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Sleepless in Seattle, FHLB-Seattle That Is

Having broached expectant difficulties in the Federal Home Loan Bank system last spring, I try to keep a close eye out for news of note on this largely unknown – but critically important – system of banks. To a large extent, the FHLBs have been flying under the radar despite some serious problems within their investment portfolios and loan books.

High five to KD for pointing out that the folks at FHLB-Seattle probably are not getting much sleep these days. Why is that? Insufficient capital will do it to you every time. As the American Banker offers, FHLB Seattle Still “Undercapitalized,” Regulator Says:

The Federal Housing Finance Agency said late Friday that the Federal Home Loan Bank of Seattle remains “undercapitalized” and will not be allowed to redeem or repurchase stock or pay dividends.

At the end of 2004, as the bank struggled with the size of its mortgage purchase program, it said members who wish to redeem their stock must wait five years before receiving their money.

But with that time period almost up, the Finance Agency said it would not allow the bank to begin redeeming stock, fearing it could lower its capital base.

While technically the Seattle Home Loan bank appears to have met all its minimum capital requirements as of the end of the third quarter, the Finance Agency made a “discretionary determination” that the bank remains undercapitalized.

“The Seattle Bank is ‘undercapitalized’ because of several factors, including the possibility that modest declines in the value of its private-label mortgage-backed securities could cause it again to fall below its risk-based capital requirement,” the agency said in a press release. “In addition, the Bank would be in jeopardy of exhausting its retained earnings if credit losses on these securities in the fourth quarter were of similar magnitude to the third-quarter credit losses.”

American Banker first reported earlier this week that the FHFA was expected to stop the bank from redeeming its stock.

FHFA Acting Director Edward DeMarco said the action was necessary to protect the bank.

“I am taking this action today to promote the longer-term financial stability of the Federal Home Loan Bank of Seattle,” said DeMarco. “This action should ultimately benefit all of the Bank’s member-owners by maintaining their existing capital investments and enhancing the Bank’s opportunity to strengthen its financial position.”

The agency added that “capital redemptions will resume once the Seattle Bank demonstrates performance in line with the plan and that the improvements in performance and capital strength appear sustainable.”

The bank said last week that it lost $144.3 million in the first nine months of 2009, $93.8 million of which was reported during the third quarter. Also troubling is that the Seattle bank’s advance business, which totaled $24.9 billion, is roughly half of what it was a year earlier.

The latest earnings slump stems from other-than-temporary impairment charges that have been levied against the Seattle bank’s portfolio of private-label mortgage-backed securities, which totaled $130.1 million during the third quarter.

Are we potentially looking at another bailout situation? Don’t think for a second that is not a possibility. Continued deterioration in its mortgage portfolio along with slack loan demand is a recipe for continued capital depletion.

Yes, I would guess that the management of this bank is very much a depiction of “sleepless in Seattle.”

LD

Related Sense on Cents Commentary:
Freddie Mac, Fannie Mae Deja Vu (May 28, 2009)