“Although the restructuring process under the Montreal Accord continues to make good progress, with an agreement in principle in place and an expectation that the restructuring will be substantially complete by March 31, 2008, we have determined that an additional provision against our current ABCP holdings is required” said Dave Mowat, President and CEO of ATB Financial. “As the restructuring process evolves, we continue to analyze more details regarding the expected outcome and other detailed information on which to base our valuation. This information is not complete, but with what we know, we have determined that it is prudent to record an additional provision this quarter of $29.3 million. This increases ATB’s total provision from 6.9 per cent of our holdings of impacted ABCP at September 30, 2007 to 10.2 per cent at December 31, 2007.
Our expectation is that the restructuring will succeed – but the question is still at what ultimate cost to investors. In December 2007, our holdings of $91.9 million in Skeena Capital Trust were successfully restructured with a net write-down of $0.6 million – or 0.69 per cent.”
“Notwithstanding the challenge of ABCP, we remain focused on ATB Financial’s key business – and are pleased to report that despite the additional provision this quarter, we generated net income of $43.1 million, with both loan and deposit growth exceeding that experienced last year at this time.”
Loan balances increased in the third quarter by $159.1 million (or 4.48 per cent), exceeding growth of $136.9 million (or 4.61 per cent) in the third quarter last year.
Operating revenue of $25.4 million in the third quarter represents an improvement over operating revenue of $20.5 million generated in the third quarter of the prior year.
As announced on August 24, 2007, ATB held $1.2 billion of third-party- or non-bank-sponsored asset backed commercial paper (“ABCP”) in its corporate investment portfolio. The Canadian market for third-party-sponsored ABCP suffered a liquidity disruption in mid-August 2007, following which a group of financial institutions and other parties agreed, pursuant to the Montreal Accord (the “Accord”), to a standstill period in respect of ABCP sold by twenty-three conduit issuers. A Pan-Canadian Investors Committee (“Investors Committee”) was subsequently established to oversee the orderly restructuring of these instruments during this standstill period. ATB is a signatory to the Accord, a member of the Investors Committee, and continues to actively support the restructuring process.
On December 23, 2007, the Investors Committee announced that an agreement in principle had been reached to restructure the subject ABCP – whereby the ABCP notes held by ATB and other investors will be exchanged for longer-term notes that will more closely match the maturity dates of the underlying assets. Detailed negotiations to finalize the agreement in principle are underway. The final agreement is subject to the approval of investors and various other parties. The Investors Committee currently anticipates that the restructuring will be substantially completed by March 31, 2008.
As of December 31, 2007, ATB held a variety of investments in ABCP totaling $1.1 billion. Of these holdings, investments in eleven conduits amounting to $1.0 billion are subject to the Montreal Accord (September 30, 2007: $1.1 billion). ATB’s investment of $91.9 million in ABCP notes issued by Skeena Capital Trust was successfully restructured in December 2007. ATB received a combination of cash and a long-term floating-rate note issued by a successor trust in exchange for its holdings in Skeena Capital Trust, and recognized a net loss of $0.6 million from this restructuring.
In the absence of an active market for third-party-sponsored ABCP during the standstill period, ATB has estimated the fair value of these assets as at December 31, 2007 using an internal valuation model. The valuation model incorporates management’s updated best estimates of credit risk attributable to underlying assets, the net discounted cash flows ATB expects to earn from those assets, the relevant market discount rate for such investments, and assumptions regarding the likelihood that the restructuring process will proceed as outlined by the Investors Committee. ATB had recorded a $77.6 million provision for losses (together with a $2.0 million provision for expected restructuring costs) as at September 30, 2007, reflecting our then best estimate of the reduction in the fair value of these investments as at that date. ATB has since updated its valuation model to reflect its understanding of additional details of the restructuring agreement in principle together with updated asset- and market-related information. As at December 31, 2007, ATB has recognized an additional provision of $29.3 million to reflect our best estimate of the fair value of these assets. This brings the total cumulative provision to $106.3 million (or 10.2 per cent of our impacted holdings, including accrued interest).
