WASHINGTON — The Federal Home Loan Bank of Chicago provided more details Monday on the depth of the problems it is facing after its aborted merger talks with the Home Loan Bank of Dallas.
The Chicago bank said it lost $78 million for the first quarter, largely because of its troubled mortgage program and volatility in the broader market. Despite its struggles, the loss is the bank's first since it began filing with the Securities and Exchange Commission.
Last week the bank announced that it was stopping purchases under the Mortgage Partnership Finance program. Observers said the Chicago bank may need years to recover from losses associated with its mortgage holdings.
"The short answer is it could take two to three years before they can work their way through the magnitude of the situation," said Jim Vogel, the head of fixed-income research at First Horizon National Corp.'s FTN Financial Capital Markets Corp.
Central to most of the Chicago bank's problems is the mortgage finance program, which it designed more than a decade ago to create a line of business that would rake in profits. Instead, the bank said interest rate volatility in its mortgage holdings cost it $47 million in hedging and derivative expenses during the first quarter, compared with $5 million of such costs for all of last year.
The decision to stop the purchases "may result in disruptions in business" for some of the Chicago bank's members, Matthew Feldman, its acting president, acknowledged in a letter to members dated Monday. "I want to assure you that we are working to establish an alternative investor channel for these loans and are also prepared to provide recommendations as to third parties that might provide support for our members participating in the MPF program."
The Chicago bank began merger negotiations with the Dallas bank in response to its troubles last year. But those talks fell apart this month, in part because of problems estimating the Chicago bank's net worth. It has vowed to come up with a plan to stay independent.
More details on the Chicago bank's financial position will come in a quarterly filing due to the SEC by May 7. But the letter made clear that mortgage-backed securities are adding to the bank's headaches. Mr. Feldman wrote that his bank planned to write down $33 million of triple-A, private-label securities collateralized by first-lien mortgages to subprime borrowers.
"Certain securities in our private-issue MBS portfolio have been downgraded due to credit deterioration of the underlying mortgages collateralizing the individual deals or because of rating actions on the financial guarantors," he wrote. "All of these securities were rated triple-A at the time of purchase. However, future downgrades and writedowns of the portfolio are possible."
As of April 17, Mr. Feldman wrote, 94% of the private-issue mortgage-backed portfolio was rated double-A or higher, and 90% carried a triple-A rating.
The Chicago bank also blamed its losses on a net interest income drop caused in part by narrowing spreads between assets and liabilities.
The bank appears to be largely alone in its troubles. The Federal Home Loan banks' Office of Finance said Monday that systemwide net income rose 12.2%, to $697 million.
Still, some losses were expected in Chicago. The losses "will continue for some time," the bank said in its 2007 annual report. "We will seek to implement strategic alternatives in 2008 to improve our earnings position, but we cannot ensure that these strategies will be effective, the length of time to implement strategies, or how long it may take to improve our earnings position."
Mr. Feldman also wrote that his bank has submitted a capital plan to the Federal Housing Finance Board, and that he expects to receive approval soon. A cease-and-desist order the Finance Board issued in October calls on the bank to convert its capital to five-year stock, as required under the Gramm-Leach-Bliley Act. The Chicago bank is the only one in the Federal Home Loan Bank System that continues to provide members with stock that can be redeemed in six months.
The order also allows stock to be redeemed only with the Finance Board's approval. Mr. Feldman wrote in his letter that the board had rejected a request to redeem $8.1 million of capital stock.
