FEDERAL HOME LOAN BANKS & INSURANCE COMPANIES: A Blossoming Relationship ACLI Annual Conference 2013 October 29, 2013 Jon Griffin, Chief Credit and Marketing Officer, FHLB Indianapolis Julie Spiker, Deputy General Counsel, FHLB Pittsburgh
GSE created by FHLB Act of 1932 Original members were thrifts and insurance companies Current members include banks, thrifts, credit unions, insurance companies, and community development financial institutions Mission includes providing liquidity to the housing markets and community and economic development 12 FHLBs are autonomous, member-owned financial services cooperatives Individual FHLBs linked by joint and several liability for repayment of System debt securities Consolidated obligations are rated Aaa and P-1 by Moody s and AA+ and A-1+ by Standard & Poor's 2
Insurers included in original FHLB Act of 1932 Insurance membership concentration varies by district, but Life, P&C, Health, and Captive industries represented Insurers have significant investments in Residential mortgage assets Commercial R/E assets Section 42 low income housing tax credits Insurance industry participation in mortgage market and community involvement fit well within FHLB mission 3
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Name Domicile District Assets ($Billions) Metropolitan Life Insurance NY New York 360.50 The Prudential Insurance NJ New York 285.09 John Hancock Life Insurance MI Indianapolis 227.14 Lincoln National Life Insurance IN Indianapolis 180.03 Massachusetts Mutual Life Insurance MA Boston 155.65 American General Life Insurance TX Dallas 149.63 AXA Equitable Life Insurance NY New York 144.83 Hartford Life Insurance CT Boston 140.50 Jackson National Life Insurance MI Indianapolis 136.82 New York Life Insurance NY New York 134.73 Principal Life Insurance IA Des Moines 131.33 Nationwide Life Insurance OH Cincinnati 106.58 Transamerica Life Insurance IA Des Moines 106.00 Pacific Life Insurance NE Topeka 101.54 RiverSource Life Insurance MN Des Moines 96.76 Allianz Life Insurance MN Des Moines 94.43 MetlLife Investors USA DE Pittsburgh 85.99 The Variable Annuity Life TX Dallas 70.61 Prudential Retirement Insurance and Annuity CT Boston 69.27 ING USA Annuity and Life Insurance IA Des Moines 68.91 9
Considerations Application and underwriting process Membership policies differ across FHLBs Credit policies differ across FHLBs Equity stake required Borrowings are fully collateralized 10
Membership Stock vs. Activity Stock Redemption/withdrawal period varies by district Purchased/Traded at $100 par value not publicly traded NAIC classified unaffiliated common stock Favorable 1.1% pretax RBC factor Dividends paid quarterly Determined by each FHLB s Board of Directors Paid in cash or additional shares of stock Payout/retention ratios varies by FHLB 11
Eligibility and haircuts vary by FHLB district. Below are eligible collateral types for the FHLB Indianapolis (FHLBI) Securities Treasuries Agencies MBS, CMBS, CMOs, and some mortgage-related ABS Whole Loans Multifamily loans Commercial real estate 1-4 family whole loans Home equity loans 12
Benefits Backup liquidity facility with proven reliability through credit crisis Capacity allows for carrying of less cash Access to low-cost funding for strategic and tactical opportunities Ability to customize long-term funding structures. Ability to increase and diversify earnings with operational leverage trades (funding agreements) Ability to mitigate asset/liability mismatches Assists in managing Dodd-Frank counterparty collateral Access to community investment funding (at cost) and affordable housing grants 13
Access to global capital markets Cooperative structure Fully collateralized FHLBs maintain large cash positions for benefit of membership Tested during recent events (9/11, Mortgage Crisis, Hurricane Sandy, Debt Ceiling) 14
7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% Treasury FHLB DNs LIBOR 0.00% Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 15
FHLB programs provide financial flexibility for insurance company members and are an attractive source of capital due to the low rate offered for advances. (FHLB) Funding availability proved A.M. Best s Perspective on Operating Leverage, to be particularly important during the Ratings Methodology, January 12, 2012. financial crisis, when access to traditional capital market sources decreased. Fitch Ratings Special Report, June 12, 2013, The Federal Home Loan Bank System, Its Role in the Life Insurance Industry. All else being equal, a company that prudently manages its capital structure, investments underwriting, and risk management can enhance its financial flexibility from FHLB capital funding How Federal Home Loan Bank Funding Figures in Ratings on Insurers, S&P Ratings Direct, May 15, 2013. 16
#1 Backup Liquidity Augment and/or replace existing facilities Gain liquidity from relatively illiquid assets Fund unexpected liquidity needs without selling earning assets Avoid fire sales Manage capital gains and losses Incorporate into ERM 17
#2 Increase Profitability of Treasury Operations Actively reduce cash and liquidity balances Invest proceeds in higher yielding, collateraleligible assets Remain fully-invested and borrow, as needed, to fund shortfalls Manage Dodd-Frank collateral requirements for derivatives without carrying excess liquidity 18
#3 Actively Use for Tactical Funding Take advantage of low rate environment to lock in term financing to fund working capital Opportunistic matched trades Lock in term financing to reduce disintermediation and/or inflation risk Utilize FHLB borrowings to assist in financing New facilities (CICA Program) M&A Etc. 19
