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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20529
FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO :
COMMISSION FILE NUMBER 0-25188
WASHINGTON MUTUAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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WASHINGTON 91-1653725
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
1201 THIRD AVENUE 98101
SEATTLE, WASHINGTON (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 461-2000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock The Nasdaq Stock Market
9.12% Noncumulative Perpetual Preferred Stock, Series C The Nasdaq Stock Market
7.60% Noncumulative Perpetual Preferred Stock, Series E The Nasdaq Stock Market
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the last 90 days. YES X NO __.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of January 31, 1997:
COMMON STOCK -- $5,625,829,311(1)
(1) Does not include any value attributable to 8,000,000 shares that are held in
escrow and not traded.
The number of shares outstanding of the issuer's classes of common stock as
of January 31, 1997:
COMMON STOCK -- 126,272,191(2)
(2) Includes the 8,000,000 shares held in escrow.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the Annual Meeting of
Shareholders to be held April 15, 1997, are incorporated by reference into Part
III.
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WASHINGTON MUTUAL, INC.
1996 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I.................................................................................. 1
ITEM 1. BUSINESS...................................................................... 1
The Company........................................................................ 1
The Reorganization................................................................. 1
Business Strategy.................................................................. 2
Washington Mutual's Operating Subsidiaries......................................... 2
Lending Activities................................................................. 4
Asset Quality...................................................................... 9
Investing Activities............................................................... 10
Sources of Funds................................................................... 12
Asset and Liability Management..................................................... 14
Business Combinations.............................................................. 16
Employees.......................................................................... 16
Taxation........................................................................... 16
Environmental Regulation........................................................... 17
Regulation and Supervision......................................................... 18
Competitive Environment............................................................ 24
Principal Officers................................................................. 24
ITEM 2. PROPERTIES.................................................................... 25
ITEM 3. LEGAL PROCEEDINGS............................................................. 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................... 26
PART II................................................................................. 26
ITEM 5. MARKET FOR WASHINGTON MUTUAL'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS............................................................................ 26
Common Stock....................................................................... 26
Preferred Stock.................................................................... 27
Payment of Dividends and Policy.................................................... 27
ITEM 6. SELECTED FINANCIAL DATA....................................................... 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF
OPERATIONS......................................................................... 30
General............................................................................ 30
Results of Operations.............................................................. 30
Review of Financial Position....................................................... 39
Asset Quality...................................................................... 42
Interest Rate Risk Management...................................................... 48
Liquidity.......................................................................... 53
Capital Requirements............................................................... 53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................... 54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE......................................................................... 54
PART III................................................................................ 54
PART IV................................................................................. 54
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.............. 54
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PART I
ITEM 1. BUSINESS
THE COMPANY
With a history dating back to 1889, Washington Mutual, Inc. ("Washington
Mutual" or the "Company") is a regional financial services company committed to
serving consumers and small to mid-sized businesses throughout the Western
United States. Through its subsidiaries, the Company engages in the following
activities:
- MORTGAGE LENDING AND CONSUMER BANKING ACTIVITIES. Through its principal
subsidiaries, Washington Mutual Bank ("WMB"), American Savings Bank, F.A.
("ASB"), and Washington Mutual Bank fsb ("WMBfsb"), at December 31, 1996,
the Company operated 413 consumer financial centers and 96 loan centers
offering a full complement of mortgage lending and consumer banking
products and services. In 1996, WMB was the leading originator of
first-lien, single-family residential loans in Washington and Oregon,
while ASB was the second largest originator of such loans in California.
- COMMERCIAL BANKING ACTIVITIES. Through the commercial banking division of
WMB, at December 31, 1996, the Company operated 48 full-service business
branches offering a range of commercial banking products and services to
small and mid-sized businesses. WMB commenced its commercial banking
activities through the acquisition of Enterprise Bank of Bellevue,
Washington ("Enterprise") in 1995 and Western Bank of Coos Bay, Oregon
("Western") in 1996.
- INSURANCE ACTIVITIES. Through WM Life Insurance Company ("WM Life") and
ASB Insurance Services Inc. ("ASB Insurance"), the Company underwrites
and sells annuities and sells a range of life insurance contracts, and
selected property and casualty insurance policies.
- SECURITIES ACTIVITIES. Through ASB Financial Services, Inc. ("ASB
Financial"), Murphey Favre, Inc. ("Murphey Favre") and Composite Research
& Management Co. ("Composite Research"), the Company offers full service
securities brokerage and acts as the investment advisor to and the
distributor of mutual funds.
The Company operates in Washington, California, Oregon, Utah, Idaho,
Montana, Arizona, Colorado and Nevada. At December 31, 1996, the Company had
consolidated assets of $44.6 billion, deposits of $24.1 billion and
stockholders' equity of $2.4 billion.
On December 20, 1996, Washington Mutual consummated the merger of Keystone
Holdings, Inc. ("Keystone Holdings") with and into the Company and certain other
transactions in connection therewith (the "Keystone Transaction") and thereby
acquired ASB. Washington Mutual issued 47,883,333 shares of common stock to
complete the Keystone Transaction. At December 31, 1996, ASB had assets of $21.9
billion and deposits of $12.9 billion and operated 158 branches and 66 loan
centers, substantially all of which were located in California.
Washington Mutual continues to operate ASB under the name "American Savings
Bank" in ASB's markets. Washington Mutual intends to introduce its consumer
banking products and approaches throughout ASB's branch system and to expand
ASB's loan origination capabilities.
THE REORGANIZATION
Washington Mutual was formed in August 1994 by its predecessor, Washington
Mutual Savings Bank ("WMSB"), a Washington state-chartered savings bank, for the
purpose of serving as a holding company in the reorganization of WMSB into a
holding company structure (the "Reorganization"). The Reorganization was
completed in November 1994 through the merger of WMSB into WMB, with WMB as the
surviving entity. As a result of the Reorganization, Washington Mutual became
the parent company of the companies of which WMSB was, prior to the
Reorganization, the parent company.
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As a result of the Reorganization, all common and preferred shareholders of
WMSB became shareholders of Washington Mutual on a one-for-one basis with
substantially the same relative rights, privileges and preferences. Except as
noted otherwise, references herein to "Washington Mutual" or the "Company" refer
to both (i) Washington Mutual, Inc. and its consolidated subsidiaries after the
consummation of the Reorganization; and (ii) WMSB and its consolidated
subsidiaries prior to the consummation of the Reorganization.
BUSINESS STRATEGY
The main elements of the Company's strategic plan are:
- Strengthen the Company's consumer banking franchise throughout the
West. The Company focuses on increasing the number of households served
within its market areas and the scope of its customer relationships.
Washington Mutual primarily attracts new customers by offering
competitive consumer-oriented deposit products, including "Free Checking"
and money market accounts. The Company also offers residential mortgages
and a variety of higher margin consumer loan products, including
manufactured housing loans, home equity loans and lines of credit,
automobile and boat loans, student loans, and unsecured consumer loans,
as well as investment products such as mutual funds and annuities. To
further its penetration within its principal markets, Washington Mutual
delivers its products through several alternative distribution channels
that allow it to target sub-markets within its franchise area. These
alternative delivery channels complement the Company's freestanding
financial center network and include in-store financial centers, loan
centers, interactive banking kiosks, and telephone banking operations.
The Company plans to strengthen its franchise through the continued
introduction of its consumer banking products to all of its market areas,
targeted de novo branch openings, and selected in-market acquisitions.
- Expand the commercial banking franchise. The Company is developing a
growing commercial banking presence in Washington, Oregon and Idaho. The
commercial banking division of WMB, which operates primarily as "Western
Bank," focuses on serving the needs of small and mid-sized businesses and
offers a full range of commercial banking products, including business
checking accounts and secured and unsecured loans. The lending activities
of the commercial banking division generally provide higher margins than
the Company's residential mortgage lending activities. The Company plans
to expand its commercial banking activities within its existing market
areas and eventually to other parts of the Company's franchise.
- Limit sensitivity to interest rate movements. The Company intends to
limit the sensitivity of its net interest income to movements in market
interest rates. Through purchases and sales of loans and mortgage-backed
securities and the retention of internally originated adjustable-rate
mortgages ("ARMs"), the Company has decreased the percentage of
fixed-rate assets and increased the percentage of adjustable-rate assets
in its loan and investment portfolios in order to more closely match its
liability base. The acquisition of ASB, with its portfolio of
adjustable-rate loans and mortgage-backed securities ("MBS") furthered
this strategy.
The Company historically has used acquisitions to further its strategic
plan. Since 1988, the Company has completed 20 acquisitions, two of which were
commercial banks, which have expanded the Company's geographic service area
beyond the state of Washington. The Company anticipates that acquisitions will
continue to be an important element of its strategic plan in the future.
WASHINGTON MUTUAL'S OPERATING SUBSIDIARIES
Washington Mutual Bank. WMB's principal business is providing a broad
range of financial services, primarily to consumers. These services include
accepting deposits from the general public and making residential mortgage
loans, consumer loans and limited types of commercial real estate loans,
primarily loans secured by multi-family properties. Beginning in the latter half
of 1995, WMB, through its mergers with Enterprise and Western, diversified its
activities by entering into commercial banking.
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At December 31, 1996, WMB had assets of $20.6 billion, deposits of $10.8
billion and operated 226 consumer financial centers, of which 155 were in
Washington and 71 were in Oregon; 27 loan centers, of which 19 were in
Washington and eight were in Oregon; and 48 full-service business branches, of
which two were in Washington and 46 were in Oregon. WMB operates under Title 32
(Mutual Savings Banks) of the Revised Code of Washington. Its deposits are
insured by the Federal Deposit Insurance Corporation ("FDIC") through the Bank
Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF").
On January 15, 1997, WMB completed the acquisition of United Western
Financial Group, Inc. ("United") and its subsidiaries, including United Savings
Bank, Uniwest Service Corporation and Western Mortgage Loan Corporation, for
approximately $79.5 million in cash. United operated eight branches in Utah, one
branch in Idaho and seven loan production offices. At January 15, 1997, United
had assets of $404.1 million and deposits of $299.9 million.
American Savings Bank, F.A. ASB's principal business is accepting deposits
from the general public and making residential mortgage loans and loans secured
by multi-family properties. At December 31, 1996, ASB had assets of $21.9
billion, deposits of $12.9 billion and operated 158 branches in California and
66 loan offices, of which 61 were in California, two in Arizona, two in Colorado
and one in Nevada. ASB's deposits are insured by the FDIC through the SAIF.
Washington Mutual Bank fsb. WMBfsb's principal business includes accepting
deposits from the general public and making residential loans, consumer loans
and limited types of commercial real estate loans, primarily loans secured by
multi-family properties. At December 31, 1996, WMBfsb had assets of $935.3
million, deposits of $445.4 million, and operated 29 financial centers, of which
19 were in Utah, seven were in Idaho, two were in Montana and one was in Oregon,
and operated one loan center in Idaho and two in Utah. On November 30, 1996,
WMBfsb acquired by merger Utah Federal Savings Bank ("Utah Federal"), which
operated five branches and two loan production offices in Utah and had assets of
$122.1 million, deposits of $106.7 million and stockholders' equity of $12.0
million. WMBfsb's deposits are insured by the FDIC through the SAIF.
