InsideWaMu

I’ll blog a more detailed writeup over the weekend after going through the WaMu earnings release, but here are my quick thoughts:

• $5.9B loan loss provision this quarter?  Wow.  Even scarier, the residential provisioning model more or less assumed 20% frequency and 50% loss severity on outstanding residential pool.  This means - unless I’m missing something - 1 in 5 mortgages still in the portfolio will default and half the value of those mortgage will be lost.  Are you kidding me?  How were these loans ever approved in the first place??
• Those trends in the credit attachment sure don’t look good, and show NO signs of an inflection point.  How much money would you pay to see those charts in monthly not quarterly periods though?
• Anyone else chuckle when prepared remarks ran a full 45 minutes of the scheduled hour call?  At about minute 43 I had visions of Killinger going the entire hour without opening the floor to questions and was about to give him a CEO of the year award.  But even though he wussed out minute 45, it was nice to extend the call instead of screwing the analysts and only giving them 15 minutes of Q&A.
• I hear absolutely great things about John McMurray from everyone I talk to but he had a bit of a rough first few minutes on the call.   Anyone out there know if McMurray was involved on Countrywide earnings calls?  Even though it was an honest mixup, saying WaMu is seeing 100% loss severity on first-lien non performing loans is enough to give WaMu leadership and TPG investors a heart attack.  Saying it on an earnings call is even scarier.  Fortunately as we’ll discuss later it seems all of the WaMu analysts on the call were either a) asleep, b) high as study abroad students in an Amsterdam weed bar or c) shockingly compassionate about the mixup (very unlikely though given their behavior on prior calls).  McMurray recovered very nicely though on a later question showing a sense of humor explaining that he didn’t explain things clearly at all the first time.  He also really knew the credit numbers well and in my opinion dodged a question with the skill of a grizzled earnings call veteran on why second-lien loans are being carried as NPA’s vs charge-off even though he’d said earlier second-lien loans are seeing 100% loss severity.  Yes - why indeed?  All in all, we should look forward to hearing from him on future calls.
• My quick math on Tom Casey’s updated earnings drivers got to $4.5B of pretax, preprovision income.  Sounds good until you realize there’s already been $9B of provision through Q2 and unofficially I’d guess at least $5B more rest of the year.  So WaMu will have pretax net income of -$10B this year?  Yikes.  I’m not the smartest with tax laws, but at least they should get 40% of it back as a tax credit this year, or an asset to offset future earnings.
• Anyone else catch Kerry’s freudian slip when asked about his long-term vision for the company?  He stated a few objectives and then said “So we have, I think, a very clear plan for the next 18 … next period of time that we see to get back to the level of profitability that we should have.”  Sounds like KK is on an 18 month timetable to get the company back clicking on all cylinders.  I’m sure that’s not related at all to TPG being locked into their capital infusion for 18 months, then being able to sell a 1/18th stake for each month for months 19-36.  Good news is it sounds like WM will be independent for at least 18 months - provided credit doesn’t completely implode.  Though odds of WaMu being independent past 18 months looks a lot longer.
• Were all of the analysts hitting the bong before the call?  Was there seriously not a single question about Retail?  Only two about card and none on Commercial?  No questions on post-IndyMac deposit runoff?  No questions on how after placing all your eggs in the Retail segment basket you turn around and change retail presidents?
• And speaking of blazed-out analysts, did Louise Pitt of Goldman Sachs at the end of the call really ask if a pending Moody’s downgrade would lead to a cut in WaMu’s dividend?  Hello?!?  Do you realize dividend is only a penny/quarter now?  At a penny a share and ~2 billion common shares outstanding after the TPG capital infusion WaMu’s dividend runs $20MM a quarter.  If we’re ever to point where $20MM in capital will make or break WaMu’s capital/insolvency ratios there’ll be a lot bigger problems to worry about than discounted present value of a $20MM/qtr revenue stream.

Questions?  What did you think of the call?  What were your takeaways?

One of the joys of being a WaMu shareholder, employee or interested party is listening to the hourlong earnings call each quarter.  If you are any of the above you really should call in Tuesday July 22nd at 2:00PM Pacific.  Webcasts are available at http://www.wamu.com/ir.

These usually proceed with precision of a Swiss timepiece.

