FHFA review of the FHLB system and its impact on insurers

Dec 7, 2023
  • BlackRock

The Federal Home Loan Banks (“FHLBs”) have undergone minimal change since their founding in 1932 during the Great Depression despite significant shifts in their membership. Beginning in the fall of 2022 and over a period of several months, the Federal Housing Finance Agency (“FHFA”) undertook a review and analysis of the FHLB system, in part through a series of public listening sessions, regional roundtable discussions, and receipt of comments from multiple stakeholders. The six areas of focus were:

  1. The FHLBs’ mission and purpose in a changing marketplace
  2. Organization, operational efficiency, and effectiveness
  3. Role in promoting affordable, sustainable, equitable, and resilient housing and community investment
  4. Addressing the unique needs of rural and financially vulnerable communities
  5. Member products, services, and collateral requirements
  6. Membership eligibility and requirements

This ultimately culminated in a report (“FHLBank System at 100: Focusing on the Future”) that the FHFA released on November 7, 2023.

The common thread throughout is the FHFA’s desire to clarify and satisfy the FHLB’s mission of:

  1. providing liquidity to members, and
  2. supporting housing and community development.

Although the report makes no formal updates to the FHLB system, there are several recommendations that the FHFA has indicated it will pursue through ongoing supervision or guidance, rulemaking, and coordination with Congress for those requiring statutory changes. Implementation is expected to take place over a multi-year period and in collaboration with stakeholders.

As a reminder, FHLB members are primarily depository institutions, with almost no insurance company membership prior to 1989. Today, insurers make up only 9% by member count and 17% by advances. Although much of the focus is on banks, many of the proposed reforms will also impact insurers.

Impacted areas

Potential implications for insurers

Liquidity backstop

FHLB has historically been a source of contingent liquidity, but the FHFA is concerned that FHLB has become a lender of last resort. Although primarily a bank concern, the FHFA has unveiled a proposal that poses knock-on effects for insurers. The new proposal would require that at least 10% of member assets be held in residential mortgage loans (or equivalent mission assets) on an ongoing basis rather than only at the time of application. This may reduce the attractiveness FHLB as a liquidity source, and cause insurers to turn to costlier forms of liquidity.

Use of proceeds

Currently, FHLB advances to members do not include provisions on use of proceeds. Proposed rules contemplate discounted advance rates or increased dividends on stock to members demonstrating higher commitment to the FHLB’s mission, which could affect spread lending strategies.

Access to long-term advances

Currently, long-term advances (maturity of 5yrs+) must be used to fund residential housing finance (but this is only proxied by comparison to the total book value of residential assets held), and shorter advances may be used for any purpose. The FHFA is considering an update to the definition of long-term advances to a term of >1 year, which would subject additional advances to the residential housing requirement. It is also exploring additional community investment standards for access to long-term advances, such as evaluating a member’s record of lending to first time homebuyers. Such updates could affect spread lending strategies and would also likely reduce the amount of liquidity available.

Agency CMBS

The FHLBs are large investors in the Agency CMBS market, owning more than 10% of outstandings. Retrenchment of FHLB investment portfolios could potentially affect the liquidity and value of Agency CMBS held by insurers.

Membership eligibility

The number of members may shrink as FHLB eligibility criteria becomes more restrictive. The FHFA has raised the possibility of requiring that members demonstrate measurable and ongoing commitment to housing finance.

Oversight

Following the regional banking turmoil in early 2023, there is interest in expanding examinations of member safety and soundness. Potential changes include greater scrutiny of capital adequacy and financial performance monitoring.

Disclosure and district impact

Insurers may be expected to report on their alignment with the mission-focused objectives of the FHLB and describe in more detail their impact on their local communities.

Standardization

Some insurers are members of multiple FHLB districts and tap funding opportunistically. The FHFA may consolidate the number of FHLBs, which could lead to increased borrowing costs.

Chart Sources: BlackRock and FHFA, as of December 2023.