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entitled 'Federal Housing Finance Agency: Oversight of the Federal 
Home Loan Banks' Agricultural and Small Business Collateral Policies 
Could Be Improved' which was released on August 11, 2010. 

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Report to the Chairman, Subcommittee on Capital Markets, Insurance, 
and Government Sponsored Enterprises, Committee on Financial Services, 
House of Representatives: 

United States Government Accountability Office: 
GAO: 

July 2010: 

Federal Housing Finance Agency: 

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

GAO-10-792: 

GAO Highlights: 

Highlights of GAO-10-792, a report to the Chairman, Subcommittee on 
Capital Markets, Insurance, and Government Sponsored Enterprises, 
Committee on Financial Services, House of Representatives. 

Why GAO Did This Study: 

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. 

What GAO Found: 

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 (see 
table). 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. 

Table: Range of FHLBank Haircuts Applied to Various Collateral Types
          
FHLBank district: Ranges; 
Alternative collateral haircuts: Small business: 40-80%; 
Alternative collateral haircuts: Small farm: 40-80%; 
Alternative collateral haircuts: Small agribusiness: 40-80%; 
Single-family mortgages: 7-44%; 
Commercial real estate mortgages: 40-67%. 

Source: GAO analysis of FHLBank collateral policies. 

[End of table] 

What GAO Recommends: 

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. 

View [hyperlink, http://www.gao.gov/products/GAO-10-792] or key 
components. For more information, contact William Shear at (202) 512-
8678 or shearw@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

FHLBank and CFI Officials Cited Several Factors, Including Lack of 
Interest and Risk-Management Policies, to Explain Minimal Use of 
Alternative Collateral: 

FHFA's Oversight of the FHLBanks' Alternative Collateral Policies and 
Practices Has Been Limited: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the Federal Housing Finance Agency: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Characteristics of CFI Members and Assets in the 12 FHLBanks, 
as of December 31, 2009: 

Table 2: Number and Total Assets of Agricultural CFIs by FHLBank 
District, as of December 31, 2009: 

Table 3: Number and Total Assets of Small Business CFIs by FHLBank 
District, as of September 30, 2009: 

Table 4: Percentage Haircut Requirements for the 10 FHLBanks That 
Accept Alternative, Single-Family, and Commercial Real Estate 
Collateral under a Blanket Lien Option: 

Table 5: CFIs Reported Use of Alternative Collateral to Secure 
Advances: 

Table 6: Characteristics of GAO's Nongeneralizable, Random Sample of 
30 CFIs: 

Figure: 

Figure 1: The 12 FHLBank Districts: 

Abbreviations: 

AHP: Affordable Housing Program: 

CFI: Community Financial Institution: 

CIP: Community Investment Program: 

FDIC: Federal Deposit Insurance Corporation: 

Federal Reserve: Board of Governors of the Federal Reserve System: 

FHFA: Federal Housing Finance Agency: 

FHFB: Federal Housing Finance Board: 

FHLBank: Federal Home Loan Bank: 

FHLBank System: Federal Home Loan Bank System: 

FHLBank Act: Federal Home Loan Bank Act: 

FIRREA: Financial Institutions Reform, Recovery, and Enforcement Act 
of 1989: 

GLBA: Gramm-Leach-Bliley Act of 1999: 

GSE: Government-sponsored Enterprise: 

HERA: Housing and Economic Recovery Act of 2008: 

SBA: Small Business Administration: 

[End of section] 

United States Government Accountability Office: Washington, DC 20548: 

July 20, 2010: 

The Honorable Paul E. Kanjorski: 
Chairman: 
Subcommittee on Capital Markets, Insurance, and Government Sponsored 
Enterprises: 
Committee on Financial Services: 
House of Representatives: 

Dear Mr. Chairman: 

The Federal Home Loan Bank System (FHLBank System) is a government- 
sponsored enterprise (GSE) that consists of 12 regionally based 
Federal Home Loan Banks (FHLBank), the primary mission of which is to 
support housing finance and community and economic development. To 
carry out its mission, the FHLBank System issues debt in capital 
markets, generally at relatively favorable rates due to its GSE 
status, and each FHLBank makes loans (advances) to member financial 
institutions, such as banks and thrifts, located in its district. 
Traditionally, member institutions have secured advances by pledging 
single-family mortgages or investment-grade securities as collateral 
to their FHLBank. However, section 604 of title VI of the Gramm-Leach-
Bliley Act (GLBA), also known as the Federal Home Loan Bank System 
Modernization Act of 1999, authorizes FHLBanks to accept alternative 
collateral, such as small business and small farm loans, from small 
members, known as Community Financial Institutions (CFI), which are 
defined as having $1.029 billion or less in total assets.[Footnote 1] 
In enacting the GLBA reforms, the goal was to help smaller banks or 
thrifts, which may have limited single-family mortgages and other 
traditional assets to pledge as collateral, gain greater access to the 
liquidity offered by FHLBank advances.[Footnote 2] In so doing, the 
GLBA reforms were supposed to help improve economic development credit 
opportunities in rural areas and other underserved communities. 
[Footnote 3] 

GLBA's legislative history also contains language suggesting that the 
FHLBanks and their former financial soundness and mission regulator, 
the Federal Housing Finance Board (FHFB), should "prioritize" the 
FHLBank System's economic development efforts through the use of 
alternative collateral.[Footnote 4] FHFB regulations required each 
FHLBank to develop strategic business plans that established 
quantitative performance goals for products, which could include 
alternative collateral, related to small business, small farm, and 
small agribusiness lending.[Footnote 5] In 2008, as part of the 
provisions of the Housing and Economic Recovery Act of 2008 (HERA), 
FHFB was abolished and replaced by the Federal Housing Finance Agency 
(FHFA), which assumed FHFB's financial soundness and mission oversight 
responsibilities for the FHLBank System. 

While the FHLBanks have been authorized to accept alternative 
collateral for more than 10 years, its use has been minimal, according 
to FHFA data. Specifically, FHFA data indicate that alternative 
collateral secured about 1 percent of all FHLBank advances in 2008 and 
that percentage has been fairly constant at 1 percent or less since 
2001.[Footnote 6] In general, FHLBanks located in regions with 
significant agriculturally based economies--such as the FHLBanks 
located in Dallas, Des Moines, and Topeka--generally report higher 
acceptance of alternative collateral than other FHLBank districts. 
Several FHLBanks, including those in Atlanta, Cincinnati, and New 
York, either have not sought regulatory approval to accept alternative 
collateral or CFI members in their districts have not pledged such 
collateral.[Footnote 7] 

You requested that we review issues pertaining to the FHLBanks' 
implementation of the GLBA collateral reforms. Specifically, this 
report (1) discusses factors that may limit the use of alternative 
collateral to secure FHLBank advances; and (2) assesses selected 
aspects of FHFA's oversight of the FHLBanks' alternative collateral 
policies and practices. 

To address the first objective, we analyzed relevant sections of GLBA 
and HERA, and FHLBank collateral policies and procedures, particularly 
those pertaining to alternative collateral. While we were able to 
review each FHLBank's collateral policies and procedures, the 
confidentiality of such information limited what we could publicly 
disclose in our report.[Footnote 8] We also conducted interviews with 
officials from FHFA, the 12 FHLBanks, the Council of Federal Home Loan 
Banks, and the Independent Community Bankers of America. Further, we 
identified 796 CFI members, as of September 30, 2009, that either (1) 
met criteria established by the FDIC defining them as significant 
agricultural lenders or (2) met criteria established by the Small 
Business Administration's (SBA) Office of Advocacy defining them as 
significant small business lenders.[Footnote 9] We also identified 
several CFIs that met the definition of both an agricultural and small 
business lender. From these populations, we interviewed a 
nongeneralizable, random sample of 30 CFI members.[Footnote 10] 
Therefore, the sample consists of CFIs that might be expected to 
encounter challenges in obtaining FHLBank advances by pledging 
traditional forms of collateral. The sample also was designed to 
ensure that it included the perspective of CFIs (1) located in FHLBank 
districts that have high, some, or no use of alternative collateral; 
and (2) are very small (that is, those with less than $100 million in 
assets). The views expressed by the banks in our sample cannot be 
generalized to the universe of CFIs. For the second objective, we 
analyzed FHFA's regulations, examination policies and procedures, and 
recent FHLBank examination results to understand the nature of rules 
and information used by the agency to assess the FHLBanks' collateral 
management efforts. We also reviewed GLBA, HERA, and Financial 
Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) 
requirements, as well as the FHLBanks' strategic business and Targeted 
Community Lending Plans and federal internal control standards. 
Finally, we reviewed FDIC's asset valuation estimates for various loan 
types in banks that recently failed or were on the verge of failure. 
To assess the reliability of FDIC, FHFA, and SBA's Office of Advocacy 
data, we (1) interviewed officials knowledgeable about the data; (2) 
assessed the data for obvious outliers and missing information; (3) 
checked a sample of the data against publicly available financial 
information on banks and thrifts; and (4) reviewed independent 
reports, and determined that the data were sufficiently reliable for 
our purposes. Appendix I contains a detailed description of our scope 
and methodology. 

We conducted this performance audit from October 2009 to July 2010, in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Background: 

The FHLBank System was established in 1932 and consists of 12 FHLBanks 
(see figure 1). Member financial institutions, which typically are 
commercial banks and thrifts (or savings and loans), cooperatively own 
each of the 12 FHLBanks. To become a member of its local FHLBank, a 
financial institution must maintain an investment in the capital stock 
of the FHLBank in an amount sufficient to satisfy the minimum 
investment required for that institution in accordance with the 
FHLBank's capital plan.[Footnote 11] In addition to the ability to 
obtain advances, other benefits of FHLBank membership for financial 
institutions include earning dividends on their capital investments 
and access to various products and services, such as letters of credit 
and payment services. As of December 31, 2009, more than 8,000 
financial institutions with approximately $13 trillion in assets were 
members of the FHLBank System. The FHLBank System's total outstanding 
advances stood at more than $631 billion. 

Figure 1: The 12 FHLBank Districts: 

[Refer to PDF for image: map of the U.S. indicating district 
boundaries] 

District 1: Boston; 
District 2: New York; 
District 3: Pittsburgh; 
District 4: Atlanta; 
District 5: Cincinnati; 
District 6: Indianapolis; 
District 7: Chicago; 
District 8: Des Moines; 
District 9: Dallas; 
District 10: Topeka; 
District 11: San Francisco; 
District 12: Seattle. 

Sources: FHFB data; Map Resources (map). 

[End of figure] 

As established by statute and FHFA regulations, the FHLBanks are 
required to develop and implement collateral standards and other 
policies to mitigate the risk that member institutions may default on 
outstanding advances. To help do so, the FHLBanks generally apply a 
blanket lien on all or specific categories of a member's assets to 
secure the collateral underlying the advance. In general, a blanket 
lien agreement is intended to fully protect the FHLBank by securing 
its right to take and possibly sell any or all of a member's assets in 
the event it fails or defaults on its outstanding advances. In limited 
circumstances, FHLBanks may permit or require their members to pledge 
collateral under (1) a listing (specific detail) lien agreement in 
which the members are to report detailed information, such as the loan 
amount, payments, maturity date, and interest rate for the loans 
pledged as collateral; or (2) a delivery lien agreement, in which 
members are required to deliver the collateral to the FHLBank or an 
approved safekeeping facility.[Footnote 12] From a member's 
perspective, the benefits of listing collateral in lieu of a blanket 
lien agreement can include better pricing terms. Some FHLBanks may 
require members to list or deliver collateral to better protect their 
financial interests in instances in which a member is in danger of 
failure or its financial condition begins to deteriorate. 

