Sunday, November 04, 2007

Angst at Wamu

Wamu, formerly known as Washington Mutual, is under some serious pressure these days. Its stock has not traded at its current level since 1997, it's down almost 50% since January, and the dividend yield is now around 8.5%. As the nation's largest savings and loan and 7th largest banking concern overall, Wamu's treatment at the hands of the market is a big deal.

Wamu is an interesting company that has always had an ambitious agenda that bordered on audacious. Stepping beyond their home west coast markets into a national franchise with a unique culture was not an easy goal, but the Seattle based company has seemed to think it can do for consumer banking what their neighbor Starbucks has done for coffee. With the competition already entrenched and their product, money, being a commodity that's hard to dress up with whipped cream and chocolate, the challenge was big. Against the odds, in the minds of some, the company has persevered and often performed. That may be changing.

The investment thesis for Wamu has been based on their acceptable performance as a value stock, their generous dividend, and the expectation of a take-out if their strategy ever faltered. In other words, the investor gets paid well to wait, if the company is successful there's some capital appreciation as well, and if not the foundation they have in place will be as valuable if not more valuable to another player such that a premium might be paid for the company at some point if their growth ambitions prove unattainable.

Now that investment thesis is frayed. With the mortgage business under serious cyclical pressure and their retail franchise still half baked(at best) in many markets, the performance is expected to suffer, and it is unlikely that there are any players with the appetite for a takeover. Apparently subprime loans make up almost 9% of the company's total loan portfolio and their overall portfolio has concentrations in ARMs and home equity loans. In their broader consumer banking push they are in 15 states, and have a market share position in the top four in only four of those states. In the New York area that I observe, they have a 1.8% deposit share and rank 8th in the market yet they advertise heavily and even acquired rights to sponsor the 5000 seat Madison Square Garden Theater adjacent to the sports facility, now the Wamu Theater at Madison Square Garden. To be fair it should be noted the Wamu's New York strategy is primarily based in metro NY only and so the deposit share in their target area is likely better than noted above, but even if double what's noted they are facing a lot more investment to get to where they need to be.

The problem now revolves around the fact that financial institutions are heavily leveraged by definition. They depend on liquidity and ready access to borrowed funds. When the market turns on a financial company it can be fast and ugly. The fear of this can at times be self perpetuating and investors begin to play a game of chicken with each other to see who can stay in for the gains or who can get out to avoid the losses. It can go beyond a company's control. That's not to suggest that this is happening or can happen to a company as substantial as Wamu, but the fear is there in some quarters. So if the worst scenario even began to develop who could rescue them and at least save the initial investment thesis, and maybe get a great deal. That's the rub at the moment. Looking at some names:
---Citi---not in the game with everything that's going on in the firm it would seem, but once seemed like a decent match given their sub-scale U.S. branch network.
---BofA---deposit share already maxed out by regulation, and already committed pretty much as a take-out for Countrywide if that situation deteriorates.
---JPM---given the size of their mortgage business they don't need and likely don't want Wamu as a whole, although they would covet the West Coast retail branches.
---HSBC---several years ago they were the natural buyers, but with their bizarre purchase of Household Finance they are unlikely to want another taste of that kind of apple.
---Wachovia---bought Golden West at the peak, so they've got West Coast and mortgage already.
---Wells Fargo---already have better West Coast, same size mortgage, would not go east with Wamu's little footprint.

The usual suspects are not lined up. With the weakness of the dollar it's not impossible that an unexpected foreign buyer like a large Spanish bank could show up. The subprime mess, however, has created such bad news among investors globally that it's probably not the kind of thing a Board of Directors has the stomach for at the moment, especially one from another market.

The next few weeks will be telling. Wamu is well funded today, is making money, capital levels are ok and it should weather this storm. Sounds like a "buy", but the way the market is pricing the stock is worrisome.

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