[Federal Register Volume 64, Number 65 (Tuesday, April 6, 1999)]
[Rules and Regulations]
[Pages 16788-16791]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-8357]
[[Page 16787]]
_______________________________________________________________________
Part II
Federal Housing Finance Board
_______________________________________________________________________
12 CFR Parts 935, et al.
Prohibition on Payment Fee in Lieu of Mandatory Excess Capital Stock
Redemption; Final Rule
Mandatory Excess Capital Stock Redemption; Prohibited Stock Dividends;
Proposed Rule
Federal Register / Vol. 64, No. 65 / Tuesday, April 6, 1999 / Rules
and Regulations
[[Page 16788]]
FEDERAL HOUSING FINANCE BOARD
12 CFR Part 935
[No. 99-21]
RIN 3069-AA83
Prohibition on Payment of Fee In Lieu of Mandatory Excess Capital
Stock Redemption
AGENCY: Federal Housing Finance Board.
ACTION: Interim final rule.
-----------------------------------------------------------------------
SUMMARY: The Federal Housing Finance Board (Finance Board) is amending
its regulation governing Federal Home Loan Bank (Bank) advances to
prohibit the Banks from imposing or accepting a fee in lieu of
redeeming a member's excess capital stock held in the Bank. The Finance
Board has determined that allowing the payment of such fees would
detract from the agency's ongoing efforts and initiatives to ensure
that the Banks carry out their housing finance and community investment
mission.
EFFECTIVE DATE: This interim final rule shall be effective on April 6,
1999. The Finance Board will accept written comments on this interim
final rule on or before May 6, 1999.
FOR FURTHER INFORMATION CONTACT: Joseph A. McKenzie, Deputy Chief
Economist, (202) 408-2845, Office of Policy, Research and Analysis; or
Sharon B. Like, Senior Attorney-Advisor, (202) 408-2930, or Jane S.
Converse, Senior Attorney-Advisor, (202) 408-2976, Office of General
Counsel, Federal Housing Finance Board, 1777 F Street, N.W.,
Washington, D.C. 20006.
SUPPLEMENTARY INFORMATION:
I. Statutory and Regulatory Background
A. The Banks' Housing Finance and Community Investment Mission
The Federal Home Loan Bank System (Bank System) is comprised of 12
District Banks that are federally chartered and managed by boards of
directors that set policies pursuant to regulations established by the
Finance Board. As government-sponsored enterprises (GSEs), the Banks
act as intermediaries in the capital markets, raising funds on
favorable terms and passing the proceeds on to member institutions in
the form of advances (loans).
Under section 10(a) of the Federal Home Loan Bank Act (Bank Act)
and part 935 of the Finance Board's regulations, the Banks have broad
authority to make advances in support of housing finance, which
includes community investment finance. See 12 U.S.C. 1430(a), (i), (j);
12 CFR part 935. The Banks also are required to offer two programs, the
Affordable Housing Program (AHP) and the Community Investment Program
(CIP), to provide subsidized or at-cost advances, respectively, in
support of unmet housing finance or economic development credit needs.
See 12 U.S.C. 1430(i), (j); 12 CFR parts 960, 970. In addition, section
10(j)(10) of the Bank Act, as implemented by a recently issued Finance
Board regulation, authorizes the Banks to establish Community
Investment Cash Advance (CICA) Programs for community lending, defined
as providing financing for economic development projects for targeted
beneficiaries. See 12 U.S.C. 1430(j)(10); 63 FR 65536 (Nov. 27, 1998).
The Bank Act provides that the Finance Board's primary duty is to
ensure that the Banks operate in a financially safe and sound manner.
See id. section 1422a(a)(3)(A). The Bank Act further provides that, to
the extent consistent with this primary duty, the Finance Board also is
responsible for supervising the Banks, ensuring that the Banks carry
out their housing finance mission, and ensuring that the Banks remain
adequately capitalized and able to raise funds in the capital markets.
See id. section 1422a(a)(3)(B).
