Home Loan Banks must look at members' finances, not just collateral: FHFA

Ting Shen/Bloomberg

The Federal Home Loan Banks must assess the financial condition and creditworthiness of its members before advancing funds, the system's regulator said Friday.

The Federal Housing Finance Agency said in a 10-page advisory bulletin that the Home Loan Banks must establish processes to regularly monitor the financial health and industry conditions of its members, including changes in borrowing behavior, enforcement actions and unstable funding sources. That includes concentrations of brokered deposits and uninsured deposits.

FHFA also said the system needs to coordinate better with primary regulators when lending to troubled institutions in a way that contributes to "positive outcomes in the most difficult situations."

During recent exams, the FHFA's supervisory staff found weaknesses in the Home Loan Banks' credit risk management along with "misconceptions about the role an FHLBank should play in lending to members in a distressed financial condition," the regulator said. 

FHFA Director Sandra Thompson, who launched a review of the system last year, has said that it's not enough for the 11 regional Federal Home Loan Banks to engage in collateral-based lending, they also must assess the financial condition of their members. 

"This guidance provides clarity for the FHLBanks' effective management of credit risk and coordination with other financial regulators so that member institutions can maintain the ability to access liquidity when needed," Thompson said in a press release. 

The FHFA's guidance encourages banks, particularly large depositories, to be prepared to borrow from the Federal Reserve's discount window. The system must have procedures in place for subordinating liens and for releasing collateral to the Federal Reserve Banks. When a Home Loan Bank continues to provide funding to a troubled institution, it must get written confirmation from the appropriate prudential regulator or deposit insurer, or both, to continue providing funding, the FHFA said. 

Ryan Donovan, president and CEO of the Council of Federal Home Loan Banks, the system's trade group, said he hopes the FHFA's goal is for the 6,500 banks, insurance companies and credit unions that are members of the system to continue to have access to the system's reliable source of low-cost liquidity through all economic cycles. 

"It's too early to determine whether this is going to be a heavy lift," Donovan said. "This advisory bulletin clarifies what the expectations are in respect to determining the credit risk of a member."

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The Government Accountability Office issued a report in April that examined the role of the Federal Home Loan Banks in providing liquidity during the spring 2023 regional banking crisis. The report provided a granular view of loans, known as advances, that were made to Silicon Valley Bank, Signature Bank and First Republic Bank before their collapse as well as to embattled crypto-friendly Silvergate Bank, the parent of which filed for Chapter 11 bankruptcy last week.

The Home Loan Bank System, a government-sponsored enterprise, has so-called "super lien" priority that protects the system from losses, which instead are borne by the Federal Deposit Insurance Corp.'s Deposit Insurance Fund. Critics of the system have claimed the super lien provides a perverse incentive for the 11 regional banks to lend to institutions right up until they fail. 

The FHFA said that each Home Loan Bank can limit or deny a member's application for a loan if there is evidence of "financial or managerial deficiencies."

The guidance clarifies FHFA's expectations that safe and sound underwriting and credit decisions should not hinge solely on the quality of the pledged collateral for advance lending, but should take into consideration the credit worthiness of the member "at that time" they are borrowing. Further, each Home Loan Bank must have agreements in place with its members to request and obtain nonpublic financial information from members, including between reporting periods, in case there are "material adverse financial changes" that a member may not have disclosed at the time of a request to borrow.