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FHLBs brace for impending loss of many captive insurance company members

The impactof a new Federal Housing Finance Agency rule restricting captive insurance companiesfrom continued membership in the federal home loan bank system will vary widelyby institution.

The of theFHLBanks Office of Finance,which SNL obtained March 26, reveals that captive insurance companies accountedfor 6.1% of the $631.23 billion par value in combined total outstanding advancesmade by the 11 federal home loan banks as of Dec. 31, 2015. But a review of Form10-K filings by the individual federal home loan banks finds that four of the institutionshad been responsible for nearly all of the $38.7 billion in advances extended tocaptive insurance companies: the FederalHome Loan Bank of Des Moines, the Federal Home Loan Bank of Chicago, the Federal Home Loan Bank of Cincinnati and the .

The FHLBanksOffice of Finance said in the combined financial report that the 11 institutionshad extended membership on a combined basis to a total of 55 captive insurance companies.

"Themagnitude of the impact will depend, in part, on certain FHLBanks' financial conditionand results of operations at the time of membership termination or maturity of relatedadvances," the office said in the report.

Captiveinsurance companies that obtained membership in a federal home loan bank subsequentto the FHFA's September 2014 publication of its proposed rule are not permittednew advances or renewal of existing advances, and they must repay outstanding advancesby Feb. 19, 2017, the first anniversary of the final rule's effective date. Membershipwill terminate in February 2021 for captive insurance companies whose membershippredates the publication of the proposed rule, and they may obtain new advancesto the extent that total outstanding advances do not exceed 40% of theirtotal assets.

Captiveinsurance companies accounted for approximately 34% of the $36.61 billion in totalpar value of advances outstanding at the Chicago home loan bank, according to itsForm 10-K filing. Whilethe associated dollar value of the captive insurance company advances of $12.5 billionlagged that reported by the Des Moines home loan bank, the relative amount of thoseadvances ranked by far the highest among the 11 institutions.

"Alladvances made to our captive insurance company members prior to the final rule takingeffect, which range in maturity up to 10 years with a current weighted remainingtenor of 4.3 years, may remain outstanding until such advances mature," theChicago home loan bank said in the filing. "However, once our three captiveinsurance company members have their membership terminated and their advances mature,our advance and capital stock levels would decrease."

The threecaptive insurance company members of the institution are One Mortgage Partners Corp.,mortgage REIT Redwood Trust Inc.'sRWT Financial LLC and Prospect MortgageLLC's Prospect Mortgage Insurance LLC.

One MortgagePartners, a Vermont captive that is a subsidiary of JPMorgan Chase & Co., ranked as the Chicago home loanbank's single-largest borrower based on its $11 billion in advances outstandingas of Dec. 31, 2015. Licensed in October 2002, it is a longtime member of the Chicagohome loan bank as Bank One NA transferred advance balances to it subsequent to JPMorganChase's 2004 acquisitionof Bank One Corp., according to regulatory filings. The Chicago home loan bank acceptedRWT Financial as a member in June 2014, and the captive had advances outstandingof approximately $1.48 billion as of year-end 2015.

"Unlesswe experience an increased demand for our advance products from our current or futuremembers, this will result in a material decrease in our outstanding advance levelsand our results of operations may be adversely affected," the Chicago homeloan bank said in the Form 10-K. "Further, we could experience lower demandfor advances and other products and services, including letter of credit activity.In addition, our core mission asset ratio may be negatively impacted. The magnitudeof the impact will depend, in part, on our size and profitability at the time ofmembership termination or maturity of related advances."

The DesMoines home loan bank, whose 13 captive insurance company members had borrowingsof $15.2 billion as of Dec. 31, 2015, or approximately 17% of the total par valueof its advances outstanding, offered a similar cautionary statement in its .

"Onceour captive insurance company members have their membership terminated and theiradvances mature, our advance and capital stock levels will decrease," the companysaid. "Further, we could experience lower demand for advances and other productsand services, including letter of credit activity. Our core mission asset ratiomay also be negatively impacted. The magnitude of the impact of the final rule willdepend, in part, on our size and profitability at the time of membership terminationor maturity of the related advances."

