FHFA's Oversight of Two Mission-Related Requirements for Federal Home Loan Bank Long-Term Advances

Published by the Federal Housing Finance Agency, Office of Inspector General on 2015-03-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             Federal Housing Finance Agency
                 Office of Inspector General

      FHFA’s Oversight of Two
   Mission-Related Requirements for
       Federal Home Loan Bank
         Long-Term Advances

Evaluation Survey Report  ESR-2015-005  March 31, 2015
                                        March 31, 2015

TO:           Sandra Thompson, Deputy Director, Division of Housing Mission and Goals
              Fred Graham, Deputy Director, Division of Federal Home Loan Bank Regulation

FROM:         Kyle D. Roberts, Acting Deputy Inspector General for Evaluations

SUBJECT:      FHFA’s Oversight of Two Mission-Related Requirements for Federal Home Loan
              Bank Long-Term Advances (ESR-2015-005)


This memorandum closes our evaluation of the Federal Housing Finance Agency’s (FHFA or
Agency) oversight of two mission-related requirements for long-term advances.

Our review identified instances in which FHFA’s implementation of the community support
requirement for long-term advances greater than one year fell short of the Agency’s regulatory
requirements. Although these deficiencies have not been fully remediated, FHFA has
represented to us that it is in the process of addressing them. We also conducted a limited
review of FHFA’s oversight of the residential housing finance requirement for long-term
advances greater than five years and found no material noncompliance.

This closing memorandum is intended to promote the Agency’s efficient administration
of its own regulations setting forth the terms under which the Federal Home Loan Banks
(FHLBanks) can make long-term advances to FHLBank members. We intend to monitor
developments on these issues and will subsequently test whether FHFA has fulfilled its
responsibility to remediate deficiencies.

   Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015

The FHLBank Act, as amended, authorized the FHLBanks to provide secured loans, known as
advances, to their members.1 For long-term advances, the FHLBank Act provided that certain
mission-related requirements had to be met.2 The FHLBank Act directed the Federal Housing
Finance Board (FHFB), FHFA’s predecessor, to “adopt regulations establishing standards of
community investment or service for members . . . to maintain continued access to long-term
advances” and specified that these standards include “factors such as a member’s performance
under the Community Reinvestment Act” and “the member’s record of lending to first-time
homebuyers.”3 Pursuant to this statutory directive, FHFB issued regulations, which are now
enforced by FHFA, defining any advance with an original maturity greater than one year as
a “long-term advance.”4 Additionally, the FHLBank Act required that long-term advances
generally had to be made for residential housing finance, defined for this purpose by regulations
as advances with original maturities greater than five years.5


FHFA’s Implementation of the Community Support Requirement

FHFA regulations require the Agency to review FHLBank members approximately every two
years to determine whether they meet the standards to FHFA’s satisfaction.6 An FHLBank
member selected for community support review must provide to FHFA: (1) its Community
Reinvestment Act (CRA) rating, if it is subject to the CRA, and (2) information about its support
for first-time homebuyers.7 As implemented, the first-time homebuyer support standard is
satisfied by a showing of one of a number of specified activities.8 As FHFA Director Watt

  12 U.S.C. § 1430(a)(1). The FHLBank System was created by the FHLBank Act of 1932 to support
mortgage lending. The FHLBank System is currently comprised of 12 regional banks and the FHLBank
System’s fiscal agent, the Office of Finance. In total, the FHLBanks have approximately 7,500 members.
Members of the FHLBanks include banks, thrift institutions, credit unions, insurance companies, and
community development financial institutions. For a description of the FHLBank System and its operations,
see FHFA Office of Inspector General, Semiannual Report to the Congress: April 1, 2014, through September
30, 2014, at 56-58 (Oct. 31, 2014) (online at: www.fhfaoig.gov/Content/Files/EighthSemiannualReport_0.pdf).
   As the Office of Inspector General (OIG) for FHFA, one aspect of our mission is to “conduct . . . activities
. . . for the purpose of promoting economy and efficiency in the administration of [the Agency].” Inspector
General Act of 1978, 5 U.S.C. App. § 4(a)(3).
    12 U.S.C. § 1430(g)(1), (2).
 12 C.F.R. § 1290.1. One year was chosen so that the requirement would apply to more advances. See
56 Fed. Reg. 58639, 58642 (Nov. 21, 1991).
    12 U.S.C. § 1430(a)(2)(A); 12 C.F.R. § 1266.1.
    12 C.F.R. §§ 1290.2(a), 1290.3(c).
    See 12 C.F.R. §§ 1290.2(c), 1290.3(a)-(c).
    The list of activities tracks a list specified in the regulations at 12 C.F.R. § 1290.3(c)(1)(i)-(iv):

       Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
recently testified: “The mission focus of the FHLBank System is an important component of
FHFA’s regulatory activities.”9 Within FHFA, the Division of Housing Mission and Goals
(DHMG) is responsible for conducting the biennial community support reviews.

Our evaluation showed that FHFA failed to follow its own regulatory requirements, in several

       Failure to conduct biennial reviews. By regulation, FHFA reviews FHLBank
        members for community support approximately every two years. FHFA has
        recognized the importance of these biennial reviews, stating: “[i]f FHFA did not
        collect the information at least biennially, it would be unable to determine effectively

        (i) Has an established record of lending to first-time homebuyers;
        (ii) Has a program whereby it actively seeks to lend or support lending to first-time homebuyers,
        including, but not limited to, the following—
                 (A) Providing special credit products with flexible underwriting standards for first-time
                 (B) Participating in Federal, State, or local government, or nationwide homeownership
                 lending programs that benefit, serve, or are targeted to, first-time homebuyers; or
                 (C) Participating in loan consortia for first-time homebuyer loans or loans that serve
                 predominantly low- or moderate-income borrowers;
        (iii) Has a program whereby it actively seeks to assist or support organizations that assist potential
        first-time homebuyers to qualify for mortgage loans, including, but not limited to, the following—
                 (A) Providing, participating in, or supporting special counseling programs or other
                 homeownership education activities that benefit, serve, or are targeted to, first-time
                 (B) Providing or participating in marketing plans and related outreach programs targeted to
                 first-time homebuyers;
                 (C) Providing technical assistance of financial support to organizations that assist first-time
                 (D) Participating with or financially supporting community or nonprofit groups that assist
                 first-time homebuyers;
                 (E) Holding investments or making loans that support first-time homebuyer programs;
                 (F) Holding mortgage-backed securities that may include a pool of loans to low- and
                 moderate-income homebuyers;
                 (G) Participating or investing in service organizations that assist credit unions in providing
                 mortgages; or
                 (H) Participating in Bank targeted community lending programs; or
        (iv) Has any combination of the elements described in paragraphs (c)(1)(i), (ii), or (iii) of this section.
 U.S. House of Representatives Committee on Financial Services, Written Testimony of FHFA Director
Melvin L. Watt, Sustainable Housing Finance: An Update from the Director of the Federal Housing Finance
Agency, at 17 (Jan. 27, 2015) (online at http://financialservices.house.gov/UploadedFiles/HHRG-114-BA00-

    Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
         whether [FHLBank] members satisfy the community support standards they are
         required by statute to meet in order to maintain access to long-term [FHLBank]
         advances.”10 FHFA launched the 2010-2011 review cycle in 2010 but did not
         complete that review cycle until 2013. As a result, the Agency never conducted the
         2012-2013 review cycle.

         A DHMG employee reported to us that one employee had been conducting community
         support reviews, with the help of some interns. According to a May 2012 email from a
         DHMG employee to the Deputy Director of FHFA’s Division of Federal Home Loan
         Bank Regulation (DBR), other assignments pushed the community support work to the
         back burner. FHFA’s tardy completion of the 2010-2011 review cycle in 2013 meant
         that FHLBank members were reviewed once, rather than twice, during this four-year

         We identified a member that received long-term advances even though it would have
         been restricted if FHFA had conducted a timely 2012-2013 review.11 As a result of its
         failure to conduct the 2012-2013 review cycle, FHFA, the FHLBanks, and the public
         lack assurance that FHLBank members that received long-term advances were, in fact,
         eligible for them.

