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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 JUNE 30, 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 July 31, 2008:


 

 

Common Stock — 1,705,359,302 (1)

 

 

 

 

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

 

 



WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2008
TABLE OF CONTENTS

 
  Page  

PART I – Financial Information

    1  
 

Item 1. Financial Statements

    1  
   

Consolidated Statements of Income (Unaudited) –
Three and Six Months Ended June 30, 2008 and 2007

    1  
   

Consolidated Statements of Financial Condition (Unaudited) –
June 30, 2008 and December 31, 2007

    2  
   

Consolidated Statements of Stockholders' Equity and Comprehensive Income (Unaudited) –
Six Months Ended June 30, 2008 and 2007

    3  
   

Consolidated Statements of Cash Flows (Unaudited) –
Six Months Ended June 30, 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

    31  
         

Risk Factors

    31  
         

Controls and Procedures

    32  
         

Critical Accounting Estimates

    33  
         

Overview

    35  
         

Recently Issued Accounting Standards Not Yet Adopted

    37  
         

Summary Financial Data

    38  
         

Earnings Performance

    39  
         

Review of Financial Condition

    48  
         

Operating Segments

    54  
         

Off-Balance Sheet Activities

    60  
         

Risk Management

    62  
         

Credit Risk Management

    63  
         

Liquidity Risk and Capital Management

    76  
         

Market Risk Management

    80  
         

Operational Risk Management

    85  
         

Goodwill Litigation

    86  
 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

    80  
 

Item 4. Controls and Procedures

    32  

PART II – Other Information

   
88
 
 

Item 1.   Legal Proceedings

    88  
 

Item 1A. Risk Factors

    31  
 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

    93  
 

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

    94  
 

Item 6.   Exhibits

    95  

i


Part I – FINANCIAL INFORMATION

WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2008   2007   2008   2007  
 
  (in millions, except per share amounts)
 

Interest Income

                         
 

Loans held for sale

  $ 52   $ 421   $ 138   $ 984  
 

Loans held in portfolio

    3,604     3,786     7,559     7,686  
 

Available-for-sale securities

    335     351     691     682  
 

Trading assets

    117     108     233     221  
 

Other interest and dividend income

    94     82     171     183  
                   
   

Total interest income

    4,202     4,748     8,792     9,756  

Interest Expense

                         
 

Deposits

    1,115     1,723     2,443     3,495  
 

Borrowings

    791     991     1,878     2,146  
                   
   

Total interest expense

    1,906     2,714     4,321     5,641  
                   
     

Net interest income

    2,296     2,034     4,471     4,115  
 

Provision for loan losses

    5,913     372     9,423     606  
                   
     

Net interest income (expense) after provision for loan losses

    (3,617 )   1,662     (4,952 )   3,509  

Noninterest Income

                         
 

Revenue from sales and servicing of home mortgage loans

    (109 )   300     302     425  
 

Revenue from sales and servicing of consumer loans

    159     403     407     846  
 

Depositor and other retail banking fees

    767     720     1,470     1,385  
 

Credit card fees

    177     183     358     355  
 

Securities fees and commissions

    64     70     122     131  
 

Insurance income

    32     29     63     58  
 

Loss on trading assets

    (305 )   (145 )   (521 )   (253 )
 

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

    (402 )   7     (384 )   41  
 

Gain (loss) on extinguishment of borrowings

    100     (14 )   113     (7 )
 

Other income

    78     205     199     318  
                   
   

Total noninterest income

    561     1,758     2,129     3,299  

Noninterest Expense

                         
 

Compensation and benefits

    939     977     1,853     1,979  
 

Occupancy and equipment

    460     354     818     731  
 

Telecommunications and outsourced information services

    123     132     253     261  
 

Depositor and other retail banking losses

    61     58     124     119  
 

Advertising and promotion

    103     113     208     211  
 

Professional fees

    57     55     96     93  
 

Foreclosed asset expense

    217     56     372     95  
 

Other expense

    443     393     831     755  
                   
   

Total noninterest expense

    2,403     2,138     4,555     4,244  
 

Minority interest expense

    75     42     151     85  
                   
     

Income (loss) before income taxes

    (5,534 )   1,240     (7,529 )   2,479  
     

Income taxes

    (2,206 )   410     (3,063 )   865  
                   

Net Income (Loss)

  $ (3,328 ) $ 830   $ (4,466 ) $ 1,614  
                   

Net Income (Loss) Applicable to Common Stockholders

  $ (6,689 ) $ 822   $ (7,892 ) $ 1,599  
                   

Earnings Per Common Share:

                         
 

Basic

  $ (6.58 ) $ 0.95   $ (8.43 ) $ 1.83  
 

Diluted

    (6.58 )   0.92     (8.43 )   1.78  

Dividends declared per common share

    0.01     0.55     0.16     1.09  

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

    1,016,081     868,968     936,502     871,876  

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

    1,016,081     893,090     936,502     896,304  

See Notes to Consolidated Financial Statements.

1


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(UNAUDITED)

 
  June 30,
2008
  December 31,
2007
 
 
  (dollars in millions)
 

Assets

             
 

Cash and cash equivalents

  $ 7,235   $ 9,560  
 

Federal funds sold and securities purchased under agreements to resell

    2,750     1,877  
 

Trading assets (including securities pledged of zero and $388)

    2,308     2,768  
 

Available-for-sale securities, total amortized cost of $25,756 and $27,789:

             
   

Mortgage-backed securities (including securities pledged of $121 and $1,221)

    18,241     19,249  
   

Investment securities (including securities pledged of $112 and $3,078)

    6,134     8,291  
           
       

Total available-for-sale securities

    24,375     27,540  
 

Loans held for sale

    1,877     5,403  
 

Loans held in portfolio

    239,627     244,386  
 

Allowance for loan losses

    (8,456 )   (2,571 )
           
       

Loans held in portfolio, net

    231,171     241,815  
 

Investment in Federal Home Loan Banks

    3,498     3,351  
 

Mortgage servicing rights

    6,175     6,278  
 

Goodwill

    7,284     7,287  
 

Other assets

    23,058     22,034  
           
       

Total assets

  $ 309,731   $ 327,913  
           

Liabilities

             
 

Deposits:

             
   

Noninterest-bearing deposits

  $ 31,112   $ 30,389  
   

Interest-bearing deposits

    150,811     151,537  
           
       

Total deposits

    181,923     181,926  
 

Federal funds purchased and commercial paper

    75     2,003  
 

Securities sold under agreements to repurchase

    214     4,148  
 

Advances from Federal Home Loan Banks

    58,363     63,852  
 

Other borrowings

    30,590     38,958  
 

Other liabilities

    8,566     8,523  
 

Minority interests

    3,914     3,919  
           
       

Total liabilities

    283,645     303,329  

Stockholders' Equity

             
 

Preferred stock

    3,392     3,392  
 

Common stock, no par value: 3,000,000,000 shares authorized, 1,705,343,797 and 869,036,088 shares issued and outstanding

         
 

Capital surplus – common stock

    12,916     2,630  
 

Accumulated other comprehensive loss

    (1,079 )   (359 )
 

Retained earnings

    10,857     18,921  
           
       

Total stockholders' equity

    26,086     24,584  
           
       

Total liabilities and stockholders' equity

  $ 309,731   $ 327,913  
           

See Notes to Consolidated Financial Statements.

2


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

                    1,614     1,614  
 

Other comprehensive income (loss), net of tax:

                                     
   

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

                (303 )       (303 )
   

Net unrealized gain from cash flow hedging instruments

                22         22  
                                     

Total comprehensive income

                        1,333  

Cash dividends declared on common stock

                    (961 )   (961 )

Cash dividends declared on preferred stock

                    (15 )   (15 )

Common stock repurchased and retired

    (74.9 )       (3,297 )           (3,297 )

Common stock issued

    6.1         187             187  
                           

BALANCE, June 30, 2007

    875.7   $ 492   $ 2,715   $ (568 ) $ 21,571   $ 24,210  
                           

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

                    (4,466 )   (4,466 )
 

Other comprehensive income (loss), net of tax:

                                     
   

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

                (702 )       (702 )
   

Net unrealized loss from cash flow hedging instruments

                (23 )       (23 )
   

Amortization and deferral of gains, losses and prior service costs from defined benefit plans

                5         5  
                                     

Total comprehensive loss

                        (5,186 )

Preferred stock issued

        5,010                 5,010  

Conversion of preferred stock into common stock

    646.5     (5,010 )   5,010              

Common stock issued

    189.8         1,552             1,552  

Warrants issued

            434             434  

Beneficial conversion feature

            3,290         (3,290 )    

Cash dividends declared on common stock

                    (140 )   (140 )

Cash dividends declared on preferred stock

                    (136 )   (136 )

Cash dividends returned (1)

                    4     4  
                           

BALANCE, June 30, 2008

    1,705.3   $ 3,392   $ 12,916   $ (1,079 ) $ 10,857   $ 26,086  
                           

(1)
Represents accumulated dividends on shares returned from escrow.

