WASHINGTON — As it pursues a potential merger with the Federal Home Loan Bank of Dallas, earnings at the Home Loan Bank of Chicago continue to plummet, falling more in the second quarter than at any other bank in the Home Loan Bank System.
Profits at the Chicago bank dropped 50% from a year earlier, to $27 million, in part because of problems with its mortgage program and lower interest income. Advances fell 9%, to $23.8 billion.
The Chicago bank was not the only one to experience a bruising second quarter. A volatile housing market, higher interest rates, and continued talk of industry consolidation sent profits down at half of the 12 Federal Home Loan banks. Even those that are consistently strong, such as the Atlanta and New York banks, reported a profit drop.
But the situation has been particularly rough at the Chicago bank, which once was considered one of the system's strongest. Net income fell 23% last year and 58.9% in the first quarter. The bank is trying to cut costs and said in its quarterly filing with the Securities and Exchange Commission that it laid off 81 employees in the first six months of this year. Further layoffs are likely, the filing said.
The bank is facing fallout from its Mortgage Partnership Finance program, which the Federal Housing Finance Board is scrutinizing for rate risk management. The bank is also scaling back the program; it said in its quarterly report that it is working with its regulator to transition to a "more traditional advance bank."
The Chicago bank also said its net income dropped as a result of a decline in interest income, partly because funding from the program matured and was replaced with higher-rate debt. That shift, combined with accounting changes, is leading to pessimism about the bank's financial future as it continues merger talks.
"We anticipate that these factors also will significantly lower future net income in 2007 and beyond compared to previous years and expect income over the remaining six months of 2007 to further decrease as compared to the first six months of 2007," the bank said in its quarterly report.
In a press release, Mike Thomas, the Chicago bank's chief executive, blamed the decline on larger market forces.
"Like our members, we continue to face market and industry challenges that impact our net interest margin," he said.
The bank's continuing financial woes are the primary driver behind its merger talks with the Dallas bank. The two banks confirmed this month that they are in merger discussions after American Banker learned of talks.
The earnings situation was better at the Dallas bank. Profits grew 2.9%, to $28.7 million, even though advances — its core business — dropped 11.5%, to $36.4 billion.
Rising short-term interest rates helped the bottom line, but maturing loans hurt the core advance business. The bank said nearly two-thirds of its advance decline can be attributed to lost business from Washington Mutual Inc., which took over Bank United Corp.'s advances when it acquired the Houston company in 2001.
Wamu cannot renew Bank United's advances when they mature, because the Seattle thrift company is not in the Dallas bank's district. In the third quarter, $987 million of the Dallas bank's advances to Wamu will mature, and another $368 million will mature in the third quarter of next year.
The Dallas bank is facing a similar scenario with the loss of Hibernia National Bank, which Capital One Financial Corp. acquired in 2005. The Home Loan bank has said that $100 million in advances to Hibernia will mature in the second half of this year, along with $201 million next year and $602 million in 2009.
"The loss of Washington Mutual Bank's remaining advances and those borrowed by Capital One are expected to have a modestly negative impact on the bank's return on capital stock," the Dallas bank said in its quarterly filing. "In the event the bank were to lose one or more additional large borrowers that represent a significant proportion of its business, it could, depending on the magnitude of the impact, lower dividend rates, raise advances rates, attempt to reduce operating expenses (which could cause a reduction in service levels), or undertake some combination of these actions."
Combined net income at the 12 Home Loan banks fell 2.7% during the second quarter, to $624.5 million, while advances were virtually flat at $640 billion. Some of the banks said their members are finding less expensive funding sources elsewhere.
"We … expect that existing members will continue to utilize excess liquidity from maturing investments and from other sources such as customer deposits to fund any increased loan demand before turning to the FHLBank for wholesale borrowings in the form of advances," the Home Loan Bank of Topeka said in its quarterly report.
That situation could change, however, as members turn to the Home Loan banks for liquidity during the current credit crunch. Evidence of such a change is already beginning to emerge. The Home Loan Bank of Seattle said its advances grew 14.2% from June 30 to Aug. 9, to $32.1 billion.
