Wachovia Q3 2007 Earnings Call Transcript

Wachovia Corp. (WB)

Q3 2007 Earnings Call

October 19, 2007 10:00 a.m. ET

Executives

Alice Lehman - Head of IR

G. Kennedy Thompson - Chairman, President and CEO

Thomas J. Wurtz - EVP and CFO

Donald K. Truslow - Senior EVP and Chief Risk Officer

Analysts

Bob Patton – Morgan Keegan

Gerard Cassidy – RBC Capital Markets

Gary Townsend – FBR Capital Markets

Matthew O’Connor - UBS

Presentation

Operator

At this time, I would like to welcome everyone to the Wachovia third quarter 2007 earnings call (Operator Instructions) I would now like to turn the conference over to Ms. Alice Lehman, Director of Wachovia Investor Relations. Please go ahead, Ma’am.

G. Kennedy Thompson

This is Ken Thompson. The line got very staticky when you started talking and I’m wondering if you can check to see if people can hear me. Operator?

Operator

Yes, sir. You’re good and clear.

G. Kennedy Thompson

Okay. Good.

Alice Lehman

Thanks for joining our call this morning. This is Alice Lehman from investor relations. We hope you’ve received our earnings release by now, as well as the supplemental quarterly earnings report. If you haven’t, both are available on our investor relations website at Wachovia.com/investor.

In this call, we’ll review the first 16 pages of the quarterly earnings report. In addition to this teleconference, this call is available through a listen-only live audio webcast. Replay of the teleconference will be available by about 2:30 today and will continue through 5:00 on Friday, January 11^th. The replay phone number is area code 706-645-9291 and the access code is 12547240.

Our CEO, Ken Thompson, will kick things off. He’ll be followed by our CFO, Tom Wurtz, and our Chief Risk Officer, Don Truslow. We’ll be happy to take your questions at the end.

Of course, before we begin I have a few reminders. First, any forward-looking statements made during this call are subject to risks and uncertainties. Factors that could cause Wachovia’s results to differ materially from any forward-looking statements are set forth in Wachovia’s public reports filed with the SEC including Wachovia’s current report on Form 8-K filed today.

Second, some of the discussion about our company’s performance today will include reference to non-GAAP financial measures. Information that reconciles those measures to GAAP measures can be found in our filings with the SEC and in the news release and supplemental material located at Wachovia.com/investor.

Finally, when you ask questions please give your name and your firm’s name. Now, let me turn things over to Ken.

G. Kennedy Thompson

Good morning, everybody and I apologize for the problems we’ve had with the telephone line. I hope it’s working okay now. I want to thank you all for joining us on the call. Undoubtedly you’ve already reviewed our earnings document and you know that in the third quarter we earned $1.7 billion or $0.89 per common share, which is down 10% from the same quarter last year.

It’s clearly been a challenging environment and the disruption in the global fixed income markets has dominated much of our focus in the quarter. Unfortunately, the markets most affected by the disruption are those where we have some of our most developed businesses in our corporate and investment banks. Specifically, those would be leveraged finance, structured products, and commercial real estate securitization. Mark-to-market loses in those three businesses constituted approximately 90% of our net valuation losses of $1.3 billion in the quarter.

As you all know, we’ve built very successful leverage finance and structured products businesses that have produced strong results for us over the last several years. In fact, in those two businesses they’ve produced over $4 billion in revenue in 2005 and 2006. While 2007’s results will be materially lower than that, I’ve got confidence that we’ll continue to grow these businesses over the long term. The leaders of these businesses have made very good strategic decisions while we were building the businesses and they continue to have my full confidence.

We’ve built the number one ranked domestic CMDS business and leading structured products and leveraged finance businesses, and we have very strong talent in place. We’ve got plenty of capital and we’ve got great liquidity to go forward in those businesses.

The shorter term outlook is less clear for the commercial real estate securitization business. The situation there is we have significant warehouse positions remaining in many of our competitors’ balance sheets. Deal flow has slowed and investors are skittish in the face of liquidity challenges. As a result of that, we think that revenue from that business will be challenged over the next several quarters.

In response to that, we’ve taken, and we’re continuing to take, decisive steps on expenses through actions on head count, incentives, and discretionary spending within our corporate and investment bank. But we remain firmly committed to these businesses and expect that over time they will perform well in an environment where going forward, we’re going to see much more attractively priced risk.

Now moving outside our corporate and investment bank, our diversified model and other fundamental strengths are continuing to serve us well. I’m pleased that we continue to see good sales activity throughout our organization, and our lend and deposit trends were solid in the quarter.

Our general bank’s earnings were up 3% linked quarter, even while we completed our Western State Branch conversion, which concluded this weekend and I’m really happy to say that there were literally no serious glitches in that integration. We’re very optimistic about our growth prospects in these fast-growing western markets and we believe we’re well positioned for opportunities in a now much less crowded mortgage industry.

We saw good retail checking account growth coming out of the Golden West franchise. In fact, World Savings Branches contributed 93,000 of the 832,000 year-to-date growth in net new checking accounts. Equally impressive during the quarter was the performance in our capital management group. Even with no closed end fund syndicate activity in this quarter and, even with a $40 million evaluation loss on commercial paper investments, they generated 18% year-over-year growth, and their poised for even more success now that our new AG Edwards colleagues are on board. It’s admittedly early days, but the AG Edwards integration is proceeding as we had planned to date.

