Nothing but Red Ink for WaMu

As posted here last week, Washington Mutual (WM) continues to go from bad to worse. In November I raised the possibility that WM would struggle to post a profit for 2008 as loan loss priovisions would gobble up their bottom line. Late Tuesday that scenario became worse when the cmpany report a loss of $1.14 billion for 1Q08. From marketwatch.com:

WaMu reports $1.14 billion quarterly net loss Lender sets aside $3.51 bln of provisions; finance committee director resigns

Washington Mutual Inc. reported a $1.14 billion first-quarter net loss late Tuesday as the lender suffered from the mortgage meltdown and broader credit crunch....

....The Seattle-based company also said it closed a previously announced deal to raise $7 billion from a group of investors led by private-equity firm Texas Pacific Group. It also reported "steady" results from its retail banking, credit card and commercial businesses.

WaMu shares edged 28 cents higher to $10.60 in after-hours trading on Tuesday. The stock gained 3% during regular trading.

WaMu said it lost $1.14 billion, or $1.40 a share, in the period, vs. net income of $784 million, or 86 cents a share, during the first quarter of 2007.

The company (WM) set aside $3.51 billion of provisions to cover potential loan losses as the economy weakens and home values continue to slide. That's more than double the amount the lender set aside in the fourth quarter of 2007.

The chart above tells a very nasty story, even more nasty than the one told by Wachovia just a few days ago. It now looks likely that WaMu will rack up losses in the billions in 2008.

Also consider this. Mortgage rests peaked in March of this year. It typically takes 6 months from the reset date until foreclosure. Thus loan loss provisions will remain extremely elevated for the remainder of this year and well into next.

Already it is becoming obvious that 2009 will be a tough year for companies like WaMu and Wachovia and that some hope of a return to a normal operating environment will be pushed out until at least 2010 but possibly even further.

Is the RBA done raising rates?

The RBA today released the minutes of their Monetary Policy Meeting on April 1st. The tone of the minutes seemed to indicate that the RBA is done raising rates for now and quite possibly for the forseeable future. Below are some of the highlights:

On the domestic economy:

Members were informed that the CPI data for the March quarter, to be released towards the end of April, were likely to show inflation of around 4 per cent on a year-ended basis in the March quarter. A large quarterly increase was expected partly because of recent rises in retail petrol prices. Underlying inflation was also expected to rise in year-ended terms in the March quarter, before declining over time. The staff’s inflation forecast through to 2010 would be revised after the release of the March quarter CPI, but the preliminary assessment, based on current policy settings, was that inflation on both a CPI and underlying basis would fall by a little more than earlier thought over the next two to three years. This was premised on demand growth slowing sufficiently to reduce capacity pressures. Members recognised that a considerable degree of uncertainty continued to surround the outlook for both demand and inflation.

On the outlook for Monetary policy:

Members noted that the economy continued to be affected by a number of cross-currents. Large increases in real income were likely to flow from further increases in the terms of trade, foreshadowed by recent contract price negotiations for key bulk commodities. On the other hand, the slowing global economy and tighter financial conditions in Australia were likely to reduce expansionary forces on the economy. Members judged that, taking account of the additional rises in funding costs that banks had passed on to borrowers, the current stance of monetary policy was exerting a significant restraining influence on both households and businesses. Further, there had been some tightening in credit standards for more risky borrowers.

These developments were working to foster the moderation in demand growth that was needed to ease the pressure on inflation. Provided this moderation continued, members expected inflation to decline over time, though they recognised that there were significant risks in both directions. Members also noted that in the short term inflation was likely to remain relatively high, with both the CPI and underlying measures expected to rise further in year-ended terms in the March quarter.

The important parts are in bold. Basically the RBA sees evidence that the economy is slowing and believe that interest rate rises are having the desired restraining effect on the economy. However they also acknowledge that risks remain that inflation could get out of hand.

The RBA is essesntially hedging their bets. If things play out as they expect and the Australian economy slows then we may not see another rate rise in the current cycle. However further rate rises cannot be ruled out if inflation stays stubbornly high.

Wachovia's Turn To Dilute Shareholder Wealth

Last week it was Washington Mutual (WM) this week it's Wachovia's (WB) turn to slash their dividend, dilute the crap out of existing shareholders by raising new capital and raise their loan loss provisions to parabolic proportions: From marketwatch.com

Wachovia to raise $7 billion of capital, slash payout
Banking giant posts loss and increases loan-loss provisions

Wachovia Corp said on Monday that it would raise $7 billion of capital and slash its dividend as it posted a $350 million first-quarter net loss and a higher loan-loss provision....

