Wachovia's deal from hell

Who knew that Wachovia’s acquisition of World Savings parent Golden West Financial would be such a disaster? Actually, lots of people. The 2006 Golden West purchase was roundly criticized at the time by investors who argued that the price was too high and the California real estate market was too precarious. But the Wachovia folks just couldn't pass up the chance to break into California in one fell swoop ($32 billion in deposits and 123 branches). Today, Wachovia's market cap has tumbled to around $25 billion, which is roughly what the bank paid for the California thrift. The WSJ's Deal Journal has already christened it The Deal from Hell:

Taking on the mantle of “Deal From Hell” isn’t a casual affair; it is a difficult-to-achieve level of shame inspired by Robert Bruner, dean of the Darden School of Business at the University of Virginia, and his book, “Deals From Hell: M&A Lessons That Rise Above the Ashes.” Bruner’s requirements for consideration included destruction of market value; financial instability; impaired strategic position; organizational weakness; damaged reputation; or violation of ethical norms and laws. Another Deal From Hell, for instance, is Sprint’s disastrous merger with Nextel. Wachovia/Golden West now seems to qualify, if only because of the “destruction of market value” criterion.

Much of the market value was wiped out by loan programs that in retrospect seem almost laughable. Money & Co.'s Tom Petruno reminds us of those Pick-A-Pay mortgages that allowed borrowers to name their payment. Sometimes they paid so little that loan balances actually rose. Of the $5.6 billion Wachovia set aside last quarter for loan losses, $3.3 billion were for Pick-A-Pay loans.

The combination of minimal loan payments and falling home prices has jacked up LTV ratios across the bank’s Pick-A-Pay portfolio, but particularly in California. In the Central Valley, for example, Wachovia has $10.2 billion in Pick-A-Pay loans outstanding. The average LTV ratio now is 109%, the bank said, using estimated valuations from May. When the loans were made the average LTV was 72% in the Central Valley, according to Wachovia.

But here's the kicker: Wachovia, which reported a second-quarter loss this morning of nearly $9 billion, also saw its stock jump 27.4 percent. Investors are betting that Wachovia is dumping out all its dirty linen at one time, a painful but necessary cleansing. The logic speaks volumes about the market's newfound optimism that the financial mess is bottoming out – whether or not it is.