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Analysts Pare Washington Mutual Earnings Outlook Costly Acquisition, Falling Mortgage Rates Trigger Action

Washington Mutual Inc. shares have fallen nearly 20 percent since October amid investor concern that falling mortgage rates and a costly acquisition will yield disappointing profits.

Some of the drop can be blamed on the overall market’s retreat since the beginning of the year, but shares of the largest U.S. thrift have fallen at a steeper rate than its peers during the period because “the initial projections for their acquisitions were very aggressive,” said Guy Elliffe, an analyst at Jurika & Voyles Inc., an Oakland, Calif., investment firm that holds 2.3 million shares. “Earnings expectations have come down modestly.”

Since October, 10 analysts cut 1998 estimates for Seattle-based Washington Mutual, double the number who have boosted estimates, according to IBES International Inc.

Several of those who trimmed estimates for Washington Mutual said the thrift would have a tough time meeting the financial targets set for its $8 billion acquisition of Great Western Financial Corp. last year.

Washington Mutual “made aggressive assumptions” in its Great Western bid, said Morgan Stanley Dean Witter Discover & Co. analyst Kenneth Posner, who last month downgraded the thrift to “outperform” from “strong buy” and cut his 1998 estimate 10 cents because he expects it to save less than originally expected in the acquisition.

While Washington Mutual’s 1998 consensus estimate is down just 1 percent since October to $4.76 a share, analysts say it could be cut back further.

“The consensus is too high and everyone’s lowering their numbers,” said Sanford C. Bernstein & Co. analyst Jonathan Gray. Still, Gray, whose $4.45 1998 estimate is the lowest on Wall Street, rates Washington Mutual “outperform” and considers the stock undervalued.

The new consensus represents a 42 percent jump in per-share profits from the $3.35 a share expected for 1997. All the same, investor expectations were raised sky high during the Great Western takeover, leaving the stock vulnerable to disappointments.

Washington Mutual Chief Financial Officer William Longbrake said in an interview the thrift remains confident it will earn $4.81 a share, its 1998 projection when it bought Great Western.

Washington Mutual’s stock closed Thursday at $57.81-1/4, down nearly $3.41 for the day. Thursday’s close is down from a record high of $72.37-1/2 in October.

Investor skepticism is new for Washington Mutual and its Chairman and Chief Executive Kerry Killinger. Killinger became a Wall Street darling as he created a western U.S. financial powerhouse from a local S&L; and multiplied its stock price nine-fold in the 1990s.

“Everybody loves Kerry Killinger. He has a tremendous amount of good will on the Street,” said NationsBanc Montgomery Securities Inc. analyst Caren Mayer, who rates Washington Mutual “hold.”

Investor support was crucial earlier this year when, as a “white knight,” Washington Mutual put together its friendly offer for Great Western, topping Ahmanson’s hostile bid.

In the heat of the takeover battle, Washington Mutual paid a price of more than three times Great Western’s book value, or its assets minus liabilities. To make the acquisition pay off quickly, Washington Mutual set ambitious financial goals, promising $334 million in annual cost savings and $340 million in extra revenue by 1999.

Washington Mutual now says it may not make its cost savings target because it will close 90 California branches instead of the 100 previously projected and spend more on advertising that projected.

The thrift doesn’t want to repeat the mistake San Francisco-based Wells Fargo & Co. made in its purchase of First Interstate Bancorp, Longbrake said. The steps Wells took to slash expenses crippled service levels, prompting a massive customer exodus.

“The Wells experience has not been lost on us,” said Longbrake. “Rather than blindly keeping to (projections), we’re focusing on customer retention.”

The thrift will offset smaller-than-expected cost savings by getting more customers through the door than it originally anticipated, Longbrake said. The thrift opened about 31,000 new checking accounts a month in October and November through Great Western, a pace more than double what it predicted it would achieve in 1998 and 1999.

Washington Mutual, like other thrifts, may have a tougher time meeting its profit target if interest rates keep falling.

Average rates on 30-year, fixed-rate mortgages have dropped about 0.50 percentage points in the last seven months, encouraging borrowers to prepay existing mortgages and refinance.

When rates are low, more borrowers lock in low interest by taking out fixed-rate loans. Washington Mutual will sell off most newly-originated fixed mortgages, getting origination and loan servicing income, while giving up the interest payment stream.

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