On August 31, 2022, the Federal Housing Finance Agency (FHFA) announcement that it would conduct a comprehensive review of the Federal Home Loan Bank (FHLB) system. This article discusses two legal issues relevant to the review:
- The FHFA’s statutory authority to reduce the number of federal home loan banks, and
- The application of FHLBank’s statutory “super privilege”
FHFA’s power to reduce the number of federal mortgage banks
The Federal Home Loan Bank Act establishes a maximum number of 12 Federal Home Loan Bank districts and expects there to be no less than eight districts. There are nuances to reducing the number of FHLBanks to less than eight, but the maximum number is fixed.
The most recent example of a decline in districts to ll resulted from the 2015-2016 merger of Seattle and Des Moines institutions into a Des Moines District Bank. This transaction was not motivated by a desire to reduce the number of FHLBanks, but rather by security and soundness concerns.
Seattle Bank’s membership had shrunk, its capital base had eroded to an undercapitalized level, and the need for nearly six years of heightened oversight led to a consent decision to undertake the merger.
The FHLB Act provides that the FHFA Director may make “adjustments” to districts by altering the states that are in a particular district, and that the Director may create new districts, so long as there are none. no more than 12.
The law also provides that the Director may reduce the number of districts to less than eight pursuant to a voluntary merger or liquidation of an FHLBank under the trusteeship and receivership powers of the FHFA. In other words, reducing the number of districts below eight does not seem justifiable solely for reasons of efficiency or economy.
Reducing the number or districts below eight must be based on a voluntary merger of the FHLBanks or the existence of a very troubled FHLBank that requires prompt corrective action.
The FHLB Act also permits the Director of the FHFA to conclude that “the efficient and economical achievement of the objectives of [the Act] shall be aided” by action under the regulations promulgated to liquidate or reorganize one FHLBank and another FHLBank may acquire its assets.
This provision may be challenged by the relevant FHLBank in legal proceedings. The provision appears to require a conclusion related to the safety and soundness of FHLBank, and not based on general authority to eliminate a district.
In summary, the FHFA Director has the statutory authority to reduce the number of districts from the current 11 to eight or even fewer. However, the reduction from 12 to 11 was based on safety and solidity considerations, and any reduction below eight must be based on a voluntary meltdown or a significant safety and solidity issue.
The application of the FHLBanks statutory super privilege
The basic purpose of the Federal Home Loan Bank System is housing finance. FHLBanks achieve this goal by providing low-cost loans (advances) to member institutions. When the FHLB Act was passed in 1932, membership was limited to mortgage lenders (e.g., savings and loan associations, thrifts, and cooperative banks) and insurance companies.
It was not until 1989 that Congress expanded membership to all federally insured depository institutions. In 2008, membership was again expanded by Congress to include Community Development Financial Institutions (CDFIs) and finally, in 2015, to include non-federally insured credit unions.
In expanding the membership categories, Congress was aware that the FHLBanks were created to serve an important public policy purpose and that their safe and sound operation should not be compromised by including members who are not subject to appropriate state or federal oversight. Thus, all members must be in the mortgage origination industry and are generally required to meet minimum mortgage asset requirements.
In addition, advances must be fully secured by one or more specific types of collateral, including residential mortgages and residential mortgage-backed securities, but other collateral includes government securities, cash, other real estate collateral and, in some cases, small secured collateral. business, agricultural or community development loans, or securities backed by such loans.
In most cases, members must use proceeds from long-term advances (i.e. advances with an original term to maturity of more than five years) to fund residential housing finance . However, smaller FDIC-insured member institutions are permitted to obtain long-term advances to fund small business and community development activities. Short-term advances are not so limited.
When a member institution becomes a member of an FHLBank, it can sign an “advances and guarantees” agreement which establishes a general lien covering all eligible guarantees. FHLBank may make advances up to a specified percentage of the value of the collateral.
In 1987, at the height of the savings and loan crisis, Congress amended the FHLB Act so that any security interest given by a member to an FHLBank would have priority over the claims of any other unsecured party, including a custodian or receiver, such as the FDIC, in the case of an insured depository institution, or the NCUA, in the case of a federally insured credit union. This provision is commonly referred to as a “super privilege”.
This super privilege is often cited as one of the reasons why no FHLBank has ever suffered a credit loss on an advance, and it is considered a key factor in its AAA credit rating. This reduces the cost of their funds and the savings are passed on to members in the form of lower interest charges on advances.
Some have argued that the super lien is less important in light of changes to the Uniform Commercial Code that make it easier for creditors to perfect security interests in mortgage-related assets.
The FDIC argued that the super lien makes it more costly for it to resolve failing depository institutions since FHLBank must be paid in full (including prepayment penalties) before releasing its super-collateralized interest. Concerns have also been raised that the super lien could reduce incentives for FHLBanks to underwrite and carefully monitor their advances and that the super lien insulates FHLBanks from market discipline.
Finally, since FHLBanks are generally over-collateralized, the protection afforded by the super lien may make it more expensive for members to obtain private funding sources. Unsecured funding encourages institutions to operate in a safe and sound manner (eg, imposes market discipline).
Although the super privilege applies to all “members” of a federal mortgage bank, some wonder if it can apply to members of the insurance company in light of the McCarran-Ferguson Act. . This statute provides that state law generally governs the regulation of insurance and shall not be preempted by federal law unless federal law expressly regulates insurance business.
Thus, if there is a conflict between the super lien and the state insurance law, it is unclear which legal system will prevail.
Additionally, CDFIs do not have a dedicated escrow, and if a CDFI defaults, FHLBank would have to seize and sell the collateral in order to recover its loan, adding time and uncertainty to the process of recovery. As a result, FHLBanks have set higher collateral requirements for advances to CDFIs.
When Congress allowed non-federally insured credit unions to become members of a federal mortgage bank in 2015, it expressly preempted state laws that would otherwise allow a custodian or receiver of a credit union to repudiate contracts relating to an FHLBank advance or security. held by an FHLBank as security for an advance.
The 2015 amendment also specified that an FHLBank would have the same priority and rights as if the advance had been made to a federally insured credit union.
If the proposed exam of the Federal Home Loan Bank System results in a recommendation to Congress to expand membership opportunities, it is essential that the recommendation take into account both the public policy objectives of the FHLBanks and the need to ensure their safe and secure operation. continued.
This should include careful consideration of whether to extend FHLBanks’ super privilege to noncustodial institutions, and whether changes need to be made, as has been done in the case of non-federally insured credit unions. This should include a solicitation of public comment regarding the current super privilege, whether it should continue in its current form, and if and how it should apply to any new categories of members.
Raymond Natter is a former Deputy Chief Counsel for the Office of the Comptroller of the Currency. He is a partner at the law firm Sivon, Natter & Wechsler, PC, in Washington, DC, and acts as counsel to the international law firm Squire Patton Boggs (US) LLP.
Alfred Pollard is a former FHFA Chief Counsel. He is an attorney with the law firm Sivon, Natter & Wechsler, PC in Washington, DC, and of counsel with the international law firm Squire Patton Boggs (US) LLP.
This column does not necessarily reflect the opinion of the editorial staff of HousingWire and its owners.
To contact the authors of this story:
Raymond Natter at [email protected]
Alfred Pollard at [email protected]
To contact the editor responsible for this story:
Sarah Wheeler at [email protected]