Item 1A. Risk Factors
Ownership of our common stock involves risk. Investors should carefully consider, in addition to the other information included in this Annual Report on Form 10-K, the following risk factors. The risks described below may adversely affect our business, financial condition and results of operations. These risks are not the only risks we face; additional risks and uncertainties not currently known or that are currently considered to be immaterial may also materially and adversely affect our business.
Operational Risks
The COVID-19 pandemic is adversely affecting us and our customers, counterparties, employees, and third-party service providers, and the adverse impacts on our business, financial position, results of operations, and prospects could be significant.
The spread of COVID-19 has created a global public-health crisis that has impacted household, business, economic, and market conditions, including in the western United States where we conduct nearly all of our business.
During 2020, the most notable impact of the COVID-19 pandemic on our results of operations was a higher provision expense for credit losses. Our provision expense was $21,750,000 in 2020, primarily due to the unfavorable market conditions associated with COVID-19, as compared to a $1,650,000 release of allowance for loan losses for the year ended September 30, 2019. As of September 30, 2020, our allowance for credit losses increased to $191,955,000. Additionally, our operations have been impacted by the need to close certain offices and limit how customers conduct business through our branch network. We also face increased operational risks associated with the transition of a portion of our employees to remote working environments, including increased cybersecurity risks such as phishing, malware, and other cybersecurity attacks, all of which could expose us to liability and could seriously disrupt our business operations.
Governments have taken unprecedented steps to partially mitigate the adverse effects of their containment measures. For example, in late March 2020, the CARES Act was enacted to inject more than $2 trillion of financial assistance into the U.S. economy. The Federal Reserve Bank has taken decisive and sweeping actions as well. Since March 15, 2020, their actions have included a reduction in the target range for the federal funds rate to 0 to 25 basis points, a program to purchase an indeterminate amount of Treasury securities and agency mortgage-backed securities, corporate bonds and other investments, and numerous facilities to support the flow of credit to households and businesses. The degree to which our actions and those of governments and others will directly or indirectly assist our customers, counterparties, and third-party service providers and advance our business and the economy generally is not yet clear. The possibility of negative interest rates on U.S. Treasury or other market instruments could adversely affect our results of operations by, for example, reducing asset yields or spreads, creating operating and system issues, or having other adverse impacts on our business.
The full extent of the impact of the COVID-19 pandemic on our capital, liquidity, and other financial positions and on our business, results of operations, and prospects is still uncertain, and will depend on a number of evolving factors, including:
•The duration, extent, and severity of the pandemic. COVID-19 has not yet been contained and could affect significantly more households and businesses, or cause additional limitations on commercial activity, increased unemployment, increased property vacancy rates and general economic and financial instability. The continuation of the pandemic may also negatively impact regional economic conditions for a period of time, resulting in declines in loan demand and collateral values. The duration and severity of the pandemic continues to be impossible to predict, as is the potential for a seasonal or other resurgence and the economic impact will likely continue even after the COVID-19 outbreak has subsided, continuing to affect our business, financial position, results of operations and prospects.
•The response of governmental authorities. To date, many of the actions of governmental authorities have been directed toward curtailing household and business activity to contain COVID-19 while simultaneously deploying fiscal- and monetary-policy measures to partially mitigate the adverse effects on individual households and businesses. The success or impact of these actions and their effect on our customers and the economy generally is not yet clear. Further, some measures, such as a suspension of mortgage and other loan payments and foreclosures, may have a negative impact on our business.
•The effect on our customers, counterparties, employees, and third-party service providers. COVID-19 and its associated consequences and uncertainties are affecting individuals, households, and businesses differently and unevenly. Negative impacts on our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans.
•The effect on economies and markets. Whether the actions of governmental and nongovernmental authorities will be successful in mitigating the adverse effects of COVID-19 is unclear. National, regional, and local economies and
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markets could suffer disruptions that are lasting. Governmental actions are meaningfully influencing the interest-rate environment and financial-market activity and could have lasting effects on taxes and other economic factors, which could adversely affect our results of operations and financial condition.
As a participating lender in the SBA Paycheck Protection Program (“PPP”), we are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.
On March 27, 2020, President Trump signed the CARES Act, which included a loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. We have participated as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there was some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes us to potential risks relating to noncompliance with the PPP.
Since the opening of the PPP, several other banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP and claims related to agent fees. We may be exposed to the risk of similar litigation, from both customers and non-customers that approached us regarding PPP loans, regarding our process and procedures used in processing applications for the PPP, or litigation from agents with respect to agent fees. If any such litigation is filed against us and is not resolved in a favorable manner, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.
We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which a PPP loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.
We have adopted new accounting guidance, specifically CECL, to account for our credit losses that may be more volatile and may adversely impact our financial statements when forecasted market conditions change.
Effective October 1, 2020, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update 2016-13, "Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments," which replaces the previous "incurred loss" model for recognizing credit losses with an "expected loss" model referred to as CECL. Under CECL, we are required to present certain financial assets carried at amortized cost, such as loans and leases held for investment, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model, which delays recognition until it is probable a loss has been incurred. CECL may create more volatility in our earnings and the level of our allowance for credit losses.
Our allowance for credit losses ("ACL") may not be adequate to cover future loan losses, which could adversely affect our financial condition and results of operations.