        Failure to include all FHLBank members subject to community support review
         in the 2010-2011 review cycle. Our evaluation showed that FHFA failed to review all
         FHLBank members that were subject to community support review during the 2010-
         2011 review cycle, which was the last completed review cycle, and we drew the
         following observations:

             o The database DHMG uses to select members for community support reviews
               is missing a substantial number of members. For the 2010-2011 review cycle,
               FHFA reviewed nearly 6,000 FHLBank members,12 but the Office of Finance
               reports that the number of FHLBank members exceeded 7,500 at year-end
               2010 through 2013.13 OIG asked FHFA to provide the DHMG community

 FHFA, Community Support Requirements (OMB Number 2590-0005) (online at
   In July 2012, the member received a CRA rating of “substantial noncompliance,” which should have
resulted in its access to long-term advances being restricted subsequently. FHFA did not conduct the 2012-
2013 review cycle, however, and the member received an additional $35 million in long-term advances.
  For the 2010-2011 cycle, conducted from 2010 through 2013, FHFA told OIG that it reviewed 5,954
   FHLBank members totaled 7,849 at year-end 2010; 7,774 at year-end 2011; 7,635 at year-end 2012; and
7,504 at year-end 2013. OIG recognizes that not all of the FHLBank members should be reviewed: new
members are not reviewed in their first year of membership; some FHLBank members leave the FHLBank
System, and community development financial institutions are not subject to community support reviews.
After accounting for these factors, OIG estimates that more than 700 members were omitted from the 2010-
2011 review cycle.

     Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
                   support database, in database format, to allow comparison with DBR’s
                   spreadsheet of FHLBank members used for other business purposes. Instead,
                   FHFA provided a hard-copy list of members in the DHMG database, noting
                   that this format would maintain the integrity of the data. OIG compared
                   DHMG’s list to DBR’s and noted more than 1,000 active members missing
                   from DHMG’s list, many of which joined the FHLBank System after October
                   2008.14 DHMG officials confirmed to us that the DHMG database used to
                   identify FHLBank members for community support reviews did not include all
                   FHLBank members.15 OIG observed that FHFA did not routinely add new
                   members to the community support database.

              o In addition, some members in the DHMG database were not reviewed. By
                way of example, information provided by FHFA on 120 large borrowers
                showed that, for the 2010-2011 cycle, FHFA did not review 19 large insurance
                company borrowers that were in DHMG’s database.16 Six of these omitted
                insurance companies had been reviewed in prior cycles. An FHFA official was
                unable to explain why some previously reviewed members were not reviewed
                in the 2010-2011 cycle.

FHFA officials advised OIG that efforts are underway to reconcile DHMG’s community support
database with DBR’s membership database.17 In addition, based on the work done to date for the
2014-2015 review cycle, an FHFA employee projected to us that this review cycle is on track to
be completed on time. FHFA reported to us that it is drafting policies and procedures for its
community support reviews, with an estimated completion date of the second quarter of 2015.

