oversight

Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ Significantly

Published by the Government Accountability Office on 2003-09-08.

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

                 United States General Accounting Office

GAO              Report to Congressional Requesters




September 2003
                 FEDERAL HOME
                 LOAN BANK SYSTEM
                 Key Loan Pricing
                 Terms Can Differ
                 Significantly




GAO-03-973
                 a
                                                September 2003


                                                FEDERAL HOME LOAN BANK SYSTEM

                                                Key Loan Pricing Terms Can Differ
Highlights of GAO-03-973, a report to the       Significantly
Ranking Minority Member, Senate
Committee on Banking, Housing and
Urban Affairs and the Chairman,
Subcommittee on Capital Markets, House
Committee on Financial Services




The Federal Home Loan Bank                      Federal statutes and regulations require that the FHLBanks set advance
System’s (FHLBank System)                       interest rates above their borrowing costs and fully secure advances with
traditional approach to providing               eligible forms of collateral, such as single-family mortgage loans. However,
community and housing finance                   within this framework, each of the 12 FHLBanks has independent authority
through 12 regional FHLBanks (see               to set advance pricing terms, which can result in several significant key
figure) faces continual challenges
due to consolidation in the
                                                differences among the banks. For example, due to differing costs and
financial services industry and the             business strategies, FHLBank advance interest rates may differ and many
emergence of mortgage lenders                   FHLBanks charge lower interest rates based on advance size while others do
with nationwide operations.                     not. Moreover, FHLBanks may set differing collateral requirements for their
In addition, the Federal Housing                members. For example, one FHLBank allows its members to borrow up to
Finance Board (FHFB), the                       60 percent of the value of single family mortgages pledged as collateral to
System’s financial regulator, is                secure advances while another allows up to 85 percent.
analyzing the benefits and costs of
potential changes to the System’s               Among the FHLBanks’ differing approaches to setting advance pricing terms,
membership rules that would make                FHFB has not found that any practice results in significant violations of
it easier for financial institutions to         statute or regulation. However FHFB also collects collateral data from the
join multiple FHLBank districts
(referred to as multidistrict
                                                FHLBanks that have questionable value in their current format for
membership). To provide                         monitoring the System’s safety and soundness. Because FHLBank officials
information that would be helpful               do not have clear information about how FHFB would like the data reported,
in assessing the potential safety               the FHLBanks use different reporting definitions and criteria, which limits
and soundness implications of                   the data’s analytical usefulness. Moreover, FHFB has not collected data
these developments, GAO was                     necessary to assess the current extent of competition within the FHLBank
asked among other items to (1)                  System and the implications of holding companies with subsidiaries that
determine whether key differences               operate in multiple FHLBank districts as well as multidistrict membership.
exist in the terms—such as interest
rates and collateral requirements—
                                                Locations of Federal Home Loan Banks
that FHLBanks make on loans, also
known as advances, to member
financial institutions such as banks
and thrifts and (2) discuss FHFB’s                                                                              District 7     District 6
oversight of the FHLBanks and                                                                                  Chicago        Indianapolis
                                                                                                                                              District 2
safety and soundness data                                                                                                       District 5    New York
reporting requirements.                                     Seattle                                                            Cincinnati
                                                                                                                                   District 3
                                                                                                                                  Pittsburgh
                                                                      District 12               District 8
                                                                                                             Des
GAO recommends that FHFB                                                                                    Moines
collect data necessary to monitor                   San Francisco
System safety and soundness. In                                                                                                                    Boston
                                                                                    District 10 Topeka                                             District 1
written comments, FHFB and the
FHLBanks agreed with GAO’s                                District 11
recommendations.                                                                                                                   Atlanta
                                                                                                           Dallas            District 4
                                                                                              District 9
www.gao.gov/cgi-bin/getrpt?GAO-03-973.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact William B.
Shear at (202) 512-8678 or                      Source: FHFB.
ShearW@gao.gov.
Contents



Letter                                                                                               1
                             Results in Brief                                                        4
                             Background                                                              8
                             Statutes and Regulations Establish the General Pricing and Other
                                Terms Each FHLBank Can Offer on Advances to Member
                                Institutions                                                        12
                             Significant Differences Exist in Key Advance Pricing Terms among
                                the FHLBanks                                                        15
                             Holding Companies Can Generally Transfer Funds and Assets
                                among Their Insured Subsidiaries                                    25
                             FHFB Has Not Identified Significant Advance Term Pricing
                                Deficiencies, but FHLBank Safety and Soundness Data Reporting
                                Can Be Improved                                                     28
                             Conclusions                                                            32
                             Recommendations                                                        33
                             Agency Comments and Our Evaluation                                     34


Appendixes
              Appendix I:    Objectives, Scope, and Methodology                                     36
             Appendix II:    Advance Interest Rates Charged by Specific FHLBanks on
                             Selected Dates                                                         38
             Appendix III:   Comments from the Federal Housing Finance Board                        39
             Appendix IV:    Comments from the Federal Home Loan Bank Presidents’
                             Conference                                                             41
              Appendix V:    GAO Acknowledgments and Staff Contacts                                 42
                             GAO Contacts                                                           42
                             Acknowledgments                                                        42


Tables                       Table 1: FHLBank System Assets, as of June 30, 2003                    10
                             Table 2: Types of Eligible Collateral in the FHLBank System            14
                             Table 3: FHLBanks’ Average Annual Dividend Rates, 1997-2002            16
                             Table 4: Comparison of Selected FHLBank Interest Rates on Fixed
                                      Rate Advances (June 10, 2003)                                 18
                             Table 5: Tiered Advance Pricing Programs at the FHLBanks               19
                             Table 6: FHLBank Haircuts for Single-Family Mortgage Collateral
                                      under the Blanket Lien Option                                 21
                             Table 7: FHLBank System Borrowing Capacity Limits                      23




                             Page i                                    GAO-03-973 FHLBank Advance Terms
         Contents




         Table 8: FHLBanks’ Advances Activity Based Stock Purchase
                   Requirements                                                                 24
         Table 9: FHFB Data on Collateralization and Advances as of
                   December 31, 2002                                                            31
         Table 10: Comparison of Selected FHLBank Interest Rates on Fixed
                   Rate Advances (July 18, 2003)                                                38
         Table 11: Comparison of Selected FHLBank Interest Rates on Fixed
                   Rate Advances (July 25, 2003)                                                38


Figure   Figure 1: Location of the 12 Federal Home Loan Banks                                       9




         Abbreviations

         CFI                     Community Financial Institution
         FDIC                    Federal Deposit Insurance Corporation
         FHLBank Act             Federal Home Loan Bank Act
         FHLBanks                Federal Home Loan Banks
         FHLBank System          Federal Home Loan Bank System
         FHFB                    Federal Housing Finance Board
         GLBA                    Gramm-Leach-Bliley Act
         ORERC                   Other Real Estate Related Collateral
         MPF                     Mortgage Partnership Finance
         MPP                     Mortgage Purchase Program
         WAMU                    Washington Mutual

          This is a work of the U.S. government and is not subject to copyright protection in the
          United States. It may be reproduced and distributed in its entirety without further
          permission from GAO. However, because this work may contain copyrighted images or
          other material, permission from the copyright holder may be necessary if you wish to
          reproduce this material separately.




         Page ii                                              GAO-03-973 FHLBank Advance Terms
A
United States General Accounting Office
Washington, D.C. 20548



                                    September 8, 2003                                                                      Leter




                                    The Honorable Paul S. Sarbanes
                                    Ranking Minority Member
                                    Committee on Banking,
                                     Housing, and Urban Affairs
                                    United State Senate

                                    The Honorable Richard H. Baker
                                    Chairman, Subcommittee on Capital Markets,
                                     Insurance, and Government Sponsored Enterprises
                                    Committee on Financial Services
                                    House of Representatives

                                    The Federal Home Loan Bank System’s (FHLBank System) traditional
                                    cooperative approach to providing housing and community finance
                                    through 12 regionally based Federal Home Loan Banks (FHLBank) faces
                                    continual challenges due to consolidation in the financial services industry
                                    and the emergence of mortgage lenders with nationwide operations.
                                    Traditionally, each FHLBank made loans, known as advances, that were
                                    secured by eligible collateral (e.g., single family mortgage loans) to
                                    member institutions—particularly thrifts—located in its district to support
                                    housing finance. However, many large bank and thrift holding companies
                                    now own subsidiaries located in various FHLBank districts. Each eligible
                                    subsidiary may join the FHLBank in which district its headquarters is
                                    located, and may obtain advances from that FHLBank.1 Thus, these bank
                                    and thrift holding companies may, in effect, have access (through their
                                    subsidiaries) to advances from multiple FHLBanks.




                                    1
                                     Commercial banks, which may be owned by bank holding companies, were not allowed to
                                    join the FHLBank System until 1989.




                                    Page 1                                            GAO-03-973 FHLBank Advance Terms
Some observers have expressed concerns that these holding companies
can pressure the FHLBanks to compete with one another on advance
pricing terms—such as interest rates and collateral requirements—and that
this competition could impair the overall safety and soundness of the
FHLBanks, which were jointly and severally liable for $710 billion in debt
obligations as of June, 2003.2 For example, the concern exists that a
holding company could shift assets at a subsidiary located in one FHLBank
district to pledge as collateral at a subsidiary in another district offering
more favorable advance terms. Recently, these concerns have been
heightened as the Federal Housing Finance Board (FHFB), the FHLBank
System’s financial regulator, has analyzed the benefits and costs associated
with potential changes to the System’s membership requirements that
would allow financial organizations to join more than one FHLBank district
(these potential changes to the System’s membership rules are commonly
referred to as multidistrict membership).3 Supporters of multidistrict
membership believe that it is necessary to modernize the FHLBank
System’s structure, while critics believe that multidistrict membership
would increase the potential for dangerous competition between the
FHLBanks.

As discussed with your staff, this report provides an overview of advance
term pricing requirements and practices within the FHLBank System that
could be useful in assessing the extent of current competition among the
FHLBanks and the potential competitive impacts of multidistrict
membership. Specifically, you asked that we

1. describe the laws and regulations pertaining to the terms that
   FHLBanks can offer on advances;

2. provide information on whether key differences exist in current
   advance pricing and other terms across the FHLBanks;



2
 Joint and several liability means that, with respect to consolidated obligations, each
FHLBank is responsible for its own debt obligations as well as the debt obligations of the
other FHLBanks in the System. If one FHLBank experienced financial problems, and was
unable to satisfy its repayment obligations, the other FHLBanks would be responsible for
honoring them.
3
 Bank or thrift holding companies may establish separately chartered subsidiaries in two or
more FHLBank districts. Under one concept of multidistrict membership, financial
organizations—such as banks or thrifts—would be able to join multiple FHLBank districts
without establishing separately chartered institutions.




Page 2                                                GAO-03-973 FHLBank Advance Terms
3. determine whether holding companies face any legal or regulatory
   barriers in transferring assets among subsidiaries who are members of
   different FHLBank districts; and

4. describe FHFB’s safety and soundness oversight of the FHLBanks’
   advance pricing practices and review selected data that FHFB collects
   to monitor safety and soundness practices within the FHLBank System.