FHLBanks also seek to manage risk and mitigate potential losses by 
applying varying haircuts, or discounts, to collateral pledged to 
secure advances. To illustrate: suppose that an FHLBank member sought 
to pledge a single-family residential mortgage loan portfolio with a 
value of $100 million to secure an advance from its district FHLBank. 
If the FHLBank applied a haircut of 25 percent to such collateral, the 
member would generally be able to secure advances of up to $75 million 
subject to other risk-management policies the FHLBank may have 
established.[Footnote 13] In general, the FHLBanks' haircut levels 
tend to increase based on the perceived risks associated with the 
collateral being pledged. As described in this report, single-family 
mortgages and other forms of traditional collateral generally are 
perceived as representing less risk than alternative forms of 
collateral, such as agricultural and small business loans. Since 
FHLBanks generally issue advances under blanket lien agreements, they 
may calculate a member's total borrowing capacity by applying varying 
haircuts to each form of eligible collateral on the member's books and 
communicating this information to the member on a periodic basis. 

In the event that a member institution fails, FHLBanks have a "first 
lien" on its assets. That is, they have priority over all other 
creditors, including FDIC, to obtain the collateral necessary to 
protect against losses on their outstanding advances. In a typical 
bank or thrift failure, FDIC pays off outstanding FHLBank advances in 
full and takes possession of the collateral on the institution's books 
to help offset its losses. According to the FHLBank Office of Finance, 
in the 78-year history of the FHLBank System, no FHLBank has ever 
suffered a credit loss on an advance. 

The FHLBanks' haircuts and other risk management policies are intended 
to mitigate potential losses; however, they also may limit some 
members' interest in obtaining advances. For example, an FHLBank 
member may perceive that the level of haircuts applied to the 
collateral it pledges may unduly restrict the amount of financing it 
would like to obtain through advances. Administrative and other costs 
associated with obtaining advances also may factor into an FHLBank 
member's decision making process. For example, FHLBank officials 
conduct on-site inspections to assess members' collateral management 
practices or require members to have such practices independently 
audited. For some FHLBank members, the costs of such administrative 
procedures may outweigh the potential benefits of obtaining advances, 
particularly if they view the haircuts applied to the collateral as 
unreasonable. 

While the FHLBank System's primary mission over the years has been to 
promote housing finance generally through its advance business, it is 
also required by statute and regulation to meet other specific mission 
requirements. For example, FIRREA authorizes both the Affordable 
Housing Program (AHP) and the Community Investment Program (CIP) to 
assist the FHLBanks' affordable housing mission.[Footnote 14] Under 
AHP, each FHLBank is required to set aside 10 percent of its previous 
year's earnings to fund interest rate subsidies on advances to members 
engaged in lending for long-term, low-and moderate-income, owner- 
occupied, and affordable rental housing at subsidized interest rates. 
[Footnote 15] In using the advances, the FHLBank members are to give 
priority to qualified projects, such as the purchase of homes for low-
or moderate-income families or to purchase or rehabilitate government-
owned housing. FIRREA also established CIP, which requires FHLBanks to 
provide flexible advance terms for members to undertake community-
oriented mortgage lending. CIP advances may be made at the FHLBank's 
cost of funds (for advances with similar maturities) plus the cost of 
administrative fees. Moreover, FIRREA requires FHFB (now FHFA) to 
establish standards of community investment or service for members of 
FHLBanks to maintain continued access to long-term advances.[Footnote 
16] These standards include the development of a Targeted Community 
Lending Plan (which is designed to help the FHLBanks assess the credit 
needs of the communities that they serve) and quantitative lending 
goals that address identified credit needs and marketing opportunities 
in each FHLBank's district. 

FHFA has safety and soundness and mission oversight for the FHLBank 
System and Fannie Mae and Freddie Mac.[Footnote 17] For example, FHFA 
is responsible for ensuring that the FHLBanks establish appropriate 
collateral management policies and practices to mitigate the risks 
associated with their advance business. From a mission standpoint, 
FHFA also is responsible for ensuring that the FHLBanks are in 
compliance with statutes and regulations pertaining to the AHP and CIP 
programs. While GLBA does not establish specific requirements for 
alternative collateral, its legislative history suggests that the 
FHLBanks and FHFB, and by extension FHFA, should prioritize the 
FHLBank System's economic development activities through the use of 
alternative collateral. To carry out its responsibilities, FHFA may 
issue regulations, establish capital standards, and conduct on-site 
safety and soundness or mission-related examinations. FHFA also may 
take enforcement actions, such as issuing cease and desist orders, and 
may place an FHLBank, Fannie Mae, or Freddie Mac into conservatorship 
or receivership if they become undercapitalized or critically 
undercapitalized.[Footnote 18] 

FHLBank and CFI Officials Cited Several Factors, Including Lack of 
Interest and Risk-Management Policies, to Explain Minimal Use of 
Alternative Collateral: 

Officials from the 12 FHLBanks cited several factors to help explain 
the minimal use of alternative collateral to secure advances in the 
FHLBank System. These factors include a potential lack of interest 
among many CFI members; the view that many CFIs belong to the FHLBank 
System primarily to have access to letters of credit and other 
products or to obtain a backup source of liquidity; and that many CFIs 
may have sufficient holdings of traditional collateral to secure 
advances. Moreover, due to the potential risks associated with 
alternative collateral, the 10 FHLBanks that accept it have 
established risk-management strategies to mitigate potential losses, 
which also may limit its use. In particular, the FHLBanks generally 
have applied higher haircuts to alternative collateral than to any 
other type of collateral used to secure advances. Officials from many 
of the 30 CFIs we interviewed said that they valued their 
relationships with their local FHLBanks and the products and services 
provided. However, officials from half of these CFIs expressed 
concerns about the level of the haircuts applied to alternative 
collateral or other FHLBank risk-management strategies. In some cases, 
they said the haircuts or policies limited their willingness to pledge 
such collateral to obtain advances. 

FHLBank Officials Generally Attributed the Minimal Use of Alternative 
Collateral to Limited Demand among Many CFI Members and Ready 
Availability of Traditional Collateral: 

According to representatives from the 12 FHLBanks, they have ongoing 
member outreach programs that are intended, in part, to address 
members' credit and collateral needs and the various products 
available to them. The FHLBank officials said that outreach activities 
can include telephone calls or visits to members to discuss the 
availability of alternative collateral and its potential use by CFI 
members. Some FHLBanks also have annual meetings, online product 
tutorials, and electronic bulletins that provide information about 
alternative collateral. 

While officials from the 12 FHLBanks said they had outreach programs 
in place, some officials cited the significant differences in the 
membership characteristics across the FHLBank System as affecting the 
use of alternative collateral (see table 1). For example, CFIs 
represent more than 80 percent of the membership and about 30 percent 
of the assets of the FHLBanks in Dallas and Topeka, and many of these 
CFI members focus on agricultural lending due to its prominence in the 
regional economies. While CFI assets represented a relatively small 
proportion, or 13 percent, of the total assets of members in the Des 
Moines FHLBank district, officials said that alternative collateral 
was of significant interest to their members due to the prominence of 
agricultural-related businesses in the district. In contrast, CFI 
assets represented a relatively small portion, or less than 10 
percent, of all membership assets in the FHLBank districts of Atlanta 
and New York, neither of which have submitted new business activity 
notices to FHFA requesting approval to accept alternative collateral; 
and the FHLBank of Cincinnati reported no alternative collateral 
activity at year-end 2008. Officials from these three FHLBanks said 
that their memberships had not expressed an interest in pledging 
alternative collateral. Similarly, although CFI membership and assets 
also were relatively significant in the Chicago FHLBank district, 
officials said that their membership had not expressed much interest 
in using alternative collateral to secure advances. One FHLBank 
official noted that, given the cooperative nature of the FHLBank 
System, membership interest often drove the decision to make certain 
products and services available. 

Table 1: Characteristics of CFI Members and Assets in the 12 FHLBanks, 
as of December 31, 2009: 

Dollars in millions: 

FHLBank district: Atlanta; 
Total CFI members: 946; 
Total members: 1,194; 
Percentage of CFI members: 79%; 
Total CFI assets: $259,916; 
Total member assets: $3,455,365; 
Percentage of CFI assets: 8%. 

FHLBank district: Boston; 
Total CFI members: 252; 
Total members: 462; 
Percentage of CFI members: 55%; 
Total CFI assets: $94,176; 
Total member assets: $692,444; 
Percentage of CFI assets: 14%. 

FHLBank district: Chicago; 
Total CFI members: 695; 
Total members: 790; 
Percentage of CFI members: 88%; 
Total CFI assets: $148,981; 
Total member assets: $499,675; 
Percentage of CFI assets: 30%. 

FHLBank district: Cincinnati; 
Total CFI members: 563; 
Total members: 735; 
Percentage of CFI members: 77%; 
Total CFI assets: $19,168; 
Total member assets: $872,869; 
Percentage of CFI assets: 14%. 

FHLBank district: Dallas[A]; 
Total CFI members: 776; 
Total members: 922; 
Percentage of CFI members: 84%; 
Total CFI assets: $83,467; 
Total member assets: $601,072; 
Percentage of CFI assets: 31%. 

FHLBank district: Des Moines[A]; 
Total CFI members: 1,078; 
Total members: 1,226; 
Percentage of CFI members: 88%; 
Total CFI assets: $81,984; 
Total member assets: $1,455,698; 
Percentage of CFI assets: 13%. 

FHLBank district: Indianapolis; 
Total CFI members: 254; 
Total members: 417; 
Percentage of CFI members: 61%; 
Total CFI assets: $57,894; 
Total member assets: $450,396; 
Percentage of CFI assets: 13%. 

FHLBank district: New York; 
Total CFI members: 208; 
Total members: 331; 
Percentage of CFI members: 63%; 
Total CFI assets: $68,860; 
Total member assets: $1,581,211; 
Percentage of CFI assets: 4%. 

FHLBank district: Pittsburgh; 
Total CFI members: 245; 
Total members: 316; 
Percentage of CFI members: 78%; 
Total CFI assets: $73,689; 
Total member assets: $984,503; 
Percentage of CFI assets: 7%. 

FHLBank district: San Francisco; 
Total CFI members: 254; 
Total members: 406; 
Percentage of CFI members: 63%; 
Total CFI assets: $69,810; 
Total member assets: $1,785,012; 
Percentage of CFI assets: 4%. 

FHLBank district: Seattle; 
Total CFI members: 244; 
Total members: 384; 
Percentage of CFI members: 64%; 
Total CFI assets: $66,775; 
Total member assets: $388,666; 
Percentage of CFI assets: 17%. 

FHLBank district: Topeka[A]; 
Total CFI members: 756; 
Total members: 873; 
Percentage of CFI members: 87%; 
Total CFI assets: $122,190; 
Total member assets: $444,338; 
Percentage of CFI assets: 27%. 

