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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, 1997
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 WHICH
TITLE OF EACH CLASS REGISTERED
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Common Stock 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, 1998:
COMMON STOCK -- $15,530,272,661(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, 1998:
COMMON STOCK -- 257,781,511(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 21, 1998, are incorporated by reference into Part
III.
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WASHINGTON MUTUAL, INC.
1997 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I...................................................... 1
ITEM 1. BUSINESS.......................................... 1
Overview............................................... 1
Corporate Developments................................. 2
Integration of Operations.............................. 2
Lending Activities..................................... 5
Asset Quality.......................................... 8
Investing Activities................................... 10
Sources of Funds....................................... 10
Business Combinations.................................. 12
Employees.............................................. 12
Taxation of the Company................................ 12
Environmental Regulation............................... 13
Regulation and Supervision............................. 14
Competitive Environment................................ 20
Principal Officers..................................... 21
ITEM 2. PROPERTIES........................................ 22
ITEM 3. LEGAL PROCEEDINGS................................. 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS................................................ 23
PART II..................................................... 23
ITEM 5. MARKET FOR WASHINGTON MUTUAL'S COMMON STOCK AND
RELATED SECURITY HOLDER MATTERS........................ 23
Common Stock........................................... 23
Preferred Stock........................................ 23
Payment of Dividends and Policy........................ 24
ITEM 6. SELECTED FINANCIAL DATA........................... 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
POSITION AND RESULTS OF OPERATIONS..................... 27
General................................................ 27
Results of Operations.................................. 28
Review of Financial Position........................... 37
Asset Quality.......................................... 43
Market Risk and Asset/Liability Management............. 50
Liquidity.............................................. 56
Capital Adequacy....................................... 57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....... 57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.................... 57
PART III.................................................... 57
PART IV..................................................... 57
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K.................................... 57
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PART I
ITEM 1. BUSINESS
OVERVIEW
With a history dating back to 1889, Washington Mutual Inc. ("Washington
Mutual" or the "Company") is a financial services company committed to serving
consumers and small to mid-sized businesses. The Company operates principally in
California, Washington, Oregon, Florida and Utah, but has operations in a total
of 36 states. At December 31, 1997, the Company had consolidated assets of
$96.98 billion, deposits of $50.99 billion and stockholders' equity of $5.31
billion. Through its subsidiaries, the Company engages in the following
activities:
Mortgage Lending and Consumer Banking Activities
The Company's primary line of business is mortgage lending and consumer
banking, which it conducts through its principal banking subsidiaries,
Washington Mutual Bank, FA ("WMBFA"), Washington Mutual Bank ("WMB"), and
Washington Mutual Bank fsb ("WMBfsb"). At December 31, 1997, the Company
operated approximately 1,100 consumer financial centers and home loan centers
offering a full complement of mortgage lending and consumer banking products and
services. In the first 10 months of 1997, the Company's banking subsidiaries
were the leading originators of one-to-four family residential mortgage ("SFR")
loans in California, Washington and Oregon.
Washington Mutual Bank, FA. WMBFA's principal areas of operation are
California and Florida, where at December 31, 1997, it operated 568 consumer
financial centers. WMBFA also operates home loan centers in California, Florida
and 21 additional states. At December 31, 1997, WMBFA had assets of $67.21
billion and deposits of $39.14 billion. Its deposits are insured by the Federal
Deposit Insurance Corporation (the "FDIC") primarily through the Savings
Association Insurance Fund ("SAIF").
Washington Mutual Bank. At December 31, 1997, WMB had assets of $26.02
billion and deposits of $11.47 billion. WMB operates in Washington, Oregon, Utah
and Idaho, and at December 31, 1997, operated 250 consumer financial centers and
28 home loan centers. Its deposits are insured by the FDIC through the Bank
Insurance Fund ("BIF") and the SAIF.
Washington Mutual Bank fsb. At December 31, 1997, WMBfsb had assets of
$1.06 billion and deposits of $454.5 million. WMBfsb operates in Utah, Idaho and
Montana and, at December 31, 1997, operated 32 consumer financial centers and 4
home loan centers. WMBfsb's deposits are insured by the FDIC through the SAIF.
Consumer Finance Activities
Through Aristar, Inc. and its subsidiaries ("Aristar"), the Company makes
direct consumer installment loans and purchases retail installment contracts
from local retail establishments through a network of approximately 500 branch
offices located in 22 states, primarily in the southeastern United States. It
also accepts deposits through its industrial banks in Colorado and Utah.
Aristar's business is generally conducted under the names Blazer, City Finance
and First Community. At December 31, 1997, Aristar had assets of $2.54 billion
and deposits of $163.2 million.
Commercial Banking Activities
At December 31, 1997, through Western Bank, the commercial banking division
of WMB, the Company operated 47 Western financial centers and 23 business
banking centers offering a range of commercial banking products and services to
small to mid-sized businesses. WMB commenced its commercial banking activities
through the acquisitions of Enterprise Bank ("Enterprise") in 1995 and Western
Bank ("Western") in 1996.
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Securities Activities
Broker-Dealer Activities. Through WM Financial Services, Inc. ("WM
Financial"), Great Western Financial Securities Corporation ("GWFSC"), Composite
Funds Distributor, Inc. ("CFDI") and Sierra Investment Services Corporation
("SISC"), the Company offers a broad range of securities brokerage services,
including distribution of mutual funds. WM Financial and GWFSC make their
registered representatives available for consultation regularly or by
appointment in many of the Company's financial centers.
Investment Advisor Activities. Composite Research & Management Co.
("Composite Research"), Sierra Investment Advisors Corporation ("SIAC") and SISC
are registered investment advisors. At December 31, 1997, Composite Research was
the investment advisor to eight mutual funds, and SIAC and SISC between them
were the investment advisor to 36 mutual funds. At December 31, 1997, Composite
Research had a total of $1.72 billion in funds under management in the eight
mutual funds and SIAC and SISC had a total of $3.01 billion in funds under
management in their mutual funds.
CORPORATE DEVELOPMENTS
On December 20, 1996, Washington Mutual consummated the merger of Keystone
Holdings, Inc. ("Keystone Holdings") with and into the Company and certain other
transactions (the "Keystone Transaction") and thereby acquired American Savings
Bank, F.A. ("ASB"). Washington Mutual issued 47,883,333 shares of common stock
to complete the Keystone Transaction.
On July 1, 1997, Washington Mutual consummated the merger of Great Western
Financial Corporation ("GWFC") with and into a subsidiary of the Company (the
"Great Western Merger"). All of GWFC's subsidiaries, including Great Western
Bank, a Federal Savings Bank ("GWB") and Aristar, became subsidiaries of the
Company. The Company issued 125,649,551 shares of common stock in the Great
Western Merger.
On October 1, 1997, GWB was merged with and into ASB. Simultaneously, the
name of ASB was changed to Washington Mutual Bank, FA. The Company has announced
that it intends to operate all of its former Great Western Bank and American
Savings Bank consumer financial and home loan centers under the Washington
Mutual name commencing in 1998.
The above mentioned transactions were accounted for as poolings of
interests. See "Consolidated Financial Statements -- Note 2: Business
Combinations/Restructuring."
On December 31, 1997, the Company and SAFECO Corporation ("SAFECO")
completed the formation of a strategic alliance to distribute SAFECO and other
annuities through the Company's consumer financial center network. As part of
this alliance, SAFECO acquired the Company's insurance subsidiary, WM Life
Insurance Co. ("WM Life").
INTEGRATION OF OPERATIONS
This section contains forward-looking statements that have been prepared on
the basis of the Company's best judgments and currently available information.
These forward-looking statements are inherently subject to significant business,
economic and competitive uncertainties and contingencies, many of which are
beyond the control of the Company. In addition, these forward-looking statements
are subject to assumptions with respect to future business strategies and
decisions that are subject to change. Accordingly, there can be no assurance
that the cost savings and revenue enhancements described herein will be achieved
in the amounts or within the time periods currently estimated. See "Cautionary
Statements" below for a discussion of factors that may cause such
forward-looking statements to differ from actual results.
The integration of ASB and its subsidiaries with the Company is
substantially complete. All major back office functions and data processing
systems were consolidated and the deposit and loan processing systems were
converted to the Company's systems by the end of the third quarter of 1997. At
the beginning of 1997, the Company introduced its "Free Checking" product into
the ASB system, which resulted in approximately
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83,000 net new checking accounts in 1997. The Company also introduced its full
line of SFR loan products and standardized loan pricing throughout the ASB
lending system.
The integration of GWFC and its subsidiaries with the Company is proceeding
on schedule. Administration of payroll, employee benefit plans, incentive
compensation systems, and accounts payable were consolidated effective January
1, 1998. The conversion of the deposit and loan processing systems is scheduled
for the second quarter of 1998.
During the fourth quarter of 1997, the Company's "Free Checking" product
was introduced at GWB consumer financial centers in California and Florida. This
introduction resulted in approximately 79,000 net new accounts during that
quarter, after having net account losses of approximately 134,000 during the
first nine months of the year. The Company also introduced its full line of SFR
loan products and standardized loan pricing throughout the GWB lending system.
Prior to the Great Western Merger, the Company estimated that 100 ASB and
GWB consumer financial centers would be consolidated as a result of the Great
Western Merger. Also prior to the Great Western Merger, GWFC identified five
consumer financial centers for closure. In November 1997, the Company identified
an additional 85 consumer financial centers for closure. A total of 90 consumer
financial center closures are expected to be completed in the third quarter of
1998.
The Company estimated $334 million in revenue enhancements as a result of
the Great Western Merger to be realized fully in 1999 with an approximately $173
million increase during 1998. For 1999, total fee increases of $88 million were
projected with the remaining $246 million resulting from an incremental increase
in net interest income. Based upon the success of the introduction of the "Free
Checking" product in the GWB system, and the additional experience gained from
operating the combined Company for six months, management believes the estimated
fee enhancements are reasonable and will be realized as anticipated.
The increase in net interest income was projected to result from the
leveraging of the additional capital generated by the Great Western Merger. The
rate of growth during the second half of 1997 was consistent with the
projections presented at the time of the Great Western Merger. However, during
the fourth quarter of 1997, the yield on a 10-year U.S. government note declined
approximately 36 basis points while the yield on a three-month U.S. treasury
bill increased 25 basis points. This change in the interest rate environment is
expected to result in an increase in loan refinancing and prepayment of existing
loans as well as in fixed-rate loans being more attractive to borrowers than
adjustable-rate mortgage ("ARM") loans. Because it is the Company's practice to
sell most conforming fixed-rate SFR loans, the persistence of lower interest
rates and a narrow spread between short and long-term interest rates for an
extended period of time will result in higher fixed-rate originations, making
full realization of the net interest income revenue enhancements difficult. The
Company expects that this will be partially mitigated by gains from the sale of
an increased amount of conforming fixed-rate SFR loans.
Annual cost savings before taxes of $340 million were projected as part of
the benefits of the Great Western Merger. Approximately $208 million savings
were originally anticipated for 1998, with the full benefit being realized in
1999. Realization of cost savings during 1998 may be negatively affected by an
estimated $60 to $80 million in one-time incremental transaction costs to merge
systems and provide customer support during the conversion period. These
expenses are in addition to the transaction-related expenses accrued in the
third quarter of 1997 and the transaction-related period costs incurred during
1997. The Company does not currently expect there to be significant transaction
costs related to the Great Western Merger in 1999. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Other Expense."
Cautionary Statements
Increased Origination of Loans May Not Be Achieved. Washington Mutual's
business plan assumes that it will be able to increase net interest income by
originating and retaining a greater volume of loans than either Washington
Mutual or GWB would have on a stand-alone basis. To the extent that the Company
is not able to generate a sufficient volume of new loans or retain such loans in
its portfolio at the levels or of the types
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assumed in the business plan and forward-looking statements, the estimates of
future net income contained therein may differ materially from actual results.
Cost Savings May Not Be Realized. No assurance can be given that the cost
savings which are anticipated through the consolidation of consumer financial
centers and home loan centers of WMBFA and of administrative functions of the
Company will be achieved or will occur in the time periods anticipated. In
addition, when consumer financial centers are consolidated or closed, financial
institutions often lose customers and deposits as a result. To the extent that
the Company loses customers or deposits significantly in excess of the amount
anticipated, the operations of the Company could be materially adversely
affected, particularly in the short term. The forward-looking statements assume,
based on Washington Mutual's historical experience following acquisitions, that
the deposit base of the Company will remain substantially intact during the
period presented in the forward-looking statements. To the extent that the
change in ownership of GWB, the consolidation of branches of WMBFA or other
factors result in a significant temporary or long-term loss of deposits, actual
results of operations may vary materially from the forward-looking information
presented.
Consumer Banking Expansion Risks. The forward-looking statements assume an
increase in fee income from the Company's consumer banking operations. The
sources of these fee increases include introduction of a debit card, a new
pricing policy for checking account services in California and Florida revised
policies for checking account services in accordance with Washington Mutual's
programs, implementation of the Company's checking programs throughout the WMBFA
system and improved revenues in financial services subsidiaries. Washington
Mutual has relatively limited experience with the introduction of these business
initiatives in California and Florida, where the greatest expansion of consumer
banking activities is expected to occur. Accordingly, there can be no assurance
that the Company's emphasis on consumer banking activities will be successful in
the California or Florida markets or that any increase in fee income anticipated
by the forward-looking statements will be achieved.
Concentration of Operations in California. At December 31, 1997, 52% of
Washington Mutual's loan portfolio was concentrated in California. In addition,
at December 31, 1997, approximately three quarters of the Company's deposits
were on deposit at consumer financial centers in California. As a result, the
financial condition and results of operations of the Company will be subject to
general economic conditions, and particularly the conditions in the
single-family and multi-family residential markets, in California. If economic
conditions generally, or in California in particular, worsen or if the market
for residential real estate declines, the Company may suffer decreased net
income or losses associated with higher default rates and decreased collateral
values on its existing portfolio, and may not be able to originate the volume or
type of loans or achieve the level of deposits and mutual fund assets currently
anticipated.
The forward-looking statements regarding the Company's results of
operations assume that the California economy and real estate market will remain
healthy. A worsening of current economic conditions or a significant decline in
real estate values in California could cause actual results to vary materially
from the forward-looking statements.
Interest Rate Risk. Washington Mutual realizes its income principally from
the differential between the interest earned on loans, investments and other
assets and the interest paid on interest-bearing liabilities. Net interest
spreads are affected by the difference between the repricing characteristics of
interest-earning assets and deposits and other borrowings. Market interest rates
have an impact on the volume and rates on loans, investments, deposits and
borrowings. Significant fluctuations in interest rates and spreads may adversely
affect net income. In addition, at the end of 1997, long-term interest rates
declined dramatically and the yield curve became much flatter. In this type of
interest rate environment, the Company's customers tend to prefer fixed-rate
loans to ARMs, and thus, the Company's ability to grow its asset size by
retaining ARMs in its portfolio could be adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Market Risk and Asset/Liability Management."
Competition. Washington Mutual faces significant competition both in
attracting and retaining deposits and in making loans in all of its markets. The
most direct competition has historically come from other savings institutions,
credit unions, mortgage companies, insurance companies, commercial banks, and
other institu-
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tional lenders doing business in the Company's market areas of California,
Washington, Oregon, Florida and Utah. Competition from commercial banks has been
particularly strong due to their extensive distribution systems. As with all
banking organizations, however, the Company has experienced increasing
competition from nonbanking sources, including mutual funds, securities
brokerage companies and government-sponsored enterprises ("GSEs") such as the
Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage
Corporation ("FHLMC"), and the Government National Mortgage Association
("GNMA"). Some of these competitors have significantly greater financial
resources, larger market share and greater name recognition than the Company.
There can be no assurance that competition from such sources will not increase
in the future and adversely affect the Company's ability to achieve its
financial goals. In addition, the Company's lending activities are heavily
influenced by competitive factors such as the lower cost structure of less
regulated originators and the influence of GSEs in establishing rates.
LENDING ACTIVITIES
General
The Company's principal lending activities are carried on through its
banking subsidiaries, WMBFA, WMB and WMBfsb, and through Aristar. At December
31, 1997, the Company's total loan portfolio of $67.81 billion (exclusive of
reserve for loan losses) included $53.43 billion of SFR loans; $877.4 million of
SFR construction loans; $6.61 billion of mortgage loans secured by commercial
real estate such as apartment buildings, office buildings, warehouses and
shopping centers; $1.08 billion of loans secured by manufactured housing; $2.73
billion of consumer loans; $2.31 billion of consumer finance loans; and $772.5
million of 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. WMBFA and WMBfsb, as federally chartered
institutions, 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.
SFR and SFR Construction Loans
General. The bulk of the Company's residential loan portfolio is in
California, Washington, Oregon, Florida and Utah. 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 and characteristics 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.
Under federal regulations, a real estate loan made by a depository
institution 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 SFR loan (including builder construction loans) with an
initial loan-to-value ratio in excess of 85%. The guidelines further provide
that depository institutions should not originate any owner-occupied SFR loan
with a loan-to-value ratio of 90% or above 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 institution 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
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depository institution's records and reported at least quarterly to its board of
directors. At December 31, 1997, 3% of the Company's SFR loan portfolio had
loan-to-value ratios of 90% or above at origination and were without mortgage
insurance.
SFR Lending. In the first 10 months of 1997, the Company's banking
subsidiaries were the leading originators of SFR loans in California, Washington
and Oregon. The Company makes available to borrowers a full range of SFR loans,
including FHA-insured and VA-guaranteed loans, conventional fixed-rate loans
with a variety of maturities and amortization schedules, and ARMs. ARMs are
advantageous to the Company because adjustable-rate loans better match the
Company's natural liability base. In recent years, and particularly in the
California market, the Company has emphasized the origination of ARMs. The
primary ARM products presently being offered are either indexed to the Cost of
Funds Index of the Eleventh District Federal Home Loan Bank (San Francisco)
("COFI") or to the one-year Moving Treasury Average ("MTA"). During 1997, 69% of
loan originations were ARMs and 31% had a fixed rate. Under the Company'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 have annual payment adjustments caps of 7.5% per year.
Under most options, 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 Company originates loans through its consumer financial centers in
Washington, Oregon, Utah, Idaho and Montana, and through home loan centers
throughout its franchise. The Company intends to introduce loan originations
through its consumer financial centers in California and Florida in 1998. The
Company also originates nearly half of its loans through loan brokers. To
monitor credit quality, the Company 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 home loan centers.
The Company originates loans for its portfolio that meet secondary market
standards established by GSEs ("conforming" loans) as well as those that meet
the Company's underwriting standards but do not conform to the requirements of
the GSEs for sale in the secondary market ("nonconforming" loans). Nonconforming
loans comprised approximately half of 1997's total residential originations.
These loans may be nonconforming because they exceed the maximum amount allowed
by the secondary market ("jumbo loans"), because the loan documentation lacks
some information relating to the borrower's credit or employment history
unrelated to the value of the collateral, or because the borrower's credit
history does not meet secondary market standards. All nonconforming loans are
fully supported by appraisals and title insurance. In addition, the
loan-to-value requirements are generally lower for nonconforming loans than for
conforming loans and decrease as the amount of the loan increases. The
delinquency experience on the Company's nonconforming loan portfolio as a whole
has not been significantly higher than on conforming loans.
SFR Construction Loans. The Company provides financing for two different
categories of SFR construction loans. A custom construction loan is made to the
intended occupant of a house to finance its construction and typically is
combined with the permanent financing of the constructed home. Builder
construction loans are made to borrowers who are in the business of building
homes for resale. Builder construction loans are made either on a house-by-house
basis or, in certain circumstances, through a collateralized, limited line of
credit. Builder construction lending involves somewhat more risk than custom
construction loans and involves different underwriting considerations. All SFR
construction loans require approval by various levels of Company personnel,
depending on the size and characteristics of the loan. SFR 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.
SFR construction loans are an integral part of the Company's overall
lending program. Builder construction loans are of short duration, generally 12
to 18 months and are generally priced at a higher rate than are permanent
residential loans. In addition, SFR construction loans provide a source of SFR
loans.
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Custom Construction loans may be of short duration, generally 9 to 12 months, or
maybe 15 to 30 years if combined with permanent financing.
At December 31, 1997, 61% of the SFR construction portfolio was custom
construction loans and 39% was builder construction loans. Originations of SFR
construction loans for 1997 totaled $1.45 billion, an increase of 12% from $1.29
billion in 1996. Substantially all of the 1997 SFR construction loan
originations were made in Washington, Oregon and Utah.
Commercial Real Estate Loans
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, particularly the
interest rate environment. Commercial real estate values tend to be cyclical
and, while commercial real estate values have trended upward in many areas of
the country in 1997, management carefully monitors the commercial real estate
environment to determine the level of the Company's activity in this area.
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 and characteristics of the loan.
Historically, the Company focused its commercial real estate lending on
small to mid-sized apartment lending (loans of $2.5 million or less). During
1996 and 1997, the Company began to broaden its lending scope by originating
$295.4 million and $495.0 million of nonresidential real estate loans, compared
to $549.0 million and $691.6 million of apartment loans. This change in emphasis
was occasioned in part by the acquisitions of Enterprise and Western and the
development of the Company's commercial banking operations. Both the Enterprise
and Western commercial real estate portfolios are predominantly nonresidential
commercial real estate. As the amount of commercial real estate lending
increases, the risk characteristics of the Company's commercial loan portfolio
will generally increase.
Loan Securitization
The Company from time to time, depending on its asset and liability
management strategy, converts a portion of its SFR loans into either FHLMC
participation certificates, GNMA mortgage-backed securities or FNMA
mortgage-backed securities (collectively, "MBS"). This securitization of its
loans provides the Company with increased liquidity both because the MBS are
more readily marketable than the underlying loans and because they can be used
as collateral for borrowing.
The Company generally securitizes a substantial portion of its fixed-rate
SFR loan production in order to sell the MBS in the secondary market. These
fixed-rate loans are generally securitized and 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, 1996 and 1997, the Company securitized loans with FHLMC and FNMA
under programs in which the GSE has recourse against the originator of the loans
("Recourse MBS"). These securitizations primarily involve ARMs and are generally
less costly and may require less documentation than securitizations without
recourse. These Recourse MBS are generally saleable in the secondary market and
can be used as collateral for borrowings and to meet regulatory liquidity
requirements. The Company has retained the majority of Recourse MBS. The Company
has also sold Recourse MBS and has established a contingent liability to cover
the estimated recourse obligation. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Asset Quality."
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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 are included in the Company's total nonaccrual
assets.
Manufactured Housing, Second Mortgage and Other Consumer Loans
WMB and WMBfsb offer consumer loans 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 purposes, including secured and
unsecured loans made under Washington Mutual's line of credit programs. Consumer
loans, in addition to being an important part of the Company's orientation
toward consumer financial services, provide greater net interest income due to
their generally higher yields. The size of the consumer loan portfolio has grown
in recent years. Management has begun to introduce these products into WMBFA'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. 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.
Consumer Finance Loans
Aristar makes direct consumer installment loans and purchases retail
installment contracts from local retail establishments. These consumer credit
transactions are primarily for personal, family or household purposes.
Installment loans typically have original terms ranging from 12 to 360 months,
and for 1997 originations had an average original term of 72 months. In the year
ended December 31, 1997, 61% of the originations of all installment loans were
unsecured or secured by luxury goods, automobiles or other personal property,
with the remaining 39% secured by real estate. Retail installment contracts are
generally acquired without recourse to the originating merchant. These contracts
are typically written with original terms of from three to 60 months and for
1997 had an average original term of 27 months.
Aristar's operations are currently located in 22 states, primarily in the
southeastern United States. The Company anticipates that Aristar will
significantly increase its lending volume in Texas as a result of changes in
Texas law which permit non-purchase money home equity lending for the first
time, commencing January 1, 1998. These changes allow borrowers to obtain loans
for a variety of purposes, such as renovation and remodeling of property, as
well as, for the first time, for uses unrelated to the security.
Commercial Business Loans
The Company, primarily through the Western Bank division of WMB, offers a
full range of commercial banking products and services. The Company's commercial
business loans are mainly loans to individuals and to small to mid-sized
businesses, and they are secured by a variety of business and personal assets
or, in some cases, are unsecured. In 1997, the Company originated $669.6 million
of commercial business loans, and the commercial business loan portfolio totaled
$772.5 million at December 31, 1997.
ASSET QUALITY
General
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. Reserves
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are maintained for assets classified as substandard or doubtful. Any portion of
an asset classified as loss is immediately written off or specifically reserved.
The principal measures of asset problems are the levels of nonaccrual loans
and foreclosed assets, the levels of impaired loans, the amount of the provision
for loan losses, the amount of loan charge offs, and writedowns in the value of
foreclosed assets. In 1997, the Company changed its accounting policy with
respect to reserving for losses on loans securitized and retained. See
"Management's Discussion and Analysis of Financial Position and Results of
Operations -- Asset Quality."
Management ceases to accrue interest income on any loan that is four
payments or more delinquent (generally beyond 90 days) 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 or
commercial business loan, management stops accruing interest on the loan,
whether or not it has reached the four payment 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.
Foreclosed Assets
Real estate or personal property that served as security for a defaulted
loan and becomes a foreclosed asset 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 is foreclosed is less
than the loan balance, the loan is written down at that time by a charge to the
reserve for loan losses. See "Management's Discussion and Analysis of Financial
Position and Results of Operations -- Asset Quality."
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
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.
Commercial real estate, commercial business and builder construction loans are
evaluated individually for impairment. This detailed analysis includes
estimating the fair value of loan collateral and assessing the potential
existence of 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 that has not yet been identified. In
determining the adequacy of unallocated reserves, management considers changes
in the size and composition of the loan portfolio, actual historical loan loss
experience, current and anticipated economic conditions, and the Company's
credit administration and asset management philosophies and procedures.
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
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Financial Position and Results of Operations -- Asset Quality -- Provision for
Loan Losses and Reserve for Loan Losses."
INVESTING ACTIVITIES
Washington Mutual has authority under Washington state law to make any
investment, but Washington Mutual's banking subsidiaries are subject to
investment restrictions imposed by state and federal law. Under Washington state
law, WMB has authority, subject to a numerical limit, 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.
WMBFA and WMBfsb have authority to make investments specified by the Home
Owners' Loan Act ("HOLA") and applicable regulations, including the purchase of
governmental obligations, investment-grade commercial paper, and
investment-grade corporate debt securities. Despite these broad investment
powers, at December 31, 1997, MBS accounted for $22.87 billion or 95% of the
Company's total investment portfolio. Of MBS, at December 31, 1997, 91% were GSE
MBS. The remainder, $2.09 billion, were private-issue MBS and collateralized
mortgage obligations ("CMOs"). See "Consolidated Financial Statements -- Note 4:
Securities."
Historically, the yield on private-issue MBS, 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 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 loans with principal balances in
amounts larger than can be sold as GSE MBS.
The Company has 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.
SOURCES OF FUNDS
Deposits
The Company offers money market deposit accounts ("MMDAs") and checking
accounts as well as the more traditional savings accounts and time deposit
accounts. The MMDAs generally require higher minimum balances and offer higher
yields than savings accounts. The Company offers checking accounts that both
bear interest and are noninterest bearing. The interest-bearing checking
accounts are subject to monthly service charges, unless a minimum balance is
maintained. The vast majority of the noninterest-bearing checking accounts have
no monthly fees.
At December 31, 1997, the Company had $50.99 billion in deposits, of which
$28.13 billion were time deposit accounts, $14.94 billion were MMDAs and savings
accounts; and $7.91 billion were checking accounts. Although 55% of deposits at
the end of 1997 were time deposit accounts, $23.41 billion or 83% of total time
deposit accounts had remaining maturities of one year or less.
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At December 31, 1997, $3.53 billion of the Company's total deposits did not
bear interest. Since 1995, WMB and WMBfsb have been actively promoting a "Free
Checking" account, and the Company introduced this product into its California
and Florida operations during 1997. This account has helped to reduce the
overall cost of funds by increasing the percentage of deposits that are
noninterest bearing. The Company expects to continue to actively promote its
"Free Checking" account throughout its markets.
The Company has also actively promoted MMDAs because, while a somewhat
volatile source of deposits, they have the advantage of being variable-rate
liabilities. At December 31, 1997, the Company had an aggregate of $11.67
billion in MMDAs and only $3.27 billion in regular savings accounts.
Wholesale deposits, primarily time deposit accounts, are offered to
political subdivisions and public agencies. The Company considers wholesale
deposits to be a borrowing source rather than a customer relationship.
Borrowings
Because deposits have declined in recent years, the Company has
increasingly relied on wholesale borrowings to fund its asset growth. Borrowings
include securities sold under agreements to repurchase ("reverse repurchase
agreements"), the purchase of federal funds, the issuance of mortgage-backed
bonds or notes, capital notes and other types of debt securities, the issuance
of commercial paper and funds obtained as advances from the Federal Home Loan
Bank ("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 reverse repurchase agreements
are not deemed borrowings under such law, and borrowings from federal, state or
municipal governments, agencies or instrumentalities, including the FHLBs, also
are not subject to the 30% limit.
The Company actively engages in reverse repurchase agreements with
authorized broker-dealers and major customers, selling U.S. government and
corporate debt securities and MBS under agreements to repurchase them or similar
securities at a future date. At December 31, 1997, the Company had $12.28
billion of such borrowings.
WMB and WMBfsb are members of the FHLB of Seattle and WMBFA 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 1997, WMBFA, WMB and WMBfsb had credit lines ranging
from 40% to 45% of total assets. At December 31, 1997, advances under these
credit lines totaled $20.30 billion and were secured by mortgage loans and deeds
of trust and securities of the U.S. government and agencies thereof.
Federal law requires that a member of an FHLB pay in to the FHLB, in
exchange for stock of the FHLB, an amount equal to at least 5% of the aggregate
outstanding advances made by the FHLB to the member. At December 31, 1997, the
Company held stock in FHLBs with an aggregate value of $1.06 billion.
In addition to the borrowings discussed above, at December 31, 1997, the
Company was in a position to obtain approximately $21 billion in additional
borrowings, 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."
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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 23.51
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........... 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
Great Western Financial
Corporation........................ July 1, 1997 32,448.3 27,785.1 43,769.8 1,138
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(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.
See "Consolidated Financial Statements -- Note 2: Business
Combinations/Restructuring" for a discussion of accounting treatment for certain
of the acquisitions.
EMPLOYEES
The number of full-time equivalent employees at the Company decreased from
19,906 at December 31, 1996 to 19,880 at December 31, 1997. The Company believes
that it has been successful in attracting quality employees and believes its
employee relations are good.
TAXATION OF THE COMPANY
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.
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Tax Bad Debt Reserve Recapture
The Small Business Job Protection Act of 1996 (the "Job Protection Act")
requires that qualified thrift institutions, such as WMBFA, WMB 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 an additional approximately $4.2 million
(based upon current federal income tax rates) in 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.
Washington imposes on businesses a business and occupation tax based on a
percentage of gross receipts. 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, Florida, Utah, Idaho and Montana, as well
as many of the other states in which the Company does business, have corporate
income taxes, which are imposed on companies doing business in those states. The
Company's operations in California, Oregon and Florida 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.
Assistance Agreement
As a result of the Keystone Transaction, the Company and certain of its
affiliates are parties to an agreement (the "Assistance Agreement") with a
predecessor of the Federal Savings & Loan Insurance Corporation ("FSLIC")
Resolution Fund (the "FRF"), which is 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 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 "Provision for 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 19: Payments in Lieu of Taxes."
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
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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 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 on such loans.
REGULATION AND SUPERVISION
General. Washington Mutual, 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 the Department
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. WMBFA 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 WMBFA and WMBfsb.
The Company owns two industrial banks, First Community Industrial Bank
("FCIB") in Denver, Colorado and Great Western Thrift & Loan ("GWTL") in Salt
Lake City, Utah. FCIB and GWTL (collectively, the "Industrial Banks") are state
chartered institutions which are regulated by state authorities in addition to
being regulated by the FDIC. State laws specify the investments which these
institutions may make and the activities in which they may engage.
The Company's consumer finance subsidiaries are governed by state and
federal laws. Federal laws relate primarily to fair credit practice matters.
State laws establish applicable licensing requirements, provide for periodic
examinations and establish maximum finance charges on credit extensions.
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. The Company is a multiple savings and loan
holding company, as defined by federal law, because it owns three savings
associations -- WMB, WMBFA 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 WMBFA and WMBfsb are deemed to have been acquired in
supervisory transactions. The Company will become subject to the MHC
Restrictions, however, if any one of WMB, WMBFA or WMBfsb fails to be a
qualified thrift lender ("QTL"), meaning generally that either (i) at least 65%
of a specified asset base must consist of loans to small businesses, including
credit card loans, educational loans or certain assets related to domestic
residential real estate, including residential mortgage loans and mortgage
securities; or (ii) 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 WMBFA and WMBfsb, among other things, to branch, to pay dividends and to
obtain such advances. Each of WMB, WMBFA and WMBfsb are currently in compliance
with QTL standards.
