JP Morgan Chase Becomes 2nd Largest Bank in US

As the pro and contra over a $700 billion bank rescue rages on in Washington, one of the nation's largest banks, Seattle-based Washington Mutual Inc. (WaMu), has collapsed under the weight of its extremely large bad bets on the mortgage market.

WaMu, which was founded in 1889, is the largest bank to fail by far in the country's history. Its $307 billion in assets eclipse the $40 billion of Continental Illinois National Bank, which failed in 1984, and the $32 billion of IndyMac, which the government seized in July.

WaMu ran into serious trouble after it was caught up in the once-booming subprime mortgage business. Troubles then spread to other parts of WaMu's home loan portfolio, namely its "option" adjustable-rate mortgage loans. Option ARM loans offer very low introductory payments and let borrowers defer some interest payments until later years. The bank stopped originating those loans in June.

Actually, problems in WaMu's home loan business began to appear in 2006, when the bank reported that the division lost $48 million, compared with net income of about $1 billion in 2005.

At the start of 2007, following the release of the company's annual financial report, then-CEO Kerry Killinger said the bank had prepared for a slowdown in its housing business by sharply reducing its subprime mortgage lending and servicing of loans. Alan H. Fishman, the former president and chief operating officer of Sovereign Bank and president and CEO of Independence Community Bank, replaced Killinger earlier this month.

As more borrowers became having failed on their mortgages, WaMu worked to assist troubled debtors refinance their loans as a way to avoid default and foreclosure, committing $2 billion to the effort last April. However, it was all too late. At the same time, fears of growing credit problems kept investors from purchasing debt backed by those loans, drying up a source of cash flow for banks that made subprime loans.

In December, WaMu said it would shutter its subprime lending business and reduce expenses with layoffs and a dividend cut. Then, WaMu in July has reported a $3 billion second-quarter loss, the biggest in its history, as it boosted its reserves to more than $8 billion to cover losses on bad loans. Over the last three quarters, it added $10.9 billion to its loan-loss provisions.

Actually, the downfall of WaMu has been widely anticipated for some time because of the company's heavy mortgage-related losses. As investors panic about the bank's health, its stock price plunged 95% from a 52-week high of $36.47 to its close of $1.69 Thursday. On Wednesday, it suffered a ratings downgrade by Standard & Poor's that put it in danger of collapse.

The Federal Deposit Insurance Corp. seized WaMu on Thursday, and then sold the thrift's banking assets to JPMorgan Chase & Co. for $1.9 billion. One positive is that the sale of WaMu's assets to JPMorgan Chase prevents the thrift's collapse from depleting the FDIC's insurance fund. However, it seems that the detail is likely to give only marginal solace to Americans facing tighter lending and watching their stock portfolios plunge in the wake of the nation's most momentous financial collapse since the Great Depression.

WaMu is JPMorgan Chase's second acquisition this year of a major financial institution hobbled by losing bets on mortgages. In March, JPMorgan bought the investment bank Bear Stearns Cos. for about $1.4 billion, plus another $900 million in stock ahead of the deal to secure it.

JPMorgan Chase is now the second-largest bank in the U.S. after Bank of America Corp., which recently bought Merrill Lynch in a flurry of events that included Lehman Brothers Holdings Inc. going bankrupt and American International Group Inc., the world's largest insurer, which has controlled over by the government. JPMorgan also said that it plans to sell $8 billion in common stock to raise capital.

Because of WaMu's souring mortgages and other bad debt, JPMorgan plans to write down WaMu's loan portfolio by about $31 billion, a figure that could change if the government goes through with its rescue plan and JPMorgan decides to take advantage of it.

Besides JPMorgan Chase, Wells Fargo & Co., Citigroup Inc., HSBC, Spain's Banco Santander and Toronto-Dominion Bank of Canada were also reportedly possible suitors. WaMu was believed to be talking to private equity firms as well.

The seizure by the government means shareholders' equity in WaMu was wiped out. The deal leaves private equity investors including the firm TPG Capital, which led a $7 billion cash infusion in the bank this spring, on the sidelines empty handed.

JPMorgan Chase said it was not acquiring any senior unsecured debt, subordinated debt, and preferred stock of WaMu's banks, or any assets or liabilities of the holding company, Washington Mutual Inc. JPMorgan said it would not take on the lawsuits facing the holding company. Moreover, the acquisition will give it 5,400 branches in 23 states, and that it plans to close less than 10% of the two companies' branches.

The WaMu acquisition would add 50 cents per share to JPMorgan's earnings in 2009, the bank said, adding that it expects to have pretax merger costs of approximately $1.5 billion while achieving pretax savings of approximately $1.5 billion by 2010.

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