Here is something you can have fun digging with...Woes at Financier
Of Mortgages
Spur Concerns
Home Loan Bank of New York Takes
Mobile-Home Hit, Triggering Oversight Calls
By PATRICK BARTA , JATHON SAPSFORD AND JOHN D. MCKINNON
Staff Reporters of THE WALL STREET JOURNAL
Financial difficulties within the little-known Federal Home Loan Bank system, which provides crucial funding for the lending industry, have opened a new front in the battle over how to regulate the $6 trillion U.S. mortgage-finance market. The problems have set off a new wave of concern about the institutions that helped finance the decade-long housing boom.
For decades, the 12 Federal Home Loan Banks operated beneath investors' and lawmakers' radar screens, quietly providing capital to mostly small-town lenders so they could make more home loans. But the Federal Home Loan Bank of New York caught attention in the markets this week when it said it would have to suspend dividend payments after suffering $183 million in losses from soured investments in mobile-home loans -- losses that may have been evident as long ago as early August but weren't made public until this week. That news came on the heels of an 82% drop in second-quarter earnings at the Federal Home Loan Bank of Pittsburgh, which was stung by a sudden move in interest rates.
The home-loan banks were established by the federal government during the Depression to make funding available for home loans in local, often rural, communities. They've expanded in recent years from that low-key mission into some of the same types of mortgage business that Freddie Mac and Fannie Mae dominate, for instance buying and holding mortgages from banks. Some on Wall Street have begun to question whether the home-loan banks have moved out of their league.
The home-loan banks' surprising stumbles come at a time of rising concern about the risks coursing throughout the U.S. mortgage market as it cools down from one of the biggest housing booms in U.S. history. Lawmakers were already debating ways to boost regulation of Fannie Mae and its smaller sibling, Freddie Mac, which recently acknowledged that it used accounting gimmicks to smooth the volatility in its earnings (see related article). Thursday, the debate shifted to include the Federal Home Loan Banks, which, together, now have $809 billion in assets and $710 billion in debts, making them larger than Freddie Mac.
At a hearing of the House Financial Services Committee Thursday, several members of Congress pushed to include the home-loan banks in a bill being drafted to give the Treasury Department oversight of Fannie Mae and Freddie Mac. Fannie Mae, Freddie Mac and the home-loan banks all were chartered by the government and have access to lower-cost financing and other perks because of that relationship.
"The case for putting you all under Treasury is just profound," Rep. James Leach, an Iowa Republican, told a representative of the home-loan banks at the hearing. "I am very concerned with the supervision of these banks." California Republican Rep. Ed Royce added that he thinks the home-loan banks' current regulator, the obscure and thinly-staffed Federal Housing Finance Board, "failed to protect against systemic risk" in the current spate of surprises.
John Korsmo, chairman of the Federal Housing Finance Board, addressed many of these concerns in Congressional testimony Thursday. He said the board, an independent agency who's sole responsibility is to oversee the home-loan banks, was inadequately focused on safety and soundness prior to his arrival in 2001. He said he and his colleagues "have undertaken a disciplined, continuing, and, I believe, successful effort to improve the agency's supervision and regulation of the Federal Home Loan Banks." He cited numerous initiatives, including increasing the regulator's number of examiners.
Friday, the chief executives of many of the 300 lenders that are members of the Federal Home Loan Bank of New York will gather for a hastily-arranged breakfast meeting at a resort hotel in southern New Jersey, where they have been attending a conference this week. The member bankers are expected to pepper Federal Home Loan Bank of New York President Alfred DelliBovi, a former member of the New York state Assembly, about the $183 million his bank lost in bungled investments. The lost dividends will cut into member banks' profits.
The financial industry first got wind of possible troubles at the Federal Home Loan Bank of New York on Aug. 8, when Standard & Poor's Corp., which monitors corporate creditworthiness, lowered its opinion of the bank's financial outlook. "The revision reflects the incremental risk the bank has taken over time, particularly in its investment portfolio," Standard & Poor's said in a release on that day. For weeks, that was the only sign of trouble at the institution. Then, on Monday, the bank sent a letter to the chief executives of its member banks -- many of them en route to the conference near Atlantic City when the letter arrived. The letter said that certain highly rated bonds held by the bank, backed by mortgages on prefabricated and mobile homes, had been downgraded. For the bank's critics, the letter underscored one of the big complaints of the federal-home-loan-bank system: a lack of transparency. Providing few details, the letter said only that the bank expected to meet all of its debt obligations in the financial markets.
Some member banks, however, began demanding more information, according to people familiar with the matter. So two days later, the Federal Home Loan Bank sent a second letter to shareholders and posted the letter on its Web site. The trouble was centered on a holding in bonds with face value of $1.03 billion, or roughly 1% of the bank's total of $98 billion in loans and other assets. The bank, the second letter said, had sold those troubled bonds, for a loss of $183 million. The bank tried to dispel investor concerns by noting that its capital-to-assets ratio, a key measure of a financial institution's health, was 4.68%, well above the required 4%.
When asked to comment, a representative of the Federal Home Loan Bank of New York referred to prepared remarks that Mr. DelliBovi will deliver to the gathering of bankers this morning. "We will continue to keep you advised of all material developments," Mr. DelliBovi is expected to say. "The Bank remains ready and able to respond to your business needs."
