10-Q 1 q2-2001.txt JUNE 30, 2001 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 or ( ) 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 1-3521 WASHINGTON MUTUAL FINANCE CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 95-4128205 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 8900 Grand Oak Circle, Tampa, FL 33637-1050 (Address of principal executive offices) (Zip Code) (813) 632-4500 (Registrant's telephone number, including area code) 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 past 90 days. Yes X No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of July 31, 2001, there were 1,000 shares of Common Stock outstanding. Registrant meets the conditions set forth in General Instruction (H)(1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format. 2 WASHINGTON MUTUAL FINANCE CORPORATION AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS Page PART I Item 1. Financial Statements .................................................3 Consolidated Statements of Financial Condition - June 30, 2001 and December 31, 2000 ..................................3 Consolidated Statements of Operations, Comprehensive Income and Retained Earnings - Three and Six Months Ended June 30, 2001 and 2000..........4 Consolidated Statements of Cash Flows - Three and Six Months Ended June 30, 2001 and 2000.....................5 Notes to Consolidated Financial Statements................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................10 Overview ................................................................10 Consolidated Results of Operations.......................................11 Lines of Business........................................................14 Asset Quality ...........................................................15 Liquidity ...............................................................16 Capital Management.......................................................16 Interest Rate Risk.......................................................17 PART II Item 6. Exhibits and Reports on Form 8-K.....................................18 Signatures ...................................................................19 3 Item 1. Financial Statements WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries Consolidated Statements of Financial Condition (Dollars in thousands, except share information) June 30, December 31, 2001 2000 -------------- -------------- (Unaudited) ASSETS Consumer finance receivables, net $ 3,670,153 $ 3,623,763 Investment securities available for sale 153,369 185,288 Cash and cash equivalents 61,798 14,602 Property, equipment and leasehold improvements, net 25,078 25,398 Goodwill, net 44,495 46,777 Other assets 32,252 31,877 -------------- -------------- TOTAL ASSETS $ 3,987,145 $ 3,927,705 ============== ============== LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities Commercial paper borrowings $ - $ 683,654 Senior debt 2,957,873 2,196,445 Federal Home Loan Bank borrowings 119,800 156,800 -------------- -------------- Total debt 3,077,673 3,036,899 Customer deposits 222,575 189,793 Accounts payable and other liabilities 137,790 161,925 -------------- -------------- Total liabilities 3,438,038 3,388,617 -------------- -------------- Stockholder's equity Common stock: $1.00 par value; 10,000 shares authorized; 1,000 shares issued and outstanding 1 1 Paid-in capital 57,710 57,710 Retained earnings 489,811 481,524 Accumulated other comprehensive income (loss) 1,585 (147) -------------- -------------- Total stockholder's equity 549,107 539,088 -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 3,987,145 $ 3,927,705 ============== ==============

See Notes to Consolidated Financial Statements. 4 WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries Consolidated Statements of Operations, Comprehensive Income and Retained Earnings (Unaudited) For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------- ---------------------- (Dollars in thousands) 2001 2000 2001 2000 ----------- ----------- ---------- ----------- Interest income: Loan interest and fee income $ 146,034 $ 136,021 $ 291,360 $ 262,873 Investment securities income 3,420 3,166 6,890 5,950 ----------- ----------- ---------- ---------- Total interest income 149,454 139,187 298,250 268,823 Interest and debt expense 53,308 49,192 109,557 92,733 ----------- ----------- ---------- ---------- Net interest income before provision for credit losses 96,146 89,995 188,693 176,090 Provision for credit losses 32,458 25,363 64,042 49,840 ----------- ----------- ---------- ---------- Net interest income 63,688 64,632 124,651 126,250 ----------- ----------- ---------- ---------- Noninterest income 7,578 7,406 15,135 15,278 Noninterest expense: Personnel 24,273 22,670 50,380 45,655 Occupancy 3,727 3,504 7,536 6,777 Advertising 1,578 1,855 3,290 3,731 Goodwill amortization 1,140 1,140 2,281 2,281 Other 11,908 8,379 24,672 17,400 ----------- ----------- ---------- ---------- Total noninterest expense 42,626 37,548 88,159 75,844 ----------- ----------- ---------- ---------- Income before income taxes 28,640 34,490 51,627 65,684 Provision for federal and state income taxes 10,450 13,110 18,840 24,960 ----------- ----------- ---------- ---------- Net income 18,190 21,380 32,787 40,724 Net unrealized holding (loss) gain on securities arising during period, net of tax (322) (412) 1,732 (1,504) ----------- ----------- ---------- ---------- Comprehensive income $ 17,868 $ 20,968 $ 34,519 $ 39,220 =========== =========== ========== ========== Retained earnings: Beginning of period $ 484,121 $ 446,979 $ 481,524 $ 427,635 Net income 18,190 21,380 32,787 40,724 Dividends paid (12,500) (3,000) (24,500) (3,000) ----------- ----------- ---------- ---------- End of period $ 489,811 $ 465,359 $ 489,811 $ 465,359 =========== =========== ========== ==========

