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
Fluctuating interest rates could adversely affect our business.
Significant increases in market interest rates on loans, or the perception that an increase may occur, could adversely affect both our ability to originate new loans and our ability to grow. Beginning early in 2022, in response to growing signs of inflation, the Federal Reserve Bank has increased interest rates rapidly and the federal funds rate currently sits at a 22-year high. Although the FRB left its benchmark rates steady in September and November of 2023, the FRB suggested that additional rate increases in the future may be necessary to mitigate inflationary pressures. Rapid changes in interest rates make it difficult for the Bank to balance its loan and deposit portfolios, which may 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 increased market interest rates could also adversely affect the ability of our floating-rate borrowers to meet their higher payment obligations.
Further, our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits, borrowings, and other 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 of Governors (the “FOMC”) and market interest rates. 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. Further, recent changes in the Federal Reserve Bank's purchase of assets, commonly known as "quantitative easing," have created significant volatility in market interest rates and recent, rapid increases in federal benchmark rates and additional increases in such rates are creating additional uncertainty and making it more difficult for us to balance our loan and deposit portfolios.
As a result of the high interest rates, our interest expense on both deposits and borrowings has increased significantly. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect our interest rate spread, and, in turn, our profitability. For example, 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.
We are currently anticipating that there will be further increases in the target federal funds rate in 2024 to combat recent inflationary trends; however, if interest rates do not rise, or if the Federal Reserve were to rapidly lower the target federal funds rate, the reduction in rates could continue to constrain our interest rate spread and may adversely affect our business forecasts. On the other hand, increases in interest rates, to combat inflation or otherwise, may result in a change in the mix of noninterest and interest-bearing accounts. All else being equal, if the interest rates on the Company's interest-bearing liabilities
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increase at a faster pace than the interest rates on our interest-earning assets, the result would be a reduction in net interest income and with it, a reduction in net earnings.We are unable to predict changes in interest rates, which are affected by factors beyond our control, including inflation, deflation, recession, unemployment, money supply and other changes in financial markets.
Inflationary pressures and rising prices may affect our results of operations and financial condition.
Inflation rates remained elevated in 2023 however we did see a decrease from the highs seen in 2022. Inflation pressures are currently expected to remain elevated throughout 2023 and are likely to continue into 2024 as the inflation rate remains above the Federal Reserve Bank’s target rate of 2%. Inflation has led to increased costs to our customers, making it more difficult for them to repay their loans or other obligations increasing our credit risk. Sustained higher interest rates by the Federal Reserve may be needed to tame persistent inflationary price pressures, which could push down asset prices and weaken economic activity. A deterioration in economic conditions in the United States and our markets could result in a further increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, all of which, in turn, would adversely affect our business, financial condition and results of operations.
The Company’s pending merger with Luther Burbank Corporation may expose the Company to certain risks.
On November 13, 2022, the Company announced that it had entered into a definitive merger agreement pursuant to which it intends to acquire Luther Burbank Corporation (“Luther Burbank”) and its wholly-owned subsidiary, Luther Burbank Savings, in an all-stock transaction valued at approximately $654 million based upon the closing price of the Company’s Common Stock on November 11, 2022. As part of the merger agreement, shares of common stock of Luther Burbank will be converted into, and canceled in exchange for, the right to receive 0.3353 shares of the Company’s Common Stock, with Luther Burbank shareholders receiving cash in lieu of fractional shares of Company Common Stock. On May 4, 2023, the Company's shareholders approved the issuance of shares of Company Common Stock to the shareholders of Luther Burbank in connection with the merger, and the Luther Burbank shareholders approved the proposed merger agreement and merger with the Company and a proposal to approve on a non-binding basis the compensation that certain named executives of Luther Burbank may receive that is based on or otherwise relates to the merger. The Company has submitted an application for approval of the Merger to the Washington State Department of Financial Institutions (“WDFI”), the Federal Deposit Insurance Corporation (“FDIC”) and the Board of Governors of the Federal Reserve System (“Federal Reserve”). On October 13, 2023, the WDFI approved the Merger, subject to approval by the Federal Reserve and the FDIC. The Company continues to work with the Federal Reserve and the FDIC, and the merger remains subject to their approval. If approved, the Merger will result in the Bank’s footprint expanding to include the state of California. Because regulatory approval has not yet been achieved, it is possible the transaction may not be consummated as planned or at all, and may expose the Company to certain risks, prior to or after completion, including but not limited to:
•Regulatory approvals may not be received, may take longer than expected, or may impose conditions not presently anticipated or that could have an adverse effect on the combined company following the merger.
•The Company and Luther Burbank will be subject to business uncertainties and contractual restrictions on their respective operations while the merger is pending and the announcement and pendency of the merger could cause disruptions in the businesses of the Company and Luther Burbank, which could have an adverse effect on their respective business and financial results, and consequently on the combined company if the merger is consummated.
•Litigation from shareholders of either Luther Burbank or the Company could attempt to prevent or delay the consummation of the merger and result in additional unanticipated costs.
•Denial or delay of approval as a result of the February 3, 2023 comment letter to the FDIC from the California Reinvestment Coalition co-signed by other community groups and organizations. This letter requested that the FDIC hold public hearings on the bank merger application, and urged the FDIC to deny the bank merger application.
•Termination of the merger agreement or failure to complete the merger for whatever reason could adversely impact the Company.
•The value of the merger consideration to be issued by the Company is uncertain because the market price of the Company’s Common Stock will fluctuate.
•The market price of the Company’s stock after the merger may be affected by factors different from those that currently affect the shares of the Company.
•Changes in the operations and prospects of the Company or Luther Burbank, general market and economic conditions and other factors that may be beyond the control of the Company and Luther Burbank may alter the value of WaFd or Luther Burbank or the market price for shares of Company Common Stock or Luther Burbank common stock by the time the merger is completed.
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•Combining Luther Burbank with the Company may prove more difficult, costly or time consuming than expected, and the anticipated benefits and cost savings of the merger may not be realized.
•The merger is subject to certain closing conditions that, if not satisfied or waived, will result in the merger not being completed, which may cause the price of the Company’s Common Stock to decline.
•The growth opportunities and cost savings from the merger may not be fully realized or may take longer to realize than expected.
•Operating costs, customer losses and business disruption following the merger, including adverse effects of relationships with employees, may be greater than expected.
•The interest rate environment has changed, causing margins to compress and adversely affecting net interest income.
•The fair value of the Luther Burbank assets to be acquired in the merger are sensitive to the interest rate environment and may fluctuate as a result of changes in interest rates, which could reduce or eliminate the anticipated benefits of the merger for the Company.
•The combined company may be unable to retain Company and/or Luther Burbank personnel.
•The Company may incur substantial costs associated with the merger and the integration of Luther Burbank.
•Issuance of shares of Company Common Stock in connection with the merger may adversely affect the market price of Company Common Stock.
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. The pandemic caused a global economic slowdown, and while we have seen some economic recovery, continuing supply chain issues, labor shortages and inflation risks continue to affect the economic recovery. U.S. debt ceiling and budget deficit concerns have increased the possibility of additional credit-rating downgrades and economic slowdowns, or a recession in the United States. There remain increased risks of a government shutdown if the spending bills necessary to fund the government through the fiscal year that ends September 30, 2024 are not passed by Congress.Future deterioration in the U.S. credit and financial markets could result in losses or significant deterioration in the fair value of our U.S. government issued, sponsored or guaranteed investments. At September 30, 2023, we had $1.6 billion invested in U.S. government and agency obligations, and further downgrades could affect the stability of securities issued or guaranteed by the federal government and the valuation or liquidity of our portfolio of such investment securities.
While a government-wide shutdown can reduce GDP growth, the additional economic uncertainty, or a recessionary or stagnant economy, could result in financial stress on the Bank's borrowers, which could adversely affect our business, financial condition and results of operations. We decreased the expense for credit losses over fiscal year 2021 and 2022 as the economy began to recover, however, deteriorating conditions in the regional economies we serve, or in certain sectors of those economies, in excess of the reasonable and supportable forecasts used to estimate credit losses, 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 stagnation or 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.
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•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.
Changes to monetary policy by the Federal Reserve could adversely impact our results of operations.
The Federal Reserve is responsible for regulating the supply of money in the United States, including open market operations used to stabilize prices in times of economic stress, as well as setting monetary policies. These activities strongly influence our rate of return on certain investments, our hedge effectiveness for mortgage servicing and our mortgage origination pipeline, as well as our costs of funds for lending and investing, all of which may adversely impact our liquidity, results of operations, financial condition and capital position.
Unstable global economic conditions may have serious adverse consequences on our business, financial condition, and operations.
The global credit and financial markets have from time to time experienced extreme volatility and disruptions, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, high rates of inflation, and uncertainty about economic stability. The financial markets and the global economy may also be adversely affected by the current or anticipated impact of military conflict, including the conflict between Russia and Ukraine, and the evolving conflict in Israel and Gaza. These events have increased and are expected to continue to increase volatility in commodity and energy prices, including oil, and continuing hostilities raise the possibility of supply disruptions.Rising tensions and global instability have the potential to affect consumer confidence in the U.S. and abroad, therefore having a broader effect on financial markets. Sanctions imposed by the United States and other countries in response to such conflict could further adversely impact the financial markets and the global economy, and any economic countermeasures by the affected countries or others could exacerbate market and economic instability. Our general business strategy may be adversely affected by any such economic downturn, volatile business environment, hostile third-party action or continued unpredictable and unstable market conditions.
