Federal Home Loan Banks: Collateral Requirements Discourage Some Community Development Financial Institutions from Seeking Membership
Released: 2015-05-22T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: The Housing and Economic Recovery Act of 2008 (HERA) made nondepository CDFIs eligible for membership in the FHLBank System. The System includes 12 regional FHLBanks that make loans, known as advances, to their members at favorable rates. GAO was asked to review the FHLBanks' implementation of HERA provisions relating to nondepository CDFIs. Among other things, this report discusses (1) challenges posed by membership and collateral requirements for nondepository CDFIs, and (2) FHFA and FHLBank efforts to facilitate broader nondepository CDFI participation in the System.

GAO analyzed data on membership rates as of December 2014 and advances obtained as of September 2014; reviewed requirements for gaining membership and obtaining advances; and interviewed FHLBank and FHFA officials and a sample of nondepository CDFIs based on selected criteria, including geography and asset size. Specifically, GAO interviewed 10 nondepository CDFIs that were members (one from each FHLBank district with a nondepository CDFI member when GAO began work) and 12 that were not members (one from each of the 12 districts).

GAO makes no recommendations in this report. GAO provided a draft of this report to FHFA and the 12 FHLBanks for comment. FHFA and four FHLBanks provided technical comments that were incorporated into the report as appropriate.

section_title: What GAO Found
paragraphs: Collateral requirements rather than membership requirements discouraged some nondepository community development financial institutions (CDFI)—loan or venture capital funds—from seeking membership in the Federal Home Loan Bank (FHLBank) System. CDFIs are financial institutions that provide credit and financial services to underserved communities. Less than 6 percent of nondepository CDFIs (30 of 522) were members of the System as of December 2014 (see figure). Requirements for membership (such as stock purchase amounts) can vary where regulation gives FHLBanks discretion, but nondepository CDFIs GAO interviewed generally stated these requirements did not present a challenge. In addition, most FHLBanks imposed collateral requirements on nondepository CDFIs—such as haircuts (discounts on the value of collateral)—comparable with those for depository members categorized as higher risk. (This was sometimes also the case for other nondepository members such as insurance companies.) FHLBank officials stated nondepository CDFIs have different risks compared with depository members (for example, nondepository CDFIs are not supervised by a prudential federal or state regulator as are other FHLBank members). To address these risks, they imposed more restrictive requirements. Some of the nondepository CDFIs GAO interviewed cited limited availability of eligible collateral and steep haircuts as challenges for obtaining advances and therefore a disincentive to seeking membership. Less than half of the nondepository CDFIs that were members as of September 2014 had borrowed from the FHLBanks; the cumulative advances from October 2010 to September 2014 totaled about $307 million (less than 1 percent of the total advances outstanding as of December 2014). Two FHLBanks made the majority of the advances.

The Federal Housing Finance Agency (FHFA), which oversees the System, and FHLBanks have facilitated efforts to broaden nondepository CDFI participation in the System by educating about and promoting membership to nondepository CDFIs. For example, FHFA officials told us that they encouraged the FHLBanks to hold a conference to discuss nondepository CDFI membership. Officials from 10 FHLBanks also stated that they had solicited applications from CDFIs. In late 2014, several FHLBanks amended stock purchase and collateral requirements to better accommodate nondepository CDFI membership and access to advances.

section_title: Letter
paragraphs: The Federal Home Loan Bank System (FHLBank System), which is a  government-sponsored enterprise created to support mortgage lending  and related community development, includes 12 regional Federal Home  Loan Banks (FHLBank) with over 7,300 financial institutions that are  active members. The primary mission of the FHLBank System is to serve  as a reliable source of liquidity for its members. To carry out its mission,  the FHLBank System issues debt in capital markets, generally at  relatively favorable rates due to its status as a government-sponsored  enterprise, and each FHLBank makes loans known as advances to its  member financial institutions. As of December 31, 2014, the FHLBanks  had about $566 billion in total outstanding advances. FHLBank members  must pledge collateral to secure these advances.

FHLBank members include banks, thrifts, credit unions, and insurance  companies—as well as community development financial institutions  (CDFI) certified by the Community Development Financial Institutions Fund (CDFI Fund) within the Department of the Treasury (Treasury).CDFIs can be federally insured depository institutions such as community  development banks and certain credit unions or nondepository institutions  such as community development loan funds or venture capital funds.  Depository CDFIs have been eligible to apply for FHLBank membership  since 1989 and nondepository CDFIs since 2010, when the Federal  Housing Finance Agency (FHFA) implemented provisions of the Housing  and Economic Recovery Act of 2008 (HERA) that authorized such  membership. FHFA is the supervisor and regulator of the FHLBank  System and aims to promote the safe and sound operation of FHLBanks  and the achievement of their mission.

You asked us to examine the FHLBanks’ implementation of HERA  provisions relating to nondepository CDFIs. This report discusses (1) how  nondepository CDFIs differ from other members of the FHLBank System,  in particular depository members; (2) the membership and collateral  requirements for nondepository CDFIs and challenges posed by these  requirements; and (3) FHFA oversight of FHLBanks in relation to  nondepository CDFIs and efforts by FHFA and FHLBanks to increase  participation of nondepository CDFIs in the FHLBank System.

To describe differences between nondepository CDFIs and other  members of the FHLBank System, we reviewed relevant sections of  HERA, FHFA’s final rule on nondepository CDFI membership, and other  relevant information from the FHLBanks and CDFI industry. We analyzed  data on members’ asset size from FHFA’s membership database as of  December 31, 2014. To address membership and collateral  requirements, we reviewed relevant legislation and regulations, and  documentation (such as membership applications and FHLBank guidance  on assessing nondepository CDFIs for membership) to determine  membership requirements and identify any differences among FHLBank   We analyzed data on the number of nondepository CDFIs that  policies.were members in calendar years 2010 through 2014 from FHFA’s  membership database as of December 31, 2014. We calculated the  membership rate (the percentage of nondepository CDFIs in each district  that were members) by using data from FHFA’s membership database  and Treasury’s CDFI Fund. In addition, we reviewed relevant  documentation such as FHLBank collateral guidelines and product and  credit policies to determine the FHLBanks’ requirements for obtaining  advances. While we were able to review each FHLBank’s collateral  policies and procedures, the confidentiality of such proprietary information  limited what we could publicly disclose in our report. We also obtained  data from each FHLBank on the amount of advances nondepository CDFI  members obtained from October 2010 through September 2014 (the most  recent data available at the time of our request). We reviewed  documentation on and interviewed knowledgeable officials about the data  we used and determined they were sufficiently reliable for assessing  members’ asset size (data from FHFA’s membership database), the  membership rates for nondepository CDFIs (data from FHFA’s  membership database and the CDFI Fund), and the amount of advances  each nondepository CDFI member obtained (data from individual  FHLBanks).

We interviewed officials from the 12 FHLBanks, 3 trade groups, 10  nondepository CDFIs that were members of the FHLBanks, and 12  nondepository CDFIs that were not members to help understand the level  of demand for FHLBank membership and obtain views on any challenges  associated with obtaining membership and advances. We selected the  two purposive, nonrandom samples of nondepository CDFIs (10  members and 12 nonmembers) using data from FHFA’s membership  database. We sought variation in factors such as geographic location and  asset size. The results of our interviews with the 22 nondepository CDFIs  cannot be generalized to all nondepository CDFIs.

