Capital Classifications and Critical Capital Levels for the Federal Home Loan Banks, 38508-38514 [E9-18581]

Agencies

• FEDERAL HOUSING FINANCE AGENCY

[Federal Register Volume 74, Number 148 (Tuesday, August 4, 2009)]
[Rules and Regulations]
[Pages 38508-38514]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-18581]


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FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1229

RIN 2590-AA21


Capital Classifications and Critical Capital Levels for the 
Federal Home Loan Banks

AGENCY: Federal Housing Finance Agency.

ACTION: Final rule.

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SUMMARY: The Federal Housing Finance Regulatory Reform Act, Division A 
of the Housing and Economic Recovery Act of 2008 (HERA), requires the 
Director of the Federal Housing Finance Agency (FHFA) to establish 
criteria based on the amount and type of capital held by a Federal Home 
Loan Bank (Bank) for each of the following capital classifications: 
Adequately capitalized; Undercapitalized; Significantly 
undercapitalized; and Critically undercapitalized. In addition, HERA 
provides that the critical capital level for each Bank shall be the 
amount of capital that the Director by regulation shall require. HERA 
also sets forth prompt corrective action (PCA) authority that the 
Director has for the Banks. To implement these new provisions, FHFA 
published in the Federal Register on January 30, 2009 an interim final 
rule to define critical capital for the Banks, establish the criteria 
for each of the capital classifications identified in HERA and 
delineate its PCA authority over the Banks. FHFA requested comments on 
all aspects of the regulation. It also sought comment on whether it 
should establish a ``well-capitalized'' classification and on what 
criteria may be appropriate to define such a new category. After 
considering the comments received on the interim final rule, FHFA is 
adopting the interim final rule as a final regulation, subject to 
amendments meant to clarify certain provisions.

DATES: The final regulation is effective August 4, 2009.

FOR FURTHER INFORMATION CONTACT: Julie Paller, Senior Financial 
Analyst, (202) 408-2842, and Anthony G. Cornyn, Senior Associate 
Director, (202) 408-2522, Division of Federal Home Loan Bank 
Regulation, Federal Housing Finance Agency, 1625 Eye Street, NW., 
Washington, DC 20006; or Thomas E. Joseph, Senior Attorney-Advisor, 
(202) 414-3095, Office of General Counsel, Federal Housing Finance 
Agency, 1700 G St., NW., Washington, DC 20552. The telephone number for 
the Telecommunications Device for the Deaf is (800) 877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

A. Federal Housing Finance Agency and Recent Legislation

    Effective July 30, 2008, HERA, Public Law 110-289, 122 Stat. 2654 
(2008), transferred the supervisory and oversight responsibilities of 
the Office of Federal Housing Enterprise Oversight (OFHEO) over the 
Federal National Mortgage Association (Fannie Mae), and the Federal 
Home Loan Mortgage Corporation (Freddie Mac) (collectively, the 
Enterprises) and the oversight responsibilities of the Federal Housing 
Finance Board (Finance Board) over the Banks and the Office of Finance 
(which acts as the Banks' fiscal agent) to a new independent executive 
branch agency, FHFA. FHFA is responsible for ensuring that the 
Enterprises and the Banks operate in a safe and sound manner, including 
that they maintain adequate capital and internal controls, that their 
activities foster liquid, efficient, competitive and resilient national 
housing finance markets, and that they carry out their public policy 
missions through authorized activities. See id. at Sec.  1102, 122 
Stat. 2663-64.
    Section 1141 of HERA states that the Director shall adopt 
regulations specifying the critical capital level for each Bank no 
later than the expiration of the 180 day period from the date that HERA 
was enacted. See id. at Sec.  1141, 122 Stat. 2730 (adopting 12 U.S.C. 
4613(b)). In establishing this requirement, HERA provides that the 
Director shall take due consideration of the critical capital levels 
established for the Enterprises, with such modifications as the 
Director determines to be appropriate to reflect the difference in 
operations between the Banks and the Enterprises.
    In addition, section 1142 of HERA requires that the Director, no 
later than 180 days from its enactment, establish for the Banks 
criteria for each of the four following capital classifications: 
Adequately capitalized; Undercapitalized; Significantly 
undercapitalized; and Critically undercapitalized. See id. at Sec.  
1142, 122 Stat. 2730-32. HERA specifies that the criteria should be 
based on the amount and types of capital held by a Bank and the risk-
based, minimum and critical capital levels for the Banks, taking due 
consideration of the capital classifications established for the 
Enterprises, with such modifications as the Director determines to be 
appropriate to reflect the difference in

[[Page 38509]]

operations between the Banks and the Enterprises. HERA also provides 
FHFA prompt corrective action (PCA) authority over the Banks and amends 
the Federal Housing Enterprises Financial Safety and Soundness Act of 
1992 (Safety and Soundness Act) so that specific mandatory or 
discretionary supervisory actions and restrictions under that statute 
would apply to any Bank determined to be undercapitalized, 
significantly undercapitalized or critically undercapitalized. See id. 
at Sec. Sec.  1143-1145, 122 Stat. 2732-34. The general purpose for the 
PCA framework is to supplement the FHFA's other regulatory and 
supervisory authority and provide for timely and, in some situations, 
mandatory intervention by the regulator.

