With Countrwide "Contained," Is Washington Mutual Next?

Miracles do happen.

The Plunge Protection Team er, The President's Working Group on Financial Markets meets, and not even a week later we have a bid for Countrywide (CFC). The timing is almost amazing, isn't it? Oh, to be the fly on the wall during that conversation.

I wrote this on a message board Thursday night:

Call me a conspirasist but I think the govt is doing this. Citi can't do it, so BAC is 2nd largest, absorb this piece of (edited for language! haha) and we'll make sure you are ok on the other side.

Now we need to find someone to buy WaMu and then we have about 40% of the U.S. mortgage market "saved."

• • •

Here is the reality, a Republican administration does not want to be seen bailing out a leading financial institution with tax dollars. Additionally, a CFC bankruptcy would of caused serious panic as I believe it handles about 20% of the country's mortgages. It would kill confidence. Rightly or wrongly, the sharks have been circling Countrywide, and many bankruptcies are accelerated by lack of confidence. Vendors stop sending product to a manufacturer because they are afraid of not getting paid back, bank lines of credit dry up, and it feeds on itself. This is the scenario that has been playing out with Countrywide.

The facts on the ground, are that 7% of Countrywide loans are now delinquent, which is up from 5% a year ago, and foreclosures have almost doubled. And that's coming off a "great" 2007 in the economy. These don't sound like huge numbers, but again we are just ENTERING the real credit mess, most of these two-year ARMs are just now jumping (and will be continuing to do so throughout 2008). People will try their best to pay for a few quarters (or use credit cards to pay mortgages), but eventually, they will succumb, and lose their homes.

The height of defaults will probably hit about a year from now and into 2009. Countrywide won't last that long. 9%, 11%, and 13% delinquency rates a year from now would be a nail in Countrywide's coffin. They are dependent on new funding and its lines of credit would dry up. (One could argue that the company still has its bank deposits, but did you see the lines at Northern Rock once panic hits?) ["Northern Rock Drops 30% Today"]

So what do we have here instead? We have one of our stronger banks, Bank of America (BAC) buying a company on life support, and with the implicit backing of the government. Trust me, the government will be helping Bank of America on the back end, "behind closed doors," because these loans are like asbestos. They have huge future unknown liabilities. Would anyone buy a company with asbestos exposure in the 1990s, knowing the huge future liabilities? No. But if you have the government doing a behind the scenes bailout for you, it gives you entry into the mortgage market, a 20% share, and you have a balance sheet that is good enough to live through the next few years, and then when we come out of this in 3-4 years you have a dominant position in a great long-term business (mortgages).

Alone, Countrywide wouldn't make it through another year, not to mention the 3-4 years. Keep in mind that a year ago, Bank of America was in talks to potentially acquire CFC when it was in the $40s. And at that time they paid around $2 billion when it was around $18 in August. So to get the franchise for under $7, with a $4 billion price tag is nothing. $4 billion? In the financial world these days, companies write that amount off every month.

The other dog is Washington Mutual (WM). I am sure the same arrangement will be made for an implicit behind the scenes, government bailout of whomever takes over WM. It won't be Citigroup (C) since the company itself is in such a bad situation, but it will be one of the top 5-7 banks like a Wells Fargo (WFC) type who actually ran its business reasonably well (again, it's all relative), and has no SIVs or off-balance sheet junk. And in the long run it will strengthen its business just like the situation with Bank of America. But you need to be strong enough financially to weather the next 1-2 years to get out "the other side." Maybe it's next week, maybe it's next month, but within 6 months I would expect WM to be taken out.

As investors we won't have to hear about this issue day in, and day out. From that perspective, it's 'containable. About 35%+ of our mortgage market will go from "weak hands" to "strong hands" (those who can handle asbestos exposure for the next few years), and the needed write downs on this portfolio can continue in the background - and your U.S. tax dollars can make sure it all works out well in the end.

From a stock market perspective, this is a win as these 2 dogs won't be the underpinnings of angst on a daily basis. From a "free market" perspective, it's laughable.

Comments

[Pj568:]

Too early for WaMu to be next as then have't had a crisis event yet and remain overvalued. Maybe when the price drops by half.

2008 Jan 14 02:18 PM

[NoLongerAWA...:]

Good riddance WAMU. The EXECUTIVE MANAGEMENT TEAM SHOULD ALL BE FIRED!!! I am a former employee from the appraisal department. The entire appraisal department was eliminated, seen as "holding up" making loans. The Credit Execs used to hold up the "Countrywide Model" as the goal WAMU should attain. How about KILLINGER'S head on a plate? Alas, he and his backslapping execs will get bonuses for running a company into the ground. Only in the U.S., failure is the ultimate success!

