WASHINGTON With banks navigating an increasingly unsteady interest-rate environment, the Federal Home Loan Bank System appears suddenly to be in vogue again.
In the years since the financial crisis, the Home Loan Bank System had seen a sharp drop-off in its advances as the so-called flight to safety swelled bank deposit balances. But the Federal Deposit Insurance Corp.'s second-quarter industry update illustrated a significant shift as depositors finally opted to seek higher returns elsewhere. With banks looking for funding alternatives, FHLB advances held by banks enjoyed their biggest percentage increase in nearly six years.
"There is no doubt that the Home Loan banks have always played this role of buffering changes in bank balance sheet liquidity," said Steven Abrahams, an analyst at Deutsche Bank. "Banks will find the most efficient source of funds and the Home Loan banks have been a reliably valuable source of liquidity."
The numbers reflect only one quarter of activity, and industry totals for deposits and advances are prone to fluctuation. Still, deposits decreased by a mere 0.4% to $10.78 trillion for the first time in 12 quarters. Meanwhile, banks held over $368 billion in FHLB advances, which was 11.6% more than in the previous quarter, the biggest such increase since the third quarter of 2007. The nominal increase of $38 billion was the biggest such growth since the third quarter of 2008, when advances grew by nearly $80 billion.
"The apparent decline in bank deposits and rise in FHLB advances in the second quarter may reflect a shift by bank customers out of cash and into equities as markets rallied during this period," said Clifford Rossi, a professor at the University of Maryland's Robert H. Smith School of Business. "This outcome is certainly a boon to FHLBs which have seen banks sharply reduce their reliance on advances following the financial crisis."
To be sure, banks are still awash in deposits, and the industry's appetite for FHLB funding would have to continue over a sustained period to get even close to its peak level for outstanding advances, reached in the third quarter of 2008, of $911 billion.
"The increase in advances looks larger in percentage terms because the base was so small. The FHLB advances are still only a third of what they were five years ago," said Philip Shively, associate director of the risk analysis branch in the FDIC's division of insurance research. Shively noted that the increase in advances was primarily at institutions with more than $1 billion in assets.
But analysts say the intense draw of bank deposits in the wake of the crisis attracting individuals looking for a risk-free destination for funds following the crash is waning.
"Depositors had no place else to go without taking what many imagined could be excessive risk," Abrahams said.
Not only is consumer confidence leading more Americans to make purchases, rather than just save, but the higher interest rates has left depositors willing to walk away from the paltry yields on their bank accounts.
"This is a reversal of what we had seen in the last six years, during which yields went down but balances were still increasing," said Dan Geller, executive vice president of Market Rates Insight. "We are looking at $51 billion in deposits during the first half of the year that went to other uses."
Edward Kane, a finance professor at Boston College, said "there is pent-up anger especially among retired depositors about the absence of good returns" on their deposits.
He said while regulators are always interested in ways institutions can deal with interest rate risk, the inverse relationship between growth in FHLB advances and a deposit decline has a side benefit for the FDIC. While a smaller deposit base eases the universe of funds the FDIC must insure, if a bank is taking out more advances it is still charged an FDIC premium for those funds under a new pricing system meant to capture all of an institution's liabilities.
"The beauty of this for the FDIC is that they switched to an assessment base of assets. So it does widen the difference between their assessment base and what they cover," Kane said. "If it were a private insurance company, its stock price would probably go up."
Yet the interest rate environment suggests a possible role reversal for the FHLB system as well.
After 12 straight quarters of a decline in advances, demand for funding by the FHLB began to recover slightly in late 2011. But the industry's balances of advances hit a low during the cycle of $305.8 billion in the first quarter of 2012.
John Von Seggern, president of the Council of Federal Home Loan Banks, said the uptick in advances may be filling a need by banks that have lost deposits to fund longer-term assets.
"The Federal Home Loan banks have always been a key source of strength for our members in managing interest rate risk," he said. "The loans are locked in for a longer term. So what you have to do is find a source of longer-term funding. What is probably happening is a hedging by members to get some longer-term funding than what the deposits would otherwise provide."