B. Statutory and Regulatory Minimum Capital Stock, Dividend and
Redemption Provisions
Under the Bank Act and implementing Finance Board regulations, a
member's required minimum capital stock investment in its Bank is the
greater of: (1) 1 percent of the member's aggregate unpaid loan
principal (defined as the member's home mortgage loans, home purchase
contracts, and similar obligations) but not less than $500; (2) 0.3
percent of the member's total assets; or (3) 5 percent of total
advances outstanding to the member. In the case of members that are not
``qualified thrift lenders'' (QTLs), the third option is computed as 5
percent of total advances outstanding to the member divided by the
member's ``actual thrift investment percentage'' (as defined in 12
U.S.C. 1467a(m)). See 12 U.S.C. 1426(b)(1), (2), (4); 1430(c), (e)(1),
(3); 12 CFR 933.20(a).
Section 6(b)(1) further provides that the Bank shall annually
adjust, at such time and in such manner as the Finance Board may by
regulations or otherwise prescribe, the amount of capital stock held by
each member so that such member shall have invested its minimum capital
stock requirement. See id. section 1426(b)(1); 12 CFR 933.22(b)(1).
Section 6(b)(1) also provides that if the Bank finds that the
investment of any member in capital stock is greater than that required
under section 6(b), the Bank may, unless prohibited by the Finance
Board, in its discretion and upon application of the member, retire the
capital stock of such member in excess of the amount so required. See
id. section 1426(b)(1); 12 CFR 933.22(b)(2).
Section 16(a) of the Bank Act provides, among other things, that
dividends may be paid by the Banks with the approval of the Finance
Board. See 12 U.S.C. 1436(a). Section 6(g) of the Bank Act provides
that all stock of any Bank shall share in dividend distributions
without preference. See id. section 1426(g). Section 934.17 of the
Finance Board's regulations on the operations of the Banks implements
these provisions by providing, among other things, that dividends may
be paid by the Banks in cash or in the form of stock. See 12 CFR 932.3;
63 FR 65683, 65687 (Nov. 30, 1998) (redesignating Sec. 932.3 as
Sec. 934.17).
Section 935.15(b) of the Finance Board's Advances Regulation
provides that ``[a] Bank, after providing 15 calendar days advance
written notice to a member, may unilaterally redeem that amount of the
member's Bank stock that exceeds'' the member's minimum statutory and
regulatory capital stock requirements. See 12 CFR 935.15(b). Section
935.15(b) further provides that the Bank shall have discretion to
determine the timing of such unilateral redemption, provided that the
Bank's redemption policy is consistent with the requirement in section
7(j) of the Bank Act that the affairs of the Bank shall be administered
fairly and impartially and without discrimination in favor of or
against member borrowers, see 12 U.S.C. section 1427(j).
The Bank Act and Sec. 935.15(b) of the Advances regulation are
silent on whether a Bank, in administering its mandatory redemption
policy, may impose on or accept from a member a fee in lieu of
redeeming the member's excess Bank capital stock.
II. Analysis of the Interim Final Rule
A. Proposed Fee In Lieu of Mandatory Excess Capital Stock Redemption
A Bank has adopted a policy, effective March 31, 1999, pursuant to
which the Bank generally will redeem that amount of each member's
capital stock exceeding 115 percent of the member's minimum statutory
capital stock requirement, with an option, if lawful and appropriate,
for the member to pay
[[Page 16789]]
a fee to the Bank in lieu of such redemption. The Bank has requested
confirmation from the Finance Board that the proposed fee would be
authorized under the Bank Act and Finance Board regulations.
As noted above, the Bank Act and Sec. 935.15(b) of the Finance
Board's Advances regulation are silent on whether a Bank may impose on
or accept from a member a fee in lieu of redeeming the member's excess
Bank capital stock. Even though the Bank Act is susceptible to an
interpretation that the payment of such fees would be authorized under
law, the Finance Board has determined that allowing the payment of such
fees would detract from the agency's ongoing efforts and initiatives to
ensure that the Banks carry out their housing finance and community
investment mission, as discussed below. Therefore, the Finance Board is
adopting this interim final rule prohibiting the payment of such fees.
Although this interim final rule will become effective on the date of
publication in the Federal Register, the Finance Board requests comment
on all aspects of the rule during a 30-day comment period.
