FEDERAL HOME LOAN BANKS. Collateral Requirements Discourage Some Community Development Financial Institutions from Seeking Membership

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1 United States Government Aountaility Offie Report to Congressional Requesters April 2015 FEDERAL HOME LOAN BANKS Collateral Requirements Disourage Some Community Development Finanial Institutions from Seeking Memership GAO

2 Highlights of GAO , a report to ongressional requesters April 2015 FEDERAL HOME LOAN BANKS Collateral Requirements Disourage Some Community Development Finanial Institutions from Seeking Memership Why GAO Did This Study The Housing and Eonomi Reovery At of 2008 (HERA) made nondepository CDFIs eligile for memership in the FHLBank System. The System inludes 12 regional FHLBanks that make loans, known as advanes, to their memers at favorale rates. GAO was asked to review the FHLBanks implementation of HERA provisions relating to nondepository CDFIs. Among other things, this report disusses (1) hallenges posed y memership and ollateral requirements for nondepository CDFIs, and (2) FHFA and FHLBank efforts to failitate roader nondepository CDFI partiipation in the System. GAO analyzed data on memership rates as of Deemer 2014 and advanes otained as of Septemer 2014; reviewed requirements for gaining memership and otaining advanes; and interviewed FHLBank and FHFA offiials and a sample of nondepository CDFIs ased on seleted riteria, inluding geography and asset size. Speifially, GAO interviewed 10 nondepository CDFIs that were memers (one from eah FHLBank distrit with a nondepository CDFI memer when GAO egan work) and 12 that were not memers (one from eah of the 12 distrits). GAO makes no reommendations in this report. GAO provided a draft of this report to FHFA and the 12 FHLBanks for omment. FHFA and four FHLBanks provided tehnial omments that were inorporated into the report as appropriate. View GAO For more information, ontat Daniel Garia-Diaz at (202) or GariaDiazD@gao.gov. What GAO Found Collateral requirements rather than memership requirements disouraged some nondepository ommunity development finanial institutions (CDFI) loan or venture apital funds from seeking memership in the Federal Home Loan Bank (FHLBank) System. CDFIs are finanial institutions that provide redit and finanial servies to underserved ommunities. Less than 6 perent of nondepository CDFIs (30 of 522) were memers of the System as of Deemer 2014 (see figure). Requirements for memership (suh as stok purhase amounts) an vary where regulation gives FHLBanks disretion, ut nondepository CDFIs GAO interviewed generally stated these requirements did not present a hallenge. In addition, most FHLBanks imposed ollateral requirements on nondepository CDFIs suh as hairuts (disounts on the value of ollateral) omparale with those for depository memers ategorized as higher risk. (This was sometimes also the ase for other nondepository memers suh as insurane ompanies.) FHLBank offiials stated nondepository CDFIs have different risks ompared with depository memers (for example, nondepository CDFIs are not supervised y a prudential federal or state regulator as are other FHLBank memers). To address these risks, they imposed more restritive requirements. Some of the nondepository CDFIs GAO interviewed ited limited availaility of eligile ollateral and steep hairuts as hallenges for otaining advanes and therefore a disinentive to seeking memership. Less than half of the nondepository CDFIs that were memers as of Septemer 2014 had orrowed from the FHLBanks; the umulative advanes from Otoer 2010 to Septemer 2014 totaled aout $307 million (less than 1 perent of the total advanes outstanding as of Deemer 2014). Two FHLBanks made the majority of the advanes. Rates of Nondepository CDFI Memership y FHLBank Distrit, as of Deemer 2014 The Federal Housing Finane Ageny (FHFA), whih oversees the System, and FHLBanks have failitated efforts to roaden nondepository CDFI partiipation in the System y eduating aout and promoting memership to nondepository CDFIs. For example, FHFA offiials told us that they enouraged the FHLBanks to hold a onferene to disuss nondepository CDFI memership. Offiials from 10 FHLBanks also stated that they had soliited appliations from CDFIs. In late 2014, several FHLBanks amended stok purhase and ollateral requirements to etter aommodate nondepository CDFI memership and aess to advanes. United States Government Aountaility Offie

3 Contents Letter 1 Bakground 4 Nondepository CDFIs Differ from Other FHLBank Memers in Several Ways 9 Collateral Requirements Pose Greatest Challenge for Nondepository CDFIs 13 FHFA and FHLBanks Have Made Efforts to Failitate Broader Partiipation of Nondepository CDFIs in the FHLBank System 30 Ageny and Third Party Comments and Our Evaluation 33 Appendix I Ojetive, Sope, and Methodology 36 Appendix II Federal Home Loan Bank Collateral Requirements for Nondepository Community Development Finanial Institutions and Depository Institutions 41 Appendix III Federal Home Loan Bank Advane Terms and Borrowing Limits for Nondepository Community Development Finanial Institutions and Depository Institutions 44 Appendix IV GAO Contat and Staff Aknowledgments 46 Tales Tale 1: Distriution of Total Assets for FHLBank Memers y Type, as of Deemer 31, 2014 (Dollars in Millions) 10 Tale 2: Requirements for Purhases of Memership Stok y FHLBank, as of Novemer Tale 3: Perentage Hairut (Disount) for Seleted Seurities Collateral for Depository Institutions and Nondepository CDFIs y FHLBank, as of Deemer Tale 4: Perentage Hairut (Disount) for Seleted Loan Collateral for Depository Institutions and Nondepository CDFIs y FHLBank, as of Deemer Page i GAO CDFI Memership in FHLBanks

