CHICAGO - Standard & Poor's yesterday placed on negative watch the short-term ratings of $375 million of bonds sold by the Illinois Housing Development Authority and the Wisconsin Housing and Economic Development Authority because they carry liquidity support from the Federal Home Loan Bank of Chicago.

Standard & Poor's last week placed the FHLB of Chicago's AA-plus long-term rating and A-1-plus counterparty rating on CreditWatch with negative implications after the Dallas and Chicago Federal Home Loan Banks ended their merger talks amid questions over the Chicago branch's exposure in the subprime mortgage market.

"The development heightens our concerns regarding the strategic direction and financial condition of FHLB Chicago," Standard & Poor's analyst Dan Teclaw wrote in the agency's report last week. Analysts wrote that the Chicago FHLB's deteriorating profitability is largely due to hedging losses that stem from a drop in the value of derivatives it entered into to hedge rates on some of its mortgage programs.

The merger talks were first announced in August and in a statement last week officials said only that the banks were unable to reach an agreement after a due diligence process.

P. David Kuhl, chairman of the FHLB Chicago board, said in a statement: "The bank will now focus all its efforts on operating as an independent entity, continuing our transition to a more traditional Home Loan Bank business model and financial structure."

The IDHA deals impacted include 2004A $50 million mortgage revenue bonds, 2004B series for $92 million, and 2004 C-3 series for $16 million. The WHEDA bonds include Series 2003A, B, D, and E for $27 million, the 2002D-I series for $59 million, another 2003A series for $74 million and a 2002C and D series for $55.6 million. The long-term ratings range from double-A to triple A.

The FHLB of Chicago provides liquidity facilities on all of the series. An IDHA official said yesterday the agency had not seen rates on the weekly remarketing period shoot up and were monitoring the market and any rating action.

The Federal Home Loan Bank of Chicago is an $89 billion wholesale bank and government-sponsored enterprise that provides housing finance to more than 830 member commercial banks, savings institutions, credit unions, and insurance companies within its district that covers Illinois and Wisconsin. The 12-member system was established during the Great Depression to promote housing finance.

About 39% of its assets come from individual home mortgages, although most are fixed rate and few are overdue. Some believe, however, that the bank will have to writedown the value of its mortgage securities as home values fall. The bank reported income of $98 million last year, representing a 49% drop over the previous year. The bank was considered aggressive in its purchase of loans in recent years. Standard & Poor's expects its review to be completed within 90 days.

While the Chicago bank has struggled of late, the overall system is considered fiscally sound and, pending legislation before Congress, would elevate the role of the Federal Home Loan Bank system in efforts to ease the market's credit crunch stemming from the collapse of the subprime market. The pending bills would allow the FHLB to provide letters of credit to municipal issuers on a temporary basis and enable the banks to temporarily invest in student loan-related securities, accept student loans and student-loan related securities as collateral and permit the banks to provide secured advances to its members to originate student loans.

The dollar amounts were provided by Thomson Financial.


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