Credit unions gain CMO solution.

New Federal Financial Institution Examination Council rules have put many collaterized mortgage obligations off limits to credit unions, but a new mortgage-backed security designed with those new credit union regulations in mind lets them return to the market.

In a classic case of government regulatory action spawning invention, Prudential Securiues developed a hybrid security called Credit Union Bonds, or CUBs, a collateralized mortgage obligation tailored to credit union requirements.

CUBs are a type of CMO backed by Fannie Mae and Freddie Mac mortgage pass-through securities. But what makes them different from normal CMOs is that while most have a 15- to 30-year maturity periods,

CUBs reach maturity in just 10 years.

CUBs also differ in that they may not extend beyond their stated average life, while their CMO cousins may extend well beyond expected average life if prepayment levels fall.

The security got off to a fast start when it was issued Aug. 24. Several organizations have already bought the security and, according to Prudential, more have inquired about it.

The development of CUBs was spurred by the National Credit Union Administration's decision to replace rules on eligible credit union investments in favor of more stringent Federal Financial Institutions Examination Council rules currently used by banks and thrifts.

Prudential developed the security after asking credit unions what their optimal investments would hold. The credit unions indicated they were interested in safety, liquidity and yield - in that order, said Christopher Ricciardi, a mortgage-backed securities trader at Prudential.

Under the new FFIEC rules adopted July 30, any mortgage-backed security a credit union wanted to purchase, like a CMO, would have to pass a stress test, which consists of a number of exams, including scrutiny of average life volatility, price volatility and average life. As long as it passes those tests, credit unions may invest in it.

"This bond meets those requirements with any model you use, which is not true of all CMOs," Ricciardi said.

But the majority of interest may be restricted to the 800-pound gorillas of the market. Some small organizations, like Coca-Cola's Red Disk Federal Credit Union - one of the security's first purchasers - may be interested, but many may not.

"[We've] never invested in CMOs," said Karen Ross, staff manager at Indiana Telco Credit Union, an Indianapolis organization with $155 million in assets. "We keep our investment portfolio very simple and veryshort-term. But continued deterioration of short-term certificate of deposit rates might push us in that direction. We wouldn't do it if it was limited to a 10-year-maturity rate."

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