1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period Ended June 30, 1999. or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from __________ to __________ Commission file number: 1-14667 Washington Mutual, Inc. ----------------------- (Exact name of registrant as specified in its charter) 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) (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 [ ] The number of shares outstanding of the issuer's classes of common stock as of July 31, 1999: Common Stock - 579,107,856
2 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999 TABLE OF CONTENTS <TABLE> <CAPTION> Page ---- <S> <C> <C> PART I Item 1. Financial Statements: Consolidated Statements of Income-- Three and Six Months Ended June 30, 1999 and 1998.................... 2 Consolidated Statements of Comprehensive Income- Three and Six Months Ended June 30, 1999 and 1998.................... 3 Consolidated Statements of Financial Condition-- June 30, 1999 and December 31, 1998.................................. 4 Consolidated Statements of Stockholders' Equity-- Six Months Ended June 30, 1999 and 1998.............................. 5 Consolidated Statements of Cash Flows-- Six Months Ended June 30, 1999 and 1998.............................. 6 Notes to Consolidated Financial Statements............................. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: General............................................................ 14 Results of Operations.............................................. 15 Review of Financial Condition...................................... 22 Asset Quality...................................................... 23 Asset and Liability Management Strategy............................ 27 Liquidity.......................................................... 27 Capital Adequacy................................................... 28 Year 2000 Project.................................................. 28 PART II Item 4. Submission of Matters to a Vote of Security Holders.................... 31 Item 6. Exhibits and Reports on Form 8-K....................................... 31 </TABLE> i
3 PART I ITEM 1. FINANCIAL STATEMENTS In the opinion of management, the accompanying consolidated statements of financial condition and related interim consolidated statements of income, comprehensive income, stockholders' equity 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. Certain reclassifications have been made to the 1998 financial statements to conform to the 1999 presentation. All significant intercompany transactions and balances have been eliminated. When Washington Mutual, Inc. ("Washington Mutual" or the "Company") acquires a company through a material pooling of interests, 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 mergers. The financial information of Washington Mutual contained herein has been restated for the merger with H.F. Ahmanson & Company ("Ahmanson"), which was effective on October 1, 1998. The information included in this Form 10-Q should be read in conjunction with Washington Mutual's 1998 Annual Report to the Securities and Exchange Commission on Form 10-K. Interim results are not necessarily indicative of results for a full year. 1
4 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ----------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ (dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> INTEREST INCOME Loans $ 2,013,372 $ 2,059,908 $ 4,041,874 $ 4,050,105 Available-for-sale securities 646,322 430,389 1,185,334 810,982 Held-to-maturity securities 258,416 305,922 505,793 621,965 Other interest income 41,512 46,364 80,739 86,767 ------------ ------------ ------------ ------------ Total interest income 2,959,622 2,842,583 5,813,740 5,569,819 INTEREST EXPENSE Deposits 792,694 927,429 1,606,321 1,831,225 Borrowings 1,018,220 825,457 1,931,516 1,588,595 ------------ ------------ ------------ ------------ Total interest expense 1,810,914 1,752,886 3,537,837 3,419,820 ------------ ------------ ------------ ------------ Net interest income 1,148,708 1,089,697 2,275,903 2,149,999 Provision for loan losses 42,857 44,394 84,557 94,369 ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 1,105,851 1,045,303 2,191,346 2,055,630 OTHER INCOME Depositor and other retail banking fees 182,114 135,216 345,531 254,696 Loan servicing income 23,881 30,926 49,912 63,273 Loan related income 26,859 30,161 53,406 55,252 Securities fees and commissions 69,364 51,701 128,886 98,486 Insurance fees and commissions 10,269 13,586 20,939 26,377 Mortgage banking income 28,021 40,614 66,383 67,662 Gain on sale of other assets 4,392 13,640 16,325 14,787 Provision for recourse liability -- (10,314) (5,142) (25,519) Other operating income 19,218 23,873 40,022 38,751 ------------ ------------ ------------ ------------ Total other income 364,118 329,403 716,262 593,765 OTHER EXPENSE Salaries and employee benefits 302,120 305,407 603,729 596,638 Occupancy and equipment 137,160 126,366 272,064 246,583 Telecommunications and outsourced information services 67,180 66,729 137,244 126,290 Regulatory assessments 14,840 16,635 30,203 32,891 Transaction-related expense 36,569 24,473 60,371 56,282 Amortization of intangible assets 23,262 26,241 48,635 49,825 Foreclosed asset (income) expense (869) 10,345 729 19,228 Other operating expense 168,362 151,552 325,516 274,756 ------------ ------------ ------------ ------------ Total other expense 748,624 727,748 1,478,491 1,402,493 ------------ ------------ ------------ ------------ Income before income taxes 721,345 646,958 1,429,117 1,246,902 Income taxes 268,671 248,357 532,325 477,527 ------------ ------------ ------------ ------------ NET INCOME $ 452,674 $ 398,601 $ 896,792 $ 769,375 ============ ============ ============ ============ Net income attributable to common stock $ 452,674 $ 393,761 $ 896,792 $ 755,811 ============ ============ ============ ============ Net income per common share: Basic $ 0.78 $ 0.70 $ 1.54 $ 1.37 Diluted 0.78 0.68 1.54 1.33 </TABLE> See Notes to Consolidated Financial Statements. 2
5 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------------- ------------------------- 1999 1998 1999 1998 ---------- ---------- ---------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> Net income $ 452,674 $ 398,601 $ 896,792 $ 769,375 Other comprehensive income, net of income taxes: Gross unrealized gain (loss) on securities: Unrealized holding gain (loss) during the period, net of deferred income tax (benefit) of $(270,105), $55,002, $(310,087), and $70,145 (413,361) 86,028 (474,546) 109,713 Less: adjustment for gains included in net income, net of income taxes of $96, $5,320, $932 and $5,767 (146) (8,320) (1,427) (9,020) Less: amortization of market adjustment for mortgage-backed securities ("MBS") transferred in 1997 from available for sale to held to maturity, net of deferred income taxes of $1,904, $2,903, $4,384, and $4,977 (2,913) (4,541) (6,709) (7,784) ---------- ---------- ---------- ---------- (416,420) 73,167 (482,682) 92,909 Minimum pension liability adjustment -- -- (1,760) -- ---------- ---------- ---------- ---------- Other comprehensive income (loss) (416,420) 73,167 (484,442) 92,909 ---------- ---------- ---------- ---------- Comprehensive income $ 36,254 $ 471,768 $ 412,350 $ 862,284 ========== ========== ========== ========== </TABLE> See Notes to Consolidated Financial Statements. 3
6 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited) <TABLE> <CAPTION> June 30, December 31, 1999 1998 -------------- -------------- (dollars in thousands) <S> <C> <C> ASSETS Cash $ 1,642,285 $ 2,695,454 Cash equivalents 64,669 61,520 Trading securities 29,899 39,068 Available-for-sale securities, amortized cost of $40,801,138 and $32,861,818: MBS 39,663,120 32,399,591 Investment securities 405,992 517,462 Held-to-maturity securities, fair value of $14,232,483 and $14,112,620: MBS 14,145,918 13,992,235 Investment securities 138,135 137,247 Loans: Loans held in portfolio 111,142,106 107,612,197 Loans held for sale 824,494 1,826,549 Reserve for loan losses (1,053,589) (1,067,840) -------------- -------------- Total loans 110,913,011 108,370,906 Investment in Federal Home Loan Banks ("FHLBs") 2,419,151 2,030,027 Foreclosed assets 244,188 274,767 Premises and equipment 1,530,636 1,421,162 Intangible assets 960,091 1,009,666 Mortgage servicing rights 492,619 461,295 Other assets 2,391,700 2,082,881 -------------- -------------- Total assets $ 175,041,414 $ 165,493,281 ============== ============== LIABILITIES Deposits: Interest-bearing checking accounts $ 6,017,288 $ 6,686,682 Noninterest-bearing checking accounts 7,528,790 6,774,049 Savings accounts and money market deposit accounts ("MMDAs") 31,499,804 28,285,868 Time deposit accounts 38,079,432 43,745,542 -------------- -------------- Total deposits 83,125,314 85,492,141 Federal funds purchased and commercial paper 3,448,525 2,482,830 Securities sold under agreements to repurchase ("reverse repurchase agreements") 26,286,536 17,519,538 Advances from FHLBs 46,223,504 39,748,613 Other borrowings 4,894,603 5,449,508 Other liabilities 2,001,370 5,456,251 -------------- -------------- Total liabilities 165,979,852 156,148,881 STOCKHOLDERS' EQUITY Common stock, no par value: 1,600,000,000 shares authorized - 582,765,123 and 593,408,525 shares issued -- -- Capital surplus - common stock 2,574,473 2,994,653 Accumulated other comprehensive income (loss): Unrealized gain (loss) on available-for-sale securities (395,077) 87,605 Minimum pension liability adjustment (15,084) (13,324) Retained earnings 6,897,250 6,275,466 -------------- -------------- Total stockholders' equity 9,061,562 9,344,400 -------------- -------------- Total liabilities and stockholders' equity $ 175,041,414 $ 165,493,281 ============== ============== </TABLE> See Notes to Consolidated Financial Statements. 4