....Wachovia's need for capital comes only two months after the Charlotte, N.C., bank raised $3.5 billion through a preferred-stock sale.

At the time, The Wall Street Journal reported, the company told shareholders that those funds made the company more confident that it was well positioned in 2008, and Wachovia officials denied that dividend payments would be reduced to conserve cash.

But on Monday the company said it cut its dividend to 37.5 cents a share from 64 cents, payable June 16 to holders of record May 30. The move will preserve $2 billion of capital annually.

Reflecting preferred-dividend payments, Wachovia posted a loss of $393 million, or 20 cents a share, compared with net income of $2.3 billion, or $1.20, in the year-earlier period. Revenue fell 4.5% to $7.9 billion.

"The precipitous decline in housing-market conditions and unprecedented changes in consumer behavior prompted us to update our credit-reserve modeling and rely less heavily on historical trends to forecast losses. As a result, we have substantially increased our reserves," said Ken Thompson, Wachovia's chief executive officer, in a statement.

The provision for credit losses in the 2008 first quarter was $2.83 billion, compared with $1.5 billion in the fourth quarter and $177 million in the year-earlier first period.

The chart speaks for itself, loan loss provisions are growing to astronomical proportions for a number of banks. Whilst many have been focusing on the dollar amount of writedowns, they have neglected the staggering increases in loan loss provisions.

The enormous hike in provisions is going to eat into profits for a number of banks for the rest of 2008 and into 2009. Returning to some sense of normalcy for some of these banks could be 2 - 3 years away.

US Consumer Sentiment Hits 26 Year Low

Consumer Sentiment plunged to levels not seen since 1982 according to the latest to the latest Michigan survey. If that translates into a 1982 like recession, things could get really ugly. From marketwatch.com:

Consumer sentiment plunges to 26-year-low

Consumer sentiment sunk to its lowest level in 26 years in early April, according to a report on Friday from University of Michigan/Reuters, as worries about the economy, unemployment and inflation deflated hopes for future.

U.S. consumer sentiment index fell to 63.2 in early April from 69.5 in March. Sentiment is at its lowest level since March 1982. Economists surveyed by MarketWatch were looking for an April result of 68.8.

The expectations index fell to 53.4 in April -- the lowest since November 1990 -- from 60.1 in March, noted Ian Shepherdson, chief U.S. economist at High Frequency Economics. There's no sign that confidence bottomed out yet, he said.

"If sustained at this level, the index is consistent with a 0.5% year-over-year rate of outright decline in real consumption," Shepherdson wrote. "Bearing in mind that more than half of all consumption is non-discretionary (food, energy, housing, etc) this means discretionary spending will fall at a 1% rate or more, something we haven't seen since 1991."

Consumers have been more cautious about spending, according to recent confidence readings. Last month, after reporting a drop in consumer sentiment, Richard Curtin, the director of the survey, said a recession has occurred whenever the index has declined as much as it has fallen during the past year.

The current conditions index fell to 78.4 in April from 84.2 in March. The one-year inflation expectation rose to 4.8% from 4.3%.

"One-year inflation expectations have moved above the post-Katrina spike to the highest levels seen since 1982," wrote John Ryding, U.S. chief economist for Bear Stearns.

Elsewhere Friday, the Labor Department reported that a surge in prices for imported petroleum pushed prices of goods imported into the U.S. higher by 2.8% in March, the most since November 2007.

PWK Upgrades 2009 Guidance

Pipe Networks continues to go from strength to strength upgrading their FY09 earnings forecast to a range between $11 - $12m up from $10.7m previously. The company stated that by July this year, recurring revenues will increase to $3.5m per month up from $2.0m per month currently.

The company also announced that they are currently conducting due diligence on a strategic acquisition in the range of $1m but are unable to release any further details at this time.

At a time when earnings at listed companies may start to feel some pressure Pipe Networks continues to power ahead. Of course the key risk is still the company's ability to execute the Guam to Sydney pipeline. However, given the company's excellent track record on delivering on forecasts they overwhelmingly get my vote of confidence.

Citigroup - Less Than Meets The Eye

Citigroup has managed to get rid of $12 billion in loans it doesn't want for what seems to be a reasonable price, from Rueters:

Citi financing its $12 bln sale of loans: source

Citigroup Inc's (C.N: Quote, Profile, Research) plan to sell $12 billion of loans and bonds made to private equity firms is seen as a positive for the bank and the loan market, but the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.