According to the Bank, the purpose of the Bank's proposed
redemption policy is to enhance the Bank's competitiveness vis a vis
other Banks by increasing its earnings per share and therefore its
dividend rate. The Bank forecasts that mandatory redemption of surplus
capital stock or payment of the fee in lieu of redemption would add
approximately 12 basis points to the Bank's quarterly dividend. The
Bank has a number of large members owned by holding companies that also
have subsidiaries located in other Bank districts. The Bank is
concerned that these members may discontinue borrowing from the Bank
and that their affiliates will become members and borrow from these
other Banks because those Banks pay higher dividend rates than the
Bank.
Under the Bank's proposed policy, the Bank would unilaterally
redeem ``surplus'' capital stock (defined by the Bank as capital stock
in excess of 115 percent of minimum capital stock requirements but not
less than $100,000) held by all members, unless the member pays a fee
to the Bank, on a monthly basis, to continue holding its surplus
capital stock. The 115 percent threshold was adopted to allow
membership flexibility for future borrowings from the Bank and absorb
the stock dividends. The $100,000 minimum was adopted in order to
reduce the operational impact of the redemption policy on smaller
members. The Bank states that the fee, which is 1.65 percent of the
value of a member's surplus capital stock, was designed to make the
Bank financially indifferent to a member's decision to continue to hold
surplus capital stock. The fee income paid to the Bank would act as an
offset to the dividend dilution caused by those members holding surplus
capital stock.
As of August 31, 1998, the Bank had excess capital stock of $554
million, or 14 percent of its total capital of $3.9 billion. The Bank's
total ``surplus'' capital stock, as of August 31, 1998, was $312
million. One mandatory thrift member held 70 percent of the Bank's
total surplus capital stock as of that date. The Bank has excess
capital stock, in part, because it pays members quarterly stock
dividends rather than cash dividends. The Bank has indicated that
paying a stock dividend rather than a cash dividend provides tax
benefits for its members, and the Bank intends to continue paying stock
dividends for this reason.
B. The Banks Are Significantly Overcapitalized
By many standards, the 12 Banks are significantly overcapitalized.
As of December 31, 1998, the 12 Banks had total capital stock of $22.8
billion, with $2.8 billion, or 12.6 percent, of this amount
constituting capital stock in excess of the Banks' statutory minimum
capital stock requirements. On a risk-adjusted basis (using the current
risk-based standards applicable to federally regulated depositories),
the total capital is estimated at 22 percent of the Banks' total
assets, a level far above that of large commercial banks and other
housing GSEs.\1\ The highest percentage of excess capital stock to
total capital stock at a Bank was 30.1 percent, and the lowest was 1.2
percent.
---------------------------------------------------------------------------
\1\ A depository institution generally is deemed to be ``well-
capitalized'' if it has a total risk-based capital ratio of 10
percent or greater, a Tier 1 risk-based capital ratio of 6 percent
or greater, and a leverage ratio of 5 percent or greater. See 12 CFR
6.4(b)(1), 208.33(b)(1), 325.103(b)(1), 565.4(b)(1). The minimum
capital requirement for the other housing GSEs--the Federal National
Mortgage Association and the Federal Home Loan Mortgage
Corporation--generally is 2.5 percent of on-balance sheet assets
plus .45 percent of off-balance sheet obligations. See 12 U.S.C.
4612(a).
---------------------------------------------------------------------------
Even without excess capital stock in the Bank System, i.e., capital
stock at only the statutorily required minimum stock levels, the Banks
would be significantly overcapitalized. A redemption of all excess
capital stock in the Bank System would reduce the Banks' risk-based
capital ratio to approximately 19.2 percent.
Members have excess capital stock holdings, in part, because they
receive stock dividends from the Banks. Currently, five Banks pay stock
dividends, and seven Banks pay cash dividends. The Internal Revenue
Service has ruled that the issuance of stock dividends by the Banks is
not taxable income for members. See IRS Rev. Rul. 90-98, November 26,
1990, 1990-48-I.R.B.4, 26 CFR 1.305-2. However, cash dividends and
redemptions of stock received as dividends generally are taxable income
to members. See 26 U.S.C. 301(c), 302(a). Because of the deferred tax
liability associated with stock dividends, many members may have
allowed their stock dividends to accumulate rather than request
redemption of their capital stock, as is their option under the Bank
Act. See 12 U.S.C. 1426(b)(1).