7 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) <TABLE> <CAPTION> Capital Accumulated Common Surplus- Other Stock Preferred Common Comprehensive Retained in Total Stock Stock Income (Loss) Earnings Treasury ----------- --------- ----------- ------------- ----------- --------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> BALANCE, December 31, 1998 $ 9,344,400 $ -- $ 2,994,653 $ 74,281 $ 6,275,466 $ -- Net income 896,792 -- -- -- 896,792 -- Cash dividends on common stock (275,008) -- -- -- (275,008) -- Repurchase of common stock, net (457,993) -- (457,993) -- -- -- Common stock issued through employee stock plans, including tax benefit 37,583 -- 37,583 -- -- -- Common stock issued under dividend reinvestment plan 230 -- 230 -- -- -- Other comprehensive loss, net of related income tax benefit (484,442) -- -- (484,442) -- -- ----------- --------- ----------- --------- ----------- --------- BALANCE, June 30, 1999 $ 9,061,562 $ -- $ 2,574,473 $(410,161) $ 6,897,250 $ -- =========== ========= =========== ========= =========== ========= BALANCE, December 31, 1997 $ 7,601,085 $ 597,262 $ 2,629,377 $ 62,297 $ 5,244,509 $(932,360) Net income 769,375 -- -- -- 769,375 -- Cash dividends on preferred stock (15,279) -- -- -- (15,279) -- Cash dividends on common stock (196,835) -- -- -- (196,835) -- Repurchase of common stock, net (24,082) -- -- -- -- (24,082) Redemption or conversion of preferred stock (263,790) (314,684) (19,881) -- -- 70,775 Common stock issued to acquire Coast Savings Financial, Inc. ("Coast") 925,143 -- 373,078 -- -- 552,065 Common stock issued through employee stock plans, including tax benefit 87,575 -- 84,788 -- -- 2,787 Common stock issued under dividend reinvestment plan 149 -- 149 -- -- -- Other comprehensive income, net of related income taxes 92,909 -- -- 92,909 -- -- ----------- --------- ----------- --------- ----------- --------- BALANCE, June 30, 1998 $ 8,976,250 $ 282,578 $ 3,067,511 $ 155,206 $ 5,801,770 $(330,815) =========== ========= =========== ========= =========== ========= </TABLE> See Notes to Consolidated Financial Statements. 5
8 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, ----------------------------- 1999 1998 ------------ ------------ (dollars in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 896,792 $ 769,375 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 84,557 94,369 Mortgage banking income (66,383) (67,662) Gain on sale of other assets (16,325) (14,791) Depreciation and amortization 160,031 153,006 Stock dividends from FHLBs (61,300) (51,500) Provision for recourse liability 5,142 25,519 Decrease in trading securities 9,658 97,201 Origination of loans held for sale (2,768,851) (6,733,602) Sales of loans held for sale 5,976,890 8,802,703 Increase in other assets (318,835) (55,716) Decrease in other liabilities (1,274,439) (168,645) Other, net 9,333 (7,888) ------------ ------------ Net cash provided by operating activities 2,636,270 2,842,369 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities (16,572,405) (6,841,361) Purchases of held-to-maturity securities (86,510) (12,036) Sales of available-for-sale securities 1,930,570 1,150,512 Maturities of available-for-sale securities 128,269 254,448 Maturities of held-to-maturity securities 2,408 2,712 Principal payments on securities 7,009,769 3,847,800 Purchases of FHLB stock (335,502) (142,146) Purchases of loans (2,905,987) (668,739) Sales of loans 25,215 18,790 Origination of loans, net of principal payments (5,473,844) (4,072,982) Proceeds from sales of foreclosed assets 189,896 341,825 Cash from Coast acquisition -- 399,591 Purchases of premises and equipment (206,789) (158,674) Other, net -- (12,602) ------------ ------------ Net cash used in investing activities (16,294,910) (5,892,862) CASH FLOWS FROM FINANCING ACTIVITIES Decrease in deposits (2,366,827) (1,784,719) Increase in short-term borrowings 3,220,314 3,284,697 Proceeds from long-term borrowings 60,072,591 36,417,472 Repayments of long-term borrowings (47,621,381) (35,060,623) Cash dividends paid on preferred and common stock (275,008) (212,114) Redemption of preferred stock -- (263,813) Repurchase of common stock, net (457,993) (24,082) Other capital transactions 36,924 57,253 ------------ ------------ Net cash provided by financing activities 12,608,620 2,414,071 ------------ ------------ Decrease in cash and cash equivalents (1,050,020) (636,422) Cash and cash equivalents, beginning of period 2,756,974 2,719,997 ------------ ------------ Cash and cash equivalents, end of period $ 1,706,954 $ 2,083,575 ============ ============ </TABLE> See Notes to Consolidated Financial Statements. 6
9 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, ------------------------ 1999 1998 ---------- ---------- (dollars in thousands) <S> <C> <C> NONCASH INVESTING ACTIVITIES Loans exchanged for MBS $2,335,484 $ 647,020 Loans exchanged for trading securities -- 107,544 Real estate acquired through foreclosure 197,818 277,338 Loans originated to facilitate the sale of foreclosed assets 28,973 35,939 Loans held for sale originated to refinance existing loans 2,216,823 2,273,107 Loans held in portfolio originated to refinance existing loans 2,210,116 1,044,551 Trade date purchases not yet settled 673,793 -- Trade date sales not yet settled -- 100,230 CASH PAID DURING THE PERIOD FOR Interest on deposits 1,551,258 1,769,645 Interest on borrowings 2,007,509 1,516,457 Income taxes 473,518 501,298 </TABLE> See Notes to Consolidated Financial Statements. 7
10 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1: EARNINGS PER SHARE ("EPS") Basic EPS excludes dilution and is computed by dividing income attributable to common stock 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 Six Months Ended June 30, June 30, ------------------------------ ------------------------------ 1999 1998 1999 1998 ------------ -------------- ------------ -------------- (dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Net income: Net income $ 452,674 $ 398,601 $ 896,792 $ 769,375 Less: accumulated dividends on preferred stock -- (4,840) -- (13,564) ------------ -------------- ------------ -------------- Basic net income attributable to common stock 452,674 393,761 896,792 755,811 Add: accumulated dividends paid on convertible preferred stock -- 3,904 -- 8,160 ------------ -------------- ------------ -------------- Diluted net income attributable to common stock $ 452,674 $ 397,665 $ 896,792 $ 763,971 ============ ============== ============ ============== Weighted average shares: Basic weighted average number of common shares outstanding 580,214,730 560,688,632 581,072,470 553,053,350 Dilutive effect of outstanding common stock equivalents 2,179,938 22,787,039 2,387,996 23,416,731 ------------ -------------- ------------ -------------- Diluted weighted average number of common shares outstanding 582,394,668 583,475,671 583,460,466 576,470,081 ============ ============== ============ ============== Net income per common share: Basic $ 0.78 $ 0.70 $ 1.54 $ 1.37 Diluted 0.78 0.68 1.54 1.33 </TABLE> The decline in the dilutive effect of outstanding common stock equivalents from the prior year's periods was primarily attributable to the conversion to common stock of the Company's 6.00% Cumulative Convertible Preferred Stock, Series D in the third quarter of 1998, which caused a corresponding increase in the average number of common shares outstanding. As part of the business combination with Keystone Holdings, Inc., 12 million shares of common stock, with an assigned value of $27.7417 per share, were issued to an escrow for the benefit of the general and limited partners of Keystone Holdings, Inc. and the FSLIC Resolution Fund and their transferees. The conditions upon which these shares are contingently issuable are not based on earnings or market price. The contingencies had not occurred at June 30, 1999, and, therefore, the contingently issuable shares have not been included in the above computations. 8
11 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 2: BORROWINGS Other borrowings included Company-obligated mandatorily redeemable capital securities of the Company's subsidiary trusts holding solely $950.0 million aggregate liquidation amount of subordinated deferrable interest debentures of the Company as of both June 30, 1999 and December 31, 1998. In August 1999, the Company issued senior debt securities totaling $750.0 million and bearing a fixed rate of 7.50%. The notes are due on August 15, 2006. 9
12 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 3: LINES OF BUSINESS Washington Mutual is managed along five major lines of business: mortgage banking, consumer banking, commercial banking, financial services, and consumer finance. The treasury group, although not considered a line of business, is responsible for the management of investments and interest rate risk. The financial performance of these business lines is measured by the Company's profitability reporting processes, which utilize various management accounting techniques to ensure that each business line's financial results reflect the underlying performance of that business. Assets not originated through the Company's business operations are allocated to the treasury group. Prior to the Ahmanson merger and during the fourth quarter of 1998, Ahmanson was managed as a distinct business segment of Washington Mutual, and was therefore previously presented as a separate segment. Subsequent to year-end, management began integrating the operations of Ahmanson into the Company's five major lines of business. The corresponding information for periods in 1998 has been restated to conform with the Company's current basis of segmentation. Financial highlights by lines of business: <TABLE> <CAPTION> Three Months Ended June 30, 1999 ------------------------------------------------------------------------------------------------ Mortgage Consumer Commercial Financial Consumer Treasury/ Banking Banking Banking Services Finance Other Total ---------- ---------- -------- -------- ---------- ---------- ------------ (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Condensed income statement: Net interest income after provision for loan losses $ 214,983 $ 601,962 $ 98,069 $ 501 $ 54,454 $ 135,882 $ 1,105,851 Other income 68,586 193,515 10,854 83,661 6,868 634 364,118 Transaction-related expense 9,352 24,992 283 722 -- 1,220 36,569 Direct expense 61,565 245,490 20,645 50,410 32,774 5,508 416,392 ---------- ---------- -------- -------- ---------- ---------- ------------ Income before income taxes 212,652 524,995 87,995 33,030 28,548 129,788 1,017,008 Income taxes 78,944 194,897 32,771 12,518 11,132 48,182 378,444 ---------- ---------- -------- -------- ---------- ---------- ------------ Net income (before centrally managed expense) 133,708 330,098 55,224 20,512 17,416 81,606 638,564 Centrally managed expense 72,729 210,262 5,490 86 262 6,834 295,663 Income taxes (27,000) (78,057) (2,045) (33) (102) (2,536) (109,773) ---------- ---------- -------- -------- ---------- ---------- ------------ Net income $ 87,979 $ 197,893 $ 51,779 $ 20,459 $ 17,256 $ 77,308 $ 452,674 ========== ========== ======== ======== ========== ========== ============ </TABLE> 10
