Federal Home Loan Bank Capital Requirements
| Published date | 20 February 2019 |
| Citation | 84 FR 5308 |
| Record Number | 2018-27918 |
| Section | Rules and Regulations |
| Court | Federal Housing Finance Agency,Federal Housing Finance Board |
Federal Register, Volume 84 Issue 34 (Wednesday, February 20, 2019)
[Federal Register Volume 84, Number 34 (Wednesday, February 20, 2019)]
[Rules and Regulations]
[Pages 5308-5333]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27918]
[[Page 5307]]
Vol. 84
Wednesday,
No. 34
February 20, 2019
Part IIIFederal Housing Finance Board-----------------------------------------------------------------------Federal Housing Finance Agency-----------------------------------------------------------------------12 CFR Parts 930, 932, and 1277Federal Home Loan Bank Capital Requirements; Final Rule
Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 /
Rules and Regulations
[[Page 5308]]
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FEDERAL HOUSING FINANCE BOARD
12 CFR Parts 930 and 932
FEDERAL HOUSING FINANCE AGENCY
12 CFR Part 1277
RIN 2590-AA70
Federal Home Loan Bank Capital Requirements
AGENCY: Federal Housing Finance Board; Federal Housing Finance Agency.
ACTION: Final rule.
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SUMMARY: The Federal Housing Finance Agency (FHFA) is issuing this
final rule to adopt as its own portions of the regulations of the
Federal Housing Finance Board (Finance Board) pertaining to the capital
requirements for the Federal Home Loan Banks (Banks). The final rule
carries over most of the existing Finance Board regulations without
material change, but substantively revises the credit risk component of
the risk-based capital requirement, as well as the limitations on
extensions of unsecured credit. The principal revisions to those
provisions remove requirements that the Banks calculate credit risk
capital charges and unsecured credit limits based on ratings issued by
a Nationally Recognized Statistical Rating Organization (NRSRO), and
instead require that the Banks use their own internal rating
methodology. The final rule also revises the percentages used in the
tables to calculate the credit risk capital charges for advances and
non-mortgage assets. FHFA retains the percentages used in the existing
table to calculate the capital charges for mortgage-related assets, but
revises the approach to identify the appropriate percentage within the
table. FHFA also has revised the table numbers in the final rule to
align with the Federal Register's new formatting standards, which were
revised after publication of the proposed rule.
DATES: This rule is effective on January 1, 2020.
FOR FURTHER INFORMATION CONTACT: Scott Smith, Associate Director,
Division of Bank Regulation, Scott.Smith@FHFA.gov, 202-649-3193; Julie
Paller, Principal Financial Analyst, Division of Bank Regulation,
Julie.Paller@FHFA.gov, 202-649-3201; Neil R. Crowley, Deputy General
Counsel, Neil.Crowley@FHFA.gov, 202-649-3055; or Vickie R. Olafson,
Assistant General Counsel, Vickie.Olafson@FHFA.gov, 202-649-3025 (these
are not toll-free numbers), Federal Housing Finance Agency, 400 Seventh
Street SW, Washington, DC 20219. The telephone number for the
Telecommunications Device for the Hearing Impaired is 800-877-8339.
SUPPLEMENTARY INFORMATION:
I. Background
A. The Bank System
The eleven Banks are wholesale financial institutions organized
under the Federal Home Loan Bank Act (Bank Act).\1\ The Banks are
cooperatives. Only members of a Bank may purchase the capital stock of
a Bank, and only members or certain eligible housing associates (such
as state housing finance agencies) may obtain access to secured loans,
known as advances, or other products provided by a Bank.\2\ Each Bank
is managed by its own board of directors and serves the public interest
by enhancing the availability of residential mortgage and community
lending credit through its member institutions.\3\
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\1\ See 12 U.S.C. 1423, 1432(a).
\2\ See 12 U.S.C. 1426(a)(4), 1430(a), 1430b.
\3\ See 12 U.S.C. 1427.
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B. Federal Home Loan Bank Capital and Capital Requirements
In 1999, the Gramm-Leach-Bliley Act (GLB Act) \4\ amended the Bank
Act to replace the subscription capital structure of the Bank System.
It required the Banks to replace their existing capital stock with new
classes of capital stock that would have different terms from the stock
then held by Bank System members. Specifically, the GLB Act authorized
the Banks to issue new Class A stock, which is redeemable on six
months' notice, and Class B stock, which is redeemable on five years'
notice. The GLB Act allowed Banks to issue Class A and Class B stock in
any combination and to establish terms and preferences for each class
or subclass of stock issued, consistent with the Bank Act and
regulations adopted by the Finance Board.\5\ The classes of stock to be
issued, as well as the terms, rights, and preferences associated with
each class of Bank stock are governed by a capital structure plan,
which is established by each Bank's board of directors and approved by
FHFA.
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\4\ Public Law 106-102, 113 Stat. 1338 (Nov. 12, 1999).
\5\ See 12 U.S.C. 1426; 12 CFR part 1277.
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The GLB Act also amended the Bank Act to impose on the Banks new
total, leverage, and risk-based capital requirements similar to those
applicable to depository institutions and other housing government
sponsored enterprises (GSEs), and directed the Finance Board to adopt
regulations prescribing uniform capital standards for the Banks.\6\ The
Finance Board carried out that statutory directive in 2001 when it
published a final capital rule, and later adopted amendments to that
rule.\7\ In addition to addressing minimum capital requirements, the
rules established minimum liquidity requirements for each Bank and set
limits on a Bank's unsecured credit exposure to individual
counterparties and groups of affiliated counterparties.\8\ These
Finance Board regulations remain in effect and have not been
substantively amended since 2001.
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\6\ See 12 U.S.C. 1426(a). In 2008, the Housing and Economic
Recovery Act of 2008 (HERA) amended the risk-based capital
provisions in the Bank Act to allow FHFA greater flexibility in
establishing these requirements. Public Law 110-289, 122 Stat. 2654,
2676 (July 30, 2008) (amending 12 U.S.C. 1426(a)(3)(A)).
\7\ See Capital Requirements for Federal Home Loan Banks, 66 FR
8262 (Jan. 30, 2001) (``Final Finance Board Capital Rule''); and
Amendments to Capital Requirements for Federal Home Loan Banks, 66
FR 54097 (Oct. 26, 2001). The Finance Board regulations are found at
12 CFR part 932.
\8\ See Final Finance Board Capital Rule, 66 FR 8262; Amendments
to Capital Requirements for Federal Home Loan Banks, 66 FR 54097.
See also Final Rule: Unsecured Credit Limits for Federal Home Loan
Banks, 66 FR 66718 (Dec. 27, 2001) (amending 12 CFR 932.9).
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The GLB Act amendments to the Bank Act also defined the types of
capital that the Banks must hold--specifically permanent and total
capital. Permanent capital consists of amounts paid by members for
Class B stock plus the Bank's retained earnings, as determined in
accordance with generally accepted accounting principles (GAAP).\9\
Total capital is made up of permanent capital plus the amounts paid by
members for Class A stock, any general allowances for losses held by a
Bank under GAAP (but not allowances or reserves held against specific
assets or specific classes of assets), and any other amounts from
sources available to absorb losses that are determined by regulation to
be appropriate to include in total capital.\10\ As a matter of
practice, however, each Bank's total capital consists of its permanent
capital plus the amounts, if any, paid by its members for Class A
stock.
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\9\ See 12 U.S.C. 1426(a)(5).
\10\ Id. Neither the Finance Board nor FHFA has approved
including within a Bank's total capital any other amounts that are
available to absorb losses, and no Bank has any such general
allowances for losses as part of its capital.
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The Bank Act requires each Bank to hold total capital equal to at
least 4 percent of its total assets. The statute separately requires
each Bank to meet a leverage requirement of total capital to total
assets equal to 5 percent, but
[[Page 5309]]
provides that in determining compliance with this leverage requirement,
a Bank must calculate its total capital by multiplying the amount of
its permanent capital by 1.5 and adding to this product any other
component of total capital.\11\
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\11\ See 12 U.S.C. 1426(a)(2). See also 12 CFR 932.2.
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The GLB Act also required each Bank to meet a risk-based capital
requirement by maintaining permanent capital in an amount at least
equal to the sum of its credit risk and market risk, and the Finance
Board further required each Bank to maintain permanent capital to
support its operations risk.\12\ Under the Finance Board's implementing
regulations, a Bank must calculate a credit risk capital charge for
each of its assets, off-balance sheet items, and derivative contracts
to determine its risk-based capital requirement. The basic charge is
based on the book value of an asset, or other amount calculated under
the rule, multiplied by a credit risk percentage requirement (CRPR) for
that particular asset or item, which is derived from one of the tables
set forth in the rule. Generally, the CRPR varies based on the rating
assigned to the asset by an NRSRO and the maturity of the asset.\13\
The market risk capital charge is calculated separately, as the maximum
loss in the Bank's portfolio under various stress scenarios, estimated
by an approved internal model, such that the probability of a loss
greater than that estimated by the model is not more than one
percent.\14\ The operational risk capital charge equals 30 percent of
the combined credit and market risk charges for the Bank, although the
regulations allow a Bank to demonstrate that a lower charge should
apply, provided that FHFA approves its alternative approach and other
conditions are met.\15\
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\12\ See 12 U.S.C. 1426(a)(3)(A); 12 CFR 932.3 (Finance Board
implementing regulation). In 2008, HERA amended this provision to
require that FHFA establish risk-based capital regulations that
ensure that each Bank operates in a safe and sound manner, with
sufficient permanent capital and reserves to support the risks that
arise from its operations and management.
\13\ See 12 CFR 932.4. The capital charges for advances and
certain other ``unrated assets'' are not based on actual or imputed
NRSRO credit ratings.
\14\ See 12 CFR 932.5.
\15\ See 12 CFR 932.6.
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C. The Dodd-Frank Act and Bank Capital Rules
Section 939A of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) requires federal agencies to: (i)
Review regulations that require the use of an assessment of the credit-
worthiness of a security or money market instrument; and (ii) to the
extent those regulations contain any references to, or requirements
based on, NRSRO credit ratings, remove such references or
requirements.\16\ In place of such NRSRO rating-based requirements,
agencies are instructed to substitute appropriate standards for
determining creditworthiness. The Dodd-Frank Act further provides that,
to the extent feasible, an agency should adopt a uniform standard of
creditworthiness for use in its regulations, taking into account the
entities regulated by it and the purposes for which such regulated
entities would rely on the creditworthiness standard.
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\16\ See section 939A, Public Law 111-203, 124 Stat. 1887 (July
21, 2010) (15 U.S.C. 78o-7 note).
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Several provisions of the Finance Board capital regulations include
requirements that are based on NRSRO credit ratings, and thus must be
revised to comply with the Dodd-Frank Act provisions related to use of
NRSRO ratings.\17\ Specifically, as already noted, the credit risk
capital charges for certain Bank assets are calculated in large part
based on the credit ratings assigned by NRSROs to a particular
counterparty or specific financial instrument. In addition, the rule
related to the operational risk capital charge allows a Bank to
calculate an alternative capital charge if the Bank obtains insurance
to cover operational risk from an insurer with an NRSRO credit rating
of no lower than the second highest investment grade rating. Finally,
the capital rules addressed by this rulemaking also establish unsecured
credit limits for the Banks based on NRSRO credit ratings of their
counterparties. The final rule brings each of these provisions into
compliance with the Dodd-Frank Act by removing the references to NRSRO
credit ratings and replacing them with the provisions described below.
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\17\ See Advance Notice of Proposed Rulemaking: Alternatives to
Use of Credit Ratings in Regulations Governing the Federal National
Mortgage Association, the Federal Home Loan Mortgage Corporation,
and the Federal Home Loan Banks, 76 FR 5292, 5294 (Jan. 31, 2011).
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D. The Proposed Rule
Neither the Finance Board nor FHFA has amended the capital
regulations since their adoption in 2001. FHFA issued the proposed rule
principally to remove the references to NRSRO credit ratings, relocate
the Finance Board's capital regulations to the FHFA chapter of the
regulations, and make certain other amendments to the risk-based
capital provisions of the regulations.\18\ FHFA proposed to adopt most
of the provisions of the Finance Board regulations as its own without
substantive change. Thus, the proposed rule would have carried over the
Finance Board regulations addressing a Bank's total capital requirement
and risk-based capital requirement without change, and would have made
only modest revisions to the Finance Board regulations addressing
market risk, operational risk, and reporting requirements.\19\ FHFA
proposed to rescind as moot Sec. 932.1 of the Finance Board
regulations, which required agency approval of the Banks' initial
market risk models, and to rescind Sec. 932.8, which established a
contingency liquidity requirement for the Banks, because FHFA intended
to address liquidity requirements as part of a separate rulemaking.\20\
The proposed rule would have made significant substantive revisions to
only two provisions of the Finance Board regulations: Sec. 932.4,
regarding the determination of a Bank's credit risk capital
requirement; and Sec. 932.9, regarding limits on unsecured credit
exposures. In both cases, the proposed rule would have replaced
requirements based on NRSRO credit ratings with requirements based on a
Bank's own internal credit rating methodologies, and also would have
added new provisions in response to developments in the marketplace
relating to derivative contracts, specifically, the Dodd-Frank Act
mandate for clearing certain derivative transactions. With respect to
the credit risk capital charges, the proposed rule also would have
revised the CRPRs used in the current regulation's tables to calculate
the credit risk capital charges for advances and for non-mortgage
assets, off-balance sheet items, and derivative contracts. With respect
to the unsecured credit limits,
[[Page 5310]]
the proposed rule also would have codified the substance of certain
FHFA regulatory interpretations that have addressed the application of
the unsecured credit limits in particular situations. The proposed rule
would not have changed the basic percentage limits used to calculate
the amount of unsecured credit a Bank can extend to a single
counterparty or group of affiliated counterparties.
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\18\ See Proposed Federal Home Loan Bank Capital Requirements,
82 FR 30776 (July 3, 2017). FHFA previously repealed the Finance
Board regulations governing the classes of capital stock that the
Banks may issue and the requirements for their capital structure
plans, and incorporated the substance of those provisions, with
certain amendments, into its own regulations, at 12 CFR part 1277,
subparts C and D. See Final Rule on Federal Home Loan Bank Capital
Stock and Capital Plans, 80 FR 12753 (Mar. 11, 2015).
\19\ See 12 CFR 932.2 (total capital), 932.3 (risk-based
capital), 932.5 (market risk), 932.6 (operational risk), 932.7
(reporting requirements).
\20\ Since the date of the proposed rule, FHFA has issued an
advisory bulletin addressing Bank liquidity management, AB 2018-07
(Aug. 27, 2018), and does not currently intend to pursue a separate
rulemaking on that topic. The advisory bulletin is available at:
https://www.fhfa.gov/SupervisionRegulation/AdvisoryBulletins/Pages/Federal-Home-Loan-Bank-Liquidity-Guidance.aspx. The advisory
bulletin also rescinds prior supervisory guidance that FHFA had
issued in March 2009 on the topic of liquidity management. As
proposed, the final rule rescinds the contingency liquidity
provision currently located at 12 CFR 932.8 of the Finance Board
regulations.
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E. Overview of Comments on the Proposed Rule
The proposed rule provided a comment period of 60 days, which
closed on September 1, 2017. FHFA received only one comment letter on
the proposed rule, which was a joint letter from the eleven Banks. The
paragraphs immediately below provide brief descriptions of the
principal issues addressed by the Banks' comment letter. Those issues
are discussed in greater detail within the relevant provisions of the
section-by-section discussion of the final rule, set out at Section II,
below. Office of the Federal Register standards now require tables be
numbered consecutively within the section. Accordingly, FHFA has also
revised the tables to Sec. 1277.4 that were labelled 1.1, 1.2, 1.3,
1.4, and 2 in the proposed rule to Tables 1, 2, 3, 4, and 5,
respectively, in the final rule, and will be referenced as such in the
preamble.
Capital charges. The Banks contended that the proposed rule would
have set capital charges for certain categories of assets higher than
they should be, given the historical performance of those asset types.
With respect to advances, the Banks questioned the proposed increases
in capital charges, which would have increased modestly for all
maturities over those in the current rule. The Banks asserted that FHFA
should instead reduce the capital charges for advances in light of
their historical performance and the Banks' priority security interest
in collateral pledged to secure the advances. With respect to
derivative contracts between a Bank and its members, the Banks asked
that FHFA retain the current capital provision for those contracts,
under which the capital charge is the same as that for an advance with
the same maturity. The proposed rule would have treated derivative
contracts with Bank members in the same manner as derivative contracts
with other counterparties, which carry higher capital charges. The
Banks reasoned that retaining the current capital treatment for
derivative contracts with their members was appropriate, given that all
such derivative contracts are fully secured in the same manner as their
advances, and that the Banks are exposed to less credit risk on such
transactions than is the case with derivative contracts with dealer
counterparties. The proposed rule had included a zero percent capital
charge for obligations issued by the Enterprises while those
obligations are backed by the direct financial support of the United
States Treasury Department. The Banks asked that FHFA extend that
provision to all other GSEs, regardless of whether they received such
federal support.
The Banks also questioned the proposed CRPRs for collateralized
mortgage obligations (CMOs), most of which would be higher than the
CRPRs for mortgage-backed securities structured as pass-through
instruments. The Banks contended that the current market value and
historical performance of the senior tranches of CMOs support a capital
requirement similar to that imposed on pass-through securities. The
Banks requested, therefore, that the final rule treat all categories of
CMOs the same as the corresponding categories of pass-through
securities, unless a particular CMO exhibits the characteristics of a
subordinated tranche and the performance of an unsecured investment. In
a similar fashion, the Banks disagreed with the proposed rule's
treatment of multifamily mortgage backed securities (MBS) and
commercial mortgage backed securities (CMBS), notwithstanding that the
proposed rule would not have changed the capital charges for those
instruments from the charges imposed by the current regulations. The
Banks contended that multifamily MBS perform more like single family
residential mortgage securities and should, therefore, be subject to
similar capital charges. As an alternative, the Banks suggested that
FHFA create separate CRPR tables for both multifamily MBS and for CMBS,
noting that both of these security types have performed better than
unsecured or subordinated debt instruments.
The Banks also requested that FHFA revise the operational risk
capital requirement, which requires each Bank to maintain permanent
capital equal to 30 percent of the sum of its credit and market risk
requirements, and which can be reduced to no less than 10 percent of
that amount if FHFA approves a Bank's alternative methodology for
quantifying operational risk. The Banks asked that FHFA remove the 10
percent lower bound for approved alternative methodologies, reasoning
that a fixed minimum is not necessary if FHFA has approved a Bank-
developed methodology. The Banks further asked that FHFA provide
analytical support for the 30 percent and 10 percent thresholds, which
FHFA had proposed to carry over from the Finance Board regulations
without change.
Unsecured extensions of credit. The Banks raised three issues
relating to the proposed limits for unsecured extensions of credit. The
first issue relates to FHFA's proposal to eliminate the special
treatment currently afforded to extensions of unsecured credit to GSEs.
The current rule allows a Bank to extend unsecured credit to a GSE in
an amount equal to 100 percent of the lesser of the total capital of
the Bank or the GSE counterparty. The proposed rule would have reduced
the general limit for all GSEs (other than those operating with
explicit financial support of the United States) by treating them in
the same manner as any other counterparty, meaning that the maximum
limit for extensions of unsecured credit to a GSE could not exceed 15
percent of the lesser of the total capital of the Bank or the GSE, or
30 percent when including overnight exposures. The Banks asked that
FHFA retain a special unsecured limit for all GSEs, and not just for
those operating with direct government support. The second issue sought
clarification of an exception within Sec. 1277.7(g)(2) of the proposed
rule, which would have excluded cleared derivative transactions from
being subject to the unsecured credit limits, by extending it to
include as well any posted collateral associated with the cleared
derivative transactions. The third issue pertained to the reporting
period for total secured and unsecured extensions of credit, which the
Banks asked be changed from monthly to quarterly to be consistent with
the change in the reporting periods that FHFA proposed for both the
market and credit risk-based capital requirements.
