Quick, what’s the largest and oldest government-sponsored enterprise devoted to housing?
If you said Fannie Mae, wrong.
If you said Freddie Mac, wrong again.
The answer is the Federal Home Loan Bank (FHLB) system. Created by Congress in 1932 to help kickstart home mortgage lending, the FHLB system is one of the largest sources of capital for lenders in the country today. If you have ever taken out a loan from a conventional bank, there’s a good chance it played a role in getting that loan to you.
Until recently, the FHLB system was only open to the same, conventional banking system that has historically discriminated against low-income communities, particularly those of color. As of December 31, 2013, the FHLB system had $492 billion in capital deployed to its 8,000 members, but $135 billion of that went to its four largest members alone: JPMorgan Chase, Wells Fargo, Bank of America and Citigroup.
CDFIs (community development financial institutions) are now blazing the trail to change that, a trail that bridges mainstream finance and community development finance. FHLB membership first opened to CDFIs in 2010. To date, 40 CDFIs have become members of their regional FHLB.
CDFIs are collectively responsible for 65 to 90 percent of lending volume in underserved communities. As more CDFIs become FHLB members, it could represent a return to the FHLB system’s original purpose: to kickstart lending on a massive scale in communities where it isn’t currently happening.
“It is imperative that the opportunity finance industry ensures that the FHLB system continues to reach disinvested communities and does not merely maintain the status quo,” says Jackeline Stewart, spokeswoman for Opportunity Finance Network (OFN), a national network of CDFIs.
Here’s how it works: The FHLB system consists of 11 regional FHLBs (originally one for each of the 12 Federal Reserve regions, but Seattle and Des Moines merged last year). Each FHLB is cooperatively owned by its members. Lending organizations, usually banks, become members by purchasing an ownership stake in their regional FHLB (the size of the stake usually depends on the size of the applicant). With the staked dollars as collateral, and the implicit backing of the U.S. government, the FHLB system can borrow at extremely low interest rates from international capital markets. Each regional FHLB then re-lends that capital at slightly higher interest rates to its members, earning just enough to fund its operations. No taxpayer funds are involved in the operation of FHLBs.
“FHLB membership means a CDFI can borrow capital at rates that are at or below their current borrowings,” says Ellis Carr, CFO of Capital Impact Partners, an Arlington, Virginia-based CDFI that works nationwide. Capital Impact Partners became a member of FHLB Atlanta in March 2015.
FHLB members have historically been required to have at least 10 percent of their business in mortgage-related lending, but they are not required to use FHLB loans only for home mortgages. Most importantly, FHLB transactions can often be completed on the same day as the request, and loan terms can be as long as 30 years. FHLB membership thus means access to cheap, flexible, essentially on-demand capital.
“FHLB membership will allow us to expand our reach in the communities that we serve,” says Carr. “We’ll be able to do deals that we probably couldn’t do otherwise.”
Capital Impact Partners hasn’t taken out an FHLB loan yet, but Carr anticipates they could take up to $15 million in 2016.
There is a catch. For every FHLB loan, members including CDFIs must pledge a certain amount of collateral to ensure they will be repaid in case something goes wrong. CDFIs, however, tend to have assets that FHLBs aren’t used to seeing as collateral — loans to charter schools, small health clinics and multifamily affordable housing developments. For that reason, FHLBs generally have required CDFIs to set aside more collateral than conventional banks for loans of otherwise equal value.
Collateral requirements have discouraged many CDFIs from becoming FHLB members, according to the GAO. A handful of CDFIs are working with their respective FHLB branches to tweak collateral requirements to encourage more CDFIs to join.
“FHLB Atlanta made the needed adjustments to these rules, demonstrating their flexibility and desire to be a strong partner to CDFIs,” says Lori Chatman, president of Enterprise Community Loan Fund (and also currently board chair of OFN). Enterprise joined FHLB Atlanta in April 2015.
With collateral requirements tweaked to fit CDFIs better, Carr says the membership process was relatively quick and straightforward. What’s more, greater CDFI membership in regional FHLBs could have even bigger ripple effects into the future. Since FHLBs have been around for so long, and have long worked with conventional banks, membership can serve as a stamp of approval for large investors who might not be as familiar with CDFIs.
“It helps to bridge the gap between traditional capital markets and community development finance,” Carr says.
The Equity Factor is made possible with the support of the Surdna Foundation.
Oscar is Next City's senior economic justice correspondent. He previously served as Next City’s editor from 2018-2019, and was a Next City Equitable Cities Fellow from 2015-2016. Since 2011, Oscar has covered community development finance, community banking, impact investing, economic development, housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha and Fast Company.