The Obama administration's proposals to support the development of a covered bond market and limit large bank access to the Federal Home Loan Bank (FHLB) advance window could weaken the FHLB System, according to a new report from Moody's Investors Service.

"The combination of these two factors are credit negative for the FHLBanks because it would reduce the overall footprint and profitability" of the system, Moody's analysts wrote in their "Weekly Credit Outlook" report.

The administration's proposal would refocus the FHLBs on serving their small- and medium-size members and place limits on the advances large banks can borrow. Large and small members currently use system advances to finance mortgages they hold in portfolio.

Covered bonds would give large banks an alternative to advances and a way to tap U.S. and foreign markets for low-cost, long-term financing for their mortgage portfolios. As an alternative to FHLB advances, the Treasury Department says it will support the development of a covered bond market for large banks.

Reps. Scott Garrett, R-N.J. and Rep. Carolyn Maloney, D-N.Y., recently introduced a bill (H.R. 940) that would create a regulatory framework for federally insured banks to issue covered bonds.

Moody's analysts also raise concerns that the administration's proposal and H.R. 940 could weaken the FHLB's ability to increase their lending in times of financial stress.

During the 2008 financial meltdown, total FHLB advances increased by $400 billion during a six-month period, while European covered bond issuance declined. "The U.S. housing finance market may not function as well during periods of stress if greater reliance is placed on the covered bond market versus the FHLBanks," Moody's analysts warned.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.