1. Introduction by Alan Magleby IR maestro
2. Opening comments by Kerry noting the “unprecedented turmoil” of the current mortgage market.  (If the last four quarters have each been unprecedented, at what point does it become precedented though?)
3. A comment on how Home Loans had a very rough quarter and lost another chunk of money larger than the GDP of most Pacific Island countries (it has been a period of unprecedented turmoil after all), but that this latest turnaround plan is going to work and Home Loans will turn a profit in next 12 months (Project Restart is the latest of many turnaround plans - from my knowledge of the extremely limited scope of it though, I promise there will be a Project Reboot, Restore, Rescope or Resize next quarter).
4. A comment by Kerry that the other three segments are churning along nicely though and the “diversified revenue streams” from each segment will allow the company to see these unprecedented times through.
5. A very competent runthrough of financials by CFO Casey (I really do think we’re lucky to have him still at WM - and most of the analyst reports I’ve read agree on that).
6. Followed by the unveiling of the latest WM earnings drivers.  Now hopefully the second the call starts you were already skimming ahead in the prepared notes and running the drivers through your calculator to figure out what “the number” for this year will be, so when Tom gets to the drivers you’re a step ahead.  It is a very easy calculation to do and can add another level of fun to the call.  Two quarters ago I ran the numbers 30 seconds into call and realized WM was not scheduled to turn a profit while IR man Alan was still reading the disclaimers.  Kerry’s intro was that much more interesting once I knew that little tidbit…
7. Tom hands off back to Kerry to discuss some political/external issues,
8. And then at the bottom of the hour the fun begins with analyst questions.  Pay attention to Tom on these, he is like Michael Jordan in the mid-90’s on these questions.  The man never gets stumped, often corrects the analysts questions and knows every number by heart.  If asked to state WM exposure to loans in zipcode 90210, with a FICO under 700, that have reset in last six months, with two children in residence, and have a palm tree on left side of the driveway, Tom wouldn’t just know the answer he’d give them the splits between option ARM’s and regular ARMs - by memory.  The man is a beast and the analysts are as ineffective as Bryon Russell trying to trip up MJ in the Finals.  Just don’t ask Tom to provide NIM splits by month if you know what’s good for you.
9. Another fun item to watch is how many analyst questions Rotella jumps in to answer with the prepared talking points.  I’m not knocking him - it’s his job to hammer these home for the analysts, and he does it well, but it is absolutely hilarious.  You’ll know they’re talking points when he answers unrelated questions such as: credit card production per retail store and a question on subprime HELOC exposure with >75% the same answer.  What is especially funny is that the talking points will be unrelated to either question (did you know that WM has plenty of liquidity and capital?  And that our commercial segment had a kickass quarter?).  So loyal readers, keep score at home and as you see how many of these points will be hit on tomorrows earnings call ask yourself if they did or didn’t just replay the first 30 minutes from an earlier earnings call.

Rotella’s internal blog has been abuzz this week with stories from the field of nervous depositors.  Yahoo and the other online boards are counting down the days until WaMu is taken over by the FDIC / OTS.  We’ll find out for sure on the July 22nd earnings call just how many deposits have run off since the IndyMac collapse, but taking a step back could WaMu really be going down?  Do the numbers add up? Short answer: No.  Long answer: Let’s take a look at the evidence.

As of March 31 WaMu had $188B in total deposits with $152B in retail deposits and $46B in FDIC uninsured deposits (from the Thrift Financial Reports - enter in Washington Mutual, look in the “DI” Deposits report at lineitem DI210). 

That is a strong position but IndyMac also had decent liquidity on March 31.  After all that was over 135 days ago.  However earlier this week WM preannounced in a press release that as of June 30th they have $150B in retail deposits and more than $40B in “excess liquidity”. 

So deposits clearly hadn’t deteriorated noticeably as of June 30th (and remember Sen. Schumer’s letter that started IndyMac’s downfall was June 26).  $40B in excess liquidity and $46B in uninsured deposits sounds decent, ought to be able to cover a minor run on bank (if such a thing exists) but it certainly should cause a little alarm since there’s potential for disaster if things go wrong.  But let’s dig a little deeper.  With $188B in total deposits and $150B in retail/small business deposits, that leaves $38B in wholesale, escrow and brokered deposits which generally are a) much larger than retail on a per-account basis,  b) locked up for longer durations and c) deposited by more cool-headed customers than retail customers.  Conservatively assuming that 50% of these non-retail deposits are uninsured ($19B) and are unable/don’t see the need to liquidate in a bankrun, that leaves $27B in uninsured retail deposits with $40B in excess liquidity.  Is the heart-rate returning to normal now?  That would be a lot closer call than anyone would hope but WaMu would still be solvent even if all $27B in uninsured retail deposits left the bank.

But, Flash, you ask.  What about the customers who are insured but withdraw their money anyways?  And there’s the rub.  Despite fact that all insured IndyMac customers were unimpacted; they had their money available the next business day, their debit cards still work and their deposit interest rates haven’t changed, people would get caught up in a real WaMu deposit panic and yank their money out.  Many did with IndyMac though largely only after Sen Schumer released his letter on June 26 and the regular media started beating the IndyMac drum.  Honestly, how many times before they collapsed had you read stories like this, and read about IndyMac losing roughly 1% of deposits a day after June 26.

