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New particulars on rush of Dwelling Mortgage financial institution borrowings at three failed banks

Silicon Valley Bank - First Republic Bank - Signature Bank

The Government Accountability Office found that Silicon Valley, Signature and First Republic banks on the eve of their failures borrowed substantially more from the Home Loan Bank System than a group of their peers that included 16 commercial banks.

Silicon Valley Bank, Signature Bank and First Republic Bank increased their outstanding borrowings from the Federal Home Loan Bank System by more than a third each shortly before failing, according to the Government Accountability Office.

The increase in borrowings is the subject of a 27-page GAO report issued last week that examines the role of the Federal Home Loan banks in providing liquidity to their members during the banking crisis in the spring of 2023. The report provides a granular take on where money was going to the failed banks in the ninth inning of their existence as each sought to stem massive outflows from depositors. 

The GAO found that the three banks borrowed substantially more from the Home Loan Bank System than a group of their peers that included 16 commercial banks.

The report is the first in a series in which the GAO will look at broader issues related to the Home Loan Bank System. The private network of 11 regional, cooperative banks was created in 1932 after the Great Depression to serve as a source of funding for thrifts originating mortgages. The report was requested by House Financial Services Committee Chairman Patrick McHenry, R-N.C., and the panel’s ranking Democrat, Rep. Maxine Waters of California.

“GAO found the FHLBs of New York and San Francisco provided significant levels of advances to these banks compared to others, and that Signature Bank used FHLB advances to offset liquidity gaps it experienced related to crypto-related deposits,” Waters said last week in a press release. “Meanwhile, SVB was unable to reposition collateral quickly enough from its FHLB to the Fed’s discount window to access emergency liquidity.”

Starting on March 1, 2023, SVB increased its borrowings by 50% to $30 billion and then failed a week later. Signature’s borrowings rose 37% to $11.2 billion in the first two weeks of March before it failed that same month. And First Republic’s borrowings jumped 45% to $28.1 billion in the first two weeks of March before it failed in May, the GAO report found. 

The GAO looked at the communication and coordination of the Home Loan banks with the Federal Deposit Insurance Corp. and Federal Reserve System — the failed banks’ primary federal regulators — and the repayment of the failed banks’ outstanding loans, known as advances, to the system. 

“One of the main areas of focus is: Are the Federal Home Loan banks managing their relationships and their counterparty risk with institutions as they begin to fail, and do they have the right agreements and oversight in place with the Fed and others?” said Jim Parrott, co-owner of Parrott Ryan Advisors and a nonresident fellow at the Urban Institute. “When everything’s going 90 miles an hour, as an institution begins to take on water, are all of the relevant regulators and others who are in some sense indirectly responsible for taxpayer risks … coordinating?”

The GAO said that SVB failed before the Federal Home Loan Bank of San Francisco was able to request additional supervisory information from the Federal Reserve Bank of San Francisco. The New York and San Francisco Home Loan banks both were able to communicate with the FDIC about Signature and First Republic as those banks were declining, the GAO said.

“It was striking to me that [the Home Loan banks] kept lending to these failing banks until the very last week or days before they failed,” said Sharon Cornelissen, director of housing at the Consumer Federation of America and chair of the Coalition for FHLB Reform. “Only because the Federal Home Loan Bank of San Francisco does not lend over the weekend, SVB was frantically trying to gain access to the [Fed’s] discount window at the very last moment.”

The report was released several months after the Federal Housing Finance Agency’s review of the system. FHFA, the system’s regulator, released a 100-year review of the Home Loan banks in November that included 50 recommendations for reforms. Waters said she is working on legislation to implement many of the FHFA’s recommendations, including doubling the system’s contributions to affordable housing to 20% from the current congressionally-mandated 10%. She also is exploring ways to improve access and functioning of the Fed’s discount window. 

Teresa Bazemore, president and CEO of the San Francisco Home Loan Bank, said in an interview last week that it is important to understand what was happening ahead of the March 2023 liquidity crisis. Banks and credit unions were flush with record levels of deposits in 2021 from government stimulus programs in response to the pandemic. At that time, the Home Loan banks’ core business of providing liquidity to members had dried up. But in 2022, money market mutual funds started offering depositors higher rates, putting many banks in a squeeze.  

“Some of the money started to outflow from [member] banks at the same time those institutions had already invested some of that money. They’d already loaned it out, they’d already made mortgage loans [and] put them in their portfolios. They bought securities,” Bazemore said. “So if you compare where things were at the end of 2021 to the end of 2022, you saw our advances go up as a system because of that transfer of deposits out of the banks and credit unions. And that’s really what the system was set up for.”