The members' holdings of excess capital stock are concentrated,
with the largest holder of excess capital stock having 9 percent of the
Bank System's total excess capital stock. The top five holders of
excess capital stock represent 19 percent of the Bank System's total
excess capital stock.
Excess capital stock holdings also arise where members' total
assets, home mortgage loans or outstanding advances have decreased
since their last capital stock purchases, or where members have changed
to QTL status, thereby reducing their advances-based capital stock
requirement. Members may continue to hold some excess capital stock in
order to minimize the transaction costs associated with capital stock
purchases that would be required if the member's levels of total
assets, home mortgage loans or outstanding advances fluctuate.
C. The Banks' Arbitrage Activities With Non-Core Mission Assets Detract
From the Mission of the Banks To Promote Housing Finance and Community
Investment
The Banks pay dividends on all capital stock, including excess
capital stock. Since the average Bank System dividend rate of 6.64
percent exceeds the rate of return a Bank can earn by investing
members' capital in core mission assets, a Bank must leverage its
excess capital stock to pay dividends. The leveraging cannot involve
advances, since they are already capitalized by required capital stock.
Thus, the Banks must leverage excess capital stock by investing in non-
core mission assets in order to generate sufficient earnings to pay a
uniform dividend on all capital stock, including the excess capital
stock.
There is a strong correlation between the amount of excess capital
stock at a Bank and the level of that Bank's non-
[[Page 16790]]
core mission assets. In demonstrating the correlation between excess
capital stock and non-mission-related assets, the Finance Board looked
at the concept of ``core mission assets,'' defined as Bank advances,
which include AHP advances and subsidies, CIP advances, community
lending advances, Mortgage Partnership Finance assets, and other assets
generated for the Banks by members and nonmember borrowers. Core
mission assets do not include mortgage-backed securities (MBS) and
money market instruments, which are not generated for the Banks by
members or nonmember borrowers and their purchase by the Banks does not
materially facilitate housing and community lending by members or
nonmember borrowers. As demonstrated in the following table, the Banks
with the highest levels of excess capital stock also have the lowest
ratios of core mission assets to consolidated obligations:
Excess Capital Stock and Core Mission Assets
----------------------------------------------------------------------------------------------------------------
Core mission
assets to Excess capital
Bank consolidated Descending stock to total Rank
obligations rank capital stock
(%) (%)
----------------------------------------------------------------------------------------------------------------
A............................................... 86.5 1 10.4 7
B............................................... 85.1 2 1.0 1
C............................................... 81.8 3 10.2 6
D............................................... 81.3 4 4.2 2
E............................................... 80.7 5 3.0 3
F............................................... 79.7 6 7.8 4
G............................................... 70.5 7 9.3 5
H............................................... 69.4 8 17.1 10
I............................................... 65.4 9 26.8 11
J............................................... 63.8 10 15.2 8
K............................................... 59.9 11 30.1 12
L............................................... 58.6 12 16.2 9
Bank System..................................... 75.8 .............. 12.6 ..............
----------------------------------------------------------------------------------------------------------------
Approximately 75.8 percent of total Bank System consolidated
obligations are invested in core mission assets.
The four Banks with the highest ratios of core mission assets to
consolidated obligations had ratios of excess capital stock to total
capital stock of 10.4 percent, 1.2 percent, 10.4 percent, and 4.2
percent. The five Banks with the lowest ratios of core mission assets
to consolidated obligations had the highest ratios of excess capital
stock to total capital stock. Of these five, three pay stock dividends,
and one pays the highest dividend in the Bank System. At present, core
mission assets are no more than 86.5 percent of consolidated
obligations at any Bank.
The Finance Board believes that the Banks' arbitrage activities for
the purpose of generating sufficient earnings to pay adequate dividends
on excess capital stock detract from the mission of the Banks to
promote housing finance and community investment, by encouraging
activities not related to the Banks' mission and thereby detracting
from the financial incentive to engage in mission-related activity.
