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Wachovia's `Great Success' Became $122 Billion Burden
By: Bob Ivry

Sept. 29 (Bloomberg) -- On a May 2007 conference call, Wachovia Corp.'s then-Chief Executive Officer Ken Thompson trumpeted the $24 billion acquisition of Golden West Financial Corp., a California lender that specialized in payment-option adjustable-rate mortgages.

``I think that 12 months or so from now people are going to look at the acquisition of Golden West as one that produced great success for Wachovia,'' Thompson said.

Seventeen months later, Thompson is gone and so is Wachovia. After losing 82 percent of its market value since that conference call due to mounting losses on option ARMs, the bank was sold to Citigroup Inc. today in a deal brokered by the Federal Deposit Insurance Corp.

``Golden West was the beginning of the end'' for Wachovia, said Anat Bird, a former Wells Fargo & Co. executive who now runs SCB Forums Ltd., a Granite Bay, California, company that conducts peer group conferences for bankers. Golden West ``had lousy assets, lousy liabilities and they paid a fortune for it.''

Wachovia holds $122 billion of option ARMs, which the Charlotte, North Carolina-based bank calls ``pick-a-pay'' mortgages, 72 percent of its residential loan portfolio, according to its Web site, and the most of any U.S. bank.

Four of the five biggest holders of option ARMs no longer exist, according to a ranking by Bethesda, Maryland-based industry newsletter Inside Mortgage Finance.

Washington Mutual

Seattle-based Washington Mutual Inc., which held $52.9 billion of Option ARMs at the end of the second quarter, was seized by U.S. regulators on Sept. 26 and bought by New York-based JPMorgan Chase & Co.

In July, Countrywide Financial Corp., the Calabasas, California-based lender, which held $25.4 billion, was bought by Bank of America Corp. and Indymac Bancorp Inc., a Countrywide spinoff based in Pasadena, California, was taken over by the Federal Deposit Insurance Corp. IndyMac held $3.5 billion in option ARMs.

Only Downey Financial Corp., a thrift based in Newport Beach, California, remains in business. Downey had $6.9 billion of option ARMs at the end of the second quarter, 65 percent of the home loans they held. Downey has lost 97 percent of its market value since May 1, 2007.

As many as 45 percent of borrowers with option ARMs issued from 2004 to 2007 and bundled into securities may default, according to Fitch Ratings analysts Roelof Slump and Stefan Hilts.

Assume Losses

As part of the purchase, Citigroup agreed to assume losses from Wachovia's option ARM portfolio, the FDIC said in a statement. The federal agency would be exposed only if option-ARM losses exceed $42 billion, the statement said.

The U.S. House of Representatives today rejected a $700 billion plan, supported by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke, to bail out holders of distressed mortgage assets. Bernanke warned of ``grave threats'' to the financial system if Congress rejected the plan.

It was unclear how any rescue package might affect Wachovia's portfolio of bad loans, said Kenneth Thomas, an independent banking consultant and economist in Miami.

Federal officials ``probably told Citigroup that if they do this deal, we'll figure out a way to make to work,'' Thomas said. ``The biggest fear of regulators is seeing lines of people on TV trying to withdraw their money.''

Skip Payments

Option ARMs allow borrowers to skip part of their payment and add that sum to their principal. Monthly payments increase after five years or once the loan balance reaches a predetermined limit, usually 110 percent to 125 percent. Introductory interest rates can be as low as 1 percent.

For the average option ARM borrower, payments will rise 63 percent, or an additional $1,053 a month, when their rates reset, according to a Sept. 2 report by New York-based Fitch.

Oakland, California-based Golden West was led by Herbert and Marion Sandler, a husband-and-wife team who increased profit 172 percent in five years by selling option ARMs. They sold the company just as housing prices peaked.

Wachovia has worked with 26,000 borrowers in the last year to make their payments more manageable, said spokesman Don Vecchiarello. The bank is soliciting pick-a-pay customers by phone, e-mail and direct mail to give them the option of refinancing into a Federal Housing Administration product or a fixed-rate loan guaranteed by Fannie Mae or Freddie Mac, the biggest U.S. mortgage financing companies, he said.

``There have been some issues with housing depreciation in California and Florida, where a lot of our loans were made,'' Vecchiarello said.

Wachovia issued 58 percent of its option ARMs in California, according to the bank's second-quarter earnings presentation to investors. California home prices fell a record 41 percent in August from a year earlier, according to the California Association of Realtors in Los Angeles.

The bank made 9 percent of its option ARMs in Florida, the state with the fourth-highest foreclosure rate, according to RealtyTrac Inc., an Irvine, California-based real estate data provider.

Wachovia's pick-a-pay portfolio consists of 448,000 loans with an average value of $271,000, according to a Sept. 9 presentation by CEO Robert Steel, who took over from Thompson in July.

Because Wachovia holds the mortgages, it's easier to modify them than if the loans were bundled into securities and sold to investors, Steel said.

`All the Levers'

``We have all the levers that any lender would have,'' Steel said. ``We basically have the ability to consider principal reduction. We can lower or adjust the interest rate. We can also adjust the term of the loan. I pledge to you that we're moving decisively and smartly as we think about this from that perspective.''

On his May 2007 conference call, Thompson said that ``credit quality is not an issue'' and the option ARM product line would ``hit the ball out of the park.''

Wachovia spokesman Vecchiarello declined to comment on the Golden West acquisition.

``We're trying to look toward the future rather than look to the past,'' he said.

To contact the reporter on this story: Bob Ivry in New York at
Last Updated: September 29, 2008 14:42 EDT