See Notes to Consolidated Financial Statements.

3


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
  Six Months Ended
June 30,
 
 
  2008   2007  
 
  (in millions)
 

Cash Flows from Operating Activities

             
 

Net income (loss)

  $ (4,466 ) $ 1,614  
 

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

             
   

Provision for loan losses

    9,423     606  
   

Loss (gain) from home mortgage loans

    19     (214 )
   

Gain from credit card loans

        (259 )
   

Loss (gain) on available-for-sale securities

    384     (41 )
   

(Gain) loss on extinguishment of borrowings

    (113 )   7  
   

Depreciation and amortization

    150     306  
   

Change in fair value of MSR

    492     333  
   

Stock dividends from Federal Home Loan Banks

    (72 )   (55 )
   

Capitalized interest income from option adjustable-rate mortgages

    (591 )   (706 )
   

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

    (18,605 )   (54,637 )
   

Proceeds from sales of loans originated and held for sale

    20,271     57,928  
   

Net decrease (increase) in trading assets

    481     (825 )
   

Increase in other assets

    (570 )   (382 )
   

(Decrease) increase in other liabilities

    (437 )   80  
           
     

Net cash provided by operating activities

    6,366     3,755  

Cash Flows from Investing Activities

             
 

Purchases of available-for-sale securities

    (5,694 )   (8,981 )
 

Proceeds from sales of available-for-sale securities

    6,822     4,370  
 

Principal payments and maturities on available-for-sale securities

    1,566     1,227  
 

Purchases of Federal Home Loan Bank stock

    (130 )   (24 )
 

Redemption of Federal Home Loan Bank stock

    55     1,188  
 

Origination and purchases of loans held in portfolio, net of principal payments

    2,138     6,526  
 

Proceeds from sales of loans

    19     22,692  
 

Proceeds from sales of foreclosed assets

    545     354  
 

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

    (873 )   476  
 

Purchases of premises and equipment, net

    (30 )   (123 )
           
     

Net cash provided by investing activities

    4,418     27,705  

(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.)

 
  Six Months Ended
June 30,
 
 
  2008   2007  
 
  (in millions)
 

Cash Flows from Financing Activities

             
 

Decrease in deposits

  $ (3 ) $ (12,576 )
 

(Decrease) increase in short-term borrowings

    (5,512 )   1,907  
 

Proceeds from long-term borrowings

        13,054  
 

Repayments of long-term borrowings

    (8,828 )   (10,120 )
 

Proceeds from advances from Federal Home Loan Banks

    19,157     20,016  
 

Repayments of advances from Federal Home Loan Banks

    (24,647 )   (42,904 )
 

Proceeds from issuance of preferred stock

    5,010      
 

Proceeds from issuance of common stock

    1,552     154  
 

Proceeds from issuance of warrants

    434      
 

Proceeds from issuance of preferred securities by subsidiary

        497  
 

Cash dividends paid on preferred and common stock

    (276 )   (976 )
 

Repurchase of common stock

        (3,297 )
 

Other

    4     4  
           
   

Net cash used by financing activities

    (13,109 )   (34,241 )
           
   

Decrease in cash and cash equivalents

    (2,325 )   (2,781 )
   

Cash and cash equivalents, beginning of period

    9,560     6,948  
           
   

Cash and cash equivalents, end of period

  $ 7,235   $ 4,167  
           

Noncash Activities

             
 

Conversion of preferred stock into common stock

  $ 5,010   $  
 

Loans exchanged for mortgage-backed securities

    59     472  
 

Real estate acquired through foreclosure

    1,088     627  
 

Loans transferred from held for sale to held in portfolio

    1,434     2,624  
 

Loans transferred from held in portfolio to held for sale

    2     2,908  

Cash Paid During the Period For

             
 

Interest on deposits

  $ 2,461   $ 3,556  
 

Interest on borrowings

    1,991     2,404  
 

Income taxes

    149     1,146  

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/A.

    Cumulative Effect from the Adoption of Accounting Pronouncements

        On January 1, 2008, the Company adopted Financial Accounting Standards Board ("FASB") Statement No. 157, Fair Value Measurements ("Statement No. 157"), Emerging Issues Task Force ("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 ("FSP FAS 142-3"), 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

6


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)


identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in 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.

        In May 2008, the FASB issued Statement No. 163, Accounting for Financial Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60 ("Statement No. 163"). Statement No. 163 requires an insurance enterprise that issues financial guarantee insurance contracts to initially recognize the premiums received (or premiums expected to be received) for issuing the contracts as unearned premium revenue and to recognize that premium revenue over the period of the contract and in proportion to the amount of insurance protection provided. Statement No. 163 also requires recognition of a claim liability before an event of default if there is evidence that credit deterioration of the guaranteed obligation has occurred. This statement is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, except for some disclosures about the insurance enterprise's risk-management activities and claim liabilities. Statement No. 163 requires that disclosures about the risk-management activities of the insurance enterprise and its claim liabilities be effective for the first period (including interim periods) beginning after its issuance. The Company is currently evaluating the effect, if any, that Statement No. 163 will have on the Consolidated Financial Statements.

        In May 2008, the FASB issued FSP Accounting Principles Board ("APB") 14-1, Accounting for Convertible Debt Instruments That May be Settled in Cash Upon Conversion (Including Partial Cash Settlement) ("FSP APB 14-1"). FSP APB 14-1 addresses the accounting for convertible debt securities that, upon conversion, may be settled by the issuer fully or partially in cash (i.e., if the investor elects to convert, the issuer has the right to pay some or all of the conversion value in cash rather than to settle the conversion value fully in shares). Such guidance is effective for fiscal years and interim periods beginning after December 15, 2008. It requires retrospective application to instruments that are within the scope of this guidance and were outstanding during any period presented in the financial statements. The Company is currently evaluating the effect that FSP APB 14-1 will have on the Consolidated Financial Statements.

        In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities ("FSP EITF 03-6-1"). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the process of allocating earnings for purposes of computing earnings per share pursuant to the two-class method that is described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings Per Share. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early application is not permitted. The Company is currently evaluating the effect, if any, FSP EITF 03-6-1 will have on the Consolidated Financial Statements.

        In June 2008, the FASB ratified the consensus reached by the EITF on Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock ("Issue No. 07-5"). Issue No. 07-5 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008 and is applicable to outstanding instruments as of January 1, 2009. The cumulative effect of the change in accounting principle, if any, shall be recognized as an adjustment to

7


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(UNAUDITED)


beginning retained earnings as of January 1, 2009. The Company is currently evaluating the effect, if any, that Issue No. 07-5 will have on the Consolidated Financial Statements.

        In June 2008, the FASB ratified the consensus reached by the EITF on Issue No 08-3, Accounting By Lessees for Maintenance Deposits ("Issue No. 08-3"), which clarifies that maintenance deposits shall be recognized as deposit assets and the amount that is not probable of being returned shall be recognized as additional expense. Issue No. 08-3 is effective for financial statements that are issued for fiscal years and interim periods beginning after December 15, 2008. The Company is currently evaluating the effect, if any, that Issue No. 08-3 will have on the Consolidated Financial Statements.

        In June 2008, the FASB ratified the consensus reached by the EITF on Issue No. 08-4, Transition Guidance for Conforming Changes to EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios ("Issue No. 08-4"). Such guidance shall be effective for financial statements that are issued for fiscal years ending after December 15, 2008, with early application permitted. The Company does not expect the application of Issue No. 08-4 to have a material effect on the Consolidated Financial Statements.


Note 2: Restructuring Activities

        In the second quarter of 2008, the Company implemented a series of initiatives designed to further consolidate the Home Loans business and corporate support and other business functions and significantly reduce future operating costs. As part of these activities, the Company discontinued all lending conducted through its wholesale channel, closed all of its remaining freestanding home loan centers and sales offices, closed or consolidated certain loan fulfillment centers and reduced functions that primarily supported home loans activities that have been discontinued. In connection with these activities, the Company expects to incur pre-tax restructuring charges of approximately $390 million, which consists of approximately $110 million in termination benefits, approximately $140 million in lease terminations and other decommissioning costs and approximately $140 million in fixed asset write-downs. Of the total expense expected to be incurred, $204 million was recorded in the second quarter of 2008, which consisted of $66 million in employee termination benefits, $46 million in lease termination and other decommissioning costs and $92 million of fixed asset write-downs. These restructuring activities are expected to be substantially completed by the fourth quarter of 2008.