Due to the declining economic conditions, our customers may not be able to repay their loans according to the original terms, and the collateral securing the payment of those loans may be insufficient to pay any remaining loan balance. While we maintain, and have increased, our ACL to provide for loan defaults and non-performance, losses may exceed the value of the collateral securing the loans and the allowance may not fully cover any excess loss.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Our ACL is based on these judgments, as well as historical loss experience and an evaluation of the other risks associated with our loan portfolio, including but not limited to, economic trends and conditions, changes in underwriting standards, management, competition, and trends in delinquencies, non-accrual and adversely classified loans. the size and composition of
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the loan portfolio, current economic conditions and geographic concentrations within the portfolio. We have also included assumptions about the severity and duration of the effects of the COVID-19 pandemic on our borrowers, their industry, and on economic conditions in general, all of which are highly uncertain and for which we have no historical experience to draw upon.Federal regulatory agencies, as part of their examination process, review our loans and ACL. If our assumptions and judgments used to determine the ACL prove to be incorrect, if the value of the collateral securing the loans decreases substantially or if regulators disagree with its judgments, we may need to increase the ACL in amounts that exceed our expectations. Material additions to the ACL would adversely affect our results of operations and financial condition.
We have a risk of systems failures and cyber-security risk, including "hacking" and "identity theft."
We rely extensively on the successful and uninterrupted functioning of information technology and telecommunications systems to conduct our business. This includes internally developed systems, the systems of third-party service providers, and digital and mobile technologies. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems, and could damage our reputation, result in loss of customer business, subject us to regulatory scrutiny, or expose us to civil litigation and possible financial liability.
We believe we have information systems and security procedures, controls and policies designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, however, because the techniques used to obtain unauthorized access, disable or degrade systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate protective measures.
Cybersecurity and the continued development and enhancement of controls, processes and practices designed to protect customer information, systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for the Company. As cybersecurity threats continue to evolve, we may be required to expend additional resources to continue to enhance, modify and refine our protective measures against these evolving threats.
To date, we have no knowledge of a successful cyber-attack or other material information security breach affecting our systems. However, our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and our plans to continue to implement internet banking and mobile banking channels, expand operations and use third-party information systems. Recent instances of attacks specifically targeting financial services businesses indicate that the risk to our systems remains significant. If we were to experience a cyber-attack or information security breach, we could suffer damage to our reputation, and incur substantial additional expenses, including remediation expenses, costs associated with customer notification and credit monitoring services, increased insurance premiums, regulatory penalties and fines and costs associated civil litigation, any of which could have a material adverse effect on our business, financial conditions and results of operations.
In addition, the Bank’s customers and vendors increasingly rely on personal technology, such as smartphones, tablets, and other mobile devices, to contact and conduct business with the Bank.If the devices of the Bank’s customers or vendors become the target of cyber attacks or other information security breaches, it could result in the unauthorized release, misuse, or loss of the Bank’s or a Bank customer’s confidential data.Third parties using improperly obtained personal or financial information of Bank customers can attempt to obtain loans, lines of credit, or other financial products from the Bank, or attempt to fraudulently induce Bank employees, customers, or other users of Bank systems to disclose confidential information in order to gain improper access to the Bank’s systems.
We also face additional costs when our customers become the victims of cyber attacks.For example, various retailers have reported that they have been the victims of cyber attacks in which large amounts of their customers’ data, including debit and credit card information, is obtained.Our customers may be the victims of phishing scams, providing cyber criminals access to their accounts or credit or debit card information.In these situations, we incur costs to replace compromised cards and address fraudulent transaction activity affecting our customers.
Both internal and external fraud and theft are risks.If personal, non-public, confidential or proprietary information of Bank customers were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage and financial loss.Such mishandling or misuse could include, for example, if such information were erroneously provided to parties who are not permitted to have the information, either by fault of our systems, employees, or counterparties, or if such information were to be intercepted or otherwise inappropriately taken by third parties. These activities can occur in connection with the origination of loans and lines of credit, ACH transactions, wire transactions, ATM transactions, and checking transactions, and result in financial losses as well as reputational damage.
Operational errors include clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. Because of the Bank’s large transaction volume and its necessary dependence upon automated systems to record and process these transactions, there is a risk that technical flaws or tampering or manipulation of those automated systems, arising from events wholly or partially
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beyond its control, may give rise to disruption of service to customers and to financial loss or liability.We are exposed to the risk that our business continuity and data security systems prove to be inadequate.
The occurrence of any of these risks could result in a diminished ability for us to operate our business, additional costs to correct defects, potential liability to clients, reputational damage and regulatory intervention, any of which could adversely affect our business, financial condition and results of operations.
The ongoing COVID-19 pandemic is increasing cyber-security risks.
The ongoing COVID-19 pandemic is introducing additional risk to our information systems and security procedures, controls and policies as a result of employees, contractors and other corporate partners working remotely.As a result of the increased remote workforce, we must increasingly rely on information technology systems that are outside our direct control, and these systems are also vulnerable to cyber-based attacks and security breaches.In addition, since the beginning of pandemic, there has been an increase attacks by cyber criminals on businesses and individuals, utilizing interest in pandemic-related information and the fear and uncertainty caused by the pandemic to increase phishing, malware, and other cybersecurity attacks designed to trick victims into transferring sensitive data or funds, steal credentials or deploy malware that compromises information systems. If one of our employees were to fall victim to one of these attacks, or our information technology systems are compromised, our operations could be disrupted, or we may suffer financial loss, reputational loss, loss of customer business or other critical assets, or become exposed to regulatory fines and intervention or civil litigation.
