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 unconfirmed talk of a deal that would pump $5 billion into the company’s coffers lifted the stock on Monday.
Shares of the Seattle-based bank, one of the leaders in lending to consumers and small businesses, shot up 29.3% to $13.15 on Apr. 7, eclipsing an 11.5% drop on Apr. 4.
Access to ample capital has been has 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.
On Apr. 7, the Wall Street Journal reported that private equity firm TPG and other investors are close to cementing a deal to inject $5 billion into WaMu’s balance sheet in exchange for stock. The capital infusion could enable the U.S.'s largest thrift to meet all its capital requirements amid deep losses from the mortgage crisis, but would dilute current holders' stakes.
The investment would take the form of an offering of both common and preferred stock, with the latter eligible to be converted into common shares sometime in the future, subject to shareholder approval, the WSJ reported. TPG is expected to keep a large minority interest in the bank, which would probably be less than 25% to avoid having to register as a financial holding company as required by government rules, according to the newspaper.
The investment is also expected to secure the private equity firm one seat on WaMu’s current 14-member board. Large current WaMu shareholders and possibly some other buyout firms are purportedly among the other investors. But the WSJ said an agreement had not been finalized and could collapse.
Some analysts were optimistic about the prospective deal, which WaMu declined to confirm in an email to BusinessWeek.com.
Given the writeoffs the company took for mortgage-related losses in the fourth quarter, $5 billion in cash 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 writeoffs 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. However, with WaMu’s loss allowance at only 42% of nonperforming loans, S&P said it expects additions to loss provisions in the quarters ahead to be significant. (S&P, like Businessweek, is a unit of McGraw-Hill Companies (MHP).)
“Certainly, along with most other players, [WaMu is] going to have to increase its provisions for future loan losses,” says Tom Kersting, an analyst at Edward Jones & Co. in St. Louis, Mo. “They’ve been dramatically increasing it over the last couple of quarters and we expect it to remain at even higher levels through 2008.” (Edward Jones has received compensation from WaMu for investment banking services within the last 12 months and expects to do so in the next three months.)
How high those provisions go will depend on how bad the housing market gets, particularly in California, where WaMu has originated a lot of loans.