The Office of Inspector
General (OIG) for the Federal Housing Finance Agency (FHFA) has released an
assessment of the FHFA’s oversight of troubled banks within the Federal Home
Loan Bank (FHLBank) System. While the OIG found positive actions on the part of
FHFA, it specifically criticized  a lack
of policies, systems, and documentation standards that could strengthen that
oversight.

Of the 12 FHLBanks that
exist regionally, four have experienced significant financial and operational
difficulties dating back to at least 2008. 
The four, located in Boston, Chicago, Pittsburgh, and Seattle and
classified as of “supervisory concern” due to problems arising from their investments
in certain high-risk mortgage securities.

The primary mission of FHLBanks
is to support housing finance and the system issues debt in the capital markets
at relatively favorable rates due to its status as a government sponsored
enterprise (GSE).  The proceeds of the
debt are used by the individual banks to make secured “advances” to member
financial institutions which secure these advances using single-family
mortgages or investment-grade securities as collateral.   The FHLBanks also hold investment portfolios
that contain assets such as mortgage-backed securities (MBS). 

FHFA has oversight
responsibility for the FHLBanks and recognizes the need to ensure that they do
not abuse their GSE status or act imprudently. 
FHFA’s own examination guidance states that the agency will initiate a
formal enforcement action, such as a cease and desist order, when a bank is
identified as having significant “supervisory concerns” within the system.

According to the OIG,
the four troubled banks have experienced “significant financial and operational
deterioration primarily due to their investments in private-label MBS secured
by non-traditional mortgages.”  Two of
the banks, in fact, hold more than twice the level of securities rated “below
investment grade” than the average for the eight healthier banks.

Another
identified risk is a concentration of advances in a few member banks.  Both the Pittsburgh and Seattle banks have a
high percentage of their advance business confined to ten members (the
situation only recently changed in respect to Boston) which leaves them
vulnerable should one or more such institutions fail or withdraw from the
system.  OIG also found that the troubled
banks tend to demonstrate a limited demand for advances, a high percentage of
investments to total assets, and significant risk management and operational
deficiencies.

OIG
said a major concern is that troubled FHLBanks potentially have greater
incentives to engage in higher risk business strategies in order to achieve
higher returns.  This means that FHFA
needs to monitor their activities and control actions that could potentially
lead to greater financial and operational deterioration and cause greater
long-term risks.

The
OIG found that FHFA has taken some steps to monitor and control the four banks
which present “supervisory concern.”

• Ensuring that they
  restrict the payment of dividends to preserve their retained earnings and
  capital.
• Encouraging FHLBank
  boards to place limits on investment activities.
• Monitoring through
  annual examinations and regular communications.
• Discussing with board
  members and managers the possibility of merging with healthier FHLBanks.

While
FHFA’s examination guidance specifies enforcement, OIG claims that FHFA does
not view this as constituting a policy or requiring a course of action.  FHFA believes, by initiating enforcement
action on a case-by-case basis it has acted appropriately.

The
OIG disagrees and views “FHFA’s lack of a consistent and transparent written
enforcement policy as undermining the Agency’s oversight of troubled FHLBanks.”  FHFA and its predecessor FHFB have initiated
formal enforcement against only two of the banks, Consent Orders issued against
Chicago in 2007 and Seattle in 2010.

OIG
faulted FHFA for the following:

• Its failure to
  establish a clear, consistent and transparent written enforcement policy for
  troubled banks has led to a discretion-based approach. This, in turn, has resulted in a lack of
  clarity for FHFA examination staff and the banks, neither of which have steady
  benchmarks against which to gauge their actions.
• The Agency has not
  established an automated management information reporting system to track
  FHLBank examinations finds. By relying
  instead on a manual system, FHFA managers are limited in their ability to
  assess the extent to which individual banks are correcting deficiencies and
  this has also impeded the ability of the OIG to assess the effectiveness of the
  Agency’s oversight efforts.
• FHFA does not
  consistently document key actions with respect to its oversight of the troubled
  banks. This was a problem that OIG found
  particularly troublesome as applied to personnel actions as it identified cases
  where FHFA had influenced boards to terminate employees without adequately
  documenting its actions or the reasons for them.

In
concluding its report the OIG made three specific recommendations which
paralleled the above findings; recommending that FHFA

• Develop and implement a
  clear, consistent and transparent written enforcement policy that requires
  troubled banks to correct identified deficiencies within a specific time frame,
  establishes consequences for failure to do so, and defines exceptions to the
  policy.
• Develop and implement a
  reporting system that permits Agency managers and outside reviewers to assess
  examination report findings, planned corrective actions and timeframes, and
  their status.
• Document key activities
  consistently including personnel actions involving FHLBanks.

The performance period for this
evaluation was from May 2011 to November 2011.

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