Wachovia Corp. had spent the better part of two years trying to convince Wall Street that mortgage exposure from its Golden West Financial Corp. acquisition could be contained through stringent underwriting.
On Monday whatever was left of that optimism vanished in a multipronged announcement. The Charlotte company reported it lost $350 million in the first quarter, forcing it to slice 41% from its dividend and seek an additional $7 billion of capital. It cited a jump in defaults in its pick-a-payment mortgage portfolio, which made up 71% of its $170 billion mortgage book on March 31.
But when asked during conference calls Monday to pinpoint what changed during the quarter and where, executives at the $808 billion-asset Wachovia would not say whether credit issues had spread beyond California or Florida, states they had flagged as worrisome in recent weeks. They also would not speculate on future trouble spots.
Instead, G. Kennedy Thompson, Wachovia's chairman and chief executive, spoke broadly about managing its mortgage exposure and said that after analyzing data in late February and early March, it altered its modeling and reserve methodology. The results were "harsher than we expected prior to that time."
He characterized the additional capital as more than a stopgap, saying it should provide "definitely more" than Wachovia would need. "We decided to do it now and not go back to the window in the future."
Donald Truslow, Wachovia's chief risk officer, would not say where the next housing issues could occur, though he did forecast a "sobering and realistic" 7.5% cumulative loss rate for this year and next year in the loans in its pick-a-payment portfolio.
"What I don't know, and I guess we're just learning over time, is whether the same sort of behavioral trends and patterns" found in California "will spread to other markets," he said during a conference call with analysts.
Mr. Truslow gave a similar response later during a news media call when pressed on how much degradation might occur from defaults tied to borrowers with good credit ratings — a trend he said that has picked up steam in California and led Wachovia to change its modeling for defaults and losses. "This phenomenon … is new and something we're trying to get our arms around," he said.
As recently as last month, the message from Wachovia had been that, despite the poor timing of the October 2006 acquisition of Golden West, the majority of the mortgage exposure was limited to several bad markets in California, with some additional risk in Florida.
Though Mr. Thompson, Wachovia's chairman, president, and chief executive, acknowledged in mid-January that it could sell more preferred stock, he had said he was happy with capital levels and the security of its quarterly dividend. In his annual letter to investors filed with regulators in February, he said Wachovia was facing "a moment of truth" that would show its "proven mettle."
During the news media call, Mr. Thompson defended the sudden change in tone in discussing credit quality and capital adequacy. "We felt very confident in those statements when we made them," he said.
Meanwhile, Thomas Wurtz, the company's chief financial officer, also said that Wachovia had begun reducing its exposure to home equity lines. The company's home equity originations in the first quarter fell 41% from a year earlier.
Analysts said the slew of surprises came at a bad time for Wachovia, a week before its annual meeting and near the two-year anniversary of announcing the $24 billion deal for Golden West. Since announcing the deal in May 2006, Mr. Thompson and other executives have been pressed to defend it, and Monday's revelations are sure to apply more pressure on that front.
"It all comes down to whether they are being conservative enough, given how much they have missed the mark already," along with "the about-face that occurred in a short period of time," Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners LP, said in an interview Monday. Though it is "to early too tell" if Wachovia has taken appropriate steps, "I don't have a lot of confidence about it right now."
Wachovia did provide some general parameters for mortgage credit quality. Mr. Thompson said that the capital-raising effort should cover any needs if the housing malaise continues for another 12 to 15 months.
Mr. Truslow attempted to guide on credit losses, which led Wachovia to reserve $2.8 billion in the first quarter, including $1.1 billion dedicated to its pick-a-payment product. During the analyst call, Wachovia showed a chart projecting $5.6 billion to $6.6 billion of credit costs in that portfolio this year and the next.
Robert Patten, an analyst with Regions Financial Corp.'s Morgan Keegan & Co. Inc., said those numbers are not reliable.
"It is unclear where they are with this transformation," he said in an interview Monday. "The toxicity in the Golden West portfolio is becoming more apparent."
Though Mr. Truslow would not say where deterioration might occur, Wachovia provided an expanded breakdown of its pick-a-pay mortgage exposure, listing New Jersey, Arizona, and Texas as the other major markets where it has a high concentration of exposure. A spokeswoman would not say how the remaining exposure was distributed, though Golden West had sizable portfolios in Illinois, Virginia, and Washington before selling itself to Wachovia.
Wachovia also reported that its investment banking unit posted $1.56 billion of writedowns and a $77 million first-quarter loss. The company said it would eliminate about 500 investment banking positions this quarter. The company has already cut more than 200 positions in that unit since October.
But Mr. Thompson said he was far more concerned about mortgage-lending setbacks and their contribution to a first-quarter net loss of 20 cents a share, compared with a profit of $2.3 billion, or $1.20 a share, a year earlier. He said during the news media call that Wachovia is looking to make further adjustments to its mortgage model beyond its decision last week to implement a minimum credit score and requiring applicants to verify employment and assets. A drastic overhaul is unlikely, he said, but the goal would be more balance among products and in its decisions about whether to hold or sell mortgages.
"The option ARM will certainly be one of those products," Mr. Thompson said. "We see mortgage as a big opportunity for us. … We will tinker with the model for that."
