Nearly half of U.S. Central Federal Credit Union's $2.2 billion base-case loss estimates can be attributed to subprime mortgage-backed securities, while the other half is split between alt-A, negative amortization and home equity backed bonds.

So reveals Clayton IPS' first-quarter 2009 U.S. Central portfolio valuation, obtained by Credit Union Times. The report provides detail about how far U.S. Central strayed from agency securities, and how much those investment decisions contributed to corporate stabilization costs.

Subprime, alt-A and negative amortization mortgage-backed securities composed about 75% of U.S. Central's nearly $20 billion MBS portfolio. Prime or agency securities represented only about 10%. Another 10% was invested in second-lien and home equity backed securities, and the remaining 5% was classified “other,” and included commercial mortgage-backed securities.

The NCUA revealed April 10 U.S. Central's mortgage backed portfolio was predominantly nonagency but stressed that nearly 95% of the securities were rated AAA at time of purchase. Despite those stellar ratings, nearly half of U.S. Central's MBS are projected to suffer losses, Clayton reported.

Actual losses aren't expected to peak until early 2011, when principal and interest distribution will also peak. A number of “interdependent economic variables” will determine if the estimates hold true, Clayton said; in particular, home price appreciation will have the greatest impact.

Loss estimates vary widely when comparing optimistic to pessimistic scenarios, from a best-case $500 million write-down to a worst-case loss of nearly $6.5 billion. Clayton's pessimistic scenario reflects an additional 20% loss in home values, a national unemployment rate around 15%, and further distress to financial markets. Additionally, pessimistic scenarios include the failure of all monoline insurers.

The optimistic scenario includes home prices bottoming in 2009 and unemployment generally remaining below 10%. Optimistic losses were predominantly in subprime, alt-A and negative amortization bonds. Home equity backed investments would suffer less than $10 million in write downs, and agency bonds would incur no write-downs whatsoever.

Though pessimistic loss estimates are nearly three times those of base cases, Clayton's methodology reveals the firm included rather pessimistic assumptions in its base-case modeling. The firm cited a nearly 50% default rate on modified mortgages and Freddie Mac and Fannie Mae's end to foreclosure moratoriums in April as evidence that losses could increase further.

Though seasoned alt-A fixed and conforming asset pools have experienced more than 20% voluntary prepayments, 2006 and 2007 vintage alt-As continue to deteriorate.

Vintage negative amortization securities are also performing better than 2006 and 2007 origination pools, with voluntary prepayments decreasing. Clayton had little good to say about negative amortization securities, also called option ARMs; the firm even questioned if loss projections should be increased when loans recast to amortizing payments because homes are so far upside-down in markets where the product was most popular, such as California.

Second-lien or home equity bonds have performed the worst of all MBS, Clayton said, because many of the whole loans backing them served as down payments for subprime or alt-A mortgage deals.

Natural person credit unions had little reaction to the news, saying U.S. Central's concentration risk is water under the bridge now that credit unions have already covered corporate stabilization costs.

Erick Orellana, president/CEO of the $87 million Nikkei Credit Union, said he hasn't decided yet if he will request a copy of the Clayton reports. Orellana said the information has the potential to help credit unions determine how corporates should “change direction” in the future, but it won't help balance sheets today.

“If the information would allow us to change the decisions that have already been made, I'd be the first to sign up for it,” he said. “But as a mid-sized credit union with only 12 staff members, including myself, we have better uses for our time.”

Sue Longson, president/CEO of the $62 million Sonepco Federal Credit Union, agreed. “To be honest, I haven't even given it any thought,” she said when asked if she will request Clayton reports from the NCUA. “We're too busy trying to be one of the trees left standing.”

Longson, whose credit union is headquartered in hard-hit Las Vegas, said she doesn't think U.S. Central or WesCorp strayed from their missions or the credit union philosophy when they invested so heavily in nonagency securities.

“Looking back, sure, perhaps the concentration risk wasn't good, but hindsight is 20/20,” Longson said. “We could bring that question back to the credit union level and ask, would I still have offered an A borrower a 100% loan-to-value home equity line? Would I have given a 15-year employee with a 750 credit score a $10,000 credit card limit? Absolutely, even though we're charging those kinds of loans off now.”

Members of corporate credit unions asked for high yields, Longson said, so credit unions shouldn't “throw stones” at any corporates for doing exactly what members asked of them.

Rod Staatz, president/CEO of State Employees Credit Union of Maryland, applauded the NCUA's decision to release the Clayton reports, commending the agency for improved transparency. Staatz is leading an effort by CUNA roundtable credit unions to raise money to fund an independent database and valuation of some of U.S. Central and WesCorp's riskiest securities. He said despite the release of the Clayton reports, the group is still pursuing its goal so credit unions will have the benefit of “more than one voice.”

Staatz said the roundtable credit unions haven't “dropped everything” to pursue the database, because the project is long-term.

“We're taking our time, this isn't a short-term issue,” he said.

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