4 Tale 5: Requirements for Pledge Method and Hairut (Disount) y FHLBank, as of Deemer Tale 6: Advane Terms and Borrowing Limits y FHLBank 44 Figures Figure 1: The 12 Federal Home Loan Banks and Distrits 6 Figure 2: Rates of Nondepository CDFI Memership y FHLBank Distrit, as of Deemer 31, Figure 3: Total Advanes Made to Nondepository CDFIs y FHLBank Distrit, from Otoer 2010 through Septemer Areviations CARS CDFI CDFI Fund FDIC FHFA FHLBank FHLBank System GAAP HERA NCUA OFN Treasury CDFI Assessment and Ratings System ommunity development finanial institution Community Development Finanial Institutions Fund Federal Deposit Insurane Corporation Federal Housing Finane Ageny Federal Home Loan Bank Federal Home Loan Bank System generally aepted aounting priniples Housing and Eonomi Reovery At of 2008 National Credit Union Administration Opportunity Finane Network Department of the Treasury This is a work of the U.S. government and is not sujet to opyright protetion in the United States. The pulished produt may e reprodued and distriuted in its entirety without further permission from GAO. However, eause this work may ontain opyrighted images or other material, permission from the opyright holder may e neessary if you wish to reprodue this material separately. Page ii GAO CDFI Memership in FHLBanks

5 Letter 441 G St. N.W. Washington, DC April 23, 2015 The Honorale Maxine Waters Ranking Memer Committee on Finanial Servies House of Representatives The Honorale Carolyn Maloney Ranking Memer Suommittee on Capital Markets and Government-Sponsored Enterprises Committee on Finanial Servies House of Representatives The Honorale Keith Ellison House of Representatives The Federal Home Loan Bank System (FHLBank System), whih is a government-sponsored enterprise reated to support mortgage lending and related ommunity development, inludes 12 regional Federal Home Loan Banks (FHLBank) with over 7,300 finanial institutions that are ative memers. The primary mission of the FHLBank System is to serve as a reliale soure of liquidity for its memers. To arry out its mission, the FHLBank System issues det in apital markets, generally at relatively favorale rates due to its status as a government-sponsored enterprise, and eah FHLBank makes loans known as advanes to its memer finanial institutions. As of Deemer 31, 2014, the FHLBanks had aout $566 illion in total outstanding advanes. FHLBank memers must pledge ollateral to seure these advanes. FHLBank memers inlude anks, thrifts, redit unions, and insurane ompanies as well as ommunity development finanial institutions (CDFI) ertified y the Community Development Finanial Institutions Fund (CDFI Fund) within the Department of the Treasury (Treasury). 1 CDFIs an e federally insured depository institutions suh as ommunity development anks and ertain redit unions or nondepository institutions 1 The CDFI Fund was estalished y the Riegle Community Development and Regulatory Improvement At of 1994, Pu. L. No , 104, 108 Stat. 2160, 2166 (1994). Page 1 GAO CDFI Memership in FHLBanks

6 suh as ommunity development loan funds or venture apital funds. Depository CDFIs have een eligile to apply for FHLBank memership sine 1989 and nondepository CDFIs sine 2010, when the Federal Housing Finane Ageny (FHFA) implemented provisions of the Housing and Eonomi Reovery At of 2008 (HERA) that authorized suh memership. 2 FHFA is the supervisor and regulator of the FHLBank System and aims to promote the safe and sound operation of FHLBanks and the ahievement of their mission. You asked us to examine the FHLBanks implementation of HERA provisions relating to nondepository CDFIs. This report disusses (1) how nondepository CDFIs differ from other memers of the FHLBank System, in partiular depository memers; (2) the memership and ollateral requirements for nondepository CDFIs and hallenges posed y these requirements; and (3) FHFA oversight of FHLBanks in relation to nondepository CDFIs and efforts y FHFA and FHLBanks to inrease partiipation of nondepository CDFIs in the FHLBank System. To desrie differenes etween nondepository CDFIs and other memers of the FHLBank System, we reviewed relevant setions of HERA, FHFA s final rule on nondepository CDFI memership, and other relevant information from the FHLBanks and CDFI industry. We analyzed data on memers asset size from FHFA s memership dataase as of Deemer 31, To address memership and ollateral requirements, we reviewed relevant legislation and regulations, and doumentation (suh as memership appliations and FHLBank guidane on assessing nondepository CDFIs for memership) to determine memership requirements and identify any differenes among FHLBank poliies. 3 We analyzed data on the numer of nondepository CDFIs that were memers in alendar years 2010 through 2014 from FHFA s memership dataase as of Deemer 31, We alulated the 2 See Pu. L. No , 1206, 122 Stat. 2654, 2787 (2008) (odified at 12 U.S.C. 1424(a)); 12 C.F.R. Parts 1263, In addition to ommunity development loan funds and venture apital funds, HERA made state-hartered redit unions without federal insurane eligile for FHLBank memership. They must meet striter finanial standards than federally insured depository institutions. See 12 CFR ()(3)(iii). 3 Nondepository CDFIs are sujet to speifi finanial ondition requirements. We requested and reeived finanial data from the CDFI Fund ut determined that the dataset did not ontain relevant data needed to determine how many nondepository CDFIs ould meet these finanial ondition requirements. Page 2 GAO CDFI Memership in FHLBanks

