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Speech

Speech of Melvin L. Watt, Director, FHFA, at 2014 FHLBanks Directors Conference

FOR IMMEDIATE RELEASE
5/6/2014
Thank you for inviting me to speak today before the Annual Directors Conference.  It is a pleasure to address the directors and executive staff representing the 12 Federal Home Loan Banks (FHLBanks or Banks).
 
As members of the boards of FHLBanks, you have an important role in setting the direction of your Bank and the FHLBank System.  I thank you for your commitment to this important role.
 
Since being sworn in as Director of the Federal Housing Finance Agency in January, I have been evaluating and assessing the Agency, getting to know the staff and meeting with the regulated entities.  In that time, I’ve traveled to Dallas to see first-hand what you do and how you do it.  I also had the opportunity to meet with the FHLBank Presidents and hear their priorities.
 
Today I would like to discuss the important role the FHLBanks play in housing finance.  I’ve selected you as the first audience I’ve spoken to since being sworn in.  Next week, as recently announced, I will be discussing the next steps in the conservatorships of Fannie Mae and Freddie Mac.  Today’s speech and the one I will be delivering next week provide opportunities for me to discuss my views about the goals of FHFA.
 
The FHLBanks continue to have an important role to play in housing finance by providing a reliable funding source, access to the secondary mortgage market and other services to member institutions, in particular smaller institutions that have limited access to these services.  In addition, the Banks have specific statutory requirements related to affordable housing and have been successful in meeting this important affordable housing goal.
 
FHFA has been and will continue to focus on ensuring that the FHLBanks accomplish these housing finance and affordable housing roles in a safe and sound manner.  Recent results have been positive:
 
  • FHLBank income trends have been positive – every FHLBank has recorded positive net income for each of the past ten quarters;
  • Advance volume has increased;
  • Capital is stronger now than in the past, and the accumulation of retained earnings is a positive development; and 
  • Over the past several years, changes in composite exam ratings have been upward.
 
Today I would like to touch on five subjects that I believe both FHFA and the FHLBanks should focus on to ensure that we are working together to continue to be successful. 
 
First, I think that Franchise Value is something that we should continue to focus on.  
 
The FHLBanks are somewhat unique when it comes to thinking about “franchise value.”  Unlike private for-profit entities, franchise value for FHLBanks is not reflected in stock price.  Since FHLBanks are organized as cooperatives for which stock is purchased and redeemed at par, the concept of franchise value for an FHLBank relates to delivering the benefits of System membership to its members.  At the most basic level, these benefits include access to funding, other services that connect members to capital markets, support for the affordable housing and community development activities of their member entities, and a reliable dividend.  And delivering these benefits must be done in a safe and sound way with adequate capital and with an overall focus on the FHLBank System’s mission. 
 
Perhaps the two most important factors in considering FHLBank franchise value are advance demand and membership.  While we have seen an increase in advance demand in 2013, much of that was concentrated among larger members.  Beyond this 2013 increase, serious questions remain about whether changes in advance demand are cyclical or whether they are more structural.  The cyclical factors are well known – a slow economic recovery, high levels of deposits at member institutions, and reduced lending in general.
 
But there have also been some structural factors that could have even more profound and longer-term impacts on advance demand.  Member consolidation, deposit insurance premiums and coverage, and interest on excess reserves have decreased advance demand.  More recently, changes in Basel III liquidity requirements and expectations have increased advance demand from some larger members.
 
Understanding the factors that are leading to changes in advance demand and evaluating the membership composition and long-term ability of your FHLBank to deliver the benefits of System membership remain important considerations in sustaining franchise value.  What the FHFA has observed is that the Banks that have benefited from upward advance demand have some common characteristics: core mission focus, low-risk investments, a stable dividend, and the ability to easily repurchase or redeem excess stock.
 
This leads me nicely to the second topic I’d like to say a few words about - Core Mission Activities.
 
You’ll recall that in 2013, FHFA started a discussion with the FHLBanks about core mission activities.  That discussion began in the context of FHFA’s rule on strategic business plans that asked each FHLBank to develop a plan that, among other things, included "maximizing activities that enhance the carrying out of the mission of the Bank". 
 
While core mission activities are defined in regulation, FHFA’s effort, as I understand it, was focused at its most basic level on how the FHLBanks directly use the benefits of the funding advantage they receive from being Government Sponsored Enterprises for housing finance and community development purposes.  This led FHFA to propose benchmarks that were based on advances and acquired member assets (mortgage loans originated by members and purchased by an FHLBank) in relation to consolidated obligations.
 
