On August 31, 2022, the Federal Housing Finance Agency (FHFA) announced that it will conduct a comprehensive review of the Federal Home Loan Bank (FHLB) system. This article addresses two legal issues relevant to the review:
- FHFA’s statutory authority to reduce the number of Federal Home Loan Banks, and
- The application of the FHLBank statutory “super lien”
FHFA’s authority to reduce the number of federal home loan banks
The Federal Home Loan Bank Act establishes a maximum number of 12 Federal Home Loan Bank districts and an expectation that there should be no less than eight districts. There are nuances for reducing the number of FHLBanks below eight, but the maximum number is fixed.
The most recent example of a decrease in districts to ll resulted from the 2015-2016 merger of the Seattle and Des Moines institutions into a Des Moines district bank. That transaction was not driven by a desire to reduce the number of FHLBanks, but rather safety and reliability concerns.
The Seattle Bank’s membership declined, its capital base eroded to an undercapitalized level, and the need for nearly six years of enhanced supervision led to a decision by consent to undertake the merger.
The FHLB Act states that the director of FHFA can make “re-adjustments” to the districts by changing which states are in a particular district, and that the director can create new districts, provided there are no more than 12.
The Act also provides that the director may reduce the number of districts to less than eight pursuant to a voluntary merger or the liquidation of an FHLBank under FHFA’s conservatorship and receivership powers. In other words, reducing the number of districts below eight does not appear to be justifiable solely on the basis of efficiency or cost savings.
The reduction of the number or districts below eight must be based on a voluntary merger of FHLBanks or the existence of a very troubled FHLBank that requires prompt corrective action.
The FHLB Act also allows the FHFA Director to make a finding that “the efficient and economical achievement of the purposes of [the Act] will be assisted” by action under promulgated regulations to liquidate or reorganize an FHLBank and another FHLBank may acquire its assets.
This provision can be challenged by the affected FHLBank under legal process. The provision appears to require a finding related to the safety and soundness of the FHLBank, not one based on a general authority to eliminate a district.
In summary, the director of FHFA 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 health considerations, and any reduction below eight must be based on a voluntary merger or a significant safety and health problem.
The application of the FHLBanks statutory super lien
The fundamental purpose of the Federal Home Loan Bank System is housing finance. The FHLBanks carry out this purpose by making low-cost loans (advances) to member institutions. When the FHLB Act was passed in 1932, membership was limited to mortgage lenders (eg, savings and loan associations, savings banks, 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.
When the membership classes were expanded, Congress was aware that the FHLBanks were established to serve an important public policy objective, and that their safe and sound operation should not be jeopardized by including members who are not subject to appropriate state or federal oversight. All members must therefore be in the business of making home mortgage loans and are generally required to meet minimum home mortgage asset requirements.
In addition, advances must be fully secured by one or more specific types of collateral, including residential mortgage loans and residential mortgage-backed securities, but other collateral includes government bonds, cash, other property-related collateral, and, in some cases, secured small business, agricultural or community development loans, or securities backed by such loans.
In most cases, members must use the proceeds of long-term advances (that is, advances with an original term to maturity of more than five years) to fund residential housing finance. However, the smaller FDIC-insured institution members are permitted to obtain long-term advances to finance 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 security” agreement that establishes a blanket lien covering all eligible collateral. The FHLBank can 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 to provide that any security interest granted 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 called a “super lien”.
This super lien is often cited as one reason why no FHLBank has ever had a credit loss on an advance, and it is considered a key factor in their AAA credit rating. This reduces their cost of funds and the savings are passed on to members in the form of lower interest costs on advances.
Some have argued that the super lien is less significant in light of amendments 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 expensive for it to resolve failed depository institutions, since the FHLBank must be paid in full (including prepayment penalties) before it will release its oversecured interests. Concerns have also been raised that the super lien may reduce the incentives for the FHLBanks to closely underwrite and monitor their advances and that the super lien insulates the FHLBanks from market discipline.
Finally, since the FHLBanks are typically over-guaranteed, the protection afforded by the super lien may make it more expensive for members to obtain private sources of funding. Unsecured funding encourages institutions to operate in a safe and sound manner (eg imposes market discipline).
While the super lien applies to all “members” of a Federal Home Loan Bank, some question whether it can apply to insurance company members in light of the McCarran-Ferguson Act. That law provides that state law generally governs the regulation of insurance and is not preempted by federal law unless federal law expressly regulates the business of insurance.
Thus, if there is a conflict between the super lien and state insurance law, it is unclear which statutory system will prevail.
In addition, CDFIs do not have a dedicated receiver, and in the event of the failure of a CDFI, the FHLBank would have to seize and sell the collateral to recover on their loan, adding time and uncertainty to the recovery process. As a result, the FHLBanks impose higher collateral requirements for advances to CDFIs.
When Congress authorized non-federally insured credit unions to become members of a Federal Home Loan Bank in 2015, it expressly preempted state laws that would otherwise allow a credit union custodian or receiver to enforce contracts related to hold with an FHLBank advance or repudiate a security interest held by an FHLBank in collateral support of an advance.
The 2015 amendment also specified that an FHLBank would have the same priority and rights as if the advance were made to a federally insured credit union.
If the proposed revision of the Federal Home Loan Bank System results in a recommendation to Congress to expand membership opportunities, it is imperative that the recommendation consider both the public policy purposes of the FHLBanks and the need to ensure their continued safe operation .
This should include careful consideration of whether the FHLBanks’ super lien should be extended to non-depository institutions, and whether any modifications should be made, as has been done in the case of non-federally insured credit unions. It should include a call for public comment on the current super lien, whether it should continue in its current form, and whether and how it should apply to any new classes of members.
Raymond Natter is a former deputy general counsel for the Office of the Comptroller of the Currency. He is a partner at the Washington, DC law firm of Sivon, Natter & Wechsler, PC, and serves as counsel at the international law firm of Squire Patton Boggs (US) LLP.
Alfred Pollard is a former general counsel for the FHFA. He is of counsel at the Washington, DC law firm of Sivon, Natter & Wechsler, PC, and serves as counsel at the international law firm of Squire Patton Boggs (US) LLP.
This column does not necessarily reflect the opinion of HousingWire’s editorial department 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]