WFSL Lowered to Underperform

We have recently downgraded our recommendation on Washington Federal Inc. (WFSL) to Underperform from Neutral based on its sizable exposure to risky loan portfolios and rising costs.

Washington Federal’s fiscal fourth-quarter 2010 earnings missed the Zacks Consensus Estimate by a nickel. Results primarily benefited from a rise in revenue and a fall in the provision for loan losses. On the other hand, weak loan demand and increase in operating expenses were among the negatives.

Though the majority of Washington Federal’s loan portfolio comprises high quality single-family residential loans, we are concerned about its sizable exposure to land acquisition & development and speculative construction loan portfolios, which are still extremely risky.

During the last two years, the majority of nonperforming loans and charge-offs have come from these portfolios. Though Washington Federal has been reducing its exposure to these loan portfolios, we don’t expect the company to shed the burden completely anytime soon.

Though the interest margin has benefited recently from the ongoing low rate environment and is expected to continue to benefit in the coming quarters, the situation will take a turn for the worse once the Fed starts raising the interest rates. At the end of fiscal 2010, market interest rates were significantly below the average of the last 20 years.

Also, given the current economic conditions, Washington Federal’s allowance for loan losses may not be adequate to cover actual losses as it is primarily based on the company’s historical loss experience.

However, though Washington Federal's credit costs remain inflated, credit quality continues to improve with the contraction of nonperforming assets and net charge-offs. Also, in response to stabilizing credit conditions, the company decreased its allowance for loan losses. We expect credit quality to continue to improve in the upcoming quarters with the gradual recovery of the housing market.

Though an increased market share through acquisitions will be a great support, we are concerned about the company’s significant exposure to real estate markets. We also believe that the ongoing soft market conditions will continue to force the company to aggressively write down problem assets.

We are however, maintaining our Neutral recommendation on Washington Federal’s peers Wells Fargo & Company (WFC - Analyst Report) and Zions Bancorp (ZION - Analyst Report).

Read the full analyst report on WFSL

Read the full analyst report on WFC

Read the full analyst report on ZION