UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the Quarterly Period Ended March 31, 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
April 30, 1999:
Common Stock - 594,850,100
EXPLANATORY NOTE
This amendment to Form 10-Q on Form 10-Q/A has been prepared to reflect
reclassifications within categories of allocated and unallocated reserves as
presented in the table on Page 15 and to reflect additional borrowing capacity
of the Company as described on Page 19. These amended items are included in
Item 2., Management's Discussion and Analysis of Financial Condition and
Results of Operations. These amended items had no effect on net income or
total assets, total liabilities or total equity as previously reported.
No part of the Form 10-Q for March 31, 1999 as previously filed, other than
Item 2., was affected by this amendment.
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.
During 1998 and continuing in 1999, the Company has faced the challenge of
deploying excess capital. Although total loan originations were higher in 1998
as well as in the first quarter of 1999, compared with the same periods of the
prior year, the loan portfolio has not grown significantly. Reflecting the low
interest rate environment, the Company has experienced a high level of
prepayments and a high volume of originations of fixed-rate loans, which the
Company generally sells in the secondary market. In order to utilize excess
capital, the Company has developed alternative strategies, predominantly the
purchase of investment grade mortgage-backed securities ("MBS") and whole loans.
These strategies, however, create assets with generally lower rates of return
than loans originated and retained in portfolio. Accordingly, in order to
enhance the Company's capital deployment strategies, Washington Mutual announced
in April 1999 that its Board of Directors approved a share repurchase program to
acquire, from time to time, up to 20 million shares of Washington Mutual's
common stock. As a result of the share repurchases, coupled with a continuation
of the current interest rate environment, the Company does not expect
significant asset growth during the remainder of 1999.
RESULTS OF OPERATIONS
OVERVIEW. The Company's net income for the first quarter of 1999 was $444.1
million, compared with $370.8 million for the first quarter of 1998. Variances
between the first quarter of 1999 and 1998 were partially attributable to the
acquisition of Coast Savings Financial, Inc. ("Coast") by H.F. Ahmanson &
Company ("Ahmanson") on February 13, 1998. Since the transaction was accounted
for as a purchase, Coast operations prior to February 13, 1998 were not included
in the Company's first quarter 1998 results.
NET INTEREST INCOME. Net interest income for the first quarter of 1999 was
$1.13 billion, a 6% increase from $1.06 billion in the first quarter of 1998.
The increase was due to an 11% rise in average interest-earning assets to
$158.66 billion from $143.19 billion in the first quarter of 1998. The net
interest spread, however, declined to 2.60% in the first quarter of 1999 from
2.74% in the first quarter of 1998.
The yield on loans declined 39 basis points due primarily to the high level of
loan prepayments as a result of relatively lower interest rates and the strong
economy during the first quarter of 1999. In addition, adjustable-rate mortgages
("ARMs") held in portfolio were repricing to lower rates. The yield on MBS
declined 48 basis points due to the purchase of $13.09 billion in MBS at a
weighted average rate of 6.25% during the first quarter of 1999 and the effect
of repricing on adjustable-rate MBS. Offsetting these declines, the cost of
deposits decreased 34 basis points from first quarter 1998 to the same period in
1999 as a result of a change in the composition of deposits. Higher-costing time
deposits decreased from 59% of total deposits at March 31, 1998 to 50% at March
31, 1999, which reflected the Company's focus on growth in retail transaction
accounts rather than time deposits. Savings accounts, money market deposit
accounts ("MMDAs") and checking accounts have increased as a percentage of total
deposits. These products have the benefit of lower interest costs, compared with
time deposits. In addition, the decline of 52 basis points in the Company's cost
of borrowings from first quarter 1998 to first quarter 1999 primarily reflected
the easing of interest rates by the Federal Reserve Bank. Average borrowings
from the Federal Home Loan Banks increased from 48% of total average borrowings
for first quarter 1998 to 58% for the same period in 1999.