HOLA and OTS regulations require the Company, 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
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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, WMBFA and WMBfsb, as holding company subsidiaries that are
depository institutions, are subject to both qualitative and quantitative
limitations on the transactions they conduct with the Company 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 the Company
controls WMB, WMBFA, WMBfsb and the Industrial Banks).
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.
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 the Company's banking subsidiaries 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
savings banks, including WMB and the Industrial Banks. A portion of WMB's
deposits are also insured through SAIF. The SAIF is a deposit insurance fund for
most savings associations, such as WMBFA and WMBfsb. A small portion of WMBFA's
deposits are insured through the BIF. At December 31, 1997, approximately 90% of
the combined deposits of the Company 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 and the Industrial
Banks qualify for the lowest rate on its BIF deposits, and WMB, WMBFA 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
charge of $312.6 million. Even though the one-time charge reduced the Company's
1996 earnings by $200.0 million, management believes the legislation is in the
best interests of the Company due to the reduction in SAIF assessment rates.
WMB, WMBFA, WMBfsb and the Industrial Banks currently pay no assessment for
deposit insurance. However, under the legislation recapitalizing the SAIF, the
FDIC is authorized to collect assessments against insured deposits to be paid to
the Finance Corporation ("FICO") to service FICO debt incurred in the 1980s. The
current FICO assessment rate for BIF-insured deposits is 1.256 cents per $100 of
deposits per year and 6.28 cents per $100 of deposits per year for SAIF-insured
deposits.
Capital Requirements. The Company is not subject to any regulatory capital
requirements. However, each of its subsidiary depository and insurance
institutions is subject to various capital requirements. WMB and the Industrial
Banks are each subject to FDIC capital requirements, while WMBFA and WMBfsb are
subject to OTS capital requirements.
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WMB and the Industrial Banks. 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 items 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 5.86% as of December 31,
1997. FCIB and GWTL have calculated their respective leverage ratios to be
22.35% and 11.84% as of December 31, 1997.
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 SFR properties
and certain private-issue MBS 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 I capital to risk-weighted assets must be at least 4.00%. WMB
has calculated its total risk-based ratio to be 10.93% and its Tier 1 risk-based
capital ratio to be 10.13% as of December 31, 1997. FCIB and GWTL have
calculated their total risk-based ratios to be 29.53% and 16.03%, and their Tier
1 risk-based capital ratios to be 28.26% and 14.77% as of December 31, 1997. 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.
WMBFA and WMBfsb. The OTS requires savings associations, such as WMBFA 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,
1997, WMBFA's core capital and tangible capital ratios were 5.78% each, and
WMBfsb's core capital and tangible capital ratios were 6.66% each. 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, 1997, WMBFA had core risk-based and
total risk-based capital ratios of 9.54% and 11.11%, while WMBfsb had ratios of
10.84% and 11.95%.
FDICIA Requirements. FDICIA created a statutory framework that increased
the importance of meeting applicable capital requirements. FDICIA establishes
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
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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 control and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure by
WMB, WMBFA, WMBfsb or the Industrial Banks to comply with applicable capital
requirements would, if unremedied, result in restrictions on their activities
and lead to enforcement actions against WMB or the Industrial Banks by the FDIC
or against WMBFA 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.
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 WMBFA 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 WMBFA 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 evaluate the 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.
Legal Restrictions on Dividends of Depository Institutions. A depository
institution such as WMB, WMBFA 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 WMBFA 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.
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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 WMBFA 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 WMBFA's securities and insurance
affiliates and on such affiliates' transactions with WMB, WMBFA and WMBfsb.
These restrictions include requirements that such affiliates follow practices
and procedures to distinguish them from WMB, WMBFA and WMBfsb and that such
affiliates give customers notice from time to time of their separate corporate
status 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, 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 WMBFA and WMBfsb, are subject to
regulatory oversight and examination by the OTS and the FDIC. HOLA and OTS
regulations delineate 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 require that WMBFA and WMBfsb maintain liquid
assets in excess of a specified limit. See "Management's Discussion and Analysis
of Financial Position and Results of Operations -- Liquidity."
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
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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,
WMBFA, WMBfsb and the Industrial Banks 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, WMBFA and WMBfsb
each maintain reserves against net transaction accounts in the amount of 3% on
amounts of $47.8 million or less, plus 10% on amounts in excess of $47.8
million. Institutions may designate and exempt $4.7 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.
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.
Under new regulations that apply to all CRA performance evaluations after
July 1, 1997, 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.
Under the regulations applicable before July 1, 1997, WMBFA and WMBfsb each
received an "outstanding" CRA rating from the OTS, and WMB and the Industrial
Banks 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. No assurance can be given, however, that the CRA performance of these
institutions will result in "outstanding" ratings under the new regulations in
the future. 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.
In April 1997, the Company made a public commitment to make $75.00 billion
in loans and investments over a 10-year period to families and small businesses
in the communities it serves. The primary components of the commitment include
$50.00 billion in affordable housing loans to minorities and borrowers in low-
to moderate-income census tracts; $8.00 billion in consumer loans to low- to
moderate-income borrowers; $7.00 billion in multi-family loans for properties
serving low- to moderate-income tenants; $1.00 billion of investments in, and
loans to, various community development projects; and $9.00 billion in small
business loans of $50,000 or less.
Recent and Proposed Federal Legislation and Regulation. Effective June 1,
1997, federal legislation repealed 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.
WMBFA and WMBfsb already have authority to establish interstate branches under
current federal law and regulations, so management expects that such legislation
will primarily benefit competitors of the Company.
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Various legislative proposals relating to financial services companies 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 to require federal savings institutions such as WMBFA
and WMBfsb to convert to commercial banks. The outcome of these legislative
proposals cannot be forecast reliably.
The OTS on January 7, 1998, published a proposal that would allow a federal
savings institution such as WMBFA or WMBfsb to pay dividends and make capital
distributions in an aggregate amount not exceeding the sum of the institution's
net income for the year to date, plus previously undistributed net income for
the preceding two years, without application to the OTS. This proposal would
make OTS regulations on capital distributions more similar to the rules of other
federal banking agencies. As subsidiaries of a savings and loan holding company,
however, WMBFA and WMBfsb would still be required to notify the OTS 30 days
before declaration of a dividend.
Regulation of Nonbanking Affiliates. As broker-dealers registered with the
Securities and Exchange Commission and as members of the National Association of
Securities Dealers ("NASD"), WM Financial, CFDI, GWFSC and SISC are subject to
various regulations and restrictions imposed by those entities, as well as by
various state authorities. As registered investment advisors, Composite
Research, SIAC and SISC are subject to various federal and state securities
regulations and restrictions.
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 the Company'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 savings institutions, credit
unions and commercial banks doing business in its primary market areas of
California, Washington, Oregon, Florida and Utah. As with all banking
organizations, however, Washington Mutual has also experienced 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 savings institutions, commercial banks,
mortgage companies, credit unions, insurance companies and other institutional
lenders. Many of these competitors have more significant financial resources,
larger market shares and greater name recognition than the Company. The
activities 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 and Florida, each of 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 and Florida markets.
Although consolidation has decreased the number of institutions competing
in the Company's market, both savings 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 1997
(through October), WMB's originations of SFR loans ranked first in both
Washington and Oregon and WMBFA's originations of residential mortgages ranked
first in California.
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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................ 48 Chairman of the Board of Directors, 1983
President and Chief Executive Officer
Fay L. Chapman.................... 51 Executive Vice President and General Counsel 1997
Craig S. Davis.................... 46 Executive Vice President 1996
Steven P. Freimuth................ 41 Executive Vice President 1988
Lee D. Lannoye.................... 60 Executive Vice President 1988
William A. Longbrake.............. 54 Executive Vice President and 1996
Chief Financial Officer
Deanna W. Oppenheimer............. 39 Executive Vice President 1985
Craig E. Tall..................... 52 Executive Vice President 1985
S. Liane Wilson................... 55 Executive Vice President 1985
Richard M. Levy................... 39 Senior Vice President and Controller 1998
Norman H. Swick................... 48 Senior Vice President and General Auditor 1980
Douglas G. Wisdorf................ 43 Senior Vice President and 1976
Deputy Chief Financial Officer
Mr. Killinger has been Chairman, President and Chief Executive Officer of
Washington Mutual 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.
Ms. Chapman became an Executive Vice President and General Counsel and
member of the Executive Committee of Washington Mutual in September 1997. Prior
to that appointment, Ms. Chapman had been a partner with Foster Pepper &
Shefelman, a Seattle, Washington law firm, since 1979.
Mr. Davis became an Executive Vice President and member of the Executive
Committee in January 1997, following the Company'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 Services,
Inc. from 1989 to 1993.
Mr. Freimuth became an Executive Vice President and member of the Executive
Committee of the Company in 1997. In this capacity, he is responsible for
corporate lending administration. He joined WMB as a Vice President in 1988 and
became a Senior Vice President in 1991.
Mr. Lannoye has been an Executive Vice President of the Company since its
organization. He has been an Executive Vice President of WMB since 1988 and a
member of the 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 Washington Mutual 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 FDIC. Mr. Longbrake was Senior Executive Vice President and Chief Financial
Officer of the Company 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.
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Ms. Oppenheimer has been an Executive Vice President of Washington Mutual
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 Washington Mutual 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, commercial banking and consumer finance.
Ms. Wilson has been an Executive Vice President of Washington Mutual 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. Levy has been a Senior Vice President and Controller since February
1998. In this capacity he is the principal accounting officer of the Company.
Prior to joining the Company, Mr. Levy was Executive Vice President and Chief
Financial Officer of Community Trust Bancorp from 1995 to 1997. Prior to that,
he was the Controller of Bank of America Texas, N.A.
Mr. Swick has been Senior Vice President and General Auditor of Washington
Mutual 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 the Company's
internal controls and compliance with all laws and regulations.
Mr. Wisdorf has been Deputy Chief Financial Officer since 1996 and Senior
Vice President of Washington Mutual since its organization. Mr. Wisdorf was
Controller of the Company from 1994 to February 1998. He became Vice President
and Controller of WMB in 1986 and has been an officer since 1978.
ITEM 2. PROPERTIES
As of December 31, 1997, the Company's banking subsidiaries conducted
business from 850 consumer financial centers, 47 Western financial centers, 23
business banking centers and over 200 home loan centers in 26 states. Consumer
finance operations were conducted in approximately 500 locations in 22 states.
Washington Mutual's administrative offices are located at 1201 Third
Avenue, Seattle, Washington, 98101 where, as of December 31, 1997, the Company
leased approximately 178,000 square feet pursuant to a lease agreement that
starts to terminate in 2007 with multiple options to renew at the Company's
discretion. The Company also leases approximately 158,000 square feet of space
in Seattle in the Second and Seneca Building pursuant to a lease agreement that
starts to terminate in 2001; approximately 75,000 square feet in the adjoining
building pursuant to a lease agreement that starts to terminate in 2006;
approximately 97,000 square feet in Seattle in the 1st Interstate Building at
999 Third Avenue pursuant to a lease agreement that starts to terminate in 1999;
and approximately 61,000 square feet in Seattle in the 1111 3rd Avenue Building
pursuant to a lease agreement that starts to terminate in 2004. The Company has
multiple options to renew leases at all locations.
WMBFA administrative and subsidiary operations are conducted from owned
office space totaling 280,000 square feet in Irvine, California, 237,000 square
feet in Stockton, California and 305,000 square feet in Chatsworth, California.
WMBFA administrative and subsidiary operations are also conducted from leased
office space totaling 795,000 square feet in Chatsworth pursuant to a lease
agreement that starts to terminate in 2005 with options to renew at the
Company's discretion.
Aristar administrative operations are conducted from owned office space
totaling 71,000 square feet in Tampa, Florida.
See "Consolidated Financial Statements -- Note 10: Premises and Equipment."
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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
None.
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, 1998, there were 257,781,511 shares issued
and outstanding held by 22,931 shareholders of record. The last reported sales
price of common stock on February 20, 1998 was $67.75 per share.
The high and low common stock prices by quarter were as follows:
YEAR ENDED
DECEMBER 31, 1997
------------------
HIGH LOW
------- -------
Fourth quarter............................................. $72.38 $60.31
Third quarter.............................................. 70.25 58.88
Second quarter............................................. 62.69 45.38
First quarter.............................................. 58.88 42.75
YEAR ENDED
DECEMBER 31, 1996
------------------
HIGH LOW
------- -------
Fourth quarter............................................. $45.88 $36.50
Third quarter.............................................. 39.25 28.50
Second quarter............................................. 30.38 26.13
First quarter.............................................. 32.25 27.63
The cash dividends paid by quarter were as follows:
YEAR ENDED
DECEMBER 31,
----------------
1997 1996
------ ------
Fourth quarter............................................. $ 0.28 $ 0.24
Third quarter.............................................. 0.27 0.23
Second quarter............................................. 0.26 0.22
First quarter.............................................. 0.25 0.21
These dividends do not include amounts paid by acquired companies prior to
their combination with the Company.
PREFERRED STOCK
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,
1997. At December 31, 1996, there were 1,970,000 shares issued and outstanding
held by
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344 shareholders of record. The last reported sales price of the Series E
Preferred Stock on February 20, 1998 was $25.38 per share.
The high and low stock prices by quarter were as follows:
YEAR ENDED
DECEMBER 31,
----------------
1997
----------------
HIGH LOW
------ ------
Fourth quarter............................................. $26.00 $25.38
Third quarter.............................................. 26.00 25.50
Second quarter............................................. 25.88 25.25
First quarter.............................................. 25.75 25.00
YEAR ENDED
DECEMBER 31,
----------------
1996
----------------
HIGH LOW
------ ------
Fourth quarter............................................. $25.75 $24.25
Third quarter.............................................. 24.75 24.00
Second quarter............................................. 25.00 23.63
First quarter.............................................. 25.63 24.50
PAYMENT OF DIVIDENDS AND POLICY
Payment of future dividends is subject to 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, WMBFA and WMBfsb
to pay 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, 1997 included a pre-1988
thrift bad debt reserve for tax purposes of $1.22 billion for which no federal
income taxes have 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 of Washington Mutual and the notes thereto,
which are included in this Annual Report on Form 10-K. The Great Western Merger
in 1997 and the Keystone Transaction in 1996 were accounted for as poolings of
interests. The assets, liabilities, stockholders' equity, and results of
operations have been recorded on the books of Washington Mutual at their values
as carried on the books of the respective companies, and no goodwill was
created. Washington Mutual's financial information contained herein has been
restated as if the respective companies had been combined for all periods
presented. As such, the information presented herein is not comparable with that
reflected in the Company's annual report on Form 10-K/A for the year ended
December 31, 1996.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT DATA
Interest income..................... $ 6,810,964 $ 6,387,090 $ 6,158,371 $ 4,928,851 $ 4,883,407
Interest expense.................... 4,154,491 3,814,143 3,860,018 2,642,806 2,509,827
------------ ------------ ------------ ------------ ------------
Net interest income................. 2,656,473 2,572,947 2,298,353 2,286,045 2,373,580
Provision for loan losses........... 207,139 392,435 251,424 327,068 620,808
Other income........................ 713,400 658,164 603,567 694,228 648,925
Other expense....................... 2,261,608 2,428,599 1,802,886 1,883,348 1,922,639
------------ ------------ ------------ ------------ ------------
Income before income taxes,
extraordinary items, cumulative
effect of accounting changes, and
minority interest................. 901,126 410,077 847,610 769,857 479,058
Income taxes........................ 402,116 141,220 273,006 265,180 126,034
Provision for payments in lieu of
taxes............................. 17,232 25,187 7,887 (824) 14,075
Extraordinary items, net of federal
income tax effect(1).............. -- -- -- -- (8,953)
Cumulative effect of change in tax
accounting method................. -- -- -- -- 13,365
Minority interest in earnings of
consolidated subsidiaries......... -- 13,570 15,793 13,992 13,991
------------ ------------ ------------ ------------ ------------
Net income.......................... $ 481,778 $ 230,100 $ 550,924 $ 491,509 $ 320,546
============ ============ ============ ============ ============
Net income attributable to common
stock............................. $ 460,346 $ 191,386 $ 507,325 $ 447,910 $ 253,764
============ ============ ============ ============ ============
Net income per common share:
Basic............................. $1.87 $0.81 $2.19 $1.98 $1.30
Diluted........................... 1.86 0.81 2.16 1.96 1.30
Average diluted common shares used
to calculate earnings per share... 247,045,339 237,683,414 244,555,332 232,633,542 224,329,524
SELECTED FINANCIAL DATA
Cash dividends paid per common
share:
Pre-business combinations(2)...... $1.06 $0.90 $0.77 $0.70 $0.50
Post-business combinations(3)..... 1.11 1.09 0.75 0.82 0.75
Common stock dividend payout
ratio(3).......................... 56.83% 112.13% 33.16% 38.73% 62.81%
Return on average assets............ 0.52 0.27 0.66 0.67 0.36
Return on average stockholders'
equity............................ 9.21 4.40 11.58 11.36 6.14
Return on average common
stockholders' equity.............. 9.25 3.86 11.33 11.07 5.54
25
28
SELECTED FINANCIAL DATA
DECEMBER 31,
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Assets...................... $ 96,981,099 $ 87,426,497 $ 86,613,386 $ 79,699,553 $ 71,961,681
Available-for-sale
securities................ 11,373,922 16,095,343 20,749,500 7,780,460 4,917,290
Held-to-maturity
securities................ 12,779,614 4,479,056 5,084,456 10,791,135 6,270,139
Loans....................... 67,140,157 61,153,968 54,080,189 53,850,887 51,725,601
Deposits.................... 50,986,017 52,666,914 53,697,888 52,044,953 54,876,165
Annuities................... -- 878,057 855,503 799,178 713,383
Borrowings.................. 38,998,647 27,407,744 25,169,766 21,078,049 10,416,757
Stockholders' equity........ 5,309,071 4,993,088 5,364,180 4,338,622 4,188,961
Stockholders' equity
ratio..................... 5.47% 5.71% 6.19% 5.44% 5.82%
Diluted book value per
common share(4)........... $20.80 $19.44 $20.62 $16.91 $16.55
Number of diluted common
shares at end of
period(4)................. 249,560,018 242,230,645 246,366,127 239,731,824 235,938,428
- ---------------
(1) Included losses in 1993 of $2.3 million on the redemption of subordinated
capital notes and $10.8 million from the penalty for prepayment of FHLB
advances and the related income tax benefits of $4.1 million.
(2) Amounts paid by acquired companies prior to their combination with the
Company were not included.
(3) Based on dividends paid and earnings of the Company after restatement of
financial statements for significant transactions accounted for as poolings
of interests.
(4) 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 and their
transferees was not included.
26
29
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 financial services company committed to serving
consumers and small to mid-sized businesses. 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.
The Company's consumer finance operations provide direct installment loans and
related credit insurance services and purchase retail installment contracts.
Washington Mutual also markets annuities and 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.
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 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 the merger of Keystone
Holdings with and into Washington Mutual. New West was subsequently liquidated.
The Great Western Merger. On July 1, 1997, GWFC merged with and into New
American Capital, Inc. ("NACI"), a wholly-owned subsidiary of the Company, and
all of the subsidiaries of GWFC, including GWB and Aristar, became subsidiaries
of NACI. On October 1, 1997, GWB was merged with and into ASB; simultaneously
the name of ASB was changed to WMBFA. GWFC was a diversified financial services
company with more than 1,000 mortgage lending, retail banking and consumer
finance offices nationwide. GWB conducted most of its real estate lending
operations in 23 states, with business concentrated in California and Florida.
Aristar operates in 22 states primarily in the southeastern United States,
principally under the names Blazer, City Finance and First Community.
In connection with the closing of the Great Western Merger, the Company
recorded transaction-related expenses of $431.1 million in 1997. As anticipated,
the largest of these expenses were in the categories of severance and management
payments, facilities and equipment impairment, and legal, underwriting and other
direct transaction costs
Additionally, in October 1997, the Company securitized $1.22 billion of SFR
loans from GWB's portfolio which the Company had previously identified as having
both high loan-to-value ratios and borrowers whose credit history was marginal.
These loans were transferred to a trust that issued five classes of securities.
Management's intent with this securitization was to isolate the highest credit
risk portion of these loans by assigning that credit risk to a separate class of
securities so that, as market conditions and execution capabilities permit, a
decision to sell this class can be made. At September 30, 1997, the estimated
loss of $100.0 million on this highest risk class was included in gain (loss) on
sale of loans and leases as a lower of cost or market adjustment. The highest
credit risk class is held in the Company's trading portfolio. The Company is
holding the lower credit risk classes of the securitization in its investment
portfolio as it does with other retained MBS.
27
30
In addition to the transaction-related expenses and the market adjustment
described above, during 1997, the Company recorded $116.5 million in tax
benefits related to the exercise of options under the GWFC stock option plan.
This benefit was recorded directly as an increase to stockholders' equity as the
options were exercised. The net effect upon stockholders' equity of all
adjustments from the Great Western Merger in 1997 was a reduction of $271.6
million.
On December 31, 1997, the Company sold its insurance subsidiary, WM Life to
SAFECO for a gain of $20.8 million. The sale was in connection with the
negotiation of a distribution agreement with a subsidiary of SAFECO, which will
provide annuities for distribution through Washington Mutual's consumer banking
network. The agreement with SAFECO should add to Washington Mutual's future fee
income, while enabling the Company to redeploy the capital previously invested
in WM Life.
RESULTS OF OPERATIONS
Overview. In each of 1996 and 1997, Washington Mutual completed a
transaction which had the effect of doubling the asset size of the Company.
Together, the Keystone Transaction and the Great Western Merger (collectively,
the "Transactions") transformed the Company from a regional financial services
institution whose activities were concentrated in Washington, Oregon and Utah to
a company with operations in 36 states, including California, where it is the
third largest depository institution. Since the Transactions were accounted for
as poolings of interests and the Company's financial statements have been
restated for all prior periods, certain of the effects of these combinations are
not reflected in the financial statements. For example, prior to the Keystone
Transaction, Washington Mutual was in the process of a major restructuring of
its loan portfolio to reduce the percentage of fixed-rate assets through large
sales of fixed-rate loans and MBS and the purchase of ARMs and MBS consisting of
ARMs. The loan portfolios of both ASB and GWB consisted primarily of ARMs and
so, as a result of the Transactions, the Company successfully accomplished the
portfolio restructuring program on which it embarked in 1995. In addition, the
operating performance of the Company has been on a positive trend, even though
net income has been negatively affected by transaction-related expenses, the
one-time assessment in 1996 to recapitalize the SAIF and additions to the loan
loss reserve and write downs of loans securitized and held in the trading
portfolio.
Washington Mutual's net income for 1997 was $481.8 million compared with
$230.1 million in 1996 and $550.9 million in 1995. The Company's net income
during 1997 was reduced by charges associated with the Great Western Merger
totaling $531.1 million for transaction-related expenses and the write down of
loans securitized and held in the trading portfolio. Net income during 1996 was
reduced by $489.4 million as a result of charges of $158.1 million for
transaction-related expenses and $125.0 million in loan loss provisions due to
the Keystone Transaction, the special SAIF assessment of $312.6 million, $68.3
million for restructuring expenses at GWFC prior to the Great Western Merger and
a $50.0 million loan loss provision for the bulk sale by GWB of nonperforming
loans. Diluted earnings per share were $1.86 in 1997, $0.81 in 1996 and $2.16 in
1995. The various transaction-related expenses, the special SAIF assessment and
the addition to the loan loss reserve and loan write downs discussed above
negatively affected the various financial ratios which are commonly used to
assess the performance of financial institutions. Due to the unusual nature of
the merger activity in the past two years, the Company does not believe that the
1996 and 1997 ratios are indicative of the Company's overall performance in
those years nor will they necessarily be indicative of the Company's performance
in 1998 and subsequent years.
Net Interest Income. Net interest income for 1997 of $2.66 billion
increased from $2.57 billion in 1996 and $2.30 billion in 1995. The net interest
margin for 1997 was 3.03% compared with 3.13% in 1996 and 2.91% in 1995.
The 1997 increase in net interest income was due to a 7% rise in
average-earning assets to $87.72 billion in 1997, which more than offset the
decline in the net interest spread to 2.89% in 1997 from 2.99% in 1996. The
increase in net interest income and margin from 1995 to 1996 reflected the
effect of two primary factors. First, average interest-earning assets of $82.3
billion increased 4% from 1995. Second, the net interest spread rose to 2.99%
for 1996 from 2.81% 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
28
31
yield curve environment. During 1997, the difference between the yields on a
three-month U.S. Treasury bill and a 10-year U.S. government note averaged 117
basis points compared with 128 basis points a year earlier, and 94 basis points
in 1995. This difference declined significantly to 40 basis points at year-end
1997 from 101 basis points at September 30, 1997 and 126 basis points at June
30, 1997.
Approximately 80% of the Company's interest-sensitive assets have
adjustable rates that change with movements in short- to mid-term market
interest rates as do the majority of the liabilities contributing to the
Company's cost of funds. Market interest rates generally declined during 1996
and then increased only slightly during 1997. The Company's yield on its loan
and investment portfolio reflected this trend as it decreased 3 basis points
from 7.79% in 1995 to 7.76% in 1996 and then rose only slightly to 7.77% during
1997. The Company's cost of funds tends to be much more sensitive to changes in
market interest rates; the cost of funds declined 21 basis points from 4.98% in
1995 to 4.77% in 1996 and then increased to 4.88% in 1997.
29
32
Average statements of financial position, together with the total dollar
amounts of interest income and expense and the weighted average interest rates
were as follows:
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1995
------------------------------- ------------------------------- -------------------------------
INTEREST INTEREST INTEREST
INCOME INCOME INCOME
AVERAGE OR AVERAGE OR AVERAGE OR
BALANCE(1) RATE EXPENSE BALANCE(1) RATE EXPENSE BALANCE(1) RATE EXPENSE
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash equivalents,
securities and FHLB
stock(2)................ $22,728,040 7.06% $1,605,457 $25,026,183 7.06% $1,765,937 $23,291,051 7.08% $1,649,792
New West Note............. -- -- -- -- -- -- 723,800 8.13 58,841
Loans(3).................. 64,995,237 8.01 5,205,507 57,273,243 8.07 4,621,153 55,048,673 8.08 4,449,738
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total interest-earning
assets.............. 87,723,277 7.77 6,810,964 82,299,426 7.76 6,387,090 79,063,524 7.79 6,158,371
Other assets.............. 4,529,082 4,377,424 4,617,038
----------- ----------- -----------
Total assets.......... $92,252,359 $86,676,850 $83,680,562
=========== =========== ===========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits:
Checking accounts....... $ 7,463,552 0.78 58,389 $ 6,898,233 0.83 57,449 $ 6,744,793 0.95 63,958
Savings accounts and
MMDAs................. 14,708,431 3.47 510,001 13,670,008 3.18 434,691 13,541,539 3.32 449,813
Time deposit accounts... 29,620,788 5.39 1,597,714 32,458,419 5.39 1,748,162 33,205,445 5.54 1,838,132
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total deposits........ 51,792,771 4.18 2,166,104 53,026,660 4.22 2,240,302 53,491,777 4.40 2,351,903
Annuities and borrowings:
Annuities................. 801,178 5.07 40,657 812,185 5.01 40,658 801,129 5.58 44,716
Federal funds purchased
and commercial paper.... 2,787,848 5.71 159,129 2,040,637 5.40 110,247 1,898,473 6.19 117,442
Reverse repurchase
agreements.............. 12,527,774 5.71 715,047 14,360,452 5.50 790,483 14,800,811 6.11 904,698
Advances from FHLBs....... 13,621,867 5.75 783,338 6,509,897 5.56 361,695 3,668,898 5.73 210,324
Trust preferred securities
and other............... 3,659,226 7.93 290,216 3,143,556 8.61 270,758 2,867,735 8.05 230,935
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total annuities and
borrowings.......... 33,397,893 5.95 1,988,387 26,866,727 5.86 1,573,841 24,037,046 6.27 1,508,115
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Total interest-bearing
liabilities......... 85,190,664 4.88 4,154,491 79,893,387 4.77 3,814,143 77,528,823 4.98 3,860,018
----------- ---- ---------- ----------- ---- ---------- ----------- ---- ----------
Other liabilities........... 1,830,494 1,552,701 1,392,702
----------- ----------- -----------
Total liabilities......... 87,021,158 81,446,088 78,921,525
Stockholders' equity........ 5,231,201 5,230,762 4,759,037
----------- ----------- -----------
Total liabilities and
stockholders' equity...... $92,252,359 $86,676,850 $83,680,562
=========== =========== ===========
Net interest spread and
net interest income....... 2.89% $2,656,473 2.99% $2,572,947 2.81% $2,298,353
==== ========== ==== ========== ==== ==========
Net interest margin......... 3.03% 3.13% 2.91%
- ---------------
(1) Average balances were obtained from the best available daily, weekly or
monthly data, which in all cases approximated the average balances
calculated on a daily basis.
(2) The Company held a small amount of tax exempt securities, but chose not to
report the applicable interest income and yield on a tax equivalent basis.
(3) Nonaccrual loans were included in their respective loan categories.
Amortized net deferred loan fees were included in the interest income
calculations. The amortization of net deferred loan fees was $67.4 million
in 1997, $63.7 million in 1996 and $83.1 million in 1995.
30
33
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. Changes
attributable to (i) changes in volume (changes in average outstanding balances
multiplied by the prior period's rate), (ii) changes in rate (changes in average
interest rate multiplied by the prior period's volume), and (iii) changes in
rate/volume (changes in rate times the change in volume that were allocated
proportionately to the changes in volume and the changes in rate) were as
follows:
1997 VS. 1996 1996 VS. 1995
--------------------------------- ---------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
--------------------- TOTAL --------------------- TOTAL
VOLUME(1) RATE CHANGE VOLUME(1) RATE CHANGE
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
INTEREST INCOME
Cash equivalents, securities
and FHLB stock.............. $(162,339) $ 1,859 $(160,480) $122,412 $ (6,267) $ 116,145
New West Note................. -- -- -- (58,841) -- (58,841)
Loans(2)...................... 618,194 (33,840) 584,354 179,476 (8,061) 171,415
--------- --------- --------- -------- --------- ---------
Total interest
income.............. 455,855 (31,981) 423,874 243,047 (14,328) 228,719
INTEREST EXPENSE
Deposits:
Checking accounts........... 3,611 (2,671) 940 1,496 (8,005) (6,509)
Savings accounts and MMDAs.. 34,384 40,926 75,310 4,319 (19,441) (15,122)
Time deposits............... (153,062) 2,614 (150,448) (40,845) (49,125) (89,970)
--------- --------- --------- -------- --------- ---------
Total deposit
expense............. (115,067) 40,869 (74,198) (35,030) (76,571) (111,601)
Borrowings:
Annuities................... 84 (85) (1) 627 (4,685) (4,058)
Reverse repurchase
agreements............... (106,118) 30,682 (75,436) (26,300) (87,915) (114,215)
Advances from FHLBs......... 408,551 13,092 421,643 157,640 (6,269) 151,371
Federal funds purchased and
commercial paper......... 42,345 6,537 48,882 10,405 (17,600) (7,195)
Trust preferred securities
and other................ 37,616 (18,158) 19,458 23,108 16,715 39,823
--------- --------- --------- -------- --------- ---------
Total borrowing
expense............. 382,478 32,068 414,546 165,480 (99,754) 65,726
--------- --------- --------- -------- --------- ---------
Total interest
expense............. 267,411 72,937 340,348 130,450 (176,325) (45,875)
--------- --------- --------- -------- --------- ---------
Net interest income........... $ 188,444 $(104,918) $ 83,526 $112,597 $ 161,997 $ 274,594
========= ========= ========= ======== ========= =========
- ---------------
(1) Average balances were obtained from the best available daily, weekly or
monthly data, which in all cases approximated the average balances
calculated on a daily basis.
(2) Nonaccrual loans were included in the average loan amounts outstanding.
Amortized net deferred loan fees were included in the interest income
calculations. The amortization of net deferred loan fees was $67.4 million
in 1997, $63.7 million in 1996 and $83.1 million in 1995.
31
34
Other Income. Income of $713.4 million in 1997 included a $100.0 million
loss as a result of the write down of loans securitized and held in the trading
portfolio. Other income totaled $658.2 million in 1996 and $603.6 million in
1995.
Other income consisted of the following:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Depositor and other retail banking fees:
Checking account and MMDA charges................ $280,476 $201,366 $160,155
ATM transaction fees............................. 38,061 36,398 30,569
Other............................................ 47,346 44,704 43,155
-------- -------- --------
Total depositor and other retail banking
fees........................................ 365,883 282,468 233,879
Loan servicing fees................................ 89,824 86,987 84,474
Securities fees and commissions.................... 132,071 131,066 135,655
Insurance fees and commissions..................... 47,759 44,417 33,284
Other operating income............................. 136,275 88,836 71,932
Gain (loss) on sale of loans and leases:
Gain (loss) on sale of mortgage loans(1)......... (62,642) 20,828 10,529
Gain on sale of student loans.................... 1,494 24,069 495
Gain on sale of leases........................... 805 811 14,909
-------- -------- --------
Total gain (loss) on sale of loans and
leases...................................... (60,343) 45,708 25,933
Gain (loss) on sale of other assets:
Gain on sale of trading securities............... 207 31 529
Gain on sale of available-for-sale securities.... 7,511 8,009 21,056
Gain on sale of WM Life.......................... 20,845 -- --
Gain (loss) on sale of premises and equipment.... 10,860 (460) (2,958)
Gain on sale of Mutual Travel.................... -- 4,100 --
Gain on sale of MBS.............................. -- 4,030 --
Other............................................ -- 1,311 1,203
-------- -------- --------
Net gain on sale of assets.................... 39,423 17,021 19,830
Write down on loans securitized and retained....... (27,621) (38,339) (19,651)
Write off of consulting fees....................... (9,871) -- --
FDIC assistance on covered assets.................. -- -- 55,630
Loss on sale of covered assets..................... -- -- (37,399)
-------- -------- --------
Total other income............................ $713,400 $658,164 $603,567
======== ======== ========
- ---------------
(1) Included $100.0 million write down of loans securitized and held in the
trading portfolio.