WM Life Insurance Company. WM Life, an Arizona-domiciled life insurance
company, is licensed under state law to issue annuities in seven states. In
addition, WM Life owns Empire Life Insurance Co. ("Empire"), a
Washington-domiciled life insurance company, which is currently licensed under
state law to issue annuities in 28 states. WM Life currently issues fixed and
variable flexible premium deferred annuities, single premium fixed deferred
annuities and single premium immediate annuities. Empire currently issues fixed
flexible premium deferred annuities and single premium immediate annuities. Both
companies conduct business through licensed independent agents. The majority of
such agents are employees of affiliates of the Company and operate in WMB's
financial centers. Annuities presently are issued primarily in Washington and
Oregon. At December 31, 1996, WM Life had assets of $1.1 billion.
ASB Insurance Agency, Inc. ASB Insurance is a registered insurance broker
that offers a wide array of products, including life, property and casualty
insurance and annuities in California.
ASB Financial Services, Inc. ASB Financial is a registered broker-dealer
that distributes a broad array of mutual funds in California. ASB Financial
representatives are available for consultation regularly or by appointment in
many of ASB's branches.
Composite Research & Management Co. Composite Research is a registered
investment advisor and is the investment advisor of eight mutual funds. At
December 31, 1996, Composite Research had a total of $1.4 billion in funds under
management in the eight mutual funds.
Murphey Favre, Inc. Murphey Favre is a registered broker-dealer that
offers a broad range of securities brokerage services, including distribution of
mutual funds in Washington, Oregon, Idaho, Utah and Montana. Murphey Favre has
eight free-standing offices with representatives available for consultation
regularly or by appointment in many of WMB's financial centers.
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LENDING ACTIVITIES
General. The Company's lending activities are carried on through its
banking subsidiaries, WMB, ASB and WMBfsb. At December 31, 1996, the Company's
total loan portfolio (carried at historical cost) of $30.7 billion (exclusive of
reserve for loan losses) included $22.7 billion in mortgage loans secured by
first liens on 1-4 family residential properties; $723.6 million in residential
construction loans; $3.8 billion in mortgage loans secured by commercial real
estate such as apartment buildings, office buildings, warehouses, shopping
centers and medical office buildings; $3.2 billion in consumer loans; and $340.1
million in commercial business loans. For a discussion of the fair value of the
loan portfolio, see "Consolidated Financial Statements -- Note 28: Fair Value of
Financial Instruments."
Washington state law gives state-chartered savings banks such as WMB broad
lending powers, subject to certain statutory restrictions on total investment in
different types of loans. WMB may make loans secured by residential and
commercial real estate, secured and unsecured consumer loans, and secured and
unsecured commercial loans. ASB and WMBfsb have somewhat narrower lending
authority, but can make loans secured by residential and commercial real estate,
certain secured and unsecured consumer loans, and a limited amount of secured
and unsecured commercial loans.
In originating loans, the Company must compete directly with other savings
banks, savings and loan associations, commercial banks, credit unions, mortgage
companies and life insurance companies (primarily in the commercial real estate
area) and indirectly with government-sponsored entities ("GSEs") such as the
Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage
Corporation ("FHLMC"), or the Government National Mortgage Association ("GNMA").
In addition, the Company's lending activities are heavily influenced by economic
trends affecting the availability of funds and by general interest rate levels,
as well as by competitive factors such as the lower cost structure of less
regulated originators and the influence of GSEs in establishing rates. The
condition of the construction industry and the demand for housing also directly
affect residential and commercial real estate lending volumes.
In addition to interest earned on loans, the Company receives fees for
originating loans and for providing loan commitments. The Company also charges
fees for loan modifications, late payments, changes in property ownership and
other miscellaneous services. Fees received in connection with loan originations
are deferred and amortized into interest income over the life of the loan. The
Company also receives fees for servicing loans for others.
Residential Loans
General. The bulk of the Company's residential loan portfolio is in
California, Washington and Oregon . All of the Company's residential mortgage
lending is subject to nondiscriminatory underwriting standards. All loans are
subject to underwriting review and approval by various levels of Company
personnel, depending on the size of the loan.
The Company requires title insurance on all first liens on real property
securing loans and also requires that fire and casualty insurance be maintained
on properties in an amount at least equal to the total of the Company's loan
amount plus all prior liens on the property or the replacement cost of the
property, whichever is less.
Mortgage insurance currently is required on all residential real estate
loans originated at a loan-to-value ratio of 90% or above. Any exceptions must
be reported to the board of directors of the subsidiary bank issuing the credit.
At December 31, 1996, 6% of the Company's residential real estate loan portfolio
had loan-to-value ratios that equaled or exceeded 90% at origination and were
without mortgage insurance.
Under federal regulations, a real estate loan may not exceed 100% of the
appraised value of the property at the time of origination. In addition,
depository institutions are required by regulation to adopt written policies
that establish appropriate limits and standards for real estate loans and to
consider certain regulatory guidelines in establishing these policies. These
guidelines specify that depository institutions should not originate any
commercial, multi-family or nonowner-occupied 1-4 family mortgage loan with an
initial loan-to-value ratio in excess of 85%. The guidelines further provide
that depository institutions should not originate
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any owner-occupied 1-4 family mortgage loan with a loan-to-value ratio that
equals or exceeds 90% at origination, unless such loan is protected by an
appropriate credit enhancement in the form of either mortgage insurance or
readily marketable collateral. These real estate lending guidelines recognize
that it may be appropriate for a depository institutions to originate mortgage
loans with loan-to-value ratios exceeding these specified levels, provided that
the aggregate amount of all loans in excess of these limits does not exceed a
specified level of such depository institution's total capital and such loans
are identified in the depository institution's records and reported at least
quarterly to its board of directors.
WMB and WMBfsb Residential Lending. WMB makes available to borrowers in
Washington and Oregon a full range of residential loans, including FHA-insured,
VA-guaranteed and conventional fixed-rate loans for terms of five, 15 or 30
years, in addition to ARMs. WMBfsb makes the same loan products available to
customers in Utah, Montana and Idaho.
ARMs are advantageous to the Company because adjustable-rate loans better
match the Company's natural liability base. However, WMB's and WMBfsb's ability
to originate ARMs in lieu of fixed-rate loans has varied in response to changes
in market interest rates. Between 1992 and 1993, ARMs constituted less than 25%
of WMB's residential loan originations, reflecting continuing lower market
interest rates. When interest rates rose in 1994, ARMs totaled 62% of WMB's
residential loan originations. However, interest rates declined in mid-1995 and,
as a result, ARMs totaled 32% of WMB's and 28% of WMBfsb's residential loan
originations during 1995. For the year ended December 31, 1996, ARMs accounted
for 35% of WMB's and 33% of WMBfsb's residential loan originations.
Under WMB's and WMBfsb's current ARM programs, the borrower may choose
among loans that have the initial interest rate fixed for one, three or five
years before the adjustments begin. Currently, such ARMs are indexed to the
one-year Constant Maturity Treasury Index and have annual caps of 2%. Under most
programs, the borrower may elect, between the sixth and the sixtieth months, to
convert to a fixed-rate loan payable over the remainder of the original term.
There is no conversion fee, and the fixed interest rate is indexed to the
then-current required net yield for loans sold to FNMA.
The majority of WMB's and WMBfsb's loan originations satisfy all
requirements to make them saleable in the secondary market. In 1996, WMB and
WMBfsb securitized and sold $1.0 billion of their fixed-rate loans, but did not
sell any ARMs. See "-- Loan Securitization."
WMB and WMBfsb originate loans through all of their branches, as well as
through home loan centers and loan representatives located in real estate
brokers' offices. In addition, a small portion of their originations comes
through loan brokers. WMB was the leading originator of first lien residential
mortgage loans in both Washington and Oregon for the year ended December 31,
1996.
ASB Residential Lending. ASB offers an array of mortgage products to
customers in California, Arizona, Nevada and Colorado. The primary products are
ARMs indexed to the 11th District Cost of Funds Index ("COFI") that adjust
monthly with maturities up to a maximum of 40 years; mortgages that have a fixed
initial rate for up to five years and then reprice monthly at a set margin over
COFI until maturity ("Flex-5 Loans"); and fixed-rate 15-, 20- and 30-year
mortgages. During 1996, substantially all of ASB's ARM residential loan
originations were indexed to COFI.
As interest rates increased in the latter part of 1994 and the first part
of 1995, the rates on COFI ARMs rose and the difference between those rates and
the rates on fixed-rate loans narrowed. As a result, ASB's origination volume of
fixed-rate loans increased, while the origination volume of adjustable-rate
loans stabilized. The same conditions also made the Flex-5 Loans more popular.
In 1996, even though long-term interest rates were generally higher than in
1995, originations of fixed-rate products remained consistent with 1995. ASB no
longer offers Flex-5 Loans. Nevertheless, because ASB sells virtually all of its
fixed-rate product on the secondary market, its portfolio is composed almost
entirely of ARMs. At December 31, 1996, ASB's gross loan balance consisted of
98% ARMs and 2% fixed-rate loans. Interest rates on the majority of the ARMs
adjust monthly to a predetermined margin over COFI.
The monthly payments on substantially all of ASB's ARMs adjust annually
with the adjustment limited to 7.5% per year (except at the end of each
five-year interval during the life of the loan, when the payment
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may be adjusted by more than 7.5% to assure that the loan will amortize over the
remaining term). These protections for borrowers can result in monthly payments
that are greater or less than the amount necessary to amortize a loan by its
maturity at the interest rate in effect in any particular month. In the event
that a monthly payment is not sufficient to pay the interest accruing on the
loan, the shortage is added to the principal balance and is repaid through
future monthly payments. This is referred to as negative amortization. The
portion of outstanding loan principal arising from negative amortization was
$30.7 million at December 31, 1996.
The majority of ASB's fixed-rate loan originations are saleable in the
secondary market either through FNMA or FHLMC or, in the case of loans with
balances larger than the FNMA/FHLMC limit for conforming loans ("Jumbo loans"),
to private investors. Substantially all such originations during 1996 (15% of
residential loan originations) have been sold. The remainder of ASB's
residential loan originations, consisting almost entirely of COFI ARMs, was
retained in ASB's portfolio.
One of the primary market segments in which ASB originates loans for its
portfolio is that group of borrowers who generally meet ASB underwriting
standards, but who are unable to provide some of the documentation required to
meet GSE secondary market rules. These loans are referred to as low
documentation (or alternative documentation) loans. Approximately 48% of ASB's
1996 portfolio originations consisted of low documentation loans. The
documentation that is omitted generally relates to the credit or employment
history of the borrower and not to the value of the collateral. All low
documentation loans are fully supported by appraisals and title insurance. In
addition, the maximum loan-to-value ratio on low documentation loans is 80% and
such ratio decreases as the amount of the loan increases. The average
loan-to-value ratio on all low documentation loans originated during 1996 was
70%.
