[Federal Register: July 1, 2004 (Volume 69, Number 126)]
[Rules and Regulations]
[Page 39827-39833]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01jy04-3]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 703 and 704
Investment in Exchangeable Collateralized Mortgage Obligations
AGENCY: National Credit Union Administration.
ACTION: Final rule.
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SUMMARY: The National Credit Union Administration (NCUA) is issuing
final revisions to its regulations regarding investment in
collateralized mortgage obligations (CMOs) to authorize all federal
credit unions (FCUs) and corporate credit unions to invest in
exchangeable CMOs representing interests in one or more SMBS subject to
certain safety and soundness limitations. Currently, NCUA regulations
prohibit FCUs and certain corporate credit unions from investing in
stripped mortgage backed securities (SMBS) and exchangeable CMOs that
represent interests in one or more SMBS. NCUA has safety and soundness
concerns with direct investment in SMBS, but recognizes that some
exchangeable CMOs representing interests in one or more SMBS may be
safe investments for credit unions. This rule will also authorize FCUs
and corporate credit unions to accept exchangeable CMOs as assets in a
repurchase transaction or as collateral on a securities lending
transaction regardless of whether the CMO contains SMBS. Finally, this
rule contains miscellaneous technical corrections and minor changes to
NCUA's Investment and Deposit Activities rule and Corporate Credit
Unions rule.
DATES: This rule is effective August 2, 2004.
FOR FURTHER INFORMATION CONTACT: Steve Sherrod, Senior Investment
Officer, Office of Strategic Program Support and Planning (OSPSP) at
the above address or telephone (703) 518-6620; Kim Iverson, Senior
Investment Officer, Office of Strategic Program Support and Planning,
at the above address or telephone (703) 518-6620; George Curtis,
Corporate Program Specialist, Office of Corporate Credit Unions at the
above address or telephone (703) 518-6640; or Paul Peterson, Staff
Attorney, Office of General Counsel, at the above address or telephone
(703) 518-6555.
Supplementary Information:
A. Background
The Federal Credit Union Act permits FCUs and corporate credit
unions to purchase mortgage related securities (MRS) subject to such
regulations as the NCUA Board may prescribe. 12 U.S.C. 1757(15)(B).
NCUA regulations generally permit the purchase of CMOs, a multi-class
MRS, but not if the CMO is a stripped mortgage backed security (SMBS).
12 CFR 703.14(d) and 703.16(e); 704.5(c)(5) and (h)(4). SMBS include
interest-only CMOs (IOs) and principal-only CMOs (POs).
Currently, many CMO issues contain one or more classes of
exchangeable CMOs. An exchangeable CMO represents a beneficial
ownership interest in a combination of two or more underlying CMOs, and
the owner may pay a fee and take delivery of the underlying CMOs. In
many cases, these underlying CMOs include IOs and POs.
Because NCUA regulations prohibit investment in SMBS, the
regulations also prohibit investment in an exchangeable CMO that
represents an interest in one or more IOs or POs. Certain exchangeable
CMOs representing IOs or POs, however, do not carry the risk or raise
the same safety and soundness concerns associated with direct
investment in an SMBS.
On January 22, 2004, the NCUA Board issued a notice of proposed
rulemaking to amend NCUA rules to authorize FCUs and corporate credit
unions to invest in an exchangeable CMO representing interests in one
or more IOs or POs if the exchangeable CMO meets certain conditions. 69
FR 4886 (February 2, 2004).
The first condition concerned the rate of amortization of the
underlying IOs and POs. For an exchangeable CMO representing one or
more IOs, the Board proposed that the notional principal of each IO
must decline at the same rate as the principal on one or more non-IO
CMOs included in the combination. For an exchangeable CMO representing
one or more POs, the Board proposed that 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. The Board
also proposed a second condition: that, at the time of purchase, the
ratio of the market price of the CMO to its remaining principal balance
is between .8 and 1.2, meaning that the discount or premium of the
market price to par must be less than 20 points. The proposed rule also
stated that credit unions may not exercise the right to exchange an
exchangeable CMO if it represents an interest in one or more SMBS that
would be impermissible for that credit union to hold as a separate
investment.
