Washington Mutual (WAMUQ)

TOP CONTRIBUTORS

Kai Ross

Sean Hinton

Waseem Alim

Washington Mutual (NYSE: WM) is a leading U.S. commercial bank ($14.2 billion in net revenue in 2007) providing retail banking, credit card services, commercial services, and home mortgage originations and services. The company has 2,257 stores in the US. and is the third-largest mortgage originator with a 7% share of the total market.

By creating a friendly and convenient environment for its clients and providing products such as free checking accounts, WaMu, as it is known by its customers, has managed to attract loyal customers; on average, a checking account holder with a two-year tenure at WaMu uses about 6.7 other WaMu products.

Despite attempts to diversify its loan portfolio, nearly 67% of Wamu's current loans are mortgages. This ratio is 1.8 to 4.5 times that of its competitors. This has been a point of concern through 2007 and into 2008 as credit conditions worsened and U.S. home prices began to decline. WaMu has taken steps to avoid or greatly limit its exposure to fallout from the collapse of the subprime lending industry, choosing to stay away from the riskiest mortgages that are causing other lenders and banks to lose billions. Despite this, a general downturn in the U.S. economy will inevitably harm WaMu's bottom line, as its $67 million net loss for 2007 shows.^[1]

Business Segments

Retail Banking

WaMu’s over 2,200 banking branches nationwide provide a full array of retail banking products for consumers and small businesses. In addition to offering deposit hold services, WaMu also offers annuities, private investment advisory and brokerage services, home equity loans, lines of credit, and related retail banking products. By and large, the Retail Banking segment is WaMu's most significant, accounting for 59% of its net revenue in 2007.

Because of difficulty in increasing the volume of its deposits in lower branch concentration areas such as Chicago and Atlanta, WaMu has held a relatively smaller share of the total domestic market compared to some of its larger peers, though its Retail Banking division did grow deposits by 3% in 2007 to an average of over $144 billion. Despite relatively smaller market share, WaMu’s acquisition of Commercial Capital in 2006 and Providian in 2005 has increased cross-selling opportunities for its Retail Banking segment. As a result, the average number of WaMu products used by a checking account customer of two years was 7.2 as of 2007. Plans to expand further in high branch concentration areas such as California and Texas will additionally increase these cross-selling opportunities.

Card Services

Accounting for 21% of WaMu’s 2007 net revenue, the Card Services segment of WaMu takes on the responsibility of originating and servicing credit card loans. As the eighth-largest card issuer in the United States managing over $27 billion in assets, Card Services's credit card loans have grown at a 13% compound annual growth rate (CAGR) since the acquisition of Providian in 2005, compared to a CAGR of 8% prior to the acquisition.

Commercial

The Commercial Group provides financing to developers and contractors for the creation and acquisition of multifamily units, office complexes, and other commercial properties. WaMu services all loans that originate through the Commercial Group; with the acquisition of Commercial Capital Bancorp, the multi-family loan portfolio has grown to over $31 billion, establishing WaMu as the nation’s leading multi-family lender.

Home Loans

WaMu’s Home Loans Group, the third-largest mortgage originator in the U.S. with a 7% share of the domestic market, offers various mortgage products including fixed-rate, adjustable-rate, hybrid, and pay-option adjustable-rate mortgage loans. In early 2006, the Home Loans Group was strategically focused on building its non-traditional mortgage origination and investment; in particular, the Home Loans portfolio consisted of 46% option-adjustable rate mortgages (option-ARMs) and 11% subprime mortgages.

By the end of 2006, current management had taken note of slowing growth in housing markets and significantly reduced nontraditional mortgage origination and portfolio weight, as shown by its sale of nearly all subprime mortgage originations and a $2.4 billion decrease in the value of subprime mortgages in WaMu's total portfolio. By mid-2007, when the subprime lending industry collapsed and mortgages began entering default, WaMu had taken these and other steps to limit its exposure, though the Home Loans division did report a net loss of $2.46 billion in 2007.

Business Drivers

Mortgage Market

As it was founded in 1889 to facilitate the rebuilding of a city in shambles, WaMu has long been a leader in the mortgage origination and service market. On aggregate, the mortgage market depends most on the current housing and credit markets. WaMu adjusted its Home Loans Segment portfolio composition of mortgages based on major fluctuations in either market.

• Housing Market: As of late, WaMu is well posistioned to reap the benefits of rising house prices and rising demand of adjustable rate mortgages; at the end of the third quarter in 2006, WaMu had originated 8% of the floating adjustable rate mortgages.

• Credit Market: In an environment of increasingly poor credit and bank regulation of non-traditional mortgages, the profit margin in originating sub-prime and option-ARM mortgages has narrowed. As a result, WaMu has tightened its underwriting standards for these mortgages, restructured its home loans by placing less weight on sub-prime mortgages, and has sold nearly all of its sub-prime originations.

In addition, WaMu has ceased origination of government guaranteed loans and shifted focus on higher margin mortgage products such as home equity, Alt A, and options-ARM mortgage loans.

Interest Rates

Historically, deposit taking banks generated profits by collecting cash deposits, holding a percentage of those deposits (as dictated by the Federal Reserve) in bank reserves, and issuing leveraged loans. The interest payments paid by the bank on deposits and paid to the bank on loans are dictated by the yield curve. In general, the yield curve is an increasing, concave expression of interest rate as a function of time. Because, under normal conditions, the short term interest rates tend to be lower than the long-term interest rates, banks give short-term interest rates for deposits and charge long-term interest rates for loans; the difference between these two interest rates is called the net interest margin and spells profit for banks.

Industry Analysis

Primarily a savings and loan bank, WaMu's main focus is on retail banking, commercial lending, and originating and servicing mortgages. By maintaining customer-friendly environments in local branches and offering services such as providing loans to small businesses and free checking, WaMu has established itself as one of the major savings and loan providers in the Texas, California, and New York areas. WaMu's major competitors are Countrywide Financial (CFC), Wells Fargo (WFC), JP Morgan Chase (JPM), Citigroup (C), and Bank of America (BAC); of these, Countrywide and Wells Fargo most directly compete with WaMu's mortgage business, whereas JP Morgan, Citi, and Bank of America are much larger, diversified financial services firms. Bank of America will, however, become a much greater direct competitor after it completes its acquisition of Countrywide.

References

1. ↑ Washington Mutual Inc Financial Statements | Stocks | Reuters.com
2. ↑ WaMu | Investor Relations | Annual Reports