The delinquency experience on low documentation loans originated by ASB in
1994, 1995 and 1996 is comparable to the experience on ASB's COFI ARM portfolio
as a whole. The delinquency experience on ASB's portfolio as a whole has
historically been higher than the delinquency experience at WMB and WMBfsb.
ASB does not originate residential mortgage loans in its branches. All
direct originations (49% of total 1996 residential originations) are through its
66 loan centers. In addition, ASB indirectly originates loans through
independent mortgage brokers throughout the state of California. Indirect
originations accounted for the balance of total 1996 residential loan
originations.
ASB's wholesale mortgage broker distribution channel was established in
1991 to serve geographic regions not covered by residential loan centers.
Initially the participating brokers were primarily in northern California, but
in 1993 the program was expanded to the rest of the state. Participation grew
through 1996 and the broker distribution channel is now a significant element of
ASB's overall lending strategy, including its more recently opened loan
production offices in Arizona, Colorado and Nevada. To monitor credit quality,
ASB conducts extensive due diligence and reviews the stability and credit
experience of each broker prior to accepting any loan packages. Loan production
from the wholesale channel is subjected to the same underwriting standards as
loan production from the residential loan centers. All underwriting decisions
are made by ASB personnel.
Residential Construction Loans. WMB and WMBfsb provide financing for two
different categories of residential construction loans. A custom construction
loan is made to the intended occupant of a house to finance its construction.
Speculative construction loans are made to borrowers who are in the business of
building homes for resale. Speculative construction loans are made either on a
house-by-house basis or, in certain circumstances, through a collateralized,
limited line of credit. Speculative construction lending involves somewhat more
risk than custom construction loans and involves different underwriting
considerations. All construction loans require approval by various levels of WMB
and WMBfsb personnel, depending on the size of the loan. Construction loans for
nonconforming residential properties (properties other than single-family
detached houses) are subject to more stringent approval requirements than loans
for conforming properties.
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Residential construction loans are an integral part of WMB's and WMBfsb's
overall lending program. Construction loans are of short duration, generally 12
to 18 months, and have adjustable rates, so they are an important element in the
Company's interest rate sensitivity management. Speculative construction loans
are generally priced at a higher spread than are permanent residential loans.
In addition, the residential construction loan program provides a source of
permanent loans. Most custom construction loans have provisions for conversion
to permanent loan status upon completion of construction. Speculative
construction builders are a good source of referrals when their buyers need
financing. WMB and WMBfsb have a program under which they waive certain closing
fees for borrowers who are buying homes for which WMB and WMBfsb provided
construction financing.
At December 31, 1996, 59% of the residential construction portfolio was
custom construction loans and 41% was speculative construction loans. The demand
for residential construction loans is sensitive to the same factors as the
market for residential loans generally. Low market interest rates help to
improve the market for houses generally and this, in turn, stimulates new
construction. As a result, originations of residential construction loans for
1996 totaled $1.3 billion, an increase of 38% from $935.8 million in 1995.
Historically, ASB has not originated residential construction loans.
Commercial Real Estate Loans.
General. Commercial real estate lending generally entails greater risks
than residential mortgage lending. Commercial real estate loans typically
involve large loan balances concentrated with single borrowers or groups of
related borrowers. In addition, the payment experience on loans secured by
income-producing properties usually depends on the successful operation of the
related real estate project and thus may be subject, to a greater extent, to
adverse conditions in the real estate market or in the economy generally. In
recent years, commercial real estate values in many areas of the country have
substantially declined, particularly in California, as a result of excess supply
and weak economies.
In all commercial real estate lending, the Company considers the location,
marketability and overall attractiveness of the project. Washington Mutual's
current underwriting guidelines for commercial real estate loans require an
economic analysis of each property with regard to the annual revenue and
expenses, debt service coverage and fair value to determine the maximum loan
amount. Commercial real estate loans require approval at various levels of
Company personnel, depending on the size of the loan.
WMB and WMBfsb Commercial Real Estate Lending. The Boards of Directors of
both WMB and WMBfsb have adopted lending policies that generally limit future
commercial real estate loan originations to Washington, Oregon, Idaho, Utah,
Montana, and contiguous states. WMB's existing commercial real estate loan
portfolio is principally concentrated in Washington, Oregon and California.
WMBfsb's commercial real estate loan portfolio is concentrated in Utah and
Montana.
During the past few years, WMB and WMBfsb focused their commercial real
estate lending on small and mid-sized apartment lending (loans of $2.5 million
or less). During 1996, WMB and WMBfsb broadened their lending scope by
originating or approving $101.3 million of nonresidential real estate loans in
addition to $209.3 million of apartment loans. In addition, both the Enterprise
and Western commercial real estate portfolios were predominantly nonresidential.
However, the relatively small size of both Enterprise and Western before they
merged with WMB placed constraints on the size and to some extent the type of
loans they could make. For example, the individual loan size limitations made
meaningful participation in office building and urban retail loans impossible.
With the added flexibility provided by WMB's size, the type and size of
commercial real estate loans that the commercial banking division will be able
to make will change. This will generally increase the risk characteristics of
the commercial loan portfolio.
ASB Commercial Real Estate Lending. ASB's commercial real estate loan
portfolio is concentrated in California. Due to ASB's past desire to remain a
"traditional thrift lender," management historically did not emphasize
commercial loan originations other than for apartment properties. No commercial
loans, other than apartment and mobile home park loans, have been originated by
ASB since 1994, at which time such commercial loans represented approximately 1%
of total loan originations by principal balance. Because of
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credit weaknesses in the small and mid-sized apartment house market in
California, ASB tightened its underwriting of apartment loans in 1994. Due to
tightened underwriting standards, apartment loan originations declined as a
percentage of total real estate lending from 11% in 1994 to 5% in both 1995 and
1996. From time to time, ASB refinances its existing nonresidential commercial
real estate loans.
Loan Securitization. The Company from time to time, depending on its asset
and liability management strategy, converts a portion of its loans into either
FHLMC participation certificates, GNMA MBS or FNMA conventional MBS
(collectively, "GSE MBS"). This securitization of its loans provides the Company
with increased liquidity both because the mortgage securities are more readily
marketable than the underlying loans and because they can be used as collateral
for borrowing.
WMB has historically securitized a portion of its fixed-rate loan
production that is held for sale or originated with the intent to hold for sale
in order to sell those MBS in the secondary market and, from time to time,
securitizes other loans and retains the resulting MBS as investment securities.
ASB generally securitizes substantially all of its FNMA/FHLMC conforming
fixed-rate production for potential sale in the secondary market. Loans
securitized through GSEs for sale in the secondary market are sold without
recourse and become obligations of the applicable GSE. Generally, the servicing
of the loans is retained by the Company with the servicing fee income fixed by
the relevant GSE.
In 1995 and 1996, the Company securitized loans with FHLMC and FNMA under
programs in which the GSE has recourse against the originator of the loans.
These securitizations are generally less costly and may require less
documentation than securitizations without recourse. These MBS are generally
saleable in the secondary market and can be used as collateral for borrowings
and to meet regulatory liquidity requirements. Generally, however, MBS created
under this program are retained by the originator, and the Company has retained
the majority of MBS created under these programs. The Company has also sold
securitized loans with recourse. At December 31, 1996, the Company's total
recourse obligation with respect to securitized loans was $7.3 billion.
In 1995, ASB created a real estate mortgage investment conduit (a "REMIC")
by means of which it securitized a pool of loans consisting of $1.2 billion in
apartment loans and $200.0 million of its Flex-5 Loans. To date, ASB has not
sold any portion of this REMIC and the entire amount is still owned by ASB with
full recourse.
When MBS composed of loans originated by the Company's banking subsidiaries
are owned by such banking subsidiaries, they are serviced in the same manner as
any other loan in the loan portfolio. In addition, when loans sold with recourse
become nonperforming, the loans and the associated collateral properties are
included in the Company's total nonaccruing assets.
Manufactured Housing, Second Mortgage and Other Consumer Loans. WMB and
WMBfsb offer consumer loan programs in Washington, Oregon, Utah, Idaho and
Montana that include: (i) manufactured housing loans; (ii) second mortgage loans
for a variety of purposes, including purchase, renovation, or remodeling of
property, and for uses unrelated to the security; (iii) loans for the purchase
of automobiles, pleasure boats and recreational vehicles; (iv) student loans;
and (v) loans for general household purposes, including loans made under
Washington Mutual's secured line of credit programs. Consumer loans, in addition
to being an important part of the Company's orientation toward consumer
financial services, promote greater net interest income stability because of
their somewhat shorter maturities and faster prepayment characteristics. The
size of the consumer loan portfolio has grown in recent years. It is
management's intention to introduce these products into ASB's service area.
Lending in this area may involve special risks, including decreases in the value
of collateral and transaction costs associated with foreclosure and
repossession.
Consumer loans generally are secured loans and are made based on an
evaluation of the collateral and the borrower's creditworthiness, including such
factors as income, other indebtedness and credit history. Secured consumer loan
amounts typically do not exceed 80% of the value of the collateral, less the
outstanding balance of any first-mortgage loan. Manufactured housing loans do
not exceed 90% of the value of the collateral plus taxes and other costs.
Additional limitations may be based on the customer's income, credit history and
other
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factors showing creditworthiness. Lines of credit are subject to periodic
review, revision and, when deemed appropriate by the Company, cancellation as a
result of changes in the borrower's financial circumstances.
ASB has originated various types of consumer loans that are generally
unsecured lines of credit and loans that are secured by personal property. These
loans have historically been provided as a service to ASB's existing customers
and have not represented a significant portion of its business. In the first
quarter of 1994, ASB discontinued its credit card operations and sold its entire
credit card portfolio for a gain of $25.0 million.
Commercial Business Loans. At year-end 1996, the commercial banking
division offered a full range of commercial banking products and services
through 48 free-standing, full-service business branches, supplemented by 10
business banking centers located near or in WMB financial centers. The Company's
commercial business loans are mainly loans to small and mid-sized businesses and
to individuals. They are secured by a variety of business and personal assets
or, in some cases, are unsecured. In 1996, the division originated $348.4
million of commercial business loans and the commercial business loan portfolio
totaled $340.1 million at December 31, 1996.
ASSET QUALITY
General. Washington Mutual reviews its assets for weakness on a regular
basis. Reserves are maintained for assets classified as substandard or doubtful.
Any portion of an asset classified as loss is immediately written off.
Washington Mutual's comprehensive process for identifying impaired assets,
classifying assets and asset review is performed on a quarterly basis. The
objective of the review process is to identify any trends and determine the
levels of loss exposure to evaluate the need for an adjustment to the reserve
accounts.
The principal measures of asset problems are the levels of nonaccrual
loans, loans under foreclosure and real estate owned ("REO"), which collectively
are classified as nonperforming assets, levels of impaired loans, the amount of
the provision for loan losses, loan charge-offs, and write-downs in the value of
REO. See "Management's Discussion and Analysis of Financial Position and Results
of Operations -- Asset Quality -- Classified Assets."
