Fed Funds and Libor Spread Bolsters Corporate Financials

SAN DIMAS, Calif. — Western Corporate filed September financials that just barely crossed into the black, recording a slim $115,000 net income for the month.

WesCorp is still enjoying a healthy revenue stream, thanks to the spread between the Fed funds rate and Libor that is boosting all corporates this year, but the $27 billion institution took both expected and unexpected lumps on the investment side of the books at quarter-end.

In the unexpected category, WesCorp was forced to end its swap derivative business with Lehman Brothers, which declared bankruptcy Sept. 15. Swaps are agreements between two parties to exchange cash flow based on the values of the underlying assets on specific, agreed-upon future dates. So, depending upon underlying values, one party is either owed, or conversely owes, money to the other party.

When Lehman Bros. went under, WesCorp had to settle up, paying $3.9 million to unwind the swap and place it with another party, said Chief Financial Officer Jim Hayes. The way swaps work, that $3.9 million will come back to WesCorp when the contract matures, he said.

Not unexpected was a $3 million income reversal related to a 2006 audit, in which certain hedge positions did not qualify for hedge accounting treatment under current SFAS 133 guidelines. As a result, WesCorp added income to 2005 and 2006 statements it knew it would have to reverse in 2007, 2008 and 2009. Most of it was turned around in 2007, Hayes said, leaving about $13 million to reverse in 2008 and another $10 million in 2009. As of Sept. 30, WesCorp has reversed $10.7 million of the $13 million expected for 2008, which means it will reverse the remaining $2.3 million at December month-end.

WesCorp also recorded $6.5 million of derivatives expense related to a short-term derivative transaction. However, because this transaction matures before the end of the year, the $6.5 million will reverse at that time and is simply a timing difference, Hayes explained.

Hayes said he's remaining hopeful that the accounting powers that be will make modifications to fair value standards. WesCorp has not taken any other-than-temporary impairments–contrary to rumors that corporates are hiding OTTI losses in the pipeline, hoping accounting standards will change before they are forced to report them–Hayes said that is not the case at WesCorp.

“We continue to monitor our portfolio for other-than-temporary impairment and would record such losses when they became known as required by accounting guidelines,” Hayes said. “We don't anticipate losses in the fourth quarter, but the continued deterioration of the markets obviously impacts our portfolio, so we are keeping a close watch on the situation.”

Liquidity is holding steady, with WesCorp's borrowed funds slightly lower than last month by about $100 million, though the corporate did tap its new Fed discount window line for the first time in September. Total shares are down, with the decline being attributed to both the seasonal and special liquidity needs at natural person credit unions.

On a positive note, WesCorp's retained earnings increase is $10 million ahead of budget year-to-date.

On the other hand, the $10 billion Southwest Corporate has been preparing members for OTTI losses since Lehman declared bankruptcy Sept. 15, by sending out executives to meet with members in person, addressing the subject in monthly financial Webcasts and again during its economic forum in late October. Southwest Corporate reported a $24.7 million other-than-temporary impairment.

The charge weighed on month-end net loss numbers, but, again thanks to the Fed-Libor spread, Southwest said it has nearly made it all up in additional year-to-date net interest income, which is up more than $23 million over this time last year.

All told, Southwest is currently $20 million in the black so far this year, and according to Senior Vice President/Chief Financial Officer Melissa Wardell, the corporate expects to finish 2008 with strong earnings.

“We anticipate our year-end capital ratio to exceed 6.50% and year-end retained earnings ratio to exceed 3.00%. This compares to December 2007 capital and retained earnings ratios of 5.57% and 2.50% respectively,” she said.

Southwest has increased its outstanding borrowings at the Federal Home Loan Bank of Dallas over the past year, with $1 billion outstanding at month-end compared to $755 million for same period last year. However, the corporate has a total credit line of $2.3 billion at the FHLB, so it's got plenty of additional liquidity to spare. Southwest did access the central liquidity facility in September, to the tune of $100 million as of Sept. 30.

The $1.6 billion corporate's financials aren't normally categorized with larger aggregates like WesCorp and Southwest Corporate. However, when Fitch Ratings placed Constitution on watch negative this past spring, and subsequently downgraded the corporate along with two larger peers Oct. 16, the Connecticut-based corporate was thrust into the trade press spotlight.

September was a tough month for Constitution, as the corporate took impairments on its investments in the amount of $6.3 million. Despite receiving the same Fed-Libor spread boost as the other corporates and posting a year-to-date net income before impairment charges, the corporate nonetheless posted a year-to-date net loss Sept. 30 of $2.9 million.

“These losses are manageable in the context of the corporate's capital and reserves, which continue to exceed all regulatory minimums,” the corporate stated in its financial summary.

Constitution Corporate recorded a regulatory capital ratio of 6.81% as of Sept. 30, 2008. That marks an increase over same period last year, when the corporate posted a capital ratio of 6.46%.

–handerson@cutimes.com