U.S. Central, WesCorp Portfolio Summaries Show a Growth in Risk

The NCUA’s April 10 corporate credit union update included a summary of its analysis of distressed securities held by U.S. Central FCU and Western Corporate FCU.The report showed U.S. Central and WesCorp suffered from ratings declines, and WesCorp additionally took hits on its own strategy of investing in increasing concentrations of mortgage-backed securities.In 2003, the corporate system as a whole invested 24% of its portfolio. That number rose steadily to 37% by 2008. U.S. Central’s exposure vacillated, from 33% in 2003 down to 27% in 2005, and back up to 34% by 2008.WesCorp had far more exposure to MBS. In 2003, MBS made up 40% of the San Dimas, Calif-based corporate’s portfolio; that number had nearly doubled to 79% by 2008.Historically, MBS had been good investments for corporate credit unions. However, the NCUA report said that between 2003 and 2008, the mortgage market changed, with more subprime, Alt-A and interest-only loans available to consumers.Despite the increased risk profile, the two corporates didn’t break any NCUA rules or regulations. Almost all had AAA or AA ratings as assigned by the nationally recognized statistical rating organizations, the NCUA said, which were the standard for determining investment quality.The NCUA’s announcement provided an example of the mismatch, for example, more than one-third of WesCorp’s securities were mezzanine securities backed by Alt-A and Option-ARM loans. Based on WesCorp’s $23 billion portfolio, that represents more than $7.5 billion of subordinate securities that absorb losses before senior securities within the same bond structure.“Despite this support role, these securities were rated AAA (or equivalent) at purchase,” the NCUA report stated. It cited Moody’s estimates that the securities will lose between 20% and 30% of their original balance.“Furthermore, many mezzanine securities are expected to take losses in excess of 50% of remaining principal due to their first loss position,” the report said.Credit ratings have plummeted within both corporates’ portfolios since purchase. U.S. Central purchased 94.4% AAA-rated investments, but by Feb. 23, 2009, only 45.3% were still rated AAA. Even worse, nearly one-third of the portfolio has slipped below investment grade.The majority of U.S. Central’s securities are non-agency MBS, with the vast majority of risk and projected losses from securities originated in 2006 and 2007, and backed by subprime, Alt-A, and Option-ARM, or negative amortization, loans.Of WesCorp’s investments, 86.5% were AAA at time of purchase, with the remaining 13.5% rated AA. However, as of Feb. 23, a staggering 46.5% had slipped to noninvestment grade; comparatively, only 36.3% of WesCorp’s portfolio is rated AAA. In addition to the mezzanine securities, WesCorp also invested in collateralized debt obligations and subprime.The NCUA expanded upon accusations that WesCorp management favored its own projections over those of its external auditors, which included popular credit union audit firm RiskSpan.“WesCorp’s own external vendor analysis resulted in a credit loss estimate more than $500 million greater than WesCorp’s internal estimates,” the report stated of year-end 2008 financials. “Furthermore, the credit-loss projections for these securities made by WesCorp’s external vendor were within a range of $175 million of the credit-loss projections made by NCUA’s outside vendor. WesCorp’s senior management was prepared to report an OTTI number based on the lower internal analysis estimate.”Additionally, the NCUA wrote that of WesCorp’s approximately 950 individual securities within its investment portfolio, its own filtering process determined that 253 securities had the potential to be assessed other-than-temporary impairments. However, only 44 of the 253 were subjected to external vendor analysis.“Between the internal and external analysis performed, ultimately 47 of these 253 securities were determined to have OTTI as of Dec. 31, 2008. Comparison of results between WesCorp’s internal analysis and the external, independent analysis implies that had WesCorp externally modeled a greater portion of its investment portfolio, credit loss projections would have been greater resulting in greater OTTI charges,” the report stated.Although he declined to discuss the matter in detail, saying “a battle with the NCUA isn’t productive for credit unions,” former WesCorp Chief Investment Officer Robert Burrell said there was “no conspiracy” among WesCorp executives to “make the numbers look better than they were.”The 12-year WesCorp veteran, who said he’s never been unemployed before, defended his investment reporting, calling it “very transparent,” and saying WesCorp’s portfolio was “constantly scrutinized” by the NCUA’s in-house examiner, and outside audit firms.Burrell stressed what NCUA Executive Director David Marquis said during the agency’s March 23 Webinar discussing WesCorp and U.S. Central FCU’s March 20 conservatorships: a small difference in modeling can result in big variations given the size of investment portfolios.Burrell said he still stands by his numbers, though he said he understands why the NCUA would tend toward more conservative modeling. A regulator’s job is to safeguard the industry; retail corporates also have the added expectation to produce returns for their members, he said.“Everybody wants to be reasonable, and that’s certainly what the folks at WesCorp tried to do,” he said.Have the accusations tarnished the WesCorp brand? NCUA spokesman John McKechnie said no. He credited the corporate deposit guarantee at both institutions and the NCUA’s “hold to maturity” strategy, which he said the agency intends to stick to.“Finally, both conserved corporates have continued normal operations throughout, something that is not affected by whatever information becomes public regarding the prior management,” McKechnie said.Furthermore, liquidity remains stable in both institutions, as he said “there seems to be a growing awareness that the overall cost of the recovery will increase if liquidity becomes problematic.”The NCUA has initiated several communication efforts with WesCorp members recently, including a conference call with the California/Nevada Credit Union League the first week in April, a series of calls with small credit unions mid-month, town hall meetings in May with CEO Phillip Perkins.–[email protected]