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Wachovia Slumps After WaMu's Seizure, Bailout Impasse

By David Mildenberg and Linda Shen

Sept. 26 (Bloomberg) -- Wachovia Corp. slumped, leading other banks stocks lower, after negotiations on the government's financial bailout stalled and Washington Mutual Inc. was seized by regulators and sold to JPMorgan Chase & Co.

Wachovia, which the New York Times said today is in early merger talks with Citigroup Inc., dropped $3.70, or 27 percent, to $10 at 4 p.m. in New York Stock Exchange composite trading. Wells Fargo & Co. and Banco Santander SA are also suitors, the Wall Street Journal said. Cleveland-based National City Corp. fell 27 percent and Downey Financial Corp. slipped 48 percent. All three lenders plunged more than 80 percent in the past 12 months.

``Washington Mutual showed that one of the big ones can go down, and if you are looking at who else in the top 10 is facing the most pressure, Wachovia is right there,'' said Stan Smith, a banking professor at the University of Central Florida in Orlando.

WaMu was taken over by regulators yesterday in the biggest U.S. bank failure after customers of the Seattle-based lender withdrew $16.7 billion from accounts since Sept. 16. The savings and loan was ``unsound,'' the Office of Thrift Supervision said. The collapse came as lawmakers planned to meet again after talks on Treasury Secretary Henry Paulson's bailout reached an impasse.

The Times said there's no guarantee the talks between Citigroup and Wachovia will result in a deal, citing people briefed on the matter. Citigroup spokeswoman Christina Pretto declined to comment on the Times report. Santander spokesman Peter Greiff declined to comment on the Journal's report, as did Wells Fargo's Julia Tunis Bernard.

Steel's E-Mail

Fears of mounting losses on Wachovia's $122 billion in option adjustable-rate mortgages helped push the Charlotte, North Carolina-based company's shares down by 64 percent this year before today's trading. Chief Executive Officer Robert Steel is treating the loans as distressed debt and named a senior bank official, David Carroll, to lead an effort to minimize losses on option ARMs that the bank expects to total about $14 billion.

Steel sent an e-mail to employees today saying he's ``optimistic'' about the government rescue package.

``The Treasury plan under consideration by Congress and the fact that the WaMu situation was smoothly resolved for its customers are two constructive and important steps toward restoring confidence in the financial system,'' Steel wrote in the e-mail, which was confirmed by the bank. ``We are aggressively addressing our challenges and are working to strategically strengthen and manage capital and liquidity in this challenging environment.''

`Silent' Run

Still, customers may not be assuaged. Louise Pitt, a credit analyst at Goldman Sachs Group Inc., wrote in a report today that Wachovia may face the possibility of a ``silent'' run on desposits similar to that confronted by WaMu.

Outflows could come because of ``negative industry headlines and fear among retail customers,'' Pitt wrote in a report today. The bank has about $391 billion in core deposits out of a total of $436 billion, said Pitt, who cut her rating on Wachovia to ``trading sell'' from ``outperform.''

Christy Phillips-Brown, a spokeswoman for the bank, said the company doesn't comment on analyst reports. She noted that the bank has opened 745,000 retail deposit accounts since June, a 6 percent increase from the average daily sales rate in the first half of the year. Customers have also reinvested their certificates of deposits with Wachovia at a faster clip than during the first half of the year, she said.

CD Rates

The lender is paying among the highest CD rates among U.S. banks, which is typically seen as a signal that is struggling to win investor confidence, analyst Sean Ryan of Sterne Agee & Leach Inc. said today in an interview.

National City is well capitalized, has strong deposit inflows and has a fundamentally different business model than WaMu, said spokeswoman Kristen Baird Adams in an interview today.

``National City is a diversified commercial bank'' with no option ARMs, Adams said. ``WaMu was a thrift whose primary business was mortgage related.''

Wachovia had a total of $167 billion in mortgages as of June 30, ranking second among U.S. lenders behind Bank of America Corp.'s $239 billion, and followed by Citigroup Inc.'s $145 billion, according to an Oppenheimer & Co. report.

``All eyes are now on Wachovia,'' said Anton Schutz, president of Mendon Capital Advisors Corp. in Rochester, New York.

Option-ARM Mortgages

Wachovia became the largest option-ARM seller through its $24 billion acquisition in 2006 of Golden West Financial Corp., the Oakland, California-based lender that popularized the product over the previous 30 years. Wachovia expects cumulative losses of about 11 percent to 12 percent on its option-ARM loans.

``We feel it is likely that Wachovia will need to issue equity to provide greater reassurance about its liquidity and solvency,'' Mike Mayo, an analyst at Deutsche Bank AG, wrote in a note today. He reduced his target price to $11 from $16 a share.

