Tom A's Stock Picks

WaMu - Mighty no more

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I'm glad WM came up as the QOTW - I held it in my personal portfolio until January 07, making respectable returns, and with the stock trading at less than 25% of what I last sold it for I have been interested in looking at it as a value investment. The sell high, buy low strategy.

The history - from 2000 to 2004 WaMu was a success story, riding the wave of the housing bubble. In 2004 problems surfaced in the mortgage operation, hedges that went awry, as I recall. From there on in it was rumors, at intervals, WM would be acquired by this or that larger competitor. Or it was the sum of the parts argument, that their retail banking and commercial banking were worth more than the stock traded for, so that you got the mortgage operation for free. Or the expense reduction, that they would bring their expense ratio in line with the industry, creating shareholder value. None of this materialized and it traded in a range of 2 to 3 x tangible book value. I became concerned that the mortgage business was problematical and management just didn't seem to be cleaning up the mess and made what proved to be a very timely exit.

After the horrendous 1Q 2008 quarter, and the more or less simultaneous recapitalization by TPG and others, I recomputed the tangible book value per share, making an allowance for the dilution, and came up with 12. The reason to use tangible book is that their assets include a lot of goodwill from acquisitions. If WM, which recently traded at 11.66, were to get to the lower end of its historical price to tangible book ratio, it would be a doubler. If it got to the high end, it would be a tripler. That is the attraction of this situation.

The "what ifs" are numerous, but I will only offer one. WaMu's 1Q 2008 financial info as available on their website shows that they have a total of 71.378 Billion of ARMs in the portfolio, of which 55.846 are Option ARMs. Unfortunately, the unpaid principal balances are larger than the original principal amounts, and the difference has been growing every quarter. These mortgages are not reducing principal. WaMu does a lot of business in California, so the market value of the houses involved is probably decreasing. This is not a situation that can continue indefinitely. To place the size of the issue in perspective, the tangible book value is 19 billion after the recapitalization. The bookkeeping here is, after the customer pays an amount that does not reduce principal, or even cover interest, you add interest to the balance of the mortgage, which is an asset on the books.

TPG and other investors got a good deal on the recapitalization. They effectively bought the shares at 8.75 while the stock traded at 10.95 and now stands at 11.66. Too bad the ordinary shareholder can't participate in these deals. Actually he does, as the victim. This brings to mind the troubles and hardships I recently experienced and endured when MBI and ABK did equity offerings. Shares of both companies have traded at less than the share price of the additional shares sold to raise capital, ie, less than the smart money paid. As a big for instance, Warburg Pincus, which I thought was smart money, got involved with MBI at 31.00. The stock subsequently traded as low as 6.75.

So, my suggestion here is, if you can get past the what ifs, that you buy where the smart money bought, which would be 8.75. I personally would not get involved, why should I buy a company that started messing up in the mortgage business in 2004, when it was a cakewalk, and never really cleaned up the situation? Particularly when you get the same management that created the problem.

Also, there are a lot of banks out there - you could start with Wells Fargo (WFC): Russ recommends it. How about Regional Banks, some of which are well run and don't have trouble like WM, NCC, C, or BSC et al? I normally prefer to pick my own stocks, but in my personal portfolio I have been accumulating a small position in a mutual fund - John Hancock Bank/Thrift Opportunity (BTO). My thinking is, banks should be attractive as recovery commences, but diversification would be a must. The expense ratio for BTO (1.43%) might be money well spent, particularly when it trades a discount to NAV.

Tom