Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

  x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003  

 

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

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

1201 Third Avenue, Seattle, Washington   98101
(Address of principal executive offices)   (Zip Code)

 

(206) 461-2000

(Registrant’s telephone number, including area code)

 


 

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 ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x      No ¨

 

The number of shares outstanding of the issuer’s classes of common stock as of July 31, 2003:

 

Common Stock – 923,252,415 (1)

 

(1)   Includes 16,650,000 shares held in escrow pending resolution of the Company’s asserted right to the return of such shares.

 



Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

FORM 10-Q

 

FOR THE QUARTER ENDED JUNE 30, 2003

 

TABLE OF CONTENTS

 

     Page

PART I    Financial Information

   1

Item 1.    Financial Statements

   1

Consolidated Statements of Income—
Three and Six Months Ended June 30, 2003 and 2002

   1

Consolidated Statements of Financial Condition—
June 30, 2003 and December 31, 2002

   2

Consolidated Statements of Stockholders’ Equity and Comprehensive Income—
Six Months Ended June 30, 2003 and 2002

   3

Consolidated Statements of Cash Flows—
Six Months Ended June 30, 2003 and 2002

   4

Notes to Consolidated Financial Statements

   6

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

   17

Cautionary Statements

   17

Controls and Procedures

   17

Critical Accounting Policies

   17

Recently Issued Accounting Standards

   18

Summary Financial Data

   19

Earnings Performance

   20

Review of Financial Condition

   32

Operating Segments

   35

Off-Balance Sheet Activities

   39

Asset Quality

   39

Liquidity

   43

Capital Adequacy

   44

Market Risk Management

   45

Maturity and Repricing Information

   48

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

   45

Item 4.     Controls and Procedures

   17

PART II    Other Information

   55

Item 4.    Submission of Matters to a Vote of Security Holders

   55

Item 6.    Exhibits and Reports on Form 8-K

   55


Table of Contents

PART I—FINANCIAL INFORMATION

 

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Three Months Ended
June 30,


     Six Months Ended
June 30,


 
     2003

     2002

     2003

     2002

 
     (in millions, except per share amounts)  

Interest Income

                                   

Loans held for sale

   $ 626      $ 361      $ 1,216      $ 804  

Loans held in portfolio

     2,050        2,335        4,155        4,746  

Available-for-sale securities

     469        812        986        1,759  

Other interest and dividend income

     72        77        152        159  
    


  


  


  


Total interest income

     3,217        3,585        6,509        7,468  

Interest Expense

                                   

Deposits

     548        666        1,135        1,317  

Borrowings

     644        819        1,332        1,655  
    


  


  


  


Total interest expense

     1,192        1,485        2,467        2,972  
    


  


  


  


Net interest income

     2,025        2,100        4,042        4,496  

Provision for loan and lease losses

     118        160        243        335  
    


  


  


  


Net interest income after provision for loan and lease losses

     1,907        1,940        3,799        4,161  

Noninterest Income

                                   

Home loan mortgage banking income (expense):

                                   

Loan servicing fees

     593        560        1,206        1,100  

Amortization of mortgage servicing rights

     (1,032 )      (504 )      (2,000 )      (983 )

Mortgage servicing rights impairment

     (309 )      (1,107 )      (272 )      (1,062 )

Revaluation gain from derivatives

     598        857        815        842  

Net settlement income from certain interest-rate swaps

     84        101        224        107  

Gain from mortgage loans

     622        220        1,210        471  

Other home loan mortgage banking income, net

     149        117        246        156  
    


  


  


  


Total home loan mortgage banking income

     705        244        1,429        631  

Depositor and other retail banking fees

     454        398        875        759  

Securities fees and commissions

     100        98        189        180  

Insurance income

     53        39        105        86  

Portfolio loan related income

     111        75        227        140  

Gain (loss) from other available-for-sale securities

     137        137        131        (161 )

(Loss) gain on extinguishment of securities sold under agreements to repurchase

     (49 )      121        (136 )      195  

Other income

     118        96        215        186  
    


  


  


  


Total noninterest income

     1,629        1,208        3,035        2,016  

Noninterest Expense

                                   

Compensation and benefits

     867        732        1,638        1,422  

Occupancy and equipment

     375        283        679        571  

Telecommunications and outsourced information services

     143        134        287        273  

Depositor and other retail banking losses

     50        48        102        98  

Amortization of other intangible assets

     15        17        31        34  

Advertising and promotion

     83        69        146        113  

Professional fees

     68        52        124        107  

Other expense

     317        251        619        490  
    


  


  


  


Total noninterest expense

     1,918        1,586        3,626        3,108  
    


  


  


  


Income before income taxes

     1,618        1,562        3,208        3,069  

Income taxes

     598        572        1,185        1,123  
    


  


  


  


Net Income

   $ 1,020      $ 990      $ 2,023      $ 1,946  
    


  


  


  


Net Income Attributable to Common Stock

   $ 1,020      $ 988      $ 2,023      $ 1,942  
    


  


  


  


Net income per common share:

                                   

Basic

   $ 1.12      $ 1.04      $ 2.21      $ 2.04  

Diluted

     1.10        1.01        2.17        2.00  

Dividends declared per common share

     0.30        0.26        0.59        0.51  

Basic weighted average number of common shares outstanding (in thousands)

     910,921        954,662        915,974        951,177  

Diluted weighted average number of common shares outstanding (in thousands)

     929,386        974,153        932,109        968,717  

 

See Notes to Consolidated Financial Statements.

 

 

1


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

     June 30,
2003


    December 31,
2002


 
     (dollars in millions)  

Assets

                

Cash and cash equivalents

   $ 7,388     $ 7,208  

Federal funds sold and securities purchased under resale agreements

     2,085       2,015  

Available-for-sale securities, total amortized cost of $43,306 and $42,592:

                

Mortgage-backed securities (including assets pledged of $7,433 and $6,570)

     24,875       28,375  

Investment securities (including assets pledged of $15,686 and $10,679)

     20,292       15,597  
    


 


       45,167       43,972  

Loans held for sale

     40,631       33,996  

Loans held in portfolio

     153,866       147,528  

Allowance for loan and lease losses

     (1,680 )     (1,653 )
    


 


Total loans held in portfolio, net of allowance for loan and lease losses

     152,186       145,875  

Investment in Federal Home Loan Banks

     3,596       3,703  

Mortgage servicing rights

     4,598       5,341  

Goodwill

     6,253       6,270  

Other assets

     21,299       19,918  
    


 


Total assets

   $ 283,203     $ 268,298  
    


 


Liabilities

                

Deposits:

                

Noninterest-bearing deposits

   $ 46,505     $ 37,515  

Interest-bearing deposits

     119,952       118,001  
    


 


Total deposits

     166,457       155,516  

Federal funds purchased and commercial paper

     3,579       1,247  

Securities sold under agreements to repurchase

     22,964       16,717  

Advances from Federal Home Loan Banks

     46,127       51,265  

Other borrowings

     14,700       15,264  

Other liabilities

     8,315       8,155  
    


 


Total liabilities

     262,142       248,164  

Stockholders’ Equity

                

Common stock, no par value: 1,600,000,000 shares authorized, 924,237,997 and 944,046,787 shares issued and outstanding

            

Capital surplus—common stock

     5,193       5,961  

Accumulated other comprehensive income

     386       175  

Retained earnings

     15,482       13,998  
    


 


Total stockholders’ equity

     21,061       20,134  
    


 


Total liabilities and stockholders’ equity

   $ 283,203     $ 268,298  
    


 


 

 

See Notes to Consolidated Financial Statements.

