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

Note 1: Summary of Significant 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”). The Company’s financial reporting and accounting policies conform to accounting principles generally accepted in the United States of America (“GAAP”). All intercompany transactions and balances have been eliminated. Certain amounts in prior periods have been reclassified to conform to the current period’s presentation. In particular, prepayment fees were reclassified from noninterest income to interest income and expenses related to low income housing partnerships were reclassified from noninterest expense to other income.

The reclassification of prepayment fees was made in conjunction with changes made to regulatory financial reporting standards by the Office of Thrift Supervision. The amount reclassified to interest income totaled $83 million and $155 million for the three and six months ended June 30, 2005. Prepayment fees totaled $67 million and $131 million for the three and six months ended June 30, 2006.

In the second quarter of 2006, the Company reclassified expenses related to its investments in low income housing partnerships. The amount reclassified to other income totaled $13 million and $25 million for the three and six months ended June 30, 2005 and $20 million for the three months ended March 31, 2006. Such expenses totaled $44 million for the six months ended June 30, 2006.

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 2005 Annual Report on Form 10-K/A.

Recently Issued Accounting Standards Not Yet Adopted

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) No. 155, Accounting for Certain Hybrid Financial Instruments . This Statement amends Statements No. 133, Accounting for Derivative Instruments and Hedging Activities and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities to simplify and achieve more consistency in the accounting for certain financial instruments. This Statement permits fair value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided the entire instrument is accounted for on a fair value basis and establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. Statement No. 155 is effective for all of the Company’s financial instruments acquired or issued after December 31, 2006. The Company is currently evaluating the impact this guidance will have on the Consolidated Statements of Income and the Consolidated Statements of Financial Condition.

In June 2006, the FASB issued Interpretation 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes , an interpretation of FASB Statement No. 109, Accounting for Income Taxes. This Interpretation requires that a tax position be recognized only if it is “more likely than not” to be sustained, based solely on its technical merits, as of the reporting date. A tax position that meets the more-likely-than-not criterion shall be measured at the largest amount of benefit that is more than 50 percent likely of being realized upon ultimate settlement. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact this guidance will have on the Consolidated Statements of Income and the Consolidated Statements of Financial Condition.

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

In June 2006, the Emerging Issues Task Force (“EITF”) reached consensus on the guidance provided by EITF 05-1, Accounting for the Conversion of an Instrument that Becomes Convertible Upon the Issuer’s Exercise of a Call Option . The issuance of equity securities to settle an instrument (pursuant to the instrument’s original conversion terms) that becomes convertible upon the issuer’s exercise of a call option should be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date (i.e., no gain or loss should be recognized related to the equity securities issued to settle the instrument). Additionally, the issuance of equity securities to settle an instrument that, as of its issuance date, does not contain a substantive conversion feature should be accounted for as a debt extinguishment and the fair value of the equity securities issued should be considered a component of the reacquisition price of the debt. The EITF also reached a consensus that Issue No. 03-7, Accounting for the Settlement of the Equity-Settled Portion of a Convertible Debt Instrument That Permits or Requires the Conversion Spread to Be Settled in Stock (Instrument C of Issue No. 90-19) , should be amended to clarify that Issue 03-7 does not apply to settlements within the scope of Issue 05-1. The guidance is effective for all conversions within its scope that result from the exercise of call options in interim or annual reporting periods beginning after June 28, 2006, and is not expected to have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition.

Note 2: Restatement of Financial Statements

After announcing its earnings for the second quarter ended June 30, 2006, the Company completed a comprehensive review and reconciliation of its current and deferred income tax accounts and concluded that a $337 million reduction to retained earnings was necessary, representing cumulative adjustments to net income recorded in prior periods up to and including 2001. No adjustments were made to net income or earnings per share for any of the periods from 2002 through June 30, 2006. The adjustments reflect corrections to the tax accounting records related to matters occurring prior to 2002 at the Company and predecessor companies, including H.F. Ahmanson & Co., Great Western Financial Corp. and American Savings Bank, which the Company acquired in the late 1990s. The adjustments arose primarily from inadequate tax records, delays in reconciling tax accounts and errors in recording the impact of certain tax payments and the income tax expense of the Company during those years. Accordingly, these adjustments affected the balance of retained earnings and certain tax accounts at December 31, 2001 and each period thereafter. Refer to Note 2 to the Consolidated Financial Statements – “Restatement of Financial Statements” in the Company’s 2005 Annual Report on Form 10-K/A for further information regarding the effects of this restatement on the Company’s Consolidated Statements of Financial Condition at December 31, 2005.

