J.P. Morgan Buys WaMu's Assets, Deposits

For its $1.9 billion, J.P. Morgan is getting a large branch network and about $160 billion of deposits, according to our estimates. It will be the second-largest U.S. retail bank after Bank of America BAC. The deal is likely to result in about $2 billion of merger costs, but that should be offset by $1.5 billion in annual cost savings. J.P. Morgan expects to shut down about 10% of WaMu's branch network because of overlap with its own network, in addition to the usual combining of back offices. We believe J.P. Morgan has pulled off its second smart, government-assisted acquisition of the year.

However, it will also be taking on WaMu's estimated $176 billion troubled mortgage book. J.P. Morgan will take $29.9 billion of write-downs on this piece of the loan book through acquisition accounting, which assumes 20% losses on WaMu's option adjustable-rate mortgage portfolio, 23% losses on its home-equity portfolio, and 40% losses on its subprime exposure. These marks assume a peak-to-trough decline in home prices of 25% across the U.S., but 44% in California and Florida. If these losses prove to be too optimistic, J.P. Morgan's earnings assumptions will be too high and we will see additional loan-loss provisions.

This deal also significantly affects J.P. Morgan's capital balance; the firm is adding assets without adding any equity. Consequently, in conjunction with the deal, J.P. Morgan announced an $8 billion capital-raising for Friday before the market opening. This will help shore up the bank's capital position and leave it within its target 8%-8.5% Tier 1 ratio, but still significantly below the 9.2% it had June 30. This shrewd deal has wiped out the firm's dry powder, but with Bear Stearns and now WaMu to integrate, J.P. Morgan has enough on its plate to worry about without looking for additional acquisitions, and an 8.3% Tier 1 ratio is a very healthy figure.