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FHLB's Secondary Market Program Faces New Scrutiny

Federal regulators have taken aim at the Mortgage Partnership Finance program and they have directed the Federal Home Loan Bank of Chicago to cap the growth of its mortgage portfolio at 10% a year.

Under a supervisory agreement with the Federal Housing Finance Board, the Chicago bank must submit a draft of a business and capital management plan by Aug. 30.

The bank also agreed to evaluate its management and risk systems and make necessary changes.

The disclosure of the supervisory agreement came on the same day that the FHLBank's president, Alex Pollock, officially stepped down. Mr. Pollock previously announced his intention to resign and become a resident fellow at a Washington think tank.

Mr. Pollock insisted the special examination of the Chicago bank and the supervisory agreement had nothing to do with his departure. "There are no risk issues. The MPF program is very well managed," Mr. Pollock said.

The newly appointed acting president, Charles Huston, emphasized that the Chicago bank is in "excellent financial shape," even though Standard & Poor's downgraded the bank's "AAA" rating to an "AA+" rating.

"As the mortgage assets on our balance sheet have increased due to the success of the MPF program, Standard & Poor's has consistently indicated to us their intention to align our individual rating with those of the other housing government-sponsored enterprises," Mr. Huston said.

The Chicago bank under Mr. Pollock launched the MPF and it has funded $138.7 billion in residential mortgages over the past seven years. Other FHLBanks participate in the MPF program. And three FHLBanks have created a similar secondary market program called the mortgage purchase program.

But the Chicago bank stands out because it holds $48.5 billion of MPF loans on its books, which is more than half of the bank's assets.

FHFB examiners concluded that the bank's management systems, controls, record keeping and audit capacity had not kept pace with the rapid growth of the MPF program.

FHFB supervision director Stephen Cross said it is time for the Chicago bank to catch its "breath" since the growth of the MPF program had exposed the bank to "more complex risks."

The MPF and MPP programs are a "very significant focus of our examination activity," Mr. Cross said. "It is not that we are trying to shut these programs down."

In addition, these programs are increasing the interest rate risk exposures of the banks, which is not associated with the FHLBanks' traditional advance business.

S&P also has been wary of the Chicago bank's MPF activities. "This agreement confirms many of the concerns Standard & Poor's has had with the rapid growth of the bank's on-balance-sheet, longer-dated, fixed-rate mortgage assets, which had led to a negative outlook revision in Novembers 2003," S&P credit analyst Jonathan Ukeiley said.

Mr. Huston, the new acting president, called the recommendations spelled out in the supervisory agreement "prudent and sensible."

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