WaMu’s Cards: Restructuring Is About the Only One Left 12 comments
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Washington Mutual’s (WM) announcement last week that it has no plans to raise additional capital sent the stock up temporarily, but as soon as investors did some simple math on the numbers, it came down to a more realistic, albeit still inflated, number. Wamu boosted its loss reserve to $8.46bn and expects to suffer losses “toward the upper end of the range it disclosed in April” of $12-19bn. If we add Wamu’s current excess capital of $7bn to its loss reserve, we find that Wamu is at risk of running short of capital to pay for the upper end of its own loss forecast.
The only good news is that the loss forecast has become more realistic:
“Approximately one third of the second quarter provision for loan losses related to significant changes in key assumptions the company used to estimate incurred losses in its loan portfolio in response to the increasingly adverse credit trends. Specifically, the company shortened the historical time period used to evaluate default frequencies for its prime mortgage portfolio from a three-year period to a one-year period to reflect the evolving risk profile of the loan portfolio and adjusted its severity assumptions for all single family mortgages to reflect the continuing decline in home prices.”
In plain English: Wamu now projects future defaults based on the 2007 experience and no longer uses data from the low-default years of 2005 and 2006. We won’t ask why they haven’t thought of that earlier.
To add insult to injury, both rating agencies have Wamu on watch for a possible downgrade to junk status. As a result, Wamu’s CDS spreads reportedly trade at 500bp, in addition to a 1,750% upfront haircut, compared to a net interest margin of 3.22%. Fortunately, Wamu funds itself mainly through deposits, so there is little immediate risk from the deterioration of its spread - at least as long as its depositors remain faithful. It will take some time until Wamu will have to lure depositors with higher rates. A run on the bank is more likely to come from a less obvious part of Wamu’s business: its swap counterparties will require it to post collateral on its hedges. This could lead eventually to a liquidity crunch. Given that CDS trade at an upfront basis, it would be irresponsible for a counterparty not to ask for additional collateral. Clearly, current CDS levels are unsustainable. They risk becoming a self-fulfilling prophecy (Mish’s Global Economic Analysis shows a chart of WAMU’s CDS spreads).
Moreover, raising additional equity capital will be prohibitively expensive. When Wamu raised $7bn at $8.75 per share from a group of private equity funds including Texas Pacific Group, it agreed to reimburse these investors for the dilution if it were to raise more capital later at a lower valuation. If Wamu were to raise capital today, it could do so at best at $3/share, most likely even les
s. This means that on top of its actual capital needs, it would need to raise a further $4.5bn just to reimburse David Bonderman & Co. Who would want to participate in a $9bn equity offering if you know that half of the funds raised will go to a private equity fund that made an ill-timed investment?
The only way to rescue Wamu is if TPG is willing to give up some of its anti-dilution claim. TPG might come to the rescue, but we doubt that it will throw good money after bad. Bonderman will play hardball to minimize its losses, but in the end, Wamu’s management can play the restructuring card.
Of course, there’s always the possibility that Bernanke will throw free money at Wamu. If he does, we doubt he will do so with a partial bail out of shareholders like at Bear Stearns. Wamu is less pivotal to the financial system, and there is no pressure to get a deal done overnight. It’s safe to assume that Bernanke would use Wamu’s shareholders as an example that not everyone will get bailed out at any cost.
Wamu has maneuvered itself into a corner with the TPG financing and is at the mercy of CDS spreads. The most likely outcome is that Wamu will go through an out-of-court restructuring under federal oversight that brings together TPG, regulators and some creditors. No matter how it will be structured, it will be so dilutive to current equity holders that they will be virtually wiped out.
Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which is long and short various elements of Wamu’s capital structure.
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This article has 12 comments:
- Have u actually looked at WaMu's finl's? If so, you'll see WaMu has over $26 bill in equity. WaMu makes about $1 bill a quarter; or $4 bill a year in "normalized" earnings. They have customer deposits of $181.9 bill; much of in non-interest bearing checking accounts. My point is that you're only focused on historical loan losses; & totally neglecting the WaMu's profits to cover the losses. This is why TPG invested $7 bill in WaMu earlier in the year. I can't guarantee WaMu doesn't fold or have to raise more $$'s; just that there appears to be some huge positives in WaMu's business if u look beyond the loan writedowns.
All I can say is add Mr. Kirchner to your watchlist, then ignore him...
and can't find them so they trash WM to keep it at 3 dollars a share. That gives them few million shares to can borrow and purchase to cover.
Can you imagine what would happen to WM price if all the naked shorts try to cover their shorts all at the same time? Think about it. Sooner or later they'll have to.
finance.yahoo.com/q/bc...
"What we're seeing is mostly just investor panic," said Gerard Cassidy, RBC Capital Markets analyst, who does not believe that either bank is on the verge of failure. "These companies have a considerable amount of capital."
At the time of collapse, IndyMac's debt was 140% of its tangible capital and reserves, but both WaMu and National City have a debt level of less than 50% of its assets, Cassidy said.
"It's bad and it's not over yet, but investors are throwing out the baby with the bath water," he added. "The prospect of one of these banks failing is far-fetched. Both have ample liquidity."