WASHINGTON — The Federal Housing Finance Agency may face legislation or a lawsuit in the near future as it tries to force captive insurance companies to exit the Federal Home Loan Bank System.
The agency approved a rule last week that would require real estate investment trusts that gained membership and access to advances through a captive insurance company to leave the system within five years.
But the rule has engendered significant opposition from the Home Loan banks, the real estate investment trust and others that are weighing whether and how to fight the rule.
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Community bankers and credit unions scored a significant victory while others in the mortgage industry lost out in the Federal Housing Finance Agency's final rule establishing membership standards for the Home Loan banks.
January 12 -
The agency scrapped a part of its 2014 proposal that would have required Home Loan bank members to maintain a certain percentage of residential mortgage assets in order to keep their membership. But it held fast on a provision that would disqualify captive insurance firms from membership.
January 12 -
Legislation would require GAO to study the impact the FHFA membership rule would have on the FHLB System and its members.
October 23 -
WASHINGTON Four more Federal Home Loan Banks have won regulatory approval to participate in a program that allows member institutions to sell jumbo mortgage loans through a conduit to Redwood Trust.
August 14
"We are evaluating possible next steps," said David Jeffers, senior vice president of the Council of Federal Home Loan Banks, which represents all 11 institutions.
One likely avenue is to seek relief from Congress, where lawmakers have already raised objections to the FHFA's membership rule.
"I would expect there will be push on the Hill to include mortgage REITs in the FHLB System," said Edward Mills, a policy analyst at FBR Capital Markets.
Congress has already expanded the membership of the Home Loan banks several times and could do so again. Lawmakers laid the groundwork for such a move late last year when a bipartisan group introduced a bill to block the FHFA from implementing its membership proposal. They argued that the FHFA was overstepping its authority.
After the rule was finalized on Jan. 12, Rep. Blaine Luetkemeyer, D-Mo., one of the bill's co-sponsors, said the housing finance agency "needs to comply with standards already set in law. Congress changes the law, not the FHFA."
Yet passing legislation in the current political environment is an uphill battle, particularly where the government-sponsored enterprises are concerned.
"There is nothing simple when it involves a GSE," Mills said.
Home Loan banks and captive insurers could simultaneously pursue a different strategy, however—taking the FHFA to court.
Law firms have already challenged the legality of the FHFA's move. In a comment letter sent in October 2014 to the agency, Thomas Vartanian, a partner at Dechert LLP, warned that the agency's proposal to kick REITs out was unlawful.
The Federal Home Loan Bank Act is "unambiguous in its mandate that 'any' insurance company may be eligible for membership in an FHLB," Vartanian wrote.
He claimed the statute does not make distinctions between life insurance companies and captive insurance companies that provide self-insurance for their parent company or REIT. He added that the agency also lacks the power to kick out existing Home Loan bank members.
Some said a lawsuit was likely.
"There are a number of parties who could challenge this rule, but mortgage REITs and their captive insurance companies would likely be the mostly favorably situated to have standing," said John Bowman, a partner at the Venable law firm, which also filed a comment letter in this rulemaking. "I am confident a judge would accept this case."
He noted that the Federal Home Loan Bank Act says an insurance company can be a Home Loan bank member. The FHFA's argument rests on the idea that a captive insurance company is not an insurance company, he said.
"I would argue among other things that the regulator acted outside its regulatory charter and their rule is legislative rather than regulatory," Bowman said in an interview.
Still, a lawsuit could also be an uphill battle as the courts normally show deference to the regulators. Even if a lawsuit prevailed, the outcome is uncertain. "The court could require the FHFA to go back and redo the rulemaking. Who knows want the result could be?" Bowman said.
The boards of directors of the 11 district Home Loan banks have "exclusive authority" over the termination of members under a provision included in the Gramm-Leach-Bliley Act of 1999, Vartanian wrote.
But the FHFA disagrees, pointing to amendments to the financial modernization law that gave a bank's board of directors some "discretion" to terminate a member.
"In this case," the FHFA director "has adopted regulatory amendments implementing a provision in the [Federal Home Loan Bank] Act in a way that makes captives — including those that were previously admitted ineligible for membership," the housing finance agency says in the final rule.
"It is not plausible to suggest, as do the commenters, that Congress thereby stripped the regulator of its authority to require the removal of a member when doing so is necessary to halt a violation of the statute or regulations."
The FHFA argues that captives can be used as funding conduits for REITs and other entities that "Congress did not deem eligible" for Home Loan bank membership. The final rule is designed to close what the agency sees as a loophole.
There are currently 40 captive insurers in the Home Loan Bank System with $35 billion in advances.
But the Home Loan banks argue that captive insurance firms are critical to their mission.
"We are deeply disappointed that, despite our efforts, the FHFA has disqualified captive insurance companies from membership altogether," Matt Feldman, president and chief executive of the Federal Home Loan Bank of Chicago, said in a statement after the final rule came out.
"Captive insurance companies have been members of the FHLBC for more than 10 years," the statement said. "As members, they help deepen and diversify the flow of funds in the mortgage markets."
The Chicago bank does significant business with Redwood Trust, a REIT that owns a captive insurance company that belongs to the bank. The bank has said that the membership rule will not affect one of its key programs, under which Redwood Trust buys jumbo mortgages from Chicago Home Loan Bank members.
"The rule does not impact Redwood Trust as our partner for the MPF product," said a spokeswoman for the bank, referring to the Mortgage Partnership Finance program.
However, it appears the final rule will limit the ability of Redwood Trust's captive insurer, RWT Financial, to obtain new advances from the Chicago Home Loan Bank.
"RWT Financial may not be able to obtain additional advances or increases to its borrowing capacity," Redwood said in a Jan. 13 statement.
RWT Financial has $2 billion in borrowing capacity and it already has $2 billion in outstanding Chicago Home Loan Bank advances, according to Redwood.
Current advances can "remain outstanding until the scheduled maturity, even if it extends beyond the five-year transition period," Redwood Trust said. However, the membership rule places limits on new advances during that five-year period.