Derivatives and collateral. A number of the Banks' comments focused
on the proposed capital treatment of cleared derivatives, as well as of
the collateral relating to a derivative contract that is either held or
posted by the Banks. These comments requested that FHFA clarify that,
for purposes of determining the current credit exposure on a cleared
derivative contract under Sec. 1277.4(i)(1)(i) of the final rule, the
mark-to-market value of the contract be characterized as a de minimis
amount. The Banks also requested that FHFA modify Sec. 1277.4(i)(2) of
the proposed rule, which specified alternative means for determining
the potential future credit exposure on a derivative contract, to allow
the use of the initial margin models used by Derivatives Clearing
Organizations (DCOs). The Banks also
[[Page 5311]]
asked that FHFA not assess any capital charge against the amount of the
collateral posted by a Bank to a DCO that exceeds the Bank's current
credit exposure to the DCO, reasoning that the credit risk capital
charge should include only the potential future credit exposure, and
not also the initial margin required and held by the DCO as collateral.
The Banks also asked that the final rule clarify that the collateral
posted by a Bank should be valued without reduction for any discounts
or haircuts imposed by agreement or regulation, and that FHFA retain
the proposed provision that would require that collateral held by a
Bank be valued after such discounts. The Banks further requested that
the final rule provide that the capital charge on collateral pledged by
a Bank only reflect the incremental CRPR attributable to the risk of
the collateral custodian because the pledged collateral would already
be subject to its own capital charge by virtue of being an asset on the
Bank's balance sheet. The Banks raised one other issue relating to the
credit risk capital requirement for uncleared derivative contracts,
asking that the final rule exclude any capital charge applicable to
collateral held by the Bank that is used to reduce the current, and
possibly also the potential future, exposures.
Other Comments. Most of the other comments addressed lesser issues
or were more technical in nature. With respect to the capital treatment
for private label MBS, the Banks requested that FHFA clarify that their
internal credit ratings for such assets should be based on potential
future losses to the amortized cost of the asset. The Banks also
requested that FHFA modify the proposed language to require that a Bank
address any deficiencies in its methodology identified by FHFA, rather
than allowing FHFA, on a case-by-case basis, to direct a Bank to change
the calculated credit risk charge on particular assets. Another Bank
comment suggested that FHFA be consistent in its treatment of
guarantors under both the capital and unsecured credit provisions, some
of which mandate that a Bank use the creditworthiness of the guarantor
in applying a regulation and others of which are permissive and allow a
Bank to use creditworthiness of the counterparty or the guarantor in
applying other regulations. Specifically, the Banks asked that FHFA
amend the unsecured credit limits to allow the Banks to choose either
the counterparty or its third-party guarantor when determining its
maximum unsecured credit exposure to the counterparty. The Banks also
requested that FHFA clarify that the term ``remaining maturity''
contained in Table 2 means the ``weighted average life of the asset.''
The Banks also asked that FHFA shorten the historical observation
period that the Banks must use when running their internal market risk
models. Section 1277.5(b)(4)(ii) of the proposed regulation carried
over the substance of the Finance Board regulation, which requires that
the observation period begin in 1978, and the Banks asked that FHFA
allow them to commence the period in 1992, to be consistent with other
FHFA guidance.
II. Section-by-Section Analysis of the Final Rule
A. Definitions--Sec. 1277.1
The proposed rule included definitions for seven new terms, which
are: ``collateralized mortgage obligation,'' ``derivatives clearing
organization,'' ``eligible master netting agreement,'' ``non-mortgage
asset,'' ``non-rated asset,'' ``residential mortgage,'' and
``residential mortgage security.'' FHFA received no comments on these
definitions and is adopting them as proposed. The Banks' comment letter
asked that the final rule also define the terms ``internal market-risk
model'' and ``internal cash-flow model.'' Both terms are used, but not
defined, in 12 CFR 932.5 of the Finance Board regulations (the market
risk capital requirement) and were carried forward into the
corresponding provisions of the proposed rule. FHFA agrees that
defining these terms would add clarity to the regulation by describing
the time dimension of the analysis that is to be done with each of the
two model approaches under the market risk provisions of the
regulation. FHFA has defined ``internal market-risk model'' as a model
that is used to assess the effect on portfolio value from an
instantaneous shock to interest rates, volatilities, and option
adjusted spreads, and has defined ``internal cash-flow model'' as a
model that is used to assess the evolution in portfolio value and cash-
flows over a time-path of such shocks that could extend out for a
period of years.
In response to another comment questioning the need for the Banks
to hold capital against any excess collateral that a Bank has posted to
a DCO, FHFA has added the term ``bankruptcy remote'' to Sec.
1277.4(e)(5)(ii)(C) and also has defined that term. As defined,
``bankruptcy remote'' describes collateral that a Bank has pledged to a
DCO counterparty but that would not be included in that counterparty's
estate under any insolvency or similar proceedings. If any excess
collateral pledged to a DCO is held in a manner that is bankruptcy
remote a Bank need not hold capital against that amount. If the excess
collateral pledged to a DCO is held in a manner that is not bankruptcy
remote, the Bank would have to hold capital against it, as provided by
Sec. 1277.4(e)(5)(ii)(C). The final rule also includes a new
definition of ``residential mortgage asset,'' which includes individual
one-to-four family residential mortgage loans, pools of such loans, and
residential mortgage pass-through securities. FHFA has added that
definition to distinguish between the types of mortgage-related assets
for which CRPRs are derived from categories in the top half of Table 4
and CMOs, for which CRPRs are derived from the categories in the lower
half of Table 4.
B. Total Capital and Risk-Based Capital Requirements--Sec. Sec. 1277.2
and 1277.3
FHFA is adopting proposed Sec. Sec. 1277.2 and 1277.3, each of
which is identical in substance to the corresponding provision in the
Finance Board regulations, as final without change. Section 1277.2 sets
forth the minimum total capital and leverage ratios that each Bank must
maintain under section 6(a)(2) of the Bank Act.\21\ Section 1277.3 sets
forth a Bank's risk-based capital requirement and requires each Bank to
hold at all times an amount of permanent capital that is equal to or
greater than the sum of its credit risk, market risk, and operational
risk capital requirements.\22\ In turn, Sec. Sec. 1277.4, 1277.5, and
1277.6 establish, respectively, the requirements for calculating a
Bank's credit risk, market risk, and operational risk capital charges,
as described below.
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\21\ 12 U.S.C. 1426(a)(2).
\22\ FHFA believes that this approach remains consistent with
the amendments made by HERA to the risk-based capital requirements
in the Bank Act. As amended, the Bank Act provides the Director with
broad authority to establish by regulation risk-based capital
standards for the Banks that ensure the Banks operate in a safe and
sound manner with sufficient permanent capital and reserves to
support the risks arising from their operations. See 12 U.S.C.
1426(a)(3)(A).
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C. Credit Risk Capital Requirements--Sec. 1277.4
1. Overview of Proposed Sec. 1277.4
The principal revisions to the current credit risk capital
requirements included in proposed Sec. 1277.4 would have changed how a
Bank determines the CRPRs used to calculate capital charges for its
non-mortgage assets,
[[Page 5312]]
derivative contracts, and off-balance sheet items (Table 2 in the final
rule), and for its residential mortgage assets (Table 4 in the final
rule). In both cases, the proposed rule would have required a Bank to
determine the capital charge based on a credit rating that the Bank
calculates internally, rather than on an NRSRO credit rating, as had
been the case under the Finance Board regulations. In addition, the
proposed rule would have updated the individual CRPRs in Tables 1 and
2, which are used to calculate the applicable capital charges for
advances and non-mortgage assets, respectively. The proposed rule also
would have changed the frequency of a Bank's calculation of its credit
risk capital charges from monthly to quarterly.\23\ FHFA received no
comments on the structure of proposed Sec. 1277.4, which addresses all
aspects of the credit risk capital requirement, and is adopting that
structure without change. As discussed below, FHFA received a number of
comments suggesting modifications to certain aspects of proposed Sec.
1277.4.
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\23\ Section 1277.5(e) of the proposed rule also would have
required the Banks to calculate their market risk capital charge
quarterly, rather than monthly, and the final rule adopts that
provision.
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2. Credit Risk Capital Requirements: General Requirement--Sec.
1277.4(a); Credit Risk Capital Charge for Residential Mortgage Assets
and Collateralized Mortgage Obligations--Sec. 1277.4(b); Credit Risk
Capital Charge for Advances, Non-Mortgage Assets, and Non-Rated
Assets--Sec. 1277.4(c)
FHFA received no comments on paragraphs (a) through (c) of proposed
Sec. 1277.4 and is adopting them as final without change. The general
requirement under Sec. 1277.4(a) provides that a Bank's credit risk
capital requirement shall equal the sum of the individual credit risk
capital charges for its advances, residential mortgage assets, non-
mortgage assets, off-balance sheet items, derivative contracts, and
non-rated assets. Section 1277.4(b) directs the Banks to determine
capital charges for residential mortgages, residential mortgage pools,
residential mortgage securities, and collateralized mortgage
obligations in accordance with Sec. 1277.4(g). Section 1277.4(c)
directs the Banks to determine capital charges for advances, non-
mortgage assets, and non-rated assets pursuant to Sec. 1277.4(f), and
to use the amortized cost of the asset in doing so, i.e., a Bank
determines the capital charges for those assets by multiplying the
amortized cost of the asset by the CRPR assigned to the asset under the
appropriate table. Section 1277.4(c) also includes an exception for any
asset that a Bank carries at fair value and for which the Bank
recognizes changes in that asset's fair value in income. For these
assets, the Bank would multiply the fair value of the asset by the
applicable CRPR to determine its capital charge. As explained in the
proposed rule, FHFA is requiring Banks to use the amortized cost or
fair value (rather than the book value as required in the current
Finance Board regulation) because those are the current financial
instrument recognition and measurement attributes used in relevant
accounting guidance.\24\
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\24\ The final rule includes a similar provision, at 12 CFR
1277.4(g)(1), which pertains to the calculation of capital charges
related to residential mortgage assets and collateralized mortgage
obligations.
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3. Credit Risk Capital Charge for Off-Balance Sheet Items--Sec.
1277.4(d)
Section 1277.4(d) addresses capital charges for off-balance sheet
items and is identical in substance to the current Finance Board
regulation. FHFA received no comments on paragraph (d) of proposed
Sec. 1277.4 and is adopting it as final without change. Under this
provision, the capital charge for such items will continue to be equal
to the credit equivalent amount of the item multiplied by the
appropriate CRPR assigned to the item by Table 2 of Sec. 1277.4,
except for standby letters of credit, for which the CRPR will be the
same as the CRPR established under Table 1 for an advance with the same
maturity. Section 1277.4(d) further directs the Banks to determine the
credit equivalent amount for all off-balance sheet items in accordance
with Sec. 1277.4(h), which also is identical in substance to the
corresponding Finance Board regulation. Thus, a Bank may continue to
calculate the credit equivalent amount for an off-balance sheet item by
using either an FHFA-approved model or the credit conversion factors
set forth in Table 5 to Sec. 1277.4. Section 1277.4(h) also carries
over the provision of the current regulation that allows the Banks to
use a credit conversion factor of zero for any off-balance sheet
commitments that are unconditionally cancelable or effectively provide
for cancellation upon deterioration in the borrowers' creditworthiness.
4. Credit Risk Capital Requirements for Derivative Contracts--Sec.
1277.4(e)
Section 1277.4(e) of the final rule establishes the general
requirements for calculating credit risk capital charges for derivative
contracts. The proposed rule included a number of changes to the
current Finance Board regulation's capital treatment of derivatives.
These changes reflect developments in derivatives regulations brought
about by the Dodd-Frank Act, including the clearing requirement for
many standardized over-the-counter (OTC) derivative contracts and the
adoption by FHFA, jointly with other federal regulators, of the Final
Rule on Margin and Capital Requirements for covered Swap Entities,
which established margin and capital requirements for uncleared swap
contracts.\25\ FHFA received comments relating to several provisions of
Sec. 1277.4(e) in the proposed rule relating to derivative contracts
and has revised the final rule in certain respects to address those
comments, as described below. Overall, however, the derivatives
provisions of the final rule are in most respects substantively the
same as the proposed rule. Section 1277.4(e)(1), (2), and (3), which
address the method of calculating the capital charge, the use of
collateral to reduce the capital charge, and the requirements for using
such collateral, respectively, are in substance the same as the
corresponding provisions of the proposed rule. FHFA revised the
language of paragraph (e)(1)(i), relating to the calculation of the
current credit exposure, to state more directly that the Banks should
use the column within Table 2 for items with maturities of one year or
less when determining the CRPR for a derivative contract; the proposed
rule had been phrased in terms of deeming the contract to have a
maturity of one year or less. FHFA also revised paragraph (e)(1)(iii)
to refer to the ``undiscounted amount'' of excess collateral posted by
a Bank on a contract, in response to a comment from the Banks. FHFA has
revised the language of paragraph (e)(2) of the final rule with the
intent of describing with more clarity the manner in which the Banks
may use collateral provided by their counterparties to reduce the
capital charge on a derivative contract. Section 1277.4(e)(3), which
describes conditions that must be satisfied in order for such
collateral to be eligible to reduce the capital charge, is unchanged
from the proposed rule. FHFA has added a new paragraph (e)(4) to Sec.
1277.4 of the final rule in response to comments received from the
Banks. This provision now deals with derivative contracts between a
Bank and its members and effectively reinstates a provision that is in
the current Finance
[[Page 5313]]
Board regulations. Paragraph (e)(5) of the final rule, which sets the
capital charges for certain foreign exchange rate contracts and for
cleared derivatives contracts, is the same as paragraph (e)(4) of the
proposed rule, with one revision. Under that revision, a Bank would
have to hold capital against any excess collateral that it has posted
to a DCO only if the DCO holds the collateral in a manner that is ``not
bankruptcy remote.'' The final rule also added a definition of
``bankruptcy remote,'' as described previously. The discussion below
provides a more detailed description of the various provisions of the
final rule addressing derivative contracts.
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\25\ See Final Rule on Margin and Capital Requirements for
Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015), as amended, 83
FR 50805 (Oct. 10, 2018).
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i. General Credit Risk Capital Charge Calculations for Derivative
Contracts
Uncleared Derivative Contracts
Section 1277.4(e)(1) of the final rule establishes credit risk
capital charges for uncleared derivative contracts to which a Bank is
party.\26\ The initial credit risk capital charge for an uncleared
derivative contract equals the sum of: (i) The current credit exposure
on the contract multiplied by the appropriate CRPR; (ii) the potential
future credit exposure multiplied by the appropriate CRPR; and (iii)
the undiscounted amount of any collateral posted by the Bank with
respect to the contract that exceeds its payment obligation, multiplied
by the CRPR assigned to the entity holding the collateral. A Bank must
calculate its current and potential future credit exposures on a
derivative contract in accordance with Sec. 1277.4(i)(1)(ii) and
(i)(2), respectively. A Bank may reduce that capital charge if it holds
certain collateral against its counterparty's payment obligations, as
provided in Sec. 1277.4(e)(2), which is described below.\27\
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\26\ The current Finance Board regulations do not impose any
capital charge on cleared derivative contracts. When the Finance
Board adopted those regulations, the only type of cleared derivative
contracts that the Banks used were exchange-traded futures
contracts, which the Banks did not use to a significant degree. The
Banks, however, have long used OTC derivative contracts in
connection with their business, principally for hedging purposes.
Given the Dodd-Frank Act clearing requirements, Banks will now be
required to clear a significant percentage of their OTC derivative
contracts. For that reason, FHFA determined that it was prudent to
apply a capital charge to the Banks' exposure under such contracts.
Because a futures contract is a type of cleared derivative contract,
such contracts will be subject to the new capital charges.
\27\ See discussion infra section II.C.4.iii, addressing the
requirements under Sec. 1277.4(e)(2).
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Cleared Derivative Contracts and Foreign Exchange Rate Contracts
Section 1277.4(e)(5)(ii) of the final rule includes a separate
provision for determining the credit risk capital charge for a cleared
derivative contract. While the credit risk capital charge for an
uncleared derivative contract is based on the applicable CRPR and
deemed maturity from Table 2 under Sec. 1277.4, the credit risk
capital charge for all cleared derivative contracts is set at a fixed
percentage of the sum of the three elements listed in Sec.
1277.4(e)(5)(ii)(A) through (C) of the final rule. Section
1277.4(e)(5)(ii) provides that the credit risk capital charge for a
cleared derivative contract will be equal to 0.16 percent times the sum
of a Bank's current credit exposure on the contract,\28\ plus its
potential future credit exposure on the contract, plus the amount of
any excess collateral posted by the Bank and held by the clearing
organization in a manner that is not ``bankruptcy remote.'' \29\
Section 1277.4(e)(5)(ii)(A) and (B) further provide that a Bank must
calculate its current and potential future credit exposures on a
cleared derivative in accordance with Sec. 1277.4(i)(1)(i) and (i)(2),
respectively. FHFA has made one clarifying revision to Sec.
1277.4(e)(5)(ii)(A) by replacing a cross-reference to ``paragraph
(i)(1)'' with a reference to ``paragraph (i)(1)(i).'' The original text
had included provisions related to single derivative contracts--which
could include both cleared and uncleared transactions--as well as to
multiple contracts with one counterparty that were subject to an
eligible master netting agreement--which category would include only
uncleared derivative contracts. The revision makes clear that the
provisions of Sec. 1277.4(i)(1)(ii) regarding contracts subject to
netting agreements do not apply when determining the current credit
exposure for a cleared derivative contract. Section 1277.4(e)(5)(i)
also includes a separate provision that carries over from the Finance
Board regulations an exception for certain foreign exchange rate
contracts. That provision establishes a zero percent capital charge for
foreign exchange rate contracts (excluding gold contracts), that have
an original maturity of 14 calendar days or less, and explicitly
excludes gold contracts from this provision.
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\28\ This capital charge for cleared derivative contracts is
consistent with the minimum total capital charge that would be
applicable to cleared derivative contracts under the standardized
approach in the capital rules adopted by federal banking regulators.
For example, the risk weight applied to a cleared derivative
contract under the FDIC regulations is two percent of the trade
exposure amount. See 12 CFR 324.35(b)(3)(i)(A), (c)(3). The total
capital ratio required under the FDIC regulations is eight percent
of the risk-weighted asset. See 12 CFR 324.10(a)(3). Thus, the
required capital for a cleared contract would be eight percent of
the contract's risk weight, which would be two percent of its
exposure amount, or 0.16 percent of the exposure amount. FHFA,
however has not adjusted the charge to account for any additional
capital amounts needed to comply with the capital conservation
buffer under the federal banking regulators' rules.
\29\ Section 1277.4(e)(5)(ii)(A) provides that the current
credit exposure for a cleared derivative contract is to be
calculated in accordance with Sec. 1277.4(i)(1)(i), which sets
forth the method to calculate current credit exposures for a single
derivative contract. As noted in the proposed rule, given that most
clearing organizations effectively settle a cleared derivative
contract at the end of the day, the current credit exposure for any
such contract often would be zero or a small amount, depending on
the timing of the daily settlement.
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Derivative Contracts With a Member
As noted previously, Sec. 1277.4(e)(4) of the final rule
reinstates a provision from the Finance Board regulations that
establishes a different means of determining the credit risk capital
charge for a derivative contract between a Bank and one of its members.
