Exhibit
99.1
Washington
Mutual, Inc.
Prepared
Remarks for Second Quarter 2006 Earnings Conference Call
July
19, 2006
Please
see the Forward-Looking Statement at the end of this
document
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Remarks of
Kerry
Killinger
Chairman
and CEO (continued)
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Good
afternoon - thank you for joining us for a review of our second quarter
earnings
- as well as a discussion of the actions we announced today which represent
a
major acceleration point in the ongoing transformation of our business.
Q2
2006 Earnings
Earlier
today, we announced second quarter net income of $767 million, or $0.79
per
diluted share which included an after tax adjustment of $101 million, or
$0.10
cents per share, to reflect today’s announced sale price on $2.6 billion in
mortgage servicing rights and $52 million, or $0.05 per share in after
tax
restructuring charges associated with operating efficiency initiatives.
Excluding
these items, earnings per share would have been $0.94, compared to $0.95
per
diluted share in the second quarter a year ago.
The
second
quarter results reflect strong performance, especially in retail banking
and
card services. Our business model continued to perform well even in this
difficult interest rate and flat yield curve environment.
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Since
there were three important and transformational initiatives announced today,
let
me focus on them for a moment. Two of these initiatives had a negative impact
on
second quarter earnings. While, we expect the combined effect of all three
initiatives will be to increase 2006 earnings, they are likely to cause our
quarterly earnings to be more uneven than normal due to expected timing of
sales
and consolidation activities. But most importantly, we believe these actions
will have a net positive affect on ongoing earnings and efficiency, including
an
improvement of approximately 5 to 10 cents in earnings per share in 2007.
Now
let’s discuss these three initiatives.
The
first
initiative we announced today was the pending sale of $2.6 billion in mortgage
servicing rights to Wells Fargo. This sale significantly reduces our market
risk
profile and accelerates our winding down of certain non-strategic home loan
products, such as government and single-service customer fixed rate loans.
This
enhances our ability to focus on higher margin products such as Option ARMs,
home equity, Alt A and subprime loans. The second quarter results reflect
an
after tax reduction in the carrying value of MSRs of $101 million to
reflect this transaction. When the MSR sale closes at the end of July, our
MSR
to stockholders’ equity ratio will fall from 35 percent at June 30th to
approximately 25 percent. As part of the sale, Washington Mutual will also
transfer its Milwaukee servicing operations and approximately 800 employees
to
Wells Fargo. We expect to incur approximately $50 million, after taxes, in
additional transaction and shutdown costs related to this sale, most of which
will be incurred in the third quarter.
The
second
initiative is the announcement of our intention to exit the mutual fund
management business. It is our plan to sell WM Advisors, Inc, our subsidiary
that provides investment management, distribution and shareholder services
to
the WM Group of Funds. This decision is in keeping with our strategy to
streamline our business model. The funds management business, which generates
net income of about one cent per quarter, is being presented this quarter
as
discontinued operations. If we are successful in selling the business, we
expect
the gain from the sale of the funds management business to be significant
and
more than offset the cost of the other initiatives announced today.
The
third
initiative is the acceleration of our operating efficiency initiatives. During
the second quarter we recorded $52 million in after tax restructuring charges.
It is our intention to accelerate our operating efficiency initiatives during
the remainder of 2006. We expect these initiatives to include migrating more
of
our back office operations to lower cost domestic locations such as San Antonio
and Jacksonville. We also expect to materially increase our offshore vendor
positions to as many as 7,500 by the end of 2007. As a result of these efforts
we will be able to consolidate our remaining real estate footprint in
higher-cost markets to minimize our occupancy costs. These actions should
position us well to further improve our operating efficiency. We remain resolute
in our intent to reach a 45 percent operating efficiency ratio by the end
of
2009.
Each
of
our business units is driving productivity initiatives that resulted in staffing
reductions during the second quarter. Overall, total company staffing declined
by more than 4,000 or 7 percent in the second quarter.
