Financial thoughts

Wachovia Corp. posted a nearly $9 billion loss for its second quarter Tuesday on losses related to home mortgages and the bank’s declining market value.

The shortfall exceeded the estimates of Wall Street analysts, but shares rose 27% after falling in early trading.

The nation’s fourth-largest bank reported a net loss for the three months ended June 30 totaling $8.9 billion, or $4.20 per share, compared with a profit of $2.34 billion, or $1.22 per share, a year earlier.

Excluding a one-time, $6.1 billion charge related to "declining market valuations," the Charlotte, N.C.-based bank said it lost $2.67 billion, or $1.27 per share. Analysts polled by Thomson Financial, which typically excludes one-time items from their estimates, were expecting a loss of 78 cents per share.

It was the second-consecutive quarterly loss for Wachovia, marking the first time the bank reported back-to-back losses in 20 years. Some analysts think the bank’s continued weak performance may make it an attractive purchase for a bigger company.

"Wachovia as an asset will be an attractive takeover, especially since they took a pretty big write-down, so they’re closer to a clean slate." said Eric Schopf, portfolio manager with Hardesty Capital Management. "Investors are seeing that now and that’s driving up the stock."

Revenue for the quarter fell 13.7% to $7.5 billion from $8.69 billion last year. That missed analysts’ forecast of $8.37 billion in revenue.

"These bottom-line results are disappointing and unacceptable," Lanty L. Smith, Wachovia’s board chairman said in a statement. "While to some degree they reflect industry headwinds and weaker macroeconomic conditions, they also reflect performance for which we at Wachovia accept responsibility."

The bank did not give any specific guidance in its report, but it signaled that the outlook wasn’t rosy, with a continued difficult economic climate and falling home prices in the future.

"We are being prudently paranoid," said Wachovia chief executive Robert Steel on a conference call with analysts. "We understand our issues and challenges, and we are already addressing them."

Wachovia pre-announced its loss when it named former Treasury undersecretary Steel its new chief executive on July 9, so the numbers should not have come as a surprise to analysts. Prior to that announcement, analysts were expecting Wachovia to post a profit.

"We already knew this was going to be a bad quarter, so the new CEO is trying to put a fence around the bad stuff," said Kevin Fitzsimmons, analyst with Sandler O’Neill & Partners. "This is Steel’s only chance to get all the bad news out there and take dramatic steps before his honeymoon period is over."

Accordingly, the company outlined two new measures to return to profitability. First, it cut its quarterly dividend to 5 cents per share from 37.5 cents. It was the second straight quarter in which it slashed its dividend, though this was a much more severe cut than in the first quarter.

"As we consider the company’s position, it is clearly prudent and necessary to further reduce our common dividend," said Steel. "While this is a difficult decision, it is the best course for our shareholders over the long term."

The bank also reiterated a plan announced Monday that it plans to leave the wholesale mortgage lending business by the end of the week http://fcrwizard.com. It will no longer offer mortgages through brokers, and it will cut a total of 6,350 jobs.

Analysts said the bank took appropriate and necessary action.

"They can’t just say they’re fine and then raise capital later - [former CEO] Ken Thompson already did that," said Fitzsimmons. "They needed to cut their dividend and raise capital this quarter."

As the housing market deteriorates further with no imminent signs of recovery for the U.S. economy, many financial institutions have set aside more cash to compensate for bad loans.

Likewise, Wachovia said it added $5.6 billion to its loan loss reserve, $1.4 billion of which covered net charge-offs. The bank said it expects home prices to fall another 14%.

But the company insisted it is adequately capitalized, with a tier 1 ratio of 8%. The tier 1 ratio is a measure of a bank’s capital. Most analysts agree that a bank with at least an 8% tier 1 ratio is adequately capitalized.

"Wachovia’s new management has pulled its head of out the sand and is fully acknowledging the problems it faces with the loss provision," said Bart Narter, senior analyst with financial research firm Celent. "The bank is making changes in its business to contain these losses."

