WASHINGTON — The Federal Home Loan Bank System has been one of the few success stories to emerge during the financial crisis by pumping billions of dollars into banks with fast, low-cost loans while generating hefty profits.
But as the market turmoil deepens, growing pressure on Home Loan bank advances could make them less attractive to members.
The debt that funds advances is becoming more expensive to sell, according to Home Loan bank insiders, and the cost of loans to members ultimately will rise as a result. Also, the system is encountering unexpected competition from the Federal Reserve Board, which has dramatically eased access to the discount window over the past year.
"This is the best of times and the worst of times," said Alfred DelliBovi, the president and chief executive officer of the Home Loan Bank of New York. "The cooperative is performing very well and exactly as intended, and we're continuing to provide funds to Joe the plumber. But it is a tough environment, and the costs of our borrowing are going to go up."
Those higher costs ultimately would be covered by member banks, which would shell out more for the advances that have proven crucial to liquidity in the past year.
The loans will "cost community banks more money," said John von Seggern, the president of the Council of Federal Home Loan Banks. "If we're being penalized for our strength, community banks are going to have to pick up for that cost."
The 12 Home Loan banks continue to have access to funding markets. A spokesman for the Home Loan Bank System's Office of Finance, which issues debt on behalf of the banks, said the system raised $180 billion in the last week.
Anecdotal evidence also suggests the system will post strong growth in its advance business when third-quarter earnings reports are filed next month.
Yet the Home Loan banks say they are suffering perverse consequences of last month's government takeover of Fannie Mae and Freddie Mac. Though the banks are widely seen as fundamentally strong, they have paid between 20 to 30 basis points more for some debt than the government-operated Fannie and Freddie.
"The Home Loan Bank System has the same safety net as Fannie and Freddie, but the Home Loan banks didn't need the safety net," said Robert Davis, the American Bankers Association's executive vice president for government relations. "As a result, Fannie and Freddie are in conservatorship because of their troubles and made the relative pricing of Home Loan bank debt less attractive."
That point is not lost on Home Loan bank officials.
"This is the ultimate irony," Mr. DelliBovi said. "We stuck to our knitting and performed well. The two GSEs got into trouble and are in conservatorship, and investors say they're a better bet."
Another complicating factor is last week's announcement that the Federal Deposit Insurance Corp. would temporarily guarantee all unsecured bank debt. That announcement, which effectively made bank debt one of the safest bets for investors, helped drive up the cost of government-sponsored enterprise debt, which has historically been seen as low-risk.
"What's made it worse is the FDIC guarantee," said Bert Ely, an independent analyst in Alexandria, Va. "The FDIC program on the debt guarantee … has got to really whack the Federal Home Loan banks in terms of shorter-term advances."
The Home Loan banks were already trying to adjust to new competition. The system has long had the market for quick, cheap liquidity, but the Fed's discount window is becoming increasingly attractive for some institutions.
The central bank lowered the rate on discount loans from 5.25% on Sept. 20, 2007, to 1.75% on Oct. 8. The rate is likely to drop again when the Fed's policymaking committee meets at the end of the month. And though it takes haircuts on collateral brought to the discount window, the Fed now accepts a far wider range of assets than the Home Loan banks to support borrowing.
"There are more funding sources available, and there's more regular use of facilities at the Federal Reserve," Mr. Davis said. "Some institutions may choose to use some of those instead of advances."
Borrowing from the Fed has soared recently, posting records for five consecutive weeks. The Fed said loans through the discount window reached $441.4 billion on Wednesday, including a record $101.9 billion directed to traditional commercial banks, which have tended to shy away from borrowing out of concerns about a stigma.
Still, Mr. DelliBovi said advances are more attractive than discount window loans, and he insists the Fed is not emerging as a big competitor to the Home Loan banks.
"I have not seen our members go to the discount window," he said.
The high borrowing from the Fed is a blip that is unlikely to develop into a long-term trend, Mr. DelliBovi said. "This isn't going to continue. I don't think that most community bankers who are in this for the long term want to have a temporary partner. The Fed will go back to being what it always was: a lender of last resort."
The Federal Housing Finance Agency also defended the value of advances. "The Federal Home Loan banks remain a good source of longer-term funding," a spokeswoman for the agency said.
Home Loan banks still have a pricing advantage on most of their short-term loans. Loans from the discount window carry a 1.75% rate, but the posted rate for a one-week advance from the Home Loan Bank of Boston, for example, is 1.15%. A three-week advance costs 1.38%, and loans maturing in one month carry a 1.53% rate.
But if a bank wanted a three-month advance, it would pay 2.69%. It could borrow "primary credit" from the discount window for three months at 1.75%.
The spike in prices for Home Loan bank debt is not unexpected. Several banks warned in their second-quarter earnings reports that market turmoil was hurting their ability to sell debt. "To the extent the FHLBanks receive sub-optimal funding, member institutions will, in turn, generally experience higher costs for advance borrowings," the Home Loan Bank of Des Moines said in its report.
Many Home Loan bank officials are spending time reassuring investors of their strength and pointing out differences between the system and Fannie and Freddie. But beyond education efforts, some say there is little the system can do but ride out the market.
"This doesn't prevent the Home Loan banks from providing attractive funding to their institutions," Mr. Davis said. "It's an issue of what's available in the market. It's a bit like going to the bakery and wanting cinnamon buns, and they only had doughnuts, and that's what you've got to eat."