        Charges for termination benefits were recorded in compensation and benefits expense; charges for lease terminations, other decommissioning costs and fixed asset write-downs were recorded in occupancy and equipment expense 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.

        At June 30, 2008, the outstanding liability of these restructuring charges was $103 million. Substantially all of the outstanding liability related to termination benefits is expected to be paid during the remainder 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, 2013.

8


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
June 30,
  Six Months Ended
June 30,
 
 
  2008   2007   2008   2007  
 
  (in millions)
 

Revenue from sales and servicing of home mortgage loans:

                         
 

Sales activity:

                         
   

Gain (loss) from home mortgage loans and originated mortgage-backed securities (1)

  $ (162 ) $ 66   $ (19 ) $ 214  
   

Revaluation gain (loss) from derivatives economically hedging loans held for sale

    11     126     (9 )   72  
                   
     

Gain (loss) from home mortgage loans and originated mortgage-backed securities, net of hedging and risk management instruments

    (151 )   192     (28 )   286  
 

Servicing activity:

                         
   

Home mortgage loan servicing revenue (2)

    438     526     908     1,041  
   

Change in MSR fair value due to payments on loans and other

    (301 )   (401 )   (531 )   (757 )
   

Change in MSR fair value due to valuation inputs or assumptions

    542     530     42     434  
   

Revaluation loss from derivatives economically hedging MSR

    (637 )   (547 )   (89 )   (579 )
                   
     

Home mortgage loan servicing revenue, net of MSR valuation changes and derivative risk management instruments

    42     108     330     139  
                   
       

Total revenue from sales and servicing of home mortgage loans

  $ (109 ) $ 300   $ 302   $ 425  
                   

(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).

9


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
June 30,
  Six Months Ended
June 30,
 
 
  2008   2007   2008   2007  
 
  (in millions)
 

Fair value, beginning of period

  $ 5,726   $ 6,507   $ 6,278   $ 6,193  
 

Home loans:

                         
   

Additions

    205     592     386     1,351  
   

Change in MSR fair value due to payments on loans and other

    (301 )   (401 )   (531 )   (757 )
   

Change in MSR fair value due to valuation inputs or assumptions

    542     530     42     434  
   

Sale of MSR

            (1 )    
 

Net change in commercial real estate MSR (1)

    3     3     1     10  
                   

Fair value, end of period

  $ 6,175   $ 7,231   $ 6,175   $ 7,231  
                   

Unrealized gain still held (2)

  $ 544   $ N/A   $ 42   $ 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 gains for the period included in earnings attributable to the change in unrealized gains relating to MSR still held at June 30, 2008.

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

 
  Three Months Ended June 30,   Six Months Ended June 30,  
 
  2008   2007   2008   2007  
 
  (in millions)
 

Balance, beginning of period

  $ 449,126   $ 467,782   $ 456,484   $ 444,696  
 

Home loans:

                         
   

Additions

    9,828     29,949     19,690     74,500  
   

Sale of servicing

            (109 )    
   

Loan payments and other

    (17,534 )   (24,213 )   (34,711 )   (46,682 )
 

Net change in commercial real estate loans

    181     1,349     247     2,353  
                   

Balance, end of period

  $ 441,601   $ 474,867   $ 441,601   $ 474,867  
                   


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

10


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


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 required to either repurchase the loan or indemnify the investor for losses sustained. Reserves established to repurchase loans or indemnify investors are recorded as a reduction to revenue from sales and servicing of home loans on the Consolidated Statements of Income.

        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 $375 million and $268 million as of June 30, 2008 and December 31, 2007, to cover its estimated exposure related to all of the aforementioned loss contingencies.

        From time to time, the Company and its subsidiaries enter into agreements in connection with the issuance of debt or equity securities which contain standard representations, warranties and indemnifications to third parties against damages, losses and expenses arising from those transactions. The extent of the Company's obligation under these agreements depends on the occurrence of future events that cannot be determined. Accordingly, the Company's potential future liability under these agreements cannot be estimated and it has therefore not accrued for these potential future liabilities.


Note 5: Covered Bond Program

        In September 2006, WMB launched a €20 billion Covered Bond Program ("the Program") intended to diversify its investor base, lengthen the maturity profile of its liabilities and provide an additional source of stable funding. Under the Program, the Company may, from time to time, issue floating rate US dollar-denominated mortgage bonds secured principally by its portfolio of residential mortgage loans to a statutory trust not affiliated with the Company, which in turn will issue Euro-denominated covered bonds secured by the mortgage bonds.

        At June 30, 2008 and December 31, 2007, €6.00 billion in principal amount of Euro-denominated covered bonds with an average interest rate of 4.08% and $7.78 billion in principal amount of mortgage bonds, which are included in other borrowings on the Consolidated Statements of Financial Condition, have been issued and are outstanding. Mortgage bonds are floating rate instruments with the applicable interest rate payable on mortgage bonds tied to short-term interest rates. Euro-denominated covered bonds (and related mortgage bonds) issued on September 26, 2006, mature on each of September 27, 2011 and September 27, 2016, respectively; additional Euro-denominated covered bonds (and related mortgage bonds) issued on May 18, 2007, mature on May 19, 2014.

        At June 30, 2008, rating agencies required 13.4% over-collateralization with respect to assets comprising the cover pool. Over-collateralization requirements may change from time to time based on rating agency requirements, market conditions and composition of the cover pool.

        To be included in the cover pool, mortgage loans must satisfy eligibility criteria which are as follows: (a) no mortgage bond issuer event of default would occur as a result of including the mortgage loan in the cover pool; (b) current ratings on covered bonds would not be adversely affected as a result

11


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


of including the mortgage loan in the cover pool; (c) the mortgage loan does not have an outstanding principal balance greater than $3,000,000; and (d) the mortgage loan is approved for inclusion in the cover pool by the rating agencies. The foregoing eligibility criteria may change from time to time subject to approval by the rating agencies. The Company may add and remove mortgage loans from the cover pool that collateralizes mortgage bonds.

        At June 30, 2008, outstanding Euro-denominated covered bonds were rated AAA by each of Standard & Poor's and Fitch, and A2 by Moody's. Euro-denominated covered bonds were on "negative watch" by Moody's and Fitch. Mortgage bonds are not rated. Under current program covenants, due to the recent downgrades of Washington Mutual Bank's long-term rating by Moody's and Standard & Poor's, the Program may not issue additional covered bond series.

        There are no material contingent liabilities, guarantees, or reimbursement programs entered into between the Company, its affiliates and the issuing trusts established under the Program. The Company is obligated to reimburse the issuing trusts for certain fees and expenses (primarily rating agency fees and trustee service fees) associated with the issuance of covered bonds as such fees and expenses become due; however, these are not material.

        The statutory trusts formed in connection with the Program are not qualifying special purpose entities ("QSPEs") that meet all the conditions for non-consolidation in FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("Statement No. 140"). The statutory trusts are special purpose entities ("SPEs") (which also meet the definition of variable interest entities), for purposes of FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities ("FIN46(R)"), but do not qualify for consolidation in the Company's financial statements. Specifically, under the Program documentation, the Company's interests in the statutory trusts do not cause the Company to absorb the majority of expected losses or entitle it to receive the majority of residual returns, if any, upon the liquidation of the statutory trusts. The statutory trusts' variable interests, including the covered bonds they issued, and the swap and the guaranteed investment contracts into which they entered, collectively absorb the majority of expected losses. Finally, the Company does not control the exercise of decision-making over the statutory trusts and has no voting rights with respect to the statutory trusts.

        In addition, the Company created a separate account to guarantee payments to the statutory trusts SPEs. The separate account does not guarantee payments to an issuing trust. Rather, it constitutes an account to support payments under the mortgage bonds, which are direct obligations of the Company's principal banking subsidiary, WMB. Pre-funding arrangements for direct obligations of the Company or its subsidiaries would not affect consideration of the obligations by downstream holders of the obligations. The documentation for the Program does not entitle or obligate the Company to absorb potential gains or losses from the statutory trusts.

        The issuing trusts enter into swap arrangements which economically hedge the interest rate and currency risks borne by those trusts. Those risks result from the differences between cash inflows from the mortgage bonds held by the trust and cash outflows of the covered bonds issued by the trust. The Company does not satisfy the conditions to consolidate the trusts and therefore is not subject to accounting requirements under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities , ("Statement No. 133") with respect to those derivative instruments.

        The Company has no reporting or disclosure obligations under Statement No.133 regarding foreign currency hedges and FASB Statement No. 52, Foreign Currency Translation, with respect to foreign

12


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


exchange transactions. The Company is not the issuer of the Euro-denominated covered bonds; its obligations under the Program are denominated in US Dollars. In addition, it is the non-consolidated statutory trusts, rather than the Company, that are parties to the currency hedging arrangements related to the Program.

