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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20529
FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO :
COMMISSION FILE NUMBER 0-25188
WASHINGTON MUTUAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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WASHINGTON 91-1653725
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
1201 THIRD AVENUE 98101
SEATTLE, WASHINGTON (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 461-2000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock The Nasdaq Stock Market
9.12% Noncumulative Perpetual Preferred Stock, Series C The Nasdaq Stock Market
7.60% Noncumulative Perpetual Preferred Stock, Series E The Nasdaq Stock Market
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 last 90 days. YES X NO __.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of January 31, 1997:
COMMON STOCK -- $5,625,829,311(1)
(1) Does not include any value attributable to 8,000,000 shares that are held in
escrow and not traded.
The number of shares outstanding of the issuer's classes of common stock as
of January 31, 1997:
COMMON STOCK -- 126,272,191(2)
(2) Includes the 8,000,000 shares held in escrow.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the Annual Meeting of
Shareholders to be held April 15, 1997, are incorporated by reference into Part
III.
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WASHINGTON MUTUAL, INC.
1996 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I.................................................................................. 1
ITEM 1. BUSINESS...................................................................... 1
The Company........................................................................ 1
The Reorganization................................................................. 1
Business Strategy.................................................................. 2
Washington Mutual's Operating Subsidiaries......................................... 2
Lending Activities................................................................. 4
Asset Quality...................................................................... 9
Investing Activities............................................................... 10
Sources of Funds................................................................... 12
Asset and Liability Management..................................................... 14
Business Combinations.............................................................. 16
Employees.......................................................................... 16
Taxation........................................................................... 16
Environmental Regulation........................................................... 17
Regulation and Supervision......................................................... 18
Competitive Environment............................................................ 24
Principal Officers................................................................. 24
ITEM 2. PROPERTIES.................................................................... 25
ITEM 3. LEGAL PROCEEDINGS............................................................. 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................... 26
PART II................................................................................. 26
ITEM 5. MARKET FOR WASHINGTON MUTUAL'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS............................................................................ 26
Common Stock....................................................................... 26
Preferred Stock.................................................................... 27
Payment of Dividends and Policy.................................................... 27
ITEM 6. SELECTED FINANCIAL DATA....................................................... 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF
OPERATIONS......................................................................... 30
General............................................................................ 30
Results of Operations.............................................................. 30
Review of Financial Position....................................................... 39
Asset Quality...................................................................... 42
Interest Rate Risk Management...................................................... 48
Liquidity.......................................................................... 53
Capital Requirements............................................................... 53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................... 54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE......................................................................... 54
PART III................................................................................ 54
PART IV................................................................................. 54
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.............. 54
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PART I
ITEM 1. BUSINESS
THE COMPANY
With a history dating back to 1889, Washington Mutual, Inc. ("Washington
Mutual" or the "Company") is a regional financial services company committed to
serving consumers and small to mid-sized businesses throughout the Western
United States. Through its subsidiaries, the Company engages in the following
activities:
- MORTGAGE LENDING AND CONSUMER BANKING ACTIVITIES. Through its principal
subsidiaries, Washington Mutual Bank ("WMB"), American Savings Bank, F.A.
("ASB"), and Washington Mutual Bank fsb ("WMBfsb"), at December 31, 1996,
the Company operated 413 consumer financial centers and 96 loan centers
offering a full complement of mortgage lending and consumer banking
products and services. In 1996, WMB was the leading originator of
first-lien, single-family residential loans in Washington and Oregon,
while ASB was the second largest originator of such loans in California.
- COMMERCIAL BANKING ACTIVITIES. Through the commercial banking division of
WMB, at December 31, 1996, the Company operated 48 full-service business
branches offering a range of commercial banking products and services to
small and mid-sized businesses. WMB commenced its commercial banking
activities through the acquisition of Enterprise Bank of Bellevue,
Washington ("Enterprise") in 1995 and Western Bank of Coos Bay, Oregon
("Western") in 1996.
- INSURANCE ACTIVITIES. Through WM Life Insurance Company ("WM Life") and
ASB Insurance Services Inc. ("ASB Insurance"), the Company underwrites
and sells annuities and sells a range of life insurance contracts, and
selected property and casualty insurance policies.
- SECURITIES ACTIVITIES. Through ASB Financial Services, Inc. ("ASB
Financial"), Murphey Favre, Inc. ("Murphey Favre") and Composite Research
& Management Co. ("Composite Research"), the Company offers full service
securities brokerage and acts as the investment advisor to and the
distributor of mutual funds.
The Company operates in Washington, California, Oregon, Utah, Idaho,
Montana, Arizona, Colorado and Nevada. At December 31, 1996, the Company had
consolidated assets of $44.6 billion, deposits of $24.1 billion and
stockholders' equity of $2.4 billion.
On December 20, 1996, Washington Mutual consummated the merger of Keystone
Holdings, Inc. ("Keystone Holdings") with and into the Company and certain other
transactions in connection therewith (the "Keystone Transaction") and thereby
acquired ASB. Washington Mutual issued 47,883,333 shares of common stock to
complete the Keystone Transaction. At December 31, 1996, ASB had assets of $21.9
billion and deposits of $12.9 billion and operated 158 branches and 66 loan
centers, substantially all of which were located in California.
Washington Mutual continues to operate ASB under the name "American Savings
Bank" in ASB's markets. Washington Mutual intends to introduce its consumer
banking products and approaches throughout ASB's branch system and to expand
ASB's loan origination capabilities.
THE REORGANIZATION
Washington Mutual was formed in August 1994 by its predecessor, Washington
Mutual Savings Bank ("WMSB"), a Washington state-chartered savings bank, for the
purpose of serving as a holding company in the reorganization of WMSB into a
holding company structure (the "Reorganization"). The Reorganization was
completed in November 1994 through the merger of WMSB into WMB, with WMB as the
surviving entity. As a result of the Reorganization, Washington Mutual became
the parent company of the companies of which WMSB was, prior to the
Reorganization, the parent company.
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As a result of the Reorganization, all common and preferred shareholders of
WMSB became shareholders of Washington Mutual on a one-for-one basis with
substantially the same relative rights, privileges and preferences. Except as
noted otherwise, references herein to "Washington Mutual" or the "Company" refer
to both (i) Washington Mutual, Inc. and its consolidated subsidiaries after the
consummation of the Reorganization; and (ii) WMSB and its consolidated
subsidiaries prior to the consummation of the Reorganization.
BUSINESS STRATEGY
The main elements of the Company's strategic plan are:
- Strengthen the Company's consumer banking franchise throughout the
West. The Company focuses on increasing the number of households served
within its market areas and the scope of its customer relationships.
Washington Mutual primarily attracts new customers by offering
competitive consumer-oriented deposit products, including "Free Checking"
and money market accounts. The Company also offers residential mortgages
and a variety of higher margin consumer loan products, including
manufactured housing loans, home equity loans and lines of credit,
automobile and boat loans, student loans, and unsecured consumer loans,
as well as investment products such as mutual funds and annuities. To
further its penetration within its principal markets, Washington Mutual
delivers its products through several alternative distribution channels
that allow it to target sub-markets within its franchise area. These
alternative delivery channels complement the Company's freestanding
financial center network and include in-store financial centers, loan
centers, interactive banking kiosks, and telephone banking operations.
The Company plans to strengthen its franchise through the continued
introduction of its consumer banking products to all of its market areas,
targeted de novo branch openings, and selected in-market acquisitions.
- Expand the commercial banking franchise. The Company is developing a
growing commercial banking presence in Washington, Oregon and Idaho. The
commercial banking division of WMB, which operates primarily as "Western
Bank," focuses on serving the needs of small and mid-sized businesses and
offers a full range of commercial banking products, including business
checking accounts and secured and unsecured loans. The lending activities
of the commercial banking division generally provide higher margins than
the Company's residential mortgage lending activities. The Company plans
to expand its commercial banking activities within its existing market
areas and eventually to other parts of the Company's franchise.
- Limit sensitivity to interest rate movements. The Company intends to
limit the sensitivity of its net interest income to movements in market
interest rates. Through purchases and sales of loans and mortgage-backed
securities and the retention of internally originated adjustable-rate
mortgages ("ARMs"), the Company has decreased the percentage of
fixed-rate assets and increased the percentage of adjustable-rate assets
in its loan and investment portfolios in order to more closely match its
liability base. The acquisition of ASB, with its portfolio of
adjustable-rate loans and mortgage-backed securities ("MBS") furthered
this strategy.
The Company historically has used acquisitions to further its strategic
plan. Since 1988, the Company has completed 20 acquisitions, two of which were
commercial banks, which have expanded the Company's geographic service area
beyond the state of Washington. The Company anticipates that acquisitions will
continue to be an important element of its strategic plan in the future.
WASHINGTON MUTUAL'S OPERATING SUBSIDIARIES
Washington Mutual Bank. WMB's principal business is providing a broad
range of financial services, primarily to consumers. These services include
accepting deposits from the general public and making residential mortgage
loans, consumer loans and limited types of commercial real estate loans,
primarily loans secured by multi-family properties. Beginning in the latter half
of 1995, WMB, through its mergers with Enterprise and Western, diversified its
activities by entering into commercial banking.
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At December 31, 1996, WMB had assets of $20.6 billion, deposits of $10.8
billion and operated 226 consumer financial centers, of which 155 were in
Washington and 71 were in Oregon; 27 loan centers, of which 19 were in
Washington and eight were in Oregon; and 48 full-service business branches, of
which two were in Washington and 46 were in Oregon. WMB operates under Title 32
(Mutual Savings Banks) of the Revised Code of Washington. Its deposits are
insured by the Federal Deposit Insurance Corporation ("FDIC") through the Bank
Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF").
On January 15, 1997, WMB completed the acquisition of United Western
Financial Group, Inc. ("United") and its subsidiaries, including United Savings
Bank, Uniwest Service Corporation and Western Mortgage Loan Corporation, for
approximately $79.5 million in cash. United operated eight branches in Utah, one
branch in Idaho and seven loan production offices. At January 15, 1997, United
had assets of $404.1 million and deposits of $299.9 million.
American Savings Bank, F.A. ASB's principal business is accepting deposits
from the general public and making residential mortgage loans and loans secured
by multi-family properties. At December 31, 1996, ASB had assets of $21.9
billion, deposits of $12.9 billion and operated 158 branches in California and
66 loan offices, of which 61 were in California, two in Arizona, two in Colorado
and one in Nevada. ASB's deposits are insured by the FDIC through the SAIF.
Washington Mutual Bank fsb. WMBfsb's principal business includes accepting
deposits from the general public and making residential loans, consumer loans
and limited types of commercial real estate loans, primarily loans secured by
multi-family properties. At December 31, 1996, WMBfsb had assets of $935.3
million, deposits of $445.4 million, and operated 29 financial centers, of which
19 were in Utah, seven were in Idaho, two were in Montana and one was in Oregon,
and operated one loan center in Idaho and two in Utah. On November 30, 1996,
WMBfsb acquired by merger Utah Federal Savings Bank ("Utah Federal"), which
operated five branches and two loan production offices in Utah and had assets of
$122.1 million, deposits of $106.7 million and stockholders' equity of $12.0
million. WMBfsb's deposits are insured by the FDIC through the SAIF.
WM Life Insurance Company. WM Life, an Arizona-domiciled life insurance
company, is licensed under state law to issue annuities in seven states. In
addition, WM Life owns Empire Life Insurance Co. ("Empire"), a
Washington-domiciled life insurance company, which is currently licensed under
state law to issue annuities in 28 states. WM Life currently issues fixed and
variable flexible premium deferred annuities, single premium fixed deferred
annuities and single premium immediate annuities. Empire currently issues fixed
flexible premium deferred annuities and single premium immediate annuities. Both
companies conduct business through licensed independent agents. The majority of
such agents are employees of affiliates of the Company and operate in WMB's
financial centers. Annuities presently are issued primarily in Washington and
Oregon. At December 31, 1996, WM Life had assets of $1.1 billion.
ASB Insurance Agency, Inc. ASB Insurance is a registered insurance broker
that offers a wide array of products, including life, property and casualty
insurance and annuities in California.
ASB Financial Services, Inc. ASB Financial is a registered broker-dealer
that distributes a broad array of mutual funds in California. ASB Financial
representatives are available for consultation regularly or by appointment in
many of ASB's branches.
Composite Research & Management Co. Composite Research is a registered
investment advisor and is the investment advisor of eight mutual funds. At
December 31, 1996, Composite Research had a total of $1.4 billion in funds under
management in the eight mutual funds.
Murphey Favre, Inc. Murphey Favre is a registered broker-dealer that
offers a broad range of securities brokerage services, including distribution of
mutual funds in Washington, Oregon, Idaho, Utah and Montana. Murphey Favre has
eight free-standing offices with representatives available for consultation
regularly or by appointment in many of WMB's financial centers.
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LENDING ACTIVITIES
General. The Company's lending activities are carried on through its
banking subsidiaries, WMB, ASB and WMBfsb. At December 31, 1996, the Company's
total loan portfolio (carried at historical cost) of $30.7 billion (exclusive of
reserve for loan losses) included $22.7 billion in mortgage loans secured by
first liens on 1-4 family residential properties; $723.6 million in residential
construction loans; $3.8 billion in mortgage loans secured by commercial real
estate such as apartment buildings, office buildings, warehouses, shopping
centers and medical office buildings; $3.2 billion in consumer loans; and $340.1
million in commercial business loans. For a discussion of the fair value of the
loan portfolio, see "Consolidated Financial Statements -- Note 28: Fair Value of
Financial Instruments."
Washington state law gives state-chartered savings banks such as WMB broad
lending powers, subject to certain statutory restrictions on total investment in
different types of loans. WMB may make loans secured by residential and
commercial real estate, secured and unsecured consumer loans, and secured and
unsecured commercial loans. ASB and WMBfsb have somewhat narrower lending
authority, but can make loans secured by residential and commercial real estate,
certain secured and unsecured consumer loans, and a limited amount of secured
and unsecured commercial loans.
In originating loans, the Company must compete directly with other savings
banks, savings and loan associations, commercial banks, credit unions, mortgage
companies and life insurance companies (primarily in the commercial real estate
area) and indirectly with government-sponsored entities ("GSEs") such as the
Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage
Corporation ("FHLMC"), or the Government National Mortgage Association ("GNMA").
In addition, the Company's lending activities are heavily influenced by economic
trends affecting the availability of funds and by general interest rate levels,
as well as by competitive factors such as the lower cost structure of less
regulated originators and the influence of GSEs in establishing rates. The
condition of the construction industry and the demand for housing also directly
affect residential and commercial real estate lending volumes.
In addition to interest earned on loans, the Company receives fees for
originating loans and for providing loan commitments. The Company also charges
fees for loan modifications, late payments, changes in property ownership and
other miscellaneous services. Fees received in connection with loan originations
are deferred and amortized into interest income over the life of the loan. The
Company also receives fees for servicing loans for others.
Residential Loans
General. The bulk of the Company's residential loan portfolio is in
California, Washington and Oregon . All of the Company's residential mortgage
lending is subject to nondiscriminatory underwriting standards. All loans are
subject to underwriting review and approval by various levels of Company
personnel, depending on the size of the loan.
The Company requires title insurance on all first liens on real property
securing loans and also requires that fire and casualty insurance be maintained
on properties in an amount at least equal to the total of the Company's loan
amount plus all prior liens on the property or the replacement cost of the
property, whichever is less.
Mortgage insurance currently is required on all residential real estate
loans originated at a loan-to-value ratio of 90% or above. Any exceptions must
be reported to the board of directors of the subsidiary bank issuing the credit.
At December 31, 1996, 6% of the Company's residential real estate loan portfolio
had loan-to-value ratios that equaled or exceeded 90% at origination and were
without mortgage insurance.
Under federal regulations, a real estate loan may not exceed 100% of the
appraised value of the property at the time of origination. In addition,
depository institutions are required by regulation to adopt written policies
that establish appropriate limits and standards for real estate loans and to
consider certain regulatory guidelines in establishing these policies. These
guidelines specify that depository institutions should not originate any
commercial, multi-family or nonowner-occupied 1-4 family mortgage loan with an
initial loan-to-value ratio in excess of 85%. The guidelines further provide
that depository institutions should not originate
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any owner-occupied 1-4 family mortgage loan with a loan-to-value ratio that
equals or exceeds 90% at origination, unless such loan is protected by an
appropriate credit enhancement in the form of either mortgage insurance or
readily marketable collateral. These real estate lending guidelines recognize
that it may be appropriate for a depository institutions to originate mortgage
loans with loan-to-value ratios exceeding these specified levels, provided that
the aggregate amount of all loans in excess of these limits does not exceed a
specified level of such depository institution's total capital and such loans
are identified in the depository institution's records and reported at least
quarterly to its board of directors.
WMB and WMBfsb Residential Lending. WMB makes available to borrowers in
Washington and Oregon a full range of residential loans, including FHA-insured,
VA-guaranteed and conventional fixed-rate loans for terms of five, 15 or 30
years, in addition to ARMs. WMBfsb makes the same loan products available to
customers in Utah, Montana and Idaho.
ARMs are advantageous to the Company because adjustable-rate loans better
match the Company's natural liability base. However, WMB's and WMBfsb's ability
to originate ARMs in lieu of fixed-rate loans has varied in response to changes
in market interest rates. Between 1992 and 1993, ARMs constituted less than 25%
of WMB's residential loan originations, reflecting continuing lower market
interest rates. When interest rates rose in 1994, ARMs totaled 62% of WMB's
residential loan originations. However, interest rates declined in mid-1995 and,
as a result, ARMs totaled 32% of WMB's and 28% of WMBfsb's residential loan
originations during 1995. For the year ended December 31, 1996, ARMs accounted
for 35% of WMB's and 33% of WMBfsb's residential loan originations.
Under WMB's and WMBfsb's current ARM programs, the borrower may choose
among loans that have the initial interest rate fixed for one, three or five
years before the adjustments begin. Currently, such ARMs are indexed to the
one-year Constant Maturity Treasury Index and have annual caps of 2%. Under most
programs, the borrower may elect, between the sixth and the sixtieth months, to
convert to a fixed-rate loan payable over the remainder of the original term.
There is no conversion fee, and the fixed interest rate is indexed to the
then-current required net yield for loans sold to FNMA.
The majority of WMB's and WMBfsb's loan originations satisfy all
requirements to make them saleable in the secondary market. In 1996, WMB and
WMBfsb securitized and sold $1.0 billion of their fixed-rate loans, but did not
sell any ARMs. See "-- Loan Securitization."
WMB and WMBfsb originate loans through all of their branches, as well as
through home loan centers and loan representatives located in real estate
brokers' offices. In addition, a small portion of their originations comes
through loan brokers. WMB was the leading originator of first lien residential
mortgage loans in both Washington and Oregon for the year ended December 31,
1996.
ASB Residential Lending. ASB offers an array of mortgage products to
customers in California, Arizona, Nevada and Colorado. The primary products are
ARMs indexed to the 11th District Cost of Funds Index ("COFI") that adjust
monthly with maturities up to a maximum of 40 years; mortgages that have a fixed
initial rate for up to five years and then reprice monthly at a set margin over
COFI until maturity ("Flex-5 Loans"); and fixed-rate 15-, 20- and 30-year
mortgages. During 1996, substantially all of ASB's ARM residential loan
originations were indexed to COFI.
As interest rates increased in the latter part of 1994 and the first part
of 1995, the rates on COFI ARMs rose and the difference between those rates and
the rates on fixed-rate loans narrowed. As a result, ASB's origination volume of
fixed-rate loans increased, while the origination volume of adjustable-rate
loans stabilized. The same conditions also made the Flex-5 Loans more popular.
In 1996, even though long-term interest rates were generally higher than in
1995, originations of fixed-rate products remained consistent with 1995. ASB no
longer offers Flex-5 Loans. Nevertheless, because ASB sells virtually all of its
fixed-rate product on the secondary market, its portfolio is composed almost
entirely of ARMs. At December 31, 1996, ASB's gross loan balance consisted of
98% ARMs and 2% fixed-rate loans. Interest rates on the majority of the ARMs
adjust monthly to a predetermined margin over COFI.
The monthly payments on substantially all of ASB's ARMs adjust annually
with the adjustment limited to 7.5% per year (except at the end of each
five-year interval during the life of the loan, when the payment
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may be adjusted by more than 7.5% to assure that the loan will amortize over the
remaining term). These protections for borrowers can result in monthly payments
that are greater or less than the amount necessary to amortize a loan by its
maturity at the interest rate in effect in any particular month. In the event
that a monthly payment is not sufficient to pay the interest accruing on the
loan, the shortage is added to the principal balance and is repaid through
future monthly payments. This is referred to as negative amortization. The
portion of outstanding loan principal arising from negative amortization was
$30.7 million at December 31, 1996.
The majority of ASB's fixed-rate loan originations are saleable in the
secondary market either through FNMA or FHLMC or, in the case of loans with
balances larger than the FNMA/FHLMC limit for conforming loans ("Jumbo loans"),
to private investors. Substantially all such originations during 1996 (15% of
residential loan originations) have been sold. The remainder of ASB's
residential loan originations, consisting almost entirely of COFI ARMs, was
retained in ASB's portfolio.
One of the primary market segments in which ASB originates loans for its
portfolio is that group of borrowers who generally meet ASB underwriting
standards, but who are unable to provide some of the documentation required to
meet GSE secondary market rules. These loans are referred to as low
documentation (or alternative documentation) loans. Approximately 48% of ASB's
1996 portfolio originations consisted of low documentation loans. The
documentation that is omitted generally relates to the credit or employment
history of the borrower and not to the value of the collateral. All low
documentation loans are fully supported by appraisals and title insurance. In
addition, the maximum loan-to-value ratio on low documentation loans is 80% and
such ratio decreases as the amount of the loan increases. The average
loan-to-value ratio on all low documentation loans originated during 1996 was
70%.
The delinquency experience on low documentation loans originated by ASB in
1994, 1995 and 1996 is comparable to the experience on ASB's COFI ARM portfolio
as a whole. The delinquency experience on ASB's portfolio as a whole has
historically been higher than the delinquency experience at WMB and WMBfsb.
ASB does not originate residential mortgage loans in its branches. All
direct originations (49% of total 1996 residential originations) are through its
66 loan centers. In addition, ASB indirectly originates loans through
independent mortgage brokers throughout the state of California. Indirect
originations accounted for the balance of total 1996 residential loan
originations.
ASB's wholesale mortgage broker distribution channel was established in
1991 to serve geographic regions not covered by residential loan centers.
Initially the participating brokers were primarily in northern California, but
in 1993 the program was expanded to the rest of the state. Participation grew
through 1996 and the broker distribution channel is now a significant element of
ASB's overall lending strategy, including its more recently opened loan
production offices in Arizona, Colorado and Nevada. To monitor credit quality,
ASB conducts extensive due diligence and reviews the stability and credit
experience of each broker prior to accepting any loan packages. Loan production
from the wholesale channel is subjected to the same underwriting standards as
loan production from the residential loan centers. All underwriting decisions
are made by ASB personnel.
Residential Construction Loans. WMB and WMBfsb provide financing for two
different categories of residential construction loans. A custom construction
loan is made to the intended occupant of a house to finance its construction.
Speculative construction loans are made to borrowers who are in the business of
building homes for resale. Speculative construction loans are made either on a
house-by-house basis or, in certain circumstances, through a collateralized,
limited line of credit. Speculative construction lending involves somewhat more
risk than custom construction loans and involves different underwriting
considerations. All construction loans require approval by various levels of WMB
and WMBfsb personnel, depending on the size of the loan. Construction loans for
nonconforming residential properties (properties other than single-family
detached houses) are subject to more stringent approval requirements than loans
for conforming properties.
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Residential construction loans are an integral part of WMB's and WMBfsb's
overall lending program. Construction loans are of short duration, generally 12
to 18 months, and have adjustable rates, so they are an important element in the
Company's interest rate sensitivity management. Speculative construction loans
are generally priced at a higher spread than are permanent residential loans.
In addition, the residential construction loan program provides a source of
permanent loans. Most custom construction loans have provisions for conversion
to permanent loan status upon completion of construction. Speculative
construction builders are a good source of referrals when their buyers need
financing. WMB and WMBfsb have a program under which they waive certain closing
fees for borrowers who are buying homes for which WMB and WMBfsb provided
construction financing.
At December 31, 1996, 59% of the residential construction portfolio was
custom construction loans and 41% was speculative construction loans. The demand
for residential construction loans is sensitive to the same factors as the
market for residential loans generally. Low market interest rates help to
improve the market for houses generally and this, in turn, stimulates new
construction. As a result, originations of residential construction loans for
1996 totaled $1.3 billion, an increase of 38% from $935.8 million in 1995.
Historically, ASB has not originated residential construction loans.
Commercial Real Estate Loans.
General. Commercial real estate lending generally entails greater risks
than residential mortgage lending. Commercial real estate loans typically
involve large loan balances concentrated with single borrowers or groups of
related borrowers. In addition, the payment experience on loans secured by
income-producing properties usually depends on the successful operation of the
related real estate project and thus may be subject, to a greater extent, to
adverse conditions in the real estate market or in the economy generally. In
recent years, commercial real estate values in many areas of the country have
substantially declined, particularly in California, as a result of excess supply
and weak economies.
In all commercial real estate lending, the Company considers the location,
marketability and overall attractiveness of the project. Washington Mutual's
current underwriting guidelines for commercial real estate loans require an
economic analysis of each property with regard to the annual revenue and
expenses, debt service coverage and fair value to determine the maximum loan
amount. Commercial real estate loans require approval at various levels of
Company personnel, depending on the size of the loan.
WMB and WMBfsb Commercial Real Estate Lending. The Boards of Directors of
both WMB and WMBfsb have adopted lending policies that generally limit future
commercial real estate loan originations to Washington, Oregon, Idaho, Utah,
Montana, and contiguous states. WMB's existing commercial real estate loan
portfolio is principally concentrated in Washington, Oregon and California.
WMBfsb's commercial real estate loan portfolio is concentrated in Utah and
Montana.
During the past few years, WMB and WMBfsb focused their commercial real
estate lending on small and mid-sized apartment lending (loans of $2.5 million
or less). During 1996, WMB and WMBfsb broadened their lending scope by
originating or approving $101.3 million of nonresidential real estate loans in
addition to $209.3 million of apartment loans. In addition, both the Enterprise
and Western commercial real estate portfolios were predominantly nonresidential.
However, the relatively small size of both Enterprise and Western before they
merged with WMB placed constraints on the size and to some extent the type of
loans they could make. For example, the individual loan size limitations made
meaningful participation in office building and urban retail loans impossible.
With the added flexibility provided by WMB's size, the type and size of
commercial real estate loans that the commercial banking division will be able
to make will change. This will generally increase the risk characteristics of
the commercial loan portfolio.
ASB Commercial Real Estate Lending. ASB's commercial real estate loan
portfolio is concentrated in California. Due to ASB's past desire to remain a
"traditional thrift lender," management historically did not emphasize
commercial loan originations other than for apartment properties. No commercial
loans, other than apartment and mobile home park loans, have been originated by
ASB since 1994, at which time such commercial loans represented approximately 1%
of total loan originations by principal balance. Because of
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credit weaknesses in the small and mid-sized apartment house market in
California, ASB tightened its underwriting of apartment loans in 1994. Due to
tightened underwriting standards, apartment loan originations declined as a
percentage of total real estate lending from 11% in 1994 to 5% in both 1995 and
1996. From time to time, ASB refinances its existing nonresidential commercial
real estate loans.
Loan Securitization. The Company from time to time, depending on its asset
and liability management strategy, converts a portion of its loans into either
FHLMC participation certificates, GNMA MBS or FNMA conventional MBS
(collectively, "GSE MBS"). This securitization of its loans provides the Company
with increased liquidity both because the mortgage securities are more readily
marketable than the underlying loans and because they can be used as collateral
for borrowing.
WMB has historically securitized a portion of its fixed-rate loan
production that is held for sale or originated with the intent to hold for sale
in order to sell those MBS in the secondary market and, from time to time,
securitizes other loans and retains the resulting MBS as investment securities.
ASB generally securitizes substantially all of its FNMA/FHLMC conforming
fixed-rate production for potential sale in the secondary market. Loans
securitized through GSEs for sale in the secondary market are sold without
recourse and become obligations of the applicable GSE. Generally, the servicing
of the loans is retained by the Company with the servicing fee income fixed by
the relevant GSE.
In 1995 and 1996, the Company securitized loans with FHLMC and FNMA under
programs in which the GSE has recourse against the originator of the loans.
These securitizations are generally less costly and may require less
documentation than securitizations without recourse. These MBS are generally
saleable in the secondary market and can be used as collateral for borrowings
and to meet regulatory liquidity requirements. Generally, however, MBS created
under this program are retained by the originator, and the Company has retained
the majority of MBS created under these programs. The Company has also sold
securitized loans with recourse. At December 31, 1996, the Company's total
recourse obligation with respect to securitized loans was $7.3 billion.
In 1995, ASB created a real estate mortgage investment conduit (a "REMIC")
by means of which it securitized a pool of loans consisting of $1.2 billion in
apartment loans and $200.0 million of its Flex-5 Loans. To date, ASB has not
sold any portion of this REMIC and the entire amount is still owned by ASB with
full recourse.
When MBS composed of loans originated by the Company's banking subsidiaries
are owned by such banking subsidiaries, they are serviced in the same manner as
any other loan in the loan portfolio. In addition, when loans sold with recourse
become nonperforming, the loans and the associated collateral properties are
included in the Company's total nonaccruing assets.
Manufactured Housing, Second Mortgage and Other Consumer Loans. WMB and
WMBfsb offer consumer loan programs in Washington, Oregon, Utah, Idaho and
Montana that include: (i) manufactured housing loans; (ii) second mortgage loans
for a variety of purposes, including purchase, renovation, or remodeling of
property, and for uses unrelated to the security; (iii) loans for the purchase
of automobiles, pleasure boats and recreational vehicles; (iv) student loans;
and (v) loans for general household purposes, including loans made under
Washington Mutual's secured line of credit programs. Consumer loans, in addition
to being an important part of the Company's orientation toward consumer
financial services, promote greater net interest income stability because of
their somewhat shorter maturities and faster prepayment characteristics. The
size of the consumer loan portfolio has grown in recent years. It is
management's intention to introduce these products into ASB's service area.
Lending in this area may involve special risks, including decreases in the value
of collateral and transaction costs associated with foreclosure and
repossession.
Consumer loans generally are secured loans and are made based on an
evaluation of the collateral and the borrower's creditworthiness, including such
factors as income, other indebtedness and credit history. Secured consumer loan
amounts typically do not exceed 80% of the value of the collateral, less the
outstanding balance of any first-mortgage loan. Manufactured housing loans do
not exceed 90% of the value of the collateral plus taxes and other costs.
Additional limitations may be based on the customer's income, credit history and
other
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factors showing creditworthiness. Lines of credit are subject to periodic
review, revision and, when deemed appropriate by the Company, cancellation as a
result of changes in the borrower's financial circumstances.
ASB has originated various types of consumer loans that are generally
unsecured lines of credit and loans that are secured by personal property. These
loans have historically been provided as a service to ASB's existing customers
and have not represented a significant portion of its business. In the first
quarter of 1994, ASB discontinued its credit card operations and sold its entire
credit card portfolio for a gain of $25.0 million.
Commercial Business Loans. At year-end 1996, the commercial banking
division offered a full range of commercial banking products and services
through 48 free-standing, full-service business branches, supplemented by 10
business banking centers located near or in WMB financial centers. The Company's
commercial business loans are mainly loans to small and mid-sized businesses and
to individuals. They are secured by a variety of business and personal assets
or, in some cases, are unsecured. In 1996, the division originated $348.4
million of commercial business loans and the commercial business loan portfolio
totaled $340.1 million at December 31, 1996.
ASSET QUALITY
General. Washington Mutual reviews its assets for weakness on a regular
basis. Reserves are maintained for assets classified as substandard or doubtful.
Any portion of an asset classified as loss is immediately written off.
Washington Mutual's comprehensive process for identifying impaired assets,
classifying assets and asset review is performed on a quarterly basis. The
objective of the review process is to identify any trends and determine the
levels of loss exposure to evaluate the need for an adjustment to the reserve
accounts.
The principal measures of asset problems are the levels of nonaccrual
loans, loans under foreclosure and real estate owned ("REO"), which collectively
are classified as nonperforming assets, levels of impaired loans, the amount of
the provision for loan losses, loan charge-offs, and write-downs in the value of
REO. See "Management's Discussion and Analysis of Financial Position and Results
of Operations -- Asset Quality -- Classified Assets."
Management ceases to accrue interest income on any loan that becomes 90
days or more delinquent and reserves all interest accrued up to that time. In
addition, when circumstances indicate concern as to the future collectibility of
the principal of a commercial real estate loan, management stops accruing
interest on the loan, whether or not it has reached the 90-day delinquency
point. Thereafter, interest income is accrued only if and when, in management's
opinion, projected cash proceeds are deemed sufficient to repay both principal
and interest. All loans on which interest is not being accrued are referred to
as loans on nonaccrual status.
Nonperforming loans include loans on which payment is 90 days or more
delinquent and loans that are under foreclosure (a category that includes
properties for which decrees of foreclosure have been granted but that are held
under sheriffs' certificates pending expiration of the borrowers' redemption
rights).
REO. Real estate that served as security for a defaulted loan and becomes
REO is recorded on the Company's books at the lower of the outstanding loan
balance (net of any reserves charged off) or fair value, the determination of
which takes into account the effect of sales and financing concessions that may
be required to market the property. If management's estimate of fair value at
the time a property becomes REO is less than the loan balance, the loan is
written down at that time by a charge to the reserve for loan losses.
The REO reserve provides for losses that may result from unforeseen market
changes in the REO portfolio and declines in fair values of properties
subsequent to their initial transfer to REO. REO properties are analyzed
periodically to determine the adequacy of the REO reserve. Any adjustment in the
reserve that results from such evaluations is charged to the results of REO
operations in the period in which it is identified. Personal property that has
been repossessed is recorded at the lower of the outstanding loan balance (net
of any charge-offs) or fair value at the time the property was repossessed. See
"Management's Discussion and Analysis of Financial Position and Results of
Operations -- Asset Quality" for further discussion.
Provision for Loan Losses and Reserve for Loan Losses. Loan loss reserves
are based upon management's continuing analysis of pertinent factors underlying
the quality of the loan portfolio. These factors
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include changes in the size and composition of the loan portfolio, historical
loan loss experience, industry-wide loss experience, current and anticipated
economic conditions and detailed analysis of individual loans and credits for
which full collectibility may not be assured, as well as management's policies,
practices and intentions with respect to credit administration and asset
management.
As part of the process of determining the adequacy of the reserve for loan
losses, management reviews the Company's loan portfolio for specific weaknesses.
Residential construction, commercial real estate and commercial business loans
are evaluated individually for impairment. This detailed analysis includes
techniques to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. When available information confirms
that specific loans or portions thereof are uncollectible, those amounts are
charged-off against the reserve for loan losses. The existence of some or all of
the following criteria will generally confirm that a loss or impairment has
incurred: the loan is significantly delinquent and the borrower has not
evidenced the ability or intent to bring the loan current; the Company has no
recourse to the borrower, or if it does, the borrower has insufficient assets to
pay the debt; or the fair value of the loan collateral is significantly below
the current loan balance, and there is little or no near-term prospect for
improvement.
Unallocated reserves are established for loss exposure that may exist in
the remainder of the loan portfolio but has not yet been identified. In
determining the adequacy of unallocated reserves, management considers changes
in the size and composition of the loan portfolio, historical loan loss
experience, current and anticipated economic conditions, and the Company's
credit administration and asset management philosophies and procedures.
The Company recorded an additional $125.0 million to the reserve for loan
losses at the closing of the merger with Keystone Holdings. The additional
reserve for loan losses was provided principally because a number of credit
administration and asset management philosophies and procedures of WMB differed
from those of ASB. The Company is conforming ASB's administration, philosophies
and procedures to those of WMB and WMBfsb. The additional reserve for loan
losses was to a lesser degree provided because the Company believed that while
there had been an increase in the value of residential real estate in certain
California markets, a decline in collateral values in some portions of the
California real estate market occurred in 1996.
It is possible that the provision for loan losses may, in the future,
change as a percentage of total loans. The reserve for loan losses is maintained
at a level sufficient to provide for estimated loan losses based on evaluating
known and inherent risks in the loan portfolio. See "Management's Discussion and
Analysis of Financial Position and Results of Operations -- Asset
Quality -- Provision for Loan Losses and Reserve for Loan Losses."
INVESTING ACTIVITIES
General. Washington Mutual has authority under state law to make any
investment, but may be subject to certain restrictions imposed by the Home
Owners' Loan Act ("HOLA"). Under Washington state law, WMB has authority to make
any investment deemed prudent by its board of directors, and may invest in
commercial paper, corporate bonds, mutual fund shares, debt and equity
securities issued by creditworthy entities and interests in real estate located
inside or outside of Washington state. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), however, prohibits a state bank (such as
WMB) from making or retaining equity investments that are not permissible for a
national bank, subject to certain exceptions.
ASB and WMBfsb have authority to make investments specified by HOLA and
applicable regulations, including the purchase of governmental obligations,
investment-grade commercial paper, and investment-grade corporate debt
securities. Under the laws of the states of Arizona and Washington,
respectively, WM Life and Empire have broad authority to make investments in
debt and equity securities subject to applicable reserve requirements and
risk-based capital requirements.
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Effective January 1, 1994, Washington Mutual adopted, as required,
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for
Certain Investments in Debt and Equity Securities. This statement required
investment and equity securities to be segregated into three categories:
"trading" securities, "held-to-maturity" securities and "available-for-sale"
securities. As a result of SFAS No. 115, at December 31, 1996, a net unrealized
gain (on an after-tax basis) of $41.7 million associated with available-for-sale
securities was included as a separate component of stockholders' equity. At
December 31, 1996, the Company's investment portfolio included $2.9 billion of
held-to-maturity securities (with a fair value of $2.9 billion), $9.1 billion of
available-for-sale securities and $1.6 million of trading account securities. At
December 31, 1996, MBS accounted for $10.5 billion or 87% of the total
investment portfolio.
The Company's investment portfolio by investment type at carrying value
consisted of the following:
DECEMBER 31,
------------------------------------------
1996 1995 1994
----------- ----------- ----------
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations............. $ 279,189 $ 345,510 $ 565,025
Corporate debt obligations......................... 479,836 607,926 617,548
Municipal obligations.............................. 108,271 92,508 80,762
Equity securities.................................. 639,287 525,153 387,997
----------- ----------- ----------
1,506,583 1,571,097 1,651,332
Mortgage-backed securities:
U.S. government agency............................. 9,633,439 12,561,748 6,113,146
Private issue...................................... 831,432 1,222,270 913,941
----------- ----------- ----------
10,464,871 13,784,018 7,027,087
Derivative instruments:
Interest rate exchange agreements.................. (646) (11,847) 18,654
Interest rate cap agreements....................... 2,460 9,415 41,690
----------- ----------- ----------
1,814 (2,432) 60,344
----------- ----------- ----------
Total investment portfolio...................... $11,973,268 $15,352,683 $8,738,763
=========== =========== ==========
For a discussion of the stated maturities of the Company's investment
portfolio at December 31, 1996, see "Consolidated Financial Statements -- Note
4: Available-for-Sale Securities" and "-- Note 5: Held-to-Maturity Securities."
The risk of loss upon default of the borrower is generally greater for
corporate debt securities than for real estate loans. In addition, investments
by the Company in debt or equity securities of an issuer are generally much
larger than investments in any particular real estate loan, resulting in a
greater effect on the Company in the event of default or decline in market
value. The Company regularly analyzes these securities for impairment of value
and makes adjustments in their carrying value or yield as appropriate.
Historically, the yield on private-issue MBS, collateralized mortgage
obligations ("CMOs"), and purchased loan pools has exceeded the yield on GSE MBS
because they expose the Company to certain risks that are not inherent in GSE
MBS, such as credit risk and liquidity risk. These assets are not guaranteed by
the U.S. government or one of its agencies because the loan size, underwriting
or underlying collateral of these assets often does not meet set industry
standards. Consequently, there is a higher potential of loss of the principal
investment. Additionally, the Company may not be able to sell such assets in
certain market conditions as the number of interested buyers may be limited at
that time. Furthermore, the complex structure of certain collateralized mortgage
obligations in the Company's portfolio increases the difficulty in assessing the
portfolio's risk and its fair value. Examples of some of the more complex
structures include certain collateralized mortgage obligations where the Company
holds subordinated tranches, certain collateralized mortgage obligations that
have been resecuritized, and certain securities that contain a significant
number of Jumbo loans.
