Friday, January 9, 2009

Banks May Take Hit on FHLB Stock Holdings

Posted by Teri Buhl on the Housing Wire:

Serious cracks are showing in the nation’s Federal Home Loan Bank system, and it now appears as if member banks are being forced to take at least some of the hit for it. Various banking industry sources suggested Friday afternoon that some Home Loan banks are squeezing the liquidity faucet, and refusing to pay banks back for FHLB stock they purchased.

When banks take loans from a Home Loan bank, besides paying interest, they also have to buy a percentage of FHLB-restricted and non-public stock, based on how much they borrowed and the credit quality of the collateral they posted. The system was set up as a way to basically help support the FHLBs’ capital as banks borrow against it. When a member first signs on, the Home Loan bank sets up a clearing account that works like a check book; when member banks borrow money, the FHLB takes cash out of this account and in return gives the borrowing bank stock that pays a dividend. As a bank pays off the loan, the FHLB credits back their cash account by repurchasing the stock.

At least, that’s how it usually works. Now, reports are surfacing that suggest that the FHLBs themselves are running into their own problems, from owning billions in toxic mortgage bonds that are becoming worthless. Moody’s Investors Service said in a report earlier this week that the Federal Home Loan Bank System’s $76.2 billion private-label MBS portfolio contained $13.5 billion in unrealized losses at the end of Q3; values have likely fallen further since that time.

According to various banking sources who spoke on the condition of autonomy, at least five Home Loan banks have already notified members as early as mid-December that they will not pay dividends and will stop buying back the excess FHLB stock members hold. These banks included: Pittsburgh, Dallas, Seattle, Des Moines and Boston. Decisions are made independently at each of the 12 Home Loan banks nationwide, but some analysts have suggested they expect more FHLBs to follow this move.

As a result, speculation is mounting that at least some of the Home Loan banks will fall below regulatory capital minimums. “If an FHLB Bank falls below its regulatory capital, it will not be permitted to pay dividends to shareholders; it will not be permitted to repurchase member stock; and it will be required to file with the agency a capital restoration plan,” a spokeswoman from the Federal Housing Finance Agency, which regulates the FHLBs, said in an e-mailed response to questions.

A member of the Seattle FHLB who spoke on the condition of anonymity said, “They simply ran out of cash and are unable to repurchase stock right now. Until they get more capital, we don’t expect they can buy back the stock we hold.”

“This is disappointing,” said a Pennsylvania-based bank president, whose bank is a member of the Pittsburgh FHLB. “They are basically taking members’ money – money [member banks] expected would be safe because it’s federally-backed. I guess it proves the government can do whatever they want.”

Despite mounting concerns now being directed towards Federal Home Loan Banks, not all analysts see the problems facing the FHLB system as insurmountable. Analysts at RBS Greenwich Capital, in a research note Thursday, suggested “regardless of headline risk, we think that FHLB has strong funding power as well as ability to hold capital captive.” The FHLB has access to a Treasury line of credit, the analysts noted.

Nonetheless, at least one regional bank, Seattle-based Washington Federal (WFSL: 13.14 -3.24%), has already warned in a recent filing with the Securities and Exchange Commission that they might have to write off some or all of the FHLB stock they hold.

“The FHLBs have always had poor risk controls,” said Paul Miller, an analyst with Friedman Billings Ramsey Group Inc. “It’s a concern as a source of liquidity, especially for the smaller banks that really depend on the FHLB for advances. It won’t wipe them out, but it’s definitely one more difficult hurdle they have to jump through to get cash.”

According a report from the FHLB Finance Board, as of Sept. 30, 2008, four of the nation’s top banks hold $12.4 billion in FHLB stock. Citigroup Inc. (C: 6.75 -5.73%) holds $4.7 billion, followed by JP Morgan Chase & Co. (JPM: 25.97 -4.59%), which holds $4.1 billion; Bank of America Corp. (BAC: 12.99 -4.06%), via Countrywide, holds $2 billion, while Wells Fargo & Co. (WFC: 25.14 -2.26%), via Wachovia, now holds $1.6 billion in such stock.

JP Morgan, Bank of America, and Citi declined to comment on whether they intended to take a write down on the FHLB stock they hold in the next quarter; officials at Wells Fargo could not be reached for comment.

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