Washington Federal Balances Growth, Credit Strains in Call

Washington Federal ((WAFD)) has held its Q1 earnings call. Read on for the main highlights of the call.

Washington Federal’s latest earnings call struck a cautious but constructive tone, as management balanced strong bottom-line growth and capital returns with rising credit stress and near-term pressure on margins. Executives highlighted a 40% year-over-year jump in earnings per share and a leaner cost base, while openly acknowledging higher nonperforming assets, growing delinquencies and the earnings drag from nonaccrual loans and stepped-up securities purchases. The message to investors was clear: the bank is executing on its strategic pivot and capital deployment, but doing so against a more challenging credit and funding backdrop.

EPS Surges on Solid Quarter for Core Profitability

Washington Federal delivered net income available to common shareholders of $60.5 million, translating to diluted EPS of $0.79 for the quarter, up from $0.54 in the first quarter of fiscal 2025 and $0.72 in the prior quarter. Management emphasized that this represents 40% year-over-year EPS growth and 10% linked-quarter growth, underscoring improved profitability despite a flat reported net interest margin. The earnings beat was supported by stable net interest income, tighter expense control and a modest contribution from securities purchases, helping offset the impact of nonaccrual interest reversals and credit costs.

Loan Production Accelerates With a Growing, Diversified Pipeline

Loan growth remained a bright spot, with total originations of $1.1 billion outpacing $1.0 billion of repayments and payoffs. The production mix skewed toward business lending: 46% commercial and industrial (C&I), 23% commercial real estate, and 25% construction, consistent with management’s strategy to tilt the portfolio toward relationship-based business banking. The lending pipeline increased by $697 million, or 28% quarter-over-quarter, to $3.2 billion from $2.5 billion, giving management confidence in achieving its medium-term loan growth targets and signaling continuing demand across core markets.

Deposit Mix Improves Even as Overall Balances Edge Down

The bank reported notable progress in deposit composition, even though total deposits dipped by $21 million in the quarter. Noninterest-bearing deposits grew by $125 million, or 4.9% sequentially, and interest-bearing deposits rose $434 million, or 4.5%, while higher-cost time deposits fell by $580 million, down 6.4%. As a result, core deposits climbed to 79.7% of total deposits, up from 77.9% in the prior quarter, and the loan-to-deposit ratio improved to 92.7%, a significant shift from levels above 110% two years ago. Management acknowledged that deposit gathering remains competitive, but highlighted the mix shift toward lower-cost transaction accounts as a structural positive for funding.

Securities Purchases Add Incremental NII but Weigh on Near-Term Margin

Washington Federal leaned into its investment strategy this quarter, purchasing discount-priced agency mortgage-backed securities with an effective yield of 4.93%. Investment securities and MBS balances increased by $728 million, generating about $1.2 million of net interest income in the period and helping to offset runoff in the single-family mortgage book. While these purchases offer attractive risk-adjusted returns and diversify earning assets, management noted that their ramp-up contributes to near-term net interest margin pressure, as the yield benefit takes time to fully flow through.

Cost Discipline Drives Better Efficiency

Operating efficiency improved as management continued to moderate expenses. Total noninterest expense fell by $1.3 million, or 1.2% quarter-over-quarter, driven mainly by lower compensation and technology spending. This cost focus pushed the efficiency ratio down to 55.3%, from 56.8% in the prior quarter, aligning the bank more closely with its long-term operating goals. Management framed this as a key lever to protect earnings while navigating a tougher rate and credit environment, and a core component of its broader Build 2030 strategic plan.

Capital Strength Supports Ongoing Buybacks

The bank underscored its strong capital position, noting that all regulatory capital ratios remain comfortably above well-capitalized thresholds. Against this backdrop, Washington Federal continued to return capital to shareholders, repurchasing roughly 1.95 million shares at an average price of $29.75 during the quarter. These buybacks added an estimated $0.02 to EPS and leave authorization for approximately 6.3 million additional shares. Management pointed out that the stock trades around 1.1 times tangible book value, and reiterated its stance on opportunistic repurchases, signaling ongoing confidence in intrinsic value.

Wealth Management Launch Adds a New Fee-Income Leg

The launch of WaFd Wealth Management on August 31 marks a strategic step to diversify revenue beyond spread income. Assets under management have already grown to just over $400 million by quarter-end, and management is targeting $1 billion in AUM within two years. Early traction was described as encouraging, with the new platform expected to contribute to noninterest income growth over time and deepen client relationships, particularly in the bank’s expanding business and affluent customer segments.

Reserve Levels Bolstered to Cover Emerging Credit Risk

In response to rising credit stress indicators, Washington Federal increased its allowance for credit losses. The total allowance, including reserves for unfunded commitments, now stands at 1.05% of gross loans, up from 1.00% a year earlier. For commercial loans specifically, the allowance is 1.33% of net loans, compared with 1.26% a year ago. Management positioned these reserve levels as prudent given the recent migration of loans into criticized and nonperforming categories, aiming to provide investors with confidence that the balance sheet is appropriately buffered against potential losses.

