our sample, we used a Web-based
protocol to conduct structured telephone interviews. The majority of
responses, 29, were obtained by telephone; and 1 was obtained by e-
mail. We used data from FHFA on the use of alternative collateral
throughout the FHLBank System and information from our interviews with
the 12 FHLBank representatives to develop our structured interview. We
pretested the structured interview protocol and made revisions as
necessary. Questions from the structured interview focused on the
background and local economies of the CFIs, their use of products and
services from their local FHLBank, and their views of and experience
with pledging alternative collateral to obtain an advance from an
FHLBank. The views expressed by representatives of the CFIs in our
sample cannot be generalized to the entire population of all CFIs.
To present details and illustrative examples regarding the information
obtained from the CFI interviews, we analyzed the narrative (open-
ended) and closed-ended responses and developed summaries. These
summaries were then independently reviewed to ensure that original
statements were accurately characterized.
To assess the FHFA and FDIC data used in our analyses, we interviewed
agency officials knowledgeable about the data. In addition, we
assessed FHFA, FDIC, and SBA's Office of Advocacy data for obvious
outliers and missing information. To assess the accuracy of the SBA's
Office of Advocacy and FHFA data, we compared a sample of it against
public information from the Federal Financial Institutions Examination
Council's Uniform Bank Performance Report, which is an analytical tool
created for bank supervisory, examination, and management purposes and
can be used to understand a bank's financial condition. We determined
that the data were sufficiently reliable for the purpose of this
engagement.
For the second objective, we reviewed FHFA's examination policies and
procedures and federal internal control standards, as well as a total
of 23 FHFA and Federal Housing Finance Board (the FHFA predecessor)
examinations covering each of the 12 FHLBanks over the past three
examination cycles. We reviewed FHFA's regulation pertaining to the
development of strategic business plans and we reviewed 11 FHLBanks'
plans for 2010; and 1 plan submitted for 2009 because it was the most
recently available for that FHLBank. Additionally, we reviewed FHFA's
regulation pertaining to the development of Targeted Community Lending
Plans and we reviewed each of the 12 FHLBanks' plans for 2010. We also
discussed FHFA's oversight program for alternative collateral with
senior agency officials.
Finally, we conducted limited analysis to gain a perspective on the
level of FHLBank haircuts applied to alternative collateral. To do so,
we obtained and reviewed documentation of analyses from 3 FHLBanks;
the other 9 FHLBanks generally did not provide such documentation.
Confidentiality considerations limited the amount of information we
could disclose about the analyses from the 3 FHLBanks that provided
documentation. We also obtained and analyzed data from FDIC on the
estimated losses from banks that failed or were on the verge of
failure, by various loan types, for the period January 2009 through
February 2010. These data were obtained through asset specialists who
were contracted by FDIC to review the asset portfolios of failed
institutions and to develop anticipated loss rates, expressed as a
percentage of outstanding loan balances, on the various categories of
the banks' asset portfolios. As discussed in this report, this
approach has several important limitations, including not providing a
historical basis for estimating the risks associated with alternative
collateral over time or controlling for any other factors that may be
related to the characteristics of the loans made by the banks. To
assess the reliability of the FDIC data, we interviewed agency
officials knowledgeable about the data. In addition, these data are
corroborated by information from our CFI interviews and several
independent reports which suggest that the agricultural sector has
performed somewhat better than the broader economy in recent years. We
determined that the data were sufficiently reliable for the purpose of
this engagement, which was to understand the FHLBanks collateral
haircuts relative to the recent performance of alternative collateral
assets in the financial markets.
We conducted this performance audit from October 2009 to July 2010, in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Comments from the Federal Housing Finance Agency:
Federal Housing Finance Agency:
Office of the Director:
1700 G Street, N.W.
Washington, D.C. 20552-0003:
202-414-3800:
202-414-3823 (fax):
July 9, 2010:
Mr. William B. Shear:
Director:
Financial Markets and Community Investment:
Government Accountability Office (GAO):
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Shear:
Thank you for the opportunity to review and comment on the Government
Accountability Office (GAO) Report, Federal Housing Finance Agency:
Oversight of the Federal Home Loan Banks' Agricultural and Small
Business Collateral Policies Could he Improved.
