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 September 30, 1998.
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: 0-25188
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 October 31, 1998.
Common Stock - 593,252,788
2
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
Page
----
PART I
Item 1. Financial Statements:
Consolidated Statements of Income--
Three and nine months ended September 30, 1998 and 1997.............. 2
Consolidated Statements of Financial Position--
September 30, 1998 and December 31, 1997............................. 3
Consolidated Statements of Stockholders' Equity--
Nine months ended September 30, 1998 and 1997........................ 4
Consolidated Statements of Cash Flows--
Nine months ended September 30, 1998 and 1997........................ 5
Notes to Consolidated Financial Statements............................. 7
Item 2. Management's Discussion and Analysis of Financial Position and
Results of Operations:
General............................................................ 10
Results of Operations.............................................. 10
Review of Financial Position....................................... 15
Asset Quality...................................................... 18
Market Risk and Asset/Liability Management......................... 21
Liquidity.......................................................... 22
Capital Adequacy................................................... 23
PART II
Item 1. Legal Proceedings...................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders.................... 24
Item 6. Exhibits and Reports on Form 8-K....................................... 24
i
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PART I
ITEM 1. FINANCIAL STATEMENTS
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.
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, Inc. ("Washington
Mutual" or the "Company") 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 mergers. The financial information of Washington
Mutual contained herein has not 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 1997 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)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(dollars in thousands, except per share amounts)
INTEREST INCOME
Loans $1,407,008 $1,320,754 $4,154,969 $3,826,055
Available-for-sale securities 256,724 230,337 710,358 773,559
Held-to-maturity securities 216,426 136,027 678,558 305,084
Cash equivalents and other 31,669 41,435 95,331 109,620
---------- ---------- ---------- ----------
Total interest income 1,911,827 1,728,553 5,639,216 5,014,318
---------- ---------- ---------- ----------
INTEREST EXPENSE
Deposits 512,662 547,798 1,540,445 1,629,078
Borrowings 683,024 525,104 1,943,285 1,416,662
---------- ---------- ---------- ----------
Total interest expense 1,195,686 1,072,902 3,483,730 3,045,740
---------- ---------- ---------- ----------
Net interest income 716,141 655,651 2,155,486 1,968,578
Provision for loan losses 35,250 52,131 126,998 155,940
---------- ---------- ---------- ----------
Net interest income after provision for
loan losses 680,891 603,520 2,028,488 1,812,638
---------- ---------- ---------- ----------
OTHER INCOME
Depositor and other retail banking fees 121,082 92,431 319,042 267,409
Loan servicing income 16,283 22,066 49,729 65,150
Loan related income 17,679 14,431 52,106 38,663
Securities fees and commissions 39,135 39,988 118,155 116,132
Insurance fees and commissions 12,497 13,356 36,349 40,270
Mortgage banking gains (losses) 26,551 (89,173) 69,644 (76,707)
Gain on sale of other assets 8,455 6,691 25,318 17,697
Write down of loans securitized and retained (8,234) (7,744) (18,371) (20,166)
Other operating income 13,238 19,067 38,360 39,063
---------- ---------- ---------- ----------
Total other income 246,686 111,113 690,332 487,511
---------- ---------- ---------- ----------
OTHER EXPENSE
Salaries and employee benefits 205,444 198,038 600,444 598,417
Occupancy and equipment 76,047 80,871 227,260 239,718
Telecommunications and outsourced
information services 51,141 40,137 153,114 126,210
Regulatory assessments 9,102 8,822 27,457 26,026
Transaction-related expense 20,465 366,860 53,588 424,886
Amortization of intangible assets arising
from acquisitions 13,733 16,387 40,761 47,833
Foreclosed asset (income) expense (9,546) 5,166 (5,945) 9,710
Other operating expense 122,996 109,685 337,577 320,454
---------- ---------- ---------- ----------
Total other expense 489,382 825,966 1,434,256 1,793,254
---------- ---------- ---------- ----------
Income (loss) before income taxes 438,195 (111,333) 1,284,564 506,895
Income taxes 159,911 11,313 480,564 250,093
Provision for payments in lieu of taxes 3,987 4,308 11,961 12,924
---------- ---------- ---------- ----------
NET INCOME (LOSS) $ 274,297 $ (126,954) $ 792,039 $ 243,878
========== ========== ========== ==========
Net income (loss) attributable to common stock $ 273,028 $ (132,883) $ 788,096 $ 226,091
========== ========== ========== ==========
Net income (loss) per common share:
Basic $0.73 $(0.36) $2.10 $0.62
Diluted 0.73 (0.36) 2.10 0.62
See Notes to Consolidated Financial Statements
2
5
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Unaudited)
September 30, December 31,
1998 1997
------------- -------------
(dollars in thousands)
ASSETS
Cash $ 1,313,409 $ 1,285,222
Cash equivalents 40,750 275,668
Investments:
Trading securities 38,452 23,364
Available-for-sale securities, amortized cost
$18,284,691 and $11,258,232:
Mortgage-backed securities ("MBS") 17,899,773 10,188,107
Investment securities 556,209 1,185,815
Held-to-maturity securities, fair value $11,240,535
and $12,699,653:
MBS 11,283,139 12,659,217
Investment securities 130,790 120,397
------------- -------------
Total investments 29,908,363 24,176,900
------------- -------------
Loans:
Loans held in portfolio 72,010,875 67,124,935
Loans held for sale 1,083,435 685,716
Reserve for loan losses (686,156) (670,494)
------------- -------------
Total loans 72,408,154 67,140,157
------------- -------------
Investment in Federal Home Loan Banks ("FHLBs") 1,408,871 1,059,491
Foreclosed assets 157,500 205,272
Premises and equipment 1,077,958 937,198
Intangible assets arising from acquisitions 316,398 356,650
Mortgage servicing rights 262,340 215,360
Other assets 1,465,323 1,329,181
------------- -------------
Total assets $ 108,359,066 $ 96,981,099
============= =============
LIABILITIES
Deposits:
Checking accounts $ 8,133,689 $ 7,914,375
Savings accounts and money market deposit accounts 17,033,630 14,940,045
Time deposit accounts 25,391,716 28,131,597
------------- -------------
Total deposits 50,559,035 50,986,017
------------- -------------
Federal funds purchased and commercial paper 4,448,523 2,928,282
Securities sold under agreements to
repurchase ("reverse repurchase agreements") 13,991,989 12,279,040
Advances from FHLBs 26,795,229 20,301,963
Other borrowings 3,288,679 3,489,362
