By : Steven Marlin | May, 20 2009
Banks are being urged by regulators to pay closer attention to structured credit products in their portfolios, including mortgage-backed securities, collateralized debt obligations, and asset-backed securities.
In a letter to bank executives, the FDIC said banks face heightened losses as a result of significant investments in these products.
“The letter serves as a reminder to banks that they need to pay attention to risk policies and procedures surrounding structured credit products,” David Barr, an FDIC spokesman, told Markets Media Thursday.
Structured credit products, particularly MBS and CDOs, have experienced deteriorating collateral performance, price declines, and credit rating downgrades.
When appraising structured credit products, bank examiners have the authority to adversely classify a security despite it having an investment grade rating.
“The requirement that valuation modeling should be independent and unbiased, periodically validated, understood by users, and available for supervisory review will lead a greater number of institutions to get outside third-party valuations of their positions,” Espen Robak, president of Pluris Valuation Advisors, told Markets Media. “Through an outside appraisal, the institution will ensure independence – plus have a report available when outside reviewers ask.”
The FDIC told banks that risk management of investments in structured credit products should include adequate due diligence, reasonable exposure limits, accurate time measurement, understanding of the tranched structure, and investment suitability.
As such, banks shouldn't rely solely on credit ratings when evaluating the risk present in such products. Banks should have a reasonable, documented, and consistently applied approach to pricing high risk, illiquid, complex structured credit products.
