24/7 Wall St. 2007 Break-Up Values: Wash Mutual $59 (Current Price: $45.50)

By Ryan Barnes. Edited By Douglas A. McIntyre

Washington Mutual (WM)

WaMu is the largest savings & loan operator in the U.S., with nearly $350b in assets, gained chiefly through retail banking and mortgage businesses.  The company also has designated segments for credit card services and commercial lending operations. 

WaMu is overexposed to the downturn in housing, with a large sub-prime business as well as geographic exposure in many overheated markets in the Western portion of the U.S.  Bad loan provisions more than doubled versus the previous quarter, and if things continue to get worse in retail housing, the losses will magnify quickly.  The Home Loans group alone went from a billion-dollar profit in 2005 to a small loss in 2006.  The Credit Card group is growing fast in terms of customers but they’re not quality customers; bad loan provisions here have eroded all profit growth as well.

The 5% dividend yield is a nice buffer for investors, but there aren’t any real signs of shareholder value or multiple expansion on the horizon.  Retail banking is the most stable business, and Commercial Lending is a more stable source of cash flow than the Home Loans segment. 

The problem is the Home Loans group, and it’s a big one.  The Efficiency Ratio, which is a great industry measure of how much it costs for the next dollar of revenue (where lower is better), is 53% for retail banking, 29% for card services, and 33% for commercial lending.  And home loans?  A whopping 95%, up from 59% the year before.  End of story.  The Home Loans segment needs to be dumped for the sake of the shareholders.  It doesn’t a large percentage of fee income, and WaMu can still retain the servicing rights to the mortgage portfolio (a good source of residual cash flow) if they divest the loans themselves, which is what really needs to happen.  They won’t get a great price for it, but by using a moving average of earnings at the group over the past three years, we can arrive at a price of about $9b for the group.

With the home loan portfolio off the books, WaMu should trend towards and industry-level multiple of 14x current earnings, as the rest of the business is strong and well-managed, with the retail channel still the driver of growth, and the commercial lending division is an up-and-comer that provides some diversity to the cash flows.  5% yield still intact, the breakup value for WaMu comes to $59/share.

Ryan Barnes

Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others.  Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.

Methodology