Investment Services
September Financials Continue to Show Strong Earnings
Through the third quarter of 2008, WesCorp continues, on a cumulative basis, to record strong earnings that exceed planned levels.
WesCorp’s net income for the nine months of 2008 totaled $40.8 million. Net income for September, a modest $115 thousand, was expected as it reflected more than $3 million related to the reversal of income recorded in the previous year's restatement of certain derivative transactions. Through September 2008, WesCorp has recorded $10.7 million of the nearly $13 million anticipated reversals to be recognized during 2008.
In addition, September saw an overall decrease to retained earnings amounting to $477 thousand, comprised of net interest income of $1.6 million and other operating income of $2.8 million, offset by other operating expenses of $4.3 million and PIC dividends of $.6 million. September was adversely impacted by an expense of $6.5 million resulting from a valuation of a derivative hedge that could not attract hedge accounting treatment under FAS133. All of this expense will be reversed in the fourth quarter when the transactions mature. On a year-to-date basis, WesCorp’s increase to retained earnings was $34.9 million, which is well ahead of budgeted amounts by $25.2 million.
Average member balances declined $1.1 billion from August to an average of $17.6 billion for September. This decline is in line with normal seasonal patterns for this time of year, in combination with the increased liquidity needs of our member credit unions. As expected, the normal seasonal inflows started in October, and through the first half of the month, member balances are up ~$300 million over September. In addition to member balances, net interest income continues to show a positive trend, and we expect the fourth quarter to be our strongest quarter in 2008.
On September 25, 2008, WesCorp informed Lehman Brothers that it was in default on outstanding financial derivative transactions with WesCorp. Using the corrective measures prescribed in the International Swaps & Derivative Association (contracts that govern all of these transactions), WesCorp calculated that it owed Lehman Brothers some $3.9 million to cancel and replace these transactions. The amount was subsequently paid to Lehman and the transactions were replaced with a creditworthy party in early 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 September. 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 leveraged funds, continued to make markets nervous, prompting them to react negatively to any bad news that surfaced. Given these conditions, the month of September saw aggregate unrealized losses in WesCorp’s securities portfolio and hedge positions increase to $1.8 billion from $1.7 billion at the end of August. We believe the depressed fair values of these investments are attributable to the dislocation in the securities market caused by the current illiquidity and credit conditions, and not to the underlying credit quality 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 September 30, these securities amounted to $9.4 billion. Of the $1.8 billion of unrealized losses contained in other comprehensive income at September 30, $676 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 EXPECTED TO PERFORM
WesCorp remains very confident that our security holdings will continue to perform to expectations and return principal and interest in full. We continue to internally perform extensive cash flow analysis on a monthly basis using some of the most comprehensive and sophisticated cash flow modeling available. 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.
Given the results of our own internal analysis and the external independent validations to date, WesCorp has not had to recognize anything as other-than-temporarily-impaired in our income statement, in accordance with FASB Staff Position Nos. FAS 115-1 and FAS 124-1.
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.
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—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 September here.
For more information, call a WesCorp account executive today at (800) 442-4366, ext. 6307.