See Notes to Consolidated Financial Statements. 5 WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) For the Three Months For the Six Months Ended June 30, Ended June 30, -------------------------- -------------------------- (Dollars in thousands) 2001 2000 2001 2000 ----------- ----------- ------------ ----------- Operating activities Net income $ 18,190 $ 21,380 $ 32,787 $ 40,724 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 32,458 25,363 64,042 49,840 Depreciation and amortization 4,725 4,952 9,743 9,289 (Decrease) increase in accounts payable and other liabilities (39,964) 16,993 (24,966) (136) Decrease (increase) in other assets 2,207 (4,645) (375) (5,579) ----------- ----------- ----------- ---------- Net cash provided by operating activities 17,616 64,043 81,231 94,138 ----------- ----------- ----------- ---------- Investing activities Investment securities purchased (3,173) (9,350) (10,763) (61,828) Investment securities matured or sold 27,469 2,024 45,349 16,366 Net increase in consumer finance receivables (64,005) (248,004) (115,104) (508,111) Net increase in short-term note receivable - (40,000) - (40,000) Net decrease (increase) in property, equipment and leasehold improvements 1,425 (2,690) (2,641) (4,646) ----------- ----------- ----------- ---------- Net cash used in investing activities (38,284) (298,020) (83,159) (598,219) ----------- ----------- ----------- ---------- Financing activities Net (decrease) increase in commercial paper borrowings (690,484) (201,192) (683,654) 14,704 Proceeds from issuance of senior debt 995,065 449,347 995,065 449,347 Repayments of senior debt (250,000) - (250,000) - Proceeds from early termination of hedging activity 9,831 - 16,431 - Net (decrease) increase in Federal Home Loan Bank borrowings (23,100) 10,000 (37,000) 30,849 Net increase (decrease) in customer deposits 21,035 (14,118) 32,782 (27,168) Capital contributed by parent - - 8,750 Dividends paid (12,500) (3,000) (24,500) (3,000) ---------- ---------- ----------- ---------- Net cash provided by financing activities 49,847 241,037 49,124 473,482 ---------- ---------- ----------- ---------- Net increase (decrease) in cash and cash equivalents 29,179 7,060 47,196 (30,599) Cash and cash equivalents Beginning of period 32,619 2,349 14,602 40,008 ----------- ----------- ----------- ----------- End of period $ 61,798 $ 9,409 $ 61,798 $ 9,409 =========== =========== =========== =========== Supplemental disclosures of cash flow information Interest paid $ 59,055 $ 49,630 $ 102,317 $ 88,059 Federal and state income taxes paid (net of refunds) $ 17,856 $ 2,426 $ 21,281 $ 2,313

See Notes to Consolidated Financial Statements. 6 WASHINGTON MUTUAL FINANCE CORPORATION and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note 1 Basis of Presentation The accompanying consolidated financial statements of Washington Mutual Finance Corporation and subsidiaries have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in our 2000 Annual Report on Form 10-K filed with the Securities and Exchange Commission. Interim results are not necessarily indicative of results for a full year. Washington Mutual Finance Corporation is an indirect, wholly-owned subsidiary of Washington Mutual, Inc. ("Washington Mutual"). When we refer to "we", "our", "us", or the "Company" in this Form 10-Q, we mean Washington Mutual Finance Corporation and its subsidiaries, all of which are wholly-owned. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Note 2 Lines of Business We are engaged primarily in the consumer financial services business and our operations consist principally of a network of 500 branch offices located in 24 states, primarily in the southeast, southwest and California ("consumer finance"). These offices operate under the name Washington Mutual Finance. We make secured and unsecured consumer installment loans and purchase installment contracts from local retail establishments. The consumer credit transactions are primarily for personal, family or household purposes. From time to time, we purchase consumer loans from national mortgage banking operations, servicing released, that are secured by real estate. We also provide consumer financial services through our industrial banking subsidiary, First Community Industrial Bank ("FCIB"), which has 9 branches in Colorado and Utah ("consumer banking"). In addition to making consumer loans and purchasing retail installment contracts, FCIB also accepts deposits insured by the Federal Deposit Insurance Corporation. We are managed along two major lines of business, as discussed above: consumer finance and consumer banking. The financial performance of these business lines is measured by our profitability reporting processes. 