13 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1999 -------------------------------------------------------------------------------------------------- Mortgage Consumer Commercial Financial Consumer Treasury/ Banking Banking Banking Services Finance Other Total --------- ----------- --------- --------- --------- --------- ----------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Condensed income statement: Net interest income after provision for loan losses $ 422,935 $ 1,199,360 $ 199,256 $ 1,095 $ 107,242 $ 261,458 $ 2,191,346 Other income 142,746 373,580 18,878 154,491 13,523 13,044 716,262 Transaction-related expense 13,730 42,543 421 2,196 -- 1,481 60,371 Direct expense 126,305 487,980 40,718 96,322 67,048 9,485 827,858 --------- ----------- --------- --------- --------- --------- ----------- Income before income taxes 425,646 1,042,417 176,995 57,068 53,717 263,536 2,019,379 Income taxes 158,052 387,073 65,894 21,634 20,948 97,930 751,531 --------- ----------- --------- --------- --------- --------- ----------- Net income (before centrally managed expense) 267,594 655,344 111,101 35,434 32,769 165,606 1,267,848 Centrally managed expense 149,202 415,067 11,250 218 635 13,890 590,262 Income taxes (55,402) (154,124) (4,188) (83) (248) (5,161) (219,206) --------- ----------- --------- --------- --------- --------- ----------- Net income $ 173,794 $ 394,401 $ 104,039 $ 35,299 $ 32,382 $ 156,877 $ 896,792 ========= =========== ========= ========= ========= ========= =========== </TABLE> <TABLE> <CAPTION> June 30, 1999 -------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> Total assets $32,686,457 $85,861,092 $19,123,506 $117,758 $2,909,371 $34,343,230 $175,041,414 =========== =========== =========== ======== ========== =========== ============ </TABLE> <TABLE> <CAPTION> Three Months Ended June 30, 1998 ----------------------------------------------------------------------------------------------- Mortgage Consumer Commercial Financial Consumer Treasury/ Banking Banking Banking Services Finance Other Total ---------- ---------- -------- -------- -------- -------- ------------ (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Condensed income statement: Net interest income after provision for loan losses $ 164,730 $ 641,257 $ 95,618 $ 660 $ 49,657 $ 93,381 $ 1,045,303 Other income 128,437 150,281 4,575 62,234 5,777 (21,901) 329,403 Transaction-related expense 5,547 14,277 216 2,624 -- 1,809 24,473 Direct expense 59,023 238,458 18,007 42,222 32,637 17,500 407,847 ---------- ---------- -------- -------- -------- -------- ------------ Income before income taxes 228,597 538,803 81,970 18,048 22,797 52,171 942,386 Income taxes 89,284 205,350 31,249 6,885 9,001 19,998 361,767 ---------- ---------- -------- -------- -------- -------- ------------ Net income (before centrally managed expense) 139,313 333,453 50,721 11,163 13,796 32,173 580,619 Centrally managed expense 78,445 201,992 4,435 358 255 9,943 295,428 Income taxes (30,638) (76,984) (1,691) (137) (101) (3,859) (113,410) ---------- ---------- -------- -------- -------- -------- ------------ Net income $ 91,506 $ 208,445 $ 47,977 $ 10,942 $ 13,642 $ 26,089 $ 398,601 ========== ========== ======== ======== ======== ======== ============ </TABLE> 11
14 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1998 --------------------------------------------------------------------------------------------------- Mortgage Consumer Commercial Financial Consumer Treasury/ Banking Banking Banking Services Finance Other Total ------------ ------------ ------------ --------- ----------- ------------ ------------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Condensed income statement: Net interest income after provision for loan losses $ 366,887 $ 1,260,060 $ 187,704 $ 1,165 $ 98,564 $ 141,250 $ 2,055,630 Other income 184,894 283,030 11,242 115,541 12,266 (13,208) 593,765 Transaction-related expense 12,263 37,365 634 2,756 -- 3,264 56,282 Direct expense 121,915 459,218 37,728 83,298 66,417 33,089 801,665 ------------ ------------ ------------ --------- ----------- ------------ ------------- Income before income taxes 417,603 1,046,507 160,584 30,652 44,413 91,689 1,791,448 Income taxes 161,310 398,888 61,219 11,751 17,573 35,110 685,851 ------------ ------------ ------------ --------- ----------- ------------ ------------- Net income (before centrally managed expense) 256,293 647,619 99,365 18,901 26,840 56,579 1,105,597 Centrally managed expense 140,375 372,908 9,935 1,937 435 18,956 544,546 Income taxes (54,224) (142,138) (3,787) (743) (173) (7,259) (208,324) ------------ ------------ ------------ --------- ----------- ------------ ------------- Net income $ 170,142 $ 416,849 $ 93,217 $ 17,707 $ 26,578 $ 44,882 $ 769,375 ============ ============ ============ ========= =========== ============ ============= </TABLE> <TABLE> <CAPTION> June 30, 1998 --------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> Total assets $ 29,592,109 $ 91,295,004 $ 20,169,581 $ 104,322 $ 2,492,109 $ 12,400,147 $ 156,053,272 ============ ============ ============ ========= =========== ============ ============= </TABLE> 12
15 WASHINGTON MUTUAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 4: IMPACT OF APPLICABLE RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS Statement of Financial Accounting Standards ("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, and for hedging activities. The Financial Accounting Standards Board has issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133," which delays the implementation date of SFAS No. 133 for one year, to fiscal years beginning after June 15, 2000. The effect of the adoption of this statement on the results of operations or the financial condition of the Company has not yet been determined. SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise," was issued in October 1998. Prior to issuance of SFAS No. 134, when a mortgage banking company securitized mortgage loans held for sale but did not sell the security in the secondary market, the security was classified as trading. SFAS No. 134 requires that the security be classified as either trading, available for sale or held to maturity according to the Company's intent unless the Company has already committed to sell the security before or during the securitization process. The adoption of this statement by the Company on January 1, 1999 did not affect the results of operations or financial condition of the Company. NOTE 5: LONG BEACH FINANCIAL CORPORATION MERGER On May 19, 1999, Washington Mutual announced that the Company had signed a definitive agreement to purchase California-based Long Beach Financial Corporation ("Long Beach"). Each share of Long Beach common stock will be converted into the right to receive cash in the amount of $15.50 or a number of shares of Washington Mutual common stock determined by dividing $15.50 by the current market value of Washington Mutual common stock. On a pro forma combined basis, the purchase is expected to create goodwill of approximately $280 million. The transaction requires the approvals of certain state regulators and Long Beach shareholders and is expected to close by the beginning of the fourth quarter of 1999. 13
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report. This report contains forward-looking statements, which are not historical facts and pertain to future operating results of Washington Mutual, Inc. These forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements for the reasons, among others, discussed under the heading "Business-Risk Factors" in the Company's 1998 Annual Report on Form 10-K. GENERAL Washington Mutual, Inc. ("Washington Mutual" or the "Company") is a financial services company committed to serving consumers and small to 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 limited types of 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. As interest rates decreased during 1998, the Company experienced a substantial increase in the percentage of fixed-rate single-family residential ("SFR") mortgage originations. Since the Company's policy is to sell a substantial portion of its fixed-rate originations, during 1998 and the first half of 1999, the Company purchased investment grade mortgage-backed securities ("MBS") and whole loans in the secondary market in order to utilize its excess capital. These purchases, however, created assets with generally lower rates of return than loans originated by the Company and retained in its portfolio. Commencing in late 1998 and continuing through early 1999, mortgage interest rates generally decreased. During the second quarter of 1999, a rise in long-term interest rates prompted renewed interest in adjustable-rate mortgage ("ARM") loans with a corresponding decrease in fixed-rate loan originations. ARMs comprised 60% of the Company's SFR originations in the first six months of 1999 compared to 44% in the first six months of 1998. Despite this increase in ARM originations, principal repayments in the Company's MBS and loan portfolios have remained above 20%. Although the Company has continued to purchase whole loans and MBS in the secondary market, it has not been able to achieve its asset growth goals at anticipated spreads. In April 1999, the Company's Board of Directors approved a share repurchase program to acquire up to 20 million shares of common stock. During the second quarter of 1999, the Company repurchased 12.3 million common shares at an average price of $37.21. In May 1999, the Company's Board of Directors authorized the repurchase of common shares which the Company intends to reissue to shareholders of Long Beach Financial Corporation as consideration in the pending merger with Long Beach Financial. In July 1999, the Board of Directors authorized the Company to repurchase up to 30 million additional shares. 14
