It often gets lost in the shuffle, but the Federal Housing Finance Agency (FHFA) is not just the regulator and conservator of the government sponsored enterprises Fannie Mae and Freddie Mac, it also regulates the Federal Home Loan Banking System (FHLBank). Melvin L. Watt, Director of FHFA spoke to directors of those banks on Tuesday, at their Directors' Conference.
Watt said that the System had its most profitable year ever in 2016, with net earnings of $3.4 billion. This, however, was in part due to litigation settlements over private label securities which contributed $952 million of the total. "Earnings, while still strong," Watt said, "would have been more in line with recent annual System earnings, without this non-recurring settlement income."
The consistent profitability of the System has also allowed the FHLBanks to add almost $7.8 billion to their accumulated retained earnings over the last five years. System-wide retained earnings now constitute more than 1.5 percent of aggregate FHLBank assets and more than 30 percent of regulatory capital, up from 16 percent five years ago. These earnings however are not evenly distributed across the System.
Advances grew by $71.2 billion to $705.2 billion in 2016, pushing system assets above $1 trillion for the first time since 2010. While the ten largest borrowers accounted for 80 percent of the increase, there were increases in advances to smaller borrowers System-wide. The banks also generated $392 million in Affordable Housing Program funding, pushing the average contribution for the last five years to over $300 million per year.
Watt said the System has several regulatory issues of concern, related to funding, liquidity, capital, and large member concentrations. Regarding funding, FHLBanks are heavily reliant on short-term funding of longer-term assets. This can strain the System's capacity to issue short-term debt at attractive spreads. Right now, he said, this is not an issue but a future downturn under the existing conditions would pressure the banks to exacerbate the mismatch. Additionally, rolling short-term debt is more challenging when interest rates are rising. Watt said, a year after raising the issue, FHFA has seen some progress on this front although some FHLBanks are doing better than others.
FHFA's has also be looking at its existing FHLBank liquidity requirements to determine what standards should be put in place going forward. The primary goal is to ensure that the FHLBanks can continue their operations even if market demand for their debt is disrupted. Watt said he understands that the liquidity and funding challenges facing the FHLBanks differ from those facing depository institutions and the agency intends to issue a new rule by the end of this year to replace the 2009 liquidity letter that currently sets expectations in this area.
Third, FHFA is reviewing and working to revise the current risk-based capital regulation. New data and modeling improvements have become available since 2001 when the Finance Board issued the current rule and the agency will take advantage of these advances to revise the rule and get into compliance with the Dodd-Frank Act's requirement. The latter does not prohibit the use of ratings from Nationally Recognized Statistical Rating Organizations to assess credit risk, but does forbit sole reliance on this source.
Finally, FHFA continues to monitor the concentration of advances for the System as a whole, and for some FHLBanks in particular, to a few large members. This is to ensure that each Bank is pricing their advances to large members appropriately and has appropriate contingency plans if a large member decreases its demand for advances or is unable to repay those it has.
Watt said in conclusion that, after several years of preparation, FHFA started including FHLBank performance on diversity in its regular examinations as of last January. Each FHLBank board should be providing leadership on diversity and inclusion and leadership for the housing finance industry as a whole. The diversity and inclusion examinations focus on assessing seven components of each entity's program: Board Oversight, Strategic Planning, Organizational Framework, Supplier Diversity and Inclusion, Workforce Diversity and Inclusion, Reporting, and Compliance/Audit. Watt said he is encouraged by the progress examiners have seen thus far.