Down for the count

The numbers — and a global credit crisis — were crushing
Wachovia, but CEO Bob Steel squirmed out of a terrible deal.
By Frank Maley


The morning of Sept. 11, almost seven years to the hour after jetliners slammed into twin towers in the nation’s largest financial center, a gray shroud hovers so low it hides the tops of Charlotte’s skyscrapers. The crown of Bank of America headquarters seems sucked into celestial murk. A few blocks away, in an executive suite 40 floors above damp streets, Bob Steel starts another day as his company’s last best hope. Just two months ago, the Durham native and former Wall Street investment banker had been lured from the Treasury Department and given a task as daunting as this day: Fix Wachovia Corp., the nation’s fourth-largest bank holding company, whose home here, along with BofA’s, makes this the nation’s No. 2 money center. It has posted two straight quarterly losses — nearly $9 billion in the second alone — and slashed the quarterly dividend twice, from 64 cents to a nickel, to conserve capital. Steel, 57, can’t say when the sun will shine again. “There are too many things I can’t control.”

His handshake is firm, his gaze steady, but he’s still groping for answers. Wachovia is in good shape, he contends, but he’s still working through problems, primarily with a $122 billion portfolio of adjustable-rate mortgages acquired in 2006 when it bought Golden West Financial Corp. While cutting costs, the bank is eyeing ways to raise capital. One way is selling assets. “With proceeds of hundreds of millions of dollars,” he adds, “not billions of dollars.” He has invested $16 million of his own money in Wachovia stock.

But Steel has no idea how big the problem he faces really is — a global credit crisis that dwarfs even his giant of a bank. No idea that by the end of the month it will be in a financial meltdown and he will be presiding over a fire sale. Shares, which had traded in the low 50s late last year, will dwindle to $10, then to less than a buck in the span of a weekend. Propping up Wachovia by pairing it with another bank will become top priority for regulators intent on preventing a domino effect of failing companies, restoring confidence on world markets and staving off Great Depression 2.0.

Wachovia, a name that has been an icon of North Carolina business for well over a century, will go from storied brand to punch line on Saturday Night Live. The misery of its investors, some of whom will lose fortunes, and the anxiety of its 120,000 employees — about 30,000 in the state, 20,000 in and around Charlotte — an unknown number of whom might lose their livelihood, will be shared by taxpayers who must foot the $700 billion bill to bail out and nationalize a major segment of the financial industry. Robert K. Steel, who had wanted his last job to be as Wachovia’s CEO, will have to settle for being Wachovia’s last CEO. The only consolation he or anyone connected with the company will have is that it could have been worse.

On this gray morning, Steel is so new to the job that he can vividly remember his first day — the excitement, the uncertainty, the weight of responsibility. “It’s a bit daunting. You want to do a good job. Lots of people are counting on you.” He holds history in his hands. Wachovia’s roots go back to 1879 in Winston-Salem, but it’s the fruit of Union National, started in Charlotte soon after the turn of the 20th century. As First Union, it bought the older institution and assumed its name in 2001, one of more than 150 deals in the last 50 years that turned a homegrown hybrid into a bicoastal colossus.

One reason for shedding the First Union brand was a series of setbacks, the most notable being the $2.1 billion purchase of The Money Store, a Sacramento, Calif.-based subprime lender, in 1998. It dragged down earnings, and new CEO Ken Thompson, Steel’s predecessor, shut it three years later. History would repeat itself on a grander scale. Five years after the Wachovia merger, the bank paid $24 billion for Oakland, Calif.-based Golden West, which had 285 branches in 10 states. But it came with a portfolio larded with a type of adjustable-rate mortgage that allowed borrowers to defer interest on their monthly payments, which can drive up the amount they owe, ultimately saddling them with payments they can’t afford. And it came when the mortgage market was at its peak and the real-estate bubble about to burst.

As with The Money Store, Wachovia had paid too much in an attempt to get a toehold in California, says Tony Plath, associate professor of finance at UNC Charlotte. The deal might have worked if Wachovia aggressively had sold the risky mortgages and pushed Golden West to operate like Wachovia, instead of the other way around. “The error that cost them the franchise was not what they did in buying Golden West, it was what they did in keeping Golden West after they bought it.”

