PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
It's always bad when a company announces that it will miss its earnings projections for the current quarter. It's a disaster when a top-tier, high-quality company misses earnings. It's a cataclysm when that company is a bank.
That explains the 21% drop in Wachovia Corp.'s (WB) stock on June 15. The Winston-Salem (N.C.) bank announced that day that there's no way it will reach its earnings targets for the June 30 quarter. At the market's close on June 16, the stock had bounced up slightly to $56.44 -- still down 19.6% from its opening the day before.
Most banks don't fall so hard so fast, even when they produce a nasty surprise. But Wachovia has always had a reputation as being above the norm when it comes to producing high-quality earnings. It's known for its portfolio of top-performing loans with the highest credit quality, its low-risk profile, and its less-than-fantastic but consistently positive earnings growth.
Wachovia is also a barometer for the rest of the banking industry. For whatever reason, it tends to foretell trends for other banks -- a quarter or two early. That's why most bank also stocks fell on June 15. The Philadelphia Stock Exchange Bank Index was down 10% by June 16, mainly thanks to the Wachovia news.
MOMMA SAID.
Look below the surface, however, and it appears the market probably overreacted. Little can be gleaned about the state of the banking industry from the specifics of Wachovia's announcement. The only problem that afflicts both Wachovia and the industry is rising interest rates -- and those aren't news.
If anyone should be a believer in Wachovia's conservative reputation, it should be me. I grew up in Winston-Salem, and every member of my family and every friend I knew used the bank. I knew dozens of people who worked for it (I don't use the bank anymore -- for geographical reasons -- and I can't say that I know a single person who still works there). The manager at our local branch never failed to boast of Wachovia's conservatism or to show my father the results of studies that put the bank on the top of the list when it came to the safety of deposits.
My father was persuaded. In my family, the devils of the banking world were those hotshots from Charlotte, First Union Corp. (FTU) and Nations Bank (today Bank of America Corp. [BAC]), who believed in fast profits, mergers, and impersonal service. After college, when I moved North, my mother sent me a Wachovia credit card "because you never know when those New York banks are just going to disappear."
"SAFEST OF THE SAFE."
Wall Street was a believer as well. When derivatives scandals struck company after company in the early '90s, Wachovia was glorified for having little if any exposure to the exotic financial instruments. During the collapse of the Mexican market in 1994, research reports were written about Wachovia having no emerging-market debt, while other banks were writing off millions in nearly worthless paper. "They had the highest-quality loans during the last recession [1990-91], so they were one of the only banks to exit it without losses," says Brown, Brothers Harriman analyst Katrina Blecher. "They've always had a reputation for being the safest of the safe banks."
Is the reputation deserved? No one can dispute that the company takes a stern line when it comes to underwriting loans. It has the highest credit rating attainable from rating agencies Standard & Poor's and Fitch.
A bank's risk profile is more than the credit quality of its loans, however. Every bank holds a fund in reserve -- called the loan-loss reserve -- so that it can cover loans that go bad. The average loan-loss reserve for regional banks is around 1.4%. So for every $100 million in loans that the bank has underwritten, it has $1.4 million in its loan-loss reserve. As of the end of last quarter, Wachovia's loan loss reserve was 1.17%, well below the national average.
EARLY WARNINGS.
Wachovia Chief Financial Officer Bob McCoy says it made sense last year and earlier this year to keep the reserve so low. "We read the economy at the time, and we felt that we were in a very safe spot with our loans. So we felt we didn't need a large loan-loss reserve," says McCoy. Not all analysts who covered the company agreed. Fitch analyst Ian Jaffe (no relation to this writer), who covers the company as a debt analyst, warned about Wachovia's low loan reserve last November. Prudential Equity analyst Nancy Bush also prophesied trouble last year because of the low loan reserve. And now, the problem has surfaced and bitten McCoy and company you know where.
The bank announced on June 15 that it would take a $200 million charge against income in the second quarter to boost its loss reserve back up to the national average. It also said it had $70 million in nonperforming loans, $50 million of which was in one, as-yet unnamed loan agreement. Again, though, it's too early to start writing Jeremiads, says Fitch's Jaffe. "If they had declared the $200 million charge over eight quarters, no one would have batted an eyelash," he says. "They chose to take all their lumps at once and then rebuild their credibility. That just means that the worst is over for them."
The real problem isn't that Wachovia is in terrible credit trouble, or that the entire banking industry is facing a wave of defaults. It's that Wachovia has slightly modified its image recently, without cluing in Wall Street first. "Few people have noticed that Wachovia has become slightly more aggressive in the last few years," says Jaffe. "That's not necessarily a bad thing. They certainly have plenty of room to relax their standards and still have a better loan portfolio than their competitors."
CLEARANCE SALE.
Wachovia isn't trying to hide its new aggressiveness. "We want to be known for one thing: being good to our customers. The word conservative doesn't fit us anymore. We don't shy away from the fact that we're risk takers," says CFO McCoy.
While the Wall Street Establishment gets used to that idea, investors can buy Wachovia's stock at one of its lowest prices in years. Its current price-to-tangible-book ratio (a good tool to use when analyzing banks) of 2.39 is much lower than the S&P regional bank index ratio of 4.43. And Wachovia's stock price is barely above a 52-week low. Bargain hunters, take note.
Sam Jaffe covers investing for Business Week Online
Got a question or comment? Go to our Ask Sam Jaffe Forum now!
Get BusinessWeek directly on your desktop with our RSS feeds.
Add BusinessWeek news to your Web site with our headline feed.
Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.
To subscribe online to BusinessWeek magazine, please click here.
Copyright 2000 , by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
