Wachovia latest to seek merger rescue

Wachovia Corp., the Philadelphia region's biggest bank, yesterday became the latest firm swept up in frantic merger talks, trying to survive the deepening financial crisis.

The investment bank Morgan Stanley and Wachovia, based in Charlotte, N.C., held preliminary talks yesterday on a possible combination, according to the Wall Street Journal and the New York Times.

In the credit crunch that has been rocking Wall Street since the weekend, Wachovia has been thrust into the spotlight because of speculation that mortgage losses in California have wounded it so severely that it would have to seek a buyer under duress.

Wachovia's stock has dropped more than that of any other major U.S. bank in this week of Wall Street turmoil that has seen the bankruptcy of Lehman Bros. Holdings Inc., the sale of Merrill Lynch & Co. Inc., and an $85 billion federal loan to insurance giant American International Group Inc.

Wachovia's shares fell nearly 21 percent yesterday, to $9.12, with trading volume five times the daily average over the last year.

In another blow, Wachovia's mutual fund subsidiary, Evergreen Investments, disclosed yesterday that three of its money market funds owned $494 million in Lehman Bros. debt, which has plummeted in value.

A local Wachovia executive said the bank was ensuring its long-term health by cutting expenses, trimming its balance sheet, and making sure it had enough cash to meet its obligations.

"Wachovia's got choices. We've got options. I think we've got an opportunity to get through this. I think we're going to get through this," said Hugh Long, who oversees commercial banking for Wachovia from Virginia to Connecticut.

The huge volume of Wachovia shares that changed hands on the New York Stock Exchange over the last week suggests that traders have been ganging up on the company in a bet that the shares would fall even further.

Banking experts and analysts are not suggesting that Wachovia - whose new chief executive officer, Robert K. Steel, has taken quick action to boost the bank's financial strength - is doomed.

"I'm much more worried about Washington Mutual than about Wachovia," said Ed Kane, a professor of finance at Boston University. "Wachovia at least has a lot more diversification than Washington Mutual. Wachovia is a bank that acquired a thrift, and Washington Mutual is mostly home loans."

One analyst said he would not be surprised to see the sale of Wachovia. "I think that the choice of Steel suggests that the final plan will be a sale of the company," said Gary B. Townsend, chief executive of Hill-Townsend Capital L.L.C. in Chevy Chase, Md.

Townsend, whose partner is Commerce Bancorp Inc. founder Vernon Hill, based his hunch on Steel's background as an investment banker with the Goldman Sachs Group Inc.

For now, Wachovia's most valuable asset may be its network of 3,300 branches in 21 states, giving it the nation's third-largest deposit base, according to investment-research firm Friedman, Billings, Ramsey & Co. Inc.

That vast presence - including about 200 branches in the Philadelphia region - allows it to gather billions in deposits from consumers, businesses and governments. In July and August alone, Wachovia added $20 billion in certificates of deposit.

The ability to gather relatively low-cost deposits to make loans and conduct other operations is what makes commercial banks such as Wachovia attractive to Morgan Stanley and other investment banks, which depend heavily on forms of funding that can dry up during times of crisis.

Wachovia's retail network was built through dozens of acquisitions since the 1980s, including the purchase of CoreStates Financial in 1998 - at that point, the biggest banking merger.

A calamitous misstep occurred in 2006 with the $24.2 billion purchase of mortgage-lender Golden West Financial Corp. at the height of the easy-credit boom.

A painful legacy of that deal is a $120 billion portfolio of adjustable-rate mortgages that allowed borrowers to choose how much to pay each month.

That made houses seem affordable in then-hot markets, such as California and Florida, but it turned into a bad deal for borrowers and the bank when prices headed down.

Now, many borrowers owe more than their houses are worth. Wachovia has projected total losses on those loans of 12 percent, or about $14 billion, but some analysts say they think the losses could be much higher.

Wachovia CEO Steel has argued that the bank has the advantage of holding those problematic loans on its balance sheet rather than in securities. That means the bank can negotiate directly with borrowers to limit losses. It has dispatched 1,000 employees to contact borrowers.

How much success it will have is unknown. For Wachovia, and most other troubled financial institutions, the key is, in the words of Wachovia official Long: "How low can it go in terms of housing in the United States?"