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FHFA changes to FHLBs would devastate REIT membership

FHFA director proposes ongoing stake, more stringent definitions

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The Federal Housing Finance Agency is proposing a new rule that would revise the requirements for financial institutions to apply for and retain membership in one of the 12 Federal Home Loan Banks, and dial real estate investment trusts out.

The proposed rule would revise FHFA’s existing membership regulation to require that members maintain a commitment to housing finance and that only eligible entities can gain access to bank advances and the benefits of membership. 

As noted first by Jody Shenn at Bloomberg, this will have a devastating impact on real estate investment trusts' membership.

REITs use specialized insurers to join Federal Home Loan Banks, and the proposed new rules would dial those specialized insurers out. These specialized “capitive insurers” would have their memberships sunset after five years.

REITs that buy mortgage debt andsome other lenders use captive insurers, Shenn notes. These firms then turn to FHLBs because they offer better terms.  

Director Mel Watt said back in May in a speech to the Federal Home Loan Bank Director’s Conference that banks must ensure that they remain focused on their housing finance mission.

A client note from Compass Point Research & Trading, however, suggests that it will be hard for REITs to push back against the FHA proposal

“Our sense remains that state insurance regulators and the FHLBs themselves are supportive of the captive insurance model being used by mortgage REITs. Notably, the FHFA stated that at least 3 state insurance regulators objected to the FHFA’s proposed change,” they said. “Furthermore, in an interview with Bloomberg a top FHLB representative stated: ‘In a period where housing finance is limping along and a sluggish economy needs all the help it can get, mucking around with a model that works doesn’t make sense…This proposal may be the first step in dismantling a very successful model. As an anti-liquidity regulation it hurts housing and hurts growth.’

“We believe that there will be a pushback against the FHFA’s FHLB proposal but our sense is that the esoteric nature of this particular issue, coupled with the slate of other FHFA proposals outstanding, may make it difficult to organize an effective opposition campaign,” Compass Point said.

The FHFA proposal, which is open for comment through November 1, would require members to:

1. Maintain 1% of assets in home mortgage loans

The proposal would establish a new quantitative test requiring all members to hold one percent of their assets in home mortgage loans and to do so on an ongoing basis. 

Under current rules, applicants for membership need only demonstrate a nominal amount of HML on their balance sheet at the time of their application, but not thereafter.

2. Maintain 10% residential mortgage loans ongoing

The revision would require certain members that are subject to the 10% residential mortgage loans requirement to adhere to this requirement on an ongoing basis. 

Under the current rules, these members are subject to the 10% RML requirement only when they initially apply for membership in a Bank, but not thereafter.

3. Redefine and specify what insurance companies are

This is where the REITs could be most impacted, because of their reliance on captive insurers. The revision would redefine “insurance company” to mean a company that has as its primary business the underwriting of insurance for nonaffiliated persons. This would effectively exclude captive insurers from membership and prevent entities not eligible for membership from gaining access to bank advances through a captive insurer.  

4. Clarify and define “principle place of business”

The proposed revisions would clarify the standards by which an insurance company’s “principal place of business” is to be identified in determining the appropriate bank district for membership.

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