To address these objectives, we obtained and reviewed applicable federal
laws and regulations pertaining to the terms that the FHLBanks can offer
on advances. We also interviewed the 12 FHLBank presidents, credit and
collateral staff from 7 of the 12 FHLBanks, and FHFB officials. We sent a
set of structured questions to each of the 12 banks and reviewed their
credit and collateral policies. In addition, we obtained and reviewed
applicable laws and regulations regarding the transfer of funds and assets
among holding companies and their subsidiaries, and interviewed
representatives from the Federal Reserve Board and a large holding
company. The scope of our work included a description of FHFB’s
examination program pertaining to advances but did not include an
analysis of the program’s effectiveness. However, we did analyze FHFB’s
collateral reporting requirements for the 12 FHLBanks. Because the
information contained in this report is potentially sensitive, we generally
do not identify individual FHLBanks in this report. Instead, we identify
each of the 12 banks by the letters A-L. For each report table, we changed
the individual FHLBanks identified by the letters A-L. Appendix I contains
a detailed description of the scope and methodology of our work.

We conducted our review from January to September 2003 in Washington,
D.C.; New York, New York; Topeka, Kansas; Dallas, Texas; Atlanta, Georgia;
and Pittsburgh, Pennsylvania, and Indianapolis, Indiana, in accordance
with generally accepted government auditing standards.




Page 3                                      GAO-03-973 FHLBank Advance Terms
Results in Brief   The Federal Home Loan Bank Act (FHLBank Act), as amended by the
                   Gramm-Leach-Bliley Act (GLBA), and FHFB regulations establish the
                   general pricing and other terms that each FHLBank can offer on its
                   advances to member institutions. The FHLBanks are required to set
                   interest rates on advances above their borrowing costs and must also
                   factor in administrative and other expenses. The FHLBank Act and GLBA
                   also require that each FHLBank take the necessary steps to ensure that its
                   loans are fully secured by eligible collateral. The eligible collateral
                   includes cash, residential mortgages, government and agency securities,
                   qualified nonagency mortgage-backed securities, other real estate related
                   collateral (ORERC), and small business and agricultural loans or securities
                   representing a whole interest in such loans held by community financial
                   institutions (CFI).4

                   Within the framework established by statute and regulation for setting
                   advance pricing terms and their independent authority within the FHLBank
                   System, the FHLBanks have implemented several key differences in their
                   policies, procedures, and practices. First, the FHLBanks have established
                   sometimes differing formulas and business strategies to determine the
                   interest rates to be charged on their advances. Moreover, some FHLBank
                   officials told us that competition from other funding sources can influence
                   advance interest rates, and some nationwide mortgage lenders play one
                   FHLBank against another in an attempt to obtain favorable advance rates.
                   Because of these differing business strategies and competitive pressures,
                   available evidence indicates that there can be significant differences in
                   stated advance rates among the FHLBanks for advances with comparable
                   maturities. Many FHLBanks also charge different rates, depending upon
                   the size of the advance, while others do not. Second, the FHLBanks have
                   established differing collateral requirements for securing advances.




                   4
                    Residential mortgages include single-family mortgages—defined as mortgages financing
                   properties with 1-4 residential units—and multifamily mortgages. ORERC includes home
                   equity loans and commercial real estate loans. Currently, CFIs are insured depository
                   institutions with assets that do not exceed $538 million. The asset size limit is adjusted
                   annually for inflation and is based on a 3-year average of each institution’s total assets.




                   Page 4                                                 GAO-03-973 FHLBank Advance Terms
For example, the FHLBanks may apply differing haircuts to the same types
of collateral (for example, one bank applies a 40 percent haircut to the
book value of single-family mortgage loans pledged as collateral, while
another bank applies a 15 percent haircut).5 Third, the FHLBanks have
established different advance borrowing capacity limits for their members;
for example, 35 percent of a members’ total assets at one FHLBank
compared to 50 percent of assets at another. Fourth, although all 12
FHLBanks require their members to invest additional capital in the
FHLBank based on their level of advances, the stock purchase
requirements can differ (for example, from 3.5 percent of advances at one
FHLBank to 5.0 percent at another).

Holding companies face few direct regulatory restrictions in transferring
assets among their federally insured bank or thrift subsidiaries who are
members of different FHLBank districts.6 Sections 23A and 23B of the
Federal Reserve Act and Federal Reserve Regulation W and other federal
laws do impose restrictions on certain transactions (for example,
purchases of assets) between federally insured banks or thrifts and
affiliated companies that are not insured so as to protect the financial
condition of the insured institutions.7 However, Sections 23A and B and
Regulation W and other federal laws generally exempt qualified insured
banks or thrifts from these requirements when they engage in certain
transactions with one another.8 According to Federal Reserve officials,
these exemptions reflect the fact that under federal law, a federally insured
institution within a holding company is generally liable for any losses


5
 Haircuts refer to the discounts that the FHLBanks apply to collateral that is pledged to
secure advances. For example if the FHLBank has a 40 percent haircut for single-family
mortgage loans, a member bank could borrow up to 60 percent of the value of the single-
family mortgage loans that it pledged as collateral.
6
 Most members of the FHLBank System are separately chartered commercial banks or
thrifts, which are insured by the Federal Deposit Insurance Corporation.
7
 Among other requirements, Section 23A imposes quantitative limits on covered
transactions; for example, an insured bank’s covered transactions with any single affiliate
cannot exceed 10 percent of the bank’s capital stock and surplus, and transactions with all
affiliates combined cannot exceed 20 percent. Section 23B requires that certain
transactions between insured banks and thrifts and uninsured affiliates take place on
market terms.
8
 The exemption under 23A applies if the holding company owns or controls 80 percent or
more of the voting securities of both insured institutions or if one insured institution owns
or controls 80 percent of the voting securities of the other. Under 23B, transactions between
a bank and a nonbank affiliate are restricted.




Page 5                                                 GAO-03-973 FHLBank Advance Terms
incurred by the Federal Deposit Insurance Corporation (FDIC) as a result
of the failure of any other federally insured institution controlled by the
holding company. The exemptions allow insured depository affiliates to
conduct business with each other without needing to comply with financial
restrictions with the understanding that the FDIC can offset its losses
resulting from the failure of one or more insured depository affiliates by
seizing the assets of insured affiliates that do not fail. Although few direct
regulatory restrictions exist to transferring assets, holding companies may
face other hurdles in transferring assets among their insured depository
subsidiaries, such as meeting bank regulatory capital requirements or the
stock purchase requirements of individual FHLBanks.9 We also note that
the Federal Reserve has not quantified the extent to which transfers of
assets among subsidiaries take place and it is not clear whether holding
companies engage in such transfers to increase competitive pressures
within the FHLBank System.

FHFB carries out its safety and soundness oversight responsibilities for the
FHLBank System by conducting annual examinations and through off-site
monitoring.10 In 2001 and 2002, FHFB examinations did not identify
significant violations in the FHLBank’s advance term pricing or collateral
practices. However, we identified weaknesses in the data that FHFB
collects from the FHLBanks, which could limit FHFB’s ability to monitor
current and emerging trends within the System. On an annual basis, FHFB
requests that the FHLBanks provide data on collateral securing advances in
order to, along with other items, exhibit the System’s safety and soundness.
Because FHLBank officials do not have clear information about how FHFB
would like the data reported, the FHLBanks use different reporting
definitions and criteria, which limits the data’s analytical usefulness.
Although FHFB officials said that FHFB examiners used the collateral data
during the FHLBank examination process, the agency plans to study
current data reporting and collection procedures. Moreover, FHFB has not
collected data necessary to assess the current extent of competition within
the FHLBank System and the implications of holding companies with

9
 Bank regulators, such as FDIC, impose capital requirements that apply to the insured
subsidiaries of bank or thrift holding companies. In addition, each member of an FHLBank
must purchase capital stock in that FHLBank. We do not address the potential application of
state law to transfers of assets.
10
  Off-site monitoring involves FHFB headquarters staff reviewing financial data on the
FHLBanks on a continual basis. Off-site monitoring can serve as an effective supplement to
the annual examination process by, for example, identifying rapid changes in FHLBank
financial risks and serving to assist examiners in planning examinations.




Page 6                                                GAO-03-973 FHLBank Advance Terms
subsidiaries that operate in multiple FHLBank districts. By collecting data
on, for example, the advance terms—such as interest rates—that holding
company subsidiaries obtain from different FHLBanks, FHFB would be in a
better position to (1) determine whether competition may affect FHLBank
safety and soundness and (2) assess the potential impacts of multidistrict
membership.

To strengthen its oversight capacity for the FHLBank System, we
recommend that FHFB review the effectiveness of its current collateral
data collection program and work with the FHLBanks to obtain data that
are useful in assessing practices within the System. We also recommend
that FHFB work with the FHLBanks to collect data necessary to assess the
potential effects of competition on the safety and soundness of the
FHLBank System.

We provided a draft of this report to FHFB, the FHLBank Presidents’
Conference, and the Board of Governors of the Federal Reserve System for
their review and comment. We received written comments from FHFB and
the FHLBank Presidents’ Conference—which are reprinted in appendixes
III and IV---and technical comments from these organizations and the
Federal Reserve, which have been incorporated where appropriate. FHFB
agreed with the recommendations in the draft report that it review its data
collection and reporting procedures to assess the FHLBanks collateral
practices and competition within the System. The FHLBank Presidents’
Conference commented that statutes and regulations allow individual
FHLBanks to set advance pricing terms that allow the banks to meet the
needs of their members while continuing to operate in a safe and sound
manner. The Conference also said that they would work with FHFB to
collect revised collateral data.




Page 7                                      GAO-03-973 FHLBank Advance Terms
Background   Established in 1932, each FHLBank is a government-sponsored enterprise
             (GSE) that is cooperatively owned by its members (see fig. 1 for the
             location of the 12 FHLBanks). The 12 FHLBanks, along with the Office of
             Finance (which issues debt on behalf of the FHLBanks), comprise the
             FHLBank System. The members of each FHLBank must buy stock in the
             FHLBank as a prerequisite for obtaining advances and other FHLBank
             services. FHLBank System assets consist of advances and investments,
             such as money market funds and mortgage-backed securities (see table 1).
             In addition, FHLBank assets consist of acquired mortgages that the
             FHLBanks purchase from their members under the Mortgage Partnership
             Finance (MPF) program or Mortgage Purchase Program (MPP).11 The
             FHLBank-purchased mortgages consist of both conventional mortgages
             and federally insured and guaranteed mortgages.12




             11
              “Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of
             Chicago.
             12
               Conventional mortgages do not have federal insurance or guarantees. FHLBank acquired
             mortgages are below the conforming mortgage loan limit, which is currently $322,700 for
             single-family properties. Fannie Mae and Freddie Mac, the other two housing GSEs, also
             purchase conventional conforming mortgages and issue mortgage backed securities.