To evaluate FHFA’s oversight, we reviewed relevant laws, legislative  history, and regulations in relation to authority to expand membership to  nondepository CDFIs and FHFA’s oversight authority. We also reviewed  FHFA’s examination policies for membership and collateral requirements  to obtain advances. To determine what, if any, findings concerned  membership and advance practices, we analyzed each FHLBank’s  examination results for fiscal years 2010 through 2013 (the most recent  available at the time of our request). We interviewed FHFA and the 12  FHLBanks to further understand examination policies and practices for  membership and advances and discuss any efforts to facilitate broader  nondepository CDFI participation in the FHLBank System. See appendix I  for a more detailed description of our methodology.

We conducted this performance audit from May 2014 to April 2015 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.
subsections: section_title: Background
paragraphs: The CDFI Fund provides certification to CDFIs that meet the six statutory  and regulatory criteria of the Fund.on CDFIs that have the primary mission of providing capital and  development services to economically distressed communities generally  underserved by conventional financial institutions. CDFIs provide  products and services (such as mortgage financing for low-income and  first-time homebuyers and financing for not-for-profit affordable housing  developers) that otherwise may not be accessible in these communities.  CDFIs can be for-profit or nonprofit institutions and can be funded by  private and public sources. Depository CDFIs such as community  development banks and credit unions obtain capital from customers and  nonmember depositors. Depository and nondepository CDFIs may obtain  funding from conventional financial institutions, such as banks, in the form  of loans. In addition, both types of CDFIs may receive funding from  corporations, individuals, religious institutions, and private foundations.  Finally, CDFIs may apply for federal grants and participate in federal loan  programs. For example, Treasury’s CDFI Fund makes grants, equity  investments, loans, and deposits to help CDFIs serve low-income people   CDFI Fund certification is conferred  and communities.administered by the Department of Agriculture and the Small Business  Administration. As of December 31, 2014, there were a total of 933  certified CDFIs (411 depository and 522 nondepository).

Other federal funding sources include loan programs  The 12 FHLBanks are regionally based cooperative institutions owned by  member financial institutions (see fig. 1). regional FHLBank, a financial institution (such as a nondepository CDFI)  must meet certain eligibility requirements and purchase capital stock;  thereafter, it must maintain an investment in the capital stock of the  FHLBank sufficient to satisfy the minimum investment required for that  institution in accordance with the FHLBank’s capital plan.

On February 27, 2015, the FHLBank of Des Moines and the FHLBank of Seattle  announced that the members of both FHLBanks had ratified an agreement approved by  their boards of directors in September 2014 to merge. The FHLBanks anticipate that the  merger will be effective by the middle of 2015.

Single-family mortgage loans are loans for 1–4 unit properties. risk-management policies of the FHLBank.haircuts based on factors such as risks associated with the member’s  creditworthiness, the type of collateral being pledged, and illiquidity of the  collateral.

section_title: Nondepository CDFIs Differ from Other FHLBank Members in Several Ways
paragraphs: The differences among nondepository CDFIs and other FHLBank  members range from the degree to which they focus on community  development to differences in size and supervision. Two member types— nondepository and depository CDFIs—share a primary community  development focus. As noted previously, both types of CDFIs must have  a primary mission of promoting community development to be certified by  the CDFI Fund. CDFIs serve as intermediary financial institutions that  promote economic growth and stability in low- and moderate-income  communities. Frequently, CDFIs serve communities that are underserved  by conventional financial institutions and may offer products and services  that generally are not available from conventional financial institutions.  Such products and services include mortgage financing for low-income  and first-time homebuyers; homeowner or homebuyer counseling;  financing for not-for-profit affordable housing developers; flexible  underwriting and risk capital for needed community facilities; financial  literacy training; technical assistance; and commercial loans and  investments to assist start-up businesses in low-income areas. Although  other FHLBank members may provide similar services to similar  populations, community development may not be their primary mission.

Nondepository CDFIs are smaller in asset size than most depository  institution and insurance company FHLBank members. As of December  31, 2014, active members of the FHLBank System had approximately  $20 trillion in assets. As shown in table 1, as of the same date, median  assets for nondepository CDFI members (approximately $43 million) were  lower than median assets for both depository members (approximately  $207 million) and insurance company members (approximately $975  million). The largest nondepository CDFI had about $708 million in  assets, while the largest insurance company member had assets of about  $393 billion and the largest depository member had assets of about $2  trillion. In addition, the 30 nondepository CDFI members altogether  accounted for about .01 percent of the total assets of all active FHLBank  members, whereas depository and insurance company members held  about 77 percent and about 23 percent of FHLBanks assets, respectively.

In addition, nondepository CDFIs are not supervised by a prudential  federal or state regulator unlike other FHLBank members. Depository  FHLBank members are regulated and supervised by federal and state  agencies that have responsibility for helping ensure the safety and  soundness of the financial institutions they oversee, promoting stability in  the financial markets, and enforcing compliance with applicable consumer   To achieve these goals, regulators establish capital  protection laws.requirements for banks and conduct on-site examinations and off-site  monitoring that assesses their financial condition, including assessing  their compliance with applicable laws, regulations, and agency guidance.  The insured depository institutions also must submit to their regulators  quarterly financial information commonly known as Call Reports that  follow generally accepted accounting principles (GAAP). Insurance  companies are regulated primarily by state insurance commissioners and  are subject to examination. While the CDFI Fund’s review standards are  not equivalent to the examination standards applicable to regulated  depository institutions, the Fund requires a nondepository CDFI to submit  its most recent year-to-date financial statements prepared in conformity  with GAAP for certification and funding eligibility. The CDFI Fund also  requires nonprofit and for-profit nondepository CDFIs receiving awards to  annually submit financial statements—including information on financial  position, operations, activities, and cash flows—that have been audited  by an independent certified public accountant. However, only a subset of  CDFIs receives CDFI Fund awards and is subject to such reporting.

In addition to financial statements of individual nondepository CDFIs,  other sources can provide information on the financial performance of  nondepository CDFIs overall or individually. For example, the CDFI Fund  reports on its analysis of financial data from nondepository CDFIs. The  CDFI Snapshot Analysis for fiscal year 2012 (the most recent available at  the time of our review) notes that community development loan funds,  one type of nondepository CDFI, had rates of loan loss (loans that may  prove uncollectible) of 1 percent, which compared favorably with  depository CDFIs and mainstream financial institutions. A national network of CDFIs reported that its members’ annual net charge-off rate  (debts an entity is unlikely to collect) was the same as for all FDIC- insured institutions in fiscal year 2012. It also noted that its members  had provided more than $33 billion in cumulative financing for community  development activities from their inception through the end of fiscal year  2012. This financing, the network reported, helped to create or maintain  nearly 600,000 jobs, support the development or rehabilitation of more  than 960,000 housing units, and start or expand nearly 94,000  businesses and microenterprises. And, for a fee, a community  development loan fund can be assessed by an independent third party,  and receive a financial strength and performance rating.rates a CDFI using a methodology similar to that used by banking  regulators.

