After the welcome diversions of the last two posts, I’m back to the issue at hand – estimating what resources the FHLBs can apply towards affordable housing initiatives.
After the Banks are done counting their profits for the year, they decide what to do with them – but they only have two choices: pay dividends or add to retained earnings (their own savings account).
Dividends are the fun part – lots of smiles and a sense of accomplishment – but as I’ve shown, you can only pay so much in dividends. At current levels, after including the hefty dividends, member institutions can borrow from the FHLBs at about the same rates the US Treasury borrows. That is the best deal in town, and you can’t do better than the best. So, a cap on dividends has been suggested.
The balance of the profits goes to retained earnings. A more passive route akin to saying, ‘we have this money, but we don’t know what to do with it, so we’ll just save it’. That’s not very creative. This dilemma has confronted the FHLBs for years – and the result: a massive accumulation of retained earnings (aka, money they don’t know how to deploy) as shown previously.
To be fair, some level of retained earnings is required to cover risk exposure. Each FHLB calculates their aggregate risk exposures and makes sure it has sufficient retained earnings to cover these potential losses. The FHFA has a similar measurement process, the basis of the regulatory Risk Based Capital Requirement (RBC).
At year end 2023, the RBC requirement was about $14 billion, and accumulated retained earnings had amassed to $28 billion with a $3 billion add in 2023 alone, that is two times that required for risk.
Adding to retained earnings is okay – but without limit?
Rather, as I have suggested limits on dividends, I now propose that until such time the FHLBs develop strategies to meaningfully develop mission consistent ways to deploy retained earnings (which I’m hoping will happen soon), they should at least stop adding to them. Enough is enough.
2 Responses
Come on George you can do better than this given your tenure as a CRO at a couple of FHLBanks.
last i checked retained earnings are needed to do more than just absorb losses. just a cursory glance at the jun-30, 2024 combined financial statement details about $430b of assets that are likely not capitalized through membership/activity stock ($1.277b assets less $781b advances and $65b in whole mortgages). These $430b of non-self-capitalized assets require about $17b of retained earnings just to meet the regulatory required 4% capital ratio. Looks like there is just barely enough of retained earnings, $30b, to meet what is minimally required ($17b capitalization plus $14b to cover estimated losses).
perhaps the story6 is more enough is enough of shoddy analysis
Those are important points, and I appreciate the comments – or most at least.
I do agree with your math, but not the conclusion. Remember, the FHLBs control the amount of capital members are required to contribute. The FHLBs also control the amount of non-self-capitalized assets on balance sheet. And the FHLBs can control the amount of risk they take on. As you point out, the combination of their decisions on these three fronts leaves little excess retained earnings, but that has been their choice – and it is not immutable.
While retained earnings, the only permanent source of capital should be available to cover risk, members should supply the capital required to run the business. Any leftover retained earnings can be invested as appropriate – including as I suggested in affordable housing and community development initiatives.
That is not radical, but it is not the status quo.
As this blog has focused on – think differently.
first, the FHLBanks do not fully control the amount of their liquidity holdings, which are driven by the FHFA.
second, while the FHLBanks can establish activity and membership stock requirements, but you know if those are set too high, then most members would not borrow, leading to a decline in income and ultimately a lower affordable housing contribution.
third, the problem is that activity and membership stock have maximum retention period of 5 years. a member can request both activity and member stock; if so, that capital is re-classified as debt in GAAP financial statements, so member requested stock for redemption is not available to maintain adequate capitalization in GAAP statements.
fourth, members are supplying the capital to run the current business, as the FHLBanks can only raise capital from their members. While you may not like that the Gramm-Leach-Bliley act adopted by congress in 1989 explicitly states retained earnings belongs to the members, get congress to undo that part of the act. until then, the members are providing sufficient capital to run the business, they do it in two forms stock (membership and activity) and retained earnings, just because you do not like that form of member capital, it does not mean that the current level of retained earnings is by any means excessive and not currently needed to maintain the safe & sound operations of the FHLBanks.