It must be emphasized that ATB’s estimate of the fair value of the third-party-sponsored ABCP investments as at December 31, 2007 is subject to significant uncertainty, especially with regards to critical assumptions underlying our valuation model. The eventual resolution of these uncertainties could be such that the ultimate fair value of these investments may vary significantly from management’s current best estimate and the magnitude of any such difference could be material to our financial results.
To ensure ATB maintained its strong liquidity position following the ABCP market disruption, additional investments were promptly made in other liquid assets, funded through the issuance of short- and mid-term notes. We have continued to maintain our strong liquidity position. The liquidity disruption in the Canadian market for third-party-sponsored ABCP has had no other significant impact on ATB’s operations or financial position. Under the current restructuring proposal, ATB’s holdings in eleven conduits will be combined into three new investments and the magnitude of one investment would exceed ATB’s current regulatory limits. ATB is currently working with the Government of Alberta to resolve this matter.
In December, Edmonton and area associates organized a number of activities to support the Christmas Bureau. The Christmas Bureau is Edmonton's longest serving not-for-profit organization and provides a meal and gifts for those in the community that would not otherwise be able to celebrate the holiday season. This year ATB associates were able to raise over $47,000.
ATB's associate volunteer program, Community Stars, was established to recognize our associates who are actively involved as volunteers in their community. ATB makes a $200 donation to the not-for-profit organizations that are important to our associates. During the third quarter, cheques were provided on behalf of 45 associates.Since last quarter, economic and financial conditions in the US have deteriorated markedly. On January 22, 2008 – a full week prior to its expected announcement date – the US Federal Reserve reduced its trend-setting ”fed funds” rate by 75 basis points to 3.50 per cent; it reduced the rate by another 50 basis points the following week to 3.0 per cent. These cuts were made in response to the significant write-downs and associated losses at financial institutions, the extreme volatility in the stock markets, and the concern of a looming recession in the US. The Bank of Canada also lowered its overnight lending rate by 25 basis points to 4.00 per cent on January 22, 2008.
The major story of the fourth quarter of 2007 was the rise in value of the Canadian dollar. Since falling back from its high point in November, the dollar has stabilized and remains close to parity. Sales of gas, beef, forest products, crude oil, and tourism services continue to be negatively impacted by the higher Canadian dollar.
ATB Financial’s Business Sentiments IndexTM (“BSI”) for the first quarter of 2008 stands at 124.7. This is down noticeably from a level of 149.7 in Q1 2006 and 140.2 in Q1 2007. In this latest survey, the BSI for Northern Alberta was 130.0, compared with 119.0 for Southern Alberta. This regional spread continues a pattern that first became evident last summer.
Despite these setbacks, Alberta’s economy is still healthy. Housing prices in Edmonton and Calgary – which had been declining in the fall – appear to have stabilized in January. Inflation was 3.6 per cent in January, and the most recent employment figures show that the labour market remains very tight. It is still expected that Alberta’s real GDP will be among the fastest growing in the country in 2008, with growth in the range of 3.0 to 3.5 per cent. Management's Discussion and Analysis (unaudited)
Net Income
ATB Financial reported net income of $43.1 million for its third quarter ended December 31, 2007 compared to $8.5 million for the previous quarter and $69.2 million for the third quarter last year. This represents a $34.5 million increase from the previous quarter's net income and a decrease of $26.1 million or 37.74 per cent from last year’s third quarter net income.
The current quarter’s provision of $29.3 million relative to certain third-party-sponsored asset-backed commercial paper (“ABCP”) is less than the amount recorded in the prior quarter. This is the primary driver for the increase in net income in the third quarter, offsetting the increase of $6.5 million in the provision for credit losses and the $2.7 million increase in non-interest expenses over the prior quarter.
The decrease in net income in the third quarter over the same period last year is a result of the current quarter’s ABCP provision. Excluding the provision, net income would have increased over the prior year by $3.2 million, due to increased operating revenues being only partially offset by increased non-interest expenses and credit losses.
