WAFDP - Washington Federal Is Well-Positioned For Future Growth

Summary

• Fiscal Q1 2023 performance was strong by most all accounts.
• The bank is expanding into new markets.
• Asset quality and return metrics are improving.
• There is room for the dividend to grow.

In late summer and early fall of 2022, we pushed our members to start buying financials . Shares of many banks have been in rally mode for about three months and rightfully so. The higher rates have really been boosting margins and net interest income per loan. Loan demand itself has slowed with higher rates, especially for homes, though credit card balances and personal loans remain strong, broadly speaking. We believe banks, and especially those that are more regionally focused, will enjoy tailwinds for many quarters thanks to the return of higher rates. Banks are now well-positioned for growth over the next few years. Rising rates really help banks that participate in traditional banking. We are referring to the simple model of taking in deposits, paying a small amount of interest on those deposits, and then lending those deposits out to other customers as term loans at higher rates.

We are kicking off our bank earnings seasons coverage with Washington Federal ( WAFD ) which is a bit of an under-the-radar, but relatively larger regional bank. The bank just reported its fiscal Q1 earnings . This is a bank doing business with consumers and businesses in the northwest, headquartered in Seattle and having a footprint in 8 states, and recently made a move to expand operations into California. We think the company is poised to do well in 2023 and 2024 as rates are and will be much higher on the loans they make. This bank is operationally healthy and pays a decent 2.6% yield , with room for improvement as operations and earnings expand. We view the stock as a buy in the $30-35 range, and believe this market will retrace again and give you a better entry opportunity. We like the stock in the medium- and long-term because the return metrics are strong, there is loan and deposit growth, and asset quality is improving. Let us discuss the just reported earnings.

Fiscal Q1 2023 performance strong

A cursory glance will reveal that Washington Federal's headline numbers were relatively strong in the quarter. There was growth on both the top and bottom lines. Washington Federal reported a top line growth of 28.8% to $196.8 million, surpassing consensus estimates by $3.2 million. The strong increase in revenues year-over-year was tempered by an increase in loan loss provisions. There was however some strong net interest income. Overall, Washington Federal reported net income of $79.5 million for the quarter compared to net income of $50.3 million for the quarter a year ago, rising 58%. On a per share basis, this was $1.16 this quarter, down from $0.71 last year. While there was higher expenses and loan loss provisions, there was strong growth in loans and deposits.

Loans grow, deposits dip slightly

Loans are up from the start of the year and from a year ago. Growth in loans and deposits is key for any bank to see growth. Total assets are $21.7 billion which rose from $20.8 billion to start the quarter. Total loans receivable were up 5.5% from the start of the quarter, and now total $17.0 billion. Despite the rising rate environment, loan demand for loan products remained strong but there was very large demand in the commercial sector. The bank likes to focus on commercial loans, and these types of loans were 84% of all new originations in fiscal Q1. These loans have floating rates, which help in a rising rate environment.

The company is prioritizing organic loan growth funded from customer deposits. And total deposits were strong, but down slightly from last quarter, down 0.4%. Total deposits came in at $16.0 billion at quarter-end, up 3.3% from the start of the year. Securing deposits is becoming harder with higher rates and bank competing for customer dollars. But with higher rates on new loans, margins should be expanding, though a rising cost of funds is weighing slightly, but we can expect ongoing net interest margin strength.

Margins widened despite a higher cost of funds

So the cost of funds is on the rise as banks have to pay more on deposits. The cost of funds was nearly doubled from last quarter. Cost of funds rose 86 basis points from a year ago. But net interest margin widened to 3.69% versus 2.87% a year ago. This is because the increase in the average yields increased 149 basis points from a year ago. While new loans are going out at a higher rate, the impact was offset by the higher costs of funds somewhat, but margins also widened from 3.64% last year. We predict margins will remain well over 3% in coming quarters. We see both the cost of funds and the yield on the loan portfolio both continuing to increase in 2023. Net interest income was $183 million, an increase of $48.7 million or 36.3% from a year ago.

Return metrics are strong

We love to watch the return metrics for a bank. It is critical to know whether the return on average assets and return on average equity are improving. These are key measures of efficiency. Well, the return on average assets actually expanded to 1.50% from 1.02% a year ago, while the return on average equity expanded to 15.15% from 10.12%. Further, the bank became more efficient, with the efficiency ratio improving dramatically 46.78% from 58.64% a year ago. What about asset quality?

Asset quality continues to strengthen

There are strong trends in the asset quality metrics here and we expect this will continue as rates rise further and new loans are made. As we mentioned before, the loan loss provisions were increased so that weighed some. The provision for loan losses was $2.5 million versus $0.5 million a year ago. Nonperforming assets decreased by $5.9 million, to $38.7 million representing 0.18% of total assets, a big improvement from 0.21% of all loans to start the quarter. Things are getting better and better. The allowance for loan losses was $0.2 million, which was 1.03% of total loans, pretty much flat from the start of the quarter.

Valuation metrics

We also like the valuation numbers here even with the growth in the stock recently increasing valuation. The performance continues to be strong. With a share price of $36.35 at the time of this writing, we have a stock trading at 9.4X trailing twelve-month earnings, which is attractive on its own. What about on a forward basis? Well, we assume earnings will grow 15% in 2023 over 2022 so that would suggest a sub 8X FWD EPS.

The stock is also pretty attractive relative to book value at 1.05X. Most banks are trading well above their book values now. This is not overpriced in anyway, particularly for a growing bank with room to increase the dividend.

Take home

This was a good quarter and Washington Federal is an attractive stock. We think there is room for the dividend to grow, and believe margins will remain strong. Earnings power is strong. They are expanding into new markets. If shares retrace with the market, start buying under $35.

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