Use of secured loans or advances from the 12 Federal Home
Loan Banks (FHLBanks) by their four largest members has surged over the last
two years. The primary mission of the
FHLBanks is to support housing finance and they do so by providing advances to
their 7,500 member institutions which include banks, thrifts, credit unions,
and insurance companies. By law the
members can use these advances to originate mortgages or for other
Use of these advances had declined by about 62 percent from a
2008 peak of about $1 trillion to $381 billion in March 2012. Then advances began to increase, reaching
$500 billion by December 2013. The
growth was driven primarily by a 158 percent increase in advances to JP Morgan
Chase, Bank of America, Citigroup, and Wells Fargo to a group total of $135.11 billion.
According to the Federal Housing Finance Agency (FHFA) which
regulates the FHLBanks, the increase in advances to these four members is
largely attributable to bank liquidity standards established in December 2010
by the International Basel Committee on Bank Supervision. These so-called Basil III standards require
that banks increase their holdings of high quality liquid assets such as U.S.
Treasury securities, to improve their ability to withstand sudden financial and
economic stress. FHFA said that large
numbers of system members have recently taken advances, in part to purchase the
securities necessary under these rules.
FHFA OIG has concluded an audit of these advances to
determine whether the surge in advances will continue, will spread to other
member institutions, or if it has peaked.
OIG also looked at how effectively the FHLBanks are managing the
concentration of advances and the associated risks, and what the implications
might be for the System's housing mission if its members increasingly use
advances to meet liquidity requirements.
Specifically OIG looked at the
How bank holding company subsidiaries may be members
of multiple FHL Banks and thus borrow from more than one Bank.
The growth in advances to the four largest
System members since early 2012.
The role played by recently adopted liquidity
standards in this growth.
The benefits and risks associated with this
The effectiveness of FHFA oversight of the management
of risks associated with these advances.
That four large banks have dramatically increased their use
of FHLBank advances is magnified by the structure of the System. An eligible institution may become a member
of only one of the 12 banks, but bank and thrift holding companies may own
subsidiaries situated in several FHLBank districts and each may join the bank
in the district in which it is situated.
FHFA confirms that 49 institutions currently operate through
subsidiaries in two or more System districts.
Thus the four large institutions not only are the largest members of the
system in terms of total advances but each holds advances from multiple banks.
As of December 31, 2013 JP Morgan Chase held $61. 83 billion
in advances from five FHLBanks, with 67.4 percent of the total lent by Cincinnati. Bank of America held $28.94 billion from four
banks, 60 percent of which was borrowed from the Atlanta Bank while Citigroup's,
$25.20 billion and Wells Fargo's 19.14 billion were almost totally from the New
York and Des Moines banks respectively.
While the individual numbers were not large, the four institutions had all
received advances from the San Francisco FHLBank totaling over $17 billion in
While each of the four banks have increased their borrowing
significantly, Chase and Wells Fargo grew at triple digit rates while Bank of
America and Citigroup doubled their rate of advances. Further, Chase's increase in advances of $48
billion accounted for 59 percent of the total of $84 billion in advances to all
four during the period.
The increases in advances to the four banks contrasts
sharply with the relatively stable rate at which advances were made to other
System members during the period. While
the four increased their use of advances by 158 percent other systems members
posted an average increase of 9 percent.
Further, the 9 percent occurred entirely in the last three months of the
period; from March 31 2012 to September 30, 2013 other member advances declined
by 1 percent. As the four big banks
increased their total advances they also increased their relative share of all
System advances, accounting for 27 percent of advances at the end of the period
compared to 14 percent on March 31, 2012.
The most significant concentration of advances was from the
Cincinnati bank to JP Morgan Chase. At
the end of the second quarter $4 billion in advances to Chase represented 11.6
percent of that bank's total; by years end Chase held 64 percent of all of the
Cincinnati's banks advances to its members.