Other liabilities 3,474,624 1,687,364
------------- -------------
Total liabilities 102,558,079 91,672,028
------------- -------------
STOCKHOLDERS' EQUITY
Preferred stock, no par value,
liquidation preference, 10,000,000
shares authorized - none and 4,722,500
shares issued and outstanding -- 118,063
Common stock, no par value, 1,600,000,000
shares authorized - 387,599,422 and
386,340,027 shares issued and outstanding -- --
Capital surplus - common stock 1,975,074 1,943,294
Accumulated other comprehensive income 159,488 134,610
Retained earnings 3,666,425 3,113,104
------------- -------------
Total stockholders' equity 5,800,987 5,309,071
------------- -------------
Total liabilities and stockholders' equity $ 108,359,066 $ 96,981,099
============= =============
See Notes to Consolidated Financial Statements
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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
Nine Months Ended
September 30,
-------------------------------
1998 1997
----------- -----------
(dollars in thousands)
PREFERRED STOCK
Balance, beginning of period $ 118,063 $ 283,063
Redemption of Preferred Stock, Series C (68,813) --
Redemption of Preferred Stock, Series E (49,250) --
----------- -----------
Balance, end of period -- 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 31,546 311,278
Common stock issued under dividend reinvestment plan 234 847
Common stock acquired -- (32,016)
----------- -----------
Balance, end of period 1,975,074 1,944,979
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of period 134,610 118,625
Other comprehensive income 24,878 47,638
----------- -----------
Balance, end of period 159,488 166,263
RETAINED EARNINGS
Balance, beginning of period 3,113,104 2,926,530
Net income 792,039 243,878
Minimum pension liability adjustment (2,504) --
Cash dividends declared on preferred stock (3,943) (17,787)
Cash dividends declared on common stock (232,271) (201,722)
Common stock issued and other miscellaneous transactions -- (8,099)
----------- -----------
Balance, end of period 3,666,425 2,942,800
----------- -----------
Total stockholders' equity $ 5,800,987 $ 5,337,105
=========== ===========
Nine Months Ended
September 30,
-------------------------------
1998 1997
----------- -----------
(number of shares in thousands)
PREFERRED STOCK
Balance, beginning of period 4,723 5,383
Redemption of Preferred Stock, Series C (2,753) --
Redemption of Preferred Stock, Series E (1,970) --
----------- -----------
Balance, end of period -- 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 1,254 7,833
Common stock issued under dividend reinvestment plan 5 20
Common stock acquired -- (908)
----------- -----------
Balance, end of period 387,599 257,176
=========== ===========
See Notes to Consolidated Financial Statements
4
7
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-------------------------------
1998 1997
----------- -----------
(dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 792,039 $ 243,878
Adjustments to operating activities:
Provision for loan losses 126,998 155,940
Mortgage banking (gains) losses (69,644) 76,707
Gain on sale of other assets (25,318) (17,697)
Depreciation and amortization 89,345 133,182
Stock dividends from FHLBs (58,179) (46,686)
Transaction-related (accrual reversal) expense (37,448) 278,751
Decrease in trading securities 96,978 1,647
Origination of loans held for sale (5,840,878) (2,719,142)
Proceeds from sales of loans held for sale 8,786,241 3,248,089
Increase in other assets (74,181) (183,746)
Decrease in other liabilities (370,257) (269,261)
----------- -----------
Net cash provided by operating activities 3,415,696 901,662
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities (9,301,106) (2,004,161)
Principal payments and maturities of available-for-sale securities 2,718,765 1,754,288
Sales of available-for-sale securities 1,373,072 1,963,165
Purchases of held-to-maturity securities (13,079) (27,550)
Principal payments and maturities of held-to-maturity securities 2,006,193 285,827
Increase in loans (9,225,283) (10,666,115)
Proceeds from sale of foreclosed assets 248,610 292,537
Purchases of premises and equipment, net (204,409) (83,605)
----------- -----------
Net cash used by investing activities (12,397,237) (8,485,614)
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in deposits (426,982) (1,374,097)
Increase in annuities -- 5,956
Increase in federal funds purchased and commercial paper 1,520,241 2,093,792
Increase (decrease) in short-term reverse repurchase agreements 1,783,804 (3,125,862)
Proceeds from long-term reverse repurchase agreements 1,146,205 7,195,188
Repayments on long-term reverse repurchase agreements (1,215,591) (4,408,407)
Proceeds from FHLBs advances 39,871,933 39,443,154
Repayments on FHLBs advances (33,379,116) (32,813,109)
(Repayments on) proceeds from other borrowings (200,683) 90,035
Cash dividends paid (236,214) (219,509)
Redemption of preferred stock (118,063) --
Common stock repurchased -- (32,016)
Other capital transactions 29,276 304,026
----------- -----------
Net cash provided by financing activities 8,774,810 7,159,151
----------- -----------
Decrease in cash and cash equivalents (206,731) (424,801)
Cash and cash equivalents, beginning of period 1,560,890 1,665,355
----------- -----------
Cash and cash equivalents, end of period $ 1,354,159 $ 1,240,554
=========== ===========
See Notes to Consolidated Financial Statements
5
8
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
Nine Months Ended
September 30,
-------------------------------
1998 1997
----------- -----------
(dollars in thousands)
NONCASH INVESTING ACTIVITIES
Loans held for sale originated to refinance existing loans $ 3,273,438 $ 760,817
Trade date purchases not yet settled 2,178,226 703,088
Loans held in portfolio originated to refinance existing loans 1,402,902 326,064
Loans exchanged for MBS 647,020 2,710,300
Trade date sales not yet settled 272,589 157,207
Real estate acquired through foreclosure 242,220 336,325
Loans exchanged for trading securities 107,544 --
Loans originated to facilitate the sale of foreclosed assets 41,382 64,862
Reserves transferred to contingent liability 833 2,747
Transfer to held-to-maturity securities -- 4,359,814
Loans transferred to loans held for sale -- 1,236,796
Reserves transferred to MBS impairment -- 16,505
CASH PAID DURING THE PERIOD FOR
Interest on borrowings 1,736,201 1,347,919
Interest on deposits 1,527,974 1,623,707
Income taxes 543,017 194,866
See Notes to Consolidated Financial Statements
6
9
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 shareholders 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:
Three Months Ended September 30,
-----------------------------------------------------------------------------------
1998 1997
----------------------------------------- ----------------------------------------
Income Shares Per Share Income Shares Per Share
(numerator) (denominator) Amounts (numerator) (denominator) Amounts
