Fed Analyst Questioned ’06 Deal By Wachovia

Feb. 03--Weeks after Wachovia Corp.'s near failure, a Federal Reserve analyst questioned whether the regulator should have allowed the Charlotte bank in 2006 to buy Golden West Financial Corp., a mortgage lender that contributed to its weakened financial condition.

The analyst's November 2008 case study on Wachovia also said it wasn't clear whether the bank was either "prepared for, understood, or tried to prevent" the run on commercial deposits that accelerated as the financial crisis peaked in September 2008. The bank team analyzing the outflow was understaffed and had insufficient data, the study found.

Greg Feldberg , a senior supervisory financial analyst with the Fed in Washington, presented his findings at a bank examiner conference held in Atlanta a little more than a month after Wells Fargo & Co. agreed to buy the tottering bank. His PowerPoint presentation was cited in the Financial Crisis Inquiry Commission report issued last week, providing a window into the normally non-public thinking of examiners.

The FCIC cited the study in a section of the report that detailed Wachovia's struggles and the actions that ultimately led to its sale. In general, the commission found that "regulators either failed or were late to identify the mistakes and problems of commercial banks and thrifts or did not react strongly enough when they were identified."

Senior supervisors told the commission that it was difficult to express concerns about financial institutions when they were generating record profits. Later, some said they feared taking public enforcement actions against banks out of fear of aggravating existing problems.

The study indicates regulators began to worry about Wachovia's financial condition in the second half of 2007, as a global credit crunch wreaked havoc on banks around the world. As the crisis grew, Wachovia's "pre-existing conditions" included the strains from buying the Oakland, Calif.-based seller of nontraditional mortgages, as well as exposure to souring mortgage-backed investments in its corporate and investment bank, the presentation said.

Wachovia's financial problems became clearer in April 2008 when the bank announced a $350 million first-quarter loss. The main culprit was rising losses in the bank's "Pick-A-Payment" adjustable-rate mortgage portfolio. Those loans -- a Golden West mainstay -- allowed borrowers to make a minium payment that didn't always cover the interest owed, increasing the borrower's balance. Wachovia continued to originate the mortgages, which were heavily concentrated in California regions slammed by the housing market collapse.

From January to August 2008, the bank took steps to be more transparent with investors about its problems and worked to prepare for deposit runs each time executives issued dismal quarterly earnings reports, according to the presentation. By July, the board had named former Treasury Department official Bob Steel as chief executive, replacing the ousted Ken Thompson .

That summer regulators downgraded the bank's supervisory ratings and ordered executives to take corrective actions, although cash on hand was deemed adequate. Investor and depositor concerns, however, ramped up in September after Lehman Brothers Holdings Inc. fell into bankruptcy and Seattle-based lender Washington Mutual Inc. failed. By Oct. 3, Wells Fargo had agreed to buy Wachovia, trumping an earlier deal by Citigroup Inc.

In the "lessons learned" section of the presentation, Feldberg said Wachovia did some things right, including taking steps to attract deposits in the summer of 2008 by promoting certificates of deposit with attractive interest rates. The bank also issued earnings releases that were "significantly more transparent about credit problems" than previous ones.

But the study also detailed the bank's problems monitoring its deposit exodus. Wachovia had trouble reconciling reports from different sources, and two-day-old data made it "difficult to track most important liquidity drains," the study found.

It also took Wachovia "too long" to admit its decline in deposits was specific to the bank, according to the presentation. "Declines were blamed on weekly fluctuations, on monthly tax day, on a never-quantified large withdrawal from the World Bank," the 30-page PowerPoint presentation said.

In examining the role of regulators, the study asked how effective the Fed was in helping Wachovia, whether it had the right information and "under what grounds could regulators have blocked the Golden West purchase."

Among the lessons learned for the Fed, the presentation said the regulator should question "top-of-the-market acquisitions." The central bank approved Wachovia's $25.5 billion Golden West purchase in the fall of 2006, as the housing market was cresting.

In addition, the presentation concluded that "systemic risk is real," saying the Lehman bankruptcy and the failure of Washington Mutual "had real repercussions for Wachovia."

Lessons learned

Wells Fargo spokeswoman Mary Eshet said the San Francisco-based bank's "risk management practices and processes" are now in place for the entire company. The bank has studied the liquidity issues Wachovia faced during the financial crisis and has incorporated "key learnings into systems and processes," she said.

The study was presented by Feldberg at a private conference for Fed examiners and represented his own views, not those of the Federal Reserve Board. Asked whether the Fed has applied any of the lessons from Wachovia's collapse, a spokeswoman pointed to remarks by Fed Chairman Ben Bernanke at an FCIC hearing in September in which he said the central bank had made "substantial changes to our supervisory framework."

The Fed is now taking a broader look across the industry to identify potential problems, Bernanke said. It's also using data analysis and modeling to look for vulnerabilities, centralizing more supervisory functions and communicating more frequently with senior bank executives and directors.

"Where necessary," he added, "we will increase the use of formal and informal enforcement actions to ensure prompt and effective remediation of serious issues."

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