7 memership rate (the perentage of nondepository CDFIs in eah distrit that were memers) y using data from FHFA s memership dataase and Treasury s CDFI Fund. In addition, we reviewed relevant doumentation suh as FHLBank ollateral guidelines and produt and redit poliies to determine the FHLBanks requirements for otaining advanes. While we were ale to review eah FHLBank s ollateral poliies and proedures, the onfidentiality of suh proprietary information limited what we ould pulily dislose in our report. 4 We also otained data from eah FHLBank on the amount of advanes nondepository CDFI memers otained from Otoer 2010 through Septemer 2014 (the most reent data availale at the time of our request). We reviewed doumentation on and interviewed knowledgeale offiials aout the data we used and determined they were suffiiently reliale for assessing memers asset size (data from FHFA s memership dataase), the memership rates for nondepository CDFIs (data from FHFA s memership dataase and the CDFI Fund), and the amount of advanes eah nondepository CDFI memer otained (data from individual FHLBanks). We interviewed offiials from the 12 FHLBanks, 3 trade groups, 10 nondepository CDFIs that were memers of the FHLBanks, and 12 nondepository CDFIs that were not memers to help understand the level of demand for FHLBank memership and otain views on any hallenges assoiated with otaining memership and advanes. We seleted the two purposive, nonrandom samples of nondepository CDFIs (10 memers and 12 nonmemers) using data from FHFA s memership dataase. We sought variation in fators suh as geographi loation and asset size. The results of our interviews with the 22 nondepository CDFIs annot e generalized to all nondepository CDFIs. To evaluate FHFA s oversight, we reviewed relevant laws, legislative history, and regulations in relation to authority to expand memership to nondepository CDFIs and FHFA s oversight authority. We also reviewed FHFA s examination poliies for memership and ollateral requirements to otain advanes. To determine what, if any, findings onerned memership and advane praties, we analyzed eah FHLBank s 4 Speifially, eause the ollateral hairut (disount) poliies of the FHLBanks generally are onsidered proprietary information, we were unale to attriute speifi poliies to individual FHLBanks. Where appropriate, we used randomly assigned numers when disussing FHLBank ollateral poliies to prevent dislosure of FHLBank identities. Page 3 GAO CDFI Memership in FHLBanks

8 examination results for fisal years 2010 through 2013 (the most reent availale at the time of our request). We interviewed FHFA and the 12 FHLBanks to further understand examination poliies and praties for memership and advanes and disuss any efforts to failitate roader nondepository CDFI partiipation in the FHLBank System. See appendix I for a more detailed desription of our methodology. We onduted this performane audit from May 2014 to April 2015 in aordane with generally aepted government auditing standards. Those standards require that we plan and perform the audit to otain suffiient, appropriate evidene to provide a reasonale asis for our findings and onlusions ased on our audit ojetives. We elieve that the evidene otained provides a reasonale asis for our findings and onlusions ased on our audit ojetives. Bakground The CDFI Fund provides ertifiation to CDFIs that meet the six statutory and regulatory riteria of the Fund. 5 CDFI Fund ertifiation is onferred on CDFIs that have the primary mission of providing apital and development servies to eonomially distressed ommunities generally underserved y onventional finanial institutions. CDFIs provide produts and servies (suh as mortgage finaning for low-inome and first-time homeuyers and finaning for not-for-profit affordale housing developers) that otherwise may not e aessile in these ommunities. CDFIs an e for-profit or nonprofit institutions and an e funded y private and puli soures. Depository CDFIs suh as ommunity development anks and redit unions otain apital from ustomers and nonmemer depositors. Depository and nondepository CDFIs may otain funding from onventional finanial institutions, suh as anks, in the form of loans. In addition, oth types of CDFIs may reeive funding from orporations, individuals, religious institutions, and private foundations. Finally, CDFIs may apply for federal grants and partiipate in federal loan programs. For example, Treasury s CDFI Fund makes grants, equity investments, loans, and deposits to help CDFIs serve low-inome people 5 The CDFI Fund onfers ertifiation to a legal entity that meets six statutory and regulatory riteria: the CDFI must have a primary mission of promoting ommunity development; serve prinipally an investment area or targeted population; e an insured depository institution, or make loans or development investments as its predominant usiness ativity; provide development servies (suh as tehnial assistane or ounseling) in onjuntion with its finaning ativity; maintain aountaility to its target market; and e a nongovernmental entity. Page 4 GAO CDFI Memership in FHLBanks

9 and ommunities. 6 Other federal funding soures inlude loan programs administered y the Department of Agriulture and the Small Business Administration. As of Deemer 31, 2014, there were a total of 933 ertified CDFIs (411 depository and 522 nondepository). The 12 FHLBanks are regionally ased ooperative institutions owned y 7 memer finanial institutions (see fig. 1). To eome a memer of its regional FHLBank, a finanial institution (suh as a nondepository CDFI) must meet ertain eligiility requirements and purhase apital stok; thereafter, it must maintain an investment in the apital stok of the FHLBank suffiient to satisfy the minimum investment required for that institution in aordane with the FHLBank s apital plan. 8 6 The CDFI Fund administers a numer of programs that make awards to CDFIs annually through ompetitive appliation proesses. Its programs inlude those that provide finanial assistane awards, tehnial assistane grants, ond guarantees, and tax redit alloation authority. 7 On Feruary 27, 2015, the FHLBank of Des Moines and the FHLBank of Seattle announed that the memers of oth FHLBanks had ratified an agreement approved y their oards of diretors in Septemer 2014 to merge. The FHLBanks antiipate that the merger will e effetive y the middle of C.F.R (d). Page 5 GAO CDFI Memership in FHLBanks

10 Figure 1: The 12 Federal Home Loan Banks and Distrits The FHLBanks extend advanes almost exlusively to their memers, whih in turn an use the advanes to fund lending suh as mortgages. 9 Advanes are the largest ategory of assets of the FHLBanks on a omined asis, representing aout 62 perent of all assets as of Septemer 30, Other enefits of FHLBank memership for finanial institutions inlude earning dividends on their apital investments and aess to various produts and servies, suh as letters of redit and payment servies. The FHLBanks also offer affordale housing and ommunity and eonomi development lending through the Affordale Housing Program and the Community Investment Program. Under these programs, the FHLBanks provide grants and advanes to their memers, and the memers use these funds to enefit ertain households or 9 Although they are not FHLBank memers, the FHLBanks also make advanes to eligile housing assoiates (primarily state housing finane agenies). The eligiility requirements and appliation proess for organizations seeking to e ertified y FHLBanks as housing assoiates are set forth in 12 CFR Part Housing assoiates represented approximately 0.06 perent of the par value of advanes outstanding as of Deemer 31, Page 6 GAO CDFI Memership in FHLBanks

