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


FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008

Commission File Number 1-14667


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

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

1301 Second Avenue, Seattle, Washington

 

98101
(Address of principal executive offices)   (Zip Code)

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


        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ý     No  o .

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ý   Accelerated filer  o   Non-accelerated filer  o
(Do not check if a smaller reporting company)
  Smaller reporting company  o .

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o     No  ý .

        The number of shares outstanding of the issuer's classes of common stock as of April 30, 2008:


 

 

Common Stock – 1,058,827,858 (1)

 

 

 

 

(1) Includes 6,000,000 shares held in escrow.

 

 





WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2008
TABLE OF CONTENTS

 
  Page
PART I – Financial Information   1
  Item 1. Financial Statements   1
    Consolidated Statements of Income (Unaudited) –
Three Months Ended March 31, 2008 and 2007
  1
    Consolidated Statements of Financial Condition (Unaudited) –
March 31, 2008 and December 31, 2007
  2
    Consolidated Statements of Stockholders' Equity and Comprehensive Income (Unaudited) –
Three Months Ended March 31, 2008 and 2007
  3
    Consolidated Statements of Cash Flows (Unaudited) –
Three Months Ended March 31, 2008 and 2007
  4
    Notes to Consolidated Financial Statements (Unaudited)   6
  Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   23
          Risk Factors   23
          Controls and Procedures   24
          Critical Accounting Estimates   25
          Overview   26
          Recently Issued Accounting Standards Not Yet Adopted   28
          Summary Financial Data   29
          Earnings Performance   30
          Review of Financial Condition   36
          Operating Segments   42
          Off-Balance Sheet Activities   47
          Capital Adequacy   49
          Risk Management   50
          Credit Risk Management   50
          Liquidity Risk and Capital Management   62
          Market Risk Management   66
          Operational Risk Management   71
  Item 3. Quantitative and Qualitative Disclosures About Market Risk   66
  Item 4. Controls and Procedures   24

PART II – Other Information

 

72
  Item 1.   Legal Proceedings   72
  Item 1A. Risk Factors   23
  Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   76
  Item 4.   Submission of Matters to a Vote of Security Holders   76
  Item 6.   Exhibits   76

i



Part I – FINANCIAL INFORMATION

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 
  Three Months Ended
March 31,

 
 
  2008
  2007
 
 
  (in millions, except
per share amounts)

 
Interest Income              
  Loans held for sale   $ 87   $ 562  
  Loans held in portfolio     3,954     3,900  
  Available-for-sale securities     357     332  
  Trading assets     116     113  
  Other interest and dividend income     77     101  
   
 
 
    Total interest income     4,591     5,008  
Interest Expense              
  Deposits     1,329     1,772  
  Borrowings     1,087     1,155  
   
 
 
    Total interest expense     2,416     2,927  
   
 
 
      Net interest income     2,175     2,081  
  Provision for loan losses     3,511     234  
   
 
 
      Net interest income (expense) after provision for loan losses     (1,336 )   1,847  
Noninterest Income              
  Revenue from sales and servicing of home mortgage loans     411     125  
  Revenue from sales and servicing of consumer loans     248     443  
  Depositor and other retail banking fees     704     665  
  Credit card fees     181     172  
  Securities fees and commissions     58     60  
  Insurance income     30     29  
  Loss on trading assets     (216 )   (108 )
  Gain on other available-for-sale securities     18     35  
  Other income     135     120  
   
 
 
    Total noninterest income     1,569     1,541  
Noninterest Expense              
  Compensation and benefits     914     1,002  
  Occupancy and equipment     358     376  
  Telecommunications and outsourced information services     130     129  
  Depositor and other retail banking losses     63     61  
  Advertising and promotion     105     98  
  Professional fees     39     38  
  Foreclosed asset expense     155     39  
  Other expense     388     362  
   
 
 
    Total noninterest expense     2,152     2,105  
  Minority interest expense     75     43  
   
 
 
      Income (loss) before income taxes     (1,994 )   1,240  
      Income taxes     (856 )   456  
   
 
 
Net Income (Loss)   $ (1,138 ) $ 784  
   
 
 
Net Income (Loss) Applicable to Common Stockholders   $ (1,203 ) $ 777  
   
 
 
Earnings Per Common Share:              
  Basic   $ (1.40 ) $ 0.89  
  Diluted     (1.40 )   0.86  
Dividends declared per common share     0.15     0.54  
Basic weighted average number of common shares outstanding (in thousands)     856,923     874,816  
Diluted weighted average number of common shares outstanding (in thousands)     856,923     899,706  

See Notes to Consolidated Financial Statements.

1



WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(UNAUDITED)

 
  March 31,
2008

  December 31,
2007

 
 
  (dollars in millions)

 
Assets              
  Cash and cash equivalents   $ 10,089   $ 9,560  
  Federal funds sold and securities purchased under agreements to resell     2,527     1,877  
  Trading assets (including securities pledged of $138 and $388)     2,483     2,768  
  Available-for-sale securities, total amortized cost of $24,907 and $27,789:              
    Mortgage-backed securities (including securities pledged of $87 and $1,221)     18,140     19,249  
    Investment securities (including securities pledged of $66 and $3,078)     5,466     8,291  
   
 
 
        Total available-for-sale securities     23,606     27,540  
  Loans held for sale     4,941     5,403  
  Loans held in portfolio     242,814     244,386  
  Allowance for loan losses     (4,714 )   (2,571 )
   
 
 
        Loans held in portfolio, net     238,100     241,815  
  Investment in Federal Home Loan Banks     3,514     3,351  
  Mortgage servicing rights     5,726     6,278  
  Goodwill     7,283     7,287  
  Other assets     21,399     22,034  
   
 
 
        Total assets   $ 319,668   $ 327,913  
   
 
 
Liabilities              
  Deposits:              
    Noninterest-bearing deposits   $ 31,911   $ 30,389  
    Interest-bearing deposits     156,138     151,537  
   
 
 
        Total deposits     188,049     181,926  
  Federal funds purchased and commercial paper     250     2,003  
  Securities sold under agreements to repurchase     215     4,148  
  Advances from Federal Home Loan Banks     64,009     63,852  
  Other borrowings     32,710     38,958  
  Other liabilities     8,072     8,523  
  Minority interests     3,914     3,919  
   
 
 
        Total liabilities     297,219     303,329  
Stockholders' Equity              
  Preferred stock     3,392     3,392  
  Common stock, no par value: 1,600,000,000 shares authorized, 882,609,898 and 869,036,088 shares issued and outstanding          
  Capital surplus – common stock     2,646     2,630  
  Accumulated other comprehensive loss     (1,141 )   (359 )
  Retained earnings     17,552     18,921  
   
 
 
        Total stockholders' equity     22,449     24,584  
   
 
 
        Total liabilities and stockholders' equity   $ 319,668   $ 327,913  
   
 
 

See Notes to Consolidated Financial Statements.

2


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Continued)

(UNAUDITED)


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

AND COMPREHENSIVE INCOME

(UNAUDITED)

 
  Number of
Common
Shares

  Preferred
Stock

  Capital
Surplus –
Common
Stock

  Accumulated
Other
Comprehensive
Income (Loss)

  Retained
Earnings

  Total
 
 
  (in millions)

 
BALANCE, December 31, 2006   944.5   $ 492   $ 5,825   $ (287 ) $ 20,939   $ 26,969  
Cumulative effect from the adoption of FASB Interpretation No. 48                   (6 )   (6 )
   
 
 
 
 
 
 
Adjusted balance   944.5     492     5,825     (287 )   20,933     26,963  
Comprehensive income:                                    
  Net income                   784     784  
  Other comprehensive income (loss), net of tax:                                    
    Net unrealized gain from securities arising during the period, net of reclassification adjustments               7         7  
    Net unrealized gain from cash flow hedging instruments               13         13  
    Amortization and deferral of gains, losses and prior service costs from defined benefit plans               (1 )       (1 )
                               
 
Total comprehensive income                       803  
Cash dividends declared on common stock                   (477 )   (477 )
Cash dividends declared on preferred stock                   (7 )   (7 )
Common stock repurchased and retired   (61.4 )       (2,797 )           (2,797 )
Common stock issued   5.0         93             93  
   
 
 
 
 
 
 
BALANCE, March 31, 2007   888.1   $ 492   $ 3,121   $ (268 ) $ 21,233   $ 24,578  
   
 
 
 
 
 
 

BALANCE, December 31, 2007

 

869.0

 

$

3,392

 

$

2,630

 

$

(359

)

$

18,921

 

$

24,584

 
Cumulative effect from the adoption of accounting pronouncements, net of income taxes                   (36 )   (36 )
   
 
 
 
 
 
 
Adjusted balance   869.0     3,392     2,630     (359 )   18,885     24,548  
Comprehensive loss:                                    
  Net loss                   (1,138 )   (1,138 )
  Other comprehensive income (loss), net of tax:                                    
    Net unrealized loss from securities arising during the period, net of reclassification adjustments               (661 )       (661 )
    Net unrealized loss from cash flow hedging instruments               (123 )       (123 )
    Amortization and deferral of gains, losses and prior service costs from defined benefit plans               2         2  
                               
 
Total comprehensive loss                       (1,920 )
Cash dividends declared on common stock                   (130 )   (130 )
Cash dividends declared on preferred stock                   (65 )   (65 )
Common stock issued   13.6         16             16  
   
 
 
 
 
 
 
BALANCE, March 31, 2008   882.6   $ 3,392   $ 2,646   $ (1,141 ) $ 17,552   $ 22,449  
   
 
 
 
 
 
 

See Notes to Consolidated Financial Statements.

3



WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
  Three Months Ended
March 31,

 
 
  2008
  2007
 
 
  (in millions)

 
Cash Flows from Operating Activities              
  Net income (loss)   $ (1,138 ) $ 784  
  Adjustments to reconcile net income (loss) to net cash provided by operating activities:              
    Provision for loan losses     3,511     234  
    Gain from home mortgage loans     (143 )   (149 )
    Gain from credit card loans         (155 )
    Gain on available-for-sale securities     (18 )   (35 )
    Depreciation and amortization     90     163  
    Change in fair value of MSR     733     455  
    Stock dividends from Federal Home Loan Banks     (33 )   (33 )
    Capitalized interest income from option adjustable-rate mortgages     (336 )   (361 )
    Origination and purchases of loans held for sale, net of principal payments     (11,440 )   (27,880 )
    Proceeds from sales of loans originated and held for sale     10,341     27,267  
    Net decrease (increase) in trading assets     366     (797 )
    Decrease in other assets     1,343     683  
    Increase in other liabilities     57     124  
   
 
 
      Net cash provided by operating activities     3,333     300  
Cash Flows from Investing Activities              
  Purchases of available-for-sale securities     (2,889 )   (1,366 )
  Proceeds from sales of available-for-sale securities     4,895     3,436  
  Principal payments and maturities on available-for-sale securities     921     586  
  Purchases of Federal Home Loan Bank stock     (130 )    
  Redemption of Federal Home Loan Bank stock         508  
  Origination and purchases of loans held in portfolio, net of principal payments     1,297     4,412  
  Proceeds from sales of loans         21,482  
  Proceeds from sales of foreclosed assets     246     167  
  Net increase in federal funds sold and securities purchased under agreements to resell     (650 )   (4,536 )
  Purchases of premises and equipment, net     (48 )   (44 )
   
 
 
      Net cash provided by investing activities     3,642     24,645  

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

See Notes to Consolidated Financial Statements.

4


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(UNAUDITED)

(Continued from the previous page.)

 
  Three Months Ended
March 31,

 
 
  2008
  2007
 
 
  (in millions)

 
Cash Flows from Financing Activities              
  Increase (decrease) in deposits   $ 6,123   $ (3,747 )
  Decrease in short-term borrowings     (4,773 )   (2,617 )
  Proceeds from long-term borrowings         7,882  
  Repayments of long-term borrowings     (7,784 )   (6,603 )
  Proceeds from advances from Federal Home Loan Banks     13,351     13,508  
  Repayments of advances from Federal Home Loan Banks     (13,195 )   (33,072 )
  Proceeds from issuance of preferred securities by subsidiary         5  
  Cash dividends paid on preferred and common stock     (195 )   (484 )
  Repurchase of common stock         (2,797 )
  Other     27     79  
   
 
 
    Net cash used by financing activities     (6,446 )   (27,846 )
   
 
 
    Increase (decrease) in cash and cash equivalents     529     (2,901 )
    Cash and cash equivalents, beginning of period     9,560     6,948  
   
 
 
    Cash and cash equivalents, end of period   $ 10,089   $ 4,047  
   
 
 

Noncash Activities

 

 

 

 

 

 

 
  Loans exchanged for mortgage-backed securities   $ 51   $ 114  
  Real estate acquired through foreclosure     625     276  
  Loans transferred from held for sale to held in portfolio     1,382     998  
  Loans transferred from held in portfolio to held for sale         2,736  

Cash Paid During the Period For

 

 

 

 

 

 

 
  Interest on deposits   $ 1,301   $ 1,735  
  Interest on borrowings     1,218     1,351  
  Income taxes     54     475  

See Notes to Consolidated Financial Statements.

5



WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


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," the "Company," "we," "us" or "our"). The Company's financial reporting and accounting policies conform to accounting principles generally accepted in the United States of America ("GAAP"), which include certain practices of the banking industry. In the opinion of management, all normal recurring adjustments have been included for a fair statement of the interim financial information. All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements.

        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 2007 Annual Report on Form 10-K.

    Cumulative Effect from the Adoption of Accounting Pronouncements

        On January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements ("Statement No. 157"), EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements ("Issue No. 06-4") and EITF Issue No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements ("Issue No. 06-10"). The cumulative effect, net of income taxes, on the Consolidated Statements of Stockholders' Equity and Comprehensive Income upon the adoption of Statement No. 157, Issue No. 06-4 and Issue No. 06-10 was $1 million, $(35) million and $(2) million.

