© Reuters. FILE PHOTO: Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado November 3, 2009. REUTERS/Rick Wilking/File Photo
By Koh Gui Qing
NEW YORK (Reuters) – Major life insurers are accessing cheap funding at record levels from a U.S. government-backed financing system, sapping billions of dollars meant to help increase affordable housing, interviews with industry executives and regulatory disclosures show.
When Federal Home Loan Banks (FHLBs) were created in 1932 in the aftermath of the Great Depression to finance firms that offer home loans, insurers were granted access to this system because they provided mortgages.
They stopped providing mortgages in the following decades as they became an industry distinct from banking. Starting in 2008, they have been aggressively drawing on FHLBs, arguing they support housing because they invest in residential mortgages and related securities.
The extent to which FHLBs finance insurers has not been previously reported. Reuters interviews with more than a dozen industry executives and regulators, a review of regulatory disclosures and data show this borrowing has not been matched by a rise in home loan affordability, with the cost of mortgages soaring to its highest in 23 years.
The practice has been lucrative for insurance firms that have locked in billions of dollars in profits by investing the borrowed money in areas such as commercial real estate mortgages and corporate and government bonds. It has been predominantly used by life insurers, because they need to boost their investment returns with cheap funding to meet long-term liabilities.
FHLBs typically have a lower cost of borrowing than what is otherwise commercially available, because these banks enjoy an implicit U.S. taxpayer-backed guarantee on their debt. They provide the cheap funding to banks and insurers in exchange for collateral to ensure they get their money back.
A spokesperson for the Federal Housing Finance Agency (FHFA), which oversees the FHLBs, declined to comment specifically on insurers tapping FHLBs, but said the regulator was considering implementing new requirements for borrowing from FHLBs to ensure the support of housing and community development. They declined to provide more details.
Ryan Donovan, president and CEO of the Council of Federal Home Loan Banks, a trade association for FHLBs, said the banks have “abided by the will of Congress” to provide liquidity and support affordable housing.
BORROWING BILLIONS
FHLBs lent a record $137.1 billion to life insurance firms last year, building on a trend that started around 2008, according to the FHLB Office of finance.
Yet the industry’s investments in home mortgages have dropped. National Association of Insurance Commissioners (NAIC) data shows that insurance companies have been buying fewer residential-backed mortgage securities (RMBS), which boost liquidity in the home mortgage market, while purchases of commercial-mortgage backed securities (CMBS) have been steady.
In 2022, life insurance companies bought $193.1 billion worth of RMBS, down 6% from $205.3 billion in 2021, as soaring inflation soured their appetite to invest more. In contrast, their appetite for CMBS remained steady, with purchases totaling $203.6 billion in 2022, almost flat compared to $204.7 billion in 2021.
Lawrence White, an economics professor at New York University who recently co-authored research about FHLBs, said insurers did not need to borrow from FHLBs to invest in mortgages in the first place.
“It’s an artifact of the 1930s that insurance companies are part of the FHLB system,” White said.
MetLife Inc (NYSE:), Equitable Holdings (NYSE:) Inc, TIAA, Corebridge Financial and Brighthouse Financial (NASDAQ:) Inc are among the insurance firms that are prolific users of FHLB funding, their regulatory filings show.
MetLife, TIAA, Corebridge, Brighthouse and Equitable declined to comment.
JUICING RETURNS
Cynthia Beaulieu, a managing director and portfolio manager at Conning, which manages $205 billion in assets for investors such as insurance companies, said a majority of her clients use FHLB loans to generate extra returns because “the arbitrage was really attractive.”
Life insurers can lock in returns between 85 and 140 basis points by taking FHLB loans and investing the money in pools of loans such as collateralized loan obligations, Wellington Management, a Boston-based investment manager, said on its website in July. A percentage point is 100 basis points.
Insurers are entitled to tap FHLB funding. Yet U.S. taxpayers are backstopping the insurance industry’s profits with little to show, said Cornelius Hurley, a lecturer at the Boston University School of Law and a member of the Coalition for FHLB Reform, a group that calls for changes to the FHLB system to address unmet housing needs.
“All (insurers) do is they happen to have some government securities and mortgage-backed securities in their investment portfolios. But they don’t provide any public benefit in return for that,” Hurley said.
AIDED BY REGULATORS
To be sure, banks have also been stepping up their borrowing from FHLBs to tap cheap funding. An FHFA report published last month showed how some troubled regional banks, including Silicon Valley Bank and First Republic, were using FHLBs as lender of last resort, encouraging risk-taking that hastened their collapse.
Insurers’ borrowing from FHLBs picked up in 2008 financial crisis, as those that spread themselves thin with aggressive investments scrambled for cash. Subsequent regulatory changes emboldened insurers to borrow more.
The National Association of Insurance Commissioners (NAIC), which sets policy that many state insurance regulators follow, allowed insurers in 2009 to treat FHLB borrowing as “operating leverage” rather than debt, as long as they use the money for investments.
This gives insurers more room to saddle themselves with more with debt, because borrowing from FHLBs weighs less on their capital ratios than commercial borrowing, FHLB officials, analysts and economists say. It can also give them a more favorable credit rating, allowing them to borrow more debt at cheaper rates.
In 2018, the NAIC again made FHLB borrowing more attractive for insurance companies, by requiring them to hold less money aside for every dollar they borrow from FHLBs.
The NAIC declined to comment.
The reduced capital charges can more than double insurers’ return on investments from FHLB loans, according to FHLB Chicago. On its website, it gives examples of how insurers can borrow from it to invest in commercial mortgage securities, rather than residential mortgage securities that benefit the housing market directly.
Michael Ericson, the president and CEO of FHLB Chicago, said the use of mortgages and mortgage-backed securities as collateral for FHLB loans helps maintain the FHLBs’ nexus to housing finance.
Insurers have lobbied to maintain the current arrangement. The American Council of Life Insurers (ACLI) and the Insurance Coalition wrote to the FHFA in letters reviewed by Reuters, arguing that curbing their FHLB borrowing would remove liquidity from the market for mortgages. They did not explain why insurers need FHLB funding to invest in mortgages.
ACLI spokesman Jack Dolan said that life insurers’ FHLB borrowings represented a small fraction of the $8.3 trillion in assets held by the industry, and that tapping FHLBs was “part of prudent, long-term risk management strategies.” The Insurance Coalition did not respond to a request for comment.
