June 18, 2012 / RB 2012-02
Guidance on Commercial Mortgage-Related Securities
Introduction
Credit unions have long been authorized to invest in mortgage-related securities issued by federal government-sponsored enterprises. Recently a question arose whether this authority includes commercial mortgage-related securities issued by a federal government-sponsored enterprise. This Bulletin discusses the authority to invest in certain commercial mortgage-related securities and provides safety and soundness guidelines applicable to these securities.
Interpretation
Generally, 7 TAC Section 91.803 provides that credit unions may not purchase commercial mortgage-related securities. Section 124.351 of the Finance Code and 7 TAC Section 91.802, however, authorize credit unions to invest in securities issued by federal government-sponsored enterprises such as the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).
Title 7 TAC Section 91.802(a)(10) incorporates United States Code Annotated, Title 15, Section 78c(a)(41)’s definition of mortgage-related security, which includes securities issued by an entity, other than a federal government-sponsored enterprise, backed by mortgages secured by real estate upon which is located a dwelling, mixed residential and commercial structure, residential manufactured home, or commercial structure. Reconciling the authorization of 7 TAC Section 81.802 with the prohibition in 7 TAC Section 91.803, a credit union is prohibited from purchasing commercial mortgage-related securities of an issuer other than a federal government-sponsored enterprise. Conversely, a credit union may purchase a commercial mortgage-related security issued by a federal government-sponsored enterprise.
Safety and Soundness Considerations
While this investment is permitted, it may not be suitable for every credit union. When selecting commercial mortgage-related securities consistent with safety and soundness, credit unions must carefully analyze the underlying commercial mortgages and corresponding collateral, as well as analyzing the cash flow, credit structure, and market performance of the security. As with all investments, credit unions must understand and be capable of managing the risks associated with commercial mortgage-related securities before purchasing them. 7 TAC Section 91.802 requires a credit union’s board of directors to develop investment policies that address credit, liquidity, interest rate, and concentration risks. Policies must also identify investment characteristics that are suitable for the credit union. Credit unions that purchase commercial mortgage-related securities must develop sound risk management policies and construct limits that represent the board’s risk tolerance.
Conclusions
Credit unions may invest in commercial mortgage-related securities issued by a federal government-sponsored enterprise but these investments require the same sound investment policies and practices as other investments. In brief, the board of credit unions purchasing commercial mortgage-related securities should:
- diversify these investments by type, maturity, and degree of risk;
- follow investment strategy that includes an asset-liability and rate sensitivity analysis;
- deal with established, financially sound, and reputable broker/dealers;
- determine that proper safekeeping of securities is maintained; and
- monitor investments continually, review management performance, and determine compliance with policy.