Steel said the bank will be able to generate or preserve more than $5 billion of capital by cutting its dividend.

"Our balance sheet and liquidity position are strong, and we are committed to keeping them that way," said Steel. "We will be intensely focused on improving that [tier 1] level between now and the end of 2009."

Wachovia is still ailing from its ill-timed 2006 acquisition of California mortgage lender Golden West Financial Corp, which offered so-called "Pick-a-Pay" loans that allowed customers to pay less than the full interest payment on new mortgages. When the housing bubble burst shortly after the buyout of Golden West, many homeowners with the special loans defaulted.

The bank posted a surprising $708 million loss in the previous quarter and announced plans to raise $7 billion in capital through the sale of common and preferred stock.

In June, former CEO Ken Thompson became the latest casualty of the credit crunch when he stepped down under pressure from the bank’s board.

Wachovia (WB, Fortune 500) has been the subject of much analyst scrutiny in the weeks leading up to its report, most notably from influential banking analyst Meredith Whitney of Oppenheimer & Co. Whitney said the bank will face its "greatest reckoning" in the coming quarters due to surging credit costs.

Last Thursday, regulators from several states inspected documents and records in the company’s St. Louis headquarters. Regulators searched the Wachovia Securities unit, which is tied to the company’s auction-rate securities sales.

Wachovia’s quarterly report follows those of peers Bank of America (BAC, Fortune 500), Citigroup (C, Fortune 500), JPMorgan (JPM, Fortune 500), and Wells Fargo (WFC, Fortune 500), all of whom reported hefty losses or declines in profit, but still managed to beat analysts’ expectations. 

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Federal Reserve Bank of Philadelphia Charles Plosser said the central bank should raise interest rates “sooner rather than later'' to lower inflation and prevent price expectations from getting out of control.

“We will need to reverse course — the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later,'' Plosser, who argued against cutting interest rates in two Fed decisions this year, said in a speech today in King of Prussia, Pennsylvania. “It will likely need to begin before either the labor market or the financial markets have completely turned around.''

Plosser joins Minneapolis Fed President Gary Stern, who also votes on rate decisions this year, in making the case for raising borrowing costs, a move Fed Chairman Ben S. Bernanke avoided discussing in congressional testimony last week. Record oil prices and rising food costs this year have increased investor expectations for the Fed to raise the benchmark interest rate.

“Monetary policy cannot control changes in the relative price of a key commodity, like oil or food,'' Plosser said at a breakfast hosted by the Philadelphia Business Journal. “But it can help ensure that a relative price increase doesn't turn into a rise in overall inflation.''

Stern, the longest-serving Fed policy maker, said in a July 18 interview that “we can't wait until we clearly observe the financial markets at normal, the economy growing robustly, and so on and so forth, before we reverse course.''

The Nov. 4 presidential election won't influence the Fed's decision incoming meetings, Plosser told reporters after the speech.

Market Expectations

Investors expect the Fed to raise the benchmark U.S. interest rate at least a quarter-point by year-end, based on futures prices. The Federal Open Market Committee next meets Aug. 5 in Washington.

Plosser dissented from the Federal Open Market Committee's March 18 decision to lower the main interest rate by 0.75 percentage point. He voted against the April 30 move to cut the rate by a quarter-point to 2 percent. At the last meeting, June 24-25, he supported the decision to leave the rate at 2 percent, a pause after seven straight reductions.

Plosser, 59, a former professor and business-school dean at the University of Rochester in New York, has taken one of the toughest anti-inflation stances on the Fed since joining the central bank in 2006.

`Laying the Ground'

His position today is “not necessarily reflective'' of the broader group of Fed policy makers, said Richard DeKaser, chief economist at National City Corp. in Cleveland, in an interview with Bloomberg Television. At the same time, “inflationary risks have risen,'' and “they want to start laying the ground for eventual rate hikes to come,'' he said.

Plosser said recent turmoil at Fannie Mae and Freddie Mac, the largest U.S. mortgage finance companies, has “shaken confidence in our financial institutions and markets,'' which has increased the “uncertainty surrounding forecasts for the economy, including my own.''

