An unspectacular sunset for mortgage REITs' FHLB membership

A yearslong battle over captive insurance company membership in the Federal Home Loan Bank system, primarily by means of vehicles owned by publicly traded mortgage real estate investment trust, is about to end relatively quietly.

Under a controversial final rule implemented in 2016 by the Federal Housing Finance Agency, the FHLBs' regulator, captive insurers that joined the system prior to 2014 will have their memberships terminated no later than Feb. 19. Only six captive insurance subsidiaries of publicly traded mortgage REITs began 2020 as FHLB members, and it appears that no more than two of them will have any outstanding borrowings in place beyond the first quarter.

The rule spawned legislation and several years of lobbying for reconsideration, and a February 2020 FHFA request for input as part of a periodic review of FHLB membership criteria elicited strong opinions both for and against captive insurance membership from a wide range of interested parties.

At year-end 2015, S&P Global Market Intelligence counted 26 captive insurance subsidiaries of mortgage REITs and one equity REIT unit as holding FHLB membership. Their aggregate outstanding FHLB advances at that time exceeded $23.6 billion, but the vast majority of those captive insurers, including three of the four largest borrowers in the group as of Dec. 31, 2015, lost access to the FHLB no later than February 2017 under the FHFA's rule.

The rule required captive insurers with memberships terminating in 2017 to repay their advances prior to leaving the system. For the remaining captives, the rule permitted advances scheduled to mature beyond February 2021 to remain in place, but it prohibited the issuance or renewal of advances beyond the termination date.

Captive insurance units of Annaly Capital Management Inc., Invesco Mortgage Capital Inc., Ladder Capital Corp, Redwood Trust Inc., Starwood Property Trust Inc. and Two Harbors Investment Corp. held FHLB advances of $9.39 billion in the aggregate as of Dec. 31, 2019. The borrowings among the six captives plunged to $5.50 billion three months later. By June 30, 2020, Two Harbors' TH Insurance Holdings Co. LLC repaid its advances from the Federal Home Loan Bank of Des Moines, and the remaining outstanding borrowings of the five other mortgage REIT captives slumped to a total of $2.18 billion as Redwood's RWT Financial LLC advances dwindled to just $1 million from $1.37 billion in a three-month span. Annaly's Truman Insurance Co. LLC and Invesco's IAS Services LLC repaid their remaining borrowings during the third quarter of 2020.

In Invesco's case, the Federal Home Loan Bank of Indianapolis had modified the terms of its captive unit's secured borrowings in April 2020 after it determined that the mortgage REIT had fallen out of compliance with the covenants of the underlying agreement. The modified terms required repayment of the outstanding borrowings, which totaled $1.35 billion as of March 31, 2020, by December 2020. IAS Services also terminated its FHLB membership in the third quarter of 2020.

Starwood's Prospect Mortgage Insurance LLC held $619.5 million in borrowings from the Federal Home Loan Bank of Chicago as of Sept. 30, 2020. A table of scheduled and projected principal repayments in Starwood's most recent Form 10-Q showed that the company expected to pay down $277.5 million in the fourth quarter of 2020 in connection with an expected securitization of certain residential loans. For the remaining $342 million, Starwood said it expected to pay that amount off in the first quarter of 2021 through proceeds of a residential loan securitization or alternative means of financing.

That would leave only two mortgage REIT captives with any potential ongoing FHLB borrowings.

Redwood's token remaining amount of advances from the Chicago home loan bank mature in 2026. During the second quarter of 2020, the company completed the sale of nearly all its residential loans previously held for investment that it financed with the FHLB facility.

Ladder Capital's Tuebor Captive Insurance Co. LLC maintained $326 million of borrowings from the Indianapolis home loan bank as of Sept. 30, 2020, down from $1.07 billion at the end of 2019. The remaining maturities are staggered from 2020 through 2024, Ladder Capital said in its most recent Form 10-Q, and it expects to fund additional paydowns from the natural amortization of securities over time, loan payoffs, and/or sales of loan and securities collateral.

President Pamela McCormack said during a July 2020 conference call that Ladder maintains a good relationship with the home loan bank, and the facility "continues to be our lowest cost of funding."