Earlier this month there was an article in Bloomberg “Shadow Bank REITs Draw Regulator Scrutiny Over Financing” by Heather Perlberg and Jody Shenn. We had heard rumblings of REITs accessing cash from FHLBs and this served to confirm it. Most people involved in repo would be a bit surprised.
The article said,
“…Three real estate investment trusts — Annaly Capital Management Inc. (NLY), Invesco Mortgage Capital Inc. (IVR)and Two Harbors Investment Corp.(TWO) — set up insurance units that allowed them to gain access to an FHLB in the past seven months. Commercial real-estate lender Ladder Capital Corp. (LADR) joined the network of 12 regional cooperatives in 2012. Two Harbors and Ladder had borrowed a total of about $1.5 billion through March…”
“…Annaly, the largest mortgage REIT with $82 billion of assets, last quarter had an insurance subsidiary join the Des Moines bank. The New York-based REIT will use the loans “as one of the many complementary funding alternatives available” to the company, President Kevin Keyes said in an e-mail. “The FHLBs are very strict with respect to their credit process and criteria for access to advances.”
Invesco Mortgage Capital’s unit joined an FHLB last quarter and started borrowing against its AA rated commercial-mortgage securities, Chief Executive Officer Richard King said on a conference call last month. The Atlanta-based firm in the future may use the membership for residential and commercial mortgages, he said.
Ladder Capital uses its FHLB funding from Indianapolis to buy mostly AAA rated bonds, CEO Brian Harris said last month in a conference call. The New York-based firm is in the process of applying to increase the $1.4 billion in available financing from the FHLB, Chief Financial Officer Marc Fox said on the call…”
We know that insurance companies can access funds at the FHLB. It is surprising that REITs, which can be highly leveraged, could tap FHLB money as well. Of course, depending on the asset and financing terms, these may be very secure deals. The FHLB is collateralized and has a history of never losing a dime on collateralized lending trades since they started in 1932. But like many cash rich institutions, they are looking for ways to put their money to work. The FHLB can’t park their cash at the Fed’s IOER account — they have to actually lend it in the Fed Funds market (and are the largest lenders in that market by far) and have powerful incentives to do better than the single digit returns they get in that market.
From the FHLB website:
“…The FHLBank Act also allows the FHLBanks to accept as eligible collateral for advances only certain United States government or government agency securities, residential mortgage loans and securities backed by such, cash, deposits in the FHLBank, and other real estate related assets…”
Based on the published guideline, the FHLBs take possession of the collateral, charge appropriate initial margins (based on both the liquidity of the collateral and the creditworthiness of the counterparty) and margin daily.
The FHLB offers pretty decent lending rates. For example recent postings showed a 1 year term indexed to 3 month LIBOR + 13bp, 5 year indexed off of 1 month LIBOR + 39bp, and 10 year indexed off of 3 month LIBOR + 58bp. These certainly are longer terms (and for some types of collateral, perhaps cheaper levels) than bank repo desks would give. As an aside, FHLB advances could give an interesting outlet for long-dated collateral transformation trades with FHLB-member insurance companies…providing competition for the banks and securities lenders. We wonder if the FHLBs have to worry about LCR, NSFR or SLR? Is the FHLB really just a shadow bank?
We were concerned when reading:
“…Securities delivered to an FHLBank, or a third-party for the benefit of the FHLBank…are marked-to-market using independent sources such as Bloomberg, Interactive Data, or the FHLBank’s third party safekeeping agents…”
Taking in collateral that a lender doesn’t actively trade in the cash markets can be risky when markets become stressed. In a volatile market the models generating the prices and where a security will actually sell can become out of synch. Said another way, the FHLBs need to think like a repo desk.
Some REITs have had difficult times and opted to de-lever suddenly, unnerving repo counterparties. We referred to this in our June 5th post “FT article on repo market “Big Investors replace banks in $4.2tn repo market” — the data doesn’t make sense”. We hope that the FHLBs aren’t going to be the next cautionary tale in a long line of liquidity providers.