The net interest margin declined to 2.79% in the first quarter of 1999 from
2.91% for the same period in 1998. The decrease in the net interest margin was
due primarily to the growth in purchased MBS and the narrower spreads these
assets earned over the cost of borrowed funds. Since a large portion of the
additional MBS was purchased late in the first quarter of 1999, the net interest
margin is expected to decrease further in the second quarter of 1999 and then
stabilize during the remainder of the year. Any future change in interest rates
would affect the net interest margin.
Selected average financial balances and the net interest spread and margin
were as follows:
Three Months Ended
March 31,
--------------------------
1999 1998
------------ ------------
(dollars in thousands)
Average Balances:
Loans $109,289,268 $101,912,526
MBS 45,765,022 37,234,969
Investment securities 3,606,580 4,041,704
------------ ------------
Total interest-earning assets 158,660,870 143,189,199
Deposits 84,289,648 86,293,066
Borrowings 68,015,000 51,900,360
------------ ------------
Total interest-bearing liabilities 152,304,648 138,193,426
Total assets 164,220,074 149,137,681
Stockholders' equity 9,488,284 8,194,071
Weighted Average Yield On:
Loans 7.43% 7.82%
MBS 6.78 7.26
Investment securities 5.56 6.13
Interest-earning assets 7.20 7.63
Weighted Average Cost of:
Deposits 3.91 4.25
Borrowings 5.44 5.96
Interest-bearing liabilities 4.60 4.89
Net interest spread 2.60 2.74
Net interest margin 2.79 2.91
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.
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:
Three Months Ended March 31,
1999 vs. 1998
------------------------------
Increase/(Decrease) Due to
------------------------------
Volume Rate Total
-------- --------- --------
(dollars in thousands)
Interest Income:
Loans $122,847 $ (84,542) $ 38,305
MBS 140,262 (39,982) 100,280
Investment securities (6,292) (5,411) (11,703)
-------- --------- --------
Total interest income 256,817 (129,935) 126,882
Interest Expense:
Deposits (20,594) (69,575) (90,169)
Borrowings 208,178 (58,020) 150,158
-------- --------- --------
Total interest expense 187,584 (127,595) 59,989
-------- --------- --------
Net interest income $ 69,233 $ (2,340) $ 66,893
======== ========= ========
OTHER INCOME. Other income was $352.1 million for the quarter ended March 31,
1999, compared with $264.4 million for the same period in 1998.
Other income consisted of the following:
Three Months Ended
March 31,
-------------------
1999 1998
-------- --------
(dollars in thousands)
Depositor and other retail banking fees:
Checking and MMDA charges $144,979 $ 99,021
ATM transaction fees 8,192 7,366
Other 10,246 13,093
-------- --------
Total depositor and other retail banking fees 163,417 119,480
Loan servicing income 26,031 32,347
Loan related income 26,547 25,091
Securities fees and commissions 59,522 46,785
Insurance fees and commissions 10,670 12,791
Mortgage banking income 38,362 27,048
Gain on sale of other assets 11,933 1,147
Provision for recourse liability (5,142) (15,205)
Other operating income 20,804 14,878
-------- --------
Total other income $352,144 $264,362
======== ========
Depositor and other retail banking fees of $163.4 million for the quarter
ended March 31, 1999 increased 37% from $119.5 million for the same period in
1998, primarily reflecting the expansion of the Company's consumer banking
strategy in the California financial centers. These fees grew as a result of a
20% increase in the number of checking accounts from December 31, 1997 to
4,005,605 at March 31, 1999. The increase in depositor fees for nonsufficient
funds, overdraft protection, debit card, check stock and other checking program
fees more than offset decreases in monthly service charges on checking accounts
in former Home Savings and Coast Savings branches converted to the Company's
"Free Checking" product.
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.
