Cap Corp was one of the nation's largest corporate credit unions when it failed in January 1995 and was placed in conservatorship by the NCUA. A historical cost "hold to maturity" accounting methodology obscured the effects of rising interest rates on CapCorp's investment portfolio, which had almost 70% of assets in CMOs-an MBS derivative security.
Processing Content
As interest rates increased in 1994, the CMOs included on Cap Corp's balance sheet extended and declined in value. Rather than liquidating these investments at a loss to meet member withdrawals, Cap Corp borrowed in excess of regulatory limits, further leveraging its balance sheet. Eventually, the NCUA stepped in.
The approximate $60 million in losses incurred by Cap Corp were borne entirely by its member credit unions. Neither credit union members nor the Share Insurance Fund lost a dime.
The fiasco raised appropriate concerns about the amount of interest rate risk being assumed by credit unions and the role of CMOs in portfolios. The Government Accounting Office (GAO) cited several additional contributing factors, including the lack of effective risk management and board oversight at Cap Corp, poor examination and supervision on the part of the NCUA, and inadequate capital requirements for corporate credit unions.
Characteristics of Mortgage-Backed Securities
Attractive yields available
High credit quality (AAA rating)
Deep markets with good liquidity
But, "hidden" negative convexity risk