That's because Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.

Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar.

"The bank still has some of the same risk, but they have a lot of equity in front of them, and it's not on their balance sheet anymore," said David Bailin, head of alternative investments at Bank of America, speaking at the Reuters Hedge Funds and Private Equity Summit. Bailin had no direct knowledge of the Citi deal.

After the sale, Citi would no longer have to mark down the original leveraged loans if their value falls further, a real possibility in the currently disrupted credit markets. It also allows the bank to confirm the recorded values of other leveraged loans in its portfolio.

Or is it a reasonable price? The part in bold is the most interesting. Basically Citi is lending private equity money to buy these loans at around $0.90 on the dollar. What isn't mentioned is that Citi has agreed to indemnify the buyers of the first 20% of losses.

So the real price is somewhere between $0.70 - $0.90. Mr Practical summed up the situation best on Minyanville's Buzz and Banter yesterday:

Less than meets the eye...

As investors bid up the Citigroup (C) stock price early on the news that the bank sold $12 billion of bad loans at not too much of a discount, perhaps they should look closer at the deal.

In order to get that price, C had to agree to indemnify the buyers of the first 20% of losses.

Citi obviously did the deal at this artificial price so that it would not have to mark down too significantly the rest of its portfolio. Not to let facts get in the way, but the price it sold the loans at, if you include the indemnification, is very poor.

Risk is high and growing.

Anything to avoid real price discovery is the name of the game. Even whilst Citi dodges another bullet, I suspect that will still need to eliminate their dividend to shore up yet more capital.

WaMu's Great Dilution

I've written repeatedly here about the woes of Washington Mutual. Back in November I noted that Wamu's loan loss provisions would wipe out their entire profit for 2008. That now looks like an optimistic scenario.

The company now expects $3.5 billion in loan loss provision for 1Q08 up from the previously forecast $3 billion and expects costs of $1.4 billion from uncollectible loans. On top of that the company slashed its dividend from $0.15 to $0.01 and plans to lay off 3,000 employees.

Back when Bear Stearns decided to give itself away I noted that it would be worth keeping an eye on WaMu as it was a prime candidate for chapter 11 or to be taken out. Today we learnt that WaMu rejected an offer from JP Morgan to be taken out. Probably because they got a lifeline in the form of $7 billion in capital yesterday.

The company will issue 804 million new shares which amounts to almost a doubling of the number of shares outstanding. That is a massive dilution for existing shareholders who are already staring down the barrel of a 75% drop in the share price. Of course the stock rallied on the news as bankruptcy fears have receeded.

So the bottom callers continue to believe that this another sign that the end is near. However Minyan Peter at Minyanville had a different view yesterday:

WaMu's $7 billion Share Offering Doesn't Spell Bottom

Washington Mutual's (WM) capital raising effort is being cited a sign of a healthy bottoming process.

Despite how it may be portrayed by others in the media, this is an all “common” deal. The distinction between common and preferred is solely due to the number of available shares. Once the existing shareholders approve more common shares, the “contingently” convertible will become common at the same $8.75 per share price.

As I have written previously, when things get worse, banks have to issue common stock. Because of how the bank regulations work, preferred stock “credit” for capital purposes is limited by the amount of common stock below it. With its first quarter writedowns, WaMu had no choice. And importantly, many other banks that have been to the straight preferred and convertible preferred troughs recently in size are in the same position.

Big losses increasingly mean flat out dilution. Ask UBS (UBS), ask Societe Generale. That the market is celebrating all this as a sign of the bottom confounds me. Closer to the bottom? – absolutely, but bottoms are when deals don’t happen.

Be careful about the phrase “increased due to investor demand” – a near 30% discount to market is bound to drum up a little interest. Even with the deal’s generous terms, some of the investors were given additional warrants for agreeing to a five year lock up. Don’t underestimate the role of the regulators telling WaMu how much capital the bank needed to avoid action.

Finally, notwithstanding the company’s current $12.00 trading price, $8.75 is now the ceiling for additional WaMu common equity, should the bank need to come back.

I have a lot of respect for the team at TPG and have no doubt that based on their prior experiences in banking crises, WAMU looks cheap, particularly at $8.75. I would emphasize, however, the phrase “based on their prior experiences in banking crises.”

I think the problem for most market participants right now is that the assumption is what we're experiencing looks something like “their prior experiences in banking crises.” And to me that's why we have seen such a big rally over the past two weeks – because, based on prior experience a rally feels very right, right about now.

But for all the reasons I have shared before, this one is different.