11 ommunities. 10 Some of the FHLBanks have their own programs designed to support ommunity development. For instane, FHLBank- Chiago developed its Community First Fund in 2013 as a $50 million revolving loan fund that supports memer and nonmemer ommunity development institutions, inluding CDFIs. The FHLBanks protet against redit risk on advanes y requiring orrowers to pledge ollateral. As estalished y statute and FHFA regulations, the FHLBanks must develop and implement ollateral standards and other poliies to mitigate the risk of default on outstanding advanes. Collateral arrangements vary with orrower redit quality, orrowing apaity, and ollateral availaility, as well as the FHLBank s overall redit exposure to the orrower. Eah FHLBank estalishes orrowing apaity y determining the amount it will lend against eah ollateral type. An FHLBank an require additional or sustitute ollateral during the life of an advane to protet its seurity interest. For example, additional ollateral is required when a memer does not have suffiient ollateral pledged to support outstanding redit exposure. Sustitution generally ours if the orrower s previously pledged ollateral eomes ineligile. An FHLBank also may estalish separate or additional ollateral requirements for different memer types (suh as insurane ompanies) pereived to have different types of risks than federally insured depository institutions. Based on the orrower s finanial ondition, the ollateral pledge method generally falls into one of three ategories: lanket lien, listing, and delivery. Blanket lien is the least restritive ollateral status and generally is assigned to lower-risk institutions. A lanket-lien agreement seures 10 Eah FHLBank must ontriute annually to its Affordale Housing Program the greater of (1) 10 perent of the FHLBank s net earnings for the previous year or (2) the FHLBank s pro rata share of an aggregate of $100 million to e ontriuted in total y the FHLBanks. 12 U.S.C. 1430(j)(5)(C); 12 C.F.R (a). Reipients are to use Affordale Housing Program funds to enefit very-low inome and low- or moderate-inome households. Very low-inome households are defined as households with inomes of 80 perent or less of area median inome. Very low-inome households are defined as households with inomes of 50 perent or less of area median inome. 12 C.F.R Under the Community Investment Program, housing advanes must enefit households at or elow 115 perent of area median inome, while eonomi development advanes must enefit either low- or moderate-inome households or eonomi development projets loated in low- or moderate-inome neighorhoods. 12 U.S.C. 1430(i)(2). Page 7 GAO CDFI Memership in FHLBanks

12 the right of the FHLBank to speified memer assets, whih may e all of the memer s assets in the event the memer fails or defaults on outstanding advanes, usually on a first lien status. Generally, the FHLBank has priority over all other reditors, inluding the Federal Deposit Insurane Corporation (FDIC). 11 Most FHLBanks rely on a lanket lien agreement to seure advanes without taking possession of the ollateral, and the orrower may retain possession of doumentation on eligile ollateral pledged to the FHLBank. Under listing status, the orrower may retain possession of doumentation on speifi ollateral pledged, ut must provide a list of loans pledged with detailed loan information. Under delivery status, the orrower delivers pledged ollateral to the FHLBank or a third-party ustodian approved y the FHLBank. 12 This typially puts the seurity interest of the FHLBank in the most senior position over other reditors. FHLBanks also seek to manage risk and mitigate potential losses y applying varying hairuts, or disounts, to ollateral pledged to seure advanes. For example, an FHLBank memer might seek to pledge a portfolio of single-family residential mortgage loans with a value of $ million to seure an advane from its distrit FHLBank. If the FHLBank applied a hairut of 25 perent to suh ollateral, the memer generally would e ale to seure advanes of up to $75 million, sujet to other 11 In a typial ank or thrift failure, FDIC, ating as reeiver, is responsile for all advanes and other redit oligations of the failed institution. Generally, FDIC will failitate a purhase and assumption transation with another finanial institution, whih then will eome responsile for the FHLBank advanes. If another finanial institution were not found to assume the failed institution s oligations, FDIC would e responsile for the payment of the FHLBank advanes y selling the failed institution s assets, inluding ollateral that had een pledged to seure the advanes, to mitigate losses to the Deposit Insurane Fund. However, suh a sale ould not our until FDIC had fully satisfied or repaid the outstanding redit oligations of the failed institution. An aquiring ank also may purhase and assume the assets and liailities of the failed memer, inluding ollateral that had een pledged to seure advanes. 12 The method of delivery depends on the type of ollateral eing pledged. Tangile ollateral, suh as ertified seurities or mortgage promissory notes, is delivered y physially transferring these douments to the FHLBank or its ustodian. Intangile ollateral, suh as seurities that exist only in eletroni form, is delivered y rediting them to the aount of the FHLBank or its ustodian. 13 Single-family mortgage loans are loans for 1 4 unit properties. Page 8 GAO CDFI Memership in FHLBanks