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. We maintain an ACL to provide for loan defaults and non-performance, however, 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 the loan portfolio, current economic conditions and geographic concentrations within the portfolio. 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 our 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 are exposed to risks related to our operational, technological, and third-party provided technology infrastructure.
We rely extensively on the successful and uninterrupted functioning of information technology and telecommunications systems to conduct our business. This includes internally developed systems, internally managed systems, outsourced systems provided by third-party service providers, internet facing digital products and services, mobile technologies and the on-going operational maintenance of each service. Any disruptions, failures, or inaccuracies of these systems, including changes and improvements, could result in our inability to service customers, manage operations, manage risk, meet regulatory obligations, or provide timely and accurate financial reporting which 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.
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In many instances, the Company’s products and services to customers are dependent upon third-party service providers, 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 necessary products and services for our customers.
In recent years, we have made a significant ongoing investment to enhance our technological capabilities with the objectives of enhancing customer experience, growing revenue, and improving operating efficiency. 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.
We are exposed to risks related to fraud and cyber-attacks.
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.
We are continuously enhancing and expanding our digital products and services to meet customer and business needs with desired outcomes. These digital products and services often include storing, transmitting, and processing confidential customer, employee, financial, and business information. Due to the nature of this information, and the value it has for internal and external threat actors, we, and our third-party service providers, continue to be subject to cyber-attacks and fraud activity that attempts to gain unauthorized access, misuse information and information systems, steal information, disrupt or degrade information systems, spread malicious software, and other illegal activities.
We believe we have robust preventive, detective, and administrative safeguards and security controls to minimize the probability and magnitude of a material event. However, if we are unable to maintain them, we may fall victim to a material adverse cybersecurity event. Because the tactics and techniques used by threat actors to bypass safeguards and security controls change frequently, and often are not recognized until after an event has occurred, we may be unable to anticipate future tactics and techniques, or to implement adequate and timely protective measures.
We are subject to additional risk with respect to third-party vendors that process or handle personal and financial data of our customers, partners, suppliers or employees. These third-party vendors may themselves use other vendors to store or process our data, which further elevates our risk exposure. Our third-party vendors have been, and may in the future be, subject to security incidents, including those caused by computer viruses, malware, ransomware, phishing attempts, social engineering, hacking or other means of unauthorized access. Control failures of security measures managed by our third-party service providers could cause us to suffer damage to our reputation and could require us to incur substantial expenses, which could have a materially adverse effect on our business, financial condition, and results of operations.
To date, we have no knowledge of a material cyber-attack or other material information security incident affecting the systems we operate and control. However, our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the continuation of a remote or hybrid work environment for our employees and service providers, and our plans to continue to implement and expand digital banking services, expand operations, and use third-party information systems that includes cloud-based infrastructure, platforms, and software. Recent instances of attacks specifically targeting banks and financial services businesses indicate that the risk to our systems remains significant. We, and our third-party providers, are regularly the subject of attempted attacks and the ability of the attackers continues to grow in sophistication.Potential threats to our technologies, systems, networks, and other devices, as well as those of our employees, third party vendors, and other third parties with whom we interact, include Distributed Denial of Service ("DDoS") attacks, computer viruses, hacking, malware, ransomware, credential stuffing, phishing, and other forms of social engineering. Such cyber-attacks and other security incidents are designed to lead to various harmful outcomes, such as unauthorized transactions against our customers’ accounts, unauthorized or unintended access to confidential information, or the release, gathering, monitoring, disclosure, loss, destruction, corruption, disablement, encryption, misuse, modification or other processing of confidential or sensitive information (including personal information), intellectual property, software, methodologies or business secrets, disruption, sabotage or degradation of service, systems or networks, or other damage. These threats may derive from, among other things, error, fraud or malice on the part of our employees, insiders, or third parties or may result from accidental technological failure. Any of these parties may also attempt to fraudulently induce employees, service providers, customers, partners or other third-party users of our systems or networks to disclose confidential or sensitive information (including personal information) in order to gain access to our systems, networks or data or that of our customers, partners, or third parties with whom we interact, or to unlawfully obtain monetary benefit through misdirected or otherwise improper payment. A cyber-attack or other security incident on the systems we operate and control could cause us to suffer damage to our reputation, result in productivity losses, require us to incur substantial expenses, including response costs associated with
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investigation and resumption of services, remediation expenses costs associated with customer notification and credit monitoring services, increased insurance premiums, regulatory penalties and fines, and costs associated with civil litigation, any of which could have a materially adverse effect on our business, financial condition, and results of operations.
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 a cyber-attack 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, as well as potential increases to insurance premiums for policies we may maintain to cover these losses.
Both internal and external fraud and theft are risks. If confidential customer, employee, monetary, or business information 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, or if our own employees abused their access to financial systems to commit fraud against our customers and the Company. These activities can occur in connection with activities such as 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 can include information system misconfiguration, clerical or record-keeping errors, or disruptions from faulty or disabled computer or telecommunications systems. Because the nature of the financial services business involves a high volume of transactions, certain errors, which may be automated or manual, may be repeated or compounded before they are discovered and successfully rectified. Because of the Company’s large transaction volume and its necessary dependence upon automated systems to record and process these transactions, there is a risk that technical flaws, tampering, or manipulation of those automated systems, arising from events wholly or partially beyond its control, may give rise to disruption of service to customers and to financial loss or liability.
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.
A resurgence of the COVID-19 pandemic, or a similar health crisis, may adversely affect our business and our customers, counterparties, employees, and third-party service providers in the future.
The spread of COVID-19 created a global public-health crisis that resulted in significant economic uncertainty, and has impacted household, business, economic, and market conditions, including in the western United States where we conduct nearly all of our business.
Throughout the pandemic our operations were impacted by the need to close certain offices and limit how customers conduct business through our branch network. Many of our employees continue to work remotely, which exposes us to 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.
A resurgence of the COVID-19 pandemic, or a similar crisis, could negatively impact our capital, liquidity, and other financial positions and our business, results of operations, and prospects. A resurgence in spread, caused by the rise of new variants, 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. A slow-down or reversal in the economic recovery of the regions in which we conduct our business could result in declines in loan demand and collateral values. Negative impacts on our customers caused by COVID-19 or other pathogens could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans. Future actions of governmental authorities taken in response to a pandemic or similar crisis, such as eviction forbearance, occupancy restrictions, vaccine mandates, or suspension of mortgage foreclosures, could have a negative impact on our business.
If we are not able to retain or attract key employees, or if we were to suffer the loss of a significant number of employees, we could experience a disruption in our business.
If a key employee or a substantial number of employees depart or become unable to perform their duties, it may negatively impact our ability to conduct business as usual. Unanticipated departures might require us to divert resources from other areas of our operations, which could create additional stress for other employees, including those in key positions. The
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loss of qualified and key personnel, or an inability to continue to attract, retain and motivate key personnel could adversely affect our business and consequently impact our financial condition and results of operations.
Our risk management framework may not be effective in mitigating risks and losses to us.
Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risks to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances and may not adequately mitigate any risk of loss to us. If our framework is not effective, we could suffer unexpected losses and our financial condition, operations or business prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
Climate change could adversely affect our business, affect client activity levels and damage our reputation.
Concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts around the world to mitigate those impacts. Consumers and businesses are also changing their behavior and business preferences as a result of these concerns. New governmental regulations or guidance relating to climate change, as well as changes in consumers’ and businesses’ behaviors and business preferences, may affect whether and on what terms and conditions we will engage in certain activities or offer certain products or services. The governmental and supervisory focus on climate change could also result in our becoming subject to new or heightened regulatory requirements, such as requirements relating to operational resiliency or stress testing for various climate stress scenarios. Any such new or heightened requirements could result in increased regulatory, compliance or other costs or higher capital requirements. In connection with the transition to a low carbon economy, legislative or public policy changes and changes in consumer sentiment could negatively impact the businesses and financial condition of our clients, which may decrease revenues from those clients and increase the credit risk associated with loans and other credit exposures to those clients. Our business, reputation and ability to attract and retain employees may also be harmed if our response to climate change is perceived to be ineffective or insufficient.
Furthermore, the long-term impacts of climate change will have a negative impact on our customers and their business. Physical risks include extreme storms or wildfires that damage or destroy property and inventory securing loans we make, or may interrupt our customer’s business operations, putting them in financial difficulty, and increasing the risk of default. Our customers are also facing changes in energy and commodity prices driven by climate change, as well as new regulatory requirements resulting in increased operational costs.