Advances at the Home Loan Bank of New York grew 2.5% between Aug. 6 and Aug. 13, to $62.3 billion. The Home Loan Bank of Cincinnati did not release data detailing its advance growth since June, but a spokesman said two members have bought more stock recently to clear the way for more advance borrowing. The Atlanta bank's advances also grew 7% during the past two weeks but a spokesman declined to specify the bank's total advances.
Richard Dorfman, the new chief executive of the Home Loan Bank of Atlanta, said in an interview Monday that demand is rising for advances from large and small banks. "The fact is we have a very ideal mix of clients in terms of type and in terms of size. The big people are doing big things, and many smaller banks are doing small things."
He also said he was not surprised that many banks have flocked to the Home Loan banks during the credit crunch. "Our mission is exactly that. We provide liquidity."
As many Home Loan banks seek to provide liquidity in reaction to shaky markets, the system continues to be dogged by lower interest income, the biggest source of profit for many of the banks.
That was much of the problem at the Home Loan Bank of Boston, whose earnings fell 14.2%, to $40.1 million. The bank blamed much of the falloff to a decline in interest income as funding costs rose for advances and mortgage products. Advances, meanwhile, grew 4%, to $38.8 billion, as the bank's largest members became more active borrowers.
The Atlanta bank was also hit with lower interest income. Profits slid 13.1%, to $93.2 million, as interest expenses overtook any income that would have resulted from interest-bearing assets. Advances grew 2.7%, to $104.2 billion, and the Home Loan bank said in its quarterly report that it expects modest growth to continue in its advance business.
Mr. Dorfman said the Atlanta bank has faced investment challenges as demand for mortgages has dried up. "We were constrained to invest away from the mortgage market, which wasn't going to provide us with the level of payback we would like to have."
Profits at the Home Loan Bank of Indianapolis fell 11.3%, to $26.1 million, while advances fell 1.3%, to $22 billion. The bank attributed the profit decline to lower interest income and said the decline in advances resulted from reduced demand from one large borrower.
As it did in the first quarter, the Indianapolis bank warned its members that advance business could be slow to pick up, because of the sluggish economy in Indiana and Michigan and the loss of commercial bank members. But the bank said it has noticed an increase in advance demand from insurance companies.
The New York bank's second-quarter net income fell 6.4%, to $70.6 million. The bank said it enjoyed higher average interest-earning assets during the second quarter of last year. Advances rose 3.8%, to $61.2 billion.
Earnings at the Home Loan Bank of Pittsburgh dropped 3.3%, to $52.2 million, due to losses on derivatives and hedge accounting activities. The bank said its advances grew 13.3%, to $55.9 billion, because of increased demand from its four largest customers, which were Sovereign Bank, GMAC Bank, Citicorp Trust Bank, and Lehman Brothers Bank at the end of the first quarter.
While many Home Loan banks were grappling with losses, the Seattle bank continued to grow out of the problems related to its failed mortgage program. Its profits jumped 490.1%, to $14.6 million. The bank said it had reinvested low-yield investments reaching maturity into higher-yielding assets like federal funds, giving it reason to be optimistic about the future.
Last year the Finance Board approved the Seattle bank's plan to create an excess stock pool to support more advances. But the business was mostly flat during the second quarter, rising just 0.6%, to $28.1 million.
The Cincinnati bank again reported a strong quarter. Earnings rose 14%, to $70.5 million, and advances grew 12.8%, to $47.3 billion.
But the bank's success could be stunted this year when Royal Bank of Scotland Group PLC's Charter One Bank consolidates its charter with those of other Royal Bank units, taking it outside of the Cincinnati bank's district.
The consolidation would eliminate one of the Cincinnati bank's largest customers, which accounted for 24% of the advance business on June 30. The Home Loan bank said the consolidation, which could happen as early as next month, did not affect its financial standing during the second quarter, through it is too soon to know the precise challenges the consolidation will pose in the long term.
"We believe it will not materially affect the adequacy of our liquidity, our profitability in terms of the dividend rates available to pay remaining stockholders, our ability to make timely principal and interest payments... and the ability to continue providing sufficient membership value to our members," the bank said.
