September 26, 2007 / 4:55 PM / 12 years ago

UPDATE 2-FHLB Chicago receives draft cease-and-desist order

(Adds background, analyst comment)

NEW YORK, Sept 26 (Reuters) - The Federal Home Loan Bank of Chicago on Wednesday said its regulator may prohibit some capital stock repurchases and redemptions with a cease-and-desist order.

The draft order received from the Federal Housing Finance Board appears to be pointed at the bank’s capital levels, which may be reduced if big shareholders, such as LaSalle Bank Corp., end their relationships, Margaret Kerins, a strategist at RBS Greenwich Capital Markets said in a client note.

The 12 Federal Home Loan banks, which provide low-cost ‘advances’ for real estate loans to member banks that hold their stock, have come under pressure as regulatory scrutiny increases and consolidation among members pinches earnings.

A loss of LaSalle due to its merger with Bank of America Corp (BAC.N), and MidAmerica Bank, which was acquired by National City Corp NCC.N, as members would cut capital at the Chicago bank, it said in a second-quarter regulatory filing.

“This might be driving the draft cease-and-desist,” Kerins wrote in a note to clients that detailed the filing.

Profit challenges led the FHLB of Chicago and the FHLB of Dallas, which faced the loss of its largest member to a merger with Wachovia Corp., to begin merger talks last month.

The FHLB of Chicago is still exploring options to merge with the Dallas bank, though it is possible an agreement will not be reached, Mikesell Thomas, chief executive of the Chicago FHLB, said in a letter to members on Wednesday.

FHLB of Dallas Chief Executive Terry Smith in a statement said the bank will continue discussions with Chicago bank.

Nancy Schachman, a spokeswoman for the FHLB Chicago, declined to comment on the purpose of the draft order. FHFB spokesman Daris Meeks said the board does not comment on potential enforcement actions.

The Federal Home Loan Bank system, created by Congress to raise money for housing, sell debt and use proceeds to provide low-cost “advances” earmarked mostly for residential real estate loans to more than 8,000 commercial banks, thrifts and other lenders across the nation. FHLB bonds did not react to the FHLB Chicago filing, one analyst said.

The FHLB of Chicago has come under scrutiny in the past, beginning with a 2004 FHFB report that found shortcomings in risk management and capital management. The FHFB in 2006 acted to strengthen capital of all FHLBs by limiting dividends if a minimum level of retained earnings is not maintained.

Advances from the FHLB of Chicago will probably not be affected by the order, Thomas said in the letter. Advances by the FHLBs have soared this year as lenders seek to replace funding lost as investors stopped buying many types of securities tied to mortgage assets.

“We do not expect the final version of an order to impact any products or services offered by the bank to our members,” Thomas said.

The FHLB of Chicago made the announcement in a filing with the U.S. Securities and Exchange Commission.

Additional reporting by Lynn Adler in New York and Patrick Rucker in Washington

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