[Federal Register Volume 74, Number 148 (Tuesday, August 4, 2009)]
[Notices]
[Pages 38618-38626]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-18545]
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FEDERAL HOUSING FINANCE AGENCY
[No. 2009-N-10]
Federal Home Loan Bank Collateral for Advances and Interagency
Guidance on Nontraditional Mortgage Products
AGENCY: Federal Housing Finance Agency.
ACTION: Notice of study and recommendations and request for comment.
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SUMMARY: Section 1217 of the Housing and Economic Recovery Act of 2008
(HERA) requires the Director of the Federal Housing Finance Agency
(FHFA) to conduct a study on the extent to which loans and securities
used as collateral to support Federal Home Loan Bank (FHLBank) advances
are consistent with the interagency guidance on nontraditional mortgage
products. The study must be submitted to the Committee on Banking,
Housing and Urban Affairs of the Senate and the Committee on Financial
Services of the House of Representatives no later than July 30, 2009,
one year after the date of the HERA enactment. Further, the study (the
HERA Section 1217 Study) must consider and recommend any additional
regulations, guidance, advisory bulletins, or other administrative
actions necessary to ensure that the FHLBanks are not supporting loans
with predatory characteristics. Section 1217 of HERA also requires that
the public have an opportunity to comment on any recommendations made
as a result of the study. This Federal Register Notice is intended to
inform the public about the HERA Section 1217 Study and provide the
public with the requisite opportunity to comment.
DATES: Comments must be received on or before October 2, 2009.
ADDRESSES: You may submit your comments on the HERA Section 1217 Study,
identified by a subject line of ``HERA Section 1217 Study,'' by any of
the following methods:
U.S. Mail, United Parcel Post, Federal Express, or Other
Mail Service: The mailing address for comments is: Alfred M. Pollard,
General Counsel, Attention: Comments/HERA Section 1217 Study, Federal
Housing Finance Agency, Fourth Floor, 1700 G Street, NW., Washington,
DC 20552.
Hand Delivered/Courier: The hand delivery address is:
Alfred M. Pollard, General Counsel, Attention: Comments/HERA Section
1217 Study, Federal Housing Finance Agency, Fourth Floor, 1700 G
Street, NW., Washington, DC 20552. The package should be logged at the
Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m.
E-mail: Comments to Alfred M. Pollard, General Counsel,
may be sent by e-mail at [email protected]. Please include ``HERA
Section 1217 Study'' in the subject line of the message.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments. If you submit your
comment to the Federal eRulemaking Portal, please also send it by e-
mail to FHFA at [email protected] to ensure timely receipt by the
agency. Please include ``HERA Section 1217 Study'' in the subject line
of the message.
FOR FURTHER INFORMATION CONTACT: Louis M. Scalza, Associate Director,
(202) 408-2953 or Linda L. Campbell, Senior Bank Examiner, (202) 408-
2586, Division of Federal Home Loan Bank Regulation; or Neil R.
Crowley, Deputy General Counsel, Office of General Counsel, (202) 343-
1316, Federal Housing Finance Agency, 1625 Eye Street, NW., Washington,
DC 20006. The telephone number for the Telecommunications Device for
the Deaf is (800) 877-8339.
SUPPLEMENTARY INFORMATION: Section I of this Notice provides background
on FHFA, the FHLBank System, and the collateral securing FHLBank
advances. Section II summarizes the provisions of the interagency
guidance and three Federal Housing Finance Board (FHFB) advisory
bulletins relating to nontraditional, subprime, and anti-predatory
lending. Section III describes the resources used to complete the HERA
Section 1217 Study, including a collateral data survey that FHFA
conducts annually, in-depth secured credit reviews performed during
recent examinations, and a specific questionnaire related to the HERA
Section 1217 issues that FHFA sent to the FHLBanks. Sections IV and V
of this report present FHFA's analysis and conclusions from the HERA
Section 1217 Study and Section VI requests comments on specific related
questions.
The HERA Section 1217 Study reports that FHLBanks' reliance on
collateral described as nontraditional, subprime or Alt-A declined
during 2008, accounting for about one-fifth of collateral securing
advances as of December 31, 2008. Some portion of this collateral
predates the issuance of the interagency guidance, but the FHLBanks
need to manage and mitigate the risks associated with all of the
collateral supporting advances.
FHFA, through advisory bulletins issued by the prior regulator of
the
[[Page 38619]]
FHLBanks, the FHFB, has issued explicit written guidance to the
FHLBanks on anti-predatory, nontraditional, and subprime lending. The
FHLBanks have adopted policies which address nontraditional and
subprime collateral, although in-depth secured credit reviews found
some weaknesses in those policies and practices. The FHLBanks'
responses to an FHFA questionnaire indicate that they have adopted
policies, procedures and practices that would require that loans and
MBS used as collateral to support advances be consistent with the
interagency guidance. FHFA will continue to assess the adequacy of the
FHLBank's policies and procedures and monitor the FHLBank's remediation
efforts. FHFA determines the appropriateness of issuing additional
guidance based on examination results and its assessment of legislative
developments.
