Wachovia's Asset Class Exposure Relatively Low - Fitch

Fitch Ratings Monday issued a relatively favorable prognosis for Wachovia’s (WB) debt, despite the bank’s reported $350-million first quarter loss and write-downs.

Fitch affirmed the ‘AA-/F1+’ long- and short-term Issuer Default Ratings (IDRs) for Wachovia Corporation and its subsidiaries following review of first quarter 2008 (1Q’08) results and assuming successful completion of a planned capital offering. Fitch’s Rating Outlook is Stable.

Fitch said Wachovia’s exposure to the troubled California residential mortgage market is considerable at approximately $78 billion.

“Wachovia estimates aggregate credit losses on its $121 billion Pick-A-Pay portfolio of $3.7 billion to $4.5 billion over the two year period 2008 through 2009. The $1.1 billion reserve build modeled specifically for this portfolio (in addition to another $1 billion for other loans) positions WB better to absorb future credit losses yet suggests that normal quarterly provisions will remain elevated over the intermediate term, relative to levels experienced during the past several years through mid 2007.”

Although Fitch has affirmed Wachovia’s ratings at this time, if credit losses deteriorate such that, for example, Pick-A-Pay losses materially exceed the implied upper end annual loss level of 1.9% of that portfolio over the 2008 to 2009 period, it would likely have negative rating implications for Wachovia.

Of note, Fitch said, credit losses on Pick-A-Pay mortgages in 1Q’08 were still only $240 million or 0.79% of the portfolio, annualized, albeit markedly worse than 0.31% in 4Q’07. Wachovia recognized charges of $2 billion primarily associated with market valuation declines on securities held in its Corporate & Investment Bank business including further write-downs on its ABS CDOs, CMBS and leveraged loans.

Wachovia’s cumulative write-downs through the past three quarters and residual exposure to these various asset classes is meaningful but considered manageable by Fitch, and is comparatively lower than many of the other large U.S. banks as Wachovia has moved aggressively to work down many of these assets.

Critical to Fitch’s rating affirmation is the additional flexibility created through Wachovia’s capital improvement plans, which include a 41% reduction in its common stock dividend and a significant capital offering. Wachovia is expected to raise at least $7 billion of new capital through the offering of both common equity and convertible preferred in the very near term. Liquidity remains prudently managed, despite challenging market conditions. Wachovia has been an active and opportunistic user of the capital markets, while core deposits have shown good growth momentum and fund nearly $400 billion of total assets, Fitch said.

Standard & Poor’s took a dimmer view, revising its outlook to negative from stable. S&P affirmed its ‘AA-/A-1+’ counterparty credit rating.

In the near term, we expect lower earnings in 2008 as Wachovia manages through the tough credit cycle for residential mortgages and lower fixed-income volumes within its capital markets group, which specializes in commercial real estate [CRE] finance. Besides the GDW California-based residential mortgage portfolio, Wachovia’s exposure to other higher risk asset classes is quite small relative to its business and relative to some of its large bank peers.

The ratings on Wachovia Corp. reflect the strengths of its retail banking franchise and its strong diversification of business and earnings. Wachovia’s retail banking franchise currently holds a strong market position in several major Southeastern and Mid-Atlantic states and continues to post strong core deposit growth, S&P said.

Meawnhile, Felix Salmon at Portfolio.com wonders why Wachovia needs another $7 billion of equity capital, on top of the $8.3 billion it raised earlier this year.

Most likely this capital infusion is an attempt to prepare for an enormous write-down related to the $25.5 billion acquisition of mortgage lender Golden West Financial in May 2006. If Golden West’s business is worth only say $5 billion today, then at some point Wachovia’s going to have to take an enormous one-time loss, and it doesn’t have the capital to be able to do that right now.

Doug McIntyre at 24/7Wall Street says Wachovia did make its life worse by buying Golden West, which had many of its loans in the troubled California market. But, the need for capital is also a sign that Q1 earnings at most banks could be worse than expected.

Wachovia may be reporting earlier than most large financial firms, but its numbers are likely to tell Wall Street that the crisis in the credit markets is far from over. The omens of trouble are back in the atmosphere.

Andrew Horowitz at Bloggingstocks.com says while it is possible for some perma-bulls to look at Wachovia’s capital-raising in a favorable manner, it is not in the best interests of anyone’s net worth to invest in a company that willingly shreds its share price over a weekend. What this really means is that management is not only desperate, but that they knew much more than they let onto during the last few months. That is not a good situation for an investor to be in.

Do not let the smokescreen fool you. There are still a great deal of problems within the financial sector. These bailouts are designed to bring life to corpses… Dr. Frankenstein, calling Dr. Frankenstein.

On a more positive note, FT Alphaville reports that Lehman Bros includes Wachovia among its top picks for deep value stocks, in a report published prior to the latest developments for the bank.

As such, a view on value necessarily comprises a view on the Financials. We think that the sector will rally from here, that it offers extreme value compared with its history and it has gone through a period of intense downgrades, with signs of moderating downgrading activity over the past two weeks.

The last word goes to Wachovia CEO G. Kennedy Thompson. According to The New York Times DealBook, Thompson said on a conference call that Wachovia was raising capital “not simply to fill a hole in our balance sheet” but to provide the bank with flexibility if conditions worsen. He said the dividend cut was “not taken lightly” but was the right decision given the company’s earnings outlook. And new, more conservative estimates have caused the bank to significantly increase the money it is setting aside for future loan losses.

Comments

[Pj568:]

It seems to me that the divergence of views between the credit rating firms and the others are due to one group looking at the eventual cash effect while the others are looking at book equity anticipating a substantial impairment charge on the 17B in goodwill recorded for the acquisition.

2008 Apr 15 08:41 AM