    Recently Issued Accounting Standards Not Yet Adopted

        In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133 ("Statement No. 161"). Statement No. 161 amends and requires enhanced qualitative, quantitative and credit risk disclosures about an entity's derivative and hedging activities, but does not change the scope or accounting principles of Statement No. 133. Statement No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. Because Statement No. 161 impacts the Company's disclosure and not its accounting treatment for derivative financial instruments and related hedged items, the Company's adoption of Statement No. 161 will not impact the Consolidated Statement of Income and the Consolidated Statement of Financial Condition.

        In April 2008, the FASB issued FASB Staff Position ("FSP") FAS 142-3, Determination of the Useful Life of Intangible Assets which amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets . FSP FAS 142-3 is effective for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the effect FSP FAS 142-3 will have on the Consolidated Financial Statements.

        In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles ("Statement No. 162"). Statement No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in

6


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)


preparing financial statements that are presented in conformity with GAAP for nongovernmental entities. This statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . The Company is currently evaluating the effect, if any, that Statement No. 162 will have on the Consolidated Financial Statements.


Note 2: Restructuring Activities

        During the fourth quarter of 2007, the Company announced that it significantly changed the strategic focus of its Home Loans business to accelerate its alignment with the Company's retail banking operations. In connection with these activities, the Company incurred pre-tax restructuring charges of $106 million, which consisted of $29 million in termination benefits, $43 million in lease terminations and other decommissioning costs and $34 million in fixed asset write-downs. Substantially all of these expenses were recorded in the fourth quarter of 2007. Charges for termination benefits were recorded in compensation and benefits; charges for lease terminations, other decommissioning costs and fixed asset write-downs were recorded in occupancy and equipment in the Consolidated Statements of Income. All of these charges were recorded within the Corporate Support/Treasury and Other category of the Company's operating segment structure.

        Changes in the balance of the Home Loans restructuring liability were as follows:

 
  Termination
Benefits

  Lease Terminations and Other
Decommissioning Costs

  Total
Restructuring
Liability

 
 
  (in millions)

 
Balance, December 31, 2007   $ 33   $ 35   $ 68  
  Change in estimate     (4 )   9     5  
  Cash payments     (24 )   (9 )   (33 )
   
 
 
 
Balance, March 31, 2008   $ 5   $ 35   $ 40  
   
 
 
 

        The outstanding liability related to termination benefits is expected to be paid during the second quarter of 2008. The liability related to lease terminations is expected to be paid over the remaining terms of the leases, substantially all of which will expire by December 31, 2011.

        On April 8, 2008, the Company announced its intent to further consolidate its Home Loans business by discontinuing all lending conducted through its wholesale channel and closing all of its remaining freestanding home loan centers and sales offices. Additionally, the Company plans to close or consolidate certain loan fulfillment centers. Altogether, these actions are expected to result in the elimination of approximately 2,600 to 3,000 positions. In connection with these actions, the Company estimates that it will incur a pre-tax restructuring charge of approximately $140 million to $180 million, comprised of approximately $40 million in termination benefits, approximately $80 million to $110 million in lease terminations and other decommissioning costs, and approximately $20 million to $30 million in fixed asset write-downs. The Company estimates that of the total estimated pre-tax restructuring charge, approximately $120 million to $150 million are expected to result in future cash outlays. These restructuring actions are expected to be substantially completed by September 30, 2008.

7


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)


Note 3: Mortgage Banking Activities

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

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
Revenue from sales and servicing of home mortgage loans:              
  Sales activity:              
    Gain from home mortgage loans and originated mortgage-backed securities (1)   $ 143   $ 149  
    Revaluation loss from derivatives economically hedging loans held for sale     (21 )   (54 )
   
 
 
      Gain from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments     122     95  
  Servicing activity:              
    Home mortgage loan servicing revenue (2)     470     514  
    Change in MSR fair value due to payments on loans and other     (230 )   (356 )
    Change in MSR fair value due to valuation inputs or assumptions     (499 )   (96 )
    Revaluation gain (loss) from derivatives economically hedging MSR     548     (32 )
   
 
 
      Home mortgage loan servicing revenue, net of MSR valuation changes and derivative risk management instruments     289     30  
   
 
 
          Total revenue from sales and servicing of home mortgage loans   $ 411   $ 125  
   
 
 

(1)
Originated mortgage-backed securities represent available-for-sale securities retained on the balance sheet subsequent to the securitization of mortgage loans that were originated by the Company.
(2)
Includes contractually specified servicing fees (net of guarantee fees paid to housing government-sponsored enterprises, where applicable), late charges and loan pool expenses (the shortfall of the scheduled interest required to be remitted to investors and that which is collected from borrowers upon payoff).

8


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)

        Changes in the balance of mortgage servicing rights ("MSR") were as follows:

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
Fair value, beginning of period   $ 6,278   $ 6,193  
  Home loans:              
    Additions     181     760  
    Change in MSR fair value due to payments on loans and other     (230 )   (356 )
    Change in MSR fair value due to valuation inputs or assumptions     (499 )   (96 )
    Sale of MSR     (1 )    
  Net change in commercial real estate MSR (1)     (3 )   6  
   
 
 
Fair value, end of period   $ 5,726   $ 6,507  
   
 
 
Unrealized loss still held (2)   $ (502 )   N/A  
   
 
 

(1)
Changes in commercial real estate MSR fair value are included in other income on the Consolidated Statements of Income.
(2)
Pursuant to the disclosure requirements of Statement No. 157 that was adopted by the Company on January 1, 2008, this represents the amount of losses for the period included in earnings attributable to the change in unrealized losses relating to MSR still held at March 31, 2008.

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

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
Balance, beginning of period   $ 456,484   $ 444,696  
  Home loans:              
    Additions     9,862     44,550  
    Sale of servicing     (109 )    
    Loan payments and other     (17,177 )   (22,469 )
  Net change in commercial real estate loans     66     1,005  
   
 
 
Balance, end of period   $ 449,126   $ 467,782  
   
 
 


Note 4: Guarantees

        In the ordinary course of business, the Company sells loans to third parties and in certain circumstances retains credit risk exposure on those loans and may be required to repurchase them. The Company may also be required to repurchase sold loans when representations and warranties made by the Company in connection with those sales are breached. Under certain circumstances, such as when a loan sold to an investor and serviced by the Company fails to perform according to its contractual terms within the six months after its origination or upon written request of the investor, the Company will review the loan file to determine whether or not errors may have been made in the process of originating the loan. If errors are discovered and it is determined that such errors constitute a breach of a representation or warranty made to the investor in connection with the Company's sale of the loan, then if the breach had a material adverse effect on the value of the loan, the Company will be

9


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)


required to either repurchase the loan or indemnify the investor for losses sustained. In addition, the Company is a party to and from time to time enters into agreements that contain general indemnification provisions, primarily in connection with agreements to sell and service loans or other assets or the sales of mortgage servicing rights. These provisions typically require the Company to make payments to the purchasers or other third parties to indemnify them against losses they may incur due to actions taken by the Company prior to entering into the agreement or due to a breach of representations, warranties and covenants made in connection with the agreement or possible changes in or interpretations of tax law. The Company has recorded reserves of $232 million and $268 million as of March 31, 2008 and December 31, 2007, to cover its estimated exposure related to all of the aforementioned loss contingencies.


Note 5: Earnings Per Common Share

        Information used to calculate earnings per common share was as follows:

 
  Three Months Ended
March 31,

 
 
  2008
  2007
 
 
  (dollars in millions, except per share amounts; shares in thousands)

 
Net income (loss)   $ (1,138 ) $ 784  
Preferred dividends     (65 )   (7 )
   
 
 
Net income (loss) applicable to common stockholders for basic EPS     (1,203 )   777  
Effect of dilutive securities         (1 )
   
 
 
Net income (loss) applicable to common stockholders for diluted EPS   $ (1,203 ) $ 776  
   
 
 
Basic weighted average number of common shares outstanding     856,923     874,816  
Dilutive effect of potential common shares from:              
  Awards granted under equity incentive programs         13,212  
  Common stock warrants         10,501  
  Convertible debt         1,177  
   
 
 
Diluted weighted average number of common shares outstanding     856,923     899,706  
   
 
 
Earnings per common share:              
  Basic   $ (1.40 ) $ 0.89  
  Diluted     (1.40 )   0.86  

        Options under the equity incentive programs to purchase an additional 57.4 million and 18.3 million shares of common stock were outstanding at March 31, 2008 and 2007, and were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect. Also excluded from the computation of diluted earnings per share for the three months ended March 31, 2008 because of their antidilutive effect were 141.2 million shares of common stock related to Series R Non-cumulative Perpetual Convertible Preferred Stock, 1.2 million shares of common stock related to convertible debt and 49.9 million shares of common stock related to common stock warrants and restricted stock granted under equity incentive programs.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        Additionally, as part of the 1996 business combination with Keystone Holdings, Inc., 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. The escrow account also holds both cash dividends paid on escrowed shares as well as interest accumulated on those cash dividends. The Company is currently entitled to receive quarterly cash payments from the escrow, each in an amount equal to approximately 2% of the then value of the escrow. Beginning in 2009, the Company is entitled to receive quarterly distributions from the escrow, each consisting of 130,435 shares of the Company's common stock and the dividends and interest then in the escrow that are attributable to such shares. The conditions under which the Company shares in the escrow can be released to certain of the former investors in Keystone Holdings and their transferees are related to the outcome of certain litigation and are not based on future earnings or market prices. At March 31, 2008, the conditions for releasing the shares from escrow to those investors and their transferees were not satisfied and therefore none of the shares in the escrow were included in the above computations.


Note 6: Employee Benefits Programs

    Pension Plan

        Washington Mutual maintains a noncontributory cash balance defined benefit pension plan (the "Pension Plan") for eligible employees. Benefits earned for each year of service are based primarily on the level of compensation in that year, plus a stipulated rate of return on the cash balance. It is the Company's policy to contribute funds to the Pension Plan on a current basis to the extent the amounts are sufficient to meet minimum funding requirements as set forth in employee benefit and tax laws, plus such additional amounts the Company determines to be appropriate.

    Nonqualified Defined Benefit Plans and Other Postretirement Benefit Plans

        The Company, as successor to previously acquired companies, has assumed responsibility for a number of nonqualified, noncontributory, unfunded postretirement benefit plans, including retirement restoration plans for certain employees, supplemental retirement plans for certain officers and multiple outside directors' retirement plans (the "Nonqualified Defined Benefit Plans"). Benefits under the retirement restoration plans are generally determined by the Company. Benefits under the supplemental retirement plans and outside directors' retirement plans are generally based on years of service.

        The Company, as successor to previously acquired companies, maintains unfunded defined benefit postretirement plans (the "Other Postretirement Benefit Plans") that make medical and life insurance coverage available to eligible retired employees and their beneficiaries and covered dependents. The expected cost of providing these benefits to retirees, their beneficiaries and covered dependents was accrued during the years each employee provided services.

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        Components of net periodic benefit cost for the Pension Plan, Nonqualified Defined Benefit Plans and Other Postretirement Benefit Plans were as follows:

 
  Three Months Ended March 31,
 
  2008
  2007
 
  Pension Plan
  Nonqualified Defined Benefit Plans
  Other Postretirement Benefit Plans
  Pension Plan
  Nonqualified Defined Benefit Plans
  Other Postretirement Benefit Plans
 
  (in millions)

Net periodic benefit cost:                                    
Interest cost   $ 25   $ 2   $   $ 25   $ 2   $ 1
Service cost     20     1         23     1    
Expected return on plan assets     (43 )           (36 )      
Amortization of prior service cost     4             3        
Recognized net actuarial loss                 5        
   
 
 
 
 
 
  Net periodic benefit cost   $ 6   $ 3   $   $ 20   $ 3   $ 1
   
 
 
 
 
 


Note 7: Fair Value

        On January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements ("Statement No. 157"). Statement No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements for fair value measurements. The Company deferred the application of Statement No. 157 for nonfinancial assets and nonfinancial liabilities as provided for by FASB Staff Position ("FSP") FAS 157-2, Effective Date of FASB Statement No. 157 . Issued in February 2008, FSP FAS 157-2 defers the effective date of Statement No. 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for nonfinancial assets and nonfinancial liabilities, except items that are recognized or disclosed at fair value in an entity's financial statements on a recurring basis (at least annually).

        Statement No. 157 nullifies the guidance in EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities , which required the deferral of gains or losses at inception of a transaction involving a derivative financial instrument in the absence of observable data supporting the valuation and requires retrospective application for certain financial instruments as of the beginning of the fiscal year it is adopted.

        The Company's adoption of Statement No. 157 on January 1, 2008 resulted in a $1 million cumulative-effect adjustment, net of income taxes, to the opening balance of retained earnings.

    Fair Value Hierarchy

        Statement No. 157 defines the term "fair value" as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. As required by Statement No. 157, the

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

Company's policy is to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.

        Statement No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels, considering the relative reliability of the inputs. The fair value hierarchy assigns the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of an input to the valuation that is significant to the fair value measurement. The three levels of inputs within the fair value hierarchy are defined as follows:

    Level 1 – Quoted prices in active markets for identical assets or liabilities. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

    Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market.

    Level 3 – Valuation is modeled using significant inputs that are unobservable in the market. These unobservable inputs reflect the Company's own estimates of assumptions that market participants would use in pricing the asset or liability.