The Fed announced on July 13 that it would lend to the government-chartered companies if necessary free credit report.com. The central bank is “just kind of a bystander here,'' Plosser told reporters.

Washington-based Fannie Mae has fallen about 65 percent this year in New York trading, while McLean, Virginia-based Freddie Mac has tumbled about 74 percent amid concerns the companies lack enough capital to weather the worst housing slump since the Great Depression.

Inflation Accelerates

U.S. consumer prices surged 5 percent last month from a year earlier, the biggest increase since 1991, a government report showed last week. Such figures are fueling speculation the Fed will raise rates even as a yearlong credit contraction threatens to constrain economic growth.

Bernanke, in congressional testimony last week, said there are “significant downside risks to the outlook for growth,'' and “upside risks to the inflation outlook have intensified.''

American households foresee average annual inflation of 3.4 percent over the next five years, the highest expectation since 1995, according to the Reuters/University of Michigan survey.

“If we remain overly accommodative in the face of these large relative price shocks to energy and other commodities, we will ensure that they will translate into more broad-based inflation that — once ingrained in expectations — will be very difficult to undo,'' Plosser said today. “I believe we must and will take the appropriate steps to ensure that does not happen.''

Bernanke said last week that markets and institutions “remain under considerable stress.'' The benchmark Standard & Poor's 500 Index has dropped almost 20 percent from its record high in October. The subset of financial stocks has tumbled about 45 percent from May 2007.

`Sluggish' Growth

While the outlook for economic growth this year is “somewhat better'' than a few months ago, Plosser said he expects “sluggish'' growth in the second half and a rising unemployment rate. So far, economic conditions aren't “nearly as dire as some people predicted,'' he said afterward.

At the same time, Plosser said he's “generally more optimistic about 2009,'' projecting that growth in gross domestic product will rise to about 2.75 percent, with the jobless rate declining to 5.25 percent by the end of next year.

Inflation, both including and excluding food and energy costs, will drop to a range of 2 percent to 2.25 percent by the end of 2009, “provided we set monetary policy appropriately to restrain inflation and keep inflation expectations well- anchored,'' he said.

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Treasury Secretary Henry Paulson, aiming to create a new source of U.S. mortgage financing, wants banks to start issuing covered bonds without waiting for legislation from Congress.

Regulators can provide the guidance that lenders are asking to be set in law, said a Treasury official working on the issue who declined to be identified. Banks want a standardized definition of a covered bond, which requires the lender to make good on payments if homeowners default, and guidelines on bondholder protections.

Paulson is promoting the debt as an alternative to mortgage-backed bonds, the securities that sparked more than $426 billion in writedowns and credit losses as delinquency rates soared. Covered bonds also offer a way to diminish the role of Fannie Mae and Freddie Mac, the troubled firms behind more than two-thirds of new U.S. mortgages, according to the Treasury.

“If they'd asked for'' legislation, there would be “a question whether they could even get it done this year,'' said Wayne Abernathy, an executive director at the American Bankers Association in Washington and a former Treasury official. “There is a need today for additional types of forms of providing liquidity and forms of providing funding for housing.''

Covered bonds offer banks a way to raise money for new mortgages without either selling the loans or packaging them into securities. Instead, a bank issues bonds that are backed by a dedicated and regularly updated pool of loans.

European Model

In Europe, covered bonds represent a $3 trillion market that's a primary source of financing for home loans and municipal debt. The securities have been used in the U.S. since 2006, after introductory offerings by Seattle-based Washington Mutual Inc. and Bank of America Corp. of Charlotte, North Carolina.

While a law would be helpful for issuers, it isn't required, the Treasury official said last week. The department hasn't yet signaled its next move.

“What we may see from them first is more like a game plan,'' laying out “here's what we think a covered bond is,'' said Michael Durrer, partner at law firm Sidley Austin LLP in London who has worked with both of the U.S. covered bond issuers.