Terri McKay, a spokesperson for the Federal Home Loan Bank of Pittsburgh, said the bank's troubles earlier this year don't suggest a need for more regulation. She said the bank's problems were the result of an "unprecedented" surge of refinance activity caused by falling interest rates. "We wished we had hedged it differently."
Although problems at the Federal Home Loan Banks came as news to many people, Treasury officials in both the Clinton and Bush administrations have worried for some time about the banks' fast growth and rising risk. And unlike Fannie Mae and Freddie Mac, which despite much criticism are considered to be highly capable of managing their business, many question whether the home-loan banks have the sophistication to master the complexities of mortgage-market risk.
For many years, Peter Fisher, the departing Treasury under secretary, has told other officials that he "loses more sleep" over the Federal Home Loan Banks than he does over Freddie Mac and Fannie Mae. Adds Charles Peabody, an analyst at Portales Partners LLC, an independent research boutique in New York: The Federal Home Loan Banks are "worse than Fannie and Freddie, and to me pose a greater systemic risk, because they're not being policed in the way that Fannie and Freddie are."
It's unlikely, however, that the troubles at the New York and Pittsburgh banks will cause the kind of broad troubles that could follow if similar difficulties were to emerge at the likes of Freddie Mac or Fannie Mae. For one thing, assets -- and risks -- within the home-loan bank system are dispersed among the 12 banks and the simultaneous failure of all of the banks is considered a long shot. Moreover, right now, housing continues to remain one of the strongest components of the U.S. economy, though mortgage activity has slowed considerably in recent weeks due to rising interest rates.
Still, there are growing concerns about the potential impact of the recent surge in interest rates on companies and investors that own mortgages, including Freddie Mac, Fannie Mae, the home-loan banks and other investors, such as mutual funds. When rates move suddenly, either up or down, it can expose these investors to unexpected losses. For example, when rates rise, it can drive the investors' borrowing costs above the interest they are receiving on their loans. "I think there's a lot more pain out there in mortgage-land" that has not yet shown up in financial statements, says James Bianco, president of Bianco Research LLC, an investment research firm in Chicago.
The Federal Home Loan Banks, known in the industry as "Flubs," are important to thousands of small banks, credit unions and other lenders across the country -- often in rural communities -- that rely on the home-loan banks for big chunks of their funding.
A typical example: Warwick Community Bancorp., of Warwick N.Y., which says it relies on the Federal Home Loan Bank of New York to fund roughly 26% of its $828 million in outstanding loans or other assets. To qualify for that funding, which the bank says it gets at favorable rates, the bank holds an equity stake in the New York Home Loan Bank of roughly $10.4 million. Because of that stake, the bank received $650,000 in dividends in 2002.
Created in 1932, the 12 Federal Home Loan Banks use their ties to the federal government to borrow money at favorable rates, and then lend that cheap money to their member institutions. Whenever the banks turn a profit, they then pay a dividend to member banks.
The collapse of many savings and loans in the 1980s could have led to the demise of the home-loan banks, just as it did the thrifts' federal regulator. Instead, Congress wound up expanding their scope and powers. Eventually, almost all commercial banks and even many credit unions became eligible to become member-owners. The home-loan banks also were able to expand their mission far beyond housing, to encourage other kinds of lending as well, including business and agricultural loans.
For a long time, the Federal Home Loan Banks were viewed as more conservative than Fannie Mae and Freddie Mac, in part because they had tougher capital standards. But that perception changed in recent years, as the banks grew bigger. Between 1996 and 2002, the Federal Home Loan Banks' assets swelled 161%, while net income grew 35% to $1.8 billion.
At the same time, the banks began to muscle in on Fannie Mae's and Freddie Mac's turf, using their government advantages to accumulate a big portfolio of home loans, just as Fannie and Freddie have done. This business, in contrast to the home-loan banks' other business of lending to member institutions, increases the banks' exposure to interest-rate shifts. And while the amount of mortgage loans held by the home-loan banks is minuscule compared with Fannie Mae and Freddie Mac -- $90.4 billion at the home-loan banks versus more than $1.3 trillion between Fannie and Freddie -- the home-loan banks' portfolio business is growing much faster. Its portfolio swelled about 119% last year, compared with 15% at Fannie and Freddie.
To many analysts, such growth represents unnecessary risk, driven by the banks' desire to boost profits from the recent housing boom. The banks are highly leveraged. Critics say they disclose less about their operations than do Fannie Mae and Freddie Mac. And there are concerns about corporate governance at the individual banks, which have their own boards of directors, many of whom are lenders that are served by the banks.
A spokesman for the Federal Housing Finance Board said the method by which the individual banks choose their directors is set by statute. He said that to boost disclosure, the Board approved a proposed rule this month that would require the 12 banks to register with the Securities and Exchange Commission, which they currently are not required to do.
But significant political hurdles remain to moving oversight of the home-loan banks away from the Federal Housing Finance Board. The home-loan banks enjoy powerful loyalty among many members of Congress, particularly those from states where the 12 banks are located.
Write to Patrick Barta at patrick.barta@wsj.com, Jathon Sapsford at jathon.sapsford@wsj.com and John D. McKinnon at john.mckinnon@wsj.com. |