    Estimation of Fair Value

        Fair value is based on quoted prices in an active market when available. In certain cases where a quoted price for an asset or liability is not available, the Company uses internal valuation models to estimate its fair value. These models incorporate inputs such as forward yield curves, loan prepayment assumptions, expected loss assumptions, market volatilities and pricing spreads utilizing market-based inputs where readily available. The Company's estimates of fair value reflect inputs and assumptions which management believes are comparable to those that would be used by other market participants. The valuations are the Company's estimates, and are often calculated based on internal valuation models and consider the economic environment, estimates of future loss experience, the risk characteristics of the asset or liability and other such factors. As an estimate, the fair value cannot be determined with precision and may not be realized in an actual sale or transfer of the asset or liability in a current market exchange.

        The following is a description of the valuation methodologies used for assets and liabilities measured at fair value and the general classification of these instruments pursuant to the fair value hierarchy.

        Trading assets and available-for-sale securities – Trading assets and available-for-sale securities are carried at fair value on a recurring basis. When available, fair value is based on quoted prices in an active market and as such, would be classified as Level 1 (e.g., U.S. Government securities). If quoted market prices are not available, fair values are estimated using quoted prices of securities with similar characteristics, discounted cash flows or other pricing models. Trading assets and available-for-sale securities that the Company classifies as Level 2 include certain agency and non-agency mortgage-backed securities, U.S. states and political subdivisions debt securities and other debt and equity securities. Trading assets classified as Level 3 include certain retained interests in securitizations, which are largely comprised of interests retained from credit card securitizations and other such securities for

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


which fair value estimation requires the use of unobservable inputs. The Company values interests retained in credit card securitizations using a discounted cash flow approach that incorporates the Company's expectations of prepayment speeds and its expectations of net credit losses or finance charges related to the securitized assets. Risk-adjusted discount rates are based on quotes from third party sources.

        In addition, trading assets and available-for-sale securities classified as Level 3 include certain non-agency mortgage-backed securities for which quoted prices or readily observable market inputs are not available and the fair value is estimated using significant assumptions that are unobservable in the market. Since the third quarter of 2007, the valuation of certain mortgage-backed securities has been impacted by adverse market conditions as the observability of inputs to the valuation of these securities has diminished significantly. The Company generally values its non-agency mortgage-backed securities using a discounted cash flow approach using spreads for similar securities obtained from third-party sources such as broker-dealers. Due to the decline in liquidity in the mortgage-backed securities market, the spreads for certain securities obtained from multiple sources may not be available or may vary widely. As a result, the Company must exercise significant judgment in selecting the spreads used to estimate the fair values of these securities. The Company also employs a credit model within the valuation process that projects loss expectations including severity and frequency as an input in valuing credit-sensitive securities.

        Loans held for sale – Loans that the Company intends to sell or securitize are designated as held for sale. In some instances, the Company may use a fair value hedge, as prescribed by FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities ("Statement No. 133"). Loans held for sale achieving hedge accounting treatment, as prescribed by Statement No. 133, will be carried at fair value on a recurring basis. Loans held for sale where hedge accounting treatment does not apply are carried at the lower of cost or fair value and as such, when these loans are reported at fair value, it is on a nonrecurring basis. The fair values of loans held for sale are generally based on observable market prices of securities that have loan collateral or interests in loans that are similar to the held-for-sale loans or whole loan sale prices if formally committed. If market quotes are not readily available, fair value is estimated using a discounted cash flow model, which takes into account expected prepayment factors and the degree of credit risk associated with the loans. Conforming mortgage loans which are carried at fair value are largely classified as Level 2. Nonconforming loans held for sale where fair value is based on unobservable inputs are classified as Level 3.

        Loans which are transferred from held for sale to held in portfolio are transferred at the lower of cost or fair value and as such, are reported at fair value on a nonrecurring basis. Such loans are classified as either Level 2 or Level 3. The Company may also record nonrecurring fair value adjustments to commercial real estate loans that are deemed impaired, as prescribed by FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan , where the fair value is based on the current appraised value of the loan's collateral.

        Mortgage servicing rights ("MSR") – MSR is classified as Level 3 as quoted prices are not available and the Company uses an Option Adjusted Spread ("OAS") valuation methodology to estimate the fair value of MSR. The OAS methodology projects cash flows over multiple interest rate scenarios and discounts these cash flows using risk-adjusted discount rates. Significant unobservable inputs include mortgage prepayment assumptions. Additionally, an independent broker estimate of the fair value of the MSR is obtained quarterly along with other market-based evidence. Management uses this information along with the OAS valuation methodology to estimate the fair value of MSR.

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        Derivatives – Quoted market prices are used to value exchange traded derivatives, such as futures which the Company would classify as Level 1. However, substantially all of the Company's derivatives are traded in over-the-counter ("OTC") markets where quoted market prices are not readily available. The fair value of OTC derivatives, which may include interest rate swaps, foreign currency swaps, forwards and options, is determined using quantitative models that require the use of multiple observable market inputs including forward interest rate projections, exchange rates and interest rate volatilities. Significant market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. These instruments fall within Level 2.

        The Company has also entered into mortgage loan commitments that are accounted for as derivatives and are valued based upon models with significant unobservable market inputs. These mortgage loan commitments are classified as Level 3. In accordance with the provisions of SEC Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings Under Generally Accepted Accounting Principles , which the Company adopted on January 1, 2008, the expected net future cash flows related to the associated servicing of loans should be included in the fair value estimation of derivative loan commitments. Under previous accounting rules, the expected value of net servicing cash flows was not recognized until the loan was funded and sold.

    Assets and Liabilities Measured at Fair Value on a Recurring Basis

        The following table presents for each hierarchy level the Company's assets and liabilities that are measured at fair value on a recurring basis at March 31, 2008:

 
  Total
  Level 1
  Level 2
  Level 3
 
  (in millions)

Assets                        
  Trading assets   $ 2,483   $ 49   $ 190   $ 2,244
  Available-for-sale securities     23,606     128     21,751     1,727
  Loans held for sale (1)     2,649         2,649    
  Mortgage servicing rights     5,726             5,726
  Derivatives, included in other assets     2,817         2,771     46
   
 
 
 
    Total   $ 37,281   $ 177   $ 27,361   $ 9,743
   
 
 
 
Liabilities                        
  Derivatives, included in other liabilities   $ 746   $   $ 742   $ 4
  Other liabilities (2)     79     79        
   
 
 
 
    Total   $ 825   $ 79   $ 742   $ 4
   
 
 
 

(1)
Loans achieving hedge accounting treatment as prescribed by Statement No. 133.
(2)
Represents deferred compensation balances in which the value is based on exchange-traded securities.

15


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        The following table presents changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended March 31, 2008:

 
  Trading Assets
  Available-for-sale Securities
  Derivatives (3)
 
 
  (in millions)

 
Fair value, January 1, 2008   $ 2,413   $ 2,749   $ 15  
Total gains or (losses) (realized/unrealized):                    
  Included in earnings     24     (53 )   65  
  Included in other comprehensive income (loss)         (437 )   1  
Purchases, issuances and settlements     (196 )   (59 )   (39 )
Net transfers into or out of Level 3 (1)     3     (473 )    
   
 
 
 
Fair value, March 31, 2008   $ 2,244   $ 1,727   $ 42  
   
 
 
 
Net unrealized gains still held (2)   $ 24   $ 14   $ 40  
   
 
 
 

Note: For changes in the fair value of MSR, see Note 3 to the Consolidated Financial Statements – "Mortgage Banking Activities."

(1)
Assets and liabilities transferred into or out of Level 3 during the quarter are reported at their fair values on the last day of the same quarter.
(2)
Represents the amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held at March 31, 2008.
(3)
Level 3 derivative assets and liabilities have been netted on these tables for presentation purposes only.

        The following table summarizes gains and losses due to changes in fair value, including both realized and unrealized gains and losses, recorded in earnings for Level 3 assets and liabilities for the three months ended March 31, 2008:

 
  Total Gains and Losses
 
  Trading Assets
  Available-for-sale Securities
  Derivatives (1)
 
  (in millions)

Interest income – available-for-sale securities   $   $ 13   $
Interest income – trading assets     103        
Revenue from sales and servicing of home mortgage loans             62
Revenue from sales and servicing of consumer loans     109        
Loss on other available-for-sale securities         (66 )  
Loss on trading assets     (188 )      
Other income             3
   
 
 
  Total   $ 24   $ (53 ) $ 65
   
 
 

(1)
Gains and losses on Level 3 derivative exposures have been netted on these tables for presentation purposes only.

    Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

        Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or recognition of impairment of assets.

16


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        Loans held for sale at March 31, 2008, included loans which were adjusted to fair value using Level 3 inputs within the fair value hierarchy. These loans had an aggregate cost of $41 million and a fair value of $37 million. The loss of $4 million was included in earnings, within the revenue from sales and servicing of home mortgage loans classification for the three months ended March 31, 2008. Other loans held for sale were adjusted to the lower of cost or fair value using Level 2 inputs for commercial loans and Level 3 inputs for home loans transferred to loans held in portfolio during the first quarter of 2008. These transfers at fair value included commercial loans with an aggregate cost of $145 million and a fair value of $143 million. The loss of $2 million was included within other noninterest income. Home loans with an aggregate cost of $47 million and a fair value of $38 million were also transferred at fair value, resulting in a loss of $9 million, which was included within revenue from sales and servicing of home mortgage loans.

    Fair Value Option

        FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("Statement No. 159") became effective on January 1, 2008. Statement No. 159 permits an instrument by instrument irrevocable election to account for selected financial assets and financial liabilities at fair value. The Company did not elect to apply the fair value option to any eligible financial assets or financial liabilities on January 1, 2008 or during the first quarter of 2008. Subsequent to the initial adoption, the Company may elect to account for selected financial assets and financial liabilities at fair value. Such an election could be made at the time an eligible financial asset, financial liability or firm commitment is recognized or when certain specified reconsideration events occur.


Note 8: Operating Segments

        The Company has four operating segments for the purpose of management reporting: the Retail Banking Group, the Card Services Group, the Commercial Group and the Home Loans Group. The Company's operating segments are defined by the products and services they offer. The Retail Banking Group, the Card Services Group and the Home Loans Group are consumer-oriented while the Commercial Group serves commercial customers. In addition, the category of Corporate Support/Treasury and Other includes the community lending and investment operations; the Treasury function, which manages the Company's interest rate risk, liquidity position and capital; the Corporate Support function, which provides facilities, legal, accounting and finance, human resources and technology services; and the Enterprise Risk Management function, which oversees the identification, measurement, monitoring, control and reporting of credit, market and operational risk.

        The principal activities of the Retail Banking Group include: (1) offering a comprehensive line of deposit and other retail banking products and services to consumers and small businesses; (2) holding the substantial majority of the Company's held for investment portfolios of home loans, home equity loans and home equity lines of credit (but not the Company's held for investment portfolios of home loans, home equity loans and home equity lines of credit made to higher risk borrowers through the subprime mortgage channel); (3) originating home equity loans and lines of credit; and (4) providing investment advisory and brokerage services, sales of annuities and other financial services.

        Deposit products offered to consumers and small businesses 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. Many products are offered in retail banking stores and online. Financial consultants provide investment advisory and securities brokerage services to the public.

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        The Card Services Group manages the Company's credit card operations. The segment's principal activities include: (1) issuing credit cards; (2) either holding outstanding balances on credit cards in portfolio or securitizing and selling them; (3) servicing credit card accounts; and (4) providing other cardholder services. Credit card balances that are held in the Company's loan portfolio generate interest income from finance charges on outstanding card balances, and noninterest income from the collection of fees associated with the credit card portfolio, such as performance fees (late, overlimit and returned check charges) and cash advance and balance transfer fees.

        The Card Services Group acquires new customers primarily by leveraging the Company's retail banking distribution network and through direct mail solicitations, augmented by online and telemarketing activities and other marketing programs including affinity programs. In addition to credit cards, this segment markets a variety of other products to its customer base.

        The Company evaluates the performance of the Card Services Group on a managed basis. Managed financial information is derived by adjusting the GAAP financial information to add back securitized loan balances and the related interest, fee income and provision for credit losses.

        The principal activities of the Commercial Group include: (1) providing financing to developers and investors, or acquiring loans for the purchase or refinancing of multi-family dwellings and other commercial properties; (2) either holding multi-family and other commercial real estate loans in portfolio or selling these loans while retaining the servicing rights; and (3) providing deposit services to commercial customers.

        The principal activities of the Home Loans Group include: (1) the origination, fulfillment and servicing of home loans; (2) the origination, fulfillment and servicing of home equity loans and lines of credit; (3) managing the Company's capital markets operations, which includes the selling of all types of real estate secured loans in the secondary market; and (4) holding the Company's held for investment portfolios of home loans, home equity loans and home equity lines of credit made to higher risk borrowers through the subprime mortgage channel.

        During the fourth quarter of 2007, the Company announced that it significantly changed the strategic focus of its Home Loans business to accelerate the alignment of its distribution channels with the Company's retail banking operations. As part of these activities, the Company discontinued all remaining lending through its subprime mortgage channel. Further advancing this retail-focused home lending strategy, the Company announced on April 8, 2008 its intent to discontinue all lending conducted through its wholesale channel, close all of its freestanding home loan centers and sales offices and close or consolidate certain loan fulfillment centers.

        The segment offers a wide variety of real estate secured residential loan products and services. Such loans are held in portfolio by the Home Loans Group, sold to secondary market participants or transferred through inter-segment sales to the Retail Banking Group. The decision to retain or sell loans, and the related decision to retain or not retain servicing when loans are sold, involves the analysis and comparison of expected interest income and the interest rate and credit risks inherent with holding loans in portfolio, with the expected servicing fees, the size of the gain or loss that would be realized if the loans were sold and the expected expense of managing the risk related to any retained mortgage servicing rights.