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In 1996, in an effort to reduce the aforementioned risks, the Company
instituted a policy of performing credit reviews on each individual security or
loan pool prior to purchase. Such a review includes consideration of the
collateral characteristics, borrower payment histories and information
concerning loan delinquencies and losses of the underlying collateral. After a
security is purchased, similar information is monitored on a periodic basis.
Furthermore, the Company has established internal guidelines limiting the
geographic concentration of the underlying collateral.
At December 31, 1996, the Company held $831.4 million of private-issue MBS.
Of that amount, 20% were the highest investment grade (AAA), 66% were rated
investment grade (AA or A), 9% were rated lowest investment grade (BBB) and 5%
were rated below investment grade (BB or below). The Company's policy is not to
purchase securities that are below investment grade. The below investment grade
securities in the Company's portfolio at December 31, 1996 were the result of
downgrades of such securities by the rating agencies. The Company recognized
losses of $2.4 million during 1996 and $8.4 million in 1995 on certain
securities in the below investment grade portfolio due to credit quality
deterioration.
At December 31, 1996, the Company held $639.3 million of equity securities
in its available-for-sale securities portfolio. Federal Home Loan Bank ("FHLB")
stock was $465.1 million or 73% of the total.
SOURCES OF FUNDS
Deposits. At December 31, 1996, WMB accepted deposits at 274 financial
centers in Washington and Oregon, ASB accepted deposits at 158 branches in
California, and WMBfsb accepted deposits at 29 financial centers in Utah, Idaho,
Montana and Oregon. The Company's banking subsidiaries compete with other
financial institutions in attracting savings deposits. Competition from
commercial banks has been particularly strong due to their extensive
distribution systems. In addition, there is strong competition for customer
dollars from credit unions, mutual funds and nonbank corporations, such as
securities brokerage companies and other diversified companies, some of which
have nationwide networks of offices.
In recent years, deposit growth has resulted almost exclusively from
business combinations. At December 31, 1996, the Company's deposits totaled
$24.1 billion. Business combinations during 1994, 1995 and 1996 added $211.5
million, $417.1 million and $13.7 billion in deposits, including $12.9 billion
in deposits from the Keystone Transaction. ASB has also grown deposits through
acquisitions, with $4.0 billion in acquired deposits over its eight-year life.
Without the addition of the acquired deposits, the Company's deposits would have
decreased from December 31, 1993 to December 31, 1996.
The Company offers traditional passbook and statement savings accounts as
well as checking accounts. In addition, the Company offers money market deposit
accounts ("MMDAs") with higher minimum balances that offer higher yields.
WMB's and WMBfsb's Deposits. WMB and WMBfsb offer a broad range of deposit
products and at December 31, 1996 had a total of $11.1 billion in deposits, $5.3
billion of which were time deposits, $4.2 billion of which were MMDAs and
savings accounts; and $1.6 billion of which were checking accounts. The most
popular time deposit is a product called "Investor's Choice," which is a time
deposit with maturities available from one to 120 months in any one of three
deposit size categories. Interest rates on Investor's Choice time deposits
generally increase with increased maturity and amount. Less than 50% of deposits
at December 31, 1996 were time deposits and of those, only $1.0 billion or 19%
of total time deposits had remaining maturities longer than one year.
Since 1995, WMB and WMBfsb have been heavily promoting a "Free Checking"
account. This account has helped to reduce the overall cost of funds by
increasing the percentage of deposits that are noninterest-bearing. At December
31, 1996, $726.6 million or 44% of WMB's and WMBfsb's total checking accounts
did not bear interest.
WMB and WMBfsb have also actively promoted MMDAs because, while a somewhat
volatile source of deposits, they have the advantage of being variable-rate
liabilities. At December 31, 1996, WMB and WMBfsb had an aggregate of $3.3
billion in MMDAs and only $921.3 million in regular savings accounts.
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Wholesale deposits, primarily time deposits, are sold to political
subdivisions and public agencies. The Company considers wholesale deposits to be
a borrowing source rather than a customer relationship.
ASB's Deposits. Like WMB and WMBfsb, ASB's deposit liabilities are
primarily short term. Of ASB's total deposits of $12.9 billion at December 31,
1996, only $1.1 billion was in time deposits with remaining maturities of longer
than one year.
Like WMB and WMBfsb, ASB has also promoted a checking account product, in
its case, "Mileage Checking." Mileage Checking is, unlike Free Checking, an
interest-bearing checking account product. At December 31, 1996, ASB had total
interest-bearing checking deposits of $1.2 billion. Management of the Company
hopes to reduce ASB's cost of funds in the future by introducing Free Checking
in ASB's markets and discontinuing Mileage Checking. Management also hopes to
interest more of ASB's depositors in MMDAs, which currently account for only 15%
of ASB's deposits.
Borrowings and Annuities. The Company uses borrowings, in addition to
deposit acquisitions, as an integral part of funding its growth. In addition to
the borrowings discussed below, at December 31, 1996, the Company was in a
position to obtain an additional $9.7 billion, primarily through the use of
collateralized borrowings and deposits of public funds using unpledged
mortgage-backed securities and other wholesale borrowing sources. See
"Management's Discussion and Analysis of Financial Position and Results of
Operation -- Liquidity."
Borrowings include the sale of securities subject to repurchase agreements,
the purchase of federal funds, the issuance of mortgage-backed bonds or notes,
capital notes and other types of debt securities, and funds obtained as advances
from the FHLB of Seattle and the FHLB of San Francisco. The Company also has
access to the Federal Reserve Bank's discount window. Under Washington state
law, WMB may borrow up to 30% of total assets, but sales of securities subject
to agreements to repurchase are not deemed borrowings under such law, and
borrowings from federal, state or municipal governments, agencies or
instrumentalities thereof also are not subject to the 30% limit.
The Company actively engages in repurchase agreements with authorized
broker-dealers and major customers selling U.S. government and corporate
securities and MBS under agreements to repurchase them or similar securities at
a future date. At December 31, 1996, the Company had $7.8 billion of such
borrowings.
WMB, WMBfsb and WM Life are members of the FHLB of Seattle and ASB is a
member of the FHLB of San Francisco. As members, each company maintains a credit
line that is a percentage of its total regulatory assets, subject to
collateralization requirements. At year-end 1996, WMB, ASB, WMBfsb, and WM Life
had credit lines of 30%, 30%, 45% and 20%, respectively, of total regulatory
assets. At December 31, 1996, advances under these credit lines totaled $7.2
billion and were secured in aggregate by grants of security interests in all
FHLB stock owned, deposits with the FHLB, and certain mortgage loans and deeds
of trust and securities of the U.S. government and agencies thereof.
In August 1995, the Company filed a registration statement with the
Securities and Exchange Commission ("SEC") for the offering, on a delayed or
continuous basis, of up to $250.0 million of debt securities, of which $100.0
million remains available.
In December 1996, Washington Mutual entered into two Revolving Credit
Facilities (the "Facilities"): a $100.0 million 364-day facility and a $100.0
million four-year facility. Chase Manhattan Bank is administrative agent for the
Facilities. At December 31, 1996, no monies had been drawn. However, in January
1997, $150.0 million was borrowed, in part, for the redemption of $354.0 million
of debt securities of a Keystone Holdings' subsidiary, and in February 1997,
another $20.0 million was drawn. See "Consolidated Financial Statements -- Note
16: Other Borrowings" for further discussion. The remaining proceeds of the
Facilities are available for general corporate purposes, including providing
capital at a subsidiary level.
WM Life and Empire issue fixed annuity contracts through licensed agents
who are employees of subsidiaries of the Company and operate in WMB financial
centers. Currently, annuities are issued primarily in Washington and Oregon. At
December 31, 1996, the policy value of such contracts was $807.4 million. WM
Life also issues variable annuity contracts. At December 31, 1996, the policy
value of such contracts was
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$70.7 million. All annuity contracts impose a contractual surrender charge in
the event of a customer's withdrawal of funds within a certain number of years
(in the case of most of WM Life's fixed annuity contracts, five years) from the
date the annuity contract was issued.
ASSET AND LIABILITY MANAGEMENT
The long-run profitability of the Company depends not only on the success
of the services it offers to its customers and the quality of its loans and
investments, but also the extent to which its earnings are unaffected by changes
in interest rates. The Company's asset and liability management strategy
attempts to reduce the risk of a significant decrease in net interest income
caused by interest rate changes without unduly penalizing current earnings.
WMB and WMBfsb, as is true of many financial institutions, have had a
mismatch between the maturity of its assets and liabilities. Their customers
generally prefer short-term deposits (see "Sources of Funds -- Deposits") and
many of them also prefer long-term fixed-rate loans. This mismatch is not a
problem when interest rates are stable or declining. However, with a rise in
short-term interest rates, as was experienced throughout most of 1994, the
interest paid on deposits and other short-term borrowings increases much more
quickly than the interest earned on loans and investments. The result for WMB
and WMBfsb was a reduction in their net interest spread and corresponding
pressure on net interest income in both 1994 and 1995. One means of reducing the
effect of interest rate volatility on net interest income is to shorten asset
durations. In recent years, WMB and WMBfsb have attempted to do this by
emphasizing ARMs and short-term consumer loan programs. At December 31, 1996,
the portion of WMB's and WMBfsb's residential loans and MBS that were adjustable
rate was approximately 52%. ASB does not suffer from the same asset liability
mismatch as WMB and WMBfsb because the majority of its assets are COFI ARMs
which reprice monthly. In times of rising interest rates, however, the Company
is negatively affected by an inherent timing difference between the repricing of
its ARM assets and its liabilities. The effect of this timing difference, or
"lag," will be favorable during a period of declining interest rates and
unfavorable in a rising interest rate environment. Although the effect of this
lag generally balances out over the life of a loan, it can produce short-term
volatility in the Company's net interest income during periods of interest rate
movement.
The lifetime interest rate caps which the Company offers to its ARM
borrowers introduce another element of interest rate risk to the Company. In
periods of high interest rates, it is possible for the index to exceed the rate
on the lifetime interest rate caps offered to customers. When determined
appropriate by management, the Company manages this risk by purchasing COFI- and
LIBOR-based interest rate cap agreements.
In 1995, the Company reclassified $4.9 billion of securities from its
held-to-maturity category to the available-for sale category. See "Management's
Discussion and Analysis of Financial Position and Results of
Operations -- Review of Financial Position." More than one-half of the
securities reclassified were fixed rate. The reclassification gave the Company
the flexibility to dispose of a portion of such securities over time and replace
them with adjustable-rate assets as part of its interest rate risk management
program. During 1996, the Company securitized and then sold a substantial
portion of the fixed-rate loans it originated, while retaining nearly all of its
adjustable-rate loan production. Generally, the Company retained the servicing
rights to the loans that were sold. In addition, as part of the restructuring
strategy initiated in late 1995, the Company purchased adjustable-rate assets
and sold fixed-rate mortgage-backed assets.
In the future, it is anticipated that a portion of the remaining fixed-rate
securities may be replaced with adjustable-rate GSE MBS, adjustable-rate
private-issue MBS, collateralized mortgage obligations, and purchased loan pools
as well as new originations of ARMs, as the fixed-rate securities pay down or
are sold as market conditions permit. During periods of moderate to high market
interest rates, originations of ARMs have been well received by customers.
During periods of low market interest rates, however, customers have preferred
fixed-rate mortgage loans. This portfolio restructuring strategy is intended to
reduce the Company's interest rate sensitivity while simultaneously protecting
its yield. As the Company substitutes adjustable-rate assets for fixed-rate
assets, its sensitivity to future changes in interest rates decreases, because,
unlike fixed-rate securities, interest rates on adjustable-rate assets change,
within certain periodic and lifetime cap
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restraints, with corresponding changes in market rates. However, substituting
adjustable-rate assets for fixed-rate assets can have two disadvantages. First,
adjustable-rate assets, when compared with similar fixed-rate assets, carry
additional credit risk in an increasing interest rate environment. As these
assets reprice upward, the borrower's creditworthiness may become impaired.
Second, the holding of adjustable-rate assets will decrease the overall
portfolio yield in a stable or declining interest rate environment. Accordingly,
the Company plans to replace some of its fixed-rate MBS with private-issue MBS,
collateralized mortgage obligations, and purchased loan pools to minimize the
potential decline in portfolio yield.
Another way to reduce the effect of the volatility of interest rates is to
lengthen liability durations, which is difficult because of depositors'
preferences for liquidity. This was apparent from the fact that at December 31,
1996, the Company's MMDAs accounted for $5.2 billion or 22% of total deposits,
and time deposits with maturities less than one year totaled $12.2 billion or
50% of total deposits.
At December 31, 1996, interest-sensitive assets of $31.8 billion and
interest-sensitive liabilities of $33.4 billion were scheduled to mature or
reprice within one year. At December 31, 1996, the Company's one-year gap was a
negative 3.64%. The Company's interest rate sensitivity has decreased with the
sale of WMB's fixed-rate MBS undertaken in 1996 and the retention of ARMs
originated by ASB. It still, however, suffers, from some short-term volatility
of net income because of the effect of COFI lag. Management hopes to reduce this
short-term volatility in part by increasing production of non-COFI
adjustable-rate products and short-term fixed-rate products such as consumer
loans. In addition to managing the terms of its actual assets and liabilities,
the Company uses derivative instruments, such as interest rate exchange
agreements and interest rate cap agreements, to mitigate interest rate risk. At
December 31, 1996, the Company had entered into interest rate exchange
agreements and interest rate cap agreements with notional values of $9.1
billion. Without these instruments, the Company's one-year gap at December 31,
1996, would have been a negative 9.81% as opposed to a negative 3.64%. See
"Consolidated Financial Statements -- Note 17: Interest Rate Risk Management"
for a discussion of the use of derivative instruments.
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BUSINESS COMBINATIONS
Most of the Company's growth since 1988 has occurred as a result of banking
business combinations. The following table summarizes Washington Mutual's
business combinations since April 1988:
NUMBER OF
ACQUISITION NAME DATE ACQUIRED LOANS DEPOSITS ASSETS LOCATIONS
- -------------------------------------- ---------------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
Columbia Federal Savings Bank and
Shoreline Savings Bank.............. April 29, 1988 $ 551.0 $ 555.0 $ 752.6 26
Old Stone Bank(1)..................... June 1, 1990 229.5 292.6 294.0 7
Frontier Federal Savings
Association(2)...................... June 30, 1990 -- 95.6 -- 6
Williamsburg Federal Savings
Bank(2)............................. Sept. 14, 1990 -- 44.3 -- 3
Vancouver Federal Savings Bank........ July 31, 1991 200.1 253.4 260.7 7
CrossLand Savings, FSB(2)............. Nov. 8, 1991 -- 185.4 -- 15
Sound Savings and Loan Association.... Jan. 1, 1992 16.8 20.5 23.5 1
World Savings and Loan
Association(2)...................... March 6, 1992 -- 37.8 -- 2
Great Northwest Bank.................. April 1, 1992 603.2 586.4 710.4 17
Pioneer Savings Bank.................. March 1, 1993 624.5 659.5 926.5 17
Pacific First Bank, A Federal Savings
Bank................................ April 9, 1993 3,770.7 3,831.7 5,861.3 129
Far West Federal Savings Bank(2)...... April 15, 1994 -- 42.2 -- 3
Summit Savings Bank................... Nov. 14, 1994 127.5 169.3 188.1 4
Olympus Bank, a Federal Savings
Bank................................ April 28, 1995 237.8 278.6 391.4 11
Enterprise Bank....................... Aug. 31, 1995 92.8 138.5 153.8 1
Western Bank.......................... Jan. 31, 1996 500.8 696.4 776.3 42
Utah Federal Savings Bank............. Nov. 30, 1996 88.9 106.7 122.1 5
American Savings Bank, F.A.(3)........ Dec. 20, 1996 14,562.9 12,815.4 21,893.5 224
United Western Financial Group........ Jan. 15, 1997 272.7 299.9 404.1 16
- ---------------
(1) This was an acquisition of selected assets and liabilities.
(2) The acquisition was of branches and deposits only. The only assets acquired
were branch facilities or loans collateralized by acquired savings deposits.
(3) Information given as of November 30, 1996.
See "Consolidated Financial Statements -- Note 2: Business Combinations"
for a discussion of the accounting treatment of certain of the acquisitions.
EMPLOYEES
The number of full-time equivalent employees at the Company increased from
7,903 at December 31, 1995 to 8,322 at December 31, 1996. The Company believes
that it has been successful in attracting quality employees and believes its
employee relations are good.
TAXATION
General. For federal income tax purposes, the Company reports its income
and expenses using the accrual method of tax accounting and uses the calendar
year as its tax year. Except for the interest expense rules pertaining to
certain tax exempt income applicable to banks and the recently repealed bad debt
reserve deduction, the Company is subject to federal income tax, under existing
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), in
generally the same manner as other corporations.
Tax Bad Debt Reserve Recapture. The recently enacted Small Business Job
Protection Act of 1996 (the "Job Protection Act") requires that qualified thrift
institutions, such as WMB, ASB and WMBfsb, generally recapture, for federal
income tax purposes, that portion of the balance of their tax bad debt reserves
that exceeds the December 31, 1987 balance, with certain adjustments. Such
recaptured amounts are to be
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generally taken into ordinary income ratably over a six-year period beginning in
1997. Accordingly, Washington Mutual will have to pay approximately $4.2 million
(based upon current federal income tax rates) in additional federal income taxes
each year of the six-year period due to the Job Protection Act.
The Job Protection Act also repeals the reserve method of accounting for
tax bad debt deductions and, thus, requires thrifts to calculate the tax bad
debt deduction based on actual current loan losses.
State Income Taxation. The state of Washington does not currently have a
corporate income tax. A business and occupation tax based on a percentage of
gross receipts is assessed on businesses. Currently, interest received on loans
secured by first mortgages or deeds of trust on residential properties is not
subject to such tax. However, it is possible that legislation will be introduced
that would repeal or limit this exemption.
The states of California, Oregon, Utah, Idaho, Montana and Colorado have
corporate income taxes, which are imposed on companies doing business in those
states. The Company's operations in California and Oregon result in substantial
corporate income tax expenses in such states. As the Company's operations in the
remaining states increase, the corporate income taxes will have an increasing
effect on the Company's results of operations or financial condition.
If and to the extent the Company carries on activities in other states, the
Company may in certain circumstances be subject to taxation in such states.
Assistance Agreement. Keystone Holdings and certain of its affiliates are
parties to an agreement (the "Assistance Agreement") with a predecessor of the
FSLIC Resolution Fund (the "FRF"), which was designed, in part, to provide that
over time 75% of most of the federal tax savings and 19.5% of most of the
California tax savings (in each case computed in accordance with specific
provisions contained in the Assistance Agreement) attributable to the
utilization of certain tax losses or tax loss carryforwards of New West Federal
Savings and Loan Association ("New West") are paid ultimately to the FRF. The
provision for such payments is reflected in the financial statements as
"Payments in Lieu of Taxes." See "Management's Discussion and Analysis of
Financial Position and Results of Operations -- General -- The Keystone
Transaction" and "Consolidated Financial Statements -- Note 20: Payments in Lieu
of Taxes."
Due to Section 382 of the Code, most of the value of the net operating loss
carryforward deductions of Keystone Holdings and its subsidiaries was eliminated
due to the Keystone Transaction. Accordingly, the future tax savings
attributable to such net operating loss carryforward deductions (other than
amounts used to offset bad debt reserve deduction recapture for ASB) will be
greatly reduced.
ENVIRONMENTAL REGULATION
The Company's business and properties are subject to federal and state laws
and regulations governing environmental matters, including the regulation of
hazardous substances and wastes. For example, under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("CERCLA") and similar
state laws, owners and operators of contaminated properties may be liable for
the costs of cleaning up hazardous substances without regard to whether such
persons actually caused the contamination. Such laws may affect the Company both
as an owner of properties used in or held for its business and as a secured
lender of property that is found to contain hazardous substances or wastes.
Further, although CERCLA exempts holders of security interests, the
exemption may not be available if a secured party engages in the management of
its borrower or the collateral property in a manner deemed beyond the protection
of the secured party's interest. Recent federal and state legislation, as well
as guidance issued by the United States Environmental Protection Agency and a
number of court decisions, have provided assurance to lenders regarding the
activities they may undertake and remain within CERCLA's secured party
exemption. However, these assurances are not absolute and generally will not
protect a lender or fiduciary that participates or otherwise involves itself in
the management of its borrower, particularly in foreclosure proceedings. As a
result, CERCLA and similar state statutes may affect the Company's decision
whether to foreclose on property that is found to be contaminated. It is the
Company's general policy to obtain an environmental assessment prior to
foreclosure of commercial property. The existence of hazardous substances
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or wastes on such property may cause the Company to elect not to foreclose on
the property, thereby limiting, and in some instances precluding, the Company
from realizing its investment in such loans.
REGULATION AND SUPERVISION
General. WMI, in its capacity as a savings and loan holding company, is
subject to regulation by the Office of Thrift Supervision ("OTS"). WMB is
subject to regulation and supervision by the Director of Financial Institutions
of the State of Washington ("State Director"). Its deposit accounts are insured
by the FDIC through both the BIF and SAIF. The FDIC undertakes examination and
regulation of WMB and other state-chartered banks that are not members of the
Federal Reserve system ("FDIC-regulated banks"). Federal and state laws and
regulations govern, among other things, investment powers, deposit activities,
borrowings, maintenance of guaranty funds and retained earnings. ASB and WMBfsb
are subject to extensive regulation and examination by the OTS, which is their
primary federal regulator. Their deposit accounts are insured through the SAIF
by the FDIC, which also has some authority to regulate ASB and WMBfsb.
The description of statutory provisions and regulations applicable to
depository institutions, insurance companies, securities companies and their
holding companies set forth in this annual report does not purport to be a
complete description of the statutes and regulations mentioned herein, nor of
all such statutes and regulations.
Holding Company Regulation. WMI is a multiple savings and loan holding
company, as defined by federal law, because it owns three savings
associations -- WMB, ASB and WMBfsb. WMB has elected to be treated as a savings
association for purposes of the federal savings and loan holding company law.
WMI is treated as a unitary savings and loan holding company and is not subject
to certain federal statutory restrictions on activities and investments (the
"MHC Restrictions") as are some multiple savings and loan holding companies,
because ASB and WMBfsb are deemed to have been acquired in supervisory
transactions. WMI will become subject to the MHC Restrictions, however, if any
one of WMB, ASB or WMBfsb fails to be a qualified thrift lender ("QTL"), meaning
generally that either (a) at least 65% of a specified asset base must consist of
loans to small businesses, credit card loans, educational loans or certain
assets related to domestic residential real estate, including residential
mortgage loans and mortgage securities; or (b) at least 60% of total assets must
consist of cash, United States government or government agency debt or equity
securities, fixed assets, or loans secured by deposits, by real property used
for residential, educational, church, welfare or health purposes, or by real
property in certain urban renewal areas. Failure to remain a QTL also would
impose conditions on WMB's ability to obtain advances from the FHLB, and would
restrict the ability of ASB and WMBfsb, among other things, to branch, to pay
dividends and to obtain such advances. Each of WMB, ASB and WMBfsb are currently
in compliance with QTL standards.
HOLA and OTS regulations require WMI, as a savings and loan holding
company, to file periodic reports with the OTS. In addition, it must observe
such recordkeeping requirements as the OTS may prescribe and is subject to
holding company examination by the OTS. The OTS may take enforcement action if
the activities of a savings and loan holding company constitute a serious risk
to the financial safety, soundness or stability of a subsidiary savings
association. WMB, ASB and WMBfsb, as holding company subsidiaries that are
depository institutions, are subject to both qualitative and quantitative
limitations on the transactions they conduct with WMI and its other
subsidiaries.
The FDIC has authority to require FDIC-insured banks and savings
associations to reimburse the FDIC for losses incurred by the FDIC in connection
with the default of a commonly controlled depository institution or with the
FDIC's provision of assistance to such an institution. Institutions are commonly
controlled if they are controlled by the same holding company or if one
depository institution controls another depository institution (as WMI controls
WMB, ASB and WMBfsb).
State Regulation and Supervision. Savings banks in Washington, such as
WMB, are empowered by state statute to take deposits and pay interest thereon
and, subject to various conditions and limitations, to make loans on or invest
in residential and other real estate, to make consumer loans, to make commercial
loans, to invest in corporate obligations, government debt securities, and other
securities, and to offer various trust and banking services to their customers.
See " -- The Company" and " -- Washington Mutual's
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Operating Subsidiaries." Under state law, savings banks in Washington also
generally have all of the powers that federal mutual savings banks have under
federal laws and regulations.
FDIC Insurance. Deposits in WMB, ASB and WMBfsb are separately insured by
the FDIC to the applicable maximum limits in each institution. The FDIC
administers two separate deposit insurance funds. The BIF is a deposit insurance
fund for commercial banks and some state-chartered banks, including WMB. A
portion of WMB's deposits are also insured through SAIF. The SAIF is a deposit
insurance fund for most savings associations, such as ASB and WMBfsb. At
December 31, 1996, approximately 79% of the combined deposits of WMB, ASB and
WMBfsb were insured through SAIF.
The FDIC has developed a deposit insurance system under which the
assessment rate for an insured depository institution varies according to the
level of risk it poses to the BIF or SAIF. This system bases an institution's
risk category partly upon whether the institution is well capitalized,
adequately capitalized, or less than adequately capitalized. See "Regulation and
Supervision -- Capital Requirements." Each insured depository institution is
also assigned to one of three supervisory subgroups based on reviews by the
institution's primary federal or state regulator, statistical analyses of
financial statements, and other information relevant to gauging the risk posed
by the institution. Based on its capital and supervisory subgroups, each
institution is assigned an annual FDIC assessment rate. WMB qualifies for the
lowest rate on its BIF deposits, and WMB, ASB and WMBfsb qualify for the lowest
rate on their SAIF deposits. Regardless of the potential risk to the insurance
fund, Federal law requires the FDIC to establish assessment rates that will
maintain each insurance fund's ratio of reserves to insured deposits at $1.25
per $100.
The BIF reached the $1.25 per $100 of insured deposits reserve ratio and,
effective January 1996, BIF premiums declined. On September 30, 1996, President
Clinton signed legislation intended, among other things, to recapitalize the
SAIF and to reduce SAIF premiums. The legislation provided for a special
one-time assessment on SAIF-insured deposits that were held as of March 31,
1995, including certain deposits acquired after that date. This assessment
brought the SAIF's reserve ratio to the legally required $1.25 per $100 of
insured deposits level. Washington Mutual's special assessment resulted in a
pretax charge of $124.2 million. Even though the one-time charge reduced the
Company's 1996 earnings by $84.8 million, management believes the legislation is
in the best interests of the Company due to the reduction in SAIF assessment
rates. Beginning in January 1997, deposits insured through the SAIF at ASB,
WMBfsb and WMB are subject to regular FDIC assessments amounting to 6.48 cents
per $100 of insured deposits per year, while deposits insured through the BIF at
WMB are subject to regular FDIC assessments amounting to 1.30 cents per $100 of
insured deposits per year.
Capital Requirements. WMI is not subject to any regulatory capital
requirements. However, each of its subsidiary depository and insurance
institutions is subject to various capital requirements. WMB is subject to FDIC
capital requirements, while ASB and WMBfsb are subject to OTS capital
requirements. WM Life is subject to National Association of Insurance
Commissioners ("NAIC") capital requirements.
WMB. FDIC regulations recognize two types or tiers of capital: core ("Tier
1") capital and supplementary ("Tier 2") capital. Tier 1 capital generally
includes common stockholders' equity and noncumulative perpetual preferred
stock, less most intangible assets. Tier 2 capital, which is limited to 100% of
Tier 1 capital, includes such items as qualifying general loan loss reserves,
cumulative perpetual preferred stock, mandatory convertible debt, term
subordinated debt and limited life preferred stock; however, the amount of term
subordinated debt and intermediate term preferred stock (original maturity of at
least five years but less than 20 years) that may be included in Tier 2 capital
is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to total assets. Most
banks are required to maintain a minimum leverage ratio of at least 4.00% to
5.00%. The FDIC retains the right to require a particular institution to
maintain a higher capital level based on an institution's particular risk
profile. WMB has calculated its leverage ratio to be 5.76% as of December 31,
1996.
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FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight -- 0%, 20%, 50% or
100% -- based on the relative risk of that category. For example, U.S. Treasury
Bills and GNMA securities are placed in the 0% risk category, FNMA and FHLMC
securities are placed in the 20% risk category, loans secured by 1-4 family
residential properties and certain privately issued mortgage-backed securities
are generally placed in the 50% risk category, and commercial real estate and
consumer loans are generally placed in the 100% risk category. In addition,
certain off-balance sheet items are converted to balance sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories. Under
the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital)
to risk-weighted assets must be at least 8.00%, and the ratio of Tier 1 capital
to risk-weighted assets must be at least 4.00%. WMB has calculated its total
risk-based ratio to be 11.09% as of December 31, 1996, and its Tier 1 risk-based
capital ratio to be 10.28%. In evaluating the adequacy of a bank's capital, the
FDIC may also consider other factors that may affect a bank's financial
condition. Such factors may include interest rate risk exposure, liquidity,
funding and market risks, the quality and level of earnings, concentration of
credit risk, risks arising from nontraditional activities, loan and investment
quality, the effectiveness of loan and investment policies, and management's
ability to monitor and control financial operating risks.
ASB and WMBfsb. The OTS requires savings associations, such as ASB and
WMBfsb, to meet each of three separate capital adequacy standards: a core
capital leverage requirement, a tangible capital requirement and a risk-based
capital requirement. OTS regulations require savings associations to maintain
core capital (which may include, for a limited time, certain amounts of
qualifying supervisory goodwill) of at least 3.00% of assets and tangible
capital (excluding all goodwill) of at least 1.50% of assets. As of December 31,
1996, ASB's core capital and tangible capital ratios were 5.17% each and
WMBfsb's core capital and tangible capital ratios were each 6.90%. Most savings
institutions are required to maintain a minimum leverage ratio of at least
4.00%. OTS regulations incorporate a risk-based capital requirement that is
designed to be no less stringent than the capital standard applicable to
national banks and is modeled in many respects on, but not identical to, the
risk-based capital requirements adopted by the FDIC. These regulations require a
core risk-based capital ratio of at least 4.00% and a total risk-based capital
ratio of at least 8.00%. As of December 31, 1996, ASB had core risk-based and
total risk-based capital ratios of 8.90% and 10.92%, while WMBfsb had ratios of
10.50% and 11.58%, respectively.
FDICIA Requirements. FDICIA created a statutory framework that increased
the importance of meeting applicable capital requirements. For WMB, ASB and
WMBfsb, FDICIA established five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a risk-based
capital measure, a leverage ratio capital measure, and certain other factors.
The federal banking agencies (including the FDIC and the OTS) have adopted
regulations that implement this statutory framework. Under these regulations, an
institution is treated as well capitalized if its ratio of total capital to
risk-weighted assets is 10.00% or more, its ratio of core capital to risk-
weighted assets is 6.00% or more, its ratio of core capital to adjusted total
assets is 5.00% or more and it is not subject to any federal supervisory order
or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not
less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and a
leverage ratio of not less than 4.00%. Any institution which is neither well
capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure by
WMB, ASB or WMBfsb to comply with applicable capital requirements would, if
unremedied, result in restrictions on their activities and lead to enforcement
actions against WMB by the FDIC or against ASB or WMBfsb by the OTS, including,
but not limited to, the issuance of a capital directive to ensure the
maintenance of required capital levels. FDICIA requires the federal banking
regulators to take prompt corrective action with respect to depository
institutions that do not meet minimum capital requirements. Additionally, FDIC
or OTS approval of any regulatory application filed for their review may be
dependent on compliance with capital requirements.
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Federal law requires that the federal banking agencies risk-based capital
guidelines take into account various factors including interest rate risk,
concentration of credit risk, risks associated with nontraditional activities,
and the actual performance and expected risk of loss of multi-family mortgages.
In 1994, the federal banking agencies jointly revised their capital standards to
specify that concentration of credit and nontraditional activities are among the
factors that the agencies will consider in evaluating capital adequacy. In that
year, the OTS and FDIC amended their risk-based capital standards with respect
to the risk weighting of loans made to finance the purchase or construction of
multi-family residences. The OTS adopted final regulations adding an interest
rate risk component to the risk-based capital requirements for savings
associations (such as ASB and WMBfsb), although implementation of the regulation
has been delayed. Management believes that the effect of including such an
interest rate risk component in the calculation of risk-adjusted capital will
not cause ASB or WMBfsb to cease to be well capitalized. In June 1996, the FDIC
and certain other federal banking agencies (not including the OTS) issued a
joint policy statement providing guidance on prudent interest rate risk
management principles. The agencies stated that they would determine banks'
interest rate risk on a case-by-case basis, and would not adopt a standardized
measure or establish an explicit minimum capital charge for interest rate risk.
WM Life. WM Life is subject to risk-based capital requirements developed
by the NAIC. The NAIC measure uses four major categories of risk to calculate an
appropriate level of capital to support an insurance company's overall business
operations. The four risk categories are asset risk, insurance risk, interest
rate risk and business risk. At December 31, 1996, WM Life's actual capital was
663% of its required regulatory risk-based level.
Legal Restrictions on Dividends of Depository Institutions. A depository
institution such as WMB, ASB or WMBfsb may not make a capital distribution if,
following such distribution, the institution will be undercapitalized under the
FDICIA provisions described above. In addition, Washington state law prohibits
WMB from declaring or paying a dividend greater than its retained earnings or if
doing so would cause its net worth to be reduced below (i) the amount required
for the protection of preconversion depositors or (ii) the net worth
requirements, if any, imposed by the State Director.
OTS regulations limit the ability of savings associations such as ASB and
WMBfsb to pay dividends and make other capital distributions according to the
institution's level of capital and income, with the greatest flexibility
afforded to institutions that meet or exceed their OTS capital requirements.
Under current OTS regulations, a savings association that exceeds its OTS
regulatory capital requirements both before and after a proposed dividend (or
other distribution of capital) and has not been advised by the OTS that it is in
need of more than normal supervision may, after prior notice to but without the
approval of the OTS, make capital distributions during a calendar year up to the
higher of (i) 100% of its income during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the institution's excess
capital over its capital requirements) at the beginning of the calendar year or
(ii) 75% of its net income over the most recent four-quarter period. In
addition, such an institution may make capital distributions in excess of the
foregoing limits if the OTS does not object within a 30-day period following
notice by the institution.
A savings association that would not meet OTS capital requirements
following payment of a dividend is subject to additional restrictions. It is not
anticipated that ASB or WMBfsb will pay any dividend that would cause either of
them to fail to meet OTS capital requirements.
FDIC and OTS Regulation and Examination. The FDIC has adopted regulations
to protect the deposit insurance funds and depositors, including regulations
governing the deposit insurance of various forms of accounts. The FDIC has also
adopted numerous regulations to protect the safety and soundness of FDIC-
regulated banks. These regulations cover a wide range of subjects including
financial reporting, change in bank control, affiliations with securities firms
and capital requirements. In certain instances, these regulations restrict the
exercise of powers granted by state law.
An FDIC regulation and a joint FDIC/OTS policy statement place a number of
restrictions on the activities of WMB's and ASB's securities and insurance
affiliates, and on such affiliates' transactions with WMB, ASB and WMBfsb. These
restrictions include requirements that such affiliates follow practices and
procedures to distinguish them from WMB, ASB and WMBfsb and that such affiliates
give customers notice
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from time to time of this distinction and of the distinction between insured
deposits and uninsured nondeposit products.
FDICIA also prohibited banks such as WMB and their subsidiaries from
exercising certain powers that were granted by state law to make investments or
carry on activities as principal (i.e. for their own account) unless either (i)
national banks have power under federal law to make such investments or carry on
such activities, or (ii) the bank and such investments or activities meet
certain requirements established by FDICIA and the FDIC.
FDICIA imposed new supervisory standards requiring annual examinations,
independent audits, uniform accounting and management standards, and prompt
corrective action for problem institutions. As a result of FDICIA, depository
institutions and their affiliates are subject to federal standards governing
asset growth, interest rate exposure, executive compensation, and many other
areas of depository institution operations. FDICIA contains numerous other
provisions, including reporting requirements and revised regulatory standards
for, among other things, real estate lending.
The FDIC may sanction any FDIC-regulated bank that does not operate in
accordance with FDIC regulations, policies and directives. Proceedings may be
instituted against any FDIC-regulated bank, or any institution-affiliated party,
such as a trustee, director, officer, employee, agent, or controlling person of
the bank, who engages in unsafe and unsound practices, including violations of
applicable laws and regulations. The FDIC may revalue assets of an institution,
based upon appraisals, and may require the establishment of specific reserves in
amounts equal to the difference between such revaluation and the book value of
the assets. The State Director has similar authority under Washington state law
and the OTS has similar authority under HOLA. The FDIC has additional authority
to terminate insurance of accounts, after notice and hearing, upon a finding
that the insured institution is or has engaged in any unsafe or unsound practice
that has not been corrected, or is operating in an unsafe or unsound condition,
or has violated any applicable law, regulation, rule, or order of or condition
imposed by the FDIC.
Federal savings institutions, such as ASB and WMBfsb, are subject to
regulatory oversight and examination by the OTS and the FDIC. HOLA and OTS
regulations delimit such institutions' investment and lending powers. Federal
savings institutions may not invest in noninvestment-grade debt securities, nor
may they generally make equity investments, other than investments in service
corporations.
Federal law and regulations requires ASB and WMBfsb to maintain, for each
calendar month, an average daily balance of liquid assets equal to not less than
5% of its average daily balance of total savings accounts and borrowings payable
in one year or less, subject to certain adjustments for deposit outflows. This
liquidity requirement may be changed from time to time.
Federal regulation of depository institutions is intended for the
protection of depositors (and the BIF and SAIF), and not for the protection of
stockholders or other creditors. In addition, a provision in the Omnibus Budget
Reconciliation Act of 1993 ("Budget Act") requires that in any liquidation or
other resolution of any FDIC-insured depository institution, claims for
administrative expenses of the receiver and for deposits in U.S. branches
(including claims of the FDIC as subrogee of the insured institution) shall have
priority over the claims of general unsecured creditors.
Federal Reserve Regulation. Under Federal Reserve Board regulations, WMB,
ASB and WMBfsb are each required to maintain reserves against their transaction
accounts (primarily checking and NOW accounts). Because reserves must generally
be maintained in cash or in noninterest-bearing accounts, the effect of the
reserve requirements is to increase an institution's cost of funds. These
regulations generally require that WMB, ASB and WMBfsb each maintain reserves
against net transaction accounts in the amount of 3% on amounts of $49.3 million
or less, plus 10% on amounts in excess of $49.3 million. Institutions may
designate and exempt $4.4 million of certain reservable liabilities from these
reserve requirements. These amounts and percentages are subject to adjustment by
the Federal Reserve Board. A savings bank, like other depository institutions
maintaining reservable accounts, may borrow from the Federal Reserve Bank
discount window, but the Federal Reserve Board's regulations require the savings
bank to exhaust other reasonable alternative sources before borrowing from the
Federal Reserve Bank.
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Numerous other regulations promulgated by the Federal Reserve Board affect
the business operations of the Company's banking subsidiaries. These include
regulations relating to equal credit opportunity, electronic fund transfers,
collection of checks, truth in lending, truth in savings and availability of
funds.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
financial institutions regulated by the federal financial supervisory agencies
to ascertain and help meet the credit needs of their delineated communities,
including low-income and moderate-income neighborhoods within those communities,
while maintaining safe and sound banking practices. The regulatory agency
assigns one of four possible ratings to an institution's CRA performance and is
required to make public an institution's rating and written evaluation. The four
possible ratings of meeting community credit needs are outstanding,
satisfactory, needs to improve, and substantial noncompliance.
Many factors play a role in assessing a financial institution's CRA
performance. The institution's regulator must consider its financial capacity
and size, legal impediments, local economic conditions and demographics,
including the competitive environment in which it operates. The evaluation does
not rely on absolute standards and the institutions are not required to perform
specific activities or to provide specific amounts or types of credit.
ASB and WMBfsb each has received an "outstanding" CRA rating from the OTS,
and WMB has received an "outstanding" CRA rating from the FDIC. These ratings
reflect Washington Mutual's commitment to meeting the credit needs of the
communities it serves. The Company maintains a CRA statement for public viewing,
as well as an annual CRA highlights document. These documents describe
Washington Mutual's credit programs and services, community outreach activities,
public comments and other efforts to meet community credit needs.