FHLBank district: FHLBank System total; 
Total CFI members: 6,271; 
Total members: 8,056; 
Percentage of CFI members: 78%; 
Total CFI assets: $1,446,910; 
Total member assets: $13,211,249; 
Percentage of CFI assets: 11%. 

Source: GAO analysis of FHFA data. 

[A] Indicates FHLBanks whose officials said that alternative 
collateral was significant to their membership. 

[End of table] 

Officials from several FHLBanks also said that CFIs often do not take 
out advances from their local FHLBank and, therefore, have no reason 
to use alternative collateral. Rather than taking out advances, 
several FHLBank officials said many CFIs derive other benefits from 
their membership, particularly letters of credit, and other services. 
The officials added that CFIs also may belong to the FHLBank System to 
have a backup source of liquidity in case other sources, including 
customer deposits or the federal funds market become unavailable or 
prohibitively expensive.[Footnote 19] 

According to some FHLBank officials, many CFIs may have sufficient 
traditional collateral, such as single-family mortgages and investment-
grade securities, to secure advances. Officials at the FHLBanks of 
Boston, Cincinnati, and Pittsburgh said that they reported no or low 
levels of alternative collateral securing advances at year-end 2008, 
in part, because their members had sufficient levels of other eligible 
collateral. Atlanta and New York FHLBank officials said that they 
conducted regular analyses to determine whether any banks in their 
membership were collaterally constrained and, therefore would need 
alternative collateral to obtain an advance. Officials at these banks 
said since 2000, their annual analyses have determined that 
alternative collateral was not needed among their membership. 

Our analysis of FHFA, FDIC, and SBA's Office of Advocacy data found 
that while most CFIs may have sufficient traditional sources of 
collateral to secure advances, a considerable minority of CFIs with 
significant holdings of alternative collateral on their books may face 
challenges in doing so. For example, we identified 480 CFIs with $47.3 
billion in assets, as of December 31, 2009, that met the FDIC's 
definition of an agricultural bank (see table 2). The FHLBanks of Des 
Moines and Topeka had the most agricultural CFI members and the CFIs 
in these two districts had the greatest amount of total assets for 
such lenders. 

Table 2: Number and Total Assets of Agricultural CFIs by FHLBank 
District, as of December 31, 2009: 

Dollars in millions: 

FHLBank district: Atlanta; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 946; 
Agricultural CFIs as a percentage of all CFIs: 0.00%; 
Agricultural CFI assets: $0; 
All CFI assets: $259,916; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00%. 

FHLBank district: Boston; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 252; 
Agricultural CFIs as a percentage of all CFIs: 0.00; 
Agricultural CFI assets: $0; 
All CFI assets: $94,176; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00. 

FHLBank district: Chicago; 
Number of agricultural CFIs: 29; 
Number of all CFIs: 695; 
Agricultural CFIs as a percentage of all CFIs: 4.17%; 
Agricultural CFI assets: $2,934; 
All CFI assets: $148,981; 
Agricultural CFI assets as a percentage of all CFI assets: 1.97%. 

FHLBank district: Cincinnati; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 563; 
Agricultural CFIs as a percentage of all CFIs: 0.00; 
Agricultural CFI assets: $0; 
All CFI assets: $119,169; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00. 

FHLBank district: Dallas; 
Number of agricultural CFIs: 39; 
Number of all CFIs: 776; 
Agricultural CFIs as a percentage of all CFIs: 5.03%; 
Agricultural CFI assets: $3,380; 
All CFI assets: $183,467; 
Agricultural CFI assets as a percentage of all CFI assets: 1.84%. 

FHLBank district: Des Moines; 
Number of agricultural CFIs: 213; 
Number of all CFIs: 1,078; 
Agricultural CFIs as a percentage of all CFIs: 19.76%; 
Agricultural CFI assets: $23,373; 
All CFI assets: $181,984; 
Agricultural CFI assets as a percentage of all CFI assets: 12.84%. 

FHLBank district: Indianapolis; 
Number of agricultural CFIs: 1; 
Number of all CFIs: 254; 
Agricultural CFIs as a percentage of all CFIs: 0.39%; 
Agricultural CFI assets: $48; 
All CFI assets: $57,893; 
Agricultural CFI assets as a percentage of all CFI assets: 0.08%. 

FHLBank district: New York; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 208; 
Agricultural CFIs as a percentage of all CFIs: 0.00; 
Agricultural CFI assets: $0; 
All CFI assets: $68,860; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00. 

FHLBank district: Pittsburgh; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 245; 
Agricultural CFIs as a percentage of all CFIs: 0.00; 
Agricultural CFI assets: $0; 
All CFI assets: $73,689; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00. 

FHLBank district: San Francisco; 
Number of agricultural CFIs: 0; 
Number of all CFIs: 254; 
Agricultural CFIs as a percentage of all CFIs: 0.00; 
Agricultural CFI assets: $0; 
All CFI assets: $69,810; 
Agricultural CFI assets as a percentage of all CFI assets: 0.00. 

FHLBank district: Seattle; 
Number of agricultural CFIs: 11; 
Number of all CFIs: 244; 
Agricultural CFIs as a percentage of all CFIs: 4.51%; 
Agricultural CFI assets: $741; 
All CFI assets: $66,775; 
Agricultural CFI assets as a percentage of all CFI assets: 1.11%. 

FHLBank district: Topeka; 
Number of agricultural CFIs: 187; 
Number of all CFIs: 756; 
Agricultural CFIs as a percentage of all CFIs: 24.74%; 
Agricultural CFI assets: $16,858; 
All CFI assets: $122,190; 
Agricultural CFI assets as a percentage of all CFI assets: 13.80%. 

FHLBank district: FHLBank System total; 
Number of agricultural CFIs: 480; 
Number of all CFIs: 6,271; 
Agricultural CFIs as a percentage of all CFIs: 7.65%; 
Agricultural CFI assets: $47,334; 
All CFI assets: $1,446,910; 
Agricultural CFI assets as a percentage of all CFI assets: 3.27%. 

Source: GAO analysis of FHFA, FDIC, and SBA's Office of Advocacy data. 

[End of table] 

Using SBA's Office of Advocacy data we also found 326 CFIs with $102.3 
billion in assets, as of September 30, 2009, that were identified as 
the largest small business lenders (see table 3).[Footnote 20] The 
number and assets of small business CFIs appeared to be more evenly 
distributed across the FHLBank System than agricultural CFIs. We 
interviewed a limited sample of 30 representatives from these 
agricultural and small business CFIs and discuss their perspectives on 
FHLBank alternative collateral policies and practices later in this 
report. 

Table 3: Number and Total Assets of Small Business CFIs by FHLBank 
District, as of September 30, 2009: 

Dollars in millions: 

FHLBank district: Atlanta; 
Number of small business CFIs: 51; 
Number of all CFIs: 948; 
Small business CFIs as a percentage of all CFIs: 5.38%; 
Small business CFI assets: $18,214; 
All CFI assets: $247,370; 
Small business CFI assets as a percentage of all CFI assets: 7.36%. 

FHLBank district: Boston; 
Number of small business CFIs: 13; 
Number of all CFIs: 247; 
Small business CFIs as a percentage of all CFIs: 5.26%; 
Small business CFI assets: $6,961; 
All CFI assets: $89,078; 
Small business CFI assets as a percentage of all CFI assets: 7.81%. 

FHLBank district: Chicago; 
Number of small business CFIs: 19; 
Number of all CFIs: 702; 
Small business CFIs as a percentage of all CFIs: 2.71%; 
Small business CFI assets: $4,913; 
All CFI assets: $144,137; 
Small business CFI assets as a percentage of all CFI assets: 3.41%. 

FHLBank district: Cincinnati; 
Number of small business CFIs: 28; 
Number of all CFIs: 564; 
Small business CFIs as a percentage of all CFIs: 4.96%; 
Small business CFI assets: $8,247; 
All CFI assets: $116,593; 
Small business CFI assets as a percentage of all CFI assets: 7.07%. 

FHLBank district: Dallas; 
Number of small business CFIs: 39; 
Number of all CFIs: 778; 
Small business CFIs as a percentage of all CFIs: 5.01%; 
Small business CFI assets: $10,790; 
All CFI assets: $172,949; 
Small business CFI assets as a percentage of all CFI assets: 6.24%. 

FHLBank district: Des Moines; 
Number of small business CFIs: 44; 
Number of all CFIs: 1,082; 
Small business CFIs as a percentage of all CFIs: 4.07%; 
Small business CFI assets: $12,638; 
All CFI assets: $174,460; 
Small business CFI assets as a percentage of all CFI assets: 7.24%. 

FHLBank district: Indianapolis; 
Number of small business CFIs: 17; 
Number of all CFIs: 259; 
Small business CFIs as a percentage of all CFIs: 6.56%; 
Small business CFI assets: v3,877; 
All CFI assets: $58,161; 
Small business CFI assets as a percentage of all CFI assets: 6.67%. 

FHLBank district: New York; 
Number of small business CFIs: 20; 
Number of all CFIs: 203; 
Small business CFIs as a percentage of all CFIs: 9.85%; 
Small business CFI assets: $9,126; 
All CFI assets: $63,950; 
Small business CFI assets as a percentage of all CFI assets: 14.27%. 

FHLBank district: Pittsburgh; 
Number of small business CFIs: 15; 
Number of all CFIs: 242; 
Small business CFIs as a percentage of all CFIs: 6.20%; 
Small business CFI assets: $5,679; 
All CFI assets: $66,820; 
Small business CFI assets as a percentage of all CFI assets: 8.50%. 

FHLBank district: San Francisco; 
Number of small business CFIs: 16; 
Number of all CFIs: 260; 
Small business CFIs as a percentage of all CFIs: 6.15%; 
Small business CFI assets: $5,585; 
All CFI assets: $69,042; 
Small business CFI assets as a percentage of all CFI assets: 8.09%. 

FHLBank district: Seattle; 
Number of small business CFIs: 25; 
Number of all CFIs: 238; 
Small business CFIs as a percentage of all CFIs: 10.50%; 
Small business CFI assets: $9,610; 
All CFI assets: $63,879; 
Small business CFI assets as a percentage of all CFI assets: 15.04%. 

FHLBank district: Topeka; 
Number of small business CFIs: 39; 
Number of all CFIs: 758; 
Small business CFIs as a percentage of all CFIs: 5.15%; 
Small business CFI assets: $6,644; 
All CFI assets: $118,760; 
Small business CFI assets as a percentage of all CFI assets: 5.59%. 

FHLBank district: FHLBank System total; 
Number of small business CFIs: 326; 
Number of all CFIs: 6,281; 
Small business CFIs as a percentage of all CFIs: 5.19%; 
Small business CFI assets: $102,284; 
All CFI assets: $1,385,199; 
Small business CFI assets as a percentage of all CFI assets: 7.38%. 

Source: GAO analysis of FHFA and SBA's Office of Advocacy data. 