 

2


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(Unaudited)

 

     Number
of
Shares


    Capital
Surplus-
Common
Stock


    Accumulated
Other
Comprehensive
Income (Loss)


    Retained
Earnings


    Total

 
     (in millions)  

BALANCE, December 31, 2001

   873.1     $ 3,178     $ (243 )   $ 11,128     $ 14,063  

Comprehensive income:

                                      

Net income

                     1,946       1,946  

Other comprehensive income (loss), net of tax:

                                      

Net unrealized gain from securities arising during the period, net of reclassification adjustments

               507             507  

Net unrealized loss on cash flow hedging instruments

               (274 )           (274 )

Minimum pension liability adjustment

               (2 )           (2 )
                                  


Total comprehensive income

                                   2,177  

Cash dividends declared on common stock

                     (496 )     (496 )

Cash dividends declared on redeemable preferred stock

                     (4 )     (4 )

Common stock repurchased and retired

   (1.0 )     (37 )                 (37 )

Common stock issued for acquisitions

   96.4       3,672                   3,672  

Fair value of Dime stock options

         90                   90  

Common stock issued

   5.7       132                   132  
    

 


 


 


 


BALANCE, June 30, 2002

   974.2     $ 7,035     $ (12 )   $ 12,574     $ 19,597  
    

 


 


 


 


BALANCE, December 31, 2002

   944.0     $ 5,961     $ 175     $ 13,998     $ 20,134  

Comprehensive income:

                                      

Net income

                     2,023       2,023  

Other comprehensive income (loss), net of tax:

                                      

Net unrealized gain from securities arising during the period, net of reclassification adjustments

               240             240  

Net unrealized loss on cash flow hedging instruments

               (25 )           (25 )

Minimum pension liability adjustment

               (4 )           (4 )
                                  


Total comprehensive income

                                   2,234  

Cash dividends declared on common stock

                     (539 )     (539 )

Common stock repurchased and retired

   (26.4 )     (972 )                 (972 )

Common stock issued

   6.6       204                   204  
    

 


 


 


 


BALANCE, June 30, 2003

   924.2     $ 5,193     $ 386     $ 15,482     $ 21,061  
    

 


 


 


 


 

 

 

See Notes to Consolidated Financial Statements.

 

3


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

    

Six Months Ended

June 30,


 
     2003

    2002

 
     (in millions)  

Cash Flows from Operating Activities

                

Net income

   $ 2,023     $ 1,946  

Adjustments to reconcile net income to net cash (used) provided by operating activities:

                

Provision for loan and lease losses

     243       335  

Gain from mortgage loans

     (1,210 )     (471 )

(Gain) loss from securities

     (132 )     141  

Revaluation gain from derivatives

     (815 )     (842 )

Loss (gain) on extinguishment of securities sold under agreements to repurchase

     136       (195 )

Depreciation and amortization

     2,235       1,265  

Mortgage servicing rights impairment

     272       1,062  

Stock dividends from Federal Home Loan Banks

     (76 )     (107 )

Origination and purchases of loans held for sale, net of principal payments

     (177,297 )     (86,364 )

Proceeds from sales of loans held for sale

     168,930       96,990  

Decrease (increase) in other assets

     173       (433 )

Decrease in other liabilities

     (275 )     (190 )
    


 


Net cash (used) provided by operating activities

     (5,793 )     13,137  

Cash Flows from Investing Activities

                

Purchases of securities

     (5,537 )     (41,410 )

Proceeds from sales and maturities of mortgage-backed securities

     866       5,439  

Proceeds from sales and maturities of other available-for-sale securities

     957       34,265  

Principal payments on securities

     4,805       4,880  

Purchases of Federal Home Loan Bank stock

     (279 )     (4 )

Redemption of Federal Home Loan Bank stock

     463       503  

Proceeds from sales of mortgage servicing rights

     388       711  

Origination and purchases of loans held in portfolio

     (49,660 )     (37,333 )

Principal payments on loans held in portfolio

     42,044       34,472  

Proceeds from sales of foreclosed assets

     250       166  

Net (increase) decrease in federal funds sold and securities purchased under resale agreements

     (70 )     2,167  

Net cash used for acquisitions

           (2,215 )

Purchases of premises and equipment, net

     (483 )     (307 )
    


 


Net cash (used) provided by investing activities

   $ (6,256 )   $ 1,334  

 

(The Consolidated Statements of Cash Flows are continued on the next page.)

 

See Notes to Consolidated Financial Statements.

 

4


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(Continued from the previous page.)

 

    

Six Months Ended

June 30,


 
     2003

    2002

 
     (in millions)  

Cash Flows from Financing Activities

                

Increase in deposits

   $ 10,941     $ 6,716  

Increase (decrease) in short-term borrowings

     5,417       (9,537 )

Proceeds from long-term borrowings

     6,603       20,113  

Repayments of long-term borrowings

     (4,263 )     (19,514 )

Proceeds from advances from Federal Home Loan Banks

     42,421       22,681  

Repayments of advances from Federal Home Loan Banks

     (47,548 )     (33,363 )

Cash dividends paid on preferred and common stock

     (539 )     (500 )

Repurchase of common stock

     (972 )     (37 )

Other

     169       116  
    


 


Net cash provided (used) by financing activities

     12,229       (13,325 )
    


 


Increase in cash and cash equivalents

     180       1,146  

Cash and cash equivalents, beginning of period

     7,208       3,563  
    


 


Cash and cash equivalents, end of period

   $ 7,388     $ 4,709  
    


 


Noncash Activities

                

Loans exchanged for mortgage-backed securities

   $ 1,639     $ 2,518  

Real estate acquired through foreclosure

     239       212  

Cash Paid During the Period for

                

Interest on deposits

   $ 1,106     $ 1,275  

Interest on borrowings

     1,321       1,618  

Income taxes

     2,607       1,742  

 

 

 

See Notes to Consolidated Financial Statements.

 

5


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1:    Accounting Policies

 

Basis of Presentation

 

The accompanying Consolidated Financial Statements are unaudited and include the accounts of Washington Mutual, Inc. (together with its subsidiaries “Washington Mutual” or the “Company”). Washington Mutual’s accounting and financial reporting policies are in accordance with accounting principles generally accepted in the United States of America. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with Washington Mutual, Inc.’s 2002 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current period classifications.

