Some other banks are encountering difficulties today — namely the Federal Home Loan Banks, one of the biggest providers of funding for US mortgages.
The Federal Home Loan Bank of Seattle said it will suspend dividends and “excess” stock repurchases, becoming the second of the government-chartered lending cooperatives to say its capital may be running low.
The likely capital shortfall as of Dec. 31 was caused by “unrealized market value losses” on residential mortgage bonds without government backing, the bank said in a U.S. Securities and Exchange Commission filing today…
The FHLBs, of which there are 12 in the States, have been under pressure as the value of their MBS declines. Their risk-based capital requirements are based on market prices, which means the requirement gets higher the more the market value of their assets falls below book value. Thus we saw the San Francisco FHLB issuing a statement last week saying that it too was taking steps to maintain its reserves after losses on its MBS investments.
Indeed, Moody’s said last week that eight of the 12 FHLBs are in danger of falling below their capital regulatory requirements because of declines in MBS. Nevertheless, the ratings agency planned to preserve their triple-A rating based on the premise that the government would bail them out, rather than see them fall and impact the wider market.
A bailout would be a big deal — as we noted last week, the FHLBs have something like $1.25 trillion worth of debt between them. According to Bloomberg they’re the US’s biggest collective borrowers — bigger even than Fannie or Freddie. Their contribution to liquidity in recent months was second only to the Federal Reserve. So neither the US government, nor the FHLBs themselves, likely want an outright bailout or failure.
One other option would be altering the rules of the capital requirement — and this seems to be what the FHLBs are now aiming for.
Richard Riccobono, President and CEO of the FHLB Seattle, is already lobbying for it. From his Jan. 12 letter to bank members:
As you are aware, the ongoing turmoil in the capital and mortgage markets has caused a decline in the market value of the Seattle Bank’s private-label mortgage-backed securities, significantly beyond any expected actual loss. Unfortunately, the risk-based capital rules that apply to the Seattle Bank rely on market value rather than expected loss as the measure for determining our risk-based capital requirement. As a result, the Seattle Bank will likely report a risk-based capital deficiency as of December 31, 2008. I believe it is important that our members be informed of this situation, the reason why it has occurred, and its possible implications…Of course, with volatility in the MBS market there’s always a possibility that the Seattle FHLB could get back up to its regulatory capital requirement (the bank calculates its risk-based capital requirement on a monthly basis) but we’re guessing that’s unlikely in these markets.
We believe that the calculation of risk-based capital under the current rules significantly overstates our market risk in the current market environment. In our opinion, the Seattle Bank-with nearly $2.8 billion in permanent capital (Class B stock plus retained earnings)-has more than enough capital to cover the risks reflected in the bank’s balance sheet. While the market values of mortgage-based assets are currently under extraordinary pressure, the vast majority of the private-label mortgage-backed securities that we hold are highly rated, credit-enhanced, adjustable-rate securities that we have the ability and intent to hold until they mature.
We have communicated our concerns regarding the current risk-based capital methodology to our regulator and have requested that they review the regulation, but we have not yet received a final determination as to whether or not there will be any relief on this issue. ..
Incidentally, WaMu and Merrill Lynch were the biggest stakeholders and borrowers in the Seattle FHLB, according to Bloomberg.