17 RESULTS OF OPERATIONS NET INTEREST INCOME. Net interest income for the second quarter of 1999 was $1.15 billion, a 5% increase from $1.09 billion in the second quarter of 1998. The increase was due to an 11% rise in average interest-earning assets to $167.43 billion from $150.28 billion in the second quarter of 1998, which more than offset the decline in the net interest spread to 2.58% in the second quarter of 1999 from 2.72% in the second quarter of 1998. The 6% increase in net interest income for the first half of 1999 to $2.28 billion was also due to an 11% rise in average interest-earning assets from the first half of 1998. The net interest spread declined to 2.60% in the first six months of 1999 from 2.73% for the same period in 1998. The Company's net interest margin declined to 2.74% in the second quarter of 1999 from 2.89% for the same period in 1998. Similarly, the net interest margin declined to 2.76% in the first half of 1999 from 2.90% for the same period in 1998. The yield on loans declined 43 basis points to 7.36% for the second quarter of 1999 from 7.79% for the same period in 1998. The yield on loans declined 40 basis points to 7.40% for the first half of 1999 from 7.80% for the same period in 1998. This resulted from a gradual decline in market interest rates during 1998 and early 1999, which reduced the yield on the Company's ARM portfolio and encouraged the prepayment of loans with higher rates. In addition, rates on new ARMs originated by the Company were generally lower than the rates on loans in the Company's portfolio. The yield on MBS declined 51 basis points to 6.61% for the second quarter of 1999 from 7.12% for the same period in 1998. This decline was attributable to paydowns on higher yielding MBS, purchases of $13.15 billion of MBS at a weighted average rate of 6.33% during the latter half of 1998 and $14.75 billion at a weighted average rate of 6.25% during the first half of 1999, and the downward effect of market interest rates on repricing of adjustable-rate MBS. The yield on MBS declined 51 basis points to 6.68% for the first half of 1999 from 7.19% for the same period a year ago. The 39 basis points decrease in the cost of deposits to 3.79% for second quarter 1999 from 4.18% for the same period in 1998 was primarily a result of a change in the composition of deposits. Higher-costing time deposits decreased from 57% of total deposits at June 30, 1998 to 46% at June 30, 1999, which reflected the Company's focus on growing retail transaction accounts rather than time deposits. Transaction accounts, consisting of savings accounts, money market deposit accounts ("MMDAs") and checking accounts, have the benefit of lower interest costs, compared with time deposits. 15
18 The Company's cost of borrowings declined 63 basis points to 5.26% for second quarter 1999 from 5.89% for second quarter 1998, reflecting a decline in short-term rates. For example, the three-month London Interbank Offering Rate ("LIBOR") dropped from an average rate of 5.69% during second quarter 1998 to an average rate of 5.07% for second quarter 1999. At June 30, 1999, 46% of the Company's borrowings were indexed to LIBOR. Although there was a modest rise in interest rates late in the second quarter of 1999, the Company's overall cost of borrowings was lower during the first half of 1999, compared with the same period in 1998. The cost of borrowings decreased 59 basis points to 5.34% for the first half of 1999, as compared with 5.93% for the same period a year ago. 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, ----------------------------- ----------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ (dollars in thousands) <S> <C> <C> <C> <C> Average Balances: Loans $109,523,390 $105,844,558 $109,400,323 $103,889,404 MBS 54,227,044 40,323,676 50,019,420 38,787,855 Investment securities 3,681,555 4,116,370 3,646,188 4,079,243 ------------ ------------ ------------ ------------ Total interest-earning assets 167,431,989 150,284,604 163,065,931 146,756,502 Deposits 83,920,105 88,979,283 84,103,172 87,643,595 Borrowings 77,666,546 56,170,181 72,861,536 54,047,066 ------------ ------------ ------------ ------------ Total interest-bearing liabilities 161,586,651 145,149,464 156,964,708 141,690,661 Total assets 173,205,859 156,435,935 168,748,350 152,806,969 Stockholders' equity 9,509,791 8,847,867 9,483,253 8,496,603 Weighted Average Yield On: Loans 7.36% 7.79% 7.40% 7.80% MBS 6.61 7.12 6.68 7.19 Investment securities 5.54 6.28 5.55 6.21 Interest-earning assets 7.07 7.57 7.14 7.60 Weighted Average Cost of: Deposits 3.79 4.18 3.85 4.21 Borrowings 5.26 5.89 5.34 5.93 Interest-bearing liabilities 4.49 4.85 4.54 4.87 Net interest spread 2.58 2.72 2.60 2.73 Net interest margin 2.74 2.89 2.76 2.90 </TABLE> The net interest spread is the difference between the Company's weighted average yield on its interest-earning assets and the weighted average cost of its interest-bearing liabilities. The net interest margin measures the Company's annualized net interest income as a percentage of average interest-earning assets. 16
19 The dollar amounts of interest income and interest expense fluctuate depending upon changes in interest rates and upon changes in amounts (volume) of the Company's interest-earning assets and interest-bearing liabilities. Changes attributable to (i) changes in volume (changes in average outstanding balances multiplied by the prior period's rate), (ii) changes in rate (changes in average interest rate multiplied by the prior period's volume), and (iii) changes in rate/volume (changes in rate times the change in volume that were allocated proportionately to the changes in volume and the changes in rate) were as follows: <TABLE> <CAPTION> Three Months Ended June 30, Six Months Ended June 30, 1999 vs. 1998 1999 vs. 1998 ------------------------------------- ------------------------------------- Increase/(Decrease) Due to Increase/(Decrease) Due to ------------------------------------- ------------------------------------- Volume Rate Total Volume Rate Total --------- --------- --------- --------- --------- --------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Interest Income: Loans $ 69,850 $(116,386) $ (46,536) $ 209,058 $(217,289) $ (8,231) MBS 232,553 (55,334) 177,219 380,594 (103,109) 277,485 Investment securities (6,450) (7,194) (13,644) (12,686) (12,647) (25,333) --------- --------- --------- --------- --------- --------- Total interest income 295,953 (178,914) 117,039 576,966 (333,045) 243,921 Interest Expense: Deposits (50,835) (83,900) (134,735) (71,991) (152,913) (224,904) Borrowings 289,674 (96,911) 192,763 512,478 (169,557) 342,921 --------- --------- --------- --------- --------- --------- Total interest expense 238,839 (180,811) 58,028 440,487 (322,470) 118,017 --------- --------- --------- --------- --------- --------- Net interest income $ 57,114 $ 1,897 $ 59,011 $ 136,479 $ (10,575) $ 125,904 ========= ========= ========= ========= ========= ========= </TABLE> OTHER INCOME. Other income was $364.1 million and $716.3 million for the second quarter and first six months of 1999, compared with $329.4 million and $593.8 million for the same periods in 1998. Other income consisted of the following: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ---------------------- ------------------------ 1999 1998 1999 1998 -------- ---------- ---------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> Depositor and other retail banking fees $182,114 $ 135,216 $ 345,531 $ 254,696 Loan servicing income 23,881 30,926 49,912 63,273 Loan related income 26,859 30,161 53,406 55,252 Securities fees and commissions 69,364 51,701 128,886 98,486 Insurance fees and commissions 10,269 13,586 20,939 26,377 Mortgage banking income 28,021 40,614 66,383 67,662 Gain on sale of other assets 4,392 13,640 16,325 14,787 Provision for recourse liability -- (10,314) (5,142) (25,519) Other operating income 19,218 23,873 40,022 38,751 -------- ---------- ---------- ---------- Total other income $364,118 $ 329,403 $ 716,262 $ 593,765 ======== ========== ========== ========== </TABLE> 17
20 Depositor and other retail banking fees of $182.1 million for the second quarter of 1999 increased from $135.2 million for the same period a year ago. Depositor and other retail banking fees of $345.5 million for the first six months of 1999 increased from $254.7 million for the same period a year ago. The increases primarily reflected the implementation of the Company's consumer banking strategy in the former Great Western and American Savings Bank financial centers. The strategy emphasizes the sale of value-added, fee-based services and an increased emphasis on the collection of fees. Additionally, an 8% increase in the number of checking accounts contributed to the increase in fees. The growth in depositor and other retail banking fees has been offset somewhat by an increase in the amount of deposit account-related losses (included in other operating expense) incurred by the Company resulting from the increased number of checking accounts. The number of net new retail checking accounts increased by 78,622 accounts during the second quarter of 1999 and 172,284 accounts during the first half of 1999. Securities fees and commissions increased to $69.4 million in the second quarter of 1999 from $51.7 million for the same period in 1998. These fees increased to $128.9 million in the first six months of 1999 from $98.5 million for the comparable period in 1998. The increases were primarily attributable to higher sales of mutual funds and annuities. In addition, the former Ahmanson securities brokerage business began to offer Washington Mutual's products and services in early 1999, which generate higher fees. Loan servicing income declined to $23.9 million for the second quarter of 1999 from $30.9 million for the comparable period in 1998. Loan servicing income declined to $49.9 million for the six months ended June 30, 1999 from $63.3 million for the same period in 1998 due primarily to a four basis point drop in the average servicing fee. The decrease for the