Note 3: Discontinued Operations

In July 2006 the Company announced its exit from the mutual fund management business and subsequently entered into a definitive agreement to sell its subsidiary, WM Advisors, Inc. WM Advisors provides investment management, distribution and shareholder services to the WM Group of Funds. Accordingly, the results of its operations have been removed from the Company’s results of continuing operations for all periods presented on the Consolidated Statements of Income and Note 8 to the Consolidated Financial Statements – “Operating Segments,” and are presented in aggregate as discontinued operations. Assets and liabilities of WM Advisors have been reclassified to other assets and other liabilities on the Consolidated Statements of Financial Condition. The sale is expected to close in the fourth quarter of 2006.

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

Results of operations for WM Advisors were as follows:

		Three Months Ended June 30,										Six Months Ended June 30,
		2006					2005					2006					2005
		(in millions)
Net interest income			$	–				$	–				$	1				$	–
Noninterest income			69					66					136					129
Noninterest expense			57					49					110					94
Income taxes			4					6					10					12
Net income			$	8				$	11				$	17				$	23

 

Note 4: Earnings Per Share

Information used to calculate earnings per share was as follows:

		Three Months Ended June 30,				Six Months Ended June 30,
		2006		2005		2006		2005
		(in thousands)
Weighted average shares:
Basic weighted average number of common shares outstanding		947,023		865,221		960,245		865,078
Dilutive effect of potential common shares from:
Awards granted under equity incentive programs		15,275		12,665		16,009		13,468
Common stock warrants		11,071		9,364		10,754		9,474
Convertible debt (1)		1,179		–		1,922		–
Accelerated share repurchase program		956		–		478		–
Diluted weighted average number of common shares outstanding		975,504		887,250		989,408		888,020

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(1)                  Acquired on October 1, 2005 through the merger with Providian Financial Corporation.

For the three months and six months ended June 30, 2006, options to purchase approximately 15.4 million and 15.6 million 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 six months ended June 30, 2005, options to purchase approximately 8.8 million and 8.7 million 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.

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 to certain of the former investors in Keystone Holdings and their transferees are related to the outcome of certain litigation and not based on future earnings or market prices. At June 30, 2006, the conditions for releasing the shares from escrow did not exist, and therefore, none of the shares in the escrow were included in the above computations.

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

Note 5: Mortgage Banking Activities

In March 2006, the FASB issued Statement No. 156, Accounting for Servicing of Financial Assets , which amends Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities . For each class of separately recognized servicing asset, this Statement permits an entity to choose either to amortize such assets in proportion to and over the period of estimated net servicing income and perform an impairment assessment at each reporting date, or to report servicing assets at fair value at each reporting date and record changes in fair value in earnings in the period in which the changes occur. At its initial adoption, the Statement permits a one-time reclassification of available-for-sale securities to trading securities, provided that the securities are identified as offsetting the entity’s exposure to changes in fair value of servicing assets that are reported at fair value.

As permitted by the early adoption provisions of this accounting standard, the Company applied Statement No. 156 to its financial statements on January 1, 2006 and elected to measure all classes of mortgage servicing assets at fair value. The Company also elected to transfer its January 1, 2006 portfolio of available-for-sale mortgage servicing rights (“MSR”) risk management securities to trading. The effects of these changes were recorded as a cumulative effect of a change in accounting principle adjustments to retained earnings as of January 1, 2006 and were comprised of a $35 million adjustment, net of taxes, from the MSR fair value election and a $(6) million adjustment, net of taxes, from the transfer of available-for-sale securities, designated as MSR risk management instruments, to the trading portfolio. Upon electing the fair value method of accounting for its mortgage servicing assets, the Company discontinued the application of fair value hedge accounting. Accordingly, beginning in 2006, all derivatives held for MSR risk management are treated as economic hedges, with valuation changes recorded as revaluation gain (loss) from derivatives economically hedging MSR. Additionally, upon the change from the lower of cost or fair value accounting method to fair value accounting under Statement No. 156, the calculation of amortization and the assessment of impairment were discontinued and the MSR valuation allowance was written off against the recorded value of the MSR. Those measurements have been replaced by fair value adjustments that encompass market-driven valuation changes and the runoff in value that occurs from the passage of time, which are each separately reported.