 

Recently Adopted Accounting Standards

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities . This Interpretation provides guidance on how to identify a variable interest entity and determine when the assets, liabilities, noncontrolling interests and results of operations of a variable interest entity should be consolidated by the primary beneficiary. The primary beneficiary is the enterprise that will absorb a majority of the variable interest entity’s expected losses or receive a majority of the expected residual returns as a result of holding variable interests. The recognition and measurement provisions of this Interpretation apply at inception to any variable interest entity formed after January 31, 2003, and become effective for existing variable interest entities on the first interim or annual reporting period beginning after June 15, 2003. The Company adopted the provisions of FIN 46 for variable interest entities formed on or after February 1, 2003, which did not have a material effect on the Company’s Consolidated Financial Statements. The Company adopted the provisions of FIN 46 for existing variable interest entities on July 1, 2003. As of June 30, 2003, the Company had variable interests in securitization trusts, which are discussed in the 2002 Annual Report on Form 10-K in Note 5 to the Consolidated Financial Statements— “Mortgage Banking Activities.” These trusts are qualifying special-purpose entities, which are exempt from the consolidation requirements of FIN 46. The Company reports its rights and obligations related to these qualifying special-purpose entities according to the requirements of Statement of Financial Accounting Standards (“Statement” or “SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities . The Company has not identified any unconsolidated investments in variable interest entities that are not qualifying special-purpose entities as of June 30, 2003.

 

In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure , which amends Statement No. 123, Accounting for Stock-Based Compensation . This Statement provides alternative methods of transitioning, on a voluntary basis, from the intrinsic value method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees , to the fair value method of accounting for stock-based employee compensation. Effective January 1, 2003 and in accordance with the transitional guidance of Statement No. 148, the Company elected to prospectively apply the fair value method of accounting for stock-based awards granted subsequent to December 31, 2002. Stock-based awards granted prior to January 1, 2003, and not modified after December 31, 2002, will continue to be accounted for under APB Opinion No. 25.

 

6


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Had compensation cost for the Company’s stock-based compensation plans been determined using the fair value method consistent with Statement No. 123 for all periods presented, the Company’s net income attributable to common stock and net income per common share would have been reduced to the pro forma amounts indicated below:

 

     Three Months Ended
June 30,


     Six Months Ended
June 30,


 
     2003

     2002

     2003

     2002

 
     (dollars in millions, except per share amounts)  

Net income attributable to common stock

   $ 1,020      $ 988      $ 2,023      $ 1,942  

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

     22        8        33        14  

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

     (39 )      (22 )      (69 )      (40 )
    


  


  


  


Pro forma net income attributable to common stock

   $ 1,003      $ 974      $ 1,987      $ 1,916  
    


  


  


  


Net income per common share:

                                   

Basic:

                                   

As reported

   $ 1.12      $ 1.04      $ 2.21      $ 2.04  

Pro forma

     1.10        1.02        2.17        2.01  

Diluted:

                                   

As reported

     1.10        1.01        2.17        2.00  

Pro forma

     1.08        1.00        2.13        1.98  

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others , which expands on the accounting guidance of Statements No. 5, 57, and 107 and incorporates without change the provisions of FASB Interpretation No. 34, which is being superseded. This Interpretation requires a guarantor to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition requirements of FIN 45 apply prospectively to guarantees issued or modified after December 31, 2002. Refer to Note 4 to the Consolidated Financial Statements—“Guarantees” for discussion on significant guarantees that have been entered into by the Company.

 

Recently Issued Accounting Standards

 

In April 2003, the FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities . Statement No. 149 provides clarification on the definition of derivative instruments within the scope of FASB Statement No. 133. Generally, this Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003, and is not expected to have a material impact on the Consolidated Financial Statements.

 

In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity . Statement No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement, which was effective for financial instruments entered into or modified after May 31, 2003 and for all financial instruments on July 1, 2003, did not have a material impact on the Consolidated Financial Statements.

 

7


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 2:    Earnings Per Share

 

Information used to calculate earnings per share (“EPS”) was as follows:

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2003

   2002

    2003

   2002

 
     (dollars in millions, except per share amounts)  

Net income

                              

Net income

   $ 1,020    $ 990     $ 2,023    $ 1,946  

Accumulated dividends on preferred stock

          (2 )          (4 )
    

  


 

  


Net income attributable to common stock

   $ 1,020    $ 988     $ 2,023    $ 1,942  
    

  


 

  


Weighted average shares (in thousands)

                              

Basic weighted average number of common shares outstanding

     910,921      954,662       915,974      951,177  

Dilutive effect of potential common shares from:

                              

Stock options

     9,435      9,911       8,403      9,256  

Premium Income Equity Securities SM

          1,671            1,516  

Trust Preferred Income Equity Redeemable Securities SM

     9,030      7,909       7,732      6,768  
    

  


 

  


Diluted weighted average number of common shares outstanding

     929,386      974,153       932,109      968,717  
    

  


 

  


Net income per common share

                              

Basic

   $ 1.12    $ 1.04     $ 2.21    $ 2.04  

Diluted

     1.10      1.01       2.17      2.00  

 

For the three and six months ended June 30, 2003, options to purchase an additional 41,700 and 1,907,973 shares of common stock were outstanding, but were not included in the computation of diluted EPS because their inclusion would have had an antidilutive effect. For the three and six months ended June 30, 2002, options to purchase an additional 269,689 and 318,187 shares of common stock were outstanding, but were not included in the computation of diluted EPS because their inclusion would have had an antidilutive effect.

 

Additionally, as part of the 1996 business combination with Keystone Holdings, Inc. (the parent of American Savings Bank, F.A.), 18 million shares of common stock, with an assigned value of $18.4944 per share, were, as of January 1, 2003, held in escrow for the benefit of the investors in Keystone Holdings, the Federal Deposit Insurance Corporation (“FDIC”) as manager of the Federal Savings and Loan Insurance Corporation Resolution Fund and their transferees. The conditions under which these shares can be released from escrow to the Keystone Holdings’ investors and the FDIC are related to the outcome of certain litigation and not based on future earnings or market prices. The escrow would have by its terms automatically expired on December 20, 2002, absent the occurrence of certain circumstances that would extend it. The Company contends that these circumstances have not occurred, while the Keystone Holdings’ investors and the FDIC contend that they have occurred.

 

Pursuant to an amended tolling agreement, the parties agreed to return to the Company 225,000 shares per month through June 30, 2003. During the six months ended June 30, 2003, 900,000 of these shares were returned to the Company and the return of an additional 450,000 shares was in process. These 450,000 shares have since been returned to the Company subsequent to June 30, 2003. At June 30, 2003, the Company continues to assert the conditions for releasing the remaining shares to the Keystone Holdings’ investors and the FDIC had not occurred, and thus the remaining shares were still in the escrow. Therefore, none of the shares in the escrow during the periods indicated above were included in the above computations.

