MBS and other Asset-Backed Investments in the Prompt Corrective Action—Risk-Based Capital Proposed Rule
April 17, 2014
The proposed rule promotes two options for determining the risk-weights of asset-backed investments, such as mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs).
One uses the current weighted average life for mortgage-backed investments. The other assigns an arbitrary risk weighting of 1,250%.
“Proposed §702.104(c)(2)(x) would require that credit unions assign a 1,250 percent risk-weight (8% * 1,250% = 100%) to an asset-backed investment for which the credit union is unable to demonstrate, as required under §702.104(d), a comprehensive understanding of the features of the asset-backed investment that would materially affect its performance. A 1,250 percent risk-weight is equivalent to holding capital equal to 100 percent of the investment’s balance sheet value [emphasis added].” (Source: Prompt Corrective Action—Risk-Based Capital Proposed Rule)
If this rule passes, and the credit union can’t demonstrate a comprehensive understanding as noted above, the penalty can be severe.
If your credit union is holding a material portfolio that includes these types of investments, it can’t be too soon to reassess appropriate understanding of the investments held. The proposed rule is not clear on who in the credit union needs to demonstrate a comprehensive understanding. It is probably a safe bet that, minimally, the ALCO would need to demonstrate this type of understanding.
