California's mortgage woes keep landing on Wall Street's doorstep.
Wachovia Corp. surprised investors Monday by saying it had raised $7 billion in new capital and slashed its dividend. The nation's fourth-largest bank is shackled with billions of dollars in troubled adjustable-rate mortgages from its 2006 acquisition of a California savings and loan.
Also Monday, struggling lender Fremont General Corp. in Brea said it would sell its retail operations, including 22 bank branch offices in California and $5.6 billion in deposits, to CapitalSource Inc. of Chevy Chase, Md.
The New York Stock Exchange suspended trading of Fremont shares and moved to delist the company, once the nation's fifth-largest provider of home loans to those with poor or little credit. The NYSE noted that Fremont had fallen below Big Board listing standards into penny-stock territory, with its stock trading at less than $1 for more than 30 consecutive days.
Wachovia's actions came as it reported a first-quarter loss of $393 million, a major disappointment to industry analysts who had expected a profit of about $900 million. The Charlotte, N.C., bank also set aside $2.8 billion for anticipated loan losses, a move that some experts said would probably be repeated in coming quarters.
"You're still left wondering how much more there is to come," said analyst Donn Vickrey of Gradient Analytics Inc. in Scottsdale, Ariz. He said the rate of nonperforming loans at Wachovia was "still accelerating."
Wachovia's dismal earnings report weighed on other banking shares Monday and helped drag the stock market's major indexes slightly into negative territory. The Dow Jones industrial average fell 23.36 points to 12,302.06. Wachovia shares sank $2.26, or 8%, to $25.55, their lowest closing price since 2000.
Much of Wachovia's trouble stems from so-called option ARMs acquired in the bank's purchase of Oakland-based Golden West Financial Corp. Under the leadership of industry legends Herb and Marion Sandler, Golden West pioneered mortgages -- marketed under the name Pick-a-Pay -- that let borrowers choose their own payment options, including paying less than current principal and interest.
When Wachovia acquired Golden West, nearly all of the savings and loan's mortgages were option ARMs. The loans now account for $121 billion of Wachovia's $170 billion of mortgages, the company said. More than two-thirds of the loans were made in California and Florida, two of the states hardest hit by the continuing mortgage crisis.
One of the tricky aspects of option ARMs is that it can be hard to tell whether borrowers are tapped out or simply choosing to pay less than they owe. That contributes to the difficulty in quantifying the extent of the default problem.
Wachovia's headaches didn't surprise everybody on Wall Street. Despite repeated denials by executives, Oppenheimer & Co. analyst Meredith Whitney predicted last week that the bank would cut its dividend. She was vindicated Monday when Wachovia said it would cut the quarterly dividend 41% to 37.5 cents a share.
She said the denials and the company's slowness to recognize publicly the extent of its mortgage-related problems -- well after such rivals as Bank of America Corp. took major write-offs -- raised "an issue of management credibility."
Whitney said $18 billion worth of Wachovia's mortgages now exceeded the value of the underlying homes. She predicted that the bank would have to continue adding to its loan-loss reserves for at least the next two quarters.
Vickrey estimated that Wachovia also has $8 billion to $10 billion of additional mortgage-related exposure that doesn't show up on its balance sheet. For example, although the company hedged its mortgage exposure through offsetting investments, Vickrey said its ability to collect on those investments depends on the financial condition of investors on the other side of the trades.
On the Fremont deal, CapitalSource, a middle-market commercial lender, is buying $2.7 billion worth of commercial loans in which Fremont was a participant, but it is not taking on any of the company's troubled home loans.
The point of the deal is to enable CapitalSource to diversify its funding sources by acquiring a healthy deposit-gathering business in California, CapitalSource Chief Executive John K. Delaney said.
"We're very interested in the franchise," he said. He added that Fremont is "old fashioned" in a good way, in that nearly all of its deposits come through the doors of its 22 branches rather than via telephone or Internet marketing.
Delaney said that the Fremont branches would stay open with many of the same employees and that there would be no changes in the interest rates or other terms of existing certificates of deposit or other accounts.