Tag Archives: federal savings association

Banks Should Know Their Investment Risks

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Nathaniel Zumbach

The latest issue of the Federal Deposit Insurance Corporation’s Supervisory Insights (Devoted to Advancing the Practice of Bank Supervision) has an esoteric, but important article on Bank Investment in Securitizations: The New Regulatory Landscape in Brief (starting on page 13). The article opens,

The recent financial crisis provided a reminder of the risks that can be embedded in securitizations and other complex investment instruments. Many investment grade securitizations previously believed by many to be among the lowest risk investment alternatives suffered significant losses during the crisis. Prior to the crisis, the marketplace provided hints about the embedded risks in these securitizations, but many of these hints were ignored. For example, highly rated securitization tranches were yielding significantly greater returns than similarly rated non-securitization investments. Investors found highly rated, high yielding securitization structures to be “too good to pass up,” and many investors, including community banks, invested heavily in these instruments. Unfortunately, when the financial crisis hit, the credit ratings of these investments proved “too good to be true;” credit downgrades and financial losses ensued.

In the aftermath of the financial crisis, interest rates have remained at historic lows, and the allure of highly rated, high-yielding securitization structures remains. Much has been done to mitigate the problems experienced during the financial crisis with respect to securitizations. Congress responded with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and regulators developed and issued regulations and other guidance designed to increase investment management standards and capital requirements.

The gist of these new requirements is simple: banks should understand the risks associated with the securities they buy and should have reasonable assurance of receiving scheduled payments of principal and interest. This article summarizes the most pertinent of these requirements and provides practical advice on how the investment decision process can be structured so the bank complies with the requirements.

The guidance and regulations applicable to bank investment activities reviewed in this article are: „

  • Office of the Comptroller of the Currency (OCC): 12 CFR, Parts 1, 5, 16, 28, 60; Alternatives to the Use of External Credit Ratings in the Regulations of the OCC;
  • OCC: Guidance on Due Diligence Requirements to determine eligibility of an investment (OCC Guidance);
  • Federal Deposit Insurance Corporation (FDIC): 12 CFR Part 362, Permissible Investments for Federal and State Savings Associations: Corporate Debt Securities;
  • FDIC: 12 CFR Part 324, Regulatory Capital Rules; Implementation of Basel III (Basel III); and  „
  • FDIC: 12 CFR Part 351, Prohibitions on certain investments (The Volcker Rule).

As financial institutions move into an investment world where relying on credit ratings from third party providers is not longer sufficient, the advice in this article is welcome. One wonders though what the consequences will be, if any, for those who do not follow it.

Mortgage Market Trending in the Right Direction, but . . .

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The Office of the Comptroller of the Currency (OCC) released its OCC Mortgage Metrics Report, First Quarter 2014. the report is a “Disclosure of National Bank and Federal Savings Association Mortgage Loan Data,” and it “presents data on first-lien residential mortgages serviced by seven national banks and a federal savings association with the largest mortgage-servicing portfolios. The data represent 48 percent of all first-lien residential mortgages outstanding in the country and focus on credit performance, loss mitigation efforts, and foreclosures.” (8, footnote omitted) As a result, this data set is not representative of all mortgages, but it does cover nearly half the market.

The report found that

93.1 percent of mortgages serviced by the reporting servicers were current and performing, compared with 91.8 percent at the end of the previous quarter and 90.2 percent a year earlier. The percentage of mortgages that were 30 to 59 days past due decreased 20.9 percent from the previous quarter to 2.1 percent of the portfolio, a 19.8 percent decrease from a year earlier and the lowest since the OCC began reporting mortgage performance data in the first quarter of 2008. The percentage of mortgages included in this report that were seriously delinquent—60 or more days past due or held by bankrupt borrowers whose payments were 30 or more days past due — decreased to 3.1 percent of the portfolio compared with 3.5 percent at the end of the previous quarter and 4.0 percent a year earlier. The percentage of mortgages that were seriously delinquent has decreased 22.4 percent from a year earlier and is at its lowest level since the end of June 2008.

At the end of the first quarter of 2014, the number of mortgages in the process of foreclosure fell to 432,832, a decrease of 52.3 percent from a year earlier. The percentage of mortgages that were in the process of foreclosure at the end of the first quarter of 2014 was 1.8 percent, the lowest level since September 2008. During the quarter, servicers initiated 90,852 new foreclosures — a decrease of 49.1 percent from a year earlier. Factors contributing to the decline include improved economic conditions, aggressive foreclosure prevention assistance, and the transfer of loans to servicers outside the reporting banks and thrift. The number of completed foreclosures decreased to 56,185, a decrease of 7.5 percent from the previous quarter and 33.9 percent from a year earlier. (4)

These trends are all very good of course, but it is worth remembering how far we have to go to get back to historical averages, particularly for prime mortgages.  Pre-Financial Crisis prime mortgages typically have done much better than these numbers, with delinquency rates in the very low single digits.