While the Banks' interest in paying a reasonable dividend to members is
a legitimate business consideration, and it is appropriate to redeem
excess capital stock to assist in this purpose, allowing members to pay
a fee in lieu of such mandatory redemption would perpetuate excess
capital stock at the Banks and the Banks' continued need to invest in
non-core mission assets to pay dividends on such excess stock.
D. Amendment of Advances Regulation To Prohibit Payment of Fee In Lieu
of Mandatory Excess Capital Stock Redemption--Sec. 935.15(b)
For the reasons discussed above, this interim final rule amends
Sec. 935.15(b) of the Finance Board's Advances regulation to prohibit
the Banks from imposing on or accepting from a member a fee in lieu of
mandatory redemption of the member's excess capital stock.
Specifically, the interim final rule adds a new paragraph (b)(2) which
provides that: ``A Bank may not impose on or accept from a member a fee
in lieu of redeeming the member's excess Bank capital stock.''
In addition, the second sentence of current Sec. 935.15(b), which
is redesignated as paragraph (b)(1), is revised to clarify that the
Bank's implementation of its redemption policy, and not just the timing
of redemptions, shall be consistent with the requirement of section
7(j) of the Bank Act (12 U.S.C. 1427(j)) that the affairs of the Bank
shall be administered fairly and impartially and without discrimination
in favor of or against any member borrower.
This action is taken as an interim final rule, effective on the
date of publication in the Federal Register, because the Bank's
proposed fee policy is intended to be effective on March 31, 1999.
III. Issues For Consideration
Reducing Levels of Excess Capital Stock by Prohibiting Payment of Stock
Dividends and Requiring Unilateral Redemption of Excess Capital Stock
The Finance Board believes that the Banks' levels of excess capital
stock should be significantly reduced. As discussed above, the Banks
are substantially overcapitalized and, thus, reduction in the amount of
their excess capital would not adversely affect the safety and
soundness of the Banks. The statutory minimum capital stock
requirements guarantee that a Bank's capital stock will grow as the
scope of its operations increases.
As discussed above, excess capital stock requires the Banks to
generate earnings, through investments in non-core mission assets, in
order to pay dividends on such stock, which is not needed to capitalize
advances and other core mission assets. The Banks' arbitrage activities
for this purpose detract from the mission of the Banks to promote
housing finance and community investment, by encouraging activities not
related to the Banks' mission and thereby detracting from the financial
incentive to engage in mission-related activity. A reduction in the
amount of excess capital stock would reduce the amount of capital stock
on which dividends must be paid, thereby
[[Page 16791]]
reducing the level of arbitrage activities conducted in order to
generate earnings to pay dividends on such capital stock.
One cause of the Banks' excess capital stock levels is the payment
by some Banks of stock dividends rather than cash dividends to members.
Prohibiting the Banks from paying stock dividends would help reduce
excess capital stock levels in the Bank System and the consequent
arbitrage activities.
Another way to reduce excess capital stock in the Bank System and
thereby reduce arbitrage activities in non-core mission assets by the
Banks, would be to require the Banks to unilaterally redeem members'
excess capital stock. In the past year, five Banks unilaterally
redeemed their excess capital stock expressly for the purpose of
reducing the amount of their money market investments.
The Finance Board recognizes that payment of stock dividends has
Federal tax advantages to members over payment of cash dividends, and
that excess capital stock redemptions incur Federal tax liabilities for
members. However, the private financial advantage to members from
minimizing their taxes through the payment of stock dividends, while
having no safety and soundness implications for the Banks, ultimately
detracts from the Banks' housing finance and community investment
mission and serves no other legitimate business purpose for the Banks.