Loan servicing income declined from $32.3 million for the quarter ended March
31, 1998 to $26.0 million for the same period in 1999. This decrease was
primarily attributable to a 7 basis point drop in the average servicing fee,
partially offset by an increase of $4.05 billion in the average balance of loans
serviced for others.
Securities and insurance fees and commissions increased from $59.6 million in
the first quarter of 1998 to $70.2 million for the same period in 1999. The
increase was primarily attributable to the Company's recent emphasis on selling
products that generate higher commissions. The introduction of the Consumer Bank
Annuity Program in California and Florida also contributed to an overall
increase in fees during the first quarter of 1999.
Mortgage banking income during the first quarter of 1999 was $38.4 million,
compared with $27.0 million for the same period in 1998. The increase was due
primarily to higher capitalization of mortgage servicing rights.
The sale of other assets resulted in net gains of $11.9 million for the
quarter ended March 31, 1999, compared with $1.1 million for the same period in
1998. The net gain in the first quarter of 1999 included a $7.1 million gain
recognized on the sale of the former Coast headquarters property, a $1.8 million
gain on the sale of assets associated with the expiration of a leveraged lease
and a $461,000 gain on the sale of contract collection accounts.
The provision for recourse liability decreased from $15.2 million in the first
quarter of 1998 to $5.1 million for the same period in 1999 reflecting a lower
level of charge offs in the recourse portfolio. The decrease in the balance of
recourse loans and MBS brought about by significant paydown activity, combined
with continued improvement in the California economy, contributed to the lower
level of charge offs.
OTHER EXPENSE. Other expense totaled $729.9 million for the quarter ended
March 31, 1999, compared with $674.7 million for the same period in 1998.
Other expense consisted of the following:
Three Months Ended
March 31,
------------------
1999 1998
-------- --------
(dollars in thousands)
Salaries and employee benefits $301,609 $291,231
Occupancy and equipment:
Premises and equipment 84,324 96,122
Data processing 50,580 24,095
-------- --------
Total occupancy and equipment 134,904 120,217
Telecommunications and outsourced information services 70,064 59,561
Regulatory assesments 15,363 16,256
Transaction-related expense 23,802 31,809
Amortization of intangible assets 25,373 23,584
Foreclosed asset expense 1,598 8,883
Other operating expense:
Advertising and promotion 26,850 27,054
Operating losses and settlements 26,817 12,695
Postage 22,051 17,930
Professional fees 16,217 11,353
Office supplies 7,848 10,923
Other 57,371 43,249
-------- --------
Total other operating expense 157,154 123,204
-------- --------
Total other expense $729,867 $674,745
======== ========
Salaries and employee benefits increased to $301.6 million for the quarter
ended March 31, 1999, from $291.2 million for the same period in 1998. Full-time
equivalent employees ("FTE") were 28,363 at March 31, 1999, compared with 28,211
at March 31, 1998. FTE increased during the first quarter of 1999 because of
additions to staff in loan production and deposit operation areas that were
partially offset by a decrease in administrative support areas.
The Company has been experiencing improved efficiencies in originating loans,
which resulted in lower origination costs and a lower deferral of salary and
benefits expense in first quarter 1999 compared with first quarter 1998. The
reduction in the deferral contributed to a $12.0 million increase in salary
expense during the first quarter of 1999.
Occupancy and equipment expense was $134.9 million for the first quarter of
1999, compared with $120.2 million for the same period in 1998. Contributing to
the increase were additional capitalizations of fixed assets, resulting in
increased depreciation expense; higher rent expense due to the addition of
multiple locations in Seattle; and a higher volume of maintenance expenses and
accrual for property taxes during the first quarter of 1999.
Telecommunications and outsourced information services expense of $70.1
million for the first quarter of 1999 was up from $59.6 million for the same
period in 1998. This change 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 $23.8 million for the quarter ended March 31, 1999 and $31.8 million
for the same period in 1998. The majority of the charges were for one-time
nonrecurring costs associated with 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
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 first quarter 1999, during which time several key systems
and departments as well as branches in Texas were converted.