 

8


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

While the Company and Keystone Holdings have been willing to extend the tolling agreement beyond June 30, 2003, the FDIC has refused to do so. Accordingly, since the Company contends that it is entitled to the shares in the escrow, the Company expects to take all appropriate actions to seek the return of these shares, including if necessary the commencement of litigation against Keystone Holdings and the FDIC.

 

Note 3:    Mortgage Banking Activities

 

Changes in the portfolio of loans serviced for others were as follows:

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2003

    2002

    2003

    2002

 
     (in millions)  

Balance, beginning of period

   $ 591,917     $ 459,375     $ 604,504     $ 382,500  

Home loans:

                                

Additions through acquisitions

                       49,242  

Other additions

     105,992       49,795       185,508       109,157  

Sales

     (2,960 )           (2,960 )      

Loan payments and other

     (110,867 )     (31,872 )     (203,423 )     (63,619 )

Net change in commercial real estate loans serviced for others

     (259 )     11       194       29  
    


 


 


 


Balance, end of period

   $ 583,823     $ 477,309     $ 583,823     $ 477,309  
    


 


 


 


 

Changes in the balance of mortgage servicing rights (“MSR”), net of the valuation allowance, were as follows:

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 
     2003

    2002

    2003

    2002

 
     (in millions)  

Balance, beginning of period

   $ 5,210     $ 7,955     $ 5,341     $ 6,241  

Home loans:

                                

Additions through acquisitions

                       926  

Other additions

     976       856       1,915       2,078  

Amortization

     (1,032 )     (504 )     (2,000 )     (983 )

Impairment provision

     (309 )     (1,107 )     (272 )     (1,062 )

Sales

     (247 )     (711 )     (388 )     (711 )

Net change in commercial real estate MSR

                 2        
    


 


 


 


Balance, end of period (1)

   $ 4,598     $ 6,489     $ 4,598     $ 6,489  
    


 


 


 



(1)   At June 30, 2003 and 2002, the aggregate mortgage servicing rights fair value was $4.63 billion and $6.49 billion.

 

9


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Changes in the valuation allowance for MSR were as follows:

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2003

    2002

    2003

    2002

 
     (in millions)  

Balance, beginning of period

   $ 3,864     $ 1,669     $ 4,521     $ 1,714  

Impairment provision

     309       1,107       272       1,062  

Other than temporary impairment

     (579 )           (1,115 )      

Sales

     (150 )     (208 )     (234 )     (208 )
    


 


 


 


Balance, end of period

   $ 3,444     $ 2,568     $ 3,444     $ 2,568  
    


 


 


 


 

At June 30, 2003, the expected weighted average life of the Company’s MSR was 3 years. Projected amortization expense for the gross carrying value of MSR at June 30, 2003 is estimated to be as follows (in millions):

 

Remainder of 2003

   $ 1,654  

2004

     1,938  

2005

     1,158  

2006

     799  

2007

     581  

2008

     432  

After 2008

     1,480  
    


Gross carrying value of MSR

     8,042  

Less: valuation allowance

     (3,444 )
    


Net carrying value of MSR

   $ 4,598  
    


 

The projected amortization expense of MSR is an estimate and should be used with caution. The amortization expense for future periods was calculated by applying the same quantitative factors, such as estimated MSR prepayment assumptions, that were used to determine amortization expense for the second quarter of 2003. These factors are inherently subject to significant fluctuations, primarily due to the effect that changes in mortgage rates have on loan prepayment experience. Accordingly, any projection of MSR amortization in future periods is limited by the conditions that existed at the time the calculations were performed, and may not be indicative of actual amortization expense that will be recorded in future periods.

 

Note 4:    Guarantees

 

In the ordinary course of business, the Company sells loans with recourse. For loans that have been sold with recourse, the recourse component is considered a guarantee. When the Company sells a loan with recourse, it commits to stand ready to perform, if the loan defaults, and to make payments to remedy the default. As of June 30, 2003 and December 31, 2002, loans sold with recourse totaled $3.61 billion and $4.26 billion. The Company’s recourse reserve related to these loans totaled $10 million and $11 million at June 30, 2003 and December 31, 2002.

 

The Company sells loans without recourse that may have to be subsequently repurchased due to defects that occurred during the loan’s origination process. The defects are categorized as documentation errors, underwriting errors and fraud. When a loan sold to an investor without recourse fails to perform according to its contractual terms, the investor will typically review the loan file to determine whether defects in the origination process

 

10


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

occurred. If a defect is identified, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no defects, the Company has no commitment to repurchase the loan. As of June 30, 2003 and December 31, 2002, the amount of loans sold without recourse totaled $583.17 billion and $600.25 billion, which substantially represents the unpaid principal balance of the Company’s loans serviced for others portfolio. The Company has reserved $115 million as of June 30, 2003 and $74 million as of December 31, 2002 to cover the estimated loss exposure related to the loan origination process defects that are inherent within this portfolio.

 

Note 5:    Operating Segments

 

The Company has identified three major operating segments for the purpose of management reporting: Banking and Financial Services; Home Loans and Insurance Services; and Specialty Finance. Unlike financial accounting, there is no comprehensive, authoritative guidance for management reporting. The management reporting process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. The Company’s operating segments are defined by the products and services they offer.

 

The Company uses various methodologies to assign certain balance sheet and income statement items to the responsible operating segment. Methodologies that are applied to the measurement of segment profitability include: (1) a funds transfer pricing system, which matches assets and liabilities with the market benchmark (approximation) of the Company’s cost of funds based on interest rate sensitivity and maturity characteristics and determines how much each interest margin source contributes to the Company’s total net interest income; (2) a calculation of the provision for loan and lease losses based on management’s current assessment of the long-term, normalized net charge-off ratio for loan products within each segment, which differs from the “losses inherent in the loan portfolio” methodology that is used to measure the allowance for loan and lease losses under accounting principles generally accepted in the United States of America. This methodology is used to provide segment management with provision information for strategic decision making; (3) the utilization of an activity-based costing approach to measure allocations of certain operating expenses that were not directly charged to the segments; (4) the allocation of goodwill and other intangible assets to the operating segments based on benefits received from each acquisition; (5) capital charges for goodwill as a component of an internal measurement of return on the goodwill allocated to the operating segment; and (6) an economic capital model which is the framework for assessing business performance on a risk-adjusted basis. Changing economic conditions, further research and new data may lead to the update of the capital allocation assumptions.

 

The Company continues to enhance its segment reporting process methodologies. Changes to the operating segment structure and the funds transfer pricing methodology were made during the first quarter of 2003. Additionally, effective January 1, 2003, the primary management responsibilities for the Company’s originated home loan mortgage-backed securities portfolio were transferred from the Home Loans and Insurance Services Group to the Company’s corporate treasury operations. Accordingly, the earnings performance and financial condition of this portfolio are now included within the Corporate Support/Treasury and Other category. Results for the prior periods have been restated to conform to all of these changes.