Accordingly, simultaneously with this rulemaking, the Finance Board
in a separate Advance Notice of Proposed Rulemaking (ANPRM) published
elsewhere in this issue of the Federal Register, is requesting comment
on how, by what means, and to what extent prohibiting or limiting the
Banks' ability to pay stock dividends to members would assist the
Finance Board in achieving the goal of reducing excess capital stock in
the Bank System. Similarly, the Finance Board is requesting comment on
whether the Banks should be required to unilaterally redeem members'
excess Bank capital stock to help achieve the goal of reducing excess
capital stock in the Bank System. Regarding required unilateral
redemption of excess capital stock, the Finance Board specifically
requests comment on whether a member should be allowed to maintain some
amount of excess capital stock, e.g., 10 percent of its total minimum
capital stock requirement, in anticipation of fluctuations in its
assets or outstanding advances that may affect its minimum capital
stock requirement. The Finance Board also requests comment on what the
timing of unilateral redemptions should be, e.g., no less frequently
than quarterly, semi-annually, or annually at the time of the Banks'
adjustments of the members' minimum capital stock requirements? The
Finance Board also requests comment on whether the currently required
15 days' notice to members before redemption should be retained or
modified. In addition, the Finance Board requests comment on whether
Sec. 933.23 of the Finance Board's membership regulation, which permits
a member to purchase excess capital stock if approved by the Bank,
should be removed or modified. See 12 CFR 933.23.
In the alternative, the Finance Board requests comment on whether
the Banks should be permitted to hold excess capital stock, but be
prohibited from paying dividends on such stock, as a way to reduce the
Banks' arbitrage activities with non-core mission assets. The Finance
Board also requests comment on whether and to what extent excess
capital stock holdings could be allowed so long as they are not being
leveraged in the consolidated obligations market. In addition, the
Finance Board requests comment on whether excess capital stock holdings
should be permitted for a limited period of time, such as up to six
months, where the member indicates that it intends to increase its
advance borrowings during that time period.
Comments received in response to the ANPRM will be reviewed and
considered by the Finance Board in preparation for further action in
connection with the issues discussed in the ANPRM.
IV. Regulatory Flexibility Act
Because no notice of proposed rulemaking is required for this
interim final rule, the provisions of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.) do not apply.
V. Paperwork Reduction Act
This interim final rule does not contain any collections of
information pursuant to the Paperwork Reduction Act of 1995. See 44
U.S.C. 3501 et seq. Therefore, the Finance Board has not submitted any
information to the Office of Management and Budget for review.
VI. Notice and Public Participation
The Finance Board for good cause finds that the notice and public
comment procedure required by the Administrative Procedure Act is
impracticable, unnecessary or contrary to the public interest in this
instance, because the change made by this interim final rule prohibits
an immediately pending Bank action that would detract from the Banks'
mission to promote housing finance and community investment. See 5
U.S.C. 553(b)(3)(B).
List of Subjects in 12 CFR Part 935
Credit, Federal home loan banks, Reporting and recordkeeping
requirements.
Accordingly, the Finance Board hereby amends title 12, chapter IX,
part 935 of the Code of Federal Regulations as follows:
PART 935--ADVANCES
1. The authority citation for part 935 continues to read as
follows:
Authority: 12 U.S.C. 1422a(a)(3), 1422b(a)(1), 1426, 1429, 1430,
1430b, 1431.
2. Section 935.15 is amended by revising paragraph (b) to read as
follows:
Sec. 935.15 Capital stock requirements; unilateral redemption of
excess stock.
* * * * *
(b) Unilateral redemption of excess capital stock; fee in lieu
prohibited. (1) A Bank, after providing 15 calendar days advance
written notice to a member, may require the redemption of that amount
of the member's Bank capital stock that exceeds the capital stock
requirements set forth in paragraph (a) of this section or, in the case
of a non-QTL member, the capital stock requirements set forth in
Sec. 935.13(a)(1)(ii) of this part, provided the minimum amount
required in sections 6(b)(1) and 10(e)(3) of the Act is maintained. The
Bank shall have the discretion to determine the timing of such
unilateral redemption. The Bank's implementation of its redemption
policy shall be consistent with the requirement of section 7(j) of the
Act (12 U.S.C. 1427(j)) that the affairs of the Bank shall be
administered fairly and impartially and without discrimination in favor
of or against any member borrower.
(2) A Bank may not impose on or accept from a member a fee in lieu
of redeeming the member's excess Bank capital stock.
Dated: March 19, 1999.
By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairman.
[FR Doc. 99-8357 Filed 4-5-99; 8:45 am]
BILLING CODE 6725-01-P