WASHINGTON - The Federal Housing Finance Board is expected to issue today a proposal that would radically change the capital structure of the Federal Home Loan banks.
Mandated by the Gramm-Leach-Bliley Act, the proposal is part of that law's efforts to make it easier for banks and thrifts to enter and exit the Home Loan Bank system while still providing the system with a stable capital structure for the long term.
Though industry officials are reserving judgment until after the proposal is released, they are concerned that the new capital rules could lower earnings and dividends and may be too complicated for small institutions.
The proposal is expected to make the capital structure of the 12 Home Loan banks more risk-based. Lawmakers and regulators wanted to tie the banks' capital reserves more closely to the risks they face - and to decrease the amount of capital available for profitable investments that do not further the banks' public mission of lowering the cost of housing.
As part of its move to a more risk-based capital system, the 12 Home Loan banks would offer two new types of stock to their members. These stock sales are the main source of capital for the system, which advances money to members to fund more mortgages and other loans.
Banks and thrifts could purchase Class A stock, which could be sold back to their regional Home Loan banks with only six months' notice, or to fellow members at any time. The tradeoffs for being able to unload Class A stock relatively quickly would be more fixed dividends and restricted voting rights.
Under the proposal, member banks and thrifts would have to give five years' notice before selling back Class B stock. However, their stock would entitle them to greater voting rights, potentially more lucrative dividends, an ownership interest in the Home Loan banks' retained earnings, and other advantages.
How much stock is sold to members would depend largely on how much "permanent capital" - retained earnings and Class B stock - a Home Loan bank needs to meet risk-based capital requirements and leverage requirements. Each individual Home Loan bank would be required to calculate the necessary permanent capital by assessing its credit, market, and operational risks.
Though the Home Loan banks are likely to be free to set their own thresholds for the different types of risk under the proposal, the Finance Board is expected to release minimum requirements at today's board meeting.
Some industry officials are concerned that the proposal, when coupled with the Finance Board's pending rule prohibiting Home Loan bank purchase of mortgage-backed securities, could significantly affect a member institution's return on investment.
Member institutions receive dividends on the stock issued by its Home Loan bank. Industry representatives fear that if Home Loan banks are forced out of profitable investments such as equities or other high-yielding securities, members could lose money on their investments. That could discourage members' participation in the system.
"In the end, the members will decide if they're going to sign the check for this stock or not," said John L. von Seggern, executive vice president of the Council of Federal Home Loan Banks. "They will have to be comfortable with this process in the end, and it's best that the regulators and the Home Loan Banks remember that."
House Banking Committee Chairman Jim Leach, R-Iowa, and others worried that under early drafts of the proposal a member institution could acquire enough shares in its Home Loan bank to unfairly influence its operation. In response, the proposal is expected that would restrict a member institution's control of voting rights on a Home Loan bank's board to 20% of outstanding stock. A member is also expected to be prohibited from holding more than 40% of either class of a Home Loan bank's stock.
The proposal is expected to be open for comment 90 days after publication. A final rule would have to be approved by Nov. 12, after which the Home Loan banks would get about nine months to submit a new capital structure plan for Finance Board approval. The new capital structure would be phased in over five years.
