President's Report

June 16, 2009

Remarks by Alfred A. DelliBovi

Alfred A. DelliBovi's speech at the 27th Annual Lawrence B. Mink Income Property Investment Conference.

I appreciate the opportunity to speak with you at this conference during these times of extraordinary stress in the mortgage and credit markets.  I plan to focus on how our economy got here, discuss our response to financial crisis, and touch on future opportunities.

The financial crisis that began in August 2007 has entered its second year.  Its immediate cause was the end of the U.S. housing boom.  Serious deficiencies in the underwriting and credit rating of some mortgages, particularly subprime mortgages with adjustable interest rates funded by the capital markets, became apparent.  As the next 14 months unfolded, the excesses of subprime mortgage lending were only a part of the problem.  Risk was underpriced.  Leverage was excessive.  And complex and opaque financial instruments proved all too fragile under stress.  The unwinding began.  Severe financial strain and tight credit now damp down economic growth not just in the U.S. but across the globe.

When I was a New York State Legislator in the 1970's, virtually no mortgages were financed by the capital markets.  In those good old days, savings and loans gathered deposits and used those funds to make mortgages.  But today, mortgage markets are deeply affected and some would say infected by the shadow funding of the capital markets.

Yet community banks are still making mortgage loans with market-appropriate standards.  The private capital market to borrowers with weaker credit histories is currently closed.  With the securitization market for private-label mortgage-backed securities shut down, Fannie Mae, Freddie Mac, and Ginnie Mae currently are the only conduits through which mortgages can be securitized and sold to investors.  In sharp contrast, in 2005, the private sector represented about 50 percent of the entire securitization market.

Last summer, investors became increasingly concerned about the capital positions of Fannie Mae and Freddie Mac.  At the recommendation of the Administration, Congress subsequently passed the Housing and Economic Recovery Act.  The Act, among other things, created a new regulator for all three housing GSEs, the Federal Housing Finance Agency (FHFA), and provided the Treasury with powers to purchase GSE debt and equity.  But because of Fannie's and Freddie's weak capital position, the director of the FHFA placed Fannie and Freddie into conservatorship on September 7, 2008.  These actions are consistent with maintaining financial stability, supporting the housing market, and protecting the taxpayer.

Up until September 7, Fannie Mae and Freddie Mac, combined with the 12 regionally-owned Federal Home Loan Banks, collectively made up the 14 Government Sponsored Enterprises.  Now, with Fannie and Freddie placed into conservatorship, a new category has been created:  Government Controlled Enterprises, or GCEs.

In contrast, the 12 regional Federal Home Loan Banks remain GSEs, regulated by the Federal Housing Finance Agency and supported by a solid capital foundation.  It is an elegant model in which the capital level is primarily determined by member lender usage of advances.  As advance usage declines, capital decreases; as advances go up, capital does as well.  This relationship can be seen in the increase of FHLBank capital in the first year of the credit crisis, from $44.6 billion on June 30, 2007, to $56.6 billion on June 30, 2008.  This increase reflects the growth of advances for the FHLBanks in the same period from $641.0 billion to $913.9 billion.  As the markets tightened at the first signs of this crisis, the Federal Home Loan Bank system remained a significant source of funds for our members, funds that became the home and small business loans that kept our economy going.

Further adding to the stability of the Home Loan Bank System, the capital stock is held at par value by the member lenders only, and this stock cannot be publicly traded.  The 12 Federal Home Loan Banks have followed our business model and quietly supported the thousands of community lenders who each day make well underwritten, prudent loans to families and businesses from coast to coast.  In fact, the Federal Home Loan Banks have performed very well throughout the nation’s current financial crisis.  In the past 15 months, the System has provided more than $300 billion in additional liquidity while continuing to adhere to high standards of credit risk management.

The bottom line is this:  the Federal Home Loan Banks are providing vital liquidity to the banking system.  To strengthen our economy, two things must happen:  (1) credit must continue to flow to communities and families; and (2) the financial system must operate in a safe and sound manner.  The Federal Home Loan Banks make an important contribution to these two objectives and play a unique role in building and sustaining the nation’s economic strength.

Now, the success of the Federal Home Loan Bank System is dependent upon one thing:  the community member lender.  During the past year, the value of the strongly regulated community lenders has become apparent.  Community lenders are able to close loans in all market environments because of their responsible lending and loan administration practices and access to reliable Federal Home Loan Bank funding.  Our members are solidbecause they have followed the tried and true formula of the four Cs:  Capacity, Credit, Capital, and Collateral.

Our members have branches in virtually every town, freehold, and county of New Jersey.  And they remain active lenders and suppliers of credit to families and businesses across the State.  From July 30, 2007, to March 31, 2009, the Home Loan Bank of New York saw advances to our Garden State members increase from $20 billion to $36 billion.  This represents an impressive 80% increase in demand, a demand that reflects the continued lending activity of our New Jersey members.  These are safe, responsible loans made by conservative institutions.  They are not the mortgages that have created our current problems.  If the community banker had been involved in the origination of these mortgages in the first place, a strong case can be made that we would not be suffering through this financial hurricane.  But this storm will pass.  And opportunities will emerge.  In an interview on Bloomberg Television last month, Mark Zandi, chief economist at Moody’s, said that he expects home prices will find a bottom next year, and that he expects price growth by 2011 or 2012.  As he said in the interview, “We’re clearly heading in the right direction.”

