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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K


ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

Commission File Number 1-14667

WASHINGTON MUTUAL, INC.
(Exact name of registrant as specified in its charter)


Washington
(State or other jurisdiction of
incorporation or organization)
  91-1653725
(I.R.S. Employer
Identification Number)

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

 

98101
(Zip Code)

Registrant's telephone number, including area code: (206) 461-2000


Securities registered pursuant to Section 12(b) of the Act:

Title of each class
  Name of each exchange on which registered
Common Stock   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

Title of each class
  Name of each exchange on which registered
Litigation Tracking Warrants™   NASDAQ

        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  ý  No  o .

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o .

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

        The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2004:

Common Stock – $33,368,030,966 (1)
(1) Does not include any value attributable to 6,000,000 shares held in escrow.

        The number of shares outstanding of the issuer's classes of common stock as of February 28, 2005:

Common Stock – 879,248,564 (2)
(2) Includes 6,000,000 shares held in escrow.

Documents Incorporated by Reference

        Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held April 19, 2005, are incorporated by reference into Part III.




WASHINGTON MUTUAL, INC.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

 
 
   
 
  Page
PART I   1
  Item 1.   Business   1
        Overview   1
        Available Information   2
        Employees   2
        Factors That May Affect Future Results   2
        Environmental Regulation   5
        Regulation and Supervision   6
        Executive Officers   10
  Item 2.   Properties   12
  Item 3.   Legal Proceedings   12
  Item 4.   Submission of Matters to a Vote of Security Holders   13
PART II   13
  Item 5.   Market for our Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities   13
  Item 6.   Selected Financial Data   20
  Item 7.   Management's Discussion and Analysis of Financial Condition and Results of
Operations
  14
        Controls and Procedures   14
        Overview   14
        Critical Accounting Policies   17
        Recently Issued Accounting Standards   18
        Five-Year Summary of Selected Financial Data   20
        Ratios and Other Supplemental Data   21
        Earnings Performance from Continuing Operations   22
        Review of Financial Condition   32
        Operating Segments   35
        Risk Management   42
        Credit Risk Management   42
        Liquidity Risk Management   50
        Off-Balance Sheet Activities and Contractual Obligations   52
        Capital Adequacy   54
        Market Risk Management   54
        Maturity and Repricing Information   59
        Operational Risk Management   65
        Tax Contingency   65
        Goodwill Litigation   65
  Item 7A.   Quantitative and Qualitative Disclosures about Market Risk   54
  Item 8.   Financial Statements and Supplementary Data   68
  Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   68
  Item 9A.   Controls and Procedures   14
  Item 9B.   Other Information   68
PART III   69
  Item 10.   Directors and Executive Officers of the Registrant   69
  Item 11.   Executive Compensation   69
  Item 12.   Security Ownership of Certain Beneficial Owners and Management   69
  Item 13.   Certain Relationships and Related Transactions   69
  Item 14.   Principal Accounting Fees and Services   69
PART IV   70
  Item 15.   Exhibits, Financial Statement Schedules   70

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PART I

BUSINESS

Overview

        With a history dating back to 1889, Washington Mutual, Inc. (together with its subsidiaries, "Washington Mutual," or the "Company") is a retailer of financial services to consumers and small businesses. Based on our consolidated assets at December 31, 2004 we were the largest thrift holding company in the United States and the seventh largest among all U.S.-based bank and thrift holding companies.

        Our earnings are primarily driven by real estate secured lending and deposit taking activities which generate net interest income and by activities that generate noninterest income, including the sale and servicing of loans and providing fee-based services to our customers. Real estate secured loans and mortgage-backed securities generate more than 90% of interest income and this concentration is likely to continue as a result of our decision to exit certain non-core businesses, such as lending to mid- and large-sized companies.

        We strive to be the nation's leading retailer of financial services for consumers and small businesses. We plan to achieve this by building strong, profitable relationships with a broad spectrum of consumers and businesses. Expanding our retail banking franchise and achieving efficiencies in our operations will be critical to future success.

        Following the acquisition of the three largest California-based thrift institutions in the latter part of the 1990s, we continued to expand nationally by acquiring companies with strong retail banking franchises in Texas and the greater New York metropolitan area. During this period, we developed and launched our award-winning and innovative retail banking stores that serve customers in an open, free-flowing retail environment. With the goal of combining our strengths as a deposit taker and portfolio lender with those of a mortgage banker, we also expanded our presence in the home loan origination and servicing businesses through acquisition. These mortgage banking acquisitions also served to further broaden our national footprint.

        Having created a viable branch presence in many of the largest metropolitan areas over the past decade, our current retail banking store expansion strategy is focused primarily on middle market consumers in those states where we have both a home loan and retail banking presence. As compared to our branching strategy over the last decade, this focus on our existing markets carries lower execution risk because it enables us to leverage both existing infrastructure and brand awareness and is concentrated in markets with characteristics of both above average household growth and below average branch density. For more detail on the products and services offered by our Retail Banking and Financial Services Group, refer to Management's Discussion and Analysis – "Operating Segments."

        In the mortgage banking business, we are building scalable and repeatable processes that will enable us to enhance customer service and offer products at prices that are both competitive and profitable. The ending of the refinance boom in the latter part of 2003 and the ensuing decline in home loan volume resulted in an unacceptably high mortgage banking fixed cost structure. This was largely the result of not having integrated the loan fulfillment operations and the technologies of acquired companies. Our goal is to make this business more competitive by improving productivity and enhancing customer service. For more detail on the products and services offered by our Mortgage Banking Group, refer to Management's Discussion and Analysis – "Operating Segments."

        Multi-family lending complements the Company's expertise in residential real estate secured lending. As a result of productivity improvements completed in this business in 2004, we are well-positioned to execute on our strategy of increasing market share in our top 15 targeted metropolitan markets. These markets have stable demand, a large disparity between the cost of renting and the cost of home ownership, and households that typically rent for an extended period of time. Our target markets also have supply

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constraints such as geographic barriers, rent control and zoning restrictions. For more detail on the products and services offered by our Commercial Group, of which multi-family lending is the most significant part, refer to Management's Discussion and Analysis – "Operating Segments."

Available Information

        We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, available free of charge on or through our website located at www.wamu.com/ir as soon as reasonably practicable after filing with the United States Securities and Exchange Commission.

        The Company's Code of Conduct, which applies to all officers, directors and employees of the Company, and the Code of Ethics for Senior Financial Officers, which applies to the Company's Chief Executive Officer, Chief Financial Officer, Controller, and each business segment or business line chief financial officer and controller, as well as any waiver of our Code of Conduct or Code of Ethics for Senior Financial Officers, are disclosed on our website located at www.wamu.com/ir.

Employees

        At December 31, 2004, we had 52,579 employees, compared with 63,720 at December 31, 2003 and 55,200 at December 31, 2002, which included zero, 2,346 and 2,330 employees related to the Company's discontinued operations. During 2004, our number of employees decreased primarily due to the Company's cost containment initiative directed at reducing the fixed cost structure of the mortgage banking business through reduced employee headcount. During 2003, our number of employees increased substantially to accommodate the high refinancing activity in the earlier part of the year and the opening of new retail banking stores. We believe that we have been successful in attracting quality employees and that our employee relations are good.

Factors That May Affect Future Results

        Our Form 10-K and other documents that we file with the Securities and Exchange Commission have 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, which could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements.

        Some of these factors are described below.

    Volatile interest rates impact our mortgage banking business and could adversely affect our earnings.

        Changes in interest rates affect the mortgage banking business in complex and significant ways. Changes in interest rates can affect loan origination fees, gain from mortgage loans and loan servicing fees, which are the principal components of home loan mortgage banking income. When mortgage rates decline, we would generally expect loan volumes to increase as borrowers refinance, which leads to accelerated payoffs of mortgage loans in our servicing portfolio, which reduces the fair value of our mortgage servicing rights ("MSR"), and to increased loan origination fees and gain from mortgage loans, as our mix of originated mortgage loans generally shifts to saleable fixed-rate products. When mortgage rates rise, we

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would generally expect loan volumes to decrease, which generally leads to reduced payoffs in our servicing portfolio, which increases the fair value of our MSR, and to reduced loan origination fees and gain from mortgage loans, as our mix or originated mortgage loans generally shifts to adjustable-rate products we hold in portfolio.

        To mitigate changes in fair value of our MSR, we purchase and sell financial instruments, such as mortgage-backed securities and fixed-rate investment securities; enter into interest rate contracts and forward commitments to purchase or sell mortgage-backed securities, which tend to increase in value when mortgage rates decline and decrease in value when mortgage rates rise; and we adjust the mix and amount of such financial instruments or contracts to take into account the effects of different interest rate environments. Our management must exercise judgment in selecting the amount, type and mix of financial instruments and contracts to mitigate changes in fair value of our MSR. We cannot assure that the amount, type and mix of financial instruments and contracts we select will offset significant decreases in the value of the MSR and the Company's earnings could be adversely affected. Moreover, some of the risk management instruments we use may experience periods of illiquidity in the secondary markets, in which case our ability to effectively mitigate changes in the fair value of the MSR could be adversely affected.

        Historically, the Company has held adjustable-rate mortgage ("ARM") loans in its portfolio; however, the industry-wide increase in the origination volume of adjustable-rate mortgages has facilitated the development of a secondary market for these products and has allowed us to sell a significant portion of our signature adjustable-rate mortgage, the Option ARM, into this market. The Company believes that secondary market prices offered for its Option ARM product may result in stronger gain from mortgage loans than its conforming fixed and hybrid products; therefore, a downturn in customer demand for this product or a prolonged period of secondary market illiquidity could have an adverse effect on the Company's earnings.

        For further discussion of how interest rate risk, basis risk and prepayment risk are managed, refer to Management's Discussion and Analysis – "Market Risk Management."

    Rising unemployment or a decrease in housing prices could adversely affect our credit performance.

        The Company's credit performance has been strong, reflecting a generally favorable economic environment for real estate lending. The Company continually monitors changes in the economy, particularly unemployment rates and housing prices. If unemployment were to rise and either a slowdown in housing price appreciation or outright declines in housing prices were to occur, borrowers may be unable to repay their loans. As a result, the Company could experience higher credit losses in its mortgage loan portfolios, which could adversely affect our earnings.

    A continuing emphasis on subprime lending could negatively impact our business.

        The Company began accelerating purchases of subprime loans in 2003, increased its specialty mortgage finance portfolio significantly in 2004 and intends to continue to grow this portfolio in the future. The specialty mortgage finance portfolio has generally performed well as a result of a strong mortgage market, housing price appreciation and the Company's disciplined approach in re-underwriting these assets. However, if there were a downturn in the national economy or local economies where we do business, the credit performance of this portfolio could suffer, with a potential adverse effect on our earnings.

    The potential for negative amortization in the Option ARM product could have an adverse effect on the Company's credit.

        The Option ARM loan is a unique adjustable-rate mortgage that can provide the borrower with up to four payment options each month and an introductory rate of interest ("start rate") that is usually much lower than the loan's fully-indexed interest rate and will last from one month to five years, depending on the type of Option ARM selected by the borrower. The minimum monthly payment is a fully amortizing

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payment based on the start rate and is the lowest payment that the borrower may select, which means that any other payment option, such as interest only, will not be available in any month that it is less than the minimum payment. After an initial introductory period, the interest rate can adjust monthly based on movements in the index. However, the minimum monthly payment adjusts no more frequently than annually and each annual payment adjustment cannot exceed, in amount, a specified percentage of the previous year's minimum monthly payment. As a result, depending on how the interest rate adjusts, the minimum monthly payment may not be sufficient to pay all the interest that accrued during the previous month. When this occurs and the borrower selects the minimum payment option, the unpaid interest is added to the principal balance. This is called negative amortization.

        To limit the amount of negative amortization that can accrue, after every 60 months of the loan, the loan is reamortized without regard to the annual payment cap. The new minimum monthly payment will then be sufficient to repay the loan based on the interest rate, principal balance and remainder of the loan term. Furthermore, the loan is automatically reamortized without regard to the annual payment cap whenever the loan balance exceeds the original loan balance by a stated percentage.

        The Company continually monitors the credit risk inherent in the Option ARM and assesses the adequacy of its loan loss allowance for its portfolio of Option ARMs in light of prevailing circumstances and the historical and current levels of negative amortization in its Option ARM portfolio. If credit risks associated with the Option ARM were to increase in severity, the Company's earnings could be adversely affected.

    We face competition from banking and nonbanking companies.

        The Company operates in a highly competitive environment and expects competition to continue as financial services companies combine to produce larger companies that are able to offer a wide array of financial products and services at competitive prices. In addition, customer convenience and service capabilities, such as product lines offered and the accessibility of services are significant competitive factors.

        Our most direct competition for loans comes from commercial banks, other savings institutions and national mortgage companies. Our most direct competition for deposits comes from commercial banks, other savings institutions and credit unions doing business in our market areas. As with all banking organizations, we have also experienced competition from nonbanking sources, including mutual funds, corporate and government debt securities and other investment alternatives offered within and outside of our primary market areas. In addition, technological advances and the growth of e-commerce have made it possible for non-depository institutions to offer products and services that were traditionally offered only by banks. Many of these competitors have fewer regulatory constraints and some have lower cost structures.

        We also face competition for talent. Our success depends, in large part, on our ability to hire and keep key people. Competition for the best people in most businesses in which we engage can be intense. If we are unable to attract and retain talented people, our business could suffer.

    Changes in the regulation of financial services companies and housing government-sponsored enterprises could adversely affect our business.

        Proposals for further regulation of the financial services industry are continually being introduced in Congress. The agencies regulating the financial services industry also periodically adopt changes to their regulations. Proposals that are now receiving a great deal of attention include consumer protection initiatives relating to bank overdraft practices, security of customer information, marketing practices, the Real Estate Settlement Procedures Act and predatory lending. It is possible that one or more legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. For further discussion of the regulation of financial services, see "Regulation and Supervision."

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        The Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Federal Home Loan Banks are housing government-sponsored enterprises ("GSEs") which play a powerful role in the mortgage industry. We have significant business relationships with these GSEs, particularly the sale of loans to these entities. Proposals being considered in Congress include establishing a new independent agency to regulate GSEs, imposing new regulatory restrictions on the activities and operations of GSEs and reducing or limiting certain business benefits GSEs receive from the federal government. The enactment of any of these proposals could increase the costs incurred by, or otherwise adversely affect the business of, the GSEs, which in turn could have an adverse impact on our business.

        If we are unable to sell our loans to the GSEs due to limitations imposed on their business, our liquidity in the secondary market could be reduced and our earnings could be adversely affected. For further discussion of the Federal Home Loan Bank System and the regulation of financial services, see "Regulation and Supervision."

    General business and economic conditions, including movements in interest rates, may significantly affect our earnings.

        Our business and earnings are sensitive to general business and economic conditions. These conditions include the slope of the yield curve, inflation, the money supply, the value of the U.S. dollar as compared to foreign currencies, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy and the local economies in which we conduct business. Changes in these conditions may adversely affect our business and earnings.  For example, when short-term interest rates rise, there is a lag period until our adjustable-rate mortgages reprice. As a result, the Company may experience compression of its net interest margin with a commensurate adverse effect on earnings. Likewise, if a flat or inverted yield curve develops, our earnings could be adversely affected as this may also compress the margin and hinder our ability to increase the amount of adjustable-rate loans that are held in portfolio. A prolonged economic downturn could increase the number of customers who become delinquent or default on their loans, or a rising interest rate environment could decrease customer demand for loans. An increase in delinquencies or defaults could result in a higher level of charge-offs and provision for loan and lease losses, which could adversely affect our earnings.

        In addition, our business and earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies. We are particularly affected by the policies of the Board of Governors of the Federal Reserve, which regulates the supply of money and credit in the United States. Federal Reserve System policies directly and indirectly influence the yield on our interest-earning assets and the cost of our interest-bearing liabilities. Changes in those policies are beyond our control and difficult to predict.

    Negative public opinion could damage our reputation and adversely affect our earnings.

        Reputational risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from the actual or perceived manner in which we conduct our business activities, including our sales and trading practices, including practices in our origination and servicing operations and retail banking operations; our management of actual or potential conflicts of interest and ethical issues; and our protection of confidential customer information. Negative public opinion can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action. We take steps to minimize reputation risk in the way we conduct our business activities and deal with our customers and communities.

Environmental Regulation

        Our business and properties are subject to federal and state laws and regulations governing environmental matters, including the regulation of hazardous substances and wastes. For example, under the federal Comprehensive Environmental Response, Compensation, and Liability Act and similar state

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laws, owners and operators of contaminated properties may be liable for the costs of cleaning up hazardous substances without regard to whether such persons actually caused the contamination. Such laws may affect us both as an owner or former owner of properties used in or held for our business, and as a secured lender on property that is found to contain hazardous substances or wastes. Our general policy is to obtain an environmental assessment prior to foreclosing on commercial property. We may elect not to foreclose on properties that contain such hazardous substances or wastes, thereby limiting, and in some instances precluding, the liquidation of such properties.

Regulation and Supervision

        The following discussion describes elements of the extensive regulatory framework applicable to savings and loan holding companies as well as federal savings associations and provides some specific information relevant to us. This regulatory framework is primarily intended for the protection of depositors, federal deposit insurance funds and the banking system as a whole rather than for the protection of shareholders and creditors.

        To the extent that this section describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Those statutes and regulations, as well as related policies, are subject to change by Congress, state legislatures and federal and state regulators. Changes in statutes, regulations or regulatory policies applicable to the Company, including interpretation or implementation thereof, could have a material effect on the Company's business.

    General

        Washington Mutual, Inc. is a Washington State corporation. It owns two federal savings associations as well as numerous nonbank subsidiaries. Washington Mutual, Inc. is a savings and loan holding company. As a savings and loan holding company, Washington Mutual, Inc. is subject to regulation by the Office of Thrift Supervision (the "OTS").

        Our federal savings associations are subject to extensive regulation and examination by the OTS, their primary federal regulator, as well as the Federal Deposit Insurance Corporation ("FDIC"). On January 1, 2005, our state savings bank, Washington Mutual Bank ("WMB") merged into Washington Mutual Bank, FA ("WMBFA"), and ceased to exist; consequently, we no longer own a state savings bank that is subject to regulation and supervision by the Director of Financial Institutions of the State of Washington and by the FDIC. Our nonbank financial subsidiaries are also subject to various federal and state laws and regulations.

        All of our banking subsidiaries are under the common control of Washington Mutual, Inc. and are insured by the FDIC. If an insured institution fails, claims for administrative expenses of the receiver and for deposits in U.S. branches (including claims of the FDIC as subrogee of the failed institution) have priority over the claims of general unsecured creditors. In addition, the FDIC has authority to require any of our banking subsidiaries to reimburse it for losses it incurs in connection either with the failure of another of our banking subsidiaries or with the FDIC's provision of assistance to one of our banking subsidiaries that is in danger of failure.

    Payment of Dividends

        Washington Mutual, Inc. is a legal entity separate and distinct from its banking and nonbanking subsidiaries. Its principal sources of funds are cash dividends paid by those subsidiaries, investment income, and borrowings. Federal laws limit the amount of dividends or other capital distributions that a banking institution, such as our federal savings associations, can pay. Each of our banking subsidiaries has a policy to remain well-capitalized and, accordingly, would not pay dividends to the extent payment of the dividend would result in it not being well-capitalized. In addition, our federal savings associations must file a notice with the OTS at least 30 days before they can pay dividends to their parent companies. See Note 18 to the Consolidated Financial Statements – "Regulatory Capital Requirements and Dividend Restrictions" for a more detailed description of the limits on the dividends our subsidiary banks can pay.

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    Capital Adequacy

        Washington Mutual, Inc. is not currently subject to any regulatory capital requirements, but each of its subsidiary depository banking institutions is subject to OTS capital requirements. An institution's capital category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure, a tangible equity ratio measure, and certain other factors.

        Federal law and regulations establish minimum capital standards, and under the OTS regulations, an institution (that is not in the most highly-rated category) is required to have a leverage ratio of core capital to adjusted total assets of at least 4.00%, a Tier 1 risk-based capital ratio of at least 4.00%, a total risk-based capital ratio of at least 8.00% and a tangible capital ratio of at least 1.50%. Federal law and regulations also establish five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution is treated as well-capitalized if its ratio of total capital to risk-weighted assets is 10.00% or more, its ratio of Tier 1 capital to risk-weighted assets is 6.00% or more, its leverage ratio is 5.00% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and (unless it is in the most highly-rated category) a leverage ratio of not less than 4.00%. Any institution that is neither well-capitalized nor adequately capitalized will be considered undercapitalized. Any institution with a tangible equity ratio of 2.00% or less will be considered critically undercapitalized.

