Washington Mutual (WM) joined the earnings parade late Tuesday by announcing that it lost $3.33 billion in the second quarter, as it significantly hiked its loan loss reserves by $3.74 billion to $8.46 billion — but the staggering losses seemed to take a back seat to the company’s announcement that it would cut $1 billion in costs, and an assertion by CEO Kerry Killinger that further capital wouldn’t be needed. At least immediately. Shares in the battered savings & loan soared as a result of the cost-cutting news, and were up to $6.05, a four percent gain, when this story was published. (Don’t ask us why; the provision for loan losses soars to $5.9 billion in Q2 — up 68 percent from just one quarter ago — and a $1 billion cost cutting maneuver somehow assuages investor fears? Go figure.) The second quarter loss is far deeper than the $1.14 billion hole dug during the first quarter, and CEO Kerry Killinger said in a press statement that the company also now expects losses in its residential mortgage portfolio to be in the upper end of its April guidance for 2008. Total nonperforming assets at the Seattle-based bank jumped to $11.2 billion at the end of the second quarter, up 22 percent from the first quarter and nearly three times the NPAs recorded one year earlier. Almost all of that total is non-performing residential mortgage loans — $9.3 billion. While Wamu set aside a large amount in loss provisions during the second quarter, it’s worth nothing that NPAs remained significantly above loss reserves anyway; this suggests that future provisioning activity is likely in future quarters, sources told HW. Option ARMs, home equity loom big Out of WaMu’s $231.1 billion loan portfolio, it’s $52.9 billion in option ARMs and another $62.5 billion in home equity loans and lines of credit that are drawing the most attention from analysts and investors. “That’s more than $110 billion in mortgages that are among the most problematic in the current cycle,” said one source, an analyst that asked not to be identified in this story.
Roughly 6 percent of the bank’s option ARM portfolio was classified as non-performing by the end of Q2, according to the company’s investor presentation. With the recast schedule (see right) showing that the vast majority of the bank’s option ARM loans have not yet hit the reset button, it seems pretty fair to think that the bank has yet to feel the full effects of this loan class in terms of its impact on credit losses. In a presentation to investors, the bank did note that the rate of growth in delinquencies has been slowing down for the past two quarters; it’s not a trend shared by the bank’s option ARM portfolio, however, which the company said has been growing at roughly the same rate since the third quarter of 2007. All of which means that despite cost-cutting moves at by Killinger, the bank still has some very tough challenges ahead. Not that the WaMu CEO has bowed under pressure thus far. “In the face of unprecedented housing and mortgage market conditions, we are continuing to execute on a comprehensive plan designed to ensure that we have strong capital and liquidity, an appropriately-sized expense base and a strong, profitable retail franchise,” he said. Moody’s Investors Service didn’t buy the company line, however, and warned that it would review the bank’s credit ratings for a possible downgrade, suggesting that significant provisioning would yet be needed to cove sizeable credit losses running through 2009. “WaMu’s financial flexibility has been reduced due to the significant decline in its market value,” the rating agency said in a press statement, noting that it felt that “it would be expensive, at best, for WaMu to raise new equity capital or issue new debt given the market’s current negative opinion of the company.” Related links: credit risk summary Disclosure: The author held no positions in WM when this story was written; indirect holdings may exist, however, via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.