I
can’t
overemphasize the significance of these actions for us. Improving our operating
efficiency, reducing the market volatility of our earnings and refocusing
our
home loans unit on higher margin businesses will increase the core profitability
of the company. And this will position us even better for the leverage which
is
inherent in our business model when the interest rate environment improves.
Our
Board
of Directors recently completed its annual in-depth review of our strategic
plan. They reviewed all of our key strategies for creating significant value
for
shareholders.
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Following
the completion of that assessment, they concluded that execution of that plan
would likely lead to creation of significant shareholder value and they directed
management to execute the plan. In addition, they approved a new 150 million
stock repurchase plan. We expect to actively utilize that authority, as we
find
our stock to be very attractive compared to other asset investment alternatives.
The
Directors also decided to increase the cash dividend by one cent to 52 cents
per
share - for the 44
th
consecutive quarter.
Retail
Banking
Our
Retail
Banking operations continued their strong performance in the second quarter.
Income from continuing operations of $670 million was up 7 percent from the
same
quarter a year ago and up 3 percent on a linked quarter basis. Retail
banking net income, excluding the contribution from portfolio management, of
$483 million was up 31 percent from the same period a year ago. And this isn’t
just a recent result, the Retail Banking Network has achieved compounded
earnings growth of 44 percent over the past two years.
A
full
quarter’s production of our new WaMu Free Checking
TM
product
resulted in a second straight quarterly record for net checking accounts.
The
net account growth of 404,000 for the second quarter, which includes both
retail
and small business activity, was up 66 percent from the same quarter a year
ago
and 19 percent higher on a linked quarter basis. This equates to a quarterly
rate of 184 net new checking accounts per retail banking store, which we
believe
is one of the best in the industry.
Driven
by
new account growth, our depositor and other retail banking fees increased
to
$641 million in the second quarter, up 19 percent from last year and 11 percent
on a linked quarter basis.
We
have
clearly created a market disrupting product with new WaMu Free
Checking
TM
.
Our
customers love it and it’s leading to record retail banking household growth and
higher customer cross-sell levels. In the second quarter, net household growth
was up 50 percent year over year and 23 percent on a linked quarter basis.
Our
customer cross-sell ratios hit 6.53 products per household.
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During
the
second quarter we also rolled out a unique on-line checking account opening
capability which allows customers to open an account online in less than
10
minutes. This feature enhances our robust and highly-rated on-line retail
banking platform.
Card
Services
Card
Services continued to perform well during the second quarter. Net income
of $183
million was down from $210 during the first quarter, due to the unusually
low
credit provision in the first quarter, reflecting the higher level of
bankruptcies in the fourth quarter of last year.
Managed
receivables growth was very strong in the quarter, growing 5 percent on a
linked
quarter basis to $21.1 billion at quarter end. Approximately one-third of
the
new account growth in the quarter resulted from sales to WaMu customers.
Second
quarter retail card growth of 274,000 accounts was up 7 percent on a linked
quarter basis, raising the cards issued to WaMu customers since the acquisition
to 694,000. In total, including those WaMu customers that had a Providian
card
prior to the acquisition, 1.4 million WaMu households now have our credit
card.
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Credit
ratios for the second quarter remained very strong compared to historic
averages. Net credit losses for the quarter totaled 5.99 percent and 30-day
plus
delinquencies were 5.23 percent at quarter end.
The
success of cross selling credit cards to WaMu customers has exceeded our initial
expectations. The Card Services group has integrated extremely well, both
operationally and culturally with WaMu. Given the strong credit card receivables
growth, we also expect to exceed our pace of remixing our balance sheet by
holding more receivables on the balance sheet. In the end, we expect to deliver
on or exceed all the projections we set out for you when we announced the
deal.
Commercial
Group
The
Commercial group continued to drive strong loan volume and balance growth during
the second quarter. Average loan balances for Commercial, which are comprised
primarily of multi-family loans, increased 7 percent from the second quarter
a
year ago.