Loan losses and the fear of them eroded earnings, and the board forced Thompson, a 32-year veteran, to retire in June. Chairman Lanty Smith consulted Steel — they had served together on the Duke University Board of Trustees — about finding a replacement. Then undersecretary of treasury for domestic finance, Steel didn’t consider himself a candidate — he figured he would have to leave his post when the new president took office and planned to take some time off. He can’t recall whether he or Smith broached the idea that he succeed Thompson. He got the blessing of Treasury Secretary Henry Paulson, who had been his boss at New York-based Goldman Sachs Group Inc. and has known him more than 30 years. Steel had left the Wall Street firm as vice chairman in 2004 and joined Paulson in Washington in 2006.

He took the Wachovia job knowing it wouldn’t be easy. And with news July 22 of staggering second-quarter losses came a dividend cut and job cuts that eventually would total nearly 7,000. To reduce risk and avoid foreclosures, the bank began refinancing “Pick-a-Pay” mortgages into conventional ones. Steel split out the distressed mortgages, assigning special personnel to squeeze as much value as possible. “In three decades at Goldman Sachs, we dealt with lots of situations where investments presented a different perspective than we planned, and you have to get at it.” Two days later, Wachovia said its chief financial officer would step down as soon as a re- placement could be found. By the end of the month, it had announced that its chief risk officer was retiring.

By Sept. 11, Steel was optimistic. “The underlying tone of lots of our business is quite good. It will just take some time to work through all these issues.” But the storm that had been building for months was about to gain hurricane strength and make landfall in Charlotte. The previous day, New York-based Lehman Brothers Holdings Inc., one of the largest investment banks, had announced a $3.9 billion quarterly loss. The following week, it would file for bankruptcy. Another New York investment bank, Merrill Lynch & Co., rushed into the arms of BofA.

The dominoes kept falling, clacking their way toward Wachovia. On Sept. 16, the feds pumped $85 billion into the nation’s largest insurer, New York-based American International Group Inc., to keep it afloat. The next day, newspapers reported that Wachovia and New York investment bank Morgan Stanley were considering a merger. Later that week, the Bush administration announced a plan to bail out the financial industry. On Sunday, Goldman Sachs and Morgan Stanley agreed to become bank-holding companies, gaining greater access to funding from the Federal Reserve. The next day, Morgan Stanley said it would pursue a strategic alliance with Japan’s largest banking group. Meanwhile, the bailout bill had stalled in Congress.

When Steel was hired in July, Smith had conceded that the company had experienced a difficult quarter but added, “We are pleased that Wachovia’s capital and liquidity provide a solid foundation in the face of these challenges.” In normal times, that might have been true. But Lehman’s fall led to lending gridlock and put a premium on well-capitalized banks, says Gary Townsend, a former regulator who heads Chevy Chase, Md.-based Hill-Townsend Capital LLC. “Unfortunately, Wachovia had not taken advantage of opportunities it might have had to raise additional capital.”

On Sept. 25, just two weeks after Steel had said Wachovia’s underlying health was good, Seattle-based Washington Mutual Inc. failed. Taken over by the Federal Deposit Insurance Corp., its banking operations were sold for $1.9 billion to New York-based JPMorgan Chase & Co. Time was running out. Investors and analysts feared Wachovia would be next. Then Steel’s phone rang. “After WaMu went down, the chair of the FDIC called him and said, ‘Find a partner, find somebody to be acquired by — by Monday — or we’re going to come in and take over the bank,’” says Charlie Steel, Bob’s brother and a tax lawyer in Raleigh. “It was just that sudden.”

Wachovia stock plummeted 27% Friday, Sept. 26, and depositors started pulling out their money — $5 billion that day, according to a court filing. Worse, banks stopped lending it money. “Nobody wanted to be the last bank to loan money to Wachovia before they were taken over by the FDIC,” Charlie Steel says. His brother began talking with New York-based Citigroup Inc. about buying Wachovia. Saturday, Sept. 27, he spoke with San Francisco-based Wells Fargo & Co., according to an affidavit. That weekend, both companies pored over Wachovia data. Citigroup, coming off three straight quarterly losses, was interested only in the banking operations and needed FDIC assistance to make the deal work. Wells — still in the black, though profits had fallen — wanted the whole company.

