Bankers wary of plan to define 'high-risk' debt.

Bankers Wary Of Plan to Define |High-Risk' Debt

Bankers are urging regulators to scrap or modify a proposed policy that would define "high-risk" mortgage-backed securities and limit banks' ability to own them.

The Federal Financial Institutions Examination Council has received more than 70 comment letters since circulating the policy proposal in August. Most of the letters take issue with at least one of the specific standards being proposed, according to an official who has seen the letters.

Tests Criticized

"It's pretty clear to me the tests are too restrictive," said Frederic Pennekamp, treasurer of First Fidelity Bancorp. and chairman of the American Bankers Association"s bank investments and capital markets division.

But like his peers who criticize some aspects of the proposal, Mr. Pennekamp does not deny a need for more regulation than now exists. "The basic approach looks good," he said, "but the specific tests don't work."

If regulators adopt the policy statement, it could take effect as early as December. That would force banks to begin reporting new purchases of many types of mortgage-backed securities at the lower of their cost or market value. And some banks with large quantities of mortgage-backed securities soon could face discussions with regulators about liquidating these port-folios.

The change could slash bank's ability to take on high-yielding investments at a time when yields on most other acceptable investments are low. Banks' capital ratios could be affected as well: There's a chance bank regulators would require banks to set aside more capital against mortgage-backed securities deemed high-risk, according to Robert Storch, chief of the accounting section of the Federal Deposit Insurance Corp.

Questions of Application

"There have been questions all along about how the risk-based capital guidelines apply to these securities," he said. The FDIC already requires banks it regulates to use the highest possible risk weighting on certain mortgage-backed securities, Mr. Storch said, but each bank regulatory agency must review the risk weighting assigned to a variety of mortgage-backed securities if the council's proposal is adopted.

Candidates for high-risk classifications comprise a list of arcane titles: stripped mortgage-backed securities, certain collateralized mortgage-backed securities, residuals, and original-issue discount securities.

Mortgage-backed securities are more important to banks today than they ever have been. With loan demand light and interest rates on Treasury securities low, banks have plowed funds into mortgage-backed securities for the past two years in search of relative safety and high yield.

Bankers and securities industry representatives are objecting to the numerical standards set forth in the council's proposal. For example, a number of bankers object to this proposed measure of price volatility for a mortgage security: If the price of a security were to fluctuate more than 16% if interest rates moved 300 basis points, the security would be deemed high-risk.

Treasury Bond |High-Risk'?

That standard would make it impossible for a bank to buy a 10-year Treasury bond, according to First Fidelity's Mr. Pennekamp, because simple arithmetic indicates its price would change more than 16%.

The Public Securities Association has set forth a laundry list of items it objects to in the proposal, including the test for price sensitivity, the standard proposed on the average life of securities, and the basic concept of applying a risk standard to individual securities rather than to an overall portfolio.

And the American Bankers Association, while expressing its appreciation of the council's willingness to modify its proposal in response to industry concerns, urged it "to adopt a cautious approach and consider all possible market reactions to the proposed policy statement."

Officials at large banks say they have the analytical capability to invest sensibly in many securities that could be labeled risky - but they say smaller banks could be more vulnerable.

Big Banks' Ability

"I can be relatively comfortable making these investments because I can do a lot of analytics," said William Tennille, a managing director at Manufacturers Hanover Corp. "A lot of (institutions) don't have that luxury."

The move to flag certain mortgage backed securities began in January. The council proposed rules on portfolio policies, unsuitable investment practices, and the selection of securities dealers. But bankers criticized the proposed standards on selecting mortgage-backed securities as too vague and subjective. More specific standards were published Aug. 3.

Employees of all bank regulatory agencies are reviewing the comments they have received since then, and they may have their findings ready for discussion at the council's Sept. 24 meeting, according to Mr. Storch of the FDIC. If the council adopts the standards, and if other bank regulators adopt similar rules, they could take effect by the time banks file their year-end financial statements with regulators.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER