Editor's note: This piece originally appeared in the April edition of the MReport, available online.
The Federal Home Loan Bank Chicago (FHLBank Chicago) is a case study in how diversity and inclusion (D&I), when integrated with business strategy, can create a win-win for an organization as well as the people it serves.
“Our tagline is, ‘member-owned and member-focused.’ We recognize that our members create value in the markets and the communities that they participate in, and for us it’s part of our business strategy,” said Cedric D. Thurman, SVP, Chief Diversity Officer at FHLBank Chicago. “We’re going to be more effective as an organization delivering value to our members when we have employees who are highly engaged, who come to work excited to be here every single day looking to do their best for our members. This attitude helps our members do best in their communities.”
It’s the members of the Federal Home Loan Banks (FHLBanks) who are driving the growth of the Federal Home Loan Bank System (FHLBank System). In 2018, a year where most lenders saw a declining origination environment, FHLBanks used their Mortgage Partnership Finance (MPF) Program product to purchase about $13.6 billion worth of mortgage loans from their member institutions, most of which are small- to medium-size community banks and credit unions. When compared with the $11.9 billion worth of loans purchased by the program in 2017, the portfolio grew 14 percent year-over-year. This, in a year when the typical lender probably saw a reduction in their originations.
“The MPF Program focuses on members of the Federal Home Loan Bank System particularly community lenders,” said John Stocchetti, EVP and Group Head of the MPF Program at FHLBank Chicago. “It gives a platform to some of the smaller players who would not get the attention of secondary market players, except for the fact that we bring economic muscle to their ability in the secondary market.” But, to truly understand how the MPF Program and other initiatives have helped to foster D&I not only at the community banks level but also within FHLBank Chicago, it is important to get a historical perspective on the FHLBank System and how a crisis helped to create regulation that has made D&I an integral strategy at these institutions.
Though it isn’t a very well-known fact, the FHLBanks were founded through the Federal Home Loan Bank Act of 1932 making them the oldest housing government-sponsored enterprise (GSE). Fannie Mae was founded in 1938 and Freddie Mac, the youngest of the group, was founded in 1970. Collectively the FHLBank System is one of the largest financial institutions in the country with around $1.1 trillion in assets across 11 FHLBanks. As of December 31, 2018, the FHLBank System has a customer base of over 6,800 members. To become a member, the institution must be a bank or a credit union, insurance company, or a community development finance institution.
“Everyone places Fannie, Freddie, and FHLBanks in that order in terms of size. When I say we’re virtually similar, people are surprised,” said Steve Thomas, Senior Managing Director, Mortgage Capital Markets, at FHLBank Chicago. “In terms of active MPF loan sellers each year, the FHLBanks have about the same number of customers as Fannie and Freddie in that when you add the two FHLBanks that run their mortgage programs independently we’re a little over 1,000 sellers just like they are.”
In 2008, when the crisis struck and the Housing and Economic Recovery Act (HERA) regulation came into effect, the legislation added very specific language that laid the groundwork of creating a business that was driven by D&I.
“In that regulation, it called for greater inclusion, utilization of minorities and women and firms owned by them in the business activities of Fannie, Freddie, and the Federal Home Loan Banks,” Thomas explained. “That was the catalyst to real change and a new discussion within the Federal Home Loan Bank System of looking at D&I not just from a work force perspective but in all areas such as our capital markets activity, and even activities with diverse vendors and suppliers.” The FHLBank Chicago did its first assets transaction, a purchase of a bond with a diverse firm in 2015 through a program which established a framework under which we could qualify diverse vendors like women-, minority-, and disabled veteran-owned broker dealers as counterparts,” Thomas said.
Since then, FHLBank Chicago has focused on this effort in two different ways. “The first was to develop standards to approve counterparties, new diverse firms, and today we have 12 diverse firms as counterparties,” Thomas said. “The second goal has been to utilize them, to do transactions with them.”
On the asset side, “approximately a third of our transactions in 2018 were conducted with diverse firms. It exceeded the normal activities that you would think business folks are doing with diverse firms on Wall Street,” Thomas said.
A Driving Force
The MPF Program was introduced in the late 90s by the FHLBank Chicago to make mortgage purchase available to its members. Today, FHLBank Chicago does the back-office processing for eight FHLBanks (that also includes Chicago) to run a successful MPF Program. “Chicago basically acts like the backroom office for all of the processing of those loan purchases, and we provide that service to the other Federal Home Loan Banks that participate with us,” said Eric Schambow, SVP and Senior Director of MPF Product Management at FHLBank Chicago.
“By providing operational support of those processes to each of the FHLBanks that participate in the MPF Program, we don’t have to duplicate those processes in their individual districts,” Schambow said. “It’s more economical for us to do a shared service across the eight Federal Home Loan Banks in providing this product line in each of those FHLBanks’ districts.”
