Exhibit
99.3
Washington
Mutual, Inc.
Prepared
Remarks for First Quarter 2006 Earnings Conference Call
April
18, 2006
Please
see the Forward-Looking Statement at the end of this
document
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Remarks of
Kerry
Killinger
Chairman
and CEO
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Good
afternoon - or evening, as the case may be - thank you for joining us for
our
first quarter earnings call.
Q1
2006 Earnings
Earlier
today, concurrent with our Annual Shareholders’ meeting, we announced first
quarter net income of $985 million, or $0.98 per diluted share, compared
to $902
million or $1.01 per diluted share in the first quarter a year ago and $0.85
per
diluted share in the fourth quarter of 2005.
Our
Board
of Directors once again increased the cash dividend by one cent to 51 cents
per
share - the 43rd consecutive quarter the Board has elected to increase the
cash
dividend.
Before
I
get started, I’d like to welcome Regina Montoya who was elected to our board of
directors earlier today. Regina is the chief executive officer of Washington
D.C.-based New America Alliance and is a nationally-recognized leader in
the
legal, corporate and nonprofit communities.
I’d
also
like to welcome James Corcoran. James is our new President of Retail Banking.
We’re very excited to have him as he joins us for a period of substantial
growth
for our Retail Banking group. He has a proven track record of driving
significant organic growth and bottom line results. He comes to us from
Halifax
Bank of Scotland, where he was the Managing Director of Retail Distribution
since 2000. He has extensive consumer banking experience from prior positions
at
First USA, Citicorp and American Express. James will report directly to
our
President and COO Steve Rotella.
This
past
quarter we had outstanding results in Retail Banking and Card Services,
as well
as solid performance in our Commercial Group. At the same time, the ongoing
difficult interest-rate environment continued to challenge the results
in our
Home Loans business.
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Net
income
in our two most profitable segments - Retail Banking and Card Services -
was up
significantly, with fee income in Retail Banking, in particular, up sharply
from
a year ago. Customer growth was very strong in both segments, fueled by the
introduction of new products. By the end of the quarter, we had attracted
210,000 net new retail households and opened 340,000 net new checking accounts,
which was a record for us. Strong cross selling efforts by Card Services
resulted in 256,000 WaMu credit card accounts, which was about one-third
of our
gross new card account growth. Both of these businesses are demonstrating
very
strong momentum.
We
continued to see strong multi-family loan demand in our Commercial Group;
however, earnings were down on a comparative basis, primarily due to significant
one-time gains in the prior quarters. While the increase in interest rates
also
put pressure on the net interest margin, we do expect it to recover once
short-term interest rates stabilize.
Results
in
our Home Loans business continue to be negatively impacted by rising short-term
interest rates and the flat yield curve. Our Mortgage Servicing Right hedging
costs remained very high and we saw some slowing in our lending volumes.
While
we are taking steps to adjust our business to the environment, which I’ll come
back to, there will be a lag before we see the full benefit of these
actions.
We
had
very good financial results across most of our operations, despite the difficult
interest rate environment. The one area which has negatively impacted earnings
is our MSR hedging costs, which increased $364 million during the past year,
negatively impacting after tax net income by $226 million, or 23 cents per
share. This MSR hedging impact reflects the adoption of the new accounting
pronouncement for these assets with pro forma application to prior periods
that
Tom will discuss in more detail. The important point, however, is that the
positive results of the rest of the company nearly offset that shortfall.
I’m
very encouraged by the positive changes and results we are seeing across
the
company.
Retail
Banking
As
I
mentioned, we continued to see strong results from our Retail Banking
operations. Net income of $660 million was up 11 percent from the same
quarter a year ago and up 5 percent on a linked quarter basis. Retail
banking net income (net of portfolio management) of $441 million was up 38
percent from the same period a year ago.
Depositor
and other retail banking fees of $578 million were up 18 percent year over
year,
and down only slightly on a linked quarter basis, despite the seasonal decline
generally experienced in the first quarter.
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On
March
13th we launched our new WaMu Free Checking
TM
product -
an innovative new product designed to once again shake up the banking industry.
