Tough enough to take a few punches.

The words "chargeoff" and "Wachovia" hardly ever appear in the same sentence. This year they did. CEO Bud Baker offers some reasons why

For years, Wachovia Corp.--the $72-billion-asset king company with headquarters in Winston-Salem, N.C. and Atlanta--was banking's fair-haired child.

With its legendary credit culture, pragmatic growth philosophy and respectable earnings, Wachovia stood as a role model of stability in a not-so-commonsensical competitive environment. Deflecting criticism that it was perhaps too conservative in what pundits dubbed an "increasingly fast-paced, global economy," Wachovia maintained a steady course throughout the late 1990s, earning good marks in a variety of industry performance rankings. While other peers stumbled in the execution of overly ambitious expansion and re-engineering initiatives, Wachovia appeared to be on track.

But the year 2000 would yield a host of challenges. Credit quality cracks began surfacing at a number of banks, thanks to a changing interest-rate climate and economic fluctuations, among other factors. Sensing deteriorating credit on the horizon, Wachovia announced in June a $200 million additional loan loss provision to increase the loan loss reserve. Simultaneously, it said that earnings for the year looked doubtful, with respect to meeting investor expectations, thanks to revenue weakness in non-interest income areas tied directly to financial markets. The market reacted swiftly to the news, as Wachovia stock dropped around 19% that day. (As of Nov. 20, it was trading at 48, a tad over its 52-week low of 47.) Then in August, the bank announced it would eliminate 1,800 jobs--almost 8.5% of its work force--as part of its ongoing Performance Project, designed, in part, to reinvigorate profit growth. Third-quarter earnings, released in October, further underscored pervasive credit issues. Excluding merger cos ts and restructuring charges, Wachovia's earnings were up around 4% to $270.2 million, or $1.32 a share. Including the charges, the bank earned $205.3 million or $1.00 a diluted share, in the third quarter. That compares with reported net income of $257.5 million or $1.25 a share a year ago. Throughout Wachovia's third-quarter conference call, analyst questions remained focused on asset quality.

"Credit, credit, credit--that's the story at Wachovia right now," says Marni Pont O'Doherty, a Keefe, Bruyette & Woods analyst in New York. "Nonperforming assets rose $163 million linked-quarter and net charge-offs also spiked linked quarter. As predictive models are recalibrated in what is a rapidly changing environment," she added, "more lumpiness in NPAs and charge-offs will likely be in the offing."

"I think what has happened at Wachovia recently is what happens to many banks," says Nancy Bush, a senior vice-president at Prudential Securities. "They go by their past experiences in understanding credit risk."

Despite the effect of "rising rates and a slowing economy," Wachovia chief executive officer Leslie M. "Bud" Baker says that Wachovia showed good growth in operating earnings in the quarter and that the company is continuing to aggressively manage credit risk. "In recent months, we have made difficult but necessary decisions that are on track to lift earnings and position Wachovia for the future," Baker asserts.

The adjustments did not subdue the company's measured acquisition strategy. In October Wachovia announced the acquisition of $3.4 billion-asset Republic Security Financial Corp., West Palm Beach, Fla.

Wachovia also made headlines this year regarding its management team. Most compelling was the September announcement of 55-year old President and Chief Operating Officer G. Joseph Prendergast's retirement, slated for Jan. 1. No new president was named, but 42-year-old banking division head Stanhope Kelly and 44-year-old chief technology and operations officer Jean Davis will assume expanded roles.

Many analysts say the changes have more to do with Wachovia's tradition of grooming new leaders than any reaction to a challenging year. Baker's contract as CEO runs to 2004.

Tougher to be excellent

While some contend that Wachovia may have relied too much on past successes in understanding risk, others argue that Wachovia' s recent experiences stand in testimony to the magnitude of change confronting financial services competitors today. In a broader sense, Wachovia's challenges may also reflect the impact of an evolving economy whose fundamentals may be more elusive to grasp than in the past. And while the contemporary asset-quality issue isn't exclusive to Wachovia the bank garnered attention because it was Wachovia.

But Baker says Wachovia has never been the type of company to "tuck away problems from an accounting standpoint," and that it moved expediently.

"We' re in an environment where excellence is increasingly hard to achieve and difficult to maintain," Baker asserts. "When we sensed that something was changing in the economy and in our credit circumstances, there was never any question regarding how we would handle the situation--honestly and in a forthright manner. Our practice has been and continues to be to identify problems early and to take aggressive action to mitigate risk. That's a part of the fabric of our company."

Pundits have argued that credit cycles of the past were dead, but Baker asserts that Wachovia never subscribed to that notion. "We have believed throughout that the basic factors historically causing companies to encounter difficulties still exist. Some of these factors include rising interest rates and a concurrent slowdown in demand following a period when balance sheets have taken on leverage," Baker says.