During the first quarter of 1999, these transaction-related expenses were
partially offset by reductions in the estimates of contract cancellation fees of
$8.9 million and other accruals of $800,000. The reduction in estimates for
contract cancellation fees was primarily the result of contract negotiations
resulting in lower than originally estimated fees or eliminating them entirely.
The Company expected staff reductions related to the Ahmanson merger of
approximately 3,400. As of March 31, 1999, 1,426 employee separations had
occurred. The remaining employee separations are planned to be completed by the
end of September 1999.
At March 31, 1999, the carrying amount of all assets acquired through mergers
and held for future disposal was $61.1 million.
Reconciliation of the transaction-related expense and accrual activity was as
follows:
December 31, 1999 Activity March 31, Three Months
1998 Charged 1999 Ended
Accrued Against Accrued March 31, 1999
Balance Accrual(1) Balance Period Costs(2)
------------ ------------- --------- --------------
(dollars in thousands)
Severance $ 86,014 $(29,797) $ 56,217 $ 5,345
Premises and equipment 158,932 (2,822) 156,110 5,914
Legal, underwriting and other
direct transaction costs - - - 1,969
Contract cancellation costs 15,678 (8,861) 6,817 (6,701)
Other 1,406 (1,406) - 17,275
-------- -------- -------- -------
$262,030 $(42,886) $219,144 $23,802
======== ======== ======== =======
- ------------
(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.
Amortization of intangible assets was $25.4 million for the first quarter of
1999, up from $23.6 million for the same period a year ago. In February 1998,
Ahmanson acquired Coast under the purchase accounting method, which created
intangible assets of $516.5 million and amortization expense of $7.4 million in
first quarter 1999, compared with $2.5 million in first quarter 1998. These
increases were partially offset by a reduction of $1.5 million in the
amortization of goodwill resulting from $41.7 million of write offs on goodwill
related to the Company's 1993 acquisition of Pacific First Bank, a Federal
Savings Bank.
Foreclosed asset expense decreased from $8.9 million for the quarter ended
March 31, 1998 to $1.6 million for the same period in 1999. The decrease in
foreclosed asset expense reflected increased gains on the sales of real estate
owned, predominantly of SFR properties, and a decrease in the provision for
losses. The improvement of the California real estate market, in addition to the
continued strength of the Northwest real estate market, contributed to the
increase in gains from $2.4 million during first quarter 1998 to $7.0 million
for the quarter just ended, as well as a decrease in the provision for losses
from $4.6 million in first quarter 1998 to $2.3 million in first quarter 1999.
Other operating expense increased to $157.2 million in the first quarter of
1999, from $123.2 million for the same period in 1998. The growth in the number
of checking accounts was the primary cause of a $14.1 million increase in
operating losses. Postage costs were $22.1 million in the quarter ended March
31, 1999, up from $17.9 million for the same period in 1998 due to the system
conversions related to the Ahmanson merger which required several special
customer notifications as well as increased mailings related to various
marketing campaigns.
The other category of other operating expense was $57.4 million for the
quarter ended March 31, 1999, compared with $43.2 million for the same period in
1998. 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, other insurance
and other miscellaneous expense. The higher expense reflects the increased
complexity 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 $263.7 million for the first quarter
of 1999 represented an effective tax rate of 37.25%. Income taxes were $229.2
million for the first quarter of 1998, which represented an effective tax rate
of 38.20%. The decline in the effective tax rate was, in part, due to a decrease
in state income taxes resulting from a smaller apportionment of income subject
to California state income taxes.
REVIEW OF FINANCIAL CONDITION
ASSETS. At March 31, 1999, the Company's assets were $174.30 billion, an
increase of 5% from $165.49 billion at December 31, 1998. The growth was the
result of the purchase of investment grade MBS in the secondary market and the
retention of ARM originations. Despite record first quarter loan originations,
asset growth was hampered by prepayments and sales of a majority of the
Company's fixed-rate loan production.