B. The Bank System Generally

    The twelve Banks are instrumentalities of the United States 
organized under the Federal Home Loan Bank Act (Bank Act).\1\ See 12 
U.S.C. 1423, 1432(a). The Banks are cooperatives. Only members of a 
Bank may purchase the capital stock of a Bank, and only members or 
certain eligible housing associates (such as state housing finance 
agencies) may obtain access to secured loans, known as advances or 
other products provided by a Bank. See 12 U.S.C. 1426(a)(4), 1430(a), 
1430b. Each Bank is managed by its own board of directors and serves 
the public interest by enhancing the availability of residential 
mortgage and community lending credit through its member institutions. 
See 12 U.S.C. 1427. Any eligible institution (generally a federally-
insured depository institution or state-regulated insurance company) 
may become a member of a Bank if it satisfies certain criteria and 
purchases a specified amount of the Bank's capital stock. See 12 U.S.C. 
1424; 12 CFR part 925. The Banks also require members to purchase 
certain amounts of stock to become a member of the Bank and to 
undertake specific activities and transactions with the Bank. These 
stock purchase requirements are set forth in a Bank's capital structure 
plan as required by amendments to the Bank Act made by the Gramm Leach 
Bliley Act (GLB Act) in 1999.\2\
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    \1\ Each Bank is generally referred to by the name of the city 
in which it is located. The twelve Banks are located in: Boston, New 
York, Pittsburgh, Atlanta, Cincinnati, Indianapolis, Chicago, Des 
Moines, Dallas, Topeka, San Francisco, and Seattle.
    \2\ All the Banks but the Chicago Bank operate pursuant to a 
capital structure plan required under the GLB Act. The Chicago Bank, 
which has not yet implemented its capital structure plan, still 
operates in accordance with stock purchase requirements set forth in 
the Bank Act prior to its amendment by the GLB Act. See 12 U.S.C. 
1426(a)(6).
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C. Interim Final Rule

    On January 30, 2009, the FHFA published in the Federal Register an 
interim final rule with requests for comments, which added new subpart 
A of part 1229 to 12 CFR chapter XII, subchapter B. See 74 FR 5595. The 
comment period for the interim final rule originally was scheduled to 
close on April 30, 2009, but on March 26, 2009, the FHFA published a 
notice extending the comment period for an additional 15 days. See 74 
FR 13083. FHFA received 14 comments on the interim final rule, 
including comments from all twelve of the Banks. Two industry 
associations that represent many Bank members also commented. Comments 
are available at the FHFA Web site, https://www.fhfa.gov.
    The interim final rule implemented the PCA provisions set forth in 
sections 1363 through 1369D of the Safety and Soundness Act, as these 
provisions had been amended and made applicable to the Banks by HERA. 
The interim final rule also incorporated certain restrictions on 
capital distributions that are imposed on the Banks by the Bank Act and 
it's implementing regulations, and made clear that those restrictions 
will continue to apply to any Banks that do not meet their capital 
requirements or that incur charges against their capital, and that they 
will apply, in addition to the new PCA restrictions made applicable to 
the Banks by the Safety and Soundness Act. See e.g., 12 U.S.C. 1426(f) 
and (h)(3); 12 CFR 917.9(b).
    As required by HERA, the interim final rule established the 
critical capital level for the Banks. The interim final rule also 
defined the criteria for the four capital classification categories 
that HERA applied to the Banks. It set forth the process that govern 
the Director's required quarterly determination of each Bank's capital 
classification as well as the mandatory and discretionary restrictions 
and requirements that must or can be imposed on a Bank that the 
Director determines is less than adequately capitalized.
    FHFA asked for comments on all aspects of the interim final rule. 
It specifically requested comments on whether consideration of the 
differences between the Enterprises and the Banks with regard to the 
Banks' cooperative ownership structure, mission of providing liquidity 
to members, affordable housing and community development mission, 
capital structure, and joint and several liability should result in 
revision to the interim final rule.
    FHFA also sought comment on whether it should adopt a fifth capital 
classification of ``well-capitalized'' as part of the regulation, 
although the interim final rule did not adopt such a category. Among 
the questions posed by FHFA with regard to a potential well-capitalized 
classification were:
    (1) What criteria would be appropriate to define a ``well-
capitalized'' category?
    (2) Whether a retained earnings or a market value of equity to par 
value of capital stock (MVE/PVCS) target would be useful or appropriate 
for defining a well-capitalized category? and
    (3) What restrictions on an adequately capitalized Bank would be 
appropriate to create an incentive for a Bank to achieve a well-
capitalized rating?
    The FHFA also asked whether it should adopt a retained earnings or 
MVE/PVCS target as part of the Banks' risk-based capital regulations or 
as a requirement that would be separate and distinct from the risk-
based capital regulations.