I. Background
A. Federal Housing Finance Agency
Effective July 30, 2008, HERA, Public Law 110-289, 122 Stat. 2654
(2008), transferred the supervisory and oversight responsibilities of
the Office of Federal Housing Enterprise Oversight (OFHEO) over the
Federal National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises),
and the oversight responsibilities of the FHFB over the FHLBanks and
the Office of Finance (which acts as the FHLBanks' fiscal agent) to
FHFA, a new independent agency of the Federal Government. FHFA is
responsible for ensuring that the Enterprises and the FHLBanks operate
in a safe and sound manner, maintain adequate capital and internal
controls, foster liquid, efficient, competitive and resilient national
housing finance markets, and carry out their public policy missions
through authorized activities. See Sec. 1102, Public Law 110-289, 122
Stat. 2663-64. The Enterprises and the FHLBanks continue to operate
under regulations promulgated by OFHEO and the FHFB until FHFA issues
its own regulations. See id. at Sec. Sec. 1302, 1312, 122 Stat. 2795,
2798. The Division of Federal Home Loan Bank Regulation is the
principal organizational unit within FHFA responsible for supervision
of the FHLBanks.
B. The FHLBank System
The twelve FHLBanks are instrumentalities of the United States
organized under the Federal Home Loan Bank Act (Bank Act). See 12
U.S.C. 1423, 1432(a). The FHLBanks are cooperatives; only members of an
FHLBank may own the capital stock of an FHLBank and only members or
certain eligible housing associates (such as state housing finance
agencies) may obtain access to the products provided by an FHLBank. See
12 U.S.C. 1426, 1430(a), 1430b. Each FHLBank is managed by its own
board of directors and serves the public by enhancing the availability
of residential mortgage and community lending credit through its member
institutions. See 12 U.S.C. 1427. Any eligible institution
(principally, federally-insured depository institutions or state-
regulated insurance companies) may become a member of an FHLBank by
satisfying certain criteria and by purchasing a specified amount of the
FHLBank's capital stock. See 12 U.S.C. 1424, 1426; 12 CFR part 931.
As government sponsored enterprises (GSEs), the FHLBanks are
normally able to borrow funds in the capital markets on terms more
favorable than could be obtained by most private entities. Until
recently, the FHLBank System could borrow funds at a modest spread over
the rates on U.S. Treasury securities of comparable maturity, across a
wide range of maturities. In 2008, market conditions contributed to
substantially wider spreads between FHLBank consolidated obligations
and U.S. Treasuries, particularly at longer maturities. Although the
wider spreads may have contributed to a decline in advances that began
in the fourth quarter of 2008, the FHLBanks continue to serve as a
source of liquidity to their members.
The FHLBanks pass along their GSE funding advantage to their
members--and ultimately to consumers--by providing advances (secured
loans) and other financial services at rates that would not otherwise
be available to their members. Some of the FHLBanks also have Acquired
Member Asset (AMA) programs whereby they acquire fixed-rate, single-
family mortgage loans from participating member institutions.
The FHLBanks raise funds in the capital markets by issuing
consolidated obligations consisting of bonds and discount notes.
Consolidated obligations are issued by the Office of Finance on behalf
of the twelve FHLBanks and are the principal source of funding not only
for FHLBank advances, but also for AMA programs, and investments.
Although an FHLBank is primarily liable for the portion of the
consolidated obligations corresponding to the proceeds received by that
FHLBank, each FHLBank is also jointly and severally liable with the
other eleven FHLBanks for the payment of principal of, and interest on,
all consolidated obligations. See 12 U.S.C. 1431; 12 CFR 966.9.
C. Collateral Securing FHLBank Advances
The United States Government established the Federal Home Loan Bank
System in 1932 to stimulate mortgage finance by providing liquidity
from the FHLBanks to its member financial institutions. Members,
generally financial institutions, increase liquidity by obtaining
advances from the FHLBanks. Those advances are secured by eligible
collateral, typically government securities, residential mortgages, or
other real estate related collateral (e.g., commercial real estate
loans, home equity lines of credit and second mortgage loans). Total
advances at the end of June 2009 were $721 billion, down from a peak
exceeding $1 trillion in October 2008.
All advances are collateralized, which protects the FHLBank should
the member default. The FHLBanks secure member advances in several
ways: a blanket lien on all or specific categories of a member's
assets, a lien on specific member assets for which the member provides
a listing of collateral characteristics to the FHLBank, a lien on
assets that a member delivers to the FHLBank, or some combination
thereof. The level of collateralization depends on the level of risk
associated with the collateral. To date, the FHLBanks have never
incurred a credit loss on an advance.
A member may pledge only the following types of collateral for an
advance: (a) Fully disbursed, whole first mortgages on improved
residential property not more than 90 days delinquent; (b) securities
issued, insured, or guaranteed by the U.S. Government or any agency
thereof; (c) cash or deposits of an FHLBank; (d) other real estate
related collateral acceptable to the FHLBank, provided the value of
such collateral is readily ascertainable and the FHLBank can perfect
its interest in the collateral; and (e) for institutions that qualify
as ``community financial institutions'' (CFIs), secured loans for small
business, agriculture, or community development activities, or
securities representing a whole interest in such secured loans. See 12
U.S.C. 1430(a)(3) as amended. Whole first mortgage loans on residential
real property represent the largest source of member-provided
collateral to the System. As of December 31, 2008, whole residential
mortgage loans pledged as collateral for advances
[[Page 38620]]
were $859 billion or 59.7 percent of the total collateral securing
advances.
II. HERA Section 1217 Study Regulatory Guidance
HERA Section 1217, which mandated this study, specifically refers
to interagency guidance on nontraditional mortgage products. This
section provides a summary of the interagency guidance on
nontraditional mortgage products along with the related statement on
subprime residential mortgage lending. It then summarizes the advisory
bulletins issued by the FHFB to apply the principles of the interagency
guidance to the supervision of the FHLBanks, as well as an advisory
bulletin on anti-predatory lending.\1\
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\1\ Advisory bulletins provide guidance to the FHLBanks
regarding particular supervisory issues. Although an advisory
bulletin does not have the force of a regulation or an order, it is
integrated into the examination programs. Advisory bulletins are
effective upon issuance and remain in effect until rescinded.