        At June 30, 2008 and December 31, 2007, loans totaling $9.74 billion and $9.09 billion were pledged to secure borrowings issued under the Program.


Note 6: Equity Issuance

        In April 2008, the Company sold $7.2 billion of equity securities to investment vehicles managed by TPG Capital ("TPG Investors") and to other qualified institutional buyers and institutional accredited investors ("Other Investors"), including many of the Company's largest institutional shareholders.

    Preferred Stock

        The Company issued 56,570 shares of preferred stock at a purchase price and liquidation preference of $100,000 per share. The preferred stock consisted of 19,928 shares of Series T Contingently Convertible Perpetual Non-cumulative Preferred Stock issued to TPG Investors and 36,642 shares of Series S Contingently Convertible Perpetual Non-cumulative Preferred Stock issued to Other Investors ("Series S and Series T Preferred Stock"). The conversion price of the Series S and Series T Preferred Stock was $8.75 per share. The recorded amount of the Series S and Series T Preferred Stock, based upon an allocation of the total proceeds, was $5.01 billion, net of issuance costs. All of the Series S and Series T Preferred Stock issued in April 2008 were converted into the Company's common stock on June 30, 2008. Prior to the conversion, the conversion prices of the Series S and Series T Preferred Stock were subject to anti-dilution adjustments.

    Common Stock

        The Company issued 176.3 million shares of its common stock, which included 822,857 shares issued to TPG Investors and 175.5 million shares issued to Other Investors, at $8.75 per share.

        With the receipt of certain approvals, including the approval of the Company's shareholders, the Series S and Series T Preferred Stock was automatically converted into the Company's common stock on June 30, 2008. With the conversion of the Series S and Series T Preferred Stock, TPG Investors received 227.7 million shares and Other Investors received 418.8 million shares of the Company's common stock.

        With limited exceptions, TPG Investors are restricted from disposing of the common stock acquired in this transaction. However, following the 18-month anniversary of the closing date of the transaction, TPG Investors may dispose of 1/18 th  of their securities each month. All restrictions are removed following the three-year anniversary of the closing date of the transaction. Restrictions on the dispositions of the common stock acquired by certain of the Other Investors are similar except they are allowed to dispose of 1/9 th  of the securities owned each month following the nine-month anniversary of the closing date of the transaction and all restrictions are removed following the 18-month anniversary of the closing date.

        Warrants to acquire 68.3 million shares of the Company's common stock were issued to investors, including TPG Investors and certain of the Other Investors, who agreed to the above described transfer

13


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


restrictions on their shares, with the warrants being subject to the same restrictions. In accordance with the terms of the warrants, with the receipt of certain approvals, all of which were obtained prior to the end of the second quarter, the warrants became exercisable. The exercise price of the warrants is $10.06 per share and is no longer subject to a $0.50 per share reduction following each six-month anniversary from the issuance date of the warrants. The warrants are exercisable at any time until the fifth anniversary of the issuance of the warrants. The exercise price of the warrants is subject to anti-dilution adjustments. In addition, if certain events that constitute a fundamental change in control of the Company occur, investors may be permitted to put the instrument to the Company at fair value. The fair value of the warrants is $434 million and was recorded in capital surplus – common stock on the Consolidated Statements of Financial Condition.

        If the Company engages in certain transactions, such as an issuance or sale of more than $500 million of common stock or other equity-linked securities (such as securities that are convertible into, exchangeable or exercisable for, or otherwise linked to the Company's common stock) or if there occurs a fundamental change in the ownership of the Company (such as a consolidation, merger, liquidation, or sale of all, or substantially all, the Company's assets) within 18 months from the closing date of the equity issuance, TPG Investors would, in the event that the effective price of a future transaction or fundamental change is less than $8.75 per share, receive from the Company either cash or shares of the Company's common stock and a reduction in the effective per share exercise price of any outstanding warrants (the "Price Protection Feature"). The Price Protection Feature also applies, with similar terms, to certain of the Other Investors who also agreed to the above described transfer restrictions on their shares, for those events which occur within 9 months of the closing date. Upon the occurrence of a triggering event, for each share of common stock subject to the Price Protection Feature (including those resulting from the exercise of warrants), investors would receive an amount equal to the difference between what the investor paid to acquire the stock and the effective per share price of the event that triggered the Price Protection Feature. In addition, the per share exercise price of any outstanding warrants would be reduced to the same effective per share price of the triggering event. The Price Protection Feature is recognized as a derivative and is recorded in other liabilities on the Consolidated Statements of Financial Condition with changes in fair value recognized in earnings.

    Issuance Costs

        The Company incurred $255 million in transaction-related costs that are recorded in capital surplus – common stock as a reduction of the proceeds from the equity issuance.

14


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


Note 7: Earnings Per Common Share

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

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2008   2007   2008   2007  
 
  (dollars in millions, except per share amounts; shares in thousands)
 

Net income (loss)

  $ (3,328 ) $ 830   $ (4,466 ) $ 1,614  

Preferred dividends declared:

                         
 

Series K

    (5 )   (8 )   (13 )   (15 )
 

Series R

    (60 )       (117 )    
 

Series S and Series T

    (6 )       (6 )    

Beneficial conversion feature

    (3,290 )       (3,290 )    
                   

Net income (loss) applicable to common stockholders for basic EPS

    (6,689 )   822     (7,892 )   1,599  

Effect of dilutive securities

                (1 )
                   

Net income (loss) applicable to common stockholders for diluted EPS

  $ (6,689 ) $ 822   $ (7,892 ) $ 1,598  
                   

Basic weighted average number of common shares outstanding

    1,016,081     868,968     936,502     871,876  

Dilutive effect of potential common shares from:

                         
 

Awards granted under equity incentive programs

        12,946         13,026  
 

Common stock warrants

        9,999         10,225  
 

Convertible debt

        1,177         1,177  
                   

Diluted weighted average number of common shares outstanding

    1,016,081     893,090     936,502     896,304  
                   

Earnings per common share:

                         
 

Basic

  $ (6.58 ) $ 0.95   $ (8.43 ) $ 1.83  
 

Diluted

    (6.58 )   0.92     (8.43 )   1.78  

        The Company accounted for a contingent beneficial conversion feature ("BCF") related to the conversion option in the Series S and Series T 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 , during the second quarter of 2008. The BCF was measured based on its intrinsic value at the commitment date, April 7, 2008. The intrinsic value of the BCF was based on the difference between the fair value of the Company's common stock and the effective conversion price per common share. The BCF was recognized as a one-time deemed preferred dividend in the second quarter of 2008 upon shareholder approval of the conversion. The BCF is a non-cash item that did not affect the Company's net loss but did have the effect of reducing earnings per common share as a subtraction from net loss applicable to common stockholders. The BCF was accounted for as a $3.29 billion reduction in retained earnings and a corresponding increase in capital surplus-common stock.

15


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        During the second quarter of 2008, dividends on the Series S and Series T Preferred Stock were payable, on a non-cumulative basis, in cash, on an as-converted basis. Dividends were payable at the same rate that dividends were payable to holders of shares of the Company's common stock. Due to this dividend feature, the Series S and Series T Preferred Stock, for purposes of calculating earnings per share, were considered to be participating securities and received application of the two-class method in accordance with FASB Statement No. 128, Earnings Per Share . During this period, holders of the Series S and Series T Preferred Stock received a $6 million dividend distribution which was subtracted from net loss applicable to common stockholders as a preferred dividend. Application of the two-class method had no impact on earnings per share in the second quarter.

        Options under the equity incentive programs to purchase an additional 55.6 million and 19.1 million shares of common stock were outstanding at June 30, 2008 and 2007, and were not included in the above computations of diluted earnings per share because their inclusion would have had an antidilutive effect. Also outstanding at June 30, 2008 and excluded from the above computations of diluted earnings per share because of their antidilutive effect were 141.2 million shares of potential common stock related to Series R Non-cumulative Perpetual Convertible Preferred Stock, warrants to acquire an additional 68.3 million shares of common stock that were issued to TPG Investors and certain of the Other Investors, warrants to acquire an additional 29.2 million shares of common stock that were issued to holders of Trust Preferred Income Equity Redeemable Securities SM and 18.6 million shares of potential common stock related to restricted stock and restricted stock units granted under equity incentive programs.

        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. At June 30, 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.

        Additionally, if an event were to occur which triggered the provisions of the Price Protection Feature, the Company would have a choice of settlement either with cash or (subject to certain restrictions) through the issuance of additional shares of common stock. At June 30, 2008, none of the events or conditions that would trigger a settlement of the Price Protection Feature had occurred and therefore there was no impact to the above computations of earnings per share.


