1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q ------------------------ (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998. OR [ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM ____________TO ____________ . COMMISSION FILE NUMBER: 0-25188 WASHINGTON MUTUAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) <TABLE> <S> <C> WASHINGTON 91-1653725 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1201 THIRD AVENUE, SEATTLE, WASHINGTON 98101 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) </TABLE> (206) 461-2000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. APPLICABLE ONLY TO CORPORATE ISSUERS: The number of shares outstanding of the issuer's classes of common stock as of July 31, 1998. COMMON STOCK -- 387,234,619 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
2 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1998 TABLE OF CONTENTS <TABLE> <S> <C> <C> PART I Item 1. Financial Statements: Consolidated Statements of Income -- Three and six months ended June 30, 1998 and June 30, 1997...................................................... 1 Consolidated Statements of Financial Position -- June 30, 1998 and December 31, 1997....................... 2 Consolidated Statements of Stockholders' Equity -- Six months ended June 30, 1998 and June 30, 1997.......... 3 Consolidated Statements of Cash Flows -- Six months ended June 30, 1998 and June 30, 1997.......... 4 Notes to Consolidated Financial Statements.................. 5 Item 2. Management's Discussion and Analysis of Financial Position and Results of Operations: General..................................................... 8 Results of Operations....................................... 8 Review of Financial Position................................ 14 Asset Quality............................................... 16 Market Risk and Asset/Liability Management.................. 18 Liquidity................................................... 19 Capital Adequacy............................................ 20 Impact of Recently Issued or Adopted Accounting Standards... 21 PART II Item 1. Legal Proceedings........................................... 22 Item 4. Submission of Matters to a Vote of Security Holders......... 22 Item 5. Other Information........................................... 22 Item 6. Exhibits and Reports on Form 8-K............................ 22 </TABLE> i
3 PART I ITEM 1. FINANCIAL STATEMENTS WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ----------------------- ----------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> INTEREST INCOME Loans......................................... $1,390,656 $1,268,733 $2,747,961 $2,505,301 Available-for-sale securities................. 247,539 271,640 453,634 543,222 Held-to-maturity securities................... 227,729 111,464 462,132 182,859 Cash equivalents and other.................... 34,813 18,512 63,662 54,383 ---------- ---------- ---------- ---------- Total interest income................. 1,900,737 1,670,349 3,727,389 3,285,765 INTEREST EXPENSE Deposits...................................... 511,882 543,792 1,027,783 1,081,280 Borrowings.................................... 662,383 473,172 1,260,261 891,558 ---------- ---------- ---------- ---------- Total interest expense................ 1,174,265 1,016,964 2,288,044 1,972,838 ---------- ---------- ---------- ---------- Net interest income............................. 726,472 653,385 1,439,345 1,312,927 Provision for loan losses....................... 46,405 49,999 91,748 103,809 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses........................................ 680,067 603,386 1,347,597 1,209,118 OTHER INCOME Depositor and other retail banking fees....... 105,652 92,305 197,960 174,978 Loan servicing fees........................... 18,625 19,908 33,446 43,084 Loan related income........................... 19,302 11,724 34,427 24,232 Securities fees and commissions............... 40,438 39,763 79,020 76,144 Insurance fees and commissions................ 12,003 14,315 23,852 26,914 Gain on sale of loans and leases.............. 28,007 5,415 43,451 14,210 Gain on sale of other assets.................. 13,184 2,097 16,505 9,262 Write down of loans securitized and retained................................... (2,871) (6,172) (10,137) (12,422) Other operating income........................ 15,477 8,792 25,122 19,996 ---------- ---------- ---------- ---------- Total other income.................... 249,817 188,147 443,646 376,398 OTHER EXPENSE Salaries and employee benefits................ 205,561 197,112 395,000 400,379 Occupancy and equipment....................... 78,917 78,263 151,213 158,847 Telecommunications and outsourced information services................................... 52,785 42,847 101,973 86,073 Regulatory assessments........................ 8,878 8,561 18,355 17,204 Transaction-related expense................... 24,473 24,305 33,123 58,026 Amortization of intangible assets arising from acquisitions............................... 12,327 15,683 27,028 31,446 Foreclosed asset expense...................... 2,725 902 3,601 4,544 Other operating expenses...................... 116,990 104,519 214,581 210,769 ---------- ---------- ---------- ---------- Total other expense................... 502,656 472,192 944,874 967,288 ---------- ---------- ---------- ---------- Income before income taxes...................... 427,228 319,341 846,369 618,228 Income taxes.................................. 162,184 123,977 320,653 238,780 Provision for payments in lieu of taxes....... 3,773 4,307 7,974 8,616 ---------- ---------- ---------- ---------- NET INCOME...................................... $ 261,271 $ 191,057 $ 517,742 $ 370,832 ========== ========== ========== ========== Net income attributable to common stock......... $ 260,335 $ 185,128 $ 515,068 $ 358,974 ========== ========== ========== ========== Net income per common share: Basic......................................... $0.69 $0.51 $1.37 $0.99 Diluted....................................... $0.69 $0.50 $1.37 $0.98 </TABLE> See Notes to Consolidated Financial Statements 1
4 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED) <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ------------ ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> ASSETS Cash...................................................... $ 992,346 $ 1,285,222 Cash equivalents.......................................... 47,147 275,668 Investments: Trading securities..................................... 36,024 23,364 Available-for-sale securities, amortized cost $15,023,959 and $11,258,232: Mortgage-backed securities ("MBS")................... 14,447,696 10,188,107 Investment securities................................ 716,153 1,185,815 Held-to-maturity securities, fair value $12,233,607 and $12,699,653: MBS.................................................. 12,246,295 12,659,217 Investment securities................................ 127,054 120,397 ------------ ----------- Total investments................................. 27,573,222 24,176,900 Loans: Loans held in portfolio................................ 70,035,896 67,124,935 Loans held for sale.................................... 931,448 685,716 Reserve for loan losses................................ (684,436) (670,494) ------------ ----------- Total loans....................................... 70,282,908 67,140,157 Investment in Federal Home Loan Banks ("FHLBs")........... 1,220,350 1,059,491 Foreclosed assets......................................... 180,108 205,272 Premises and equipment.................................... 1,025,847 937,198 Intangible assets arising from acquisitions............... 329,608 356,650 Mortgage servicing rights................................. 247,527 215,360 Other assets.............................................. 1,497,889 1,329,181 ------------ ----------- Total assets...................................... $103,396,952 $96,981,099 ============ =========== LIABILITIES Deposits: Checking accounts...................................... $ 8,499,938 $ 7,914,375 Savings accounts and money market deposit accounts..... 15,325,566 14,940,045 Time deposit accounts.................................. 26,635,641 28,131,597 ------------ ----------- Total deposits.................................... 50,461,145 50,986,017 Federal funds purchased and commercial paper.............. 3,705,298 2,928,282 Securities sold under agreements to repurchase ("reverse repurchase agreements")................................ 15,100,651 12,279,040 Advances from FHLBs....................................... 23,853,137 20,301,963 Trust preferred securities................................ 800,000 800,000 Other borrowings.......................................... 2,557,297 2,689,362 Other liabilities......................................... 1,283,772 1,687,364 ------------ ----------- Total liabilities................................. 97,761,300 91,672,028 STOCKHOLDERS' EQUITY Preferred stock, no par value, 10,000,000 shares authorized -- 1,970,000 and 4,722,500 shares issued and outstanding, liquidation preference.................... 49,250 118,063 Common stock, no par value, 800,000,000 shares authorized -- 387,124,870 and 386,340,027 shares issued and outstanding........................................ -- -- Capital surplus -- common stock........................... 1,966,249 1,943,294 Accumulated other comprehensive income.................... 144,171 134,610 Retained earnings......................................... 3,475,982 3,113,104 ------------ ----------- Total stockholders' equity............................. 5,635,652 5,309,071 ------------ ----------- Total liabilities and stockholders' equity........ $103,396,952 $96,981,099 ============ =========== </TABLE> See Notes to Consolidated Financial Statements 2
