Wachovia Preens but Fails to Impress

So Wachovia (WB Quote) has polished up its balance sheet and dropped a few extra pounds as it pretties itself for a possible merger with First Union (FTU Quote). But the bank's less-than-stellar growth shows why it's been placed on the auction block in the first place.

Wachovia posted second-quarter profits of $1.22 a share Tuesday morning, 2 cents ahead of the Thomson Financial/First Call consensus and a substantial 86% above earnings in the same period last year. But don't get too excited. Aggressive credit management and outsize security gains have helped prop up this quarter's results. Meanwhile, year-over-year comparisons were easy: This time last year, Wachovia was struggling as it faced up to some serious credit issues.

Popping Up

"I don't really think year over year is a fair comparison, since they bolstered their loan-loss provision significantly last year," says Katrina Blecher, banks analyst at Sandler O'Neill. Wachovia shelled out a hefty $200 million to boost its reserve for loan losses in the second quarter of 2000, which cut heavily into profits. Factoring in that provision, Wachovia's net interest income popped nearly 20% this year. But excluding the drag on last year's earnings, it rose a paltry 1.8%.

In addition, Wachovia sold off $125 million worth of loans in the latest quarter, roughly half of which were nonperformers. (Nonperformers are loans that are past due but remain on a company's balance sheet.) The bank also took advantage of interest-rate volatility to book about $97 million in securities gains, compared with last year's $59,000, the bulk of which was used to offset higher credit costs.

Even after the loans were sold, Wachovia reported a 33.9% increase in nonperforming loans, which rose to $379.8 million from $283.6 million a year ago. Measuring this quarter's one-time boost against last year's dismal quarter may make things look better on the surface than underlying trends would suggest.

Wax On

Wachovia is currently the target of an increasingly nasty takeover fight between First Union and SunTrust (STI Quote), the latter of which launched a hostile bid in mid-May after Wachovia spurned it in favor of First Union. Weak profits growth is one of the main reasons Wachovia agreed to a merger in the first place. So Wall Street wasn't much concerned by Tuesday's news. The stocks themselves were little changed: Wachovia rose 27 cents to $67.88, SunTrust gained 56 cents to $63.42, and First Union edged up 9 cents to $33.16.

"It's always good to polish the brass and clean up the books" before a merger, says Blecher of the patina on Wachovia's results. She notes that First Union and SunTrust have been under greater pressure to deliver strong earnings than Wachovia is. SunTrust reported earnings Friday. First Union will report tomorrow. (Blecher's firm has no underwriting relationship with any of the banks.)

"It's less important for Wachovia, since it's the bride being bought," says Blecher.

Some dowry.