[End of table] 

FHLBank Policies That Focus On Potential Risks May Also Limit the Use 
of Alternative Collateral: 

FHFA and some FHLBank officials said that alternative collateral 
generally has been viewed as representing greater risks than single- 
family mortgages and investment-grade securities. For example, FHFA 
officials said that it could be difficult to establish a value for 
agricultural and small business loans because they generally have not 
been actively traded in secondary markets. In the absence of secondary 
markets, alternative collateral may be relatively illiquid, which 
means an FHLBank might face difficulties in selling such underlying 
collateral if a CFI failed or defaulted on its advance.[Footnote 21] 
As described earlier, FDIC generally pays the FHLBank the principal 
balance of the outstanding advances of failed members and takes 
possession of the underlying collateral. However, FDIC may not always 
follow this procedure in future bank failures and the possibility of a 
CFI defaulting on a loan or failing would put the FHLBank at a risk of 
losses, as it might be unable to sell the alternative collateral in a 
timely manner.[Footnote 22] In contrast, FHLBanks generally can more 
easily estimate values for traditional collateral because mortgages 
often are pooled into securities and actively traded on secondary 
markets. In the event a member failed or defaulted on its outstanding 
advances, the FHLBanks generally would be able to sell the underlying 
collateral that secured the mortgages or securities. 

In a previous report, we commented on the challenges associated with 
establishing values for small business loans as compared with single- 
family mortgage loans.[Footnote 23] Unlike mortgage lending, small 
business loans exhibit greater heterogeneity and more complexity. For 
example, although mortgage lending has become more complicated in 
recent years, the type of financing that prospective homebuyers seek 
remains fairly standardized (two general categories--fixed-or variable-
rate loans) and the collateral securing mortgages, generally single-
family residences, is relatively easy to understand and market. In 
contrast, the types of financing that small businesses typically seek 
can range from revolving lines of credit to term loans, and the 
collateral pledged against such loans also may vary widely in risk and 
marketability (from relatively secure real estate to less secure 
inventory). 

The 10 FHLBanks that accept alternative collateral have adopted risk- 
management policies intended to mitigate the perceived risks of such 
collateral, but which also may limit its appeal to CFIs. These 
FHLBanks generally apply higher haircuts to alternative collateral 
than to any other type of collateral that may be used to secure 
advances. As shown in table 4, the haircuts, or range of haircuts, 
that the FHLBanks apply to alternative collateral generally have been 
higher than for traditional forms of collateral, such as single-family 
mortgages or commercial real estate loans. The maximum haircut applied 
by an FHLBank to alternative collateral is 80 percent under a blanket 
lien policy, which generally means that the member could take out an 
advance of up to 20 percent of the value of such collateral, whereas 
the maximum haircut applied to commercial real estate collateral is 67 
percent. Over the years, commercial real estate has been viewed as a 
potentially risky type of asset that has resulted in significant bank 
losses and numerous bank failures.[Footnote 24] 

Table 4: Percentage Haircut Requirements for the 10 FHLBanks That 
Accept Alternative, Single-Family, and Commercial Real Estate 
Collateral under a Blanket Lien Option[A]: 

FHLBank district: Bank A; 
Alternative collateral haircuts: Small business: 40; 
Alternative collateral haircuts: Small farm: 50; 
Alternative collateral haircuts: Small agribusiness: 50; 
Single-family: 17; 
Commercial real estate: 40 or 60. 

FHLBank district: Bank B; 
Alternative collateral haircuts: Small business: 50[C]; 
Alternative collateral haircuts: Small farm: 50[C]; 
Alternative collateral haircuts: Small agribusiness: 50[C]; 
Single-family: 25; 
Commercial real estate: 67[C]. 

FHLBank district: Bank C[B]; 
Alternative collateral haircuts: Small business: 67-80; 
Alternative collateral haircuts: Small farm: 67-80; 
Alternative collateral haircuts: Small agribusiness: 67-80; 
Single-family: 20-43; 
Commercial real estate: 46-58. 

FHLBank district: Bank D[B]; 
Alternative collateral haircuts: Small business: 40; 
Alternative collateral haircuts: Small farm: 60; 
Alternative collateral haircuts: Small agribusiness: 60; 
Single-family: 25; 
Commercial real estate: 40. 

FHLBank district: Bank E[B]; 
Alternative collateral haircuts: Small business: 67; 
Alternative collateral haircuts: Small farm: 50; 
Alternative collateral haircuts: Small agribusiness: [D]; 
Single-family: 31; 
Commercial real estate: 50. 

FHLBank district: Bank F[B]; 
Alternative collateral haircuts: Small business: 55-65; 
Alternative collateral haircuts: Small farm: 55-65; 
Alternative collateral haircuts: Small agribusiness: 55-65; 
Single-family: 31-40; 
Commercial real estate: 45-55. 

FHLBank district: Bank G; 
Alternative collateral haircuts: Small business: 50; 
Alternative collateral haircuts: Small farm: 50; 
Alternative collateral haircuts: Small agribusiness: 50; 
Single-family: 25; 
Commercial real estate: 50. 

FHLBank district: Bank H[B]; 
Alternative collateral haircuts: Small business: 50-76; 
Alternative collateral haircuts: Small farm: [D]; 
Alternative collateral haircuts: Small agribusiness: 50-76; 
Single-family: 15-44; 
Commercial real estate: 46-57. 

FHLBank district: Bank I[B]; 
Alternative collateral haircuts: Small business: 75; 
Alternative collateral haircuts: Small farm: 75; 
Alternative collateral haircuts: Small agribusiness: 75; 
Single-family: 36-41; 
Commercial real estate: 48-53. 

FHLBank district: Bank J[B]; 
Alternative collateral haircuts: Small business: 50-51; 
Alternative collateral haircuts: Small farm: 35; 
Alternative collateral haircuts: Small agribusiness: 50; 
Single-family: 7-30; 
Commercial real estate: 51. 

FHLBank district: Total haircut range; 
Alternative collateral haircuts: Small business: 40-80; 
Alternative collateral haircuts: Small farm: 40-80; 
Alternative collateral haircuts: Small agribusiness: 40-80; 
Single-family: 7-44; 
Commercial real estate: 40-67. 

Source: GAO analysis of FHLBank collateral policies. 

[A] The FHLBanks use different methods to reflect the percentage 
haircut requirement on collateral. We have converted their different 
measures to one consistent standard for purposes of comparison. 

[B] Indicates FHLBanks whose haircuts for alternative collateral are 
generally higher than for single family and commercial real estate 
collateral: 

[C] Data reflect haircuts under a specific or listed lien agreement 
because the FHLBank does not accept these collateral types under a 
blanket lien. 

[D] The FHLBank does not accept the loan type as collateral. 

[End of table] 

The haircuts that the FHLBanks apply to alternative collateral can 
vary significantly. For example, the haircut on small business loans 
ranges from 40 to 80 percent. In contrast, two FHLBanks apply a 
uniform 50 percent haircut to all three types of alternative 
collateral (see table 4). We discuss the extent to which the FHLBanks 
have an analytical basis for the haircuts applied to alternative 
collateral later in this report. 

Some FHLBanks also maintain other collateral policies designed to 
mitigate the perceived risks associated with alternative collateral. 
For example, the FHLBanks have established borrowing capacity limits 
to further minimize the risks associated with making advances and 
generally apply them to all members. However, some FHLBanks have 
established more stringent borrowing limits for members pledging 
alternative collateral. For example, in addition to applying haircuts 
of more than 50 percent, one FHLBank limits the amount of alternative 
collateral that a member may pledge to 20 percent of the member's 
total assets. One FHLBank sets the limit at 10 percent, in addition to 
its 50 percent haircut. In contrast, most other FHLBanks' policies set 
borrowing capacity rates from 30 to 55 percent for members. 

CFIs Generally Valued Their Relations With FHLBanks, but Half Raised 
Concerns about Haircuts on Alternative Collateral or Other FHLBank 
Risk-Management Policies: 

While many CFIs may have significant traditional collateral resources 
to pledge to secure advances, we conducted interviews with 30 CFIs 
that could be constrained in their ability to obtain FHLBank advances 
due to their significant involvement in agricultural or small business 
lending. Most of the CFIs in our sample said that they valued the 
products and services they received from their local FHLBank.[Footnote 
25] Officials from many of the CFIs said that FHLBank membership 
provided their institutions with access to a stable and relatively low-
cost source of liquidity or provided access to a key source of backup 
liquidity, among other things. Officials from several CFIs that have 
significant concentrations in agricultural loans said that their 
ability to pledge such loans as collateral helped them to obtain 
advances and thereby expand their lending activities, because the 
advances generally allowed CFIs to provide borrowers with long-term 
financing on favorable terms. 

To some degree, the results from our interviews with officials from 
the 30 CFIs were consistent with rationales offered by FHLBank and 
FHFA officials about the minimal use of alternative collateral in the 
FHLBank System. Officials from 15 of the 30 CFIs we interviewed said 
that they had pledged alternative collateral to help secure FHLBank 
advances and officials from all but one of these reported having 
advances outstanding (see table 5). Officials from the other 15 CFIs 
said they had not used alternative collateral to secure an advance 
because, for example, they generally had sufficient traditional 
collateral to secure advances or sufficient levels of other sources of 
liquidity, such as customer deposits, to finance their lending 
activities (see table 5). As discussed previously, FHLBank officials 
have stated that readily available traditional collateral is one 
reason that many CFIs have not pledged alternative collateral to 
obtain advances. 

Table 5: CFIs Reported Use of Alternative Collateral to Secure 
Advances: 

Reported alternative collateral usage: Used; 
Reported currently having outstanding advances: 14; 
Did not report currently having outstanding advances: 1; 
No response: 0; 
Total: 15. 

Reported alternative collateral usage: Not used; 
Reported currently having outstanding advances: 9; 
Did not report currently having outstanding advances: 5; 
No response: 1; 
Total: 15. 

Reported alternative collateral usage: Total; 
Reported currently having outstanding advances: 23; 
Did not report currently having outstanding advances: 6; 
No response: 1; 
Total: 30. 

Source: GAO. 

[End of table] 

However, officials from 15 of the 30 CFIs we interviewed expressed 
concern about the haircuts applied to alternative collateral or other 
FHLBank policies that may limit its appeal and use. Of these 15 CFIs, 
officials from 11 specifically expressed concern about the level of 
haircuts. These officials, some of whom had not yet pledged 
alternative collateral to secure an advance, said that their local 
FHLBank's large haircuts were a factor in their banks' decision not to 
pledge alternative collateral. Some of the officials also said that 
their local FHLBank's haircuts were not consistent with historical 
losses on small business, small farm, or small agribusiness loans. 
[Footnote 26] 

Officials from 4 of the 15 CFIs expressed concern about other FHLBank 
policies unrelated to haircuts, which included limitations on the 
types of alternative collateral accepted by some FHLBanks and limits 
on borrowing that some FHLBanks apply to alternative collateral. 
[Footnote 27] For example, an official from an agricultural CFI with 
$56 million in total assets said that its local FHLBank has a policy 
that limits the amount of an advance a CFI member could obtain using 
alternative collateral to 10 percent of total assets. The official 
characterized the policy as highly restrictive, particularly for a 
small agricultural lender. The FHLBank to which this lender belongs 
permits non-CFI members using traditional collateral to secure an 
advance to borrow up to 35 percent of their total assets. 