             Page 8                                              GAO-03-973 FHLBank Advance Terms
Figure 1: Location of the 12 Federal Home Loan Banks




                                                                                District 7    District 6
                                                                                Chicago      Indianapolis
                                                                                                                   District 2
                                                                                               District 5          New York
                                                                                              Cincinnati
                 Seattle
                                                                                                      District 3
                                                                                                     Pittsburgh
                              District 12                   District 8


                                                                         Des Moines
      San Francisco
                                                                                                                           Boston
                                            District 10      Topeka                                                        District 1

                District 11


                                                                                                    Atlanta

                                                                       Dallas                District 4

                                                          District 9




Source: FHFB.




                                            Page 9                                               GAO-03-973 FHLBank Advance Terms
Table 1: FHLBank System Assets, as of June 30, 2003

Dollars in billions
Advances                     Mortgages    Investments                Othera    Total assets
$506                               $90             $206                  $7           $809
Source: Office of Finance.
a
These assets include interest bearing deposits and federal funds sold.


The FHLBank System raises funds in the capital markets partially on the
strength of its ties to the federal government. Due to these ties, investors
perceive an implied guarantee by the federal government on the System
debt based on the belief that the government would come to the rescue of
the FHLBank System rather than allow it to default on its obligations in the
event of severe financial difficulties. The primary source of funds for the
FHLBank System is the issuance of debt securities known as consolidated
obligations, through its Office of Finance, which stood at $710 billion as of
June 30, 2003. Consolidated obligations are the “joint and several”
obligations of the FHLBanks and all of the banks may be required to cover
such obligations of another bank that defaults on its repayment obligations.
Under the joint and several structure, the potential for moral hazard exists.
That is, FHLBanks may have incentives to take financial risks knowing that
their losses would be covered by other FHLBanks or, ultimately, the federal
government. Federal statutes and regulations as well as FHFB’s oversight
efforts—which are discussed in this report—are designed to help ensure
that the FHLBanks conduct their business in a safe and sound manner.

The FHLBank Act provides that an eligible institution may become a
member only of the FHLBank district in which its principal place of
business is located, or an adjoining district for convenience purposes and if
approved by FHFB. However, bank or thrift holding companies may own
subsidiaries in two or more FHLBank districts and each eligible subsidiary
may become a member of its district FHLBank. To become a FHLBank
member, each subsidiary must be a separately chartered institution, such
as a national bank or state-chartered bank or thrift. According to FHFB,
approximately 100 bank or thrift holding companies currently operate in
two or more FHLBank districts by having established separately chartered
subsidiaries in those districts.

In 2000 and 2001, continuing a long standing trend, several holding
companies with subsidiaries that operated in two or more FHLBank
districts merged with or purchased financial institutions that were also



Page 10                                                    GAO-03-973 FHLBank Advance Terms
members of FHLBank districts. These holding companies sought to
consolidate the merged or purchased institutions under one existing
charter and did not want to maintain separately chartered institutions. For
example, Washington Mutual (WAMU)—a thrift holding company with
subsidiaries in the Seattle, San Francisco, and Topeka FHLBank districts—
purchased Bank United, a member of the Dallas FHLBank district, and
Dime Savings, a member of the New York FHLBank district. WAMU chose
not to maintain separate charters for Bank United and Dime Savings for
business purposes and instead decided to merge the institutions into its
existing subsidiaries. However, under FHFB regulations Dime Savings and
Bank United could no longer remain members of the FHLBank System and
could no longer obtain new advances or other services from the FHLBank
of Dallas and the FHLBank of New York. Therefore, WAMU was required
to pay back Bank United and Dime Savings’ outstanding balances under
their original terms.

In 2000, the FHLBank of Dallas submitted to the FHFB an application
(which the FHFB subsequently treated as a petition) to grant approval to
WAMU’s thrift subsidiary’s application for membership in the FHLBank of
Dallas while maintaining its membership in the FHLBank of San Francisco
(the petition has been referred to as advocating multidistrict membership).
The Dallas FHLBank filed the petition under the “demanded by
convenience” standard. 13 After the initial petition, FHFB received similar
requests from three other FHLBanks, requests to intervene, and comment
letters both in favor and against.14 Given the controversy associated with
these petitions and their potential effects on the System (including the
potential for increased competition among the FHLBanks), FHFB did not
act on them and, in October 2001, requested comments from the public on
the petitions. In 2002, FHFB obtained a legal opinion from a law firm
stating that it had the legal authority, under certain conditions, to approve

13
  The FHLBank of Dallas requested that the WAMU thrift subsidiary belong to both the San
Francisco and Dallas districts. FHLBank Dallas interpreted the phrase in the FHLBank Act
stating that a member can join the district where it is headquartered or an adjoining district
if demanded by convenience as meaning the WAMU subsidiary could join both districts
without establishing a separately chartered subsidiary in Dallas. Traditionally, the phrase
has been understood to mean a FHLBank member can join either the district where it is
headquartered or the adjoining district, but not both.
14
 A member, FHLBank, or the Office of Finance may file a request to intervene in the
consideration of the petition, in support or against, if it believes its rights may be affected.
These requests must include a statement of the facts, a description of the relief requested,
and be filed with the Secretary to the Federal Housing Finance Board within 45 days from
the date the petition is filed.




Page 11                                                   GAO-03-973 FHLBank Advance Terms
                           multidistrict membership under its broad safety and soundness regulatory
                           authority and requested that the 12 FHLBanks answer questions related to
                           multidistrict membership, which the FHLBanks did by February 2003.
                           During 2003, FHFB staff, at the direction of the agency’s chairman,
                           analyzed the benefits and costs associated with multidistrict membership.



Statutes and               The FHLBank Act, as amended by GLBA, and FHFB regulations establish
                           the general pricing and other terms that each FHLBank can offer on its
Regulations Establish      advances.15 Statutory and regulatory provisions establish requirements for
the General Pricing and    FHLBank pricing on advances, allow for price differentiation at the
                           FHLBanks, require that advances must be fully secured, and establish
Other Terms Each           eligible types of collateral. FHFB regulations establish more specific
FHLBank Can Offer on       requirements to help ensure that the FHLBanks conduct their advance
Advances to Member         business in a safe and sound manner.
Institutions

General Requirements for   According to FHFB regulations issued pursuant to the FHLBank Act,
Terms on Advance Pricing   FHLBank advances may not be priced below the marginal cost to the
                           FHLBank of raising matching term and maturity funds in the marketplace,
                           including embedded options, plus the administrative and operating costs
                           associated with making advances.16 FHLBanks are allowed to differentiate
                           in advance prices based on the FHLBank’s assessment of the credit and
                           other risk of lending to any particular member, or other reasonable criteria.




                           15
                            Section 7(j) of the FHLBank Act (12 U.S.C. 1427(j)) requires that each Bank's board of
                           directors administer the affairs of the Bank "fairly and impartially and without
                           discrimination in favor of or against a member," and section 9 of the FHLBank Act (12 U.S.C.
                           1429) provides that a Bank "may at its discretion deny any such application (for an advance)
                           or may grant it on such conditions as the (Bank) may prescribe."
                           16
                                12 C.F.R. 950.5(b)(1).




                           Page 12                                               GAO-03-973 FHLBank Advance Terms
Per FHFB’s guidance, such differentiation could include providing
discounts to members based on the volume of the advance.17 Each
FHLBank is to include in its member products policy standards and criteria
for differential pricing and is to apply its standards and criteria consistently
and without discrimination to all members.

The FHLBank Act, as amended by GLBA, requires that FHLBanks fully
secure their advances with eligible collateral. The eligible collateral, as
listed in table 2, ranges from whole single family mortgages to small
business and agricultural loans.18 GLBA, which amended the FHLBank Act,
expanded the collateral that member institutions could use to secure an
advance. In particular, GLBA allowed CFIs, those FHLBank System
members that are FDIC insured depository institutions that currently have
$538 million or less in total assets, to pledge small business and agricultural
loans as collateral. GLBA allowed CFIs to use the expanded collateral
categories because some small institutions lacked a sufficient quantity of
other types of assets—such as mortgage loans—necessary to secure
FHLBank advances. GLBA also allowed all FHLBank members to make
greater use of ORERC—such as commercial real estate loans and home
equity loans—as collateral for advances. The FHLBanks may restrict the
types of eligible collateral available to them as security, based upon the
creditworthiness or operations of the borrower, the quality of the
collateral, or other reasonable criteria.




17
   According to the preamble to the final rule on advances, published May 20, 1993, 58 FR
29456, the Board concluded that the extension of credit to FHLBank members based on the
member's creditworthiness, or other reasonable criteria applied equally to all members,
does not constitute "discrimination" under 7(j) of the FHLBank Act. The Board also
approved risk based pricing, stating, "risk based pricing of advances should enhance the
fairness of the Banks' credit programs, since the terms of advances to more creditworthy
members should be more favorable than those to members posing a greater credit risk to a
Bank." In addition, the Board approved of differential pricing of advances based upon
criteria other than risk, subject to the application of consistent standards to all borrowing
members. The preamble cited the fact that “certain Banks have offered ‘volume discounts’
to members who finance a certain percentage of their total assets with Bank advances,” as
an example of allowable differential pricing. 1993 WL 167293 (F.R.)
18
 Single-family mortgages are mortgages on dwellings that include condominiums, planned
unit developments, townhomes, and qualified mobile homes affixed to the land. The
FHLBanks typically prefer that these mortgages are on owner-occupied dwellings.




Page 13                                                GAO-03-973 FHLBank Advance Terms
                             Table 2: Types of Eligible Collateral in the FHLBank System

                             1.   Fully disbursed, whole first single-family or multifamily mortgages on improved
                                  residential property (not more than 90 days delinquent), or securities representing a
                                  whole interest in these mortgages.
                             2.   Securities issued, insured, or guaranteed by the United States or a U.S. agency,
                                  including mortgage-backed securities issued by Fannie Mae or Freddie Mac.a
                             3.   Cash or deposits at a FHLBank.
                             4.   Other real estate related collateral, such as home equity loans or commercial real
                                  estate, acceptable to the FHLBank and subject to certain conditions.
                             5.   Secured loans for small business, agriculture, or securities representing a whole
                                  interest in such secured loans, in the case of any CFI.
                             Source: FHLBank Act as amended.
                             a
                             As part of their business activities, Fannie Mae and Freddie Mac issue mortgage-backed securities.


                             By fully securing advances with eligible collateral as required by the
                             FHLBank Act, FHLBanks can protect their interests should one or more of
                             their members fail. Typically, FHLBanks make advances on what is known
                             as a blanket lien; that is, the FHLBank has the authority to take control of
                             all the assets that are eligible as collateral on a member’s books. In cases in
                             which an FHLBank determines that a member is experiencing financial
                             difficulty, the FHLBank may require the member to list specific assets that
                             are securing advances or may even require the member to deliver the
                             collateral to the FHLBank.19 Should the member fail, the FHLBank can sell
                             the pledged collateral to ensure repayment of principal and the interest on
                             the advance. Due in part to the collateralization requirements, the
                             FHLBank System has never experienced a loss on an advance.



