Is WaMu the Next Countrywide?

WaMu Could Get Wobbly

At Washington Mutual, as at the other institutions, credit quality is in decline, and reserves appear somewhat skimpy. Given those trends, in a worsening economic environment liquidity -- as well as the bank's dividend -- could come under pressure.

The bank reported nonperforming assets comprising 1.40% of total assets as of June 30, double the level from a year ago. The thrift's net income rose 9% from a year ago in the second quarter, but its ratio of reserves to nonperforming loans dropped to 43.4% -- its lowest level in more than five years.

Meanwhile, Washington Mutual's ratio of nonperforming assets to core capital and loan-loss reserves was 19.17% -- a very high level for a large bank. Most banks and thrifts we surveyed showed a number well below 10%.

If we assume that when disposing of a repossessed home a bank is likely to recover 70% of the remaining loan balance, the institution would still be comfortably well-capitalized, with a risk-based capital ratio of 11.76% (it needs to be 10% to be considered well-capitalized).

OK so far, but what if a significant portion of the loans past due only 30-90 days are eventually foreclosed? Loans past due 30-89 days totaled $2.9 billion. Addressing the expectation of a continued decline in credit quality, CFO Thomas Casey revised the holding company's guidance for reserves for the second half, saying the company would set aside $900 million to $1.1 billion for reserves during the second half of 2007. This will have a major impact on earnings.

If banking industry conditions deteriorate, Washington Mutual's divdend could come under pressure. The company paid out 60% of its second-quarter earnings to shareholders. This payout ratio is high, considering that the thrift is under under-reserved -- so it is conceivable that the dividend may have to be reduced in coming quarters, if asset quality continues its dramatic decline.

Liquidity is also a major concern. A high percentage of Washington Mutual's deposits are in non-retirement accounts with balances exceeding $100,000. We call these large, partially insured deposits "hot money." Washington Mutual's hot-money ratio was 37.6% as of June 30. As we saw last week with Countrywide Bank, these deposits can fly quickly in a time of uncertainty.

Nat City Regroups

National City faces similar issues to Washington Mutual. National City Bank tops the list in terms of capital exposure, with a ratio of nonperforming assets to core capital and loan-loss reserves of 19.72%. Its ratio of nonperforming assets has tripled over the past year, to 1.40% as of June 30.