first six months of 1999 was primarily due to a 5.5 basis point drop in the average servicing fee. The Company had mortgage banking income during the second quarter of 1999 of $28.0 million, compared with $40.6 million for the same period a year ago. It is the Company's strategy to sell the majority of its conforming fixed-rate loan production in the secondary market. However, due to the anticipated rise in interest rates and resulting customer shift to ARMs, the Company originated and therefore sold fewer fixed-rate mortgage loans during second quarter 1999. Fixed-rate SFR loan originations declined to $3.77 billion during second quarter 1999 from $4.50 billion in first quarter 1999 and $5.59 billion in second quarter 1998. The Company had mortgage banking income during the first half of 1999 of $66.4 million, compared with $67.7 million for the same period a year ago. Fixed-rate SFR loan originations decreased to $8.27 billion during the first half of 1999, compared with $10.88 billion for the same period a year ago. The sale of other assets resulted in net gains of $4.4 million for the second quarter of 1999, compared with $13.6 million for the same period in 1998. The net gains in the second quarter of 1999 included a $2.1 million gain on the sale of receivables related to financial services activities and a $1.2 million gain on the sale of certain commercial banking trust assets. The net gains during the second quarter of 1998 primarily resulted from sales and calls of mortgage-backed and investment securities as well as an increase in the valuation of securities held for trading. The sale of other assets resulted in net gains of $16.3 million during the six months ended June 30, 1999, compared with $14.8 million for the same period in 1998. In addition to the gains recognized during the second quarter of 1999, the net gains during the first half of 1999 included a $7.1 million gain recognized on the sale of the former Coast headquarters property and a $1.8 million gain on the sale of assets associated with the expiration of a leveraged lease. There was no provision for recourse liability in the second quarter of 1999, compared with $10.3 million for the same period in 1998. This provision declined to $5.1 million in the first half of 1999 from $25.5 million for the same period one year ago. The June 1999 quarterly analysis of the recourse liability on loans securitized and retained with recourse and loans sold with recourse confirmed the adequacy of the recourse liability when compared to the recourse obligation at June 30, 1999. 18
21 OTHER EXPENSE. Other expense totaled $748.6 million and $1.48 billion for the second quarter and first six months of 1999, compared with $727.7 million and $1.40 billion for the same periods in 1998. Other expense consisted of the following: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ----------------------- ------------------------ 1999 1998 1999 1998 ---------- -------- ---------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> Salaries and employee benefits $ 302,120 $305,407 $ 603,729 $ 596,638 Occupancy and equipment: Premises and equipment 86,676 98,974 171,000 195,096 Data processing 50,484 27,392 101,064 51,487 ---------- -------- ---------- ---------- Total occupancy and equipment 137,160 126,366 272,064 246,583 Telecommunications and outsourced information services 67,180 66,729 137,244 126,290 Regulatory assessments 14,840 16,635 30,203 32,891 Transaction-related expense 36,569 24,473 60,371 56,282 Amortization of intangible assets 23,262 26,241 48,635 49,825 Foreclosed asset (income) expense (869) 10,345 729 19,228 Other operating expense: Advertising and promotion 28,883 30,609 55,733 57,663 Operating losses and settlements 31,874 14,002 58,691 26,697 Postage 21,333 18,655 43,384 36,585 Professional fees 16,995 19,685 33,212 31,038 Office supplies 9,285 12,120 17,133 23,043 Other 59,992 56,481 117,363 99,730 ---------- -------- ---------- ---------- Total other operating expense 168,362 151,552 325,516 274,756 ---------- -------- ---------- ---------- Total other expense $ 748,624 $727,748 $1,478,491 $1,402,493 ========== ======== ========== ========== </TABLE> Salaries and employee benefits decreased to $302.1 million for the second quarter of 1999 from $305.4 million for the same period in 1998. Salaries and employee benefits increased to $603.7 million for the first six months of 1999 from $596.6 million for the same period in 1998. Despite decreases in full-time equivalent employees ("FTE") in administrative support areas, FTE increased during the first half of 1999 because of additions to staff in loan production and deposit operation areas. FTE were 28,108 at June 30, 1999, compared with 27,768 at June 30, 1998 and 27,931 at March 31, 1999. Also affecting the decrease in salaries and employee benefits was the alignment of Ahmanson loan agent compensation with the Washington Mutual model. The decline was partially offset by a lower deferral of salary and benefits expense resulting from improved efficiencies in originating loans, which resulted in lower origination costs. Occupancy and equipment expense was $137.2 million for the second quarter of 1999, up from $126.4 million for the same period a year ago. Occupancy and equipment expense was $272.1 million for the first six months of 1999 compared with $246.6 million for the same period in 1998. The primary contributors to these increases were computer system upgrades and the conversion of systems at the former Ahmanson financial centers to Washington Mutual's platforms. Also contributing to the increase were higher rental expenses, a higher volume of maintenance expenses and an increase in property taxes. Telecommunications and outsourced information services expense increased slightly to $67.2 million for the second quarter of 1999 from $66.7 million for the same period in 1998. For the first six months of 1999, this expense was $137.2 million, up from $126.3 million for the same period a year ago. These changes reflected increased volume and usage, resulting from the Company's growth, the need for higher levels of customer support services, and the continued use of outsourced data processing services. As a result of merger activity, the Company recorded transaction-related expense of $36.6 million for the second quarter of 1999 and $24.5 million for the same period in 1998. For the first six months of 1999 and 1998, this expense was $60.4 million and $56.3 million. The majority of the charges were for contract and temporary employment services, severance and related payments, facilities and equipment impairment, and other costs, which are being expensed as incurred. Transaction-related expense in the 19
22 first quarter of 1998 included $23.2 million related to the Coast acquisition. The Company continued to incur transaction-related expenses in connection with the Ahmanson merger in second quarter 1999, during which time several key computer systems were converted. During the second quarter of 1999, these transaction-related expenses were partially offset by reductions in the estimates of facilities holding costs of $7.9 million and other accruals of $1.1 million. The reduction in estimates of facilities holding costs and lease payments is attributable in part to the fact that certain office space was subleased more quickly and at higher rates than expected. The Company expected staff reductions related to the Ahmanson merger of approximately 3,400. As of June 30, 1999, 2,978 employee separations had occurred. The majority of the remaining employee separations are planned to be completed by the end of September 1999. The actual number of staff reductions is not anticipated to be materially different from the original estimate. At June 30, 1999, the carrying amount of all assets acquired through mergers and held for future disposal was $52.0 million. 20
23 Reconciliation of the transaction-related expense and accrual activity was as follows: <TABLE> <CAPTION> Three Months March 31, Ended June 30, Three Months 1999 June 30, 1999 1999 Ended Accrued Activity Charged Accrued June 30, 1999 Balance Against Accrual(1) Balance Period Costs(2) --------- ------------------ --------- --------------- (dollars in thousands) <S> <C> <C> <C> <C> Severance $ 56,217 $ (36,357) $ 19,860 $ 4,544 Premises and equipment 156,110 (35,082) 121,028 (3,143) Legal, underwriting and other direct transaction costs -- -- -- 2,072 Contract cancellation costs 6,817 (890) 5,927 123 Other -- -- -- 32,973 --------- --------- -------- -------- $ 219,144 $ (72,329) $146,815 $ 36,569 ========= ========= ======== ======== </TABLE> <TABLE> <CAPTION> Six Months December 31, Ended June 30, Six Months 1998 June 30, 1999 1999 Ended Accrued Activity Charged Accrued June 30, 1999 Balance Against Accrual(1) Balance Period Costs(2) ------------ ------------------ -------- --------------- (dollars in thousands) <S> <C> <C> <C> <C> Severance $ 86,014 $ (66,154) $ 19,860 $ 9,889 Premises and equipment 158,932 (37,904) 121,028 2,771 Legal, underwriting and other direct transaction costs -- -- -- 4,041 Contract cancellation costs 15,678 (9,751) 5,927 (6,578) Other 1,406 (1,406) -- 50,248 --------- --------- -------- -------- $ 262,030 $(115,215) $146,815 $ 60,371 ========= ========= ======== ======== - ----------- (1) Amounts include activity charged against the accrual, additional accruals and reversals of excess accruals. (2) Amounts include additional accruals and reversals of excess accruals. </TABLE> Amortization of intangible assets was $48.6 million for the first six months of 1999, down slightly from $49.8 million for the same period in 1998. In February 1998, Ahmanson acquired Coast under the purchase accounting method, which created intangible assets of $516.5 million and amortization expense of $14.2 million in the first six months of 1999, compared with $10.1 million in the same period of 1998. This increase was offset by the $3.3 million decrease from goodwill and other intangible assets that were fully amortized during the second quarter of 1999. Foreclosed assets generated net income of $0.9 million during second quarter 1999, compared with net expense of $10.3 million during the same period in 1998. Similarly, foreclosed asset expense declined to $0.7 million for the first half of 1999 from $19.2 million for the comparable period in 1998. The decrease for the comparable second quarters primarily reflected a $5.1 million decline in write downs and increased net gains on the sales of real estate owned of $3.8 million. For the first six months of 1999, compared with the same period a year ago, the decrease in foreclosed asset expense was primarily comprised of an $8.4 million increase in net gains on the sales of real estate owned and a $7.4 million decline in write downs. The overall decrease in foreclosed asset expense during the 1999 periods, compared with the same periods in 1998, reflected the improvement in real estate values, as shown by the higher gains and lower write downs. Other operating expense increased to $168.4 million in the second quarter of 1999 from $151.6 million for the same period in 1998 primarily as a result of an increase in operating losses and settlements to $31.9 million for second quarter 1999 from $14.0 million for the same period a year ago. Other operating expense increased to $325.5 million during the first six months of 1999 from $274.8 million for the same period in 1998. The higher operating losses and settlements reflected the continued growth in deposit accounts and losses related to deposit system conversions in connection with 21
