June 7, 2000
Ms. Elaine Baker
Executive Secretary
Federal Housing Finance Board
1777 F Street, N.W.
Washington, DC 20006

Re: Proposed Rule; Federal Home Loan Bank Advances, Eligible Collateral, New Business Activities and Related; 12 CFR Parts 900, 917, 926, 944, 950, 952, 961, and 980; 65 Federal Register 26518, May 8, 2000.

Dear Ms. Baker:

The American Bankers Association ("ABA") appreciates this opportunity to comment on the proposed rule issued by the Federal Housing Finance Board ("Finance Board") amending regulations related to advances made by the Federal Home Loan Banks ("the Banks") and the eligible collateral for such advances. The American Bankers Association brings together all categories of banking institutions to best represent the interests of the rapidly changing industry. Its membership - which includes community, regional and money center banks and holding companies, as well as savings associations, trust companies and savings banks - makes ABA the largest banking trade association in the country.

The proposed rule would implement the provisions of the Gramm/Leach/Bliley Financial Modernization Act relating to acceptable collateral for Community Financial Institution (CFI) members of the Federal Home Loan Bank System. Specifically, the proposed rule would define the newly eligible collateral including "small business loans", "small farm loans", and "small agribusienss loans".

Expanding the categories of eligible collateral to include small business and agricultural loans was a key provision in the Gramm/Leach/Bliley Act, and was a significant factor in the ABA's strong support of that legislation. Many community banks face serious funding shortages. The liquidity provided by the Federal Home Loan Banks through advances has already become a vital source of funds for these institutions. It is expected that the expanded categories of collateral will greatly enhance member institutions' ability to use advances to meet the credit needs of their communities. For that reason, ABA is pleased that the Finance Board has developed a thoughtful and well-reasoned proposed rule in a relatively short time frame.

However, ABA does believe that the rule can be improved in several areas. Our comments below reflect these views.

Proposed Section 950.1 defines "small agri-business loans", "small business loans" and "small farm loans". While ABA believes, and will address later in this letter, that there are better definitions of these loans available, we are concerned that the proposed regulation does not define "agricultural loans".

The proposed regulation (in 950.7(b)) establishes "Additional collateral eligible as security for advances to CFI members or their affiliates." This section authorizes the Banks to accept "small business loans, small farm loans or small agri-business loans fully secured by collateral other than real estate…" as eligible collateral. However, section 604(a)(5)(C) of Gramm/Leach/Bliley establishes as eligible collateral "secured loans for small business, agriculture, or securities representing a whole interest in such secured loans, in the case of any community financial institution" (emphasis added). The clear intent of the statute is to allow all secured agricultural loans to be eligible for community financial institutions (CFIs) to pledge as collateral for advances. The limitation to small farm loans and small agri-business loans applies to advances only, not to acceptable collateral. For purposes of eligible collateral for CFIs the regulation should define "agricultural loans" as "loans to producers of livestock, crops, poultry, fish, food, fiber, forestry and other products grown in a controlled or selected environment."

ABA also believes that the definitions of "small business loans", "small agri-business loans" and "small farm loans"

are too restrictive to allow the Banks to readily accept these types of collateral. We believe these definitions can be substantially streamlined in a way which will make it easier for both the Banks and their members to determine what types of loans are eligible for advances.

The regulation would require that members of the System seeking to pledge small business loans of greater than $1 million must document, on a case-by-case basis, that a particular loan fits in to the Small Business Administration's Standard Industry Classification ("SIC") codes for "small". Such a process is an unnecessary regulatory burden for both the pledging member, who must spend time and resources preparing the documentation, and the Bank which must spend time and resources confirming the documentation.

All insured depository institutions are subject to loans to one borrower (LTOB) limitations. Institutions meeting the qualifications to be determined a Community Financial Institution (having $500 million in assets or less), are limited by their primary regulator to making loans of $6 million or less in compliance with the LTOB rules. As the Finance Board recognized in 1998 when it amended the collateral regulations for combination properties, limiting the size of the members which may pledge loans effectively limits the size of the loans themselves. The rationale stated by the Board at that time was that since the maximum loan amount for a $500 million member would be $6 million, it was unlikely that the loans pledged by the member would be large commercial or agri-business loans. (See 63 Fed. Reg. 3511 (June 29, 1998)). The same rationale applies in this instance. Therefore, we propose that a "small business loan" for a CFI should be defined as a "commercial and industrial loan as reported on the institution's call report that is within the CFI's legal lending limit."

