Editor's note: Our "On the Brink" series will provide daily insight into the financial firms facing capital shortfalls and the growing pressure from short sellers in the market.
shares plunged as much as 10% after Merrill Lynch cut its rating on the troubled bank to the equivalent of a sell.
Merrill analyst Ed Najarian cut the Charlotte, N.C., lender to underperform from market perform on concerns about higher-than-expected credit losses, particularly in its commercial portfolio, loan loss provisioning and weaker fee income, according to a note published Tuesday.
He slashed earnings estimates on Wachovia by 60 cents this year to a loss of $1 a share and by 40 cents to $1.40 a share for 2009. Additionally, Najarian cut his third quarter earnings estimates by 38 cents to a loss of 10 cents a share as a result of impairment charges related to its auction-rate securities, a loss on the sale of GSE preferred securities and weak retail brokerage revenue.
The main source of Wachovia's troubles amid the deterioration in the housing market is its $122 billion option adjustable-rate mortgage loan portfolio, which it inherited when it bought California residential real estate lender Golden West in 2006. The company has been struggling with losses in the portfolio as home prices decline. More than half of the portfolio is mortgages on homes in California, where home prices have fallen substantially.
Najarian is now predicting higher losses in Wachovia's $216 billion combined commercial and industrial loans and commercial real estate portfolio, as well as a lower revenue from retail brokerage, investment banking, trading and commercial mortgage-backed securities businesses.
"While most of Wachovia's credit weakness (relative to the nation's other large banks) has been driven by the rapid deterioration in its option ARM loan portfolio (attained via the Golden West acquisition), it is also important to note that Wachovia's commercial loan portfolio is also deteriorating faster than those of the other major banks," Najarian writes.
He notes that Wachovia's commercial and commercial real estate loan portfolios had aggregate delinquent and non-accrual loans of $6.26 billion -- the highest of the nation's six largest banks.
Wachovia's total delinquent and non-accrual loans were $21.7 billion at the end of the second quarter, he writes.
We remain concerned that Wachovia's credit loss ratios and loan loss provisions could materially exceed investor expectations, potentially causing Wachovia to significantly miss consensus
earnings per share estimates and pressuring the stock," according to Najarian.
CEO Robert Steel, who was hired in July to rehabilitate the ailing company by replacing ex-chairman and CEO Ken Thompson, acknowledged Tuesday that within Wachovia's commercial portfolio, there is approximately $11 billion worth of residential-related commercial real estate loans, which are "challenging." The portfolio consists of $5 billion is land loans and $6 billion is condo loans.
"We're putting the focus on that and we're doing our best to work through it," he said.
But the rest of the commercial portfolio is performing well, he said.
In the note, Najarian reiterated that he expects cumulative losses on Wachovia's option ARM portfolio to be 15% to 17%, "given that Wachovia's option ARM's are not ... conforming
to government-sponsored enterprises
and most would probably not qualify to refinance into conforming mortgages."
Steel said the company has separated the Golden West portfolio from the rest of its mortgage business.
"We approach the Golden West portfolio as if we were a distressed investment manager," he said during a presentation at the Lehman Brothers financial services conference in New York. Owning the loans and handling the servicing "gives us a great deal of flexibility," he added.
Steel said that "a significant portion" of the Golden West portfolio -- with roughly 450,000 loans averaging at $217,000 -- "will be refinanceable into
Federal Housing Administration loans."
Steel reiterated that the company expects cumulative losses of 12% on the Golden West portfolio in answer to a conference participant's question.
"The latest data we have does not offer any perspective different," he said.
Shares were most recently were down 9.2% to $17.25.