In our asset management business we took action to ensure investor confidence in our Evergreen Money Market Mutual Funds and we were rewarded with substantial inflows to our funds in the third quarter.

All of our businesses across Wachovia have battened down the hatches and are focusing on controlling expenses. Outside of acquisition impact, there was really little expense growth at all in the third quarter.

In terms of asset quality, Don Truslow will share more details shortly, so let me just say that we are seeing weakening in some of our businesses from a credit standpoint. And as you have witnessed all week in other calls, this is happening across the industry.

Trends in mortgage credit are deteriorating faster than we would have expected. Our statistics remain better for consumer assets than those of most of our peers, but it’s clear that we are in an environment of building reserves. Our provisions exceeded charge-offs by $200 million this quarter and it’s not unlikely that a similar pattern may be required next quarter, not as a result of actual losses, but due to a disconnect between historical experience and what we see today in NPA growth.

When all is said and done, of course I’m deeply disappointed that our overall results for the quarter are not better. You can rest assured that we will apply the lessons of the recent extraordinary market conditions to adjust our infrastructure and governance and make our company even stronger, but you will not see substantial shifts in our business model.

I’m confident our company is in the right businesses for the long term and that our strategy of being in high growth businesses and markets, our laser focus on customer service, our expense discipline, and our commitment to strong credit risk management, will create value for our shareholders in the future.

Now, I’m certain you’re going to have many questions for us which we want to fully address, so now I’m going to turn this over to Tom Wurtz, who will go over the results of the quarter in detail, and he’ll also go over our outlook for both the full year and the fourth quarter on its own. Tom.

Thomas J. Wurtz

Thank you, Ken. Good morning to everyone on the call. Thanks for joining us. I’ll now turn to the quarterly earnings report document. So if I could ask you to turn to page 2, you can see the performance of our four business units compared to last quarter’s results and compared to last year. Overall, we had pretty solid results in core operations for three of the four segments. There are one-time issues which negatively impact the quarter results for wealth management and CMG that tend to mask the underlying performance of those businesses.

You can see the general bank is up 3% on a linked quarter basis, or 12% annualized. It’s both a good revenue story and a good expense story, which I’ll share with you as we go forward.

Next you see wealth management, down 12%, but here essentially all the decline is associated with the write-off a receivable in the insurance business. The core activities were relatively flat linked quarter and there was good sales activity.

The corporate investment bank is down 86% and we’ll spend a fair amount of time detailing the components of the writedowns that contributed to those results, and also highlight some of the businesses exhibiting strength in the quarter.

Capital management, down 5% on a linked quarter. That is the result of $40 million in marks taken out of commercial paper assets purchased out of Evergreen Money Market Funds Ken referred to, and that was really during the height of the market’s illiquidity disruption. Absent this, results were up from a record second quarter and essentially up 29% year over year, so great momentum there.

Overall, revenues declined 16% from the second quarter, primarily as a result of marks. A clear positive is the 2% increase in net interest income. I think we’re in an environment now where NI growth will again be a driver of revenue growth, which is a nice change from the sluggish environment we’ve been over the last couple years.

Interestingly, in the quarter we maintained extraordinary liquidity to be prepared to serve our customers very well and we were a source of liquidity of the entire industry during the period. The consequence of that is it ballooned the balance sheet and impaired the capital ratio a little bit from that standpoint. Also, there’s a negative drag on net interest margin and actually cost us net interest income as we borrowed longer term at rates tied to LIBOR and essentially sold Fed funds overnight. But we thought it was the prudent and responsible thing to do in that environment and we were able to sleep each night during the quarter, unlike probably some other folks.

Fee income was down $1.4 billion as a result of asset marks and really overwhelmed improvements in service charges, interchange income, fiduciary and asset management fees, and strong principal investing results.

We controlled expenses very well in response to the environment. Essentially, every category of expense was down on a linked-quarter basis, except sundry expense where one of the factors contributing to growth was an increase in legal reserves. Obviously the personnel line was the biggest source of reduction as incentives were right-sized to performance.

We experienced good organic growth in loans where commercial growth was 6%. Organic growth in consumer was about 2%, but consumer growth was offset by sale and securitization activity which I’ll describe later. Core deposits were about flat on a linked-quarter basis, but up 6% from a year ago. Very nice results considering the extraordinary amount of time that we dedicated in the quarter to preparation for what turned out to be a seamless conversion of the out-of-market World Savings Branches.

As Ken mentioned, we’ve clearly passed the inflection point in credit performance. While charge-offs remained at only 19 basis points or $206 million for the quarter, we did see further deterioration underlying credit trends in some portfolios and ultimately our provision expense exceeded charge-offs by about $200 million.

In aggregate, NPAs increased about $880 million to $3 billion or 63 basis points of loans.

The tax rate of 28.8% largely simply reflects lower level of income in the quarter.

Capital ratios are generally in line with expectations. We’ve conditioned folks to expect about a 4.6% or 4.7% tangible ratio. We ended up around 4.6% and that’s a reflection of the balance sheet growing a little bit quicker and obviously income was not quite as high in the quarter as we would have anticipated early on. We only repurchased about 4 million shares in the quarter.

In terms of integration work, there’s actually fantastic work going on with the AG Edwards integration planning and execution. The deal closed October 1^st and I’ll touch on that later.

