DALLAS — While much discussion regarding subprime lending hasfocused on direct loan portfolio risk, little has been said aboutanother type of balance sheet exposure: mortgage-backedinvestments, which gained in popularity during the real estateboom.

For the record, there's very little, if anything, to worryabout, according to Angela Calvert, partner at ALM First FinancialAdvisors.

“The vast majority of mortgage-backed paper is issued by FannieMae and Freddie Mac, which to date, have never defaulted on amortgage investment. There's an implicit guarantee involved withsuch a transaction, so really, you have two lines of defense. Oneis the mortgage itself, and the other is implicit guarantee by theagency. If they underwrote that pool of mortgages, they areguaranteeing that pool from default,” Calvert said.

Credit unions that invested in private-label securities mayexperience losses, but Calvert said it would be rare for a creditunion to have such an investment in their portfolio.

According to research by California Credit Union LeagueEconomist Terrin Mendivil, if statistics in California can becompared to the rest of the country, risk to credit unions isminimal.

Mendivil said that, according to NCUA statistics, only 6% ofCalifornia credit unions' investment portfolios were invested inmortgage pass-through securities as of March 2007. An additional 6%is in collateralized mortgage obligations (CMOs) or real estatemortgage investment conduits (REMICs).

“I'm unable to determine which level of risk credit unionspurchased, though my guess would be the least risky,” Mendivilsaid. “Most of the news stories about MBS losses are focused on themost risky tranches (AKA investment pools), but it does have thepotential to spill into the less risky tranches.”

Mendivil said California credit unions did purchase commercialmortgage backed securities, but they only amount to about 2% ofinvestment portfolios.

Calvert pointed out that the threat of a loan going bad is notthe only kind of loss credit unions might experience due tosubprime mortgages. Credit unions may also be exposed to risk dueto price fluctuations and a loss of liquidity.

“Liquidity becomes an issue when people no longer want topurchase in that investment class,” Calvert said. “It can bedifficult to get a bid on subprime pieces. Sometimes, you can't geta bid at all.”

The investment expert explained that if a credit union mustliquidate such an asset, and can't get a bid, it has a negativeeffect on capital.

“As bids go away in the mortgage market, it widens spreads,which makes prices decline. So, a security you held a couple ofyears ago has probably decreased in value, because there is lessdemand,” she said.

How much have prices declined? Calvert said a triple-rated CMO,a typical credit union investment, was trading at a spread of 75 tothe curve in the height of the mortgage boom. Recently, suchinvestments closed at 98 to the curve.

“This example is typical of what has happened. There areconcerns with outstanding loans, that even a qualified buyer willnot be able to make payment, especially if the rate adjustsupwards. In fact, we've seen spreads widen more in adjustable rateproducts,” she said.

Additionally, she said, a nationwide decrease in home valueswill hurt the U.S. economy, affecting both lenders andinvestors.

“I think for the past couple of years, people taking equity outof their homes funded economic growth. There are two major concernswith that: first, what was stimulating the economy in 2006 is nothappening this year; and, an even bigger concern for lenders, isthat people who took equity out of their homes may be left upsidedown on their loans.”

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