What's the Point of the FHLBs? Lots of Risk, Few Beneficiaries

Ah! Government sponsored enterprises! Last year saw Freddie and Fannie come to grief. But 2009 could be the year the 12 Federal Home Loan Banks, wounded already by falling MBS values and the merger and resolution of several large shareholder/members and borrowers. Just what the financial system needs. You’ll be forgiven if you’re not familiar with the details of this particular corner of the federal banking system. The Federal Home Loan Banks make up a $1.4-trillion (asset) lending cooperative originally chartered in the 1930s to facilitate mortgage lending. The banks’ shares don’t trade publicly; instead, shares are owned by 8,154 insured commercial banks, thrifts, credit unions, and insurance companies. But while the system may be semi-obscure, some of the industry’s largest institutions rely on it heavily for funding, often those banks and thrifts having the weakest deposit franchises. In fact, both ownership and borrowing within the system are concentrated among just a few member banks. In 2008, for instance, ten members owned 34% of the system’s capital stock. Lending is even more concentrated. Some 75% of the FHLB’s $1 trillion in advances are outstanding to just 1.5% of its members, according to the FHLBs’ most recent financial report. The numbers aren’t publicly disclosed, but it’s likely that less than 5% of the system’s members borrow more than 90% of its advances. And that was before some of its largest members and borrowers, such as Washington Mutual, IndyMac, Wachovia, Countrywide, National City, and LaSalle, were acquired or placed in conservatorship. Going forward, concentrations will surely increase. One long-standing accusation is that the FHLBs enable members’ aggressive lending, that they are the ones that provide the financial alcohol to the alcoholic lender that can’t stay off the sauce. IndyMac, for example, was probably the system’s largest single borrower when it was seized by regulators back in July. To resolve the company, the FDIC had to pay prepayment fees of $341 million to one FHLB and repaid $6.3 billion in advances, a substantial proportion of the total $8.5 billion to $9.4 billion estimated cost. But now, the system’s problems are also home-grown. A week ago, Moody’s reported that the 12 system banks will see “substantial impairment” of their $77 billion portfolio of private-label residential MBS, commercial MBS, and home equity securities. Under Moody’s “worst case” scenario, only four of the banks would meet the minimum regulatory capital requirement of 4%. (There is no well-capitalized standard.) On January 9, the FHLB of Pittsburgh warned that other-than-temporary impairments could exceed its retained earnings. And a retained earnings deficiency is a problem that TARP funds can’t fix. So far, the implications are not dire, at least for the FHLBs. The individual banks and system as a whole are highly rated by S&P and Moody’s, with long/short term ratings of AAA/A-1+ and Aaa/P-1, respectively. (The sole exception is the Chicago bank, rated AA/A-1+ by S&P.) But retained earnings are thin as a hatchet, at just $3.9 billion, or 7.2% of capital. Just a 5% investment mark would burn through the system’s consolidated retained earnings--hardly unlikely in this environment. Overall profitability is thinner still, at only 19 bps on average assets and 6.16% on equity in 2008 through September 30. Those numbers provide a strong argument for consolidation from 12 banks to perhaps six, or just one FHLB. Even the Farm Credit System found means to consolidate into fewer banks. Immediate implications are somewhat greater for the system’s 8,154 members, which collectively have invested $54 billion in its capital stock. The greater risk is that individual FHLBs will be unable to pay a dividend on members’ investment. (Dividends averaged 3.5% over the first three quarters of 2008.) Or members’ accountants may deem their clients’ FHLB investment impaired, spurring inopportune losses. Which companies have the largest investments? Citibank (C) is largest with $4.7 billion in stock. JPMorgan Chase (JPM) owns $4.1 billion. Bank of America (BAC) owns just under $3 billion. After its Wachovia acquisition, Wells Fargo (WFC) owns $2.7 billion. Among the large banks, USBank (USB) comes in last with a paltry $846 million in stock. Whether these risks become manifest, it is increasingly difficult to understand why they are acceptable, given that the vast preponderance of benefits go to the few and the large.

Comments

[Ishortyou:]

they got to get rid off the oversupply of housing and the new house starts and building permits if they want to come out of this mess.

Jan 23 07:30 AM

[Ray Taylor:]

This writer needs a proofreader. There's not a complete sentence
until the second paragraph. There are a few coherent thoughts
scattered through the gibberish.

Jan 23 08:33 AM

[surferdude808:]

" To resolve the company, the FDIC had to pay prepayment fees of $341 million to one FHLB and repaid $6.3 billion in advances, a substantial proportion of the total $8.5 billion to $9.4 billion estimated cost."

first, the fdic did not pay a pre-payment fee as the advance will be assumed by the acquirers. moreover, if the fee was going to be paid, feet dragging by the fdic caused it to rise. at the time IMB failed, the fee was less than half of the $341 million. the fdic did not pay back the advance at that time because they did not have the cash. as interest rates fell, the fee rose; hence, it was the fdic actions that were contributing to the cost.

it is a red herring to compare the size of the advance ($6.3b) to the resolution cost of IMB ($8.5b to $9.4b). Advances, deposits, or other borrowings do not cause losses. the losses at IMB came from the crappy construction and residential mortgage loans on the other side of the balance sheet. your inaccurate comparison of the advance to resolution cost shows you have a fundamental lack of understanding of financial intermediaries. stick to writing about something you actually know.

Jan 23 11:09 AM

[user #56024:]

This writer has no insight as to how the 12 fhlb banks serve the customers (large or small) in their local geograhic districts or how the fhlb banks and the FDIC act when a bank begins to have trouble. If it wasnt for the fhlbs providing liquidity by secured lending the TARP would have been 3x as large. Furthermore, the writer has no apparent understanding what is causing MBS impairment. Just what the financial system doesnt need is another misleading article from someone who has little insight of what they are writing about.

Jan 23 12:17 PM

[drbob66:]

" The individual banks and system as a whole are highly rated by S&P and Moody’s..."

Do you really still take the ratings agencies' opinions seriously? These guys are hacks.

Jan 24 04:04 PM