Management ceases to accrue interest income on any loan that becomes 90
days or more delinquent and reserves all interest accrued up to that time. In
addition, when circumstances indicate concern as to the future collectibility of
the principal of a commercial real estate loan, management stops accruing
interest on the loan, whether or not it has reached the 90-day delinquency
point. Thereafter, interest income is accrued only if and when, in management's
opinion, projected cash proceeds are deemed sufficient to repay both principal
and interest. All loans on which interest is not being accrued are referred to
as loans on nonaccrual status.
Nonperforming loans include loans on which payment is 90 days or more
delinquent and loans that are under foreclosure (a category that includes
properties for which decrees of foreclosure have been granted but that are held
under sheriffs' certificates pending expiration of the borrowers' redemption
rights).
REO. Real estate that served as security for a defaulted loan and becomes
REO is recorded on the Company's books at the lower of the outstanding loan
balance (net of any reserves charged off) or fair value, the determination of
which takes into account the effect of sales and financing concessions that may
be required to market the property. If management's estimate of fair value at
the time a property becomes REO is less than the loan balance, the loan is
written down at that time by a charge to the reserve for loan losses.
The REO reserve provides for losses that may result from unforeseen market
changes in the REO portfolio and declines in fair values of properties
subsequent to their initial transfer to REO. REO properties are analyzed
periodically to determine the adequacy of the REO reserve. Any adjustment in the
reserve that results from such evaluations is charged to the results of REO
operations in the period in which it is identified. Personal property that has
been repossessed is recorded at the lower of the outstanding loan balance (net
of any charge-offs) or fair value at the time the property was repossessed. See
"Management's Discussion and Analysis of Financial Position and Results of
Operations -- Asset Quality" for further discussion.
Provision for Loan Losses and Reserve for Loan Losses. Loan loss reserves
are based upon management's continuing analysis of pertinent factors underlying
the quality of the loan portfolio. These factors
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include changes in the size and composition of the loan portfolio, historical
loan loss experience, industry-wide loss experience, current and anticipated
economic conditions and detailed analysis of individual loans and credits for
which full collectibility may not be assured, as well as management's policies,
practices and intentions with respect to credit administration and asset
management.
As part of the process of determining the adequacy of the reserve for loan
losses, management reviews the Company's loan portfolio for specific weaknesses.
Residential construction, commercial real estate and commercial business loans
are evaluated individually for impairment. This detailed analysis includes
techniques to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. When available information confirms
that specific loans or portions thereof are uncollectible, those amounts are
charged-off against the reserve for loan losses. The existence of some or all of
the following criteria will generally confirm that a loss or impairment has
incurred: the loan is significantly delinquent and the borrower has not
evidenced the ability or intent to bring the loan current; the Company has no
recourse to the borrower, or if it does, the borrower has insufficient assets to
pay the debt; or the fair value of the loan collateral is significantly below
the current loan balance, and there is little or no near-term prospect for
improvement.
Unallocated reserves are established for loss exposure that may exist in
the remainder of the loan portfolio but has not yet been identified. In
determining the adequacy of unallocated reserves, management considers changes
in the size and composition of the loan portfolio, historical loan loss
experience, current and anticipated economic conditions, and the Company's
credit administration and asset management philosophies and procedures.
The Company recorded an additional $125.0 million to the reserve for loan
losses at the closing of the merger with Keystone Holdings. The additional
reserve for loan losses was provided principally because a number of credit
administration and asset management philosophies and procedures of WMB differed
from those of ASB. The Company is conforming ASB's administration, philosophies
and procedures to those of WMB and WMBfsb. The additional reserve for loan
losses was to a lesser degree provided because the Company believed that while
there had been an increase in the value of residential real estate in certain
California markets, a decline in collateral values in some portions of the
California real estate market occurred in 1996.
It is possible that the provision for loan losses may, in the future,
change as a percentage of total loans. The reserve for loan losses is maintained
at a level sufficient to provide for estimated loan losses based on evaluating
known and inherent risks in the loan portfolio. See "Management's Discussion and
Analysis of Financial Position and Results of Operations -- Asset
Quality -- Provision for Loan Losses and Reserve for Loan Losses."
INVESTING ACTIVITIES
General. Washington Mutual has authority under state law to make any
investment, but may be subject to certain restrictions imposed by the Home
Owners' Loan Act ("HOLA"). Under Washington state law, WMB has authority to make
any investment deemed prudent by its board of directors, and may invest in
commercial paper, corporate bonds, mutual fund shares, debt and equity
securities issued by creditworthy entities and interests in real estate located
inside or outside of Washington state. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), however, prohibits a state bank (such as
WMB) from making or retaining equity investments that are not permissible for a
national bank, subject to certain exceptions.
ASB and WMBfsb have authority to make investments specified by HOLA and
applicable regulations, including the purchase of governmental obligations,
investment-grade commercial paper, and investment-grade corporate debt
securities. Under the laws of the states of Arizona and Washington,
respectively, WM Life and Empire have broad authority to make investments in
debt and equity securities subject to applicable reserve requirements and
risk-based capital requirements.
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Effective January 1, 1994, Washington Mutual adopted, as required,
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for
Certain Investments in Debt and Equity Securities. This statement required
investment and equity securities to be segregated into three categories:
"trading" securities, "held-to-maturity" securities and "available-for-sale"
securities. As a result of SFAS No. 115, at December 31, 1996, a net unrealized
gain (on an after-tax basis) of $41.7 million associated with available-for-sale
securities was included as a separate component of stockholders' equity. At
December 31, 1996, the Company's investment portfolio included $2.9 billion of
held-to-maturity securities (with a fair value of $2.9 billion), $9.1 billion of
available-for-sale securities and $1.6 million of trading account securities. At
December 31, 1996, MBS accounted for $10.5 billion or 87% of the total
investment portfolio.
The Company's investment portfolio by investment type at carrying value
consisted of the following:
DECEMBER 31,
------------------------------------------
1996 1995 1994
----------- ----------- ----------
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. government and agency obligations............. $ 279,189 $ 345,510 $ 565,025
Corporate debt obligations......................... 479,836 607,926 617,548
Municipal obligations.............................. 108,271 92,508 80,762
Equity securities.................................. 639,287 525,153 387,997
----------- ----------- ----------
1,506,583 1,571,097 1,651,332
Mortgage-backed securities:
U.S. government agency............................. 9,633,439 12,561,748 6,113,146
Private issue...................................... 831,432 1,222,270 913,941
----------- ----------- ----------
10,464,871 13,784,018 7,027,087
Derivative instruments:
Interest rate exchange agreements.................. (646) (11,847) 18,654
Interest rate cap agreements....................... 2,460 9,415 41,690
----------- ----------- ----------
1,814 (2,432) 60,344
----------- ----------- ----------
Total investment portfolio...................... $11,973,268 $15,352,683 $8,738,763
=========== =========== ==========
For a discussion of the stated maturities of the Company's investment
portfolio at December 31, 1996, see "Consolidated Financial Statements -- Note
4: Available-for-Sale Securities" and "-- Note 5: Held-to-Maturity Securities."
The risk of loss upon default of the borrower is generally greater for
corporate debt securities than for real estate loans. In addition, investments
by the Company in debt or equity securities of an issuer are generally much
larger than investments in any particular real estate loan, resulting in a
greater effect on the Company in the event of default or decline in market
value. The Company regularly analyzes these securities for impairment of value
and makes adjustments in their carrying value or yield as appropriate.
Historically, the yield on private-issue MBS, collateralized mortgage
obligations ("CMOs"), and purchased loan pools has exceeded the yield on GSE MBS
because they expose the Company to certain risks that are not inherent in GSE
MBS, such as credit risk and liquidity risk. These assets are not guaranteed by
the U.S. government or one of its agencies because the loan size, underwriting
or underlying collateral of these assets often does not meet set industry
standards. Consequently, there is a higher potential of loss of the principal
investment. Additionally, the Company may not be able to sell such assets in
certain market conditions as the number of interested buyers may be limited at
that time. Furthermore, the complex structure of certain collateralized mortgage
obligations in the Company's portfolio increases the difficulty in assessing the
portfolio's risk and its fair value. Examples of some of the more complex
structures include certain collateralized mortgage obligations where the Company
holds subordinated tranches, certain collateralized mortgage obligations that
have been resecuritized, and certain securities that contain a significant
number of Jumbo loans.
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In 1996, in an effort to reduce the aforementioned risks, the Company
instituted a policy of performing credit reviews on each individual security or
loan pool prior to purchase. Such a review includes consideration of the
collateral characteristics, borrower payment histories and information
concerning loan delinquencies and losses of the underlying collateral. After a
security is purchased, similar information is monitored on a periodic basis.
Furthermore, the Company has established internal guidelines limiting the
geographic concentration of the underlying collateral.
At December 31, 1996, the Company held $831.4 million of private-issue MBS.
Of that amount, 20% were the highest investment grade (AAA), 66% were rated
investment grade (AA or A), 9% were rated lowest investment grade (BBB) and 5%
were rated below investment grade (BB or below). The Company's policy is not to
purchase securities that are below investment grade. The below investment grade
securities in the Company's portfolio at December 31, 1996 were the result of
downgrades of such securities by the rating agencies. The Company recognized
losses of $2.4 million during 1996 and $8.4 million in 1995 on certain
securities in the below investment grade portfolio due to credit quality
deterioration.
At December 31, 1996, the Company held $639.3 million of equity securities
in its available-for-sale securities portfolio. Federal Home Loan Bank ("FHLB")
stock was $465.1 million or 73% of the total.
SOURCES OF FUNDS
Deposits. At December 31, 1996, WMB accepted deposits at 274 financial
centers in Washington and Oregon, ASB accepted deposits at 158 branches in
California, and WMBfsb accepted deposits at 29 financial centers in Utah, Idaho,
Montana and Oregon. The Company's banking subsidiaries compete with other
financial institutions in attracting savings deposits. Competition from
commercial banks has been particularly strong due to their extensive
distribution systems. In addition, there is strong competition for customer
dollars from credit unions, mutual funds and nonbank corporations, such as
securities brokerage companies and other diversified companies, some of which
have nationwide networks of offices.
In recent years, deposit growth has resulted almost exclusively from
business combinations. At December 31, 1996, the Company's deposits totaled
$24.1 billion. Business combinations during 1994, 1995 and 1996 added $211.5
million, $417.1 million and $13.7 billion in deposits, including $12.9 billion
in deposits from the Keystone Transaction. ASB has also grown deposits through
acquisitions, with $4.0 billion in acquired deposits over its eight-year life.
Without the addition of the acquired deposits, the Company's deposits would have
decreased from December 31, 1993 to December 31, 1996.
The Company offers traditional passbook and statement savings accounts as
well as checking accounts. In addition, the Company offers money market deposit
accounts ("MMDAs") with higher minimum balances that offer higher yields.