7 Financial highlights by line of business were as follows: (Dollars in thousands) Three Months Ended June 30, ----------------------------------------------------------------------------- 2001 2000 -------------------------------------- ------------------------------------- Consumer Consumer Consumer Consumer Finance Banking Total Finance Banking Total Condensed income statement: ----------- ----------- ----------- ----------- ----------- ----------- Interest income $ 139,154 $ 10,300 $ 149,454 $ 129,056 $ 10,131 $ 139,187 Interest and debt expense 48,142 5,166 53,308 43,776 5,416 49,192 Provision for credit losses 32,169 289 32,458 25,463 (100) 25,363 ----------- ----------- ----------- ----------- ----------- ----------- Net interest income 58,843 4,845 63,688 59,817 4,815 64,632 Noninterest income 7,541 37 7,578 7,265 141 7,406 Noninterest expense 40,569 2,057 42,626 35,605 1,943 37,548 ---------- ----------- ----------- ----------- ----------- ----------- Income before income taxes 25,815 2,825 28,640 31,477 3,013 34,490 Provision for federal and state income taxes 9,369 1,081 10,450 11,957 1,153 13,110 ----------- ----------- ----------- ----------- ----------- ----------- Net income $ 16,446 $ 1,744 $ 18,190 $ 19,520 $ 1,860 $ 21,380 =========== =========== =========== =========== =========== =========== (Dollars in thousands) Six Months Ended June 30, ----------------------------------------------------------------------------- 2001 2000 -------------------------------------- ------------------------------------- Consumer Consumer Consumer Consumer Finance Banking Total Finance Banking Total Condensed income statement: ----------- ----------- ----------- ----------- ----------- ----------- Interest income $ 277,408 $ 20,842 $ 298,250 $ 248,919 $ 19,904 $ 268,823 Interest and debt expense 98,731 10,826 109,557 82,224 10,509 92,733 Provision for credit losses 63,501 541 64,042 50,240 (400) 49,840 ----------- ----------- ----------- ----------- ----------- ----------- Net interest income 115,176 9,475 124,651 116,455 9,795 126,250 Noninterest income 15,084 51 15,135 15,042 236 15,278 Noninterest expense 84,107 4,052 88,159 71,972 3,872 75,844 ----------- ----------- ----------- ----------- ----------- ----------- Income before income taxes 46,153 5,474 51,627 59,525 6,159 65,684 Provision for federal and state income taxes 16,746 2,094 18,840 22,604 2,356 24,960 ----------- ----------- ----------- ----------- ----------- ----------- Net income $ 29,407 $ 3,380 $ 32,787 $ 36,921 $ 3,803 $ 40,724 =========== =========== =========== =========== =========== ===========

Other disclosures: June 30, 2001 December 31, 2000 -------------------------------------- ------------------------------------- (Dollars in thousands) Consumer Consumer Consumer Consumer Finance Banking Total Finance Banking Total Consumer finance receivables: ----------- ----------- ----------- ----------- ----------- ----------- Real estate secured loans $ 1,963,947 $ 360,360 $ 2,324,307 $ 1,893,504 $ 362,540 $ 2,256,044 Other installment loans 1,632,382 8,709 1,641,091 1,629,812 11,034 1,640,846 Retail installment contracts 359,259 10,315 369,574 364,215 15,858 380,073 Gross consumer finance ----------- ----------- ----------- ----------- ----------- ----------- receivables 3,955,588 379,384 4,334,972 3,887,531 389,432 4,276,963 Less: Unearned finance charges and deferred loan fees (554,230) (48) (554,278) (548,569) (44) (548,613) Allowance for credit losses (107,369) (3,172) (110,541) (101,415) (3,172) (104,587) Consumer finance receivables, ----------- ----------- ----------- ----------- ----------- ----------- net $ 3,293,989 $ 376,164 $ 3,670,153 $ 3,237,547 $ 386,216 $ 3,623,763 =========== =========== =========== =========== =========== =========== Investment securities available for sale $ 116,459 $ 36,910 $ 153,369 $ 167,915 $ 17,373 $ 185,288 Total assets $ 3,565,313 $ 421,832 $ 3,987,145 $ 3,500,185 $ 427,520 $ 3,927,705 Total equity $ 485,889 $ 63,218 $ 549,107 $ 479,371 $ 59,717 $ 539,088

8 Note 3 Hedging Activities Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. We adopted SFAS No. 133 effective January 1, 2001. Our risk management policy provides for the use of certain derivatives and financial instruments in managing certain risks. We do not enter into derivatives or other financial instruments for trading or speculative purposes. Managed risk includes the risk associated with changes in fair value of long-term fixed rate debt. In accordance with our risk management policy, such risk is hedged by entering into pay floating interest rate exchange agreements. The instruments designated in these fair value hedges include interest rate swaps that qualify for the "short cut" method of accounting under SFAS No. 133. Under the "short cut" method, we assume no ineffectiveness in a hedging relationship. Since the terms of the interest rate swap qualify for the use of the "short cut" method, it is not necessary to measure effectiveness and there is no charge to earnings for changes in fair value. All changes in fair value are recorded as adjustments to the basis of the hedged borrowings based on changes in the fair value of the derivative instrument. When derivative instruments are terminated prior to their maturity, or the maturity of the hedged liability, any resulting gains or losses are included as part of the basis adjustment of the hedged item and amortized over the remaining term of the liability. At June 30, 2001, the deferred gain on terminated hedging transactions totaled $15.7 million. At June 30, 2001, we had three outstanding interest rate swap agreements with a combined notional amount of $450.0 million and a total fair value of ($3.7) million. Note 4 Legal Proceedings Several of the Company's subsidiaries and their current and former employees are defendants in a number of suits pending in the state and federal courts of