------------- ----------- --------- ----------- ------------- ---------
(dollars in thousands, except per share amounts)
Basic EPS:
Net income (loss) $ 274,297 $ (126,954)
Less: preferred stock dividends (1,269) (5,929)
------------- -------------
Income (loss) attributable to
common shareholders 273,028 375,361,082 $0.73 (132,883) 370,959,425 $ (0.36)
Diluted EPS:
Effect of dilutive securities:
Stock options -- 1,015,334 -- 1,529,020
------------- ----------- ------------- -----------
Income (loss) attributable to
common shareholders and
assumed conversions $ 273,028 376,376,416 $0.73 $ (132,883) 372,488,445 $ (0.36)
============= =========== ============= ===========
Nine Months Ended September 30,
--------------------------------------------------------------------------------------
1998 1997
--------------------------------------- -------------------------------------------
Income Shares Per Share Income Shares Per Share
(numerator) (denominator) Amounts (numerator) (denominator) Amounts
----------- ------------ --------- ------------- ------------- ---------
(dollars in thousands, except per share amounts)
Basic EPS:
Net income $ 792,039 $ 243,878
Less: preferred stock dividends (3,943) (17,787)
---------- -------------
Income attributable to
common shareholders 788,096 374,879,413 $ 2.10 226,091 365,854,485 $0.62
Diluted EPS:
Effect of dilutive securities:
Stock options -- 1,237,622 -- 1,369,254
---------- ----------- ------------- -------------
Income attributable to
common shareholders and
assumed conversions $ 788,096 376,117,035 $ 2.10 $ 226,091 367,223,739 $0.62
========== =========== ============= =============
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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
NOTE 2: COMPREHENSIVE INCOME
Washington Mutual 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 nine months ended September 30,
1998 and 1997, the Company's comprehensive income (loss) was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
1998 1997 1998 1997
----------- ----------- ----------- ------------
(dollars in thousands)
Net income (loss) $274,297 $(126,954) $792,039 $243,878
Other comprehensive income 15,317 85,277 24,878 47,638
-------- --------- -------- --------
Total comprehensive income (loss) $289,614 $ (41,677) $816,917 $291,516
======== ========= ======== ========
NOTE 3: THE AHMANSON MERGER
On March 17, 1998, Washington Mutual and Ahmanson announced the signing of
a definitive merger agreement. The merger was approved by the shareholders of
both companies at special meetings held on August 28, 1998. Holders of
Washington Mutual common stock and holders of Washington Mutual preferred stock
also approved an amendment to Washington Mutual's Articles of Incorporation to
increase the number of authorized shares of common stock from 800,000,000 shares
to 1,600,000,000 shares. The merger was approved by the Office of Thrift
Supervision in September 1998.
The merger was effective on October 1, 1998 and was accounted for as a
pooling of interests. Each share of Ahmanson common stock was converted into the
right to receive 1.68 shares of Washington Mutual common stock with cash paid in
lieu of fractional shares. In connection with the merger, approximately
205,582,840 shares of Washington Mutual common stock were issued. On
October 3, 1998, the Company merged Ahmanson's banking subsidiary, Home Savings
of America, FSB, into Washington Mutual Bank, FA.
NOTE 4: STOCKHOLDERS' EQUITY
On September 16, 1998, the Company redeemed its Series E preferred stock
at a price equal to $25 per share plus accrued and unpaid dividends. The
preferred issue carried a dividend rate of 7.6% and was issued in September
1993.
NOTE 5: OTHER BORROWINGS
Other borrowings included Company-obligated mandatorily redeemable capital
securities of the Company's subsidiary trusts holding solely $800.0 million
aggregate principal amount of subordinated deferrable interest debentures of the
Company as of September 30, 1998 and December 31, 1997.
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 by the Company on January 1, 1998. Provisions of this statement require
annual disclosure in the year of adoption and interim reporting for periods
thereafter. This statement does not affect the results of operations or
financial position of the Company.
SFAS No. 132, "Employers' Disclosure about Pensions and Other
Postretirement Benefits," was issued in 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 by the Company as of January 1, 1998.
8
11
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
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 statement is
effective for all fiscal years beginning after June 15, 1999. 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 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 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 in accordance with SFAS No. 115
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 statement is effective for all
fiscal years beginning after December 15, 1998. This statement is not expected
to have a material impact on the results of operations or financial position of
the Company.
9
12
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 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, 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.
THE AHMANSON MERGER. On October 1, 1998, H.F. Ahmanson & Company
("Ahmanson") merged with and into Washington Mutual. On October 3, 1998,
Ahmanson's banking subsidiary, Home Savings of America, FSB, was merged with and
into WMBFA.
RESULTS OF OPERATIONS
OVERVIEW. The Company's net income for the third quarter of 1998 was
$274.3 million, compared with a net loss of $127.0 million for the third quarter
of 1997. For the nine months ended September 30, 1998, net income was $792.0
million, compared with $243.9 million for the nine months ended September 30,
1997. Net income for the periods in both years was reduced by
transaction-related expenses in connection with the GWFC merger and the results
for 1998 also included transaction-related expenses for the Ahmanson merger. For
the third quarter of 1998 and 1997, pretax charges for transaction-related
expenses totaled $20.5 million and $366.9 million. For the nine months ended
September 30, 1998 and 1997, pretax charges for transaction-related expenses
totaled $53.6 million and $424.9 million.
NET INTEREST INCOME. Net interest income for the third quarter of 1998 was
$716.1 million, a 9% increase from $655.7 million in the third quarter of 1997.
The increase was due to a 12% rise in average interest-earning assets to $100.54
billion from $89.97 billion in the third quarter of 1997. The net interest
spread, however, declined to 2.70% in the third quarter of 1998 from 2.76% in
the third quarter of 1997. The 9% increase in net interest income for the nine
months ended September 30, 1998 to $2.16 billion was also due to a rise in
average interest-earning assets.
