AF Astoria Financial Corp. (delisted)

We are downgrading our recommendation on Washington Federal Inc. (WFSL) to Underperform from Neutral based on the pressure on net interest margin (NIM) and its lag with respect to deposit re-pricing.

Washington Federal’s fiscal second quarter (ended March 31, 2011) earnings came in at 23 cents per share, 2 cents shy of the Zacks Consensus Estimate.  

Results for the reported quarter primarily benefited from increased interest income, lower expenses and a substantial drop in provision for loan losses. However, loan demand remained weak and profitability metrics deteriorated.

Washington Federal is behind its competitors with respect to deposit re-pricing. The likely rise in the interest rate environment will further ruin the company’s deposit re-pricing effort.

Pressure on NIM is a concern at this point. Though improved deposit costs are expected to support NIM, the negative impact ofloan re-pricing and run-off will be the offsetting factors.

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 and development as well as 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 Federalhas been reducing its exposure to these loan portfolios, we don’t expect the company to shed the burden completely anytime soon.

On the other hand, in December 2010, Washington Federal increased its annual cash dividend by 20% to $0.24 per share from $0.20. This follows a 2.4% increase in July 2007. However, following the financial crisis, the company had to lower its dividend in December 2008. 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 contraction of nonperforming assets and net charge-offs. However, management expects credit costs to ultimately decline.

Also, in response to stabilizing credit conditions, the company has been decreasing its provision for loan losses in the recent quarters. We expect credit quality to continue to improve in the quarters to come with the gradual recovery in the housing market.

Though interest income expansion and non-performing asset contraction will significantly support the bottom line, we remain concerned about Washington Federal's considerable exposure to real estate markets where values remain soft.

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

 
ASTORIA FINL CP (AF): Free Stock Analysis Report
 
WASH FEDL INC (WFSL): Free Stock Analysis Report
 
Zacks Investment Research