ALEXANDRIA, Va. - No hard numbers are available on how manycredit unions invest in collateralized mortgage obligations (CMOs),but some may be scared off by their risky structure even as recentregulations eased some limitations on their use. NCUA's Boardrecently authorized all federal credit unions and corporates toinvest in exchangeable CMOs representing interests in one or morestripped mortgage-backed securities (SMBS) with certain safety andsoundness limitations. While NCUA still prohibits investing in SMBSand exchangeable CMOs that represent interests in one or more SMBS,the amended rule does offer some flexibility. While the authorityhas expanded, the risks are still there, NCUA warned. Anexchangeable CMO represents a beneficial ownership interest in acombination of two or more underlying CMOs, and the owner may pay afee and take delivery of the underlying CMOs, according to NCUA. Inmany cases, these underlying CMOs include interest-only andprincipal-only, IO and PO, respectively. Because NCUA regulationsprohibit investment in SMBS, the regulations also prohibitinvestment in an exchangeable CMO that represents an interest inone or more IOs or POs. Certain exchangeable CMOs representing IOsor POs, however, do not carry the risk or raise the same safety andsoundness concerns associated with direct investment in an SMBS,NCUA said. In January, the NCUA Board issued a notice of proposedrulemaking to amend NCUA rules to authorize FCUs and corporatecredit unions to invest in an exchangeable CMO representinginterests in one or more IOs or POs if the exchangeable CMO meetscertain conditions. Those conditions concern the rate ofamortization of the underlying IOs and POs. For an exchangeable CMOrepresenting one or more IOs, NCUA proposed that the notionalprincipal of each IO must decline at the same rate as the principalon one or more non-IO CMOs included in the combination. For anexchangeable CMO representing one or more POs, the NCUA Boardproposed that the principal of each PO must decline at the samerate as the notional principal of one or more IOs included in thecombination or at the same rate as the principal on one or moreinterest-bearing CMOs included in the combination. NCUA alsoproposed a second condition: that, at the time of purchase, theratio of the market price of the CMO to its remaining principalbalance is between .8 and 1.2, meaning that the discount or premiumof the market price to par must be less than 20 points. Theproposed rule also stated that credit unions may not exercise theright to exchange an exchangeable CMO if it represents an interestin one or more SMBS that would be impermissible for that creditunion to hold as a separate investment. Despite the new authority,NCUA still "believes that CMOs are not appropriate for all creditunions." "Those with investment authority at a credit union must bequalified by education or experience to assess the riskcharacteristics of every investment that they make, includingCMOs," the NCUA Board advised. Since exchangeable CMOs are a morecomplex investment, the final rule specifically requires that acredit union seeking to invest in exchangeable CMOs must have theexpertise to apply the unique price range and amortizationconditions in this rule; the rule applies only to CMOs that areaccepted by the credit union as assets associated with repurchasetransactions or as collateral associated with securities lendingTransactions; and the rule clarifies that derivatives in the formof interest rate lock commitments and forward sales commitments onloans originated by the credit union are not prohibited. NCUA isdirecting applications for participation in an Investment PilotProgram to the Office of Strategic Program Support and Planning.Credit unions were previously direct to the Office of Examinationand Insurance. [email protected]