As we all know, the housing market is driving everything in this bust. And the financials, as the source of all the financing for the housing market, have borne the brunt of the pain and have led the entire stock market lower for a year now.
Think about it: whenever somebody buys a home or a commercial property, they take out a loan. That loan is either held on the books of a bank or securitized and sold to investors. Ultimately, if borrowers have trouble paying back their loans it’s the banks (or investors) that take the hit. And believe me: The banks are getting killed.
For instance, let’s take a look at Wachovia’s (WB) 2nd quarter report released this morning (WB Earnings Release).
They announced a $9 billion loss. $6 billion of that is a non-cash goodwill impairment charge. So really they lost $3 billion.
The reason they lost so much money is that borrowers are increasingly falling behind on and falling to pay back the loans Wachovia made to them. Wachovia has a loan portfolio of about $500 billion. About 60% of that is consumer loans, primarily real estate, and about 40% is commerical. At the end of the 2nd quarter, $12 billion of those loans, 2.44%, was non-performing. To give you an idea of the kind of crisis we’re in, that’s up from $2 billion, 0.50%, at the end of the 2nd quarter of 2007.
The core of the distress, as we all know, is in the residential real estate portfolio. Of the $12 billion in non-performing assets, $7.6 bilion is in the secured residential real estate portfolio. That’s up from $1.4 billion a year ago.
Let’s step back and try to look at the big picture and what this means for Wachovia’s business overall. Wachovia has a book value of about $82 billion. Book value is an accounting measure that somewhat (emphasis on somewhat!) approaches what the firm should be worth. It is the firms assets minus its liabilities. The caveat is that the numbers used are accounting, rather than market value, numbers. Wachovia’s market value is about $36 billion. So, as you can see, investors don’t entirely trust book value believing that Wachovia’s assets are worth less than what they are carried for on the books.
Anyways, as we said, non-performing assets in Wachovia’s $500 billion portfolio are $12 billion or 2.44%, up from 0.50% a year ago. Imagine that this number increases by 50% to 3.6% over the next year – a likely scenario given the continued fallout in the real estate market. That represents a $6 billion increase in non-performing assets. Imagine that non-performing assets reaches 5%, or $25 billion, at some point. That’s a $13 billion increase in non-performing assets.
These kinds of problems with Wachovia’s book crush the company’s overall value. Like I said, the market is valuing Wachovia at $36 billion so a $13 billion increase in non-performing assets represents about 40% of its market value.
So, while the financials are bouncing this week, including Wachovia’s stock today (WB YTD Chart), the fundamentals continue to deteriorate. I can’t see a sustained rally in the financials until the performance of their books starts to stabilize and look up. A review of the recent financial reports makes it clear that that is nowhere in sight.
Disclosure: Top Gun has no position in Wachovia (WB) shares.