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JPMorgan Has Its Hands Full With WaMu

Dan Freed

You can find more stories like this in our On the Brink series.

The market loved JPMorgan Chase's (JPM Quote) acquisition of Washington Mutual (WM Quote), sending shares of what is now the largest U.S. depository up 11% Friday -- despite getting diluted by $10 billion.

But are investors getting ahead of themselves? Are JPMorgan's fortunes so different from those of the U.S. economy?

"The economy is weak. If it gets weaker it will affect our businesses. We've never said we're immune from that," CEO Jamie Dimon said during a press conference Friday.

The Washington Mutual deal gives JPMorgan Chase a major retail footprint across the West Coast and Florida, while beefing up its presence in several other states. Is that a good thing at the moment?

JPMorgan appeared to be far more aggressive than other potential bidders for WaMu, according to a private-equity investor and a senior bank executive who were familiar with the negotiations. Those interested parties were said to include Wells Fargo (WFC Quote), Toronto-Dominion (TD Quote) and Banco Santander (STD Quote).

"The ability to get in in such a large way in one fell swoop in those very attractive marketplaces really makes this just an absolute unique opportunity for us," said Charles Scharf, the bank's head of Retail Financial Services, during the company's conference call with analysts Thursday night to discuss the deal.

The takeover, arranged by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation after WaMu was seized, excludes the senior unsecured debt, subordinated debt and preferred stock of Washington Mutual's banks. JPMorgan Chase won't acquire any assets or liabilities of the banks' parent holding company or the holding company's nonbank subsidiaries.

JPMorgan expects to convert Washington Mutual's consumer banking, home lending and credit card businesses to the Chase brand and technology platforms over the next two years.

The difficulty of turning a thrift into a full-service bank is not to be underestimated. One investment banker believes the difficulty of making this transition is likely what made Wells Fargo comfortable that it did not need to try and outbid JPMorgan to keep it out of its backyard.

Tony Davis, an analyst at Stifel Nicolaus & Co., says the cultural differences between banks and thrifts are substantial, with commercial banks tending to be more aggressive in terms of product sales. He notes that the thrift charter, when it was originated in the 1930s, was designed just to serve the residential mortgage market.

"Even though thrifts have been able to offer other products for over a decade, the mentality is still that the mortgage business is really what they were born and bred to do," he says.

Another banker believes Wells Fargo did not want to establish a regional banking presence in Florida, because it is so distressed at the moment due to an oversupply of both residential and commercial real estate. A Wells Fargo spokeswoman declined to comment on whether the bank would consider establishing or acquiring a regional banking business in the state.

"We've always said that we're looking in the west, but we've never made specific comments about Florida," she said, noting that the company does have home mortgage and debt consolidation businesses there.

As part of the transaction, JPMorgan Chase will pay the FDIC about $1.9 billion. Washington Mutual was once the largest U.S. thrift, and its failure is the biggest ever for a domestic bank.

In connections with the Washington Mutual acquisition, JPMorgan Chase will be marking down the acquired loan portfolio by about $31 billion, which primarily represents the company's estimate of remaining credit losses related to impaired loans.

Some observers question whether JPMorgan should not have taken a higher mark. While Meredith Whitney, analyst at Oppenheimer & Co., does not explicitly say the amount was too low in her report discussing the acquisition, she writes that JPMorgan's "base case" assumption of a 25% national home price decline is short of the Case-Shiller futures market assumption of a 33% decline.

This is the second time this year JPMorgan has come to the rescue. Just six months ago, it bought Bear Stearns after the investment bank nearly collapsed.

Washington Mutual had been staggering for several months, and its acquisition makes it the latest financial institution to fall victim to the credit crisis and downturn in housing.

In the past three weeks, the government has rescued Fannie Mae (FNM Quote), Freddie Mac (FRE Quote) and AIG (AIG Quote), Lehman Brothers has filed for bankruptcy, Merrill Lynch (MER Quote) was purchased by Bank of America (BAC Quote), and Goldman Sachs (GS Quote) and Morgan Stanley (MS Quote) decided to become bank holding companies.

Before WaMu failed, 12 U.S. banks were seized this year by the government. Amid the meltdown, Treasury Secretary Henry Paulson has proposed a $700 bailout of the financial sector.