Recent and Proposed Federal Legislation. Federal legislation was enacted in
1994, which will repeal, effective June 1, 1997, certain restrictions on the
establishment of interstate branches by national banks and state-chartered
banks. In addition, bank holding companies are now generally permitted to buy
banks in any state. WMBfsb already has authority to establish interstate
branches under current federal law and regulations, and management expects that
such legislation will primarily benefit competitors of the Company.
Various legislative proposals relating to depository institutions have been
or are expected to be introduced in the current session of Congress. These
include proposals to restrict or further regulate the sales of mutual funds and
annuities by depository institutions or their affiliates, to restrict
affiliations between the Company and nonbanking corporations including life
insurance companies, and effectively to require federal savings institutions
such as ASB and WMBfsb to convert to banks. The outcome of these legislative
proposals cannot be forecast reliably.
Regulation of Nonbanking Affiliates. As insurance companies, WM Life and
Empire are subject to comprehensive regulation and supervision by the states in
which they are domiciled (WM Life is domiciled in the state of Arizona and
Empire is domiciled in the state of Washington) as well as the states in which
they transact business. The laws of the various states establish supervisory
agencies with broad administrative and supervisory powers. Such agencies set
standards related to granting and revoking licenses to transact business,
regulation of trade practices and market conduct, licensing of agents, approval
of policy forms, regulating of certain premium rates, setting of insurance
liability and investment reserve requirements, determining the form and content
of required financial statements, determining the reasonableness and adequacy of
capital and surplus, and prescribing the types and amounts of permitted
investments. Insurance companies are subject to periodic examinations by such
supervisory agencies. State insurance laws and regulations also impose limits on
the extent to which the insurance company subsidiaries may pay dividends or lend
or otherwise supply funds to the Company.
As broker-dealers registered with the Securities and Exchange Commission
and as members of the National Association of Securities Dealers ("NASD"),
Murphey Favre and ASB Financial are subject to various regulations and
restrictions imposed by those entities, as well as by various state authorities.
As a registered investment advisor, Composite Research is subject to various
federal and state securities regulations and restrictions.
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The NASD has adopted and forwarded to the SEC for approval rules concerning
NASD member operations conducted in branches of depository institutions.
Although many of the NASD's proposed requirements are substantially similar to
the joint FDIC/OTS policy statement governing the activities of WMB's securities
affiliates, the NASD proposal, if approved by the SEC, could impose additional
restrictions on these affiliates.
COMPETITIVE ENVIRONMENT
Washington Mutual faces significant competition in attracting and retaining
deposits and making loans in all of its market areas. Its most direct
competition for deposits has historically come from other thrift institutions,
credit unions and commercial banks doing business in its primary market areas of
Washington, California and Oregon. As with all banking organizations, however,
Washington Mutual has experienced increasing competition from nonbanking
sources, including mutual funds, corporate and governmental debt securities and
other investment alternatives. Washington Mutual's competition for loans comes
principally from credit unions, insurance companies and other institutional
lenders. Many of these competitors have more significant financial resources,
larger market share and greater name recognition than the Company. The existence
of such competitors may make it difficult for Washington Mutual to achieve its
financial goals. In addition to the normal competitive factors described above,
Washington Mutual management at the holding company level has limited operating
experience in California, which has a much larger population with more large
financial institution competitors than the states in which WMB has historically
operated. Accordingly, there can be no assurance that the Company's consumer
banking strategy will prove successful in the California market.
Although consolidation has decreased the number of institutions competing
in the Company's market, both thrifts and commercial banks have reemphasized
their focus on the consumer, making competition for retail deposits and loans
extremely fierce. While the increased competitive pressures make the banking
environment more difficult, the Company remains a strong market force. For 1996,
WMB's originations of residential mortgage loans ranked first in both Washington
and Oregon, and ASB's originations of residential mortgages ranked second in
California.
PRINCIPAL OFFICERS
The following table sets forth certain information regarding the principal
officers of Washington Mutual:
EMPLOYEE OF
PRINCIPAL OFFICERS AGE CAPACITY IN WHICH SERVED COMPANY SINCE
- -------------------------- --- ------------------------------------------------------- -------------
Kerry K. Killinger........ 47 Chairman of the Board of Directors, President and Chief 1983
Executive Officer
Craig S. Davis............ 45 Executive Vice President 1996
Steven P. Freimuth........ 40 Executive Vice President 1988
Lee D. Lannoye............ 59 Executive Vice President 1988
William A. Longbrake...... 53 Executive Vice President and Chief Financial Officer 1996
Deanna W. Oppenheimer..... 38 Executive Vice President 1985
Craig E. Tall............. 51 Executive Vice President 1985
S. Liane Wilson........... 54 Executive Vice President 1985
Norman H. Swick........... 47 Senior Vice President and General Auditor 1980
Douglas G. Wisdorf........ 42 Senior Vice President, Deputy Chief Financial Officer, 1976
and Controller
Mr. Killinger has been Chairman, President and Chief Executive Officer of
WMI since its organization. He has been Chairman of the Board of Directors of
WMB since 1991 and Chief Executive Officer since 1990. Mr. Killinger became an
Executive Vice President of WMB in 1983, a Senior Executive Vice President of
WMB in 1986 and the President and a director of WMB in 1988.
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Mr. Davis became an Executive Vice President and member of the Executive
Committee of WMI in January 1997, following WMI's merger with Keystone Holdings.
In his capacity as Executive Vice President, Mr. Davis is responsible for
lending and financial services. He was Director of Mortgage Origination of ASB
from 1993 through 1996 and served as President of ASB Financial from 1989 to
1993.
Mr. Freimuth has been an Executive Vice President of WMI and a member of
the Executive Committee since January 1997. In this capacity, he is responsible
for corporate lending administration. He joined WMB as a Senior Vice President
in 1988.
Mr. Lannoye has been an Executive Vice President of WMI since its
organization. He has been an Executive Vice President of WMB since 1988 and a
member of the Company's Executive Committee since its formation in 1990. In his
capacity as Executive Vice President, Mr. Lannoye is responsible for corporate
administration and credit.
Mr. Longbrake rejoined WMI in October 1996 as Executive Vice President and
Chief Financial Officer and a member of the Company's Executive Committee. In
his capacity as Executive Vice President, Mr. Longbrake is responsible for
corporate finance. From March of 1995 through September of 1996, he served as
Deputy to the Chairman for Finance and Chief Financial Officer of the Federal
Deposit Insurance Corporation. Mr. Longbrake was Senior Executive Vice President
and Chief Financial Officer of WMI from its organization through February 1995.
He was Chief Financial Officer of WMB from 1988 to 1995 and a member of the
Company's Executive Committee from its formation in 1990 until 1995 and again
since 1996. Mr. Longbrake became an Executive Vice President and Treasurer of
WMB in 1982 and a Senior Executive Vice President of WMB in 1986.
Ms. Oppenheimer has been an Executive Vice President of WMI since its
organization. She has been an Executive Vice President of WMB since 1993 and a
member of the Company's Executive Committee since its formation in 1990. In this
capacity, Ms. Oppenheimer is responsible for corporate marketing and consumer
bank distribution. She has been an officer of WMB since 1985. She became an
Assistant Vice President of WMB in 1986, a Vice President in 1987 and a Senior
Vice President in 1989.
Mr. Tall has been an Executive Vice President of WMI since its
organization. He had been an Executive Vice President of WMB since 1987 and a
member of the Company's Executive Committee since its formation in 1990. In his
capacity as Executive Vice President, Mr. Tall is responsible for corporate
development and commercial banking.
Ms. Wilson has been an Executive Vice President of WMI since its
organization. She has been an Executive Vice President of WMB since 1988 and a
member of the Company's Executive Committee since its formation in 1990. In her
capacity as Executive Vice President, Ms. Wilson is responsible for corporate
operations.
Mr. Swick has been Senior Vice President and General Auditor of WMI since
its organization. He has been an officer of WMB since 1980. Mr. Swick became a
Vice President in 1984, Senior Vice President in 1988, and General Auditor of
WMB in 1989. In this capacity, he monitors WMI's internal controls and
compliance with all laws and regulations.
Mr. Wisdorf has been Deputy Chief Financial Officer since 1996 and Senior
Vice President and Controller of WMI since its organization. Mr. Wisdorf has
been Senior Vice President and Controller of WMB since 1991. In this capacity,
he serves as principal accounting officer of WMI. He joined WMB in 1976 and has
been an officer since 1978. Since 1986, he has served as Vice President and
Controller.
ITEM 2. PROPERTIES
Washington Mutual's administrative offices are located at 1201 Third
Avenue, Seattle, Washington, 98101 where, as of December 31, 1996, WMB leased
approximately 180,000 square feet pursuant to a lease agreement that terminates
in 2007 with multiple options to renew at WMB's discretion. WMB also leased
approximately 160,000 square feet of space in Seattle in the Second and Seneca
Building pursuant to a lease agreement that terminates in 2001 and approximately
75,000 square feet in the adjoining building, pursuant to
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a lease agreement that terminates in 2006, with multiple options to renew both
leases at WMB's discretion. ASB administrative and subsidiary operations are
conducted from owned office space totaling 280,000 square feet in Irvine,
California and 237,000 square feet in Stockton, California. As of December 31,
1996, Washington Mutual's banking subsidiaries conducted business from 413
consumer financial centers, 48 business branches and 96 loan centers in
Washington, California, Oregon, Utah, Idaho, Montana, Arizona, Colorado and
Nevada. Nonbanking subsidiary operations were conducted in 8 non-financial
center locations in Washington, Oregon and Montana. See "Consolidated Financial
Statements -- Note 9: Premises and Equipment."
ITEM 3. LEGAL PROCEEDINGS
Washington Mutual has certain litigation and negotiations in progress
resulting from activities arising from normal operations. In the opinion of
management, none of these matters is likely to have a materially adverse effect
on the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 18, 1996, the Company held a special meeting of shareholders to
vote on approval of the merger with Keystone Holdings and related transactions
and on an amendment to the Company's Articles of Incorporation to increase the
number of authorized shares of common stock.
The results of the votes cast on each matter were as follows:
ABSTENTIONS
FOR AGAINST AND NON-VOTES
---------- --------- -------------
Keystone Transaction................................... 57,344,192 233,170 2,736,252
Amendment to Articles
Common Shares........................................ 58,016,532 1,902,606 12,388,372
Aggregate Common and Preferred Shares................ 61,390,613 2,051,200 14,988,097
PART II
ITEM 5. MARKET FOR WASHINGTON MUTUAL'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
COMMON STOCK
Washington Mutual's common stock trades on The Nasdaq Stock Market under
the symbol WAMU. As of January 31, 1997, there were 126,255,891 shares issued
and outstanding held by 15,975 shareholders of record. The last reported sales
price of common stock on February 14, 1997 was $55.19 per share.
The high and low common stock prices by quarter were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995
----------------- -----------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First quarter........................... $32.25 $27.63 $20.75 $16.63
Second quarter.......................... 30.38 26.13 24.75 20.00
Third quarter........................... 39.25 28.50 26.75 22.50
Fourth quarter.......................... 45.88 36.50 29.50 24.75
The cash dividends paid by quarter were as follows:
YEAR ENDED
DECEMBER 31,
---------------
1996 1995
----- -----
First quarter................................................ $0.21 $0.19
Second quarter............................................... 0.22 0.19
Third quarter................................................ 0.23 0.19
Fourth quarter............................................... 0.24 0.20
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PREFERRED STOCK
9.12% Noncumulative Perpetual Preferred Stock, Series C. Washington
Mutual's Series C Preferred Stock trades on The Nasdaq Stock Market under the
symbol WAMUO. The Series C Preferred Stock has a liquidation preference of $25
per share plus dividends accrued and unpaid for the then-current dividend
period. Dividends, if and when declared by Washington Mutual's Board of
Directors, are at an annual rate of $2.28 per share. Dividends of $0.57 per
share have been declared for each quarter for the two years ended December 31,
1996. At December 31, 1996, there were 2,752,500 shares issued and outstanding
held by 476 shareholders of record. The last reported sales price of the Series
C Preferred Stock on February 14, 1997 was $25.50 per share.
The high and low stock prices by quarter were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995
----------------- -----------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First quarter........................... $27.00 $25.88 $25.88 $24.75
Second quarter.......................... 26.25 25.38 26.50 25.88
Third quarter........................... 26.38 25.63 26.88 25.63
Fourth quarter.......................... 26.31 25.00 26.75 26.00
7.60% Noncumulative Perpetual Preferred Stock, Series E. Washington
Mutual's Series E Preferred Stock trades on The Nasdaq Stock Market under the
symbol WAMUM. The Series E Preferred Stock has a liquidation preference of $25
per share plus dividends accrued and unpaid for the then-current dividend
period. Dividends, if and when declared by Washington Mutual's Board of
Directors, are at an annual rate of $1.90 per share. Dividends of $0.475 per
share have been declared for each quarter for the two years ended December 31,
1996. At December 31, 1996, there were 1,970,000 shares issued and outstanding
held by 391 shareholders of record. The last reported sales price of the Series
E Preferred Stock on February 14, 1997 was $25.25 per share.
The high and low stock prices by quarter were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995
----------------- -----------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First quarter........................... $25.63 $24.50 $23.75 $21.75
Second quarter.......................... 25.00 23.63 25.00 22.75
Third quarter........................... 24.75 24.00 24.63 23.63
Fourth quarter.......................... 25.75 24.25 25.00 24.38
PAYMENT OF DIVIDENDS AND POLICY
Payment of future dividends is subject to a declaration by Washington
Mutual's Board of Directors. Factors considered in determining the size of
dividends are the amount and stability of profits, adequacy of capitalization,
and expected asset and deposit growth of its subsidiaries. The dividend policy
of Washington Mutual is also dependent on the ability of WMB, ASB and WMBfsb to
make dividends to their respective parent company, which is influenced by legal,
regulatory and economic restrictions. See "Business -- Regulation and
Supervision -- Legal Restrictions on Dividends of Depository Institutions."
Retained earnings of the Company at December 31, 1996 included a pre-1988
thrift bad debt reserve for tax purposes of approximately $450.0 million for
which no federal income taxes had been provided. In the future, if the thrift
bad debt reserve is used for any purpose other than to absorb bad debt losses,
or if any of the banking subsidiaries no longer qualifies as a bank, the Company
will incur a federal income tax liability at the then prevailing corporate tax
rate, to the extent of such subsidiaries pre-1988 thrift bad debt reserve. As a
result, the Company's ability to pay dividends in excess of current earnings may
be limited.
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data for
Washington Mutual and is derived from and should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto, which are included
elsewhere herein. The Keystone Transaction and merger with Western in 1996 and
the merger with Pioneer Savings Bank in 1993 were accounted for as
poolings-of-interests. The assets, liabilities, and results of operations of the
acquired companies have been recorded on the books of Washington Mutual at their
values as carried on the books of the acquired companies, and no goodwill was
created. Washington Mutual financial information contained herein has been
restated as if the respective companies had been combined for all periods
presented.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Interest income............................... $3,149,236 $2,916,086 $2,295,413 $2,198,578 $2,170,969
Interest expense.............................. 1,958,229 1,923,436 1,335,358 1,211,896 1,302,489
----------- ----------- ----------- ----------- -----------
Net interest income........................... 1,191,007 992,650 960,055 986,682 868,480
Provision for loan losses..................... 201,512 74,987 122,009 158,728 158,537
Other income.................................. 259,264 208,339 220,794 246,576 174,365
Other expense................................. 1,025,304 700,514 695,517 687,519 561,688
----------- ----------- ----------- ----------- -----------
Income before income taxes, extraordinary
items and cumulative effect of change in tax
accounting method........................... 223,455 425,488 363,323 387,011 322,620
Income taxes.................................. 70,420 111,906 109,880 96,034 42,462
Provision for payments in lieu of taxes....... 25,187 7,887 (824) 14,075 53,980
Extraordinary items, net of federal income tax
effect...................................... -- -- -- (8,953) (4,638)
Cumulative effect of change in tax accounting
method...................................... -- -- -- 13,365 60,045
Minority interest in earnings of consolidated
subsidiaries................................ 13,570 15,793 13,992 13,991 14,030
----------- ----------- ----------- ----------- -----------
Net income.................................... $ 114,278 $ 289,902 $ 240,275 $ 267,323 $ 267,555
=========== =========== =========== =========== ===========
Net income attributable to common stock....... $ 95,859 $ 271,318 $ 221,691 $ 253,764 $ 262,140
=========== =========== =========== =========== ===========
Net income per common share(1):
Primary..................................... $0.85 $2.47 $2.09 $2.42 $2.82
Fully diluted............................... 0.85 2.42 2.06 2.36 2.71
Cash dividends paid per common share(1)(2).... 0.90 0.77 0.70 0.50 0.33
Common stock dividend payout ratio(2)(3)...... 29.01% 25.74% 24.50% 15.98% 15.43%
Return on average assets...................... 0.27 0.73 0.69 0.84 1.29
Return on average stockholders' equity........ 4.59 13.44 12.66 15.95 21.05
Return on average common stockholders'
equity...................................... 4.39 13.73 12.95 16.78 21.05
Average fully diluted common shares used to
calculate earnings per share(5)............. 113,138,724 115,363,724 111,664,374 110,753,774 103,446,289
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DECEMBER 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Assets................................... $44,551,925 $42,026,622 $37,481,296 $33,614,912 $27,678,923
Available-for-sale securities............ 9,111,274 12,154,725 4,282,160 1,751,905 --
Held-to-maturity securities.............. 2,860,347 3,197,720 4,456,031 5,663,635 4,638,473
Loans:
Residential............................ 22,660,715 17,303,305 17,766,215 13,828,459 11,734,594
Residential construction............... 723,645 615,814 549,271 430,215 366,808
Commercial real estate................. 3,810,968 3,487,574 4,699,220 4,515,449 3,194,184
Manufactured housing, second mortgage
and other consumer.................. 3,158,741 2,841,854 2,573,327 2,403,169 1,431,834
Commercial business.................... 340,149 179,568 129,048 131,468 118,717
Reserve for loan losses................ (363,442) (235,275) (244,989) (245,062) (179,612)
----------- ----------- ----------- ----------- -----------
Total loans......................... 30,330,776 24,192,840 25,472,092 21,063,698 16,666,525
========== ========== ========== ========== ==========
Deposits................................. 24,080,141 24,462,960 23,344,006 23,516,317 20,729,204
Annuities................................ 878,057 855,503 799,178 713,383 571,428
Borrowings............................... 16,805,931 13,724,132 11,147,389 6,653,241 4,563,052
Preferred stock.......................... 113,695 250,168 252,034 252,053 266,633
Stockholders' equity..................... 2,397,888 2,541,704 1,854,836 1,765,560 1,467,835
Stockholders' equity ratio............... 5.38% 6.05% 4.95% 5.25% 5.30%
Fully diluted book value per common
share(1)(4)............................ $19.30 $20.70 $15.33 $14.84 $12.78
Number of fully diluted common shares at
end of period(5)....................... 126,142,285 125,107,107 121,140,169 118,876,251 117,351,928
- ---------------
(1) Net income per common share, cash dividends paid per common share, fully
diluted book value per common share and number of common shares outstanding
for 1992 have been adjusted for the third quarter 1993 50% stock dividend.
(2) Dividends include only amounts paid to Washington Mutual, Inc. shareholders.
(3) Dividend payout ratio is based on Washington Mutual's net income prior to
business combinations.
(4) Does not include 8,000,000 shares of common stock issued to an escrow for
the benefit of the general and limited partners of Keystone Holdings and the
FRF.
(5) As part of the business combination with Keystone Holdings, 8,000,000 shares
of common stock, with an assigned value of $42.75 per share, were issued to
an escrow for the benefit of the general and limited partners of Keystone
Holdings and the FRF and their transferees. The Company will use the
treasury stock method to determine the effect of the shares upon the
Company's financial statements. At December 31, 1996, the dilutive effect of
the 8,000,000 shares of common stock on primary and fully diluted earnings
per share was minimal.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and Notes thereto presented elsewhere in
this report.
GENERAL
Washington Mutual is a regional financial services company committed to
serving consumers and small and mid-sized businesses throughout the Western
United States. The Company's banking subsidiaries accept deposits from the
general public, make residential loans, consumer loans, limited types of
commercial real estate loans (primarily loans secured by multi-family
properties), and engage in certain commercial banking activities. Washington
Mutual also underwrites and sells annuities, sells other insurance products,
offers full service securities brokerage, and acts as the investment advisor to
and the distributor of mutual funds.
The Keystone Transaction. In December 1996, Keystone Holdings merged with
and into Washington Mutual, and all of the subsidiaries of Keystone Holdings,
including ASB, became subsidiaries of the Company. ASB will remain an operating
subsidiary of the Company. The Keystone Transaction was accounted for as a
pooling-of-interests. The financial information presented herein has been
restated as if the respective companies had been combined for all periods
presented. Accordingly, unless otherwise noted, all references to Washington
Mutual or the Company refer to the combined entity, including Keystone Holdings.
Keystone Holdings commenced operations in December 1988 as an indirect
holding company for ASB. ASB was formed to effect the December 1988 acquisition
(the "1988 Acquisition") of certain assets and liabilities of the failed savings
and loan association subsidiary (the "Failed Association") of Financial
Corporation of America. In connection with the 1988 Acquisition, the Federal
Savings and Loan Insurance Corporation ("FSLIC") received warrants (the
"Warrants") that represented the right to purchase capital stock of ASB's
corporate parent, an intermediary holding company between Keystone Holdings and
ASB. In addition, the 1988 Acquisition had a "good bank/bad bank" structure,
with ASB, the "good bank," acquiring substantially all of the Failed
Association's performing loans and fixed assets and assuming substantially all
of its deposit liabilities. New West, the "bad bank," was formed to acquire the
Failed Association's other assets (including nonperforming loans) and
liabilities with a view toward their liquidation. New West was transferred to
the FDIC as manager of the FRF, prior to consummation of the Keystone
Transaction. New West was subsequently liquidated.
The Company anticipates that it will consolidate certain head office
functions and back office operations of ASB. The Company anticipates achieving
certain cost savings from such consolidations. However, the Company expects the
actual level of expenses to rise modestly as a result of anticipated growth in
ASB's residential lending and other consumer banking activities. In addition,
the Company will pursue opportunities to acquire other California operations. If
successful, the Company anticipates a further rise in expenses.
Other Acquisition Activity. In recent years, Washington Mutual has
continued to expand its operations through business combinations with other
financial institutions with locations in Washington, Oregon, Utah, and Montana.
Beginning in 1995, Washington Mutual took steps to diversify its operations into
commercial banking. In August 1995, the Company acquired Enterprise, a
Seattle-area commercial bank, and in January 1996, acquired Western, a
commercial bank with branch operations throughout Oregon. Each of these
transactions was accounted for as a pooling-of-interests.
RESULTS OF OPERATIONS
Washington Mutual's 1996 net income of $114.3 million was down from $289.9
million in 1995 and $240.3 million in 1994. Earnings for 1996 were reduced by
$294.6 million due to an after-tax charge of $209.8 million for
transaction-related expenses resulting from the Keystone Transaction, and by a
third quarter after-tax charge of $84.8 million representing the Company's
portion of the one-time assessment paid by savings institutions and banks
nationally to recapitalize the SAIF. Fully diluted earnings per share were $0.85
in 1996, compared with $2.42 in 1995 and $2.06 in 1994. Washington Mutual's
return on average assets for 1996 equaled 0.27%, down from 0.73% in 1995 and
0.69% in 1994. Its return on common stockholders'
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equity for 1996 was 4.39%, also down from 13.73% in 1995 and 12.95% in 1994. An
increase of approximately 250 basis points in short-term market interest rates
in 1994 led to a compression of the net interest margin and a corresponding
pressure on net interest income in 1994 and 1995. Certain short-term interest
rates decreased 25 basis points in mid-1995 and again in December 1995,
resulting in an improved operating environment for the Company during 1996 and
1995 over 1994.
Net Interest Income. Net interest income for 1996 of $1.2 billion
increased 20% from $992.7 million in 1995, which in turn was 3% higher than the
$960.1 million earned during 1994. The net interest margin (which measures the
Company's net interest income as a percentage of average interest-earning
assets) for 1996 was 2.89%, compared with 2.62% in 1995 and 2.90% in 1994. The
1996 increase in net interest income and margin reflected the effect of two
primary factors. First, average interest-earning assets of $41.2 billion
increased 9% from 1995. Second, the net interest spread (which is the difference
between the Company's yield on interest-earning assets and its cost of funds)
rose to 2.75% for 1996 from 2.53% during 1995. To a certain extent, the
Company's net interest spread is affected by changes in the yield curve. Savings
institutions generally have better financial results in a steep yield curve
environment. During 1996, the difference between the yield on a three-month
treasury bill and a 30-year bond was 155 basis points compared with 124 basis
points a year earlier. This increased differential helped increase the Company's
net interest spread.
The net interest spread rose to 2.75% during 1996 from 2.53% for 1995.
Although long-term interest rates were generally higher during 1996 when
compared with 1995, the Company's yield on loans and investments dropped 6 basis
points to 7.64% during 1996, compared with 7.70% for 1995. As part of a strategy
initiated in late 1995 and continued in 1996 to restructure the Company's asset
base, the Company purchased adjustable-rate assets while selling fixed-rate
assets. See "-- Interest Rate Risk Management." The disposition of these higher
yield fixed-rate assets and inclusion of more adjustable-rate assets more than
offset the increased yields resulting from higher market interest rates. The
decrease in market short-term interest rates during 1996 led to a decline in the
Company's cost of funds to 4.89% for 1996, from 5.17% during 1995. In addition
to the favorable interest rate environment, the Company's cost of funds was
positively affected by a change in its deposit mix. Maturing time deposit
accounts were replaced, in part, with lower interest-cost money market and
checking accounts.
The growth in net interest income in 1995 was due primarily to an increase
in average interest-earning assets. Although average interest-earning assets
increased 14% during 1995, a decline in the net interest spread from 2.82% in
1994 to 2.53% in 1995 limited the increase in net interest income. The full
effect of the rise in short-term rates that began in late 1994 was felt in 1995
(mitigated somewhat by a subsequent lowering of short-term rates mid-year)
increasing the cost of funds during 1995 to 5.17% from 4.11% during 1994. The
yield on interest-earning assets during 1995 increased to only 7.70% from 6.93%
during 1994 because long-term interest rates did not increase as much as
short-term rates. The Company also was not in a position to take full advantage
of the increase in long-term interest rates because a sizable portion of its
earning assets were fixed rate during this period. The net interest spread
declined to 2.53% for 1995 from 2.82% in 1994.
Rising interest rates during 1994 and into 1995 also had a negative effect
on the net interest spread due to the lag in repricing of the Company's ARMs,
particularly its ARMs indexed to COFI. In both 1995 and 1994, the net interest
spread was negatively affected by the lag between COFI and changes in the
repricing of the Company's interest-bearing liabilities. However, during 1996,
short-term interest rates, the main component of COFI, declined slightly with
the result that the repricing lag provided a slight benefit to the net interest
spread. See "-- Interest Rate Risk Management" and "Consolidated Financial
Statements -- Note 17: Interest Rate Risk Management."
31
34
The following table sets forth information regarding the Company's
consolidated average statements of financial condition, together with the total
dollar amounts of interest income and expense and the weighted average interest
rates for the periods presented.
YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994
--------------------------------- --------------------------------- ---------------------------------
INTEREST INTEREST INTEREST
INCOME INCOME INCOME
AVERAGE OR AVERAGE OR AVERAGE OR
BALANCE(1) RATE EXPENSE BALANCE(2) RATE EXPENSE BALANCE(2) RATE EXPENSE
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Investments........... $14,327,183 7.05% $1,009,723 $11,260,051 7.06% $ 795,444 $ 8,790,748 5.64% $ 495,556
New West Note......... 723,800 8.13 58,841 2,346,753 6.01 141,039
Loans(3).............. 26,903,243 7.95 2,139,513 25,877,673 7.97 2,061,801 21,987,836 7.54 1,658,818
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total
interest-earning
assets.......... 41,230,426 7.64 3,149,236 37,861,524 7.70 2,916,086 33,125,337 6.93 2,295,413
Other assets.......... 1,771,424 1,841,038 1,744,338
----------- ----------- -----------
Total assets...... $43,001,850 $39,702,562 $34,869,675
=========== =========== ===========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits:
Checking accounts... $ 2,449,233 1.00 24,578 $ 2,389,793 1.20 28,672 $ 2,424,250 1.22 29,530
Savings and money
market accounts... 7,115,008 3.40 242,023 6,648,539 3.94 261,958 6,107,997 2.74 167,091
Time deposits....... 14,482,419 5.48 794,222 15,242,445 5.54 844,188 14,557,602 4.51 656,045
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total deposits.... 24,046,660 4.41 1,060,823 24,280,777 4.67 1,134,818 23,089,849 3.69 852,666
Borrowings:
Annuities........... 812,185 5.01 40,658 801,129 5.58 44,716 734,969 4.51 33,143
Federal funds
purchased......... 847,690 5.46 46,269 305,468 5.30 16,188 -- -- --
Securities sold
under agreements
to repurchase..... 8,987,234 5.51 495,483 7,749,929 6.23 482,698 4,328,894 4.68 202,677
Advances from the
FHLB.............. 4,655,111 5.57 259,243 3,482,200 5.81 202,422 3,962,913 5.38 213,259
Other
interest-bearing
liabilities....... 675,507 8.25 55,753 558,320 7.63 42,594 397,307 8.46 33,613
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total
borrowings...... 15,977,727 5.62 897,406 12,897,046 6.11 788,618 9,424,083 5.12 482,692
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total
interest-bearing
liabilities..... 40,024,387 4.89 1,958,229 37,177,823 5.17 1,923,436 32,513,932 4.11 1,335,358
---- ---------- ---- ---------- ---- ----------
Other liabilities..... 486,701 367,702 458,350
----------- ----------- -----------
Total
liabilities..... 40,511,088 37,545,525 32,972,282
Stockholders'
equity.............. 2,490,762 2,157,037 1,897,393
----------- ----------- -----------
Total liabilities
and
stockholders'
equity.......... $43,001,850 $39,702,562 $34,869,675
=========== =========== ===========
Net interest spread
and net interest
income.............. 2.75% $1,191,007 2.53% $ 992,650 2.82% $ 960,055
==== ========== ==== ========== ==== ==========
Net interest margin... 2.89% 2.62% 2.90%
- ---------------
(1) Average balances were calculated on a monthly basis. Due to the relative
consistency of the Company's asset and liability balances during 1996, the
average balances calculated on a monthly basis approximate the average
balances calculated on a daily basis and were representative of the
Company's operations in 1996.
(2) Average balances were calculated on a daily basis for Keystone Holdings and
were calculated on a monthly basis for Washington Mutual. Due to the
relative consistency of the Company's asset and liability balances during
1995 and 1994, the average balances calculated on a monthly basis
approximate the average balances calculated on a daily basis and were
representative of the Company's operations in 1995 and 1994.
(3) Nonaccruing loans were included in the average loan amounts outstanding.
32
35
The following table presents certain information regarding changes in
interest income and interest expense of the Company during the periods
indicated. The dollar amounts of interest income and interest expense fluctuate
depending upon changes in interest rates and upon changes in amounts (volume) of
the Company's interest-earning assets and interest-bearing liabilities. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to: (i) changes in volume
(changes in average outstanding balances multiplied by the prior period's rate)
and (ii) changes in rate (changes in average interest rate multiplied by the
prior period's volume). Changes in rate/volume (changes in rate times the change
in volume) are allocated proportionately to the changes in volume and the
changes in rate.
1996 VS. 1995 1995 VS. 1994
------------------------------- -------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
-------------------- TOTAL -------------------- TOTAL
VOLUME(1) RATE CHANGE VOLUME(2) RATE CHANGE
--------- -------- -------- --------- -------- --------
(DOLLARS IN THOUSANDS)
INTEREST INCOME
Investments....................... $216,155 $ (1,876) $214,279 $ 157,735 $142,153 $299,888
New West Note..................... (58,841) -- (58,841) (167,731) 85,533 (82,198)
Loans(3).......................... 81,552 (3,840) 77,712 305,959 97,024 402,983
-------- -------- -------- --------- -------- --------
Total interest income........ 238,866 (5,716) 233,150 295,963 324,710 620,673
INTEREST EXPENSE
Deposits:
Checking accounts............... 734 (4,828) (4,094) (417) (441) (858)
Savings and money market
accounts..................... 21,029 (40,964) (19,935) 15,877 78,990 94,867
Time deposits................... (41,748) (8,218) (49,966) 32,067 156,076 188,143
-------- -------- -------- --------- -------- --------
Total deposit expense........ (19,985) (54,010) (73,995) 47,527 234,625 282,152
Borrowings:
Annuities....................... 627 (4,685) (4,058) 3,178 8,395 11,573
Federal funds purchased......... 29,582 499 30,081 16,188 -- 16,188
Securities sold under agreements
to repurchase................ 45,540 (32,755) 12,785 197,482 82,539 280,021
Advances from the FHLB.......... 64,912 (8,091) 56,821 (31,996) 21,159 (10,837)
Other........................... 9,467 3,692 13,159 11,855 (2,874) 8,981
-------- -------- -------- --------- -------- --------
Total borrowing expense...... 150,128 (41,340) 108,788 196,707 109,219 305,926
-------- -------- -------- --------- -------- --------
Total interest expense....... 130,143 (95,350) 34,793 244,234 343,844 588,078
-------- -------- -------- --------- -------- --------
Net interest income............... $108,723 $ 89,634 $198,357 $ 51,729 $(19,134) $ 32,595
======== ======== ======== ========= ======== ========
- ---------------
(1) Average balances in 1996 were calculated on a monthly basis. Due to the
relative consistency of the Company's asset and liability balances during
1996, the average balances calculated on a monthly basis approximate the
average balances calculated on a daily basis and were representative of the
Company's operations in 1996.
(2) Average balances were calculated on a daily basis for Keystone Holdings and
were calculated on a monthly basis for Washington Mutual. Due to the
relative consistency of the Company's asset and liability balances during
1995 and 1994, the average balances calculated on a monthly basis
approximate the average balances calculated on a daily basis and were
representative of the Company's operations in 1995 and 1994.
(3) Nonaccruing loans were included in the average loan amounts outstanding.
33
36
Other Income. Other income was $259.3 million in 1996, up from $208.3
million in 1995 and $220.8 million in 1994.
Other income consisted of the following:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Depositor fees..................................... $102,597 $ 79,017 $ 45,255
Loan servicing fees................................ 41,303 29,315 23,247
Securities, annuities and other fees............... 53,350 49,679 65,248
Other operating income............................. 36,419 31,035 39,630
Gain on sale of loans.............................. 19,729 1,717 23,488
Gain (loss) on sale of other assets................ 5,866 (655) 23,926
Loss on sale of covered assets..................... -- (37,399) --
FDIC assistance on covered assets.................. -- 55,630 --
-------- -------- --------
Total other income............................... $259,264 $208,339 $220,794
======== ======== ========
Depositor fees of $102.6 million in 1996 increased substantially from fees
of $79.0 million in 1995 and $45.3 million in 1994. The increases reflected a
revised fee structure on checks drawn on nonsufficient funds and overdraft fees
combined with an aggressive marketing campaign that substantially increased the
number of checking accounts. The number of retail checking accounts grew to
863,837 in 1996 from 743,852 in 1995 and 611,482 in 1994. The primary component
of this growth was noninterest-bearing checking accounts, which management
considers the core accounts of its consumer banking strategy. Checking accounts
are an attractive means of providing low-cost deposits, producing added fee
income and generating opportunities to sell the Company's other products and
services. The growth in depositor fees has been tempered somewhat by an increase
in the amount of deposit account-related losses (included in other operating
expense) incurred by the Company resulting from the increased number of checking
accounts. Management closely monitors the amount of losses incurred to assure
the profitability of its revised fee structure.
Loan servicing fees were $41.3 million in 1996, up from $29.3 million in
1995 and $23.2 million in 1994. Included in the 1996 increase was $1.4 million
of additional loan servicing fees booked in September 1996 resulting from a
change of accounting method related to the loan servicing system. The higher
level of loan servicing fees recognized reflected the increase in the amount of
loans serviced for others. The average balance of loans serviced for others
during 1996 increased approximately 48% from 1995 due primarily to the
securitization and sale of residential loans. Loans serviced for others totaled
$23.0 billion at December 31, 1996. The increase in the portfolio of loans
serviced for others to $21.4 billion at December 31, 1995, from $15.3 billion at
the end of 1994 was due to the purchase of servicing rights on $4.2 billion of
loans and loan securitizations. During 1994, the Company purchased the rights to
service $3.9 billion of ARMs and sold servicing rights relating to $1.9 billion
of its fixed-rate loan portfolio.
Loan servicing fees consisted of the following:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Loan servicing income.............................. $ 71,918 $ 53,155 $ 43,665
Amortization of mortgage servicing rights.......... (30,615) (23,840) (20,418)
-------- -------- --------
Loan servicing fees.............................. $ 41,303 $ 29,315 $ 23,247
======== ======== ========
Securities, annuities and other fees were principally generated by the
Company's nonbanking subsidiaries and totaled $53.4 million for 1996, compared
with $49.7 million for 1995 and $65.2 million for 1994. During 1994, Mutual
Travel Inc. ("Mutual Travel"), the Company's travel agency subsidiary, recorded
$14.2 million of service fees. With the sale of Mutual Travel in March 1995,
fees recorded by the company amounted to
34
37
only $3.6 million for 1995. The lower level of service fees during 1995 was also
the result of lower than anticipated sales activity at Murphey Favre.
Other operating income during 1996 was $36.4 million, compared with $31.0
million in 1995 and $39.6 million in 1994. The majority of other operating
income was derived from loan-related fees.
Gain on sale of loans totaled $19.7 million in 1996, compared with $1.7
million in 1995 and $23.5 million in 1994. Most of the gains recognized during
1996 were the result of selling $2.0 billion of fixed-rate loans as part of the
Company's program of selling fixed-rate loan production with the objective of
reducing the effect of future movements in interest rates. See below for further
discussion of gain recognition under a new accounting pronouncement. During 1995
and 1994, Washington Mutual retained or securitized most of its loan production.
During 1994, a $25.0 million gain was realized on the sale of the Company's
credit card portfolio with a book value of $151.9 million.
The balance of mortgage servicing rights increased to $140.7 million at
December 31, 1996, from $104.5 million at the end of 1995 and $70.9 million at
the end of 1994. The higher level of capitalized servicing rights reflected the
increase in the amount of loans serviced for others and the implementation of
SFAS No. 122, Accounting for Mortgage Servicing Rights by the Company in 1995.
SFAS No. 122 eliminates the distinction between servicing rights that are
purchased and those that are retained upon the sale or securitization of loans.
The statement requires mortgage servicers to record the servicing rights on
loans as separate assets, no matter what their origin. Banks that sell or
securitize loans and retain the servicing rights are required to allocate the
total cost of the loans between servicing rights and principal balance.
Capitalizing the mortgage servicing rights on loans originated for sale
effectively reduces the Company's cost basis in the loans and leads to higher
gains on sale. As a result, gains on the sale of loans were $17.4 million more
in 1996 than would have been recognized under prior accounting policies.
Mortgage servicing rights were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year......................... $104,495 $ 70,911 $ 66,031
Additions........................................ 74,398 58,306 38,385
Sales............................................ (5,395) -- (13,087)
Amortization..................................... (30,615) (23,840) (20,418)
Valuation allowance.............................. (2,158) (882) --
-------- -------- --------
Balance, end of year............................... $140,725 $104,495 $ 70,911
======== ======== ========
Gain (loss) on sale of other assets consisted of the following:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
Securities transactions............................... $(2,617) $ (400) $ 4,156
Mortgage servicing rights............................. 4,030 -- 20,396
Premises and equipment................................ (958) (1,458) (1,270)
Recognition of deferred gain on sale of Mutual
Travel.............................................. 4,100 -- --
Other................................................. 1,311 1,203 644
------- ------- -------
Total gain (loss) on sale of assets................. $ 5,866 $ (655) $23,926
======= ======= =======
Net gains on the sale of other assets of $5.9 million during 1996 included
the recognition of a $4.1 million previously deferred gain on the March 1995
sale of Mutual Travel; a $4.0 million gain on the sale of mortgage servicing
rights related to $586.8 million of loans serviced for others; and a $2.6
million net loss on securities transactions. The net loss on the sale of
securities were incurred in connection with the Company's strategy to
35
38
reduce its exposure to movements in interest rates. See "-- Net Interest Income"
and "-- Interest Rate Risk Management." During 1995, the net loss of $655,000 on
the sale of other assets was primarily due to an $8.4 million write-down
recorded due to credit quality deterioration on certain MBS partially offset by
gains generated through the sale of fixed-rate MBS. Included in gains on the
sale of other assets in 1994 of $23.9 million was the recognition of a $20.4
million gain on the sale of mortgage servicing rights related to $1.9 billion of
loans serviced for others.