WMB's and WMBfsb's Deposits. WMB and WMBfsb offer a broad range of deposit
products and at December 31, 1996 had a total of $11.1 billion in deposits, $5.3
billion of which were time deposits, $4.2 billion of which were MMDAs and
savings accounts; and $1.6 billion of which were checking accounts. The most
popular time deposit is a product called "Investor's Choice," which is a time
deposit with maturities available from one to 120 months in any one of three
deposit size categories. Interest rates on Investor's Choice time deposits
generally increase with increased maturity and amount. Less than 50% of deposits
at December 31, 1996 were time deposits and of those, only $1.0 billion or 19%
of total time deposits had remaining maturities longer than one year.
Since 1995, WMB and WMBfsb have been heavily promoting a "Free Checking"
account. This account has helped to reduce the overall cost of funds by
increasing the percentage of deposits that are noninterest-bearing. At December
31, 1996, $726.6 million or 44% of WMB's and WMBfsb's total checking accounts
did not bear interest.
WMB and WMBfsb have also actively promoted MMDAs because, while a somewhat
volatile source of deposits, they have the advantage of being variable-rate
liabilities. At December 31, 1996, WMB and WMBfsb had an aggregate of $3.3
billion in MMDAs and only $921.3 million in regular savings accounts.
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Wholesale deposits, primarily time deposits, are sold to political
subdivisions and public agencies. The Company considers wholesale deposits to be
a borrowing source rather than a customer relationship.
ASB's Deposits. Like WMB and WMBfsb, ASB's deposit liabilities are
primarily short term. Of ASB's total deposits of $12.9 billion at December 31,
1996, only $1.1 billion was in time deposits with remaining maturities of longer
than one year.
Like WMB and WMBfsb, ASB has also promoted a checking account product, in
its case, "Mileage Checking." Mileage Checking is, unlike Free Checking, an
interest-bearing checking account product. At December 31, 1996, ASB had total
interest-bearing checking deposits of $1.2 billion. Management of the Company
hopes to reduce ASB's cost of funds in the future by introducing Free Checking
in ASB's markets and discontinuing Mileage Checking. Management also hopes to
interest more of ASB's depositors in MMDAs, which currently account for only 15%
of ASB's deposits.
Borrowings and Annuities. The Company uses borrowings, in addition to
deposit acquisitions, as an integral part of funding its growth. In addition to
the borrowings discussed below, at December 31, 1996, the Company was in a
position to obtain an additional $9.7 billion, primarily through the use of
collateralized borrowings and deposits of public funds using unpledged
mortgage-backed securities and other wholesale borrowing sources. See
"Management's Discussion and Analysis of Financial Position and Results of
Operation -- Liquidity."
Borrowings include the sale of securities subject to repurchase agreements,
the purchase of federal funds, the issuance of mortgage-backed bonds or notes,
capital notes and other types of debt securities, and funds obtained as advances
from the FHLB of Seattle and the FHLB of San Francisco. The Company also has
access to the Federal Reserve Bank's discount window. Under Washington state
law, WMB may borrow up to 30% of total assets, but sales of securities subject
to agreements to repurchase are not deemed borrowings under such law, and
borrowings from federal, state or municipal governments, agencies or
instrumentalities thereof also are not subject to the 30% limit.
The Company actively engages in repurchase agreements with authorized
broker-dealers and major customers selling U.S. government and corporate
securities and MBS under agreements to repurchase them or similar securities at
a future date. At December 31, 1996, the Company had $7.8 billion of such
borrowings.
WMB, WMBfsb and WM Life are members of the FHLB of Seattle and ASB is a
member of the FHLB of San Francisco. As members, each company maintains a credit
line that is a percentage of its total regulatory assets, subject to
collateralization requirements. At year-end 1996, WMB, ASB, WMBfsb, and WM Life
had credit lines of 30%, 30%, 45% and 20%, respectively, of total regulatory
assets. At December 31, 1996, advances under these credit lines totaled $7.2
billion and were secured in aggregate by grants of security interests in all
FHLB stock owned, deposits with the FHLB, and certain mortgage loans and deeds
of trust and securities of the U.S. government and agencies thereof.
In August 1995, the Company filed a registration statement with the
Securities and Exchange Commission ("SEC") for the offering, on a delayed or
continuous basis, of up to $250.0 million of debt securities, of which $100.0
million remains available.
In December 1996, Washington Mutual entered into two Revolving Credit
Facilities (the "Facilities"): a $100.0 million 364-day facility and a $100.0
million four-year facility. Chase Manhattan Bank is administrative agent for the
Facilities. At December 31, 1996, no monies had been drawn. However, in January
1997, $150.0 million was borrowed, in part, for the redemption of $354.0 million
of debt securities of a Keystone Holdings' subsidiary, and in February 1997,
another $20.0 million was drawn. See "Consolidated Financial Statements -- Note
16: Other Borrowings" for further discussion. The remaining proceeds of the
Facilities are available for general corporate purposes, including providing
capital at a subsidiary level.
WM Life and Empire issue fixed annuity contracts through licensed agents
who are employees of subsidiaries of the Company and operate in WMB financial
centers. Currently, annuities are issued primarily in Washington and Oregon. At
December 31, 1996, the policy value of such contracts was $807.4 million. WM
Life also issues variable annuity contracts. At December 31, 1996, the policy
value of such contracts was
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$70.7 million. All annuity contracts impose a contractual surrender charge in
the event of a customer's withdrawal of funds within a certain number of years
(in the case of most of WM Life's fixed annuity contracts, five years) from the
date the annuity contract was issued.
ASSET AND LIABILITY MANAGEMENT
The long-run profitability of the Company depends not only on the success
of the services it offers to its customers and the quality of its loans and
investments, but also the extent to which its earnings are unaffected by changes
in interest rates. The Company's asset and liability management strategy
attempts to reduce the risk of a significant decrease in net interest income
caused by interest rate changes without unduly penalizing current earnings.
WMB and WMBfsb, as is true of many financial institutions, have had a
mismatch between the maturity of its assets and liabilities. Their customers
generally prefer short-term deposits (see "Sources of Funds -- Deposits") and
many of them also prefer long-term fixed-rate loans. This mismatch is not a
problem when interest rates are stable or declining. However, with a rise in
short-term interest rates, as was experienced throughout most of 1994, the
interest paid on deposits and other short-term borrowings increases much more
quickly than the interest earned on loans and investments. The result for WMB
and WMBfsb was a reduction in their net interest spread and corresponding
pressure on net interest income in both 1994 and 1995. One means of reducing the
effect of interest rate volatility on net interest income is to shorten asset
durations. In recent years, WMB and WMBfsb have attempted to do this by
emphasizing ARMs and short-term consumer loan programs. At December 31, 1996,
the portion of WMB's and WMBfsb's residential loans and MBS that were adjustable
rate was approximately 52%. ASB does not suffer from the same asset liability
mismatch as WMB and WMBfsb because the majority of its assets are COFI ARMs
which reprice monthly. In times of rising interest rates, however, the Company
is negatively affected by an inherent timing difference between the repricing of
its ARM assets and its liabilities. The effect of this timing difference, or
"lag," will be favorable during a period of declining interest rates and
unfavorable in a rising interest rate environment. Although the effect of this
lag generally balances out over the life of a loan, it can produce short-term
volatility in the Company's net interest income during periods of interest rate
movement.
The lifetime interest rate caps which the Company offers to its ARM
borrowers introduce another element of interest rate risk to the Company. In
periods of high interest rates, it is possible for the index to exceed the rate
on the lifetime interest rate caps offered to customers. When determined
appropriate by management, the Company manages this risk by purchasing COFI- and
LIBOR-based interest rate cap agreements.
In 1995, the Company reclassified $4.9 billion of securities from its
held-to-maturity category to the available-for sale category. See "Management's
Discussion and Analysis of Financial Position and Results of
Operations -- Review of Financial Position." More than one-half of the
securities reclassified were fixed rate. The reclassification gave the Company
the flexibility to dispose of a portion of such securities over time and replace
them with adjustable-rate assets as part of its interest rate risk management
program. During 1996, the Company securitized and then sold a substantial
portion of the fixed-rate loans it originated, while retaining nearly all of its
adjustable-rate loan production. Generally, the Company retained the servicing
rights to the loans that were sold. In addition, as part of the restructuring
strategy initiated in late 1995, the Company purchased adjustable-rate assets
and sold fixed-rate mortgage-backed assets.
In the future, it is anticipated that a portion of the remaining fixed-rate
securities may be replaced with adjustable-rate GSE MBS, adjustable-rate
private-issue MBS, collateralized mortgage obligations, and purchased loan pools
as well as new originations of ARMs, as the fixed-rate securities pay down or
are sold as market conditions permit. During periods of moderate to high market
interest rates, originations of ARMs have been well received by customers.
During periods of low market interest rates, however, customers have preferred
fixed-rate mortgage loans. This portfolio restructuring strategy is intended to
reduce the Company's interest rate sensitivity while simultaneously protecting
its yield. As the Company substitutes adjustable-rate assets for fixed-rate
assets, its sensitivity to future changes in interest rates decreases, because,
unlike fixed-rate securities, interest rates on adjustable-rate assets change,
within certain periodic and lifetime cap
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restraints, with corresponding changes in market rates. However, substituting
adjustable-rate assets for fixed-rate assets can have two disadvantages. First,
adjustable-rate assets, when compared with similar fixed-rate assets, carry
additional credit risk in an increasing interest rate environment. As these
assets reprice upward, the borrower's creditworthiness may become impaired.
Second, the holding of adjustable-rate assets will decrease the overall
portfolio yield in a stable or declining interest rate environment. Accordingly,
the Company plans to replace some of its fixed-rate MBS with private-issue MBS,
collateralized mortgage obligations, and purchased loan pools to minimize the
potential decline in portfolio yield.
Another way to reduce the effect of the volatility of interest rates is to
lengthen liability durations, which is difficult because of depositors'
preferences for liquidity. This was apparent from the fact that at December 31,
1996, the Company's MMDAs accounted for $5.2 billion or 22% of total deposits,
and time deposits with maturities less than one year totaled $12.2 billion or
50% of total deposits.
At December 31, 1996, interest-sensitive assets of $31.8 billion and
interest-sensitive liabilities of $33.4 billion were scheduled to mature or
reprice within one year. At December 31, 1996, the Company's one-year gap was a
negative 3.64%. The Company's interest rate sensitivity has decreased with the
sale of WMB's fixed-rate MBS undertaken in 1996 and the retention of ARMs
originated by ASB. It still, however, suffers, from some short-term volatility
of net income because of the effect of COFI lag. Management hopes to reduce this
short-term volatility in part by increasing production of non-COFI
adjustable-rate products and short-term fixed-rate products such as consumer
loans. In addition to managing the terms of its actual assets and liabilities,
the Company uses derivative instruments, such as interest rate exchange
agreements and interest rate cap agreements, to mitigate interest rate risk. At
December 31, 1996, the Company had entered into interest rate exchange
agreements and interest rate cap agreements with notional values of $9.1
billion. Without these instruments, the Company's one-year gap at December 31,
1996, would have been a negative 9.81% as opposed to a negative 3.64%. See
"Consolidated Financial Statements -- Note 17: Interest Rate Risk Management"
for a discussion of the use of derivative instruments.
