Washington Federal: The Issue Is Credit Quality

Includes: HBNC, WAFD
by: Zacks Investment Research

Click to enlargeWashington Federal Inc.’s (WFSL) fiscal fourth quarter (ended September 30, 2010) earnings came in at 14 cents per share missing the Zacks Consensus Estimate of 19 cents. However, this compares favorably with the year-ago quarter’s earnings of 11 cents. For the fiscal year, earnings of $1.05 per share were behind the Zacks Consensus Estimate of $1.10 but compares favorably with earnings of 46 cents in the year-ago period.

Results benefited from a rise in revenue, net interest income and fall in provision for loan losses. However, high operating expenses were on the downside. The results also include earnings from the Horizon Bank (NASDAQ:HBNC), which the company had acquired in early 2010.

Quarter in Detail

Net income available to common shareholders for the reported quarter came in at $15.9 million, compared with $9.6 million in the prior-year quarter.

For the fiscal year, net income was $118.7 million, up significantly from $40.7 million in the prior period, and was aided by a $54.8 million after-tax gain on the FDIC-assisted acquisition of certain assets and liabilities of the former Horizon Bank and the favorable resolution of a $39 million contingent federal tax liability.

Washington Federal’s total revenue reported during the quarter was $100.4 million, slightly up from $100.5 million in the prior-year quarter and missed the Zacks Consensus Estimate of $105.0 million. Total revenue for the year was up 31.3% year over year to $514.9 million, substantially beating the Zacks Consensus Estimate of $433.0 million.

Washington Federal’s net interest income (before provision for loan losses) for the quarter increased 5.2% year over year to $100.4 million. This increase was primarily the result of a considerable decline in deposit costs, partially offset by reduced yield on earnings assets. Net interest income (before provision for loan losses) for the fiscal year was $394.5 million, up 5.7% year over year.

As of September 30, 2010, the interest rate spread decreased to 3.09% from 3.17% as of the end of September 30, 2009.

Operating expenses for the quarter were up $5.2 million or 19.6% to $31.7 million compared with $26.5 million in the year-ago quarter. The rise was mainly a result of higher compensation and benefits expenses and FDIC insurance premiums. For the fiscal year, operating expenses were $131.5 million, up from $107.1 million in the prior year.

Washington Federal’s efficiency ratio is among the lowest in the industry and came in at 26.3%, down from 27.3% from the prior year.

Credit Quality

Washington Federal’s credit quality showed considerable improvement during the year. In response to the improving credit conditions of its loan portfolio, the company recorded a provision for loan losses of $180 million for the year, significantly down from $193 million in the prior year.

Allowance for loan losses was $163.1 million as of September 30, 2010, down from $168.8 million in the prior year. Nonperforming assets as a percentage of total assets fell 120 basis points from the year-ago period to 3.22% as of September 30, 2010.

Balance Sheet and Profitability Metrics

Washington Federal’s total assets increased $13.5 billion up from $12.6 billion as of September 30, 2009, primarily due the acquisition of the Horizon Bank.

Profitability metrics improved on a year-over-year basis. Return on equity (ROE) was 0.89% compared with 0.33% in the prior year. Return on assets (ROA) was 6.55% compared with 2.87% in the prior year.

Our Take

Considering the increased market share through acquisitions, net income expansion and decreased non-performing assets will be a great support going forward, but we are concerned about Washington Federal’s significant exposure to real estate markets and apprehend further credit quality deterioration. We believe that the ongoing soft market conditions will continue to force the company to aggressively write down problem assets.

Washington Federal currently retains a Zacks #3 Rank, which indicates a short-term Hold rating. Also, considering the fundamentals, we maintain our long-term Neutral recommendation on the shares.

Disclosure: No position