ABA Letter to FHFA on FHLB Membership

Mr. Andre D. Galeano
Deputy Director,
Federal Housing Finance Agency
Division of Federal Home Loan Bank Regulation
400 7th Street, SW
7th Floor
Washington, DC 20219

Dear Deputy Director Galeano:

The American Bankers Association (ABA) is pleased to submit comments on the Federal Housing Finance Agency’s (FHFA) request for input (RFI) on Federal Home Loan Bank (FHLB) membership. The RFI is part of a holistic review of FHLB membership in light of recent developments within the FHLBank System and changes in the nation’s housing finance markets. We welcome the FHFA's current membership review to develop a set of principles and requirements of general applicability guided by housing finance and public policy objectives of the FHLBank System.

The RFI follows a final rule issued in 2016 which made a significant change to membership in the System by effectively banning captive insurance companies from membership in the System. ABA submitted comments3 on that proposal, noting that we share FHFA’s concerns about the use of captive insurance companies as conduits for otherwise ineligible members to gain entry to the System. However, we took issue with FHFA’s approach, raising concerns that deeming captive insurers as ineligible for membership ran counter to the clear meaning of the statute. ABA also objected to the proposal to impose ongoing tracking of mission related activities by members. We appreciate FHFA’s decision to reconsider both topics, and offer member feedback on both subjects, which is consistent with that expressed in our previous comment letter.

General Membership Eligibility

As FHFA appropriately notes, the categories of eligible System members is established in the statute byCongress. FHFA should not, unless clearly and specifically directed by Congressional statute, authorizeexpanded membership to other entities that are not already authorized by statute.

These are the overriding principles that must inform FHFA’s regulation of membership eligibility. FHFAshould take no action that circumvents or otherwise thwarts the intent of Congress. Entities deemedeligible for membership by Congress should not be made ineligible through regulatory fiat as was donewith regard to all captive insurance companies under the previous rulemaking. Instead, FHFA’s focusshould be on ensuring that all members deemed eligible by Congress are allowed into the System in amanner that protects the overall safety and soundness and mission of the System.

Therefore, we support the approach outlined in the RFI, which recognizes that membership eligibilityrequirements must be “guided by the twin objectives of ensuring that the System remains safe and soundand able to provide liquidity for housing finance through the housing and business cycle and ensuring thatall members have an appropriate nexus to the housing finance and community development mission ofthe FHLBanks.”

Safety and Soundness

Judged by these standards, we believe FHFA should revisit its previous decision to deny all captiveinsurance companies membership. Instead, FHFA should be guided by Congressional intent to allowthese insurance companies membership in the System, but FHFA should limit each individual captiveinsurer’s ability to access the System based upon its potential to impact the safety and soundness of theSystem.

The Federal Home Loan Bank System is a cooperative with joint and several liability. Therefore, aparamount duty of FHFA is to ensure the safety and soundness of the System in order to protect eligibleexisting members’ capital investment in, and ability to access, the System. As a general rule, a basicrequirement that members be subject to prudential regulation reduces credit risk within the System andprotects the FHLBanks’ ability to access global capital markets. However, FHFA should alsoacknowledge that prudential regulation and examination standards for eligible members differsignificantly. Not all entities eligible for membership in the FHLBs are subject to the same regulatoryrequirements or to comparable regulatory oversight and examination as provided by the OCC, FDIC,Federal Reserve and state banking regulators.

We believe FHFA should factor differences in prudential regulation and supervision into its regulation ofmember access to the system and adjust eligible members’ System access as needed to protect allmembers’ capital investment. Where Congress has designated entities that are not subject to prudentialregulation as eligible members, FHFA should consider a parent organization’s prudential regulation, ifapplicable. For example, member access standards should differ for a captive insurer owned by a Federally regulated and supervised depository institution versus a captive insurer owned by an entity notsubject to prudential regulation and capital standards sufficient to protect against the potential losses thatmember could present to the System and its members. In the latter example, it is conceivable that acaptive insurer, owned by a parent without sufficient regulation or capital, could be technically eligiblefor membership in the System but effectively unable to borrow, due to the risks such borrowing mightpresent. Similarly, we recommend that FHFA establish clear, consistent, and risk based member accessstandards that account for differences in prudential regulation such as for less stringently regulated creditunions and for non-depository CDFI’s.

To further safety and soundness for all eligible members, FHFA should continue to allow, and indeed,encourage, the development of sound, risk-based collateral policies by each of the individual FederalHome Loan Banks that protect the individual Bank and its members based upon the risk profile of theborrowing member. These member access standards include overcollateralization and actual delivery ofcollateral, as well as a requirement to share reports of examinations with the FHLBank, among otherpossible requirements.

Mission Adherence

As noted in our previous comment, rules for ensuring the adherence to the mission of the Systemcurrently exist. Imposing a further on-going test is unnecessary and would in fact hinder the effectivenessof the System.

