Summary:
Washington Federal’s third-quarter fiscal 2016 (ended Jun 30) earnings beat the
Zacks Consensus Estimate, largely driven by higher net interest income, a provision
reversal and falling operating expenses. However, a marginal dip in other income was
an undermining factor. While growing demand for loans should continue fueling the
company’s organic growth, a robust capital position will help it grow inorganically.
Also, the company’s steady capital deployment activities should draw investors’
attention. However, we remain apprehensive about the impact of weak cost control,
compressed margin and substantial exposure to a risky loan portfolio on the
company’s profitability.
Reasons To Buy:
- Growth in loans indicates a strong business trend for Washington Federal. With improvement in the economy and investors’ rising confidence, the demand for loans is expected to grow further. The company generated net loans of $9.63 billion as of Jun 30, 2016, which constituted 65% of its total assets.
- Washington Federal's credit quality continues to improve. Since fiscal 2010, credit costs (including provision for loan losses and gains/losses on sales of REO) have declined significantly. Notably, provision for loan losses reflected a reversal of $1.7 million in the first nine months of fiscal 2016 compared with an expense of $45.0 million in fiscal 2010.
- Washington Federal’s earnings streak, along with its trend of returning capital to shareholders, should boost investors’ confidence in the stock. The company has been consistently hiking its dividend over the past several fiscal years – 18% in 2015, 10% in 2014, 11.1% in 2013, 12.5% in 2012, 33.3% in 2011 and 20.0% in 2010. Additionally, the company has share buyback authorization in place. As of Jun 30, 2016, the company had authorization to repurchase around 1 million shares.
Risks:
- Mounting operating expenses pose a major challenge for Washington Federal. Over the last 6 years (2010–2015), expenses have increased at a CAGR of 11.3%, with the same trend continuing in the fiscal first nine months of 2016. Expenses should increase further due to branch acquisitions and continued investment in franchise.
- Washington Federal is benefiting from deposit re-pricing due to lower deposit rates, but it is lagging its competitors with respect to the same. Though NIM increased in the fiscal first nine months of 2016 and in fiscal 2015, it has been declining over the past 4 fiscal years – 3.35% in 2011, 3.18% in 2012, 3.17% in 2013 and 3.05% in 2014 – due to lower yields on cash and investment balances. We expect NIM to remain under pressure until the interest rate environment improves significantly.
- Further, Washington Federal has considerable exposure to risky loan portfolios. Nearly 69% of the company’s loan originations comprise of commercial loans. We also remain concerned about the company’s exposure to consumer loans, accounting for the remaining 31% of the total loan originations. Though the company has been reducing its exposure to these loan portfolios, we do not anticipate significant improvement any time soon.
