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We have maintained our long-term ‘Neutral’ recommendation on Washington Federal Inc. (WAFD - Analyst Report) reflecting the company’s continued capital deployment activities, strategic acquisitions and balance sheet restructuring initiatives. Yet, once the rates start rising, the company’s deposit re-pricing efforts will likely undermine its financial performance.

Washington Federal continues to be an asset for yield seeking investors. In 2011, the company increased its quarterly cash dividend by 33% to 8 cents per share and has ever since maintained the same level. Further, the company continues to buy back shares. In fiscal 2012, the company returned about 55% of earnings to its shareholders in the form of dividends and share repurchases. We expect management to continue to effectively deploy excess capital going forward.

Further, Washington Federal's credit quality continues to improve with the contraction of nonperforming assets and net charge-offs. Also, in response to stabilizing credit conditions, the company has been lowering its provision for loan losses in the last few quarters. We expect the credit quality to continue to improve in the subsequent quarters with a gradual recovery in the housing sector.

Additionally, Washington Federal is steadily gaining market share through strategic acquisitions. Historically, the company has grown with the help of mergers and assumptions of deposits. These have helped the company to increase its assets, branch network and workforce, and thereby improve its financials.

On the flip side, a vast majority of Washington Federal’s loan portfolio comprises high quality single-family residential loans. A large percentage of non-acquired and non-accrual loans form a part of this portfolio. Though the company has been reducing its exposure to these loan portfolios, we do not expect a significant reduction anytime soon.

Moreover, most of Washington Federal’s assets are conservative long-term investments such as prime residential mortgage loans and AAA-rated mortgage-backed securities that return a fixed rate and pay off slowly. As these assets are funded largely by customer deposits with maturities of one year or less, rising interest rates will compress the margin between fixed asset returns and variable funding costs, putting pressure on profit.

Washington Federal currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Among its peers, the Zacks #2 Ranked (short term Buy) stocks include Banner Corporation (BANR - Snapshot Report).

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