Mississippi. The lawsuits generally allege unfair lending and insurance related practices. Similar suits are pending against other financial services companies in Mississippi. In one of the pending cases, Carolyn Baker, et al. v. Washington Mutual Finance Group, LLC f/k/a City Finance Company, a judgment based on a jury verdict of $71,265,000 was rendered against Washington Mutual Finance Group, LLC, a Delaware limited liability company ("WMF Group"), in the second quarter. WMF Group has filed a motion for new trial, a motion for judgment notwithstanding the verdict, and a motion to reduce the verdict, each of which is based on numerous grounds. The filing of these post-trial motions has stayed execution on the judgment, pending the trial court's ruling. If the trial court does not grant the requested relief, WMF Group intends to file an appeal of the judgment to the Mississippi Supreme Court, and to post a bond to stay execution of such judgment. 9 Note 5 Sale of Building On May 25, 2001, the Company sold its headquarters building in Tampa, Florida for gross sale proceeds of $6.7 million. Concurrent with the sale of the building, we entered into a leaseback, whereby we leased our office facilities from the purchaser at a monthly base rent of $64,000, with annual increases approximating 3.5% per year. The lease term is 5 years, with an additional five-year option to renew. The gain on sale of the building totaled $1.0 million and will be amortized over the ten-year period representing the total lease term. Note 6 Recently Issued Accounting Standard Adopted Amortization of goodwill and other intangible assets of $1.1 million and $2.3 million were unchanged for the three and six-month periods ended June 30, 2001 compared to the same periods of 2000. In June 2001, the FASB issued Statements of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. SFAS No. 142 eliminates the amortization of goodwill relating to past and future acquisitions and instead subjects goodwill to an impairment assessment. The provisions of SFAS No. 142 will apply to existing goodwill and other intangible assets for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 142 will cease further amortization of goodwill and will have an impact of approximately $4.6 million (pretax) on an annual basis. All of the provisions of the statements will be applied, effective July 1, 2001. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This report contains forward-looking statements, which are not historical facts and pertain to our future operating results. These forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and similar expressions are generally intended to identify forward-looking statements. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements for the reasons, among others, discussed under the heading "Business-Risk Factors" included in our 2000 Annual Report on Form 10-K filed with the Securities and Exchange Commission, which is incorporated herein by reference. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report. Overview Our results in the six months ended June 30, 2001 are reflective of the re-mixing of the receivables portfolio in favor of real estate secured receivables and the ongoing commitment to develop infrastructure, both of which were initiated in the prior year. Net income totaled $18.2 million and $32.8 million for the three- and six-month periods ended June 30, 2001, as compared to $21.4 million and $40.7 million in the same periods of 2000. The primary reasons for this decline were a lower net interest margin, higher provisions for credit losses and increased operating expenses. As a result of these factors, our return on average assets for the three- and six-month periods ended June 30, 2001 were 1.83% and 1.66%, compared to 2.37% and 2.36% in the same periods of 2000. Consumer finance receivables (net of unearned finance charges and deferred loan fees) remained relatively flat for the six months, increasing $52.3 million, or 1.4%. These results are reflective of tightened underwriting standards in light of recent economic conditions. Our strategy continues to target portfolio growth; however, our loan underwriting and acquisition strategy will continue to take into account the state of the economy in the markets we currently serve or are targeting. At June 30, 2001, real estate secured loans comprised approximately 54% of the total portfolio, as compared to 51% one year ago. As a result of this continued shift in portfolio mix, the yields earned on consumer finance receivables declined from 15.93% and 16.04% in the three- and six-month periods ended June 30, 2000 to 15.54% and 15.53% in the same periods of 2001. Net interest spread and net interest margin for the quarter and year-to-date were down compared to the same periods in the prior year. These decreases are a result of the decline in earned yields discussed above, offset partially by a decrease in the weighted-average cost of funds of 43 and 8 basis points, which 11 is a reflection of borrowing activity and changes in funding costs subsequent to the second quarter of 2000. See "Consolidated Results of Operations." Operating efficiency is defined as the ratio of noninterest expense (excluding the amortization of goodwill) to total revenue (which is comprised of net interest income before provision for credit losses and noninterest income). In the three- and six-month periods ended June 30, 2001, our operating efficiency ratio increased to 40.00% and 42.13% from 