FHFB Regulations Establish   FHFB has issued several regulations that are designed to help ensure that
Additional Advance Term      the FHLBanks make advances in a safe and sound manner. For example,
                             FHFB has established regulations pertaining to the use of ORERC and
Requirements                 small business and agricultural loans as collateral, which are generally
                             considered riskier than other forms of collateral, such as single-family
                             mortgages. FHFB regulations require that FHLBanks can reliably discount
                             the value of ORERC and small business and agricultural loans pledged as
                             collateral. Under its regulations, FHFB also has the authority to require an


                             19
                              Many FHLBanks also have several non financial triggers that require specific listing or
                             delivery of assets that are pledged as collateral.




                             Page 14                                                    GAO-03-973 FHLBank Advance Terms
                              FHLBank to increase its standards for all forms of eligible collateral. FHFB
                              requires through regulation that FHLBanks take the necessary steps to
                              ensure that collateral is secure and to establish written procedures for
                              verifying the existence of collateral.



Significant Differences       Although the FHLBank Act and FHFB regulations establish the advance
                              pricing framework, each FHLBank has independent authority within the
Exist in Key Advance          framework to establish specific policies and procedures to meet its
Pricing Terms among           business and member requirements. Our review of key advance pricing
                              terms—advance interest rates, collateral requirements, advance borrowing
the FHLBanks                  capacity, and capital stock purchase requirements—identified several
                              significant differences among the 12 FHLBanks. The FHLBanks may
                              charge different interest rates on advances with comparable maturities,
                              some may establish interest rates on the basis of advance size while others
                              do not, and the FHLBanks apply differing haircuts to the same type of
                              collateral, establish different borrowing limits, and require members to
                              purchase FHLBank stock in differing amounts depending upon their levels
                              of advances outstanding.



Advance Interest Rates May    The process of setting advance interest rates can depend on several key
Vary Based on FHLBank         factors, including cost of funds, operating expenses, business strategies,
                              and competition from other sources, and may differ from one FHLBank to
Operating Costs, Business     another. In general, each FHLBank attempts to set advance interest rates
Strategies, and Competition   at a level that covers its costs—including cost of funds and operating
from Other Sources            expenses—while allowing for the payment of a reasonable rate of return
                              (typically through the payment of dividends) to member institutions.
                              Although the FHLBanks generally have the same cost of funds because
                              they borrow through the Office of Finance, they may have different
                              operating expenses to administer their advance business.20 Moreover, the
                              business strategies adopted by individual FHLBanks may also influence the
                              advance interest rates that they charge to members. In particular,
                              FHLBank officials said that there can be a connection between the advance
                              interest rate that they charge and the dividend rate that they pay. That is,
                              an FHLBank choosing to pay a relatively high dividend may need to charge
                              a relatively high advance rate to earn sufficient profits to cover the costs


                              20
                               Total FHLBank System operating expenses of $396 million are very small compared to
                              other expenses, such as interest expenses, which totaled nearly $18 billion in 2002.




                              Page 15                                             GAO-03-973 FHLBank Advance Terms
                                        associated with the dividend. In contrast, other FHLBanks may decide to
                                        provide value to their members through lowering their advance rates,
                                        which may mean a decrease in their dividend. Table 3 shows that some
                                        FHLBanks consistently pay higher dividends than others. For example,
                                        Bank E paid an average dividend of 7.63 percent from 1997 through 2002,
                                        which was 250 basis points higher than the average dividend of Bank L over
                                        the same period.



Table 3: FHLBanks’ Average Annual Dividend Rates, 1997-2002

FHLBanks                    1997       1998           1999              2000         2001             2002             Average               Rank
A                             6.1      5.76            5.36             7.17          5.99             5.45                  5.97                   10
B                            6.82      6.63            6.69             7.38          6.34             5.25                  6.52                   6
C                            6.48       6.4            6.54             7.63          5.87             3.68                  6.10                   9
D                              7       6.63             6.3             6.92          4.45                 3                 5.73                   11
E                            7.99      8.01                8            8.25          7.44             6.06                  7.63                   1
F                            7.25      7.38            7.13             8.03          6.78             4.56                  6.86                   4
G                             6.6      7.25             6.8             6.95          6.29             4.51                  6.40                   7
H                            7.19      7.19            7.06             7.34          6.75             4.63                  6.69                   5
I                            7.69      7.69            7.36               6.5         6.88             5.98                  7.02                   2
J                            6.38       6.5            6.63             7.06           6.5             3.56                  6.11                   8
K                            7.25      7.44            7.56             7.75          6.75             5.31                  7.01                   3
L                            5.95      5.92             5.5             6.36          4.13             2.94                  5.13                   12
Source: FHLBanks.

                                        Note: The A-L listing of the FHLBanks in this table differs from the A-L listings in other tables in this
                                        report.


                                        FHLBank business strategies involving other assets—such as mortgage
                                        purchase programs and other investments—may also influence the interest
                                        rate that they charge on advances. For example, the potential exists that
                                        the degree to which an FHLBank participates in the MPP or the MPF
                                        program would affect its advance interest rate. If an FHLBank commits
                                        substantial resources to the MPP or the MPF program, it may use any
                                        profits earned to offset the advance interest rate or it may use funds earned
                                        from advances to support the MPP or MPF program. Or, the FHLBank
                                        could use the profits to pay a higher dividend and leave advance rates
                                        unchanged or some combination thereof. Available evidence suggests that
                                        there is wide variation within the FHLBank System on the extent to which
                                        individual banks participate in the asset purchase programs. For example,
                                        more than 46 percent of the assets at one FHLBank now consist of acquired



                                        Page 16                                                         GAO-03-973 FHLBank Advance Terms
mortgages while the ratio is only 1.5 percent at another FHLBank.
Similarly, FHLBanks could also increase investments in other types of
assets, such as mortgage-backed securities, and use the income derived to
offset advance interest rates or pay a higher dividend.

Some FHLBank officials told us that competition from other sources can
also influence the interest rates that they charge on advances. For
example, officials said that they monitor other financial markets—such as
the repo market—to determine how competitive their advance rates are
with other funding sources. 21 In addition, some FHLBank officials said that
competition may also arise from the advance interest rates and other terms
offered by other FHLBanks. The officials said that large bank or thrift
holding companies that have subsidiaries in multiple FHLBank districts
sometimes play one FHLBank against another in an attempt to obtain more
favorable advance pricing terms. Some FHLBank officials said that they
will adjust their advance interest rates within established parameters to
ensure that their rates are competitive with other sources of funds. An
individual FHLBank’s willingness to compete with other fund providers
could influence differences in advance rates across the FHLBanks.

Given the variety of factors that may be involved in setting advance interest
rates, we are unable to explain completely why individual FHLBanks
charge the rates that they do. Nevertheless, limited available data indicate
that these factors result in sometimes significant differences in interest
rates on advances with comparable maturities. Table 4 shows the advance
interest rates for eleven FHLBanks on June 10, 2003 (the other FHLBank
stated that its advance interest rate data were proprietary). The
differences between the lowest and highest interest rates can be
significant. For example, for an advance of 12 months, the difference
between Bank H and D was 36 basis points.




21
   A repurchase agreement, commonly referred to as a “repo,” is a transaction in which a
dealer in effect borrows money by selling securities and simultaneously agreeing to buy
them back at a higher price at a later time.




Page 17                                               GAO-03-973 FHLBank Advance Terms
Table 4: Comparison of Selected FHLBank Interest Rates on Fixed Rate Advances (June 10, 2003)a

                                                                                                                                            Difference
                                                                                                                                              in basis
Term         Bank A Bank B Bank C Bank D Bank E Bank F Bank G Bank H                            Bank I Bank J Bank K                  Range     points
12 mo.            1.16       1.29   1.10   1.43       1.37       1.29        1.22       1.07       1.31         1.3      1.41      1.07-1.43              36
24 mo.            1.42       1.45   1.35   1.62       1.58       1.51        1.46       1.36       1.56       1.55       1.62      1.35-1.62              27
36 mo.            1.75       1.82   1.74   1.92       2.01       1.88        1.79       1.71       1.91         1.9      1.95      1.71-2.01              30
48 mo.            2.16       2.27   2.18   2.39       2.42       2.27        2.21       2.21       2.39         2.3      2.36      2.16-2.42              26
60 mo.            2.53       2.58   2.53   2.71       2.79       2.63        2.58       2.55       2.74       2.66       2.72      2.53-2.79              26
Source: Selected FHLBanks.

                                                  Note: The A-K listing of the FHLBanks in this table differs from the alphabetic listings in other tables in
                                                  this report.
                                                  a
                                                   The interest rates shown are generally for regular fixed term and rate advances with no discounting.
                                                  We also obtained advance interest rate data from the FHLBanks on July 18 and 25, 2003 to replicate
                                                  our results (see app. II). The FHLBanks also differ in their policies regarding payment frequency and
                                                  daycount accrual methods. No attempt is made here to harmonize the data to a single payment
                                                  frequency and daycount accrual standard.
                                                  Due to our reporting deadlines, the scope of our work did not involve obtaining comparable historical
                                                  data on the advance interest rates charged by individual FHLBanks. We obtained the data from the
                                                  Web sites of nine FHLBanks while two other FHLBanks provided the data separately. One FHLBank
                                                  stated that its advance interest rate data were proprietary. Of the nine FHLBanks that do publish
                                                  advance interest rate data on their Web sites, some publish historical data while others do not. Of
                                                  banks that do report historical rate data, some use different and incomparable reporting
                                                  methodologies. Additionally, the FHLBanks reserve the right to negotiate with members on advance
                                                  interest rates; therefore, the advance interest rates posted on the FHLBanks Web sites may or may not
                                                  be the rate paid by all members.




Most FHLBanks Offer                               Our review indicates that eight FHLBanks have established specific
Discounts on Advance Rates                        programs that offer volume-driven advance rate discounts, while four
                                                  others have not established such programs (see table 5). Under these
Based on Volume
                                                  programs, also referred to as tiered pricing, the FHLBank may reduce the
                                                  standard interest rate charged on advances depending upon the size of the
                                                  advance. The programs operate similarly as each passes on to members
                                                  the economies of scale the FHLBanks realize from high-volume
                                                  transactions. However, as table 5 illustrates, the number of pricing tiers at
                                                  each FHLBank varies; three banks have established two tiers, two banks
                                                  have established three tiers, two banks have established four tiers, and one
                                                  bank states that it provides volume-driven discounts. The basis point
                                                  discounts that the FHLBanks offer on volume driven discounts can also
                                                  vary. For example, one FHLBank reduces its advance rates 15 to 20 basis
                                                  points for advances over $25 million, while another FHLBank reduces its
                                                  advance interest rates 6 to 12 basis points.