The net interest spread declined to 2.74% in the nine months ended
September 30, 1998 from 2.83% in the nine months ended September 30, 1997. To a
certain extent, the Company's net interest spread is affected by changes in the
yield curve. During the third 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
26 basis points, compared with 106 basis points for the same period a year
earlier. During the nine months ended September 30, 1998, the difference between
the yield on a three-month U.S. Treasury bill and a 10-year U.S. Government note
averaged 39 basis points, compared with 132 basis points for the same period a
year earlier.
10
13
Selected average financial balances and the net interest spread and margin
were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ------------ -------------
(dollars in thousands)
Selected Average Balances:
Loans $ 71,417,642 $67,037,118 $ 69,809,714 $64,647,077
Investments 29,124,944 22,935,483 28,466,636 22,428,951
------------ ----------- ------------ -----------
Total interest-earning assets 100,542,586 89,972,601 98,276,350 87,076,028
Deposits 50,407,583 51,670,233 50,738,940 52,004,850
Borrowings 46,360,159 35,061,690 44,083,025 31,904,807
------------ ----------- ------------ -----------
Total interest-bearing liabilities 96,767,742 86,731,923 94,821,965 83,909,657
Total assets 103,944,145 93,764,401 101,845,313 90,386,754
Stockholders' equity 5,719,128 5,358,598 5,528,083 5,161,239
Weighted Average Interest Rates:
Yield on loan portfolio 7.87% 7.86% 7.94% 7.89%
Yield on investment portfolio 6.93 7.11 6.95 7.06
Yield on interest-earning assets 7.60 7.67 7.65 7.68
Cost of deposits 4.03 4.21 4.06 4.19
Cost of borrowings 5.85 5.94 5.89 5.94
Cost of interest-bearing liabilities 4.90 4.91 4.91 4.85
Net interest spread 2.70 2.76 2.74 2.83
Net interest margin 2.88 2.94 2.92 3.00
The net interest spread is the difference between the Company's yield on its
loan and investment portfolios and its cost of deposits and borrowings. The net
interest margin measures the Company's annualized net interest income as a
percentage of average interest-earning assets.
OTHER INCOME. Other income was $246.7 million and $690.3 million for the three
and nine months ended September 30, 1998 compared with $111.1 million and $487.5
million for the same periods in 1997.
Depositor and other retail banking fees of $121.1 million and $319.0 million
for the three and nine months ended September 30, 1998 increased from $92.4
million and $267.4 million for the same periods in 1997. The increase reflected
an increase in the volume of nonsufficient funds charges and overdraft
protection charges on checking accounts and money market deposit accounts
("MMDAs"). There was also an increase in the number of such accounts since
September 1997.
Contributing to the decline in loan servicing income for the three and nine
months ended September 30, 1998 was an increase in the amortization of mortgage
servicing rights. The increased amortization was related to the higher rate of
prepayments in the loan servicing portfolio. The amortization of mortgage
servicing rights increased from $28.3 million for the nine months ended
September 30, 1997 to $42.3 million for the same period in 1998.
Higher prepayment activity generated by the declining interest-rate
environment also resulted in an increase in prepayment fees, which are included
in loan related income.
Mortgage banking gains during the three and nine months ended September 30,
1998 were $26.6 million and $69.6 million, compared with net losses of $89.2
million and $76.7 million for the same periods in 1997. The Company's strategy
is to sell the majority of its fixed-rate loan originations in the secondary
market and during the three and nine months ended September 30, 1998, $2.65
billion and $8.72 billion of fixed-rate loans were sold. The relatively low
interest-rate environment led to fixed-rate single family residential ("SFR")
loan originations of $7.56 billion and $23.05 billion for the three and nine
months ended September 30, 1998. Included in the third quarter and year-to-date
losses during 1997 was a $100.0 million write down of loans securitized and held
in the trading portfolio.
11
14
The sale of other assets resulted in net gains of $8.5 million and $25.3
million for the three and nine months ended September 30, 1998, compared with
$6.7 million and $17.7 million for the same periods in 1997. The increases in
the 1998 periods were due to sales and calls of mortgage-backed and investment
securities, as well as an increase in 1998 of $4.5 million in the valuation of
securities held in the trading portfolio compared with the write down in 1997
discussed above. The first nine months of 1997 included a $4.2 million gain
associated with the sale of branch premises at GWB.
OTHER EXPENSE. Other expense totaled $489.4 million and $1.43 billion for the
three and nine months ended September 30, 1998, compared with $826.0 million and
$1.79 billion for the same periods in 1997.
Salaries and employee benefits increased to $205.4 million and $600.4 million
for the three and nine months ended September 30, 1998, compared with $198.0
million and $598.4 million for the three and nine months ended September 30,
1997, as a result of increased incentive compensation due to expanded loan
originations. Full-time equivalent employees ("FTEs") were 19,499 at September
30, 1998, compared with 19,954 at September 30, 1997. The decrease in FTEs was
primarily due to staff reductions in connection with the GWFC merger and
restructuring plan. However, this decrease was partially offset by increased
staffing levels throughout the Company to support its growth.
As a result of merger activity, the Company recorded transaction-related
expense of $20.5 million and $53.6 million for the three and nine months ended
September 30, 1998, compared with $366.9 million and $424.9 million for the same
periods in 1997. For the three and nine months ended September 30, 1998, the
majority of the charges were for one-time nonrecurring incremental costs
associated with combining entities, which are being expensed as incurred.
These transaction-related charges were partially offset by reductions in the
estimates of contract cancellation fees of $13.6 million, severance of $8.0
million and other accruals of $3.0 million, and from gains on the disposition of
surplus real estate of $12.8 million during the first nine 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 was primarily the result of more employees voluntarily
terminating without severance than was originally estimated. All staff
reductions related to the Keystone Holdings and GWFC mergers have been
completed. The remaining severance accruals relate to installment payments to
employees that have already departed. The gains from the disposition of surplus
real estate were a result of the value of excess branch properties being higher
than originally estimated due to increases in real estate values in Southern
California.
