WASHINGTON — Federal Housing Finance Agency Director Mel Watt sounded alarm bells Wednesday about Federal Home Loan banks' reliance on short-term funding in the form of discount notes.

During a speech to the banks' directors conference, Watt noted that at the end of 2015 discount notes made up 54% of outstanding Home Loan Bank debt, compared with 43% in 2014 and 39% in 2013.

"Short-term funding requires more frequent debt rollover than longer-term funding and this could become a safety and soundness issue if liquidity dries up unexpectedly," Watt said. "The FHLBs and the Office of Finance are having ongoing discussions about how to address this issue."

Watt's warning alarmed Jaret Seiberg, a Washington policy analyst at Guggenheim Partners.

Forcing the Home Loan banks to rely on "longer-term financing will boost the cost of advances," Seiberg wrote in a note to clients. "That could be a negative for housing by raising the costs of mortgage lending that is supported with advances."

Watt also reiterated concerns regarding insurance companies and large bank members, saying that some Home Loan banks have large exposures to a few individual members.

"Across the system, the top four borrowers accounted for 24% of aggregate advances at the end of 2015," Watt said. "We continue to encourage you to exercise due diligence to establish conservative haircuts and controls over collateral pledged" to support advances.

Seiberg said the comments suggest "more scrutiny over big users of advances."

"That could result in big borrowers using the FHLB system for fewer advances. Anything that reduces volume risks raising costs for all borrowers," Seiberg said in his research report.

In his speech, Watt said that 2015 was a very profitable year for the Home Loan banks and they continued to build retained capital and increased their assets by 6% to $969.6 billion due primarily to increases in advances to member depository institutions.

He also told the directors that the FHFA is developing a new exam guide to improve racial and gender diversity within the ranks of the Federal Home Loan Bank System.

"We are developing diversity and inclusion examination activities that we will integrate into the agency's supervision program," Watt said. "Our goal is to ensure that diversity and inclusion examination activities will be part of our regular examination work conducted for all regulated entities in 2017."

Watt said that the FHFA has surveyed the 11 Home Loan banks, as well as Fannie Mae and Freddie Mac, about their existing practices with regard to diversity and inclusion, as well as their supplier and workforce diversity programs and reporting procedures.

"FHFA staff followed up on the responses to the survey by visiting each FHLBank and the Office of Finance to interview officials, a process we are currently finishing with Fannie Mae and Freddie Mac as well," Watt said. "This information will be critically important in enabling us to establish benchmarks against which we can measure and evaluate each entity's progress going forward."

The FHFA is also considering whether to provide guidance about incorporating diversity and inclusion in assessing Home Loan bank executive incentive compensation programs.

"I applaud the efforts already being undertaken voluntarily by the Chicago, Dallas and Pittsburgh FHLBanks to tie their executive compensation to specific diversity and inclusion goals," Watt said.

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