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SEATTLE-Washington Mutual on Tuesday estimated its first-quarter net loss at $1.1 billion and announced a major retrenchment that it hopes will result in a return to profitability in the face of “elevated credit costs” in 2008 and 2009 related to its residential mortgage business. The locally based thrift said it will close all free-standing home loan branches, exit the wholesale lending business altogether and raise $7 billion, including the sale of $2 billion of new stock.

The store closings will occur during the second quarter, resulting in thousands of layoffs. The capital infusion means a dilution for current shareholders — WaMu’s total market cap is $11-billion — but industry analysts have said it is the only option that enables the company to both meet regulatory requirements for the necessary capital ratios and satisfy ratings agencies.

If the transaction sets the company up for a return to profitability, it also sets them up for a takeover, analysts said. While its residential mortgage business is not pretty, the company’s retail-banking unit and credit-card business are still healthy enough to be attractive, they said.

The pre-emptive capital raise and early net loss estimate may help maintain the company’s share price. WaMu shares rose 29% to $13.15 on Monday on news of the $7-billion solution. In noontime-trading Wednesday, shares stood at $11.24, down 4.9% but well ahead of its 52-week low of $8.72, which is about the price upon which the capital raise was based.

The transaction calls for the company to sell approximately 176 million shares of its common stock at a purchase price of $8.75 per share to an investment vehicle managed by TPG Capital (TPG), and to other investors. In addition, the company agreed to issue an aggregate of approximately 55,000 shares of contingently convertible, perpetual non-cumulative preferred stock at a purchase price and liquidation preference of $100,000 per share.

The convertible preferred stock would automatically convert into WaMu common stock at an initial exercise price of $8.75 per share, subject to adjustment. In addition, certain investors who agreed to transfer restrictions on their shares will receive warrants, which, upon obtaining certain approvals, will become exercisable for common stock based on a post-closing reference price. The warrants have a term of five years.

To further shore up the company’s capital position, the board of directors intends to reduce the quarterly dividend rate to $0.01 per common share from its most recent quarterly dividend rate of $0.15 per common share, which will preserve approximately $490 million of capital annually.

“This substantial new capital— along with the other steps we are announcing today— will position us for a return to profitability as these elevated credit costs subside,” said WaMu Chairman and CEO Kerry Killinger in a prepared statement.

WaMu will call a special shareholders’ meeting to increase the number of common shares available for issuance and to approve conversion of the preferred stock into common stock. WaMu’s board of directors intends to appoint TPG founding partner David Bonderman to the board. In addition, Larry Kellner, chairman and chief executive officer of Continental Airlines and former executive vice president and chief financial officer of American Savings Bank, will become a board observer at TPG’s request.

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