REQUIRED READING: The 12 regional Federal Home Loan Banks (FHLBanks) are a critical resource to community banks, the vast majority of which are FHLB members and active advance users or look to the FHLBanks as a primary source of liquidity when needed. FHLBank advances play a significant role in supporting community-bank mortgage, small business and agricultural lending, and in helping community banks manage the interest-rate risk in their portfolios.
The FHLBanks help community banks compete with the too-big-to-fail banks in our markets by also offering a variety of correspondent services. Agricultural community banks must also have access to FHLBank advances to compete with Farm Credit System lenders, the only government-sponsored enterprise (GSE) that offers credit at the retail level, with the advantage of direct access to low-cost capital markets funding.
The FHLBanks serve a vital role and must remain a strong, stable and reliable source of funding for community banks. Their value was proven during the recent financial crisis when they continued to provide advances without disruption while other segments of the capital markets ceased to function.
Any broad-based recovery of the housing market must involve community-bank mortgage lending, to which the FHLBanks lend critical support. Community banks represent approximately 20% of the mortgage market. But, more importantly, the mortgage lending is often concentrated in the small towns and rural areas of this country, which are not effectively served by large banks.
Surveys by the Independent Community Bankers of America (ICBA) show that while the FHLBanks offer a wide range of products and services, the availability of advances – or collateralized loans – is, by far, the most important reason why they choose to be FHLBank members. For example, my institution, Standard Bank, held $33.2 million in advances as of the end of August 2010.
FHLBanks offer advances in a variety of maturities, from overnight to over 20 years, and they customize terms to help their members manage interest-rate risk. Community banks use advances to fund new originations and existing portfolios of mortgages and other types of loans, and to manage the substantial interest-rate risk associated with holding longer-term fixed-rate loans in portfolio.
Some community banks use advances to adjust the duration of their liabilities to better match their assets and manage risks. Short-term, on-demand advances can be used to provide liquidity in the event of unexpected deposit runoff or to take advantage of an opportunity to lend. Advances benefit a broad spectrum of consumers by lowering the cost of credit.
While deposits are the most important source of funding for community banks, advances are a critical complement to deposits. During periods when loan growth outstrips deposit growth, community banks must be able to turn to advances as a dependable and convenient source of funds in order to serve their communities.
Without access to advances at such times, community banks would lose market share to large banks, which are able to directly access the capital markets to raise funds. Moreover, advances can be customized to match the funds required during the longer duration on many customer loans in a way that is not possible with checking or savings accounts or certificates of deposit. There is an ongoing need for advances to structure funding for loans.
Because most community banks have assets of less than $1.04 billion, they qualify as ‘community financial institutions’ as defined by the 1999 Gramm-Leach-Bliley Act (GLBA) and, therefore, are eligible to pledge collateral in the form of small-business loans and agriculture loans.
Smaller community banks are able to use advances to meet the broad spectrum of credit needs of their communities and thereby create and sustain jobs during these challenging economic times. The broader mission of the FHLBanks is another aspect in which they differ from Fannie Mae and Freddie Mac that are focused exclusively on residential mortgage lending.
An FHFA obstacle
The ICBA strongly opposes a Federal Housing Finance Agency (FHFA) advanced notice of proposed rulemaking that would re-impose a mortgage lending test on FHLBank members. The aforementioned GLBA also lifted the mortgage asset test for community finance institutions, which is significant for rural lenders that have few residential mortgage lending opportunities but greatly benefit from FHLBank membership. Many banks believe it is critical that they continue to be able to pledge agricultural and other non-housing collateral for advances.
It is very troubling that the FHFA has now proposed to reverse, by regulation, Congress' removal of the asset test. The proposal cuts against the grain of Congress' clearly expressed intention of expanding the mission and role of the FHLBanks beyond residential housing finance to supporting small- and medium-sized businesses and other critical community needs, such as senior housing.
The FHLBank system is able to fund advances by selling debt instruments in the world capital markets using its strong credit rating. This market access is absolutely critical to community banks' ability to compete with large banks and serve their communities.
Because the debt instruments are joint obligations of the FHLBanks, they carry less risk and lower interest rates. Buyers include mutual funds, commercial banks and government bodies – both in the U.S. and abroad. Broad market access is critical to the FHLBanks' financial strength and reliability.
Merging the FHLBank system with Fannie Mae and Freddie Mac is not the right solution to address the future of the two housing GSEs. While community banks have benefited from the existing FHLBank secondary market programs, the primary business of the FHLBanks must remain advances.
Community banks are well served by the regional nature of the FHLBanks that allows each bank to tailor its products and services to the needs of the regional economy. It is important to preserve the regional FHLBanks, which are better able to understand the environment in the communities their members serve, particularly the special needs of rural communities.
The FHLB system is owned and governed by its members, and any move toward consolidation should develop from the grassroots level, based on what members perceive to be the best operational and/or geographic structure for their district FHLB to meet their needs.
The cooperative nature of the system also must be maintained, with membership having a strong voice in governance. There is a need for both large and small institutions to enjoy FHLBank membership. The cooperative structure of the FHLBanks gives small members the same access to products and services offered to the largest members.
Forty percent of all FHLBank directors are independent, and the rules for election of member directors limit the number of votes that large members can cast, effectively ensuring that smaller members are well represented. As a result, 63% of all member directors represent institutions with less than $1 billion in assets.
While housing has been the FHLBanks' historic focus, they now provide support to community financial institutions for a much broader range of lending and banking services. The FHLBanks proved to be solid and effective in supporting liquidity and housing finance through the financial meltdown. Their loss, or any changes that would impair their ability to offer low-cost funding, would present a very significant challenge to the community banks that serve a variety of markets from coast to coast.
Timothy K. Zimmerman is president and CEO of Monroeville, Pa.-based Standard Bank. He can be reached at (412) 856-0354. This article was adapted from testimony delivered before the House Committee on Financial Services Subcommittee on Oversight and Investigations on behalf of the Independent Community Bankers of America.