During 1995, a loss of $37.4 million was recognized on the sale of certain
assets by ASB. These assets, single-family residential loans, were acquired by
ASB in the 1988 Acquisition and were designated by relevant agreements as
covered assets. The loss on the sale of the covered assets was offset by a $55.6
million payment received during the same year from the FRF representing
compensation, under the terms of the 1988 Acquisition, for the remaining value
of such covered assets computed in accordance with the Assistance Agreement.
Other Expense. Other expense in 1996 totaled $1.0 billion, compared with
$700.5 million in 1995 and $695.5 million in 1994. Included in other expense in
1996 were transaction-related expenses of $158.1 million resulting from the
Keystone Transaction and the one-time SAIF recapitalization assessment of $124.2
million.
Other expense consisted of the following:
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- --------- ---------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits............................ $ 336,065 $ 313,304 $ 315,424
Occupancy and equipment................................... 124,278 110,981 102,403
Regulatory assessments.................................... 43,171 54,909 54,887
SAIF special assessment................................... 124,193 -- --
Data processing fees...................................... 40,733 36,538 33,862
Other operating expense................................... 159,541 143,794 146,463
Transaction-related expense............................... 158,121 2,000 --
Amortization of goodwill and other intangible assets...... 27,672 28,306 29,076
REO operations............................................ 11,530 10,682 13,402
---------- -------- --------
Total other expense..................................... $ 1,025,304 $ 700,514 $ 695,517
========== ======== ========
Salaries and employee benefits increased to $336.1 million during 1996 from
$313.3 million during 1995 and $315.4 million during 1994 due primarily to
increases in staffing levels in commercial banking, consumer financial centers
and loan administration. Full-time equivalent employees were 8,322 at December
31, 1996, up from 7,903 at year-end 1995. The increase in full-time equivalent
employees was moderated by the sale of the Company's item processing operation
and outsourcing of functions in the information systems and property management
departments during 1996. The number of full-time equivalent employees at the end
of 1995 was virtually unchanged from 7,915 at the end of 1994.
The increase in occupancy and equipment expense to $124.3 million in 1996
from $111.0 million in 1995 and $102.4 million in 1994 was primarily due to the
growth in the number of consumer financial centers, an expansion of head office
facilities and technology upgrades.
Regulatory assessments (excluding the one-time SAIF recapitalization
assessment) decreased to $43.2 million from $54.9 million in both 1995 and 1994,
reflecting a reduction in the assessment rate on the portion of the Company's
deposits insured through the BIF. Although total deposits outstanding increased
in 1995, the increase in deposit balances was offset by a reduction in the
premium rate for BIF-insured deposits.
On September 30, 1996, President Clinton signed legislation intended in
part to recapitalize the SAIF and to reduce the gap between SAIF premiums and
BIF premiums. The legislation provided for a special one-time assessment on
SAIF-insured deposits that were held as of March 31, 1995, including certain
deposits acquired after that date. The assessment was designed to bring the
SAIF's reserve ratio to the legally required level of $1.25 for every $100 in
insured deposits. Prior to this legislation, deposits of Washington Mutual
36
39
subsidiaries insured through the SAIF were subject to regular FDIC assessments
of 23 cents per $100 of insured deposits per year. Beginning in January 1997,
deposits of well-capitalized institutions insured through the SAIF are subject
to regular FDIC assessments of 6.48 cents per $100 per year, while deposits of
well-capitalized institutions insured through the BIF are subject to regular
FDIC assessments of 1.30 cents per $100 per year.
Washington Mutual's special assessment on deposits held by WMB, ASB and
WMBfsb resulted in a pretax charge of $124.2 million, which was taken in the
quarter ended September 30, 1996. Based on current levels of deposits,
Washington Mutual estimates that the reduction in the regular assessment on its
SAIF deposits beginning in 1997 should result in annual savings of approximately
$31 million.
Data processing fees in 1996 were $40.7 million, compared with $36.5
million in 1995 and $33.9 million in 1994. The year-to-year increase reflected
the continued use of outsourced data processing services.
Other operating expense increased to $159.5 million in 1996 from $143.8
million in 1995 and $146.5 million (inclusive of a $5.0 million expense for a
legal settlement) in 1994. See "-- Nonbanking Subsidiary Operations." Increases
in 1996 were due in part to higher telecommunications expenses and professional
fees associated with process reengineering projects. In general, other operating
expense tends to rise with the increased size of the Company.
Transaction-related expenses in 1996 associated with the Keystone
Transaction were related to severance and management payments, payments related
to a tax settlement between Keystone Holdings and the FRF, write-downs on
software and equipment, premiums paid on redemption of debt securities of a
Keystone Holdings subsidiary, professional fees and investment banking fees. As
part of the merger with Olympus Capital Corporation in 1995, the Company
recorded transaction-related expenses of $2.0 million.
Goodwill and other intangible assets have resulted from business
combinations accounted for as purchase transactions. Goodwill and other
intangible assets are amortized using the straight-line method over the period
that is expected to be benefited. The acquisition of Pacific First Bank, A
Federal Savings Bank in the second quarter of 1993 was the most significant of
such business combinations and resulted in the creation of $178.2 million in
goodwill and other intangible assets to be amortized over 10 years. The
amortization of goodwill and other intangible assets was $27.7 million in 1996,
compared with $28.3 million in 1995 and $29.1 million in 1994.
The expense from REO operations included provisions for REO losses of $7.1
million in 1996, $10.5 million in 1995 and $15.5 million in 1994. The provision
for REO losses mostly reflected credit problems in California. See "-- Asset
Quality -- Provision for Loan Losses and Reserve for Loan Losses." In general,
REO operations in California resulted in net operating expenses, as opposed to
net operating income in Washington.
Taxation. Income taxes include federal income taxes and applicable state
income taxes. See "Business -- Taxation."
In connection with the 1988 Acquisition, the Internal Revenue Service
entered into a closing agreement (the "Closing Agreement") with respect to the
federal income tax consequences of the 1988 Acquisition and certain aspects of
the taxation of Keystone Holdings and certain of its affiliates. The Closing
Agreement contains provisions that are intended to ensure that losses generated
by New West would be available to offset income of ASB for federal income tax
purposes. In connection with the 1988 Acquisition, Keystone Holdings and certain
of its affiliates entered into a number of continuing agreements with the
predecessor to the FRF, which agreements were designed, in part, to provide that
over time 75% of most of the federal income tax savings and 19.5% of most of the
California tax savings (in each case computed in accordance with specific
provisions contained in the Assistance Agreement) attributable to the
utilization of certain tax loss carryforwards of New West are paid ultimately to
the FRF. The provision for such payments is reflected in the financial
statements as "payments in lieu of taxes." Due to the above arrangements, the
Company's effective tax rate (including payments in lieu of taxes) for the two
years ended December 31, 1995 has ranged from approximately 28% to 30%, compared
to a normal corporate tax rate of 35%.
37
40
The provision for income taxes of $95.6 million for 1996 represented an
effective tax rate of 43%. The 1996 provision included a $25.2 million provision
for payments in lieu of taxes. In 1996, the benefit for use of net operating
loss carryover decreased due to the change of control as of December 20, 1996.
1996 was also the first year in which New West's current losses were not
included in ASB's taxable income. In addition, ASB realized in 1995 and 1994
benefits from increases to tax base year bad debt reserves which were not
realized in 1996. See "Consolidated Financial Statements -- Note 19: Income
Taxes."
Due to Section 382 of the Code, most of the value of the net operating loss
carryforward deductions of Keystone Holdings and its subsidiaries was eliminated
due to the Keystone Transaction. Accordingly, the future tax savings
attributable to such net operating loss carryforward deductions (other than
amounts used to offset bad debt reserve deduction recapture for ASB) will be
greatly reduced.
Nonbanking Subsidiary Operations. For a description of the Company's
principal nonbanking subsidiaries, see "Business -- Washington Mutual's
Operating Subsidiaries."
Nonbanking subsidiary results of operations were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
WM Life................................................... $16,269 $14,292 $12,482
ASB Financial............................................. 12,616 10,599 11,245
Composite Research........................................ 3,364 2,967 2,854
ASB Insurance............................................. 1,690 1,100 --
Murphey Favre............................................. 1,461 437 (2,249)
Mutual Travel............................................. -- 229 1,178
Other..................................................... 4,520 (644) (23)
------- ------- -------
Net income before amortization of goodwill and other
intangible assets, elimination of intercompany
transactions, and income taxes ("pretax operating
income")................................................ 39,920 28,980 25,487
Amortization of goodwill and other intangible assets...... 106 932 1,501
------- ------- -------
Net income before elimination of intercompany transactions
and income taxes........................................ $39,814 $28,048 $23,986
======= ======= =======
Pretax operating income for 1996 was $39.9 million, compared with $29.0
million in 1995 and $25.5 million in 1994.
WM Life improved its pretax operating income to $16.3 million during 1996
from $14.3 million in 1995 and $12.5 million in 1994. Most of the increase
during 1996 was due to higher net interest income resulting from growth in net
interest-earning assets funded in part by $79.3 million in advances from the
FHLB outstanding at the end of 1996. The improvement in earnings in 1995
primarily reflected asset growth funded by annuity sales. Annuities outstanding
at year-end 1995 were up 7% to $855.5 million from $799.2 million at the end of
1994 due to a high level of surrenders of annuity contracts. Annuities rose a
modest 3% during 1996 to end the year at $878.1 million.
ASB Financial had pretax operating income of $12.6 million in 1996, an
increase of 19%, compared with $10.6 million during 1995, primarily as a result
of greater securities sales. Higher sales commissions and salary expense,
related to higher securities commission revenues, resulted in a decrease in
pretax operating income in 1995 from $11.2 million in 1994.
Composite Research's pretax operating income improved slightly to $3.4
million during 1996 from $3.0 million during 1995 and $2.9 million during 1994.
Assets of the Composite Group of mutual funds, managed by Composite Research,
were $1.4 billion at December 31, 1996, $1.3 billion at year-end 1995 and $1.1
billion at December 31, 1994. The differences in asset balances are primarily
due to fluctuations in market valuation of the mutual fund assets.
38
41
Pretax operating income for ASB Insurance for 1996 totaled $1.7 million,
compared with $1.1 million for 1995. ASB Insurance began operations in 1995.
Murphey Favre posted pretax operating income of $1.5 million during 1996,
compared with $437,000 during 1995. During 1996, Murphey Favre recorded a $1.7
million charge resulting from a legal settlement. Lower sales reduced pretax
operating income to $437,000 in 1995. The pretax net loss of $2.2 million in
1994 resulted primarily from the $5.0 million expense of a legal settlement.
The results of operations during 1996 for other nonbanking subsidiaries
included the recognition of a previously deferred gain of $4.1 million on the
1995 sale of Mutual Travel. In March 1995, Washington Mutual sold Mutual Travel
to a company whose principal shareholders were Mutual Travel's management team.
The sales price resulted in a pretax gain of $4.1 million, which was recognized
in 1996.
REVIEW OF FINANCIAL POSITION
Assets. At December 31, 1996, the Company's assets were $44.6 billion, an
increase of 6% from $42.0 billion at December 31, 1995. During 1995, total
assets grew $4.5 billion. Most of the growth during 1996 and 1995 resulted from
retaining originated loans (either as part of the loan portfolio or as MBS).
Investment Activities. Washington Mutual's investment portfolio of $12.0
billion at December 31, 1996 declined 22% from the December 31, 1995 balance of
$15.4 billion. Contributing to the decline were paydowns of investment
securities and the Company's decision to continue the restructuring of its
investment portfolio by selling fixed-rate securities and replacing them with
adjustable-rate loans and securities. This portfolio restructuring was intended
to reduce Washington Mutual's sensitivity to changes in market interest rates.
As noted above, however, the portfolio restructuring also negatively affected
the yield on interest-earning investment securities. See "-- Net Interest
Income."
At December 31, 1996, the Company's investment portfolio included $9.1
billion of available-for-sale securities, $2.9 billion of held-to-maturity
securities (with a fair value of $2.9 billion), and $1.6 million of trading
account securities. MBS constituted $10.5 billion or 87% of the total investment
portfolio.
The Company's investment portfolio increased 76% to $15.4 billion at
December 31, 1995 from $8.7 billion a year earlier, primarily due to the
Company's retention of $6.6 billion of loans which it securitized. Also in 1995,
Washington Mutual leveraged its capital through purchases of investment
securities. These purchases were funded mostly through borrowings. By leveraging
the balance sheet through the use of these wholesale activities, Washington
Mutual generated additional net interest income.
At December 31, 1995, the Company's investment portfolio included $12.2
billion of available-for-sale securities, $3.2 billion of held-to-maturity
securities (with a fair value of $3.3 billion), and $238,000 of trading account
securities. During 1995, the Financial Accounting Standards Board ("FASB")
issued a report entitled A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities, Questions and
Answers which allowed companies a one-time reassessment and related
reclassification from the held-to-maturity category to the available-for-sale
category without adverse accounting consequences for the remainder of the
portfolio. Pursuant to the FASB report, Washington Mutual reclassified $4.9
billion of its held-to-maturity securities into the available-for-sale category
on December 1, 1995. Of the securities transferred, over half were fixed-rate
securities. See "Business -- Asset and Liability Management."
Loans. Total loans outstanding at December 31, 1996 were $30.3 billion, up
from $24.2 billion at December 31, 1995. Changes in the loan balances are
primarily driven by originations of new loans, prepayments of existing loans,
scheduled repayments of principal, and loan securitizations.
39
42
Loans, exclusive of reserve for loan losses, consisted of the following:
DECEMBER 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Loans:
Residential................... $22,660,715 $17,303,305 $17,766,215 $13,828,459 $11,734,594
Residential construction...... 723,645 615,814 549,271 430,215 366,808
Commercial real estate........ 3,810,968 3,487,574 4,699,220 4,515,449 3,194,184
Manufactured housing, second
mortgage and other
consumer................... 3,158,741 2,841,854 2,573,327 2,403,169 1,431,834
Commercial business........... 340,149 179,568 129,048 131,468 118,717
----------- ----------- ----------- ----------- -----------
Total loans................ $30,694,218 $24,428,115 $25,717,081 $21,308,760 $16,846,137
========== ========== ========== ========== ==========
Loans as a percentage of total
loans:
Residential................... 74% 71% 69% 65% 70%
Residential construction...... 2 2 2 2 2
Commercial real estate........ 13 14 18 21 19
Manufactured housing, second
mortgage and other
consumer................... 10 12 10 11 8
Commercial business........... 1 1 1 1 1
--- --- --- --- ---
Total loans................ 100% 100% 100% 100% 100%
=== === === === ===
Loans originated were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ---------- ----------
(DOLLARS IN THOUSANDS)
Real estate:
Residential (1-4 family units):
Fixed rate........................................... $ 3,708,874 $2,365,603 $1,040,035
Adjustable rate...................................... 6,240,190 4,455,740 5,288,231
Residential construction:
Custom............................................... 779,698 583,658 705,655
Speculative.......................................... 510,047 352,169 328,521
Apartment buildings..................................... 504,531 348,942 618,201
Other commercial real estate............................ 267,043 166,987 136,749
----------- ---------- ----------
Total real estate loans.............................. 12,010,383 8,273,099 8,117,392
Consumer:
Second mortgage and other consumer...................... 953,952 722,871 776,176
Manufactured housing.................................... 334,721 274,115 277,358
----------- ---------- ----------
Total consumer loans................................. 1,288,673 996,986 1,053,534
Commercial business....................................... 348,400 167,830 128,539
----------- ---------- ----------
Total loans originated............................... $13,647,456 $9,437,915 $9,299,465
=========== ========== ==========
Residential refinances to total residential
originations............................................ 38.71% 42.14% 48.31%
The strong housing market, attractive interest rates, and an increased
number of distribution outlets led to record lending volumes during 1996. In
early 1994, the Company's originations included significant refinancing activity
that was generated by low market interest rates. The onset of higher interest
rates later in 1994 curtailed refinancing activity for the year and resulted in
an increase in residential adjustable-rate originations compared to residential
fixed-rate originations. While refinancings increased again during the second
half of 1995 and during 1996 as market interest rates declined, they were
overshadowed by the rise in loans to purchase homes. Loans to purchase homes
accounted for $6.0 billion of residential originations during 1996
40
43
while refinancing activity produced $3.9 billion of loans, compared with the
previous year's $3.9 billion of loans to purchase homes and $2.9 billion of
refinance activity. In addition, of the total residential loans originated in
1996, 63% were adjustable rate -- about the same as in 1995. The decline in
apartment building originations from 1994 to 1995 was due to a management
decision at ASB to reduce lending volumes in that product line.
Deposits. Total deposits were $24.1 billion at December 31, 1996, compared
with $24.5 billion at the end of 1995.
Deposits consisted of the following:
DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Checking accounts:
Interest bearing...................................... $ 2,138,782 $ 2,111,124 $ 2,342,407
Noninterest bearing................................... 841,180 665,205 499,282
----------- ----------- -----------
2,979,962 2,776,329 2,841,689
Savings accounts........................................ 1,660,376 1,905,659 2,224,784
MMDAs................................................... 5,181,685 4,667,884 3,502,981
Time deposit accounts:
Due within one year................................... 12,159,123 12,696,186 10,496,491
After one but within two years........................ 1,011,934 1,410,809 2,780,944
After two but within three years...................... 647,988 409,580 765,219
After three but within four years..................... 333,234 243,541 293,167
After four but within five years...................... 102,681 258,415 293,522
After five years...................................... 3,158 94,557 145,209
----------- ----------- -----------
14,258,118 15,113,088 14,774,552
----------- ----------- -----------
Total deposits..................................... $24,080,141 $24,462,960 $23,344,006
=========== =========== ===========
Time deposits decreased during 1996 because management chose not to be
aggressive in their repricing. Partially offsetting the $855.0 million decline
in time deposits were increases in the level of money market and checking
accounts. Both of these products have the benefit of lower interest costs.
While the vast majority of its deposits are retail in nature, the Company
does engage in certain wholesale activities -- primarily accepting time deposits
from political subdivisions and public agencies. The Company considers wholesale
deposits to be an alternative borrowing source rather than a customer
relationship, and as such, their levels are determined by management's decisions
as to the most economic funding sources.
Financial data pertaining to deposits were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Decrease due to deposit outflow..................... $(1,550,305) $ (432,942) $(1,236,514)
Increase due to acquired deposits................... 106,663 417,078 211,537
Increase due to interest credited................... 1,060,823 1,134,818 852,666
----------- ----------- -----------
(Decrease) increase in total deposits.......... $ (382,819) $ 1,118,954 $ (172,311)
=========== =========== ===========
Total deposits at end of period..................... $24,080,141 $24,462,960 $23,344,006
Weighted average rate for the period................ 4.41% 4.69% 3.69%
Borrowings and Annuities. Washington Mutual's borrowings primarily take the
form of federal funds purchased, securities sold under agreements to repurchase
and advances from the FHLBs of Seattle and San Francisco. See
"Business -- Sources of Funds -- Borrowings and Annuities." The exact mix at any
given time is dependent upon the market pricing of the individual borrowing
sources. The increase in the level of borrowings in 1996 was used to fund the
Company's asset growth.
41
44
Borrowings and annuities consisted of the following:
DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Annuities....................................... $ 878,057 $ 855,503 $ 799,178
Federal funds purchased......................... 1,052,000 433,420 --
Securities sold under agreements to
repurchase.................................... 7,835,453 7,984,756 6,637,346
Advances from the FHLB.......................... 7,241,492 4,715,739 4,128,977
Other borrowings................................ 676,986 590,217 381,066
----------- ----------- -----------
Total borrowings.............................. $17,683,988 $14,579,635 $11,946,567
=========== =========== ===========
In August 1995, the Company filed a registration statement with the SEC for
the offering, on a delayed or continuous basis, of up to $250.0 million of debt
securities, of which $100.0 million remains available.
In December 1996, Washington Mutual entered into two Facilities: a $100.0
million 364-day facility and a $100.0 million 4-year facility. At December 31,
1996, no monies had been drawn. However, in January 1997, $150.0 million was
drawn for the redemption of debt securities of a Keystone Holdings' subsidiary
and in February 1997, another $20.0 million was drawn. The remaining proceeds of
the Facilities are available for general corporate purposes, including providing
capital at a subsidiary level.
SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, was issued in June 1996 and established,
among other things, new criteria for determining whether a transfer of financial
assets in exchange for cash or other consideration should be accounted for as a
sale or as a pledge of collateral in a secured borrowing. As issued, Statement
No. 125 is effective for all transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. In December
1996, the FASB issued SFAS No. 127, Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125. In general, SFAS No. 127 defers for one
year the effective date of SFAS No. 125. The Company will implement SFAS No.
125, as amended by SFAS No. 127 as required. The adoption is not anticipated to
have a material impact on the results of operations or financial position of the
Company.
ASSET QUALITY
Provision for Loan Losses and Reserve for Loan Losses. The provision for
loan losses is based upon management's estimate of the amount necessary to
maintain adequate reserves for losses inherent in the Company's loan portfolio.
The estimate of inherent losses is developed by management considering a number
of factors, including matters pertinent to the underlying quality of the loan
portfolio and management's policies, practices and intentions with respect to
credit administration and asset management. The provision for loan losses during
1996 was $201.5 million, which included a $125.0 million addition to the reserve
for loan losses at the date of the merger with Keystone Holdings. The additional
reserve for loan losses was provided principally because a number of Washington
Mutual's credit administration and asset management philosophies and procedures
differed from those of ASB. Those differences consisted principally of the
following: (i) Washington Mutual is more proactive in dealing with emerging
credit problems and tends to prefer foreclosure actions to induce borrowers to
correct defaults, whereas ASB was not as proactive and tended to prefer workouts
in lieu of a more aggressive foreclosure stance; and (ii) ASB considered the
risk characteristics of its portfolio of loans secured by apartment buildings of
less than $1.0 million to be similar to its single-family residential portfolio;
Washington Mutual, on the other hand, considers the risk characteristics of that
portfolio to be more closely aligned with its commercial real estate loan
portfolio, which tends to have a higher incidence of loan losses than the
single-family residential portfolio. Washington Mutual is conforming ASB's asset
management practices, administration, philosophies and procedures to those of
WMB and WMBfsb. The plan of realization of troubled loans differed between the
companies and therefore resulted in different levels of loss reserves. The
addition to the reserve for loan losses was to a lesser degree provided because
Washington Mutual believed that, while there had been an increase in the value
of residential real estate in certain California markets, a decline in
collateral values for some portions of the California real estate market
occurred in 1996. Management of the Company has individually reviewed ASB's
large performing and
42
45
nonperforming loans and performed a review of its other loan portfolios and is
developing appropriate strategies for such credits. As a result, Washington
Mutual allocated approximately 43% of the additional $125.0 million provision to
loans in the commercial real estate loan portfolio. The remainder was attributed
to ASB's various residential loan portfolios, for which specific reserve
allocations were not recorded.
In addition to the $125.0 million discussed above, the provision for loan
losses for 1996 included $76.5 million of charges, which was substantially
unchanged from the $75.0 million in 1995, reflecting the fact that the dollar
amounts of nonperforming assets were substantially the same in both periods. The
balance of the reserve for loan losses was $363.4 million or 110.29% of
nonperforming assets at December 31, 1996, compared with $235.3 million or
69.42% of nonperforming assets at December 31, 1995.
The provision for loan losses during 1995 was $75.0 million, compared with
$122.0 million in 1994 and $158.7 million in 1993. The 1995 provision reflected
a decline in the level of nonperforming assets, particularly California
residential and apartment building real estate loans. The 1994 provision
reflected a significant decline in the levels of certain nonperforming assets,
but was increased from levels otherwise indicated by $12.5 million related to
losses resulting from the Northridge, California earthquake in January 1994.
The provision for loan losses of $158.7 million during 1993 was virtually
unchanged from 1992's level of $158.5 million. During 1991, California's general
economic indicators, including employment, consumer confidence and the value of
residential real estate, began to deteriorate. These trends continued through
1992 and 1993. In response to these trends, the Company increased its reserve
for loan losses through the provision for loan losses during those years and
tightened underwriting standards at ASB. Management believes that the stricter
underwriting standards initiated at ASB in the latter part of 1991 and 1992 have
helped to alleviate the level of loan delinquencies, despite the recessionary
conditions that existed in California. The delinquency experience of loans
originated by ASB subsequent to 1992 has been significantly less than that of
those originated prior to 1992. Management believes that the high rate of
delinquencies in prior years' originations can be attributed to a subsequently
discontinued limited documentation program offered by ASB during 1989 and 1990,
as well as the general decline in the value of residential real estate that
resulted in the deterioration of many borrowers' equity. The loan loss provision
in 1992 and 1993 was also affected by the increase in the size of the loan
portfolio, and in 1993, caution about the quality of the loans acquired from
Pacific First.
Integral to determining the level of the provision for loan losses in any
given year is an analysis of actual loss experience and plans for problem loan
administration and resolution. Loan charge-offs, net of recoveries for 1996
totaled $74.4 million, which was less than the level of net charge-offs of $90.1
million in 1995, $123.0 million in 1994, $139.3 million in 1993, and $114.7
million in 1992. The downward trend in residential charge-offs over the past
several years resulted in declines in the overall provision for loan losses.
Charge-offs on loans secured by commercial real estate in 1996 were lower,
compared with the previous three years. Although charge-offs had been higher,
commercial real estate delinquencies as a percentage of the total commercial
real estate loan portfolio had declined significantly, contributing to the lower
overall provision for loan losses. At year-end 1992, commercial credits, which
consisted primarily of high-yield bonds, declined to $14.0 million from $22.2
million at the end of the previous year. This decline was mostly due to $6.6
million in sales during the year. However, by the end of 1992, nonperforming
assets in this portfolio had increased to $8.5 million from $360,000 one year
earlier. This increase in nonperforming credits was anticipated by management.
43
46
Changes in the reserve for loan losses were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year.............. $235,275 $244,989 $245,062 $179,612 $130,423
Provision for loan losses............... 201,512 74,987 122,009 158,728 158,537
Reserves added through business
combinations.......................... 1,077 5,372 921 46,000 5,321
Loans charged-off:
Residential........................... (53,993) (57,147) (89,637) (93,799) (77,815)
Residential construction.............. (16) (125) (190) (297) (937)
Commercial real estate................ (21,752) (33,149) (26,835) (26,967) (19,377)
Manufactured housing, second mortgage
and other consumer................. (6,639) (6,888) (10,544) (16,964) (17,017)
Commercial business/credits........... (435) (813) (2,065) (3,065) (1,321)
-------- -------- -------- -------- --------
(82,835) (98,122) (129,271) (141,092) (116,467)
Recoveries of loans previously
charged-off:
Residential........................... 4,437 2,393 2,522 45 17
Residential construction.............. -- 47 -- -- --
Commercial real estate................ 3,197 4,426 2,186 889 571
Manufactured housing, second mortgage
and other consumer................. 705 701 1,117 768 313
Commercial business/credits........... 74 482 443 112 897
-------- -------- -------- -------- --------
8,413 8,049 6,268 1,814 1,798
-------- -------- -------- -------- --------
Net charge-offs......................... (74,422) (90,073) (123,003) (139,278) (114,669)
-------- -------- -------- -------- --------
Balance, end of year.................... $363,442 $235,275 $244,989 $245,062 $179,612
======== ======== ======== ======== ========
Net charge-offs as a percentage of
average loans......................... 0.28% 0.35% 0.56% 0.70% 0.69%
As part of the process of determining the adequacy of the reserve for loan
losses, management reviews the loan portfolio for specific weaknesses. A portion
of the reserve is then allocated to reflect the identified loss exposure.
Residential real estate and consumer loans are not individually analyzed for
impairment and loss exposure because of the significant number of loans and
their relatively small individual balances. Residential construction, commercial
real estate and commercial business loans were evaluated individually for
impairment. Allocated reserves at the end of 1996 increased significantly to
$78.3 million. During 1996, the Company's review of ASB's loan portfolio
resulted in approximately 43% of the additional $125.0 million provision being
allocated to loans in the commercial real estate loan portfolio.
Unallocated reserves are established for loss exposure that may exist in
the remainder of the loan portfolio but has yet to be identified. In determining
the adequacy of unallocated reserves, management considers changes in the size
and composition of the loan portfolio, historical loan loss experience, current
and anticipated economic conditions, and the Company's credit administration and
asset management philosophies and procedures.
44
47
An analysis of the reserve for loan losses was as follows:
DECEMBER 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Allocated reserves:
Commercial real estate............ $ 77,054 $ 16,488 $ 20,025 $ 22,833 $ 22,496
Residential construction.......... -- 158 1,327 1,503 1,219
Commercial business/credits....... 1,285 -- -- 1,718 5,597
-------- -------- -------- -------- --------
Total allocated reserves....... 78,339 16,646 21,352 26,054 29,312
Unallocated reserves................ 285,103 218,629 223,637 219,008 150,300
-------- -------- -------- -------- --------
Total loan loss reserves....... $363,442 $235,275 $244,989 $245,062 $179,612
======== ======== ======== ======== ========
Total reserve for loan losses as a
percentage of:
Nonperforming loans............... 160.52% 110.04% 87.22% 72.74% 54.58%
Nonperforming assets.............. 110.29 69.42 58.52 46.91 31.98
A reserve for REO losses is maintained for any subsequent decline in the
value of foreclosed property. The reserve for REO losses was $7.1 million at
December 31, 1996, compared with $10.1 million at December 31, 1995. The level
is based upon a routine review of the REO portfolio and the strength of national
and local economies.
Classified Assets. The following table sets forth the Company's classified
assets, which consist of nonaccrual loans, loans under foreclosure, REO and
performing loans (including substandard troubled debt restructurings) and
securities that exhibit credit quality weaknesses. When and if loans sold on a
recourse basis are nonperforming, they are included in nonaccrual loans. See
"Consolidated Financial Statements -- Note 1: Summary of Significant Accounting
Policies."
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Nonaccrual loans and loans under foreclosure........................... $226,412 $213,802
REO.................................................................... 103,111 125,101
-------- --------
Total nonperforming assets........................................... 329,523 338,903
Troubled debt restructurings (classified as substandard)............... 82,048 85,483
Other classified assets................................................ 136,442 129,264
-------- --------
Total classified assets.............................................. $548,013 $553,650
======== ========
Nonperforming assets decreased to 0.74% of total assets at December 31,
1996 or $329.5 million, compared with $338.9 million or 0.81% of total assets at
December 31, 1995. Nonperforming assets decreased 19% to $338.9 million at the
end of 1995, from $418.7 million at the end of 1994. At December 31, 1996,
nonperforming assets in California accounted for 63% of total nonperforming
assets, down from 75% and 83% at the ends of 1995 and 1994. The decline in
nonperforming assets since 1992 was largely a result of a tightening of
underwriting standards at ASB beginning in mid-1991. Declining market rents and
occupancy rates in certain areas of Los Angeles that were negatively affected by
the economic environment during the three years ended December 31, 1995, as well
as the Los Angeles riots in 1992 and the Northridge earthquake in January 1994,
contributed to higher charge-offs in the apartment loan portfolio in 1994 and
1995, thereby reducing the level of nonperforming apartment loans. See
" -- Provision for Loan Losses and Reserve for Loan Losses."
45
48
Nonperforming assets and troubled debt restructurings consisted of the
following:
DECEMBER 31,
----------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Nonaccrual loans and loans under
foreclosure:
Real estate loans:
Residential............................ $180,438 $158,040 $172,136 $233,618 $253,888
Residential construction............... 9,235 9,550 4,640 8,527 5,856
Apartment buildings.................... 7,642 23,300 70,944 53,474 37,059
Other commercial real estate........... 6,555 12,663 23,549 20,516 14,883
-------- -------- -------- -------- --------
Total real estate loans.............. 203,870 203,553 271,269 316,135 311,686
Second mortgage and other consumer
loans.................................. 13,199 7,502 6,969 14,783 7,218
Manufactured housing loans................ 8,275 1,923 1,643 2,207 1,571
Commercial business loans/credits......... 1,068 824 1,018 3,785 8,580
-------- -------- -------- -------- --------
Total nonperforming loans............ 226,412 213,802 280,899 336,910 329,055
REO, net of REO reserves.................... 103,111 125,101 137,767 185,492 232,568
-------- -------- -------- -------- --------
Total nonperforming assets........... $329,523 $338,903 $418,666 $522,402 $561,623
======== ======== ======== ======== ========
Troubled debt restructurings................ $112,287 $ 90,623 $ 54,583 $ 68,670 $104,538
Nonperforming assets as a percentage of
total assets.............................. 0.74% 0.81% 1.12% 1.55% 2.03%
Nonperforming assets by geographic concentration were as follows:
DECEMBER 31, 1996
-------------------------------------------------------------------------
OTHER
CALIFORNIA WASHINGTON OREGON UTAH STATES TOTAL
---------- ---------- ------- ------ ------- --------
(DOLLARS IN THOUSANDS)
Real estate loans:
Residential............... $ 119,524 $ 42,119 $ 9,516 $1,908 $ 7,371 $180,438
Residential
construction........... -- 5,823 2,143 1,130 139 9,235
Apartment buildings....... 5,840 1,759 -- -- 43 7,642
Other commercial real
estate................. 1,979 1,718 227 -- 2,631 6,555
-------- ------- ------- ------ ------- --------
Total real estate
loans................ 127,343 51,419 11,886 3,038 10,184 203,870
Second mortgage and other
consumer loans............ 1,605 5,514 3,010 278 2,792 13,199
Manufactured housing
loans..................... -- 3,893 1,818 330 2,234 8,275
Commercial business loans... -- 193 691 -- 184 1,068
-------- ------- ------- ------ ------- --------
Total nonperforming
loans................ 128,948 61,019 17,405 3,646 15,394 226,412
REO......................... 82,862 25,019 461 160 1,753 110,255
REO reserves................ (7,144)
-------- ------- ------- ------ ------- --------
Total nonperforming
assets............... $ 211,810 $ 86,038 $17,866 $3,806 $17,147 $329,523
======== ======= ======= ====== ======= ========
Nonperforming assets by
state as a percentage of
total nonperforming
assets.................... 63% 26% 5% 1% 5% 100%
Impaired Loans. On January 1, 1995, the Company adopted SFAS No. 114,
Accounting by Creditors for Impairment of a Loan as modified by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures. It is applicable to all loans except large groups of
smaller-balance homogeneous loans that are collectively evaluated for
impairment. Loans collectively evaluated for impairment include residential real
estate and consumer loans. All residential construction, commercial real estate
and commercial business loans are individually evaluated for impairment. Factors
involved in determining impairment include, but are not limited to, the
financial condition of the borrower, the value of the underlying collateral, and
current economic conditions. SFAS No. 114 also applies to all loans that are
46
49
restructured in a troubled debt restructuring, subsequent to the adoption of
SFAS No. 114, as defined by SFAS No. 15, Accounting by Debtors and Creditors for
Troubled Debt Restructurings. A troubled debt restructuring is a restructuring
in which the creditor grants a concession to the borrower that it would not
otherwise consider. At December 31, 1996, the Company had $112.3 million of
restructured loans of which $82.0 million, though performing, were considered to
be impaired. Troubled debt restructurings that were not considered to be
impaired were restructured prior to 1995 and have been performing according to
the terms of the restructure in the year subsequent to the restructure.
A loan is considered impaired when it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. Impaired loans include all loans on nonaccrual, any substandard loan,
whether or not performing, with an allocated reserve and certain troubled debt
restructurings. SFAS No. 114 requires that impairment of loans be measured based
on the present value of expected future cash flows discounted at the loan's
effective interest rate or, as a practical expedient, at the loan's observable
market price or the fair value of the collateral if the loan is collateral
dependent. The Company bases the measurement of loan impairment on the fair
value of the loan's underlying collateral. The amount by which the recorded
investment in the loan exceeds the value of the impaired loan's collateral is
included in the Company's allocated reserve for loan losses. Any portion of an
impaired loan classified as loss under regulatory guidelines is charged off.
At December 31, 1996, loans totaling $317.3 million were impaired, of which
$260.7 million had allocated reserves of $42.9 million. The remaining $56.6
million were either nonperforming or previously written down and had no reserves
allocated to them. Of the $317.3 million of impaired loans, $22.7 million were
on nonaccrual status or under foreclosure. The average balance of impaired loans
during 1996 was $302.6 million and the Company recognized $14.6 million of
related interest income. Interest income is normally recognized on an accrual
basis; however, if the impaired loan is nonperforming, interest income is then
recorded on the receipt of cash. The rise in the level of impaired loans during
1996 reflected, for the most part, the Company's review of large commercial real
estate loans at ASB. Of the $125.0 million addition to the reserve for loan
losses, $18.9 million was allocated to $110.3 million of commercial real estate
loans that management deemed to be impaired.
The amount of impaired loans based upon the fair value of the underlying
collateral and the related allocated reserve for loan losses were as follows:
DECEMBER 31, 1996
------------------------------------------------------
GROSS LOAN PRINCIPAL NET LOAN ALLOCATED
AMOUNT CHARGED-OFF AMOUNT RESERVES
---------- ----------- -------- ----------
(DOLLARS IN THOUSANDS)
Nonaccrual loans and loans under foreclosure:
With allocated reserves...................... $ 10,909 $ 400 $ 10,509 $ 3,079
Without allocated reserves................... 15,792 3,552 12,240 --
-------- ------ -------- -------
26,701 3,952 22,749 3,079
Troubled debt restructurings:
With allocated reserves...................... 45,248 -- 45,248 7,960
Without allocated reserves................... 37,368 569 36,799 --
-------- ------ -------- -------
82,616 569 82,047 7,960
Other impaired loans:
With allocated reserves...................... 205,563 645 204,918 31,851
Without allocated reserves................... 12,437 4,833 7,604 --
-------- ------ -------- -------
218,000 5,478 212,522 31,851
-------- ------ -------- -------
Total impaired loans...................... $327,317 $ 9,999 $317,318 $ 42,890
======== ====== ======== =======
At December 31, 1995, loans totaling $169.1 million were impaired, of which
$91.7 million had allocated reserves of $16.6 million. The remaining $77.4
million were either nonperforming or previously written down and had no reserves
allocated to them. Of the $169.1 million of impaired loans, $26.7 million were
on
47
50
nonaccrual status or under foreclosure, and $142.3 million (including $57.1
million of troubled debt restructurings) were performing but judged to be
impaired.
The amount of impaired loans based upon the fair value of the underlying
collateral and the related allocated reserve for loan losses were as follows:
DECEMBER 31, 1995
------------------------------------------------------
GROSS LOAN PRINCIPAL NET LOAN ALLOCATED
AMOUNT CHARGED-OFF AMOUNT RESERVES
---------- ----------- -------- ----------
(DOLLARS IN THOUSANDS)
Nonaccrual loans and loans under foreclosure:
With allocated reserves...................... $ 9,853 $ 1,224 $ 8,629 $ 2,192
Without allocated reserves................... 19,226 1,113 18,113 --
-------- ------- -------- -------
29,079 2,337 26,742 2,192
Troubled debt restructurings:
With allocated reserves...................... 16,917 -- 16,917 3,115
Without allocated reserves................... 40,733 516 40,217 --
-------- ------- -------- -------
57,650 516 57,134 3,115
Other impaired loans:
With allocated reserves...................... 66,161 33 66,128 11,339
Without allocated reserves................... 25,665 6,600 19,065 --
-------- ------- -------- -------
91,826 6,633 85,193 11,339
-------- ------- -------- -------
Total impaired loans...................... $178,555 $ 9,486 $169,069 $ 16,646
======== ======= ======== =======
INTEREST RATE RISK MANAGEMENT
Washington Mutual engages in a comprehensive asset and liability management
program that attempts to reduce the risk of significant decreases in net
interest income caused by interest rate changes. One of the Company's strategies
to reduce the effect of future movements in interest rates is to increase the
percentage of adjustable-rate assets in its portfolio. During 1996, the Company
securitized and then sold the majority of the fixed-rate loans it originated,
while retaining nearly all of its adjustable-rate loan production. In addition,
as part of the restructuring strategy initiated in late 1995, the Company
purchased adjustable-rate assets and sold fixed-rate mortgage-backed securities.
The Company still, however, has short-term volatility of net interest income
because of the effect of the COFI lag. Management plans to reduce this
short-term volatility in part by increasing production of non-COFI
adjustable-rate products and short-term fixed-rate products such as consumer
loans.
