WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1:  Accounting Policies

Basis of Presentation

The accompanying Consolidated Financial Statements are unaudited and include the accounts of Washington Mutual, Inc. and its subsidiaries (“Washington Mutual” or the “Company”). Washington Mutual’s accounting and financial reporting policies are in accordance with accounting principles generally accepted in the United States of America. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with Washington Mutual, Inc.’s 2004 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current period classifications.

Recently Adopted 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 specific valuation allowances 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 is effective for loans and debt securities acquired after December 31, 2004. The adoption of SOP 03-3 did not have a material effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition .

In March 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position Emerging Issues Task Force 85-24-1 (“FSP EITF 85-24-1”), Distribution Fees by Distributors of Mutual Funds That Do Not Have a Front-End Sales Charge . FSP EITF 85-24-1 considers the appropriate accounting for cash received from a third party for a distributor’s right to future cash flows relating to distribution fees for shares previously sold. The FASB staff concluded that revenue recognition is appropriate when cash is received from a third party if the distributor no longer has any continuing involvement or recourse associated with the rights. The Company applied FSP EITF 85-24-1 as of April 1, 2005. The adoption of FSP EITF 85-24-1 did not have a material effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

In December 2004, the FASB issued Statement of Financial Accounting Standards (“Statement”) No. 153, Exchange of Nonmonetary Assets . Statement 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 Principles Board (“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 after the second quarter of 2005. The adoption of Statement No. 153 did not have a material effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

7

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Stock-Based Compensation

In accordance with the transitional guidance of Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123 , the Company elected to prospectively apply the fair value method of accounting for stock-based awards granted subsequent to December 31, 2002 . For such awards, fair value is estimated using a modified Black-Scholes model, with compensation expense recognized in earnings over the required service period. Stock-based awards granted prior to January 1, 2003, and not modified after December 31, 2002, will continue to be accounted for under APB Opinion No. 25, Accounting for Stock Issued to Employees . The pro forma presentation of the impact these awards would have on the consolidated financial statements, if they were accounted for on the fair value basis, will continue to be disclosed in the Notes to Consolidated Financial Statements until the last of those awards vest in December 2005.

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

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
		(dollars in millions, except per share amounts)
Net income		$	821		$	674		$	2,567		$	2,210
Add back: Stock-based employee compensation expense included in reported net income, net of related tax effects		28			14			69			54
Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects		(34		)	(26		)	(87		)	(87		)
Pro forma net income		$	815		$	662		$	2,549		$	2,177
Net income per common share:
Basic:
As reported		$	0.95		$	0.78		$	2.97		$	2.56
Pro forma		0.94			0.77			2.94			2.52
Diluted:
As reported		0.92			0.76			2.89			2.50
Pro forma		0.92			0.75			2.87			2.46

 

Recently Issued Accounting Standards

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

8

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

prospectively apply the fair value method of accounting for stock-based awards granted subsequent to December 31, 2002. The Company will prospectively apply Statement No. 123R to its financial statements as of January 1, 2006. However, as the Company has already adopted Statement No. 148 and substantially all stock-based awards granted prior to its adoption will be fully vested by the end of this year, Statement No. 123R will not have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

In March 2005, Securities and Exchange Commission (‘‘SEC’’) Staff Accounting Bulletin No. 107 (‘‘SAB 107’’) was issued, which expresses views of the staff regarding the interaction between Statement No. 123R, Share-Based Payment , and certain SEC rules and regulations and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company will consider the guidance provided by SAB 107 as part of its adoption of Statement No. 123R.

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), Accounting for Conditional Asset Retirement Obligations , an interpretation of FASB Statement No. 143, Accounting for Asset Retirement Obligations . FIN 47 generally applies to long-lived assets and requires a liability to be recognized for a conditional asset retirement obligation if the fair value of that liability can be reasonably estimated. A conditional asset retirement obligation is defined as a legal obligation to perform an activity associated with an asset retirement in which the timing and/or method of settlement are conditional on a future event that may or may not occur or be within the control of the company. A liability should be recognized when incurred (based on its fair value at that date), which generally would be upon acquisition or construction of the related asset. Upon recognition, the offset to the liability would be capitalized as part of the cost of the asset and depreciated over the estimated useful life of that asset. The Interpretation is effective no later than December 31, 2005, with early application encouraged. The Company is evaluating the impact of FIN 47. At this time, the Company does not expect the application of FIN 47 to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

