Download Demystifying the Federal Home Loan Banks:

Demystifying the Federal Home Loan Banks:
We’re Your GSE
By David Feldhaus
Demystifying the FHLBanks
Here is a little known fact that could make a big difference to your credit union: Of
the three Government Sponsored Enterprises created by Congress to encourage
homeownership, only one is a cooperative. The Federal Home Loan Banks (FHLBanks),
founded in 1932 during the Great Depression to promote economical housing
finance, today exist to support homeownership as well as to serve a critical role
as a reliable source of short-term liquidity and long-term funding for our member
financial institutions in all economic cycles. m The fact that each of the 11 regional
FHLBanks is owned by our member institutions, and operated on their behalf,
fundamentally differentiates our organization from other entities. Credit unions
understand well how our cooperative structure allows us to serve as “trusted
advisors” for our members. We share the same passion to assist our members
with their financial challenges and help them better serve their communities as
you do with your members. Added to this is our GSE status, which enables us
to reliably provide low-cost financial products and services to them. Together,
these features make the FHLBanks a powerful partner for your credit union.
July 2015 - PIPELINE 19
Demystifying the FHLBanks
The
11 FHLBanks across the country collectively serve
about 7,300 members including credit unions,
banks, thrifts, insurance companies and Community Development Financial Institutions (CDFIs). Credit unions
are the fastest growing membership component, accounting
for 1,272 or 17% of all FHLBank members as of the beginning
of the year. Why are they joining? Increasingly, many recognize the capabilities we have and how we can benefit
their institutions. Some join and immediately plan to borrow from us or sell mortgages to us. Others join with no intention
of ever using us–and that’s OK too. For
them, we are a “break glass in case of emergency” contingency plan that allows them
to sleep better at night. Either way, there is
value in belonging to a GSE cooperative.
What’s in a Name?
We may lack a cute, easy-to-remember name like
the other housing GSEs—Fannie Mae and Freddie Mac—
but our name speaks to our historical mission and purpose.
Each word denotes an important characteristic. “Federal” reflects our Congressional origin and public mission that provides the implicit backing from the U.S. government, allowing
us to raise funds at the lowest possible cost. This perception
of government support in the bond market also ensures we
can issue debt whenever the U.S. Treasury can, making us an
incredibly reliable source of liquidity no matter what the economic conditions. The liquidity crisis of 2008 convincingly
demonstrated our worth. We were able to provide our members with continuous, daily access to the global bond markets,
even as their other sources of wholesale liquidity dried up.
“Home Loan” speaks to the importance of our traditional housing finance mission to promote and encourage
Figure 1
homeownership. Today, however, Congress has expanded our
mission to facilitate broader lending for community financial
institutions in areas such as small business, agriculture and
agri-business, as well as support for community development
activities.
Finally, as lenders, each of us is a “bank,” but as memberowned cooperatives, we are operated to earn a reasonable return for our members, but not to maximize profits at their expense. Members must purchase
stock to initially join and buy additional stock
to capitalize their borrowings, for which
they receive dividends. All FHLBank stock
is bought and sold at par–it never trades.
When members repay their borrowings,
they can have their additional stock repurchased by their FHLBank, which often occurs
on the same day. This structure allows us to
expand and contract our balance sheet as our
members’ needs demand, but remain safely and
soundly capitalized at all times.
In essence, the FHLBanks serve as financial intermediaries linking “Wall Street to Main Street.” By issuing debt in
the global capital markets, we channel low-cost funding from
investors around the world to our members in local communities. Although most people have never even heard of the
Federal Home Loan Banks, we are quietly operating behind
the scenes as a crucial part of the “plumbing” that helps the
U.S. financial system ensure liquidity and funding is available
when needed.
A Decentralized System, Uniquely Bound Together
Historically, there have been 12 FHLBanks with districts
that follow state lines. Due to the recent voluntary merger of
the Des Moines and Seattle FHLBanks, the first such combina-
FHLBank System Credit Union Members and
Borrowings
20 PIPELINE - July 2015
During the housing and
economic crisis, the
Federal Home Loan Banks
demonstrated their ability
to meet the credit needs
of members by increasing
the amount of FHLBank
advances to credit unions
by $27.2 billion between
Q1 2007 and Q3 2008.