FHFA's Oversight of the FHLBanks' Alternative Collateral Policies and 
Practices Has Been Limited: 

While FHFB held a conference in 2005 on the use of alternative 
collateral which may have focused the FHLBanks' attention on the 
issue, regulatory oversight of the FHLBanks' policies and practices 
for such collateral, from a mission standpoint, has been limited. 
[Footnote 28] For example, FHFA examiners have not been routinely 
directed to assess the FHLBanks' analytical basis for the haircuts on 
alternative collateral, although they are directed to do so for 
traditional forms of collateral. In the absence of regulatory 
oversight, the FHLBanks have exercised wide discretion in establishing 
policies and practices pertaining to alternative collateral over the 
years. Although the FHLBanks may view these policies and practices as 
necessary to protect their financial soundness, our review also 
indicates that many FHLBanks have not substantiated through 
documentation the analytical basis for such policies, including 
establishing the haircut levels. Available FHLBank documentation 
suggests that some haircuts applied to alternative collateral may need 
to be lowered and others raised. Moreover, a majority of the FHLBanks 
have not established quantitative performance goals for products, 
related to agricultural and small business lending in their strategic 
business plans, which could include alternative collateral, as 
required by agency regulations. Additionally, the FHLBanks are not 
required to identify and address agricultural and small business 
financing needs in their communities, including potential uses for 
alternative collateral, through a process of market analysis and 
consultations with stakeholders as they are required to do by FHFA 
regulations for their Targeted Community Development Plans, which 
agency officials said largely pertain to the AHP and CIP programs. 
FHFA officials said they have not focused oversight efforts on 
alternative collateral policies and practices because its minimal use 
within the FHLBank System does not represent a safety and soundness 
concern. But, without more proactive oversight by FHFA from a mission 
standpoint, the appropriateness of FHLBank alternative collateral 
policies may not be clear. 

FHFA Examinations Do Not Include Reviews of the FHLBanks' Analytical 
Basis for Their Alternative Collateral Policies and Practices: 

While FHFA examination guidance does not require reviews of FHLBank 
alternative collateral policies and practices, it does include 
procedures related to general collateral management policies and 
practices. For example, examiners are expected to assess whether each 
FHLBank has addressed appropriate levels of collateralization, 
including valuation and collateral haircuts. According to FHFA 
officials, at every examination an examiner will review documentation 
of the FHLBanks' general collateral valuation and haircut analyses, 
and any available underlying financial models. 

Our review of FHFB and FHFA examinations of each of the 12 FHLBanks 
over the past three examination cycles confirmed that examiners did 
not address the FHLBanks' alternative collateral management policies 
and practices.[Footnote 29] However, consistent with the examination 
guidance, the examinations did include analysis of the FHLBanks' 
general collateral policies and practices. For example, FHFA examiners 
noted that one FHLBank did not regularly review its collateral 
haircuts and that the current haircuts had not been validated by well-
documented analyses. Examiners also found that another FHLBank 
disregarded the results of a collateral valuation model to establish 
haircuts for certain members without sufficient analysis to support 
the decision. FHFA officials we contacted said that due to mounting 
concerns about the FHLBanks' safety and soundness in 2009, the agency 
conducted a focused review of the FHLBanks' collateral management 
practices, including valuation and haircut methodologies. They also 
noted that they have been monitoring the FHLBanks' progress in 
responding to examiners' recommendations to improve documentation of 
their general collateral haircut policies. 

FHFA guidance also includes procedures for assessing the FHLBanks' 
compliance with other mission-related programs. Specifically, the 
examination guidance includes procedures for assessing the FHLBanks' 
implementation of the AHP and the CIP programs. As established by FHFA 
guidance, examiners should assess the effectiveness of these programs 
at each FHLBank and whether program operations were consistent with 
the laws and policies that govern them. For example, the examination 
guidance indicates that examiners should evaluate the reasonableness 
of fees associated with these programs, whether the FHLBank has met 
its established community lending goals, and the extent to which the 
projects funded by the programs benefited eligible targeted businesses 
or households. Our review found that the examinations generally 
included sections that assessed the FHLBanks' implementation of AHP 
and CIP programs. 

FHFA officials cited several reasons why the agency's examination 
procedures and practices did not specifically address alternative 
collateral. First, they said that the use of alternative collateral 
was minimal and did not represent a significant safety and soundness 
concern. Because single-family mortgages, investment-grade securities, 
and commercial real estate loans represent the vast majority of member 
assets that are pledged to secure advances, FHFA officials said that 
they have focused their examination resources on them. They wanted to 
ensure that the FHLBanks have established adequate policies and 
procedures for managing such collateral, including the analytical 
basis for the haircuts applied to it, and the mitigation of potential 
losses. Furthermore, FHFA officials said important differences between 
alternative collateral and other mission-related programs, such as the 
AHP program, explained the differences in the agency's oversight 
approaches. They said that FIRREA establishes specific requirements 
for how the AHP program is to be funded and implemented. For example, 
the statute establishes the level of annual contribution from each 
FHLBank to fund their AHP programs as well as minimum requirements for 
the FHLBanks' mandated AHP implementation plans. In contrast, FHFA 
officials said GLBA only authorizes the FHLBanks to accept alternative 
collateral to secure advances, and does not establish specific 
requirements for operating the program that could be assessed through 
examinations. 

In the Absence of FHFA Examination Oversight, FHLBanks Have Wide 
Discretion to Establish Haircuts and Other Policies for Alternative 
Collateral, but Documentation to Support These Policies Is Limited: 

While FHFA may prioritize FHLBank safety and soundness concerns and 
the structure of the AHP and CIP programs may facilitate their 
oversight from a mission standpoint, FHFA's, as well as FHFB's, 
limited oversight of alternative collateral may have limited its 
appeal within the FHLBank System. By not implementing examination 
procedures that are consistent with its general approaches to 
monitoring FHLBank collateral practices, FHFA has provided the 
FHLBanks with wide discretion in adopting policies and practices for 
alternative collateral. Although the FHLBanks may have adopted 
policies that they believe are necessary to protect their financial 
interests while complying with their missions, our work indicates that 
the analytical bases for these generally have not been fully 
documented. 

Although federal internal control standards established that key 
decisions need to be documented, one of the two FHLBanks that has not 
accepted alternative collateral provided a documented basis for its 
policy.[Footnote 30] Further, of the 10 FHLBanks that accept 
alternative collateral, 3 provided documentation of the basis of the 
haircuts that they applied to such collateral. Analysis from 2 
FHLBanks suggested that their haircuts for all types of alternative 
collateral were too high and 1 FHLBank subsequently revised the 
haircuts downward by an average of about 11 percentage points. The 
other FHLBank's analysis suggested that the haircuts it applied to 
agricultural collateral might be too high, while the haircuts for 
small business collateral might be too low. Of the 7 FHLBanks that did 
not provide any documentation of their alternative collateral 
haircuts, officials from 3 said they have not documented such analysis 
and the other 4 did not respond to our requests. An official from 1 of 
the FHLBanks that has not established documentation for its 
alternative haircuts said they had been set at a level to be 
"conservative." As discussed previously, FHFA guidance directs 
examiners to assess the analytical basis for the haircuts applied to 
other forms of collateral. 

We also analyzed FDIC data on the estimated losses on various loan 
categories in banks that failed or were on the verge of failure 
between January 2009 and February 2010, which raises some questions 
and reinforces the need for further analysis of the risks associated 
with alternative collateral. Prior to a bank's failure, FDIC 
contractors conduct on-site reviews to assess the value (defined as 
the estimated market value of the loans as a percentage of the 
outstanding balances) of the assets held by the bank to calculate how 
much the failure will cost the Deposit Insurance Fund.[Footnote 31] 
According to FDIC officials, estimates are made on the value of the 
loans of such banks, including single-family residential loans, 
residential and nonresidential construction loans, consumer loans, 
business loans, and agricultural loans. According to the FDIC data, 
the estimated value of agricultural loans was higher than the value of 
any other type of loan reviewed. Our discussions with several 
agricultural CFIs and reviews of some regulatory and independent 
reports also suggest that the U.S. agricultural economy has performed 
somewhat better than the broader economy in recent years, which may 
explain why such collateral recently may have outperformed other types 
of loans as suggested by FDIC data.[Footnote 32] Furthermore, while 
the commercial and industrial loans category (which includes small 
business loans) had a lower estimated value than the agricultural, 
consumer, and single-family mortgage loan categories, according to the 
FDIC's asset valuation estimates, it had a higher estimated value than 
the nonresidential and residential construction loan categories. 
[Footnote 33] 

However, important limitations apply to any analysis of these FDIC 
data. First, because the data only cover recent bank failures or near 
failures, they do not provide a historical basis to assess the 
relative risk of the various loan types. Many banks have failed 
recently primarily due to substantial losses on residential mortgages 
and commercial real estate loans, of which each has experienced 
significant price declines.[Footnote 34] Second, the analysis does not 
control for any other factors that may be related to FDIC's asset 
valuation estimates, such as the characteristics of the loans made by 
the banks. Nevertheless, these data raise questions about the 
FHLBanks' analytical basis for the haircuts that are currently applied 
to alternative collateral as well as the need for FHFA to routinely 
review the basis for these policies from a mission standpoint to help 
ensure that they are not unduly limiting the use of such collateral to 
secure advances. 

FHFA Has Not Enforced or Amended Regulations That Could Focus the 
FHLBanks' Attention on Agricultural and Small Business Lending, 
Including the Use of Alternative Collateral: 

In 2000, FHFB issued regulations, which remain in effect today, that 
require each FHLBank's board of directors to adopt a strategic 
business plan that describes how the business activities of the 
FHLBank will achieve its mission. As part of the strategic business 
plan, FHLBanks must establish quantitative performance goals for 
products related to multifamily housing, small business, small farm, 
and small agribusiness lending. Such products could include advances 
to CFIs that are secured by alternative collateral. As part of its 
mission oversight responsibilities, FHFA is responsible for ensuring 
that the FHLBanks comply with these annual goal requirements in 
establishing their plans. 

Our review indicates that the strategic business plans of five 
FHLBanks do not include such goals. While the remaining seven FHLBanks 
have established goals for alternative collateral lending, three have 
set goals at zero. The four FHLBank strategic business plans that 
include the required goals establish annual benchmarks for the number 
or dollar amount of advances made to members for the purpose of 
lending to small businesses, small farms, and small agribusinesses. 
FHFA officials said that lending goals for alternative collateral are 
not part of its planned review of FHLBanks' 2010 strategic business 
plans. In the absence of vigorous oversight and enforcement by FHFA, 
many FHLBanks may continue to place a low priority on requirements 
that they establish quantitative annual goals for products related to 
agricultural and small business lending, which could include advances 
secured by alternative collateral. 

According to FHFA officials, the regulation pertaining to the AHP and 
CIP programs requires the FHLBanks to develop annual Targeted 
Community Lending Plans to address identified credit needs and market 
opportunities for targeted community lending in their districts. 
[Footnote 35] To develop these plans, FHLBanks are to consult with 
members, economic development organizations, and others, and establish 
quantitative community lending goals. FHLBanks also must conduct 
market research to ascertain their district's economic development 
needs and opportunities. The regulator then uses the Targeted 
Community Lending Plans to help determine the extent to which FHLBanks 
have achieved their mission to provide community and economic 
development opportunities in their districts. 

