(WFSL) Washington Federal Upgraded

We are upgrading our recommendation on Washington Federal Inc. (WFSL) to Neutral from Underperform based on improving credit quality and decreasing expenses. 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, interest income expansion and non-performing asset contraction will significantly support the bottom line.

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. However, results were substantially better than the year-ago quarter’s adjusted loss of 11 cents.

Results for the second 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.

In December 2010, Washington Federal increased its annual cash dividend by 20% to 24 cents per share from 20 cents. 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 upcoming quarters with the gradual recovery in the housing market.

On the flip side, Washington Federal is behind its competitors with respect to deposit re-pricing. The expected rising interest rate environment will further ruin the company’s deposit re-pricing effort.

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

Washington Federal currently retains a Zacks #2 Rank, which translates into a short-term ‘Buy’ 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

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