        As of December 31, 2004 each of our banking subsidiaries met all capital requirements to which it was subject and satisfied the requirements to be treated as well-capitalized. See Note 18 to the Consolidated Financial Statements – "Regulatory Capital Requirements and Dividend Restrictions" for an analysis of our regulatory capital.

        The Company continues to actively follow the progress of the U.S. banking agencies and the Basel Committee on Banking Supervision in developing a new set of regulatory risk-based capital requirements. The Basel Committee on Banking Supervision is a committee established by the central bank governors of certain industrialized nations, including the United States. The new requirements are commonly referred to as Basel II or The New Basel Capital Accord. The Company is participating in efforts to refine these standards to ensure that they measure risk as precisely as possible within the framework of The New Basel Capital Accord. The Company is working to ensure that its internal measurement of credit risk, market risk, and operational risk will comply with the standards of The New Basel Capital Accord. The Company is also assessing the potential impacts The New Basel Capital Accord may have on its business practices as well as broader competitive effects within the industry.

    Holding Company Status and Acquisitions

        Washington Mutual, Inc. is a multiple savings and loan holding company, as defined by federal law, because it owns more than one savings association. Washington Mutual, Inc. is regulated as a unitary savings and loan holding company, however, because the OTS deems our federal savings associations to have been acquired in supervisory transactions. Therefore, we are exempt from certain restrictions that would otherwise apply under federal law to the activities and investments of a multiple savings and loan holding company. These restrictions will apply to Washington Mutual, Inc. if any of our banking institutions fails to meet a qualified thrift lender test established by federal law. As of December 31, 2004, the Company's banking subsidiaries were in compliance with qualified thrift lender standards.

        Washington Mutual, Inc. may not acquire control of another savings association unless the OTS approves. Washington Mutual, Inc. may not be acquired by a company, other than a bank holding company, unless the OTS approves, or by an individual unless the OTS does not object after receiving notice. Washington Mutual, Inc. may not be acquired by a bank holding company unless the Board of Governors of the Federal Reserve System (the "Federal Reserve") approves. In any case, the public must have an opportunity to comment on the proposed acquisition, and the OTS or Federal Reserve must complete an

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application review. Without prior approval from the OTS, Washington Mutual, Inc. may not acquire more than 5% of the voting stock of any savings institution that is not one of its subsidiaries.

        The Gramm-Leach-Bliley Act generally restricts any non-financial entity from acquiring Washington Mutual, Inc. unless such non-financial entity was, or had submitted an application to become, a savings and loan holding company as of May 4, 1999. Since Washington Mutual, Inc. was treated as a unitary savings and loan holding company prior to that date, Washington Mutual, Inc. may engage in non-financial activities and acquire non-financial subsidiaries.

    Federal Home Loan Bank System

        The primary purpose of the Federal Home Loan Banks (the "FHLBs") is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. The FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions. The FHLB System consists of twelve regional FHLBs; each is federally chartered but privately owned by its member institutions. The Federal Housing Finance Board ("Finance Board"), a government agency, is generally responsible for regulating the FHLB System.

        One of our federal savings associations, WMBFA, currently is a member of the San Francisco FHLB. Our other federal savings association, Washington Mutual Bank fsb ("WMBfsb"), is a member of the Seattle FHLB.

        The Finance Board has issued a regulation that will require each FHLB to register a class of its equity securities with the United States Securities and Exchange Commission by filing a Form 10 no later than June 30, 2005 and having the registration be effective no later than August 29, 2005. As a result, each FHLB will be required to file quarterly, annual and supplemental financial disclosures with the Securities and Exchange Commission and to provide more public disclosure.

        Congress is considering proposals which would establish a new regulator for the FHLB system, as well as for other housing government-sponsored enterprises. We cannot predict at this time which, if any, of these proposals may be adopted or what effect they would have on the business of the Company.

    Deposit Insurance

        The FDIC insures the deposits of each of our banking subsidiaries to the applicable maximum in each institution, and such insurance is backed by the full faith and credit of the United States government. The FDIC administers two separate deposit insurance funds, the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF"). The BIF is a deposit insurance fund for commercial banks and some federal and state-chartered savings banks. The SAIF is a deposit insurance fund for most savings associations. Our federal savings associations are members of the SAIF, but a small portion of WMBFA's deposits are insured through the BIF.

        The FDIC has established a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution's insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern. During 2004, the assessment rate for both SAIF and BIF deposits ranged from zero to 0.27% of assessable deposits. Our banking subsidiaries qualified for the lowest rate on their deposits in 2004 and paid no deposit insurance assessments.

    Affiliate Transaction Restrictions

        Our two banking subsidiaries are subject to, and comply with, the affiliate and insider transaction rules applicable to member banks of the Federal Reserve System as well as additional limitations imposed by the OTS. These provisions prohibit or limit a banking institution from extending credit to, or entering into certain transactions with, affiliates (such as Washington Mutual, Inc.), principal stockholders, directors and executive officers of the banking institution and its affiliates.

8



    Federal Reserve, Consumer and Other Regulation

        Numerous regulations promulgated by the Federal Reserve Board affect the business operations of our banking subsidiaries. These include regulations relating to equal credit opportunity, electronic fund transfers, collection of checks, truth in lending, truth in savings and availability of funds.

        Under Federal Reserve Board regulations, each of our banking subsidiaries is required to maintain a reserve against its transaction accounts (primarily interest-bearing and noninterest-bearing checking accounts). Because reserves must generally be maintained in cash or in noninterest-bearing accounts, the effect of the reserve requirements is to increase an institution's cost of funds.

        The Gramm-Leach-Bliley Act included provisions that give consumers new protections regarding the transfer and use of their nonpublic personal information by financial institutions. In addition, states are permitted under the Gramm-Leach-Bliley Act to have their own privacy laws, which may offer greater protection to consumers than the Gramm-Leach-Bliley Act. Numerous states in which the Company does business have enacted such laws.

        The USA PATRIOT Act, which was enacted following the events of September 11, 2001, included numerous provisions designed to fight international money laundering and to block terrorist access to the U.S. financial system. We have established policies and procedures to ensure compliance with the USA PATRIOT Act's provisions, and the impact of the Act on our operations has not been material.

    Community Reinvestment Act

        The Community Reinvestment Act ("CRA") requires that our banking subsidiaries ascertain and help meet the credit needs of the communities we serve, including low- to moderate-income neighborhoods, while maintaining safe and sound banking practices. The primary federal regulatory agency assigns one of four possible ratings to an institution's CRA performance and is required to make public an institution's rating and written evaluation. The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs to improve, and substantial noncompliance. In 2004, each of our federal associations received an "outstanding" CRA rating from the OTS. We maintain a CRA public file that is available for viewing. The file includes copies of our most recent CRA Public Evaluations, descriptions of our products and services, delivery outlet information, and public comments.

        In September 2001, we announced a ten-year $375 billion community commitment, effective January 2002. This commitment replaced prior ones made by us and the companies we acquired. As of December 31, 2004, we had exceeded our yearly targets for lending in low- to moderate-income neighborhoods and underserved market areas .

    Regulatory Enforcement

        The OTS and the FDIC may take regulatory enforcement actions against any of their regulated institutions that do not operate in accordance with applicable regulations, policies and directives. Proceedings may be instituted against any banking institution, or any institution-affiliated party, such as a director, officer, employee, agent, or controlling person, who engages in unsafe and unsound practices, including violations of applicable laws and regulations. Each of the OTS and the FDIC has authority under various circumstances to appoint a receiver or conservator for an insured institution that it regulates, to issue cease and desist orders, to obtain injunctions restraining or prohibiting unsafe or unsound practices, to revalue assets and to require the establishment of reserves. The FDIC has additional authority to terminate insurance of accounts, after notice and hearing, upon a finding that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, is operating in an unsafe or unsound condition, or has violated any applicable law, regulation, rule, or order of, or condition imposed by the FDIC.

9



    Regulation of Nonbanking Affiliates

        As broker-dealers registered with the Securities and Exchange Commission and as members of the National Association of Securities Dealers, Inc., our broker-dealer subsidiaries are subject to various regulations and restrictions imposed by those entities, as well as by various state authorities. As a registered investment advisor, WM Advisors is subject to various federal and state securities regulations and restrictions. Our specialty mortgage finance subsidiary is subject to various federal and state laws and regulations, including those relating to truth-in-lending, equal credit opportunity, fair credit reporting, real estate settlement procedures, debt collection practices and usury. Our insurance subsidiaries are subject to regulation by various state insurance regulators. Some of our subsidiaries are subject to various state licensing and examination requirements.

Executive Officers

        The following table sets forth certain information regarding the executive officers of Washington Mutual:

Executive Officers

  Age
  Capacity in Which Served

  Employee of
Company
Since

Kerry K. Killinger   55   Chairman of the Board of Directors and Chief Executive Officer   1983
Michael L. Amato   48   Executive Vice President and President, Retail Banking Distribution   1982
Thomas W. Casey   42   Executive Vice President and Chief Financial Officer   2002
Craig J. Chapman   48   President, Commercial Group   1998
Fay L. Chapman   58   Senior Executive Vice President and General Counsel   1997
Daryl D. David   50   Executive Vice President, Human Resources   2000
Debora D. Horvath   50   Executive Vice President and Chief Information Officer   2004
Kenneth E. Kido   47   Executive Vice President and President, Banking Products and Operations   2001
William A. Longbrake   62   Vice Chair   1996
Robert H. Miles   48   Senior Vice President and Controller   1999
J. Benson Porter   39   Executive Vice President and Chief Administrative Officer   1996
Stephen J. Rotella   51   President and Chief Operating Officer   2005
James G. Vanasek   61   Executive Vice President and Chief Enterprise Risk Officer   1999

        Mr. Killinger established the Executive Committee in 1990 to facilitate and coordinate decision making and communication among the most senior executive officers of the Company who, as a committee, determine the Company's strategic direction. The executive officers serving on this committee are indicated below.

        Mr. Killinger is Chairman and Chief Executive Officer of Washington Mutual. He was named President and a Director in 1988, Chief Executive Officer in 1990 and Chairman in 1991. He served as President through 2004. He has been a member of the Executive Committee since its formation in 1990.

        Mr. Amato is Executive Vice President and President, Retail Banking Distribution. He is responsible for the management and operations of nearly 2,000 financial centers in 14 states including the Company's small business operations. Additionally, Mr. Amato oversees WM Advisors, Inc. and WM Financial Services, Inc. He became a member of the Executive Committee in 2005. Mr. Amato began his career at Washington Mutual in 1982 and served as manager of the national branch network beginning in 2000.

        Mr. Casey is Executive Vice President and Chief Financial Officer of Washington Mutual. As a member of the Executive Committee, he oversees all aspects of Washington Mutual's corporate finance, strategic planning and investor relations functions. Prior to joining Washington Mutual, Mr. Casey was

10



with GE Capital Corp. from 1992 through 2002 where he held advising, controllership and analyst positions prior to becoming a vice president of GE and Senior Vice President and Chief Financial Officer of GE Financial Assurance in 1999.

        Mr. Chapman is President of the Commercial Group. He is responsible for the Company's multi-family lending, commercial real estate lending, mortgage banker finance, Long Beach Mortgage Company and specialty mortgage finance. Mr. Chapman joined Washington Mutual in 1998 as President and Chief Executive Officer of Washington Mutual Finance Corporation and became a member of the Executive Committee in 2001. In addition to his current responsibilities, Mr. Chapman also led the Company's mortgage banking business from June 2004 to March 2005.

        Ms. Chapman is Washington Mutual's General Counsel and has been Senior Executive Vice President since 1999. She became Executive Vice President, General Counsel and a member of the Executive Committee in 1997. Prior to joining Washington Mutual, she was a partner at the Seattle law firm of Foster Pepper & Shefelman PLLC from 1979 to 1997.

        Mr. David joined Washington Mutual in 2000 as Executive Vice President, Human Resources. He is responsible for talent acquisition, organizational capabilities, leadership development and rewards and benefits. Mr. David became a member of the Executive Committee in 2001. He joined Washington Mutual from Amazon.com where he was Vice President of Strategic Growth and Human Resources from 1999 to 2000. Previously, he served in executive human resource positions with Sanga International, Magnetek, Inc., and Allied Signal from 1992 to 1999.

        Ms. Horvath joined Washington Mutual in 2004 as Executive Vice President and Chief Information Officer and became a member of the Executive Committee at that time. She is responsible for overseeing the Company's enterprise-wide technology efforts. Prior to joining Washington Mutual, she served as Senior Vice President and Chief Information Officer with GE Capital – Great Northern Annuity, GE Financial Assurance and GE Insurance from 1995 to 2004.

        Mr. Kido is Executive Vice President and President, Banking Products and Operations. He manages all aspects of consumer lending and deposit product management and operations, and oversees senior management of the ethnic and diversity initiatives of the Company. He became a member of the Executive Committee in 2005. Mr. Kido joined Washington Mutual in July 2001 after spending 24 years with Bank of America, most recently as head of their Consumer Card Division.

        Mr. Longbrake has been Vice Chair since 1999 and a member of the Executive Committee since 1996. He serves as the Company's primary executive liaison with regulators, legislators, industry trade organizations, and government-sponsored enterprises. Mr. Longbrake was an Executive Vice President from 1996 to 1999 and served as the Company's Chief Financial Officer from 1996 to 2002.

        Mr. Miles has been Senior Vice President and Controller since January 2001. He serves as Washington Mutual's principal accounting officer. Mr. Miles joined the Company as Senior Vice President, Corporate Tax in June 1999. Prior to joining the Company, Mr. Miles was Director, Domestic Taxes of the former BankBoston, N.A. from 1996 to 1999.

        Mr. Porter is Executive Vice President and Chief Administrative Officer. In this role, he oversees teams that provide company-wide support for sourcing and purchasing, program management, operational excellence initiatives, corporate property management, community affairs, community lending and investment and wire room services. Mr. Porter joined Washington Mutual in 1996 and became a member of the Executive Committee in 2004.

        Mr. Rotella became President and Chief Operating Officer of Washington Mutual in January of 2005 and became a member of the Executive Committee at that time. He is responsible for the oversight of the Company's retail, commercial and mortgage lines of business and technology group, as well as day-to-day corporate administration. Prior to joining Washington Mutual, he was an Executive Vice President with JPMorgan Chase and served on its executive committee from 2001 to 2004. In addition, he was the Chief

11



Executive Officer of Chase Home Finance from 2001 to 2004 and the Chief Operating Officer from 1998 to 2001.

        Mr. Vanasek is Executive Vice President and Chief Enterprise Risk Officer. He is responsible for overseeing credit risk management for the Company, as well as compliance, market and operational risk, internal audit and business continuity planning. Mr. Vanasek became a member of the Executive Committee in 2001. Prior to joining Washington Mutual in 1999, he spent eight years at the former Norwest Bank, in a variety of lending risk management positions including Chief Credit Officer.


Properties

        The Company's primary executive and business segment headquarters are located at 1201 Third Avenue, Seattle, Washington 98101. The Company leases approximately 400,000 square feet at this location and an additional 1 million square feet in downtown Seattle locations for administrative functions.

        The Company, in a joint venture with the Seattle Art Museum, is constructing a new headquarters building in downtown Seattle. On completion of the building, the Company will own approximately 900,000 square feet and will lease from the Seattle Art Museum an additional 250,000 square feet for a period of up to 25 years. The lessor has the right to cancel the lease, in whole or in part, at any time after the tenth year of the lease. Occupancy and the term of the lease are expected to commence concurrently in 2006 at which time the leases referenced above will not be renewed and the majority of the occupants will move to the new headquarters building.

        As of December 31, 2004, the Company or its subsidiaries owned or leased property in 42 states through 1,939 retail banking stores, 478 lending stores and centers and 500 administrative and other offices. Administrative facilities include the ownership or leasing of approximately 3 million square feet in California, 900,000 square feet in Florida, 800,000 square feet in Texas and 700,000 square feet in Illinois.


Legal Proceedings

        In the ordinary course of business, the Company and its subsidiaries are routinely defendants in or parties to a number of pending and threatened legal actions and proceedings, including actions brought on behalf of various classes of claimants. In certain of these actions and proceedings, claims for substantial monetary damages are asserted against the Company and its subsidiaries. Certain of these actions and proceedings are based on alleged violations of consumer protection, banking and other laws.

        During 2004, six plaintiffs filed lawsuits in the U.S. District Court, Western Division of Washington, alleging violations of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), Rule 10b-5 thereunder and Section 20(a) of the Exchange Act. Each plaintiff purported to represent a class of purchasers of Washington Mutual, Inc., securities from April 15, 2003 through June 28, 2004, and the defendants included the Company and various of its senior executives. Subsequently, a stipulated Order was submitted to the court through which the six cases were consolidated into a single action, lead plaintiffs and lead plaintiffs' counsel were appointed, and a schedule was set for further filings.

        Pursuant to that schedule, lead plaintiffs filed their Consolidated Amended Complaint on March 1, 2005. In brief, the amended complaint alleges that in various public statements the defendants purportedly made misrepresentations and failed to disclose material facts concerning, among other things, alleged internal systems problems and hedging issues. The complaint also asserts that these and related problems were such that the Company's financial statements were not in compliance with generally accepted accounting principles ("GAAP") and Securities and Exchange Commission ("SEC") regulations.

        The Company anticipates that the defendants will seek to dismiss the case. The defendants' motion to dismiss is to be filed by May 17, 2005, and briefing is to be completed by August 16, 2005. No oral argument has been set on defendants' anticipated motion.

12


        See Note 14 to the Consolidated Financial Statements – "Commitments, Guarantees and Contingencies" for a further discussion of pending and threatened litigation action and proceedings against the Company.


Submission of Matters to a Vote of Security Holders

        None.


PART II

Market for our Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities

        Our common stock trades on The New York Stock Exchange under the symbol WM. As of February 28, 2005, there were 879,248,564 shares issued and outstanding (including 6 million shares held in escrow) held by 53,804 shareholders of record. The information regarding high and low quarterly sales prices of the Company's common stock, and the quarterly cash dividends declared thereon, is set forth in this Form 10-K in the "Quarterly Results of Operations" table included under Supplementary Data on page 147 and is expressly incorporated herein by reference.

        The table below represents share repurchases made by the Company for the quarter ended December 31, 2004. Management may engage in future share repurchases as liquidity conditions permit and market conditions warrant.

Issuer Purchases of Equity Securities

  Total
Number
of Shares
(or Units)
Purchased (1)

  Average
Price Paid
per Share
(or Unit)

  Total
Number of
Shares (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs (2)

  Maximum
Number (or
Approximate
Dollar Value) of
Shares (or Units)
that May Yet
Be Purchased
Under the Plans
or Programs

October 1, 2004 to October 31, 2004     $     43,465,506
November 1, 2004 to November 30, 2004   2,447     40.83     43,465,506
December 1, 2004 to December 31, 2004   11,307     41.25     43,465,506
   
             
Total   13,754     41.18     43,465,506

(1)
In addition to shares repurchased pursuant to our publicly announced repurchase program, this column includes shares acquired under equity compensation arrangements with the Company's employees and directors.
(2)
Effective July 15, 2003, the Company adopted a share repurchase program approved by the Board of Directors. Under the program, the Company is authorized to repurchase up to 100 million shares of its common stock, as conditions warrant. As of September 30, 2004, the Company had repurchased 56,534,494 shares.

13



MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    Discontinued Operations

        In January 2004, the Company sold its subsidiary, Washington Mutual Finance Corporation, for approximately $1.30 billion in cash. Accordingly, Washington Mutual Finance is presented in this report as a discontinued operation with the results of operations and cash flows segregated from the Company's results of continuing operations for all periods presented on the Consolidated Statements of Income, Cash Flows and Notes to the Consolidated Financial Statements as well as the tables presented herein, unless otherwise noted. Likewise, the assets and liabilities of Washington Mutual Finance are presented as separate captions on the Consolidated Statements of Financial Condition.

Controls and Procedures

        The Company's management, under the direction of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934.

        We review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and improve our controls and procedures over time and correct any deficiencies that we may discover. While we believe the present design of our disclosure controls and procedures is effective, future events affecting our business may cause us to modify our disclosure controls and procedures.

        There have not been any changes in the Company's internal controls over financial reporting during the fourth quarter of 2004 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. For additional discussion of the Company's internal controls over financial reporting, refer to Management's Report on Internal Control Over Financial Reporting on page 73.