Current uncertain economic conditions pose challenges, and could adversely affect our business, financial condition and results of operations.
We are operating in an uncertain economic environment, with much of the uncertainty driven by the continuation of the COVID-19 pandemic.The pandemic is causing a global economic slowdown, with record unemployment and declining GDP in the United States. Continued economic uncertainty and a recessionary economy could result in financial stress on the Bank's borrowers, which could adversely affect our business, financial condition and results of operations. We have significantly increased the expense for credit losses as a result of this uncertainty, however, deteriorating conditions in the regional economy served by our Company, or in certain sectors of the economy, could drive losses beyond that which is provided for in our allowance for loan losses. We could also face the following risks in connection with the following events:
•Market developments and economic slowdown may affect consumer confidence levels and may cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities.
•The processes we use to estimate the allowance for credit losses and other reserves may prove to be unreliable. Such estimates rely upon complex modeling inputs and judgments, including forecasts of economic conditions, which may be rendered inaccurate and/or no longer subject to accurate forecasting.
•Our ability to assess the creditworthiness of our borrowers may be impaired if the models and approaches we use to select, manage, and underwrite loans become less predictive of future charge-offs.
•Regulatory scrutiny of the industry could increase, leading to increased regulation of the industry that could lead to a higher cost of compliance, limit our ability to pursue business opportunities and increase our exposure to litigation or fines.
•Ineffective monetary policy or other market conditions could cause rapid changes in interest rates and asset values that would have a materially adverse impact on our profitability and overall financial condition.
•Further erosion in the fiscal condition of the U.S. Treasury could lead to new taxes that would limit our ability to pursue growth and return profits to shareholders.
If these conditions or similar ones continue to exist or worsen, we could experience continuing or increased adverse effects on our financial condition.
Regulatory and Litigation Risks
Failure to comply with the 2020 and 2013 Consent Orders from the Consumer Financial Protection Bureau regarding our Home Mortgage Disclosure Act submissions could result in additional regulatory enforcement action.
In March 2020, the Consumer Financial Protection Bureau (the “CFPB”) Office of Enforcement formally notified us of alleged violations of the Home Mortgage Disclosure Act (“HMDA”) associated with our HMDA reporting submissions. The CFPB alleged that the Bank did not accurately report all required relevant information within the annual HMDA submissions. We responded to the CFPB, noting that the Bank has instituted enhanced procedures to ensure compliance with HMDA, and submitted amended HMDA filings.In October 2020, after further discussions with the CFPB, we entered into a consent order related to our HMDA reporting, under which we agreed to pay a $200,000 civil money penalty, and implement a HMDA compliance management system while adhering to a compliance plan. The consent order will be in effect for 10 years.We had
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previously entered in a consent order with the CFPB in 2013, also relating to HMDA reporting deficiencies, resulting in a $34,000 civil money penalty. The 2013 HMDA Consent Order remains in effect. Any further deficiencies in our HMDA reporting submissions could result in additional regulatory enforcement actions, cause us to incur additional significant compliance costs and subject us to larger fines. Moreover, continued deficiencies in our HMDA reporting could have serious reputational consequences for the Bank. Any of these results could have a material adverse effect on our business, financial condition and results of operations.
Non-Compliance with the USA PATRIOT Act, Bank Secrecy Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act, Community Reinvestment Act, Fair Lending Laws, Flood Insurance Reform Act or other laws and regulations could result in fines or sanctions, and curtail our expansion opportunities.
Financial institutions are required under the USA PATRIOT Act of 2001 (the “Patriot Act”) and Bank Secrecy Act ("BSA") to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury Department's Office of Financial Crimes Enforcement Network. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with the Patriot Act and BSA statutes and regulations could result in fines or penalties, curtailment of expansion opportunities, enforcement actions, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations, and we are subject to a Consent Order with respect to our BSA Program, as described below. In addition, the U.S. Government imposed and is expected to continue to expand laws and regulations relating to residential and consumer lending activities that could create significant new compliance burdens and financial costs.
The Office of the Comptroller of the Currency has issued a Consent Order with respect to our BSA compliance, requiring the Company to implement additional controls and systems and curtail expansion plans.Failure to comply with the Consent Order could result in additional regulatory enforcement action, including fines or sanctions.
