FHL Banks Give A Boost To U.S. Mortgage Market

The Federal Home Loan Banks (FHLBanks or FHLB) is one of the beneficiaries of 2016 money-market fund overhaul, something that gives fresh support to U.S. mortgage market change, as interest rates increase slowly. J.P Morgan Chase borrowed $79.5 billion, Well Fargo $68.7 billion, Citigroup $31.6 billion, PNC Financial Services $17.1 billion and Capital On $16.3 billion.

Funds that invest in government debt are fueling a rise in debt issuance by the FHLBanks. FHL Banks are 11 banks sponsored by the U.S. government that provide reliable liquidity to member financial institutions to support housing finance and community investment. The increase will help a lot FHLB member banks such as J.P. Morgan Chase and Wells Fargo which borrow from the FHLB to fund mortgage lending.

The banks’ outstanding debt on home loans increased by 10% in 2016 and reached $989.3 billion, its highest level since 2009. About 30% of their debt is now floating-rate debt, the most since at least 2002.

Each of the 11 FHLBanks lends to local banks and other financial institutions, secured by the mortgage loans or bonds posted by the borrowers. FHLBs has been created by Congress and therefore their debt is considered as “next best thing to government debt”.

The lending surge isn’t the first turn in the spotlight for the FHL Banks. In the 2008, the Federal Reserve called FHLB the “lender of next-to-last resort” in an effort to to help lenders survive the financial crisis.

Katy Burne explains in a Wall Street Journal (WSJ) article that “It is the latest sign of how far-reaching the 2016 money-market overhaul has been. That effort, overseen by the Securities and Exchange Commission, aimed to prevent a repeat of the 2008 run on a large money-market fund that lost money on debt holdings issued by Lehman Brothers Holdings Inc. The new regulations required so-called prime money-market funds holding mostly corporate securities to report daily share prices that fluctuate with changes in their portfolios, rather than fixed share values. Over the past year, this prompted many investors to shift about $1 trillion from prime funds into government-debt funds that aren’t subject to the same restrictions. Funds flowed out of prime funds that once were the leading purchasers of bank commercial paper and certificates of deposit and into government-only funds”.

Now the FHL Banks, the second-largest issuer of debt held by U.S.-taxable money-market funds, after the Treasury, are lending money to banks that have been reduced to access prime-fund cash.

Government money funds, those that invest at least 99.5% of its total assets in cash, government securities, and/or repurchase agreements that are collateralized by cash or government securities, prefer to buy the FHLB’s floating-rate securities because while they have maturities ranging from six to 18 months, their interest rates reset monthly or quarterly with the London interbank offered rate benchmark, and are attractive to investors anticipating a rising-rate environment.

In 2016 the Federal Housing Finance Agency that also regulates government-backed mortgage giants Fannie Mae and Freddie Mac has warned the FHL Banks that they have been exposing themselves to the risk that they could be unable to refund maturing short-term debt called “discount notes” if the market dried up. After this warning, discount notes have fallen to 41.5% of outstanding FHL Banks debt, down from a peak of 54% in December 2015.

WSJ explains that “the increased lending by FHLBs also is timely because demand for their secured loans is growing, on account of new federal rules requiring banks to have predetermined levels of cash on hand”.

In times than the American banks are restricted by new liquidity rules and cannot do too much short-term borrowing, the FHL Banks will be able to provide them with low-cost loans.