WM(NYSE)

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Washington Mutual (WM, NYSE)

Last Updated October 06, 2001

Humans do but monkeys don't know that scratching the wound directly may lead to serious complications, even death. I don't know by design or accident, but the U.S. Federal Reserve does not wish to attack the current economic problem directly either. I am sure they knew that prior to the September 11, the U.S. economy was well on its way to recovery; problem was the technology sector. And even after the disaster, problem for the economy and the stock market is not the consumer but technology over-build. Lowering interest rates will do little to solve that problem although it will alleviate the potential global recession facing us now. This stock market meltdown is not like previous ones and the recession may also be quite different.

While it is too early to predict, consumer is not the culprit and is likely to bounce back quite soon as long as the layoffs don't accelerate and house prices don't take a nosedive. In the mean time, we are all receiving an unexpected gift of lower interest rates, lower than any time in the recent past. This, as in the past, will have a positive impact on certain sectors. Unfortunately that will not include technology. Not any time soon, any way.

The way lower interest rates are supposed to work is that cheap money available to banks leads to cheaper money for the consumer. You can already see that with the number of 0.9% car financing signs on auto lots. I haven't seen this since the early nineties when the Fed was desperately trying to resuscitate the economy. Some worry that such drastic cuts in rates will have limited impact on consumer sentiment and purchase behaviour. Japan being the example cited most often. It could happen here also if our financial institutions were in similar dire conditions. Based on what I can gather from literature, the Japanese consumer hardly benefits from the near zero cost of money. Bankrupt financial institutions in Japan use the cheap source of cash to extract another year of survival. Not so, here. Most banks are in reasonable shape, at least for now. This may change if corporate loans get worse.

The recession in early nineties had a similar problem. No matter how low the rates went, industrial companies like GM, GE and IBM did not react. The first real beneficiary of the windfall was the bank and finance companies that lend to consumers, for cars, houses and other consumer items. Unfortunately, in the ensuing decade, most banks have embarked on a campaign to diversify into riskier businesses such as mutual funds and even direct equity into technology companies. That includes most of our Canadian banks.

It is hard to find a so-called "pure" old style bank that gets most of its business form managing loans. There is some fear out there about the consumer being stretched and debt levels being too high. But as long as the job situation is reasonable and they can refinance their houses, consumers do and will pay the significantly lower loan costs. Even in the savings and loan disaster of the last decade, most consumers did fork out the cash. Try to remember the last time your bank said to you, times are tough so we forgive your loan. They will get your house first.

I did find one; Seattle based Washington Mutual (WM, NYSE),  is the largest thrift in the US, offering traditional consumer and commercial banking (targeting small and mid-sized businesses) through nearly 2,000 facilities across more than 40 states. California accounts for the majority of WM's deposits and loans; other key markets include Florida, Oregon, Texas, Utah, and Washington. The thrift writes sub-prime real estate loans via its Long Beach Mortgage unit; other segments provide specialty finance, insurance, and investment management services. It is entering New York City, the biggest banking market in the US, with its planned acquisition of Dime Bancorp.

WM has also diversified out of dependence on the spread business (borrowing cheap Fed money and lending at higher rates) but majority of that diversification is still in loan servicing and transaction fees. Recently the stock has taken a tumble along with the rest of the market but nowhere near as severely as the rest. There is of course the fear that this may be the first time when massive loan losses may occur on account of the debt-laden consumer.

Chart:

The P/E chart places full value for this stock at 15 times this year's earnings of $2.88. Even if there is no growth in EPS this year, WM trades at a 20% discount to fair value. Analysts actually expect a fair growth to $3.57 a share but I am not holding my breath. As in nearly every situation the estimates may come down.

The following information was used to compute fundamental value of WM:

EPS, this year 2.88, next year 3.57 Beta 0.7 Plowback 70% Debt/Equity 50% Return on Equity 17%