The U.S. Federal Home Loan Banks’ unsecured lending to foreign institutions skyrocketed last year as the European sovereign debt crisis intensified, raising concerns about their risk management, an auditor’s report said today.
The Federal Housing Finance Agency, which oversees the 12 regional Home Loan Banks, should tighten limits on such lending and improve monitoring of whether that lending exceeds the limits, the FHFA Office of Inspector General said in the report.
“FHFA’s current regulation continues to permit FHLBanks to build large unsecured credit portfolios that may produce unreasonable risk,” wrote Richard Parker, director of the auditor’s Office of Policy, Oversight and Review. “FHFA should, therefore, reassess the counterparty risk limits associated with its existing regulation.”
Several Home Loan Banks last year made short-term loans totaling about $3 billion to two European banks that had received government bailouts and were on a credit watch, according to the report.
Federal Home Loan Banks’ unsecured lending to foreign banks peaked in April of 2011 at $101 billion before falling to $41 billion at the end of the year, the audit found.
In a written response, Stephen M. Cross, deputy director of the FHFA’s division of Federal Home Loan Bank Regulation, said that unsecured foreign lending had dropped in response to increased FHFA oversight. “Nevertheless, underwriting of FHLBank credit to domestic offices of foreign-owned counterparties was and is a concern to FHFA,” he wrote.
The Home Loan Banks were chartered by Congress in 1932 to provide liquidity to the U.S. mortgage market. The banks are also permitted to make unsecured loans to foreign and domestic financial institutions to enhance revenue under the terms of their congressional charters.
The FHFA failed to notice that some of the banks had made loans exceeding regulatory limits, the Office of Inspector General said. In one case, an unidentified Home Loan Bank using a manual evaluation system failed to notice that a borrower had been subject to a credit-rating downgrade, auditors found.
FHFA officials described the agency’s rules governing unsecured lending as “outdated and overly permissive,” according to the report.
“Even when an FHLBank operates within the established limits it can amass the sort of large unsecured credit exposure that has been the source of considerable regulatory concern,” the auditors found.
The regulator plans to issue new rules governing unsecured lending by April of next year, Parker said in his written response to the audit.
The volume of unsecured lending, particularly to foreign institutions, rose in part to offset a decrease in the Home Loan Banks’ traditional activities providing funding to domestic lenders for home mortgages, according to the report.
Home Loan Banks in Seattle, Topeka, and Boston, had the greatest unsecured credit exposure to foreign borrowers, the audit found.