Washington Federal, Inc. — Fiscal 2015 First-Quarter 10-Q
Reporting period: Three months ended December 31, 2014; comparisons are generally with the quarter ended December 31, 2013. Washington Federal is a bank holding company operating through its federally insured national bank, focused on deposits and residential, multifamily, and commercial lending. Amounts below are in U.S. dollars.
Financial performance and position
- Profit: Net income was $38.4 million, down 4.5% from $40.2 million. Diluted EPS was $0.39, unchanged. Income before taxes was $59.8 million versus $62.6 million.
- Revenue and margin: Interest income was $133.3 million, up from $131.3 million; net interest income rose to $102.2 million from $98.3 million. Net interest margin declined to 3.01% from 3.12%, as earning-asset yields fell more than funding costs. Other income was $5.4 million versus $5.8 million.
- Expenses and credit costs: Other expense increased 21.5% to $53.6 million from $44.1 million. The company recorded a $5.5 million reversal of loan-loss provision, compared with a $4.6 million reversal a year earlier. The effective tax rate was 35.75% in both periods.
- Cash flow: Operating cash flow was $18.3 million versus $51.5 million. Investing provided $28.7 million versus $758.6 million, with the prior-year period including acquisition-related cash. Financing used $286.1 million versus $46.3 million, including deposit outflows, debt repayment, dividends, and share repurchases. Cash and equivalents ended at $542.8 million, down from $781.8 million at September 30, 2014.
- Balance sheet and funding: Total assets were $14.49 billion, down from $14.76 billion at September 30. Net loans were $8.25 billion, up from $8.15 billion; customer accounts were $10.58 billion, down from $10.72 billion. FHLB advances were $1.83 billion, down from $1.93 billion. Shareholders’ equity was $1.98 billion, or 13.67% of assets.
- Capital and asset quality: The Bank reported a 23.16% total risk-based capital ratio, 21.90% Tier 1 risk-based ratio, and 11.33% Tier 1 leverage ratio; each exceeded the filing’s stated well-capitalized threshold. Nonperforming assets were $164.3 million, or 1.13% of assets, versus $197.9 million, or 1.37%, a year earlier; they had risen from 1.00% at September 30, 2014. Non-accrual loans were $98.4 million, up from $87.4 million at September 30, but down year over year.
Material changes and unusual items
- Net interest income benefited from a larger average earning-asset base, associated in part with the prior fiscal year’s Bank of America branch acquisitions. The company reported 247 branches versus 235 a year earlier.
- Management cited higher staffing, occupancy, product-delivery, and technology costs, including preparation for a 2015 core-system upgrade. Deposit fee income rose to $6.0 million from $1.7 million, attributed to more customers and branches.
- The quarter included corrections of prior-period errors: an $8.2 million upward adjustment to real estate owned and other income, and an $8.9 million reduction to accrued interest receivable and other income for an over-accrual dating back to fiscal 2011. Management said the corrections were not material to the current or previously reported periods.
- Other unusual items included a $2.6 million FHLB advance prepayment penalty, which management expected to be offset by lower interest expense over the remaining nine months of the fiscal year, and a $2.0 million write-down of the FDIC indemnification asset.
- The company purchased $100 million of bank-owned life insurance; management cited a 5.14% pro forma 2015 pretax-equivalent yield and employee-benefit funding as purposes.
- Quarterly dividends paid were $0.15 per share, reflecting a one-time schedule change and four-month proration; the company announced a subsequent $0.13 dividend, up from the normal $0.11 rate. It repurchased 1.12 million shares during the quarter.
Outlook, risks, and contingencies
- No earnings or revenue guidance was provided. Management said it expected an effective tax rate of 35.75% going forward.
- Interest-rate exposure remains important: an immediate parallel 200-basis-point rate increase was estimated to reduce next-year net interest income by 1.4%; a gradual 200-basis-point increase over 12 months was estimated to reduce first-year net interest income by 2.2%. An immediate 200-basis-point increase was estimated to reduce net portfolio value by 18.9%. These are model estimates based on stated assumptions, not forecasts.
- Management reported a negative one-year repricing gap of 11.0% of assets, meaning funding costs may adjust faster than asset yields when rates change. The company held $1.52 billion of long-term fixed-rate mortgage-backed securities classified as held-to-maturity; management noted potential unrealized losses if rates rise.
- Most FDIC loss-share coverage on covered loans was expected to expire during fiscal 2015. Management estimated that, if coverage had expired by December 31, 2014, the NPA ratio would have been 1.33% rather than 1.13%, and the delinquency rate 1.61% rather than 1.47%.
- Management identified economic conditions, interest rates, deposit flows, funding costs, loan demand and quality, competition, regulation, and technology as risks that could cause actual results to differ materially. It said the allowance plus reserve for unfunded commitments totaled $110.6 million, or 1.26% of gross loans, and was sufficient for estimated inherent losses.
- The company reported ordinary-course legal proceedings that it did not consider material. It stated disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- How recurring earnings compare with reported earnings after considering the $8.2 million and $8.9 million accounting corrections and other unusual items.
- Whether the rise in nonperforming assets from September reflects sustained commercial real estate deterioration; the filing also says a significant commercial loan later paid off during the quarter.
- Whether loan-loss reversals remain appropriate as non-accrual loans rose sequentially and FDIC loss-share coverage expires.
- How deposit trends, elevated operating expenses, and the planned technology upgrade affect future margins and efficiency.
- The assumptions and sensitivity behind the interest-rate, net interest income, and net portfolio value estimates.
- The effect of share repurchases, dividends, and the $100 million insurance purchase on liquidity and capital; the filing provides no explicit forward earnings guidance.