FBR analyst Paul Miller has reinstated coverage of Wachovia (WB) with an Underperform rating and $12 target. Miller thinks that the worst of Wachovia’s woes are still ahead and that the lender’s California option ARMs are a ticking time bomb counting down to a massive write-down:
Yesterday, we reinitiated coverage of Wachovia Corporation at Underperform with a $12 price target, equal to 16.0x our 2009 operating EPS estimate of $0.75, 1.0x 2Q08 tangible book value of $12.34. Wachovia’s outsized exposure to residential real estate and, more specifically, its California option adjustable-rate mortgages (option ARMs), should result in higher credit costs than the Street anticipates, which should drive earnings and valuation lower over the next 12 months.
Miller thinks that charge-offs won’t peak until 2009 or 2010, and that a deteriorating economy will continue to take its toll:
Our macro view is that industry charge-offs will not peak until late 2009 or early 2010. We expect that Wachovia’s stock will trade lower as losses continue to grow, and that near-term valuation will be driven by expected losses in Wachovia’s option ARM portfolio. A weakening economy poses further risk to Wachovia’s commercial loan book.
But don’t worry, there is some good news. Miller thinks that, despite its troubles, Wachovia will survive:
Over a longer time horizon, we believe that Wachovia will be a survivor and will gain market share
through the current cycle and emerge as a stronger company. Many of Wachovia’s businesses are doing well, and its strong deposit base and diversified revenue sources should make Wachovia a long-term beneficiary of current market stress.
See Also: The Next Mortgage Bomb: Option ARMs
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