Note 8: 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

16


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

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.

        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 June 30,  
 
  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   $   $ 17   $ 2   $  

Service cost

    20     1         24     1      

Expected return on plan assets

    (43 )           (36 )        

Amortization of prior service cost

    4             (3 )        

Recognized net actuarial loss

                1          
                           
 

Net periodic benefit cost

  $ 6   $ 3   $   $ 3   $ 3   $  
                           

 

 
  Six Months Ended June 30,  
 
  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

  $ 51   $ 4   $ 1   $ 42   $ 4   $ 1  

Service cost

    39     2         47     1      

Expected return on plan assets

    (86 )           (71 )        

Amortization of prior service cost

    7                      

Recognized net actuarial loss

                5     1      
                           
 

Net periodic benefit cost

  $ 11   $ 6   $ 1   $ 23   $ 6   $ 1  
                           

17


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


Note 9: 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 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.

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WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

    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 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 and finance charges and fees 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

19


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


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 held for sale 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 assumptions used in the valuation of MSR include market interest rates, projected prepayment speeds, cost of service, ancillary income and option adjusted spreads. 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.

        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, forward commitments to purchase or sell mortgage-backed securities, options and foreign currency swaps, 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

20


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


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.

        In connection with the April 2008 equity issuance, the agreements provided a Price Protection Feature to certain investors. The Price Protection Feature is accounted for by the Company as a derivative liability. The fair value of the Price Protection Feature derivative is estimated using a valuation method based on the Black-Scholes option pricing formula and taking into account contractual features and management assumptions. As the fair value estimation includes significant unobservable inputs, the Price Protection Feature derivative is classified as Level 3.

    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 June 30, 2008:

 
  Total   Level 1   Level 2   Level 3  
 
  (in millions)
 

Assets:

                         
 

Trading assets

  $ 2,308   $   $ 424   $ 1,884  
 

Available-for-sale securities

    24,375     124     22,429     1,822  
 

Loans held for sale (1)

    1,005         1,005      
 

Mortgage servicing rights

    6,175             6,175  
 

Derivatives, included in other assets

    1,809         1,799     10  
                   
   

Total

  $ 35,672   $ 124   $ 25,657   $ 9,891  
                   
   

As a percentage of total assets

    11 %   %   8 %   3 %

Liabilities:

                         
 

Derivatives, included in other liabilities

  $ 893   $   $ 822   $ 71  
 

Other liabilities (2)

    62     62          
                   
   

Total

  $ 955   $ 62   $ 822   $ 71  
                   

(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.

21


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 and six months ended June 30, 2008:

 
  Three Months Ended
June 30, 2008
  Six Months Ended
June 30, 2008
 
 
  Trading
Assets
  Available-for-
sale
Securities
  Derivatives (3)   Trading
Assets
  Available-for-
sale
Securities
  Derivatives (3)  
 
  (in millions)
 

Fair value, beginning of period

  $ 2,244   $ 1,727   $ 42   $ 2,413   $ 2,749   $ 15  

Total gains or (losses) (realized/unrealized):

                                     
   

Included in earnings

    (158 )   (395 )   (58 )   (134 )   (448 )   7  
   

Included in other comprehensive income (loss)

        281             (156 )    

Purchases, issuances and settlements

    (230 )   (95 )   (45 )   (426 )   (154 )   (83 )

Net transfers into or out of Level 3 (1)

    28     304         31     (169 )    
                           

Fair value, end of period

  $ 1,884   $ 1,822   $ (61 ) $ 1,884   $ 1,822   $ (61 )
                           

Net unrealized gains (losses) still held (2)

  $ (158 ) $ (397 ) $ (48 ) $ (136 ) $ (450 ) $ (48 )
                           

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 period are reported at their fair values on the last day of the same period.
(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 June 30, 2008.
(3)
Level 3 derivative assets and liabilities have been netted on these tables for presentation purposes only.

22


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        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 and six months ended June 30, 2008:

 
  Three Months Ended
June 30, 2008
  Six Months Ended
June 30, 2008
 
 
  Trading
Assets
  Available-for-
sale
Securities
  Derivatives (1)   Trading
Assets
  Available-for-
sale
Securities
  Derivatives (1)  
 
  (in millions)
 

Interest income – available-for-sale securities

  $   $ 11   $   $   $ 24   $  

Interest income – trading assets

    112             216          

Revenue from sales and servicing of home mortgage loans

            (2 )           60  

Revenue from sales and servicing of consumer loans

    12             121          

Loss on other available-for-sale securities

        (406 )           (472 )    

Loss on trading assets

    (282 )           (471 )        

Other income

            (56 )           (53 )
                           
 

Total

  $ (158 ) $ (395 ) $ (58 ) $ (134 ) $ (448 ) $ 7  
                           

Note: For gains and losses due to changes in fair value of MSR, see Note 3 to the Consolidated Financial Statement – "Mortgage Banking Activities."

(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.

        Loans held for sale included loans which were adjusted to fair value using Level 2 and Level 3 inputs within the fair value hierarchy. These loans had an aggregate cost of $687 million and $41 million and a fair value of $685 million and $37 million at June 30, 2008 and March 31, 2008. The losses of $2 million and $6 million were included in earnings within the revenue from sales and servicing of home mortgage loans classification for the three and six months ended June 30, 2008.

23


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        The following table summarizes loans transferred from loans held for sale to loans held in portfolio, including losses for the three and six months ended June 30, 2008:

 
  Three Months Ended
June 30, 2008
  Six Months Ended
June 30, 2008
 
 
  Aggregate Cost   Fair Value   Loss   Aggregate Cost   Fair Value   Loss  
 
  (in millions)
 

Commercial loans transferred to loans held in portfolio (1)

  $   $   $   $ 145   $ 143   $ (2 )

Home loans transferred to loans held in portfolio (2)

    21     17     (4 )   68     55     (13 )
                           
   

Total

  $ 21   $ 17   $ (4 ) $ 213   $ 198   $ (15 )
                           

(1)
Loans were adjusted to the lower of cost or fair value using Level 2 inputs with losses included within other noninterest income.
(2)
Loans were adjusted to the lower of cost or fair value using Level 3 inputs with losses 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 half 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 10: 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

24


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


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.

        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 interchange, performance fees (late, overlimit and returned check charges) and cash advance and balance transfer fees.

        In response to tightening secondary markets, the Company has substantially ceased credit card securitizations, resulting in on-balance sheet funding of new originations.

        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 and home equity loans and lines of credit; (2) managing the Company's capital markets operations, which includes the selling of all types of real estate secured loans in the secondary market, which in light of continuing illiquid market conditions, are substantially limited to conforming loans sold to government-sponsored enterprises; and (3) 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, of which all lending activities were discontinued in the fourth quarter of 2007.

        In conjunction with the resizing of the home loans business, the Company has decided to eliminate negatively amortizing products including the Option ARM from the product line, 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

25


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)


transferred through inter-segment sales to the Retail Banking Group. Beginning in the second half of 2007, loans that historically had been transferred to the held for investment portfolio within the Retail Banking Group were retained within the held for investment portfolio within the Home Loans 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 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 restructuring activities;

    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.

26


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

        Financial highlights by operating segment were as follows:

 
  Three Months Ended June 30, 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

  $ 1,210   $ 769   $ 203   $ 240   $ 254   $ (506 ) $ 126 (3) $ 2,296  
 

Provision for loan losses

    3,823     911     17     1,637     55     (530 )       5,913  
 

Noninterest income

    842     187     5     (97 )   (327 )   (24 )   (25 ) (4)   561  
 

Inter-segment revenue (expense)

    7     (5 )       (2 )                
 

Noninterest expense

    1,232     297     63     484     327             2,403  
 

Minority interest expense

                    75             75  
                                   
 

Income (loss) before income taxes

    (2,996 )   (257 )   128     (1,980 )   (530 )       101     (5,534 )
 

Income taxes

    (959 )   (82 )   41     (635 )   (247 )       (324 ) (5)   (2,206 )
                                   
 

Net income (loss)

  $ (2,037 ) $ (175 ) $ 87   $ (1,345 ) $ (283 ) $   $ 425   $ (3,328 )
                                   

Performance and other data:

                                                 
 

Average loans

  $ 138,671   $ 26,314   $ 41,891   $ 54,880   $ 1,648   $ (16,872 ) $ (1,123 ) (6) $ 245,409  
 

Average assets

    145,800     28,844     43,875     65,074     47,151     (14,739 )   (1,123 ) (6)   314,882  
 

Average deposits

    149,509     n/a     6,632     5,202     23,267     n/a     n/a     184,610  

(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 difference between the tax amounts recorded by the segments and the amount recognized in the Company's Consolidated Statements of Income.
(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.

