High-yield/macroeconomics (fka YIELD)

[DewDiligence]

Washington Mutual's Earnings Suffer from Mortgage Woes

[Investors continue to ignore these “one time” write-offs as though they were really non-recurring. I see these kinds of write-offs as part and parcel of the business and hence ignoring them in earnings projections overstates the company’s profit-generating potential.]

http://online.wsj.com/article/SB119158679781650088.html

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By LINGLING WEI
October 5, 2007 12:16 p.m.

NEW YORK -- Washington Mutual Inc., the largest U.S. savings and loan, said Friday it expects a 75% drop in third-quarter net income [ouch], joining other financial-services firms reporting big writedowns and loan-loss provisions to reflect this summer's credit-market storm and worsening loan quality.

At the same time, Chief Executive Kerry Killinger said the company "continues to have the liquidity and capital" to grow its business and support its current dividend. "We look forward to an improved fourth quarter," he said. Shares of WaMu, which have declined 22% this year, recently were up 64 cents, or 1.8%, to $35.92.

The profit warning by the Seattle-based WaMu, which centered on non-cash charges, followed those by other large banks in recent days. For instance, Citigroup Inc., UBS AG, Merrill Lynch & Co. all said they would record multibillion-dollar write-downs for the third quarter to reflect, in part, declined values in mortgage loans and bonds as soaring delinquencies have driven investors to pull back from the home-loan markets.

Shares of those banks have rebounded as investors look at those charges as a sign that the worst might be over. "Each one of these companies are writing off as much as they can so that they can clean up their books' for future quarters,” said analyst Richard Bove at Punk Ziegel & Co.

The analyst continues to recommend investors to buy WaMu shares, noting that the dividend on the stock "is likely to be maintained or even increased." WaMu in July raised its cash dividend for 48 straight times, to 56 cents a share.

The company said it would set aside $975 million in the third quarter to cover future loan losses, primarily reflecting the weakening credit quality of subprime mortgages -- or those to people with low credit profiles -- and home-equity loans. That reserve figure exceeds by about $550 million the amount of loans it expects to charge off as uncollectible. WaMu "has more subprime-mortgage exposure than any other bank we follow and continues to face challenges in its overall mortgage-lending business," Bear Stearns analysts wrote in a research note. The firm now expects WaMu to earn 20 cents a share in the quarter ended in September, down from its previous view of 66 cents a share.

Subprime mortgages, including loans funded by WaMu itself and those it purchased from other lenders, accounted for 6% of the company's total assets in the second quarter. WaMu, which ranks sixth among the nation's home-mortgage lenders based on volumes, has expected subprime loans to range between 5% and 10% of its assets.

Home-equity and other consumer loans represented 18% of its assets in the quarter ended in June. Home-equity loans, also known as "second-lien" loans and available mostly to relatively creditworthy borrowers, are taken out by people on homes that have already been pledged as collateral on another mortgage. Many lenders, including Countrywide Financial Corp., Citigroup and Bank of America Corp., in recent months have warned about rising late-payments on those loans amid the housing downturn.

In addition, WaMu said it would write down by a total of $410 million the value of mortgage loans and related securities it holds. During the quarter, investors' resistance to buying home mortgages forced the company to shift about $17 billion of loans it intended to sell to its investment portfolio and subsequently cut the value of those loans.

WaMu has been reducing its reliance on the home-loan business over the past year and a half, in light of the slowing U.S. housing market, rising past-due mortgages and growing investor aversion to risky home loans. Instead, it has bulked up its retail-banking operations and ventured into credit-card services. CEO Killinger said he continues to expect "good operating performance" this quarter in the company's retail-banking, card-services and commercial businesses.

WaMu reported net income of $748 million, or 77 cents a share, in the year-earlier period. It is set to report its third-quarter results on Oct. 17.
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