Harvard Case - Washington Mutual's Covered Bonds
"Washington Mutual's Covered Bonds" Harvard business case study is written by Daniel B. Bergstresser, Robin Greenwood, James Quinn. It deals with the challenges in the field of Finance. The case study is 25 page(s) long and it was first published on : Mar 13, 2009
At Fern Fort University, we recommend Washington Mutual (WaMu) proceed with issuing covered bonds, but with a strategic approach that mitigates risks and maximizes value creation. This recommendation is based on a comprehensive analysis of WaMu's financial position, the evolving market for covered bonds, and the potential benefits and challenges associated with this financing strategy.
2. Background
This case study focuses on Washington Mutual, a major U.S. savings and loan association, in 2007. WaMu was facing increasing pressure from the subprime mortgage crisis, which had significantly impacted its asset quality and profitability. The company was exploring alternative financing options to strengthen its capital base and improve its liquidity position. Covered bonds, a relatively new instrument in the U.S. market, presented a potential solution.
The main protagonists in this case are:
- Kerry Killinger: WaMu's CEO, who is responsible for making the final decision on whether to issue covered bonds.
- The WaMu Executive Team: They must analyze the potential benefits and risks of issuing covered bonds and advise Killinger accordingly.
- Investors: They will be the ultimate buyers of the covered bonds, and their perception of risk and return will influence the success of the issuance.
3. Analysis of the Case Study
This case study can be analyzed through the lens of financial strategy and risk management. We will examine WaMu's financial position, the potential benefits and risks of issuing covered bonds, and the competitive landscape.
Financial Analysis:
- Capital Structure: WaMu's capital structure was heavily reliant on debt financing, which exposed it to significant financial risk. Issuing covered bonds could help diversify its funding sources and reduce its reliance on traditional debt.
- Liquidity: The subprime mortgage crisis had significantly impacted WaMu's liquidity, making it difficult to meet its short-term obligations. Covered bonds could provide a stable source of funding, improving its liquidity position.
- Profitability: WaMu's profitability was declining due to the mortgage crisis. Covered bonds could potentially lower its cost of funding, improving its profitability.
Risk Assessment:
- Credit Risk: Issuing covered bonds would expose WaMu to credit risk, as investors would be relying on the underlying mortgage assets for repayment.
- Interest Rate Risk: Changes in interest rates could impact the value of covered bonds, potentially leading to losses for WaMu.
- Market Risk: The market for covered bonds was still developing in the U.S., which could create volatility and uncertainty for WaMu.
Competitive Landscape:
- Covered Bonds Market: The U.S. market for covered bonds was relatively new, with limited issuance history.
- International Experience: European countries had a more developed covered bond market, providing valuable insights into the potential benefits and risks.
- Investor Demand: WaMu needed to assess investor appetite for covered bonds, considering their risk tolerance and return expectations.
4. Recommendations
WaMu should proceed with issuing covered bonds, but with a strategic approach that addresses the identified risks and maximizes value creation.
- Targeted Issuance: WaMu should target specific investor segments with a strong appetite for covered bonds, such as institutional investors and pension funds.
- Structured Issuance: The covered bonds should be structured to minimize credit risk and interest rate risk. This could include using a diversified pool of mortgage assets, incorporating interest rate caps and floors, and utilizing hedging strategies.
- Transparency and Disclosure: WaMu should provide clear and transparent information to investors about the underlying mortgage assets and the structure of the covered bonds.
- Strategic Pricing: The pricing of the covered bonds should reflect the inherent risks and the competitive landscape.
- Ongoing Monitoring: WaMu should continuously monitor the performance of the covered bonds and adjust its strategy as needed.
5. Basis of Recommendations
Our recommendations are based on the following considerations:
- Core Competencies: WaMu's core competency lies in mortgage lending. Issuing covered bonds leverages this expertise by providing a financing mechanism based on its existing asset base.
- External Customers: The issuance of covered bonds would attract new investors, diversifying WaMu's funding sources and potentially reducing its reliance on traditional debt.
- Competitors: WaMu's competitors were also exploring alternative financing options. By issuing covered bonds, WaMu could maintain its competitive position and potentially gain a first-mover advantage in the U.S. market.
- Attractiveness: Covered bonds offered the potential for lower borrowing costs compared to traditional debt financing, which could improve WaMu's profitability and shareholder value.
6. Conclusion
Issuing covered bonds presents a strategic opportunity for WaMu to strengthen its financial position, improve its liquidity, and enhance its profitability. By carefully considering the risks and implementing a well-structured issuance strategy, WaMu can successfully leverage this financing option to navigate the challenging market environment.
7. Discussion
Alternative options to issuing covered bonds include:
- Raising Equity Capital: This would dilute existing shareholders but provide a strong capital buffer.
- Selling Assets: This could raise cash quickly but may involve significant losses on distressed assets.
The key risks associated with issuing covered bonds include:
- Credit Risk: The default of underlying mortgage assets could lead to losses for investors.
- Interest Rate Risk: Rising interest rates could reduce the value of covered bonds, potentially leading to losses for WaMu.
- Market Risk: A lack of investor demand or adverse market conditions could hinder the issuance of covered bonds.
8. Next Steps
- Develop a Detailed Issuance Plan: This plan should outline the structure, pricing, and marketing strategy for the covered bonds.
- Secure Investor Commitment: WaMu should engage with potential investors to gauge their interest and secure commitments for the issuance.
- Obtain Regulatory Approvals: WaMu should obtain the necessary approvals from regulatory authorities for the issuance of covered bonds.
- Implement the Issuance: WaMu should execute the issuance of covered bonds according to the approved plan.
- Monitor and Evaluate: WaMu should continuously monitor the performance of the covered bonds and evaluate the effectiveness of its issuance strategy.
This timeline should be flexible and adjusted based on market conditions, regulatory approvals, and investor feedback.
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Case Description
Washington Mutual issued 6 billion Euro of covered bonds in 2006. The objective of the case is to ask whether these bonds are mispriced in late 2008. The case is set in September 2008, and Washington Mutual is facing considerable distress due to mounting losses on its mortgage portfolio. Following investment bank Lehman Brother's Chapter 11 bankruptcy protection filing in mid September, the price of Washington Mutual's covered bonds has fallen to 75 per 100 of face value. As these bonds are overcollateralized, the case asks students to evaluate the underlying collateral portfolio in the event of liquidation, as well as assessing the likelihood of different outcomes. The case takes place during a period of considerable uncertainty in the global capital markets.
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