DeMarco Discusses the Future of FHLBanks
Edward J. DeMarco, Acting Director of the Federal Housing Finance Agency (FHFA) told Federal Home Loan Bank (FHLBank) directors yesterday that their Banks' proven ability to access global markets could play a large role in their future. DeMarco spoke to the directors as they met in conference in Washington, DC.
DeMarco said that most FHLBanks had emerged from the recent crisis in relatively good condition and all 12 were profitable last year. Retained earnings have increased dramatically in the past five years and now top $9 billion and should continue to increase as a result of the capital plan provisions adopted last year to set aside 20 percent of income in restricted retained earnings. The quality of assets held by the Banks has also improved as holding of private label mortgage-backed securities (MBS) have declined. Credit-related other than temporary impairment charges on those securities also dropped in each of the last three quarters. "In a reversal from just a few years ago, the market value of equity exceeds the par value of capital stock at most FHLBanks," Demarco said.
The banks still face headwinds, the largest being the decline in the volume of advances, "and the outlook for advances growth is not promising in the short-term as members remain flush with cash and loan demand remains slack." Expenses have not contracted as fast as assets and advances and persistent low interest rates have reduced the return on invested capital, both contributing to weakened earnings.
Growth of membership over the past year has been concentrated among insurance companies. Their collateral arrangements with the FHLBanks differ in some critical ways from those with insured depository institutions and, DeMarco said, these arrangements bear watching as does market risk, especially at Banks with large holdings of mortgages and MBS relative to assets.
In the current climate housing finance reform is a critical concern and, while the futures of Fannie Mae and Freddie Mac are central to that discussion, the FHLBanks should be part of it as well. The Banks, DeMarco said, have long been a conduit to global capital markets and have enhanced the liquidity and funding of mortgages for decades. "Expanding, maintaining, or refining that role will be the focus of the conversation as it pertains to the FHLBanks."
There are more than $10 trillion in single-family mortgage loans in the nation, there are not enough deposits in the country to fund them all, and the risk management challenges for domestic financial institutions to manage all the associated risks in the portfolio are substantial. The U.S. Housing market of the future, like the market today, needs access to global capital markets.
"A critical question for policy makers is how to build or rebuild the plumbing necessary to connect global market investors with individual families seeking a mortgage to buy a home," he said. FHLBanks have already demonstrated their scalability and their ability to access the markets, even during the height of the liquidity crisis. By issuing debt into global markets the FHLBanks raise funds that support housing through funding advances for mortgages going into members' portfolios. The ready availability of advances also makes those mortgages more liquid than they would otherwise be, thereby reducing the liquidity risk in members' mortgage portfolios. This also allows the FHLBanks to issue market-worth letters of credit which, in turn, allows members to attract their own funds for use in housing finance. "Furthermore, as market intermediaries, the FHLBanks now serve as facilitators in the securitization process, collecting mortgage loans from members for sale in the secondary market."
The FHLBanks already have strong relationships, including a cooperative ownership structure, to their nearly 8,000 front-line local lenders and these relationships give the Banks an important role as market intermediaries. This makes them well suited to be part of an evolving housing market.
DeMarco laid out three ways in the Banks might be affected by moves to rebuild the housing finance infrastructure. Congress could choose to expand the FHLBanks' permissible business activities and such expansion might also require a review of the System's capital structure and requirements and its approach to risk management. Congress could choose to add some limits or restrictions on the Banks, essentially requiring some degree of contraction such as suggested in the Administration's finance reform white paper by way of adding restrictions on the access of larger members to advances. Or Congress could decide that the System is working well and leave it largely unchanged from where it is today.
If the decision is to stay the course, FHLBanks would remain focused on providing advances to members and providing a competitive and balanced finance and servicing system. For members interested in retaining mortgages in portfolio the FHLBanks can continue to provide liquidity; for members interested in selling those mortgages, the banks have already demonstrated an ability to serve as a conduit to the secondary market. And by serving as an aggregator in this process, the Banks are doing two important things; enabling community financial institutions to obtain better pricing and providing quality control by ensuring mortgages are securitized to meet the standards of the AMA programs.
DeMarco told the directors their most important role is to oversee and advise on the strategic planning process at their banks which means planning for the future. For an organization to compete effectively it must build its strategic plan around its competitive advantage and for FHLBanks that advantage is their government-sponsored enterprise borrowing privilege. It is the directors' responsibility to product that privilege by using it to fund core mission activities safely and soundly.
DeMarco told the directors that the key to planning is to envision the future before it arrives. Unfortunately, he said, because almost everything about the future is uncertain and unpredictable, "The question that faces the strategic decision-maker is not what his organization should do tomorrow. It is 'What do we have to do today to be ready for an uncertain tomorrow?' "This," he told the directors, "is your role."