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 previously entered into 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. Our failure or our inability to comply with the
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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 were subject to a Consent Order and have paid a civil money penalty with respect to our Anti Money Laundering/Combating the Financing of Terrorism Program, (“AML/CFT Program”) (formerly known as 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 Bank was previously subject to a Consent Order from the Office of the Comptroller of the Currency (“OCC”) for its BSA program that was issued in February 2018 (the “BSA Consent Order”). The BSA Consent Order resulted in the Bank incurring significant expenses to implement an effective AML/CFT Program, including payment of a $2,500,000 civil money penalty. The OCC terminated the BSA Consent Order in December 2021. However, the Bank remains subject to the BSA, the Patriot Act, and other laws and regulations requiring 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. Failure to maintain an effective AML/CFT program could have serious business, financial and 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 WDFI, CFPB and the FDIC. In addition, the FRB 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 WDFI, 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. In particular, the FDIC has specific authority to take “prompt corrective action,” if the Bank’s capital falls below its current “well capitalized” level, including limiting the Bank’s ability to take brokered deposits, requiring the Bank to raise additional capital and subject it to progressively more severe restrictions on its operations, management and capital distributions, and replacement of senior executive officers and directors. If the Bank ever became “critically undercapitalized,” it would also be subject to the appointment of a conservator or receiver.
Failure to comply with applicable laws and regulations can result in a range of sanctions and enforcement actions, including the imposition of civil money penalties, formal agreements and cease and desist orders; identified deficiencies in our HMDA reporting and AML/CFT programs have resulted in Consent Orders from the CFPB and OCC, required us to incur significant expenses and compliance costs and subjected us to civil penalties. 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.
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.
The recent failures of Silicon Valley Bank and Signature Bank are expected to result in modifications to or additional laws and regulations governing banks and bank holding companies, including increasing capital requirements, modifications to regulatory requirements with respect to liquidity risk management, deposit concentrations, capital adequacy, stress testing and contingency planning, and safe and sound banking practices, or enhanced supervisory or enforcement activities. Other legislative initiatives could detrimentally impact our operations in the future. Regulatory bodies may enact new laws or
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promulgate new regulations or view matters or interpret laws and regulations differently than they have in the past, or commence investigations or inquiries into our business practices. For example, the Biden Administration announced a government-wide effort to eliminate “junk fees” which could subject our business practices to even further scrutiny. The CFPB’s action on junk fees thus far has largely focused on fees associated with deposit products, such as “surprise” overdraft fees and non-sufficient funds fees.However, what constitutes a “junk fee” remains undefined. The CFPB is actively soliciting consumer input on fee practices associated with other consumer financial products or services, signaling that the “junk fee” initiative is likely to continue to broaden in scope. As a result of this regulatory focus, we have changed how we assess overdraft and non-sufficient funds fees and we may be required to implement additional changes based on regulatory directives or guidance.Such changes have led to and may continue to cause a reduction in our non-interest income thus impacting our overall net income.
The extent of the impact of any future legislation will be dependent on the specific details of the final legislation passed, if any, but the potential changes outlined above could, among other things, increase our costs, limit our ability to pursue business opportunities and the types of financial services and products we may offer, and impact future growth, any of which could materially and adversely affect our business, results of operations or financial condition.
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. Historically, unfavorable economic conditions increased bank failures and these additional bank failures decreased the DIF. Extraordinary growth in insured deposits during the first and second quarters of 2020 caused the ratio of the DIF to total insured deposits to fall below the current statutory minimum of 1.35%. In order to restore the DIF to its statutorily mandated minimums, the FDIC significantly increased deposit insurance premium rates, including the Bank's, resulting in increased expenses. The revised assessment rate schedules became effective January 1, 2023, and are applicable to the first quarterly assessment period of 2023 (i.e., January 1 through March 31, 2023, with an invoice payment date of June 30, 2023). The FDIC may further increase the assessment rates or impose additional special assessments in the future to restore and then steadily increase the DIF to these statutory target levels. Any increase in the Bank's FDIC premiums could have an adverse effect on its business, financial condition and results of operations. FDIC insurance premiums could increase in the future in response to similar declining economic conditions.
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, including claims alleging deceptive practices or violations of account terms in connection with non-sufficient funds or overdraft charges and violations of the Fair Labor Standards Act (“FLSA”). In 2022, the Bank paid $495,000 plus claims administrative expenses to settle a class action lawsuit related to allegations of improper assessments of overdraft and insufficient funds fees. In April 2023, we received a letter from an attorney alleging violations of the FLSA and seeking to recover damages for allegedly unpaid wages and overtime for certain of our non-exempt employees. We do not believe these allegations have merit and will oppose any lawsuit if one is filed. If this, or another class action lawsuit is filed or 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.
Our real estate lending also exposes us to the risk of environmental liabilities.
In the course of our business, it is necessary to foreclose and take title to real estate, which could subject us to environmental liabilities with respect to these properties. Hazardous substances or waste, contaminants, pollutants or sources thereof may be discovered on properties during our ownership or after a sale to a third party. We could be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic
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substances or chemical releases at such properties. The costs associated with investigation or remediation activities could be substantial and could substantially exceed the value of the real property. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. We may be unable to recover costs from any third party. These occurrences may materially reduce the value of the affected property, and we may find it difficult or impossible to use or sell the property prior to or following any environmental remediation. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
Market and Industry Risks
Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system.
The recent high-profile bank failures have generated significant market volatility among publicly traded bank holding companies and, in particular, regional banks like the Company. These market developments have negatively impacted customer confidence in the safety and soundness of regional banks. While the Department of the Treasury, the FRB, and the FDIC have taken steps to ensure that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in regional banks and the banking system more broadly. If other banks and financial institutions enter receivership or become insolvent in the future due to financial conditions affecting the banking system and financial markets, it could cause further disruption to the financial services industry and customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations.
Reflecting concerns about liquidity and the uncertain economic environment, many lenders have reduced funding to borrowers.This tightening of credit has also contributed to a lack of consumer confidence and increased market volatility.
A worsening of any of the foregoing conditions would likely exacerbate the adverse effects of these challenging market conditions on us and others in the banking industry. In particular, we may face increased regulation of our industry, including increased compliance costs and limitations on our ability to pursue business opportunities; significantly higher Federal Deposit Insurance Corporation premiums; adverse impacts on our stock price and volatility of our Common Stock; and increased competition for deposits due to a lack of consumer confidence in regional banks. If these conditions or similar ones continue to exist or worsen, we could experience continuing or increased adverse effects on our financial condition.
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, in particular commercial real estate loans which are generally viewed as having more risk of default than residential real estate loans or certain other types of loans or investments. 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.Because our loan portfolio contains commercial real estate loans with relatively large balances, the deterioration of these loans may cause a significant increase in our nonperforming loans which could result in a loss of earnings from these loans, an increase in the provision for loan losses, or an increase in loan charge-offs, any of which would have an adverse impact, which could be material, on our business, financial condition, and results of operations.
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.
Changes in retail distribution strategies and consumer behavior may adversely impact our business, financial condition and results of operations.
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We have significant investments in bank premises and equipment for our branch network as well as our retail work force and other branch banking assets. Advances in technology such as e-commerce, telephone, internet and mobile banking, and in-branch self-service technologies including automatic teller machines and other equipment, as well as changing customer preferences for these other methods of accessing our products and services, could decrease the value of our branch network or other retail distribution assets and may cause us to change our retail distribution strategy, close and/or sell certain branches or parcels of land held for development and restructure or reduce our remaining branches and work force. As a result of the current market environment and customer behavior, we have undertaken a branch optimization strategy that has led to the closure, consolidation or sale of certain branches in our network. These actions could lead to losses on these assets or could adversely impact the carrying value of other long-lived assets and may lead to increased expenditures to renovate and reconfigure remaining branches or to otherwise further reform our retail distribution channel. In addition, any changes in our branch network strategy could adversely impact our business, financial condition or operations if it results in the loss of customers or deposits which we rely on as a low cost and stable source of funds for our loans and 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 operations are focused in the western United States, subjecting us to the risks of general economic conditions in these market areas.
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 repay loans.
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. During the COVID-19 emergency, certain states in which we do business enacted temporary stays on evictions and foreclosures, or instituted a right to forbearance for homeowners experiencing financial hardship. Even before the adoption of these emergency policies, 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. Should these stays or rights to forbearance be enacted again, or if new legislation is passed regarding residential foreclosures, we may be limited in our ability 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.
Impairment of goodwill may adversely impact future results of operations.
Accounting standards require that we account for acquisitions using a method that could result in goodwill. If the purchase price of the acquired company exceeds the fair value of the acquired net assets, the excess will be included in the Company's Statement of Financial Condition as goodwill. The Company has a significant goodwill balance and, in accordance
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with GAAP, we evaluate it for impairment at least annually and more often if events or circumstances indicate the possibility of impairment. Evaluations may be based on many factors, some of which are the price of our Common Stock, discounted cash flow projections and data from comparable market acquisitions. A significant and sustained decline in our stock price and market capitalization, a significant decline in our expected future cash flows, a significant adverse change in the business climate or slower growth rates could result in impairment of our goodwill. Future evaluations of goodwill may result in the impairment and write-down of our goodwill balance which could have a material adverse impact on our earnings and adversely affect our operating results.