II. Discussion of Comments and Changes to the Interim Final Rule

A. Overview of Comments

    Most commenters provided suggestions for changes to the published 
text of the interim final rule or asked that clarifications be made to 
certain provisions. Specifically, the comment letters urged FHFA to 
exempt advances from limits on asset growth applicable to Banks that 
are not adequately capitalized, alter the definition of executive 
officer to narrow the scope of persons covered, extend the time period 
for submission of a capital restoration plan, and clarify the scope of 
certain mandatory restrictions on Bank acquisitions and on payment of 
executive compensation or bonuses that become applicable once a Bank is 
deemed to be undercapitalized or significantly undercapitalized. Each 
of the suggested changes is addressed more fully below.
    Commenters also responded to FHFA questions about different aspects 
of instituting a fifth capital classification of well-capitalized. Nine 
of the comment letters expressed at least mild support or did not 
affirmatively oppose adopting the fifth capital classification, 
although most of these commenters did not support any approach that 
would effectively raise current minimum capital standards. Five 
commenters stated that such a classification was unnecessary or 
inappropriate. To the extent that they specifically addressed the 
issue, commenters also believed that

[[Page 38510]]

FHFA should not impose restrictions on an adequately capitalized Bank 
if a well-capitalized category were adopted. A number of commenters 
suggested specific positive regulatory incentives that FHFA could adopt 
to encourage Banks to achieve a well-capitalized rating.
    Generally, commenters believed that if a well-capitalized category 
were adopted, the defining criteria should focus on the composition of 
Bank capital (i.e., retained earnings) rather than the level of 
capital. All but one of the commenters specifically opposed using an 
MVE/PVCS measure as part of the defining criteria or as a separate 
capital requirement. The one commenter that did not specifically oppose 
the MVE criteria, however, thought that an MVE/PVCS requirement should 
be adopted only after a separate rulemaking in which FHFA provided a 
more thorough analysis of the matter.
    FHFA has determined that it will not adopt the well-capitalized 
category as part of this final regulation. Instead, it will consider 
the comments and suggestions in developing any proposed future 
amendments to the PCA regulation concerning a well-capitalized 
category, including any proposals related to the criteria for defining, 
and for creating an incentive structure for the Banks to achieve, a 
well-capitalized rating. In developing any amendments, FHFA also would 
consider any changes that it may propose to the Banks' risk-based 
capital requirements. FHFA also will continue to weigh whether it would 
be appropriate to propose a separate target for retained earnings and/
or MVE/PVCS, either as a stand-alone regulation or as part of any risk-
based capital proposal.

