25726 Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules

such advances at rates below the price

of advances of similar amounts,

maturities, and terms made pursuant to

section 10(a) of the Act. (12 U.S.C.

1430(a)).

(2) Advances to nonmember

borrowers. A Bank shall price advances

to nonmember borrowers made under a

CICA program established pursuant to

this section as provided in § 935.24 of

this chapter, and may price such

advances at rates below the price of

advances of similar amounts, maturities,

and terms made pursuant to section 10b

of the Act. (12 U.S.C. 1430b).

§ 970.8 Limits on access to CICA program

advances.

Any limit established by a Bank upon

members’ or nonmember borrowers’

access to CICA advances shall not

discriminate in favor of or against any

member.

§ 970.9 Reporting.

(a) CICA policies. Each Bank shall

submit to the Finance Board annually a

copy of the policies governing the

Bank’s CICA programs.

(b) Quarterly reports. Each Bank shall

report quarterly to the Finance Board on

the Bank’s use of CICAs.

Dated: April 22, 1998.

By the Board of Directors of the Federal

Housing Finance Board.

Bruce A. Morrison,

Chairman.

[FR Doc. 98–11951 Filed 5–7–98; 8:45 am]

BILLING CODE 6725–01–P

FEDERAL HOUSING FINANCE BOARD

12 CFR Part 938

[No. 98–17]

RIN 3069–AA61

Federal Home Loan Bank Standby

Letters of Credit

AGENCY: Federal Housing Finance

Board.

ACTION: Proposed Rule.

SUMMARY: The Federal Housing Finance

Board is proposing to codify its existing

policies on Federal Home Loan Bank

(FHLBank) standby letters of credit into

the form of a regulation and to amend

these policies to allow for broader use

of these products by FHLBank members

and eligible nonmember mortgagees.

The proposed rule also would eliminate

some of the restrictions currently

imposed on issuance of standby letters

of credit by FHLBanks that limit the

usefulness of these products to members

and eligible nonmember mortgagees.

DATES: Comments are due on or before

August 6, 1998.

ADDRESSES: Mail comments to Elaine L.

Baker, Executive Secretary, Federal

Housing Finance Board, 1777 F Street,

N.W., Washington D.C. 20006.

Comments will be available for

inspection at this address.

FOR FURTHER INFORMATION CONTACT:

Diane E. Dorius, Associate Director,

Program Development, Office of Policy,

(202) 408–2576; or Eric M. Raudenbush,

Attorney-Advisor, Office of General

Counsel, (202) 408–2932, Federal

Housing Finance Board, 1777 F Street,

N.W., Washington, D.C. 20006.

SUPPLEMENTARY INFORMATION:

I. Background

The FHLBanks have been permitted to

engage in standby letter of credit (LOC)

transactions since 1983, when the

predecessor agency to the Federal

Housing Finance Board (Finance Board),

the former Federal Home Loan Bank

Board (FHLBB), first adopted its Policy

Guidelines for Issuance of FHLBank

Standby Letters of Credit (FHLBB

Guidelines). Underlying this policy was

a 1983 FHLBB legal opinion which

concluded that FHLBank issuance of

standby LOCs on behalf of members is

permissible under the FHLBanks’

authority to make secured advances, set

forth in section 10 of the Bank Act, 12

U.S.C. 1430, because a FHLBank

standby LOC is the functional

equivalent of an advance in that it

involves an extension of credit by the

FHLBank to its member. Because the

FHLBB considered the authority to issue

standby LOCs to derive from the

authority to make secured advances, the

1983 FHLBB Guidelines, and the 1985

and 1989 revisions thereto, applied the

statutory and regulatory requirements

pertaining to advances to standby LOC

transactions. The substance of the

FHLBB Guidelines was maintained

when the Finance Board (created by the

Financial Institutions Reform, Recovery,

and Enforcement Act of 1989, Pub. L.

No. 101–73, 103 Stat. 412 (1989), to

succeed the FHLBB as regulator of the

FHLBanks) adopted its first standby

LOC policy in 1991.

FHLBank participation in standby

LOC transactions currently is governed

by the Finance Board’s Interim Policy

Guidelines for FHLBank Standby Letters

of Credit (Interim Guidelines), which

were adopted in 1993. The Interim

Guidelines permit FHLBanks to issue or

confirm standby LOCs on behalf of

members to facilitate: the purchase of,

or commitment to purchase mortgage

loans; the collateralization of public

unit deposits; the collateralization of

Internal Revenue Code (IRC) Section

936 deposits (deposits made in Puerto

Rican financial institutions by

corporations operating in Puerto Rico);

interest rate swaps and other

transactions that assist a member’s

asset/liability management; transactions

that promote home financing, housing

activity, or members’ involvement in

commercial and economic development

activities that benefit low-and moderateincome families or activities that are

located in low-and moderate-income

neighborhoods (community

development); and tax-exempt bonds or

notes designed to promote housing or

the financing of community

development. In addition, the Interim

Guidelines permit FHLBanks to issue

LOCs on behalf of nonmember

mortgagees eligible to obtain advances

under section 10b of the Bank Act, 12

U.S.C. 1430b, for transactions that

promote home financing, housing

activity, and community development.

Because the Finance Board retained

the substance of the FHLBB Guidelines

and, by implication, the 1983 FHLBB

legal analysis, the Interim Guidelines

continued to impose upon LOCs all of

the regulatory requirements and

restrictions that apply to advances. For

example, the Interim Guidelines require

that LOCs: be fully secured with

collateral eligible to secure advances

under § 935.9(a) of the Finance Board’s

regulations, 12 CFR 935.9(a); be counted

in the calculation of a member’s

FHLBank stock-to-advances ratio; be

issued only for housing finance

purposes if they have a term to maturity

in excess of five years, or are issued on

behalf of non-qualified thrift lender

(non-QTL) members; and be included in

the calculation of the limitation on

advances to non-QTL members set forth

in § 935.13 of the regulations, id.

§ 935.13, if issued on behalf of non-QTL

members. In addition, the Interim

Guidelines limit LOCs and

confirmations used for purposes other

than interest rate swap transactions to

terms of ten years or less and prohibit

use of LOC confirmations solely to

promote a member’s LOC program or to

increase a member’s profitability from

this fee-based service.