The implementation of strategies to reduce interest rate risk, however,
generally has a negative effect on earnings. The Company monitors its interest
rate sensitivity and attempts to reduce the risk of a significant decrease in
net interest income caused by a change in interest rates; nevertheless, rising
interest rates or a flat yield curve adversely affect the Company's operations.
Management tries to balance these two factors in administering its interest rate
risk program.
As part of its asset and liability management program, the Company actively
manages asset and liability maturities and at various times uses derivative
instruments, such as interest rate exchange agreements and interest rate cap
agreements, to reduce the negative effect that rising rates could have on net
interest income. Derivative instruments, if not used appropriately, can subject
a company to unintended financial exposure. Management, in conjunction with the
Company's Board of Directors, has established strict policies and guidelines for
the use of derivative instruments. Moreover, Washington Mutual has used these
instruments for many years to mitigate interest rate risk. These instruments
generally are not intended to be used as techniques to generate earnings by
speculating on the movements of interest rates, nor does the Company act as a
dealer of these instruments. See "Consolidated Financial Statements -- Note 17:
Interest Rate Risk Management."
48
51
A conventional measure of interest rate sensitivity for savings
institutions is the one-year gap, which is calculated by dividing the difference
between assets maturing or repricing within one year and total liabilities
maturing or repricing within one year by total assets. The Company's assets and
liabilities that mature or reprice within one year were as follows:
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
Interest-sensitive assets......................................... $30,613,301 $27,732,380
Derivative instruments designated against assets.................. 1,150,000 1,825,000
Interest-sensitive liabilities.................................... (34,984,865) (31,469,960)
Derivative instruments designated against liabilities............. 1,598,400 832,000
----------- -----------
Net liability sensitivity....................................... $(1,623,164) $(1,080,580)
=========== ===========
One-year gap...................................................... (3.64)% (2.57)%
At the end of 1996, Washington Mutual's one-year gap was a negative 3.64%,
compared with a negative 2.57% at the end of 1995. While the Company's
consolidated one-year gap at December 31, 1996 was fairly neutral, WMB's and
ASB's one-year gap positions were quite different. WMB's one-year gap was a
negative 18.19% at the end of 1996 due in large part to the preference of its
customers for fixed-rate loan products. Management can compensate for this
preference by selling fixed-rate loans, purchasing adjustable-rate assets, and
strategically using hedging instruments, all of which were done during 1996.
Since the vast majority of interest-earning assets at ASB were COFI ARM
products, its one-year gap at the end of 1996 was a positive 12.85%. At December
31, 1996, the Company had entered into interest rate exchange agreements and
interest rate cap agreements with notional values of $9.1 billion. Without these
instruments, the Company's one-year gap at December 31, 1996, would have been a
negative 9.81% as opposed to a negative 3.64%. See "Consolidated Financial
Statements -- Note 17: Interest Rate Risk Management" for a discussion of the
use of derivative instruments.
49
52
Interest sensitivity analysis by maturity or repricing period was as
follows:
DECEMBER 31, 1996
--------------------------------------------------------------------------------------------
DUE WITHIN DUE WITHIN AFTER ONE AFTER TWO AFTER FIVE
0-3 4-12 BUT WITHIN BUT WITHIN BUT WITHIN AFTER
MONTHS MONTHS TWO YEARS FIVE YEARS 10 YEARS 10 YEARS TOTAL
----------- ----------- ----------- ---------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
INTEREST-SENSITIVE ASSETS
Cash, cash equivalents, and trading
account securities(1)............ $ 1,089,527 $ -- $ -- $ 1,648 $ -- $ -- $ 1,091,175
Available-for-sale securities(2)... 4,528,217 2,276,537 176,759 712,406 586,049 766,347 9,046,315
Held-to-maturity securities........ 2,673,283 1,445 12,144 35,495 51,698 86,282 2,860,347
Loans(3):
Real estate...................... 15,533,194 3,674,232 1,524,297 3,918,552 2,280,039 2,561,670 29,491,984
Manufactured housing, second
mortgage and other consumer.... 335,209 215,226 137,456 154,309 82,017 35,200 959,417
Commercial business.............. 259,559 26,872 11,549 19,733 2,832 -- 320,545
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total loans.................. 16,127,962 3,916,330 1,673,302 4,092,594 2,364,888 2,596,870 30,771,946
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total interest-sensitive
assets..................... 24,418,989 6,194,312 1,862,205 4,842,143 3,002,635 3,449,499 43,769,783
Derivative instruments affecting
interest sensitivity:
Interest rate exchange agreements:
Designated against
available-for-sale
securities..................... 500,000 -- (300,000) (200,000) -- -- --
Interest rate cap agreements:
Designated against
available-for-sale
securities..................... 1,050,000 (400,000) (650,000) -- -- -- --
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total effect of derivative
instruments................ 1,550,000 (400,000) (950,000) (200,000) -- -- --
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total interest-sensitive
assets..................... 25,968,989 5,794,312 912,205 4,642,143 3,002,635 3,449,499 43,769,783
INTEREST-SENSITIVE LIABILITIES
Deposits(4)........................ 10,390,870 8,071,838 1,583,909 460,865 77,810 3,493,255 24,078,547
Borrowings and other liabilities... 14,639,325 1,882,832 490,240 375,853 253,529 42,209 17,683,988
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total interest-sensitive
liabilities................ 25,030,195 9,954,670 2,074,149 836,718 331,339 3,535,464 41,762,535
Derivative instruments affecting
interest sensitivity:
Interest rate exchange
agreements:
Designated against deposits and
short-term borrowings........ (1,269,400) 286,500 337,500 636,200 9,200 -- --
Interest rate cap agreements:
Designated against deposits and
short-term borrowings........ (615,500) -- 254,000 361,500 -- -- --
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total effect of derivative
instruments................ (1,884,900) 286,500 591,500 997,700 9,200 -- --
----------- ----------- ----------- ---------- ---------- ---------- -----------
Total interest-sensitive
liabilities................ 23,145,295 10,241,170 2,665,649 1,834,418 340,539 3,535,464 41,762,535
----------- ----------- ----------- ---------- ---------- ---------- -----------
Net asset (liability)
sensitivity................ $ 2,823,694 $(4,446,858) $(1,753,444) $2,807,725 $2,662,096 $ (85,965) $ 2,007,248
=========== =========== =========== ========== ========== ========== ===========
Cumulative net (liability) asset
sensitivity...................... $ 2,823,694 $(1,623,164)
Cumulative net (liability) asset
sensitivity as a percentage of
total assets..................... 6.34% (3.64)%
- ---------------
(1) Includes accrued interest on interest-earning assets.
(2) Excludes mark-to-market adjustment.
(3) Excludes deferred loan fees, reserve for loan losses and premium and
discount on purchased loans.
(4) Excludes premium on purchased deposits. Deposits without stated maturity are
included in the category "Due within 0-3 months."
50
53
While the one-year gap helps provide some information about a financial
institution's interest sensitivity, it does not predict the trend of future
earnings. For this reason, Washington Mutual uses financial modeling to forecast
earnings under different interest rate projections. Although this modeling is
very helpful in managing interest rate risk, it does require significant
assumptions for the projection of loan prepayment rates, loan origination
volumes and liability funding sources that may prove to be inaccurate.
Washington Mutual adopted, as required, SFAS No. 115. This statement
requires investment and equity securities to be segregated into three
categories: trading, held-to-maturity and available-for-sale.
The available-for-sale portfolio is maintained as a source of investment
income as well as potential liquidity should it be necessary for the Company to
raise cash or reduce its asset size. Because the available-for-sale portfolio is
required to be carried at fair value, its carrying value fluctuates with changes
in market factors, primarily interest rates. This portfolio is substantially
composed of MBS, of which 84% have adjustable rates and the remainder have fixed
rates. In an attempt to modify the interest flows on these securities, as well
as protect against market value changes, certain interest rate exchange
agreements and interest rate cap agreements have been designated to the
available-for-sale portfolio. The effect of such agreements in a rising interest
rate environment is to shorten the effective repricing period of the underlying
assets. Specifically, as short-term interest rates increase, the overall yield
of the portfolio rises. However, the yield is constrained by periodic and
lifetime interest rate adjustment limits or caps on the underlying
adjustable-rate assets and also by the very nature of the fixed-rate assets in
the portfolio. The Company, therefore, seeks to shorten the repricing period by
entering into interest rate cap agreements that are intended to provide an
additional layer of interest rate protection against the effect of the periodic
and lifetime interest rate adjustment limits or caps and fixed-rate securities
in the portfolio. Through the use of specific interest rate cap agreements,
management attempts to reduce the repricing ceiling of the portfolio and to
effectively shorten the repricing period. Thus, the Company has a degree of
interest rate protection when interest rates increase because the interest rate
cap agreements provide a mechanism for repricing the investment portfolio
generally on pace with current market rates. In a similar way, interest rate
exchange agreements are utilized to provide protection in an increasing rate
environment, but also result in sensitivity in a downward market. There can be
no assurance that interest rate exchange agreements and interest rate cap
agreements will provide the Company with protection in all scenarios or to the
full extent of the Company's exposure.
The following table presents the effect interest rate exchange agreements
and interest rate cap agreements would have had on the repricing period of
securities in the available-for-sale portfolio in an increasing interest rate
environment (up 200 basis points) for the period the derivatives are
outstanding:
DECEMBER 31, 1996
--------------------------------------------------------------------
DUE WITHIN AFTER ONE
DUE WITHIN 4-12 BUT WITHIN AFTER
0-3 MONTHS MONTHS TWO YEARS TWO YEARS TOTAL
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Principal amount of
securities.................... $4,528,217 $2,276,537 $ 176,759 $2,064,802 $9,046,315
Effect of derivative
instruments................... 2,225,000 -- (159,126) (2,065,874) --
---------- ---------- --------- ---------- ----------
Principal amount of securities
after effect of derivative
instruments................... $6,753,217 $2,276,537 $ 17,633 $ (1,072) $9,046,315
========== ========== ========= ========== ==========
51
54
The following table presents the effect interest rate exchange agreements
and interest rate cap agreements would have had on the repricing period of
securities in the available-for-sale portfolio in a decreasing interest rate
environment (down 200 basis points) for the period the derivatives are
outstanding:
DECEMBER 31, 1996
--------------------------------------------------------------------
DUE WITHIN AFTER ONE
DUE WITHIN 4-12 BUT WITHIN AFTER
0-3 MONTHS MONTHS TWO YEARS TWO YEARS TOTAL
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Principal amount of
securities.................... $4,528,217 $2,276,537 $ 176,759 $2,064,802 $9,046,315
Effect of derivative
instruments................... 700,000 -- -- (700,000) --
---------- ---------- -------- ---------- ----------
Principal amount of securities
after effect of derivative
instruments................... $5,228,217 $2,276,537 $ 176,759 $1,364,802 $9,046,315
========== ========== ======== ========== ==========
Management actively manages the liability maturities and at various times
uses derivative instruments, such as interest rate exchange agreements and
interest rate cap agreements, to reduce the negative effect that rising rates
could have on net interest income. The Company seeks to lengthen the repricing
period of its deposits and borrowings by entering into interest rate cap
agreements to provide an additional layer of interest rate protection should
interest rates on deposits and borrowings rise. Through the use of these
agreements, management attempts to offset increases in interest expense related
to these deposits and borrowings and effectively lengthen the repricing period.
Thus, the Company has a degree of interest rate protection when interest rates
increase because the interest rate cap agreements provide a mechanism for
repricing the deposits and borrowings generally on pace with current market
rates. In a similar way, interest rate exchange agreements are utilized to
provide protection in an increasing rate environment, but also result in
sensitivity in a downward market. There can be no assurance that interest rate
exchange agreements and interest rate cap agreements will provide the Company
with protection in all scenarios or to the full extent of the Company's
exposure.
The following table presents the effect interest rate exchange and interest
rate cap agreements would have had on the repricing period of deposits and
borrowings currently (as of December 31, 1996) or in an increasing rate
environment (up 200 basis points) for the period the derivatives are
outstanding:
DECEMBER 31, 1996
-----------------------------------------------------------------
AFTER ONE
DUE WITHIN DUE WITHIN BUT WITHIN AFTER
0-3 MONTHS 4-12 MONTHS TWO YEARS TWO YEARS TOTAL
----------- ----------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
Amount of deposits and
borrowings...................... $25,030,195 $ 9,954,670 $2,074,149 $4,703,521 $41,762,535
Effect of derivative
instruments..................... (6,897,400) 3,460,500 963,000 2,473,900 --
----------- ----------- ---------- ---------- -----------
Amount of deposits and borrowings
after effect of derivative
instruments..................... $18,132,795 $13,415,170 $3,037,149 $7,177,421 $41,762,535
=========== =========== ========== ========== ===========
The following table presents the effect interest rate exchange agreements
and interest rate cap agreements would have had on the repricing period of
deposits and borrowings currently (as of December 31, 1996) or in a decreasing
interest rate environment (down 200 basis points) for the period the derivatives
are outstanding:
DECEMBER 31, 1996
-----------------------------------------------------------------
AFTER ONE
DUE WITHIN DUE WITHIN BUT WITHIN AFTER
0-3 MONTHS 4-12 MONTHS TWO YEARS TWO YEARS TOTAL
----------- ----------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
Amount of deposits and
borrowings...................... $25,030,195 $ 9,954,670 $2,074,149 $4,703,521 $41,762,535
Effect of derivative
instruments..................... (1,642,400) 459,500 397,500 785,400 --
----------- ----------- ---------- ---------- -----------
Amount of deposits and borrowings
after effect of derivative
instruments..................... $23,387,795 $10,414,170 $2,471,649 $5,488,921 $41,762,535
=========== =========== ========== ========== ===========
52
55
LIQUIDITY
Liquidity management focuses on the need to meet both short-term funding
requirements and long-term growth objectives. The long-term growth objectives of
the Company are to attract and retain stable consumer deposit relationships and
to maintain stable sources of wholesale funds. Because the low interest rate
environment of recent years inhibited consumer deposits, Washington Mutual has
supported its growth through business combinations with other financial
institutions and by increasing its use of wholesale borrowings. Should the
Company not be able to increase deposits either internally or through
acquisitions, its ability to grow would be dependent upon, and to a certain
extent limited by, its borrowing capacity.
Washington Mutual monitors its ability to meet short-term cash requirements
using guidelines established by its Board of Directors. The operating liquidity
ratio is used to ensure that normal short-term secured borrowing capacity is
sufficient to satisfy unanticipated cash needs. The volatile dependency ratio
measures the degree to which the Company depends on wholesale funds maturing
within one year weighted by the dependability of the source. At December 31,
1996, the Company had substantial liquidity compared with its established
guidelines.
The Company also computes ratios promulgated by the FDIC to monitor the
liquidity position of WMB. The regulatory liquidity ratio measures WMB's ability
to use liquid assets to meet unusual cash demands. The regulatory dependency
ratio measures WMB's reliance upon potentially volatile liabilities to fund
long-term assets. WMB manages both ratios to remain within the acceptable ranges
and, at December 31, 1996, met the established FDIC guidelines.
Regulations promulgated by the OTS require that ASB and WMBfsb maintain for
each calendar month an average daily balance of liquid assets at least equal to
5.00 percent of the prior month's average daily balance of net withdrawable
deposits plus borrowings due within one year. At December 31, 1996, the
liquidity ratio for ASB was 5.04% and for WMBfsb it was 8.29%.
Washington Mutual's major sources of funds are the collection of loan
principal and interest payments, attracting deposits, and borrowing from the
FHLBs of Seattle and San Francisco and elsewhere. In addition, Washington Mutual
is able to generate funds through the sale of loans and investment securities
available for sale. The Company uses these funds primarily to originate loans
and maintain its investment portfolio. See "Consolidated Financial
Statements -- Consolidated Statements of Cash Flows."
At December 31, 1996, the Company was in position to obtain an additional
$9.7 billion through the use of collateralized borrowings using unpledged
mortgage-backed securities and other wholesale sources. The ability of the
Company's banking subsidiaries to make dividends to the Company is influenced by
legal, regulatory and economic restrictions.
CAPITAL REQUIREMENTS
At December 31, 1996, Washington Mutual's banking subsidiaries exceeded all
current regulatory capital requirements and were categorized as well
capitalized, the highest regulatory standard.
The regulatory capital ratios of WMB, ASB and WMBfsb and minimum regulatory
requirements to be categorized as well capitalized were as follows:
DECEMBER 31, 1996 WELL-
---------------------- CAPITALIZED
WMB ASB WMBFSB MINIMUM
----- ----- ------ -----------
Capital ratios:
Leverage................................................... 5.76% 5.17% 6.90% 5.00%
Tier 1 risk-based.......................................... 10.28 8.90 10.50 6.00
Total risk-based........................................... 11.09 10.92 11.58 10.00
In addition, ASB and WMBfsb are required by OTS regulations to maintain
core capital of at least 3.00% of assets and tangible capital of at least 1.50%
of assets. Both ASB and WMBfsb satisfied this requirement at December 31, 1996.
See "Business -- Regulation and Supervision."
53
56
WM Life is subject to risk-based capital requirements developed by the
National Association of Insurance Commissioners. This measure uses four major
categories of risk to calculate an appropriate level of capital to support an
insurance company's overall business operations. The four risk categories are
asset risk, insurance risk, interest rate risk and business risk. At December
31, 1996, WM Life's capital was 663% of its required regulatory risk-based
level.
The Company's securities subsidiaries are also subject to capital
requirements. At December 31, 1996, all of Washington Mutual's securities
subsidiaries were in compliance with their applicable capital requirements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For financial statements, see index on page 56.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Part III is incorporated by reference from the Company's definitive proxy
statement issued in conjunction with the Company's Annual Meeting of
Shareholders to be held April 15, 1997. Certain information regarding the
principal officers of Washington Mutual is set forth in "Business -- Principal
Officers."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS
See Index to Consolidated Financial Statements on page 56.
(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are not
applicable or not required, or because the required information is included in
the consolidated financial statements or the notes thereto.
(b) REPORTS ON FORM 8-K:
Form 8-K filed October 18, 1996, amended October 23, 1996 and October 25,
1996. Items 5 and 7. Financial Statements filed -- Washington Mutual, Inc.
audited restated financial statements for the year ended December 31, 1995.
(c) EXHIBITS:
See Index of Exhibits on page 114.
54
57
SIGNATURES BY REGISTRANT
Pursuant to the requirements of the Section 13 of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on February 18, 1997.
WASHINGTON MUTUAL, INC.
/s/ KERRY K. KILLINGER
--------------------------------------
Kerry K. Killinger
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities indicated on February 18, 1997.
/s/ KERRY K. KILLINGER /s/ WILLIAM A. LONGBRAKE
- -------------------------------------------- --------------------------------------------
Kerry K. Killinger William A. Longbrake
Chairman, President and Chief Executive Executive Vice President and Chief Financial
Officer; Director (Principal Executive Officer (Principal Financial Officer)
Officer)
/s/ DOUGLAS G. WISDORF
--------------------------------------------
Douglas G. Wisdorf
Deputy Chief Financial Officer, Senior Vice
President and Controller (Principal
Accounting Officer)
/s/ DOUGLAS P. BEIGHLE /s/ ANNE V. FARRELL
- -------------------------------------------- --------------------------------------------
Douglas P. Beighle Anne V. Farrell
Director Director
/s/ WILLIAM P. GERBERDING
- -------------------------------------------- --------------------------------------------
David Bonderman William P. Gerberding
Director Director
/s/ HERBERT M. BRIDGE /s/ DR. SAMUEL B. MCKINNEY
- -------------------------------------------- --------------------------------------------
Herbert M. Bridge Dr. Samuel B. McKinney
Director Director
/s/ J. TAYLOR CRANDALL /s/ MICHAEL K. MURPHY
- -------------------------------------------- --------------------------------------------
J. Taylor Crandall Michael K. Murphy
Director Director
/s/ ROGER H. EIGSTI /s/ LOUIS H. PEPPER
- -------------------------------------------- --------------------------------------------
Roger H. Eigsti Louis H. Pepper
Director Director
/s/ JOHN W. ELLIS /s/ WILLIAM G. REED, JR.
- -------------------------------------------- --------------------------------------------
John W. Ellis William G. Reed, Jr.
Director Director
/s/ DANIEL J. EVANS /s/ JAMES H. STEVER
- -------------------------------------------- --------------------------------------------
Daniel J. Evans James H. Stever
Director Director
55
58
CONSOLIDATED FINANCIAL STATEMENTS OF
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
INDEX
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1996, 1995 AND 1994
Independent Auditors' Report........................................................ 57
Consolidated Statements of Income for the years ended December 31, 1996, 1995 and
1994............................................................................. 58
Consolidated Statements of Financial Position as of December 31, 1996 and 1995...... 59
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1996, 1995 and 1994.............................................................. 60
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995
and 1994......................................................................... 61
Notes to Consolidated Financial Statements.......................................... 63
56
59
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF WASHINGTON MUTUAL, INC.:
We have audited the accompanying consolidated statements of financial
position of Washington Mutual, Inc. and subsidiaries ("the Company") as of
December 31, 1996 and 1995, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. The consolidated
financial statements give retroactive effect to the merger of Washington Mutual,
Inc. and Keystone Holdings, Inc., which has been accounted for as a pooling of
interests as described in Note 2 to the consolidated financial statements. We
did not audit the consolidated balance sheet of Keystone Holdings, Inc. and
subsidiaries as of December 31, 1995, or the related consolidated statements of
earnings, stockholder's equity, and cash flows for the years ended December 31,
1995 and 1994, which statements reflect total assets constituting 47% of
consolidated total assets as of December 31, 1995, and total net income
constituting 31% and 25% for the years ended December 31, 1995 and 1994,
respectively. Those statements were audited by other auditors whose report,
dated, January 26, 1996 (except as to Note 27 to the consolidated financial
statements, which is as of February 8, 1996) has been furnished to us, and our
opinion, insofar as it relates to the amounts included for Keystone Holdings,
Inc. and subsidiaries for 1995 and 1994, is based solely on the report of such
other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of the other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
such consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Washington Mutual,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the financial statements, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 122, Accounting for
Mortgage Servicing Rights, on September 30, 1995.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
February 14, 1997
Seattle, Washington
57
60
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Keystone Holdings, Inc.:
We have audited the consolidated balance sheet of Keystone Holdings, Inc.
and subsidiaries as of December 31, 1995, and the related consolidated
statements of earnings, stockholder's equity, and cash flows for each of the
years in the two-year period ended December 31, 1995 (not presented separately
herein). These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Keystone
Holdings, Inc. and subsidiaries as of December 31, 1995, and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 1995, in conformity with generally accepted accounting
principles.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
January 26, 1996, except as to note 27
to the consolidated financial statements,
which is as of February 8, 1996
58
61
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE
AMOUNTS)
INTEREST INCOME
Loans.............................................. $2,139,513 $2,061,801 $1,658,818
Note receivable.................................... -- 58,841 141,039
Available-for-sale securities...................... 782,737 381,633 258,678
Held-to-maturity securities........................ 220,673 409,063 235,709
Cash equivalents................................... 6,313 4,748 1,169
------- ------- -------
Total interest income............................ 3,149,236 2,916,086 2,295,413
INTEREST EXPENSE
Deposits........................................... 1,060,823 1,134,818 852,666
Borrowings......................................... 897,406 788,618 482,692
------- ------- -------
Total interest expense........................... 1,958,229 1,923,436 1,335,358
------- ------- -------
Net interest income........................... 1,191,007 992,650 960,055
Provision for loan losses.......................... 201,512 74,987 122,009
------- ------- -------
Net interest income after provision for loan
losses...................................... 989,495 917,663 838,046
OTHER INCOME
Depositor fees..................................... 102,597 79,017 45,255
Loan servicing fees................................ 41,303 29,315 23,247
Securities, annuities and other fees............... 53,350 49,679 65,248
Other operating income............................. 36,419 31,035 39,630
Gain on sale of loans.............................. 19,729 1,717 23,488
Gain (loss) on sale of other assets................ 5,866 (655) 23,926
Loss on sale of covered assets..................... -- (37,399) --
Federal Deposit Insurance Corporation ("FDIC")
assistance on covered assets..................... -- 55,630 --
------- ------- -------
Total other income............................ 259,264 208,339 220,794
OTHER EXPENSE
Salaries and employee benefits..................... 336,065 313,304 315,424
Occupancy and equipment............................ 124,278 110,981 102,403
Regulatory assessments............................. 43,171 54,909 54,887
SAIF special assessment............................ 124,193 -- --
Data processing fees............................... 40,733 36,538 33,862
Other operating expense............................ 159,541 143,794 146,463
Transaction-related expense........................ 158,121 2,000 --
Amortization of goodwill and other intangible
assets........................................... 27,672 28,306 29,076
Real estate owned ("REO") operations............... 11,530 10,682 13,402
------- ------- -------
Total other expense........................... 1,025,304 700,514 695,517
------- ------- -------
Income before income taxes and minority
interest.................................... 223,455 425,488 363,323
Income taxes....................................... 70,420 111,906 109,880
Provision (benefit) for payments in lieu of
taxes............................................ 25,187 7,887 (824)
------- ------- -------
Income before minority interest............... 127,848 305,695 254,267
Minority interest in earnings of consolidated
subsidiaries..................................... 13,570 15,793 13,992
------- ------- -------
Net Income......................................... $ 114,278 $ 289,902 $ 240,275
======= ======= =======
Net Income Attributable to Common Stock............ $ 95,859 $ 271,318 $ 221,691
======= ======= =======
Net income per common share:
Primary.......................................... $0.85 $2.47 $2.09
Fully diluted.................................... 0.85 2.42 2.06
See Notes to Consolidated Financial Statements
59
62
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and cash equivalents......................................... $ 831,063 $ 983,833
Trading account securities........................................ 1,647 238
Available-for-sale securities, amortized cost $9,050,960 and
$11,919,009..................................................... 9,111,274 12,154,725
Held-to-maturity securities, fair value $2,922,552 and
$3,262,850...................................................... 2,860,347 3,197,720
Loans, net of reserve for loan losses............................. 30,103,386 24,109,136
Loans held for sale............................................... 227,390 83,704
REO............................................................... 103,111 125,101
Premises and equipment............................................ 482,391 452,743
Goodwill and other intangible assets.............................. 133,509 161,127
Other assets...................................................... 697,807 758,295
----------- -----------
Total assets................................................. $44,551,925 $42,026,622
=========== ===========
LIABILITIES
Deposits:
Checking accounts............................................... $ 2,979,962 $ 2,776,329
Savings and money market deposit accounts....................... 6,842,061 6,573,543
Time deposit accounts........................................... 14,258,118 15,113,088
----------- -----------
Total deposits............................................... 24,080,141 24,462,960
Annuities......................................................... 878,057 855,503
Federal funds purchased........................................... 1,052,000 433,420
Securities sold under agreements to repurchase.................... 7,835,453 7,984,756
Advances from the Federal Home Loan Bank ("FHLB")................. 7,241,492 4,715,739
Other borrowings.................................................. 676,986 590,217
Other liabilities................................................. 389,908 362,323
----------- -----------
Total liabilities............................................ 42,154,037 39,404,918
Minority interest................................................. -- 80,000
Contingencies (Note 26)........................................... -- --
STOCKHOLDERS' EQUITY
Preferred stock, no par value: 10,000,000 shares
authorized -- 4,722,500 and 6,122,500 shares issued and
outstanding..................................................... -- --
Common stock, no par value: 350,000,000 shares
authorized -- 126,142,285 and 119,687,860 shares issued and
outstanding..................................................... -- --
Capital surplus................................................... 952,747 920,406
Valuation reserve for available-for-sale securities............... 41,666 188,715
Retained earnings................................................. 1,403,475 1,432,583
----------- -----------
Total stockholders' equity................................... 2,397,888 2,541,704
----------- -----------
Total liabilities, minority interest and stockholders'
equity...................................................... $44,551,925 $42,026,622
=========== ===========
See Notes to Consolidated Financial Statements
60
63
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CAPITAL
NUMBER OF SHARES SURPLUS VALUATION
------------------- OFFSET AGAINST RESERVE TOTAL
PREFERRED COMMON CAPITAL NOTE RETAINED FOR AFS STOCKHOLDERS'
STOCK STOCK SURPLUS RECEIVABLE EARNINGS SECURITIES EQUITY
--------- ------- -------- -------------- ---------- --------- ------------
(IN THOUSANDS)
BALANCE AT JANUARY 1, 1994.............. 6,200 113,457 $862,949 $ (167,000) $1,039,954 $ 29,657 $1,765,560
Establishment of valuation reserve for
available-for-sale securities
-- Washington Mutual, Inc............. -- -- -- -- -- 13,836 13,836
Net income.............................. -- -- -- -- 240,275 -- 240,275
Miscellaneous stock transactions........ -- 384 7,762 -- (7,774) -- (12)
Cash dividends paid on preferred
stock................................. -- -- -- -- (18,584) -- (18,584)
Cash dividends paid on common stock..... -- -- -- -- (67,835) -- (67,835)
Adjustments in valuation reserve for
available-for-sale securities......... -- -- -- -- -- (104,742) (104,742)
Common stock issued through stock
options and employee stock plans...... -- 426 10,038 -- -- -- 10,038
Immaterial business combination
accounted for as a
pooling-of-interests.................. -- 1,454 9,595 -- 6,705 -- 16,300
------ ------- -------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1994............ 6,200 115,721 890,344 (167,000) 1,192,741 (61,249) 1,854,836
Net income.............................. -- -- -- -- 289,902 -- 289,902
Miscellaneous stock transactions........ -- (1) (13) -- -- -- (13)
Cash dividends paid on preferred
stock................................. -- -- -- -- (18,584) -- (18,584)
Cash dividends paid on common stock..... -- -- -- -- (57,997) -- (57,997)
Adjustments in valuation reserve for
available-for-sale securities......... -- -- -- -- -- 249,964 249,964
Common stock issued through stock
options and employee stock plans...... -- 539 8,379 -- -- -- 8,379
Capital surplus previously offset
against note receivable............... -- -- -- 167,000 -- -- 167,000
Repurchase of Series C and Series E
preferred stock....................... (77) -- (1,866) -- (124) -- (1,990)
Immaterial business combination
accounted for as a
pooling-of-interests.................. -- 3,429 23,562 -- 26,645 -- 50,207
------ ------- -------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1995............ 6,123 119,688 920,406 -- 1,432,583 188,715 2,541,704
Net income.............................. -- -- -- -- 114,278 -- 114,278
Cash dividends paid on preferred
stock................................. -- -- -- -- (18,418) -- (18,418)
Cash dividends paid on common stock..... -- -- -- -- (124,968) -- (124,968)
Adjustments in valuation reserve for
available-for-sale securities......... -- -- -- -- -- (147,049) (147,049)
Common stock issued through stock
options and employee stock plans...... -- 692 20,604 -- -- -- 20,604
Redemption/conversion of Series D
preferred stock....................... (1,400) 5,415 (107) -- -- -- (107)
Immaterial business combination
accounted for as a
pooling-of-interests.................. -- 347 11,844 -- -- -- 11,844
------ ------- -------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1996............ 4,723 126,142 $952,747 $ -- $1,403,475 $ 41,666 $2,397,888
====== ======= ======== ========= ========== ========= ==========
See Notes to Consolidated Financial Statements
61
64
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
----------- ---------- ----------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................ $ 114,278 $ 289,902 $ 240,275
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses........................... 201,512 74,987 122,009
(Gain) on sale of loans............................. (19,729) (1,717) (23,488)
(Gain) loss on sale of other assets................. (5,866) 655 (23,926)
Loss on sale of covered assets...................... -- 37,399 --
FDIC assistance on covered assets................... -- (55,630) --
REO operations...................................... 11,530 10,682 13,402
Depreciation and amortization....................... 85,741 54,361 58,939
FHLB stock dividend................................. (34,744) (23,155) (22,108)
(Increase) decrease in trading account securities... (1,404) 749 691
Origination of loans held for sale.................. (1,964,072) (822,025) (263,055)
Sales of loans held for sale........................ 2,005,610 1,127,076 764,710
(Increase) in interest receivable................... (9,881) (58,902) (28,800)
(Decrease) increase in interest payable............. (4,767) 31,027 22,159
(Decrease) increase in income taxes payable......... (10,575) 38,683 40,205
Decrease (increase) in other assets................. 91,563 (88,951) 10,757
Increase (decrease) in other liabilities............ 37,394 (23,527) (65,641)
---------- ---------- ----------
Net cash provided by operating activities........ 496,590 591,614 846,129
CASH FLOWS FROM INVESTING ACTIVITIES
Sales of available-for-sale securities................ 4,370,458 1,673,853 499,719
Purchases of available-for-sale securities............ (1,817,811) (2,312,072) (1,480,421)
Principal payments and maturities of
available-for-sale securities....................... 1,339,910 817,048 545,753
Purchases of held-to-maturity securities.............. (3,414,473) (697,470) (1,931,537)
Principal payments and maturities of held-to-maturity
securities.......................................... 3,744,147 885,205 1,109,796
Sales of loans........................................ 55,188 84,197 221,069
Principal payments of loans........................... 3,972,002 3,067,145 3,332,483
Origination and purchases of loans.................... (11,446,810) (8,562,080) (8,666,382)
Payments received on New West Federal Savings and Loan
Association ("New West") Note....................... -- 1,682,040 1,569,018
Sales and operations of REO........................... 142,404 150,530 201,138
Sales of premises and equipment....................... 2,064 4,871 2,211
Purchase of premises and equipment.................... (84,985) (102,877) (58,396)
Purchase of mortgage servicing rights................. (16,243) (38,270) (37,605)
Cash acquired through acquisitions.................... 3,506 68,358 40,679
---------- ---------- ----------
Net cash (used) by investing activities.......... (3,150,643) (3,279,522) (4,652,475)
62
65
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM FINANCING ACTIVITIES
(Decrease) increase in deposits....................... $ (480,059) $ 707,375 $ (380,297)
Increase in annuities................................. 22,554 56,325 85,795
Increase in federal funds purchased................... 622,000 433,420 --
(Decrease) increase in securities sold under
short-term agreements to repurchase................. (1,475,122) (186,833) 2,289,611
Proceeds from securities sold under long-term
agreements to repurchase............................ 2,497,407 2,872,557 1,391,682
Repurchase of securities sold under long-term
agreements to repurchase............................ (1,175,008) (1,408,127) (260,713)
Proceeds from FHLB advances........................... 14,332,232 4,710,333 8,209,790
Repayments of FHLB advances........................... (11,804,037) (4,123,336) (7,698,071)
Proceeds (repayments) of other borrowings............. 179,230 210,397 (3,488)
Repayments to minority interest....................... (95,372) -- --
Other capital transactions, net....................... 20,844 (1,298) 14,742
Cash dividends paid................................... (143,386) (76,581) (96,419)
---------- ---------- ----------
Net cash provided by financing activities........ 2,501,283 3,194,232 3,552,632
---------- ---------- ----------
(Decrease) increase in cash and cash
equivalents.................................... (152,770) 506,324 (253,714)
Cash and cash equivalents at beginning of year... 983,833 477,509 731,223
---------- ---------- ----------
Cash and cash equivalents at end of year......... $ 831,063 $ 983,833 $ 477,509
========== ========== ==========
NONCASH INVESTING ACTIVITIES
Loans exchanged for mortgage-backed securities........ $ 896,976 $6,588,124 $ 183,269
Implementation of new accounting standard -- reclass
to available-for-sale portfolio..................... -- -- 2,127,890
Transfer of securities to the available-for-sale
portfolio........................................... -- 4,924,168 --
Real estate acquired through foreclosure.............. 231,681 255,028 334,499
Loans originated to facilitate the sale of REO........ 68,995 65,693 92,415
Loans transferred to loans held for sale.............. 214,991 621,267 --
CASH PAID DURING THE YEAR FOR
Interest on deposits.................................. 1,068,198 1,125,226 851,546
Interest on borrowings................................ 893,190 762,000 458,033
Income taxes.......................................... 111,948 73,130 92,172
DIVIDENDS DECLARED AND PAYABLE IN DIFFERENT YEARS
Common stock dividends................................ -- -- (10,000)
See Notes to Consolidated Financial Statements
63
66
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of Washington
Mutual, Inc. ("WMI" and together with its subsidiaries "Washington Mutual" or
the "Company"). WMI was formed in August 1994 by the Company's predecessor,
Washington Mutual Savings Bank ("WMSB"), a Washington state-chartered savings
bank, in connection with the reorganization of WMSB into a holding company
structure. The reorganization was completed in November 1994 through the merger
of WMSB into Washington Mutual Bank ("WMB"), the Company's Washington
state-chartered savings bank subsidiary, with WMB as the surviving entity. WMB
continued as a wholly owned subsidiary of WMI.
On December 20, 1996, Keystone Holdings, Inc. ("Keystone Holdings") merged
with and into Washington Mutual, and all of the subsidiaries of Keystone
Holdings, including American Savings Bank, F.A. ("ASB"), became subsidiaries of
the Company (the "Keystone Transaction"). The financial statements reflect the
accounting for the merger as a pooling-of-interests and are presented as if the
companies were merged as of the earliest period shown.
Certain reclassifications have been made to the 1995 and 1994 financial
statements to conform to the 1996 presentation. All significant intercompany
transactions and balances have been eliminated. Results of operations of
companies acquired and accounted for as purchases are included from the dates of
acquisition. When Washington Mutual acquires a company through a material
pooling-of-interests, current and prior-period financial statements are restated
to include the accounts of merged companies. Previously reported balances of the
merged companies have been reclassified to conform to the Company's presentation
and restated to give effect to the combinations.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements. Changes in
these estimates and assumptions are considered reasonably possible and may have
a material impact on the financial statements.
Lines of Business
Washington Mutual provides a broad range of financial services to consumers
and small and mid-sized businesses throughout the Western United States through
its subsidiary operations. Financial services of the Company include accepting
deposits from the general public and making residential loans, consumer loans,
limited types of commercial real estate loans (primarily loans secured by
multi-family properties), and commercial business loans which are offered
principally through WMB, ASB and Washington Mutual Bank fsb ("WMBfsb").
Washington Mutual, through other subsidiaries, also issues and markets annuity
contracts and is the investment advisor to and distributor of mutual funds.
Washington Mutual diversified its business mix by merging WMB with
Enterprise Bank of Bellevue, Washington ("Enterprise"), a Seattle-area
commercial bank in 1995 and Western Bank of Coos Bay, Oregon ("Western"),
Oregon's largest community-based commercial bank in 1996.
Derivative Instruments
The Company uses derivative instruments, such as interest rate exchange
agreements and interest rate cap agreements, forward sales of financial
instruments, financial futures and options to reduce its exposure to interest
rate risk. Interest rate exchange agreements and interest rate cap agreements
are used only if they
64
67
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
have the effect of changing the interest rate characteristics of the assets or
liabilities to which they are designated. Such effect is measured either through
ongoing correlation or effectiveness tests.
Interest rate exchange agreements and interest rate cap agreements are
designated either against the available-for-sale portfolio or against deposits
and borrowings. Agreements designated against available-for-sale securities are
included at fair value in the available-for-sale portfolio and any
mark-to-market adjustments are reported with the change in value of the
available-for-sale portfolio. Interest rate exchange agreements and interest
rate cap agreements designated against deposits and borrowings are reported at
historic cost.
The interest differential paid or received on interest rate exchange
agreements is recorded as an adjustment to interest income or interest expense.
The purchase premium of interest rate cap agreements is capitalized and
amortized and included as a component of interest income or interest expense
over the original term of the interest rate cap agreement. No purchase premiums
are paid at the time interest rate exchange agreements are entered into.
From time to time, the Company terminates interest rate exchange agreements
and interest rate cap agreements prior to maturity. Such circumstances arise if,
in the judgment of management, such instruments no longer cost effectively meet
policy objectives. Often such instruments are within one year of maturity. Gains
and losses from terminated interest rate exchange agreements and interest rate
cap agreements are recognized, consistent with the gain or loss on the asset or
liability designated against the agreement. When the asset or liability is not
sold or paid off, the gains or losses are deferred and amortized on a
straight-line basis as additional interest income or interest expense over the
original terms of the agreements or the remaining life of the designated asset
or liability, whichever is less. When the asset or liability is sold or paid
off, the gains or losses are recognized in the current period as an adjustment
to the gain or loss recognized on the corresponding asset or liability.
From time to time, the Company redesignates interest rate exchange
agreements and interest rate cap agreements between available-for-sale
securities and deposits and borrowings. Such redesignations are recorded at fair
value at the time of transfer.
The Company may also buy put or call options on mortgage instruments. The
purpose and criteria for the purchase of options are to manage the interest rate
risk inherent in secondary marketing activities. The costs of such options are
capitalized and amortized on a straight-line basis as a reduction of other
income over the original terms of the options. The fair value of options matched
against closed loans are included in the lower of cost or market analysis.