After declining as loan
demand fell, today the
level of advances to credit
unions is again rising as
more credit unions choose
to join the FHLBanks and
borrow from them.
Demystifying the FHLBanks
Figure 2
FHLBank Districts
Eleven FHLBanks serve districts that
include all states, D.C. and 4 U.S. territories.
tion in 83 years, today 11 FHLBanks serve the 50 states, the
District of Columbia and 4 U.S. territories. Membership is determined by the state in which members are chartered. It is
important to note that each FHLBank operates as a separate entity; we are not branches of each other. Each has its own board
of directors, management, culture and views reflecting the regional differences of their members. As a result, you should inquire with the FHLBank serving your district about the specific
products and services they offer, because they do vary.
That said, we do talk to each other continually, comparing notes and experiences, leading many of our products and
services to be very similar. We also share a common regulator,
the Federal Housing Finance Agency, which encourages a certain level of commonality. Additionally, we are bound together
through an unique mandate that each FHLBank is jointly and
severally responsible for the debt of the others. This means that
if one FHLBank were not able to repay its bond obligations for
any reason, the other FHLBanks would be required to ensure
the debt is paid in full. This feature gives investors in our bonds
an added measure of security, providing the lowest possible
cost of funding. It also insulates American taxpayers from the
unlikely event of a government bailout because the cost of one,
or even several, FHLBank failures at the same time likely would
be absorbed by the other FHLBanks. This unique tie encourages
communication among the FHLBanks. We in Chicago want to
know what is happening at our sister FHLBanks and they want
to know what we are up to. It is a unique, self-policing system
that works well for us, our members and the country.
What Products and Services are Offered?
All FHLBanks offer a menu of loan products with a wide
variety of terms and structures to provide members with
same-day, low-cost funding and help them mitigate interest
rate risk. Historically, our main product has been loans, called
“advances,” that can be simple or structured, depending on a
member’s needs. For lenders who portfolio their mortgages
and other loans, FHLBank advances can be an ideal product to
help match the duration of assets to liabilities.
A significant benefit of advance funding is the ability to
customize the loans for each member. Maturities can range
from overnight to 30 years. Interest can be fixed or floating.
Repayment schedules can be bullet or amortizing. If needed,
advance structures can incorporate options such as caps, floors,
collars, swaps, swaptions or other features to suit a member’s
specific requirements. Perhaps as importantly, expert FHLBank staff is available to consult with members about these
features. They can discuss not only the market implications,
but the accounting consequences as well. As employees of a
member-owned cooperative, their only goal is to tailor a solution that works best for you.
To fully understand how advances work, you need to be
aware of the prominent role that collateral plays. Unlike most
lenders, our loans must be over-collateralized at all times. Borrowers are required to pledge high-quality collateral, such as
1-4 family mortgages, agency MBS and Treasury bonds, with a
value in excess of their borrowings. The amount of the haircut
depends on the quality of the collateral, which can be swapped
out or topped up, if needed. FHLBanks are always in a secured
position and we monitor the collateral value closely to ensure
it is sufficient. Largely because of this, no FHLBank has ever
lost money lent to a member in 83 years of existence. As a GSE
lender, credit losses are not part of our core lending business.
Collateral also comes into play regarding the price of an advance. As a cooperative, we seek to offer all members the same
interest rate on a given day for a given term. Weaker mem-
July 2015 - PIPELINE 21
Demystifying the FHLBanks
bers who pose a greater credit risk receive the
same rate as stronger members. However, the
amount of the required collateral may be increased, and the method of securing it may be
heightened, such as by listing or by requiring
physical delivery of the documents.
Beyond advances, the FHLBanks also offer
products such as letters of credit that provide
members a low-cost and efficient way to attract and secure agreements with third parties.
