WaMu lowered to junk by S&P

Already battered, Washington Mutual shares fall 27% as potential capital sources' attention is diverted.

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By Tami Luhby, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- Washington Mutual had its credit rating lowered to junk Monday by Standard & Poors amid continuing weakness in the housing market.

The action follows downgrades of the nation's largest savings-and-loan by Fitch Ratings and Moody's last week as WaMu tries to reassure nervous investors that it has the ability to survive the credit crunch.

"Increasing market turmoil and the related impact from managing its concentrated mortgage franchise in this troubled housing and credit cycle led to the downgrade of WaMu," said Victoria Wagner, an S&P credit analyst, who lowered the bank's rating to BB- with a negative outlook.

Last week, Fitch Rating lowered WaMu (WM, Fortune 500) to BBB- with a negative outlook, while Moody's took it down into junk territory with a Baa3 rating with a negative outlook.

S&P's announcement follows another brutal day for the bank on Wall Street. Shares plummeted nearly 27% to close at $2.

Investors are concerned that potential sources of capital have disappeared in the upheaval this weekend on Wall Street that saw Lehman Brothers (LEH, Fortune 500) file the nation's largest bankruptcy and Bank of America (BAC, Fortune 500) scoop up Merrill Lynch (MER, Fortune 500).

After this weekend's turmoil, however, WaMu has fewer places to turn if it needs another injection of capital beyond the $7 billion it raised in April. No one stepped in to save Lehman and Bank of America will now be busy digesting Merrill. Meanwhile, JPMorgan Chase (JPM, Fortune 500) and Goldman Sachs (GS, Fortune 500) are reportedly trying to arrange $75 billion in loans for troubled insurer American International Group (AIG, Fortune 500).

WaMu is one of the largest players in the mortgage market, which brought it prosperity during the housing boom and may lead to its downfall during the bust.

Seeking to reassure investors, the bank said late Thursday that it had sufficient capital and liquidity to see it through these tough times. It reported that it plans to set aside $4.5 billion in the quarter for loan losses, down from $5.9 billion in the prior period but more than two times expected charge-offs, or uncollectable loan losses. Reserves for loan losses should build to $10.3 billion, up from $8.5 billion.

The growth of net charge-offs is expected to slow to less than 20% in the quarter. In the prior period, charge-offs soared nearly 60%.

The bank said it expects its capital ratio, a measure of its ability to withstand loan losses, to remain "significantly above the levels for well-capitalized institutions." It has about $50 billion of liquidity from "reliable" funding sources.

Analysts had mixed reaction to the report. Fitch Ratings and Moody's subsequently downgraded WaMu, concerned about its ability to raise capital, while other analysts voiced concerns about depositors' reactions.

"The biggest risk for WM is a run on deposits," said Chris Brendler, analyst with Stifel Nicolaus & Co. "With all the negative headlines and recent IndyMac failure, WM's retail deposit franchise is a huge concern to us as a significant outflow of consumer deposits could lead to devastating liquidity problems since the company has apparently already lost access to the capital markets."

But some analysts said the results should restore some confidence in the company. They were heartened by the fact that the company feels it can put less aside for loan losses.

Even in downgrading the stock, S&P said it recognizes that the company has enough liquidity to meet all its fixed obligations through 2010 and is operating with enough capital from a regulatory perspective.

Other analysts agreed.

"Although not out of the woods yet, WM appears to be moving in the right direction on credit and 2008 is likely to be the peak year for provisioning," Fox-Pitt Kelton analysts wrote in a note to clients. To top of page

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