As part of an ongoing effort to

determine both how FHLBank standby

LOCs might be made more useful to

member institutions and nonmember

mortgagees and how to encourage

greater use of LOCs in carrying out the

housing and community investment

mission of the FHLBank System, the

Finance Board recently undertook a

survey of the FHLBanks to determine

the uses of standby LOCs and the needs

of the FHLBanks in issuing standby
Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules 25727

LOCs. The Finance Board also

undertook a review of the legal bases on

which the FHLBanks’ LOC authority has

been, and could be, grounded. As a

result of these efforts, the Finance Board

has concluded that FHLBank authority

to engage in standby LOC transactions is

not limited to the provisions addressed

in the 1983 FHLBB legal opinion, but

also may be considered to be part of,

and incidental to, the FHLBanks’

deposit-taking and payment processing

powers set forth in section 11(e) of the

Bank Act. 12 U.S.C. 1431(e). If a

FHLBank’s involvement in a standby

LOC transaction is considered to be part

of its payment processing activity,

however, FHLBank fees for LOCs may

be subject to a private sector adjustment

factor under section 11(e)(2) of the Bank

Act. 12 U.S.C. 1431(e)(2). The Finance

Board specifically requests comment

regarding the consequences of this

possibility.

The Finance Board also has

determined that the authority of a

FHLBank to issue a standby LOC may be

considered, in the alternative, to be part

of the FHLBanks’ incidental authority to

enter into commitments to make

advances. On the basis of this refined

analysis, the Finance Board has

concluded that, although there may be

safety and soundness and other policy

reasons for requiring certain restrictions,

it is unnecessary as a matter of law to

subject FHLBank LOCs to all of the

statutory and regulatory restrictions and

limitations that apply to advances.

This rulemaking proposes to amend

the Interim Guidelines to provide the

FHLBanks with greater flexibility to

respond to member needs for standby

LOCs in a manner that ensures that

FHLBanks’ use of standby LOCs is

consistent with the FHLBank System’s

housing and community investment

mission and to codify these policies as

a regulation. Accordingly, these

proposed standby LOC regulations

permit FHLBank members to request

standby LOCs for a broader range of

purposes and remove many of the

restrictions on FHLBank standby LOC

issuance that have limited the

usefulness of such LOCs in the past.

The Finance Board requests

comments on all aspects of the proposed

rule.

II. Analysis of the Proposed Rule

This rulemaking proposes to add to

the Finance Board’s regulations, 12 CFR

chapter IX, a new part 938 to govern

FHLBank Standby LOCs. Definitions

relevant to the proposed FHLBank

Standby LOC regulation are set forth in

§ 938.1 of the proposed regulation.

Because these definitions have been

drafted in order to implement

substantive provisions, they are

discussed, as necessary, below in the

context of their use in the body of the

regulation.

Section 938.2 of the proposed

regulation governs FHLBank standby

LOCs issued or confirmed on behalf of

member institutions. Paragraph (a)

authorizes FHLBanks to issue standby

LOCs on behalf of members, and to

confirm standby LOCs issued by

members, that conform to the

requirements of proposed part 938 and

that are issued for the purposes

enumerated in paragraphs (a)(1) through

(a)(4). The term ‘‘standby letter of

credit,’’ as defined in § 938.1, is

intended to include those instruments

that are commonly referred to as such;

i.e., LOCs that effectively guarantee the

applicant’s payment or performance in

an underlying transaction with the

beneficiary. The term does not include

LOCs that are intended to serve as a

short-term payment mechanism to

finance the movement of goods

(commonly known as ‘‘commercial’’

LOCs). The Finance Board considers

‘‘direct pay’’ LOCs, which are designed

to act as the primary mechanism for

satisfying an applicant’s payment

obligations over a period of time (for

example, to make payments of principal

and interest on commercial paper and

medium-term notes) to be a form of

standby LOC which FHLBanks would

be authorized to issue under the

proposed regulation.

Under paragraph (a) of proposed

§ 938.2, FHLBanks would be authorized

to issue or confirm standby LOCs for

any of four broad purposes: (1) To

facilitate residential housing finance or

other housing activity; (2) to facilitate

the financing of targeted economic

development projects; (3) to assist

members with asset/liability

management; or (4) to provide members

with liquidity or other funding. This list

of approved purposes would replace the

more specific and restrictive list set

forth in the Interim Guidelines. By

replacing the specific list with the

broader purposes set forth in paragraph

(a) of § 938.2, the Finance Board intends

to ensure that FHLBanks’ use of standby

LOCs is consistent with the FHLBank

System’s housing and community

development mission and, at the same

time, provide the FHLBanks with

greater flexibility to respond to member

needs for such credit. Under the

proposed regulation, FHLBanks would

determine, subject to Finance Board

review and oversight, whether

particular transactions fall within any of

the above-described categories.

The term ‘‘residential housing

finance’’ refers to the purchase or

funding of ‘‘residential housing finance

assets,’’ or other activities that support

the development or construction of

residential housing. As defined in

§ 935.1 of the Finance Board’s

regulations, the term ‘‘residential

housing finance assets’’ includes: Loans

secured by residential real property;

mortgage-backed securities;

participations in loans secured by

residential real property; loans financed

by CIP advances (under the proposed

Community Investment Cash Advance

(CICA) rule, discussed below, reference

to CIP advances would be amended to

refer to loans or investments financed

by advances made pursuant to a CICA

program); loans secured by

manufactured housing; or any other

assets that the Finance Board

determines to be residential housing

finance assets. The term ‘‘residential

housing finance,’’ as defined in § 938.1

of the proposed regulation, also is

intended to encompass activities that

are aimed toward providing residential

housing for individuals and families,

but that do not fall within the existing

regulatory definition of ‘‘residential

housing finance assets,’’ which refers

only to loans and securities backed by

loans. For example, a FHLBank would

be permitted to issue a standby LOC to

serve as a performance bond to secure

a builder’s performance in a housing

construction project. Paragraph (a)(1) of

§ 938.2 is intended to provide the

FHLBanks with the same scope of

authority to issue and confirm housingrelated standby LOCs that currently

exists under the Interim Policy.

