The sub-prime lending crisis, which began in mid-2007, sharply raised the number of mortgage defaults and home foreclosures. The crisis has widened since then, restricting access to consumer and commercial credit, reducing corporate earnings, slowing consumer spending, and threatening to push the U.S. into recession.
While sub-prime-related losses have been concentrated within those mortgage-backed and asset-backed securities that are not issued by government agencies, other types of fixed income securities have been affected because credit conditions in general have worsened. These include SIV-issued debt, municipal auction-rate securities and bonds with direct or indirect exposure to monoline bond insurers.
Throughout this developing crisis, TIAA-CREF’s fixed income and guaranteed accounts have had, and have maintained, low exposures to sub-prime securities and other types of fixed income securities that have been the focus of investor concern. As of April 15, 2008, losses or impairments as a result of such holdings have remained within very limited levels, reflecting the depth of fundamental credit analysis TIAA-CREF applies in the selection of all securities purchases.
TIAA General Account and TIAA-CREF Fixed-Income Accounts—Holdings Details. To address investor concerns about credit market conditions, we are providing a detailed description of our exposure to each type of fixed income securities that has been the focus of concern.
Sub-Prime Mortgages
Background: The effect of increasing mortgage defaults has been most directly seen within those mortgage- and asset-backed securities that are not issued by government agencies. A disproportionate share of sub-prime mortgage-related losses has been concentrated within a class of securities known as ABS CDOs (Asset-Backed Securities Collateralized Debt Obligations). These securities are, in many cases, made up of pools of lower quality mortgages and/or home equity loans. As credit conditions have deteriorated, these lower-quality loans have experienced high default rates.
TIAA General Account: Please note that no investor can invest in the TIAA General
Account. Our current holdings in the sub-prime area are generally of high quality
(largely AAA and AA rated) and represent a very small percentage (approximately 2%-
3%) of the General Account’s holdings. More importantly, the General Account has
extremely limited exposure to ABS CDOs; this consists of only two positions, which are
not meaningful given the size of the General Account. Sub-prime-related downgrades
have affected 57 securities with a total value of $275 million (less than one – fifth of 1%
of assets). These downgrades have been balanced to some extent by upgrades of 51 sub-
prime securities with a total value of $221 million.
CREF Bond Market, Inflation-Linked Bond, and Money Market accounts: Sub-prime holdings within the CREF Bond Market Account are generally of high credit
quality and represent approximately 4% of account assets. Although the Bond Market Account has realized no principal losses as a result of sub-prime holdings, the account has sustained 13 downgrades of positions totaling $101 million (representing less than 1% of account assets). The Bond Market Account has no exposure to ABS CDOs. Twelve of the thirteen downgrades occurred due to the downgrade of monoline insurers providing policies on the BMA positions. To a large extent, purchases of insurance-wrapped securities are based on the credit quality of the underlying issuer and not on the degree of credit enhancement provided by insurance in place.
The CREF Inflation-Linked Bond and Money Market accounts have no sub-prime-related exposure and no ABS CDO holdings.
SIV-Issued Commercial Paper
Background: During the fourth quarter of 2007, concern over commercial paper (short-term debt securities) issued by entities known as structured investment vehicles (SIVs) reached high levels. These securities faced liquidity problems because many of them had exposure to mortgage-backed securities.
SIVs typically issue short-term, asset-backed commercial paper and use the capital raised to buy to short- and medium-term floating rate debt holdings, including mortgage-backed securities. Prior to the onset of sub-prime-related problems, SIV-issued debt was frequently purchased by money market funds and other holders of short-term securities.
The deteriorating credit quality of SIVs caused some money market funds to incur losses, but a larger-scale crisis was averted when a number of SIV assets were absorbed onto related bank balance sheets and existing SIV-issued commercial paper matured.
TIAA General Account and CREF Bond Market, Inflation-Linked Bond and Money Market accounts: Previous holdings of SIV-issued commercial paper have matured, and the TIAA General Account and the CREF Bond Market, Inflation-Linked Bond, and Money Market accounts currently have no exposure to SIV-issued commercial paper or other SIV-related debt. In addition, none of our accounts or funds have sustained any losses or impairments related to SIV-issued securities.
Monoline Bond Insurers
Background: Monoline bond insurers guarantee the timely repayment of a bond’s principal and its interest; the term “monoline” refers to the fact that these insurers operate within single industries. As the credit crisis has deepened, attention has focused on monoline bond insurers facing possible credit downgrades because they lack sufficient capital to cover the bonds they insure. Such downgrades could have cascading effects across a wide range of insured bonds and thus cause extensive credit market disruptions. Recently, concerns over some of the larger bond insurers have subsided somewhat with the announcement of various plans to restructure bond insurer assets and raise additional capital.
TIAA General Account and CREF Bond Market, Inflation-Linked Bond, and Money Market accounts: Direct exposure to bond insurers and exposure to insured (or insurance wrapped) securities within the TIAA General Account represent less than 3% of the account’s assets, the majority of exposure related to insurance-wrapped holdings.
