WAFD INC quarterly report, Q1 FY2020

Business context and reporting period

Washington Federal, Inc. (WaFd Bank) is a Seattle-based bank holding company serving consumers and businesses through 234 branches in eight states. This unaudited Form 10-Q covers the three months ended December 31, 2019, the first quarter of fiscal 2020; year-over-year comparisons are to the quarter ended December 31, 2018. Balance-sheet comparisons are to September 30, 2019.

Financial performance and condition

Quarterly net income increased 24% year over year. The filing attributes the jump in other income chiefly to a $32.6 million gain on sales of fixed assets. Operating expenses rose to $82.6 million from $71.7 million, including an information-technology impairment charge of $5.9 million. Income before taxes was $83.5 million, and the effective tax rate was 21.35%.

Net cash from investing activities was $136.5 million, versus net cash used of $330.8 million a year earlier; proceeds from premises and equipment sales were $53.8 million. Financing activities used $145.4 million, compared with providing $285.3 million in the prior-year quarter. Cash increased by $64.6 million over the quarter.

Material changes versus comparable periods

• Net interest income rose only $0.5 million year over year as average earning assets grew, while net interest margin declined 6 basis points to 3.15%. The filing cites lower asset yields and higher deposit costs.
• Other income rose $27.4 million, principally due to the fixed-asset sale gain; the prior-year quarter included a $6.4 million net gain on fixed-asset sales and valuation adjustments.
• Other expense increased $11.0 million, including higher technology costs and compensation. The company reported a 4.8% increase in full-time-equivalent staff year over year.
• Gross loans increased $92.0 million from September 30, but net loans fell $25.7 million, largely reflecting higher loans in process. Single-family residential loans declined $133.1 million; construction and commercial and industrial balances grew $136.3 million and $84.0 million, respectively.
• Non-accrual loans decreased to $30.1 million from $33.7 million, and non-performing assets fell to $39.7 million from $43.8 million. Delinquencies increased slightly, to 0.30% of loans from 0.29%.
• Customer deposits declined $58.6 million from September 30. Time deposits decreased, while transaction deposit balances increased; transaction and savings accounts represented 61% of deposits.

Outlook, risks, contingencies and unusual items

The filing provides no specific earnings or growth guidance. Management says it is seeking to reduce interest-rate risk by growing shorter-term loans and transaction deposits. Its model estimates that an immediate parallel 200-basis-point rate increase would lift next-year net interest income by 0.7%; an assumed gradual increase of 300 basis points in short rates and 100 basis points in long rates over two years would reduce net interest income by 0.1% in year one and 3.6% in year two, absent management action. A 200-basis-point immediate increase is estimated to reduce net portfolio value by $369.8 million, or 14.5%.

Key risks cited include economic deterioration and borrower stress, real-estate and housing-market declines, interest-rate changes and LIBOR reform, credit and collateral valuation, regulatory changes, access to external financing, and technology and competitive factors. The company also identifies risks relating to remediation of its Bank Secrecy Act program, including possible higher costs or enforcement actions beyond those contemplated by the Consent Order.

The company recorded a $1.0 million release of loan-loss allowance, compared with a $0.5 million release in the prior-year quarter. It said recoveries more than offset charge-offs and that the allowance plus the reserve for unfunded commitments totaled $140.0 million, or 1.04% of gross loans. Unfunded credit exposures were $2.64 billion, with a $7.5 million reserve. Management noted that $64.5 million of loans less than 90 days delinquent were classified as substandard; including them as non-performing would raise non-performing assets plus performing restructured loans to 1.28% of assets.

The company expects the new expected-credit-loss standard (CECL) could increase its allowance at adoption, but the amount was still being evaluated. It adopted the lease standard on October 1, 2019, recognizing $29.0 million each in right-of-use assets and lease liabilities, with no opening retained-earnings adjustment. Legal proceedings are described as ordinary-course matters not expected by management to have a material financial effect. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Most important facts for investors to verify

• How much of the earnings increase is recurring, given the $32.6 million fixed-asset sale gain and the $5.9 million technology impairment charge.
• Whether net interest margin and deposit costs stabilize, and how actual results compare with the filing’s interest-rate sensitivity assumptions.
• Credit quality trends, including substandard loans, delinquencies, restructured loans, and the adequacy of both funded and unfunded credit-loss reserves.
• The eventual CECL adoption impact and any changes in the allowance as economic conditions and portfolio composition evolve.
• Progress and costs in Bank Secrecy Act remediation and any developments involving the Consent Order or regulatory enforcement.
• Capital and liquidity levels, including the $2.25 billion of FHLB advances, deposit trends, and the effect of dividends and share repurchases.