The Bank Secrecy Act, the Patriot Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. On February 28, 2018, pursuant to a Stipulation and Consent to the Issuance of a Consent Order (the “Stipulation”), the OCC issued a Consent Order relating to the Bank, the terms of which are intended to further enhance its BSA program. Copies of the Stipulation and the Consent Order were filed with the SEC on March 1, 2018 as exhibits to our Current Report on Form 8-K. The Bank expects to continue to incur significant expenses as it strengthens its BSA program and implements additional policies and procedures associated with complying with the Consent Order. The Bank does not expect to pursue acquisitions or branch expansion until its BSA program has improved. Issuance of the Consent Order does not preclude further government action with respect to the Bank’s BSA program, including the imposition of fines, sanctions, additional expenses and compliance costs, and/or restrictions on the activities of the Bank. In addition, failure to comply with the Consent Order could subject us to additional expense and further regulatory enforcement action, including the imposition of material restrictions on the activities of the Bank or the assessment of fines or penalties, which could prevent the Bank from executing its business strategy and negatively impact its business. Any further deficiency in the Bank's BSA/AML policies, procedures and systems could cause us to incur additional significant compliance costs and could subject it to fines and further regulatory actions. Moreover, failure to maintain and implement an effective BSA program could also have serious reputational consequences for the Bank. Any of these results could have a material adverse effect on our business, financial condition and results of operations.
We operate in a highly regulated industry, which limits the manner and scope of our business activities.
We are subject to extensive supervision, regulation and examination by the OCC, CFPB and the FDIC. In addition, the Federal Reserve is responsible for regulating the holding company. This regulatory structure is designed primarily for the protection of the deposit insurance funds and consumers and not to benefit our shareholders. This regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies to address not only compliance with applicable laws and regulations (including laws and regulations governing consumer credit, and anti-money laundering and anti-terrorism laws), but also capital adequacy, asset quality and risk, management ability and performance, earnings, liquidity, data reporting and various other factors. As part of this regulatory structure, we are subject to policies and other guidance developed by the regulatory agencies with respect to capital levels, the timing and amount of dividend payments, the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Under this structure the OCC, the FDIC, the CFPB and the Federal Reserve have broad discretion to impose restrictions and limitations on our operations if they determine, among other things, that our operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies. This supervisory framework could materially impact the conduct, growth and profitability of our operations.
Failure to comply with applicable laws and regulations could also result in a range of sanctions and enforcement actions, including the imposition of civil money penalties, formal agreements and cease and desist orders. In addition to monetary fines, failure to meet regulatory requirements could require the Bank to incur additional significant costs in order to bring our programs and operations into compliance, negatively impact our reputation, and have a material adverse effect on our business, financial condition and results of operations.
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In addition, the OCC has specific authority to take “prompt corrective action,” depending on the Bank's capital level. Currently, the Bank is considered “well-capitalized” for prompt corrective action purposes. If the Bank were designated by the OCC as “adequately capitalized,” its ability to take brokered deposits would become limited. If the Bank were to be designated by the OCC in one of the lower capital levels “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” it would be required to raise additional capital and would be subject to progressively more severe restrictions on its operations, management and capital distributions, and replacement of senior executive officers and directors.If the Bank became “critically undercapitalized,” it would also be subject to the appointment of a conservator or receiver.
Recent national and state legislation and regulatory initiatives to support the financial services industry have been coupled with numerous restrictions and requirements that could detrimentally affect our business.
The Dodd-Frank Act has had a substantial impact on the financial services industry since its passage in 2010. The Dodd-Frank Act creates a framework through which regulatory reform has been and continues to be written. While many of the rules required by the Dodd-Frank Act have been implemented, others are still being drafted. As a result, the impact of the future regulatory requirements continues to be uncertain. We expect the way we conduct business to continue to be affected by these regulatory requirements, including through limitations on our ability to pursue certain lines of business, capital requirements, enhanced reporting obligations, and increased costs.
Other legislative initiatives could detrimentally impact our operations in the future. The extent of the impact of any such legislation will be dependent on the specific details of the final legislation passed, if any.
Deposit insurance premiums could increase further in the future.
The FDIC insures deposits at FDIC-insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund ("DIF") at a specific level. The Bank's FDIC insurance premiums increased substantially beginning in 2009, and it expects to pay significant premiums in the future. Unfavorable economic conditions, increased bank failures and additional failures decreased the DIF. In order to restore the DIF to its statutorily mandated minimum of 1.35% of total deposits, the FDIC may need to increase deposit insurance premium rates.Insured institutions with assets of $10 billion or more are responsible for funding this increase. The FDIC has issued regulations to implement these provisions of the Dodd-Frank Act.The FDIC has also established a higher reserve ratio of 2% as a long term goal and the minimum level needed to withstand future financial crises of the magnitude of past crises. The FDIC may increase the assessment rates or impose additional special assessments in the future to keep the DIF at the statutory target level. Any increase in the Bank's FDIC premiums could have an adverse effect on its business, financial condition and results of operations.
We are subject to various claims and litigation, which could result in significant expenses, losses and damage to our reputation.
We are, from time to time, subject to claims and proceedings related to our operations.These claims and legal actions could include supervisory or enforcement actions by our regulators, criminal proceedings by prosecutorial authorities, or civil claims by our customers, former customers, contractual counterparties, and current and former employees.We may also face class action lawsuits for alleged violations of employment, state wage and hour and consumer protection laws. These claims could involve large monetary demands, including civil money penalties or fines imposed by government authorities, and significant defense costs.If such claims and legal actions are brought, and are not resolved in a manner favorable to the Company, they could result in financial liability and/or reputational harm, which could have a material adverse effect on our financial condition and results of operations.