5 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED ------------------------ JUNE 30, JUNE 30, 1998 1997 ---------- ---------- (DOLLARS IN THOUSANDS) <S> <C> <C> PREFERRED STOCK Balance, beginning of period.............................. $ 118,063 $ 283,063 Redemption of Preferred Stock, Series C................... (68,813) -- ---------- ---------- Balance, end of period.................................... 49,250 283,063 CAPITAL SURPLUS - COMMON STOCK Balance, beginning of period.............................. 1,943,294 1,664,870 Common stock issued through stock options, restricted stock grants and employee stock plans, including tax benefits............................................... 22,806 91,083 Common stock issued under dividend reinvestment plan...... 149 847 Common stock acquired..................................... -- (32,016) ---------- ---------- Balance, end of period.................................... 1,966,249 1,724,784 ACCUMULATED OTHER COMPREHENSIVE INCOME Balance, beginning of period.............................. 134,610 118,625 Other comprehensive income................................ 9,561 (37,639) ---------- ---------- Balance, end of period.................................... 144,171 80,986 RETAINED EARNINGS Balance, beginning of period.............................. 3,113,104 2,926,530 Net income................................................ 517,742 370,832 Cash dividends declared on preferred stock................ (2,674) (11,858) Cash dividends declared on common stock................... (152,190) (133,128) Miscellaneous stock transactions.......................... -- 479 ---------- ---------- Balance, end of period.................................... 3,475,982 3,152,855 ---------- ---------- Total stockholders' equity........................ $5,635,652 $5,241,688 ========== ========== </TABLE> <TABLE> <CAPTION> SIX MONTHS ENDED ------------------------- JUNE 30, JUNE 30, 1998 1997 -------- -------- (NUMBER OF SHARES IN THOUSANDS) <S> <C> <C> PREFERRED STOCK Balance, beginning of period.............................. 4,723 5,383 Redemption of Preferred Stock, Series C................... (2,753) -- ------- ------- Balance, end of period.................................... 1,970 5,383 ======= ======= COMMON STOCK Balance, beginning of period.............................. 386,340 250,231 Common stock issued through stock options, restricted stock grants and employee stock plans, including tax benefits............................................... 782 2,670 Common stock issued under dividend reinvestment plan...... 3 20 Common stock acquired..................................... -- (908) ------- ------- Balance, end of period.................................... 387,125 252,013 ======= ======= </TABLE> See Notes to Consolidated Financial Statements 3
6 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED ---------------------------- JUNE 30, JUNE 30, 1998 1997 ------------ ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income................................................ $ 517,742 $ 370,832 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses............................... 91,748 103,809 (Gain) on sale of loans and leases...................... (43,451) (14,653) (Gain) on sale of other assets.......................... (16,505) (9,262) Depreciation and amortization........................... 85,635 85,723 Stock dividends from FHLBs.............................. (37,038) (25,104) Write down of loans securitized and retained............ 10,137 12,422 Decrease in trading securities.......................... 97,201 477 Origination of loans held for sale...................... (6,307,615) (2,224,751) Sales of loans held for sale............................ 6,104,976 2,123,691 (Increase) in other assets.............................. (221,985) (167,892) (Decrease) increase in other liabilities................ (411,160) 151,921 ------------ ------------ Net cash (used) provided by operating activities... (130,315) 407,213 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities................ (6,841,361) (1,854,614) Principal payments and maturities of available-for-sale securities.............................................. 1,819,457 929,684 Sales of available-for-sale securities.................... 1,150,512 1,619,278 Purchases of held-to-maturity securities.................. (12,036) (19,773) Principal payments and maturities of held-to-maturity securities.............................................. 1,049,149 235,094 Sales of loans............................................ 18,790 53,409 Origination of loans, net of principal payments........... (3,902,294) (6,557,635) Proceeds from sale of foreclosed assets................... 165,695 234,846 Purchases of premises and equipment, net.................. (132,591) (48,327) ------------ ------------ Net cash (used) by investing activities............ (6,684,679) (5,408,038) CASH FLOWS FROM FINANCING ACTIVITIES (Decrease) in deposits.................................... (524,872) (903,974) Increase in annuities..................................... -- 10,397 Increase in federal funds purchased and commercial paper................................................... 777,016 1,287,868 Increase (decrease) in short-term reverse repurchase agreements.............................................. 2,700,534 (3,016,656) Proceeds from long-term reverse repurchase agreements..... 1,146,205 3,954,254 Repayments on long-term reverse repurchase agreements..... (1,023,673) (1,098,834) Proceeds from FHLBs advances.............................. 31,962,490 22,980,633 Repayments on FHLBs advances.............................. (28,411,316) (18,695,589) Proceeds from trust preferred............................. -- 700,000 Repayments on other borrowings............................ (132,065) (457,657) Common stock repurchased.................................. -- (32,016) Common stock issued....................................... 22,955 92,406 Redemption of preferred stock............................. (68,813) -- Cash dividends paid....................................... (154,864) (144,983) ------------ ------------ Net cash provided by financing activities.......... 6,293,597 4,675,849 ------------ ------------ (Decrease) in cash and cash equivalents................... (521,397) (324,976) Cash and cash equivalents, beginning of period............ 1,560,890 1,665,355 ------------ ------------ Cash and cash equivalents, end of period.................. $ 1,039,493 $ 1,340,379 ============ ============ NONCASH INVESTING ACTIVITIES Loans exchanged for MBS................................... $ 647,020 $ 2,696,300 Loans exchanged for trading securities.................... 107,544 -- Loans originated to facilitate the sale of foreclosed assets.................................................. 31,469 45,217 Loans originated to refinance existing loans.............. 3,085,067 628,210 Real estate acquired through foreclosure.................. 172,000 231,966 CASH PAID DURING THE PERIOD FOR Interest on deposits...................................... 1,019,099 1,068,831 Interest on borrowings.................................... 1,164,833 871,111 Income taxes.............................................. 456,781 157,628 </TABLE> See Notes to Consolidated Financial Statements 4
7 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1: BASIS OF PRESENTATION In the opinion of management, the accompanying balance sheets and related interim statements of income and cash flows reflect all adjustments (which include reclassifications and normal recurring adjustments) that are necessary for a fair presentation in conformity with generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the financial statements. Interim results are not necessarily indicative of results for a full year. Certain reclassifications have been made to the 1997 financial statements to conform to the 1998 presentation. All significant intercompany transactions and balances have been eliminated. When Washington Mutual acquires a company through a material pooling of interests, current and prior period financial statements are restated to include the accounts of merged companies. Previously reported balances of the merged companies have been reclassified to conform to the Company's presentation and restated to give effect to the combinations. The information included in this Form 10-Q should be read in conjunction with Management's Discussion and Analysis and financial statements and notes thereto included in the 1997 Washington Mutual Annual Report and Form 10-K. NOTE 2: EARNINGS PER SHARE ("EPS") Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Information used to calculate EPS was as follows: <TABLE> <CAPTION> THREE MONTHS ENDED --------------------------------------------------------------------------------- JUNE 30, 1998 JUNE 30, 1997 --------------------------------------- --------------------------------------- INCOME SHARES PER SHARE INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNTS (NUMERATOR) (DENOMINATOR) AMOUNTS ----------- ------------- --------- ----------- ------------- --------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> <C> <C> Basic EPS: Net income............................ $261,271 $191,057 Less: preferred stock dividends....... (936) (5,929) -------- -------- Income available to common shareholders........................ 260,335 374,974,662 $0.69 185,128 363,789,497 $0.51 Diluted EPS: Effect of dilutive securities: Stock options....................... -- 1,612,248 -- 4,065,612 -------- ----------- -------- ----------- Income available to common shareholders and assumed conversions......................... $260,335 376,586,910 $0.69 $185,128 367,855,109 $0.50 ======== =========== ======== =========== </TABLE> 5