Under this provision, a Bank will calculate the capital charge for such
transactions in accordance with Sec. 1277.4(e)(1), which applies to
uncleared derivative contracts, but will obtain the CRPRs from Table 1
of the final rule (which applies to advances), rather than from Table
2, which otherwise would apply and which has somewhat higher CRPRs.
ii. Collateral Valuation for Derivative Contracts
Collateral Valuation--Uncleared Derivative Contracts
FHFA proposed the requirement relating to a Bank's excess pledged
collateral under Sec. 1277.4(e)(1)(iii) in order to address a credit
risk exposure that is not addressed by the current Finance Board
regulations. Specifically, this provision of the final rule takes into
account the credit exposure that arises from the amount of collateral
that a Bank posts in excess of the Bank's current, marked-to-market
obligation to its counterparty under a particular derivative
contract.\30\ In most instances, the value of the Bank's posted
collateral will exceed the Bank's current obligation under the
derivative contract. That amount of excess collateral constitutes a
credit exposure for the Bank because of the possibility that the party
holding the collateral may fail and the Bank may not be able to recover
its excess collateral. Under Sec. 1277.4(e)(1)(iii), a Bank will
calculate the specific charge for the posted excess collateral based on
a CRPR obtained from Table 2, using the Bank's internal rating for the
counterparty or custodian
[[Page 5314]]
holding such collateral, with the rating determined in accordance with
Sec. 1277.4(f)(1)(ii), and using the column in Table 2 for items with
a maturity of one year or less. The Banks asked that FHFA clarify the
final rule by stating that they need not discount the value of the
collateral they have posted when applying this provision. FHFA agrees
that they need not do so and has revised Sec. 1277.4(e)(1)(iii) to
refer to ``the undiscounted amount of collateral posted by the Bank.''
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\30\ Generally, this amount should equal the initial margin that
a Bank would post under its derivative contracts with a particular
counterparty.
---------------------------------------------------------------------------
The Banks also questioned the appropriateness of applying a capital
charge to the excess collateral they post on a derivative contract,
contending that any such collateral would equal the initial margin,
which they suggested performs a similar risk mitigation and protection
function as potential future exposure. The Banks reasoned that
assessing a capital charge for both the potential future exposure under
the contract and for any collateral posted to cover initial margin
would be duplicative, and that FHFA should remove the capital charge on
the excess collateral from the rule. FHFA does not agree that these
risk exposures are the same and therefore has made no change to Sec.
1277.4(e)(1) of the final rule in response to this comment. The
potential future exposure component of the rule addresses the risk to
the Bank that the counterparty will not make payment on its obligations
under the derivative contract, whereas the provision addressing the
excess collateral posted by the Bank is intended to address the risk to
the Bank that the entity holding its collateral will not return it to
the Bank. Imposing a capital charge on both of these credit exposures
also is consistent with actions taken by the federal banking regulators
in the context of cleared derivatives contracts, where the minimum
total capital charge that applies to those contracts under the
standardized approach in those capital rules includes such a
provision.\31\
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\31\ In this rule, FHFA has not required that the Banks adjust
the capital charge to account for any additional capital amounts
needed to comply with the capital conservation buffer, as is the
case under the federal banking regulators' rules.
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Collateral Valuation--Cleared Derivative Contracts
The credit risk capital charge related to the excess collateral
that a Bank pledges to its counterparty for a cleared derivative has
been revised from the proposed rule in response to Bank comments on a
related issue, and now differs from the corresponding charge for an
uncleared derivative. The Banks had questioned the provision of the
proposed rule that addressed excess collateral, noting that collateral
posted to a DCO to cover initial margin must be held by the DCO under
strict legal requirements, including segregation, control, and
investment limitations, all of which protect the initial margin from
loss and largely eliminate credit risk arising from the pledging of the
collateral. FHFA agrees with that assessment and therefore has amended
Sec. 1277.4(e)(5)(ii)(C) of the final rule so that it now imposes a
capital charge on excess collateral posted for a cleared derivative
only if the collateral is held by the custodian in a manner that is not
``bankruptcy remote.'' If the excess collateral is held in a manner
that is bankruptcy remote, then the final rule does not impose any
capital charge on that collateral, i.e., the final rule effectively
assigns a zero capital charge to any such excess collateral held by a
custodian in a manner that is bankruptcy remote. This provision also is
consistent with the regulations of the other federal banking
regulators, which recognize this risk and have instituted similar
capital charges for excess collateral posted to their institutions' DCO
derivative counterparties that is not held in a manner that is
bankruptcy remote.\32\
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\32\ See, e.g., 12 CFR 217.35(b)(2)(i)(B) (Federal Reserve
System); 12 CFR 324.35(b)(2)(i)(B) (FDIC).
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iii. Reduction of Credit Risk Capital Charge Calculated Under Sec.
1277.4(e)(2)
Section 1277.4(e)(2) of the final rule also includes two provisions
that would allow a Bank to reduce the capital charge on an uncleared
derivative contract if its counterparty has provided collateral to
support its payment obligation or has obtained a third-party guarantee
for its payment obligations. First, under Sec. 1277.4(e)(2)(i) a Bank
may reduce its credit risk capital charge for the current and potential
future exposures of its derivative contracts based on the discounted
value of collateral posted by the counterparty. As noted previously,
the substance of this provision is the same as the proposed rule, but
the language has been revised to provide greater clarity. This
provision specifies the manner in which the Bank may apply the
counterparty's collateral--first, to reduce the current credit
exposure, and second, to reduce the potential future exposure. In such
cases, the capital charge for the derivative contract will equal the
amount of the initial capital charge that remains after having been
reduced by the value of the pledged collateral. The final rule requires
that a Bank also must hold capital against that portion of the
discounted collateral that the Bank has applied to reduce its exposure.
The Banks' comment letter suggested that the language describing the
calculation of the capital charge for the collateral was ambiguous with
respect to whether the collateral must be multiplied by the applicable
CRPR before or after it is applied to reduce the exposures. FHFA
intended that the capital charge for the pledged collateral would be
assessed only after the full amount of the discounted collateral had
been applied to reduce the credit exposures, and has amended Sec.
1277.4(e)(2)(i) of the final rule to clarify that intent.
Second, under Sec. 1277.4(e)(2)(ii) a Bank may adjust the
otherwise applicable capital charge for any derivative contract for
which the counterparty's payment obligation is unconditionally
guaranteed by a third party. This provision is permissive, not
mandatory, and allows the Banks the option of using either the CRPR
associated with the derivative counterparty or that associated with the
guarantor, whichever results in the lower capital charge.
iv. Collateral Eligibility Requirements--Derivative Contracts
With respect to collateral pledged by a counterparty, Sec.
1277.4(e)(2)(i) provides that the collateral must satisfy the
eligibility requirements set out in Sec. 1277.4(e)(3) before it may be
used to reduce the otherwise applicable capital charge on the
derivative contract. As discussed previously, the eligibility
provisions of Sec. 1277.4(e)(3) of the final rule are unchanged from
the proposed rule. That section generally requires that the collateral
must be held by the Bank or its custodian, be legally available to
absorb losses, be of a readily determinable value at which it can be
liquidated, and be subject to an appropriate discount.\33\ These
provisions of the final rule are intended to ensure that any collateral
pledged by a counterparty must meet certain minimum standards before a
Bank may use it to reduce the otherwise applicable credit risk capital
charge for its derivative contracts. These standards are slightly more
stringent than the collateral standards in the current Finance Board
regulation, but they are consistent with the stricter requirements for
derivative contracts that have
[[Page 5315]]
evolved subsequent to the recent financial crisis.\34\
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\33\ Collateral held by a third-party custodian must be held
pursuant to a custody agreement that satisfies the requirements of
12 CFR 1221.7(c), (d) of FHFA's regulations, regarding margin and
capital requirements for covered swap entities. The collateral
discount also must be at least equal to the minimum discount
required under appendix B to part 1221 of the FHFA regulations.
\34\ For any derivative transactions with swap dealers or major
swap participants, the Bank would already have to meet these higher
collateral standards under applicable uncleared swaps margin and
capital rules. Thus, FHFA does not anticipate that the proposed
change would affect transactions with these types of counterparties.
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The final rule does not limit the collateral that a Bank may accept
to those items that satisfy the eligibility requirements for collateral
under the uncleared derivatives rule, because not all Bank derivative
counterparties are subject to these requirements.\35\ This is a change
from the current Finance Board regulation, which allows Banks to take
account of collateral held against derivatives exposures only if a
member or affiliate of the member holds the collateral. The current
rule also does not impose specific minimum discounts on any type of
collateral but allows a Bank to determine a suitable discount.
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\35\ See 12 CFR 1221.6. Under the final rule, a Bank must apply
at least the minimum discount listed in appendix B of the margin and
capital rule for uncleared swaps to any collateral listed in that
appendix or it could apply a suitable discount determined by the
Bank based on appropriate assumptions about price risk and
liquidation costs to collateral not listed in appendix B.
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v. Calculation of Current and Potential Future Credit Exposures on
Derivative Contracts
Calculation of Current Exposure on Derivative Contracts
A separate provision of the final rule, Sec. 1277.4(i), addresses
the method for calculating a Bank's current and potential future credit
exposures under a derivative contract. This paragraph of the final rule
is identical to the proposed rule except for the addition of a new
provision that allows the Banks to use an initial margin model that is
employed by a derivatives clearing organization as one option for
calculating the potential future credit exposure on their derivative
contracts. As proposed, the final rule carries over the same approach
for calculating the current credit exposure as under the Finance Board
regulations. Specifically, Sec. 1277.4(i)(1)(i) provides that the
current credit exposure for a single derivative contract that is not
subject to an eligible master netting agreement equals the marked-to-
market value of the contract if that value is positive or zero if that
marked-to-market value is zero or negative. The Banks' comment letter
requested that Sec. 1277.4(i)(1)(i) be revised ``to specify that the
mark-to-market value for cleared derivative contracts is de minimis.''
FHFA has not made that requested revision. To the extent the Banks
asked that there be no capital charge for this credit exposure or that
they not be required to perform the calculation for these contracts
given the small amounts involved, FHFA notes that no other financial
regulator excludes a capital charge on the current credit exposure
because it might be de minimis. Moreover, FHFA previously acknowledged
in the proposed rule and reiterated in the discussion of Sec.
1277.4(e)(5)(ii) above that the current credit exposure of a cleared
derivative contract would often be zero or a small amount.\36\
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\36\ See Proposed Federal Home Loan Bank Capital Requirements,
82 FR 30776, 30781 n.30 (July 3, 2017); supra note 28.
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Section 1277.4(i)(1)(ii) of the final rule allows a Bank to
calculate on a net basis the current credit exposure for all derivative
contracts that are executed with a single counterparty and that are
subject to an ``eligible master netting agreement.'' FHFA has aligned
the Sec. 1277.1 definition of ``eligible master netting agreement''
with that of Sec. 1221.2 in the FHFA regulations pertaining to margin
and capital for uncleared swaps by stating that the term ``has the same
meaning as set forth in Sec. 1221.2.'' \37\
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\37\ See 12 CFR 1221.2. The ``eligible master netting
agreement'' definition under Sec. 1221.2 was amended effective
November 9, 2018. See Margin and Capital Requirements for Covered
Swap Entities; Final Rule, 83 FR 50805, 50813 (Oct. 10, 2018).
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Calculation of Potential Future Credit Exposure on Derivative Contracts
Section 1277.4(i)(2) of the proposed rule would have provided a
Bank three options for calculating the potential future credit exposure
on a derivative contract. A Bank could use an initial margin model
approved by FHFA under Sec. 1221.8 of the margin and capital rules for
uncleared swaps, or a model that has been approved by another regulator
for use by the Bank's counterparty under standards that are similar to
those in Sec. 1221.8, or by using the standard calculation set forth
in appendix A to part 1221 of the FHFA regulations.\38\ The final rule
retains each of these options. FHFA received one comment on this
provision, which asked that FHFA allow the Banks the additional option
of calculating the potential future credit exposure by using an initial
margin model that is employed by a DCO. FHFA agrees that such DCO
models would not have fit within any of the three options allowed under
the proposed rule, and that they should be acceptable because they are
market tested and are subject to periodic review and validation under
CFTC rules. Accordingly, FHFA has added a new provision, at Sec.
1277.4(i)(2)(iii) of the final rule, that allows a Bank to use such
models for calculating the potential future credit exposures. Thus, in
addition to that new provision, the final rule allows a Bank to rely on
the initial margin calculation done by a swap dealer or other
counterparty that uses a model approved by the CFTC, other federal
banking regulator, or a foreign regulator whose model rules have been
found to be comparable to the United States rules.\39\ If neither party
to the derivative contract uses an approved model, or if the Bank
otherwise chooses, the Bank can calculate its potential future exposure
using the method set forth in appendix A to part 1221.\40\
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\38\ See 12 CFR 1221.8; 12 CFR part 1221, appendix A. As no Bank
is currently a swap dealer or major swap participant that otherwise
needs to develop an initial margin model, FHFA expects the Banks
would generally rely on the calculations done by a counterparty
using its approved model or using appendix A to the part 1221 rules.
\39\ See 12 CFR 1221.9.
\40\ See Final Rule on Margin and Capital Requirements for
Covered Swap Entities, 80 FR 74840, 74881-882 (Nov. 30, 2015), as
amended, 83 FR 50805 (Oct. 10, 2018).
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5. Determination of Credit Risk Percentage Requirements
Sections 1277.4(f) and (g) of the final rule set forth the method
and criteria by which a Bank will identify the CRPRs to use when
calculating the credit risk capital charges for its assets, off-balance
sheet items, and derivative contracts. Section 1277.4(f) addresses the
capital charges for a Bank's advances, non-mortgage assets, off-balance
sheet items, derivative contracts, and non-rated assets. Section
1277.4(g) addresses the capital charges for a Bank's residential
mortgage assets. The applicable CRPRs are set forth in four separate
tables within those two sections. Table 1 includes the CRPRs for
advances. Table 2 includes the CRPRs for internally rated non-mortgage
assets, derivative contracts, and off-balance sheet items. Table 3
includes the CRPRs non-rated assets, which are cash, premises, plant
and equipment, and certain specific investments. Table 4 includes the
CRPRs for residential mortgage loans, residential mortgage securities,
and collateralized mortgage obligations.
Section 1277.4(f). Each of the provisions of Sec. 1277.4(f) of the
final rule is the same as in the proposed rule, with the exceptions
noted below. Section 1277.4(f) generally directs the Banks to use the
tables included within that section to obtain the CRPRs for their
advances, non-mortgage assets, off-balance sheet items, derivative
contract, and non-rated assets, and includes certain exceptions to the
otherwise applicable CRPRs.
[[Page 5316]]
CRPRs for Advances: Table 1. The proposed rule included a version
of Table 1 that was much the same as the corresponding table in the
current Finance Board regulations, except that it included modestly
higher CRPRs for advances than those in the current regulation. The
Banks' comment letter asked that FHFA either reinstate the CRPRs from
the current Finance Board regulation or lower them to levels below
those in the current regulation. The Banks reasoned that lower capital
charges for advances were warranted because no Bank has ever suffered a
credit loss on an advance to a member, but the Banks did not propose a
new methodology that FHFA could use for deriving reduced CRPRs for
their advances. The final rule retains in Table 1 the CRPRs that were
included in the proposed rule. As FHFA explained in the proposed rule,
advances, which represent approximately two-thirds of the Banks'
assets, do present some degree of credit risk, and thus should be
included within the risk-based capital requirements. That degree of
credit risk is difficult to measure precisely because there is no
comparable loss history for advances as there is, for example, for
corporate debt instruments. The Finance Board determined that the
capital charge for advances should be greater than zero but less than
the capital charge for other assets rated at the highest investment
grade. Accordingly, it developed a methodology for setting the CRPRs
for advances within that range based on the estimated default rate of
investment grade corporate debt securities and a specific loss-given-
default rate, as described in the proposed rule. FHFA believes that the
original methodology remains a reasonable approach for estimating
credit risk associated with advances, and thus has retained that
approach in Table 1 of the final rule. In determining the CRPRs for
advances, FHFA had the benefit of default data that was more recent
than what had been available to the Finance Board, as well as a more
standardized methodology.\41\ The fact that the CRPRs in the final rule
are modestly higher than the current CRPRs is solely a result of
employing the updated methodology. Moreover, the amount of risk-based
capital that a Bank must hold against its advances remains modest, in
keeping with the very low risk posed by advances.
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\41\ Proposed Federal Home Loan Bank Capital Requirements, 82 FR
30776, 30782-30783 (July 3, 2017) (discussing in detail the new
methodology to derive the CRPRs for Table 1.1 in the proposed rule,
which is Table 1 in the final rule).
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CRPRs for Internally Rated Assets: Table 2. Under the existing
Finance Board regulations, the CRPRs used to calculate the capital
charges for non-mortgage assets, off-balance sheet items, and
derivative contracts are determined based on a table that delineates
the CRPRs by NRSRO rating and maturity range. The proposed rule would
have made two revisions to that table. First, as required by the Dodd-
Frank Act, the proposal would have replaced the NRSRO rating categories
with FHFA Credit Ratings categories, to which the Banks would have to
assign the instruments covered by the table based on their own internal
credit ratings. Second, FHFA included revised percentages for most of
the CRPRs within Table 2 because FHFA had updated both the data and the
methodology that the Finance Board had used to develop the original
CRPRs. As a result of those updates, the CRPR percentages for most of
the line items in proposed Table 2 were higher than those in the
current Finance Board regulation. As explained in the proposed rule,
FHFA derived the CRPRs in proposed Table 2 using a modified version of
the Basel II internal ratings-based credit risk model. FHFA received no
comments on the methodology used to derive the CRPRs in proposed Table
2 or on the requirement for the Banks to use their internal credit
ratings, and therefore is adopting Table 2 as proposed.\42\ The Banks'
comment letter asked that FHFA clarify that the language in the column
heading that refers to an instrument's ``remaining maturity'' means the
``weighted average life of the asset,'' rather than its contractual
maturity. FHFA based the table on bond credit losses over a specific
time horizon, and not the weighted average life of those assets, and
therefore believes that the remaining contractual maturity is the
appropriate measure. In the final rule FHFA has revised the heading of
Table 2 to state that the ratings are ``Based on Remaining Contractual
Maturity'' to make that point clear.
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\42\ See Proposed Federal Home Loan Bank Capital Requirements,
82 FR 30776, 30786 (July 3, 2017) (setting forth the methodology
used to derive proposed Table 2).
---------------------------------------------------------------------------
The FHFA Credit Rating categories in Table 2 are intended to
achieve the same purpose previously served by the NRSRO credit ratings,
which is to create a hierarchy of credit risk exposure categories, to
which a Bank would assign each instrument covered by Table 2. FHFA has
established the individual FHFA Credit Rating categories, and the CRPR
for each category, based on historical loss experience. In this
respect, the categories of FHFA Credit Ratings are comparable to the
NRSRO ratings categories, which also are based on historical loss
experience. Because of that common foundation, and because Table 2 of
the final rule has the same number of categories as the corresponding
table in the current Finance Board regulation, there should be a high
correlation between the categories of the new and old tables. For
example, the historical loss experience for the ``highest investment
grade'' category used in the current Finance Board regulation should
correspond closely to the historical loss experience that FHFA
determined for the FHFA 1 Credit Rating category in Table 2 of the
final rule, and the same should be true for the remaining categories.
The final rule differs from the current Finance Board regulation by
requiring that each Bank determine the appropriate FHFA Credit Rating
category for each instrument covered by Table 2. The Bank would do so
by first calculating its own internal credit rating for each
instrument, as required by Sec. 1277.4(f)(1)(ii), rather than by
determining the instrument's NRSRO rating, as is the case under the
current regulation. Each Bank then would need to map its various
internal credit ratings to one of the FHFA Credit Rating categories in
Table 2. Given the similarity in structure and basis between Table 2 of
the final rule and the corresponding table in the current Finance Board
regulations, as well as the historical data connection of both tables
to historical loss rates reflected in NRSRO ratings, the Banks should
be able to map their internal credit ratings to the appropriate FHFA
Credit Rating categories in Table 2 of the final rule in a
straightforward manner. Because the final rule relies on a Bank's
internal credit ratings and the manner in which it maps those internal
ratings to the appropriate FHFA Credit Rating category, it is possible
that the CRPR for a particular instrument or counterparty determined
under the final rule would differ from the CRPR that is assigned under
the current regulations. Because the internal ratings methodologies may
differ from Bank to Bank, it also is possible that one Bank may rate a
particular instrument differently from another Bank.
