Home Loan bank dividends are not 'excessive.' They're oddly low.

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The 11 Federal Home Loan banks rank among the largest cooperative organizations in the U.S. Like all cooperatives, the Home Loan banks return a portion of invested capital as quarterly dividends. Recently, Senator Elizabeth Warren has joined others in claiming that these payouts are "excessive." Dividend strategies vary substantially across the banks, but basic economic and cooperative principles suggest that, over the long haul, Federal Home Loan bank payouts have been too low rather than high.

The Home Loan bank boards of directors establish dividends (expressed as a percentage of capital stock) and must act in the fiduciary interests of members. Amounts not so paid flow onto the Home Loan banks' balance sheets as retained earnings, where (with capital stock) they provide a buffer against the various risks assumed by the banks and protect the par value of the stock.

Home Loan bank capital has unique characteristics relevant to dividend decisions. First, the value of each share is fixed at $100 and cannot appreciate. Second, there is no secondary market in Home Loan bank shares, which consequently are illiquid. Third, members have limited claims on ownership of retained earnings and sometimes surrender them without compensation. Finally, each bank guarantees the debt obligations of the others in a "joint and several liability" arrangement.

These facts imply that the 6,800 Home Loan member banks have weak "property rights" in their invested capital. Strong rights imply that owners have exclusive rights to an asset's use, can earn income from it and have the right to sell it. Member banks lack exclusive rights to retained earnings (given joint and several liability) and cannot sell their claims (since stock is illiquid). Members can earn income when retained earnings are invested, but the Home Loan banks purchase only low-return assets and investments cannot yield an increase in the fixed stock price. And most members have superior investment options to the Home Loan banks when it comes to investing cash they receive as dividends. If a member voluntarily exits the system or is acquired by an institution in a different district, it surrenders its claim on any accumulated retained earnings. While members cannot sell their stock, they can redeem it with the issuing Federal Home Loan bank. But it can take up to five years to close the transaction.

Weak property rights erode capital values in this cooperative setting, especially the retained earnings component. Members realize the full value of claims on retained earnings only if a Home Loan bank is liquidated, an extremely unlikely event. Once retained earnings are sufficient to buffer against relevant risks, members should prefer owning capital stock. Stock has stronger property rights because it promises periodic returns and can be redeemed in designated situations.

So, what do the Home Loan banks actually do when it comes to the dividend/retained earnings tradeoff? All 11 Home Loan banks have similar business models because their regulator, the Federal Housing Finance Agency, makes it so. Each must satisfy a requirement that the sum of advances (loans to members) and mortgage purchases exceed 70% of debt obligations. At year-end 2023, the average ratio was 77% and seven of the banks were less than two percentage points from this mean. Consequently, it's reasonable to expect that the bank boards would follow roughly similar strategies in rewarding members with capital distributions. The data strongly suggest otherwise.

Data from the Federal Home Loan Banks Office of Finance indicates that the average payout ratio (dividends/net income) at the 11 Home Loan banks over 2022-23 was 46.7%, down from an average of 60% over the prior four years. The 2023 payout range was large, with the high of 67.8% (New York) more than doubling the low at 33.8% (Dallas). Rationalizing these sharp differences is difficult, given the similarity in cooperative business models. A payout ratio of less than 50% signals board preferences for retained earnings over dividends. 

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Over the last decade total Home Loan bank retained earnings grew 129% to a level of $27.9 billion, while capital stock holdings increased only about 34%. Retained earnings ranged from almost $5 billion (Chicago) to $1.4 billion (Topeka), again an enormous difference across a set of similar institutions. Asset sizes vary across the Home Loan banks and over time will influence dividend declarations. But payout ratios have no relation to bank size, and the amount of each bank's retained earnings reflects a very long history of payout decisions.

All the Home Loan banks estimate retained earnings required to buffer against a variety of risks in extremely stressed environments. Seven of the banks disclosed these "targets" in 2023 annual reports and they vary sharply. The average ratio of actual retained earnings to the target levels at the reporting banks was 118%, with an enormous low-to-high range of 21% to 275%. There are no regulations addressing retained earnings in the capital structure of the Home Loan banks, but FHFA requires that capital stock be at least two percent of assets to assure that members have sufficient "skin in the game." And in the system's 90-year history, there has never been a case in which a Home Loan bank defaulted on its promise of par redemption of stock.

Property-right principles suggest that capital stock should exceed retained earnings if Home Loan bank boards are behaving in their members' interests. Indeed, there was 60% more capital stock than retained earnings on the banks' combined balance sheets at the end of 2023. But the range of capital stock/retained earnings outcomes is remarkably large, from a high of 2.92 (Cincinnati) to a low of 0.57 (San Francisco). Contrary to what property rights arguments imply, two banks had more retained earnings than capital stock. What accounts for the enormous, and anomalous, range of capital distribution results across the Home Loan banks in both the short and long runs? The answers cannot be found in any Home Loan bank-produced documents. 

Home Loan bank boards (and CEOs, who play key dividend decision roles, but do not hold board seats) may be unaware of how property rights affect capital values or might discount their relevance. Or board members may apply approaches used in their companies that typically are not cooperatives. But standard "principles" for resolving dividend/retained earnings tradeoffs in a public-company setting do not apply at cooperatives like the Home Loan banks. An example concerns what one Home Loan bank cites as the potential "strategic value" of retained earnings. These funds cannot be the source of value creation discussed in MBA classes when the stock price is fixed at $100. And retained earnings are irrelevant to both the prospect and outcome of a merger between Home Loan banks for property-rights-related reasons.

So why Home Loan bank boards and their top management employ vastly different strategies of rewarding members with capital distributions remains a puzzle. The considerable amount of retained earnings on some banks' balance sheets reflects a history of "withheld dividends" that, given the relevance of property rights, may not have been in members' economic interests. If the Home Loan banks were operating in a competitive environment, it seems highly unlikely these sizable differences in payout strategies could survive. Since directors associated with member organizations constitute a majority of Home Loan bank boards, they especially would seem to have a strong incentive to resolve the puzzle.