During the course of its review, GAO identified steps that the Federal
Housing Finance Agency (FHFA) should take to assure that the FHLBanks
are providing Community Financial Institution (CFI) members sufficient
access to advances through the acceptance of small business, small
farm, and agricultural loans pledged as alternative collateral
(hereinafter, "CFI collateral"). In addition, GAO has recommended that
the FIII,Banks develop effective business and outreach strategies to
encourage the use of such collateral. FHFA accepts those
recommendations and will implement them as detailed below.
To date FHFA has no evidence that any CFI member is collateral
constrained and unable to access advances as a result of the FHLBanks'
collateral risk management practices. Nor does FHFA have evidence that
the issues identified by GAO have resulted in, or contributed to a
lack of liquidity for small farm, agriculture, and small business
lending. In many cases, CFI members obtain sufficient liquidity using
real estate-related collateral for advances. As the GAO has found in
its review, CFI members value the System as a source of liquidity.
Their access to liquidity is not limited to the amount of advances
they can receive by pledging CFI collateral.
FHFA recognizes that Congress intends for FHLBanks to allow for a
broader range of eligible collateral for CFI members. At the same
time, this collateral generally is less liquid and harder to value
than traditional mortgages and mortgage-backed securities used as
collateral. Thus, both as a practical business matter and a matter of
safety and soundness, FHFA generally would expect relatively more
reliance on mortgage-related collateral than other types of collateral.
The use of mortgage-related collateral by CFIs may make the data on
CFI collateral pledged by member institutions difficult to interpret.
For example, the GAO study is correct in stating that at year-end 2008
CFI collateral was approximately one percent of total collateral
directly and specifically pledged to the FHLBanks for advances
outstanding. However, the FHLBanks have accepted an additional $158
billion of CFI collateral, constituting more than 11 percent of total
reported collateral against which future advances could be secured.
The FHFA's detailed responses to the GAO's recommendations are
discussed below.
GAO Recommendations for Executive Action: The GAO recommends that the
Acting Director of FHFA take the following actions:
* Revise the FHFA examination guidance to include requirements that
its examiners periodically assess the FHLBanks' alternative collateral
policies and practices. Specifically, FHFA should ensure that
examiners periodically assess the FHLBanks' analytical basis for
either (1) not accepting alternative collateral, or (2) establishing
their haircuts and other risk-management policies for such collateral.
FHFA Response: The FHFA accepts the intent of the GAO's recommendation
but notes that the authority and responsibility to periodically review
the FHLBanks' collateral policies already exists in the FHLBank
examination manual and related supervisory guidance. The FHFA believes
a supervisory Advisory Bulletin to the Banks would achieve the end
sought by the GAO. Commencing with the 2011 annual supervisory
examination cycle of the FHLBanks, and thereafter as warranted, the
FHFA will review each FHLBank's policies and practices to assure that
the FHLBanks arc serving their CFI members' need for advances, and,
that the FHLBanks can substantiate their collateral acceptance,
discount and risk management practices.
* Enforce regulatory requirements that the FHLBanks' strategic
business plans include quantitative performance goals for products
related to agricultural and small business financing, including the
use of alternative collateral as appropriate.
FHFA Response: By October 31, 2010, the FHFA will issue an Advisory
Bulletin providing supervisory guidance to the FHLBanks on the
preparation of their strategic business plans to include goals for CFI
collateral commencing with their 2011 strategic business plans. FHFA
will review the FHLBanks' strategic business plans to ensure they
include quantitative goals for CFI collateral.
* Consider requiring the FHLBanks, through a process of market
analysis and consultations with stakeholders, to periodically identify
and address agricultural and small business financing needs in their
communities, including the use of alternative collateral. Such
requirements could be established through revisions to FHFA's
regulations pertaining to Targeted Community Development Plans or
strategic business plans or through other measures as deemed
appropriate.
FHFA Response: As previously mentioned, the FHLBanks' market analysis
and outreach plans will be included in the FHLBanks' strategic
business plans and each FHLBank's progress will be monitored as part
of the FHFA's review of the FHLBanks' strategic business plan
accomplishments. FHFA examiners and analysts will monitor the
FHLBanks' outreach and CFI collateral needs assessment efforts as part
of FHFA's ongoing supervisory review, both for safety and soundness
and for mission fulfillment.
