March 2017 – The FHLBanks serve a unique role in connecting global investors to homeowners, funneling funds from the capital markets to local communities to help facilitate residential mortgage lending. We can act as this vital conduit because of the cooperative relationships with shareholder financial institutions and our ability to access the capital markets on a large scale and without interruption. This regular and ready access enables us to achieve our mission of delivering affordable financing to shareholders and supporting the credit needs of communities.
Capital Markets Activity
The FHLBanks connect to the capital markets in several ways and for several important purposes. First, we raise funding for our balance sheets in the capital markets. Unlike a commercial bank, the FHLBanks do not raise funds through deposits, so we depend on issuing debt to provide funds for extending advances to shareholders and investment activity. We are very active issuers of debt and are in the markets on a daily basis. At the end of 2016, the FHLBanks had outstanding debt of $989 billion, making us larger issuers than Fannie Mae and Freddie Mac.
The second way the FHLBanks connect to the capital markets is through derivatives activity. When we issue debt, we generally swap it to a LIBOR-based floating-rate structure. We also use derivatives to hedge advances. Entering into derivatives helps us manage interest-rate risk and creates balance sheet flexibility, enabling us to better meet investor demand for debt and serve shareholders’ borrowing needs through a wide variety of advance structures at cost-effective pricing.
The third way the FHLBanks access the capital markets is to invest in debt instruments, such as mortgage-backed securities and agency debt. This investing activity is aligned with our housing finance mission because it contributes to a more liquid mortgage market. We also benefit from an additional and diversified source of interest income generated by these investments.
The current environment for FHLBank debt is strong. Investors have a healthy appetite for our debt because of our size, ability to tailor debt instruments to meet investor demand, and our history of never having booked a loss on an advance. Global issuances grew four to five times in 2016, with high demand for two-, three-, and five-year fixed-rate instruments. Additionally, because of recent changes in money market fund regulations, nearly $1 trillion have flowed from prime money market funds to government money market funds. Demand for FHLBank short-term discount notes from government money market funds has risen in tandem with this market shift.
The FHLBanks are able to meet this growing domestic and global demand because we require a large amount of funding, are in the markets regularly, and are very adaptable to changing investor needs. Swapping our debt gives us flexibility in the types of structures we issue. Furthermore, while the 11 FHLBanks issue and guarantee debt jointly, each Bank determines its own debt requirements and holds its own debt on its balance sheet. Through this unique structure, investors essentially have access to 11 different debt issuers, each with their own funding needs. If an investor is looking for a specific type of debt structure, one or more of the 11 FHLBanks is likely to be able to fill this demand.
Connecting the Dots to Shareholders and Communities
Since demand is high and there are relatively few debt issuers of our size in the market today, borrowing rates for the FHLBanks are favorable. Shareholders ultimately benefit from these rates because we are cost-plus lenders and pass along savings in the form of more competitive and stable advance rates. This stability has been particularly important to shareholders as interest rates have been volatile over the past few quarters.
Borrowing from the FHLBanks at attractive rates enables shareholder institutions to extend affordable credit to homeowners and small businesses in their communities. This cycle of connecting investors to homeowners through our shareholders creates a thriving cooperative system and a stronger, more stable housing finance market.
Executive Vice President and Chief Financial Officer