        The principal activities of, and charges reported in, the Corporate Support/Treasury and Other category include:

    management of the Company's interest rate risk, liquidity position and capital. These responsibilities involve managing a majority of the Company's portfolio of investment securities

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

      and providing oversight and direction across the enterprise over matters that impact the profile of the Company's balance sheet. Such matters include determining the optimal product composition of loans that the Company holds in 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;

    enterprise-wide management of the identification, measurement, monitoring, control and reporting of credit, market and operational risk;

    community lending and investment activities, which help fund the development of affordable housing units in traditionally underserved communities;

    general corporate overhead costs associated with the Company's facilities, legal, accounting and finance functions, human resources and technology services;

    costs that the Company's chief operating decision maker did not consider when evaluating the performance of the Company's four operating segments, including costs associated with the Company's productivity and efficiency initiatives;

    the impact of changes in the unallocated allowance for loan losses;

    the net impact of funds transfer pricing for loan and deposit balances; and

    items associated with transfers of loans from the Retail Banking Group to the Home Loans Group when home loans previously designated as held for investment are transferred to held for sale, such as lower of cost or fair value adjustments and the write-off of the inter-segment profit factor.

        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. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting. The management accounting process measures performance based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. 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 takes into account the interest rate risk profile of the Company's assets and liabilities and concentrates their sensitivities within the Treasury Division, where the risk profile is centrally managed. Certain basis and other residual risks are managed and reported in the operating segments;

    the allocation of charges for services rendered to certain segments by functions centralized within another segment, as well as the allocation of certain operating expenses that are not directly charged to the segments (i.e., corporate overhead), which generally are based on each segment's consumption patterns;

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

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

    the accounting for inter-segment transactions, which include the transfer from the Home Loans Group to the Retail Banking Group of certain originated home and home equity loans that are to be held in portfolio and a revenue arrangement between Home Loans and Retail Banking. When originated home and home equity loans are transferred to the Retail Banking Group, the Home Loans Group records a gain on the sale of the loans based on an assumed inter-segment profit factor. This profit factor is included in the book value of the transferred loans and is amortized as an adjustment to the net interest income recorded by the Retail Banking Group while the loan is held for investment. When a loan that was designated as held for investment within the Retail Banking Group is subsequently transferred to held for sale, the remaining inter-segment profit factor is written off through Corporate Support/Treasury and Other. When home loans initiated through retail banking stores are transferred to held for sale, the Retail Banking Group records a gain on the sale of those loans based on an assumed inter-segment profit factor. 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; and

    a provisioning methodology that is consistent with that used in financial accounting.

        Financial highlights by operating segment were as follows:

 
  Three Months Ended March 31, 2008
 
 
   
   
   
   
  Corporate Support/ Treasury and Other
  Reconciling Adjustments
   
 
 
  Retail Banking Group
  Card Services Group (1)
  Commercial Group
  Home Loans Group
   
 
 
  Securitization (2)
  Other
  Total
 
 
  (in millions)

 
Condensed income statement:                                                  
  Net interest income   $ 1,203   $ 765   $ 196   $ 250   $ 132   $ (503 ) $ 132 (3) $ 2,175  
  Provision for loan losses     2,300     626     29     907     119     (470 )       3,511  
  Noninterest income     775     418     (8 )   319     86     33     (54) (4)   1,569  
  Inter-segment revenue (expense)     9     (5 )       (4 )                
  Noninterest expense     1,221     260     68     499     104             2,152  
  Minority interest expense                     75             75  
   
 
 
 
 
 
 
 
 
  Income (loss) before income taxes     (1,534 )   292     91     (841 )   (80 )       78     (1,994 )
  Income taxes     (491 )   93     29     (269 )   (68 )       (150) (5)   (856 )
   
 
 
 
 
 
 
 
 
  Net income (loss)   $ (1,043 ) $ 199   $ 62   $ (572 ) $ (12 ) $   $ 228   $ (1,138 )
   
 
 
 
 
 
 
 
 
Performance and other data:                                                  
  Average loans   $ 142,720   $ 26,889   $ 40,934   $ 55,672   $ 1,556   $ (17,391 ) $ (1,220) (6) $ 249,160  
  Average assets     151,609     29,244     43,004     66,841     45,525     (15,075 )   (1,220) (6)   319,928  
  Average deposits     146,734     n/a     7,474     5,469     24,627     n/a     n/a     184,304  

(1)
Operating results for the Card Services Group are presented on a managed basis as the Company treats securitized and sold credit card receivables as if they were still on the balance sheet in evaluating the overall performance of this operating segment.
(2)
The managed basis presentation of the Card Services Group is derived by adjusting the GAAP financial information to add back securitized loan balances and the related interest, fee income and provision for credit losses. Such adjustments to arrive at the reported GAAP results are eliminated within Securitization Adjustments.
(3)
Represents the difference between mortgage loan premium amortization recorded by the Retail Banking Group and the amount recognized in the Company's Consolidated Statements of Income. For management reporting purposes, certain mortgage loans that are held in portfolio by the Retail Banking Group are treated as if they are purchased from the Home Loans Group. Since the cost basis of these loans includes an assumed profit factor paid to the Home Loans Group, the amortization of loan premiums recorded by the Retail Banking Group reflects this assumed profit factor and must therefore be eliminated as a reconciling adjustment.

20


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

(4)
Represents the difference between gain from mortgage loans recorded by the Home Loans Group and gain from mortgage loans recognized in the Company's Consolidated Statements of Income.
(5)
Represents the tax effect of reconciling adjustments.
(6)
Represents the inter-segment offset for inter-segment loan premiums that the Retail Banking Group recognized upon transfer of portfolio loans from the Home Loans Group.

 
  Three Months Ended March 31, 2007
 
   
   
   
   
  Corporate
Support/
Treasury
and
Other

   
   
   
 
   
   
   
   
  Reconciling Adjustments
   
 
  Retail
Banking
Group

  Card
Services
Group (1)

  Commercial
Group

  Home
Loans
Group

   
 
  Securitization (2)
  Other
  Total
 
  (in millions)

Condensed income statement:                                                
  Net interest income (expense)   $ 1,284   $ 641   $ 211   $ 244   $ (22 ) $ (414 ) $ 137 (3) $ 2,081
  Provision for loan losses     62     388     (10 )   49     27     (282 )       234
  Noninterest income     751     474     15     161     94     132     (86) (4)   1,541
  Inter-segment revenue (expense)     18             (18 )              
  Noninterest expense     1,069     329     74     522     111             2,105
  Minority interest expense                     43             43
   
 
 
 
 
 
 
 
  Income (loss) before income taxes     922     398     162     (184 )   (109 )       51     1,240
  Income taxes     346     149     61     (69 )   (69 )       38 (5)   456
   
 
 
 
 
 
 
 
  Net income (loss)   $ 576   $ 249   $ 101   $ (115 ) $ (40 ) $   $ 13   $ 784
   
 
 
 
 
 
 
 
Performance and other data:                                                
  Average loans   $ 155,206   $ 23,604   $ 38,641   $ 53,254   $ 1,345   $ (12,507 ) $ (1,479) (6) $ 258,064
  Average assets     165,044     26,039     41,005     71,382     40,875     (10,961 )   (1,479) (6)   331,905
  Average deposits     144,030     n/a     12,028     8,501     46,205     n/a     n/a     210,764

(1)
Operating results for the Card Services Group are presented on a managed basis as the Company treats securitized and sold credit card receivables as if they were still on the balance sheet in evaluating the overall performance of this operating segment.
(2)
The managed basis presentation of the Card Services Group is derived by adjusting the GAAP financial information to add back securitized loan balances and the related interest, fee income and provision for credit losses. Such adjustments to arrive at the reported GAAP results are eliminated within Securitization Adjustments.
(3)
Represents the difference between mortgage loan premium amortization recorded by the Retail Banking Group and the amount recognized in the Company's Consolidated Statements of Income. For management reporting purposes, certain mortgage loans that are held in portfolio by the Retail Banking Group are treated as if they are purchased from the Home Loans Group. Since the cost basis of these loans includes an assumed profit factor paid to the Home Loans Group, the amortization of loan premiums recorded by the Retail Banking Group reflects this assumed profit factor and must therefore be eliminated as a reconciling adjustment.
(4)
Represents the difference between gain from mortgage loans recorded by the Home Loans Group and gain from mortgage loans recognized in the Company's Consolidated Statements of Income.
(5)
Represents the tax effect of reconciling adjustments.
(6)
Represents the inter-segment offset for inter-segment loan premiums that the Retail Banking Group recognized upon transfer of portfolio loans from the Home Loans Group.


Note 9: Equity Issuance

        In April 2008, the Company sold $7.2 billion of equity securities to investment vehicles managed by TPG Capital ("TPG") and to other qualified institutional buyers and institutional accredited investors, including many of the Company's largest institutional shareholders. The Company issued approximately 176 million shares of its common stock at a purchase price of $8.75 per share. In addition, the Company issued, in the aggregate, 56,570 shares of contingently convertible, perpetual non-cumulative preferred stock ("Preferred Stock") at a purchase price and liquidation preference of $100,000 per share. Warrants to acquire approximately 68 million shares of common stock were issued to investors, including TPG and others, who agreed to transfer restrictions on their shares. After receipt of certain approvals, including

21


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


approval of the Company's shareholders, the Preferred Stock will automatically convert into the Company's common stock and the warrants will become exercisable for common stock.

        Dividends on the Preferred Stock are initially payable, on a non-cumulative basis, in cash, on an as-converted basis. If all necessary approvals to convert the Preferred Stock into the Company's common stock are not obtained by June 30, 2008, the Preferred Stock will remain outstanding in accordance with its terms and will bear non-cumulative dividends commencing with the quarterly dividend period ending on September 15, 2008 at an annual rate of 14% of the liquidation preference of the Preferred Stock. To the extent that all necessary approvals are not obtained, this rate would further increase to 15.5% of the liquidation preference commencing with the quarterly dividend period ending March 15, 2009 and to 17% of the liquidation preference commencing with the quarterly dividend period ending on September 15, 2009. However, dividends on the Preferred Stock will always be paid at the higher of the amount payable in accordance with the applicable percentage rate described above and the dividend payable on an as-converted basis. The initial conversion price of the Preferred Stock is $8.75 per share. The warrants are exercisable at an initial price of $10.06 per share of the Company's common stock. Until the required approvals for conversion of the Preferred Stock and exercise of the warrants are obtained, the conversion price of the Preferred Stock, and the exercise price of the warrants, would each be reduced by $0.50 per common share following each six-month anniversary from the issuance date of the Preferred Stock and the warrants, up to a maximum reduction of $2.00 per common share. The conversion price of the Preferred Stock and the exercise price of the warrants are subject to anti-dilution adjustments.

        If the Company engages in certain transactions involving common stock or other equity-linked securities within 18 months from the closing date of this equity issuance, the Company will be required to compensate the TPG investors and certain other investors (solely for issuances within 9 months from the closing date) in the event that the effective sales price of a future common stock or other equity-linked securities transaction is less than $8.75 per share (the "Price Protection Feature").

        The transactions had no impact on the Company's results for the first quarter of 2008. The Company will account for this equity issuance in its financial statements for the second quarter of 2008 and subsequent periods. The accounting will include recognition of the common shares, Preferred Stock and warrants in stockholders' equity and recognition of the Price Protection Feature as a derivative measured at fair value. Any dilutive effects of the Preferred Stock as participating securities and the warrants will be considered in the calculation of earnings per share. The Company will account for a contingent beneficial conversion feature ("BCF") related to the conversion option in the Preferred Stock in accordance with EITF Issue 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios , and EITF Issue 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments . The BCF will be measured based on its intrinsic value at the commitment date, April 7, 2008, based on the difference between the fair value of the Company's common stock and the effective conversion price per common share. The BCF will be recognized as a one-time deemed preferred dividend when contingencies associated with the conversion are resolved, including the shareholder approval of the conversion. This BCF one-time deemed dividend is a non-cash item that will not affect the Company's net income or loss but will have the effect of reducing earnings per common share as a subtraction from net income (loss) applicable to common stockholders. If the conversion contingencies are resolved in the second quarter, the BCF will reduce earnings per common share in the second quarter. If the Preferred Shares are converted later than the second quarter of 2008 with a lower conversion price according to the terms of the security, the one-time, non-cash reduction in EPS due to the recognition of the BCF will be greater.

22


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

Risk Factors

        The Company's Form 10-Q and other documents that it files with the Securities and Exchange Commission ("SEC") contain forward-looking statements. In addition, the Company's 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 management's current expectations or predictions of future conditions, events or results. They may include projections of the Company's revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items, descriptions of management's plans or objectives for future operations, products or services, or descriptions of assumptions underlying or relating to the foregoing. 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 made and management does not undertake to update them to reflect changes or events that occur after that date except as required by federal securities laws.

        There are a number of significant factors which could cause actual conditions, events or results to differ materially from those described in the forward-looking statements, many of which are beyond management's control or its ability to accurately forecast or predict. Factors that might cause our future performance to vary from that described in our forward-looking statements include market, credit, operational, regulatory, strategic, liquidity, capital and economic factors as discussed in "Management's Discussion and Analysis" and in other periodic reports filed with the SEC. In addition, other factors besides those listed below or discussed in reports filed with the SEC could adversely affect our results and this list is not a complete set of all potential risks or uncertainties. Significant among the factors are the following which are described in greater detail in Part I Item 1A – "Risk Factors" in the Company's 2007 Annual Report on Form 10-K:

    Economic conditions that negatively affect housing prices and the job market have resulted, and may continue to result, in a deterioration in credit quality of the Company's loan portfolios, and such deterioration in credit quality has had, and could continue to have, a negative impact on the Company's business;

    The Company's access to market-based liquidity sources may be negatively impacted if market conditions persist or if further ratings downgrades occur. Funding costs may increase from current levels, and gain on sale may be reduced, leading to reduced earnings;

    If the Company has significant additional losses, it may need to raise additional capital, which could have a dilutive effect on existing shareholders, and it may affect its ability to pay dividends on its common and preferred stock;

    Changes in interest rates may adversely affect the Company's business, including net interest income and earnings;

    Certain of the Company's loan products have features that may result in increased credit risk;

    The Company uses estimates in determining the fair value of certain of our assets, which estimates may prove to be imprecise and result in significant changes in valuation;

    The Company is subject to risks related to credit card operations, and this may adversely affect its credit card portfolio and its ability to continue growing the credit card business;

23


    The Company is subject to operational risk, which may result in incurring financial losses and reputational issues;

    The Company's failure to comply with laws and regulations could have adverse effects on the Company's operations and profitability;

    Changes in the regulation of financial services companies, housing government-sponsored enterprises, mortgage originators and servicers, and credit card lenders could adversely affect the Company;

    The Company's business and earnings are highly sensitive to general business, economic and market conditions, and continued deterioration in these conditions may adversely affect its business and earnings;

    The Company may face damage to its professional reputation and business as a result of allegations and negative public opinion as well as pending and threatened litigation; and

    The Company is subject to significant competition from banking and nonbanking companies.