Mayo expects the firm will need an additional $11 billion in capital, assuming a 20 percent discount on its ARM portfolio, he wrote. If common shares were issued at yesterday's closing price, it would dilute current shareholders by about one third.

California Slump

Merrill Lynch & Co. analyst Edward Najarian expects the losses to be in the 15 percent to 17 percent range, according to a Sept. 9 report. Housing prices in California declined by a record 41 percent in August from a year earlier, the California Association of Realtors said yesterday. Almost half of Wachovia's option ARMs are in California.

Option ARMs allow borrowers to skip part of their payment and add that sum to their principal. Monthly costs eventually increase after introductory interest rates as low as 1 percent.

Because typical option ARM borrowers make less than the full payment each month, according to Fitch Ratings, they don't build equity in their homes. When house prices fall, borrowers often owe more than their homes are worth. That leaves lenders facing losses if the borrower defaults.

Downey, based in Newport Beach, California, ranked fourth among option ARM lenders behind Wachovia, WaMu and Bank of America's Countrywide Financial Corp. Downey said it held $6.9 billion in option ARMs at the end of the second quarter.

Downey Financial

Downey now has less than a month to submit a long-term business plan to its chief regulator, the Office of Thrift supervision. The agency ordered the bank on Sept. 5 to raise cash by the end of the year and halt dividend payments.

Downey spokeswoman Elizabeth Stover declined to comment.

``A bailout plan needs to be approved as credit markets have frozen, credit spreads have widened and it's getting more difficult for businesses and consumers to get access to credit,'' said BMO Capital Markets analyst Peter Winter in a note to investors today.

Wachovia's shares advanced last week on speculation it would be a beneficiary of the Treasury's rescue plan. The company's option ARMs may be simpler to sell to the government than securitized pools of loans, said Kevin Stein, associate director of the California Reinvestment Coalition, a San Francisco-based nonprofit.

Wachovia holds the loans on its balance sheet, while WaMu and other big option-ARM lenders pooled the loans into securities that were sold to investors, he said.

`A Major Hit'

``If Wachovia could unload a third or a half of its option-ARM portfolio without taking a major hit to earnings, that would be a very positive development,'' said Gerard Cassidy, an analyst at RBC Capital Management in Portland, Maine. ``Whole loans are a lot easier for the government to buy than CDOs or CDO squared,'' he said, referring to collateralized debt obligations.

At the time of its failure, WaMu had $28.4 billion in outstanding bonds, with Capital Research and Management the largest debt-holder, Bloomberg data show. All three major credit agencies rate WaMu junk, the only company in the 24-member KBW Bank Index that's below investment grade.

Wachovia, which has $125.9 billion of outstanding bonds, has investment-grade ratings from Moody's Investors Service, Standard & Poor's Corp. and Fitch. Moody's and Fitch have a negative outlook on the lender, indicating a possible downgrade.

The cost to protect against a default by Wachovia soared to distressed levels today. Credit-default swap sellers demanded 25 percentage points upfront and 5 percentage points a year to protect Wachovia bonds from default for five years, according to broker Phoenix Partners Group. That means it would cost $2.5 million initially and $500,000 a year to protect $10 million in Wachovia bonds, compared with $670,000 a year and no upfront payment yesterday.

During the past three quarters, WaMu lost $6.3 billion. It kept skidding even after joining a list of financial companies the U.S. Securities and Exchange Commission protected from short selling in an effort to stabilize stock markets.

To contact the reporters on this story: Linda Shen in New York at lshen21@bloomberg.net; David Mildenberg in Charlotte at dmildenberg@bloomberg.net

Last Updated: September 26, 2008 17:27 EDT
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Breaking News: Looks like the WaMu "milk" has officially expired!

J.P. Morgan to Take Over Faltering WaMu

U.S. Government Helps Broker a Deal to Dispose of Huge Thrift; Banking Giant Expected to Get Deposits, Branches

By ROBIN SIDEL, DAVID ENRICH and DAMIAN PALETTA

Source: Wall Street Journal

J.P. Morgan Chase & Co. was expected to announce as early as Thursday night a deal to acquire the bulk of Washington Mutual Inc.'s operations in a deal that would mark the end of independence for what once was the largest U.S. thrift.

Associated Press

Pedestrians walk past a Washington Mutual branch in downtown Seattle.

Federal regulators have been heavily involved in orchestrating the transaction, which comes as WaMu was besieged by a mountain of bad mortgage loans. Seattle-based WaMu has been scrambling to find a solution and put itself on the auction block last week. A number of interested parties have been poring over WaMu's books, but the bank didn't receive any offers.