24 the Ahmanson merger. Postage costs also increased by $2.7 million and $6.8 million for the second quarter and first six months of 1999 as a result of the Ahmanson merger, which required several special customer notifications as well as increased mailings related to various marketing campaigns. For the six months ended June 30, 1999, the other category of other operating expense increased to $117.4 million from $99.7 million for the same period a year ago. Included in the other category are items such as travel and training, loan expenses, other proprietary mutual fund expense, other real estate expense, outside printing and forms, security services, contributions, insurance and other miscellaneous expense. Overall, the higher level of other operating expense reflects the growth and geographic expansion of the Company. TAXATION. Income taxes include federal and applicable state income taxes and payments in lieu of taxes. Income taxes of $268.7 million and $532.3 million for the second quarter and first six months of 1999 represented an effective tax rate of 37.25%. Income taxes were $248.4 million and $477.5 million for the second quarter and first six months of 1998, which represented effective tax rates of 38.39% and 38.30%. The decline in the effective tax rate was due, in part, to benefits realized from certain tax strategies of the Company. REVIEW OF FINANCIAL CONDITION ASSETS. At June 30, 1999, the Company's total assets were $175.04 billion, an increase of 6% from $165.49 billion at December 31, 1998. The asset growth was the result of loan originations and asset purchases, partially offset by payments on loans and MBS. SECURITIES. The Company's securities portfolio increased by $7.30 billion to $54.38 billion during the first half of 1999 due to the purchase of $14.75 billion in investment grade MBS in the secondary market. At June 30, 1999, 55% of MBS in the Company's securities portfolio were adjustable rate, compared with 71% at December 31, 1998. At June 30, 1999, of the $29.61 billion in MBS with an adjustable rate, 82% were indexed to COFI, 13% were indexed to U.S. Treasury securities, and 5% were indexed to LIBOR. LOANS. Total loans (net of reserve for loan losses) at June 30, 1999 were $110.91 billion, a 2% increase from $108.37 billion at December 31, 1998. Loans held in portfolio increased by $3.53 billion during the first half of 1999 as a result of originations of $20.53 billion offset by a high level of prepayment activity during the first six months of 1999, compared with the same period a year ago. The $1.00 billion decrease in loans held for sale was primarily due to lower fixed-rate loan production. During the first six months of 1999, the Company purchased $1.75 billion of whole loans, of which $1.04 billion were subprime loans at a weighted average yield of 8.27%. ARM production accounted for 66% and 60% of total SFR originations in the second quarter and first six months of 1999, up from 48% and 44% for the same periods a year ago. In particular, medium-term ARM originations rose to 39% of total SFR originations in the second quarter of 1999 from 20% in the second quarter of 1998. Similarly, for the first half of 1999, these originations rose to 36% from 20% for the same period in 1998. The shift by borrowers from fixed-rate mortgages to medium-term ARMs was in response to a recent increase in rates for fixed-rate loans and a steepening of the yield curve. The difference between the yield on a three-month U.S Treasury bill and a ten-year U.S. government note averaged 90 basis points and 73 basis points in the second quarter of 1999 and first six months of 1999, compared with 50 basis points and 45 basis points for the same periods in 1998. LIABILITIES. Due to increased market competition for customer deposits, the Company has increasingly relied upon wholesale borrowings to fund its asset growth. The decrease in deposits from $85.49 billion at December 31, 1998 to $83.13 billion at June 30, 1999 reflected the competitive environment of banking institutions and the wide array of investment opportunities available to consumers. The Company's strategy has been to increase its ratio of transaction accounts to total deposits. As a result of this strategy, transaction accounts have increased as a percentage of total deposits to 54% at June 30, 1999, from 49% at year-end 1998. Transaction accounts generally carry 22
25 lower interest costs to the Company, compared with time deposit accounts. Even though transaction accounts are more 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 than time deposits. The Company's asset growth during the first half of 1999 was funded by borrowings in the form of securities sold under agreements to repurchase ("reverse repurchase agreements") and advances from the FHLBs of Seattle and San Francisco. The exact mix of borrowings at any given time is dependent upon a variety of factors, primarily the market pricing of the individual borrowing sources. ASSET QUALITY PROVISION AND RESERVE FOR LOAN LOSSES. The Company analyzes several important elements in determining the level of the provision for loan losses in any given period, such as current and anticipated economic conditions, nonperforming asset trends, historical loan loss experience, and plans for problem loan administration and resolution. These elements are also captured in a migration analysis performed on the loan portfolio on a quarterly basis and used in determining the loan loss provision. During the second quarter of 1999, net charge offs increased to $59.0 million from $42.0 million for the same period in 1998. Net charge offs increased to $104.0 million for the first half of 1999 from $93.7 million for the same period a year ago. Included in the 1999 periods were charge offs of $17.8 million in previously established specific reserves on four commercial real estate properties that were obtained through acquisitions. Excluding the charge off of these specific reserves, charge offs have continued to decline from 1998 levels, which reflects the improvements in credit quality and real estate values. The Company's analysis of these trends, growth in the loan portfolio and other factors considered in the quarterly determination of the adequacy of the loan loss reserve resulted in a lower provision for loan losses from the prior year's periods. The provision for loan losses declined to $42.9 million for second quarter 1999 from $44.4 million for the same period a year ago. Similarly, the provision for the first six months of 1999 was $84.6 million, down from $94.4 million for the comparable period in 1998. Because of favorable credit trends, the provision for loan losses was $16.1 million and $19.5 million less than net charge offs for the second quarter and first half of 1999. The Company's consistent application of its loan loss reserve methodology has resulted in reduced provision levels. 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 Company's ongoing examination process and that of its regulators, will not require significant increases in the reserve for loan losses. 23
26 Changes in the reserve for loan losses were as follows: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ------------------------------ 1999 1998 1999 1998 ------------ ------------ ------------ ------------ (dollars in thousands) <S> <C> <C> <C> <C> Balance, beginning of period $ 1,069,719 $ 1,153,921 $ 1,067,840 $ 1,047,845 Provision for loan losses 42,857 44,394 84,557 94,369 Reserves added through business combinations -- -- -- 107,830 Reserves transferred to recourse liability -- -- (7,500) -- Reserves transferred from other liabilities -- -- 12,714 -- Loans charged off: SFR and SFR construction (8,524) (17,046) (19,604) (39,042) Manufactured housing, second mortgage and other consumer (10,435) (9,097) (23,845) (18,295) Commercial business (1,261) (1,408) (3,716) (2,767) Commercial real estate (22,878) (9,225) (26,803) (18,970) Consumer finance (22,808) (21,588) (46,632) (43,693) ------------ ------------ ------------ ------------ (65,906) (58,364) (120,600) (122,767) Recoveries of loans previously charged off: SFR and SFR construction 152 5,597 2,247 8,699 Manufactured housing, second mortgage and other consumer 737 524 1,274 982 Commercial business 223 88 451 184 Commercial real estate 1,692 5,518 4,366 10,263 Consumer finance 4,115 4,669 8,240 8,942 ------------ ------------ ------------ ------------ 6,919 16,396 16,578 29,070 ------------ ------------ ------------ ------------ Net charge offs (58,987) (41,968) (104,022) (93,697) ------------ ------------ ------------ ------------ Balance, end of period $ 1,053,589 $ 1,156,347 $ 1,053,589 $ 1,156,347 ============ ============ ============ ============ Net charge offs as a percentage of average loans 0.22% 0.16% 0.19% 0.18% </TABLE> An analysis of the reserve for loan losses was as follows: <TABLE> <CAPTION> June 30, December 31, 1999 1998 ---------- ------------ (dollars in thousands) <S> <C> <C> Specific and allocated reserves: Commercial real estate $ 84,983 $ 133,167 Commercial business 18,158 9,690 Builder construction 3,622 852 ---------- ---------- 106,763 143,709 Unallocated reserves 946,826 924,131 ---------- ---------- $1,053,589 $1,067,840 ========== ========== Total reserve for loan losses as a percentage of: Nonaccrual loans 128% 114% Nonperforming assets 99 88 Total loans (exclusive of the reserve for loan losses) 0.94 0.98 </TABLE> 24
