August 19, 1987

TO THE CHIEF EXECUTIVE OFFICER OF THE STATE CHARTERED BANK ADDRESSED:

We have received numerous inquiries from bankers, investment brokers, and attorneys concerning the permissible investment authorization by state banks in collateralized mortgage obligations, commonly referred to as CMOs. Based upon Iowa Code Section 524.901(2)(a) (1987), we had determined that CMOs were limited to 20 percent of the state bank's capital and surplus, both on an individual issue basis and on an aggregate parent entity basis. Since that initial determination, we have had an opportunity to review Public Law 98-440 entitled the "Secondary Mortgage Market Enhancement Act of 1984" (SMMEA). This federal law defines "mortgage related securities" and authorizes investments in "mortgage related securities" to the same extent existing federal and state laws allow obligations issued by or guaranteed as to principal and interest by the United States or any agency or instrumentality thereof to be invested in by depository institutions. After consultation with a representative of the Attorney General's Office, we have determined that CMOs meet the definition of "mortgage related securities" and thus have concluded that a state bank may invest, without limitation, in any CMO rated in one of the two highest rating categories by at least one nationally recognized statistical rating organization. Any investment in unrated CMOs or CMOs rated below the two highest grades will continue to be limited to 20 percent of the state bank's capital and surplus on an individual or aggregate parent entity basis.

Additionally, based upon our interpretation of the Act, we believe SMMEA also preempts state law as it relates to investments in Federal National Mortgage Association (FNMA) securities and Federal Home Loan Mortgage Corporation (Freddie Mac) securities. While state banks have been permitted to invest in obligations issued by FNMA without limit, pursuant to Iowa Code 524.901(1)(c) (1987), state banks were limited to 20 percent of capital and surplus in investments in obligations issued by Freddie Mac. In essence, SMMEA preempts Iowa law by authorizing state banks to invest in obligations of Freddie Mac without limitation.

In closing, please be mindful that this letter has addressed the permissible investment authorization of collateralized mortgage obligations, FNMA securities and Freddie Mac securities by state banks and has not attempted to address the quality considerations of these issues or the appropriateness of these issues for a particular bank's investment portfolio. We would recommend that a complete analysis of the risks associated with the investment be performed by the state bank on an independent basis. Also, since SMMEA has taken the liberty to preempt Iowa's safety and soundness banking statutes, we would strongly suggest that the principle of risk diversification be exercised by all state banks.

Sincerely,

Steven C. Moser
Deputy Superintendent

krb