   However, OIG also identified several FHLBank members that were not on the hard copy list but, according
to FHFA, were reviewed in the 2010-2011 cycle, raising questions about the accuracy of the list DHMG
   An FHFA official who formerly oversaw this area told OIG he was aware that a significant number of
members were not included in the community support database. He speculated that FHFA’s proposal to shift
responsibility for community support reviews to the FHLBanks might have led FHFA to defer database
upgrades. For the proposal, see 76 Fed. Reg. 70069 (Nov. 10, 2011).
   FHFA provided OIG with the most recent community support review for the 10 largest advance borrowers
for each of the 12 FHLBanks as of the end of 2013. These 120 members accounted for nearly three-quarters
of advances outstanding. Of these 120 members, 30 were insurance companies, 20 of which should have been
reviewed in the 2010-2011 cycle (i.e., they were not in their first year of membership). However, FHFA did not
review any of these 20 insurance companies in that cycle. Together they held between approximately $31 billion
and $39 billion of long-term advances with original terms greater than one year at year-end 2013. All FHLBank
members combined held $341 billion of long-term advances. Of these 20 non-reviewed insurance companies, 19
were in DHMG’s database and 1 was missing. In contrast to insurance companies, FHFA did review most other
large borrowers during the 2010-2011 cycle. The omission of insurance company members is notable given that
nearly 90% of insurance company advances outstanding were long term at year-end 2013, and insurance companies
are not subject to CRA.
     OIG observed that, during the 2014-2015 cycle, FHFA selected some new FHLBank members for review.

      Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
OIG considers these steps responsive to deficiencies identified during our work and anticipates
that FHFA will take the actions necessary to comply with its regulations.

FHFA’s Oversight of the Residential Housing Finance Requirement

Under the FHLBank Act, as amended, long-term advances generally “may only be made for the
purposes of . . . providing funds to any member for residential housing finance.”18 Governing
regulations define long-term advances for this purpose as advances with original maturities
greater than five years.19 To satisfy this statutory directive, FHFB adopted a proxy test:20 prior
to approving a long-term advance, the FHLBank must determine that the total dollar amount of
the member’s long-term advances is equal to or less than the total book value of the member’s
residential housing finance assets.21 Satisfaction of the proxy test is not an ongoing requirement.
Members can sell residential housing finance assets after receiving a long-term advance as long
as the advance remains collateralized.

According to FHFA officials, its examiners typically do not assess the FHLBanks’
administration of the proxy test during annual examinations. FHFA considers this area to be
a low risk for two reasons: advances are frequently collateralized with residential housing
finance assets in an amount sufficient to pass the proxy test,22 and most advances are short-term
advances not subject to the residential housing finance requirement.

OIG reviewed data on recent long-term advances made by five FHLBanks to 41 large borrowers.
This review identified only one instance of technical noncompliance with FHFA’s regulatory
requirements.23 FHFA represented to us that it discussed the matter with the affected FHLBank
and that the FHLBank committed to consider improvements to its processes.

     12 U.S.C. § 1430(a)(2).
     12 C.F.R. § 1266.1.
   FHFB recognized that “the fungibility of money makes it very difficult and costly to track the actual use of
an advance.” 58 Fed. Reg. 29456, 29465-67 (May 20, 1993).
   Residential housing finance assets are defined in regulations as: (1) loans secured by residential real
property; (2) mortgage-backed securities (MBS); (3) participations in loans secured by residential real
property; (4) loans or investments providing financing for economic development projects for targeted
beneficiaries; (5) loans secured by manufactured housing; (6) any loans or investments which FHFA, in its
discretion, otherwise determines to be residential housing finance assets; and (7) for community financial
institution (CFI) members, small business loans, small farm loans, small agribusiness loans, or community
development loans. 12 C.F.R. § 1266.1. A CFI is a depository institution member insured by the Federal
Deposit Insurance Corporation with assets below a cap (approximately $1.1 billion for 2014). See 12 U.S.C.
§ 1422(10).
   In contrast to the proxy test, collateral is an ongoing requirement. Collateral is often but not necessarily
residential housing finance assets.
  In this instance, the proxy test was met using outdated member financial information. FHFA advised us that it
believes the proxy test would have been met using current information, but it was unfortunate that the FHLBank
relied on outdated information.

      Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015

This memorandum closes OIG’s survey of FHFA’s oversight of the community support and
residential housing finance requirements for long-term advances.