27 Based on the Company's quarterly analysis of the adequacy of the reserve for loan losses, the reserve decreased slightly from year-end 1998 to June 30, 1999. As a result of this decline and the $2.53 billion increase in the loan portfolio, the reserve as a percentage of the overall loan portfolio declined during the first half of 1999. However, the reserve as a percentage of nonaccrual loans and nonperforming assets has increased due to the decline in these assets. See "Nonperforming Assets." This decline reflects the overall improvement in credit quality, as described above. The Company follows the practice of securitizing (with and without recourse) certain loans and retaining them in its investment portfolio. The Company's intent is to hold the majority of these securities to maturity. In addition to retaining securitized loans with recourse, the Company has, from time to time, sold these securities in the secondary market. At June 30, 1999, the Company had $21.85 billion of loans securitized and retained with recourse, and $5.18 billion of loans and MBS sold with recourse. At June 30, 1999, the total liability for this recourse was $122.0 million. Changes in the recourse liability were as follows: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ----------------------- ----------------------- 1999 1998 1999 1998 ---------- -------- ---------- -------- (dollars in thousands) <S> <C> <C> <C> <C> Balance, beginning of period $ 127,966 $ 77,661 $ 144,257 $ 80,157 Transfer of reserve on held-to-maturity REMIC securities -- -- (22,500) -- Transfer from reserve for loan losses -- -- 7,500 -- Charge offs, net of provision for losses (5,963) (3,614) (7,254) (6,110) ---------- -------- ---------- -------- Balance, end of period $ 122,003 $ 74,047 $ 122,003 $ 74,047 ========== ======== ========== ======== </TABLE> 25
28 NONPERFORMING ASSETS. Assets considered to be nonperforming include nonaccrual loans and foreclosed assets. When loans securitized or sold on a recourse basis are nonperforming, they are repurchased upon foreclosure by the Company and included in foreclosed assets. Management's classification of a loan as nonaccrual does not necessarily indicate that the principal of the loan is uncollectible in whole or in part. Loans are generally placed on nonaccrual status when they are four payments or more past due. Nonperforming assets were $1.06 billion or 0.61% of total assets at June 30, 1999, compared with $1.21 billion or 0.73% of total assets at December 31, 1998. Nonperforming assets consisted of the following: <TABLE> <CAPTION> June 30, December 31, 1999 1998 ---------- ------------ (dollars in thousands) <S> <C> <C> Nonaccrual loans: SFR $ 649,379 $ 752,261 SFR construction 12,210 9,188 Manufactured housing 16,391 14,669 Second mortgage and other consumer 30,289 24,284 Commercial business 6,994 7,416 Apartment buildings 37,167 43,653 Other commercial real estate 14,244 33,077 Consumer finance 53,744 53,412 ---------- ---------- 820,418 937,960 Foreclosed assets 244,188 274,767 ---------- ---------- $1,064,606 $1,212,727 ========== ========== Nonperforming assets as a percentage of total assets 0.61% 0.73% </TABLE> SFR nonaccrual loans declined $102.9 million from December 31, 1998 to June 30, 1999. In addition, commercial real estate nonaccrual loans dropped $25.3 million during the same period. The decrease in these nonaccrual loans is primarily due to the improvement in the California economy. 26
29 ASSET AND LIABILITY MANAGEMENT STRATEGY 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 not negatively affected 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. As part of this strategy, the Company actively manages the amounts and maturities of its assets and liabilities. One key component of the Company's program is the origination and retention of short-term and adjustable-rate assets whose repricing characteristics more closely match the repricing characteristics of the Company's liabilities. At June 30, 1999, 73% of the Company's total SFR loan and MBS portfolio had adjustable rates, compared with 80% at December 31, 1999 due to purchases of fixed-rate MBS primarily in the first quarter of 1999. In addition to originating and holding in portfolio adjustable-rate and short-term loans in order to better control the interest sensitivity of its assets, the Company also attempts to manage its liability durations by utilizing a variety of borrowing types and sources. In addition, it utilizes derivative instruments to adjust the interest-sensitivity characteristics of certain of its borrowings and deposits to better match those of the assets which the liabilities fund. 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 growth of 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. These guidelines ensure that short-term secured borrowing capacity is sufficient to satisfy unanticipated cash needs. As part of this process, the Company is developing plans for potential liquidity requirements for the year 2000. Refer to separate discussion of "Year 2000 Project" below. Regulations promulgated by the Office of Thrift Supervision ("OTS") require that the Company's federal savings banks maintain for each calendar quarter an average daily balance of liquid assets at least equal to 4.00% of the prior quarter end's balance of withdrawable deposits plus borrowings due within one year. At June 30, 1999, both of the Company's federal savings banks had liquidity ratios in excess of 4.00%. As presented in the Consolidated Statements of Cash Flows, the sources of liquidity vary between the comparable periods. 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 1999 of $896.8 million, $122.1 million for noncash items and $1.62 billion of other net cash inflows 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 1999, cash flows from investing activities included sales, maturities and principal payments on securities totaling $9.07 billion. Loans originated and purchased for investment were in excess of repayments and sales by $8.35 billion, and $16.99 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 the issuance of long-term debt. For the first half of 1999, the above mentioned financing activities decreased cash and cash equivalents by 27
30 $1.05 billion on a net basis. Cash and cash equivalents were $1.71 billion at June 30, 1999. See "Consolidated Financial Statements - Consolidated Statements of Cash Flows." At June 30, 1999, the Company was in a position to obtain approximately $36.67 billion in additional borrowings primarily through the use of collateralized borrowings and deposits of public funds using unpledged MBS and other wholesale borrowing sources. CAPITAL ADEQUACY The Company's capital (stockholders' equity) was $9.06 billion at June 30, 1999, down from $9.34 billion at December 31, 1998. During the second quarter of 1999, the Company repurchased 12.3 million shares of common stock at an average price of $37.21. These stock repurchases and the growth in assets contributed to a decline in the ratio of capital to total assets of 5.18% at the end of second quarter 1999, compared with 5.65% at December 31, 1998. The regulatory capital ratios of WMBFA, WMB and WMBfsb and the minimum regulatory requirements to be categorized as well-capitalized were as follows: <TABLE> <CAPTION> June 30, 1999 ---------------------------------- Well-Capitalized WMBFA WMB WMBfsb Minimum ------ ------ ------ ---------------- <S> <C> <C> <C> <C> Capital ratios: Leverage 5.69% 5.50% 7.26% 5.00% Tier 1 risk-based 10.15 10.28 11.38 6.00 Total risk-based 11.54 11.06 12.64 10.00 </TABLE> In addition, Aristar, Inc.'s industrial bank, First Community Industrial Bank, met all Federal Deposit Insurance Corporation requirements to be categorized as well-capitalized at June 30, 1999. The Company's federal savings banking 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 both satisfied these requirements at June 30, 1999. The Company's broker-dealer subsidiary is also subject to capital requirements. At June 30, 1999, it was in compliance with its applicable capital requirements. YEAR 2000 PROJECT This section contains forward-looking statements that have been prepared on the basis of management's best judgments and currently available information and constitutes a Year 2000 Readiness Disclosure within the meaning of the Year 2000 Readiness Disclosure Act of 1998. These forward-looking statements are inherently subject to significant business, third-party and regulatory uncertainties and contingencies, many of which are beyond the Company's control. In addition, these forward-looking statements are based on current assessments and remediation plans, which are based on certain representations of third-party service providers and are subject to change. Accordingly, there can be no assurance that the Company's results of operations will not be adversely affected by difficulties or delays in the Company's or third parties' Year 2000 readiness efforts. See "Risks" below for a discussion of factors that may cause such forward-looking statements to differ from actual results. The Company has implemented a company-wide program to renovate, test and document the readiness ("Year 2000 readiness") of its electronic systems, programs and processes ("Computer Systems") and facilities to properly recognize dates to and through the year 2000 (the "Year 2000 Project"). While the Company is in various stages of modification and testing of individual Year 2000 Project components, the Year 2000 Project is proceeding generally on schedule. The Company has assigned its Executive Vice President of Operations to oversee the Year 2000 Project, has set up a Year 2000 Project Office, and has charged a senior management team representing all of its significant operational areas to act as a Steering Committee. The Company has dedicated a substantial amount of management and staff time on the Year 2000 Project. In addition, it has engaged IBM to provide 28