12
15
Reconciliation of the transaction-related expense and accrual activity was as
follows:
Three Months Three Months Three Months
Ended Ended Ended
June 30, September 30, September 30, September 30, September 30,
1998 1998 1998 1998 1997
Accrued Activity Charged Accrued Period Period
Balance Against Accrual(1) Balance Costs(2) Costs
--------- ------------------ -------------- -------------- -------------
(dollars in thousands)
Severance ................... $ 50,146 $(13,074) $37,072 $ 1,705 $122,933
Premises and equipment ..... 46,891 (14,095) 32,796 (9,539) 146,286
Legal, underwriting and other
direct transaction costs .. 111 (35) 76 721 55,288
Contract cancellation costs . 18,744 (17,091) 1,653 1,155 33,207
Other ....................... 6,738 (2,830) 3,908 26,423 9,146
--------- -------- ------- --------- --------
$ 122,630 $(47,125) $75,505 $ 20,465 $366,860
========= ======== ======= ========= ========
Nine Months Nine Months Nine Months
Ended Ended Ended
December 31, September 30, September 30, September 30, September 30,
1997 1998 1998 1998 1997
Accrued Activity Charged Accrued Period Period
Balance Against Accrual(1) Balance Costs(2) Costs
------------ ------------------ -------------- -------------- -------------
(dollars in thousands)
Severance ................... $ 93,104 $ (56,032) $37,072 $ (3,923) $122,933
Premises and equipment ...... 57,304 (24,508) 32,796 (12,789) 146,286
Legal, underwriting and other
direct transaction costs .. 742 (666) 76 7,413 113,314
Contract cancellation costs . 33,699 (32,046) 1,653 (11,527) 33,207
Other ....................... 11,243 (7,335) 3,908 74,414 9,146
--------- --------- ------- --------- --------
$ 196,092 $(120,587) $75,505 $ 53,588 $424,886
========= ========= ======= ========= ========
- ----------
(1) Amounts include activity charged against the accrual, additional accruals
and reversals of excess accruals.
(2) Amounts include reversals of excess accruals.
Telecommunications and outsourced information services expense of $51.1
million and $153.1 million for the three and nine months ended September 30,
1998 was up from $40.1 million and $126.2 million for the same periods in 1997.
This change resulted from increased volume and usage.
Foreclosed assets generated net income of $9.5 million and $5.9 million for
the three and nine months ended September 30, 1998 compared with net expenses of
$5.2 million and $9.7 million for the same periods in 1997. During the third
quarter of 1998, the Company reversed $3.1 million in excess reserves on
foreclosed assets and recorded a gain of $4.2 million on the sale of two
foreclosed commercial properties.
13
16
Other operating expense consisted of the following:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(dollars in thousands)
Other operating expense:
Advertising and promotion $ 23,380 $ 22,638 $ 70,776 $ 62,747
Operating losses and settlements 21,946 13,909 45,904 37,481
Postage 14,011 12,049 39,835 37,333
Professional fees 11,585 13,944 31,517 40,913
Office supplies 6,510 3,899 17,196 14,249
Other expense 45,564 43,246 132,349 127,731
-------- -------- -------- --------
Total other operating expense $122,996 $109,685 $337,577 $320,454
======== ======== ======== ========
Operating losses and settlements refer primarily to uncollected overdrafts and
other deposit-related activity. As the volume of checking accounts increased, so
did losses associated with these accounts. Management closely monitors these
losses, especially in light of the growth in checking accounts.
Included in the other category listed above are such expenses as travel and
training, security services, outside printing, insurance expenses, and other
operating costs.
TAXATION. Income taxes include federal and applicable state income taxes and
payments in lieu of taxes. The provision for income taxes was $163.9 million for
the third quarter of 1998, compared with $15.6 million for the third quarter of
1997. The 1997 third quarter pretax loss of $111.3 million included
transaction-related expenses which were not deductible for tax purposes. For the
nine months ended September 30, 1998, the provision was $492.5 million, which
represented an effective tax rate of 38.3%, compared with a 51.9% effective tax
rate for the nine months ended September 30, 1997. The change in the tax rate
resulted from a reduction in the tax valuation allowance in 1998 and
nondeductible merger costs in 1997.
CONSUMER FINANCE OPERATIONS. During the three and nine months ended September
30, 1998, Aristar had net income of $14.8 million and $41.4 million, up from
$10.2 million and $34.3 million for the same periods in 1997. The 1997 third
quarter net income had been reduced as a result of a pretax interest accrual
reversal of $4.2 million. The improvement in net interest income was due to the
growth in the loan portfolio. The increase in the loan loss provision reflected,
in part, this growth of the loan portfolio and the credit risk inherent in
consumer finance lending.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(dollars in thousands)
Consumer finance operations:
Net interest income $ 71,791 $ 58,474 $ 206,655 $180,790
Provision for loan losses (21,800) (16,200) (58,100) (47,200)
Other income 7,844 6,592 20,110 19,647
Other expense (33,322) (31,821) (100,174) (96,585)
-------- -------- --------- --------
Income before income taxes 24,513 17,045 68,491 56,652
Income taxes (9,700) (6,800) (27,100) (22,400)
-------- -------- --------- --------
Net income $ 14,813 $ 10,245 $ 41,391 $ 34,252
======== ======== ========= ========
14
17
REVIEW OF FINANCIAL POSITION
ASSETS. At September 30, 1998, the Company's assets were $108.36 billion, an
increase of 12% from $96.98 billion at December 31, 1997. The growth during the
nine months ended September 30, 1998 resulted primarily from the purchase of
agency and high quality MBS in the secondary market and the retention of
adjustable-rate mortgage ("ARM") loan originations. Despite record loan
originations during the nine months ended September 30, 1998, asset growth was
hampered by increases in principal payments and sales of a majority of the
Company's fixed-rate loan production.
SECURITIES. The Company's securities portfolio increased by $5.73 billion to
$29.91 billion during the nine months ended September 30, 1998 primarily due to
the purchase of agency and high quality MBS in the secondary market.
At September 30, 1998, 72% of MBS in the Company's securities portfolio were
adjustable rate. This was down from 84% at June 30, 1998 primarily due to the
purchase of fixed-rate securities with short durations. Of the securities
indexed to an adjustable rate, 70% were indexed to the Cost of Funds Index of
the Federal Home Loan Bank ("FHLB") Eleventh District ("COFI"), 20% were indexed
to U.S. Treasury indices, and 10% were indexed to the London Interbank Offering
Rate. The remaining 28% of MBS were fixed rate.
