Community Banks Push Back Against Plan to Restrict FHLB Membership

WASHINGTON — Community banks are fighting back against a plan unveiled by the Federal Housing Finance Agency this week to restrict membership in the Home Loan Bank System.

Under the proposal, many banks and thrifts would have to maintain at least 10% of their assets in the form of home loans or mortgage-backed securities. Smaller institutions with less than $1 billion of assets would have to maintain at least 1% of their assets in mortgages.

Banks that joined the system after 1998 have faced such a test to obtain membership with a Home Loan Bank, but have not had to maintain those asset levels on an ongoing basis.

The FHFA's plan has sparked an outcry from the banking industry, which argues it unnecessarily penalizes some long-time members that can't or won't meet an ongoing test.

"We are not sure what is driving this," said Ron Haynie, an executive vice president with the Independent Community Bankers of America. "I can't imagine that community banks that have been members for years, for decades, now all of a sudden pose some outsized risk."

The FHFA issued the plan on Sept. 2 in an effort to refocus the Home Loan Bank System on its mission. The proposal would also shut the door on allowing captive insurance companies to become new members, and sunset existing captive insurers after five years.

The agency first floated a similar plan in 2010, which was opposed by the industry at the time. But the new version is already under fire.

Stephen Cross, a former top examiner of the Home Loan Banks, said the FHFA is trying to crack down on banks that aren't really interested in mortgages, but are simply using membership for access to advances. He said some institutions meet the 10% test when they are first approved for membership, but then quickly sell off their mortgage holdings.

"Without a regulation like this, the agency does not have the power to attack this issue," said Cross, who is now a senior director at Wolters Kluwer Financial Services consulting firm.

But Haynie said many small banks rely on Home Loan Bank advances as a stable low-cost source of funding.

"This proposal could take that source of funding away from some banks for no apparent reason," he said.

The Council of Federal Home Loan Banks warns that banks could be significantly hurt by the plan.

"Hundreds of current members would be negatively impacted by the proposed anti-liquidity regulation and perhaps even forced out of the Home Loan Banks," said David Jeffers, executive vice president of the trade group, which represents the 12 Home Loan Banks.

The American Bankers Association argues FHFA's proposal will require banks to constantly monitor their portfolios to ensure they are in compliance with the residential mortgage test.

It increases regulatory burden and reduces management's flexibility when it comes to managing the portfolio, according Joe Pigg, a senior counsel for the ABA.

"The current system works just fine," he said, because members can only borrow if they have mortgage loans on their books to pledge as collateral for advances.

"It is an unnecessary rule change," Pigg said.

Robert Davis, an executive vice president for the ABA, said that the proposal would be particularly harmful now because the demand for mortgages is so low.

"Do you really want to squeeze an institution that wants to be a bigger mortgage lender out of the system before demand for mortgage loans picks up?" he asked.

Although the FHFA did not comment for this article, Cross said it's a priority for the agency to ensure members have a commitment to home loan lending.

"It has to be more than just a one-shot deal," Cross said.

Compliance with the mortgage test would be based on a three-year rolling average, according to the proposal. Once a Home Loan Bank informs a member that they are below the 10% requirement, they will have one year to come into compliance. If one year is not enough, the member will have another year to get back into compliance.

Even as community bankers object to that part of the proposal, captive insurers would also be affected by the plan, which would effectively kick them out of the system after five years.

This proposal would impact five mortgage real estate investment trusts that use captive insurance subsidiaries to gain access to Home Loan Bank advances: Invesco Mortgage Capital Inc., Annaly Capital Management, Two Harbors, Ladder Capital and Redwood Trust.

Compass Point Research & Trading noted that Two Harbors has borrowed $1.5 billion from the Des Moines Home Loan Bank.

"However, the use of FHLB borrowings was fairly limited for the (mortgage REIT) sector to date," according to Jason Stewart, an analyst at Compass.

"While FHLB funding was largely consistent with promoting a healthy housing finance system, we view the proposed revisions as largely a non-event for the group," Steward said in a Sept. 3 report.

The Des Moines Home Loan Bank declined to comment for this article.

Redwood Trust is currently working on a pilot program called MPF Direct with the Chicago Home Loan Bank to create a conduit for prime jumbo loans. Redwood said the FHFA proposal will not impact the jumbo program, which involves the Chicago bank buying large mortgages and reselling them to Redwood.

"FHLB financing is not a big part of our business," said Mike McMahon, a spokesman for Redwood. "We got along fine for 20 years without FHLB financing and we will get along fine without it in the future."

The mortgage REIT recently secured access to FHLB advances through its wholly-owned insurance subsidiary RTW Financial LLC, which is a captive insurance agency. As of July 31, "we had utilized $26 million of FHLBC advances to fund $30 million of jumbo residential loans," Redwood said in a second quarter financial report.

The announcement by FHFA "does not impact our MPF Direct program," McMahon said.