Forced to live with a regulatory stress test they opposed, members of the Public Securities Association are trying to persuade bank and thrift regulators to minimize the number of mortgage-backed derivatives that are found to be high-risk.
They are seeking a meeting with the regulators to discuss the implementation of a stress test developed last year by the Federal Financial Institutions Examination Council, which was aimed mainly at MBS derivatives.
The principal concerns of PSA are that examiners be well-trained in their application of the stress test, that some thought be given to relieve burden of applying the stress test annually and that some apparently anomalous results of the stress test be addressed, according to James Faust, vice president of the First Tennessee Bank NA in Memphis and chairman of the Sales and Marketing Committee of PSA's Mortgage Securities Division. PSA opposed application of the stress test to each investment, arguing that it should be applied to the portfolio as a whole. But the regulators rejected that view, and examiners must now give the three-part test to each investment. Faust said PSA members want to be assured that examiners understand the purpose and the mechanics of the stress so that suitable investments will not be challenged.
They also would like some "safe harbors" developed that would relieve portfolio managers from the burden of retesting their investments every year.
He suggested that in the case of a floater, if, at the time of purchase, the interest rate were more than 300 basis points away from the lifetime cap, it shouldn't have to be tested again. Faust said portfolio managers "are seeing tranches that fail the test because they make too much money if rates go down," he said. (See The mortgage Marketplace, July 6, page 1.)
Brian Smith, executive vice president of the Savings and Community Bankers of America, said he had heard few complaints from his members, many of whom "are shunning any security that might be put into the high-risk category." He conceded, however, that the test "can put the mark of Cain on some securities that don't deserve it."
Under the FFIEC policy, any investment that fails any one of three tests will be termed high-risk and must be held in the trade account, which is marked to market, or the held-for-sale account, which are carried at the lower of cost or market.
The three tests are:
Average Life - Any derivative that has an expected average life of more than 10 years.
Average life sensitivity - If the expected average life extends by more than four years with an immediate sustained upward shift in the yield curve of 300 basis points of the expected average life shortens by more than six years with a downward shift of 300 basis points.
Price sensitivity test - If the estimated price of a derivative would change by more than 17% with an immediate, sustained, parallel shift in the yield curve of plus or minus 300 basis points.