America's Community Bankers last week urged members of Congress to prohibit the Federal Housing Finance Board from adopting a proposed rule that would radically overhaul the Federal Home Loan Bank system's capital and investment until Congress can review the proposal.

ACB sent letters to many members of Congress, including Senate Banking Committee Chairman Phil Gramm and House Banking Committee Chairman Jim Leach.

At issue are the elements of a new financial management and mission achievement policy that was published last week in the Federal Register for a 90-day comment period. The controversial proposal calls for the 12 Home Loan banks to pool mortgages and share the credit and interest risks with originators, as well as divest themselves of all mortgage-backed securities.

"The proposed rule is extremely complex, has far-reaching implications for the FHLBank System and may pose new restrictions and inappropriate risks on the System," said Robert R. Davis, director of government relations for ACB.

One example of the need to delay and review the proposed regulation is the mandated elimination of MBS by the FHLBanks and the replacement of these core assets with "member mortgage assets." (MMA) The proposal would phase out the FHLBank's authority to invest in MBS and require that these investments be replaced with MMA.

"With these MMA's, there is an added operational cost, because you have to underwrite and manage them, and track the servicer, which you don't have to do with regular MBS," said Brian Smith, the head of economic research and policy at ACB. "You also have an added credit risk, a risk exposure you don't have with MBS, so even if gross return was the same for the FHLBanks, the net return, adjusted for operational costs and credit risk, would not be the same."

According to market sources, the board's decision could severely impact the regional home loan banks and weaken their ability to support their multiple housing missions, including servicing the indebtedness on FICO securities.

"The plan would effectively diminish the capability of the regional banks to serve their statutory mission, and that should concern anyone who is an exponent of affordable housing in the U.S.," said Michael Youngblood, director of real estate at Banc of America Securities.

Risk and Reward?

According to sources in the banking community, the new proposal was a culmination of many years on the part of the Finance Board of trying to point the FHLBanks in a different direction in terms of the types of assets they purchased. It was also an attempt to change the capital structure of the FHLB system from an asset-based structure to a risk-based one.

"The only problem with that goal is that the home loan banks are not in charge of how much capital they have," Smith noted. "When members come in they have to buy subscription capital and that cannot be managed, and consequently the ability of the FHLBanks to really have a risk-based system is totally a fantasy."

A chief economist at the FHFB met with a select group of people last week, sources said, trying to discuss the proposal, which has a 90-day comment period ending on December 27.

It is not yet clear whether the new "MMA" assets will provide the same risk and reward that traditional MBS have provided for the FHLBanks.

"I find it hard to think that there are alternative investments that are superior both with respect to risk and reward than what [the banks] now own," said Youngblood. "If they existed, these institutions would have acquired them and built their portfolios around them. These will have to be instruments that are newly created and newly designed, and who knows where they are going to come out on the efficient' frontier of risk and reward."

The five-year-phase-out of MBS purchases will begin on Jan. 1, 2000, when 80% of the money the banks raise will have to go to mission-related activities only; the year after, 85% must be mission-consistent, increasing by 5% each year until Jan.1, 2005, when 100% of what the system borrows must be compliant with mission-related guidelines.

"So, there are standards you have to meet all the way through," ACB's Smith said. "Trying to meet unreasonable standards could cause many problems for the banks."

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