37.38% and 38.44% for the same periods in the prior year. This deterioration is due to the lower net interest income as a result of lower margin, coupled with increased noninterest expense to support our expanded operations. However, operating efficiency improved in the second quarter 2001 over the first quarter (from 44.35% to 40.00%) due to better management of interest and debt expense. See "Consolidated Results of Operations." Net charge-offs totaled $29.5 million and $58.2 million for the three and six months ended June 30, 2001, as compared to $24.0 million and $46.7 million during the same periods in 2000. This increase is due primarily to increased charge-offs in the personal loan portfolio, which is a result of the seasoning of the portfolio that grew significantly in recent years. Annualized net charge-offs as a percentage of average consumer finance receivables (excluding unearned finance charges and deferred loan fees) were 3.13% in the six months ended June 30, 2001, as compared to 2.85% in the same period of 2000. Consolidated Results of Operations Net Interest Income before Provision for Credit Losses Net interest income before provision for credit losses for the six months ended June 30, 2001 increased 7.2% to $188.7 million, compared to $176.1 million in the same period of 2000. For the second quarter of 2001 this amount increased 6.8% to $96.1 million, compared to $90.0 million in the same period of 2000. Net interest margin for both the quarter and year-to-date was 9.68% and 9.53%, compared to 10.03% and 10.21% during the same periods in 2000. The increase in net interest income before provision for credit losses during the six months ended June 30, 2001 reflects growth in average net consumer finance receivables to $3.75 billion, which was $473.6 million, or 14.5%, greater than the average balance during the same period in 2000. This is primarily a result of management's continued implementation of the internal growth initiative through the branch network, as well as an ongoing pursuit of strategic acquisitions. Partially offsetting this portfolio growth is a 51 basis point decrease in average portfolio yield. This yield compression is a result of remixing the portfolio to a larger percentage of lower-yielding real estate secured loans. Another factor adversely impacting the portfolio yield was interest rate restrictions on larger loan balances. In general, due to state laws, as loan size increases, the maximum interest rate allowed by law decreases. Due to rising average loan size, the average interest rate allowed by law was lowered. As a result of the higher average receivables balance, average debt outstanding increased $541.4 million, or 19.6%, to $3.30 billion during the six months ended June 30, 2001, as compared to the same period in the prior year. The increased interest expense was a result of this growth, offset by a lower cost of borrowings. Due to favorable interest rate conditions, we issued $1 billion in senior notes in May 2001. These borrowings included a $500 million issuance with 12 a coupon rate of 6.25%, due May 15, 2006 and a $500 million issuance with a coupon rate of 6.875%, due May 15, 2011. The proceeds of these issuances were used to pay off all maturing commercial paper borrowings and senior debt during the remainder of the quarter. On June 15, 2001, there were two maturities of senior debt, $100 million at 7.25% and $150 million at 7.75%. As a result of the activity in our funding book, the overall cost of debt decreased 8 basis points for the six months ended June 30, 2001, as compared to the same period in 2000. The following chart reflects the average balances and related effective yields during the three- and six-month periods ended June 30, 2001 and 2000, as described above: (Dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, -------------------------------------------- ----------------------------------------------- 2001 2000 2001 2000 -------------------- ---------------------- ---------------------- ---------------------- Average Average Average Average Balance Rate Balance Rate Balance Rate Balance Rate Interest-earning assets: ----------- ------- ----------- ------- ----------- --------- ------------- ------- Consumer finance receivables: Real estate secured loans $ 2,044,618 12.86% $ 1,753,249 12.42% $ 2,030,100 12.82% $ 1,634,140 12.47% Other installment loans 1,387,625 20.93 1,363,132 21.51 1,390,822 21.02 1,347,959 21.49 Retail installment contracts 326,095 9.41 299,715 11.01 330,727 9.10 295,942 10.90 Total consumer ----------- ----------- ----------- ----------- finance receivables 3,758,338 15.54 3,416,096 15.93 3,751,649 15.53 3,278,041 16.04 Investment securities 213,138 6.42 173,987 7.28 210,290 6.55 171,541 6.94 ----------- ----------- ----------- ----------- Total interest-earning assets $ 3,971,476 15.05% $ 3,590,083 15.51% $ 3,961,939 15.06% $ 3,449,582 15.59% =========== =========== =========== =========== Interest-bearing liabilities: Senior debt $ 2,641,981 6.61% $ 2,108,658 6.97% $ 2,451,718 6.78% $ 2,060,369 6.89% Commercial paper 358,530 5.24 468,112 6.66 502,603 6.38 384,433 6.54 Customer deposits 213,252 6.22 170,485 5.65 205,555 6.24 177,085 5.54 FHLB borrowings 131,025 5.07 144,253 6.29 141,514 5.57 138,060 6.16 ----------- ----------- ----------- ----------- Total interest-bearing liabilities $ 3,344,788 6.38% $ 2,891,508 6.81% $ 3,301,390 6.64% $ 2,759,947 6.72% =========== =========== =========== =========== Net interest spread 8.68% 8.70% 8.42% 8.87% Net interest margin 9.68% 10.03% 9.53% 10.21%

