Investment Services
July Financials Show Strong Results
On a cumulative basis, through the first seven months of 2008, WesCorp continues to record strong financial results with YTD earnings well exceeding plan.
For the month ended July 31 an overall increase to retained earnings was recorded amounting to $5.4 million, comprised of net interest income of $10.3 million and other operating income of $2.7 million offset by other operating expenses of $7.0 million and PIC dividends of $0.6 million.
The increase to retained earnings for July 31 was $5.4 million (after distribution of PIC dividends), which is above plan by $1.9 million. On a year-to-date basis WesCorp’s increase to retained earnings was $30.0 million, which is ahead of budgeted amounts by $22.8 million.
Average member balances declined $1.7 billion from June to an average of $20.1 billion for July. This decline is in line with normal seasonal patterns for this time of year.
Liquidity Remains a Key Strength
Liquidity remains one of WesCorp’s key strengths, giving us the ability to ride out the severe dislocations in the credit markets. 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 July. With continuing news of major problems in mortgage loans, the viability of FNMA and FHLMC came under severe scrutiny. Their stock dropped precipitously causing a rushed Governmental support plan to be implemented. Despite the passing of the support plan, pressure continued, and, although both agencies were able to issue debt, their spreads to Treasury widened. As concern 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. This only adds to the problems if willing house buyers with good credit standings are not able to raise financing. All the adverse news, coupled with continued forced liquidations by leveraged funds, has continued to make markets nervous and react negatively to any bad news that comes along.
Given these conditions, the month of July saw aggregate unrealized losses in WesCorp’s security portfolio and hedge positions increase to $1.6 billion from $1.4 billion at the end of June. WesCorp believes the depressed fair values are attributable to the dislocation in the securities market caused by the current illiquidity and credit conditions and not the underlying credit quality of our holdings. Although the securities we hold in our portfolio continue to perform well and retain their high ratings, the portfolio continues to be impacted by the overall mentality that’s been paralyzing the markets for some time. As WesCorp has the ability and intent to hold these investments until a price recovery occurs or maturity, these investments are not considered by management to be other-than-temporarily impaired.
In March, WesCorp re-designated $9.7 billion in securities, formerly classified as “Available-for- Sale,” to “Held-to-Maturity.” At July 31, these securities amounted to $9.5 billion. 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 re-classification more accurately reflects WesCorp’s intent and ability to hold them to maturity.
Two CDO holdings that total $197 million and had been downgraded below regulatory minimums in January 2008 remain in the AFS account. We had not received approval from the NCUA to continue to hold them in time for a reclassification and therefore could not clearly demonstrate the ability to hold them to maturity. In May, we received that approval from NCUA. As of June month-end seven additional holdings totaling $189 million were also downgraded below regulatory minimums. Internal and external analyses project that these holdings will pay principal and interest in full even under stressed economic conditions. Again, approval is being sought from the NCUA to retain these holdings.
Security Holdings Expected to Perform to Expectations
WesCorp remains extremely confident that all of our security holdings will continue to perform to expectations, and return principal and interest in full. We continue to perform extensive cash-flow analysis on a monthly basis using some of the most comprehensive and sophisticated cash-flow modeling available. WesCorp’s 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 had 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 internal analysis and the external independent validations, WesCorp has not had to recognize anything as “other-than-temporarily-impaired” (OTTI) in our income statement, in accordance with FASB Staff Position Nos. FAS 115-1 and FAS 124-1.
Level 3 Pricing
WesCorp moved to Level 3 pricing, in accordance with SFAS 157, on parts of our portfolio at the end of March because market conditions caused some of the external pricing services that were in use to become unreliable, as evidenced by erratic and inconsistent pricing among similar securities. Those conditions persist today. The Level 3 pricing schema was discussed with the NCUA and our 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 Position Remains Strong
Liquidity remains at a premium in the marketplace as most financial institutions are trying to manage their capital, leverage positions and risk positions.
So far these adverse market conditions have not had a major affect on WesCorp. WesCorp continues to position its balance sheet to be long cash on any given day, thereby resulting in being a net lender in the overnight markets. On July 31, WesCorp had placed approximately $3.8 billion in various money market instruments such as fed funds, repurchase transactions, Eurodollars, and our overnight account at U.S. Central.
While most credit sources remain open to WesCorp, the cost of accessing these sources has gotten marginally more expensive. WesCorp continues to work to minimize its borrowing costs while striving to maintain as many credit sources as possible.
The bulk of WesCorp’s funding comes from our strong relationships with our member/owners and ready access to a wide range of wholesale funding sources. On July 31, WesCorp had just under $9 billion in borrowings from the wholesale markets. These borrowings, primarily longer-term borrowings, come from the $1.25 billion in issuance of its medium-term notes, and $6.0 billion in term borrowings from the Federal Home Loan Bank. Short-term borrowings, such as fed funds and repurchase agreements, totaled only $1.6 billion. Our borrowings from the Federal Home Loan Bank consist of floating-rate term borrowings “laddered” to mature on a monthly basis over the next 13 months. The Federal Home Loan Bank continues to be a very cost effective borrowing source.
WesCorp has a number of unused sources of borrowings including a $1.2 billion advised line of credit from U.S. Central, the unused portion of our $2.0 billion Global Medium Term Note Program, $3.0 billion additional capacity at the FHLB under our cap, access to the repo markets, and a number of Federal Funds lines from other financial institutions.
Extensive Expertise Means Added Value
Along with liquidity, the extensive expertise of our portfolio managers and investment professionals are bringing added value not only to our strength but also to our team effort, day in and day out.
They foresaw the turbulent waters in advance, altered the portfolio strategy, and curtailed activity in the sub-prime mortgage sector at the end of 2005, subsequently shifting purchases to only AAA rated investments and focusing on higher-quality Prime, Alt-A and CMBS investment sectors. That keen foresight helped strengthen the position we maintain today.
Financial Strength and Stability
At a time when all financial institutions find their balance sheets and portfolios saddled by market volatility, it’s good to know that WesCorp has been conservative in managing the balance sheet, following prudent investment strategies that enable us to weather the financial storm. While the depth of the financial crisis is unprecedented in recent history, our conservative management approach has been vindicated through the confirmations of independent third-party reviews by companies such as RiskSpan and Moody's Investors Service. After all, the trust you place in us requires that we do no less.
You are our strength, and the solidarity you show by your continued confidence and trust in WesCorp will ultimately be seen as the defining edge of success for our financial cooperatives during this market dislocation.
You can find an online copy of WesCorp's financial statement for July here.
For more information, call a WesCorp account executive today at (800) 442-4366, ext. 6307.