In These New Times

Forbes
Miriam Marcus, 07.22.08, 8:41 PM ET

Washington Mutual is optimistic about its ability to weather the mortgage crisis, but some analysts warn it may be a bit too optimistic.

After the close Tuesday, Washington Mutual (nyse: WM – news – people ) reported a steep profit loss in the second quarter, far worse than had been expected, as it significantly increased its loan loss reserves in response to continued declines in housing prices nationwide.

Bracing themselves for bad news, investors pushed the ailing stock up 6.2%, or 34 cents, to close at $5.82. Earlier in the day, Wachovia posted a gaping $8.9 billion quarterly loss, also largely due to pain related to soured mortgages. Still, riding an industrywide rally, Wachovia (nyse: WB – news – people ) shares soared 27.4%, or $3.61, to close at $16.79.

Both firms’ share prices have been sliding since autumn, when Wachovia traded above $50 and WaMu traded near $40.

Despite its widening loss, WaMu Chief Executive Kerry K. Killinger insisted “we remain confident that we have sufficient capital to successfully manage our way through this challenging period.” Killinger’s assurance came after the firm’s previous announcement that it would exit the wholesale lending business and close all remaining standalone home loan centers. WaMu said it will instead focus its mortgage-originating efforts in its retail bank branches and Web site, and by expanding its call center operations.

Lehman Brothers analyst Bruce Harting said he expected the bank to remain unprofitable until credit costs normalize some time in the second half of 2009. “The combination of revenue growth, loan-loss reserves already established and new capital should be sufficient to cover the losses that Washington Mutual will need to absorb in the next several years,” he said.

WaMu became one of the first retail banks to seek outside cash in the wake of the credit crisis when it agreed to sell equity securities to an investment fund managed by TPG Capital and to other investors this spring.

Harting said he expected WaMu would need to add “substantially” to its loan loss reserves in the second quarter, and the remainder of the year, as home prices and mortgage credit show no signs of stabilizing, he noted. He said he expected the bank to set aside as much as $4.0 billion in the quarter to cover bad loans, with charge-offs rising to $1.8 billion. Harting projected a loss of $1.48 per share.

WaMu reported setting aside an additional $3.7 billion in loan loss reserves in the quarter to $8.5 billion. The quarter’s provision was $5.9 billion, compared with $2.2 billion of net charge-offs.

“Past assumptions regarding losses have, in hindsight, proven to be a bit optimistic, and there is no guarantee that current assumptions will not require further downward adjustments,” said Walter O’Haire, senior analyst with Boston-based research firm Celent.

“As is the case with its peers, the bank listed a litany of risk factors and market factors that could adversely impact business. However, Washington Mutual understands the need to focus on moving forward and growing its business. Reserves are up and the bank is aggressively monitoring expenses, targeting $1 billion in pre-tax cost savings,” he added.

The Seattle-based bank reported a net loss of $3.3 billion, or $6.58 loss per share, compared with profits of $830.0 million, or 92 cents per share, in the year-earlier quarter. Analysts polled by Thomson Financial had expected WaMu to post a net loss of $1.5 million, or $1.05 loss per share.

Earlier this month, Edward Jones analyst Tom Kersting downgraded WaMu shares to “Sell” from “Hold,” based on his concern over the bank’s capital position and its ability to raise capital in the future.

“It is likely that WaMu will need to raise additional capital to bolster its financial position due to increasing losses in its loan portfolio,” Kersting wrote. “We are concerned about what it will take and how long it may take to improve the performance of the mortgage business, and we believe further near-term disappointments are possible.”

Management has said it expects potential mortgage-related losses of $12.0 billion to $19.0 billion over the next three to four years, but Kersting believes this number could be higher given the company’s focus on mortgages and geographic concentrations in higher-risk markets.