The Board's proposal also contained several definitional changes
and other technical corrections to Parts 703 and 704 of NCUA's rules
and regulations. In Part 703, the Board proposed to add a definition of
``collateralized mortgage obligation;'' amend the definitions of
``put,'' ``call,'' ``custodial agreement,'' ``derivative,'' and
``european financial options;'' and change the phrase ``nationally
recognized statistical rating
[[Page 39828]]
agency'' to ``nationally recognized statistical rating organization.''
In Part 704, the Board proposed to add a definition of ``derivative,''
amend the definitions of ``small business related security'' and
``weighted average life,'' and change the phrase ``interest rate risk
simulation tests'' to ``interest rate sensitivity analysis
requirements.''
B. Summary of Changes From the Proposed Rule
In this final rule, the Board generally adopts the rule as proposed
with some variations. The Board will permit the purchase of
exchangeable CMOs representing interests in SMBS only if the CMOs
satisfy the conditions established in the proposed rule. The final rule
differs from the proposed rule as follows: First, the Board believes
that CMOs are not appropriate for all credit unions, and notes that
those with investment authority at a credit union must be qualified by
education or experience to assess the risk characteristics of every
investment that they make, including CMOs. Since exchangeable CMOs are
a more complex investment, the final rule specifically requires that a
credit union seeking to invest in exchangeable CMOs must have the
expertise to apply the unique price range and amortization conditions
in this rule. Second, the final rule relaxes the proposed conditions on
exchangeable CMOs containing SMBS, but only for CMOs that are accepted
by the credit union as assets associated with repurchase transactions
or as collateral associated with securities lending transactions.
Third, the rule clarifies that derivatives in the form of interest rate
lock commitments and forward sales commitments on loans originated by
the credit union are not prohibited. Fourth, the rule changes the NCUA
office to which applications for an Investment Pilot Program should be
addressed from the Office of Examination and Insurance to the Office of
Strategic Program Support and Planning.
C. Public Comments
NCUA received 30 comment letters regarding the proposed rule. Many
commenters supported the exchangeable CMO portion of the proposed rule
without reservation, and all but a few of the remaining commenters
expressed general support for the Board's intent to allow credit unions
to invest in certain exchangeable CMOs containing strips. In addition,
the commenters uniformly supported the miscellaneous technical
corrections and clarifying amendments.
Comments Requesting Elimination of the Proposed Safety and Soundness
Conditions
Several commenters supported authorizing credit unions to purchase
exchangeable CMOs representing SMBS without conditions, or with
significantly lesser conditions, than those NCUA proposed.
One commenter suggested that NCUA authorize credit unions to buy
any exchangeable CMO containing strips, without restriction, so long as
the credit union does not exercise the exchange option. This commenter
believes a simple statement that the exchange option cannot be
exercised is sufficient, and no other conditions are necessary.
Several commenters thought that, for corporate credit unions, NCUA
should focus on the interest rate risk associated with the corporate's
aggregate portfolio and should not place conditions on particular
individual investments such as exchangeable CMOs and strips. These
commenters believe that the proposed conditions on the purchase of
individual exchangeable CMOs are unnecessary and overly complex in
light of the requirement that corporate credit unions conduct a
periodic interest rate sensitivity analysis on their investment
portfolios and limit their risk exposure as described in Sec. 704.8.
12 CFR 704.8.
Two commenters said NCUA should allow FCUs to invest directly in
SMBS, and in exchangeable CMOs containing SMBS, without restriction
when used for the purpose of reducing balance sheet risk and earnings
volatility.
One commenter suggested that credit unions qualifying under NCUA's
Regulatory Flexibility Program, 12 CFR part 742, should be exempt from
the Part 703 prohibition on investment in SMBS and any prohibition on
exchangeable CMOs representing SMBS.
A few commenters question the need for the proposed rule. One of
these commenters stated, ``It appears that the proposed rule is
basically seeking to prevent practices that simply do not exist today.
Current rules clearly state that investing in IO and PO Strips is not
allowed because of the highly volatile nature of theses investments.
Exchangeable CMOs are clearly not MBS strips.'' The commenter requests
a simple clarification that ``a credit union may not exercise the right
to exchange an exchangeable CMO nor undertake any re-engineering of
mortgage cash flows that results in the creation of securities that are
impermissible under NCUA rules and regulations.''
