Following is the text of a comment letter from Brian P. Smith, executive vice president of the Savings arid Community Bankers of America, to the Federal Housing Finance Board in support of the FHFB's proposal to ease the minimum ratio of capital to outstanding consolidated obligations of the Federal Home Loan Bank System.
The Savings & Community Bankers of America are pleased to offer their comments on the proposal of the Federal Housing Finance Board to adjust the minimum ratio of capital to outstanding consolidated obligations of the Federal Home Loan Bank System. In general, SCBA strongly endorses the thrust of the proposal and supports its immediate adoption, though we do suggest some minor adjustments below.
Together with a number of more technical adjustments, the basic proposal moves the maximum leverage ratio [to 20-to-1 from 12-to-1] This is consistent with the underlying statute and the current advances-based user-stock purchase requirement (for a borrower that satisfies the Qualified Thrift Lender Test).
Consequently, given the inevitable capital holdings by institutions not currently borrowing, but constrained by the portfolio-based maintenance stock requirement, the leverage ratio of the system win never violate the higher [20-to-1] limit.
The new limit would apply to not only consolidated obligations but also to the newly defined class of unsecured senior liabilities. The major component of the latter class is member deposits. Since many SCBA members rely on the investment services of the 12 FHL Banks - at times, depositors out number borrowers - we appreciate the inclusion of these liabilities within the capital discipline of the system. We do, however, note one caveat on this score under the "event risk" heading discussed below.
We suggest that the Board reconsider and amend the items that may be counted toward satisfying the leverage limit.
It would be more consistent with the nature of the leverage requirement already applicable to depository institutions and under development for the other housing sector government-sponsored enterprises if the eligible capital accounts were to be restricted to paid-in capital and retained earnings.
The roll of loss reserve accounts should be to meet a companion risk-based capital requirement that would, as for depositories, consider the exposure from off balance sheet liabilities, such as issuance of letters of credit. We encourage the Board to adopt such a risk based system even if not so prompted by statutory amendments.
The suggested restriction on capital eligible under the leverage limit would strengthen the assurance to consolidated obligation investors, but maintain the flexibility of the Board in future adoption of the appropriate capital regime.
We have no objection to the modest extension of the list of items that must be maintained as investment assets at least equal in amount to the level of senior bonds outstanding. In essence, the extension covers mortgage-related securities. We presume that the relationship is predicated on appropriate [generally accepted accounting principles) for the balance sheet carrying values of such investment or trading account securities.
We would further presume that the position taken in these items will remain subject to appropriate prudential regulation by the Board for each of the individual FHL Banks.
Under proposed Section [section] 910.6, the Board undertakes, in essence, not to loosen the amended leverage restrictions when senior bonds are outstanding unless: a) such bonds are "defeased" by the pledge of full faith and credit government bonds into a "sinking fund" escrow; or b) a comfort letter on such a change is obtained from either a securities rating firm to the effect that outstanding or to-be-issued bonds would not be downgraded or from an investment banking firm that such change would not have a "materially adverse" effect on outstanding or to-be-issued bonds.
Given the greater investor awareness and caution regarding "event risk" in the wake of debt service problems on previously issued corporate debt after leveraged buyouts, it is wholly appropriate to address such concerns so that current funding costs do not include an uncertainty premium for future potential loosening of the leverage discipline.
A few suggesuons are appropriate on this topic.
Ibe Board should consider explicitly dropping the coverage of other senior unsecured debt, i.e., deposits, from the covenant in this r-egar-d. Though we support the current inclusion of such liabflities, the Board should not necessarily surrender the fleidbility of subsequently excluding these items if such a move makes sense in the future.
Depositors can exert discipline sixuply by withdr-awing and do not need such restrlctive covenant protection. Such comfort is appr-opriate for investors in noncauable paper for whom the eidt strategy is an open market sale to anolher investor.
Further-inore, despite the language in the preamble, the reqtdred defeasance amount to be put in escr-ow does not fuuy anticipate interest on the contributed items. If a goverrunent bond is contributed, the periodic coupons can, indeed, be factored in, but no reinvestinent income is considered.
Consistent with the spirit of the proposed Seclion Ss910.6(b)(2), credit could be given in companion Ss91.06(b)(1) for -float earnings- at no more than the rate permitted by the nationally recognized ratings agencies for triple-a-rated] structured tlnancings. Such credit would increase the efficiency of the escrow process.
It is also not absolutely clear from the proposed language whether the Board retains the option, subject to meeting the requirements of applicable [generally accepted accounting principles], of expunging defeased consolidated obligation liabilities from ils balance sheet and thereby fr-om the subsequent leverage calculation. Given the irrevocable comniitment of the escrowed assets. however. we presume that such is the intent of a formal defeasance.
As regards the other sources of exception under heading b) above, the process via the ratings agency approach may be somewhat infleiable-in essence a perpetual pledge of [triple-al status-or unduly loose via the investrnent banker opinion: 'a inaterially adverse effect on creditworthiness- could certainly be interpreted to mean the eqtdvalent of no rating downgrade, but could also encompass sixnply continued probabwty of current debt service and repayment of principal at maturity.
Under the ratings maintenance approach, the Board is comndtted to a higher rating than currently achieved on a pro forma stand-alone basis by other GSES. (Of course, the basic leverage ratio value is also far higher.) Under the investment banker certification, it is not clear what assurance is actually pr-ovided. The Board may wish to clarify these ambiguities either in the text of the ftnal r-egulation or in the preamble thereto.
Mis proposal indicates that the Board has valuable fle)dbility in addressing capitalization issues even within the current statutory framework. To maintain the consistency of the advances based r-equirement with the 120- to- I ] capital ratio, we do not suggest any r-e-evaluation of current requirements in that regard. We would commend to the Board's attenuon the possibfflty of reconsidering Lhe deflriltion of -mortgage assets' for purposes of the 1% portfollo-based requirement applicable to non- or low-users of the advances window. Obviously, however, any truly major adjustinent on this score would r-equire statutory revision but the Board may wish to consider its options in the meantime. Ll