The CREF Bond Market Account has no direct exposure to bond insurers, although approximately 3% of its holdings consist of insurance-wrapped securities. The Inflation-Linked Bond and Money Market accounts have no exposure to bond insurers or insurance-wrapped securities. To a large extent, purchases of insurance-wrapped securities are based on the credit quality of the underlying issuer and not on the degree of credit enhancement provided by insurance in place.
TIAA-CREF Institutional Mutual Funds—Tax-Exempt Bond Fund: Approximately 49% of the Tax-Exempt Bond Fund holdings are insured. This relatively high level of insurance-wrapped bond exposure reflects the prevalent use of bond insurance as a means of credit enhancement in the municipal bond markets. By comparison, approximately 44% of the fund’s benchmark index, the Lehman Brothers 10-Year Municipal Bond Index are insurance-wrapped. As indicated above, purchases of insurance-wrapped securities are based on the credit quality of the underlying issuer and not on the degree of credit enhancement provided by insurance in place.
Municipal Auction-Rate Securities
Background: Municipal auction-rate securities are a type of debt security that has a long-term stated maturity but pays an interest rate that is reset at frequent intervals through auctions typically held every 7, 28, or 35 days. Because of the frequent auctions and rate resets, auction-rate securities generally pay interest rates that are tied to short-term rates.
Due in part to concerns over the credit quality of monoline bond insurers that commonly insure auction-rate securities issues, a number of municipal auction-rate securities have failed to find buyers in some recent auctions, causing interest rates for some of these securities to increase sharply. Disruptions within this market have caused some auction-rate security issuers to seek alternative means of financing and have caused concerns among holders of those securities about reduced liquidity in this class of investments.
The higher interest rates being paid on certain auction-rate securities issues, many of them with a high credit quality, have been drawing increasing interest from investors seeking the high relative value offered by selected auction-rate issues.
TIAA General Account: The TIAA Traditional Account holds approximately $39 million of municipal auction-rate securities, all of them purchased during recent weeks to take advantage of the higher yields recently available within this class of securities. The decision to purchase these securities was made based on the credit quality of the issuing entities, in accordance with TIAA’s stringent credit requirements and was not based on any credit enhancement (such as that provided through bond insurance) associated with the securities purchased.
CREF Bond Market, Inflation-Linked Bond, and Money Market accounts: The CREF Bond Market Account holds approximately $16 million of auction-rate securities. These holdings were purchased under similar circumstances as described above for the TIAA General Account and following thorough credit analysis of the purchased securities. The Inflation-Linked Bond and Money Market accounts have no exposure to auction-rate securities.
Commercial Mortgage-Backed Securities (CMBS)
Background: In recent weeks, reduced availability of credit and concern about the vulnerability of commercial real estate properties in an economic downturn have resulted in a sharp increase in the yields of commercial mortgage-backed securities (CMBS). While these higher yields indicate higher expected default rates among such securities, commercial real estate fundamentals (e.g., property valuations, occupancy rates and rental growth) remain sound, and CMBS delinquencies remain at historically low levels.
TIAA General Account: Commercial mortgage-backed securities holdings represent approximately 13% of the General Account’s holdings. Our CMBS portfolio is
defensively positioned, with an emphasis on high-quality issues that are diversified across various dates of issue.
CREF Bond Market, Inflation-Linked Bond, and Money Market accounts: Commercial mortgage-backed securities holdings represent approximately 5% of the CREF Bond Market holdings, while CREF Inflation-Linked Bond and Money Market Accounts contain no CMBS holdings.
Commercial mortgage-backed securities (CMBS) are a type of bond backed by mortgages on commercial, rather than residential, real estate. CMBS issues are comprised of pools of commercial mortgages and are often structured into multiple tranches, or classes of holdings, that may vary with respect to duration, yield, or credit quality of the underlying mortgage loans. CMBS are subject to interest rate, income, and credit risks.
Asset-backed securities collateralized debt obligations (ABS CDOs) are a type of asset-backed security and structured credit product. CDOs gain exposure to the credit of a portfolio of fixed income assets and divide the credit risk among different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added risk. CDOs serve as an important funding vehicle for portfolio investments in credit-risky fixed income assets. ABS CDOs are subject to interest rate risk and pre-payment/extension risk as well income risk and credit risk.
Investing in the fixed income accounts listed above involves a number of risks, including interest rate risk, income volatility risk, credit risk, prepayment and extension risk, illiquid security risk, and foreign investment risks.
Please note that holdings of the Accounts discussed above are subject to change. This document speaks as of the date specified above.
The CREF Money Market Account is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although each Fund seeks to preserve the value of your investment, it is possible to lose money by investing in these Funds.
You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877-518-9161 or log on to www.tiaa-cref.org for a current prospectus that contains this and other information. Please read the prospectus carefully before investing.
TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., Members FINRA, distribute securities products.
Annuity products are issued by TIAA (Teachers Insurance and Annuity
Association), New York, NY.
© 2008 and prior years, Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), New York, NY 10017