Overview

        Net income for 2004 was $2.88 billion, or $3.26 per diluted share, a decrease from $3.88 billion, or $4.21 per diluted share in 2003. The decline was largely the result of lower net interest income and home loan mortgage banking income. Included in earnings for 2004 was an after-tax gain of $399 million, or 45 cents per diluted share, from the first quarter sale and disposal of the Company's consumer finance subsidiary, Washington Mutual Finance. This subsidiary contributed $87 million, or 9 cents per diluted share, to earnings in 2003.

        Net interest income was $7.12 billion in 2004, compared with $7.63 billion in 2003. The decrease was primarily due to contraction in the net interest margin, which declined from 3.11% in 2003 to 2.82% in 2004. This 29 basis point decline was largely the result of declining asset yields during the first half of 2004 and a decline in noninterest-bearing custodial and escrow balances that resulted from much lower levels of mortgage refinancing activity. The effect of declines in asset yields and noninterest-bearing custodial and escrow balances on the net interest margin was partially offset by a decrease in funding costs on interest-bearing liabilities. This was largely the result of actions taken during 2004 that resulted in the early termination of certain higher cost repurchase agreements and Federal Home Loan Bank ("FHLB") advances and lower rates paid on interest-bearing checking accounts. In particular, the average rate paid on Platinum checking accounts declined from 1.83% in 2003 to 1.39% in 2004.

        As domestic economic indicators continued to strengthen in 2004, the Federal Reserve took steps to reduce the potential threat of inflation by initiating a series of 25 basis point increases in the targeted

14



federal funds rate. As a result this benchmark interest rate, which was at a modern-day historical low of 1.00% during the first half of the year, increased to 2.25% by the end of 2004. As our adjustable-rate loans and securities reprice to current market rates more slowly than our wholesale borrowing sources, we expect the net interest margin will contract further while the Company's interest-sensitive assets and liabilities adjust to the higher interest rate environment. The contraction is likely to be more significant if the Federal Reserve initiates further rate increases at a more accelerated pace, or if competitive conditions require the Company to increase rates offered on its deposit products.

        Home loan mortgage banking income was $1.39 billion in 2004, a decrease of $587 million from $1.97 billion in 2003. As mortgage rates during 2004 stayed above the historical low levels reached during 2003, refinancing activity, which in 2003 was primarily comprised of fixed-rate mortgages that were sold in the secondary market, declined significantly. This resulted in a decline in gain from mortgage loans from $1.25 billion in 2003 to $649 million in 2004. During the latter part of 2003, higher long-term interest rates widened the interest rate differential between adjustable-rate mortgages and fixed-rate loan products, which shifted customer preferences for the financing of home purchases to adjustable-rate products. This change in customer preferences also continued throughout 2004, and resulted in a substantial increase in loan volume for the Company's signature adjustable-rate home loan product, the Option ARM. The strong customer demand for this product during 2004 allowed the Company to direct over $31 billion of Option ARM volume for sale to the secondary market, while still retaining a majority of the volume for the loan portfolio.

        Continued strong levels of home sales, stable or rising home prices in most of the Company's markets and an upward-sloping yield curve fueled adjustable-rate mortgage growth in the total home loan portfolio, which increased from $113.02 billion at December 31, 2003 to $129.13 billion at December 31, 2004. In addition to the strong demand for adjustable-rate mortgages, the Company also grew its portfolio of purchased subprime home loans during 2004. This portfolio, which totaled $12.97 billion at the end of 2003, increased to $19.14 billion at December 31, 2004. Strong home equity loan and line of credit volume that was generated primarily through the Company's retail banking network was also a significant contributor to growth in our loan portfolio in 2004. Outstanding home equity loan and line of credit balances have increased by $16.00 billion, or 58%, since December 31, 2003.

        We continue to grow our retail banking business by opening new stores and enhancing our product suite. Total transaction accounts, which consist of checking and savings accounts for consumers and small businesses, increased by nearly 1.3 million during 2004. We achieved our goal of opening 250 new stores during the year, and we plan to continue this pace of expansion by adding 250 more stores in our existing markets during 2005.

        The Company achieved its target of holding 2004 noninterest expense essentially flat with expenses incurred during 2003. This goal was attained through a cost containment initiative that was launched in the fourth quarter of 2003. In 2004, this initiative was primarily directed at reducing the fixed cost structure of the mortgage banking business through employee headcount reductions and facilities closures. By the end of that year, this initiative had resulted in cumulative headcount reductions of approximately 10,000 with an additional 300 who had received termination notices as of that date. The primary components of noninterest expense that have been impacted by this initiative are compensation and benefits expense due to the headcount reductions and severance charges associated with those reductions, and occupancy and equipment expense due to facilities closures. As planned, the cost savings from this initiative have offset expenses incurred from the continuing expansion of the retail banking franchise.

        Improving the cost structure of our mortgage banking business will continue to be an area of focus in the foreseeable future. Two significant milestones that streamlined the cost structure of this business occurred during the third quarter of 2004, when the Company completed its conversion of all home loan customer records onto a single servicing system and consolidated 12 mortgage banking loan fulfillment centers into the 34 remaining centers and reduced staffing levels at those remaining locations. The Company also announced in that quarter that the mortgage banking business will focus its activities in

15



markets in which the Company believes it can optimize its retail banking cross-selling opportunities. This initiative resulted in the sale or closure of approximately 100 retail mortgage lending offices.

        The Company also determined during the third quarter that the Commercial Group will exit certain activities that are no longer aligned with the Company's strategic objectives. These activities include home construction loans made to builders and commercial loans made to companies whose annual revenues typically exceed $5 million. This initiative resulted in the closure of 53 commercial banking locations and the elimination of approximately 850 positions.

16


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 facts and circumstances as of December 31, 2004.

        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 two 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 MSR and the methodology that determines our allowance for loan and lease losses. The table below represents information about the nature of and rationale for the Company's critical accounting estimates:


Critical
Accounting
Policy

  Consolidated
Statements
of Financial
Condition Caption

  Consolidated
Statements of
Income Caption

  Nature of Estimates Required
  Reference

Fair value of mortgage servicing rights   Mortgage servicing rights   Home loan mortgage banking income (expense): Mortgage servicing rights valuation adjustments   Determining the fair value of our MSR requires us to anticipate future prepayment speeds. The Company's loan servicing portfolio is subject to prepayment risk, which subjects our MSR to impairment risk.


The fair value of our MSR is estimated using a discounted cash flow model. The discounted cash flow model calculates the present value of the estimated future net cash flows of the servicing portfolio based on various assumptions, such as servicing costs, expected prepayment speeds and discount rates. This model is highly sensitive to changes in assumptions. Changes in anticipated prepayment speeds, in particular, result in substantial fluctuations in the estimated fair value of MSR. If actual prepayment experience differs from the anticipated rates used in the Company's model, this difference may result in a material change in MSR fair value.


While the Company's model estimates a value, the specific value used is based on a variety of factors, such as documented observable data and anticipated changes in market conditions. All assumptions are based on standards used by market participants in valuing MSR. The reasonableness of these assumptions is evaluated through quarterly independent broker surveys. Independent appraisals of the fair value of our servicing portfolio are obtained periodically, but not less frequently than quarterly, and are used by management to evaluate the reasonableness of the fair value estimates.
  Limitations to the measurement of MSR fair value and the key economic assumptions and the sensitivity of the current fair value for home loans' MSR to immediate changes in those assumptions are described in the subsequent section of Management's Discussion and Analysis – "Earnings Performance" on page 29 and in Note 6 to the Consolidated Financial Statements – "Mortgage Banking Activities."

17



Critical
Accounting
Policy

  Consolidated
Statements
of Financial
Condition Caption

  Consolidated
Statements of
Income Caption

  Nature of Estimates Required
  Reference

Allowance for loan and lease losses   Allowance for loan and lease losses   Provision for loan and lease losses   The allowance for loan and lease losses represents management's estimate of incurred credit losses inherent in the Company's loan and lease portfolios as of the balance sheet date. The estimation of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of our borrowers, adverse situations that have occurred that may affect the borrowers' ability to repay, the estimated value of underlying collateral, the interest rate climate as it affects adjustable-rate loans and general economic conditions. Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing may result in significant changes in the allowance for loan and lease losses in future periods.   The estimates and judgments are described in further detail in the subsequent section of Management's Discussion and Analysis – "Credit Risk Management" on page 45 and in Note 1 to the Consolidated Financial Statements – "Summary of Significant Accounting Policies."

        Management has discussed the development and selection of these critical accounting policies with the Company's Audit Committee. The Company no longer considers its accounting policy for interest rate lock commitments on loans to be held for sale to be critical as the value of the expected servicing rights that the Company retains when the underlying loans are sold is no longer recognized at the issuance of the rate lock as prescribed by the guidance issued in Securities and Exchange Commission Staff Accounting Bulletin No. 105, which the Company applied as of January 1, 2004. The Company also no longer considers its accounting policy for net periodic benefit cost recognized under postretirement benefit plans to be critical as the effect of changes in the assumptions used to calculate this amount would not be expected to have a material effect on the Consolidated Statements of Income. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussion and Analysis and in Note 1 to the Consolidated Financial Statements – "Summary of Significant Accounting Policies."

Recently Issued Accounting Standards

        In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3 ("SOP 03-3"), Accounting for Certain Loans or Debt Securities Acquired in a Transfer . SOP 03-3 addresses the accounting for differences between the contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality. SOP 03-3 does not permit the carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows expected to be collected. To the extent that the purchased loans experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. The Company does not expect the adoption of SOP 03-3 to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

        In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("Statement") No. 153, Exchanges of Nonmonetary Assets . Statement

18



No. 153 addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets of Accounting Principals Bulletin ("APB") Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, and is not expected to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

        In December 2004, the FASB issued a revised version of the original Statement No. 123, Accounting for Stock-Based Compensation. Statement No. 123R, Share-Based Payment , supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This Statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This Statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair value-based measurement method in accounting for share-based payment transactions with employees, except for equity instruments held by employee stock ownership plans. Effective January 1, 2003 and in accordance with the transitional guidance of Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, the Company elected to prospectively apply the fair value method of accounting for stock-based awards granted subsequent to December 31, 2002. The Company is still in the process of evaluating the impact of Statement No. 123R which will be prospectively applied as of July 1, 2005. However, as the Company has already adopted Statement No. 148 and stock-based awards generally vest at the end of a three-year period, only those awards issued during 2002 that have not yet vested will be affected by Statement No. 123R. As such, the Company does not expect this Statement to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

19


Five-Year Summary of Selected Financial Data

 
  December 31,
 
  2004
  2003
  2002
  2001
  2000
 
  (in millions, except per share amounts)

Income Statement Data (for the year ended)                              
  Net interest income   $ 7,116   $ 7,629   $ 8,129   $ 6,492   $ 3,952
  Provision for loan and lease losses     209     42     404     426     77
  Noninterest income     4,612     5,850     4,469     3,176     1,925
  Noninterest expense     7,535     7,408     6,188     4,416     2,970
  Net income     2,878     3,880     3,861     3,104     1,871
  Basic earnings per common share (1) :                              
    Income from continuing operations     2.88     4.20     4.01     3.57     2.24
    Income from discontinued operations, net     0.46     0.09     0.08     0.07     0.09
   
 
 
 
 
    Net income     3.34     4.29     4.09     3.64     2.33
  Diluted earnings per common share (1) :                              
    Income from continuing operations     2.81     4.12     3.94     3.51     2.23
    Income from discontinued operations, net     0.45     0.09     0.08     0.07     0.09
   
 
 
 
 
    Net income     3.26     4.21     4.02     3.58     2.32
  Dividends declared per common share (1)     1.74     1.40     1.06     0.90     0.76
Balance Sheet Data (at year end)                              
  Securities   $ 19,219   $ 36,707   $ 43,905   $ 58,233   $ 58,547
  Loans held for sale     42,743     20,837     39,623     27,574     3,404
  Loans held in portfolio     207,071     175,150     143,028     126,396     115,898
  Mortgage servicing rights     5,906     6,354     5,341     6,241     1,017
  Goodwill     6,196     6,196     6,213     2,116     919
  Assets     307,918     275,178     268,225     242,468     194,688
  Deposits     173,658     153,181     155,516     106,946     79,384
  Securities sold under agreements to repurchase     15,944     28,333     16,717     39,447     29,756
  Advances from Federal Home Loan Banks     70,074     48,330     51,265     61,072     57,698
  Other borrowings     18,498     15,483     14,712     9,925     7,734
  Stockholders' equity     21,226     19,742     20,061     14,025     10,138
Supplemental Data                              
  Loan volume:                              
    Home loans:                              
      Adjustable rate   $ 103,305   $ 99,899   $ 84,627   $ 37,224   $ 37,286
      Fixed rate     77,723     263,604     180,745     108,105     6,631
      Specialty mortgage finance (2)     31,334     20,678     14,077     10,333     7,549
   
 
 
 
 
    Total home loan volume     212,362     384,181     279,449     155,662     51,466
    Total loan volume     266,733     432,245     309,419     172,951     62,973

(1)
Restated for all stock splits.
(2)
Represents purchased subprime loan portfolios and mortgages originated by Long Beach Mortgage Company.

20


Ratios and Other Supplemental Data

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (dollars in millions, except per share amounts)

 
Profitability                    
  Return on average assets (1)     1.01 %   1.37 %   1.42 %
  Return on average common stockholders' equity (1)     14.02     18.85     19.34  
  Net interest margin     2.82     3.11     3.41  
  Efficiency ratio (2)(3)     64.25     54.96     49.12  
Asset Quality                    
  Nonaccrual loans (4)(5)   $ 1,534   $ 1,626   $ 2,155  
  Foreclosed assets (4)     261     311     328  
   
 
 
 
    Total nonperforming assets (4)(5)     1,795     1,937     2,483  
  Nonperforming assets/total assets (4)(5)     0.58 %   0.70 %   0.93 %
  Restructured loans (4)   $ 34   $ 111   $ 98  
   
 
 
 
    Total nonperforming assets and restructured loans (4)(5)     1,829     2,048     2,581  
  Allowance for loan and lease losses (4)     1,301     1,250     1,503  
  Allowance as a percentage of total loans held in portfolio (4)     0.63 %   0.71 %   1.05 %
  Net charge-offs   $ 135   $ 309   $ 248  
Capital Adequacy (4)                    
  Stockholders' equity/total assets     6.89 %   7.17 %   7.48 %
  Tangible common equity (6) /total tangible assets (6)     5.05     5.26     5.26  
  Estimated total risk-based capital/risk-weighted assets (7)     11.34     10.94     11.53  
Per Common Share Data                    
  Number of common shares outstanding at end of period (in thousands)     874,262     880,986     944,047  
  Common stock dividend payout ratio     52.10 %   32.63 %   25.92 %
  Book value per common share (4)(8)   $ 24.45   $ 22.56   $ 21.66  
  Market prices:                    
    High     45.28     46.55     39.45  
    Low     37.63     32.98     28.41  
    Year end     42.28     40.12     34.53  

(1)
Includes income from continuing and discontinued operations.
(2)
Based on continuing operations.
(3)
The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(4)
As of year end.
(5)
Excludes nonaccrual loans held for sale.
(6)
Excludes unrealized net gain/loss on available-for-sale securities and derivatives, goodwill and intangible assets, but includes MSR.
(7)
Estimate of what the total risk-based capital ratio would be if Washington Mutual, Inc. were a bank holding company that is subject to Federal Reserve Board capital requirements.
(8)
Excludes 6 million shares at December 31, 2004 and 2003, and 18 million shares at December 31, 2002, held in escrow.

21


Earnings Performance from Continuing Operations

    Net Interest Income

        For 2004, net interest income decreased $513 million, or 7%, compared with 2003. The decrease resulted primarily from contraction of the net interest margin, which declined 29 basis points from the year ended December 31, 2003. Yields on interest-earning assets declined through the first half of 2004, reflecting the sale and runoff of higher yielding loans and debt securities during that period and diminished levels of refinancing activity, which led to a decline in noninterest-bearing custodial and escrow balances throughout the year. The decline in net interest income was partially offset by growth in home loans and home equity loans and lines of credit balances and by lower rates on interest-bearing Platinum checking accounts and wholesale borrowings.

        For 2003, net interest income decreased $500 million, or 6%, compared with 2002. The decrease resulted from a 30 basis point decline in the net interest margin. Yields on interest-earning assets declined as loans and debt securities repriced downward from the higher interest rate environment of 2002. The decline in the net interest margin was partially offset by decreases in the rates paid on interest-bearing deposits. The free funding impact of noninterest-bearing sources that resulted from high average custodial balances also partially offset the contraction in the margin for 2003.

        Interest rate contracts, including embedded derivatives, held for asset/liability interest rate risk management purposes decreased net interest income by $222 million in 2004. Interest rate contracts, including embedded derivatives, decreased net interest income by $617 million in 2003 and by $424 million in 2002.

22



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

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  Average
Balance

  Rate
  Interest
Income

  Average
Balance

  Rate
  Interest
Income

  Average
Balance

  Rate
  Interest
Income

 
  (dollars in millions)

Assets                                                
Interest-earning assets:                                                
  Federal funds sold and securities purchased under agreements to resell   $ 884   1.42 % $ 13   $ 2,570   1.45 % $ 37   $ 2,352   1.70 % $ 40
  Trading securities     2,368   6.39     151     1,235   6.78     84     239   16.41     39
  Available-for-sale securities (1) :                                                
    Mortgage-backed securities     10,255   3.99     409     20,977   4.91     1,030     24,654   5.46     1,345
    Investment securities     10,732   3.30     355     18,742   3.77     708     32,387   4.96     1,606
  Loans held for sale (2)     29,721   4.95     1,472     45,438   5.51     2,501     31,080   6.18     1,921
  Loans held in portfolio (2) (3) :                                                
    Loans secured by real estate:                                                
      Home     107,518   4.21     4,529     86,443   4.77     4,124     86,039   5.90     5,077
      Purchased subprime     15,767   4.84     763     10,794   5.43     586     9,028   6.27     566
   
     
 
     
 
     
        Total home loans     123,285   4.29     5,292     97,237   4.84     4,710     95,067   5.94     5,643
      Home equity loans and lines of credit     35,859   4.69     1,683     21,163   4.98     1,053     13,382   5.91     790
      Home construction (4)     2,489   5.50     137     2,062   5.90     122     2,222   6.85     152
      Multi-family     21,090   4.96     1,046     19,409   5.30     1,029     17,973   6.01     1,081
      Other real estate     6,396   5.94     380     7,243   6.35     460     8,368   6.83     572
   
     
 
     
 
     
        Total loans secured by real estate     189,119   4.51     8,538     147,114   5.01     7,374     137,012   6.01     8,238
    Consumer     899   10.11     91     1,208   8.87     107     2,340   9.41     220
    Commercial business     4,415   4.43     196     4,165   4.49     187     4,097   5.19     213
   
     
 
     
 
     
        Total loans held in portfolio     194,433   4.54     8,825     152,487   5.03     7,668     143,449   6.04     8,671
  Other     4,108   3.05     125     3,874   3.47     135     4,274   5.46     233
   
     
 
     
 
     
        Total interest-earning assets     252,501   4.50     11,350     245,323   4.96     12,163     238,435   5.81     13,855
Noninterest-earning assets:                                                
  Mortgage servicing rights     6,406               5,721               6,650          
  Goodwill     6,196               6,198               5,996          
  Other assets (5)     18,975               25,877               20,339          
   
           
           
         
        Total assets   $ 284,078             $ 283,119             $ 271,420          
   
           
           
         

(This table is continued on 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 $351 million, $314 million, and $246 million for the years ended December 31, 2004, 2003 and 2002.
(4)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.
(5)
Includes assets of continuing and discontinued operations.

