A Rescue for WaMu?

A much-needed cash infusion could allow the mortgage broker to return to profitability sooner

by David Bogoslaw

The grim outlook for mortgage defaults as the housing slump deepens has kept pressure on banks such as Washington Mutual (WM) that continue to have a lot of mortgage-related exposure. But a cash infusion of $7 billion that the bank announced on Apr. 8 could give investors more confidence that WaMu will be able to ride out the mortgage storm.

On Apr. 7, unconfirmed talk of a large cash injection, based on a Wall Street Journal report, was enough to push shares of the Seattle-based bank up 29.3% to $13.15, eclipsing an 11.5% drop on Apr. 4. WaMu is one of the leaders in lending to consumers and small businesses.

WaMu said it had entered into definitive agreements to raise an aggregate $7 billion through the sale of stock to an investment group led by TPG Capital, which includes many of WaMu's top institutional shareholders. TPG's investment vehicle, as anchor investor, will buy $2 billion in newly issued WaMu stock.

The bank will sell about 176 million shares of its common stock at $8.75 per share and will also issue roughly 55,000 shares of contingently convertible preferred stock at a purchase price and liquidation preference of $100,000 per share. After getting certain approvals, including that of WaMu's shareholders, the convertible preferred stock will automatically convert into common stock at an initial price of $8.75 per share, subject to adjustment.

Some investors who agreed to transfer restrictions on their shares will also receive five-year warrants that will become exercisable for common stock, subject to certain approvals, based on a post-closing reference price.

The investment will also secure a seat on WaMu's 14-member board for David Bonderman, a founding partner of TPG. Larry Kellner, chairman and chief executive of Continental Airlines, and a former chief financial officer of American Savings Bank, will become a board observer at TPG's request.

WaMu also said it plans to cut its quarterly dividend to 1¢ from the current 15¢ per share to further bolster its capital position. That is expected to preserve about $490 million of capital a year.

In a preview of its first-quarter financial results, slated for Apr. 15, the bank on Apr. 8 announced a net loss of $1.1 billion, or $1.40 per share, and said it was setting aside $3.5 billion for loan losses for the quarter and expects net charge-offs of roughly $1.4 billion.

Access to ample capital has been a central concern for investors in these financial companies who worry that the banks aren't sufficiently capitalized to weather ongoing losses as more homeowners default on their mortgages and their homes go into foreclosure.

Some analysts were optimistic about the deal. Given the write-offs the company took for mortgage-related losses in the fourth quarter, the cash infusion should make regulators and anyone else concerned about the strength of the balance sheet happy, says Gary Gordon, an analyst at Portales Partners in New York.

"This gives them more flexibility, to take more write-offs today and get more of their losses behind them or to limit their amount of asset shrinkage, or [use capital for growth]," he says. "The odds are this is more to plug a potential hole caused by losses." (Gordon, who has a hold rating on the stock, owns WaMu preferred stock, which he says isn't convertible to common shares.)

If the bank were to use a fairly large portion of the capital to build its reserves to cover potential losses, that could speed its return to profitability once the mortgage cycle has run its course, he adds.

Standard & Poor's Equity Research reaffirmed its hold rating on the stock, but said that despite the dilutive effect it would have, the potential capital injection is positive for the bank, given its fourth-quarter Tier-1 capital ratio of 8.30%, which was below its peers.