One component of the financial system that is not heading in the right direction is the CMBS market.  According to Credit Suisse, CMBS issuance dropped from $234 billion in 2007 to just $12 billion in 2008.  Two years ago, these were the hottest financial products offered.  Now, they’re completely off the stove.  No one wants to touch them.  The reason that investors have turned away is the poor performance of the commercial loans packaged into these securities.

Just yesterday it was reported that, according to the latest Fitch Ratings Loan Delinquency Index, large loan defaults coupled with declining performance on multifamily and retail properties resulted in a 2.07% delinquency rate in May for CMBS.  This marks the highest percentage of delinquencies since this Index began in 2001.  Underscoring this point, Managing Director and U.S. CMBS group head Susan Merrick said, “Defaults on larger loans continue to drive delinquency increases because later vintage transactions have larger loans, many underwritten with now unrealized pro forma income, as well as now-depleted debt service reserves and high leverage.”

Despite the problems with securities, we all know that there are many good credit lending opportunities available.  If these loans are created and managed responsibly and with superior underwriting standards, opportunities in this space will exist.  You see, our members did not loosen their underwriting standards, but chose instead to stick to their knitting and offer liquidity in a time-tested, prudent fashion.  The decision not to waver from their core operating principles may have cost them business in the short run, but too many times since September of last year have we been reminded of what happens to institutions that only focus on the short term.  In the long run, the wisdom of our members’ decision has borne out in the continued strong performance of their commercial loan origination.

Now, the CMBS market is closed, but our members remain open and willing to lend with the same responsible principles that they have always used.  These principles are simple:  Know your customer and know your local markets.  Without this knowledge, prudent lending is not possible.

And the message here is simple:  If you can produce good loans, you should be looking to partner with community bankers who want those loans.  Now remember, I am the president of the Federal Home Loan Bank of New York.  I emphasize the word “home.”  Increasing homeownership by providing liquidity for residential lending is the primary focus of our business.  It has been so since 1932, when Congress mandated this mission for the Home Loan Banks.  But we represent a diverse membership that operates in many different sectors, and we support our members in any way that we can, within sound banking principles.

In the liquidity crisis last year, many of our members needed to pledge more collateral to access our funding.  This meant that institutions that were normally giving us 1-to-4-family loans were now pledging multi-family or commercial real estate loans.  We try to accommodate our members in any way we can, as long as the collateral pledged is up to our standards.  In 2008 alone, we were able to expand what more than 40 of our members were able to pledge to us.  So, you see, we will take commercial real estate as collateral from our members.  We are able to do this because we know our members and we make it a point to know this collateral.  We go on-site and review the loans.  And when we offer liquidity on this collateral, we do so conservatively with appropriate haircuts.  We balance the increased risk of commercial mortgage assets with at least an equal share of residential 1-to-4-family and multi-family mortgage assets.  We have strict guidelines for the kind of CRE we can accept, and we pride ourselves on our rigorous screening process, but prudently and responsibly, we do help support this market.

Our acceptance of commercial real estate is critical to our members and the communities they serve.  We currently have more than 180 members pledging nearly $40 billion of income-producing collateral.  Half of this collateral is multi-family, which directly supports the main mission of the Bank.  The commercial real estate that our members pledge is not just strip malls and gas stations, but the hospitals, support centers for the disabled, municipal buildings, and houses of worship that support the communities we serve.

And the acceptance of this collateral can be beneficial to you, too.  According to a recent analysis done by Foresight Analytics, New Jersey will see $11 billion in commercial and multi-family mortgages reach maturity over the next two years.  This represents a tremendous opportunity for you to partner with our members.  Last week, the Federal Reserve Board reported weakened commercial real estate markets in each of its 12 districts over the past three months.  To strengthen this important market, it is vital that you to work to develop a business relationship with our members.  I have no doubt you will find them to be reliable and competitive sources of funding for mortgages, valued partners for the long term.  And who are our members? you might ask.  You will find the complete list on our website

The history of our meeting site today can provide us with a valuable lesson going forward.  The Liberty Science Center was created not with one broad action, but through the work of many.  Those who saw the need for increased science education wrote editorials in the newspaper to gather support.  Soon, a group of local companies working together raised the necessary funds, and the Center became a reality.  In our reality, organizations working together at the local level can bring about broad economic recovery.  The Federal Home Loan Bank and our members are a solid link between homebuyers and capital markets.  Tap into this link.  Together we will make the responsible loans the State needs for a stable economy.  Together, we can help strengthen New Jersey.  To borrow a phrase from the New Jersey bankers, “with New Jersey banks, New Jersey prospers.”

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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This report may contain forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements are based upon our current expectations and speak only as of the date hereof. These statements may use forward-looking terms, such as “projected,” “expects,” “may,” or their negatives or other variations of these terms. The Bank cautions that, by their nature, forward-looking statements involve risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, regulatory and accounting rule adjustments or requirements, changes in interest rates, changes in projected business volumes, changes in prepayment speeds on mortgage assets, the cost of our funding, changes in our membership profile, the withdrawal of one or more large members, competitive pressures, shifts in demand for our products, and general economic conditions. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

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