Paulson `Proactive'

Paulson has done “precisely the right thing'' by trying to move forward without getting bogged down in the legislative process, said former U.S. Securities and Exchange Commission Chairman Arthur Levitt in an interview today with Bloomberg Radio.

“What we're seeing here is a very proactive secretary of the Treasury recognizing that almost any plan he puts forth will be debated endlessly by the Congress, and we can't afford endless anything at this time of crisis,'' Levitt said. “It's part of the whole arsenal of activities that Paulson has called upon to try to restore public confidence to our market and gain a measure of liquidity that simply has been so reluctant to appear.''

A take-off in covered bond issuance may reduce the role of Fannie Mae and Freddie Mac, which own or guarantee almost half the $12 trillion of U.S http://pay-day-home.com. mortgages outstanding. Paulson told lawmakers last week the firms “touch'' 70 percent of new loans. Mortgage originations totaled $525 billion in the second quarter, according to a Mortgage Bankers Association estimate.

Fannie, Freddie

Washington-based Fannie Mae has slumped 55 percent in the past month, and McLean, Virginia-based Freddie Mac is down 61 percent, on concern the companies lack sufficient capital to cover writedowns and losses. Paulson July 13 asked Congress for the power to make unlimited loans to the firms, and make equity purchases, to combat a collapse in confidence.

Covered bonds are a “promising financing vehicle,'' Paulson said in a July 8 speech. They offer a way to “increase the availability and lower the cost of mortgage financing to accelerate the return of normal home-buying activity,'' he said.

The Treasury hosted a private meeting last month between regulators and market participants to work out concerns about guidelines for issuance. If U.S. bond issuers, dealers and investors all jump into the market at once, each will avoid the risk of going first, the Treasury official said.

Federal Reserve Chairman Ben Bernanke expressed doubt this month whether covered bonds can take off without action by Congress. “It's not yet known whether this can be successful without legislation,'' he told lawmakers July 10.

FDIC's Rule

The Federal Deposit Insurance Corp., rebuffing requests by banks, issued a final rule on covered bonds on July 15 that will allow investors to access their collateral more quickly in the event of a bank failure. The regulations alleviate some of the industry's concern about how regulators will treat covered bonds when a bank goes under.

The FDIC also provided the first definition from U.S. regulators about what kind of collateral qualifies for covered bonds. In doing so, the agency rejected appeals to include a broader pool than in its April interim guidance.

Mortgage-industry participants say a U.S. market won't take off without a new law. While the Treasury's efforts to boost the covered bond market have been welcome, lenders judge it “requires legislative change,'' said Tim Ryan, head of the Securities Industry and Financial Markets Association.

The FDIC rules were “underwhelming'' in defining covered bonds and how they might be handled if an issuing bank failed, said Anna Pinedo, a New York-based partner at the law firm Morrison & Foerster LLP. The first U.S. regulations to mention covered bonds specifically are “very cautious'' and don't make much use of the extensive industry feedback that greeted the agency's initial proposal, she said.

The private sector has some leeway to start on its own, Pinedo said.

“I think it would be a shame if market participants were to sit on the sidelines,'' she said. “It's quite possible to access the market in the absence of legislation.''

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European Central Bank President Jean- Claude Trichet said the bank expects the euro-region economy to gather strength toward the end of the year after a “trough'' in the previous six months.

“We will have a trough in the profile of growth'' in the second and third quarters before “a progressive return to ongoing moderate growth,'' Trichet told four newspapers in an interview published on the ECB's Web site today. Trichet said he has “nothing to add or withdraw from'' the July 3 statement when the bank raised its key rate to 4.25 percent.

The 15-member euro region is losing momentum as record oil prices sap the spending power of companies and consumers just as a stronger euro makes exports less competitive. European economic confidence fell to the lowest in more than three years in June. Still, the ECB is concerned about companies raising prices and wages after inflation surged to 16-year high in June.

“The ECB itself seems unsure about the next move,'' said David Mackie, chief European economist at JPMorgan Chase & Co. in London. “Our forecast suggests that there is no resolution over the coming months: growth keeps sliding and headline inflation keeps rising.''