                                                  Page 18                                                        GAO-03-973 FHLBank Advance Terms
Table 5: Tiered Advance Pricing Programs at the FHLBanks

FHLBanks Tiered pricing (Y/N) Tiered pricing program descriptions
Bank A         No
Bank B         Yes                        2 Tiers:    Advances under $25 million
                                                      Advances over $25 million
Bank C         No
Bank D         No
Bank E         Yes                                    Volume discounts on large advances
Bank F         Yes                        2 Tiers:    Advances under $10 million
                                                      Advances $10 million and over
Bank G         Yes                        2 Tiers:    Advances under $25 million
                                                      Advances $25 million and over
Bank H         Yes                        4 Tiers:    Advances $5-24 million
                                                      Advances $25-49 million
                                                      Advances $50-99 million
                                                      Advances $100 million and over
Bank I         Yes                        4 Tiers:    Advances under $10 million
                                                      Advances $10-24 million
                                                      Advances $25-99 million
                                                      Advances $100 million and over
Bank J         Yes                        3 Tiers:    Advances under $5 million
                                                      Advances $5-25 million
                                                      Advances over $25 million
Bank K         Yes                        3 Tiers:    Advances for less creditworthy members
                                                      required to deliver collateral
                                                      Advances under $10 million (standard
                                                      pricing tier)
                                                      Advances over $10 million
Bank L         No
Source: FHLBanks.

Note: The A-L listing of the FHLBanks in this table differs from the A-L listing in other tables in this
report.


FHLBank officials said that their large members are the primary
beneficiaries of the tiered pricing programs because they have the capacity
to borrow in large volumes. However, officials from two FHLBanks also
said that they will aggregate advance requests from smaller members so
that they can benefit from volume-driven rates as well. Representatives
from several FHLBanks, including those that do not have tiered pricing
programs, said that they also periodically offer “special deals” on advance
rates to all of their members. If a FHLBank, for example, obtains favorable
borrowing costs, it may pass these savings on to its members through
special deals that are announced by fax or e-mail.



Page 19                                                         GAO-03-973 FHLBank Advance Terms
                              With respect to the four FHLBanks that do not have specific tiered pricing
                              programs, officials said that they preferred to offer the same advance rate
                              to all members. Although these FHLBanks do not have specific tiered
                              pricing programs based on volume, they may differentiate in price in other
                              ways. For example, one FHLBank offers standard rates on all advances
                              requested by telephone but offers specified discounts on advance requests
                              made through its secured Web site. Officials from this bank said that more
                              than 98 percent of its advances are made through the Web site. Banks that
                              do offer tiered pricing programs may also offer differing advance rates on
                              the basis of the creditworthiness of their members. For example, one
                              FHLBank has established 10 separate categories that have different interest
                              rates and collateral requirements depending upon a member’s
                              creditworthiness. This FHLBank, as do other FHLBanks, establishes
                              members’ creditworthiness through, among other steps, reviewing publicly
                              available financial information and conducting on-site visits to review
                              collateral management practices.

                              We also note that analyzing the FHLBanks’ tiered pricing programs was
                              difficult, because the programs are not fully transparent as some banks
                              “negotiate” prices with larger members. Some FHLBank officials said that
                              larger members periodically request advance terms that differ from posted
                              rates and that FHLBank representatives do have some authority to
                              customize deals. For example, officials at one FHLBank said that its
                              representatives had the authority to negotiate the stated advance interest
                              rates. None of the FHLBank officials we contacted said that they had
                              authority to negotiate based on collateral standards. Some FHLBank
                              officials said that they notify their members of the terms of negotiated
                              transactions whenever they take place (for example, by e-mail). Other
                              FHLBank officials said that they will make the terms of negotiated deals
                              available only when another member requests an advance with similar
                              features.



FHLBanks Have Established     The FHLBanks may also apply differing haircuts to collateral pledged by
Sometimes Differing           member institutions to secure advances. Table 6 shows the haircuts that
                              the FHLBanks apply under their blanket liens to single-family mortgage
Collateral Requirements for
                              collateral, which is considered one of the most secure forms of collateral.
Securing Advances             Several FHLBanks apply a range of haircuts to single-family collateral (for
                              example, FHLBank C) based on their assessments of the credit risk of the
                              collateral. For those banks that apply one haircut to single-family
                              collateral, the haircut differences can be significant. For example, a
                              member could borrow up to 85 percent of its pledged single-family



                              Page 20                                      GAO-03-973 FHLBank Advance Terms
collateral at FHLBank L (which has a 15 percent haircut) but only up to 60
percent at FHLBank J (which has a 40 percent haircut). We note that the
FHLBanks have established other advance borrowing limits for their
members, which are discussed in the next section.



Table 6: FHLBank Haircuts for Single-Family Mortgage Collateral under the Blanket
Lien Option

FHLBanks                                                                             Collateral haircuta
Bank A                                                                                            9 -20% b
Bank B                                                                                               20% c

Bank C                                                                                           20-43% d

Bank D                                                                                                 17%

Bank E                                                                                                 25%

Bank F                                                                                       25% or more
Bank G                                                                                           17-44% e

Bank H                                                                                         31 or 40% f

Bank I                                                                                                 31%

Bank J                                                                                                 40%

Bank K                                                                                                 25%

Bank L                                                                                                 15%
Source: FHLBanks.

Note: The A-L listing of the FHLBanks in this table differs from the A-L listing in other tables in this
report.
a
 The FHLBanks use different methods to reflect the percentage haircut requirement on collateral. We
have converted their different measures to one consistent standard for purposes of comparison.
Eleven of the 12 FHLBanks generally apply haircuts to the book value of eligible collateral, while one
has established a methodology to apply haircuts to the fair market value of the collateral.
b
    Haircut depends upon the creditworthiness of the member.
c
 Bank determines fair market value of collateral. The Bank will use "book value" as fair market value
for nondelivered, nonsecurities collateral where a fair market value estimate is unavailable.
d
    Range depends on a creditworthiness assessment rating.
e
    The haircut depends upon the relative riskiness of the collateral.
f
Amount reflected is for reviewed loans that have either an adjustable rate (31%) or a fixed rate (40%).




Page 21                                                          GAO-03-973 FHLBank Advance Terms
                            Our review also identified other differences in the FHLBanks collateral
                            standards. For example, we found that several FHLBanks require or prefer
                            their members to pledge all of their single-family mortgages as collateral
                            before they will consider the use of other types of collateral—such as
                            ORERC or small business and agricultural loans—to secure advances. In
                            contrast, other FHLBanks allow members to pledge any form of eligible
                            collateral—such as commercial real estate loans—to secure advances
                            without requiring that other types of eligible collateral be used first.



Borrowing Capacity Limits   To minimize the risks associated with making advances to their members,
Vary Across the FHLBanks    the FHLBanks have also established borrowing capacity limits, which can
                            vary. Table 7 shows that three FHLBanks allow their members to obtain
                            advances equal to the value of all their eligible collateral after appropriate
                            haircuts have been applied. These FHLBanks borrowing limits do not
                            include a specific limit on the ratio of advances to a member’s total assets
                            as is the case at the other nine banks. Of the nine banks with specific ratio
                            limits, the borrowing limits vary to some extent; for example, one FHLBank
                            sets total advance borrowings at 35 percent of a member’s assets. Other
                            FHLBanks may allow members to borrow up to 50 percent of their total
                            assets without board approval and, in one case, up to 55 percent if
                            approved by the bank president. The borrowing capacity of individual
                            members is determined on a case-by-case basis depending on the
                            creditworthiness of the member and the member’s collateral.




                            Page 22                                       GAO-03-973 FHLBank Advance Terms
Table 7: FHLBank System Borrowing Capacity Limits

FHLBank               Member bank borrowing capacity (BC) limitsa
Bank A                Total eligible collateral after appropriate discounts.
Bank B                40 percent of total assets.
                      Financial status may dictate a lower BC.
Bank C                Total eligible collateral multiplied by appropriate haircut, minus the
                      member bank’s obligations.
Bank D                 40 percent of total assets, up to 55 percent if approved by the bank
                      president.
Bank E                50 percent of member's total assets.
                      Financial status and/or collateral requirements may dictate a higher/lower
                      BC.
Bank F                Overall credit exposure to total assets may not exceed 50 percent. Bank
                      may apply additional borrowing limits as applicable.
Bank G                Bank assigns borrowing capacity percentage to eligible collateral.
Bank H                50 percent of a member's total assets, higher with consent of the board.
Bank I                Total eligible (unpledged) collateral after appropriate haircuts.
Bank J                40 percent of total assets.
Bank K                50 percent of adjusted assets (member’s assets minus borrowings from
                      all sources).
Bank L                Under blanket lien, total secured borrowings must be less than 35 percent
                      of total assets. Single-family mortgage loans should equal at least 10
                      percent of total assets.
Source: FHLBank policy manuals and interviews with FHLBank officials.

Note: The A-L listing of the FHLBanks in this table differs from the A-L listing in other tables in this
report.
a
Capacity limits established by banks are always subject to the amount of eligible collateral held by a
member.




Page 23                                                                 GAO-03-973 FHLBank Advance Terms
FHLBanks Require          FHLBanks have also established activity based stock purchase
Members to Purchase       requirements for advances, which can differ (see table 8).22 As the table
                          indicates, the specific capital ratio requirements can differ; for example,
Different Amounts of      FHLBank L has a 3.5 percent stock purchase requirement while FHLBank
Capital Stock Depending   G has a 5 percent requirement.
upon Advance Activity

                          Table 8: FHLBanks’ Advances Activity Based Stock Purchase Requirements

                          FHLBank                                                                           Capital requirementa
                          A                                                                                                     4.7%
                          B                                                                                                   4.75%
                          C                                                                                                     4.5%
                          D                                                                                                  2 – 4%b
                          E                                                                                                     4.5%
                          F                                                                                                   4.25%
                          G                                                                                                          5%
                          H                                                                                                     4.5%
                          I                                                                                                   4.45%
                          J                                                                                                     4.5%
                          K                                                                                                          5%
                          L                                                                                                     3.5%
                          Source: FHLBanks.

                          Note: The A-L listing of the FHLBanks in this table differs from the A-L listing in other tables in this
                          report.
                          a
                           FHFB has approved new capital plans for all 12 FHLBanks. These plans include the capital
                          requirements for each of the FHLBanks. The table reflects the approved capital requirements of the 12
                          FHLBanks. As of the time of this report, 5 banks have implemented their new requirements. The
                          FHLBank boards of directors set ranges of capital to advances ratios, and then choose a specific ratio
                          of capital stock that members are required to meet when taking out advances. Only the specific ratios
                          are shown in the table.




                          22
                            These activity based capital requirements are in addition to minimum membership
                          requirements for being a member of a FHLBank. Each FHLBank requires its members to
                          invest capital based on the amount of advances they have outstanding. FHLBank boards of
                          directors typically set ranges of capital to advances ratios. FHLBank boards of directors
                          also typically set specific ratios within the range that members are required to meet when
                          taking out advances. Members must comply with the activity-based requirement as long as
                          the relevant activity remains outstanding, including periods beyond the termination of the
                          member’s membership in a FHLBank. The advances investment requirements are
                          calculated daily and each time a member enters into a new advances transaction.




