This article first appeared in the St. Louis Beacon: October 22, 2008 - Wachovia said Wednesday that it lost nearly $24 billion during the third quarter, producing results well below Wall Street's already lowered expectations.
The battered banker's St. Louis-based brokerage business contributed to the financial carnage thanks, in part, to a decline in fees caused by a sinking stock market and to expenses for settling problems with certain securities.
However, the brokerage unit was able to maintain virtually the same number of experienced financial advisors as in the second quarter.
Although client assets have dropped by 16 percent since the acquisition of A.G. Edwards 12 months ago, Wachovia said the S&P-500 stock index was down 24 percent during the same period.
Wachovia said the integration of A.G. Edwards into Wachovia's original brokerage business is more than 50 percent complete. The combination is scheduled to be finished next year, but it will be done under new management.
Wachovia said it expects its acquisition by Wells Fargo to be accomplished by year's end. On Oct. 9, Wells Fargo agreed to buy the whole company without requiring any government bailout money.
Wells Fargo trumped an offer by Citigroup, which wanted bailout money and only the banking and mortgage businesses. Citigroup would have left the brokerage and asset-management units as a separate company.
The Federal Reserve Board has approved Wells Fargo's proposal, which still must be endorsed by Wachovia shareholders. No voting date has been set.
"The reason Wachovia was forced into a merger was also evident during the quarter," said Jaime Peters, of the independent financial research firm Morningstar, in a Wednesday research note.
"Period-end deposits show the company lost $30 billion of deposits during the third quarter," she said. "Most of the deposit outflow occurred at the very end of the quarter and probably continued into October. The Wells Fargo announcement may have helped stop the bleeding."
Analyst Jefferson Harralson told clients Wednesday that Wachovia had an incentive to report enormous losses in the July-September period because new accounting rules will allow such red ink to help its acquirer.
"With the near-term sale to Wells Fargo, it's hard to grasp what Wachovia's earnings would have been had the company remained independent," said Harralson of Keefe, Bruyette and Woods. Fears of insolvency "ultimately led to Wachovia's fire sale." His firm has had a recent investment banking relationship with Wachovia.
Despite the huge third-quarter loss and another brutal day for all stocks, Wachovia's stock lost 6.2 percent to close at $5.71 on Wednesday. That's because Wachovia is tethered to the performance of Wells Fargo, which has offered slightly less than one-fifth of a share for each share of Wachovia. Wells Fargo closed at $31.30, or down 4.1 percent.
Big loss, Poor performance
For those keeping score, Wachovia lost $23.9 billion, or $11.18 a share, for the July-September quarter. For the same period last year, it earned $1.62 billion, or 85 cents a share.
Much of the latest loss, or $18.7 billion, was designated as a goodwill impairment, which reflected "declining market valuations and the terms of the merger with Wells Fargo," Wachovia said.
Goodwill impairment is a one-time, non-cash charge for intangible matters, such as a company's reputation and relations with customers. Wachovia took a $6.1 billion charge in the second quarter.
Financial analysts don't count goodwill or other one-time charges or gains when they make quarterly estimates because they concentrate on continuing operations. Even by those standards, however, Wachovia performed poorly.
Excluding one-time events, Wachovia still managed to lose $4.76 billion, or $2.23 a share. The consensus estimate by analysts, polled by Thomson Reuters, was for a profit of 2 cents a share. Individual predictions ranged from a profit of 53 cents to a loss of 54 cents.
"Wachovia's third quarter results were very much in line with our expectations," said John Stumpf, Wells Fargo's president and CEO, in a prepared statement. "We believe that it was prudent for Wachovia to put these losses behind them," added Howard Atkins, the Wells Fargo's chief financial officer.
Market impact
Although analysts focused primarily on the enduring damage caused by Wachovia's mortgage business and the diminished confidence among depositors, the company also was hurt by what financiers call "market disruption-related losses."
When the economy declines, customers invest less, brokers do less business and the value of assets under management declines. And when the economy declines, so does the brokerage business.
Comparing the third quarter of 2008 with the same period last year isn't easy because A.G. Edwards didn't join Wachovia until the fourth quarter of 2007.
However, the combined results of the brokerage and asset management -- Evergreen mutual funds -- businesses illustrate market disruption-related losses.
Third-quarter revenue fell to $1.36 billion from $1.7 billion in the third quarter of 2007. The latest results include a 33 percent drop in brokerage fees and other income to $968 million.
For the second quarter of 2008, total revenue for the brokerage and asset management units was $2.3 billion.
Total assets under management were $209.1 billion at Sept. 30, down 27 percent from the third quarter of 2007, largely due to customers withdrawing assets and to lower values of existing assets.
This brokerage-asset management segment lost $499 million during the recent quarter compared to a profit of $294 for the same period last year.
The performance was blamed on declining asset values and trading losses, fewer brokerage fees and problems related to auction rate securities. Wachovia paid $497 million in settlement costs for these securities during the third quarter, assigning $432 million of those costs to the brokerage-asset management segment.
Auction rate securities -- municipal bonds, corporate bonds, preferred stock -- were marketed to customers as products that were as safe as money market funds with higher yields. The investments' success depend on the holders' ability to reset interest rates during periodic auctions.
When credit markets tightened earlier this year, the auctions failed because there were more sellers than buyers. As a consequence, investors were told their money was frozen. Wachovia announced in mid-August it would buy back $8.8 billion in these securities.
Robert W. Steyer is a freelance business journalist in New York.