23


 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  Average
Balance

  Rate
  Interest
Expense

  Average
Balance

  Rate
  Interest
Expense

  Average
Balance

  Rate
  Interest
Expense

 
  (dollars in millions)

Liabilities                                                
Interest-bearing liabilities:                                                
  Deposits:                                                
    Interest-bearing checking deposits   $ 59,826   1.28 % $ 766   $ 62,723   1.69 % $ 1,057   $ 40,338   2.55 % $ 1,028
    Savings and money market deposits     35,927   1.11     399     28,085   0.94     263     31,529   1.48     466
    Time deposits     35,917   2.44     878     31,416   2.69     845     37,253   3.13     1,167
   
     
 
     
 
     
      Total interest-bearing deposits     131,670   1.55     2,043     122,224   1.77     2,165     109,120   2.44     2,661
  Federal funds purchased and commercial paper     3,522   1.50     53     3,158   1.18     37     2,976   1.90     57
  Securities sold under agreements to repurchase     16,660   2.26     377     22,318   2.44     545     34,830   2.31     804
  Advances from Federal Home Loan Banks     58,622   2.16     1,268     49,441   2.62     1,296     59,369   2.82     1,676
  Other     13,724   3.59     493     13,315   3.68     491     12,172   4.34     528
   
     
 
     
 
     
      Total interest-bearing liabilities     224,198   1.89     4,234     210,456   2.15     4,534     218,467   2.62     5,726
   
     
 
     
 
     
Noninterest-bearing sources:                                                
  Noninterest-bearing deposits     33,738               41,361               25,396          
  Other liabilities (6)     5,614               10,724               7,624          
  Stockholders' equity     20,528               20,578               19,933          
   
           
           
         
      Total liabilities and stockholders' equity   $ 284,078             $ 283,119             $ 271,420          
   
           
           
         
Net interest spread and net interest income         2.61   $ 7,116         2.81   $ 7,629         3.19   $ 8,129
             
           
           
Impact of noninterest-bearing sources         0.21               0.30               0.22      
Net interest margin         2.82               3.11               3.41      

(6)
Includes liabilities of continuing and discontinued operations.

24


        The dollar amounts of interest income and interest expense fluctuate depending upon changes in interest rates and upon changes in the volume of our 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) which were allocated proportionately to the changes in volume and the changes in rate and included in the relevant column below were as follows:

 
  2004 vs. 2003
  2003 vs. 2002
 
 
  Increase/(Decrease)
Due to

   
  Increase/(Decrease)
Due to

   
 
 
  Total
Change

  Total
Change

 
 
  Volume
  Rate
  Volume
  Rate
 
 
  (in millions)

 
Interest Income                                      
Federal funds sold and securities purchased under agreements to resell   $ (24 ) $   $ (24 ) $ 3   $ (6 ) $ (3 )
Trading securities     73     (6 )   67     80     (35 )   45  
Available-for-sale securities:                                      
  Mortgage-backed securities     (454 )   (167 )   (621 )   (189 )   (126 )   (315 )
  Investment securities     (273 )   (80 )   (353 )   (573 )   (325 )   (898 )
Loans held for sale     (798 )   (231 )   (1,029 )   808     (228 )   580  
Loans held in portfolio:                                      
  Loans secured by real estate:                                      
    Home     926     (521 )   405     24     (977 )   (953 )
    Purchased subprime     246     (69 )   177     102     (82 )   20  
   
 
 
 
 
 
 
      Total home loans     1,172     (590 )   582     126     (1,059 )   (933 )
    Home equity loans and lines of credit     693     (63 )   630     403     (140 )   263  
    Home construction (1)     24     (9 )   15     (10 )   (20 )   (30 )
    Multi-family     86     (69 )   17     82     (134 )   (52 )
    Other real estate     (52 )   (28 )   (80 )   (74 )   (38 )   (112 )
   
 
 
 
 
 
 
      Total loans secured by real estate     1,923     (759 )   1,164     527     (1,391 )   (864 )
  Consumer     (30 )   14     (16 )   (101 )   (12 )   (113 )
  Commercial business     11     (2 )   9     3     (29 )   (26 )
   
 
 
 
 
 
 
      Total loans held in portfolio     1,904     (747 )   1,157     429     (1,432 )   (1,003 )
Other     7     (17 )   (10 )   (19 )   (79 )   (98 )
   
 
 
 
 
 
 
      Total interest income     435     (1,248 )   (813 )   539     (2,231 )   (1,692 )
Interest Expense                                      
Deposits:                                      
  Interest-bearing checking deposits     (47 )   (244 )   (291 )   450     (421 )   29  
  Savings and money market deposits     82     54     136     (45 )   (158 )   (203 )
  Time deposits     114     (81 )   33     (169 )   (153 )   (322 )
   
 
 
 
 
 
 
      Total deposits     149     (271 )   (122 )   236     (732 )   (496 )
Federal funds purchased and commercial paper     5     11     16     3     (23 )   (20 )
Securities sold under agreements to repurchase     (130 )   (38 )   (168 )   (304 )   45     (259 )
Advances from Federal Home Loan Banks     218     (246 )   (28 )   (266 )   (114 )   (380 )
Other     15     (13 )   2     47     (84 )   (37 )
   
 
 
 
 
 
 
      Total interest expense     257     (557 )   (300 )   (284 )   (908 )   (1,192 )
   
 
 
 
 
 
 
Net interest income   $ 178   $ (691 ) $ (513 ) $ 823   $ (1,323 ) $ (500 )
   
 
 
 
 
 
 

(1)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

25


    Noninterest Income

        Noninterest income from continuing operations consisted of the following:

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (in millions)

   
   
 
Home loan mortgage banking income (expense):                            
  Loan servicing income (expense):                            
    Loan servicing fees   $ 1,950   $ 2,273   $ 2,237   (14 )% 2 %
    Amortization of MSR     (2,521 )   (3,269 )   (2,616 ) (23 ) 25  
    MSR valuation adjustments:                            
      Statement No. 133 MSR accounting valuation adjustments     699              
      Statement No. 133 fair value hedging adjustments (1)     (468 )            
   
 
 
         
      MSR net ineffectiveness under Statement No. 133     231              
      MSR lower of cost or market adjustment     (466 )   712     (3,219 )    
   
 
 
         
        Net MSR valuation adjustments     (235 )   712     (3,219 )    
    Other, net (2)     (279 )   (592 )   (271 ) (53 ) 118  
   
 
 
         
        Net loan servicing expense     (1,085 )   (876 )   (3,869 ) 24   (77 )
  Revaluation gain from derivatives     1,011     338     2,517   199   (87 )
  Net settlement income from certain interest-rate swaps     538     543     382   (1 ) 42  
  Gain from mortgage loans     649     1,250     1,375   (48 ) (9 )
  Loan related income     272     399     268   (32 ) 49  
  Gain from sale of originated mortgage-backed securities     2     320     34   (99 ) 841  
   
 
 
         
        Total home loan mortgage banking income     1,387     1,974     707   (30 ) 179  
Depositor and other retail banking fees     1,999     1,818     1,634   10   11  
Securities fees and commissions     426     395     362   8   9  
Insurance income     226     188     155   20   21  
Portfolio loan related income     401     439     349   (9 ) 26  
Trading securities income     89     116     156   (23 ) (26 )
Gain from other available-for-sale securities     50     676     768   (93 ) (12 )
Gain (loss) on extinguishment of borrowings     (237 )   (129 )   282   84    
Other income     271     373     56   (27 ) 566  
   
 
 
         
        Total noninterest income   $ 4,612   $ 5,850   $ 4,469   (21 ) 31  
   
 
 
         

(1)
Represents changes in fair value of derivatives designated as MSR fair value hedges.
(2)
Includes loan pool expenses, which represent the shortfall of what is remitted to investors compared to what is collected from the borrowers.

    Home Loan Mortgage Banking Income

        The decrease in home loan servicing fees for the year ended December 31, 2004 was the result of the decrease in our loans serviced for others portfolio and a steady decline in the average servicing fee per loan in 2003. Our loans serviced for others portfolio decreased during the second half of 2003 as the Company's loan volume mix began to shift from loans that are designated for sale and sold to loans that are retained in the portfolio. As such, the volume of new salable loan production was lower than the paydown rate of the servicing portfolio.

        The weighted average servicing fee decreased from 38 basis points at the end of the first quarter of 2003 to 34 basis points at the end of the fourth quarter of 2003 primarily due to transactions in which a portion of the future contractual servicing cash flows were securitized and sold to third parties. These transactions decreased the net MSR balance by $628 million during 2003, but had no impact on the unpaid principal balance of the loans serviced for others portfolio.

26


        The following table presents the aggregate valuation adjustments for the MSR and the corresponding hedging and risk management derivative instruments and securities, and amortization of the MSR during the years ended December 31, 2004, 2003 and 2002:

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (in millions)

 
Statement No. 133 MSR accounting valuation adjustments   $ 699   $   $  
Change in value of MSR accounted for under lower of cost or market value methodology     (466 )   712     (3,219 )
   
 
 
 
    Total MSR valuation changes     233     712     (3,219 )
Statement No.133 fair value hedging adjustments (1)     (468 )        
MSR risk management:                    
  Revaluation gain from derivatives     931     526     2,645  
  Net settlement income from certain interest-rate swaps     538     514     382  
  Gain from securities     82     305     795  
  Gain on extinguishment of borrowings             257  
   
 
 
 
    Net valuation change in hedging and risk management instruments     1,083     1,345     4,079  
Amortization of MSR     (2,521 )   (3,269 )   (2,616 )
      Total change in MSR valuation, net of hedging and risk management instruments and amortization   $ (1,205 ) $ (1,212 ) $ (1,756 )
   
 
 
 

(1)
Represents changes in fair value of derivatives designated as MSR fair value hedges.

        The following tables separately present the risk management results associated with the economic hedges of MSR, loans held for sale and other risk management activities included within noninterest income during the years ended December 31, 2004, 2003 and 2002:

 
  Year Ended December 31, 2004
 
  MSR
  Loans Held
for Sale

  Other
  Total
 
  (in millions)

Revaluation gain from derivatives   $ 931   $ 80   $   $ 1,011
Net settlement income from certain interest-rate swaps     538             538
Gain from securities:                        
  Gain from other available-for-sale securities     1         49     50
  Trading securities income     81 (1)       8     89
   
 
 
 
    Total   $ 1,551   $ 80   $ 57   $ 1,688
   
 
 
 

(1)
Represents revaluation gains from principal-only mortgage-backed securities.

 
  Year Ended December 31, 2003
 
  MSR
  Loans Held
for Sale

  Other
  Total
 
  (in millions)

Revaluation gain (loss) from derivatives   $ 526   $ (188 ) $   $ 338
Net settlement income from certain interest-rate swaps     514     29         543
Gain from securities:                        
  Gain from other available-for-sale securities     305         371     676
   
 
 
 
    Total   $ 1,345   $ (159 ) $ 371   $ 1,557
   
 
 
 
 
  Year Ended December 31, 2002
 
  MSR
  Loans Held
for Sale

  Other
  Total
 
  (in millions)

Revaluation gain (loss) from derivatives   $ 2,645   $ (128 ) $   $ 2,517
Net settlement income from certain interest-rate swaps     382             382
Gain (loss) from securities:                        
  Gain (loss) from other available-for-sale securities     795         (27 )   768
Gain on extinguishment of borrowings     257         25     282
   
 
 
 
    Total   $ 4,079   $ (128 ) $ (2 ) $ 3,949
   
 
 
 

27


        Revaluation gain (loss) from derivatives is the earnings impact of the changes in fair value from certain derivatives where the Company either has not attempted to achieve, or has attempted but did not achieve, hedge accounting treatment under Statement No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities .

        The Company began applying fair value hedge accounting treatment, as prescribed by Statement No. 133, as of April 1, 2004 to most of its MSR. The application of this guidance results in netting of the changes in fair value of the hedged MSR with the changes in fair value of the hedging derivative in the Consolidated Statements of Income, to the extent the hedge relationship is determined to be highly effective. We use conventional statistical methods of correlation to determine if the results of the changes in value of the hedged MSR and the hedging derivative meet the Statement No. 133 criteria for a highly effective hedge accounting relationship. Under lower of cost or market value accounting, impairment is recognized through a valuation allowance. The portion of the MSR in which the hedging relationship is determined not to be highly effective will continue to be accounted for at the lower of cost or market value.

        During 2004, the Company recorded an other-than-temporary MSR impairment of $895 million on the MSR asset. This amount was determined by applying an appropriate interest rate shock to the MSR in order to estimate the amount of the valuation allowance we may expect to recover in the foreseeable future. To the extent that the gross carrying value of the MSR, including the Statement No. 133 valuation adjustments, exceeded the estimated recoverable amount, that portion of the gross carrying value was written off as other-than-temporary impairment. Although the writedowns had no impact on our results of operations or financial condition, they did reduce the gross carrying value of the MSR, which is used as the basis for MSR amortization. The Company recorded other-than-temporary MSR impairment of $1.11 billion in 2003.

        MSR amortization expense was lower in 2004, compared with 2003, due to a decline in the high prepayment rates experienced in the first half of 2003 and the large other-than-temporary MSR impairment recorded in that year. MSR amortization expense was higher in 2003, compared with 2002, due to lower prepayment activity in 2002 and the acquisition of HomeSide in the fourth quarter of 2002, which added approximately $1 billion to the amortization base of MSR.

        The decrease in "Other, net" home loan servicing expense in 2004 and the increase in 2003 resulted from higher loan pool expenses in 2003 due to higher levels of refinancing activity, compared with 2004. When loans that have been sold to investors are prepaid, certain pools governed by the requirements of the pooling and servicing agreements stipulate that we remit a full month of interest to those investors during the month when a loan has prepaid, even though the borrower only pays interest through the payoff date. Pool expense represents the shortfall of what is remitted to those investors compared to what is collected from the borrowers.

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        In evaluating the MSR for impairment, we stratify the loans in our servicing portfolio based on loan type and coupon rate. An impairment valuation allowance for a stratum is recorded when, and in the amount by which, its fair value is less than its gross carrying value. A reversal of the impairment allowance for a stratum is recorded when its fair value exceeds its net carrying value. However, a reversal in any particular stratum cannot exceed its valuation allowance. At December 31, 2004, we stratified the loans in our servicing portfolio as follows:

 
   
  December 31, 2004
 
  Rate Band
  Gross
Carrying
Value

  Valuation
Allowance

  Net
Carrying
Value

  Fair
Value

 
   
  (in millions)

Primary Servicing:                            
  Adjustable   All loans   $ 1,241   $ 143   $ 1,098   $ 1,098
  Government-sponsored enterprises   6.00% and below     2,772     514     2,258     2,258
  Government-sponsored enterprises   6.01% to 7.49%     1,405     639     766     766
  Government-sponsored enterprises   7.50% and above     172     63     109     109
  Government   6.00% and below     474     99     375     375
  Government   6.01% to 7.49%     491     225     266     266
  Government   7.50% and above     226     98     128     128
  Private   6.00% and below     463     28     435     435
  Private   6.01% to 7.49%     261     113     148     148
  Private   7.50% and above     85     28     57     57
       
 
 
 
    Total primary servicing         7,590     1,950     5,640     5,640
Master servicing   All loans     110     17     93     93
Subprime   All loans     154     13     141     141
Multi-family   All loans     33     1     32     32
       
 
 
 
    Total       $ 7,887   $ 1,981   $ 5,906   $ 5,906
       
 
 
 

        The value of our MSR asset is subject to prepayment risk. Future expected net cash flows from servicing a loan in our servicing portfolio will not be realized if the loan pays off earlier than anticipated. Moreover, since most loans within our servicing portfolio do not contain penalty provisions for early payoff, we will not receive a corresponding economic benefit if the loan pays off earlier than expected. MSR represent the discounted present value of the future net cash flows we expect to receive from our servicing portfolio. Accordingly, prepayment risk subjects our MSR to potential impairment.

        We estimate fair value of each MSR stratum using a discounted cash flow model. The discounted cash flow model calculates the present value of the estimated future net cash flows of the servicing portfolio based on various factors, such as servicing costs, expected prepayment speeds and discount rates, about which management must make assumptions based on future expectations. While the Company's model estimates a value, the specific value used is based on a variety of market-based factors, such as documented observable data and anticipated changes in prepayment speeds. The reasonableness of management's assumptions about these factors is evaluated through quarterly independent broker surveys. Independent appraisals of the fair value of our servicing portfolio are obtained periodically, but not less frequently than quarterly, and are used by management to evaluate the reasonableness of the fair value conclusions.

        The fair value of MSR is highly sensitive to changes in assumptions. For example, our determination of fair value uses anticipated prepayment speeds. Actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time. Refer to "Market Risk Management" for

29



discussion of how MSR prepayment risk is managed and to Note 1 to the Consolidated Financial Statements – "Summary of Significant Accounting Policies" for further discussion of how MSR impairment is measured. For a quantitative analysis of key economic assumptions used in measuring the fair value of MSR, and a sensitivity analysis based on changes to those assumptions, see Note 6 to the Consolidated Financial Statements – "Mortgage Banking Activities."

        The Company recorded gain from mortgage loans, net of hedging and risk management instruments, of $729 million in 2004, compared with a net gain of $1.09 billion in 2003 and $1.25 billion in 2002. The decrease of $362 million from 2003 to 2004 was primarily the result of historical low mortgage interest rates during the first part of 2003 which generated extremely high levels of fixed-rate home loan volume, most of which was the result of refinancing activity. When the industry-wide refinancing boom ended later that year, customer preferences began to shift away from fixed-rate loans to adjustable-rate products. Accordingly, the Company's fixed-rate home loan volume declined from $270.50 billion in 2003 to $84.10 billion in 2004. Conversely, short-term adjustable-rate loan volume increased from $32.27 billion in 2003 to $70.16 billion in 2004.

        As part of its normal servicing activities, the Company repurchases delinquent mortgages contained within Government National Mortgage Association ("GNMA") loan servicing pools and, in general, resells them to secondary market participants. Accordingly, gains from the resale of these mortgages are reported as gain from mortgage loans. Gain from the sale of these loans was $156 million in 2004, $369 million in 2003 and $126 million in 2002.

        The fair value changes in loans held for sale and the offsetting changes in the derivative instruments used as fair value hedges are recorded within gain from mortgage loans when hedge accounting treatment is achieved. Loans held for sale where hedge accounting treatment is not achieved ("nonqualifying" loans held for sale) are recorded at the lower of cost or market value. Due to changes in the fair value of derivatives acquired to mitigate the risk of fair value changes to these nonqualifying loans, a net gain of $80 million was recognized as revaluation gain/loss from derivatives during 2004, compared with a net loss of $188 million in 2003 and a net loss of $128 million in 2002. A gain may be recognized when the loans are subsequently sold if the fair value of those loans is higher than the carrying amount. As of December 31, 2004, the fair value of loans held for sale was $43.02 billion with a carrying amount of $42.74 billion. As of December 31, 2003, the fair value and carrying amount of loans held for sale were $20.84 billion, and as of December 31, 2002, the fair value was $39.68 billion with a carrying amount of $39.62 billion.

        Net settlement income from certain interest-rate swaps primarily represents income from our interest-rate swaps that are designated as MSR risk management instruments. At December 31, 2004, the total notional amount of such swaps was $14.91 billion, compared with $30.69 billion at December 31, 2003 and $20.82 billion at December 31, 2002. As the Company has changed the mix of instruments used for hedging activities, the balance of interest-rate swaps has declined.

        Loan related income decreased during 2004 primarily due to decreased fees charged to our correspondent lenders resulting from decreased loan volume. Loan related income increased during 2003 primarily due to increased fees charged to our correspondent lenders and higher levels of late charges on the loans serviced for others portfolio.

    All Other Noninterest Income Analysis

        The increase in depositor and other retail banking fees in 2004 and 2003 was mostly due to higher levels of checking fees that resulted from an increase in the number of noninterest-bearing checking accounts and an increase in debit card interchange and ATM related income. The number of noninterest-bearing checking accounts at December 31, 2004 totaled approximately 7.1 million, compared with approximately 6.5 million at December 31, 2003 and 5.8 million at December 31, 2002.

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        Insurance income increased during 2004 and 2003 predominantly due to the continued growth in our captive reinsurance programs, which are arrangements whereby a third party or primary insurer cedes a percentage of its premiums to the Company and in return the Company agrees to participate in losses, if they were to materialize.

        The growth in portfolio loan related income in 2003 was mostly due to increased late charges on the loan portfolio and high levels of loan prepayment fees as a result of refinancing activity.

        Several securities sold under agreements to repurchase ("repurchase agreements") with embedded pay-fixed swaps were terminated during the third quarter of 2004, resulting in a net loss on extinguishment of borrowings of $147 million. During the first half of 2004, the Company terminated certain pay-fixed swaps hedging variable rate FHLB advances, resulting in a loss of $90 million. During 2003, the Company restructured certain repurchase agreements containing embedded pay-fixed swaps resulting in a loss of $129 million. Each of these transactions had the immediate effect of reducing the Company's wholesale borrowing costs.

        Other income decreased in 2004 compared with 2003 primarily due to a $100 million fee received from Freddie Mac for swapping certain multi-family loans for 100% of the beneficial interest in those loans in the form of mortgage-backed securities in 2003. In addition, the Company completed the sale of the Ahmanson Ranch property to the Mountains Recreation and Conservation Authority of California for $150 million in the fourth quarter of 2003 which resulted in a gain of $77 million. During 2004 the Company also sold certain commercial loans which resulted in gains of $69 million.