31 supplemental technical and management resources to assess and test the Year 2000 readiness of its Computer Systems, Deloitte Consulting Group LLC to assist in documenting certain aspects of the Year 2000 Project, and CB Richard Ellis to provide technical and management resources in executing the Year 2000 Project with respect to facilities. Monthly progress reports are made to the Board of Directors, and the Board's Audit Committee reviews Year 2000 Project progress on a quarterly basis. The Project The Company has divided its Year 2000 Project into the following general phases, consistent with guidance issued by the Federal Financial Institutions Examinations Council (the "FFIEC"): (i) inventory and assessment; (ii) renovation, which includes repair or replacement; (iii) validation, which includes testing of Computer Systems and its connections with other computer systems; (iv) due diligence on third-party service providers; and (v) development of contingency plans. The Year 2000 Project is divided into four categories: mainframe systems, non-mainframe systems, third-party service providers, and facilities. The inventory and assessment phase is substantially complete, and each component that has been identified has been assigned a priority rating corresponding to its significance. The rating has allowed the Company to direct its attention to those Computer Systems, third-party service providers, and facilities that it deems more critical to its ongoing business and the maintenance of good customer relationships. The Company has also completed the process of repairing or replacing and testing the components of its Computer Systems it deems most critical and has tested these Computer Systems in an integrated environment. It has also completed the process of repairing or replacing and testing the components of its facilities it deems most critical. It has also adopted business contingency plans for the Computer Systems and facilities that it has determined to be most critical. These plans conform to guidance from the FFIEC on business contingency planning for Year 2000 readiness. Contingency plans include, among other actions, manual workarounds and identification of resource requirements and alternative solutions for resuming critical business processes in the event of a year 2000-related failure. The Company continues to assess the readiness of its third-party service providers, though it is currently unable to predict their final readiness. Prior to 1998, the Company undertook strategic business initiatives that shifted a significant portion of the cost for Year 2000 readiness to third-party service providers. Following the merger with Ahmanson and after the data processing conversions associated with that merger, the Company will rely on third-party service providers for significant business processes such as item processing, loan servicing, and desktop and communications management. It has been communicating with its third-party service providers to assess and monitor their Year 2000 readiness. The Company has completed its due diligence on third-party service providers for its most critical business processes, including the testing of connections with these service providers, where possible, although the monitoring of these service providers will continue. The Company has established contingency plans for the service providers it deems most critical and will continue monitoring to determine whether to implement specific contingency plans. The Company has completed testing the connections between its Computer Systems and third-party computer systems that it deems most critical. Additional testing of these Computer Systems and third-party computer systems will continue through 1999. On October 1, 1998, the parent company of Washington Mutual acquired Ahmanson and began to manage its Year 2000 planning process. As of December 31, 1998, Ahmanson's planning process was consolidated into the Company's Year 2000 Project, because all of Ahmanson's critical computer systems will be converted to the Company's systems as a part of the integration process. The Company continues to assess its risk from other environmental factors over which it has little control, such as electrical power supply, and voice and data transmission. Because of the nature of the factors, however, the Company is not actively engaged in any repair, replacement or testing efforts for these services. 29
32 Costs While the Company does not believe that the process of making its Computer Systems Year 2000 ready 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. The Company spent approximately $16.5 million during 1998 and the first half of 1999 on its Year 2000 Project, and it currently expects to spend approximately $12.5 million more before it concludes its Year 2000 readiness efforts. In 1996 and 1997, the Company spent approximately $30.3 million on technology-related initiatives, which had the effect of reducing its current cost of Year 2000 readiness. Risks Based on its current assessments and remediation plans, which are based in part on certain representations of third-party service providers, the Company does not expect that it will experience a significant disruption of its operations as a result of the change to the new millennium. Although the Company has no reason to conclude that a failure will occur, the most reasonably likely worst-case Year 2000 scenario would entail a disruption or failure of its power supply or voice and data transmission suppliers, a Computer System, a third-party service provider, or a facility. If such a failure were to occur, the Company would implement its contingency plan. While it is impossible to quantify the impact of such a scenario, the most reasonably likely worst-case scenario would entail a diminishment of service levels, some customer inconvenience, and additional costs from the contingency plan implementation, which are not currently estimable. While the Company has contingency plans to address a temporary disruption in these services, there can be no assurance that any disruption or failure will be only temporary, that the contingency plans will function as anticipated, or that the Company's results of operations will not be adversely affected in the event of a prolonged disruption or failure. 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 the Year 2000 Project. 30
33 PART II ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Washington Mutual, Inc. held its annual meeting of shareholders on April 20, 1999. 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: Elizabeth A. Sanders (term ending 2000) 500,935,386 3,593,731 William D. Schulte (term ending 2001) 500,949,380 3,579,737 David Bonderman (term ending 2002) 500,925,359 3,603,758 Roger H. Eigsti (term ending 2002) 500,981,263 3,547,854 Phillip D. Matthews (term ending 2002) 500,949,431 3,579,686 William G. Reed, Jr. (term ending 2002) 500,908,460 3,620,657 James H. Stever (term ending 2002) 500,958,063 3,571,054 2. Amendment to Washington Mutual's Articles of Incorporation ("Articles") to provide for Mandatory Indemnification of Directors. 487,202,025 14,552,830 92,236,520 3. Amendment to the Articles to reduce the vote required to amend the Articles. 444,958,068 8,762,891 140,270,416 4. Amendment to the Articles to eliminate the requirement to publish notice of certain shareholder meetings, and clarify the Board's authority to amend the Articles. 470,356,112 31,974,096 91,661,166 5. Amendment to the Articles to eliminate the provision relating to dealings with interested persons. 437,724,974 15,035,466 141,230,935 6. Modification to the Articles relating to shareholder approval of merger transactions. 445,027,662 8,461,987 140,501,726 7. Ratification of the appointment of Deloitte & Touche LLP as the Company's Independent Auditors. 500,864,228 2,042,224 91,084,923 </TABLE> ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits See Index of Exhibits on page 33. (b) Reports on Form 8-K During the second quarter of 1999, the Company filed a report on Form 8-K dated April 23, 1999. The report included under Item 7 of Form 8-K a press release announcing Washington Mutual's first quarter 1999 financial results and audited consolidated financial statements for the quarter ended March 31, 1999. During the second quarter of 1999, the Company also filed a report on Form 8-K dated May 18, 1999. The report included under Item 7 of Form 8-K the following exhibits: (i) Agreement and Plan of Merger dated May 18, 1999 between Washington Mutual and Long Beach Financial Corporation, (ii) Stock Option Agreement dated May 18, 1999 between Washington Mutual and Long Beach Financial Corporation, and (iii) Press Release dated May 18, 1999 regarding the execution of a definitive merger agreement with Long Beach Financial Corporation. 31
34 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 13, 1999. WASHINGTON MUTUAL, INC. By: /s/ FAY L. CHAPMAN ----------------------------------------- Fay L. Chapman Senior Executive Vice President and General Counsel By: /s/ RICHARD M. LEVY ----------------------------------------- Richard M. Levy Senior Vice President and Controller (Principal Accounting Officer) 32
35 WASHINGTON MUTUAL, INC. INDEX OF EXHIBITS <TABLE> <CAPTION> Exhibit No. - ----------- <S> <C> 3.1 Restated Articles of Incorporation of the Registrant, as amended (filed herewith). 3.2 Restated By-laws of the Registrant, as amended (filed herewith). 4.1 Rights Agreement dated October 16, 1990 (filed as an exhibit to the Company's Current Report on Form 8-K dated November 29, 1994 and incorporated herein by reference. File No. 0-25188). 4.2 Amendment No. 1 to Rights Agreement, dated October 31, 1994 (filed as an exhibit to the Company's Current Report on Form 8-K dated November 29, 1994 and incorporated herein by reference. 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 Financial Data Schedule.* - ----------- * Filed electronically with the Securities and Exchange Commission. </TABLE> 33