As one of the first banks to offer Free Checking over 10 years ago, we have
once
again redefined Free Checking with this innovative new product and added
more
fuel to our already very effective Retail Banking model. Supported by a new
national advertising campaign, the response has been tremendous - from customers
as well as non-customers alike.
The
new
product has turbo-charged our successful Retail Banking model, driving in
new
households and new checking account customers. Net new account growth of
340,000
set a new record for the company. And we expect this momentum to continue
at a
very strong pace. Retail banking households grew this past year at about
a 9
percent annual pace and we anticipate that the pace may quicken as the new
product gains momentum. Cross-sales also continued to increase reaching 6.46
products per household at quarter end.
In
addition to our exciting new product, we are also focused on the considerable
growth opportunities in Small Business Banking. And we continue to see
impressive growth. Net new small business checking accounts of 53,000 were
up 23
percent year over year and 28 percent on a linked quarter basis. A few
weeks ago, we announced that Frank Vella had joined us from JPMorgan Chase,
where he spent nearly 10 years in Small Business Banking, to head up our
efforts
and increase our momentum in this important segment.
Card
Services
Turning
to
Card Services, net income of $210 million was up 27 percent from the fourth
quarter of 2005. We’re very pleased with the performance of Card Services and
their customer growth for the quarter. Despite what is normally a seasonal
paydown period, average managed receivables topped $20 billion with over
10
million customers. And credit remained very strong.
WaMu
retail card growth was 256,000 accounts in the first quarter, adding to
the
strong production of our national and partnership programs. Since we added
Card
Services on October 1st, we have booked 417,000 new accounts with Washington
Mutual customers.
I’m
pleased to report that we have now implemented our pre-approved card
distribution capability in WaMu retail stores throughout most of the country.
The rollout will be completed by the end of this month. And because our
market
studies indicate that the WaMu name tests stronger than Providian, we will
use
WaMu in all of our new sales campaigns and will transition legacy cards
branded
under the Providian name out to the Washington Mutual name.
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The
acquisition of Providian was a terrific transaction for WaMu and our
shareholders. It met a critical product need for our customers, with an
excellent platform and top-notch management team. The integration of Card
Services has been nearly flawless and is effectively completed with employee
benefit programs, department consolidations and most systems already converted.
In the end, we will deliver on or exceed all the projections we set out for
you
last June when we announced the deal. In short, I’m very pleased with our team
and the work they’ve done on this one.
Commercial
Group
The
Commercial group continued to drive strong loan volume, especially in their
industry leading multi-family market, with total loan volume up 14 percent
year
over year.
However,
net income was down primarily due to significant one-time gains in the prior
quarters. Last year’s first quarter included $59 million or $36 million after
tax, from gain on sale from a real estate investment. Excluding the real
estate
gain, net income for the first quarter declined 26 percent from the same
quarter
in the prior year.
The
decline in net income was primarily due to net interest margin compression,
resulting from the lag in our adjustable-rate loan portfolio compared to
rising
short-term interest rates. As with the portfolio in the Retail Bank, we
anticipate a similar margin recovery in our multi-family portfolio once the
Fed
stops raising interest rates.
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Home
Loans
Wrapping
up with our Home Loans Group - which now includes Long Beach Mortgage - net
income for the quarter was $38 million versus net income of $323 million
in the
first quarter of 2005 and $45 million in the fourth quarter of
2005.
As
we told
you during our January earnings conference call, we expected the difficult
environment to continue in the first quarter. And as I’ve said, the cost of
hedging our Mortgage Servicing Right continues to be high.
Excluding
MSR risk management, home loans net income was $134 million compared to
$193
million in the same quarter last year. The largest driver of the difference
was
net interest income, which declined 32 percent to $268 million from $396
million
in the first quarter of last year. The decline was primarily driven by the
compression of the net interest margin on our loans held for sale portfolio.
Although
the industry remains competitive, during the first quarter our gain on sale
margins increased, which partially offset a lower volume of loans sold during
the quarter.
