WaMu: The Next K-Mart?

Includes: JPM, SHLD, WMIH
by: Troy Racki

On Monday the fight over Washington Mutual (WAMUQ.PK) remained intensified as the debtor’s counsel of Weil, Gotshal and Manges fired back a rapid response aimed squarely at shooting down the estate’s recently formed equity committee. In their motion to disband, the debtor’s counsel revealed – for the first time – that WaMu’s debts could surpass $50 billion making hopes of any recovery for the equity, “extremely remote.”

The filing is yet another punch thrown in the battle over whether or not the WaMu estate, which is currently in chapter eleven, should have an equity committee. For the last sixteen months the equity had been denied a seat at the bargaining table because the US Trustee, Roberta DeAngelis, did not see the need for one. Spurned retail investors responded by forming an ad hoc committee that campaigned on the internet, eventually leading to a petition of over 3,500 signatures that represented some 100 million common shares in the company. The Trustee eventually complied when it was revealed that the estate could see an additional $2.6 billion in tax refunds because of new stimulus law.

In the weeks prior to the announcement of an equity committee, senior bonds in WaMu’s holding company, Washington Mutual Investments, steadily climbed. On January 5th they reached a high of 101.5, a startling premium to pay for any company in bankruptcy. Questions on a Yahoo message board began to erupt as to why. One theory seemed to make the most sense, and still does; that WaMu’s bondholders will attempt to pull a blue light special on its equity.

In 2002 K-Mart entered chapter eleven due to struggling sales from fierce competition and alleged fraud by its management. Investors holding the stock believed for a time that they would see some recovery in part because of K-Mart’s extensive real estate holdings. Bondholders on the other hand had other ideas and issued a reorganization plan that jettisoned the equity. As part of the company’s reorganization process the bondholders forgave K-Mart’s debt in return for complete ownership of the new company. In 2003 K-Mart reemerged and saw its shares climb dramatically, gaining over 250% in the first year alone. Eventually K-Mart was purchased by Sears Holding Corporation (NASDAQ:SHLD).

Can WaMu’s bondholders attempt the same and if so, what’s in it for them?

The theory currently proposed is that bondholders could reorganize the estate and drop the equity after which they would continue to pursue their litigation alone against JP Morgan (NYSE:JPM) and the FDIC. Without an equity committee any recovery from such litigation would not have to be shared. So how much is currently at stake? If the bondholders of WaMu’s $4.1 billion in senior debt were able to capture the entire current estimate of $20.55 billion in assets they could stand to make a 500% return.

Will the equity really be cancelled?

If the reality is that the holding company truly owes $50 billion then its very likely equity will be cancelled. But if $50 billion is an accurate representation of WaMu’s liabilities, why then does its senior debt currently trade at 99? Shouldn’t it trade much lower? With possible assets of $20 billion and possible liabilities of $50 billion, shouldn’t senior debt be trading for less?

It looks like it’s up to the judge to figure this one out. Her final ruling in regards to the equity committee will come on Thursday.

Disclosure: Author holds a long position in WAMUQ.PK