B. Specific Suggestions for Changing the Interim Final Rule

    Commenters addressed a number of different provisions and suggested 
a number of changes to the interim final rule. FHFA has carefully 
considered these comments. As is discussed below, while FHFA has 
adopted some changes to the interim final rule in response to the 
comments, it did not feel that all the suggested amendments were 
appropriate in light of statutory requirements and policy 
considerations.
    Definition of Executive Officer (Sec.  1229.1). A number of 
commenters asked for specific changes to the definition of ``Executive 
Officer'' set forth in the regulation. This definition is needed to 
implement the provision limiting bonuses and compensation paid to 
executive officers of significantly undercapitalized Banks under Sec.  
1229.8(f) of the regulation. Commenters requested three principal 
changes be made to the definition in Sec.  1229.1 to provide more 
clarity as to which employees were executive officers and establish a 
more appropriate scope for the definition.
    First, they asked that the regulation require FHFA to inform the 
Banks, in advance, which persons in charge of a principal business 
unit, division or function would be considered an executive officer. 
This approach, the commenters argued, would be consistent with the 
treatment provided the Enterprises. Second, they asked, without 
providing further explanation, that the reference to chief operating 
officer in the regulation be changed to chief executive officer. 
Finally, commenters asked that the regulation clarify that 
administrative or support staff that answer directly to the president 
or chief operating officer of the Bank or the chairman or vice-chairman 
of the Bank's board of directors not be considered executive officers. 
One commenter further stated that the regulation should specify that 
positions or persons identified by functional area would be within the 
scope of the definition only if they truly performed the duties of an 
executive officer.
    The Safety and Soundness Act, as amended by HERA, refers to 
executive officers of a regulated entity in various provisions 
including the PCA provision and a provision providing the Director with 
oversight and approval authority for compensation paid to executive 
officers. It does not, however, specifically define the term. Given 
that the statute does not differentiate between the term ``executive 
officer'' as used in the PCA provision and as used in the provision 
addressing executive compensation and the two provisions deal with the 
question of limiting compensation or bonus to certain Bank employees, 
FHFA believes the definition used in the two regulations ultimately 
should be the same.
    The definition of executive officer in Sec.  1229.1 is similar to 
the definition of executive officer with respect to a Bank that was 
proposed for comment as part of the executive compensation regulation 
on June 5, 2009. See Proposed Rule: Executive Compensation, 74 FR 
26989. While there are some wording differences between the definition 
adopted in the PCA regulation and that being proposed in the executive 
compensation regulation (and the proposed definition in the executive 
compensation regulation may provide the Director with less discretion 
to remove persons from coverage than does the definition in Sec.  
1229.1), the definitions remain substantively the same. FHFA also 
expects that the definition in the PCA regulation will be amended in 
the future to conform to what is ultimately adopted in the executive 
compensation regulation. In the meantime, FHFA believes that the 
current definition of executive officer in Sec.  1229.1 sufficiently 
identifies the persons that are subject to the PCA regulation 
restrictions and provides the Director with sufficient flexibility to 
add or remove specific persons from the list of Bank executive officers 
so that the concerns raised in the comments can be addressed on a case-
by-case basis, if needed. Therefore, FHFA is not revising the 
definition of executive officer in the PCA regulation at this time.
    Advances and Limitations on Asset Growth (Sec.  1229.6(a)(4)). Most 
of the commenters requested that the mandatory limitation on asset 
growth applicable to an undercapitalized Bank and set forth in Sec.  
1229.6(a)(4) of the interim final rule be modified to exclude advances 
from its coverage. This provision prevents the average total assets of 
a Bank, that was less than adequately capitalized, from exceeding its 
average total assets of the previous quarter, unless the Director 
determines the increase is consistent with an approved capital 
restoration plan and meets other requirements. The commenters argued 
that in light of the safety and low-risk profile of advances, the self-
capitalizing nature of the product and the centrality of advances to 
the Bank's mission, limits should not be put on advance growth even if 
the Bank were less than adequately capitalized.
    The regulatory language in the interim final rule, however, closely 
follows the statutory provision that was added to section 1365(a)(4) of 
the Safety and Soundness Act by section 1143 of HERA. The statutory 
language appears straightforward and contains no exception for advances 
or other mission assets of either the Banks or the Enterprises. 
Instead, the statute allows the Director to waive the limit on asset 
growth when certain conditions are met. These conditions are carried 
over to the regulation and include that the growth be consistent with 
the capital restoration plan and that the ratio of the Bank's tangible 
equity to total assets is increasing at a rate that will allow the Bank 
to become adequately capitalized in a reasonable period of time. Thus, 
it is not clear that the language of the statute provides flexibility 
to implement this suggested change.
    Moreover, Sec.  1229.6(a)(4) imposes a limit on total assets and 
not on

[[Page 38511]]