While the Board appreciates these comments, it is concerned about
the volatile and risky nature of SMBS. The Board believes SMBS are
generally inappropriate investments for credit unions and are not
normally well suited to risk reduction practices such as hedging, even
in a well-run credit union or a credit union conducting aggregate
portfolio interest rate risk analysis. On the other hand, the Board
agrees that very few, if any, of the existing exchangeable CMOs that
represent SMBS are overly risky. In fact, the Board believes that all
or almost all currently existing exchangeable CMOs satisfy the safety
and soundness conditions imposed in the final rule. Nevertheless, the
securities market is constantly evolving, and the Board anticipates
that, in the future, the market may include exchangeable CMOs
representing SMBS that do have the substantive risks of those SMBS. The
Board wants to make clear in this rulemaking how federal credit unions
and corporate credit unions can determine the permissibility of any
exchangeable CMO representing SMBS.
Comments Expressing Concern About the Complexity of Exchangeable CMO
Investments
Two commenters remarked on the complexity of the exchangeable CMO
investment and thought credit unions that invest in them should
demonstrate a complete understanding of how these products work and the
risks they entail. Another commenter noted that SMBS are volatile and
should only play a limited role, if any, as a core investment. Still
another commenter thought NCUA should not authorize credit unions to
purchase exchangeable CMOs representing SMBS because of a perceived
lack of expertise and sophistication at some credit unions.
The Board appreciates that CMOs may offer a unique risk-reward
tradeoff among the various investments permitted for FCUs by the FCU
Act, and that CMOs may play an important role in a well-diversified
investment portfolio. Still, the Board agrees with these commenters
that CMOs are not appropriate investments for all credit unions and
notes that NCUA's investment regulation specifically provides that
``those with investment authority [at the FCU] must be qualified by
education or experience to assess the risk characteristics of
investments and investment transactions.'' 12 CFR 703.3(g). The Board
expects FCUs and corporate credit unions to understand each and every
investment that they make, including CMOs, and how those investments
work. Since exchangeable CMOs are a more complex investment and subject
to unique price range and amortization conditions, the final rule
[[Page 39829]]
specifically requires that a credit union seeking to invest in
exchangeable CMOs must have the expertise to apply the price range and
amortization conditions.
Comments on the Proposed Price Range Condition for Exchangeable CMOs
Representing SMBS
Most commenters thought the .8 to 1.2 range on the ratio of
purchase price to par was a reasonable method to separate out those
exchangeable CMOs with risk characteristics substantially similar to
the underlying SMBS. Some commenters suggested variations on this
condition.
A few commenters suggest NCUA should treat exchangeable CMOs
containing PO strips differently from those containing IO strips. These
commenters believe NCUA should allow the purchase at less than 80% of
par of exchangeable CMOs containing PO strips. One commenter states ``A
PO that trades at a steep discount (less than 80% of par) is often less
risky than one that trades at par, since it can result in significant
gains if paid off early, and it does not have more downside risk than a
PO CMO purchased at greater than 80% of par.''
One commenter suggests that, to keep an exchangeable CMO from
having the substantive risk characteristics of an IO, NCUA should limit
the coupon rate of the exchangeable CMO so that it is no higher than
the coupon on the underlying collateral. The same commenter suggests
that, to keep the exchangeable CMO from having the substantive risk
characteristics of a PO, NCUA should require eligible securities to
have a coupon at the time of issuance that is above a readily available
index. For example, if the security has an expected weighted average
life of 3 years at the time of issuance, the coupon for such security
can not be below the yield on a 3 year Treasury plus a set spread, such
as 50 basis points.
One commenter suggests that a credit union with adequate staff and
resources to monitor an exchangeable CMO would be in the best position
to determine acceptable risk tolerances and set premium or discount
limits.
As stated above, the Board believes some safety and soundness
conditions on exchangeable CMOs representing SMBS are necessary. The
conditions in the final rule are simple enough for a credit union to
apply but specific enough to ensure that any exchangeable CMO that
meets these conditions will not be too risky. Any FCU that wishes to
invest in exchangeable CMOs subject to different conditions may always
submit an application seeking NCUA approval for an investment pilot
program. 12 CFR 703.19.
Comments on the Proposed Amortization Condition for Exchangeable CMOs
Representing SMBS
Another commenter asks that NCUA provide more flexibility to allow
for underlying IOs to amortize slower than other non-IO portions of
exchangeable CMO. The commenter believes this would allow the investing
credit union to receive more income over the life of the investment.