 

The Banking and Financial Services Group offers a comprehensive line of financial products and services to a broad spectrum of consumers and small- to mid-sized businesses. The Group offers various deposit products including the Group’s signature Free Checking accounts as well as other personal and business checking accounts, savings accounts, money market deposit accounts and time deposit accounts. It also offers consumer loans as well as small business and commercial loans to small- and mid-sized businesses. The Group’s services are offered through multiple delivery channels, including financial center stores, business banking centers, ATMs, the internet and 24-hour telephone banking centers.

 

11


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The principal activities of the Home Loans and Insurance Services Group include: originating and servicing the Company’s home loans, buying and selling home loans in the secondary market and managing the home loan portfolio. Home loans are either originated or purchased, and are either held in portfolio or held for sale and subsequently sold into the secondary market. The Group offers home loans through multiple distribution channels, which include retail home loan centers, financial center stores, correspondent channels, wholesale home loan centers and directly to consumers through call centers and the internet. The Home Loans Group also includes the Company’s community reinvestment functions and the activities of Washington Mutual Insurance Services, Inc., WaMu Capital Corp. and Washington Mutual Mortgage Securities Corp.

 

The Specialty Finance Group provides financing to developers, investors, mortgage bankers and homebuilders for the acquisition, construction and development of apartment buildings (“multi-family” lending), other commercial real estate and homes. The Group also services commercial real estate mortgages as part of its commercial asset management business and conducts a consumer finance business through Washington Mutual Finance Corporation.

 

The Corporate Support/Treasury and Other category includes management of the Company’s interest rate risk, liquidity, capital, borrowings, and investment securities and home loan mortgage-backed securities portfolios. To the extent not allocated to the business segments, this category also includes the costs of the Company’s technology services, facilities, legal, accounting and human resources. Also reported in this category is the net impact of funds transfer pricing for loan and deposit balances including the effects of changes in interest rates on the Company’s net interest margin and the effects of inter-segment allocations of gains and losses related to interest rate risk management instruments. The funds transfer pricing methodology isolates the majority of interest rate risk and concentrates it in our Treasury operations. It captures historical interest rate sensitivity of the balance sheet, risk management decisions within approved limits and the temporary divergence of funds transfer pricing assumptions from the actual duration of assets and liabilities. Certain basis and other residual risk remains in the operating segments.

 

12


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Financial highlights by operating segment were as follows:

 

     Three Months Ended June 30, 2003

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income (expense)

   $ 891     $ 1,155     $ 344     $ (365 )   $     $ 2,025  

Provision for loan and lease losses

     38       46       52       8       (26 ) (1)     118  

Noninterest income (expense)

     624       1,002       20       (17 )           1,629  

Noninterest expense

     949       903       114       164       (212 ) (2)     1,918  

Income taxes (benefit)

     201       450       74       (215 )     88   (3)     598  
    


 


 


 


 


 


Net income (loss)

   $ 327     $ 758     $ 124     $ (339 )   $ 150     $ 1,020  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     54.84 % (4)     38.59 % (4)     25.00 % (4)     n/a       n/a       52.49 % (5)

Average loans

   $ 25,570     $ 141,997     $ 30,933     $ 99     $ (383 ) (6)   $ 198,216  

Average assets

     33,998       176,709       34,814       38,980       (383 ) (6)     284,118  

Average deposits

     125,025       30,257       3,393       5,005       n/a       163,680  

 

     Three Months Ended June 30, 2002

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


   Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                               

Net interest income

   $ 762     $ 750     $ 297     $ 291    $     $ 2,100  

Provision for loan and lease losses

     41       45       61       8      5  (1)     160  

Noninterest income

     541       600       19       48            1,208  

Noninterest expense

     880       668       96       150      (208 ) (2)     1,586  

Income taxes

     145       242       60       51      74   (3)     572  
    


 


 


 

  


 


Net income

   $ 237     $ 395     $ 99     $ 130    $ 129     $ 990  
    


 


 


 

  


 


Performance and other data:

                                               

Efficiency ratio

     58.67 % (4)     44.36 % (4)     23.00 % (4)     n/a      n/a       47.95 % (5)

Average loans

   $ 20,627     $ 118,996     $ 29,722     $ 13    $ (479 ) (6)   $ 168,879  

Average assets

     28,850       138,427       31,784       68,267      (479 ) (6)     266,849  

Average deposits

     111,425       11,073       2,701       5,449      n/a       130,648  

(1)   Represents the difference between the long-term, normalized net charge-off ratio used to assess expected loan and lease losses for the operating segments and the “losses inherent in the loan portfolio” methodology used by the Company.
(2)   Represents the corporate offset for goodwill cost of capital allocated to segments.
(3)   Represents the tax effect of reconciling adjustments.
(4)   The efficiency ratio is defined as noninterest expense, excluding a cost of capital charge on goodwill, divided by total revenue (net interest income and noninterest income).
(5)   The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(6)   Represents the corporate offset for allowance for loan and lease losses allocated to segments.

 

13


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     Six Months Ended June 30, 2003

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income (expense)

   $ 1,757     $ 2,245     $ 683     $ (643 )   $     $ 4,042  

Provision for loan and lease losses

     75       85       103       14       (34 ) (1)     243  

Noninterest income (expense)

     1,208       1,880       28       (81 )           3,035  

Noninterest expense

     1,868       1,676       219       285       (422 ) (2)     3,626  

Income taxes (benefit)

     389       881       146       (399 )     168   (3)     1,185  
    


 


 


 


 


 


Net income (loss)

   $ 633     $ 1,483     $ 243     $ (624 )   $ 288     $ 2,023  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     55.08 % (4)     37.20 % (4)     24.39 % (4)     n/a       n/a       51.24 % (5)

Average loans

   $ 24,602     $ 139,411     $ 30,768     $ 88     $ (386 ) (6)   $ 194,483  

Average assets

     33,205       174,496       34,437       40,724       (386 ) (6)     282,476  

Average deposits

     124,716       27,757       3,198       5,138       n/a       160,809  

 

     Six Months Ended June 30, 2002

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income

   $ 1,425     $ 1,597     $ 614     $ 860     $     $ 4,496  

Provision for loan and lease losses

     75       91       128       16       25   (1)     335  

Noninterest income (expense)

     1,054       993       43       (74 )           2,016  

Noninterest expense

     1,689       1,225       195       391       (392 ) (2)     3,108  

Income taxes

     271       488       126       102       136   (3)     1,123  
    


 


 


 


 


 


Net income

   $ 444     $ 786     $ 208     $ 277     $ 231     $ 1,946  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     59.29 % (4)     42.27 % (4)     23.11 % (4)     n/a       n/a       47.72 % (5)

Average loans

   $ 19,954     $ 122,110     $ 30,169     $ 56     $ (480 ) (6)   $ 171,809  

Average assets

     28,021       141,451       32,200       74,359       (480 ) (6)     275,551  

Average deposits

     107,820       10,854       2,700       5,895       n/a       127,269  

(1)   Represents the difference between the long-term, normalized net charge-off ratio used to assess expected loan and lease losses for the operating segments and the “losses inherent in the loan portfolio” methodology used by the Company.
(2)   Represents the corporate offset for goodwill cost of capital allocated to segments.
(3)   Represents the tax effect of reconciling adjustments.
(4)   The efficiency ratio is defined as noninterest expense, excluding a cost of capital charge on goodwill, divided by total revenue (net interest income and noninterest income).
(5)   The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(6)   Represents the corporate offset for allowance for loan and lease losses allocated to segments.

