Financials Not Out of the Woods Yet

Today we look at a couple finance industry companies, in hopes we might be able to glean when a good time to buy up some of these stocks at a bargain may be. We are hoping to find some of these firms at very attractive valuations currently. Zacks senior equities analyst Neena Mishra helped us.

Have you picked up any new financial coverage lately?

We are initiating coverage on the shares of Washington Federal, Inc. (WFSL) with a Hold rating and a six-month target price of $19.50 per share. WFSL operates as a non-diversified unitary savings and loan holding company.

What led you to this conclusion initially?

During 2Q08 (ended March 31), the company reported diluted operating earnings of $0.34 per share, missing the consensus by three cents. The miss stemmed from a high increase in the provision expense, though the expansion in the interest margin was impressive, owing to WFSL’s liability sensitivity.

Credit quality significantly worsened during the quarter, and we anticipate the deterioration in the credit quality to continue, in the coming quarters, resulting in higher credit costs, which will be partially offset by the growth in the interest rate spread.

Our six-month target price of $19.50 per share equates roughly to 2.10 times our projected book value of $9.30 per share at September 30, 2008, or 13.3 times our 2008 EPS estimate. With $0.21 per share annual dividend, this target price implies a 6.6% expected total return over the same period, which is consistent with our Hold rating.

The Sell recommendation for PMI Group (PMI) last year around the $30 mark was particularly well-timed. Do you still carry a sell recommendation, even though the shares are under $2 per share?

We do. Its U.S. Mortgage Insurance continues to have a challenging time. Net loss for this segment totaled $172.5 million during 1Q08. All the other segments also incurred significant losses during 1Q08.

With an increased loss ratio, PMI’s combined ratio deteriorated to 271.4%, compared to 68.4% in the prior-year quarter. Book value declined to $27.58 per share at March 31, 2008, as compared to $42.21 per share at March 31, 2007.

What about a forward outlook for the company?

Fitch revised its Rating Outlook on all the ratings for PMI Group to Negative from Stable. Standard & Poor’s and Moody’s also downgraded some of the segments and placed credit watch with negative implications for the other segments. As delinquencies continue to rise, the losses may remain high through 2008 and a part of 2009.

Claim rates and average claim sizes are likely to continue increasing going forward. As a result, PMI’s operating results could continue to suffer significantly. During the current quarter, the company determined its investments in FGIC as other than temporarily impaired and thus, reduced the carrying value of the investment in FGIC to zero from $103.6 million in December 31, 2007.

How do you view its valuation currently?

At current levels, shares of PMI trade at 0.13x the company’s 1Q08 book value of $27.58 per share, which is significantly below its historical 2.2x high. The rise in delinquencies and defaults on loan payments may continue for a longer time than expected earlier, leading to increased losses for the mortgage insurers. We do not expect any correction to the multiple in the near future.

Neena Mishra is a senior analyst covering financial institutions for Zacks Equity Research.

Comments

[lou hannen]

Yes, but--assume that over the next year the book value drops to $10, company gets back to break even operations--at that point it could reinsure away its remaining insurance and quietly go out of business at somewhere close to $10. The near term news is terrible, but the longer term for the stock, if not the company, is pretty interesting from a speculative point of view.