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BUSINESS COMBINATIONS
Most of the Company's growth since 1988 has occurred as a result of banking
business combinations. The following table summarizes Washington Mutual's
business combinations since April 1988:
NUMBER OF
ACQUISITION NAME DATE ACQUIRED LOANS DEPOSITS ASSETS LOCATIONS
- -------------------------------------- ---------------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
Columbia Federal Savings Bank and
Shoreline Savings Bank.............. April 29, 1988 $ 551.0 $ 555.0 $ 752.6 26
Old Stone Bank(1)..................... June 1, 1990 229.5 292.6 294.0 7
Frontier Federal Savings
Association(2)...................... June 30, 1990 -- 95.6 -- 6
Williamsburg Federal Savings
Bank(2)............................. Sept. 14, 1990 -- 44.3 -- 3
Vancouver Federal Savings Bank........ July 31, 1991 200.1 253.4 260.7 7
CrossLand Savings, FSB(2)............. Nov. 8, 1991 -- 185.4 -- 15
Sound Savings and Loan Association.... Jan. 1, 1992 16.8 20.5 23.5 1
World Savings and Loan
Association(2)...................... March 6, 1992 -- 37.8 -- 2
Great Northwest Bank.................. April 1, 1992 603.2 586.4 710.4 17
Pioneer Savings Bank.................. March 1, 1993 624.5 659.5 926.5 17
Pacific First Bank, A Federal Savings
Bank................................ April 9, 1993 3,770.7 3,831.7 5,861.3 129
Far West Federal Savings Bank(2)...... April 15, 1994 -- 42.2 -- 3
Summit Savings Bank................... Nov. 14, 1994 127.5 169.3 188.1 4
Olympus Bank, a Federal Savings
Bank................................ April 28, 1995 237.8 278.6 391.4 11
Enterprise Bank....................... Aug. 31, 1995 92.8 138.5 153.8 1
Western Bank.......................... Jan. 31, 1996 500.8 696.4 776.3 42
Utah Federal Savings Bank............. Nov. 30, 1996 88.9 106.7 122.1 5
American Savings Bank, F.A.(3)........ Dec. 20, 1996 14,562.9 12,815.4 21,893.5 224
United Western Financial Group........ Jan. 15, 1997 272.7 299.9 404.1 16
- ---------------
(1) This was an acquisition of selected assets and liabilities.
(2) The acquisition was of branches and deposits only. The only assets acquired
were branch facilities or loans collateralized by acquired savings deposits.
(3) Information given as of November 30, 1996.
See "Consolidated Financial Statements -- Note 2: Business Combinations"
for a discussion of the accounting treatment of certain of the acquisitions.
EMPLOYEES
The number of full-time equivalent employees at the Company increased from
7,903 at December 31, 1995 to 8,322 at December 31, 1996. The Company believes
that it has been successful in attracting quality employees and believes its
employee relations are good.
TAXATION
General. For federal income tax purposes, the Company reports its income
and expenses using the accrual method of tax accounting and uses the calendar
year as its tax year. Except for the interest expense rules pertaining to
certain tax exempt income applicable to banks and the recently repealed bad debt
reserve deduction, the Company is subject to federal income tax, under existing
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), in
generally the same manner as other corporations.
Tax Bad Debt Reserve Recapture. The recently enacted Small Business Job
Protection Act of 1996 (the "Job Protection Act") requires that qualified thrift
institutions, such as WMB, ASB and WMBfsb, generally recapture, for federal
income tax purposes, that portion of the balance of their tax bad debt reserves
that exceeds the December 31, 1987 balance, with certain adjustments. Such
recaptured amounts are to be
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generally taken into ordinary income ratably over a six-year period beginning in
1997. Accordingly, Washington Mutual will have to pay approximately $4.2 million
(based upon current federal income tax rates) in additional federal income taxes
each year of the six-year period due to the Job Protection Act.
The Job Protection Act also repeals the reserve method of accounting for
tax bad debt deductions and, thus, requires thrifts to calculate the tax bad
debt deduction based on actual current loan losses.
State Income Taxation. The state of Washington does not currently have a
corporate income tax. A business and occupation tax based on a percentage of
gross receipts is assessed on businesses. Currently, interest received on loans
secured by first mortgages or deeds of trust on residential properties is not
subject to such tax. However, it is possible that legislation will be introduced
that would repeal or limit this exemption.
The states of California, Oregon, Utah, Idaho, Montana and Colorado have
corporate income taxes, which are imposed on companies doing business in those
states. The Company's operations in California and Oregon result in substantial
corporate income tax expenses in such states. As the Company's operations in the
remaining states increase, the corporate income taxes will have an increasing
effect on the Company's results of operations or financial condition.
If and to the extent the Company carries on activities in other states, the
Company may in certain circumstances be subject to taxation in such states.
Assistance Agreement. Keystone Holdings and certain of its affiliates are
parties to an agreement (the "Assistance Agreement") with a predecessor of the
FSLIC Resolution Fund (the "FRF"), which was designed, in part, to provide that
over time 75% of most of the federal tax savings and 19.5% of most of the
California tax savings (in each case computed in accordance with specific
provisions contained in the Assistance Agreement) attributable to the
utilization of certain tax losses or tax loss carryforwards of New West Federal
Savings and Loan Association ("New West") are paid ultimately to the FRF. The
provision for such payments is reflected in the financial statements as
"Payments in Lieu of Taxes." See "Management's Discussion and Analysis of
Financial Position and Results of Operations -- General -- The Keystone
Transaction" and "Consolidated Financial Statements -- Note 20: Payments in Lieu
of Taxes."
Due to Section 382 of the Code, most of the value of the net operating loss
carryforward deductions of Keystone Holdings and its subsidiaries was eliminated
due to the Keystone Transaction. Accordingly, the future tax savings
attributable to such net operating loss carryforward deductions (other than
amounts used to offset bad debt reserve deduction recapture for ASB) will be
greatly reduced.
ENVIRONMENTAL REGULATION
The Company's business and properties are subject to federal and state laws
and regulations governing environmental matters, including the regulation of
hazardous substances and wastes. For example, under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("CERCLA") and similar
state laws, owners and operators of contaminated properties may be liable for
the costs of cleaning up hazardous substances without regard to whether such
persons actually caused the contamination. Such laws may affect the Company both
as an owner of properties used in or held for its business and as a secured
lender of property that is found to contain hazardous substances or wastes.
Further, although CERCLA exempts holders of security interests, the
exemption may not be available if a secured party engages in the management of
its borrower or the collateral property in a manner deemed beyond the protection
of the secured party's interest. Recent federal and state legislation, as well
as guidance issued by the United States Environmental Protection Agency and a
number of court decisions, have provided assurance to lenders regarding the
activities they may undertake and remain within CERCLA's secured party
exemption. However, these assurances are not absolute and generally will not
protect a lender or fiduciary that participates or otherwise involves itself in
the management of its borrower, particularly in foreclosure proceedings. As a
result, CERCLA and similar state statutes may affect the Company's decision
whether to foreclose on property that is found to be contaminated. It is the
Company's general policy to obtain an environmental assessment prior to
foreclosure of commercial property. The existence of hazardous substances
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or wastes on such property may cause the Company to elect not to foreclose on
the property, thereby limiting, and in some instances precluding, the Company
from realizing its investment in such loans.
REGULATION AND SUPERVISION
General. WMI, in its capacity as a savings and loan holding company, is
subject to regulation by the Office of Thrift Supervision ("OTS"). WMB is
subject to regulation and supervision by the Director of Financial Institutions
of the State of Washington ("State Director"). Its deposit accounts are insured
by the FDIC through both the BIF and SAIF. The FDIC undertakes examination and
regulation of WMB and other state-chartered banks that are not members of the
Federal Reserve system ("FDIC-regulated banks"). Federal and state laws and
regulations govern, among other things, investment powers, deposit activities,
borrowings, maintenance of guaranty funds and retained earnings. ASB and WMBfsb
are subject to extensive regulation and examination by the OTS, which is their
primary federal regulator. Their deposit accounts are insured through the SAIF
by the FDIC, which also has some authority to regulate ASB and WMBfsb.
The description of statutory provisions and regulations applicable to
depository institutions, insurance companies, securities companies and their
holding companies set forth in this annual report does not purport to be a
complete description of the statutes and regulations mentioned herein, nor of
all such statutes and regulations.
Holding Company Regulation. WMI is a multiple savings and loan holding
company, as defined by federal law, because it owns three savings
associations -- WMB, ASB and WMBfsb. WMB has elected to be treated as a savings
association for purposes of the federal savings and loan holding company law.
WMI is treated as a unitary savings and loan holding company and is not subject
to certain federal statutory restrictions on activities and investments (the
"MHC Restrictions") as are some multiple savings and loan holding companies,
because ASB and WMBfsb are deemed to have been acquired in supervisory
transactions. WMI will become subject to the MHC Restrictions, however, if any
one of WMB, ASB or WMBfsb fails to be a qualified thrift lender ("QTL"), meaning
generally that either (a) at least 65% of a specified asset base must consist of
loans to small businesses, credit card loans, educational loans or certain
assets related to domestic residential real estate, including residential
mortgage loans and mortgage securities; or (b) at least 60% of total assets must
consist of cash, United States government or government agency debt or equity
securities, fixed assets, or loans secured by deposits, by real property used
for residential, educational, church, welfare or health purposes, or by real
property in certain urban renewal areas. Failure to remain a QTL also would
impose conditions on WMB's ability to obtain advances from the FHLB, and would
restrict the ability of ASB and WMBfsb, among other things, to branch, to pay
dividends and to obtain such advances. Each of WMB, ASB and WMBfsb are currently
in compliance with QTL standards.
HOLA and OTS regulations require WMI, as a savings and loan holding
company, to file periodic reports with the OTS. In addition, it must observe
such recordkeeping requirements as the OTS may prescribe and is subject to
holding company examination by the OTS. The OTS may take enforcement action if
the activities of a savings and loan holding company constitute a serious risk
to the financial safety, soundness or stability of a subsidiary savings
association. WMB, ASB and WMBfsb, as holding company subsidiaries that are
depository institutions, are subject to both qualitative and quantitative
limitations on the transactions they conduct with WMI and its other
subsidiaries.
The FDIC has authority to require FDIC-insured banks and savings
associations to reimburse the FDIC for losses incurred by the FDIC in connection
with the default of a commonly controlled depository institution or with the
FDIC's provision of assistance to such an institution. Institutions are commonly
controlled if they are controlled by the same holding company or if one
depository institution controls another depository institution (as WMI controls
WMB, ASB and WMBfsb).
State Regulation and Supervision. Savings banks in Washington, such as
WMB, are empowered by state statute to take deposits and pay interest thereon
and, subject to various conditions and limitations, to make loans on or invest
in residential and other real estate, to make consumer loans, to make commercial
loans, to invest in corporate obligations, government debt securities, and other
securities, and to offer various trust and banking services to their customers.
