Correction to This Article
This article inaccurately described the action Wachovia said it was taking to shore up its loan loss reserves. The bank did not say it was raising new capital. Wachovia said it was setting aside money for its reserves and would report a second-quarter loss of $2.6 billion to $2.8 billion.
Wachovia Faces Shallow Reserves but Says It Is Setting Aside More Capital

By David Cho and Renae Merle
Washington Post Staff Writers
Wednesday, July 16, 2008

Wachovia's stock fell to a 17-year low yesterday after an analyst warned that the commercial bank, which holds more deposits than any other in the Washington region, will face two years of losses arising from the credit crisis and a dramatic restatement of troubled assets on its books.

The amount of the bank's bad loans is growing faster than what the company is stashing away, and its reserves are markedly lower than the industry average, according to bank officials and regulators. Wachovia has enough money to cover about 84 percent of its non-performing loans, the bank said yesterday.

As fears mount over the health of the nation's banking system, Wachovia will have to take exceptional steps to raise enough capital to meet its obligations, analysts said. This does not mean that the bank will fail anytime soon or that depositors face imminent danger.

"Wachovia is a fundamentally strong and stable company on solid footing . . . and is well-capitalized," said spokeswoman Christy Phillips-Brown.

Company officials disclosed yesterday that the bank was setting aside money to add $4.2 billion to its reserves and $1.3 billion more to cover losses in the second quarter. Those sums are in the same league as the provisions made by the biggest banks in the country to cover losses due to the credit crisis.

Such problems are not unique to Wachovia. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said she had seen "slippage" among loss reserves across the banking system.

Yesterday, Bair, President Bush and other senior regulators made a concerted effort to reassure people that their money is safe and that the nation's banking system is sound. Noting that the vast majority of banks remain well-capitalized, Bair said it had been an "uphill battle" to counter false rumors and restore calm among investors and bank customers.

"This is not a serious situation. I would call it challenging, increasingly challenging," she said in an interview. "We've had five bank failures this year. That is not huge. . . . I don't want to overreact or underreact, but let's get the facts. We are at a very low level of failures compared to previous cycles of economic distress."

Federal Reserve Chairman Ben S. Bernanke offered similar assurances during testimony yesterday before the Senate Banking Committee. "Our banking system is well-capitalized. It came in with strong capital. We are watching the situation very carefully," he said.

Despite the efforts by regulators, tensions remained high on Wall Street and Main Street. The Dow Jones industrial average closed below 11,000 for the first time in two years, losing 92.65 points, or 0.8 percent, to end the day at 10,962.54. The broader Standard & Poor's 500-stock index fell 13.39 points, or 1.1 percent, to close at 1214.91.

Shares of Bank of America, which recently completed its acquisition of mortgage lender Countrywide Financial, lost 8.1 percent in trading yesterday. National City, an Ohio-based bank whose shares have taken a recent beating, was down 4.5 percent. U.S. Bancorp, Minnesota's biggest bank, said that its second-quarter earnings fell 18 percent and that its level of bad loans would continue to rise as more customers fell behind on payments. Its shares dropped as much as 12 percent before recovering to end the day slightly in the red.

The S&P banking index was down 5.4 percent yesterday and 14 percent since Friday. "There continues to be a number of people who are worried about the health of the financial system, and they are putting pressure on financial stocks," said Andy Brooks, head of stock trading at T. Rowe Price.

In California, police were called to calm crowds of anxious customers who lined up early in the morning yesterday to withdraw their money from local branches of IndyMac Bancorp, which last week became the third-largest bank in U.S. history to fail.

The current environment is risky for financial firms. Rumors and false reports can trigger a run on a bank even if it is well-capitalized. Two institutions have been sunk by such panics this year, the 85-year-old brokerage house Bear Stearns and IndyMac.

Investors "are just scared that there is another shoe to fall," said Douglas S. Roberts, an analyst with Channel Capital Research. "These things don't quickly turn around. It takes time."

Wachovia is in better shape than those institutions, analysts said. Still, since the credit crisis began last summer, Wachovia's losses have totaled $13.7 billion, which is relatively large for its size, according to Bloomberg.

Meredith Whitney, an Oppenheimer analyst whose grim report yesterday triggered an immediate 20 percent drop in Wachovia's stock price, said the worst was ahead for the bank. She said the bank needed to drop the value of its portfolio at a time when its losses are growing. She also forecast a loss for this year and for 2009.

"Expenses simply cannot come down fast enough, seriously jeopardizing Wachovia's ability to generate earnings," Whitney wrote in her report. "We fear the company will have the greatest reckoning with asset re-valuation and/or credit costs."

The bank's woes are rooted in its real estate business, where its losses have mounted faster than many of its peers. At the end of June 2007, non-performing residential and construction loans totaled about $1.5 billion. At the end of March, they had soared to $6.8 billion, according to Byron MacLeod, an earnings quality analyst at Gradient Analytics.

Reserves have grown at a much slower rate. At the beginning of 2007, Wachovia had enough money to cover more than twice the amount of its loan losses. At the end of the first quarter, the bank could pay only 84 cents for every dollar lost. The industry average has also fallen and is now about 89 cents on the dollar, according to the FDIC.

"The biggest issue for Wachovia is the allowance for loan losses is on the light side," MacLeod said. "Either management was blindsided by the losses or they knew that there were losses that would come through the pipeline and they chose not to properly accrue for those losses."

Another cause for concern, MacLeod added, is that loan losses continue to accelerate.

Company officials said that they were aggressively building up reserves and that they had access to up to $150 billion if the bank needed it. Bank officials did not elaborate.

The firm is also in the middle of a turnaround. On June 2, it ousted Kennedy Thompson as chief executive, hiring Treasury Undersecretary Robert K. Steel to replace him July 9. Steel, a former vice chairman of Goldman Sachs, had been the Treasury Department's point person on efforts to address the financial crisis.

Wachovia also announced it would slice its dividend 41 percent, raise $8 billion in capital and craft a plan to reduce its mortgage exposure. When Steel was hired, the bank said it would report a second-quarter loss of $2.2 billion to $2.6 billion.

So far, the moves haven't bolstered Wall Street's confidence in the bank. The stock has plunged 83 percent since the end of last summer and 30 percent since Friday, including an 8 percent decline yesterday.

Investors are concerned that they have not seen all of the mortgage-related losses from Wachovia, which purchased a major subprime mortgage lender, Golden West Financial, in 2006, for $25 billion.

"The expectations are of a difficult earnings environment with more write-downs to come," said Joseph Brusuelas, chief U.S. economist at California-based Merk Investments. "Whether the new leadership [at Wachovia] will be able to change that is a major outstanding question for the firm."

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