13 risk-management poliies of the FHLBank. 14 The FHLBanks may apply hairuts ased on fators suh as risks assoiated with the memer s reditworthiness, the type of ollateral eing pledged, and illiquidity of the ollateral. Nondepository CDFIs Differ from Other FHLBank Memers in Several Ways The differenes among nondepository CDFIs and other FHLBank memers range from the degree to whih they fous on ommunity development to differenes in size and supervision. Two memer types nondepository and depository CDFIs share a primary ommunity development fous. As noted previously, oth types of CDFIs must have a primary mission of promoting ommunity development to e ertified y the CDFI Fund. CDFIs serve as intermediary finanial institutions that promote eonomi growth and staility in low- and moderate-inome ommunities. Frequently, CDFIs serve ommunities that are underserved y onventional finanial institutions and may offer produts and servies that generally are not availale from onventional finanial institutions. Suh produts and servies inlude mortgage finaning for low-inome and first-time homeuyers; homeowner or homeuyer ounseling; finaning for not-for-profit affordale housing developers; flexile underwriting and risk apital for needed ommunity failities; finanial literay training; tehnial assistane; and ommerial loans and investments to assist start-up usinesses in low-inome areas. Although other FHLBank memers may provide similar servies to similar populations, ommunity development may not e their primary mission. Nondepository CDFIs are smaller in asset size than most depository institution and insurane ompany FHLBank memers. As of Deemer 31, 2014, ative memers of the FHLBank System had approximately $20 trillion in assets. As shown in tale 1, as of the same date, median assets for nondepository CDFI memers (approximately $43 million) were lower than median assets for oth depository memers (approximately $207 million) and insurane ompany memers (approximately $975 million). The largest nondepository CDFI had aout $708 million in assets, while the largest insurane ompany memer had assets of aout $393 illion and the largest depository memer had assets of aout $2 trillion. In addition, the 30 nondepository CDFI memers altogether 14 For example, FHLBanks may set limits on the total amount of outstanding advanes to an individual memer. These limits are independent of the level of eligile ollateral that a memer must pledge to seure its advanes. Page 9 GAO CDFI Memership in FHLBanks

14 aounted for aout.01 perent of the total assets of all ative FHLBank memers, whereas depository and insurane ompany memers held aout 77 perent and aout 23 perent of FHLBanks assets, respetively. Tale 1: Distriution of Total Assets for FHLBank Memers y Type, as of Deemer 31, 2014 (Dollars in Millions) Nondepository ommunity development finanial institutions a Numer of ative memers 30 Minimum assets 25th perentile Median 75th perentile Maximum assets $0.90 $20.65 $42.57 $83.20 $ Depository institutions 7, ,008, Insurane ompanies , , Soure: GAO analysis of FHFA data. GAO a Assets for one nondepository CDFI are as of Deemer 31, 2013, assets for another nondepository CDFI are as of Marh 31, 2014, and assets for a third nondepository CDFI are as of June 30, Assets for all other nondepository CDFIs are as of Deemer 31, Depository institution memers inlude ommerial anks, redit unions, depository CDFIs, savings assoiations, and savings anks. Assets for one redit union and one ommerial ank were not availale. Assets for all other depository institutions are as of Deemer 31, Assets for two insurane ompanies were not availale. Assets for all other insurane ompanies are as of Deemer 31, In addition, nondepository CDFIs are not supervised y a prudential federal or state regulator unlike other FHLBank memers. Depository FHLBank memers are regulated and supervised y federal and state agenies that have responsiility for helping ensure the safety and soundness of the finanial institutions they oversee, promoting staility in the finanial markets, and enforing ompliane with appliale onsumer protetion laws. 15 To ahieve these goals, regulators estalish apital requirements for anks and ondut on-site examinations and off-site monitoring that assesses their finanial ondition, inluding assessing their ompliane with appliale laws, regulations, and ageny guidane. The insured depository institutions also must sumit to their regulators quarterly finanial information ommonly known as Call Reports that 15 See 12 U.S.C. 1831o. The Board of Governors of the Federal Reserve System oversees state-hartered anks and trust ompanies that elong to the Federal Reserve System; FDIC regulates state-hartered anks that do not elong to the Federal Reserve System as well as federally insured state savings anks and thrifts; the National Credit Union Administration (NCUA) supervises federally hartered or insured redit unions; and the Offie of the Comptroller of the Curreny supervises national anks and federal savings assoiations. The Bureau of Consumer Finanial Protetion supervises the onsumer usinesses of anks with over $10 illion in assets. Page 10 GAO CDFI Memership in FHLBanks

15 follow generally aepted aounting priniples (GAAP). 16 Insurane ompanies are regulated primarily y state insurane ommissioners and are sujet to examination. 17 While the CDFI Fund s review standards are not equivalent to the examination standards appliale to regulated depository institutions, the Fund requires a nondepository CDFI to sumit its most reent year-to-date finanial statements prepared in onformity with GAAP for ertifiation and funding eligiility. The CDFI Fund also requires nonprofit and for-profit nondepository CDFIs reeiving awards to annually sumit finanial statements inluding information on finanial position, operations, ativities, and ash flows that have een audited y an independent ertified puli aountant. However, only a suset of CDFIs reeives CDFI Fund awards and is sujet to suh reporting. In addition to finanial statements of individual nondepository CDFIs, other soures an provide information on the finanial performane of nondepository CDFIs overall or individually. For example, the CDFI Fund reports on its analysis of finanial data from nondepository CDFIs. The CDFI Snapshot Analysis for fisal year 2012 (the most reent availale at the time of our review) notes that ommunity development loan funds, one type of nondepository CDFI, had rates of loan loss (loans that may prove unolletile) of 1 perent, whih ompared favoraly with 18 depository CDFIs and mainstream finanial institutions. A national network of CDFIs reported that its memers annual net harge-off rate (dets an entity is unlikely to ollet) was the same as for all FDIC- 16 A Federal Finanial Institutions Examination Counil Call Report (offiially known as the Consolidated Report of Condition and Inome) must e filed y all FDIC-insured depository institutions on a quarterly asis. Insured redit unions must file quarterly Call Reports with NCUA. An NCUA Call Report may reflet regulatory aounting priniples other than GAAP if the redit union has total assets of less than $10 million (exept that a federally insured state-hartered redit union may e required y its state redit union supervisor to follow GAAP regardless of asset size). 17 State insurane regulators typially ondut on-site finanial solveny examinations every 3 to 5 years. Insurane ompanies file annual National Assoiation of Insurane Commissioners statements with their state regulators. 18 Of the 296 ommunity development loan funds in the sample of 350 CDFIs, 253 provided loan loss rates. See Department of the Treasury, CDFI Fund, Offie of Finanial Strategies and Researh, CDFI Snapshot Analysis: Fisal Year 2012 (Washington, D.C.: April 2014). The CDFI Fund notes that data were self-reported y ommunity development loan funds and pulished data were ased on validation reporting rules and leansing protools. Page 11 GAO CDFI Memership in FHLBanks