27


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

 
  Three Months Ended June 30, 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)

  $ 1,291   $ 649   $ 208   $ 211   $ (4 ) $ (459 ) $ 138 (3) $ 2,034  
 

Provision for loan losses

    91     523     2     101     (51 )   (294 )       372  
 

Noninterest income

    820     393     63     389     60     165     (132 ) (4)   1,758  
 

Inter-segment revenue (expense)

    16             (16 )                
 

Noninterest expense

    1,131     306     74     547     80             2,138  
 

Minority interest expense

                    42             42  
                                   
 

Income (loss) before income taxes

    905     213     195     (64 )   (15 )       6     1,240  
 

Income taxes

    340     80     73     (24 )   (37 )       (22 ) (5)   410  
                                   
 

Net income (loss)

  $ 565   $ 133   $ 122   $ (40 ) $ 22   $   $ 28   $ 830  
                                   

Performance and other data:

                                                 
 

Average loans

  $ 149,716   $ 24,234   $ 38,789   $ 43,312   $ 1,367   $ (13,888 ) $ (1,301 ) (6) $ 242,229  
 

Average assets

    159,515     26,762     41,184     60,342     41,789     (12,287 )   (1,301 ) (6)   316,004  
 

Average deposits

    145,252     n/a     15,294     8,372     37,847     n/a     n/a     206,765  

(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 difference between the tax amounts recorded by the segments and the amount recognized in the Company's Consolidated Statements of Income.
(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.

28


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

 
  Six Months Ended June 30, 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

  $ 2,413   $ 1,534   $ 400   $ 490   $ 386   $ (1,010 ) $ 258 (3) $ 4,471  
 

Provision for loan losses

    6,122     1,537     47     2,544     173     (1,000 )       9,423  
 

Noninterest income

    1,617     604     (3 )   221     (241 )   10     (79 ) (4)   2,129  
 

Inter-segment revenue (expense)

    15     (9 )       (6 )                
 

Noninterest expense

    2,453     557     131     983     431             4,555  
 

Minority interest expense

                    151             151  
                                   
 

Income (loss) before income taxes

    (4,530 )   35     219     (2,822 )   (610 )       179     (7,529 )
 

Income taxes

    (1,450 )   11     70     (904 )   (316 )       (474 ) (5)   (3,063 )
                                   
 

Net income (loss)

  $ (3,080 ) $ 24   $ 149   $ (1,918 ) $ (294 ) $   $ 653   $ (4,466 )
                                   

Performance and other data:

                                                 
 

Average loans

  $ 140,695   $ 26,601   $ 41,413   $ 55,275   $ 1,602   $ (17,131 ) $ (1,171 ) (6) $ 247,284  
 

Average assets

    148,704     29,044     43,439     65,958     46,338     (14,907 )   (1,171 ) (6)   317,405  
 

Average deposits

    148,122     n/a     7,053     5,335     23,947     n/a     n/a     184,457  

(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 difference between the tax amounts recorded by the segments and the amount recognized in the Company's Consolidated Statements of Income.
(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.

29


WASHINGTON MUTUAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(UNAUDITED)

 
  Six Months Ended June 30, 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)

  $ 2,575   $ 1,290   $ 420   $ 455   $ (26 ) $ (874 ) $ 275 (3) $ 4,115  
 

Provision for loan losses

    153     912     (7 )   150     (25 )   (577 )       606  
 

Noninterest income

    1,571     867     78     550     154     297     (218 ) (4)   3,299  
 

Inter-segment revenue (expense)

    34             (34 )                
 

Noninterest expense

    2,201     635     148     1,069     191             4,244  
 

Minority interest expense

                    85             85  
                                   
 

Income (loss) before income taxes

    1,826     610     357     (248 )   (123 )       57     2,479  
 

Income taxes

    685     229     134     (93 )   (106 )       16 (5)   865  
                                   
 

Net income (loss)

  $ 1,141   $ 381   $ 223   $ (155 ) $ (17 ) $   $ 41   $ 1,614  
                                   

Performance and other data:

                                                 
 

Average loans

  $ 152,445   $ 23,921   $ 38,715   $ 48,255   $ 1,356   $ (13,201 ) $ (1,389 ) (6) $ 250,102  
 

Average assets

    162,264     26,403     41,094     65,831     41,335     (11,627 )   (1,389 ) (6)   323,911  
 

Average deposits

    144,644     n/a     13,671     8,436     42,002     n/a     n/a     208,753  

(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 difference between the tax amounts recorded by the segments and the amount recognized in the Company's Consolidated Statements of Income.
(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.

30


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/A:

    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;

31


    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 second 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/A, "Management's Report on Internal Control Over Financial Reporting."

32


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 June 30, 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/A 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.

33


        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 June 30, 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 $9.89 billion at June 30, 2008 and represented approximately 28% of total assets measured at fair value on a recurring basis and approximately 3% of the Company's total assets.

        See Note 9 to the Consolidated Financial Statements – "Fair Value" for a further description of the valuation methodologies used for assets and liabilities measured at fair value.

    Fair Value of Reporting Units and Goodwill Impairment

        Under FASB Statement No. 142, Goodwill and Other Intangible Assets , goodwill must be allocated to reporting units and tested for impairment. The Company tests goodwill for impairment at least annually or more frequently if events or circumstances, such as adverse changes in the business, indicate that there may be justification for conducting an interim test. Impairment testing is performed at the reporting unit level, which is the same level as the Company's four operating segments identified in Note 10 to the Consolidated Financial Statements – "Operating Segments." The Company's goodwill totaled $7.28 billion as of June 30, 2008, and is recorded in three of its operating segments: the Retail Banking Group, the Card Services Group and the Commercial Group. The first part of the test is a comparison, at the reporting unit level, of the fair value of each reporting unit to its carrying value, including goodwill. If the fair value is less than the carrying value, then the second part of the test is needed to measure the amount of potential goodwill impairment. The implied fair value of the reporting unit goodwill is calculated and compared with the actual carrying value of goodwill recorded

34


within the reporting unit. If the carrying value of reporting unit goodwill exceeds the implied fair value of that goodwill, then the Company would recognize an impairment loss for the amount of the difference, which would be recorded as a charge against net income.

        The estimation of fair value for each reporting unit is determined primarily through a discounted cash flow approach that considers the market environment and the Company's expectations about future conditions. Estimated fair value computed under this approach contemplates cash flow projections based on the internal business forecasts for each reporting unit, and appropriate discount rates. Estimation of fair value involves significant management judgment about future conditions that are inherently uncertain, including the results of operations and the extent and timing of credit losses. In addition, analysis using market-based trading and transaction multiples, where available, is used to assess the reasonableness of the valuations derived from the discounted cash flow models.

        In the second quarter, the Company considered the continuing adverse conditions within the market environment and the Company's best estimates regarding future conditions including credit losses, and concluded that there was no goodwill impairment within its reporting units with recorded goodwill as of June 30, 2008. A continuing period of market disruption, the Company's diminished trading value and market capitalization, or further market deterioration are factors the Company will continue to consider in future evaluations of recorded goodwill for impairment, including particularly its annual evaluation to be conducted in the third quarter of 2008 and subsequent evaluations.

        For additional information regarding the carrying values of goodwill by operating segment, see Note 9 to the Consolidated Financial Statements – "Goodwill and Other Intangible Assets" in the Company's 2007 Annual Report on Form 10-K/A.

Overview

        The Company recorded a net loss in the second quarter of 2008 of $3.33 billion, compared with net income of $830 million in the second quarter of 2007, primarily due to the Company's significant increase in loan reserves by $3.74 billion to $8.46 billion. Diluted loss per share was $6.58 for the quarter ended June 30, 2008. Diluted loss per share in the second quarter was negatively impacted by a one-time, non-cash adjustment of $(3.24) per share related to the conversion in June 2008 of Series S and Series T convertible preferred stock issued in April 2008 in connection with the Company's $7.2 billion capital raise. This non-cash adjustment had no effect on the Company's capital ratios or the net loss recorded in the second quarter, but had the effect of reducing retained earnings by $3.29 billion and increasing capital surplus-common stock by a corresponding amount. Excluding this one-time adjustment, diluted loss per share in the second quarter was $3.34 per share, compared with diluted earnings per share of $0.92 in the second quarter of 2007. The conversion option in the Series S and Series T Preferred Stock created a beneficial conversion feature as defined within generally accepted accounting principles and is described in further detail in Note 7 to the Consolidated Financial Statements — "Earnings Per Common Share."