Banking institutions are also increasingly the target of class action lawsuits, most recently claiming deceptive practices or violations of account terms in connection with non-sufficient funds or overdraft charges.In September 2020, we received notice a similar class action had been filed against WaFd Bank, alleging that we have been improperly charging our customers overdraft fees on items re-presented for payment.While we have not been served with this lawsuit to date, we do not believe the claims have merit, and intend to oppose the lawsuit and the certification of the class.However, the results of litigation are inherently unpredictable, and defending against these claims is expected to be time consuming and costly, and could require significant amounts of management time and divert significant resources. If this or another class action lawsuit is determined adversely to us, or we were to enter into a settlement agreement in connection with such a matter, we could be exposed to monetary damages, reputational harm, or subject to limits on our ability to operate our business, which could have an adverse effect on our financial condition, and operating results.
Market and Industry Risks
Our operations are focused in the western United States, subjecting us to the risks of general economic conditions in these market areas.
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Substantially all of the Bank's loans are to individuals, businesses and real estate developers in the Pacific Northwest, Arizona, Utah, Texas, New Mexico and Nevada. As a result, our business depends significantly on general economic conditions in these market areas. A substantial increase in unemployment rates, or severe declines in housing prices and property values in these primary market areas could have a material adverse effect on our business due to a number of factors, including:
•Loan delinquencies may increase.
•Problem assets and foreclosures may increase.
•Demand for the Bank's products and services may decline.
•Collateral for loans made by the Bank, especially real estate, may decline in value, in turn reducing a customer's borrowing power and reducing the value of assets and collateral associated with the loans.
•Natural disasters and catastrophic events such as wildfires, floods and earthquakes may damage or destroy collateral for loans made by the Bank and negatively impact the collateral’s value and a customer’s ability to repayloans.
A downturn in the real estate market would hurt our business.
The Bank’s business activities and credit exposure are concentrated in real estate lending. The market for real estate is cyclical and the outlook for this sector is uncertain.A downturn in the real estate market, accompanied by falling values and increased foreclosures would hurt our business because a large majority of our loans are secured by real estate.
If a significant decline in market values occurs, the collateral for loans will provide decreasing levels of security.As a result, our ability to recover the principal amount due on defaulted loans by selling the underlying real estate will be diminished, and we will be more likely to suffer losses on defaulted loans.
We own real estate as a result of foreclosures resulting from non-performing loans.If other lenders or borrowers liquidate significant amounts of real estate in a rapid or disorderly fashion, or if the FDIC elects to dispose of significant amounts of real estate from failed financial institutions in a similar fashion, it could have an adverse effect on the values of the properties owned by the Company by depressing the value of these real estate holdings.In such a case, we may incur further write-downs and charge-offs, which could, in turn, adversely affect our business, financial condition and results of operations.
We may suffer losses in our loan portfolio due to inadequate or faulty underwriting and loan collection practices.
There are risks inherent in any loan portfolio, which we attempt to address by adhering to specific underwriting and loan collection practices. Underwriting practices often include analysis of a borrower's prior credit history; financial statements; tax returns; cash flow projections; valuation of collateral; personal guarantees of loans to businesses; and verification of liquid assets. If the underwriting process fails to capture accurate information or proves to be inadequate, we may incur losses on loans that appeared to meet our underwriting criteria, and those losses may exceed the amounts set aside as reserves in the allowance for credit losses. Loan collection resources may be expanded to meet increases in nonperforming loans resulting from economic downturns or to service any loans acquired, resulting in higher loan administration costs. We are also exposed to the risk of improper documentation of foreclosure proceedings that would also increase the cost of collection.
Our systems, technology and digital capabilities may not provide the desired results, which may expose us to significant risks.
In many instances, the Bank’s products and services to customers are dependent upon third-party vendors, who provide necessary or critical services and support. Any disruption of such services, or an unplanned termination of a third-party license or service agreement related thereto, could adversely affect our ability to provide and service products which our customers need or demand.
In recent years, we have made a significant ongoing investment to enhance our technology capabilities with the objectives of enhancing customer experience, growing revenue and improving operating efficiency over time. There is a risk that these investments may not provide the anticipated benefits and/or will prove significantly more costly and time consuming to produce.If this occurs, we may see a loss of customers, and our financial results and ability to execute on our strategic plan may be adversely impacted.
Our business is subject to interest rate risk, and changes in market interest rates may negatively affect our business, financial condition and results of operations.
Our primary source of income is net interest income, which is the difference between the interest income generated by interest-earning assets and the interest expense generated by interest-bearing liabilities. The level of net interest income is a function of the average balances of interest-earning assets and interest-bearing liabilities and the spread between the amounts of the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and the mix of interest-earning assets and interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board
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of Governors (the “FOMC”) and market interest rates. Management is unable to predict these external factors, including the fluctuations of market interest rates, which are affected by many drivers, including inflation, recession, unemployment, monetary policy, domestic and international disorder, instability in domestic and foreign financial markets and investor and consumer demand.