Net
income
for the quarter of $100 million was flat with the same quarter of last year,
as
average balance growth offset the impact of margin compression resulting from
the lag in our adjustable-rate loan portfolio compared to rising short-term
interest rates.
The
acquisition of Commercial Capital Bancorp is on schedule. The Special Meeting
of
Shareholders will be held next Tuesday and the transaction is anticipated to
close early in the fourth quarter, thereby enhancing our already strong position
in the California multi-family lending market.
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Home
Loans
Home
Loans
had net income in the second quarter of $32 million. Excluding MSR risk
management, Home Loans net income was $61 million, compared to $223 million,
on
a pro forma basis, in the same quarter last year. The largest driver of the
difference was net interest income, which declined 54 percent to $206 million
from $449 million in the second quarter of last year. The decline was driven
by
lower average balances in our loans held for sale portfolio, reflecting the
slower mortgage lending market and lower net interest margins due to the flat
yield curve.
The
cost
of our MSR risk management activities of $29 million declined from pro forma
costs of $96 million on a linked quarter basis due, to a somewhat improved
hedging environment than existed during the first quarter of this year. A year
ago, we enjoyed a very favorable hedging environment during which pro forma
MSR
risk management generated $69 million in net income.
As
I
mentioned, as part of our servicing sale, we are also transferring our Milwaukee
servicing operations, which will reduce our servicing locations to two primary
locations in Jacksonville, Florida and Florence, South Carolina. During the
quarter, the Home Loans Group took several steps to further its long-term
goals
to diversify its product set, leverage distribution, and reduce its cost
structure. The Home Loans Group announced that it was realigning its traditional
correspondent business to a conduit structure. It consolidated 26 operations
support sites to 10 and continued to integrate Long Beach Mortgage under
one
management team. As a result, Home Loans staffing declined 13 percent on
a
linked quarter basis to 13,964.
I
would
like to congratulate David Schneider and the entire Home Loans team for
addressing a challenging environment head on and making strategic changes
which
should lead to stronger profitability and lower earnings volatility.
We
are
committed to being a leader in the home loans. But we will strive to maximize
our returns by focusing on those parts of the mortgage business where we
can
achieve our high risk adjusted targeted returns.
That’s
an
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. But beyond driving those businesses to achieve
their
potential, we are also taking steps to reposition the company for the operating
environment we see ahead. Our recent initiatives and our current outlook
will
mean some changes for our earnings driver guidance, which I’ll go over at the
end of my comments on the quarter’s results.
Asset
Growth and Net Interest Margin
During
the
quarter, average assets were $349.6 billion, up 9 percent from the second
quarter of last year. This growth is slightly above the 6 to 8 percent
asset
growth range we provided you for the year and was mostly driven by the
Providian
acquisition. However, as we have said previously, we expect much slower
growth
in the remainder of the year.
The
Federal Reserve continued to increase the Fed Funds rate reaching 5.25
percent
in the second quarter. Rising short-term rates resulted in a decline
in our net
interest margin to 2.65 percent for the quarter, down 10 basis points
on a
linked quarter basis. The decline in NIM reflected the 50 basis point
increase
in Fed Funds rate during the quarter as well as competitive pressure
on deposit
pricing as short-term interest rates moved above 5
percent.
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There
seems to be more optimism in the market today that we may be nearer the end
of
the Fed tightening cycle than we were a quarter ago. At this point the forward
yield curve suggests one more Fed tightening of 25 basis points in August.
As we
have pointed out in the past our loan portfolio includes approximately $80
billion in one-year MTA loans. Once short-term interest rates stabilize, that
portfolio will continue to reprice, helping move our NIM back into a normalized
range of 3.10 to 3.20 percent.
Credit
Shifting
to credit, we are pleased with the ongoing stability and strength 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.
At
quarter
end, our nonperforming assets ratio of 62 basis points was up slightly but
remains low from a historical perspective. Our provision for the quarter
totaled
$224 million, up from $82 million last quarter. The primary difference came
out
of our Card Services division where the provision, on a GAAP basis, was up
$95
million from the first quarter. The increase, in part, reflects a $20 million
increase in charge offs as well as our strategy to remix the balance sheet
and
hold a larger portion of card receivables on the balance
sheet.