According to the FHFA's Division of Federal Home Bank
Regulation (DBR) and internal records the large member banks have increased
their use of advances as part of an overall strategy to meet the Basel III liquidity
requirements. DBR stressed that this use
is consistent with the FHLBanks collateral requirements, lending limits, and
other statutory, regulatory and internal standards and that" there are no restrictions
on the uses to which members may put the advances other than those that already
exist in law and regulation."
OIG spoke with representatives of the Securities and
Exchange Commission and with officials of three of the large banks about the
use of advances for meeting Basel III requirements and the SEC and two of the
banks verified this theory. Chase
identified the advances as one source available for funding a reported 53
percent increase in its high quality asset holdings. Officials from two other banks confirmed that
the Basel III requirements contributed to their increased use of advances with
one identifying it as the primary driver.
The fourth bank did not respond to OIG's requests.
DBR officials speculated that a deposit run-off at member
institutions may have contributed to the increases in advances to the remaining
FHLBank members in the fourth quarter of 2013 as depositors may have withdrawn
money from low interest savings accounts seeking higher returns in the stock
OIG said there were both risks and benefits associated with
the surge in advances to large members.
The advances could help stabilize the finances of the 12 banks and
potentially the system as a whole, increasing the dividends available to large
and small member banks and allowing larger contributions to the Affordable
Housing Programs which receives 10 percent of each FHLBank's net income each
year. However, OIG notes that these
growing advances have not yet translated into materially higher interest
income. As overall interest rates have declined
the rates paid by large members have fallen even as their advance balances have
grown. Further, many of the advances to
larger members were floating rate advances at very low initial rates. However, the advances may serve to offset
some of the System's non-core mission assets such as PLMBS which have been
criticized in earlier OIG reports.
Risks inherent in the growth of advances are largely those
of concentration. An FHLBank could
experience substantial losses if a large member defaulted on its advances and
if the lender had not ensured and monitored its collateral. OIG said that both FHFA and System officials claimed
that collateral management is a high priority and that FHFA evaluates the
System's risk management controls at every annual examination.
There is also the possibility that the System's banks could
become overly dependent on the interest income from the large banks and could
face financial challenges if a large member reduced its advances or withdrew
its membership. DBR said that some of
the Banks are better able to "scale" their advance activity than others and
mitigate such risks.
There is also a potential that FHLBanks could favor large
members over smaller ones to gain business; lowering advance rates or easing
capital or collateral requirements or that a company that belonged to more than
one FHLBank could redirect funding to cause price competition within the
Lastly, FHFA officials said there may be an increased "image
risk" associated with the pattern of advances.
Concerns about the housing mission focus could be raised by the Basel
III purpose of the advances. FHFA,
however, classifies all advances to be core housing mission assets and only
those with maturities longer than five years are designated specifically for
OIG found that oversight of the surge in advances was a
priority of DBR in its 2013 examination cycle and will remain so in 2014. Examiners have focused on the System's risk
management practices such as collateral management and have maintained regular
communications with officials about the growth of advances to the four largest
members. Weaknesses found by examiners
at three FLHBanks are currently being corrected.
DHR exams found no indication of favorable treatment to
large member banks; it appeared lending was transparent and consistent with
established policies and no pricing discrepancies were identified. The regulator also said it had plans to study
at least on large member to evaluate the risks association with the
concentration of advances. The study
would likely assess the members' advance activity, pricing, and the FHLBanks'
risk management procedures.
OIG concluded that the rapid growth of advances from March
2012 through December 2013 was primarily due to a surge in advances by the
System's four largest members which was likely driven by the need to meet Basil
III liquidity requirements. The advance
trend, if it continues, offers potential benefits to the System including
higher interest rate income and an increased focus on core housing mission
assets. The surge however presents
safety and soundness risks that must be mitigated and increasing use of
advances for liquidity needs could raise public concerns about the System's commitment
OIG said it believes that FHFA can take steps to enhance
transparency about the advances and recommends that the agency collect and
analyze information on FHLBank advances in 2014 and report publicly on this as an
advance trend, the reasons for such advances, the effectiveness of System risk
management practices, and the consistency of such advances with the System's