    Noninterest Expense

        Noninterest expense from continuing operations consisted of the following:

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (in millions)

   
   
 
Compensation and benefits   $ 3,428   $ 3,304   $ 2,813   4 % 17 %
Occupancy and equipment     1,659     1,592     1,136   4   40  
Telecommunications and outsourced information services     479     554     507   (14 ) 9  
Depositor and other retail banking losses     195     154     179   27   (14 )
Advertising and promotion     276     278     234   (1 ) 19  
Professional fees     158     267     201   (41 ) 33  
Postage     232     220     192   6   15  
Loan expense     199     253     211   (21 ) 20  
Other expense     909     786     715   16   10  
   
 
 
         
  Total noninterest expense   $ 7,535   $ 7,408   $ 6,188   2   20  
   
 
 
         

        The increase in employee compensation and benefits in 2004 over 2003 was primarily due to lower levels of compensation expense that were deferred as direct loan origination costs. The Company also incurred $105 million in charges for severance and benefits expense related to staffing reductions that occurred as part of the Company's cost containment initiative. A decline in compensation and benefits expense that resulted from those staffing reductions substantially offset the overall increase in employee compensation and benefits expense. The increase in 2003 over 2002 was substantially due to higher personnel costs to accommodate the high refinancing activity in the earlier part of 2003 and the opening of new retail banking stores. The number of employees was 52,579 at December 31, 2004 compared with 61,374 at December 31, 2003 and 52,870 at December 31, 2002.

        The increase in occupancy and equipment expense in 2004 resulted primarily from increased equipment depreciation expense and higher building rent expense. Equipment depreciation expense increased by $58 million and building rent expense increased by $41 million as a result of the Company's

31



continued expansion of its retail distribution network, but was partially offset by a decline in technology equipment maintenance expense as a result of the consolidation of systems. The increase in 2003 occurred primarily due to the completion of technology projects. In the fourth quarter of 2003, the Company wrote off approximately $150 million of capitalized costs as a result of its decision to discontinue the development of a loan origination system and to migrate and consolidate its loan origination fulfillment activities onto a smaller complex of preexisting systems.

        Telecommunications and outsourced information services expense decreased in 2004 predominantly due to negotiated reductions in vendor charges, reduced call center volume, and lower costs due to the consolidation of information system platforms related to the Company's cost containment efforts.

        The increase in depositor and other retail banking losses in 2004 was largely due to higher levels of overdraft charge-offs, losses from returned deposited checks and a general increase in debit card and check fraud.

        Professional fees decreased in 2004 over 2003, largely due to a reduction in the use of project consultants. Professional fees increased in 2003 over 2002, primarily as a result of increased consultant usage for technology and corporate services-related projects.

        The decrease in loan expense in 2004 was primarily due to an overall reduction in home loan origination volume for the year. The increase in loan expense in 2003 over 2002 was primarily due to higher loan closing costs and mortgage payoff expenses, which were attributable to an overall increase in loan originations, purchases and refinancing activity.

        The increase in other expense in 2004 was primarily due to lower levels of deferrable consumer and mortgage loan costs, an increase in the accrual for estimated losses related to certain outstanding litigation claims and settlements, higher proprietary mutual funds expense, reinsurance expense and outside services expense. A majority of the increase in other expense during 2003 was due to higher foreclosed assets expense, outside services and charitable contributions.

Review of Financial Condition

    Securities

        Securities included the following:

 
  December 31,
 
  2004
  2003
 
  (in millions)

Available-for-sale securities, total amortized cost of $19,047 and $36,858:            
  Mortgage-backed securities   $ 14,923   $ 10,695
  Investment securities     4,296     26,012
   
 
    Total available-for-sale securities   $ 19,219   $ 36,707
   
 

        Our investment securities decreased $21.72 billion during 2004 predominantly due to the sale of U.S. Government and agency bonds. The proceeds from the sale of these securities were used, in part, to allow for the growth in the loan portfolio. Refer to Note 4 to the Consolidated Financial Statements – "Securities" for additional information on securities, classified by security type.

32


    Loans

        Total loans consisted of the following:

 
  December 31,
 
  2004
  2003
  2002
  2001
  2000
 
  (in millions)

Loans held for sale   $ 42,743   $ 20,837   $ 39,623   $ 27,574   $ 3,404
Loans held in portfolio:                              
  Loans secured by real estate:                              
    Home     109,991     100,043     82,842     79,624     80,181
    Purchased subprime     19,143     12,973     10,128     8,209     5,541
   
 
 
 
 
      Total home loans     129,134     113,016     92,970     87,833     85,722
    Home equity loans and lines of credit     43,650     27,647     16,168     7,970     5,772
    Home construction (1)     2,344     2,220     1,949     2,602     1,431
    Multi-family (2)     22,282     20,324     18,000     15,608     15,657
    Other real estate (3)     5,664     6,649     7,986     6,089     3,920
   
 
 
 
 
      Total loans secured by real estate     203,074     169,856     137,073     120,102     112,502
  Consumer     792     1,028     1,663     2,009     1,669
  Commercial business     3,205     4,266     4,292     4,285     1,727
   
 
 
 
 
      Total loans held in portfolio   $ 207,071   $ 175,150   $ 143,028   $ 126,396   $ 115,898
   
 
 
 
 

(1)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.
(2)
Includes multi-family construction balances of $333 million in 2004, $325 million in 2003, $491 million in 2002, $385 million in 2001 and $90 million in 2000.
(3)
Includes other commercial real estate construction balances of $277 million in 2004, $382 million in 2003, $469 million in 2002, $608 million in 2001 and $177 million in 2000.

        With the increase in short-term adjustable-rate loan volume from $32.27 billion in 2003 to $70.16 billion in 2004, a higher proportion of the 2004 volume was held for sale, resulting in a rise in the balance of loans held for sale at year-end 2004 as compared with 2003. During most of 2003, loans held for sale remained at elevated levels due to the high volume of fixed-rate mortgage refinancing activity, which the Company generally sold to secondary mortgage market participants. As refinancing activity subsided in the latter part of the year, loans held for sale declined sharply, ultimately resulting in a decline in the year-end balance, as compared with the balance at December 31, 2002.

        Our loans held in portfolio increased $31.92 billion at year-end 2004, as compared with 2003 predominantly due to an increase in home loans and home equity loans and lines of credit. Substantially all of the growth in the home loan and home equity loan and line of credit portfolios resulted from the origination of short-term adjustable-rate products. Our short-term adjustable-rate home loans (excluding purchased subprime loans) increased from $54.44 billion at December 31, 2003 to $70.56 billion at December 31, 2004. These loans were predominantly comprised of Option ARM loans.

33



        Home, multi-family and other commercial real estate construction loans and commercial business loans by maturity date were as follows:

 
  December 31, 2004
 
  Due
Within
One Year

  After One
But Within
Five Years

  After
Five Years

  Total
 
  (in millions)

Home construction:                        
  Adjustable rate   $ 1,152   $ 209   $ 1   $ 1,362
  Fixed rate     226     3     753     982
Multi-family construction:                        
  Adjustable rate     158     112     1     271
  Fixed rate     15     27     20     62
Other commercial real estate construction:                        
  Adjustable rate     94     127     32     253
  Fixed rate     18     5     1     24
Commercial business:                        
  Adjustable rate     1,850     801     180     2,831
  Fixed rate     35     258     81     374
   
 
 
 
    Total   $ 3,548   $ 1,542   $ 1,069   $ 6,159
   
 
 
 

    Deposits

        Deposits consisted of the following:

 
  December 31,
 
  2004
  2003
 
  (in millions)

Retail deposits:            
  Checking deposits:            
    Noninterest bearing   $ 17,463   $ 13,724
    Interest bearing     51,099     67,990
   
 
      Total checking deposits     68,562     81,714
  Savings and money market deposits     36,836     22,131
  Time deposits     27,268     24,605
   
 
      Total retail deposits     132,666     128,450
Commercial business deposits     7,611     6,433
Wholesale deposits     18,448     2,579
Custodial and escrow deposits (1)     14,933     15,719
   
 
      Total deposits   $ 173,658   $ 153,181
   
 

(1)
Substantially all custodial and escrow deposits reside in noninterest-bearing checking accounts.

        The increase in noninterest-bearing retail checking deposits was driven by an increase in the number of individual and small business checking accounts. Interest-bearing checking deposits decreased as customers shifted from the Platinum Checking to the Platinum Savings product, resulting in a corresponding increase in savings deposits. The increase in time deposits reflects renewed customer interest as a result of higher interest rates offered for these products. The $15.87 billion increase in wholesale deposits from year-end 2003 was due to an increase in our institutional investor base that resulted primarily from an upgrade in our credit rating from a major rating agency in the early part of 2004, making our wholesale deposit products more attractive.

34



        Transaction accounts (checking, savings and money market deposits) comprised 79% of retail deposits at December 31, 2004, compared with 81% at year-end 2003. These products generally have the benefit of lower interest costs, compared with time deposits. These products represent the core customer relationship that we maintain within our retail banking franchise. Deposits funded 56% of total assets at December 31, 2004 and 2003.

Operating Segments

        The Company has three operating segments: the Retail Banking and Financial Services Group, the Mortgage Banking Group and the Commercial Group. Both the Retail Banking and Financial Services Group and the Mortgage Banking Group are consumer-oriented while the Commercial Group serves commercial customers. In addition, the category of Corporate Support/Treasury and Other includes the Treasury function, which manages the Company's interest rate risk, liquidity, capital, borrowings, and a majority of the Company's investment securities. The Corporate Support function provides facilities, legal, accounting and finance, human resources and technology services.

        We serve the needs of our 11.7 million consumer households through multiple distribution channels including 1,939 retail banking stores, 478 lending stores and centers, 3,350 ATMs, correspondent lenders, telephone call centers and online banking.

        The Retail Banking and Financial Services Group's principal activities include:

    Originating, managing and servicing home equity loans and lines of credit;

    Offering a comprehensive line of deposit and other retail banking products and services to consumers and small businesses;

    Providing investment advisory and brokerage services, sales of annuities, mutual fund management and other financial services; and

    Holding the Company's portfolio of home loans held for investment.

        Deposit products offered by the segment in all its stores include the Company's signature free checking and interest-bearing Platinum checking accounts, as well as other personal checking, savings, money market deposit and time deposit accounts.

        Financial consultants provide investment advisory and securities brokerage services to the public while licensed bank employees offer fixed annuities. The Company's mutual fund management business offers investment advisory and mutual fund distribution services.

        The Retail Banking and Financial Services Group holds loans in portfolio that are originated by the Mortgage Banking Group. Through the Company's specialty mortgage finance operations, the segment also purchases and re-underwrites loans to subprime borrowers. Loans held in portfolio generate interest income and loan-related noninterest income, such as late fees and prepayment fees.

        The Mortgage Banking Group's principal activities include:

    Originating and servicing home loans;

    Buying and selling home loans in the secondary market; and

    Selling insurance-related products and participating in reinsurance activities with other insurance companies.

        Home loans are either originated in the retail and wholesale channels or are purchased from other lenders through the correspondent channel. The profitability of each channel varies over time and our emphasis on each channel varies accordingly. The segment offers a wide variety of home loans, including:

    Fixed-rate home loans;

35


    Adjustable-rate home loans or "ARMs" (where the interest rate may be adjusted as frequently as every month);

    Hybrid home loans (where the interest rate is fixed for a predetermined time period, typically 3 to 5 years, and then converts to an ARM that reprices monthly or annually, depending on the product);

    Option ARMs (a variation on the ARM in which the borrower may select one of four monthly payment options); and

    Government insured or guaranteed home loans.

        From an enterprise-wide perspective, loans are either retained or sold. Loans which are sold generate gain or loss on sale as well as interest income from the time they are funded until the time they are sold, while loans held in portfolio generate interest income and ancillary noninterest income. Fixed-rate home loans, which subject us to more interest rate risk than other types of home loans, are generally sold as part of our overall asset/liability risk management process. The decision to retain or sell other home loan products requires balancing the combination of additional interest income and the interest rate and credit risks inherent with holding loans in portfolio, with the size of the gain or loss that would be realized if the loans were sold. Such decisions are elements of the Company's capital management process.

        For management reporting purposes, all originated home loans are treated as if they are sold. Home loans are either sold to the Retail Banking and Financial Services Group or are sold to secondary market participants, including the housing government-sponsored enterprises – such as the Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie Mac") and the regional branches of the Federal Home Loan Banks. The premium received on inter-segment sales to the Retail Banking and Financial Services Group is based on prices available in the secondary market, adjusted for any hedging costs.

        In addition to selling loans to secondary market participants, the Company generates both interest income and noninterest income by acquiring home loans from a variety of sources, pooling and securitizing those loans, selling the resulting mortgage-backed securities to secondary market participants and providing ongoing servicing and bond administration for all securities issued.

        Mortgage servicing involves the administration and collection of home loan payments. In servicing home loans we collect and remit loan payments, respond to borrower inquiries, apply the collected principal and interest to the individual loans, collect, hold and disburse escrow funds for payment of property taxes and insurance premiums, counsel delinquent customers, supervise foreclosures and property dispositions and generally administer the loans. In return for performing these functions, we receive servicing fees and other remuneration. The Mortgage Banking Group performs home loan servicing activities for substantially all of the Company's managed portfolio – whether the home loans are held in portfolio or have been sold to secondary market participants.

        The Mortgage Banking Group makes insurance products available to its customers that complement the mortgage process, including private mortgage insurance, mortgage life insurance, flood, homeowners', earthquake and other property and casualty insurance. Other types of insurance products made available include accidental death and dismemberment and term and whole life insurance. This segment also manages the Company's captive reinsurance activities.

        The Commercial Group's principal activities include:

    Providing financing to developers and investors for the acquisition or construction of multi-family dwellings and, to a lesser extent, other commercial properties;

    Originating and servicing multi-family and other commercial real estate loans and either holding such loans in portfolio as part of its commercial asset management business or selling them in the secondary market;

    Providing financing to mortgage bankers for the origination of residential loan products; and

36


    Originating, selling and servicing home loans to subprime borrowers through the Company's subsidiary, Long Beach Mortgage Company.

        The multi-family lending business, which accounts for a majority of the Group's revenues, is comprised of three key activities: originating and managing loans retained in the loan portfolio, servicing all originated loans, whether they are retained or sold, and providing ancillary banking services to enhance customer retention. Combining these three activities into one integrated business model has allowed the Commercial Group to become a leading originator and holder of multi-family loans. The Group's multi-family lending program has a market share of more than 20% in certain key cities along the west coast and is building market share on the east coast with offices located in Boston, Washington, D.C., New York, and Miami.

        As part of the Company's specialty mortgage finance operations, the Group also originates home loans to subprime borrowers through the broker network maintained by Long Beach Mortgage, a wholly-owned subsidiary of the Company. The Company sells such loans to secondary market participants, but generally retains the servicing relationship.

        The Corporate Support/Treasury and Other category includes enterprise-wide management of interest rate risk, liquidity, capital, borrowings, and a majority of the Company's investment securities. As part of the Company's asset and liability management process, the Treasury function provides oversight and direction across the enterprise over matters that impact the profile of the Company's balance sheet, such as product composition of loans that we hold in the portfolio, the appropriate mix of wholesale and capital markets borrowings at any given point in time, and the allocation of capital resources to the business segments. This category also includes the costs of the Company's technology services, facilities, legal, human resources, and accounting and finance functions to the extent not allocated to the business segments. Also reported in this category is the net impact of funds transfer pricing for loan and deposit balances and charges incurred from the Company's cost containment initiative.

    Management Accounting Methodologies

        The Company uses various management accounting methodologies, which are enhanced from time to time, 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:

    A funds transfer pricing system, which allocates interest income funding credits and funding charges between the operating segments and the Treasury Division. A segment will receive a funding credit from the Treasury Division for its liabilities and its share of risk-adjusted economic capital. Conversely, a segment is assigned a charge by the Treasury Division to fund its assets. The system is based on the interest rate sensitivities of assets and liabilities and is designed to extract net interest income volatility from the business units and concentrate it in the Treasury Division, where it is managed. Certain basis and other residual risk remains in the operating segments;

    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 is recalibrated periodically to the latest available loan loss experience data. This process differs from the "losses inherent in the loan portfolio" methodology that is used to measure the allowance for loan and lease losses for consolidated reporting purposes. This methodology is used to provide segment management with provision information for strategic decision making;

    The utilization of an activity-based costing approach to measure allocations of certain operating expenses that were not directly charged to the segments;

    The allocation of goodwill and other intangible assets to the operating segments based on benefits received from each acquisition;

37


    Capital charges for goodwill as a component of an internal measurement of return on the goodwill allocated to the operating segment; and

    Inter-segment activities which include the transfer of originated mortgage loans that are to be held in portfolio from the Mortgage Banking Group to the Retail Banking and Financial Services Group and a broker fee arrangement between Mortgage Banking and Retail Banking and Financial Services. When originated mortgage loans are transferred, the Mortgage Banking Group records a gain on the sale of the loans based on an assumed profit factor. This profit factor is included in the value of the transferred loans and is amortized as an adjustment to the net interest income recorded by the Retail Banking and Financial Services Group. Inter-segment broker fees are recorded by the Retail Banking and Financial Services Group when home mortgage loan originations are initiated through retail banking stores, while the Mortgage Banking Group records a broker fee when the origination of home equity loans and lines of credit are initiated through home loan stores. The results of all inter-segment activities are eliminated as reconciling adjustments that are necessary to conform the presentation of management accounting policies to the accounting principles used in the Company's consolidated financial statements.

        Financial highlights by operating segment were as follows:

    Retail Banking and Financial Services Group

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (dollars in millions)

   
   
 
Condensed income statement:                            
  Net interest income   $ 4,989   $ 3,872   $ 3,602   29 % 8 %
  Provision for loan and lease losses     177     183     223   (3 ) (18 )
  Noninterest income     2,758     2,500     2,226   10   12  
  Inter-segment revenue     24     179     96   (87 ) 85  
  Noninterest expense     4,434     3,939     3,550   13   11  
   
 
 
         
  Income before income taxes     3,160     2,429     2,151   30   13  
  Income taxes     1,180     931     825   27   13  
   
 
 
         
    Net income   $ 1,980   $ 1,498   $ 1,326   32   13  
   
 
 
         
Performance and other data:                            
  Efficiency ratio (1)     50.39 %   52.24 %   51.36 % (4 ) 2  
  Average loans   $ 163,329   $ 120,705   $ 113,003   35   7  
  Average assets     175,696     132,427     124,575   33   6  
  Average deposits     130,337     125,440     112,034   4   12  
  Employees at end of period     30,107     29,364     26,880   3   9  

(1)
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).

        The increase in net interest income during 2004 was mostly due to higher average balances of home loans and home equity loans and lines of credit. Average home loans increased $23.21 billion, or 27% in 2004, resulting from portfolio growth in short-term adjustable-rate mortgages. Average home equity loans and lines of credit increased $14.70 billion, or 70% in 2004. The overall increase in 2003 was driven mostly by lower funding costs resulting from the lower interest rate environment, compared with 2002, partially offset by lower interest income from loans that resulted from the downward pricing of the loan portfolio.

        The increases in noninterest income during 2004 and 2003 were primarily driven by depositor and other retail banking fees that resulted from growth in the number of retail checking accounts, an increase in product fee pricing and higher debit card interchange fees. Noninterest-bearing retail checking accounts increased by approximately 600,000 in 2004 and 687,000 in 2003.

38



        Inter-segment revenue declined in 2004 due to lower broker fees received from the Mortgage Banking Group for the origination of mortgage loans, which resulted from the overall decline in refinancing activity during 2004.

        Noninterest expense increases during 2004 and 2003 were primarily due to higher employee compensation and benefits expense, occupancy and equipment expense and technology expenses, all of which resulted from expansion of the Group's distribution network, which included the opening of 250 new retail banking stores in 2004 and 260 new retail banking stores in 2003.

        The increases in average deposits during 2004 and 2003 were largely driven by the growth in interest-bearing Platinum accounts, partially offset by decreases in money market and time deposit accounts.

    Mortgage Banking Group

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (dollars in millions)

   
   
 
Condensed income statement:                            
  Net interest income   $ 1,237   $ 2,382   $ 1,747   (48 )% 36 %
  Provision for loan and lease losses         14       (100 )  
  Noninterest income     2,304     2,986     2,370   (23 ) 26  
  Inter-segment expense     24     179     96   (87 ) 85  
  Noninterest expense     2,607     3,076     2,282   (15 ) 35  
   
 
 
         
  Income before income taxes     910     2,099     1,739   (57 ) 21  
  Income taxes     340     801     652   (58 ) 23  
   
 
 
         
    Net income   $ 570   $ 1,298   $ 1,087   (56 ) 19  
   
 
 
         
Performance and other data:                            
  Efficiency ratio (1)     68.19 %   55.28 %   51.89 % 23   7  
  Average loans   $ 23,591   $ 42,990   $ 29,792   (45 ) 44  
  Average assets     41,938     70,308     49,674   (40 ) 42  
  Average deposits     16,299     27,112     13,583   (40 ) 100  
  Employees at end of period     14,197     22,541     17,845   (37 ) 26  

(1)
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).