Our
Home
Loans management team is intensely focused on quickly and effectively adjusting
our operations to improve profitability in this more challenging, lower lending
volume environment. This means taking actions to lower our expenses, improve
our
efficiency and increase productivity.
These
strategies include focusing on the cross-business opportunities we have
identified, targeting the most profitable products, as well as consolidating
real estate and moving back office functions to lower cost domestic and offshore
locations such as the consolidation of our Home Loans processing offices
from 26
to 16 offices during the first quarter which resulted in an elimination of
approximately 2,500 jobs.
The
realignment of Long Beach Mortgage under one management team in the Home
Loans
group also allows us to streamline and simplify operations and drive
efficiencies and operational excellence consistently across all our
single-family residential mortgage lending operations.
The
results of both of these significant actions will be reflected in reduced
costs
over the rest of the year. We will continue to focus on adjusting the cost
structure of the home loans business and managing capacity to better match
current and anticipated mortgage market conditions.
Summary
That
was a
quick overview of the performance of each of our businesses in the quarter.
Now,
I’ll turn it over to Tom to go into more specifics on our financial
performance.
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Remarks of
Tom
Casey
Executive
Vice President and CFO
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Thank
you,
Kerry.
As
you
said, most of our businesses are doing extremely well, despite the difficult
interest rate environment. We had outstanding customer and revenue growth
in
both our Retail Bank and Card Services businesses and this led directly to
improved bottom line results for both. The performance of Home Loans continues
to be impacted by higher interest rates and the flat yield curve, but our
team
is working hard to adjust to the environment.
Asset
Growth and Net Interest Margin
Let
me
start out by reviewing our balance sheet activity. As we told you during
last
quarter’s earnings call, we are looking for modest asset growth for the year.
While average assets for the first quarter are up 12 percent from a year
ago, we
expect average asset growth to slow for the remainder of the year to around
3 or
4 percent.
On
the
liabilities side of the balance sheet, while average deposits for the quarter
were lower, the end of period balances were up 4 percent, reflecting steady
growth. The increase can be attributed to significant growth in most product
categories towards the end of the quarter. Compared with the first quarter
of
2005, average deposits were up $15.9 billion, or 9 percent, primarily due
to the addition in deposits from Providian and growth in both retail and
wholesale deposits.
Before
I
review our income performance for the quarter, I need to explain a change
in
revenue classification that impacted both net interest income and noninterest
income. During the first quarter, we reclassified prepayment fee income from
noninterest income to interest income on loans. This change was done in
conjunction with revised guidance issued by the OTS on their regulatory reports
to make OTS reporting consistent with that of other banking agencies. The
change
had no bottom line impact for the first quarter. Prior periods were also
restated and the full impact for 2005 was to move $335 million from noninterest
income to interest income. This reclassification resulted in an increase
in our
2005 net interest margin of about 10 basis points. This change will have
an
impact on our earnings driver guidance that I’ll review with you in just a few
minutes.
So,
with
the reclassification adjustment covered, let’s review the impact of further
Federal Reserve tightening during the first quarter. We saw our net interest
margin compress 13 basis points during the quarter to 2.75 percent. About
6
basis points of the decrease was attributable to the rise in short-term
interest
rates. This is about the same as we’ve seen in recent quarters. Another
contributing factor to the decline in net interest margin was the result
of the
timing of securitizations of our credit card receivables. While average
managed
card receivables increased $614 million on a linked quarter basis, the
receivables on a GAAP basis actually declined
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$451 million
due to securitization transactions. So while the NIM is down, the economics
of
securitized credit card receivables flows through revenue from sales and
servicing from consumer loans in noninterest income.
At
some
point short-term interest rates will stabilize. When that happens, our portfolio
of lagging index loans will fully catch up to market interest rates. In the
past
we have indicated that our normalized NIM is in the range of 3.00 to 3.10
percent, so with the prepayment change I mentioned, it should now be in a
range
of 3.10 to 3.20 percent.
Credit
Turning
to
credit - we are pleased with the ongoing strong credit performance of our
portfolio. The economy remains strong, and the quality of our portfolio
continues to be fairly stable with only a slight increase in our nonperforming
assets.