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A. Interagency Guidance
The term ``interagency guidance'' is not specifically defined in
the HERA legislation. For purposes of this report, FHFA uses the term
``interagency guidance'' to mean the guidance issued jointly by five
federal financial institution regulatory agencies--the Office of the
Comptroller of the Currency, the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance Corporation, the Office
of Thrift Supervision, and the National Credit Union Administration--
concerning nontraditional mortgage products and subprime lending.\2\
The principal interagency guidance on nontraditional and subprime
residential mortgage loans can be summarized as follows.
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\2\ Although HERA specifically refers to the interagency
guidance on nontraditional mortgage products, the FHFA believes that
the issue of subprime mortgage lending is closely related.
Therefore, the FHFA has expanded the scope of the study to include
subprime lending.
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Interagency Guidance on Nontraditional Mortgage Product Risks (2006)
The federal financial institution regulatory agencies issued the
Interagency Guidance on Nontraditional Mortgage Product Risks on
October 4, 2006. This notice instructs financial institutions on how to
offer nontraditional mortgage products in a safe and sound manner and
in a way that clearly discloses the benefits and risks to borrowers.
The guidance focuses on nontraditional residential mortgage products
that permit borrowers to defer payment of principal or interest,
including interest-only residential mortgage loans, payment option
adjustable-rate residential mortgage loans, and negative amortization
residential mortgage loans. It also covers other higher-risk practices
often associated with nontraditional residential mortgage loans, such
as simultaneous second-lien residential mortgage loans, variable
interest rates with below-market introductory rates, and the use of
reduced documentation in the evaluation of an applicant's
creditworthiness. The guidance establishes that financial institutions
should recognize and mitigate the risks inherent in these products by
ensuring that loan terms and underwriting standards are clearly
disclosed and consistent with prudent lending practices, including
credible consideration of a borrower's repayment capacity.
Statement on Subprime Mortgage Lending (2007)
The federal financial institution regulatory agencies subsequently
issued the Statement on Subprime Mortgage Lending on July 10, 2007. The
Statement addresses issues relating to certain adjustable-rate mortgage
products that can cause the borrower's monthly payment to increase
significantly and potentially become unaffordable. The Statement
establishes prudent safety and soundness and consumer protection
standards that should be followed to ensure that consumers, especially
subprime borrowers, obtain loans they can afford to repay and receive
information that adequately describes product features. These standards
include qualifying the borrower using a fully-indexed interest rate
(i.e., the interest rate after any lower, introductory interest rate in
the early period of a loan) and a fully-amortizing repayment schedule.
The standards also convey the regulators' expectation that stated
income and reduced documentation should be accepted by the lender only
if there are documented mitigating factors that clearly minimize the
need for verification of a borrower's repayment capacity. The Statement
reiterates that institutions should develop strong control systems to
monitor compliance with risk management and consumer protection
policies and practices, including clear disclosures to customers and
limits on prepayment penalties.
B. FHFB Guidance
FHFA--like its predecessor agencies the Federal Housing Finance
Board and the Office of Federal Housing Enterprise Oversight--is
mindful of the potential risk to the FHLBanks and the impact on the
public if the FHLBanks were to provide liquidity to support predatory
loans or inappropriately underwritten nontraditional and subprime
residential mortgage loans. Accepting such loans as collateral for
advances could pose a safety and soundness risk to the FHLBanks and
would also be inconsistent with the overarching housing finance mission
of the FHLBanks.
As a result of concerns about predatory lending, in 2005 the former
FHFB issued an advisory bulletin to the FHLBanks requiring each FHLBank
to establish and communicate to its member institutions its anti-
predatory lending policies. The FHLBanks were required to establish
those policies to avoid accepting loans with predatory characteristics
as collateral for advances. In 2007 and 2008, the FHFB also issued
advisory bulletins on nontraditional and subprime residential mortgage
loans as a complement to the interagency guidance. The FHFB guidance
established that any nontraditional or subprime mortgage loans
originated or acquired by the member after July 10, 2007 could serve as
eligible collateral only if those loans were underwritten consistent
with the interagency guidance. The 2007 and 2008 guidance expanded the
reach of the interagency guidance by establishing that the standards in
the interagency guidance would apply not just to loans purchased by the
FHLBanks, but also to whole loans collateralizing advances and to loans
underlying MBS that serve as collateral for advances or that the
FHLBanks purchase as investment securities. Further, the FHFB
instructed the FHLBanks to apply the interagency standards to loans and
MBS accepted as collateral from FHLBank member institutions that were
not otherwise directly subject to the interagency guidance, e.g.,
insurance companies. The following provides a summary of the three
advisory bulletins.
Advisory Bulletin 2005-AB-08
In August of 2005, the FHFB issued Advisory Bulletin 2005-AB-08,
Guidance on FHLBank Anti-Predatory Lending Policies. This Bulletin
establishes that each FHLBank must have in place comprehensive anti-
predatory lending policies to govern the purchases of residential
mortgage loans and the level of advances that can be made to its
members. Although the advisory bulletin acknowledged that there is no
single definition of predatory lending in federal, state, and local
laws and regulations, it noted that over the preceding several years,
federal, state, and local jurisdictions had adopted anti-
[[Page 38621]]
predatory lending measures to combat abusive practices in the mortgage
market.
