WaMu Junior Debt Recovery Becoming Unlikely

Includes: DIMEQ, WAHUQ
by: Troy Racki

Washington Mutual junior debt holders (OTC:WAHUQ) exhaled a little after federal bankruptcy judge Mary Walrath denied a long standing claim raised by Dime Savings Bank (OTC:DIMEQ) warrant holders which would have resulted in a $337 million dollar general unsecured claim were it approved. The possibility of such a massive claim against the estate drove junior debt shares down to just a 3 percent recovery in the days prior to the ruling. Shares then surged upwards some 90 percent after the claim was denied and relegated to common equity. A settlement between WMI and DIMEQ later followed, paying DIMEQ $9 million and granting them a subordinated claim of $10 million as well as 2.631% of the reorganized company's shares.

Not every ruling went Washington Mutual's way, however. The judge also upheld a $49.6 million general unsecured claim by Tranquility Master Fund which holds WaMu and WMALT Trust Certificates. WaMu had attempted to subordinate Tranquility to a lower class not likely to see any recovery and projected the claim as such in their liquidation analysis. While the Tranquility claim is currently on appeal, given the direction other appeals have taken in the WaMu case, the judge is unlikely to change her mind. Consequently the $49.6 million will likely come directly out of recoveries otherwise destined for WAHUQ shares.

A Flawed Liquidation Analysis

WaMu's liquidation analysis also failed to anticipate the possibility of continued intercreditor interest levied against junior bondholders while the estate continues to liquidate assets not destined for the reorganized company. Approximately $592 million of assets marked as cash will not be immediately available for distribution as they are pending litigation or sale. WaMu projects that it could take up to six months for the liquidation trust to mobilize these funds, resulting in approximately $22.9 million of additional intercreditor interest, assuming a blended rate of 7.75%.

As if this was not enough, WaMu's liquidation analysis then failed to recognize that still $464 million in disputed claims exist against the estate, of which only a $375 million reserve has been established. This leaves the possibility of another $88 million that WAHUQ debt holders may be on the hook for. In all a recovery for the class is beginning to look more short than long.

Debtor's Anticipated Recovery: $94.0M
DIMEQ Settlement: ($9.0M)
Tranquility Claim Loss Projection: ($49.6M)
Liquidating Trust Interest Projection: ($22.9M)
Class 12 Reserve Best Case: ($0.0M)
Class 12 Reserve Worst Case: ($88.4M)
WAHUQ Projected Best Recovery: $12.5M or $.54/share
WAHUQ Projected Worst Recovery: ($75.9M)

Some of WAHUQ's holders are not going down without a fight however. Whitebox Partners LP filed an objection on behalf of the group arguing, in part, that the Rule of Explicitness should overturn paying up some $600 million in intercreditor interest. Other parties have argued that the Absolute Priority Rule should preclude lesser classes from receiving any recovery when junior debt shares are receiving none of their $54 million in post-petition interest.

However given the direction this bankruptcy has taken it is unlikely Whitebox's objection or absolute priority will be upheld. Kevin Starke of CRT Capital Group wrote investors in December that, "...it would be warranted for such parties to object that this plan violates the absolute priority rule. Unfortunately, by ordering mediation, Judge Walrath seems to have set up precisely the outcome we now have before us, no matter how much it offends our sensibilities."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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