Our
Credit
Card portfolio, in particular, had very low charge offs during the quarter.
This, in part, was due to the acceleration of bankruptcy claims and thereby
charge offs in the fourth quarter of last year with the anticipated change
in
bankruptcy law. The result was a benefit in the first quarter which had lower
charge offs and a lower provision. We expect both charge offs and the provision
related to credit cards to increase to a more normal level in future quarters
now that this bankruptcy law transition is behind us.
As
a
result of the favorable credit performance, especially in our Credit Card
portfolio, our provision for the quarter was $82 million, compared to $217
million in the fourth quarter.
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Noninterest
Income
Noninterest
income of $1.7 billion for the quarter was up 8 percent on a linked quarter
basis and 29 percent year over year. The increase from last year was primarily
due to the addition of Card Services, which added approximately $570 million
in
revenue compared to the first quarter of 2005. Also, as we disclosed in our
10K,
this past quarter’s noninterest income included a pretax goodwill settlement of
$134 million related to a claim by Home Savings, whom we acquired in 1998.
An
important story in noninterest income is the 18 percent growth, year over
year,
in depositor and other retail banking fees driven by our Retail Bank. We
expect
strong depositor fee growth to continue throughout the year, as we attract
customers with our new WaMu Free Checking
TM
product.
Higher
interest rates and the competitive mortgage environment have challenged the
production side of our mortgage banking operations, but we’re actually
performing fairly well. Lending volume for the quarter totaled $55 billion,
down
13 percent on a linked quarter basis, but a decline of only 8 percent from
the
same quarter a year ago. During the first quarter we generated $209 million
gain
on sale compared to $238 million in the fourth quarter of last year. Improvement
in the gain on sale margins during the first quarter, when compared to the
fourth quarter of last year, helped offset the 33 percent reduction in loans
sold on a linked quarter basis.
However,
offsetting a portion of the revenue momentum of the organization is the growing
cost of hedging our MSR. We have been telling you over the past six months
of
the rising hedging costs as the yield curve has flattened. During the first
quarter of this year, the total cost of MSR risk management was $151 million
compared to the pro forma net revenue of $213 million from this activity
in the
first quarter of last year. This $364 million increase in MSR risk management
costs has occurred during a period of extreme flattening of the yield curve.
As
an illustration, over the past year, the 2-year to 10-year swap spread has
compressed from 81 basis points to only 8 basis points.
While
not
materially impacting the result of our MSR hedging program, during the first
quarter we did adopt SFAS No. 156, the new standard
Accounting
for Servicing of Financial Assets
.
The
standard permits the recognition of mortgage servicing rights at fair value
and
eliminates the lower of cost or market accounting requirement. To reflect
the
change in accounting, we revised our disclosure on pages WM-12 and WM-13
to
include pro forma financial results. In particular, I’d like to draw your
attention to schedule WM-13 in which we provide a total MSR risk management
measure that we believe provides a very good view of the cost and performance
of
our hedging program. We continue to be satisfied with the quality and
effectiveness of our hedging program, but clearly the cost of hedging the
MSR in
this interest rate environment is very expensive, and we are taking steps
to
reduce our hedging costs while maintaining our risk management
discipline.
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Noninterest
Expense
Shifting
to noninterest expense - while noninterest expense was up 20 percent on a
year
over year basis, primarily due to the addition of Card Services, operating
expenses actually declined
3
percent
on a linked quarter basis
Our
expense management focus is not just on cutting costs but, more importantly,
on
driving improved productivity so we can fund our growth, as well as achieve
our
efficiency target. This means that we are fueling the company’s growth prospects
- and not reducing them by short sighted cost cuts. Each of our businesses
has
critical productivity measures by which they manage their operations.
Overall,
I’m pleased with the energy and management focus we have on effective expense
management. We will continue with our outsourcing, offshoring and other
efficiency efforts and I expect our noninterest expense to decline during
the
remainder of the year.
Capital
Management
Before
I
give an update on our earnings drivers, I’d like to take a moment to comment on
capital management. In addition to driving earnings growth, it’s important for
us to effectively deploy capital to maximize shareholder value.