The final rule does not require a Bank to obtain FHFA approval of
either its method of calculating the internal credit rating or its
mapping of such ratings to the FHFA Credit Ratings categories. Instead,
Sec. 1277.4(f)(1)(ii) of the final rule provides that a Bank's rating
method must involve an evaluation of
[[Page 5317]]
counterparty or asset risk factors, which may incorporate, but not rely
solely upon, credit ratings available from an NRSRO or other credit
rating entities. An evaluation of a risk factors may include measures
of the counterparty's scale, earnings, liquidity, asset quality, or
capital adequacy, among other things. FHFA intends to rely on the
examination process to review the Banks' internal rating methodologies
and mapping processes, which is appropriate because the Banks have been
using internal rating methodologies for some time, and any adjustments
to those methodologies that may be required for supervisory reasons
would not likely have a material effect on a Bank's overall credit risk
capital requirement. FHFA also has revised a related provision of the
final rule, Sec. 1277.4(f)(4), which now requires a Bank to provide to
FHFA, upon request, the methodology, model, and analyses used to assign
these instruments to their FHFA Credit Rating categories. That
provision also authorizes FHFA to direct any Bank to revise its
methodology or model to remedy any deficiencies identified by FHFA. The
proposed rule would have allowed FHFA, on a case-by-case basis, to
direct a Bank to change the calculated credit risk capital charge for
particular instruments, as necessary to remedy any deficiency that FHFA
identified with respect to a Bank's internal credit rating methodology
for those instruments. FHFA revised this provision in response to the
Banks' comment letter, which suggested that it would be more
appropriate for FHFA to require a Bank to revise its methodology and
model than for FHFA to direct a Bank to revise capital charges for
individual instruments on a case-by-case basis. FHFA agrees with the
Banks' suggestion and has revised both Sec. 1277.4(f)(4), which
pertains to Table 2, and Sec. 1277.4(g)(2)(iii), which pertains to
Table 4, for mortgage assets, in the manner described above.
CRPRs for Non-Rated Assets: Table 3. The proposed rule included a
version of Table 3 that was identical to the corresponding table in the
current Finance Board regulation.\43\ FHFA received no comments on this
table and is adopting it as proposed. Table 3 sets forth the CRPRs for
Non-Rated Assets, which are defined as cash, premises, plant and
equipment, and investments authorized under 12 CFR 1265.3(e) and (f).
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\43\ In the Finance Board regulations, the corresponding table
is designated as ``Table 1.4'' but the assets and CRPRs included
within that table are the same as those of Table 3 of this final
rule.
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Reduced Charges for non-mortgage assets. Section 1277.4(f)(2) of
the final rule provides for two exceptions to the process described
above for determining the capital charges for non-mortgage assets that
are secured by certain collateral or are subject to an unconditional
guarantee from a third-party. This provision is unchanged from the
proposed rule and carries over provisions from the current Finance
Board regulations. Under those provisions, a Bank may substitute the
CRPR associated with the guarantor or the collateral for the charge
associated with the portion of the non-mortgage asset that is subject
to the guarantee or collateral. Section 1277.4(f)(2)(ii) describes the
conditions that must be satisfied in order for the collateral to be
deemed to ``secure'' the non-mortgage asset. The final rule also
includes a separate but similar provision, located at Sec. 1277.4(j),
that allows the Banks the option of using credit derivatives that meet
the requirements of that section to reduce or eliminate the otherwise
applicable capital charges on their non-mortgage assets. Section
1277.4(j) is the same as the proposed rule, apart from two instances in
which FHFA has replaced the term ``book value'' with ``amortized cost,
or fair value'' when referring to the calculation of the capital charge
for hedged non-mortgage assets. The substance of this provision also is
the same as the current Finance Board regulation. The final rule does
not alter the substance of the current Finance Board regulations as to
the criteria that a Bank must meet for this special provision to apply
or the method of calculating the capital charges. Generally, under this
provision, a Bank would be able to substitute the capital charge
associated with the credit derivatives (as calculated under Sec.
1277.4(e)) for all or a portion of the capital charge calculated for
the non-mortgage assets, if the hedging relationships meet the criteria
in the proposed provision.\44\
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\44\ See Final Finance Board Capital Rule, 66 FR 8262, 8292-94
(Jan. 30, 2001).
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Charge for Obligations Issued by the Enterprises. Section
1277.4(f)(3) of the proposed rule would have applied a capital charge
of zero to any non-mortgage debt instrument issued by either of the
Enterprises, recognizing that they are currently operating with the
financial support of the United States and thus present no credit risk.
The final rule retains this provision with only one revision, which
clarifies that the zero capital charge may continue only for so long as
the Enterprises' debt obligations actually are supported by the United
States. When the capital support provided by the U.S. Government
ceases, the capital charges for Enterprise debt instruments will be
determined by using the appropriate CRPR in Table 2 in the same manner
as would be the case for any debt instruments issued by other entities,
i.e., based on the Bank's internal credit rating for the issuing
Enterprise and the maturity of the instrument. At present, the
financial support provided by the U.S. Department of the Treasury under
the Senior Preferred Stock Purchase Agreements (PSPA) \45\ ensures that
the Enterprises will repay these obligations, which effectively
eliminates the credit exposure otherwise associated with these
instruments and warrants a capital charge of zero while the instruments
continue to have the financial support of the United States. The Banks'
comment letter asked that the final rule also apply a zero percent
capital charge to the non-mortgage debt instruments issued by other
GSEs. The Banks made the same request with respect to Sec.
1277.4(g)(2)(i), which assigns a zero percent capital charge for
mortgage-related obligations issued by the Enterprises. The Banks
reasoned that the obligations of all GSEs should be treated equally for
risk-based capital purposes. FHFA has not included those requested
changes in the final rule. FHFA has assigned a zero percent capital
charge to those Enterprise obligations because of the explicit
financial support provided by the United States through the PSPAs. The
obligations of other GSEs are not similarly backed by the United
States, and therefore a zero percent capital charge is not warranted.
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\45\ See https://www.fhfa.gov/Conservatorship/Pages/Senior-Preferred-Stock-Purchase-Agreements.aspx (containing links to the
PSPAs and to the First, Second, and Third Amendments to them, as
well as to the Letter Agreement of December 21, 2017, on capital
reserves).
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Credit Risk Capital Charge for Multifamily MBS and CMBS. Under the
proposed rule both multifamily MBS and CMBS would constitute ``non-
mortgage assets'' and Banks would determine their capital charges by
reference to Table 2. This approach is the same as under the current
Finance Board regulations and is retained in the final rule without
change.\46\ The Banks'
[[Page 5318]]
comment letter asked that FHFA either apply the capital charges for
single family MBS (which are set out in Table 4) to multifamily MBS or
develop a separate table for capital charges for multifamily MBS that
would be based on their loss histories. The Banks also asked that FHFA
develop a separate table of capital charges for CMBS based on their
loss history. The Banks did not, however, provide any supporting data
on loss histories for those instruments from which FHFA might
conceivably develop separate capital charges for those assets.
---------------------------------------------------------------------------
\46\ Although multifamily MBS and CMBS are backed by loans that
are secured by a mortgage on real estate, they are treated as ``non-
mortgage assets'' for regulatory capital purposes because their
underlying loans are not ``residential mortgage loans,'' which term
includes only loans that are secured by a mortgage on a residential
structure that contains a one-to-four family dwelling unit.
---------------------------------------------------------------------------
FHFA has not incorporated either of those suggestions into the
final rule. With respect to multifamily MBS, FHFA notes that the final
rule allows the Banks to apply a zero capital charge to any Fannie Mae
or Freddie Mac multifamily securities they own if they are covered by
the financial support currently provided by the U.S. Department of the
Treasury under the PSPAs. Currently, the vast majority of the
multifamily MBS owned by the Banks are issued by Fannie Mae and Freddie
Mac. Accordingly, those instruments likely would qualify for a zero
capital charge under Sec. 1277.4(f)(3). FHFA also notes that the Banks
typically do not own any CMBS. Consequently, FHFA does not consider it
necessary to develop separate tables or to employ an alternative
methodology. Furthermore, in the event a multifamily MBS or CMBS
security does not qualify for a zero capital charge under Sec.
1277.4(f)(3), the final rule requires the Banks to determine the
capital charge based principally on their own internal credit rating of
the instrument, which would allow them an opportunity to more closely
align their capital charge to their assessment of the associated credit
risk, provided the Banks have developed adequate support for their
ratings of particular instruments.
Credit Risk Capital Charge for Residential Mortgage Assets. Section
1277.4(g)(1) of the proposed rule would have established the capital
charges for residential mortgage assets that would be equal to the
amortized cost, or fair value, of the asset multiplied by the CRPR
assigned to the asset under Table 4 of proposed Sec. 1277.4(g). The
principal difference between the proposed rule and the current Finance
Board regulations was that the proposal would have replaced the current
NRSRO ratings-based approach for determining the capital charge for a
mortgage asset with one based on each Bank's internal rating of the
individual asset. To do that, the proposed rule would have required
each Bank to develop a methodology to assign an internal credit risk
rating to each mortgage asset, then to align each of its internal
ratings to the appropriate category of the table of capital charge
percentages set out in the proposed rule. After aligning its internal
ratings to the FHFA table, each Bank would have been required to assign
each mortgage asset to the appropriate category of the table, based on
its internal credit risk rating for that asset. The proposed rule also
would have required the Banks to align their internal credit ratings to
the categories in Table 4 with reference to the terms ``AMA Investment
Grade'' and ``Investment Quality,'' i.e., by ensuring that any internal
ratings that a Bank mapped to one of the four highest categories in
that table could include only assets that would qualify as either ``AMA
Investment Grade'' or ``Investment Quality,'' as those terms are
defined in 12 CFR 1268.1 and 1267.1 for mortgage loans and investment
securities, respectively. The proposal also would have required that a
Bank's internal ratings categories, like the categories in Table 4, be
ranked based on their respective credit quality, i.e., that the credit
risk associated with each category would increase progressively, when
viewing the categories from top to bottom. Additionally, Sec.
1277.4(g)(1) of the proposed rule included two exceptions to the
capital charges set out in Table 4, which would allow the Banks to
assign a zero capital charge to any mortgage assets that are guaranteed
or insured by the full faith and credit of the United States, or that
have been guaranteed by one of the Enterprises while it was receiving
financial support from the United States. Lastly, the proposal included
a provision allowing FHFA to direct a Bank to adjust the capital
charges for individual mortgage assets, as necessary to account for any
deficiencies that FHFA may find in its internal credit rating
methodology.
The Banks' comment letter addressed several issues relating to
these provisions. The Banks first questioned the capital charges for
CMOs under Table 4, contending that they were disproportionately high
when compared to the credit risk associated with the securities that
the Banks typically acquire. The Banks asked that the final rule revise
the capital charges for CMOs in categories 3 through 7 of Table 4 by
making them the same as those for similarly rated mortgage-backed
securities structured as pass-through instruments. The Banks also asked
that FHFA revise Sec. 1277.4(g)(1)(iii), which requires each Bank to
align each of its internal ratings to a category in Table 2, so that it
would require the Banks to consider the potential future losses on a
particular mortgage asset when making that alignment. The Banks
reasoned that the amount of risk-based capital required for a
particular mortgage asset should be equal to the amount of capital
needed to protect against future potential losses under the 99.9
percent confidence level stress scenario assumed by FHFA. Lastly, the
Banks asked that FHFA revise Sec. 1277.4(g)(2)(iii), which would allow
FHFA to require a Bank to change the capital charge for particular
assets if FHFA determined the Bank's methodology to be deficient, so
that it would instead authorize FHFA to require changes to a Bank's
methodology, rather than to the capital charges for individual assets.
With respect to the capital charges for CMOs, FHFA had explained in
the proposed rule that the use of the term ``subordinated classes''
within the table in the Finance Board regulation created an ambiguity
regarding the application of the capital charges within that table. The
Finance Board table has two separate sets of capital charges--those in
the top half of the table appear under the heading of ``type of
residential mortgage asset,'' while those in the bottom half appear
under the heading ``subordinated classes of mortgage assets.'' Each
half of that table has seven categories, each of which corresponds to a
particular NRSRO credit rating. The capital charges for each of top two
categories in each half of the Finance Board table--which correspond to
instruments with NRSRO ratings of AAA or AA--are identical, meaning,
for example, that a pass-through MBS with an NRSRO rating of AA would
carry the same capital charge as a CMO with the same rating. For the
remaining five categories in each half of the table, however, the
capital charges in the bottom portion of the table are higher than
those in the top portion of the table. It is FHFA's belief that the
Finance Board intended that all of the categories in the top half of
the table were to be applied only to whole mortgage loans and to
mortgage pass-through securities, and that all of the categories in the
bottom half of the table were to apply to ``structured'' mortgage-
related securities, such as CMOs. The fact that the Finance Board
assigned identical capital charges for the top two categories of pass-
through securities and the top two categories of structured securities
is consistent with reading the
[[Page 5319]]
table in that manner. That said, FHFA also recognizes that the Banks
may have construed the term ``subordinated classes,'' as used in the
bottom half of the table, as meaning that those capital charges were to
apply only to the subordinated tranches of a CMO, i.e., any tranches
other than the most senior tranche, and that the capital charge for the
most senior tranche of any CMO should be determined based on the CRPRs
in the top half of the table. In proposing to revise the table headings
FHFA intended to give effect to the Finance Board's original intent for
this table. Thus, the proposed rule would have revised the subheading
for the bottom half of the table by replacing ``subordinated classes of
mortgage assets'' with ``categories for collateralized mortgage
obligations'' to make that point clear. The principal effect of the
proposed revision would be that Banks would determine the capital
charge for the most senior tranche of their CMO investments based on
the percentages set out in the bottom half of Table 4, rather than
those from the top half of the table. As the Banks noted in their
comment letter, they typically invest only in highly rated CMOs. Under
the current Finance Board regulation, a CMO tranche with an NRSRO
rating of AAA or AA would carry the same capital charge regardless of
whether a Bank used the CRPRs in the top or bottom half of the table,
but in the event an NRSRO were to downgrade that instrument, the
capital charges calculated under the bottom half of the table would be
higher than those calculated under the top half. In a similar fashion,
if a Bank were to lower its internal rating of an existing CMO
investment to below the top two FHFA Rating Categories, then the
proposed rule would have required it to use the higher CRPR from the
bottom half of the table. The proposed rule would not have affected the
capital charges for the Banks' investments in any subordinated CMO
tranches because the Banks already use the CRPRs in the bottom half of
the table to determine the capital charges for those instruments.
FHFA has not incorporated the Banks' request to reduce the capital
charges for the lower rated categories of CMOs to equal those for pass-
through MBS into the final rule. As noted above, FHFA's sole objective
in revising the headings to Table 4 was to eliminate an ambiguity from
the existing table of capital charges, with the intent of giving effect
to the Finance Board's original intent regarding capital charges for
all CMOs. Moreover, because FHFA, based on its experience with the
mortgage markets and the Banks' role in them, saw no need to alter any
of the CRPRs for mortgage loans and mortgage-related assets, it had not
developed any analytical data that could support revisions to the CRPRs
for CMOs in the final rule. The Banks' comment letter also did not
provide any data on which FHFA might reasonably rely to reduce the
capital charges for the lower-rated categories of CMOs. In the absence
of such information, FHFA cannot introduce such revised CRPRs into the
final rule. The final rule, however, does include other provisions that
should address the Banks' concern about the capital charges for the
lower-rated categories of CMOs being disproportionate to their credit
risk. First, Sec. 1277.4(g)(1)(i) of the final rule will require that
the Banks apply the CRPR for a particular mortgage asset only to the
asset's amortized cost (or fair value), not to its book value as is
currently the case. The use of amortized cost should result in lower
capital charges for lower-rated CMOs, even if the CRPR for the asset
remains the same, because the amortized cost will generally be lower
than book value, such as when the Bank has recognized a loss on an
asset through a charge for an other-than-temporary impairment. Second,
as described in more detail below, FHFA has incorporated into Sec.
1277.4(g)(1)(iii) of the final rule new language, derived from one of
the Banks' comments, regarding the use of potential future losses as a
measure of the capital charge for a particular mortgage asset. That
revision should address the Banks' concern about the CRPRs for the
lower-rated categories of CMOs being disproportionate to their credit
risk because the amount of risk-based capital that a Bank would have to
hold for any mortgage-related asset would be based principally on the
amount of the potential future loss from the current amortized cost
that a Bank estimates for such asset.
As noted above, the Banks' comment letter asked that the final rule
clarify that the measure of risk-based capital should be the amount
needed to cover the potential future losses under a stress scenario
assumed by FHFA, and that the potential future losses should be
measured from the amortized cost, or fair value, of the asset. FHFA
agrees with the comment regarding the use of potential future losses
and has revised Sec. 1277.4(g)(1)(iii) of the final rule accordingly.
The Banks appear to have been principally concerned that the proposed
rule could be read as requiring them to calculate the risk-based
capital requirement for a CMO based on its face or par value,
regardless of whether the Bank had previously recorded as a loss
through income that portion of the CMO's par value that the Bank had
determined to be other-than-temporarily-impaired. Although the proposed
rule explicitly stated that the capital charge for any mortgage asset
is to be the product of the appropriate CRPR and the amortized cost of
the asset, FHFA has revised the final rule to clarify the relationship
between amortized cost and potential future losses. The proposed rule
implied, but did not state explicitly, that the appropriate FHFA credit
rating category should be determined by assessing the risk that the
Bank may incur further loss or charge-off to the remaining amortized
cost value of the CMO and other mortgage-related securities. For
example, for a Bank that owns a CMO for which it has previously charged
off 40 percent of the par value, FHFA had intended that the proposed
rule would have required the Bank to then assess the likelihood of
incurring additional losses to the remaining 60 percent of the par
value (or current amortized cost value) of the CMO to determine how
much risk-based capital is required. Under the proposed rule, if a Bank
were to determine that the likelihood of additional loss to its
amortized cost value is near zero, it could assign to the CMO a very
high internal rating, which would have allowed the Bank to assign the
CMO to one of the higher FHFA credit rating categories in Table 4,
resulting in a low capital charge. That would be true even if the CMO
carried a significantly lower NRSRO rating, because an NRSRO rating
does not take into account the extent to which a particular investor
may have charged off a portion of the security. To make that process
more clear, FHFA has revised Sec. 1277.4(g)(1)(iii) of the final rule
to state explicitly that the Banks must estimate the potential future
losses that may yet occur on their mortgage assets from their current
amortized cost (or fair value).
The Banks' request to add language about potential future losses
into the regulation also prompted FHFA to revise another aspect of the
rule relating to the methodology to be used in assigning individual
mortgage assets to the particular categories in Table 4 of the final
rule. The proposed rule would have required the Banks to develop a
methodology to assign an internal credit rating to each mortgage-
related asset, and then align their internal ratings to the FHFA credit
rating categories set forth in Table 4, in order to determine
[[Page 5320]]
the credit risk-based capital requirement for each asset. The Banks
asked that FHFA revise the final rule to state explicitly that the
internal ratings ``should at least in part be related to [a Bank's]
potential future losses.'' The Banks reasoned that the required amount
of risk-based capital should be the amount needed to protect against
potential future losses determined under a stress scenario. In
considering that comment, FHFA determined that using potential future
losses as the method for assigning mortgage assets to the categories in
Table 4 was a superior approach to that described in the proposed
rule.\47\ FHFA also agrees that the most appropriate method of
estimating potential future losses is through use of a mortgage asset
stress test. Using the potential future stress-loss estimates as the
basis for assigning a mortgage asset to the appropriate category of
Table 4 also would be a simpler and more direct means for the Banks to
determine the capital charge than under the proposed rule, which as a
practical matter would have required a Bank to determine a potential
future stress-loss estimate for each mortgage asset, then convert that
estimate into an internal rating, and then map each internal rating to
a corresponding FHFA credit rating category in Table 4.
