On November 7, 2023, the Federal Housing Finance Agency (“FHFA”) released its much-anticipated report “FHLBank System at 100: Focusing on the Future” (the “Report”), containing the results of the FHFA’s year-long comprehensive review of the Federal Home Loan Bank System (“FLHB System”) and a series of proposed regulatory and legislative reforms. Although the FHFA’s review of the FHLB System has received relatively little press attention, the FHFA’s proposed reforms, if adopted, could significantly alter the structure and operation of the FHLB System, and potentially materially change the requirements of being a Federal Home Loan Bank (“FHLBank”) member. This Legal Update provides an overview of the Report and its legislative and regulatory recommendations.
Over the past year, the FHFA has conducted a comprehensive review of the FHLB System that included several public listening sessions, roundtables with thought-leaders and solicitations for written comments. In anticipation of the FHLB System’s upcoming centenary, the FHFA undertook the review to assess what changes may be needed to enable the FHLB System to complete its mission in the years ahead. In the Report, the FHFA states that its “vision for the future is to have an effectively governed [FHLB] System that efficiently provides stable and reliable funding to creditworthy members and delivers innovative products and services to support the housing and community development needs of the communities its members serve, all in a safe and sound manner.” To realize this vision, the FHFA proposes four categories of reforms:
1) Mission of the FHLB System;
2) Stable and reliable source of liquidity;
3) Housing and community development; and
4) FHLB System operational efficiency, structure, and governance.
Appendix A to this Legal Update lists each of the FHFA’s specific statutory and regulatory reform recommendations contained in the Report. The FHFA also indicates that it intends to implement other reforms through the supervisory process or other administrative means, such as the issuance of guidance. The FHFA’s key recommendations are discussed in more detail below.
1. The Mission of the FHLB System
In the Report, the FHFA notes that no specific institutional mission for the FHLB System was provided when the FHLB System was established in 1932. The FHFA contends that a more explicit mission statement is warranted, and states that it intends to develop a statement that expressly incorporates the objectives of:
1) providing liquidity to members, and
2) supporting housing and community development.
Once the FHLB System mission is clarified, the FHFA wants to further incentivize mission compliance by expanding the scope of examinations to which FHLBanks are subject, and by rewarding the institutions that demonstrate commitment to FHLB System mission objectives. Finally, the FHFA plans to broaden the FHLBanks’ reporting obligations to include a more detailed discussion of their district needs and their performance in meeting such needs.
2. Stable and Reliable Liquidity
Recognizing that the FHLB System was established to provide liquidity to members and support the housing market, the FHFA states its intent to enhance the FHLBanks’ ability to meet this core objective. In the Report, the FHFA describes its plans to ensure that FHLBank funding remains low-cost even in times of high demand and to improve the FHLBanks' ability to manage intra-day liquidity to meet member needs, including by restricting debt issuance by a single FHLBank and increasing limits on FHLBanks’ unsecured extensions of credit using deposits held in interest-bearing deposit accounts (IBDAs) to equal the limit on overnight fed funds sales.
However, the FHFA states that it wants to make sure that member commercial banks and thrifts do not turn to the FHLBanks, rather than the Federal Reserve, as lenders of last resort during times of financial distress. Legal and operational limitations constrain the ability of the FHLBanks to play this role. The FHFA states that it intends to work with the Federal Reserve Board and federal banking regulators to facilitate the use of the discount window for institutions in weakened condition, rather than relying on the FHLBanks. In addition, the FHFA will work with its large depository members to ensure that they have agreements in place to borrow from the discount window, and negotiate with the Federal Reserve Banks to facilitate the movement of collateral from FHLBanks to Federal Reserve Banks to support discount window lending.
In the Report, the FHFA also describes its plans to require the FHLBanks to engage in more intensive risk management of their members to mitigate the safety and soundness risk that can arise from a member’s poor financial performance. To that end, the FHFA seeks to enhance its oversight of each FHLBank’s credit risk evaluation of its members, tighten limits on a member’s ability to access advances without sufficient capital, and reassess prepayment penalties that can exacerbate the costs of member failure. The FHFA also intends to increase its scrutiny of FHLBanks’ own capital management practices by reviewing each FHLBank’s retained earnings policies, and by imposing annual stress testing assessment and disclosure requirements. Finally, the FHFA outlines its plan to require FHLBanks to incorporate climate resiliency efforts into their core business and housing programs to account for higher insurance costs and risk to collateral stemming from climate change.