Competitive Risks
The Bank faces strong competition from other financial institutions and new market participants, offering services similar to those offered by the Bank.
Many competitors, including fintech companies, offer the same types of loan and deposit services that the Company offers. These competitors include national and multinational banks, other regional 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.
We may not be able to continue to grow organically or through acquisitions.
Historically, we have expanded through a combination of organic growth and acquisitions. If market and regulatory conditions change, we may be unable to grow organically or successfully compete for, complete, and integrate potential future acquisitions at the same pace as we have achieved in recent years, or at all. We have historically used our strong stock currency and capital resources to complete acquisitions. Downturns in the stock market and the market price of our stock, changes in our capital position, and changes in our regulatory standing could each have a negative impact on our ability to complete future acquisitions.
The Company’s entry into California may present increased risk that may adversely impact our business, prospects and financial condition.
The merger will result in WaFd significantly expanding our operations into the state of California where we have limited operating experience. The banking and financial services business in California is highly competitive. Our entry into California will present us with different competitive conditions and we will be required to compete for loans, deposits and customers for financial services with many new competitors in California. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than we do. As a result, there can be no assurance that we will be able to compete effectively in California, and the results of our operations could be materially and adversely affected if we are unable to compete effectively.
Security Ownership Risks
Our ability to pay dividends is subject to limitations that may affect our ability to continue to pay dividends to shareholders.
The Company is a separate legal entity from the bank subsidiary and does not have significant operations of its own. The availability of dividends from the Bank is limited by the Bank's earnings and capital, as well as various federal and state 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 preferred or Common Stock to our shareholders. If the Bank earnings are not sufficient to make dividend payments to us while maintaining adequate capital levels, then our liquidity may be affected and 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.
Our 4.875% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) ranks senior to our Common Stock, and we are prohibited from paying dividends on our Common Stock unless we have paid dividends on our Series A Preferred.
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Shares of our Series A Preferred Stock rank senior to our Common Stock with respect to the payment of dividends and distributions of assets upon liquidation, dissolution or winding up. Holders of Series A Preferred Stock are entitled to receive, when, as, and if declared by our Board of Directors (or a duly authorized committee of our Board of Directors), out of assets legally available for the payment of dividends under Washington law, non-cumulative cash dividends based on the liquidation preference of the Series A Preferred Stock at a rate equal to 4.875% per annum for each quarterly dividend period, beginning on April 15, 2021. If we do not or are unable to pay quarterly dividends on our Series A Preferred Stock, we may not pay a dividend to the holders of our Common Stock. 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.
In addition, if we fail to pay, or declare and set apart for payment, dividends on our Series A Preferred Stock for six quarterly dividend periods, whether or not consecutive, the number of directors on our Board of Directors will automatically be increased by two, and the holders of shares of Series A Preferred Stock will have the right to elect two additional members of our Board of Directors (the “Preferred Stock Directors”) to fill such newly created directorships.
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. We expect to see additional volatility in the financial markets due to the uncertainty caused by the continuing global conflicts, commodity shortages and price fluctuations, recent bank failures, uncertainty over the U.S. government debt ceiling, risks of government shutdowns and changing Federal Reserve policy. 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 U. S. and the financial markets generally.
•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, including the pending merger with Luther Burbank.
•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.
If the merger with Luther Burbank is approved, the Company’s shareholders will have less influence as a shareholder of the combined company than as a shareholder of Company.
The Company’s shareholders currently have the right to vote in the election of the Board of Directors and on other matters affecting the Company. Based on WaFd’s stock price as of November 1, 2023, following completion of the merger, the shareholders of Luther Burbank as a group are expected to hold a maximum ownership interest of approximately 21% of the Company. As a result, after the merger, a current Company's shareholders’ percentage ownership of the combined company will be smaller than such shareholder’s current percentage ownership of the Company’s 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 or depositary shares.
Our Board of Directors is authorized to cause the Company to issue one or more classes or series of preferred stock junior to our Series A Preferred Stock from time to time without any action on the part of our shareholders, and our Board of Directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights, and preferences over the Common Stock with respect to dividends or upon our dissolution, winding up and liquidation and other terms.
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. We may also elect to use Common Stock to fund new acquisitions, which will further dilute existing shareholders. Holders of our Common Stock have no preemptive rights that
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entitle 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 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.
If we need additional funds for our liquidity needs, we may seek additional debt 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, without complying with certain shareholder approval requirements. An acquiring person is defined as a person or group of persons that beneficially own 10% or more of our voting securities. 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.
The Company’s business or the value of its common shares could be negatively affected as a result of actions by activist shareholders.
The Company values constructive input from shareholders, and our Board of Directors and management team are committed to acting in the best interests of all of the Company’s shareholders. Activist shareholders who disagree with the composition of the Board of Directors, the Company’s strategic direction, or the way the Company is managed may seek to effect change through various strategies that range from private engagement to public filings, proxy contests, efforts to force transactions not supported by the Board of Directors, and litigation. Responding to some of these actions can be costly and time-consuming, may disrupt the Company’s operations and divert the attention of the Board of Directors and management. Such activities could interfere with the Company’s ability to execute its strategic plan and to attract and retain qualified executive leadership. The perceived uncertainty as to the Company’s future direction resulting from activist strategies could also affect the market price and volatility of the Company’s common shares.
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, as well as certain branch properties. 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 locations as necessary to maintain efficient and attractive premises. For further information on these activities, see Notes J andM to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.
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
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Common Stock
The Company’s Common Stock is traded on the Nasdaq Global Select Market of The Nasdaq Stock Market LLC under the symbol “WAFD.” At September 30, 2023, the number of shareholders of record was 1,045. This figure does not represent the actual number of beneficial owners of Common Stock because shares are frequently held in “street name” by securities dealers and others for the benefit of individual owners who may vote the shares.
Additional information about stock options and other equity compensation plans is included in Note P to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.
The Company’s ability to pay dividends is subject to bank regulatory requirements, including (but not limited to) the capital adequacy regulations and policies established by the Board of Governors of the Federal Reserve System. The Company’s Board of Directors' dividend policy is to review our financial performance, capital adequacy, regulatory compliance and cash resources on a quarterly basis, and, if such review is favorable, to declare and pay a quarterly cash dividend to common shareholders.
The Company’s 4.875% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred”), ranks senior to the Company’s Common Stock with respect to payment of dividends, and dividends (if declared) accrue and are payable on the Series A Preferred a rate of 4.875% per annum, payable quarterly, in arrears. While the Series A Preferred is outstanding, unless the full dividend for the preceding quarterly period is paid in full, or declared and a sum set aside, no dividend may be declared or paid on the Company’s Common Stock.
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 76,956,264 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, 2023.
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Performance Graphs
The following graphs compare the cumulative total return to WaFd shareholders (stock price appreciation plus reinvested dividends) to the cumulative total return of the Nasdaq Stock Market Index (U.S. Companies) and the KBW Bank Index for the five year period ended September 30, 2023, and since WaFd first became a publicly traded company on November 9, 1982, respectively. The graphs assume that $100 was invested on September 30, 2018, and November 9, 1982, respectively, in WaFd Common Stock, the Nasdaq Stock Market Index and the Nasdaq Financial Stocks Index, and that all dividends were reinvested. Management of WaFd cautions that the stock price performance shown in the graphs below should not be considered indicative of potential future stock price performance.
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Item 6. [Reserved]
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with our Consolidated Financial Statements and related notes in “Item 8. Financial Statements and Supplementary Data” of this report. In the following discussion, unless otherwise noted, references to increases or decreases in average balances in items of income and expense for a particular period and balances at a particular date refer to the comparison with corresponding amounts for the period or date for the previous year.
In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. For management's review of the factors that affected our results of operations for the years ended September 30, 2022 and 2021, refer to our Annual Report on Form 10-K for the year ended September 30, 2022, which was filed with the Securities and Exchange Commission on November 18, 2022.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to use judgment in making estimates and assumptions that affect the reported amounts within the consolidated financial statements. Actual results may differ from these estimates. While our significant accounting policies are described in more detail in Note A to the Consolidated Financial Statements, we believe that the accounting policies discussed below are critical for understanding our historical and future performance. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of the matters that are inherently uncertain.
Allowance for Credit Losses. Management’s determination of the amount of the ACL is a critical accounting estimate as it requires significant reliance on the credit risk we ascribe to individual borrowers, the use of estimates and significant judgment as to the amount and timing of expected future cash flows on individually evaluated loans, significant reliance on historical loss rates on homogeneous portfolios, consideration of our quantitative and qualitative evaluation of past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts.
Going forward, the methodology used to calculate the ACL will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the allowance for credit losses, and therefore, greater volatility in our reported earnings.
Goodwill. Goodwill represents the excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed. We have determined our goodwill balance is all related to a single reporting unit and perform an annual impairment assessment on August 31st, or sooner if an impairment indicator exists. We perform a quantitative impairment assessment and, upon performing the quantitative test, if the carrying value of the reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
When performing the quantitative assessment of goodwill impairment, we estimate the fair value of our reporting unit using the market capitalization approach, based on quoted market prices of our securities, adjusted for the effect of a control premium. Based on the results of the annual quantitative evaluation for 2023, the fair value of our single reporting unit exceeded its respective carrying value and did not result in impairment for the reporting unit.
