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An expensive lesson

History should judge TPG’s $1.3bn WaMu loss not for its size but for its miscalculation of risk, writes Cezary Podkul.

Type the words “worst private equity deal ever” into Google and the verdict seems savagely swift: topping the list is TPG’s $1.3 billion (€900 million) loss stemming from its investment in just-collapsed US bank Washington Mutual.

But the real story here isn’t the size of the loss. Instead, it’s that TPG – like many investors who have thus far been left with bleeding hands after trying to catch the proverbial falling knife – seems to have gravely miscalculated its risk.

To be sure, a $1.3 billion loss wouldn’t over-excite any GP investing multibillion funds – but it is, as TPG said, a

TPG’s greatest risk was never dilution or loss of cash from a lowball bid: it was the potential for bankruptcy

small percentage of an enormous, extremely diversified portfolio. 

Still, one hesitates to think that “unprecedented turmoil in global financial markets and resulting macro crisis of confidence”, as TPG characterised it, were solely to blame for the loss.

When TPG originally inked the deal, it sought to protect its investment with anti-dilution measures such as price reset payment provisions, adjustments in the conversion price of its preferred holdings and increases in the number of common shares issuable upon the exercise of its Warrants in case WaMu raised additional capital in excess of $500 million.

Cezary Podkul

In a typical private investment in a public entity (PIPE), these would all be laudable terms since the two biggest risks PIPE investors typically face are dilution and loss of principal.

But this was no typical PIPE.

TPG’s greatest risk was never dilution or loss of cash from a lowball bid: it was the potential for bankruptcy. As of 30 June, the thrift had $53 billion in payment option adjustable rate mortgages and $16 billion in subprime loans on its books that continued to bleed and had no buyers in sight. Consequently, few investors would want to throw good money after bad by participating in additional capital raisings or even buying the bank at fire sale prices – especially with billions of potential cash payments to TPG standing in the way and the threat of mandatory dilution.

By the time TPG removed the price reset provisions “to maximise the bank's flexibility in this difficult environment”, it was already too late. It became clear that no one would buy the bank before it failed and, with billions of deposits running out the door on a daily basis after a further credit downgrade by S&P, failure became its only option.

The lesson likely to be taught to future MBA students using WaMu as a private equity case study is this: When bankruptcy is a PIPE’s biggest risk – particularly a PIPE pertaining to a federally regulated banking institution – no amount of cash resets and full ratchet adjustments will save the deal. Instead, these measures only set up further roadblocks to a White Knight rescue or a last-ditch capital raise.