WASHINGTON — As the Seattle and Des Moines Home Loan banks inch closer to the first successful voluntary merger in the system's history, observers are beginning to ask the question: who's next?

The consolidation of the 12 Federal Home Loan banks has been a perennial discussion point for at least the past two decades; an American Banker story from 1998 hinted that it was just around the corner. 

But it's clear that if the Seattle and Des Moines merger goes through — which most observers expect to happen next year barring a last-minute surprise — it could pave the way for more combinations.

The difficult part, however, is figuring out which of the remaining 10 banks are most likely to seek a merger. A look at basic financial information, including profitability, isn't that helpful, observers said.

"External analytics don't tell you anything because it's not a financially driven transaction," said Karen Shaw Petrou, managing partner of Federal Financial Analytics. "The ultimate decision is based as much on what the members want of the bank regardless of profitability and the goal of the CEO. Those are nonpublic drivers that can only be inferred retroactively."

But there are other factors, like a stagnant or declining membership base, that could shape the decision — and provide some critical clues about which institutions will seek to merge next. Following is a guide to which banks are considered the most likely candidates to seek merger partners and why:

1) The Federal Home Loan Bank of Chicago
Of the remaining 10 banks in the system, Chicago is the one most identified as a merger candidate because it fits several criteria.


For one, it faces similar struggles that the Seattle bank faced when it decided to merge with the Des Moines bank. The Seattle bank had a declining field of membership and was struggling to grow its advance business, which is considered the traditional mission of the Home Loan Banks by their regulator, the Federal Housing Finance Agency.

"It has a small membership base in terms of number of institutions," Steve Cross, the former top examiner of the Federal Home Loan Banks, said of the Seattle bank. "They have a significant limit in how many advances they can have outstanding to their membership. With the justification of the expectations of the FHFA that the banks demonstrate commitment to housing finance, they were having a hard time being the size necessary to support the infrastructure with the limited advance base they have."

Seattle's advances-to-assets ratio had fallen to 28% by the end of the second quarter, the lowest in the system. But the Chicago bank's ratio is not much better, standing at 36% as of June 30. The FHFA has been pushing banks to have a significantly higher ratio.

While Chicago has a larger pool of existing members — 759 by the end of 2013 — it only has two states, Illinois and Wisconsin, from which to draw for more, which limits growth opportunities. The FHFA has been putting pressure on the banks to boost their advances, which may be tough for the Chicago bank to do.

Chicago has also already publicly embraced the idea of a merger. In 2007 it attempted to combine with the Dallas bank, but that deal fell apart because of accounting issues related to the Chicago bank's financial health at the time.

Since then, the Chicago bank has recovered financially, earning $175 million in the second quarter (though most of its income appears unrelated to advances). That means it would not face the same accounting obstacles to a merger that it did seven years ago.

A spokeswoman for the Chicago bank declined to comment.

2) The Federal Home Loan Bank of Indianapolis
While the Indianapolis bank has a better advances-to-assets ratio than Chicago, just below 50%, it too faces a declining membership base.


It had just over 400 members at the end of last year, down from 416 two years earlier, and like Chicago, has only two state, Indiana and Michigan, from which to draw new recruits. Indeed, Chicago and Indianapolis are the only Home Loan banks to have just two states as part of their membership area. Given their proximity to each other, many observers privately have suggested the two Home Loan banks could merge.

The Indianapolis bank is profitable, earning $67 million in the second quarter, but could look to nearby Home Loan Banks — like Chicago — as a way to expand their membership base and potentially grow advances.

A spokesman for the Indianapolis bank said it is "focused on all our members' best interests" but "we have no plans to pursue a merger."


"We are profitable, well above our capital requirements, with growing retained earnings," he said.

The spokesman said that by adding purchased mortgage loans held in portfolio, its total mission-to-assets ratio would be 65% at the end of the second quarter.

3) The Federal Home Loan Bank of Dallas
The Dallas bank is seen as one that could look to expand via merger because it tried to merge with the Chicago Home Loan Bank seven years ago. But it recently changed its top leadership, appointing Sanjay Bhasin as its president in April, so it's hard to imagine a deal happening soon.


Bhasin was hired from the Chicago bank, which could theoretically make it easier to restart merger talks with that institution, but the Dallas bank for now appears more focused on growing its advance business. It also doesn't face the same regulatory or business pressures that the Chicago bank does.

The Dallas bank has a 54% advances-to-assets ratio and had 875 members as of the end of last year. More importantly, it has a large geographic area — five states including Texas — from which to generate new membership.

"Our sole focus right now is on serving our 867 member financial institutions, who collectively hold approximately one trillion in assets, through new and enhanced product offerings," said Bre Chapman, a senior vice president of the Dallas Home Loan Bank. "We are not exploring nor do we have any interest in merging with another Home Loan Bank."


4) The Federal Home Loan Bank of Topeka
The Topeka bank is mentioned as a potential merger partner primarily because it is the smallest Home Loan Bank in the system. With just $33 billion of assets, a little over half of which are in advances, observers privately suggest it might reach out to a larger institution for a merger.

Yet it's far from clear that it will or should do so. Although it has a relatively small number of advances (around $17 billion), it has more than 800 members and can recruit from four states.

Andy Jetter, the president of the Home Loan Bank of Topeka, acknowledged that the bank is small by asset size, but noted it is "one of the larger FHLBanks based on the number of members."

"We have a long record of being one of the most profitable FHLBanks, paying superior dividends, maintaining one of the highest levels of market value of equity, and achieving very high levels of member satisfaction," Jetter said in a statement to American Banker. "In short, there is little in our district or in our financial situation to suggest a need to consider a merger."

To be sure, there are also many factors working against any further mergers within the Home Loan Bank system. The biggest one is that there is little upside and significant downsides. Unlike in a commercial bank combination, Home Loan bank shareholders do not make money if their institution is merged out of existence. Meanwhile, executives may be reluctant to endorse a merger because one set of them would likely lose their jobs as a result. Local representation on Home Loan Bank board of directors may also be diminished, depending on the final terms of the deal.

A critical factor that often goes overlooked is the relationship of the two bank CEOs. In the case of Seattle, it had relatively few options and a CEO that had recently worked for the Des Moines bank, smoothing the path of a merger.

"The impediments to a merger could be a circumstance in which you have two strong presidents and only one slot to fill," said Cross, who is now with Wolters Kluwer. "That's going to be difficult."

At the same time, however, a retiring president could create an opportunity. Dean Schultz, the head of the Federal Home Loan Bank of San Francisco, announced Friday that he is leaving early next year. It's not clear that the bank would pursue a merger and a spokeswoman declined to comment, but the fact that it did not immediately name a successor raises questions about its future.

"One final consideration is internal succession plans," said Cross, who was not speaking specifically about any one Home Loan Bank. "Does a Federal Home Loan Bank have in-house the people that they think are prepared to step into leadership roles in the bank? If they don't, they too should be looking to partnerships with a bank that has a next generation of leaders."

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