Credit Unions in trouble

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I wish it were not so, but it is increasingly obvious that every part of the financial sector in the United States is infected by this menacing plague of credit losses and writedowns. Now it comes to light that the five biggest U.S. credit unions have lost so much on residential mortgage-backed securities that it has wiped out their entire equity base.

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The Wall Street Journal has issued a damning report today which suggests that losses at credit unions are large.

Five of the nation’s largest credit unions are reporting big paper losses on mortgage-related securities, a sign that housing-market distress is spreading even to the most risk-averse financial sectors.

The federal regulator overseeing credit unions says the losses are likely to be reversed when mortgage markets stabilize, and that the institutions are sound and adequately capitalized. But some outside observers are concerned that the credit unions are underestimating the depth of their mortgage-market problems.

[Banking Alternative]

“This is a serious situation,” says Gerald Hanweck, a finance professor at George Mason University, who studies the banking industry and is a visiting scholar at the Federal Deposit Insurance Corp. Mr. Hanweck believes the five firms have sufficient access to funding to handle a deeper downturn, but he worries that perceptions of added risk could lead to a run on one or more of them.

Credit unions are not-for-profit, member-owned cooperatives that take deposits and lend money like banks. The mortgage problems are focused on so-called corporate credit unions, which are key players in the industry. They don’t deal directly with consumers, but provide investment services and financing to regular credit unions, which do.

The five corporates showing big mortgage-related losses, according to federal regulatory filings, are U.S. Central Federal Credit Union; Western Corporate Federal Credit Union; Members United Corporate Federal Credit Union; Southwest Corporate Federal Credit Union; and Constitution Corporate Federal Credit Union. Together, they reported about $5.7 billion in “unrealized” losses as of the end of May, the filings indicate. Unrealized losses happen when the market value of a security falls, even if it hasn’t been sold.

Credit unions in general are among the most conservatively run financial institutions in the U.S. That some are showing strains indicates that almost no financial sector is immune from the mortgage meltdown that has caused widespread carnage among commercial banks and on Wall Street. Financial-services firms have already taken writedowns of more than $300 billion in connection with the mortgage mess.

WSJ, 11 Aug 2008

The Wall Street Journal doesn’t take off the kid gloves here because $5.7 billion wipes these credit unions out. Housing Wire gets more to the point, also suggesting that some are trying to hide these losses.

Corporate credit unions aren’t consumer facing, but provide investment services and financing to more regular credit unions nationwide.

The $5.7 billion in losses on paper are enough to wipe out the net worth of each of the five credit unions, the Journal said; aggregate negative equity after accounting for so-called “unrealized” losses on the RMBS securities is $2.9 billion, although that total doesn’t account for membership capital, or the float of funds tied to regular credit unions.

A shell game?
The most explosive allegations in the Journal’s story, however, are that the two credit unions absorbing the biggest RMBS hits — U.S. Central FCU and Western Corporate FCU — are using accounting tricks to potentially hide further losses. The games being played here aren’t all that different from what’s being observed in other sectors, but take on new significance because credit unions don’t have ready access to new capital, a la Merrill Lynch & Co. and others.

Both credit unions earlier this year reclassified a huge chunk of their assets as “held for investment,” moving them out of the more traditional “available for sale” accounting category; it’s a shift that the federal regulator overseeing credit unions said had never been done in the industry’s past. It’s also a shift that means any valuation changes that are deemed temporary in nature don’t have to be recorded against income.

By June, U.S. Central had placed $10.9 billion of its $35.3 billion in investments into the “held for investment” category, according to the Journal, while Western Corporate has moved one-third of its total investments — $9.6 billion — into the same category. Both moves came as the secondary markets locked up and the companies say they decided it would be better to hold the assets until maturity (or they realized they’d never be able to sell an illiquid asset, take your pick).

But how much of the current depressed valuations of subprime and Alt-A — even the AAA-grade stuff — can honestly be considered “temporary?” At what point is an other-than-temporary permanent impairment charge warranted?

In our view, the two credit unions in question might be the last holdouts on Earth at this point still adamantly saying their securities will recover in value at some point, or that they’ll be able to hold them to maturity. More than a few commercial and investment banks strutted the same point out roughly two quarters ago, and have since abandoned the line of thought as the mess has come into clearer view.

Housing Wire, 11 Aug 2008

Read these stories again. What we have here are financial institutions that are effectively bankrupt. Were they to sell these assets and take the loss, they would have to be declared insolvent. The NCUA (the Credit Union’s equivalent of the FDIC) would have to step in. For some, this may come as no surprise. However, this event only represents the tip of the iceberg of what is lurking out there in hidden losses, not just at financial institutions, but at Pension Funds and Mutual Funds as well.

The regulators are nonplussed about the whole affair. The Wall Street Journal says:

Kent Buckham, director of the office of corporate credit unions for the National Credit Union Administration, the federal regulator, says the mortgage investments held by corporate credit unions are safer than many that are causing havoc on Wall Street, and are very likely to rebound in value. In his view, the paper losses reported by the corporate credit unions reflect unrealistically low market values for mortgage investments, in part due to investor nervousness about the sector. He says he doesn’t expect the firms will have to sell those assets at “fire-sale prices.”

I thought credit unions were supposed to be conservative institutions — apparently not. In my view, This is just the type of wishful thinking and loss aversion I wrote about a couple of days ago. It’s only a matter of time before the Grim Reaper comes calling for some of these financial institutions. Uninsured depositors should rightly start to become worried at this state of affairs.

The U.S. Government needs to hive off these bad debts into a Resolution Trust Corporation
like entity NOW before we see more bank runs and systemic risk. The longer Bush & co. dither, the greater the likelihood for an disorderly unwind.

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