A recent announcement by the Federal Housing Finance Agency, seeking input on potential expansion to the membership of the Federal Home Loan Banks system, would be a negative for the system but a positive for nonbank mortgage companies, Moody’s said in a report.
The FHLB system is a cooperative of 11 regional banks, and the request from FHFA was on the possibility of expanding membership in the system to nonbank institutions.
The move by the FHFA revisits its 2016 membership rule, which excluded captive insurance companies from FHLB membership. Moody’s said that rule was a response to a dramatic increase in FHLB advances by these captive insurers, whose parent entities were otherwise ineligible, a practice the FHFA viewed as circumventing the Federal Home Loan Bank Act.
“Despite the potential growth opportunities for the FHLBank System, extending membership to nonbanks would be credit negative for the FHLBank System because it would introduce elevated risks of lending to nonbank companies compared with lending to bank and traditional insurance company members,” Moody’s wrote in the report. “That is because nonbanks and their affiliates are financially weaker than traditional FHLBank members. Conversely, the move would be materially credit positive for residential and commercial nonbank mortgage firms because they would be able to improve their liquidity profiles by taking advantage of FHLBank advances providing cost-effective, stable funding.”
The FHLB system has never incurred a loss on an advance, which Moody’s attributes to strong collateral protections and – more importantly – statutory rights.
“Nonbanks are on average financially weaker than traditional FHLBank members, and would create a greater reliance on the FHLBank's collateral policies. Resolutions of nonbank mortgage company borrowings also risks introducing new complexities,” Moody’s wrote.
Moody’s said the credit strength of the system centers on its traditional core loan program with traditional bank and insurance company membership. When FHLB has incurred some stress, it largely came in products beyond their traditional business, Moody’s said.
“Allowing nonbanks access to the FHLBank System would be a strong credit positive for nonbank mortgage companies, improving their liquidity profiles by providing a stable funding source, diversifying their funding and reducing their borrowing costs,” the report stated. “Notably, FHLBank advances remained readily available to members during the financial crisis at very attractive costs.”