        The decrease in net interest income in 2004 was largely driven by a decline in the average balances of loans held for sale and a decline in noninterest-bearing custodial and escrow deposits. This occurred due to a reduction in fixed-rate loan refinancing activity, compared with 2003 when interest rates were at record low levels. Total loan volume in 2004 was $181.03 billion, compared with $363.50 billion in 2003. This decrease was partially offset by lower funding costs.

        The decrease in noninterest income in 2004 was mostly due to lower mortgage banking income resulting from lower gain on sale of mortgage loans. The increase in 2003 was largely due to a recovery of MSR impairment resulting from an increase in mortgage rates during the second half of the year.

        The decline of inter-segment expense in 2004 resulted from lower broker fees paid to the Retail Banking and Financial Services Group for their origination of mortgage loans. Those originations declined in 2004 as a result of the overall decline in refinancing activity, compared with 2003.

        The decrease in noninterest expense in 2004 was primarily due to lower occupancy and equipment, technology and compensation expenses resulting from the Company's cost containment initiative and includes the consolidation of various locations and functions, the conversion to a single loan servicing platform and headcount reductions, which decreased to 14,197 at December 31, 2004 from 22,541 at December 31, 2003. This initiative also resulted in the sale or closure of approximately 100 retail mortgage

39



lending offices in non-strategic markets. These 100 offices accounted for approximately 10% of the retail mortgage network's noninterest expense, approximately 7% of its revenue, approximately 24% of its offices, by number, and approximately 5% of retail home loan volume. The increase in 2003 was mostly driven by increases in compensation and benefits and occupancy expense to support the increased refinancing activity and a write-down of capitalized technology costs.

    Commercial Group

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (dollars in millions)

   
   
 
Condensed income statement:                            
  Net interest income   $ 1,332   $ 1,321   $ 1,179   1 % 12 %
  Provision for loan and lease losses     45     103     177   (57 ) (42 )
  Noninterest income     314     472     504   (33 ) (6 )
  Noninterest expense     639     602     527   6   14  
   
 
 
         
  Income from continuing operations before income taxes     962     1,088     979   (12 ) 11  
  Income taxes     329     392     348   (16 ) 13  
   
 
 
         
  Income from continuing operations     633     696     631   (9 ) 10  
  Income from discontinued operations, net of taxes         87     72   (100 ) 20  
   
 
 
         
    Net income   $ 633   $ 783   $ 703   (19 ) 11  
   
 
 
         
Performance and other data:                            
  Efficiency ratio (1)     31.67 %   26.95 %   24.63 % 18   9  
  Average loans   $ 38,804   $ 35,490   $ 32,691   9   9  
  Average assets     43,990     44,037     39,684     11  
  Average deposits     7,141     5,407     4,014   32   35  
  Employees at end of period (2)     3,100     5,627     5,137   (45 ) 10  

(1)
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).
(2)
Includes 2,346 and 2,330 employees reported as part of discontinued operations at December 31, 2003 and 2002.

        Net interest income was flat in 2004, compared with 2003, as average loan balances increased by approximately $3.31 billion, or 9% resulting from a shift in product mix towards short-term adjustable-rate and hybrid loans, partially offset by a decrease in investment securities interest income due to sales in 2003. The increase in 2003 was mostly due to higher average balances of home loans held for sale and multi-family loans and from lower funding costs.

        The decrease in the provision for loan and lease losses in 2004 was driven by stronger credit performance. During the fourth quarter of 2003 the Company achieved a significant improvement in the risk profile of its loan portfolio by entering into sales transactions to dispose of its franchise finance loan portfolio. These sales led to lower actual charge-offs during 2004 and declining expected charge-off rates for the remaining portfolio of commercial and multi-family loans.

        The difference in noninterest income in 2004, compared with 2003, was substantially due to transactions occurring in the second half of 2003 that resulted in a gain of $68 million recognized from the sale of mortgage-backed securities and a fee of $100 million received as consideration for swapping approximately $6 billion of multi-family loans with Freddie Mac. The decrease in 2003 noninterest income, as compared with 2002, was predominantly due to lower gain from mortgage loans, partially offset by the previously mentioned transactions.

        Noninterest expense increased in 2004 largely due to higher employee compensation and benefits expense, occupancy and equipment expense and other expenses due to growth in Long Beach Mortgage

40



Company. The number of employees in this entity increased by approximately 600 during 2004. The increase in 2003 was primarily due to higher employee compensation and benefits, occupancy and equipment and technology expenses to accommodate the increase in multi-family refinancing activity during the year and expansion of the Group's multi-family lending network.

    Corporate Support/Treasury and Other

 
  Year Ended December 31,
  Percentage Change
 
 
  2004
  2003
  2002
  2004/2003
  2003/2002
 
 
  (dollars in millions)

   
   
 
Condensed income statement:                            
  Net interest income (expense)   $ (874 ) $ (302 ) $ 1,307   189 % %
  Provision for loan and lease losses         4       (100 )  
  Noninterest income (expense)     (156 )   644     (60 )    
  Noninterest expense     699     634     645   10   (2 )
   
 
 
         
  Income (loss) from continuing operations before income taxes     (1,729 )   (296 )   602   484    
  Income taxes (benefit)     (652 )   (110 )   222   495    
   
 
 
         
  Income (loss) from continuing operations     (1,077 )   (186 )   380   478    
  Income from discontinued operations, net of taxes     399              
   
 
 
         
    Net income (loss)   $ (678 ) $ (186 ) $ 380   264    
   
 
 
         
Performance and other data:                            
  Average assets   $ 24,230   $ 38,168   $ 59,249   (37 ) (36 )
  Average deposits     11,631     5,626     4,885   107   15  
  Employees at end of period     5,175     6,188     5,338   (16 ) 16  

        The increases in net interest expense during 2004 and 2003 were primarily driven by declining average balances of investment securities. The average balances of investment securities declined by $11.98 billion, or 40% in 2004 and declined $20.45 billion, or 40% in 2003, as compared with 2002, reflecting the sale of higher yielding securities during those periods. The impact of changes in funds transfer pricing rates on Treasury's operations in 2004, compared with 2003 also contributed to the increase in net interest expense, as lower transfer pricing rates were charged to the segments for the funding of loans. The lower rates were the result of the shift in the balance sheet towards assets with shorter repricing frequencies during 2004. The increase in net interest expense during 2004 was partially offset by a 12% decrease in the average rate paid on interest-bearing liabilities, reflecting the lower interest rate environment that existed during the first half of 2004.

        The difference in noninterest income in 2004, compared with 2003, was mostly due to gains realized during 2003 from the sale of available-for-sale securities and losses of $237 million from the early termination of certain wholesale borrowings with embedded pay-fixed interest rate swaps during 2004.

        The increase in noninterest expense in 2004 was mostly due to an increase in technology-related and restructuring charges resulting from the Company's cost containment initiative, which began in the fourth quarter of 2003. All such charges incurred from this initiative, which amounted to $274 million in 2004, are charged to this unit. The ensuing decline in headcount in 2004, which resulted from the cost containment initiative, partially offset the increase. The headcount reductions occurred primarily within the Company's technology support operations.

        The increase in average deposits in 2004 was substantially due to growth in wholesale deposits held by institutional investors.

41


Risk Management

        The Company is exposed to four major categories of risk: credit, liquidity, market and operational.

        The Company's Chief Enterprise Risk Officer is responsible for enterprise-wide risk assessment. The Company's Enterprise Risk Management function oversees the identification, measurement, monitoring, control and reporting of credit, market and operational risks. The Company's Treasury function is responsible for the measurement, management and control of liquidity risk. The Internal Audit function, part of Enterprise Risk Management, provides independent assessment of the Company's compliance with risk management controls, policies and procedures.

        The Audit Committee of the Board of Directors oversees both the Internal Audit and Enterprise Risk Management functions and provides governance and oversight of operational risk. The Corporate Relations Committee of the Board of Directors oversees the Company's reputation and those elements of operational risk that impact the Company's reputation. Governance and oversight of credit, liquidity and market risks are provided by the Finance Committee of the Board of Directors. Risk oversight is also provided by management committees whose membership includes representation from the Company's lines of business and the Enterprise Risk Management function. These committees include the Enterprise Risk Management Committee, the Credit Policy Committee, the Market Risk Committee and the Asset and Liability Committee.

        Enterprise Risk Management works with the lines of business to establish appropriate policies, standards and limits designed to maintain risk exposures within the Company's risk tolerance. Significant risk management policies approved by the relevant management committees are also reviewed and approved by the Audit and Finance Committees. Enterprise Risk Management also provides objective oversight of risk-taking activities and oversees compliance with laws and regulations.

        Business lines are responsible for determining and executing business strategies that may give rise to one or more types of risk; their return on economic and other forms of capital is measured and compared to targets with the overall objective of ensuring that the risk/reward balance is acceptable. Business lines, Enterprise Risk Management and Treasury divide the responsibilities of conducting measurement and monitoring of the Company's risk exposures. Risk exceptions, depending on their type and significance, are elevated to management or Board committees responsible for oversight.

Credit Risk Management

        Credit risk is the risk of loss arising from adverse changes in a borrower's ability to meet its financial obligations under agreed upon terms and exists primarily in our lending and derivative portfolios. The degree of credit risk will vary based on many factors, including the size of the asset or transaction, the credit characteristics of the borrower, the contractual terms of the agreement and the availability and quality of collateral.

        The Finance Committee of the Board of Directors, by means of a broad set of policies and principles contained in the Company's Credit Policy, approves the framework for the Company's credit risk management activities. The Credit Policy Committee, chaired by the Chief Credit Officer and comprised of senior management, develops standards and procedures and is responsible for oversight of the credit risk management function.

        The Credit Policy Committee's primary responsibilities include ensuring the adequacy of the Company's credit risk management infrastructure, overseeing credit risk management strategies and methodologies, monitoring conditions in real estate and other markets having an impact on lending activities, and evaluating and monitoring overall credit risk. The Chief Credit Officer's primary responsibilities include overseeing the work of the Credit Policy Committee, monitoring the quality of the Company's credit portfolio, determining the reasonableness of the Company's allowance for loan and lease losses, reviewing and approving large credit exposures, setting underwriting criteria for credit-related products and programs, and for delegating credit approval authority.

42



        Credit risk management is based on analyzing the creditworthiness of the borrower, the adequacy of underlying collateral given current events and conditions and the existence and strength of any guarantor support. Trends in these factors are dynamic and are reflected in the tables and commentary that follow.

    Nonaccrual Loans, Foreclosed Assets and Restructured Loans

        Loans are generally placed on nonaccrual status when they are 90 days past due. Additionally, loans in non-homogeneous portfolios are placed on nonaccrual status prior to becoming 90 days past due when payment in full of principal or interest is not expected. Management's classification of a loan as nonaccrual or restructured does not necessarily indicate that the principal or interest of the loan is uncollectible in whole or in part. Nonaccrual loans and foreclosed assets ("nonperforming assets") and restructured loans from continuing operations consist of the following:

 
  December 31,
 
 
  2004
  2003
  2002
  2001
  2000
 
 
  (dollars in millions)

 
Nonperforming assets and restructured loans (1) (2) :                                
  Nonaccrual loans:                                
    Loans secured by real estate:                                
      Home   $ 542   $ 736   $ 1,068   $ 1,010   $ 509  
      Purchased subprime     674     597     438     292     127  
   
 
 
 
 
 
        Total home nonaccrual loans     1,216     1,333     1,506     1,302     636  
      Home equity loans and lines of credit     66     47     36     34     27  
      Home construction (3)     28     35     49     36     18  
      Multi-family     12     19     50     56     10  
      Other real estate     162     153     413     376     35  
   
 
 
 
 
 
        Total nonaccrual loans secured by real estate     1,484     1,587     2,054     1,804     726  
    Consumer     9     8     22     16     14  
    Commercial business     41     31     79     100     12  
   
 
 
 
 
 
        Total nonaccrual loans held in portfolio     1,534     1,626     2,155     1,920     752  
  Foreclosed assets     261     311     328     216     144  
   
 
 
 
 
 
        Total nonperforming assets   $ 1,795   $ 1,937   $ 2,483   $ 2,136   $ 896  
   
 
 
 
 
 
        As a percentage of total assets     0.58 %   0.70 %   0.93 %   0.88 %   0.46 %
  Restructured loans   $ 34   $ 111   $ 98   $ 118   $ 120  
   
 
 
 
 
 
        Total nonperforming assets and restructured loans   $ 1,829   $ 2,048   $ 2,581   $ 2,254   $ 1,016  
   
 
 
 
 
 

(1)
If interest on nonaccrual loans under the original terms had been recognized, such income is estimated to have been $64 million in 2004, $86 million in 2003 and $118 million in 2002.
(2)
Nonaccrual loans held for sale, which are excluded from the nonaccrual balances presented above, were $76 million, $66 million, $119 million, $123 million and $32 million at December 31, 2004, 2003, 2002, 2001 and 2000.
(3)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

43


        Loans held in portfolio (excluding the allowance for loan and lease losses) and nonaccrual loans by geographic concentration at December 31, 2004 were as follows:

 
  California
  Washington/Oregon
  New York/New Jersey
 
 
  Portfolio
  Nonaccrual
  Portfolio
  Nonaccrual
  Portfolio
  Nonaccrual
 
 
  (dollars in millions)

 
Loans secured by real estate:                                      
  Home   $ 52,010   $ 120   $ 5,683   $ 49   $ 11,844   $ 65  
  Purchased subprime     4,811     56     529     19     2,089     87  
   
 
 
 
 
 
 
    Total home loans     56,821     176     6,212     68     13,933     152  
  Home equity loans and lines of credit     23,686     20     5,926     14     2,627     4  
  Home construction (1)     1,018     4     399     3     127      
  Multi-family     16,425     5     1,346     4     2,488     1  
  Other real estate     1,633     10     1,296     16     1,076     5  
   
 
 
 
 
 
 
    Total loans secured by real estate     99,583     215     15,179     105     20,251     162  
Consumer     285     2     304     4     42      
Commercial business     1,607     10     301     12     393     3  
   
 
 
 
 
 
 
    Total loans held in portfolio   $ 101,475   $ 227   $ 15,784   $ 121   $ 20,686   $ 165  
   
 
 
 
 
 
 
Loans and nonaccrual loans as a percentage of total loans and total nonaccrual loans     49 %   15 %   8 %   8 %   10 %   11 %

(1)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

 
  Florida
  Texas
  Illinois
 
 
  Portfolio
  Nonaccrual
  Portfolio
  Nonaccrual
  Portfolio
  Nonaccrual
 
 
  (dollars in millions)

 
Loans secured by real estate:                                      
  Home   $ 8,951   $ 47   $ 1,474   $ 16   $ 4,517   $ 35  
  Purchased subprime     1,753     43     949     63     1,068     56  
   
 
 
 
 
 
 
    Total home loans     10,704     90     2,423     79     5,585     91  
  Home equity loans and lines of credit     2,363     3     3,401     10     623      
  Home construction (1)     165     3     206     11     30      
  Multi-family     192         233     1     360      
  Other real estate (2)     95     2     482     63     22     1  
   
 
 
 
 
 
 
    Total loans secured by real estate     13,519     98     6,745     164     6,620     92  
Consumer     32         27         1      
Commercial business     128     1     204     8     29      
   
 
 
 
 
 
 
    Total loans held in portfolio   $ 13,679   $ 99   $ 6,976   $ 172   $ 6,650   $ 92  
   
 
 
 
 
 
 
Loans and nonaccrual loans as a percentage of total loans and total nonaccrual loans     7 %   6 %   3 %   11 %   3 %   6 %

(1)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.
(2)
Includes $40 million of nonaccrual loans in Texas that were acquired from Bank United in 2001, of which $35 million is owed by a single borrower in the health care industry.

44


 
  Other (2)
  Total
 
 
  Portfolio
  Nonaccrual
  Portfolio
  Nonaccrual
 
 
  (dollars in millions)

 
Loans secured by real estate:                          
  Home   $ 25,512   $ 210   $ 109,991   $ 542  
  Purchased subprime     7,944     350     19,143     674  
   
 
 
 
 
    Total home loans     33,456     560     129,134     1,216  
  Home equity loans and lines of credit     5,024     15     43,650     66  
  Home construction (1)     399     7     2,344     28  
  Multi-family     1,238     1     22,282     12  
  Other real estate     1,060     65     5,664     162  
   
 
 
 
 
    Total loans secured by real estate     41,177     648     203,074     1,484  
Consumer     101     3     792     9  
Commercial business     543     7     3,205     41  
   
 
 
 
 
    Total loans held in portfolio   $ 41,821   $ 658   $ 207,071   $ 1,534  
   
 
 
 
 
Loans and nonaccrual loans as a percentage of total loans and total nonaccrual loans     20 %   43 %   100 %   100 %

(1)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.
(2)
Of this category, Minnesota had the largest portfolio balance of approximately $1.77 billion and the largest nonaccrual amount of $68 million.

    Provision and Allowance for Loan and Lease Losses

        The allowance for loan and lease losses represents management's estimate of credit losses inherent in the Company's loan and lease portfolios as of the balance sheet date. The estimation of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of our borrowers, adverse situations that have occurred that may affect the borrowers' ability to repay, the estimated value of underlying collateral, the interest rate climate as it affects adjustable-rate loans and general economic conditions. Determining the adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan and lease losses in future periods.

        The allowance provides for incurred losses that are inherent in the loan portfolio. Losses are recognized when (a) available information indicates that it is probable that a loss has been incurred and (b) the amount of the loss can be reasonably estimated. Generally, borrowers are impacted by events that result in loan default and eventual loss well in advance of a lender's knowledge of those events. Examples of such loss-causing events for home loans are borrower job loss, divorce and medical crisis. An example for commercial real estate loans would be the loss of a major tenant.

        In determining the allowance for loan and lease losses, the Company allocates a portion of the allowance to its various loan product categories based on an analysis of individual loans and pools of loans. However, the entire allowance (both the allocated component and the portion that remains unallocated) is available to absorb credit losses inherent in the total loan portfolio as of the balance sheet date.

        The allocated allowance for homogeneous loans (such as home loans, home equity loans and lines of credit and purchased subprime loans) is determined using statistical forecasting models that estimate default and loss outcomes based on an evaluation of past performance of loans in the Company's portfolio and other factors as well as industry historical loan loss data. Management periodically reviews these models for reasonableness and updates the assumptions used in these models.

        Non-homogeneous loans (such as multi-family and non-residential real estate loans) are individually reviewed and assigned a risk grade. The loans are then categorized by their risk grade into pools, with each

45



pool having a pre-assigned loss factor commensurate with the applicable level of estimated risk. Loss factors are then multiplied by the unpaid principal balance of loans in each pool to determine the allocated allowance applicable to that pool.

        We also evaluate certain loans on an individual basis for impairment (as defined by Statement No. 114, Accounting by Creditors for Impairment of a Loan ) and record an allowance for impaired loans as appropriate. Such loans are excluded from other loan loss analyses so as to avoid double counting the loss exposure.

        To mitigate the imprecision inherent in estimates of credit losses, the allocated component of the allowance is supplemented by an unallocated component. The unallocated component reflects management's assessment of various risk factors that are not adequately reflected in the models used to determine the allocated component of the allowance. These factors include general economic and business conditions affecting its key lending products and markets, credit quality and collateral value trends, loan concentrations, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, duration of the current business cycle and the impact of new product initiatives and other such variables for which recent historical performance does not reflect the risk profile of the portfolio.

