CMBS Market Is Offering CUs Promise Of Diversification

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A year after NCUA opened the faucet to the commercial mortgage-backed securities (CMBS) market, credit unions have been slow to wade into the water.

But at least one credit union has dipped its toe in and found the CMBS market inviting.

"We have bought some short-duration commercial MBSs," confirmed Christopher Sullivan, chief investment officer for United Nations FCU, of the recently approved investments for natural-person CUs.

The NCUA rule, approved in May 2003, allows Reg-Flex-eligible credit unions to invest up to 50% of their net worth in commercial mortgage-backed securities that are Triple A rated.

Diversification Opportunity

The commercial-backed securities give credit unions another way to diversify their holdings, while providing the potential for a little bit more yield than traditional residential mortgage-backed securities, long popular among CUs.

Sullivan, who directs a portfolio of about $1.1 billion, said so far he's invested about $15 million in CMBSs.

Returns Can Be Rewarding

The returns can be rewarding, while making for a good diversification play, he said. For example, some CMBSs with an average life of around five years will provide a 4% return. Another issue held by the credit union, with an average life of around three years, is yielding 3.77%.

There is broad protection for the purchaser, Sullivan noted. First, the rules require that the securities be Triple A-rated. And, unlike the residential MBS market, the purchaser is generally protected from prepayments because the underlying loans have severe penalties for prepayments. The purchaser of the first tranche is protected from defaults, which are absorbed by the lower quality tranches. The pricing is good, too, because the market is broad, with wide participation from banks, insurance companies and other institutions, explained Sullivan."This will be a product we will be returning to," said Sullivan.

Fannie Mae Option Popular

Another CMBS that has gained in popularity is the delegated underwriting and servicing (DUS) Balance MBS issued by Fannie Mae. While more broadly traded CMBSs are created from a pool of commercial loans, the DUS Balance is generally created from a single loan (usually on a multi-family residential property).

These CMBSs have become more popular for CUs because Fannie Mae has been marketing the funding of multi-family projects to banks and S&Ls as a way to comply with their Community Reinvestment Act requirements.

According to Frank Santucci, director of asset/liability management at credit union bond house First Empire Securities, these securities are popular for their yields-as much as 100 basis points over comparable Treasuries-and their safety, too. They are guaranteed by Fannie Mae, there are large prepayment penalties on the loans, significantly reducing prepayment risk, and there are no partial prepayments because the are based on a single loan.

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