In May 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement replaces APB Opinion No. 20, Accounting Changes , and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements , and changes the requirements for the accounting and reporting of a change in accounting principle. This Statement requires changes in accounting principle to be retrospectively applied to the prior periods presented in the financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This Statement applies to all voluntary changes in accounting principles and also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement also carries forward, without substantive change, the provisions for the correction of an error from APB Opinion No. 20. Statement No. 154 is effective for accounting changes and corrections of errors made after December 31, 2005. The Company does not expect the application of this Statement to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

Note 2:  Discontinued Operations

During the first quarter of 2004 the Company sold its consumer finance subsidiary, Washington Mutual Finance Corporation. Accordingly, this former subsidiary has been accounted for as a discontinued operation and its results of operations and cash flows have been removed from the Company’s results of continuing operations for the nine months ended September 30, 2004 on the Consolidated Statements of

9

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Income and Cash Flows. The results from discontinued operations in 2004 amounted to $399 million net of tax, which includes a pretax gain of $676 million ($420 million, net of tax) that was recorded upon the sale of Washington Mutual Finance Corporation.

Note 3:  Earnings Per Share

Information used to calculate earnings per share was as follows:

		Three Months Ended September 30,				Nine Months Ended September 30,
		2005		2004		2005		2004
		(in thousands)
Weighted average shares:
Basic weighted average number of common shares outstanding		866,541		862,004		865,571		861,933
Dilutive effect of potential common shares from:
Awards granted under equity incentive programs		12,165		11,744		13,034		12,644
Trust Preferred Income Equity Redeemable Securities SM		9,789		8,575		9,579		9,491
Diluted weighted average number of common shares outstanding		888,495		882,323		888,184		884,068

 

For the three months and nine months ended September 30, 2005, options to purchase an additional 8,508,734 and 8,565,734 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect. Likewise, for the three and nine months ended September 30, 2004, options to purchase an additional 11,599,147 and 1,657,852 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion also would have had an antidilutive effect.

Additionally, as part of the 1996 business combination with Keystone Holdings, Inc. (the parent of American Savings Bank, F.A.), 6 million shares of common stock, with an assigned value of $18.4944 per share, are being held in escrow for the benefit of certain of the former investors in Keystone Holdings and their transferees. During 2003, the number of escrow shares was reduced from 18 million to 6 million as a result of the return and cancellation of 12 million shares to the Company. The escrow will expire on December 20, 2008, subject to certain limited extensions. The conditions under which these shares can be released from escrow are related to the outcome of certain litigation and not based on future earnings or market prices. At September 30, 2005, the conditions for releasing the shares from escrow had not occurred, and therefore, none of the shares in the escrow were included in the above computations.

10

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note 4:  Mortgage Banking Activities

Revenue from sales and servicing of home mortgage loans consisted of the following:

		Three Months Ended September 30,										Nine Months Ended September 30,
		2005					2004					2005			2004
		(in millions)
Revenue from sales and servicing of home mortgage loans:
Sales activity:
Gain from home mortgage loans and originated mortgage-backed securities			$	206				$	210			$	637		$	494
Revaluation gain (loss) from derivatives			73					(23		)		74			56
Gain from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments			279					187				711			550
Servicing activity:
Home mortgage loan servicing revenue, net (1)			538					485				1,576			1,464
Amortization of MSR			(555		)			(589		)		(1,689		)	(1,884		)
MSR valuation adjustments (2)			412					165				874			(493		)
Revaluation gain from derivatives			40					256				137			1,398
Home mortgage loan servicing revenue, net of hedging and derivative risk management instruments (3)			435					317				898			485
Total revenue from sales and servicing of home mortgage loans			$	714				$	504			$	1,609		$	1,035

---

⁽¹⁾           Includes late charges, prepayment fees and loan pool expenses (the shortfall of the scheduled interest required to be remitted to investors compared to what is collected from the borrowers upon payoff).

⁽²⁾           Net of fair value hedge ineffectiveness as well as any impairment/reversal recognized on MSR that results from the application of the lower of cost or market value accounting methodology.