advances, specifically, so that an undercapitalized Bank would not face 
a barrier to continued advances growth as long as it reduces its 
investment portfolio or other asset holdings. In addition, despite 
commenters' claims, nothing assures that new advances will be self- 
capitalizing, since a number of the Banks' capital structure plans 
provide them discretion to set the advances stock purchase requirement 
below the level of their minimum capital requirements. Further, Bank 
members often do not have to buy additional stock to take down new 
advances, as they may have excess stock that can be applied to meeting 
the stock purchase requirement, or otherwise may not have to buy 
additional stock, to cover the new advances.\3\ Thus, a Bank that did 
not meet its capital requirements, unless it took some other action 
(e.g., reduce other assets), could become more highly leveraged if it 
were allowed unconditionally to expand advances. Arguably, the 
restrictions in the PCA provisions are designed to make sure the Bank 
has a plan of action that has been reviewed by FHFA to prevent this 
outcome from occurring.
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    \3\ All of the stock outstanding, including excess stock, 
however, would already have been counted as part of the Bank's 
capital. Thus, in these cases the new advances would increase the 
Bank's assets without necessarily increasing its capital from the 
level which was already determined to be insufficient to meet 
regulatory requirements.
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    Given these considerations FHFA has decided not to adopt the 
changes to Sec.  1229.6(a)(4) suggested by commenters.
    Clarify Prohibition on Acquisition of Assets (Sec.  1229.6(a)(5)). 
A number of commenters asked that FHFA clarify the scope of the 
restriction in Sec.  1229.6(a)(5) that prohibits a Bank that is not 
adequately capitalized from acquiring directly or indirectly, any 
interest in any entity. They asked especially for FHFA to confirm that 
this restriction would not prevent the Banks from undertaking 
authorized activities in the ordinary course of business, such as 
making otherwise authorized investments in financial instruments. One 
commenter also noted that existing regulations would likely already 
require a Bank to receive FHFA approval before making an acquisition in 
another entity. After considering these comments, FHFA agrees that the 
language used in the provision is vague, especially in light of other 
restrictions placed on Bank activities, and that some clarification 
would be useful.
    The regulatory language that is the subject to these comments 
closely follows the language that was added to section 1365(a)(5) of 
the Safety and Soundness Act by section 1143 of HERA. The restriction 
on the acquisition of an interest in an entity is one of a series of 
restrictions imposed on regulated entities that are not adequately 
capitalized, which includes limits on asset growth, new business 
activities and capital distributions. The Director is allowed under the 
statute and the regulation to waive this restriction if the Bank has an 
approved capital restoration plan, the Bank is implementing that plan, 
the acquisition of the interest is consistent with the plan and with 
the Bank's safe and sound operations, and will further its compliance 
with its capital requirements.
    There appears to be little or no legislative history as to what 
Congress intended by this restriction. Given that the statute 
separately limits the ability of a Bank that is less than adequately 
capitalized to expand its activity through asset growth or undertaking 
new business activities, it would be reasonable that this particular 
restriction is meant to limit a Bank's expansion through acquisition of 
other operating businesses or lines of business in which the Bank 
already may be involved. FHFA therefore has decided to clarify the 
meaning of Sec.  1229.6(a)(5) by revising the restriction to apply to 
the acquisition of any equity interest in another operating entity.\4\ 
The revised language also makes clear that the restriction is not meant 
to prevent a Bank from enforcing any security interest granted to it or 
otherwise taking possession of collateral in the normal course of 
business.
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    \4\ Such an interpretation also would appear to bring the 
meaning of this provision close to that of a similar PCA restriction 
imposed on insured depository institutions by Sec.  38(e)(4) of the 
Federal Deposit Insurance Act (FDI Act)(12 U.S.C. Sec.  
1831o(e)(4)). The FDI Act provision restricts an undercapitalized 
institution's acquisition of any interest in any company or in 
another insured depository institution and limits the right to 
establish or acquire any additional branch offices.
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    FHFA recognizes that under current regulations the Banks would have 
few if any opportunities to take equity positions in other operating 
entities without first receiving FHFA's approval. Nevertheless, it is 
important to carry over into the regulation all the statutory 
restrictions even if such restrictions may have limited practical 
effect at this time. The revised language should clarify, however, 
FHFA's intent that the restriction on the acquisition of interests in 
any entity was not meant to restrict a Bank's investment in authorized 
investments such as mortgage backed securities or acquired member 
assets or otherwise restrict the Bank's ability to accept pledges of 
security as part of its business.
    Submission of Capital Restoration Plan (Sec.  1229.11(b)). Most of 
the commenters supported extending the period in which a Bank has to 
submit a capital restoration plan from the 10 calendar-days required 
under Sec.  1229.11(b) of the interim final rule. The commenters 
recognized that the 10 day period was based on requirements currently 
applicable to the Enterprises but believed the difference in capital 
structures between the Banks and the Enterprises justified a longer 
period for the Banks to prepare and submit their capital restoration 
plans. In this respect, a number of the commenters stated that the 
Banks would need to amend their GLB Act capital structure plans and 
take other actions that would not be applicable to the Enterprises to 
implement the capital restoration plan.\5\ After consideration of these 
comments, FHFA has decided there is merit to the suggestions and is 
extending the period of time for submitting a capital restoration plan 
by a Bank to 15 business-days after a Bank receives written 
notification that such a plan is required.
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    \5\ This comment suggests that some Banks may believe that they 
have to complete any contemplated amendments to their GLB Act 
capital structure plan prior to the submission of the capital 
restoration plan. This is not the case, however. Under Sec.  1229.11 
of the final rule, a Bank would need to identify in its capital 
restoration plan any changes to its stock purchase requirements that 
it intends to make but it does not necessarily need to have those 
changes in place at the time it submits its capital restoration plan 
for approval.
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    The Safety and Soundness Act, as amended by HERA, allows up to 45 
days after the date of notification for a regulated entity to submit a 
capital restoration plan. While the majority of the commenters 
suggested a 30 calendar-day period for submission of the plan, FHFA 
believes that 30 calendar-days is too long a period given that a Bank 
needs to begin taking action immediately to restore capital when a 
capital deficiency is identified. Moreover, having an approved capital 
restoration plan in place is a necessary pre-condition imposed by the 
statute for the Director's granting an exception to many of the 
restrictions that are imposed on the activities of an undercapitalized 
or a significantly undercapitalized Bank. Given that the Banks, in 
their comments, to other regulation provisions have suggested that some 
of these restrictions may be problematic, FHFA does not want to draw 
out the period for submission and approval of a capital restoration 
plan more than necessary. Moreover, Banks will be aware of the 
likelihood that they will be classified as less than adequately 
capitalized before the Director issues a