Crude oil prices have increased 70 percent in the past year, reaching an all-time high of $147.27 a barrel on July 11.

Core Inflation

Some labor unions are already pushing for more pay to compensate workers for faster inflation. Deutsche Lufthansa AG, Europe's second-largest airline, earlier this month offered German baggage handlers and cabin crews a 6.7 percent wage increase after employees staged strikes. The Frankfurt-based carrier previously offered 5.5 percent more pay.

In Germany, Europe's largest economy, producer-price inflation accelerated to the fastest pace in 26 years in June, the Federal Statistics Office in Wiesbaden said today. European core inflation, excluding volatile costs such as energy, accelerated to 1.8 percent in June from 1.7 percent.

Trichet reiterated that the 21-member governing council is “never pre-committed'' to a definite rate plan and “will do in the future what is appropriate to deliver price stability.'' The ECB aims to keep inflation just below 2 percent.

“Today price setters and social partners must take into account that we will be back to price stability — in line with our definition — say over 18 months,'' Trichet said payday loan cash advance loan. The ECB has “no further indication'' for “future interest rates.''

`Relatively Hawkish'

“The overall message in my view is still relatively hawkish,'' said James Nixon, an economist at Societe Generale SA in London. “The ECB could well hike rates again even as the economy skirts falling into an outright recession.''

For now, ECB council members are more concerned about faster inflation than slowing growth. Nout Wellink from the Netherlands told Elsevier magazine in an interview published on July 17 that “it's a mistake to think that inflation will slow as the economy weakens.'' Portugal's Vitor Constancio said on July 15 that he doesn't see “risks of recession'' in Europe.

The International Monetary Fund yesterday raised its global growth forecast for this year and said that higher borrowing costs may be necessary to combat inflation. The euro-region may expand 1.7 percent this year instead of a previously forecast 1.4 percent, the Washington-based fund said.

`Strong Dollar'

Investors have nevertheless scaled back bets on the ECB raising interest rates further this year, Eonia swap contracts show. The December contract is at 4.36 percent today, down from 4.55 percent on June 16. The April contract is at 4.40 percent.

Trichet reiterated that U.S. authorities' support of a “strong dollar'' is “very important.'' He also repeated China should allow its currency to appreciate, saying that it “will be in the interest of all parties concerned.''

The euro has gained 9 percent against the dollar this year, prompting European policy makers to fret that it may deepen a European slowdown. German exports dropped the most in almost four years in May and French shipments also fell.

The interview was published in France's Le Figaro, Ireland's Irish Times, Germany's Frankfurter Allgemeine Zeitung and Portugal's Jornal de Negocios.

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The price of diesel fuel hit a record high and gasoline resumed its march upward, a daily survey from auto club AAA showed Sunday.

The price of diesel, which is used to power most trucks and commercial vehicles, hit $4.817 a gallon. It had dipped to $4.811 on Friday and Saturday after reaching a record $4.814 last week.

The average price of unleaded gasoline increased to $4.104 a gallon from $4.098 on Saturday.

The nationwide average is down from the all-time high of $4.108 a gallon, set July 7.

Prices for regular unleaded gas are 35% higher than where they were last year, and diesel prices have risen by more than 65% over the same period.

State levels. Alaska continues to lead the country in the gas runup with prices at $4.617 a gallon on average. California, the other state with prices above $4.50 a gallon, comes in second at $4.518. Hawaii is just pennies away from the mark at $4.463.

South Carolina has the cheapest average prices for regular unleaded at $3.894 per gallon, while Oklahoma has the cheapest diesel at $4.607.

Meanwhile, a separate survey released on Sunday found that the average price of gasoline jumped more than penny over the past three weeks - the smallest price hike this year.

That survey showed that the average price was a fraction of a cent above $4.11 a gallon, said survey publisher Trilby Lundberg.

That was up 1.5 cents a gallon from the last survey three weeks ago, Lundberg said.