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

Revenue from sales and servicing of home mortgage loans, including the effects of derivative risk management instruments, consisted of the following:

		Three Months Ended June 30,										Six Months Ended June 30,
		2006					2005					2006			2005
		(in millions)
Revenue from sales and servicing of home mortgage loans:
Sales activity:
Gain from home mortgage loans and originated mortgage-backed securities			$	184				$	250			$	341		$	431
Revaluation gain (loss) from derivatives economically hedging loans held for sale			67					(79		)		119			1
Gain from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments			251					171				460			432
Servicing activity:
Home mortgage loan servicing revenue (1)			586					523				1,159			1,032
Change in MSR fair value due to valuation inputs or assumptions			435					–				849			–
Change in MSR fair value due to payments on loans and other			(460		)			–				(869		)	–
MSR valuation adjustments (2)			–					(77		)		–			462
Amortization of MSR			–					(564		)		–			(1,133		)
Revaluation gain (loss) from derivatives economically hedging MSR			(433		)			61				(956		)	96
Adjustment to MSR fair value pursuant to MSR sale (3)			(157		)			–				(157		)	–
Home mortgage loan servicing revenue (expense), net of MSR valuation changes and derivative risk management instruments			(29		)			(57		)		26			457
Total revenue from sales and servicing of home mortgage loans			$	222				$	114			$	486		$	889

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(1)    Includes late charges 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 fair value accounting methodology in 2005.

(3)    Sale consists of approximately $2.6 billion of mortgage servicing rights.

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

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

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
		(in millions)
Balance, beginning of period		$	569,501		$	542,797		$	563,208		$	540,392
Home loans:
Additions		30,949			36,174			65,974			70,706
Loan payments and other		(30,377		)	(35,689		)	(59,440		)	(68,550		)
Net change in commercial real estate loans		279			42			610			776
Balance, end of period		$	570,352	(1)	$	543,324		$	570,352	(1)	$	543,324

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(1)    Does not include the effects of MSR sale, which reduced the unpaid principal balance of the servicing portfolio by $141 billion in July 2006.

Changes in the balance of MSR were as follows:

		Three Months Ended June 30,										Six Months Ended June 30,
		2006					2005					2006			2005
		(in millions)
Balance, beginning of period (1)			$	8,736				$	6,802			$	8,041		$	5,906
Home loans:
Additions			607					555				1,239			1,044
Changes in MSR fair value due to valuation inputs or assumptions			435					–				849			–
Payments on loans and other			(460		)			–				(869		)	–
Adjustment to MSR fair value pursuant to MSR sale			(157		)			–				(157		)	–
Fair value basis adjustment (2)			–					–				57			–
Amortization			–					(564		)		–			(1,133		)
(Impairment) reversal			–					(250		)		–			177
Statement No. 133 MSR accounting valuation adjustments			–					(813		)		–			(268		)
Net change in commercial real estate MSR			1					–				2			4
Balance, end of period (1)			$	9,162				$	5,730	(3)		$	9,162		$	5,730	(3)

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(1)           Net of valuation allowance for all periods in 2005.

(2)           Pursuant to the adoption of Statement No. 156 on January 1, 2006, the $57 million difference between the net carrying value and fair value was recorded as an increase to the basis of the Company’s MSR.

(3)           At June 30, 2005, aggregate MSR fair value was $5.74 billion.