That distinct lack of deposit hysteria in the broad media about WaMu (if WaMu was losing 1% of deposits a day ($1.9B) you can be sure it’d be in every paper every day, and you can be even more sure Wells, Chase and B of A would be running ads encouraging WM customers to jump ship), along with other anecdotes such as the lack of a line at any WaMu store you enter (and it’s not just me), WaMu refusing to accept IndyMac cashiers checks with a reasonable hold-time (8 weeks are you kidding me?  Despite being backed by the Federal government?), and WaMu deposit rates roughly 0.5% below the market leaders in the West Coast states would seem to indicate that WaMu is not nearly as hard up for deposits as the blogosphere would have you believe; and accordingly, that the risk of everyday insured depositors fleeing WM is nowhere near as real as the message boards would have you believe.

On the flipside for the case against WaMu IndyMac itself was denying it was about to collapse 10 days before it did, there is a belief that WM is among the weaker banks around, and perception can be reality in financial crises (ask Jimmy Caine at Bear, or anyone in IndyMac’s executive suite).  Maybe that’s enough to trump the actual numbers stated above.  Only time will tell.

So what do you think?  What are odds WaMu is really having a bank run?  And for the record while I do work at WaMu, this is not an official blog and I am certainly not a WaMu apologist (read my other posts!!).  Feel free to post comments.  By virtue of reading my blog you are not only devilishly handsome with a rapier wit, but you clearly posses above average intellect so I can’t wait to hear your thoughts.

One is former Democratic presidential candidate.  The other is a preeminent capitalist.  But is it possible that Howard Dean and our CFO Tom Casey were separated at birth?  Take a look and try to tell yourself they’re not related. 

Which other WaMulians have a celebrity doppelganger?  When they make WaMu: The Movie who will play Kerry, Steve and the other execs? 

Imagine the preview with the deep voice movie guy: “in a world where crackwhores without incomes qualified for $700k option arms, only one man could stop the insanity” cue Howard Dean playing Tom Casey talking some jibberish about liquidity, defaults and covered bonds.

Maybe they could even then get Tom Casey to then play Howard Dean, as the head of a political party trying to force WaMu and other lenders to stop foreclosures, and maybe Jay Buhner could play Hank Paulson?

How could it not be a blockbuster?

One of the most amazing things about the recent credit crunch is how it blindsided nearly everyone in the industry except John Paulson  (who turned a nifty $3.7B profit shorting subprime bonds in ‘07).  CEO’s heads have rolled, bigger banks are starting to fail, and Wachovia just admitted Friday that buying Golden West for $25B was a mistake.

For those of us with pieces of our net worth tied up in WaMu stock we also know all too well that that WaMu management was also caught offguard.  While perusing a recent 10Q I was reminded WM bought back $2.8B of stock in Q1 ‘07 at $45.55 a share at a time when we know they knew NPA’s were starting to climb.  In retrospect this was probably not the wisest allocation of capital.  I went back and tallied up all the share repurchases since 12/31/05 when talk of the housing bubble (and the resulting bubble pop) began to intensify.

Over that period WaMu repurchased $6.5B in stock at average price of $44.18.  Does the $6.5B number sound familiar?  It is fairly close to the $7B in stock sold to TPG & co at $8.75 a share this past April (I’m leaving out the $2.9B in preferred stock issued in December - a separate issue).  So in effect, Washington Mutual purchased 148 million shares for $6.5B (at $44.18/share); then realized less than a year later after the largest purchase, that we now would need the capital to survive, and turned around selling stock to get back $7B in capital (selling at $8.75/share).  By my math this transaction cost WaMu $35.43 a share, and works out to a $5B transfer of wealth from existing shareholders to TPG & co; simply by timing the market wrong and buying high/selling low. 

This is particularly galling on two counts: WaMu should have had among the top 5 best “inside information” and knowledge of the mortgage market by virtue of their market share, reams of data available to them to model potential losses, their internal historical data on mortgage servicing, etc - yet they completely misread the market.

Even more galling, with exception of Kerry being stripped of Chairman title and two board members leaving there have evidently been no ramifications for such a colossal screwjob to the shareholders.  I’m sorry but Ron Cathcart and James Corcoran were not the guys making the calls on balance sheet/capital management.  Unless TPG is playing a much stronger hand in the boardroom than I’m seeing at my level, and with peers in the bank I talk to, by all accounts the same people who made those capital mismanagement calls will be the ones making calls in the near future.  And with that thought I need to go drink. 

If anyone reading this blog was involved with the decisioning back in ‘06 and ‘07 to buy back shares I’d love to hear your side of the story and other considerations people were thinking back then.  Feel free to comment, or email me if you’d like to stay confidential.