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Moody's Reviews the FHLBanks

APRIL 23, 2004


Moody's Reviews the FHLBanks

A Moody's Investors Service report on the Federal Home Loan Banks says the FHLBs have improved their operations, but suggests that some additional "improvement opportunities" exist.

Communication and Coordination. Formal and informal structures, including the Office of Finance, promote internal communications and sharing of best practices. However, Moody's is concerned that limited central leadership within the system constrains the effectiveness of coordination, inter-bank performance monitoring and political lobbying efforts.

The report calls for better coordination of communications to investors, particularly when FHLBs disclose financial difficulties as three did last year. Moody's believes joint and several liability for system debt requires the FHLBs to make a greater effort to monitor their peers and share information.

Moody's noted that efforts to provide a "one-system view" on key public policy issues has not been fully effective, as evidenced by differing views by FHLBs on SEC registration. While policy differences result from each FHLB representing its own members' interests, it can dilute the effectiveness of the system's lobbying efforts.

Risk Management. Regulatory oversight has improved with more rigorous examinations and oversight, stronger transparency and better peer analysis, according to the report. Moody's noted that the FHLBs have experienced rapid growth recently and credits them for voluntarily adopting some of the Sarbanes-Oxley Act governance practices.

The FHLBs have added risk from mortgage purchases and the acceptance of new collateral as a result of the Gramm-Leach-Bliley Act (though the latter represents only 1.5% of advances as of year-end 2003) and upgraded their risk management Moody's views changes in the FHLBs' capital structure as a "net credit positive" because they resulted in a more permanent capital structure and stronger capital policies, offsetting the higher risks. Moody's sees opportunities for more improvement in risk management, particularly in interest-rate and prepayment risk management.

Member Concentration. Moody's is concerned about member concentration, as the top ten stockholders hold 21% of system capital as of year-end 2003. At the same time, the top ten advance holders accounted for 25% of system advances. The report notes FHLB collateral policies offset some concentration risk and single borrower exposure. But in Moody's view, this level of concentration gives certain larger members significant influence over their respective FHLBs and the system, though this influence cannot be exerted over director elections.

FHLBank Directors. Moody's notes that FHLB director turnover is high and director tenure is low compared to large publicly traded companies. A significant majority of FHLB directors have less than two years' tenure as compared to an average of eight years for large companies. Short tenure could constrain a director's ability to become knowledgeable about the FHLBs. Director pay is modest and they have a greater time commitment compared to the private sector, which is particularly burdensome for those from smaller institutions. Appointed directors not from financial institutions have a greater learning challenge. Since the regulator must appoint a number of directors, Moody's sees board independence as relatively high, though the majority of directors are member elected.

Also, while some have criticized salary levels for FHLB presidents, Moody's is concerned that executive pay levels may constrain the ability to attract talent from outside, as pay levels are modest compared to private sector counterparts.