The Board notes that if the underlying IO amortized more slowly
than the other non-IO portions of the exchangeable CMO, the credit
union would eventually hold an exchangeable CMO that represented only
an IO and had risk characteristics identical to the underlying IO. This
is unacceptable to the Board and demonstrates the need for the
amortization condition.
One commenter agreed with the proposed price range restrictions but
stated that the amortization limitations do not materially advance
NCUA's safety and soundness objectives and may unnecessarily restrict
the investment flexibility of FCUs.
Another commenter also supported the ``pre-purchase'' condition,
meaning the limit on premium or discount of purchase price to par, but
objects to the ``post-purchase'' condition, meaning the amortization
requirement. This commenter believes the latter issue is addressed for
corporate credit unions by the interest rate modeling of Sec. 704.8,
and that ``to require separate risk management requirements specific to
exchangeable CMOs is both unnecessary and overly burdensome.''
The Board does not intend that the amortization condition be a
``post-purchase'' condition; that is, that the credit union monitor
amortization speeds after purchase. The Board is changing the language
of the final rule to clarify that the determination of whether a
particular CMO complies with the amortization condition will be made at
the time of purchase from estimates of amortization speeds contained in
the offering circular or other official information.
Comments on the Proposed Requirement That Credit Unions Not Exercise
the Exchange Option if One or More of the Underlying CMOs Is an
Impermissible IO or PO
One commenter suggests NCUA allow credit unions that hold otherwise
permissible exchangeable CMOs representing IOs or POs to exchange the
CMO for the underlying securities if the credit union immediately sells
the impermissible IOs or POs resulting from the exchange. This
commenter believes this approach will allow the credit union
flexibility to make best use of the exchangeable CMO feature.
As stated above, the Board is generally opposed to credit unions
holding SMBS. A credit union that invests in exchangeable CMOs
representing impermissible SMBS and that would like to exercise the
exchange option may, however, submit an investment pilot program for
NCUA review and possible approval. 12 CFR 703.19.
Miscellaneous Comments on the Proposed Exchangeable CMO Rule
Several commenters state a final prospectus may not be available
for CMOs purchased at time of issue. These commenters ask that, for
investments in exchangeable CMOs made before issuance of the final
prospectus, NCUA authorize the credit union to rely on a preliminary
prospectus to determine if the CMO is exchangeable and, if so,
permissible. If the preliminary prospectus does not indicate the CMO
will be exchangeable or does not include decrement tables allowing the
CU to determine if the underlying investments amortize at the same
rate, these commenters want NCUA to allow the credit union to purchase
and hold the investment even if the final prospectus indicates the
investment is an exchangeable CMO that fails the amortization
requirement.
The Board appreciates that credit unions may have difficulty
ascertaining if a CMO purchased at or before issuance satisfies the
requirements of this final rule. Before committing to purchase, a
credit union should use its best efforts to examine the available
documentary information to determine if the CMO will satisfy the
requirements. If necessary, a credit union may seek assurances of
compliance from the issuer. If an FCU uses its best efforts, and then
determines after purchase that the CMO fails the requirements of this
rule, it should process the investment as specified in its investment
policies for investments that fail a requirement of part 703. 12 CFR
703.3(j). Corporate credit unions should process the failed investment
under the Investment Action Plan provisions of the corporate rule. 12
CFR 704.10.
Several commenters ask that NCUA provide guidance to credit unions
currently holding exchangeable CMOs that fail the requirements in the
proposed rule, preferring that NCUA allow credit unions to continue
holding
[[Page 39830]]
these CMOs. One of these commenters also noted that in 1993 NCUA
indicated some CMOs created from SMBS might be permissible. See 58 FR
34868 (June 30, 1993) (``The NCUA Board notes that recently some CMOs
and REMICs have been created from stripped mortgage-backed securities.
These instruments are permitted if they can pass the high-risk security
tests.'') This 1993 statement has lead the commenter to believe that
there is no regulatory prohibition on CMOs containing strips.