Economic development projects that

would be eligible for support through a

FHLBank standby LOC would include

commercial, manufacturing, social

service, public or community facility,

and public or private infrastructure

projects or activities that benefit

families with incomes of 100 percent or

less of area median income in urban

areas, 115 percent or less of area median

income in rural areas, or with an income

at or below a target level established by

a FHLBank to address unmet housing or

economic development credit needs.

Projects would be deemed to benefit

such families if: The project is located

in a neighborhood in which more than

50 percent of the families have incomes

at or below the targeted income level;

the project is located in a rural or urban

Champion Community, a rural or urban

Empowerment Zone, or rural or urban

Enterprise Community; the project is

located in a federally declared disaster

area; the project involves property
25728 Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules

eligible for a federal Brownfield Tax

Credit; the project is located in an area

affected by a federal military base

closing or realignment; the project is

located in an area identified as a

designated community under the

Community Adjustment and Investment

Program; the annual salaries for at least

75 percent of the permanent full- and

part-time jobs, computed on a full-time

equivalent basis, created or retained by

the project, other than construction jobs,

are at or below the targeted income

level; the project qualifies as a small

business; or more than 50 percent of the

families who otherwise benefit from

(other than through employment) or are

provided services by the project have

incomes at or below the targeted income

level.

These provisions and the concepts

underlying them were developed as part

of the Finance Board’s proposed

Community Investment Cash Advance

(CICA) program regulation, which has

been published elsewhere in this issue

of the Federal Register. The proposed

CICA Regulation would establish a

general framework under which the

FHLBanks may establish programs to

provide advances to be used in support

of financing for housing and economic

development activities that benefit

income-targeted families that may not

benefit from advances made under the

FHLBanks’ existing Affordable Housing

Programs (AHP) and Community

Investment Programs (CIP).

Specifically, the proposed CICA

Regulation would authorize each

FHLBank to establish: A Rural

Development Advance (RDA) program

to provide advances to members and

nonmember borrowers to finance

economic development projects in rural

areas that benefit families with incomes

at or below 115 percent of the area

median income; an Urban Development

Advance (UDA) program to provide

advances to members and nonmember

borrowers to finance economic

development projects in urban areas

that benefit families with incomes at or

below 100 percent of the area median

income; and other CICA programs to

provide financing for economic

development projects benefiting

families with incomes at or below a

level established by the Bank to address

unmet economic development credit

needs (defined as those for which

financing is not generally available, or is

available at lower levels or under less

attractive terms). Regulation of the

existing CIP would also be subsumed

within the CICA Regulation.

Under the Interim Guidelines,

FHLBanks are permitted to issue

standby LOCs to support only those

economic development activities that

benefit families earning less than 80

percent of area median income, or that

are located in a neighborhood in which

51 percent or more of the households

earn less than 80 percent of area median

income, for which a member could

receive a CIP advance. Having

determined that it may authorize

FHLBanks to issue standby LOCs to

support a wider array of activities than

is currently permitted under the Interim

Guidelines, the Finance Board sought

ways to permit FHLBanks to respond

better to member requests for LOC

products while, at the same time,

assuring that FHLBanks’ use of standby

LOCs is consistent with the public

policy purposes of the FHLBank

System. The inclusion of the CICArelated targeted economic development

provisions, which already had been

subject to much study and discussion in

the process of developing the proposed

CICA Regulation, as one parameter for

FHLBank LOC use appears to meet both

criteria by maximizing the ability of

FHLBanks to benefit areas with unmet

economic development credit needs, as

well as furthering regulatory

consistency.

A thorough discussion of the

reasoning behind the Finance Board’s

inclusion of particular substantive

criteria in its conception of targeted

economic development may be found in

the preamble to the proposed CICA

Regulation, published elsewhere in this

issue of the Federal Register. It is

anticipated that, if and when the CICA

and Standby LOC Regulations are

promulgated as final rules, the Standby

LOC Regulation will describe the

economic activities that may be

appropriately supported by FHLBank

LOCs merely by cross-referencing the

CICA Regulation, as opposed to

including all of the CICA-related

definitions therein. Because the CICA

Regulation thus far has been published

only as a proposed rule, the Finance

Board found it appropriate to restate

those definitions in their entirety within

the proposed Standby LOC Regulation

in order to make its scope more readily

apparent to the reader.

Under paragraph (a) of proposed

§ 938.2, FHLBanks also would be

permitted to issue standby LOCs to

assist members with their asset/liability

management and to provide members

with liquidity or other funding.

Although the Interim Guidelines permit

FHLBanks to issue short-term LOCs to

facilitate interest rate swaps and other

transactions that assist in asset/liability

management, such LOCs would no

longer be limited to a term of five years

or less, or limited only to QTL members,

under the proposed regulation. In

addition, although liquidity and other

funding purposes are not mentioned

expressly in the Interim Guidelines,

they have been included in the

proposed regulation to make clear that

the FHLBanks may use their LOC

authority to further this central memberservice function and to bring within the

purview of the regulation permissible

standby LOC activities that might not be

easily traceable to a particular housing

or economic development purpose, such

as securing public unit deposits and IRC

Section 936 deposits.

Paragraph (b) of proposed § 938.2

requires that FHLBank standby LOCs

made to members be secured at the time

of issuance for the full amount of the

LOC by collateral described in

paragraph (c) of that section. This would

continue the requirement of the Interim

Guidelines that LOCs be fully secured at

the time of issuance, although, as

discussed below, members would be

able to use a wider range of collateral

and would no longer need to pledge

their FHLBank stock as additional

collateral for LOCs. Although the

Finance Board has concluded that, as a

matter of law, the Bank Act does not

necessarily require that LOCs be

collateralized fully at the time of

issuance, it has determined that such a

requirement is advisable as a matter of

safe and sound banking practice. The

Finance Board requests comments on

whether there are any circumstances

under which the FHLBanks could safely

and soundly issue LOCs that are not

fully collateralized.

