Captive Insurers Banned in New FHFA Rule, FBR Capital Notes (LADR) (TWO) (IVR) (more...)

FBR Capital analyst Daniel Altscher noted he FHFA released final rules establishing new standards for membership to the Federal Home Loan Bank (FHLB) system which negatively impact the mREIT space. Under the new rules, captive insurance companies will be excluded from FHLB membership.

Altscher notes currently, some mREITs establish captive insurance subsidiaries, which then enjoy low-cost funding through FHLB advances. The FHFA has seen an uptick in such transactions since 2012 and believes it is a circumvention of current law. Current captive insurers with FHLB membership will be allowed to remain FHLB members for five years after the rules go into effect, subject to certain requirements. Captives that became FHLB members after within the last 15 months must terminate their charter within a year. There are currently 40 captive insurers in the FHLB system. In our view, while losing access to FHLB advances is not positive news, it is not a structural financing issue, but rather an earnings issue. mREITs—including the four under our coverage—will likely find new financing more expensive than existing financing.

Within the firm's coverage, there are seven companies that currently access the FHLB. Ladder Capital Corp (NASDAQ: LADR) has 40% of outstanding debt advanced under the FHLB ($1.8 billion), Two Harbors Investment Corp.(NYSE: TWO) has around 27% of its current financing outstanding under FHLB ($3.7 billion). Invesco Mortgage Capital Inc. (NYSE: IVR) has 9% of its total financing outstanding under FHLB sources ($1.7 billion). Arlington Asset Investment Corp.'s (NYSE: AI) FHLB advances comprise 10% of outstanding debt ($309 million), MFA Financial, Inc. (NYSE: MFA) has less than 3% ($265 million) of total financing derived from FHLB advances. Lastly, Annaly Capital Management, Inc. (NYSE: NLY) has a de minimis amount relative to its overall financing structure of less than 1% and Starwood Property Trust, Inc. (ASDAQ: STWD) has not currently drawn down anything from the FHLB as of 3Q15.

The firm sees potential earnings downside, but notes five years is a long time.

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