Thursday, January 8, 2009

FHLBs May Fall Below Capital Minimums, Moody’s Says

According to Housing Wire's Paul Jackson:

Unconfirmed but reliable rumor has it FHLB Atlanta is going to be taken over by regulators Fri. The FHLB system = mess.

Earlier today, Bloomberg reported:

The Federal Home Loan Banks face potentially “substantial” losses on mortgage bonds, and in a worst-case scenario only four of the 12 would remain above regulatory capital minimums, Moody’s Investors Service said.

The FHLBs, government-chartered cooperatives owned by U.S. financial companies, hold about $76.2 billion of “private- label” mortgage securities that may cause losses under accounting rules, the New York-based ratings firm said in a statement today. Moody’s said it is unlikely to lower the system’s Aaa debt grades because of their government support.

The U.S. may decide to put some of the FHLBs, the largest U.S. borrower after the federal government, into conservatorship or force them into mergers with others, Moody’s said. At issue is whether declines in the market value of the mortgage bonds, totaling $13.5 billion on Sept. 30, will be deemed “other-than- temporary impairments,” or OTTI, and how much of the losses their regulator will see as irreversible, the statement said.

The response by the Federal Housing Finance Agency to any shortfalls is “something of an open question,” Brian Harris, a senior vice president at Moody’s, said in a telephone interview. “To the extent they think the economic loss is much lower than what the OTTI is, I think that would affect their actions.”

Thrifts, Credit Unions

The Federal Home Loan Bank system has $1.25 trillion of debt. The regional FHLBs lend the money they raise as a group in the so-called agency debt market to more than 8,000 thrifts, credit unions, insurers and commercial banks at below-market rates, mainly to finance their mortgage holdings.

In September, the U.S. placed mortgage-finance companies Fannie Mae and Freddie Mac, government-sponsored enterprises with public shareholders, into conservatorship. The government pledged $200 billion of capital injections for Fannie and Freddie as needed to protect holders of their more than $5 trillion of debt and mortgage bonds.

With troubled FHLBs, the government may only seek agreements that restrict activities such as dividends to banks and stock repurchases, rather than conducting takeovers, Harris said. FHFA is unlikely to force reductions in the FHLBs’ lending partly because it is “so significant” to the financial system, the statement said. Cutting lending also may not be necessary because banks must buy more equity in the FHLBs when borrowing from them, Moody’s said.

Chris McEntee, a spokesman for the Federal Home Loan Bank of Atlanta, said in an interview today that “there’s no basis in fact for the rumor” that the bank is in talks with the Federal Reserve about selling the central bank its portfolio of mortgage securities.

Accounting Issue

Stefanie Mullin, a spokeswoman for the FHFA, declined to immediately comment. Michael Ciota, a spokesman for the home loan bank system’s finance office in Reston, Virginia, said in an e- mailed statement that “the principal conclusion of the report was the FHLBanks have the ability and intent to hold these securities to maturity, and the expected economic loss was modest and could be absorbed by each” without capital shortfalls.

“It’s an accounting issue that unfortunately does not reflect the true economics of the Federal Home Loan Bank system,” John von Seggern, the president of the Council of Federal Home Loan Banks, said. “These OTTI issues are the same issues the entire banking system is having.”

Reports about the issues highlighted by Moody’s will likely increase the FHLBs’ borrowing costs, according to Jim Vogel, head of agency debt research at FTN Financial in Memphis, Tennessee.

“Moody’s sees a small chance of large economic losses among the banks (as do we), but the headlines are 100 percent under the control of accountants,” Vogel wrote in an e-mail to clients today. “So, auditor and regulator decisions are what will matter over the short run.”

Spreads

The difference between yields on a 4 percent FHLB note maturing in 2013 and similar Treasury rose 0.02 percentage point to 0.90 percentage point at 11 a.m. in New York, down from a record 1.88 percentage point on Nov. 20, Bloomberg data show.

Combined third-quarter net income at the Federal Home Loan Banks fell 31 percent from a year earlier to $506 million, driven by $252 million in losses stemming mostly from the bankruptcy of Lehman Brothers Holdings Inc. The Fed last month began buying FHLB bonds along with Fannie and Freddie corporate debt under at $100 billion program aimed at lowering mortgage rates.

Private-label, or non-agency, mortgage securities lack guarantees from Fannie or Freddie or U.S. agency Ginnie Mae. The worst-case scenario for the FHLBs’ mortgage-bond losses under accounting rules, for which only the Cincinnati, Dallas, Des Moines and New York banks would have enough capital, is “unlikely,” Moody’s said. The firm, which has been criticized for assigning top grades to mortgage debt that proved worthless, said realized losses will probably be less than $1 billion.

FASB Rule

The Financial Accounting Standards Board yesterday approved a measure that may help companies deem fewer asset-value declines as “other-than-temporary” and record fewer writedowns, after U.S. banks blamed accounting rules for eroding their capital.

Companies can “exercise judgment when assessing whether declines in fair-value are indicative of a decline in the cash flows expected from the issuer of the security,” FASB said in a statement.

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