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Wachovia watchers predict trouble, doubt leadership

Wachovia's stock took a sharp drop Tuesday as investors wondered who would fill the Charlotte bank's leadership void and whether the company would have a fresh round of troubles to spring on Wall Street.

The most pessimistic observers predicted a second-straight quarterly loss for the banking giant, another cut in the dividend paid to shareholders and the need to tap markets for more cash. Some analysts also wondered whether Lanty Smith, named the interim chief executive, should be in charge even for a short term.

The concerns continued to dog a company whose board felt compelled to dump longtime chief executive Ken Thompson on Sunday after an embarrassing series of financial and regulatory missteps. How the story plays out is critical to Charlotte, where Wachovia employs about 21,000; some analysts have said its current straits make it susceptible to a takeover, perhaps by JPMorgan Chase.

Analysts, on average, figure the bank can still pull out a profit of 49 cents per share when it reports earnings next month after losing 14 cents per share in the first quarter. But estimates vary widely. Dick Bove, an analyst for Ladenburg Thalmann, said the bank probably would feel justified in reporting losses this quarter, to show that it is rooting out problems and effecting a turnaround.

“There's going to be a loss,” Bove said. “They're going to do everything possible to validate firing Ken Thompson.”

Most observers continued to pin the majority of the bank's balance-sheet troubles on the 2006 purchase of Golden West Financial, a California mortgage known for risky adjustable-rate loans, known as Pick-a-Pay.

Wachovia in the first quarter set aside $2.8 billion for potential credit losses, including $1.1 billion for Pick-a-Pay. Defaults in those mortgages rose to $240 million in the first quarter from $1 million the year before.

In the worst case, the bank could have to set aside a cumulative $17 billion for mortgage losses, said David Hendler, a CreditSights analyst. (He estimates the bank already has set aside $3.7 billion.)

Though that scenario “remains fairly remote, we note that recent housing indicators have shown no real signs of stabilization in housing values,” Hendler wrote on Monday.

Others, including Jefferson Harralson at Keefe, Bruyette & Woods, speculated that the bank might have to raise capital again, after selling stock and securities worth about $8 billion in April. Raising capital strengthens the bank's balance sheet but hurts existing shareholders by diluting the value of their shares.

Wachovia also might need to cut its dividend for a second time this year to conserve capital, said Gary Townsend, a former bank analyst who has launched a Maryland-based investment firm. The bank cut its dividend by 41 percent, to 37.5 cents, in April, keeping $2.1 billion a year instead of distributing it to shareholders.

Bove wondered if defaults in auto loans would emerge as the next big consumer problem at Wachovia, which in 2006 bought Westcorp, an auto lender that makes subprime loans.

But other loan problems, like mounting numbers of bad commercial loans, are common to financial institutions right now, analysts said.

Several analysts questioned the board's decision to put Smith in charge, even for a short time. Smith, a Wachovia director for more than 20 years, is too tied to the old Thompson administration to effect a needed turnaround, analysts said. They also advocated for a shakeup in Wachovia's boardroom, where directors should share blame for deals like the Golden West purchase.

“Lanty Smith voted for some of the worst acquisitions in the history of banking,” said Thomas Brown, chief executive of the Second Curve Capital investment firm in New York. “If they're going to force Ken Thompson to take responsibility, maybe they should, too.”

Wachovia's shares, down 60 percent over the year, fell 6.32 percent to $21.92 on Tuesday, the lowest since 1995. It was an off day for most financial firms. Bank of America's shares fell nearly 1 percent to $33.31, the lowest price in about five years.

To be sure, Wachovia's general bank, which accounts for 70 percent of earnings, could be its saving grace. It's still a strong brand, many analysts said, and Wachovia often earns high marks in customer service studies.

“If they don't get bought out, I do see them as a survivor,” said James Early, a senior analyst at The Motley Fool investment Web site. Citigroup and mortgage-specific companies, Early added, are worse off than Wachovia.

Brown predicted a second-straight loss in the second quarter, but didn't specify how much. “I don't think they have much of an idea right now either,” he said, referring to the bank.

Wachovia's shares will probably remain in the low $20s for the next few quarters, predicted Kevin Fitzsimmons of Sandler O'Neill + Partners, citing uncertainty about Wachovia's future leadership and long-term restructuring of its operations.

“We think some of today's downward pressure reflects investor speculation over whether there will be another ‘shoe to drop' in the coming days,” Fitzsimmons wrote.

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