#4 Improve Spread Lending Liquidity Liquefy relatively illiquid earning assets Use FHLB funding agreements to Execute tightly matched trades Fill maturity gaps and reduce roll-over risk 20
FHFA Advisory Bulletin No. 2012-N-14 Proposed principles that would be used to evaluate insurance member financial health and quality of collateral FHLB regulator has serious misunderstanding of the national state based system of insurance regulation * FHFA expected to revise Advisory Bulletin following comments received; gained better understanding of status of secured creditors of insurance company *NAIC Comment Letter on the FHFA s Advisory Bulletin No. 2012-N-14 on Collateralization of Advances and Other Credit Products Provided by Federal Home Loan Banks to Insurance Company Members, November 28, 2012. 21
OIG Audit Report No. AUD-201-2013-0006 OIG Recommendation: FHFA request access to supervisory information from state regulators in identified FHLB districts (DM, Indy, Topeka, NY and Cincinnati) FHFA has established relationship and ongoing contacts with NAIC FHLBs engaged in outreach to state regulators and have participated in three successful rehabilitations Future FHFA guidance on lending and collateral requirements generally could impact insurance company members 22
FHFA Revisions to Membership Regulation ANPR issued December 2010 ANPR teed-up proposals to fundamentally change membership requirement for all members to include ongoing housing nexus requirement Requested input on ongoing (housing assets test dollar amount or percentage of assets) requirement Extreme change to membership rules; No ongoing requirement since 1989 Would effectively act to reinstate a type of qualified thrift lender test Inconsistent with prudent asset diversification by depository institutions and insurance companies Significant comment letters from ACLI and insurance industry 23
Next Step: FHFA expected to issue proposed Membership Regulation Will likely include ongoing housing assets test Will provide cure period for member falling out of compliance Reduces attractiveness of FHLB membership and burdens members Unnecessary given existing FHLB Act limit on access to long-term (greater than 5 years) advances by members with low levels of on-balance sheet housing assets Proposal will have public comment period Critical for insurance company members and trade groups to actively participate in process 24
NAIC Statutory Accounting Principles and Blanks Initiative Restricted Asset Subgroup project examined disclosures of: 1) FHLBank stock and 2) collateral pledged for FHLB advances Focus on enhancing SAP quarterly disclosures of FHLB stock holdings, borrowings, and pledged collateral Discussed and considered requiring disclosure of estimated prepayment fees on advances and treatment of pledged collateral as an admitted asset 25
Final version recommended to Blanks Group Effective for 1 st quarter 2014 reporting Pledged collateral still an admitted asset; no prepayment fee estimates; intra-period data reporting on maximum amount pledged Need to continually monitor other NAIC efforts Update from NAIC Restricted Asset Subgroup call on liquidity of FHLB stock 26
2012 NAIC RBC Pledged Asset Proposal Does not consider rating agency guidelines and distinctions between operating and financial leverage Adversely impacts insurers pledging assets for derivatives and FHLB advances to hedge risk Reduces value of FHLBs as a catastrophic liquidity backstop (run-on-the-bank scenario) Encourages insurers to only pledge most liquid collateral to FHLBs to get more bang for their buck Comments received and reviewed during Fall NAIC meeting. Action deferred. 27
FHLB State Law Initiative Initiated to seek further clarity and certainty in states laws regarding FHLBs status as secured creditors of insurance companies; similar to protections afforded to FHLBs under federal law relating to advances to depositories ACLI supports FHLB Legislation Currently being reviewed by FHLB Legislation Subgroup of NAIC Receivership and Insolvency Task Force NAIC concerns regarding FHLB stock and collateral levels Receiver community concerned generally with secured borrowing by insurance companies 28
FHLB State Law Initiative Proposed legislation enables FHLBs to improve terms of lending For example, require less collateral to be pledged/improve haircuts and expand eligible collateral Currently FHLBs provide less lending value for collateral pledged due to consideration of stay and preference risk Example Insurance company member pledging Treasury securities to secure FHLB advance for $5 million loses between $96,000 and $778,000 in lending value on those securities compared to FHLB depository institution member Note: Illustrative example only; each FHLBank maintains its own collateral policies and requirements. Insurance company members need to understand the specific requirements of their FHLBank. 29
FHLB State Law Initiative Summary Legislation has already been enacted in Indiana, Michigan, Nebraska, and Oklahoma Proposed legislation will never result in FHLB recovering more than it would otherwise be entitled under security agreement Provides opportunity for better execution/use of insurance company assets as collateral Allows for FHLB to accept less liquid collateral such as commercial real estate mortgage loans Benefits insurance companies facing increased need for securities collateral in other areas such as cleared derivatives Provides additional flexibility to insurance companies in assetliability management 30
Jon Griffin, FHLBI Chief Credit & Marketing Officer jgriffin@fhlbi.com Julie Spiker, FHLB Pittsburgh Deputy General Counsel julie.spiker@fhlb-pgh.com 31