Apart from its flagship product that consists of conventional and conforming loans that the bank can acquire through its risk sharing products, it also buys government loans. “We buy FHA, VA, rural housing, and loans in smaller quantity for the Native American tribal land loans for residential purposes,” Schambow explained. “We also buy those loans and place them on our balance sheet as an asset.”
Over the 21 years since the MPF Program first started, the program has evolved some of its product suite. In 2008, it partnered with Fannie Mae to be able to buy conventional, conforming loans but not put them under a credit risk sharing arrangement. Instead, the product allows it to be a Fannie Mae-style product and the FHLBanks can buy loans from the members of the FHLBanks that participate under the MPF Program and collectively resell those loans to Fannie Mae.
“We continue to acquire loans through that product since 2008 and sell them immediately to Fannie Mae,” Schambow said. “We also buy government loans and have been partners with Ginnie Mae since 2015 to securitize government loans through the agency. So, some of the government loans we put on our balance sheet, and others we pool into Ginnie Mae securities.”
Thomas and his Mortgage Capital Markets team or the trade desk, is the part that joins FHLBank Chicago to the MPF Program, which is part of the larger FHLBank system. “We’re really performing dual functions for FHLBank Chicago. For the balance sheet we’re buying mortgage security related investments from Wall Street and MPF loans from our members,” Thomas said. “Then we are also responsible for producing what we call a national price for the MPF products. This is the price that each FHLBank can use so they don’t have to individually set their own price and can use our price to adjust it up or down to their liking for their own balance sheet.”
Thomas’ team is also responsible for the MPF Government mortgage-backed security (MBS) product for which it has partnered with Ginnie Mae, to produce rate sheets for the product every day. “We put out prices every day to acquire those loans and then buy, hedge, and ultimately securitize them into Ginnie Mae MBS,” he said.
“Essentially, we’re like a cash window for Ginnie Mae since we’re able to buy from all our local financial institutions that participate and accumulate and pool those into monthly issuances of securities, but all the servicing can still remain in their local institutions across the country—a very important piece of what we designed under this product and what helps to make it work,” Schambow added. “We acquire those loans here in Chicago on behalf of all the FHLBanks that participate in that product and we build our assets on our balance sheet to securitize the loans.”
Leveling the Playing Field
The MPF Program in many ways has given smaller community banks and credit unions a chance to effectively access the secondary market. “One way that we foster competition is by purchasing loans where we are the ultimate investor in some cases,” Stocchetti said. “In that case, we’re adding more bids in the marketplace. We’re adding more competition directly by offering to purchase loans.” According to Stocchetti the program, which began over 21 years ago, was started because community lenders were not getting recognized or getting value for loans they were originating or selling. Some of the pricing they received was ignoring the high-quality loans that they produced.
“Think of us as standing in the middle for over 900 active loan sellers in the market who happen to be our members in the program. The typical community lending institution tends to be a smaller bank or credit union, that, in fact, if you looked at the numbers, about two-thirds of our members in the program are organizations whose total asset size is around $500 million or less. They tend to originate a handful of loans a month that they sell into the program,” he said.
In 2018, over 900 institutions sold loans to an FHLBank. “What we’ve done over the years is really try to keep that same principle in place of providing them with the best possible execution, leverage in us as a cooperative and our ability to price; that would then make them as competitive as anyone else in a market place that is doing a lot of volume,” Schambow said. “Whether that’s a nonbank or a large bank. It’s all about making the smaller community institutions competitive in their local marketplace.”
In effect, FHLBank Chicago has become a catalyst for change for its members. “It’s important that our products meet the needs of our members in the communities in which they serve,” said Michael Ericson, EVP and Group Head Members and Markets, FHLBank Chicago. “We can tailor the products to our members from a community investment aspect, from an advances perspective, and from a lending perspective to support the financial institutions that support those communities. They’re able to then work with their customer and borrower base in making sure that their institution is more inclusive to the communities in which they serve.”
For community banks, increasing the market share translates to more volume, which in turn means that they get to distribute the cost base of the program over more transactions. “More volume is good for everybody that is in the program. In fact, one of the reasons you want to grow the program, is so that everyone has a lower per unit cost,” Stocchetti said.
And it is this commitment towards serving its members that drives Stocchetti and his team in all their efforts. “We’re a cooperative. Obviously, we also want to make sure we’re distributing cost properly and that we have a return for members. If you were to talk to my people here who support the MPF Program, they would tell you that I often say ‘keep focused on the value that we’re bringing to those community lenders and their customers. Their customers essentially are people like us, who are buying homes and raising families.’ I think it’s important to keep that in mind as well in terms of what it means as we’re increasing value and volume,” he said.
This makes D&I literally part of FHLBank Chicago’s business strategy.
Business and Diversity
Today, FHLBank Chicago’s Capital Markets Working Group has individuals representing multiple departments. One of this group’s goals is to look at how FHLBank Chicago can expand its business with diverse dealers.
