FHLB…What is it?

The more I dig into community banks, the more I find funny things in the financials that do not exist in non-banking companies. One of those items is FHLB stock. This article will be a quick overview on FHLB stock and what it means when you see FHLB stock in a bank’s balance sheet.

FHLB

The FHLB or the Federal Home Loan Banks is a cooperative consisting of 11 US government-sponsored banks that provide liquidity to its members. A map of the 11 existing FHLB institutions is shown in the map below…

fhlb

In 1932, the FHLB was formed in order to provide members with financial products, services and liquidity; in order to help develop and finance community lending across the nation. Members of the FHLB consist of commercial banks, credit unions, savings and loan associations and insurance companies.

Stepping back in time, pre-Great Depression, it was very common to see very short-term mortgages—we’re talking less than five years—carrying variable interest rates and requiring a nasty balloon payment; which usually needed to be refinanced. After the Great Recession rocked the economy, the federal government stepped in, and created long-term, fixed rate and fully amortizing mortgages, through their creation of a financial institution known as the FHLB.

Today, the reason why financial institutions join the FHLB is due to the quick and dependable liquidity through a type of secured loan. The liquidity is funded in a type of discount note, term debt or consolidated obligation.

The FHLB is a type of union for banks. The equity in the FHLB are held by the thousands of members of the FHLB. Interestingly, in order to become a member, a bank must purchase FHLB stock. After purchasing the stock, they will then become members and subsequently receive access to low-cost funding and dividends based upon the ownership they own in the FHLB. The basis of FHLB stock is not for capital gains growth or dividends, but rather to capital advances.

On the balance sheet, FHLB stock is sold at par, accounted for at par and redeemed at par. Furthermore, FHLB stock can only be sold to and from the FHLB or another member in the FHLB. Thus, the FHLB stock really doesn’t have a liquid market other than the members and the FHLB itself.

Regulations

One regulation put into place that had a long lasting implication on FHLB members was The Financial Institutions Recovery and Reform Act of 1989 or otherwise known as FIRREA. The first implication gave all depository institutions with more than 10% of portfolios in residential mortgages clear access to join the cooperative. This allowed a vast majority of credit unions and commercial banks to join the FHLB. Interestingly, membership increased from 3,200 to 8,000 from 1989 to 2005.

The FIRREA also imposed an income tax on the members of the FHLB. The tax required members to pay 20% of their net earnings in order to cover a portion of the interest on the Resolution Funding Corporation or REFCORP bonds. The REFCORP bonds were initially used to help finance the thrift ‘cleanup’.

For those who don’t know, the REFCROP bonds were issued in order to rescue savings and loan institutions that failed to save during the loan crises. The crises began in the late 70s and lasted through the early 90s. Many speculate that the crises happened because S&L companies increased their risk profile by speculating in commercial real estate and junk bond investing because their deposits were insured by the Federal Savings and Loan Insurance Corporation or FSLIC. Due to the rampant speculation, the FSLIC eventually became an insolvent government institution.

On August 5th, 2011, the FHLB banks were told that they satisfied their obligation to the Resolution Funding Corporation. Instead of paying 20% of net earnings to the Resolution Funding Corp, banks now pay 20% of their net income into its own restricted retained earnings account, until the account equates to one percent of the bank’s outstanding consolidated obligations.

Takeaway

This is just a quick introduction article on FHLB stock. The depth and breadth and analysis of the FHLB could go on and on, deserving the attention of a research report. If you want to learn more about the FHLB I suggest you start here…

The Federal Home Loan Banks in the Housing Finance System

FHLBANKS

Federal Housing Finance Industry

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