Furthermore, movements in interest rates, the pace at which such movements occur and the volume and mix of our interest-bearing assets and liabilities influence the level of net interest income. The cost of customer deposits is largely based on short-term interest rates, the level of which is driven by the FOMC. However, the yields generated by long-term loans, such as single-family residential and multifamily mortgage loans, and securities are typically driven by longer-term (10 year) interest rates, which are set by the market and vary from day to day. During the last few years, the Federal Reserve's unprecedented involvement in the purchase of assets, commonly known as "quantitative easing," has caused interest rates to be lower than they would have been without such involvement. The COVID-19 pandemic has led the Federal Reserve to reverse its unwinding of quantitative easing and instead dramatically increase their non-traditional activites. These activities supress long-term interest rates and could lead to unforseen consequences.
If the interest rates on interest-bearing liabilities increase at a faster pace than the interest rates on interest-earning assets, the result could be a reduction in our net interest income and with it, a reduction in earnings. The same could be true if interest rates on interest-earning assets decline faster than the rates on interest-bearing liabilities. Net interest income and earnings would be similarly impacted were the interest rates on interest-earning assets to decline more quickly than the interest rates on interest-bearing liabilities. In addition, changes in interest rates could affect the Bank's ability to originate loans and attract and retain deposits; the fair values of its securities and other financial assets; the fair values of its liabilities; and the average lives of its loan and securities portfolios. Additionally, decreases in interest rates could lead to increased loan refinancing activity, which, in turn, would alter the balance of our interest-earning assets and impact net interest income. Increases in interest rates could reduce loan refinancing activity, which could result in compression of the spread between loan yields and more quickly rising funding rates.
We may also be exposed to movements in market rates to a degree not experienced by other financial institutions, as a result of our significant portfolio of fixed-rate single-family home loans, which are longer-term in nature than the customer accounts and borrowed money that constitute our liabilities.
Our liquidity may be adversely impacted by issues arising from certain industry deficiencies in foreclosure practices, including delays and challenges in the foreclosure process.
Foreclosure process issues and the potential legal and regulatory responses to them could negatively impact the process and timing to completion of foreclosures for residential mortgage lenders, including the Bank. Foreclosure timelines have increased in recent years due to, among other reasons, delays associated with the significant increase in the number of foreclosure cases as a result of economic downturns, additional consumer protection initiatives related to the foreclosure process and voluntary or mandatory programs intended to permit or require lenders to consider loan modifications or other alternatives to foreclosure.In addition, due to the COVID-19 emergency, certain states in which we do business have enacted temporary stays on evictions and foreclosures, or instituted a right to forbearance for homeowners experiencing financial hardship.Should these stays or rights to forbearance continue, we may be limited in our inability to take timely possession of real estate assets collateralizing loans, which may increase our loan losses.Increases in the foreclosure timeline may also have an adverse effect on collateral values and the our ability to minimize our losses.
The replacement of the LIBOR benchmark interest rate may have an impact on the our business, financial condition or results of operations.
Certain loans made by us and financing extended to us are made at variable rates that use LIBOR as a benchmark for establishing the interest rate. In addition, we also have investments and interest rate derivatives that reference LIBOR. On July 27, 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates are ongoing, and the Alternative Reference Rate Committee ("ARRC") has recommended the use of a Secured Overnight Funding Rate ("SOFR"). SOFR is different from LIBOR in that it is a backward looking secured rate rather than a forward looking unsecured rate. These differences could lead to a greater disconnect between the Bank's costs to raise funds for SOFR as compared to LIBOR. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations. These reforms may cause LIBOR to cease to exist, new methods of calculating LIBOR to be established or the establishment of multiple alternative reference rate(s). These consequences cannot be entirely predicted and could have an adverse impact on the market value for or value of LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us.
Our ability to originate mortgage loans has been adversely affected by the increased competition resulting from the involvement of the U.S. Government, the Federal Reserve and Government-Sponsored Enterprises (“GSEs”) in the residential mortgage market.
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Over the past few years, we have faced increased competition for mortgage loans due to the increased involvement of the GSEs in the mortgage market, which has caused interest rates for thirty year fixed-rate mortgage loans that conform to GSE guidelines to remain artificially low. Mortgage loan repayments on one-to-four family residential properties have been elevated, and it is possible that these mortgage loan repayments will outpace our loan production as a result of this competition, making it difficult for us to grow our mortgage loan portfolio and balance sheet, and having an adverse effect on our business.
The Bank faces strong competition from other financial institutions and new market participants, offering services similar to those offered by the Bank.
Many competitors offer the same types of loans and deposit services that the Company offers. These competitors include other national banks, savings associations, community banks, credit unions and other financial intermediaries. In particular, our competitors include national banks and major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, recent technological breakthroughs have made it possible for other non-traditional competitors to enter the marketplace and compete for traditional banking services.Increased competition within our geographic market area may result in reduced loan originations and deposits. Ultimately, competition from current and future competitors may affect our business materially and adversely.
Security Ownership Risks
Our ability to pay dividends is subject to limitations that may affect our ability to continue to pay dividends to Shareholders.
We are a separate legal entity from our bank subsidiary and do not have significant operations of our own. The availability of dividends from the Bank is limited by the Bank's earnings and capital, as well as various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors, that the Bank may not be able to pay dividends to the Company.If the Bank is unable to pay dividends to the Company, then we may not be able to pay dividends on our common stock to our shareholders. Our stock price may be negatively affected by our inability to pay dividends, which will have an adverse impact on both the Company and our shareholders.
The market price for our common stock may be volatile.