16 insured institutions in fisal year It also noted that its memers had provided more than $33 illion in umulative finaning for ommunity development ativities from their ineption through the end of fisal year This finaning, the network reported, helped to reate or maintain nearly 600,000 jos, support the development or rehailitation of more than 960,000 housing units, and start or expand nearly 94,000 usinesses and miroenterprises. And, for a fee, a ommunity development loan fund an e assessed y an independent third party, and reeive a finanial strength and performane rating. 20 The third party rates a CDFI using a methodology similar to that used y anking regulators. In the ase of finanial failure, nondepository CDFIs and depository memers also undergo different proesses for liquidating assets to repay the FHLBanks for any advanes. Depository memers, inluding depository CDFIs, are insured y FDIC or NCUA, whih means that FDIC 21 or NCUA would serve as the reeiver in the event of failure. In a typial ank or thrift failure, FDIC, ating as reeiver, is responsile for outstanding advanes of the failed institution. FDIC will failitate a purhase and assumption transation with another finanial institution or sell the failed institution s assets, inluding ollateral that had een pledged to seure the advanes, to mitigate losses to FDIC s Deposit 19 See Opportunity Finane Network (OFN), Opportunity Finane Institutions Side y Side, Fisal Year 2012 OFN Memer Data Analysis/Fifteenth Edition (Philadelphia, Pa.). The primary soure of data for this puliation was OFN s Fisal Year 2012 Annual Memer Survey. The survey was sent to all CDFIs that were network memers as of August 31, 2013; 200 memers ompleted the survey. OFN supplemented survey data with pulily availale data for one CDFI, and new memer appliation data for 8 CDFIs that eame memers after the survey was onduted. The puliation presents data points for as many as 209 CDFIs. 20 The CDFI Assessment and Ratings System (known as CARS ) is a proprietary tool owned y Aeris, an information servie for ommunity investors. As of Marh 2015, Aeris had rated more than 100 CDFIs. The tool assesses a nondepository CDFI s ondition in five areas: apital, asset quality, management, earnings, and liquidity. Eah omponent is rated on a sale of 1 to 5, with 1 eing the est. The omponent ratings are then used to develop a omposite rating of 1 to 5. This rating methodology is ased on the CAMELS analysis used y regulators to rate anks. 21 FHLBanks generally have priority over all other reditors, inluding FDIC, to otain the ollateral neessary to protet against losses on their outstanding advanes. The proedures for liquidating an insurane ompany vary from state to state. Page 12 GAO CDFI Memership in FHLBanks

17 Insurane Fund. 22 Beause nondepository CDFIs are not federally or state insured, aording to FHFA, the FHLBanks likely would go through the federal ankrupty proess to settle laims should a nondepository CDFI with FHLBank advanes fail. Collateral Requirements Pose Greatest Challenge for Nondepository CDFIs Collateral requirements (whih must e met to otain advanes) rather than the memership requirements themselves an disourage nondepository CDFIs from seeking FHLBank memership. Beause regulations allow the FHLBanks to set their own thresholds for meeting some memership requirements, the requirements varied. The rates of nondepository CDFI memership also varied y FHLBank and were low. The FHLBanks generally impose ollateral requirements on nondepository CDFIs that are omparale to those imposed on depository memers ategorized as higher risk and in some ases, omparale to those imposed on insurane ompanies. Offiials from the nondepository CDFIs we interviewed generally ited steep hairuts (disounts) and the availaility of eligile ollateral as the primary hallenges to otaining advanes; in addition, some viewed the requirements as a disinentive to seeking memership (eause advanes are a primary enefit of memership). Although FHLBanks Had Varying Thresholds for Some Memership Requirements, Most Nondepository CDFIs We Interviewed Were Ale to Meet the Requirements Certain Memership Requirements Varied While nondepository CDFIs must meet seven standards for FHLBank memership, the thresholds the FHLBanks set for meeting ertain of the requirements varied. The Federal Home Loan Bank At and FHFA s regulations estalish the memership requirements for nondepository CDFIs. Nondepository CDFIs must 22 FDIC ould not sell the assets the failed institution had pledged to the FHLBank until FDIC had fully satisfied or repaid the failed institution s outstanding redit oligations to the FHLBank. Page 13 GAO CDFI Memership in FHLBanks