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\47\ FHFA recently issued new guidance on the Banks' use of
models and methodologies for assessing mortgage-asset credit risk
arising from AMA programs and investments. See Advisory Bulletin AB
2018-02 (April 25, 2018). That guidance encourages Banks to assess
the credit risk by using a loan-level mortgage-asset credit risk
model to estimate the potential future losses of the asset under a
stress scenario acceptable to FHFA. Although that bulletin did not
specifically address the assessment of credit risk in the context of
the risk-based capital requirements for mortgage assets, the degree
of credit risk associated with a particular investment is the same
regardless of the regulatory context in which it is being measured.
The bulletin states that the potential future stress-loss estimate
on a mortgage-related asset can be used as an appropriate measure of
the economic capital that the Banks can consider when conducting
their due diligence prior to purchasing a mortgage-related asset.
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Accordingly, FHFA has revised Sec. 1277.4(g)(1)(iii) of the final
rule to require that each Bank develop a methodology to estimate the
potential future stress losses on each mortgage-related asset that may
yet occur from its current amortized cost. The Banks must then convert
the estimate for each asset into a stress loss percentage, which is to
be expressed as a percentage of the amortized cost (or fair value) of
the mortgage asset. The Banks would then use that percentage to
determine the appropriate category in Table 4 to be used for
determining the CRPR for each mortgage asset, with the charges for AMA
and mortgage pass-through securities being taken from the top half of
the table and the charges for all CMOs and other structured mortgage
assets being taken from the bottom half of the table. To do so, the
Banks would assign each mortgage asset to the FHFA credit rating
category from Table 4 whose CRPR equals the asset's stress loss
percentage or, if those two amounts are not equal, to the FHFA category
with the next highest percentage. For example, the CRPR for a mortgage-
backed pass-through security assigned to the FHFA RMA rating category
of ``2'' under the final rule is 0.60 percent of the security's
amortized cost. If a Bank were to determine that such a security had a
potential future loss estimate of 0.55 percent of the remaining
amortized cost value, it would assign that security to the FHFA 2
category, and would apply the 0.60 percent CRPR. If a Bank were to
determine, however, that the security had a potential future loss
estimate of 0.61 of its amortized cost, then it must assign the
security to the FHFA RMA rating category of ``3'' and apply the 0.86
CRPR required for instruments in that category. Under this approach,
the regulatory capital charge will exceed the loss estimate by some
amount whenever the loss estimate falls between the CRPRs specified for
two adjacent categories of Table 4. That also would have been the case
under the proposed rule, given that Table 4 uses categories of CRPRs,
rather than the exact amount of the loss estimate.
Because of the revised approach described above, the final rule
does not include the language from Sec. 1277.4(g)(1)(iii) of the
proposed rule that would have required the Banks to develop their own
methodologies to assign internal ratings to all mortgage assets and
then map those internal ratings to the appropriate categories in Table
4. FHFA also has not carried over the provisions of the proposed rule
that would have directed the Banks to establish a hierarchy of relative
creditworthiness for each of their internal ratings categories and
ensure that any asset assigned to the top four FHFA ratings categories
have a credit quality at least equal to ``AMA Investment Grade'' (for
AMA) or ``Investment Quality'' (for mortgage-related securities).
As described previously, Sec. 1277.4(g)(2)(i) and (iii) of the
proposed rule included two exceptions that provided for a capital
charge of zero for mortgage assets that are guaranteed by either of the
Enterprises while they are receiving capital support from the federal
government, or that are subject to a guarantee or insurance provided by
a federal department or agency that carries the full faith and credit
of the United States. The final rule revises the first exception
slightly by adding language clarifying that the zero capital charge for
Enterprise instruments will continue ``only for so long as'' the
Enterprises' instruments are receiving capital support or other form of
direct financial assistance from the United States government that
enables them to repay their obligations. The financial support
currently provided by the United States Department of the Treasury
under the PSPAs qualifies under this provision. This exception is
identical in substance to Sec. 1277.4(f)(3), which allows the Banks to
apply a zero capital charge to any non-mortgage-related debt
instruments issued by the Enterprises. The intent of these revisions is
to make clear that the zero capital charge for Enterprise obligations
will terminate when the capital support provided by the United States
ceases. The final rule adopts without change the other exception under
Sec. 1277.4(g)(2)(ii) for instruments backed by the full faith and
credit of the United States. As also noted previously in the discussion
of Sec. 1277.4(f)(4), FHFA has revised Sec. 1277.4(g)(2)(iii) of the
final rule in response to the Banks' comment letter. As revised, this
provision requires a Bank to provide its methodology for estimating
future stress losses and related documents to FHFA upon request, and
authorizes FHFA to require a Bank to revise its methodologies to
address any deficiencies identified by FHFA. The new provision replaces
language in the proposed rule that would have authorized FHFA to direct
a Bank to revise capital charges for individual assets on a case-by-
case basis to remedy any deficiencies in the methodology.
Frequency of Calculation. Section 1277.4(k) of the proposed rule
would have reduced the frequency with which a Bank would be required to
calculate its credit risk capital charges from monthly to at least
quarterly, unless directed otherwise by FHFA. The final rule adopts
this provision without change, apart from the addition of a reference
to mortgage pools to the list of assets described. The amounts of the
assets and other items on which the risk-based capital requirement is
calculated would be determined as of the last business day of the
immediately preceding calendar quarter.\48\ Notwithstanding that
quarterly
[[Page 5321]]
calculation requirement, Sec. 1277.3 separately requires that each
Bank at all times maintain permanent capital in an amount at least
equal to its risk-based capital requirement. FHFA construes these two
provisions as requiring that each Bank will monitor how their business
activities and associated risks evolve during a calendar quarter such
that a Bank can ensure maintenance of sufficient risk-based capital
throughout the quarter as well as when the requirement is recalculated
at the end of the quarter. Section 1277.4(k) also explicitly reserves
FHFA's right to require a Bank to conduct its risk-based capital
calculations more frequently than quarterly, which FHFA may require if
it determines that circumstances warrant such change. In prior years,
the Banks' total risk-based capital requirements have not varied
significantly from quarter to quarter. Because of that, FHFA has
determined that the reduced frequency of the required calculations
should not raise any safety or soundness concerns that cannot be
addressed through FHFA's normal supervisory and examination functions.
FHFA anticipates that the reduction in the frequency of the required
risk-based capital calculations will reduce the operational burdens on
the Banks.
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\48\ For example, early in the second calendar-year quarter, a
Bank would need to calculate its credit risk capital charge based on
assets, off-balance sheet items and derivative contracts held as of
the last business day of the first calendar year quarter.
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D. Market Risk Capital Requirements
Section 1277.5 of the proposed rule would have carried over nearly
all of the Finance Board regulation addressing the market risk capital
requirement, with the exceptions noted below. The proposed rule would
have repealed the existing requirement that market risk capital must
include an amount equal to the extent to which the current market value
of the Bank's total capital is less than 85 percent of the book value
of its total capital. The proposed rule also would have revised the
language regarding independent validations of a Bank's internal market
risk to require that they be performed periodically, commensurate with
their risk, rather than annually, as is the case currently. In
addition, the proposal would have reduced the number of times that each
Bank would be required to conduct the market risk calculations from
monthly to quarterly. The proposed rule included a grandfather
provision, the effect of which was to make clear that any internal
market risk models that FHFA or its predecessor had previously approved
would be deemed to satisfy the approval requirement under the new FHFA
regulation. The Banks did not comment on those proposed revisions, all
of which have been included in Sec. 1277.5 of the final rule. The
change regarding the required frequency of a Bank's calculation of its
market risk capital requirement under the proposed rule from monthly to
quarterly was done so that it would correspond to the frequency of
calculation for the Bank's credit risk capital requirement. Thus, under
the final rule each Bank will be required to calculate its market risk
capital requirement at least quarterly under Sec. 1277.5(e), based on
assets held as of the last business day of the immediately preceding
calendar quarter, unless otherwise instructed by FHFA. The Bank would
be expected to meet the calculated capital charges throughout the
quarter.
The Banks' comment letter asked that FHFA revise Sec.
1277.5(b)(4)(ii) by changing the starting date for the historical
observation period required under that provision from ``1978'' to
``1992.'' The Banks reasoned that doing so would align the regulation
with guidance that FHFA had issued on that topic.\49\ During the period
following receipt of the comment, FHFA undertook empirical testing to
consider whether using a 1998 start date would diminish the severity of
the scenarios that the Banks currently include in the stress test. That
testing showed that the Banks could use an historical observation
period that commenced in 1998 without compromising the severity of the
stress scenarios used by the Banks. Accordingly, FHFA issued revised
guidance addressing the scenarios to be used by the Banks' market risk
models, which allowed the use of an observation period commencing in
1998.\50\ In light of that development, FHFA has revised Sec.
1277.5(b)(4)(ii) of the final rule so that it too provides that the
starting date for the historical observation period must go back to the
beginning on 1998.
---------------------------------------------------------------------------
\49\ See Revised Technical Guidance for Calculation of Market
Risk Capital Requirements (Apr. 25, 2013).
\50\ See Advisory Bulletin AB 2018-01 (Feb. 7, 2018).
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E. Operational Risk Capital Requirement
The current Finance Board regulations set the operational risk
capital requirement at 30 percent of the sum of the credit risk and
market risk capital requirements, but allow a Bank to reduce that
requirement to as low as 10 percent of the sum of those two amounts by
obtaining FHFA's approval for an alternative methodology for
quantifying operations risk or by obtaining insurance from a company
with an NRSRO credit rating of AA or better. Section 1277.6 of the
proposed rule would have carried over the current approach, but would
have replaced the NRSRO credit rating provision with language requiring
that the insurer be acceptable to FHFA. The Banks' comment letter asked
that FHFA eliminate the 10 percent threshold, reasoning that it was not
necessary if FHFA were to approve an alternative methodology, and that
FHFA provide analytical support for the 10 and 30 percent provisions
described above.
FHFA has decided to retain the 10 percent floor in Sec. 1277.6 of
the final rule, believing that there are prudential reasons for doing
so. Although this provision has been in the Finance Board regulations
since they were first adopted, no Bank has ever developed an
alternative methodology for measuring operational risk for which it has
sought the agency's approval. Thus, FHFA has had no prior opportunity
to evaluate alternative methods for measuring operational risk or to
determine whether any such Bank-developed alternatives would provide
sufficient capital to cover a Bank's actual operational risks. Although
there are challenges to quantifying operational risk at any financial
institution, operational risks at the Banks do exist and should be
supported by adequate capital. Even if a Bank were to develop an
alternative methodology for measuring operational risk, however, FHFA
has no reason to believe that the alternative methodology would
necessarily be so precise as to capture fully all potential operational
loss risks to which a Bank would be exposed. Given those uncertainties,
FHFA believes that retaining the 10 percent floor provides some
reasonable assurance that the amount of risk-based capital required by
the operational risk capital provision would be sufficient if FHFA ever
were to allow a Bank to use an alternative methodology for measuring
those risks.
With respect to the Banks' second request, regarding the analytical
support for the 10 and 30 percent requirements, FHFA has not undertaken
any additional analyses to support those two provisions, both of which
FHFA proposed to carry over unchanged from the Finance Board
regulations. However, the Banks' letter did not provide any empirical
data or other materials demonstrating that the amount of capital
required by the current regulation is excessive or what other levels
would be more appropriate measures for the operational risk capital
requirement. As noted above, there are challenges to developing a
methodology for measuring operational risk, and the financial
institution regulatory agencies have yet to achieve consensus on how
best to do so. In the absence of any
[[Page 5322]]
widely accepted standards for determining the amount of capital needed
to support the operational risks associated with a Bank's operations,
which might provide a basis for displacing the Finance Board's
judgment, FHFA believes that the existing 30 percent operational risk
charge continues to provide a reasonable measure of capital to protect
against those risks, and has not proven to be burdensome to the Banks
over the years that it has been in effect. FHFA recognizes that
assessing a Bank's operational risk exposure is challenging and
therefore intends to continue monitoring developments in the industry
in pursuit of an improved approach.
F. Limits on Unsecured Extensions of Credit
Section 1277.7 of the proposed rule generally would have carried
over the Finance Board unsecured credit limits with only one
significant revision, which was to remove all references to NRSRO
credit ratings, on which the Finance Board limits were based. In their
place, the proposed rule would have required a Bank to assign each
counterparty an internal credit rating and use that rating to place the
counterparty into one of the five FHFA credit rating categories in
Table 1 to Sec. 1277.7. The proposed rule also would have revised the
existing limit for unsecured credit exposures to GSEs. The Finance
Board regulations set that limit at the lesser of the Bank's total
capital or the GSE's total capital, which was considerably higher than
the limit for the most highly rated non-GSE counterparties, which was
15 percent (or 30 percent when including overnight federal funds
transactions) of the lesser of those amounts. The proposed rule would
have subjected all GSEs to the same unsecured credit limits as any
other non-GSE counterparty, with the exception of any GSEs operating
with direct financial assistance from the United States, for which the
limit would be equal to the Bank's total capital.
The Banks' comment letter addressed several of these provisions
under proposed Sec. 1277.7, asking that the final rule apply the same
unsecured credit limit to all GSEs, regardless of whether they are
operating with the financial support of the United States. Further, the
Banks asked that FHFA reinstate the existing 100 percent of capital
limit as the unsecured credit limit for all GSEs, rather than treat
GSEs the same as other non-GSE counterparties, and that it clarify how
the limits will apply after a GSE operating with federal financial
support loses that support. The Banks also asked that FHFA change the
frequency of credit reporting to FHFA from monthly to quarterly, and
revise the provision regarding debt that is guaranteed by a third party
so that it allows, rather than mandates, that the Banks consider the
guarantor to be the counterparty for regulatory purposes. With respect
to reporting frequency, FHFA is retaining the existing monthly
reporting requirements in Sec. 1277.7(e), which require a Bank to
report to FHFA any unsecured exposures that exceed 5 percent of the
lesser of its capital or the counterparty's capital, as well as the
amount of any secured and unsecured exposures that exceed 5 percent of
the Bank's total assets. FHFA believes that receiving monthly reports
of each Bank's secured and unsecured credit exposures above those
thresholds is important to its supervisory responsibilities and thus
has not accepted that suggestion. With respect to guarantors, FHFA
agrees with the comment and has revised Sec. 1277.7(a) so that Banks
may, but are not required to, treat a third-party guarantor as if it
were the counterparty for purposes of the unsecured credit limit. With
the exception of that revision and those described below, the final
rule is the same as the proposed rule.
FHFA Credit Ratings. The principal substantive revision made by the
final rule is that, as in the proposed rule, a Bank will determine the
unsecured credit limits for a particular counterparty based on its
internal credit rating for that counterparty, rather than on an NRSRO
credit rating. Section 1277.7(a)(4) of the final rule directs a Bank to
use its internal credit rating to assign a counterparty to the
appropriate FHFA Credit Rating category in Table 1 to Sec. 1277.7, and
further provides that the credit rating category assigned for unsecured
credit purposes shall be the same as the FHFA category that the Bank
would use under Table 2 of Sec. 1277.4 if it were determining the
risk-based capital charge for an obligation issued by that
counterparty. The substance of that requirement had been located in
Sec. 1277.7(a)(5) of the proposed rule, which also would have required
a Bank to align its internal credit ratings to the FHFA Rating
Categories in Table 1 of Sec. 1277.7 ``using the same methodology''
that it uses for the risk-based capital categories. FHFA has deleted
the reference to the methodology from the final rule and relocated into
Sec. 1277.7(a)(4) the sentence requiring the FHFA credit rating
categories to be the same for both capital and unsecured credit
purposes. The final rule also removes all distinctions between short-
and long-term ratings. The Finance Board regulations distinguished
between those ratings because the NRSRO ratings on which the
regulations were based included those distinctions. Under the final
rule, a Bank would determine a single rating for a specific
counterparty or obligation when applying the unsecured credit limits,
regardless of the term of the underlying unsecured credit obligations.
Limits on Exposure to a Single Counterparty. The final rule retains
most of the structure and operational aspects of the current Finance
Board regulation on unsecured credit exposures. Thus, Sec.
1277.7(a)(1) of the final rule sets a general limit on unsecured credit
exposures to a single counterparty that includes all extensions of
unsecured credit to that counterparty, other than unsecured exposures
arising from sales of federal funds that have a maturity of one day or
less or that are subject to a continuing contract. Section 1277.7(a)(2)
of the final rule sets a separate additional overall limit that
includes all unsecured extensions of credit to that counterparty,
including all sales of federal funds. The overall limit for a single
counterparty is set at twice the amount of the general limit. A Bank
determines the limit for a particular counterparty by obtaining the
appropriate maximum capital exposure limit (which is expressed as a
percentage) for that counterparty from Table 1 to Sec. 1277.7 and then
multiplying the lesser of the Bank's total capital or the
counterparty's Tier 1 capital by that percentage.\51\ As described
previously, a Bank will obtain the appropriate maximum capital exposure
limit for a particular counterparty from Table 1, based on its internal
credit rating of that counterparty. The numerical limits for each of
the five categories within Table 1 of the final rule are the same as
those in the current rule. The only difference between Table 1 of the
final rule and the corresponding table in the Finance Board regulations
is that the categories in the final rule are labeled as ``FHFA Credit
Rating'' categories, rather than as categories based on NRSRO
ratings.\52\
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\51\ If the counterparty is not subject to a Tier 1 capital
requirement, a Bank may use the counterparty's total capital or some
similar comparable measure identified by the Bank. The terms ``total
capital'' and ``Tier 1 capital'' are to be as defined by the
counterparty's principal regulator.
\52\ The Finance Board explained its reasons for setting these
maximum capital exposure limits when it proposed the current
unsecured credit rule. See Proposed Rule on Unsecured Credit Limits
for Federal Home Loan Banks, 66 FR 41474, 41478-80 (Aug. 8, 2001).
The Finance Board also explained its reasons for limiting sales of
overnight federal funds when it adopted the current unsecured credit
regulation, stating that Banks have financial incentives to lend
into the federal funds markets, i.e., the GSE funding advantage and
a limited range of permissible investments, and that permitting such
lending without limits would be imprudent. See Final Rule on
Unsecured Credit Limits for Federal Home Loan Banks, 66 FR 66718,
66720-21 (Dec. 27, 2001) (Finance Board Final Unsecured Credit
Rule).
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[[Page 5323]]
Section 1277.7(d) of the final rule addresses how the unsecured
credit limit for a particular counterparty will be affected if a Bank
revises its internal rating for that counterparty. This is similar to a
provision of the current Finance Board regulations, which is based on
NRSRO rating downgrades of a counterparty or obligation. The final rule
provides that if a Bank revises its internal credit rating for a
particular counterparty or obligation, it shall thereafter assign the
counterparty or obligation to the appropriate FHFA Credit Rating
category in Table 1 based on that revised internal rating. The final
rule further provides that if the revised rating results in a lower
FHFA Credit Rating category, then any subsequent extension of unsecured
credit must comply with the new limit calculated using the lower
internal credit rating. The final rule makes clear, however, that a
Bank need not unwind any existing unsecured credit exposures as a
result of the lower limit, provided they were originated in compliance
with the unsecured credit limits in effect at that time. The final rule
continues to consider any renewal of an existing unsecured extension of
credit, including a decision not to terminate a sale of federal funds
subject to a continuing contract, as a new transaction, which would be
subject to the recalculated limit.