Depositor and other retail banking fees of $365.9 million in 1997 increased
from $282.5 million in 1996 and $233.9 million in 1995. The increases reflected
an expanded collection of overdraft protection and NSF charges on checking
accounts and MMDAs combined with a focused marketing campaign that increased the
number of checking accounts. During 1997, the number of checking accounts
increased 186,000 or 8% to approximately 2,520,000. The growth in the Northwest
comprised the greatest portion, increasing 149,000 or 24% to 766,000. The
introduction of "Free Checking" at the former ASB offices during 1997 increased
its checking base by 83,000 or 35% to 321,000. GWB, prior to its merger with the
Company, had focused on increasing deposit fee income by raising its fees on
products. Although this was a successful strategy, in that fee income did
increase, it also resulted in the loss of 134,000 accounts through the first
nine months of 1997. The degree of account losses slowed during the third
quarter, and reversed during the fourth quarter, growing by 79,000 as a result
of the introduction of "Free Checking." "Free Checking" generates income
primarily through NSF charges and charges for overdraft protection. As this
product becomes a larger portion of the
32
35
California accounts, it is anticipated that the level of service charges on
checking accounts will decline; however, management believes that the lost
service charge income will be more than offset by the revenue generated by "Free
Checking."
The growth in depositor and other retail banking fees has been offset
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.
Other operating income totaled $136.3 million in 1997, compared with $88.8
million in 1996 and $71.9 million in 1995. Other operating income includes
nonrecurring income as well as various types of miscellaneous income that tends
to grow with the size of the Company.
Impairment charge-offs on MBS are reported in the line item -- write down
on loans securitized and retained -- as a charge to earnings in other income.
Write downs on loans securitized and retained were $27.6 million for 1997,
compared with $38.3 million in 1996 and $19.7 million in 1995. The increase from
1995 to 1996 primarily reflected the Company's decision to securitize more of
its loans with recourse. The improvement of the California economy resulted in
lower losses during 1997.
During 1997, the Company had a net loss on the sale of loans and leases of
$60.3 million. Included in the net loss was the $100.0 million write down on
loans securitized and held in the trading portfolio. Excluding this transaction
the Company had a net gain of $39.7 million in 1997, compared with $45.7 million
in 1996 and $25.9 million in 1995. During 1997, the Company sold $4.5 billion of
SFR loans, primarily from its fixed-rate loan production. During 1996, GWB sold
a substantial portion of its student loan portfolio for $356.6 million,
realizing a gain of $22.5 million. Most of the remaining gains recognized during
1996 were the result of selling $2.0 billion of fixed-rate loans.
Net gain on the sale of other assets was $39.4 million during 1997,
compared with $17.0 million during 1996 and $19.8 million during 1995. On
December 31, 1997, the Company recorded a $20.8 million gain on the sale of its
insurance subsidiary, WM Life, to SAFECO. The sale was in connection with the
negotiation of a distribution agreement with a subsidiary of SAFECO, which will
provide annuities for distribution through Washington Mutual's consumer banking
network. The agreement with SAFECO should add to Washington Mutual's future fee
income, while enabling the Company to redeploy the capital previously invested
in WM Life. During 1997, WM Life contributed $17.1 million to pretax earnings to
the Company, compared with $16.3 million in 1996 and $14.3 million during 1995.
The gain on sale of premises and equipment in 1997 was primarily the result of
the disposition of surplus assets as a result of the GWB restructuring plan
implemented in 1996 and the Great Western Merger.
During 1995, a loss of $37.4 million was recognized on the sale of certain
assets by ASB. These assets, SFR 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 1997 totaled $2.26 billion, compared with
$2.43 billion in 1996 and $1.80 billion in 1995. In connection with the closing
of the Great Western Merger, the Company recorded transaction-related expenses
of $431.1 million in 1997. Included in other expense in 1996 were restructuring
charges of $68.3 million at GWFC, transaction-related expenses of $158.1 million
resulting from the Keystone Transaction and the one-time SAIF recapitalization
assessment of $312.6 million.
33
36
Other expense consisted of the following:
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits................. $ 821,446 $ 819,965 $ 793,971
Occupancy and equipment:
Premises and equipment....................... 219,932 218,418 226,734
Data processing.............................. 102,509 102,724 82,634
---------- ---------- ----------
Total occupancy and equipment............. 322,441 321,142 309,368
Telecommunications and outsourced information
services..................................... 168,322 151,312 138,564
Regulatory assessments......................... 34,873 108,271 121,274
SAIF special assessment........................ -- 312,552 --
Restructuring expense.......................... -- 68,293 --
Transaction-related expense.................... 431,125 158,121 2,000
Other operating expense:
Advertising and promotion.................... 84,163 63,505 62,098
Operating losses and settlements............. 51,399 62,805 36,165
Professional fees............................ 48,801 56,346 36,075
Postage...................................... 46,906 35,395 31,535
Office supplies.............................. 23,128 27,459 25,296
Other........................................ 154,838 159,734 160,783
---------- ---------- ----------
Total other operating expense............. 409,235 405,244 351,952
Amortization of intangible assets arising from
acquisitions ................................ 63,588 65,394 68,592
Foreclosed asset expense, net.................. 10,578 18,305 17,165
---------- ---------- ----------
Total other expense....................... $2,261,608 $2,428,599 $1,802,886
========== ========== ==========
Salaries and employee benefits totaled $821.4 million during 1997, compared
with $820.0 million during 1996 and $794.0 million during 1995. Full-time
equivalent employees ("FTE") were 19,880 at December 31, 1997, compared with
19,906 at year-end 1996 and 18,169 at year-end 1995. As part of the
restructuring plan at GWFC prior to the Great Western Merger, total FTE were
significantly reduced. However, because the terminations occurred at the end of
1996, overall salary expense at GWFC did not decrease until 1997. Offsetting the
decreases at GWFC, salary and commission expense was higher in 1997 and 1996 at
WMB and ASB due to increases in the number of employees resulting from record
loan production and the integration of ASB.
Expense for telecommunications and outsourced information services in 1997
was $168.3 million, compared with $151.3 million in 1996 and $138.6 million in
1995. Several outsourcing initiatives were undertaken in 1996, and during 1997
GWB contracted for additional telecommunication services. In general, the
year-to-year increase reflected the Company's increased complexity and growth,
higher levels of customer support services and continued use of outsourced data
processing services.
Regulatory assessments were $34.9 million in 1997, down from $108.3 million
in 1996 and $121.3 million in 1995, reflecting a reduction in the assessment
rate paid on the Company's deposits as a result of the recapitalization of the
SAIF. During 1996, Washington Mutual was subject to a special assessment on SAIF
deposits held by its banking subsidiaries which resulted in a charge of $312.6
million. See "Business -- Regulation and Supervision -- FDIC Insurance."
Other operating expense increased to $409.2 million in 1997, from $405.2
million in 1996 and $352.0 million in 1995. In general, other operating expense
tends to rise with the increased size of the Company. Contributing to the rise
in advertising costs in 1997 were marketing campaigns designed to bring the
Company's products into California. Increases in 1996 were due in part to higher
professional fees
34
37
associated with process reengineering projects designed to increase income,
improve strategies and operations and reduce costs. Postage costs increased
during 1997 due to the system conversions of ASB which required several special
customer notifications as well as increased mailings related to various
marketing campaigns.
During 1996, GWFC implemented a restructuring plan to improve its
competitive position, accelerate expense reduction and enhance future revenue
growth by streamlining operations, making efficient use of premises and
modernizing its systems platform. The Company recorded $68.3 million of
restructuring charges in 1996. The components of the restructuring charge were
severance and related payments, and facilities and equipment impairment. At
December 31, 1996, $47.1 million of these charges remained accrued. The
incomplete GWFC restructuring activities have been integrated into the
consolidation activities associated with the Great Western Merger and are now
accounted for in connection with the transaction-related expenses discussed
below.
As a result of the Great Western Merger and the Keystone Transaction, the
Company recorded transaction-related expenses of $431.1 million and $226.4
million (inclusive of the $68.3 million of restructuring charges discussed
above) during 1997 and 1996. The majority of the charges were for severance and
related payments, facilities and equipment impairment, and various investment
banking, legal and contract exit fees, all of which were incremental expenses.
The accrual of $196.1 million at year-end 1997 and the $126.6 million (inclusive
of the $47.1 million of restructuring charges discussed above) at year-end 1996
related primarily to costs for specifically identified severance programs, the
impairment of premises and equipment and the liability for contract exit fees
for duplicate services.
The Company expected staff reductions related to the Keystone Transaction
and Great Western Merger (inclusive of the GWFC restructuring plan) of
approximately 2,850. As of December 31, 1997 and 1996 approximately 1,660 and
630 employee separations had occurred under these plans. The remaining employee
separations of approximately 1,190 are planned to be completed by the end of
June 1998. Additional staff reductions are anticipated as a result of normal
attrition.
Offices used by the Company on the Chatsworth campus are being consolidated
in order to make more efficient use of the building space. As a result of this
consolidation, the Company anticipates that approximately 565,000 square feet,
located predominantly in six buildings, will become available to sublet to third
party tenants. It is expected that the space will be available for subleasing by
June 1998. In addition, the Company has identified 90 consumer financial centers
which will be closed and will have their operations consolidated with
neighboring financial centers by the end of the third quarter of 1998.
In order to meet the Company's goal to consolidate its current systems
platform, certain computer hardware and software equipment has been or will be
abandoned and written off. The consolidation of systems will allow the Company
to increase operational efficiency, improve processing capacity and establish a
common user workstation environment.
35
38
Reconciliations of the restructuring and transaction-related expenses and
accrual activity during 1996 and 1997 were as follows:
DECEMBER 31,
1996 1996 ACTIVITY 1996
1996 1996 TOTAL CHARGED AGAINST ACCRUED
PERIOD COSTS ACCRUAL EXPENSES ACCRUAL BALANCE
------------ -------- -------- --------------- ------------
(DOLLARS IN THOUSANDS)
Severance.................... $ -- $ 59,714 $ 59,714 $ (2,776) $ 56,938
Premises..................... -- 29,456 29,456 -- 29,456
Equipment.................... -- 29,101 29,101 (18,388) 10,713
Legal, underwriting and other
direct transaction costs... 23,179 3,232 26,411 -- 3,232
Contract cancellation
costs...................... -- 12,300 12,300 -- 12,300
Other........................ 55,456 13,976 69,432 -- 13,976
-------- -------- -------- --------- --------
$ 78,635 $147,779 $226,414 $ (21,164) $126,615
======== ======== ======== ========= ========
DECEMBER 31,
1997 1997 ACTIVITY 1997
1997 1997 TOTAL CHARGED AGAINST ACCRUED
PERIOD COSTS ACCRUAL EXPENSES ACCRUAL BALANCE
------------ -------- -------- --------------- ------------
(DOLLARS IN THOUSANDS)
Severance.................... $ 28,807 $ 94,126 $122,933 $ (57,960) $ 93,104
Premises..................... -- 97,165 97,165 (69,317) 57,304
Equipment.................... -- 49,121 49,121 (59,834) --
Legal, underwriting and other
direct transaction costs... 109,811 3,503 113,314 (5,993) 742
Contract cancellation
costs...................... -- 33,207 33,207 (11,808) 33,699
Other........................ 8,640 6,745 15,385 (9,478) 11,243
-------- -------- -------- --------- --------
$147,258 $283,867 $431,125 $(214,390) $196,092
======== ======== ======== ========= ========
Net foreclosed asset expense was $10.6 million in 1997, compared with $18.3
million in 1996 and $17.2 million in 1995. During 1997, the Company recorded a
net recovery of $2.8 million to the provision for losses on foreclosed assets
reflecting improved market values of foreclosed assets. During 1996, the Company
recorded a net recovery of $5.9 million to the provision as a result of the
reduction in nonperforming real estate assets and improving prospects for the
remainder of the California portfolio. The provision for losses totaled $12.0
million during 1995 and reflected deteriorated real estate values in California.
See "-- Asset Quality -- Provision for Loan Losses and Reserve for Loan Losses."
In general, foreclosed asset operations resulted in net operating expenses in
California, as opposed to net operating income in Washington.
Year 2000. Washington Mutual has initiated a program to prepare the
Company's computer systems and applications for the year 2000. This issue
affects computer systems that have time-sensitive programs that may not properly
recognize the year 2000. This could result in major system failures or
miscalculations for companies that have not successfully adapted their systems
or applications. The Company is assessing all internal programs and systems as
well as contacting software vendors and others with which it conducts business
to ensure that potential problems are identified and resolved. The Company
expects to incur internal staff costs as well as consulting and other expenses
related to infrastructure enhancements necessary to prepare the systems for the
year 2000 and to perform appropriate testing. The Company does not believe that
the process of making its systems and applications ready for year 2000 will
result in a material cost to the Company.
Taxation. Income taxes include federal and applicable state income taxes
and payments in lieu of taxes. The provision for income taxes was $419.3 million
for 1997, which represented an effective tax rate of 47%, due in part to the
nondeductibility of certain transaction-related expenses and a settlement with
the Internal Revenue Service (the "Service") for 1986 and 1987 for GWFC.
36
39
The provision for income taxes of $166.4 million for 1996 represented an
effective tax rate of 41%. 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 18: Income
Taxes and Note 19: 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 recapture for ASB) will be greatly
reduced.
In connection with the 1988 Acquisition, the 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 were 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 reported in the line
item -- provision for payments in lieu of taxes. Due to the above arrangements,
the Company's effective tax rate (including payments in lieu of taxes) for 1995
was below 34%, compared with a statutory corporate tax rate of 35%.
Consumer Finance Operations. During 1997, the consumer finance line of
business had net income of $45.5 million, down from $61.0 million in 1996 and
$64.3 million in 1995. Credit quality for the markets served by Aristar
deteriorated in 1997 and 1996. The increase in consumer finance delinquencies,
charge-offs and loan loss provision reflected, in part, the growth of the
portfolio but also a decline in the credit quality of the portfolio. The loan
loss provision increased to $66.6 million in 1997 from $58.8 million in 1996 and
$48.5 million in 1995.
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Consumer finance operations:
Net interest income.............................. $251,086 $260,988 $258,044
Provision for loan losses........................ 66,600 58,800 48,500
Other income..................................... 42,183 49,539 58,329
Other expense.................................... 151,422 150,744 161,281
-------- -------- --------
Net income before income taxes................... 75,247 100,983 106,592
Income taxes..................................... 29,744 40,000 42,300
-------- -------- --------
Net income.................................... $ 45,503 $ 60,983 $ 64,292
======== ======== ========
REVIEW OF FINANCIAL POSITION
Assets. At December 31, 1997, the Company's assets were $96.98 billion, an
increase of 11% from $87.43 billion at December 31, 1996. During 1997, total
assets grew $9.55 billion. Most of the growth during 1997 and 1996 resulted from
retaining originated loans either as part of the loan portfolio or as MBS.
37
40
Interest-earning assets. The Company's interest-earning assets consisted of
the following:
DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Cash equivalents............................ $ 275,668 $ 632,976 $ 551,700
Securities:
Trading securities........................ 23,364 1,647 238
Available-for-sale securities:
MBS.................................... 10,188,107 13,968,875 18,789,067
Investment securities.................. 1,185,815 2,126,468 1,960,433
Held-to-maturity securities:
MBS.................................... 12,659,217 4,286,361 4,795,960
Investment securities.................. 120,397 192,695 288,496
----------- ----------- -----------
24,176,900 20,576,046 25,834,194
Loans:
Loans held in portfolio................... 67,124,935 61,497,847 54,108,904
Loans held for sale....................... 685,716 333,262 569,409
Reserve for loan losses................... (670,494) (677,141) (598,124)
----------- ----------- -----------
67,140,157 61,153,968 54,080,189
Investment in FHLBs......................... 1,059,491 843,002 755,491
----------- ----------- -----------
$92,652,216 $83,205,992 $81,221,574
=========== =========== ===========
Interest-earning assets were $92.65 billion at December 31, 1997, an 11%
increase from $83.21 billion at year-end 1996. During 1997, the Company retained
most of its ARMs as either loans or through securitization as MBS while selling
the majority of its fixed-rate SFR loan production. As a result of the
Transactions, the Company's interest rate sensitivity targets were attained on a
consolidated basis.
Securities. The Company's trading, available-for-sale and held-to-maturity
securities consisted of the following (at carrying value):
DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Agency MBS...................................... $20,781,456 $16,906,066 $21,700,810
Private-issue MBS............................... 2,088,248 1,347,356 1,886,649
U.S. government and agency...................... 530,566 884,972 962,178
Corporate debt.................................. 478,823 1,118,888 1,053,240
Municipal....................................... 100,150 108,073 92,508
Equity securities............................... 196,673 208,877 141,241
----------- ----------- -----------
24,175,916 20,574,232 25,836,626
Derivative instruments.......................... 984 1,814 (2,432)
----------- ----------- -----------
$24,176,900 $20,576,046 $25,834,194
=========== =========== ===========
The Company's securities portfolio increased by $3.60 billion at December
31, 1997, compared with the prior year. The increase was due to the
securitization of Company-originated loans into MBS for liquidity purposes, the
purchase of agency securities in the secondary market and the creation of a
$1.22 billion Real Estate Mortgage Investment Conduit ("REMIC") from loans
originated by GWB. The increase in 1997 was in contrast to a decline in the
securities portfolio in 1996. The decline during 1996 was due to paydowns on the
current portfolio as well as the decision to sell fixed-rate MBS and replace
them with ARM loans.
In determining which security to invest in, the Company considers, among
other factors, relative rates, liquidity and credit quality. At December 31,
1997, there were no securities issued by a single issuer (excluding the U.S.
government and its agencies and corporations) that exceeded 10% of stockholders'
equity.
38
41
Securities classified as held to maturity increased by $8.30 billion in
1997 while securities classified as available for sale decreased by $4.72
billion. The increase in the held-to-maturity category, and the corresponding
decline in the available-for-sale category, was due in part to the transfer of
$4.36 billion in MBS from available-for-sale to held-to-maturity. Since these
securities were created from GWB-originated loans and the intent is to hold
these securities to maturity, they were reclassified from available for sale to
held to maturity subsequent to the Great Western Merger. In addition to the
transfer, an additional $4.50 billion in Company-originated loans were
securitized and classified as held to maturity during 1997.
Trading securities increased by $21.7 million due to the creation of the
REMIC during 1997. The REMIC is made up of five tranches. The fifth tranche was
classified as trading because this was a securitization of loans which
management intended to sell. The remaining four tranches were classified as
available for sale, as management intended to hold these securities in a manner
consistent with other internal securitizations.
At December 31, 1997, 92% of MBS in the Company's securities portfolio were
adjustable rate. Of the 92% indexed to an adjustable rate, 72% were indexed to
COFI, 19% to U.S. Treasury indexes, and 1% to LIBOR. The remaining 8% of MBS
were fixed rate.
Loans. Total loans (exclusive of the reserve for loan losses) at December
31, 1997 were $67.81 billion, up from $61.83 billion at December 31, 1996.
Changes in the loan balances are primarily driven by originations of new loans,
prepayments of existing loans, scheduled repayments of principal, and loan
securitizations and sales. The increase in SFR loans was due to strong
originations, the majority of which were ARMs which the Company retained in its
portfolio.
Loans (exclusive of the reserve for loan losses) consisted of the
following:
DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Loans:
Real estate loans:
SFR................ $53,431,451 $48,689,404 $41,907,598 $42,737,451 $41,171,112
SFR construction... 877,449 728,121 629,280 559,365 435,307
Commercial real
estate........... 6,613,541 6,488,254 6,467,013 6,086,906 6,095,881
----------- ----------- ----------- ----------- -----------
60,922,441 55,905,779 49,003,891 49,383,722 47,702,300
Manufactured housing,
second mortgage and
other consumer..... 3,806,337 3,399,278 3,358,832 2,894,327 2,678,169
Consumer finance...... 2,309,407 2,185,903 2,136,022 1,998,830 1,830,995
Commercial business... 772,466 340,149 179,568 257,048 261,468
----------- ----------- ----------- ----------- -----------
$67,810,651 $61,831,109 $54,678,313 $54,533,927 $52,472,932
=========== =========== =========== =========== ===========
Loans as a percentage of
total loans (exclusive
of the reserve for
loan losses):
SFR................... 79% 79% 77% 78% 78%
SFR construction...... 1 1 1 1 1
Commercial real
estate............. 10 10 12 11 12
Manufactured housing,
second mortgage and
other consumer..... 6 5 6 5 5
Consumer finance...... 3 4 4 4 3
Commercial business... 1 1 -- 1 1
----------- ----------- ----------- ----------- -----------
100% 100% 100% 100% 100%
=========== =========== =========== =========== ===========
39
42
Real estate loans by product type were as follows:
DECEMBER 31, 1997
--------------------------------
PERCENT OF TOTAL
AMOUNT REAL ESTATE LOANS
----------- -----------------
(DOLLARS IN THOUSANDS)
Short-term ARMs:
COFI......................................... $32,108,461 53%
MTA.......................................... 1,602,123 3
CMT.......................................... 3,800,156 6
Other........................................ 4,553,499 7
----------- ---
42,064,239 69
Medium-term ARMs:
CMT.......................................... 4,135,947 7
COFI......................................... 1,244,357 2
Other........................................ 2,880,587 5
----------- ---
8,260,891 14
Fixed-rate mortgages........................... 10,597,311 17
----------- ---
$60,922,441 100%
=========== ===
Number of real estate loans.................... 513,417
Short-term ARMs reprice within a year. Medium-term ARMs have an initial
fixed rate for more than one year and then convert to short-term ARMs.
Loan originations were as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Real estate loans:
SFR:
Adjustable rate............................ $15,167,522 $11,087,922 $10,374,740
Fixed rate................................. 6,798,487 4,930,874 3,583,603
----------- ----------- -----------
21,966,009 16,018,796 13,958,343
SFR construction:
Custom..................................... 883,211 779,698 583,658
Builder.................................... 565,305 513,972 377,169
Apartment buildings........................... 691,566 548,978 391,942
Other commercial real estate.................. 494,965 295,377 242,987
----------- ----------- -----------
24,601,056 18,156,821 15,554,099
Manufactured housing............................ 324,583 334,721 274,115
Second mortgage and other consumer.............. 1,828,268 1,269,849 1,005,871
Consumer finance................................ 2,179,136 1,995,696 2,124,368
Commercial business............................. 669,613 380,609 167,830
----------- ----------- -----------
$29,602,656 $22,137,696 $19,126,283
=========== =========== ===========
SFR refinances to total SFR originations........ 46% 41% 40%
40
43
SFR originations by product type were as follows:
YEAR ENDED DECEMBER 31, 1997
----------------------------------------
AMOUNT % OF CATEGORY % OF TOTAL
----------- ------------- ----------
(DOLLARS IN THOUSANDS)
Short-term ARMs:
COFI.............................................. $ 6,688,444 63% 30%
MTA............................................... 1,699,542 16 8
CMT............................................... 1,362,150 13 6
Other............................................. 812,800 8 4
----------- --- ---
10,562,936 100% 48
===
Medium-term ARMs:
CMT............................................... 3,729,243 81% 17
COFI.............................................. 21,238 -- --
Other............................................. 854,105 19 4
----------- --- ---
4,604,586 100% 21
===
Fixed-rate mortgages................................ 6,798,487 31
----------- ---
$21,966,009 100%
=========== ===
The strong housing market, attractive interest rates, and an increased
number of distribution outlets led to record lending volumes during 1997.
Refinancings have increased since the second half of 1995 as market interest
rates have declined.
Interest-bearing liabilities. The Company uses customer deposits and
wholesale borrowings to fund its operations. Due to increased market competition
for customer deposits, the Company has increasingly relied on wholesale
borrowings to fund its asset growth.
Deposits. Total deposits of $50.99 billion at December 31, 1997, were down
from 1996 and 1995.
Deposits consisted of the following:
DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Checking accounts:
Interest bearing.......................... $ 4,380,133 $ 4,980,766 $ 5,194,668
Noninterest bearing....................... 3,534,242 2,576,822 2,243,622
----------- ----------- -----------
7,914,375 7,557,588 7,438,290
Savings accounts............................ 3,267,732 3,265,995 3,668,641
MMDAs....................................... 11,672,313 10,320,276 9,494,137
Time deposit accounts....................... 28,131,597 31,523,055 33,096,820
----------- ----------- -----------
$50,986,017 $52,666,914 $53,697,888
=========== =========== ===========
The total decrease in deposits reflected the competitive environment of
banking institutions and the wide array of investment opportunities available to
consumers. Partially offsetting the $3.39 billion decline during 1997 in time
deposit accounts were increases in the level of MMDAs and checking accounts.
These latter two products have the benefit of lower interest costs compared to
time deposit accounts. While MMDAs and checking accounts are liquid, they are
considered by the Company to be the core relationship with its customers. In the
aggregate, the Company views these core accounts to be a stable source of
long-term funding.
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
41
44
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.
Changes in deposits were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Deposits, beginning of year................. $52,666,914 $53,697,888 $52,044,953
Decrease due to deposit outflow............. (4,146,855) (3,377,939) (1,116,046)
Increase due to acquired deposits........... 299,854 106,663 417,078
Increase due to interest credited........... 2,166,104 2,240,302 2,351,903
----------- ----------- -----------
(Decrease) increase in total deposits....... (1,680,897) (1,030,974) 1,652,935
----------- ----------- -----------
Deposits, end of year....................... $50,986,017 $52,666,914 $53,697,888
=========== =========== ===========
Weighted average rate for the year.......... 4.18% 4.22% 4.40%
Borrowings. Washington Mutual's borrowings primarily take the form of
federal funds purchased, commercial paper, reverse repurchase agreements and
advances from the FHLBs of Seattle and San Francisco. The exact mix at any given
time is dependent upon the market pricing of the individual borrowing sources.
Annuities and borrowings consisted of the following:
DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Annuities(1)................................ $ -- $ 878,057 $ 855,503
Federal funds purchased and commercial
paper..................................... 2,928,282 2,153,506 1,749,833
Reverse repurchase agreements............... 12,279,040 12,033,119 14,853,052
Advances from FHLBs......................... 20,301,963 10,011,425 5,570,819
Trust preferred securities.................. 800,000 100,000 100,000
Other borrowings............................ 2,689,362 3,109,694 2,896,062
----------- ----------- -----------
$38,998,647 $28,285,801 $26,025,269
=========== =========== ===========
- ---------------------------
(1) Annuities were held by WM Life, which was sold by the Company at the end of
1997.
The Company's wholesale borrowing portfolio increased by $10.71 billion at
December 31, 1997, compared with the prior year. The increase was due to the
Company's inability to obtain additional retail deposits as a funding source for
asset growth. Specifically, due to relative pricing advantages, the Company
primarily used advances from FHLBs to fund its balance sheet growth during 1997.
The Company also issued $700.0 million in trust preferred securities during
1997. See "Consolidated Financial Statements -- Note 16: Trust Preferred
Securities."
In December 1996, the Company entered into two revolving credit facilities
with The Chase Manhattan Bank ("Chase"): a $100.0 million 364-day facility and a
$100.0 million four-year facility. In November 1997, these facilities were
amended by increasing the amounts for each from $100.0 million to $200.0
million. The facilities are available for general corporate purposes, including
providing capital to the Company's subsidiaries. As of December 31, 1997, there
were no outstanding borrowings under these facilities. As of December 31, 1997,
the Company had entered into five other credit agreements with various parties
permitting aggregate borrowings up to $735.1 million. The two largest of these
agreements were a $550.0 million revolving credit facility with Bank of Montreal
and Chase to back Aristar's commercial paper program and a $177.1 million letter
of credit with the FHLB of San Francisco to provide credit enhancement on
certain of the Company's private-issue MBS.
42
45
Debt ratings of the Company, WMBFA and Aristar were as follows:
DECEMBER 31, 1997
--------------------------------------------------------
STANDARD & POOR'S MOODY'S INVESTORS SERVICE
------------------------ ----------------------------
WMI WMBFA ARISTAR WMI WMBFA ARISTAR
---- ----- ------- ------ ------- -------
Short-term debt....................... -- A2 A2 -- P1 P2
Senior term debt...................... BBB+ A- A- A3 A2 A3
Subordinated term debt................ -- BBB+ BBB+ Baa1 A3 Baa1
Trust preferred securities............ BBB- -- -- a3 -- --
Noncumulative preferred stock......... BBB- -- -- baa1 -- --
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 Company's determination of the level of the reserve and, correspondingly,
the provision for loan losses rests upon various judgments and assumptions,
including current and anticipated economic conditions, the underlying quality of
the loan portfolio, prior loan loss experience, the Company's credit
administration and asset management philosophy and procedures, and the
regulatory examination process. The Company has an Officer's Loan Committee
("OLC") that reports to the Board of Directors and continuously reviews loan
quality. The Company also has internal staff regularly review the classification
of commercial loans and report such classification to the OLC. Such reviews also
assist management in establishing the level of the reserve. The Company is also
examined by its primary regulators. These examinations generally occur annually
and target various activities of the Company, including specific segments of the
loan portfolio.
The provision for loan losses during 1997 was $207.1 million compared with
$392.4 million in 1996, 251.4 million in 1995, $327.1 million in 1994 and $620.8
million in 1993, reflecting a generally declining trend in nonperforming assets
since 1993. The provision during 1997 reflected the general improvement in the
California economy.
The provision for loan losses during 1996 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 was
more proactive in dealing with emerging credit problems and tended 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 SFR portfolio; Washington Mutual, on the other hand,
considered the risk characteristics of that portfolio to be more closely aligned
with its commercial real estate loan portfolio, which tended to have a higher
incidence of loan losses than the SFR portfolio. Washington Mutual has conformed
ASB's asset management practices, administration, philosophies and procedures to
those of WMB and WMBfsb. 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 reviewed ASB's large
performing and nonperforming loans on an individual loan basis, reviewed its
other loan portfolios in the aggregate, and implemented 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.
During 1996, the Company also recorded a loan loss provision of $50.0
million for the bulk sale of nonperforming loans at GWB.
43
46
The high level of the provision for loan losses in 1993 was deemed
necessary to counter the deterioration in California's general economic
indicators, including employment, consumer confidence and the value of
residential real estate. The decline in the value of residential real estate and
resultant deterioration of many borrowers' equity led to a high rate of
delinquencies, foreclosures and charge offs.
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. During 1997, the California economy improved
significantly, resulting in a dramatic turnaround in the housing market. The
median price for California homes had declined steadily from a high of $211,000
in 1991 to a low point of $168,000 in February 1997. By December 1997 the median
price of homes had increased to $190,000, up $22,000 or 13% from earlier in the
year. Most of this improvement occurred during the second half of the year. The
result has been a decline in residential loan charge offs and a slowing in
foreclosure activity toward the end of 1997. Loan charge offs, net of
recoveries, for 1997 totaled $200.2 million, which was less than net charge offs
of $314.5 million in 1996 and $341.7 million in 1995.
The California economic growth and the recovery of commercial real estate
markets nationwide also resulted in significant improvement in the quality of
the apartment building and commercial real estate portfolio. At the end of 1996,
management was particularly concerned about potential losses in this portfolio
and had increased allocated reserves to it. During 1997, the apartment building
and commercial real estate portfolios have improved steadily reflecting the
growth in jobs and population. Average occupancy levels and rental rates have
increased as has the average sales price per square foot. During the period from
the second quarter of 1996 to the second quarter of 1997 the average sales price
in California increased approximately 19% and the average rental rates increased
approximately 11%. The result has been a reduction in the level of nonperforming
loans in these portfolios and reduced allocated reserves during 1997.
During 1996, the charge off policy for consumer finance was changed from
charging off loans when they are 120 days delinquent to charging them off when
they are 180 days delinquent. This had the effect of reducing the level of
charge offs during 1996 from what it would otherwise have been by approximately
$12.0 million. The increases in charge offs of consumer finance loans in recent
years reflects some deterioration in credit quality of the consumer finance loan
portfolio. The deterioration in credit quality appears to be a reflection of
general economic conditions also being experienced by similar lenders.
