WaMu's Hopes for Capital Drying Up - TheStreet

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

Updated from Wednesday, Sept. 24

With

Washington Mutual's

(WM) - Get Report

efforts to sell itself seemingly stalled, the ailing thrift's options for addressing its shrinking capital base appear to be thinning.

Washington Mutual

last week put itself on the auction block amid the market chaos, but despite reported interest from several banks a deal has yet to materialize. While the likes of

JPMorgan Chase

(JPM) - Get Report

,

Citigroup

(C) - Get Report

,

Wells Fargo

(WFC) - Get Report

,

Toronto-Dominion

(TD) - Get Report

and

Banco Santander

(STD)

are interested, WaMu's potential suitors appear to prefer waiting to see what the federal

bailout

looks like in its final form before pulling the trigger.

Meanwhile, WaMu's situation continues to grow more dire. Federal regulators reportedly have been pressuring the thrift to recapitalize or find a buyer, and two major ratings firms downgraded its credit rating further into junk territory this week.

Private equity investors were given a new incentive to invest in bank stocks Tuesday, when the

Federal Reserve

eased certain restrictions. But, like potential buyers, investors want to know how much of WaMu's portfolio of toxic mortgages weighing down the bank's attractive retail franchise can be assumed by the federal government in the $700 billion pool being debated by

Congress

.

"The chance for

WaMu to remain independent ... seems to be dimming the more and more," says Jaime Peters, an equity analyst covering large-cap banks at

Morningstar

.

However,

the Wall Street Journal

reports Thursday that WaMu has approached private equity firms about a potential takeover.

Carlyle Group

and

Blackstone Group

, who would team up with Texas billionaire and bank investor Gerald J. Ford, are among the private equity firms considering a possible deal, the

Journal

reports, citing people familiar with the situation.

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Jim Eckenrode, a banking and payments research analyst at TowerGroup, agrees that a sale may be the only option for WaMu, "just because the loan loss provisions have gone through the roof," which is "certainly a drain on capital," he says.

Private investors have been loath to purchase larger stakes in banks because it would trigger a provision in which the firm would become a bank holding company, subjecting it to more rigorous regulation.

Under the revised rules, the Fed on Monday said that an investor may purchase up to 33% -- up from 25% -- of a banking institution without becoming a controlling interest. Investors that hold between 10% and 24.9% of voting stock will also be able to hold a board seat without triggering the bank holding company status.

The easing of the equity investment rules for banks allows private equity firms to "put some more dollars" into banks, says Robert Kennedy, an attorney at Jones Day that specializes in private equity and M&A.

But even with the easing of certain restrictions, raising capital is likely difficult for WaMu.

On the one hand, TPG and other investors that already pumped $7.2 billion into the mortgage-heavy firm have seen their investments sink underwater. Shares have fallen almost 70% from the $8.75 price that TPG and its consortium bought the shares at in April.

The investors may not want to inject more money into an already sinking ship, some say. An outside spokesman for TPG Managing Partner David Bonderman said he was not available for comment.

WaMu's debt ratings are also at junk status at this point, on fears that the firm does not have sufficient capital to protect itself against losses.

This week both Standard & Poor's and Moody's Investor Services downgraded the firm even further into junk status.

Moody's Investor Services earlier in the week downgraded the financial strength of WaMu's bank subsidiary to "E," its lowest rating, saying the thrift's "severe asset quality issues" are "depleting its capital base and leading to an erosion of its franchise."

S&P on Wednesday lowered the holding company's counterparty credit rating to "poor quality" of CCC/C from BB-/B on "increased likelihood that a potential sale of the company may not involve the whole company, which increases the risk of default for holding company creditors," S&P analyst Victoria Wagner said.

S&P affirmed its 'BBB-/A-3' counterparty credit rating on Washington Mutual Bank because of the breadth of its retail franchise.

Prior to this month, a sale of the company or capital raise "did not appear to be necessary," Morningstar's Peters says.

Shares of WaMu are down more than 90% since the same time last year. The stock has been particularly volatile in the last few weeks, as the Seattle-based company struggles to navigate the waters in which several big-name financial companies have already drowned.

This month alone, the government has had to bail out insurance titan

American International Group

(AIG) - Get Report

along with mortgage-finance entities

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

.

Meanwhile,

Lehman Brothers

filed for bankruptcy and is in the process of selling parts of its business to

Barclays

(BCS) - Get Report

and

Nomura

, while

Merrill Lynch

(MER)

hastily solidified a deal to sell itself to

Bank of America

(BAC) - Get Report

.

Another concern at WaMu is the safety of its deposits.

"The early third quarter numbers suggested that retail deposits were flat with beginning of the year," according to Peters. Deposits were up $5 billion at June 30, suggesting that some customers are taking money out of the bank, she says.

"These are retail deposits," she says. "If they are really truly having deposit pressure, then the pressure to sell is probably going to be quite great."

Howard Shapiro, an analyst at Fox-Pitt, Kelton Cochran Caronia Waller, wrote in a note last week that if WaMu is to remain independent, its long-term challenge is rebuilding the bank in a model less reliant on mortgages.

"At the same time, any commercial bank buyer would already have the product set to drive through Washington Mutual's attractive deposit footprint," Shapiro writes. "So we have always regarded a sale as the best long-term outcome for the company."

WaMu has not publicly confirmed any of the rumors regarding a sale, so it remains "unlikely, but possible" that it is aiming to stay independent, Peters says. But the pressure to sell is overwhelming, she says.

"If you listen to the rumor mill, you would find that Washington Mutual has very few options now," Peters says.