July 25 (Bloomberg) -- The cost to protect Washington Mutual Inc. bonds from default rose for a third day to a record amid concern that the biggest U.S. savings and loan won't be able to weather the worst housing crisis since the Great Depression.

Credit-default swaps on Seattle-based Washington Mutual traded at a record high after Gimme Credit LLC analyst Kathleen Shanley said yesterday that unsecured creditors are ``pulling funds.'' Washington Mutual this week reported a $3.3 billion second-quarter loss and increased loan loss provisions 69 percent to $5.9 billion as borrowers fell behind on their mortgages.

``These guys have not done a stellar job; now they're paying the price for it,'' said Scott MacDonald, the head of research at Aladdin Capital Management LLC in Stamford, Connecticut.

The upfront price that credit-default swap sellers demanded to protect Washington Mutual bonds from default for five years rose 6 percentage points to 20 percentage points, according to London-based CMA Datavision. That's in addition to an annual fee of 5 percent, meaning costs $2 million upfront and $500,000 annually to protect $10 million of the bonds. The contracts earlier reached a record 21 percent upfront, CMA prices show.

Mortgage-related losses through 2011 will be at the high end of a $12 billion to $19 billion forecast, Washington Mutual said July 22. Moody's Investors Service said it may reduce ratings on the company's senior debt to below investment grade, citing the potential for ``sizable quarterly losses through 2009.''

Shanley told clients yesterday that Washington Mutual's second-quarter results suggested that ``many creditors have quietly been pulling funds'' which is ``presenting an increasing funding challenge'' for the lender.

Adequate Capital

Washington Mutual, in a statement responding to Shanley yesterday, said it does all of its business through banking operations and ``does not rely on commercial paper,'' one of the sources of funding that Shanley cited.

``I think their capital is adequate right now, however if you cause a run on the bank and people panic, you erode the confidence and it's a dicier environment,'' MacDonald said. ``Financials really depend on confidence.''

The company has boosted liquidity by $10 billion since the quarter ended, financial news network CNBC reported, citing a company spokesman. Liquidity is now $50 billion, CNBC said.

The subprime meltdown at Washington Mutual turned into a broader mortgage crisis as tumbling home prices in California, where the lender has half its loans, left an increasing number of customers unable to make payments. Chief Executive Officer Kerry Killinger, 59, is under pressure after cutting 10 percent of the workforce, slashing the dividend twice and presiding over a 90 percent drop in the stock in the past year.

Washington Mutual fell 8 cents, or 1.9 percent, to $3.95 at 11:11 a.m. in New York Stock Exchange composite trading.

Markit CDX Index

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality.

Credit-default swaps on the Markit CDX North America Investment Grade Index of 125 companies in the U.S. and Canada rose 1 basis point to 137.5 as of 10:36 a.m. in New York, according to Deutsche Bank AG.

A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net

Last Updated: July 25, 2008 11:12 EDT