SECURITIES. The Company's securities portfolio increased by $9.75 billion to
$56.83 billion during the quarter ended March 31, 1999 due to the purchase of
$13.09 billion in agency and investment grade MBS in the secondary market. The
Company used purchases of MBS to invest excess capital.
At March 31, 1999, 60% of MBS in the Company's securities portfolio were
adjustable rate, compared with 71% at December 31, 1998. During the quarter, the
Company purchased fixed-rate MBS with short durations. Of the securities indexed
to an adjustable rate, 51% were indexed to the Cost of Funds Index of the
Federal Home Loan Bank ("FHLB") Eleventh District, 6% were indexed to U.S.
Treasury indices, and 3% were indexed to the London Interbank Offering Rate. The
remaining 40% of MBS were fixed rate.
LOANS. Total loans at March 31, 1999 were $108.04 billion, a slight decrease
from $108.37 billion at December 31, 1998. Loan originations during the quarter
were offset by a high level of prepayment activity and the sale of fixed-rate
loans. It is the Company's strategy to sell the majority of its conforming
fixed-rate loan production.
ARM production accounted for 54% of total SFR originations in the first
quarter of 1999, up from 39% for the same period a year ago. In particular,
medium-term ARM originations rose to 32% of total SFR originations in the first
quarter of 1999 from 19% in the first quarter of 1998. The shift from fixed-rate
mortgages to medium-term ARMs was in response to a slight increase in rates for
fixed-rate loans and a modest steepening of the yield curve, as the difference
between the yields on a three-month U.S Treasury bill and a ten-year U.S.
government note averaged 47 basis points in the first quarter of 1999, compared
with 41 basis points for the same period 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 slight decrease in deposits from $85.49 billion at December 31, 1998
to $84.18 billion at March 31, 1999 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 slightly
as a percentage of total deposits to 50% at March 31, 1999, from 49% at year-end
1998. 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 during the first quarter 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 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 first quarter of 1999, the Company's analysis of these elements
indicated continued improvement in loss experience, as net charge offs decreased
from $51.7 million during the quarter ended March 31, 1998 to $45.0 million for
the same period in 1999. As a result of these lower charge offs, the Company
reduced its provision for loan losses from $50.0 million for the first quarter
of 1998 to $41.7 million for the first quarter of 1999 in order to maintain its
loan loss reserve at levels consistent with the analysis of the credit quality
of the loan portfolio 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.
Due to the favorable economy, the Company expects continued good credit
performance during 1999, resulting in low levels of net charge offs. Based on
these factors, the provision for loan losses is expected to be at lower levels
compared to the same periods in 1998, although growth in the loan portfolio
could lead to a modest increase in future provisions.
Changes in the reserve for loan losses were as follows:
Three Months Ended
March 31,
-----------------------
1999 1998
---------- ----------
(dollars in thousands)
Balance, beginning of period $1,067,840 $1,047,845
Provision for loan losses 41,700 49,975
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 (11,080) (21,996)
Manufactured housing, second mortgage and
other consumer (13,410) (9,198)
Commercial business (2,455) (1,359)
Commercial real estate (3,925) (9,745)
Consumer finance (23,824) (22,105)
---------- ----------
(54,694) (64,403)
Recoveries of loans previously charged off:
SFR and SFR construction 2,096 3,102
Manufactured housing, second mortgage and
other consumer 535 458
Commercial business 228 96
Commercial real estate 2,674 4,745
Consumer finance 4,126 4,273
---------- ----------
9,659 12,674
---------- ----------
Net charge offs (45,035) (51,729)
---------- ----------
Balance, end of period $1,069,719 $1,153,921
========== ==========
Net charge offs as a percentage of average loans 0.16% 0.20%
An analysis of the reserve for loan losses was as follows:
March 31, December 31,
1999 1998
------------ ----------
(dollars in thousands)
Specific and allocated reserves:
Commercial real estate $ 112,072 $ 133,167
Commercial business 16,157 9,690
Builder construction 782 852
---------- ----------
129,011 143,709
Unallocated reserves 940,708 924,131
---------- ----------
$1,069,719 $1,067,840
========== ==========
Total reserve for loan losses as a percentage of:
Nonaccrual loans 119% 114%
Nonperforming assets 90 88
Total loans (exclusive of the reserve for loan losses) 0.98 0.98
The Company considers the reserve for loan losses of $1.07 billion adequate to
cover losses inherent in the loan portfolio at March 31, 1999. The reserve as a
percentage of nonaccrual loans and nonperforming assets was higher at March 31,
1999 than at year-end 1998 due primarily to the decline in the amounts of
nonaccrual loans and nonperforming assets. See "Nonperforming Assets." The
credit quality of the Company's loan portfolio, as measured by its nonperforming
loans, has remained relatively unchanged during the first quarter of 1999 and,
therefore, the absolute level of loss reserves has also remained at comparable
levels.