As I noted, the out-of-market branch conversion of World Savings Branches occurred this past weekend and just was a marvelous success.

If I could ask you to turn to page 3, that details the impact of the market disruption on our corporate and investment bank. A couple of key points before I get into the detail. First, I believe we’re providing a pretty complete view of the businesses impacted by the re-pricing of risk we experience in the quarter. It might not be terribly easy for you to reconcile with peer information, which included perhaps a narrower list of businesses. So I think we’ve been pretty exhaustive in terms of describing the impact to it.

Second, the level of loss we experienced, it’s not out of line with the scale of the businesses we’re in and when we’ve been asked in the past to dimension our risk tolerance in CIB we’ve routinely said that our risk to an extreme market disruption is one-quarter earnings for the Corporate Investment Bank, and basically that’s what you’re seeing here.

Third, the losses are associated primarily with spread volatility and illiquidity. Those are essentially risks that are inherent in an originate-and-distribute business model and we’re comfortable taking that risk.

So, if I could ask you to look to the table tracking to the bottom of the chart, you’ll see a total loss of $1.34 billion. So that’s on a pre-tax basis. You go up one line, you see $40 million associated with the capital management’s purchase of the Evergreen asset by the Evergreen Funds. So the remainder is in CIB. So now we’ll start at the top of the CIB category.

The first line, mark-to-market of warehouse positions and commitments in the commercial mortgage business, along with highly rated CMDS securities and trading portfolios, totaled $488 million. That’s one where I said, I’ve not really heard a lot of peers talk to the commercial mortgage securitization business despite the fact that across the industry there are multiple billions of dollars in warehouse and pipeline positions. So that would be one that you might not be able to reconcile terribly easy to others.

Next is the marks on leveraged finance assets and commitments. Here we have marked all our positions which are scheduled to fund this year, as well as next. We started out with an aggregate exposure of about $11 billion at the beginning of the quarter and ended up with a similar level of total exposure. Essentially that’s primary bank loans. We have a very, very modest $50 million equity bridge, so we would conclude that we are on the less risky end of the credit spectrum when it comes to the aggregate portfolio.

It’s probably worth noting that as you read the chart it’s probably important to look at the 334 as an indicator of what the mark was net of fees. So it’s something over 3%, fairly consistent with what a lot of other folks have shown.

The next line addresses CDOs and CLOs and other structured products. Here we have the marks on warehouse positions and trading inventory, both of which we hold in trading portfolios. Here the mark was $438 million. This includes the positions Ken referred to in his reference to sub-prime mortgage exposure to AAA rated securities. About $308 million is associated with AAA rated sub-prime securities. Basically there we never would have expected that you would see AAA securities trade so far, so quickly, from par.

Finally, the consumer mortgage total of $103 million represents the mark on inventory positions in our wholesale mortgage lending business and customer warehouse positions. So, overall, these marks account for about 80% of the quarter-over-quarter diminution and revenue, with the remainder of the difference being primarily a slowdown in deal flow.

So with that, generally we pass over page 4 pretty quickly and just reconcile GAAP earnings, operating earnings, and cash earnings. Page 5, a summary of the income statement, which we’ll go through in greater detail each line item, but here I’d point out that net interest up $97 million or 2% and strong earning asset growth of $22.8 billion, and improving loans spreads fuelled that.

In here there’s about a $39 million benefit that’s kind of a catch up from a re-amortization of loan origination activity and so if you back that back out you’re up about $60 million, but I would say the drag from maintaining access liquidity positions was something a little bit more than $10 million, so probably up to $70 million on a core basis quarter over quarter. I think that’s going to be the source of some growth going forward.

Turning to page 6, if you bring your eye down to the first circle you’ll see the overhead efficiency ratio, 57.83. Clearly when we had set out on our overall efficiency goals we laid out what our expectations were. By the time we got to the end of this year we’ve had some acquisitions which have impacted that in a beneficial way. So we had suggested that we could get to 51.5 to 53.5 by the end of this year. That’s not going to occur by the end of this year, but I think that is a pretty reasonable expectation in the relatively near future, so I think we’re on pretty good track with that.

I would just reinforce what Ken said, is that there’s an awful lot of focus on expenses across the company and I couldn’t be more pleased with the response we’re seeing from our leaders on that front.

Net interest margins, down a couple basis points reflective of the significant liquidity positions we have during the quarter. You see charge-offs of 19 basis points, right in line with expectations. Moving your eye down a little bit further you see the capital ratios, the 4.6 tangible ratio, where 4.7 would be a target for us; the leverage ratio slightly above the target of 6.

If we turn now to loan deposit growth you see trading assets up $3.6 billion, reflecting growth in structured product warehouses. Securities up $3 billion, and that reflects the effect of investing excess liquidity. Commercial loans increase 6% or $9.2 billion on the quarter. That was really across strength in large corporate, foreign middle market and business banking, and the commercial real estate portfolio. Period end loans went up about $14.2 billion.

Consumer loans, the growth in real estate consumer loans was really masked by the movement of $2 billion of student loans to available for sale, which we intend to sell those loans, and our credit card portfolio of about $1.6 billion we’ve moved to available for sale and we’ll securitize those loans.