Affiliated Counterparties. Section 1277.7(b) of the final rule
would readopt without substantive change the current provision of the
Finance Board regulation limiting a Bank's aggregate unsecured credit
exposure to groups of affiliated counterparties. Thus, in addition to
being subject to the limits on individual counterparties, a Bank's
unsecured credit exposure from all sources, including federal funds
transactions, to all affiliated counterparties under the final rule
could not exceed thirty percent of the Bank's total capital. The final
rule would also readopt the current definition of affiliated
counterparty.
State, Local or Tribal Government Obligations. Section 1277.7(a)(3)
of the final rule also carries over without substantive change from the
Finance Board regulations the special provision applicable to
calculating limits for certain unsecured obligations issued by state,
local or tribal governmental agencies. This provision allows a Bank to
calculate the limit for these covered obligations based on its total
capital--rather than on the lesser of the Bank or counterparty's
capital--and the internal credit rating assigned to the particular
obligation. As under the current rule, all obligations from the same
issuer and having the same assigned rating may not exceed the limit
associated with that rating, and the exposure from all obligations from
that issuer cannot exceed the limit calculated for the highest rated
obligation that a Bank actually has purchased. As explained by the
Finance Board when it adopted the current rule, this special provision
reflected the fact that the state, local or tribal agencies at issue
often had low capital, their obligations had some backing from
collateral but were not always fully secured in the traditional sense,
and the Banks' purchase of these obligations had a mission nexus.\53\
---------------------------------------------------------------------------
\53\ See Finance Board Final Unsecured Credit Rule, 66 FR at
66723-24 (Dec. 27, 2001).
---------------------------------------------------------------------------
GSE Provision. Section 1277.7(c) of the final rule carries over
without change from the proposed rule the special limit that applies to
a GSE counterparty that is operating with capital support or other form
of direct financial assistance from the United States government that
enables it to repay its obligations. In such cases, the limit for all
unsecured credit exposures, including all federal funds transactions,
equals 100 percent of the Bank's total capital. That limit currently
applies to the Banks' exposures to the Enterprises by virtue of FHFA
Regulatory Interpretation 2010-RI-05 (Nov. 9, 2010), which the final
rule codifies. As noted above, the Banks requested that FHFA extend
this same limit to other GSEs that are not operating with the direct
financial support of the United States. FHFA declines to do so because
the unsecured credit obligations of those other GSEs are not supported
by the United States through means such as the PSPAs, as are the
obligations of the Enterprises, and that distinction alone warrants
having different unsecured credit limits. Thus, the unsecured
extensions of credit to a single counterparty provisions under Sec.
1277.7(a) remain unchanged from the proposed rule and therefore are
applicable to GSEs that are not backed by the capital support of the
United States government. The Banks also asked FHFA to clarify that the
special limit described above for GSEs operating with capital support
from the United States would continue in effect through the maturity of
the instruments, even after the capital support ceases. Because
compliance with the unsecured credit limits is determined at the time
that a Bank extends the unsecured credit, the loss of the financial
support of the United States for a GSE at some point in the future will
not cause any then-existing unsecured credit exposures made under the
limits of this provision to violate the regulation. Thus, Banks with
such exposures may allow them to mature in the normal course after the
financial support ceases. Because the loss of the financial support of
the United States will cause the unsecured credit limits for those GSEs
to drop, however, from 100 percent of a Bank's capital to a maximum of
15 percent (or 30 percent when including overnight federal funds) of a
Bank's capital, the immediate effect of the loss of the federal
financial support will be to prevent the Banks from making any new
extensions of unsecured credit to those GSEs until after the amount of
their then-existing unsecured credit has been reduced to below the new
exposure limit. That new exposure limit will be determined for each GSE
under Table 1 to Sec. 1277.7 based on a Bank's internal rating of the
GSE at that time. Section 1277.7(d) of the final rule addresses the
situation where a counterparty's internal rating changes, and
specifically provides that a Bank need not unwind any existing
unsecured credit exposures, which would include those extended to GSEs,
as a result of a new and lower limit being imposed, provided that the
existing exposures were within the applicable limit when originated.
FHFA has not included in the final rule the Banks' request that FHFA
retain the existing special unsecured credit limit for all GSEs, which
allows unsecured credit exposures of up to 100 percent of the lesser of
the Bank's total capital or the counterparty's total capital. As noted
above, FHFA has preserved a special limit for GSEs, but only for those
that are operating with the direct financial support of the United
States. The proposed rule reflected FHFA's policy judgment that
unsecured credit limits for all counterparties, other than those
explicitly backed by the United States, should be determined based on
the Banks' assessment of the credit risk posed by those counterparties.
Tying the unsecured credit limit to an assessment of creditworthiness
of the counterparty also introduces a degree of market discipline that
is absent under the current Finance Board regulations. This approach is
consistent with that taken by FHFA with respect to the treatment
[[Page 5324]]
of GSE collateral under the rule on uncleared derivative contracts.\54\
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\54\ FHFA and other prudential regulators jointly issued a
regulation addressing the margin and capital rules for uncleared
swaps. In the margin and capital final rules, the agencies provide
different treatment for collateral issued by a GSE that is operating
with explicit United States government support from collateral that
is issued by other GSEs. See Final Rule on Margin and Capital
Requirements for Covered Swap Entities, 80 FR 74840, 74870-71 (Nov.
30, 2015).
---------------------------------------------------------------------------
Measurement of Unsecured Extensions of Credit. Section 1277.7(f) of
the final rule establishes the requirements for measuring a Bank's
unsecured credit exposures. FHFA received no comments on this provision
and is adopting it without change from the proposed rule. For on-
balance sheet transactions, other than for derivative transactions that
have not been accepted for clearing by a derivatives clearing
organization, Sec. 1277.7(f)(1)(i) of the final rule provides that the
unsecured extension of credit shall equal the amortized cost of the
transaction plus net payments due the Bank. If a Bank carries an item
at fair value where any change in fair value is recognized in income,
the rule provides that the unsecured extension of credit shall equal
the fair value of the item, rather than its amortized cost. This
approach is similar to the approach applied under Sec. 1277.4 for
calculating credit risk capital charges for non-mortgage assets. FHFA
believes that this approach best captures the amount that a Bank has at
risk should a counterparty default on any unsecured credit extended by
the Bank. For an off-balance sheet item, Sec. 1277.7(f)(1)(ii)
provides that the unsecured extension of credit shall equal the credit
equivalent amount for that item, calculated in accordance with Sec.
1277.4(h).
Section Sec. 1277.7(f)(1)(iii) of the final rule addresses how to
measure the unsecured credit exposure related to an uncleared
derivative transaction. In that case, the amount of the unsecured
extension of credit equals the sum of the Bank's current and future
potential credit exposures under the contract (which amount may be
reduced by certain collateral held by the Bank, as described below),
plus the amount of any collateral posted by the Bank that exceeds the
amount the Bank owes to its counterparty and that is held by a person
or entity other than a third-party custodian that is acting under a
custody agreement that meets the requirements of FHFA's margin and
capital rule for uncleared swaps.\55\ With respect to a Bank's use of
collateral pledged by its counterparty to reduce the Bank's current and
future exposures on a derivative contract, Sec. 1277.7(f)(1)(iii)(A)
of the final rule requires that the collateral must meet the
requirements of Sec. 1277.4(e)(2) and (3), which address the manner in
which a Bank may use collateral to reduce the credit risk capital
charge on a derivative contract, and the terms under which the
collateral must be held in order to be eligible to reduce those
charges, respectively.
---------------------------------------------------------------------------
\55\ See 12 CFR 1221.7(c), (d). Thus, the amount of collateral
that is posted by a Bank and is segregated with a third-party
custodian consistent with the requirements of the swaps margin and
capital rule would not be included in the Bank's unsecured credit
exposure arising from a particular derivative contract.
---------------------------------------------------------------------------
As with the current rule, Sec. 1277.7(f)(2) provides that any debt
obligation or debt security (other than a mortgage-backed security,
other asset-backed security, or acquired member asset) shall be
considered to be an unsecured extension of credit for purposes of the
unsecured credit limits. The final rule carries over the existing
exception from the Finance Board regulations that excludes from the
unsecured credit limits any amount owed to the Bank under a debt
obligation or debt security for which the Bank holds collateral
consistent with the requirements of Sec. 1277.4(f)(2)(ii) or any other
amount that FHFA determines on a case-by-case basis should not be
considered to be an unsecured extension of credit.
Exceptions to the unsecured credit limits. Section 1277.7(g) of the
final rule provides four separate exceptions to the regulatory limits
on extensions of unsecured credit. One of those exceptions provides
that a derivative contract that is accepted for clearing by a
derivatives clearing organization is not subject to the unsecured
credit limits. FHFA proposed this exception to avoid any conflict with
the Dodd-Frank Act, which mandated that parties clear certain
standardized derivative transactions. When a Bank submits a derivative
contract for clearing, the derivatives clearing organization becomes
the Bank's counterparty to the contract. There are only a limited
number of derivatives clearing organizations that the Banks can use to
clear their derivative contracts, and in some cases there may be only a
single organization that clears specific classes of derivative
contracts. Because of those factors, imposing the unsecured limits on
cleared derivative contracts could make it difficult for the Banks to
fulfill the legal requirement that they clear all of these contracts,
which would frustrate the intent of the Dodd-Frank Act. In addition,
because the derivatives clearing organizations are subject to
comprehensive federal regulatory oversight, including regulations
designed to protect the customers that use the clearing services, FHFA
believes that the Banks will not be exposed to any undue risks as a
result of this exception. Notwithstanding the exception, FHFA expects
that the Banks will develop internal policies to address their
unsecured credit exposures to specific clearing organizations that take
account of the Bank's specific derivatives activity and clearing
options.
The Banks' comment letter viewed this provision as encompassing the
collateral that a Bank may post with the derivatives clearing
organization and asked that FHFA make this point clear in the preamble
to the final rule. FHFA agrees with that suggestion, but has addressed
the matter by revising the text of Sec. 1277.7(g)(2) to include an
explicit reference to such collateral. The three other exceptions to
the unsecured credit limits, which pertain to obligations of or
guaranteed by the United States, extensions of credit between Banks,
and investments in certain bonds issued by state housing finance
agencies, prompted no comments and are included in paragraphs (g)(1),
(3), and (4) to the final rule without change from the proposed rule.
III. Considerations of Differences Between the Banks and the
Enterprises
When promulgating regulations relating to the Banks, section
1313(f) of the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992 requires the Director of FHFA to consider the
differences between the Banks and the Enterprises with respect to the
Banks' cooperative ownership structure; mission of providing liquidity
to members; affordable housing and community development mission;
capital structure; and joint and several liability.\56\ FHFA noted this
requirement in the proposed rule and requested comments from the public
on the extent to which any of those factors may be implicated by the
proposed rule. FHFA did not receive any comments on this topic, and in
preparing this final rule, has considered the differences between the
Banks and the Enterprises as they relate to the above factors.
---------------------------------------------------------------------------
\56\ See 12 U.S.C. 4513.
---------------------------------------------------------------------------
IV. Paperwork Reduction Act
The final rule amendments do not contain any collections of
information pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C.
3501 et seq.). Therefore, FHFA has not submitted any
[[Page 5325]]
information to the Office of Management and Budget for review.
V. Regulatory Flexibility Act
The Regulatory Flexibility Act \57\ requires that a regulation that
has a significant economic impact on a substantial number of small
entities, small businesses, or small organizations must include an
initial regulatory flexibility analysis describing the regulation's
impact on small entities. Such an analysis need not be undertaken if
the agency has certified that the regulation will not have a
significant economic impact on a substantial number of small
entities.\58\ FHFA has considered the impact of the final rule under
the Regulatory Flexibility Act. The General Counsel of FHFA certifies
that the final rule will not have a significant economic impact on a
substantial number of small entities because the regulation applies
only to the Banks, which are not small entities for purposes of the
Regulatory Flexibility Act.
---------------------------------------------------------------------------
\57\ 5 U.S.C. 601 et seq.
\58\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
VI. Congressional Review Act
In accordance with the Congressional Review Act,\59\ FHFA has
determined that this final rule is not a major rule and has verified
this determination with the Office of Information and Regulatory
Affairs of the Office of Management and Budget (OMB).
---------------------------------------------------------------------------
\59\ See 5 U.S.C. 804(2).
---------------------------------------------------------------------------
List of Subjects
12 CFR Parts 930 and 932
Capital, Credit, Federal home loan banks, Investments, Reporting
and recordkeeping requirements.
12 CFR Part 1277
Capital, Credit, Federal home loan banks, Investments, Reporting
and recordkeeping requirements.
Accordingly, for the reasons stated in the Preamble, and under the
authority of 12 U.S.C. 1426, 1436(a), 1440, 1443, 1446, 4511, 4513,
4514, 4526, and 4612, FHFA amends subchapter E of chapter IX and
subchapter D of chapter XII of title 12 of the Code of Federal
Regulations as follows:
CHAPTER IX--FEDERAL HOUSING FINANCE BOARD
Subchapter E--[Removed and Reserved]
0
1. Subchapter E, consisting of parts 930 and 932, is removed and
reserved.
CHAPTER XII--FEDERAL HOUSING FINANCE AGENCY
Subchapter D--Federal Home Loan Banks
PART 1277--FEDERAL HOME LOAN BANK CAPITAL REQUIREMENTS, CAPITAL
STOCK AND CAPITAL PLANS
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2. The authority citation for part 1277 continues to read as follows:
Authority: 12 U.S.C. 1426, 1436(a), 1440, 1443, 1446, 4511,
4513, 4514, 4526, 4612.
Subpart A--Definitions
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3. Amend Sec. 1277.1 by adding in alphabetical order definitions for
``Affiliated counterparty,'' ``Bankruptcy remote,'' ``Collateralized
mortgage obligation,'' ``Commitment to make an advance or acquire a
loan subject to certain drawdown,'' ``Credit derivative,'' ``Credit
risk,'' ``Derivatives clearing organization,'' ``Derivative contract,''
``Eligible master netting agreement,'' ``Exchange rate contracts,''
``Government Sponsored Enterprise,'' ``Internal cash-flow model,''
``Internal market-risk model,'' ``Market risk,'' ``Market value-at-
risk,'' ``Non-mortgage asset,'' ``Non-rated asset,'' ``Operational
risk,'' ``Residential mortgage,'' ``Residential mortgage asset,''
``Residential mortgage security,'' ``Sales of federal funds subject to
a continuing contract,'' and ``Total assets'' to read as follows:
Sec. 1277.1 Definitions.
* * * * *
Affiliated counterparty means a counterparty of a Bank that
controls, is controlled by, or is under common control with another
counterparty of the Bank. For the purposes of this definition only,
direct or indirect ownership (including beneficial ownership) of more
than 50 percent of the voting securities or voting interests of an
entity constitutes control.
Bankruptcy remote means, in the context of any asset that a Bank
has posted as collateral to a counterparty, that the asset would be
excluded from that counterparty's estate in receivership, insolvency,
liquidation, or similar proceeding.
* * * * *
Collateralized mortgage obligation, or CMO, means any instrument
backed or collateralized by residential mortgages or residential
mortgage securities, that includes two or more tranches or classes, or
is otherwise structured in any manner other than as a pass-through
security.
Commitment to make an advance or acquire a loan subject to certain
drawdown means a legally binding agreement that commits the Bank to
make an advance or acquire a loan, at or by a specified future date.
Credit derivative means a derivative contract that transfers credit
risk.
Credit risk means the risk that the market value, or estimated fair
value if market value is not available, of an obligation will decline
as a result of deterioration in the creditworthiness of the obligor.
Derivatives clearing organization means an organization that clears
derivative contracts and is registered with the Commodity Futures
Trading Commission as a derivatives clearing organization pursuant to
section 5b(a) of the Commodity Exchange Act (7 U.S.C. 7a-1), or that
the Commodity Futures Trading Commission has exempted from registration
by rule or order pursuant to section 5b(h) of the Commodity Exchange
Act (7 U.S.C. 7a-1(h)), or is registered with the Securities and
Exchange Commission as a clearing agency pursuant to section 17A of the
Securities Exchange Act of 1934 (15 U.S.C. 78q-1), or that the SEC has
exempted from registration as a clearing agency under section 17A of
the Securities Exchange Act of 1934 (15 U.S.C. 78q-1(k)).
Derivative contract means generally a financial contract the value
of which is derived from the values of one or more underlying assets,
reference rates, or indices of asset values, or credit-related events.
Derivative contracts include interest rate, foreign exchange rate,
equity, precious metals, commodity, and credit derivative contracts,
and any other instruments that pose similar counterparty credit risks.
Eligible master netting agreement has the same meaning as set forth
in Sec. 1221.2 of this chapter.
Exchange rate contracts include cross-currency interest-rate swaps,
forward foreign exchange rate contracts, currency options purchased,
and any similar instruments that give rise to similar risks.
* * * * *
Government Sponsored Enterprise, or GSE, means a United States
Government-sponsored agency or instrumentality established or chartered
to serve public purposes specified by the United States Congress, but
whose obligations are not obligations of the United States and are not
guaranteed by the United States.
Internal cash-flow model means a model developed and used by a Bank
to estimate the potential evolving changes in the cash flows and market
values of a portfolio for each month, extending
[[Page 5326]]
out for a period of years, subject to a variety of plausible time paths
of changes in interest rates, volatilities, and option adjusted
spreads, and that incorporates assumptions about new or revolving
business, including the roll-off and possible replacement of assets and
liabilities as required.
Internal market-risk model means a model developed and used by a
Bank to estimate the potential change in the market value of a
portfolio subject to an instantaneous change in interest rates,
volatilities, and option-adjusted spreads.
Market risk means the risk that the market value, or estimated fair
value if market value is not available, of a Bank's portfolio will
decline as a result of changes in interest rates, foreign exchange
rates, or equity or commodity prices.
Market value-at-risk is the loss in the market value of a Bank's
portfolio measured from a base line case, where the loss is estimated
in accordance with Sec. 1277.5.
* * * * *
Non-mortgage asset means an asset held by a Bank other than an
advance, a non-rated asset, a residential mortgage asset, a
collateralized mortgage obligation, or a derivative contract.
Non-rated asset means a Bank's cash, premises, plant and equipment,
and investments authorized pursuant to Sec. 1265.3(e) and (f) of this
chapter.
Operational risk means the risk of loss resulting from inadequate
or failed internal processes, people and systems, or from external
events.
* * * * *
Residential mortgage means a loan secured by a residential
structure that contains one-to-four dwelling units, regardless of
whether the structure is attached to real property. The term
encompasses, among other things, loans secured by individual
condominium or cooperative units and manufactured housing, whether or
not the manufactured housing is considered real property under state
law, and participation interests in such loans.
Residential mortgage asset, or RMA, means any residential mortgage,
residential mortgage pool, or residential mortgage security.
Residential mortgage security means any instrument representing an
undivided interest in a pool of residential mortgages.
Sales of federal funds subject to a continuing contract means an
overnight federal funds loan that is automatically renewed each day
unless terminated by either the lender or the borrower.
Total assets mean the total assets of a Bank, as determined in
accordance with generally accepted accounting principles (GAAP).
* * * * *
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4. Add subpart B, consisting of Sec. Sec. 1277.2 through 1277.8, to
read as follows:
Subpart B--Bank Capital Requirements
Sec.
1277.2 Total capital requirement.
1277.3 Risk-based capital requirement.
1277.4 Credit risk capital requirement.
1277.5 Market risk capital requirement.
1277.6 Operational risk capital requirement.
1277.7 Limits on unsecured extensions of credit; reporting
requirements.
1277.8 Reporting requirements.
Sec. 1277.2 Total capital requirement.