8 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED --------------------------------------------------------------------------------- JUNE 30, 1998 JUNE 30, 1997 --------------------------------------- --------------------------------------- INCOME SHARES PER SHARE INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNTS (NUMERATOR) (DENOMINATOR) AMOUNTS ----------- ------------- --------- ----------- ------------- --------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> <C> <C> Basic EPS: Net income............................ $517,742 $370,832 Less: preferred stock dividends....... (2,674) (11,858) -------- -------- Income available to common shareholders........................ 515,068 374,776,022 $1.37 358,974 363,302,015 $0.99 Diluted EPS: Effect of dilutive securities: Stock options....................... -- 1,539,055 -- 4,513,669 -------- ----------- -------- ----------- Income available to common shareholders and assumed conversions......................... $515,068 376,315,077 $1.37 $358,974 367,815,684 $0.98 ======== =========== ======== =========== </TABLE> NOTE 3: COMPREHENSIVE INCOME Washington Mutual, Inc. ("Washington Mutual" or the "Company") adopted Statement of Financial Accounting Standards ("SFAS") No. 130 Reporting Comprehensive Income, effective January 1, 1998. The standard requires that comprehensive income and its components be disclosed in the financial statements. The Company's comprehensive income includes all items which comprise net income plus the unrealized holding gains on available-for-sale securities. For the three and six months ended June 30, 1998 and 1997, the Company's comprehensive income was as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Net income.............................. $261,271 $191,057 $517,742 $370,832 Other comprehensive income.............. 7,043 52,125 9,561 (37,639) -------- -------- -------- -------- Total comprehensive income.... $268,314 $243,182 $527,303 $333,193 ======== ======== ======== ======== </TABLE> NOTE 4: THE AHMANSON MERGER On March 17, 1998, Washington Mutual and H.F. Ahmanson & Company ("Ahmanson") announced the signing of a definitive merger agreement that would create one of the nation's ten largest banking institutions, based on total 1997 year-end assets of approximately $150 billion. Under the agreement, each share of Ahmanson common stock will convert into the right to receive 1.68 shares of Washington Mutual common stock. The Ahmanson merger is expected to be accounted for as a pooling of interests. The merger, which requires regulatory approval and the approval of both companies' shareholders, is expected to close during the latter part of 1998. Special meetings for the shareholders of both companies to consider the transaction are scheduled for August 28, 1998. The Company expects to merge Ahmanson's subsidiary, Home Savings of America, FSB, into WMBFA and to operate the subsidiary under the Washington Mutual name. NOTE 5: STOCK SPLIT On April 20, 1998, the Company's Board of Directors declared a 3-for-2 common stock split in the form of a 50% stock dividend payable on June 1, 1998 to shareholders of record as of May 18, 1998. All references 6
9 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) in the financial statements to number of shares, per share amounts and market prices of the Company's common stock have been restated to reflect the increased number of common shares outstanding. NOTE 6: IMPACT OF RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information was issued in June 1997 and redefined how operating segments are determined. SFAS No. 131 requires disclosure of certain financial and descriptive information about a company's operating segments. This statement was adopted on January 1, 1998. Provisions of this statement require annual disclosure in the year of adoption and interim reporting for periods thereafter. This statement is not expected to have a material impact on the results of operations or financial position of the Company. SFAS No. 132, Employers' Disclosure about Pensions and Other Postretirement Benefits was issued February 1998 and standardizes the annual disclosure requirements for pensions and other postretirement benefits. This statement does not affect the results of operations or financial position of the Company. SFAS No. 132 was adopted as of January 1, 1998. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities was issued in June 1998 and establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after June 1998. The impact of the adoption of the provisions of this statement on the results of operations or the financial position of the Company has not been determined. 7
10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements. GENERAL Washington Mutual, Inc. ("Washington Mutual" or the "Company") is a financial services company committed to serving consumers and small and mid-sized businesses. The Company's banking subsidiaries, Washington Mutual Bank, FA ("WMBFA"), Washington Mutual Bank ("WMB") and Washington Mutual Bank, fsb ("WMBfsb"), accept deposits from the general public, make residential loans, consumer loans, and commercial real estate loans (primarily loans secured by multi-family properties) and engage in certain commercial banking activities. The Company's consumer finance operations provide direct installment loans and related credit insurance services and purchase retail installment contracts. Washington Mutual also markets annuities and other insurance products, offers full service securities brokerage, and acts as the investment advisor to and the distributor of mutual funds. The Keystone Transaction. In December 1996, Keystone Holdings, Inc. ("Keystone Holdings") merged with and into Washington Mutual (the "Keystone Transaction") and all of the subsidiaries of Keystone Holdings, including American Savings Bank, F.A. ("ASB"), became subsidiaries of the Company. The Great Western Merger. On July 1, 1997, Great Western Financial Corporation ("GWFC") merged with and into New American Capital, Inc. ("NACI"), a wholly-owned subsidiary of the Company (the "Great Western Merger"), and all of the subsidiaries of GWFC, including Great Western Bank, a Federal Savings Bank ("GWB") and Aristar, Inc. ("Aristar") became subsidiaries of NACI. On October 1, 1997, GWB was merged with and into ASB; simultaneously the name of ASB was changed to Washington Mutual Bank, FA. RESULTS OF OPERATIONS Overview. The Company's net income for the second quarter of 1998 was $261.3 million compared with $191.1 million for the second quarter of 1997. The Company's net income for the second quarter of 1998 and 1997 was reduced by pretax charges of $24.5 million and $24.3 million for transaction-related expenses in connection with the Great Western Merger and the proposed Ahmanson merger. The Company's net income for the first six months of 1998 was $517.7 million compared with $370.8 million for the first six months of 1997. The Company's net income for the first six months of 1998 and 1997 was reduced by pretax charges of $33.1 million and $58.0 million for transaction-related expenses in connection with the Great Western Merger and the proposed Ahmanson merger. Net Interest Income. Net interest income for the second quarter of 1998 was $726.5 million, an 11% increase from $653.4 million in the second quarter of 1997. The increase was due to a 14% rise in average earning assets to $99.52 billion from $86.98 billion in the second quarter of 1997, which more than offset the decline in the net interest spread to 2.74% in the second quarter of 1998 from 2.81% in the second quarter of 1997. The 10% increase in net interest income in the first six months of 1998 to $1.44 billion was also due to a 14% rise in average earning assets. The net interest spread declined to 2.75% in the first six months of 1998 from 2.86% in the first six months of 1997. To a certain extent, the Company's net interest spread is affected by changes in the yield curve. During the second quarter of 1998, the difference between the yield on a three-month U.S. Treasury bill and a 10-year U.S. Government note averaged 50 basis points compared with 152 basis points for the same period a year earlier. During the first six months of 1998, the difference between the yield on a three-month U.S. Treasury bill and a 10-year U.S. Government note averaged 46 basis points compared with 145 basis points for the same period a year earlier. 8