However, Baker believes there's much more going on. He says that technological innovations are radically altering the business process, as well as global manufacturing and marketing. Because challenges do not impact just one segment of the economy, it is more difficult to anticipate and isolate problems.

"Balance sheets that were audited and looked strong last year by traditional measures have been undermined because a competitor bought new technology, rendering the company's business process obsolete," Baker says. "Conversely, some companies attempted to employ innovative technology, but lost control of their businesses. Some companies with premier consumer brands are finding that growth is tied to demographics and the accompanying customer base is not growing.

"In reality," Baker continues, "corporate lending is an art, not a science. Modeling, with all of its exciting possibilities, still gives only a partial answer when applied to commercial risk. Professional human judgment is necessary and appropriate."

Building a "wealth" franchise

Although Wachovia's 2000 credit experience has been out of sync with its track record, Baker says he believes that the bank is making progress in several lines of business, including wealth management and consumer banking. Further, Wachovia possesses several key competitive advantages. Geographically, its franchise is located in attractive economic markets. Wachovia's home states--North Carolina, Georgia, Virginia, South Carolina and Florida--are projected to grow more than 50% faster than the national average and include the top three states in the eastern United States. Significantly, Wachovia ranks first or second in market share in several attractive MSAs, including Atlanta; Winston-Salem/Greensboro, N.C.; Richmond, Va; Raleigh/Durham, N.C.; Greenville, S.C.; and Charleston, S.C.

The company has carved an enviable niche in asset and wealth management services, with more than $125 billion in assets under administration, including more than $50 billion of assets under discretionary management. Two distinct business models serve the needs of the affluent consumer across Wachovia's footprint. Private financial advisor sales teams provide integrated wealth management in key markets. The teams comprise financial advisors and specialists in financial and estate planning, investments, credit, and insurance. Brokerage, mortgage, business banking, and capital markets experts provide additional support to the sales teams.

The 1999 acquisitions of OFFITBANK Holdings, a New York-based wealth management company, and Barry, Evans, Josephs & Snipes, an insurance broker with a national presence, strengthened Wachovia's wealth management capabilities and expanded its foundation for providing these services.

The April 1999 acquisition of Interstate/Johnson Lane, a major regional brokerage firm, enhanced Wachovia's brokerage business model. IJL's 450 financial consultants in 62 offices complemented Wachovia's 150 branch-based investment consultants.

Baker says that Wachovia has significantly refined its business model for serving affluent and high-net-worth clients in recent years and that a great deal of potential exists in Wachovia's own system. "Resident within Wachovia's retail bank are 400,000 households classified as affluent. Currently, 40,000 of those are being served by our wealth management business. These are customers. They are not distant prospects. Experience has shown that we can move appropriate households to the wealth management business, enhance household profitability and better serve customers."

Prudential Securities' Nancy Bush sees Wachovia's emphasis in wealth and asset management as positive, providing the company with greater diversification.

Wachovia has also earned a reputation over the years as a leading corporate bank, with more than 28,000 business relationships and global activities in 40 countries. Wachovia has also won several awards for excellence in service and relationship management in the treasury services areas and in May, the company received highest possible award from customers in the Phoenix-Hecht Cash Management Survey. Despite current market conditions, Baker believes that corporate banking activities will continue to represent significant areas of opportunity for Wachovia in the future.

Making a performance culture

It's not enough these days for banks to deal with changing external conditions, they must also address internal operations and dynamics. In 1999, the Performance Project was started within Wachovia, designed to advance an evolving performance culture -- a culture that emphasizes the critical importance of designating and executing performance goals. Baker says the project is multi-faceted and aggressively pursues revenue enhancement, productivity gains, resource allocation improvement and expense reduction throughout the company.

"The Performance Project has three overriding purposes in mind -- to provide a lift to earnings in anticipation of moderating economic conditions, to provide flexibility for investment in new initiatives, and to give our people exposure to issues involving performance and prepare them for the challenge of the world ahead," Baker states.

The annual pretax earnings lift from the performance and cost project will be $425 million when fully implemented by the end of 2002, the company estimates. Roughly one-half of this benefit represents revenue enhancement.

Even though Wachovia enjoys a presence in vibrant geographic markets and has earned a strong reputation in several lines of business, Baker says that companies like Wachovia must continue to work towards aligning capabilities with customer interests, while excelling in delivery and execution.

"In order to grow in the world we see moving forward, it will be necessary to be in good markets. It will be important to directly link products with critical areas of customer interest. But it will also be imperative to be precise in going to customers at their point and time of greatest need. Strategic agility will be an essential corporate skill."

Karen Kahler Holiday, a freelance writer based in Belden, Miss.