Thousands of banks and savings institutions own stock in their district Federal Home Loan Bank, and the 12 district banks hold a combined $75.7 billion in private-label residential mortgage-backed securities among them. Some expect those holdings to expose the Home Loan Banks to “other than temporary impairment.”

Does this mean that such OTTI charges suffered by the government banks should in turn affect the private banks’ financials?

Absolutely not, according to banks that have assessed the accounting standards and the recoverability of the par value of the stock. ABA recently release a paper sharing the anlaysis banks have used to support the conclusion.

Scoping out FHLB OTTI
In a February credit analysis, Moody’s notes that substantial OTTI could reduce the privately owned cooperatives’ capital levels below regulatory requirements. On the other hand, Moody’s observed that “the expected loss on this portfolio is low, approximately $1 billion, and manageable when compared with [the Home Loan Bank System’s] $57.1 billion capital base.” Moody’s also pointed out that the system has never seen a credit loss on advances made to member institutions, which continues to be its primary business.

However, private banks have been concerned about the impact of Home Loan Bank OTTI on their own accounting, as some accounting firms have raised this as an issue. Member institutions must hold stock in their area Home Loan Bank in order to obtain credit advances. The greater the advance activity required, the higher the required holdings.

In an effort to give bank members some background information, the Federal Home Loan Bank of New York’s President, Alfred DelliBovi, for instance, issued a report in late January stating, “To our knowledge, no member of any FHLBank has taken an OTTI charge on the member’s investment in its FHLBank stock. My understanding is that an appropriate analysis of impairment with respect to the capital stock of an FHLBank takes into account the fact that capital stock is an integral part of membership in the FHLBank and that it is a long-term investment.”

Moody’s February report points out that 95.4% of the private label mortgage backed securities, and 53.1% of the home equity securities were rated Aaa at the end of the third quarter 2008. And it notes that as of the date of its report, only three Home Loan Banks—Chicago, Atlanta, and Seattle—have reported OTTI, and in relatively modest amounts.

“Banks and auditors are concluding that OTTI does not currently exist for FHLB stock,” ABA states in a new white paper.

Essentials about FHLB stock and OTTI
Under current conditions bankers and their accounting firms have been reviewing many types of investments through an OTTI filter. While stock in the FHLBs comes up in these discussions, ABA notes that according to the analyses, they shouldn’t be at risk.

A key point is that banks mainly purchase FHLB stock in order to qualify for membership in and for advances from the Home Loan Banks, which are cooperatives. While the shares pay dividends, which influence the cost of advances, Home Loan Bank stock does not trade at all. Shares are bought and sold at par, between the Home Loan Banks themselves or member institutions. And the shares are typically held for a long time.

As a result of these special circumstances, under Financial Accounting Standards Board Statement 115, “Accounting for Certain Investments in Debt and Equity Securities,” there is no fair value that can be determined readily. Investments such as this stock, ABA maintains, are carried at cost.

“Thus,” ABA stated, “when evaluating FHLB stock for impairment, its value should be determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.”

For ABA’s complete reasoning, see the white paper, which members can obtain at www.aba.com.

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