11 Selected average financial balances and the net interest spread and margin were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED --------------------------- --------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 ------------ ----------- ------------ ----------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Selected Average Balances: Loans............................. $ 69,926,446 $64,181,743 $ 69,076,452 $63,432,249 Investments....................... 29,590,385 22,797,092 28,224,977 22,171,487 ------------ ----------- ------------ ----------- Total interest earning assets.................. 99,516,831 86,978,835 97,301,429 85,603,736 Deposits.......................... 50,887,011 51,988,921 50,828,632 52,174,931 Borrowings........................ 45,221,930 31,730,572 42,990,338 30,300,204 ------------ ----------- ------------ ----------- Total interest bearing liabilities............. 96,108,941 83,719,493 93,818,970 82,475,135 Total assets...................... 103,034,804 90,440,848 100,969,122 88,669,939 Stockholders' equity.............. 5,518,615 5,113,595 5,434,282 5,059,955 Net Interest Spread: </TABLE> <TABLE> <S> <C> <C> <C> <C> Yield on loans.................... 7.95% 7.91% 7.97% 7.91% Yield on investments.............. 6.90 7.05 6.94 7.04 ------------ ----------- ------------ ----------- Combined yield on earning assets.................. 7.64 7.68 7.67 7.68 Cost of deposits.................. 4.03 4.20 4.08 4.18 Cost of borrowings................ 5.88 5.98 5.91 5.93 ------------ ----------- ------------ ----------- Combined cost of funds.... 4.90 4.87 4.92 4.82 Net interest spread............... 2.74 2.81 2.75 2.86 Net interest margin............... 2.91 2.99 2.93 3.04 </TABLE> The net interest spread is the difference between the Company's yield on assets and its cost of funds. The net interest margin measures the Company's annualized net interest income as a percentage of average interest earning assets. 9
12 Other Income. Other income was $249.8 million and $443.6 million for the second quarter and first six months of 1998 compared with $188.1 million and $376.4 million for the same periods in 1997. Other income consisted of the following: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Depositor and other retail banking fees: Checking and money market deposit account ("MMDA") charges........................... $ 94,116 $ 75,737 $171,772 $141,657 Automated teller machine ("ATM") transaction fees....................................... 6,488 5,758 12,064 12,194 Other......................................... 5,048 10,810 14,124 21,127 -------- -------- -------- -------- Total depositor and other retail banking fees........................ 105,652 92,305 197,960 174,978 Loan servicing fees............................. 18,625 19,908 33,446 43,084 Loan related income............................. 19,302 11,724 34,427 24,232 Securities fees and commissions................. 40,438 39,763 79,020 76,144 Insurance fees and commissions.................. 12,003 14,315 23,852 26,914 Gain on sale of loans and leases: Gain on sale of mortgage loans................ 27,816 5,213 43,093 12,466 Gain on sale of student loans................. 191 206 358 1,033 (Loss) gain on sale of leases................. -- (4) -- 711 -------- -------- -------- -------- Total gain on sale of loans and leases.............................. 28,007 5,415 43,451 14,210 Gain on sale of other assets: Gain on sale of premises and equipment........ 410 466 316 7,306 Gain on sale of available-for-sale securities................................. 7,702 1,631 11,117 1,864 Gain on sale of trading securities............ 2,875 -- 2,875 92 Gain on sale of other assets.................. 2,197 -- 2,197 -- -------- -------- -------- -------- Total gain on sale of other assets.... 13,184 2,097 16,505 9,262 Write down of loans securitized and retained.... (2,871) (6,172) (10,137) (12,422) Other operating income.......................... 15,477 8,792 25,122 19,996 -------- -------- -------- -------- Total other income.................... $249,817 $188,147 $443,646 $376,398 ======== ======== ======== ======== </TABLE> Depositor and other retail banking fees of $105.7 million and $198.0 million for the second quarter and first six months of 1998 increased from $92.3 million and $175.0 million for the same periods in 1997. The increase reflected an expanded collection of nonsufficient funds ("NSF") charges and overdraft protection charges on checking accounts and MMDAs, increased ATM transaction charges, and an increase in the number of checking accounts. The growth in depositor and other retail banking fees has been offset somewhat by losses (included in other operating expense) incurred by the Company resulting from the increased number of checking accounts. Management closely monitors the amount of such losses incurred. Loan servicing fees of $18.6 million declined 6% from $19.9 million in the second quarter of 1997. Contributing to the 22% decline in loan servicing fees from $43.1 million to $33.4 million in the first six months of 1998 was an increase in the amortization of mortgage servicing rights by approximately $5.0 million during the first quarter of 1998 compared with the first quarter of 1997. The increased amortization was due to the higher rate of prepayment in the loan servicing portfolio. The Company had loan related income of $19.3 million and $34.4 million in the second quarter and first six months of 1998 up from $11.7 million and $24.2 million for the same periods in 1997. Approximately one-half of the increase was the result of loan prepayment fees resulting from greater prepayment activity from the declining interest rate environment. 10
13 The Company had a net gain on the sale of loans and leases of $28.0 million and $43.5 million for the second quarter and first six months of 1998, compared with $5.4 million and $14.2 million for the same periods in 1997. Due to the increase in fixed-rate loan production resulting from the relatively low interest rate environment, the Company sold $3.64 billion and $6.06 billion of fixed-rate single family residential ("SFR") loans during the second quarter and first six months of 1998. The Company had a net gain on the sale of other assets of $13.2 million and $16.5 million for the second quarter and first six months of 1998 compared with $2.1 million and $9.3 million for the same periods in 1997. These increases were due to sales and calls of mortgage-backed and investment securities as well as an increase in the valuation of securities held for trading. The $7.3 million gain on sale of premises and equipment for the first six months of 1997 included a gain associated with the sale of branch premises at GWB. Impairment charge offs on mortgage-backed securities ("MBS") are reported in the line item -- Write down of loans securitized and retained -- as a charge to earnings in other income. Write downs on loans securitized and retained were $2.9 million and $10.1 million for the second quarter and first six months of 1998 down from $6.2 million and $12.4 million for the same periods in 1997. The decrease was due to improved credit performance as well as an adjustment of $2.1 million to the contingent liability reserve. Other Expense. Other expense totaled $502.7 million and $944.9 million for the second quarter and first six months of 1998 compared with $472.2 million and $967.3 million for the same periods in 1997. Other expense consisted of the following: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Salaries and employee benefits.................. $205,561 $197,112 $395,000 $400,379 Occupancy and equipment: Premises and equipment........................ 58,430 58,272 112,370 117,518 Data processing............................... 20,487 19,991 38,843 41,329 -------- -------- -------- -------- Total occupancy and equipment.............. 78,917 78,263 151,213 158,847 Telecommunications and outsourced information services...................................... 52,785 42,847 101,973 86,073 Regulatory assessments.......................... 8,878 8,561 18,355 17,204 Transaction-related expense..................... 24,473 24,305 33,123 58,026 Amortization of intangible assets arising from acquisitions.................................. 12,327 15,683 27,028 31,446 Foreclosed asset expense........................ 2,725 902 3,601 4,544 Other operating expense: Advertising and promotion..................... 26,879 23,717 47,396 40,109 Postage....................................... 13,122 12,945 25,824 25,284 Operating losses and settlements.............. 12,296 9,945 23,958 23,572 Professional fees............................. 11,989 12,423 19,932 26,969 Office supplies............................... 5,761 5,236 10,686 10,350 Other......................................... 46,943 40,253 86,785 84,485 -------- -------- -------- -------- Total other operating expense.............. 116,990 104,519 214,581 210,769 -------- -------- -------- -------- Total other expense................... $502,656 $472,192 $944,874 $967,288 ======== ======== ======== ======== </TABLE> Salaries and employee benefits increased to $205.6 million for the second quarter of 1998 from $197.1 million for the second quarter of 1997 as a result of increased incentive compensation due to expanded loan originations. Salaries and employee benefits decreased to $395.0 million for the first six months of 1998 from $400.4 million for the first six months of 1997. Full-time equivalent employees ("FTEs") were 19,694 at June 30, 1998 compared with 20,099 at June 30, 1997. The decrease in FTEs was primarily due to employee 11