In the case of financial failure, nondepository CDFIs and depository  members also undergo different processes for liquidating assets to repay  the FHLBanks for any advances. Depository members, including  depository CDFIs, are insured by FDIC or NCUA, which means that FDIC  or NCUA would serve as the receiver in the event of failure. In a typical bank or thrift failure, FDIC, acting as receiver, is responsible for  outstanding advances of the failed institution. FDIC will facilitate a  purchase and assumption transaction with another financial institution or  sell the failed institution’s assets, including collateral that had been  pledged to secure the advances, to mitigate losses to FDIC’s Deposit  Insurance Fund.state insured, according to FHFA, the FHLBanks likely would go through  the federal bankruptcy process to settle claims should a nondepository  CDFI with FHLBank advances fail.

section_title: Collateral Requirements Pose Greatest Challenge for Nondepository CDFIs
paragraphs: Collateral requirements (which must be met to obtain advances) rather  than the membership requirements themselves can discourage  nondepository CDFIs from seeking FHLBank membership. Because  regulations allow the FHLBanks to set their own thresholds for meeting  some membership requirements, the requirements varied. The rates of  nondepository CDFI membership also varied by FHLBank and were low.  The FHLBanks generally impose collateral requirements on  nondepository CDFIs that are comparable to those imposed on  depository members categorized as higher risk and in some cases,  comparable to those imposed on insurance companies. Officials from the  nondepository CDFIs we interviewed generally cited steep haircuts  (discounts) and the availability of eligible collateral as the primary  challenges to obtaining advances; in addition, some viewed the  requirements as a disincentive to seeking membership (because  advances are a primary benefit of membership).
subsections: section_title: Although FHLBanks Had Varying Thresholds for Some Membership Requirements, Most Nondepository CDFIs We Interviewed Were Able to Meet the Requirements
subsections: section_title: Certain Membership Requirements Varied
paragraphs: While nondepository CDFIs must meet seven standards for FHLBank  membership, the thresholds the FHLBanks set for meeting certain of the  requirements varied. The Federal Home Loan Bank Act and FHFA’s  regulations establish the membership requirements for nondepository  CDFIs. Nondepository CDFIs must be duly organized under tribal law, or the laws of any state or the  United States. be certified by the CDFI Fund. make long-term home mortgage loans, which are defined by statute to  include loans secured by first liens on residential real property. Under  FHFA regulations, institutions satisfy this requirement if they originate  or purchase long-term first mortgage loans on single-family or  multifamily residential property, or certain farm or business property  that also includes a residence, or purchase mortgage pass-through  securities representing an undivided ownership in such loans. By  regulation, FHFA has defined “long-term” loans to include those with  an original term to maturity of 5 years or more. be in a financial condition that would allow advances to be safely  made to it. FHFA developed four financial condition standards for the  FHLBanks to use in their assessments—a net asset ratio of at least  20 percent; positive average net income over the preceding 3 years; a  ratio of loan loss reserves to loans and leases 90 days or more  delinquent of at least 30 percent; and an operating liquidity ratio of at  least 1.0 for the 4 most recent quarters, and for 1 or both of the 2  preceding years. If the nondepository CDFI met the standards, it  would be presumed to be financially sound, and satisfy the  requirement. If the CDFI did not meet one or more standards, the  CDFI may offer a rebuttal and the FHLBank would perform a separate  analysis to determine if the CDFI was financially sound. have management whose character is consistent with sound and  economical home financing. Under FHFA’s regulations, an applicant  meets this requirement if it certifies to the FHLBank that neither the  CDFI nor its senior officials have been the subject of any criminal,  civil, or administrative proceedings reflecting upon creditworthiness,  business judgment, or moral turpitude in the past 3 years and that  there are no known potential criminal, civil, or administrative monetary  liabilities, lawsuits, or unsatisfied judgments arising within the past 3  years that are significant to the applicant’s operations. have a home financing policy that is consistent with sound and  economical home financing. Under FHFA regulations, applicants meet  this requirement if they provide a written justification, acceptable to  the FHLBank, explaining how and why their home financing policy is  consistent with the FHLBank System’s housing finance mission. have mortgage-related assets that reflect a commitment to housing  finance. They are not required to meet the statutory requirement that  applies to certain insured depository institutions to hold at least 10  percent of their assets in residential mortgage loans to be eligible for  FHLBank membership.

In addition, the FHLBanks also must require all new members to  purchase capital stock.

The FHLBanks have discretion in developing rules to assess compliance  with some of the listed requirements. For example, the FHLBanks can set  thresholds (such as dollar amounts or percentages) to satisfy  requirements for which FHFA has not set thresholds—such as the  requirement for making long-term home mortgage loans and the  requirement to hold mortgage-related assets.develop its own requirement for membership stock purchases, subject to  FHFA approval. We reviewed the three requirements for which the  FHLBanks have discretion in making rules and found that the  requirements varied across the FHLBanks.

Making long-term mortgages. Eight of the 12 FHLBanks we reviewed  had not developed a threshold for nondepository CDFIs to satisfy the  long-term mortgage requirement, while four had specified a dollar amount  or percentage of assets in long-term mortgage loans. FHFA expects that  in assessing the applicant, the FHLBanks will assess the extent to which  nondepository CDFIs have a commitment to housing finance  requirements in light of their unique mission and community development  orientation. The four FHLBanks that had quantitative minimums had  minimum requirements that ranged from $1,000 to $1 million in dollar  amounts, and from 1 percent to 2 percent of total assets. One FHLBank’s  stated policy included an exemption from its particular minimum  requirement for nondepository CDFIs that plan to incorporate long-term  mortgage loans into future business strategies. Another FHLBank that  had a dollar minimum recently gave a nondepository CDFI an exemption  from the minimum requirement based on the assessment that the CDFI  had significant commitment to housing in accordance with regulatory and  membership requirements. For the remaining eight FHLBanks that did not  set a minimum requirement, nondepository CDFIs can satisfy the long- term mortgage requirement by documenting that they have originated or  purchased more than one such loan or qualifying mortgage investment.

Mortgage-related assets. Four of the 12 FHLBanks we reviewed did not  have minimum requirements for the mortgage-related asset requirement,  5 had quantitative and qualitative measures (such as an assessment of  the CDFI’s housing-related activities and mission), and 3 had only  quantitative measures. The highest minimum quantitative requirement  for mortgage-related assets as a percentage of total assets was 10  percent. The three FHLBanks with only quantitative requirements had the  lowest requirements, with one FHLBank requiring two mortgage-related  assets, another requiring $1,000 in mortgage-related assets, and another  requiring the lower of 1 percent of total assets or $10 million in mortgage- related assets.

Stock purchases. The amount of stock that members must purchase  varied according to each FHLBank’s funding strategy (see table 2).  FHLBank members must hold a certain amount of membership capital  stock as a continuing condition of membership. Each FHLBank  determines as a part of its capital plan the amounts that all members  must purchase in membership capital stock and sets its requirement  based on the FHLBank’s business model. Five of the 12 FHLBanks we  reviewed calculated the membership stock purchase as a percentage of  the member’s total assets. The other 7 FHLBanks calculated the  purchase as a percentage of a specific asset category, such as  mortgage-related assets or certain assets eligible to be pledged as  collateral.

The FHLBanks also require members to purchase activity-based stock.  That is, members must acquire a specific amount of stock based on the  product—such as advances or letters of credit—the FHLBank provided to  that member. The purchases are specified as a percentage of the dollar  amount of each transaction the member conducted with the FHLBank.  For example, among the 12 FHLBanks, the purchase requirements on  advances ranged from 2 percent to 5 percent. For instance, if a member  had a $2 million advance transaction with the FHLBank, it would have to  purchase from $40,000 to $100,000 in capital stock.

section_title: Most CDFIs Were Able to Meet Membership Requirements
paragraphs: While FHLBank and CDFI industry officials we interviewed cited several  membership requirements that could pose a challenge for nondepository  CDFI applicants (including financial condition, long-term home mortgage  loan, mortgage-related assets, and stock purchase requirements), most  of the nondepository CDFIs we interviewed were able to meet these  requirements or stated that they would be able to meet the requirements.

