Keeping the market guessing

IFR Top 250 Borrowers 2008
5 min read

The recent banking environment had evolved to a cycle where asset writedowns were countered with significant capital raises. Although Wachovia failed to avoid that repetition, it distinguished itself during the liquidity squeeze with some dramatic moves to address concerns about its liquidity and capital positions.

Wachovia's approach to the capital markets utilised stark, sometimes unorthodox strategies in addressing its funding needs. The most urgent of those manoeuvres was the earlier-than-expected release of its first-quarter results, which featured a US$393m net loss on nearly US$2bn in writedowns. By advancing the release of first-quarter results by a day, the company jumped ahead of other banks posting results that week. It detailed a capital raising plan consisting of a 41% cut in its common stock dividend and an US$8bn capital raise, comprised of common equity and convertible preferred transactions.

Although jumping ahead of the other banks' releases was an aggressive move, management maintained a steady composure when describing the added capital. "Our equity capital issuance of US$7bn is not simply to fill a hole in our balance sheet, but to increase sharply our capital ratios to provide the flexibility to deal with almost any conceivable circumstances that might develop in the future," said Wachovia's CEO Ken Thompson at the time.

After management had stated that the dividend was secure and the bank’s capital base adequate, overseeing the capital raise turned out to be one of Thompson's last duties at Wachovia. The bank again showed its flair for the dramatic by pushing the CEO out in early June. Wachovia's poor timing on its US$25bn acquisition of Golden West Financial exacerbated its writedown exposure, and was one of the major blemishes on Thompson's track record.

Should Wachovia embark on another capital raising transaction – considered likely even before the CEO headed for the door – additional fallout from the Golden West purchase or upcoming disclosures in the wake of its management change could ensure a change of tack. "For [Wachovia], substantial additional reserve building still lies ahead, in our view,” said Merrill Lynch's Edward Najarian. “For instance, we note that the commercial portfolio appears to be under-reserved, and we think the 2.5% to 2.8% loan loss reserve ratio targeted by management for the pick-a-pay portfolio (as well as the 7-8% cumulative loss ratio) may ultimately prove to be too low."

In past marketing efforts for its equity and convertible securities, the bank turned to existing investors rather than sovereign wealth funds or a private equity firms. Courting that latter investor base could now be an option – as could the acquisition of the entire bank by a suitor such as Wells Fargo.

Of US banks, Wachovia is near the top in terms of capital raised. Taking account of all types of Tier 1 issuance, Citi has raiesd US$42bn through April 30th, followed by Bank of America at US$18bn and Wachovia at US$15bn, according to a table assembled by UBS. In the fourth quarter of 2007, Wachovia issued US$838m in hybrids and US$2.3bn in non-cumulative preferred stock. That raise was followed with another US$3.5bn for

non-cumulative preferred securities in the first quarter of 2008 and another US$4.025bn of preferreds in the second quarter of the year. The company also completed a US$4.025bn common equity offering in the second quarter.

If Wachovia does find itself needing additional capital, the bank will likely maintain its flair for the dramatic: its options look increasingly limited. Following the preferred and common issuance, Wachovia's equity has yet to find any traction. As of mid-June, the stock had broken down to its lowest level since late 1992. That development makes any equity offering all the more difficult. Another round of preferred issuance may jeopardise the bank’s credit ratings.

Despite the threats surrounding the bank, Wachovia still has the advantage of a conservative funding base – around 50% of its funding comes from its core deposit base, according to the bank. It terms of straight debt issuance, the firm has tapped the dollar market for US$7.45bn in a variety of maturities, including an increasingly rare benchmark-sized two-year floater. Wachovia has also appeared in the euro market with a €2.75bn five-year deal, with German investors taking more than a third of the deal.