As stated above, the Board believes that few, if any, existing
exchangeable CMOs will fail the conditions established in this final
rule. Any CMOs that do fail the conditions should be processed under
the FCU's investment policies or, for corporate credit unions, under an
Investment Action Plan. 12 CFR 703.3(j), 704.10. While the NCUA
recognized in 1993 that some CMOs had been created from SMBS and that
they might be permissible if they passed the high-risk securities test
(HRST), any CMO that had substantially the same risk characteristics as
the underlying SMBS would likely have failed the HRST. NCUA regulations
no longer require HRS testing. To ensure that credit unions do not hold
exchangeable CMOs with significant risks from the underlying SMBS,
those CMOs must satisfy the conditions provided in this final rule.
One corporate credit union commenter is particularly concerned
about the effect of the rule on repurchase transactions. FCUs and
corporate credit unions may only accept as repurchase assets those
assets in which they can invest directly, and this commenter believes
it will be difficult to identify and cull out impermissible
exchangeable CMOs. 12 CFR 703.13(c)(1), 704.5(d)(2). The commenter
states that, since credit unions are a small portion of the repurchase
market, it is improbable that repurchase custodians will restrict
repurchase assets to those CMOs qualifying under this proposal. Given
the speed and volume of repurchase transactions, the commenter believes
it would be onerous for a credit union to review each CMO that is part
of the repurchase transaction to ensure it complies with this proposal.
The Board appreciates the commenter's concerns about the
difficulties in separating out impermissible assets and collateral in
these transactions. The Board also notes that, in both repurchase
transactions and securities lending transactions, a credit union relies
primarily on the creditworthiness of the counterparty to get its money
back and only secondarily on the repurchase asset or securities lending
collateral. The potential for interest rate risk and price volatility
associated with CMOs representing interests in SMBS is less significant
in these transactions. Accordingly, the Board is amending parts 703 and
704 to indicate that exchangeable CMOs representing interests in SMBS
may be used as assets or collateral in investment repurchase
transactions or securities lending transactions, and the price range
and amortization conditions need not be applied to exchangeable CMOs
used in this way.
One commenter seeks clarification that the rule applies to both
privately issued and federally issued CMOs. The Board intends that the
rule apply to all exchangeable CMOs, regardless of issuer.
Miscellaneous Comments on the Exchangeable CMO Rule
Two commenters suggested that NCUA modify the proposed exchangeable
CMO definition, and references to CMOs in the rule text, to reflect
that the purchase of a CMO is an investment in a particular class of a
CMO structure, not in an instrument that is a multi-class CMO
structure. The Board agrees with the commenter and amends the final
rule text as suggested.
One commenter states credit unions should set aggregate investment
limits, not NCUA. Another commenter states NCUA should amend the call
report to obtain additional detail on exchangeable CMOs. These issues
are beyond the scope of the proposed rule and are not addressed in the
final rule.
Comments on the Proposed Miscellaneous Technical Corrections and
Clarifying Amendments
One commenter states that, if NCUA does not intend with its
proposed change to the definition of derivative to expand or contract
permissible types of investments for credit unions, it should say so.
The Board does not intend, through its changes to the derivative
definition and other provisions of parts 703 and 704 that reference
that definition, to either expand or contract the universe of
investments currently permissible for FCUs and corporate credit unions.
D. Other Changes in the Final Rule
The Board is making additional changes not triggered by specific
public comment. The Board proposed to change the definition of
derivative so it would track the definition of derivative instrument
used under generally accepted accounting principles (GAAP) while
excluding those derivatives that, under GAAP, do not have to be
recognized as an asset or liability in the statement of financial
condition and be valued at fair market value. The Board's intent was to
ensure that: (1) The regulatory definition of derivative is consistent
with the accounting definition; and (2) embedded options in an
otherwise permissible investment that are not significant enough to
require separate accounting under GAAP would not cause that investment
to be considered a prohibited derivative. The final rule retains the
Board's intent but achieves it through different rule text. Instead of
excluding embedded options from the regulatory definition of
derivative, the final rule recognizes them as derivatives but excludes
them from the general prohibition on derivatives.