The 2005 advisory bulletin requires that the FHLBanks' policies
preclude purchasing residential mortgage loans or accepting as eligible
collateral for advances loans that violate applicable federal, state,
or local anti-predatory lending laws. The FHLBanks' anti-predatory
lending policies must also, at a minimum, address: residential mortgage
loans subject to the Home Ownership and Equity Protection Act (HOEPA),
prepaid single-premium credit life or similar insurance, prepayment
penalties beyond the early years of the loan, and mandatory
arbitration. In addition, the FHLBanks must require each member to
certify that it is aware of the FHLBanks' anti-predatory lending
policies and will comply with those policies in the sale of residential
mortgage loans to the FHLBank or when obtaining advances from the
FHLBank. Each FHLBank must also develop written procedures and
standards for verifying member compliance with its anti-predatory
lending mortgage purchase and advance policies, paying particular
attention to any loans that are otherwise not subject to review by a
federal financial institution supervisory agency. Finally, each FHLBank
must have agreements in place with its members to provide for
replacement or indemnity for any loan or collateral that is found to be
in noncompliance with the FHLBanks' policies. See http://www.fhfb.gov/webfiles/4201/2005-AB-08.pdf.
Advisory Bulletin 2007-AB-01
Issued in April 2007, Advisory Bulletin 2007-AB-01, Nontraditional
and Subprime Residential Mortgage Loans, requires the FHLBanks to
implement policies and risk management practices that establish risk
limits for, and mitigation of, credit exposure on nontraditional and
subprime mortgage loans. The advisory bulletin requires that an
FHLBank's policies and procedures must address how the FHLBank
measures, monitors and controls risks arising from exposures to
nontraditional and subprime mortgage loans. The advisory bulletin
further requires that an FHLBank's policies must be discussed with and
approved by its board of directors and must identify the attributes of
nontraditional and subprime residential mortgage loans that have the
potential for increased risk. The policies should establish limits and
require regular monitoring of exposure to nontraditional and subprime
residential mortgage loans, including limits and acceptable adjustments
to collateral coverage requirements or ``haircuts.'' The procedures for
monitoring collateral securing advances should allow an FHLBank to
identify the volume of nontraditional and subprime residential mortgage
loans pledged to secure advances. Finally, the collateral review
procedures should also include assessments and testing of member
underwriting and monitoring of nontraditional and subprime loans and
address the acceptance of MBS with nontraditional and subprime
collateral. See http://www.fhfb.gov/webfiles/6372/2007-AB-01.pdf.
Advisory Bulletin 2008-AB-02
Issued in July 2008, Advisory Bulletin 2008-AB-02, Application of
Guidance on Nontraditional and Subprime Residential Mortgage Loans to
Specific FHLBank Assets, provides written guidance regarding
residential mortgage loans purchased under the FHLBank's Acquired
Member Assets programs, investments in private-label MBS, and
collateral securing advances. The advisory bulletin states that
residential mortgage loans that were originated or acquired by the
member after July 10, 2007 may be included in calculating the amount of
advances that can be made to a member only if those loans were
underwritten consistent with all aspects of the interagency guidance.
The guidance in the advisory bulletin applies to whole mortgage loans
and to the residential mortgage loans that underlie private-label MBS
used as collateral for advances.
Further, the advisory bulletin requires the FHLBanks to take the
quality control steps necessary to ensure compliance with the 2006 and
2007 interagency guidance on nontraditional and subprime mortgage
loans. Those quality controls include requiring the adoption of
business practices including, but not limited to: conducting due
diligence on the mortgages or assets it acquires or collateralizes
itself, relying on an independent third party to assess compliance, or
relying on certifications, representations or warranties provided by
the member. The FHLBanks may rely on representations and warranties and
third-party assurances only if the FHLBank has a credible plan to test
and verify their dependability. See http://www.fhfb.gov/webfiles/6906/2008-AB-02.pdf.
Coverage and Applicability of FHFB Guidance
According to Advisory Bulletin 2008-AB-02, in order to be eligible
collateral for advances, nontraditional and subprime residential
mortgage loans originated or acquired by a member after July 10, 2007--
and such loans backing private-label MBS issued after that date--must
conform to the interagency guidance. By adopting the effective date of
the interagency guidance,\3\ the FHFB chose not to apply the advance
collateral guidance retroactively. To have done so might have reduced
access to liquidity and potentially added to the financial stress of
some FHLBank member institutions at a time of increasing uncertainty in
financial and housing markets.
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\3\ Statement on Subprime Mortgage Lending, 72 FR 37569 (July
10, 2007).
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Recap of the Three FHFB Advisory Bulletins
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FHFB advisory bulletins 2005-AB-08 2007-AB-01 2008-AB-02
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Anti-predatory lending policies and procedures............... X
Home Ownership and Equity Protection Act................. X
Single-premium credit life or similar insurance.......... X
Prepayment penalties beyond the early loan years......... X
Mandatory arbitration.................................... X
Nontraditional and subprime mortgage loan risk management.... ............... X
Mitigation of nontraditional and subprime credit exposure ............... X
Nontraditional and subprime collateral limitations....... ............... X
Compliance with interagency guidance on nontraditional and ............... ............... X
subprime mortgage lending...................................
Whole loans securing advances............................ ............... ............... X
MBS with underlying applicable loans securing advances... ............... ............... X
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[[Page 38622]]
III. HERA Section 1217 Study Resources
For purposes of the HERA Section 1217 Study, FHFA primarily relied
on three resources: a collateral data survey that FHFA conducts
annually, in-depth secured credit reviews performed during recent
examinations, and a questionnaire related to the HERA Section 1217
issues that FHFA sent to the FHLBanks. This section describes each of
these information resources.
