A new rule proposed by the Federal Housing Finance Agency (FHFA) would force some REITs to look for a new source of funding by redefining ‘insurance company’ to exclude the kind of captive insurance firms that some had been using to access secure, low-cost debt from Federal Home Loan Banks (h/t Jody Shenn at Bloomberg). If the rule is put into effect as written following the 60 day public comment period it would sunset captive insurance involvement over the next five years.

REITs

“The proposed rule would revise FHFA’s existing Bank membership regulation to ensure that members maintain a commitment to housing finance and that only eligible entities can gain access to Bank advances and the benefits of membership,” says the FHFA press release.

REITs currently access FHLB system through captive insurance

REITs that invest in mortgage debt have been able to meet the requirements to take part in the government sponsored FHLB system through captive insurance companies – basically wholly owned subsidiaries that exist to insure the parent company. But under the new rules an insurance company would only qualify if its primary business is insuring ‘nonaffiliated persons’.

“This would continue to include traditional insurance companies but would effectively exclude captive insurers from membership and prevent entities not eligible for membership from gaining access to Bank advances through a captive insurer,” says the statement.

While FHFA doesn’t specifically mention REITs or other parts of the shadow banking system in the statement, it’s clear that the agency’s aim is to make sure that only traditional finance companies are able to access FHLB funding.

Existing requirements for applicants would be extended to members

The proposed rule makes a couple of other significant changes to the requirements necessary for membership in the FHLB system, including extending two requirements that currently only affect applicants. Right now an applicant has to show a nominal amount of home mortgage loans on its balance sheet to qualify for the FHLB system, but the new rule would force all members to maintain at least 1% of assets as mortgages to remain in the system. Similarly, members that had to meet the 10% residential mortgage loan requirement when they applied would have to meet that requirement on an ongoing basis instead.

FHFA also said that the new rule would clear up which of the 12 federal home loan banks a member should apply to based on where its principal place of business actually is.