                          Page 24                                                         GAO-03-973 FHLBank Advance Terms
                              b
                               The FHLBank’s advance activity capital requirement range of 2 to 4 percent has been set by its board
                              within a larger range of 1 to 6 percent. The capital requirement within the 2 to 4 percent range is
                              based on the extent of the excess stock held by each member and the FHLBank at any particular point
                              in time. The member may use (borrow) FHLBank excess stock under certain conditions rather than
                              purchase additional stock, which could make the FHLBank overcapitalized.




Holding Companies             Although Section 23A and 23B of the Federal Reserve Act and Regulation W
                              impose restrictions on the transfer of assets among some subsidiaries of
Can Generally Transfer        holding companies, these restrictions generally do not apply to transfers of
Funds and Assets              assets between depository institution subsidiaries that are federally
                              insured.23 Accordingly, each of the more than 100 holding companies that
among Their Insured           have federally insured bank or thrift subsidiaries that are members of
Subsidiaries                  various FHLBank districts may be able to transfer assets among their
                              insured depository subsidiaries with few restrictions under specified
                              conditions. However, holding companies may face some hurdles—such as
                              managing their balance sheets or meeting capital requirements—when
                              transferring assets from one insured subsidiary to another. We also note
                              that the Federal Reserve has not quantified the extent to which transfers of
                              assets among subsidiaries take place, and it is not clear whether holding
                              companies engage in such transfers to increase competitive pressures
                              within the FHLBank System.



Sections 23A and 23B of the   Sections 23A and 23B of the Federal Reserve Act set limits on covered
Federal Reserve Act Limit     transactions between a depository institution and its affiliates.24 Sections
                              23A and 23B are designed to protect against a depository institution
Transactions between
                              suffering losses in transactions with affiliates. They limit the ability of a
Affiliates                    depository institution to transfer to its affiliates the subsidy arising from
                              the institution’s access to the federal safety net, including the deposit
                              insurance funds. Under section 23A, a bank’s affiliates include, among


                              23
                               12 U.S.C. 371c, 12 U.S.C. 371c-1 and 12 C.F.R. Part 223. Section 11(a)(1) of the Home
                              Owners’ Loan Act, 12 U.S.C. 1468(a)(1), generally applies sections 23A and 23B of the
                              Federal Reserve Act to every savings association in the same manner and to the same extent
                              as if the savings association were a member bank of the Federal Reserve System. The Office
                              of Thrift Supervision has issued proposed regulations on transactions with affiliates that
                              reflect Regulation W.
                              24
                               A “covered transaction” is defined as a loan or extension of credit to an affiliate, the
                              purchase of or investment in securities issued by an affiliate, the purchase of assets from an
                              affiliate, acceptance of securities issued by an affiliate as collateral security for a loan or
                              extension of credit, issuance of a guarantee, acceptance, or a letter of credit on behalf of an
                              affiliate.




                              Page 25                                                     GAO-03-973 FHLBank Advance Terms
other companies, any companies that control the bank, any companies
under common control with the bank, and certain investment funds that
are advised by the bank or an affiliate of the bank. Affiliate has the same
meaning under 23B as the meaning given under 23A, except that the term
affiliate under 23B does not include an insured bank or an insured savings
association.

According to Section 23A, a bank’s covered transactions with any single
affiliate cannot exceed 10 percent of the bank’s capital stock and surplus,
and transactions with all affiliates combined cannot exceed 20 percent of
the bank’s capital stock and surplus. All transactions between a bank and
its affiliates must be on terms and conditions that are consistent with safe
and sound banking practices, and a bank cannot purchase low quality
assets from its affiliates. Finally, section 23A requires that a bank’s
extensions of credit to affiliates and guarantees on behalf of affiliates be
appropriately secured by a statutorily defined amount of collateral.
Section 23B requires that certain transactions between a bank and its
affiliates occur on market terms. This is defined to mean that the
transaction must take place on terms and under circumstances that are
substantially the same, or at least as favorable to the bank, as those
prevailing at the time for comparable transactions with unaffiliated
companies.

Transactions that are covered by 23A and 23B include (1) purchases of
assets by a bank from an affiliate, (2) extensions of credit by a bank to an
affiliate, (3) investments by a bank in securities issued by an affiliate, (4)
guarantees by a bank on behalf of an affiliate, and (5) certain other
transactions that expose the bank to an affiliate’s credit or investment risk.
Section 23B also applies to any sale of assets by the bank to an affiliate, any
payment of money or furnishing of services by the bank to an affiliate, and
any transaction by the bank with a third party if an affiliate has a financial
interest in the third party or in an affiliate that is a participant in the
transaction.




Page 26                                        GAO-03-973 FHLBank Advance Terms
Sister Banking Exemption     Section 23A exempts several types of transactions from certain aspects of
Allows Transfer of Assets    the statute. One exemption, known as the Sister Bank Exemption, exists
                             for transactions between a bank or thrift and another bank or thrift if a
among Subsidiaries of Bank   company controls 80 percent or more of the voting securities of both banks
and Thrift Holding           or thrifts or if one bank controls 80 percent or more of the voting securities
Companies                    of the other. The exemption applies only to transactions between insured
                             depository institutions. Because Section 23B exempts banks and thrifts
                             from its definition of affiliate, sister banks (those banks that qualify for the
                             exemption) are also exempt from the requirement that transactions
                             between insured banks or thrifts and their affiliates be conducted on an
                             arm’s length basis. According to the Federal Reserve, these exemptions
                             reflect the fact that, under the cross-guarantee provisions of the Federal
                             Deposit Insurance Act, an insured depository institution is generally liable
                             for any loss incurred by the FDIC in connection with the default of a
                             commonly controlled depository institution. All transactions between a
                             bank and its affiliates (including sister bank affiliates) are required, though,
                             to be on terms and conditions that are consistent with safe and sound
                             banking practices.25 In addition, a bank may not purchase a low-quality
                             asset from an affiliate (including a sister bank affiliate) unless the bank or
                             its subsidiary, pursuant to an independent credit evaluation, committed
                             itself to purchase such asset prior to the time such asset was acquired by
                             the affiliate. Although a Federal Reserve official could not provide specific
                             data on the number of insured holding company subsidiaries that qualify
                             for the exemption, he estimated that more than 90 percent do so.

                             While Sections 23A and 23B and Regulation W impose few legal restrictions
                             on holding companies selling assets among their insured depository
                             subsidiaries for securing advances from different FHLBanks, there can be
                             some bookkeeping and regulatory hurdles. Officials from one large thrift
                             holding company with whom we spoke said that there are balance sheet
                             management hurdles associated with the sale of assets from one subsidiary
                             to another. For example, the officials said that asset sales may involve




                             25
                              A Federal Reserve official stated that the Federal Reserve would interpret safe and sound
                             banking practices to include that sales of assets between subsidiaries be conducted on
                             market terms.




                             Page 27                                               GAO-03-973 FHLBank Advance Terms
                         “de-pledging” assets pledged as collateral to secure advances at one
                         FHLBank and pledge them to another FHLBank. Subsidiaries meeting the
                         sister bank requirements must also ensure that the sale of assets meets
                         bank regulatory agency capital requirements.26 In addition, each FHLBank
                         has established membership stock purchase requirements, which would
                         require a subsidiary that received assets from an affiliate to purchase
                         additional capital from the FHLBank. We note that the membership capital
                         requirements for each FHLBank can differ.

                         We also note that it is difficult to determine the extent to which holding
                         companies transfer assets between their subsidiaries and whether any such
                         transfers result in competition between the FHLBanks. Federal Reserve
                         officials said that they do not collect data on transfers of assets among
                         subsidiaries, although one Federal Reserve official said that such transfers
                         occur frequently. FHFB officials commented that it was not clear that
                         holding companies had financial incentives to move collateral from one
                         subsidiary to another to obtain favorable advance rates. The FHFB
                         officials said that if a subsidiary had sufficient cash to purchase collateral
                         from an affiliate, it already would have sufficient eligible collateral to
                         secure advances from its local FHLBank and would not need additional
                         collateral.



FHFB Has Not             FHFB is responsible for helping ensure that the FHLBanks follow statutory
                         and regulatory requirements in making advances and that competitive
Identified Significant   pressures within the FHLBank System do not compromise the System’s
Advance Term Pricing     safety and soundness. Although the FHLBanks have adopted differing
                         approaches to setting advance pricing terms, FHFB’s examination program
Deficiencies, but        has not identified significant violations in the banks’ practices over the past
FHLBank Safety and       several years. However, as part of its oversight efforts, FHFB collects data
Soundness Data           on FHLBank collateral practices that have questionable value in their
                         current format. In addition, FHFB does not collect data necessary to fully
Reporting Can Be         assess competition within the FHLBank System, such as data on the
Improved                 advance terms that holding company subsidiaries may receive from
                         different FHLBanks. Such data would also help FHFB assess the potential
                         risks associated with multidistrict membership.




                         26
                            Banking regulators, such as FDIC, require insured depository institutions to meet leverage
                         and risk-based capital requirements.




                         Page 28                                                GAO-03-973 FHLBank Advance Terms
FHFB Examinations Have   FHFB carries out its oversight responsibilities through, among other
Not Identified Serious   means, annual examinations and off-site monitoring. During the
                         examination process, FHFB examiners review a range of activities at each
Advance Term Pricing     FHLBank, such as its asset and liability management, collateral
Deficiencies             management practices, and compliance with relevant laws and regulations.
                         Off-site monitoring is typically carried out by FHFB headquarters staff and
                         involves the review of financial data that provides information and insights
                         into the safety and soundness of the FHLBanks. Regular off-site
                         monitoring between annual examinations is important because the
                         FHLBanks’ financial conditions and risks can change significantly in a
                         short period. Off-site monitoring can help target examination reviews
                         towards emerging risks at a particular FHLBank or across the System.

                         In reviewing advance pricing term compliance, FHFB examiners are
                         responsible for determining whether the FHLBanks price their advances
                         above the cost of issuing debt, the FHLBank’s member products policy
                         clearly outlines the standards and criteria for differential pricing, and the
                         FHLBanks apply these standards and criteria consistently and without
                         discrimination to all members. In reviewing collateral compliance, FHFB
                         examination teams look at the policies the FHLBanks use to conduct their
                         collateral verification site visits and the agreements they use to perfect
                         their liens. FHFB examiners also review the procedures that the
                         FHLBanks have established to ensure that they value their members’
                         collateral frequently so that it is in line with the haircuts that they apply.

                         FHFB did not identify significant problems in the FHLBanks’ advance term
                         pricing practices in examinations completed in 2001 and 2002. FHFB
                         officials said that their examinations have generally concluded that the
                         FHLBanks comply with collateral requirements and setting advance
                         interest rates. FHFB examinations completed between 2001 and 2002 that
                         we reviewed identified no serious deficiencies.27 According to FHFB
                         examination criteria, a “violation” represents a significant deficiency at a
                         FHLBank while a recommendation is less serious. With the exception of
                         one violation for failure to perform advance collateral verification, FHFB
                         examinations regarding collateral contained only recommendations that
                         FHLBanks develop or expand policies. Similarly, according to the FHFB



                         27
                          An FHFB official provided us with copies of all examination reports for 2001 and 2002 that
                         noted any findings related to collateral management practices.




