The FHFA is requiring FHLBank boards to adopt acquired member asset risk management procedures that specifically address four risk factors.
A new Federal Housing Finance Agency Advisory Bulletin summarizes the agency’s regulations and guidance on how Federal Home Loan Bank boards should manage the risks that arise when the FHLBanks buy loans that have been originated by their members. FHLBank boards are expected to establish risk limits on their acquired member asset (AMA) portfolios that include at least:
- portfolio limits;
- concentration limits;
- third-party originator limits; and
- price limits.
The FHFA says that FHLBanks must be able to show progress toward compliance with the bulletin by Sept. 30, 2020, and they must be in full compliance by Dec. 31, 2020 (AB 2020-01).
AMA purpose. FHLBanks are to provide funding to member banks and housing associates that furthers housing and community lending. One way to accomplish this is by FHLBank purchases of loans. Properly managing the risks from these purchases is "critical to safety and soundness" and requires established and enforced limits, the FHFA says. These limits must be set by the FHLBank’s board.
In setting limits, a board needs to balance risk against the need to serve as a liquidity source for the Bank’s members. Particular attention should be given to the needs of smaller members that might be less able to sell loans on the secondary market, the bulletin says.
Limits and thresholds. Enforcing portfolio limits calls for setting thresholds that will help an FHLBank monitor its risk exposure. These thresholds should be enough lower than the risk limits that bank management will be able to detect and correct risks before the portfolio risk limits are exceeded, the FHFA says.
There should be a formal correction process in place that management can follow, according to the bulletin. Corrective actions could include placing acquisition limits on various types of loans, or on loans from a member that has accounted for an unusually large portion of the FHLBank’s AMA portfolio, or the sale of part of the Bank’s portfolio to other FHLBanks.
General portfolio limits. An FHLBank’s portfolio limits should be set based on the factors that affect both the purchased assets and the Bank’s operations, the FHFA says. Specific considerations should include a maximum portfolio size, growth limits, and restrictions on purchases of loans from any single member or associate.
Concentration limits. Loans that have common characteristics can present concentration risk, according to the bulletin. Examples of characteristics that present concentration risks include common geographic areas and high-balance loans. The FHLBank should be able to detect these risks in its portfolio.
Third-party originator limits. Loans can be purchased only if the FHLBank member or affiliate originated the loan or bought it from a third-party originator for what the FHFA’s regulations define as a "valid business purpose." An FHLBank must have a process that ensures the member has ensured that there was a valid business for its purchase of the loan, the bulletin says, and a "perfunctory assessment" by the FHLBank is insufficient.
There should be specific limits on an FHLBank’s purchases of AMA that were originated by third parties, the bulletin says. However, it might not be appropriate to apply these limits to smaller members that do not originate loans, the FHFA conceded.
Pricing limits. As the price an FHLBank pays for a loan increases, the earnings from the loan can be expected to fall, the bulletin notes. FHLBanks should not pay so much for AMA that they will be unable to fund their own operations. Also, loans that impose higher premiums on borrowers have a higher prepayment risk.
Price limits should apply both to individual loans and to the FHLBank’s entire portfolio amortized cost basis, according to the FHFA.
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