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Letter 45: Investment in the Common Stock of the Federal Home Loan Bank

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) opened membership in the Federal Home Loan Bank System to commercial banks. Recent changes in Wisconsin Statutes provide that Wisconsin state chartered banks may purchase capital stock of the Federal Home Loan Bank (FHLB) for the purpose of becoming a member of the FHLB and establish limitations for pledging of bank assets to the FHLB if borrowing privileges are exercised.

A bank may invest in common stock of the FHLB to the extent permitted under both s. 221.0306, Wis. Stats., and s. 221.0321, Wis. Stats. A bank's aggregate investment in common stock of the FHLB is determined by adding (1) the minimum level of common stock required for a bank's membership in the FHLB under s. 221.0306, Wis. Stats, and, (2) for common stock in an amount greater than the minimum level required for membership, the level at which a bank is permitted to invest in equity investments established by the division under s. 221.0321(3), Wis. Stats.

The purpose of membership in the FHLB is to provide financial institutions a funding source through borrowings from the FHLB. The purpose of this letter is to advise you on issues which should be considered in evaluating if an investment in and borrowing from the FHLB is beneficial for the bank. The statutes require that the investment in FHLB stock be approved by the bank's board of directors. The division of banking may prohibit a bank from becoming a member if the bank's capital and surplus is less than the amount required for that bank or if the division finds that the bank is in an unsafe or unsound condition. It is expected that any activity undertaken will be managed effectively and monitored by the board of directors.

To become a member of the FHLB, the bank must purchase FHLB stock based on a formula. The board of directors should consider if FHLB stock is a good investment. The return on this investment will depend on the profitability of the regional FHLB being invested in. It should also be determined if additional profits can be generated from the use of available credit services to fully offset the expected expense of the membership.

Under FHLB requirements, eligibility for membership, purpose for borrowing, and assets acceptable for collateral are largely dependent on the level of residential mortgages or other real estate related assets of the bank. Therefore, the board of directors should consider the bank's ability to meet local residential mortgage loan demand and the role of housing finance in the bank's overall strategy. The bank's loan, investment and asset/liability management policies should be reviewed, revised, and approved as necessary.

As borrowing from the FHLB must be fully collateralized and carry a prepayment penalty, the board of directors should consider the bank 's capacity for managing interest rate risk, liquidity risk, and the bank's ability to cover or to pass on the potential expense of the prepayment penalty. Pledges of collateral to and loans from the Federal Home Loan Bank are restricted under s. 221.0324(9), Wis. Stats.

Other factors to be considered by the board of directors include the bank's ability to safely and soundly manage asset growth resulting from the related debt with the FHLB, and the adequacy and ability of support personnel to properly process loan documents and other related paperwork.

Bkg. Ltr. #45, August 19, 1991, Commissioner Sherry
Bkg. Ltr. #45, Amended July 22, 2002, Michael J. Mach, Administrator