Federal Housing Finance Agency:

Oversight of the Federal Home Loan Banks' Agricultural and Small Business Collateral Policies Could Be Improved

GAO-10-792: Published: Jul 20, 2010. Publicly Released: Aug 11, 2010.

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The Federal Home Loan Bank System is a government-sponsored enterprise comprising 12 regionally-based Federal Home Loan Banks (FHLBank), the primary mission of which is to support housing finance and community and economic development. Each FHLBank makes loans (advances) to member financial institutions in its district, such as banks, which traditionally are secured by single-family mortgages. In 1999, the Gramm-Leach-Bliley Act (GLBA) authorized FHLBanks to accept alternative forms of collateral, such as agricultural and small business loans, from small members. GAO was asked to assess (1) factors that may limit the use of alternative collateral; and (2) selected aspects of the Federal Housing Finance Agency's, (FHFA) related regulatory oversight practices. GAO reviewed FHLBank policies and FHFA documentation; and interviewed FHLBank and FHFA officials, and a nongeneralizable random sample of 30 small lenders likely to have significant levels of agricultural or small business loans in their portfolios.

FHLBank and FHFA officials cited several factors to help explain why alternative collateral represents about 1 percent of all collateral that is used to secure advances. These factors include a potential lack of interest by small lenders in pledging such collateral to secure advances or the view that many such lenders have sufficient levels of single-family mortgage collateral. Officials from two FHLBanks said their institutions do not accept alternative collateral at all, at least in part for these reasons. Further, FHLBank officials said alternative collateral can be more difficult to evaluate than single-family mortgages and, therefore, may present greater financial risks. To mitigate these risks, the 10 FHLBanks that accept alternative collateral generally apply higher discounts, or haircuts, to it than any other form of collateral, which may limit its use. For example, an FHLBank with a haircut of 80 percent on alternative collateral generally would allow a member to obtain an advance worth 20 percent of the collateral's value. While GAO's interviews with 30 small lenders likely to have significant alternative collateral on their books found that they generally valued their relationships with their local FHLBanks, officials from half said the large haircuts on alternative collateral or other policies limited the collateral's appeal. FHFA's oversight of FHLBank alternative collateral policies and practices has been limited. For example, FHFA guidance does not direct its examiners to assess the FHLBanks' alternative collateral policies. As a result, the FHLBanks have wide discretion to either not accept alternative collateral or apply relatively large haircuts to it. While the FHLBanks may view these policies as necessary to mitigate potential risks, 9 of the 12 FHLBanks did not provide documentation to GAO to substantiate such policies. Further, the documentation provided by three FHLBanks suggests that, in some cases, haircuts applied to alternative collateral may be too large. Also, the majority of the FHLBanks have not developed quantitative goals for products related to agricultural and small business lending, such as alternative collateral, as required by FHFA regulations. FHFA officials said that alternative collateral has not been a focus of the agency's oversight efforts because it does not represent a significant safety and soundness concern. However, in the absence of more proactive FHFA oversight from a mission standpoint, the appropriateness of FHLBank alternative collateral policies is not clear. FHFA should revise its examination guidelines to include periodic analysis of alternative collateral, and enforce its regulation pertaining to quantitative goals for products related to agricultural and small business lending. FHFA agreed with these recommendations.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In April 2011, FHFA issued Examiner Guidance Bulletin 2011-EGB-01 which states that commencing in 2011, the Division of Federal Home Loan Bank Regulation will review each Bank's outreach, lending, collateral, and risk management activities with respect to CFI members; and evaluate how the Banks address CFI member advance needs and support their CFI collateral risk management practices. The Guidance includes questions that examiners are to consider, at a minimum, in their assessment of the FHLBanks' CFI collateral polices and practices. Specifically, the guidance suggests that examiners evaluate the existence and appropriateness of the Bank's (1) decision to accept CFI collateral, (2) methods for validating and supporting its CFI collateral discounts; and (3) data sources used to evaluate loan delinquency, market liquidity, and current pricing conditions. With the issuance of 2011-EGB-01, FHFA has sufficiently implemented the recommendation to revise its examination guidance regarding FHLBanks' alternative collateral policies and practices.

    Recommendation: To help ensure that the FHLBanks' economic development mission-related activities include the appropriate use of alternative collateral, as provided for in GLBA, the Acting Director of FHFA should revise FHFA examination guidance to include requirements that its examiners periodically assess the FHLBanks' alternative collateral policies and practices, similar to the manner in which other forms of collateral, such as single-family mortgages, are assessed. Specifically, FHFA should revise its guidance to ensure that examiners periodically assess the FHLBanks' analytical basis for either (1) not accepting alternative collateral, or (2) establishing their haircuts and other risk-management policies for such collateral.

    Agency Affected: Federal Housing Finance Agency

  2. Status: Closed - Implemented

    Comments: According to FHFA's November 9, 2010 Advisory Bulletin (2010-AB-02), it re-emphasizes the requirements of Section 917.5 that an FHLBank's strategic plan establish quantitative performance goals for FHLBank products related to multifamily housing, small business, small farm, and small agri-business lending and report annually to the FHFA on its performance in achieving those goals. Beginning with the 2011 examination cycle, the Bulletin indicates that examiners will (1) evaluate the existence and appropriateness of quantitative performance goals for products related to agricultural and small business financing, including the use of alternative and appropriate collateral; and (2) monitor an FHLBank's outreach and Community Financial Institution collateral needs assessments efforts for safety and soundness and mission fulfillment purposes. FHFA has sufficiently implemented our recommendation through the Advisory Bulletin (2010-AB-02), which re-emphasizes the quantitative performance goals required in the FHLBank's strategic plans and includes an examiner's assessment of the FHLBanks' compliance with the requirement during examinations commencing in 2011.

    Recommendation: To help ensure that the FHLBanks' economic development mission-related activities include the appropriate use of alternative collateral, as provided for in GLBA, the Acting Director of FHFA should enforce regulatory requirements that the FHLBanks' strategic business plans include quantitative performance goals for products related to agricultural and small business financing, including the use of alternative collateral as appropriate.

    Agency Affected: Federal Housing Finance Agency

  3. Status: Closed - Implemented

    Comments: FHFA issued an Advisory Bulletin on November 9, 2010 (2010-AB-02) which sets forth the principles that FHFA will use in evaluating the FHLBanks' strategic plans. The Bulletin indicates that FHFA staff will look for whether the strategic plan (1) describes the FHLBank's current and projected future financial condition and risk level; (2) includes sufficient information to allow the FHLBank's senior management and board of directors to benchmark the progress of the FHLBank relative to the plan; and (3) enables an informed reader to determine whether the strategic plan is realistic, in keeping with the FHLBank's mission, and ensures the appropriate management of risk levels. The Bulletin also indicates that in developing the strategic plans, FHLBanks are also meeting the requirement to annually report to FHFA on their performance in achieving the quantitative performance goals for FHLBank products related to multifamily, small business, small farm, and small agri-business lending. FHFA has sufficiently implemented our recommendation through the Advisory Bulletin (2010-AB-02).

    Recommendation: To help ensure that the FHLBanks' economic development mission-related activities include the appropriate use of alternative collateral, as provided for in GLBA, the Acting Director of FHFA should consider requiring the FHLBanks, through a process of market analysis and consultations with stakeholders, to periodically identify and address agricultural and small business financing needs in their communities, including the use of alternative collateral. Such requirements could be established through revisions to FHFA's regulations for Targeted Community Development Plans or strategic business plans or through other measures as deemed appropriate.

    Agency Affected: Federal Housing Finance Agency

 

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