[Federal Register Volume 59, Number 25 (Monday, February 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-2726]


[[Page Unknown]]

[Federal Register: February 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33546; File No. SR-PTC-92-16]

 

Self-Regulatory Organizations; Filing of Proposed Rule Change by 
Participants Trust Company Relating to Margin Levels for Collateralized 
Mortgage Obligations

January 31, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 28, 1992, the 
Participants Trust Company (``PTC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
primarily by the self-regulatory organization. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The purpose of the proposed rule change is to allow PTC to 
establish margin levels on Collateralized Mortgage Obligations (``CMO 
security'' or ``CMO'') currently eligible for deposit or which may 
become eligible for deposit at PTC by formula as follows:
    Each time a CMO security initially is deposited at PTC, PTC's 
management will set the margin level for each tranche of that CMO 
security (``CMO tranche'') at a percentage which exceeds the CMO 
tranche's maximum two-day downward price volatility, based on a model 
which assumes: i) A change in prepayment speeds based on a sustained 
change in interest rates; and ii) the largest historic two day movement 
in the yield of the underlying Treasury security.\2\ Margin on CMO 
tranches which cannot be modeled by an independent pricing source will 
be set at 100%.
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    \2\The latter assumes:
    A 35 basis point upward shift in the underlying Treasury 
security for CMO securities which exhibit ``positive effective 
duration'' (i.e., rise in value with falling interest rates) (letter 
from Michael D. Frieband, Senior Vice President & Chief Financial 
Officer, PTC, to Judith Poppalardo, Assistant Director, Division of 
Market Regulation (``Division''), Commission, and James Hodgetts, 
Assistant Vice President, Federal Reserve Bank of New York 
(``FRBNY''), amending the original proposed use of a 25 basis point 
upward shift in the underlying Treasury security); or
    A 50 basis point move in the underlying Treasury 
security for CMO securities which exhibit ``negative effective 
duration'' (i.e., decline in value with falling interest rates).
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

    The proposed rule change would allow PTC to establish a method for 
calculating the percentages (i.e., margin) to be deducted from the 
market value of CMO securities, as distinguished from GNMA securities, 
currently eligible for deposit or which may become eligible for deposit 
at PTC. Currently, the only CMO securities eligible for deposit at PTC 
are VA REMICs.\3\
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    \3\A REMIC is a Real Estate Mortgage Investment Conduit. VA 
REMICs are securities for which the full and timely payment of 
principal and interest is guaranteed by the United States Department 
of Veterans Affairs and backed by the full faith and credit of the 
United States government.
    The Commission approved VA REMICs, guaranteed by the United 
States government, as eligible for deposit at PTC in Securities 
Exchange Act Release Nos. 30792 (June 10, 1992), 57 FR 27495, and 
31914 (February 24, 1993), 58 FR 12295.
    Subsequent to its initial filing, PTC submitted additional 
information concerning the method by which margin for VA REMICs will 
be calculated. See letter from Leopold S. Rassnick, Vice President & 
General Counsel, PTC, to Ester Saverson, Branch Chief, Division, 
Commission (January 12, 1993) (containing prospectuses for VA REMIC 
issues 1992-1 and 1992-2, PTC internal analysis entitled ``Margins 
in Collateralized Mortgage Obligations,'' and sales literature from 
Trepp Pricing Services, Inc. (``Trepp'') entitled ``CMO/REMIC 
Valuation Methodology''); letters from Michael D. Frieband, Senior 
Vice President & Chief Financial Officer, PTC, to Judith Poppalardo, 
Assistant Director, Division, Commission, and James Hodgetts, 
Assistant Vice President, Federal Reserve Bank (June 11, 1993, and 
July 1, 1993) (containing data comparing actual CMO prices to Trepp 
predicted prices); letter from Michael D. Frieband, dated August 17, 
1993, supra note 2 (containing additional volatility information).
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    PTC requires its participants to maintain Net Free Equity of zero 
or greater in each of their agency, pledgee transfer, or proprietary 
accounts in order for transactions to be processed. Net Free Equity 
represents PTC's calculation of the amount of excess equity, available 
in a participant's account, which PTC may borrow against or liquidate 
in the event a participant's debit balance is not satisfied at the end 
of the day. Under Article II, Rule 9 of PTC's Rules, a certain 
percentage, as determined by PTC (``Applicable Percentage''), of the 
market value of securities is included in the computation of Net Free 
Equity. Net Free Equity is calculated as the sum of:

    (a) The cash balance;
    (b) The Applicable Percentage of the market value of securities 
in the account;
    (c) The value of the optional deposits to the Participants Fund 
which are allocated to that account;
    (d) 20% of the mandatory deposits to the Participants Fund for 
the master account; and
    (e) Reserve on gain.

    The Applicable Percentage is determined by deducting certain 
percentages (i.e., margin) from the market value of securities. By 
including only a portion of the market value of securities in Net Free 
Equity, PTC attempts to limit the risk caused by fluctuations in the 
market value of these securities. For GNMA securities (other than 
construction loan, project loan, and mobile home), margins are set at 
5%, which is a rate that exceeds their largest historic consecutive 
two-day downward price movement.
    Unlike GNMA securities, CMO securities are structured as a series 
of tranches or classes. Each tranche within a CMO is a separate 
security with unique characteristics, such as differing payment 
schedules and price volatility. In addition, historical price data, to 
determine volatility, exists for GNMA securities, whereas historical 
price data to determine CMO securities' volatility does not yet exist. 
For CMO securities, therefore, PTC has developed a model utilizing the 
yield on Treasury securities to predict the potential movement of a CMO 
tranche based on the rise or fall of interest rates. Under PTC's model, 
the largest two day movement for CMO tranches which exhibit positive 
effective duration was a 35 basis point upward move in the underlying 
Treasury securities. For CMO tranches which exhibit negative effective 
duration, the largest two-day move was a 50 basis point downward move 
in the underlying Treasury security. For CMO tranches which cannot be 
modeled, PTC will set the margin at 100% (i.e., the Applicable 
Percentage will be zero). PTC proposes to establish the margin for each 
CMO tranche based on this method, rather than assigning a specific 
percentage for CMO securities, because each CMO security has unique 
characteristics. Without historical information, such as that available 
for GNMA securities, PTC believes the use of an analytical model is the 
best method to determine the expected volatility of a CMO tranche. The 
margin for each CMO tranche will be set by PTC management, on the basis 
of the stated analysis and formula, as the CMO tranche is deposited in 
PTC.
    Since the proposed rule change provides for the safeguarding of 
securities and funds within PTC's custody or control or for which it is 
responsible, PTC believes it is consistent with Section 17A of the Act 
and the rules and regulations thereunder applicable to PTC.

B. Self-Regulatory Organization's Statement on Burden on Competition

    PTC does not believe that the proposed rule change will impose any 
burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    PTC has not solicited, and does not intend to solicit, comments on 
this proposed rule change. PTC has not received any unsolicited 
comments from participants or other interested parties.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:

    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street, NW., 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of PTC. All submissions 
should refer to File Number SR-PTC-92-16 and should be submitted by 
February 28, 1994.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2726 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M