Letters of credit are a way to leverage our Aaa/
AA+ long-term debt credit rating at a competitive price to help their communities. They can
be used to provide liquidity by serving as an
alternative form of collateral to secure municipal deposits. They can also be used to provide
financing opportunities through credit enhancement to support an affordable housing
or community development project.
The FHLBanks also offer a wide array of
products and tools to directly support the affordable housing and community lending initiatives of our members. These include down
payment assistance grants to low–and moderate–income homebuyers, grants to finance
affordable rental and ownership housing, low-cost credit programs to assist in the development and revitalization of communities, disaster relief programs, and revolving loan funds to
economic development projects. Each FHLBank has different
products designed for its region, but the intent is the same.
These products demonstrate how the FHLBanks are able
to harness the financial capabilities of a GSE within a cooperative structure to deliver economical and reliable financing
solutions for our members. Your regional FHLBank can be a
powerful partner as you seek to serve the financial needs of
your members and your community.
These programs were begun to help community lenders retain more of the value of
their mortgage originations. Lenders, particularly smaller lenders who know their
customers better than any GSE can, have
traditionally originated very high-quality
fixed-rate mortgages. However, they often
were not able to realize their full value when
they sold them into a secondary market that
priced the loans largely based on the volume
delivered, rather than their credit quality. As
the only other housing GSE, the FHLBanks
are ideally situated to add competition to
this market. We are able to raise funds at
the same rates, or even slightly better rates,
as our sister GSEs, and as tax-exempt cooperatives, we can offer our members the most
competitive price for their mortgage loans.
However, the FHLBank mortgage programs
have an interesting twist consistent with
the our cooperative structure: participating
members have the opportunity to share the
credit risk of the loans they originate with
their FHLBank and get paid for it.
Members sell the loans to the FHLBanks
through one of the mortgage programs, alleviating members
of the interest rate risk. But in the traditional products, participating members are paid by their FHLBank based on the
credit performance of their loans, rather than paying guarantee fees to compensate someone else to take the credit risk.
The programs use slightly different structures to essentially
do the same thing. Participating members using the tradi-
The FHLBanks
also offer a
wide array of
products and
tools to directly
support the
affordable
housing and
community
lending
initiatives of our
members.
Figure 3
Mortgage Program
Participation, by FHLBank
Mortgage Programs That Reward Lenders for Their
Credit Decisions
Among the more recent products the FHLBanks have begun offering are programs designed for members wishing to
sell mortgage loans rather than hold them in portfolio. First
begun in the 1990s by our FHLBank in Chicago, today all of the
FHLBanks offer one of two mortgage programs to their members as alternatives to the secondary mortgage market. The
Mortgage Partnership Finance® (MPF®) Program is currently
available to members of nine FHLBanks, while the Mortgage
Purchase Program (MPP) is offered by two FHLBanks. While
the structures of these programs differ slightly, they both allow participating members to originate, sell, and service (if
they choose) fixed-rate residential mortgage loans. Often, these
programs are the only option available for low-volume lenders
that have difficulty accessing the secondary market. Without
these programs, many members would not be able to offer
their customers long-term, fixed-rate mortgages.
22 PIPELINE - July 2015
All of the FHLBanks offer a mortgage program
for members wishing to sell loans in the secondary market. Many of the FHLBanks have been
offering these products since the late 1990s.
Demystifying the FHLBanks
tional MPF products receive monthly fees
that vary depending on the product. A First
Loss Account (FLA) is established to absorb
expected losses, after the borrowers equity
and any Primary Mortgage Insurance. Participating members credit enhance their
loans to the equivalent of a AA-rate mortgage
bond, for which they receive monthly credit
enhancement (CE) fees. These CE fees can
be reduced or eliminated to compensate for
losses in the FLA, depending on the product.
Members bear any further losses, to the AA
level, by directly reimbursing the FHLBank.
Catastrophic losses beyond this level are the
responsibility of the FHLBank.
Additional MPF products have been
developed to address members’ risk-based
Figure 4
It is important
to contact
the regional
FHLBank
serving your
area. Program
and product
availability
can vary.
capital positions and other portfolio management strategies.
