Friday, July 25, 2008

WaMu: We don't have any choice

Here is my quick take on Washington Mutual. First the credit markets. CDS on WaMu are now trading 20 points up front, up from 14 yesterday. That's getting into Ambac territory.

I read a really interesting Merrill Lynch research report on option ARMs recently. It showed definitively that among big option ARM originators, WaMu had the strongest underwriting standards. In terms of loan-to-value, FICO, etc., WaMu had the strongest portfolio. Unfortunately, WaMu's option ARM portfolio was so large that it still looks like losses are going to be larger than they can handle.

It looks to me like WaMu is digging itself in for a long fight. According to Bloomberg, WaMu has paid off most of their Fed Funds (and actually has sold nearly $2.75 billion). This means that they are actually lending short-term, which gives them a good deal of liquidity. They've also "pre-funded" short-term maturities. Overall, WaMu claims to have over $50 billion in liquidity and $7 billion in excess capital.

Now its been long speculated that J.P. Morgan was interested in WaMu. In fact, its been rumored that J.P. Morgan offered WaMu a take-under price just before WaMu got a capital infusion from TPG. I believe the price rumored was something like $7/share when the company was trading at $9. Now its probably too late, certainly too late for $7/share. Maybe Jamie Dimon would offer $1 and figure that the embedded losses in WaMu's loan portfolio would be worth expanding Morgan's retail reach. I don't know.

But I'm betting that WaMu takes a different tact. Put yourself in Kerry Killinger's shoes. Say, for the sake of argument, that Dimon offers $1/share. From Killinger's perspective, what's the difference between accepting $1 and going bankrupt?

On the other hand, it is possible, however likely, that WaMu can muddle through, and survive into 2010, what's the stock worth? Probably $10 or more. Consider that by that time home prices have probably bottomed and most of the losses in WaMu's portfolio will have been realized. So if they've survived it, the stock is worth much more than today.

Now, I think WaMu is probably toast. And I think the markets are going to behave badly while we worry about WaMu's future. But I also think WaMu is going to roll the dice and see if they can make it on their own.

6 comments:

Rajesh said...

Wouldn't Well Fargo be a better match? They would not face the national market share ceiling that J.P. Morgan bumps up against.

adan said...

it'd be nice to see someone survive on their own, esp since, as you say, they went at it w/stringet (sp) rules re the loans they took

bode said...

I just finished reviewing the WM Q2 conference call:

http://investors.wamu.com/Cache/1001141986.PDF?FID=1001141986&O=PDF&T=&D=&IID=102028&Y=

Can you perhaps go into more detail about how exactly they are going to go under? They are shrinking their balance sheet, really make money, don't rely on hot money (52% mom and pop deposits, 21% FHLB loan advances). They aren't remotely like IMB, and I don't foresee a run like some in the blogosphere (i.e. esp. the people who said the bank was being taken over by the FDIC this weekend).

I don't doubt that they are cutting it close -- but they're making real money as a bank, NIM is good, costs are cut, and they've got a pretty hefty cushion. Even if losses are 50% worse, it appears they'll survive. And, that's not tomorrow, that's a year or more away.

So I have to ask, where is the fire? I see smoke, but I don't see how it's even a 50-50 proposition here, at this point in the game. Heck, their OA portfolio was not even as bad as I thought. They aren't too big to fail, but they don't actually seem like they hit the iceberg yet?

tortfesor said...

> From Killinger's perspective, what's the difference between accepting $1 and going bankrupt?

Its the same reason why Bear Stearns couldn't reject the $2 offer -- there is a legal obligation for a CEO to avoid bankruptcy if possible.

PNL4LYFE said...

The difference between Wamu and Bear is that Bear was much more enmeshed in the web of counterparties for OTC contracts. WM is relatively insulated from causing a contagion if it were to fail. If Killinger rolls the dice, the possible outcomes are survival or FDIC takeover. For Bear, there was no plan in place to protect other broker/dealers in the event that Bear failed. From a systemic risk perspective, I think that made it much more important to prevent a Bear failure than it would be to save Wamu

Accrued Interest said...

I completely agree with PNL. Its a known what happens if a bank fails. FDIC steps in. Insured depositors get paid off. Plus WaMu is a classic bank, no IB operation.

As far as "how can they fail?" Look, they have a very large option-ARM portfolio in California. Just about the worst thing going. Have they provisioned enough for losses in that portfolio? I don't think so. I don't think its even close.

However, they claim they can handle $11 billion in losses, and I think they are looking at $15ish over the next 3 years. But if indeed they can handle $11 billion, and it takes 3 years to lose $15 billion, they may well survive that.