18 e duly organized under trial law, or the laws of any state or the United States. e ertified y the CDFI Fund. make long-term home mortgage loans, whih are defined y statute to inlude loans seured y first liens on residential real property. Under FHFA regulations, institutions satisfy this requirement if they originate or purhase long-term first mortgage loans on single-family or multifamily residential property, or ertain farm or usiness property that also inludes a residene, or purhase mortgage pass-through seurities representing an undivided ownership in suh loans. By regulation, FHFA has defined long-term loans to inlude those with an original term to maturity of 5 years or more. e in a finanial ondition that would allow advanes to e safely made to it. FHFA developed four finanial ondition standards for the FHLBanks to use in their assessments a net asset ratio of at least 20 perent; positive average net inome over the preeding 3 years; a ratio of loan loss reserves to loans and leases 90 days or more delinquent of at least 30 perent; and an operating liquidity ratio of at least 1.0 for the 4 most reent quarters, and for 1 or oth of the 2 preeding years. 23 If the nondepository CDFI met the standards, it would e presumed to e finanially sound, and satisfy the requirement. If the CDFI did not meet one or more standards, the CDFI may offer a reuttal and the FHLBank would perform a separate analysis to determine if the CDFI was finanially sound. have management whose harater is onsistent with sound and eonomial home finaning. Under FHFA s regulations, an appliant meets this requirement if it ertifies to the FHLBank that neither the CDFI nor its senior offiials have een the sujet of any riminal, ivil, or administrative proeedings refleting upon reditworthiness, usiness judgment, or moral turpitude in the past 3 years and that 23 Net asset ratio is alulated as the residual value of assets over liailities. Net inome, also alled earnings, is alulated as gross revenues less total expenses. Loan loss reserves are the amount reserved for loans expeted to e unolletile. Liquidity is alulated with the numerator of the ratio eing unrestrited ash and ash equivalents and the denominator of the ratio eing the average quarterly operating expense for the 4 most reent quarters. Net asset ratio, net inome, and loan loss reserves are alulated ased on information derived from the appliant s most reent finanial statement. Page 14 GAO CDFI Memership in FHLBanks

19 there are no known potential riminal, ivil, or administrative monetary liailities, lawsuits, or unsatisfied judgments arising within the past 3 years that are signifiant to the appliant s operations. have a home finaning poliy that is onsistent with sound and eonomial home finaning. Under FHFA regulations, appliants meet this requirement if they provide a written justifiation, aeptale to the FHLBank, explaining how and why their home finaning poliy is onsistent with the FHLBank System s housing finane mission. have mortgage-related assets that reflet a ommitment to housing finane. They are not required to meet the statutory requirement that applies to ertain insured depository institutions to hold at least 10 perent of their assets in residential mortgage loans to e eligile for FHLBank memership. In addition, the FHLBanks also must require all new memers to purhase apital stok. The FHLBanks have disretion in developing rules to assess ompliane with some of the listed requirements. For example, the FHLBanks an set thresholds (suh as dollar amounts or perentages) to satisfy requirements for whih FHFA has not set thresholds suh as the requirement for making long-term home mortgage loans and the requirement to hold mortgage-related assets. 24 Eah FHLBank also an develop its own requirement for memership stok purhases, sujet to FHFA approval. We reviewed the three requirements for whih the FHLBanks have disretion in making rules and found that the requirements varied aross the FHLBanks. Making long-term mortgages. Eight of the 12 FHLBanks we reviewed had not developed a threshold for nondepository CDFIs to satisfy the long-term mortgage requirement, while four had speified a dollar amount or perentage of assets in long-term mortgage loans. FHFA expets that 24 In Septemer 2014, FHFA issued a proposed rule that would hange the FHLBank memership requirements. For example, the proposed rule would estalish a new quantitative test requiring all memers, inluding nondepository CDFIs, to hold 1 perent of their assets in home mortgage loans on an ongoing asis. Beause this new ongoing quantitative asset requirement would susume the existing regulatory memership eligiility requirement that CDFIs and other nondepositories hold an unspeified amount of undefined mortgage-related assets at the time of appliation for memership, the rule would also delete the latter requirement. See 79 Fed. Reg (Sept. 12, 2014). Page 15 GAO CDFI Memership in FHLBanks

20 in assessing the appliant, the FHLBanks will assess the extent to whih nondepository CDFIs have a ommitment to housing finane requirements in light of their unique mission and ommunity development orientation. The four FHLBanks that had quantitative minimums had minimum requirements that ranged from $1,000 to $1 million in dollar amounts, and from 1 perent to 2 perent of total assets. One FHLBank s stated poliy inluded an exemption from its partiular minimum requirement for nondepository CDFIs that plan to inorporate long-term mortgage loans into future usiness strategies. Another FHLBank that had a dollar minimum reently gave a nondepository CDFI an exemption from the minimum requirement ased on the assessment that the CDFI had signifiant ommitment to housing in aordane with regulatory and memership requirements. For the remaining eight FHLBanks that did not set a minimum requirement, nondepository CDFIs an satisfy the longterm mortgage requirement y doumenting that they have originated or purhased more than one suh loan or qualifying mortgage investment. Mortgage-related assets. Four of the 12 FHLBanks we reviewed did not have minimum requirements for the mortgage-related asset requirement, 5 had quantitative and qualitative measures (suh as an assessment of the CDFI s housing-related ativities and mission), and 3 had only quantitative measures. 25 The highest minimum quantitative requirement for mortgage-related assets as a perentage of total assets was 10 perent. The three FHLBanks with only quantitative requirements had the lowest requirements, with one FHLBank requiring two mortgage-related assets, another requiring $1,000 in mortgage-related assets, and another requiring the lower of 1 perent of total assets or $10 million in mortgagerelated assets. Stok purhases. The amount of stok that memers must purhase varied aording to eah FHLBank s funding strategy (see tale 2). FHLBank memers must hold a ertain amount of memership apital stok as a ontinuing ondition of memership. Eah FHLBank determines as a part of its apital plan the amounts that all memers must purhase in memership apital stok and sets its requirement ased on the FHLBank s usiness model. Five of the 12 FHLBanks we reviewed alulated the memership stok purhase as a perentage of 25 Five FHLBanks have poliies that allow them disretion to onsider other variales if a nondepository CDFI does not meet the quantitative requirement. Page 16 GAO CDFI Memership in FHLBanks

