Golden West deal hobbled Wachovia

Wachovia's biggest deal ever – the 2006 purchase of mortgage specialist Golden West Financial – may lead to an even bigger one: the Charlotte bank's own takeover.

Amid disconcerting times for most financial institutions, Wachovia's distressed $122 billion Pick-A-Payment loan portfolio, which the bank inherited in the acquisition, is a particularly heavy weight that threatens to drag the bank into even deeper financial trouble. The failure Thursday of Washington Mutual, which made similar exotic loans, highlighted Wachovia's problems and helped spur Friday's 27 percent plunge in the company's stock price, analysts said.

Now Wachovia chief executive Bob Steel is reportedly feeling out possible deals with a number of suitors. Executives reportedly aren't in a rush to reach an agreement but likely are eyeing bailout talks in Washington and the opening of financial markets Monday. Analysts suspect the bank needs to make a deal or raise more capital to assure investors it has the capacity to cover future losses.

For employees and investors, it means more uncertainty about the company's future as well as rising anger about how the company got into this situation. For Charlotte, it raises major worries about one

of the city's biggest employers and civic players.

For some, Wachovia's travails are particularly galling because the bank didn't learn from its purchase of The Money Store, an ailing nontraditional lender that it was forced to close in 2000. And Wachovia's difficulties come as its Tryon Street rival, Bank of America, is healthy enough to buy up wounded companies such as brokerage Merrill Lynch.

“I guess the lesson here is to stick with what you know and stick with your principles,” said a former executive who left Wachovia after the Golden West deal. If Wachovia had not bought Golden West, “it could be out there taking advantage of this market instead of being a victim. It's a shame.”

When Wachovia bought the Oakland, Calif.-based lender, chief executive Ken Thompson trumpeted the banking presence he gained in attractive California markets, as well as Golden West's sterling track record in the mortgage business. Two and a half years later, Thompson has lost his job and Wachovia has racked up billions in losses, largely because of that deal. The bank is in the midst of cutting 5,000 of the 11,500 jobs in its mortgage unit.

If Wachovia hadn't bought the mortgage lender, analyst Gerard Cassidy of RBC Capital Markets said, the bank “would be stronger than today but it would still have the problems not associated with Golden West. Also, Thompson would not have been fired.”

Golden West's Pick-A-Payment loans, also known as option adjustable rate mortgages, are problematic because they were concentrated in California and Florida markets that have seen dramatic declines in home values, leading some borrowers to walk away from their mortgages. The loans also have a minimum payment option that adds to the balance of the loan, instead of shrinking it.

To combat the issue, the bank has stopped making Pick-A-Pay mortgages and is working to refinance existing customers into more traditional loans. In a recent CNBC appearance, Steel emphasized that the bank is tackling its problems but also noted that it has plenty of well-performing traditional mortgages and commercial loans. “We have a lot of very good loans that are doing well, and we're going to focus like crazy, as I said, on the (Golden West loans),” Steel said.

In July, the bank said it expected to set aside $8.7 billion in 2008 to cover Pick-A-Payment losses, followed by another $5.6 billion in 2009. Overall, the bank has said it expects cumulative losses of 12 percent over the lifetime of the portfolio, up from an earlier estimate of 7.5 percent. But investors now are worried that losses could be even bigger, starting with third-quarter earnings set to be released Oct. 22.

Seattle-based WaMu's failure and sale to JPMorgan Chase brought new attention to these concerns. In announcing the deal, JPMorgan said it planned to write down the value of WaMu's $50.3 billion option ARM portfolio by $8.2 billion, about 16 percent. New York-based JPMorgan also said it expects lifetime losses of $10.3 billion on the loans. That contrasts with Wachovia's latest estimate of about $14 billion in losses on its Pick-A-Payment loan book, which is more than twice as big.

Besides hurting profits, loan losses are a concern because they can require banks to raise more capital. This dilutes the holdings of existing shareholders. At the end of the second quarter, Wachovia had a so-called Tier 1 capital ratio, a measure of a bank's capital cushion to assets, of 8 percent, well above the 6 percent mark that is considered “well-capitalized” by regulators. WaMu, however, was considered well-capitalized before it failed. That changed when depositors began pulling their money from the savings and loan.

On Friday, these worries assailed Wachovia's stock price, which fell by as much as 40 percent at one point and ultimately closed at $10. It's down 73 percent for the year. Possibly fueling the fire was a Goldman Sachs research report that said if WaMu's markdowns were applied to Wachovia “the levels of potential losses would bring (Wachovia) very close to the threshold of being considered ‘well capitalized.'”

As the stock fell, Wachovia worked to assure customers, employees and investors that the bank was financially sound, noting it had a “large and stable” deposit base. The bank raked in $20 billion in certificates of deposits in July and August, according to research firm CreditSights. Steel sent a message to employees that stressed the company's franchises “are extremely valuable and continue to operate well relative to our competition.”

“We are aggressively addressing our challenges and are working to strategically strengthen and manage capital and liquidity in this challenging environment,” Steel added. He said the bank also was closely monitoring negotiations over a government bailout that could aid the bank.

Virginia-based banking consultant Bert Ely said the company was a victim Friday of worries about rising losses as well as a “contagion effect” stoked by a loss of confidence in the financial sector. “To some extent, (Wachovia) has problems, but also they were hit because of Washington Mutual,” he said. Investors “see it as the next one.”

Ely suspects financial markets won't relax about Wachovia unless it announces a big capital infusion or does a deal. Steel, according to the Financial Times, made the first call to three banks, Citigroup of New York, Wells Fargo of San Francisco and Banco Santander of Spain. The Financial Times also said Saturday that a Canadian bank, Toronto Dominion, had been interested in WaMu and may take a look at Wachovia. Ely said he doesn't rule out a bid by investment banks Morgan Stanley or Goldman Sachs, which want to build their deposit bases.

Wachovia spokeswoman Christy Phillips-Brown declined comment. Santander couldn't be reached; representatives of the other banks declined comment.

Meanwhile, Wachovia's 20,000 employees in Charlotte await the bank's next move. Employees said Friday was a particularly surreal day. Some have growing anger toward Thompson, a well-liked leader, for doing the Golden West deal.

Steve Luquire, a board member of the Charlotte Regional Partnership economic development group, said he talked about the Wachovia news with several friends at breakfast Saturday morning. He, like others, hopes Wachovia won't be bought. But if it is, and if a number of workers are laid off, Luquire hopes other companies would set up shop in Charlotte. He said it's ironic that a potential Wachovia sale came less than two weeks after Bank of America's coup in purchasing Merrill Lynch.

“But in this environment,” Luquire said, “I think we've all got to have some expectation that you can't stay on a roll forever.”