Well, no, not really, but there is a connection.
Dollar Libor continued its upward drive for a fourth day today — the longest run of rising rates since early October and interestingly, the upward tick may have something to do with the US’s Federal Home Loan Banks, or FHLBs, which have been on an FT Alphaville deathwatch in recent weeks.
Recall that the FHLBs, of which there are 12, rank among the biggest providers of funds for US mortgages. The FHLBs themselves have been under pressure as the value of their mortgage-backed securities declines. Their regulatory capital requirements are risk-weighted and based on market prices, so as the value of their MBS portfolios falls the more capital they need to have, hence we’ve seen them struggling to meet requirements in recent weeks. The Seattle Home Loan for instance, has said it will suspend dividends to preserve its capital.
As for the relationship with Libor specifically, Bank of America’s Michael Cloherty elaborates:
In order to borrow from the Home Loan system, banks must buy FHLB capital notes which pay a dividend. The FHLB system then levers up this capital roughly 20 to 1 by issuing debt, and lends the proceeds back to the borrowing bank. So the all-in cost to the borrowing bank is the rate on the loan minus the dividend income received on the capital note.
Historically, in order to preserve capital the regional Home Loan Banks first stop paying dividends on their capital notes (other options include not allowing banks to redeem capital notes that are not being fully borrowed against, calling in more capital from member banks, or receiving a capital injection from the Treasury). This dividend reduction is already underway-in Q3 2007, the average dividend was 5.16%, while in Q3 2008 it was 3.50%.
But if we assume one of the FHL Banks pushed its dividend to 0% to preserve capital (a 350bp reduction), that would raise the cost of funds for a bank borrowing to full capacity (assume 20 to 1) by roughly 15bps. This would likely cause banks to be more aggressive in financing themselves through wholesale deposits, which would impact the LIBOR setting.
Combine FHLBs’ troubles with rising CDS spreads on the Libor bank panel – i.e. the 16 banks who report rates – which has jumped 25bps since the start of 2009, plus renewed stress in money market funds, and you have your slightly higher dollar Libor.
Now the FHLBs have some $1,250bn worth of debt between them — more than Fannie and Freddie, according to Bloomberg data — and their contribution to liquidity in recent months has been second only to the Federal Reserve. Rather than bail them out, a cheap and easy way for the US to help them and help thaw interbank lending, would be to change the way in which FHLB’s capital requirements are calculated — a move expected to be announced this week.
Related links:
Fannie, Freddie, now FHLBs? – FT Alphaville
Home-loan banks struggle to maintain capital – WSJ