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Washington Federal Inc.’s (WAFD - Analyst Report) fiscal third-quarter 2012 earnings (ended June 30) of 33 cents per share, beat the Zacks Consensus Estimate by a penny. This was also better than the year-ago quarter’s earnings of 27 cents.

Higher net unrealized gains along with constantly declining credit costs were responsible for the improved results. However, higher operating expenses coupled with a decline in net interest income were the headwinds. Overall, continuous improvement in asset quality and enhanced capital ratios were impressive.

Washington Federal’s net income surged 16.7% to $35.2 million from $30.1 million in the prior-year quarter.

Quarter in Detail

Washington Federal’s total revenue was $100.1 million, down 9.3% from $110.4 million in the prior-year quarter. The decline was attributable to lower net interest income and reduced income from other sources. Total revenue also lagged the Zacks Consensus Estimate of $107.0 million.

Net interest income (before provision for loan losses) fell 9.0% year over year to $96.5 million mainly due to lower asset yields. Similarly, net interest margin for the reported quarter declined 39 basis points on a year-over-year basis to 3.05%.

Operating expenses surged 5.2% from the year-ago quarter to $36.0 million in the quarter under review. The rise was mainly a result of higher compensation and benefits expenses, occupancy costs as well as other costs, partially mitigated by lower Federal Deposit Insurance Corporation (FDIC) premiums.

Efficiency ratio declined to 35.9% compared with 31.0% in the year-ago quarter. Increase in efficiency ratio indicates deterioration in profitability.

Credit Quality

During the fiscal third quarter, credit quality continued to improve with Washington Federal reporting lower balances of provision for loan losses, nonperforming assets, net charge-offs and loan delinquencies. The company recorded provision for loan losses of $10.4 million as of June 30, 2012, which dipped nearly 51.0% from $21.0 million as of June 30, 2011. Net loan charge-offs for the reported quarter came in at $16.0 million, declining 33.3% from the year-ago quarter.

As of June 30, 2012, total loan delinquencies were 2.69% of total loans as against 3.43% as of September 30, 2011. Similarly, nonperforming assets totaled $278.0 million or 2.07% of total assets at June-end, falling 24.8% from September 30, 2011.

Profitability Metrics

Washington Federal’s profitability metrics continued to display enhancement. Return on equity (ROE) was 7.33% compared with 6.55% in the prior-year quarter. Return on assets (ROA) was 1.04% as compared with 0.90% in the year-ago period.

Other developments

On April 4, Washington Federal announced a deal to acquire Oregon-based South Valley Bancorp Inc. The deal is anticipated to be closed by October. Upon acquisition, the combined company will have 189 offices spread across eight western states. In addition, the acquisition will lead to an enhanced branch network, higher liquidity and increased lending capacity, which will boost the profitability in the long-run.

On June 22, Washington Federal completed the divestiture of two of its branches located in El Paso, Texas. The sale included $19 million of deposits but loans were not a part of the deal.

Our Viewpoint

Presently, Washington Federal continues to enjoy the benefits of lower interest rates, but the anticipated rise in interest rates will likely hurt the company’s deposit re-pricing effort going forward. Moreover, extensive capital deployment activities along with the recent acquisitions will continue to boost investors’ confidence in the stock. Further, nonperforming asset contraction will significantly support the bottom line.

Though Washington Federal is optimistic about the uptrend in the economy, we remain concerned about the company’s sizeable exposure to real estate markets, where pricing remains soft.

Two of Washington Federal's peers, Astoria Financial Corporation (AF - Snapshot Report) and Sterling Financial Corporation are expected to report their second-quarter 2012 earnings results on July 18 and July 26, respectively.

Currently, Washington Federal retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term ‘Neutral’ recommendation on the stock.
 

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