3. Housing and Community Development
A recurring theme throughout the Report is the strengthening of the FHLB System’s role as a facilitator of affordable housing and community development. The FHFA states that it wants to take additional steps to ensure that collateral securing FHLBank advances furthers this objective. To do so, the FHFA intends to find ways to bring more non-depository community development financial institutions (CDFIs) into FHLBank programs. The FHFA also wants the FHLBanks to establish “mission-oriented” collateral programs, and seeks to support this initiative by allowing all CDFI and credit union members to pledge Community Financial Institution (CFI) collateral to secure FHLBank advances (a benefit currently only available to FDIC-insured depository institutions). CFI collateral includes small business loans, small farm loans, small agri-business loans, community development loans, and certain related securities. The FHFA takes the view that permitting CDFI and credit union members, which would qualify as CFIs were their deposits FDIC-insured, to pledge CFI collateral would help these institutions support the FHLB System’s housing and community development goals. In the Report, the FHFA states its intent to study whether FHLBank advances should be more strictly tied to uses of funds that advance FHLB System mission objectives. The FHFA notes its interest in potentially broadening the definition of a “long-term” advance, which would require a greater proportion of FHLBank advances to be tied to FHLB System mission objectives.
In the Report, the FHFA also calls for increasing (both on a voluntary basis and through congressional action) the minimum statutory funding for the Affordable Housing Program (AHP) from the current 10% of each FHLBank’s yearly net earnings, and expanding the use of Community Investment Programs and Community Investment Cash Advance programs by members. The FHFA also states that it intends to expand access to AHP programs—potentially by updating AHP regulatory provisions for revolving loan funds, assessing options for area median income (AMI) flexibility in high-cost areas, increasing per-household homeownership set-aside grants in high-cost areas, and revising certain project compliance and monitoring requirements to increase programmatic efficiency. The FHFA also seeks to enhance the scope of the Targeted Community Lending Plan. Finally, the FHFA states that it wants to look at ways to increase support for pilot programs to address district needs, to increase multifamily housing support and support for first-time homebuyers, to enhance requirements for member financing in their own communities, and to expand the FHLBanks’ mortgage loan purchasing activities in minority census tracts.
4. FHLB System Efficiency, Structure, and Governance
The FHFA proposes a series of reforms to the operations of the FHLB System. The FHFA states that FHLB System membership requirements should be strengthened and harmonized, such as by requiring members to demonstrate an ongoing commitment to mission objectives and by taking a more stringent approach to members’ compliance with membership requirements.
Probably most importantly, the FHFA intends to require members to have at least 10% of their assets in residential mortgage loans or equivalent mission assets on an ongoing basis, rather than only at the time of application. The FHFA also discusses potential changes to FHLBank membership requirements, including the possibility of extending membership to additional entity types (as long as they are subject to existing membership requirements) such as nonbank mortgage companies and mortgage real estate investment trusts (REITs). The FHFA acknowledges that stakeholders have increasingly asked for the inclusion of these institutions within the FHLB System, but states that this reform would require a statutory change. If Congress were to amend the membership eligibility requirements, the FHFA recommends that any newly eligible entities be subject to the generally applicable membership requirements to ensure safety and soundness and mission orientation, including (1) inspection and regulation, (2) community support or service requirements, and (3) the requirement that 10% of their assets be in residential mortgage loans or an equivalent mission asset or activity requirement. The FHFA will also issue guidance aimed at achieving parity between members that have access to multiple FHLBanks and those with access only to one FHLBank.
The FHFA also states that it plans to review the number of FHLBanks and the distribution of members among them, observing that members are unevenly distributed among the 11 existing FHLBanks, which are themselves unevenly distributed across the US states. While the FHFA raises the possibility of reorganizing districts and consolidating FHLBanks, it acknowledges that the number of FHLBanks is required by statute to be between 8 and 12.
Finally, the FHFA discusses whether there is a need to change expectations with respect to an FHLBank’s board size, composition, and executive compensation. The FHFA notes that the statutory “grandfather provision” can result in imbalances in representation between states. The FHFA contends that board composition could benefit from increased diversity of experience, skills, and technical subject matter expertise. The FHFA also states that it will recommend that Congress pass legislation to grant the FHFA more authority over the setting of FHLBank executive compensation. Further, the FHFA states that it will seek to clarify each FHLBank board’s duty to more closely tie executive compensation with FHLB System mission objectives.
The Report signals the initiation of a significant effort by the FHFA to reform the FHLB System. For most FHLBank members, the most consequential reforms are likely to be any changes to the requirements to obtain FHLBank advances and FHLBank membership requirements. In addition, the proposed changes in FHLBank lending to distressed banks, if adopted, could limit FHLBank members’ access to FHLBank advances when they are most in need. To the extent that the Federal Reserve’s discount window lending does not provide a perfect substitute for the loss of access to FHLBank advances, members could find themselves with less access to liquidity during times of financial distress. Conversely, new limits on FHLBank advances to distressed banks could finally cause a revival in the use of the discount window, which banks have been reluctant to borrow from due to a perceived stigma associated with its use.
