Several US federal home loan banks are improving their risk management systems in response to regulatory and rating agency pressure. The group of 12 banks that fund residential mortgages and community development loans are examining derivatives accounting before they, along with the US government mortgage giants Freddie Mac and Fannie Mae, register with the US Securities and Exchange Commission (SEC) later this year. The banks are registering in response to calls for greater transparency.
When the banks register they must comply with the SEC Act of 1934, which requires disclosure of financial statements and information related to transactions. They will also be subject to the Sarbanes-Oxley Act, which demands enhanced accounting disclosure for derivatives.
Some of the mortgage banks have already been downgraded because of risk management concerns. Last December, Standard & Poor’s (S&P) lowered its long-term credit rating on the Federal Home Loan Bank of Seattle to AA+ from AAA, and did the same to the Federal Home Loan Bank of Chicago’s rating in July.
ALM risk
Both downgrades followed agreements between the bank and its regulator to address asset/liability management risk from growth in businesses in longer-dated, fixed-rate mortgage loans, according to S&P. Although S&P has reported the Seattle bank is improving its risk management structure, the bank itself declined to comment.
The Federal Home Loan Bank of Chicago has been more open about its plans. It is using a new enterprise risk management system to improve its risk management and minimise the operational risk associated with managing its mortgage hedge book. Massachusetts-based risk management software provider CXO Systems is providing the system, which was developed in partnership with James Lam, president of James Lam and Associates.
“The CXO system will offer a consolidation of data at a much higher level of functionality,” says Matt Feldman, chief risk officer at the Federal Home Loan Bank of Chicago. As a large collateralized lender and purchaser of mortgages and mortgage-backed securities, it needs to closely monitor and manage its exposure daily, and produce asset/liability management and regulatory reports on a monthly basis. As of December 31, 2003, the bank had a total outstanding hedged notional of $53.7 million.