Loans held for sale up about $2.6 billion. Largely on the transfer of $2 billion of student loans and $1.6 billion of credit cards I described before, as well as other activity in the quarter. Other earning assets up $5.1 billion and that’s largely liquidity positions, interest bearing bank balances, and Fed funds.

Finally, core deposits up just a tad on growth in retail CDs, money market and foreign, offset by some declines in DDA and savings.

If I could ask you to turn to page 8, Fee and Other Income, and again, there are some good stories here. Services charges, you can see, are up 3% on a linked-quarter basis, 8% from the third quarter of last year. Consumers up about 5%. Commercial service charges relatively flat. Other banking fees heavily impacted by mortgage servicing right valuations. Underneath that, however, is good interchange activity and we are pleased with that.

Commissions declined $49 million, largely related to brokerage. If you think about the quarter, we had had real nice activity in closed-end funds over the course of the last three or four quarters and essentially when the disruption occurred that market shut down. So despite the fact that one of the really attractive products had been taken out of the mix for the third quarter, brokerage still did a fantastic job and had a profit margin of about 28% for the quarter, so very strong.

Advisory underwriting and investment banking fees decreased 13% on weakness in high-grade equities and loan syndications, somewhat offset by improvement in the structured credit products. Trading account results reflect the marks, primarily.

Principle investing, net gains of $372 million, up about $74 million from last quarter results. That was somewhat offset by lower results in the public portfolio.

In the quarter, principal investing reflects the fact that over the past six to nine months, had been working on an opportunity to add public funds to our principal investing activities. So we sold a 25% interest in our private portfolios and also obtained commitments to fund additional principal investment activity. I think it’s a real testament to the strength of that team and the confidence that institutional investors have in their abilities. Security losses reflects the $40 million mark taken on Evergreen Funds. Finally, other income decreased, again primarily as the result of marks which we’ve described.

Expenses, a great story here. As I noted, every line is down with the exception of sundry up about $77 million and the primary increase there would be increase to legal reserves.

Turning to the General Bank, a very solid story. Up 3% on a linked-quarter basis. Great efficiency ratio story; down to 44.75, a nice improvement. Customer satisfaction very high, loyalty up to 53%. New loss ratio, 1.34. We had positive operating leverage in retail, mortgage, wholesale.

So again, across the board, a very good story of execution there. I’m very pleased with the results. Again, that was at a time that we opened 37 De Novo Branches and consolidated 17 branches, as well as converted 214 branches from World Savings; so a lot of activity and strong execution.

Wealth management, as I mentioned, included in these results is the write-off of an $11 million receivable related to the insurance business, and absent of that, you have pretty flat results with the prior quarter, although underlying that, there’s some very solid activity in the sales of fiduciary and asset management accounts, so a nice story there. Good control of expenses. You can see assets under management increased 4% on linked-quarter basis.

The Corporate Investment Bank, obviously the bottom line results are the product of the marks which we’ve described. You can see revenue of $819 million decreased $1.4 billion from the prior quarter. Net interest income is up strong and again I would expect that that would be a source of growth there for a couple of reasons: (1) there will be more assets held in portfolio; and (2) spreads are wider. So I think that’s going to be a good story there.

Finally, after the entire industry laboring under incredibly narrow spreads we’re finally seeing a decent risk-return profile and that should be a source of growth, both for CIB and for the company.

Overall, expenses down 39%. That would be in the personnel line, as well as every other line item in their income statement. Great control there and I think there’s reason to believe you’ll see that kind of discipline displayed going forward.

Average core deposits up about 1% or 17% from last year.

Capital Management, turning to page 13, segment earnings of $275 million. As you can do the math, if you add $40 million hit on the market funds after tax, add somewhere around $23 million, $24 million, and so absent that you would have had again record results. There’s a good story across many different areas. Brokerage was great in terms of adding advisors, great expense control, great margin. In the money market area, I think there was flight to quality and we saw a $6 billion increase in institutional money market accounts since June 30^th. That’s up about 18%.

On the AG Edwards front, we’ve completed our due diligence efforts, which is a really deep dive into all the elements of the expense and income statements. We’ve selected senior leaders. We’re probably about 90 days ahead of where we would have been with the Pru integration at this point, which I think is great from that standpoint. We’ve revalidated all the expenses saves and revenue synergies that we put in our model and feel good about where we’re situated on AG Edwards.

With that I will turn it over to Don before we get back to guidance.

Donald K. Truslow

Thanks, Tom. Looking at page 14 here, while we’ve been expecting an upturn in credit costs for some time, as Ken and Tom have alluded to, the accelerated decline in the housing market particularly as evidenced by trends over the last month or so, caused credit costs toward the end of the quarter to rise somewhat faster than we had projected.

I’ll first give a high-level recap of the quarter. Some of the information Tom’s already touched on. Then probably appropriate to dive a little deeper into a couple of key areas.

Non-performing assets rose $881 million to 63 basis points during the quarter. The largest component of that was a $587 million increase in consumer real estate loans and a $127 million increase in consumer foreclosed real estate. Commercial real estate non-performing loans were up $128 million, ending the quarter at $289 million, with most of that increase representing softness in the residential home-building sector. Commercial and other consumer non-perform increases were pretty modest during the quarter.

Turning to charge-offs, losses rose to $206 million from $150 million in the second quarter. We ended the quarter with a 19 basis point charge-off ratio. Commercial charge-offs were up $7 million, primarily reflecting lower recoveries of $5 million and represented just 8 basis points.

