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WaMu's Bonus Guidelines Vague on Credit

Laurie Kulikowski

Washington Mutual(WM) executives stand to gain handsomely through 2008 bonuses if they help turn the struggling bank around, according to a regulatory filing.

But WaMu's potential largess has at least one analyst questioning why more concrete expectations for executives' credit management skills were not laid out among the four components on which this year's cash bonuses will be based.

The Seattle-based consumer centric company, which has been hit hard by the housing downturn, said in a filing with the Securities and Exchange Commission late Monday that 2008 bonuses for four top executives will be based on net operating profit, excluding loan losses (but not credit card losses) and expenses related to foreclosures; noninterest expenses, excluding any restructuring moves and foreclosures; deposit and retail banking fees; and customer loyalty.

By hitting the bank's targets, CEO Kerry Killinger -- who said in January he would forgo his bonus for 2007 amid dismal earnings results by the company -- could get up to 365% of his 2008 base salary, the filing said. Several other executives also stand to make more than double their salaries. Executives could stand to receive up to 150% of the targeted bonus amount, if the bank exceeds the best of its expectations, WaMu added in the filing.

Fred Cannon, the associate director of research and chief equity strategist at Keefe, Bruyette & Woods, is surprised that WaMu didn't include credit expenses in the bonus targets. WaMu's board will "subjectively evaluate" the company's performance in credit risk management and other strategic actions that impact overall corporate profitability when deciding on bonuses, the filing says.

"In our view this management incentive structure could result in executive focus away from issues, particularly credit management, that we feel are critical to the success of Washington Mutual in 2008," Cannon writes in a note.

Minimizing credit costs, particularly those related to home foreclosures, "should be a primary focus of management in 2008 given that credit costs are a primary driver of our expectations for the company to lose $1.45 per share [this year]," he writes. Analysts on average expect the company to post a loss of 92 cents a share, according to Thomson Financial.

Cannon points out that there are many assets available at deep discounts, but with significant credit risk. WaMu could purchase some assets in order boost operating profits before considering credit expenses, he worries.

"WaMu management does not have an incentive to minimize credit costs," Cannon adds. "In our view, it is the proper management of credit problems in the current cycle that is critically important to restoring shareholder value."

As one of the largest mortgage lenders in the U.S., WaMu, like other lenders including Countrywide Financial(CFC), stumbled last year as home prices declined, borrower defaults on subprime and home-equity loans spiked and the secondary markets for mortgage-backed securities seized up. WaMu posted a fourth-quarter loss of $1.87 billion, or $2.19 a share, missing the average analyst estimate by 83 cents a share.

The extended credit crunch forced WaMu into crisis mode. In December, it slashed its dividend 73% to 15 cents a share, raised $2.9 billion in a convertible offering and said it will cut more than 3,000 jobs -- mostly in the first quarter -- and exited the subprime lending business through a restructuring of its home loans unit. The bank has also feverishly ramped up reserves for loan losses to cushion against expected greater delinquencies on subprime mortgages and home-equity loans.

In addition to Killinger's potential 365% bump, WaMu's filing also said CFO Tom Casey could get a cash bonus of up to 179% of his salary, while president and COO Stephen Rotella will receive a bonus of up to 304% of his paycheck. Finally, WaMu's president of retail banking James Corcoran will receive up to 137% of his salary, according to the filing. The percentages were unchanged from 2007's bonus targets, the filing said.

Annual salaries for the four executives will be disclosed in the company's 2008 proxy statement, which is expected to be filed later this month.

Monday's filing is the latest decision by WaMu regarding executive compensation that has sparked criticism in recent months.

While WaMu executives -- excluding Killinger -- received cash bonuses last year equal to just 32.6% of their salaries, that doesn't mean the executives went home hungry. Rotella received a 2007 cash bonus of $912,800, Casey received a bonus of $391,200, while Corcoran received a bonus of $277,100, according to a January filing.

As WaMu's stock has dropped nearly 70% from a year earlier, the bank has made restoring shareholder value as well as executive retention top priorities this year for determining executives' long-term awards, it said.

WaMu increased Killinger's stock options grant to 3.2 million, 15% more than last year, according to the January filing. Half of the options will vest at the later of either the three-year anniversary date or if WaMu's stock trades at or above $26 a share for 15 consecutive days. The other half vest at the later of the fourth anniversary date or when the stock trades at or above $35 a share, it said.

Other executives named in the January filing received a 2008 stock option grant "approximately equal to the aggregate award value of his total 2007 long-term equity incentive award."

WaMu did not immediately comment. Shares plunged as much as 11% on Tuesday, reaching a low of $12.15, but closed the day at $13.39.