The Securities and Exchange Commission will be looking more closely at morigage-backed securities losses due to prepayments and start requiring capital adjustmenis to cover those losses.

Like other financial regulators, the SEC has become increasingly concerned over the effects declining interest rates have on mortgage-backed investmenis and whether the holders of those securities are properly recognizing the resulting erosion in values.

As a result. according to Michael D. Foley. professional accounting fellow at the SEC. the agency will scrutinize financial entitles'accounting for prepayment on mortgagebacked securities more closely and even require reduction in regulatory capital due to erosions in the value of such holdings. Foley made his comments during the recent American Institute of Certified Public Accountants' banking convention.

Financial institution regulators have been looking more closely at investments in MBS and their derivatives. Also, the General Accounting Office recently embarked on a study that some believe could become the basis for future federal regulation of the sometimes highly volatile products. (See The Mortgage Markelplace, Oct. 26, page 3.)

Foley said the SEC has grown more concerned that publicly owned entities. which report to the agency, are not properly accounting for the declines in value of those mortgage-backed securities, like interest-only derivatives, that result from prepayments. The prepayments on mortgages over the last year, caused by the record decline in interest rates, has eroded the value of many of these mortgage securities.

Some entities, said Foley, are inappropriately aggregating the accounts for mortgage securities and lumping them together, which allows them to hide the losses and value declines with the winners.

He called on the FInancial Accounting Standards Board, the AICPA and other accounting standard setters to provide the financial community with more guidance on how to account for value declines in mortgage securities due to prepayment.

Foley's remarks come at a time when there is some disagreement among experts over the outlook for prepayments. While many experts have predicted the pattern of refinancings and the resultant prepaymenis to continue strong into next year, Telerate Advance Factor Service predicted that the peak occurred in October and will begin to decline.

'Refinancings have steadily declined since the end of the summer, indicating burnout,' said Thomas DeLorenzo, a prepayment analyst for AFS. 'Two indexes support this viewpoint: The Mortgage Bankers Association index for refinancings has dropped from a late July peak of 1,354.1 to its present level of 768.4, and the AFS index of title researches has declined from an August high of 26,000 to its current level of 19,810. Using these figures. we predict a prepayment slowdown will occur sooner than the December slowdown cited by other analysts."

DeLorenzo said if mortgage interest rates rise toward 9% and refinancings drop back to a level below 35% of mortgage applications, prepayments from low- to middle-coupon securities will drop off significantly after November. These coupons could reach the lows of June 1992 as soon as next February, he said, while premium coupons in 1993 will drop under the 1992 lows.

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