Washington Mutual Looking To Shift Focus Away From Mortgage Lending

Looking to reinvent its reputation, Washington Mutual wants to establish itself as a diversified financial player instead of a mortgage-oritented bank.

CEO Kerry Killinger told his investors that the nation’s top savings and loan is “leaving its legacy behind” by limiting its shaky mortgage servicing rights business to about 25 percent of its balance sheet and de-emphasizing home lending as well. The company’s acquisition of Providian Financial marks its entry into the credit card business, with greater focus to be dedicated to on its retail operations. Washington Mutual is soon expected to begin opening new branches and cross-selling its insurance, credit card and home loan products to both consumers and small businesses.

Killinger said he sees the shift in focus as an “evolution” that will make Washington Mutual “more akin to large commercial banks” rather than a mortgage depot. But is this a smart move? Experts are still on the fence. Fully diversified banks such as Citigroup and Bank of America have 2006 price-earnings multiples that are roughly in line with Washington Mutual’s current figure of 10.1 times earnings, while a specialized thrift such as Golden West Financial trades at 11.8 times earnings. That raises the question of whether diversification is worth the trouble as far as stock price is concerned, anaylsts say.

Is this reincarnation for real?

Dick Bove, an analyst at Punk Ziegel & Co., thinks the company’s mortgage division will remain its core business and that talk of rebirth is a little overblown.

“By law, if they want to maintain their charter as a thrift, 65 percent of their assets have to be in real estate lending, they can use the remaining 35 percent to go into other businesses, like the credit card business,” He said. “But the likelihood of them changing the essential character of their business is nil.”

Many analysts think Washington Mutual is looking to step into other areas due to slowdown in the housing market. With mortgage rates on the rise, as well as the flattening yield curve (which squeezes margins as borrowing costs rise), the high margin credit card business and other forms of non-prime lending look increasingly appealing. Bove said that while WaMu’s line of thinking is rational, it signals more than anything else that the company’s core business is weaking — making it a bona fide takeover target.

The company doesn’t appear to be putting itself up for sale as of right now, but if problems continue to mount, that could change very quickly. One possible trouble spot could be Washington Mutual’s heavy involvement in the Option ARMs market. An option ARM is an adjustable-rate mortgage that typically lets borrowers choose one of four different payments each month. A borrower can elect to make the minimum payment with no principal, and less interest than what accrues on the loan, resulting in negative amortization.

The concern, however, is that once the initial grace period is over and mortgage payments skyrocket to reflect a rise in interest rates, borrowers could go belly up in record numbers — leaving Washington Mutual with a high number of mortgage defaults and losses. Rapid growth in assets from option ARMs) will invariably lead to trouble, some experts believe, especially since the honeymoon period is likely to end before the company’s paradigm shift can provide it with a financial cushion. Currently the company is one of the largest sellers of this type of adjustable-rate mortgage, which has been in high demand over the past 18 months.

Will there be any takeover attempts?

There is speculation within the industry that Citigroup may emerge as a potential buyer. Since Citigroup is a huge mortgage lender but wants to expand its domestic base - particularly in Texas and Florida real estate markets where Washington Mutual has a significant presence - the two seem to be a good fit. For now, at least, Washington Mutual is talking more about making acquisitions than being acquired.

Killinger emphasized that while the company is focused internally on its own growth, it remains open to acquisitions. By and large, the company’s investors have been less than thrilled with the stock’s recent performance. Shares are down about 2 percent this year, underperforming compared to its peers on the S&P 500 Financial’s sub-index, which has risen about 5 percent.