Paragraph (c) describes the types of

collateral that are eligible to secure

FHLBank standby LOCs issued on

behalf of members. It provides that all

LOCs may be secured with collateral

that is eligible to secure FHLBank

advances to members under § 935.9(a) of

the Finance Board’s regulations. 12 CFR

935.9(a). In addition, in order to

facilitate the use of LOCs to support

housing and targeted economic

development activities and to permit

greater access to LOCs by members that

lack sufficient § 935.9(a)—eligible

collateral, the proposed regulation also

would permit members to secure LOCs

that are issued for the purpose of

facilitating residential housing finance

or targeted economic development

activities with: (1) secured or federallyguaranteed loans to small businesses (as

defined by the Office of Thrift

Supervision); (2) investment-grade

obligations of state or local government

agencies; and (3) ‘‘other real estaterelated collateral’’ described in

§ 935.9(a)(4) of the regulations in excess
Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules 25729

of the ‘‘30 percent of capital’’ limitation

set forth in paragraph (a)(4)(iii) thereof.

Under the Interim Guidelines, LOCs

may be secured only by collateral that

is eligible to secure advances, regardless

of the purpose for which the LOC is

issued. Such collateral includes Small

Business Administration—(SBA)

guaranteed securities. However because

most small business loans are not SBAguaranteed, the proposed regulation, by

permitting all secured or federallyguaranteed small business loans to be

used as collateral for LOCs, could

encourage members to provide

financing for smaller or start-up

businesses that often have a more

difficult time accessing credit than wellestablished or larger enterprises.

Expanded use of small business loans as

collateral will support the FHLBanks’

mission of providing support for

targeted economic development

lending—the targeted universe in this

case being small commercial and

business entities, including small farms.

Commercial bank members and

Community Development Financial

Institution (CDFI) members, in

particular, may have substantial

amounts of such loans available to use

as collateral.

Under the proposed regulation, an

additional source of collateral for LOCs

would be state and municipal bonds

rated investment grade by a nationallyrecognized rating agency (such as bonds

rated BBB or better by Moody’s or Bbb

or better by Standard & Poor’s). Under

the Interim Guidelines, FHLBanks may

accept real estate-related state and

municipal housing bonds as collateral

for LOCs only as part of the limited

basket of other real estate-related

collateral. See 12 CFR 935.9(a)(4)(iii).

Expanding eligible collateral for LOCs to

include investment grade state or

municipal bonds could benefit members

who hold such investments and who

have insufficient advances-eligible

collateral. Because there is an

established secondary market for these

bonds, they can be easily valued and, if

necessary, liquidated by a FHLBank.

The proposed regulation also permits

members to secure LOCs issued for

housing finance or targeted economic

development purposes with other real

estate-related collateral in excess of the

‘‘30 percent of capital’’ limitation set

forth in § 935.9(a)(4)(iii) of the Advances

Regulation. 12 CFR 935.9(a)(4)(iii). If so

permitted, members that have

substantial amounts of such collateral,

such as commercial banks, could

expand their use of FHLBank LOCs. For

example, members specializing in

community development lending could

pledge, without limit, loans secured by

community facilities, such as day care

centers and health clinics and lenders in

rural areas could pledge more of their

farm loans.

The proposed regulation would

permit each FHLBank to establish limits

on the use of these additional types of

collateral. FHLBanks accepting such

collateral would be expected to include,

as part of their standby LOC policies

required under § 938.5(a)(1), policies

and procedures for valuing and securing

such collateral that are consistent with

safe and sound banking practice. The

Finance Board believes that any

additional risks that might arise from

the use of these additional types of

collateral should be adequately

managed in accordance with the

collateral provisions of the Advances

Regulation that are referenced in

proposed § 938.5(d). Among other

things, the Advances Regulation

requires the FHLBanks to establish

written procedures for determining the

value of collateral, and to follow those

procedures in ascertaining the value of

a particular asset offered as collateral.

See 12 CFR 935.12. The Advances

Regulation also permits the FHLBanks

to require a member to support the

valuation of any collateral with an

appraisal or other investigation of the

collateral as the FHLBank deems

necessary. Id.

The Finance Board expects that if

proposed part 938 is adopted as a final

rule, each FHLBank will review its

collateral valuation procedures, and will

amend them as necessary to reflect the

availability of these additional types of

collateral to secure standby LOCs,

before accepting such collateral. The

Finance Board also expects that the

FHLBanks, as a matter of practice, will

conduct careful review and, if

necessary, require an appraisal of such

collateral. Such appraisal should take

into account the security of the loan

itself, as well as any additional risks

inherent in such collateral and each

FHLBank’s own ability to evaluate those

risks. The Finance Board specifically

requests comment on whether there are

other assets that should be considered

as eligible collateral for LOCs and

whether the Finance Board should

establish limits on these additional

types of collateral based upon the assets

that secure the loans themselves.

Section 938.3 of the proposed

regulation governs FHLBank standby

LOCs issued or confirmed on behalf of

customers that have been certified as

eligible nonmember mortgagees

pursuant to § 935.22(b) of the Finance

Board’s regulations. 12 CFR 935.22(b).

Paragraph (a) of proposed § 938.3 would

authorize FHLBanks to issue or confirm

on behalf of nonmember mortgagees

standby LOCs that are fully secured by

Federal Housing Administration-(FHA)

insured loans or Government National

Mortgage Association (GNMA)

securities backed by FHA-insured loans,

for the same broad purposes for which

FHLBanks may issue or confirm LOCs

on behalf of member institutions. In

addition, paragraph (b) of proposed

§ 938.3 would authorize FHLBanks to

issue or confirm, on behalf of

nonmember mortgagees that have

qualified as state housing finance

agencies (SHFAs) by meeting the

requirements of § 935.22(d) of the

regulations, 12 CFR 935.22(d), standby

LOCs that are fully secured by collateral

eligible under § 935.9(a) of the

regulations, id. 935.9(a), to secure

advances. Standby LOCs secured by

such collateral would be required to

facilitate residential or commercial

lending that benefits individuals or

families meeting the income

requirements in section 142(d) or 143(f)

of the IRC.

Proposed § 938.3 would continue the

general policy of the Interim Guidelines

by requiring that FHLBank LOCs issued

on behalf of nonmember mortgagees be

subject to the same limitations and

restrictions that apply to advances made

to nonmembers under section 10b of the

Bank Act, 12 U.S.C. 1430b, and § 935.24

of the regulations, 12 CFR 935.24. In its

legal review of the sources of statutory

authority for issuance of LOCs by

FHLBanks, the Finance Board

determined that, unlike LOCs issued on

behalf of members, the issuance of LOCs

on behalf of nonmembers could not be

considered to fall within the FHLBanks’

payment processing authority, which

expressly applies only to FHLBank

dealings with members and financial

institutions eligible to apply for

FHLBank membership. See 12 U.S.C.

