As the GSEs struggle to preserve capital and indicate that they are not likely to be growing their portfolios, the Federal Home Loan Banks' (FHLB) agency portfolio growth has remained strong, Lehman Brothers said in a recent report. 

Analysts noted that, while asset growth slowed in 2Q08 to $22 billion compared with $51 billion in the first quarter, these agencies added $15.1 billion in agency MBS, dipping just just slightly from $16.5 billion. 

Lehman analysts suggested the slowing in asset growth was a result of improved liquidity in the second quarter, helped by the various funding facilities set up by the Federal Reserve in the first quarter.

What matters though is that the FHLBs look to have the ability to remain a steady source of support for the sector. In the report, Lehman analysts reviewed the various regulations that apply to MBS growth in FHLB portfolios to quantify their potential support.

One of the binding rules is that MBS cannot exceed 300% of total capital. However, the current limit has been temporarily raised to 600%.  Based on this requirement and current equity, Lehman analysts estimated that the FHLBs can add $185 billion in MBS assets before hitting this limit. 

A second constraint is capital requirements.  Based on this requirement, analysts estimate the FHLBs can grow assets by around $126 billion without having to raise additional capital. 

The last restriction is that an FHLB cannot increase holdings of MBS in any one-calendar quarter by more than 50% of its total capital at the beginning of that quarter. Lehman analysts said this appears to be the most binding constraint for the FHLBs to grow their MBS portfolios. However, examining capital levels at the end of the second quarter, Lehman projected the FHLBs can add a maximum of $28 billion in MBS over the third quarter. 

Analysts also said that even if the FHLBs decide not to grow their balance sheet, they could add MBS by shedding other assets.  For example, they noted that the banks currently have $90 billion in Fed Funds that they could free up to add MBS.

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