13 The dollar amounts of interest income and interest expense fluctuate depending upon changes in volume and changes in interest rates of our interest-earning assets and interest-bearing liabilities. The following table details changes attributable to (i) changes in volume (changes in average outstanding balances multiplied by the prior period's rate) and (ii) changes in rate (changes in average interest rate multiplied by the prior period's volume). Changes in rate/volume (changes in rate times the change in volume) were allocated proportionately to the changes in volume and the changes in rate. (Dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, 2001 vs. 2000 2001 vs. 2000 ------------------------------- -------------------------------- Increase/(Decrease) Due to Increase/(Decrease) Due to ------------------------------- -------------------------------- Volume Rate Total Change Volume Rate Total Change Interest income: -------- -------- ------------ --------- -------- ------------ Consumer finance receivables $ 13,298 $ (3,285) $ 10,013 $ 36,781 $ (8,294) $ 28,487 Investment securities 628 (374) 254 1,270 (330) 940 -------- -------- ---------- --------- -------- --------- Total interest income 13,926 (3,659) 10,267 38,051 (8,624) 29,427 Interest expense: Interest-bearing liabilities 7,224 (3,108) 4,116 17,968 (1,144) 16,824 -------- -------- ---------- --------- -------- --------- Net interest income $ 6,702 $ (551) $ 6,151 $ 20,083 $ (7,480) $ 12,603 ======== ======== ========== ========= ======== =========

Provision for Credit Losses The provision for credit losses for the three- and six-month periods ended June 30, 2001 were $32.5 million and $64.0 million compared to $25.4 million and $49.8 million in the same periods of 2000. For the six months ended June 30, 2001, the annualized provision for credit losses was 3.41% of average consumer finance receivables (excluding unearned finance charges and deferred loan fees), as compared to 3.04% during the same period of 2000. See further discussion in "Allowance for Credit Losses." Noninterest Income Noninterest income increased 2.3% to $7.6 million for the three-month period ended June 30, 2001, compared to $7.4 million during the same period of 2000. Noninterest income decreased 0.9% to $15.1 million for the six-month period ended June 30, 2001, compared to $15.3 million for the same period in the prior year. Noninterest income is comprised of revenue earned from the sale of various ancillary products to borrowers at the branch locations including life insurance, accident and health insurance, property and casualty insurance, accidental death and dismemberment insurance, involuntary unemployment insurance and auto club memberships. The decrease in 2001 is primarily due to a decrease in the number of loans originated during the six months ended June 30, 2001, as compared to the same period in 2000. Noninterest Expense Noninterest expense for the quarter and year-to-date ended June 30, 2001 increased 13.5% and 16.2% to $42.6 million and $88.2 million, as compared to $37.5 million and $75.8 million for the same periods in the prior year. The 10.4% increase in personnel expense is primarily a result of increased salaries, wages and benefits associated with increased headcount subsequent to the first half of 2000. This increase is a result of staffing needs at our facility in Pensacola, Florida, which opened in the fourth quarter of 1999, as well as the 14 addition of key employees at our headquarters location in Tampa, Florida. The 11.2% increase in occupancy expense is due primarily to the impact of the amortization of branch renovations completed during 2000. The 30.1% increase in other expenses is primarily a result of costs associated with developing advanced system platforms in the branch network and the Pensacola location and the development of an internet distribution channel. Provision for Income Taxes The provision for income taxes during the three- and six-month periods ended June 30, 2001 were $10.5 million and $18.8 million, which represents an effective tax rate of 36.5%. This compares to $13.1 million and $25.0 million or 38.0% in the same periods of 2000. We are actively managing our effective tax rate by restructuring the business, utilizing limited liability companies, where possible and practical, for our operating subsidiaries. Lines of Business We are managed along two major lines of business: consumer finance and consumer banking. Following is an overview of the performance of each line of business in the six months ended June 30, 2001: Consumer Finance o Net income decreased 15.4% and 20.4 % to $16.4 million and $29.4 million for the three- and six-month periods ended June 30, 2001 from $19.5 million and $36.9 million in the same periods of 2000. o The consumer finance receivables portfolio (net of unearned finance charges and deferred loan fees) increased $62.4 million, or 1.9% during the six months ended June 30, 2001. o Net interest margin decreased as a result of yield erosion on receivables caused by the shift in product mix toward lower-yielding real estate secured loans. This was partially offset by a decrease in the cost of funds as discussed in "Consolidated Results of Operations." Consumer Banking o Net income decreased 6.2% and 11.1% to $1.7 million and $3.4 million for the three- and six-month periods ended June 30, 2001, from $1.9 million and $3.8 million during the same periods of 2000. o The consumer banking receivables portfolio decreased $10.1 million, or 2.6% during the six months ended June 30, 2001. o Net interest margin decreased as a result of slight yield erosion on receivables, coupled with an increased cost of funds due to higher rates paid on customer deposits. 