How Will Corporates' Bonds Perform?
But how will U.S. Central and other corporate loss estimates stack up against real losses?
One corporate executive, requesting anonymity, told Credit Union Times that one U.S. Central member spoke out against possible future write-downs of remaining member capital accounts during a Sept. 14 conference call. Due to GAAP accounting rules, once a bond is permanently impaired, it can't be written back up if it performs better than anticipated. Likewise, U.S. Central told its members, once the wholesale's member capital shares are gone, they're gone for good, no matter how well the portfolio performs.
Any gains above loss estimates will go back on U.S. Central's books as an asset. However, members will still face the task of recapitalizing U.S. Central, assuming it survives corporate restructuring.
When the NCUA applied other-than-temporary impairment charges to U.S. Central and Western Corporate FCU after the two institutions' conservatorships, the agency based the figures on future credit losses.
U.S. Central's base estimate losses were $2.2 billion, according to the NCUA's May 1 weekly corporate credit union update. After applying a $2.3 billion OTTI as of March 31, U.S. Central's paid-in capital was completely exhausted, and member capital shares were impaired 63%.
Four months later, those estimates still hold.
However, the top to bottom, optimistic to pessimistic loss estimates varied widely. The NCUA said Clayton estimated actual losses would be as low as $600 million or as high as $6.5 billion, depending upon actual investment performance.
Additionally, Clayton's WesCorp loss estimates varied widely. The NCUA-controlled WesCorp took a $5.8 billion OTTI as of March 31. However, actual losses could be as low as $3 billion or as high as $7.9 billion.
CUNA Chief Economist Bill Hampel said the future performance of local housing markets will determine actual corporate losses.
"Everybody wants to know when the losses will come and how much they will be, but the reality is, nobody will know until the future becomes the present," he said. Unfortunately, GAAP accounting requires credit unions to record estimated losses now, he added.
Hampel said the housing market is performing better than was predicted earlier this year, and added he thinks the worst markets have already bottomed out.
"The housing market is definitely leveling off," Hampel said. "But whether it's enough to protect corporate-owned bonds, I don't know."
However, he did express "some room for optimism" that bonds owned by U.S. Central and WesCorp will perform as expected, and the NCUA's loss estimates will hold true.
When asked how the NCUA expects the economy to perform and what effect it might have on corporate bonds, the Office of Corporate Credit Unions official Scott Hunt said economic forecasting is not the regulator's business.
However, Hunt said until housing markets in the sand states of California, Nevada, Arizona and Florida stabilize, mortgage-backed securities owned by corporates will experience "continued pressure."
Hunt said he will know more about the state of corporate investments next month, after Clayton Holdings delivers valuation reports to many corporates. U.S. Central Chief Financial Officer Kathy Brick said her shop anticipates releasing its third-quarter Clayton report around Oct. 31.
In an April 10 summary of distressed corporate securities, the NCUA reported that both U.S. Central and WesCorp invested heavily in bonds backed by in 2006 and 2007 vintage alt-A and option ARM loans, and those securities represented the greatest risk and loss projections.
Credit unions aren't privy to the specific economic benchmarks used by Clayton or PIMCO to estimate corporate bond performance. This information is considered proprietary.
According to a Federal Reserve Web site (www.newyorkfed.org/mortgagemaps), as of June 2009 there were more than two million alt-A mortgages. Predictably, California leads the nation with more than 600,000 Alt-As, and also the highest percentage of Alt-As, with 37.6 per 1,000 housing units. One-third were underwritten as interest-only payments, and almost as many had negative amortization.
With an average age of 39 months, many California Alt-As have reset to full principle payments within the last 12 months, and it shows in foreclosure figures: only 4.4% have foreclosed, but another 11.6% are in foreclosure, and almost 13% are 90 days or more past due. Only 63% of California Alt-A loans are current.
As bad as those statistics sound, they are consistent with national figures. Nationwide, 3.2% of Alt-A mortgages have been foreclosed upon, with another 10.3% in the pipeline. Nine percent are 90 days or more past due, and 69.5% are current.