If you have any questions, please Stephen Cross, Deputy Director
Division of Bank Regulation at 202-408-2980 or Sylvia Martinez, Senior
Adviser, at (202) 408-2825.
Sincerely,
Signed by:
Edward J. DeMarco:
Acting Director:
xc: Stephen Cross, Chief Operating Officer:
Paula Hayes, Deputy Chief Operating Officer:
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
William B. Shear, (202) 512-8678 or shearw@gao.gov:
Staff Acknowledgments:
In addition to the individual named above, Wesley M. Phillips,
Assistant Director; Benjamin Bolitzer; Tiffani Humble; Ronald Ito;
Fred Jimenez; Grant Mallie; Timothy Mooney; Linda Rego; Barbara
Roesmann; Jerome Sandau; and Rebecca Shea made key contributions to
this report.
[End of section]
Footnotes:
[1] 12 U.S.C. § 1430(a)(3)(E). CFIs are defined as any FHLBank member
with deposits insured by the Federal Deposit Insurance Corporation
(FDIC) and with total assets of up to $1.029 billion, as of January 1,
2010. 12 U.S.C. § 1422(10); 75 Fed. Reg. 9601 (Mar. 3, 2010). GLBA
also allows FHLBank members to make greater use of other real estate
related collateral--such as commercial real estate loans and home
equity loans--as collateral for FHLBank advances.
[2] The House Report to H.R. 10, the House bill that preceded GLBA,
states that the section on collateral for FHLBank advances was
intended "to give 'community financial institutions' greater access to
the FHLBank System," and, for the first time, the ability "to obtain
long-term advances for providing funds for small business,
agricultural, rural development, or low-income community development
lending." H.R. Rep. 106-74(I), 127-128 (1999).
[3] In supplemental remarks, the Chairman and Ranking Member of the
Subcommittee on Capital Markets, Securities, and Government Sponsored
Enterprises, House of Representatives Committee on Banking and
Financial Services, stated that by granting smaller community banks
greater access to longer-term funding with a broader base of
collateral for advances, CFIs would then be able to increase the level
of competition in underserved markets. They also stated that the
reforms would serve as an integral tool to assist well-capitalized
community banks, especially community banks in rural areas, inner
cities, and underserved neighborhoods, to obtain a more stable funding
source for intermediate-and long-term assets. See H.R. Rep. 106-74(I),
235 (1999) (statements by Rep. Baker and Rep. Kanjorski).
[4] Comments made by the Chairman of the House of Representatives,
Committee on Banking and Financial Services and the Ranking Member of
the Subcommittee on Capital Markets, Securities, and Government
Sponsored Enterprises during debate on GLBA stressed the importance of
the expanded collateral reforms in facilitating the ability of CFIs to
offer agricultural and small business financing. As a result of the
reforms, the Ranking Member stated that GLBA would provide a framework
for CFIs to offer safe, sound, and fully collateralized economic
development loans, and that he expected the FHLBanks and the Finance
Board to prioritize the system's economic development efforts. See 145
Cong. Rec. H11513, H11529, H11544 (1999) (statements of Rep. Leach and
Rep. Kanjorski).
[5] 12 C.F.R. § 917.5(a)(3).
[6] For example, FHFA has reported that while the amount of
alternative collateral securing advances doubled to $10.1 billion in
2007, it "remained low at just .8 percent of total collateral." See
Federal Housing Finance Agency, "Report on Collateral Securing
Advances at the Federal Home Loan Banks," Prepared for the Committee
on Banking, Housing, and Urban Affairs of the Senate and the Committee
on Financial Services of the House of Representatives, January 2009.
[7] As discussed in this report, the Atlanta and New York FHLBanks
have not requested approval from FHFA to accept alternative collateral
and the Cincinnati FHLBank does not report any of its CFI members
using it to secure advances, as of year-end 2008.
[8] Specifically, the collateral discount (haircut) levels established
by some of the 12 FHLBanks are considered proprietary information.
Therefore, where appropriate we use an alphabetic system to refer to
individual FHLBanks to protect their identities.
[9] FDIC defines an agricultural lender as having 25 percent or more
of its loans in that sector. In a 2009 study, SBA's Office of Advocacy
identified the largest small business lenders by state, primarily
based on the percentage of small business loans (defined as loans with
a value of $1 million or less) in their business loan portfolios. See
Small Business Administration's Office of Advocacy, Small Business and
Micro Business Lending in the United States for Data Years 2007-2008,
(Washington, D.C., May 2009).