LOANS. Total loans at September 30, 1998 were $72.41 billion, up from $67.14
billion at December 31, 1997. Changes in total loans for the nine months ended
September 30, 1998 were as follows:
Nine Months Ended September 30, 1998
----------------------------------------------
Cash Basis Noncash Items Total Change
------------ ------------- -------------
(dollars in thousands)
Loans held in portfolio and reserve for loan losses:
Loans originated (1) $ 18,591,332 $ 1,402,902 $ 19,994,234
Loans originated to facilitate the sale of
foreclosed assets -- 41,382 41,382
Loans purchased 1,687,830 -- 1,687,830
Loans securitized -- (754,564) (754,564)
Real estate acquired through foreclosure -- (242,220) (242,220)
Proceeds from loans sold (24,574) -- (24,574)
Loan payments and other (1) (11,139,808) (4,676,340) (15,816,148)
Change in loan loss reserve 110,503 (126,165) (15,662)
------------ ----------- ------------
Change in loans held in portfolio and
reserve for loan losses 9,225,283 (4,355,005) 4,870,278
Loans held for sale:
Loans originated (1) 5,840,878 3,273,438 9,114,316
Proceeds from loans sold (8,786,241) -- (8,786,241)
Mortgage banking gains 69,644 -- 69,644
------------ ------------ ------------
Change in loans held for sale (2,875,719) 3,273,438 397,719
------------ ------------ ------------
Total change in loans $ 6,349,564 $(1,081,567) $ 5,267,997
============ ============ ============
- ----------
(1) Noncash items include loans originated to refinance existing loans.
15
18
Loans (exclusive of the reserve for loan losses) consisted of the following:
September 30, December 31,
1998 1997
------------- ------------
(dollars in thousands)
Real estate loans:
SFR $58,103,428 $53,431,451
SFR construction 973,669 877,449
Apartment buildings 4,109,321 4,187,580
Other commercial real estate 2,332,706 2,425,961
----------- -----------
65,519,124 60,922,441
Manufactured housing 1,097,766 1,081,193
Second mortgage and other consumer 3,069,575 2,725,144
Consumer finance 2,433,183 2,309,407
Commercial business 974,662 772,466
----------- -----------
$73,094,310 $67,810,651
=========== ===========
Real estate loans (exclusive of the reserve for loan losses) by product type
were as follows:
September 30, 1998 December 31, 1997
------------------------------- --------------------------------
Percent of Percent of
Total Real Total Real
Amount Estate Loans Amount Estate Loans
----------- ------------ ----------- ------------
(dollars in thousands)
Short-term ARMs:
COFI $27,965,445 43% $32,108,461 53%
Moving Treasury Average ("MTA") 6,261,732 9 1,602,123 3
Constant Maturity Treasury ("CMT") 3,098,686 5 3,800,156 6
Other 3,125,165 5 4,553,499 7
----------- --- ----------- ---
40,451,028 62 42,064,239 69
Medium-term ARMs:
MTA 5,347,763 8 2,880,587 5
CMT 3,220,619 5 4,135,947 7
COFI 903,228 1 1,244,357 2
Other 2,658,495 4 -- --
----------- --- ----------- ---
12,130,105 18 8,260,891 14
Fixed-rate mortgages 12,937,991 20 10,597,311 17
----------- --- ----------- ---
$65,519,124 100% $60,922,441 100%
=========== === =========== ===
Number of real estate loans 516,432 513,417
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.
16
19
Loan originations were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
(dollars in thousands)
Real estate loans:
SFR:
Adjustable rate $3,905,075 $4,084,265 $11,299,226 $11,359,513
Fixed rate 3,654,218 1,770,245 11,750,052 4,632,757
---------- ---------- ----------- -----------
7,559,293 5,854,510 23,049,278 15,992,270
SFR construction:
Custom 310,045 235,814 755,459 642,527
Builder 184,819 122,353 546,826 430,398
---------- ---------- ----------- -----------
494,864 358,167 1,302,285 1,072,925
Apartment buildings 149,585 212,071 424,489 524,912
Other commercial real estate 97,557 159,256 306,575 364,730
---------- ---------- ----------- -----------
8,301,299 6,584,004 25,082,627 17,954,837
Manufactured housing 83,815 96,515 221,273 247,670
Second mortgage and other consumer 469,258 495,257 1,404,452 1,420,495
Consumer finance 724,966 531,835 1,806,937 1,508,541
Commercial business 186,272 149,046 634,643 474,256
---------- ---------- ----------- -----------
$9,765,610 $7,856,657 $29,149,932 $21,605,799
========== ========== =========== ===========
SFR originations by product type were as follows:
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
---------------------------------- ---------------------------------
Percent Percent Percent Percent
of of of of
Amount Category Total Amount Category Total
---------- -------- ------- ----------- -------- -------
(dollars in thousands)
Short-term ARMs:
MTA $1,679,415 94% 22% $ 4,616,572 85% 20%
COFI 99,787 5 2 619,675 11 3
CMT 13,354 1 * 165,197 3 1
Other 1,210 * * 38,779 1 *
---------- --- --- ----------- --- ---
1,793,766 100% 24 5,440,223 100% 24
=== ===
Medium-term ARMs:
MTA 2,034,873 96% 27 5,189,960 89% 22
CMT 19,262 1 * 429,467 7 2
COFI 57,174 3 1 57,174 1 *
Other -- -- -- 182,402 3 1
---------- --- --- ----------- --- ---
2,111,309 100% 28 5,859,003 100% 25
=== ===
Fixed-rate mortgages 3,654,218 48 11,750,052 51
---------- --- ----------- ---
$7,559,293 100% $23,049,278 100%
========== === =========== ===
- ----------
* Less than one percent
17
20
The strong housing market and lower interest rates led to strong loan
production which included a significant amount of refinance activity during the
nine months ended September 30, 1998. The low interest-rate environment also led
to an increase in borrower preference for fixed-rate mortgages. Fixed-rate loan
production accounted for 48% of total SFR originations in the third quarter of
1998, up from 30% in the third quarter of 1997, and 51% of total SFR
originations during the nine months ended September 30, 1998, compared with 29%
during the nine months ended September 30, 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 upon wholesale borrowings
to fund its asset growth. The slight decrease in deposits from $50.99 billion as
of December 31, 1997 to $50.56 billion as of September 30, 1998 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, savings accounts, MMDAs and checking accounts
have increased as a percentage of total deposits to 50% at September 30, 1998
compared with 45% at year-end 1997. These latter three products generally carry
lower interest costs to the Company compared with time deposit accounts. Even
though savings accounts, 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 asset growth was funded by borrowings that primarily take the
form of federal funds purchased, securities sold under agreements to repurchase
("reverse repurchase agreements") and advances from the 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
NONPERFORMING ASSETS. Assets considered to be nonperforming include nonaccrual
loans and securities, foreclosed assets and real estate held for investment
purposes that do not generate sufficient income to meet return on investment
criteria. When loans securitized or sold with recourse provisions become
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 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 $748.5 million or 0.69% of total assets at September
30, 1998, compared with $806.6 million or 0.83% of total assets at December 31,
1997.