While FHFA tried to make it clear that these were proposed benchmarks that no FHLBank would be examined against, as I understand it, the core mission activity concept generated fairly substantial discussion between FHFA and the FHLBanks.  Questions were raised about the level of the targets, measurement of other System activities that help to achieve the FHLBanks’ mission, and where this process fits into FHFA’s supervisory framework. 
 
While these are all good questions, we still need to continue these discussions.  The FHLBanks have submitted their plans, FHFA staff are conducting detailed analyses of those plans, and FHFA staff will be contacting the Banks regarding the various issues that were raised. 
 
Focusing on your core mission is very much related to safety and soundness and is much less likely to cause financial difficulties.  It is a source of historic pride that the FHLBanks have never experienced a credit loss on advances.  But, some of the Banks’ investments outside their core mission prior to the housing crisis brought them close to economic peril and affected their ability to perform normal FHLBank functions like repurchasing stock. 
 
Clearly demonstrating that the FHLBanks are achieving their core mission remains an important issue for FHFA, and I want it to continue to be an important issue for you.  So I look forward to continuing FHFA’s plan to evaluate the core mission activities of each FHLBank and finding common ground with you about how best to move forward on this objective. 
 
Let me move quickly to a third subject that I want to say a word or two about – Membership Composition.
 
One of the fundamental changes occurring in the FHLBank System is membership composition.  While the traditional membership base has been contracting, membership interest from insurance companies has been expanding.  Advances to insurance companies have increased from one percent of advances in 2000 to 14 percent in 2013 and the number of insurance company members in the System is now up to 290. 
 
While lending to insurance companies has been permitted since the creation of the FHLBanks in 1932, lending to insurance companies does present different risks than lending to insured depository institutions.  In December 2013, FHFA issued an advisory bulletin on risks associated with lending to insurance companies.  While we have found that overall the FHLBanks lend safely and soundly to insurance companies, we encourage each of your credit risk managers to closely follow the advisory bulletin.
 
One area of insurance company membership – captive insurers – deserves some additional attention.  Captive insurance borrowing and membership in the FHLBank System raises a number of possible issues related to safety and soundness and access to the System.  While I won’t elaborate on these issues today, you will certainly be hearing more about this as we move forward.
 
My fourth subject is the Affordable Housing Program.
 
After almost 25 years, the Affordable Housing Program (AHP) continues to be a success.  Part of that success has been partnering with local institutions that understand the needs of their communities.  From 1990 through 2013, the FHLBanks have contributed almost $5 billion in grants to fund affordable housing.
 
In response to FHFA’s Notice of Regulatory Review, the FHLBanks requested that FHFA review the AHP regulation.  We agree with you that the AHP regulation needs to be reviewed.
 
FHFA will be conducting a thorough evaluation of the AHP and we intend to begin the rule-making process in 2015.  We are asking program users to identify features of the AHP that should be retained and those that should be reconsidered.  We are seeking input from the FHLBanks, their Community Investment Officers, Advisory Councils, and other stakeholders.  In my recent meeting with the FHLBank Presidents, I learned that the Banks already have a process for gathering and providing your collective input on possible improvements and I very much look forward to hearing how to make this important program work better.
 
Finally, some comments about placing a higher priority on Minority and Women Inclusion. 
 
Each FHLBank, Fannie Mae, Freddie Mac and FHFA are required to have an Office of Minority and Women Inclusion.  Specifically, Congress requires:
 
  • First, that each FHLBank have a designated Office of Minority and Women Inclusion that is clearly identified in its organization chart and the OMWI Director must report to the CEO or COO equivalent; and 
  • Second, that each OMWI promote minority and women inclusion in employment, in management (including the board of directors), in business activities, and in contracts for services.
You can anticipate that FHFA’s focus on OMWI activities and effectiveness, both internally at FHFA and at our regulated entities, will increase.  In that regard, I will soon be naming a permanent OMWI Director at FHFA who will be working with each FHLBank to ensure full compliance with both the letter and spirit of the law.  
 
Conclusion
 
Let me conclude where I began, by thanking you for the important roles you are playing in keeping our FHLBank System strong and vibrant in these challenging and changing times and by assuring you that I look forward to working with you in our joint effort to ensure that the FHLBanks continue their operations in a manner that is both safe and sound and consistent with their mission. 
 
Thank you for your support of my role in these efforts.   

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Contacts:

Corinne Russell (202) 649-3032 / Stefanie Johnson (202) 649-3030

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