Wachovia: The Sharks start to Smell Blood

As the credit crunch continues to deepen, the Wall St. sharks are beginning to surround the weakest links. Rumors continue to swirl that Wachovia's poor loan portfolios have pushed them to the brink of insolvency.

There were two pieces in the Wall Street Journal that highlighted Wachovia's problems.

The first article is a piece on Michael Price explaining why he is shorting Wachovia. Whats interesting here is Michael Price usually likes to buy distressed financials and bet long. Seeing him short here on Wachovia is a major red flag in my opinion.

The WSJ a subscription but here is the link. I will hightlight the piece below:

"A Bear Claws at Wachovia
Michael Price Says The Stock's Floor Hasn't Been Met
By PETER EAVIS
June 3, 2008

Michael Price has made millions buying shares in battered financial stocks. But he isn't buying Wachovia Corp. And the bank's dumping of its chief executive doesn't change his mind.

Mr. Price, who led the Mutual Series funds group and later sold it to Franklin Templeton Investments, isn't one who delights in piling on to wounded financial firms.

At Wachovia, removing goodwill and other intangible assets, as well as preferred shares, gets to a book value of about $14.80 a share, after the most recent capital raise. That is well below Wachovia's closing price Monday of $23.40, down 1.7%, or 40 cents, in 4 p.m. New York Stock Exchange composite trading.

But Mr. Price notes that Wachovia deserves some credit in this calculation for its low-interest-rate deposits, for which potential acquirers likely would pay a premium. Assuming a 5% premium on the bank's $278 billion of low-interest-rate deposits, $6.60 a share would have to be added to the $14.80 a share in book value. This gets to an approximate share-price target of $21.40, not that far below Monday's close.

But the bank has $121.2 billion of adjustable-rate mortgages, most of which were taken onto its balance sheet when it acquired Golden West Financial Corp. Any value calculation for Wachovia has to take into account the losses the bank likely will have to book as it builds its loan-loss reserve against defaults on these mortgages.

Mr. Price believes a new CEO at Wachovia likely would be more aggressive in recognizing the ARM problems. "More losses are coming. They need to fess up," he said.

The financial pain from doing that could be intense. At the end of March, the loan-loss reserve for Wachovia's adjustable-rate mortgages was equivalent to 1.55% of the $121.2 billion total, which looks too low given how fast they are going bad.If Mr. Price is right, Wachovia's share price is wrong.

If Mr. Price is right, Wachovia's share price is wrong."


Quick Take:

The Paragraph in bold tells you how poorly Wachovia has prepared for losses on their massive $121 billion loan portfolio of adjustable rate mortgages. Now I don't know the breakdown of this portfolio, but we already know subprime is defaulting at about a 30% clip and Alt-A loans are about 10% delinquent.

When you have only 1.55% in your loan loss reserve to cover these losses, you are way under capitalized as these foreclosures mount. Say 15% of these loans end up going bad. That's about a $20 billion loss. I doubt Wachovia can handle that. We will see. Now lets move on to problem #2.


Wachovia's Construction Loan Dilemma

Here is the second link on Wachovia discussing their construction loan portfolio. Some highlights:

"While Wachovia Corp.'s residential-mortgage woes have gotten most of the blame for the ouster of Chief Executive G. Kennedy Thompson, another real-estate specter looms.

Wachovia has been the country's second-largest maker of construction loans after Bank of America Corp., with $23.9 billion of debt outstanding to developers of single-family homes, condominiums, office buildings, stores and other commercial projects at the end of the first quarter.

"A large part of the risk in Wachovia's portfolio stems from its higher proportion of single-family-construction lending," said Matthew Anderson, a partner at Foresight Analytics.

"It's no question construction loans are going to show increases in losses in the coming quarters," said stock analyst Dick Bove at Ladenburg Thalmann & Co., speaking about Wachovia.

Analysts expect a sharp increase in bad construction loans partly because many of them were made with "interest reserves," pools of money developers set aside to pay interest while projects get built. Once they burn through those reserves, developers of troubled projects can't pay debt service, forcing banks to classify the loans as nonperforming.

Analysts believe this is primarily because of Wachovia's high exposure to single-family-home development. Delinquencies on construction loans tied to such projects reached 15.1% in the first quarter, according to Foresight. By comparison, the industry average was 10.8%."


Quick Take:

So on top of Wachovia's home lending problems, they now have new construction loans blowing up at a 15% clip which is 50% higher than the industry average.

Wachovia was the number two player in this market with $23.9 billion in new construction debts. These loans are dangerous because when the music stops and the housing cycle ends, the builders can't pay the loans back because they cannot sell what they built.

This is when the bankrupties in the building sector start to rise. As a result, Wachovia will be left holding the bag.

So the question on Wachovia now becomes this. Can they survive this 1-2 punch? Capital will become more difficult to acquire as housing prices continue to drop, and many financials are forced to look for handouts. I would not be surprised to see Wachovia go belly up when this is all said and done.


It looks like Lehman needs to raise more capital

FYI. I find this amusing because a month ago they sais they didn't need to raise capital. Oooops!

Here is the link.

The Credit Crisis is roaring once again, and it looks like stocks have pulled back after a morning bounce.

I expect a Bear Stearns part two very soon. Wachovia and Lehman seem to be two of the weaker links. Of course Countrywide must be on this list as well!

Stay tuned.