44
47
Changes in the reserve for loan losses were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Balance, beginning of year..... $ 677,141 $ 598,124 $ 683,040 $ 747,331 $ 624,509
Provision for loan losses...... 207,139 392,435 251,424 327,068 620,808
Reserves added through business
combinations................. 10,908 1,077 5,372 921 46,000
Reserves transferred to MBS
impairment................... (21,755) -- -- -- --
Reserves transferred to
contingent liability......... (2,747) -- -- -- --
Adoption of SFAS No. 114....... -- -- -- -- 47,974
Loans charged off:
SFR.......................... (100,860) (232,653) (240,489) (278,786) (346,565)
SFR construction............. (52) (16) (125) (190) (297)
Commercial real estate....... (24,073) (36,354) (55,888) (69,816) (178,667)
Manufactured housing, second
mortgage and other
consumer.................. (17,621) (11,127) (8,905) (14,306) (40,058)
Consumer finance............. (79,697) (60,520) (62,206) (54,041) (50,174)
Commercial business.......... (2,569) (435) (813) (2,065) (3,065)
--------- --------- --------- --------- ---------
(224,872) (341,105) (368,426) (419,204) (618,826)
Recoveries of loans previously
charged off:
SFR.......................... 1,353 5,693 3,891 3,942 2,070
SFR construction............. 90 -- 47 -- --
Commercial real estate....... 2,725 3,425 5,286 5,110 5,162
Manufactured housing,
second mortgage and other
consumer.................. 2,916 1,221 951 1,861 3,999
Consumer finance............. 17,375 16,197 16,057 15,568 15,523
Commercial business.......... 221 74 482 443 112
--------- --------- --------- --------- ---------
24,680 26,610 26,714 26,924 26,866
--------- --------- --------- --------- ---------
Net charge offs.............. (200,192) (314,495) (341,712) (392,280) (591,960)
--------- --------- --------- --------- ---------
Balance, end of year......... $ 670,494 $ 677,141 $ 598,124 $ 683,040 $ 747,331
========= ========= ========= ========= =========
Charge offs as a percentage
of average loans.......... 0.31% 0.55% 0.62% 0.74% 1.14%
As part of the process of determining the adequacy of the reserve for loan
losses, management reviews the loan portfolio for weaknesses. A portion of the
reserve is then either specified or allocated to reflect the identified loss
exposure. SFR and consumer loans are not individually analyzed for impairment
because of the significant number of loans and their relatively small individual
balances. Commercial real estate, commercial business and builder construction
loans are evaluated individually for impairment. At December 31, 1997, the
Company had specific or allocated reserves totaling $90.5 million. Specific and
allocated reserves at year-end 1996 were $118.6 million, a significant increase
from $66.6 million at December 31, 1995. During 1996, the Company's review of
ASB's loan portfolio resulted in approximately 43% of the additional $125.0
million provision in 1996 being allocated to loans in the commercial real estate
loan portfolio. This allocation reflected the decline in some portions of the
California real estate market during 1996. During 1997 the economy in California
improved significantly and boosted the value of real estate across the state,
particularly during the second half of the year. This increase in real estate
values resulted in a reduction in allocated reserves for commercial real estate
loans during 1997.
45
48
Unallocated reserves are established for loss exposure that is not yet
identified but may exist in the remainder of the loan portfolio. 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.
An analysis of the reserve for loan losses was as follows:
DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Specific and allocated reserves:
Commercial real estate................ $ 84,969 $117,343 $ 66,397 $ 58,595 $ 60,005
Commercial business................... 3,277 1,285 -- -- 1,718
Builder construction.................. 2,207 -- 158 1,327 1,503
-------- -------- -------- -------- --------
90,453 118,628 66,555 59,922 63,226
Unallocated reserves.................... 580,041 558,513 531,569 623,118 684,105
-------- -------- -------- -------- --------
$670,494 $677,141 $598,124 $683,040 $747,331
======== ======== ======== ======== ========
Total reserve for loan losses as a
percentage of:
Nonaccrual loans...................... 112% 118% 85% 81% 78%
Nonperforming assets.................. 83 84 60 59 52
The Company considers the reserve for loan losses of $670.5 million
adequate to cover losses inherent in the loan portfolio at December 31, 1997.
However, no assurance can be given that the Company will not, in any particular
period, sustain loan losses that are sizable in relation to the amount reserved,
or that subsequent evaluation of the loan portfolio, in light of the factors
then prevailing, including economic conditions and the Company's ongoing
examination process and that of its regulators, will not require significant
increases in the reserve for loan losses.
When determining the adequacy of the reserve for loan losses, management
has historically looked not only to those loans currently in its loan portfolio,
but also to any loan pool where the Company has a recourse obligation resulting
from securitization of its loans. With the Great Western Merger, the Company
began recording losses on loans repurchased from Recourse MBS as a write down on
the security, rather than as a charge against the reserve for loan losses. Write
downs on these Recourse MBS were included as a component of other income in the
line item -- write down of loans securitized and retained. GWB had adopted this
accounting policy in 1996. Prior periods have been restated so that charge offs
on SFR loans are comparable period to period.
Also, as part of the Great Western Merger, the Company reclassified the
identified impairment on Recourse MBS from the reserve for loan losses to a
reduction in the basis of the security. During 1997, impairment of $21.8 million
was recorded through a transfer from the reserve for loan losses. The impairment
was based upon an analysis of the loans underlying Recourse MBS. Because this
reclassification was immaterial to the Company's statement of financial
position, prior periods have not been restated. The impairment on MBS is
evaluated periodically and any subsequent impairment is recorded as a write down
to MBS. At December 31, 1997, the Company had securitized $15.00 billion of
loans with recourse. The corresponding impairment was recorded as a basis
adjustment to the MBS and totaled $35.6 million at the end of 1997.
The Company also maintains a contingent liability to cover potential losses
on Recourse MBS sold to third parties and loans sold with recourse. During 1997,
an additional $2.7 million was set aside to cover losses on these Recourse MBS
and loans sold with recourse. At December 31, 1997 the Company had sold $2.13
billion of Recourse MBS and loans sold with recourse, and the contingent
liability totaled $8.8 million, which the Company considers adequate to cover
inherent losses.
46
49
Delinquent Assets. The Company regularly reviews its portfolio of accruing
and performing loans for delinquencies. The three-year trend in loans with two
or three delinquent payments was as follows:
DECEMBER 31,
---------------------------------------------------------------------------
1997 1996 1995
----------------------- ----------------------- -----------------------
% OF % OF % OF
AMOUNT PORTFOLIO(1) AMOUNT PORTFOLIO(1) AMOUNT PORTFOLIO(1)
-------- ------------ -------- ------------ -------- ------------
Delinquent loans:
SFR...................... $499,638 0.73% $526,242 0.86% $386,854 0.71%
SFR construction......... 9,143 1.04 6,674 0.92% 1,563 0.27
Commercial real estate... 30,685 0.34 33,341 0.51% 29,268 0.46
Manufactured housing..... 24,647 2.28 10,347 1.14% 3,252 0.42
Second mortgage and other
consumer.............. 55,121 2.02 40,742 1.53% 38,190 1.35
Consumer finance......... 68,814 2.98 62,000 2.84% 60,000 2.81
Commercial business...... 1,013 0.13 20 -- -- --
-------- ---- -------- ---- -------- ----
$689,061 0.81% $679,366 0.90% $519,127 0.78%
======== ==== ======== ==== ======== ====
- ---------------
(1) Loans that have been securitized or sold for which the Company retains the
credit risk were also included.
Nonperforming Assets. Assets considered to be nonperforming include
nonaccrual loans and securities, foreclosed assets and real estate held for
investment purposes ("REI") that does not generate sufficient income to meet
return on investment criteria. When loans securitized or sold on a recourse
basis are nonperforming, they are included in nonaccrual loans. Management's
classification of a loan as nonaccrual does not necessarily indicate that the
principal of the loan is uncollectible in whole or in part. Loans are generally
placed on nonaccrual status when they are four payments or more past due. See
"Consolidated Financial Statements -- Note 1: Summary of Significant Accounting
Policies."
Nonperforming assets were $806.6 million or 0.83% of total assets at
December 31, 1997, compared with $805.1 million or 0.92% of total assets at
December 31, 1996. Since 1993, nonperforming assets as a percentage of total
assets have steadily declined.
47
50
Nonperforming assets consisted of the following:
DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- ---------- ----------
(DOLLARS IN THOUSANDS)
Nonaccrual loans:
Real estate loans:
SFR............................. $469,127 $461,730 $590,040 $ 662,136 $ 754,618
SFR construction................ 10,413 9,235 9,550 4,640 8,527
Apartment buildings............. 17,296 19,659 36,300 110,944 93,474
Other commercial real estate.... 25,825 14,616 26,663 35,549 63,516
-------- -------- -------- ---------- ----------
522,661 505,240 662,553 813,269 920,135
Manufactured housing............... 11,127 8,721 1,923 1,643 2,207
Second mortgage and other
consumer........................ 14,071 14,346 9,266 8,077 16,487
Consumer finance................... 50,930 45,622 25,772 21,277 20,667
Commercial business................ 2,585 1,068 824 1,018 3,785
-------- -------- -------- ---------- ----------
601,374 574,997 700,338 845,284 963,281
Foreclosed assets.................... 205,272 222,883 286,705 313,392 470,167
Other nonperforming assets........... -- 7,232 4,564 4,980 --
-------- -------- -------- ---------- ----------
$806,646 $805,112 $991,607 $1,163,656 $1,433,448
======== ======== ======== ========== ==========
Nonperforming assets as a percentage
of total assets.................... 0.83% 0.92% 1.14% 1.46% 1.99%
The increase in consumer finance delinquencies, charge offs and loan loss
provision reflected, in part, the growth of the portfolio but also a decline in
the credit quality of the portfolio.
During 1996, the Company sold $292.4 million of nonperforming loans and
real estate. The loans and properties were primarily associated with
originations that occur between 1989 and 1992. As a result of the improving
economies where WMBFA operates, bulk sales of foreclosed properties were
discontinued in mid-1997 and Washington Mutual began using retail sales channels
to dispose of WMBFA's foreclosed assets.
Loans and nonaccrual loans by geographic concentration at December 31, 1997
were as follows:
OREGON
CALIFORNIA WASHINGTON FLORIDA
------------------------ ------------------------ -----------------------
PORTFOLIO NONACCRUAL PORTFOLIO NONACCRUAL PORTFOLIO NONACCRUAL
----------- ---------- ----------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Real estate loans:
SFR...................... $30,343,943 $327,262 $11,427,196 $51,439 $1,959,902 $22,660
SFR construction......... 16,174 -- 741,498 3,771 536 --
Apartment buildings...... 3,119,766 17,296 797,671 -- 46,691 --
Other commercial real
estate................ 1,233,720 22,158 916,054 2,266 31,578 --
----------- -------- ----------- ------- ---------- -------
34,713,603 366,716 13,882,419 57,476 2,038,707 22,660
Manufactured housing....... 11,749 194 825,451 7,947 -- --
Second mortgage and other
consumer................. 385,758 3,983 1,942,703 7,175 49,533 115
Consumer finance........... 195,137 2,999 -- -- 126,918 2,928
Commercial business........ 73,355 149 534,793 2,182 2,935 24
----------- -------- ----------- ------- ---------- -------
$35,379,602 $374,041 $17,185,366 $74,780 $2,218,093 $25,727
=========== ======== =========== ======= ========== =======
Loans and nonaccrual loans
as a percentage of total
loans and total
nonaccrual loans......... 52% 62% 26% 13% 3% 4%
48
51
CONNECTICUT
MASSACHUSETTS
NEW YORK OTHER(1) TOTAL
----------------------- ------------------------ ------------------------
PORTFOLIO NONACCRUAL PORTFOLIO NONACCRUAL PORTFOLIO NONACCRUAL
---------- ---------- ----------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
Real estate loans:
SFR......................... $2,214,675 $18,137 $ 7,485,735 $ 49,629 $53,431,451 $469,127
SFR construction............ -- -- 119,241 6,642 877,449 10,413
Apartment buildings......... 112 -- 223,652 -- 4,187,892 17,296
Other commercial real
estate................... 107 -- 244,190 1,401 2,425,649 25,825
---------- ------- ----------- -------- ----------- --------
2,214,894 18,137 8,072,818 57,672 60,922,441 522,661
Manufactured housing.......... 243,993 2,986 1,081,193 11,127
Second mortgage and other
consumer.................... 335 -- 346,815 2,798 2,725,144 14,071
Consumer finance.............. -- -- 1,987,352 45,003 2,309,407 50,930
Commercial business........... 760 -- 160,623 230 772,466 2,585
---------- ------- ----------- -------- ----------- --------
$2,215,989 $18,137 $10,811,601 $108,689 $67,810,651 $601,374
========== ======= =========== ======== =========== ========
Loans and nonaccrual loans as
a percentage of total loans
and total nonaccrual
loans....................... 3% 3% 16% 18% 100% 100%
- ---------------
(1) No one other state represented more than 1% of the total.
At December 31, 1997, nonaccrual loans in California accounted for 62% of
total nonaccrual loans, down from 65% in 1996. The California real estate market
requires continual review. In general, real estate values have improved during
1997. However, there may be regional differences in economic performance within
California and among property types which are attributable to differing recovery
rates for the wide range of economic activities within California.
Impaired Loans. Commercial real estate, commercial business and builder
construction loans are individually evaluated for impairment. A loan in one of
these categories is considered impaired when it is (i) probable that a creditor
will be unable to collect all amounts due according to the contractual terms of
the loan agreement, or (ii) a substandard loan, whether or not performing.
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.
At December 31, 1997, loans totaling $551.3 million were impaired, of which
$454.6 million had allocated reserves of $90.5 million. The remaining $96.6
million were either nonperforming or previously written down and had no reserves
allocated to them. Of the $551.3 million of impaired loans, $49.5 million were
on nonaccrual status. 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 made at the date of the merger with Keystone Holdings, $18.9 million was
allocated to $110.3 million of commercial real estate loans that management
deemed to be impaired.
49
52
The amount of impaired loans and the related allocated reserve for loan
losses were as follows:
DECEMBER 31,
-------------------------------------------------
1997 1996
--------------------- ------------------------
LOAN ALLOCATED ALLOCATED
AMOUNT RESERVES LOAN AMOUNT RESERVES
-------- --------- ----------- ---------
(DOLLARS IN THOUSANDS)
Nonaccrual loans:
With allocated reserves................... $ 33,980 $ 7,760 $ 19,071 $ 6,641
Without allocated reserves................ 15,481 -- 39,609 --
-------- ------- -------- -------
49,461 7,760 58,680 6,641
Other impaired loans:
With allocated reserves................... 420,662 82,693 384,272 73,168
Without allocated reserves................ 81,160 -- 177,516 --
-------- ------- -------- -------
501,822 82,693 561,788 73,168
-------- ------- -------- -------
$551,283 $90,453 $620,468 $79,809
======== ======= ======== =======
The average balance of impaired loans and the related interest income
recognized were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Average balance of impaired loans...................... $572,727 $607,514 $436,034
Interest income recognized............................. 38,523 34,248 28,815
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Nature of risk
The long-run profitability of the Company depends not only on the success
of the services it offers to its customers and the credit quality of its loans
and securities, but also the extent to which its earnings are unaffected by
changes in interest rates. The Company 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 without unduly
penalizing current earnings. A key component of this program is the origination
and retention of short-term and adjustable-rate assets whose repricing
characteristics more closely match the repricing characteristics of the
Company's liabilities. At the same time, the Company's policy is to sell most
fixed-rate loan originations. In certain interest rate environments this
strategy makes it difficult for the Company to increase or even maintain its
asset size, which can have an adverse effect on net interest income. As a result
of the program described above, the Company is subject to various types of
interest rate risk. Management characterizes these risks as yield curve,
prepayment, lag, basis and cap risk.
Yield curve risk
During periods of moderate to high market interest rates, originations of
ARMs have been well received by customers. When interest rates are relatively
low, however, unless long-term rates remain appreciably higher than short-term
rates (what is referred to as a steep yield curve environment), borrowers show a
preference for fixed-rate loans rather than ARMs. During the fourth quarter of
1997, interest rates on the 10-year U.S. government note declined approximately
36 basis points while interest rates on three-month U.S. Treasury bill increased
25 basis points. This flattened the slope of the yield curve so that there was
only a 40 basis point difference between the three-month U.S. Treasury bill rate
and the 10-year U.S. government note rate at year-end 1997 versus a 101 basis
point difference three months earlier. The effect of this interest rate
environment in late 1997 and early 1998 has been a decrease in the percentage of
ARM originations and an increase in the percentage of fixed-rate originations.
Because it is the Company's practice to sell conforming fixed-rate loans, lower
levels of ARM originations could have an adverse effect on the Company's asset
size.
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53
Prepayment risk
In a low interest rate environment with a flat yield curve, customers'
preference for fixed-rate loans may result in the prepayment and refinancing of
existing loans, fixed-rate and ARMs, to lower, fixed-rate mortgage loans. This
preference may make it more difficult for the Company to increase the size of
its loan and MBS portfolio during these periods when combined with its policy of
selling most all of its fixed-rate loan production. Premiums related to loans
and MBS on the Company's balance sheet, as well as the servicing rights
attributed to loans serviced for others, would need to be written off at the
time of repayment, and could have an adverse impact on earnings.
Lag risk
In times of rising interest rates, 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. Although the effect of this lag
generally balances out over the life of a given loan, it can produce short-term
volatility in the Company's net interest income during periods of interest rate
movement. One example of this is the delay in the repricing of COFI based
assets, commonly referred to as "COFI lag." This lag results from the two month
delay in reporting COFI because of the time required to gather the data needed
to compute the index. Consequently, the COFI used to reprice ARMs and adjustable
rate MBS actually reflects the cost of funds for a two month prior period. As a
result, COFI loans reprice more slowly than the Company's liabilities.
Basis risk
The repricing of the Company's assets and liabilities is subject to
additional interest rate risk because generally the repricing of its assets and
liabilities is tied to different indices which may react differently to changes
in interest rates. Loans tied to the COFI index create a form of basis risk for
the Company because the portion of the Company's liabilities that are borrowings
rather than deposits is higher than for most of the other savings institutions
whose costs of funds are a component of COFI. Borrowings are generally more rate
sensitive than deposits and reprice more quickly as market interest rates (such
as treasury rates) change. To the extent that other loan indexes move at a
different rate or direction from the Company's cost of funds, additional basis
risk may be realized.
Cap risk
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 market interest rates to
exceed the lifetime interest rate caps of existing ARM loans.
Loan indexes
As discussed previously, the majority of the Company's loans and MBS have
adjustable rates that are tied to a market index. The Company's cost of funds
compared to various indexes were as follows:
WASHINGTON WASHINGTON MUTUAL'S COST OF FUNDS
MUTUAL'S LESS THAN (GREATER THAN)
COST OF ----------------------------------
FOR THE QUARTER ENDED: FUNDS COFI CMT MTA LAMA COFI CMT MTA LAMA
---------------------- ---------- ---- ---- ---- ---- ------- ------ ------ ------
December 31, 1997............... 4.90 4.95 5.53 5.63 5.65 0.05 0.63 0.73 0.75
September 30, 1997.............. 4.88 4.90 5.61 5.66 5.58 0.02 0.73 0.78 0.70
June 30, 1997................... 4.86 4.82 5.75 5.67 5.53 (0.04) 0.89 0.81 0.67
March 31, 1997.................. 4.75 4.81 5.64 5.58 5.47 0.06 0.89 0.83 0.72
51
54
Quantitative Information About Interest Rate Risk
The table below represents in tabular form contractual balances of the
Company's financial instruments at the expected maturity dates as well as the
fair value of those financial instruments at December 31, 1997. The expected
maturity categories take into consideration historical prepayment speeds as well
as actual amortization of principal and does not take into consideration
reinvestment of cash. Principal prepayments are the amounts of principal
reduction over and above normal amortization. The Company has used prepayment
assumptions that are materially higher than normal for this analysis based on
the current yield curve environment. The weighted average interest rates for the
various assets and liabilities presented are actual as of December 31, 1997. The
principal/notional amounts and fair values presented in the table do not include
the reserve for loan losses, impairment on Recourse MBS or market adjustments on
securities. See "Consolidated Financial Statements -- Note 28: Fair Value of
Financial Instruments."
PRINCIPAL/NOTIONAL AMOUNT MATURING IN:
---------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 THEREAFTER TOTAL
----------- ----------- ----------- ---------- ---------- ----------- -----------
(DOLLARS IN THOUSANDS)
INTEREST RATE SENSITIVE ASSETS:
Adjustable-rate loans.......... $10,616,419 $ 8,821,821 $ 6,706,714 $4,939,289 $3,700,939 $18,021,634 $52,806,816
Average interest rate........ 6.83% 7.65% 7.70% 7.68% 7.69% 7.66% 7.50%
Fixed-rate loans............... 3,864,751 2,338,619 1,651,611 1,216,639 931,910 5,000,305 15,003,835
Average interest rate........ 12.37 10.81 9.70 8.84 9.54 7.58 9.77
Adjustable-rate securities..... 3,311,033 2,430,146 2,028,213 1,639,151 1,350,215 11,057,019 21,815,777
Average interest rate........ 6.88 6.63 6.67 6.61 6.56 6.48 6.59
Fixed-rate securities.......... 645,385 547,124 165,706 200,773 220,253 1,658,782 3,438,023
Average interest rate........ 6.90 6.76 6.87 7.14 6.86 6.44 6.67
Cash and cash equivalents...... 1,560,890 -- -- -- -- -- 1,560,890
Average interest rate........ 1.14 -- -- -- -- -- 1.14
----------- ----------- ----------- ---------- ---------- ----------- -----------
$19,998,478 $14,137,710 $10,552,244 $7,995,852 $6,203,317 $35,737,740 $94,625,341
=========== =========== =========== ========== ========== =========== ===========
7.47% 7.96% 7.80% 7.62% 7.69% 7.23% 7.52%
DERIVATIVES MATCHED AGAINST
ASSETS:
Pay fixed swaps................ $ 300,000 $ 500,000 $ -- $ -- $ -- $ -- $ 800,000
Average pay rate............. 6.05% 5.97% -- -- -- -- 6.00%
Average receive rate......... 5.83 5.88 -- -- -- -- 5.86
Interest rate caps............. 650,000 -- -- -- -- -- 650,000
Average strike rate.......... 6.17 -- -- -- -- -- 6.17
Average index rate........... 5.89 -- -- -- -- 5.89
----------- ----------- ----------- ---------- ---------- ----------- -----------
$ 950,000 $ 500,000 $ -- $ -- $ -- $ -- $ 1,450,000
=========== =========== =========== ========== ========== =========== ===========
INTEREST RATE SENSITIVE
LIABILITIES:
Noninterest-bearing checking
accounts..................... $ 1,413,697 $ 353,424 $ 353,424 $ 353,424 $ 353,424 $ 706,849 $ 3,534,242
Average interest rate........ --% --% --% --% --% --% --%
Interest-bearing checking
accounts, savings accounts
and MMDAs.................... 10,728,825 4,399,262 897,488 817,832 765,122 1,711,649 19,320,178
Average interest rate........ 3.45 3.54 1.63 1.62 1.61 1.63 3.07
Time deposit accounts.......... 23,411,811 2,746,532 879,090 546,680 462,110 85,374 28,131,597
Average interest rate........ 5.32 5.62 6.19 5.74 5.83 6.96 5.40
Short-term and adjustable-rate
borrowings................... 6,421,934 10,673,549 4,949,504 468,900 50,000 550,905 23,114,792
Average interest rate........ 5.78 5.80 5.80 5.83 5.81 5.84 5.79
Fixed-rate borrowings.......... 10,799,317 1,742,667 1,024,210 598,984 555,898 1,162,779 15,883,855
Average interest rate........ 5.76 6.17 6.56 7.43 7.05 8.18 6.14
----------- ----------- ----------- ---------- ---------- ----------- -----------
$52,775,584 $19,915,434 $ 8,103,716 $2,785,820 $2,186,554 $ 4,217,556 $89,984,664
=========== =========== =========== ========== ========== =========== ===========
4.95% 5.20% 5.22% 4.18% 3.72% 3.82% 4.92%
DERIVATIVES MATCHED AGAINST
LIABILITIES:
Pay fixed swaps................ $ 506,533 $ 277,600 $ 159,000 $ 234,600 $ -- $ 9,200 $ 1,186,933
Average pay rate............. 6.07% 7.94% 5.55% 5.48% --% 5.58% 6.37%
Average receive rate......... 5.59 5.45 4.90 4.90 -- 4.90 5.00
Pay variable rate swaps........ -- -- 100,000 -- -- -- $ 100,000
Average pay rate............. -- -- 5.70 -- -- -- 5.73
Average receive rate......... -- -- 9.03 -- -- -- 9.03
Interest rate caps............. 565,500 855,750 265,000 154,000 80,000 304,750 2,225,000
Average strike rate.......... 7.89 7.16 8.00 7.60 8.63 8.24 7.68
Average index rate........... 5.82 5.33 5.53 5.32 4.96 5.03 5.42
----------- ----------- ----------- ---------- ---------- ----------- -----------
$ 1,072,033 $ 1,133,350 $ 524,000 $ 388,600 $ 80,000 $ 313,950 $ 3,511,933
=========== =========== =========== ========== ========== =========== ===========
FAIR VALUE
DECEMBER 31,
1997
------------
INTEREST RATE SENSITIVE ASSETS:
Adjustable-rate loans.......... $53,067,161
Average interest rate........ --
Fixed-rate loans............... 15,540,836
Average interest rate........ --
Adjustable-rate securities..... 21,629,263
Average interest rate........ --
Fixed-rate securities.......... 3,526,183
Average interest rate........ --
Cash and cash equivalents...... 1,560,890
Average interest rate........ --
-----------
$95,324,333
===========
--
DERIVATIVES MATCHED AGAINST
ASSETS:
Pay fixed swaps................ $ (218)
Average pay rate............. --
Average receive rate......... --
Interest rate caps............. 1,202
Average strike rate.......... --
Average index rate........... --
-----------
$ 984
===========
INTEREST RATE SENSITIVE
LIABILITIES:
Noninterest-bearing checking
accounts..................... $ 3,534,242
Average interest rate........ --%
Interest-bearing checking
accounts, savings accounts
and MMDAs.................... 19,320,178
Average interest rate........ --
Time deposit accounts.......... 28,062,263
Average interest rate........ --
Short-term and adjustable-rate
borrowings................... 23,117,105
Average interest rate........ --
Fixed-rate borrowings.......... 16,048,062
Average interest rate........ --
-----------
$90,081,850
===========
--
DERIVATIVES MATCHED AGAINST
LIABILITIES:
Pay fixed swaps................ $ 9,958
Average pay rate............. --
Average receive rate......... --
Pay variable rate swaps........ (6,549)
Average pay rate............. --
Average receive rate......... --
Interest rate caps............. (202)
Average strike rate.......... --
Average index rate........... --
-----------
$ 3,207
===========
52
55
A conventional measure of interest rate sensitivity for savings
institutions is the one-year gap, which is calculated 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,
----------------------------
1997 1996
------------ ------------
(DOLLARS IN THOUSANDS)
Interest-sensitive assets............................... $ 74,938,422 $ 66,697,670
Derivative instruments designated against assets........ 1,450,000 1,150,000
Interest-sensitive liabilities.......................... (70,204,799) (66,759,281)
Derivative instruments designated against liabilities... 1,078,400 1,707,433
------------ ------------
Net asset sensitivity......................... $ 7,262,023 $ 2,795,822
============ ============
One-year gap.................................. 6.50% 3.20%
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. This is due in part to the lag risk, described previously. 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. 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.
Asset and Liability Strategy
The Company's asset/liability strategy is to reduce the risk of significant
decreases in net interest income caused by interest rate changes without unduly
penalizing current earnings. The implementation of strategies to reduce interest
rate risk, however, generally has a negative effect on earnings. 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 this strategy, the Company actively
manages asset and liability maturities. An inherent characteristic of the
Company deposit structure is customers' preference for liquidity. This is
apparent from the fact that at December 31, 1997, the Company's MMDAs accounted
for $11.67 billion or 23% of total deposits, and time deposit accounts with
maturities less than one year totaled $23.41 billion or 46% of total deposits.
Because its principal funding source of deposits is very interest rate
sensitive, the Company's primary asset strategy is to originate and hold in
portfolio ARMs. During 1997, the Company securitized and then sold the majority
of the fixed-rate loans it originated, while retaining nearly all of its ARM
production. At December 31, 1997, approximately 80% of the Company's total loan
and MBS portfolio had adjustable rates.
Although ARMs reduce the Company's level of interest rate risk, it is not
entirely eliminated because of the lag and basis risk. Lag risk is generally not
a significant problem because the timing difference between when assets and
liabilities reprice is relatively short. ARMs indexed to COFI, however, also
introduce basis risk for the Company because of the larger percentage of assets
funded by borrowings compared to the average of 11th District institutions which
comprise COFI. To reduce basis risk, during 1997, the Company introduced the MTA
loan. This loan has all the same borrower advantages as the COFI product, such
as a 7.5% annual payment cap and the negative amortization feature. However, the
MTA loan is indexed to the 12 month moving average of the one-year Treasury bill
which more closely reflects the Company's borrowing costs. During 1997, $1.7
billion or 11% of all SFR ARM originations were MTA loans. During the fourth
quarter of 1997, MTA originations were 22% of total SFR ARM originations.
Management hopes to reduce potential net interest income volatility caused by
COFI basis risk by increasing its production of MTA and other non-COFI
adjustable-rate products and short-term fixed-rate products such as consumer
loans.
In addition to originating and holding in portfolio adjustable-rate and
short-term loans, the Company also lengthens its liability duration through mid-
to long-term borrowings. This is primarily done through borrowings from the
FHLBs.
53
56
To further manage interest rate risk, the Company uses derivative
instruments, such as interest rate exchange agreements and interest rate cap
agreements, to mitigate interest rate risk. At December 31, 1997, the Company
had entered into interest rate exchange agreements and interest rate cap
agreements with notional values of $4.96 billion. Derivative instruments, if not
used appropriately, can subject a company to unintended financial exposure.
These instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the statement of financial condition. The contract
or notional amount of these instruments reflects the extent of involvement the
Company has in particular classes of financial instruments.
The Company utilizes counterparties in order to conduct various banking
operations, including cash management and wholesale funding. If a counterparty
were to default, the Company could be exposed to a financial loss. A loss would
result to the extent the value of the collateral or funds held by the
counterparty exceeded the value of the collateral or funds held by the Company.
In order to minimize the risk, all counterparties are evaluated for financial
strength on at least an annual basis. Exposure limits are then established for
each counterparty. The Company's primary focus is to deal with well established,
reputable and financially strong firms. The majority of the counterparties are
U.S. based companies. Total exposure to foreign broker-dealers and banks as of
December 31, 1997, was $50.8 million, of which $5.6 million was with Asian
firms.
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 27: Interest Rate
Risk Management."
One of the main uses of derivative instruments is to lengthen the repricing
period of the Company's deposits and borrowings. For example, the Company has
entered 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 second major use of derivatives is to reduce the risk of the
available-for-sale portfolio. 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 the vast
majority 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 available-for-sale portfolio generally on pace with current
54
57
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 effect that interest rate exchange and interest rate cap agreements
would have had on the repricing period of MBS in the available-for-sale
portfolio in an increasing rate environment (up 200 basis points) for the period
the derivatives are outstanding was as follows:
DECEMBER 31, 1997
---------------------------------------------------------------------------
AFTER THREE MONTHS AFTER ONE
DUE WITHIN BUT WITHIN BUT WITHIN AFTER
THREE MONTHS ONE YEAR TWO YEARS TWO YEARS TOTAL
------------ ------------------ ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Amount of MBS.................. $ 5,142,414 $ 3,332,725 $ 307,095 $ 1,306,818 $10,089,052
Effect of derivative
instruments.................. 1,450,000 (575,000) -- (875,000) --
----------- ----------- ----------- ----------- -----------
Amount of MBS after effect of
derivative instruments....... $ 6,592,414 $ 2,757,725 $ 307,095 $ 431,818 $10,089,052
=========== =========== =========== =========== ===========
The effect that interest rate exchange agreements and interest rate cap
agreements would have had on the repricing period of MBS in the
available-for-sale portfolio in a decreasing interest rate environment (down 200
basis points) for the period the derivatives are outstanding was as follows:
DECEMBER 31, 1997
---------------------------------------------------------------------------
AFTER THREE MONTHS AFTER ONE
DUE WITHIN BUT WITHIN BUT WITHIN AFTER
THREE MONTHS ONE YEAR TWO YEARS TWO YEARS TOTAL
------------ ------------------ ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Amount of MBS.................. $ 5,142,414 $ 3,332,725 $ 307,095 $ 1,306,818 $10,089,052
Effect of derivative
instruments.................. 800,000 -- -- (800,000) --
----------- ----------- ----------- ----------- -----------
Amount of MBS after effect of
derivative instruments....... $ 5,942,414 $ 3,332,725 $ 307,095 $ 506,818 $10,089,052
=========== =========== =========== =========== ===========
The effect that interest rate exchange agreements and interest rate cap
agreements would have had on the repricing period of deposits and borrowings in
a increasing interest rate environment (up 200 basis points) for the period the
derivatives are outstanding was as follows:
DECEMBER 31, 1997
------------------------------------------------------------------------------
AFTER THREE MONTHS AFTER ONE
DUE WITHIN BUT WITHIN BUT WITHIN AFTER
THREE MONTHS ONE YEAR TWO YEARS TWO YEARS TOTAL
------------ ------------------ -------------- ----------- -----------
(DOLLARS IN THOUSANDS)
Amount of deposits and
borrowings................. $49,985,482 $20,219,316 $ 9,461,138 $10,318,728 $89,984,664
Effect of derivative
instruments................ (3,511,933) 1,072,033 1,133,350 1,306,550 --
----------- ----------- ----------- ----------- -----------
Amount of deposits and
borrowings after effect of
derivative instruments..... $46,473,549 $21,291,349 $10,594,488 $11,625,278 $89,984,664
=========== =========== =========== =========== ===========
55
58
The effect that interest rate exchange agreements and interest rate cap
agreements would have had on the repricing period of deposits and borrowings in
a decreasing interest rate environment (down 200 basis points) for the period
the derivatives are outstanding was as follows:
DECEMBER 31, 1997
------------------------------------------------------------------------------
AFTER THREE MONTHS AFTER ONE
DUE WITHIN BUT WITHIN BUT WITHIN AFTER
THREE MONTHS ONE YEAR TWO YEARS TWO YEARS TOTAL
------------ ------------------ -------------- ----------- -----------
(DOLLARS IN THOUSANDS)
Amount of deposits and
borrowings................. $49,985,482 $20,219,316 $9,461,138 $10,318,728 $89,984,664
Effect of derivative
instruments................ (1,286,933) 506,533 277,600 502,800 --
----------- ----------- ---------- ----------- -----------
Amount of deposits and
borrowings after effect of
derivative instruments..... $48,698,549 $20,725,849 $9,738,738 $10,821,528 $89,984,664
=========== =========== ========== =========== ===========
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,
1997, 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, 1997, met the established FDIC guidelines.