Although the most consequential reforms will require statutory changes that are unlikely to pass during the remainder of the current term of Congress, the FHFA could be well-positioned to secure legislation in the next Congress depending on the results of the 2024 elections. In the near term, the FHFA is now expected to issue rulemakings to implement the proposals that do not require statutory changes. Accordingly, FHLBank members should be prepared for a series of rulemakings by the FHFA over the course of the next year. The FHFA’s statutory and regulatory recommendations are listed below in Appendix A. Because the FHFA expressly states its intent to also adopt certain reforms through the supervisory process, FHLBanks should expect more stringent supervisory actions from the FHFA. The Report is just the beginning of what is likely to be a long reform process of the FHLB System.
Appendix A: List of Specific Statutory and Regulatory Proposals1
- Amend the Federal Home Loan Bank Act (Bank Act) to require each FHLBank to at least double its contributions to its AHP.
- After study, potentially amend the Bank Act to lower the minimum number of FHLBanks to a number below eight.
- After study, potentially remove statutory “grandfather provision” requiring the FHFA to allocate to each state in each FHLBank district at least as many member directorships as the state held in 1960.
- Amend the Federal Housing Financial Safety and Soundness Act of 1992 to eliminate the restrictions on the FHFA’s authority to prescribe levels or ranges for the compensation of executive officers of the FHLBanks.
- Amend the Bank Act to authorize all CDFI and credit union members with assets below the statutory cap to pledge CFI collateral to secure FHLBank advances.
- As necessary, recommend that Congress amend the Bank Act to provide the flexibility to permit individuals with technical subject matter expertise to serve on FHLBank boards, even if they do not reside in the district as is currently required, in order to help attract directors with specialized knowledge and skills.
- If Congress expands FHLBank membership to entities that are currently ineligible under existing law, such as nonbank mortgage companies or mortgage REITs, subject such entities to membership requirements that currently apply to most members, including: (1) inspection and regulation, (2) community support or service requirements, and (3) the requirement that 10% of their assets be in residential mortgage loans or an equivalent mission asset or activity requirement.
- Revise and clarify the FHLB System mission statement and set forth criteria for assessing mission achievement.
- Enhance the scope of the Targeted Community Lending Plan by amending the requirements contained in the regulation governing Community Support Requirements (CSR).
- Implement a meaningful framework that recognizes members with a strong and demonstrable commitment to the mission of the FHLB System.
- Require the FHLBanks to publish more comprehensive annual reports on their affordable housing and community development activities that include evaluation of outcomes and assessments of program effectiveness.
- Amend limits on unsecured extensions of credit to provide deposits held in interest-bearing deposit accounts (IBDAs) at highly-rated banks with the higher limit that currently applies only to overnight fed funds.
- Amend the advances regulation to make the FHLBank, or the FHLBank System, responsible for prepayment fees due from a failed member on long-term advances provided shortly before the member fails and without consultation with the primary federal regulator.
- Require certain stress testing protocols for the FHLBanks, and adjust the scenarios published by the Federal Reserve, as warranted, to reflect the risks present in the FHLB System, which may differ in some ways from the risks faced by financial institutions that are subject to stress testing under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
- Provide more transparency on collateral pledged by FHLBank members, including with respect to the amount and types of Mission-Oriented Collateral (MOC) pledged to incentivize the use of collateral with a strong connection to the mission of the FHLB System.
- Revise the definition of a long-term advance in the Advances and Community Support Requirements (CSR) regulation to promote use of FHLBank advances for purposes consistent with the mission of the FHLB System.
- Amend the Community Investment Cash Advance (CICA) regulation to promote increased use of the Community Investment Programs (CIP) and CICA programs and enhance the FHLBanks’ ability to respond to an evolving economic landscape.
- Enhance community support standards set out in the CSR regulation, potentially to require more detail from members about their lending or activities to support first-time homebuyers, and establishing additional standards that demonstrate support for multifamily housing or community development.
- Expand affordable housing goal categories for Acquired Member Asset (AMA) purchases that support housing finance in minority census tracts.
- Require that certain members have at least 10% of their assets in residential mortgage loans or equivalent mission assets (including assets that qualify as CFI collateral where appropriate) on an ongoing basis to remain eligible for FHLBank financing.
- Strengthen and harmonize implementation of membership requirements and ensure that members continue to support the FHLBank mission. Possible amendments to FHLBank membership regulation could include requiring that all applicants for membership demonstrate a measurable and ongoing commitment to housing finance, standardizing the financial documents that each type of entity must submit as part of a membership application, and strengthening the standards by which compliance with certain membership requirements is assessed.
- Amend the AHP regulation to streamline certain requirements and expand access to AHP programs, potentially including updating AHP regulatory provisions for revolving loan funds, assessing options for area median income (AMI) flexibility in high-cost areas, increasing per-household homeownership set-aside grants in high-cost areas, and revising certain project compliance and monitoring requirements to increase programmatic efficiency.