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Some aren't buying it. "It's curious," says one close observer, referring to Thompson's firing. "Something caused the camel's back to break." The expectation of worse to come for a bank hurt badly enough by mortgage market woes, especially after buying mortgage originator Golden West Financial Corp. for $25 billion at the top of the market in May 2006, is understandable. After all, market bottoms that were suddenly not bottoms at all have caused a continuing crisis among financial institutions that still hasn't ended. Wachovia's shares have been particularly hard hit, falling more than 50% over the last year, closing on June 3 at $21.92 a share. A year ago, the stock was trading at around $54. One banker says it's unlikely Wachovia's board knows something investors don't, considering how Smith was careful to say the firing came as a result of "previously disclosed disappointments." One looming issue, however, may have been the proverbial last straw. Specifically, Wachovia could be on the hook for a substantial payout to Prudential Financial Inc. as early as July 1. That's when Prudential can exercise its right to put back to Wachovia its stake in a joint venture it formed with the Charlotte, N.C., bank in February 2003. Under terms of the agreement, Wachovia has one year after Prudential exercises its put option to pay back the insurer in cash, Wachovia stock or a combination of both. Newark, N.J.-based insurer Prudential and Wachovia merged their brokerage forces, calling the new entity Wachovia Securities Financial Holdings LLC, with combined assets under management of $537 billion. At the time of formation, Prudential held a 38% stake in the new business, while Wachovia had 62%. Prudential's stake, however, was diluted when Wachovia acquired brokerage A.G. Edwards Inc. in May 2007 for $6.8 billion. In its most recent quarterly earnings report, Wachovia noted that the acquisition diluted Prudential's position to about 23%, although the precise reduction won't be known until the companies complete a post-A.G. Edwards valuation of the business. Also unclear is the exact value of Prudential's stake, although Pru states in Securities and Exchange Commission filings that it has the ability to put the stake back to Wachovia at "fair market value." One investor estimates the value of the stake at about $5 billion, but a Wachovia spokeswoman would not confirm the number, adding that a final valuation would depend on both Wachovia and Prudential completing third-party audits of the brokerage business and averaging the two results. Complicating matters is that as part of the A.G. Edwards deal, Wachovia gave Prudential a "look-back option" that allows the insurer, as of October 2009, to decide whether to contribute money, at October 2007 valuations, to the joint venture, to return its stake to the original 38%. One banker says the look-back option is very valuable to Prudential because it enables the insurer to wait until 2009 to decide on whether to cash out of the joint venture or buy into it at relatively low valuations, assuming the brokerage operation continues to perform. According to Wachovia's first-quarter earnings report, brokerage operations registered revenue of $2.2 billion, resulting in a net profit of $445 million. Assets under management totaled $1.1 trillion at the end of March. "[Prudential] probably won't do that [exercise the put] unless it needs the money," the banker says. The Wachovia spokeswoman said there's been no indication from Prudential that it would exercise its put. Prudential did not return calls. The insurer, however, doesn't seem to need capital. According to Reuters, Prudential CEO John Strangfeld said May 29 that the life insurer likely won't see losses from its securitized mortgage portfolio rise above $400 million over the next five years and the company was headed for double-digit earnings growth, percentage-wise, over the next few years. -- Vipal Monga See related story: Wachovia board ousts CEO Categories Deal Video
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