LENEXA, Kansas — Standard & Poor's rating agency recently lowered U.S Central's long-term debt rating to AA+, its second highest, from AAA, its highest. The new rating assignment was “prompted by S&P's concern over values of mortgage-related securities in U.S. Central's investment portfolio,” according to U.S. Central.

The change was preceded by a report in Bloomberg news, stating that U.S. Central took a 2% loss on its total assets by taking a $760 million fourth quarter write-down on the $40 billion in investment securities in its portfolio and that credit unions are ultimately vulnerable to losses on home loans and related bonds. U.S. Central Executive Vice President Dave Dickens termed that take inaccurate. “FASB 115 has three different accounting methods (held-to maturity, available for sale, or trading) Dickens explained. “If we had to sell our total mark-to-market $40 billion portfolio its value would be $1.1 billion less than what we paid for it. While everyone is looking at the difficulties in fixed income securities today, unlike banks, we have ample liquidity.”

U.S. Central announced its strong confidence in the assets it holds, given that 95% of the portfolio consists of “AAA”-rated securities. “U.S. Central is a healthy and profitable financial institution with $2.4 billion in capital as of Dec. 31, 2007, and access to more than $20 billion in available liquidity,” said Francis Lee, president/CEO of U.S. Central.

Essentially, U.S. Central is not in a position yet where it has to sell the securities at a loss. But the larger picture points out how little is actually known about the true value of many collateralized debt obligations that may be owned by U.S. Central or other corporate CUs. S&P said it had “mounting concerns regarding U.S. Central's exposure to losses from its large portfolio of higher-risk subprime and Alt-A mortgage-backed securities.”

Fitch Ratings also cut its outlook on U.S. Central's credit rating to “negative” from “stable,” on concern that the loans underlying the securities might deteriorate. USC stresses its credit strength, nothing that two other leading financial institutions–Bank of America and U.S. Bank–have the same rating, and only one institution, Wells Fargo, has a higher rating of AAA. It may be difficult to know exactly how much exposure lies in the amount of collateralized debt obligations owned by U.S. Central and the corporates. One source noted to Credit Union Times, “Look, the big institutional banks are getting caught in all this mess, I've got to think the corporates bought these things, too.”

Plenty of Liquidity

“This rating is an acknowledgement of the continued strength of U.S. Central's balance sheet and high liquidity position at a time of considerable uncertainty in the financial markets,” said USC of the S&P rating change. As the liquidity source for the corporate network U.S. Central plays a “unique” role and S&P found it to have a “strong funding and liquidity profile, which allows it to continue to hold these securities despite the market value declines.”

U.S. Central also maintains that the “increase in the portion of residential loans that are packaged into mortgage-backed securities or the securitization of home loans of all kinds must be taken into consideration.” USC's explanation:

“These securities generally are structured with subordinated (lower credit-rated) tranches or other credit enhancements that absorb the first losses on any defaulted loans used as collateral before the senior tranches are impacted. The subordinated tranches, with their higher risk and higher yields, have been particularly attractive to investors with higher appetites for risk, such as hedge fund managers. The senior tranches typically are purchased by more risk-averse investors, such as U.S. Central. Meanwhile, the growth in asset-backed commercial paper (ABCP) conduits also has fueled the growth in MBS. These conduits issue commercial paper to investors and then use the proceeds to purchase securities, often MBS. The conduit manager typically earns fees for managing the conduit, or in other ways earns spread income from the conduit. The abundant funding supply provided by hedge funds, ABCP conduits, and other investors has had the effect of increasing the demand for MBS.”

The mega write downs taken by Citicorp and other Wall Street investment banks helped lead to the credit crunch now affecting the markets. Fed by the decline in the housing market over the past summer, the rise in foreclosures, home value declines, and oversupply of homes for sale, MBS markets have been adversely affected, said economic sources contacted for this story. According to USC, “MBS investors began to demand higher spreads on MBS investments relative to U.S. Treasury securities and, correspondingly, the market value of most outstanding MBS declined abruptly.”

When the sell-off in MBS holdings began, the purchase of commercial paper from those ABCP conduits also dropped off. “The previously liquid market of mortgage origination and securitization became illiquid almost overnight. This lack of liquidity has made the valuation of MBS more difficult. Within just a few weeks, what started as a subprime mortgage crisis has evolved into the most severe dislocation in the credit markets in the modern era,” said U.S. Central.

Sandlot

Moody's report on Dec. 13, 2007 said U.S. Central established its own $10 billion extendable asset-backed commercial program called Sandlot Funding LLC. Moody's stated that Sandlot, managed by U.S. Central, was set up as an extension of its balance sheet to provide additional funding capacity to help manage cyclical corporate credit union member deposit flows. As of Sept. 30, the program had $3.8 billion of predominantly high-quality mortgage ABS, about 98% was Aaa. Most of the assets within Sandlot were sourced from U.S. Central's balance sheet. “The current market dislocation within the ABCP market has resulted in sharp rollover pricing increases for virtually all ABCP programs, including Sandlot. Given the decline in investor appetite for extendable ABCP, USC has had to use its own liquidity to bring most of the program's assets back on to its own balance sheet, either by buying the paper as maturities rolled off, or by extending repurchase funding to the program,” said Moody's.

Sandlot Funding LLC did repay all of the outstanding ABCP notes the following day, (Dec. 14, 2007). Following the repayment of the notes, USC asked for the 'A-1+' rating to be withdrawn. Standard & Poor's Ratings Services withdrew that rating on Feb. 6, 2008.

FASB accounting rules make a distinction between “temporary impairment” versus “permanent impairment” allowing a corporate to carry an investment at cost even if its value is lowered. The losses are 'unrealized' or not real losses until the security is sold. But if the rating on underlying assets is downgraded, it becomes not “temporary.”

Dickens said that the ratings on Sandlot were not reduced, but simply withdrawn by request. “Sandlot always had the highest rating, but at our request they stopped rating it because we weren't going to issue any more commercial paper.”

U.S Central now has Sandlot's assets on its balance sheet, and therefore has no assets it needs to fund with the capital markets, added Dickens. That being the case, it was no longer necessary to pay the high-cost of rating Sandlot. The timing of the Moody's report, the repayment of the outstanding ABCP notes, the request to withdraw the Sandlot rating, and the S&P rating declining a notch on USC's portfolio are definitely not related, said Dickens.

According to Moody's, in the third quarter the U.S. Central book “realized impairment” charges of $28 million on a portfolio of “A” rated MBS tranches that resulted in a net loss of $16.9 billion for the quarter. As a result, USC reported year-to-date net income through September totaling $26.6 million, a 48% decline, according to Moody's. The ratings service found the loss not “insignificant” but said the portfolio is relatively small at about $70 million. USC's unrealized securities market losses increased sharply, however, they said, going from $61.5 billion at June 20 to $342 million as of Sept. 30, 2007. Moody's found the quality and intrinsic value of the portfolio to be high.

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