46



        Changes in the allowance for loan and lease losses were as follows:

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
  2001
  2000
 
 
  (dollars in millions)

 
Balance, beginning of year   $ 1,250   $ 1,503   $ 1,278   $ 909   $ 942  
Allowance acquired through business combinations             148     120      
Other     (23 )   14     (79 )       (36 )
Provision for loan and lease losses (1)     209     42     404     426     77  
   
 
 
 
 
 
      1,436     1,559     1,751     1,455     983  
Loans charged off:                                
  Loans secured by real estate:                                
    Home     (39 )   (65 )   (52 )   (29 )   (19 )
    Purchased subprime     (39 )   (39 )   (33 )   (25 )   (4 )
   
 
 
 
 
 
      Total home loan charge-offs     (78 )   (104 )   (85 )   (54 )   (23 )
    Home equity loans and lines of credit     (22 )   (14 )   (14 )   (4 )   (3 )
    Home construction (2)     (1 )   (2 )   (1 )       (1 )
    Multi-family     (2 )   (5 )   (1 )       (2 )
    Other real estate     (11 )   (97 )   (60 )   (35 )   (4 )
   
 
 
 
 
 
      Total loans secured by real estate     (114 )   (222 )   (161 )   (93 )   (33 )
  Consumer     (53 )   (69 )   (70 )   (51 )   (41 )
  Commercial business     (21 )   (79 )   (73 )   (49 )   (9 )
   
 
 
 
 
 
      Total loans charged off     (188 )   (370 )   (304 )   (193 )   (83 )
Recoveries of loans previously charged off:                                
  Loans secured by real estate:                                
    Home         10     2     2     1  
    Purchased subprime     3     3             1  
   
 
 
 
 
 
      Total home loan recoveries     3     13     2     2     2  
    Home equity loans and lines of credit     4     1     1     1      
    Multi-family     3     1     1         1  
    Other real estate     10     17     12     3     1  
   
 
 
 
 
 
      Total loans secured by real estate     20     32     16     6     4  
  Consumer     19     15     13     4     4  
  Commercial business     14     14     27     6     1  
   
 
 
 
 
 
      Total recoveries of loans previously charged off     53     61     56     16     9  
   
 
 
 
 
 
        Net charge-offs     (135 )   (309 )   (248 )   (177 )   (74 )
   
 
 
 
 
 
Balance, end of year   $ 1,301   $ 1,250   $ 1,503   $ 1,278   $ 909  
   
 
 
 
 
 
Net charge-offs as a percentage of average loans held in portfolio     0.07 %   0.20 %   0.17 %   0.14 %   0.07 %
Allowance as a percentage of total loans held in portfolio     0.63 %   0.71 %   1.05 %   1.01 %   0.78 %

(1)
Includes a $202 million reversal of provision for loan and lease losses recorded in the fourth quarter of 2003.
(2)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

        The risk profile of the Company's loan portfolio changed significantly during 2001 and 2002. In a five quarter span from January 2001 to March 31, 2002, the Company consummated four purchase business combinations: Bank United Corp. (Bank United), the mortgage operations of The PNC Financial Services Group, Inc., Fleet Mortgage Corp. and Dime Bancorp, Inc. (Dime). As a result of these acquisitions, the Company's loan portfolio contained substantially higher levels of credit risk. In particular, Bank United's commercial lending activities were concentrated in underperforming sectors of the economy, such as

47



assisted living facilities, Small Business Administration loans and highly leveraged syndicated lending. This change in the loan portfolio composition was exacerbated by the downturn in the national economy, which continued to worsen following the events of September 11, 2001. From December 31, 2000 to the end of 2001, the Company's nonperforming assets increased from $896 million to $2.14 billion and net charge-offs increased from $74 million in 2000 to $177 million in 2001. To address these negative trends that displayed no signals of imminent change, the Company believed it was prudent to record a loan loss provision in 2001 of $426 million.

        Although the national economy showed some intermittent signs of stabilizing performance in 2002, the overall climate was still one of significant uncertainty, as demonstrated by the continuing high levels of unemployment, distressed levels of consumer confidence and continuing concerns of housing price bubbles in some of the Company's real estate markets. After their substantial growth in 2001, nonperforming asset trends stabilized in 2002 but remained at elevated levels, decreasing slightly to $2.48 billion at December 31, 2002 after reaching a first quarter peak of $2.68 billion. Though the Company continued to provision at levels that exceeded net charge-offs as a result of the continuing economic malaise, the gap between these statistical measures had declined from $74 million in the first quarter of 2002 to $2 million by the fourth quarter of that year. This reflected the Company's cautious belief that, while the economy had not demonstrated signals of a sustained economic recovery, it at least did not appear to be deteriorating any further. This assessment was also evident in the quarterly trend of the allowance for loan and lease losses as a percentage of total loans held in portfolio. After growing steadily from 0.82% in the first quarter of 2001 to 1.08% in the second quarter of 2002, it stabilized during the remainder of that year, ending at 1.05% at December 31, 2002.

        During 2003, nonperforming assets declined from $2.48 billion at the beginning of the year to $1.94 billion at December 31, 2003. Beginning in the fourth quarter of 2002, the Company initiated a program of periodically selling nonperforming assets in order to reduce its exposure to potential credit losses. This program continued throughout 2003 with the sale of $619 million of nonperforming loans and was substantially the reason for the decline in nonperforming assets. As the charge-offs that were sustained from the sales of these loans were, in general, at lower levels than the Company believes it would have incurred had these loans been allowed to season further, the sales had the effect of limiting the potential provisioning that these loans would otherwise have required.

        As economic conditions improved during 2003, the Company's assessment of the economic climate progressed from one of continuing concern in the first quarter of 2003 to one of guarded optimism by the third quarter of that year. However, a discernable, positive trend was not evident until various economic statistics were released in the fourth quarter. Those statistics provided conclusive evidence that key economic indicators that affect the Company's credit risk profile had improved. Those indicators included a stable interest rate environment, a consistent pattern of stable or increasing housing prices, strong levels of residential home construction, lower unemployment levels, increasing capital expenditures, steady to improving corporate profits and stronger levels of exports from a weakening U.S. dollar. These favorable external factors were augmented by the Company's ability to sell its underperforming franchise finance loan portfolio in the fourth quarter of 2003 at a price that exceeded its carrying value by $82 million. As a result of all of these events, the Company determined that a $202 million reversal of the provision for loan and lease losses in the fourth quarter of 2003 was appropriate.

        During 2004, strong loan portfolio growth, especially in the higher-risk purchased subprime portfolio, resulted in management recording a provision for loan and lease losses that exceeded net charge-offs by $74 million. However, as a reflection of the continuing favorable trend in key domestic economic indicators which facilitated a relatively benign credit environment throughout the year, the allowance for loan and lease losses as a percentage of loans held in portfolio declined from 0.71% at December 31, 2003 to 0.63% at December 31, 2004. The positive economic outlook was also affirmed by the Federal Reserve's decision to initiate a series of measured increases in the targeted Federal Funds rate during the second half of 2004, thus reducing the degree of stimulus that the Federal Reserve believes is necessary to sustain continuing economic growth.

48


        An analysis of the allowance for loan and lease losses was as follows:

 
  December 31,
 
 
  2004
  2003
  2002
 
 
  Allowance
for Loan
and
Lease
Losses

  Allocated
Allowance
as a %
of Loan
Category

  Loan
Category
as a %
of Total
Loans (1)

  Allowance
for Loan
and
Lease
Losses

  Allocated
Allowance
as a %
of Loan
Category

  Loan
Category
as a %
of Total
Loans (1)

  Allowance
for Loan
and
Lease
Losses

  Allocated
Allowance
as a %
of Loan
Category

  Loan
Category
as a %
of Total
Loans (1)

 
 
  (dollars in millions)

 
Allocated allowance:                                            
  Loans secured by real estate:                                            
    Home   $ 215   0.20 % 53.12 % $ 321   0.32 % 57.12 % $ 251   0.30 % 57.92 %
    Purchased subprime     242   1.26   9.24     84   0.65   7.41     169   1.67   7.08  
   
     
 
     
 
     
 
      Total home loans     457   0.35   62.36     405   0.36   64.53     420   0.45   65.00  
    Home equity loans and lines of credit     83   0.19   21.08     82   0.30   15.78     46   0.29   11.31  
    Home construction (2)     12   0.51   1.13     18   0.81   1.27     22   1.13   1.36  
    Multi-family     101   0.45   10.76     139   0.68   11.60     146   0.81   12.59  
    Other real estate     116   2.05   2.74     110   1.65   3.80     296   3.71   5.58  
   
     
 
     
 
     
 
      Total allocated allowance secured by real estate     769   0.38   98.07     754   0.44   96.98     930   0.68   95.84  
  Consumer     36   4.55   0.38     49   4.77   0.59     70   4.21   1.16  
  Commercial business     51   1.59   1.55     72   1.69   2.43     116   2.70   3.00  
   
     
 
     
 
     
 
      Total allocated allowance held in portfolio     856   0.41   100.00     875   0.50   100.00     1,116   0.78   100.00  
Unallocated allowance     445   0.22       375   0.21       387   0.27    
   
 
 
 
 
 
 
 
 
 
      Total allowance for loan and lease losses   $ 1,301   0.63 % 100.00 % $ 1,250   0.71 % 100.00 % $ 1,503   1.05 % 100.00 %
   
 
 
 
 
 
 
 
 
 

(Continued on next table.)


(1)
Excludes loans held for sale.
(2)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

 
  December 31,
 
 
  2001
  2000
 
 
  Allowance
for Loan
and
Lease
Losses

  Allocated
Allowance
as a %
of Loan
Category

  Loan
Category
as a %
of Total
Loans (1)

  Allowance
for Loan
and
Lease
Losses

  Allocated
Allowance
as a %
of Loan
Category

  Loan
Category
as a %
of Total
Loans (1)

 
 
  (dollars in millions)

 
Allocated allowance:                              
  Loans secured by real estate:                              
    Home   $ 290   0.36 % 63.00 % $ 250   0.31 % 69.18 %
    Purchased subprime     97   1.18   6.49     52   0.94   4.78  
   
     
 
     
 
      Total home loans     387   0.44   69.49     302   0.35   73.96  
    Home equity loans and lines of credit     27   0.34   6.31     20   0.35   4.98  
    Home construction (2)     32   1.23   2.05     7   0.49   1.24  
    Multi-family     138   0.88   12.35     138   0.88   13.51  
    Other real estate     161   2.64   4.82     100   2.55   3.38  
   
     
 
     
 
      Total allocated allowance secured by real estate     745   0.62   95.02     567   0.50   97.07  
  Consumer     71   3.53   1.59     70   4.19   1.44  
  Commercial business     92   2.15   3.39     33   1.91   1.49  
   
     
 
     
 
      Total allocated allowance held in portfolio     908   0.72   100.00     670   0.58   100.00  
Unallocated allowance     370   0.29       239   0.20    
   
 
 
 
 
 
 
      Total allowance for loan and lease losses   $ 1,278   1.01 % 100.00 % $ 909   0.78 % 100.00 %
   
 
 
 
 
 
 

(1)
Excludes loans held for sale.
(2)
Represents loans to builders for the purpose of financing the acquisition, development and construction of single-family residences for sale and construction loans made directly to the intended occupant of a single-family residence.

49


        Growth in our purchased subprime portfolio since 2000 has resulted in a substantial increase in the allocated allowance attributable to this portfolio and a significant increase in nonaccrual loans. We seek to mitigate the credit risk in this portfolio by re-underwriting all purchased subprime loans.

        Home equity loans and lines of credit increased from $5.77 billion at December 31, 2000 to $43.65 billion at December 31, 2004. With the strong housing market that has existed during the current decade, home equity loans and lines of credit have become an increasingly popular product as they enable homeowners to borrow a portion of their equity for personal expenditures. Although the allocated allowance for this portfolio increased from $20 million at December 31, 2000 to $83 million at the end of 2004, that allowance as a percentage of loans in this portfolio declined from 0.35% to 0.19% during that same period, reflecting generally high credit scores among borrowers, lower risk loan to value ratios and a significant portion of loans that are in a first lien position.

    90 or More Days Past Due

        Loans held in portfolio that were 90 or more days contractually past due and still accruing interest were $85 million, $46 million, $60 million, $86 million and $45 million at December 31, 2004, 2003, 2002, 2001 and 2000. The majority of these loans are either VA- or FHA-insured with little or no risk of loss of principal or interest.

Liquidity Risk Management

        The objective of liquidity management is to ensure the Company has the continuing ability to maintain cash flows that are adequate to fund operations and meet its other obligations on a timely and cost-effective basis. The Company establishes liquidity guidelines for the parent holding company, Washington Mutual, Inc., as well as for its principal operating subsidiaries. The Company also maintains contingency liquidity plans that outline alternative actions and enable appropriate and timely responses under stress scenarios.

    Washington Mutual, Inc.

        Liquidity for Washington Mutual, Inc. is generated through its ability to raise funds through dividends from subsidiaries and in various capital markets such as unsecured debt and commercial paper.

        One of Washington Mutual, Inc.'s primary funding sources during 2004 was from dividends paid by our banking subsidiaries. Washington Mutual, Inc. received dividends from its subsidiaries during the third quarter of 2004 and expects to continue to receive dividends in the future. Banking subsidiaries dividends may be reduced from time to time to ensure that internal capital targets are met. Various regulatory requirements related to capital adequacy and retained earnings also limit the amount of dividends that can be paid by our banking subsidiaries. For more information on dividend restrictions applicable to our banking subsidiaries, refer to "Business – Regulation and Supervision" and Note 18 to the Consolidated Financial Statements – "Regulatory Capital Requirements and Dividend Restrictions."

        During 2003, Washington Mutual, Inc. filed two shelf registration statements with the Securities and Exchange Commission, registering a total of $7 billion in debt securities, preferred stock and depositary shares in the United States and in international capital markets. The Company has issued $3.25 billion of debt securities under the registration statements as follows. In 2003, the Company issued $1.65 billion of fixed- and adjustable-rate senior debt securities. In March 2004, the Company issued $750 million of fixed-rate subordinated debt securities. In December 2004, the Company issued $850 million of fixed- and adjustable-rate senior debt securities. At December 31, 2004, the Company had $3.75 billion available for issuance under these registration statements.

        In addition to the issuances described above, the Company has issued $5.5 billion in debt securities under earlier registration statements. At December 31, 2004, the Company had a total of $8.8 billion debt outstanding in principal. As of December 31, 2004, the Company's senior debt was rated A by Fitch, A3 by Moody's and A– by Standard and Poor's.

50



        Washington Mutual, Inc. also has a commercial paper program and a revolving credit facility that are sources of liquidity. The commercial paper program provides for up to $500 million in funds. The revolving credit facility totaling $800 million provides credit support for Washington Mutual, Inc.'s commercial paper program as well as funds for general corporate purposes. At December 31, 2004, Washington Mutual, Inc. had no commercial paper outstanding and the entire amount of the revolving credit facility was available. As of December 31, 2004, the Company's commercial paper was rated F1 by Fitch, P2 by Moody's and A2 by Standard and Poor's.

        Washington Mutual, Inc. maintains sufficient liquidity to cover all debt obligations maturing over the next twelve months without incremental access to the capital markets.

    Banking Subsidiaries

        The principal sources of liquidity for our banking subsidiaries are customer deposits, wholesale borrowings, the maturity and repayment of portfolio loans, securities held in our available-for-sale portfolio and mortgage loans designated as held for sale. Among these sources, transaction deposits and wholesale borrowings from FHLB advances and repurchase agreements continue to provide the Company with a significant source of stable funding. During 2004, those sources funded 72% of average total assets. Our continuing ability to retain our transaction deposit base and to attract new deposits depends on various factors, such as customer service satisfaction levels and the competitiveness of interest rates offered on our deposit products. We continue to have the necessary assets available to pledge as collateral to obtain FHLB advances and repurchase agreements to offset any potential declines in deposit balances.

        In 2004, the Company's proceeds from the sales of loans held for sale were approximately $127 billion. These proceeds were, in turn, used as the primary funding source for the origination and purchases, net of principal payments, of approximately $148 billion of loans held for sale during the same period. Typically, a cyclical pattern of sales and originations/purchases repeats itself during the course of a period and the amount of funding necessary to sustain our mortgage banking operations does not significantly affect the Company's overall level of liquidity resources. In 2004, originations/purchases of loans held for sale, net of principal payments, exceeded the proceeds from the sale of loans held for sale by approximately $21 billion.

        To supplement our primary funding sources, our banking subsidiaries also raise funds in domestic and international capital markets. In August 2003, the Company established a $20 billion Global Bank Note Program for Washington Mutual Bank, FA ("WMBFA") and Washington Mutual Bank ("WMB") to issue senior and subordinated notes in the United States and in international capital markets in a variety of currencies and structures. Under this program, WMBFA is allowed to issue up to $15 billion in notes, of which $5 billion can be issued as subordinated notes subject to regulatory approval. As a result of the merger of WMB into WMBFA on January 1, 2005, the $5 billion credit facility that was issuable by WMB under this program is no longer available. The maximum aggregate principal amount of notes with maturities greater than 270 days from the date of issue offered by WMBFA may not exceed $7.5 billion.

        Under the Global Bank Note Program, WMBFA issued a total of $2.5 billion of subordinated notes during 2004. WMBFA issued $750 million of 10 year fixed-rate subordinated notes in August 2004 and an additional $250 million with identical terms in September 2004. In November 2004, WMBFA issued an additional $1 billion of 10 year fixed-rate subordinated notes and $500 million of 10 year floating rate subordinated notes. After these issuances, WMBFA had a total of $12.50 billion available under this program.

        In addition to the issuances described above, WMB and WMBFA have issued $2.8 billion in senior and subordinated notes under earlier programs. At December 31, 2004, the banking subsidiaries had $5.3 billion debt outstanding in principal. As of December 31, 2004, senior unsecured long-term obligations at both WMB and WMBFA were rated A by Fitch, A2 by Moody's and A by Standard and Poor's. Short-term obligations were rated F1 by Fitch, P1 by Moody's and A1 by Standard and Poor's. As a result of the merger described above, WMBFA assumed all of WMB's debt.

51



    Non-banking Subsidiaries

        Long Beach Mortgage has revolving credit facilities with non-affiliated lenders totaling $7 billion that are used to fund loans held for sale. At December 31, 2004, Long Beach Mortgage had borrowings outstanding of $4 billion under these credit facilities.

Off-Balance Sheet Activities and Contractual Obligations

    Asset Securitization

        We transform loans into securities, which are sold to investors – a process known as securitization. Securitization involves the sale of loans to a qualifying special-purpose entity ("QSPE"), typically a trust. The QSPE, in turn, issues securities, commonly called asset-backed securities, which are secured by future collections on the sold loans. The QSPE sells securities to investors, which entitle the investors to receive specified cash flows during the term of the security. The QSPE uses proceeds from the sale of these securities to pay the Company for the loans sold to the QSPE. These QSPEs are not consolidated within our financial statements since they satisfy the criteria established by Statement No. 140 , Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities . In general, these criteria require the QSPE to be legally isolated from the transferor (the Company), be limited to permitted activities, and have defined limits on the assets it can hold and the permitted sales, exchanges or distributions of its assets.

        When we sell or securitize loans, we generally retain the right to service the loans and may retain senior, subordinated, residual, and other interests, all of which are considered retained interests in the sold or securitized assets. Retained interests may provide credit enhancement to the investors and, absent the violation of representations and warranties, generally represent the Company's maximum risk exposure associated with these transactions. Retained interests in securitizations were $1.62 billion at December 31, 2004, of which $1.60 billion have either a AAA credit rating or are agency insured. Additional information concerning securitization transactions is included in Note 6 to the Consolidated Financial Statements – "Mortgage Banking Activities."

52


    Contractual Obligations

        The following table presents, as of December 31, 2004, the Company's significant fixed and determinable contractual obligations, within the categories described below, by payment date or contractual maturity. These contractual obligations, except for the operating lease obligations and purchase obligations, are included in the Consolidated Statements of Financial Condition. The payment amounts represent those amounts contractually due to the recipient.

 
  Payments Due by Period (in millions)
Contractual Obligations

  Total
  Less than
1 year

  1 but
less than
3 years

  3 but
less than
5 years

  5 years
or more

Debt obligations   $ 104,489   $ 55,701   $ 36,896   $ 3,287   $ 8,605
Capital lease obligations     63     7     12     12     32
Operating lease obligations     2,040     451     649     392     548
Purchase obligations (1)     357     193     128     29     7
   
 
 
 
 
Total contractual obligations   $ 106,949   $ 56,352   $ 37,685   $ 3,720   $ 9,192
   
 
 
 
 

(1)
Purchase obligations are defined as legally binding agreements whereby the Company commits to a minimum purchase amount of $1 million or more over a specified period of time. Estimated payments for contracts that may be terminated early without penalty are shown through the first termination date, all others are shown through the date of contract termination. Excluded from the table are purchase obligations expected to be settled in cash within 90 days of the end of the reporting period.

        The Company enters into derivative contracts under which the Company is required to either receive cash or pay cash to counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the Consolidated Statements of Financial Condition with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of the contracts changes daily as market interest rates change. Further discussion of derivative instruments is included in Note 1 – "Summary of Significant Accounting Policies" and Note 21 – "Derivative Financial Instruments" to the Consolidated Financial Statements.