The Company continuously monitors for events and circumstances that could negatively impact the key assumptions in determining fair value. While the Company believes the judgments and assumptions used in the goodwill impairment test are reasonable, different assumptions or changes in general industry, market and macro-economic conditions could change the estimated fair values and, therefore, future impairment charges could be required, which could be material to the consolidated financial statements.
Select information regarding the ACL is under the "Allowance for Credit Losses" heading within this section below. For further details on the ACL or goodwill, see Notes A andE to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data.”
UPDATE ON LUTHER BURBANK MERGER
On November 13, 2022, the Company announced that it had entered into a definitive agreement and plan of reorganization with Luther Burbank Corporation (“Luther Burbank”), pursuant to which Luther Burbank will be merged with and into WaFd with WaFd as the surviving institution, promptly followed by the merger of Luther Burbank’s wholly-owned bank subsidiary, Luther Burbank Savings, (“LBS”) with and into WaFd Bank (the “Merger”). The proposed Merger is an all-stock transaction valued at approximately $654 million based upon the closing price of the Company’s Common Stock on November 11, 2022. As part of the merger agreement, Luther Burbank shares of Common Stock will be converted into, and canceled in exchange for, the right to receive 0.3353 shares of the Company’s Common Stock, with Luther Burbank shareholders receiving cash in lieu of fractional shares of Company Common Stock. The Company has submitted an application for approval of the Merger to the Washington State Department of Financial Institutions (“WDFI”), the Federal Deposit Insurance Corporation (“FDIC”) and the Board of Governors of the Federal Reserve System (“Federal Reserve”). Shareholders of both companies approved the Merger at special meetings of their respective shareholders on May 4, 2023. On October 13, 2023, the WDFI approved the Merger subject to approval by the Federal Reserve and the FDIC. The Company continues to work with the Federal Reserve and the FDIC to receive their approval. Luther Burbank is headquartered in Santa Rosa, CA and operates 10 full service branches in
39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
California, 1 full service branch in Washington, 6 loan production offices in California and one loan production office in Oregon. If approved, the Merger will result in the Bank’s footprint expanding to include the state of California.
RECENT INDUSTRY DEVELOPMENTS
During the first calendar quarter of 2023, the banking industry experienced significant volatility with multiple high-profile bank failures, primarily due to liquidity concerns. This resulted in industry-wide uncertainty and concerns related to liquidity, deposit outflows, unrealized securities losses and eroding consumer confidence in the banking system. The Company took a number of preemptive actions which included proactive outreach to clients and actions to maximize funding sources in response to these recent developments. These actions included increasing the target cash balance range, enhancing deposit flow and concentration monitoring, and utilizing the Federal Reserve's Bank Term Funding Program as an additional source of liquidity.
Despite these negative industry developments, the Company's liquidity position and balance sheet remain strong and the Company did not experience negative impacts to its financial condition outside of those observed generally across the industry, such as increasing funding costs. The Company experienced net deposit inflows for the year ending September 30, 2023 with total deposits increasing slightly by 0.25%. Our deposit base is highly diversified with little industry or customer concentration and 74% of total deposits are FDIC insured or collateralized as of September 30, 2023. Furthermore, the Company remains well capitalized. The Company's capital at September 30, 2023 remains at high levels with common equity tier 1 capital ("CET1") and total risk-based capital ratios of 10.37% and 13.31%, respectively, for the Company and 11.63% and 12.81% for the Bank, respectively, which exceed the regulatory minimum well-capitalized guidelines of 6.50% and 10.00%.
The FDIC has approved a final rule to implement a special assessment to recover the loss to the DIF following the recent bank closures. The special assessment will be 13.4 basis points applied to estimated uninsured deposits greater than $5 billion, collected over eight quarterly assessment periods beginning in the first quarterly assessment period of 2024. The assessment is subject to true ups based on the changes to the estimated loss from the receiverships and corrective amendments to the amount of uninsured deposits reported for December 31, 2022. Management does not expect the resulting expense to be material to its financial results given the Company's low level of uninsured deposits.
40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ALLOWANCE FOR CREDIT LOSSES
The following table provides detail regarding the Company's allowance for credit losses (periods prior to 2020 applied the incurred loss model as the current expected credit loss methodology ("CECL") was implemented in 2020).
(In thousands)
Charge-offs:
Commercial loans
Multi-Family — — — — —
Construction — — — — —
Land – Acquisition & Development — 11 2 11 107
Consumer loans
Construction – Custom — — — — 1,973
Recoveries:
Commercial loans
Multi-Family — — — 498 —
Consumer loans
Construction – Custom — — — — —
(1) This does not include a reserve for unfunded commitments of $24,500,000, $32,500,000, $27,500,000, $25,000,000 and $6,900,000 as of September 30, 2023, 2022, 2021, 2020 and 2019 respectively.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows changes in the Company's allowance for credit losses since the prior year.
(In thousands)
Allowance for credit losses:
Commercial loans
Consumer loans
The allowance for loan losses increased by $4,399,000, or 2.55%, from $172,808,000 as of September 30, 2022, to $177,207,000 at September 30, 2023. As of September 30, 2023, the allowance of $177,207,000 is for loans that are evaluated on a pooled basis, which was comprised of $107,049,000 related to the quantitative component and $70,158,000 related to management's qualitative overlays.
The Company recorded a provision for credit losses of $41,500,000 in 2023, compared to a provision of $3,000,000 for 2022. These amounts are net of provision and recapture related to the unfunded commitments reserve. In 2023, provisioning was largely due to adjustments resulting from one large charge-off taken, offset by reduced unfunded commitment balances. For the year ended September 30, 2023, net charge-offs were $45,101,000, compared to recoveries of $3,508,000 in the prior year. The ratio of the total ACL to total gross loans decreased to 1.03% as of September 30, 2023, as compared to 1.06% as of September 30, 2022. The decrease was primarily related to a shift in mix of loan types within the portfolio. Loan portfolios with lower historical losses, like multi-family and single family residential saw increased balances while those with higher historical losses, like construction, saw decreases.
The reserve for unfunded loan commitments was $24,500,000 as of September 30, 2023, compared to $32,500,000 as of September 30, 2022.
Management believes the total ACL is sufficient to absorb estimated losses inherent in the portfolio of loans and unfunded commitments.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the amount of the Company’s allowance for loan losses by loan portfolio and class (periods prior to 2020 applied the incurred loss model as CECL was implemented in 2020).
($ in thousands)
Commercial loans
Consumer loans
___________________
(1)Represents the loans receivable for each respective loan class as a % of total loans receivable.
(2)Represents the allowance for each respective loan class as a % of loans receivable for that same loan class. The underlying commercial & industrial loan balances for September 30, 2023, 2022, 2021, 2020 include PPP loans for which no allowance was recorded. These PPP loan balances were $1,000,000, $10,000,000, $312,000,000 and $745,000,000 as of September 30, 2023, 2022, 2021, and 2020 respectively.
(3)This does not include a reserve for unfunded commitments of $24,500,000, $32,500,000, $27,500,000, $25,000,000 and $6,900,000 as of September 30, 2023, 2022, 2021, 2020 and 2019, respectively.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSET QUALITY
Troubled debt restructured loans ("TDRs"). TDRs are reserved for under the Company's CECL methodology. Most TDRs are performing and accruing loans where the borrower has proactively approached the Company about modifications due to temporary financial difficulties. Each request is individually evaluated for merit and likelihood of success. The concession for these loans is typically a payment reduction through a rate reduction of 100 to 200 basis points for a specific term, usually six to twelve months. Interest-only payments may also be approved during the modification period.
Concessions for construction, land A&D and multi-family loans are typically an extension of maturity combined with a rate reduction of normally 100 basis points. Before granting approval to modify a loan in a TDR, a borrower’s ability to repay is considered by evaluating current income levels, debt-to-income ratio, credit score, loan payment history and an updated evaluation of the secondary repayment source.
If a loan is on non-accrual status before becoming a TDR, it will stay on non-accrual status following restructuring until it has been performing for at least six months, at which point it may be moved to accrual status. If a loan is on accrual status before it becomes a TDR, and it is concluded that a full repayment is highly probable, it will remain on accrual status following restructuring. If the homogeneous restructured loan does not perform, it is placed in non-accrual status when it is 90 days delinquent. For commercial loans, six consecutive payments on newly restructured loan terms are required prior to returning the loan to accrual status. After the required six consecutive payments are made, a management assessment may conclude that collection of the entire principal and interest due is still in doubt. In those instances, the loan will remain non-accrual. A loan that defaults and is subsequently modified would impact the Company's delinquency trend, which is part of the qualitative risk factors component of the CECL methodology. Any modified loan that re-defaults and is charged-off would impact the quantitative component of the CECL methodology.