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Sevenof its captive insurance company members, which accounted for $6 billion of theoutstanding borrowings, joined subsequent to the FHFA's publication of the proposedrule. Six, including its second-largest captive insurance company member, did soprior to the publication date.

MortgageREIT American Capital Agency Corp.'sOld Georgetown Insurance Co. LLC had $3.75 billion of advances outstanding fromthe Des Moines home loan bank as of year-end 2015, behind the $37 billion associatedwith Wells Fargo & Co.'sWells Fargo Bank NA andthe $3.79 billion for mortgage REIT TwoHarbors Investment Corp.'s TH Insurance Holdings Co. LLC. The membershipof the latter company would terminate in February 2021 under the final FHFA rule.

Anotherof the home loan banks with material concentration of captive insurance companyadvances appeared to downplay the risks associated with the rule.

The Cincinnatihome loan bank said in its Form 10-Kthat it had 15 captive insurance company members with $6.6 billion in associatedadvances outstanding as of Dec. 31, 2015. Although that accounts for nearly halfof the $13.43 billion in advances outstanding to all types of insurance companies,it represented approximately 9% of the par value of the Cincinnati home loan bank'stotal advances.

"Webelieve that the final rule will not materially affect our financial condition orresults of operations despite the loss of current and potential captive insurancemembers," the institution said in the filing. "However, we are concernedthat the rule could constrain the ability of the FHLBanks to fulfill their missionof promoting housing finance through providing liquidity and funding to financialinstitutions engaged in housing finance activities. We believe captive insurancecompanies are important institutions in helping to deepen and diversify the flowof funds in the mortgage markets."

The captiveinsurance unit of Capstead MortgageCorp. ranked as the Cincinnati home loan bank's largest insurance companymember with $2.88 billion in advances outstanding as of Dec. 31, 2015, and third,overall, behind JPMorgan Chase BankNA and U.S. Bancorp'sU.S. Bank NA.

The FederalHome Loan Bank of Indianapolis, meanwhile, reported in its Form 10-K that captive insurance company members accountingfor $3.5 billion of its more than $4.3 billion in advances outstanding to that companytype would not have their membership status terminated under the final rule untilFebruary 2021. The home loan bank has a total of 11 captive insurance company members:three that had been admitted prior to September 2014, six that obtained membershipbetween September 2014 and December 2015, and two that have been admitted sincethe start of 2016.

Captivesaccounted for approximately 30% of the $14.28 billion in advances the Indianapolishome loan bank had made to insurance companies as of Dec. 31, 2015. Insurers accountedfor 53.3% of the Indianapolis home loan bank's aggregate advances outstanding atpar value, by far the highest percentage for any of the 11 institutions.

"Webelieve that advances outstanding to our insurance company members and the relativepercentage of their advances to the total could increase, based upon the significantportion of total financial assets held by insurance companies in our district,"the Indianapolis home loan bank said in the filing. Insurance companies accountedfor nearly 61.3% of its advances outstanding at year-end 2014.

Acrossthe home loan bank system, there were 372 insurance company members as of year-end2015, up from 304 a year earlier. Advances to insurance company members increasedas of Dec. 31, 2015, to $98.41 billion, or 15.6% of the total, from $71.82 billion,or 12.7% of the consolidated amount as of the same date in 2014. The group ranked as the largestinsurance company borrower at the consolidated level, based on $15.49 billion inadvances outstanding as of Dec. 31, 2015.

The 37%year-over-year growth in insurance-company advances represented the largest expansionin the dollar amount of that category of borrowings since they soared 91.3% in 2008.The year-over-year growth rates achieved in 2012 through 2014 had been in the double-digitson an annual basis but no higher than the 20.9% expansion achieved in 2014.

Withapproximately $13.05 billion in advances as of Dec. 31, 2015, associated with thecaptive insurance units and/or affiliates of REITs that will have their home loanbank membership terminate by February 2017, according to SNL's analysis of disclosuresin regulatory filings and earnings reports as first published March 16 and subsequently updated to include thereceipt of new information, the system will be hard-pressed to duplicate the samesort of expansion in raw dollar or percentage terms in 2016.Several of those captives have already repaid all or a substantial portion of theiradvances.