"This is the most stable we have seen prices all year," she said http://payday-badcredit.com. But it’s not likely to stay this way, she added.

The main reason for the slowdown in rising gas prices was that oil refiners and gas retailers did not pass on increases in crude oil prices to consumers. They also did not raise their prices because they had seen a recent decline in demand for gas, Lundberg said.

A government report released Wednesday showed an unexpected climb in national gasoline stockpiles, which analysts said could indicate that drivers just aren’t buying as much fuel.

The price of crude oil, which is used to make gasoline and other refined fuels, has been trading at record levels. The increase in prices has put a squeeze on refiners over the past month as products like gasoline have become more expensive to produce.

But refiners and retailers cannot continue to refrain from passing on the higher costs to consumers, Lundberg explained. If the price of crude oil continues to go up, gas prices will have to follow.

The Lundberg survey tallies prices from about 5,000 gas stations nationwide every two weeks. AAA gets its information from Oil Price Information Service, which tracks prices at about 85,000 stations daily.

Gas prices have climbed to record levels. Are you feeling the pinch? Tell us how gas prices are affecting you and what you’re doing to cope. Send us your photos and videos, or email us to share your story. 

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European Central Bank council member Mario Draghi said last week's “timely'' interest rate increase is already easing investors' inflation concerns, suggesting he sees no immediate need for a further move.

“In the days following the increase, the tendency of inflation expectations to increase in the financial markets has peaked and seems to be decreasing,'' Draghi said in a speech in Rome today. “A timely monetary adjustment reduces the risk of late and violent corrections.''

Investors' inflation expectations have dropped since the ECB last week increased its benchmark rate by a quarter point to 4.25 percent. At the same time, ECB President Jean-Claude Trichet today reiterated that inflation at the fastest pace in 16 years is “worrying'' and Executive Board member Jose Manuel Gonzalez- Paramo said the Frankfurt-based bank is ready to take any further necessary steps to get inflation under control.

The breakeven rate on five-year French inflation-indexed bonds, which measures price expectations, was at 2.49 percent today. That's down from a record 2.76 percent on July 2, the day before the ECB raised its benchmark rate.

Crude oil has more than doubled in the past year and inflation in the 15 euro nations accelerated to 4 percent in June, twice the ECB's 2 percent target.

`Timely Fashion'

“By acting in a timely fashion, we intend to try to avert the risk that increases'' in energy and food prices triggers second-round effects, Draghi said. The aim is to “gradually bring down inflation to levels coherent with medium-term price stability.''

Maize prices have almost tripled since the beginning of 2006, prices of soybeans have more than doubled and wheat prices have risen by more than 80%, the ECB said in its June monthly report faxless payday loans.

Central banks “have the duty to avoid risks to price stability from materializing. So they must, we must, act firmly,'' ECB governing council member Miguel Angel Fernandez Ordonez said in Madrid today. The increase in commodity prices may “be a leading indicator of stronger, more generalized inflation pressures at a global level.''

The ECB is worried that companies will raise prices to pass on soaring raw-material costs and unions will push through bigger wage deals to compensate workers for the increased cost of living, leading to more persistent inflation.

`Strongly Concerned'

Trichet said in the European Parliament in Strasbourg today that the ECB is “strongly concerned'' about so-called second- round effects. European labor costs rose 3.3 percent in the first quarter from year earlier, the most in almost five years.

Deutsche Lufthansa AG, Europe's second-biggest airline, canceled about one-third of its flights yesterday after pilots at its Cityline carrier went on strike, marking the most disruptive stoppage in seven years. Vereinigung Cockpit union said in May that Cityline pilots wanted a “double-digit'' percentage pay raise.

Investors expect the ECB to lift the key rate once again by the end of March next year, taking it to 4.5 percent, according to Eonia forward contracts.

Speaking in Madrid, Gonzalez-Paramo said the ECB currently has “no bias,'' which he said means the bank “will do what is necessary at every moment grounded in data and figures to ensure we permanently fulfil our mandate.''

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