⁽³⁾           Does not include the effects of other non-derivative instruments used by the Company as part of its overall MSR risk management program.

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

		Three Months Ended September 30,								Nine Months Ended September 30,
		2005			2004					2005					2004
		(in millions)
Balance, beginning of period		$	543,324			$	558,388				$	540,392				$	582,669
Home loans:
Additions		43,418				29,699					114,124					105,909
Loan payments and other		(39,005		)		(37,035			)		(107,555			)		(139,481			)
Net change in commercial real estate loans serviced for others		(159		)		193					617					2,148
Balance, end of period		$	547,578			$	551,245				$	547,578				$	551,245

 

11

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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

		Three Months Ended September 30,								Nine Months Ended September 30,
		2005				2004				2005				2004
		(in millions)
Balance, beginning of period		$		5,730		$		7,501		$		5,906		$		6,354
Home loans:
Additions		605				348				1,651				1,463
Amortization		(555			)	(589			)	(1,689			)	(1,884			)
(Impairment) reversal		413				(266			)	590				(646			)
Statement No. 133 MSR accounting valuation adjustments		849				(885			)	580				822
Net change in commercial real estate MSR		–				3				4				3
Balance, end of period (1)		$	7,042			$	6,112			$	7,042			$	6,112

---

⁽¹⁾           At September 30, 2005 and 2004, aggregate MSR fair value was $7.06 billion and $6.11 billion.

Changes in the valuation allowance for MSR were as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2005				2004				2005				2004
		(in millions)
Balance, beginning of period		$		1,746		$		2,417		$		1,981		$		2,435
Impairment (reversal)		(413			)	266				(590			)	646
Other-than-temporary impairment		(18			)	(22			)	(63			)	(410			)
Other		(3			)	(8			)	(16			)	(18			)
Balance, end of period		$	1,312			$	2,653			$	1,312			$	2,653

 

At September 30, 2005, the expected weighted average life of the Company’s MSR was 3.7 years. Projected amortization expense for the gross carrying value of MSR at September 30, 2005 is estimated to be as follows (in millions):

Remainder of 2005		$	501
2006		1,668
2007		1,230
2008		933
2009		731
After 2009		3,291
Gross carrying value of MSR		8,354
Less: valuation allowance		(1,312		)
Net carrying value of MSR		$	7,042

 

The projected amortization expense of MSR is an estimate and should be used with caution. The amortization expense for future periods was calculated by applying the same quantitative factors, such as projected MSR prepayment estimates and discount rates, as were used to determine amortization expense at the end of the third quarter of 2005 . These factors are inherently subject to significant fluctuations,

12

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

primarily due to the effect that changes in mortgage rates have on loan prepayment experience. Accordingly, any projection of MSR amortization in future periods is limited by the conditions that existed at the time the calculations were performed, and may not be indicative of actual amortization expense that will be recorded in future periods.

Note 5:  Guarantees

The Company sells loans without recourse that it may be required to repurchase if it is subsequently revealed that an error was made in the process of originating the loan which results in a violation of a material representation or warranty concerning the loan made in connection with its sale. When a loan sold to an investor without recourse fails to perform according to its contractual terms, the investor will typically review the loan file to identify errors that may have been made in the process of originating the loan and, if identified, whether such errors constitute a violation of a material representation or warranty concerning the loan made to the investor in connection with its sale. In such circumstances, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained . If no such errors are identified, the Company has no obligation to repurchase the loan. As of September 30, 2005 and December 31, 2004, the amount of loans sold without recourse totaled $540.60 billion and $533.51 billion, which substantially represents the unpaid principal balance of the Company’s loans serviced for others portfolio. The Company has accrued $201 million as of September 30, 2005 and $148 million as of December 31, 2004 to cover the estimated loss exposure related to loan origination process errors that are inherent within this portfolio.

Note 6:  Subsequent Event

On October 1, 2005 the Company completed its acquisition of Providian Financial Corporation in a stock and cash transaction with an estimated purchase price of approximately $6.2 billion. For each share of Providian common stock, Providian stockholders received .4005 shares of Washington Mutual common stock and $2.00 in cash. As a result of this acquisition, the Company now ranks as the ninth largest among all credit card issuers. The business activities of this entity will be conducted through a new operating segment entitled “Washington Mutual Card Services.”