The MPP uses a different approach to
share the risks: the FHLBank establishes a
Lender Risk Account (LRA) at the time the
loans are sold. Funds not used to absorb
losses are disbursed to the member over a
predetermined schedule. The use of the LRA
structure and payment schedule are capitalfriendly to MPP sellers.
Regardless of the approach, all of the MPF
and MPP risk-sharing products allow members to bifurcate the risks of their loans and
better allocate them between originators and
investors. Amore efficient mortgage financing is the result.”
MPF® Program Loan Performance
FHLBank members know their customers and understand local market conditions. They are in the best position to ensure their
customers receive mortgages appropriate for their financial situations. As a result of this knowledge and the risk-sharing partnership
of the MPF Program, the credit performance of MPF loans have been significantly better than the industry average for conventional
loans, both before and since the financial crisis.
July 2015 - PIPELINE 23
Demystifying the FHLBanks
Options Without Risk Sharing
The FHLBanks
are working
to provide
members
with more
channels to
the secondary
mortgage
market for the
mortgage loans
they wish
to sell.
The MPF Program also has developed several products that allow members to sell their
loans to other investors without a risk-sharing
structure. For example, the MPF Xtra® product allows members to sell conventional, conforming loans through the MPF Program to
the FHLBank of Chicago, which in turn sells
the loans to Fannie Mae in a back-to-back
transaction. Aggregating larger volumes of
loans from across the FHLBank System affords the opportunity for better loan execution. A similar back-to-back structure between
the FHLBanks and Redwood Trust, called
MPF Direct, allows members to sell their nonconforming, jumbo loans to $1.5 million. And
our new MPF Government MBS product allows members to sell FHA, VA, USDA Rural
Housing Service and HUD Section 184 tribal
loans to their FHLBank for placement into
Ginnie Mae securities. These products are designed to give members more choices by providing numerous channels for their loans into the secondary
market, helping them to better serve homebuyers.
Servicing for most MPF loans is performed by the participating members who sell them. Remittance options can
include actual/actual, schedule/schedule or single remittance,
depending on the product. Additionally, members usually can
choose to sell loans servicing-released, if they wish. In that
case, the servicing transfers to a third party provider that has
agreed not to cross sell to the borrower. Finally, be aware that
some MPF products that involve sales to other investors, such
Figure 5
A Cooperative for Cooperatives—
We’re Your GSE
I hope I have cleared away enough mystery about the FHLBanks to convince you
to take the next step and talk to your local
FHLBank about what they can do for you.
We were created to help local financial institutions, like yours. As cooperatives, we exist
to help our members and their communities
by delivering economical and reliable funding
products. As GSEs, the FHLBanks can be powerful partners, in good times and especially in
bad. I encourage you to find out for yourself.
Please visit www.fhlbanks.com to determine which FHLBank could service your
credit union and to learn about their membership requirements. For more information about MPF Products visit www.fhlbmpf.com.
David Feldhaus is Senior Vice President, External Affairs with
the Federal Home Loan Bank of Chicago. This content is a condensed version of “Taking the Mystery Out of the Federal Home
Loan Banks,” a presentation Dave shared at recent ACUMA
Workshops. You can contact Dave at [email protected].
Mortgage Partnership Finance, MPF and MPF Xtra are registered trademarks of the Federal Home Loan Bank of Chicago.
MPF Traditional Product Credit Loss
Structure
24 PIPELINE - July 2015
as MPF Direct, do not allow the servicing to
be retained; only servicing-released sales currently are permitted.
The risk-sharing structure
of the traditional MPF
products establishes a First
Loss Account to absorb
expected losses, after the
borrowers’ equity and any
Primary Mortgage Insurance.
Participating members credit
enhance their loan to the “AA”
level, for which they receive
monthly “CE fees.” These fees
can be reduced or eliminated
to compensate for losses in
the FLA, depending on the
product. Members bear any
further losses, to the “AA”
level, by reimbursing the
FHLBank. Catastrophic losses
beyond the “AA” level are the
responsibility of the FHLBank.