Is Washington Mutual next to fall?

By BusinessWeek

Washington Mutual (WM, news, msgs), which once considered itself the Starbucks (SBUX, news, msgs) of banking, now has a stock price lower than that of a latte.

Shares of the Seattle company, the nation's largest savings and loan, fell 27% to $2 Monday on news that other struggling financial-services giants Lehman Bros. (LEH, news, msgs) and Merrill Lynch (MER, news, msgs) had succumbed to the mortgage meltdown.

WaMu shares rose 16% on Tuesday to close at $2.32 as investors responded to rumors that banking giant JPMorgan Chase (JPM, news, msgs) may make an offer for the company.

The question on many investors' minds is whether WaMu is more like IndyMac, the big bank taken over by the Federal Deposit Insurance Corp. in July, or Wachovia (WB, news, msgs), a troubled institution that under new CEO Robert Steel appears to have won back some investor confidence.

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The man in the spotlight at WaMu is Alan Fishman, a banking-industry veteran who took the job as chief executive on Sept. 8. Fishman replaced Kerry Killinger, a 25-year veteran of the bank, who built WaMu from a small thrift to a national player in mortgages, only to see that business collapse with the housing bust.

A WaMu failure could cost taxpayers $24 billion, figures Richard Bove, an analyst with the brokerage firm Ladenburg Thalmann.

In a 12-minute conference call with investors on Sept. 8, Fishman offered little in the way of new strategy, opting instead for just some words of inspiration for the troops. "I know I need to hit the ground running, and I'm prepared to do that," he said.

Run he did. In Fishman's first week on the job, WaMu announced it was cooperating with the federal Office of Thrift Supervision to provide more information about its operations and business plans.

When credit-rating agency Moody's downgraded the bank to junk-bond status, citing its limited financial flexibility, WaMu pre-announced its earnings for the third quarter in an effort to soothe investors. The bank noted that it had $50 billion in "liquidity" available and capital ratios "significantly above the levels of well-capitalized institutions."

Even so, Fishman has a tough road ahead.

WaMu has $239 billion in real-estate loans, according to Bove. Some $53 billion of those are the dreaded Option ARM loans, where borrowers could skip monthly payments and add what they owed to the principal of their loan. Losses on those could reach 35%, according to Bove.

In July, the analyst put WaMu on a list of several dozen shaky institutions. Bove figured any bank with nonperforming loans greater than 40% of its reserves and equity was in trouble. WaMu's was right at that 40% threshold.

Bove's loss estimates are close to those of other analysts. Fred Cannon, a bank analyst at Keefe, Bruyette & Woods, put out a research note on Monday estimating that WaMu's losses could hit $28 billion this year and next.

If that were the case, the bank would need to raise a further $5 billion in capital, Cannon said.

Where that money would come from is uncertain. The bank has already raised $10 billion in the past year, including $7.2 billion in April from a group of private equity investors led by TPG.

Many analysts feel Fishman's best bet is to find a merger partner, but there are fewer of those around these days. Bank of America's (BAC, news, msgs) acquisitive Chief Executive Kenneth Lewis said Monday that he had no interest in WaMu.

The most likely candidate remains JPMorgan Chase, which allegedly made an $8-per-share offer earlier this year. Nancy Bush, a banking-industry analyst with her own firm, NAB Research, said, "They better hope somebody buys them fast."

Retail banking is a strength

Words of support came, oddly enough, from Moody's analysts after they announced their downgrade last week. David Fanger, a senior vice president at the company, said that WaMu, by its nature as a federally insured institution, has some capital-raising advantages over investment banks. Its two main sources of funding are consumer deposits, which are largely stable even in tough times, and loans from the Federal Home Loan Banks system.

In the S&L crisis of the late 1980s and early '90s, financial institutions received similarly poor credit ratings and were able to survive. Some were later acquired by WaMu during its aggressive expansion over the past two decades.

WaMu has lately been luring retail depositors with interest rates on 13-month certificates of deposit offering 4.5%, at the very high end of the industry.

The company has some strong retail banking positions, including top market-share positions in Southern California, Miami and Seattle.

In his Sept. 8 conference call, Fishman dismissed a question about selling bank branches to raise money as "way early." He also said he didn't immediately foresee a need for the bank to raise additional capital.

Fishman said, "The opportunity to create a great national retail franchise has never been better."

This article was reported and written by Christopher Palmeri for BusinessWeek.