Central Reserve Depository Institutions, NEC

SIC 6019

Industry report:

This classification includes central reserve depository institutions, other than federal reserve banks, primarily engaged in providing credit to and holding deposits and reserves for their member commercial banks, thrift and loan associations, credit unions, insurance companies, and other federally insured financial institutions that hold at least 10 percent of their assets in residential mortgage loans.

The Federal Home Loan Bank (FHLB) System was established by Congress in 1932 with the passage of the Federal Home Loan Bank Act. The FHLB System's intended role was to provide readily available, low-cost funds to federally insured savings institutions. As it was originally constituted, the FHLB System acted as regulator and supervisor of federally chartered savings institutions and federally insured, state-chartered savings institutions.

Coming on the heels of the savings and loan debacle of the 1980s was the creation of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and the dissolution of the Federal Home Loan Bank Board (FHLBB). FIRREA eliminated the FHLBB and transferred those powers to the Federal Housing Finance Board (FHFB). Thrift institutions that were members of the FHLB System continued, as before, to be regulated by the Office of Thrift Supervision, which was part of the U.S. Treasury. FIRREA simultaneously expanded member eligibility in the FHLB System to include commercial banks, credit unions, thrift and loan associations, and other federally insured financial institutions.

After the dismantling of the FHLBB, the 12 regional governing banks in the system acted as wholesale banks only, providing their shareholders with an important link to the U.S. capital markets. In 2010, more than 8,000 member banks composed the FHLB System.

The banks' mission is to provide access to housing for all Americans and to improve the quality of credit by raising funds for their lender institutions/shareholders through the Office of Finance which, in turn, issues and services debt for the banks. The FHLB System is one of the three largest issuers of debt in the world. The system's consolidated debt rating is designated AAA by both Standard and Poor's and Moody's rating services. According to the FHLB web site, "The AAA rating on the debt of the FHLB System reflects the System's status as one of three housing GSEs [government-sponsored enterprises], its important role as a primary liquidity provider to U.S. mortgage and housing market participants, its diverse global investor base that enables ample liquidity at low funding costs across maturities, and its excellent aggregate asset quality in its lending portfolio (advance business)."

Until 2008, the FHLB System was regulated by the FHFB, an independent agency of the executive branch responsible for ensuring that the banks carry out their housing finance mission, remain adequately capitalized, raise funds in capital markets, and be fiscally solvent. The finance board also established policies and regulations governing the operations of the banks.

With regulatory authority and supervisory oversight responsibility for the 12 FHLB banks, the FHFB had a five-director board, one of whom was the secretary of housing and urban development. The four other directors were appointed by the president and subject to Senate confirmation. The FHFB's directors were chosen from a pool of people who had extensive experience in housing and community development finance or with a commitment to representing consumer or community interest in services, credit needs, housing, or consumer protection.

The FHFB was supported by assessments from the 12 FHLB banks. The banks financed their own operations through investments, the sale of collateralized obligations, and by charging for credit products and services they provided to member institutions. No tax dollars or other appropriations were used to support the operations of the FHFB or the bank system.

The FHLB System underwent significant change between 1990 and 2005. Prior to the 1990s, the System was made up primarily of thrift institutions, but after the passage of FIRREA in 1989, which came on the heels of the failure of hundreds of thrift banks during the 1980s, commercial banks joined the ranks of FHLB in significant numbers. By 2010 about 80 percent of FHLB System members were commercial banks.

Although FIRREA strengthened the System and shored up the thrifty industry, there were fears that the capital structure was inherently unstable because commercial bank members were allowed to withdraw stock from their FHLB on just six months' notice. As a result, several more provisions were enacted to firm up the System's foundation. Of particular importance was the Gramm-Leach-Bliley Act of 1999, which created a risk-based capital structure and required members to invest capital for a minimum period of five years.

A major issue in the early 2000s was the FHFB's reaction to an increasing interest in acquiring mortgage assets, which was expanding rapidly. In 2003, mortgage assets totaled $113 billion, or about 14 percent of total assets. However, concerns were raised by the FHFB that the FHLBanks could not adequately manage the risks associated with holding mortgages. In 2004, the FHFB reined in two FHLBanks for their mortgage program risk management practices. This proved to be a fortunate move, as the effects of the subprime mortgage crisis began to be felt later in the decade.

In a move much opposed by the industry, in June 2005 FHLBanks were required to register with the Security and Exchange Commission. By August 2006, all 12 banks had complied. This move also required them to comply with the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act mandates that organizations be run by an independent board of directors and provides guidelines for financial expertise on the boards.

Further legislation included the Housing and Economic Recovery Act of 2008, passed in July of that year. One of the changes was that the existing regulator of the FHLB System (the FHFB) was replaced with the Federal Housing Finance Agency (FHFA). The other change granted the Secretary of the Treasury authorization to purchase FHLBank debt securities in any amount through December 31, 2009. In September 2008 the U.S. placed GSE mortgage-finance companies Fannie Mae and Freddie Mac into conservatorship and pledged $200 billion in funds to help protect shareholders' more than $5 trillion of debt and mortgage bonds. In January 2009, Moody's speculated that the FHLBanks may also be put into conservatorship or merged with other companies, as their debt totaled more than $1 trillion at the time. However, by July 2009, 11 of the 12 FHLBs were reported to have met their capital requirements.

In the FHLBanks Combined Financial Report for 2009, the combined assets of the 12 banks were approximately $1.01 trillion. This included $631.1 billion in advances, $284.3 billion in investments, and $71.4 billion in mortgage loans. Combined net income totaled $1.8 billion, down from $2.5 billion in 2005.

In 2010, the FHLB System as well as other financial institutions in the United States prepared to deal with the implications of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed into law on July 21. The Dodd-Frank Act proposed sweeping changes to financial regulation in the United States. In addition, according to Bloomberg News Service, the U.S. Securities and Exchange Commission voted in October 2010 to consider "a requirement that Wall Street underwriters scrutinize mortgages and other debt that is bundled for the sale of bonds." The Dodd-Frank Act "required the SEC to propose the rule after banks were faulted for selling debt to investors without concern for whether the underlying loans would go bad." As of October 2010, the Federal Home Loan Bank of Chicago was suing Bank of America Corp. and others for their "failure to disclose relaxed subprime mortgage underwriting standards, [which] led it to unknowingly buy risky mortgage-backed securities." Indeed, in 2010 the entire U.S. financial services industry was in turmoil, a condition that was expected to remain until the fallout from the crisis of the late 2000s had spent itself.

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