During
the
first quarter, we announced the issuance of $2 billion in Perpetual
Non-cumulative Preferred securities. These securities qualify as Tier 1
regulatory capital and are classified as minority interest on our balance
sheet.
Importantly, the rating agencies also assign a high level of equity content
for
these securities in their capital evaluations. At quarter end, our tangible
capital ratio, including these Preferred securities was 5.85 percent, putting
us
well in excess of our target ratio of 5.50 percent. Also, our Tier 1 capital
to
adjusted total assets for Washington Mutual Bank equaled 6.86
percent.
During
the
quarter asset growth was modest, so limited capital was needed to fund growth.
We utilized our excess capital, as well as a portion of the proceeds from
the
preferred securities, to repurchase 47 million shares of common stock. As
a
result, we ended the quarter with 959 million shares outstanding, down 4
percent
from year-end 2005.
As
we look
forward, we continue to generate sufficient capital to grow the balance sheet
and maintain our dividend. We intend to complement our capital generating
capability with the use of hybrid securities, such as these new preferred
securities, as the market continues to mature.
Earnings
Driver Guidance
Now,
let
me walk you through our present thinking concerning our six earnings
drivers.
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Driver
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January
2006 Guidance
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New
Guidance
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1)
Average Asset Growth
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6-8
percent
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2)
Net interest margin
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2.70-2.80
percent
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2.75-2.85
percent
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3)
Credit provisioning
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$750-$850
million
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$650-$750
million
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4)
Depositor and other retail banking fees
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10-12
percent growth
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12-14
percent growth
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5)
Noninterest income
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$7.1-$7.4
billion
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$6.5-$6.8
billion
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6)
Noninterest expense
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$9.0
billion
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$8.6-$8.8
billion
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1)
Average Assets
We
continue to be comfortable with average asset growth guidance of 6 to 8 percent.
This guidance anticipates approximately 3 to 4 percent further asset growth
for
the remainder of the year.
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2)
Net Interest Margin
Our
beginning of the year guidance for the net interest margin of 2.70 to 2.80
percent was prior to the reclassification of prepayment fees. Adjusting for
that
reclassification, our initial guidance would have been 2.80 to 2.90
percent.
Our
original guidance was also based on the forward yield curve, which at the
start
of the year projected one to two 25 basis point Fed Fund increases. With
those
increases occurring in the first quarter, the forward yield curve is now
anticipating an additional one to two more 25 basis points rate increases.
As a
result, we now believe our margin for the full year will fall into a range
of
2.75 to 2.85 percent. The one variable we can’t predict is what the Fed and
interest rates will do, so we will continue to update you each quarter on
this
driver.
3)
Credit Provisioning
Credit
quality continues to surpass our expectations. Given the good credit quality
and
provision level of this quarter, we are revising our credit provision outlook
downward to $650 to $750 million.
4)
Depositor and Retail Banking Fees
Our
new
WaMu Free Checking
TM
product
has us feeling very confident about our Retail Bank’s momentum. We expect we
will give up some fee income as customers migrate to the new Free Checking
product, but based on the first quarter’s strong results, we are raising our
guidance for depositor and other retail banking fees to 12 to 14
percent.
5)
Noninterest Income
Now
let’s
talk about noninterest income. We’re reducing our guidance for noninterest
income by $600 million. Half, or $300 million, of this adjustment is due
to the
reclassification of prepayment fee income that I just covered. So that’s just a
shift from one revenue line item to another. While there are many moving
parts
within noninterest income, the one we are most concerned about is our MSR
hedging costs. As I reviewed with you, the cost of hedging our MSR is very
expensive in the current interest rate environment. While we are taking actions
to reduce this cost, we don’t see the interest rate environment improving in the
short term, so we are reducing our guidance by another $300 million. So our
new
guidance for noninterest income is a range of $6.5 to $6.8 billion.
6)
Noninterest Expense
Noninterest
expense is something we are better able to control. Over the past three years,
we have done a good job of keeping costs essentially flat. However, more
needs
to be done if we are to achieve our operating efficiency goal. This year
we
expect several activities to drive our operating costs lower:
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First,
we expect that our cost savings from the Card Services group
to exceed our
original projection by approximately 40
percent.
