The OTS issued a bulletin Aug. 15 on structured notes that appears to have been inspired in part by loose talk and a dust-up over undue use of the wrong rules. Experts welcome the new measure anyway. Thrift Bulletin 65 in essence warns S&Ls to take care when purchasing structured notes to assure they know what they want to buy and that they dont get wrong ideas when acquiring the notes from government- sponsored enterprises. The derivatives scare lies behind this declaration of caveat emptor. Structured notes are a relatively new form of debt securities that often have the same variable rates and embedded options as are found in derivatives deals. They often are sold by such old friends to thrifts as Fannie Mae, Freddie Mac and the Federal Home Loan Banks. The trouble with structured notes is that they can carry lots of risksome of it unexpected unless one stays wary, OTS said. For example, an OTS regional director in Atlanta found one thrift had purchased bonds with coupon rates that depended on the relationship between two constantly changing indices. Some bonds held by Southeastern thrifts that were linked to changes in indices have dropped in value as much as 30%, he said. But such cases appear to be rare. What were doing here is responding to anecdotal evidence that some institutions may have purchased these instruments thinking they were riskless because they were issued by a GSE, said Anthony G. Cornyn, head of the risk management division and deputy assistant director of the Office of Thrift Supervision. But when asked for examples, he said that most of the cases he hears come when reporters call and suggest thrifts dont know what theyre buying. Marti Sworobuk, an accounting ex-pert with the Savings & Community Bankers of America, also finds it ironic that most structured notes are custom-ized by GSEs and companies at the request of thrifts to meet those financial institutions particular objectives. She added that S&Ls already have to follow interest-rate risk guidelines and have decades of experience dealing with GSEs, so if any group is mature enough to handle structured notes, its them. Everybody knows theres market risk, interest rate risk, she said, so perhaps all that was needed was some cautious language. Thrift Bulletin 65 also resolves a controversy in the Southeast when the Atlanta OTS office issued a statement suggesting that structured notes should undergo the same three-part stress test as Thrift Bulletin 52 requires S&Ls to inflict on their mortgage-backed securities. Richard Riccobono, the acting OTS director in Atlanta, said he issued the statement on July 29 because his office was worried about the notes and TB52 was the only rule that could be stretched to take in the notes. Cornyn said that ruling clearly was a misinterpretation, as structured notes arent mortgage derivatives. The new bulletin should settle any confusion over how to handle the notes, he said. The bulletin says the most common structured notes involve step-up bonds, where the coupon rate changes if the bonds arent called on certain dates; index amortizing notes, which repay principal according to an amortization schedule linked to an index; dual index notes; deleveraged bonds, which pay according to a formula based upon a fraction of the change in a specified index (thus lagging overall movements in the market); range bonds, which pay an above-market coupon rate so long as the reference rate stays within certain levels; and inverse floaters, in which the coupon value travels in the opposite direction as a particular index.

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