Each Bank shall maintain at all times:
(a) Total capital in an amount at least equal to 4.0 percent of the
Bank's total assets; and
(b) A leverage ratio of total capital to total assets of at least
5.0 percent of the Bank's total assets. For purposes of determining
this leverage ratio, total capital shall be computed by multiplying the
Bank's permanent capital by 1.5 and adding to this product all other
components of total capital.
Sec. 1277.3 Risk-based capital requirement.
Each Bank shall maintain at all times permanent capital in an
amount at least equal to the sum of its credit risk capital
requirement, its market risk capital requirement, and its operational
risk capital requirement, calculated in accordance with Sec. Sec.
1277.4, 1277.5, and 1277.6, respectively.
Sec. 1277.4 Credit risk capital requirement.
(a) General requirement. Each Bank's credit risk capital
requirement shall equal the sum of the Bank's individual credit risk
capital charges for all advances, residential mortgage assets, CMOs,
non-mortgage assets, non-rated assets, off-balance sheet items, and
derivative contracts, as calculated in accordance with this section.
(b) Credit risk capital charge for residential mortgage assets and
collateralized mortgage obligations. The credit risk capital charge for
residential mortgages, residential mortgage pools, residential mortgage
securities, and collateralized mortgage obligations shall be determined
as set forth in paragraph (g) of this section.
(c) Credit risk capital charge for advances, non-mortgage assets,
and non-rated assets. Except as provided in paragraph (j) of this
section, each Bank's credit risk capital charge for advances, non-
mortgage assets, and non-rated assets shall be equal to the amortized
cost of the asset multiplied by the credit risk percentage requirement
assigned to that asset pursuant to paragraph (f)(1) or (2) of this
section. For any such asset carried at fair value where any change in
fair value is recognized in the Bank's income, the Bank shall calculate
the capital charge based on the fair value of the asset rather than its
amortized cost.
(d) Credit risk capital charge for off-balance sheet items. Each
Bank's credit risk capital charge for an off-balance sheet item shall
be equal to the credit equivalent amount of such item, as determined
pursuant to paragraph (h) of this section, multiplied by the credit
risk percentage requirement assigned to that item pursuant to paragraph
(f)(1) of this section and Table 2 to this section, except that the
credit risk percentage requirement applied to the credit equivalent
amount for a standby letter of credit shall be that for an advance with
the same remaining maturity as that of the standby letter of credit, as
specified in Table 1 to this section.
(e) Derivative contracts. (1) Except as provided in paragraphs
(e)(4) (transactions with members) and (5) (cleared transactions and
foreign exchange rate contracts) of this section, the credit risk
capital charge for a derivative contract entered into by a Bank shall
equal, after any adjustment allowed under paragraph (e)(2) of this
section, the sum of:
(i) The current credit exposure for the derivative contract,
calculated in accordance with paragraph (i)(1) of this section,
multiplied by the credit risk percentage requirement assigned to that
derivative contract pursuant to Table 2 to this section, provided that
a Bank shall use the credit risk percentages from the column for
instruments with maturities of one year or less for all such derivative
contracts; plus
(ii) The potential future credit exposure for the derivative
contract, calculated in accordance with paragraph (i)(2) of this
section, multiplied by the credit risk percentage requirement assigned
to that derivative contract pursuant to Table 2 to this section, where
a Bank uses the actual remaining maturity of the derivative contract
for the purpose of applying Table 2 to this section; plus
(iii) A credit risk capital charge applicable to the undiscounted
amount of collateral posted by the Bank with respect to a derivative
contract that exceeds the Bank's current payment obligation under that
derivative contract, where the charge equals the amount of such excess
collateral multiplied by the credit risk percentage requirement
assigned under Table 2 to
[[Page 5327]]
this section for the custodian or other party that holds the
collateral, and where a Bank deems the exposure to have a remaining
maturity of one year or less when applying Table 2 to this section.
(2)(i) A Bank may reduce the credit risk capital charge calculated
under paragraph (e)(1) of this section by the amount of the discounted
value of any collateral that is held by or on behalf of the Bank
against an exposure from the derivative contract, and that satisfies
the requirements of paragraph (e)(3) of this section. If the total
amount of the discounted value of the collateral is less than the
credit risk capital charge calculated under paragraph (e)(1) of this
section for a particular derivative contract, then the credit risk
capital charge for the derivative contract shall equal the amount of
the initial charge that remains after having been reduced by the
collateral. A Bank that uses a counterparty's pledged collateral to
reduce the capital charge against a derivative contract under this
provision, shall also apply a capital charge to the amount of the
pledged collateral that it has used to reduce its credit exposure on
the derivative contract. The amount of that capital charge shall be
equal to the capital charge that would be required under paragraph (b)
or (c) of this section, whichever applies to the type of collateral, as
if the Bank were to own the collateral directly. In reducing the
capital charge on a particular derivative contract, the Bank shall
apply the discounted value of the collateral for that derivative
contract in the following manner:
(A) First, to reduce the current credit exposure of the derivative
contract subject to the capital charge; and
(B) Second, and only if the total discounted value of the
collateral held exceeds the current credit exposure of the contract,
any remaining amounts may be applied to reduce the amount of the
potential future credit exposure of the derivative contract subject to
the capital charge.
(ii) If a counterparty's payment obligations to a Bank under a
derivative contract are unconditionally guaranteed by a third-party,
then the credit risk percentage requirement applicable to the
derivative contract may be that associated with the guarantor, rather
than the Bank's counterparty.
(3) The credit risk capital charge may be reduced as described in
paragraph (e)(2)(i) of this section for collateral held against the
derivative contract exposure only if the collateral is:
(i) Held by, or has been paid to, the Bank or held by an
independent, third-party custodian on behalf of the Bank pursuant to a
custody agreement that meets the requirements of Sec. 1221.7(c) and
(d) of this chapter;
(ii) Legally available to absorb losses;
(iii) Of a readily determinable value at which it can be liquidated
by the Bank; and
(iv) Subject to an appropriate discount to protect against price
decline during the holding period and the costs likely to be incurred
in the liquidation of the collateral, provided that such discount shall
equal at least the minimum discount required under appendix B to part
1221 of this chapter for collateral listed in that appendix, or shall
be estimated by the Bank based on appropriate assumptions about the
price risks and liquidation costs for collateral not listed in appendix
B to part 1221.
(4) The credit risk capital charge for any derivative contracts
entered into between a Bank and its members shall be calculated in
accordance with paragraph (e)(1) of this section, except that the Bank
shall use the credit risk percentage requirements from Table 1 to this
section, which sets forth the credit risk percentage requirements for
advances.
(5) Notwithstanding any other provision in this paragraph (e), the
credit risk capital charge for:
(i) A foreign exchange rate contract (excluding gold contracts)
with an original maturity of 14 calendar days or less shall be zero;
and
(ii) A derivative contract cleared by a derivatives clearing
organization shall equal 0.16 percent times the sum of the following:
(A) The current credit exposure for the derivative contract,
calculated in accordance with paragraph (i)(1)(i) of this section;
(B) The potential future credit exposure for the derivative
contract calculated in accordance with paragraph (i)(2) of this
section; and
(C) The amount of collateral posted by the Bank and held by the
derivatives clearing organization, clearing member, or custodian in a
manner that is not bankruptcy remote, but only to the extent the amount
exceeds the Bank's current credit exposure to the derivatives clearing
organization.
(f) Determination of credit risk percentage requirements--(1)
General. (i) Each Bank shall determine the credit risk percentage
requirement applicable to each advance and each non-rated asset by
identifying the appropriate category from Table 1 or 3 to this section,
respectively, to which the advance or non-rated asset belongs. Except
as provided in paragraphs (f)(2) and (3) of this section, each Bank
shall determine the credit risk percentage requirement applicable to
each non-mortgage asset, off-balance sheet item, and derivative
contract by identifying the appropriate category set forth in Table 2
to this section to which the asset, item, or contract belongs as
determined in accordance with paragraph (f)(1)(ii) of this section, and
remaining maturity. Each Bank shall use the applicable credit risk
percentage requirement to calculate the credit risk capital charge for
each asset, item, or contract in accordance with paragraph (c), (d), or
(e) of this section, respectively. The relevant categories and credit
risk percentage requirements are provided in the following Tables 1
through 3 to this section--
Table 1 to Sec. 1277.4--Requirement for Advances
------------------------------------------------------------------------
Percentage
Maturity of advances applicable
to advances
------------------------------------------------------------------------
Advances with:
Remaining maturity 4 years to 7 years................... 0.23
Remaining maturity >7 years to 10 years.................. 0.35
Remaining maturity >10 years............................. 0.51
------------------------------------------------------------------------
Table 2 to Sec. 1277.4--Requirement for Internally Rated Non-Mortgage Assets, Off-Balance Sheet Items, and
Derivative Contracts
[Based on remaining contractual maturity]
----------------------------------------------------------------------------------------------------------------
Applicable percentage
-------------------------------------------------------------------------------
FHFA Credit Rating >3 yrs to 7 >7 yrs to 10
1 yr to 3 yrs yrs yrs >10 yrs
----------------------------------------------------------------------------------------------------------------
U.S. Government Securities...... 0.00 0.00 0.00 0.00 0.00
FHFA 1...................... 0.20 0.59 1.37 2.28 3.32
[[Page 5328]]
FHFA 2...................... 0.36 0.87 1.88 3.07 4.42
FHFA 3...................... 0.64 1.31 2.65 4.22 6.01
FHFA 4...................... 3.24 4.79 7.89 11.51 15.64
FHFA 5...................... 9.24 11.46 15.90 21.08 27.00
FHFA 6...................... 15.99 18.06 22.18 26.99 32.49
FHFA 7...................... 100.00 100.00 100.00 100.00 100.00
----------------------------------------------------------------------------------------------------------------
Table 3 to Sec. 1277.4--Requirement for Non-Rated Assets
------------------------------------------------------------------------
Applicable
Type of unrated asset percentage
------------------------------------------------------------------------
Cash....................................................... 0.00
Premises, Plant and Equipment.............................. 8.00
Investments Under 12 CFR 1265.3(e) & (f)................... 8.00
------------------------------------------------------------------------
(ii) Each Bank shall develop a methodology to be used to assign an
internal credit risk rating to each counterparty, asset, item, and
contract that is subject to Table 2 to this section. The methodology
shall involve an evaluation of counterparty or asset risk factors, and
may incorporate, but must not rely solely on, credit ratings prepared
by credit rating agencies. Each Bank shall align its various internal
credit ratings to the appropriate categories of FHFA Credit Ratings
included in Table 2 to this section. In doing so, FHFA Categories 7
through 1 shall include assets of progressively higher credit quality.
After aligning its internal credit ratings to the appropriate
categories of Table 2 to this section, each Bank shall assign each
counterparty, asset, item, and contract to the appropriate FHFA Credit
Rating category based on the applicable internal credit rating.
(2) Exception for assets subject to a guarantee or secured by
collateral. (i) When determining the applicable credit risk percentage
requirement from Table 1 to this section for a non-mortgage asset that
is subject to an unconditional guarantee by a third-party guarantor or
is secured as set forth in paragraph (f)(2)(ii) of this section, the
Bank may substitute the credit risk percentage requirement associated
with the guarantor or the collateral, as appropriate, for the credit
risk percentage requirement associated with that portion of the asset
subject to the guarantee or covered by the collateral.
(ii) For purposes of paragraph (f)(2)(i) of this section, a non-
mortgage asset shall be considered to be secured if the collateral is:
(A) Actually held by the Bank, or an independent third-party
custodian on the Bank's behalf, or, if posted by a Bank member and
permitted under the Bank's collateral agreement with that member, by
the Bank's member or an affiliate of that member where the term
``affiliate'' has the same meaning as in Sec. 1266.1 of this chapter;
(B) Legally available to absorb losses;
(C) Of a readily determinable value at which it can be liquidated
by the Bank;
(D) Held in accordance with the provisions of the Bank's member
products policy established pursuant to Sec. 1239.30 of this chapter,
if the collateral has been posted by a member or an affiliate of a
member; and
(E) Subject to an appropriate discount to protect against price
decline during the holding period and the costs likely to be incurred
in the liquidation of the collateral.
(3) Exception for obligations of the Enterprises. A Bank may use a
credit risk capital charge of zero for any debt instrument or
obligation issued by an Enterprise, other than a residential mortgage
security or a collateralized mortgage obligation, provided that, and
only for so long as, the Enterprise receives capital support or other
form of direct financial assistance from the United States government
that enables the Enterprise to repay those obligations.
(4) Methodology and model review. A Bank shall provide to FHFA upon
request the methodology, model, and any analyses used by the Bank to
assign any non-mortgage asset, off-balance sheet item, or derivative
contract to an FHFA Credit Rating category. FHFA may direct a Bank to
promptly revise its methodology or model to address any deficiencies
identified by FHFA.
(g) Credit risk capital charges for residential mortgage assets--
(1) Bank determination of credit risk percentage. (i) Each Bank's
credit risk capital charge for a residential mortgage, residential
mortgage pool, residential mortgage security, or collateralized
mortgage obligation shall be equal to the asset's amortized cost
multiplied by the credit risk percentage requirement assigned to that
asset pursuant to paragraph (g)(1)(ii) or (g)(2) of this section. For
any such asset carried at fair value where any change in fair value is
recognized in the Bank's income, the Bank shall calculate the capital
charge based on the fair value of the asset rather than its amortized
cost.
(ii) Each Bank shall determine the credit risk percentage
requirement applicable to each residential mortgage, residential
mortgage pool, and residential mortgage security by identifying the
appropriate FHFA RMA category set forth in the following Table 4 to
this section to which the asset belongs, and shall determine the credit
risk percentage requirement applicable to each collateralized mortgage
obligation by identifying the appropriate FHFA CMO category set forth
in Table 4 to this section to which the asset belongs, with the
appropriate categories being determined in accordance with paragraph
(g)(1)(iii) of this section.
(iii) Each Bank shall develop a methodology to estimate the
potential future stress losses on its residential mortgages,
residential mortgage pools, residential mortgage securities, and
collateralized mortgage obligations, as may yet occur from the current
amortized cost (or fair value) of those assets, and that converts those
loss estimates into a stress loss percentage for each asset, expressed
as a percentage of its amortized cost (or fair value). A Bank shall use
the stress loss percentage for each asset to determine the appropriate
FHFA RMA or CMO ratings category for that asset, as set forth in Table
4 to this section. A Bank shall do so by assigning each such asset to
the category whose credit risk percentage requirement equals the
asset's stress loss percentage, or to the category with the next
highest credit risk percentage requirement. For residential mortgages
[[Page 5329]]
and residential mortgage pools, the methodology shall involve an
evaluation of the residential mortgages and residential mortgage pools
and any credit enhancements or guarantees, including an assessment of
the creditworthiness of the providers of such enhancements or
guarantees. In the case of a residential mortgage security or
collateralized mortgage obligation, the methodology shall involve an
evaluation of the underlying mortgage collateral, the structure of the
security, and any credit enhancements or guarantees, including an
assessment of the creditworthiness of the providers of such
enhancements or guarantees.
Table 4 to Sec. 1277.4--Requirement for Residential Mortgage Assets
and CMOs
------------------------------------------------------------------------
Credit risk
percentage
------------------------------------------------------------------------
Categories for residential mortgage assets:
FHFA RMA 1............................................... 0.37
FHFA RMA 2............................................... 0.60
FHFA RMA 3............................................... 0.86
FHFA RMA 4............................................... 1.20
FHFA RMA 5............................................... 2.40
FHFA RMA 6............................................... 4.80
FHFA RMA 7............................................... 34.00
Categories for Collateralized Mortgage Obligations:
FHFA CMO 1............................................... 0.37
FHFA CMO 2............................................... 0.60
FHFA CMO 3............................................... 1.60
FHFA CMO 4............................................... 4.45
FHFA CMO 5............................................... 13.00
FHFA CMO 6............................................... 34.00
FHFA CMO 7............................................... 100.00
------------------------------------------------------------------------
(2) Exceptions. (i) A Bank may use a credit risk capital charge of
zero for any residential mortgage asset or collateralized mortgage
obligation, or portion thereof, guaranteed by an Enterprise as to
payment of principal and interest, provided that, and only for so long
as, the Enterprise receives capital support or other form of direct
financial assistance from the United States government that enables the
Enterprise to repay those obligations;
(ii) A Bank may use a credit risk capital charge of zero for any
residential mortgage asset or collateralized mortgage obligation, or
any portion thereof, guaranteed or insured as to payment of principal
and interest by a department or agency of the United States government
that is backed by the full faith and credit of the United States; and
(iii) A Bank shall provide to FHFA upon request the methodology,
model, and any analyses used to estimate the potential future stress
losses on its residential mortgages, residential mortgage pools,
residential mortgage securities, and collateralized mortgage
obligations, and to determine a stress loss percentage for each such
asset. FHFA may direct a Bank to promptly revise its methodology or
model to address any deficiencies identified by FHFA.
(h) Calculation of credit equivalent amount for off-balance sheet
items--(1) General requirement. The credit equivalent amount for an
off-balance sheet item shall be determined by an FHFA-approved model or
shall be equal to the face amount of the instrument multiplied by the
credit conversion factor assigned to such risk category of instruments
by the following Table 5 to this section, subject to the exceptions in
paragraph (h)(2) of this section.
Table 5 to Sec. 1277.4--Credit Conversion Factors for Off-Balance
Sheet Items
------------------------------------------------------------------------
Credit
conversion
Instrument factor (in
percent)
------------------------------------------------------------------------
Asset sales with recourse where the credit risk remains 100
with the Bank..........................................
Commitments to make advances subject to certain
drawdown.
Commitments to acquire loans subject to certain
drawdown.
Standby letters of credit............................... 50
Other commitments with original maturity of over one
year.
Other commitments with original maturity of one year or 20
less...................................................
------------------------------------------------------------------------
(2) Exceptions. The credit conversion factor shall be zero for
``Other Commitments With Original Maturity of Over One Year'' and
``Other Commitments With Original Maturity of One Year or Less'' for
which Table 5 to this section would otherwise apply credit conversion
factors of 50 percent or 20 percent, respectively, if the commitments
are unconditionally cancelable, or effectively provide for automatic
cancellation due to the deterioration in a borrower's creditworthiness,
at any time by the Bank without prior notice.
(i) Calculation of credit exposures for derivative contracts--(1)
Current credit exposure--(i) Single derivative contract. The current
credit exposure for derivative contracts that are not subject to an
eligible master netting agreement shall be:
(A) If the mark-to-market value of the contract is positive, the
mark-to-market value of the contract; or
(B) If the mark-to-market value of the contract is zero or
negative, zero.
(ii) Derivative contracts subject to an eligible master netting
agreement. The current credit exposure for multiple uncleared
derivative contracts executed with a single counterparty and subject to
an eligible master netting agreement shall be calculated on a net basis
and shall equal:
(A) The net sum of all positive and negative mark-to-market values
of the individual derivative contracts subject to the eligible master
netting agreement, if the net sum of the mark-to-market values is
positive; or
(B) Zero, if the net sum of the mark-to-market values is zero or
negative.
(2) Potential future credit exposure. The potential future credit
exposure for derivative contracts, including derivative contracts with
a negative mark-to-market value, shall be calculated:
(i) Using an internal initial margin model that meets the
requirements of Sec. 1221.8 of this chapter and is approved by FHFA
for use by the Bank, or using an initial margin model that has been
approved under regulations similar to Sec. 1221.8 of this chapter for
use by the Bank's counterparty to calculate initial margin for those
derivative contracts for which the calculation is being done; or
(ii) By applying the standardized approach in appendix A to part
1221 of this chapter; or
[[Page 5330]]
(iii) Using an initial margin model that is employed by a
derivatives clearing organization.
