ALEXANDRIA, Va. – An analysis by NCUA of the investments held by U.S. Central FCU and WesCorp FCU prior to the March 20 takeover of the troubled corporate credit union giants shows a vast exposure to risky subprime, Alt-A and Option ARM mortgage securities held by the two institutions.
The analysis released Friday and based on the review by bond experts PIMCO shows that securities backed by the risky mortgages, most of them rated AAA at purchase, continued to deteriorate over the past two years as defaults and foreclosures on these types of loans have skyrocketed, forcing down the ratings on many of them to below investment-grade. The exposure of the two roubled corporates became more acute by the end of 2008 by which time 34% of U.S. Central's and a whopping 79% of WesCorp's investments were in mortgage-backed securities, according to NCUA.
At U.S. Central, where 95% of its $35 billion of holdings were rated AAA at purchase, more than half of those holdings–a staggering $17 billion worth-had slid below AAA, while almost a third, $11 billion worth, were below investment grade at Feb. 23.
The vast majority of U.S. Central’s risk and projected losses are from securities originated in 2006 and 2007, said NCUA. Of the 2006 and 2007 originated securities, the risk is concentrated in securities backed by subprime, Alt-A, and Option ARM loans.
At WesCorp, the figures were even more stark, according to NCUA. While 86.5% of the corporate’s $23 billion of investments were rated AAA at purchase, by Feb. 23, 64% of the portfolio–$14.6 billion–had eroded below that, with 46.5% of the holdings, or $10.7 billion having fallen below investment grade.
NCUA said its decision to take over WesCorp was based on the fact the management of the corporate giant was preparing to report loss figures that were $500 million less than what an external expert hired by WesCorp had estimated. "WesCorp’s senior management," reported NCUA, "was prepared to report an OTTI number based on the lower internal analysis estimate."
After the March 20 takeovers, NCUA Chairman Michael Fryzel said NCUA was no longer confident that the financial information the two corporates were providing the regulator was reliable.
In its report, NCUA explained as the yields in other investments started to decline, all corporates began to load up on mortgage-backed securities in 2003, so that by 2007 35% of all corporate investments were in MBSs. The federal regulator became alarmed and issued a directive in mid-2007 for corporates to stop buying private-label MBSs, those not guaranteed by a government agency, like Fannie Mae or Freddie Mac.
"During the time frame in which corporate credit unions were investing more heavily in mortgage related securities, significant changes were taking place in the mortgage industry. The use of sub-prime, Alt-A, and interest only mortgage loan products grew at a very rapid rate. These loan products were packaged into the private label MBSs that were being marketed at an increasing magnitude in 2006 and 2007," wrote NCUA.
While the MBS were mostly rated AAA during this period, "no reliable historical data existed relating to the performance of the sub-prime and other types of loans that were originated in a period of rapid home price increases and relaxed underwriting criteria," explained the regulator. "As such, ratings did not prove to be a reliable means of determining the quality of these securities.
"Since late-2007, analysis of these securities has been based on actual performance of the underlying assets and projected future performance. This has led to very significant downgrades in the (Wall Street) ratings of many of the securities held by corporate credit unions. The downgrades had the most severe impact on the portfolios of WesCorp and U.S. Central."
Beginning in mid-2007, credit and liquidity issues associated with sub-prime mortgages began to surface. By the end of 2007 and into early 2008, what started out as a sub-prime mortgage problem spread to Alt-A loans, Option ARM loans, and finally to prime mortgage loans, NCUA explained.
Additionally, mortgage delinquencies were increasing, foreclosures rates began to rise, housing prices were declining leading to lower recoveries, and confidence in the markets dropped significantly. As a result, the market for mortgage related securities became inactive. Corporate credit unions with significant levels of investments in mortgage related securities faced two critical issues as a result of the inactive market: liquidity and market value losses.