 

14


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     Year Ended December 31, 2002

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income

   $ 3,018     $ 3,409     $ 1,262     $ 652     $     $ 8,341  

Provision for loan and lease losses

     160       187       271       34       (57 ) (1)     595  

Noninterest income (expense)

     2,222       2,522       114       (68 )           4,790  

Noninterest expense

     3,508       2,661       400       631       (818 ) (2)     6,382  

Income taxes (benefit)

     602       1,143       265       (73 )     321   (3)     2,258  
    


 


 


 


 


 


Net income (loss)

   $ 970     $ 1,940     $ 440     $ (8 )   $ 554     $ 3,896  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     58.24 % (4)     40.28 % (4)     22.55 % (4)     n/a       n/a       48.60 % (5)

Average loans

   $ 20,915     $ 124,566     $ 30,488     $ 32     $ (468 ) (6)   $ 175,533  

Average assets

     29,071       151,537       32,653       58,674       (468 ) (6)     271,467  

Average deposits

     113,250       13,730       2,836       4,885       n/a       134,701  

 

     Year Ended December 31, 2001

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income

   $ 2,142     $ 1,635     $ 1,023     $ 2,076     $     $ 6,876  

Provision for loan and lease losses

     146       189       298       32       (90 ) (1)     575  

Noninterest income (expense)

     1,793       1,474       74       (93 )           3,248  

Noninterest expense

     2,512       1,456       294       613       (258 ) (2)     4,617  

Income taxes

     483       566       189       452       128   (3)     1,818  
    


 


 


 


 


 


Net income

   $ 794     $ 898     $ 316     $ 886     $ 220     $ 3,114  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     61.89 % (4)     42.43 % (4)     22.73 % (4)     n/a       n/a       44.23 % (5)

Average loans

   $ 13,123     $ 107,528     $ 27,684     $ 411     $ (432 ) (6)   $ 148,314  

Average assets

     17,931       121,603       29,261       57,210       (432 ) (6)     225,573  

Average deposits

     82,384       7,860       2,613       3,665       n/a       96,522  

(1)   Represents the difference between the long-term, normalized net charge-off ratio used to assess expected loan and lease losses for the operating segments and the “losses inherent in the loan portfolio” methodology used by the Company.
(2)   Represents the corporate offset for goodwill cost of capital allocated to segments.
(3)   Represents the tax effect of reconciling adjustments.
(4)   The efficiency ratio is defined as noninterest expense, excluding a cost of capital charge on goodwill, divided by total revenue (net interest income and noninterest income).
(5)   The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(6)   Represents the corporate offset for allowance for loan and lease losses allocated to segments.

 

15


Table of Contents

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     Year Ended December 31, 2000

 
     Banking
and
Financial
Services


    Home
Loans and
Insurance
Services


    Specialty
Finance


    Corporate
Support/
Treasury
and Other


    Reconciling
Adjustments


    Total

 
     (dollars in millions)  

Condensed income statement:

                                                

Net interest income (expense)

   $ 2,061     $ 1,645     $ 822     $ (217 )   $     $ 4,311  

Provision for loan and lease losses

     65       101       148       (1 )     (128 ) (1)     185  

Noninterest income (expense)

     1,403       548       42       (9 )           1,984  

Noninterest expense

     2,010       679       215       361       (139 ) (2)     3,126  

Income taxes (benefit)

     528       537       190       (267 )     97   (3)     1,085  
    


 


 


 


 


 


Net income (loss)

   $ 861     $ 876     $ 311     $ (319 )   $ 170     $ 1,899  
    


 


 


 


 


 


Performance and other data:

                                                

Efficiency ratio

     56.80 % (4)     27.69 % (4)     21.94 % (4)     n/a       n/a       48.34 % (5)

Average loans

   $ 9,315     $ 86,044     $ 22,383     $       n/a     $ 117,742  

Average assets

     12,441       109,130       22,839       43,162       n/a       187,572  

Average deposits

     78,074       1,213       191       798       n/a       80,276  

(1)   Represents the difference between the long-term, normalized net charge-off ratio used to assess expected loan and lease losses for the operating segments and the “losses inherent in the loan portfolio” methodology used by the Company.
(2)   Represents the corporate offset for goodwill cost of capital allocated to segments.
(3)   Represents the tax effect of reconciling adjustments.
(4)   The efficiency ratio is defined as noninterest expense, excluding a cost of capital charge on goodwill, divided by total revenue (net interest income and noninterest income).
(5)   The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(6)   Represents the corporate offset for allowance for loan and lease losses allocated to segments.

 

16


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Cautionary Statements

 

Our Form 10-Q and other documents that we file with the Securities and Exchange Commission contain forward-looking statements. In addition, our senior management may make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

 

Forward-looking statements provide our expectations or predictions of future conditions, events or results. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. There are a number of factors, many of which are beyond our control, that could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. Some of these factors are:

 

    General business and economic conditions may significantly affect our earnings;

 

    If we are unable to effectively manage the volatility of our mortgage banking business, our earnings could be adversely affected;

 

    A failure to effectively implement our business operations technology solutions could adversely affect our earnings and financial condition;

 

    The financial services industry is highly competitive; and

 

    Changes in the regulation of financial services companies could adversely affect our business.

 

Controls and Procedures

 

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2003. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective.

 

We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures.

 

Critical Accounting Policies

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in our Consolidated Financial Statements and accompanying notes. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances as of June 30, 2003.

 

17


Table of Contents

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, we have identified four accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, and the sensitivity of our Consolidated Financial Statements to those judgments, estimates and assumptions, are critical to an understanding of our Consolidated Financial Statements. These policies relate to the valuation of our mortgage servicing rights (“MSR”) and rate lock commitments, the methodology that determines our allowance for loan and lease losses, and the assumptions used in the calculation of our net periodic pension expense.

 

Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors. In addition, there are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards. These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance with Statement of Financial Accounting Standards (“Statement”) No. 133, Accounting for Derivative Instruments and Hedging Activities , and the applicable hedge deferral criteria. These policies and the judgments, estimates and assumptions are described in greater detail in the Company’s 2002 Annual Report on Form 10-K in the “Critical Accounting Policies” section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial Statements—“Summary of Significant Accounting Policies.”