Scope and Methodology

The objective of this evaluation was to assess FHFA’s oversight of two mission-related
requirements for FHLBank long-term advances. To address this objective, OIG interviewed
officials and reviewed documents from FHFA and from five FHLBanks. The sample of
FHLBanks included FHLBanks with varying percentages of long-term advances outstanding.
It was not chosen as a statistical sample, and OIG does not project the results to the other
FHLBanks. OIG obtained information from a sixth FHLBank about advances to one of its
members. The documents OIG reviewed included the five FHLBanks’ policies and procedures
related to community support reviews and to the proxy test. OIG also reviewed documents such
as the FHLBank Act, regulations regarding community support reviews and the proxy test,
FHFA’s notices published in the Federal Register listing FHLBank members selected to be
reviewed for community support, related FHFA examination modules, and recent FHFA Reports
of Examination of the FHLBanks.

Regarding the community support requirement, OIG obtained a summary of the results of
FHFA’s reviews by review cycle. OIG also obtained FHFA’s most recent community support
review for the ten largest advance borrowers from each of the 12 FHLBanks based on advances
outstanding at year-end 2013; these 120 members accounted for nearly three-quarters of
advances outstanding. OIG obtained the dates individual members joined the FHLBank System
in order to determine whether the members without community support reviews should have
been reviewed in the 2010-2011 cycle. OIG also compared the number of members FHFA
reviewed for community support during the 2010-2011 review cycle to the number of FHLBank
members, considering changes in membership. In addition, OIG compared DBR’s list of active
FHLBank members with the members in DHMG’s community support database. OIG also
identified FHLBank members that had received CRA ratings of “substantial noncompliance”
in recent years and whether they had received long-term advances. OIG reviewed email
correspondence of a former FHFA employee who had managed the Agency’s community
support review process. OIG also reviewed all comments FHFA received from the public
regarding FHLBank members being reviewed for community support in the 2010-2011 cycle.

Regarding the residential housing finance requirement, OIG asked five FHLBanks to identify
their three largest long-term (greater than five years) advance borrowers in 2013 for each of three
member types: commercial banks, thrift institutions, and insurance companies. For these nine
FHLBank members (or seven members in two cases where the FHLBank had only one insurance
company that received long-term advances in 2013), OIG obtained information about their long-
term advances made in 2012 and 2013. For each such advance, the information included the
member’s total long-term advances and residential housing finance assets so that OIG could
assess whether, based on the data provided, the proxy test was met.

OIG did not independently test the reliability of FHFA’s or the FHLBanks’ data systems.

   Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
This review was conducted under the authority of the Inspector General Act in accordance with
the Quality Standards for Inspection and Evaluation (January 2012), which was promulgated by
the Council of the Inspectors General on Integrity and Efficiency. These standards require OIG
to plan and perform an evaluation that obtains evidence sufficient to provide a reasonable basis
to support its conclusions. OIG believes that this review meets these standards.

A draft of this memorandum was sent to FHFA.

The performance period for this review was April 2014 to February 2015.

This review was led by Beth Preiss, Senior Investigative Evaluator, in collaboration with Ezra
Bronstein, Investigative Counsel, and Angela Choy, Director, Division of Program Oversight.

We appreciate the cooperation of FHFA and the FHLBanks and the assistance of all those who
contributed to the preparation of this report. It has been distributed to Congress, the Office of
Management and Budget, and others and will be posted on OIG’s website, www.fhfaoig.gov.

cc:      The Honorable Melvin L. Watt, FHFA Director

      Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015
Additional Information and Copies

For additional copies of this report:

      Call: 202-730-0880

      Fax: 202-318-0239

      Visit: www.fhfaoig.gov

To report potential fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

      Call: 1-800-793-7724

      Fax: 202-318-0358

      Visit: www.fhfaoig.gov/ReportFraud

      Write:
                FHFA Office of Inspector General
                Attn: Office of Investigation – Hotline
                400 Seventh Street, S.W.
                Washington, DC 20024

    Federal Housing Finance Agency Office of Inspector General • ESR-2015-005 • March 31, 2015