Consumer charge-offs rose $49 million and were mostly driven by seasonally higher auto loan losses. Consumer real estate secured loan charge-offs were up a modest $18 million in the quarter and totaled just 8 basis points.

Tom touched on provision expense totaled $408 million. That resulted in an increase to the allowance for credit losses of a little over $200 million before the transfer out of $63 million for the movement of loans transferred to held for sale, most of that being attributed to the credit card portfolio being moved to held for sale.

The increase in the overall allowance was really driven by two things: (1) increased loan volumes. As we’ve said, there was some modest deterioration in credit quality. Also included in the allowance calculation is an $88 million correction in the consumer formula-based component for overdrafts, which had the effect of reducing the amount of reserves needed. Additionally, there is a $75 million increase to the unassigned portion of our allowance reflecting a less certain outlook for our credit environment.

Stepping back, it’s worth making a couple of comments about some key areas in the loan accounts. Starting with the mortgage company, non-performing loans continue to have a low loan to value on average, and therefore we believe represent relatively low loss content. Loan to values at the origination of these non-performing loans averaged 75%. Periodically we go through and we update those values using AVM estimated value analysis, and we did that in August. That’s all done at the loan level. So when we ran this analysis in August we saw a little bit of deterioration in the loan to value numbers, but they were still at a very conservative 77%.

Charge-offs from the mortgage company portfolio were a modest $21 million or about 5.5 basis points on an annualized basis. At the end of the quarter, total loans past due 30 days or more, including non-performs, were still relatively low at 3.6%.

Much of the increase in non-performing loans and the losses, although still low, are on loans in certain California markets that have experienced fairly steep declines in prices. Our delinquency call centers report that the primary reasons for borrowers struggling to pay are threefold. First it’s reduction of income or underemployment. Second is the assumption of additional debt from lenders other than Wachovia and thereby changing their credit profile from the origination of the loan. Third, unemployment. We have seen some uptake on unemployment in some of these markets.

Now, let me also point out that while the average current estimate of the appraised value of non-performing loans is 77%, there is $380 million in balances out of the total $1.7 billion where the current estimate of value is over 90%. Actually, on that pool averages in the high 90’s. Again, reflecting the dramatic decline of house prices in certain markets. These particular loans had a low loan to value of just under 80% at origination. It’s interesting to note here that problems in these markets, really for all lenders, seem to be across the board without regard to originating FICO, the type of loan or the condition of the property.

Given our outlook for continued weakness in the housing market and the possibility for a slowing consumer sector, we anticipate that non-performing loans on our consumer mortgage book will continue to increase over the next few quarters and that losses will be up, albeit at fairly modest charge-off rates.

To manage the increase in loans in foreclosure, we have significantly increased our staff responsible for handling OREO properties and working with delinquent borrowers. When we do foreclose on a property we are moving as aggressively as we can to prepare and price the property to sell, and sometimes choosing to maybe take a somewhat higher loss on that sale rather than risk holding out for a top dollar opportunity that may or may not come down the road.

The commercial real estate portfolio continues to perform very well overall. Loans secured with income-producing property continues to enjoy solid underlying fundamentals with favorable vacancy rates and cash flows. As we have noted, probably on the last couple of calls, the portion of the commercial real estate portfolio connected to housing is experiencing an upward trend in criticized assets resulting in modestly higher charge-offs and non-performs. While these loans have generally performed well overall and the charge-offs in the total real estate financial services portfolio were only $3 million in the quarter.

We do anticipate further softening and have recently undertaken a thorough review of our residential related commercial real estate loans. Nearly all of these loans are on a ‘with recourse’ basis and as we identify potential weaknesses we are and will be moving aggressively to work with borrowers to either shore up or move those loans as best we can. As we have worked through the scrub of the portfolio, while we believe credit costs will be rising, we believe the deterioration will be manageable.

Commercial middle market, business banking, as well as the credit quality in our large corporate loans continues to perform very well. It’s also worth noting that second lien residential consumer loans continues to show very strong performance. Nearly all of our second lien loans are relationship driven and originated through our branches. As we’ve published in a couple of recent presentations, these loans are well secured and carry high average FICO scores. The end of the quarter, 90-day past-due loans including non-performs on this second lien portfolio total just 45 basis points and total non-performing loans on second lien loans were just $41 million.

As we enter the fourth quarter and head into 2008 we do see credit costs rising from the very low levels which we’ve experienced for the last couple of years. While somewhat subjective, we have been guessing or basically estimating that the average through the cycle charge-off rate for our loan portfolio, given the mix of businesses, is probably somewhere in the 30 basis point range, give or take. While moving back to that rate over time is what we’ve been expecting, the negative trends in the housing market and probable softer economic outlook, especially as it may impact the consumer, means that we will likely see a faster adjustment to that norm as we head into 2008 than we thought as we entered the third quarter.

We are adjusting our annual guidance for 2007 for charge-offs to the high teens. It’s noted in the outlook session in the pages that follow for the fourth quarter, we anticipate charge-offs for this quarter to be in the mid to upper-20 basis point range. Also as Ken has mentioned in his opening remarks, we will continue to examine credit trends each quarter and add to our reserve as appropriate.

