As I've read the various articles and opinions on the financial state of the corporate credit unions I'm struck by the lack of questions about the quality of the corporates' investment portfolio. As I read the comments of the corporate officials and representatives I get the feeling that there isn't complete transparency in their comments. I hope I'm wrong, but I offer up the following questions that I believe if they were answered fully and completely by the corporate credit unions they would clear the air on what is in the corporates' investment portfolios that could cause risk to the corporates and more importantly to their member credit unions in the future.
Question No. 1
Are there any CDOs or SIVs in the corporates' investment portfolio?
The following definitions of CDOs and SIVs come from Wikipedia and give a basic understanding that will be important in the questions to follow:
Collateralized debt obligations are a type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. CDOs serve as an important funding vehicle for fixed-income assets.
A structured investment vehicle is a fund that borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference. SIVs are a type of structured credit product; they are usually from $1 billion to $30 billion in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. A SIV has an open-ended (or evergreen) structure; it plans to stay in business indefinitely by buying new assets as the old ones mature, and the SIV manager is allowed to exchange investments without providing investors transparency/the ability to look through to the structure.
Question No. 2
If the corporates have CDOs or SIVs or any other asset- backed investments on their books, does the underlying structure of the security contain any mezzanine or support tranches from private label mortgage pools? The reason this question is so important is that as mortgages go bad in these pools the losses are absorbed by the mezzanine or support tranches of the private label mortgage pools.
If the corporates have these type of investments in their portfolio and they've seen the price drop on the investments there's a reason. The mezzanine or support tranches are getting eaten up and therefore will be close to worthless. These tranches may still be getting scheduled interest payments but it's only a matter of time before the tranches are eaten up by the losses. Interest payments will cease and the bonds will be totally worthless.
Question No. 3
This is related to question No. 2. If the corporates have investments on their books that are backed by private label mortgages, namely CDOs or CMOs have the credit supports on the investments increased or decreased since the time of purchase? Credit supports are the tranches below your tranche in the mortgage pool. In a well-designed pool the credit supports for the A or AA classes should be increasing throughout the life of the investment because the principal pay down to the A or AA tranches will be greater as a percentage than the loan losses are as a percent of the supporting tranches. If the credit supports are decreasing it could spell trouble for even the A or the AA classes of the structure because the support tranches may be totally eaten away by losses exposing the A or AA classes to potential loss.
Question No. 4
Have any of your investments been downgraded by any of the three major rating agencies in the past year. Note that I said any of the three rating agencies. A common trick by companies trying to hide a problem is to show that their investments haven't been downgraded by one of the rating agencies but they may have been downgraded by one or two of the other agencies.
Question No. 5
Related to question No. 4. When was the effective date of the last rating of all of your private label investments by the three rating agencies? There's so much of this garbage out there that the rating agencies are playing a catch up game trying to get all of the pools rated. If the last rating was sometime in late 2007 that could indicate a problem that hasn't been identified as of yet. Plus the rating agencies are under pressure because they contributed to this mess in a big way by their rating of some of the sub-prime pools.
Question No. 6
What pricing source are you using to value your holdings? If the assets are not being priced by an independent pricing source, then it throws into question the investment valuations presented by the corporates.
The answers to questions two, three and four above are critical. If the corporates have investments that are permanently impaired then they should write them down or off immediately. And don't fool yourself if there are mezzanine tranches or falling credit supports involved then chances are that there's also permanent impairment involved.
Why do I ask these questions? Because I get this feeling that we're not being told all that there is to know about this story. If the corporates have a problem and we're going to be asked to help them recapitalize or even worse if the NCUSIF needs to be recapitalized I'd rather know about it sooner rather than later. And there are a number of credit unions that have such severe problems of their own that they may not survive never mind assisting in a recapitalization of a corporate. These are my reasons for asking these six questions.
Evan Clark, CEO
Department of Commerce FCU, Washington
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