Stock of the Day
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Washington Mutual (WM)
Will WaMu Be Bailed Out?
Washington Mutual became the latest victim of the subprime mortgage mess late yesterday afternoon. The nation's largest savings and loan association (S&L) by market value announced that defaults in its subprime mortgage portfolio are worse than expected and it is taking a laundry list of measures including a massive dividend reduction, job cuts and emergency financing to get through this situation in one piece. WaMU is just another bank in the long list of financial institutions that have been burnt in 2007 by subprime mortgages. And just like the others before it, it has shown all the classic signs of being in trouble - overzealous exposure to one segment of the mortgage market, underestimation of losses and potential write-downs, stunning announcement of larger than expected losses, emergency financing and rumors about a CEO in trouble. WaMu's stock has lost about 6% since the announcement after close of trading yesterday and is down 60% this year. This has predictably given rise to the takeover talk? So is that the road Washington Mutual is traveling down and if so, will that provide the stock with some sort of a floor?
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| Stock Analysis |
Washington Mutual grew rapidly during the earlier part of the decade fueled in large part by acquisitions which propelled it from an obscure S&L thrift to a nationally recognized financial institution with assets totaling about $486 billion (according to the Wall Street Journal). Also, as the Journal points out today, lackluster growth in the middle part of the decade partly due to poorly managed expansion of operations was one of the reasons that CEO Kerry Killinger decided to take some bold initiatives to keep the gravy train on track, so as to speak. Unfortunately for WaMu, one of those initiatives included a greater focus on originating loans to borrowers with weak credit - i.e. subprime borrowers. WaMu looked around and saw that almost every financial institution was making substantial amounts of money in the mortgage market by originating such loans and trading in them. As former Citigroup CEO Chuck Price once said, the music was playing and everybody was dancing. WaMu was just one of the dancers.
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And now the company has to deal with the fallout from all its adventures in the subprime mortgage market. For a few months this year, WaMu tried to convince the street that its exposure to these mortgages was well contained but a month ago, the Seattle based bank said 2007 credit losses would be in the $2.7 to $2.9 billion range, almost double its earlier predictions. And yesterday brought more bad news. WaMu announced that the fourth quarter dividend is going to be cut to 15 cents from 56 cents, it will completely exit the subprime mortgage business and eliminate about 3150 positions. It will also raise $2.5 billion in fresh capital by selling preferred stock. Also, there is speculation that Mr. Killinger will be shown the door soon and one major shareholder has already blamed him for the poor management of the subprime mortgage business.
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So what does WaMu's short to medium term future look like? A number of analysts believe that WaMu is now a takeover candidate and that the company's retail banking business (which is still doing well) makes it prey for someone like JP Morgan who has a CEO that has been suppressing his well-known acquisition appetite recently and who has been largely insulated from the subprime mortgage meltdown. But the chances of a deal taking place have to be slim. The bottom in the mortgage market has not been reached yet and hence, we continue to see a wave of write-downs. The pricing of mortgage backed securities remains fluid and all signs point to further deterioration in this space which means prices will have to be adjusted further down and more write-downs will be forthcoming. The pain is not over and JP Morgan knows that. Hence, they will like to stay away from WaMu's credit portfolio as much as possible. Can a deal be done which involves just WaMu's retail operations? It's possible but not likely. Also, one has to believe that before WaMu decided to sell preferred stock and raise emergency funds; an act which is dilutive for current shareholders, the company explored other avenues for financing and opportunities for acquisitions. If the feelers put out at that time were ignored by JP Morgan, why will they be answered now?
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