                         Page 29                                               GAO-03-973 FHLBank Advance Terms
                            officials, the agency has only recommended that certain FHLBanks
                            describe more clearly their policies on differential advance term pricing.



FHFB’s FHLBank System       Although FHFB has collected collateral data from the FHLBanks since 2000
Safety and Soundness Data   that are intended to assist in monitoring the FHLBanks’ safety and
                            soundness, the data have questionable value in their current format. On an
Reporting Procedures Have   annual basis, FHFB has requested that the FHLBanks provide data on the
Limitations                 level of collateral securing advances. FHFB requests data on, among other
                            things, the total value of collateral securing advances, collateralization by
                            member type (such as commercial bank and thrifts), collateralization by
                            member size (such as members with $10 billion or more in assets), and the
                            use of eligible collateral by member institutions (such as the use of single-
                            family mortgages and small business and agricultural CFI collateral).
                            According to the FHFB’s 2003 request letter, these data are “very valuable
                            in exhibiting the System’s safety and soundness and the extent to which
                            traditional types of collateral secure advances.” Additionally, FHFB stated
                            in the letter that the information would help FHFB ascertain the
                            acceptance and placement of small business and agricultural collateral by
                            CFIs.

                            Although FHFB has identified such data as useful for assessing the
                            FHLBank System’s safety and soundness, we found that FHLBanks do not
                            have clear information on how FHFB wants the data to be reported.
                            Several FHLBanks that we visited report specific collateral—such as
                            individual single-family mortgages or CFI loans—that has been pledged by
                            their members to support outstanding advances. Officials at these
                            FHLBanks said that they had provided the data in the format requested by
                            FHFB. In contrast, other FHLBank officials told us that they reported all of
                            the eligible collateral on the books of their members. A senior official from
                            one of these FHLBanks said that since the bank has access to all the
                            eligible collateral with whom it has blanket lien agreements, there was no
                            need to report more specific loan-level data to FHFB. Officials from one
                            FHLBank said that FHFB provided only general guidance on what
                            collateral data to report, which required each FHLBank to develop its own
                            reporting criteria.

                            Table 9 illustrates the differing approaches that the FHLBanks use to report
                            collateral data to FHFB. The table shows the total advances outstanding,
                            the reported collateral securing those advances, and the ratio of collateral
                            to advances at each FHLBank as of December 31, 2002. The ratios at
                            FHLBanks B and K show that their collateral to advance ratios are 1.23 to 1



                            Page 30                                       GAO-03-973 FHLBank Advance Terms
and 1.26 to 1, respectively. These FHLBanks report to FHFB individual
collateral securing advances. In contrast, FHLB E’s ratio of 7.15 to 1 is
explained by the fact that the bank reports to FHLBank the value of all the
eligible collateral held by its members.



Table 9: FHFB Data on Collateralization and Advances as of December 31, 2002

Dollars in millions
FHLBanks                     Total collateral         Total advances             Collateralization ratio
Bank A                                $62,497                  $24,027                                 2.60
Bank B                                $30,297                  $24,651                                 1.23
Bank C                                $81,210                  $27,490                                 2.95
Bank D                               $158,553                  $77,205                                 2.05
Bank E                               $196,007                  $27,428                                 7.15
Bank F                                $77,510                  $25,991                                 2.98
Bank G                               $152,840                  $80,252                                 1.90
Bank H                                $62,294                  $23,044                                 2.70
Bank I                               $117,248                  $38,237                                 3.07
Bank J                               $113,604                  $66,017                                 1.72
Bank K                                $46,010                  $36,488                                 1.26
Bank L                                $55,041                  $19,686                                 2.80
Source: FHFB.

Note: The A-L listing of the FHLBanks in this table differs from the A-L listing in other tables in this
report.


Because certain FHLBanks may report all of the eligible collateral held by
their members, the data that FHFB receives on the acceptance and
placement of CFI collateral—one of FHFB’s stated reasons for collecting
the data---is difficult to assess. As of December 31, 2002, the FHLBanks
reported to FHFB that there was $7.2 billon in small business and
agricultural loans securing advances by CFIs. Of that $7.2 billion figure,
$3.6 billion—or approximately 50 percent—was reported by one FHLBank,
which reported the value of all the collateral on its members’ books. This
FHLBank reported the highest value of CFI collateral in the FHLBank
System. However, an official from this FHLBank said that a small number
of its members secured advances with CFI collateral and estimated that the
total amount of such advances was $25 million.

The Director of FHFB’s Office of Supervison said that the agency planned
to review its current collateral data collection and reporting procedures for



Page 31                                                         GAO-03-973 FHLBank Advance Terms
              the FHLBanks. The Director said that the collateral data are currently used
              to complement FHFB’s safety and soundness supervision program and that
              the data provided a broad overview of trends and anomalies. However, the
              Director also said that the collateral data did not substitute for FHFB’s
              annual examinations at each FHLBank, which we discussed earlier.
              Although the FHLBank collateral data may provide some benefits for
              FHFB’s examination program, FHFB’s decision to review current reporting
              procedures appears to be appropriate. The current data do not allow for
              meaningful comparisons across the FHLBank System and the reported data
              on the placement of CFI collateral are potentially misleading. With better
              collateral data, FHFB’s ability to monitor the FHLBank System’s safety and
              soundness could be enhanced.

              FHFB’s oversight of the FHLBank System could also be enhanced by
              reviewing the extent to which competition may currently take place
              between FHLBanks and its potential effects on the System’s safety and
              soundness. Available evidence suggests that competition may take place
              between the FHLBanks, including (1) key differences in advance term
              pricing across the FHLBank System, (2) statements by some FHLBank
              officials that holding company subsidiaries may play one FHLBank against
              another to obtain more favorable advance rates, and (3) the legal authority
              of holding company subsidiaries to transfer assets between one another
              thereby creating the potential that collateral may be moved from one
              subsidiary to another to obtain more favorable advance rates. Although
              there is evidence that competition between the FHLBanks takes place, the
              evidence is largely anecdotal and has not been quantified. Given FHFB’s
              oversight responsibilities for the FHLBank System, it could benefit by
              collecting data necessary to better understand the degree of competition
              within the System. For example, FHFB could collect data on the advance
              terms---including interest rates---that the subsidiaries of holding companies
              obtain on advances and whether the eligible collateral at each subsidiary
              has fluctuated over time. By collecting such data, FHFB could identify the
              potential effects that holding company subsidiaries have on competition
              between the FHLBanks and whether such competition in any way has
              affected the FHLBanks’ underwriting standards. Additionally, such data
              could assist FHFB in assessing the potential competitive and safety and
              soundness implications of multidistrict membership.



Conclusions   Within the framework established by statute and regulation, the FHLBanks
              have independent authority to set advance pricing terms that meet their
              business needs and the needs of their members. As a result, advance



              Page 32                                       GAO-03-973 FHLBank Advance Terms
                  pricing terms vary across the FHLBank System as evidenced by sometimes
                  differing interest rates, tiered-pricing programs, collateral requirements,
                  borrowing limits, and advance activity capital requirements. Because many
                  holding companies have multiple subsidiaries, each of which may be
                  eligible for membership in a different FHLBank, they have the opportunity
                  to obtain advances from those FHLBanks that offer the most advantageous
                  terms. Under exemptions to Sections 23A and 23B of the Federal Reserve
                  Act, moreover, the potential also exists that holding companies can transfer
                  assets from one subsidiary to another to obtain favorable advance pricing.
                  These conditions create the potential for competition on advance pricing
                  among the FHLBanks and any such pressures may be enhanced under
                  multidistrict membership.

                  FHFB has a critical responsibility in helping to ensure that the FHLBanks
                  sometimes differing advance pricing terms are conducted within statutory
                  and regulatory requirements. In particular, FHFB is responsible for
                  ensuring that the FHLBanks do not price advances below the cost of funds
                  and fully secure advances with eligible forms of collateral. Although FHFB
                  has not identified any serious violations in advance pricing terms in recent
                  years, the agency has an important responsibility to ensure that any
                  competitive pressures do not threaten the FHLBank System’s safety and
                  soundness. However, the data that FHFB currently collects on collateral
                  from the FHLBanks is of questionable value in their current format for
                  understanding the System’s safety and soundness. Moreover, FHFB does
                  not collect data that could be helpful in assessing the competitive
                  implications of holding companies whose subsidiaries operate in different
                  FHLBank districts as well as multidistrict membership.



Recommendations   To strengthen FHFB’s safety and soundness oversight, we recommend that
                  FHFB review its current collateral reporting requirements and work with
                  the FHLBanks to obtain data that are useful in understanding collateral
                  practices within the System. We also recommend that FHFB work with the
                  FHLBanks to obtain data necessary to understand the competitive and
                  safety and soundness implications of holding companies whose
                  subsidiaries operate in different FHLBank districts as well as multidistrict
                  membership.




                  Page 33                                      GAO-03-973 FHLBank Advance Terms
Agency Comments and   We received written comments on a draft of this report from FHFB and the
                      Federal Home Loan Bank President’s Conference, which are reprinted in
Our Evaluation        appendixes III and IV, respectively. We also received technical comments
                      from FHFB, several FHLBanks, and the Board of Governors of the Federal
                      Reserve, which have been incorporated into the report where appropriate.

                      FHFB agreed to implement the recommendations contained in the report.
                      FHFB stated that while the collateral data discussed in the report were
                      used during the examination process, the data did not substitute for annual
                      examinations. FHFB stated that it planned to examine the effectiveness of
                      the collateral policies and procedures at each FHLBank and to identify
                      practices, possibly to include enhanced data collection and reporting, to
                      further the use of the most effective collateral practices. FHFB also stated
                      that it planned to work with the FHLBanks to assess the value of additional
                      data collection and reporting to monitor the competitive and safety and
                      soundness influences of holding company subsidiaries that operate in
                      multiple FHLBank districts. FHFB stated that its examinations have found
                      that advance term pricing differed among the FHLBanks for many reasons,
                      including the trade-offs between dividends and advance rates and
                      competitive pressures. FHFB stated that it would be worthwhile to
                      examine the extent to which competition—both between the FHLBanks
                      and from the capital markets—can be a healthy influence on the efficient
                      operation of the FHLBanks.

                      The FHLBank President’s Conference stated that the report correctly noted
                      that the advance pricing and collateral practices of the 12 FHLBanks differ.
                      The Conference stated that the FHLBank Act and FHFB regulations
                      establish a framework in which individual FHLBanks can establish policies
                      that meet the needs of their member institutions. The Conference also
                      stated that statutory and regulatory provisions that require advance
                      interest rates to be set above borrowing costs and advances to be secured
                      by eligible collateral ensure that the FHLBanks operate in a safe and sound
                      manner. The Conference also stated that its members were prepared to
                      work with FHFB to collect data necessary to understand the collateral
                      practices across the FHLBanks.