[10] We interviewed 14 CFIs that met the definition of a small
business lender; 13 CFIs that met the definition of an agricultural
lender; and 3 that met both definitions. See appendix I for more
information on our sampling methodology.
[11] 12 C.F.R. § 931.3(d).
[12] FHLBank policies vary regarding member and/or collateral
requirements applicable to each lien type.
[13] For example, FHLBanks may set limits on the total amount of
outstanding advances to an individual member. These limits are
independent of the level of eligible collateral that a member must
pledge to secure its advances.
[14] 12 U.S.C. § 1430(i)-(j).
[15] 12 U.S.C. § 1430(j). Each FHLBank's contribution to AHP must
currently equal "10 percent of the preceding year's net income, or
such prorated sums as may be required to assure that the aggregate
contribution of the Banks shall not be less than $100,000,000 for each
such year. 12 U.S.C. § 1430(j)(5)(C).
[16] 12 U.S.C. § 1430(g). Regulations implementing this provision
require FHLBanks to have a community support program, which must
include an annual Targeted Community Lending Plan. This plan requires
the FHLBank to conduct market research in its district, describe how
it will address identified credit needs and market opportunities for
targeted community lending, and establish quantitative targeted
community lending performance goals. 12 C.F.R. § 1290.6.
[17] Fannie Mae and Freddie Mac are housing GSEs that issue debt in
the capital markets and use the proceeds to purchase mortgages from
banks and thrifts to help facilitate liquidity in the U.S. housing and
mortgage markets.
[18] On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac in
conservatorships due to their deteriorating financial condition. As
conservator, FHFA has full power to control the assets and operations
of the firms. The Congressional Budget Office estimates that the
Fannie Mae and Freddie Mac conservatorships could cost the federal
government nearly $400 billion over the next 10 years.
[19] The federal funds market refers to the principal monetary policy
tool of the Board of Governors of the Federal Reserve System (Federal
Reserve). A goal of the Federal Reserve is to promote open market
operations by achieving a desired quantity of reserves or desired
price--the federal funds rate--through the purchase and sale of U.S.
Treasury and federal agency securities. The federal funds rate is the
interest rate at which depository institutions lend balances at the
Federal Reserve to other depository institutions overnight.
[20] These data are as of September 30, 2009. Because there is no
established definition of a small business lender, we use SBA's Office
of Advocacy data as a proxy to identify significant small business
lenders. SBA's Office of Advocacy defines a small business loan as a
business loan of $1 million or less and uses a ranking methodology,
involving four variables, to create a composite score for the lending
activities of individual lenders, ranking the lenders by state. The
four variables are (1) ratio of small business loans to total assets,
(2) ratio of small business loans to total business loans, (3) dollar
value of small business loans, and (4) number of small business loans.
According to SBA's Office of Advocacy, small institutions tend to
score higher in some categories than larger institutions and vice
versa. For example, smaller lenders have a higher percentage of total
assets in small business loans, but larger lenders lead in the sheer
number and value of small loans. SBA's Office of Advocacy states that
using two ratio variables and two value variables permits a balanced
measure of lending performance by lenders of different sizes.
[21] The risk of default can be tied to the advance, the failure of
the CFI, or both.
[22] With certain exceptions, FHLBanks generally are entitled under 12
U.S.C. § 1430(e) to have priority over the claims and rights of any
party. As discussed in the text, FDIC generally pays off outstanding
FHLBank advances when a bank or thrift fails and sells the
institution's assets, including collateral that had been pledged to
secure the advances, to mitigate losses to the Deposit Insurance Fund.
See also 12 C.F.R. § 360.2.
[23] See GAO, Fair Lending: Race and Gender Data Are Limited for
Nonmortgage Lending, [hyperlink,
http://www.gao.gov/products/GAO-08-698] (Washington, D.C.: June 27,
2008).
[24] During the late 1980s and early 1990s, many banks failed in New
England and elsewhere due to concentrations in real estate lending.