Although FHFA's regulation that requires the establishment of Targeted 
Community Lending Plans may provide a means for the FHLBanks to 
identify lending and economic development needs within their 
communities and respond accordingly, it does not specifically require 
the FHLBanks to analyze small business and agricultural lending needs 
or opportunities for the use of alternative collateral. According to 
FHFA officials, this is because the regulation pertains specifically 
to the AHP and CIP programs. Given that FHFA does not require the 
FHLBanks to include an assessment of opportunities to use alternative 
collateral to support small business and agricultural lending in their 
Targeted Community Lending Plans, such plans generally have not 
addressed such issues. One FHLBank's Targeted Community Lending Plan--
that of the FHLBank of Indianapolis--did discuss issues pertaining to 
agricultural and small business lending. Specifically, the plan for 
2010 stated that the Bank intends to increase its small business, 
small farm, or small agribusiness lending by 5 percent in the next 
year. 

While FHFA officials told us that the regulation that requires the 
FHLBanks to develop Targeted Community Lending Plans does not pertain 
to alternative collateral, we note that the general process involved 
in creating the plans is potentially beneficial in that it calls on 
the FHLBanks to review relevant information and consult with 
stakeholders in their communities to identify and address relevant 
lending needs. A similar process--through revisions to FHFA's 
regulations pertaining to Targeted Community Lending Plans, or 
strategic business plans, or other measures as appropriate--that would 
require the FHLBanks to assess agricultural and small business lending 
needs as well as opportunities to use alternative collateral, could 
better focus their attention on potential opportunities and strategies 
to enhance such financing. 

Conclusions: 

GLBA's inclusion of new types of collateral for CFIs indicates that 
these types of available collateral should be taken in account when 
formulating strategies for the FHLBanks' economic development efforts. 
However, the regulators' limited oversight of FHLBank alternative 
collateral policies and practices over the years has provided the 
FHLBanks with wide discretion to establish risk-management policies, 
which although viewed as necessary to protect against potential losses 
may involve an off-setting trade-off. That is, they may unduly limit 
the appeal and use of alternative collateral. 

We have identified several areas of concern. In many cases the 
FHLBanks have not substantiated and documented their reasons for not 
accepting alternative collateral or applying relatively high haircuts 
to it. Available FHLBank documentation suggests that some alternative 
collateral haircuts may be too high; limited FDIC asset valuation 
estimates indicate that the risks associated with alternative 
collateral can vary over time; and 15 of the 30 CFI representatives we 
interviewed expressed concerns about haircuts applied to such 
collateral and other risk-management practices, some of whom said such 
policies and practices limited their willingness to use alternative 
collateral. In addition, because FHFA has not leveraged its existing 
examination procedures to include an assessment of the FHLBanks' 
alternative collateral policies, the appropriateness of such policies 
may not be clear. Furthermore, FHFA has not ensured that all FHLBanks 
establish quantitative goals for products related to agricultural and 
small business lending, which could include alternative collateral, in 
their strategic business plans as required by the agency's 
regulations. Finally, FHFA has not taken steps, such as revising its 
regulations pertaining to Targeted Community Development Plans, or 
strategic business plans, or other measures as may be appropriate, to 
follow a process whereby they conduct market analysis and consult with 
a range of stakeholders in their communities to identify and address 
agricultural and small business financing needs, including the use of 
alternative collateral. We recognize that FHFA has critical 
responsibilities to help ensure that the FHLBanks' operate in a safe 
and sound manner, and has not focused on alternative collateral 
because it was not deemed a risk to safety and soundness. 
Nevertheless, the agency also has an obligation to take reasonable 
steps to help ensure that the FHLBank System is achieving the missions 
for which it was established, including economic development through 
the use of alternative collateral. 

Recommendations for Executive Action: 

We recommend that the Acting Director of FHFA take the following 
actions to help ensure that the FHLBanks' economic development mission-
related activities include the appropriate use of alternative 
collateral, as provided for in GLBA. 

* 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. 

* 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. 

* 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 Comments and Our Evaluation: 

We provided a draft of this report to FHFA for its review and comment. 
We received written comments from FHFA's Acting Director, which are 
reprinted in appendix II. In its comments, FHFA expressed certain 
reservations about the analysis in the draft as discussed below, but 
agreed to implement our recommendations. Specifically, FHFA stated 
that the agency would (1) review each FHLBank's policies and 
practices, starting with the 2011 annual supervisory examination 
cycle, to assure that they can substantiate their collateral practices 
and are meeting their CFI members' liquidity needs; (2) issue an 
Advisory Bulletin to the FHLBanks that provides supervisory guidance 
on how to include goals for alternative collateral in the preparation 
of FHLBank strategic business plans beginning in 2011, and review 
those plans to ensure they include such goals; and (3) direct the 
FHLBanks to document their outreach and alternative collateral needs 
assessment efforts in their strategic business plans, and instruct 
examiners to monitor the FHLBanks' efforts in these areas as part of 
the agency's ongoing supervisory review. FHFA also provided technical 
comments, which we incorporated as appropriate. 

In commenting on the draft report, FHFA said that it has no evidence 
that any CFI member is collaterally constrained and unable to access 
advances as a result of the FHLBanks' collateral risk management 
practices. FHFA also said that it has no evidence that any issues 
discussed in the draft report have resulted in or contributed to a 
lack of liquidity for small farm, agriculture, and small business 
lending. In addition, FHFA noted that in many cases, CFI members 
obtain sufficient liquidity by pledging real estate-related collateral 
and, therefore, CFI members' ability to obtain an advance is not 
limited by the type of collateral they have. While our draft report 
noted that most CFIs may not be collaterally constrained, we 
identified nearly 800 CFIs, constituting about 13 percent of all CFIs, 
that may face challenges in obtaining an advance using traditional 
collateral because they have substantial amounts of small business and 
agricultural collateral on their books. Further, we interviewed a 
nongeneralizable sample of 30 of these CFIs and found that half of 
them expressed concerns with FHLBank haircuts and other policies 
related to alternative collateral. Several CFIs said that the haircuts 
applied to alternative collateral were a factor in their decision not 
to pledge alternative collateral to secure an advance. In agreeing to 
implement the recommendations, FHFA will have the information 
necessary to help assess the extent to which CFIs may face challenges 
in obtaining financing as well as the appropriateness of FHLBank 
alternative collateral policies and practices. 

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, we will send copies of this report 
to other interested congressional committees and to the Acting 
Director of the Federal Housing Finance Agency. In addition, the 
report will be available at no charge on GAO's Web site at [hyperlink, 
http://www.gao.gov]. 

If you or your staff have any questions regarding this report, please 
contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. GAO staff who made major contributions 
to this report are listed in appendix III. 

Signed by: 

William B. Shear: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

The objectives of this report were to (1) discuss factors that may 
limit the use of alternative collateral to secure Federal Home Loan 
Bank (FHLBank) advances; and (2) assess selected aspects of the 
Federal Housing Finance Agency's (FHFA) oversight of the FHLBanks' 
alternative collateral policies and practices. 

To address the first objective, we reviewed relevant sections of the 
Gramm-Leach-Bliley Act of 1999, the Housing and Economic Recovery Act 
of 2008, and FHLBank collateral policies and procedures, particularly 
those pertaining to alternative collateral. While we were able to 
review each FHLBank's collateral policies and procedures, the 
confidentiality of such information limited what we could publicly 
disclose in our report. Specifically, because the collateral haircut 
policies of some of the FHLBanks generally are considered to be 
proprietary, we were unable to specify the policies of individual 
FHLBanks. Where appropriate, we used an alphabetic system when 
discussing FHLBank collateral policies and limited discussion of 
details to ensure the protection of the FHLBanks' identities. We also 
conducted interviews with representatives from FHFA, the regulator of 
the FHLBank System; the 12 FHLBanks; the Council of Federal Home Loan 
Banks; the Independent Community Bankers of America; and obtained 
information from a nongeneralizable, random sample of 30 Community 
Financial Institutions (CFI). 

To develop the nongeneralizable, stratified random sample of 30 CFIs, 
we first identified the population of CFIs that may have limited 
sources of traditional collateral to secure FHLBank advances. To 
identify CFIs that may have relatively large volumes of agriculturally 
related loans on their books, we used the Federal Deposit Insurance 
Corporation's (FDIC) definition of an agricultural bank; that is, a 
bank having 25 percent or more of its loans associated with 
agricultural lending. FHFA provided a list of 6,281 CFI members as of 
September 30, 2009--of which 470 met FDIC's definition of an 
agricultural bank, meaning that they held at least 25 percent of their 
assets in agricultural loans. (We note that the report includes 
updated data on agricultural banks as of year-end 2009.) To identify 
CFIs that may have relatively large volumes of small business loans on 
their books, we used information from the Small Business 
Administration's (SBA) Office of Advocacy.[Footnote 36] Specifically, 
because there is no similar threshold to define a small business 
lender, we used the SBA's Office of Advocacy's determination of the 
top 10 percent of small business lenders in each state to determine 
the small business sample population. We then matched and merged this 
list of institutions, by institution name, with FHFA's list of CFI 
members. The resulting list included 326 small business CFIs and their 
total assets for each FHLBank district. The final sample population of 
agricultural and small business CFIs totaled 796. From this final 
sample population, we identified 10 lenders that met the definition of 
both an agricultural and small business CFI. We sampled this dual-
status CFI population separately because of its potential to provide a 
unique perspective on alternative collateral in the FHLBank System. 

Our sample was stratified to ensure that it included the perspective 
of CFIs located in FHLBank districts that had (1) high, some, or no 
use of alternative collateral, as of year-end 2008; and, (2) banks 
that are very small, meaning less than $100 million in total assets. 
We defined an FHLBank as having had a "high" acceptance of alternative 
collateral if it accepted more than $500 million in alternative 
collateral in 2008; "some" acceptance if it accepted from $1 to $500 
million in alternative collateral in 2008; and "no" acceptance if it 
accepted no alternative collateral ($0) in 2008. We then over sampled 
within each stratum to accommodate refusals to participate and 
randomly selected a nongeneralizable sample of 30 CFIs (see table 6). 

Table 6: Characteristics of GAO's Nongeneralizable, Random Sample of 
30 CFIs: 

FHLBank district: Atlanta; 
Level of acceptance of alternative collateral: None; 
Small business CFI: 2; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: Boston[A]; 
Level of acceptance of alternative collateral: Some; 
Small business CFI: [Empty]; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: Chicago; 
Level of acceptance of alternative collateral: Some; 
Small business CFI: 2; 
Agricultural CFI: 5; 
Dual-status CFI: [Empty]. 

FHLBank district: Cincinnati; 
Level of acceptance of alternative collateral: None; 
Small business CFI: 1; 
Agricultural CFI: 1; 
Dual-status CFI: [Empty]. 

FHLBank district: Dallas; 
Level of acceptance of alternative collateral: High; 
Small business CFI: 1; 
Agricultural CFI: [Empty]; 
Dual-status CFI: 1. 

FHLBank district: Des Moines; 
Level of acceptance of alternative collateral: High; 
Small business CFI: 1; 
Agricultural CFI: 4; 
Dual-status CFI: 1. 