Non-Performing Assets. When a borrower violates a condition of a loan, the Bank attempts to cure the default by contacting the borrower. In most cases, defaults are cured promptly. If the default is not cured within an appropriate time frame, typically 90 days, the Bank may institute appropriate action to collect the loan, such as making demand for payment or initiating foreclosure proceedings on the collateral. If foreclosure occurs, the collateral will typically be sold at public auction and may be purchased by the Bank.
Loans are placed on nonaccrual status when, in the judgment of management, the probability of collecting interest or principal is deemed to be insufficient to warrant further accrual. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income. The Bank does not accrue interest on loans 90 days past due or more. See Note A to the Consolidated Financial Statements included in Item 8 hereof for additional information.
The Bank will consider modifying the interest rate and terms of a loan if it determines that a modification is deemed to be the best option available for collection in full or to minimize the loss to the Bank. Most loans restructured in TDRs are accruing and performing loans where the borrower has proactively approached the Bank about a modification due to temporary financial difficulties. Each request is individually evaluated for merit and likelihood of success. The modification of these loans is typically a payment reduction through a rate reduction of between 100 to 200 bps for a specific term, usually six to twelve months. Interest-only payments may also be approved during the modification period. Principal forgiveness generally is not an available option for restructured loans. As of September 30, 2023, single-family residential loans comprised 84.7% of restructured loans. The Bank reserves for restructured loans within its pool based general reserve methodology, except in instances where management considers it appropriate to evaluate individually.
Real estate acquired by foreclosure or deed-in-lieu thereof (“REO” or “Real Estate Owned”) is classified as real estate held for sale. When property is acquired, it is recorded at the fair market value less estimated selling costs at the date of acquisition. Interest accrual ceases on the date of acquisition and all costs incurred in maintaining the property from that date forward are expensed as incurred. Costs incurred for the improvement or development of such property are capitalized. See Note A to the Consolidated Financial Statements included in Item 8 hereof for additional information.
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth information regarding the Company's restructured loans and non-performing assets.
(In thousands)
Non-accrual loans:
Commercial loans
Land – acquisition & development — — 2,340 — 169
Consumer loans
Construction – custom 88 435 — — —
Total non-performing assets to total assets 0.26 % 0.21 % 0.22 % 0.20 % 0.27 %
___________________
(1) For the year ended September 30, 2023, the Company recognized $2,824,000 in interest income on cash payments received from borrowers on non-accrual loans. The Company would have recognized interest income of $1,981,000 for the same period had these loans performed according to their original contract terms. The recognized interest income may include more than twelve months of interest for some of the non-accrual loans that were brought current or paid off. In addition to the non-accrual loans reflected in the above table, the Company had $263,075,000 of loans that were less than 90 days delinquent at September 30, 2023 but were classified as substandard for one or more reasons. If these loans were deemed non-performing, the Company's ratio of total non-performing assets and performing restructured loans as a percent of total assets would have increased to 1.63% at September 30, 2023. For a discussion of the Company's policy for placing loans on non-accrual status, see Note A to the Consolidated Financial Statements included in Item 8 of this report.
Non-performing assets increased 30.0% to $57,924,000, or 0.26% of total assets, at September 30, 2023, compared to $44,554,000, or 0.21% of total assets, at September 30, 2022. The increase was primarily a result of an increase of $15,888,000 in non-accrual loans partially offset by a $2,518,000 decline in real estate owned. Other property owned of $3,353,000 as of September 30, 2023 is comprised entirely of a government guarantee related to equipment obtained via a commercial loan foreclosure.
45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TDRs declined to $46,117,000 as of September 30, 2023, from $56,817,000 as of September 30, 2022. As of September 30, 2023, $45,167,000 or 97.9% of TDRs were performing. Non-performing TDRs of $950,000 are included in NPAs. Total NPAs and performing TDRs as a percent of total assets have declined to 0.46% as of September 30, 2023, from 0.48% as of September 30, 2022. During 2023, there were no TDR additions and reductions of $10,700,223 due to prepayments and normal payment activity. As of September 30, 2023, 84.7% of TDRs are comprised of single-family residential loans.
As of September 30, 2023, real estate owned totaled $4,149,000, a decrease of $2,518,000, or 37.8%, from $6,667,000 as of September 30, 2022, primarily due to sales of REO properties offset by new REO additions. During 2023, the Company sold real estate owned properties for total net proceeds of $7,192,000. The majority of REO properties are former bank premises that are expected to be sold.
The ratio of the allowance for loan losses to non-accrual loans decreased to 351% as of September 30, 2023, from 500% as of September 30, 2022.
46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CHANGES IN FINANCIAL CONDITION
Cash and cash equivalents: Cash and cash equivalents increased to $980,649,000 at September 30, 2023, as compared to $683,965,000 at September 30, 2022. The change was meant to increase balance sheet liquidity and was used to fund growth in the loan portfolio. The increase in cash was the result of the $40,759,000 increase in customer accounts and $1,525,000,000 increase in borrowings.
Available-for-sale investment securities: Available-for-sale securities decreased $55,940,000, or 2.7%, during the year ended September 30, 2023, to $1,995,097,000, primarily due to principal repayments of $420,154,000, which exceeded purchases of $376,481,000, a $9,360,000 decline in the value of available-for-sale securities, and sales of $1,169,000. As of September 30, 2023, the Company had a net unrealized loss on available-for-sale securities of $123,519,000, which is recorded net of tax within AOCI, compared to an unrealized loss of $111,700,000 as of September 30, 2022.
Substantially all of the Company’s available-for-sale debt securities are issued by U.S. government agencies or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government and have a long history of zero credit loss. The remaining securities are issued by highly-rated municipalities or corporate borrowers. The Company does not believe that any of its available-for-sale debt securities have credit loss impairment as of September 30, 2023, therefore, no allowance was recorded. The impact going forward will depend on the composition, characteristics, and credit quality of the securities portfolios as well as the economic conditions at future reporting periods.
Held-to-maturity investment securities: Held-to-maturity securities decreased by $39,713,000 to $423,586,000, or 8.6%, during the year ended September 30, 2023, primarily due to principal repayments and maturities of $39,414,000. There were no held-to-maturity securities sold during the year ended September 30, 2023. As of September 30, 2023, the net unrealized loss on held-to-maturity securities was $68,398,000, compared to $56,439,000 the year prior, which management attributes to the change in interest rates since acquisition.
All of the Company’s held-to-maturity debt securities are issued by U.S. government agencies or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government and have a long history of zero credit loss, thus the Company did not record an allowance for credit losses for held-to-maturity securities as of September 30, 2023. The impact going forward will depend on the composition, characteristics, and credit quality of the securities portfolios as well as the economic conditions at future reporting periods.
The table below shows the available-for-sale and held-for-investment securities portfolios categorized by maturity band.
September 30, 2023 AmortizedCost Weighted Average Yield
($ in thousands)
For further information on our investment portfolio, see Note C to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.
Loans receivable: Loans receivable, net of related contra accounts, increased $1,362,986,000, or 8.5%, to $17,476,550,000 at September 30, 2023, from $16,113,564,000 one year earlier. The increase resulted primarily from originations of $4,702,156,000, a decrease to loans-in-process of $1,110,083,000 and loan purchases of $80,015,000, partially offset by loan repayments of $4,435,269,000 during the year ended September 30, 2023. Commercial loan originations accounted for 73.9% of total originations and consumer originations were 26.1% as the Company continues to focus on commercial lending, coupled with growing economies in all major markets in which we operate.
The following table presents loan balances by category and the year-over-year change.
47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
($ in thousands) ($ in thousands) $ %
Gross loans by category
Commercial loans
Consumer loans
Less:
The following table summarizes the Company’s loan portfolio balances, at amortized cost, due for the periods indicated based on contractual terms to maturity or repricing.
September 30, 2023 Total Less than1 Year 1 to 5Years 5 to 15Years After 15Years
(In thousands)
Commercial loans
Consumer loans
48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The contractual loan payment period for residential mortgage loans originated by the Company normally ranges from 15 to 30 years. Experience during recent years has indicated that, because of prepayments in connection with refinancing and sales of property, residential loans typically have a weighted average life of approximately five years.
The following tables provide information regarding loans receivable by loan class and geography.
(In thousands)
Percentage by geographic area
As % of total gross loans
Percentage by geographic area as a % of each loan type
As % of total gross loans
49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows the change in the geographic distribution by state of the loan portfolio since the prior year.
(1) Includes loans from outside of our eight state footprint.
Allowance for credit losses: For details, see the “Allowance for Credit Losses" section above in this report.
Non-performing assets: For details, see the “Asset Quality" section above in this report.
Troubled debt restructured loans ("TDRs"): For details, see the “Asset Quality" section above in this report.
Real estate owned: For details, see the “Asset Quality" section above in this report.
Interest receivable:Interest receivable was $87,003,000 as of September 30, 2023, an increase of $23,131,000, or 36.2%, since September 30, 2022. The increase was the result of an 8.5% increase in loans receivable combined with the increase in interest rates.
Bank Owned Life Insurance: Bank-owned life insurance increased to $242,919,000 as of September 30, 2023 from $237,931,000 as of September 30, 2022, primarily as a result of increases in the cash surrender value of the policies. The investments in bank-owned life insurance serve to assist in funding growing employee benefit costs.