15 Asset Quality Consumer Finance Receivables Consumer finance receivables consisted of the following: June 30, December 31, (Dollars in thousands) 2001 2000 ------------ ------------ Consumer finance receivables: Real estate secured loans $ 2,324,307 $ 2,256,044 Other installment loans 1,641,091 1,640,846 Retail installment contracts 369,574 380,073 ------------ ----------- Gross consumer finance receivables 4,334,972 4,276,963 Less: Unearned finance charges and deferred loan fees (554,278) (548,613) Allowance for credit losses (110,541) (104,587) ------------ ------------ Consumer finance receivables, net $ 3,670,153 $ 3,623,763 ============ ============

Allowance for Credit Losses Activity in the allowance for credit losses was as follows: Six Months Ended June 30, (Dollars in thousands) 2001 2000 ----------- ------------ Balance, beginning of period $ 104,587 $ 100,308 Provision for credit losses 64,042 49,840 Amounts charged-off: Real estate secured loans (3,244) (874) Other installment loans (58,353) (48,310) Retail installment contracts (6,395) (6,255) ---------- ------------ (67,992) (55,439) Recoveries: Real estate secured loans 164 112 Other installment loans 8,300 7,179 Retail installment contracts 1,290 1,418 ----------- ------------ 9,754 8,709 ----------- ------------ Net charge-offs (58,238) (46,730) Allowances on notes purchased 150 - ----------- ------------ Balance, end of period $ 110,541 $ 103,418 =========== ============

In order to establish our allowance for credit losses, the consumer finance receivables portfolio is segmented into two categories: real estate secured and non-real estate secured (other installment loans and retail installment contracts). The determination of the level of the allowance for credit losses and, correspondingly, the provision for credit losses for these homogeneous loan pools rests upon various judgments and assumptions used to determine the risk characteristics of each portfolio. These judgments are supported by analyses 16 that fall into three general categories: (i) economic conditions as they relate to our current customer base and geographic distribution; (ii) a predictive analysis of the outcome of the current portfolio (a migration analysis); and (iii) prior loan loss experience. Additionally, every real estate secured loan that reaches 60 days delinquency is reviewed by our credit administration management to assess collectibility and determine a future course of action, at times resulting in the need to foreclose on the property. Management establishes the allowance for credit losses based on estimated losses inherent in the portfolio. Using the analysis techniques described above to measure the adequacy of the allowance for credit losses, the results of those analyses are compared to the historical trends of the loss coverage ratio, which represents the ratio of the allowance for credit losses to annualized net charge-offs. During the first six months of 2001, the loss coverage ratio decreased from 102% at December 31, 2000 to 95% at June 30, 2001. We have been remixing our loan portfolio, which has resulted in a reduction in the level of unsecured loans and an increase in the amount of real estate secured loans. The increased proportion of secured loans in the portfolio is expected to result in a relative decrease in credit losses for the remainder of 2001 and beyond. Accordingly, the loss coverage ratio at June 30, 2001 appears to be at a level that is consistent with the credit quality characteristics of the receivables portfolio. As a result of the analyses performed as described above, the allowance for credit losses as of June 30, 2001 was $110.5 million, which is an increase of $5.9 million, or 5.7% as compared to December 31, 2000. Management considers the allowance for credit losses adequate to cover losses inherent in the portfolio at June 30, 2001. No assurance can be given that we will not, in any particular period, sustain credit losses that are sizable in relation to the amount reserved, or that subsequent evaluation of the portfolio, in light of the factors then prevailing, including economic conditions and our ongoing examination process and that of our regulators, will not require significant increases in the allowance for credit losses. The following table sets forth, by loan type, the amount of receivables delinquent for 60 days or more, on a contractual basis, and the ratio of that amount to gross consumer finance receivables outstanding in each category: (Dollars in thousands) June 30, 2001 December 31, 2000 ------------------- ------------------- Real estate secured loans $ 36,185 1.56% $ 31,634 1.40% Other installment loans 80,338 4.89 74,851 4.56 Retail installment contracts 9,420 2.55 9,335 2.46 --------- ------- --------- ------ $ 125,943 2.91% $ 115,820 2.71% ========= ======= ========= ======

