Critics of FHLB membership rule aren’t thrilled with prospect of repeal

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WASHINGTON — A bill to allow captive insurance companies to be reinstated as members of the Federal Home Loan Bank System appears to be dividing the Home Loan bank community.

The bill, sponsored by Sen. Tammy Duckworth, D-Ill., would reverse a 2016 rule by the Federal Housing Finance Agency that had expelled captive insurance companies from FHLB membership.

Community banks and the Home Loan banks had opposed the FHFA proposal, particularly the restrictions on existing Home Loan Bank System members. Small banks objected to a proposed mortgage loan asset test for retaining FHLB membership, but that test was removed in the final rule.

The Mortgage Bankers Association supports the Duckworth plan, yet banking industry representatives and other FHLB stakeholders are shying away from the legislative proposal to reinstate captive insurers.

Some argue it goes too far in allowing entry for captive insurance companies, which they say could expose the Home Loan Bank System to new risks.

"We have not taken an official position on the captive insurer bill, ... but ICBA, like most FHLBs, are concerned the bill could change the risk profile of the FHLB System," said Ron Haynie, senior vice president of mortgage finance policy at the Independent Community Bankers of America.

That FHFA rule requires captive insurers that were Home Loan Bank System members at the time to end their membership by 2021, while those that entered the system after the FHFA issued its proposal, had to leave in one year. Under the Duckworth bill, captive insurance companies in both camps could keep their membership.

The National Association of Real Estate Investment Trusts estimates the Duckworth bill would allow 47 captive insurers to rejoin or maintain their FHLB memberships.

"Captive insurers whose housing focus is aligned with that of the FHLB System act as a stabilizing force in the housing finance market and create a reliable source of capital for lenders and investors," according to MBA President and CEO David Stevens.

In a press release announcing the bill, Duckworth said the FHFA rule has had a "particularly devastating impact on the Chicago FHLB's membership because its long-standing captive insurers provide the bank with nearly one-third of its total borrowings."

But similar to the ICBA and the American Bankers Association, the Council of Federal Home Loan Banks says it has not taken a position on the bill.

"In January 2016, we were objecting to a regulatory proposal" that imposed "parameters on existing FHLBank members," according to David Jeffers, the council's executive vice president. "Today, the issue is a separate legislative proposal for which the Council does not have a consensus position."

Haynie said the ICBA is "grateful" that the Duckworth bill did not get added to the bipartisan regulatory relief legislation that the Senate passed last week.

He signaled that allowing new captive insurers into the Home Loan Bank System is different from allowing existing members, which must leave by 2021 under the rule, to remain members.

"It is one thing to just reinstate the 'five-year' captives," but "it's another to reinstate every captive," Haynie said. "My sense is most of the FHLBs would support or wouldn’t oppose reinstating the five-year captives, but I don’t think they all support reinstating those that got in at the end while the [FHFA] rule was being proposed."

Federal Home Loan bank advances are collateralized by the member's assets. Unlike nonbanks, Home Loan banks can seize assets from failing banks or credit unions through agreements with the Federal Deposit Insurance Corp. and National Credit Union Administration to minimize any losses. The failure of a captive insurer would have to go through the bankruptcy process.

While captive insurers belonging to a Federal Home Loan bank would likely invest in residential mortgages, they can also invest in commercial mortgages such as hotels and office buildings. "That injects a very different risk profile into the FHLB system. If one or more of these captives failed during a period of economic stress, losses at one FHLB could impact the availability and cost of advances throughout the entire FHLBank system," Haynie said.

The National Association of Real Estate Investment Trusts supports the Duckworth bill, according to the trade group's spokesman, Ron Kuykendall.

A position paper from the real estate investment trust group states that the bill is limited in scope. "It would only allow approximately 29 one-year and 18 five-year captives to rejoin or maintain their FHLB membership. It does not open membership to new captives but does operate to correct the perverse outcome of the FHFA rulemaking."

Joe Pigg, senior vice president and senior counsel for the American Bankers Association, said that if Congress decided to allow captive insurers to become full-fledged FHLB members again, the legislation should include safety and soundness limitations and other necessary measures, such as a requirement that captive insurers "over-collateralize their loans."

"Otherwise, these non-depository lenders will put our members' capital at risk," Pigg said.

Still, the barring of captive insurers through the FHFA rule is seen as partly responsible for declining advances.

The Federal Home Loan Bank of Des Moines recently released its 2017 financial results and it shows a significant drop in advances — partially due to the FHFA rule. Six captive insurers dropped their membership and withdrew $7 billion in advances from the Des Moines bank. The remaining six captive insurers still have $7.5 billion in advances at the Des Moines Home Loan Bank at the end of 2017.

Separately, the Des Moines bank's largest member, Wells Fargo Bank, reduced its Home Loan bank borrowings by $31 billion last year. But Wells still has $45.8 billion in advances outstanding at the Des Moines bank. And the Des Moines bank still has $102.6 billion in total advances, according to its fourth-quarter securities report.

Overall, the Des Moines Home Loan Bank, which supports member banks and thrifts in 13 states stretching from Hawaii to Minnesota, saw its net income decline to $518 million in 2017 from $649 million in the prior year.

"Our total assets decreased to $145.1 billion at December 31, 2017, from $180.6 billion at December 31, 2016 due primarily to a decrease in advances," the bank said in its earnings report.

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