Federal Housing Finance Agency acting director Edward DeMarco testified before a House subcommittee yesterday about the current status of government sponsored enterprises.  While his prepared remarks primarily concerned the future condition and possible future of Freddie Mac and Fannie Mae, he touched briefly on another group regulated by FHFA, the 12 Federal Home Loan Banks (FHLBanks).

DeMarco said that the Banks' assets have been in a decline since September 2008 and now stand at $937 billion.  This was matched by a decrease in advance activity which now stands at $540 billion, 46 percent below the record levels of October 2008.  The pace of the decline appears to be slowing but is still in stark contrast to the 2007 liquidity crisis when the FHLBanks increased advances to its members by 58 percent in 15 months.  The decline since then is primarily a reflection of the strong deposit growth and tepid loan demand at member banks.

While the credit quality of mortgages held by the FHLBanks is much above the industry average, they have pulled back from mortgage purchase activity.  At the end of the second quarter they held $66.8 billion in mortgage loans, only 7 percent of their combined assets.  This is a result of decreased new activity and an increase in prepayments but also reflects an assessment by many of the FHLBanks "that the returns associated with mortgages are insufficient to outweigh the associated funding and hedging risks."

Ten of the 12 FHLBanks reported a net profit in the second quarter and all 12 had a collective net income of $326.4 million, about the same as the previous quarter.   The banks have seen some setbacks associated with the deterioration of mortgage markets.  At the end of June the banks held private-label MBS equivalent to 4.9 percent of assets.  Shortfalls of principal or interest have occurred only 1 percent of these assets but the system has taken $3.3 billion in credit-related impairments on those investments and recorded an additional $10.8 billion in non-credit-related, other-than-temporary-impairments. The Pittsburgh, Seattle, and San Francisco FHLBanks have filed complaints in state courts alleging fraud, misrepresentation, and violations of state and federal laws in connection with their purchase of certain securities.

DeMarco said it appears that within the next 18 months the FHLBanks will fulfill their obligations to pay a portion of the interest on bonds issued by the Resolution Funding Corporation during the savings and loan clean-up of 1989.  Payments on this obligation consume 20 percent of each bank's net earnings.  Because of this obligation, the banks have not rebuilt or maintained retained earnings adequate to the size and risks of their current businesses.  DeMarco said the fulfillment of this 20 year obligation presents an opportunity to help the banks work through current financial problems and be better prepared for the future by accelerating the rate at which the banks build their retained earnings.