WASHINGTON, DC—The Federal Housing Finance Agency on Tuesday shut out mortgage REITs from membership in Federal Home Loan Banks. NAREIT expressed disappointment with the ruling announced by FHFA director Mel Watt, which closes a loophole that allowed investors, including mortgage REITs, to create captive insurance companies as a means of gaining FHLB membership.

"We note that the FHFA acknowledged a well-known fact," that 'mortgage REITs play an important role in the residential mortgage market,' " according to a NAREIT statement issued Tuesday afternoon. "We look forward to continuing our dialogue with FHFA, other federal regulators and Congress to explore how mortgage REITs may play an even greater role in the future in furthering national housing finance policy aims."

Insurance companies are eligible for FHLB membership, which provides access to low-cost, government-backed funding. In redefining "insurance companies" to exclude captive insurers, FHFA sought to prevent entities that otherwise don't meet the statutory membership requirements from circumventing those requirements by establishing and using captives as conduits. "The primary business of a captive insurer is underwriting insurance for its parent company or for other affiliates, rather than for the public at large, and captives are generally easier and less expensive to charter, capitalize and operate" than standalone insurers, according to FHFA. 

"FHFA has the authority and the duty to implement the statutory membership provisions of the Federal Home Loan Bank Act and by adopting the proposal to exclude captives from the definition of insurance company we are making sure that institutions can't frustrate the intent of Congress," Watt says. "Congress has amended the Federal Home Loan Bank Act in the past to allow additional entities to become members of a Federal Home Loan Bank and it can certainly do so again if it wants some of these entities to be eligible for membership."

The Wall Street Journal reported Wednesday that 40 captives had become FHLB members as of this past Sept. 30. As of mid-November, they had outstanding borrowings of more than $35 billion, the WSJ reported.

Mortgage REITs that became FHLB members prior to September 2014, when FHFA issued a proposed rule on membership, have five years to cancel their memberships. Those that became members after that date have one year to do so.

Michael Widner, an analyst for Keefe, Bruyette & Woods, told the WSJ that mortgage REITs have been hesitant to rely on the home-loan banks for a large portion of their funding because of the uncertainty surrounding membership. Accordingly, Widner told the WSJ he didn't expect the FHFA decision to have a near-term impact on REIT earnings. Nineteen of 24 publicly traded mortgage REITs have captive insurers that are home-loan bank members, according to the WSJ.