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Risk Management of Investments in Structured Credit Products

April 30, 2009

Summary

A number of insured banks with portfolio holdings in private label mortgage-backed securities, collateralized debt obligations (CDOs), or asset-backed securities (ABS) are facing heightened losses as a result of significant investments in these products. Certain structured credit products, particularly private label mortgage-backed securities (MBS) and CDOs, have experienced deteriorating collateral performance, price declines, and credit rating downgrades. Management due diligence regarding purchases of these products was often lacking. This Financial Institution Letter reiterates and clarifies existing supervisory guidance on the purchase and holding of complex structured credit products. It focuses on the various supervisory concerns related to these securities: pre-purchase analysis, suitability determination, risk limits, credit ratings, valuation, ongoing due diligence, adverse classification, and capital treatment. 

Highlights

  • Risk management of investments in structured credit products should include adequate due diligence, reasonable exposure limits, accurate risk measurement, an understanding of the tranched structure, knowledge of the collateral performance, and a determination of investment suitability.
  • Institutions should consider credit ratings as a factor in the risk management process; however, credit ratings should not be the sole factor considered when evaluating the risk present in structured credit products.
  • Institutions should have a reasonable, documented, and consistently applied approach to pricing high risk, illiquid, complex structured credit products.
  • Examiners' classification of structured credit products is governed by the guidance in the "Uniform Agreement on the Classification of Assets and Appraisal of Securities." This guidance permits examiners to adversely classify a security when supported by current credit information despite an investment grade credit rating.

Distribution: 
FDIC-Supervised Banks (Commercial and Savings) 

Suggested Routing: 
Chief Executive Officer 
Chief Financial Officer 
Chief Investment Officer 
Chief Risk Officer 

Referenced Guidance: 
Supervisory Policy Statement on Investment Securities and End-User Derivatives Activities, FIL-45-98 
Uniform Agreement on the Classification of Assets and Appraisal of Securities, FIL-70-2004 

Note: 
Paper copies of FDIC financial institution letters may be obtained through the FDIC's Public Information Center, 3501 Fairfax Drive, E-1002, Arlington, VA 22226 (1-877-275-3342 or 703-562-2200). 

Additional Related Topics:

  • Risk-Based Capital Rules
  • 12 CFR Part 325
Attachment(s)
Risk Management of Investments in Structured Credit Products

Last Updated: April 30, 2009