Ailing WaMu says it's making headway

Washington Mutual's top executives insisted Tuesday that they're making progress in turning around the ailing lender, despite second-quarter results that provided ample evidence of continuing difficulties.

Along with reporting a $3.3 billion quarterly loss, WaMu said its pile of unpaid mortgages, foreclosed homes and other nonperforming assets continues to grow, as do credit-card delinquencies. The company also cut its growth forecast for fees paid by its banking customers, a key earnings driver.

"We are working hard, we are making headway, and I'm confident in the future of the company," Chief Executive Kerry Killinger said in a conference call with analysts and investors.

But not everyone is convinced the worst is over. Moody's, the credit-rating agency, said it was considering whether to cut WaMu's debt rating to junk status. And at least one analyst warned about being too optimistic too soon.

Killinger and other top executives pointed to the progress WaMu has made in whittling down its bulging inventories of "option" adjustable-rate mortgages, home-equity loans and other loans at high risk of going bad.

And they noted that much of the eye-popping $3.3 billion loss was due to the decision to set aside $5.9 billion to cover future loan losses, reflecting more cautious — or perhaps realistic — assumptions about how many homeowners are likely to default on their loans. Excluding that reserve, income from WaMu's core business — lending out depositors' money for more than it pays them — actually grew by 5.6 percent.

At least one important shareholder — TPG, the private-equity firm that led a consortium that pumped $7.2 billion into WaMu in April — expressed satisfaction with the thrift's second-quarter results.

"What they outlined today — building up loan-loss reserves, increasing coverage ratios — was a prudent and appropriate step to return to profitability," TPG spokesman Owen Blicksilver said.

But the report prompted Moody's to say it would review whether to cut its rating on WaMu's senior unsecured debt to non-investment grade, or "junk," status.

The sharp decline in WaMu's stock price — it's down 86 percent over the past year and is trading at a substantial discount to book value — and second-quarter declines in certain deposit categories mean that "it would be expensive, at best, for WaMu to raise new equity capital or issue new debt given the market's current negative opinion of the company," Moody's said in a statement.

"This reduced financial flexibility makes it more difficult for the company to successfully navigate through unanticipated events," Moody's vice president and senior credit officer Craig Emrick said in the statement.

WaMu released its earnings shortly after the close of regular New York Stock Exchange trading, in which its shares gained 34 cents to close at $5.82. The stock initially moved higher in after-hours trading, topping $6, but later fell back to around $5.58.

A changing lender

WaMu's quarterly report showed how much its business model has changed in the year or so since the U.S. housing boom began to fizzle and the market for mortgage-backed securities cratered.

In the second quarter of 2007, WaMu made $15.7 billion in "option ARM" loans — home mortgages with variable monthly payments that in many cases left borrowers owing more than they originally borrowed.

Though popular and profitable, those loans have also proved highly vulnerable to default, and WaMu has all but sworn them off. Last quarter, it made just $241 million worth.

WaMu also has ratcheted back its home-equity lending, another high-risk part of its portfolio. It made just $1.8 billion in such loans during the second quarter, versus $17.6 billion a year earlier, and it canceled $17.7 billion in authorized but untapped home-equity lines of credit.

Rather than the nationwide mortgage powerhouse it briefly became earlier this decade, WaMu going forward will concentrate on its retail-banking network, trying to sell more products and collect more fees from its depositors.

WaMu said it opened 250,000 new checking accounts in the second quarter. Fees paid by depositors — for overdrafts, ATM withdrawals and the like — totaled $767 million, up 8.9 percent from the first quarter and 6.5 percent over the past year.

But Chief Financial Officer Thomas Casey warned that the weak U.S. economy is cutting into WaMu's retail-banking fees, and he cut the predicted growth this year in those fees to 7 to 10 percent.

WaMu also is relying more on the credit-card business it acquired from Providian a few years back. However, card delinquencies also are on the rise: 7.05 percent of WaMu's card debt was more than 30 days late, up from 6.9 percent in the first quarter.

Killinger said the company expects card losses for the full year to be about 10.5 percent of the total portfolio. In response, he said, WaMu has been tightening its credit-card standards.

WaMu also has been aggressively cutting expenses, announcing an additional 1,200 layoffs just last month and closing its 160 remaining home-loan offices. Such moves are expected to save $1 billion a year, starting in 2009.

The company also disclosed Tuesday that Killinger, Casey and Chief Operating Officer Steve Rotella would not receive bonuses this year. An earlier bonus plan had been sharply criticized for minimizing the impact of WaMu's housing-related woes; under shareholder pressure, the company withdrew it in April.

So far this year, WaMu has set aside $9.4 billion to cover the future cost of loans that go bad; Killinger said he expects such set-asides to peak this year. But one observer sounded a note of caution.

"Unfortunately, the year is only half over," said Walter O'Haire, a senior analyst with Celent, a Boston financial research and consulting firm. "Past assumptions regarding losses have, in hindsight, proven to be a bit optimistic."

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