Changes in the fair value of options designated against the Company's loan
pipeline are deferred to the extent they qualify as hedges, otherwise they are
carried at fair value with the corresponding gain or loss recognized in other
income.
The Company may write covered call options on its available-for-sale
portfolio. If the option is exercised, the option fee is an adjustment to the
gain or loss on the sale of the security. If the option is not exercised, it is
recognized as fee income. Covered call options are carried at fair value.
Additionally, to lock in prices on sales of loans originated for mortgage
banking activities, the Company uses forward sales of financial instruments to
lock in prices on similar types and coupons of financial instruments and thereby
limit market risk until these financial instruments are sold.
In the event that any of the derivative instruments fail to meet the above
established criteria, they are marked to market with the corresponding gain or
loss recognized in income.
Investment Securities
The Company accounts for investment and equity securities in the following
three categories: trading, held-to-maturity and available-for-sale.
65
68
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trading Securities
Trading securities are purchased and held principally for the purpose of
reselling them within a short period of time. Their unrealized gains and losses
are included in earnings.
Held-To-Maturity Securities
Investments classified as held-to-maturity are accounted for at amortized
cost, but a company must have both the positive intent and the ability to hold
those securities to maturity. There are limited circumstances under which
securities in the held-to-maturity category can be sold without jeopardizing the
cost basis of accounting for the remainder of the securities in this category.
Other than temporary declines in fair value are recognized as a reduction to
current earnings.
Available-For-Sale Securities
Securities not classified as either trading or held-to-maturity are
considered to be available-for-sale. Gains and losses realized on the sale of
these securities are based on the specific identification method. Unrealized
gains and losses for available-for-sale securities are excluded from earnings
and reported (net of tax) as a net amount in a separate component of
stockholders' equity until realized.
The available-for-sale portfolio contains some private-issue securities.
Private-issue securities include mortgage-backed securities ("MBS") and
collateralized mortgage obligations ("CMOs") that expose the Company to certain
risks that are not inherent in agency securities, primarily credit risk and
liquidity risk. Because of this added risk, private-issue securities have
historically paid a greater rate of interest than agency securities, enhancing
the overall yield of the portfolio. Such securities are not guaranteed by the
U.S. government or one of its agencies because the loan size, underwriting or
underlying collateral of these securities often does not meet industry
standards. Consequently, there is the possibility of loss of the principal
investment. For this reason, it is possible that the Company will not receive an
enhanced overall yield on the portfolio and, in fact, could incur a loss.
Additionally, the Company may not be able to sell such securities in certain
market conditions as the number of interested buyers may be limited at that
time. Furthermore, the complex structure of certain CMOs in the Company's
portfolio increases the difficulty in assessing the portfolio's risk and its
fair value. Examples of some of the more complex structures include certain CMOs
where the Company holds subordinated tranches, certain CMOs that have been
"resecuritized," and certain securities that contain a significant number of
jumbo, nonconforming loans. In 1996, in an effort to reduce the aforementioned
risks, the Company instituted a policy of performing a credit review on each
individual security prior to purchase. Such a review includes consideration of
the collateral characteristics, borrower payment histories and information
concerning loan delinquencies and losses of the underlying collateral. After a
security is purchased, similar information is monitored on a periodic basis.
Furthermore, the Company has established internal guidelines limiting the
geographic concentration of the underlying collateral.
Loans
Loans held for investment are stated at the principal amount outstanding,
net of deferred loan fees and any discounts or premiums on purchased loans. The
deferred fees, discounts and premiums are amortized using the interest method
over the estimated life of the loan. The Company sells residential fixed-rate
loans in the secondary market. At the date of origination, the loans so
designated and meeting secondary market guidelines are identified as loans held
for sale and carried at the lower of net cost or fair value on an aggregate
basis, net of their related hedge gains and losses.
Management ceases to accrue interest income on any loan that becomes 90
days or more delinquent and reverses all interest accrued up to that time.
Thereafter, interest income is accrued only if and when, in
66
69
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
management's opinion, projected cash proceeds are deemed sufficient to repay
both principal and interest. All loans for which interest is not being accrued
are referred to as loans on nonaccrual status.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan as
modified by SFAS No. 118, Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosures. This standard is applicable to all
loans except large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment. Loans that are collectively evaluated for
impairment by Washington Mutual include residential real estate and consumer
loans. Residential construction, commercial real estate and commercial business
loans are individually evaluated for impairment. Factors involved in determining
impairment include, but are not limited to, the financial condition of the
borrower, value of the underlying collateral, and current economic conditions.
SFAS No. 114 also applies to all loans that are restructured in a troubled debt
restructuring subsequent to the adoption of SFAS No. 114, as defined by SFAS No.
15, Accounting by Debtors and Creditors for Troubled Debt Restructurings. A
troubled debt restructuring is a restructuring in which the creditor grants a
concession to the borrower that it would not otherwise consider.
A loan is considered impaired when it is probable that a creditor will be
unable to collect all amounts due according to the terms of the loan agreement.
SFAS No. 114 requires that the valuation of impaired loans be based on the
present value of expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, at the loan's observable market
price or the fair value of the collateral if the loan is collateral dependent.
The Company bases the measurement of loan impairment on the fair value of the
loan's underlying collateral. The amount by which the recorded investment in the
loan exceeds the value of the impaired loan's collateral is included in the
Company's allocated reserve for loan losses. Any portion of an impaired loan
classified as loss under regulatory guidelines is charged-off. The adoption of
SFAS No. 114 had no material impact on the results of operations or financial
position of the Company.
The Company has full recourse on certain loans that have been securitized
or sold. Securitized MBS may or may not be held as part of the Company's
investment portfolio.
Reserve for Loan Losses
The reserve for loan losses is maintained at a level sufficient to provide
for estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. The reserve is based on management's continuing analysis of the
pertinent factors underlying the quality of the loan portfolio. These factors
include changes in the size and composition of the loan portfolio, loan loss
experience, current and anticipated economic conditions, and detailed analysis
of individual loans and credits for which full collectibility may not be
assured. The detailed analysis includes techniques to estimate the fair value of
loan collateral and the existence of potential alternative sources of repayment.
The appropriate reserve level is estimated based upon factors and trends
identified by management at the time financial statements are prepared.
When available information confirms that specific loans or portions thereof
are uncollectible, these amounts are charged-off against the reserve for loan
losses. The existence of some or all of the following criteria will generally
confirm that a loss has been incurred: the loan is significantly delinquent and
the borrower has not evidenced the ability or intent to bring the loan current;
the Company has no recourse to the borrower, or if it does, the borrower has
insufficient assets to pay the debt; or the fair value of the loan collateral is
significantly below the current loan balance, and there is little or no
near-term prospect for improvement.
Commercial real estate loans are considered by the Company to have somewhat
greater risk of uncollectibility than residential real estate loans due to the
dependency on income production or future development of the real estate.
67
70
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The ultimate recovery of all loans is susceptible to future market factors
beyond the Company's control. These factors may result in losses or recoveries
differing significantly from those provided in the financial statements.
REO
REO includes properties acquired through foreclosure that are transferred
to REO at the lower of cost or fair value, less estimated selling costs, which
represents the new recorded basis of the property. Subsequently, properties are
evaluated and any additional declines in value are provided for in the REO
reserve for losses. The amount the Company ultimately recovers from REO may
differ substantially from the net carrying value of these assets because of
future market factors beyond the Company's control or because of changes in the
Company's strategy for sale or development of the property.
Commercial REO that is managed and operated by the Company is depreciated
using the straight-line method over the property's estimated useful life.
Mortgage Servicing Rights
In May 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 122, Accounting for Mortgage Servicing Rights. The statement eliminates the
distinction between servicing rights that are purchased and those that are
retained upon the sale or securitization of loans. The statement requires
mortgage servicers to recognize the servicing rights on loans as separate
assets, no matter how acquired. Banks that sell or securitize loans and retain
the servicing rights are required to allocate the total cost of the loans
between servicing rights and loans based on relative fair values if their values
can be estimated. In September 1995, the Company elected early adoption of SFAS
No. 122, as permitted by the Statement, and implemented it as of January 1,
1995.
Purchased servicing rights represents the cost of acquiring the right to
service mortgage loans. Originated servicing rights are recorded when mortgage
loans are originated and subsequently sold or securitized with the servicing
rights retained. The total cost of the mortgage loans is allocated to the
servicing rights and the loans (without the servicing rights) based on relative
fair values. The cost relating to purchased and originated servicing is
capitalized and amortized in proportion to, and over the period of, estimated
future net servicing income.
The Company assesses impairment of the capitalized servicing rights based
on the fair value of those rights on a stratum-by-stratum basis with any
impairment recognized through a valuation allowance for each impaired stratum.
For purposes of measuring impairment, the servicing rights are stratified based
on the following predominant risk characteristics of the underlying loans:
fixed-rate mortgage loans by coupon (less than 6%, 1% increments between 6% and
12% and greater than 12%); and adjustable-rate mortgage loans ("ARMs") by index,
such as the 11th District Cost of Funds Index ("COFI"), Treasury, or the London
Interbank Offering Rate ("LIBOR"). The amount of impairment recognized is the
amount by which the capitalized mortgage servicing rights for a stratum exceed
their fair value.
In order to determine the fair value of the servicing rights, the Company
primarily uses a valuation model that calculates the present value of future
cash flows. Assumptions used in the valuation model include market discount
rates and anticipated prepayment speeds. The prepayment speeds are determined
from market sources for fixed-rate mortgages with similar coupons, and
prepayment reports for comparable ARMs. In addition, the Company uses market
comparables for estimates of the cost of servicing per loan, an inflation rate,
ancillary income per loan, and default rates.
68
71
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Premises and Equipment
Land, buildings, leasehold improvements and equipment are carried at
amortized cost. Buildings and equipment are depreciated over their estimated
useful lives using the straight-line method. Leasehold improvements are
amortized over the shorter of their useful lives or lease terms.
Annuity and Insurance Accounting
WM Life Insurance, Inc. ("WM Life") is an Arizona-domiciled life insurance
company. WM Life is authorized under state law to issue annuities in seven
states. In addition, WM Life owns Empire Life Insurance Co. ("Empire"), which is
currently licensed under state law to issue annuities in 28 states. WM Life
currently issues fixed and variable flexible premium deferred annuities, single
premium fixed deferred annuities and single premium immediate annuities. Empire
currently issues fixed flexible premium deferred annuities and single premium
immediate annuities. Both companies conduct business through licensed
independent agents. The majority of such agents are employees of affiliates of
the Company and operate in the Company's financial centers. Currently, annuities
are primarily issued in Washington and Oregon.
The Company defers certain costs, such as commissions and the expenses of
underwriting and issuing policies, that are involved in acquiring new annuity
and life insurance business. These costs, which are included in other assets in
the accompanying Consolidated Statements of Financial Position, are amortized
over the lives of the policies in relation to the estimated gross profit.
Annuities equal the policy value as defined in the policy contract as of the
balance sheet date.
Securities Sold Under Agreements to Repurchase
The Company enters into sales of securities under agreements to repurchase
the same ("reverse repurchase agreements") or similar ("dollar repurchase
agreements") securities. Reverse repurchase agreements and dollar repurchase
agreements are accounted for as financing arrangements, with the obligation to
repurchase securities sold reflected as a liability in the Consolidated
Statements of Financial Position. The dollar amount of securities underlying the
agreements remain in the respective asset accounts.
Trust Assets
Assets held by the Company in fiduciary or agency capacity for customers
are not included in the Consolidated Statements of Financial Position as such
items are not assets of the Company. Assets totaling $85.8 million and $67.3
million as of December 31, 1996 and 1995 were held by the Company in fiduciary
or agency capacity.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under
this method, a deferred tax asset or liability is determined based on the
enacted tax rates which will be in effect when the differences between the
financial statement carrying amounts and tax bases of existing assets and
liabilities are expected to be reported in the Company's income tax returns. The
deferred tax provision for the year is equal to the change in the deferred tax
liability from the beginning to the end of the year. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date.
The Company reports income and expenses using the accrual method of
accounting and files a consolidated tax return that includes all of its
subsidiaries excluding Keystone Holdings and its subsidiaries. Keystone Holdings
and its subsidiaries filed a separate consolidated tax return for periods prior
to December 20, 1996. The Keystone Holdings returns included losses of ASB's
nominee, New West, incurred through
69
72
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
October 24, 1995. Net operating losses of New West incurred prior to that date
are available for carryforward by ASB and have been included in the schedule of
net operating loss carryforwards presented in Note 19.
For periods subsequent to the merger with Keystone Holdings, the Company
will file a consolidated tax return that includes all of its subsidiaries. For
California franchise tax purposes, ASB joins in the filing of a combined return
with its subsidiaries and with ASB Real Estate Group, Inc. ("AREG"). AREG
formerly managed certain real estate related assets of New West and is now
inactive as a result of a restructuring transaction in 1993.
NOTE 2: BUSINESS COMBINATIONS
On April 28, 1995, Washington Mutual merged with Olympus Capital
Corporation of Salt Lake City, Utah ("Olympus"), the holding company of Olympus
Bank, a Federal Savings Bank ("Olympus Bank"). At the merger date, Olympus (on a
consolidated basis) had assets of $391.4 million, deposits of $278.6 million and
stockholders' equity of $37.2 million. Olympus Bank operated 11 branches in Utah
and Montana. Under the terms of the transaction, Olympus Bank merged into
WMBfsb. The merger was treated as a pooling-of-interests. Due to the immaterial
nature of the transaction, prior-period information has not been restated as if
the companies had been combined.
On August 31, 1995, Washington Mutual acquired Enterprise through a merger
of Enterprise with and into WMB. Enterprise, a Seattle-based commercial bank
specializing in lending to small and mid-size businesses, had assets of $153.8
million, deposits of $138.5 million and stockholders' equity of $14.0 million on
August 31, 1995. The merger was treated as a pooling-of-interests. Due to the
immaterial nature of the transaction, prior-period information has not been
restated as if the companies had been combined.
On January 31, 1996, the Company acquired Western through a merger of
Western with and into WMB. At the time of the merger, Western had 42 offices in
35 communities and was Oregon's largest community-based commercial bank. At
January 31, 1996 Western had assets of $776.3 million, deposits of $696.4
million and stockholders' equity of $69.5 million. The Company issued 5,865,235
shares of common stock to complete the merger with Western. The merger was
treated as a pooling-of-interests. The financial information presented in this
document reflects the pooling-of-interests method of accounting for the merger
of Western into the Company. Accordingly, under generally accepted accounting
principles, the assets, liabilities and stockholders' equity of Western were
recorded on the books of the resulting institution at their values as reported
on the books of Western immediately prior to the consummation of the merger with
Western. No goodwill was created in the merger with Western. This presentation
required the restatement of prior periods as if the companies had been combined
for all years presented.
70
73
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following information represents the results of operations of the
Company and Western for 1995 and 1994 on an individual as well as a combined
basis. This information does not necessarily indicate the results that would
have been obtained, nor are they necessarily indicative of the future operations
of the combined companies. The supplemental results of operations were as
follows:
YEAR ENDED DECEMBER 31,
-------------------------
1995 1994
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT FOR PER SHARE
AMOUNTS)
Washington Mutual:
Total revenue..................................... $1,625,451 $1,315,651
---------- ----------
Net income........................................ $ 190,624 $ 172,304
========== ==========
Net income per common share:
Primary........................................... $2.68 $2.54
Fully diluted..................................... 2.59 2.46
YEAR ENDED DECEMBER 31,
-----------------------
1995 1994
------- -------
(DOLLARS IN THOUSANDS)
Western:
Total revenue..................................... $71,383 $61,401
------- -------
Net income........................................ $ 9,177 $ 9,018
======= =======
The restated results of operations were as follows:
YEAR ENDED DECEMBER 31,
-------------------------
1995 1994
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT FOR PER SHARE
AMOUNTS)
Washington Mutual and Western:
Total revenue..................................... $1,696,834 $1,377,052
---------- ----------
Net income........................................ $ 199,801 $ 181,322
========== ==========
Net income per common share:
Primary........................................... $2.59 $2.45
Fully diluted..................................... 2.51 2.38
On November 30, 1996, WMI merged with Utah Federal Savings Bank ("Utah
FSB") by merging Utah FSB with and into WMBfsb. At November 30, 1996, Utah FSB,
which was an Ogden-based institution, had assets of $122.1 million, deposits of
$106.7 million and stockholders' equity of $12.0 million. The merger was
accounted for as a pooling-of-interests. Due to the immaterial nature of the
transaction, the Company has not restated prior-period information as if the
companies had been combined.
On December 20, 1996, WMI merged with Keystone Holdings. Keystone Holdings
was the indirect parent of ASB, a California-based federally chartered savings
bank. At November 30, 1996, Keystone Holdings had assets of $21.9 billion,
deposits of $12.8 billion and stockholder's equity of $808.6 million. The
Company issued 47,883,333 shares of common stock to complete the merger with
Keystone Holdings. The merger was treated as a pooling-of-interests. The
financial information presented in this document reflects the
pooling-of-interests method of accounting for the merger of Keystone Holdings
into the Company. Accordingly, under generally accepted accounting principles,
the assets, liabilities and stockholders' equity of Keystone Holdings were
recorded on the books of the resulting institution at their values as reported
on the books of Keystone Holdings immediately prior to the consummation of the
merger with Keystone Holdings. No goodwill was created in the merger with
Keystone Holdings. This presentation required the restatement of
71
74
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
prior periods as if the companies had been combined for all years presented.
Certain amounts in Keystone Holdings' financial statements have been restated to
conform to WMI's presentation.
The following information represents the results of operations of the
Company and Keystone Holdings for 1996, 1995 and 1994 on an individual as well
as a combined basis. This information does not necessarily indicate the actual
results that would have been obtained, nor are they necessarily indicative of
the future operations of the combined companies. The pro forma results of
Keystone Holdings have been adjusted to (i) eliminate earnings attributable to
the warrant holders and (ii) reflect the preferred stock dividends to related
parties as minority interest. The supplemental results of operations were as
follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT FOR PER SHARE AMOUNTS)
Washington Mutual:
Total revenue........................ $1,845,777 $1,696,834 $1,377,052
---------- ---------- ----------
Net income........................... $ 223,761 $ 199,801 $ 181,322
========== ========== ==========
Net income per common share:
Primary.............................. $2.82 $2.59 $2.45
Fully diluted........................ 2.73 2.51 2.38
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Keystone Holdings:
Total revenue........................ $1,562,723 $1,427,591 $1,139,155
---------- ---------- ----------
Net income........................... $ (109,656) $ 90,101 $ 58,953
========== ========== ==========
The restated results of operations were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT FOR PER SHARE AMOUNTS)
Washington Mutual and Keystone
Holdings:
Total revenue........................ $3,408,500 $3,124,425 $2,516,207
---------- ---------- ----------
Net income........................... $ 114,278 $ 289,902 $ 240,275
========== ========== ==========
Net income per common share:
Primary.............................. $0.85 $2.47 $2.09
Fully diluted........................ 0.85 2.42 2.06
On January 15, 1997, Washington Mutual acquired United Western Financial
Group, Inc. ("United Western") of Salt Lake City and its United Savings Bank and
Western Mortgage Loan Corporation subsidiaries for $79.5 million in cash. At
January 15, 1997, United Western had assets of $404.1 million, deposits of
$299.9 million, and stockholders' equity of $53.7 million.
The acquisition of United Western was treated as a purchase for accounting
purposes. Accordingly on January 15, 1997, under generally accepted accounting
principles, the assets and liabilities of United Western were recorded on the
books of the Company at their respective fair market values at the time of the
consummation of the acquisition of United Western. Goodwill, the excess of the
purchase price over the net fair value of the assets and liabilities, including
indentified intangible assets, was recorded at $4.2 million.
72
75
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Amortization of goodwill over a 10-year period will result in a charge to
earnings of approximately $420,000 per year.
NOTE 3: CASH AND CASH EQUIVALENTS
Cash and cash equivalents consisted of the following:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Cash and demand deposits............................... $781,185 $689,258
Cash equivalents:
Overnight investments................................ 48,031 293,000
Time deposits........................................ 1,847 1,575
-------- --------
49,878 294,575
-------- --------
$831,063 $983,833
======== ========
For the purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, overnight investments and time deposits.
Generally, time deposits are short term, with an original maturity of three
months or less.
Federal Reserve Board regulations require depository institutions to
maintain certain minimum reserve balances. Included in cash and demand deposits
were required deposits at the Federal Reserve of $22.9 million and $107.9
million at December 31, 1996 and 1995.
73
76
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: AVAILABLE-FOR-SALE SECURITIES
Available-for-sale securities classified by type and contractual maturity
date consisted of the following:
DECEMBER 31, 1996
---------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE YIELD(1)
---------- ---------- ---------- ---------- -----
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations:
Due after one but within five years..... $ 271,426 $ 58 $ (1,680) $ 269,804 6.62%
After five but within 10 years.......... 2,042 107 (2) 2,147 8.15
After 10 years.......................... 595 14 -- 609 6.58
---------- -------- -------- ---------- ----
274,063 179 (1,682) 272,560 6.63
Corporate debt obligations:
Due after one but within five years..... 129,469 3,164 (283) 132,350 7.54
After five but within 10 years.......... 167,294 2,764 (2,229) 167,829 7.12
After 10 years.......................... 98,693 3,354 (1,832) 100,215 7.64
---------- -------- -------- ---------- ----
395,456 9,282 (4,344) 400,394 7.39
Equity securities:
Preferred stock......................... 171,029 4,012 (831) 174,210 6.88
FHLB stock(2)........................... 465,056 -- -- 465,056 7.06
Other stock............................. 18 3 -- 21 --
---------- -------- -------- ---------- ----
636,103 4,015 (831) 639,287 7.01
---------- -------- -------- ---------- ----
1,305,622 13,476 (6,857) 1,312,241 7.05
Mortgage-backed securities:
U.S. government agency:
Due within one year..................... 308 -- (2) 306 4.89
After one but within five years......... 390,317 7,899 (817) 397,399 7.20
After five but within 10 years.......... 161,475 5,118 (2) 166,591 7.35
After 10 years.......................... 6,361,044 72,337 (31,890) 6,401,491 6.98
---------- -------- -------- ---------- ----
6,913,144 85,354 (32,711) 6,965,787 7.00
Private issue/corporate:
Due after five but within 10 years...... 24,175 791 (97) 24,869 7.59
After 10 years.......................... 803,374 7,581 (4,392) 806,563 7.73
---------- -------- -------- ---------- ----
827,549 8,372 (4,489) 831,432 7.73
---------- -------- -------- ---------- ----
7,740,693 93,726 (37,200) 7,797,219 7.08
Derivative instruments:
Interest rate exchange agreements.......... -- 265 (911) (646) --
Interest rate cap agreements............... 4,645 271 (2,456) 2,460 --
---------- -------- -------- ---------- ----
4,645 536 (3,367) 1,814 --
---------- -------- -------- ---------- ----
$9,050,960 $107,738 $(47,424) $9,111,274 7.08%
========== ======== ======== ========== ====
- ---------------
(1) Weighted average yield at end of year.
(2) FHLB stock is carried at cost and is evaluated by the Company for
impairment.
74
77
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1995
-----------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE YIELD(1)
----------- ---------- ---------- ----------- -----
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations:
Due within one year................... $ 65,120 $ -- $ (64) $ 65,056 4.72%
After one but within five years....... 184,837 526 (29) 185,334 6.48
After five but within 10 years........ 9,755 41 (125) 9,671 7.23
After 10 years........................ 59,813 121 (770) 59,164 7.02
----------- -------- -------- ----------- ----
319,525 688 (988) 319,225 6.24
Corporate debt obligations:
Due within one year................... 1,502 10 -- 1,512 8.27
After one but within five years....... 136,447 7,492 (205) 143,734 8.70
After five but within 10 years........ 181,038 8,237 (819) 188,456 7.02
After 10 years........................ 97,755 6,626 (98) 104,283 7.50
----------- -------- -------- ----------- ----
416,742 22,365 (1,122) 437,985 7.69
Equity securities:
Preferred stock....................... 110,532 2,535 (2,311) 110,756 7.21
FHLB stock(2)......................... 414,389 -- -- 414,389 6.74
Other stock........................... 5 3 -- 8 --
----------- -------- -------- ----------- ----
524,926 2,538 (2,311) 525,153 6.84
----------- -------- -------- ----------- ----
1,261,193 25,591 (4,421) 1,282,363 6.98
Mortgage-backed securities:
U.S. government agency:
Due within one year................... 5 -- -- 5 9.23
After one but within five years....... 467,226 14,883 (497) 481,612 7.64
After five but within 10 years........ 236,497 14,338 (86) 250,749 7.84
After 10 years........................ 8,713,086 226,286 (19,214) 8,920,158 6.93
----------- -------- -------- ----------- ----
9,416,814 255,507 (19,797) 9,652,524 6.99
Private issue/corporate:
Due after five but within 10 years.... 18,614 901 (258) 19,257 7.14
After 10 years........................ 1,211,290 8,739 (17,016) 1,203,013 7.37
----------- -------- -------- ----------- ----
1,229,904 9,640 (17,274) 1,222,270 7.37
----------- -------- -------- ----------- ----
10,646,718 265,147 (37,071) 10,874,794 7.03
Derivative instruments:
Interest rate exchange agreements........ (848) 2,225 (13,224) (11,847) --
Interest rate cap agreements............. 11,946 -- (2,531) 9,415 --
----------- -------- -------- ----------- ----
11,098 2,225 (15,755) (2,432) --
----------- -------- -------- ----------- ----
$11,919,009 $ 292,963 $ (57,247) $12,154,725 7.03%
=========== ======== ======== =========== ====
- ---------------
(1) Weighted average yield at end of year.
(2) FHLB stock is carried at cost and is evaluated by the Company for
impairment.
Proceeds from sales of investment securities in the available-for-sale
portfolio during 1996 and 1995 were $139.1 million and $626.2 million. The
Company realized $1.9 million in gains and $799,000 in losses on these sales
during 1996. Similarly, the Company realized $4.0 million in gains and $2.2
million in losses on sales during 1995. Proceeds from sales of MBS in the
available-for-sale portfolio during 1996 and 1995 were
75
78
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$3.9 billion and $1.0 billion. The Company realized $31.4 million in gains and
$35.1 million in losses on these sales during 1996 and $13.5 million in gains
and $16.2 million in losses on these sales during 1995.
Available-for-sale MBS with an amortized cost of $6.0 billion and a fair
value of $6.0 billion at December 31, 1996 were pledged to secure public
deposits, securities sold under agreements to repurchase, other borrowings,
interest rate exchange agreements, and access to the Federal Reserve discount
window.
During 1995, FASB issued a report entitled A Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities, Questions and Answers that allowed companies a one-time reassessment
and related reclassification from the held-to-maturity category to the
available-for-sale category without adverse accounting consequences for the
remainder of the portfolio. During the fourth quarter of 1995, the Company
elected to take advantage of this opportunity and reclassified held-to-maturity
securities with an amortized cost of $4.9 billion and gross unrealized gains of
$82.6 million and gross unrealized losses of $28.2 million. No transfers between
the held-to-maturity and available-for-sale categories were made during 1996.
At December 31, 1996, net unrealized gains on the available-for-sale
portfolio were $63.1 million and unrealized losses on the derivative instruments
designated against this portfolio were $2.8 million, resulting in a combined net
unrealized gain included as a separate component of stockholders' equity (on an
after-tax basis) of $41.7 million. At December 31, 1995, net unrealized gains on
the available-for-sale portfolio were $249.2 million and unrealized losses on
the derivative instruments designated against this portfolio were $13.5 million,
resulting in a combined net unrealized gain included as a separate component of
stockholders' equity (on an after-tax basis) of $188.7 million.
On December 31, 1996, the Company held $831.4 million of private-issue MBS
and CMOs. Of that amount, 20% were of the highest investment grade (AAA), 66%
were rated investment grade (AA or A), 9% were rated lowest investment grade
(BBB) and 5% were rated below investment grade (BB or below). During 1996, the
Company recognized $2.4 million in losses on securities in the below investment
grade portfolio. On December 31, 1995, the Company held $1.2 billion of
private-issue MBS and CMOs. Of that amount, 33% were of the highest investment
grade (AAA), 55% were rated investment grade (AA or A), 8% were rated lowest
investment grade (BBB) and 4% were rated below investment grade (BB or below).
During 1995, the Company recognized $8.4 million in losses on securities in the
below investment grade portfolio.
As of December 31, 1996, the Company had MBS with an amortized cost of
$249.7 million and a fair value of $249.6 million from a single issuer, the
Resolution Trust Corporation.
76
79
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: HELD-TO-MATURITY SECURITIES
Held-to-maturity securities classified by type and contractual maturity
date consisted of the following:
DECEMBER 31, 1996
---------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE YIELD(1)
---------- ---------- ---------- ---------- -----
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations:
Due after five but within 10 years...... $ 6,629 $ 559 $ -- $ 7,188 8.25%
Corporate debt obligations:
Due within one year..................... 6,607 2 -- 6,609 5.02
After one but within five years......... 41,486 2,432 (5) 43,913 8.90
After five but within 10 years.......... 14,618 919 (23) 15,514 8.68
After 10 years.......................... 15,282 1,862 -- 17,144 9.19
---------- ------- ----- ---------- ----
77,993 5,215 (28) 83,180 8.61
Municipal obligations:
Due after one but within five years..... 7,096 205 -- 7,301 6.24
After five but within 10 years.......... 30,176 1,385 -- 31,561 6.70
After 10 years.......................... 70,801 2,028 (237) 72,592 6.02
---------- ------- ----- ---------- ----
108,073 3,618 (237) 111,454 6.23
---------- ------- ----- ---------- ----
192,695 9,392 (265) 201,822 7.28
Mortgage-backed securities
U.S. government agency:
Due after 10 years...................... 2,667,652 53,078 -- 2,720,730 7.33
---------- ------- ----- ---------- ----
$2,860,347 $ 62,470 $ (265) $2,922,552 7.33%
========== ======= ===== ========== ====
- ---------------
(1) Weighted average yield at end of year.
77
80
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1995
---------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE YIELD(1)
---------- ---------- ---------- ---------- -----
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations:
Due within one year..................... $ 19,693 $ -- $ -- $ 19,693 5.24%
After five but within 10 years.......... 6,592 906 -- 7,498 8.09
---------- ------- ----- ---------- ----
26,285 906 -- 27,191 6.03
Corporate debt obligations:
Due within one year..................... 98,969 -- (9) 98,960 5.70
After one but within five years......... 31,173 2,895 (2) 34,066 8.66
After five but within 10 years.......... 22,586 2,472 (3) 25,055 8.37
After 10 years.......................... 17,162 2,310 (9) 19,463 8.91
---------- ------- ----- ---------- ----
169,890 7,677 (23) 177,544 7.00
Municipal obligations:
Due within one year..................... 1,090 1 -- 1,091 6.85
After one but within five years......... 1,658 89 -- 1,747 7.44
After five but within 10 years.......... 36,202 2,083 -- 38,285 6.88
After 10 years.......................... 53,371 2,908 -- 56,279 6.37
---------- ------- ----- ---------- ----
92,321 5,081 -- 97,402 6.60
---------- ------- ----- ---------- ----
288,496 13,664 (23) 302,137 6.78
Mortgage-backed securities
U.S. government agency:
Due after 10 years...................... 2,909,224 54,833 (3,344) 2,960,713 7.44
---------- ------- ----- ---------- ----
$3,197,720 $ 68,497 $ (3,367) $3,262,850 7.38%
========== ======= ===== ========== ====
- ---------------
(1) Weighted average yield at end of year.
Held-to-maturity MBS with an amortized cost of $2.7 billion and a fair
value of $2.7 billion at December 31, 1996 were pledged to secure public
deposits, securities sold under agreements to repurchase, other borrowings,
interest rate exchange agreements and access to the Federal Reserve discount
window. There were no sales out of the held-to-maturity portfolio during 1996
and 1995.
78
81
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: LOANS
Loans consisted of the following:
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
Real Estate:
Residential..................................... $22,660,715 $17,303,305
Residential construction........................ 723,645 615,814
Commercial real estate.......................... 3,810,968 3,487,574
----------- -----------
27,195,328 21,406,693
Second mortgage and other consumer................ 2,144,942 1,974,673
Manufactured housing.............................. 1,013,799 867,181
Commercial business............................... 340,149 179,568
Reserve for loan losses........................... (363,442) (235,275)
----------- -----------
$30,330,776 $24,192,840
=========== ===========
Included in the table above are loans held for sale of $227.4 million and
$83.7 million at December 31, 1996 and 1995.
Nonaccrual loans totaled $226.4 million and $213.8 million at December 31,
1996 and 1995. If interest on these loans had been recognized, such income would
have been $15.0 million in 1996 and $10.8 million for 1995. At December 31, 1996
and 1995, the Company had troubled debt restructurings of $112.3 million and
$90.6 million. During 1996 and 1995, these troubled debt restructurings returned
a yield of 8.83% and 8.13%, thereby contributing $9.0 million and $5.9 million
to interest income. Had these loans not been restructured and interest accrued
at their original rates, the additional interest income would not have been
material.
At December 31, 1996, loans totaling $317.3 million were impaired, of which
$260.7 million had allocated reserves of $42.9 million. The remaining $56.6
million were previously written down and had no reserves allocated to them. Of
the $317.3 million of impaired loans, $22.7 million were on nonaccrual status
and $294.6 million (including $82.0 million of troubled debt restructurings)
were performing but judged to be impaired. Similarly, at December 31, 1995,
loans totaling $169.1 million were impaired, of which $91.7 million had
allocated reserves of $16.6 million. The remaining $77.4 million were previously
written down and had no reserves allocated to them. Of the $169.1 million of
impaired loans, $26.7 million were on nonaccrual status and $142.3 million
(including $57.1 million of troubled debt restructurings) were performing but
judged to be impaired. The average balance of impaired loans during 1996 and
1995 was $302.6 million and $177.6 million and the Company recognized $14.6
million and $12.4 million of related interest income. Interest income on
impaired loans is normally recognized on the accrual basis, unless the loan is
more than 90 days past due, in which case interest income is recorded on the
cash basis. An immaterial amount of interest income was recorded on the cash
basis during 1996 and 1995.
79
82
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans, exclusive of reserve for loan losses, by geographic concentration
were as follows:
DECEMBER 31, 1996
----------------------------------------------------------------
CALIFORNIA WASHINGTON OREGON OTHER TOTAL
----------- ---------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
Real estate:
Residential..................... $13,154,086 $6,601,428 $1,890,021 $1,015,180 $22,660,715
Residential construction........ -- 374,653 256,637 92,355 723,645
Apartment buildings............. 1,617,747 558,412 272,060 110,552 2,558,771
Other commercial real estate.... 366,062 683,205 94,295 108,635 1,252,197
----------- ---------- ---------- ---------- -----------
15,137,895 8,217,698 2,513,013 1,326,722 27,195,328
Second mortgage and other
consumer........................ 96,992 1,178,797 551,165 317,988 2,144,942
Manufactured housing.............. 104,022 458,175 236,247 215,355 1,013,799
Commercial business............... -- 126,841 212,112 1,196 340,149
----------- ---------- ---------- ---------- -----------
$15,338,909 $9,981,511 $3,512,537 $1,861,261 $30,694,218
=========== ========== ========== ========== ===========
Loans in California included $5.2 billion of loans in the Los Angeles area,
$5.0 billion of loans in the San Francisco Bay area, $1.7 billion of loans in
Orange County, and $3.4 billion of loans in other California areas.
Loans, exclusive of reserve for loan losses, deferred loan fees and
premiums and discounts, by maturity or repricing date were as follows:
DECEMBER 31, 1996
---------------------
(DOLLARS IN
THOUSANDS)
Adjustable-rate loans:
Due within one year................................... $18,637,483
After one but within five years....................... 2,710,891
After five but within 10 years........................ 122,360
After 10 years........................................ 25,428
-----------
21,496,162
Fixed-rate loans:
Due within one year................................... 1,406,809
After one but within five years....................... 3,055,005
After five but within 10 years........................ 2,242,817
After 10 years........................................ 2,571,153
-----------
9,275,784
-----------
$30,771,946
===========
In addition to loans the Company serviced for its own portfolio, it
serviced loans of $23.0 billion and $21.4 billion at December 31, 1996 and 1995
for U.S. government agencies, institutions and private investors.
Loans of $9.8 billion at December 31, 1996 were pledged to secure advances
from the FHLB. Unamortized deferred loan fees were $101.1 million and $75.1
million at December 31, 1996 and 1995.
At December 31, 1996, the Company had $488.4 million in fixed-rate mortgage
loan commitments, $570.9 million in adjustable-rate mortgage loan commitments,
$650.6 million in residential construction loan commitments, $114.1 million in
commercial real estate loan commitments, $169.1 million in commercial business
loan commitments and $681.8 million in undisbursed lines of credit.
80
83
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7: RESERVE FOR LOAN LOSSES
Changes in the reserve for loan losses were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year................. $235,275 $244,989 $245,062
Provision for loan losses.................. 201,512 74,987 122,009
Reserves added through business
combinations............................. 1,077 5,372 921
Loans charged-off:
Residential.............................. (53,993) (57,147) (89,637)
Residential construction................. (16) (125) (190)
Commercial real estate................... (21,752) (33,149) (26,835)
Manufactured housing, second mortgage and
other consumer........................ (6,639) (6,888) (10,544)
Commercial business...................... (435) (813) (2,065)
-------- -------- --------
(82,835) (98,122) (129,271)
Recoveries of loans previously charged-off:
Residential.............................. 4,437 2,393 2,522
Residential construction................. -- 47 --
Commercial real estate................... 3,197 4,426 2,186
Manufactured housing, second mortgage and
other consumer........................ 705 701 1,117
Commercial business...................... 74 482 443
-------- -------- --------
8,413 8,049 6,268
-------- -------- --------
Net charge-offs............................ (74,422) (90,073) (123,003)
-------- -------- --------
Balance, end of year....................... $363,442 $235,275 $244,989
======== ======== ========
The Company provided an additional $125.0 million in loan loss provision
with the merger of Keystone Holdings. This additional loan loss provision was
provided principally because a number of Washington Mutual (prior to the
business combination with Keystone Holdings) credit administration and asset
management philosophies and procedures differed from those of ASB.
As part of the ongoing process to determine the adequacy of the reserve for
loan losses, the Company reviews the components of its loan portfolio for
specific risk of principal loss.
81
84
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
An analysis of the reserve for loan losses was as follows:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Allocated reserves:
Commercial real estate............................... $ 77,054 $ 16,488
Residential construction............................. -- 158
Commercial business.................................. 1,285 --
-------- --------
78,339 16,646
Unallocated reserves................................... 285,103 218,629
-------- --------
$363,442 $235,275
======== ========
Total reserve for loan losses as a percentage of:
Nonperforming loans.................................. 160.52% 110.04%
Nonperforming assets................................. 110.29 69.42
NOTE 8: REO
REO consisted of the following:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Real estate acquired through foreclosure............... $107,604 $134,195
Other repossessed assets............................... 2,651 1,018
Reserve for losses..................................... (7,144) (10,112)
-------- --------
$103,111 $125,101
======== ========
Changes in the REO reserve for losses were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
-------- ------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year.................. $ 10,112 $ 8,135 $ 13,330
Provision for REO losses.................... 7,125 10,523 15,491
Reserves charged-off, net of recoveries..... (10,093) (8,546) (20,686)
-------- -------- --------
$ 7,144 $10,112 $ 8,135
======== ======== ========
REO operations were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Operating expense.......................... $ (6,043) $ (3,457) $ (2,977)
Net gain on sale of REO.................... 1,638 3,298 5,066
Provision for REO losses................... (7,125) (10,523) (15,491)
-------- -------- --------
$(11,530) $(10,682) $(13,402)
======== ======== ========
82
85
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9: PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Furniture and equipment................................ $246,954 $243,527
Buildings.............................................. 331,988 363,894
Leasehold improvements................................. 59,812 54,683
Construction in progress............................... 4,052 8,080
-------- --------
642,806 670,184
Accumulated depreciation............................... (241,360) (296,779)
-------- --------
401,446 373,405
Land................................................... 80,945 79,338
-------- --------
$482,391 $452,743
======== ========
In January 1995, a wholly owned service corporation subsidiary of ASB
purchased from a related limited partnership the Irvine Plaza building
structures and adjoining land currently utilized for ASB's executive offices and
various departments. The total cash purchase price paid for the property was
$45.2 million.