14 separations in connection with the Great Western Merger and the restructuring plan at GWFC. However, this decrease was mitigated by increasing staffing levels throughout the Company to support its growth. The Company estimated total staff reductions related to the Keystone Transaction and the Great Western Merger (inclusive of the GWFC restructuring plan) of approximately 2,850. The actual number of staff reductions is not anticipated to be materially different from the original estimation of 2,850. Prior to the proposed Ahmanson merger, offices used by the Company on the Chatsworth campus were being consolidated in order to make more efficient use of building space. The Company had anticipated that approximately 565,000 square feet, located predominately in six buildings, would become available for sub- leasing to third parties. However, as a result of the proposed Ahmanson merger, it is now anticipated that the majority of the Chatsworth Campus will be utilized by the Company. The Company recorded transaction-related expense of $24.5 million and $33.1 million for the second quarter and first six months of 1998 compared with $24.3 million and $58.0 million for the same periods in 1997 as a result of merger activity (see Management's Discussion and Analysis of Financial Position and Results of Operations -- General). For the second quarter and first six months of 1998, the majority of the charges were for one-time nonrecurring incremental costs associated with combining entities, which are being expensed as incurred. These charges were partially offset by reductions in the estimates of contract cancellation fees, severance and savings from the consolidation of bank premises of $5.0 million, $8.0 million and $3.3 million for the second quarter and $13.3 million, $8.0 million and $3.3 million for the first six months of 1998. The reduction in estimates for contract cancellation fees was largely a result of maintaining certain contracts in place for longer periods than originally anticipated, thereby reducing the cancellation penalties. The reduction in severance estimates is primarily the result of more employees voluntarily terminating without severance than was originally estimated. The reduction in the estimate of premises cost is a result of the value of excess branch properties being higher than originally estimated due to increases in real estate values in Southern California. For the second quarter and first six months of 1997, the majority of transaction-related expense was for various investment banking and legal fees. Reconciliation of the transaction-related expense and accrual activity during 1998 was as follows: <TABLE> <CAPTION> THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, 1998 JUNE 30, 1998 JUNE 30, 1998 JUNE 30, 1998 ACCRUED ACTIVITY CHARGED ACCRUED PERIOD BALANCE AGAINST ACCRUAL(1) BALANCE COSTS -------------- ------------------- --------------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Severance.......................... $ 71,312 $(21,166) $ 50,146 $(5,629) Premises........................... 53,752 (6,861) 46,891 (3,250) Legal, underwriting and other direct transaction costs......... 471 (360) 111 3,914 Contract cancellation costs........ 23,639 (4,895) 18,744 (5,492) Other.............................. 7,703 (965) 6,738 34,930 -------- -------- -------- ------- $156,877 $(34,247) $122,630 $24,473 ======== ======== ======== ======= </TABLE> <TABLE> <CAPTION> SIX MONTHS SIX MONTHS ENDED ENDED DECEMBER 31, 1997 JUNE 30, 1998 JUNE 30, 1998 JUNE 30, 1998 ACCRUED ACTIVITY CHARGED ACCRUED PERIOD BALANCE AGAINST ACCRUAL(1) BALANCE COSTS ----------------- ------------------ --------------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Severance........................... $ 93,104 $(42,958) $ 50,146 $(5,629) Premises............................ 57,304 (10,413) 46,891 (3,250) Legal, underwriting and other direct transaction costs................. 742 (631) 111 3,914 Contract cancellation costs......... 33,699 (14,955) 18,744 (12,682) Other............................... 11,243 (4,505) 6,738 50,770 -------- -------- -------- ------- $196,092 $(73,462) $122,630 $33,123 ======== ======== ======== ======= </TABLE> - --------------- (1) Amounts included recoveries. 12
15 Telecommunications and outsourced information services expense of $52.8 million and $102.0 million for the second quarter and first six months of 1998 was up from $42.8 million and $86.1 million for the same periods in 1997. This change resulted from increased volume and usage. Year 2000. Washington Mutual has implemented a program to test and document the readiness of its electronic systems, programs and processes to recognize properly the year 2000. While the Company does not believe that the process of making its systems, programs and processes ready for the year 2000 will result in material cost, it is expected that a substantial amount of management and staff time will be required on the year 2000 project. Since January 1, 1998, the Company has spent approximately $3.7 million on its year 2000 project, and it currently expects to spend approximately $13.2 million more before it concludes its year 2000 readiness efforts. Prior to 1998, the Company undertook strategic business initiatives that shifted a significant portion of the cost for year 2000 readiness to third party vendors. Also, during this earlier time, the Company spent approximately $30.3 million on technology-related initiatives. The Federal Financial Institutions Examinations Council (the "FFIEC") issues periodic guidelines that clarify federal regulatory requirements for the testing and documentation of the readiness of an insured depository institution's electronic systems, programs and processes to recognize properly the year 2000. The FFIEC has recently published guidelines that require additional date testing of the Company's systems, programs and processes. These and other recent regulatory guidelines will cause the Company to perform additional work and incur additional expense in order to be in complete compliance with regulatory requirements. There can be no assurance that such future regulatory guidelines will not require additional work or cause the Company to incur additional expenses beyond those that are currently contemplated by Washington Mutual or delay the completion of Washington Mutual's Year 2000 preparations. In addition, there can be no assurance that the FFIEC or other federal regulators will not issue new regulatory requirements that require additional work by the Company and, if issued, that new regulatory requirements will not increase the cost or delay the completion of Washington Mutual's Year 2000 preparations. The Company has recently adopted business contingency plans for applications deemed critical by the Company and is further enhancing those plans to conform to the recently issued FFIEC guidance on business contingency planning for year 2000 readiness. Following the proposed Ahmanson merger and after the data processing conversions, the Company will rely on third party vendors for significant services such as electricity, voice and data transmission, desktop and communications management and item and loan processing as well as on governmental third parties such as the Federal Reserve and Federal Home Loan Bank systems. The Company has been communicating with its service providers to understand and monitor their year 2000 readiness preparations, and has undertaken a contingency planning process to be ready in case one of its significant service providers fails in its own readiness efforts. No assurance can be given, however, that the Company's third party service providers' year 2000 readiness efforts will proceed as anticipated, that the plans developed in the Company's contingency planning process will function as anticipated, or that the results of operations of the Company will not be adversely affected by difficulties or delays in third parties' year 2000 readiness efforts. Taxation. Income taxes include federal and applicable state income taxes and payment in lieu of taxes. The provision for income taxes was $166.0 million for the second quarter of 1998, which represented an effective tax rate of 38.8% as compared with a 40.2% effective tax rate for the second quarter of 1997. The provision for income taxes was $328.6 million for the first six months of 1998, which represented an effective tax rate of 38.8% as compared with a 40.0% effective tax rate for the first six months of 1997. The rate for 1997 was higher than 1998 due to transaction-related expenses in 1997 which were not deductible for tax purposes. Consumer Finance Operations. During the three and six months ended June 30, 1998, the consumer finance line of business had net income of $13.6 million and $26.6 million, up from $13.1 million and $24.0 million for the same periods in 1997. Contributing to the improvement in net income was an increase in 13
16 interest income due to growth in the loan portfolio. The increase in the loan loss provision reflected, in part, this growth of the loan portfolio and a continued national trend of a high level of personal bankruptcies. <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Consumer finance operations: Net interest income............................. $67,957 $61,384 $134,864 $122,316 Provision for loan losses....................... (18,300) (15,600) (36,300) (31,000) Other income.................................... 5,777 6,989 12,266 13,055 Other expense................................... (32,892) (31,191) (66,852) (64,764) ------- ------- -------- -------- Net income before income taxes.................. 