(j) Credit risk capital charge for non-mortgage assets hedged with
credit derivatives--(1) Credit derivatives with a remaining maturity of
one year or more. The credit risk capital charge for a non-mortgage
asset that is hedged with a credit derivative that has a remaining
maturity of one year or more may be reduced only in accordance with
paragraph (j)(3) or (4) of this section and only if the credit
derivative provides substantial protection against credit losses.
(2) Credit derivatives with a remaining maturity of less than one
year. The credit risk capital charge for a non-mortgage asset that is
hedged with a credit derivative that has a remaining maturity of less
than one year may be reduced only in accordance with paragraph (j)(3)
of this section and only if the remaining maturity on the credit
derivative is identical to or exceeds the remaining maturity of the
hedged non-mortgage asset and the credit derivative provides
substantial protection against credit losses.
(3) Credit risk capital charge reduced to zero. The credit risk
capital charge for a non-mortgage asset shall be zero if a credit
derivative is used to hedge the credit risk on that asset in accordance
with paragraph (j)(1) or (2) of this section, provided that:
(i) The remaining maturity for the credit derivative used for the
hedge is identical to or exceeds the remaining maturity for the hedged
non-mortgage asset, and either:
(A) The non-mortgage asset referenced in the credit derivative is
identical to the hedged non-mortgage asset; or
(B) The non-mortgage asset referenced in the credit derivative is
different from the hedged non-mortgage asset, but only if the asset
referenced in the credit derivative and the hedged non-mortgage asset
have been issued by the same obligor, the asset referenced in the
credit derivative ranks pari passu to, or more junior than, the hedged
non-mortgage asset and has the same maturity as the hedged non-mortgage
asset, and cross-default clauses apply; and
(ii) The credit risk capital charge for the credit derivative
contract calculated pursuant to paragraph (e) of this section is still
applied.
(4) Capital charge reduction in certain other cases. The credit
risk capital charge for a non-mortgage asset hedged with a credit
derivative in accordance with paragraph (j)(1) of this section shall
equal the sum of the credit risk capital charges for the hedged and
unhedged portion of the non-mortgage asset provided that:
(i) The remaining maturity for the credit derivative is less than
the remaining maturity for the hedged non-mortgage asset and either:
(A) The non-mortgage asset referenced in the credit derivative is
identical to the hedged non-mortgage asset; or
(B) The non-mortgage asset referenced in the credit derivative is
different from the hedged non-mortgage asset, but only if the asset
referenced in the credit derivative and the hedged non-mortgage asset
have been issued by the same obligor, the asset referenced in the
credit derivative ranks pari passu to, or more junior than, the hedged
non-mortgage asset and has the same maturity as the hedged non-mortgage
asset, and cross-default clauses apply; and
(ii) The credit risk capital charge for the unhedged portion of the
non-mortgage asset equals:
(A) The credit risk capital charge for the non-mortgage asset,
calculated as the amortized cost, or fair value, of the non-mortgage
asset multiplied by that asset's credit risk percentage requirement
assigned pursuant to paragraph (f)(1) of this section where the
appropriate credit rating is that for the non-mortgage asset and the
appropriate maturity is the remaining maturity of the non-mortgage
asset; minus
(B) The credit risk capital charge for the non-mortgage asset,
calculated as the amortized cost, or fair value, of the non-mortgage
asset multiplied by that asset's credit risk percentage requirement
assigned pursuant to paragraph (f)(1) of this section where the
appropriate credit rating is that for the non-mortgage asset but the
appropriate maturity is deemed to be the remaining maturity of the
credit derivative; and
(iii) The credit risk capital charge for the hedged portion of the
non-mortgage asset is equal to the credit risk capital charge for the
credit derivative, calculated in accordance with paragraph (e) of this
section.
(k) Frequency of calculations. Each Bank shall perform all
calculations required by this section at least quarterly, unless
otherwise directed by FHFA, using the advances, residential mortgages,
residential mortgage pools, residential mortgage securities,
collateralized mortgage obligations, non-rated assets, non-mortgage
assets, off-balance sheet items, and derivative contracts held by the
Bank, and, if applicable, the values of, or FHFA Credit Ratings
categories for, such assets, off-balance sheet items, or derivative
contracts as of the close of business of the last business day of the
calendar period for which the credit risk capital charge is being
calculated.
Sec. 1277.5 Market risk capital requirement.
(a) General requirement. (1) Each Bank's market risk capital
requirement shall equal the market value of the Bank's portfolio at
risk from movements in interest rates, foreign exchange rates,
commodity prices, and equity prices that could occur during periods of
market stress, where the market value of the Bank's portfolio at risk
is determined using an internal market-risk model that fulfills the
requirements of paragraph (b) of this section and that has been
approved by FHFA.
(2) A Bank may substitute an internal cash-flow model to derive a
market risk capital requirement in place of that calculated using an
internal market-risk model under paragraph (a)(1) of this section,
provided that:
(i) The Bank obtains FHFA approval of the internal cash-flow model
and of the assumptions to be applied to the model; and
(ii) The Bank demonstrates to FHFA that the internal cash-flow
model subjects the Bank's assets and liabilities, off-balance sheet
items, and derivative contracts, including related options, to a
comparable degree of stress for such factors as will be required for an
internal market-risk model.
(b) Measurement of market value-at-risk under a Bank's internal
market-risk model. (1) Except as provided under paragraph (a)(2) of
this section, each Bank shall use an internal market-risk model that
estimates the market value of the Bank's assets and liabilities, off-
balance sheet items, and derivative contracts, including any related
options, and measures the market value of the Bank's portfolio at risk
of its assets and liabilities, off-balance sheet items, and derivative
contracts, including related options, from all sources of the Bank's
market risks, except that the Bank's model need only incorporate those
risks that are material.
(2) The Bank's internal market-risk model may use any generally
accepted measurement technique, such as variance-covariance models,
historical simulations, or Monte Carlo simulations, for estimating the
market value of the Bank's portfolio at risk, provided that any
measurement technique used must cover the Bank's material risks.
(3) The measures of the market value of the Bank's portfolio at
risk shall include the risks arising from the non-linear price
characteristics of options and the sensitivity of the market value of
options to changes in the volatility of the options' underlying rates
or prices.
[[Page 5331]]
(4) The Bank's internal market-risk model shall use interest rate
and market price scenarios for estimating the market value of the
Bank's portfolio at risk, but at a minimum:
(i) The Bank's internal market-risk model shall provide an estimate
of the market value of the Bank's portfolio at risk such that the
probability of a loss greater than that estimated shall be no more than
one percent;
(ii) The Bank's internal market-risk model shall incorporate
scenarios that reflect changes in interest rates, interest rate
volatility, option-adjusted spreads, and shape of the yield curve, and
changes in market prices, equivalent to those that have been observed
over 120-business day periods of market stress. For interest rates, the
relevant historical observations should be drawn from the period that
starts at the end of the previous month and goes back to the beginning
of 1998;
(iii) The total number of, and specific historical observations
identified by the Bank as, stress scenarios shall be:
(A) Satisfactory to FHFA;
(B) Representative of the periods of the greatest potential market
stress given the Bank's portfolio; and
(C) Comprehensive given the modeling capabilities available to the
Bank; and
(iv) The measure of the market value of the Bank's portfolio at
risk may incorporate empirical correlations among interest rates.
(5) For any consolidated obligations denominated in a currency
other than U.S. Dollars or linked to equity or commodity prices, each
Bank shall, in addition to fulfilling the criteria of paragraph (b)(4)
of this section, calculate an estimate of the market value of its
portfolio at risk resulting from material foreign exchange, equity
price or commodity price risk, such that, at a minimum:
(i) The probability of a loss greater than that estimated shall not
exceed one percent;
(ii) The scenarios reflect changes in foreign exchange, equity, or
commodity market prices that have been observed over 120-business day
periods of market stress, as determined using historical data that is
from an appropriate period;
(iii) The total number of, and specific historical observations
identified by the Bank as, stress scenarios shall be:
(A) Satisfactory to FHFA;
(B) Representative of the periods of the greatest potential stress
given the Bank's portfolio; and
(C) Comprehensive given the modeling capabilities available to the
Bank; and
(iv) The measure of the market value of the Bank's portfolio at
risk may incorporate empirical correlations within or among foreign
exchange rates, equity prices, or commodity prices.
(c) Independent validation of Bank internal market-risk model or
internal cash-flow model. (1) Each Bank shall conduct an independent
validation of its internal market-risk model or internal cash-flow
model within the Bank that is carried out by personnel not reporting to
the business line responsible for conducting business transactions for
the Bank. Alternatively, the Bank may obtain independent validation by
an outside party qualified to make such determinations. Validations
shall be done periodically, commensurate with the risk associated with
the use of the model, or as frequently as required by FHFA.
(2) The results of such independent validations shall be reviewed
by the Bank's board of directors and provided promptly to FHFA.
(d) FHFA approval of Bank internal market-risk model or internal
cash-flow model. (1) Each Bank shall obtain FHFA approval of an
internal market-risk model or an internal cash-flow model, including
subsequent material adjustments to the model made by the Bank, prior to
the use of any model. Each Bank shall make such adjustments to its
model as may be directed by FHFA.
(2) A model and any material adjustments to such model that were
approved by FHFA or the Federal Housing Finance Board shall be deemed
to meet the requirements of paragraph (d)(1) of this section, unless
such approval is revoked or amended by FHFA.
(e) Frequency of calculations. Each Bank shall perform any
calculations or estimates required under this section at least
quarterly, unless otherwise directed by FHFA, using the assets,
liabilities, and off-balance sheet items (including derivative
contracts and options) held by the Bank, and if applicable, the values
of any such holdings, as of the close of business of the last business
day of the calendar period for which the market risk capital
requirement is being calculated.
Sec. 1277.6 Operational risk capital requirement.
(a) General requirement. Except as authorized under paragraph (b)
of this section, each Bank's operational risk capital requirement shall
at all times equal 30 percent of the sum of the Bank's credit risk
capital requirement and market risk capital requirement.
(b) Alternative requirements. With the approval of FHFA, each Bank
may have an operational risk capital requirement equal to less than 30
percent but no less than 10 percent of the sum of the Bank's credit
risk capital requirement and market risk capital requirement if:
(1) The Bank provides an alternative methodology for assessing and
quantifying an operational risk capital requirement; or
(2) The Bank obtains insurance to cover operational risk from an
insurer acceptable to FHFA and on terms acceptable to FHFA.
Sec. 1277.7 Limits on unsecured extensions of credit; reporting
requirements.
(a) Unsecured extensions of credit to a single counterparty. A Bank
shall not extend unsecured credit to any single counterparty (other
than a GSE described in and subject to the requirements of paragraph
(c) of this section) in an amount that would exceed the limits of this
paragraph (a). If a third-party provides an irrevocable, unconditional
guarantee of repayment of a credit (or any part thereof), the third-
party guarantor may be considered the counterparty for purposes of
calculating and applying the unsecured credit limits of this section
with respect to the guaranteed portion of the transaction.
(1) General limits. All unsecured extensions of credit by a Bank to
a single counterparty that arise from the Bank's on- and off-balance
sheet and derivative transactions (but excluding the amount of sales of
federal funds with a maturity of one day or less and sales of federal
funds subject to a continuing contract) shall not exceed the product of
the maximum capital exposure limit applicable to such counterparty, as
determined in accordance with the following Table 1 to this section,
multiplied by the lesser of:
(i) The Bank's total capital; or
(ii) The counterparty's Tier 1 capital, or if Tier 1 capital is not
available, total capital (in each case as defined by the counterparty's
principal regulator) or some similar comparable measure identified by
the Bank.
(2) Overall limits including sales of overnight federal funds. All
unsecured extensions of credit by a Bank to a single counterparty that
arise from the Bank's on- and off-balance sheet and derivative
transactions, including the amounts of sales of federal funds with a
maturity of one day or less and sales of federal funds subject to a
continuing contract, shall not exceed twice the limit calculated
pursuant to paragraph (a)(1) of this section.
[[Page 5332]]
(3) Limits for certain obligations issued by state, local, or
tribal governmental agencies. The limit set forth in paragraph (a)(1)
of this section, when applied to the marketable direct obligations of
state, local, or tribal government units or agencies that are excluded
from the prohibition against investments in whole mortgage loans or
other types of whole loans, or interests in such loans, by Sec.
1267.3(a)(4)(iii) of this chapter, shall be calculated based on the
Bank's total capital and the internal credit rating assigned to the
particular obligation, as determined in accordance with paragraph
(a)(4) of this section. If a Bank owns series or classes of obligations
issued by a particular state, local, or tribal government unit or
agency, or has extended other forms of unsecured credit to such entity
falling into different rating categories, the total amount of unsecured
credit extended by the Bank to that government unit or agency shall not
exceed the limit associated with the highest-rated obligation issued by
the entity and actually purchased by the Bank.
(4) Bank determination of applicable maximum capital exposure
limits. A Bank shall determine the maximum capital exposure limit for
each counterparty by assigning the counterparty to the appropriate FHFA
Credit Rating category of Table 1 to this section, based upon the
Bank's internal credit rating for that counterparty. In all cases, a
Bank shall use the same FHFA Credit Rating category for a particular
counterparty when determining its unsecured credit limit under this
section as it would use under Table 2 to Sec. 1277.4 for determining
the risk-based capital charge for obligations issued by that
counterparty under Sec. 1277.4(f).
Table 1 to Sec. 1277.7--Maximum Limits on Unsecured Extensions of
Credit to a Single Counter-party by FHFA Credit Rating Category
------------------------------------------------------------------------
Maximum capital
FHFA Credit Rating exposure limit
(in percent)
------------------------------------------------------------------------
FHFA 1............................................... 15
FHFA 2............................................... 14
FHFA 3............................................... 9
FHFA 4............................................... 3
FHFA 5 and Below..................................... 1
------------------------------------------------------------------------
(b) Unsecured extensions of credit to affiliated counterparties--
(1) In general. The total amount of unsecured extensions of credit by a
Bank to a group of affiliated counterparties that arise from the Bank's
on- and off-balance sheet and derivative transactions, including sales
of federal funds with a maturity of one day or less and sales of
federal funds subject to a continuing contract, shall not exceed 30
percent of the Bank's total capital.
(2) Relation to individual limits. The aggregate limits calculated
under paragraph (b)(1) of this section shall apply in addition to the
limits on extensions of unsecured credit to a single counterparty
imposed by paragraph (a) of this section.
(c) Special limits for certain GSEs. Unsecured extensions of credit
by a Bank that arise from the Bank's on- and off-balance sheet and
derivative transactions, including from the purchase of any debt or
from any sales of federal funds with a maturity of one day or less and
from sales of federal funds subject to a continuing contract, with a
GSE that is operating with capital support or another form of direct
financial assistance from the United States government that enables the
GSE to repay those obligations, shall not exceed the Bank's total
capital.
(d) Extensions of unsecured credit after reduced rating. If a Bank
revises its internal credit rating for any counterparty or obligation,
it shall assign the counterparty or obligation to the appropriate FHFA
Credit Rating category based on the revised rating. If the revised
internal rating results in a lower FHFA Credit Rating category, then
any subsequent extensions of unsecured credit shall comply with the
maximum capital exposure limit applicable to that lower rating
category, but a Bank need not unwind or liquidate any existing
transaction or position that complied with the limits of this section
at the time it was entered. For purposes of this paragraph (d), the
renewal of an existing unsecured extension of credit, including any
decision not to terminate any sales of federal funds subject to a
continuing contract, shall be considered a subsequent extension of
unsecured credit that can be undertaken only in accordance with the
lower limit.
(e) Reporting requirements--(1) Total unsecured extensions of
credit. Each Bank shall report monthly to FHFA the amount of the Bank's
total unsecured extensions of credit arising from on- and off-balance
sheet and derivative transactions to any single counterparty or group
of affiliated counterparties that exceeds 5 percent of:
(i) The Bank's total capital; or
(ii) The counterparty's, or affiliated counterparties' combined,
Tier 1 capital, or if Tier 1 capital is not available, total capital
(in each case as defined by the counterparty's principal regulator), or
some similar comparable measure identified by the Bank.
(2) Total secured and unsecured extensions of credit. Each Bank
shall report monthly to FHFA the amount of the Bank's total secured and
unsecured extensions of credit arising from on- and off-balance sheet
and derivative transactions to any single counterparty or group of
affiliated counterparties that exceeds 5 percent of the Bank's total
assets.
(3) Extensions of credit in excess of limits. A Bank shall report
promptly to FHFA any extension of unsecured credit that exceeds any
limit set forth in paragraph (a), (b), or (c) of this section. In
making this report, a Bank shall provide the name of the counterparty
or group of affiliated counterparties to which the excess unsecured
credit has been extended, the dollar amount of the applicable limit
which has been exceeded, the dollar amount by which the Bank's
extension of unsecured credit exceeds such limit, the dates for which
the Bank was not in compliance with the limit, and a brief explanation
of the circumstances that caused the limit to be exceeded.
(f) Measurement of unsecured extensions of credit--(1) In general.
For purposes of this section, unsecured extensions of credit will be
measured as follows:
(i) For on-balance sheet transactions (other than a derivative
transaction addressed by paragraph (f)(1)(iii) of this section), an
amount equal to the sum of the amortized cost of the item plus net
payments due the Bank. For any such item carried at fair value where
any change in fair value would be recognized in the Bank's income, the
Bank shall measure the unsecured extension of credit based on the fair
value of the item, rather than its amortized cost;
(ii) For off-balance sheet transactions, an amount equal to the
credit equivalent amount of such item, calculated in accordance with
Sec. 1277.4(h); and
(iii) For derivative transactions not cleared by a derivatives
clearing organization, an amount equal to the sum of:
(A) The Bank's current and potential future credit exposures under
the derivative contract, where those values are calculated in
accordance with Sec. 1277.4(i)(1) and (2) respectively, reduced by the
amount of any collateral held by or on behalf of the Bank against the
credit exposure from the derivative contract, as allowed in accordance
with the requirements of Sec. 1277.4(e)(2) and (3); and
(B) The value of any collateral posted by the Bank that exceeds the
current amount owed by the Bank to its counterparty under the
derivative
[[Page 5333]]
contract, where the collateral is held by a person or entity other than
a third-party custodian that is acting under a custody agreement that
meets the requirements of Sec. 1221.7(c) and (d) of this chapter.
(2) Status of debt obligations purchased by the Bank. Any debt
obligation or debt security (other than mortgage-backed or other asset-
backed securities or acquired member assets) purchased by a Bank shall
be considered an unsecured extension of credit for the purposes of this
section, except for:
(i) Any amount owed the Bank against which the Bank holds
collateral in accordance with Sec. 1277.4(f)(2)(ii); or
(ii) Any amount which FHFA has determined on a case-by-case basis
shall not be considered an unsecured extension of credit.
(g) Exceptions to unsecured credit limits. The following items are
not subject to the limits of this section:
(1) Obligations of, or guaranteed by, the United States;
(2) A derivative transaction accepted for clearing by a derivatives
clearing organization, including collateral posted by the Bank with the
derivatives clearing organization associated with that derivative
transaction;
(3) Any extension of credit from one Bank to another Bank; and
(4) A bond issued by a state housing finance agency, if the Bank
documents that the obligation in question is:
(i) Principally secured by high quality mortgage loans or high
quality mortgage-backed securities (or funds derived from payments on
such assets or from payments from any guarantees or insurance
associated with such assets);
(ii) The most senior class of obligation, if the bond has more than
one class; and
(iii) Determined by the Bank to be rated no lower than FHFA 2, in
accordance with this section.
Sec. 1277.8 Reporting requirements.
Each Bank shall report information related to capital and other
matters addressed by this part in accordance with instructions provided
in the Data Reporting Manual issued by FHFA, as amended from time to
time.
Dated: December 18, 2018.
Melvin L. Watt,
Director, Federal Housing Finance Agency.
[FR Doc. 2018-27918 Filed 2-19-19; 8:45 am]
BILLING CODE 8070-01-P