Depreciation expense for 1996, 1995 and 1994 was $42.3 million, $41.3
million and $38.4 million.
The Company has noncancelable operating leases for financial centers,
office facilities and equipment. Rental expense, including amounts paid under
month-to-month cancelable leases, amounted to $43.4 million, $40.4 million and
$44.5 million in 1996, 1995 and 1994.
Future minimum net rental commitments, including maintenance and other
associated costs, for all noncancelable leases were as follows:
DECEMBER 31, 1996
--------------------------
LAND & FURNITURE &
BUILDINGS EQUIPMENT
---------- -----------
(DOLLARS IN THOUSANDS)
Due within one year................................. $ 32,787 $ 7,401
After one but within two years...................... 30,318 5,465
After two but within three years.................... 27,752 4,139
After three but within four years................... 25,741 878
After four but within five years.................... 20,112 644
After five years.................................... 83,201 --
-------- -------
$ 219,911 $18,527
======== =======
In March 1995, the FASB issued SFAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The statement
establishes accounting standards for the impairment of long-lived assets that
either will be held and used in operations or that will be disposed of.
Effective January 1, 1996, the Company adopted SFAS No. 121. The Company
periodically evaluates long-lived assets for impairment.
83
86
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10: GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consisted of the following:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Washington Mutual Bank, net of amortization of $125,542
and $98,654.......................................... $132,425 $159,259
Murphey Favre, Inc. and Composite Research & Management
Co., net of amortization of $10,125 and $9,389....... 732 1,468
Other, net of amortization of $133 and $85............. 352 400
-------- --------
$133,509 $161,127
======== ========
Goodwill and other intangible assets result from business combinations
accounted for as a purchase of assets and an assumption of liabilities. Other
intangible assets primarily consist of core deposit intangibles and covenants
not-to-compete resulting from acquisitions of thrift branch systems. Goodwill
and other intangible assets are amortized using the straight-line method over
the period that is expected to be benefited, which ranges from three to 10
years. The average remaining amortization period at December 31, 1996 was
approximately five years. The Company periodically evaluates goodwill and other
intangible assets for impairment.
NOTE 11: MORTGAGE SERVICING RIGHTS
Mortgage servicing rights are included in other assets and consisted of the
following:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year................. $104,495 $ 70,911 $ 66,031
Additions................................ 74,398 58,306 38,385
Sales.................................... (5,395) -- (13,087)
Amortization............................. (30,615) (23,840) (20,418)
Impairment valuation allowance........... (2,158) (882) --
-------- -------- --------
Balance, end of year....................... $140,725 $104,495 $ 70,911
======== ======== ========
With the adoption of SFAS No. 122, the Company provided a valuation
allowance for impairment of mortgage servicing rights. No write-downs were
recorded in 1996, 1995 and 1994.
84
87
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12: DEPOSITS
Deposits consisted of the following:
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
Checking accounts:
Interest bearing................................ $ 2,138,782 $ 2,111,124
Noninterest bearing............................. 841,180 665,205
----------- -----------
2,979,962 2,776,329
Savings accounts.................................. 1,660,376 1,905,659
Money market deposit accounts..................... 5,181,685 4,667,884
Time deposit accounts:
Due within one year............................. 12,159,123 12,696,186
After one but within two years.................. 1,011,934 1,410,809
After two but within three years................ 647,988 409,580
After three but within four years............... 266,922 243,541
After four but within five years................ 92,004 258,415
After five years................................ 80,147 94,557
----------- -----------
14,258,118 15,113,088
----------- -----------
$24,080,141 $24,462,960
=========== ===========
Time deposit accounts in amounts of $100,000 or more totaled $3.1 billion
at both December 31, 1996 and 1995. At December 31, 1996, $506.3 million of
these deposits mature within three months, $211.2 million mature in three to six
months, $1.4 billion mature in six months to one year, and $1.0 billion mature
after one year.
Financial data pertaining to the weighted average cost of deposits were as
follows:
YEAR ENDED DECEMBER 31,
-------------------------
1996 1995 1994
----- ----- -----
Weighted daily average interest rate during the
year............................................. 4.41% 4.69% 3.69%
NOTE 13: FEDERAL FUNDS PURCHASED
The Company purchased federal funds from a variety of counterparties during
1996 and 1995. All federal funds purchased had maturities of 30 days or less,
with the majority maturing in one day. As of December 31, 1996 and 1995, the
balance of federal funds purchased was $1.1 billion and $433.4 million.
Financial data pertaining to federal funds purchased were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
---------- -------- ----
(DOLLARS IN THOUSANDS)
Weighted average interest rate at end of
year....................................... 5.99% 5.83% --%
Weighted daily average interest rate during
the year................................... 5.39 5.98 --
Daily average balance of federal funds
purchased.................................. $ 857,889 $270,861 $ --
Maximum amount of federal funds purchased at
any month end.............................. 1,474,000 998,000 --
Interest expense during the year............. 46,269 16,188 --
85
88
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase consisted of the following:
DECEMBER 31,
-------------------------
1996 1995
---------- ----------
(DOLLARS IN THOUSANDS)
Reverse repurchase agreements....................... $7,591,658 $7,592,841
Dollar repurchase agreements........................ 243,795 391,915
---------- ----------
$7,835,453 $7,984,756
========== ==========
The Company sold, under agreements to repurchase, specific securities of
the U.S. government and its agencies and other approved investments to
broker-dealers and customers. Securities underlying the agreements with
broker-dealers were delivered to the dealer who arranged the transaction or were
held by a safekeeping agent for the Company's account. Securities delivered to
broker-dealers may be loaned out in the ordinary course of operations.
Securities underlying agreements with customers were held in a segregated
account by a safekeeping agent for the Company.
Scheduled maturities or repricing of securities sold under agreements to
repurchase were as follows:
DECEMBER 31,
-------------------------
1996 1995
---------- ----------
(DOLLARS IN THOUSANDS)
Due within 30 days.................................. $3,202,302 $5,225,817
After 30 but within 90 days......................... 4,311,164 1,764,074
After 90 but within 180 days........................ 321,987 490,361
After one year...................................... -- 504,504
---------- ----------
$7,835,453 $7,984,756
========== ==========
Financial data pertaining to securities sold under agreements to repurchase
were as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Weighted average interest rate at end of
year..................................... 5.53% 5.92% 5.94%
Weighted daily average interest rate during
the year................................. 5.53 6.14 4.69
Daily average of securities sold under
agreements to repurchase................. $8,960,288 $7,859,948 $4,318,592
Maximum securities sold under agreements to
repurchase at any month end.............. 9,453,202 8,647,814 6,637,346
Interest expense during the year........... 495,483 482,698 202,677
SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, was issued in June 1996 and established,
among other things, new criteria for determining whether a transfer of financial
assets in exchange for cash or other consideration should be accounted for as a
sale or as a pledge of collateral in a secured borrowing. As issued, Statement
No. 125 is effective for all transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. In December
1996, the FASB issued SFAS No. 127, Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125. In general, SFAS No. 127 defers for one
year the effective date of SFAS No. 125. The Company will implement SFAS No.
125, as amended by SFAS No. 127 as required. The adoption is not anticipated to
have a material impact on the results of operations or financial position of the
Company.
86
89
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15: ADVANCES FROM THE FHLB
As members of the FHLB, WMB, WM Life, WMBfsb, and ASB maintain credit lines
that are percentages of their total regulatory assets, subject to
collateralization requirements. As members of the FHLB of Seattle, WMB's, WM
Life's and WMBfsb's advances are collateralized in aggregate by all FHLB stock
owned, by deposits with the FHLB, and by certain mortgages or deeds of trust and
securities of the U.S. government and agencies thereof. As a member of the FHLB
of San Francisco, ASB's advances are collateralized by all FHLB stock owned and
certain mortgages and deeds of trust.
Scheduled maturities of advances from the FHLB were as follows:
DECEMBER 31,
-----------------------------------------------------
1996 1995
------------------------ ------------------------
RANGES OF RANGES OF
INTEREST INTEREST
AMOUNT RATES AMOUNT RATES
---------- ----------- ---------- -----------
(DOLLARS IN THOUSANDS)
Due within one year...................... $5,376,850 4.38%-8.45% $2,545,594 4.74%-8.54%
After one but within two years........... 1,144,891 5.30 -8.50 1,331,000 4.38 -8.45
After two but within three years......... 67,889 6.45 -8.53 545,642 5.59 -8.50
After three but within four years........ 55,197 6.25 -9.34 57,000 8.50 -8.63
After four but within five years......... 450,000 5.40 -5.51 55,137 6.25 -9.34
After five years......................... 146,665 2.80 -8.65 181,366 2.80 -8.65
---------- ----------
$7,241,492 $4,715,739
========== ==========
Financial data pertaining to FHLB advances were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Weighted average interest rate at end
of year.............................. 5.51% 5.76% 5.72%
Weighted daily average interest rate
during the year...................... 5.57 5.72 5.38
Daily average of FHLB advances......... $4,651,883 $3,539,006 $3,966,494
Maximum FHLB advances at any month
end.................................. 7,241,492 4,715,739 4,560,891
Interest expense during the year....... 259,243 202,422 213,259
87
90
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16: OTHER BORROWINGS
Other borrowings consisted of the following:
DECEMBER 31,
------------------------------------------------
1996 1995
----------------------- -----------------------
AMOUNT INTEREST RATE AMOUNT INTEREST RATE
-------- ------------- -------- -------------
(DOLLARS IN THOUSANDS)
Series C Floating Rate Notes, due
2000............................ $175,000 6.91% $175,000 7.31%
Series B 9.60% Notes, due 1999.... 169,000 9.60 169,000 9.60
Senior notes, due 2005............ 148,007 7.25 147,845 7.25
Subordinated notes, due 2006...... 98,650 6.63 -- --
Notes payable, due 1998........... 74,111 8.16 74,482 8.16
Subordinated notes, due 1998...... 10,000 8.41 20,500 8.81
Other............................. 2,218 -- 3,390 --
-------- --------
$676,986 $590,217
======== ========
In March 1995, the Company completed the private placement of $175.0
million of its Series C Floating Rate Notes ("Series C Notes"). Interest on the
Series C Notes accrued at the three-month LIBOR plus 1.375%, reset on a
quarterly basis. The Series C Notes were redeemed in January 1997.
In January 1992, the Company completed the private placement of $169.0
million of its Series B 9.60% Notes ("Series B Notes"). The Series B Notes were
redeemed in January 1997.
In August 1995, the Company filed a registration statement with the
Securities and Exchange Commission for the offering, on a delayed or continuous
basis, of up to $250.0 million of debt securities, of which $100.0 million
remains available. In August 1995, the Company issued $150.0 million of senior
notes bearing an interest rate of 7.25%. The notes may not be redeemed prior to
maturity.
In February 1996, the Company issued $100.0 million of subordinated notes
bearing an interest rate of 6.625%.
In 1993, the Company assumed a $75.0 million note payable bearing an
interest rate of 8.16% to the City of Tampa. The City of Tampa issued capital
improvement revenue bonds in 1988 and invested a portion of the receipts with
Pacific First Bank, A Federal Savings Bank ("Pacific First"). The note is
subject to periodic withdrawals.
In October 1993, the Company issued $20.5 million of subordinated notes.
The subordinated notes accrued interest at a rate equal to the three-month LIBOR
plus 2.875%. In December 1996, $10.5 million of the notes were redeemed and the
remaining $10.0 million were redeemed in January 1997.
In December 1996, Washington Mutual entered into two Revolving Credit
Facilities (the "Facilities"): a $100.0 million 364-day facility and a $100.0
million four-year facility. Chase Manhattan Bank is the administrative agent for
the Facilities. At December 31, 1996, no monies had been drawn. However, in
January 1997, $150.0 million was drawn for the redemption of debt securities
mentioned above and in February 1997, another $20.0 million was drawn. The
remaining proceeds of the Facilities are available for general corporate
purposes, including providing capital at a subsidiary level.
NOTE 17: INTEREST RATE RISK MANAGEMENT
From time to time, the following strategies may be used by the Company to
reduce its exposure to interest rate risk: the origination and purchase of ARMs
and the purchase of adjustable-rate MBS; the sale of
88
91
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fixed-rate residential mortgage loan production or fixed-rate MBS; and the use
of derivative instruments, such as interest rate exchange agreements and
interest rate cap agreements.
As of December 31, 1996, interest-sensitive assets of $31.8 billion and
interest-sensitive liabilities of $33.4 billion were scheduled to mature or
reprice within one year. At December 31, 1996, the Company had entered into
interest rate exchange agreements and interest rate cap agreements with notional
values of $9.1 billion. Without these instruments the Company's one-year gap at
December 31, 1996 would have been a negative 9.81% as opposed to a negative
3.64%.
Interest rate exchange agreements and interest rate cap agreements expose
the Company to credit risk in the event of nonperformance by counterparties to
such agreements. This risk consists primarily of the termination value of
agreements where the Company is in a favorable position. The Company controls
the credit risk associated with its interest rate exchange agreements and
interest rate cap agreements through counterparty credit review, counterparty
exposure limits and monitoring procedures.
The Company's use of derivative instruments reduces the negative effect
that changing interest rates may have on net interest income. The Company uses
such instruments to reduce the volatility of net interest income over an
interest rate cycle. The Company does not invest in leveraged derivative
instruments. These types of instruments are riskier than the derivatives used by
the Company in that they have significant embedded options that enhance the
performance in certain circumstances but dramatically reduce the performance in
other circumstances.
During 1995, the Company terminated an interest rate exchange agreement
with a notional value of $75.0 million and recorded a deferred gain of $845,000.
There were no other terminations of interest rate exchange agreements or
interest rate cap agreements in 1995. During 1994, the Company terminated
interest rate exchange agreements with a notional value of $370.0 million for
deferred gains of $1.4 million and deferred losses of $4.8 million. During 1994,
the Company terminated interest rate cap agreements with a notional value of
$375.0 million and deferred gains of $860,000 were recorded. During 1996, the
Company did not terminate any interest rate exchange agreements or interest rate
cap agreements.
Scheduled maturities of interest rate exchange agreements were as follows:
DECEMBER 31, 1996
-------------------------------------------------------------------
NOTIONAL SHORT-TERM LONG-TERM CARRYING
AMOUNT RECEIPT RATE(1) PAYMENT RATE VALUE FAIR VALUE
---------- --------------- ------------ -------- ----------
(DOLLARS IN THOUSANDS)
Designated against available-for-sale
securities:
Due within one year.................. $ 200,000 5.56% 6.83% $ (799) $ (799)
After one but within two years....... 300,000 5.60 6.05 (112) (112)
After two but within three........... 200,000 5.87 6.09 265 265
Designated against deposits and
borrowings:
Due within one year.................. 459,500 5.71 6.60 -- (2,908)
After one but within two years....... 397,500 5.43 6.25 -- (2,581)
After two but within three years..... 282,600 5.43 7.79 -- (11,255)
After three years.................... 502,800 5.72 5.45 -- 18,066
---------- ---- ---- ------ ---------
$2,342,400 5.62% 6.34% $ (646) $ 676
========== ==== ==== ====== =========
- ---------------
(1) The terms of each agreement have specific LIBOR reset and index
requirements, which result in different short-term receipt rates for each
agreement. The receipt rate represents the weighted average rate as of the
last reset date for each agreement.
89
92
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1995
------------------------------------------------------------------
NOTIONAL SHORT-TERM LONG-TERM CARRYING
AMOUNT RECEIPT RATE(1) PAYMENT RATE VALUE FAIR VALUE
---------- --------------- ------------ -------- ----------
(DOLLARS IN THOUSANDS)
Designated against available-for-sale
securities:
Due within one year.................. $ 465,000 5.13% 5.92% $ 1,528 $ 1,528
After one but within two years....... 200,000 6.83 5.88 (4,144) (4,144)
After two but within three........... 300,000 6.05 5.92 (5,244) (5,244)
After three years.................... 200,000 6.88 5.88 (3,987) (3,987)
Designated against deposits and
borrowings:
Due within one year.................. 495,000 6.95 6.08 -- 2,385
After one but within two years....... 484,500 5.96 6.62 -- (8,461)
After two but within three years..... 276,000 6.04 6.75 -- (8,746)
After three years.................... 261,000 7.10 8.27 -- (7,793)
---------- ---- ---- -------- --------
$2,681,500 6.26% 6.38% $(11,847) $ (34,462)
========== ==== ==== ======== ========
- ---------------
(1) The terms of each agreement have specific LIBOR reset and index
requirements, which result in different short-term receipt rates for each
agreement. The receipt rate represents the weighted average rate as of the
last reset date for each agreement.
Scheduled maturities of interest rate cap agreements were as follows:
DECEMBER 31, 1996
-------------------------------------------------------------
NOTIONAL STRIKE SHORT-TERM CARRYING
AMOUNT RATE RECEIPT RATE(1) VALUE FAIR VALUE
---------- ------ --------------- -------- ----------
(DOLLARS IN THOUSANDS)
Designated against available-for-sale
securities:
Due within one year(2)................... $ 875,000 5.85% 5.89% $ 499 $ 499
After one but within two years(3)........ 650,000 6.17 5.60 1,961 1,961
Designated against deposits and borrowings:
Due within one year(4)................... 3,001,000 6.12 5.61 707 2
After one but within two years(5)........ 565,500 7.89 5.49 1,881 798
After two but within three years(6)...... 855,750 7.17 5.16 5,814 1,396
After three years(7)..................... 832,750 8.06 5.04 9,131 1,215
---------- ---- ---- -------- ------
$6,780,000 6.61% 5.51% $ 19,993 $5,871
========== ==== ==== ======== ======
- ---------------
(1) The terms of each agreement have specific LIBOR or COFI reset and index
requirements, which result in different short-term receipt rates for each
agreement. The receipt rate represents the weighted average rate as of the
last reset date for each agreement.
(2) Includes $600.0 million notional amount with a weighted average cap ceiling
of 7.75%.
(3) Includes $650.0 million notional amount with a weighted average cap ceiling
of 7.56%.
(4) Includes $45.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(5) Includes $240.0 million notional amount with a weighted average cap ceiling
of 7.83% and $150.0 million notional amount with a weighted average floor of
5.50%.
(6) Includes $839.8 million notional amount with a weighted average cap ceiling
of 8.77%.
(7) Includes $571.8 million notional amount with a weighted average cap ceiling
of 9.49%.
90
93
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1995
---------------------------------------------------------------
NOTIONAL STRIKE SHORT-TERM CARRYING FAIR
AMOUNT RATE RECEIPT RATE(1) VALUE VALUE
---------- ---- --------------- ------- -------
(DOLLARS IN THOUSANDS)
Designated against available-for-sale
securities:
Due within one year(2)............. $1,425,000 5.34% 5.90% $ 4,484 $ 4,484
After one but within two
years(3)........................ 875,000 5.85 5.83 3,799 3,799
After two but within three
years(4)........................ 250,000 6.05 5.90 1,132 1,132
Designated against deposits and
borrowings:
Due within one year(5)............. 5,193,000 7.43 5.63 151 (1,775)
After one but within two
years(6)........................ 386,000 9.18 5.60 1,241 2
After two but within three
years(7)........................ 286,000 8.81 5.49 1,177 42
After three years(8)............... 1,359,000 8.05 5.27 15,122 1,101
---------- ---- ---- ------- -------
$9,774,000 7.14% 5.64% $27,106 $ 8,785
========== ==== ==== ======= =======
- ---------------
(1) The terms of each agreement have specific LIBOR or COFI reset and index
requirements, which result in different short-term receipt rates for each
agreement. The receipt rate represents the weighted average rate as of the
last reset date for each agreement.
(2) Includes $425.0 million notional amount with a weighted average cap ceiling
of 8.06%.
(3) Includes $600.0 million notional amount with a weighted average cap ceiling
of 7.75%.
(4) Includes $250.0 million notional amount with a weighted average cap ceiling
of 7.65%.
(5) Includes $30.0 million notional amount with a weighted average cap ceiling
of 9.50% and $5.0 billion notional amount with a weighted average floor of
4.85%.
(6) Includes $45.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(7) Includes $40.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(8) Includes $1.1 billion notional amount with a weighted average cap ceiling of
9.50%.
Changes in interest rate exchange agreements and interest rate cap
agreements were as follows:
YEAR ENDED DECEMBER 31, 1996
-----------------------------
INTEREST INTEREST
RATE RATE
EXCHANGE CAP
AGREEMENTS AGREEMENTS
----------- -----------
(DOLLARS IN THOUSANDS)
Notional balance, beginning of year............. $ 2,681,500 $ 9,774,000
Purchases..................................... 668,400 3,805,500
Maturities.................................... (1,007,500) (6,799,500)
----------- -----------
Notional balance, end of year................... $ 2,342,400 $ 6,780,000
=========== ===========
The unamortized balance of prepaid fees and deferred gains and losses from
terminated interest rate exchange agreements and interest rate cap agreements
are scheduled to be amortized into interest expense as follows:
DECEMBER 31, 1996
------------------------------------
LOSS ON
AVAILABLE- LOSS ON
FOR-SALE DEPOSITS AND
SECURITIES BORROWINGS LOSS
------- ------------ -------
(DOLLARS IN THOUSANDS)
1997........................................ $(3,612) $ (1,663) $(5,275)
1998........................................ (1,033) (1,237) (2,270)
1999........................................ -- (51) (51)
------- ------- -------
Unamortized deferred loss................. $(4,645) $ (2,951) $(7,596)
======= ======= =======
91
94
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial data pertaining to interest rate exchange agreements were as
follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Weighted average net effective cost at end of year..... 0.73% 0.12% 0.42%
Weighted average net effective cost during the year.... 0.28 -- 1.44
Monthly average notional amount of interest rate
exchange agreements.................................. $2,598,250 $2,749,167 $2,803,750
Maximum notional amount of interest rate exchange
agreements at any month end.......................... 3,146,400 2,901,500 3,058,500
Net cost included with interest expense on deposits
during the year...................................... (70) 3,540 13,286
Net cost included with interest expense on borrowings
during the year...................................... 10,320 6,842 28,426
Net (benefit) included with interest income on
available-for-sale securities during the year........ (2,984) (10,495) (1,316)
Financial data pertaining to interest rate cap agreements were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
----------- ---------- ----------
(DOLLARS IN THOUSANDS)
Monthly average notional amount of interest rate cap
agreements.......................................... $10,433,750 $6,363,000 $2,557,625
Maximum notional amount of interest rate cap
agreements at any month end......................... 12,514,500 9,774,000 3,584,000
Net cost included with interest expense on deposits
during the year..................................... 6,206 7,875 2,257
Net cost included with interest expense on borrowings
during the year..................................... 2,162 415 565
Net (benefit) cost included with interest income on
available-for-sale securities during the year....... (4,686) (5,340) 1,365
NOTE 18: GAIN (LOSS) ON SALE OF OTHER ASSETS
Gain (loss) on sale of other assets consisted of the following:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
Trading account securities.................... $ 31 $ 529 $ 45
Available-for-sale securities................. (2,648) (929) 4,111
Mortgage servicing rights..................... 4,030 -- 20,396
Premises and equipment........................ (958) (1,458) (1,270)
Recognition of deferred gain on sale of travel
subsidiary.................................. 4,100 -- --
Other......................................... 1,311 1,203 644
------ ------ -------
$ 5,866 $ (655) $23,926
====== ====== =======
92
95
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19: INCOME TAXES
The provision for income taxes from continuing operations consisted of the
following:
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
------- -------- --------
(DOLLARS IN THOUSANDS)
Current income tax expense.................. $96,613 $ 92,315 $ 94,452
Deferred income tax (benefit) expense....... (26,193) 19,591 15,428
------- -------- --------
$70,420 $111,906 $109,880
======= ======== ========
In determining taxable income for years prior to 1996, savings banks were
allowed bad debt deductions based on a percentage of taxable income or on actual
experience. Each year, savings banks selected whichever method resulted in the
most tax savings. The Company primarily used the percentage method in 1995 and
1994. Effective with the adoption of SFAS No. 109, Accounting for Income Taxes,
this bad debt deduction is no longer treated as a permanent difference.
The recently enacted Small Business Job Protection Act of 1996 (the "Job
Protection Act") requires that qualified thrift institutions, such as WMB, ASB
and WMBfsb, generally recapture, for federal income tax purposes, that portion
of the balance of their tax bad debt reserves that exceeds the December 31, 1987
balance, with certain adjustments. Such recaptured amounts are to be generally
taken into ordinary income ratably over a six-year period beginning in 1997.
Accordingly, Washington Mutual will have to pay approximately $4.2 million
(based upon current federal income tax rates) in additional federal income taxes
each year of the six-year period due to the Job Protection Act.
The Job Protection Act also repeals the reserve method of accounting for
tax bad debt deductions and, thus, requires thrifts to calculate the tax bad
debt deduction based on actual current loan losses.
In addition, the Company will also be required to recapture its post-1987
additions to its tax bad debt reserves, whether such additions were made
pursuant to the percentage of taxable income method or the experience method. As
of December 31, 1995, these additions were $151.3 million which, pursuant to the
Job Protection Act, will be included in taxable income ratably over a
six-taxable-year period beginning with the year ending December 31, 1997. The
recapture of the post-1987 additions to tax basis bad debt reserves will not
result in a charge to earnings as these amounts are included in the deferred tax
liability at December 31, 1996.
93
96
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The significant components of the Company's net deferred tax asset
(liability) were as follows:
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards................ $ 1,269,124 $ 1,632,230
Book loan loss reserves......................... 173,116 106,828
Purchase accounting adjustments................. 20,153 41,343
Deferred losses................................. 41,757 --
Other........................................... 55,892 59,468
---------- ----------
1,560,042 1,839,869
Valuation allowance............................... (1,192,676) (1,150,206)
---------- ----------
Deferred tax asset, net of valuation allowance.... 367,366 689,663
Deferred tax liabilities:
Tax bad debt reserves........................... 63,193 467,125
FHLB stock dividends............................ 68,901 60,636
Deferred loan fees.............................. 41,416 32,958
Deferred gains.................................. 52,365 50,947
Purchase accounting adjustments................. 18,098 26,644
Other........................................... 83,925 63,546
---------- ----------
327,898 701,856
---------- ----------
Net deferred tax asset (liability)................ $ 39,468 $ (12,193)
========== ==========
The valuation allowances of $1.2 billion at December 31, 1996 and 1995
included $45.8 million and $130.6 million related to payments in lieu of taxes
which are expected to arise from the realization of the net deferred tax asset.
These valuation allowances represented the excess of the gross deferred tax
asset over the sum of the taxes and the payments in lieu of taxes related to:
(i) projected future taxable income; (ii) reversing taxable temporary
differences; and (iii) tax planning strategies.
The increase in the valuation allowance of $42.5 million during the year
ended December 31, 1996 was due primarily to adjustments for anticipated use of
net operating losses and a change in state tax rates.
As of December 31, 1996, the Company's net deferred tax asset was $39.5
million. In order to fully realize the net deferred tax asset, ASB will need to
generate future taxable income of approximately $342.1 million prior to the
expiration of its tax net operating losses, which begin to expire in 1999. Due
to Section 382 of the Code, most of the value of the net operating loss
carryforward deductions of Keystone Holdings and its subsidiaries was eliminated
due to the Keystone Transaction. Accordingly, the future tax savings
attributable to such net operating loss carryforward deductions (other than
amounts used to offset bad debt reserve deduction recapture for ASB) will be
greatly reduced.
In August 1996, Keystone Holdings amended prior-year federal tax returns to
reduce tax bad debt deductions and to make other amendments. As a result, the
net operating loss carryforwards for federal tax purposes were reduced by
approximately $756 million. In September 1996, ASB amended prior-year state tax
returns to reduce tax bad debt deductions. The result was to decrease state net
operating loss carryovers by approximately $545 million. The decrease in the
gross deferred tax asset as a result of the amendments which reduced the federal
and state net operating loss carryforwards was offset by an equal decrease in
the valuation allowance for the deferred tax asset.
94
97
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Federal and state income tax net operating loss carryforwards due to expire
under current law during the years indicated were as follows:
DECEMBER 31, 1996
-------------------------
FEDERAL STATE
---------- ----------
(DOLLARS IN THOUSANDS)
1999................................... $ -- $ 140
2000................................... 1,497 613,382
2001................................... 140 599,241
2002................................... 278 557,803
2003................................... 1,544,396 --
2004................................... 784,195 --
2005................................... 700,619 --
2007................................... 12,780 --
2008................................... 37,460 --
---------- ----------
$3,081,365 $1,770,566
========== ==========
In April 1994, revenue procedures were issued allowing the Company to
change its method of accounting for loan fees, effective for 1993. The change
allowed most members of the Company's consolidated filing group to defer the
recognition of loan fees for income tax purposes.
Under SFAS No. 115, where actual benefits or liabilities are expected to be
realized, the net realizable tax effects of unrealized gains and losses on
available-for-sale securities at December 31, 1996 and 1995 were included in the
deferred tax liabilities and assets. The tax effect was made directly to
stockholders' equity and was not included in the provision for income taxes.
The change in the net deferred tax asset (liability) was as follows:
YEAR ENDED DECEMBER
31, 1996
----------------------
(DOLLARS IN THOUSANDS)
Deferred tax (liability), beginning of year............... $(12,193)
Tax effect of valuation adjustment on available-for-sale
securities........................................... 23,211
Deferred income tax benefit............................. 26,193
Other adjustments....................................... 2,257
--------
Deferred tax asset, end of year........................... $ 39,468
========
95
98
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reconciliations between income taxes computed at statutory rates and income
taxes included in the Consolidated Statements of Income were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Income taxes computed at statutory rates........... $ 78,209 $148,920 $127,163
Tax effect of:
Utilization of tax losses of New West (nominee
of ASB)..................................... (31,200) (17,482) (55,100)
Amortization of goodwill and other intangible
assets...................................... 6,372 6,631 6,688
State franchise tax, net of federal tax
benefit..................................... (38,616) 3,899 (2,890)
Increase in base year reserve amount.......... (706) (16,318) (11,605)
Valuation allowance change from prior year.... 42,470 (7,114) 48,241
Dividends received deduction.................. (2,460) (987) (506)
Tax exempt income............................. (2,309) (1,973) (1,680)
Restructuring adjustments..................... 9,321 -- --
Other......................................... 9,339 (3,670) (431)
------- -------- --------
Income taxes included in the Consolidated
Statements of Income............................. $ 70,420 $111,906 $109,880
======= ======== ========
NOTE 20: PAYMENTS IN LIEU OF TAXES
Keystone Holdings and certain of its affiliates are parties to a tax
related agreement (the "Assistance Agreement") with a predecessor of the FSLIC
Resolution Fund ("FRF") which generally provides that 75.0% of most of the
federal tax savings and approximately 19.5% of most of the California tax
savings (as computed in accordance with the Assistance Agreement) attributable
to ASB's utilization of any current tax losses or tax loss carryovers of New
West are to be paid by the Company for the benefit of the FRF. The Assistance
Agreement sets forth certain special adjustments to federal taxable income to
arrive at "FSLIC taxable income." The principal adjustments effectively permit
ASB to (i) recognize loan fees ratably over seven years adjusted for loan
dispositions, (ii) treat the income and expenses of N.A. Capital Holdings and
New American Capital, Inc., subsidiaries of Keystone Holdings, as income and
expenses of ASB, and (iii) for years ending on or before December 31, 1994, to
recognize approximately 36.0% of the amortization of the mark-to-market
adjustment attributable to the acquired loan portfolio.
The provision (benefit) for payments in lieu of taxes consisted of the
following:
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
------- ------ -----
(DOLLARS IN THOUSANDS)
Federal........................................ $ 4,006 $3,450 $(137)
State.......................................... 21,181 4,437 (687)
------- ------ -----
$25,187 $7,887 $(824)
======= ====== =====
96
99
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21: STOCKHOLDERS' EQUITY
Common Stock
Cash dividends paid per share were as follows:
YEAR ENDED DECEMBER
31,(1)
-------------------------
1996 1995 1994
----- ----- -----
First quarter....................................... $0.21 $0.19 $0.16
Second quarter...................................... 0.22 0.19 0.17
Third quarter....................................... 0.23 0.19 0.18
Fourth quarter...................................... 0.24 0.20 0.19
- ---------------
(1) Does not include amounts paid by acquired companies prior to business
combinations.
Prior to the business combination with Washington Mutual, acquired
companies paid total common cash dividends of $60.0 million, $8.9 million and
$25.6 million in 1996, 1995 and 1994.
In addition to being influenced by legal, regulatory and economic
restrictions, Washington Mutual's ability to pay dividends is also predicated on
the ability of its subsidiaries to declare and pay dividends to WMI. These
subsidiaries are subject to legal and regulatory restrictions on their ability
to pay dividends.
Retained earnings of the Company at December 31, 1996 included a pre-1988
thrift bad debt reserve for tax purposes of $450.0 million for which no federal
income taxes had been provided. In the future, if this thrift bad debt reserve
is used for any purpose other than to absorb bad debt losses or if any of the
banking subsidiaries no longer qualifies as a bank, the Company will incur a
federal income tax liability, at the then prevailing corporate tax rate, to the
extent of such subsidiary's pre-1988 thrift bad debt reserve.
On October 16, 1990, the Company's Board of Directors adopted a shareholder
rights plan and declared a dividend of one right for each outstanding share of
common stock to shareholders of record on October 31, 1990. The rights have
certain anti-takeover effects. They are intended to discourage coercive or
unfair takeover tactics and to encourage any potential acquirer to negotiate a
price fair to all shareholders. The rights may cause substantial dilution to an
acquiring party that attempts to acquire the Company on terms not approved by
the Board of Directors, but they will not interfere with any friendly merger or
other business combination. The plan was not adopted in response to any specific
effort to acquire control of the Company.
As part of the business combination with Keystone Holdings, 8,000,000
shares of common stock, with an assigned value of $42.75 per share, were issued
to an escrow for the benefit of the general and limited partners of Keystone
Holdings and the FRF. Shares will be released from the Litigation Escrow, if and
only to, the extent that Washington Mutual receives net cash proceeds from
certain litigation that Keystone Holdings and certain of its subsidiaries were
pursuing against the United States, which litigation became an asset of the
Company in the Keystone Transaction.
Preferred Stock
In December 1992, the Company issued 2,800,000 shares of 9.12%
Noncumulative Perpetual Preferred Stock, Series C ("Series C Preferred Stock"),
at $25 per share for net proceeds of $67.4 million. The Series C Preferred Stock
has a liquidation preference of $25 per share plus dividends accrued and unpaid
for the then current dividend period. Dividends, if and when declared by
Washington Mutual's Board of Directors, are at an annual rate of $2.28 per
share. Dividends have been declared and paid in all quarters since issuance. The
Company may redeem the Series C Preferred Stock on or after December 31, 1997 at
the redemption price of $25 per share plus unpaid dividends, whether or not
declared, for the then current dividend period up to the date fixed for
redemption. In November 1995, the Company purchased and retired 47,500 shares of
the Series C Preferred Stock.
97
100
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Also in December 1992, the Company issued 1,400,000 shares of $6.00
Noncumulative Convertible Perpetual Preferred Stock, Series D ("Series D
Preferred Stock"), at $100 per share for net proceeds of $136.4 million. The
Series D Preferred Stock had a liquidation preference of $100 per share plus
dividends accrued and unpaid for the then current dividend period. The Series D
Preferred Stock was convertible at a rate of 3.870891 shares of common stock per
share of Series D Preferred Stock. Dividends were at an annual rate of $6.00 per
share. Prior to December 31, 1996, substantially all of the Series D Preferred
Stock was converted into shares of common stock and the Company redeemed the
remaining shares.
In September 1993, the Company issued 2,000,000 shares of 7.60%
Noncumulative Perpetual Preferred Stock, Series E ("Series E Preferred Stock"),
at $25 per share for net proceeds of $48.2 million. The Series E Preferred Stock
has a liquidation preference of $25 per share plus dividends accrued and unpaid
for the then current dividend period. Dividends, if and when declared by
Washington Mutual's Board of Directors, are at an annual rate of $1.90 per
share. Dividends have been declared and paid in all quarters since issuance. The
Company may redeem the Series E Preferred Stock on or after September 15, 1998,
at the redemption price of $25 per share plus unpaid dividends, whether or not
declared, for the then current dividend period up to the date fixed for
redemption. In November 1995, the Company purchased and retired 30,000 shares of
the Series E Preferred Stock.
In December 1988, New Capital issued $80.0 million of Cumulative Redeemable
Preferred Stock. The Cumulative Redeemable Preferred Stock was presented as a
minority interest in the Company's Consolidated Financial Statements at December
30, 1995. The Cumulative Redeemable Preferred Stock was redeemed on December 20,
1996.
The Series C Preferred Stock and Series E Preferred Stock are senior to
common stock as to dividends and liquidation, but they do not confer general
voting rights.
98
101
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22: EARNINGS PER COMMON SHARE
Primary earnings per common share have been calculated by dividing net
income, after deducting dividends on preferred stock, by the weighted average
number of shares outstanding for the period. Fully diluted earnings per common
share assume conversion of any outstanding convertible preferred stock.
Information used to calculate earnings per share was as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
Net income.............................................. $114,278 $289,902 $240,275
Preferred stock dividends:
Series C Preferred Stock.............................. (6,276) (6,384) (6,384)
Series E Preferred Stock.............................. (3,743) (3,800) (3,800)
Series D Preferred Stock.............................. (8,400) (8,400) (8,400)
-------- -------- --------
Net income attributable to primary common stock......... $ 95,859 $271,318 $221,691
======== ======== ========
Net income.............................................. $114,278 $289,902 $240,275
Preferred stock dividends:
Series C Preferred Stock.............................. (6,276) (6,384) (6,384)
Series E Preferred Stock.............................. (3,743) (3,800) (3,800)
Series D Preferred Stock.............................. (8,400)(1) -- --
-------- -------- --------
Net income attributable to fully diluted common stock... $ 95,859 $279,718 $230,091
======== ======== ========
Average common shares used to calculate earnings per
share(2)(3):
Primary............................................... 112,858,781 109,944,477 106,245,127
Fully diluted......................................... 113,138,724 115,363,724 111,664,374
- ---------------
(1) In 1996, for purposes of calculating fully diluted earnings per share, the
assumed conversion of the Series D Preferred Stock was anti-dilutive.
(2) As part of the business combination with Keystone Holdings, 8,000,000 shares
of common stock, with a assigned value of $42.75 per share, were issued to
an escrow for the benefit of the general and limited partners of Keystone
Holdings and the FRF and their transferees. The Company will use the
treasury stock method to determine the effect of the shares upon the
Company's financial statements. At December 31, 1996, the dilutive effect of
the 8,000,000 shares of common stock on primary and fully diluted earnings
per share was minimal.
(3) If the conversion of the Series D Preferred Stock had taken place on January
1, 1996, primary earnings per common share for 1996 would have been $0.88.
NOTE 23: REGULATORY CAPITAL REQUIREMENTS
WMI is not subject to any regulatory capital requirements. However, each of
its subsidiary depository and insurance institutions is subject to various
capital requirements. WMB is subject to the FDIC capital requirements while ASB
and WMBfsb are subject to the Office of Thrift Supervision ("OTS") capital
requirements. WM Life is subject to National Association of Insurance
Commissioners ("NAIC") capital requirements.
The capital adequacy requirements are quantitative measures established by
regulation that require WMB, ASB and WMBfsb to maintain minimum amounts and
ratios of capital. The FDIC requires WMB to maintain minimum ratios of Tier 1
and total capital to risk-weighted assets as well as Tier 1 capital to average
assets. The OTS requires ASB and WMBfsb to maintain minimum ratios of total
capital to risk-weighted assets, as well as ratios of core capital and tangible
capital to total assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") created a statutory framework that increased the importance of
meeting applicable capital requirements. For WMB, ASB and
99
102
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
WMBfsb, FDICIA established five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a risk-based
capital measure, a leverage ratio capital measure, and certain other factors.
The federal banking agencies (including the FDIC and the OTS) have adopted
regulations that implement this statutory framework. Under these regulations, an
institution is treated as well capitalized if its ratio of total capital to
risk-weighted assets is 10.00% or more, its ratio of core capital to
risk-weighted assets is 6.00% or more, its ratio of core capital to adjusted
total assets is 5.00% or more and it is not subject to any federal supervisory
order or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not
less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and a
leverage ratio of not less than 4.00%. Any institution which is neither well
capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure by
WMB, ASB or WMBfsb to comply with applicable capital requirements would, if
unremedied, result in restrictions on their activities and lead to enforcement
actions against WMB by the FDIC or against ASB or WMBfsb by the OTS, including,
but not limited to, the issuance of a capital directive to ensure the
maintenance of required capital levels. FDICIA requires the federal banking
regulators to take prompt corrective action with respect to depository
institutions that do not meet minimum capital requirements. Additionally, FDIC
or OTS approval of any regulatory application filed for their review may be
dependent on compliance with capital requirements.
