CUNA Comment Letter

April 2, 2004

Ms. Becky Baker
Secretary of the Board
National Credit Union Administration
1775 Duke Street
Alexandria, Virginia 22314-3428

Re: Proposal on Investment in Exchangeable Collateralized Mortgage Obligations
(Part 716)

Dear Ms. Baker:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on NCUA’s proposal on investment in exchangeable collateralized mortgage obligations (CMOs). The proposal will allow federal credit unions to invest in exchangeable CMOs representing interests in one or more stripped mortgage-backed securities (SMBS). These investments will be subject to conditions regarding the amortization rate of the underlying interest-only CMO (IO) and principal-only CMO (PO) and the requirement that the discount or premium of the market price to the remaining principal balance cannot exceed 20 percent. CUNA represents more than 90 percent of our nation’s nearly 9,700 state and federal credit unions.

Summary of CUNA's Position

Despite the fact that stripped mortgage-backed securities may have a role to play in a hedging strategy, they would perform only a limited role as a core investment. We believe credit unions agree that institutions investing in these types of CMOs must be able to demonstrate a complete understanding of how these products work and the risks that they pose to their earnings and capital, resulting from changes in the value of these instruments. In order to be successful in these types of investments, a credit union should have the appropriate tools to monitor these investments and sufficient expertise to assess the risk associated with these CMOs, whether it performs this assessment itself or relies on qualified third parties.

Aggregate limits may be appropriate, but such limits should be set by the credit union, based on its ability to acquire and manage this additional risk and its assessment of the benefits for any given level of CMO investment. An aggregate level of CMO investment that is safe and sound for one credit union may be too risky for another. We believe NCUA should work with credit unions to determine what additional information on the Call Report should be provided on these investments. This should help sufficiently minimize any unnecessary exposure to the Share Insurance Fund.

CUNA agrees with the proposed conditions that will be imposed on these investments with regard to the amortization of the underlying IOs and POs and the requirement that the premium of the market price to the remaining principal balance cannot exceed 20 percent. However, we do not support at this time the condition that the discount of the market price to par for POs be less than 20 percent. Before adopting this approach, we request NCUA provide more information regarding the safety and soundness concerns of these investments. We do not believe it is clear that deeply discounted POs pose undue risks.

We do not believe a pilot program is necessary for exchangeable CMOs. One issue would be that if a credit union participated in such a program, the credit union could be placed in a very difficult position if the pilot program was later terminated. Instead of a pilot program, we suggest that NCUA establish additional guidelines to ensure that qualified credit unions are making these types of investments in a safe and sound manner, although we would welcome the opportunity to work with NCUA if the agency decided to pursue a pilot program.

We also believe federal credit unions should be allowed to invest directly in SMBS, but only as hedging vehicles, for the purpose of reducing balance sheet risk and earnings volatility. We believe it would be reasonable that a federal credit union wishing to invest in an SMBS for this purpose be required to demonstrate how its investment in an SMBS will be used to reduce its balance sheet risk.

Thank you for the opportunity to comment on NCUA’s proposal on investment in exchangeable CMOs. If Board members or agency staff have questions about our comments, please contact Associate General Counsel Mary Dunn or me at (202) 638-5777.


Jeffrey Bloch
Assistant General Counsel