Net Interest Income
ATB’s net interest income was $164.7 million for the third quarter ended December 31, 2007 – a decrease of $4.1 million (or 2.43 per cent) compared to the prior quarter. This is a combined result of ATB’s average interest-bearing liabilities, primarily wholesale deposits, growing at a faster rate than its interest-earning assets and the reduced spread between these two items. This increased borrowing was triggered, in large part, by the current lack of liquidity in ATB’s third-party ABCP holdings and ATB’s requirement to hold a certain amount of liquid assets. However, ATB has sufficient liquid assets available to support ongoing operations.
Compared to the third quarter last year, ATB’s net interest income has increased $16.2 million (or 10.89 per cent). A significant portion of this increase ($7.4 million) can be attributed to the impact of the new accounting standards for financial instruments implemented in the first quarter of this year (refer to Note 2).
Other
Income
Other income increased $47.9 million over the prior quarter. This increase is due to the reduction in the ABCP provision booked, from $77.6 million in the prior quarter to $29.3 million this quarter. Ignoring the impact of the ABCP provisions, other income would have decreased by $0.4 million over the prior quarter.
Other income decreased by $27.9 million compared to the third quarter in the prior year. This was driven entirely by the current quarter’s provision for ABCP. Excluding the impact of this provision, other income would have increased by $1.4 million. Almost all major reporting categories increased from the prior year (ranging from a $2.2 million increase in card revenues to a $0.2 million increase in sundry other income) – but these increases were partially offset by a $5.2 million reduction in credit fees and a $0.5 million reduction in gains on derivative financial instruments. The decrease in credit fees was driven by a $5.9 million third quarter impact of the new Financial Instruments accounting standards implemented in the first quarter of fiscal 2008 (refer to Note 2).
Refer to the heading “Asset Backed Commercial Paper” for further discussion of this issue and the related provisions.
Provision
for Credit Losses
ATB recorded a $5.1 million net provision for credit losses in the third quarter ended December 31, 2007. This compares unfavorably to the $1.4 million net recovery last quarter and the $2.3 million net provision in the third quarter last year.
The net provision consists of both a general and a specific component. The general loan loss provision is management’s best estimate of probable losses not yet specifically identified in the loan portfolio while specific allowances are recorded when loans are identified as impaired. The general loan loss provision for the quarter was $5.1 million compared to a recovery of $1.4 million last quarter and a $3.9 million provision in the third quarter last year. The increase was largely due to portfolio growth, with credit quality remaining relatively stable.
The specific loan loss provision remains at less than $0.1 million, in line with last quarter, but compares unfavorably to the $1.6 million net recovery in the third quarter last year.
The quality of ATB’s loan portfolio remains strong with less than one per cent of the total gross loan portfolio being classified as impaired at the end of the quarter. The total credit loss allowance in the third quarter ending December 31, 2007 exceeded gross impaired loans by $107.5 million, compared to $97.8 million and $96.6 million at September 30, 2007 and December 31, 2006 respectively.
Non-Interest
Expenses
Total non-interest expenses were $133.2 million for the third quarter ended December 31, 2007. This was $2.7 million (or 2.09 per cent) higher than the expense in the prior quarter and $11.5 million (or 9.48 per cent) higher than the expense in the third quarter last year.
A number of line items increased from the prior quarter, but the primary driver of the increase was the normalizing of other non-interest expenses, which were abnormally low in the prior quarter due to a one-time reversal of an accounting estimate. There were certain line items with significant reductions from the prior quarter that partially offset the increase – specifically associate compensation costs (a component of human resource costs) and professional and consulting costs. Associate compensation costs generally decline in the third quarter due to annual CPP and EI contributions reaching their maximum limits. Professional and consulting costs, unusually high in the prior quarter due to a one-time accrual of $2.0 million related to the costs of third-party ABCP restructuring under the Montreal Accord, were reduced to more normal levels in the third quarter.
