Updated from 4:47 p.m. EST

Washington Mutual ( WM) is slashing its dividend and looking to raise $2.5 billion through a preferred stock sale as part of a plan to shore up its balance sheet amid the slumping housing and credit markets.

The Seattle lender plans to cut its quarterly dividend by 41 cents a share to 15 cents. It will also offer $2.5 billion worth of convertible preferred stock to bolster its capital positioning and significantly shrink its home lending business.

WaMu expects to generate about $3.7 billion in tangible equity through the offering and dividend cut, it says.

The company also plans to "resize" and make a "significant change in the strategic focus" to its home lending business. The plan includes cutting 22% of its 2,600-employee home lending unit and shuttering more than half of its 336 home loan centers. The bank also will no longer make home loans to subprime borrowers.

"A substantial infusion of new capital, significant expense reductions, the major change in our home loans business and our planned dividend reduction all combine to further fortify WaMu's strong capital and liquidity position," Chairman and CEO Kerry Killinger said in a statement. "These actions will also better position us to pursue various initiatives, particularly in our leading retail banking business -- which is at the core of our business strategy."

Soon after the announcement, ratings agencies Moody's Investor Services and Fitch Ratings hit the troubled bank with downgrades.

WaMu is not the only mortgage-centric company to slash its dividend or look to preferred offerings in order to raise capital in recent months. IndyMac Bancorp ( IMB) slashed its dividend in September and said last week that it may cut it further. The quasi-government mortgage finance company Fannie Mae ( FNM) also cut is dividend by 30% to 35 cents last week and said it plans to raise $7 billion in preferred stock offerings, while sister company Freddie Mac ( FRE) is also planning a $6 billion preferred stock offering. Mortgage insurer MGIC Investment ( MTG) also recently cut its dividend in order to shore up capital.

Washington Mutual's dividend yield is among the largest of the bank stocks and investors were attracted to the healthy payout from the lender. Cutting the dividend is typically one of the last options for a bank to play because it tends to be perceived as a sign of weakness at the company, observers say.

WaMu's trailing annual dividend yield had been 11.3% before the dividend cut, but now will yield about 3% based on Monday's closing stock price of $19.88.

The bank's stock dropped $1.63, or 8.2%, in recent after-hours trading to $18.25.

WaMu plans to cut 22% of its 2,600-employee home lending staff through the closing of more than half of its 336 home loan centers and sales offices. It is also shutting down nine loan processing and call centers, it said.

The lender is also is eliminating another 550 positions and will shutter its Wamu Capital Corp. - an institutional broker-dealer and mortgage finance operation.

WaMu will incur a $1.6 billion after-tax charge in the fourth quarter for the writedown of all the goodwill associated with its Home Loans business. The charge will result in a net loss for the fourth quarter, it said.

WaMu also expects chargeoffs in the fourth quarter to range between $1.5 billion and $1.6 billion and between $1.8 billion and $2 billion in the first quarter of 2008. The company had said last month at its annual investor day that it expected the provision to range between $1.1 billion to $1.3 billion for loan losses. The bank set aside $967 million in the third quarter to cushion against greater loan delinquencies on subprime mortgages and home equity loans.

The company believes the actions will "ensure" that it has the financial strength to weather the difficult housing and credit conditions expected to continue throughout next year, it says.

Moody's downgraded WaMu's long-term debt by two notches, to Baa2 from A3. It also cut its financial strength rating on the company's thrift operations to C minus from C plus and cut its long-term deposits to Baa1 from A2.

Moody's said in a note that credit losses from WaMu's mortgage operations will be noticeably higher than previously estimated.

"Of particular concern is WaMu's approximately $43 billion second-lien-home-equity portfolio," it says. "Higher provisions are likely to lead to poor reported results throughout 2008 and 2009. Moody's previously expected WaMu's profitability to begin to recover in 2009; however, Moody's now believes this will not occur until 2010."

But on a positive note, Moody's placed a stable outlook on the company.

"Going forward, the capital initiatives will help to stabilize WaMu's credit profile by increasing its current capital base with the new issuance, helping to sustain that base with limited dividend payments, and boosting an already good holding company liquidity profile," said Sean Jones, a Moody's senior vice president.

Fitch issued a negative outlook for WaMu, downgrading it's long-term issuer default rating to A- from A. While noting that the $1.6 billion charge the bank would take on its balance sheet for downsizing its home loan operation was "substantial," Fitch said the move would have "a negligible impact on capital ratios."

" WaMu has distinguished itself from other monoline mortgage companies over the past decade by significantly diversifying its business through the development of the retail bank (now more than 2,200 branches) and the acquisition and growth of the card business," Fitch said in a statement. "In addition, concerted efforts over the past five years to broaden funding sources and reduce reliance on wholesale money are noted; liquidity has held up comparatively well as a direct result of these efforts."

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