100
103
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The actual regulatory capital ratios calculated for WMB, ASB and WMBfsb,
along with the minimum capital amounts and ratios for capital adequacy purposes
and to be categorized as well capitalized under the regulatory framework for
prompt corrective action were as follows:
MINIMUM TO BE
CATEGORIZED AS
MINIMUM WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES(1) PROVISIONS
------------------- ----------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ----- --------- ---- ---------- -----
(DOLLARS IN THOUSANDS)
DECEMBER 31, 1996:
WMB
Total capital to risk-weighted
assets......................... $1,320,577 11.09% $ 952,810 8.00% $1,191,013 10.00%
Tier I capital to risk-weighted
assets......................... 1,224,620 10.28 476,405 4.00 714,608 6.00
Tier I capital to average
assets......................... 1,224,620 5.76 850,027 4.00 1,062,533 5.00
ASB
Total capital to risk-weighted
assets(2)...................... 1,395,814 10.92 1,022,484 8.00 1,278,105 10.00
Tier I capital to risk-weighted
assets......................... 1,137,311 8.90 n.a. n.a. 766,863 6.00
Tier I leverage capital to average
assets......................... 1,137,311 5.17 n.a. n.a. 1,099,506 5.00
Core capital to total assets...... 1,137,311 5.17 659,704 3.00 n.a. n.a.
Tangible capital to total
assets......................... 1,136,202 5.17 329,835 1.50 n.a. n.a.
WMBfsb
Total capital to risk-weighted
assets(2)...................... 71,327 11.58 49,285 8.00 61,607 10.00
Tier I capital to risk-weighted
assets......................... 64,707 10.50 n.a. n.a. 36,964 6.00
Tier I leverage capital to average
assets......................... 64,707 6.90 n.a. n.a. 46,923 5.00
Core capital to total assets...... 64,707 6.90 28,154 3.00 n.a. n.a.
Tangible capital to total
assets......................... 64,707 6.90 14,077 1.50 n.a. n.a.
DECEMBER 31, 1995:
WMB
Total capital to risk-weighted
assets......................... 1,280,948 11.58 885,259 8.00 1,106,573 10.00
Tier I capital to risk-weighted
assets......................... 1,184,144 10.70 442,629 4.00 663,944 6.00
Tier I capital to average
assets......................... 1,184,144 5.72 828,789 4.00 1,035,987 5.00
ASB
Total capital to risk-weighted
assets(2)...................... 1,131,295 10.12 894,190 8.00 1,117,738 10.00
Tier I capital to risk-weighted
assets......................... 1,049,987 9.39 n.a. n.a. 670,643 6.00
Tier I leverage capital to average
assets......................... 1,049,987 5.41 n.a. n.a. 970,949 5.00
Core capital to total assets...... 1,049,987 5.41 582,569 3.00 n.a. n.a.
Tangible capital to total
assets......................... 1,046,658 5.39 291,235 1.50 n.a. n.a.
WMBfsb
Total capital to risk-weighted
assets(2)...................... 49,620 12.64 31,401 8.00 39,252 10.00
Tier I capital to risk-weighted
assets......................... 44,696 11.39 n.a. n.a. 23,551 6.00
Tier I leverage capital to average
assets......................... 44,696 6.76 n.a. n.a. 33,065 5.00
Core capital to total assets...... 44,696 6.76 19,839 3.00 n.a. n.a.
Tangible capital to total
assets......................... 44,696 6.76 9,920 1.50 n.a. n.a.
- ---------------
(1) Regulatory requirements listed under this column are not the same as capital
adequacy requirements under prompt corrective action provisions.
(2) The OTS requires institutions to maintain Tier 1 capital of not less than
one-half of total capital.
101
104
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Management believes, as of December 31, 1996, that WMB, ASB and WMBfsb
individually met all capital adequacy requirements to which they were subject.
Additionally, as of December 31, 1996, the most recent notification from the
FDIC (for WMB) and the OTS (for ASB and WMBfsb) individually categorized WMB,
ASB and WMBfsb as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, a bank must maintain
minimum total risk-based, Tier 1 risk-based, Tier 1 leverage ratios as set forth
in the table above. There are no conditions or events since that notification
that management believes have changed WMB's, ASB's and WMBfsb's category.
Federal law requires that the federal banking agencies' risk-based capital
guidelines take into account various factors including interest rate risk,
concentration of credit risk, risks associated with nontraditional activities,
and the actual performance and expected risk of loss of multi-family mortgages.
In 1994, the federal banking agencies jointly revised their capital standards to
specify that concentration of credit and nontraditional activities are among the
factors that the agencies will consider in evaluating capital adequacy. In that
year, the OTS and FDIC amended their risk-based capital standards with respect
to the risk weighting of loans made to finance the purchase or construction of
multi-family residences. The OTS adopted final regulations adding an interest
rate risk component to the risk-based capital requirements for savings
associations (such as ASB and WMBfsb), although implementation of the regulation
has been delayed. Management believes that the effect of including such an
interest rate risk component in the calculation of risk-adjusted capital will
not cause ASB or WMBfsb to cease to be well capitalized. In June 1996, the FDIC
and certain other federal banking agencies (not including the OTS) issued a
joint policy statement providing guidance on prudent interest rate risk
management principles. The agencies stated that they would determine banks'
interest rate risk on a case-by-case basis, and would not adopt a standardized
measure or establish an explicit minimum capital charge for interest rate risk.
WM Life is subject to risk-based capital requirements developed by the
NAIC. The NAIC measure uses four major categories of risk to calculate an
appropriate level of capital to support an insurance company's overall business
operations. The four risk categories are asset risk, insurance risk, interest
rate risk and business risk. At December 31, 1996, WM Life's actual capital was
663% of its required regulatory risk-based level.
NOTE 24: STOCK OPTION PLAN AND EMPLOYEE STOCK PURCHASE PLAN
On March 8, 1984, the Company's stockholders approved the adoption of the
1983 incentive stock option plan, providing for the award of incentive stock
options or nonqualified stock options to certain officers of the Company at the
discretion of the Board of Directors. On April 19, 1994, the Company's
stockholders' approved the adoption of the 1994 stock option plan in which the
right to purchase common stock of the Company may be granted to employees,
directors, consultants and advisers of the Company. The 1994 plan is generally
similar to the 1983 plan, which terminated according to its terms in 1993.
Consistent with the Company's practice under the 1983 plan, it is anticipated
that the majority of options available under the plan will be granted to the
most senior management of the Company. The 1994 plan does not affect any options
granted under the 1983 plan.
Under the 1994 stock option plan, on the date of the grant, the exercise
price of the option must at least equal the market value per share of the
Company's common stock. The 1994 plan provides for the granting of options for a
maximum of 4,000,000 common shares.
Stock options are generally exercisable on a phased-in schedule over three
years and expire 10 years from the grant date. At December 31, 1996, options to
purchase 884,464 shares were fully exercisable.
102
105
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock options granted, exercised, surrendered or terminated were as
follows:
WEIGHTED AVERAGE
WEIGHTED AVERAGE FAIR VALUE OF
NUMBER OF EXERCISE PRICE OPTION SHARES
OPTION SHARES OF OPTION SHARES GRANTED
------------- ---------------- ----------------
Outstanding January 1, 1994.................. 1,140,340 $11.24
Granted in 1994............................ 191,631 22.27
Exercised in 1994.......................... (106,399) 7.96
--------- ------
Outstanding December 31, 1994................ 1,225,572 13.17
Granted in 1995............................ 416,618 17.47 $ 4.87
Exercised in 1995.......................... (290,981) 13.60
Terminated in 1995......................... (49,848) 22.07
--------- ------
Outstanding December 31, 1995................ 1,301,361 14.71
Granted in 1996............................ 1,029,000 36.94 9.13
Exercised in 1996.......................... (212,222) 12.69
Surrendered in 1996........................ (6,750) 5.86
Terminated in 1996......................... (47,166) 27.08
--------- ------
Outstanding December 31, 1996................ 2,064,223 $25.85
========= ======
Financial data pertaining to outstanding stock options were as follows:
DECEMBER 31, 1996
- ---------------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE
EXERCISE
WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER OF PRICE
RANGES OF NUMBER OF REMAINING EXERCISE PRICE EXERCISABLE OF EXERCISABLE
EXERCISE PRICES OPTION SHARES CONTRACTUAL LIFE OF OPTION SHARES OPTION SHARES OPTION SHARES
- ---------------- ------------- ---------------- ---------------- ------------- -------------
$ 6.03 - $ 8.44 404,375 3.7 years $ 8.07 404,375 $ 8.07
12.33 - 17.29 144,929 5.3 12.95 144,929 12.95
20.19 - 22.75 524,419 7.3 21.50 335,160 21.76
27.75 - 30.00 327,500 9.1 27.82 -- --
30.94 - 42.75 663,000 10.0 41.98 -- --
--------- ---------- ------ ------- ------
2,064,223 7.6 years $25.85 884,464 $ 14.06
========= ========== ====== ======= ======
Under the terms of the employee stock purchase plan, an employee can
purchase WMI common stock at a 15% discount without paying brokerage fees or
commissions on purchases. The Company pays for the program's administrative
expenses. The plan is open to all employees who are at least 18 years old, have
completed at least one year of service, and work at least 20 hours per week.
Participation can be by either payroll deduction or lump sum payments with a
maximum annual contribution of 10% of employees previous year's eligible cash
compensation. Under the employee stock purchase plan, dividends are
automatically reinvested.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-based
Compensation. The statement requires expanded disclosures of stock-based
compensation arrangements with employees and encourages (but does not require)
application of the fair value recognition provisions in the statement. SFAS No.
123 does not rescind or interpret the existing accounting rules for employee
stock-based arrangements. Companies may continue following those rules to
recognize and measure compensation as outlined in Accounting Principles Board
("APB") Opinion 25, Accounting for Stock Issued to Employees but they are now
required to disclose the pro forma amounts of net income and earnings per share
that would have been reported had the company elected to follow the fair value
recognition provisions of SFAS No. 123. Effective January 1, 1996, the Company
adopted the disclosure requirements of SFAS No. 123, but has determined
103
106
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that it will continue to measure its employee stock-based compensation
arrangements under the provisions of APB Opinion 25. Accordingly, no
compensation cost has been recognized for its stock option plan and its employee
stock purchase plan. Had compensation cost for the Company's compensation plans
been determined consistent with SFAS 123, the Company's net income available to
fully diluted common stock and fully diluted earning per share would have been
reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
------- --------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE
AMOUNTS)
Net income attributable to common stock:
Primary:
As reported.................................... $95,859 $271,318
Pro forma...................................... 93,241 270,728
Fully diluted:
As reported.................................... $95,859 $279,718
Pro forma...................................... 93,241 279,128
Net income per common share:
Primary:
As reported.................................... $0.85 $2.47
Pro forma...................................... 0.83 2.46
Fully diluted:
As reported.................................... $0.85 $2.42
Pro forma...................................... 0.83 2.41
The compensation expense included in the pro forma net income attributable
to fully diluted common stock and fully diluted earnings per share is not likely
to be representative of the effect on reported net income for future years
because options vest over several years and additional awards generally are made
each year.
The fair value of options granted under the Company's stock option plan is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants in 1996 and 1995:
annual dividend yield of 2.5% for both years; expected volatility of 23.99% for
1996 and 24.71% for 1995; risk-free interest rates of 5.78% for 1996 and 7.28%
for 1995; and expected lives of five years for both years.
NOTE 25: EMPLOYEE BENEFITS PROGRAMS
Washington Mutual maintains a noncontributory cash balance defined benefit
pension plan (the "Pension Plan") for substantially all eligible employees. ASB
provided a substantially similar plan (the "ASB Plan") which was terminated
effective June 30, 1995. 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 benefit balance. It is the Company's policy to fund the Pension
Plan on a current basis to the extent deductible under federal income tax
regulations. The combined net periodic pension cost for the Pension Plan and the
ASB Plan was $2.1 million, $2.0 million and $1.3 million for 1996, 1995 and
1994; the weighted average discount rate was 7.25% for 1996 and 1995 and 8.00%
for 1994: the long-term rate of return on assets was 8.00% for 1996, 1995 and
1994; and the assumed rate of increase in future compensation levels was 6.00%
for all years presented. The Pension Plan's assets consist primarily of listed
common stocks, U.S. government obligations, corporate debt obligations, and
annuity contracts.
At the termination date of the ASB plan, all participants' accrued benefits
became fully vested. The net assets of the plan were allocated as prescribed by
the Employee Retirement Income Security Act of 1974 and
104
107
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Pension Benefit Guaranty Corporation and their related regulations. All
participants received full benefits. The termination resulted in a settlement
under SFAS No. 88, Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits. ASB recognized a
gain of $1.7 million as a result of the settlement. The benefit obligation was
settled in 1996.
The Pension Plan's funded status and amounts recognized in the Company's
financial statements were as follows:
DECEMBER 31,
---------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
Benefit obligations:
Vested benefits...................................................... $(44,659) $(46,628)
Nonvested benefits................................................... (3,178) (2,367)
-------- --------
Accumulated benefit obligation......................................... (47,837) (48,995)
Effect of future compensation increases................................ (1,168) (1,598)
-------- --------
Projected benefit obligation........................................... (49,005) (50,593)
Plan assets at fair value.............................................. 65,823 61,722
-------- --------
Plan assets in excess of projected benefit obligation.................. 16,818 11,129
Unrecognized (gain) loss due to past experience different from
assumptions.......................................................... (7,800) (2,103)
Unrecognized prior service cost........................................ (352) 2,093
Unrecognized net asset at transition being recognized over 18.6
years................................................................ (2,918) (3,300)
-------- --------
Prepaid pension asset................................................ $ 5,748 $ 7,819
======== ========
The combined net periodic pension expense included the following:
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
------- -------- -------
(DOLLARS IN THOUSANDS)
Service cost -- benefits earned during the period................. $ 4,083 $ 3,240 $ 2,952
Interest cost on projected benefit obligation..................... 3,172 3,930 3,383
Actual (gain) loss on plan assets................................. (7,690) (12,831) 615
Amortization and deferral, net.................................... 2,506 7,679 (5,675)
------- -------- -------
$ 2,071 $ 2,018 $ 1,275
======= ======== =======
During 1994, the defined benefit pension plan acquired in the acquisition
of Pacific First was merged into the Company's Pension Plan. The fair value of
the Pacific First plan assets exceeded the projected benefit obligation, and the
accrued pension cost was reduced by $10.8 million.
In addition, the Company currently provides eligible retired employees with
access to medical coverage on the same basis as active employees and provides
certain other health care insurance benefits to a limited number of retired
employees. Postretirement benefits, such as retiree health benefits, are accrued
during the years an employee provides services.
105
108
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The funded status of these benefits were as follows:
DECEMBER 31,
-------------------
1996 1995
------- -------
(DOLLARS IN
THOUSANDS)
Accumulated postretirement benefit obligation............. $(5,736) $(5,484)
Unrecognized transition obligation........................ 2,356 2,503
Unrecognized (gain)....................................... (36) (36)
------- -------
Prepaid postretirement liability........................ $(3,416) $(3,017)
======= =======
Net periodic postretirement expense included the following:
DECEMBER 31,
----------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
Service cost........................................... $249 $206 $220
Interest cost.......................................... 384 344 322
Amortization of transition obligation.................. 147 147 147
---- ---- ----
$780 $697 $689
==== ==== ====
Net periodic postretirement expense was calculated using the following
assumptions: the weighted average discount rate was 7.25% for 1996 and 1995 and
8.00% for 1994; and the medical trend rate was 13.00% for 1993 and declines
steadily to 6.00% by the year 2000. The effect of a 1.00% increase in the trend
rates is not significant.
Washington Mutual maintains a retirement savings and investment plan for
substantially all eligible employees that allows participants to make
contributions by salary deduction equal to 15.00% or less of their salary
pursuant to Section 401(k) of the Internal Revenue Code. ASB maintains a
substantially similar plan. Employees' contributions vest immediately. The
Company's partial matching contributions vest over five years.
ASB implemented a Supplemental Executive Retirement Plan ("SERP") in 1990.
The SERP is a nonqualified, noncontributory defined benefit plan where benefits
are paid to certain officers using a target percentage which is based upon the
number of years of service with ASB. This percentage is applied to the
participant's average annual earnings for the highest three out of the final ten
years of employment. These benefits are reduced to the extent a participant
receives benefits from the ASB Plan.
In 1990, ASB implemented a Phantom Share Plan (the "PSP") for the benefit
of certain of its officers. As a result of the Keystone Transaction, the phantom
shares became immediately exercisable and ASB incurred an expense of $12.0
million in December 1996.
ASB established a Short-Term Incentive Plan ("STI") for the benefit of
certain of its executives. The STI provides a short-term incentive to its
participants based upon the achievement of both overall company and individual
goals.
Washington Mutual uses grants of restricted stock as a component of
compensation to provide a long-term incentive for creation of shareholder value
and to encourage the recipient to remain at Washington Mutual.
106
109
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Total employee benefit plan expense was as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
Net periodic pension expense.................. $ 2,071 $ 2,018 $ 1,275
Net periodic postretirement expense........... 780 697 689
Company's contributions to savings plan....... 12,381 10,027 12,374
SERP expense.................................. 2,161 1,590 1,900
STI expense................................... 3,609 3,247 2,219
Restricted stock expense...................... 911 701 1,046
------- ------- -------
$21,913 $18,280 $19,503
======= ======= =======
NOTE 26: CONTINGENCIES
The Company has certain litigation and negotiations in progress resulting
from activities arising from normal operations. In the opinion of management,
none of these matters is likely to have a material adverse effect on the
Company's financial position.
As part of the administration and oversight of the Assistance Agreement and
other agreements among ASB, certain of its affiliates and the FDIC, the FDIC has
a variety of review and audit rights, including the right to review and audit
computations of payments in lieu of taxes. ASB and certain of its affiliates
have entered into settlement agreements with the FDIC for all periods through
June 30, 1994, pursuant to which ASB, its affiliates and the FDIC have mutually
settled and released various claims in consideration of certain nominal
payments. The Office of Inspector General has completed its audit of
transactions and payments under the Assistance Agreement and other agreements
occurring during the period beginning July 1, 1994 and ending June 30, 1996.
Keystone Holdings has received no notice of any issues involving more than
nominal amounts arising after June 30, 1994.
As part of the Keystone Transaction, 8,000,000 shares of common stock, with
an assigned value of $42.75 per share (the "Litigation Escrow Shares"), were
issued to an escrow for the benefit of the general and limited partners of
Keystone Holdings and the FRF and their transferees (the "Litigation Escrow").
Shares will be released from the Litigation Escrow if and only to the extent
that Washington Mutual receives net cash proceeds from certain litigation that
Keystone Holdings and certain of its subsidiaries are pursuing against the
United States (the "Case"), which litigation became an asset of the Company in
the Keystone Transaction. Upon Washington Mutual's receipt of net cash proceeds
from a judgment or settlement of the Case, if any ("Case Proceeds"), all or part
of the Litigation Escrow Shares will be released, 64.9% to the general and
limited partners of Keystone Holdings and 35.1% to the FRF. The number of
Litigation Escrow Shares released will be equal to the Case Proceeds, reduced by
certain tax and litigation-related expenses, divided by $42.75. If not all of
the Litigation Escrow Shares are distributed prior to the expiration of the
Litigation Escrow, any remaining Litigation Escrow Shares will be returned to
Washington Mutual for cancellation. The Litigation Escrow expires the earlier of
the date that is the sixth anniversary of the Keystone Transaction or that the
Litigation Escrow Shares are released. In general, the Litigation Escrow will be
automatically extended to 10 years if, prior to the sixth anniversary of the
Keystone Transaction, there has been any judgment or final settlement in the
Case granted or entered in favor of Washington Mutual or any of its
subsidiaries.
107
110
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 27: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations on a quarterly basis have been restated to give
effect to the business combination with Keystone Holdings. Results of operations
on a quarterly basis were as follows:
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------------------------
FIRST QUARTER SECOND QUARTER
-------------------------------- --------------------------------
WASHINGTON KEYSTONE WASHINGTON KEYSTONE
MUTUAL HOLDINGS RESTATED MUTUAL HOLDINGS RESTATED
---------- -------- -------- ---------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Interest income..................... $415,420 $349,202 $764,622 $418,751 $357,518 $776,269
Interest expense.................... 244,425 233,195 477,620 240,607 235,901 476,508
-------- -------- -------- -------- -------- --------
Net interest income................. 170,995 116,007 287,002 178,144 121,617 299,761
Provision for loan losses........... 2,912 17,977 20,889 2,913 17,203 20,116
Other income........................ 36,762 20,248 57,010 36,752 21,872 58,624
Other expense....................... 110,092 71,002 181,094 114,687 71,364 186,051
-------- -------- -------- -------- -------- --------
Income before income taxes and
minority interest................. 94,753 47,276 142,029 97,296 54,922 152,218
Income taxes........................ 35,224 14,471 49,695 35,937 13,214 49,151
Minority interest in earnings of
consolidated subsidiary........... -- 3,527 3,527 -- 3,450 3,450
-------- -------- -------- -------- -------- --------
Net income.......................... $ 59,529 $ 29,278 $ 88,807 $ 61,359 $ 38,258 $ 99,617
======== ======== ======== ======== ======== ========
Net income attributable to common
stock............................. $ 54,924 $ 29,278 $ 84,202 $ 56,755 $ 38,258 $ 95,013
======== ======== ======== ======== ======== ========
Net income per common share:
Primary........................... $0.76 $0.75 $0.79 $0.84
Fully diluted..................... 0.74 0.74 0.76 0.83
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------
THIRD QUARTER FOURTH QUARTER
-------------------------------- --------------
WASHINGTON KEYSTONE
MUTUAL HOLDINGS RESTATED WMI
---------- -------- -------- --------------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE
AMOUNTS)
Interest income...................................... $424,086 $373,608 $797,694 $810,651
Interest expense..................................... 244,707 256,367 501,074 503,027
-------- -------- -------- --------
Net interest income.................................. 179,379 117,241 296,620 307,624
Provision for loan losses............................ 2,913 14,220 17,133 143,374
Other income......................................... 42,792 25,396 68,188 75,442
Other expense........................................ 154,630 162,767 317,397 340,762
-------- -------- -------- --------
Income before income taxes and minority interest..... 64,628 (34,350) 30,278 (101,070)
Income taxes......................................... 24,454 (11,491) 12,963 (16,202)
Minority interest in earnings of consolidated
subsidiary......................................... -- 3,527 3,527 3,066
-------- -------- -------- --------
Net income........................................... $ 40,174 $(26,386) $ 13,788 $(87,934)
======== ======== ======== ========
Net income attributable to common stock.............. $ 35,569 $(26,386) $ 9,183 $(92,539)
======== ======== ======== ========
Net income per common share:
Primary............................................ $0.49 $0.08 $(0.81)
Fully diluted...................................... 0.49 0.08 (0.81)
108
111
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------------------------
FIRST QUARTER SECOND QUARTER
-------------------------------- ---------------------------------
WASHINGTON KEYSTONE WASHINGTON KEYSTONE
MUTUAL HOLDINGS RESTATED MUTUAL HOLDINGS RESTATED
---------- -------- -------- ---------- --------- --------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Interest income...................... $367,447 $305,735 $673,182 $390,016 $ 330,727 $720,743
Interest expense..................... 218,374 228,270 446,644 240,585 242,493 483,078
-------- -------- -------- -------- -------- --------
Net interest income.................. 149,073 77,465 226,538 149,431 88,234 237,665
Provision for loan losses............ 2,800 18,869 21,669 2,850 15,664 18,514
Other income......................... 28,855 29,188 58,043 29,554 18,315 47,869
Other expense........................ 103,081 71,496 174,577 106,332 73,101 179,433
-------- -------- -------- -------- -------- --------
Income before income taxes and
minority interest.................. 72,047 16,288 88,335 69,803 17,784 87,587
Income taxes......................... 26,797 (6,081) 20,716 22,030 642 22,672
Minority interest in earnings of
consolidated subsidiary............ -- 3,948 3,948 -- 3,948 3,948
-------- -------- -------- -------- -------- --------
Net income........................... $ 45,250 $ 18,421 $ 63,671 $ 47,773 $ 13,194 $ 60,967
======== ======== ======== ======== ======== ========
Net income attributable to common
stock.............................. $ 40,604 $ 18,421 $ 59,025 $ 43,127 $ 13,194 $ 56,321
======== ======== ======== ======== ======== ========
Net income per common share:
Primary............................ $0.60 $0.55 $0.62 $0.51
Fully diluted...................... 0.58 0.54 0.60 0.51
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------------------------
THIRD QUARTER FOURTH QUARTER
-------------------------------- ---------------------------------
WASHINGTON KEYSTONE WASHINGTON KEYSTONE
MUTUAL HOLDINGS RESTATED MUTUAL HOLDINGS RESTATED
---------- -------- -------- ---------- --------- --------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Interest income..................... $405,638 $346,343 $751,981 $415,859 $ 354,321 $770,180
Interest expense.................... 248,844 246,712 495,556 252,921 245,237 498,158
-------- -------- -------- -------- -------- --------
Net interest income................. 156,794 99,631 256,425 162,938 109,084 272,022
Provision for loan losses........... 2,800 14,557 17,357 2,700 14,747 17,447
Other income........................ 28,280 18,033 46,313 31,185 24,929 56,114
Other expense....................... 102,530 68,484 171,014 105,712 69,778 175,490
-------- -------- -------- -------- -------- --------
Income before income taxes and
minority interest................. 79,744 34,623 114,367 85,711 49,488 135,199
Income taxes........................ 28,056 5,023 33,079 30,621 12,705 43,326
Minority interest in earnings of
consolidated subsidiary........... -- 3,948 3,948 -- 3,949 3,949
-------- -------- -------- -------- -------- --------
Net income.......................... $ 51,688 $ 25,652 $ 77,340 $ 55,090 $ 32,834 $ 87,924
======== ======== ======== ======== ======== ========
Net income attributable to common
stock............................. $ 47,042 $ 25,652 $ 72,694 $ 50,444 $ 32,834 $ 83,278
======== ======== ======== ======== ======== ========
Net income per common share:
Primary........................... $0.66 $0.66 $0.71 $0.75
Fully diluted..................... 0.64 0.64 0.69 0.73
NOTE 28: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are
109
112
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
not necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The fair value of financial instruments were as follows:
DECEMBER 31,
-----------------------------------------------------
1996 1995
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Financial assets:
Cash and cash equivalents................. $ 831,063 $ 831,063 $ 983,833 $ 983,833
Trading account securities................ 1,647 1,647 238 238
Available-for-sale securities............. 9,109,460 9,109,460 12,157,157 12,157,157
Held-to-maturity securities............... 2,860,347 2,922,552 3,197,720 3,262,850
Mortgage servicing rights................. 140,725 169,183 104,495 109,950
Loans, exclusive of reserve for loan
losses................................. 30,786,473 30,932,973 24,428,115 24,788,750
----------- ----------- ----------- -----------
43,729,715 43,966,878 40,871,558 41,302,778
Financial liabilities:
Deposits.................................. 24,080,141 24,225,124 24,462,960 24,624,673
Annuities................................. 878,057 878,057 855,503 855,503
Federal funds purchased................... 1,052,000 1,052,000 433,420 433,493
Securities sold under agreements to
repurchase............................. 7,835,453 7,852,852 7,984,756 7,985,202
Advances from the FHLB.................... 7,241,492 7,256,785 4,715,739 4,732,366
Other borrowings.......................... 676,985 688,579 590,217 612,240
----------- ----------- ----------- -----------
41,764,128 41,953,397 39,042,595 39,243,477
Derivative instruments(1):
Interest rate exchange agreements:
Designated against available-for-sale
securities........................... (646) (646) (11,847) (11,847)
Designated against deposits and
borrowings........................... -- 1,322 -- (22,615)
Interest rate cap agreements:
Designated against available-for-sale
securities........................... 2,460 2,460 9,415 9,415
Designated against deposits and
borrowings........................... 17,533 3,411 17,691 (630)
----------- ----------- ----------- -----------
19,347 6,547 15,259 (25,677)
Off-balance sheet loan commitments.......... -- (19) -- 3,595
----------- ----------- ----------- -----------
Net financial instruments................... $ 1,984,934 $ 2,020,009 $ 1,844,222 $ 2,037,219
=========== =========== =========== ===========
- ---------------
(1) See Note 17: Interest Rate Risk Management.
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument as of December 31, 1996 and 1995:
Cash and cash equivalents -- The carrying amount represented fair value.
Trading account securities -- Fair values were based on quoted market
prices.
110
113
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Available-for-sale securities -- Fair values were based on quoted market
prices or dealer quotes. If a quoted market price was not available, fair value
was estimated using quoted market prices for similar securities.
Held-to-maturity securities -- Fair values were based on quoted market
prices or dealer quotes. If a quoted market price was not available, fair value
was estimated using quoted market prices for similar securities.
Loans -- Loans were priced using the discounted cash flow method. The
discount rate used was the rate currently offered on similar products.
Mortgage servicing rights -- The fair value of mortgage servicing rights is
estimated using projected cash flows, adjusted for the effects of anticipated
prepayments, using a market discount rate.
Deposits -- The fair value of checking accounts, savings accounts and money
market accounts was the amount payable on demand at the reporting date. For time
deposit accounts, the fair value was determined using the discounted cash flow
method. The discount rate was equal to the rate currently offered on similar
products. Core deposit intangibles are not included.
Annuities -- The carrying amount represented fair value.
Federal funds purchased -- These were valued using the discounted cash flow
method. The discount rate was equal to the rate currently offered on similar
borrowings.
Securities sold under agreements to repurchase -- These were valued using
the discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
Advances from the FHLB -- These were valued using the discounted cash flow
method. The discount rate was equal to the rate currently offered on similar
borrowings.
Other borrowings -- These were valued using the discounted cash flow
method. The discount rate was equal to the rate currently offered on similar
borrowings.
Derivative instruments -- The fair value for interest rate exchange
agreements was determined using dealer quotations, when available, or the
discounted cash flow method. The market prices for similar instruments were used
to value interest rate cap agreements.
Off-balance sheet loan commitments -- Loan commitments are commitments the
Company made to borrowers at locked-in rates. The fair value of loan commitments
was estimated based on current levels of interest rates versus the committed
interest rates. The balance shown represents the differential between committed
value and fair value.
NOTE 29: FINANCIAL INFORMATION -- WMI
WMI was formed August 17, 1994. The following WMI (parent company only)
financial information should be read in conjunction with the other notes to the
consolidated financial statements.
111
114
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF INCOME
PERIOD OF
AUGUST 17, 1994
YEAR ENDED DECEMBER 31, (INCEPTION) TO
---------------------- DECEMBER 31,
1996 1995 1994
-------- --------- ---------------
(DOLLARS IN THOUSANDS)
INTEREST INCOME
Available-for-sale securities........................... $ 6,777 $ 8,033 $ 1,641
Cash equivalents........................................ 5,378 471 44
-------- -------- --------
Total interest income................................. 12,155 8,504 1,685
INTEREST EXPENSE
Deposits................................................ (683) -- --
Borrowings.............................................. 15,079 9,072 884
-------- -------- --------
Total interest expense................................ 14,396 9,072 884
-------- -------- --------
Net interest (expense) income...................... (2,241) (568) 801
OTHER INCOME
Equity in net earnings of subsidiaries(1)............... 132,301 293,630 13,103
Other operating income.................................. 122 8 --
(Loss) on sale of other assets.......................... -- (171) --
-------- -------- --------
Total other income.................................... 132,423 293,467 13,103
OTHER EXPENSE
Salaries and employee benefits.......................... 3,561 2,716 --
Occupancy and equipment................................. 11 1 --
Other operating expense................................. 18,013 3,289 228
Amortization of goodwill................................ 629 -- --
-------- -------- --------
Total other expense................................... 22,214 6,006 228
-------- -------- --------
Income before income taxes......................... 107,968 286,893 13,676
Income tax (benefit) expenses........................... (8,105) (865) 201
-------- -------- --------
Net income(1)........................................... $116,073 $287,758 $13,475
======== ======== ========
- ---------------
(1) Contains intercompany transactions eliminated upon consolidation.
112
115
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
-----------------------
1996 1995
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and cash equivalents............................................. $ 109,356 $ 90,096
Available-for-sale securities......................................... 82,033 99,932
Loans................................................................. 92,083 147,867
Investment in subsidiaries(1)......................................... 2,344,959 2,451,956
Other assets.......................................................... 12,917 929
---------- ----------
Total assets........................................................ $2,641,348 $2,790,780
========== ==========
LIABILITIES
Securities sold under agreements to repurchase........................ $ 68,326 $ 82,481
Other borrowings...................................................... 148,007 147,845
Other liabilities..................................................... 12,230 5,647
---------- ----------
Total liabilities................................................... 228,563 235,973
STOCKHOLDERS' EQUITY
Preferred stock, no par value: 10,000,000 shares
authorized -- 4,722,500 and 6,122,500 shares issued and
outstanding......................................................... -- --
Common stock, no par value: 350,000,000 shares
authorized -- 126,255,891 and 119,801,466 outstanding............... -- --
Capital surplus(1).................................................... 1,061,890 1,029,549
Valuation reserve for available-for-sale securities................... 1,156 2,390
Valuation reserve for available-for-sale securities -- subsidiaries... 40,510 186,325
Retained earnings(1).................................................. 1,309,229 1,336,543
---------- ----------
Total stockholders' equity.......................................... 2,412,785 2,554,807
---------- ----------
Total liabilities and stockholders' equity.......................... $2,641,348 $2,790,780
========== ==========
- ---------------
(1) Contains intercompany transactions eliminated upon consolidation.
113
116
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF CASH FLOWS
PERIOD OF
YEAR ENDED DECEMBER 31, AUGUST 17, 1994
----------------------- (INCEPTION) TO
1996 1995 DECEMBER 31, 1994
---------- ---------- -----------------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income(1)....................................... $ 116,073 $ 287,758 $ 13,475
Adjustments to reconcile net income to net cash
(used) provided by operating activities:
(Increase) decrease in interest receivable........ (69) 80 (693)
Increase in interest payable...................... 530 3,167 884
(Decrease) in income taxes payable................ (8,105) (865) (1,151)
Equity in undistributed earnings of
subsidiaries................................... (132,301) (293,630) (13,103)
(Increase) decrease in other assets............... (16,619) 9,910 39
Increase in other liabilities..................... 14,867 720 252
--------- --------- ---------
Net cash (used) provided by operating
activities................................... (195,624) 7,140 (297)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities.......... -- -- (111,984)
Principal payments of available-for-sale
securities........................................ 16,118 12,594 4,486
Principal payments of loans......................... 147,867 -- --
Origination and purchases of loans.................. (92,083) (147,867) --
Investment in subsidiary............................ (170,000) -- --
Dividends received from subsidiaries................ 280,026 136,521 --
Acquisition of wholly owned subsidiary(1)........... -- -- (82,877)
--------- --------- ---------
Net cash provided (used) by investing
activities................................... 351,928 1,248 (190,375)
CASH FLOWS FROM FINANCING ACTIVITIES
(Decrease) increase in securities sold under
agreements to repurchase.......................... (14,155) (1,848) 84,329
Proceeds of other borrowings........................ -- 147,845 --
Issuance of common stock through stock options and
employee stock plans.............................. 20,604 8,379 994
Repurchase of preferred stock....................... -- (1,990) --
Conversion of preferred stock to common stock....... (107) -- --
Cash dividends paid................................. (143,386) (76,581) --
Contribution from wholly owned subsidiaries(1)...... -- -- 111,252
--------- --------- ---------
Net cash (used) provided by financing
activities................................... (137,044) 75,805 196,575
--------- --------- ---------
Increase in cash and cash equivalents.......... 19,260 84,193 5,903
Cash and cash equivalents at beginning of
year......................................... 90,096 5,903 --
--------- --------- ---------
Cash and cash equivalents at end of year....... $ 109,356 $ 90,096 $ 5,903
========= ========= =========
- ---------------
(1) Contains intercompany transactions eliminated upon consolidation.
114
117
WASHINGTON MUTUAL, INC.
INDEX OF EXHIBITS
EXHIBIT NO. DESCRIPTION PAGE NO.
----------- --------------------------------------------------------------- ----------------
2.1* Agreement for Reorganization between the Registrant and
Washington Mutual, dated October 19, 1994.
3.1 Restated Articles of Incorporation of the Registrant, as
amended (the "Articles").
3.2 Bylaws of the Registrant (Incorporated by reference to the
Washington Mutual, Inc. Annual Report to the Securities and
Exchange Commission on Form 10-K for the year ended December
31, 1995. File No. 0-25188).
4.1* Article II, Sections D(2), D(3), and D(4) of the Articles,
which define the rights of holders of the Series C Preferred
Stock and the Series E Preferred Stock (filed together with
Exhibit 3.1 hereto).
4.2* Rights Agreement, dated October 16, 1990.
4.3* Amendment No. 1 to Rights Agreement, dated October 31, 1994.
4.4* Supplement to Rights Agreement, dated November 29, 1994.
4.5 Form of Indenture between the Registrant and Harris Trust and
Savings Bank, as Trustee for the Debt Securities (Incorporated
by reference to Washington Mutual, Inc. Registration Statement
on Form S-3, registration no. 33-93850).
4.6 First Supplemental Indenture dated November 26, 1996 and Second
Supplemental Indenture dated January 6, 1997 to the Indenture
between Washington Mutual, Inc. and Harris Trust and Savings
Bank, as Trustee, dated August 25, 1995, affecting the rights
of the holders of the Registrant's Senior Notes.
10.1* Washington Mutual 1994 Stock Option Plan.
10.2* Amended and Restated Incentive Stock Option Plan.
10.3* Amended and Restated Washington Mutual Restricted Stock Plan
(1986).
10.4* Washington Mutual Employees' Stock Purchase Program.
10.5* Washington Mutual Retirement Savings and Investment Plan.
10.6* Washington Mutual Employee Service Award Plan.
10.7 Supplemental Employee's Retirement Plan for Salaried Employees
of Washington Mutual.
10.8 Washington Mutual Supplemental Executive Retirement
Accumulation Plan.
10.9 Deferred Compensation Plan for Directors and Certain Highly
Compensated Employees.
10.10 Deferred Compensation Plan for Certain Highly Compensated
Employees.
10.11 Employment Contract of Kerry K. Killinger.
10.12 Employment Contract for Executive Officers.
10.13* Lease Agreement between Third and University Limited
Partnership and Washington Mutual Savings Bank, dated September
1, 1988.
115
118
EXHIBIT NO. DESCRIPTION PAGE NO.
----------- --------------------------------------------------------------- ----------------
10.14 Agreement For Merger, dated July 21, 1996, as amended November
1, 1996, by and among Washington Mutual, Inc., Keystone
Holdings Partners, L.P., Keystone Holdings, Inc., New American
Holdings, Inc., New American Capital, Inc., N.A.Capital
Holdings, Inc. and American Savings Bank, F.A. (Incorporated by
reference to the Washington Mutual, Inc. Current Report to the
Securities and Exchange Commission on Form 8-K dated January 3,
1997. File No. 0-25188).
10.15 Escrow Agreement, dated December 20, 1996, by and among
Washington Mutual, Inc., Keystone Holdings Partners, L.P., the
Federal Deposit Insurance Corporation as manager of the FSLIC
Resolution Fund, and The Bank of New York (Incorporated by
reference to the Washington Mutual, Inc. Current Report to the
Securities and Exchange Commission on Form 8-K dated January 3,
1997. File No. 0-25188).
10.16 Registration Rights Agreement, dated July 21, 1996, by and
among Washington Mutual, Inc., Keystone Holdings Partners,
L.P., and the Federal Deposit Insurance Corporation as manager
of the FSLIC Resolution Fund (Incorporated by reference to the
Washington Mutual, Inc. Current Report to the Securities and
Exchange Commission on Form 8-K dated January 3, 1997. File No.
0-25188).
10.17 364-Day Credit Agreement between the Registrant and The Chase
Manhattan Bank as Administrative Agent.
10.18 Four-Year Credit Agreement between the Registrant and The Chase
Manhattan Bank as Administrative Agent.
21 List of Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
23.1 Consent of KPMG Peat Marwick LLP.
23.2 Consent of KPMG Peat Marwick LLP.
27 Financial Data Schedule.
- ---------------
* Incorporated by reference to Washington Mutual, Inc. Current Report on Form
8-K dated November 29, 1994 (File No. 0-25188).
116