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Noninterest
Income
Noninterest
income of $1.6 billion for the quarter was down 4 percent on a linked quarter
basis and up 43 percent year over year. The increase from last year was
primarily due to the addition of Card Services, which contributed $575
million.
Although
noninterest income was only down slightly on a linked quarter basis, there
was
significant activity during the quarter, so I’ll walk you through it.
First,
noninterest income includes the $157 million loss related to the mortgage
servicing sale. Adjusted for the MSR sale, noninterest income would have
actually improved 6 percent.
The
loss
on the MSR sale is recorded as a reduction of revenue from sales and servicing
of home loans. As you can see on WM-15, adjusted for the MSR sale, revenue
would
have been up $116 million or 44 percent on a linked quarter basis reflecting
higher gain on sale and lower MSR hedging costs.
Higher
mortgage interest rates continued to put pressure on mortgage volumes,
and our
home loans volume for the quarter declined 3 percent to $43 billion on
a linked
quarter basis. However, consistent with our strategy of focusing on higher
margin products, our net gain on sale was up $42 million to $251 million.
Loans
sold volume of $32.6 billion was down 7 percent on a linked quarter basis,
but
higher gain on sale margins and improved mix more than offset that decline.
The
second
quarter cost of our MSR risk management declined to $45 million from a
cost of
$151 million in the first quarter versus pro forma net revenue of $108
million
in the same quarter a year ago. The lower hedging costs in the second quarter
reflect a slightly improving hedging environment, with higher long-term
rates
and slower projected prepayment speeds compared to the first quarter of
this
year.
Another
driver of noninterest income was the strength of our first full quarter
of new
WaMu Free Checking
TM
,
which
helped push depositor and retail banking fees up 19 percent year over year
and
11 percent on a linked quarter basis. Included in depositor fees this quarter
was $21 million addition in revenue for having successfully migrated 90
percent
of our debit cards over to MasterCard. Excluding that revenue, depositor
fee
income would still have been up a strong 15 percent year over year.
We
experienced double digit growth on a linked quarter basis in both revenue
from
sales and servicing of consumer loans and credit card fees, due to the
ongoing
strength of our Card Services Group.
The
loss
in trading securities this quarter included $47 million related to MSR
hedging
activities and an $82 million in fair value adjustments related to certain
assets held in our trading account.
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Earlier
today we issued a press release with more details about our MSR sale. I would
encourage you to take a look at that release. In summary, we are selling
the
servicing related to loans with unpaid balances of $140 billion. The breakdown
by type is as follows:
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·
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The
entire $43 billion of our government servicing
portfolio
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·
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$89
billion of our fixed-rate agency portfolio which is predominately
comprised of loans to single-service customers and in out-of-footprint
markets, and
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$8
billion in the fixed-rate private
portfolio
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The
sale
will reduce our MSR by $2.6 billion, or nearly 30 percent, and thereby reduce
our hedging costs and related earnings volatility.
This
sale
of servicing also brings our Mortgage Servicing business in line with our
origination focus on higher-margin, higher-yielding products. As well as
meeting
our objective of reducing our level of market risk, this provides a better
balance of credit and interest rate risk for the company.
Noninterest
Expense
Shifting
to noninterest expense, noninterest expense was up 26 percent year over year,
primarily due to the addition of Card Services.
Noninterest
expense increased 4 percent on a linked quarter basis, primarily due to
restructuring cost of $81 million incurred as part of our of efficiency
initiatives during the second quarter. Excluding this quarter’s restructuring
charges, noninterest expense was nearly flat on a linked quarter basis, despite
a $22 million increase in advertising related to WaMu Free Checking
TM
.