Intangible assets: The Company's intangible assets totaled $310,619,000 at September 30, 2023 compared to $309,009,000 as of September 30, 2022. The balance at September 30, 2023 is comprised of $304,750,000 of goodwill and the unamortized balance of the core deposit and other intangibles of $5,869,000.
Customer accounts: As of September 30, 2023, customer deposits totaled $16,070,329,000 compared with $16,029,570,000 at September 30, 2022, a $40,759,000, or 0.3%, increase. During 2023, transaction accounts decreased by $1,926,214,000 or 15.2% while time deposits increased by $1,966,973,000 or 58.9%.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows customer deposits by account type.
The following table shows the geographic distribution by state for customer deposits.
($ in thousands) September 30, 2023 September 30, 2022 $ Change % Change
The following table sets forth, by various interest rate categories, the amount of fixed-rate time deposits that mature during the periods indicated.
Maturing in
(In thousands)
Fixed-rate time deposits:
Historically, a significant number of time deposit account holders roll over their balances into new time deposits of the same term at the Bank’s then current rate. To ensure a continuity of this trend, the Bank expects to continue to offer market rates of interest. The ability to retain maturing time deposits is difficult to project; however, the Bank believes that by competitively pricing these certificates, levels deemed appropriate by management can be achieved on a continuing basis.
51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At September 30, 2023, the Bank had $1,779,272,000 of time deposits in amounts of $250,000 or more outstanding, maturing as follows: $763,615,000 within 3 months; $419,791,000 over 3 months through 6 months; $281,404,000 over 6 months through 12 months; and $314,462,000 thereafter.
Time deposits with a maturity of one year or less have penalties for premature withdrawal equal to 90 days of interest. When the maturity is greater than one year but less than four years, the penalty is 180 days of interest. When the maturity is greater than four years, the penalty is 365 days of interest. Early withdrawal penalty fee income for the years ended 2023, 2022 and 2021 amounted to $1,618,000, $267,000 and $198,000, respectively.
For additional details on customer accounts, including uninsured deposits, see Note K to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this report.
Borrowings: Total borrowings increased to $3,650,000,000 as of September 30, 2023, as compared to $2,125,000,000 at September 30, 2022. Growth in loans receivable was largely funded by new borrowings from both the FHLB and FRB. The weighted average rate for borrowings was 3.98% as of September 30, 2023, versus 2.02% at September 30, 2022, the increase being primarily due to higher rates on new short-term borrowings. The Company has entered into interest rate swaps to hedge interest rate risk and convert certain FHLB advances to fixed rate payments. Taking into account these hedges, the weighted average effective maturity of FHLB advances at September 30, 2023 is 2.01 years.
RESULTS OF OPERATIONS
COMPARISON OF 2023 RESULTS WITH 2022
Net Income: Net income increased $21,096,000, or 8.9%, to $257,426,000 for the year ended September 30, 2023, as compared to $236,330,000 for the year ended September 30, 2022. The change was due to the factors described below.
Net Interest Income: For the year ended September 30, 2023, net interest income was $690,234,000, an increase of $95,645,000 or 16.1% from the year ended September 30, 2022. Net interest margin was 3.40% for the year ended September 30, 2023 compared to 3.16% in the prior year. The increase in net interest income was primarily due to rising interest rates. The average rate earned on interest-earning assets grew by 159 basis points to 5.13% while the average rate paid on interest-bearing liabilities increased by 168 basis points to 2.18%.
The change in net interest income was also impacted by the $1,514,820,000, or 8.1%, increase in interest earning assets while average interest-bearing liabilities increased by $1,698,461,000 or 11.7%. During 2023, the average balance of loans receivable increased $2,011,903,000 or 13.3%, while the combined average balances of mortgage backed securities, other investment securities and cash decreased by $536,288,000 or 14.7%. Average noninterest-bearing deposits decreased by $279,150,000 over the same period.
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the years indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (1) changes in volume (changes in volume multiplied by old rate) and (2) changes in rate (changes in rate multiplied by old average volume). The change in interest income and interest expense attributable to changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
52
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Twelve Months Ended September 30,
Volume Rate Total Volume Rate Total Volume Rate Total
(In thousands) (In thousands) (In thousands)
Interest income:
Interest expense:
___________________
(1)Includes interest on cash equivalents and dividends on stock of the FHLB of Des Moines and FRB of San Francisco.
Provision (Release) for Credit Losses: The Company recorded a provision for credit losses of $41,500,000 in 2023, compared to a provision of $3,000,000 for 2022. In 2023, provisioning was largely due to adjustments made as a result of one large charge-off taken, offset by reduced unfunded commitment balances. For the year ended September 30, 2023, net charge-offs were $45,101,000, compared to recoveries of $3,508,000 in the prior year.
Other Income: Other income was $52,201,000 for the year ended September 30, 2023, a decrease of $14,171,000, or 21.4%, from $66,372,000 for the year ended September 30, 2022. The decrease is primarily due to unrealized gains recorded in the prior year for certain equity investments that resulted in small losses in the current year. This change made up $13,992,730 of the overall decrease.
Other Expense: Operating expense was $376,035,000 for the year ended September 30, 2023, an increase of $17,460,000, or 4.9%, from the $358,575,000 for the year ended September 30, 2022. Compensation and benefits costs increased $2,617,000 or 1.3% year-over-year primarily due to annual merit increases and investments in strategic initiatives combined with reduced cost capitalization as loan originations have decreased. FDIC Premiums increased $10,494,000 in 2023 compared to the prior year as a result of increase FDIC assessment rates. Information technology costs increased by $2,245,000 in 2023 as compared to 2022 as we continue to execute becoming a digital first bank. Also, the Company realized expenses of $2,991,000 in 2023 related to our pending merger with Luther Burbank Corporation.
The Company’s efficiency ratio was 50.7% for 2023 as compared to 54.3% for the prior year. The number of staff, including part-time employees on a full-time equivalent basis, was 2,120 and 2,132 at September 30, 2023 and 2022, respectively. Total operating expense for the years ended September 30, 2023, and 2022 were 1.74% and 1.78%, respectively, of average assets.
Gain on Real Estate Owned: Net gain on real estate owned was $176,000 for the year ended September 30, 2023, compared to a net gain of $651,000 for the year ended September 30, 2022. This amount includes ongoing maintenance expense, periodic valuation adjustments, and gains on sales of REO.
53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Income Tax Expense: Income tax expense was $67,650,000 for the year ended September 30, 2023, an increase of $3,943,000, or 6.2%, from the $63,707,000 for the year ended September 30, 2022. The increase is mostly due to an 8.3% increase in pre-tax income. The effective tax rate for 2023 was 20.81% as compared to 21.23% for the year ended September 30, 2022. The effective tax rate of 20.81% for 2023 differs from the statutory rate of 21% mainly due to the effects of state taxes, tax exempt income, tax credit investments and certain differences in book and tax deductions.
COMPARISON OF 2022 RESULTS WITH 2021
For management's review of the factors that affected our results of operations for the years ended September 30, 2022 and 2021 refer to our Annual Report on Form 10-K for the year ended September 30, 2022, which was filed with the Securities and Exchange Commission on November 18, 2022.
LIQUIDITY AND CAPITAL RESOURCES
The principal sources of funds for the Company's activities are loan repayments (including prepayments), net deposit inflows, borrowings, repayments and sales of investments and retained earnings, if applicable. The Company's principal sources of revenue are interest on loans and interest and dividends on investments. Additionally, the Company earns fee income for loan, deposit, insurance and other services.
On February 8, 2021, in connection with an underwritten public offering, the Company issued 300,000 shares of 4.875% Noncumulative Perpetual Series A Preferred Stock (“Series A Preferred Stock”). Net proceeds, after underwriting discounts and expenses, were $293,325,000. The public offering consisted of the issuance and sale of 12,000,000 depositary shares, each representing a 1/40th interest in a share of the Series A Preferred Stock, at a public offering price of $25.00 per depositary share. Holders of the depositary shares are entitled to all proportional rights and preferences of the Series A Preferred Stock (including dividend, voting, redemption and liquidation rights). The depositary shares are traded on the NASDAQ under the symbol "WAFDP." The Series A Preferred Stock is redeemable at the option of the Company, subject to all applicable regulatory approvals, on or after April 15, 2026.
The Company's shareholders' equity at September 30, 2023, was $2,426,426,000, or 10.80% of total assets, as compared to $2,274,260,000, or 10.95% of total assets, at September 30, 2022. The Company's shareholders' equity was impacted in the year by net income of $257,426,000, the payment of $63,792,000 in Common Stock dividends, payment of $14,625,000 in preferred stock dividends, $30,463,000 of treasury stock purchases, as well as other comprehensive loss of $5,560,000. The Company paid out 26.6% of its 2023 earnings in cash dividends to common shareholders, compared with 28.0% last year. For the year ended September 30, 2023, the Company returned 36.6% of net income to shareholders in the form of cash dividends and share repurchases as compared to 27% for the year ended September 30, 2022. Management believes the Company's strong net worth position allows it to manage balance sheet risk and provide the capital support needed for controlled growth in a regulated environment. The Company’s share repurchase program may be modified, suspended or terminated at any time, and the timing and amount of share repurchases is subject to market conditions and the market price of the Company’s Common Stock, as well as other factors.