21 the memer s total assets. The other 7 FHLBanks alulated the purhase as a perentage of a speifi asset ategory, suh as mortgage-related assets or ertain assets eligile to e pledged as ollateral. Tale 2: Requirements for Purhases of Memership Stok y FHLBank, as of Novemer 2014 FHLBank Stok purhase perentage Assets to whih the stok a purhase perentage is applied Minimum investment Maximum investment Atlanta 0.09% Total No minimum $15 million Boston 0.35 Suset $10, million Chiago 1.00 Suset 10,000 Lesser of 9.9% of FHLBank s total outstanding apital stok or $250 million Cininnati 0.03 to 0.15 Total 1, million Dallas 0.04 Total 1,000 7 million Des Moines 0.12 Total 10, million Indianapolis 1.00 Suset 1, million New York 0.15 Suset 1,000 No maximum Pittsurgh 0.10 Suset 10, million San Franiso 1.00 Suset million Seattle 0.50 Suset million Topeka 0.10 Total 1, ,000 Soure: GAO analysis of FHLBank information. GAO a Suset is used when the FHLBank alulates the memership stok purhase perentage using more narrowly defined assets, suh as mortgage-related assets, rather than total assets. Stok transations for FHLBank-Atlanta our in $100 inrements. The FHLBanks also require memers to purhase ativity-ased stok. That is, memers must aquire a speifi amount of stok ased on the produt suh as advanes or letters of redit the FHLBank provided to that memer. The purhases are speified as a perentage of the dollar amount of eah transation the memer onduted with the FHLBank. For example, among the 12 FHLBanks, the purhase requirements on advanes ranged from 2 perent to 5 perent. For instane, if a memer had a $2 million advane transation with the FHLBank, it would have to purhase from $40,000 to $100,000 in apital stok. Most CDFIs Were Ale to Meet Memership Requirements While FHLBank and CDFI industry offiials we interviewed ited several memership requirements that ould pose a hallenge for nondepository CDFI appliants (inluding finanial ondition, long-term home mortgage Page 17 GAO CDFI Memership in FHLBanks

22 loan, mortgage-related assets, and stok purhase requirements), most of the nondepository CDFIs we interviewed were ale to meet these requirements or stated that they would e ale to meet the requirements. Finanial ondition requirements. Offiials we interviewed from 9 of the 12 nonmemer nondepository CDFIs stated that they would e ale to meet the finanial ondition standards, while 2 stated that they would potentially fae hallenges with the finanial ondition standards. 26 In addition to interviewing offiials from nondepository CDFIs that were nonmemers, we reviewed the appliations of the 27 nondepository CDFIs that were memers as of Septemer Seven of the 27 nondepository CDFIs did not meet at least one of the finanial ondition standards at the time of their appliation, ut made suessful reuttals and eame memers. 27 Making long-term mortgages. Of the 12 nonmemer nondepository CDFIs we interviewed, offiials from 1 ited the makes long-term home mortgage loans requirement as a hallenge for memership. In addition, offiials from 1 of the 10 memer nondepository CDFI we interviewed ited this as a hallenge, ut noted that they reeived an exemption from the minimum quantitative requirement imposed y the FHLBank. The offiials from the remaining 11 nonmemer and 9 memer CDFIs did not identify this requirement as a hallenge. Offiials from two FHLBanks stated that CDFIs in general may fae hallenges meeting this requirement, as some nondepository CDFIs may not make or hold longterm home mortgage loans if they are not involved in mortgage lending. Mortgage-related assets. Although the mortgage-related asset requirement varies among the FHLBanks, none of the offiials from the 12 nonmemer nondepository CDFIs we interviewed stated that they would fae hallenges meeting this requirement. 26 Offiials at one CDFI stated that they were not suffiiently familiar with the memership requirements to know if the CDFI ould meet the requirements. 27 Four of the seven CDFIs did not meet the net asset ratio standard, three of the seven CDFIs did not meet the loan loss reserves standard, two of the seven CDFIs did not meet the positive net inome standard, and two of the seven CDFIs did not meet the liquidity ratio standard. Four of the seven CDFIs failed two finanial ondition standards, with a total of 11 standards failed among seven CDFIs. Page 18 GAO CDFI Memership in FHLBanks

23 Stok-purhase requirements. Offiials from 1 of the 12 nonmemer CDFIs we interviewed stated that the amount of memership stok they would e required to purhase was ost prohiitive, while offiials from the 10 memer CDFIs we interviewed stated that the amount required was not a hallenge to memership. Nondepository memer CDFIs we interviewed were ale to purhase the required amount of memership stok. Offiials from one nonmemer nondepository CDFI in the FHLBank-Chiago distrit said that the CDFI was approved for memership, ut did not eome a memer eause the stok purhase requirement was too high. FHLBank-Pittsurgh reently amended its apital plan y lowering the memership and ativity-ased stok purhase alulations, iting enefits to CDFIs. In addition, FHLBank- Chiago reently redued its minimum memership stok purhase requirement to make it less ostly for nondepository CDFIs and others to join. (We disuss these and other hanges later in this report.) Rates of Nondepository CDFI Memership Were Low The rates of nondepository CDFI memership generally were low, ranging from 2.08 perent to perent of nondepository CDFIs in eah FHLBank distrit (see fig. 2). As of Deemer 31, 2014, 30 of the 522 nondepository CDFIs were FHLBank memers, and 6 of the 12 FHLBanks had memership rates of less than 5 perent for the nondepository CDFIs in their distrits. The numer of nondepository CDFI memers has inreased every year sine the first joined in Forty perent (12 of 30) of the urrent nondepository CDFI memers joined the FHLBank System in As of the end of 2014, all 12 FHLBanks had at least one nondepository CDFI memer; 2 approved their first nondepository CDFI memer in 2013 and another 3 did so in Page 19 GAO CDFI Memership in FHLBanks