Recently, the GAAP definition of derivative evolved to include loan
commitments that relate to the origination of mortgage loans that will
be held for sale. Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, paragraph 6(c). FCUs
routinely enter into loan commitments such as interest rate lock
commitments and forward sales commitments on mortgage loans they
originate for sale, and the Board supports such commitments when used
in a prudent manner. Since NCUA will now tie the regulatory definition
of derivative to the GAAP definition, the general prohibition on
derivatives could be interpreted to prohibit these types of
commitments. Accordingly, the final rule clarifies that derivatives in
the form of interest rate lock commitments and forward sales
commitments on loans FCUs originate are excluded from the general
prohibition on derivatives. Similarly, for corporate credit unions, the
general prohibition on derivatives excludes forward sales commitments
on loans originated by another credit union where the corporate intends
to purchase the loan.
Currently, the responsibility for receipt and initial processing of
applications under the Investment Pilot Program rests with NCUA's
Office of Examination and Insurance. 12 CFR 703.19(c). The final rule
transfers that responsibility to NCUA's Office of Strategic Program
Support and Planning.
Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
to
[[Page 39831]]
describe any significant economic impact a proposed rule may have on a
substantial number of small credit unions (those under $10 million in
assets). This rule expands the investment authority granted to FCUs and
corporate credit unions. The rule will not have a significant economic
impact on a substantial number of small credit unions and, therefore, a
regulatory flexibility analysis is not required.
Paperwork Reduction Act
NCUA has determined that the final rule would not increase
paperwork requirements under the Paperwork Reduction Act of 1995 and
regulations of the Office of Management and Budget. NCUA currently has
OMB clearance of part 703 and part 704 collection requirements. See OMB
No. 3133-0133 for 12 CFR part 703, and OMB No. 3133-0129 for 12 CFR
part 704.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their actions on state and local interests. In
adherence to fundamental federalism principles, NCUA, an independent
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies
with the executive order. The executive order states that: ``[n]ational
action limiting the policymaking discretion of the states shall be
taken only where there is constitutional and statutory authority for
the action and the national activity is appropriate in light of the
presence of a problem of national significance.'' Portions of the rule
apply to all corporates that accept funds from federally insured credit
unions, including state chartered corporates. The Board believes that
the protection of such credit unions from unwarranted investment in
risky investments, and ultimately the National Credit Union Share
Insurance Fund (NCUSIF), warrants application of the proposed rule to
all corporates, including both state chartered and nonfederally
insured. The rule does not impose additional costs or burdens on the
states or affect the states' ability to discharge traditional state
government functions. NCUA has determined that this rule may have an
occasional direct effect on the states, on the relationship between the
national government and the states, or on the distribution of power and
responsibilities among the various levels of government. However, the
potential risk to the NCUSIF without the final changes justifies them.
The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
The NCUA has determined that this rule would not affect family
well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat.
2681 (1998).
Small Business Regulatory Enforcement Fairness Act
The Small Business Regulatory Enforcement Act of 1996 (Pub. L. 104-
121) provides generally for congressional review of agency rules. A
reporting requirement is triggered in instances where NCUA issues a
final rule as defined by section 551 of the Administrative Procedure
Act. 5 U.S.C. 551. The Office of Management and Budget is reviewing
whether this rule is a major rule for purposes of the Small Business
Regulatory Enforcement Fairness Act of 1996.
List of Subjects
12 CFR Part 703
Credit unions, Investments.
12 CFR Part 704
Corporate Credit unions, Reporting and Recordkeeping Requirements.
By the National Credit Union Administration Board on June 24,
2004.
Becky Baker,
Secretary of the Board.
0
For the reasons stated in the preamble, NCUA amends 12 CFR part 703 and
12 CFR part 704 as follows:
PART 703--INVESTMENT AND DEPOSIT ACTIVITIES
0
1. The authority citation for part 703 continues to read as follows:
Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).
0
2. Amend Sec. 703.2 to revise the definitions of Call, Custodial
Agreement, Derivatives, and Put, and add definitions of Collateralized
Mortgage Obligation and Exchangeable Collateralized Mortgage
Obligation, as follows:
Sec. 703.2 Definitions.
* * * * *
Call means an option that gives the holder the right to buy a
specified quantity of a security at a specified price during a fixed
time period.
* * * * *
Collateralized Mortgage Obligation (CMO) means a multi-class
mortgage related security.
* * * * *
Custodial Agreement means a contract in which one party agrees to
hold securities in safekeeping for others.
* * * * *
Derivatives means any derivative instrument as defined under
generally accepted accounting principles (GAAP).