Financial condition requirements. Officials we interviewed from 9 of the  12 nonmember nondepository CDFIs stated that they would be able to  meet the financial condition standards, while 2 stated that they would  potentially face challenges with the financial condition standards. In  addition to interviewing officials from nondepository CDFIs that were  nonmembers, we reviewed the applications of the 27 nondepository  CDFIs that were members as of September 2014. Seven of the 27  nondepository CDFIs did not meet at least one of the financial condition  standards at the time of their application, but made successful rebuttals  and became members.

Making long-term mortgages. Of the 12 nonmember nondepository  CDFIs we interviewed, officials from 1 cited the “makes long-term home  mortgage loans” requirement as a challenge for membership. In addition,  officials from 1 of the 10 member nondepository CDFI we interviewed  cited this as a challenge, but noted that they received an exemption from  the minimum quantitative requirement imposed by the FHLBank. The  officials from the remaining 11 nonmember and 9 member CDFIs did not  identify this requirement as a challenge. Officials from two FHLBanks  stated that CDFIs in general may face challenges meeting this  requirement, as some nondepository CDFIs may not make or hold long- term home mortgage loans if they are not involved in mortgage lending.

Mortgage-related assets. Although the mortgage-related asset  requirement varies among the FHLBanks, none of the officials from the  12 nonmember nondepository CDFIs we interviewed stated that they  would face challenges meeting this requirement.

Stock-purchase requirements. Officials from 1 of the 12 nonmember  CDFIs we interviewed stated that the amount of membership stock they  would be required to purchase was cost prohibitive, while officials from  the 10 member CDFIs we interviewed stated that the amount required  was not a challenge to membership. Nondepository member CDFIs we  interviewed were able to purchase the required amount of membership  stock. Officials from one nonmember nondepository CDFI in the  FHLBank-Chicago district said that the CDFI was approved for  membership, but did not become a member because the stock purchase  requirement was too high. FHLBank-Pittsburgh recently amended its  capital plan by lowering the membership and activity-based stock  purchase calculations, citing benefits to CDFIs. In addition, FHLBank- Chicago recently reduced its minimum membership stock purchase  requirement to make it less costly for nondepository CDFIs and others to  join. (We discuss these and other changes later in this report.)

section_title: Rates of Nondepository CDFI Membership Were Low
paragraphs: The rates of nondepository CDFI membership generally were low,  ranging from 2.08 percent to 15.38 percent of nondepository CDFIs in  each FHLBank district (see fig. 2). As of December 31, 2014, 30 of the  522 nondepository CDFIs were FHLBank members, and 6 of the 12  FHLBanks had membership rates of less than 5 percent for the  nondepository CDFIs in their districts. The number of nondepository CDFI  members has increased every year since the first joined in 2010. Forty  percent (12 of 30) of the current nondepository CDFI members joined the  FHLBank System in 2014. As of the end of 2014, all 12 FHLBanks had at  least one nondepository CDFI member; 2 approved their first  nondepository CDFI member in 2013 and another 3 did so in 2014.

According to FHFA officials, some nondepository CDFIs may not be good  candidates for FHLBank membership. They noted that the majority of  nondepository CDFIs make nonhousing loans such as microloans, small  business loans, and commercial loans. In addition, FHFA officials stated  that many of the nondepository CDFIs engaged in housing-related  activities have low asset volumes.

section_title: Nondepository CDFIs Are Subject to Comparatively More Stringent Collateral Requirements, Which Can Be a Disincentive for Obtaining Membership
paragraphs: Due to the differences between nondepository CDFIs and other FHLBank  members discussed earlier, representatives from the FHLBanks stated  that nondepository CDFIs have certain risks that depository members do  not have. The risks cited included the lack of supervision by a regulator  and uncertainty related to the liquidation process in the event of  insolvency. As noted previously, the FHLBanks are required by statute  and FHFA regulations to develop and implement collateral standards and  other policies to mitigate the risk of default on outstanding advances. To  address risks associated with nondepository CDFIs, the FHLBanks can  place limits on eligible collateral and generally impose collateral  requirements on nondepository CDFIs seeking advances that are  comparable to those imposed on depository members categorized as  higher risk and, in some cases, insurance companies. Some of the CDFIs  and FHLBanks we interviewed cited these collateral requirements as a  disincentive for nondepository CDFI membership.
subsections: section_title: Eligible Collateral for Nondepository CDFIs Varied among FHLBanks
paragraphs: Although they are allowed by regulation to accept certain types of  collateral from all of their members, some FHLBanks have chosen to limit  the types of eligible collateral that nondepository CDFIs can pledge. (This  is also sometimes the case for other nondepository members such as  insurance companies.)

FHLBanks can accept FHLBank deposits as collateral.

The securities collateral FHLBanks can accept includes U.S. Treasury  and agency securities, U.S. agency mortgage-backed securities, and  privately issued mortgage-backed securities (including residential and  commercial).

The types of mortgage collateral that FHLBanks can accept include  single-family and multifamily mortgage loans; mortgage or other loans  issued, insured, or guaranteed by the U.S. government or its  agencies; commercial real estate loans; and home equity loans or  lines of credit.

Nondepository CDFIs are eligible to pledge FHLBank deposits, securities,  and mortgage loans as collateral for advances at all 12 FHLBanks. During  the course of our work, three FHLBanks—Atlanta, New York, and  Pittsburgh—changed their policies to allow mortgage loans as eligible  collateral from nondepository CDFIs. Pittsburgh changed its policies in  August 2014, New York in September 2014, and Atlanta in December  2014. All the other FHLBanks have had policies that allowed mortgage  loans as eligible collateral from nondepository CDFIs since nondepository  CDFIs became eligible for membership in 2010. Officials from FHLBanks  in Atlanta, New York, and Pittsburgh stated that due to the different risks  posed by nondepository CDFIs, they initially took conservative stances on  accepting loan collateral. The risks they cited included the lack of a clear  resolution mechanism in the case of bankruptcy and the FHLBank not  being able to obtain blanket liens on pledged collateral.

Within the general collateral categories (such as securities and mortgage  loans), each FHLBank can impose specific collateral eligibility  requirements, such as the quality of the collateral. For example, for  nondepository CDFIs, one FHLBank disallows nonagency mortgage- backed securities, another FHLBank disallows commercial real estate  collateral, and five FHLBanks disallow home equity lines of credit or home  equity loans. At two FHLBanks, nondepository CDFIs can pledge  mortgage loan collateral only if the CDFIs have certain credit ratings.

section_title: Collateral Requirements for Nondepository CDFIs Are Comparable to Those for Higher-Risk Institutions
paragraphs: The collateral requirements—specifically, the pledge method and  haircuts—applicable to nondepository CDFIs seeking advances are  comparable to those generally imposed on depository members  categorized as higher risk and, in some cases, to those imposed on  insurance companies. Based on our review of each FHLBank’s policies,  all FHLBanks evaluate the creditworthiness and financial condition of their  members, including nondepository CDFIs. Factors included in many of  the evaluations are capital adequacy, asset quality, management quality,  earnings, and liquidity. Additionally, the FHLBanks (with the exception of  Topeka) assign credit ratings to their depository members that indicate   Of the  the creditworthiness and financial condition of these members.11 FHLBanks that assign credit ratings to depository members, 9 also  assign credit ratings to nondepository CDFIs, with 2 (Atlanta and San  Francisco) using a separate rating system specific to nondepository  CDFIs. The remaining FHLBanks (New York and Indianapolis) do not  assign credit ratings to nondepository CDFIs. While the metrics and  methodology used to evaluate members differ, policies across FHLBanks  generally reflect differential treatment between depository institutions and  nondepository CDFIs (and other nondepository institutions such as  insurance companies). For example, all FHLBanks require nondepository  members to deliver collateral but generally only depository members with  low credit ratings are required to list or deliver collateral.

