WASHINGTON - The Federal Housing Finance Board is mounting a tough defense of its plan to raise retained earnings and trim excess stock at the Federal Home Loan banks, telling lawmakers the proposal is necessary to protect the system.
But in a letter American Banker obtained Thursday, Finance Board Chairman Ronald Rosenfeld also acknowledged concerns from Congress about the plan, and he pledged to phase in any changes to ensure business is not disrupted at the Home Loan banks and their members.
Industry representatives said the letter was the clearest sign to date that the Finance Board plans to proceed with its proposal, despite widespread opposition among the 12 Home Loan banks and hundreds of community banks.
"Clearly, they do appear to be resolute in moving forward," said Ann Grochala, director of lending and accounting policy at the Independent Community Bankers of America. "They've been asked by numerous parties to withdraw the proposal, but I don't see any indication [in the letter] that they'll do that."
Mr. Rosenfeld sent the three-page letter, along with a three-page addendum with answers to specific questions, Wednesday after House Financial Services Committee Chairman Michael Oxley and Rep. Barney Frank, the panel's lead Democrat, raised concerns about the proposal this month.
The March 15 proposal would require the Home Loan banks to slash dividends until they held retained earnings equal to $50 million plus 1% of their nonadvance business. The banks also would have to limit excess stock to 1% of assets and stop issuing stock dividends.
In the letter, Mr. Rosenfeld wrote that the proposal was needed because some of the Home Loan banks had not responded to earlier attempts to raise retained earnings.
"The progress … has been modest and uneven among the banks," he wrote.
He also called excess stock an unstable source of long-term capital, because member institutions can redeem it relatively quickly. The banks have used excess stock to capitalize their mortgage purchase programs and invest in activities outside their mission, the letter said.
"Using excess stock to capitalize mortgages or other long-term assets is undesirable from a safety-and-soundness perspective to the extent that redeemable capital is supporting long-term assets," Mr. Rosenfeld wrote. "Our intention in proposing the regulation is to strengthen the capital structure of the banks and thereby ensure the long-term financial health and stability of the Federal Home Loan Bank System."
In its answers to questions from lawmakers, the Finance Board wrote that each of the four banks with excess stock above its proposed limit has advances that make up less than 56% of total assets.
"In other words, among the FHLBanks, higher levels of excess stock tend to be associated with relatively reduced levels of advance lending to members," the agency wrote.
The regulator also sought to dispel criticisms that its proposal would lower the attractiveness of belonging to the Home Loan Bank System and hurt the profits of community bankers that are members.
Many have argued that small banks are more dependent on Home Loan bank dividends, which would be decreased at several banks until they raised retained earnings.
"There is no reason to believe that the effect of the proposed changes would be systematically greater on community financial institutions than on larger members," the agency wrote.
In response to questions on whether the Home Loan banks would be harmed by the proposal, the agency wrote that some banks would be affected while others would not.
For example, the Home Loan Bank of New York already has enough retained earnings and is below the limit on excess stock, according to the agency. However, the Home Loan Bank of Cincinnati - one of the most vocal opponents of the plan - would have to reduce its excess stock by $250 million and raise at least $100 million of retained earnings.
But Mr. Rosenfeld acknowledged concerns about the plan. He wrote that the agency would ensure its regulation does not "impede good business judgment about the composition of a bank's balance sheet" or damage the value of being a Home Loan bank member.
The Finance Board chairman also wrote that regulators would not force the Home Loan banks to adjust their financial practices overnight.
"Our regulation should recognize that where a bank has engaged in prior conduct that was permissible under the then-existing rules, any change in those rules should afford the bank a reasonable time to adjust its business strategies," he wrote.
Some industry representatives greeted Mr. Rosenfeld's letter with relief.
Joe Pigg, senior counsel at the American Bankers Association, said he was pleased that the Finance Board showed willingness to take some time before instituting the proposal.
"We're not opposed to the idea of raising retained earnings. We're just concerned about the transition period," he said.
But others said they continue to view the proposal warily, and that they will withhold final judgment until the agency unveils its final rule.
"There are indications the Finance Board will provide some flexibility, and we hope that's true," Ms. Grochala said. "How much flexibility and whether it is truly workable will depend on what the specific provisions of a final rule look like."
