In one of the most vivid examples of the potential pitfalls of mortgage-backed derivatives, officials of a small New York credit union are claiming that mortgage prepayments eroded the value of their interest-only strips so much that it cost the credit union more than half its $3.2 million investment.

The losses, estimated at more than $1.6 million, 18% of the total investment portfolio, forced the $17 million Tobay Credit Union in Syosset, N.Y., to merge with Nassau County Credit Union.

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