FHLBs may see impairment on $76.2 billion MBS: Moody's

NEW YORK (Reuters) - The Federal Home Loan Banks, one of the largest providers of funding for U.S. mortgages, face the potential for substantial accounting impairments on their $76.2 billion private-label mortgage-backed securities portfolio, Moody’s Investors Service said in a recent report.

Under a worst-case scenario, only four of 12 FHLBanks’ capital would remain above regulatory minimums and while that is not necessarily probable, it suggests that the amount of loss “could be material to the banks’ capital bases,” the report said.

Moody’s, however, said that the worst-case-scenario is “unlikely.”

Based on market prices in the third quarter of 2008, the banks’ total private-label MBS portfolio was valued at $62.7 billion, thus representing a $13.5 billion unrealized loss, according to the report.

In the short term, U.S. GAAP accounting rules may require the FHLBanks to account for securities in their portfolio as “other than temporary impairments,” or OTTI, according to Senior Vice President Brian Harris, the author of the report.

“If these unrealized losses are deemed OTTI,” he said, “the FHLBanks’ capital levels would be significantly affected -- an issue that is likely to become far more evident during the next two quarters.”

“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,” he said.

But the FHLBanks’ lending activities are so important that the regulators would probably not reduce individual banks’ lending activities even if they were to incur substantial OTTI charges, he said.

“The principal conclusion was the FHLBanks have the ability and intent to hold these securities to maturity, and the expected economic loss was modest and could be absorbed by each FHLBank at current capital levels,” Mike Ciota, FHLB spokesman, said in an e-mail.

The system of 12 regional FHLB banks has become more important to the housing market since the credit crunch shriveled up other sources of funds for mortgage lenders.

Congress established the Federal Home Loan Bank System back in 1932, to fill a dire need for a stable source of funds for residential mortgages. The Great Depression had undermined the existing banking system, and with it, Americans who had recently purchased -- or wanted to purchase -- homes.

Rising loan defaults and surging foreclosures has taken a toll on the entire U.S. financial system, with few companies spared.

Reporting by Julie Haviv, Editing by Chizu Nomiyama