June 18 (Bloomberg) -- The Federal Home Loan Banks jointly agreed to a three-month moratorium on admitting captive insurers, which are being used by mortgage investors to access the government-chartered system, according to three people with knowledge of the step.
The 12 FHLBs offered the move voluntarily in a letter to their regulator, the Federal Housing Finance Agency, which has voiced concern that the trend is adding risk to the system, said the people, who asked not to be named because the talks are private. Captive insurers largely serve the needs of their parents.
Lightly regulated investment firms and lenders that lack customer deposits, known as shadow banks, are flocking to FHLBs for dependable funding that often offers better terms than traditional banks or debt markets. The new memberships are drawing scrutiny from the FHFA because they may affect the safety of a system that operates with $786 billion of debt seen by investors and credit raters as being backed by taxpayers.
The freeze may slow a boom in admissions after Redwood Trust Inc. last week said its captive insurer obtained membership in the Chicago FHLB. Redwood became the fourth real-estate investment trust focused on mortgage investments to join the network of regional lending cooperatives since October.
Annaly Capital Management Inc., Invesco Mortgage Capital Inc. and Two Harbors Investment Corp. also have insurance units that have become members.
Angie Richards, a spokeswoman for the Des Moines FHLB, and Jeff Sanders, a spokesman for the Home Loan Bank in Indianapolis, declined to comment. Melissa Warden, a spokeswoman for the Chicago FHLB, didn’t immediately respond to an e-mail seeking comment. The three FHLBs are the ones that have admitted units of REITs.
Peter E. Garuccio, an FHFA spokesman, declined to immediately comment on the moratorium. He said last week in an e-mail that the overseer plans “to address the issue of captives.”
The FHLB system was set up in 1932 after a string of bank failures caused by runs on deposits, and has accepted insurers since its start. Members buy stock in the institutions and get access to low-cost, wholesale funding in return for pledging collateral such as mortgages.
While mortgage REITs’ insurance units are overseen by state regulators, the financial health of their parent companies aren’t the responsibility of any U.S. agencies.
“Captive insurance borrowing and membership in the FHLBank system raises a number of possible issues related to safety and soundness and access to the system,” FHFA head Melvin Watt said in a speech at a conference for FHLB directors in May. “You will certainly be hearing more about this as we move forward.”
Mortgage REITs’ use of captive insurers to gain membership may create “a perception of something illicit going on,” Keefe, Bruyette & Woods analyst Michael Widner wrote in a June 16 report.
In reality, “we do not see material risk, believe there are more than adequate checks and balances in place” and view the REITs as contributing to the system’s public policy objectives, Widner said. “Nevertheless, the political nature of the issue adds uncertainty to how it will develop.”
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