WASHINGTON -- More than 100 banks in the Southwest have large investments in a seemingly safe type of derivative that has dropped in value recently, a top federal regulator said.
The banks are holding structured notes, which carry high credit ratings but can lose value quickly when interest rates rise.
"There are quite a few banks with concentrations of structured notes that are relatively large compared to their capital," said Douglas E. Harris, senior deputy comptroller at the OCC.
The agency, which is under congressional pressure to closely monitor holdings of structured notes, recently toted up the instruments at banks in Texas, Oklahoma, New Mexico, Arkansas, and Louisiana. The Comptroller's office has yet to analyze other regions.
Of 780 banks in the Southwest, 64 hold structured notes with a book value of 50% to 100% of equity capital, Mr. Harris said. Another 33 have holdings equal to 100% to 200% of capital. Ten hold notes with a book values greater than 200% of capital. And for one bank, the book value of the derivatives exceeds 400% of capital.
Such high concentrations will not necessarily spell losses, Mr. Harris and others said.
"This is not the same thing as having 400% of your equity in tall empty office buildings in Houston," said David S. Berry, director of research at Keefe Bruyette & Woods Inc.
But the banks clearly face some unusual risks. And they likely would face losses if they were forced to sell the instruments immediately.
Structured notes, which are issued mainly by government-sponsored enterprises such as Fannie Mae and Freddie Mac, have triple-A ratings for credit risks. But many buyers fail to understand the products' high liquidity and market risks. This summer, bank regulators issued warnings about the instruments.
The OCC is most concerned about investments in two kinds of structured notes: so-called dual index floaters and inverse floaters. It is less concerned about "step-up bonds," Mr. Hams said.
As the names suggest, these instruments can be quite complex. Michael Macielag, president and CEO of Chestertown Md.-based Chesapeake Bank and Trust, jokes that structured notes tied to "what the tide is on Wednesday" have caused his bank some trouble.
Smaller, less sophisticated banks are large users of structured notes. "They are used primarily for investment purposes and not hedging purposes," Mr. Harris said. "So it's really for the smaller banks to go after yield."
All bank regulatory agencies are preparing to disclose by the end of the month how much banks have lost through investments in structured notes.
House Banking Committee Chairman Henry B. Gonzalez requested the information late last month in letters to the OCC, the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision.
Those agencies said they did not yet have data on structured notes and would not comment further.
Separately, the OCC plans to release derivatives guidelines for examiners in the form of a 100-page manual, Mr. Hams said. OCC Examiners now have less than a dozen pages of guidelines.
