The National Credit Union Administration is struggling with a $23 billion question: what to do with the tanking mortgage-backed securities of two big failed corporate credit unions.

That is the face value of the securities that belonged to U.S. Central Federal Credit Union and Western Corporate Federal Credit Union, which the regulator took over March 20. The securities are now worth little more than half their original value, and their worth continues to decline, the NCUA said.

Also troubling is the fact that a large portion of those securities are made up of risky subprime, alternative-A and option adjustable-rate mortgages. Such securities are falling in value as defaults on the underlying mortgages rise at accelerated rates, according to an analysis of the two credit unions' portfolios provided by the NCUA.

The analysis is based on a review by the Newport Beach, Calif., bond fund manager Pacific Investment Management Co. The review showed that securities backed by the risky mortgages, most of them rated triple-A at purchase, continued to deteriorate over the past two years, forcing many of the ratings down to below investment-grade.

The downgrades have forced down the market values of the bonds, rendering many of them unmarketable and causing holders, like U.S. Central, WesCorp and other corporate credit unions, to mark unrealized losses on their books.

At U.S. Central, 95% of its $35 billion of holdings had a triple-A rating at purchase, but more than half of those holdings — $17 billion — have slid below triple-A, and $11 billion were below investment grade at Feb. 23, according to the NCUA's analysis.

The vast majority of U.S. Central's projected losses are from securities originated in 2006 and 2007, years notorious for poor-quality underwriting.

At WesCorp, the figures were even more stark, the NCUA said. Though 86.5% of the credit union's $23 billion of investments were rated triple-A at purchase, by Feb. 23, 64% of the portfolio — $14.6 billion — had eroded below that level, including $10.7 billion that had fallen below investment grade.

(The NCUA has said it decided to take over WesCorp because the credit union's management team was preparing to report loss figures that were $500 million less than what an external expert hired by WesCorp had estimated.)

The situation has left the NCUA with a Catch-22. It can hold the bonds to maturity — some have as many as 20 years to run — and capture much of the principal and interest. But the accelerating rate of defaults may erode much of the payments stream. Or the NCUA can sell the bonds now at a loss and realize the loss on their books.

"In the immediate term, our plans are maintaining liquidity, so the bonds don't have to be sold," said NCUA Executive Director David Marquis.

Under accounting rules, any losses would have to be recognized when the bonds are sold, Marquis said.

"We can't have that happen."

Another option is the creation of a "bad bank" in which distressed assets like the troubled securities at U.S. Central and WesCorp would be segregated from good assets and worked off over time. The bonds would either held to maturity or sold when market conditions improve.

Marquis said the NCUA's current plan is to revive the two seized corporate credit unions, at least until the regulator's board devises a plan for reforming the corporate system — a process expected to take months or longer.

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