[[Page 38512]]

final notification, so a Bank could begin work on its capital 
restoration plan prior to receiving the final notification.\6\ Thus, 
FHFA believes that 15 business-days should generally be sufficient for 
a Bank to prepare its capital restoration plan.
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    \6\ For example, under the regulations, Banks first will receive 
a preliminary notification that the Director proposes to classify 
them at a level other than adequately capitalized, prior to the 
final classification. In addition, Banks are required to notify the 
Director if their capital decreases to the extent that they would 
expect to be reclassified at a level lower than their previous 
preliminary or final classification, so that Banks should monitor 
and be aware of negative changes in their capital levels at all 
times.
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    Executive Officers Bonuses and Compensation (Sec. Sec.  1229.8(e) 
and (f)). A number of the commenters asked FHA to clarify ``whether, in 
light of contractual and constitutional concerns,'' employment 
agreements entered into prior to the effective date of the regulation 
are subject to the mandatory limits in Sec. Sec.  1229.8(e) and (f) on 
bonuses and compensation paid to an executive officer of a 
significantly undercapitalized Bank. The comments do not further 
describe what these concerns are or provide any arguments addressing 
the constitutional issues. The cited provisions prohibit a Bank that is 
significantly undercapitalized either from paying a bonus to any 
executive officer without the prior written approval of the Director or 
from compensating an executive officer at a rate exceeding the average 
rate of compensation of that officer during the 12 months preceding the 
calendar month in which the Bank became significantly undercapitalized, 
without the prior written approval of the Director.
    The regulatory language in Sec. Sec.  1229.8(e) and (f) closely 
corresponds to the language in section 1366(c) the Safety and Soundness 
Act as the provision was amended by section 1144 of HERA. The statute 
does not provide an exception for employment agreements entered into 
before a certain date or outstanding as of HERA's effective date. More 
importantly, this restriction is triggered only if a Bank becomes 
significantly undercapitalized--a future event that is unrelated to the 
date in which an executive officer signed his or her employment 
agreement. As a general matter, the point of the provision seems to be 
to preserve resources expended on compensation and prevent executives 
from benefiting from increased compensation when their behavior, 
decisions or leadership resulted in (or failed to prevent) a Bank's 
becoming significantly undercapitalized. Thus, looking to the date of 
when employment began seems irrelevant to the purpose of the provision, 
which appears to be to address a future capital deficiency and 
discourage behavior that may cause such capital problems.\7\
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    \7\ The provision related to executive officer compensation and 
bonuses is similar to restrictions on compensation in the FDI Act 
which become applicable to senior executive officers of an insured 
financial institution that becomes significantly undercapitalized. 
See 12 U.S.C. 1831o(f)(4). When federal banking regulators adopted 
rules implementing this provision of the FDI Act, those rules did 
not provide an exception for employment agreements entered into 
prior to its effective date. See 57 FR 44866 (Sept. 29, 1992).
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    The regulation also allows the Director to authorize a Bank to pay 
compensation and/or bonuses in excess of the limits established by the 
provisions. This means that under the regulation, a Bank has the right 
to make a case once its receives notice of its preliminary 
classification, or thereafter, that the Director should approve higher 
compensation or bonuses for executive officers, and allows a Bank to 
present all relevant information as to why the compensation and bonus 
restrictions are not appropriate in a particular case.\8\ Thus, FHFA 
sees no reason to provide a blanket exemption from this restriction in 
the regulation itself, and believes that such a revision would 
contradict both the plain language of the statute and would undermine 
the policy concerns that this provision addresses.
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    \8\ The issue of whether the statutory language is itself 
constitutionally flawed, as suggested by the commenters, is 
difficult to address since the comments fail to provide any specific 
arguments or theory on this point. The constitutional argument that 
usually arises in these types of cases is that the parties have some 
fundamental right or protected interest recognized by law so that 
the loss of that right is subject to due process protection under 
the Fifth Amendment. In this respect, the Supreme Court has noted 
that the ``fundamental requirement of due process is the opportunity 
to be heard `at a meaningful time and in a meaningful manner.''' 
Matthews v. Eldridge, 424 U.S. 319, 333 (1976) (citations omitted). 
The Court has identified three factors that should be balanced in 
deciding the dictates of due process generally. See id. at 335. 
These are: (i) The private interest that will be affected by the 
official action; (ii) The risk of an erroneous deprivation of such 
interest through the procedures used and the value, if any, of 
additional or substitute procedure; and (iii) The government's 
interests, including the function at issue and the fiscal and 
administrative burdens of additional or substitute procedures. See 
id. (citations omitted). The fact that the Banks can seek the 
Director's review of the restriction and provide information as to 
why the restrictions should not be applied in a particular instance 
provides an opportunity to be heard that should address the 
commenters concerns.
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    Other comments. One commenter asked FHFA to incorporate into its 
regulations previous Finance Board guidance that Other Comprehensive 
Income (OCI) is not included in calculations of permanent and total 
capital. The referenced guidance was provided by the Finance Board when 
it was proposing amendments to its capital regulation based on an 
Advanced Notice of Proposed Rulemaking (ANPR), as well as responding to 
some of the comments received as part of that ANPR. See Proposed Rules: 
Capital Requirements for the Federal Home Loan Banks, 66 FR 41462, 
41471-72 (Aug. 8, 2001). Specifically, the Finance Board's guidance 
responded to comments that the definitions of permanent and total 
capital be clarified to exclude certain elements of OCI. The Finance 
Board noted, however, that there was no need to change the definitions 
and clarified that OCI was not included in retained earnings as used in 
the calculation of total and permanent capital. Id. Given that this 
guidance was provided as part of the rulemaking for the capital 
regulation and addressed definitions in that provision, FHFA is not 
going to alter those regulations at this time as part of its adoption 
of the final PCA regulation. It will, however, affirm the Finance 
Board's prior interpretation that OCI is not an element of the Bank's 
regulatory capital.