22,542 21,582 43,978 39,607 Income taxes.................................... (8,900) (8,500) (17,400) (15,600) ------- ------- -------- -------- Net income.............................. $13,642 $13,082 $ 26,578 $ 24,007 ======= ======= ======== ======== </TABLE> REVIEW OF FINANCIAL POSITION Assets. At June 30, 1998, the Company's assets were $103.40 billion, an increase of 7% from $96.98 billion at December 31, 1997. The growth during the first six months of 1998 resulted from the purchase of agency MBS in the secondary market and the retention of adjustable-rate mortgage ("ARM") loan originations. Growth in assets slowed, despite record loan originations during the first six months of 1998, due to increased principal paydowns and sales of increased fixed-rate loan production caused by lower interest rates. It is the Company's current practice to sell the majority of its fixed-rate loan production. Securities. The Company's securities portfolio increased by $3.40 billion to $27.57 billion during the first six months of 1998 due to the purchase of agency MBS in the secondary market. At June 30, 1998, 84% of MBS in the Company's securities portfolio were adjustable rate. Of the securities indexed to an adjustable rate, 69% were indexed to the Cost of Funds Index of the Eleventh District Federal Home Loan Bank ("COFI"), 21% to U.S. Treasury indices, and 10% to LIBOR. The remaining 16% of MBS were fixed rate. Loans. Total loans (exclusive of the reserve for loan losses) at June 30, 1998 were $70.97 billion, up from $67.81 billion at December 31, 1997. Changes in the loan balances are primarily driven by originations of new loans, prepayments of existing loans, scheduled repayments of principal, loan securitizations and sales. Loans (exclusive of the reserve for loan losses) consisted of the following: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ----------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> Loans: Real estate loans: SFR.................................................. $56,161,806 $53,431,451 SFR construction..................................... 925,643 877,449 Apartment buildings.................................. 4,089,165 4,187,580 Other commercial real estate......................... 2,373,862 2,425,961 ----------- ----------- 63,550,476 60,922,441 Manufactured housing.................................... 1,081,781 1,081,193 Second mortgage and other consumer...................... 3,095,320 2,725,144 Consumer finance........................................ 2,319,026 2,309,407 Commercial business..................................... 920,741 772,466 ----------- ----------- $70,967,344 $67,810,651 =========== =========== </TABLE> 14
17 Real estate loans (exclusive of the reserve for loan losses) by product type were as follows: <TABLE> <CAPTION> JUNE 30, 1998 DECEMBER 31, 1997 --------------------------- --------------------------- PERCENT OF PERCENT OF TOTAL REAL TOTAL REAL AMOUNT ESTATE LOANS AMOUNT ESTATE LOANS ----------- ------------ ----------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Short-term ARMs: COFI.......................... $30,283,843 48% $32,108,461 53% MTA........................... 4,672,074 7 1,602,123 3 CMT........................... 3,533,828 5 3,800,156 6 Other......................... 2,977,595 5 4,553,499 7 ----------- --- ----------- --- 41,467,340 65 42,064,239 69 Medium-term ARMs: MTA........................... 5,821,061 9 2,880,587 5 CMT........................... 3,305,840 5 4,135,947 7 COFI.......................... 959,421 2 1,244,357 2 ----------- --- ----------- --- 10,086,322 16 8,260,891 14 Fixed-rate mortgages............ 11,996,814 19 10,597,311 17 ----------- --- ----------- --- $63,550,476 100% $60,922,441 100% =========== === =========== === Number of real estate loans..... 514,607 513,417 </TABLE> Short-term ARMs reprice within a year or less. Medium-term ARMs have an initial fixed rate for more than one year and then convert to short-term ARMs. Loan originations were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- -------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 ----------- ---------- ----------- ----------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Real estate loans: SFR: Adjustable rate................... $ 4,432,043 $4,643,521 $ 7,394,151 $ 7,275,248 Fixed rate........................ 4,131,102 1,493,062 8,095,834 2,862,512 ----------- ---------- ----------- ----------- 8,563,145 6,136,583 15,489,985 10,137,760 SFR construction: Custom............................ 292,694 238,371 445,414 406,713 Builder........................... 212,524 150,876 362,006 308,045 ----------- ---------- ----------- ----------- 505,218 389,247 807,420 714,758 Apartment buildings.................. 151,784 178,253 274,904 312,841 Other commercial real estate......... 109,471 119,073 209,018 205,474 ----------- ---------- ----------- ----------- 9,329,618 6,823,156 16,781,327 11,370,833 Manufactured housing................... 81,948 88,270 137,458 151,155 Second mortgage and other consumer..... 543,926 548,424 935,195 925,238 Consumer finance....................... 568,350 512,792 1,081,971 976,706 Commercial business.................... 235,441 176,806 448,371 325,210 ----------- ---------- ----------- ----------- $10,759,283 $8,149,448 $19,384,322 $13,749,142 =========== ========== =========== =========== </TABLE> 15
18 SFR originations by product type were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 1998 JUNE 30, 1998 ------------------------------- -------------------------------- PERCENT PERCENT PERCENT PERCENT OF OF OF OF AMOUNT CATEGORY TOTAL AMOUNT CATEGORY TOTAL ---------- -------- ------- ----------- -------- ------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> Short-term ARMs: MTA................................. $2,028,824 90% 24% $ 2,937,157 81% 19% COFI................................ 196,867 9 2 519,888 14 4 CMT................................. 18,292 1 * 151,843 4 1 Other............................... 14,135 * * 37,569 1 * ---------- --- --- ----------- --- --- 2,258,118 100% 26 3,646,457 100% 24 === === Medium-term ARMs: MTA................................. 2,152,136 99% 26 3,337,489 89% 21 CMT................................. 21,789 1 * 410,205 11 3 ---------- --- --- ----------- --- --- 2,173,925 100% 26 3,747,694 100% 24 === === Fixed-rate mortgages.................. 4,131,102 48 8,095,834 52 ---------- --- ----------- --- $8,563,145 100% $15,489,985 100% ========== === =========== === </TABLE> - --------------- * Less than one percent The strong housing market and attractive interest rates led to record loan production which included a significant amount of refinance activity during the first six months of 1998. As a result of borrower preference for fixed-rate mortgages, the fixed-rate loan production accounted for 48% of total SFR originations in the second quarter of 1998 compared with 24% in the second quarter of 1997, and 52% of total SFR originations during the first six months of 1998 compared with 28% during the first six months of 1997. Interest-bearing liabilities. The Company uses customer deposits and wholesale borrowings to fund its operations. Due to increased market competition for customer deposits, the Company has increasingly relied on wholesale borrowings to fund its asset growth. The slight decrease in deposits from $50.99 billion to $50.46 billion reflected the competitive environment of banking institutions and the wide array of investment opportunities available to consumers. While time deposit accounts have declined as a percentage of total deposits, MMDAs and checking accounts have increased as a percentage of total deposits to 47%. These latter two products have the benefit of lower interest costs compared with time deposit accounts. Even though MMDAs and checking accounts are liquid, they are considered by the Company to be the core relationship with its customers. In the aggregate, the Company views these core accounts to be a more stable source of long-term funding. The Company's borrowings primarily take the form of federal funds purchased, commercial paper, reverse repurchase agreements and advances from the Federal Home Loan Banks ("FHLBs") of Seattle and San Francisco. The exact mix at any given time is dependent upon the market pricing of the individual borrowing sources. ASSET QUALITY Provision for Loan Losses and Reserve for Loan Losses. The provision for loan losses is based upon management's estimate of the amount necessary to maintain an adequate reserve for loan losses inherent in the Company's loan portfolio. The Company's determination of the level of the reserve and, correspondingly, the provision for loan losses rests upon various judgments and assumptions, including current and anticipated economic conditions, the underlying quality of the loan portfolio, prior loan loss experience, the Company's credit administration and asset management philosophy and procedures, and the regulatory examination process. 16