About 6 p.m. Sunday, Wells backed out. FDIC Chairman Sheila Bair told Steel that the situation posed a “systemic risk to the banking system” and directed him to start negotiating with Citigroup. The next day, in a 6:30 a.m. telephone meeting, Steel told his board it had to cut a deal with the FDIC and Citigroup or file for bankruptcy. Citigroup would get the banking operations for $2.2 billion, about $1 a share. Everything else would remain an independent company. The FDIC committed taxpayer money to limit Citi’s losses on Wachovia’s $312 billion loan portfolio to $42 billion and would get $12 billion in Citigroup preferred stock. Wachovia wasn’t allowed to modify the agreement. Citigroup lent Wachovia money so it could stay in business, Charlie Steel says.

Regulators wanted a definitive agreement within a week. Wachovia didn’t want to split the company, but Citigroup didn’t want the whole thing. About 7:15 p.m. Thursday, Steel got a call from Bair, telling him Wells Fargo had reconsidered and would offer $7 a share for all of Wachovia. She encouraged him to give “serious consideration.” There would be no government aid and no risk to the FDIC fund, she said. At 9 p.m., Wells Chairman Richard Kovacevich called Steel to say he would be sending a board-approved merger agreement. He e-mailed it four minutes later.

At 11 p.m., the Wachovia board met by phone. Steel told directors he believed the FDIC would take the company’s banking operations into receivership unless it had a definitive agreement with Citi or Wells by the end of the next day. The board approved the Wells offer, subject to the blessing of its advisers, Goldman Sachs and Perella Weinberg Partners. When they gave the green light early the next morning, Steel signed the agreement and called Citi CEO Vikram Pandit.

The FDIC put out a statement saying it supported the Citi-Wachovia deal despite its behind-the-scenes encouragement of the Wells pact. “The fiduciary responsibility to the shareholder trumps whatever contractual obligation there may or may not have been to Citigroup,” Charlie Steel says. “Mrs. Bair was saying that to Bob but then publicly saying — because they had held the shotgun at the wedding between Citi and Wachovia — they felt some obligation to Citi, who had stepped up, to put out a statement supporting Citi’s offer.” The New York bank responded by suing Wachovia and Wells. After a week of negotiation, it dropped efforts to bar the deal but seeks $60 billion in damages. The Federal Reserve quickly approved Wells’ purchase of Wachovia.

Afterward, Bair admitted to reporters that Wachovia might have been saved had the government moved more quickly. Townsend agreed. “There have been a lot of mistakes made, certainly by Wachovia but also by the monetary and regulatory authorities. The failure to provide an adequate lifeline to Lehman was the tipping point.”

Last year, when Wachovia stock was going for $52 a share, selling the company for $7 would have seemed a disaster. But for shareholders who held on till the end — whose other choices were bankruptcy or the Citi deal — Wells’ offer was greeted with some relief. Citi insists that its offer was better, that people overlooked the tax breaks and the value of what would have remained Wachovia.

The deal should work out better for Charlotte, too. Wells’ branch network, most of it west of the Mississippi River and north of the Ohio River, has little overlap with Wachovia’s, concentrated along the Eastern Seaboard and Gulf Coast. Wells is expected to cut fewer jobs than Citi would have, and the combination will produce the biggest branch network in the U.S. and tight competition with BofA for the lead in deposits. The city might even end up with more Wells Fargo jobs than Wachovia has now. “When this global recession is over and the banking industry begins to come back, it will evolve into a different kind of industry,” Plath says. “No more standalone investment banks, no more prima donna New York companies that excel at risk taking and money losing. What this does is shift the eastern center of finance more in Charlotte’s direction.”

Most of the experts are still guessing how it will shake out, but there will be little room for Wachovia top management, including Steel. “There is not an operating role for me in the new company,” he told reporters Oct. 15. Some suspected the former investment banker’s job all along had been to get Wachovia ready to sell. Not so, says his brother. But things don’t always work out the way you plan. “Bob intended to keep Wachovia independent. He bought a million shares of Wachovia stock at $16 a share. He had a house in Charlotte. His intention was to finish out his career as CEO of Wachovia.” Maybe he did.