Kerry
provided good detail on the acceleration of our efficiency measures which
are
focused on achieving our five year financial operating efficiency target
of less
than 50 percent. Our operating efficiency ratio for the second quarter,
excluding the MSR sale and restructuring charges, was 56.6 percent. This
level
was slightly lower on a linked quarter basis, despite the net interest margin
compression we experienced in the quarter. While we have a gap to close from
the
current level to achieve our goal, we are confident that our proactive
initiatives combined with the snap back of the NIM once rates stabilize will
position us to meet our efficiency goals.
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Capital
Management
Let
me
take a moment to address capital management before I give you an update on
our
earnings drivers.
At
quarter
end, our tangible capital ratio of 5.94 percent was well in excess of our target
ratio of greater than 5.50 percent. Given our outlook on capital generation
through earnings, our remixing of capital and our expectations for current
asset
growth the Board also approved a new 150 million share repurchase plan.
Earnings
Driver Guidance
Now,
let
me walk you through our present thinking concerning our six earnings drivers
and
introduce a new driver related to our announced intention to sell our fund
management business. Given the transactions we announced today, there are many
moving parts that will affect our quarterly reported numbers. Overall, these
actions will be about 5 to 10 cents accretive in 2007 and have been factored
into our 2006 annual guidance that I will go through now.
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Driver
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April
2006 Guidance
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New
Guidance
|
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1)
Average Asset Growth
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6-8
percent
|
5-7
percent
|
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2)
Net interest margin
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2.75-2.85
percent
|
2.70-2.80
percent
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3)
Credit provisioning
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$650-750
million
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4)
Pretax Discontinued Operations*
-
Operations
-
Gain on Sale
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-
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$45-50
million
Contingent
Upon Sale
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5)
Depositor and other retail banking fees
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12-14
percent growth
|
15-17
percent growth
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6)
Noninterest income
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$6.5-$6.8
billion
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$6.3-$6.5
billion
|
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7)
Noninterest expense
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$8.6-$8.8
billion
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*
Reflects
funds management business as discontinued operations and sale.
1)
Average Assets
Since
January, our average assets are up 6 percent from 2005, which is at the lower
end of our guidance range. We plan to continue the re-mixing of the balance
sheet toward higher-risk adjusted assets, like card receivables, subprime
residential and multi-family loans but plan to constrain growth of our single
family prime portfolio given the continued risk adjusted returns we are seeing
and our ability to repurchase our shares. Therefore, we are revising our
asset
growth guidance slightly downward to a range of 5 to 7 percent.
2)
Net Interest Margin
The
Fed
continued its pace of interest rate increases during the second quarter and
again the forward yield curve is anticipating another 25 basis point rate
increase. Given this outlook and the competitive deposit pricing environment,
we
now believe our margin for the full year will come in about five basis points
lower, or in a range of 2.70 to 2.80 percent. But this driver is dependent
upon
the movement of market interest rates so we will continue to provide you
our
most updated guidance quarterly.
3)
Credit Provisioning
Credit
quality continues to be strong. The second quarter provision reflects our
asset
growth and a slight up tick in charge offs. So we are comfortable with our
range
of $650 and $750 million.
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5)
Discontinued Operations
Given
our
announced intention to sell our asset management business, beginning this
quarter it is being reclassified as discontinued operations. So we are adding
this as an earnings driver for the remainder of 2006. We expect the sale
of this
business will produce a significant gain that will more than offset the loss
on
the MSR sale and restructuring charges.
And
we
have presented the asset management business as discontinued operations.
Accordingly the revenue and expenses is extracted from the company’s ongoing
business results.
For
2006
the funds management business is expected to generate approximately $250
million
in noninterest income and $200 million in operating expenses resulting in
pretax
net income of between $45 and $50 million. So as you will see in a minute
these
adjustments do affect our drivers for noninterest income and noninterest
expense.
4)
Depositor and Retail Banking Fees
Given
the
continued strong net new account growth and fee income driven by our new
WaMu
Free Checking
TM
product,
we are again increasing our guidance for depositor and other retail banking
fee
growth to 15 to 17 percent.
