There’s no bigger issuer of debt than the Federal Home Loan Banks’ office of finance. Last year it raised $440 billion in bonds and over $900 billion of term discount notes. Even the US government doesn’t issue as much, although the rising budget deficit might mean the Treasury could soon be mounting a challenge.
For now, though, the federal home loan banking system is bigger. And not just in the amount issued. So far this year, according to John Darr, CEO of the office of finance, 82 different underwriters have taken part in its bond deals. That’s nearly four times as many as the US government uses. As a point of reference, Darr says that roughly 110 institutions are registered as bond underwriters in the US.
Yet it’s much less well known than Freddie Mac and Fannie Mae. Until May last year the FHLB had never issued what Darr describes as “unswapped, syndicated, long-term, pre-sold global bonds”.
It had never needed to. Most of its funding needs are at the shorter end of the spectrum. “We don’t make 10-year loans,” says Darr. “What we have to fund is a pool of collateral wanting short, floating-rate loans. Usually what we do is issue fixed-rate deals in two-, three- and five-year maturities, and swap that into floating.”
The collateral is made up mostly of residential mortgages – roughly $500 billion-worth of them. The originators of those mortgages are the 8,045 banks, thrifts, insurance companies and credit unions that collectively are the owners of the federal home loan banking system. They each buy a stake in their regional federal home loan bank, of which there are 12 in total, and that entitles them to borrow against their mortgage books.
But in recent years the regional home loan banks have embarked on a new strategy. “The regionals started a programme to work with their member banks to provide a secondary market alternative to Freddie and Fannie, but in a different way,” says Bill Oliva at Citigroup. “A bank can fund a mortgage by keeping it on the balance sheet or selling it to Freddie or Fannie in the secondary market. The Federal Home Loan Banks now offer to split the risk with their member banks. The latter keep the credit risk while the FHLB takes the interest rate risk. This means that the home loan bank system is starting to keep mortgages on its balance sheet, so it needs to fund them.”
Nine of the 12 regional banks offer this service, known as the mortgage partnership finance programme, but two in particular are leading the charge: “The Chicago and Seattle Home Loan Banks have been the most aggressive in pursuing the new strategy,” says one banker who covers FHLB. Of these two, Chicago, is the clear leader. Its executives were the driving force behind devising the programme, and last year it was responsible for more than 50% of the mortgages financed through the mortgage partnership finance programme.
It’s still a relatively small part of the system’s balance sheet but it has proved an enticing alternative to selling the mortgages to Freddie or Fannie: in the five years since the programme began the regional federal home loan banks have bought roughly $55 billion of mortgages.
And that needs to be financed, which is why the office of finance last year made the jump into longer-term syndicated bonds. The first was launched in May 2002, a 10-year $3 billion fixed-rate deal. It was well timed. Freddie and Fannie were coming under increasing scrutiny in the press and in Congress and investors were looking for some diversification.
And the demand has continued this year: Freddie and Fannie have both reduced the size of deals they are doing in the past couple of months. Last year Freddie issued nearly $80 billion of global syndicated bonds; this year it might only be around $30 billion. And for as long as interest rates stay at or below 1.25% any highly rated issuer offering a pick-up to US treasuries ought to be extremely popular.
A year ago, though, it was FHLB’s novelty value that initially appealed. “For many investors this was a new name,” says Oliva. And, it soon became apparent it was a new name they wanted. “Their first negotiated global, which we did with ABN Amro, was incredibly successful. It came at nine basis points though the agency’s Taps programme, and by the time the dust had cleared it was trading around the same as Freddie and Fannie, at times even through their spreads.”
It was no simple task, though. Despite being the largest issuer of debt, Darr and his team still had to go out and tell their story to investors. “We roadshowed three continents simultaneously,” he says. “It was only the second deal-specific roadshow we’d ever done, and we’d never done any kind of roadshow in the US until the president of the Chicago Federal Home Loan Bank and I did for this deal.”
Darr and his team have since followed that up with another 10-year deal in November and again last month, as well as offering five-year paper in March and a three-year deal in May. And they are all trading well. Asian institutions have bought up nearly 30% of the paper, Europe took 10% and US investors 59%, although Darr points out that about 55% of last month’s three-year deal was sold abroad, despite the weakening dollar.
Hardly a dent Each of the syndicated deals raised $3 billion, which makes for a grand total of $15 billion. That’s a fair whack to raise in just 12 months. But it’s hardly a dent next to FHLB’s overall funding requirements. And those have increased in the past couple of years because of falling interest rates. On the one hand that has enticed more borrowing and more refinancing in the residential mortgage space. But on the other it has also allowed the office of finance to reduce its borrowing costs, as most of its traditional funding is done on a callable basis.
“There’s an acceleration of calls on outstanding paper because interest rates are so low,” says Frank Keane, head of US agency debt at Banc of America Securities. “Just last week, for example, $9 billion of FHLB paper was called.”
But most of the FHLB’s funding needs are satisfied through negotiated trades. It has a daily auction process of mostly bullet two-, three- and five-year deals organized on a quarterly basis starting in February, May, August and November. On any given day the office of finance might do as many as 40 trades. “They would do deals as small as $10 million,” says Keane. “Now reverse enquiry has increased so much for asset swap deals that they’ve increased their sizes to a floor of $40 million for lockouts of three months and $20 million for lockouts of six months or more. There’s a good retail base for these deals because they are exempt from state and local tax.”
For syndicated deals FHLB is not publishing a calendar. “We’re unlikely to print a precise schedule,” says Darr. “In general, though, we’re delighted that we can give a sense of rhythm and expectation. So on the roadshow for last month’s deals, for example, we told investors that we expect to return to the market in the fall, and that it was highly likely that we’d offer some diversity in maturity.”