1431(e)(2). Thus, the Finance Board

believes that FHLBanks should issue

LOCs to a nonmember mortgagee only

under the same conditions that would

apply if the FHLBank were to enter into

an advance commitment with that

nonmember. Because the type of

collateral that a FHLBank may accept to

secure advances to nonmembers is

linked, by statute, to the purpose of the

advance, the purpose for which a LOC

is issued on behalf of a nonmember also

must govern the type of collateral that

the FHLBank may accept to secure the

LOC.

Section 938.4 of the proposed

regulation governs the obligation of both

members and nonmember mortgagees

on whose behalf an FHLBank issues a

LOC to reimburse the FHLBank for any

funds drawn by the beneficiary under
25730 Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules

the LOC. Paragraph (a) of proposed

§ 938.4 requires that, as part of the

agreement pursuant to which a LOC is

to be issued, a member or nonmember

assume an unconditional obligation to

reimburse the FHLBank fully for any

amounts drawn by the beneficiary under

the LOC by having available in its

FHLBank deposit or transaction account

on the day of the FHLBank’s payment to

the beneficiary sufficient funds to cover

such payment. The requirement that an

applicant assume an unconditional

obligation to reimburse the FHLBank

continues the policy of the Interim

Guidelines and is consistent with the

provisions of Article 5 of the Uniform

Commercial Code (UCC), as revised in

1995, which provide that an issuer that

has honored a presentation made by a

beneficiary under a LOC is entitled to be

reimbursed by the applicant in

immediately available funds not later

than the date of its payment of funds.

See UCC 5–108(i) (1995).

In order to facilitate reimbursement of

a FHLBank, to emphasize the

applicant’s responsibility to cover the

amount of any draw under a LOC, to tie

the FHLBanks’ LOC activities more

closely to their payment processing

authority (in the case of LOCs issued on

behalf of members) and for purposes of

regulatory consistency, paragraph (a)(1)

of § 938.4 requires that reimbursement

by an applicant be accomplished

through its FHLBank deposit account (if

the applicant is a member) or

transaction account (if the applicant is

a nonmember, see 12 CFR 935.24).

Paragraph (b) of proposed § 938.4

requires FHLBanks to take prompt

action to recover the funds due if an

applicant fails to have available in its

FHLBank deposit or transaction account

on the day of a draw under a LOC

sufficient funds to cover the draw.

Despite this requirement, paragraph (b)

of proposed § 938.4 authorizes an

issuing FHLBank, at the request of a

member or nonmember, but in its own

discretion, to finance an applicant’s

repayment of a LOC draw by making an

advance to the applicant. Of course,

such an advance could be made only if

the applicant is, at that time, willing

and able to comply with the advances

requirements of section 10 (if the

applicant is a member) or section 10b (if

the applicant is a nonmember) of the

Bank Act, 12 U.S.C. 1430, 1430b, and

part 935 of the Finance Board’s

regulations, 12 CFR part 935. For

purposes of complying with the

regulatory advance requirements, the

‘‘purpose’’ of an advance made to a

member or nonmember under the

conditions of proposed § 938.4(c) would

be determined using the same standards

that apply to any other type of advance.

See 12 CFR 935.13 & .14.

Section 938.5 of the proposed

regulation sets forth certain

miscellaneous provisions that would

apply to all LOCs issued on behalf of

members and nonmembers. paragraph

(a)(1) of proposed § 938.5 requires that

all LOCs issued on behalf of members or

nonmembers be issued only pursuant to

a written LOC policy established by the

FHLBank to govern its standby LOC

programs. Such a policy would be

required to: (1) implement all statutory

and regulatory provisions that apply to

standby FHLBank LOCs; (2) to set forth

underlying criteria to apply to the

issuance or renewal of standby LOCs

that is consistent with the criteria that

must be applied to the underwriting of

advances; and (3) set forth criteria

regarding the pricing of standby LOCs,

including any special criteria that could

apply to LOCs issued to facilitate the

financing of targeted economic

development projects.

It is intended that paragraph (a)(1)(ii)

of proposed § 938.5, regarding the

application of underwriting criteria

under the FHLBank’s LOC policy at the

time of the issuance or renewal of a

LOC, apply also in cases where a LOC

contains a provision stating that the

LOC will automatically renew unless

the FHLBank notifies the beneficiary of

its intent not to renew the LOC. Such

provisions must be carefully monitored

so that the FHLBank can control its risk

exposure. The renewal of any LOC

pursuant to such a provision should be

approved in the same manner as a

renewal of a LOC that does not contain

this provision. However, because an

issued LOC cannot be canceled without

agreement from the beneficiary,

FHLBanks are encouraged to issue LOCs

only for a limited term, with the

potential for renewal if the account

party remains creditworthy. This would

give the FHLBanks an opportunity to

reassess periodically their exposure on

long-term transactions.

As a matter of safety and soundness

regulation, paragraph (a)(2) of proposed

§ 938.5 would continue the policy of the

Interim Guidelines by requiring that all

LOCs issued by a FHLBank either

contain a specific expiration date, or be

for a specified term. This is consistent

with Comptroller of the Currency and

the OTS regulations on LOCs, which

specifically require that LOCs issued by

national banks and savings associations,

as a matter of sound banking practice,

be limited in duration or terminable

periodically or at will upon notice or

payment to the beneficiary. See 12 CFR

7.1016(b)(1)(iii) and 560.120(b)(1)(iii).

Similarly, paragraph (a)(3) of

proposed § 938.5 would continue the

policy of the Interim Guidelines by

requiring that the transfer of a FHLBank

LOC be approved in advance by the

issuing FHLBank. A transfer of a letter

of credit occurs when the beneficiary

transfers to a another party its right to

draw under the LOC. Requiring

approval by a FHLBank would ensure

that a LOC could not be transferred

without the FHLBank’s knowledge.