The increase over the third quarter last year arose across almost all lines, with the majority relating to associate compensation ($4.2 million) and marketing and supplies ($3.1 million). A portion of both of these increases ($0.8 million of associate compensation and $1.2 million of marketing and supplies) can be attributed to the impact of the new Financial Instruments accounting standards (refer to Note 2). The remainder of the increase in associate compensation costs reflects both the increase in the number of associates and higher compensation rates.
One of ATB’s key measurements relative to non-interest expenses is the ratio of non-interest expenses to operating revenue (net interest income before provisions, plus other income). This is known as the efficiency ratio – and measures ATB’s effectiveness at generating operating revenue. In the third quarter ended December 31, 2007, ATB’s efficiency ratio was 63.22 per cent (measured excluding the impact of the third-party ABCP provision). This compares unfavorably to 59.71 per cent in the prior quarter (measured excluding the impact of the third-party ABCP provision and related restructuring costs) and 63.00 per cent in the third quarter last year.
Balance
Sheet and Changes in Equity
ATB’s balance sheet continues to grow with the retention of profits increasing total equity to $1.73 billion, up $52.9 million from the end of the prior quarter and up $158.8 million from a year ago. Accumulated other comprehensive income, a new line of equity that resulted from the implementation of the Financial Instruments accounting standards in the first quarter (refer to Note 2), increased from a negative $6.3 million to a positive $3.5 million, reflecting the net change in fair value adjustments required by the new Financial Instrument accounting standards that were charged to other comprehensive income in the third quarter.
The two most significant components of ATB’s balance sheet are loans and deposits. Total loans, net of allowance for loan losses, increased by $678.6 million (or 3.73 per cent) compared to the previous quarter, and by $2.37 billion (or 14.39 per cent) compared to the third quarter last year. Deposits increased by $423.8 million (or 2.10 per cent) compared to the prior quarter and of $2.84 billion (or 15.95 per cent) compared to the end of the third quarter last year. Refer to the “Asset Backed Commercial Paper” section of this MD&A for details on the current status of our securities holdings.
Loans, deposits, other assets, and other liabilities were all impacted by adjustments required by the new Financial Instruments standards implemented in the first quarter (refer to Note 2), however the amounts are not considered significant in the context of the balance sheet as a whole.
Asset Backed Commercial Paper
Overview
ATB, as with other similar financial institutions, faces liquidity risk as a natural consequence of its business due to possible fluctuations in cash flows from lending, deposit taking, investing, and other activities. ATB maintains a large holding of liquid assets pursuant to its liquidity management policy. This ensures sufficient funds are available to sustain our ongoing operations, to meet customer needs, and to satisfy other obligations as they may arise. A significant portion of these funds was invested in Canadian third-party- or non-bank-sponsored asset-backed commercial paper (“ABCP”) when that market suffered a liquidity disruption in mid-August 2007.
Following that disruption, a group of market participants, including major investors, banks, asset providers, dealers, and third-party sponsors, agreed to work collectively to restructure 23 such trusts in this segment of the ABCP market. This agreement, which came to be known as the Montreal Accord, provided for a standstill period during which the ABCP notes were essentially frozen – participating investors agreed to not demand repayment of their ABCP investments as they matured and the commercial paper issuers agreed to not make liquidity calls to their liquidity providers who, in turn, would not demand additional collateral from the issuers. Participants to the Accord also agreed in principle to exchange the ABCP notes for longer-term floating-rate notes with maturities matching those of the underlying assets. A Pan-Canadian Investors Committee (“Investors Committee”) was subsequently established to oversee the orderly restructuring of these instruments during this standstill period. ATB is a signatory to the Montreal Accord, a member of the Investors Committee, and continues to actively support the restructuring process.