C. Other Changes in the Final Regulation

    In addition to making the changes described above in response to 
the comments submitted on the interim final rule, FHFA is also making 
certain clarifying changes to the regulation. First, FHFA is adding new 
paragraphs (g) and (h) to Sec.  1229.8 to clarify its view as to what 
mandatory or discretionary restrictions or obligations that apply to an 
undercapitalized Bank continue to apply to a Bank found to be 
significantly undercapitalized.
    FHFA is also revising Sec.  1229.10(d) to make clear that 
restrictions and obligations previously imposed on a significantly 
undercapitalized Bank continue to apply to a critically 
undercapitalized Bank for which FHFA has not yet been named conservator 
or receiver. As originally adopted, this provision only referred to 
``restrictions'' on a significantly undercapitalized Bank but FHFA 
recognizes that a Bank may also be obligated to take positive actions 
under the PCA provisions.
    Finally, FHFA modified Sec.  1229.11(a) to clarify the type of 
information it intends a Bank to submit in its capital restoration 
plan. These changes make clear that the Bank should describe, if 
appropriate, any actions that it would take to address any long term or 
structural problems that led to its becoming less than adequately 
capitalized and that the Bank should provide in it's capital 
restoration plan

[[Page 38513]]

projections indicating how each component of total and permanent 
capital (including retained earnings) and the major components of 
income, assets and liabilities are expected to change over the term of 
the plan. FHFA believes that this information is the type of 
information it would generally request under Sec.  1229.11(a)(5) and is 
necessary for it to judge the adequacy of the plan and to monitor the 
plan effectively over time. Thus, Sec.  1229.11(a) is being updated to 
make clear that this information should be submitted as part of a 
capital restoration plan.

III. Paperwork Reduction Act

    The regulation does not contain any collections of information 
pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et 
seq.). Therefore, FHFA has not submitted any information to the Office 
of Management and Budget for review.

IV. Regulatory Flexibility Act

    The regulation applies only to the Banks, which do not come within 
the meaning of small entities as defined in the Regulatory Flexibility 
Act (RFA). See 5 U.S.C. 601(6). Therefore, in accordance with section 
605(b) of the RFA, 5 U.S.C. 605(b), FHFA, hereby, certifies that the 
regulation will not have a significant economic impact on a substantial 
number of small entities.

V. Effective Date

    The Administrative Procedure Act provides that the required 
publication of a substantive regulation shall be made not less than 30 
days before its effective date except for: A substantive regulation 
that grants or recognizes an exemption or relieves a restriction; An 
interpretative regulation or statement of policy; or As otherwise 
provided by the agency for good cause found and published with the 
regulation. See 5 U.S.C. 553(d). In publishing the interim final rule, 
FHFA found that it had good cause for the regulation to become 
effective immediately. See 74 FR at 5604. These reasons are still true 
with regard to the final rule and the changes made to it. In addition, 
the changes made to the interim final rule clarify the scope of the 
provisions of the regulation or ease requirements that had been 
established in the interim final rule, as in the case of the longer 
period for submitting a capital restoration plan, rather than add new 
requirements. Thus, FHFA finds that there is good cause for the 
regulation to become effective on August 4, 2009.

List of Subjects in 12 CFR Part 1229

    Capital, Federal home loan banks, Government-sponsored enterprises, 
Reporting and recordkeeping requirements.

