Wachovia Shares Walloped by Downgrade

Oppenheimer analyst Meredith Whitney lowers teh bank stock to to underperform from perform, citing eroded capital levels.
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Wachovia

(WB) - Get Report

shares took a massive hit Tuesday after a prominent analyst said eroded capital levels are likely to cause the bank's earnings power to deteriorate.

Wachovia stock plummeted as much as 20% in morning trading, after Oppenheimer analyst Meredith Whitney downgraded Wachovia to underperform from perform and predicted the bank's plan to shed mortgage assets while cutting costs will prove ineffective.

Whitney estimates that the Charlotte, N.C.-based bank will have reduced its mortgage portfolio by 9% and its on-balance-sheet loans by 5% by year-end. However, she predicts that Wachovia will also have to sharply cut the value of its assets, while facing higher credit costs as well.

"We are hard-pressed to find examples of financial companies that have successfully shrunk their businesses," Whitney wrote. "The obvious challenge is lower revenues but higher expenses ultimately deteriorate the firm's capital position."

Wachovia shares are down more than 80% over the past year, as the housing and credit crises have crippled much of the financial sector. The stock lately bounced off its morning lows, edging down 15 cents, or 1.5%, at $9.69 in recent trading midday Tuesday.

Late last week, Wachovia pre-announced an expected loss of $2.6 billion to $2.8 billion, or $1.23 to $1.33 a share, for the second quarter, excluding certain charges. The firm added $4.2 billion to loan-loss reserves and charged off $1.3 billion in bad loans.

Many of those bad loans came from its controversial "Pick-a-Pay" product, which allowed customers to make payments that were less than even the interest due. Some also stemmed from commercial real-estate. Wachovia said it will have further goodwill impairment charges as well, which were not determined as of Wednesday, but added that they would not affect liquidity or capital ratios.

The bank also

named former Treasury official Robert Steel

as president and CEO last week, promising to overhaul the company's business. CEO Ken Thompson was forced to resign in June following a $708 million first-quarter loss.

Chairman Lanty Smith said Steel's "vast experience and deep knowledge make him the ideal candidate to lead Wachovia," though

others have questioned

his lack of retail banking experience.