FBR took an axe to its estimates and target on Washington Mutual (WM) after the firm’s record Q2 loss. FBR thinks WM will be forced to sell more stock (and further dilute shareholders) to raise more capital:
In 2Q08, WM lost $3.3 billion (excluding a $3.3 billion noncash expense related to the conversion of its preferred shares), or nearly half of the capital it raised in April. WM now expects single family residential loan cumulative losses of $1.9 billion, at the top of its guidance given in April for a range of $12 billion to $19 billion, equal to 10% of loans. With losses of $2.2 billion in 2Q08 and another $6 billion likely in 2H08, WM is quickly realising expected losses. If losses exceed guidance, WM could find itself in need of additional capital, which will be difficult. We believe this management team would find it very difficult to go back to the market for additional capital.
FBR concedes that WM is sufficiently capitalised to sustain expected losses of $19 billion. But it insists that the outlook for the credit environment remains unpredictable, and that if losses exceed expectations, WM would have to raise more capital:
Credit quality continues to deteriorate rapidly and appears not to be stabilizing. While net charge-off growth rates are slowing, aggregate growth continues to accelerate, as net charge-offs increased a record $803 million in 2Q08, up from $621 million in 1Q08. Credit models are failing to accurately predict losses in today’s environment and cannot be relied upon until home prices stabilise.
We do not consider WM well reserved, with an allowance equal to 3.5% of loans and losses equal to 3.6% and rising rapidly. We analyse WM’s regulatory capital and conclude that it does have sufficient capital to cover expected losses of $19 billion, but anything above that could put tremendous pressure on capital levels and could probably result in the need for additional capital.
FBR cuts its price target in half from $8 to $4 and reiterates its Underperform rating.
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