The State of the FHLBanks

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• The State of the FHLBanks
• May 2006
• By John von Seggern
• President of the Council of FHLBanks

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Overview

• The FHLBank Systems Basics
• Brief FHLBank Legislative History
• Current Regulatory Issues
• Wrap-up

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Map of the System
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2005 Operating Highlights

• 998 billion in combined total assets
• 620 billion in advances
• 105 billion in mortgage loans
• 4.45 capital to assets ratio
• 280 million in AHP contributions

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Who Are The FHLBanks?

• 12 regional Banks with a mission to meet credit
  needs of local communities through more than
  8,100 member institutions
• Congressionally chartered in 1932 to promote a
  healthy mortgage finance system
• Privately owned, wholesale Banks without publicly
  traded stock
• Unique cooperative structure

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Community Financial Institutions

• Institutions with assets of 587 million or less
• CFIs make up over 80 of FHLBank membership
• GLB expanded collateral small business,
  agriculture, community development loans
• Enabled CFIs to better meet diverse funding needs
  of their communities
• Increased borrowing capacity
• Half of our members were able to increase use of
  advances under new collateral requirements

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How Do The FHLBanks Work?

• Advances
• Loans to member institutions
• Primary funding process of the FHLBanks
• Backed primarily by housing collateral
• Asset Purchase Programs

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How Do the FHLBanks Work?

• Advances
• Asset Purchase Programs
• FHLBanks purchase loans/share the risk
• Members retain credit risk
• FHLBanks hold interest rate risk
• Strategic alternative for Member banks in the
  secondary market
• Mortgage programs includes
• Mortgage Partnership Finance (MPF)
• Mortgage Purchase Program (MPP)

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FHLB Mortgage Programs

• More profitable alternative for FHLB members
  selling fixed-rate, conforming mortgages
• As cooperatives, FHLBs have much lower ROE
  expectations than Fannie/Freddie resulting in
  better pricing for members
• Mortgage risks are allocated between lenders and
  FHLBs
• Lenders credit risk customer relationships
• FHLBs interest rate funding risk

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FHLB Mortgage Program Key Statistics
As of 12/31/05
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Overview

• The FHLBank Systems Basics
• Brief FHLBank Legislative History
• Current Regulatory Issues
• Wrap-up

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Legislative History

• FIRREA (1989)
• REFCorp. (300 million)
• AHP (10 of earnings)
• FHFB
• Expanded Membership
• Retained Earnings Taken

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Legislative History

• Gramm-Leach-Bliley (1999)
• New Capital Structure
• REFCorp. (20)
• Expanded Access for CFIs
• Voluntary Membership
• Governance Changes

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Legislative History

• GSEs in the Headlines
• March 22, 2000 Treasury Undersecretary Gary
  Gensler testifies before the House Banking
  Subcommittee on Capital Markets, Securities and
  Government Sponsored Enterprises and says Thus,
  as part of a package of reforms, we would support
  repeal of the line of credit.

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Legislative History

• Housing Finance Regulatory Improvement Act of
  2000 introduced by Cong. Baker (never enacted)
• Elimination of FHLBanks Super lien Authority
• Repeal of Treasury Backup Line-of-Credit
• Regulatory Limits on Non-Mission Assets
• New Approval Requirements for Business Activities

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Senate Banking (108th) GSE Bill

• One regulator, but two divisions
• Single head of agency with an advisory board
• Receivership measures for FF
• Affordable housing program for FF
• Requires SEC Registration
• Board Structure Changes
• FHLBank Act essentially retained

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GSE Bill (109th)

• One regulator, but three divisions
• Single head of agency with an advisory board
• Receivership measures for FF and the FHLBanks
• Portfolio caps for FF?
• Affordable housing program for FF?
• Requires SEC Registration
• Board Structure Changes
• FHLBank Act essentially retained

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Overview

• The FHLBank Systems Basics
• Brief FHLBank Legislative History
• Current Regulatory Issues
• Wrap-up

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SEC Registration

• Nine banks have registered with or have filed
  Form 10s
• Atlanta, Boston, Chicago, Cincinnati, Dallas,
  Indianapolis, New York, San Francisco, Seattle
• Three banks in the process of restating
  financials
• Des Moines, Pittsburgh, Topeka

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Key Elements of Proposed Regulation

• Excess Stock
• Excess stock limited to 1 of assets
• Sale of excess stock prohibited
• Payment of stock dividends prohibited
• FHFB Stated Objectives
• Avoid the use of excess stock to fund long-term
  assets that are not readily saleable
• Reduce non-mission related assets

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Key Elements of Proposed Regulation

• Retained Earnings and Dividends
• Retained earnings requirement equals 50 million
  plus 1 of non-advances assets (total assets
  minus advances)
• FHFB Stated Objective
• Protect against potential impairment of the par
  value of capital stock

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Key Elements of Proposed Regulation

• Retained Earnings and Dividends
• Dividends limited to 50 of current net earnings
  until target is reached (transition period)
  there is no set transition period
• Dividends only with FHFB approval if retained
  earnings drop below the target after the target
  is reached

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Key Challenges Excess Stock

• The limitation on excess stock impacts several
  FHLBanks mortgage loan programs
• Prohibition of stock dividends is a take-away of
  a significant benefit to members in the form of
  tax-deferred stock dividends
• Prohibition of stock dividends seems unnecessary
  in light of the 1 excess stock limitation

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Key Challenges Retained Earnings and
Dividends

• Effectively increases the cost of advances
• Potential shifts in FHLBank and member
  competitive landscape
• Formula is very simplistic.
• Formula will not stimulate additional discussions
  among management and boards around the riskiness
  of particular asset classes
• Money market investments, MBS, and mortgage loans
  all treated the same
• Changes in credit risk composition of
  non-advances asset balances will not affect
  retained earnings
• Changes in market risk will not affect retained
  earnings

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Suggestions for Revision

• Withdraw the present proposal and re-propose, if
  necessary
• Allow each Bank to develop its own plan
• Drop the prohibition on stock dividends
• Fix the flawed formulas to address risk
• Allow a minimum of a five year transition period

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Current Regulatory Issues

• Anti-predatory lending guidance
• Policies must address
• HOEPA
• Single-premium credit life insurance
• Prepayment penalties
• Mandatory arbitration
• Can the FHLBanks accept loans with any of those
  provisions even if legal and not prohibited by a
  members regulator?
• Can the FHLBanks rely on findings from members
  regulators?

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Current Regulatory Issues

• Proposed rule on director elections
• Purpose is to ensure Boards have necessary skills
  and expertise
• Annual assessment of current attributes and needs
• Notice to members alerting them to Boards needs
• Permits statements concerning each nominees
  skills and experience

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• Questions

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