Is Wachovia Still Golden?
California Acquisition Hurt Stock,
But Loans May Shine in the Storm
By VALERIE BAUERLEIN and ANN CARRNS
August 23, 2007
Herb and Marion Sandler successfully ran Golden West Financial for 39 years, weathering all kinds of real-estate downturns even as the California thrift grew to be one of the biggest issuers of adjustable-rate mortgages in the country. So when they sold their company to Wachovia Corp. for $24 billion last year, it looked like a classic, top-of-the-market deal.
It turns out it was, and the mortgage industry has been slammed ever since.
Wachovia has been punished for bulking up on exotic adjustable-rate home loans at the height of the market. Its stock is down 16% since the purchase was announced, compared with a 3.3% decline in a major bank index. And Wachovia's nonperforming loans jumped 19% in the second quarter, with about 60% of that increase coming from "legacy Golden West" loans.
So why is Herb Sandler, still a big shareholder in Wachovia, smiling? Because he sees opportunity in others' distress. Investors should be smiling, too, because Wachovia could take advantage of the downturn to build its lending business. And at the current valuation -- the bank's shares now trade at a 12-month trailing price-to-earnings ratio of 10.23, a 10-year low and a discount to its peers -- means investors are expecting serious losses from its mortgages, which, based on Golden West's long-term track record, are unlikely to happen.
"It's cheap," says banking analyst John McDonald of Banc of America Securities, who calls Wachovia a "buy." Wachovia shares were up 46 cents to $49.70 yesterday on the New York Stock Exchange. Investors reacted positively to Wachovia's move to raise its quarterly dividend Tuesday by 14% to 64 cents a share, giving it a yield of 5.2%
First the negatives. Golden West's loans were concentrated in California, where home prices had soared in recent years and are already taking a beating. The vast majority of those loans were option ARM loans, which let customers choose how much to pay each month, with unpaid interest added onto the mortgage and increasing the loan's balance. Negative amortization, or the additional amount owed by borrowers whose payments don't cover the interest on their loan, ballooned to $2.3 billion at the end of June, more than double the amount a year earlier.
Wachovia's decision to disclose much less information than Golden West previously did about the performance of its options ARMs hasn't helped reassure investors and analysts. Wachovia said it stopped breaking out monthly option ARM statistics once it incorporated Golden West, so as not to overemphasize one product in its broader mortgage business.
Atlanta Capital Management Co. cut its Wachovia stake to 490,000 shares at the end of June from 1.2 million a year earlier. "With the benefit of 20-20 hindsight, they bought Golden West at a time that was the peak of the housing cycle, and they're suffering as a result," said William Hackney III, managing partner of the Atlanta investment firm.
All of these negatives are well-known in the market. The positives have been lost in the stampede away from anything related to mortgages. What investors don't understand, Mr. Sandler says, is that Wachovia is a portfolio lender, which holds its option ARMs on its own books. That gives it an incentive to underwrite carefully and help borrowers who are struggling to make payments. "When you're a portfolio lender, you have skin in the game," he said.
Already Wachovia says mortgage-loan applications are rising as competitors fall off. Fewer customers are paying off their loans early -- another boon and a signal that they aren't refinancing with others.
"We think it's a much healthier market for us to realize the benefit of the Golden West model," Wachovia finance chief Tom Wurtz says. "The secondary market may return, but I doubt if the irrationality will return."
Then there is Golden West's golden track record. Mr. Sandler has proved skeptics wrong for decades, and he was frequently critical of the lax lending practices that pervaded the industry for the past few years -- even writing a letter to federal regulators last year in support of tighter standards. He admits a "perverse sense of satisfaction" at watching competitors go under and the investors holding their securities fail.
"Everything we forecast to happen has happened," says Mr. Sandler, a frequent critic of competitors who required no down payment, set interest rates that reset quickly at high rates and sold bundled loans to far-off investors. "New Century Financial? Bye-bye. Ameriquest? Bye-bye."
Golden West historically had very low levels of bad loans, which Mr. Sandler has attributed to his bank's careful vetting of borrowers and their credit. At the end of 2005 -- the last full year for which Golden West reported results separately before being acquired by Wachovia -- Golden West's ratio of nonperforming loans to its total assets was a mere 0.31%, a figure so low that the company acknowledged it would likely rise.
Golden West also averaged loan losses that were statistically zero -- lower than any major financial institution, Mr. Sandler says. "Yet they question Golden West's portfolio," he said. "It's insanity."
Wachovia has the lowest rate of total problem loans of the top 10 U.S. banks, according to an analysis of first-quarter call reports by FIG Partners LLC in Atlanta. The company employs its own appraisers, who have no incentive to pump up property values. Wachovia's mortgage loans have a 70% loan-to-value ratio, meaning that borrowers have significant equity in their homes and an incentive to keep paying their bills even if their circumstances change. Most of the bank's option ARMS have terms preventing monthly mortgage payments from increasing by more than 10% in any one year, so the risk of severe payment shock to borrowers as rates on the loans reset is limited, the bank says.
Meanwhile, G. Kennedy Thompson, Wachovia's chief executive, has bet his professional reputation on making the Golden West acquisition work. While the Charlotte, N.C., bank's nonperforming mortgage loans are on the rise, the fifth-largest U.S. bank in stock-market value brags that its $429 billion commercial- and consumer-loan portfolio is rock-solid overall and that its mortgage performance, while sliding, is still better than peers and in line with its expectations.
Mr. Sandler, 75 years old, no longer has any direct interaction with Wachovia and Golden West. "If we hadn't sold the company, and I were 20 years younger, this would be one of the greatest markets for a portfolio lender in history," he said.
Write to Valerie Bauerlein at valerie.bauerlein@wsj.com and Ann Carrns at ann.carrns@wsj.com
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