A. Collateral Data Survey
Each year FHFA surveys the FHLBanks and prepares a report on the
levels and trends in collateral securing advances by type and FHLBank.
The collateral data survey collects information on the minimum levels
of collateral required by the FHLBanks' policies to secure outstanding
advances. The survey focuses on the minimum levels of collateral
required by FHLBank policies because most FHLBanks file a blanket lien
on the assets of most of their borrowing members. The volume of
collateral under blanket lien, however, is generally not the most
meaningful indicator of collateral protection because it does not
indicate the quality or liquidity of the collateral. In general, the
FHLBanks that utilize a blanket lien establish a ``collateral
hierarchy'' in which they first consider the highest quality and most
liquid collateral when calculating collateral coverage before they look
to other types of collateral. Thus, for the collateral data survey, the
FHLBanks report the collateral that they would rely upon first to cover
any repayment shortfall resulting from member default on an outstanding
advance. The FHLBanks report in the collateral data survey the levels
of collateral that consists of subprime and nontraditional residential
mortgage loans, and Alt-A and subprime private-label MBS.\4\ The
FHLBanks may use estimates for subprime and nontraditional mortgage
loan amounts when the actual data are not available for all members,
such as members to which an FHLBank lends by using a blanket lien on
the members' assets.
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\4\ An industry standard definition of Alt-A does not exist.
Alt-A MBS have traditionally been considered to be those backed by
mortgage loans to borrowers with prime credit scores but with
features that included, for example, low or no borrower income or
asset verification. Subprime private-label MBS are those backed by
residential mortgage loans to subprime borrowers. Since there is no
industry standard for a credit score threshold under which a
borrower is considered subprime, the FHLBanks may use different
credit score thresholds in reporting subprime residential mortgage
loans in the survey.
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B. Secured Credit Reviews
FHFA evaluates the policies, procedures and practices of each
FHLBank as part of its examination and supervision program. FHFA
regulates the FHLBanks and does not, in the normal course of an
examination, examine the individual loans or MBS pledged by the
FHLBanks' member institutions.\5\ During examinations of the FHLBanks,
FHFA evaluates the FHLBanks' collateral policies, how the FHLBank
manages and secures its collateral positions, and the measures the
FHLBank takes to protect itself from risk. The FHLBanks are required to
have appropriate controls in place to protect their financial safety
and soundness, to adhere to regulatory guidance, and to carry out their
housing finance mission.
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\5\ The FHFA only evaluates or examines the collateral under
compelling circumstances such as might be presented by large member
institutions experiencing known financial stress.
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In recognition of the rapid and serious deterioration in the
residential mortgage market, as part of its examination process, FHFA
conducted in-depth secured credit reviews in 2008-2009, which focused
on the advances and collateral policies and practices of the FHLBanks.
FHFA examiners commenced the in-depth reviews with FHLBank examinations
opening the second quarter of 2008, prior to the passage of HERA. The
review process was designed to closely evaluate whether the FHLBanks
have taken appropriate steps to control and value collateral, secure
advances, and plan for the potential for member failures. The review
work program covered collateral risk management in seven areas:
collateral control, haircut and valuation methodologies, risk limits,
member failure plans, member monitoring, insurance company members, and
nontraditional and subprime mortgage loan products. The last of the in-
depth secured credit reviews was completed in the second quarter of
2009.
C. HERA Section 1217 Questionnaire
To complement the existing information on FHLBank collateral and in
response to Section 1217 of HERA, FHFA's Division of Federal Home Loan
Bank Regulation developed the HERA Section 1217 Questionnaire and
delivered it to the FHLBanks in March 2009. The Section 1217
questionnaire was used to obtain consistent information regarding the
FHLBanks' policies, procedures, and practices on nontraditional and
subprime residential mortgage loans acceptable as collateral for
advances, either directly or through MBS that are backed by such loans.
The questionnaire also requested information on anti-predatory lending
policies, procedures, and practices. The questionnaire focused on
whether the loans and securities used as collateral to support FHLBank
advances are consistent with the requirements of the advisory bulletins
and the interagency guidance on nontraditional and subprime mortgage
products and anti-predatory lending. The questionnaire was also
designed to complement the in-depth secured credit reviews,
particularly to gauge the extent to which the FHLBanks are addressing
concerns raised in the secured credit reviews regarding the acceptance
of nontraditional and subprime residential mortgage loans as collateral
for advances.
IV. HERA Section 1217 Study Results
This section presents an analysis of the information obtained for
the HERA Section 1217 Study through the collateral data survey, the
secured credit reviews, and the follow-up questionnaire to the
FHLBanks. The analysis focuses on the extent to which loans and
securities used as collateral supporting FHLBank advances are
consistent with the interagency guidance on nontraditional and subprime
mortgage products.
A. FHLBank Collateral
The tables below summarize information from the collateral surveys
for year-ends 2007 and 2008 showing the types and amounts of collateral
upon which the FHLBanks rely to secure advances. As of December 31,
2007, the par value of FHLBank advances outstanding totaled $867
billion and the FHLBanks reported that the collateral on which they
were relying to secure those advances totaled $1.3 trillion. As of
December 31, 2008, the par value of FHLBank advances outstanding
increased to $900 billion, secured by collateral totaling $1.4
trillion.
[[Page 38623]]
[GRAPHIC] [TIFF OMITTED] TN04AU09.114
From 2007 to 2008, whole loan collateral declined from $890 billion
to $859 billion, a decrease of $31 billion or 8 percentage points, yet
whole loans continue to comprise the majority of the collateral
securing advances at the FHLBanks. During this period, MBS and other
real estate related collateral grew as a component of total collateral
securing advances.