The market price of our common stock could fluctuate substantially in the future in response to a number of factors, including those discussed below. The market price of our common stock has in the past fluctuated significantly, and is currently trading near its 52-week low.We expect to see additional volatility in the financial markets due to the uncertainty of COVID-19, and if the results of the recent presidential election continue to be disrupted.Some additional factors that may cause the price of our common stock to fluctuate include:
•general conditions in the financial markets and real estate markets
•macro-economic and political conditions in the United States
•variations in the operating results of the Company and our competitors
•events affecting other companies that the market deems comparable to the Company
•changes in securities analysts' estimates of our future performance and the future performance of our competitors
•announcements by the Company or our competitors of mergers, acquisitions and strategic partnerships
•additions or departure of key personnel
•the presence or absence of short selling of the Company's common stock
•future sales by us of our common stock or debt securities
The stock markets in general have experienced substantial price and trading fluctuations. These fluctuations have resulted in volatility in the market prices of securities that often has been unrelated or disproportionate to changes in operating performance. These broad market fluctuations are expected to continue for the near future, and may adversely affect the trading price of our common stock.
There may be future sales or other dilution of the Company's equity, which may adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. The issuance of any additional shares of common or of preferred stock or convertible securities or the exercise of such securities could be substantially dilutive to existing shareholders. For instance, exercise of the warrant issued to the U.S. Treasury in connection with our participation in the Capital Purchase Program diluted the value of our common stock. We may also elect to use common stock to fund new acquisitions, which will dilute existing shareholders. Holders of our common stock have no preemptive rights that entitle
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holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our shareholders.
We rely, in part, on external financing to fund our operations and the unavailability of such funding in the future could adversely impact our growth and prospects.
We rely on customer deposits, advances from the FHLB of Des Moines and other borrowings to fund our operations. Management has historically been able to replace maturing deposits, if desired; however we may not be able to replace such funds at any given point in time if our financial condition or market conditions change or if the cost of doing so might adversely affect our business, financial condition and results of operations.
Although we consider current sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Such borrowings, if sought, may not be available to us or, if available, may not be on favorable terms. If additional financing sources are unavailable or are not available on reasonable terms, our business, financial condition and results of operations may be adversely affected.
A person holding our common stock could have the voting power of their shares of common stock on all matters significantly reduced under Washington's anti-takeover statutes, if the person acquires 10% or more of the voting stock of the Company.
We are incorporated in the state of Washington and subject to Washington state law. Some provisions of Washington state law could interfere with or restrict takeover bids or other change-in-control events affecting us. For example, Chapter 23B.19 of the Washington Business Corporation Act, with limited exceptions, prohibits a “target corporation” from engaging in specified “significant business transactions” for a period of five years after the share acquisition by an acquiring person, unless:
▪the prohibited transaction or the acquiring person's purchase of shares was approved by a majority of the members of the target corporation's board of directors prior to the acquiring person's share acquisition; or
▪the prohibited transaction was both approved by the majority of the members of the target corporation's board and authorized at a shareholder meeting by at least two-thirds of the outstanding voting shares (excluding the acquiring person's shares) at or subsequent to the acquiring person's share acquisition.An acquiring person is defined as a person or group of persons that beneficially own 10% or more of the voting securities of the target corporation. Such prohibited transactions include, among other things:
•certain mergers, or consolidations with, disposition of assets to, or issuances of stock to or redemption of stock from, the acquiring person;
•termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares;
•allowing the acquiring person to receive any disproportionate benefit as a shareholder; and
•liquidating or dissolving the target corporation.
After the five-year period, certain “significant business transactions” are permitted, if they comply with certain “fair price” provisions of the statute or are approved by a majority of the outstanding shares other than those of which the acquiring person has beneficial ownership. As a Washington corporation, the Company is not permitted to “opt out” of this statute.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
The Company owns the building in which its principal executive offices are located in Seattle, Washington. The following table sets forth certain information concerning the Company's other properties, including bank branches and administrative centers.
Location Number of Offices Owned Leased (1) Net Book Value (2)
(In thousands)
___________________________
(1) The leases have varying terms expiring from 2020 through 2070, including renewal options.
(2) Amount represents the net book value of all land, property and equipment owned by the Company and the book value of leasehold improvements, where applicable.
The Company evaluates on a continuing basis the suitability and adequacy of its offices, both branches and administrative centers, and has opened, relocated, remodeled or closed them as necessary to maintain efficient and attractive premises. The net investment in premises, equipment and leaseholds was $252,805,000 at September 30, 2020.
Item 3. Legal Proceedings
The Company and its consolidated subsidiaries are involved in legal proceedings occurring in the ordinary course of business that in the aggregate are believed by management to be immaterial to the financial statements of the Company. The effects of legal proceedings did not have a material impact on the Company's consolidated financial statements.
Item 4. Mine Safety Disclosures
None.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The information required by this item is set forth in the 2020 Annual Report to Shareholders, which is included herein as Exhibit 13.
Issuer Purchases of Equity Securities
The Company’s stock repurchase program was publicly announced by the board of directors on February 3, 1995 and has no expiration date. Under this program, a total of 66,956,264 shares of the Company’s common stock have been authorized for repurchase. The following table shows the share repurchases made for the three months ended September 30, 2020.
