WAFD INC quarterly report, Q3 FY2010

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WAFD Inc. (Washington Federal, Inc.) — Q3 FY2010 Form 10-Q

Reporting period: Quarter and nine months ended June 30, 2010. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. The company is a savings and loan holding company. The quarter included results from the January 8, 2010 FDIC-assisted acquisition of Horizon Bank.

Financial performance and position

  • Quarter: Interest income was $167.4 million, down from $169.8 million a year earlier. Net interest income rose to $99.3 million from $94.3 million. Net income available to common shareholders was $12.7 million ($0.11 per diluted share), versus $2.5 million ($0.03) in the prior-year quarter.
  • Nine months: Net interest income was $294.1 million, up from $277.7 million. Net income available to common shareholders was $102.7 million ($0.91 per diluted share), versus $31.1 million ($0.35) a year earlier. Results included significant acquisition, investment-sale, and tax benefits noted below.
  • Credit costs: Provision for loan losses was $20.7 million for the quarter, versus $52.2 million; nine-month provision was $153.9 million, versus $141.2 million. Quarter net charge-offs increased to $41.9 million from $33.6 million. The allowance was $173.4 million at June 30.
  • Credit quality: Non-performing assets were $473.1 million, or 3.45% of assets, compared with $605.9 million, or 5.03%, one year earlier. Non-accrual loans fell to $292.3 million from $492.3 million, while total restructured loans rose to $262.7 million from $136.9 million at September 30, 2009. The filing says $286.3 million of loans less than 90 days delinquent were classified as substandard; including them would raise non-performing assets plus performing restructured loans to 7.18% of assets.
  • Margins and interest-rate exposure: The interest-rate spread was 2.99% at June 30, down from 3.17% at September 30, 2009. The filing does not provide a clear net interest margin figure in the supplied text. The one-year maturity gap was negative 23% of assets, compared with negative 33% at September 30, 2009.
  • Cash flow and liquidity: Nine-month operating cash flow was $152.5 million; investing cash flow provided $419.8 million and financing cash flow provided $58.3 million. Cash and cash equivalents increased $630.6 million to $1.129 billion. Customer accounts totaled $8.887 billion, up 13.3% from September 30, 2009; the acquired Horizon deposits contributed to the increase. Total borrowings were $2.867 billion, including $2.067 billion of FHLB advances and $800 million of other borrowings.
  • Capital: Stockholders’ equity was $1.836 billion, or 13.39% of assets, compared with $1.745 billion, or 13.87%, at September 30, 2009. The Bank’s total risk-based capital ratio was 22.71%; Tier 1 risk-based and core capital ratios were each 21.49% and 11.36%, respectively.

Material changes and unusual items

  • The Horizon acquisition added assets and deposits, including $968 million of loans at book value and $820 million of deposits. Covered loans and real estate are subject to FDIC loss-sharing arrangements. The company recorded an $85.6 million pre-tax acquisition gain in the nine months.
  • Nine-month results also included a $38.9 million tax benefit from resolution of an IRS matter, reducing the reported effective tax rate for the period by 38.70 percentage points, and a $20.4 million gain on sales of investment securities. Management expected a 36% effective tax rate going forward.
  • Credit costs remain substantial: nine-month real estate foreclosure losses were $60.4 million, versus $7.7 million a year earlier. Management attributed lower quarterly provision partly to improved non-performing assets, non-accrual loans, delinquency rates, and reduced land and speculative-construction exposure.
  • Total assets rose 8.9% to $13.710 billion from September 30, 2009, largely reflecting the Horizon transaction. Excluding covered loans, the loan portfolio declined; management said it was reducing exposure to land and construction loans and would consider further portfolio contraction if low mortgage rates persisted.

Outlook, risks, and contingencies

  • Management expected loan-loss provisions to remain elevated until non-performing assets and charge-offs improve measurably, and expected non-performing assets to remain elevated until residential real estate markets stabilize and values recover.
  • On July 28, 2010, after quarter-end, the Bank entered an Office of Thrift Supervision memorandum of understanding requiring, among other actions, enhanced enterprise risk management and improvements to construction lending, portfolio valuation, interest-rate-risk management, and compliance programs. Management said compliance costs could increase and strategic expansion could be limited or delayed; failure to comply could lead to enforcement or business constraints. The MOU does not require additional capital or change dividend policy.
  • The Dodd-Frank Act was signed July 21, 2010. The company said implementation details and effects were uncertain; potential exposures include increased regulatory and compliance costs, changed capital and supervisory requirements, and possible lower debit-card interchange income.
  • Key stated risks include economic and housing-market conditions, interest rates, deposit flows and funding costs, loan and investment portfolio quality, regulatory change, and the Bank’s ability to meet MOU requirements. The filing reports disclosure controls as effective and no legal proceedings considered material.
  • The FDIC loss-share accounting remains estimate-sensitive. The company recorded a $21 million liability for a potential future true-up payment and stated that acquisition fair-value estimates could be refined for up to one year after closing.

Important facts for investors to verify

  1. How much of reported nine-month earnings is attributable to the Horizon gain, investment-sale gain, and tax benefit, and what earnings level remains after those items?
  2. Whether non-performing assets, delinquency, charge-offs, and foreclosure losses continue to improve, and how the $286.3 million of substandard loans develop.
  3. Whether FDIC-covered asset performance and updated fair-value estimates change the indemnification asset, true-up liability, or reported earnings.
  4. Progress and costs under the OTS memorandum of understanding, including any regulatory limits or enforcement actions.
  5. Whether deposit growth, funding costs, the negative one-year maturity gap, and the declining interest-rate spread affect future liquidity and earnings.