19 Changes in the reserve for loan losses were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> Balance, beginning of period.................... $673,172 $688,016 $670,494 $677,141 Provision for loan losses....................... 46,405 49,999 91,748 103,809 Reserves added through business combinations.... -- 2,647 -- 10,908 Reserves transferred to MBS impairment.......... -- (16,505) -- (16,505) Reserves transferred to contingent liability.... -- (2,747) -- (2,747) Loans charged off: SFR........................................... (9,859) (29,075) (25,064) (56,186) SFR construction.............................. (362) -- (362) -- Commercial real estate........................ (2,632) (8,930) (6,255) (14,279) Manufactured housing, second mortgage and other consumer............................. (5,515) (4,606) (12,095) (9,252) Consumer finance.............................. (21,588) (19,414) (43,693) (38,653) Commercial business........................... (884) (181) (1,915) (306) -------- -------- -------- -------- (40,840) (62,206) (89,384) (118,676) Recoveries of loans previously charged off: SFR........................................... 314 270 733 548 SFR construction.............................. -- 69 -- 69 Commercial real estate........................ 140 429 798 867 Manufactured housing, second mortgage and other consumer............................. 524 1,726 909 2,098 Consumer finance.............................. 4,669 4,321 8,942 8,460 Commercial business........................... 52 38 196 85 -------- -------- -------- -------- 5,699 6,853 11,578 12,127 -------- -------- -------- -------- Net charge offs................................. (35,141) (55,353) (77,806) (106,549) -------- -------- -------- -------- Balance, end of period.......................... $684,436 $666,057 $684,436 $666,057 ======== ======== ======== ======== </TABLE> An analysis of the reserve for loan losses was as follows: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 -------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> Specific and allocated reserves: Commercial real estate.................................... $ 74,511 $ 84,969 Commercial business....................................... 9,346 3,277 Builder construction...................................... 1,919 2,207 -------- -------- 85,776 90,453 Unallocated reserves........................................ 598,660 580,041 -------- -------- $684,436 $670,494 ======== ======== Total reserve for loan losses as a percentage of: Annualized net charge offs................................ 440% 335% Nonaccrual loans.......................................... 116 111 Nonperforming assets...................................... 89 83 </TABLE> The Company considers the reserve for loan losses of $684.4 million adequate to cover losses inherent in the loan portfolio at June 30, 1998. However, no assurance can be given that the Company will not, in any particular period, sustain loan losses that are sizable in relation to the amount reserved, or that subsequent evaluation of the loan portfolio, in light of the factors then prevailing, including economic conditions and the 17
20 Company's ongoing examination process and that of its regulators, will not require significant increases in the reserve for loan losses. In addition to reviewing the adequacy of the reserve for loan losses, management also reviews any loan pool where the Company has a recourse obligation. At June 30, 1998, the Company held in its investment portfolio $13.71 billion of securitized loans with recourse. The related impairment totaled $38.9 million at June 30,1998. The Company also maintains a contingent liability to cover potential losses on recourse MBS and loans that have been sold with recourse to third parties. At June 30, 1998, the Company had sold $1.70 billion of recourse MBS and loans sold with recourse, and the contingent liability totaled $7.3 million, which the Company considers adequate to cover estimated future losses. The impairment and contingent liability are evaluated periodically and any subsequent adjustments are recorded as a write down of loans securitized and retained. Nonperforming Assets. Assets considered to be nonperforming include nonaccrual loans and securities, foreclosed assets and real estate held for investment purposes that does not generate sufficient income to meet return on investment criteria. When loans securitized or sold on a recourse basis are nonperforming, they are included in nonaccrual loans. Management's classification of a loan as nonaccrual does not necessarily indicate that the principal of the loan is uncollectable in whole or in part. Loans are generally placed on nonaccrual status when they are four payments or more past due. Nonperforming assets were $768.6 million or 0.74% of total assets at June 30, 1998 compared with $806.6 million or 0.83% of total assets at December 31, 1997. Nonperforming assets consisted of the following: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 -------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> Nonaccrual loans: Real estate loans: SFR.................................................... $477,428 $469,127 SFR construction....................................... 11,597 10,413 Apartment buildings.................................... 15,854 17,296 Other commercial real estate........................... 5,715 25,825 -------- -------- 510,594 522,661 Manufactured housing...................................... 10,736 11,127 Second mortgage and other consumer........................ 14,088 14,071 Consumer finance.......................................... 51,059 50,930 Commercial business....................................... 2,039 2,585 -------- -------- 588,516 601,374 Foreclosed assets........................................... 180,108 205,272 -------- -------- $768,624 $806,646 ======== ======== Nonperforming assets as a percentage of total assets........ 0.74% 0.83% </TABLE> MARKET RISK AND ASSET/LIABILITY MANAGEMENT The long-run profitability of the Company depends not only on the success of the services it offers to its customers and the credit quality of its loans and securities, but also the extent to which its earnings are unaffected by changes in interest rates. The Company engages in a comprehensive asset and liability management program that attempts to reduce the risk of significant decreases in net interest income caused by interest rate changes without unduly penalizing current earnings. A key component of this program is the origination and retention of short-term and adjustable-rate assets whose repricing characteristics more closely 18
21 match the repricing characteristics of the Company's liabilities. At the same time, the Company's policy is to sell most fixed-rate loan originations. A conventional measure of interest rate sensitivity for savings institutions is the one-year gap, which is calculated by dividing the difference between assets maturing or repricing within one year and total liabilities maturing or repricing within one year by total assets. The Company's assets and liabilities that mature or reprice within one year were as follows: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ----------- ------------ (DOLLARS IN THOUSANDS) <S> <C> <C> Interest-sensitive assets................................. $78,709,513 $74,938,422 Derivative instruments designated against assets.......... 300,000 500,000 Interest-sensitive liabilities............................ (78,429,358) (70,204,799) Derivative instruments designated against liabilities..... 2,303,800 1,078,400 ----------- ----------- Net asset sensitivity................................... $ 2,883,955 $ 6,312,023 =========== =========== One-year gap.............................................. 2.79% 6.51% </TABLE> While the one-year gap helps provide some information about a financial institution's interest sensitivity, it does not predict the trend of future earnings. The Company uses financial modeling to forecast earnings under different interest rate projections. Although this modeling is very helpful in managing interest rate risk, it does require significant assumptions for the projection of loan prepayment rates, loan origination volumes and liability funding sources that may prove to be inaccurate. The Company monitors its interest rate sensitivity and attempts to reduce the risk of a significant decrease in net interest income caused by a change in interest rates. Asset and Liability Strategy The Company's asset/liability strategy is to reduce the risk of significant decreases in net interest income caused by interest rate changes without unduly penalizing current earnings. The implementation of strategies to reduce interest rate risk, however, generally has a negative effect on earnings. Nevertheless, rising interest rates or a flat yield curve adversely affect the Company's operations. Management tries to balance these two factors in administering its interest rate risk program. As part of this strategy, the Company actively manages asset and liability maturities. An inherent characteristic of the Company's deposit structure is customers' preference for liquidity. This is apparent from the fact that at June 30, 1998 the Company's MMDAs accounted for $11.81 billion or 23% of total deposits, and time deposit accounts with maturities less than one year totaled $23.01 billion or 46% of total deposits. Because its principal funding source of deposits is interest rate sensitive, the Company's primary asset strategy is to originate and retain ARMs in the portfolio. During the first six months of 1998 and 1997, the Company either sold or securitized and then sold the majority of the fixed-rate loans it originated, while retaining most of its ARM production. At June 30, 1998, 84% of the Company's total MBS portfolio and 73% of the Company's total loan portfolio had adjustable rates. LIQUIDITY Liquidity management focuses on the need to meet both short-term funding requirements and long-term growth objectives. The long-term growth objectives of the Company are to attract and retain stable consumer deposit relationships and to maintain stable sources of wholesale funds. Because the low interest rate environment of recent years inhibited consumer deposits, Washington Mutual has supported its growth through business combinations with other financial institutions and by increasing its use of wholesale borrowings. Should the Company not be able to increase deposits either internally or through acquisitions, its ability to grow would be dependent upon, and to a certain extent limited by, its borrowing capacity. Washington Mutual monitors its ability to meet short-term cash requirements using guidelines established by its Board of Directors. The operating liquidity ratio is used to ensure that normal short-term secured borrowing capacity is sufficient to satisfy unanticipated cash needs. The volatile dependency ratio measures 19
