Troubled Wachovia Seeks Out a Merger

Wachovia Corp. has entered into preliminary talks with a handful of possible buyers — the latest in a parade of banks to look for safety in the arms of a suitor amid concerns that the weak economy is pushing them deeper into peril.

The talks came as Washington Mutual Inc.’s late-Thursday failure rattled the shares of other troubled banks. Shares in Wachovia fell 27% on Friday as investors fretted about its massive mortgage portfolio.

[Wachovia image] Getty Images

People walk by a Wachovia branch in New York City.

Investors are growing concerned that a host of banks nationwide, both large and small, could come under fresh pressure to either raise more capital or else find someone willing to buy them. The trouble stems in part from the fact that a broad range of borrowers, not just mortgage holders, are now starting to default on their debt. For instance, about 2.4% of payments on credit cards are more than 90 days overdue, according to the Federal Deposit Insurance Corp., the highest level since 1991.

Wachovia is talking to potential buyers including Wells Fargo & Co., Banco Santander SA of Spain and Citigroup Inc., according to people familiar with the situation. Wachovia officials don’t believe they need to rush into a deal, and the bank isn’t feeling immediate pressure on its financial condition, people familiar with the company said.

Wachovia declined to comment on the discussions. Earlier Friday, a spokeswoman said the bank is “aggressively addressing our challenges.” Since June, Wachovia has opened 745,000 new checking accounts, she added, indicating confidence among its customers.

Banco Santander, Citigroup and Wells Fargo declined to comment.

In a sign of the depth of tension among financial institutions broadly, banks on Friday remained very skittish about making short-term loans to each other — a crucial ingredient in the banking business. The rate on three-month loans between banks eased slightly, to 3.7%, on Friday. Still, that’s almost double the level that would be expected if the market were more stable.

This reluctance to lend has implications for a broad swath of the business community: Interest rates on short-term loans that corporations routinely use to fund day-to-day expenses also remain extremely elevated.

For financial institutions, “the clock is ticking a heck of a lot faster today,” said Matthew Kelley, a bank analyst at investment-banking firm Sterne, Agee & Leach Inc. The federal government’s seizure of WaMu in the largest bank failure in U.S. history shows that regulators are “not going to mess around” with shaky banks and thrifts, especially given the chaos gripping financial markets.

The structure of J.P. Morgan Chase & Co.’s purchase of WaMu’s banking operations also sent shudders through the market for investment-grade bonds. In the deal, bondholders — who typically have a priority claim over common-stock shareholders — are likely to recover only between zero and 50 cents on the dollar, according to an analysis by independent research firm CreditSights. That could sour investors’ appetite for a wide range of financial-industry bonds.

Washington Mutual’s seizure by the government late Thursday helped push financial stocks lower on Friday. Some of the hardest hit stocks included BankUnited Financial Corp., of Coral Gables, Fla., which fell 21% to 79 cents on Nasdaq and Downey Financial Corp., Newport Beach, Calif., down 48% on the New York Stock Exchange.

Tom Richlovsky, chief financial officer at National City, said the Cleveland-based bank’s 44% stock-price drop Friday is “a temporary, irrational phenomenon.” The decline “ignores the fact that the difference between [National City and WaMu] is like night and day,” he said. National City’s woes relate to its abandoned push into mortgages in places like Florida, far from its home turf.

[Stress on the System chart]

Overall, stocks jumped in Friday trading, largely on renewed hopes that a proposed $700 billion government bailout of the financial sector might be back on track.

U.S. leaders and bank executives hope that the federal bailout package being hammered out in Washington will help steady the industry by giving banks a way to shed some of their most toxic mortgage assets. The vast majority of U.S. banks also remain well-capitalized, giving them a cushion against the sluggish economy and further declines in housing prices.

Across the country, WaMu’s branches opened as usual Friday morning, albeit under new owner J.P. Morgan Chase & Co., which bought WaMu’s banking operations for $1.9 billion.

