Wachovia ( WB) reported a miserable third quarter in which cumulative losses on its soured option adjustable-rate mortgage portfolio nearly doubled, as the bank sought to lay out its warts ahead of its merger with Wells Fargo ( WFC). Charlotte, N.C.-based Wachovia on Wednesday reported a net loss of $23.9 billion in the third quarter, after taking an $18.8 billion goodwill impairment charge ahead of the Wells Fargo deal's completion in the fourth quarter. Wachovia also saw losses exacerbated by a $6.6 billion credit provision, most of which went to reserve-building against poor quality loans acquired through its ill-fated purchase of lender Golden West. "Overall, it was an extremely noisy quarter in which it appears Wachovia was attempting to get as much of their potential losses behind them before the acquisition by Wells Fargo closes," writes Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners. Wachovia lost $11.18 a share compared to a loss of $9.1 billion, or $4.31 a share, in the second quarter and a profit of $1.6 billion, or 85 cents a share in the third quarter last year. Excluding an $18.7 billion after-tax charge for goodwill impairment, $414 million in net merger-related and restructuring expenses, Wachovia posted a net loss of $4.76 billion, or $2.23 a share. The company listed a host of special charges for the quarter. It had $2.5 billion of market disruption losses including $1.2 billion securities writedowns; $350 million of principal trading losses, not to mention auction rate securities expenses, support of Evergreen money market fund exposure to Lehman Brothers and losses on government sponsored entity preferred stock totaling $1.1 billion.
The bank reported net charge-offs of $1.9 billion, or an annualized 1.57% of average net loans, due mainly to deteriorating housing markets in Florida and California. It posted total nonperforming assets including loans held for sale of $15 billion, or 3.05% of loans, foreclosed properties and loans held for sale. Wachovia also significantly increased its expectations for total losses in the Golden West Option-ARM, or "Pick-a-Pay," mortgage portfolio to 22% from 12% just a quarter earlier. Wachovia inherited the $120-billion portfolio through its 2006 acquisition of residential mortgage lender Golden West. Wachovia's purchase of Golden West, at the height of the housing boom, was contested by Wall Street, who didn't trust Wachovia's low portfolio loss assumptions at the time. Wachovia insisted that Golden West had conservative underwriting standards, but significant home price depreciation since then -- particularly in hard hit areas like California, Golden West's main area of operation -- has speeded up the portfolio's loss rates. The company said on a conference call that two-thirds of its $4.8 billion reserve for loan losses was related to the pick-a-pay portfolio. Net charge-offs within the Option-ARM portfolio specifically rose 60% from the second quarter to $810 million, or 2.69% of the portfolio. Nonperforming loans rose 27% to $8.9 billion, or 7.57% of the portfolio. Wachovia currently has 438,000 loans through Golden West, most of which are concentrated in California. The company said on Wednesday that the current loan-to-value ratio on the Golden West loans was 95% compared to 71% originally and 85% in the second quarter.
"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) 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.