As the dust settles following the 90-day moratorium on granting captive insurers membership to the Federal Home Loan Bank (FHLB) system, many within the industry are holding their breath...
As the dust settles following the 90-day moratorium on granting captive insurers membership to the Federal Home Loan Bank (FHLB) system, many within the industry are holding their breath.
The regulator of the FHLBs, the Federal Housing Finance Agency (FHFA), has aired its suspicion towards the trend of real estate investment trusts (REITs), in particular, using captive insurance to access the government chartered system, branding it too much of a risk.
Congress created the FHLB system to be a reliable source of funds for local lenders to finance housing, jobs and economic growth. It is made up of 12 FHLBs, which are cooperatives owned by more than 7500 community financial institutions throughout the US. Insurance companies were one of the original eligible members of the FHLB system in the 1930s when the statute was passed, which has served to compound the captive industry’s feeling of persecution following the announcement of the moratorium.
In 2013, the FHLB system had almost half a trillion dollars out on loan to community banks, credit unions, insurance companies and community development financial institution members, which must put up high-quality collateral to borrow funds.
Since 1994, captives owned by some of the bigger banks like JPMorgan Chase and Wells Fargo have gained membership to the FHLB and new members, such as Redwood Trust’s REIT, were approved as recently as June 2014. Despite this, FHFA director Melvin Watt is still of the view that captive insurers deserve “some additional attention”.
In May 2014, Watt told the FHLBs Directors Conference that “Captive insurance borrowing and membership in the [FHLB system] raises a number of possible issues related to safety and soundness and access to the system.”
This scrutiny has caused many working within the industry to feel that captives are receiving something of a raw deal, as they feel that their activities are directly in line with the FHLBs’ mission to provide liquidity to the home loan market.
Scott Geromette of Honigman Miller Schwartz and Cohn LLP says: “I am not certain why the FHFA has recently placed so much emphasis on the issue of whether captive insurance companies are eligible FHLB members.”
“Captives as FHLB members is not a new phenomenon. In fact, it is my understanding that some of the largest depository institutions in the US have been participating in the FHLB through captive members, some of which date back twenty years.”
“Furthermore, based on my count, there are currently approximately twenty captive insurance companies that are FHLB members, each of which, presumably, was reviewed and approved by the FHFA as part of the membership process. If captive insurance companies have been acceptable since at least 1994, then it is unclear to me how or why there could suddenly be questions about whether captives insurance companies are eligible members. It would seem to me that this inquiry, if truly legitimate, would have arisen a long time ago and not as a result of new members joining whose activities arguably are more consistent with the FHLBs’ mission than any other type of eligible member.”
In addition to Geromette and a number of his contemporaries feeling unfairly scrutinised by the FHFA, there is the added uncertainty created by the inherent silence during a moratorium. As no details have emerged, as yet, those within the industry are forced to use rumours as a source of information.
Richard Eckert, director and analyst of mortgage REITs at investment bank MLV & Co, claims that Watt is under pressure from his critics.
Eckert explains: “Watt is very sensitive to criticisms of mission creep and has come under pressure from some of the more conservative lawmakers about expanding the mandate of government sponsored enterprises to these private, non-bank lenders. He is trying to advance the housing finance mission of the US without stifling or crowding out private capital. Basically he is using this time to make a case for himself and the FHLB are desperate to prove that they are relevant—now that the biggest thrifts have incinerated themselves.”
Regardless of what is happening behind the scenes at the FHFA, the moratorium has left captive owners in the dark as to what is next, without something tangible to fight against. In other words, as the FHFA have not adopted an official position against captives, it is difficult for the owners themselves to organise any kind of pushback.
Geromette says: “All we need to do in this window is make sure that we have all our ducks in a row and possibly put together a whitepaper. We need to make sure that we get the FHLBs to realise that there is little the FHFA should be able to do about the arrangement because (i) insurance companies are eligible members under the FHLB enabling legislation, (ii) the activities of all of the captive insurance companies with which I have worked are entirely consistent with the mission of the FHLBs, and (iii) we have all done our homework on this side of the table and are prepared to defend the arrangement, if necessary.”
Although some of the REITs involved, such as Redwood Trust and Ladder Capital, declined to comment on the issue, others on that side of the issue do not feel that the moratorium is as much of a problem as the silence suggests. Eckert claims that, in the bigger picture, not much is likely to change once the 90 days is up.
“I am not sure that I consider joining the FHLB to be a big deal and I do not consider this moratorium to be a big deal either. The only real advantage that the FHLB offers to non-bank entities is that they are a reliable source of funding. They are different in that they will not arbitrarily yank a line of credit although, much like the big banks and repurchase lenders, they will insist that borrowings are fully collateralised.”
Eckert continues: “Three months is not a very long period of time. I’ve been following the housing finance industry in one shape or another for the last 25 years. I do think that the plan will go ahead and ultimately the FHLBs will be granted the authority to admit these non-bank mortgage lenders and investors through the back door via a captive subsidiary, as it advances that housing finance mission. It helps them diversify their sources of lending.”
Whether the issue really is as trivial as some believe remains to be seen, but what cannot be denied is the potential upheaval that would present itself in the wake of the FHFA attempting to ban the membership of captives altogether. In other words, to say that captives have suddenly become ineligible would be to admit that the FHLB has been wrongly granting memberships to captives for the past 20 years. This has compelled captive owners to discover specifically what the FHFA’s issues are and what can be done to appease them.
Geromette says: “I initially pushed back on the 90-day moratorium as I felt that 12 independently owned and operated institutions cannot collectively agree to exclude or delay membership to otherwise eligible because that potentially violates some anti-collusion or anti-trust principles.”
“I want to speed the process along, because this regulatory purgatory isn’t beneficial for anyone (except perhaps the FHFA). If there is going to be a formal action by the FHFA, I would like to get to that point as soon as possible because it will help to clarify exactly what FHFA’s issue is with this arrangement.“
“Nevertheless, thus far during the moratorium, all the banks that were committed to captive insurance companies before have stated that they remain 100 percent committed. Whatever the issue may be, I am confident that it will come out in our favour.”
