CUNA Regulatory Comment Call
January 30, 2004
Investments in Exchangeable Collateralized Mortgage Obligations
(Not a Major Rule)
EXECUTIVE SUMMARY
- The NCUA Board unanimously approved a proposed rule that will allow federal credit unions (FCUs) to invest in exchangeable collateralized mortgage obligations (CMOs) representing interests in one or more stripped mortgage-backed securities (SMBS).
- These investments will be subject to conditions regarding the amortization rate of the underlying interest-only CMO (IO) and principal-only CMO (PO) and the requirement that the discount or premium of the market price to the remaining principal balance cannot exceed 20 percent. The proposed rule includes other minor changes, such as changes to the purchase of European financial options used to fund payment of dividends on share certificates and modifications of certain definitions.
- Comments are due to NCUA by April 2, 2004. Please submit your comments to CUNA by March 22, 2004.
Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.coop and to Assistant General Counsel Jeff Bloch at jbloch@cuna.coop; or mail them to Mary and Jeff in c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601. You may also contact us at 800-356-9655, ext. 6732, if you would like a copy of the proposed rule, or you may access it on the Internet at the following address:
http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/Proposed12cfrParts703and704-01-22-04.pdf
BACKGROUND
The Federal Credit Union Act permits FCUs and corporate credit unions to purchase mortgage-related securities subject to rules issued by the NCUA Board. Current rule prohibit these credit unions from investing in SMBS and exchangeable CMOs that represent the interests in one or more SMBS.
DESCRIPTION OF THE PROPOSED RULE
The proposed rule will authorize all FCUs and corporate credit unions to invest in exchangeable CMOs representing interests in one or more SMBS, which includes interest-only CMOs and principal-only CMOs. Although NCUA has safety and soundness concerns with direct investments in SMBS, it does recognize that some exchangeable CMOs representing interests in one or more SMBS may be safe investments for credit unions.
To mitigate risk, the proposed rule imposes the following conditions for credit unions that invest in an exchangeable CMO representing interests in one or more IOs or POs:
- For an exchangeable CMO representing one or more IOs, the notional principal of each IO must decline at the same rate as the principal on one or more non-IO CMO included in the combination. For an exchangeable CMO representing one or more POs, the principal of each PO must decline at the same rate as the notional principal of one or more IOs included in the combination or at the same rate as the principal on one or more interest-bearing CMOs included in the combination. This condition must be satisfied throughout the life of the investment so that a credit union may not exercise a call option, or other embedded option, that causes the exchangeable CMO to fail this condition after the purchase.
- The ratio of the market price to the remaining principal balance must be between .8 and 1.2, meaning that the discount of the market price to the principal balance must be less than 20%.
The proposed rule also includes the following minor changes to the rules regarding Investment and Deposit Activities (Part 703):
- Modification of the definition of "puts" and "calls" to reflect more accurately the relationship between these two transactions.
- Including a definition of "custodial agreement" that limits these agreements to those in which one party agrees to exercise ordinary care in the safekeeping of securities.
- Amending the definition of "derivative" to include any derivative instrument that, under generally accepted accounting principles (GAAP), must be recognized as an asset or liability in the statement of financial condition and valued at fair market value.
- Current rules allow for the purchase, under certain conditions, of European financial options contracts to fund payment of dividends on share certificates. The options expiration date must coincide with the maturity date of the certificate. The proposed rule will change this timing requirement to allow these options to expire "no later than the maturity date" of the certificate.
QUESTIONS TO CONSIDER REGARDING NCUA’s PROPOSED RULE ON INVESTMENTS IN EXCHANGEABLE COLLATERALIZED MORTGAGE OBLIGATIONS
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Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com |