    Commitments, Guarantees and Contingencies

        The Company may incur liabilities under certain contractual agreements contingent upon the occurrence of certain events. A discussion of these contractual agreements under which the Company may be held liable is included in Note 14 – "Commitments, Guarantees and Contingencies" to the Consolidated Financial Statements. In addition, the Company has commitments and obligations under pension and other postretirement benefit plans as described in Note 20 – "Employee Benefits Programs and Other Expense" to the Consolidated Financial Statements.

53


Capital Adequacy

        The regulatory capital ratios of WMBFA, WMB and Washington Mutual Bank fsb ("WMBfsb") and minimum regulatory ratios to be categorized as well-capitalized were as follows:

 
  December 31, 2004
   
 
 
  Well-Capitalized
Minimum

 
 
  WMBFA
  WMB
  WMBfsb
 
Tier 1 capital to adjusted total assets (leverage)   5.46 % 7.44 % 93.67 % 5.00 %
Adjusted tier 1 capital to total risk-weighted assets   8.12   10.92   393.52   6.00  
Total risk-based capital to total risk-weighted assets   11.68   12.35   393.56   10.00  
 
  December 31, 2003
   
 
 
  Well-Capitalized
Minimum

 
 
  WMBFA
  WMB
  WMBfsb
 
Tier 1 capital to adjusted total assets (leverage)   5.50 % 5.82 % 10.34 % 5.00 %
Adjusted tier 1 capital to total risk-weighted assets   8.72   9.10   16.36   6.00  
Total risk-based capital to total risk-weighted assets   10.80   11.23   17.04   10.00  

        Our federal savings bank subsidiaries are also required by Office of Thrift Supervision regulations to maintain tangible capital of at least 1.50% of assets. WMBFA, WMB and WMBfsb satisfied this requirement at December 31, 2004.

        Our broker-dealer subsidiaries are also subject to capital requirements. At December 31, 2004, both of our broker-dealer subsidiaries were in compliance with their applicable capital requirements.

        On February 1, 2004, WMBfsb became a subsidiary of WMBFA. This reorganization was followed by the contribution of $23.27 billion of mortgage-backed and investment securities by WMBFA to WMBfsb on March 1, 2004. Due to the low risk weights assigned to these securities under the federal banking agency regulatory capital guidelines, their contribution to WMBfsb's capital base substantially increased that entity's risk-based capital ratios.

        During 2004, the Company repurchased 16.1 million shares of our common stock at an average price of $44.14 as part of our share repurchase program. Effective July 15, 2003, the Company adopted a share repurchase program approved by the Board of Directors. Under the program, the Company is authorized to repurchase up to 100 million shares of its common stock, as conditions warrant. From January 1, 2005 through February 28, 2005, the Company did not repurchase additional shares. Management may engage in future share repurchases as liquidity conditions permit and market conditions warrant.

Market Risk Management

        Market risk is defined as the sensitivity of income, fair market values and capital to changes in interest rates, foreign currency exchange rates, commodity prices and other relevant market rates or prices. The primary market risk to which we are exposed is interest rate risk. Substantially all of our interest rate risk arises from instruments, positions and transactions entered into for purposes other than trading. These include loans, MSR, securities, deposits, borrowings, long-term debt and derivative financial instruments.

        The Company's trading securities are primarily comprised of financial instruments, such as principal-only mortgage-backed securities, used for MSR risk management activities. As such, the related interest rate risk of those financial instruments used for MSR risk management activities is considered within the sensitivity comparison, presented later within this section.

        We manage interest rate risk within a consolidated enterprise risk management framework that includes the measurement and management of specific portfolios (MSR and Other Mortgage Banking) discussed below. The principal objective of asset/liability management is to manage the sensitivity of net income to changing interest rates. Asset/liability management is governed by a policy reviewed and approved annually by our Board. The Board has delegated the oversight of the administration of this policy to the Finance Committee of the Board.

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    Types of Interest Rate Risk

        We are exposed to different types of interest rate risks. These include lag, repricing, basis, prepayment, lifetime cap and volatility risk.

    Lag/Repricing Risk

        Lag risk results from the inherent timing difference between the repricing of adjustable-rate assets and liabilities. Repricing risk is caused by the mismatch in the maturities between assets and liabilities. For example, if our assets reprice slower than our liabilities, the effect of this timing difference, or "lag," will be favorable during a period of declining interest rates and unfavorable during a period of rising interest rates. Lag/repricing risk can produce short-term volatility in net interest income during periods of interest rate movements even though the effect of this lag generally balances out over time.

    Basis Risk

        Basis risk occurs when assets and liabilities have similar repricing frequencies but are tied to different market interest rate indices.

    Prepayment Risk

        Prepayment risk results from the ability of customers to pay off their loans prior to maturity. Generally, prepayments increase in falling interest rate environments and decrease in rising interest rate environments.

    Lifetime Cap Risk

        Many of the Company's adjustable-rate home loan products contain lifetime interest rate caps, which prevent the interest rate on the loan from exceeding a contractually determined level. In periods of dramatically rising rates, adjustable-rate loans that have reached their lifetime cap rate will no longer reprice upward.

    Volatility Risk

        Volatility risk is the change to the fair value of an option, or a fixed income instrument containing options (such as mortgages) from changes in the implied market level of future volatility ("implied volatility"). For the holder of an option contract, implied volatility is a key determinant of option value with higher volatility generally increasing option value and lower volatility generally decreasing option value.

    MSR Risk Management

        We manage potential impairment in the fair value of MSR and increased amortization levels of MSR through a comprehensive risk management program. Our intent is to offset the changes in fair value and amortization levels of MSR with changes in the fair value of risk management instruments. The risk management instruments include interest rate contracts, forward purchase commitments and available-for-sale and trading securities. The securities generally consist of fixed-rate debt securities, such as U.S. Government and agency obligations and mortgage-backed securities, including principal-only strips. The interest rate contracts typically consist of interest rate swaps, interest rate swaptions and interest rate floors. We also enter into forward commitments to purchase mortgage-backed securities, which generally are agreements to purchase 15- and 30-year fixed-rate mortgage-backed securities.

        The fair value of MSR is primarily affected by changes in prepayments that result from shifts in mortgage rates. Changes in the value of MSR risk management instruments due to changes in interest rates vary based on the specific instrument. For example, changes in the fair value of interest rate swaps are driven by shifts in interest rate swap rates and the fair value of U.S. Treasury securities is based on changes in U.S. Treasury rates. Mortgage rates may move more or less than the rates on Treasury bonds or interest rate swaps. This could result in a change in the fair value of the MSR that differs from the change in fair value of the MSR risk management instruments. This difference in market indices between the MSR and the risk management instruments results in what is referred to as basis risk.

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        During the third quarter of 2004, the Company adopted an MSR risk management approach that reduces its exposure to basis risk. As a result, the amount of mortgage based risk management products, such as forward commitments to purchase and sell mortgage-backed securities, was increased, while the amount of LIBOR based products, such as interest rate swap contracts, decreased. Due to the inherent optionality in mortgage-based products, additional derivatives were also purchased to mitigate the optionality risk created by these products. This change in approach resulted in a significant increase in the total notional balance of derivative contracts as compared with 2003, that are designated as MSR risk management instruments.

        The fair value of MSR decreases and the amortization rate increases in a declining interest rate environment due to the higher prepayment activity, resulting in the potential for loss of value and a reduction in net loan servicing income. During periods of rising interest rates, the amortization rate of MSR decreases and the fair value of MSR increases.

        We manage the MSR daily and adjust the mix of instruments used to manage MSR fair value changes as interest rates and market conditions warrant. The objective is to maintain an efficient and fairly liquid mix as well as a diverse portfolio of risk management instruments with maturity ranges that correspond well to the anticipated behavior of the MSR. For that portion of the MSR which qualifies for hedge accounting treatment, all changes in fair value of the MSR, even when the fair value is higher than amortized cost, will be recorded through earnings. MSR which do not qualify for hedge accounting treatment must be accounted for at the lower of cost or market value. We also manage the size of the MSR asset. Depending on market conditions and our desire to expand customer relationships, we may periodically sell or purchase additional servicing. We also may structure loan sales to control the size of the MSR asset created by any particular transaction.

        We believe this overall risk management strategy is the most efficient approach to managing MSR fair value risk. The success of this strategy, however, is dependent on management's decisions regarding the amount, type and mix of MSR risk management instruments that we select to manage the changes in fair value of our mortgage servicing asset. If this strategy is not successful, our net income could be adversely affected.

    Other Mortgage Banking Risk Management

        We also manage the risks associated with our home loan mortgage warehouse and pipeline. The mortgage warehouse consists of funded loans intended for sale in the secondary market. The pipeline consists of commitments to originate or purchase mortgages to be sold in the secondary market. The risk associated with the mortgage pipeline and warehouse is the potential for changes in interest rates between the time the customer locks in the rate on the loan and the time the loan is sold.

        We measure the risk profile of the mortgage warehouse and pipeline daily. As needed, to manage the warehouse and pipeline risk, we execute forward sales commitments, interest rate contracts and mortgage option contracts. A forward sales commitment protects us in a rising interest rate environment, since the sales price and delivery date are already established. A forward sales commitment is different, however, from an option contract in that we are obligated to deliver the loan to the third party on the agreed-upon future date. We also estimate the fallout factor, which represents the percentage of loans that are not expected to be funded, when determining the appropriate amount of our pipeline risk management instruments.

    Asset/Liability Risk Management

        The purpose of asset/liability risk management is to assess the aggregate risk profile of the consolidated Company. Asset/liability risk analysis combines the MSR and Other Mortgage Banking activities with substantially all of the other remaining interest rate risk positions inherent in the Company's operations.

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        To analyze net income sensitivity, management projects net income in a variety of interest rate scenarios, assuming both parallel and non-parallel shifts in the yield curve. These scenarios also capture the net interest income sensitivity due to changes in the slope of the yield curve and changes in the spread between Treasury and LIBOR rates. Additionally, management measures the sensitivity of asset and liability fair value changes to changes in interest rates to analyze risk exposure over longer periods of time.

        The projection of the sensitivity of net income requires numerous assumptions. Prepayment speeds, decay rates (the estimated runoff of deposit accounts that do not have a stated maturity) and loan and deposit volume and mix projections are the most significant assumptions. Prepayments affect the size of our loan and mortgage-backed securities portfolios, which impacts net interest income, and is also a major factor in the valuation of MSR. The decay rate assumptions also impact net interest income by altering the expected deposit mix and rates in various interest rate environments. The prepayment and decay rate assumptions reflect management's best estimate of future behavior. These assumptions are derived from internal and external analysis of customer behavior.

        The slope of the yield curve, current interest rate conditions and the speed of changes in interest rates all affect our sensitivity to changes in interest rates. Our borrowings and, to a lesser extent, our interest-bearing deposits typically reprice faster than our adjustable-rate assets. An additional lag effect is inherent in our adjustable-rate loans and mortgage-backed securities indexed to the 12-month average of the annual yields on actively traded U.S. Treasury securities adjusted to a constant maturity of one year and those indexed to the 11th District FHLB monthly weighted average cost of funds index.

        The sensitivity of new loan volume and mix to changes in market interest rate levels is also projected. We generally assume a reduction in total loan production in rising interest rate scenarios accompanied by a shift towards a greater proportion of adjustable-rate production. The gain from mortgage loans also varies under different interest rate scenarios. Normally, the gain from mortgage loans increases in falling interest rate environments primarily from high fixed-rate mortgage refinancing activity. Conversely, the gain from mortgage loans may decline when interest rates increase if we choose to retain more loans in the portfolio.

        In periods of rising interest rates, the net interest margin normally contracts since the repricing period of our liabilities is shorter than the repricing period of our assets. The net interest margin generally expands in periods of falling interest rates as borrowing costs reprice downward faster than asset yields.

        To manage interest rate sensitivity, management first utilizes the interest rate risk characteristics of our balance sheet assets and liabilities to offset each other as much as possible. Balance sheet products have a variety of risk profiles and sensitivities. Some of the components of our interest rate risk are countercyclical. We may adjust the amount or mix of risk management instruments based on the countercyclical behavior of our balance sheet products.

        When the countercyclical behavior inherent in portions of our balance sheet does not result in an acceptable risk profile, management utilizes investment securities and interest rate contracts to mitigate this situation. The interest rate contracts used for this purpose are classified as asset/liability risk management instruments. These contracts are often used to modify the repricing period of our interest-bearing funding sources with the intention of reducing the volatility of net interest income. The types of contracts used for this purpose consist of interest rate swaps, interest rate corridors, interest rate swaptions and certain derivatives that are embedded in borrowings. We also use receive-fixed swaps as part of our asset/liability risk management strategy to help us modify the repricing characteristics of certain long-term liabilities to match those of our assets. Typically, these are swaps of long-term fixed-rate debt to a short-term adjustable-rate which more closely resembles our asset repricing characteristics.

    January 1, 2005 and January 1, 2004 Sensitivity Comparison

        The table below indicates the sensitivity of net interest income and net income as a result of interest rate movements on market risk sensitive instruments. The base case used for this sensitivity analysis is similar to our most recent earnings plan for the respective twelve month periods as of the date the analysis

57



was performed. The comparative results assume parallel shifts in the yield curve with interest rates rising 200 basis points in even quarterly increments over the twelve month periods ending December 31, 2005 and December 31, 2004 and interest rates decreasing by 50 basis points in even quarterly increments over the first six months of the twelve month periods. The projected interest rate sensitivities of net interest income and net income shown below may differ significantly from actual results, particularly with respect to non-parallel shifts in the yield curve or changes in the spreads between mortgage, Treasury and LIBOR rates.

        The duration of earning assets drifted lower over 2004. This was a result of the origination and retention of adjustable-rate mortgage loans, significant growth in home equity loans and lines of credit as well as discretionary activity directed at reducing interest rate risk in the face of rising interest rates. Liability duration remained relatively constant over that same period. The result was a reduction in the net duration position and projected net interest income sensitivity. The projected net income and net interest income profile may not be realized and may not be present for non-parallel shifts in the yield curve or changes in the spreads between mortgage, Treasury and LIBOR rates.

 
  Gradual Change in Rates
 
 
  –50 basis points
  +200 basis points
 
Net interest income change for the one-year period beginning:          
  January 1, 2005   2.61 % (2.18 )%
  January 1, 2004   3.01   (2.57 )
Net income change for the one-year period beginning:          
  January 1, 2005   (0.95 ) (1.37 )
  January 1, 2004   (0.34 ) (1.23 )

        The change in net income sensitivity in the declining rate scenario was mainly due to the decrease in net duration, which results in lower net interest income. In the rising interest rate scenario the decrease in net duration has the effect of decreasing sensitivity; however, this decrease in sensitivity was more than offset by a modest change in the volatility of home loan mortgage banking income, due to changes in interest rates since year end, and changes in the composition of the MSR portfolio and related hedges and risk management instruments. This resulted in a net increase in sensitivity in the rising interest rate scenario.

        These sensitivity analyses are limited in that they were performed at a particular point in time; are subject to the accuracy of various assumptions used, including prepayment forecasts and discount rate; and do not incorporate other factors that would impact the Company's overall financial performance in such scenarios, most significantly the impact of changes in gain from mortgage loans, that result from changes in interest rates. Before the second quarter of 2004, an assumed level of gain from mortgage loans had been included as a component within the sensitivity model. Accordingly, the results of the January 1, 2004 net income simulation have been restated to conform to this change in methodology. In addition, not all of the changes in fair value may impact current period earnings. For example, the portion of the MSR that does not qualify for fair value hedge accounting treatment may increase in value, but the amount of the increase that is recorded in current period earnings may be limited to the recovery of the impairment reserve within each stratum. These analyses also assume that the general composition of MSR hedging and risk management instruments remains fairly constant and that mortgage and interest rate swap spreads remain constant in all interest rate environments. These assumptions may not be realized. For example, changes in spreads between interest rate indices could result in significant changes in projected net income sensitivity. Projected net income may increase if market rates on interest rate swaps decrease by more than the decrease in mortgage rates, while the projected net income may decline if the rates on swaps increase by more than mortgage rates. For all of these reasons, the preceding sensitivity estimates should not be viewed as an earnings forecast.

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Maturity and Repricing Information

        We use interest rate risk management contracts and available-for-sale and trading securities as tools to manage our interest rate risk profile. The following tables summarize the key contractual terms associated with these contracts and available-for-sale securities. Interest rate risk management contracts that are embedded within certain adjustable- and fixed-rate borrowings, while not accounted for as derivatives under Statement No. 133, have been included in the tables since they also function as interest rate risk management tools. Substantially all of the pay-fixed swaps, receive-fixed swaps and payor swaptions at December 31, 2004 are indexed to three-month LIBOR.

        The following estimated net fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies:

 
  December 31, 2004
 
 
  Maturity Range
 
 
  Net
Fair
Value

  Total
Notional
Amount

  2005
  2006
  2007
  2008
  2009
  After
2009

 
 
  (dollars in millions)

 
Interest Rate Risk Management Contracts:                                                  
  Asset/Liability Risk Management                                                  
    Pay-fixed swaps:   $ (112 )                                          
      Contractual maturity         $ 16,013   $ 11,780   $ 1,433   $ 2,800              
      Weighted average pay rate           3.51 %   3.08 %   4.18 %   5.01 %            
      Weighted average receive rate           2.34 %   2.39 %   2.13 %   2.24 %            
    Receive-fixed swaps:     218                                            
      Contractual maturity         $ 19,930   $ 80   $ 1,000   $ 10,950   $ 850   $ 1,150   $ 5,900  
      Weighted average pay rate           2.53 %   0.62 %   2.29 %   2.53 %   2.46 %   2.74 %   2.55 %
      Weighted average receive rate           4.35 %   5.41 %   6.81 %   3.53 %   3.99 %   4.25 %   5.51 %
    Interest rate caps:     21                                            
      Contractual maturity         $ 26,075   $ 3,000   $ 19,875   $ 3,200              
      Weighted average strike rate           4.38 %   3.30 %   4.46 %   4.91 %            
    Interest rate corridors:     2                                            
      Contractual maturity         $ 2,585   $ 7                   $ 2,578  
      Weighted average strike rate – long cap           9.80 %   5.94 %                   9.81 %
      Weighted average strike rate – short cap           10.09 %   7.44 %                   10.10 %
    Payor swaptions:     1                                            
      Contractual maturity (option)         $ 500       $ 500                  
      Weighted average strike rate           5.30 %       5.30 %                
      Contractual maturity (swap)                     $ 500              
      Weighted average pay rate                       5.30 %            
    Receiver swaptions:     6                                            
      Contractual maturity (option)         $ 1,070   $ 750   $ 320                  
      Weighted average strike rate           3.87 %   3.92 %   3.75 %                
      Contractual maturity (swap)                                 $ 1,070  
      Weighted average receive rate                                   3.87 %
   
 
                                     
        Total asset/liability risk management   $ 136   $ 66,173                                      
   
 
                                     

(This table is continued on the next page.)

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(Continued from the previous page.)

 
  December 31, 2004
 
 
  Maturity Range
 
 
  Net
Fair
Value

  Total
Notional
Amount

  2005
  2006
  2007
  2008
  2009
  After
2009

 
 
  (dollars in millions)

 
Interest Rate Risk Management Contracts:                                                  
  Other Mortgage Banking Risk Management                                                  
    Forward purchase commitments:   $ 28                                            
      Contractual maturity         $ 11,625   $ 11,625                      
      Weighted average price           101.15     101.15                      
    Forward sales commitments:     (48 )                                          
      Contractual maturity         $ 31,488   $ 31,488                      
      Weighted average price           101.02     101.02                      
    Interest rate futures:                                                
      Contractual maturity         $ 18,530   $ 7,446   $ 5,914   $ 4,267   $ 628   $ 275      
      Weighted average price           96.30     96.75     96.19     95.83     95.48     95.13      
    Interest-rate corridor:     1                                            
      Contractual maturity         $ 3,439               $ 3,439          
      Weighted average strike rate – long cap           3.94 %               3.94 %        
      Weighted average strike rate – short cap           10.00 %               10.00 %        
    Mortgage put options:     4                                            
      Contractual maturity         $ 1,215   $ 1,215                      
      Weighted average strike price           101.35     101.35                      
    Pay-fixed swaps:     22                                            
      Contractual maturity         $ 9,371   $ 4,840   $ 3,280   $ 380       $ 233   $ 638  
      Weighted average pay rate           3.08 %   2.79 %   3.10 %   3.33 %       3.91 %   4.68 %
      Weighted average receive rate           2.37 %   2.40 %