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Wachovia, National City Slide on Bailout Fears

Shares of Wachovia and National City tumbled on worries about heavy mortgage losses, as talks on a $700 billion financial sector bailout bogged down and regulators seized Washington Mutual in the largest bank failure in U.S. history.

Investors are fearful that a collapse of the bailout talks in Washington could prolong and deepen the freeze in various parts of the credit markets and deepen losses on banks' balance sheets from troubled mortgages and other loans.

Late Thursday, JPMorgan Chase agreed to buy the bulk of Washington Mutual's operations, including deposits, for $1.9 billion. It also said it would take a $31 billion write-down for the loans it bought. The Federal Deposit Insurance Corp was appointed receiver for Washington Mutual.

"You're talking about the largest failure in banking history, so there is going to be a negative reaction, right?" said William Smith, president of Smith Asset Management in New York. "What you're going to see is the strong stronger, and the weak are going to die off."

(CNBC experts break down the banking picture in video at left...)

In afternoon trading, the KBW Bank Index, which includes both Wachovia and National City, was down 4 percent. JPMorgan rose 94 cents to $44.40, despite selling $10 billion of its common stock.

Also, Downey Financial , a Southern California lender heavily exposed to risky mortgages, saw its shares tumble on Friday.

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While both Wachovia and National City have several profitable businesses, investors are focused on their real estate exposures. Wachovia is the sixth-largest U.S. bank by assets, while National City is a large Midwest regional bank with a sizable presence in Florida.

"They're the ones with a similar exposure to Washington Mutual," said Bill Fitzpatrick, a portfolio manager at Optique Capital Management Inc in Milwaukee. "They are both mortgage finance companies at this point."

The cost rose for protecting Wachovia debt against default.

It cost $2.5 million upfront plus $500,000 annually to insure $10 million of debt against default for five years, according to Phoenix Partners Group. That compared with $650,000 annually and no upfront cost Thursday, Phoenix said.

Mortgage Exposures

At Wachovia, the new chief executive, Robert Steel, is trying to slash costs and bolster capital as the bank works through a $122 billion portfolio of "option" adjustable-rate mortgages.

"We are aggressively addressing our challenges and are working to strategically strengthen and manage capital and liquidity in this challenging environment," said spokeswoman Christy Phillips-Brown.

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The Charlotte, N.C.-based bank has said it expects losses of 12 percent on that portfolio, which it classifies as "distressed," but some analysts expect that to increase. Wachovia got most of the loans when it bought California lender Golden West Financial for $24.2 billion in 2006.

Meanwhile, Cleveland-based National City has said it might face charge-offs on about 20 percent of a roughly $17.4 billion portfolio of businesses it has exited, including broker-sold home equity, subprime and residential construction loans. This portfolio represents about 15 percent of the bank's loans.

"If you use JPMorgan's assumptions that they use to mark WaMu's books to market, National City is likely either a candidate for FDIC seizure, or it's a candidate for a dilutive capital raise," said James Ellman, a portfolio manager at Seacliff Capital in San Francisco. He declined to disclose whether he has a position in National City.

Thomas Richlovsky, who is National City's treasurer and will become interim chief financial officer next week, described as "ludicrous" and "ridiculous" the idea that the FDIC might seize any part of the bank.

He said National City has reduced the $17.4 billion loan portfolio by $1 billion to $1.5 billion since June. National City raised $7 billion of capital earlier this year.

"JPMorgan did a smart thing, writing down the amount to the lowest number it could justify because that gives it a clean slate going forward," Richlovsky said. "We have the capital to manage through the losses under severe stress scenarios. We have the time and the capital, and do not need to do any fire sales. The point of the capital raise was to deal with these situations."