An independent analysis of the Federal Home Loan Bank of San Francisco's investment portfolio is fueling doubts about the health of the bank, the largest of the 12 institutions in the system.

While the bank has said it expects only a $688 million credit loss on a nearly $20 billion portfolio of mortgage-backed securities, outsiders expect a loss closer to $5 billion — a figure that would wipe out the bank's retained earnings.

"The bank here has a highly aspirational view of what these things are worth," said Espen Robak, president of Pluris Valuation Advisors, which performed an analysis of the portfolio at the request of American Banker. "It's obviously not what the market expects, and it's not what the ratings agencies are expecting either. There's a reason they have a lot of these things are marked at CCC."

The bank maintains its estimates are accurate.

"The modeling we do each quarter reflects changes in actual loan performance and in market conditions, including changes in forecasted housing prices, default rates and loss severity rates," said Amy Stewart, a spokeswoman for the bank. "We are confident that our modeling is appropriate."

If Pluris' estimates are correct, the ramifications would go well beyond the San Francisco bank.

Wiping out the bank's $1.3 billion of retained earnings would effectively "break the buck" on its member stock, which is fixed at $100 par value. That's only happened once in the system's 77-year history. It would prevent the bank from paying a dividend to members and stop the return of $4.9 billion in capital stock due to be withdrawn by FHLB members over the next few years.

It also would cast doubt on the health of the bank at a time when the Home Loan banks are urging Congress to exempt them from being considered systemically risky and as lawmakers begin to debate the future of the housing finance system, of which the FHLBs are a key part.

Finally, it raises questions about whether other institutions — in and out of the Home Loan Bank System — are providing overly rosy assessments of their RMBS exposures.

Last year the Home Loan banks adopted a standard process for evaluating more than $44 billion in cumulative mortgage-backed securities holdings. Their auditor, PriceWaterhouseCoopers, also works for companies ranging from Bank of America Corp. to Freddie Mac.

The issue was first raised in March, when the San Francisco Home Loan Bank filed a lawsuit seeking to force Wall Street dealers to repurchase nearly $20 billion worth of mortgage-backed securities.

The bank claimed their sale had been premised on numerous "materially untrue or misleading statements," and the bank had "suffered a loss on each."

Yet the bank's first-quarter earnings presented the same information in softer terms. Many of those same securities will pay off in full, the bank predicted, and credit losses on its entire portfolio of private label MBS will total $688 million — on average less than five cents on the dollar.

An independent review of the bank's holdings suggests that the more pessimistic appraisal may be more accurate. While the FHLB's holdings are all "super senior," they are sometimes behind other noteholders in order of payment. Moreover, the collateral underlying the securities is frequently late-vintage loans underwritten by now-notorious entities like Countrywide Alternative Loan Trust and Bear Stearns Alt-A Trust.

At the request of American Banker, Pluris reviewed the portfolio in an effort to gauge the FHLB's likely losses. After looking at the bonds' underlying collateral and the initial offering prices of similar or identical securities, Pluris concluded that losses would likely fall between 15% and 45%, with a 30% shortfall the most likely, a figure equal to approximately $5 billion.

Other than temporary impairment charges have dogged the Home Loan Banks for the past two years. The Financial Accounting Standards Board helped the FHLBs somewhat last year when it ruled that institutions only have to recognize expected credit losses on held-for-maturity securities.

The FHLB says Pluris' assessments are too reliant on market pricing. The FHLB's own current fair-value estimate of the portfolio's worth would fall within Pluris' range, but the FHLB believes its ultimate recovery on the held-for-maturity securities will be greater. Using modeling techniques it shares with the other 11 Home Loan banks, it predicts that holding the securities to maturity will allow it to recover all but $688 million.

The bank's MBS "are held to maturity, so the amounts in" accumulated other comprehensive income, which recognizes the difference between the book value of an asset and its market value, "will not reflect improvements in estimated fair value," Stewart said. "AOCI is accreted back into equity over the remaining life of the securities, based on the amount and timing of future estimated cash flows."

The degree to which the Home Loan bank's lawsuit has disclosed its holdings is exceptional for a financial institution: schedules appended to the FHLB's filings precisely identify more than 130 Alt-A securities it holds, making a review of each bond's collateral, capital structure and performance possible.

According to a source familiar with the bank's operations in the period that the securities were acquired, members were routinely told that the bank only purchased super-senior triple-A tranches with high degrees of credit protection. But in some cases, Pluris said, the securities are top-tier in the event of an all out liquidation but might simply stop paying if the collateral failed gradually.

The deals themselves show significant losses that in many cases appear likely to overwhelm equity tranches. One example is the bank's stake in Countrywide Alternative Loan Trust 2007-18CB, a June 2007 deal composed largely of limited-documentation loans. Approximately 19% of those loans are more than 90 days past due, and Bloomberg loan level data shows that many of the mortgage holders have not paid down principal at all.

The San Francisco Federal Home Loan Bank purchased $109 million in tranche A-22, a triple-A security yielding a 6% coupon. That tranche is now rated CC by both Moody's Investors Service and Standard & Poor's, and is on negative watch for both agencies.

While the 2007 deals are generally the worst, Pluris found that even some earlier deals were at risk. The bank's holdings in a 2005 issuance by Bear Stearns Alt-A trust are rated CCC, and significant losses are all but certain, Robak said.

"We think that one is worth around 60% [of face value], and even that might be optimistic," he said. The bank is "stuck in the middle, there's the money trickling down from above, and there's the losses coming up like water from the basement."

The FHLB does not break out losses by security, making a direct comparison between its models with Pluris' judgments impossible. But in a lengthy discussion of its RMBS portfolio, the bank outlines its forecast. Its best-estimate scenario, on which its bases its accounting, calls for the housing market to bottom by yearend, and for prices to gradually improve to 4% annual increases.

The bank concedes that the majority of its alternative-A portfolio is likely to take at least some credit losses, though not deep ones. Still, the bank's most recent quarterly Securities and Exchange Commission filing suggests that the portfolio is coming under increasing stress.

Between April 1 and April 30 alone, securities with a carrying value of more than $1.3 billion were downgraded to CCC by ratings agencies, some from as high as A. The bank now holds more than $6 billion of mortgage backed securities rated CCC or below, a level that generally implies "poor standing" and "very high credit risk," according to Moody's.

The issue of OTTI valuations is of keen interest to the Federal Housing Finance Agency, the bank's regulator, which is reviewing the matter.

"We are at the present time engaged in a review, across all the banks and the government sponsored enterprises, of the underlying modeling and analysis that supports their [other than temporary impairment] determinations," said Stephen Cross, acting senior deputy director and chief operating officer of the FHFA's Division of Federal Home Loan Banks.

The FHLBs' methodology for evaluating OTTI has been refined over the five quarters its been in place, he added, and "certain of their assumptions have tended to worsen over that period of time, partly as a result of their own analysis and partly as a result of feedback from the FHFA."

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