 

Recently Issued Accounting Standards

 

Refer to Note 1 to the Consolidated Financial Statements—“Accounting Policies” for discussion of the recently issued accounting standards.

 

18


Table of Contents

Summary Financial Data

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2003

    2002

    2003

    2002

 
     (dollars in millions, except per share amounts)  

Profitability

                                

Net interest income

   $ 2,025     $ 2,100     $ 4,042     $ 4,496  

Net interest margin

     3.30 %     3.54 %     3.31 %     3.65 %

Noninterest income

   $ 1,629     $ 1,208     $ 3,035     $ 2,016  

Noninterest expense

     1,918       1,586       3,626       3,108  

Net income

     1,020       990       2,023       1,946  

Net income per common share:

                                

Basic

   $ 1.12     $ 1.04     $ 2.21     $ 2.04  

Diluted

     1.10       1.01       2.17       2.00  

Basic weighted average number of common shares outstanding (in thousands)

     910,921       954,662       915,974       951,177  

Diluted weighted average number of common shares outstanding (in thousands)

     929,386       974,153       932,109       968,717  

Dividends declared per common share

   $ 0.30     $ 0.26     $ 0.59     $ 0.51  

Return on average assets

     1.44 %     1.48 %     1.43 %     1.41 %

Return on average common equity

     19.25       20.37       19.36       20.50  

Efficiency ratio (1)

     52.49       47.95       51.24       47.72  

Asset Quality

                                

Nonaccrual loans (2)

   $ 1,996     $ 2,232     $ 1,996     $ 2,232  

Foreclosed assets

     317       274       317       274  
    


 


 


 


Total nonperforming assets

     2,313       2,506       2,313       2,506  

Nonperforming assets/total assets

     0.82 %     0.96 %     0.82 %     0.96 %

Restructured loans

   $ 89     $ 119     $ 89     $ 119  
    


 


 


 


Total nonperforming assets and restructured loans

     2,402       2,625       2,402       2,625  

Allowance for loan and lease losses

     1,680       1,665       1,680       1,665  

Allowance as a percentage of total loans held in portfolio

     1.09 %     1.14 %     1.09 %     1.14 %

Provision for loan and lease losses

   $ 118     $ 160     $ 243     $ 335  

Net charge-offs

     118       116       213       215  

Capital Adequacy

                                

Stockholders’ equity/total assets

     7.44 %     7.50 %     7.44 %     7.50 %

Tangible common equity (3) /total tangible assets (3)

     5.28       5.28       5.28       5.28  

Estimated total risk-based capital/risk-weighted assets (4)

     11.72       12.32       11.72       12.32  

Per Common Share Data

                                

Book value per common share (5)

   $ 23.22     $ 20.50     $ 23.22     $ 20.50  

Market prices:

                                

High

     43.90       39.45       43.90       39.45  

Low

     35.68       33.00       32.98       31.60  

Period end

     41.30       37.11       41.30       37.11  

(1)   The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(2)   Excludes nonaccrual loans held for sale.
(3)   Excludes unrealized net gain/loss on available-for-sale securities and derivatives, goodwill and intangible assets, but includes MSR.
(4)   Estimate of what the total risk-based capital ratio would be if Washington Mutual, Inc. was a bank holding company that complies with Federal Reserve Board capital requirements.
(5)   Excludes shares held in escrow pending resolution of the Company’s asserted right to the return of such shares; there were 17,100,000 shares in the escrow at June 30, 2003, and 18,000,000 shares at June 30, 2002.

 

19


Table of Contents

Summary Financial Data (Continued)

 

     Three Months Ended
June 30,


   Six Months Ended
June 30,


     2003

   2002

   2003

   2002

     (in millions, except per share amounts and ratios)

Supplemental Data

                           

Average balance sheet:

                           

Average loans held for sale

   $ 46,727    $ 22,211    $ 44,539    $ 24,712

Average loans held in portfolio

     151,489      146,668      149,944      147,097

Average interest-earning assets

     246,021      236,504      243,868      245,789

Average total assets

     284,118      266,849      282,476      275,551

Average interest-bearing deposits

     120,144      108,231      119,560      104,743

Average noninterest-bearing deposits

     43,536      22,417      41,249      22,526

Average stockholders’ equity

     21,193      19,401      20,898      18,946

Period-end balance sheet:

                           

Loans held for sale

     40,631      21,940      40,631      21,940

Loans held in portfolio

     152,186      144,208      152,186      144,208

Total interest-earning assets

     245,345      230,852      245,345      230,852

Total assets

     283,203      261,298      283,203      261,298

Total interest-bearing deposits

     119,952      108,441      119,952      108,441

Total noninterest-bearing deposits

     46,505      20,628      46,505      20,628

Total stockholders’ equity

     21,061      19,597      21,061      19,597

Loan volume:

                           

Home loans:

                           

Adjustable rate

     24,847      16,093      48,278      32,701

Fixed rate

     78,650      30,999      148,160      70,230

Specialty mortgage finance

     4,658      3,074      9,187      6,201
    

  

  

  

Total home loan volume

     108,155      50,166      205,625      109,132

Total loan volume

     120,322      57,779      226,942      123,466

Home loan refinancing

     81,511      27,160      153,959      67,250

Total refinancing

     83,620      28,398      157,480      69,464

 

Earnings Performance

 

Net Interest Income

 

For the three and six months ended June 30, 2003, net interest income decreased $75 million or 4% and $454 million or 10% compared with the same periods in 2002. These decreases resulted from contraction of the margin, which declined to 3.30% and 3.31% for the three and six months ended June 30, 2003 from 3.54% and 3.65% for the same periods in 2002, as yields on loans and debt securities continued to reprice downward from the higher interest rate environment of 2002. The decline in the margin was partially offset by decreases in the rates paid on interest-bearing deposits. In particular, the average rate paid on interest-bearing checking (Platinum) accounts decreased to 1.89% from 3.12% on an average balance of $54.94 billion and $30.49 billion for the three months ended June 30, 2003 and 2002, and decreased to 1.99% from 3.31% on an average balance of $53.68 billion and $23.83 billion for the six months ended June 30, 2003 and 2002. The free funding impact of noninterest-bearing sources that resulted from higher average custodial and escrow balances also offset the contraction in the margin for the three and six months ended June 30, 2003, by 16 and 15 basis points when compared with the same periods in 2002. Higher average balances of loans held for sale and home equity loans and lines of credit during the second quarter and first half of 2003, as compared with the same periods in the prior year, further reduced the decline in net interest income.

 

20


Table of Contents

Interest rate contracts, including embedded derivatives, held for asset/liability interest rate risk management purposes decreased net interest income by $151 million and $294 million for the three and six months ended June 30, 2003, compared with $92 million and $129 million for the same periods in 2002.