Item 6. Selected Financial Data
The information required by this item is set forth in the 2020 Annual Report and is incorporated herein by reference.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information required by this item is set forth in the 2020 Annual Report and is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required herein is incorporated by reference to the section titled Interest Rate Risk within this Form 10-K.
Item 8. Financial Statements and Supplementary Data
The information required by this item is set forth in the 2020 Annual Report and is incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of September 30, 2020, the Company carried out an evaluation, under the supervision and participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) of the Exchange Act. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in SEC rules and forms and were effective to ensure that such information is accumulated and communicated to the
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Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting practices in the United States of America.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2020. In making the assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the 2013 version of its Internal Control-Integrated Framework. Based on its assessment, the Company’s management believes that as of September 30, 2020, the Company’s internal control over financial reporting was effective based on this criteria.
The Company’s independent auditors, Deloitte & Touche LLP, an independent registered public accounting firm, have issued an audit report on the Company’s internal control over financial reporting, which is incorporated by reference and set forth in the 2020 Annual Report.
There have been no changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
None.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item will be set forth in the 2020 Proxy Statement and is incorporated herein by reference. The Company’s annual meeting of Shareholders is set to be held on January 26, 2021.
The Company has adopted a code of ethics that applies to all senior financial officers, including its Chief Executive Officer and Chief Financial Officer. The code of ethics is publicly available on the Company’s website at www.wafdbank.com. If the Company makes any substantive amendments to the code of ethics or grants any waiver from a provision of the code, it will disclose the nature of such amendment or waiver on its website or in a report on Form 8-K.
Item 11. Executive Compensation
The information required by this item will be set forth in the 2020 Proxy Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by this item will be set forth in the 2020 Proxy Statement and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this item will be set forth in the 2020 Proxy Statement and is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
The information required by this item will be set forth in the 2020 Proxy Statement and is incorporated herein by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
(a)(1) The following financial statements are incorporated herein by reference in the sections immediately following the Selected Financial Data of the Annual Report.
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of September 30, 2020 and 2019
Consolidated Statements of Operations for each of the years in the three-year period ended September 30, 2020
Consolidated Statements of Comprehensive Income for each of the years in the three-year period ended September 30, 2020
Consolidated Statements of Shareholders’ Equity for each of the years in the three-year period ended September 30, 2020
Consolidated Statements of Cash Flows for each of the years in the three-year period ended September 30, 2020
Notes to Consolidated Financial Statements
(a)(2) There are no financial statement schedules filed herewith.
(a)(3) The following exhibits are filed as part of this report, and this list includes the Exhibit Index:
No. Exhibit Page/Footnote
3.1 Restated Articles of Incorporation of the Company (1)
3.2 Amended and Restated Bylaws of the Company (2)
4.1 Description of Registrant's Securities
10.1 2020 Incentive Plan and Form of Award Agreements *
10.2 2011 Incentive Plan, as amended * (3)
10.3 Form of Restricted Stock Award Agreement under 2011 Incentive Plan * (4)
10.4 Form of Stock Option Agreement under 2011 Incentive Plan * (4)
10.5 Form of Indemnification Agreement * (4)
10.6 Form of Change in Control Agreement * (5)
10.7 Transition Agreement * (6)
13 Annual Report to Shareholders
23.1 Consent of Independent Registered Public Accounting Firm
31.1 Section 302 Certification by the Chief Executive Officer
31.2 Section 302 Certification by the Chief Financial Officer
32 Section 906 Certification pursuant to the Sarbanes-Oxley Act of 2002
___________________
* Management contract or compensation plan
(1)Incorporated by reference from the Registrant's Form 10-Q filed with the SEC on May 3, 2016.
(2)Incorporated by reference from the Registrant's Form 8-K filed with the SEC on November 20, 2020
(3)Incorporated by reference from the Registrant's Form 10-K filed with the SEC on November 21, 2016.
(4)Incorporated by reference from the Registrant's Form 8-K filed with the SEC on October 24, 2016.
(5)Incorporated by reference from the Registrant's Form 8-K filed with the SEC on August 19, 2015.
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(6)Incorporated by reference from the Registrant's Form 8-K filed with the SEC on January 24, 2017.
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Item 16. Form 10-K Summary
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WASHINGTON FEDERAL, INC.
November 23, 2020 By: /S/ BRENT J. BEARDALL
Brent J. Beardall, President and Chief Executive Officer
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Brent J. Beardall November 23, 2020
/s/ Vincent L. Beatty November 23, 2020
/s/ Cory D. Stewart November 23, 2020
/s/ Thomas J. Kelley November 23, 2020
Thomas J. Kelley, Chairman of the Board
/s/ Linda S. Brower November 23, 2020
Linda S. Brower, Director
/s/ Stephen M. Graham November 23, 2020
Stephen M. Graham, Director
/s/ David K. Grant November 23, 2020
David K. Grant, Director
/s/ S. Steven Singh November 23, 2020
S. Steven Singh, Director
/s/ Barbara L. Smith November 23, 2020
Barbara L. Smith, Director
/s/ Mark N. Tabbutt November 23, 2020
Mark N. Tabbutt, Director
/s/ Randall H. Talbot November 23, 2020
Randall H. Talbot, Director
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