$7 billion gives shaky WaMu firmer footing for now

Washington Mutual's $7 billion infusion of new capital should be enough to get the ailing thrift through the worst of its financial troubles, analysts and observers said Tuesday.

"I think WaMu survives now, and I had doubts two days ago," said James Bradshaw, who follows banks for the D.A. Davidson brokerage in suburban Portland.

But that's about the best news WaMu's existing shareholders — who've already seen their investments plunge nearly 73 percent over the past nine months — can take away from the massive rescue package.

Key details of the deal were still under wraps late Tuesday, but several things were clear:

• Current shareholders will own a lot less of the revamped company than they did last week.

• The new investors got a Costco-sized discount: The $8.75 share price was 14 percent below the stock's close Friday, before rumors of the deal pushed WaMu shares up Monday.

• If WaMu does recover from its mortgage mess, it will be smaller and more narrowly focused on its retail banking customer — making it potentially more of a merger candidate than the wounded giant of today.

WaMu said it will close its approximately 186 remaining stand-alone home-loan offices, including 23 in Washington, and a loan-processing center in Bellevue. It also will stop buying loans from outside mortgage brokers — known in the trade as "wholesale lending."

Those moves will leave WaMu with a much smaller mortgage business. Together, the loan offices and wholesale business accounted for 61 percent of the $58 billion in home loans originated in the second half of 2007.

About 3,000 people companywide will lose their jobs, spokeswoman Darcy Donahoe-Wilmot said. She didn't break out local job cuts.

WaMu also will slice its quarterly dividend to a nominal amount: a penny a share. That should save more than $490 million this year.

The investment group is led by TPG, formerly Texas Pacific Group, one of the nation's highest-profile private equity firms. TPG will pump $2 billion into WaMu; other so-far-unidentified investors, including some of WaMu's current institutional holders, will buy an additional $5 billion in newly issued stock.

WaMu is selling 175 million common shares at $8.75 apiece, a third below the stock's closing price Monday; that gives WaMu about $1.53 billion in new cash. The investor group also will buy $5.5 billion of preferred shares, which under certain unspecified conditions will convert into 628.5 million new common shares.

The effect will be to dilute existing shareholders' stakes by about 30 percent, said Jaime Peters, an analyst for Morningstar in Chicago.

(The Wall Street Journal reported late Tuesday that WaMu had spurned a takeover bid from JPMorgan Chase, which made a preliminary offer of $8 a share, or about $7 billion, in Morgan stock.)

WaMu now has raised a whopping $11.4 billion in new capital over the past year — money it needs to clean up the piles of defaulted and at-risk mortgages sitting on its books.

On Tuesday, WaMu also said it would set aside $3.5 billion to cover loans that go bad, and would charge off $1.4 billion worth of loans in the just-concluded first quarter. Both moves will contribute to a $1.1 billion, or $1.40-per-share, net loss for the quarter.

Powerful new player

In TPG, WaMu will be getting a new kind of shareholder — a firm that is used to taking control of troubled companies, squeezing out excess costs and exiting a few years later with a tidy profit.

Robert Parrino, a finance professor at the University of Texas and founding director of its Center for Private Equity Finance, said the WaMu deal is a notable departure from TPG's typical practice.

It won't have a controlling stake in the Seattle company, though TPG co-founder David Bonderman will have a seat on the board. Parrino predicted he would be an active director.

A Bonderman ally, Continental Airlines Chief Executive Larry Kellner, was named a nonvoting "board observer."

Since WaMu is both a publicly traded company and a federally regulated financial institution, "there are a lot of restrictions and limits to what you can do and how quickly you can do it," Parrino said.

Typically, he said, private equity firms expect to recoup their investments, plus a healthy profit, in three to five years.

That should be enough time for WaMu to clear away the bad loans and restructure its business, said Davidson's Bradshaw.

The deal relieves some of the pressure on WaMu's leaders, especially CEO Kerry Killinger, who have faced intense criticism for leading WaMu into the mortgage morass.

By 2011 or 2012, Bradshaw said, WaMu shares could be back up to $25, though "it's a lot of heavy lifting" to get there from here.

Tuesday's deal makes a buyout less likely in the near term — especially since, according to WaMu's announcement, "certain investors" have agreed to unspecified restrictions on transferring their shares in exchange for warrants for more stock in the future.

But, Bradshaw said, "two or three years out, [WaMu] will be a more attractive franchise again."

It's probably a toss-up, Parrino said, whether TPG will hang on to see the stock appreciate with WaMu as an independent company, or ultimately push for a sale when it's ready to exit from its investment.

"These folks are very pragmatic," he said. "Whatever the most profitable thing is to do at the time, that's what they'll want to do."

Mortgage mess

Until last summer, WaMu routinely packaged mortgages and sold them to outside investors. But as home sales and prices tumbled and more borrowers began defaulting, investors lost their appetite for mortgage-backed securities. Home loans backed up onto WaMu's balance sheet like a clogged drain.

At the end of 2007, WaMu owned $18.6 billion in subprime loans, $61 billion in home-equity loans and $68.4 billion in short-term adjustable-rate loans — the highest-risk categories.

Morningstar's Peters estimated there are $14 billion in future losses embedded in those loans; other analysts put the number as high as $16 billion.

The new WaMu will look a lot more like a traditional savings and loan — with more lending to its own retail customers and a lot less fishing for mortgages nationwide.

"That's not a bad model to have," Peters said. "The people who lent to their depositors are still in business and they didn't have to seek outside capital."

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com