The Federal Reserve hiked interest rates 11 times between 2022 and 2023 in an attempt to curb inflation. As a result, many banks were “upside down” and needed to borrow from the Home Loan Bank System, or alternatively, had to bring in brokered deposits, Bazemore said. Brokered deposits are typically made by companies with the assistance of a third party.

“If you’ve got a portfolio of 3% mortgage loans, where are you going to get the income to pay 4% or 5%, to compete with the money market [funds]?” Bazemore asked.

The GAO report also looked at the repayment of advances by the failed banks and whether there was a cost to the federal Deposit Insurance Fund. After regulators took aggressive steps last year to protect uninsured depositors, particularly venture capitalists after the failure of SVB, the FDIC assessed a special fee on more than 100 banks to replenish the fund, known in bank parlance as the “DIF.” 

The GAO report said that repayment “does not impose a direct cost” but that “research findings vary” regarding the risks that failed banks’ advances from the system pose to the DIF. Home Loan banks have a priority position ahead of the FDIC when a bank goes into receivership, an issue that has become a bone of contention among critics of the system. 

The GAO said that in 2000 and 2005, respectively, studies by the Fed and FDIC noted that “FHLBanks’ priority position in receivership could subsidize member bank risk-taking, which could imply greater losses for the Deposit Insurance Fund.”

The GAO also said that a 2023 FHFA review of academic literature found that Home Loan banks’ regulatory policies and practices mitigate moral-hazard concerns, while a study by the Urban Institute last year found that an increase in a commercial bank’s use of advances reduces the odds of failure, particularly for a smaller bank.

Still, the report noted that “if proceeds of the failed bank’s liquidated assets do not cover claims eligible for the fund after repayment of FHLBank advances and any other secured claims, the Deposit Insurance Fund would incur costs.”

The GAO report also detailed the fees charged by both the San Francisco and New York Home Loan banks, which varied dramatically. 

Bank failures may trigger prepayment fees that the Home Loan banks charge, which are required by the FHFA for certain products. Waiver fees also may be charged if a member-bank makes voluntary prepayments. The Home Loan banks also may waive the fees, or even charge the FDIC, as the receiver of a failed bank, a waiver fee to compensate for risks. 

Prepayment penalties also vary depending on the length and terms of an advance. The FDIC typically pays off advances and incurs a fee in order to take the collateral that has been pledged by a commercial bank to a Home Loan bank. 

After SVB failed, the FDIC transferred all its deposits and nearly all of its assets to Silicon Valley Bridge Bank, which repaid the $30 billion in outstanding advances to the San Francisco Home Loan Bank. The San Francisco bank received $266.5 million in prepayment fees and $18.8 million in waiver fees. Most of SVB’s advances had terms of one to three years. 

“SVB did not have a particular stated strategy for borrowing advances in that maturity range,” the GAO said, citing officials from the San Francisco Home Loan Bank. 

Meanwhile First Republic’s outstanding advances were assumed by JPMorgan Chase, which repaid roughly $5.8 billion in loans that had reached maturity, and has indicated that it plans to repay the remaining advances according to the advance terms. 

In contrast, after Signature Bank failed, the Federal Home Loan Bank of New York also received full repayment for Signature’s $11.2 billion in outstanding advances but received just $260,000 in prepayment fees and no waiver fees.  

“The broader discussion is whether this is the role that we want [the FHLBs] to play,” Cornelissen said. “According to the law they were within their rights to provide liquidity, but we should be more tightly regulating them because it’s not their place to be the lender of last resort. They are going to keep lending until the very last day because that’s their business model and presents no risk to them.”

Ryan Donovan, president and CEO of the Council of Federal Home Loan Banks, the system’s trade group, applauded the GAO report for finding that the system made efforts to coordinate with the Federal Reserve banks of New York and San Francisco in accordance with policies and procedures.

“We appreciate the findings in the GAO’s report, and we believe they validate what we have been saying for a year: that the FHLBanks acted as a critical shock absorber for the financial system during a period of unprecedented turbulence in the spring of 2023,” Donovan said. “The two most important takeaways from this report are that the FHLBanks provided crucial liquidity to their members in direct accordance with the structure and role laid out for them by Congress, and that the FHLBanks worked tirelessly in a coordinated fashion with primary financial regulators to ensure the safety and soundness of the U.S. banking system.”

The Federal Home Loan Bank System reported earnings of $6.7 billion at year-end, an 111% jump from a year earlier. The system also paid out a record $3.4 billion in dividends to its members, more than double the $1.4 billion paid in 2022.

The GAO report is dated March 8 but was released on April 8 after lawmakers and the Home Loan banks had a month to assess its findings. 

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