Washington Mutual Preps Itself for Sale

Updated from Thursday, Sept. 18

Citigroup ( C) is considering making a bid for Washington Mutual ( WM), the Wall Street Journal reports, citing people familiar with the situation.

Other interested parties include Banco Santander ( STD), and Wells Fargo ( WFC). JPMorgan Chase ( JPM) is biding its time on a potential bid, the Journal reported Friday.

It isn't certain that Citigroup will make a bid for WaMu, but the mortgage lender's fate could be decided in the next several days, according to people familiar with the discussions, the Journal reports.

Published reports and a regulatory filing on Wednesday suggested Washington Mutual is taking steps to prepare itself for a sale.

The ailing Seattle thrift has hired Goldman Sachs ( GS) to begin an auction, several media reports including The New York Times reported.

The news comes the same day as a Securities and Exchange Commission filing Wednesday that says private equity firm TPG, which led the $7.2 billion capital injection involving several other investors this spring, has decided to waive certain rights in its $2 billion investment in the Seattle-based thrift. TPG's original agreement require WaMu to pay the firm back for any significant dilution it would feel if the company decided to raise more capital or sell itself, according to the SEC filing.

As part of the original agreement, if within the first 18 months after the deal was completed WaMu were to sell more than $500 million of common stock for less than $8.75 a share -- the amount TPG paid for its investment -- or if there was a "change in control" where the stock was valued at less than $8.75 a share, WaMu would be required to pay TPG "an amount sufficient to compensate them for the dilution suffered."

"It became clear that it would be in the best interests of Washington Mutual and our investors to waive the price reset payment provisions that were agreed to with the bank at the time of our original investment in April 2008," TPG said in a statement. "Our goal is to maximize the bank's flexibility in this difficult market environment."

WaMu has already been the source of much speculation regarding a sale. Several media outlets have reported that the Seattle-based company was in serious discussions with JPMorgan Chase, and rumored to be getting closer to making an offer.

The New York Post, citing anonymous sources, reported Wednesday that federal regulators called a number of banks, including JPMorgan Chase, HSBC ( HBC) and Wells Fargo, asking if they would consider acquiring the ailing Seattle lender.

But so far no deal has been made. WaMu rebuffed an offer this spring by JPMorgan to acquire the company. The Post article said no discussions regarding a takeover are currently under way between WaMu and other firms.

A spokeswoman for WaMu said the company does not comment on rumors or speculation.

Companies from all factions of the financial services industry are facing liquidity and capital crises, forcing many to go under, be sold or bailed out by the government.

This week alone, mortgage-centric investment house Lehman Brothers ( LEH) filed for bankruptcy on Monday and has since agreed to sell a portion of its business to Barclays ( BCS). Merrill Lynch ( MER), fearful that it could be the next broker to go under, agreed to sell itself the same day as Lehman's bankruptcy filing in a hurried deal to Bank of America ( BAC). On late Tuesday, the world's largest insurer American International Group ( AIG) had to be bailed out by the government.

BofA is already integrating its July acquisition of the nation's largest mortgage lender, Countrywide Financial, while rival IndyMac Bancorp was seized by regulators this summer. Earlier this month the government-sponsored mortgage giants Fannie Mae ( FNM) and Freddie Mac ( FRE) had to be bailed out by the government. Bear Stearnswas acquired by JPMorgan Chase in the spring.

WaMu fired its longtime CEO Kerry Killinger last week, replacing him with Alan Fishman, who was seen as being brought in to sell the struggling thrift.

"WaMu's new leadership is probably much more receptive to a take-out offer from JPMorgan CEO Jamie Dimon," CreditSights analysts wrote in a note that explores a possible deal between JPMorgan and WaMu.

"We sense that fast moving market events of the past week are in a sense taking over," the CreditSights analysts write. "Those banks and brokers which are subjected to 'bear raids' can quickly see their range of strategic options narrow and may reconsider merger offers from stronger players, even if a similar deal was rejected only a few months ago."

"We would not be surprised to see WaMu get scooped up by JPMorgan," the note said. "We view Wachovia ( WB) and National City ( NCC) as the other banks which may be taken over."

Indeed, late Wednesday, the Times reported Wachovia had contacted Morgan Stanley ( MS) about a possible deal.

Others say that if the economy remains in trouble for an extended period of time, WaMu is likely to have to raise additional capital.

"Underlying all of the issues that face Washington Mutual is the rising and unknown level of credit expenses," writes Fred Cannon, an analyst at Keefe, Bruyette & Woods in a note Monday. "The challenge that Washington Mutual faces as a seller is the extremely weak values of its current loan portfolio in the marketplace."

If WaMu's assets were to be market-to-market in the current environment, "the net value of WaMu would be negative in such a situation ... To get back to positive value, a buyer would have to value the branch network at a 25%-plus deposit premium. Thus, even though a buyer might see significant positive economic value in the WaMu franchise, the accounting for such a transaction could put a buyer in a negative position," he writes.

Cannon estimates that WaMu could see additional provisioning and losses of $23 billion over the next two years, but in an extended down economy credit expenses could rise to $28 billion and would require the bank to have to raise roughly $5 billion in additional capital.

" W e believe that many market participants believe that this loss assumption, or even more, is a more realistic assessment of Washington Mutual's position," Cannon writes. A capital raise, "even at onerous levels, could, in our view, improve the confidence of depositors, regulators and investors. ... We believe that Washington Mutual is in a position to raise capital due to the strength of its depository franchise."

Fishman "has a number of issues to address, in our view, including ensuring the confidence of depositors, regulators and investors that Washington Mutual has the resources to weather the consumer credit storm," he writes. "We believe that he needs to act quickly, as patience appears to be an increasingly rare virtue for his constituents."

Add in one more ball to the juggling that seems to be going on in the financial sector -- the fact that the fund used by the Federal Deposit Insurance Corp. to insure deposits at banking institutions has fallen below the minimum target level set by Congress, according to an Associated Press article. So far 11 bank and thrifts insured by the FDIC have failed this year, including IndyMac.

If Washington Mutual were to fail, it would be the largest collapse of a banking institution in U.S. history, the AP article said.

Over the past week, both Moody's Investor Services and Standard & Poor's downgraded the firm's long-term debt ratings to below investment grade or so-called junk status.

Despite the fact that WaMu's current condition has not changed materially, the downgrades could "curtail WaMu's ability to raise brokered deposits and the downgrade could limit the company's funding options for the intermediate to long term even if the near term impact is not material," according to CreditSights.

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