WaMu Slides on Terms of $7 Billion Infusion

The much-needed capital dilutes existing shares and comes at a bargain basement price.
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Updated from 2:53 p.m. EDT

Washington Mutual

(WM) - Get Report

shares sank as much as 13% Tuesday after announcing that a consortium of investors led by private equity firm TPG would invest $7 billion into the struggling Seattle thrift.

The bank plans a sale of equities to an investment vehicle managed by TPG Capital and other large WaMu shareholders. TPG's investment vehicle will purchase $2 billion of newly-issued WaMu securities. The Fort Worth, Texas-based private equity firm, led by founder and ex-WaMu board member David Bonderman, was rumored to be in

discussions with WaMu regarding a capital injection

.

WaMu also forecast a first-quarter loss and slashed its quarterly dividend once again to 1 cent a share from 15 cents a share. The company said the move will preserve roughly $490 million of capital.

WaMu sold approximately 176 million shares of common stock at a purchase price of $8.75 a share. The company also offered 55,000 shares of convertible, perpetual non-cumulative preferred stock at a purchase price and liquidation preference of $100,000 a share. The convertible will convert into common stock at an initial exercise price of $8.75 a share, it said.

Cramer: WaMu Deal Removes a Hazard

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The size of the deal is enormous compared to WaMu's current $11.6 billion market cap, according to Thomson Financial.

Shares fell as low as $11.41 Tuesday as investors became disheartened by the company's forecast of a first-quarter loss and the seemingly advantageous terms of the deal for TPG and its consortium. The stock most recently was trading down $1.32 to $11.83.

Fred Cannon, the associate director of research and chief equity strategist at Keefe, Bruyette & Woods, downgraded Washington Mutual to the equivalent of a sell rating after the stock surged roughly 30% on Monday following reports that a capital injection was close. The stock had surpassed his 12-month price target of $10 a share, he wrote in a note.

Cannon said that a capital injection (originally thought to be $2 billion less) would create "significant dilution to both future earnings and book value," according to the note.

UBS analyst Eric Wasserstrom is "supportive of the company's capital position in the near term," given the sale of $1.5 billion of common stock and the issuance of $5.5 billion of preferred stock, he writes in a note issued after the WaMu deal was announced. Still "the size of the transaction ... reflects uncertainty surrounding WaMu's future credit costs, which continue to accelerate."

"We expect credit deterioration to continue, and do not expect the company to return to profitability until late 2010 or later," Wasserstrom writes. He has a neutral rating on the company.

Moody's Investor Service, however, changed its outlook on WaMu and its bank subsidiary to stable from negative. The ratings agency said that the outlook improvement is based on the $7 billion capital raise, which provides "sufficient cushion for the company to maintain capital ratios which are greater than 100 basis points above the regulatory well capitalized minimums," it says in a note.

"Moody's expects this to hold throughout the current credit cycle despite the large credit provisions WaMu will need to take in 2008 and 2009," it adds.

WaMu expects its capital ratios to remain "well above" its target levels over the next two years, despite elevated credit costs associated with the housing decline and subprime mortgage meltdown. WaMu, along with

Countrywide Financial

(CFC)

, had been one of the worst-hit lenders as the credit downturn deepened into loans besides subprime mortgages and the secondary market for mortgage-backed securities dried up.

Countrywide agreed in January to be sold to

Bank of America

(BAC) - Get Report

. WaMu had been

rumored

to be in discussions about a sale, possibly to

JPMorgan Chase

(JPM) - Get Report

, prior to the TPG-led capital injection.

The company plans at the same time to expand its strong retail banking franchise, it says.

"We're very pleased that TPG and these major investors have expressed their confidence in WaMu's underlying value and its growth potential," WaMu CEO Kerry Killinger said in a statement. "This substantial new capital -- along with the other steps we are announcing today -- will position us for a return to profitability as these elevated credit costs subside. With the support of these investors, we have every confidence in our ability to deal with today's market conditions and restore shareholder value."

WaMu expects to post a net loss of $1.1 billion, or $1.40 a share, according to preliminary results for the first quarter, it said. Analysts on average were expecting the thrift to post a loss of 49 cents a share, according to Thomson Financial.

It also recorded a $3.5 billion provision for loan losses - more than twice the provision it took in the fourth quarter. It expects charged off loans to total $1.4 billion in the first quarter.

On the other hand, the company said its net interest margin -- the profit a bank makes from taking in deposits and lending them out again -- increased by 19 basis points from the fourth quarter to 3.05% reflecting "significantly lower wholesale borrowing costs" following the 200 basis point reduction in the federal funds rate.

WaMu will report its full first quarter earnings on April 15.

As a result of the mortgage downturn, WaMu in December

cut its dividend and raised $2.9 billion

in a preferred stock offering. At the same time, the thrift had downsized its home loans business by cutting around 3,000 employees and shutting more than half of its home lending centers. At the time, it had ceased offering subprime mortgages.

WaMu said Tuesday it plans to expand its retail banking network by focusing on growing its branches and call centers and shuttering the rest of its freestanding home loan offices. The company is also exiting the wholesale lending business. WaMu said the closings should be finished by the end of June.

TPG was founded in 1992 by David Bonderman and has more than $50 billion in assets under management, it says. The company declined to comment further on the WaMu investment, according to an outside spokesman.

Bonderman already has a history with the Seattle thrift. He was previously on WaMu's board in the late 1990s and early part of this decade after WaMu purchased American Savings Bank, where Bonderman was a director, according to the

Wall Street Journal

.

This is also not the first time that Bonderman has come to banks' rescue. While working for Texas billionaire Robert Bass, he put together one of the largest bail out packages for American Savings Bank during the savings-and-loan crisis roughly 20 years ago through a capital injection, the

Journal

says.

WaMu's board intends to re-appoint Bonderman to the board. In addition, Larry Kellner, the chairman and CEO of

Continental Airlines

(CAL) - Get Report

and a former executive of American Savings Bank, will become a "board observer" at TPG's request, WaMu said.