While the exact structure of the transaction wasn't immediately known, J.P. Morgan is expected to acquire Washington Mutual's deposits and branches, as well as other operations. The deal isn't expected to result in any hit to the bank-insurance fund, according to a person familiar with the arrangement. But it's likely that another arm of government would have to pick up the tab. Some analysts have worried that a WaMu failure could cost more than $20 billion.

Federal regulators have been heavily involved in orchestrating the transaction, which comes as WaMu grapples with its bad mortgage loans. Regulators were hoping to fend off a collapse of WaMu, which, with more than $300 billion in assets, would mark by far the largest banking failure in U.S. history.

The exact structure of J.P. Morgan's acquisition of WaMu's deposits wasn't immediately known, except that the New York bank, which has long coveted WaMu as a way to secure a footprint on the West Coast, will assume most of the thrift's deposits and branches, as well as some other operations.

Unlike many of the 12 bank failures that the Federal Deposit Insurance Corp. has overseen this year, the J.P. Morgan-WaMu transaction isn't expected to impact the agency's national deposit-insurance fund. It wasn't immediately clear how the transaction would be structured to avoid the insurance fund taking a hit.

With mortgage losses mounting, and its stock price plunging, WaMu has been scrambling over the past month to find a solution; last week it put itself on the auction block. A number of banks -- including Citigroup Inc., Wells Fargo & Co. and Banco Santander SA -- pored over WaMu's books, but the bank didn't receive any offers. This week, WaMu's outside bankers approached a group of private-equity funds to gauge their interest in a deal.

Also this week, the FDIC took the step of reaching out to banks, asking them to express interest in taking over some or all of WaMu, according to people familiar with the matter. Those bids were due at 6 p.m. Wednesday. J.P. Morgan's takeover of WaMu's deposits represents a huge blow for private-equity firm TPG, which injected $7 billion into the thrift this spring. The transaction is expected to wipe out WaMu stockholders and holders of the company's senior debt, one person said. A key unknown: the fate of WaMu's bad assets, which include mortgage loans that have soured as housing markets tanked.

Arranging the deal in a way that doesn't cost the FDIC's deposit insurance fund any money would be an achievement for Chairman Sheila Bair, who has had a hawkish view about the state of many financial institutions. Federal regulators faced criticism from many after the July failure of IndyMac Bank, which the FDIC estimated might have cost the deposit insurance fund close to $9 billion.

This is the second time the government has gone to J.P. Morgan as a buyer of last resort. In March, the government agreed to backstop J.P. Morgan's takeover of Bear Stearns. This will likely prompt criticism from rivals about preferential treatment. BofA, for instance, didn't receive government assistance in its recently announced purchase of Merrill Lynch. Of course, in the case of WaMu, there were presumably other bidders who simply wouldn't offer that much for the deposits and branches. Before the deal, J.P. Morgan ranked as the fourth-largest bank as measured by branches, ranking below Bank of America Corp., Wachovia Corp. and Wells Fargo & Co. Its network of more than 3,100 branches stretches across 17 states with deep penetration in New York, Illinois, Texas, Michigan and Ohio.

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Washington Mutual passed expiration date?

WaMu is past its expiration date
Commentary: Seattle-based thrift is headed for a steep discount
By MarketWatch
Last update: 11:44 a.m. EDT Sept. 25, 2008

NEW YORK (MarketWatch) -- Washington Mutual Inc. is kind of like that milk in the refrigerator that's a couple of days past its expiration date.
It may be fine or have gone past the point of no return. Either way, it's not long before it will be gone.

Only the bankers who have been able to dig through WaMu's (WM Washington Mutual Inc portfolio can say with much certainty how long WaMu will last and judging by their reaction, they don't like what they smell.

J.P. Morgan Chase & Co., Toronto-Dominion and Citigroup Inc. all have reportedly passed on the auction of the bank. They dropped out after conducting an inspection of WaMu's mortgage portfolio -- assets that Standard & Poor's seemed convinced Wednesday could not be sold to raise capital.

Now, under pressure from the Office of Thrift Supervision, WaMu is looking for a private equity investor and has opened talks with the Carlyle Group and Blackstone Group LP about a capital infusion.

Should that fail, WaMu issued a statement Wednesday reminding its customers that their $143 billion in deposits are insured up to $100,000. WaMu is also getting desperate, offering 4% interest -- more than twice the national average -- on deposits made online.

If any deal occurs, expect buyers to take on a small part of WaMu - its branches, mortgage offices and deposits -- the rest of the bank is going bad and investors run the risk of getting sick.

- David Weidner
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