Wednesday, September 24, 2008

The FDIC and WaMu

I have noted that the FDIC seems to take a lot to take over a bank.  It took 42% non performing loans (versus about 4% and WaMu) for the FDIC to take over Ameribank. 

Against that Ameribank had slightly more deposits than loans and so liquidity was not a huge issue.

WaMu’s book is MUCH better than Ameribank – but unfortunately WaMu has much more deposits than loans and hence liquidity is and issue. 

Pretty well my entire email inbox says I am mad buying the preferred of WaMu.  I may well be. 

And here I would love a little birdie to tell me what the FDIC is thinking.  And all I can rely on is my friends from the fourth estate. 

So we go to a little article on WaMu and the FDIC.  This is in that wonderful little journal called “The Deal”, and is really the unsubstantiated gossip from investment bankers who are working on WaMu deals – or people who know investment bankers who are working on WaMu deals.  You can bet that every “source” is talking their book meaning they are trying to lobby government officials, WaMu officials, other investors or whatever to act in a way favourable to themselves.

The sale of troubled thrift Washington Mutual Inc. looks set to come to a head this weekend, according to sources. One source said WaMu could choose a buyer by Thursday, Sept. 25, and announce a deal this weekend.

There are so many sources that say that potential buyers are scouring the books that it’s got to be true.  Things are corroborated by five sources so they are right.  The “choose by Thursday announce this weekend” is insane.  If you chose you announce – and all deals are done on the weekend.  So “one source” in the second sentence is either junior and stupid or being misquoted.  My guess is misquoted.  This sources however doesn’t stick around and the next paragraph quotes another source.

However, another source said the Federal Deposit Insurance Corp. is working in parallel to structure a deal that may allow any buyer to acquire the company without taking on WaMu's toxic portfolio of mortgage securities.

The FDIC would almost certainly be thinking about how they deal with WaMu.  The deal that buys the bank without taking on the mortgage book is called an FDIC takeover.   It is precisely what happened with several deals where the deposit book was sold.  I would lose badly.  However I have never known the FDIC to shop a bank without taking it over first.  There is plenty of evidence that they do these things quickly and on the weekend – surreptitiously coming into town and even booking hotel rooms for their officers in false names.  Besides we know for certain the FDIC is looking because WaMu announced it. 

A WaMu representative declined to comment, but a source close to the situation said that there has been no indication by the FDIC of its intentions.

The FDIC does not show its intentions other than asking for information and business plans from the bank in question.  This source is almost certainly right. 

"If they're running a parallel track, they're doing it without telling the bank," the source said, noting that WaMu's managers do not feel they are operating under a government-imposed deadline to complete a deal. This source added that an auction for the company has been ongoing for five days, and bids have been coming in from multiple parties. The government, the source added, has been watching closely.

Well this has got to be the nub of it.  There is unambiguously an auction.  The bidders have been saying to the government “you guarantee this and we will buy it”.  The FDIC would then (of course) be “watching closely” but would not signal its intentions.  Signalling its intentions would be tantamount to giving government money away – and only Paulson seems to feel entitled to do that. 

"There's no doubt the government is very interested in what happens to WaMu," the source said. An FDIC representative declined to comment, citing agency policy to avoid comment on "open and operating institutions."

Well there is no doubt the FDIC is interested.  WaMu have even confirmed on 8 September when they said:

WaMu also announced that it has entered into a Memorandum of Understanding (MOU) with the Office of Thrift Supervision (OTS) concerning aspects of the bank's operations, principally in several areas of its risk management and compliance functions, including its Bank Secrecy Act compliance program. In addition, WaMu has committed to provide the OTS an updated, multi-year business plan and forecast for its earnings, asset quality, capital and business segment performance. The business plan will not require the company to raise capital, increase liquidity or make changes to the products and services it provides to customers.

Anyway back to the article – I think we can safely conclude that the FDIC is watching, not acting and not signalling its intention.  We can also safely conclude that the FDIC is not insisting that a deal be done this weekend – but would very much relieved if Warren Buffett were to pony up a spare $15 billion.  That is not going to happen – but the deal if it happens this weekend will be a winner for WaMu preferreds because it will NOT involve an FDIC takeover. 

Another sell-side source called the situation fluid, and said the FDIC is not communicating with WaMu or its advisers, which include Goldman, Sachs & Co., Morgan Stanley, and law firm Simpson Thacher & Bartlett LLP. Possible bidders reportedly include Banco Santander SA, Citigroup Inc., J.P. Morgan Chase & Co., Toronto-Dominion Bank and Wells Fargo & Co.

This just confirms what I think is obvious now – which is that the FDIC is not forcing this process – but wants to keep informed.  It is not communicating with WaMu or its advisors – which means that we are not going to get a FORCED sale this weekend.  But the FDIC would love to see a sale. 

A source close to the company said the FDIC is looking at the possibility of selling a stake in the company with an option to buy it later. That could not be confirmed independently.

Well of course they would be looking at this.  They would happily settle for a deal which says “hey you solvent bank, you chip in $5 billion and you have the option to buy the whole thing within twelve months”.  This of course gives WaMu $5 billion now – and that improves the FDIC position.  It also improves the position of the preference shares.  It does NOT improve the position of the common – but then since when has it been the FDIC’s responsibility to care for common shareholders?

