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FHLBs Could Face Massive Losses

Moody's says unrealized losses on MBS portfolio are $13.5 billion

January 8, 2009 (revised 4:15 p.m.)

By MortgageDaily.com staff


The Federal Home Loan Banks could face more than $13 billion in losses on their private-label mortgage-backed securities portfolio depending on how their regulator interprets accounting rules, a ratings agency report said. A worst-case scenario has all but four of the banks under-capitalized.

The FHLBs held $76.2 billion in private-label securities as of Sept. 30, 2008, Moody's Investors Service said in a report today. But the market value of the portfolio was only $62.7 billion.

Moody's said GAAP accounting rules might require the FHLBs to account for the securities as other-than-temporary impairments in the short term. Such a situation would require the government sponsored enterprises to recognize unrealized losses of $13.5 billion -- a "material" amount in terms of capital base.

The report indicated that only four of the 12 FHLBs would remain above regulatory minimums in an unlikely worst-case scenario.

A capital impairment could be significant since the role of the FHLBs has become increasingly important in the current credit cycle, New York-based Moody's said. They are owned by their member institutions, which have received desperately needed cash advances in exchange for collateral.

Michael Ciota, who is with the FHLB's Office of Finance, told MortgageDaily.com in a statement that virtually all of the MBS it acquired were rated AAA when purchased.

"In fact, the FHLBanks typically require structural credit enhancement beyond that needed for a triple-A rating," Ciota said. "As a result, the credit performance of our private-label MBS remains quite good, and this is reflected by the Moody's analysis -- the expected economic loss on the entire portfolio is less than $1 billion, or less than 1 percent of par."

The report's author, Brian Harris, said the impact of losses on capital levels is likely to become more evident during the first half of this year.

"The impact could have important ramifications -- both in terms of more limited, more expensive access to the capital markets and of heightened regulatory supervision due to the breach of regulatory capital minimums," Harris stated.

Harris speculated that the FHLBs' regulator -- the Federal Housing Finance Agency -- will focus on capital preservation because of the importance of FHLB activity. He said Moody's projects that ultimate losses will be less than losses incurred under other-than-temporary impairments.

"Should the regulator believe that the other-than-temporary impairments losses of any individual FHLBank will crystallize into realized losses, its actions could be severe, including conservatorship or a forced merger into a healthy FHLBank," the report said.

Ciota noted that the "FHLBanks are working together to meet the challenge of other-than-temporary impairments in the current distressed market, and plan on providing enhanced financial disclosure during Q1 so interested parties can better assess our current condition."

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