FHLBank district: Indianapolis; 
Level of acceptance of alternative collateral: Some; 
Small business CFI: 1; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: New York[A]; 
Level of acceptance of alternative collateral: None; 
Small business CFI: [Empty]; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: Pittsburgh; 
Level of acceptance of alternative collateral: None; 
Small business CFI: 2; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: San Francisco; 
Level of acceptance of alternative collateral: High; 
Small business CFI: 1; 
Agricultural CFI: [Empty]; 
Dual-status CFI: [Empty]. 

FHLBank district: Seattle; 
Level of acceptance of alternative collateral: Some; 
Small business CFI: 2; 
Agricultural CFI: 2; 
Dual-status CFI: [Empty]. 

FHLBank district: Topeka; 
Level of acceptance of alternative collateral: High; 
Small business CFI: 1; 
Agricultural CFI: 1; 
Dual-status CFI: 1. 

FHLBank district: Total; 
Level of acceptance of alternative collateral: [Empty]; 
Small business CFI: 14; 
Agricultural CFI: 13; 
Dual-status CFI: 3. 

Source: GAO. 

[A] While our sample included CFIs from the Boston and New York 
FHLBank districts, no CFIs from these districts agreed to participate 
in our interviews. 

[End of table] 

To obtain information from the CFIs in our sample, we used a Web-based 
protocol to conduct structured telephone interviews. The majority of 
responses, 29, were obtained by telephone; and 1 was obtained by e- 
mail. We used data from FHFA on the use of alternative collateral 
throughout the FHLBank System and information from our interviews with 
the 12 FHLBank representatives to develop our structured interview. We 
pretested the structured interview protocol and made revisions as 
necessary. Questions from the structured interview focused on the 
background and local economies of the CFIs, their use of products and 
services from their local FHLBank, and their views of and experience 
with pledging alternative collateral to obtain an advance from an 
FHLBank. The views expressed by representatives of the CFIs in our 
sample cannot be generalized to the entire population of all CFIs. 

To present details and illustrative examples regarding the information 
obtained from the CFI interviews, we analyzed the narrative (open- 
ended) and closed-ended responses and developed summaries. These 
summaries were then independently reviewed to ensure that original 
statements were accurately characterized. 

To assess the FHFA and FDIC data used in our analyses, we interviewed 
agency officials knowledgeable about the data. In addition, we 
assessed FHFA, FDIC, and SBA's Office of Advocacy data for obvious 
outliers and missing information. To assess the accuracy of the SBA's 
Office of Advocacy and FHFA data, we compared a sample of it against 
public information from the Federal Financial Institutions Examination 
Council's Uniform Bank Performance Report, which is an analytical tool 
created for bank supervisory, examination, and management purposes and 
can be used to understand a bank's financial condition. We determined 
that the data were sufficiently reliable for the purpose of this 
engagement. 

For the second objective, we reviewed FHFA's examination policies and 
procedures and federal internal control standards, as well as a total 
of 23 FHFA and Federal Housing Finance Board (the FHFA predecessor) 
examinations covering each of the 12 FHLBanks over the past three 
examination cycles. We reviewed FHFA's regulation pertaining to the 
development of strategic business plans and we reviewed 11 FHLBanks' 
plans for 2010; and 1 plan submitted for 2009 because it was the most 
recently available for that FHLBank. Additionally, we reviewed FHFA's 
regulation pertaining to the development of Targeted Community Lending 
Plans and we reviewed each of the 12 FHLBanks' plans for 2010. We also 
discussed FHFA's oversight program for alternative collateral with 
senior agency officials. 

Finally, we conducted limited analysis to gain a perspective on the 
level of FHLBank haircuts applied to alternative collateral. To do so, 
we obtained and reviewed documentation of analyses from 3 FHLBanks; 
the other 9 FHLBanks generally did not provide such documentation. 
Confidentiality considerations limited the amount of information we 
could disclose about the analyses from the 3 FHLBanks that provided 
documentation. We also obtained and analyzed data from FDIC on the 
estimated losses from banks that failed or were on the verge of 
failure, by various loan types, for the period January 2009 through 
February 2010. These data were obtained through asset specialists who 
were contracted by FDIC to review the asset portfolios of failed 
institutions and to develop anticipated loss rates, expressed as a 
percentage of outstanding loan balances, on the various categories of 
the banks' asset portfolios. As discussed in this report, this 
approach has several important limitations, including not providing a 
historical basis for estimating the risks associated with alternative 
collateral over time or controlling for any other factors that may be 
related to the characteristics of the loans made by the banks. To 
assess the reliability of the FDIC data, we interviewed agency 
officials knowledgeable about the data. In addition, these data are 
corroborated by information from our CFI interviews and several 
independent reports which suggest that the agricultural sector has 
performed somewhat better than the broader economy in recent years. We 
determined that the data were sufficiently reliable for the purpose of 
this engagement, which was to understand the FHLBanks collateral 
haircuts relative to the recent performance of alternative collateral 
assets in the financial markets. 

We conducted this performance audit from October 2009 to July 2010, in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Comments from the Federal Housing Finance Agency: 

Federal Housing Finance Agency: 
Office of the Director: 
1700 G Street, N.W. 
Washington, D.C. 20552-0003: 
202-414-3800: 
202-414-3823 (fax): 

July 9, 2010: 

Mr. William B. Shear: 
Director: 
Financial Markets and Community Investment: 
Government Accountability Office (GAO): 
441 G Street, NW: 
Washington, DC 20548: 

Dear Mr. Shear: 

Thank you for the opportunity to review and comment on the Government 
Accountability Office (GAO) Report, Federal Housing Finance Agency: 
Oversight of the Federal Home Loan Banks' Agricultural and Small 
Business Collateral Policies Could he Improved. 

During the course of its review, GAO identified steps that the Federal 
Housing Finance Agency (FHFA) should take to assure that the FHLBanks 
are providing Community Financial Institution (CFI) members sufficient 
access to advances through the acceptance of small business, small 
farm, and agricultural loans pledged as alternative collateral 
(hereinafter, "CFI collateral"). In addition, GAO has recommended that 
the FIII,Banks develop effective business and outreach strategies to 
encourage the use of such collateral. FHFA accepts those 
recommendations and will implement them as detailed below. 

To date FHFA has no evidence that any CFI member is collateral 
constrained and unable to access advances as a result of the FHLBanks' 
collateral risk management practices. Nor does FHFA have evidence that 
the issues identified by GAO have resulted in, or contributed to a 
lack of liquidity for small farm, agriculture, and small business 
lending. In many cases, CFI members obtain sufficient liquidity using 
real estate-related collateral for advances. As the GAO has found in 
its review, CFI members value the System as a source of liquidity. 
Their access to liquidity is not limited to the amount of advances 
they can receive by pledging CFI collateral. 

FHFA recognizes that Congress intends for FHLBanks to allow for a 
broader range of eligible collateral for CFI members. At the same 
time, this collateral generally is less liquid and harder to value 
than traditional mortgages and mortgage-backed securities used as 
collateral. Thus, both as a practical business matter and a matter of 
safety and soundness, FHFA generally would expect relatively more 
reliance on mortgage-related collateral than other types of collateral. 

The use of mortgage-related collateral by CFIs may make the data on 
CFI collateral pledged by member institutions difficult to interpret. 
For example, the GAO study is correct in stating that at year-end 2008 
CFI collateral was approximately one percent of total collateral 
directly and specifically pledged to the FHLBanks for advances 
outstanding. However, the FHLBanks have accepted an additional $158 
billion of CFI collateral, constituting more than 11 percent of total 
reported collateral against which future advances could be secured.
The FHFA's detailed responses to the GAO's recommendations are 
discussed below. 

GAO Recommendations for Executive Action: The GAO recommends that the 
Acting Director of FHFA take the following actions: 

* Revise the FHFA examination guidance to include requirements that 
its examiners periodically assess the FHLBanks' alternative collateral 
policies and practices. Specifically, FHFA should 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. 

FHFA Response: The FHFA accepts the intent of the GAO's recommendation 
but notes that the authority and responsibility to periodically review 
the FHLBanks' collateral policies already exists in the FHLBank 
examination manual and related supervisory guidance. The FHFA believes 
a supervisory Advisory Bulletin to the Banks would achieve the end 
sought by the GAO. Commencing with the 2011 annual supervisory 
examination cycle of the FHLBanks, and thereafter as warranted, the 
FHFA will review each FHLBank's policies and practices to assure that 
the FHLBanks arc serving their CFI members' need for advances, and, 
that the FHLBanks can substantiate their collateral acceptance, 
discount and risk management practices. 

* 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. 

FHFA Response: By October 31, 2010, the FHFA will issue an Advisory 
Bulletin providing supervisory guidance to the FHLBanks on the 
preparation of their strategic business plans to include goals for CFI 
collateral commencing with their 2011 strategic business plans. FHFA 
will review the FHLBanks' strategic business plans to ensure they 
include quantitative goals for CFI collateral. 

* 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 pertaining to Targeted Community Development Plans or 
strategic business plans or through other measures as deemed 
appropriate. 

FHFA Response: As previously mentioned, the FHLBanks' market analysis 
and outreach plans will be included in the FHLBanks' strategic 
business plans and each FHLBank's progress will be monitored as part 
of the FHFA's review of the FHLBanks' strategic business plan 
accomplishments. FHFA examiners and analysts will monitor the 
FHLBanks' outreach and CFI collateral needs assessment efforts as part 
of FHFA's ongoing supervisory review, both for safety and soundness 
and for mission fulfillment. 

If you have any questions, please Stephen Cross, Deputy Director 
Division of Bank Regulation at 202-408-2980 or Sylvia Martinez, Senior 
Adviser, at (202) 408-2825. 

Sincerely, 

Signed by: 

Edward J. DeMarco: 
Acting Director: 

xc: Stephen Cross, Chief Operating Officer: 
Paula Hayes, Deputy Chief Operating Officer: 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

William B. Shear, (202) 512-8678 or shearw@gao.gov: 

Staff Acknowledgments: 

In addition to the individual named above, Wesley M. Phillips, 
Assistant Director; Benjamin Bolitzer; Tiffani Humble; Ronald Ito; 
Fred Jimenez; Grant Mallie; Timothy Mooney; Linda Rego; Barbara 
Roesmann; Jerome Sandau; and Rebecca Shea made key contributions to 
this report. 

[End of section] 

Footnotes: 

[1] 12 U.S.C. § 1430(a)(3)(E). CFIs are defined as any FHLBank member 
with deposits insured by the Federal Deposit Insurance Corporation 
(FDIC) and with total assets of up to $1.029 billion, as of January 1, 
2010. 12 U.S.C. § 1422(10); 75 Fed. Reg. 9601 (Mar. 3, 2010). GLBA 
also allows FHLBank members to make greater use of other real estate 
related collateral--such as commercial real estate loans and home 
equity loans--as collateral for FHLBank advances. 

[2] The House Report to H.R. 10, the House bill that preceded GLBA, 
states that the section on collateral for FHLBank advances was 
intended "to give 'community financial institutions' greater access to 
the FHLBank System," and, for the first time, the ability "to obtain 
long-term advances for providing funds for small business, 
agricultural, rural development, or low-income community development 
lending." H.R. Rep. 106-74(I), 127-128 (1999). 

