WAFD INC quarterly report, Q2 FY2011

Business context and reporting period

Washington Federal, Inc. is a savings and loan holding company whose primary operating subsidiary is Washington Federal Savings. This unaudited Form 10-Q covers the quarter and six months ended March 31, 2011; the comparable periods are the quarter and six months ended March 31, 2010. Balance-sheet comparisons are to September 30, 2010. Amounts below are in U.S. dollars.

Financial and operating highlights

MetricQuarter ended March 31, 2011Comparable period
Interest income$158.5 million$165.0 million
Net interest income$101.6 million$97.0 million
Provision for loan losses$30.8 million$63.4 million
Net income$25.8 million$82.1 million
Diluted earnings per share$0.23$0.73
  • For the six months, net interest income was $206.3 million versus $194.8 million; net income was $50.4 million versus $90.0 million, and diluted EPS was $0.45 versus $0.80.
  • The prior-year quarter and six-month results included a $85.6 million pretax gain from the Horizon FDIC-assisted acquisition and a $38.9 million tax benefit. These items substantially affect the year-over-year earnings comparison.
  • Quarterly interest-rate spread was 3.07%, down from 3.09% at September 30, 2010. Management attributed pressure to a higher share of lower-yielding investments and mortgage refinancing at low rates.
  • Six-month operating cash flow was $167.9 million, investing cash flow was negative $48.3 million, and financing cash flow was negative $96.3 million. Cash and equivalents ended at $912.0 million.
  • Total assets were $13.39 billion, down 0.7% from September 30, 2010. Non-covered loans, net, were $8.01 billion, down from $8.42 billion; covered loans, net, were $453.3 million, down from $534.5 million. Available-for-sale securities increased to $2.91 billion from $2.48 billion.
  • Customer accounts were $8.79 billion, slightly below $8.85 billion at September 30, 2010. FHLB advances and other borrowings totaled $2.66 billion, nearly unchanged. Stockholders’ equity was $1.84 billion, or 13.73% of assets.
  • Washington Federal Savings reported a 24.24% total risk-based capital ratio, 23.00% Tier 1 risk-based ratio, and 11.68% core capital-to-adjusted-tangible-assets ratio; each exceeded the filing’s applicable “well capitalized” threshold.

Changes, outlook, and risks

  • Credit measures improved year over year: non-performing assets were $399.3 million, or 2.98% of assets, versus $538.9 million, or 3.90%; non-accrual loans were $221.7 million versus $334.9 million; and quarterly net charge-offs were $26.4 million versus $59.4 million. Loans 30 days or more delinquent were 3.37%, down from 4.39% a year earlier.
  • The allowance for loan losses was $163.6 million. Management cited improvement in several credit indicators but also continuing real-estate value declines and added reserves for single-family troubled debt restructurings. The reserve allocated to those restructurings increased by $11.0 million during the quarter. Management expects provisions to remain elevated until non-performing assets and charge-offs improve measurably.
  • Management is reducing exposure to land and construction loans and is not aggressively competing for 30-year fixed-rate mortgages below 4.50%, citing duration risk. It said the loan portfolio could continue to shrink if low mortgage rates persist.
  • Interest-rate exposure is material: liabilities repricing within one year exceeded assets repricing within one year by about $2.5 billion, a negative gap of 19% of assets. The filing estimates net interest income would decline $28.5 million (6.4%) under an immediate parallel 200-basis-point rate increase, or $8.9 million (2.0%) under a gradual increase over 12 months. These are model estimates based on stated assumptions, not guidance.
  • Management expected an effective tax rate of 36% going forward. No earnings or revenue guidance was provided.
  • The Bank remained subject to an Office of Thrift Supervision memorandum of understanding (MOU). Management said many required actions had been completed; failure to comply could lead to additional scrutiny, business constraints, or formal enforcement. Regulatory approval was obtained to consider an acquisition, but the Bank chose not to pursue it.
  • Other risks include ongoing elevated problem assets, sensitivity to interest rates, and uncertain costs and effects of Dodd-Frank implementation and the transfer of oversight from the OTS to the Federal Reserve and OCC. The filing states ordinary-course legal proceedings were not expected to materially affect financial position or results.

Important facts for investors to verify

  1. Whether credit quality continues to improve and whether the allowance is adequate, particularly for single-family restructured loans and portfolios exposed to real estate values.
  2. How loan runoff, securities growth, deposit trends, and funding costs affect net interest income and the reported 19% negative one-year repricing gap.
  3. Whether the MOU is modified, suspended, or terminated, and whether regulatory changes materially increase operating costs or constrain business activity.
  4. The drivers of earnings excluding the prior-year Horizon gain and tax benefit, and the sustainability of current provision levels and management’s 36% tax-rate expectation.
  5. Interest-rate model assumptions and actual results relative to the filing’s estimated rate-shock impacts.