         Each of the factors can significantly impact the Company's businesses, operations, activities, condition and results in significant ways that are not described in the foregoing discussion and which are beyond the Company's ability to anticipate or control, and could cause actual results to differ materially from the outcomes described in the forward-looking statements.

Controls and Procedures

    Disclosure Controls and Procedures

        The Company's management, with the participation 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 furnishes under the Securities Exchange Act of 1934.

        Management reviews and evaluates the design and effectiveness of the Company's disclosure controls and procedures on an ongoing basis, which may result in the discovery of deficiencies, and improves its controls and procedures over time, correcting any deficiencies, as needed, that may have been discovered.

    Changes in Internal Control Over Financial Reporting

        Management reviews and evaluates the design and effectiveness of the Company's internal control over financial reporting on an ongoing basis, which may result in the discovery of deficiencies, some of which may be significant. Management changes its internal control over financial reporting as needed to maintain its effectiveness, correcting any deficiencies, as needed, in order to ensure the continued effectiveness of the Company's internal control over financial reporting. There have not been any changes in the Company's internal control over financial reporting during the first quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. For management's assessment of the Company's internal control over financial reporting, refer to the Company's 2007 Annual Report on Form 10-K, "Management's Report on Internal Control Over Financial Reporting."

24


Critical Accounting Estimates

        The preparation of financial statements in accordance with the accounting principles generally accepted in the United States of America ("GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the financial statements. Various elements of the Company's accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain inherent uncertainties. It is possible that, in some instances, different estimates and assumptions could reasonably have been made and used by management, instead of those the Company applied, which might have produced different results that could have had a material effect on the financial statements.

        The Company has identified four accounting estimates that, due to the judgments and assumptions inherent in those estimates, and the potential sensitivity of its financial statements to those judgments and assumptions, are critical to an understanding of its financial statements. These estimates are: the fair value of certain financial instruments and other assets; the allowance for loan losses and contingent credit risk liabilities; other-than-temporary impairment losses on available-for-sale securities; and the determination of whether a derivative qualifies for hedge accounting.

        Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Company's Board of Directors. The Company believes that the judgments, estimates and assumptions used in the preparation of its financial statements are appropriate given the facts and circumstances as of March 31, 2008. The nature of these judgments, estimates and assumptions are described in greater detail in the Company's 2007 Annual Report on Form 10-K in the "Critical Accounting Estimates" section of Management's Discussion and Analysis and in Note 1 to the Consolidated Financial Statements – "Summary of Significant Accounting Policies."

    Fair Value of Certain Financial Instruments and Other Assets

        A portion of the Company's financial instruments are carried at fair value, including: mortgage servicing rights, trading assets including certain retained interests from securitization activities, available-for-sale securities and derivatives. In addition, loans held for sale are recorded at the lower of cost or fair value. Changes in fair value of those instruments that qualify as hedged items under fair value hedge accounting are recognized in earnings and offset the changes in fair value of derivatives used as hedge accounting instruments.

    Adoption of FASB Statement No. 157, Fair Value Measurement

        On January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurement ("Statement No. 157"). Statement No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Statement No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels, based on the relative reliability of the inputs. The fair value hierarchy assigns the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are defined as follows:

    Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities.

    Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market.

    Level 3 – Valuation is modeled using significant inputs that are unobservable in the market.

25


        In accordance with Statement No. 157, it is the Company's policy to rely on the use of observable market information whenever possible when developing fair value measurements. Generally, for assets that are reported at fair value, the Company uses quoted market prices or internal valuation models to estimate their fair value. These models incorporate inputs such as forward yield curves, loan prepayment assumptions, expected loss assumptions, market volatilities and pricing spreads utilizing market-based inputs where readily available. The degree of management judgment involved in estimating the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market value inputs. For financial instruments that are actively traded in the marketplace or whose values are based on readily available market value data, little judgment is necessary when estimating the instrument's fair value. Financial instruments that are valued using market-based information will usually be classified as either Level 1 or Level 2.

        When observable market prices and data are not readily available, significant management judgment often is necessary to estimate fair value. These financial instruments are classified as Level 3 and include those assets and liabilities in which internal valuation models using significant unobservable inputs are used to estimate fair value. The models' inputs reflect assumptions, such as discount rates and prepayment speeds, which the Company believes market participants would use in valuing the financial instruments. The various assumptions used in the Company's valuation models are periodically adjusted to account for changes in current market conditions. Accordingly, results from valuation models in one period may not be indicative of future period measurements, and changes made to assumptions could result in significant changes in valuation.

        Substantially all of the Company's Level 1 assets at March 31, 2008 were U.S. Government securities. Assets and liabilities generally included as Level 2 include substantially all of the Company's available-for-sale securities, including mortgage-backed securities, debt and equity securities issued by U.S. states, political subdivisions or commercial enterprises; those conforming mortgage loans held for sale that are carried at fair value; and derivative contracts traded in over-the-counter markets, such as interest rate swaps, forwards and options, and foreign currency swaps.

        Level 3 assets are comprised of the Company's mortgage servicing rights ("MSR"), substantially all trading assets, mortgage loan commitments that are accounted for as derivatives, and certain available-for-sale securities in which market-based information to estimate fair value was not available. The Company's Level 3 assets totaled $9.74 billion at March 31, 2008 and represented approximately 26% of total assets measured at fair value on a recurring basis and approximately 3% of the Company's total assets.

        See Note 7 to the Consolidated Financial Statements – "Fair Value" for a further description of the valuation methodologies used for assets and liabilities measured at fair value.

Overview

        The Company recorded a net loss in the first quarter of 2008 of $1.14 billion, or $1.40 per diluted share, compared with net income of $784 million, or $0.86 per diluted share in the first quarter of 2007. The decline resulted from significant credit deterioration in the Company's single-family residential ("SFR") mortgage portfolio, as steep declines in housing prices and accelerating levels of delinquencies resulted in a substantial increase in the provision for loan losses.

        The Company recorded a provision for loan losses of $3.51 billion in the first quarter of 2008, an increase of $3.28 billion from the first quarter of 2007 and significantly higher than first quarter 2008 net charge-offs, which totaled $1.37 billion. Adverse trends in key housing market indicators, including high inventory levels of unsold homes, rising foreclosure rates and the significant contraction in the availability of credit for nonconforming mortgage products exerted severe pressure on home prices, particularly in areas of the country in which the Company's lending activities have been concentrated. Nationwide sales volume of existing homes in March 2008 was 19% lower than the same month of the

26



prior year, leading to a supply of unsold homes of approximately 9.9 months, a 32% increase from March 2007, while the national median sales price for existing homes fell by 8% between those periods. Since July 2006, average home prices, as measured by the Case-Shiller Home Price Index for the 20 largest metropolitan statistical areas ("MSA"), have declined 13%, with higher and accelerating levels of declines in the Company's primary MSA markets. Housing market weakness was also evident from the national volume of foreclosure filings, which increased by 112% from the first quarter of 2007 to the first quarter of 2008. With the deteriorating housing market conditions, homeowner delinquency rates have risen sharply. The Company's nonperforming assets to total assets ratio increased from 1.02% at March 31, 2007 to 2.87% at March 31, 2008, while SFR early stage delinquencies, representing loans that are up to three payments past due, more than doubled in size between these periods. Cure rates on early stage delinquencies have also deteriorated significantly, as declining home values and the reduced availability of credit throughout the mortgage market have created conditions in which many borrowers cannot refinance their mortgage or sell their home at a price that is sufficient to repay their mortgage. In addition to higher delinquency levels, loss severities have continued to increase at accelerating rates, reflecting the steep decline in home prices. Annualized net SFR charge-offs as a percentage of the average balance of the SFR portfolio increased from 0.23% in the first quarter of 2007 to 2.51% in the first quarter of 2008. Recent growth rates in loss severities have been most pronounced within the Option ARM home portfolio and the junior lien home equity and home equity lines of credit portfolios.

        With high loss provisioning levels expected to continue, the Company took steps to bolster its capital and liquidity positions. In April 2008, the Company issued approximately $7.2 billion of equity, comprised of common stock and contingently convertible, perpetual non-cumulative preferred stock. Additionally, in the second quarter of 2008, the Company will reduce the quarterly cash dividend rate on its common stock to $0.01 per share, thereby preserving approximately $490 million of capital on an annualized basis. The actions taken are expected to maintain the Company's capital ratios well above targeted levels while elevated credit costs are absorbed in the loan portfolio in 2008 and 2009.

        Annualized net credit card charge-offs as a percentage of the average balance of the credit card portfolio were 5.46% in the first quarter of 2008 and 2.96% in the first quarter of 2007, reflecting a downturn in consumer credit quality as the U.S. economy softened. The national unemployment rate increased to 5.1% in March 2008 from 4.4% in March 2007, while the U.S. economy lost approximately 232,000 net jobs during the three months ending March 31, 2008, compared with net job growth of 143,000 for the same period in the prior year. The Company expects net credit card charge-offs will continue to rise if the economy is further constrained by higher unemployment levels and anemic, or negative, job growth.

        Net interest income was $2.18 billion in the first quarter of 2008, compared with $2.08 billion in the same quarter of the prior year. The increase was due to the expansion of the net interest margin, which increased, on a taxable-equivalent basis, from 2.80% in the first quarter of 2007 to 3.05% in the first quarter of 2008. The 25 basis point increase in the margin was primarily due to significantly lower wholesale borrowing costs, reflecting the recent decline in short-term interest rates. With the accelerating rate of deterioration in the housing market and higher rates of unemployment, the Federal Reserve has reduced the target Federal Funds rate by a total of 225 basis points since the beginning of the year. As the Company's wholesale borrowing rates are usually correlated with interest rate policy changes made by the Federal Reserve and reprice to current market levels faster than most of the Company's interest-earning assets, the actions taken by the Fed are expected to further expand the margin during 2008.

        Noninterest income totaled $1.57 billion in the first quarter of 2008, compared with $1.54 billion in the first quarter of 2007. Home mortgage loan servicing revenue, net of MSR valuation changes and derivative risk management instruments, increased from $30 million in the first quarter of 2007 to $289 million in the first quarter of 2008. With the severe contraction in home mortgage credit

27



availability, home loan refinancing activity was significantly lower in the first quarter of 2008, resulting in much slower loan paydown rates in the servicing portfolio. Lower refinancing levels also contributed to a $49 million gain in MSR valuation and risk management results in the most recent quarter, compared with a loss of $124 million in the first quarter of 2007, as that quarter's results were affected by a flat-to-inverted yield curve, which has the effect of increasing MSR hedging costs. The increase in net home mortgage loan servicing revenue was substantially offset by lower revenue from sales and servicing of consumer loans, reflecting the absence of credit card securitization activity in the first quarter of 2008, while widening credit spreads, higher credit card discount rates and securities downgrades continued to adversely affect the fair values of trading assets and certain available-for-sale mortgage-backed securities.

        Noninterest expense totaled $2.15 billion in the first quarter of 2008, compared with $2.10 billion in the first quarter of 2007. With significantly higher volumes of delinquent loans migrating to foreclosure status and the steep declines in housing prices, foreclosed asset expense increased from $39 million in the first quarter of 2007 to $155 million in the first quarter of 2008. Foreclosure expenses are expected to remain elevated until housing market conditions stabilize. Lower compensation and benefits expense, and declines in occupancy and equipment expense partially offset the higher foreclosure costs, reflecting the fourth quarter 2007 initiatives to resize the home loans business and corporate and other support functions, and to channel future home lending activities through the Company's retail banking stores. The number of employees at March 31, 2008 totaled 45,883, compared with 49,693 at March 31, 2007 and 49,403 at December 31, 2007.

        With the continuing deterioration in the credit markets, the Company took steps in April 2008 to further advance the alignment of home lending activities through its retail banking store network and reduce the scale of its home lending operations. Those steps will result in the discontinuation of all home lending conducted through the wholesale channel, the closure of all freestanding home loan centers and sales offices, and the consolidation of certain loan fulfillment centers. These actions are expected to result in the elimination of approximately 2,600 to 3,000 positions by June 30, 2008. The Company expects to fully realize in 2009 a $550 million to $650 million reduction in annual noninterest expense, through actions taken in the Home Loans business and corporate support areas.

Recently Issued Accounting Standards Not Yet Adopted

        Refer to Note 1 to the Consolidated Financial Statements – "Summary of Significant Accounting Policies."