Under current requirements, a member may only borrow from a FHLB if it has eligible collateral topledge. If a member does not make sufficient mission related loans, or hold sufficient mission relatedassets, it will not have collateral to pledge and will not be allowed to borrow further. This approach isboth efficient and elegant as it requires no on-going tracking and allows members maximum flexibilitywhile also ensuring a focus on the broader mission of the System.

The approach of tying use of the System (not eligibility for membership) to availability of eligiblecollateral is an effective way of ensuring adherence to the System’s mission. Conversely, imposing a testfor membership tied to an ongoing commitment runs counter to Congressional intent and to the effectivefunctioning of the System. Again, eligibility is determined by Congress. Eligible members remaineligible regardless of whether they are fulfilling the mission of the System, but their ability to access theSystem is tied to whether they are fulfilling that mission. A member that holds no mortgage loans orother eligible collateral on their books remains an eligible member of the System (by statute) but isunlikely to be able to make effective use of that membership, as they would lack sufficient collateral topledge for borrowing.

We must also note that the uncertainty over continued membership eligibility that would be injected intothe System through the imposition of an ongoing test would harm the entire Federal Home Loan BankSystem. Under such an approach, as members fall out of eligibility, their stock in the FHLB must beredeemed, destabilizing the capital of the individual Banks. Moreover, because the System is a joint andseveral one, the uncertainty would introduce risk to the entire FHLB System. While this may seeminconsequential on an individual bank basis, taken at scale, the entire System will be viewed by prudentialbank regulators and the capital markets as less stable and less reliable, to the detriment of all members ofthe System and to the nation’s financial structure overall.

Use of the System

Any eligible member (as determined by Congress) that meets the safety and soundness and missionadherence requirements described above should be able to access the System in line with the policies andprocedures required by each FHLB and the FHFA to effectuate those requirements. There should be noadditional limits based upon a member’s size, concentration, or potential to be used as a conduit by otherentities. Instead, the risks each member brings to the System, both generally and specifically regardingtheir use of System advances, as well as the information available as to their prudential regulation, shouldbe taken into consideration as factors impacting their ability to access the System. The FHFA should notimpose additional restrictions on any member or class of members not based upon actual risk presented.

Conduits

Entities that are not otherwise eligible for membership in the System, as defined by Congress, should notbe able to access the System through a “back door” or conduit relationship with an eligible member. Thisprinciple should hold true regardless of the ineligible entity’s nexus to the mission of the System. Inmany instances, those seeking to gain access to the System do engage in activities that are consistent withthe housing and community development mission of the System, but they are structured in a mannerinconsistent with the safe and sound operation of the cooperative structure of the System. They lackcapital and other prudential safeguards that would make their access to the System a significant risk to theSystem and its members. Absent these safeguards, Congress has not expanded membership eligibility tothese entities to protect the existing capital investment in, and usage of the System by current members.Allowing these entities to access the System through a conduit would undermine Congressional intentand subject the System and its members to undue risks.

FHFA has posed the question of whether members with a high likelihood of being used as conduits bysuch entities should be restricted from borrowing or membership in the System. While ABA recognizesboth the risks to the System posed by such conduit arrangements and the challenge of regulating theSystem to prevent improper conduit arrangements, we feel strongly that prohibiting membership to theSystem by any class of otherwise eligible members based upon these concerns is improper. Doing sosubstitutes the FHFA’s judgement for that of Congress. Potentially restricting borrowing by suchmembers may be appropriate, as discussed above in the context of safety and soundness. Suchdeterminations must be made on a case-by-case basis depending upon the risk that such borrowingpresents to the System and its members. If an otherwise ineligible member lacking regulation, oversightand capital attempts to use an eligible member as a conduit, safety and soundness considerations mustdictate that the FHLB and the FHFA restrict access by the eligible member to protect the System. FHFAand the individual FHLBs must remain vigilant in monitoring members’ use of the System and adjustcollateral and other requirements to safeguard against the risk each members’ borrowing poses.

Conclusion

The importance of the Federal Home Loan Banks as a source of liquidity and other services to ABA’smembers cannot be overstated. For the better part of the last century the Federal Home Loan Banks havemet those needs in a safe, sound, and efficient manner. Congress has, over that time, expanded eligibility for membership in the System, and has changed the regulator of the System. Even the number ofFHLBanks and their locations has changed. What has not changed is the fundamental cooperativestructure of the System and the attendant joint and several liability of members—both of which serve toensure safe, sound, and mission compliant use of the System. We very much appreciate FHFA’scommitment to ensuring that the System remains strong and available for all eligible members.

With that said, we caution FHFA not to overreach the statutory bounds of membership (and urge arevisiting of past overreaches), and urge reliance on the elegance and efficiency of the collateral basedborrowing requirements to ensure mission adherence. Adhering to Congressional intent while alsoexercising vigilant and appropriately focused regulation will ensure that the Federal Home Loan Bankscontinue effectively serving their members for many decades to come.

We appreciate this opportunity to comment. If you have questions or wish to discuss these matters inmore detail, please contact the undersigned.

Sincerely,

G. Joseph Pigg
Senior Vice President, Fair & Responsible Banking
Regulatory Compliance and Policy