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Second,
the Home Loans efficiency efforts, as well as the consolidation
of Long
Beach that began during the first quarter, will drive savings
starting in
the second quarter.
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Third,
we have revised expense targets across the company and are implementing
strategies to achieve them.
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And
lastly, our outsourcing and off-shore activities are underway,
and we
expect to see the benefits in our operating costs in the second
half of
the year.
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As
a
result, we are lowering our noninterest expense target by an additional
$200 to
$400 million to a range of $8.6 to $8.8 billion.
So
Kerry,
despite some headwinds from the interest rate environment, we’re making great
progress across the company toward achieving our longer-term goals. I’ll now
turn it back over to you for your summary comments.
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Remarks of
Kerry
Killinger
Chairman
and CEO (continued)
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Thanks,
Tom.
As
we wrap
up our overview of first quarter results, I want to emphasize that overall
I am
very pleased with our progress and performance in the quarter.
Our
underlying strategies are working well.
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Our
retail banking and credit card operations are producing excellent
results;
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Expense
management and credit costs are being tightly
managed;
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We
are being responsive to the environmental challenges currently
putting
pressure on our net interest margin and MSR hedging costs;
and
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Our
effective capital management and corresponding share repurchase
program
are positioning us well for the
future.
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In
summary, I believe we are setting the stage for strong performance when the
interest rate environment improves. I believe that we are in the low part
of the
cycle and the work we are doing on reducing costs and increasing productivity
will have leveraged benefits in a stable interest rate environment.
As
Tom
said, once the Fed stops tightening, we should see improvement in the net
interest margin by 35-45 basis points or so over the following four quarters.
So
with over $300 billion of assets, this could be a significant boost to net
interest income.
Finally,
let me reiterate that our management team is committed to achieving the goals
we’ve set in our 5-year plan of double-digit EPS growth and bringing our
efficiency ratio down to below 50 percent.
I
believe
we are making excellent progress and that this will help drive superior
shareholder returns over the next few years.
With
that,
Steve, Tom and I are happy to field your questions.
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Forward-Looking
Statement
Our
Form
10-K for 2005 and other documents that we filed with the Securities and Exchange
Commission have forward-looking statements. In addition, our senior management
may make forward-looking statements orally to analysts, investors, the media
and
others. Forward-looking statements can be identified by the fact that they
do
not relate strictly to historical or current facts. They often include words
such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,”
“estimates,” or words of similar meaning, or future or conditional verbs such as
“will,” “would,” “should,” “could” or “may.” Forward-looking statements provide
our expectations or predictions of future conditions, events or results.
They
are not guarantees of future performance. By their nature, forward-looking
statements are subject to risks and uncertainties. These statements speak
only
as of the date they are made. We do not undertake to update forward-looking
statements to reflect the impact of circumstances or events that arise after
the
date the forward-looking statements were made. There are a number of factors,
many of which are beyond our control that could cause actual conditions,
events
or results to differ significantly from those described in the forward-looking
statements. Some of these factors are:
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Volatile
interest rates impact the mortgage banking business and could adversely
affect earnings;
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·
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Rising
unemployment or a decrease in housing prices could adversely affect
credit
performance;
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·
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The
potential for negative amortization in the option adjustable-rate
mortgage
product could have an adverse effect on the company's credit
performance;
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The
company faces competition from banking and nonbanking
companies;
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Changes
in the regulation of financial services companies and housing
government-sponsored enterprises, and in particular, declines in
the
liquidity of the mortgage loan secondary market, could adversely
affect
business;
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·
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General
business and economic conditions, including movements in interest
rates,
the slope of the yield curve and the potential overextension of
housing
prices in certain geographic markets, may significantly affect
the
company’s business activities and earnings;
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Negative
public opinion could damage the company’s reputation and adversely affect
earnings; and,
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Matters
related to Washington Mutual Card Services, including, among others,
risk
related to integration of systems and the realization of expected
growth
opportunities.
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