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Washington Federal Stays Neutral

AF

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We are maintaining our Neutral recommendation on Washington Federal Inc. based on the company’s fiscal third quarter results that were slightly better than the Zacks Consensus Estimate, benefitting mainly from increased net interest income (NII) and an almost stable provision for loan losses.

However, higher operating expenses formed the downside. The company also witnessed a weak loan demand during the reported quarter

Though we remain concerned about the pressure on net interest margin (NIM) and the company’s considerable exposure to real estate markets where values remain soft, NII expansion and nonperforming asset (NPAs) contraction will significantly support the bottom line.

In December 2010, Washington Federal increased its quarterly cash dividend by 20% from 5 cents per share from 6 cents, which it maintained till the latest payment. Additionally, the company also continues to buy back of shares.

In June 2011, Washington Federal announced an additional 10 million share repurchase authorization. We expect management to continue to effectively deploy excess capital in the form of dividends and share buyback, going forward.

Though Washington Federal's credit costs remain inflated, credit quality continues to improve with the reduction of NPAs and net charge-offs. We expect the credit quality to continue improving in the upcoming quarters with the gradual recovery of the housing market.

Washington Federal has been growing its market share through acquisitions, with First Federal Banc of the Southwest Inc., First Mutual Bancshares Inc. and Horizon Bank of Bellingham acquisitions helping the company to increase its assets, branch network, and workforce.

Also, during the fiscal third quarter, the company signed an agreement to acquire $253 million deposits and six branches of Albuquerque, New Mexico-based Charter Bank. We believe with considerable experience of successful integration of acquired companies as well as a strong capital and liquidity position, the company is poised to grow through acquisitions.

On the flip side, Washington Federal is behind its competitors with respect to deposit re-pricing, though the re-pricing benefit from lower deposit rates was a significant contributor to the NIM improvement during fiscal third quarter. The expected rising interest rate environment will further ruin the company’s deposit re-pricing efforts.

Furthermore, we remain concerned about Washington Federal’s sizable exposure to land acquisition & development and speculative construction loan portfolios, which are still extremely risky. Also over the last two years, the majority of nonperforming loans and charge-offs have resulted from these portfolios. Though Washington Federal has been reducing its exposure to these loan portfolios, we do not expect the company to shed the burden completely anytime soon.

Washington Federal currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. However, Astoria Financial Corporation (AF - Snapshot Report), one of Washington Federal’s competitors, retains a Zacks #4 Rank (a short-term Sell rating).

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