 

Certain average balances, together with the total dollar amounts of interest income and expense and the weighted average interest rates, were as follows:

 

     Three Months Ended June 30,

     2003

   2002

     Average
Balance


   Rate

    Interest
Income


   Average
Balance


   Rate

    Interest
Income


     (dollars in millions)
Assets                                

Interest-earning assets:

                                       

Federal funds sold and securities purchased under resale agreements

   $ 3,448    1.29 %   $ 11    $ 1,995    1.89 %   $ 10

Available-for-sale securities (1) :

                                       

Mortgage-backed securities

     24,087    5.22       314      22,471    5.96       335

Investment securities

     14,969    4.15       155      38,436    4.97       477

Loans held for sale (2)

     46,727    5.36       626      22,211    6.50       361

Loans held in portfolio (2)(3) :

                                       

Loans secured by real estate:

                                       

Home loans

     83,426    4.95       1,033      86,315    6.02       1,299

Purchased specialty mortgage finance

     10,475    5.50       144      9,028    6.39       144
    

        

  

        

Total home loans

     93,901    5.01       1,177      95,343    6.05       1,443

Home construction loans:

                                       

Builder (4)

     1,103    4.77       13      1,379    6.15       21

Custom (5)

     927    7.48       17      893    8.58       19

Home equity loans and lines of credit:

                                       

Banking subsidiaries

     19,238    5.13       246      12,819    6.01       193

Washington Mutual Finance

     2,041    11.77       60      2,116    12.16       64

Multi-family

     19,036    5.34       255      17,425    5.98       261

Other real estate

     7,306    6.25       114      8,410    6.71       142
    

        

  

        

Total loans secured by real estate

     143,552    5.25       1,882      138,385    6.19       2,143

Consumer:

                                       

Banking subsidiaries

     1,253    8.93       28      2,719    9.31       63

Washington Mutual Finance

     1,732    19.61       85      1,702    18.68       79

Commercial business

     4,952    4.38       55      3,862    5.13       50
    

        

  

        

Total loans held in portfolio

     151,489    5.41       2,050      146,668    6.37       2,335

Other

     5,301    4.61       61      4,723    5.67       67
    

        

  

        

Total interest-earning assets

     246,021    5.23       3,217      236,504    6.06       3,585

Noninterest-earning assets:

                                       

Mortgage servicing rights

     4,754                   7,828             

Goodwill

     6,253                   6,152             

Other

     27,090                   16,365             
    

               

            

Total assets

   $ 284,118                 $ 266,849             
    

               

            

(This table is continued on the next page.)


(1)   The average balance and yield are based on average amortized cost balances.
(2)   Nonaccrual loans are included in the average loan amounts outstanding.
(3)   Interest income for loans held in portfolio includes amortization of net deferred loan origination costs of $78 million and $47 million for the three months ended June 30, 2003 and 2002.
(4)   Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale.
(5)   Represents construction loans made directly to the intended occupant of a single-family residence.

 

21


Table of Contents

(Continued from the previous page.)

 

     Three Months Ended June 30,

     2003

   2002

     Average
Balance


   Rate

    Interest
Expense


   Average
Balance


   Rate

    Interest
Expense


     (dollars in millions)
Liabilities                                

Interest-bearing liabilities:

                                       

Deposits:

                                       

Interest-bearing checking

   $ 60,597    1.74 %   $ 262    $ 36,991    2.65 %   $ 245

Savings accounts and money market deposit accounts

     28,229    0.98       69      32,249    1.51       122

Time deposit accounts

     31,318    2.77       217      38,991    3.09       299
    

        

  

        

Total interest-bearing deposits

     120,144    1.83       548      108,231    2.47       666

Federal funds purchased and commercial paper

     3,843    1.37       13      3,562    1.96       17

Securities sold under agreements to repurchase

     20,040    2.66       134      35,812    2.44       218

Advances from Federal Home Loan Banks

     51,916    2.56       334      59,651    2.75       410

Other

     14,898    4.37       163      13,976    4.98       174
    

        

  

        

Total interest-bearing liabilities

     210,841    2.26       1,192      221,232    2.69       1,485
                 

               

Noninterest-bearing sources:

                                       

Noninterest-bearing deposits

     43,536                   22,417             

Other liabilities

     8,548                   3,799             

Stockholders’ equity

     21,193                   19,401             
    

               

            

Total liabilities and stockholders’ equity

   $ 284,118                 $ 266,849             
    

               

            

Net interest spread and net interest income

          2.97     $ 2,025           3.37     $ 2,100
                 

               

Impact of noninterest-bearing sources

          0.33                   0.17        

Net interest margin

          3.30                   3.54        

 

22


Table of Contents
     Six Months Ended June 30,

     2003

   2002

     Average
Balance


   Rate

    Interest
Income


   Average
Balance


   Rate

    Interest
Income


     (dollars in millions)
Assets                                

Interest-earning assets:

                                       

Federal funds sold and securities purchased under resale agreements

   $ 4,286    1.27 %   $ 27    $ 1,569    1.79 %   $ 14

Available-for-sale securities (1) :

                                       

Mortgage-backed securities

     25,142    5.26       661      23,852    5.66       676

Investment securities

     14,979    4.35       325      43,822    4.96       1,083

Loans held for sale (2)

     44,539    5.46       1,216      24,712    6.51       804

Loans held in portfolio (2)(3) :

                                       

Loans secured by real estate:

                                       

Home loans

     83,255    5.08       2,116      87,255    6.10       2,661

Purchased specialty mortgage finance

     10,286    5.72       294      8,785    6.64       292
    

        

  

        

Total home loans

     93,541    5.15       2,410      96,040    6.15       2,953

Home construction loans:

                                       

Builder (4)

     1,080    4.90       27      1,473    6.09       44

Custom (5)

     923    7.61       35      911    8.14       37

Home equity loans and lines of credit:

                                       

Banking subsidiaries

     18,248    5.28       480      11,966    6.01       360

Washington Mutual Finance

     2,004    11.91       118      2,106    12.05       127

Multi-family

     18,758    5.50       516      17,483    6.16       539

Other real estate

     7,525    6.30       237      8,417    6.88       289
    

        

  

        

Total loans secured by real estate

     142,079    5.39       3,823      138,396    6.29       4,349

Consumer:

                                       

Banking subsidiaries

     1,293    8.94       57      2,784    9.32       130

Washington Mutual Finance

     1,728    19.57       168      1,715    18.59       159

Commercial business

     4,844    4.42       107      4,202    5.12       108
    

        

  

        

Total loans held in portfolio

     149,944    5.55       4,155      147,097    6.45       4,746

Other

     4,978    5.05       125      4,737    6.15       145
    

        

  

        

Total interest-earning assets

     243,868    5.34       6,509      245,789    6.08       7,468

Noninterest-earning assets:

                                       

Mortgage servicing rights

     5,103                   7,419             

Goodwill

     6,259                   5,875             

Other