Nonperforming Assets Jump, Pressuring Earnings Quality

Credit quality clearly moved in the wrong direction this quarter. Nonperforming assets rose to $203 million, or 0.75% of total assets, up from $143 million, or 0.54%, in the prior quarter. Nonaccrual loans alone increased by $62.7 million, a 49% jump since September 30, 2025. This spike not only reflects growing borrower stress but also weighs on reported results, as interest previously accrued on these loans must be reversed. Management acknowledged that these trends are a key watch item and a near-term drag on net interest margin.

Delinquencies and Criticized Loans Indicate Broader Credit Migration

Beyond headline nonperformers, early-stage credit metrics also deteriorated. Delinquent loans climbed to 1.07% of total loans, up sharply from 0.6% in the prior quarter and 0.3% a year ago. Criticized loans increased to 4.6% of net loans, from 4.39% in the prior quarter and 2.54% a year earlier, suggesting credit stress is broadening across multiple borrower segments rather than being confined to a handful of isolated issues. While absolute levels remain manageable by industry standards, the pace of deterioration will be critical for investors to track in upcoming quarters.

Charge-Offs Remain Low but Highlight Sector-Specific Weakness

Net charge-offs totaled $3.7 million for the quarter, equating to an annualized rate of roughly 7 basis points of total loans, still low in absolute terms. The quarter’s charge-offs were driven primarily by a single C&I energy relationship, where depressed oil prices and working capital constraints hurt the borrower’s ability to service debt. Management portrayed this as a contained, sector-specific issue rather than a systemic problem, but also as a reminder that certain cyclical industries are under pressure and warrant heightened monitoring.

Margin Squeezed by Nonaccruals and Securities Ramp-Up

Washington Federal’s reported net interest margin came in at 2.70%, essentially flat with the prior quarter’s 2.71%. However, management underscored that the underlying “spot” margin is closer to 2.79% absent unusual items. A key factor was approximately $5 million of interest reversals tied to loans moving to nonaccrual status, which created a roughly 9 basis-point gap between the spot margin and the reported figure. Additionally, accelerated MBS purchases shaved about 3 basis points from margin, as new securities take time to fully contribute to earnings. Management expects NIM to remain under pressure in the near term even as net interest income in dollar terms may continue to grow.

Funding Headwinds and Greater Reliance on Borrowings

Despite improvements in mix, total deposits were essentially flat to slightly down, decreasing by $21 million. To fund the sizable build in the securities portfolio, management increased borrowings by $671 million during the quarter, leading to a higher reliance on wholesale funding in the near term. Executives were candid that the deposit environment remains competitive and that growing low-cost relationship deposits is a work in progress. The current trajectory in core and noninterest-bearing deposits, however, is seen as laying the groundwork for a more durable funding base over time.

CRA Rating Uncertainty Adds a Regulatory Overhang

On the regulatory front, Washington Federal disclosed that it received a “Needs to Improve” Community Reinvestment Act rating from the FDIC and has appealed the determination. Management conceded that the appeal may not succeed and that the bank is preparing to move forward under the new rating. While this does not impact day-to-day operations, it can complicate branch relocation and expansion plans and may pose challenges for future mergers or acquisitions, introducing an additional strategic constraint investors will need to monitor.

Noninterest Income Healthy but Volatile

Noninterest income rose to $20.3 million, up $1.9 million from the prior quarter, but the composition was lumpy. Results benefited from a $3.2 million gain on the sale of a branch property, offset by a swing in equity method investment results, which produced a $408,000 loss this quarter compared with an $815,000 gain previously. This volatility underscores the importance of building more stable fee streams—such as the newly launched wealth management business—to complement earnings from balance sheet activities.

Forward Guidance: Margin Ambitions and Loan Growth Targets

Looking ahead, management’s guidance centered on rebuilding net interest margin and sustaining healthy loan growth while maintaining strong capital and liquidity. The bank aims to lift NIM to around 3.0% over the next two years, up from the current 2.70% reported margin and a 2.77% spot margin, with the yield on interest-earning assets at 5.05% and the cost of interest-bearing liabilities at 2.76%. Executives expect active loan growth of roughly 8–12% over the next one to two years, citing the $3.2 billion lending pipeline, and specifically pointed to a 6–10% growth range for fiscal 2026. On the funding side, Washington Federal plans to increase noninterest-bearing deposits to 20% of total deposits by 2030, from 12.6% today, building on recent growth in both balances and account counts. The bank targets an efficiency ratio near 55% and a higher return on tangible common equity—currently 10.6%, with management suggesting potential to approach the high teens if a 3% margin is achieved—while keeping the loan-to-deposit ratio in check and continuing opportunistic share repurchases under its remaining authorization.

In closing, Washington Federal’s earnings call painted a picture of a bank in transition: earnings are growing, costs are under control, capital is ample, and strategic initiatives like business banking expansion and wealth management are gaining traction. At the same time, investors must weigh mounting credit migration, higher nonperforming assets, and funding and margin headwinds that are unlikely to disappear quickly. For now, the story is one of balanced risks and rewards—solid execution and shareholder returns, tempered by a more demanding credit and regulatory environment that will define the next chapter for the franchise.