Past CFO Commentary

As we announced in our earnings release today, our Q4 '14 financial results included two nonrecurring items related to the company's non-agency residential mortgage-backed securities (RMBS) portfolio: net litigation proceeds of approximately $28 million and net losses of $8 million from selling securities totaling approximately $500 million. Taken together, these items increased pre-tax income by approximately $20 million, or $.01 per share. With the financial crisis well behind us, it's been a while since we've needed to discuss these securities, so I wanted to walk through some history and share a perspective on these recent developments.
 

When the crisis hit full swing in 2008, we owned roughly $3.5 billion of non-agency RMBS in Schwab Bank's investment portfolio. While we generally favor agency-backed securities, we had carefully researched these specific instruments and purchased them based on the representations made regarding the nature and underwriting of underlying collateral, level of credit support, etc. As the crisis continued, the credit performance of private label securities in general, and the ones in our portfolio specifically, began to deteriorate, and valuations suffered significantly. At the end of 2008, we had unrealized mark-to-market losses of $862 million on our non-agency portfolio. These bonds have been the primary source of the $170 million in impairment charges we've recognized since the crisis, and we have continually asked ourselves whether stockholders might be better off if we were to simply liquidate the position and move on.
 

The thing is, there were really two issues at stake here: the actual performance-driven impairment charges we took as the defective nature of the underlying collateral became apparent, and beyond that, unrealized losses stemming from the value the market was assigning to the securities. As you may know, we've been pursuing recovery from the underwriters of these securities in connection with misrepresentations that were made about the underlying collateral. With respect to the unrealized losses, our assessments kept telling us that the market was mispricing these securities, that while we might not recover all of their amortized cost, we were likely to do better than market prices implied. Since we had purchased these securities with the intent and ability to hold them through maturity, we therefore felt our best economic choice was to continue to hold and monitor these bonds and their market valuations. The point is simple but goes to the heart of our financial management philosophy—focus on maximizing stockholder value over the long term. In this case, why lock in a loss to avoid some near-term uncertainty when you're convinced more value is there and that incurring further loss is unnecessary?
 

The market valuations for these non-agency RMBS are now more consistent with their current performance. We are continuing to vigorously pursue our legal claims on these securities, and we've started to make progress on that front. At this point, we have chosen to sell the vast majority of our remaining non-agency RMBS in order to mitigate the risk of further impairment charges. We have marked the remaining $15 million of these securities in our portfolio to market and recorded a $0.6 million charge in Q4, so there is limited remaining downside.
 

We hope you'll agree that the patient approach is the right one for stockholders in this case.