        The Company recorded a provision for loan losses of $5.91 billion in the second quarter of 2008, an increase of $5.54 billion from the second quarter of 2007 and significantly higher than second quarter 2008 net charge-offs, which totaled $2.17 billion. Net charge-offs in the second quarter of 2007 were $271 million. Adverse trends in key credit risk indicators, including high inventory levels of unsold homes, rising foreclosure rates, the significant contraction in the availability of credit for nonconforming mortgage products and negative job growth trends exerted severe pressure on the performance of the single-family residential ("SFR") loan portfolio, particularly loans in geographic areas in which the Company's lending activities have been concentrated in recent years. Nationwide sales volume of existing homes in June 2008 was 15% lower than June 2007, leading to a supply of unsold homes of approximately 11.1 months, a 22% increase from June 2007, while the national median sales price for existing homes fell by 6% between those periods. Since July 2006, average home

35



prices declined 19%, as measured by the S&P Case-Shiller 10-City Composite Home Price Index, or 22% when this index is weighted to reflect the geographic distribution of the Company's SFR portfolio. Foreclosure filings were also up significantly, increasing by 121% from the second quarter of 2007 to the second quarter of 2008.

        The deteriorating housing market conditions resulted in sharply higher delinquency rates and restructurings of troubled loans, as the Company has intensified its efforts to work with borrowers to keep them in their homes whenever it can do so. The ratio of nonperforming assets to total assets rose to 3.62% at June 30, 2008, compared with 1.29% at June 30, 2007. Restructured nonaccrual loans accounted for 0.46% of the nonperforming assets to total assets ratio at June 30, 2008, compared with 0.05% of the ratio at June 30, 2007. Cure rates on early stage delinquencies, representing loans that are up to three payments past due, have also deteriorated, 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.

        Deteriorating trends in delinquency rates began migrating across the different types of loans in the Company's SFR portfolio starting in 2007. Rising levels of delinquencies initially occurred within the subprime mortgage channel during the first half of 2007, followed by the appearance of higher delinquencies in home equity loans and lines of credit during the second half of 2007. During the first half of 2008, Option ARMs have been the product type exhibiting the greatest increase in delinquency rates. The increases in Option ARM delinquencies are generally concentrated in geographic markets that have experienced the most significant levels of housing price depreciation, particularly in the inland regions of California and the Southeastern section of the country. While Option ARM loans that have experienced negative amortization are subject to payment recasting events, the presence of this feature has not been a significant contributor to the increase in delinquency rates, as the majority of recasts are not contractually scheduled to occur until 2010 and later years.

        In addition to higher delinquency levels within its SFR loan portfolio, the Company also began experiencing deteriorating trends in loan loss severities starting in 2007, which continued to increase in the second quarter of 2008, 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 0.39% in the second quarter of 2007 to 4.21% in the second quarter of 2008.

        In response to these deteriorating trends in housing market conditions, delinquencies and loss severities, the Company has continued in 2008 to update its loan loss provisioning assumptions for its SFR portfolio, changing key assumptions used to evaluate default frequencies and loss severities, to reflect these trends. These updated assumptions accounted for approximately one-third of the provision recorded in the second quarter of 2008 and approximately $1.2 billion of the provision recorded in the first quarter of 2008. Refer to Credit Risk Management – "Allowance for Loan Losses" section for further discussion of these changes and a general discussion of the Allowance for Loan Losses.

        The Company also experienced declines in the credit performance of its credit card portfolio during the first half of 2008, reflecting a softening U.S. economy and increased national unemployment, the macroeconomic factors that generally have the greatest impact on consumer spending and credit card performance. Annualized net credit card charge-offs as a percentage of the average balance of the credit card portfolio were 6.51% in the second quarter of 2008 and 3.63% in the second quarter of 2007. The national unemployment rate increased to 5.5% in June 2008 from 4.6% in June 2007, while the U.S. economy lost approximately 191,000 net jobs during the second quarter of 2008, compared with net job growth of 315,000 in the second quarter of 2007.

        With the elevated levels of loan loss provisioning and charge-offs in its loan portfolios, the Company took steps to bolster its capital and liquidity positions during the second quarter. In April 2008, the Company issued approximately $7.2 billion of equity, comprised of common stock; perpetual, non-cumulative convertible preferred stock that was subsequently converted into common shares on

36


June 30, 2008 after receiving approval of the conversion from the Company's shareholders; and warrants. The Company took further steps to enhance its capital position by reducing both its quarterly common stock dividend to $0.01 per share, and the size of its balance sheet by $18 billion since the beginning of 2008. The Company expects that 2008 will be the peak year for loan loss provisioning.

        At June 30, 2008, the Company's Tier 1 capital to average total assets ratio was 7.76%, and its total risk-based capital to total risk-weighted assets ratio was 13.93%, exceeding the regulatory guidelines for well-capitalized institutions, and the tangible equity to total tangible assets ratio was 7.79%, above the Company's established target of 5.50%.

        Net interest income was $2.30 billion in the second quarter of 2008, compared with $2.03 billion in the second quarter of 2007. The increase was due to the expansion of the net interest margin, which increased, on a taxable-equivalent basis, from 2.91% in the second quarter of 2007 to 3.22% in the second quarter of 2008. As the Company's short-term wholesale borrowing costs reprice to current market rates faster than most of its interest-earning assets, the margin was aided by lower short-term interest rates, reflecting the actions taken by the Federal Reserve to stimulate the economy in light of the deteriorating housing market and higher unemployment rates. Since June 30, 2007, the target Federal Funds rate declined from 5.25% to 2.00%.

        Noninterest income totaled $561 million in the second quarter of 2008, compared with $1.76 billion in the same quarter of 2007. Results from the sales and servicing of home mortgage loans declined from net revenue of $300 million in the second quarter of 2007 to net expense of $109 million in the second quarter of 2008. Continuing illiquidity in the secondary market for nonconforming loans, along with the Company's decisions to discontinue all lending through the subprime mortgage channel in the fourth quarter of 2007 and the wholesale mortgage channel in April 2008 led to significantly lower mortgage production activity. Additionally, the provision for loan repurchases rose significantly, primarily reflecting an increase in the volume of investor requests to repurchase loans the Company had previously sold. Revenue from the sales and servicing of consumer loans declined from $403 million in the second quarter of 2007 to $159 million in the second quarter of 2008 as the absence of securitization sales activity from the continued illiquid secondary market for unsecured loan products decreased the amount of gain on sale and higher net credit losses on securitized loans lowered excess servicing income. The Company also recorded a $407 million loss through earnings from the write-down of certain mortgage-backed securities within the available-for-sale securities portfolio, reflecting credit deterioration in which the declines in value were determined to represent an other-than-temporary impairment condition.

        Noninterest expense totaled $2.40 billion in the second quarter of 2008, compared with $2.14 billion in the second quarter of 2007. With high volumes of delinquent loans migrating to foreclosure status and the steep declines in home prices, foreclosed asset expense increased from $56 million in the second quarter of 2007 to $217 million in the second quarter of 2008. Foreclosure expenses are expected to remain elevated until housing market conditions stabilize. In addition to the actions taken in the fourth quarter of 2007 to resize the home loans business and corporate and other functions, the Company initiated additional measures in the second quarter of 2008 to significantly reduce expenses, primarily within the home loans business and corporate support functions. The Company expects to incur approximately $450 million of restructuring and resizing costs related to these measures, of which $207 million were recorded in the second quarter, and anticipates that annualized expense savings of approximately $1 billion will be realized upon the completion of these initiatives.

Recently Issued Accounting Standards Not Yet Adopted

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

37


Summary Financial Data

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2008   2007   2008   2007  
 
  (dollars in millions, except per share amounts)
 

Profitability

                         
 

Net interest income

  $ 2,296   $ 2,034   $ 4,471   $ 4,115  
 

Net interest margin on a taxable-equivalent basis (1)

    3.22 %   2.91 %   3.14 %   2.85 %
 

Noninterest income

  $ 561   $ 1,758   $ 2,129   $ 3,299  
 

Noninterest expense

    2,403     2,138     4,555     4,244  
 

Net income (loss)

    (3,328 )   830     (4,466 )   1,614  
 

Basic earnings per common share

  $ (6.58 ) $ 0.95   $ (8.43 ) $ 1.83  
 

Diluted earnings per common share:

                         
   

Diluted earnings per common share

    (6.58 )   0.92     (8.43 )   1.78  
   

Less: Effect of conversion feature (2)

    (3.24 )       (3.51 )    
                   
     

Diluted earnings per common share excluding effect of conversion feature

    (3.34 )   0.92     (4.92 )   1.78  
 

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

    1,016,081     868,968     936,502     871,876  
 

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

    1,016,081     893,090     936,502     896,304  
 

Dividends declared per common share

  $ 0.01   $ 0.55   $ 0.16   $ 1.09  
 

Return on average assets

    (4.23 )%   1.05 %   (2.81 )%   1.00 %
 

Return on average common equity

    (69.25 )   13.74     (45.67 )   13.36  
 

Efficiency ratio (3)

