Wachovia Corp.'s $26 billion gamble on California real estate went bust Monday, knocking out the Sacramento region's sixth-largest lender and adding yet more bulk to the three national financial titans emerging from the rubble of the credit crisis.
Wachovia moved into California in May 2006 by buying the Oakland-based parent of World Savings Bank, which had built a huge portfolio of risky adjustable-rate mortgages – including billions of dollars in loans to homeowners in the Sacramento region.
With many of those loans going bad, though, Wachovia buckled. On Monday, Citigroup Inc. swallowed the company for $2.2 billion in a deal backed in part by the Federal Deposit Insurance Corp. Citigroup will assume Wachovia's $53 billion in debt and absorb up to $42 billion in losses from the company's loan portfolio.
Like the takeover of Washington Mutual by JPMorgan Chase last week, the Wachovia deal eliminates another national player in the retail banking industry.
A spokeswoman for Wachovia, which has 12 commercial branches in the four-county Sacramento region, stressed Monday that the Citigroup takeover would not affect the bank's customers.
But banking experts said that in the long run, the remaining mega-banks – Citigroup, Bank of America and Chase – are likely to throw their weight around nationally and in California.
"There will be less competition, fewer choices and probably higher prices," said Sung Won Sohn, a professor of economics at California State University, Channel Islands, in Ventura County. "But in exchange you get some more stability. I see it as a trade-off."
Experts also noted that the turmoil could leave many customers looking for alternatives to the Big Three – a potential bonanza for the nation's roughly 8,500 regional and smaller banks nationwide.
"I think that community banks will have another bite at the apple – another opportunity to capture these customers with a different strategy," said Anat Bird, a former Wells Fargo executive in Gold River who runs peer group conferences for bank executives.
Bird also said rates for certificates of deposit are likely to fall somewhat as Wachovia and other banks go under. Desperate to generate deposits, distressed banks have been offering unsustainably high rates of return on CDs, Bird said, pushing other banks to match them.
Outside Wachovia's branch at 55th Street and Folsom Boulevard in East Sacramento on Monday, customer Charles Marsh, a retired probation officer, said his top concern in the Wachovia meltdown is simple: "Everyone with deposits here just wants to make sure they're safe," he said. "There were no long lines here. That's reassuring."
Wachovia's troubles stemmed largely from its $122 billion portfolio of a type of loan pioneered by World Savings: payment-option adjustable-rate mortgages, also known as option ARMs.
With an option ARM, borrowers pay a low initial monthly rate, which jumps sharply after about five years. What's more, during the introductory period, the loan balance grows – so if property values fall, homeowners with option ARM mortgages are stuck with loans that often far exceed the value of their homes.
"As long as the value of housing continues to rise, everything's good," Bird said. "But when that changes, it's a house of cards."
Option ARM mortgages have proven extremely difficult to restructure, said Kevin Stein, associate director of the California Reinvestment Coalition, a collection of groups working to combat predatory lending. That's one reason the mortgages have a very high default rate.
There's nothing inherently wrong with option ARMs, so long as they're made to a borrower – a law school student, for instance – whose income is very likely to grow in the near future, Stein said.
But as the real-estate market boomed and then peaked, lenders desperate to keep the market rising lowered standards, dropping requirements for borrowers to prove their income, for instance. "There was a race to the bottom," he said.
In the Sacramento region, World Savings, which dealt exclusively in option ARMs, became known as an easy source of financing, said Michael McGee, owner of Winchester McGee Real Estate & Loans in Rancho Cordova.
"You could get a little bit shakier borrower and a little bit shakier property through that conduit," he said.
From June 2005 through June 2007, World Savings and Wachovia made 11,822 loans worth $2.96 billion in the Sacramento region, according to MDA DataQuick. That gave World Savings a 2.7 percent local market share.
Call The Bee's Jim Downing, (916) 321-1065. The Associated Press contributed to this report.
