Tuesday, 11 December 2007

WaMu To Bleed Red Ink In 2008

Just over a month ago when Washington Mutual announced they were upping their loan loss provisions, I noted that they would likely make a small loss in 4Q08 and be lucky to make a profit at all in 2008. After yesterday's announcement it is no longer likely but a certainty: From marketwatch.com:

WaMu subprime exit results in over 3,000 job cuts

Washington Mutual Inc. said late Monday it will leave the subprime lending business, eliminating 3,150 jobs, while it shores up an increasingly shaky financial position by slashing its dividend by over two-thirds and selling preferred stock.

WaMu (WM) said it will stop lending through its subprime mortgage channel; close roughly 190 of its 336 home loan centers and sales offices; shut down nine home loan processing and call centers and cut about 2,600 home loan positions and 550 corporate and support employees.

The reductions will cost $140 million in the fourth quarter, but will lower non-interest expenses by about $500 million next year, WaMu said. It will now focus on offering home loans directly to more creditworthy customers through its retail branch network.

WaMu said it would cut its quarterly dividend to 15 cents a share from 56 cents a share, while the sale of convertible preferred stock will raise $2.5 billion, the lender said....

.... Mortgage losses will also likely remain high, WaMu said. Fourth-quarter provisions for loan losses will be $1.5 billion to $1.6 billion. Provisions will rise to a range of $1.8 billion to $2 billion in the first quarter of 2008.

"The first quarter range reflects the company's current view that prevailing adverse conditions in the credit and housing markets will persist through 2008," WaMu said. "The company also currently expects quarterly loan loss provisions through the end of 2008 to remain elevated."

So much for the argument put forth by a number of analysts of what good value WaMu was since it had such a high dividend yield. Today's announcement should put investors on notice that those kind of yields cannot be relied upon for distressed companies such as WaMu.

Back in November I estimated that WM would make about a -$100m loss based on a provision for loan losses of $1.3 billion in the 4th quarter. If we take the middle of the new range of between $1.5 - $1.6 billion and add the $140 billion of costs related to restructuring WM is likely to make a loss of about -$500m for 4Q07. That would put WaMu's FY07 profit in the region of $1.3 billion, less than half of the $3.6 billion they made in 2006.

Now if you think that is a miserable result check out the implications for FY08. WaMu now says provision for loan losses will be in the region of $1.8 - $2.0 billion for 1Q08 and "The company also currently expects quarterly loan loss provisions through the end of 2008 to remain elevated."

The graph above takes the lower of the 1Q08 range of $1.8 billion and multiplies it by 4 to get a $7.2 billion loan loss provision for 2008. That would mean a loss of at least -$2.0 billion taking into account the $500m expected costs savings and based on a year comparable to 2006. That is probably being generous since the mortgage market is expected to shrink by more than half to less than $1.5 trillion next year and the fact that WaMu will be a much smaller entity.

Granted that the word 'elevated' does not mean that the 1Q08 loan loss provisions will be as high for the entirety of 2008 however even a loan loss provision of $5 billion in FY08 would mean a modest loss for WaMu.

This is a lesson in the dangers of bottom fishing. As the market rallied yesterday like a druggie on the verge of his next hit the financial landscape continues to deteriorate. How long this suckers rally lasts will depend on how much the Fed cuts interest rates in the US today. However that doesn't make it any less of a sucker's rally.