At a Chicago WaMu branch on Friday, Catriona Johnson, 27 years old, said she had come intending to take out all her money. “I wanted to close my account and hold it in my bra or something,” she said. However, after being told that her account balance is federally insured, Ms. Johnson, the administrative coordinator at a Chicago company that tests homes for the presence of toxins, decided to leave the money alone for now.

WaMu’s seizure by the government eliminated one of the shakiest institutions. But the fact that no one was willing to buy its vast consumer-banking business until the institution actually failed shows how deep the industry’s woes are. In recent years, its prized network of more than 2,200 branches would likely have triggered a bidding war among suitors.

In recent weeks, Wachovia had been talks about a potential merger with Morgan Stanley. But that scenario was apparently put on hold by Morgan’s move Sunday night to convert into a bank holding company instead of an investment bank.

In addition to the problem of widening defaults on credit-card debt, delinquent loans on non-residential real estate rose 20% in the second quarter from a year earlier. Late payments on bread-and-butter business loans, which account for the bulk of the loan portfolios at many banks, jumped 15%. All those percentages are expected to keep rising.

“The housing thing is kind of behind us” in terms of the write-downs, said Ted Salter, chief financial officer of Gateway Financial Holdings Inc., a bank-holding company in Virginia Beach, Va. Now it has “moved into commercial loans, construction loans, development loans,” he said. “Next week, it’ll be something else.”

The 13 bank failures so far this year don’t come close to the savings-and-loan crisis of the late 1980s, when hundreds of shaky institutions failed, costing taxpayers about $130 billion. By other measures, though, some bank executives say the current turmoil is worse, since it is more geographically widespread and involves a broader mix of loans.

Alan Worrell, chief executive of Sterling Bank, a Montgomery, Ala.-based unit of Synovus Financial Corp., says the industry’s problems now are “far worse” because the real-estate market is so backlogged with unfinished homes and other construction projects that it will haunt lenders and borrowers for years.

After generating record profits during the housing boom, it has taken only a year for the banking industry’s profitability to evaporate. Second-quarter profit fell to just $5 billion from $36.8 billion a year earlier, its second-lowest level since 1991.

About 18% of federally insured lenders lost money in the second quarter. Dividends paid to bank-stock investors plunged by $35 billion in first six months of 2008.

Third-quarter results could show the industry’s first overall loss since the fourth quarter of 1990. One big reason: Banks need to set aside more money to cover loans that have gone sour, a move that cuts deeply into profitability.

Forced to conserve capital in order to cover ballooning losses, commercial banks are far more reluctant to lend money than they were just even a few months ago. Of 3,000 companies surveyed by RBC Capital Markets, 25% said it is harder to borrow money than 90 days ago.

There isn’t a clear way out of trouble. There aren’t many investors willing to take a bet on banks right now, particularly given WaMu’s example: In April, it received a $1.35 billion investment from the giant investment firm TPG — which lost the entire amount this week when WaMu failed.

Aside from J.P. Morgan’s purchase of WaMu, few weak banks have been snapped up by stronger ones, partly because would-be buyers have their own headaches.

Some banks are paying unusually high interest rates on deposits to replenish their capital levels. That strategy raises red flags with many bankers because it is often viewed as a sign of desperation.

It can also be a double-edged sword: Banks that don’t want to compete on rates can’t attract deposits that are critical to making loans. In any case, that strategy didn’t work for WaMu, which paid some of the highest rates in the country.

Saddled with a mountain of troubled adjustable-rate mortgages inherited through its 2006 takeover of Golden West Financial Corp., Wachovia has seen its financial condition weaken. The bank’s CEO, Robert Steel, has said the bank has ample capital, noting that it added $20 billion to its certificate-of-deposit balances last summer due in part to a high-interest-rate promotion that began in June.

“I spend a lot of time trying to lay out the fact that we believe we’re liquid,” he said earlier this month. “We believe we have the ability with our current financial position to respond to issues, and we also have some other levers to pull” to improve its financial position, he said.

—Carrick Mollencamp, Ilan Brat and Liz Rappaport contributed to this article.

Write to Robin Sidel at robin.sidel@wsj.com, David Enrich at david.enrich@wsj.com and Dan Fitzpatrick at dan.fitzpatrick@wsj.com

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