So Tom, in summary I would say that credit quality remains good by historic measures, but we are seeing more credit issues on the horizon for the industry as the housing segment of the economy continues to weaken. But given our collateral positions and underwriting at origination we firmly believe that we’re relatively well positioned to ride out this environment.

Thomas J. Wurtz

Thank you, Don. If I could ask people to turn to page 15, 15 is our full year guidance in the same form that we use every other quarter and I would say this was put in just as a convenience to folks if your models are driven in this manner. But I think if you want to be able to understand what our view is of the fourth quarter it would be much more convenient to turn to page 16. There, we simply provide a reference for what third quarter actual results are and then our outlook for the fourth quarter in reference to the third quarter results.

I would make the note, this does not reflect the impact of AG Edwards, which closed on October 1^st, which I’ll address separately.

So net interest income, $4.6 billion and we expect 1% to 3% growth relative to that value. Income, $2.8 billion, obviously at a depressed level. We expect 30% to 34% growth in the fourth quarter. Non-interest expense, $4.4 billion. Expect that growth to be in the 5% to 7% growth range. Minority interest expense, $189 million, expected to be down 20% to 30% from that level.

Loans, we expect overall loans to be mid single-digit growth range. And charge-offs, as Don mentioned, 25 to 30 basis point range. The provision, as Ken mentioned and Don mentioned, would expect to be higher. This quarter provisions exceeded charge-offs by $200 million and it isn’t at all that unreasonable that you can have something similar or even greater next quarter. We’ll just have to see what the trends suggest. If the trends had indicated that would have been appropriate this quarter we would have done that. They didn’t and so we’ll move forward to next quarter. We should achieve our target capital ratios in the quarter.

Finally, with respect to AG Edwards, on the bottom of the page we’ve shown what their last quarter results were for revenue and expense and net income, for folks that want to incorporate that into their model, and by our calculations we don’t believe that in the fourth quarter it has any material impact whatsoever. It should be about breakeven with our results. So if you get results different than that then I would suggest you try again.

With that, I’ll turn it back to Ken.

G. Kennedy Thompson

Well that completes our formal presentation, operator, and now we would like to open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Bob Patton with Morgan Keegan.

Bob Patton – Morgan Keegan

Morning, guys.

G. Kennedy Thompson

Morning, Bob.

Bob Patton – Morgan Keegan

Can you give a little color as to what the impact is with and without Golden West? I mean, obviously California markets, we know what’s going on and you’ve given some colour, Don, but can you sort of give a little more colour what’s going on in terms of the trends in some of the Golden West markets and the portfolio?

G. Kennedy Thompson

Bob, given that the kind of hot spots driving the increase in non-perform are the certain California markets and the fact that Golden West was more heavily concentrated at the time of the deal, most of the increase in non-performs does come out of the legacy Golden West portfolio.

But it really relates back to what is happening underlying in those markets as opposed to anything about the product or the underwriting at inception. As a matter of fact, I think the fact that the way those loans were underwritten and how collateral was appraised, et cetera, I think we are probably faring in much better shape than other lenders in this market.

Donald K. Truslow

What I can tell you, Bob, is from a top of the house perspective in terms of net income contribution of Golden West, net income is materially higher in 2007 than it was in 2006. I would have a fair amount of optimism or a great amount of optimism that you will see or we will see growth in 2008 as well. We’re seeing balanced growth, margins are wider, and to this point actual credit losses have been extraordinarily low and we’ve achieved all the expense cuts plus probably a little bit more as we integrated our mortgage businesses. I’d be honest with you, it didn’t hit the numbers we thought back in 2006 or 2007, but it’s clearly growing and will continue to grow at a nice healthy pace.

Bob Patton – Morgan Keegan

Don, in terms of where we are in this housing cycle, obviously it’s accelerating. Obviously we all got caught a little surprised with the rate of deterioration and provisions across the group. Where do you think we are in terms of percentage? Are we halfway there? A quarter of the way there? Is this through ’09? What’s your thoughts?

Donald K. Truslow

Gosh, Bob, it’s just hard to tell. I don’t know whether we’re a third of the way or half way through, but it’s very evident that the withdrawal of capital that existed for a segment of homebuyers out there, call it sub-prime or lower quality credits disappeared and that’s forcing a lot of inventory back on the market and it’s having widespread effects across the market. I don’t think any of us really connected those dots to understand that broad ripple effect.

Of course, there are a lot of resets that have been in the press being talked about coming up as we head into 2008 and what impact that has in further inventory coming back on the market. I think we’re just going to have to watch.

On the positive side -- and this is kind of good and bad -- but the housing start numbers the other day were low and as you would hope, so maybe that’s a signal that new inventory from construction is slowing down and hopefully will help us work through the inventory overhang out there maybe a little more quickly. Personally I think we’re looking at a very soft housing environment well into 2008, if not all the way through 2008.

G. Kennedy Thompson

I would just say, Bob, a couple of the areas where again that would be positive would be the reset issue that Don described isn’t an issue for us. Our products don’t have that feature. Second, just amplifying what Don said about the second portfolio, it’s performing extraordinarily well with only about $40 million in NPAs. So we’re insulated from that standpoint and that’s certainly a source of comfort.

Operator

Your next question will come from the line of Gerard Cassidy with RBC Capital Markets.