Regulations promulgated by the OTS require that the Company's federal
savings banks maintain for each calendar quarter an average daily balance of
liquid assets at least equal to 4.00% of net withdrawable deposits plus
borrowings due within one year calculated on either the last day of the
preceding quarter, or as a daily average for the preceding quarter.
As presented in the Consolidated Statements of Cash Flows, the sources of
liquidity vary between years. The statement of cash flows includes operating,
investing and financing categories. Cash flows from operating activities
included net income for 1997 of $481.8 million, $591.3 million for noncash items
and $887.2 million of other net cash outflows from operating activities. Cash
flows from investing activities consisted mainly of both proceeds from and
purchases of securities, and loan principal repayments and loan originations. In
1997, cash flows from investing activities included sales and principal payments
on securities totaling $5.46 billion. Loans originated and purchased for
investment were in excess of repayments by $12.46 billion, and $3.26 billion was
used for the purchase of securities. Cash flows from financing activities
consisted of the net change in the Company's deposit accounts and short-term
borrowings, the proceeds and repayments from both long-term reverse purchase
agreements and FHLB advances, and also the issuance of long-term debt. In 1997,
the above mentioned financing activities increased cash and cash equivalents by
$9.64 billion on a net basis. Cash and cash equivalents were $1.56 billion at
December 31, 1997. See "Consolidated Financial Statements -- Consolidated
Statements of Cash Flows."
56
59
At December 31, 1997, the Company was in a position to obtain approximately
$21.0 billion in additional borrowings primarily through the use of
collateralized borrowings and deposits of public funds using unpledged MBS and
other wholesale borrowing sources.
CAPITAL ADEQUACY
The Company's capital (stockholders' equity) was $5.31 billion at December
31, 1997, compared with $4.99 billion at year-end 1996. At the end of 1997, the
ratio of capital to total assets was 5.47% compared with 5.71% a year earlier.
The regulatory capital ratios of WMBFA, WMB and WMBfsb and minimum
regulatory requirements to be categorized as well capitalized were as follows:
DECEMBER 31, 1997
------------------------ WELL-CAPITALIZED
WMBFA WMB WMBFSB MINIMUM
----- ----- ------ ----------------
Capital ratios:
Leverage.................................. 5.78% 5.86% 6.66% 5.00%
Tier 1 risk-based......................... 9.54 10.13 10.84 6.00
Total risk-based.......................... 11.11 10.93 11.95 10.00
In addition, both the Industrial Banks were well capitalized at December
31, 1997.
The Company's federal savings bank subsidiaries are also 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. WMBFA and WMBfsb both satisfied this
requirement at December 31, 1997.
The Company's securities subsidiaries are also subject to capital
requirements. At December 31, 1997, 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 to Consolidated Financial Statements on
page 60.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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 21, 1998. 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 60.
(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.
57
60
(B) REPORTS ON FORM 8-K:
A Current Report on Form 8-K dated November 10, 1997 was filed with the
Securities and Exchange Commission (the "Commission") and included under Item
7(c) certain exhibits relating to the 6.50% Senior Notes issued by Aristar.
A Current Report on Form 8-K dated October 22, 1997 was filed with the
Commission and included under Item 7(a) unaudited consolidated financial
statements for the quarter ended September 30, 1997, and under Item 7(c) a press
release announcing Washington Mutual's 1997 third quarter financial results.
A Current Report on Form 8-K dated October 10, 1997, as amended on Form
8-K/A dated October 23, 1997, was filed with the Commission and included under
Item 5 a description of the merger of GWFC with and into a subsidiary of
Washington Mutual, stating that the merger was accounted for as a pooling of
interests. The report on Form 8-K as amended also included under Item 7(a)
audited supplemental consolidated financial statements for the three years ended
December 31, 1996 and unaudited supplemental consolidated financial statements
for the six months ended June 30, 1997 and 1996, each restated as if the
respective companies had been combined for all periods presented.
(C) EXHIBITS:
See Index of Exhibits on page 124.
58
61
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 27, 1998.
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 27, 1998.
/s/ KERRY K. KILLINGER /s/ WILLIAM A. LONGBRAKE
- ----------------------------------------------------- -----------------------------------------------------
Kerry K. Killinger William A. Longbrake
Chairman, President and Chief Executive Officer; Executive Vice President and Chief Financial
Director (Principal Executive Officer) Officer (Principal Financial Officer)
/s/ RICHARD M. LEVY
-----------------------------------------------------
Richard M. Levy
Senior Vice President and Controller
(Principal Accounting Officer)
/s/ DOUGLAS P. BEIGHLE /s/ WILLIAM P. GERBERDING
- ----------------------------------------------------- -----------------------------------------------------
Douglas P. Beighle William P. Gerberding
Director Director
/s/ DAVID BONDERMAN /s/ ENRIQUE HERNANDEZ, JR.
- ----------------------------------------------------- -----------------------------------------------------
David Bonderman Enrique Hernandez, Jr.
Director Director
/s/ J. TAYLOR CRANDALL /s/ DR. SAMUEL B. MCKINNEY
- ----------------------------------------------------- -----------------------------------------------------
J. Taylor Crandall Dr. Samuel B. McKinney
Director Director
/s/ ROGER H. EIGSTI /s/ MICHAEL K. MURPHY
- ----------------------------------------------------- -----------------------------------------------------
Roger H. Eigsti Michael K. Murphy
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
/s/ ANNE V. FARRELL /s/ WILLIS B. WOOD
- ----------------------------------------------------- -----------------------------------------------------
Anne V. Farrell Willis B. Wood
Director Director
/s/ STEPHEN E. FRANK
- -----------------------------------------------------
Stephen E. Frank
Director
59
62
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report................................ 61
Report of Independent Accountants........................... 62
Independent Auditors' Report................................ 63
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995.......................... 64
Consolidated Statements of Financial Position at December
31, 1997 and 1996......................................... 65
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1996
and 1995.................................................. 66
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.......................... 68
Notes to Consolidated Financial Statements.................. 70
60
63
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, 1997 and 1996, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. 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. The
consolidated financial statements give retroactive effect to the mergers of
Washington Mutual, Inc. and Great Western Financial Corporation and Washington
Mutual, Inc. and Keystone Holdings, Inc. both of which were accounted for as
poolings of interests as described in Note 2 to the consolidated financial
statements. We did not audit the consolidated statement of financial condition
of Great Western Financial Corporation as of December 31, 1996, or the related
statements of operations, changes in stockholders' equity, and cash flows for
the years ended December 31, 1996 and 1995, which statements reflect total
assets constituting 49% of consolidated total assets as of December 31, 1996,
and total net income constituting 50% and 47% of consolidated net income for the
years ended December 31, 1996 and 1995, respectively. Those statements were
audited by other auditors whose report, dated, January 22, 1997 (except as to
Note 28 to the consolidated financial statements, which is as of March 7, 1997)
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for Great Western Financial Corporation for 1996 and 1995, is based
solely on the report of such other auditors. We did not audit the consolidated
statement of earnings, stockholder's equity, and cash flows of Keystone
Holdings, Inc. and subsidiaries for the year ended December 31, 1995, which
statements reflect total net income constituting 16% of consolidated net income
for the year ended December 31, 1995. 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, 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 reports of the other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports 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, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
LOGO
February 20, 1998
Seattle, Washington
61
64
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Great Western Financial Corporation
In our opinion, the accompanying consolidated statement of financial
condition and the related consolidated statements of operations, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Great Western Financial Corporation and its
subsidiaries ("the Company") at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the two years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles. These 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. We conducted our audits of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 1 to the financial statements, the Company adopted
accounting standards that changed its methods of accounting for mortgage
servicing rights and long lived assets in 1995.
LOGO
Los Angeles, California
January 22, 1997, except as to Note 28,
which is as of March 7, 1997
62
65
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Keystone Holdings, Inc.:
We have audited the consolidated statements of earnings, stockholder's
equity and cash flows of Keystone Holdings, Inc. and subsidiaries for the year
ended December 31, 1995, which are 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Keystone Holdings, Inc. and subsidiaries for the year ended December
31, 1995 in conformity with generally accepted accounting principles.
LOGO
Los Angeles, California
January 26, 1996, except as to Note 27
to the consolidated financial statements,
which is as of February 8, 1996
63
66
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
INTEREST INCOME
Loans....................................................... $5,205,507 $4,621,153 $4,449,738
Available-for-sale securities............................... 1,005,991 1,310,781 694,957
Held-to-maturity securities................................. 501,834 366,592 882,654
Notes receivable............................................ -- -- 58,841
Cash equivalents and other.................................. 97,632 88,564 72,181
---------- ---------- ----------
Total interest income..................................... 6,810,964 6,387,090 6,158,371
INTEREST EXPENSE
Deposits.................................................... 2,166,104 2,240,302 2,351,903
Borrowings.................................................. 1,988,387 1,573,841 1,508,115
---------- ---------- ----------
Total interest expense.................................... 4,154,491 3,814,143 3,860,018
---------- ---------- ----------
Net interest income....................................... 2,656,473 2,572,947 2,298,353
Provision for loan losses................................... 207,139 392,435 251,424
---------- ---------- ----------
Net interest income after provision for loan losses....... 2,449,334 2,180,512 2,046,929
OTHER INCOME
Depositor and other retail banking fees..................... 365,883 282,468 233,879
Loan servicing fees......................................... 89,824 86,987 84,474
Securities fees and commissions............................. 132,071 131,066 135,655
Insurance fees and commissions.............................. 47,759 44,417 33,284
Other operating income...................................... 136,275 88,836 71,932
Gain (loss) on sale of loans and leases..................... (60,343) 45,708 25,933
Gain on sale of other assets................................ 39,423 17,021 19,830
Write down of loans securitized and retained................ (27,621) (38,339) (19,651)
Write off of consulting fees................................ (9,871) -- --
Federal Deposit Insurance Corporation ("FDIC") assistance on
covered assets............................................ -- -- 55,630
Loss on sale of covered assets.............................. -- -- (37,399)
---------- ---------- ----------
Total other income........................................ 713,400 658,164 603,567
OTHER EXPENSE
Salaries and employee benefits.............................. 821,446 819,965 793,971
Occupancy and equipment..................................... 322,441 321,142 309,368
Telecommunications and outsourced information services...... 168,322 151,312 138,564
Regulatory assessments...................................... 34,873 108,271 121,274
Savings Association Insurance Fund ("SAIF") special
assessment................................................ -- 312,552 --
Restructuring expense....................................... -- 68,293 --
Transaction-related expense................................. 431,125 158,121 2,000
Other operating expense..................................... 409,235 405,244 351,952
Amortization of intangible assets arising from
acquisitions.............................................. 63,588 65,394 68,592
Foreclosed asset expense.................................... 10,578 18,305 17,165
---------- ---------- ----------
Total other expense....................................... 2,261,608 2,428,599 1,802,886
---------- ---------- ----------
Income before income taxes................................ 901,126 410,077 847,610
Income taxes................................................ 402,116 141,220 273,006
Provision for payments in lieu of taxes..................... 17,232 25,187 7,887
---------- ---------- ----------
Income before minority interest in earnings of consolidated
subsidiaries.............................................. 481,778 243,670 566,717
Minority interest in earnings of consolidated
subsidiaries.............................................. -- 13,570 15,793
---------- ---------- ----------
Net income.................................................. $ 481,778 $ 230,100 $ 550,924
========== ========== ==========
Net income attributable to common stock..................... $ 460,346 $ 191,386 $ 507,325
========== ========== ==========
Net income per common share:
Basic..................................................... $1.87 $0.81 $2.19
Diluted................................................... 1.86 0.81 2.16
See Notes to Consolidated Financial Statements.
64
67
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash........................................................ $ 1,285,222 $ 1,032,379
Cash equivalents............................................ 275,668 632,976
Trading securities.......................................... 23,364 1,647
Available-for-sale securities, amortized cost $11,258,232
and $15,913,440:
Mortgage-backed securities ("MBS")........................ 10,188,107 13,968,875
Investment securities..................................... 1,185,815 2,126,468
Held-to-maturity securities, fair value $12,699,653 and
$4,545,125:
MBS....................................................... 12,659,217 4,286,361
Investment securities..................................... 120,397 192,695
Loans:
Loans held in portfolio................................... 67,124,935 61,497,847
Loans held for sale....................................... 685,716 333,262
Reserve for loan losses................................... (670,494) (677,141)
----------- -----------
Total loans............................................. 67,140,157 61,153,968
Investment in Federal Home Loan Banks ("FHLBs")............. 1,059,491 843,002
Foreclosed assets........................................... 205,272 222,883
Premises and equipment...................................... 937,198 1,034,813
Intangible assets arising from acquisitions................. 356,650 419,500
Mortgage servicing rights................................... 215,360 185,984
Other assets................................................ 1,329,181 1,324,946
----------- -----------
Total assets............................................ $96,981,099 $87,426,497
=========== ===========
LIABILITIES
Deposits:
Checking accounts......................................... $ 7,914,375 $ 7,557,588
Savings accounts and money market deposit accounts
("MMDAs")............................................... 14,940,045 13,586,271
Time deposit accounts..................................... 28,131,597 31,523,055
----------- -----------
Total deposits.......................................... 50,986,017 52,666,914
Annuities................................................... -- 878,057
Federal funds purchased and commercial paper................ 2,928,282 2,153,506
Securities sold under agreements to repurchase ("reverse
repurchase agreements")................................... 12,279,040 12,033,119
Advances from FHLBs......................................... 20,301,963 10,011,425
Trust preferred securities.................................. 800,000 100,000
Other borrowings............................................ 2,689,362 3,109,694
Other liabilities........................................... 1,687,364 1,480,694
----------- -----------
Total liabilities....................................... 91,672,028 82,433,409
Commitments and contingencies (Notes 5, 10 and 20).......... -- --
STOCKHOLDERS' EQUITY
Preferred stock, no par value: 10,000,000 shares
authorized -- 4,722,500 and 5,382,500 shares issued and
outstanding, liquidation preference....................... 118,063 283,063
Common stock, no par value: 800,000,000 shares
authorized -- 257,560,018 and 250,230,644 shares issued
and outstanding........................................... -- --
Capital surplus -- common stock............................. 1,943,294 1,664,870
Valuation reserve for available-for-sale securities......... 134,610 118,625
Retained earnings........................................... 3,113,104 2,926,530
----------- -----------
Total stockholders' equity.............................. 5,309,071 4,993,088
----------- -----------
Total liabilities and stockholders' equity.............. $96,981,099 $87,426,497
=========== ===========
See Notes to Consolidated Financial Statements.
65
68
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
PREFERRED STOCK
Balance, beginning of year............................. $ 283,063 $ 552,438 $ 554,376
Repurchase of Series C and Series E shares............. -- -- (1,938)
Redemption or conversion of preferred stock............ (165,000) (269,375) --
---------- ---------- ----------
Balance, end of year................................... 118,063 283,063 552,438
CAPITAL SURPLUS -- COMMON STOCK
Balance, beginning of year............................. 1,664,870 1,521,438 1,425,671
Common stock issued through stock options, restricted
stock grants and employee stock plans, including tax
benefit.............................................. 309,593 46,334 25,055
Immaterial business combinations accounted for as
poolings of interests................................ -- 11,844 23,562
Common stock issued under dividend reinvestment plan... 847 2,547 47,150
Conversion of preferred stock.......................... -- 268,270 --
Common stock acquired.................................. (32,016) (185,563) --
---------- ---------- ----------
Balance, end of year................................... 1,943,294 1,664,870 1,521,438
CAPITAL SURPLUS OFFSET AGAINST NOTE RECEIVABLE
Balance, beginning of year............................. -- -- (167,000)
Capital surplus previously offset against note
receivable........................................... -- -- 167,000
---------- ---------- ----------
Balance, end of year................................... -- -- --
VALUATION RESERVE FOR AVAILABLE-FOR-SALE SECURITIES
Balance, beginning of year............................. 118,625 297,148 (116,333)
Valuation adjustments, net of related income taxes..... 15,985 (178,523) 413,481
---------- ---------- ----------
Balance, end of year................................... 134,610 118,625 297,148
RETAINED EARNINGS
Balance, beginning of year............................. 2,926,530 2,993,156 2,641,908
Net income............................................. 481,778 230,100 550,924
Cash dividends declared on preferred stock............. (21,432) (38,714) (43,599)
Cash dividends declared on common stock................ (273,772) (258,012) (182,670)
Immaterial business combinations accounted for as
poolings of interests................................ -- -- 26,645
Repurchase of Series C and Series E shares............. -- -- (52)
---------- ---------- ----------
Balance, end of year................................... 3,113,104 2,926,530 2,993,156
---------- ---------- ----------
Total stockholders' equity............................. $5,309,071 $4,993,088 $5,364,180
========== ========== ==========
See Notes to Consolidated Financial Statements.
66
69
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(NUMBER OF SHARES IN THOUSANDS)
PREFERRED STOCK
Balance, beginning of year.................................. 5,383 7,301 7,379
Repurchase of Series C and Series E shares.................. -- -- (78)
Redemption or conversion of preferred stock................. (660) (1,918) --
------- ------- -------
Balance, end of year........................................ 4,723 5,383 7,301
======= ======= =======
COMMON STOCK
Balance, beginning of year.................................. 250,231 243,239 236,605
Common stock issued through stock options, restricted stock
grants and employee stock plans, net of cancellations..... 8,217 1,628 1,150
Immaterial business combinations accounted for as poolings
of interests.............................................. -- 347 3,429
Common stock issued under dividend reinvestment plan........ 20 92 2,055
Conversion of preferred stock............................... -- 11,081 --
Common stock acquired....................................... (908) (6,156) --
------- ------- -------
Balance, end of year........................................ 257,560 250,231 243,239
======= ======= =======
See Notes to Consolidated Financial Statements.
67
70
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income....................................... $ 481,778 $ 230,100 $ 550,924
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses................... 207,139 392,435 251,424
Loss (gain) on sale of loans and leases..... 60,343 (45,708) (25,933)
(Gain) on sale of other assets.............. (39,423) (17,021) (19,830)
Depreciation and amortization............... 222,317 221,679 209,936
Stock dividends from FHLBs.................. (64,086) (57,176) (39,971)
Write down of loans securitized and
retained.................................. 27,621 38,339 19,651
Transaction-related charges................. 196,628 145,023 --
Decrease (increase) in trading securities... 1,647 (1,409) 334
Origination of loans held for sale.......... (5,029,499) (3,171,102) (1,957,791)
Sales of loans held for sale................ 4,616,468 3,622,240 2,317,031
Additions to mortgage servicing rights...... (76,352) (96,189) (69,138)
Sales of mortgage servicing rights.......... -- 5,395 --
(Increase) decrease in other assets......... (486,371) 543,285 (512,624)
Increase (decrease) in other liabilities.... 67,636 22,148 (177,059)
------------ ------------ ------------
Net cash provided (used) by operating
activities............................. 185,846 1,832,039 (546,954)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities....... (3,231,900) (4,130,281) (3,897,102)
Principal payments and maturities of
available-for-sale securities.................. 2,439,250 4,825,963 2,814,550
Sales of available-for-sale securities........... 2,350,541 4,540,171 2,130,340
Purchases of held-to-maturity securities......... (31,251) (3,414,473) (697,470)
Principal payments and maturities of
held-to-maturity securities.................... 627,163 4,019,873 1,653,413
Sales of loans................................... 41,088 1,314,090 119,194
Origination of loans, net of principal
payments....................................... (12,464,718) (10,550,109) (10,003,476)
Payments received on New West Federal Savings
and Loan Association ("New West") Note......... -- -- 1,682,040
Proceeds from sale of foreclosed assets.......... 366,986 544,347 553,621
Purchases of premises and equipment, net......... (131,422) (113,086) (164,169)
Cash acquired through acquisitions............... -- 3,506 69,358
Proceeds from sale of WM Life.................... 105,000 -- --
------------ ------------ ------------
Net cash (used) by investing activities... (9,929,263) (2,959,999) (5,739,701)
See Notes to Consolidated Financial Statements.
68
71
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995
------------ ------------ -----------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM FINANCING ACTIVITIES
(Decrease) increase in deposits................... (1,680,897) (1,030,974) 1,652,935
(Decrease) increase in annuities.................. (9,538) 22,554 56,325
Increase in federal funds purchased and commercial
paper........................................... 774,776 403,673 729,372
(Decrease) in short-term reverse repurchase
agreements...................................... (2,634,089) (2,181,151) (1,049,527)
Proceeds from long-term reverse repurchase
agreements...................................... 9,800,553 4,011,148 5,347,579
Repayment of long-term reverse repurchase
agreements...................................... (6,920,543) (4,649,930) (2,381,401)
Proceeds from FHLBs advances...................... 51,718,045 24,676,544 5,472,178
Payments on FHLBs advances........................ (41,427,507) (20,235,938) (4,217,336)
Proceeds from trust preferred..................... 700,000 -- 100,000
(Repayments of) proceeds from other borrowings.... (420,332) 229,025 90,852
Repayments to minority interest................... -- (95,372) --
Common stock repurchased.......................... (32,016) (176,732) --
Common stock issued............................... 230,704 38,944 70,215
Redemption of preferred stock..................... (165,000)
Cash dividends paid............................... (295,204) (296,726) (226,269)
------------ ------------ -----------
Net cash provided by financing operations....... 9,638,952 715,065 5,644,923
------------ ------------ -----------
(Decrease) increase in cash and cash
equivalents.................................. (104,465) (412,895) 452,176
Cash and cash equivalents, beginning of year.... 1,665,355 2,078,250 1,626,074
------------ ------------ -----------
Cash and cash equivalents, end of year.......... $ 1,560,890 $ 1,665,355 $ 2,078,250
============ ============ ===========
NONCASH INVESTING ACTIVITIES
Loans exchanged for MBS........................... $ 6,408,056 $ 920,072 $ 8,585,719
Transfer to available-for-sale securities......... -- -- 10,844,168
Transfer to held-to-maturity securities........... 4,359,814 -- --
Loans transferred to foreclosed assets............ 443,412 650,079 676,001
Loans originated to facilitate the sale of
foreclosed assets............................... 83,395 145,315 152,059
Loans originated to refinance existing loans...... 1,800,512 1,227,974 908,486
Loans transferred to loans held for sale.......... -- 214,991 621,267
Transaction-related write down on premises and
equipment....................................... 129,151 18,388 --
CASH PAID DURING THE YEAR FOR
Interest on deposits.............................. 2,177,244 2,215,708 2,340,107
Interest on borrowings............................ 2,388,780 1,549,354 1,483,695
Income taxes...................................... 226,245 269,900 159,468
See Notes to Consolidated Financial Statements.
69
72
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
On July 1, 1997, Great Western Financial Corporation ("GWFC") merged with
and into a subsidiary of Washington Mutual, Inc. ("WMI" and together with its
subsidiaries "Washington Mutual" or the "Company"), and all of the subsidiaries
of GWFC including Great Western Bank, a Federal Savings Bank ("GWB") and
Aristar, Inc. and its subsidiaries ("Aristar"), became subsidiaries of the
Company (the "Great Western Merger"). 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.
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. The results of operations
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.
Certain reclassifications have been made to the 1996 and 1995 financial
statements to conform to the 1997 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 to mid-sized businesses primarily throughout the western United States
and Florida through its subsidiary operations. Financial services of the Company
include consumer banking, mortgage lending, consumer finance, commercial banking
and securities activities.
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 have the effect of changing the interest rate
characteristics of the assets or liabilities to which they are designated. Such
effect is measured 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
70
73
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
interest rate cap agreements designated against deposits and borrowings are
reported at historical cost using settlement accounting.
Under settlement accounting 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 cost 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, the
option fee 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.
Trading Securities
Securities classified as trading are accounted for at fair value with
unrealized gains and losses included in current period 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 from 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.
71
74
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Held-to-Maturity Securities
Investments classified as held to maturity are accounted for at amortized
cost, but the 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.
The Company holds a small amount of tax exempt securities, but has chosen
not to report the applicable interest income and yield on a tax equivalent
basis.
Loans
Loans held in portfolio are stated at the principal amount outstanding, net
of deferred loan fees and any discounts or premiums on purchased loans. Deferred
fees, discounts and premiums are amortized using the interest method over the
estimated life of the loan. The Company sells most of its conforming one-to-four
family residential mortgage ("SFR") 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 generally ceases to accrue interest income on any loan that
becomes more than 90 days delinquent and reverses all interest accrued up to
that time. 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 for which interest is not being accrued
are referred to as loans on nonaccrual status.
The Company evaluates commercial real estate, commercial business and
builder construction loans for impairment on an individual basis. A loan in one
of the categories is considered impaired when it is (i) probable that a creditor
will be unable to collect all amounts due according to the terms of the loan
agreement, or (ii) a substandard loan, whether or not performing. 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. The valuation of impaired loans is based on (i) the
present value of expected future cash flows discounted at the loan's effective
interest rate, (ii) the loan's observable market price, or (iii) the fair value
of the collateral if the loan is collateral dependent. The amount by which the
recorded investment in the loan exceeds either the present value of expected
future cash flows or 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 or specifically
reserved.
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
72
75
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
Consumer finance loans are also reviewed on a systematic basis. In
evaluating the adequacy of the reserve, consideration is given to recent loan
loss experience and such other factors as, in management's judgment, deserve
current recognition in estimating losses. Loans secured by collateral other than
real estate are charged off based on the number of days contractually delinquent
(180 days for substantially all loans).
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.
MBS Impairment and Contingent Liability for Loans Sold with Recourse Retained
The Company records an impairment on loans securitized with full or limited
recourse and held in its portfolio of MBS. The Company also maintains a
contingent liability to cover potential losses on loans that have been sold to
third parties where the Company has retained full or limited recourse.
Foreclosed Assets
Foreclosed assets include properties acquired through foreclosure that are
transferred 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 a reserve for losses. The amount the Company ultimately recovers from
foreclosed assets 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.
Mortgage Servicing Rights
Originated servicing rights are recorded when mortgage loans are originated
and subsequently sold or securitized (and held as available-for-sale securities)
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 their relative fair values. Purchased servicing rights represent the
cost of acquiring the right to service mortgage loans. 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. "Short
servicing" is recorded in other liabilities in instances where the cost of
servicing exceeds the servicing fees received and is amortized in proportion to,
and over the period of, estimated net servicing loss.
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 rate (less than 6%, 50 basis point
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").
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
73
76
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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. The Company
periodically reviews premises and equipment for impairment. If identified, an
impairment loss is recognized.
Intangible Assets Arising from Acquisitions
Because of the earnings power or other identifiable values of certain
purchased companies or businesses, the Company paid amounts in excess of
identifiable fair value for businesses and tangible assets acquired. Generally,
such amounts are being amortized by systematic charges to income over a period
no greater than the estimated remaining life of the assets acquired or not
exceeding the estimated average remaining life of the existing deposit base
assumed. The Company periodically reviews intangibles to assess recoverability
and impairment is recognized in operations if permanent loss of value occurs.
Reverse Repurchase Agreements
The Company enters into agreements under which the Company sells securities
subject to an obligation to repurchase the same or similar securities ("reverse
repurchase agreements"). Under these arrangements, the Company transfers legal
control over the assets but still retains effective control through an agreement
that both entitles and obligates the Company to repurchase the assets. As a
result, reverse repurchase agreements are accounted for as financing
arrangements and not as a sale and subsequent repurchase. The obligation to
repurchase the securities is reflected as a liability in the Consolidated
Statements of Financial Position while the dollar amount of securities
underlying the agreements remains 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 $137.5 million and $85.8
million as of December 31, 1997 and 1996 were held by the Company in fiduciary
or agency capacity.
Transaction-Related Expenses
The Company records transaction-related expenses in conjunction with its
major business combinations. Transaction-related expenses are comprised of three
major categories: employee severance costs, the write down of duplicate or
excess premises and equipment, and other incremental expenses related to
effecting a business combination.
The Company recognizes a liability for the cost of employee termination
benefits that management decides to provide involuntarily terminated employees
in the period in which management approves the specific plan of termination, if
all of the following conditions exist: (i) management has the appropriate level
of authority to involuntarily terminate employees, (ii) management approves and
commits the enterprise to the plan of termination, (iii) management establishes
the benefits that current employees will receive upon termination, (iv) the
benefit arrangement has been communicated to employees, (v) the communication of
the benefit arrangement includes sufficient detail to enable employees to
determine the type and amount of benefits they will receive if they are
terminated, (vi) the plan of termination specifically identifies the number
74
77
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of employees to be terminated, their job classifications or functions, and their
locations, and (vii) the period of time to complete the plan of termination
indicates that significant changes to the plan of termination are not likely.
Upon consummation of a business combination, the Company specifically
identifies duplicate or excess facilities in the combined operations. Duplicate
or excess facilities fall into two categories: facilities owned by the Company
and facilities leased by the Company. Duplicate or excess facilities owned by
the Company are recorded at the lower of cost or fair value. The loss estimated
and recorded while these facilities remain in service does not include the
portion of the cost that is properly allocable to anticipated future service of
the facility. Depreciation is recorded on these facilities while they remain in
service. The loss estimated and recorded on leased duplicate or excess
facilities represents either costs to be incurred by the Company under
contractual obligations or represents penalties that will be incurred to cancel
the contractual obligations. Lease payments made on these facilities while they
remain in service are included in occupancy and equipment expense and are not
included in transaction-related expenses.
The other incremental expenses related to effecting a business combination
consist of both period costs and accrued contract exit fees for duplicate
services provided. The period costs include actual fees of professional services
firms (legal, underwriting, etc.) that were incurred in conjunction with the
combinations, and one-time, nonrecurring incremental costs associated with
combining the entities which are being expensed as incurred. The liability for
contract exit fees for duplicate services provided is recognized when Company
management makes the decision to terminate such contracts.
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 on that basis as well. The
Company's tax filings generally include all subsidiaries.
Keystone Holdings 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 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 18: Income Taxes. For periods subsequent to the Keystone
Transaction, the Company's consolidated tax return includes Keystone Holdings.
GWFC will file separate consolidated tax returns for periods prior to July
1, 1997. For periods subsequent to the Great Western Merger, the Company's
consolidated tax return will include GWFC.
Average Balances
Average balances are obtained from the best available daily, weekly or
monthly data, which in all cases approximate the average balances calculated on
a daily basis.
Adoption of Recently Issued Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 125, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, was issued in June 1996 and established,
75
78
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, SFAS No.
125 was effective for all transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. In December
1996, the Financial Accounting Standards Board ("FASB") issued SFAS No. 127,
Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125.
SFAS No. 127 defers for one year the effective date of certain provisions of
SFAS No. 125. The Company has and 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.
SFAS No. 130, Reporting Comprehensive Income was issued in June 1997 and
requires businesses to disclose comprehensive income and its components in their
financial statements. This statement will not affect the results of operations
or financial position of the Company. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997, and is applicable to interim periods.
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information was issued in June 1997 and redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. SFAS No. 131 is effective for
the Company beginning January 1, 1998. The statement will not affect the results
of operations or financial position of the Company. The Company has not yet
completed its analysis of which operating segments it will report on.
NOTE 2: BUSINESS COMBINATIONS/RESTRUCTURING
On July 1, 1997, WMI completed its business combination with GWFC. On that
date GWFC had assets of $43.77 billion, deposits of $27.79 billion and
stockholders' equity of $2.69 billion. The Company issued 125,649,551 shares of
common stock to complete the Great Western Merger.
