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Dueling Fools: Washington Mutual Bull

By Chuck Saletta October 5, 2007

2 Recommendations

Let me start by addressing the key point that I'm certain Billy Fisher will bring up in his bearish argument: Washington Mutual (NYSE: WM) is a large player in the subprime-mortgage market. And yes, thanks to a cascading chain reaction, the American subprime-mortgage meltdown apparently caused a run on British bank Northern Rock. From the perspective of headline risk, it would seem that owning a stock that resides anywhere near the subprime-mortgage industry falls at a point between insane and suicidal.

So why on Earth would anyone want to own shares of Washington Mutual right now?

Dig a little deeper
First and foremost, Washington Mutual is a bank. And the worst problems are currently striking not banks but subprime-focused mortgage REITs, such as New Century Financial. Unlike REITs, which don't take deposits and are forced to pay out nearly all of their earnings as dividends, banks have access to cheap financing from depositors and can retain their profits. Those differences give banks such as Washington Mutual far more financial strength to ride out storms like the one they're in now.

And even if a bank falters, in reality, there'll be someone there to pick up the pieces. Just look at the way Countrywide Financial (NYSE: CFC) was bailed out by Bank of America (NYSE: BAC) when Countrywide's subprime problems came home to roost. Add in a significant non-subprime lending portfolio, and Washington Mutual looks well poised to weather the current troubles, even if the whole mess continues to unravel.

Feds to the rescue
There's also the reality that Federal Reserve Chairman Ben Bernanke has proved himself very willing to live up to his "helicopter" nickname. By lowering short-term interest rates, the Fed appears to be trying to throw money at the problem by reinflating the asset bubble, whose bursting led to this current crisis in the first place.

Even if the bubble itself doesn't reinflate, lower short-term interest rates should help homeowners with adjustable-rate mortgages (ARMs). The interest rates that those ARMs charge tend to be pegged to short-term rates, and the lower those short-term rates are, the less likely any rate resets will be devastatingly high for a struggling homeowner. And as the pressure lowers, it becomes less likely that even stretched borrowers will default. Again, this is a good thing for mortgage banks such as Washington Mutual.

What exactly is the problem?
All of that background information is a roundabout way of saying that while the environment currently looks rough, there's a difference between rough and deadly. Yet even after recently raising its loss provision, the company is still estimated to earn $3.20 per share in 2007 and $3.55 in 2008. Even its generous dividend of $0.56 per quarter ($2.24 per year) is easily covered at those lowered earnings levels. Unless the current subprime crisis is really just the tip of a very big iceberg, Washington Mutual's current 6.2% yield appears to be safe. What better way to ride out the storm than to get paid better than 6% to do so?

Yes, yields that much higher than those of the general market are often the sign of a failing business. From time to time, though, they're really a sign that the market has once again thrown the baby out with the bathwater. In Washington Mutual's case, it very much appears as though the market is serving up an opportunity to buy a great -- though weakened -- business at a significant discount.

Don't just take my word for it
Most telling of all, though, is that two Washington Mutual corporate directors recently acquired phantom shares by deferring their directors' fees:


Shares Acquired

Charles Lillis


Thomas Leppert


Investing legend Peter Lynch is famous for saying that "insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise."

A well-covered, very generous yield. Directors turning down cash to pick up shares. A solid business outside the subprime mess that's getting all the headlines. A government that seems to be willing to step in and protect the business. When you put it all together, what's not to like about Washington Mutual?

Check out the other arguments in this duel, and then vote for a winner.

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