Liquidity We fund our operations through a variety of corporate borrowings. The primary source of these borrowings is corporate debt securities issued by us. At June 30, 2001, eleven different fixed-rate senior debt issues totaling $2.96 billion were outstanding, with a weighted-average coupon of 6.84%. To meet our short-term funding needs, we typically issue commercial paper. We have a commercial paper program with several investment banks which provides $1 billion in borrowing capacity. As a result of the $1 billion senior debt issued in May, there were no commercial paper borrowings outstanding at June 30, 2001. Upon maturity of $300 million in senior notes in August 2001, which will likely be funded with commercial paper borrowings, our funding mix will be more closely aligned with our strategy of 75% long-term funding and 25% short-term funding. FCIB raises funds through both customer deposits and borrowings with the Federal Home Loan Bank of Topeka (FHLB). At June 30, 2001, the banking subsidiary's outstanding debt totaled $342.4 million, with a weighted-average cost of 5.63%. We also share, with Washington Mutual, two revolving credit facilities: a $1.2 billion 364-day facility and a $600 million four-year facility, which provide back-up for our commercial paper programs. The borrowing capacity is limited to the total amount of the two revolving credit facilities, net of the amount of combined commercial paper outstanding. At June 30, 2001, there was $1.77 billion available under these facilities. There were no borrowings under these facilities at any point during 2001 or 2000. Capital Management We establish equity leverage targets based upon the ratio of debt (including customer deposits) to tangible equity. The debt to tangible equity ratio at June 30, 2001 of 6.54:1 has remained consistent throughout the year. The determination of our dividend payments and resulting capital leverage is managed in a manner consistent with our desire to maintain strong and improved credit ratings. In addition, provisions of certain of our debt agreements restrict the payment of dividends to a maximum prescribed proportion of cumulative earnings and contributed capital. At June 30, 2001, approximately $156.4 million was available under the debt agreement restriction for future dividends. We paid dividends in the amount of $12.5 million and $24.5 million during the three- and six-month periods ended June 30, 2001. Interest Rate Risk The table below indicates the sensitivity of pretax net interest income to interest rate movements. The comparative scenarios assume that interest rates rise or fall in even monthly increments over the next twelve months for a total increase or decrease of 200 basis points. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Our net interest income sensitivity profile as of June 30, 2001 and year-end December 31, 2000 is stated below: Gradual Change in Rates -------------------------- Net interest income change for the one year period beginning: -200bp +200bp -------------------------- July 1, 2001 0.18% (0.95)% January 1, 2001 1.62% (2.44)%

Our net interest income at risk position has not changed significantly since December 31, 2000. However, changes in rates do not have a significant impact on our income, as our customers are less rate sensitive. Assumptions are made in modeling the sensitivity of net interest income. The simulation model captures expected prepayment behavior under changing interest rate environments. Sensitivity of new loan volume to market interest rate levels is included as well. 18 Item 6. Exhibits and Reports on Form 8-K (a) Exhibit Number (3) (a) Certificate of Incorporation of Washington Mutual Finance Corporation. as presently in effect. (i) (b) By-Laws of Washington Mutual Finance Corporation as presently in effect. (iii) (4) (a) Indenture dated as of July 1, 1995 between Aristar, Inc. and The Bank of New York, as trustee. (ii) (b) Indenture dated as of October 1, 1997 between Aristar, Inc. and First Union National Bank, as trustee. (iii) (c) Indenture dated as of November 15, 1997 between Aristar, Inc. and First Union National Bank, as trustee. (iv) (d) Indenture dated as of June 23, 1999 between Aristar, Inc. and Harris Trust and Savings Bank, as trustee.(iv) (e) The registrant hereby agrees to furnish the Securities and Exchange Commission upon request with copies of all instruments defining rights of holders of long-term debt of Washington Mutual Finance Corporation and its consolidated subsidiaries. (i) Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1987, Commission file number 1-3521. (ii) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, Commission file number 1-3521. (iii) Incorporated by reference to Registrant's Current Report on Form 8-K dated October 6, 1997, Commission file number 1-3521. (iv) Incorporated by reference to Registrant's Report on Form 424B2 dated November 6, 1997, Commission file number 1-3521. (b) Reports on Form 8-K On May 24, 2001, The Company filed a Current Report on Form 8-K, dated May 22, 2001, disclosing, under item (7) thereof, the terms of the issuance of $500 million aggregate principal amount of its 6.25% Senior Notes maturing May 15, 2006 and $500 million aggregate principal amount of its 6.875% Senior Notes maturing May 15, 2011. 19 SIGNATURES Pursuant to the requirements of Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 13, 2001. WASHINGTON MUTUAL FINANCE CORPORATION By: /s/ Richard M. Levy ------------------------------------------------- Richard M. Levy Senior Vice President and Chief Financial Officer (Principal Financial Officer) By: /s/ Craig A. Stein ------------------------------------------------- Craig A. Stein Vice President and Controller (Principal Accounting Officer)

WASHINGTON MUTUAL FINANCE CORP 10-Q