Results of operations of the Company and GWFC for the six months ended June
30, 1997 were as follows:
SIX MONTHS ENDED JUNE 30, 1997
--------------------------------------
WASHINGTON
MUTUAL GWFC COMBINED
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Total revenue.................................. $1,850,340 $1,811,823 $3,662,163
Net income..................................... $ 232,796 $ 138,036 $ 370,832
Reconciliations of revenue and net income previously presented by the
Company with the combined amounts presented in the accompanying consolidated
statements of income for the years ended December 31, 1996 and 1995 were as
follows.
YEAR ENDED DECEMBER 31, 1996
--------------------------------------
WASHINGTON
MUTUAL GWFC COMBINED
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Total revenue.................................. $3,414,117 $3,631,137 $7,045,254
Net income..................................... $ 114,278 $ 115,822 $ 230,100
YEAR ENDED DECEMBER 31, 1995
--------------------------------------
WASHINGTON
MUTUAL GWFC COMBINED
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Total revenue.................................. $3,132,675 $3,629,263 $6,761,938
Net income..................................... $ 289,902 $ 261,022 $ 550,924
76
79
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On December 20, 1996, the Company merged with Keystone Holdings. At
November 30, 1996, Keystone Holdings had assets of $21.89 billion, deposits of
$12.82 billion and stockholder's equity of $808.6 million. The Company issued
47,883,333 shares of common stock to complete the Keystone Transaction.
During 1996, GWFC implemented a restructuring plan to improve its
competitive position, accelerate expense reduction and enhance future revenue
growth by streamlining operations, making efficient use of premises and
modernizing its systems platform. The Company recorded $68.3 million of
restructuring charges in 1996. The components of the restructuring charge were
severance and related payments, and facilities and equipment impairment. At
December 31, 1996, $47.1 million of these charges remained accrued. The
incomplete GWFC restructuring activities have been integrated into the
consolidation activities associated with the Great Western Merger and are now
accounted for in connection with the transaction-related expenses discussed
below.
As a result of the Great Western Merger and the Keystone Transaction, the
Company recorded transaction-related expenses of $431.1 million and $226.4
million (inclusive of the $68.3 million of restructuring charges discussed
above) during 1997 and 1996. The majority of the charges were for severance and
related payments, facilities and equipment impairment, and various investment
banking, legal and contract exit fees, all of which were incremental expenses.
The accrual of $196.1 million at year-end 1997 and the $126.6 million (inclusive
of the $47.1 million of restructuring charges discussed above) at year-end 1996
related primarily to costs for specifically identified severance programs, the
impairment of premises and equipment and the liability for contract exit fees
for duplicate services.
The Company expected staff reductions related to the Keystone Transaction
and Great Western Merger (inclusive of the GWFC restructuring plan) of
approximately 2,850. As of December 31, 1997 and 1996 approximately 1,660 and
630 employee separations had occurred under these plans. The remaining employee
separations of approximately 1,190 are planned to be completed by the end of
June 1998. Additional staff reductions are anticipated as a result of normal
attrition.
Offices used by the Company on the Chatsworth campus are being consolidated
in order to make more efficient use of the building space. As a result of this
consolidation, the Company anticipates that approximately 565,000 square feet,
located predominantly in six buildings, will become available to sublet to third
party tenants. It is expected that the space will be available for subleasing by
June 1998. In addition, the Company has identified 90 consumer financial centers
which will be closed and will have their operations consolidated with
neighboring financial centers by the end of the third quarter of 1998.
In order to meet the Company's goal to consolidate its current systems
platform, certain computer hardware and software equipment has been or will be
abandoned and written off. The consolidation of systems will allow the Company
to increase operational efficiency, improve processing capacity and establish a
common user workstation environment.
77
80
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reconciliations of the restructuring and transaction-related expenses and
accrual activity during 1996 and 1997 were as follows:
1996 ACTIVITY DECEMBER 31,
1996 CHARGED 1996
1996 1996 TOTAL AGAINST ACCRUED
PERIOD COSTS ACCRUAL EXPENSES ACCRUAL BALANCE
------------ -------- -------- ------------- ------------
(DOLLARS IN THOUSANDS)
Severance..................... $ -- $ 59,714 $ 59,714 $ (2,776) $ 56,938
Premises...................... -- 29,456 29,456 -- 29,456
Equipment..................... -- 29,101 29,101 (18,388) 10,713
Legal, underwriting and other
direct transaction costs.... 23,179 3,232 26,411 -- 3,232
Contract cancellation costs... -- 12,300 12,300 -- 12,300
Other......................... 55,456 13,976 69,432 -- 13,976
-------- -------- -------- -------- --------
$ 78,635 $147,779 $226,414 $(21,164) $126,615
======== ======== ======== ======== ========
1997 ACTIVITY DECEMBER 31,
1997 CHARGED 1997
1997 1997 TOTAL AGAINST ACCRUED
PERIOD COSTS ACCRUAL EXPENSES ACCRUAL BALANCE
------------ -------- -------- ------------- ------------
(DOLLARS IN THOUSANDS)
Severance..................... $ 28,807 $ 94,126 $122,933 $ (57,960) $ 93,104
Premises...................... -- 97,165 97,165 (69,317) 57,304
Equipment..................... -- 49,121 49,121 (59,834) --
Legal, underwriting and other
direct transaction costs.... 109,811 3,503 113,314 (5,993) 742
Contract cancellation costs... -- 33,207 33,207 (11,808) 33,699
Other......................... 8,640 6,745 15,385 (9,478) 11,243
-------- -------- -------- --------- --------
$147,258 $283,867 $431,125 $(214,390) $196,092
======== ======== ======== ========= ========
On January 31, 1996, the Company acquired Western Bank ("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, the assets, liabilities and
stockholders' equity of Western were recorded on the books of the Company 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.
On January 15, 1997, Washington Mutual acquired United Western Financial
Group, Inc. ("United Western") of Salt Lake City, Utah 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 accounted for as a purchase for accounting purposes.
Accordingly, on January 15, 1997, the assets, liabilities and stockholders'
equity of United Western were recorded on the books of the Company at their
respective fair 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 intangible assets, was recorded
at
78
81
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$4.2 million. 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,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
Cash........................................................ $1,285,222 $1,032,379
Cash equivalents:
Overnight investments..................................... 257,583 381,029
Commercial paper.......................................... 10,975 --
Securities purchased under agreements to resell
("repurchase agreements").............................. -- 250,000
Time deposit accounts..................................... 7,110 1,947
---------- ----------
275,668 632,976
---------- ----------
$1,560,890 $1,665,355
========== ==========
The Company enters into repurchase agreements having terms of up to 90
days; however, repurchase agreements are typically overnight investments. The
Company generally takes possession of collateral supporting repurchase
agreements. The repurchase agreements were collateralized by U.S. government
agency securities with fair values at least 2% above the face amounts of the
repurchase agreements.
For the purpose of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, overnight investments, commercial paper,
repurchase agreements and time deposits. These time deposit accounts 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 were balances
maintained at the Federal Reserve Bank of San Francisco of $102.2 million and
$149.7 million at December 31, 1997 and 1996.
79
82
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: SECURITIES
The amortized cost, unrealized gains, unrealized losses, and fair values of
securities (exclusive of trading securities) were as follows:
DECEMBER 31, 1997
-----------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE YIELD(1)
----------- ---------- ---------- ----------- --------
(DOLLARS IN THOUSANDS)
Available-for-sale securities
Investment securities:
U.S. government and agency...... $ 528,528 $ 2,211 $ (173) $ 530,566 6.67%
Corporate debt.................. 456,064 2,849 (363) 458,550 6.51
Municipal(2).................... 25 1 -- 26 9.61
Equity securities:
Preferred stock.............. 172,199 13,188 (75) 185,312 6.33
Other securities............. 11,331 163 (133) 11,361 6.29
----------- -------- --------- ----------- ----
1,168,147 18,412 (744) 1,185,815 6.55
MBS:
U.S. government agency.......... 8,118,693 108,671 (5,542) 8,221,822 6.64
Private issue................... 1,970,359 13,492 (18,550) 1,965,301 7.35
----------- -------- --------- ----------- ----
10,089,052 122,163 (24,092) 10,187,123 6.78
Derivative instruments:
Interest rate exchange
agreements................... -- -- (218) (218) --
Interest rate cap agreements.... 1,033 169 -- 1,202 --
----------- -------- --------- ----------- ----
1,033 169 (218) 984 --
----------- -------- --------- ----------- ----
10,090,085 122,332 (24,310) 10,188,107 6.78
----------- -------- --------- ----------- ----
$11,258,232 $140,744 $ (25,054) $11,373,922 6.75%
=========== ======== ========= =========== ====
Held-to-maturity securities
Investment securities:
Corporate debt.................. $ 20,273 $ 1,152 $ (7) $ 21,418 8.21%
Municipal(2).................... 100,124 5,429 -- 105,553 5.84
----------- -------- --------- ----------- ----
120,397 6,581 (7) 126,971 6.24
MBS:
U.S. government agency.......... 12,559,634 48,337 (134,872) 12,473,099 6.38
Private issue................... 99,583 -- -- 99,583 5.90
----------- -------- --------- ----------- ----
12,659,217 48,337 (134,872) 12,572,682 6.38
----------- -------- --------- ----------- ----
$12,779,614 $ 54,918 $(134,879) $12,699,653 6.38%
=========== ======== ========= =========== ====
80
83
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
--------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE YIELD(1)
----------- ---------- ---------- ----------- --------
(DOLLARS IN THOUSANDS)
Available-for-sale securities:
Investment securities:
U.S. government and agency............. $ 878,179 $ 2,068 $ (1,904) $ 878,343 6.38%
Corporate debt......................... 1,032,876 11,168 (4,796) 1,039,248 6.51
Equity securities:
Preferred stock..................... 171,029 4,012 (831) 174,210 6.88
Other securities.................... 34,621 175 (129) 34,667 5.99
----------- -------- -------- ----------- ----
2,116,705 17,423 (7,660) 2,126,468 6.48
MBS:
U.S. government agency................. 12,541,352 231,349 (53,412) 12,719,289 6.89
Private issue.......................... 1,250,738 8,372 (11,338) 1,247,772 7.38
----------- -------- -------- ----------- ----
13,792,090 239,721 (64,750) 13,967,061 6.93
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 --
----------- -------- -------- ----------- ----
13,796,735 240,257 (68,117) 13,968,875 6.93
----------- -------- -------- ----------- ----
$15,913,440 $257,680 $(75,777) $16,095,343 6.87%
=========== ======== ======== =========== ====
Held-to-maturity securities:
Investment securities:
U.S. government and agency............. $ 6,629 $ 559 $ -- $ 7,188 8.25%
Corporate debt......................... 77,993 5,215 (28) 83,180 8.61
Municipal(2)........................... 108,073 3,618 (238) 111,453 6.23
----------- -------- -------- ----------- ----
192,695 9,392 (266) 201,821 7.28
MBS:
U.S. government agency................. 4,186,777 73,534 (7,781) 4,252,530 7.60
Private issue.......................... 99,584 -- (8,810) 90,774 5.55
----------- -------- -------- ----------- ----
4,286,361 73,534 (16,591) 4,343,304 7.56
----------- -------- -------- ----------- ----
$ 4,479,056 $ 82,926 $(16,857) $ 4,545,125 7.55%
=========== ======== ======== =========== ====
- ---------------
(1) Weighted average yield at end of year.
(2) The Company held a small amount of tax exempt securities, but chose not to
report the applicable interest income and yield on a tax equivalent basis.
81
84
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Securities (exclusive of trading securities) by contractual maturity were
as follows:
DECEMBER 31, 1997
------------------------------------------------------------------------------------------------------
DUE AFTER ONE AFTER FIVE
CARRYING WITHIN BUT WITHIN BUT WITHIN AFTER
VALUE YIELD ONE YEAR YIELD FIVE YEARS YIELD 10 YEARS YIELD 10 YEARS YIELD
----------- ----- -------- ----- ---------- ----- ---------- ----- ----------- -----
(DOLLARS IN THOUSANDS)
Available-for-sale securities
Investment securities:
U.S. government and
agency................. $ 530,566 6.67% $251,924 6.06% $ 265,517 7.24% $ 8,037 6.86% $ 5,088 6.95%
Corporate debt........... 458,550 6.51 139,043 6.37 229,503 6.53 51,776 6.77 38,228 6.47
Municipal................ 26 9.61 -- -- 26 9.61 -- -- -- --
Equity securities:
Preferred stock.......... 185,312 6.33 -- -- -- -- -- -- 185,312 6.33
Other securities......... 11,361 6.29 3,069 5.73 2,701 5.83 2,410 7.24 3,181 6.50
MBS:
U.S. government agency... 8,221,822 6.64 9,608 5.25 898,807 6.53 140,149 7.09 7,173,258 6.64
Private issue............ 1,965,301 7.35 -- -- 2,149 12.33 -- -- 1,963,152 7.35
Derivative instruments:
Interest rate exchange
agreements............. (218) -- (334) -- 116 -- -- -- -- --
Interest rate cap
agreements............. 1,202 -- 1,202 -- -- -- -- -- -- --
----------- ---- -------- ---- ---------- ----- -------- ---- ----------- ----
$11,373,922 6.75% $404,512 6.11% $1,398,819 6.68% $202,372 6.91% $ 9,368,219 6.79%
=========== ==== ======== ==== ========== ===== ======== ==== =========== ====
Held-to-maturity securities
Investment securities:
Corporate debt........... $ 20,273 8.21% $ -- --% $ 100 5.50% $ -- --% $ 20,173 8.21%
Municipal................ 100,124 5.84 -- -- 5,666 5.48 23,948 6.14 70,510 5.77
MBS:
U.S. government agency... 12,559,634 6.38 -- -- 3,564 6.59 67,322 6.79 12,488,748 6.38
Private issue............ 99,583 5.90 -- -- -- -- -- -- 99,583 5.90
----------- ---- -------- ---- ---------- ----- -------- ---- ----------- ----
$12,779,614 6.38% $ -- --% $ 9,330 5.90% $ 91,270 6.62% $12,679,014 6.38%
=========== ==== ======== ==== ========== ===== ======== ==== =========== ====
The available-for-sale portfolio contains a small amount of private-issue
securities. Private-issue securities include 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 higher
rate of interest than U.S. government agency securities, thereby enhancing the
overall yield of the portfolio. Such securities do not qualify for guarantee 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 agency
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. Other than temporary declines in fair value are
recognized as a reduction to current earnings.
At December 31, 1997, the Company held $2.09 billion of private-issue MBS
and CMOs (including the $1.22 billion Real Estate Mortgage Investment Conduit
("REMIC") created during the fourth quarter of 1997). Of the $2.09 billion, 49%
were of the highest investment grade (AAA), 38% were rated investment grade (AA
or A), 5% were rated lowest investment grade (BBB) and 8% were rated below
investment grade (BB or below). At December 31, 1996, the Company held $1.34
billion of private-issue MBS and CMOs. Of
82
85
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that amount, 16% were of the highest investment grade (AAA), 75% were rated
investment grade (AA or A), 6% were rated lowest investment grade (BBB) and 3%
were rated below investment grade (BB or below).
At December 31, 1997, $15.00 billion of MBS where the Company has retained
recourse against the loans collateralizing the MBS ("Recourse MBS") had an
associated impairment of $35.6 million.
The Company also maintains a contingent liability to cover potential losses
on Recourse MBS sold to third parties and loans sold with recourse. During 1997,
an additional $2.7 million was set aside to cover losses on these Recourse MBS
and loans sold with recourse. At December 31, 1997 the Company had sold $2.13
billion of Recourse MBS and loans sold with recourse, and the contingent
liability totaled $8.8 million, which the Company considers adequate to cover
inherent losses.
Proceeds from sales of securities in the available-for-sale portfolio
during 1997, 1996 and 1995 were $2.35 billion, $4.54 billion and $2.13 billion.
The Company realized $8.3 million in gains and $800,000 in losses on these sales
during 1997. The Company realized $42.1 million in gains and $34.1 million in
losses on sales during 1996. Similarly, the Company realized $31.1 million in
gains and $10.0 million in losses during 1995.
MBS with an amortized cost of $14.55 billion and fair value of $14.58
billion at December 31, 1997 were pledged to secure public deposits, reverse
repurchase agreements, other borrowings, interest rate exchange agreements, and
access to the Federal Reserve discount window.
At December 31, 1997, net unrealized gains on the available-for-sale
portfolio were $115.7 million and net unrealized losses on the derivative
instruments designated against this portfolio were $49,000. During 1997, certain
MBS were transferred from available for sale to held to maturity. The related
market adjustment of $101.3 million was retained in equity and will be amortized
over the life of the related securities in accordance with SFAS No. 115. The net
(after tax) result was a valuation reserve of $134.6 million included as a
separate component of stockholders' equity. At December 31, 1996, net unrealized
gains on the available-for-sale portfolio were $184.7 million and net 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 $118.6 million.
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 $10.84 billion and unrealized gains of
$225.6 million and unrealized losses of $28.2 million to the available-for-sale
category. No transfers from the held-to-maturity category to the
available-for-sale category were made during 1997 and 1996.
83
86
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: LOANS
Loans consisted of the following:
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Real estate:
SFR..................................................... $53,431,451 $48,689,404
SFR construction........................................ 877,449 728,121
Commercial real estate(1)............................... 6,613,541 6,488,254
----------- -----------
60,922,441 55,905,779
Manufactured housing...................................... 1,081,193 1,028,192
Second mortgage and other consumer........................ 2,725,144 2,371,086
Consumer finance.......................................... 2,309,407 2,185,903
Commercial business....................................... 772,466 340,149
Reserve for loan losses................................... (670,494) (677,141)
----------- -----------
$67,140,157 $61,153,968
=========== ===========
- ---------------
(1) At December 31, 1997, included $65.0 million of commercial real estate
construction lending.
Real estate construction (including SFR construction and commercial real
estate construction) and commercial business loans by maturity date were as
follows:
DECEMBER 31, 1997
----------------------------------------------------------
REAL ESTATE
CONSTRUCTION COMMERCIAL BUSINESS
--------------------- ---------------------
ARMS FIXED RATE ARMS FIXED RATE TOTAL
-------- ---------- -------- ---------- ----------
(DOLLARS IN THOUSANDS)
Due within one year.................... $339,119 $ 25,382 $435,550 $ 40,517 $ 840,568
After one but within five years........ 38,584 59,527 154,298 48,038 300,447
After five years....................... 172,319 307,503 18,948 75,115 573,885
-------- -------- -------- -------- ----------
$550.022 $392,412 $608,796 $163,670 $1,714,900
======== ======== ======== ======== ==========
Nonaccrual loans totaled $601.4 million and $575.0 million at December 31,
1997 and 1996. If interest on these loans had been recognized, such income would
have been $43.6 million in 1997, $53.5 million in 1996 and $48.9 million in
1995.
84
87
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amount of impaired loans and the related allocated reserve for loan
losses were as follows:
DECEMBER 31,
-------------------------------------------------
1997 1996
--------------------- ------------------------
LOAN ALLOCATED ALLOCATED
AMOUNT RESERVES LOAN AMOUNT RESERVES
-------- --------- ----------- ---------
(DOLLARS IN THOUSANDS)
Nonaccrual loans:
With allocated reserves................... $ 33,980 $ 7,760 $ 19,071 $ 6,641
Without allocated reserves................ 15,481 -- 39,609 --
-------- ------- -------- -------
49,461 7,760 58,680 6,641
Other impaired loans:
With allocated reserves................... 420,662 82,693 384,272 73,168
Without allocated reserves................ 81,160 -- 177,516 --
-------- ------- -------- -------
501,822 82,693 561,788 73,168
-------- ------- -------- -------
$551,283 $90,453 $620,468 $79,809
======== ======= ======== =======
The average balance of impaired loans and the related interest income
recognized were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Average balance of impaired loans...................... $572,727 $607,514 $436,034
Interest income recognized............................. 38,523 34,248 28,815
Loans totaling $24.36 billion and $12.01 billion at December 31, 1997 and
1996 were pledged to secure advances from FHLBs. At December 31, 1997, the
Company had $1.16 billion in fixed-rate SFR loan commitments, $1.46 billion in
ARM commitments, $773.8 million in SFR construction loan commitments, $155.0
million in commercial real estate loan commitments, $518.9 million in commercial
business loan commitments, and $1.60 billion in undisbursed lines of credit.
Unamortized deferred loan fees were $67.7 million and $162.0 million at
December 31, 1997 and 1996. The amortization of deferred loan fees included in
interest income totaled $67.4 million in 1997, $63.7 million in 1996 and $83.1
million in 1995.
As of December 31, 1997, the Company serviced 423 Government National
Mortgage Association ("GNMA") loan pools with an outstanding security balance of
$371.0 million. The Company did not issue any additional GNMA loan pools during
1997.
85
88
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: RESERVE FOR LOAN LOSSES
Changes in the reserve for loan losses were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Balance, beginning of year......................... $ 677,141 $ 598,124 $ 683,040
Provision for loan losses.......................... 207,139 392,435 251,424
Reserves added through business combinations....... 10,908 1,077 5,372
Reserves transferred to MBS impairment............. (21,755) -- --
Reserves transferred to contingent liability....... (2,747) -- --
Loans charged off:
SFR.............................................. (100,860) (232,653) (240,489)
SFR construction................................. (52) (16) (125)
Commercial real estate........................... (24,073) (36,354) (55,888)
Manufactured housing, second mortgage and
other consumer................................ (17,621) (11,127) (8,905)
Commercial business.............................. (2,569) (435) (813)
Consumer finance................................. (79,697) (60,520) (62,206)
--------- --------- ---------
(224,872) (341,105) (368,426)
Recoveries of loans previously charged off:
SFR.............................................. 1,353 5,693 3,891
SFR construction................................. 90 -- 47
Commercial real estate........................... 2,725 3,425 5,286
Manufactured housing, second mortgage and
other consumer................................ 2,916 1,221 951
Commercial business.............................. 221 74 482
Consumer finance................................. 17,375 16,197 16,057
--------- --------- ---------
24,680 26,610 26,714
--------- --------- ---------
Net charge offs.................................... (200,192) (314,495) (341,712)
--------- --------- ---------
Balance, end of year............................... $ 670,494 $ 677,141 $ 598,124
========= ========= =========
In connection with the Keystone Transaction, the Company provided an
additional $125.0 million in loan loss provision. 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. The
provision in 1996 also included $50.0 million attributable to a bulk sale of
loans at GWB.
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.
86
89
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
An analysis of the reserve for loan losses was as follows:
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
Specific and allocated reserves:
Commercial real estate............................. $ 84,969 $117,343
Commercial business................................ 3,277 1,285
Builder construction............................... 2,207 --
-------- --------
90,453 118,628
Unallocated reserves................................. 580,041 558,513
-------- --------
$670,494 $677,141
======== ========
Total reserve for loan losses as a percentage of:
Nonaccrual loans................................... 112% 118%
Nonperforming assets............................... 83 84
NOTE 7: MORTGAGE SERVICING
Loans serviced consisted of the following:
DECEMBER 31, 1997
----------------------
(DOLLARS IN THOUSANDS)
Loans held in portfolio and held for sale (exclusive of
loans serviced by others)............................... $ 67,351,417
Loans securitized and retained (with and without
recourse)............................................... 17,007,970
Loans serviced for others................................. 29,457,988
------------
$113,817,375
============
Changes in the balance of mortgage servicing rights were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year................. $185,984 $136,359 $ 96,846
Additions.................................. 76,352 96,189 69,138
Sales...................................... -- (5,395) --
Amortization of mortgage servicing
rights................................... (48,027) (39,011) (28,743)
Impairment adjustment...................... 1,051 (2,158) (882)
-------- -------- --------
Balance, end of year....................... $215,360 $185,984 $136,359
======== ======== ========
87
90
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in the balance of short servicing were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
Balance, beginning of year.................... $20,714 $21,214 $25,357
Additions..................................... -- 23 2,590
Sales......................................... -- -- --
Amortization.................................. (3,858) (2,166) (6,733)
Impairment adjustment......................... 1,128 1,643 --
------- ------- -------
Balance, end of year.......................... $17,984 $20,714 $21,214
======= ======= =======
Changes in the valuation for impairment of mortgage servicing rights were
as follows:
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
------- -------- -------
(DOLLARS IN THOUSANDS)
Balance, beginning of year................... $ 3,040 $ 882 $ --
Additions.................................... 2,830 2,158 882
Recoveries................................... (3,881) -- --
------- -------- -------
Balance, end of year......................... $ 1,989 $ 3,040 $ 882
======= ======== =======
NOTE 8: INVESTMENT IN FHLBS
The investment in the FHLBs of Seattle and San Francisco consisted of
capital stock, at cost, totaling $1.06 billion at December 31, 1997 and $843.0
million at December 31, 1996.
The Company earned yields of 6.66% in 1997, 6.78% in 1996 and 5.29% in 1995
from dividends on its investment in FHLBs. FHLB capital stock is pledged to
secure FHLB borrowings. Earnings on FHLB capital stock will presumably continue
to be restricted due to the funding requirements imposed on the FHLBs for
affordable housing programs and the Resolution Funding Corporation.
NOTE 9: FORECLOSED ASSETS
Foreclosed assets are primarily real estate acquired through foreclosure.
Real estate acquired through foreclosure is recorded at the lower of cost or
fair value (less estimated selling costs) at the date of acquisition and is
periodically reviewed by management to determine whether there has been
deterioration or recovery in value.
Foreclosed assets consisted of the following:
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
Real estate acquired through foreclosure............... $202,241 $229,237
Other repossessed assets............................... 6,038 2,651
Reserve for losses..................................... (3,007) (9,005)
-------- --------
$205,272 $222,883
======== ========
88
91
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Foreclosed assets operations were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Loss from operations....................... $(32,754) $(40,538) $(29,435)
Gain on sale of foreclosed assets.......... 19,359 16,298 24,293
Provision for losses....................... 2,817 5,935 (12,023)
-------- -------- --------
$(10,578) $(18,305) $(17,165)
======== ======== ========
Changes in the reserve for losses were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
------- -------- --------
(DOLLARS IN THOUSANDS)
Balance, beginning of year.................. $ 9,005 $ 36,962 $ 50,057
Provision (recovery of reserve) for
losses.................................... (2,817) (5,935) 12,023
Reserves charged off, net of recoveries..... (3,181) (22,022) (25,118)
------- -------- --------
Balance, end of year........................ $ 3,007 $ 9,005 $ 36,962
======= ======== ========
NOTE 10: PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
DECEMBER 31,
-----------------------
1997 1996
--------- ----------
(DOLLARS IN THOUSANDS)
Furniture and equipment............................. $ 641,339 $ 787,763
Buildings........................................... 594,274 627,793
Leasehold improvements.............................. 204,423 217,469
Construction in progress............................ 108,338 17,203
--------- ----------
1,548,374 1,650,228
Accumulated depreciation............................ (780,804) (785,197)
Land................................................ 169,628 169,782
--------- ----------
$ 937,198 $1,034,813
========= ==========
See "-- Note 2: Business Combinations/Restructuring."
Depreciation expense for 1997, 1996 and 1995 was $115.8 million, $117.3
million and $112.6 million.
The Company leases various branch offices, office facilities and equipment
under capital and noncancelable operating leases which expire at various dates
through 2054. Some leases contain escalation provisions for adjustments in the
consumer price index and provide for renewal options for five- to 10-year
periods. Rental expense, including amounts paid under month-to-month cancelable
leases, amounted to $116.8 million, $102.4 million and $100.9 million in 1997,
1996 and 1995.
89
92
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum net rental commitments, including maintenance and other
associated costs, for all noncancelable leases were as follows:
OPERATING LEASE CAPITAL LEASE
------------------------ ------------------------
LAND & FURNITURE & LAND & FURNITURE &
BUILDINGS EQUIPMENT BUILDINGS EQUIPMENT
--------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
Year ending December 31,
1998................................ $ 76,968 $ 6,317 $ 7,595 $1,713
1999................................ 65,583 4,588 7,595 1,713
2000................................ 57,641 1,985 7,693 1,713
2001................................ 50,340 878 7,693 1,713
2002................................ 40,169 644 7,693 291
Thereafter.......................... 167,591 -- 70,464 --
-------- ------- -------- ------
$458,292 $14,412 $108,733 $7,143
======== ======= ======== ======
NOTE 11: INTANGIBLE ASSETS ARISING FROM ACQUISITIONS
Intangible assets arising from acquisitions consisted of the following:
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
Branch acquisitions, net of amortization of $326,140 and
$289,612.................................................. $249,330 $285,991
Business combinations, net of amortization of $150,950 and
$125,542.................................................. 107,017 132,425
Other, net of amortization of $11,010 and $10,258........... 303 1,084
-------- --------
$356,650 $419,500
======== ========
Intangible assets arising from acquisitions result from acquisitions
accounted for as the purchase of assets and the assumption of liabilities and
primarily consist of goodwill, core deposit intangibles and covenants not to
compete. Intangible assets arising from acquisitions are amortized using the
straight-line method over the period that is expected to be benefited, generally
from three to 25 years. The average remaining amortization period at December
31, 1997 was approximately five years.
90
93
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12: DEPOSITS
Deposits consisted of the following:
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Checking accounts:
Interest bearing................................... $ 4,380,133 $ 4,980,766
Noninterest bearing................................ 3,534,242 2,576,822
----------- -----------
7,914,375 7,557,588
Savings accounts..................................... 3,267,732 3,265,995
MMDAs................................................ 11,672,313 10,320,276
Time deposit accounts:
Due within one year................................ 23,411,811 27,002,176
After one but within two years..................... 2,746,532 2,525,843
After two but within three years................... 879,090 713,005
After three but within four years.................. 546,680 631,922
After four but within five years................... 462,110 567,004
After five years................................... 85,374 83,105
----------- -----------
28,131,597 31,523,055
----------- -----------
$50,986,017 $52,666,914
=========== ===========
Time deposit accounts in amounts of $100,000 or more totaled $5.74 billion
and $7.08 billion at December 31, 1997 and 1996. At December 31, 1997, $1.65
billion of these deposits mature within three months, $1.34 million mature in
three to six months, $1.70 billion mature in six months to one year, and $1.05
billion mature after one year.
The following table shows the change in deposit balances:
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Checking accounts:
Interest bearing.......................................... $ (600,633) $ (213,902)
Noninterest bearing....................................... 957,420 333,200
Savings accounts and MMDAs.................................. 1,353,774 423,493
Time deposit accounts....................................... (3,391,458) (1,573,765)
----------- -----------
$(1,680,897) $(1,030,974)
=========== ===========
Financial data pertaining to the weighted average cost of deposits were as
follows:
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
---- ---- ----
Weighted average interest rate during the year.............. 4.18% 4.22% 4.40%
The weighted average interest rate is based upon stated interest rates
without giving consideration to daily compounding of interest or forfeiture of
interest because of premature withdrawals. Accrued but unpaid interest on
deposits included in other liabilities totaled $49.8 million and $51.1 million
at December 31, 1997 and 1996.
91
94
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Interest expense on deposits was as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Checking (interest bearing) accounts............... $ 58,389 $ 57,449 $ 63,958
Savings accounts and MMDAs......................... 510,001 434,691 449,813
Time deposit accounts.............................. 1,597,714 1,748,162 1,838,132
---------- ---------- ----------
$2,166,104 $2,240,302 $2,351,903
========== ========== ==========
NOTE 13: FEDERAL FUNDS PURCHASED AND COMMERCIAL PAPER
Federal funds purchased and commercial paper consisted of the following:
DECEMBER 31,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
Federal funds purchased..................................... $2,570,750 $1,681,000
Commercial paper............................................ 357,532 472,506
---------- ----------
$2,928,282 $2,153,506
========== ==========
Federal funds purchased have maturities of up to 12 months, and at December
31, 1997, the average maturity was 82 days. Aristar issues commercial paper with
original maturities of less than 270 days, with an average maturity at December
31, 1997, of 61 days.
