Wachovia Corp. and Washington Mutual Inc. posted billions of dollars in mortgage losses Tuesday, far more than analysts had forecast, but their stocks rose as investors apparently concluded that the home-lending sector could work through its deep troubles.
Despite a staggering $8.9-billion second-quarter loss -- more than it has ever earned in a full year -- Wachovia shares rocketed $3.61, or 27%, to $16.79. Shares of Washington Mutual rose 34 cents, or 6.2%, to $5.82 before it reported a $3.3-billion loss after the close of trading.
Wachovia and Washington Mutual are both major players in retail banking and mortgages. Charlotte, N.C.-based Wachovia, the fourth-largest U.S. bank, ran into trouble after its 2006 acquisition of Oakland-based Golden West Financial Corp., whose World Savings was a major adjustable-rate lender. Seattle-based Washington Mutual grew to become the nation's largest savings and loan by acquiring a series of California thrifts.
Their results illustrate how rising home-loan delinquencies, first seen among high-risk subprime mortgages, have migrated to nontraditional loans made to people with good credit scores. These adjustable-rate mortgages with low initial rates were often made without verifying borrowers' earnings.
The main contributor to Wachovia's losses was its now discontinued specialty of "option ARM" loans that allowed borrowers to pay so little that their balances rose. In the second quarter, Wachovia set aside $5.6 billion for loan losses, including $3.3 billion on option ARMs
Washington Mutual said it too was experiencing surging losses on option ARMs -- even as problems with subprime loans are "flattening out" and home-equity delinquencies "are showing signs of flattening," as company President Steve Rotella put it.
Wachovia's $8.9-billion loss, the equivalent of $4.20 a share, contrasted with net income of $2.3 billion, or $1.23 a share, in the second quarter of 2007. The bank slashed its dividend to 5 cents from 37.5 cents, the second reduction in the payout this year, and said it would eliminate 10,750 jobs.
Wachovia has $122 billion of option ARMs on its books. Of those, 58% are in California, where falling home prices and rising loan balances have devastated a key measure of the creditworthiness of mortgages.
In the Central Valley, where Wachovia has $10.2 billion in option ARMs outstanding, the ratio of the unpaid loan amounts to the value of the underlying homes was 109% in May, up from 72% when the loans were made. In the Inland Empire, home to $11.3 billion of the loans, the so-called loan-to-value ratio was 99%, Wachovia said.
Wachovia shares initially fell 12% on the earnings report but recovered after new Chief Executive Robert Steel said the company didn't plan to sell stock to raise capital. Also boosting the shares was a positive analyst report that lifted banking stocks in general.
Financial stocks in the Standard & Poor's 500 index, which were down early on Wachovia's results, ended the day up 6.6%, lifting the overall stock market. The Dow Jones industrial average gained 135 points, or 1.3%.
Steel, who replaced the ousted Ken Thompson at Wachovia this month, said it was "the best course for our shareholders over the long term" to further cut the dividend. He said that the bank would sell "selected non-core assets" and that it expected to cut expenses for the second half of this year by $490 million and reduce 2009 spending by $1.5 billion.
Wachovia said it would slow its expansion in California, Nevada and Arizona. In 2006, the bank said it planned to open 30 to 50 branches a year in California alone. The projected additions next year in all three states will now total 25 30 branches, spokeswoman Aimee Worsley said.
Washington Mutual's loss of $3.33 billion, or $6.58 a share, compared with net income of $830 million, or 92 cents a share, in the year-earlier quarter. The results included a reduction of $3.24 a share related to $7.2 billion in capital that WaMu raised from private investors in April.
WaMu set aside $5.9 billion to cover future losses, compared with $2.2 billion of current loans that it wrote off as uncollectable.
"It's a big loss for the quarter," Rotella said in an interview. "But that loss is driven by a large reserve that will help us deal with losses in the future." And as a result of the private equity investment, "our capital actually went up," he added.