Wachovia Exposes Warts Before Wells Wedding Day

"We're in the process of taking active steps to minimize the risk and maximum the value of this portfolio," said Ken Phelan, Wachovia's chief risk officer, in his prepared remarks. "In July we began an aggressive customer outreach beta program ... to refinance these mortgages to keep people in their homes and reduce losses." Wachovia estimates $77 billion of the Pick-a-Pay loans are eligible to be refinanced under the Federal Housing Authority program.

The merger with Wells Fargo is expected to close by the end of the year and the San Francisco bank has already incorporated total loss expectations on Wachovia's commercial and residential loan portfolios and other securities marks to total $74 billion before taxes. Analysts, therefore, question whether Wachovia's worsening outlook really matters. The bulk of the losses are clearly expected in Wachovia's option adjustable-rate mortgage portfolio.

"All the bad news in Wachovia, even though it's worse than people thought, has already been taken into account at Wells," says Paul Miller, an analyst at Friedman Billings Ramsey. "If Wells underestimated the losses, you won't know until a few years out."

The Federal Reserve approved Wells Fargo's acquisition of Wachovia on Tuesday, reasoning that "emergency conditions existed that justified expeditious action on this proposal."

Wells Fargo CEO and President John Stumpf, whose bank won a legal tussle with Citigroup (C Quote) for control of Wachovia earlier this month, said Wachovia's results "were very much in line with our expectations."

"We're more encouraged than ever by what we've seen in their franchise, and we're pleased that Wachovia's team continues to focus on serving customers," Stumpf said in a statement.