Recently, U.S. Central has received its share of headlines regarding our financial performance during 2007 and the impact it has had on our debt ratings from Standard & Poor’s (S&P), Moody’s and Fitch. But despite these headlines, one point remains clear: As the only wholesale corporate credit union, U.S. Central is an important investment alternative and liquidity provider to its member corporates.
In fulfilling this role, and as possibly envisioned by our founders, we have provided an effective buffer to our corporates from much of the disruption in the credit markets; and in doing so, we have not been immune to the impact of the market dislocation. Recently, S&P moved our debt rating from “AAA” to “AA+”. To put this in perspective, U.S. Central shared this “AAA” rating from S&P with only one other depository institution–Wells Fargo. Presently, we share S&P’s second-highest rating of “AA+” with only two other domestic depository institutions–Bank of America and U.S. Bank.
While the high ratings assigned by the three rating agencies are a validation of our strength and stability, my purpose in writing this letter is to attempt to clarify the events that occurred in 2007, which have generated recent press and caused confusion among credit unions.
Reasons For Reduction
Our unaudited year-end financials, (audited expected in April), show net income for 2007 substantially below 2006. The reduction in earnings is principally attributable to $96 million in unusual investment related charges, some realized and some unrealized. These charges were partially offset by an additional $40 million in net interest income (compared to 2006). U.S. Central’s unusual investment charges consisted of three main components, discussed below.
At the beginning of this market dislocation, we implemented an isolation strategy after detecting abnormal deterioration in collateral performance of securities in our $40 billion portfolio. Our analysis projected deterioration in 19 bonds that would more than likely result in a permanent impairment. With this strategy, we recognized through income a loss of $38 million, leaving a remaining principal balance of $66 million on these bonds.
U.S. Central had established an Asset Backed Commercial Paper (ABCP) conduit, for the purpose of generating fee income as well as adding an additional source of liquidity. In 2007, that market dried up. Like most conduits, it was required to be consolidated onto the balance sheet. Upon consolidation onto U.S. Central’s balance sheet, these assets were recorded at their fair market value with a charge against U.S. Central’s earnings equal to their unrealized loss, or $31 million. This loss will be accreted to income over the remaining life of the securities (approximately five years) in a similar manner as an investment security purchased at a discount.
U.S. Central recorded a $27 million unrealized loss due to declining market values of securities classified for accounting purposes as trading. Unlike securities classified as available-for-sale, market value changes on trading securities are recorded as income or loss immediately (even if the security has not been sold). The affected securities are rated “AAA” with a very strong ongoing credit profile.
Of the total unusual charges of $96 million, only the $38 million in write-downs represent permanent losses. The other $58 million represents unrealized losses that U.S. Central believes will be recovered as the markets stabilize or as the assets approach maturity. These unrealized losses are not expected to have a material impact on U.S. Central’s profitability in the future.
Additionally, as is the case with all market participants, the unrealized losses on available-for-sale securities have increased significantly during the same time period. The unprecedented credit spread widening in all fixed income markets resulted in accumulated other comprehensive income/(loss) (AOCI) increasing to an unrealized loss of $1.14 billion at December 31, 2007, representing 48% of capital. Such unrealized losses or gains in available-for-sale securities represent temporary mark-to-market adjustments related to the current market for such securities, and are not permanent changes in equity. We have the intent and ability to hold these securities until their maturity.
‘High-Performance’ Securities
By design, U.S. Central historically has and will continue to invest in senior classes of high-performing securities. We rely on an experienced nine-member credit and market risk management team with an average of 17 years of experience dedicated solely to monitoring our investments on a continued basis. The team applies rigorous pre-purchase and ongoing reviews of all the assets in our portfolio, which includes stress-testing and analysis of delinquencies and defaults based on current performance data from monthly remittance reports. This level of due diligence gives U.S. Central confidence in the assets that we hold, on top of the fact that 95% of the portfolio consists of “AAA” rated securities, with an additional 4.6% in “AA” rated securities.
U.S. Central remains one of the most highly rated depository institutions in the United States by the three most prominent rating agencies. It has a strong capital level of approximately $2.4 billion and ample resources to provide liquidity to its members–with approximately $3.5 billion in cash and equivalents available and access to more than $20 billion in liquidity.
We thank our member-owners of the Corporate Network for their ongoing confidence and support. Rest assured that U.S. Central will utilize our resources and explore all avenues to manage through these market conditions.
For more information, please contact your corporate representative or visit U.S. Central’s Web site at uscentral.coop.
Francis Lee, President/CEO
U.S. Central, Lenexa, Kan.
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