Wachovia's Newest Color: Red
Wachovia Corp. (WB) reported earnings Tuesday, and reminded investors that the mortgage and credit crisis hasn't gone anywhere, despite a spate of better-than-expected earnings earlier this week from some of the nation's largest banks. The North Carolina-based bank said Tuesday morning before market open that it lost $8.9 billion, or a net loss of $4.20 per share, during the second quarter; the loss compares to a profit of $2.34 billion, or $1.20 a share, one year earlier. It also slashed its dividend to just 5 cents a share from 37.5 cents, in an effort to preserve capital. The record loss included $5.6 billion in credit costs, including a $4.2 billion loss provision covering expected future losses in the bank's substantial mortgage holdings. Earnings were also affected by a $6.1 billion impairment to goodwill, that, oddly enough, was not tied to the bank's ill-fated $25 billion purchase of option ARM specialist Golden West Financial in 2006. "These bottom-line results are disappointing and unacceptable," said Lanty L. Smith, Wachovia's board chairman, who served as interim chief executive officer beginning June 1. "While to some degree they reflect industry headwinds and weaker macroeconomic conditions, they also reflect performance for which we at Wachovia accept responsibility." The bank installed former Treasury Undersecretary Robert Steel as CEO two weeks ago, after firing former CEO Kennedy Thompson amid mounting losses. One of Steel's first moves as CEO was to see Wachovia quit the wholesale mortgage origination channel, a move confirmed Tuesday morning and first reported Monday by the Mortgage Lender Implode-o-Meter website, which tracks failed lenders. The company said it is "redeploying" roughly 1,000 former origination employees to help attempt to restructure a growing number of troubled option ARMs. "In the short term, the entire organization is focused on protecting, preserving and generating capital," Steel said in a press statement. Pick-a-Pay, or Stuck-with-Loss? Wachovia's problematic option ARM portfolio, also known as a Pick-a-Pay mortgage, actually grew between the first and second quarters, reaching $122.2 billion of the bank's $488.2 billion in total loans; no other U.S. bank has as much exposure to option ARMs in real-dollar terms. It's worth noting that while Wachovia grew its Pick-a-Pay exposure during the quarter, it actually saw its more traditional mortgage holdings shrink. If you believe option ARMs are toxic to a bank's balance sheet, this is a telling trend, and one that Wachovia's new CEO is likely to have to tackle before anything else can be righted financially at the bank. Total non-performing assets (including foreclosed properties) at Wachovia grew to $11.9 billion in Q2, or 2.44 percent of loans -- up a stunning 42.6 percent in one quarter alone; last year, NPAs stood at $2.2 billion, underscoring the dramatic deterioration in the bank's mortgage portfolio since that time. $7.1 billion of that NPA total is tied to the bank's Pick-a-Pay loans; Wachovia's option ARMs saw NPAs grow almost seven-fold over year-ago levels, which charge-offs more than doubled between Q1 and Q2. The bank provisioned $5.6 billion for future losses, roughly double the provision expense recorded one quarter earlier and astronomically more than the $179 million provisioned in the year-ago period. Despite the steep growth in loss reserves, Wachovia's allowance for loan losses remains below the level of non-performing assets; the bank's $10.74 billion in loss reserves at the end of Q2 was 90 percent of NPAs. At the end of the first quarter, reserves were just 79 percent of NPAs. Which, in plain English, means that if losses continue to mount -- and indications now should be that this is beyond likely -- Wachovia will be forced to reserve even further beyond the huge charges taken this quarter, as it continues to catch up with the ever-growing NPA levels on its books. The bank quit origination of its Pick-a-Pay product on June 30, and said it would waive prepayment penalties for borrowers looking to get out of the loan amid housing prices that are continuing to fall in many key housing markets. Disclosure: The author held various put option contracts on WB when this story was written; further indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.