Will Wachovia Survive?

It was no surprise when Wachovia said it would restate its second quarter results. With all its wounds exposed, it was just a matter of when the first one would become infected and what it would cost. The “when” was last night, and the infection was legal provisions related to an Auction Rate Securities suit file by New York State and others. How much? A cool $1.2B:

Wachovia (NYSE:WB) says it is discussing potential settlements with various state regulators and the SEC related to investigations into the underwriting, sale and subsequent auction of auction-rate securities. The bank says it recorded a $500 million pre-tax increase to legal reserves in the second quarter, based on the probability of such settlement. That brought Wachovia’s total increase in legal reserves to $1.2 billion during the quarter.

Cost cutting is a typical belt tightening that goes with lean times:

Wachovia Corp. will cut 600 full-time positions in addition to the 6,350 layoffs it announced last month in a move that will likely have little effect locally. Wachovia also said Tuesday that its second-quarter loss has been revised to $9.1 billion from $8.9 billion.

Wachovia also will cut 4,400 open positions and contract workers. It announced those cuts — along with the elimination of 6,350 full-time workers, mostly in mortgage-related posts — on July 22.

But Wachovia is a bank on the run, and it moves like one. The wonderlandish moves of desperation make no sense on the surface, but make no mistake, the appointment of a CEO who knows nothing about banking makes us think each quarter could be Wachovia’s last:

The bank’s appointment of Paulson’s right hand man, Robert K. Steel, demonstrates the bank’s acute awareness that survival depends on playing by the Streets rules. The gutting of Bear Stearns showed everybody that the only way out is the Street’s way: bribery, kickbacks and connections.

The choice of Steel strikes some analysts as interesting, given that Wachovia had hired Goldman to analyze its loan portfolio and “evaluate various alternatives.”

Wachovia’s troubles stem not from management, but from it’s model:

“This company’s mantra was grow, grow, grow,”

And so begin the well-chronicled adventures of Wachovia: the Alt-A whirlpool; taking advantage of older customers; cutting corners on loans; having to restate losses; the expansion of the above-mentioned ARS investigation, possibly into a drug-money laundering scheme; and the oxidation of Golden West, which any double-digit IQ knew was a bust from the start.

When the list of the 19 “Protected Ones” was made public, the reality was stark. Wachovia wasn’t on the list, so they don’t get to play this time. That’s probably when the call went out to Paulson… and Steel magically appeared.

Some are surely comforted by Steel’s stellar record, but the model is the same: grab, grab, grab. They are yodeling this mantra with their distressed commercial loans.

In September 2006, Wachovia arranged a $285 million loan for Latrobe, Penn. -based drinks maker Le-Nature’s Inc.

The bank then sold the debt on to investors including Philip Falcone’s $20 billion Harbinger Capital hedge-fund firm and the Missouri State Employees’ Retirement System.

Roughly 60 days after the loan, Le-Nature’s was bankrupt. The company was later found to have fraudulently inflated revenue by about 10 times, according to federal prosecutors.

Harbinger, Missouri and other investors sued Wachovia, claiming the bank knew about Le-Nature’s problems, but went ahead with the financing anyway. The fee of more than $7 million was alluring and the deal helped Wachovia in its goal of becoming a major player in the junk-bond market, the suit alleges.

And there it is again: fees, fees, fees. But oh wait! There’s a much much bigger problem:

But Wachovia also has more than $200 billion in commercial loans that could trigger even more losses if the U.S. economy slides into recession, according to Cassidy. “This is more frightening to me because it’s bigger,” he said.

Can Wachovia wiggle enough to get bailed out? Who knows, but the model and the company cannot survive together. You see, Wachovia’s model is simply a raid on assets.

The private equity model of stripping assets is finally on the deathbed. There is not going to be easy money for pirates to borrow to continue to loot companies, soak them debt, pay themselves handsomely, only let the companies they buy rot in a death sentence.

Whether Wachovia survives or not, it will be the small shareholders who get sacrificed. Here’s a prediction: just after the insiders jump ship, we will hear some really bad news.