Note 7:  Operating Segments

The Company has three operating segments for the purpose of management reporting:  the Retail Banking and Financial Services Group, the Home Loans Group (previously called the “Mortgage Banking Group”) and the Commercial Group. Unlike financial accounting, there is no comprehensive, authoritative guidance for management reporting . The management reporting process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. The Company’s operating segments are defined by the products and services they offer.

The Retail Banking and Financial Services Group’s principal activities include:  (1) offering a comprehensive line of deposit and other retail banking products and services to consumers and small businesses; (2) originating, managing and servicing home equity loans and lines of credit; (3) providing investment advisory and brokerage services, sales of annuities, mutual fund management and other financial services; and (4) holding the Company’s portfolio of home loans held for investment, exclusive of the portion of the specialty mortgage finance home loan portfolio that represents home loans held for investment by Long Beach Mortgage Company. This segment’s home loan portfolio consists of home loan

13

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

inter-segment purchases from the Home Loans Group and home loans purchased from secondary market participants, including home loans made to subprime borrowers.

The Home Loans Group’s principal activities include:  (1) originating and servicing home loans; (2) buying and selling home loans in the secondary market; and (3) selling insurance-related products and participating in reinsurance activities with other insurance companies. For management reporting purposes, home loans originated by this segment are either transferred through inter-segment sales to the Retail Banking and Financial Services Group or are sold to secondary market participants. The segment typically retains the rights to service these loans and receives fees and other forms of remuneration for providing this service. The Home Loans Group performs servicing activities for substantially all of the Company’s home loans managed portfolio – whether the home loans are held for investment or have been sold on a servicing-retained basis to secondary market participants. Insurance products that complement the mortgage lending process, such as private mortgage insurance and property and casualty insurance, are also made available. This segment also manages the Company’s captive reinsurance activities.

The Commercial Group’s principal activities include:  (1) providing financing to developers and investors for the acquisition or construction of multi-family dwellings and, to a lesser extent, other commercial properties; (2) 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; (3) providing financing to mortgage bankers for the origination of residential mortgage loans; and (4) originating and servicing home loans made to subprime borrowers through the Company’s subsidiary, Long Beach Mortgage Company. Such loans may be held in the Company’s specialty mortgage finance home loan portfolio or sold in the secondary market.

The Corporate Support/Treasury and Other category includes enterprise-wide management of the Company’s 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 the Company holds 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 and our community lending and investment operations. Community lending and investment programs help fund the development of affordable housing units in traditionally underserved communities. Also reported in this category is the net impact of funds transfer pricing for loan and deposit balances, lower of cost or market value adjustments and the write-off of inter-segment premiums associated with transfers of loans from the Retail Banking and Financial Services Group to the Home Loans Group when home loans previously designated as held for investment are moved to held for sale and all charges incurred from the Company’s cost containment initiative, which was a key initiative during 2004.

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:  (1) 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

14

---

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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; (2) a calculation of the provision for loan and lease losses based on management’s current assessment of the long-term, normalized net charge-off ratio for loan products within each segment, which 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; (3) the utilization of an activity-based costing approach to measure allocations of certain operating expenses that were not directly charged to the segments; (4) the allocation of goodwill and other intangible assets to the operating segments based on benefits received from each acquisition; (5) capital charges for goodwill as a component of an internal measurement of return on the goodwill allocated to the operating segment; and (6) inter-segment activities which include the transfer of originated mortgage loans that are to be held in portfolio from the Home Loans Group to the Retail Banking and Financial Services Group and a broker fee arrangement between Home Loans and Retail Banking and Financial Services. When originated mortgage loans are transferred, the Home Loans Group records a gain on the sale of the loans based on an assumed profit factor. This profit factor is included as a premium to the value of the transferred loans, which is amortized as an adjustment to the net interest income recorded by the Retail Banking and Financial Services Group while the loan is held for investment. If a loan that was designated as held for investment is subsequently transferred to held for sale, the inter-segment premium is written off. Inter-segment broker fees are recorded by the Retail Banking and Financial Services Group when home loans are initiated through retail banking stores, while the Home Loans 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.

15