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2007 2008
Collateral type collateral ($ 2007 (%) collateral ($ 2008 (%)
billions) billions)
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Whole Loans..................................... $890 67.7 $859 59.7
Mortgage-backed Securities...................... 195 14.8 218 15.1
Other Securities................................ 6 0.5 17 1.2
Other Real Estate Related Collateral............ 213 16.2 329 22.8
Community Financial Institutions................ 10 0.8 17 1.2
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Total Collateral............................ 1,314 100.0 1,440 100.0
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The collateral surveys for year-ends 2007 and 2008 show
nontraditional and subprime residential mortgage loans declined as a
proportion of the collateral on which the FHLBanks rely to secure
advances. As of December 31, 2007, nontraditional and subprime
residential mortgage loans represented $410 billion or 31.2 percent of
total advance collateral of $1.3 trillion. Subprime MBS and Alt-A MBS
accounted for 3.3 percent of reported collateral. As of December 31,
2008, nontraditional and subprime residential mortgage loans
represented $267 billion or 18.5 percent of total advance collateral of
$1.4 trillion, a decline of 12.7 percentage points from 2007.
Additionally, subprime MBS and Alt-A MBS represented 2.0 percent of
reported collateral, a decline of 1.3 percentage points from the
previous year-end.\6\ Based on the totals reported, the FHLBanks relied
on higher levels of nontraditional mortgage loan collateral than
subprime mortgage loan collateral and higher levels of Alt-A MBS
collateral than subprime MBS collateral.
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\6\ Percentages from the table may not sum to the exact figures
reported in the text due to rounding.
----------------------------------------------------------------------------------------------------------------
2007 2008
Collateral type collateral ($ 2007 (%) collateral ($ 2008 (%)
billions) billions)
----------------------------------------------------------------------------------------------------------------
Subprime Mortgage Loans......................... $80 6.1 $56 3.9
Nontraditional Mortgage Loans................... 297 22.6 186 12.9
Mortgage Loans that are both Subprime and 34 2.6 24 1.7
Nontraditional.................................
Private-label Subprime MBS...................... 2 0.2 10 0.7
Private-label Alt-A MBS......................... 41 3.1 19 1.3
---------------------------------------------------------------
Subtotal: Subprime/Nontraditional/Alt-A..... 454 34.6 295 20.5
---------------------------------------------------------------
Other Collateral................................ 860 65.4 1,145 79.5
---------------------------------------------------------------
Total Collateral........................ 1,314 100.0 1,440 100.0
----------------------------------------------------------------------------------------------------------------
As of December 31, 2008, collateral described as nontraditional,
subprime or Alt-A accounted for about one-fifth of the collateral
securing advances at FHLBanks. This number is best understood as an
approximation, given the varying definitions of these terms in the
financial industry in recent years. For example, purchasers of private-
label
[[Page 38624]]
MBS, including FHLBank member institutions, relied on rating agency
characterization of the securities at the time of issuance. However,
these designations might not capture all the variation in underlying
loans within a given security nor would they reflect any subsequent
deterioration in the quality of the underlying collateral.
Some portion of collateral described as nontraditional, subprime or
Alt-A was originated or purchased prior to July 10, 2007, and
therefore, under the guidance in FHFB's advisory bulletins, is not
required to conform to the interagency guidance. The collateral survey
does not contain information sufficient to allow FHFA to determine how
much of the collateral would be subject to the interagency guidance.
However, the FHFB guidance does require the FHLBanks to have policies
in place to ensure that subprime and nontraditional loans that were
originated or acquired by the FHLBank member subsequent to the issuance
of the interagency guidance and certain effective dates in the FHFB
advisory bulletins may not be pledged as collateral for advances if
they do not conform to the guidance.
B. FHLBank Policies and Procedures Regarding Nontraditional and
Subprime Collateral--Findings From the Secured Credit Reviews
As part of its examination process, FHFA conducted in-depth reviews
of the FHLBanks' policies and procedures regarding secured credit. One
part of FHFA's in-depth reviews of secured credit focused directly on
subprime lending and nontraditional loan products. Other aspects of the
secured credit reviews that are relevant for this study included
collateral control, member monitoring, and haircut and valuation
methodologies.
Although the reviews found that the FHLBanks had policies regarding
the acceptance of subprime and nontraditional loans as collateral for
advances, examiners questioned, in some cases, the appropriateness of
the policies and implementing procedures and practices. In addition, a
number of FHLBanks had difficulty determining their exposure to
nontraditional and subprime residential mortgage loan collateral used
to support FHLBank advances. Examiners identified weaknesses in
FHLBanks' assessments and testing of member underwriting and monitoring
of nontraditional and subprime loans, haircuts and discounts for
nontraditional and subprime collateral, risk limits on the acceptance
of these types of collateral, and board reporting of exposures to the
collateral. Specifically, examiners noted the following:
Five FHLBanks did not require an assessment of member
underwriting of nontraditional or subprime loans to ensure consistency
with interagency guidance as part of their onsite collateral review
procedures. Of the remaining FHLBanks, three did not consistently
document their review of member underwriting of nontraditional or
subprime loans.
Three FHLBanks lacked analytical support or validation for
haircuts used for subprime and nontraditional mortgage products. Two
FHLBanks did not have differentiated haircuts for conventional mortgage
loan collateral and nontraditional and subprime mortgage loan
collateral.
Four FHLBanks did not have risk limits on the volume of
nontraditional and subprime mortgage loan collateral that members may
pledge to support FHLBank advances.
