As described  in this report, single-family mortgages and other forms of traditional  collateral generally are perceived as representing less risk than alternative  forms of collateral, such as agricultural and small business loans. FHLBank and CFI Officials Cited Several Factors, Including Lack of Interest and Risk-Management Policies, to Explain Minimal Use of Alternative Collateral

Officials from the 12 FHLBanks cited several factors to help explain the  minimal use of alternative collateral to secure advances in the FHLBank  System. Officials from these three FHLBanks  said that their memberships had not expressed an interest in pledging  alternative collateral. FHLBank Policies That Focus On Potential Risks May Also Limit the Use of Alternative Collateral

FHFA and some FHLBank officials said that alternative collateral  generally has been viewed as representing greater risks than single-family  mortgages and investment-grade securities. For example, FHFA officials  said that it could be difficult to establish a value for agricultural and small  business loans because they generally have not been actively traded in  secondary markets. These FHLBanks  generally apply higher haircuts to alternative collateral than to any other  type of collateral that may be used to secure advances. CFIs Generally Valued Their Relations With FHLBanks, but Half Raised Concerns about Haircuts on Alternative Collateral or Other FHLBank Risk- Management Policies

While many CFIs may have significant traditional collateral resources to  pledge to secure advances, we conducted interviews with 30 CFIs that  could be constrained in their ability to obtain FHLBank advances due to  their significant involvement in agricultural or small business lending. Moreover,  a majority of the FHLBanks have not established quantitative performance  goals for products, related to agricultural and small business lending in  their strategic business plans, which could include alternative collateral,  as required by agency regulations. But, without more proactive  oversight by FHFA from a mission standpoint, the appropriateness of  FHLBank alternative collateral policies may not be clear. In the Absence of FHFA Examination Oversight, FHLBanks Have Wide Discretion to Establish Haircuts and Other Policies for Alternative Collateral, but Documentation to Support These Policies Is Limited

While FHFA may prioritize FHLBank safety and soundness concerns and  the structure of the AHP and CIP programs may facilitate their oversight  from a mission standpoint, FHFA’s, as well as FHFB’s, limited oversight of  alternative collateral may have limited its appeal within the FHLBank  System. Further,  of the 10 FHLBanks that accept alternative collateral, 3 provided  documentation of the basis of the haircuts that they applied to such  collateral. In many cases the FHLBanks  have not substantiated and documented their reasons for not accepting  alternative collateral or applying relatively high haircuts to it. Specifically, FHFA stated that the  agency would (1) review each FHLBank’s policies and practices, starting  with the 2011 annual supervisory examination cycle, to assure that they  can substantiate their collateral practices and are meeting their CFI  members’ liquidity needs; (2) issue an Advisory Bulletin to the FHLBanks  that provides supervisory guidance on how to include goals for alternative  collateral in the preparation of FHLBank strategic business plans  beginning in 2011, and review those plans to ensure they include such  goals; and (3) direct the FHLBanks to document their outreach and  alternative collateral needs assessment efforts in their strategic business  plans, and instruct examiners to monitor the FHLBanks’ efforts in these  areas as part of the agency’s ongoing supervisory review. Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to (1) discuss factors that may limit the  use of alternative collateral to secure Federal Home Loan Bank  (FHLBank) advances; and (2) assess selected aspects of the Federal  Housing Finance Agency’s (FHFA) oversight of the FHLBanks’ alternative  collateral policies and practices. We also conducted interviews with representatives from FHFA,  the regulator of the FHLBank System; the 12 FHLBanks; the Council of  Federal Home Loan Banks; the Independent Community Bankers of  America; and obtained information from a nongeneralizable, random  sample of 30 Community Financial Institutions (CFI).
Why GAO Did This Study

The Federal Home Loan Bank System is a government-sponsored enterprise comprising 12 regionally-based Federal Home Loan Banks (FHLBank), the primary mission of which is to support housing finance and community and economic development. Each FHLBank makes loans (advances) to member financial institutions in its district, such as banks, which traditionally are secured by single-family mortgages. In 1999, the Gramm-Leach-Bliley Act (GLBA) authorized FHLBanks to accept alternative forms of collateral, such as agricultural and small business loans, from small members. GAO was asked to assess (1) factors that may limit the use of alternative collateral; and (2) selected aspects of the Federal Housing Finance Agency's, (FHFA) related regulatory oversight practices. GAO reviewed FHLBank policies and FHFA documentation; and interviewed FHLBank and FHFA officials, and a nongeneralizable random sample of 30 small lenders likely to have significant levels of agricultural or small business loans in their portfolios.

What GAO Found

FHLBank and FHFA officials cited several factors to help explain why alternative collateral represents about 1 percent of all collateral that is used to secure advances. These factors include a potential lack of interest by small lenders in pledging such collateral to secure advances or the view that many such lenders have sufficient levels of single-family mortgage collateral. Officials from two FHLBanks said their institutions do not accept alternative collateral at all, at least in part for these reasons. Further, FHLBank officials said alternative collateral can be more difficult to evaluate than single-family mortgages and, therefore, may present greater financial risks. To mitigate these risks, the 10 FHLBanks that accept alternative collateral generally apply higher discounts, or haircuts, to it than any other form of collateral, which may limit its use. For example, an FHLBank with a haircut of 80 percent on alternative collateral generally would allow a member to obtain an advance worth 20 percent of the collateral's value. While GAO's interviews with 30 small lenders likely to have significant alternative collateral on their books found that they generally valued their relationships with their local FHLBanks, officials from half said the large haircuts on alternative collateral or other policies limited the collateral's appeal. FHFA's oversight of FHLBank alternative collateral policies and practices has been limited. For example, FHFA guidance does not direct its examiners to assess the FHLBanks' alternative collateral policies. As a result, the FHLBanks have wide discretion to either not accept alternative collateral or apply relatively large haircuts to it. While the FHLBanks may view these policies as necessary to mitigate potential risks, 9 of the 12 FHLBanks did not provide documentation to GAO to substantiate such policies. Further, the documentation provided by three FHLBanks suggests that, in some cases, haircuts applied to alternative collateral may be too large. Also, the majority of the FHLBanks have not developed quantitative goals for products related to agricultural and small business lending, such as alternative collateral, as required by FHFA regulations. FHFA officials said that alternative collateral has not been a focus of the agency's oversight efforts because it does not represent a significant safety and soundness concern. However, in the absence of more proactive FHFA oversight from a mission standpoint, the appropriateness of FHLBank alternative collateral policies is not clear. FHFA should revise its examination guidelines to include periodic analysis of alternative collateral, and enforce its regulation pertaining to quantitative goals for products related to agricultural and small business lending. FHFA agreed with these recommendations.