Washington Federal, Inc. — Q1 FY2011 Form 10-Q
Business context and reporting period: Washington Federal is a savings and loan holding company whose primary operating subsidiary is Washington Federal Savings. This filing covers the quarter ended December 31, 2010; income and cash flow comparisons are against the quarter ended December 31, 2009. Balance-sheet comparisons are primarily against September 30, 2010. Figures below are in U.S. dollars.
Financial performance and position
| Metric | Quarter ended Dec. 31, 2010 | Comparable / reference |
|---|---|---|
| Interest income | $165.6 million | $165.7 million a year earlier |
| Net interest income | $104.7 million | $97.8 million a year earlier |
| Provision for loan losses | $26.0 million | $69.8 million a year earlier |
| Net income | $24.5 million; diluted EPS $0.22 | $7.9 million; diluted EPS $0.07 a year earlier |
| Operating cash flow | $78.8 million | $26.4 million a year earlier |
- Net interest spread was 3.06% at quarter-end, down from 3.09% at September 30, 2010. The filing does not provide a clear quarterly net interest margin value.
- Total assets were $13.43 billion, down 0.4% from September 30. Loans receivable, excluding covered loans, were $8.14 billion, down 3.3%; investment securities increased 13.3% to $2.88 billion, including available-for-sale and held-to-maturity securities.
- Cash and cash equivalents were $842.9 million. Customer accounts totaled $8.85 billion; FHLB advances and other borrowings totaled $2.66 billion. Stockholders’ equity was $1.84 billion, or 13.69% of assets.
- Cash declined $45.7 million during the quarter. Investing activities used $80.8 million and financing activities used $43.7 million.
- The bank reported regulatory capital ratios above the filing’s “well capitalized” thresholds, including total risk-based capital of 23.83% and Tier 1 risk-based capital of 22.61%.
Material changes versus prior periods
- Net income rose substantially year over year, mainly because the provision for loan losses and foreclosure-related losses were lower. Lower funding costs also supported net interest income.
- Comparisons include a $20.4 million investment-sale gain in the prior-year quarter; there were no investment sales or sale gains in the current quarter.
- Other expense increased 27.1% year over year to $34.3 million, primarily reflecting higher compensation and benefits, including employees added in connection with the Horizon transaction, as well as higher FDIC insurance premiums.
- Asset quality improved year over year but weakened modestly sequentially: non-performing assets were $442.7 million, or 3.30% of assets, versus $553.3 million, or 4.37%, a year earlier, and $434.5 million, or 3.22%, at September 30. Non-accrual loans were $256.4 million; loans 30 or more days delinquent were 3.41% of loans, down from 4.74% a year earlier.
- The allowance for loan losses was $159.3 million. Net charge-offs were $29.8 million, compared with $46.0 million a year earlier. The company enhanced its TDR reserve methodology, increasing reserves allocated to single-family residential troubled debt restructurings by $5.9 million versus September 30.
Outlook, risks and unusual items
- Management expects loan-loss provisions to remain elevated until non-performing assets and charge-offs improve measurably. It expects non-performing assets to remain elevated until residential real estate markets stabilize and property values recover.
- The company was limiting new 30-year fixed-rate mortgage originations at rates below 4.50% because of duration risk. Management said it may continue shrinking the loan portfolio if low mortgage rates persist, while investing additional deposits in securities.
- Interest-rate exposure is material: the one-year maturity gap was negative 30% of assets, versus negative 28% at September 30, 2010 and negative 23% a year earlier. The company cited lower asset yields and a larger share of lower-yielding investments as factors affecting spread.
- The Bank was operating under an Office of Thrift Supervision memorandum of understanding requiring enhanced risk management and policies, among other actions. Management expected to complete requirements, but compliance costs could rise and failure to comply could lead to further regulatory action or business constraints.
- The filing identifies uncertainty around implementation of the Dodd-Frank Act, deposit flows, funding costs, interest rates, loan demand and portfolio quality as risks. No formal earnings guidance is provided. Management reported disclosure controls were effective; ordinary-course legal proceedings were not considered material.
- Unusual balance-sheet considerations include $550.9 million of covered assets subject to FDIC loss-sharing agreements and a $116.2 million FDIC indemnification asset. Covered loans were not classified as non-performing and had no loan-loss allowance recorded.
Important facts for investors to verify
- Whether asset-quality improvement continues, particularly in single-family residential, speculative construction and land acquisition and development loans; also monitor the $327.8 million of substandard loans that were less than 90 days delinquent.
- Whether the $159.3 million allowance remains adequate as charge-offs, delinquencies and troubled debt restructurings evolve; management’s reserve estimate depends on economic, collateral and portfolio assumptions.
- How the shrinking loan portfolio, securities reinvestment and negative one-year maturity gap affect future net interest income and interest-rate sensitivity.
- Progress and costs associated with the regulatory memorandum of understanding and the transition of bank oversight under financial reform legislation.
- The sustainability of earnings growth: the current-year improvement principally reflects lower credit costs, while the prior-year comparison included a sizable investment-sale gain.