Washington Federal, Inc. — Q3 FY2014 Form 10-Q
Business context and reporting period. Washington Federal is a bank holding company operating a federally insured national bank focused on residential, multifamily, commercial real estate and commercial lending. This unaudited report covers the quarter and nine months ended June 30, 2014; the fiscal year ends September 30. Balance-sheet comparisons are with September 30, 2013.
Key financial results
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Interest income | $135.0 million | $128.2 million | $398.6 million | $386.0 million |
| Net interest income | $103.3 million | $94.7 million | $302.2 million | $283.2 million |
| Provision for (reversal of) loan losses | $(3.0) million | — | $(11.9) million | $3.6 million |
| Net income | $37.9 million | $37.3 million | $116.8 million | $108.6 million |
| Diluted EPS | $0.37 | $0.36 | $1.14 | $1.03 |
- Quarterly net income increased about 1.5%; nine-month net income increased about 7.6% year over year. Higher net interest income and lower credit costs supported results, partly offset by higher operating expenses.
- Quarterly net interest margin was 3.05%, down from 3.15% a year earlier. Management attributed pressure to lower loan yields, including lower yields on new originations, and a higher proportion of floating-rate loans and securities.
- Other income was $8.1 million for the quarter, up from $5.1 million; management cited deposit-related transaction fees from acquired branches. Other expense rose 28.1% to $53.3 million, including higher staffing, occupancy, technology, ATM and debit-card costs.
- At June 30, total assets were $14.79 billion, net loans were $7.97 billion, available-for-sale securities were $3.10 billion, and held-to-maturity securities were $1.58 billion. Stockholders’ equity was $1.99 billion, or 13.46% of assets.
- Customer deposits were $10.77 billion, up 18.4% from September 30, 2013; FHLB advances were unchanged at $1.93 billion. Cash and cash equivalents increased to $861.3 million from $203.6 million. The filing does not provide a conventional revenue total.
- For the nine months, operating cash flow was $94.8 million, versus $140.2 million a year earlier; investing cash flow was $840.3 million, versus $105.9 million; financing cash flow used $277.4 million, versus $350.6 million. Cash increased by $657.7 million, with branch acquisitions materially affecting investing and balance-sheet movements.
Material changes and management commentary
- The company completed acquisitions of 74 Bank of America branches during the fiscal year, bringing approximately $1.9 billion of deposits, $13 million of loans and branch properties. It paid a 1.99% deposit premium. Management expects the expanded network to attract customers, improve the deposit mix and lower funding costs.
- Loans receivable, net, increased about $438 million from September 30, 2013. Investment securities increased about $671 million; available-for-sale securities rose 31.4%, with much of the purchases funded by acquisition proceeds.
- Credit quality improved: nonperforming assets were $162.4 million, or 1.10% of assets, versus $213.6 million, or 1.63%, at September 30, 2013. Nonaccrual loans fell 28.2% to $94.2 million. The allowance for loan losses was $114.2 million, or 1.35% of gross loans; the quarter included $2.2 million of net recoveries.
- Management said the company held elevated cash due to concern about potentially rising interest rates and expected to invest opportunistically as risk-adjusted opportunities improved. It provided no quantified earnings or growth guidance.
- The company paid a quarterly dividend of $0.11 per share, up from $0.09 a year earlier, and repurchased 1.5 million shares during the quarter for $32.5 million. Nine-month dividends paid were $31.4 million and treasury stock purchases were $64.2 million.
Outlook, risks and unusual items
- Interest-rate exposure remains significant. The one-year repricing gap was negative 10.6% of assets. A modeled immediate parallel 200-basis-point rate increase would reduce next-year net interest income by 0.5% and reduce estimated net portfolio value by $493 million, lowering the NPV-to-assets ratio from 18.51% to 16.32%.
- Approximately $1.6 billion of purchased 30-year fixed-rate mortgage-backed securities were classified as held to maturity; associated unrealized net losses were $50 million at June 30. Management noted that rising rates could increase unrealized losses.
- Management reported capital ratios above “well-capitalized” regulatory thresholds for the Bank. It also noted that most FDIC loss-share coverage on covered loans is scheduled to expire during fiscal 2015; estimated NPA and delinquency ratios would be higher if coverage had already expired.
- Risks cited include economic conditions, regulation, interest rates, deposit flows and funding costs, loan demand and credit quality, competition, and changes in accounting or tax rules. Management stated that ordinary-course legal proceedings were not expected to materially affect financial position or results. Disclosure controls were reported effective, with no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether deposit growth and the acquired branches deliver the expected customer growth, funding-cost benefits and revenue relative to integration and operating expenses.
- Whether credit-quality improvement continues, particularly in residential loans, restructured loans and loans classified as substandard; nonperforming assets remain above the company’s cited 30-year average.
- Whether the negative repricing gap, mortgage-backed securities portfolio and $50 million of held-to-maturity unrealized losses create greater-than-modeled exposure if interest rates rise.
- How liquidity is deployed, and whether higher cash and securities balances support returns without undue duration or valuation risk.
- The timing and effect of FDIC loss-share coverage expiration, and the adequacy of the allowance for loan losses as acquired and covered portfolios run off.