Have large volume of nonrated securities, couldn't price. What is problem if quality ok?
Bank does not execute own securities transactions, when is it considered NOT to have authority?
When an institution has delegated authority to non-affiliated firm or individual who is not an employee, bank no longer has he ability to control its own securities, and all holding for which authority has been delegated must be reported as AFS. Still must be safe and sound. Not considered delegated if managed by the parent holding company or if bank portfolio manager is required to authorize a recommended purchase and sale transaction prior to its execution (and makes such authorizations).
Top 4 rating categories for S&P and Moody's (to determine classifications/subinvestment quality).
MOODY'S: (Investment Quality) Aaa, Aa, A-1 or A, Baa-1 or Baa
(Sub-Investment) Ba, B, Caa, Ca, C
S & P's: (Investment) AAA, AA, A, BBB
(Sub-Investment) BB, B, Ccc, cc, c, D
Securities in grades below the four highest and securities of equivalent value will be appraised at MV and depreciation will be classified doubtful; remaining BV classified Substandard.
Depreciation in defaulted securities will generally be classified Loss and remaining BV classified Substandard.
Exception: municipal GO backed by credit and taxing power of issuer. (3.2-8) The entire BV of subinvestment quality municipal GOs which are not in default will be classified Substandard.
Municipal General Obligations: backed by the credit and taxing power of the issuer.
Municipal Revenue Obligations: Ex. Water bond supported by the revenue of water bill payments.
GO bond that is AA rated - classified?
Pass
Muni Securities graded "BA" are not defaulted - how classified (See 3.2-7)? Securities below the top 4 grades are appraised at market value.........
General Obligation (if no default) = Book Value SUB
Revenue Obligation (if no default) = Depreciation DOUBT, Remaining Book Value SUB
General Obligation (if default) = Depreciation LOSS, Remaining Book Value SUB
(* interim period Book Value DOUBT)
Revenue Obligation (if default) = Depreciation LOSS, Remaining Book Value SUB
Definition of industrial revenue bond (aka Industrial Development Bonds)(3.2-7)
Municipal bonds which do not provide the bondholder with a claim on the taxes or other revenues of the municipality issuing the securities. The issuer merely functions as a conduit for funds to service the debt, and creditworthiness can only be determined by appraising the financial standing of the enterprise that is the ultimate source of debt service.
Bond typically issued by local industrial development authorities to benefit private commercial and industrial development. Provides either taxable or non-taxable income to bond holders. Rated IDBs (by a nationally recognized rating service) are reported as securities, non-rated IDBs are reported as loans unless bank individually decides.
What are the settlement dates for securities transactions, especially with government securities?
U.S. Treasuries & Agencies - Book-entry form - 1 full business day from trade date
Corporates & Municipals - Book-entry or registered form - 5 full business days after transaction
Collateralized Mortgage Obligations (CMOs) & Real Estate Mortgage Investment Conduits (REMICs), Stripped Mortgage-Backed Securities (SMBS), Asset Backed Securities (ABS) - Complex, Book-entry - Must send confirmation w/i 1 business day. Bank has 10 days from receipt date to object, otherwise bound.
Mortgage Pass-throughs - Complex, trades usually occur on a To be Announced basis, Seller notifies Buyer at least 48 hours before delivery. Seller must follow up in writing. Settlement may be up to 45 to 60 days after the trade date. The Public Securities Association designates specific settlement dates each month for various classes of mtg pass-throughs.
Extended settlements is an unsuitable investment practice - should be in trading account.
What are the different classes of securities?
1) U.S. Treasury obligations
2) U.S. Govt and Agency issues
3) State and Political Subdivisions (GOs, ROs, IRBs)
4) Mortgage-Backed Securities
Pass-Throughs (GNMA, FNMA, FHLMC, Private Issues, Sub-Invest. Qual)
CMOs & REMICs (FNMA, FHLMC, Private issued & collateralized by MBS/ FNMA/ FHLMC/ GNMA, All other private-issued MBS, High Risk Mortgage Securities)
5) Other debt securities
Asset-backed Securities
All Other Debt Securities
6) Equity securities
Mutual Funds
Other Marketable Equity Securities
All other equity securities
T or F An investment policy should be "Philosophical" in nature. (3.2-1)
Characteristics of a Leeway Security? (3.2-10)
A) Must be allowed by applicable State law
B) Must be approved by Board as "leeway securities" and so identified on the bank's GL.