The FHLBanks differed in the extent to which they varied haircuts  (discounts) for nondepository CDFIs and depository institutions. For  securities collateral, eight FHLBanks imposed the same haircut on  nondepository CDFIs as on depository members for all eligible types of  securities collateral. In contrast, four imposed higher haircut ranges on  nondepository CDFIs. For loan collateral,  six FHLBanks generally applied the same haircuts to nondepository  CDFIs and depository institutions. One applied a higher-range haircut  for single-family mortgages to nondepository CDFIs than to depository  institutions; five FHLBanks applied higher haircut ranges to nondepository CDFIs  than to depository institutions; and another FHLBank applied the lower end of the haircut range to  nondepository CDFIs.

FHLBanks generally varied the haircut based on the types and quality of  collateral, credit score or financial condition of the member, and pledge  method (for loans). In general, haircuts were higher for collateral with  lower ratings or of lower quality. See tables 3 and 4 for the specific  haircuts each FHLBank imposed on nondepository CDFIs and depository   In all cases, each FHLBank  institutions for securities and loan collateral.may change these requirements at its discretion. See appendix II for  more information on each FHLBank’s credit rating system and collateral  requirements for advances, and how they may differ for nondepository  CDFIs and depository institutions.

Four FHLBanks—Des Moines, New York, Pittsburgh, and San  Francisco—had conditions on advance terms and borrowing limits  specific to nondepository CDFIs. In general, advance terms and  conditions varied widely. For example, FHLBanks offered advances with  terms to maturity ranging from overnight to 30 years. FHLBanks may  establish an overall credit limit for their borrowers. For example, the  overall credit limit for FHLBank-Chicago was 35 percent of a member’s  total assets. However, the amount a borrower can obtain is also partly  dependent upon the amount and value of qualifying collateral available to  secure the advance. FHLBanks may impose additional restrictions  depending on the financial condition of the borrower, such as restrictions  on the type of product, term of advance, and amount of credit available.  Examples of specific conditions imposed on nondepository CDFIs by the  four FHLBanks include the following:

FHLBank-Des Moines imposed a maximum amount of borrowing  capacity and term available based on member credit ratings.  Nondepository CDFIs were subject to a lower borrowing capacity than  depository institutions with the same ratings.

FHLBank-New York limited the maximum advance term to 5 years for  nondepository CDFIs.

FHLBank-Pittsburgh limited the maximum advance term to 2 years for  nondepository CDFIs.

FHLBank-San Francisco had a term limit of 7 years for its  nondepository CDFIs.

For more information on each FHLBank’s advance terms and borrowing  limits for nondepository CDFIs and depository institutions, see appendix  III.

section_title: Lack of Eligible Collateral Viewed as Primary Challenge to Obtaining Advances and Steep Haircuts Viewed as Disincentives
paragraphs: Officials from most of the nondepository CDFIs we interviewed cited  access to low interest-rate advances from the FHLBanks as the primary  benefit of membership, and some FHLBanks and nondepository CDFIs  officials cited collateral requirements as challenges or disincentives to  obtaining advances. Officials from three FHLBanks stated that the lack of  eligible collateral was a disincentive for nondepository CDFIs seeking  membership.

Officials from 21 (10 members and 11 nonmembers) of the 22  nondepository CDFIs we interviewed cited access to low interest-rate  advances from the FHLBanks as the primary benefit of membership.

Officials from 5 of the 12 nonmember nondepository CDFIs  interviewed said that they would not be interested in membership if  they could not obtain advances.

Officials from 10 FHLBanks and 12 (6 members and 6 nonmembers)  nondepository CDFIs stated that lack of eligible collateral was a  challenge to obtaining advances for nondepository CDFIs. The  reasons the officials provided for lack of collateral eligibility included not possessing mortgage-related collateral, not having unencumbered assets (those free and clear of liens or  claims by other creditors), and not having quality collateral that met FHLBank standards.

For example, officials from FHLBank-Chicago stated that most  nondepository CDFIs possessed assets, such as small business  loans, that did not qualify based on statute and regulation as eligible  collateral. Officials from four FHLBanks and seven nondepository  CDFIs (three members and four nonmembers) stated that the  requirement to pledge unencumbered assets was a challenge for  nondepository CDFIs. Collateral encumbrance may occur when a  CDFI is also a loan consortium that makes loans to borrowers on  behalf of its members. Quality of collateral also affected collateral  eligibility. For instance, officials from FHLBank-Cincinnati provided an  example of a nondepository CDFI member whose collateral consisted  exclusively of subprime mortgage loans. Due to the FHLBank’s  constraints on exposure to subprime residential mortgage loan  collateral (no more than 60 percent of borrowing capacity could stem  from these loan types), the FHLBank was not able to accept the loans  as collateral.

Steep haircuts were cited as a disincentive to applying for advances.

Officials from 6 (2 members and 4 nonmembers) of the 22  nondepository CDFIs we interviewed cited high haircuts as a  disincentive for obtaining advances. For example, officials from a  nondepository CDFI member said that their haircuts were very steep  and that they likely will not obtain advances again unless the  FHLBank eased the requirements. Officials from a nonmember  nondepository CDFI in another district stated that the haircut was too  restrictive.

Officials from all the member nondepository CDFIs we interviewed said  that FHLBank membership had not affected their business activities or  that they had not considered changing their business activities to better  meet the collateral requirements. However, officials from three of the  nonmember nondepository CDFIs we interviewed said that they have  been taking actions to obtain assets that could be used as eligible  collateral. One of these nonmember nondepository CDFIs was buying  mortgage-backed securities to better meet collateral requirements.  Additionally, officials from five FHLBanks said that their nondepository  CDFI members had changed the structure of certain loans or repositioned  their assets to create eligible collateral for advances.

section_title: Less Than Half of Nondepository CDFI Members Have Borrowed from FHLBanks
paragraphs: From October 2010 to September 2014, less than half of the  nondepository CDFI members obtained advances from the FHLBanks.  Six FHLBanks provided 115 advances totaling about $306.7 million to 12  nondepository CDFIs during this period (see fig. 3). However, two  FHLBanks provided 57 advances to four nondepository CDFIs that  accounted for almost 98 percent of the total advance amount. Of the 115  advances, approximately 36.5 percent had terms of less than 1 year  (including advances with overnight terms), 15.7 percent had terms of  more than 1 year to less than 5 years, 44.3 percent had terms of 5 years  or longer, and 3.5 percent had open terms.