0
For the reasons stated in the preamble, the Interim Final Rule at 
subpart A of part 1229 of Title 12 CFR chapter XII, subchapter B, which 
was published at 74 FR 5595 on January 30, 2009, is being adopted by 
FHFA as a final regulation with the following changes:

PART 1229--CAPITAL CLASSIFICATIONS AND PROMPT CORRECTIVE ACTION

0
1. The authority citation for subpart A continues to read as follows:

    Authority:  12 U.S.C. 1426, 4513, 4526, 4613-4618, 4622, 4623.


0
2. Amend Sec.  1229.6 by revising paragraph (a)(5) to read as follows:


Sec.  1229.6  Mandatory actions applicable to undercapitalized Banks.

    (a) * * *
    (5) Not acquire, directly or indirectly, an equity interest in any 
operating entity (other than as necessary to enforce a security 
interest granted to the Bank) nor engage in any new business activity 
unless:
    (i) The Director has approved the Bank's capital restoration plan, 
the Bank is implementing the capital restoration plan and the Director 
determines that proposed acquisition or activity will further 
achievement of the goals set forth in that plan; or
    (ii) The Director determines that the proposed acquisition or 
activity will be consistent with the safe and sound operation of the 
Bank and will further the Bank's compliance with its risk-based and 
minimum capital requirements in a reasonable period of time.
* * * * *

0
3. Amend Sec.  1229.8 by removing the word ``and'' at the end of 
paragraph (e), removing the period at the end of paragraph (f) and 
adding a semi-colon in its place, and adding new paragraphs (g) and (h) 
to read as follows:


Sec.  1229.8  Mandatory actions applicable to significantly 
undercapitalized Banks.

* * * * *
    (g) Comply with Sec.  1229.6(a)(4) and (a)(5) of this subpart; and
    (h) Comply with any on-going restrictions or obligations that were 
imposed on the Bank by the Director under Sec.  1229.7 of this subpart.

0
4. Amend Sec.  1229.10 by revising paragraph (d) to read as follows:


Sec.  1229.10  Actions applicable to critically undercapitalized Banks.

* * * * *
    (d) Other applicable actions. Until such time as FHFA is appointed 
as conservator or receiver for a critically undercapitalized Bank, a 
critically undercapitalized Bank shall be subject to all mandatory 
restrictions or obligations applicable to a significantly 
undercapitalized Bank under Sec.  1229.8 of this subpart and will 
remain subject to any on-going restrictions or obligations that the 
Director imposed on the Bank under Sec.  1229.7 or Sec.  1229.9 of this 
subpart, or any restrictions or obligations that are applicable to the 
Bank under the terms of an approved capital restoration plan.

0
5. Amend Sec.  1229.11 by revising paragraphs (a) and (b) to read as 
follows:


Sec.  1229.11  Capital restoration plans.

    (a) Contents. Each capital restoration plan submitted by a Bank 
shall set forth a plan to restore its permanent and total capital to 
levels sufficient to fulfill its risk-based and minimum capital 
requirements within a reasonable period of time. Such plan must be 
feasible given general market conditions and the conditions of the Bank 
and, at a minimum, shall:
    (1) Describe the actions the Bank will take, including any changes 
that the Bank will make to member stock purchase requirements, to 
assure that it will become adequately capitalized within the meaning of 
Sec.  1229.3(a) of this subpart and, if appropriate, to resolve any 
structural or long term causes for the capital deficiency;
    (2) Specify the level of permanent and total capital the Bank will 
achieve and maintain and provide quarterly projections indicating how 
each component of total and permanent capital and the major components 
of income, assets and liabilities are expected to change over the term 
of the plan;
    (3) Specify the types and levels of activities in which the Bank 
will engage during the term of the plan, including any new business 
activities that it intends to begin during such term;
    (4) Describe any other actions the Bank intends to take to comply 
with any other requirements imposed on it under this subpart A of part 
1229;
    (5) Provide a schedule which sets forth dates for meeting specific 
goals and benchmarks and taking other actions described in the proposed 
capital restoration plan, including setting forth a schedule for it to 
restore its permanent and total capital to levels necessary for meeting 
its risk-based and minimum capital requirements; and

[[Page 38514]]

    (6) Address such other items that the Director shall provide in 
writing in advance of such submission.
    (b) Deadline for submission. A Bank must submit a proposed capital 
restoration plan no later than 15 business-days after it receives 
written notification that such a plan is required either because the 
notice specifically states that the Director has required the 
submission of a plan or the notice indicates that the Bank's capital 
classification or reclassification is to a category for which a capital 
restoration plan is a mandatory action required of the Bank. The 
Director may extend this deadline if the Director determines that such 
extension is necessary. Any such extension shall be in writing and 
provide a specific date by which the Bank must submit its proposed 
capital restoration plan.
* * * * *

    Dated: July 29, 2009.
James B. Lockhart, III,
Director, Federal Housing Finance Agency.
[FR Doc. E9-18581 Filed 8-3-09; 8:45 am]
BILLING CODE P