See " -- The Company" and " -- Washington Mutual's
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Operating Subsidiaries." Under state law, savings banks in Washington also
generally have all of the powers that federal mutual savings banks have under
federal laws and regulations.
FDIC Insurance. Deposits in WMB, ASB and WMBfsb are separately insured by
the FDIC to the applicable maximum limits in each institution. The FDIC
administers two separate deposit insurance funds. The BIF is a deposit insurance
fund for commercial banks and some state-chartered banks, including WMB. A
portion of WMB's deposits are also insured through SAIF. The SAIF is a deposit
insurance fund for most savings associations, such as ASB and WMBfsb. At
December 31, 1996, approximately 79% of the combined deposits of WMB, ASB and
WMBfsb were insured through SAIF.
The FDIC has developed a deposit insurance system under which the
assessment rate for an insured depository institution varies according to the
level of risk it poses to the BIF or SAIF. This system bases an institution's
risk category partly upon whether the institution is well capitalized,
adequately capitalized, or less than adequately capitalized. See "Regulation and
Supervision -- Capital Requirements." Each insured depository institution is
also assigned to one of three supervisory subgroups based on reviews by the
institution's primary federal or state regulator, statistical analyses of
financial statements, and other information relevant to gauging the risk posed
by the institution. Based on its capital and supervisory subgroups, each
institution is assigned an annual FDIC assessment rate. WMB qualifies for the
lowest rate on its BIF deposits, and WMB, ASB and WMBfsb qualify for the lowest
rate on their SAIF deposits. Regardless of the potential risk to the insurance
fund, Federal law requires the FDIC to establish assessment rates that will
maintain each insurance fund's ratio of reserves to insured deposits at $1.25
per $100.
The BIF reached the $1.25 per $100 of insured deposits reserve ratio and,
effective January 1996, BIF premiums declined. On September 30, 1996, President
Clinton signed legislation intended, among other things, to recapitalize the
SAIF and to reduce SAIF premiums. The legislation provided for a special
one-time assessment on SAIF-insured deposits that were held as of March 31,
1995, including certain deposits acquired after that date. This assessment
brought the SAIF's reserve ratio to the legally required $1.25 per $100 of
insured deposits level. Washington Mutual's special assessment resulted in a
pretax charge of $124.2 million. Even though the one-time charge reduced the
Company's 1996 earnings by $84.8 million, management believes the legislation is
in the best interests of the Company due to the reduction in SAIF assessment
rates. Beginning in January 1997, deposits insured through the SAIF at ASB,
WMBfsb and WMB are subject to regular FDIC assessments amounting to 6.48 cents
per $100 of insured deposits per year, while deposits insured through the BIF at
WMB are subject to regular FDIC assessments amounting to 1.30 cents per $100 of
insured deposits per year.
Capital Requirements. WMI is not subject to any regulatory capital
requirements. However, each of its subsidiary depository and insurance
institutions is subject to various capital requirements. WMB is subject to FDIC
capital requirements, while ASB and WMBfsb are subject to OTS capital
requirements. WM Life is subject to National Association of Insurance
Commissioners ("NAIC") capital requirements.
WMB. FDIC regulations recognize two types or tiers of capital: core ("Tier
1") capital and supplementary ("Tier 2") capital. Tier 1 capital generally
includes common stockholders' equity and noncumulative perpetual preferred
stock, less most intangible assets. Tier 2 capital, which is limited to 100% of
Tier 1 capital, includes such items as qualifying general loan loss reserves,
cumulative perpetual preferred stock, mandatory convertible debt, term
subordinated debt and limited life preferred stock; however, the amount of term
subordinated debt and intermediate term preferred stock (original maturity of at
least five years but less than 20 years) that may be included in Tier 2 capital
is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to total assets. Most
banks are required to maintain a minimum leverage ratio of at least 4.00% to
5.00%. The FDIC retains the right to require a particular institution to
maintain a higher capital level based on an institution's particular risk
profile. WMB has calculated its leverage ratio to be 5.76% as of December 31,
1996.
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FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight -- 0%, 20%, 50% or
100% -- based on the relative risk of that category. For example, U.S. Treasury
Bills and GNMA securities are placed in the 0% risk category, FNMA and FHLMC
securities are placed in the 20% risk category, loans secured by 1-4 family
residential properties and certain privately issued mortgage-backed securities
are generally placed in the 50% risk category, and commercial real estate and
consumer loans are generally placed in the 100% risk category. In addition,
certain off-balance sheet items are converted to balance sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories. Under
the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital)
to risk-weighted assets must be at least 8.00%, and the ratio of Tier 1 capital
to risk-weighted assets must be at least 4.00%. WMB has calculated its total
risk-based ratio to be 11.09% as of December 31, 1996, and its Tier 1 risk-based
capital ratio to be 10.28%. In evaluating the adequacy of a bank's capital, the
FDIC may also consider other factors that may affect a bank's financial
condition. Such factors may include interest rate risk exposure, liquidity,
funding and market risks, the quality and level of earnings, concentration of
credit risk, risks arising from nontraditional activities, loan and investment
quality, the effectiveness of loan and investment policies, and management's
ability to monitor and control financial operating risks.
ASB and WMBfsb. The OTS requires savings associations, such as ASB and
WMBfsb, to meet each of three separate capital adequacy standards: a core
capital leverage requirement, a tangible capital requirement and a risk-based
capital requirement. OTS regulations require savings associations to maintain
core capital (which may include, for a limited time, certain amounts of
qualifying supervisory goodwill) of at least 3.00% of assets and tangible
capital (excluding all goodwill) of at least 1.50% of assets. As of December 31,
1996, ASB's core capital and tangible capital ratios were 5.17% each and
WMBfsb's core capital and tangible capital ratios were each 6.90%. Most savings
institutions are required to maintain a minimum leverage ratio of at least
4.00%. OTS regulations incorporate a risk-based capital requirement that is
designed to be no less stringent than the capital standard applicable to
national banks and is modeled in many respects on, but not identical to, the
risk-based capital requirements adopted by the FDIC. These regulations require a
core risk-based capital ratio of at least 4.00% and a total risk-based capital
ratio of at least 8.00%. As of December 31, 1996, ASB had core risk-based and
total risk-based capital ratios of 8.90% and 10.92%, while WMBfsb had ratios of
10.50% and 11.58%, respectively.
FDICIA Requirements. FDICIA created a statutory framework that increased
the importance of meeting applicable capital requirements. For WMB, ASB and
WMBfsb, FDICIA established five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a risk-based
capital measure, a leverage ratio capital measure, and certain other factors.
The federal banking agencies (including the FDIC and the OTS) have adopted
regulations that implement this statutory framework. Under these regulations, an
institution is treated as well capitalized if its ratio of total capital to
risk-weighted assets is 10.00% or more, its ratio of core capital to risk-
weighted assets is 6.00% or more, its ratio of core capital to adjusted total
assets is 5.00% or more and it is not subject to any federal supervisory order
or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not
less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and a
leverage ratio of not less than 4.00%. Any institution which is neither well
capitalized nor adequately capitalized will be considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure by
WMB, ASB or WMBfsb to comply with applicable capital requirements would, if
unremedied, result in restrictions on their activities and lead to enforcement
actions against WMB by the FDIC or against ASB or WMBfsb by the OTS, including,
but not limited to, the issuance of a capital directive to ensure the
maintenance of required capital levels. FDICIA requires the federal banking
regulators to take prompt corrective action with respect to depository
institutions that do not meet minimum capital requirements. Additionally, FDIC
or OTS approval of any regulatory application filed for their review may be
dependent on compliance with capital requirements.
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Federal law requires that the federal banking agencies risk-based capital
guidelines take into account various factors including interest rate risk,
concentration of credit risk, risks associated with nontraditional activities,
and the actual performance and expected risk of loss of multi-family mortgages.
In 1994, the federal banking agencies jointly revised their capital standards to
specify that concentration of credit and nontraditional activities are among the
factors that the agencies will consider in evaluating capital adequacy. In that
year, the OTS and FDIC amended their risk-based capital standards with respect
to the risk weighting of loans made to finance the purchase or construction of
multi-family residences. The OTS adopted final regulations adding an interest
rate risk component to the risk-based capital requirements for savings
associations (such as ASB and WMBfsb), although implementation of the regulation
has been delayed. Management believes that the effect of including such an
interest rate risk component in the calculation of risk-adjusted capital will
not cause ASB or WMBfsb to cease to be well capitalized. In June 1996, the FDIC
and certain other federal banking agencies (not including the OTS) issued a
joint policy statement providing guidance on prudent interest rate risk
management principles. The agencies stated that they would determine banks'
interest rate risk on a case-by-case basis, and would not adopt a standardized
measure or establish an explicit minimum capital charge for interest rate risk.
WM Life. WM Life is subject to risk-based capital requirements developed
by the NAIC. The NAIC measure uses four major categories of risk to calculate an
appropriate level of capital to support an insurance company's overall business
operations. The four risk categories are asset risk, insurance risk, interest
rate risk and business risk. At December 31, 1996, WM Life's actual capital was
663% of its required regulatory risk-based level.
Legal Restrictions on Dividends of Depository Institutions. A depository
institution such as WMB, ASB or WMBfsb may not make a capital distribution if,
following such distribution, the institution will be undercapitalized under the
FDICIA provisions described above. In addition, Washington state law prohibits
WMB from declaring or paying a dividend greater than its retained earnings or if
doing so would cause its net worth to be reduced below (i) the amount required
for the protection of preconversion depositors or (ii) the net worth
requirements, if any, imposed by the State Director.
OTS regulations limit the ability of savings associations such as ASB and
WMBfsb to pay dividends and make other capital distributions according to the
institution's level of capital and income, with the greatest flexibility
afforded to institutions that meet or exceed their OTS capital requirements.
Under current OTS regulations, a savings association that exceeds its OTS
regulatory capital requirements both before and after a proposed dividend (or
other distribution of capital) and has not been advised by the OTS that it is in
need of more than normal supervision may, after prior notice to but without the
approval of the OTS, make capital distributions during a calendar year up to the
higher of (i) 100% of its income during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the institution's excess
capital over its capital requirements) at the beginning of the calendar year or
(ii) 75% of its net income over the most recent four-quarter period. In
addition, such an institution may make capital distributions in excess of the
foregoing limits if the OTS does not object within a 30-day period following
notice by the institution.
A savings association that would not meet OTS capital requirements
following payment of a dividend is subject to additional restrictions. It is not
anticipated that ASB or WMBfsb will pay any dividend that would cause either of
them to fail to meet OTS capital requirements.
FDIC and OTS Regulation and Examination. The FDIC has adopted regulations
to protect the deposit insurance funds and depositors, including regulations
governing the deposit insurance of various forms of accounts. The FDIC has also
adopted numerous regulations to protect the safety and soundness of FDIC-
regulated banks. These regulations cover a wide range of subjects including
financial reporting, change in bank control, affiliations with securities firms
and capital requirements. In certain instances, these regulations restrict the
exercise of powers granted by state law.