section_title: FHFA and FHLBanks Have Made Efforts to Facilitate Broader Participation of Nondepository CDFIs in the FHLBank System
paragraphs: FHFA and FHLBanks have made efforts to broaden the participation of  nondepository CDFIs in the FHLBank System. According to FHFA  officials, FHFA’s final rule implementing the HERA provisions that allow  nondepository CDFI membership in the FHLBank System allows for  certain flexibilities in meeting membership requirements. FHFA oversight  of FHLBanks did not focus on FHLBanks’ membership approval process  or advance and collateral practices as it relates to nondepository CDFIs  and did not identify any safety and soundness concerns or action plans.  FHFA and the FHLBanks have undertaken several efforts to help promote  membership of nondepository CDFIs in the FHLBank System.
subsections: section_title: FHFA Final Rule on Membership for Nondepository CDFIs Includes Flexibilities
paragraphs: As noted previously, FHFA’s final rule to implement HERA provisions on  nondepository CDFI membership in the FHLBank System allows for  certain flexibilities in meeting membership requirements. In 2009, FHFA  drafted a proposed rule that sought to amend the membership regulations  and issued it for public comment. The substantive issues raised in the  comments on membership focused on the criteria that FHFA proposed for  FHLBanks to use in evaluating the financial condition of nondepository  CDFIs applying for membership. According to FHFA officials, the CDFI  community also was concerned about nondepository CDFIs not meeting  basic membership requirements, such as making long-term mortgage  loans and carrying mortgage-related assets.

FHFA reviewed the comments and issued a final rule in January 2010. If  an applicant cannot meet the presumptive financial conditions, the final  FHFA regulations allow nondepository CDFIs to submit additional  information demonstrating that the applicant is in sufficiently sound  condition to obtain membership and advances. The final rule also did not  extend the requirement to demonstrate that 10 percent of their total  assets are in residential mortgage loans to nondepository CDFI  applicants.

section_title: Examinations of FHLBanks Found No Safety and Soundness Concerns with Advance Practices
paragraphs: FHFA oversight of FHLBanks as it relates to nondepository CDFIs did not  focus on membership processes due to the low risk posed, and its  oversight of collateral practices did not identify areas of concern. FHFA  conducts annual examinations of the FHLBanks that cover these topics,  among others. According to FHFA officials, FHFA examines FHLBanks’  membership approval processes to ensure that they comply with FHFA’s  eligibility requirements and implement a risk-management process that is  intended to mitigate the FHLBanks’ exposure to significant risks,  especially legal, credit, and operational risk.

FHFA reviewed aspects of each FHLBank’s membership process  periodically in 2010 through 2013. However, according to FHFA, it did  not focus on processes specific to nondepository CDFIs because  nondepository CDFIs pose low safety and soundness and credit risks, in  aggregate, to FHLBanks due to their low rates of membership and  advances. According to FHFA officials, FHFA currently reviews each  nondepository CDFI’s application for membership and has not objected to  any nondepository CDFI application submitted by the FHLBanks. It  primarily reviews applications to gather information about the FHLBanks’  membership approval process.

In annual examinations of each FHLBank in 2010 through 2013, FHFA  reviewed the FHLBanks’ collateral and advance practices for  nondepository CDFIs and did not find any safety and soundness issues.  FHFA’s advances and collateral examination manual calls for it to  evaluate the FHLBanks’ procedures for analyzing and monitoring  members, including nondepository CDFIs, and their outstanding  advances. The manual also advises that special attention be given to  FHLBanks’ collateral practices for CDFIs because nondepository CDFIs  have no dedicated regulator. Furthermore, FHFA advises that FHLBanks’  credit risk-management procedures be tailored to address risks unique to  each member type. For example, FHLBanks should consider that  nondepository CDFIs likely are covered by federal bankruptcy statutes  and not by the same receivership laws as insured depository institutions.

section_title: Efforts to Facilitate Nondepository CDFI Participation in the FHLBank System Include Education and Outreach
paragraphs: FHFA and the FHLBanks have undertaken several efforts to help educate  nondepository CDFIs about and promote membership in the FHLBank  System. According to FHFA officials, FHFA conducted a training session  and webinar on the membership rule in February 2009, followed up on  questions from CDFIs about the regulations, and tracked the progress of  nondepository CDFIs in gaining membership. Officials from FHFA have  made themselves available for questions about and problem solving in  relation to the rules. According to FHFA and FHLBank officials as well as  nondepository CDFIs we interviewed, FHFA has been encouraging  FHLBanks to discuss ways in which they could increase nondepository  CDFI membership and access to advances in a safe and sound manner.  For example, at a speech to the FHLBank boards and executive  management in early 2014, FHFA encouraged all the FHLBanks to meet  collectively to discuss collateral practices that might facilitate advance  activity with nondepository CDFIs, and emphasized the importance of the  FHLBanks’ understanding of CDFI business models and funding needs.  According to FHFA officials, as a result of that speech, the FHLBanks  held a conference in August 2014 with the nondepository CDFI  community to discuss facilitating membership and better understand the  business of nondepository CDFIs. As a follow-up to the conference,  FHLBank credit officers held nondepository CDFI credit review training in  October 2014.  Furthermore, the FHFA Director also met with  nondepository CDFI officials and trade groups in July 2014.

In addition, all FHLBanks performed their own outreach to the  nondepository CDFI community. For example, all the FHLBanks met with  FHFA and nondepository CDFI members and nonmembers at the August  2014 conference to better understand nondepository CDFIs. Ten of the  FHLBanks we interviewed have initiated discussions with and solicited  membership applications from nondepository CDFIs since the  conference. Some FHLBanks made changes in response to feedback  from nondepository CDFI members. As noted previously, three of the  FHLBanks that had restrictive collateral eligibility requirements amended  these requirements to make obtaining advances easier for nondepository  CDFIs. Two FHLBanks also made changes to their capital stock purchase  requirements to allow a nondepository CDFI to be able to meet the stock  purchase amount. According to the FHLBank officials, FHFA has been  supportive of the changes they made to better accommodate  nondepository CDFI membership and access to advances. FHFA officials  told us that they have continued to encourage the FHLBanks to facilitate  broader nondepository CDFI membership and access to advances.

section_title: Agency and Third Party Comments and Our Evaluation
paragraphs: We provided a draft of this report to FHFA and the 12 FHLBanks for their  review and comment. FHFA and four FHLBanks (Chicago, Cincinnati,  Indianapolis, and Topeka) provided technical comments, which we  incorporated as appropriate. The other eight FHLBanks did not provide  any comments.

In its comments, FHLBank-Chicago also stated that our report unfairly  compares nondepository CDFIs with depository institutions and that a  better comparison would be regulated institutions versus nonregulated or  less regulated institutions (because claims would be handled similarly for  regulated institutions). Specifically, FHLBank-Chicago noted that an  FHLBank likely would go through the federal bankruptcy process to settle  claims if a nondepository CDFI with FHLBank credit outstanding failed,  whereas a federal or state regulator would facilitate the process to settle  claims if a regulated institution such as a bank, credit union, or insurance  company with FHLBank credit outstanding failed. However, the purposes  of our report explicitly include discussing how nondepository CDFIs differ  from other members of the FHLBank System (in particular, depository  members) and the membership and collateral requirements for these  CDFIs. We understand that risks vary by type of institution and noted  several differences—including in supervision and the liquidation of  assets—between nondepository CDFIs and other types of FHLBank  members in our report. Comparing the collateral requirements for  nondepository CDFIs with those for depository institutions enabled us to  determine how the FHLBanks address the different risks posed by  nondepository CDFIs. Moreover, in terms of resolution treatments, there  is no uniform approach to settling claims even within the category of  “regulated institutions.” For instance, FHFA stated in one of its advisory  bulletins that “FHLBanks face risks lending to insurance companies that  differ in certain respects with lending to federally-insured depository  institutions” and noted that “laws dealing with a failed insured depository  institution are well known and uniform across the country, whereas, the  laws dealing with the failure of an insurance company are less well known  to the FHLBanks and, though similar, may vary somewhat from state to  state.” Therefore, we maintain that our comparisons were fair and made  no change to the report in response to this comment.

