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WaMu Outlook Lowered, Future Looks Uncertain

Washington Mutual shares hit an 18-year low and its credit default swaps hit a record high after Standard & Poor's reduced its outlook for the battered banking leader.

WaMu dropped as much as 30 percent in active trading as the bank continued to face investor doubts despite replacing its CEO earlier in the week and assurances from the new leader that the company would survive and grow.

"The outlook revision reflects the increasingly challenging housing and mortgage markets and their impact on WaMu's core mortgage franchise," S&P credit analyst Victoria Wagner said.

The company named Alan Fishman as its new CEO, replacing Kerry Killinger, but S&P said that only added to uncertainty for the future.

The credit default swaps, or the cost to protect WaMu's debt, traded at 40 percent upfront plus 500 basis points annually, up from 32 percent upfront plus 500 basis points a year, according to Phoenix Partners Group. That means it costs $4 million on an upfront basis plus $500,000 a year to protect $10 million of debt for five years.

There also were fears that the company would not make an attractive candidate for sale because of new mark-to-market rules for acquisitions that would weigh on the company's takoever value.

At the same time, the company faces challenges ahead as interest rates will reset for prime adjustable-rate mortgages in 2010 and 2011, presenting what some analysts feel is the next wave of trouble for banks after getting hit by subprime defaults over the past two years.

"Washington Mutual has a ton of that toxic stuff. They reported earlier in the year, in April, that option ARMs account for 50 percent of prime loans in its bank portfolio," said Christopher Mayer, analyst and managing editor for the Capital and Crisis newsletter. "These things are just going to be a complete disaster."

Along with replacing Killinger, the company announced Monday it had entered a memorandum of understanding with the Office of Thrift Supervision, meaning it is effectively on probation. The bank assured investors it would not need to raise more capital or increase liquidity, and said there would be no "changes to the products and services it provides its customers."

But Mayer noted that the company issued many of its ARMs to volatile housing regions such as California, Florida and Hawaii.

He disputed the notion that WaMu would not need to raise capital and said the bank would represent a risky acquisition for a larger institution.

"They're going to have to raise capital because they're going to have a much diluted base," Mayer said. "We're in a market too where it's incredibly difficult to raise capital, even for companies that have good finances. The amount of money that WaMu would need is really big numbers."

The lowered outlook for WaMu comes the same day that Lehman Brothers sought to assure investors it could survive, despite a $3.9 billion loss that translated to $5.92 a share. The company said it would liquidate some assets and sell its investment management unit.

A call for comment to WaMu was not returned.

-- Reuters contributed to this report.

Banks