C) Aggregate total of all such investments cannot exceed the amount authorized by applicable State law or 10% of the bank's total capital or surplus accounts, exclusive of capital notes and debentures, whichever is less.
D) Carried on the bank's books at amortized acquisition cost.
Define leeway securities.
Investments in equity or capital debt securities of minority business enterprises, securities of foreign governments, or the securities of corporations which are not merely private and entrepreneurial but whose objectives & purposes are primarily of a civic or community nature or seem desirable to the bank's BOD or trustees.
What does primary reserve consist of? (3.2-5)
Cash and demand balances due from other banks. These assets generally comprise the major segment of the bank's legally required reserves (or statutory reserves).
The Bank has TA of $175MM. It has $90MM in U.S. Treasuries and $20MM in Munis. During the past year, interest rates have declined. During the year, management was actively trading in the municipal portfolio - how would this affect earnings?
1) Increase due to appreciation in the Treasury Portfolio
2) Increase due to increased income from trading gains
3) Decrease due to a low level of loan income
4) Decrease due to losses in a trading account
(2) Trading Gains will be realized. When rates go down, the value of bonds rises.
Balance sheet remained relatively constant. Trading in municipal bond portfolio because interest rates have been declining. What will be the effect on earnings?
· Increase due to increase in interest income from trading activities
· One other choice
The bank has a lot of realized gains for securities from HTM portfolio. Management indication securities were purchased to sell for short-term profits. What should examiner tell the bank? All except:
· Bank should create suspense account to hold purchased securities in and designate them HTM or whatever later.
Classify a municipal GO in default, for which a market has not been re-established. (3.2-8)
(a) BV Substandard
(b) MV Substandard; depreciation Loss
(d) BV Loss
What are the factors to consider in a investment policy? (3.2-1)
The principal objective is to furnish guidance in maintaining an investment portfolio which provides earnings and sufficient liquidity to ensure a reasonable degree of flexibility in bank's operations.
The examiner should consider the bank's standards in the following matters (CAGE):
General character of the bank's business
What should investment policy include? (3.2-1)
Investment policy should address the following items.
Quality - top four grades. A high quality issue may be inappropriate for a bank portfolio because its maturity is too long; its purchase may result in a lack of diversification; or it may lack marketability.
Maturity - should take into consideration: bank's invested position, prevailing and anticipated loan demand, stability and mix of funding sources, and seasonal/secular trends of community. Diversification - avoid unfavorable investment concentrations in obligations of a single issuer or in securities the credit of which depends largely upon the same set of factors or circumstances.
Marketability - concentrations in obscure issues, either municipal or corporate, are undesirable. Income - No bank should become so obsessed with income that it loses sight of the safety factors of quality, maturity, diversification, and marketability. High-risk usually accompany high yields. Tax considerations.
If exam results in high volume of securities classifications, what has management failed to address in investment policy? (diversification, quality, marketability, maturity)
What are the risks of not having adequate marketability addressed in the Investment Policy?
Problems with investment portfolio, corporate debt maturing 20 years, rated AAA to C
Know how to report mutual funds on the Call Report.
The bank owns two mutual funds: Fund A purchased at $2,000 and MV $1,000; Fund B purchased at $1,700 and MV $2,000. What is the adjustment made to capital, per Cal Report instructions? (Remember that Aggregate LOCOM adjustment for marketable equity securities; mutual funds are considered marketable equity securities)
a. (1,000) Cost MV
b. (700) A 2,000 1,000
c. No adjustment B 1,700 2,000
d. 300 3,700 3,000
(700)
How frequently price mutual funds? How show on books? Policy considerations?
Mutual funds are to be priced monthly (3.2-11) and shown at the lower of cost or market (FASB 12). Policy should include:
2) mutual fund investments limited to funds where shareholders are shielded form personal liability
3) the maximum individual and aggregate investment and
4) the maximum net unrealized loss the bank is willing to absorb before considering whether to continue to hold its mutual fund investments.
Bank investment policies should NOT treat investments in mutual funds as if they were direct investments in the assets of the mutual funds.
Proper accounting for a mutual fund? (3.2-9 or 3.2-11?)
FASB 12 - Valued at the lower of aggregate cost or aggregate MV on the balance sheet.
