WaMu Feels Subprime Mortgage Pain But Not As Deeply
Larger deposit base, access to low-cost funds puts it on more solid footing than Countrywide
Despite the mortgage credit crunch, you probably won’t see Washington Mutual Inc. making scary headlines. And for investors, that is probably good news.
To be sure, Seattle-based Washington Mutual, the nation’s largest thrift, isn’t entirely immune from the subprime mortgage credit crisis. It announced recently that it plans to cut 1,000 jobs, and its investment portfolio is packed with just the type of home loans that are causing problems for homeowners and financial markets alike.
Yet Washington Mutual is unlikely to face the same kind of problems that competitor Countrywide Financial Corp. battled recently.
Washington Mutual, with more than 2,000 retail branches, has a much larger deposit base than Countrywide, meaning it is less dependent on short-term debt markets to raise financing for its operations.
Also, because Washington Mutual originates its loans as a thrift, it has much broader access to funds from the Federal Home Loan Bank.
Washington Mutual had $201 billion in deposits, while Countrywide’s filings show $60 billion, according to second-quarter financial statements.
The Federal Home Loan Bank provides low-cost financing to financial institutions. But mortgage originators that aren’t banks or thrifts for the most part don’t have access to this advantageous funding. Until recently, Countrywide was originating most of its loans outside of its thrift.
Countrywide’s well-publicized troubles occurred because it was dependent on short-term debt, such as commercial paper, to fund its mortgage lending.
So when its access to that short-term debt was shut off, the lender turned to an $11.5 billion credit line and sold a $2 billion equity stake to Bank of America Corp. On Sept. 13, Countrywide said it obtained an additional $12 billion in secured financing to help it weather the difficult environment.
Thrifts and mortgage lenders that don’t rely on short-term debt markets to fund their loans “haven’t had nearly the same problems” as companies that do, said Stuart Plesser, an equity analyst with Standard and Poor’s.
Plesser also said Washington Mutual’s credit card division and retail banking division give it more diversified sources of revenue than Countrywide.
In its second-quarter earnings report, Washington Mutual appeared to be weathering the difficult credit environment reasonably well, with pretax net operating income up 8 percent from the prior year. Washington Mutual is expected to report its next quarterly results around Oct. 18.
Washington Mutual said it plans to eliminate about 8 percent of its workforce by mid- November as it wound down its operations of purchasing mortgages from outside firms and arranging financing for other lenders.
The company also said it was expanding its direct retail lending business over the next several months.
One of the main challenges ahead for Washington Mutual, Plesser said, is the credit quality of the loans the company has in its investment portfolio.
Given that the company has a fairly large exposure to subprime mortgage loans in its portfolio — about 9.5 percent of the total $215 billion portfolio, Plesser said, a higher percentage than many of its competitors — it seems likely WaMu will face higher charge-offs because of bad loan performance in the future.
The company also has option adjustable-rate mortgage loans in its portfolio — these loans are about 25 percent of the total investment portfolio balance, based on second-quarter financial statements.
Option ARMs could lead to problems for borrowers in a declining home-price environment because the balances for these loans can actually grow over time.
“I’m wary” about the sizable option ARM holdings, Plesser said.
And assuming higher rates of default on the loans in its investment portfolio, Washington Mutual will have to increase its provisions to cover the cost of the loan losses, Plesser said.
The need to raise the amount of such provisions — something Washington Mutual already anticipates doing, having raised its expectation of loan-loss provisions in 2007 to $2 billion to $2.2 billion, up from $1.5 billion to $1.7 billion — is something that will weigh on earnings, Plesser said.
Even analysts who have a “buy” rating on Washington Mutual’s shares (WM) aren’t predicting a rosy future for the company in the near term.
“If you were to say you really think this company is going to have a bright future in the next six months, I’d have to tell you it sure as heck is not,” said Richard Bove, an analyst at Punk, Ziegel & Co.
Like Plesser, Bove cited credit quality of Washington Mutual’s retained loans as among the biggest challenges facing the company.
Bove said the reason he has a “buy” rating on the company now is simply because it pays a large dividend to stockholders. “If I can make 7 percent in dividends, I can live through what should be some pretty horrible earnings in the next couple of quarters.”