The top thrift regulator said a bomb squad is working to defuse a potentially explosive conflict between RAP and GAAP that affects billions of dollars worth of collateralized mortgage obligations.
Acting Office of Thrift Supervision Director Jonathan Fiechter said Dec. 12 that neither the Financial Accounting Standards Board nor bank regulators ever intended to discourage financial institutions from using CMOs to hedge against interest rate risk. Regulators are working to prevent all CMOs from being excluded from held-to-maturity treatment under FAS 115. Fiechter said. The tough standard governs financial reports issued after Dec. 15, 1993.
Fiechter said that regulators were working on revised wording of the interagency Policy Statement on Securities Activities.
The policy statement, issued by the Federal Financial Institutions Examination Council on Feb. 3, 1992. sets forth a test to identify "high-risk securities" and allows regulators to force banks to divest of them. In practice, however, Fiechter said this is extremely rare at his agency, which encourages thrifts to use these hedging products.
Because a divestiture cloud hangs over CMOs, the Emerging Issues Task Force of the Financial Accounting Standards Board indicated last month that these securities are ineligible for held-to-maturity status under FAS 115, Accounting for Certain Investments in Debt and Equity Securities. FAS 115 requires banks putting securities in the held-to-maturity bucket to have the positive intent and ability to hold them to maturity. The EITF concluded that the FFIEC policy erodes the ability of banks to hold to maturity any CMO that could be deemed "high risk."
The problem has far-reaching impact. Financial institutions have become major consumers of CMOS in recent years - in part goaded by regulator concerns about interest rate risk. Savings institutions have more than $49 billion in CMO assets.
They typically buy tranches with weighted-average lives at purchase of three to seven years, a fraction of the exposure risk posed by 15- or 30-year mortgages.
Many of these CMOs are issued or backed by Freddie Mac, Fannie Mae or Ginnie Mae, and are not widely considered "high-risk."
The Savings and Community Bankers of America called on top regulators to quickly dismantle this regulatory straitjacket in a Dec. 10 letter to the heads of the OTS, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Federal Reserve Board.
SCBA said the immediate CMO problem raises a more general need for regulators to distinguish between truly high-risk securities and those that help minimize interest rate risk exposure, a concern that has been raised repeatedly by Fiechter.
One solution to the immediate problem would be to narrow the number of CMOs that would be considered to pose a regulatory high-risk, Fiechter suggested.