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

Changes in the valuation allowance for MSR were as follows:

		Three Months Ended June 30,					Six Months Ended June 30,
		2005					2006			2005
		(in millions)
Balance, beginning of period			$	1,513			$	914		$	1,981
Impairment (reversal)			250				–			(177		)
Other-than-temporary impairment			(11		)		–			(45		)
Other			(6		)		(914		) (1)	(13		)
Balance, end of period			$	1,746			$	–		$	1,746

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(1)           Pursuant to the adoption of Statement No. 156, the valuation allowance was written off against the recorded value of the MSR.

Note 6: Guarantees

In the ordinary course of business, the Company sells loans to third parties but retains credit risk exposure on those loans. When loans are sold with retained credit risk provisions attached to the sale, the Company commits to stand ready to perform, if the loan defaults, by making payments to remedy the default or repurchasing the loan. The Company also sells loans without retained credit risk that it may be required to repurchase for violation of a representation or warranty made in connection with the sale of the loan that has a material adverse effect on the value of the loan, or if the Company agreed to repurchase the loan in the event of a first payment or early payment default. When a loan sold to an investor without retained credit risk fails to perform according to its contractual terms, the investor will typically review the loan file to search for errors that may have been made in the process of originating the loan. If errors are discovered and it is determined that such errors constitute a violation of a representation or warranty made to the investor in connection with the loan’s sale, then the Company will be required to either repurchase the loan or indemnify the investor for losses sustained if the violation had a material adverse effect on the value of the loan. As of June 30, 2006 and December 31, 2005, the amount of loans sold without retained credit risk totaled $561.37 billion and $555.51 billion, which substantially represents the unpaid principal balance of the Company’s loans serviced for others portfolio. The Company has recorded loss contingency reserves of $107 million as of June 30, 2006 and $130 million as of December 31, 2005 to cover the estimated loss exposure related to loan origination process errors that are inherent within this portfolio.

In 2004 and 2005, the Company’s Long Beach Mortgage division engaged in whole loan sale transactions of originated subprime loans in which it agreed to repurchase from the investor each “early payment default” loan at a price equal to the loan’s face value plus the amount of any premium paid by the investor. An early payment default occurs when the borrower fails to make the first post-sale payment due on the loan by a contractually specified date. Usually when such an event occurs, the fair value of the loan at the time of its repurchase is lower than the face value. In the fourth quarter of 2005, the Company experienced increased incidents of repurchases of early payment default loans sold by Long Beach Mortgage. The Company has recorded loss contingency reserves of $3 million as of June 30, 2006 and $40 million as of December 31, 2005 to cover estimated loss exposure related to such loan sales.

Note 7: Stock-Based Compensation

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. Effective January 1, 2006, the Company adopted Statement No. 123R, Share-Based

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

Payment , using the modified prospective application transition method. As the Company had already adopted Statement No. 148 and substantially all stock-based awards granted prior to its adoption are fully vested at December 31, 2005, Statement No. 123R did not have a significant effect on the Consolidated Statements of Income or the Consolidated Statements of Financial Condition. Prior to the Company’s adoption of Statement No. 123R, benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows in the Consolidated Statements of Cash Flows. Statement No. 123R requires excess tax benefits to be reported as a financing cash inflow rather than as a reduction of taxes paid.

Statement No. 123R requires an entity that previously had a policy of recognizing the effect of forfeitures as they occurred to estimate the number of outstanding instruments for which the requisite service is not expected to be rendered. The effect of this change in accounting principle amounted to $25 million and has been reflected as a decrease to compensation and benefits expense in the three months ended March 31, 2006.

Net income for the three and six months ended June 30, 2006 included $57 million and $114 million of compensation costs and $22 million and $43 million of income tax benefits related to the Company’s stock-based compensation arrangements. Net income for the three and six months ended June 30, 2005 included $30 million and $66 million of compensation costs and $12 million and $25 million of income tax benefits related to the Company’s stock-based compensation arrangements. As the Company elected to use the modified prospective application method, results for the three and six months ended June 30, 2005 do not reflect any restated amounts.

Washington Mutual maintains an equity incentive plan and an employee stock purchase plan. For further discussion of the Company’s equity incentive plan and employee stock purchase plan, refer to Note 20 to the Consolidated Financial Statements – “Stock-Based Compensation Plan and Shareholder Rights Plan” of Washington Mutual, Inc.’s 2005 Annual Report on Form 10-K/A.

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