Gerard Cassidy – RBC Capital Markets

A question about the net charge-off ratio that Don touched on regarding a full cycle of being about 30 basis points. Would you expect to exceed that in the down part of the cycle since you had great numbers in the last couple of years in the teens? So to get to that average do we need to exceed that 30 basis points at some point in the future?

Donald K. Truslow

I mean, that would be an average through a cycle and so we’ve kind of been tracking an interesting trend going back to the third quarter of 2001, the last cycle, and pulling through our average charge-off ratios including losses on loans that we’ve sold into market or took advantage of the cash markets.

If you average through those years up until maybe last quarter or the quarter before, wherever you want to pick, maybe the beginning of the inflection point, we’re in the low 30’s. Again, it’s subjective because markets change, every cycle is different. It’s really just an educated estimate.

But when I talk about 30 basis points give or take it really is through a cycle. So at some point in the downturn you’re in worse position and obviously at other points you’re in a better position.

Gerard Cassidy – RBC Capital Markets

The other question, can you guys give us some further color on the comment you made about the $40 million valuation loss related to the certain asset-backed commercial paper investments at Evergreen?

Donald K. Truslow

Sure, I’d be happy to, Gerard. Really, when the market was at its ultimate disruption everyone was concerned by commercial papers that was supported by assets and asset-backed commercial paper vehicles. We looked through the portfolio and we saw about $1 billion of commercial paper that was backed by what we considered to be pretty high quality underlying collateral and we felt that it would reassure customers of the Evergreen Funds to buy them out.

Essentially all the underlying positions were AAA collateral. So we bought them out and as we sit here today probably about half of it has been resolved or paid back and there’s some more coming down the line where the ultimate loss will be zero. So we’ll probably take a hit in the neighborhood of $4 million, $5 million, $6 million perhaps if we were to sell the assets and if we were to hold onto them, perhaps nothing. But we just thought it was the right thing to do and I think our customers saw that as a real sign of strength. As I mentioned, we saw great inflows during the quarter.

Gerard Cassidy – RBC Capital Markets

Finally, somebody mentioned about you guys have seen some softness in unemployment or unemployment rates rising in some of your markets. Can you tell us or identify which markets you’re seeing that happen?

Donald K. Truslow

I was mentioning that, and if you go out to pull the data from moodyseconomy.com and just track some of the markets in California and the central valley and, again, some of the places you have been reading about where there’ve been housing declines, you also see a slight corresponding uptick in unemployment. So that’s where we pulled that data.

Operator

Your next question will come from the line of Gary Townsend with FBR Capital Markets.

Gary Townsend – FBR Capital Markets

Ken, could you talk about risk management experience in the past quarter in your capital markets operations, please? Were you satisfied? What might you do better? What types of assessments are being made?

G. Kennedy Thompson

I would say to you that starting in that second or third week in July when the markets seized up we have been very hands on and very active in meeting with CIB leaders, with risk, with finance, and me on a regular basis. As I think Tom said, we think our disclosure to you on our marks is extremely transparent. That $1.3 billion in marks is essentially all of the marks we took and we think that a lot of other companies as they have presented their marks have only shown you certain areas. So we think that the $1.3 billion that you might compare us with others is maybe overstated a little bit.

But if you look back at the marks that we took, 90% of those marks are in what we consider to be very core businesses for us. That would be leverage finance, commercial real estate finance, and structured products. Those are businesses that fit our business model well. We’ve got traditional strength in those fixed income markets and those are businesses that we want to be in.

I would say to you that I’m comfortable that our capital markets leaders understand our business model, that they sized our risk limits and stress tests to the desired earnings and historical financial performance goals. I think our business unit at all times operated within approved limits. We didn’t see any situations where we got outside of limits or outside of our model.

I think without question we’re going to use the experience that we’ve just been through to refine our models. We’re certainly going to worsen some of the stress testing conditions that we look at going forward and we’ll change the way we do some things.

I would say that as we look at results I think the biggest disappointment for me is that of those $1.3 billion in marks we had about $300 million, roughly $300 million in losses on AAA sub-prime paper that was in trading desk or in inventory. The thing that disappoints me about that is we have an institutional bias here against sub-prime. We avoided it in our origination efforts and we avoided it for the most part in our securitization efforts.

So frankly, I think we had a little bit of a breakdown in having AAA sub-prime in some of our portfolios that we took losses on. I do think that it is really quite amazing that we can take $300 million of losses on AAA paper. I mean, we didn’t expect that that paper could degenerate that fast with that kind of swiftness.

So overall I would say to you that I think we did a good job in our risk management here. We have always been in this business knowing that losses could take place. Some of it is liquidity and may come back. But we’ve always had a minimum target that said we could lose one quarter’s worth of earnings in our markets business and that’s essentially what happened here and I think we’re poised to grow those businesses going forward.

Does that get at your question?

Gary Townsend – FBR Capital Markets

Quite thoroughly. Thank you. Don, could you talk about auto credit and trends there? This has obviously poked its head up now too.

Donald K. Truslow

For the quarter the uptick is primarily seasonally driven. If you go back and look at our portfolio, the track by quarter of charge-off rates, typically the first and the second quarter, particularly the second quarter, is a low point. But as the manufacturers begin to change over their model years there is an impact as we go to market with repossessions in the third quarter and the fourth quarter given that there are new car models coming on the market. So severities tend to rise.

