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ALEXANDRIA, Va. – No hard numbers are available on how many credit unions invest in collateralized mortgage obligations (CMOs), but some may be scared off by their risky structure even as recent regulations eased some limitations on their use. NCUA’s Board recently authorized all federal credit unions and corporates to invest in exchangeable CMOs representing interests in one or more stripped mortgage-backed securities (SMBS) with certain safety and soundness limitations. While NCUA still prohibits investing in SMBS and exchangeable CMOs that represent interests in one or more SMBS, the amended rule does offer some flexibility. While the authority has expanded, the risks are still there, NCUA warned. 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, according to NCUA. In many cases, these underlying CMOs include interest-only and principal-only, IO and PO, respectively. 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, NCUA said. In January, 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. Those conditions concern the rate of amortization of the underlying IOs and POs. For an exchangeable CMO representing one or more IOs, NCUA 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 NCUA 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. NCUA 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. Despite the new authority, NCUA still “believes that CMOs are not appropriate for all credit unions.” “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,” the NCUA Board advised. 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; the rule applies only to CMOs that are accepted by the credit union as assets associated with repurchase transactions or as collateral associated with securities lending Transactions; and 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. NCUA is directing applications for participation in an Investment Pilot Program to the Office of Strategic Program Support and Planning. Credit unions were previously direct to the Office of Examination and Insurance. [email protected]

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