Impact on ATB Operations
With the disruption of the active market for third-party-sponsored ABCP notes pursuant to the Montreal Accord, ATB considers them to be illiquid in the short-term. To ensure ATB maintained its strong liquidity position, additional investments were made in other liquid assets, funded through the issuance of additional short- and mid-term notes. ATB retains sufficient capacity to issue further short- and mid-term notes so as to not be constrained by this unplanned issuance. The liquidity disruption in the Canadian market for third-party-sponsored ABCP has had no other significant impact on ATB’s current or planned operations or financial position. Further, no impact on planned operations or financial position is foreseen through the next five fiscal years based on ATB’s latest strategic plans other than the measured acceleration of pre-existing plans to securitize a portion of ATB’s mortgage portfolio.
Skeena Capital Trust Restructured Successfully
ATB’s investment in Skeena Capital Trust (“Skeena”), one of the ABCP trusts that were subject to the Montreal Accord, was successfully restructured in December 2007. ATB has incurred a net loss on Skeena of $0.6 million, or 0.69 per cent of ATB’s original investment. As had been anticipated, ATB received a combination of cash and a long-term floating-rate note issued by a successor trust in exchange for its ABCP notes issued by Skeena.
Restructuring Update
On December 23, 2007, the Investors Committee announced that an agreement in principle (or “Framework Agreement”) had been reached to restructure 20 of the 22 remaining trusts subject to the Montreal Accord. All of the remaining trusts that ATB has invested in are subject to this Agreement. While all parties involved in the negotiations have agreed to the latest agreement in principle, the restructuring process is still ongoing and, once finalized, the final agreement will be subject to the approval of the parties involved as well as any requisite governmental or regulatory authorities. The Committee’s expectation is that the restructuring transaction will be substantially completed by the end of March 2008. Further details as to the anticipated restructuring process are provided in Note 3.
Summary of ABCP Holdings as at December 31, 2007
As at December 31, 2007, ATB held a variety of ABCP investments totaling $1.1 billion (or $1.0 billion, net of provisions in respect of decreases in the estimated fair value of third-party ABCP). ATB has no further exposure to third-party-sponsored ABCP beyond these direct holdings. ATB’s remaining investments in ABCP include notes issued by eleven conduits subject to the Montreal Accord amounting to $1.0 billion (or $927.5 million, net of the $106.3 million provision). As at the date of preparation of these statements (February 14, 2008), all of these investments continue to be rated “R-1 (High) - Under Review with Developing Implications” by DBRS.
ATB’s other investments in commercial paper include $91.5 million in two trusts which DBRS placed “Under Review with Developing Implications.” Each trust has at least one leveraged super-senior transaction with a “mark-to-market” margin call feature and DBRS is reviewing its rating methodologies with respect to such transactions.
Valuation of ABCP Holdings as at December 31, 2007
In the continued absence of an active market for the third-party-sponsored ABCP subject to the Montreal Accord, ATB has estimated the fair value of these assets as at December 31, 2007 using a probability-weighted discounted cash flow valuation model. This model incorporates management’s best estimates of multiple factors, updated to reflect market-related and other additional information that has become available since the corresponding valuation as at September 30, 2007.
The inherent uncertainty due to the ongoing process of negotiations to implement the Framework Agreement has required management to make a number of significant assumptions in modeling the estimated fair value of these ABCP assets. The most critical assumptions include management’s estimate that it is highly probable that the restructuring proceeds in accordance with the latest proposed Agreement, that ATB will participate in a restructuring vehicle that involves a self-insured margin funding facility, and that ATB will meet any initial commitments under that facility by issuance of a guarantee.
Other assumptions relate to the restructuring of the assets underlying the ABCP notes, including the credit risk attributable to the underlying assets, the expected yield on the restructured investments (net of applicable margin facility costs) and average term of the net yield, and the representative discount rate that the market would normally attribute to such assets. Other assumptions in the valuation model include the expected date of issuance of the restructured investments, the repayment of interest earned from the date of market disruption to the restructuring date at the various notes’ original interest rates, and the probability of each trust/series either independently restructuring itself or undergoing an orderly liquidation in the event that the restructuring fails to proceed as per the Montreal Accord. Further details as to the assumptions underlying management’s best estimate as to the fair value of these investments are provided in Note 3.