In another comment, FHLBank-Chicago stated that the report implies that  by loosening collateral requirements (some of which are dictated by law  or regulation), more nondepository CDFIs would be eligible or willing to  become FHLBank members. It noted that this was not necessarily the  case, as a majority of nondepository CDFIs would not qualify for  membership because of their lines of business (small business lending,  microlending, and commercial lending) and because they have  encumbered assets. We believe that these points are already adequately  addressed in our report. Specifically, in the report we note that the types  of eligible collateral are dictated by regulation. In addition, we state in the  report that FHFA officials told us that some nondepository CDFIs may not  be good candidates for FHLBank membership because the majority of  nondepository CDFIs make nonhousing loans such as microloans, small  business loans, and commercial loans.  Furthermore, we note that  several FHLBanks and nondepository CDFIs we interviewed told us that  the requirement to pledge unencumbered assets was a challenge for  nondepository CDFIs. We undertook these interviews to help understand  the level of demand for FHLBank membership and obtain views on any  challenges associated with obtaining membership and advances.  Therefore, we made no change to the report in response to this comment.

In its comments, FHLBank-Indianapolis stated that the report could do a  better job of making it clear that (1) FHLBanks accept assets as collateral  and develop haircut methodologies to comply with regulations and an  expectation of no losses in the event of default and (2) pledging illiquid  assets can increase the haircut. In response, we added language in the  body of the report that reiterated language in our background section  stating that FHLBanks are required by statute and FHFA regulations to  develop and implement collateral standards and other policies to mitigate  the risk of default on outstanding advances. We also added language to  the report noting that the illiquidity of assets can affect haircuts.

As agreed with your offices, 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 to the appropriate  congressional committees and members, the Director of FHFA, the  Council of the FHLBanks, and the 12 FHLBanks. This report will also be  available at no charge on our website at http://www.gao.gov.

Should you or your staff have questions concerning this report, please  contact me at (202) 512-8678 or garciadiazd@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. Key contributors to this report are listed in  appendix IV.

section_title: Appendix I: Objective, Scope, and Methodology
paragraphs: The objectives of this report were to discuss (1) how nondepository  community development financial institutions (CDFI) differ from other  members of the Federal Home Loan Bank (FHLBank) System, in  particular depository members; (2) the membership and collateral  requirements for nondepository CDFIs and challenges posed by these  requirements; and (3) Federal Housing Finance Agency (FHFA) oversight  of FHLBanks in relation to nondepository CDFIs and efforts by FHFA and  FHLBanks to increase participation of nondepository CDFIs in the  FHLBank System.

To describe differences between nondepository CDFIs and other  members of the FHLBank System, we reviewed relevant sections of the  Housing and Economic Recovery Act of 2008 (HERA) and FHFA’s final  rule on nondepository CDFI membership in the FHLBank System. In  addition, we reviewed other relevant information from the FHLBanks and  CDFI industry, such as reports by the Department of the Treasury’s  Community Development Financial Institutions Fund (CDFI Fund) and the  Opportunity Finance Network. We determined that these studies were  methodologically sound and reliable for our purposes. To compare the  asset sizes of different types of FHLBank members (nondepository  CDFIs, depository institutions, and insurance companies), we analyzed  available data on their assets from FHFA’s membership database as of  December 31, 2014. For these institution types, we calculated the  distribution of their assets (minimum assets, 25th percentile, median  assets, 75th percentile, and maximum assets). To assess the reliability of  these data, we reviewed information about the system, interviewed  knowledgeable officials, and analyzed the data for logical consistency and  completeness. We found that these data were sufficiently reliable for the  purpose of comparing the asset sizes of different types of FHLBank  members.

To address membership and collateral requirements, we reviewed  relevant legislation and regulations, such as the Federal Home Loan  Bank Act and FHFA’s final rule on nondepository CDFI membership. We  also reviewed documentation—such as nondepository CDFI membership  applications and available FHLBank guidance on assessing  nondepository CDFIs for membership—from each of the FHLBanks to  determine membership requirements and identify any differences among  FHLBank policies.FHLBank’s requirements for membership and identified differences. For  example, in the three areas where FHLBanks had discretion, the analyst  determined whether FHLBanks had set a minimum quantitative or  qualitative threshold that an applicant needed to meet. A second analyst  then verified the accuracy of this information. Nondepository CDFIs are  subject to specific financial condition requirements. We requested and  received financial data from the CDFI Fund but determined that the  dataset did not contain relevant data needed to determine how many  nondepository CDFIs could meet these financial condition requirements.

Specifically, one GAO analyst reviewed each  To determine the number of nondepository CDFIs that were members  from calendar years 2010 through 2014, we analyzed data from FHFA’s  membership database as of December 31, 2014. To calculate the  membership rate (the percentage of nondepository CDFIs in each district  that were members), we used (1) data from FHFA’s membership  database on the number of members as of December 31, 2014, and (2)  data from the CDFI Fund on the total number of nondepository CDFIs as  of December 31, 2014. We assessed the reliability of data from both  systems by reviewing any relevant documentation, interviewing  knowledgeable officials, and analyzing the data for logical consistency  and completeness. We determined that the data were sufficiently reliable  for the purposes of assessing rates of membership for nondepository  CDFIs.

To determine each FHLBank’s requirements for obtaining advances and  any differences among the FHLBanks, we reviewed relevant  documentation such as each FHLBank’s collateral guidelines and product  and credit policies. Using these documents, we identified the haircut  (discount) for eligible collateral types for depository and nondepository  institutions and other collateral requirements, such as the term of  advances and collateral pledging methods. Our review of FHLBank  documents showed that FHLBanks do not describe their collateral  requirements uniformly. Although we took several steps that enabled us  to present comparable categories of collateral across the FHLBanks, our  analysis did not account for differences in the eligibility criteria for  collateral that may be accepted, such as quality of collateral. As a result,  the haircuts for different FHLBanks are not comparable. First, we  excluded from our analysis the following types of collateral because they  were only mentioned in some FHLBanks’ documents: U.S. Treasury  separate trading of registered interest and principal securities, agency  structured bonds, agency collateralized mortgage obligation accrual  bonds, second mortgage-backed securities, student loan asset-backed  securities, agricultural real estate loans, land loans, construction loans,  student loans, mutual funds, and municipal or state and local securities.  Second, because some FHLBanks identified specific haircuts for  securities, such as those originating from the Federal Deposit Insurance  Corporation, while other FHLBanks listed haircuts for a general category  of agency securities, we grouped all the agency securities and provided  the range of haircuts. We included in the agency securities category any  securities issued or guaranteed by the U.S. government, including those  originating from the Federal Deposit Insurance Corporation, National  Credit Union Administration, Fannie Mae, Freddie Mac, Ginnie Mae, the  Federal Home Loan Banks, and the Small Business Administration. Third,  because some FHLBanks identified specific haircuts for specific  government-guaranteed loan collateral while others did not, we grouped  all government-guaranteed loan collateral together, including loans  originating from the Farm Service Agency, Department of Agriculture,  Small Business Administration, Federal Housing Administration, and  Department of Veterans Affairs. Fourth, because haircuts can vary based  on the quality of the collateral pledged, we provided the range of haircuts  for each type of collateral accepted by each FHLBank. 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 the  FHLBanks generally are considered proprietary information, we were  unable to attribute specific policies to individual FHLBanks. Where  appropriate, we used randomly assigned numbers when discussing  FHLBank collateral policies to prevent disclosure of FHLBank identities.

