Despite what appears to be a much improved outlook for the Federal Home Loan Bank of Boston, a government watchdog says the FHLBB’s regulator isn’t doing enough to spot the kind of trouble the bank found itself in over the last three years.
Steve Linick, the inspector general for the Federal Housing Financing Agency, criticized the agency for not doing enough to monitor risks among the 12 federal home loan banks. He mentioned federal home loan banks in Boston, Pittsburgh, Chicago and Seattle as particularly troubling.
The FHFA has not been aggressive enough in reviewing “supervisory concerns,” Linick said.
In a report, it said the regulator, which also oversees Fannie Mae and Freddie Mac, needed to take more formal actions against financially troubled members of the 12-bank cooperative.
“It is especially important that these banks receive strong oversight and early intervention at signs of financial or operational difficulties,” Linick said.
The Federal Home Loan Bank of Boston would not respond to Linick’s criticisms directly. It’s official line is, “FHLB Boston has earned over $200 million in profits over the last eight quarters and is in a strong position to continue to support member lending throughout New England,” according to an email from FHLBB Spokesman Mark Zelermyer.
‘Extremely Well Capitalized’
But in a recent interview, Edward Hjerpe, president and CEO of the FHLBB, went beyond discussion of the bank’s financial standing, which is in fact much improved.
As the recession approached, the FHLBB found itself in possession of a portfolio of junk, but nevertheless AAA-rated, home loans. Linick argues that FHLB banks carelessly took on such portfolios to quickly boost earnings – and that the FHFA should have done more to prevent it.
But Hjerpe said the bank, which he has led for three years, has mostly put that episode behind it.
“We’ve reduced the one troubled portfolio we had, it’s down by over two thirds,” Hjerpe said. “We’re extremely well capitalized.”
The FHLBB’s overall financial picture “looks significantly improved over the last couple of years. The bank went through some challenging times in the last couple of years, specifically ’08 and ’09, when the bank had significant losses,” Hjerpe said in an interview with Banker & Tradesman at the recent BankWorld expo at the MGM Grand at Foxwoods in Connecticut. BankWorld was produced by the Connecticut Bankers Association, in partnership with The Warren Group, publisher of Banker & Tradesman.
“Since that time, the bank made over $100 million through 2010. Through the first three quarters of 2011, we’ve made about $95 million, without yet reporting our fourth quarter earnings, and we’ve built capital, we’ve built our retained earnings.”
As private cooperatives, the 12 federal home loan banks bring in profits and pay dividends to their members – more than 8,000 financial institutions. They also buy and hold mortgage-related assets as part of their role in supporting the housing finance system.
“While FHFA has taken positive steps to improve oversight of the troubled Federal Home Loan Banks, the agency has not established policies, systems, and documentation standards that could strengthen its oversight,” Linick said. “It should do so in the near term.”
Jon Skarin, senior vice president of the Massachusetts Bankers Association, said while the Inspector General’s report may have some value as inspiration to beef up regulatory efforts before the next financial meltdown, it does relatively little for the FHLBB.
“The report is more of a look at what changes the regulator needs to happen, as opposed to any of the Federal Home Loan Banks on their own,” Skarin said. “Frankly, some of it is kind of old news. ‘You should’ve done this, and this and this.’ But I don’t know what it does to advance anything at the Boston bank. I think they’ve done a good job of working through it and coming out on the other end.”
Not Consistent, Transparent
Similar to Fannie Mae and Freddie Mac, the home loan bank system has the ability to borrow cheaply because of a perception that the federal government won’t let the cooperatives fail.
Indeed, Fannie Mae and Freddie Mac have been in government conservatorship for more than three years, leaving the fate of the secondary mortgage market in limbo.
But their housing-related investments have been weighing on the financial health of the system. Collectively, the Federal Home Loan Banks lost nearly $2 billion on private-label mortgage backed securities in 2009 and 2010, according to the inspector general.
FHFA has said four of them – Boston, Pittsburgh, Chicago and Seattle – pose “supervisory concerns,” but the inspector general noted that only two had faced regulatory enforcement actions during examinations between 2007-2010.
A senior FHFA official told the inspector general that weak finances had led home loan banks to take on more risk in an effort to drive up returns on investments, the report said.
As a result, the inspector general suggested FHFA establish clearer enforcement policies, and seek to make the banks’ investment practices and business strategies more transparent.
FHFA also needs to rely on more up to date automation as a regulatory tool, the report said. The regulator often follows up on a case-by-case basis when it comes to enforcement polices and uses manual processes, according to the watchdog.
The inspector general said the lack of consistent and transparent enforcement polices limited FHFA’s oversight ability, including a consistent lack of documentation when it comes to the actions it takes against the 12 cooperatives.
In a written response to the report, FHFA said all four of the federal home loan banks identified as supervisory concerns had received heightened regulatory scrutiny and that their business activities had been restricted.
Still, it said it would move ahead with the inspector general’s recommendations.