5)
Noninterest Income
In
looking
at noninterest income, there are two necessary adjustments to our prior outlook
of $6.5 to $6.8 billion for the year.
|
·
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First,
as I just said, we need to exclude approximately $250 million in
asset
management revenue, and.
|
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·
|
Second,
we need to back out the pre tax reduction of $157 million related
to the
sale of mortgage servicing rights.
|
As
a
result, we would adjust our guidance downward to by $400 million to a range
of
$6.1 to $6.4 billion. However, given the strength of our retail banking fees
and
credit card income we are increasing guidance for noninterest income to a
range
of $6.3 to $6.5 billion.
6)
Noninterest Expense
Similar
to
noninterest income we need to make some adjustments for noninterest expense.
However, first I want to remind you that we began the year with noninterest
expense guidance of $9 billion but then lowered that to a range of $8.6 to
$8.8
billion, because of our intensified focus on operating efficiency initiatives.
So
the
adjustments related to last quarter’s guidance are:
|
·
|
A
reduction of approximately $200 million for the exclusion of the
funds
management operating expenses.
|
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·
|
And
our projection of accelerated restructuring costs in the range
of $125 to
$150 million for the second half of the year and the estimated
$80 million
in costs related to completing the MSR
sale.
|
Given
that
these adjustments largely offset each other, we are maintaining our noninterest
expense guidance of $8.6 to $8.8 billion for the year.
So
Kerry,
we expect to have an active second half of the year, but we should be very
well
positioned for less earnings volatility and improved operating efficiency
going
into 2007.
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.
Let
me
wrap up by saying the second quarter was solid, given where we are in the
interest rate cycle. Excluding the MSR transaction and restructuring charges,
we
earned 94 cents per share. When the Fed stops raising interest rates, we
should
start benefiting from an expansion in our net interest margin back towards
the
range of 3.10 to 3.20 percent that Tom mentioned. With $350 billion of
assets,
margin expansion could result in significant operating leverage. Having
been
through many interest rate cycles, I know this leverage is something investors
and analysts don’t always fully appreciate.
The
steps
we have taken to significantly reduce our MSR and to accelerate our productivity
initiatives should add to earnings in 2007 and beyond. These actions also
reduce
the market risk of the company. In addition our
plan
is to
sell our mutual fund business to further streamline our business model,
and we
believe the gain will more than offset the cost of our other initiatives.
Accordingly,
I believe we are increasing our returns and reducing risks - something
we all
strive to achieve.
Finally,
we believe purchasing our stock at current levels is an excellent way to
deploy
capital. Rather than stretching for asset growth when credit spreads are
fairly
low and when the economy may be slowing, we would rather aggressively repurchase
our shares. The new 150 million share repurchase program represents about
17
percent of our outstanding shares. I hope we are able to purchase as many
shares
as possible at current prices.
So
overall, I am pleased with our progress and I believe that step by step
we are
creating a more diversified bank positioned for improved financial performance.
And by doing this we have the opportunity to deliver superior shareholder
returns over the next few years.
Before
I
close, I’d like to invite you to attend our Investor Day on September
6
th
and
7
th
here in
Seattle. At that meeting you will have the opportunity to meet more of
our
Management Team including James Corcoran, our new President of Retail Banking.
We will also take this opportunity to provide you our first guidance on
the
earnings drivers for 2007.
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 file 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 described in detail in our Form
10-K for
2005 and Quarterly Report on Form 10-Q for the Period Ended March 31,
2006 and
include: volatile interest rates impact the mortgage banking business;
rising
interest rates, unemployment and decreases in housing prices; risks related
to
the option adjustable-rate mortgage product; risks related to subprime
lending;
risks related to the integration of the Card Services business; risks
related to
credit card operations; changes in the regulation of financial services
companies, housing government-sponsored enterprises and credit card lenders;
competition from banking and nonbanking companies; 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;
and negative public opinion. There are other factors not described in
the Form
10-K for 2005 and Form 10-Q for the Period Ended March 31, 2006 and which
are
beyond the Company’s ability to anticipate or control that could cause results
to differ.