    84.11     56.38     69.01     57.24  

Asset Quality (at period end)

                         
 

Nonaccrual loans (4)

  $ 9,691   $ 3,275   $ 9,691   $ 3,275  
 

Foreclosed assets

    1,512     750     1,512     750  
                   
   

Total nonperforming assets (4)

    11,203     4,025     11,203     4,025  
 

Nonperforming assets (4) to total assets

    3.62 %   1.29 %   3.62 %   1.29 %
 

Allowance for loan losses

  $ 8,456   $ 1,560   $ 8,456   $ 1,560  
 

Allowance as a percentage of loans held in portfolio

    3.53 %   0.73 %   3.53 %   0.73 %

Credit Performance

                         
 

Provision for loan losses

  $ 5,913   $ 372   $ 9,423   $ 606  
 

Net charge-offs

    2,171     271     3,538     454  

Capital Adequacy (at period end)

                         
 

Stockholders' equity to total assets

    8.42 %   7.75 %   8.42 %   7.75 %
 

Tangible equity to total tangible assets (5)

    7.79     6.07     7.79     6.07  
 

Tier 1 capital to average total assets (leverage) (6)

    7.76     6.09     7.76     6.09  
 

Total risk-based capital to total risk-weighted assets (6)

    13.93     11.04     13.93     11.04  

Per Common Share Data

                         
 

Book value per common share (at period end) (7)

  $ 13.35   $ 27.27   $ 13.35   $ 27.27  
 

Tangible book value per common share (at period end) (8)

    9.01     16.59     9.01     16.59  
 

Market prices:

                         
   

High

    13.90     44.66     21.92     46.02  
   

Low

    4.65     38.76     4.65     38.73  
   

Period end

    4.93     42.64     4.93     42.64  

Supplemental Data

                         
 

Total home loan volume

    8,494     31,035     21,980     61,239  
 

Total loan volume

    12,969     46,118     30,958     88,253  

(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)
This one-time earnings per share reduction represents a beneficial conversion feature that was recorded upon the June 2008 conversion of the preferred shares issued in connection with the April 2008 capital transaction. This non-cash adjustment, which had no effect on the Company's capital ratios or the net loss recorded in the second quarter, was provided to facilitate the comparison of earnings per share to the prior reporting periods presented on this schedule.
(3)
The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).
(4)
Excludes nonaccrual loans held for sale.
(5)
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 $2.94 billion for June 30, 2008 and June 30, 2007 are included in the numerator.
(6)
The capital ratios are estimated as if Washington Mutual, Inc. were a bank holding company subject to Federal Reserve Board capital requirements.
(7)
Excludes six million shares held in escrow.
(8)
Excludes goodwill and intangible assets (except MSR).

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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 June 30,  
 
  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

  $ 2,161     2.15 % $ 11   $ 3,964     5.39 % $ 53  
 

Trading assets

    2,404     19.50     117     4,995     8.67     108  
 

Available-for-sale securities (3) :

                                     
   

Mortgage-backed securities

    19,190     5.67     271     19,177     5.39     259  
   

Investment securities

    5,287     5.06     67     7,382     5.15     95  
 

Loans held for sale

    3,672     5.62     52     26,225     6.43     421  
 

Loans held in portfolio (4) :

                                     
   

Loans secured by real estate:

                                     
     

Home loans (5)(6)

    107,299     5.83     1,563     90,818     6.44     1,462  
     

Home equity loans and lines of credit (6)

    60,964     5.12     777     54,431     7.59     1,031  
     

Subprime mortgage channel (7)

    16,933     6.05     256     20,152     6.80     343  
     

Home construction (8)

    1,973     7.41     37     2,043     6.72     34  
     

Multi-family

    32,786     6.13     502     29,419     6.65     488  
     

Other real estate

    10,205     6.26     159     6,843     7.03     120  
                               
       

Total loans secured by real estate

    230,160     5.73     3,294     203,706     6.84     3,478  
   

Consumer:

                                     
     

Credit card

    9,443     11.56     271     10,101     10.44     263  
     

Other

    180     16.85     8     254     12.44     8  
   

Commercial

    1,954     6.76     33     1,943     7.73     38  
                               
       

Total loans held in portfolio

    241,737     5.98     3,606     216,004     7.02     3,787  
 

Other

    11,052     3.01     83     2,089     5.47     29  
                               
       

Total interest-earning assets

    285,503     5.90     4,207     279,836     6.80     4,752  

Noninterest-earning assets:

                                     
 

Mortgage servicing rights

    6,115                 6,782              
 

Goodwill

    7,283                 9,054              
 

Other assets

    15,981                 20,332              
                                   
       

Total assets

  $ 314,882               $ 316,004              
                                   

(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 $77 million and $157 million for the three months ended June 30, 2008 and 2007.
(5)
Capitalized interest recognized in earnings that resulted from negative amortization within the Option ARM portfolio totaled $255 million and $344 million for the three months ended June 30, 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.

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(Continued from the previous page.)

 
  Three Months Ended June 30,  
 
  2008   2007  
 
  Average
Balance
  Rate   Interest
Income
  Average
Balance
  Rate   Interest
Income
 
 
  (dollars in millions)
 

Liabilities

                                     

Interest-bearing liabilities:

                                     
 

Deposits:

                                     
   

Interest-bearing checking deposits

  $ 22,619     1.39 % $ 78   $ 30,373     2.51 % $ 190  
   

Savings and money market deposits

    62,078     2.17     335     58,969     3.33     490  
   

Time deposits

    69,161     4.08     702     84,330     4.96     1,043  
                               
     

Total interest-bearing deposits

    153,858     2.91     1,115     173,672     3.98     1,723  
 

Federal funds purchased and commercial paper

    79     3.05     1     2,169     5.36     29  
 

Securities sold under agreements to repurchase

    406     2.20     2     8,416     5.35     112  
 

Advances from Federal Home Loan Banks

    60,402     3.36     505     22,063     5.36     295  
 

Other

    30,839     3.69     283     39,886     5.57     555  
                               
     

Total interest-bearing liabilities

    245,584     3.12     1,906     246,206     4.42     2,714  
                                   

Noninterest-bearing sources:

                                     
 

Noninterest-bearing deposits

    30,752                 33,093              
 

Other liabilities

    7,075                 9,610              
 

Minority interests

    3,913                 2,659              
 

Stockholders' equity

    27,558                 24,436              
                                   
     

Total liabilities and stockholders' equity

  $ 314,882               $ 316,004              
                                   

Net interest spread and net interest income on a taxable-equivalent basis

          2.78   $ 2,301           2.38   $ 2,038  
                                   

Impact of noninterest-bearing sources

          0.44                 0.53        

Net interest margin on a taxable-equivalent basis

          3.22                 2.91        

40


 
  Six Months Ended June 30,  
 
  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

  $ 2,139     2.81 % $ 30   $ 3,947     5.39 % $ 105  
 

Trading assets

    2,565     18.22     233     5,293     8.37     221  
 

Available-for-sale securities (3) :

                                     
   

Mortgage-backed securities

    19,068     5.74     546     18,821     5.44     511  
   

Investment securities

    5,802     5.24     152     6,785     5.18     176  
 

Loans held for sale

    4,323     6.40     138     30,810     6.40     984  
 

Loans held in portfolio (4) :

                                     
   

Loans secured by real estate:

                                     
     

Home loans (5)(6)

    108,536     6.05     3,283     94,074     6.45     3,033  
     

Home equity loans and lines of credit (6)

    61,080     5.70     1,733     53,726     7.57     2,020  
     

Subprime mortgage channel (7)

    17,519     6.19     543     20,381     6.74     686  
     

Home construction (8)

    2,058     7.54     78     2,052     6.63     68  
     

Multi-family

    32,374     6.23     1,009     29,621     6.61     979  
     

Other real estate

    10,001     6.37     317     6,803     7.03     238  
                               
       

Total loans secured by real estate

    231,568     6.02     6,963     206,657     6.81     7,024  
   

Consumer:

                                     
     

Credit card

    9,233     11.16     513     10,500     11.03     574  
     

Other

    188     17.17     16     261     12.70     17  
   

Commercial

    1,972     7.06     69     1,874     7.84     73  
                               
       

Total loans held in portfolio

    242,961     6.23     7,561     219,292     7.03     7,688  
 

Other

    8,526     3.34     141     2,776     5.65     78  
                               
       

Total interest-earning assets

    285,384     6.18     8,801     287,724     6.80     9,763  

Noninterest-earning assets:

                                     
 

Mortgage servicing rights

    5,998                 6,545              
 

Goodwill

    7,285                 9,054              
 

Other assets

    18,738                 20,588