[3] In supplemental remarks, the Chairman and Ranking Member of the 
Subcommittee on Capital Markets, Securities, and Government Sponsored 
Enterprises, House of Representatives Committee on Banking and 
Financial Services, stated that by granting smaller community banks 
greater access to longer-term funding with a broader base of 
collateral for advances, CFIs would then be able to increase the level 
of competition in underserved markets. They also stated that the 
reforms would serve as an integral tool to assist well-capitalized 
community banks, especially community banks in rural areas, inner 
cities, and underserved neighborhoods, to obtain a more stable funding 
source for intermediate-and long-term assets. See H.R. Rep. 106-74(I), 
235 (1999) (statements by Rep. Baker and Rep. Kanjorski). 

[4] Comments made by the Chairman of the House of Representatives, 
Committee on Banking and Financial Services and the Ranking Member of 
the Subcommittee on Capital Markets, Securities, and Government 
Sponsored Enterprises during debate on GLBA stressed the importance of 
the expanded collateral reforms in facilitating the ability of CFIs to 
offer agricultural and small business financing. As a result of the 
reforms, the Ranking Member stated that GLBA would provide a framework 
for CFIs to offer safe, sound, and fully collateralized economic 
development loans, and that he expected the FHLBanks and the Finance 
Board to prioritize the system's economic development efforts. See 145 
Cong. Rec. H11513, H11529, H11544 (1999) (statements of Rep. Leach and 
Rep. Kanjorski). 

[5] 12 C.F.R. § 917.5(a)(3). 

[6] For example, FHFA has reported that while the amount of 
alternative collateral securing advances doubled to $10.1 billion in 
2007, it "remained low at just .8 percent of total collateral." See 
Federal Housing Finance Agency, "Report on Collateral Securing 
Advances at the Federal Home Loan Banks," Prepared for the Committee 
on Banking, Housing, and Urban Affairs of the Senate and the Committee 
on Financial Services of the House of Representatives, January 2009. 

[7] As discussed in this report, the Atlanta and New York FHLBanks 
have not requested approval from FHFA to accept alternative collateral 
and the Cincinnati FHLBank does not report any of its CFI members 
using it to secure advances, as of year-end 2008. 

[8] Specifically, the collateral discount (haircut) levels established 
by some of the 12 FHLBanks are considered proprietary information. 
Therefore, where appropriate we use an alphabetic system to refer to 
individual FHLBanks to protect their identities. 

[9] FDIC defines an agricultural lender as having 25 percent or more 
of its loans in that sector. In a 2009 study, SBA's Office of Advocacy 
identified the largest small business lenders by state, primarily 
based on the percentage of small business loans (defined as loans with 
a value of $1 million or less) in their business loan portfolios. See 
Small Business Administration's Office of Advocacy, Small Business and 
Micro Business Lending in the United States for Data Years 2007-2008, 
(Washington, D.C., May 2009). 

[10] We interviewed 14 CFIs that met the definition of a small 
business lender; 13 CFIs that met the definition of an agricultural 
lender; and 3 that met both definitions. See appendix I for more 
information on our sampling methodology. 

[11] 12 C.F.R. § 931.3(d). 

[12] FHLBank policies vary regarding member and/or collateral 
requirements applicable to each lien type. 

[13] For example, FHLBanks may set limits on the total amount of 
outstanding advances to an individual member. These limits are 
independent of the level of eligible collateral that a member must 
pledge to secure its advances. 

[14] 12 U.S.C. § 1430(i)-(j). 

[15] 12 U.S.C. § 1430(j). Each FHLBank's contribution to AHP must 
currently equal "10 percent of the preceding year's net income, or 
such prorated sums as may be required to assure that the aggregate 
contribution of the Banks shall not be less than $100,000,000 for each 
such year. 12 U.S.C. § 1430(j)(5)(C). 

[16] 12 U.S.C. § 1430(g). Regulations implementing this provision 
require FHLBanks to have a community support program, which must 
include an annual Targeted Community Lending Plan. This plan requires 
the FHLBank to conduct market research in its district, describe how 
it will address identified credit needs and market opportunities for 
targeted community lending, and establish quantitative targeted 
community lending performance goals. 12 C.F.R. § 1290.6. 

[17] Fannie Mae and Freddie Mac are housing GSEs that issue debt in 
the capital markets and use the proceeds to purchase mortgages from 
banks and thrifts to help facilitate liquidity in the U.S. housing and 
mortgage markets. 

[18] On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac in 
conservatorships due to their deteriorating financial condition. As 
conservator, FHFA has full power to control the assets and operations 
of the firms. The Congressional Budget Office estimates that the 
Fannie Mae and Freddie Mac conservatorships could cost the federal 
government nearly $400 billion over the next 10 years. 

[19] The federal funds market refers to the principal monetary policy 
tool of the Board of Governors of the Federal Reserve System (Federal 
Reserve). A goal of the Federal Reserve is to promote open market 
operations by achieving a desired quantity of reserves or desired 
price--the federal funds rate--through the purchase and sale of U.S. 
Treasury and federal agency securities. The federal funds rate is the 
interest rate at which depository institutions lend balances at the 
Federal Reserve to other depository institutions overnight. 

[20] These data are as of September 30, 2009. Because there is no 
established definition of a small business lender, we use SBA's Office 
of Advocacy data as a proxy to identify significant small business 
lenders. SBA's Office of Advocacy defines a small business loan as a 
business loan of $1 million or less and uses a ranking methodology, 
involving four variables, to create a composite score for the lending 
activities of individual lenders, ranking the lenders by state. The 
four variables are (1) ratio of small business loans to total assets, 
(2) ratio of small business loans to total business loans, (3) dollar 
value of small business loans, and (4) number of small business loans. 
According to SBA's Office of Advocacy, small institutions tend to 
score higher in some categories than larger institutions and vice 
versa. For example, smaller lenders have a higher percentage of total 
assets in small business loans, but larger lenders lead in the sheer 
number and value of small loans. SBA's Office of Advocacy states that 
using two ratio variables and two value variables permits a balanced 
measure of lending performance by lenders of different sizes. 

[21] The risk of default can be tied to the advance, the failure of 
the CFI, or both. 

[22] With certain exceptions, FHLBanks generally are entitled under 12 
U.S.C. § 1430(e) to have priority over the claims and rights of any 
party. As discussed in the text, FDIC generally pays off outstanding 
FHLBank advances when a bank or thrift fails and sells the 
institution's assets, including collateral that had been pledged to 
secure the advances, to mitigate losses to the Deposit Insurance Fund. 
See also 12 C.F.R. § 360.2. 

[23] See GAO, Fair Lending: Race and Gender Data Are Limited for 
Nonmortgage Lending, [hyperlink, 
http://www.gao.gov/products/GAO-08-698] (Washington, D.C.: June 27, 
2008). 

[24] During the late 1980s and early 1990s, many banks failed in New 
England and elsewhere due to concentrations in real estate lending. 
See GAO, Bank and Thrift Regulation: Implementation of FDICIA's Prompt 
Regulatory Action Provisions, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-97-18] (Washington, D.C.: Nov. 21, 
1996). The Comptroller of the Currency also testified before Congress 
in October 2009 that declining real estate values caused by rising 
vacancies, falling rental rates, and weak sales have contributed to 
substantial bank losses on commercial real estate loans in recent 
years. Similarly, FDIC Chairman Sheila Bair testified that commercial 
real estate loans would drive bank failures into 2010. See testimonies 
of Sheila Bair, FDIC Chairman, and John C. Dugan, Comptroller of the 
Currency, before the Subcommittee on Financial Institutions, Senate 
Committee on Banking, Housing and Urban Affairs, Examining the State 
of the Banking Industry, 111th Cong., 1st Sess., Oct. 14, 2009. 

[25] Our sample included 30 CFIs that are heavily involved in 
agricultural lending, small business lending, or both. Eleven CFIs in 
our sample were located in the Topeka, Des Moines, and Dallas 
districts--three of the districts with the heaviest usage of 
alternative collateral. These three districts had a combined total of 
2,610 CFI members with $487.6 billion in total assets as of December 
31, 2009. The 11 CFIs in the Topeka, Dallas, and Des Moines districts 
held $2.4 billion in total assets, which represented 0.2 percent of 
the total CFI assets for the three districts combined. 

[26] Of the 11 CFIs that expressed concern about the level of FHLBank 
haircuts for alternative collateral, 5 had pledged alternative 
collateral to obtain an advance and 6 had not. Of the 5 that had 
pledged alternative collateral, all 5 characterized the haircuts 
applied to such collateral as too high. Of the 6 CFIs that had not 
pledged alternative collateral, all characterized the haircuts applied 
to such collateral as too high and all noted that the haircut levels 
for alternative collateral were a factor in their decision not to 
pledge such collateral. 

[27] Two additional CFIs expressed concern about other FHLBank 
policies, such as reporting requirements and compliance costs for 
alternative collateral. These CFIs are included among the 11 CFIs that 
specifically expressed concern about the level of haircuts applied to 
alternative collateral. 

[28] In September 2005, FHFA's predecessor, FHFB, held a conference to 
discuss why some FHLBanks were not using their authority to accept 
alternative collateral and how to make better use of the authority 
within the FHLBanks' primary mission to provide community and economic 
development lending opportunities to local communities. 

[29] We reviewed 23 FHLBank examinations, of which FHFB conducted 7 in 
2007, and FHFA conducted 16 during 2008 and 2009. 

[30] See GAO, Standards for Internal Control in the Federal 
Government, [hyperlink, 
http://www.gao.gov/products/GAO/AIMD-00-21.3.1] (Washington, D.C.: 
November 1999). 

[31] According to FDIC officials, data on estimated losses are 
collected using contractors' proprietary valuation models. Staff from 
FDIC's Division of Resolutions and Receiverships then review the data, 
which are used to help FDIC evaluate bids from prospective acquirers 
in failing bank transactions. 

[32] See Congressional Oversight Panel, Special Report on Farm Loan 
Restructuring (report submitted under Section 501 of Title 5 of the 
Helping Families Save Their Homes Act of 2009, Pub. L. No. 111-22, 123 
Stat. 1632 (2009)) and Federal Reserve Bank of Kansas City, Survey of 
Tenth District Agricultural Credit Conditions, First Quarter 2010, 
accessed at [hyperlink, 
http://www.kansascityfed.org/agcrsurv/agcrmain]. 

[33] GAO is not publicly releasing the specific figures due to their 
potential sensitivity in relation to FDIC's capacity to minimize the 
cost of resolving failing banks. 

[34] FDIC officials noted that most detailed data about failed banks 
are purged every 13 months. 

[35] This regulation was recently relocated by the FHFA as part of the 
FHFA's transfer of the community support regulations from 12 C.F.R 
part 944 to 12 C.F.R. part 1290 and is currently codified at 12 C.F.R. 
§ 1290.6. See 75 Fed. Reg. 678 (January 5, 2010). 

[36] In a 2009 study, SBA's Office of Advocacy identified the largest 
small business lenders by state based, in part, on the percentage of 
small business loans (defined as loans with a value of $1 million or 
less) in their business loan portfolios. See Small Business 
Administration, Office of Advocacy, Small Business and Micro Business 
Lending in the United States for Data Years 2007-2008, (Washington, 
D.C., May 2009). 

[End of section] 

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