Additionally, we obtained data from each FHLBank on the amount of  advances secured by each nondepository CDFI member from October  2010 to September 2014 (the most recent data available at the time of  our request). We assessed the reliability of these data by obtaining  information from the six FHLBanks that provided advances to  nondepository CDFIs on the system they used to store the data and the  procedures in place for recording and ensuring the accuracy of the data.  We also reviewed the data for logical consistency and completeness. We  determined that the data were sufficiently reliable for reporting the amount  of advances obtained by nondepository CDFs. We also interviewed  officials from the 12 FHLBanks, 3 trade groups, 10 nondepository CDFIs  that were members of the FHLBanks, and 12 nondepository CDFIs that  were not members to understand the level of demand for FHLBank  membership and obtain views on any challenges associated with  membership processes and obtaining advances.

To develop the purposive, nonrandom sample of 10 nondepository  FHLBank member CDFIs to interview, we selected a nondepository CDFI  from each of the 10 FHLBanks that had a nondepository CDFI member  as of March 31, 2014 (the most recent data available when we began our  work and selected members to interview). In addition to geographic  diversity, we sought variation in asset size, financial institution type, and  FHLBank advance status. We also selected a purposive, nonrandom  sample of 12 nondepository CDFIs that were not members of the  FHLBank System, one from each of the 12 FHLBank districts. We  selected these 12 from a sample of nondepository CDFIs that were  identified during our meetings with member CDFIs and CDFI trade groups  as being interested in FHLBank membership. In addition to geographic  diversity, we sought variation in asset size when selecting nonmembers  to interview. We interviewed officials from all 22 nondepository CDFIs by  telephone, focusing on the background of the CDFI and its experience  with and opinions of the FHLBank membership and advance processes.  The views expressed by the nondepository CDFIs in our sample cannot  be generalized to the entire population of nondepository CDFIs.

To evaluate FHFA’s oversight, we reviewed relevant laws, legislative  history, and regulations (including its final rule on nondepository CDFI  membership) to identify FHLBanks’ authority to expand membership to  nondepository CDFIs and FHFA’s oversight authority. We also reviewed  FHFA examination policies related to membership and collateral  requirement to obtain advances. To determine if membership and  advance practices were reviewed and there were any findings, we  analyzed each FHLBank’s examination results for fiscal years 2010  through 2013 (the most recent examinations available at the time of our  request). We interviewed FHFA and the 12 FHLBanks to further  understand examination policies and practices for membership and  advances and discuss any FHFA efforts to facilitate broader  nondepository CDFI participation in the FHLBank System.

We conducted this performance audit from May 2014 to April 2015, 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.

section_title: Appendix II: Federal Home Loan Bank Collateral Requirements for Nondepository Community Development Financial Institutions and Depository Institutions
paragraphs: The collateral requirements—specifically the pledge method for loan  collateral and haircuts (discounts)—assessed on advances to  nondepository community development financial institutions (CDFI) vary  from those imposed on depository members. For example, all Federal  Home Loan Banks (FHLBanks) require nondepository CDFIs to deliver  collateral (a requirement that also would be applied to higher-risk  depository institutions), and in some cases, nondepository CDFIs receive  higher haircuts than depository institutions. For each FHLBank, we  compare the pledge method and haircuts applied to depository institutions  and nondepository CDFIs below (see table 5).

section_title: Appendix III: Federal Home Loan Bank Advance Terms and Borrowing Limits for Nondepository Community Development Financial Institutions and Depository Institutions
paragraphs: Most Federal Home Loan Banks (FHLBanks) do not have advance terms  and borrowing limits specific to nondepository community development  financial institutions (CDFI). However, four FHLBanks (Des Moines, New  York, Pittsburgh, and San Francisco) do have specific advance terms and  borrowing limits. We summarize the advance terms and borrowing limits  for each FHLBank below (see table 6).

section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Paige Smith (Assistant Director),  Akiko Ohnuma (Analyst-in-Charge), Farah Angersola, Evelyn Calderon,  Pamela Davidson, Kerri Eisenbach, Courtney LaFountain, John McGrail,  Marc Molino, Barbara Roesmann, Jim Vitarello, and Weifei Zheng made  key contributions to this report.


Question-summary annotations: questions: question: What discouraged some CDFI's from seeking FHLBank membership?
answer: Collateral requirements rather than membership requirements discouraged some nondepository community development financial institutions (CDFI)—loan or venture capital funds—from seeking membership in the Federal Home Loan Bank (FHLBank) System.

question: What are CDFIs?
answer: CDFIs are financial institutions that provide credit and financial services to underserved communities.
child_questions: question: How many CDFIs are involved in the FHLBank system?
answer: Less than 6 percent of nondepository CDFIs (30 of 522) were members of the System as of December 2014 (see figure).

question: To what extent do membership requirements pose a challenge for CDFIs?
answer: Requirements for membership (such as stock purchase amounts) can vary where regulation gives FHLBanks discretion, but nondepository CDFIs GAO interviewed generally stated these requirements did not present a challenge.

question: How do CDFIs have different risks than depository members?
answer: FHLBank officials stated nondepository CDFIs have different risks compared with depository members (for example, nondepository CDFIs are not supervised by a prudential federal or state regulator as are other FHLBank members). Some of the nondepository CDFIs GAO interviewed cited limited availability of eligible collateral and steep haircuts as challenges for obtaining advances and therefore a disincentive to seeking membership.

questions: question: How have the FHFA and FHLBanks attempted to increase nondepository CDFI participation in the System?
answer: The Federal Housing Finance Agency (FHFA), which oversees the System, and FHLBanks have facilitated efforts to broaden nondepository CDFI participation in the System by educating about and promoting membership to nondepository CDFIs.
child_questions: question: How has the FHFA increased outreach?
answer: For example, FHFA officials told us that they encouraged the FHLBanks to hold a conference to discuss nondepository CDFI membership. Officials from 10 FHLBanks also stated that they had solicited applications from CDFIs.

question: How have FHLBanks attempted to make requirements more accessible for nondepository CDFIs?
answer: In late 2014, several FHLBanks amended stock purchase and collateral requirements to better accommodate nondepository CDFI membership and access to advances.

questions: question: What did HERA do?
answer: The Housing and Economic Recovery Act of 2008 (HERA) made nondepository CDFIs eligible for membership in the FHLBank System.
child_questions: question: What institutions does the System consist of?
answer: The System includes 12 regional FHLBanks that make loans, known as advances, to their members at favorable rates.

question: What was GAO asked to review?
answer: GAO was asked to review the FHLBanks' implementation of HERA provisions relating to nondepository CDFIs.
child_questions: question: What does this report discuss?
answer: Among other things, this report discusses (1) challenges posed by membership and collateral requirements for nondepository CDFIs, and (2) FHFA and FHLBank efforts to facilitate broader nondepository CDFI participation in the System.