                      As agreed with your offices, unless you publicly announce the contents of
                      this report earlier, we plan no further distribution until 30 days from the
                      report date. At that time, we will send copies of this report to the Chairman
                      of the Senate Committee on Banking, Housing, and Urban Affairs; and the



                      Page 34                                       GAO-03-973 FHLBank Advance Terms
Ranking Member of the Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises of the House Committee on Financial
Services. We will also send copies to FHFB, the FHLBank President’s
Conference, the FHLBanks, and the Board of Governors of the Federal
Reserve. We will also send copies to others upon request. In addition, this
report will be available at no charge on GAO’s Web site at
http://www.gao.gov. Please contact Mr. Wesley M. Phillips or me at
(202) 512-8678, or email (phillipsw@gao.gov or shearw@gao.gov) if you or
your staff have any questions concerning this report. GAO staff who made
major contributions to this report are listed in appendix V.




William B. Shear
Director, Financial Markets
 and Community Investment




Page 35                                     GAO-03-973 FHLBank Advance Terms
Appendix I

Objectives, Scope, and Methodology                                                       AA
                                                                                          ppp
                                                                                            ep
                                                                                             ned
                                                                                               n
                                                                                               x
                                                                                               id
                                                                                                e
                                                                                                x
                                                                                                Iis




              As discussed with your staff, our report objectives are to (1) describe the
              laws and regulations pertaining to the terms that FHLBanks can offer on
              advances; (2) provide information on whether key differences exist in
              current advance pricing and other terms across the FHLBanks; (3)
              determine whether holding companies face any legal or regulatory barriers
              in transferring assets among subsidiaries who are members of different
              FHLBank districts; and (4) describe FHFB's safety and soundness
              oversight of the FHLBanks' advance pricing practices and review selected
              data that FHFB collects to monitor the safety and soundness of the
              FHLBank System.

              To meet objective (1), we reviewed the Federal Home Loan Bank Act as
              amended. We also reviewed the FHFB regulations that govern or describe
              the terms that FHLBanks can offer on advances. We interviewed FHFB and
              FHLBank officials to obtain their views on the terms FHLBanks can offer
              on advances.

              To meet objective (2), we interviewed FHFB, the 12 FHLBank presidents,
              credit staff from 7 of the 12 FHLBanks, and we sent a structured
              questionnaire to each of the 12 FHLBanks and received responses from
              each of the banks. Additionally, we reviewed the credit policies of each of
              the 12 FHLBanks and reviewed data on advance interest rates for those
              FHLBanks that post such data on their Web sites. We note that the data
              posted on the FHLBank Web sites are subject to change and that the actual
              rates members actually pay may differ due to advance term negotiations
              between FHLBanks and their members. Two other FHLBanks separately
              provided their advance rates for the dates that we used. With this
              information, we compared advance pricing and other terms across the
              FHLBanks to identify key differences. The scope of our work did not
              involve developing a methodology to determine why individual FHLBanks
              charge the advance interest rates or other advance pricing terms that they
              do.

              To meet objective (3), we reviewed applicable laws and regulations
              regarding the transfer of funds and assets among holding companies and
              their subsidiaries, including the Federal Reserve Act, Federal Home Loan
              Bank Act, Home Owners' Loan Act, FHFB regulations, and Federal Reserve
              Board regulations. We also interviewed representatives from the Federal
              Reserve Board, FHFB and a large holding company.

              To meet objective (4), we interviewed FHFB officials, reviewed FHFB's
              advance pricing examination guidelines, and reviewed selected



              Page 36                                     GAO-03-973 FHLBank Advance Terms
Appendix I
Objectives, Scope, and Methodology




examination reports for 2001 and 2002 related to advance pricing and
collateral requirements. We did not evaluate the effectiveness of FHFB's
examination program. To assess FHFB's collateral data reporting process,
we reviewed FHFB's data request forms and the data provided by the
FHLBanks. We also interviewed officials at selected FHLBanks to
determine their approach to reporting the collateral and other data and we
interviewed FHFB officials on these issues.

We conducted our review from January to September 2003 in Washington,
D.C.; New York, New York; Topeka, Kansas; Dallas, Texas; Atlanta, Georgia;
and Pittsburgh, Pennsylvania, and Indianapolis, Indiana, in accordance
with generally accepted government auditing standards.




Page 37                                     GAO-03-973 FHLBank Advance Terms
Appendix II

Advance Interest Rates Charged by Specific
FHLBanks on Selected Dates                                                                                                                                   Appendx
                                                                                                                                                                   Ii




Table 10: Comparison of Selected FHLBank Interest Rates on Fixed Rate Advances (July 18, 2003)a

                                                                                                                                             Difference
                                                                                                                                               in basis
Term         Bank A Bank B Bank C Bank D Bank E Bank F Bank G Bank H                            Bank I Bank J Bank K                   Range     points
12 mo.            1.29       1.20   1.54   1.53       1.22       1.41        1.45       1.23       1.34       1.43       1.38      1.20-1.54               34
24 mo.            1.77       1.68   1.95   1.95       1.74       1.84        1.98       1.76       1.86       1.84       1.96      1.68-1.98               30
36 mo.            2.31       2.28    2.5   2.48       2.32       2.42        2.51       2.31       2.46       2.48         2.5     2.28-2.51               23
48 mo.            2.83       2.80   3.12   3.00       2.93       2.92        3.09       2.84       2.98       3.01       3.04      2.80-3.12               32
60 mo.            3.27       3.22    3.4   3.43       3.34       3.34        3.48       3.28       3.39       3.45       3.46      3.22-3.48               26
Source: Selected FHLBanks.

                                                  Note: The A-K listing of the FHLBanks for this table differs from the alphabetic listings in other tables in
                                                  this report.
                                                  a
                                                   The interest rates shown are generally for regular fixed term and rate advances with no discounting.
                                                  The FHLBanks also differ in their policies regarding payment frequency and daycount accrual
                                                  methods. No attempt is made here to harmonize the data to a single payment frequency and daycount
                                                  accrual standard.




Table 11: Comparison of Selected FHLBank Interest Rates on Fixed Rate Advances (July 25, 2003)a

                                                                                                                                             Difference
                                                                                                                                               in basis
Term         Bank A Bank B Bank C Bank D Bank E Bank F Bank G Bank H                            Bank I Bank J Bank K                   Range     points
12 mo.            1.26       1.56   1.36   1.45       1.55       1.40        1.40       1.21       1.30       1.44       1.24      1.21-1.56               35
24 mo.            1.78       1.97   1.85   1.96       1.96       1.94        1.84       1.73       1.80       1.84       1.78      1.73 -1.97              24
36 mo.            2.35       2.57   2.52   2.61       2.43       2.58        2.50       2.39       2.41       2.54       2.39      2.35-2.61               26
48 mo.            3.02       3.15   3.12   3.24       3.18       3.18        3.06       2.99       3.01       3.15       2.99      2.99-3.24               25
60 mo.            3.48       3.64   3.61   3.69       3.54       3.66        3.51       3.46       3.49       3.65       3.47      3.46-3.69               23
Source: Selected FHLBanks.

                                                  Note: The A-K listing of the FHLBanks for this table differs from the alphabetic listings in other tables in
                                                  this report.
                                                  a
                                                   The interest rates shown are generally for regular fixed term and rate advances with no discounting.
                                                  The FHLBanks also differ in their policies regarding payment frequency and daycount accrual
                                                  methods. No attempt is made here to harmonize the data to a single payment frequency and daycount
                                                  accrual standard.




                                                  Page 38                                                         GAO-03-973 FHLBank Advance Terms
Appendix III

Comments from the Federal Housing Finance
Board                                                        Appendx
                                                                   iI




               Page 39        GAO-03-973 FHLBank Advance Terms
Appendix III
Comments from the Federal Housing Finance
Board




Page 40                                     GAO-03-973 FHLBank Advance Terms
Appendix IV

Comments from the Federal Home Loan Bank
Presidents’ Conference                                      Appendx
                                                                  iIV




              Page 41        GAO-03-973 FHLBank Advance Terms
Appendix V

GAO Acknowledgments and Staff Contacts                                                       Append
                                                                                                  x
                                                                                                  i
                                                                                                  V




GAO Contacts      William B. Shear (202) 512-8678
                  Wesley M. Phillips (202) 512-5660



Acknowledgments   In addition to the individuals named above, Tanya Cruz, Crystal Daniels,
                  Rachel DeMarcus, M’Baye Diagne, Marc Molino, Andy Pauline, Mitchell B.
                  Rachlis, and Barbara Roesmann made key contributions to this report.




(250114)          Page 42                                    GAO-03-973 FHLBank Advance Terms
GAO’s Mission            The General Accounting Office, the audit, evaluation and investigative arm of
                         Congress, exists to support Congress in meeting its constitutional responsibilities
                         and to help improve the performance and accountability of the federal government
                         for the American people. GAO examines the use of public funds; evaluates federal
                         programs and policies; and provides analyses, recommendations, and other
                         assistance to help Congress make informed oversight, policy, and funding
                         decisions. GAO’s commitment to good government is reflected in its core values of
                         accountability, integrity, and reliability.


Obtaining Copies of      The fastest and easiest way to obtain copies of GAO documents at no cost is
                         through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-
GAO Reports and          text files of current reports and testimony and an expanding archive of older
                         products. The Web site features a search engine to help you locate documents
Testimony                using key words and phrases. You can print these documents in their entirety,
                         including charts and other graphics.
                         Each day, GAO issues a list of newly released reports, testimony, and
                         correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site
                         daily. The list contains links to the full-text document files. To have GAO e-mail this
                         list to you every afternoon, go to www.gao.gov and select “Subscribe to
                         e-mail alerts” under the “Order GAO Products” heading.


Order by Mail or Phone   The first copy of each printed report is free. Additional copies are $2 each. A check
                         or money order should be made out to the Superintendent of Documents. GAO
                         also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a single
                         address are discounted 25 percent. Orders should be sent to:
                         U.S. General Accounting Office
                         441 G Street NW, Room LM
                         Washington, D.C. 20548
                         To order by Phone:     Voice: (202) 512-6000
                                                TDD: (202) 512-2537
                                                Fax: (202) 512-6061


To Report Fraud,         Contact:
                         Web site: www.gao.gov/fraudnet/fraudnet.htm
Waste, and Abuse in      E-mail: fraudnet@gao.gov
Federal Programs         Automated answering system: (800) 424-5454 or (202) 512-7470



Public Affairs           Jeff Nelligan, Managing Director, NelliganJ@gao.gov (202) 512-4800
                         U.S. General Accounting Office, 441 G Street NW, Room 7149
                         Washington, D.C. 20548
United States                  Presorted Standard
General Accounting Office      Postage & Fees Paid
Washington, D.C. 20548-0001           GAO
                                 Permit No. GI00
Official Business
Penalty for Private Use $300
Address Service Requested