Is Washington Mutual About to Explode?

You think you've had a rough first week on the job? Talk to Alan Fishman. After just three days as the new CEO of Washington Mutual (NYSE: WM  ) , shares have tanked by some 60%.

And perhaps for good reason. An ill-timed venture into subprime has left its books looking like they just got hit by a nuclear bomb. Last quarter, net charge-offs came in at more than 3.5%, escorted by a $3.33 billion loss and a supernova of loan loss provisions to nearly $6 billion. Nonperforming loans make up 3.62% of total assets, which is equivalent to holding a hand grenade with a loose pin. At the end of last quarter, it held more than $60 billion in home equity loans and lines of credit -- which stand behind secured mortgages that are in the pits as well.

And investors? They hate it, too.
The cost to insure WaMu's debt -- called credit default swaps -- surged to 40 percentage points. That means it costs $4 million upfront plus $500,000 a year to insure $10 million of WaMu debt for five years. Translation: The derivatives market, if not predicting (dare I say it) bankruptcy, is looking for an absolutely abysmal future.

So where do we go from here? First, we'll start with the reasoning that WaMu has to do something. And soon. Waiting around while the market works itself out isn't an option. Ask Bear Stearns. In the coming quarters, one of three things could happen: WaMu gets bought out, it raises a mountain of new capital, or it goes kaput. The third option is grim and, admittedly, pretty far out there. So what about the other two?

Deal or no deal?
A couple of interesting points arise. JPMorgan Chase (NYSE: JPM  ) expressed interest in buying WaMu back in April. That deal never went anywhere, but at least it shows that a reputable name expressed some form of interest. I'd venture to guess that JPMorgan isn't interested anymore. Being rebuffed once is probably enough when so much due diligence is required before making an offer.

What about other banks? That's where a handful of dilemmas come up. WaMu is huge, with well over $300 billion in total assets. Very few banks could conceivably inherit that large of a portfolio. Moreover, the banks that could buy WaMu -- Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , perhaps Citigroup (NYSE: C  ) , and maybe even Wachovia (NYSE: WB  ) -- all have their own problems to work out. Bank of America and Wachovia, for example, both have huge exposure to risky subprime and adjustable-rate mortgages already, so why double down?

Yes, a buyout could happen, but seeing one happen in the near future seems like a long shot.

Plan B. And it's ugly.
So if a buyout isn't in the cards, what other options does WaMu have? Well, it can raise capital. To be sure, management doesn't have any current capital-raising plans, as far as we know. But here's the thing: WaMu is nowhere near out of the woods. Lehman Brothers (NYSE: LEH  ) now predicts that home prices will fall 32% peak-to-trough, with California (where WaMu is heavily invested) falling 50% -- around double the current decline. It's preposterous to think that in the coming quarters WaMu won't be required to reload its coffers as home equity loans and subprime mortgages go up in smoke.

The problem is, with a current market cap of just above $3 billion at WaMu, raising any significant amount of new money would dilute existing investors on an unprecedented scale. Heck, back in April, shareholders stomped their feet over a $7 billion infusion -- and that was when shares traded at five times their current value. It's a weird phenomenon, but because of concerns over raising capital, as long as shares stay low, shares are, well, going to stay low.

The long road ahead
My guess is that WaMu will still be around next year -- there's no reason to believe that an all-out failure is around the corner. Still, as Freddie and Fannie learned this week, it's entirely possible for a business to keep going while common shareholders get hosed.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 13, 2008, at 9:12 AM, mcdmario1 wrote:

    A few points about the article. One in reference to Wamu, this past week they undertook a grass roots campaign that was on the desperate side, offering way above market rates to depositors in hoping of quickly filling in the hole on the balance sheet. When a bank can borrow from other banks at LIBOR and they start throwing at rates that don't make sense, typically liquidity is a concern.

    Secondly, you the article sited Bank of America as a bank with substantial esposure to sub-prime. This is not true. BofA, stayed out of the subprime markets. They did not write subprime loans. Their subprime exposure is not akin to Wachovia or even in the same universe and limited to a few trading losses.

  • Report this Comment On September 13, 2008, at 10:08 AM, TMFHousel wrote:

    mcdmario1,

    Thanks for your comments. Bank of America acquired Countrywide earlier this year, which brought subprime and Alt-A mortgages onto its books.

  • Report this Comment On September 14, 2008, at 11:53 PM, michaelbraxton wrote:

    My mother has her IRA at WAMU Investments, Inc. a Washington Mutual sub. Should we move it? Can we move it without liquidating ? Its 1/3 cash (Principal Investors Money Markt) - 1/3 Principal Investors Equity Fund - and 1/3 in a Franklin Fund. The cash and the Prin Fund are WAMU related. Can we move them?

    Help

  • Report this Comment On September 15, 2008, at 11:56 AM, scmpa40 wrote:

    Should those of us that have mortgages owned by WaMu be worried?

    If yes then what can I do to protect myself?

    Thank you.

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