Finally, paragraph (b) of proposed

§ 938.5 would apply to FHLBank LOCs

issued on behalf of members and

nonmembers certain provisions set forth

in the Finance Board’s Advances

Regulation, 12 CFR part 935, including

provisions regarding the FHLBank’s

right to require additional collateral or

to limit the type of collateral that it will

accept, and matters of collateral

verification, safekeeping and valuation.

Proposed part 938 would not include

many of the restrictions on FHLBank

standby LOC transactions that currently

are imposed by the Interim Guidelines.

The Interim Guidelines require a

member to purchase FHLBank stock

when a FHLBank issues a LOC, which

is an off-balance sheet item, on behalf of

that member. This causes a decrease in

the FHLBank’s leverage because the

FHLBank’s outstanding stock is

increased without a corresponding

increase in on-balance sheet assets.

Under proposed part 938, FHLBanks

would no longer be required to include

LOCs in the computation of a member’s

advances/FHLBank capital stock ratio,

because the Finance Board no longer

considers LOCs to be the legal

equivalent of outstanding advances.

Eliminating this requirement would

remove the deleveraging effect of the

current policy and would make

FHLBank standby LOCs more attractive

to members.

By applying uniform requirements to

standby LOCs issued on behalf of any

member, without regard to the QTL

status of the member, proposed part 938

would not require that standby LOCs

issued on behalf of non-QTL members

be issued only for housing finance

purposes, as is the case under the

Interim Guidelines. In addition,

proposed part 938 would not require

that standby LOCs issued on behalf of

non-QTL members be included with

total FHLBank System advances and

advances to non-QTL members for

purposes of monitoring compliance

with the FHLBank System’s statutory 30

percent limit on advances to non-QTL

members. See 12 U.S.C. 1430(e)(2).

Again, the Finance Board has

determined that these restrictions are

not required by law because the Finance
Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules 25731

Board no longer considers LOCs to be

the legal equivalent of outstanding

advances.

Removing these restrictions on

standby LOCs issued on behalf of nonQTL members, many of which are

actively involved in financing housing

and economic development

transactions, would expand the

opportunities for FHLBanks to issue

standby LOCs to support such housing

and economic development activities. In

addition, removal of these restrictions

would enhance the ability of FHLBanks

to assist non-QTL members with their

liquidity needs.

The Interim Guidelines limit the use

of standby LOCs with tax-exempt bonds

to those issues designed to promote

housing or commercial and economic

development that benefits low-and

moderate-income families or that is

located in low-and moderate-income

neighborhoods. Under IRC section 149,

26 U.S.C. 149, it is unclear whether taxexempt bonds financing economic

development would lose their taxexempt status if supported by a

FHLBank standby LOC. The Finance

Board currently is working with

Congress to resolve this issue

legislatively. In the meantime, the

Finance Board considers this issue to be

a matter for the Internal Revenue

Service to determine and, therefore, has

not specified in the proposed regulation

the types of tax-exempt bonds for which

a FHLBank standby LOC may be issued.

The Interim Guidelines provide that

FHLBank LOC confirmations may not be

used solely to support a member’s own

LOC program or to increase a member’s

profitability. LOC confirmations serve

essentially the same purpose, and incur

for a FHLBank the same contingent

liability, as the issuance of a LOC. A

member’s access to a FHLBank’s LOC

confirmation presumably would make a

member’s LOC more acceptable to a

beneficiary and would help to increase

a member’s profitability. Because all of

the products and services offered by a

FHLBank to its members are designed to

assist members improve their liquidity,

to offer additional financing options to

its customers, and consequently

increase its income, the current

restriction on confirmations appears to

conflict with these goals. Therefore, this

restriction has not been included in

proposed part 938.

The Interim Guidelines limit the term

of a FHLBank standby LOC issued on

behalf of a QTL member to 5 years for

non-housing finance purposes and 10

years for housing finance purposes, but

impose no limit for issues that support

a member’s performance in interest rate

swap transactions. The Interim

Guidelines limit the term of a FHLBank

standby LOC issued on behalf of a nonQTL member to 10 years or less for

housing finance. In contrast, FHLBanks

may offer advances with maturities of

any length consistent with the safe and

sound operation of the FHLBank. See 12

CFR 935.6(a).

Expanding the terms for LOCs would

benefit low-income housing tax credit

transactions that often require a 15-year

letter of credit. In addition, a longer

term would permit LOCs to be used

with industrial development and other

bonds used to fund local economic

development that typically have terms

longer than 10 years. Because standby

LOCs posses no more credit risk than an

advance, there appears to be no reason

to limit the maturity of a LOC as long

as a FHLBank has established controls

that ensure the safe and sound operation

of the FHLBank. Therefore, the

proposed regulation imposes no term

limitations on FHLBank standby LOCs.

Proposed part 938 would not require

that outstanding FHLBank LOCs be

reflected on the books of the FHLBank

as contingent liabilities, as is required

under the Interim Guidelines, because

this is already required under General

Accepted Accounting Principles

(GAAP), which the FHLBanks must

follow. Finally, the requirement of the

Interim Guidelines that FHLBanks must

submit monthly LOC reports has not

been included in the proposed

regulation because this is already

subsumed within the current general

requirement that FHLBanks report

monthly to the Finance Board on all

FHLBank activities. See 12 CFR

934.7(e).

III. Regulatory Flexibility Act

The proposed rule applies only to the

FHLBanks, which do not come within

the meaning of ‘‘small business,’’ as

defined in the Regulatory Flexibility Act

(RFA). See 5 U.S.C. 601(6). Therefore, in

accordance with section 605(b) of the

RFA, 5 U.S.C. 605(b), the Finance Board

hereby certifies that this proposed rule,

if promulgated as a final rule, will not

have a significant economic impact on

a substantial number of small entities.

List of Subjects in 12 CFR Part 938

Community development, Credit,

Federal home loan banks, Housing,

Mortgages.

Accordingly, the Finance Board

hereby proposes to amend chapter IX,

title 12, Code of Federal Regulations, to

add a new part 938 to read as follows:

PART 938—STANDBY LETTERS OF

CREDIT

Sec.

938.1 Definitions.

938.2 Standby letters of credit on behalf of

members.

938.3 Standby letters of credit on behalf of

nonmember mortgagees.

938.4 Obligation to Bank under all standby

letters of credit.