Nonperforming assets consisted of the following:
September 30, December 31,
1998 1997
------------- -------------
(dollars in thousands)
Nonaccrual loans:
Real estate loans:
SFR $471,714 $469,127
SFR construction 10,955 10,413
Apartment buildings 10,971 17,296
Other commercial real estate 7,484 25,825
-------- --------
501,124 522,661
Manufactured housing 12,313 11,127
Second mortgage and other consumer 19,558 14,071
Consumer finance 55,050 50,930
Commercial business 2,974 2,585
-------- --------
591,019 601,374
Foreclosed assets 157,500 205,272
-------- --------
$748,519 $806,646
======== ========
Nonperforming assets as a percentage of total assets 0.69% 0.83%
The decrease in foreclosed assets was primarily attributable to the decline in
residential foreclosures. During the nine months ended September 30, 1998, sales
of existing foreclosed assets exceeded acquisitions, resulting in a net decrease
in the inventory. The Company also sold two foreclosed commercial properties
during the third quarter of 1998. The two properties had a combined basis of
$13.7 million and their sale generated a gain of $4.2 million.
18
21
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
adequate reserves for loan losses inherent in the Company's loan portfolio. The
Company's process to determine the level of the reserve and the related
provision for loan losses includes consideration of various factors, such as
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 regulatory requirements.
Changes in the reserve for loan losses were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(dollars in thousands)
Balance, beginning of period $684,436 $666,057 $ 670,494 $ 677,141
Provision for loan losses 35,250 52,131 126,998 155,940
Reserves added through business
combinations - - - 10,908
Reserves transferred to MBS impairment - - - (16,505)
Reserves transferred to contingent liability (833) - (833) (2,747)
Loans charged off:
SFR (8,389) (22,438) (33,453) (78,624)
SFR construction (108) (12) (470) (12)
Commercial real estate (1,077) (4,869) (7,332) (19,148)
Manufactured housing, second mortgage and
other consumer (4,961) (4,422) (17,056) (13,674)
Consumer finance (21,917) (19,683) (65,610) (58,336)
Commercial business (819) (781) (2,734) (1,087)
------- ------- -------- --------
(37,271) (52,205) (126,655) (170,881)
Recoveries of loans previously charged off:
SFR 62 327 795 875
SFR construction - 5 - 74
Commercial real estate 125 1,302 923 2,169
Manufactured housing, second mortgage and
other consumer 490 409 1,399 2,507
Consumer finance 3,761 3,754 12,703 12,214
Commercial business 136 89 332 174
-------- -------- --------- ---------
4,574 5,886 16,152 18,013
-------- -------- --------- ---------
Net charge offs (32,697) (46,319) (110,503) (152,868)
-------- -------- --------- ---------
Balance, end of period $686,156 $671,869 $ 686,156 $ 671,869
======== ======== ========= =========
An analysis of the reserve for loan losses was as follows:
September 30, December 31,
1998 1997
------------- ------------
(dollars in thousands)
Specific and allocated reserves:
Commercial real estate $ 76,073 $ 84,969
Commercial business 8,993 3,277
Builder construction 852 2,207
-------- --------
85,918 90,453
Unallocated reserves 600,238 580,041
-------- --------
$686,156 $670,494
======== ========
Total reserve for loan losses as a percentage of:
Nonaccrual loans 116% 111%
Nonperforming assets 92 83
19
22
The Company considers the reserve for loan losses of $686.2 million at
September 30, 1998 adequate to cover losses inherent in the loan portfolio.
Management bases its analysis of the adequacy of the reserve on a combination of
factors, including, but not limited to, the composition of the loan portfolio,
recent loss experience as reflected in net charge offs, fluctuations in its
nonperforming assets, and general market conditions.
The credit quality of the Company's loan portfolio as measured by its
nonperforming loans has remained relatively unchanged during 1998 and,
therefore, the absolute level of loss reserves has also remained at comparable
levels. As a result of reduced charge offs during the third quarter of 1998, the
Company has reduced its provision for loan losses in order to maintain its loan
loss reserve at levels consistent with the inherent losses described above.
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.
YEAR 2000. This section contains forward-looking statements that have been
prepared on the basis of the Company's best judgments and currently available
information. These forward-looking statements are inherently subject to
significant business, third-party and regulatory uncertainties and
contingencies, many of which are beyond the control of the Company. In addition,
these forward-looking statements are based on the Company's current assessments
and remediation plans, which are based on certain representations of third-party
servicers 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.
Washington Mutual 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 significant operational areas of the
Company 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, the
Company has engaged IBM Global Services to provide supplemental technical and
management resources to assess and test the Year 2000 readiness of the Company's
Computer Systems, Deloitte & Touche LLP 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 Company's Board of
Directors, and the Board's Audit Committee reviews Year 2000 Project progress on
a quarterly basis.
(a) 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 the Company's connections with other
computer systems; (iv) due diligence on third-party servicers; and (v)
development of contingency plans. The Year 2000 Project is divided into four
categories: mainframe systems, non-mainframe systems, third-party servicers, and
facilities.
The inventory and assessment phases are 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 servicers, and facilities
that it deems more critical to its ongoing business and the maintainance of good
customer relationships.
The Company is currently in the process of repairing or replacing and testing
the most significant components of its Computer Systems and facilities, and it
expects to be substantially complete with this phase by December 31, 1998. The
Company has also adopted business contingency plans for the Computer Systems and
facilities that it has determined to be most critical. These plans conform to
recently issued 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.
