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Will Wachovia sell the brokerage business it just bought?

This post first appeared in the St. Louis Beacon: July 31, 2008 - Although a new TV ad is a warning against rapid-fire stock trading, a few analysts say this might be a money-raising strategy for Wachovia Corp. They suggest it could sell its brokerage business, Wachovia Securities, which acquired A.G. Edwards in October.

Wachovia says it’s keeping the St. Louis-based brokerage; but that hasn’t stopped RBC Capital Markets and Sanford C. Bernstein & Co. from saying a sale would help repair some damage caused by its mortgage-lending.

However, the closer you get to St. Louis for investing advice, the less likely such a deal seems reasonable.

“It doesn’t make any sense,” said Tom Kersting, of  Edward Jones, the St. Louis-based brokerage firm that produces the TV ad about frequent buying and selling of stocks. “This is a good business.” 

The combining of the old Wachovia Securities and A.G. Edwards “is going smoothly,” said Kersting, who has a hold rating on Wachovia and who doesn’t own shares. “This is a core part of the business.”

Last week, Wachovia executives told analysts that the integration of A.G. Edwards into Wachovia Securities is “proceeding as planned” and is 40 percent completed.

The brokerage unit “is a core business for Wachovia and integral to our long-term strategy,” said a company spokesman. “Wachovia Corp. is firmly committed to our retail brokerage business and has no plans to sell it."

If it decided to divest its retail brokerage, Wachovia would have to be in “catastrophic” financial shape, said Juli Niemann, executive vice president of the Clayton financial advisory firm Smith, Moore & Co.

“I can’t imagine that Wachovia would sell [the brokerage business] having just acquired A.G. Edwards,” she said. “Who in the world will buy a financial asset at this time? There’s no idea of what financial assets are worth when the market is in free fall.”

Distinguishing between “catastrophic” and just plain lousy is a matter of perception. If you’re a long-term owner of Wachovia’s stock, or if you’re an ex-A.G. Edwards shareholder who exchanged shares for Wachovia stock and cash last year, “catastrophic” might not sound like hyperbole. 

Wachovia’s stock closed at $54.55 on May 30, the day before the banking giant announced its bid for A.G. Edwards. Wachovia’s stock closed at $50.92 on Oct. 1 when the takeover was completed. Since then, the stock has been as low as $7.80. It closed at $17.08 on July 30.

The stock has been dragged down by Wachovia’s mortgage-lending practices and its heavy exposure to the collapsing housing market, caused primarily by its 2006 acquisition of Golden West Financial, a California savings-and-loan institution and mortgage lender.

Cutting Costs, Raising Money

The mortgage mess led to Wachovia producing an $8.9 billion loss, or $4.20 per share, during the second quarter. For the same period last year, it earned $2.34 billion, or $1.22 a share. Total revenue fell to $7.51 billion from $8.73 billion.

Much of the second-quarter loss was due to a one-time, non-cash charge of $6.1 billion that relates to "declining market valuations and the resulting effects on commercial, corporate lending and investment banking." 

Wachovia has taken several steps to rebuild its financial foundation, such as halting the offering of mortgages through brokers.

In April, Wachovia sold just more than $8 billion in common and preferred stock, and it cut the quarterly dividend to 37.5 cents a share from 64 cents.

Last week, it reduced the quarterly dividend to 5 cents.  Wachovia said it would fire 6,350 people and eliminate 4,400 open jobs and contractor positions.

"There will be no effect on St. Louis,” a Wachovia spokesman said. In fact, the company expects to add 500 to 1,000 jobs in St. Louis “over the next couple of years.” Wachovia also said it will sell “non-core assets.” 

Robert K. Steel, the CEO hired in early July, told analysts on July 22 that he hadn’t determined what assets to sell. Steel is a former undersecretary of the Treasury and former Goldman Sachs executive.

He wants to cut enough expenses and sell enough assets to avoid issuing more stock. Saying that the brokerage unit has “worked out well,” Steel added that it is “a core part of our business.”

Still, a few analysts are speculating about the brokerage unit, much like participants in a fantasy baseball league are constantly making virtual trades of players.

An RBC Capital Markets analyst told the Charlotte (N.C.) Business Journal on July 18 that divesting the brokerage unit was “highly probable” and that it could fetch a good price. RBC and Sanford Bernstein analysts made similar predictions to Bloomberg News on July 28.

The brokerage unit is part of the capital management division, one of four Wachovia divisions. Capital management, which also includes the Evergreen mutual funds operation, is the second largest division with $2.3 billion in revenue for the second quarter. 

The general bank division recorded $4.73 billion in revenue. It includes retail, small business and commercial customers as well as mortgage lending.

The corporate and investment bank division contributed $1.73 billion. It provides corporate lending, investment banking and international trade finance.

The wealth management division provided $412 million. It features private banking, personal trust, financial planning and insurance brokerage.

What Is Non-core?

When it comes to speculating about its brokerage business, the odds seem remote that Wachovia would want to sell something so soon after aggressively courting A.G. Edwards with a premium price of $6.9 billion. 

Over the years, Wachovia methodically built its brokerage business. Between 1998 and 2003, it made five acquisitions and one joint venture. A.G. Edwards was its biggest addition, and Wachovia Securities is now the second largest retail brokerage behind Merrill Lynch. 

“I think the long-term value for the [brokerage] franchise is phenomenal,” said Jaime Peters, a banking analyst for the independent financial research firm Morningstar. “A.G. Edwards is making a positive contribution.”

Wachovia would have to be truly desperate to sell this business, she added. “Anything you’re going to get a good price for in this market is something you’d want to keep,” she said.

Analysts have speculated that Wachovia will sell smaller businesses or pieces of some units. “There’s no big, glaring division where you can say this is non-core,“ says Kersting of Edward Jones.

Analysts interviewed by the St. Louis Beacon also said Wachovia might try to sell some of its damaged mortgage portfolio, citing Monday’s action by Merrill Lynch as an example of what happens when a troubled company sells troubled loans.

Merrill Lynch sold $30.6 billion worth of collateralized debt obligations (CDOs) for $6.7 billion, or 22 cents on the dollar, to a private equity firm. CDOs are securities backed by bonds, loans or other assets.

“There’s always a buyer for an asset,” Kersting says. “The question is the price.” 

Robert W. Steyer is a freelance business reporter based in New York. 

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