An FDIC regulation and a joint FDIC/OTS policy statement place a number of
restrictions on the activities of WMB's and ASB's securities and insurance
affiliates, and on such affiliates' transactions with WMB, ASB and WMBfsb. These
restrictions include requirements that such affiliates follow practices and
procedures to distinguish them from WMB, ASB and WMBfsb and that such affiliates
give customers notice
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from time to time of this distinction and of the distinction between insured
deposits and uninsured nondeposit products.
FDICIA also prohibited banks such as WMB and their subsidiaries from
exercising certain powers that were granted by state law to make investments or
carry on activities as principal (i.e. for their own account) unless either (i)
national banks have power under federal law to make such investments or carry on
such activities, or (ii) the bank and such investments or activities meet
certain requirements established by FDICIA and the FDIC.
FDICIA imposed new supervisory standards requiring annual examinations,
independent audits, uniform accounting and management standards, and prompt
corrective action for problem institutions. As a result of FDICIA, depository
institutions and their affiliates are subject to federal standards governing
asset growth, interest rate exposure, executive compensation, and many other
areas of depository institution operations. FDICIA contains numerous other
provisions, including reporting requirements and revised regulatory standards
for, among other things, real estate lending.
The FDIC may sanction any FDIC-regulated bank that does not operate in
accordance with FDIC regulations, policies and directives. Proceedings may be
instituted against any FDIC-regulated bank, or any institution-affiliated party,
such as a trustee, director, officer, employee, agent, or controlling person of
the bank, who engages in unsafe and unsound practices, including violations of
applicable laws and regulations. The FDIC may revalue assets of an institution,
based upon appraisals, and may require the establishment of specific reserves in
amounts equal to the difference between such revaluation and the book value of
the assets. The State Director has similar authority under Washington state law
and the OTS has similar authority under HOLA. The FDIC has additional authority
to terminate insurance of accounts, after notice and hearing, upon a finding
that the insured institution is or has engaged in any unsafe or unsound practice
that has not been corrected, or is operating in an unsafe or unsound condition,
or has violated any applicable law, regulation, rule, or order of or condition
imposed by the FDIC.
Federal savings institutions, such as ASB and WMBfsb, are subject to
regulatory oversight and examination by the OTS and the FDIC. HOLA and OTS
regulations delimit such institutions' investment and lending powers. Federal
savings institutions may not invest in noninvestment-grade debt securities, nor
may they generally make equity investments, other than investments in service
corporations.
Federal law and regulations requires ASB and WMBfsb to maintain, for each
calendar month, an average daily balance of liquid assets equal to not less than
5% of its average daily balance of total savings accounts and borrowings payable
in one year or less, subject to certain adjustments for deposit outflows. This
liquidity requirement may be changed from time to time.
Federal regulation of depository institutions is intended for the
protection of depositors (and the BIF and SAIF), and not for the protection of
stockholders or other creditors. In addition, a provision in the Omnibus Budget
Reconciliation Act of 1993 ("Budget Act") requires that in any liquidation or
other resolution of any FDIC-insured depository institution, claims for
administrative expenses of the receiver and for deposits in U.S. branches
(including claims of the FDIC as subrogee of the insured institution) shall have
priority over the claims of general unsecured creditors.
Federal Reserve Regulation. Under Federal Reserve Board regulations, WMB,
ASB and WMBfsb are each required to maintain reserves against their transaction
accounts (primarily checking and NOW accounts). Because reserves must generally
be maintained in cash or in noninterest-bearing accounts, the effect of the
reserve requirements is to increase an institution's cost of funds. These
regulations generally require that WMB, ASB and WMBfsb each maintain reserves
against net transaction accounts in the amount of 3% on amounts of $49.3 million
or less, plus 10% on amounts in excess of $49.3 million. Institutions may
designate and exempt $4.4 million of certain reservable liabilities from these
reserve requirements. These amounts and percentages are subject to adjustment by
the Federal Reserve Board. A savings bank, like other depository institutions
maintaining reservable accounts, may borrow from the Federal Reserve Bank
discount window, but the Federal Reserve Board's regulations require the savings
bank to exhaust other reasonable alternative sources before borrowing from the
Federal Reserve Bank.
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Numerous other regulations promulgated by the Federal Reserve Board affect
the business operations of the Company's banking subsidiaries. These include
regulations relating to equal credit opportunity, electronic fund transfers,
collection of checks, truth in lending, truth in savings and availability of
funds.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
financial institutions regulated by the federal financial supervisory agencies
to ascertain and help meet the credit needs of their delineated communities,
including low-income and moderate-income neighborhoods within those communities,
while maintaining safe and sound banking practices. The regulatory agency
assigns one of four possible ratings to an institution's CRA performance and is
required to make public an institution's rating and written evaluation. The four
possible ratings of meeting community credit needs are outstanding,
satisfactory, needs to improve, and substantial noncompliance.
Many factors play a role in assessing a financial institution's CRA
performance. The institution's regulator must consider its financial capacity
and size, legal impediments, local economic conditions and demographics,
including the competitive environment in which it operates. The evaluation does
not rely on absolute standards and the institutions are not required to perform
specific activities or to provide specific amounts or types of credit.
ASB and WMBfsb each has received an "outstanding" CRA rating from the OTS,
and WMB has received an "outstanding" CRA rating from the FDIC. These ratings
reflect Washington Mutual's commitment to meeting the credit needs of the
communities it serves. The Company maintains a CRA statement for public viewing,
as well as an annual CRA highlights document. These documents describe
Washington Mutual's credit programs and services, community outreach activities,
public comments and other efforts to meet community credit needs.
Recent and Proposed Federal Legislation. Federal legislation was enacted in
1994, which will repeal, effective June 1, 1997, certain restrictions on the
establishment of interstate branches by national banks and state-chartered
banks. In addition, bank holding companies are now generally permitted to buy
banks in any state. WMBfsb already has authority to establish interstate
branches under current federal law and regulations, and management expects that
such legislation will primarily benefit competitors of the Company.
Various legislative proposals relating to depository institutions have been
or are expected to be introduced in the current session of Congress. These
include proposals to restrict or further regulate the sales of mutual funds and
annuities by depository institutions or their affiliates, to restrict
affiliations between the Company and nonbanking corporations including life
insurance companies, and effectively to require federal savings institutions
such as ASB and WMBfsb to convert to banks. The outcome of these legislative
proposals cannot be forecast reliably.
Regulation of Nonbanking Affiliates. As insurance companies, WM Life and
Empire are subject to comprehensive regulation and supervision by the states in
which they are domiciled (WM Life is domiciled in the state of Arizona and
Empire is domiciled in the state of Washington) as well as the states in which
they transact business. The laws of the various states establish supervisory
agencies with broad administrative and supervisory powers. Such agencies set
standards related to granting and revoking licenses to transact business,
regulation of trade practices and market conduct, licensing of agents, approval
of policy forms, regulating of certain premium rates, setting of insurance
liability and investment reserve requirements, determining the form and content
of required financial statements, determining the reasonableness and adequacy of
capital and surplus, and prescribing the types and amounts of permitted
investments. Insurance companies are subject to periodic examinations by such
supervisory agencies. State insurance laws and regulations also impose limits on
the extent to which the insurance company subsidiaries may pay dividends or lend
or otherwise supply funds to the Company.
As broker-dealers registered with the Securities and Exchange Commission
and as members of the National Association of Securities Dealers ("NASD"),
Murphey Favre and ASB Financial are subject to various regulations and
restrictions imposed by those entities, as well as by various state authorities.
As a registered investment advisor, Composite Research is subject to various
federal and state securities regulations and restrictions.
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The NASD has adopted and forwarded to the SEC for approval rules concerning
NASD member operations conducted in branches of depository institutions.
Although many of the NASD's proposed requirements are substantially similar to
the joint FDIC/OTS policy statement governing the activities of WMB's securities
affiliates, the NASD proposal, if approved by the SEC, could impose additional
restrictions on these affiliates.
COMPETITIVE ENVIRONMENT
Washington Mutual faces significant competition in attracting and retaining
deposits and making loans in all of its market areas. Its most direct
competition for deposits has historically come from other thrift institutions,
credit unions and commercial banks doing business in its primary market areas of
Washington, California and Oregon. As with all banking organizations, however,
Washington Mutual has experienced increasing competition from nonbanking
sources, including mutual funds, corporate and governmental debt securities and
other investment alternatives. Washington Mutual's competition for loans comes
principally from credit unions, insurance companies and other institutional
lenders. Many of these competitors have more significant financial resources,
larger market share and greater name recognition than the Company. The existence
of such competitors may make it difficult for Washington Mutual to achieve its
financial goals. In addition to the normal competitive factors described above,
Washington Mutual management at the holding company level has limited operating
experience in California, which has a much larger population with more large
financial institution competitors than the states in which WMB has historically
operated. Accordingly, there can be no assurance that the Company's consumer
banking strategy will prove successful in the California market.
Although consolidation has decreased the number of institutions competing
in the Company's market, both thrifts and commercial banks have reemphasized
their focus on the consumer, making competition for retail deposits and loans
extremely fierce. While the increased competitive pressures make the banking
environment more difficult, the Company remains a strong market force. For 1996,
WMB's originations of residential mortgage loans ranked first in both Washington
and Oregon, and ASB's originations of residential mortgages ranked second in
California.
PRINCIPAL OFFICERS
The following table sets forth certain information regarding the principal
officers of Washington Mutual:
EMPLOYEE OF
PRINCIPAL OFFICERS AGE CAPACITY IN WHICH SERVED COMPANY SINCE
- -------------------------- --- ------------------------------------------------------- -------------
Kerry K. Killinger........ 47 Chairman of the Board of Directors, President and Chief 1983
Executive Officer
Craig S. Davis............ 45 Executive Vice President 1996
Steven P. Freimuth........ 40 Executive Vice President 1988
Lee D. Lannoye............ 59 Executive Vice President 1988
William A. Longbrake...... 53 Executive Vice President and Chief Financial Officer 1996
Deanna W. Oppenheimer..... 38 Executive Vice President 1985
Craig E. Tall............. 51 Executive Vice President 1985
S. Liane Wilson........... 54 Executive Vice President 1985
Norman H. Swick........... 47 Senior Vice President and General Auditor 1980
Douglas G. Wisdorf........ 42 Senior Vice President, Deputy Chief Financial Officer, 1976
and Controller
Mr. Killinger has been Chairman, President and Chief Executive Officer of
WMI since its organization. He has been Chairman of the Board of Directors of
WMB since 1991 and Chief Executive Officer since 1990. Mr. Killinger became an
Executive Vice President of WMB in 1983, a Senior Executive Vice President of
WMB in 1986 and the President and a director of WMB in 1988.
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Mr. Davis became an Executive Vice President and member of the Executive
Committee of WMI in January 1997, following WMI's merger with Keystone Holdings.
In his capacity as Executive Vice President, Mr. Davis is responsible for
lending and financial services. He was Director of Mortgage Origination of ASB
from 1993 through 1996 and served as President of ASB Financial from 1989 to
1993.
Mr. Freimuth has been an Executive Vice Pr