See GAO, Bank and Thrift Regulation: Implementation of FDICIA's Prompt
Regulatory Action Provisions, [hyperlink,
http://www.gao.gov/products/GAO/GGD-97-18] (Washington, D.C.: Nov. 21,
1996). The Comptroller of the Currency also testified before Congress
in October 2009 that declining real estate values caused by rising
vacancies, falling rental rates, and weak sales have contributed to
substantial bank losses on commercial real estate loans in recent
years. Similarly, FDIC Chairman Sheila Bair testified that commercial
real estate loans would drive bank failures into 2010. See testimonies
of Sheila Bair, FDIC Chairman, and John C. Dugan, Comptroller of the
Currency, before the Subcommittee on Financial Institutions, Senate
Committee on Banking, Housing and Urban Affairs, Examining the State
of the Banking Industry, 111th Cong., 1st Sess., Oct. 14, 2009.
[25] Our sample included 30 CFIs that are heavily involved in
agricultural lending, small business lending, or both. Eleven CFIs in
our sample were located in the Topeka, Des Moines, and Dallas
districts--three of the districts with the heaviest usage of
alternative collateral. These three districts had a combined total of
2,610 CFI members with $487.6 billion in total assets as of December
31, 2009. The 11 CFIs in the Topeka, Dallas, and Des Moines districts
held $2.4 billion in total assets, which represented 0.2 percent of
the total CFI assets for the three districts combined.
[26] Of the 11 CFIs that expressed concern about the level of FHLBank
haircuts for alternative collateral, 5 had pledged alternative
collateral to obtain an advance and 6 had not. Of the 5 that had
pledged alternative collateral, all 5 characterized the haircuts
applied to such collateral as too high. Of the 6 CFIs that had not
pledged alternative collateral, all characterized the haircuts applied
to such collateral as too high and all noted that the haircut levels
for alternative collateral were a factor in their decision not to
pledge such collateral.
[27] Two additional CFIs expressed concern about other FHLBank
policies, such as reporting requirements and compliance costs for
alternative collateral. These CFIs are included among the 11 CFIs that
specifically expressed concern about the level of haircuts applied to
alternative collateral.
[28] In September 2005, FHFA's predecessor, FHFB, held a conference to
discuss why some FHLBanks were not using their authority to accept
alternative collateral and how to make better use of the authority
within the FHLBanks' primary mission to provide community and economic
development lending opportunities to local communities.
[29] We reviewed 23 FHLBank examinations, of which FHFB conducted 7 in
2007, and FHFA conducted 16 during 2008 and 2009.
[30] See GAO, Standards for Internal Control in the Federal
Government, [hyperlink,
http://www.gao.gov/products/GAO/AIMD-00-21.3.1] (Washington, D.C.:
November 1999).
[31] According to FDIC officials, data on estimated losses are
collected using contractors' proprietary valuation models. Staff from
FDIC's Division of Resolutions and Receiverships then review the data,
which are used to help FDIC evaluate bids from prospective acquirers
in failing bank transactions.
[32] See Congressional Oversight Panel, Special Report on Farm Loan
Restructuring (report submitted under Section 501 of Title 5 of the
Helping Families Save Their Homes Act of 2009, Pub. L. No. 111-22, 123
Stat. 1632 (2009)) and Federal Reserve Bank of Kansas City, Survey of
Tenth District Agricultural Credit Conditions, First Quarter 2010,
accessed at [hyperlink,
http://www.kansascityfed.org/agcrsurv/agcrmain].
[33] GAO is not publicly releasing the specific figures due to their
potential sensitivity in relation to FDIC's capacity to minimize the
cost of resolving failing banks.
[34] FDIC officials noted that most detailed data about failed banks
are purged every 13 months.
[35] This regulation was recently relocated by the FHFA as part of the
FHFA's transfer of the community support regulations from 12 C.F.R
part 944 to 12 C.F.R. part 1290 and is currently codified at 12 C.F.R.
§ 1290.6. See 75 Fed. Reg. 678 (January 5, 2010).
[36] In a 2009 study, SBA's Office of Advocacy identified the largest
small business lenders by state based, in part, on the percentage of
small business loans (defined as loans with a value of $1 million or
less) in their business loan portfolios. See Small Business
Administration, Office of Advocacy, Small Business and Micro Business
Lending in the United States for Data Years 2007-2008, (Washington,
D.C., May 2009).
[End of section]
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