Three FHLBanks did not regularly report exposures of
nontraditional and subprime collateral to their boards of directors.
FHFA examination staff communicated these weaknesses and
expectations for corrective action to executive management and the
boards of directors of the individual FHLBanks. Each FHLBank receiving
regulatory criticisms of its policies committed to correct the
weaknesses, and the examination staff has begun evaluating the
FHLBanks' corrective actions through follow-up visitations and
examinations. FHLBanks that have not adequately addressed the
weaknesses identified during the secured credit reviews will be subject
to a commensurately stricter supervisory response. Unsatisfactory
remediation of adverse examination findings would be a factor that FHFA
considers when determining whether formal supervisory enforcement
actions would be warranted in the future.
C. Responses to the HERA Section 1217 Questionnaire
The Section 1217 Questionnaire complements and in some cases
updates the information from the in-depth secured credit reviews. The
responses provide the FHLBanks' perspectives on a consistent set of
questions. During on-site examinations, FHFA will review documents and
independently evaluate the FHLBanks' policies, procedures and
practices. FHFA will draw final conclusions about the FHLBanks'
progress in addressing criticisms from the secured credit reviews and
in adhering to the advisory bulletins related to the interagency
guidance after completion of the next annual examinations of the
FHLBanks.
1. Do the FHLBanks have policies that exclude from eligible collateral
for advances residential mortgage loans and MBS backed by such loans
that do not conform to the interagency guidance?
Nine of the twelve FHLBanks have board-approved policies to exclude
from eligible collateral for advances nontraditional and subprime
residential mortgage loans originated or acquired by the member after
July 10, 2007 that do not conform to the interagency guidance, as well
as private-label MBS issued after July 10, 2007, with underlying
nontraditional or subprime residential mortgage loans that do not
conform to the interagency guidance. The other three FHLBanks have
adopted policies addressing, but not specifically excluding, the
acceptance of applicable nontraditional and subprime residential
mortgage loans or private-label MBS used as collateral for advances.
2. Do the FHLBanks require members to certify that residential mortgage
loans used to calculate eligible collateral comply with the interagency
guidance and obtain and provide to the FHLBank certifications from
securities issuers that loans underlying private-label MBS serving as
collateral conform to the interagency guidance?
All of the FHLBanks' policies require members to certify that the
nontraditional and subprime residential mortgage loans used to
calculate eligible collateral comply with the interagency guidance. One
FHLBank, however, requires the certification regarding subprime
residential mortgage loans only from members with established subprime
lending programs.\7\ Nine FHLBanks require that members pledging
private-label MBS certify or deliver to the FHLBank enforceable
representations and warranties from the issuer or other credible
evidence indicating that the loans backing the MBS comply with the
interagency guidance. The remaining FHLBanks do not accept as eligible
collateral for advances private-label MBS issued after July 10, 2007
that is collateralized by nontraditional and subprime residential
mortgage loans.
---------------------------------------------------------------------------
\7\ FHFA established that for purposes of determining collateral
eligibility the interagency guidance should apply regardless of
whether a member has a subprime lending program. FHFA is addressing
this matter with the FHLBank.
---------------------------------------------------------------------------
[[Page 38625]]
3. Do the FHLBanks evaluate, test, and validate member and issuer
certifications?
To evaluate and test member certifications regarding the
conformance of nontraditional and subprime residential mortgage loan
collateral to the interagency guidance, the FHLBanks review members'
underwriting policies, verify loan documentation on-site at members, or
review members' internal or external examination reports.\8\ Regarding
validation of certifications from securities issuers that loans
underlying private-label MBS originated after July 10, 2007 conform to
the interagency guidance, the FHLBanks commonly responded that although
they adopted policies to require such certifications, members have not
been able to obtain and provide them. Therefore, as a practical matter,
the FHLBanks have not accepted private-label MBS originated after July
10, 2007 as collateral for advances.
---------------------------------------------------------------------------
\8\ The results of the secured credit reviews indicate that the
quality of the FHLBanks' evaluations of member underwriting and
certifications is uneven. FHFA examination staff is addressing
identified issues with the FHLBanks.
---------------------------------------------------------------------------
4. Do the FHLBanks have in place policies and procedures that preclude
the acceptance of residential mortgage loans with predatory
characteristics as collateral for advances?
All FHLBanks have anti-predatory lending policies or procedures
that preclude acceptance as eligible collateral for advances
residential mortgage loans that violate applicable federal, state, or
local predatory lending laws and other similar credit-related consumer
protection laws. In addition, each of the FHLBanks specifically
excludes from eligible collateral loans which: have an annual
percentage rate or charge points or fees which exceed the thresholds
established by HOEPA; include requirements for prepaid, single-premium
credit life insurance; include a fee or charge for prepayment beyond
the early years of a loan; or require mandatory arbitration to resolve
disputes. Seven of the FHLBanks define ``early years'' for permissible
prepayments as a period of five years. Five FHLBanks qualify their
collateral ineligibility standard related to mandatory arbitration as a
loan requiring mandatory arbitration that is prohibited by any
applicable anti-predatory lending laws. One FHLBank qualifies its
collateral ineligibility standard related to prepayment penalties as a
loan including prepayment fees beyond the early years of the loan to
the extent prohibited or limited by any applicable anti-predatory
lending laws. The FHLBanks perform procedures to evaluate and test
member underwriting of collateral that are similar to those outlined
above for nontraditional and subprime residential mortgage loans.