Based on this analysis, ATB has determined that an incremental fair value provision of $29.3 million is required to adjust the carrying value of the third-party non-bank sponsored ABCP. This amount is in addition to the $77.6 million provision that was recognized in the preceding second quarter. As was the case last quarter, this quarter’s provision is considered to represent an “other than temporary” impairment in the value of these investments and has been reflected in our Interim Consolidated Statement of Income as a separate charge under the heading of other income. ATB’s cumulative provision represents 10.2 per cent of the total invested in these ABCP notes (including accrued interest).
In addition to this fair value provision, ATB Financial accrued $2.0 million for its estimated share of restructuring costs associated with the Montreal Accord in the second quarter. This provision is considered adequate and no additional provision for such expenditures has been recorded this quarter.
Measurement Uncertainty
The ongoing nature of the restructuring negotiations contributes to a lack of certainty with regards to the outcome of the restructuring process in general and the various details of the anticipated post-restructuring investment notes in particular. This lack of certainty, in turn, contributes to significant measurement uncertainty in ATB’s best estimate of the fair value of its current ABCP investments subject to the Montreal Accord. Since the eventual timing and amount of future cash flows attributable to these assets may vary significantly from management’s current best estimates, it is possible that the ultimate fair value of these assets may vary significantly from current estimates and that the magnitude of any such difference could be material to our financial results.
In the event further rating updates are issued by DBRS or ATB becomes aware of other relevant information with respect to any ABCP investment, ATB will re-assess its best estimate of the fair value of these other investments in the period during which such updates are issued or such information becomes known.
Segmented
Information
ATB has organized its operations and activities around three main business segments: Personal and Business Financial Services; Corporate Financial Services; and Investor Services. A fourth line is designated Other Business Units, which is comprised of business units of a corporate nature as well as expenses, general allowances, and recoveries not expressly attributed to any line of business. The provision relative to third-party ABCP and the impact of implementation of the new Financial Instruments standards are both included within Other Business Units.
On a segmented basis, total assets for Personal and Business Financial Services increased by $530.9 million (or 3.57 per cent) during the third quarter and by $2.2 billion (or 16.63 per cent) from a year ago. Total assets for Corporate Financial Services increased in the quarter by $160.9 million (or 4.47 per cent) and by $516.4 million (or 15.92 per cent) from a year ago. Investor Services’ assets under management and administration declined slightly from $4.04 billion in September 30, 2007 to $3.97 billion in December 31, 2007 – a decline of 1.66 per cent. This reduction is largely due to market conditions. Compared to December 31, 2006, Investor Services’ assets under management and administration have increased by $571.6 million (or 16.80 per cent).
Operating revenues across the three main business segments in the third quarter ended December 31, 2007 were up slightly over the prior quarter (from a 0.22 per cent increase in Personal and Business Financial Services to a 1.83 per cent increase in Corporate Financial Services). This increased operating revenue resulted in net income growth in Personal and Business Financial Services over the prior quarter. An increase in expenses for both Investor Services and Corporate Financial Services (as well as an increased provision for credit losses in Corporate Financial Services) resulted in net income decreasing from the prior quarter in these units.
Net income in all three business units increased over that earned in the third quarter of the prior year due to the increase in business levels.
Caution Regarding Forward Looking Statements
This report includes forward-looking statements. ATB Financial
from time to time may make forward-looking statements in other written
or verbal communications. These statements include objectives for the
short and medium term and strategies to achieve those objectives.
By their very nature, forward-looking statements require us to
make assumptions, are subject to inherent risks and uncertainties, and
can change due to a variety of reasons including legislative or
regulatory changes, competition, technological changes, and changes in
interest rates and general economic conditions. The foregoing list is
not exhaustive and when relying on forward-looking statements these
factors as well as other factors should be considered.
ATB cautions readers there is a significant risk that
forward-looking statements will not prove to be accurate. Readers should
not place undue reliance on forward-looking statements as actual results
may differ materially from plans, objectives and expectations. ATB does
not undertake to update any forward-looking statement contained in this
report.
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Highlights