"Small agri-business loans" should have the same definition. The Small Business Administration makes no distinction between an agri-business and a business. While the Gramm/Leach/Bliley act does distinguish between a "small business loan" and a "small agri-business loan" it allows the Finance Board to define each of these loans. Because there is no material difference between them, they should have the same definition; a "commercial and industrial loan as reported on the institution's call report that is within the CFI's legal lending limit."

Finally, we are concerned that the definition of "small farm loan" as proposed would be equally if not more burdensome than the "small business loan" definition. The regulation provides a "safe harbor" for a "small farm loan" of $500,000 or less. For any loan beyond that amount, the pledging member would have to document that the loan meets the SBA's SIC codes for the particular farming operation. As with the proposed definition of "small business loans" such a requirement would be time-consuming and overly burdensome for both the member seeking to pledge the loan and for the Bank in confirming the loan's eligibility. The result will be that few "small farm loans" will be pledged for collateral due to the time and cost burdens in confirming their eligibility. A better approach, as with "small business loans" and "small agri-business loans" is to rely on the lending limits to one borrower rules. In this instance, the definition of a "small farm loan" should be "an agricultural loan as reported by a CFI on its call report, that is within the CFI's legal lending limit". Here, again, the limit on the size of the institution will provide a more than adequate limit on the size of the loans that can be made.

The proposed rule (in Section 950.7(a)) would limit the Banks' ability to more broadly accept "other real estate related" collateral to 25 percent of each Bank's highest level of such collateral previously accepted until the Bank has met the new business activity requirements of the newly proposed part 980. ABA believes this restriction to be too severe.

The Banks have a long history in accepting "other real estate related collateral". Accepting such collateral in no way constitutes a "new business activity" for the Banks. The Gramm/Leach/Bliley Act simply removed the limitations on the amount of advances secured by such collateral that any member could receive. Therefore the Banks should not be subject to the very stringent "new business activity" requirements before accepting this collateral. As the Banks have already accepted such collateral, they should have the systems and personnel in place to evaluate this collateral, and the Finance Board should already have evaluated each Bank's ability to underwrite such collateral. Only in an instance where a Bank has never accepted any such collateral or has demonstrated an inability to manage such collateral, should the Board restrict the Bank's ability to accept it.

Additionally, ABA believes that there is no sound basis to limit the amount of "other real estate related collateral" accepted by a Bank or to require a member to pledge all other available collateral before accepting "other real estate related collateral". In keeping with the general goal of the Gramm/Leach/Bliley Act, and the Board's own goal of devolving day to day operations of the Banks to the Bank level, it is appropriate that each Bank set its own policies with regard to acceptable collateral of this type. The Banks are in the best position to evaluate their members' underwriting capacity and the quality of the loans pledged. While it is appropriate for the Board to ensure that the Banks have the appropriate systems and personnel in place to properly evaluate their borrowers and the collateral pledged, there is no reason for the Board to adopt arbitrary limits on any class of collateral. It is important to note that prior to the enactment of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), the Banks regularly accepted this type of collateral without limit, and that the System never experienced a credit loss during that time.

ABA urges the Board to reconsider removing Combination Business or Farm Property from the definition of "residential real property". The Board is correct in its observation that the removal of the 30 percent of capital investment limit for "other real estate related collateral" will, for the most part, eliminate the need for such an inclusion, as these loans will now qualify as "other real estate related collateral". The Board is also correct that Gramm/Leach/Bliley's elimination of the 10 percent mortgage test for CFIs reduces the need for inclusion of these loans as "residential real estate" for most institutions seeking to join the System. However, ABA observes that some institutions which may seek to join the System, but which do not meet the requirements to qualify as a CFI (and therefore bypass the 10 percent mortgage requirement) would benefit from the inclusion of any "combination property" loans held in portfolio so long as they continued to qualify as "residential real estate". For that reason, we urge retention of these types of loans in that definition.

The regulation proposes a new Section 980 which requires Finance Board approval of "new business activities" of the Banks. ABA agrees with the Board that it is within the regulatory purview of the Board, and reasonable for safety and soundness, that the Board review and provide prior approval before a Bank may proceed with a new program or line of business. However, ABA is concerned that the regulation very broadly defines "new business activity", so much so, in fact, that virtually any refinement or enhancement to an existing product would likely fall into the category of "new business activity". The experience of the Board in reviewing some of the pilot programs proposed by the Banks is illustrative of how long such a review can be. For that reason, ABA is very concerned that if applied in its current form, Part 980 would likely stifle innovation and refinement by the Banks. Further, we very much oppose the application of such a detailed and potentially lengthy process to the expansion of collateral eligible for the existing advance lines of business. The Banks have been in the business of making advances secured by collateral since the inception of the System. While it is certainly appropriate for the Board to ensure that the Banks have the capacity to evaluate the new categories of collateral, the advance line of business remains fundamentally unchanged. Expansion of eligible types of collateral does not rise to the level of a new business activity.

