Community bankers say a Federal Home Loan Bank's mortgage financing program is helping them lower their loan prices and compete with larger lenders.

Going beyond its traditional business of making advances, the Federal Home Loan Bank of Chicago now funds long-term, fixed-rate loans for its member banks. The lower-cost program gives banks and thrifts another option for mortgages besides keeping the loans in their own portfolios or selling them to a secondary agency.

"This has given us a very competitive place in the market," said Lee Swanson, president and chief executive officer of State Bank of Cross Plains, Wis. "If there's salvation for community banks down the road, this is the kind of program we need."

So far, 36 banks in Illinois, Wisconsin, and Texas have signed up for the 18-month-old program, which is available to members of the Chicago and Dallas Federal Home Loan banks, and more than 200 banks are joining. The members have generated $1.8 billion in commitments for the Chicago bank.

Here's how it works: Banks pay a fee to the Home Loan bank, which funds the loans, and the community bank receives fee income from the customer for servicing the loan. Community banks gain 80 to 100 basis points in servicing fees over the life of the loan-income it would forfeit if it sold the loans on the secondary market.

"On a macro level, we're changing the structure of the mortgage market," said Alex J. Pollock, president and chief executive officer of the Federal Home Loan Bank of Chicago.

Still, the program has had some controversy. Two thrift trade groups sued the Chicago bank over the program, arguing that it goes beyond the Home Loan banks' original mission of offering credit to their members. A judge ruled in June, however, that the program is within the Home Loan banks' mission.

Bankers say it enables them to match rates offered by their larger competitors, many of which can negotiate volume discounts with Fannie Mae and Freddie Mac. State Bank of Cross Plains, which has $185 million of assets, discounts its mortgages by as much as 25 basis points when the Chicago bank finances the loans, versus selling them to Fannie Mae.

State Bank has financed $74 million in mortgages through the Chicago Home Loan Bank since joining the program in an early stage in the fall of 1997.

The Chicago bank may soon expand its program to members of the Pittsburgh and New York Federal Home Loan banks. In response, Mr. Pollock said he expects Fannie Mae and Freddie Mac to reduce their prices for community banks, Mr. Pollock said.

A spokeswoman for Fannie Mae said it has no plans to change its pricing structure, however.

Still, community banks in the Chicago program are not cutting their ties to the two larger processors. Fox Valley Savings and Loan Association in Fond du Lac, Wis., plans to keep selling some loans, even though more than half of its single-family mortgages have been funded by the Chicago program since mid-1998.

"Maybe Freddie will offer something more attractive some day," said Richard W. Casper, a vice president at the $172 million-asset thrift.

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