“Part of that is looking at the list of diverse dealers that are out there, engaging them, interviewing them, meeting with them, building relationships with them,” Ericson said. “Ultimately, we are looking at those relationships and looking at opportunities in which we can transact through the asset side of our balance sheet by working with diverse dealers. What that allows us to do, is increase the competitive landscape of investment acquisition opportunities that are out there in the marketplace.”
According to Rene Cornejo, SVP Treasurer and Balance Sheet Management at FHLBank Chicago, his team works with the FHLBanks Office of Finance to modify issuance programs to make them friendlier to different kinds of dealers. “We work in concert as an FHLBank System in our effort to include more diverse dealers,” he said. “My team participates both in our Capital Markets Working Group and the FHLBank System OMWI Committee so we interface on the funding side with the System’s Committee.”
“On the debt side, the committee’s primary focus began in 2017 and continued in 2018 to review all the debt issuance programs that the FHLBank System had and to ensure that diverse firms could participate.
“Some hurdles were removed such as minimum capital, or regular participation, and rules were modified that adjusted our requirements in order to ensure that these firms could participate,” Cornejo explained.
The other aspect was an enhanced marketing outreach effort. “We have participated in that effort by going to visit dealers or have them visit us so we can explain exactly the kinds of products we are interested in using with them. This must be a win-win for both, so for them to be able to know what we’re interested in is very important because that allows them to focus on those areas,” he said.
This practice, according to Cornejo has allowed the FHLBank Chicago to increase participation year-over-year in its issuance programs. Looking at the bigger picture, Thomas explained that FHLBank Chicago is really helping these small firms develop their overall business—many times a new business—in the mortgage space.
Building relationships with diverse dealers has also been a cornerstone of FHLBank Chicago’s success with their D&I initiatives. “In 2018, we spent time reaching out to various dealers, interviewing them, understanding what their business model was, and how their niche service areas could be complemented with our needs. We spent a lot of time working with and understanding their product offerings and how they fit with us,” Ericson said. “That’s the first thing that I think is important for people to understand the offerings that are out there.”
“We’re giving them a fair shot to compete either on price or in service head-to-head with Wall Street, and we’re not looking at them in any different way. We give them the same opportunities as we give any firm, to show us product or sell us a bond. I think that’s unique,” Thomas said.
In the process, the bank has discovered that there’s no shortage of talent with these smaller shops. What they may lack is opportunity. According to Thomas, even though the firms are small, “the people are those that usually worked at the bigger Wall Street firms in the past and now have chosen to work at a smaller firm. But the quality of talent isn’t diminished.”
The FHLBank Chicago has now started talking to them about what those firms, as a diverse shop, are doing to support or contribute to their communities. Giving an example, Thomas says that one disabled veteran-owned firm they work with has made a concerted effort to hire other disabled veterans. He has also observed that some of the other diverse broker dealers are very active in charitable donations and programs in their communities.
“We have managed to achieve year-over-year increases in participation on the funding side in 2017 and 2018 as a result of shining light on this, or focusing on this segment of the dealer market,” Cornejo said. “We plan to continue to make strides in that area. We started from a low base percent and have increased every year since we have been focusing on this.”
The FHLBank Chicago is very clear that even though it strongly encourages diverse broker dealers, its first duty is towards its members. “Even though you might be a diverse firm, we’re not doing a trade with you if that’s not the most economical or best execution for us. They have to compete head-to-head with Wall Street. All we’re doing is giving them access,” Thomas said.
“We’re trying to make sure we’re transacting business with all segments of the population that can do that business for us. We don’t just target diverse brokers to be spending money with just one segment,” Thurman said. “At the end of the day we’ve got to make sure we’re getting the best transactions done at the right price for the marketplace and done efficiently.”
“There are some diverse dealers that may have a niche in a particular asset class where we can benefit. For our members, they borrow from us to the extent that we can get good deals either on the asset side or the funding side, it always benefits them in terms of their costs of borrowing or the profitability of the bank,” Cornejo said.
The FHLBank Chicago has also recognized that it must create value in the communities it serves. “Our members operate in a number of communities, but we also have community investment programs that impact a number of different people as well, and so for us it’s just part of our business strategy,” Thurman said. “It makes good business sense for us to think about this and helps us make sure we’re making the impact we choose to make.”
For Thurman, the future of their diversity strategy would also come from its members and stakeholders even though he can guess what it would be. “We are in the process of doing a number of focus groups with our key stakeholders. Those being our employees, our board of directors, our members, our trade associations we work with, community investment partners we work with, and our vendors,” he said.
“The feedback from those stakeholder meetings is really going to inform how we approach our diversity strategy.” And for firms looking to make D&I a more integral part of their business strategy like FHLBank Chicago, Thurman encourages them to take a step back and ask, “what are they doing from a holistic diversity inclusion perspective?”
“Many times, these conversations get focused singularly on representation inside an organization. They’re staff only, but to us it’s much bigger than that,” Thurman said. “It’s how do you impact the marketplace, how do you impact your members, your clients, your customers? And so I would encourage you to think holistically about D&I strategies and what can you do to impact the marketplace.”