V. Conclusions and Recommendations
Approximately one-fifth of the collateral supporting FHLBank
advances consists of subprime or nontraditional loans or Alt-A or
subprime private-label MBS. Although a significant share of the loans
or MBS in these categories may have been originated or issued prior to
July 10, 2007, and thus not technically subject to the interagency
guidance, the FHLBanks still need to manage and mitigate the risks
associated with all of the collateral underlying advances. Going
forward, the FHLBanks will need to ensure that the collateral
supporting advances remains consistent with safety and soundness as
well as the overarching housing finance mission of the FHLBanks.
Although all FHLBanks had policies addressing nontraditional and
subprime collateral, findings from the in-depth secured credit reviews
revealed some weaknesses in policies and practices, particularly in
regard to the management of the risks of this type of collateral. The
FHLBanks' responses to the HERA Section 1217 Questionnaire indicate
that they have adopted policies, procedures, and practices that would
require that the loans and MBS used as collateral to support advances
be consistent with the interagency guidance. The next cycle of
examinations will evaluate whether weaknesses that examiners previously
identified in the FHLBanks' policies and practices for subprime and
nontraditional residential mortgage loans have been corrected and
verify their responses to the HERA Section 1217 Questionnaire regarding
application of the principles of the interagency guidance to the
acceptance of collateral used to support advances. Through its
supervisory programs, FHFA will continue to assess the adequacy of the
FHLBank's policies and procedures, determine weaknesses or
deficiencies, and monitor the FHLBanks' remediation efforts.
The advisory bulletins issued by FHFB on the subjects of
nontraditional and subprime mortgage loans and predatory lending
between 2005 and 2008 provide explicit guidance for the FHLBanks.
Adoption of the policies and practices expected by the guidance has
received and will continue to receive focused attention through
supervisory programs and particularly as part of FHFA's examinations of
the FHLBanks. FHFA uses the information obtained through its
supervisory program of examinations, targeted reviews and surveys, and
off-site monitoring to develop appropriate guidance to facilitate the
FHLBanks' mission of providing liquidity to its members. For example,
FHFA's Division of Federal Home Loan Bank Regulation has recently
prepared guidance for examiners to address questions that the FHLBanks
have asked when developing policies and procedures to implement the
guidance contained in the advisory bulletins.
FHFA intends to reevaluate whether additional guidance or rules are
necessary for the FHLBanks regarding anti-predatory lending or the
acceptance of nontraditional or subprime residential mortgages as
collateral for advances after the completion of the next cycle of
examinations, which will determine if the FHLBanks have appropriately
addressed attendant weaknesses identified by the in-depth secured
credit reviews that began in 2008. At a minimum, FHFA expects to
clarify one point made in Advisory Bulletin 2008-AB-02. The advisory
bulletin states that residential mortgage loans underlying private-
label MBS issued after July 10, 2007, must conform to the interagency
guidance, but it is silent about MBS issued before that date that a
member may acquire after that date. FHFA intends to clarify that MBS
purchased by a member after July 10, 2007, is also subject to the
guidance contained in Advisory Bulletin 2008-AB-02.
Since the passage of HERA, there have been several legislative
developments addressing mortgage lending reform. FHFA is following
these developments and intends to update its regulations and guidance,
as appropriate, as issues surface in the legislative discussion. FHFA
especially notes the provision in the Mortgage Reform and Anti-
Predatory Lending Act recently passed by the House of Representatives
that adopts a borrower's ability to repay as a minimum standard defined
in the law; comments are invited on a question related to the concept
of a borrower's ability to repay in the request for comments below.
VI. Request for Comments
FHFA welcomes comments on all aspects of the HERA Section 1217
Study presented in this Notice. FHFA invites comments on the following
questions, in particular:
Should FHFA replace its existing guidance on
nontraditional, subprime,
[[Page 38626]]
or anti-predatory lending with formal regulatory standards?
Does any guidance contained in Advisory Bulletins 2005-AB-
08, 2007-AB-01, and 2008-AB-02 need additional emphasis or
clarification?
Should FHFA explicitly address other mortgage loan
features as a control against predatory lending, or is it sufficient
that Advisory Bulletin 2008-AB-02 requires an FHLBank to only accept
residential mortgage loans (and such loans backing private-label MBS)
as eligible collateral for advances when they conform to the
interagency guidance? Some loan features that may be associated with
either high risk or potentially predatory loans are addressed in the
Federal Reserve Board's Amendments to Regulation Z (Truth in Lending)
which will go into effect later in 2009 and 2010. For ``higher-priced
mortgages,'' the amended regulation addresses a borrower's ability to
repay the loan, prepayment penalties, income verification, and escrow
accounts.
Should FHFA seek any additional statutory authority to
support its ability to prohibit an FHLBank from accepting loans with
predatory characteristics as collateral for advances?
As the federal financial institution regulatory agencies,
such as through the Federal Financial Institutions Examination Council,
look to modify or enhance guidance with respect to nontraditional or
subprime mortgage products, should FHFA be formally and directly
involved?
Copies of all comments will be posted without change, including any
personal information you provide, such as your name and address, on the
FHFA internet web site at http://www.fhfa.gov. In addition, copies of
all comments received will be available for examination by the public
on business days between the hours of 10 a.m. and 3 p.m., at the
Federal Housing Finance Agency, Fourth Floor, 1700 G Street, NW.,
Washington, DC 20552. To make an appointment to inspect comments,
please call the Office of General Counsel at (202) 414-3751.
Dated: July 29, 2009.
James B. Lockhart III,
Director, Federal Housing Finance Agency.
[FR Doc. E9-18545 Filed 8-3-09; 8:45 am]
BILLING CODE 8070-01-P