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. Because these
loans are similar in all respects to the loans in its loan portfolio, the
Company estimates its recourse obligation on these securities in a manner
similar to the method it uses to estimate the reserve for losses on its loan
portfolio. The liability for this recourse is included in other liabilities.
In addition to retaining securitized loans with recourse, the Company has,
from time to time, sold these securities in the secondary market. The recourse
obligation on these securities is also accounted for in a manner similar to, and
is included in, the liability for recourse on securities the Company has
originated and retained.
At March 31, 1999, the Company had $22.96 billion of loans securitized and
retained with recourse, and $5.37 billion of loans sold with recourse. At March
31, 1999, the liability for this recourse was $128.0 million.
Changes in the recourse liability were as follows:
Three Months Ended
March 31,
-----------------------
1999 1998
--------- --------
(dollars in thousands)
Balance, beginning of period $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 (1,291) (2,496)
-------- -------
Balance, end of period $127,966 $77,661
======== =======
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 $1.18 billion or 0.68% of total assets at March 31,
1999, compared with $1.21 billion or 0.73% of total assets at December 31, 1998.
Nonperforming assets consisted of the following:
March 31, December 31,
1999 1998
------------- -------------
(dollars in thousands)
Nonaccrual loans:
SFR $ 719,061 $ 752,261
SFR construction 14,196 9,188
Manufactured housing 18,751 14,669
Second mortgage and other consumer 27,109 24,284
Commercial business 7,037 7,416
Apartment buildings 35,793 43,653
Other commercial real estate 21,325 33,077
Consumer finance 52,659 53,412
---------- ----------
895,931 937,960
Foreclosed assets 287,154 274,767
---------- ----------
$1,183,085 $1,212,727
========== ==========
Nonperforming assets as a percentage of total assets 0.68% 0.73%
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
March 31, 1999, 74% of the Company's total SFR loan and MBS portfolio had
adjustable rates.
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
certainextent 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 March 31, 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 quarter ended March 31, 1999 of
$444.1 million, $69.1 million for noncash items and $2.06 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 quarter ended March 31,
1999, cash flows from investing activities included sales, maturities and
principal payments on securities totaling $5.00 billion. Loans originated and
purchased for investment were in excess of repayments and sales by $3.63
billion, and $12.48 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 quarter ended March 31, 1999, the above mentioned
financing activities increased cash and cash equivalents by $7.79 billion on a
net basis. Cash and cash equivalents were $1.91 billion at March 31, 1999. See
"Consolidated Financial Statements - Consolidated Statements of Cash Flows."
