WASHINGTON -- Bank examiners will be taking a closer look at bank investments in structured notes under new guidelines being released today by the Office of the Comptroller of the Currency.
The OCC is giving its examiners the same advice it gave banks earlier this year by requiring examiners to pay more attention to such derivative products, which include, in large part, products issued by government-sponsored enterprises.
The comptroller's office recognizes in its new guidelines for examiners who review bank activity in derivatives that not only banks have difficulty in analyzing structured notes.
"The fact that many structured notes are government-sponsored enterprise debt does make it especially difficult for our examiners to examine the risks," Douglas Harris, the OCC's senior deputy comptroller for capital markets, said during a briefing Friday.
"They see a note issued by a government-sponsored enterprise and they are not generally inclined to look further to determine whether or not it is a particularly complex or risky structure or one that may have been inappropriate for the bank to invest in," Harris said.
Structured securities are tax-exempt or taxable debt obligations that contain embedded forwards or options or that have coupons or other cash-flow characteristics that are based on one or more indexes.
Among the largest issuers of structured securities are government-sponsored agencies such as the Federal National Mortgage Association and the Student Loan Marketing Association.
Harris said the comptroller's office singled out structured notes in its derivative guidelines because of recent difficulties that banks have experienced in managing the risks of structured notes. In July the comptroller's office issued a warning to banks about investing in the risky products.
"Smaller banks very often have a problem in determining especially complex and risky transactions," Harris said.
Losses in structured notes, however, have been discovered in other areas.
Seven top bank holding companies ranging from BankAmerica Corp. to Bankers Trust recently had to inject a total of about $129 million to shore up the net asset value of their affiliated money market funds to make up for losses in structured note investments.
In addition, a number of state and local governments have reported losses from structured note investments.
In one case, Charles County, Md., is trying to recover almost $30 million from securities firms that sold the county's former deputy treasurer risky investments, including taxable inverse floaters, collateralized mortgage obligations, and medium- and long-term derivatives.
In an attempt to beef up examiners' reviews of bank derivatives activity, the new guidelines from the comptroller's office also emphasize that senior bank management should make managers accountable for adhering to risk management.
Harris said the provision is one of the most controversial elements of the guidelines because industry representatives fear it gives investors the right to sue anytime they experience a loss.
Harris said the comptroller's office has emphasized for the last year that this provision isn't a suitability standard.
"We don't intend to create a private right of action," Harris told reporters. He said that while one of the effects of the obligation is to give customer protection, this isn't the primary purpose of the guideline.
"I'm not saying that someone that suffers a loss can't sue, but that it's very likely that someone who suffers a loss will sue," Harris said. He said it is possible that investors may attempt to use the guideline as a basis for a lawsuit.
The guidelines, which will be distributed to bank examiners and national banks within the next two weeks, expand on guidelines on derivatives activities for banks that were issued last year. The comptroller's office began work on consolidating its examination procedures for derivatives activities at that time and has since examined the activities in all national banks.
The procedures distinguish between different types of derivatives users and outline the responsibilities of a bank's board and senior management in managing derivatives activities.
Overall, the majority of banks examined are in compliance, Harris said, adding "I think that bank risk management systems are getting better."
He said the message of the new examiner guidelines to banks is: "Be able to understand what your risk is and be able to monitor it."