Financial data pertaining to federal funds purchased and commercial paper
were as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Federal funds purchased:
Weighted average interest rate at end of year.... 5.92% 5.78% 5.84%
Weighted average interest rate during the year... 5.64 5.40 6.05
Average balance of federal funds purchased....... $2,347,791 $1,344,706 $ 734,402
Maximum amount of federal funds purchased at any
month end..................................... 3,955,600 2,242,000 998,000
Interest expense during the year................. 132,450 72,639 44,413
Commercial paper:
Weighted average interest rate at end of year.... 5.99% 5.70% 5.88%
Weighted average interest rate during the year... 6.06 5.40 6.27
Average balance of commercial paper.............. $ 440,057 $ 695,931 $1,164,071
Maximum amount of commercial paper issued at any
month end..................................... 694,006 967,962 1,551,200
Interest expense during the year................. 26,679 37,608 73,029
92
95
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14: REVERSE REPURCHASE AGREEMENTS
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 reverse repurchase agreements were as
follows:
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Due within 30 days................................ $ 3,330,069 $ 5,662,338
After 30 but within 90 days....................... 1,346,043 5,455,639
After 90 but within 180 days...................... 265,000 321,987
After 180 days but within one year................ 667,197 99,067
After one year.................................... 6,670,731 494,088
----------- -----------
$12,279,040 $12,033,119
=========== ===========
Financial data pertaining to reverse repurchase agreements were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Weighted average interest rate at
end of year....................... 5.73% 5.50% 5.85%
Weighted average interest rate
during the year................... 5.71 5.50 6.11
Average balance of reverse
repurchase agreements............. $12,527,774 $14,360,452 $14,800,811
Maximum amount of reverse
repurchase agreements............. 12,574,964 15,578,289 16,192,165
Interest expense during the year.... 715,047 790,483 904,698
NOTE 15: ADVANCES FROM FHLBS
As members of the FHLBs of San Francisco and Seattle, WMBFA, WMB and WMBfsb
maintain credit lines that are percentages of their total regulatory assets,
subject to collateralization requirements. Advances are collateralized in the
aggregate by all stock owned of the FHLBs, by deposits with the FHLBs, and by
certain mortgages or deeds of trust and securities of the U.S. government and
agencies thereof. The maximum amount of credit which the FHLBs will extend for
purposes other than meeting withdrawals varies from time to time in accordance
with their policies. The interest rates charged by the FHLBs for advances vary
depending upon maturity, the cost of funds in the individual FHLB and the
purpose of borrowing.
93
96
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Scheduled maturities of advances from FHLBs were as follows:
DECEMBER 31,
---------------------------------------------------
1997 1996
------------------------ ------------------------
RANGES OF RANGES OF
INTEREST INTEREST
AMOUNT RATES AMOUNT RATES
----------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
Due within one year............. $10,271,528 5.50%-8.50% $ 7,388,583 4.38%-8.45%
After one but within two
years......................... 7,638,329 5.51 -8.53 1,698,891 5.30 -8.50
After two but within three
years......................... 1,774,099 4.50 -9.34 267,889 6.17 -8.53
After three but within four
years......................... 456,000 5.68 -5.79 59,397 4.98 -9.34
After four but within five
years......................... 50,318 3.50 -5.73 450,000 5.40 -5.51
After five years................ 111,689 2.80 -8.65 146,665 2.80 -8.65
----------- -----------
$20,301,963 $10,011,425
=========== ===========
Financial data pertaining to advances from FHLBs were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
----------- ----------- ----------
(DOLLARS IN THOUSANDS)
Weighted average interest rate at end of
year....................................... 5.78% 5.51% 5.73%
Weighted average interest rate during the
year....................................... 5.75 5.56 5.73
Average balance of advances from FHLBs....... $13,621,867 $ 6,509,897 $3,668,898
Maximum amount of advances from FHLBs at any
month end.................................. 20,301,963 10,011,425 5,570,819
Interest expense during the year............. 783,338 361,695 210,324
NOTE 16: TRUST PREFERRED SECURITIES
The Company is the guarantor of three separate issues of trust preferred
securities. In December 1995, Great Western Financial Trust I ("GWFT I") a
wholly-owned subsidiary of GWFC, issued $100.0 million of 8.25% Trust Originated
Preferred Securities (the "preferred securities"). In connection with GWFT I's
issuance of preferred securities, GWFC issued to GWFT I $103.1 million principal
amount of its 8.25% subordinated deferrable interest notes, due 2025 (the
"subordinated notes"). The sole assets of GWFT I are and will be the
subordinated notes. On January 27, 1997, Great Western Financial Trust II ("GWFT
II"), a wholly-owned subsidiary of GWFC, issued $300.0 million of 8.206% Trust
Originated Preferred Securities (the "preferred securities II"). In connection
with GWFT II's issuance of the preferred securities II, GWFC issued to GWFT II
$309.3 million principal amount of its 8.206% subordinated deferrable interest
notes, due 2027 (the "subordinated notes II"). The sole assets of GWFT II are
and will be the subordinated notes II. On May 31, 1997, Washington Mutual
Capital I ("WMC I"), a wholly-owned subsidiary of Washington Mutual issued
$400.0 million of 8.375% Subordinated Capital Income Securities (the "capital
securities"). In connection with WMC I's issuance of the capital securities,
Washington Mutual issued to WMC I $412.4 million principal amount of its 8.375%
Junior Subordinated Debentures, due 2027 (the "subordinated debentures"). The
sole assets of WMC I are and will be the subordinated debentures. GWFC's
obligations under the subordinated notes and subordinated notes II were assumed
by the Company. Washington Mutual's obligations under the subordinated notes,
subordinated notes II and subordinated debentures and related agreements, taken
together, constitute a full and unconditional guarantee by the Company of the
obligations of GWFT I under the preferred securities, of GWFT II under the
preferred securities II and of WMC I under the capital securities.
94
97
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has a right to defer payment of interest on the debentures at
any time or from time to time for a period not exceeding the extension period
described in the table below with respect to each deferral period, provided that
no extension period may extend beyond the stated maturity of the respective
debentures. Distributions paid on the securities are recorded as interest
expense in the consolidated statements of income.
Trust preferred securities and debentures were as follows:
DECEMBER 31, 1997
--------------------------------------------------------------------------------------
AGGREGATE
LIQUIDATION AGGREGATE PER
AMOUNT OF LIQUIDATION AGGREGATE STATED ANNUM
TRUST AMOUNT OF PRINCIPAL MATURITY INTEREST
PREFERRED COMMON AMOUNT OF OF RATE OF EXTENSION
NAME OF TRUST SECURITIES SECURITIES DEBENTURES DEBENTURES DEBENTURES PERIOD
------------- ----------- ----------- ---------- ---------- ---------- -------------------
(DOLLARS IN THOUSANDS)
Great Western Financial
Trust I.............. $100,000 $ 3,093 $103,093 2025 8.250% 20 consecutive
quarters
Great Western Financial
Trust II............. 300,000 9,279 309,279 2027 8.206% 10 consecutive
semi-annual periods
Washington Mutual
Capital I............ 400,000 12,371 412,371 2027 8.375% 10 consecutive
semi-annual periods
-------- ------- -------- -----
$800,000 $24,743 $824,743 8.296%
======== ======= ======== =====
DECEMBER 31, 1997
-------------------
REDEMPTION
NAME OF TRUST OPTION
------------- -------------------
Great Western Financial
Trust I.............. On or after
December 31, 2000
Great Western Financial
Trust II............. On or after
February 1, 2007
Washington Mutual
Capital I............ On or after
June 1, 2007
DECEMBER 31, 1996
--------------------------------------------------------------------------------------
AGGREGATE
LIQUIDATION AGGREGATE PER
AMOUNT OF LIQUIDATION AGGREGATE STATED ANNUM
TRUST AMOUNT OF PRINCIPAL MATURITY INTEREST
PREFERRED COMMON AMOUNT OF OF RATE OF EXTENSION
NAME OF TRUST SECURITIES SECURITIES DEBENTURES DEBENTURES DEBENTURES PERIOD
------------- ----------- ----------- ---------- ---------- ---------- -------------------
(DOLLARS IN THOUSANDS)
Great Western Financial 20 consecutive
Trust I.............. $100,000 $ 3,093 $103,093 2025 8.250%
quarters
DECEMBER 31, 1996
-------------------
REDEMPTION
NAME OF TRUST OPTION
------------- -------------------
Great Western Financial On or after
Trust I..............
December 31, 2000
95
98
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17: OTHER BORROWINGS
Other borrowings consisted of the following:
DECEMBER 31,
----------------------------------------------------------
1997 1996
--------------------------- ---------------------------
AMOUNT INTEREST RATE AMOUNT INTEREST RATE
---------- ------------- ---------- -------------
(DOLLARS IN THOUSANDS)
Senior notes:
Series C floating rate, due in
2000,
LIBOR plus 1.375%............. $ -- --% $ 175,000 6.91%
Series B 9.60%, due in 1999...... -- -- 169,000 9.60
Due in 1997...................... -- -- 352,229 7.38-9.50
Due in 1998...................... 399,903 5.75-8.63 399,728 5.75-8.60
Due in 1999...................... 199,939 6.75-7.88 199,890 6.75-7.88
Due in 2000...................... 474,037 6.13-6.38 473,706 6.12-6.38
Due in 2001...................... 349,762 6.75-7.75 349,704 6.75-7.75
Due in 2002...................... 349,068 6.30-8.60 199,410 8.60
Due in 2003...................... 149,314 6.50 -- --
Due in 2005...................... 148,182 7.25 148,007 7.25
Subordinated notes:
Due in 1998...................... 99,979 8.88 99,948 8.88
Due in 1999...................... 99,788 7.50 99,659 7.50
Due in 2000...................... 63,275 10.25-10.50 63,253 10.25-10.50
Due in 2001...................... 149,764 9.88 149,708 9.88
Floating rate due in 1998,
LIBOR plus 2.875%............. -- -- 10,000 8.41
Other:
Notes payable, due in 1998....... 71,923 8.16 74,111 8.16
Notes payable, due in 2006....... 98,765 6.63 98,650 6.63
Other............................ 35,663 7.60-10.70 47,691 7.60-10.70
---------- ----------
$2,689,362 $3,109,694
========== ==========
In December 1996, the Company entered into two revolving credit facilities
with The Chase Manhattan Bank ("Chase"): a $100.0 million 364-day facility and a
$100.0 million four-year facility. In November 1997, these credit facilities
were amended by increasing the amounts for each from $100.0 million to $200.0
million. The facilities are available for general corporate purposes, including
providing capital to the Company's subsidiaries. As of December 31, 1997, there
were no outstanding borrowings under these facilities. As of December 31, 1997,
the Company had entered into five other credit agreements with various parties
permitting aggregate borrowing up to $735.1 million. The two largest of these
agreements were a $550.0 million revolving credit facility with Bank of Montreal
and Chase to back Aristar's commercial paper program and a $177.1 million letter
of credit with the FHLB of San Francisco to provide credit enhancement on
certain of the Company's private-issue MBS.
96
99
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18: INCOME TAXES
The provision for income taxes from continuing operations consisted of the
following:
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- -------- --------
(DOLLARS IN THOUSANDS)
Current income tax expense................ $ 529,047 $166,713 $197,515
Deferred income tax (benefit) expense..... (126,931) (25,493) 75,491
--------- -------- --------
$ 402,116 $141,220 $273,006
========= ======== ========
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 experience method in 1995.
The Small Business Job Protection Act of 1996 (the "Job Protection Act")
requires that qualified thrift institutions, such as WMB, WMBFA 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, the Company will have to recapture approximately $151.3 million and
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 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, 1997.
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 January 1998, the Company completed a settlement with the Internal
Revenue Service (the "Service") for GWFC for 1986 and 1987. The Service is
currently examining GWFC for 1988 through and including 1992 and WMB for 1992
and 1993. No additional adjustments are required as of December 31, 1997, for
the above examinations.
97
100
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,
---------------------------
1997 1996
---------- -----------
(DOLLARS IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards....................... $1,039,905 $ 1,269,124
Book loan loss reserves................................ 273,932 277,360
Purchase accounting adjustments........................ 14,262 20,153
Deferred losses........................................ 132,652 41,757
Other.................................................. 322,402 254,001
---------- -----------
1,783,153 1,862,395
Valuation allowance...................................... (966,087) (1,192,676)
---------- -----------
Deferred tax asset, net of valuation allowance........... 817,066 669,719
Deferred tax liabilities:
Tax bad debt reserves.................................. 51,113 63,193
Stock dividends from FHLBs............................. 188,902 155,629
Financial leases....................................... 66,087 70,035
Deferred loan fees..................................... 245,885 229,538
Deferred gains......................................... 163,825 172,733
Purchase accounting adjustments........................ 12,757 18,098
Other.................................................. 212,966 173,820
---------- -----------
941,535 883,046
---------- -----------
Net deferred tax liability............................... $ (124,469) $ (213,327)
========== ===========
The valuation allowances of $966.1 million at December 31, 1997 and $1.19
billion at December 31, 1996 included $45.8 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 decrease in the valuation allowance of $226.6 million during the year
ended December 31, 1997 was due primarily to adjustments for anticipated use of
net operating losses and a change in state tax rates.
Due to Section 382 of the Internal Revenue 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 adjustments. 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 amendments was offset by an equal
decrease in the valuation allowance for the deferred tax asset.
98
101
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, 1997
-----------------------
FEDERAL STATE
---------- ----------
(DOLLARS IN THOUSANDS)
1999........................................................ $ -- $ 551,522
2000........................................................ 1,497 599,241
2001........................................................ 140 557,803
2002........................................................ 278 --
2003........................................................ 1,483,640 --
2004........................................................ 784,195 --
2005........................................................ 700,619 --
2007........................................................ 12,780 --
2008........................................................ 37,460 --
---------- ----------
$3,020,609 $1,708,566
========== ==========
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, 1997 and 1996 were included in the
deferred tax liabilities and assets. The tax effect was recorded directly to
stockholders' equity and was not included in the provision for income taxes.
The change in the net deferred tax liability was as follows:
YEAR ENDED
DECEMBER 31, 1997
-----------------------
(DOLLARS IN THOUSANDS)
Deferred tax liability, beginning of year................... $(213,327)
Tax effect of valuation adjustment on available-for-sale
securities................................................ (33,155)
Deferred income tax benefit................................. 126,931
Other adjustments........................................... (4,918)
---------
Deferred tax liability, end of year......................... $(124,469)
=========
99
102
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,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Income taxes computed at statutory rates............... $318,849 $155,657 $322,412
Tax effect of:
State franchise tax, net of federal tax benefit...... 38,951 (38,616) 3,899
Utilization of tax losses of New West (nominee of
ASB).............................................. (21,260) (31,200) (17,482)
Amortization of goodwill and other intangible
assets............................................ 9,649 7,865 10,430
Dividends received deduction......................... (3,241) (2,460) (987)
Tax exempt income.................................... (1,971) (2,309) (1,973)
Restructuring adjustments............................ 68,276 9,321 --
Valuation allowance change from prior year........... -- 33,073 (7,114)
Change in tax laws and rates......................... -- 9,397 --
Adjustment of deferred tax rate...................... -- (2,239) 422
Increase in base year reserve amount................. -- (706) (16,318)
Low income housing................................... -- -- (5,065)
Reversal of taxes previously provided................ -- -- (2,533)
Other................................................ (7,137) 3,437 (12,685)
-------- -------- --------
Income taxes included in the
consolidated statements of income............ $402,116 $141,220 $273,006
======== ======== ========
NOTE 19: PAYMENTS IN LIEU OF TAXES
As a result of the Keystone Transaction, the Company 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% 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 certain 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 WMBFA to recognize certain loan fees ratably over seven years
adjusted for loan dispositions and treat certain of the income and expenses of
New American Capital, Inc. as income and expenses of WMBFA.
The provision for payments in lieu of taxes consisted of the following:
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996 1995
------- ------- ------
(DOLLARS IN THOUSANDS)
Federal.............................................. $15,948 $ 4,006 $3,450
State................................................ 1,284 21,181 4,437
------- ------- ------
$17,232 $25,187 $7,887
======= ======= ======
NOTE 20: 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.
100
103
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. The
Company 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 $41.6125 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 $41.6125. 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.
The operations of the Company are significantly influenced by general
economic conditions, by the related monetary and fiscal policies of the federal
government, and by the regulatory policies of financial institution regulatory
authorities. Deposit flows and cost of funds are influenced by interest rates on
competing investments and general market rates of interest. Lending and other
investment activities are affected by the demand for mortgage financing and
consumer and other types of loans, which in turn are affected by the interest
rates at which such financing may be offered and other factors affecting the
supply of housing and the availability of funds.
NOTE 21: STOCKHOLDERS' EQUITY
Common Stock
Cash dividends paid per share were as follows(1):
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
----- ----- -----
Fourth quarter.............................................. $0.28 $0.24 $0.20
Third quarter............................................... 0.27 0.23 0.19
Second quarter.............................................. 0.26 0.22 0.19
First quarter............................................... 0.25 0.21 0.19
- ---------------
(1) Amounts paid by acquired companies prior to their combination with the
Company were not included.
Prior to the business combination with Washington Mutual, acquired
companies paid total common cash dividends of $68.9 million, $193.0 million and
$133.6 million in 1997, 1996 and 1995.
101
104
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, regulatory and debt covenant restrictions on
their ability to pay dividends.
Retained earnings of the Company at December 31, 1997 included a pre-1988
thrift bad debt reserve for tax purposes of $1.22 billion 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.
In 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.
See -- "Note 20: Contingencies" for discussion of the 8,000,000 shares of
common stock held in escrow.
Preferred Stock
In 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. The Series E Preferred Stock is senior to common stock as to
dividends and liquidation, but does not confer general voting rights. In
November 1995, the Company purchased and retired 30,000 shares of the Series E
Preferred Stock.
In 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 had 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, were at an annual rate of $2.28 per share.
Dividends were declared and paid in all quarters since issuance. In November
1995, the Company purchased and retired 47,500 shares of the Series C Preferred
Stock. The Company redeemed the Series C Preferred Stock on January 1, 1998 at
the redemption price of $25 per share plus unpaid dividends, for the then
current dividend period up to the date fixed for redemption.
In 1992, GWFC issued 6,600,000 depository shares, each representing a
one-tenth interest in a share of 8.30% Cumulative Preferred Stock ("Cumulative
Preferred Stock"). The Cumulative Preferred Stock had a liquidation value of
$250 per share. Each share of Cumulative Preferred Stock, $1.00 par value, was
redeemable at the option of the Company on or after November 1, 1997, at $250
per share, plus accrued and unpaid dividends. Dividends were cumulative from the
date of issue and were payable quarterly. Dividends were declared and paid in
all quarters since issuance. On July 1, 1997, in connection with the Great
Western Merger, each outstanding share of Cumulative Preferred Stock was
converted into one share of Washington Mutual, Inc. 8.30% Cumulative Preferred
Stock, Series F ("Series F Preferred Stock"). The terms, preferences,
limitations, privileges and rights of the Series F Preferred Stock were
substantially identical to
102
105
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
those of the Cumulative Preferred Stock. As in the case of the Cumulative
Preferred Stock, each share of Series F Preferred Stock was represented by
depository shares (the "New Washington Mutual Depository Shares"), each
representing a one-tenth interest in a share of the Series F Preferred Stock.
The Company redeemed the Series F Preferred Stock on November 1, 1997.
Also in 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 1991, the Company issued 2,587,500 depository shares, each representing
a one-fifth interest in a share of 8.75% Cumulative Convertible Preferred Stock
("Convertible Preferred Stock"). The Convertible Preferred Stock had a
liquidation value of $250 per share. The Convertible Preferred Stock was
redeemable prior to May 1, 1996. Each share of Convertible Preferred Stock,
$1.00 par value, was redeemable at the option of the Company, in whole or in
part, at prices declining to $250 per share on or after May 1, 2001, from
$260.94 per share on or after May 1, 1996, plus accrued and unpaid dividends.
Each share of Convertible Preferred Stock was convertible at the option of the
holder into shares of common stock of the Company at a conversion price of
$20.40 per share of common stock, subject to adjustment in certain events.
Dividends were cumulative from the date of issue and were payable quarterly. In
September 1996, substantially all of the depository shares were converted to
approximately 5,666,000 shares of common stock.
In 1988, a subsidiary of Keystone Holdings 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. The Cumulative Redeemable Preferred Stock was redeemed on December
20, 1996.
NOTE 22: EARNINGS PER SHARE
In February 1997, the FASB issued SFAS No. 128, Earnings per Share. This
statement established standards for computing and presenting earnings per share
("EPS"). The statement simplified the standards for computing EPS and made them
comparable to international EPS standards. It replaced the presentation of
primary EPS with the presentation of basic EPS. Basic EPS excludes dilution and
is computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. Diluted EPS is
computed similarly to previously reported fully diluted EPS. This statement
required restatement of all prior period EPS data presented.
103
106
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information used to calculate EPS was as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1997 1996
------------------------------------- -----------
PER
INCOME SHARES SHARE INCOME
(NUMERATOR) (DENOMINATOR) AMOUNTS (NUMERATOR)
----------- ------------- ------- -----------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Basic EPS:
Net income...................... $481,778 $230,100
Less: preferred stock
dividends..................... (21,432) (38,714)
-------- --------
Income available to common
shareholders.................. 460,346 246,119,646 $1.87 191,386
Diluted EPS:
Effect of dilutive securities:
Options....................... 925,693
Convertible preferred
stock.......................
Income available to
common shareholders
-------- ----------- --------
and assumed conversions....... $460,346 247,045,339 $1.86 $191,386
======== =========== ========
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995
----------------------- -------------------------------------
PER PER
SHARES SHARE INCOME SHARES SHARE
(DENOMINATOR) AMOUNTS (NUMERATOR) (DENOMINATOR) AMOUNTS
------------- ------- ----------- ------------- -------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Basic EPS:
Net income...................... $550,924
Less: preferred stock
dividends..................... (43,599)
--------
Income available to common
shareholders.................. 235,115,650 $0.81 507,325 232,104,843 $2.19
Diluted EPS:
Effect of dilutive securities:
Options....................... 2,567,764 1,323,521
Convertible preferred
stock....................... 19,720 11,126,968
Income available to
common shareholders
----------- -------- -----------
and assumed conversions....... 237,683,414 $0.81 $527,045 244,555,332 $2.16
=========== ======== ===========
Options to purchase 2,984,550 million shares of common stock at a weighted
average exercise price of $62.80 per share were outstanding at December 31,
1997, but were not included in the computation of diluted EPS because the
exercise price of the options was greater than the average market price of the
common shares during the period. Additionally, as part of the business
combination with Keystone Holdings, 8,000,000 shares of common stock, with an
assigned value of $41.6125 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 conditions upon which these shares are contingently issuable
are not based on earnings or market price. The contingencies had not been met at
December 31, 1997, and therefore the contingently issuable shares have not been
included in the above computations.
NOTE 23: REGULATORY CAPITAL REQUIREMENTS
WMI is not subject to any regulatory capital requirements. However, each of
its subsidiary depository institutions is subject to various capital
requirements. WMB is subject to FDIC capital requirements while WMBFA and WMBfsb
are subject to Office of Thrift Supervision ("OTS") capital requirements. The
Company's also owns two small industrial banks that are subject to FDIC capital
requirements. At December 31, 1997, these two institutions met all capital
requirements to which they were subject and were considered well capitalized.
The capital adequacy requirements are quantitative measures established by
regulation that require WMBFA, WMB 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 WMBFA and WMBfsb to maintain minimum ratios of total
capital to risk-weighted assets, as well as ratios of core capital and tangible
capital to tangible assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") created a statutory framework that increased the importance of
meeting applicable capital requirements. 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-
104
107
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
any of the Company's depository institutions to comply with applicable capital
requirements would, if unremedied, result in restrictions on its activities and
lead to regulatory enforcement actions against such institution 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.
The actual regulatory capital ratios calculated for WMBFA, WMB and WMBfsb,
along with the minimum capital amounts and ratios for capital adequacy purposes
and the minimum amounts required to be categorized as well capitalized under the
regulatory framework for prompt corrective action were as follows:
DECEMBER 31, 1997
------------------------------------------------------------
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)
WMBFA:
Total capital to risk-weighted
assets(2).......................... $4,497,262 11.11% $3,242,490 8.00% $4,050,336 10.00%
Tier I capital to risk-weighted
assets............................. 3,865,394 9.54 -- -- 2,434,644 6.00
Core capital to adjusted tangible
assets............................. 3,865,394 5.78 2,007,736 3.00 3,346,226 5.00
Tangible capital to tangible assets... 3,865,394 5.78 1,003,868 1.50 -- --
WMB:
Total capital to risk-weighted
assets............................. 1,605,745 10.93 1,175,592 8.00 1,469,490 10.00
Tier I capital to risk-weighted
assets............................. 1,488,610 10.13 587,796 4.00 881,694 6.00
Tier I capital to average assets...... 1,488,610 5.86 1,015,372 4.00 1,269,216 5.00
WMBfsb:
Total capital to risk-weighted
assets(2).......................... 77,813 11.95 52,077 8.00 65,096 10.00
Tier I capital to risk-weighted
assets............................. 70,535 10.84 -- -- 39,058 6.00
Core capital to adjusted tangible
assets............................. 70,535 6.66 31,789 3.00 52,982 5.00
Tangible capital to tangible assets... 70,535 6.66 15,895 1.50 -- --
105
108
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
------------------------------------------------------------
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)
WMBFA:
Total capital to risk-weighted
assets(2).......................... $4,070,395 11.12% $2,929,835 8.00% $3,660,828 10.00%
Tier I capital to risk-weighted
assets............................. 3,464,547 9.46 -- -- 2,198,843 6.00
Core capital to adjusted tangible
assets............................. 3,464,547 5.61 1,852,145 3.00 3,086,909 5.00
Tangible capital to tangible assets... 3,463,438 5.61 926,073 1.50 -- --
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 5.84 843,623 4.00 1,054,529 5.00
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 -- -- 36,964 6.00
Core capital to adjusted tangible
assets............................. 64,707 6.90 28,254 3.00 46,923 5.00
Tangible capital to tangible assets... 64,707 6.90 14,077 1.50 -- --
- ---------------
(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.
Management believes, as of December 31, 1997, that WMBFA, WMB and WMBfsb
individually met all capital adequacy requirements to which they were subject.
Additionally, as of the most recent notifications from the FDIC (for WMB) and
the OTS (for WMBFA and WMBfsb) prior to both December 31, 1997 and 1996, the
FDIC and OTS individually categorized WMBFA, WMB 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 and 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 WMBFA's, WMB'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 WMBFA 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 WMBFA 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
106
109
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
NOTE 24: STOCK OPTION PLANS 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 (the "1994
Plan") in which the right to purchase common stock of the Company may be granted
to officers, 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. The 1994 Plan does not affect any options granted under the
1983 plan.
Under the 1994 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.
On September 16, 1997, the Company's Board of Directors approved the
adoption of a broad-based stock option plan called "WAMU Shares" as part of the
Company's effort to build a unified team and to appropriately compensate its
employees. This plan provides for an award of nonqualified stock options to all
eligible employees who were employed by the Company on September 1, 1997.
Generally, full-time employees received an option to purchase 100 shares of
Company common stock, while part-time employees received an option to purchase
50 shares, and employees who were designated to receive options under the 1994
Plan were excluded. All grants were made using the fair market value of the
Company's common stock on September 1, 1997, and all options vest on September
1, 1999. The WAMU Shares plan provides for the granting of options for a maximum
of 2,200,000 common shares.
On April 26, 1988, GWFC stockholders approved the adoption of the 1988
Stock Option and Incentive Plan (the "GWFC Plan"). Options were granted at the
market value of the GWFC common stock on the date of grant. The GWFC plan
consisted of two separate plans: the Key Employee Program, under which options
(both incentive and nonqualified), stock appreciation rights, dividend
equivalents and certain other performance and incentive awards were granted to
officers, key employees and certain other individuals; and the Non-employee
Director Program, under which nonqualified options were granted to non-employee
directors under certain circumstances. Options may be exercised either by
payment of cash, or the optionee may deliver WMI common stock of an equivalent
market value at the date of exercise. As of July 1, 1997, this plan was amended
to eliminate further grants.
Stock options under all Plans are generally exercisable on a phased-in
schedule over three to five years, depending upon the date of grant, and expire
five to 10 years from the grant date. At December 31, 1997, options to purchase
1,747,416 shares were fully exercisable.
107
110
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock options granted, exercised, or forfeited were as follows:
WEIGHTED AVERAGE
WEIGHTED AVERAGE FAIR VALUE PER SHARE
NUMBER OF EXERCISE PRICE OF OF OPTIONS AT
OPTION SHARES OPTION SHARES DATE OF GRANT
------------- ----------------- --------------------
Balance, beginning of 1995............... 7,626,589 $17.65
Granted in 1995.......................... 823,012 20.01 $ 5.62
Exercised in 1995........................ (925,468) 16.58
Forfeited in 1995........................ (279,312) 20.10
---------- ------
Balance, end of 1995..................... 7,244,821 18.01
Granted in 1996.......................... 4,406,339 31.48 9.10
Exercised in 1996........................ (1,156,121) 18.07
Forfeited in 1996........................ (195,752) 21.30
---------- ------
Balance, end of 1996..................... 10,299,287 23.70
Granted in 1997.......................... 3,165,259 61.46 16.59
Exercised in 1997........................ (7,946,473) 23.17
Forfeited in 1997........................ (65,626) 31.72
---------- ------
Balance, end of 1997..................... 5,452,447 $46.32
========== ======
Financial data pertaining to outstanding stock options were as follows:
DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED AVERAGE
NUMBER OF REMAINING AVERAGE NUMBER OF EXERCISE PRICE OF
RANGES OF OPTION CONTRACTUAL EXERCISE PRICE EXERCISABLE EXERCISABLE
EXERCISE PRICES SHARES LIFE OF OPTION SHARES OPTION SHARES OPTION SHARES
- ---------------------- --------- ---------------- ---------------- ------------- -----------------
$ 7.53 through
$ 8.44.............. 380,375 2.8 $ 8.09 380,375 $ 8.09
10.53 through 13.48.. 112,579 4.2 12.75 112,579 12.75
17.29 through 26.25.. 801,796 6.4 21.64 732,801 21.78
26.53 through 38.50.. 562,647 8.4 30.30 316,308 31.73
42.63 through 42.75.. 581,000 9.0 42.64 196,353 42.64
47.50 through 67.38.. 3,014,050 9.8 62.66 9,000 49.87
--------- ------ --------- ------
5,452,447 $46.32 1,747,416 $22.51
========= ====== ========= ======
Under the terms of the Company's employee stock purchase plan ("ESPP"), 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 ESPP, 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 its fair value recognition provisions. FAS 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
108
111
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company adopted the disclosure requirements of SFAS No. 123, but has determined
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 plans and its ESPP.
Had compensation cost for the Company's compensation plans been determined
consistent with SFAS No. 123, the Company's net income available to fully
diluted common stock and fully diluted earnings per share would have been
reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
------------------------------------------------
1997 1996 1995
------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income attributable to common stock
Basic:
As reported............................ $460,346 $191,386 $507,325
Pro forma.............................. 429,395 186,568 506,503
Diluted:
As reported............................ 460,346 191,386 515,725
Pro forma.............................. 429,395 186,568 514,903
Net income per common share
Basic:
As reported............................ $1.87 $0.81 $2.19
Pro forma.............................. 1.74 0.79 2.19
Diluted:
As reported............................ 1.86 0.81 2.16
Pro forma.............................. 1.74 0.78 2.16
The compensation expense included in the pro forma net income attributable
to diluted common stock and 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 plans is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions used for grants in 1997, 1996 and
1995: annual dividend yield of 2.67% for 1997 and 2.50% for 1996 and 1995;
expected volatility of 27.37% for 1997 and 23.99% for 1996 and 1995; risk-free
interest rates of 6.01% for 1997 and 5.78% for 1996 and 1995; and expected lives
of five years for 1997, 1996 and 1995.
NOTE 25: EMPLOYEE BENEFITS PROGRAMS
Washington Mutual maintains a noncontributory cash balance defined benefit
pension plan (the "Pension Plan") for substantially all eligible employees.
Benefits earned for each year of service are based primarily on the level of
compensation in that year plus a stipulated rate of return on the 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. ASB provided a
noncontributory defined benefit pension plan (the "ASB Plan" and together with
the Pension Plan, the "Pension Plans"), which was terminated effective June 30,
1995. The combined net periodic pension cost for the Pension Plans was $3.2
million, $2.1 million and $2.0 million for 1997, 1996 and 1995; the weighted
average discount rate was 7.25% for 1997 and 1996 and 8.00% for 1995; the
long-term rate of return on assets was 8.00% for 1997, 1996 and 1995; and the
assumed rate of increase in future compensation levels was 6.00% for all years
presented. The Pension Plans' assets consist primarily of listed common stocks,
U.S. government obligations, asset-backed securities, corporate debt
obligations, and annuity contracts.
109
112
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At the termination date of the ASB Plan, all participants' accrued benefits
became fully vested. The net assets of the ASB Plan were allocated as prescribed
by the Employee Retirement Income Security Act of 1974 and 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.
WMBFA maintains a substantially similar plan from the Great Western Merger
(the "Great Western Plan"). On January 1, 1997, the Great Western Plan was
converted from a final average pay plan to a cash balance plan, under which
participants' accounts are credited with pay-related contributions and interest.
It is the Company's policy to fund the Great Western Plan on a current basis to
the extent deductible under federal income tax regulations. The net periodic
pension cost or benefit for the Great Western Plan was a benefit of $4.5 million
for 1997, and a cost of $400,000 for 1996 and a cost of $7.6 million for 1995,
the weighted average discount rate was 7.50%, 7.81%, and 8.25% for 1997, 1996
and 1995; the long-term rate of return on assets was 9.0% for all three years
presented; and the assumed rate of increase in future compensation levels was
5.25% for 1997 and 1996, and 5.50% for 1995. The Great Western Plan assets
consist primarily of listed common stocks, U.S. government obligations,
asset-backed securities, corporate debt obligations, and annuity contracts.