28


Summary Financial Data

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (dollars in millions, except
per share amounts)

 
Profitability              
  Net interest income   $ 2,175   $ 2,081  
  Net interest margin on a taxable-equivalent basis (1)     3.05 %   2.80 %
  Noninterest income   $ 1,569   $ 1,541  
  Noninterest expense     2,152     2,105  
  Net income (loss)     (1,138 )   784  
  Basic earnings per common share   $ (1.40 ) $ 0.89  
  Diluted earnings per common share     (1.40 )   0.86  
  Basic weighted average number of common shares outstanding (in thousands)     856,923     874,816  
  Diluted weighted average number of common shares outstanding (in thousands)     856,923     899,706  
  Dividends declared per common share   $ 0.15   $ 0.54  
  Return on average assets     (1.42 )%   0.95 %
  Return on average common equity     (23.27 )   12.99  
  Efficiency ratio (2)     57.49     58.13  
Asset Quality (at period end)              
  Nonaccrual loans (3)   $ 7,824   $ 2,672  
  Foreclosed assets     1,357     587  
   
 
 
    Total nonperforming assets (3)     9,181     3,259  
  Nonperforming assets (3) to total assets     2.87 %   1.02 %
  Allowance for loan losses   $ 4,714   $ 1,540  
  Allowance as a percentage of loans held in portfolio     1.94 %   0.71 %
Credit Performance              
  Provision for loan losses   $ 3,511   $ 234  
  Net charge-offs     1,368     183  
Capital Adequacy (at period end)              
  Stockholders' equity to total assets     7.02 %   7.68 %
  Tangible equity to total tangible assets (4)     6.40     5.78  
  Tier 1 capital to average total assets (leverage) (5)     6.56     5.87  
  Total risk-based capital to total risk-weighted assets (5)     12.25     11.17  
Per Common Share Data              
  Book value per common share (at period end) (6)   $ 21.74   $ 27.30  
  Market prices:              
    High     21.92     46.02  
    Low     8.72     38.73  
    Period end     10.30     40.38  
Supplemental Data              
  Total home loan volume     13,487     30,204  
  Total loan volume     17,990     42,134  

(1)
Includes taxable-equivalent adjustments primarily related to tax-exempt income on U.S. states and political subdivisions securities and loans related to the Company's community lending and investment activities. The federal statutory tax rate was 35% for the periods presented.
(2)
The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(3)
Excludes nonaccrual loans held for sale.
(4)
Excludes unrealized net gain/loss on available-for-sale securities and cash flow hedging instruments, goodwill and intangible assets (except MSR) and the impact from the adoption and application of FASB Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans . Minority interests of $3.91 billion and $2.45 billion for March 31, 2008 and March 31, 2007 are included in the numerator.
(5)
The capital ratios are estimated as if Washington Mutual, Inc. were a bank holding company subject to Federal Reserve Board capital requirements.
(6)
Excludes six million shares held in escrow.

29


Earnings Performance

        Average balances, on a taxable-equivalent basis, together with the total dollar amounts of interest income and expense related to such balances and the weighted average interest rates, were as follows:

 
  Three Months Ended March 31,
 
  2008
  2007
 
  Average Balance
  Rate
  Interest Income
  Average Balance
  Rate
  Interest Income
 
  (dollars in millions)

Assets (Taxable-Equivalent Basis (1) )                                
Interest-earning assets (2) :                                
  Federal funds sold and securities purchased under agreements to resell   $ 2,118   3.48 % $ 18   $ 3,930   5.39 % $ 52
  Trading assets     2,726   17.10     116     5,594   8.10     113
  Available-for-sale securities (3) :                                
    Mortgage-backed securities     18,945   5.80     275     18,460   5.48     253
    Investment securities     6,316   5.39     85     6,180   5.23     81
  Loans held for sale     4,974   6.98     87     35,447   6.37     562
  Loans held in portfolio (4) :                                
    Loans secured by real estate:                                
      Home loans (5)(6)     109,773   6.27     1,720     97,365   6.45     1,570
      Home equity loans and lines of credit (6)     61,196   6.28     956     53,014   7.56     989
      Subprime mortgage channel (7)     18,106   6.33     287     20,612   6.67     344
      Home construction (8)     2,142   7.65     41     2,061   6.55     34
      Multi-family     31,962   6.35     507     29,826   6.58     491
      Other real estate     9,797   6.49     158     6,763   7.03     117
   
     
 
     
        Total loans secured by real estate     232,976   6.31     3,669     209,641   6.79     3,545
    Consumer:                                
      Credit card     9,024   10.75     241     10,904   11.57     311
      Other     195   17.47     8     267   12.96     9
    Commercial     1,991   7.36     37     1,805   7.96     36
   
     
 
     
        Total loans held in portfolio     244,186   6.49     3,955     222,617   7.04     3,901
  Other     6,000   3.94     59     3,472   5.77     49
   
     
 
     
        Total interest-earning assets     285,265   6.45     4,595     295,700   6.81     5,011
Noninterest-earning assets:                                
  Mortgage servicing rights     5,882               6,304          
  Goodwill     7,286               9,054          
  Other assets     21,495               20,847          
   
           
         
        Total assets   $ 319,928             $ 331,905          
   
           
         
(This table is continued on the next page.)                                

(1)
Includes taxable-equivalent adjustments primarily related to tax-exempt income on U.S. states and political subdivisions securities and loans related to the Company's community lending and investment activities. The federal statutory tax rate was 35% for the periods presented.
(2)
Nonaccrual assets and related income, if any, are included in their respective categories.
(3)
The average balance and yield are based on average amortized cost balances.
(4)
Interest income for loans held in portfolio includes amortization of net deferred loan origination costs of $62 million and $155 million for the three months ended March 31, 2008 and 2007.
(5)
Capitalized interest recognized in earnings that resulted from negative amortization within the Option ARM portfolio totaled $336 million and $361 million for the three months ended March 31, 2008 and 2007.
(6)
Excludes home loans and home equity loans and lines of credit in the subprime mortgage channel.
(7)
Represents mortgage loans purchased from recognized subprime lenders and mortgage loans originated under the Long Beach Mortgage name and held in the investment portfolio.
(8)
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.

30


(Continued from the previous page.)

 
  Three Months Ended March 31,
 
  2008
  2007
 
  Average Balance
  Rate
  Interest Expense
  Average Balance
  Rate
  Interest Expense
 
  (dollars in millions)

Liabilities                                
Interest-bearing liabilities:                                
  Deposits:                                
    Interest-bearing checking deposits   $ 24,384   1.75 % $ 107   $ 31,821   2.63 % $ 206
    Savings and money market deposits     55,951   2.73     379     54,862   3.27     443
    Time deposits     74,225   4.57     843     91,631   4.97     1,123
   
     
 
     
      Total interest-bearing deposits     154,560   3.46     1,329     178,314   4.03     1,772
  Federal funds purchased and commercial paper     1,009   3.62     9     3,846   5.48     52
  Securities sold under agreements to repurchase     885   3.78     8     12,098   5.48     164
  Advances from Federal Home Loan Banks     62,799   4.29     670     36,051   5.38     478
  Other     34,048   4.71     400     32,808   5.67     461
   
     
 
     
      Total interest-bearing liabilities     253,301   3.83     2,416     263,117   4.51     2,927
             
           
Noninterest-bearing sources:                                
  Noninterest-bearing deposits     29,744               32,450          
  Other liabilities     8,902               9,482          
  Minority interests     3,915               2,449          
  Stockholders' equity     24,066               24,407          
   
           
         
      Total liabilities and stockholders' equity   $ 319,928             $ 331,905          
   
           
         
Net interest spread and net interest income on a taxable-equivalent basis         2.62   $ 2,179         2.30   $ 2,084
             
           
Impact of noninterest-bearing sources         0.43               0.50      
Net interest margin on a taxable-equivalent basis         3.05               2.80      

    Net Interest Income

        Net interest income and the net interest margin, both expressed on a taxable-equivalent basis, totaled $2.18 billion and 3.05% in the first quarter of 2008, compared with $2.08 billion and 2.80% in the first quarter of 2007. The increase in the net interest margin was due to the decrease in the cost of borrowed funds and deposits which outpaced the contraction in the yield on average interest-earning assets. For the first quarter of 2008, compared with the same period in 2007, the yield on average interest-earning assets decreased 36 basis points, while the yield on average interest-bearing liabilities decreased 68 basis points, reflecting lower deposits and wholesale borrowing costs following the 300 basis point reduction in the Federal Funds rate between the two periods.

31


    Noninterest Income

        Noninterest income consisted of the following:

 
  Three Months Ended
March 31,

   
 
 
  Percentage
Change

 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Revenue from sales and servicing of home mortgage loans   $ 411   $ 125   230 %
Revenue from sales and servicing of consumer loans     248     443   (44 )
Depositor and other retail banking fees     704     665   6  
Credit card fees     181     172   5  
Securities fees and commissions     58     60   (3 )
Insurance income     30     29   3  
Loss on trading assets     (216 )   (108 ) 100  
Gain on other available-for-sale securities     18     35   (47 )
Other income     135     120   12  
   
 
     
  Total noninterest income   $ 1,569   $ 1,541   2  
   
 
     

    Revenue from sales and servicing of home mortgage loans

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

 
  Three Months Ended March 31,
   
 
 
  Percentage
Change

 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Revenue from sales and servicing of home mortgage loans:                  
  Sales activity:                  
    Gain from home mortgage loans and originated mortgage-backed securities (1)   $ 143   $ 149   (4 )%
    Revaluation loss from derivatives economically hedging loans held for sale     (21 )   (54 ) (61 )
   
 
     
        Gain from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments     122     95   30  
  Servicing activity:                  
    Home mortgage loan servicing revenue (2)     470     514   (9 )
    Change in MSR fair value due to payments on loans and other     (230 )   (356 ) (36 )
    Change in MSR fair value due to valuation inputs or assumptions     (499 )   (96 ) 422  
    Revaluation gain (loss) from derivatives economically hedging MSR     548     (32 )  
   
 
     
      Home mortgage loan servicing revenue, net of MSR valuation changes and derivative risk management instruments     289     30   855  
   
 
     
          Total revenue from sales and servicing of home mortgage loans   $ 411   $ 125   230  
   
 
     

(1)
Originated mortgage-backed securities represent available-for-sale securities retained on the balance sheet subsequent to the securitization of mortgage loans that were originated by the Company.
(2)
Includes contractually specified servicing fees (net of guarantee fees paid to housing government-sponsored enterprises, where applicable), late charges and loan pool expenses (the shortfall of the scheduled interest required to be remitted to investors and that which is collected from borrowers upon payoff).

32


        The following table presents MSR valuation and the corresponding risk management derivative instruments and securities during the three months ended March 31, 2008 and 2007:

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
MSR Valuation and Risk Management:              
  Change in MSR fair value due to valuation inputs or assumptions   $ (499 ) $ (96 )
Gain (loss) on MSR risk management instruments:              
  Revaluation gain (loss) from derivatives     548     (32 )
  Revaluation gain from certain trading securities         4  
   
 
 
    Total gain (loss) on MSR risk management instruments     548     (28 )
   
 
 
      Total changes in MSR valuation and risk management   $ 49   $ (124 )
   
 
 

        The following table reconciles the gain (loss) on investment securities that are designated as MSR risk management instruments to loss on trading assets that are reported within noninterest income during the three months ended March 31, 2008 and 2007:

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
Gain (loss) on trading assets resulting from:              
  MSR risk management instruments   $   $ 4  
  Other     (216 )   (112 )
   
 
 
    Total loss on trading assets   $ (216 ) $ (108 )
   
 
 

        The fair value changes in home mortgage loans held for sale and the offsetting changes in the derivative instruments used as fair value hedges are recorded within gain from home mortgage loans when hedge accounting treatment is achieved. Home mortgage loans held for sale where hedge accounting treatment is not achieved are recorded at the lower of cost or fair value. This accounting method requires declines in the fair value of these loans, to the extent such value is below their cost basis, to be immediately recognized within gain from home mortgage loans, but any increases in the value of these loans that exceed their original cost basis may not be recorded until the loans are sold. However, all changes in the value of derivative instruments that are used to manage the interest rate risk of these loans must be recognized in earnings as those changes occur.

        The Company enters into commitments to originate or purchase loans that are intended to be sold after they are funded. These commitments represent interest rate derivative financial instruments and, accordingly, are recorded at fair value through earnings. In accordance with the provisions of SEC Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings Under Generally Accepted Accounting Principles ("SAB No. 109"), which the Company adopted on January 1, 2008, the expected net future cash flows related to the associated servicing of loans should be included in the fair value estimation of derivative loan commitments. Under previous accounting rules, the expected value of net servicing cash flows was not recognized until the loans were funded and sold. At March 31, 2008 the expected value of the future net servicing cash flows totaled $79 million and was included in gain from home mortgage loans during the first quarter. This amount is comprised of derivative loan commitments and those commitments that were subsequently funded but not sold as of the end of the quarter.

33


        Gain from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments, was $122 million in the first quarter of 2008 compared with $95 million in the same period of 2007. Liquidity in the secondary markets for subprime mortgage loans began to deteriorate in the first quarter of 2007 and expanded across the secondary market in the second half of 2007, resulting in the near-absence of liquidity for substantially all loans not eligible for purchase by the housing government-sponsored enterprises. Reflecting the severe contraction in secondary mortgage market liquidity, home loan sales volume for the three months ended March 31, 2008 totaled $10.00 billion, a 78% decrease from $45.25 billion during the same period of 2007.

        The value of the MSR asset, which is estimated using an OAS valuation methodology classified as Level 3 in the fair value hierarchy, is subject to prepayment risk. Future expected net cash flows from servicing a loan in the servicing portfolio will not be realized if the loan pays off earlier than expected. Moreover, since most loans within the servicing portfolio do not impose prepayment fees for early payoff, a corresponding economic benefit will not be received if the loan pays off earlier than expected. The fair value of the MSR is estimated from the present value of the future net cash flows the Company expects to receive from the servicing portfolio. Accordingly, prepayment risk subjects the MSR to potential declines in fair value. Due to this risk, the realization of future expected net cash flows may differ significantly from period end fair value of the MSR asset.

