WASHINGTON - The Federal Housing Finance Board's crackdown on the Home Loan Bank of Chicago, its second tough action this month, has some industry officials wondering if the board will keep flexing its muscle under Chairman Alicia Castaneda.
Ms. Castaneda, on the job just two months, drew a lot of attention last week when she pushed through a rule requiring the 12 Home Loan banks to register their stock with the Securities and Exchange Commission.
Many observers mulled what her next move would be, and some say they got their answer Wednesday, when the Finance Board announced a slew of required reforms at the Chicago bank and imposed a 10% growth limit on its controversial Mortgage Partnership Finance Program.
The bad news did not stop there - Standard & Poor's Corp. lowered its rating for the Chicago bank's credit a notch Thursday.
The repercussions - including higher borrowing costs and lower dividends - from the enforcement order may ripple out to the banks and thrifts that own the Chicago bank. The growth limit on the MPF program also could make it tougher for bankers to sell as many mortgages.
Diane Casey-Landry, the president of America's Community Bankers, said she had a broader concern: whether the cooperative system might be undermined by an activist regulator.
The board seems more interested in appearing tough than in operating in the best interest of the Home Loan Bank System, Ms. Casey-Landry said. "This is part of the Finance Board's efforts to demonstrate that they can be their view of a world-class regulator."
The board, like the Office of Federal Housing Enterprise Oversight, is the target of pending legislation that would make sweeping changes to oversight of the government-sponsored enterprises. OFHEO has taken myriad steps to crack down on Fannie Mae and Freddie Mac, and critics view the board's recent activism as copycat.
Stephen Cross, the Finance Board's director of supervision, denied any suggestion that it is acting extraordinarily or that it plans similar disciplinary actions for other banks. He said a formal move was necessary in this case, because informal requests last year had not been properly heeded.
"I would object to anyone believing that the motivation here was to send a message that we are a tough regulator," Mr. Cross said. "The motivation is wholly and completely to deal with a situation at the Chicago bank that was best dealt with this form of action: Slow down, catch your breath, let's build up the infrastructure before growing to any large extent."
Others described the agreement - which the Finance Board said it had to take public under a disclosure requirement of the Gramm-Leach-Bliley Act - as a warning for the rest of the system.
"I'm sure that this agreement will be noticed by the other banks," said Allen H. Koranda, the chairman of the Chicago bank, as well as the chairman and chief executive of Mid America Bank in Clarendon Hills, Ill.
Ms. Casey-Landry said there have been other signs.
The SEC registration was widely opposed by the industry, but the board proceeded anyway, she said. "That is not the way to develop a working relationship with the industry."
A recent move to increase banks' retained earnings "was done by directive - not rulemaking," she said. "So it's an increase in judgment and control in the hands of the regulator."
Despite such concerns, Mr. Koranda said in an interview that the cap on growth of MPF assets would not present a problem for the Chicago bank, because of the slowdown in the mortgage market. The program's assets exploded to $47 billion last year, from $26 billion in 2002, but have grown only about $1 billion in the first half.
"I don't think we'll have to turn away business to stay under 10%" this year, Mr. Koranda said. The bank thought it was cooperating with the steps the Finance Board had asked it to take, but "we don't have any major issues" with the requirements of the 13-page agreement.
In addition to limiting MPF asset growth, the order said the Chicago bank must submit a three-year capital plan for establishing stock, retained earnings, and dividend policies "appropriate for the bank's business strategies." It must maintain a capital ratio of at least 5.1% and detail plans for new business activities and the acquisition of extra capital to support them. A draft of the plan is due Aug. 31 and the final version a month later.
The bank must also hire independent consultants to complete studies of:
- The quality of board oversight management, with a focus on the director of internal audit, vice president of market risk analysis, and other top executives.
- The management of market, credit, and operations risks.
- The "independence, expertise, and staffing" of internal audit functions.
- External accounting, record keeping, and reporting practices, including debt transfer activities and hedge accounting practices.
Additionally, S&P lowered its long-term counterparty credit rating on the Chicago bank to AA-plus from AAA. It is the second Home Loan Bank - New York was the first - to lose its AAA rating.The ratings agency, which also changed its outlook to negative, said the Finance Board's move confirms its own concerns over rapid growth in "on-balance-sheet, longer-dated, fixed-rate mortgage assets."
"If the bank experiences additional regulatory intervention or a meaningful deterioration in profitability, either from loss of revenue or earnings restatements, the ratings could be lowered," S&P said in a release.
It said that Thursday's downgrade does not affect the AAA rating on the senior debt of the FHLBs' consolidated obligations.
Reacting to the downgrade, the Chicago bank released a lengthy statement Thursday defending its management and performance, and pointing to the enforcement action as a means of keeping it on the cutting-edge.
"We are a leading institution in terms of risk management and governance practices and are committed to continually enhancing our capabilities," read the statement, attributed to its acting president, Charles Huston. "The regulatory agreement announced yesterday will keep us at the forefront in these areas.
"The MPF Program is essential to serving our member financial institutions and is the principal reason for our superior financial performance, as we create a strategic alternative for our member institutions to Fannie Mae and Freddie Mac."
The arguments of those who defended the Chicago bank and said the written agreement was an isolated incident centered on two things: the bank's overall strong condition and the fact that Alex J. Pollock, the former CEO who led the buildup of the MPF program, was a lightning rod for controversy.
Because "Chicago is a bit of a pioneer," it is the bank most likely to attract regulatory attention, said John von Seggern, the president of the Council of Federal Home Loan Banks.
Mr. von Seggern said the agreement was less serious than a full cease-and-desist order and noted that the bank said it would pay out a 70% dividend to members Aug. 13. "There is no way they can pay that kind of dividend if there is a real problem."
Mr. Pollock surprised many when he announced plans for his departure a few weeks ago. That the supervisory agreement was issued the day before he started his new job as a resident fellow at the American Enterprise Institute stirred speculation that he had quit or been forced out in connection with the regulatory problems.
Mr. Koranda said Mr. Pollock was not forced off the board, and Mr. Cross said the regulator did not seek his ouster either.
In a phone interview Mr. Pollock reiterated what he has said all along: He left on his own terms because he was ready for a new challenge after many years at the Chicago bank and having reached the limit of the powers of its charter. He said that he made the decision to leave in November, long before the agreement was announced, though he had sensed hostility from regulators about the MPF program after Freddie's accounting scandal.
Still, signs of tension between Mr. Pollock and his former regulators are clear. "I'm really irritated that the transition out of the Home Loan bank I had the honor to lead - which is still far and away the top-performing Home Loan bank - is muddied by this stuff," he said.
Mr. Cross acknowledged that there had been some clashes but that they were professional disagreements.