938.5 Additional provisions applying to all

standby letters of credit.

Authority: 12 U.S.C. 1422b, 1429, 1430,

1430b, 1431.

§ 938.1 Definitions.

As used in this part:

Act means the Federal Home Loan

Bank Act, as amended (12 U.S.C. 1421–

49).

Applicant means a person or entity at

whose request or for whose account a

standby letter of credit is issued.

Bank means a Federal Home Loan Bank

established under the authority of the

Act.

Beneficiary means a person or entity

who, under the terms of a standby letter

of credit, is entitled to have its

complying presentation honored.

Benefit. An economic development

project is deemed to benefit families

with incomes at or below a targeted

income level if:

(1) The project is located in a

neighborhood in which more than 50

percent of the families have incomes at

or below the targeted income level;

(2) The project is located in a rural

Champion Community, or a rural

Empowerment Zone or rural Enterprise

Community, as designated by the

Secretary of Agriculture (in the case of

projects located in rural areas);

(3) The project is located in an urban

Champion Community, or an urban

Empowerment Zone or urban Enterprise

Community, as designated by the

Secretary of HUD (in the case of projects

located in urban areas);

(4) The project is located in a

federally declared disaster area;

(5) The project involves property

eligible for a federal Brownfield Tax

Credit authorized by 26 U.S.C. 198;

(6) The project is located in an area

impacted by a federal military base

closing or realignment;

(7) The project is located in an area

identified as a designated community

under the Community Adjustment and

Investment Program;

(8) The annual salaries for at least 75

percent of the permanent full-and parttime jobs, computed on a full-time

equivalent basis, created or retained by

the project, other than construction jobs,

are at or below the targeted income

level;

(9) The project qualifies as a small

business; or
25732 Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules

(10) More than 50 percent of the

families who otherwise benefit from

(other than through employment) or are

provided services by the project have

incomes at or below the targeted income

level.

Champion Community means a

community which developed a strategic

plan and applied for designation by

either the Secretary of Housing and

Urban Development or the Secretary of

Agriculture as an Empowerment Zone

or Enterprise Community, but was

designated a Champion Community.

Confirm means to undertake, at the

request or with the consent of the issuer,

to honor a presentation under a standby

letter of credit issued by a member or

nonmember mortgagee.

Document means a draft or other

demand, document of title, investment

security, certificate, invoice, or other

record, statement, or representation of

fact, law, right, or opinion that is

presented under the terms of a standby

letter of credit.

Economic development projects

means:

(1) Commercial, manufacturing, social

service, and public facility projects and

activities; and

(2) The construction or rehabilitation

of public or private infrastructure, such

as roads, utilities, and sewers.

Family means one or more persons

living in the same dwelling unit.

Finance Board means the agency

established by the Act as the Federal

Housing Finance Board.

Issuer means a person or entity that

issues a standby letter of credit.

Median income for the area means

one or more of the following, as

determined by the Bank:

(1) The median income for the area,

as published annually by the

Department of Housing and Urban

Development;

(2) The applicable median family

income, as determined under 26 U.S.C.

143(f) (Mortgage Revenue Bonds) and

published by a State agency or

instrumentality;

(3) The median income for the area,

as published by the United States

Department of Agriculture; or

(4) The median income for any

definable geographic area, as published

by a federal, state, or local government

entity for purposes of that entity’s

housing programs, and approved by the

Board of Directors of the Finance Board,

at the request of a Bank, for use under

the Bank’s Community Investment Cash

Advance (CICA) programs, as provided

for in part 970 of this chapter.

Member means an institution that has

been approved for membership in a

Bank and has purchased capital stock in

the Bank in accordance with § § 933.20

and 933.24 of this chapter.

Metropolitan statistical area means a

‘‘metropolitan statistical area,’’ as that

term is defined by the U.S. Bureau of

the Census.

Neighborhood means:

(1) A census tract or block numbering

area;

(2) A unit of general local government

with a population of 25,000 or less;

(3) A rural county;

(4) A trust or restricted Indian land,

Native Hawaiian Home Land, or

Alaskan Native Village; or

(5) A geographic location designated

in comprehensive plans, ordinance, or

other local documents as a

neighborhood, village, or similar

geographic designation that is within

the boundary of but does not encompass

the entire area of a unit of general local

government.

Nonmember mortgagee means an

entity certified as a nonmember

mortgagee pursuant to § 935.22(b) of this

chapter.

Nonmember SHFA means a

nonmember mortgagee that is a ‘‘state

housing finance agency,’’ as that term is

defined in § 935.1 of this chapter, and

that has met the requirements of

§ 935.22(d) of this chapter.

Presentation means delivery of a

document to an issuer, or an entity that

has undertaken a confirmation at the

request or with the consent of the issuer,

for the giving of value under a standby

letter of credit.

Residential housing finance means:

(1) The purchase or funding of

‘‘residential housing finance assets,’’ as

that term is defined in § 935.1 of this

chapter; or

(2) Other activities that support the

development or construction of

residential housing.

Rural area means:

(1) A unit of general local government

or an unincorporated place outside a

metropolitan statistical area that has a

population of less than 30,000; or

(2) A trust or restricted Indian land,

Native Hawaiian Home Land, or

Alaskan Native Village.

Small business means a ‘‘small

business concern,’’ as that term is

defined by section 3(a) of the Small

Business Act (15 U.S.C. 632(a)) and

implemented by the Small Business

Administration at 13 CFR part 121, or

any successor provisions.

Standby letter of credit means a

definite undertaking by an issuer on

behalf of an applicant that represents an

obligation to the beneficiary, pursuant

to a complying presentation, to repay

money borrowed by, advanced to, or for

the account of the applicant; to make

payment on account of any

indebtedness undertaken by the

applicant; or to make payment on

account of any default by the applicant

in the performance of an obligation. The

term standby letter of credit does not

include a commercial letter of credit, or

any short-term self-liquidating

instrument used to finance the

movement of goods.

Targeted income level means:

(1) For projects or activities that

benefit primarily individuals or families

residing in an urban area, 100 percent

of the median income for the area;

(2) For projects or activities that

benefit primarily individuals or families

residing in a rural area, 115 percent of

the median income for the area; or

(3) An income level that is based on

a percentage of median income

established by the Bank to address

unmet community investment credit

needs.