* * * * *
Exchangeable Collateralized Mortgage Obligation means a class of a
collateralized mortgage obligation (CMO) that, at the time of purchase,
represents beneficial ownership interests in a combination of two or
more underlying classes of the same CMO structure. The holder of an
exchangeable CMO may pay a fee and take delivery of the underlying
classes of the CMO.
* * * * *
Put means an option that gives the holder the right to sell a
specified quantity of a security at a specified price during a fixed
time period.
* * * * *
0
3. Amend Sec. 703.8 by revising the second sentence of paragraph
(b)(3) to read as follows:
Sec. 703.8 Broker-dealers.
* * * * *
(b) * * *
(3) * * * The Federal credit union should consider current
financial data, annual reports, reports of nationally-recognized
statistical rating organizations, relevant disclosure documents, and
other sources of financial information.
* * * * *
0
4. Amend Sec. 703.9 by revising the second sentence of paragraph (d)
to read as follows:
Sec. 703.9 Safekeeping of investments.
* * * * *
(d) * * * The Federal credit union should consider current
financial data, annual reports, reports of nationally-recognized
statistical rating organizations, relevant disclosure documents, and
other sources of financial information.
* * * * *
0
5. Amend Sec. 703.14 to revise paragraph (g)(4) and paragraph (g)(13)
introductory text to read as follows:
Sec. 703.14 Permissible investments.
* * * * *
(g) * * *
(4) The options' expiration dates are no later than the maturity
date of the share certificate.
* * * * *
[[Page 39832]]
(13) The Federal credit union provides its board of directors with
a monthly report detailing at a minimum:
* * * * *
0
6. Amend Sec. 703.16 to revise paragraphs (a) and (e) and add
paragraph (f) to read as follows:
Sec. 703.16 Prohibited investments.
(a) Derivatives. A Federal credit union may not purchase or sell
financial derivatives, such as futures, options, interest rate swaps,
or forward rate swaps. This prohibition does not apply to:
(1) Any derivatives permitted under Sec. Sec. 701.21(i) and
703.14(g) of this chapter;
(2) Embedded options not required under GAAP to be accounted for
separately from the host contract; and
(3) Interest rate lock commitments or forward sales commitments
made in connection with a loan originated by the Federal credit union.
* * * * *
(e) Stripped mortgage backed securities (SMBS). A Federal credit
union may not invest in SMBS or securities that represent interests in
SMBS except as described in paragraphs (1) and (3) below.
(1) A Federal credit union may invest in and hold exchangeable
collateralized mortgage obligations (exchangeable CMOs) representing
beneficial ownership interests in one or more interest-only classes of
a CMO (IO CMOs) or principal-only classes of a CMO (PO CMOs), but only
if:
(i) At the time of purchase, the ratio of the market price to the
remaining principal balance is between .8 and 1.2, meaning that the
discount or premium of the market price to par must be less than 20
points;
(ii) The offering circular or other official information available
at the time of purchase indicates that the notional principal on each
underlying IO CMO should decline at the same rate as the principal on
one or more of the underlying non-IO CMOs, and that the principal on
each underlying PO CMO should decline at the same rate as the
principal, or notional principal, on one or more of the underlying non-
PO CMOs; and
(iii) The credit union staff has the expertise dealing with
exchangeable CMOs to apply the conditions in paragraphs (e)(1)(i) and
(e)(1)(ii) of this section.
(2) A Federal credit union that invests in an exchangeable CMO may
exercise the exchange option only if all of the underlying CMOs are
permissible investments for that credit union.
(3) A Federal credit union may accept an exchangeable CMO
representing beneficial ownership interests in one or more IO CMOs or
PO CMOs as an asset associated with an investment repurchase
transaction or as collateral in a securities lending transaction. When
the exchangeable CMO is associated with one of these two transactions,
it need not conform to the conditions in paragraphs (e)(1)(i) and (ii)
of this section.
(f) Other prohibited investments. A Federal credit union may not
purchase residual interests in collateralized mortgage obligations,
real estate mortgage investment conduits, or small business related
securities.
0
7. Amend Sec. 703.19 by revising the introductory language of
paragraph (c) to read as follows:
Sec. 703.19 Investment Pilot Program.