Classify mutual funds (or adjust for capital) - identify dollar amount (mkt or cost) (See 3.2-9)
To the extent that a mutual fund's investment portfolio is comprised of securities and other financial instruments that are of investment quality, the mutual fund should normally be considered of investment quality.
If a mutual fund's portfolio consists largely of investments that would be deemed subinvestment if a bank owned them directly (in general securities rated below the four highest grades, unrated securities of equivalent quality, and defaulted securities), the mutual fund investment should be considered of subinvestment quality. Any excess of BV over MV should be classified LOSS, with the remaining BV classified substandard.
In a mutual fund investment, should the bank consider it an investment directly in the assets of the mutual fund? (3.2-10)
Bank A owns two mutual funds. Mutual fund A costs $2,000 (current MV $1,200) and mutual fund B costs $2,000 (current MV $2,500). How would this be accounted for on the Call Report? (3.2-9)
· $3,700 (lower of aggregate cost or market) (aggregate cost = $4,000; aggregate MV = $3,700)
A bank buys a mutual fund on January 1 for $2,000. On March 31, its market value is $1,500. On June 30, the market value is $3,000. How would this be reported on the June 30 Call Report? (3.2-9)
· $1,500 (3/31)
· $2,000 (lower of aggregate cost or market) 6/30
· $3,000
Mutual fund has a BV of $500M and a MV of $400M. A second mutual fund has a BV of $600M and a MV of $1,000M. What is the amount reported on the balance sheet? 1,100
Cost MV
A 500 400
B 6001,000
1,1001,400
STOCKS / EQUITY SECURITIES (ownership interest)
Stocks will be evaluated on their individual merits. Use rating guides. Exception will NOT be taken to corporate equities which are well regarded by knowledgeable investors, marketable and held in moderate proportions. Any stock not meeting this criteria will be considered of subinvestment quality and any excess of BV over MV will be classified LOSS, with the remaining BV classified Substandard.
Examiners should determine that the carrying values of marketable equity securities are adjusted to the lower of aggregate cost or market value on a periodic basis (i.e., quarterly or more frequently). Any unrealized loss (aggregate cost of portfolio in excess of MV) should be charged directly against the undivided profits account. Subsequent reduction to any unrealized loss should be credited directly to undivided profits.
Question about municipal bonds which are performing with no credit problem. However, they are not rated; therefore, cannot be pledged against public funds, which causes liquidity problems. What should investment policy address?
Securities portfolio includes high depreciation, excessive volume of high-risk MBSs, majority pledged to public funds. What should be addressed?
· Income
Scenario: Bank had been trading a lot of securities. Most of assets were securities. There were a lot of long term fixed rate securities, and the bank was actively trading these securities. If interest rates declined, what would be the impact on the bank's net earnings?
Earnings would increase due to increased appreciation in securities portfolio (which they would sell)
If rates fell, the NIM would increase
Export-Import Bank (Ex-Im Bank)
Federal Housing Administration (FHA)
Government National Mortgage Association (GNMA)
Maritime Administration
Small Business Administration (SBA)
Farmers Home Administration (FmHA)
Federal Agricultural Mortgage Corporation (Farmer Mac)
Federal Farm Credit Banks
Federal Home Loan Banks (FHLBs)
Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)
Federal Land Banks (FLBs)
Federal National Mortgage Association (FNMA or Fannie Mae)
Financing Corporation (FICO)
Resolution Funding Corporation (REFCORP)
Student Loan Marketing Association (SLMA or Sallie Mae)
Tennessee Valley Authority (TVA)
U.S. Postal Service
FASB 115 - Accounting for certain investments in debt and equity securities
Held-to-Maturity (HTM)
Investment securities reported at amortized cost only if the bank has the positive intent and ability to hold till maturity.
Allowable sales of HTM securities:
1) Sale of security occurs near enough to its maturity date (or call date if exercise of call is probable) that interest rate risk is substantially eliminated as a pricing factor.
2) The sale of the security occurs after the enterprise has already collected a substantial portion (at least 85%) of the principal outstanding at acquisition due either to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments over its term. For variable-rate securities, the scheduled payments need not be equal.
Trading Securities
Reported at market value.
Unrealized gains and losses shall be included in earnings.
Available-for-sale (AFS)
Unrealized gains or losses will be shown as a separate component of equity.
Losses on AFS equity securities will be deducted from Tier 1 capital.
Transfers between categories will be accounted for at fair value.