22 the degree to which the Company depends on wholesale funds maturing within one year weighted by the dependability of the source. At June 30, 1998, the Company had substantial liquidity compared with its established guidelines. WMB monitors its liquidity position as measured by certain predetermined ratios established by the FDIC as benchmarks for liquidity management. At June 30, 1998, WMB's ratios were above the minimums established by its Board of Directors. Regulations promulgated by the OTS require that the Company's federal savings banks maintain, for each calendar month, certain liquidity ratios. At June 30, 1998, each of the Company's federal savings banks' liquidity ratios was in excess of the regulatory minimums. As presented in the Consolidated Statements of Cash Flows, the sources of liquidity vary between years. The statement of cash flows includes operating, investing and financing categories. Cash flows from operating activities included net income for the first six months of 1998 of $517.7 million, $150.5 million for noncash items and $798.5 million of other net cash flows from operating activities. Cash flows from investing activities consisted mainly of both proceeds from and purchases of securities, and loan principal repayments and loan originations. For the first six months of 1998, cash flows from investing activities included sales and principal payments on securities and loans held for investment totaling $4.04 billion. Loans originated and purchased for investment required $3.90 billion, and $6.85 billion was used for the purchase of securities. Cash flows from financing activities consisted of the net change in the Company's deposit accounts and short-term borrowings, the proceeds and repayments from both long-term reverse repurchase agreements and FHLB advances, and also the issuance of long-term debt. For the first six months of 1998, the above mentioned financing activities increased cash and cash equivalents by $6.49 billion on a net basis. Cash and cash equivalents were $1.04 billion at June 30, 1998. See "Consolidated Financial Statements -- Consolidated Statements of Cash Flows." At June 30, 1998, the Company was in a position to obtain approximately $33.76 billion in additional borrowings primarily through the use of collateralized borrowings and deposits of public funds using unpledged MBS and other wholesale sources. CAPITAL ADEQUACY The Company's capital (stockholders' equity) was $5.64 billion at June 30, 1998 and $5.31 billion at December 31, 1997. At the end of second quarter 1998, the ratio of capital to total assets was 5.45% compared with 5.47% at December 31, 1997. The regulatory capital ratios of WMBFA, WMB and WMBfsb and minimum regulatory requirements to be categorized as well capitalized were as follows: <TABLE> <CAPTION> JUNE 30, 1998 ------------------------ WELL-CAPITALIZED WMBFA WMB WMBFSB MINIMUM ----- ----- ------ ---------------- <S> <C> <C> <C> <C> Capital ratios: Leverage............................... 5.87% 5.60% 6.76% 5.00% Tier 1 risk-based...................... 10.12 10.32 11.55 6.00 Total risk-based....................... 11.55 11.03 12.81 10.00 </TABLE> The Company's federal savings bank subsidiaries are also required by OTS regulations to maintain core capital of at least 3.00% of assets and tangible capital of at least 1.50% of assets. WMBFA and WMBfsb each satisfied these requirements at June 30, 1998. The Company's securities subsidiaries are also subject to capital requirements. At June 30, 1998, all of Washington Mutual's securities subsidiaries were in compliance with their applicable capital requirements. 20
23 IMPACT OF RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS SFAS No. 130, Reporting Comprehensive Income was issued in June 1997 and requires businesses to disclose comprehensive income and its components in their financial statements. This statement does not affect the results of operations or financial position of the Company. SFAS No. 130 was adopted on January 1, 1998. See "Consolidated Financial Statements -- Note 3: Comprehensive Income." SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information was issued in June 1997 and redefined how operating segments are determined. SFAS No. 131 requires disclosure of certain financial and descriptive information about a company's operating segments. This statement was adopted on January 1, 1998. Provisions of this statement require annual disclosure in the year of adoption and interim reporting for periods thereafter. This statement is not expected to have a material impact on the results of operations or financial position of the Company. SFAS No. 132, Employers' Disclosure about Pensions and Other Postretirement Benefits was issued February 1998 and standardizes the annual disclosure requirements for pensions and other postretirement benefits. This statement does not affect the results of operations or financial position of the Company. SFAS No. 132 was adopted as of January 1, 1998. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities was issued in June 1998 and establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after June 1998. The impact of the adoption of the provisions of this statement on the results of operations or the financial position of the Company has not been determined. 21
24 PART II ITEM 1. LEGAL PROCEEDINGS Washington Mutual, Inc. has certain litigation and negotiations in progress resulting from activities arising from normal operations. In the opinion of management, none of these matters is likely to have a materially adverse effect on the Company's financial position or results of operation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Washington Mutual, Inc. held its annual meeting of shareholders on April 21, 1998. A brief description of each matter voted on and the results of the shareholder voting are set forth below: <TABLE> <CAPTION> VOTES VOTES ABSTENTIONS AND FOR AGAINST NON-VOTES ---------- ---------- --------------- <S> <C> <C> <C> 1. The election of seven directors set forth below: Samuel B. McKinney (term ending 1999)............. 200,540,466 1,517,194 Willis B. Wood (term ending 2000)................. 200,629,239 1,428,421 John W. Ellis (term ending 2001).................. 200,552,361 1,505,299 Anne V. Farrell (term ending 2001)................ 200,623,303 1,434,357 Stephen E. Frank (term ending 2001)............... 200,624,176 1,433,484 William P. Gerberding (term ending 2001).......... 200,515,372 1,542,288 Enrique Hernandez, Jr. (term ending 2001)......... 200,612,606 1,445,054 2. Amendment and Restatement of the 1994 Stock Option Plan.............................................. 156,959,081 44,322,462 776,118 3. Ratification of Deloitte & Touche LLP as independent auditors.............................. 201,559,560 191,640 306,461 </TABLE> ITEM 5. OTHER INFORMATION A shareholder who intends to present a proposal at the Company's next annual meeting, other than pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, must provide the Company notice of such intention by at least February 1, 1999 or management of the Company will have discretionary voting authority at the 1999 annual meeting with respect to such proposal without any discussion of the matter in the Company's proxy statement. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS See Index of Exhibits on page 24. (b) REPORTS ON FORM 8-K During the second quarter of 1998, WMI filed reports on Form 8-K dated June 1, 1998, June 4, 1998, as amended June 18, 1998, June 10, 1998 and June 12, 1998. The June 1 report filed, pursuant to Item 7 of the report, copies of slides presented to investors at a conference on May 27, 1998. The June 4 report filed, as amended June 18, 1998 pursuant to Item 7 of the report, copies of slides presented to investors at a conference on June 3, 1998. The June 10 report disclosed, pursuant to Item 5 of the report, the WMI Board of Directors' adoption of resolutions to effect a 3-for-2 split of WMI's common stock, no par value per share, in the form of a stock dividend. The June 12 report filed, pursuant to Item 7 of the report, copies of slides presented to investors at a conference on June 9, 1998. 22
25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 14, 1998. WASHINGTON MUTUAL, INC. By: /s/ FAY L. CHAPMAN ------------------------------------ Fay L. Chapman Executive Vice President By: /s/ RICHARD M. LEVY ------------------------------------ Richard M. Levy Senior Vice President and Controller (Principal Accounting Officer) 23
26 WASHINGTON MUTUAL, INC. INDEX OF EXHIBITS <TABLE> <CAPTION> EXHIBIT NO. - ----------- <C> <S> 3.1 Restated Articles of Incorporation of the Registrant, as amended (Incorporated by reference to the Washington Mutual, Inc. Annual Report on Form 10-K for the year ended December 31, 1997, as amended on April 1, 1998. File No. 0-25188). 3.2 By-laws of the Registrant (Incorporated by reference to the Washington Mutual, Inc. Annual Report on Form 10-K for the year ended December 31, 1995. File No. 0-25188). 4.1 Rights Agreement dated October 16, 1990 (Incorporated by reference to the Washington Mutual, Inc. Current Report on Form 8-K dated November 29, 1994. File No. 0-25188). 4.2 Amendment No. 1 to Rights Agreement dated October 16, 1990 (Incorporated by reference to the Washington Mutual, Inc. Current Report on Form 8-K dated November 29, 1994. File No. 0-25188). 4.3 The registrant agrees to furnish the Securities and Exchange Commission, upon request, with copies of all instruments defining the rights of holders of long-term debt of registrant and its consolidated subsidiaries. 27.1 Financial Data Schedule. 27.2 Amended Financial Data Schedule for the period ended March 31, 1998. </TABLE> 24