* * * * *
(c) A third-party seeking approval of an investment pilot program
must submit a request to the Director of the Office of Strategic
Program Support and Planning that addresses the following items:
* * * * *
PART 704--CORPORATE CREDIT UNIONS
0
8. The authority citation for part 704 continues to read as follows:
Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.
0
9. Amend Sec. 704.2 to add definitions of Derivatives and Exchangeable
collateralized mortgage obligation, and to revise the definitions of
Small business related security and Weighted average life, as follows:
Sec. 704.2 Definitions.
* * * * *
Derivatives means any derivative instrument as defined under
generally accepted accounting principles (GAAP).
* * * * *
Exchangeable collateralized mortgage obligation means a class of a
collateralized mortgage obligation (CMO) that, at the time of purchase,
represents beneficial ownership interests in a combination of two or
more underlying classes of the same CMO structure. The holder of an
exchangeable CMO may pay a fee and take delivery of the underlying
classes of the CMO.
* * * * *
Small business related security means a security as defined in
section 3(a)(53) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(53)), e.g., a security that is rated in 1 of the 4 highest
rating categories by at least one nationally recognized statistical
rating organization, and represents an interest in 1 or more promissory
notes or leases of personal property evidencing the obligation of a
small business concern and originated by an insured depository
institution, insured credit union, insurance company, or similar
institution which is supervised and examined by a Federal or State
authority, or a finance company or leasing company. This definition
does not include Small Business Administration securities permissible
under Sec. 107(7) of the Act.
* * * * *
Weighted average life means the weighted-average time to the return
of a dollar of principal, calculated by multiplying each portion of
principal received by the time at which it is expected to be received
(based on a reasonable and supportable estimate of that time) and then
summing and dividing by the total amount of principal.
* * * * *
0
10. Amend Sec. 704.5 by revising paragraphs (h)(1) and (h)(4) and
adding paragraph (h)(5) to read as follows:
Sec. 704.5 Investments.
* * * * *
(h) * * *
(1) Purchasing or selling derivatives, except for embedded options
not required under GAAP to be accounted for separately from the host
contract or forward sales commitments on loans to be purchased by the
corporate credit union;
* * * * *
(4) Purchasing mortgage servicing rights, small business related
securities, residual interests in collateralized mortgage obligations,
residual interests in real estate mortgage investment conduits, or
residual interests in asset-backed securities; and
(5) Purchasing stripped mortgage backed securities (SMBS), or
securities that represent interests in SMBS, except as described in
subparagraphs (i) and (iii) below.
(i) A corporate credit union may invest in exchangeable
collateralized mortgage obligations (exchangeable CMOs) representing
beneficial ownership interests in one or more interest-only classes of
a CMO (IO CMOs) or principal-only classes of a CMO (PO CMOs), but only
if:
(A) At the time of purchase, the ratio of the market price to the
remaining principal balance is between .8 and 1.2, meaning that the
discount or premium
[[Page 39833]]
of the market price to par must be less than 20 points;
(B) The offering circular or other official information available
at the time of purchase indicates that the notional principal on each
underlying IO CMO should decline at the same rate as the principal on
one or more of the underlying non-IO CMOs, and that the principal on
each underlying PO CMO should decline at the same rate as the
principal, or notional principal, on one or more of the underlying non-
PO CMOs; and
(C) The credit union investment staff has the expertise dealing
with exchangeable CMOs to apply the conditions in paragraphs
(h)(5)(i)(A) and (B) of this section.
(ii) A corporate credit union that invests in an exchangeable CMO
may exercise the exchange option only if all of the underlying CMOs are
permissible investments for that credit union.
(iii) A corporate credit union may accept an exchangeable CMO
representing beneficial ownership interests in one or more IO CMOs or
PO CMOs as an asset associated with an investment repurchase
transaction or as collateral in a securities lending transaction. When
the exchangeable CMO is associated with one of these two transactions,
it need not conform to the conditions in paragraphs (h)(5)(i)(A) or (B)
of this section.
0
11. Amend Sec. 704.8 by revising paragraph (a)(4) to read as follows:
Sec. 704.8 Asset and liability management.
(a) * * *
(4) Policy limits and specific test parameters for the interest
rate sensitivity analysis requirements set forth in paragraph (d) of
this section; and
* * * * *
[FR Doc. 04-14762 Filed 6-30-04; 8:45 am]
BILLING CODE 7535-01-P