2008 Jan 14 02:30 PM

[insidiar:]

While I generally agree with you that WaMu is a dog right now, I think you should also remember that WM is not CFC. WM has 3 other strong and profitable businesses that could then hospice. If WM gets taken over, it will be because 1) the losses are much worse in '08 than predicted (I think this is likely), and 2) Card Services profitability starts to be adversely affected by the general economy. To venture a guess, I'd say that the residential mortgage unit's management is going to slowly let this play out quarter-by-quarter, not make any grand announcements on losses today for all of 2008. WM management seems to be trying to buy time, re-organizing the unit and cutting operational costs quickly...but the end-result will generally the same; more losses...just spread out (and announced) over a long period . For this reason, I'd say a takeover is going to be 6 months out or more as there is no reason for a competitor to buy WM at what could still be an inflated price tag.

2008 Jan 14 02:36 PM

[Pj568:]

Agree with a slow play. WM has 235B net held in portfolio that doesn't get marked down until delinquent, unlike the I Banks where they're "marked to market" as a security instrument, not as an individual loans. Expect to see steadily increasing write downs.

2008 Jan 14 03:27 PM

[User 139916:]

As a WAMU customer (ex customer) I hope that fold soon..they're agents were nothing but con artists selling "cofe" loans for years..payback is a bitch...hopefully my Feb 10 puts will cover my closing costs plus put a smile on my face...they'll close all their sub prime mortgage offices soon...good riddance

2008 Jan 14 05:15 PM

[Maui Investor:]

Interesting perspective on WM. Personally, I think BAC made a bad initial investment in CFC and doubled down. I'm not so sure the other large banks will be as aggressive in going after Wamu. I think its too much of a risk for anyone other than JPM, and I think their Board has a responsibility not to take their share price down on such a gamble. An acquirer has to consider that the Bush administration will be around for less than a year so what assurances does a Wamu buyer have that they will be taken care of in 2009 when more problems could surface in their ARM portfolio?

2008 Jan 15 07:58 AM

[Richard Weed:]

I love the focus on the 7% delinquency and not on the 93% on time payments coming from CFC's portfolio. Is the sky falling? When delinquencies get closer to 20% then we have something to worry about. If you carry a 1 Trillion dollar servicing portfolio and 93% is currently on time, I don't see where the panic sets in. I think the media has sensationalized the low in the market and caused chaos where it doesn't need to exist yet. I disagree that CFC couldn't weather the storm on it's own. There has been no hard evidence that they were going to file bankruptcy and we'll get a clearer picture when they announce their Q4'07 earnings end of January. Until then, I won't buy into the media hype...

2008 Jan 15 12:11 PM

[kurt walter:]

I know people that worked as loan underwriters at both CFC and WM. They tell me CFC had poor loan guidelines that got looser and looser as the real estate bubble grew. But, WM has the worst guidelines by far. The loan mess at WM is much worse than CFC.

2008 Jan 15 12:47 PM

[jb2008:]

I wouldn't really hold any credibility to an ex employee saying stuff about guidelines. Unless you can speak for yourself. I think WM is in better shape than CFC.

2008 Jan 15 03:20 PM

[Kace:]

It is still true; you can't make gold out of lead.....

2008 Jan 15 04:44 PM

[Kace:]

It is still true; you can't make gold out of lead......

2008 Jan 15 04:46 PM

[Aneu:]

It isn't as simple as the terms of its own loans. For example, I have a mortgage with WM (In my case a traditional 15 year fixed at 4.85%, not a risky proposition), but that is only because a local bank that I took out the mortgage with sold it to them. I will add that the local bank practically gave me everything but a rectal exam in order to get the loan (this bank also keeps a lot of loans on its own books, too). My point is that the other side of the coin is what type of mortgages they bought from other banks - if they were largely solid ones, then that could help compensate for their own irresponsible lending. There also could be a lot of bad purchases that might make the problem even worse. In the next few quarters, we should be finding out the answers to these questions.
I will also add that WM has ordinary banking operations. I was recently visting Illinois and noticed this. I have no idea whether or not countrywide had anything like this, or if it was only a mortgage lender/servicer.

2008 Jan 16 10:26 AM