The company said restatements are due to an error in the GAAP accounting treatment for certain of the company's assets -- specifically, credit risk transfer securities issued by government-sponsored enterprises (GSE CRTs) and interest-only strips
of residential mortgage-backed securities that are guaranteed by a US government agency (Agency MBS IOs).
Expect to see more innovation in products in the ETF space that navigate interest rate risks, including those that utilize interest-only strips
that can provide income with a negative duration.
(6) The first is credit-enhancing, interest-only strips
. Schedule HC-S instructions define these strips as:
The guidance addresses the risk-based capital treatment for (1) split or partially rated instruments, (2) nonqualification of corporate bonds or other securities for the ratings-based approach, (3) spread accounts that function as credit-enhancing interest-only strips
, (4) audits of internal credit risk rating systems, and (5) cleanup calls.
Since these residuals, called retained interest-only strips
, are reported on a bank's balance sheet, they overstate the bank's book value if they are overvalued.
For example, the inherent risk for valuation assertions based on assumptions about debt securities whose value fluctuates with changes in prepayments (for example, interest-only strips
) increases as the expected holding period lengthens.
, loans or other receivables, or retained interest in securities that can conceptually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment, should be subsequently measured like investments in debt securities classified as available-for-sale or trading securities under FASB 115.
By the beginning of this year, OAC had originated commercial real estate construction and rehabilitation loans, closing transactions totaling $57.5 million with fundings of $9.5 million; acquired a portfolio of residential interest-only strip
and inverse interest-only strips
(together, IOs), which had a carrying value of $44.5 million; acquired a portfolio of commercial interest-only strips
totaling $6.2 million, plus a number of other assorted deals.
Some of these REITs also are investors in interest-only strips
, which plummet in value in high prepayment situations.
These losses followed earlier reports of public investors who failed to follow diversification practices and invested the majority of their portfolios in risky instruments, such as principal-only or interest-only strips
The guidance addresses risk-based capital treatment pertaining to (1) split or partially rated instruments, (2) nonqualification of corporate bonds or other securities for the ratings-based approach, (3) spread accounts that function as credit-enhancing interest-only strips
, (4) audits of internal credit-risk rating systems, and (5) cleanup calls.
The final rule also imposes a "dollar-for-dollar" capital charge on residual interests and a concentration limit on credit-enhancing interest-only strips
, a subset of residual interests.