Urban area means a unit of general

local government or an unincorporated

place that is:

(1) Within a metropolitan statistical

area; or

(2) Outside a metropolitan statistical

area and has a population of more than

30,000.

§ 938.2 Standby letters of credit on behalf

of members.

(a) Authority and purposes. Each

Bank is authorized to issue or confirm

on behalf of members standby letters of

credit that comply with the

requirements of this part, for any of the

following purposes:

(1) To assist members in facilitating

residential housing finance;

(2) To assist members in facilitating

the financing of economic development

projects that benefit families with

incomes at or below a targeted income

level;

(3) To assist members with asset/

liability management; or

(4) To provide members with liquidity

or other funding.

(b) Fully secured. A Bank, at the time

it issues or confirms a standby letter of

credit on behalf of a member, shall

obtain and maintain a security interest

in collateral that is sufficient to secure

fully the member’s unconditional

obligation described § 938.4(a)(2), and

that complies with the requirements set

forth in paragraph (c) of this section.

(c) Eligible collateral. (1) Any standby

letter of credit issued on behalf of a

member may be secured by collateral

that is eligible to secure advances under

§ 935.9(a) of this chapter. In making the

calculation required under

§ 935.9(a)(4)(iii) of this chapter, only

standby letters of credit issued for the
Federal Register / Vol. 63, No. 89 / Friday, May 8, 1998 / Proposed Rules 25733

purposes described in paragraphs (a)(3)

or (a)(4) of this section shall be counted

as ‘‘outstanding advances.’’

(2) A standby letter of credit issued on

behalf of a member for a purpose

described in paragraphs (a)(1) or (a)(2)

of this section may, in addition to the

collateral described in paragraph (c)(1)

of this section, be secured by:

(i) Secured or federally-guaranteed

loans to small businesses or securities

representing interests in such loans; or

(ii) Obligations of state or local

government units or agencies, rated as

investment grade by a nationallyrecognized rating agency.

§ 938.3 Standby letters of credit on behalf

of nonmember mortgagees.

(a) Nonmember mortgagees. Each

Bank is authorized to issue or confirm

on behalf of nonmember mortgagees

standby letters of credit that are fully

secured by collateral described in

§§ 935.24(b)(1)(i) or (ii) of this chapter,

and that otherwise comply with the

requirements of this part, for any of the

following purposes:

(1) to assist nonmember mortgagees in

facilitating residential housing finance;

(2) To assist nonmember mortgagees

in facilitating the financing of economic

development projects that benefit

families with incomes at or below a

targeted income level;

(3) To assist nonmember mortgagees

with asset/liability management; or

(4) To provide nonmember

mortgagees with liquidity or other

funding.

(b) Nonmember SHFAs. Each Bank is

authorized to issue or confirm on behalf

of nonmember SHFAs standby letters of

credit that are fully secured by collateral

described in §§ 935.24(b)(2)(i)(A), (B) or

(C) of this chapter, and that otherwise

comply with the requirements of this

part, for the purpose of facilitating

residential or commercial mortgage

lending that benefits individuals or

families meeting the income

requirements in section 142(d) or 143(f)

of the Internal Revenue Code (26 U.S.C.

142(d) or 143(f)).

§ 938.4 Obligation to Bank under all

standby letters of credit.

(a) Obligation to reimburse. A Bank

may issue or confirm a standby letter of

credit only on behalf of a member or

nonmember mortgagee that has:

(1) Established with the Bank a cash

account pursuant to §§ 934.5,

935.24(b)(2)(i)(B) or 935.24(d) of this

chapter; and

(2) Assumed an unconditional

obligation to reimburse the Bank for

value given by the Bank to the

beneficiary under the terms of the

standby letter of credit by depositing

immediately available funds into the

account described in paragraph (a)(1) of

this section not later than the date of the

Bank’s payment of funds to the

beneficiary.

(b) Prompt action to recover funds. If

a member or nonmember mortgagee fails

to fulfill the obligation described in

paragraph (a)(2) of this section, the Bank

shall take action promptly to recover the

funds that such member or nonmember

mortgagee is obligated to repay.

(c) Obligation financed by advance.

Notwithstanding the obligations and

duties of the Bank and its member or

nonmember mortgagee under

paragraphs (a) and (b) of this section,

the Bank may, at its discretion, permit

such member or nonmember mortgagee

to finance repayment of the obligation

described in paragraph (a)(2) of this

section by receiving an advance that

complies with sections 10 or 10b of the

Act and part 935 of this chapter.

§ 938.5 Additional provisions applying to

all standby letters of credit.

(a) Written policy; other requirements.

Each standby letter of credit issued or

confirmed by a Bank shall:

(1) Be issued or confirmed only in

compliance with a written policy,

developed and implemented by the

Bank to govern its standby letter of

credit programs, that:

(i) Is consistent with the provisions of

the Act and this part;

(ii) Sets forth credit underwriting

criteria, consistent with the provisions

of § 935.5 of this chapter, to be applied

in evaluating applications for standby

letters of credit and renewals thereof;

and

(iii) Sets forth criteria regarding the

pricing of standby letters of credit,

including any special pricing provisions

for letters of credit that facilitate the

financing of economic development

projects that benefit families with

incomes at or below a targeted income

level;

(2) Contain a specific expiration date,

or be for a specific term; and

(3) Require approval in advance by

the Bank of any transfer of the standby

letter of credit from the original

beneficiary to another person or entity.

(b) Additional collateral provisions.

(1) A Bank may take such steps as it

deems necessary to protect its secured

position on standby letters of credit,

including requiring additional

collateral, whether or not such

additional collateral conforms to the

requirements of §§ 938.2 or 938.3.

(2) Collateral pledged by a member or

nonmember mortgagee to secure a letter

of credit issued or confirmed on its

behalf by a Bank shall be subject to the

provisions of §§ 935.9(b), 935.9(e),

935.11 and 935.12 of this chapter.

Dated: April 22, 1998.

By the Board of Directors of the Federal

Housing Finance Board.

Bruce A. Morrison,

Chairman.

[FR Doc. 98–11948 Filed 5–7–98; 8:45 am]

BILLING CODE 6725–01–P