By Marshall Eckblad
NEW YORK -(Dow Jones)- The seizure of Washington Mutual Inc. (WM) is quickly becoming a problem for Wachovia Corp. (WB).
After federal regulators on Thursday night seized the West Coast thrift and its bloated book of failing home loans, investors trained their focus on Wachovia, which itself holds piles of risky mortgages.
Wachovia shares recently traded down 30% to $9.55, while the cost of insuring Wachovia's debt against default quickly rose to distressed levels.
"When I woke up this morning, the thing I was most concerned about...was contagion" from the WaMu seizure, said Nancy Bush, a bank analyst at NAB Research.
Wachovia's shares have also been hurt by the suddenly uncertain outcome of the U.S. Treasury's proposal to rescue banks by purchasing their toxic mortgages and mortgage-backed securities.
A spokeswoman for Wachovia said the bank believes that that "the Treasury plan under consideration by Congress is a constructive and important step toward restoring confidence and stability in our financial system."
Regardless, Wachovia looks to be in substantially better shape than Washington Mutual before WaMu failed. Wachovia has a loyal and largely affluent banking clientele, and a sizable business of offering investment services to clients through financial advisors. WaMu, by contrast, was a saving-and-loan, and had far fewer business lines.
What's more, Wachovia is hardly running out of capital, says Bush.
But a bank's being well capitalized, she said, "is no longer enough" to reassure nervous depositors.
Just ask WaMu.
The Seattle savings-and-loan had seen depositors pulling their cash from WaMu at dangerous rates during September, before regulators seized the bank on Thursday.
And yet Wachovia's bread-and-butter retail banking business, by contrast, may be moving in the opposite direction of WaMu's, even as Wachovia's stock slides amid fear.
Wachovia added 226,000 retail checking accounts in the second quarter, a Wachovia spokeswoman said, and a brow-raising 745,000 since June - or nearly a million new checking customers since the second quarter began. Wachovia held average deposits of $435.5 billion in the second quarter.
"We are focused on managing our company and serving our customers with excellence," a spokeswoman for the company said. "We are aggressively addressing our challenges and are working to strategically strengthen and manage capital and liquidity in this challenging environment."
Wachovia's Pick-A-Problem
But Wachovia also holds more than $122 billion in so-called Pick-A-Pay or Option ARM mortgages, as of July 22. Pick-A-Pays are an unwieldy type of loan that have fast become notorious for producing high levels of losses, as well as high levels of risk for banks that wrote them.
Wachovia's Pick-A-Pay loans give some borrowers the option of deferring portions of their monthly interest payments, thereby increasing their loans' balance. While Wachovia has stopped writing the loans altogether, Pick-A-Pays have proved highly problematic for both WaMu and Wachovia since home prices have fallen around the nation even as many Pick-A-Pay loan balances have risen.
Wachovia famously acquired the Pick-A-Pay business in 2006, when it purchased West Coast lender Golden West, at the height of the housing boom, for $25.5 billion.
That deal quickly has quickly come to haunt Wachovia's franchise. Defenders of Golden West, a pioneer in offering Option ARM mortgages, say that Wachovia changed the product's underwriting standards, and issued the loans to riskier borrowers. But employees at Wachovia who marketed Pick-A-Pays say that the loans do not deserve to be lumped with other risky loans, including now-infamous subprime loans.
Those defenders of the Option ARM loans maintain that when banks underwrite these loans correctly, they are both safe and lucrative. But as the credit crisis has widened, Pick-A-Pays have undeniably produced rising delinquencies and - perhaps more importantly - unnerved investors.
Of Wachovia's $122 billion in Pick-A-Pays, 5.78% are considered " nonperforming," or more than 90 days past due, as of this year's second quarter. Another 5.2% of the portfolio is delinquent by less than 90 days. As of last year's second quarter, only 1.03% of the Pick-A-Pay portfolio was classified as nonperforming.
Wachovia's $44 billion in traditional mortgages, by contrast, show a nonperforming rate of 0.98%, up from 0.35% in last year's second quarter.
Of the entire Pick-A-Pay portfolio, 58% of the outstanding balances are tied to properties in California, and another 10% are tied to homes in Florida - two states hardest hit by declines in home values.
Washington Mutual had similar, though more severe, problems with its Option ARM loans. Six percent of WaMu's $52.9 billion portfolio was nonperforming through the second quarter, up from about 1.5% in last year's second quarter.
With Pick-A-Pay loans producing losses for Wachovia that reach into the billions, and more likely to come, Wachovia's board has shaken up the firm.
Wachovia ousted its long-time CEO Ken Thompson in July and replaced him with Bob Steel, a former undersecretary at the U.S. Treasury and a veteran Goldman Sachs Group Inc. (GS) banker. The firm has also announced a new chief financial officer as well as a new chief risk officer.
While CEO Steel has worked quickly to reassure investors and has promised to make the Charlotte firm more transparent, Wachovia's shares have continued their wild ride as investors appear unsure what to make of Wachovia's long-term prospects. The shares dropped below $10 in July, and did so again Friday.
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