        Home mortgage loan servicing revenue, net of loan payments, increased by $82 million for the three months ended March 31, 2008, compared with the same period in 2007. The increase in net servicing revenue was attributable to a slowdown in mortgage prepayments, reflecting diminished opportunities for borrowers to refinance during a period when the housing market is weakening, underwriting standards across the mortgage banking industry have tightened and rates for nonconforming loan products are higher.

        MSR valuation and risk management resulted in a gain of $49 million in the first quarter of 2008, compared with a loss of $124 million in the same period for 2007. While expected prepayment speeds increased as a result of lower mortgage interest rates in the first quarter of 2008, the impact of lower rates on the MSR fair value was softened by the diminished availability of home loan refinancing opportunities, which lessened the sensitivity of the MSR asset to prepayment risk. The increase in the value of MSR risk management instruments more than offset the decline in MSR valuation. The performance of the MSR risk management instruments was adversely affected by the flat-to-inverted slope of the yield curve for the three months ended March 31, 2007, which had the effect of increasing hedging costs during that period.

    All Other Noninterest Income Analysis

        Revenue from sales and servicing of consumer loans decreased $195 million for the three months ended March 31, 2008, compared with the same period in 2007. The Company did not enter into credit card securitization sales for the three months ended March 31, 2008 due to the challenging capital markets environment. This led to a decrease of $155 million in gain from securitizations for the quarter ended March 31, 2008 as compared with the same period in 2007.

        Depositor and other retail banking fees increased $39 million for the quarter ended March 31, 2008, compared with the same period in 2007, largely due to higher transaction fees and an increase in the number of noninterest-bearing checking accounts. The number of noninterest-bearing checking accounts at March 31, 2008 totaled approximately 11.3 million compared with approximately 10.0 million at March 31, 2007.

        Loss on trading assets increased $108 million for the quarter ended March 31, 2008, compared with the same period in 2007 as a result of continued illiquidity in the capital markets, contributing to less favorable economic assumptions used to measure the value of trading assets retained from mortgage loan and credit card securitizations.

34


        Driven by higher sales volume, the Company realized net gains on sales of available-for-sale securities of $85 million in the first quarter of 2008. These gains were partially offset by impairment losses of $67 million recognized on mortgage-backed securities where the Company determined that the decline in the fair value of the securities below their amortized cost represented an other-than-temporary condition.

        Included in other income for the three months ended March 31, 2008, was an $85 million gain from the partial redemption of shares associated with the Company's portion of the Visa initial public offering.

    Noninterest Expense

        Noninterest expense consisted of the following:

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Compensation and benefits   $ 914   $ 1,002   (9 )%
Occupancy and equipment     358     376   (5 )
Telecommunications and outsourced information services     130     129   1  
Depositor and other retail banking losses     63     61   3  
Advertising and promotion     105     98   8  
Professional fees     39     38   3  
Postage     103     107   (4 )
Foreclosed asset expense     155     39   300  
Other expense     285     255   12  
   
 
     
  Total noninterest expense   $ 2,152   $ 2,105   2  
   
 
     

        A significant portion of the $88 million decrease in compensation and benefits expense for the three months ended March 31, 2008, compared with the same period in 2007, was due to lower home loan mortgage banking incentive compensation that resulted from the significant decline in home loan volume. Reflecting the Company's fourth quarter 2007 initiatives to resize the home loans business and corporate and other support functions, and to channel future home lending activities through the Company's retail banking stores, the number of employees decreased from 49,693 at March 31, 2007 to 45,883 at March 31, 2008.

        Occupancy and equipment expense decreased $18 million for the three months ended March 31, 2008 compared with the same period in 2007, primarily due to a reduction in depreciation and lease expenses as a result of the closure of approximately 200 home loan locations in the fourth quarter of 2007.

        The increase in foreclosed asset expense for the three months ended March 31, 2008, compared with the same period in 2007, was due to higher foreclosures reflecting the deterioration in the credit environment and further weakening in the housing market. The total number of foreclosed properties has increased while the values of those properties have generally declined.

        Other noninterest expense during the first quarter of 2008 included a $38 million partial recovery of the Visa litigation expense recorded during the second half of 2007.

35


Review of Financial Condition

    Trading Assets

        Trading assets consisted of the following:

 
  March 31, 2008
  December 31, 2007
 
  (in millions)

Credit card retained interests   $ 1,830   $ 1,838
Mortgage-backed securities     578     854
U.S. Government and other debt securities     75     76
   
 
  Total trading assets   $ 2,483   $ 2,768
   
 

        The Company's trading assets are primarily comprised of financial instruments that are retained from securitization transactions. Credit card retained interests are mostly comprised of subordinated interests that consist of noninterest bearing beneficial interests. These retained interests are repaid after the related senior classes of securities, which are usually held by third party investors. Substantially all of the trading assets are classified as Level 3 in the fair value hierarchy.

        Trading assets at March 31, 2008 decreased $285 million from December 31, 2007 primarily due to market valuation losses on mortgage-backed trading securities reflecting the illiquidity of the capital markets. These losses were predominantly related to the remaining assets of WaMu Capital Corp. ("WCC"), which is being wound down in connection with the Company's change in strategy for its Home Loans business. During the first quarter of 2008, WCC sold substantially all of its holdings to various other subsidiaries of the Company in arms-length transactions.

        The following table presents trading assets, including mortgage-backed securities by asset type, by investment grade at March 31, 2008:

 
  AAA
  AA
  A
  BBB
  Below Investment Grade
  Total
 
  (in millions)

Credit card retained interests   $   $ 34   $ 106   $ 278   $ 1,412   $ 1,830
Mortgage-backed securities:                                    
  Prime     315     3     14     16     20     368
  Alt-A     100     33     6     6     24     169
  Subprime                 1     1 (1)   2
  Commercial                     39     39
   
 
 
 
 
 
    Total mortgage-backed securities     415     36     20     23     84     578
U.S. Government and other debt securities     75                     75
   
 
 
 
 
 
      Total trading assets   $ 490   $ 70   $ 126   $ 301   $ 1,496   $ 2,483
   
 
 
 
 
 

(1)
Represents retained interest in subprime mortgage loan securitizations, including $1 million in residual interests.

36


    Available-for-Sale Securities

        The Company holds available-for-sale securities primarily for interest rate risk management and liquidity enhancement purposes. Accordingly, the portfolio is comprised primarily of highly-rated debt securities. The following table presents the amortized cost, unrealized gains, unrealized losses and fair value of available-for-sale securities as of the dates indicated. At March 31, 2008 and December 31, 2007 there were no securities classified as held to maturity.

 
  March 31, 2008
 
  Amortized Cost
  Unrealized Gains
  Unrealized Losses
  Fair Value
 
  (in millions)

Available-for-sale securities                        
Mortgage-backed securities:                        
  U.S. Government   $ 176   $ 4   $   $ 180
  Agency     7,753     117     (49 )   7,821
  Private label     11,435     10     (1,306 )   10,139
   
 
 
 
    Total mortgage-backed securities     19,364     131     (1,355 )   18,140
Investment securities:                        
  U.S. Government     124     4         128
  Agency     1,377     39         1,416
  U.S. states and political subdivisions     1,391     18     (8 )   1,401
  Other debt securities     2,176     16     (100 )   2,092
  Equity securities     475         (46 )   429
   
 
 
 
    Total investment securities     5,543     77     (154 )   5,466
   
 
 
 
      Total available-for-sale securities   $ 24,907   $ 208   $ (1,509 ) $ 23,606
   
 
 
 
 
 
  December 31, 2007
 
  Amortized Cost
  Unrealized Gains
  Unrealized Losses
  Fair Value
 
  (in millions)

Available-for-sale securities                        
Mortgage-backed securities:                        
  U.S. Government   $ 177   $ 2   $ (1 ) $ 178
  Agency     6,968     69     (23 )   7,014
  Private label     12,356     45     (344 )   12,057
   
 
 
 
    Total mortgage-backed securities     19,501     116     (368 )   19,249
Investment securities:                        
  U.S. Government     591     3     (1 )   593
  Agency     3,614     40     (2 )   3,652
  U.S. states and political subdivisions     1,598     17     (8 )   1,607
  Other debt securities     2,030     15     (35 )   2,010
  Equity securities     455     2     (28 )   429
   
 
 
 
    Total investment securities     8,288     77     (74 )   8,291
   
 
 
 
      Total available-for-sale securities   $ 27,789   $ 193   $ (442 ) $ 27,540
   
 
 
 

        The Company monitors securities in its available-for-sale investment portfolio for other-than-temporary impairment. Impairment may result from credit deterioration of the issuer or underlying collateral, changes in market rates relative to the interest rate of the instrument, adverse changes in prepayment speeds or other influences on the fair value of securities. The Company

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performs a security-by-security analysis to determine whether impairment is other than temporary and considers many factors in determining whether the impairment is other than temporary, including but not limited to adverse changes in expected cash flows, the length of time the security has had a fair value less than the cost basis, the severity of the unrealized loss, the Company's intent and ability to hold the security for a period of time sufficient for a recovery in value, issuer-specific factors such as the issuer's financial condition, external credit ratings and general market conditions. The Company recognized other-than-temporary impairment losses of $67 million on certain mortgage securities backed by Alt-A, prime and subprime collateral during the first quarter of 2008. Continuing credit deterioration in the market for certain mortgage securities resulted in further declines in the fair value of the securities and the recognition of impairment losses through earnings. The securities for which other-than-temporary impairment losses were recognized were classified as Level 3 in the fair value hierarchy.

        Unrealized losses increased $1.07 billion during the first quarter of 2008, predominantly due to market credit spreads widening. The Company does not believe it is probable that it will be unable to collect all amounts due on these securities as it has the intent and ability to retain these securities for a sufficient period of time to allow for their recovery. Accordingly, the Company does not consider their decline in fair value to represent an other-than-temporary impairment condition.

        During the first quarter of 2008, the Company transferred $373 million of available-for-sale securities from Level 2 to Level 3 in the fair value hierarchy. The market inputs used to estimate the fair value of these securities could not be corroborated and therefore, fair value was based on unobservable inputs. For the quarter, the Company recognized unrealized losses, on the securities transferred into Level 3, of $123 million that were recorded to other comprehensive income, net of income taxes. Also during the same period, the Company transferred $845 million of available-for-sale securities from Level 3 to Level 2 as the Company was able to use observable market inputs to corroborate the fair value estimates.

        The gross gains and losses realized through earnings on available-for-sale securities for the periods indicated were as follows:

 
  Three Months Ended March 31,
 
 
  2008
  2007
 
 
  (in millions)

 
Available-for-sale securities              
Realized gross gains   $ 102   $ 39  
Realized gross losses     (84 )   (4 )
   
 
 
  Realized net gain   $ 18   $ 35  
   
 
 

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    Mortgage-backed securities

        The fair value of available-for-sale mortgage-backed securities by asset type and investment grade at March 31, 2008 is presented in the following table:

 
  AAA (1)
  AA
  A
  BBB
  Below Investment Grade
  Total
 
  (in millions)

Mortgage-backed securities:                                    
  Agency   $ 8,001   $   $   $   $   $ 8,001
  Prime     3,257     387     91     32     1     3,768
  Alt-A     581     107     36     27     22     773
  Subprime     178     33     76     24     17     328
  Commercial     5,241     14         8     7     5,270
   
 
 
 
 
 
    Total mortgage-backed securities   $ 17,258   $ 541   $ 203   $ 91   $ 47   $ 18,140
   
 
 
 
 
 

(1)
Includes securities guaranteed by the U.S. Government or U.S. Government sponsored agencies which are not rated.

    Investment securities

        At March 31, 2008, available-for-sale investment securities were comprised primarily of U.S. Government-sponsored agency securities and securities issued by U.S. states and political subdivisions. Substantially all investment securities are investment grade.

    Loans

        Total loans consisted of the following:

 
  March 31, 2008
  December 31, 2007
 
  (in millions)

Loans held for sale   $ 4,941   $ 5,403
   
 
Loans held in portfolio:            
  Loans secured by real estate:            
    Home loans (1)   $ 108,420   $ 110,387
    Home equity loans and lines of credit (1)     61,234     60,963
    Subprime mortgage channel (2) :            
      Home loans     15,032     16,092
      Home equity loans and lines of credit     2,312     2,525
    Home construction (3)     2,088     2,226
    Multi-family     32,528     31,754
    Other real estate     10,022     9,524
   
 
      Total loans secured by real estate     231,636     233,471
  Consumer:            
    Credit card     8,989     8,831
    Other     186     205
  Commercial     2,003     1,879
   
 
    Total loans held in portfolio (4)   $ 242,814   $ 244,386
   
 

(1)
Excludes home loans and home equity loans and lines of credit in the subprime mortgage channel.

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(2)
Represents mortgage loans purchased from recognized subprime lenders and mortgage loans originated under the Long Beach Mortgage name and held in the investment portfolio.
(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.
(4)
Includes net unamortized deferred loan costs of $1.42 billion and $1.45 billion at March 31, 2008 and December 31, 2007.

        Due to the illiquid market, residential mortgage loans designated as held for sale at March 31, 2008 were largely limited to conforming loans eligible for purchase by the housing government-sponsored enterprises. Additionally, as a result of the severe contraction in secondary market liquidity, the Company transferred approximately $1 billion of credit card loans held for sale to its loan portfolio during the first quarter of 2008. During the fourth quarter of 2007, the Company discontinued all lending through its subprime mortgage channel. Subprime mortgage channel home loans and home equity loans and lines of credit decreased $1.27 billion as loan payoffs in the subprime portfolio were not replaced with loan originations in the first quarter of 2008.

