Seattle FHLBank Wants to Sell Mortgage Securities

The Federal Home Loan Bank of Seattle is seeking regulatory approval to purchase mortgage-backed securities from member banks and thrifts and, for the first time, to sell MBS to outside investors.

The proposal, if approved, would bring the FHLB into closer competition with Fannie Mae and Freddie Mac. And it appears the Seattle bank wants to get its business from some of its largest members (and Fannie and Freddie's largest customers), namely Washington Mutual and Wells Fargo & Co.

But unlike Fannie and Freddie, the FHLB will not guarantee timely payments of interest and principal to MBS investors.

Instead, the Seattle bank would purchase AAA-rated and AA-rated MBS securities, hold them for investment or sell them to other investors. The MBS issuer/seller would retain the subordinated or "B" piece of the securitization.

The Chicago FHLB pioneered a similar MBS program, but it has been dormant for more than a year.

Seattle FHLB executive vice president David Bley said the bank has worked closely with its members in designing the MBS program, with the hope of giving member lenders more loan underwriting flexibility than they would get with Fannie and Freddie.

The Seattle bank calls the new initiative "MortgageChoice" and is in the throes of upgrading its infrastructure and risk-management systems to handle large MBS transactions.

Mr. Bley expects the infrastructure project will be completed in the fourth quarter and that the first MBS purchases will be negotiated before year-end.

But before the bank can move forward, MortgageChoice must be approved by its regulator, the Federal Housing Finance Board.

FHLBs have been purchasing single-family mortgages from their members for several years now but they only invest in highly rated MBS - usually Fannie/Freddie-backed securities.

In late 2002, the Chicago bank received the regulatory green light for the FHLB system's first MBS program called "shared funding." But the Chicago bank did not ask for authority to sell MBS outside the FHLB System.

Former Chicago FHLB president Alex Pollock designed the shared funding program. His goal was to repackage MBS and sell the bonds to other system members.

There are 8,000 members who hold a lot of Fannie/Freddie MBS, he said. "Our view was they would obviously like to buy FHLB MBS."

The Chicago bank completed two MBS transactions totaling $1 billion during the first half of 2003 and Mr. Pollock claims they were a success. To date, no other deals have been executed.

Industry sources seem divided over the effectiveness of the shared funding program. For now, the effort is hampered by a supervisory agreement that limits the Chicago FHLB's growth to 10% a year.

Mr. Pollock resigned as president on June 30 to become a resident scholar at a Washington think tank. In a recently published paper, he calls for the privatization of Fannie, Freddie and the FHLBs. As an interim measure, he believes the FHLBs should be able to securitize mortgages.

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