FHLBanks Slow Mortgage Lending. Funding Risks Outweigh Potential Returns

Federal HousingrnFinance Agency acting director Edward DeMarco testified before a Housernsubcommittee yesterday about the current status ofrngovernment sponsored enterprises.  Whilernhis prepared remarks primarily concerned the future condition and possiblernfuture of Freddie Mac and Fannie Mae, he touched briefly on another group regulatedrnby FHFA, the 12 Federal Home Loan Banks (FHLBanks).</p

DeMarco said thatrnthe Banks’ assets have been in a decline since September 2008 and now stand atrn$937 billion.  This was matched by arndecrease in advance activity which now stands at $540 billion, 46 percent belowrnthe record levels of October 2008.  Thernpace of the decline appears to be slowing but is still in stark contrast to thern2007 liquidity crisis when the FHLBanks increased advances to its members by 58rnpercent in 15 months.  The decline sincernthen is primarily a reflection of the strong deposit growth and tepid loanrndemand at member banks.</p

While the creditrnquality of mortgages held by the FHLBanks is much above the industry average,rnthey have pulled back from mortgage purchase activity.  At the end of the second quarter they heldrn$66.8 billion in mortgage loans, only 7 percent of their combined assets.  This is a result of decreased new activityrnand an increase in prepayments but also reflects an assessment by many of the FHLBanksrn“that the returns associated with mortgages are insufficient to outweighrnthe associated funding and hedging risks.” </p

Ten of the 12rnFHLBanks reported a net profit in the second quarter and all 12 had arncollective net income of $326.4 million, about the same as the previousrnquarter.   The banks have seen some setbacksrnassociated with the deterioration of mortgage markets.  At the end of June the banks heldrnprivate-label MBS equivalent to 4.9 percent of assets.  Shortfalls of principal or interest havernoccurred only 1 percent of these assets but the system has taken $3.3 billionrnin credit-related impairments on those investments and recorded an additionalrn$10.8 billion in non-credit-related, other-than-temporary-impairments. ThernPittsburgh, Seattle, and San Francisco FHLBanks have filed complaints in staterncourts alleging fraud, misrepresentation, and violations of state and federalrnlaws in connection with their purchase of certain securities. </p

DeMarco said itrnappears that within the next 18 months the FHLBanks will fulfill theirrnobligations to pay a portion of the interest on bonds issued by the ResolutionrnFunding Corporation during the savings and loan clean-up of 1989.  Payments on this obligation consume 20rnpercent of each bank’s net earnings. rnBecause of this obligation, the banks have not rebuilt or maintainedrnretained earnings adequate to the size and risks of their currentrnbusinesses.  DeMarco said the fulfillmentrnof this 20 year obligation presents an opportunity to help the banks workrnthrough current financial problems and be better prepared for the future byrnaccelerating the rate at which the banks build their retained earnings.

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