At March 31, 1999, the Company was in a position to obtain approximately
$53.01 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 $9.61 billion at March 31,
1999, up from $9.34 billion at December 31, 1998. However, due to asset growth,
the ratio of capital to total assets was 5.51% at the end of first 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:
March 31, 1999
----------------------------- Well-Capitalized
WMBFA WMB WMBfsb Minimum
----- ----- ------ ----------------
Capital ratios:
Leverage 5.57% 5.71% 6.98% 5.00%
Tier 1 risk-based 10.35 10.22 11.40 6.00
Total risk-based 11.89 11.04 12.66 10.00
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 March 31, 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 March 31, 1999.
The Company's broker-dealer subsidiary is also subject to capital
requirements. At March 31, 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 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 is in
the process of testing these Computer Systems in an integrated environment. It
has also substantially 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 substantially 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 its planning to test the connections between its
Computer Systems and third-party computer systems that it deems most critical.
It expects to be substantially complete with this phase of testing by June 30,
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.
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 $14.4 million during 1998 and
first quarter 1999 on its Year 2000 Project, and it currently expects to spend
approximately $11.9 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.
TAX CONTINGENCY
The Company's Consolidated Financial Statements do not contain any benefit
related to the Company's determination that it is entitled to a deduction for
the amount of its tax bases in certain state branching rights when it sold its
deposit taking business in those states, thereby abandoning such branching
rights. The Company's position is that the tax bases result from the tax
treatment of property received as assistance from the FSLIC in conjunction with
FSLIC-assisted transactions. From 1981 through 1985, the Company acquired thrift
institutions in six states through FSLIC-assisted transactions. The Company's
position is that assistance received from the FSLIC included out-of-state
branching rights valued at approximately $740.0 million. As of March 31, 1999,
the Company had sold its deposit taking business and abandoned such branching
rights in five states, the first of which was Missouri in 1993. The potential
tax benefit related to these abandonments as of March 31, 1999, could approach
$238.0 million.
The Internal Revenue Service (the "Service") is in the process of completing
its examination of the Company's federal income tax returns for the years 1990
through 1993, including the Company's proposed adjustment related to the
abandonment of its Missouri branching rights. The Services' National Office has
notified the Company that the Service is issuing an adverse ruling. The Company
believes that its position with respect to the tax treatment of these rights is
the correct interpretation. However, the Company acknowledges that no judicial
or administrative authority has ever directly addressed its position and it is
therefore impossible to predict the outcome if the issue is not settled at
appeals and the Company is required to litigate the issue. Because of these
uncertainties, the Company cannot presently determine if any of the above
described tax benefits will ever be realized and therefore, in accordance with
generally accepted accounting principles, the Company does not believe it is
appropriate at this time to reflect these tax benefits in its financial
statements.
GOODWILL LITIGATION
On August 9, 1989, the Financial Institutions Reform, Recovery and Enforcement
Act ("FIRREA") was enacted. Among other things, FIRREA raised the minimum
capital requirements for savings associations and required a phase-out of the
amount of supervisory goodwill which could be included in satisfying certain
regulatory capital requirements. The exclusion of supervisory goodwill from
regulatory capital led certain savings associations to either replace the lost
capital by issuing new qualifying debt or equity securities or to reduce assets.
Many of these savings associations filed suit against the U.S. government
alleging breach of contract and other theories of liability for the damages
caused by the loss of supervisory goodwill. As a result of various mergers, the
Company is successor to certain goodwill litigation as described in the
Company's 1998 Annual Report on Form 10-K.
In April 1999, decisions in two goodwill cases not involving the Company were
made by the U.S. Court of Claims. The courts in these cases based their
decisions on different and conflicting theories of liability and damages. As a
result of these decisions, the legal analysis of all goodwill cases has been
made more difficult. It is anticipated that the parties to the decided cases
will appeal. The Company does not anticipate that any resolution of its cases
will be possible until the legal issues created by the Court of Claims decisions
are resolved on appeal.
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule (revised)
(b) Reports on Form 8-K
None.
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 2, 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)
WASHINGTON MUTUAL, INC.
INDEX OF EXHIBITS
Exhibit
No.
- ----------
27 Financial Data Schedule.