Investment Services
Third Quarter 2008 Portfolio Update Now Available
Click here for an in-depth look at WesCorp's Third Quarter 2008 Investment Portfolio.
October Financials
Through ten months of 2008, WesCorp continues to record strong earnings that exceed planned levels. WesCorp’s net income for the ten months of 2008 totaled $48.6 million. For the month ended October 31, an overall increase to retained earnings was recorded amounting to $7.4 million, comprised of net interest income of $13.4 million (which includes $78.8 thousand of gain on financial assts) and other operating income of $2.8 million offset by other operating expenses of $8.4 million and PIC dividends of $.4 million. This was $3.2 million above budgeted levels.On a year-to-date basis, WesCorp’s increase to retained earnings is $42.3 million, which is ahead of budgeted amounts by $28.4 million. Net interest income continues to show a positive trend, and we expect the fourth quarter to be our strongest quarter for earnings in 2008.
As expected, the normal seasonal liquidity inflows started in October and average member balances were up $384.5 million over September to an average $18.0 billion in October.
MARKETS REMAIN IN TURMOIL
Despite continued efforts by the Federal Reserve and the Treasury Department to restore a sense of normalcy to the markets, investor confidence remained fragile throughout the month of October. With continuing news of major problems in mortgage loans, the viability of FNMA and FHLMC came under severe scrutiny. Their stock dropped precipitously, causing the government to implement a rushed support plan. Despite the passage of this support plan, pressure continued and, although both agencies were able to issue debt, their spreads to Treasury widened. As concern grew for the ability of consumers to service their debt, it was reported that more than 66 percent of banks tightened credit availability on all credit products including mortgages and credit cards. All the adverse news, coupled with continued forced liquidations by leverage funds, continued to make markets nervous, prompting them to react negatively to any bad news that surfaced.
Given these conditions, the month of October saw aggregate unrealized losses in WesCorp’s securities portfolio and hedge positions remain sizable. However, third party adjustments to our benchmark pricing model resulted in a modest improvement to $1.7 billion from $1.8 billion at the end of September. We believe the depressed fair values of these investments are largely attributable to the dislocation in the securities market caused by the current illiquidity and credit conditions, and do not accurately reflect the underlying credit quality and likely performance of our holdings. Although the majority of WesCorp’s portfolio continues to perform well and retain its high ratings, the overall mentality that has been paralyzing the markets for months continues to exert a negative impact. Since WesCorp has the ability and intent to hold those investments most impacted until a price recovery occurs or until maturity, those investments are not considered by management to be other-than-temporarily impaired (OTTI).
In March, WesCorp redesignated $9.7 billion in securities, formerly classified as available-for-sale, to held-to-maturity. At October 31, these securities amounted to $9.3 billion. Of the $1.7 billion of unrealized losses contained in other comprehensive income at October 31, $653 million of that amount was related to held-to-maturity securities. These securities represent WesCorp’s entire holdings of mortgage securities backed by Alt-A collateral and the bulk of WesCorp’s CDO holdings. Both of these markets remain highly illiquid and this reclassification more accurately reflects WesCorp’s intent and ability to hold the securities to maturity, as well as the lack of an active market in these sectors.
SECURITY HOLDINGS PERFORMANCE
WesCorp continues to perform extensive cash flow analysis on the majority of our holdings on a monthly basis using some of the most comprehensive and sophisticated cash flow modeling available. Additional impairment testing is carried out on a Quarterly basis. Our Investment Credit Department, which reports directly to the Supervisory Committee, also monitors and evaluates the credit performance of each security on an ongoing basis.
In addition, WesCorp has been very proactive in seeking external validation of our own due diligence. As the credit crisis began to accelerate last Fall, we utilized both major Wall Street dealers and a company called RiskSpan to perform independent analysis on our most credit-sensitive holdings. RiskSpan is a provider of leading-edge analytics to sophisticated investors, and its models provide highly differentiated analysis based on individual loan characteristics. Modeling factors are based on empirical performance data and take into account individual borrower characteristics, regional home price variations and the impact of mortgage insurance. RiskSpan has provided WesCorp with both initial evaluations and ongoing monthly analysis on more than 139 securities.
As the housing market and economic expectations continue to deteriorate, the modeling assumptions have been adjusted accordingly. While the most recent analysis performed by RiskSpan on our collateralized debt obligations (CDO) holdings still has them returning principal and interest in full, the credit support has been eroded. As a result, we may record other-than-temporary impairment (OTTI) related to certain of our CDO holdings at some point in the future, given the continuing deterioration and the stressed market environment. We own a total of ten CDO securities that total $550 million, just slightly more than two percent of our entire portfolio. If the results of our internal and external analysis indicate that it is probable we will not collect all of the principal and interest contractually due, we will record losses in accordance with appropriate accounting standards.
LEVEL 3 PRICING
Because market conditions caused some of the external pricing services that were in use to become unreliable, as evidenced by the erratic and inconsistent pricing among similar securities, WesCorp moved to Level 3 pricing on certain sectors of our portfolio at the end of March, in accordance with SFAS 157. Those conditions persist today.
The Level 3 pricing schema was discussed with NCUA and WesCorp’s external auditors, and is based on the actively traded ABX and CMBX indexes and on observable inputs for credit spreads based on Bloomberg Loss Coverage Ratios. Loss coverage ratios are widely used by investors to evaluate existing holdings and potential acquisitions. They appear to be the predominant driver of prices in today’s markets. During September, we engaged an outside consulting firm, Protiviti, to perform a review of the methodology and process used to determine Level 3 valuations for WesCorp’s portfolio, and based upon the draft report received from Protiviti, the process was found to be reasonable and could be independently validated.
LIQUIDITY
WesCorp’s primary liquidity comes from the ongoing support of our members. Additional external funding sources include Federal Home Loan Bank borrowing programs, Global Commercial Paper/Medium Term Note programs, access to the Federal Reserve Bank Discount Window, an advised line from U.S. Central, repurchase agreements, and various federal funds lines.
In addition, to ensure that adequate liquidity is available to the credit union system, the NCUA announced, on October 16, the creation of a guarantee program for new unsecured borrowings for corporate credit unions. This program, similar in nature to the program the FDIC launched for banks, will protect various forms of debt issued between October 16, 2008 and June 30, 2009. Any debt issued under this program will be insured by the NCUSIF until June 30, 2012.
EXTENSIVE EXPERTISE
At a time when all financial institutions find their investment portfolios saddled by market volatility, we at WesCorp continue to draw on our extensive experience and expertise. We consistently apply shock tests along with the most advanced analytics in managing our portfolio. Independent, third party companies such as RiskSpan and the large Wall Street investment banks are also tapped to confirm our findings and conclusions. The trust you place in us at WesCorp requires no less dedication from our team of seasoned professionals.
You are the strength of WesCorp. The solidarity you show by your continued confidence, trust and support of us—your corporate credit union; our financial cooperative—will ultimately be seen as the defining measure of success for WesCorp and all our member credit unions in weathering the current market dislocation.
Once again, we thank you for your continued trust and support.
You can find an online copy of WesCorp's financial statement for October here.
For more information, call a WesCorp account executive today at (800) 442-4366, ext. 6307.