WaMu Preferred R’s

$3B outstanding. $1000 par value. 7.75% fixed coupon, non-cumulative. Convertible into 47.05 shrs of WM until 2049.

 

This writeup will be necessarily brief. The gist is that due to the banning of shorting in many stocks, we’re getting dislocations in the markets, driven by a combination of many factors including hedge fund retrenchment/disinvestments. WaMu is a consumer and business bank with over 2200 branches and hundreds of lending stores in 36 states. This deposit base and branch network is highly valuable. It also has a large portfolio of ARMs, many of which the toxic option-ARMs. Oops. It is a question of just how deadly the ARM’s will be over time, offset by the incredible, tho possibly fleeting, value of the deposit/branch franchise.

 

At this moment in time, WM common is trading at 2.82. WM prfd K is trading 3.10. And, WM prfd R is trading at 135.

 

As we can see, 47.05 shares of WM are worth $132. So, the R’s are essentially trading as WM stock, despite being higher up the capital structure, and despite the $77.50/yr dividend. (Still current as of today.)

 

Additionally, the Pfd K’s pay 4% or US$libor plus 70bps and are perpetual and are also non-cumulative.

 

Clearly, the R’s are way too cheap either vs the K’s or the Common.

 

What can happen with WaMu?

 

1) It can muddle thru and earn their way thru their ARM losses.

 

2) They could lose depositors over time and take large mortgage losses, forcing the FDIC to take them over.

 

3) Someone desirous of their deposit franchise could buy the company.

 

4) Someone injects a lot of capital into the firm to recapitalize it.

 

Under the first scenario, the common and the prfds slowly accrete value back, with the prfds likely leading the way.

 

Under scenario two, everyone is likely wiped out, and the franchise value sold off by the FDIC.

 

Under scenario three, which is fairly likely inasmuch as many people covet the deposit franchise, the common is worth “something”, either a nominal amount, like $1 or  2, or a bit more, like $4-6.  In this case, the preferreds will be worth a lot more depending upon the deal that is struck. There is a chance that as part of a low-$ deal, the preferreds will not be made whole, but they’ll still get a nice premium from this level. If WM is taken out by a stronger name, then it’s likely the pfds will become pfds of the new entity and trade near their yield levels. In this case, the R’s will dramatically outperform the K’s since their coupon is almost double the K’s.

 

Under scenario four, the common is ok, but the pfds are much more valuable. Again, the R’s should dramatically outperform the K’s.

 

So, what’s the trade?? Well, there’s several.

 

If one can do it, the safest is to buy the R’s and short the K’s. If the firm goes bust, both are zeroes. The K’s are trading at 12.5% of par; the R’s at 13.5%, so the loss would be small. Any scenario where WM survives, the R’s will dramatically outperform the K’s. I just don’t know if one can short the K’s.

 

Buy the R’s outright, and take the risk of a total wipeout. Not as crazy as it sounds. WM is making good money and claims they are OK. Additionally, the FDIC is NOT in any hurry to push any banks into the Fund, as the FDIC has already depleted its coffers quite a bit. Worse-off banks are still operating.  Likely only  a run by depositors would cause an FDIC seizure.

 

Buy the R’s and “hedge” in the options. The synthetic short is trading for about 55cts under the common, so you would be risking this much to absolutely hedge yourself thru whatever options expiration you choose. One could also sell, say, Nov $3 for 90cts. This lowers your dollars at risk in a BK, but, limits your upside in a buyout. Realistically, a buyout is not going to be at a huge premium, and, to the extent that it is a nice price, it makes it all but certain that the pfds would be made whole.

 

Lastly, what I’ve also seen is that the pfds move around vs the common. Buying the pfds when the common sells off and the pfds come down to “parity” with the common, the pfds have usually later rallied out a couple of dollars from the common.