Therefore, ABA strongly urges the Board to revise proposed Section 980 to make it clear that the prior approval requirements are limited only to those activities which clearly do represent a new program or a new product undertaking and not merely an expansion or refinement of an existing line of business.

In addition to the items included in the proposed regulation, ABA would like to make a recommendation that the Board consider adding a provision relating to institutional underwriting.

ABA recognizes that acceptance of agricultural and small business loans as collateral presents new challenges to the Federal Home Loan Bank System. We are providing, as an appendix to this comment letter economic data that indicates that the performance of these loans, when compared to the performance of one to four family housing loans, is not materially different. We recommend that the Board allow the Banks maximum flexibility in their approach to the new collateral. We strongly believe that the Board should allow the Banks to evaluate the credit management systems of their members, rather than direct the individual Banks to attempt to evaluate the individual loans themselves. This approach, which could be termed "institutional underwriting", would allow the Banks to more efficiently implement lending secured by the new collateral. By looking at the member institution's credit management system for small business and/or agricultural loans, the Banks would be able to develop a risk assessment that should meet a reasonable safety and soundness threshold.

There are examples of institutional underwriting that the Banks could look at when developing implementation procedures. The US Small Business Administration (SBA) certifies Preferred Lenders based on the lender's ability to underwrite and comply with sound underwriting practices for small business loans. The US Department of Agriculture, acting through the Farm Service Agency, certifies Preferred Lenders based on the lender's ability to underwrite and service agricultural loans.

Such an approach to institutional underwriting will be strongly augmented by the safety and soundness reports that System Banks can obtain from the individual member bank's regulators. Through institutional underwriting, the Banks will be able to meet the challenges of ensuring safety and soundness while performing in the most efficient manner.

Therefore, we urge the Board to include in a final regulation a provision which encourages the Banks to establish institutional underwriting programs, and which provides for streamlined regulatory review for those Banks who do so.

ABA appreciates the opportunity to comment on these proposed regulations. We recognize that the expanded classes of collateral present challenges to the System, which initially appear significant. However, we believe that as the Board and the Banks become more familiar with these classes of collateral there will be an increased awareness that small business and agricultural lending is merely a variation on the home mortgage and community development lending which the System has so efficiently advanced since its inception.

Again, we appreciate this opportunity to comment. If you have any questions, or would like to discuss these matters in greater detail, please do not hesitate to contact me at (202)663-5480.

Sincerely

Joseph Pigg
Senior Counsel

Attachment

Residential and Farm Charge-off and Delinquency Rates

Delinquency Rate (%)
	93	94	95	96	97	98	99
Farm
Real Estate Loans	1.8	2.4	2.4	2.8	2.6	2.9	2
Production Loans	2.2	2.0	2.1	2.4	2.0	2.2	2.1
Non-Farm 1-4 Family Residential Loans	2.5	2.1	2.3	2.4	2.3	2.1	2.0
Total Delinquency ($ billions)
	93	94	95	96	97	98	99
Farm
Real Estate Loans	0.4	0.5	0.6	0.7	0.7	0.8	0.6
Production Loans	0.8	0.8	0.8	1	0.9	1	0.9
Non-Farm 1-4 Family Residential Loans	N/A	N/A	N/A	N/A	N/A	N/A	N/A
Charge-Off Rate (%)
	92	93	94	95	96	97	98	99
Farm
Real Estate Loans	0.23	0.12	0.05	0.05	0.03	0.06	0.02	0.002
Production Loans	0.24	0.15	0.19	0.13	0.24	0.23	0.2	0.28
Non-Farm 1-4 Family Residential Loans	0.27	0.18	0.16	0.11	0.09	0.09	0.07	0.14
Total Charge-Off ($ millions)
	92	93	94	95	96	97	98	99
Farm
Real Estate Loans	44	24	10	12	7	16	6	15
Production Loans	82	54	69	51	95	93	87	126
Non-Farm 1-4 Family Residential Loans	N/A	N/A	N/A	N/A	N/A	N/A	N/A	N/A
Total Loan Volume ($ billions)
	92	93	94	95	96	97	98	99
Farm
Real Estate Loans	19.9	20.9	22.6	23.9	25.0	27.1	29.3	31.8
Production Loans	34.7	36.8	38.7	39.8	40.5	44.2	45.5	44.2
Source: Federal Reserve

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