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FHLB San Francisco Earthquake

Posted by Larry Doyle on June 3, 2010 11:52 AM |

I first introduced readers of Sense on Cents to issues embedded within the Federal Home Loan Bank system in the spring of 2009. In an article entitled FHLBs: Red Sea, Dead Sea or Both?, I highlighted:

Charles Bowsher, the former chair of FHLB’s Office of Finance sent a warning shot loud and clear about the “hidden and embedded” losses in this system when he resigned his position as chair of the FHLB Office of Finance in late March (2009). As Bloomberg reported on April 2nd:

Bowsher, who was comptroller general of the U.S. from 1981 to 1996, had a simple reason for resigning last week as chairman of the Federal Home Loan Bank System’s Office of Finance. He didn’t want to put his name on the banks’ combined financial statements, because he was uncomfortable vouching for them.

Well, the shot Bowsher sent a year ago reverberated today in the form an earthquake as reported by the American Banker, Questioning Marks on Mortgage Bonds at San Francisco FHLB:>>>>

An independent analysis of the Federal Home Loan Bank of San Francisco’s investment portfolio is fueling doubts about the health of the bank, the largest of the 12 institutions in the system.

While the bank has said it expects only a $688 million credit loss on a nearly $20 billion portfolio of mortgage-backed securities, outsiders expect a loss closer to $5 billion — a figure that would wipe out the bank’s retained earnings.

“The bank here has a highly aspirational view of what these things are worth,” said Espen Robak, president of Pluris Valuation Advisors, which performed an analysis of the portfolio at the request of American Banker. “It’s obviously not what the market expects, and it’s not what the ratings agencies are expecting either. There’s a reason they have a lot of these things are marked at CCC.”

The bank maintains its estimates are accurate.

“The modeling we do each quarter reflects changes in actual loan performance and in market conditions, including changes in forecasted housing prices, default rates and loss severity rates,” said Amy Stewart, a spokeswoman for the bank. “We are confident that our modeling is appropriate.”

If Pluris’ estimates are correct, the ramifications would go well beyond the San Francisco bank.

Wiping out the bank’s $1.3 billion of retained earnings would effectively “break the buck” on its member stock, which is fixed at $100 par value. That’s only happened once in the system’s 77-year history. It would prevent the bank from paying a dividend to members and stop the return of $4.9 billion in capital stock due to be withdrawn by FHLB members over the next few years.

It also would cast doubt on the health of the bank at a time when the Home Loan banks are urging Congress to exempt them from being considered systemically risky and as lawmakers begin to debate the future of the housing finance system, of which the FHLBs are a key part.

Finally, it raises questions about whether other institutions — in and out of the Home Loan Bank System — are providing overly rosy assessments of their RMBS exposures.

Last year the Home Loan banks adopted a standard process for evaluating more than $44 billion in cumulative mortgage-backed securities holdings. Their auditor, PriceWaterhouseCoopers, also works for companies ranging from Bank of America Freddie Mac.

Whom do you trust? The banks and their accountants or an independent analysis and the market?

The smoke and fires surrounding FHLB San Francisco are eerily reminiscent of the same crescendo which encompassed Freddie and Fannie, albeit on a smaller scale. I projected as much a year ago and maintain the same again today:

Make no mistake, the structure, systems, and mix of business within the FHLB system is a direct corollary of our two national wards, Freddie Mac and Fannie Mae. While board members may want to play defense or execute the backstroke, I view these signs as clearcut indications that the boards know where this situation is headed. Where’s that? Again, I defer to the WSJ:

If the home-loan banks ever stumble badly, U.S. taxpayers would be called on to “rescue yet another financial entity,” warns Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research firm in Washington. These banks have about $1.26 trillion of debt outstanding, putting them among the world’s biggest borrowers.

In my opinion, it is not a question of if, but when.

Keep bailing!!

Thanks to a loyal Sense on Cents reader for bringing today’s release to my attention.


Now if you had subscribed to my work a year ago, today’s ‘news’ would actually not be news. Sign up via e-mail, an RSS feed, on Twitter or Facebook!! Thanks very much.

  • Rockie


    Moody’s & S & P ratings on the FHLBs……from our esteemed ratings people….at least S & P mentions that private label MBS comprises 5% of total assets…..and all they refer to is earnings and OTTI…but not the realistic value of asset values……but assuming a 30% haircut of private label…(probably light)….of 5% of total assets…..this is 1.5% of system wide capital…which has regulatory hurdle of 4%…..and they state in the report that the FHLBs are trying to return capital to banks………is somebody smoking something…..

    This is from the S & P report…..In line with our expectation for weakness in the housing and mortgage
    sectors through 2010, we believe the FHLB System banks will record more, but manageable, OTTI in the remaining quarters of 2010. We believe that mortgage-related losses will continue to grow through 2010 as foreclosures
    settle but inventory levels remain high while sales volumes remain low, further pressuring home values. Private-label RMBS represented only about 5%
    of total system assets at March 31, 2010. The FHLB System banks recognized $233 million of credit-related OTTI charges on certain private-label MBS during first-quarter 2010. This represents a 35% decrease from $436 million of credit-related OTTI in fourth-quarter 2009 and a 55% decrease from the $516 million of credit-related OTTI charges recorded in first–quarter 2009.

  • coe

    I’m not sure the mark-to-distress valuations derived by some third party American Banker investigation of $5B is accurate, nor am I sure that the right thing to do is to write down values to fully distressed prices, and yet at the same time the book values reflected on the financials of the FHLB of SF is probably not sufficiently captured by the $688mm OTTI number either…perhaps the “truth” lies somewhere in between…but it serves the purpose of reminding us that ALL financial statements, both for public and private companies, undoubtedly understate risks…you have been pretty consistent in pointing toward the FHLB system as another big shoe to drop, LD, and articles and work like this will help expose the additional systemic risks…somebody ought to be thinking about the banks and their impending liquidity pressures – because when the rates back up, the government exits the crisis trades, the depositors flee the banks for higher yielding MM fund returns, and FHLB advance book stops being as effective a wholesale borrowing alternative as it has proved to be these past twenty years, then who do the banks call? Ghostbusters?

  • fred


    Any idea how much of the “problem paper” on the global balance sheet originated in the U.S.?

    High leverage combined with low borrowing costs are almost always lethal. When rates begin to rise, as they sometimes will, there is a call on leverage leaving a void that cannot be filled without experiencing some amount of deflationary pressure that feeds on itself until “weak hands” are flushed out. The cycle then renews itself.

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