Seattle-based WaMu, weighed down by toxic mortgage loans, has been under pressure from federal regulators to raise capital or find a buyer to restore confidence in the bank.

Journalists puzzle me.  I think we got to the point where the Journo clearly believes his source who says that the FDIC has NOT been in contact with WaMu or its advisors.  But he is also saying that they are under pressure from Federal Regulators.  How can they be pressuring you if they are not contacting you?

I don’t doubt the FDIC would like to see things done – and is clearly in touch with business plans – but the Journalist’s sources here are pretty clear – they say the company is for sale and that the FDIC are not day-to-day forcing the process but they are listening to bids which are requesting an FDIC back-stop. 

Concerns about its book of residential mortgages has pushed WaMu's stock to single digits. On Tuesday, it traded at $3.40 a share, down some 92% from $33.54 a share one year ago.

Tell us something that we didn’t know.  But then the stock price does the analysis all the time in this business. 

WaMu this month replaced longtime CEO Kerry Killinger with Alan Fishman, former president and chief operating officer of Philadelphia-based Sovereign Bancorp. WaMu is the country's largest mortgage lender and, although any buyer would benefit from its 2,300 branches and $143 billion in deposits, there are concerns about an expected $19 billion in mortgage losses over the next 2-1/2 years.

Well this journalist does not do numbers.  If losses are “only” 19 billion in the next two and a half years WaMu doesn’t cause anyone any problems.  WaMu as I have pointed out many times has 8 billion in pre-tax, pre-provision earnings.  19 billion gets neatly absorbed over two and a half years and the capital ratios at the end of the period don’t even look stretched.  The problem with WaMu is not 19 billion in losses.  It’s the possibility of 30 or even 40 billion in losses.

But most of all I am sure that the Journo knows nothing when he makes statements like ”WaMu is the nation’s largest mortgage lender”.  I am not sure that there ever was a time that was true.  Certainly most the time the biggest lenders were Fannie and Freddie in that order, and the biggest originator was Countrywide. 

The data for WaMu now is that it has almost stopped originating for its own book.  In the first quarter of 06 it originated $51 billion total – and less than half was GSE conforming loans.  In the second quarter of 08 it originated only $9 billion – and three quarters of this was conforming loans.  For all reasonable purposes Washington Mutual has ceased to be a mortgage lender and most certainly is not now the “country’s largest mortgage lender” as our friendly journalist purports.  The fact that it has ceased being a mortgage lender tells you there really is liquidity issues here...

"We believe WaMu's capital is insufficient to absorb its mortgage losses," Moody's Investors Service senior credit officer Craig Emrick said Monday. Moody's lowered WaMu's financial strength rating to E from D+ and placed the debt ratings on review for possible downgrade on Tuesday, saying the thrift has "severe asset-quality issues."

Moody’s don’t believe the 19 billion either.   

Attempts to either inject capital or sell WaMu received a boost last week, when private equity firm TPG Capital waived an anti-dilution protection for its investment in the thrift. The move appeared to be an acknowledgment that the troubled savings and loan may need to raise more than $500 million of additional capital.

On paper, TPG had lost $1.55 billion of the $2 billion it invested in WaMu in April. Its investment came in equal portions from its fifth and sixth buyout funds and from a $6 billion fund it raised this year to make distressed investments in the financial sector, according to a TPG investor.

Ok, we know the situation is desperate though.  TPG have access to the books.  I don’t.  They waived their anti-dilution clause so they are clearly willing to get diluted to preserve some value in their position.  That is the real indicator of problems here.  The waiving of the anti-dilution clause is however a GOOD thing for the preferred holders.  Extra equity capital (diluting but not wiping out TPG) strengthens, not weakens the position of the preferreds.  However TPG are also saying "get me out of here" and given that they have access to the books I should not be comforted by that.

In a research report, Keefe, Bruyette & Woods Inc. said last week that WaMu might have enough reserves to weather future losses, but that if the losses intensify it would need new capital that it would find increasingly hard to raise.

That is fill.  Its fill however consistent with my thesis.  If the losses are “only 19 billion WaMu has enough capital to survive.  If more – then problems. 

According to one banking source not involved in the sale process, any buyer would face immediate mark-to-market pressures from WaMu's mortgage portfolio. Noting that purchase accounting rules would force a buyer to immediately mark the portfolio to market prices, the banker said that the hole in WaMu's balance sheet upon purchase could be as high as $52 billion. On the other hand, if the bank was not sold, but recapitalized, the hole would be anywhere from $12 billion to $19 billion.

The first sentence gives it away.  WaMu is a “sale process” because this journo is distinguishing between people in the know and people like me who are just interested outside observers.  [Unfortunately the said journo is not in the know.] 

The outside source however has nailed the obvious problem with “buying WaMu” which is that WaMu’s assets are mismarked – and the mismark would be exposed by any purchase.  A purchase at a token sum ($1 a share) would solve many of these problems though because there is a lot of “stated capital” left at WaMu even if there is not much real capital. 

A deal whereby someone injects equity and retains an option to purchase solves the mark-to-market problem described.  That might be the reason that deals are taking the forms stated.  A deal where the FDIC warrants that the assets are not going to be $40 billion bad (even with a fee paid to the FDIC) also solves the marking problem.  I am not sure whether the FDIC has the legislative power to cut such a deal.

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