The charge-ff rates in the auto portfolio have been pretty much tracking to the seasonal pattern we’ve seen in the past. So while charge-offs are up, the other thing that maybe is not as transparent that you’ve got to keep in mind is that it’s a very profitable business and the margins that we’re getting on the paper we feel like we’re being very well compensated for the risk.

Actually, on the Westport portfolio we are tracking well below the charge-off forecast that we anticipated at the time of the deal. So we’re very pleased about that.

Gary Townsend – FBR Capital Markets

So the weaker trend in auto you’d describe as more seasonal?

Donald K. Truslow

That was primarily what we saw in our portfolio. I guess a key question going forward for all of us looking at 2008 is if the housing disruption begins to impact the consumer in a bigger way, does that then ripple back into the auto market in some form or fashion more than we’re seeing?

Gary Townsend – FBR Capital Markets

As we talk to companies, September, and I think you mentioned this too, was a particularly weak month for credit. Is that trend, as you see it in October, about the same? Would you say it’s slowed or accelerated?

Donald K. Truslow

Still kind of early in the month, but I would say that the trends we saw late August and September, half way through this month are about the same. I wouldn’t say that they’ve accelerated, but they haven’t backed off either.

Operator

Your next question will come from the line of Matthew O’Connor, UBS.

Matthew O’Connor – UBS

Can you tell us how much reserves were set aside for your first lien residential mortgages?

Donald K. Truslow

I don’t have the number right off the top of my head specifically, but I will tell you that the ticker tape portfolio was the largest component of the first lien portfolio and we have multiples of what the losses have been and the expected losses built into our model have been somewhere around 9 basis points. We are looking at that now. Of course, charge-offs on that portfolio have been less and the overall reserve for the portfolio has been somewhere around 20, 22 basis points. But we will be taking a look at that in the fourth quarter as well as we freshen up the expected loss evident to 2008.

Matthew O’Connor – UBS

Assuming that goes higher, like under a stress scenario, if you get back to that 18 basis points that you had last time, what would that do to reserves? Is it kind of a one-to-one, two-to-one? Can you give us a sense of the ratio there?

Donald K. Truslow

Hard to know, just because of the couple of components that really drive the reserve. There`s an expected loss component that certainly would go up. There`s a variability component that may not change as much. So I don`t know that you could ascribe a one-to-one move in the reserve to charge-off trends. As a general comment, the likelihood is we would be providing more than we are today as we saw a credit worsen. Most likely a further charge-off amount.

G. Kennedy Thompson

I think it`s worth noting there that as provisions rise, what we`re also seeing is outstandings growing and we`ve got better margins in that business now. So to a certain extent we are seeing net interest income growth really we think is going to do a very good job of paying us for the credit losses that we will take as provisions go up.

Matthew O’Connor – UBS

That`s definitely a fair point. As we think about fourth quarter reserve build, is it likely to be more than we had this quarter? On a reserve to loan basis, for example, because of the good loan growth the ratio actually went down a little. If you`re going to revise up to the loss estimate should we expect a pretty meaningful build in reserves in 4Q?

Donald K. Truslow

Matt, it’s just too early to say. The reserve process basically consists of us looking at the portfolios that will come in at the end of the quarter and, as I mentioned, both look at loan volumes as well as credit quality, with some adjustment for trends that we may sense that aren’t captured in our normal other factors. So that’s, for instance, why we felt it appropriate to build our unassigned reserve somewhat this quarter and we’ll just have to watch that as we move into the quarter. I don’t know that I could give you a very clear sense of what might happen in the fourth quarter.

Operator

Ladies and gentlemen, we have reached the end of our allotted time for questions and answers, and your final question will come from the line of Keith Horowitz with Citigroup.

Keith Horowitz – Citigroup

In your 10-Q you disclosed that you had roughly I think $7 billion SIV going through your QER.It looks like you moved, you consolidated that $1.8 billion. First of all, is that correct? And if so, what happened to the remainder of the SIV? For example, were you able to sell some of those assets?

Thomas J. Wurtz

I’m going to answer your question and then also have one other note to make. I was looking through my notes as to things I wanted to mention on our marks and I noted that our marks were net of hedges, but it’s probably worthwhile noting also that given that we’re not in fair value accounting there is no mark-to-market on our own debt softening those marks in that business.

In terms of the SIV exposure, we had a $7 billion exposure and basically $3 billion of that amount appears as foreign loans and that is in Wachovia Bank International. About $2 billion is in loans held for sale. Less than $2 billion is in trading. It was a little less than $1 billion that was really a cash position in that account, so that came as cash. That’s kind of a reconciliation of where we were and where we are.

Keith Horowitz – Citigroup

It all collapsed back on balance sheet.

Thomas J. Wurtz

Correct.

G. Kennedy Thompson

You get that Keith? It’s all on balance sheet.

Keith Horowitz – Citigroup

Yeah, no, I got that. That’s the perfect answer. Thank you.

Operator

Are there any closing remarks?

G. Kennedy Thompson

I would just say thank you for your interest in Wachovia today. I hope that we’ve done a good job of answering the questions that you’ve got. Obviously, as always, Alice Lehman and her team will be available to take further questions.

Just in closing, it’s obviously been a tough environment. We’re not excited to report down earnings, but we are pretty optimistic about our model and about our ability to go forward and to do well at Wachovia. So thanks for being with us.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may all disconnect.

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