By Noah Buhayar | Bloomberg
US banking regulators confronted an unusually large penalty when they seized Silicon Valley Bank last year: $285 million in fees to prematurely wind down emergency financing from the Federal Home Loan Bank system.
That was the price tag to retire billions in financing that the firm obtained in a last-ditch attempt to survive a run on deposits, according to an internal Federal Deposit Insurance Corp. document obtained by Bloomberg.
The fee, which hasn’t been previously reported, was the largest of its kind for any bank failure since before the 2008 financial crisis, the document shows.
The ability of FHLBs to generate fees on emergency lending, even when borrowers fail, is sure to stoke the debate in Washington over how to reform the Depression-era system designed to help finance mortgage lending.
In November, the Federal Housing Finance Agency, which oversees home-loan banks, said it planned to study prepayment fees and potentially change rules. The regulator aims to ensure such institutions have an incentive “to improve their due diligence” before ramping up financing — known as advances — to struggling members.
To be sure, FHLBs incur costs when retiring the debt, and the fees they’re allowed to charge are approved by their regulator. The idea is to let the institutions recoup those expenses so that they remain financially indifferent to prepayments.
Such fees “are disclosed to all interested parties, are generally equal to the cost of unwinding the hedged transaction, and are in keeping with safe and sound banking practices,” said Ryan Donovan, chief executive officer of the Council of Federal Home Loan Banks, a trade group.
As SVB teetered on the edge of collapse last year, the FHLB of San Francisco quickly ramped up its lending to the struggling bank, eventually providing it with $30 billion. When it collapsed, that money was repaid early, along with fees.
Prepayment penalties boosted the FHLB’s first-quarter profit by $43 million last year, according to an earnings report. Most of that was tied to SVB, said Elliot Sloane, a spokesman for the home-loan bank, who declined to confirm the size of the fee charged or specify what portion was booked as income. By the end of the year, the bank’s total profit had surged 67% to $539 million.
The San Francisco FHLB “worked diligently and urgently to provide critical liquidity to Silicon Valley Bank in the days prior to its failure,” Sloane said.
When SVB failed, the FHLB had a right to recall its money but chose not to do so, he said. Instead, the bridge bank that took over SVB decided to repay the advances early and incur the cost laid out in the contract. Doing so allowed for full control of SVB’s assets that had been pledged as collateral to the home-loan bank.
Regulators ultimately sold Silicon Valley Bank to regional lender First Citizens BancShares Inc., which continues to use the brand to cater to tech entrepreneurs and their investors.
Many other banks that relied on FHLB support last year also elected to pay back the money early, stomaching penalties. At the peak of the turmoil the system loaned out about $676 billion in a single week, helping to stabilize the industry.
“Over the course of the next few months, many of our members — secure in their deposit strength — chose to prepay their advances to free up collateral and reduce their borrowing costs,” Sloane said. “In each of these cases, the FHLBSF unwound the individual hedges connected to these advances per the regulatory formula imposed by the FHFA.”
Spokespeople for the FDIC and FHFA declined to comment. In its November report, the FHFA said a home-loan bank “may choose to waive a prepayment fee if it will not result in an economic loss to the FHLBank.” The FDIC document doesn’t specify the impact, if any, of any such waivers.
Congress created FHLBs during the Great Depression to inject money into home lenders. But more recently, the private cooperatives have been used as a cheap and convenient source of cash for banks and other financial firms for purposes unrelated to housing, Bloomberg reported in a series of articles last year.
Two-thirds of the 544 banks seized since 2006 held advances at the time of their failure, totaling some $185 billion in borrowing, the FDIC document shows. Until last year, the vast majority of this debt was assumed by whatever institution ended up acquiring the failed banks.
The penalties underscore how much banks have come to rely on FHLBs for purposes other than financing places for people to live, said Sharon Cornelissen, director of housing policy for the Consumer Federation of America and chair of the Coalition for FHLB Reform.
“The Federal Home Loan Banks should be a tool to help tackle our housing crisis,” she said. “It shouldn’t be in the business of propping up failing banks.”
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