The Company's defined benefit plans' status and amounts recognized in the
financial statements were as follows:
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
Benefit obligations:
Vested benefits........................................ $(244,525) $(214,687)
Nonvested benefits..................................... (5,104) (12,571)
--------- ---------
Accumulated benefit obligation........................... (249,629) (227,258)
Effect of future compensation increases.................. (4,006) (1,168)
--------- ---------
Projected benefit obligation............................. (253,635) (228,426)
Plan assets at fair value................................ 333,000 307,168
--------- ---------
Plan assets in excess of projected benefit obligation.... 79,365 78,742
Unrecognized gain due to past experience different from
assumptions............................................ 7,613 2,303
Unrecognized prior service cost.......................... (34,204) (29,221)
Unrecognized net asset at transition being recognized
over 18.6 years........................................ (2,536) (2,918)
--------- ---------
Prepaid pension asset.................................... $ 50,238 $ 48,906
========= =========
The assumptions used in determining the actuarial present value of the
projected benefit obligation at December 31 were: weighted average discount rate
of 7.00% for 1997 and 7.50% for 1996 and 1995; rate of increase in future
compensation level was 5.25% for all years presented; and expected long-term
rate of return on plan assets was 9.00% for all years presented.
110
113
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net periodic pension expense for the Company's defined benefit plans was as
follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
Service cost -- benefits earned during the
period........................................... $ 12,604 $ 12,294 $ 12,600
Interest cost on projected benefit obligations..... 16,589 16,953 18,196
Actual (gain) on plan assets....................... (31,838) (27,253) (28,534)
Amortization and deferral, net..................... 1,313 517 7,348
-------- -------- --------
$ (1,332) $ 2,511 $ 9,610
======== ======== ========
The Company sponsors unfunded defined benefit postretirement plans that
make medical and life insurance coverage available to eligible employees and
dependents based on age and length of service. Medical coverage options are the
same as available to active employees. The cost of the plan coverage for
retirees and their qualifying dependents is based upon a point system that
combines age and years of service which results, generally, in lower costs to
retirees in conjunction with higher accumulated points within limits.
Postretirement benefits, such as retiree health benefits, are accrued during the
years an employee provides services.
The funded status of these benefits were as follows:
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
Accumulated postretirement benefit obligation............... $(34,600) $(57,836)
Unrecognized transition obligation.......................... 2,209 2,356
Unrecognized (gain)......................................... (6,249) (4,782)
-------- --------
Prepaid postretirement liability............................ $(38,640) $(60,262)
======== ========
Net periodic postretirement expense was as follows:
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ------ ------
(DOLLARS IN THOUSANDS)
Service cost............................................. $1,454 $2,445 $2,513
Interest cost............................................ 3,422 3,998 4,240
Amortization of transition obligation.................... 147 147 147
Curtailment (gain)....................................... (350) (580) (570)
------ ------ ------
$4,673 $6,010 $6,330
====== ====== ======
Net periodic postretirement expense was calculated using the following
assumptions: the weighted average discount rate was 7.25% for all years
presented; and the medical trend rate was estimated to increase at a rate of
9.00% in 1996 and 8.00% in 1997, thereafter decreasing 1.00% per year until a
stable 5.00% medical inflation rate is reached in 2000. The effect of a 1.00%
increase in the trend rates is not significant.
The Company, as successor to GWFC, has assumed responsibility for certain
unfunded post retirement benefits, including retirement restoration plans for
certain employees, a supplemental Executive Retirement Plan (the "GW SERP") for
certain senior officers and a nonqualified directors' retirement plan. At
December 31, 1997, the projected benefit obligation for these plans was $4.5
million. The Company has purchased cost recovery life insurance, primarily with
one carrier, on the lives of the participants in the GW SERP, the directors'
retirement plan and the deferred compensation plan (described below), and it is
sole owner and beneficiary of said policies. The net cash surrender value of
this life insurance, recorded in other
111
114
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
assets, was $187.5 million at December 31, 1997 and $180.3 million at December
31, 1996, and net premium income related to insurance purchased was $7.0 million
in 1997, $8.4 million in 1996 and $6.8 million in 1995.
The Company sponsors a Supplemental Executive Retirement Plan (the "ASB
SERP"), under which benefits are paid to certain officers formerly of ASB 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 10 years of employment. These benefits are
reduced to the extent a participant receives benefits from the ASB Plan and
social security benefits. WMBFA has purchased cost recovery life insurance,
primarily with two carriers, on the lives of the participants of the ASB SERP
and deferred compensation plan, and it is the sole owner and beneficiary of said
policies. The amount of coverage is designed to provide sufficient revenues to
fund said plans. The net cash surrender value of this life insurance, recorded
in other assets, was $29.6 million at December 31, 1997.
The Company sponsors a Supplemental Employee Retirement Plan ("WMI SERP")
for the benefit of certain officers. The WMI SERP is a nonqualified,
noncontributory plan designed to supplement the benefits that are accrued under
the Pension Plan with respect to compensation earned above designated
compensation limits. Compensation for the WMI SERP includes amounts deferred
into a compensation plan sponsored by the Company.
The Company also sponsors the Washington Mutual, Inc. Supplemental
Executive Retirement Accumulation Plan ("WMI SERAP") for the purpose of
providing supplemental retirement benefits for certain officers. The level of
the benefits under the SERAP is determined by the Company. The SERAP is not
funded.
The Company maintains a retirement savings and investment plan for
substantially all eligible employees that allows participants to make
contributions by salary deduction equal to 15% or less of their salary pursuant
to Section 401(k) of the Internal Revenue Code. Employees' contributions vest
immediately. The Company's partial matching contributions vest over five years.
The Company maintains a savings plan for substantially all eligible
employees formerly of GWFC that allows participants to make contributions equal
to 14% or less of their salary pursuant to Section 401(k) of the Internal
Revenue Code. The Company's partial matching contributions vest over five years.
The Company maintains optional deferred compensation plans for certain
employees formerly employed by GWFC and ASB. Eligible employees covered defer a
portion of their compensation, and the Company agrees to pay interest on the
balance of funds deferred. An enhanced rate is paid on funds deferred over three
years. No additional compensation may be deferred under these plans.
The Company provides an optional deferred compensation plan for certain
employees and directors. Eligible participants can defer a portion of their
compensation, and WMI agrees to pay interest on the balance of funds deferred.
The Company 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.
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
benefits under the PSP were payable, and ASB incurred an expense of $12.0
million in December 1996.
112
115
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Total employee benefit plan expense was as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
Company's contributions to savings plans.............. $21,373 $21,934 $19,163
SERP expense.......................................... 6,928 6,494 5,821
Net periodic postretirement expense................... 4,673 6,010 6,330
Net periodic pension expense.......................... (1,332) 2,511 9,610
Restricted stock expense.............................. 2,831 4,736 3,958
Other................................................. 4,226 3,928 4,120
------- ------- -------
$38,699 $45,613 $49,002
======= ======= =======
NOTE 26: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations on a quarterly basis have been restated to give
effect to the business combination with GWFC. Results of operations on a
quarterly basis were as follows:
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------------------------------------
FIRST QUARTER(1) SECOND QUARTER(1)
---------------------------------- ----------------------------------
WASHINGTON WASHINGTON
MUTUAL GWFC RESTATED MUTUAL GWFC RESTATED
---------- -------- ---------- ---------- -------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income............... $830,154 $785,262 $1,615,416 $876,165 $794,184 $1,670,349
Interest expense.............. 509,780 446,094 955,874 550,386 466,578 1,016,964
-------- -------- ---------- -------- -------- ----------
Net interest income........... 320,374 339,168 659,542 325,779 327,606 653,385
Provision for loan losses..... 13,420 40,390 53,810 13,927 36,072 49,999
Other income.................. 71,500 116,751 188,251 72,521 115,626 188,147
Other expense................. 194,270 300,826 495,096 195,944 276,248 472,192
-------- -------- ---------- -------- -------- ----------
Income before income taxes.... 184,184 114,703 298,887 188,429 130,912 319,341
Income taxes.................. 70,112 49,000 119,112 69,705 58,579 128,284
-------- -------- ---------- -------- -------- ----------
Net income.................... $114,072 $ 65,703 $ 179,775 $118,724 $ 72,333 $ 191,057
======== ======== ========== ======== ======== ==========
Net income attributable to
common stock................ $111,567 $ 62,279 $ 173,846 $116,219 $ 68,909 $ 185,128
======== ======== ========== ======== ======== ==========
Net income per common share:
Basic....................... $1.00 $0.72 $1.04 $0.76
Diluted..................... 0.99 0.71 1.03 0.75
113
116
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, 1997
-------------------------------
THIRD QUARTER FOURTH QUARTER
WASHINGTON WASHINGTON
MUTUAL MUTUAL
------------- --------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Interest income............................................. $1,728,553 $1,796,646
Interest expense............................................ 1,072,902 1,108,751
---------- ----------
Net interest income......................................... 655,651 687,895
Provision for loan losses................................... 52,131 51,199
Other income................................................ 111,113 225,889
Other expense............................................... 825,966 468,354
---------- ----------
Income (loss) before income taxes........................... (111,333) 394,231
Income taxes................................................ 15,621 156,331
---------- ----------
Net income (loss)........................................... $ (126,954) $ 237,900
========== ==========
Net income (loss) attributable to common stock.............. $ (132,883) $ 234,255
========== ==========
Net income (loss) per common share:
Basic..................................................... $(0.54) $0.94
Diluted................................................... (0.54) 0.94
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------------------------------------
FIRST QUARTER(1) SECOND QUARTER(1)
---------------------------------- ----------------------------------
WASHINGTON WASHINGTON
MUTUAL GWFC RESTATED MUTUAL GWFC RESTATED
---------- -------- ---------- ---------- -------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income............... $764,622 $825,240 $1,589,862 $776,269 $808,617 $1,584,886
Interest expense.............. 477,620 472,642 950,262 476,508 454,994 931,502
-------- -------- ---------- -------- -------- ----------
Net interest income........... 287,002 352,598 639,600 299,761 353,623 653,384
Provision for loan losses..... 19,910 36,021 55,931 19,396 32,566 51,962
Other income.................. 58,594 85,792 144,386 60,893 90,221 151,114
Other expense................. 183,657 283,575 467,232 189,040 280,707 469,747
-------- -------- ---------- -------- -------- ----------
Income before income taxes and
minority interest........... 142,029 118,794 260,823 152,218 130,571 282,789
Income taxes.................. 49,695 47,500 97,195 49,151 51,300 100,451
Minority interest in earnings
of consolidated
subsidiary.................. 3,527 -- 3,527 3,450 -- 3,450
-------- -------- ---------- -------- -------- ----------
Net income.................... $ 88,807 $ 71,294 $ 160,101 $ 99,617 $ 79,271 $ 178,888
======== ======== ========== ======== ======== ==========
Net income attributable to
common stock................ $ 84,202 $ 65,040 $ 149,242 $ 95,013 $ 73,029 $ 168,042
======== ======== ========== ======== ======== ==========
Net income per common share:
Basic....................... $0.75 $0.64 $0.85 $0.71
Diluted..................... 0.74 0.64 0.83 0.71
114
117
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------------------------------------
THIRD QUARTER(1) FOURTH QUARTER(1)
---------------------------------- ----------------------------------
WASHINGTON WASHINGTON
MUTUAL GWFC RESTATED MUTUAL GWFC RESTATED
---------- -------- ---------- ---------- -------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income............... $797,694 $801,486 $1,599,180 $810,651 $802,511 $1,613,162
Interest expense.............. 501,074 461,742 962,816 503,027 466,536 969,563
-------- -------- ---------- -------- -------- ----------
Net interest income........... 296,620 339,744 636,364 307,624 335,975 643,599
Provision for loan losses..... 15,269 41,671 56,940 141,702 85,900 227,602
Other income.................. 69,016 82,995 152,011 76,378 134,275 210,653
Other expense................. 320,089 449,343 769,432 343,370 378,818 722,188
-------- -------- ---------- -------- -------- ----------
Income before income taxes and
minority interest........... 30,278 (68,275) (37,997) (101,070) 5,532 (95,538)
Income taxes.................. 12,963 (28,400) (15,437) (16,202) 400 (15,802)
Minority interest in earnings
of consolidated
subsidiary.................. 3,527 -- 3,527 3,066 -- 3,066
-------- -------- ---------- -------- -------- ----------
Net income (loss)............. $ 13,788 $(39,875) $ (26,087) $(87,934) $ 5,132 $ (82,802)
======== ======== ========== ======== ======== ==========
Net income (loss) attributable
to common stock............. $ 9,183 $(44,250) $ (35,067) $(92,539) $ 1,708 $ (90,831)
======== ======== ========== ======== ======== ==========
Net income (loss) per common
share:
Basic....................... $0.08 $(0.15) $(0.82) $(0.38)
Diluted..................... 0.08 (0.15) (0.82) (0.38)
- ---------------
(1) Previously reported balances of the merged companies have been reclassified
to conform to the Company's presentation and restated to give effect to the
combination.
NOTE 27: 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 fixed-rate SFR loan
production or fixed-rate MBS; and the use of derivative instruments, such as
interest rate exchange agreements, interest rate cap agreements, cash flow swap
agreements, put options and forward sales contracts.
The Company uses forward sales contracts to hedge its exposure to
increasing interest rates with respect to fixed-rate loans which the Company
intends to sell in the secondary market. Forward sales contracts are used to
sell specific financial instruments (fixed-rate loans) at a future date for a
specified price. Gains or losses are recognized at the time the contracts mature
and are recorded as a component of gain on sale of loans and leases. At December
31, 1997, the Company had executed $812.1 million in forward sales contracts to
hedge $930.7 million in fixed-rate SFR loan commitments which are expected to
close as well as loans which have been funded but not yet sold. At December 31,
1996, the Company had executed $215.4 million in forward sales contracts.
Interest rate exchange agreements, cash flow swap agreements, interest rate
cap agreements, put options and forward sales contracts 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 various derivative agreements through counterparty credit
review, counterparty exposure limits and monitoring procedures.
115
118
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. During 1997 and 1996, the Company did not terminate any interest
rate exchange agreements, cash flow swaps or interest rate cap agreements.
Scheduled maturities of interest rate exchange agreements were as follows:
DECEMBER 31, 1997
----------------------------------------------------------------
NOTIONAL SHORT-TERM LONG-TERM CARRYING FAIR
AMOUNT RECEIPT RATE(1) PAYMENT RATE VALUE VALUE
---------- --------------- ------------ -------- -------
(DOLLARS IN THOUSANDS)
Designated against available-for-sale
securities:
Due within one year.................. $ 300,000 5.83% 6.05% $(334) $ (334)
After one but within two years....... 500,000 5.88 5.97 116 116
Designated against deposits and
borrowings:
Due within one year.................. 506,533 5.59 6.07 -- (1,541)
After one but within two years....... 277,600 5.45 7.94 -- (8,301)
After two but within three years..... 259,000 6.50 5.62 -- 6,534
After three years.................... 243,800 4.90 5.49 -- (101)
---------- ----- ----- ----- -------
$2,086,933 5.71% 6.17% $(218) $(3,627)
========== ===== ===== ===== =======
DECEMBER 31, 1996
-------------------------------------------------------------------
NOTIONAL SHORT-TERM LONG-TERM CARRYING FAIR
AMOUNT RECEIPT RATE(1) PAYMENT RATE VALUE 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 years.... 200,000 5.87 6.09 265 265
Designated against deposits and
borrowings:
Due within one year................. 578,948 7.34 6.24 (498) 6,924
After one but within two years...... 506,533 5.45 6.04 52 (1,839)
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
---------- ---- ---- ------- --------
$2,570,881 5.98% 6.23% $(1,092) $ 11,250
========== ==== ==== ======= ========
116
119
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Scheduled maturities of interest rate cap agreements were as follows:
DECEMBER 31, 1997
---------------------------------------------------------
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)...................... $ 650,000 6.17% 5.89% $ 1,202 $1,202
Designated against deposits and borrowings:
Due within one year(3)...................... 565,500 7.89 5.82 380 (771)
After one but within two years(4)........... 855,750 7.16 5.33 3,505 157
After two but within three years(5)......... 265,000 8.00 5.53 1,498 106
After three years(6)........................ 538,750 8.11 5.11 6,005 710
---------- ---- ---- ------- ------
$2,875,000 7.34% 5.53% $12,590 $1,404
========== ==== ==== ======= ======
- ---------------
(1) The terms of each agreement had specific LIBOR or COFI reset and index
requirements, which resulted in different short-term receipt rates for each
agreement. The receipt rate represented the weighted average rate as of the
last reset date for each agreement.
(2) Included $550.0 million notional amount with a weighted average cap ceiling
of 7.64% and $100.0 million notional amount with a binary (1.00%) cap.
(3) Included $150.0 million notional amount with a weighted average cap floor of
5.50% and $240.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(4) Included $839.8 million notional amount with a weighted average cap ceiling
of 8.77%.
(5) Included $112.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(6) Included $459.8 million notional amount with a weighted average cap ceiling
of 9.49%.
DECEMBER 31, 1996
---------------------------------------------------------
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)..................... $ 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 had specific LIBOR or COFI reset and index
requirements, which resulted in different short-term receipt rates for each
agreement. The receipt rate represented the weighted average rate as of the
last reset date for each agreement.
(2) Included $600.0 million notional amount with a weighted average cap ceiling
of 7.75%.
(3) Had a weighted average cap ceiling of 7.56%.
(4) Included $45.0 million notional amount with a weighted average cap ceiling
of 9.50%.
(5) Included $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) Included $839.8 million notional amount with a weighted average cap ceiling
of 8.77%.
(7) Included $571.8 million notional amount with a weighted average cap ceiling
of 9.49%.
117
120
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,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Weighted average net effective cost (benefit) at end of
year................................................. 0.55% 0.24% (0.24)%
Weighted average net effective cost (benefit) during
the year............................................. 0.60 (0.26) (0.45)
Monthly average notional amount of interest rate
exchange agreements.................................. $2,107,184 $2,882,041 $3,049,803
Maximum notional amount of interest rate exchange
agreements at any month-end.......................... 2,466,233 3,436,157 3,208,681
Net cost (benefit) included with interest expense on
deposits during the year............................. 3,951 (14,471) (9,260)
Net cost included with interest expense on borrowings
during the year...................................... 5,975 9,951 5,889
Net cost (benefit) included with interest income on
available-for-sale securities during the year........ 2,637 (2,984) (10,495)
Financial data pertaining to interest rate cap agreements were as follows:
YEAR ENDED DECEMBER 31, 1996
---------------------------------------
1997 1996 1995
---------- ----------- ----------
(DOLLARS IN THOUSANDS)
Monthly average notional amount of interest rate
cap agreements................................. $3,897,769 $10,433,750 $6,363,000
Maximum notional amount of interest rate cap
agreements at any month end.................... 3,965,000 12,514,500 9,774,000
Net cost included with interest expense on
deposits during the year....................... 5,773 6,206 7,875
Net cost included with interest expense on
borrowings during the year..................... -- 2,162 415
Net cost (benefit) included with interest income
on available-for-sale securities during the
year........................................... 3,612 (4,686) (5,340)
Changes in interest rate exchange agreements and interest rate cap
agreements were as follows:
YEAR ENDED DECEMBER 31, 1997
------------------------------
INTEREST RATE INTEREST RATE
EXCHANGE CAP
AGREEMENTS AGREEMENTS
------------- -------------
(DOLLARS IN THOUSANDS)
Notional balance, beginning of year......................... $2,570,881 $6,780,000
Additions................................................... 300,000 --
Maturities.................................................. 783,948 3,905,000
---------- ----------
Notional balance, end of year............................... $2,086,933 $2,875,000
========== ==========
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 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.
118
121
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of financial instruments were as follows:
DECEMBER 31,
-----------------------------------------------------
1997 1996
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Financial assets:
Cash and cash equivalents................. $ 1,560,890 $ 1,560,890 $ 1,665,355 $ 1,665,355
Trading securities........................ 23,364 23,364 1,647 1,647
Available-for-sale securities............. 11,372,938 11,372,938 16,093,529 16,093,529
Held-to-maturity securities............... 12,779,614 12,699,653 4,479,056 4,545,125
Loans, exclusive of reserve for loan
losses................................. 67,810,651 68,607,997 61,831,109 61,849,717
Investment in FHLBs....................... 1,059,491 1,059,491 843,002 843,002
Mortgage servicing rights................. 215,360 228,484 185,984 213,121
----------- ----------- ----------- -----------
94,822,308 95,552,817 85,099,682 85,211,496
Financial liabilities:
Deposits.................................. 50,986,017 50,916,683 52,666,914 52,779,563
Annuities................................. -- -- 878,057 878,057
Federal funds purchased and
commercial paper....................... 2,928,282 2,930,231 2,153,506 2,153,506
Reverse repurchase agreements............. 12,279,040 12,279,962 12,033,119 12,050,518
Advances from FHLBs....................... 20,301,963 20,325,343 10,011,425 10,028,513
Trust preferred securities................ 800,000 854,692 100,000 99,520
Other borrowings.......................... 2,689,362 2,774,939 3,109,694 3,286,356
----------- ----------- ----------- -----------
89,984,664 90,081,850 80,952,715 81,276,033
Derivative financial instruments(1):
Interest rate exchange agreements:
Designated against available-for-sale
securities........................... (218) (218) (646) (646)
Designated against deposits and
borrowings........................... -- (3,409) (446) 11,896
Interest rate cap agreements:
Designated against available-for-sale
securities........................... 1,202 1,202 2,460 2,460
Designated against deposits and
borrowings........................... 11,388 202 17,533 3,411
----------- ----------- ----------- -----------
Total............................. 12,372 (2,223) 18,901 17,121
Other off-balance sheet instruments:
Standby letters of credit................. -- -- -- (42)
Forward sales contracts designated
against loans.......................... -- (4,861) -- 83
Off-balance sheet loan commitments........ -- (781) -- 7,714
----------- ----------- ----------- -----------
-- (5,642) -- 7,755
----------- ----------- ----------- -----------
Net financial instruments......... $ 4,850,016 $ 5,463,102 $ 4,165,868 $ 3,960,339
=========== =========== =========== ===========
- ---------------
(1) See Note 27: Interest Rate Risk Management.
119
122
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument as of December 31, 1997 and 1996:
Cash and cash equivalents -- The carrying amount represented fair
value.
Trading securities -- Fair values were based on quoted market prices.
Available-for-sale securities -- Fair values were based on quoted
market prices. If a quoted market price was not available, fair value was
estimated using market prices for similar securities as well as internal
analytics.
Held-to-maturity securities -- Fair values were based on quoted market
prices. If a quoted market price was not available, fair value was
estimated using market prices for similar securities, as well as internal
analytics.
Loans -- Loans were priced using the discounted cash flow method. The
discount rate used was the rate currently offered on similar products.
Investment in FHLBs -- The carrying amount represented fair value.
Mortgage servicing rights -- The fair value of mortgage servicing
rights was 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
MMDAs 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
alternate funding sources with similar maturities. Core deposit intangibles
are not included.
Annuities -- The carrying amount represented fair value.
Federal funds purchased and commercial paper -- The value was
determined using the discounted cash flow method. The discount rate was
equal to the rate currently offered on similar borrowings.
Reverse repurchase agreements -- These were valued using the
discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
Advances from FHLBs -- These were valued using the discounted cash
flow method. The discount rate was equal to the rate currently offered on
similar borrowings.
Trust preferred securities -- Fair value was estimated using quoted
market prices for similar securities.
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 financial 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.
Standby letters of credit -- The fair value of standby letters of
credit was based on the estimated cost to terminate or otherwise settle the
obligations with the counterparties at the reporting date.
Forward sales contracts designated against loans -- The fair value of
forward sales contracts purchased as a hedge of fixed-rate commitments and
commitments to fund real estate loans was estimated using current market
prices adjusted for various risk factors and market volatility.
Off-balance-sheet loan commitments -- 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.
120
123
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 29: FINANCIAL INFORMATION -- WMI
The following WMI (parent company only) financial information should be
read in conjunction with the other notes to the consolidated financial
statements.
STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
INTEREST INCOME
Loans...................................................... $ 3,832 $ -- $ --
Available-for-sale securities.............................. 1,769 6,777 8,033
Cash equivalents........................................... 1,448 5,378 471
-------- -------- --------
Total interest income.................................... 7,049 12,155 8,504
INTEREST EXPENSE
Borrowings................................................. 34,839 14,396 9,072
-------- -------- --------
Total interest expense................................... 34,839 14,396 9,072
-------- -------- --------
Net interest expense.................................. (27,790) (2,241) (568)
OTHER INCOME
Other operating income..................................... 353 122 8
Gain (loss) on sale of other assets........................ 20,845 -- (171)
-------- -------- --------
Total other income....................................... 21,198 122 (163)
OTHER EXPENSE
Salaries and employee benefits............................. 6,907 3,561 2,716
Occupancy and equipment.................................... -- 11 1
Other operating expense.................................... 5,629 18,013 3,289
Transaction-related expense................................ 32,308 -- --
Amortization of goodwill................................... 731 629 --
-------- -------- --------
Total other expense...................................... 45,575 22,214 6,006
-------- -------- --------
Loss before income taxes and equity in net earnings of
subsidiaries........................................ (52,167) (24,333) (6,737)
Income tax benefit......................................... (21,523) (8,105) (865)
Equity in net earnings of subsidiaries..................... 512,422 246,328 556,796
-------- -------- --------
Net income................................................. $481,778 $230,100 $550,924
======== ======== ========
121
124
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and cash equivalents................................... $ 330,764 $ 109,356
Available-for-sale securities............................... 1,000 82,033
Loans....................................................... 11,555 92,083
Investment in subsidiaries.................................. 5,496,975 4,925,262
Other assets................................................ 114,442 12,917
---------- ----------
Total assets.............................................. $5,954,736 $5,221,651
========== ==========
LIABILITIES
Reverse repurchase agreements............................... $ -- $ 68,326
Other borrowings............................................ 562,298 148,007
Other liabilities........................................... 83,367 12,230
---------- ----------
Total liabilities......................................... 645,665 228,563
STOCKHOLDERS' EQUITY
Preferred stock, no par value: 10,000,000 shares
authorized -- 4,722,500 and 5,382,500 shares issued and
outstanding, liquidation preference....................... 118,063 283,063
Common stock, no par value: 800,000,000 shares
authorized -- 257,560,018 and 250,230,644 shares issued
and outstanding........................................... -- --
Capital surplus -- common stock............................. 1,943,294 1,664,870
Valuation reserve for available-for-sale securities......... -- 1,156
Valuation reserve for available-for-sale
securities -- subsidiaries 134,610 117,469
Retained earnings........................................... 3,113,104 2,926,530
---------- ----------
Total stockholders' equity................................ 5,309,071 4,993,088
---------- ----------
Total liabilities and stockholders' equity................ $5,954,736 $5,221,651
========== ==========
122
125
WASHINGTON MUTUAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 481,778 $ 230,100 $ 550,924
Adjustments to reconcile net income to net cash (used)
provided by operating activities:
(Gain) on sale of assets............................... (20,845) -- --
Decrease (increase) in interest receivable............. 326 (69) 80
Increase in interest payable........................... 2,624 530 3,167
Decrease in income taxes payable....................... (88,809) (8,105) (865)
Equity in undistributed earnings of subsidiaries....... (512,422) (246,328) (556,796)
Decrease (increase) in other assets.................... 6,047 (16,619) 9,910
Increase in other liabilities.......................... 60,483 14,867 720
--------- --------- ---------
Net cash (used) provided by operating activities (70,818) (25,624) 7,140
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities............. (1,000) -- --
Sales of available-for-sale securities................. 75,866 -- --
Principal payments of available-for-sale securities.... 4,191 16,118 12,594
Sale of subsidiary..................................... 102,775 -- --
Origination of loans, net of principal payments........ 80,528 55,784 (147,867)
Investment in subsidiary............................... (554,412) (170,000) --
Dividends received from subsidiaries................... 476,525 280,026 136,521
--------- --------- ---------
Net cash provided by investing activities............ 184,473 181,928 1,248
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in reverse repurchase agreements.............. (68,326) (14,155) (1,848)
Proceeds from other borrowings......................... 414,291 -- 147,845
Issuance of common stock through stock options and
employee stock plans................................. 146,266 20,604 8,379
Repurchase of preferred stock.......................... (165,000) -- (1,990)
Conversion of preferred stock to common stock.......... -- (107) --
Cash dividends paid.................................... (219,478) (143,386) (76,581)
--------- --------- ---------
Net cash provided (used) by financing activities 107,753 (137,044) 75,805
--------- --------- ---------
Increase in cash and cash equivalents.................. 221,408 19,260 84,193
Cash and cash equivalents, beginning of year........... 109,356 90,096 5,903
--------- --------- ---------
Cash and cash equivalents, end of year................. $ 330,764 $ 109,356 $ 90,096
========= ========= =========
123
126
WASHINGTON MUTUAL, INC.
INDEX OF EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
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 Washington Mutual agrees to furnish the Securities and
Exchange Commission, upon request, with copies of all
instruments defining rights of holders of long-term debt of
Washington Mutual and its consolidated subsidiaries.
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.
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).
124
127
EXHIBIT NO. DESCRIPTION
----------- -----------
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 Agreement and Plan of Merger By and Among Washington Mutual,
Inc., New American Capital, Inc., and Great Western
Financial Corporation ("GWFC"), dated as of March 5, 1997
(Incorporated by reference to Washington Mutual, Inc.
Registration Statement on Form S-4 dated May 13, 1997,
Registration no. 333-23221).
10.18 The 1998 Stock Option and Incentive Plan (as amended
effective July 26, 1994), (Incorporated by reference to
GWFC's Quarterly Report to the Securities and Exchange
Commission on Form 10-Q for the quarter ended September 30,
1994).
10.19*** Amendment No. 1996-1 to the 1988 Stock Option and Incentive
Plan, effective December 10, 1996.
10.20 Form of Director Stock Option Agreement (Incorporated by
reference to GWFC's Registration Statement on Form S-8
Registration no. 33-21469 pertaining to GWFC's 1988 Stock
Option and Incentive Plan).
10.21 Form of Director Stock Option Agreement effective January 3,
1994, (Incorporated by reference to GWFC's Annual Report to
the Securities and Exchange Commission on Form 10-K for the
fiscal year ended December 31, 1993).
10.22* GWFC Directors' Deferred Compensation Plan (1992
Restatement) (Incorporated by reference to GWFC's Annual
Report to the Securities and Exchange Commission on Form 10-
K for the fiscal year ended December 31, 1991).
10.23* Amendment to GWFC Directors', Senior Officers' and basic
Deferred Compensation Plans (1992 Restatement) (Incorporated
by reference to GWFC's Annual Report to the Securities and
Exchange Commission on form 10-K for the fiscal year ended
December 31, 1994).
10.24* Amendment No. 2 to Directors' Deferred Compensation Plan
1992 Restatement. (Incorporated by reference to GWFC's
Quarterly Report to the Securities and Exchange Commission
on Form 10-Q for the quarter ended March 31, 1996).
10.25*** Amendment No. 1996-2 to Directors' Deferred Compensation
Plan, dated December 10, 1996.
10.26 GWFC Umbrella Trust for Directors (Incorporated by reference
to GWFC's Quarterly Report to the Securities and Exchange
Commission on Form 10-Q for the quarter ended March 31,
1989).
10.27*** Amendment No. 1996-1 to Umbrella Trust for Directors, dated
December 16, 1996.
10.28 Omnibus Amendment 1995-1 to the Umbrella Trusts replacing
the Finance Committee of the Board of Directors with the
Compensation Committee of the Board of Directors as
administrator of the plans (Incorporated by reference to
GWFC's Quarterly Report to the Securities and Exchange
Commission on Form 10-Q for the quarter ended June 30,
1995.)
10.29 Restated Retirement Plan for Directors (Incorporated by
reference to GWFC's Quarterly Report to the Securities and
Exchange Commission on Form 10-Q for the quarter ended June
30, 1993.)
10.30 Employee Home Loan Program (Incorporated by reference to
GWFC's Quarterly Report to the Securities and Exchange
Commission on Form 10-Q for the quarter ended June 30,
1993.)
10.31*** Amendment No. 1996-1 to Employee Home Loan Programs,
effective December 10. 1996.
10.32*** Omnibus Amendment 1997-1 amending the definition of change
in control in the GWFC 1988 Stock Option and Incentive Plan,
as amended December 10, 1996, the GWFC Directors' Deferred
Compensation Plan (1992 Restatement), as amended December
10, 1996, the Umbrella Trust for Directors as amended
December 10, 1996, and the Employee Home Loan Program
(Revised and restated as of April 27, 1993), as Amended
December 10, 1996.
125
128
EXHIBIT NO. DESCRIPTION
----------- -----------
10.33 Amended and Restated 364-Day Credit Agreement between the
Registrant and The Chase Manhattan Bank as Administrative
Agent.
10.34 Amended and Restated 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 Price Waterhouse 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.
**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, 1996. File No. 0-25188.
***Incorporated by reference to GWFC's Annual Report to the Securities and
Exchange Commission on Form 10-K for the year ended December 31, 1997. File
No. 97553219.
126