Washington Mutual Inc.
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By Indyvestor
November 15, 2007

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Anyone who can invest the time to listen to the four hour replay of Wamu's Investor Day will be rewarded with a lot of good information.

Some interesting things I noted:

1. Wamu has $5.1 billion of subprime loans of 2006 & 2007 vintage with LTV ratios at origination of more than 80%. This is where they expect to have most of their problems. Average estimated current LTV for 2004 & prior loans is 57% & for 2005 loans, it's 69%. 68% of WM's subprime mortgage portfolio is fixed or has already experienced initial reset. $0.5 billion are experiencing reset in the fourth quarter, and $2.5 billion will experience reset in 2008. Another $1.8 billion will experience reset in 2009, with another $1.5 billion experiencing reset in 2010. This is out of $20 billion of subprime loans in total.

2. The other major area of concern is home equity loans which are second liens. Here, there are $11 billion of loans with LTV at origination of more than 80%. Average estimated current LTV for 2004 & prior loans is 52% & 67% for 2005 loans. (These are second liens only.) Average FICO score at origination for all second lien home equity loans is 727, with little variation across vintage years.

WM commented that subprime loans & second liens, when they go bad, are likely to be 100% write-offs. This will continue as long as we have a liquidity crisis. Once the liquidity crisis passes, homeowners will again be able to avoid default through refinancing and quick sale.

3. The crown jewel at WM is its retail banking business. Given the stable deposit base from that business, Wamu has no concerns about liquidity. Also, that deposit base is generating fee income growing at 12% to 15% per year. Operating income is the first line of defense for a bank. Wamu is generating a run rate of about $5 billion of pre-tax income from operations other than home loans, mostly from retail banking. Moreover, Wamu expects to continue keeping it's expenses flat. So 12% to 15% growth in fee income is dropping straight through to the bottom line.

Even considering the possibility of problems in the credit card operation, Wamu has a lot of income, independent of mortgages, against which to provision for loan losses before there are losses and capital begins to become impaired.

4. Assuming the Fed reduces the fed funds rate to 4% by June, 2008, Wamu projects increased net interest margin for 2008, which will generate an additional $1 billion of pretax income. If the Fed doesn't reduce the fed funds rate at all between now and then, an additional $850 million of pretax income is projected. This provides capacity for additional write-offs of loan losses in 2008, as needed.

This projection assumes normal LIBOR spreads are restored, which they will be sooner or later as the liquidity crisis subsides.

Additional income from mortgage servicing rights is also projected, since homeowners are unable to refinance mortgages. Prepayment rates are down a lot temporarily due to the liquidity crisis.

5. The plan for 2008 is to open 100 to 150 new retail bank locations, up from 75 to 100 in 2007. As usual, the cost of opening these new locations is being expensed against current income, and will be financed by expenses saved from downsizing the mortgage operation.

6. Factoring in all of the above, Wamu projects return on assets in 2008 at 50 to 70 basis points, versus a norm of 100 basis points or more. The lower end of that range would be sufficient to cover the current dividend.

7. Given the current stock price, stock repurchase has been elevated to the same priority as maintaining the dividend, ahead of expanding the balance sheet.

8. Wamu has $3 billion of excess capital over and above the provision for loan losses.

9. The Board has no plans to look at the dividend before the regular meeting in January. It's understandable that Wamu is giving no assurances about maintaining the dividend, as they would be creating litigation risk if they did.

10. SIVs and other financing vehicles created by Wall Street created an oversupply of capacity in the mortgage lending business. Wamu estimates there is still about a 30% oversupply. As these vehicles blow up, oversupply will subside and the mortgage business will become concentrated among a few banks with loan underwriting practices being more sound than they have been. Wamu expects to be one of the beneficiaries.

Wamu is sourcing more and more of its mortgages from its retail banking operation, and will source a bigger percentage from there as time goes on. Meanwhile, it is shutting down sources of mortgages where it has less control, such as correspondents and wholesaling. The current crisis gives Wamu the market flexibility to do this. With their retail banking growing at 12% to 15% per year (doubling every 6 or 7 years), they will have a growing capacity to source loans through their own distribution system.

Interesting stuff!