WM loan losses to reach $2.2 billion in 2007

From Marektwatch:

NEW YORK (Dow Jones)--Washington Mutual Inc. (WM) Chief Executive Kerry Killinger warned Monday that the company anticipates a continued rise in bad loans, which will take a toll on WaMu's earnings.

Killinger, speaking at a financial-services conference, said the Seattle-based thrift will set aside as much as $2.2 billion this year to cover potential loan losses. That is $500 million more than WaMu predicted as recently as July.

Killinger also cautioned that WaMu will book lower gain-on-sale income from selling mortgage loans instead of keeping them on the company's balance sheet.

Killinger offered a bleak outlook for the state of the housing industry nationwide. "Most housing markets appear to be weakening to us," he said, adding that there could be declines in housing prices around the country over the next few quarters.

Amid weakening housing prices and other factors, Killinger said, WaMu could face "a higher level of charge-offs for the foreseeable future." Nonetheless, Killinger said the company has opportunities to profit from the mortgage-industry wreckage by, among other things, boosting its market share

How does that compare to WM's loan loss provisions over the past few years? Take a look at the chart below. This can only be described as a massive increase in loan loss provisions. Consider that the provision for FY06 was 2 1/2 times that in FY05 and that FY07 is going to be another 2.7 times 2006 levels.

What impact will this have on earnings? For 1H07 WM posted Net Income of $1,612m, with $606m set aside for loan losses. That leaves $1,600m of loan losses to be provided for in the second half - a full $1 billion more than 1H07. Using 1H07 Net Income as a proxy for 2H07 that would mean Net Income of approximately $600m or a FY07 total of approximately $2,200m.

Given the state of housing market and the comment from Killinger about booking lower gain-on-sale income from selling mortgage loans instead of keeping them on the company's balance sheet, 2H07 could be substantially lower than that estimated above.

Still, giving the company the benefit of the doubt of a $2,200m bottom line for FY07 below is what WM's Net Income profile will look like.

Ouch! Looking further ahead, given that housing is expected to drag in FY08 and comments from WM's CEO that WaMu could face "a higher level of charge-offs for the foreseeable future," FY08 is shaping up as another year of profits well below those recorded in the years between 2003 - 2006.

Again, this is another example of a company that has enjoyed a period of abnormally high profits and is about to undergo a step change downward in earnings over the medium term. The only thing missing from this picture is an announcement of job cuts, expect that to be forthcoming over the next few months.