        Total home loans held in portfolio consisted of the following:

 
  March 31, 2008
  December 31, 2007
 
  (in millions)

Home loans:            
  Short-term adjustable-rate loans (1) :            
    Option ARMs (2)   $ 55,846   $ 58,870
    Other ARMs     9,088     9,551
   
 
      Total short-term adjustable-rate loans     64,934     68,421
  Medium-term adjustable-rate loans (3)     38,056     36,507
  Fixed-rate loans     5,430     5,459
   
 
      Home loans held in portfolio (4)     108,420     110,387
  Subprime mortgage channel     15,032     16,092
   
 
      Total home loans held in portfolio   $ 123,452   $ 126,479
   
 

(1)
Short-term adjustable-rate loans reprice within one year.
(2)
The total amount by which the unpaid principal balance of Option ARM loans exceeded their original principal amount was $1.93 billion and $1.73 billion at March 31, 2008 and December 31, 2007.
(3)
Medium-term adjustable-rate loans reprice after one year.
(4)
Excludes home loans in the subprime mortgage channel.

        The Option ARM home loan portfolio decreased during the first quarter of 2008, as loan payments sharply exceeded originations, reflecting tighter underwriting standards across the mortgage banking industry and increased rates for nonconforming loan products. Option ARM loan volume for the three months ended March 31, 2008 was $231 million compared with $3.95 billion for the three months ended December 31, 2007.

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    Other Assets

        Other assets consisted of the following:

 
  March 31, 2008
  December 31, 2007
 
  (in millions)

Accounts receivable   $ 3,207   $ 4,837
Investment in bank-owned life insurance     5,126     5,072
Premises and equipment     2,704     2,779
Accrued interest receivable     1,791     2,039
Derivatives     2,817     2,093
Identifiable intangible assets     351     388
Foreclosed assets     1,357     979
Other     4,046     3,847
   
 
  Total other assets   $ 21,399   $ 22,034
   
 

        The decrease in accounts receivable was due to the decrease in accrued net income tax receivable of $2.05 billion. As of December 31, 2007, the Company had accrued a net income tax receivable of approximately $2.72 billion, representing tax refund claims from various taxing authorities for periods through December 31, 2005, most of which was received from the Internal Revenue Service during the first quarter of 2008.

        The increase in derivatives was due to the increase in the fair values on certain contracts that benefited from a decrease in interest rates.

    Deposits

        Deposits consisted of the following:

 
  March 31, 2008
  December 31, 2007
 
  (in millions)

Retail deposits:            
  Checking deposits:            
    Noninterest bearing   $ 25,131   $ 23,476
    Interest bearing     23,631     25,713
   
 
      Total checking deposits     48,762     49,189
  Savings and money market deposits     51,317     44,987
  Time deposits     51,574     49,410
   
 
      Total retail deposits     151,653     143,586
Commercial business and other deposits     10,405     11,267
Brokered deposits:            
  Consumer     17,739     18,089
  Institutional     1,711     2,515
Custodial and escrow deposits     6,541     6,469
   
 
    Total deposits   $ 188,049   $ 181,926
   
 

        The increase in noninterest-bearing retail checking deposits was predominantly due to the continuing customer account growth in the Company's free checking product. Time deposits and savings and money market accounts increased as higher interest rates offered on money market

41



deposits attracted new deposits and customers shifted from interest-bearing retail checking deposits. As a result, overall deposits increased by $6.12 billion.

        Transaction accounts (checking, savings and money market deposits) comprised 66% of retail deposits at March 31, 2008 and December 31, 2007. These products generally have the benefit of lower interest costs, compared with time deposits, and represent the core customer relationship that is maintained within the retail banking franchise. Average total deposits funded 65% of average total interest-earning assets in the first quarter of 2008, compared with 64% in the fourth quarter of 2007.

    Borrowings

        Other borrowings of $32.71 billion at March 31, 2008 decreased $6.25 billion from December 31, 2007. The decrease was due to early termination of a long-term borrowing secured by single-family and multi-family mortgage loans. In addition, securities sold under agreements to repurchase decreased by $3.93 billion from the December 31, 2007 balance of $4.15 billion.

Operating Segments

        The Company has four operating segments for the purpose of management reporting: the Retail Banking Group, the Card Services Group, the Commercial Group and the Home Loans Group. The Company's operating segments are defined by the products and services they offer. The Retail Banking Group, the Card Services Group and the Home Loans Group are consumer-oriented while the Commercial Group serves commercial customers. In addition, the category of Corporate Support/Treasury and Other includes the community lending and investment operations; the Treasury function, which manages the Company's interest rate risk, liquidity position and capital; the Corporate Support function, which provides facilities, legal, accounting and finance, human resources and technology services; and the Enterprise Risk Management function, which oversees the identification, measurement, monitoring, control and reporting of credit, market and operational risk. Refer to Note 8 to the Consolidated Financial Statements – "Operating Segments" for information regarding the key elements of management reporting methodologies used to measure segment performance.

        The Company serves the needs of 19.8 million consumer households through its 2,261 retail banking stores, 228 lending stores and centers, 4,965 owned and branded ATMs, telephone call centers and online banking.

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        Financial highlights by operating segment were as follows:

    Retail Banking Group

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Condensed income statement:                  
  Net interest income   $ 1,203   $ 1,284   (6 )%
  Provision for loan losses     2,300     62    
  Noninterest income     775     751   3  
  Inter-segment revenue     9     18   (53 )
  Noninterest expense     1,221     1,069   14  
   
 
     
  Income (loss) before income taxes     (1,534 )   922    
  Income taxes     (491 )   346    
   
 
     
    Net income (loss)   $ (1,043 ) $ 576    
   
 
     
Performance and other data:                  
  Efficiency ratio     61.48 %   52.08 % 18  
  Average loans   $ 142,720   $ 155,206   (8 )
  Average assets     151,609     165,044   (8 )
  Average deposits     146,734     144,030   2  
  Loan volume     1,238     4,576   (73 )
  Employees at end of period     28,736     28,229   2  

        The decrease in net interest income for the three months ended March 31, 2008, compared with the same period in 2007, was primarily due to a decline in the spread and average balances of home mortgage loans and a decline in the funds transfer pricing credit on deposits resulting from a decline in short-term interest rates.

        The substantial increase in the provision for loan losses in the first quarter of 2008 resulted from an increase in delinquencies in the home equity and home mortgage loan portfolios and declining housing prices from the deteriorating housing market.

        The increase in noninterest income was substantially due to growth in depositor and other retail banking fees of 6% during the three months ended March 31, 2008, compared with the same period in 2007, reflecting an increase in deposit fees that was due to higher transaction fees and the increase in the number of noninterest-bearing checking accounts. The number of noninterest-bearing retail checking accounts at March 31, 2008 totaled approximately 11.3 million, compared with approximately 10.0 million at March 31, 2007.

        Noninterest expense in the first quarter of 2008 increased primarily due to the continued focus on growing the retail banking franchise and an increase in foreclosed asset expense. This retail-focused strategy was reflected in the increase in compensation and benefits expense and advertising and promotion expense. Foreclosed asset expense increased from $6 million in the first quarter of 2007 to $35 million in the first quarter of 2008.

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    Card Services Group (Managed basis)

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Condensed income statement:                  
  Net interest income   $ 765   $ 641   19 %
  Provision for loan losses     626     388   61  
  Noninterest income     418     474   (12 )
  Inter-segment expense     5        
  Noninterest expense     260     329   (21 )
   
 
     
  Income before income taxes     292     398   (27 )
  Income taxes     93     149   (37 )
   
 
     
    Net income   $ 199   $ 249   (20 )
   
 
     
Performance and other data:                  
  Efficiency ratio     22.04 %   29.51 % (25 )
  Average loans   $ 26,889   $ 23,604   14  
  Average assets     29,244     26,039   12  
  Employees at end of period     2,881     2,579   12  

        The Company evaluates the performance of the Card Services Group on a managed basis. Managed financial information is derived by adjusting the GAAP financial information to add back securitized loan balances and the related interest, fee income and provision for credit losses. Securitization adjustments within the Credit Card managed view have no impact to net income as these adjustments net to zero.

        The increase in net interest income for the three months ended March 31, 2008 was primarily due to growth in the average balance of managed credit card loans, which increased $3.29 billion when compared with the three months ended March 31, 2007. Also contributing to the increase was improved spreads on the credit card portfolio as declining funds transfer charges outpaced the decline in yields on credit card receivables.

        The increase in the provision for loan losses reflects the increase in the balance of managed credit card receivables in the first quarter of 2008 and an increase in managed net credit losses. Managed net credit losses increased to 9.32% of managed receivables in the first quarter of 2008 from 6.31% in the first quarter of 2007. As the market shifted from a relatively benign credit environment in early 2007 to the current challenging economic environment, delinquencies in the credit card portfolio increased.

        Noninterest income decreased for the three months ended March 31, 2008, compared with the same period in 2007, due to the decline in revenue from sales and servicing of consumer loans as no new securitization sales were completed during the first quarter of 2008 given the challenging capital market environment. Substantially offsetting this decline was an $85 million gain from the redemption of a portion of the Company's shares associated with the Visa initial public offering, and higher fee income.

        The decrease in noninterest expense in the first quarter of 2008, compared with the same period in 2007, substantially resulted from a partial recovery of $38 million of the Visa-related litigation expense recorded during the second half of 2007 and lower postage and marketing expense.

44


    Commercial Group

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Condensed income statement:                  
  Net interest income   $ 196   $ 211   (7 )%
  Provision for loan losses     29     (10 )  
  Noninterest income     (8 )   15    
  Noninterest expense     68     74   (9 )
   
 
     
  Income before income taxes     91     162   (44 )
  Income taxes     29     61   (52 )
   
 
     
    Net income   $ 62   $ 101   (39 )
   
 
     
Performance and other data:                  
  Efficiency ratio     36.09 %   32.85 % 10  
  Average loans   $ 40,934   $ 38,641   6  
  Average assets     43,004     41,005   5  
  Average deposits     7,474     12,028   (38 )
  Loan volume     2,835     3,671   (23 )
  Employees at end of period     1,358     1,459   (7 )

        The decrease in net interest income was primarily due to a decline in the average balance of deposits attributable to the winding-down of the mortgage banker finance warehouse lending operations in the fourth quarter of 2007. Partially offsetting this decrease was higher net interest income on commercial mortgage-backed securities due to an increase in the spread between funds transfer charges and the yield on the securities, and increased average balances of other commercial real estate and multi-family loans.

        The increase in the provision for loan losses was due to increased delinquencies and higher balances of loans held in portfolio.

        The decrease in noninterest income was due to lower gain on sale resulting from decreased sales volume and losses on trading securities. The decrease was partially offset by improved performance of derivatives held to economically hedge loans held for sale.

        The decrease in noninterest expense was predominantly due to lower compensation and benefits expense resulting from lower production volume and a reduction in the number of employees.

45


    Home Loans Group

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Condensed income statement:                  
  Net interest income   $ 250   $ 244   3 %
  Provision for loan losses     907     49    
  Noninterest income     319     161   98  
  Inter-segment expense     4     18   (80 )
  Noninterest expense     499     522   (4 )
   
 
     
  Loss before income taxes     (841 )   (184 ) 357  
  Income taxes     (269 )   (69 ) 290  
   
 
     
    Net loss   $ (572 ) $ (115 ) 397  
   
 
     

Performance and other data:

 

 

 

 

 

 

 

 

 
  Efficiency ratio     88.26 %   134.82 % (35 )
  Average loans   $ 55,672   $ 53,254   5  
  Average assets     66,841     71,382   (6 )
  Average deposits     5,469     8,501   (36 )
  Loan volume     13,774     33,780   (59 )
  Employees at end of period     9,159     13,449   (32 )

        The increase in net interest income in the first quarter of 2008, compared with the same period in 2007, was predominantly due to an increase in average balances of home mortgage loans. Also contributing to the increase was lower funds transfer pricing charges on the MSR asset. This increase in net interest income was substantially offset by lower funds transfer pricing credits on deposit balances due to both a decrease in short-term interest rates and lower average balances of deposits.

        The provision for loan losses increased in response to higher levels of delinquencies and loss severity rates as a result of deteriorating housing market conditions. Due to declining home values and reduced availability of credit throughout the mortgage market, borrowers who become delinquent are less likely to be able to cure their loans through sale or refinancing, resulting in increased foreclosures and charge-offs.

        The increase in noninterest income for the three months ended March 31, 2008, compared with the same period in 2007, was primarily driven by improved performance in MSR valuation and risk management, as well as increased net loan servicing revenue. These increases both reflect a slowdown in mortgage prepayments as underwriting standards across the mortgage banking industry tightened and the opportunities for borrowers to refinance diminished. Partially offsetting the increase was higher losses on trading assets, reflecting the illiquidity of the capital markets. In accordance with the provisions of SEC SAB No. 109, the Home Loans Group recognized noninterest income of $79 million for the expected net future cash flows related to the associated servicing of loans during the first quarter of 2008 on derivative loan commitments and those commitments that were subsequently funded but not sold as of the end of the quarter. This benefit was almost entirely offset by lower sales volume, reflecting the severe contraction in secondary mortgage market liquidity for substantially all loans not eligible for purchase by the housing government-sponsored enterprises.

        The decrease in noninterest expense for the three months ended March 31, 2008, compared with the same period in 2007, was predominantly due to the decline in loan originations and related expenses and a reduction in the number of employees, reflecting the fourth quarter 2007 initiative to resize the home loans business. This decrease was partially offset by higher foreclosed asset expense as

46



a result of the downturn in the housing market and increased defaults. Foreclosed asset expense totaled $118 million in the first quarter of 2008, compared with $33 million in the first quarter of 2007.

    Corporate Support/Treasury and Other

 
  Three Months Ended March 31,
   
 
 
  Percentage Change
 
 
  2008
  2007
 
 
  (dollars in millions)

   
 
Condensed income statement:                  
  Net interest income (expense)   $ 132   $ (22 ) %
  Provision for loan losses     119     27   351  
  Noninterest income     86     94   (8 )
  Noninterest expense     104     111   (7 )
  Minority interest expense     75     43