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Prior to 1998, the Company undertook strategic business initiatives that
shifted a significant portion of the cost for Year 2000 readiness to third-party
servicers. Following the Company's merger with Ahmanson and after the data
processing conversions associated with that merger, the Company will rely on
third-party servicers for significant business processes such as item
processing, loan servicing, and desktop and communications management. The
Company has been communicating with its third-party servicers to assess and
monitor their Year 2000 readiness, and it has undertaken a contingency planning
process to be ready in case one of the servicers that it deems most critical
fails in its own readiness efforts. The Company expects that its due diligence
on third-party servicers for its most critical business processes, including the
testing of the Company's connections with these servicers, will be substantially
complete by March 31, 1999, although its monitoring of these servicers will
continue after that date.
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.
(b) 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 has spent approximately $8.4 million during the
first nine months of 1998 on its Year 2000 Project, and it currently expects to
spend approximately $11.2 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 the
Company's current cost of Year 2000 readiness.
(c) Risks. Based on its current assessments and remediation plans, which are
based in part on certain representations of third-party servicers, the Company
does not expect that it will experience a significant disruption of its
operations as a result of the change to the new millenium. 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 the
Company's power supply or voice and data transmission suppliers, a Computer
System, a third-party servicer, 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 Company's contingency
plans will function as anticipated, or that the results of operations of the
Company 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 Washington Mutual's Year 2000 Project.
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 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:
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September 30, December 31,
1998 1997
------------- -------------
(dollars in thousands)
Interest-sensitive assets $ 79,321,675 $ 74,938,422
Derivative instruments designated against assets 300,000 500,000
Interest-sensitive liabilities (81,949,602) (70,204,799)
Derivative instruments designated against liabilities 2,211,800 1,078,400
------------ ------------
Net asset sensitivity $ (116,127) $ 6,312,023
============ ============
One-year gap (0.11)% 6.51%
The one-year gap declined to a negative 0.11% at September 30, 1998 from a
positive 6.51% at December 31, 1997. The low interest-rate environment produced
a high level of refinancings, which limited ARM originations as fixed-rate loans
were more attractive to borrowers. The Company funded a large portion of its
originations through short-term borrowings.
While the one-year gap helps provide some information about a financial
institution's interest-rate 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.
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.
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 nine months ended September 30, 1998 of $792.0
million, $120.7 million for noncash items and $2.50 billion of other net cash
flows provided by operating activities. For the nine months ended September 30,
1998, cash flows from investing activities included sales and principal payments
on securities totaling $6.10 billion. Purchases of securities required $9.31
billion and loans originated and purchased for investment net of principal
payments required $9.23 billion. 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 nine months
ended September 30, 1998, the above mentioned financing activities increased
cash and cash equivalents by $9.10 billion on a net basis. Cash and cash
equivalents were $1.35 billion at September 30, 1998.
At September 30, 1998, the Company was in a position to obtain approximately
$29.66 billion in additional borrowings primarily through the use of
collateralized borrowings and deposits of public funds using unpledged MBS and
other wholesale sources.
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 the degree to which the Company depends on wholesale funds maturing
within one year weighted by the dependability of the source. At September 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 Federal Deposit Insurance Corporation ("FDIC") as
benchmarks for liquidity management. At September 30, 1998, WMB's ratios were
above the FDIC minimum ratios.
Regulations promulgated by the Office of Thrift Supervision ("OTS") require
that the Company's federal savings banks maintain, for each calendar quarter,
certain liquidity ratios. At September 30, 1998, each of the Company's federal
savings banks' liquidity ratios was in excess of the regulatory minimums.
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CAPITAL ADEQUACY
The Company's capital (stockholders' equity) was $5.80 billion at September
30, 1998 up from $5.31 billion at December 31, 1997. However, due to asset
growth, the ratio of capital to total assets was 5.35% at the end of third
quarter 1998 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:
September 30, 1998
----------------------------- Well-Capitalized
WMBFA WMB WMBfsb Minimum
----- ----- ------ ----------------
Capital ratios:
Leverage 5.68% 5.71% 6.86% 5.00%
Tier 1 risk-based 10.18 10.76 11.92 6.00
Total risk-based 11.59 11.48 13.18 10.00
The Company's federal savings banking subsidiaries are also required by OTS
regulations to maintain core capital of at least 3.00% of assets. WMBFA and
WMBfsb each satisfied this requirement at September 30, 1998.
The Company's securities subsidiaries are also subject to capital
requirements. At September 30, 1998, all of Washington Mutual's securities
subsidiaries were in compliance with their applicable capital requirements.
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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
On August 28, 1998 at a special meeting of shareholders, holders of Washington
Mutual common stock approved the issuance of shares of common stock pursuant to
the Agreement and Plan of Merger dated as of March 16, 1998 between Washington
Mutual and Ahmanson, with 302,062,514 common share votes cast for the issuance,
843,252 votes cast against the issuance, and 614,598 abstentions. Holders of
Washington Mutual common stock and holders of Washington Mutual preferred stock
also approved an amendment to Washington Mutual's Articles of Incorporation to
increase the number of authorized shares of common stock from 800,000,000 shares
to 1,600,000,000 shares. Common shareholders cast 301,340,571 votes for the
amendment and 32,023,977 votes against the amendment, with 635,955 abstentions.
An aggregate of 303,072,407 votes were cast for and 32,058,480 votes were cast
against the amendment by the common and preferred shareholders, with 670,469
abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Index of Exhibits on page 26.
(b) Reports on Form 8-K
During the third quarter of 1998, the Company filed a report on Form 8-K dated
July 21, 1998. The report included under Item 7 of Form 8-K a press release
announcing Washington Mutual's second quarter 1998 financial results and
unaudited consolidated financial statements for the quarter ended June 30, 1998.
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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 November 13, 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)
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WASHINGTON MUTUAL, INC.
INDEX OF EXHIBITS
Exhibit No.
- -----------
3.1 Restated Articles of Incorporation of the Registrant, as amended
(filed herewith as amended).
3.2 By-laws of the Registrant (filed herewith as amended).
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 June 30, 1998.
27.3 Amended Financial Data Schedule for the period ended March 31,
1998.
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