The Bank has a credit line with the FHLB of up to 45% of total assets depending on specific collateral eligibility. This line provides a substantial source of additional liquidity if needed. Based on collateral pledged as of September 30, 2023, the Bank had $2,357,588,000 of additional borrowing capacity at the FHLB.
The Bank has entered into borrowing agreements with the FHLB to borrow funds under a short-term floating rate cash management advance program and fixed-rate term advance agreements. All borrowings are secured by stock of the FHLB, deposits with the FHLB, and a blanket pledge of qualifying loans receivable as provided in the agreements with the FHLB.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Bank has elected to utilize the Federal Reserve's Bank Term Funding program to leverage its highly favorable terms to fortify the Bank's liquidity position. These borrowings are repayable at any time without penalty and are the lowest cost funding source available. Based on collateral pledged as of September 30, 2023, the Bank had $1,119,000,000 of additional borrowing capacity within the BTFP. The Bank is also eligible to borrow under the Federal Reserve Bank's primary credit program.
The Company's cash and cash equivalents were $980,649,000 at September 30, 2023, which is a 43.4% increase from the balance of $683,965,000 as of September 30, 2022. The change was meant to increase balance sheet liquidity and was used to fund growth in the loan portfolio. The increase in cash was the result of a $40,759,000 increase in customer accounts and $1,525,000,000 increase in borrowings. The net loans balance increased by $1,362,986,000 during the year ended September 30, 2023. See “Changes in Financial Condition” above and the “Statement of Cash Flows” included in the financial statements for additional details regarding this change.
The following table presents the Company's significant fixed and determinable contractual obligations, within the categories described below, by contractual maturity or payment amount.
September 30, 2023 Total Less than1 Year 1 to 5Years Over 5Years
(In thousands)
(1) Includes non-maturing customer transaction accounts.
(2) Represents contractual maturities of FHLB advances and FRB borrowings. Taking into account cash flow hedges, the weighted average effective maturity of FHLB advances at September 30, 2023 is 2.01 years.
These obligations are included in the Consolidated Statements of Financial Condition. The payment amounts of the operating lease obligations represent those amounts contractually due.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
The primary source of income for the Company is net interest income, which is the difference between the interest income generated by interest-earning assets and the interest expense incurred for interest-bearing liabilities. The level of net interest income is a function of the average balance of interest-earning assets and interest-bearing liabilities and the difference between the yield on earning assets and the cost of interest-bearing liabilities. Both the pricing and mix of the Company's interest-earning assets and interest-bearing liabilities influence these factors. All else being equal, if the interest rates on the Company's interest-bearing liabilities increase at a faster pace than the interest rates on its interest-earning assets, the result would be a reduction in net interest income and with it, a reduction in net earnings.
Interest rate risk arises in part due to the Bank's significant holdings of fixed-rate single-family home loans, which are longer-term than customer accounts that constitute its primary liabilities. Accordingly, assets do not usually respond as quickly to changes in interest rates as liabilities. In the absence of management action, net interest income can be expected to decline when interest rates rise and to expand when interest rates fall. Shortening the maturity or repricing of the investment portfolio is one action that management can take. The composition of the investment portfolio was 45.9% variable rate and 54.1% fixed rate as of September 30, 2023 to provide some protection against rising rates. In addition, the Bank is producing more commercial loans that have shorter terms and/or variable rates. There has also been focus on increasing less rate sensitive transaction deposit accounts. These accounts make up 67.0% of the deposit portfolio as of September 30, 2023.
The Company's balance sheet strategy, in conjunction with low operating costs, has allowed the Company to manage interest rate risk, within guidelines established by the Board, through all interest rate cycles. It is management's objective to grow the dollar amount of net interest income, through the rate cycles, acknowledging that there will be some periods of time when that will not be feasible. Cash and cash equivalents of $980,649,000 and shareholders' equity of $2,426,426,000 provide management with flexibility in managing interest rate risk. Based on management's assessment of the current interest rate environment, the Company has taken steps, including growing commercial loans having shorter average lives and transaction deposit accounts, to position itself for changing interest rates.
Net Interest Income Sensitivity. We estimate the sensitivity of our net interest income to changes in market interest rates using an interest rate simulation model that includes assumptions related to the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments for multiple interest rate change scenarios. Interest rate sensitivity depends on certain repricing characteristics in our interest-earning assets and interest-bearing liabilities, including the maturity structure of assets and liabilities and their repricing characteristics during the periods of changes in market interest rates. The analysis presented below assumes a constant balance sheet. Actual results would differ from the assumptions used in this model, as management monitors and adjusts loan and deposit pricing and the size and composition of the balance sheet to respond to changing interest rates.
In the event of an immediate and parallel increase of 200 basis points in both short- and long-term interest rates, the model estimates that net interest income would decrease by 2.0% in the next year. This compares to an estimated increase of 1.9% as of the September 30, 2022 analysis. It is noted that a flattening yield curve where the spread between short-term rates and long-term rates decreases would likely result in lower net interest income and vice versa for a steepening yield curve. Management estimates that a gradual increase of 300 basis points in short-term rates and 100 basis points in long-term rates over two years would result in a 0.2% increase in net interest income in the first year and a decrease of 1.0% in the second year, assuming a constant balance sheet and no management intervention. Alternatively, in the event of an immediate and parallel decrease of 100 basis points in both short and long-term interest rates, the model estimates that net interest income would increase by 4.94%.
Net Portfolio Value ("NPV") Sensitivity. The NPV is an estimate of the market value of shareholders' equity at a point in time. It is derived by calculating the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities and off-balance-sheet contracts. The sensitivity of the NPV to changes in interest rates provides a longer term view of interest rate risk of the current balance sheet as it incorporates all future expected cash flows. As of September 30, 2023, in the event of an immediate and parallel increase of 200 basis points in interest rates, the NPV is estimated to decrease by $723,000,000, or 27.4%, and the NPV-to-total assets ratio to decline to 9.5% from a base of 12.4%. As of September 30, 2022, in the event of an immediate and parallel increase of 200 basis points in interest rates, the NPV was estimated to decrease by $617,000,000, or 20.9%, and the NPV-to-total assets ratio to decline to 12.6% from a base of 14.9%. The change in the sensitivity of the NPV ratio to this assumed change in interest rates is primarily due to the
56
flattening of the yield curve and changes in balance sheet mix year over year. Prepayment speeds for single family mortgages are low at September 30, 2023 with the Bank's conditional payment rate ("CPR") for this portfolio segment at 7.0%, down from 8.1% the year before.
As of September 30, 2023, in the event of an immediate and parallel decrease of 100 basis points in interest rates, the NPV is estimated to increase NPV by $327,000,000, or 12.38%, and increase the NPV to total assets ratio to 13.59% from a base of 12.4%.
Interest Rates. The Company measures the difference between the rate on interest-earning assets and the rate on interest-bearing liabilities at the end of each period. The period end interest rate spread was 2.61% at September 30, 2023 and 3.36% at September 30, 2022. As of September 30, 2023, the weighted-average rate on interest-earning assets increased by 103 basis points to 5.07% compared to September 30, 2022. The higher rate on interest-earning assets is due primarily to the Federal Reserve Bank's rate increases which have led to higher rates on adjustable rate loans, investment securities and cash as well as asset mix shifting to loans receivable. As of September 30, 2023, the weighted-average rate on interest-bearing liabilities increased by 178 basis points to 2.46% compared to September 30, 2022. The higher rate on interest-bearing liabilities primarily resulted from customer deposits repricing and higher rates on new borrowings. The period end interest rate spread for the last eight fiscal quarters is shown below:
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The chart below shows the volatility of our period end net interest spread (dashed line measured against the right axis) compared to the relatively consistent growth in net interest income (solid line measured against the left axis). The relative consistency of net interest income is accomplished by actively managing the size and composition of the balance sheet through different rate cycles.
Net Interest Margin. The net interest margin is measured using net interest income divided by average interest-earning assets for the period. The net interest margin increased to 3.40% for the year ended September 30, 2023, from 3.16% for the year ended September 30, 2022. The yield on interest-earning assets increased 159 basis points to 5.13% and the cost of interest-bearing liabilities increased by 168 basis points to 2.18%. The higher yield on interest-earning assets was primarily due to the impact of rising rates on adjustable rate assets and cash. The higher rate in interest-bearing liabilities was primarily due to replacing maturing borrowings at higher rates.
For the year ended September 30, 2023, average interest-earning assets increased by 8.1% to $20,327,301,000, up from $18,812,481,000 for the year ended September 30, 2022. Balance sheet growth in 2023 was primarily due to the growth in loans receivable. During 2023, average loans receivable increased $2,011,903,000, or 13.3%, while the combined average balances of mortgage-backed securities, other investment securities and cash decreased by $536,288,000 or 14.7%. Management views organic loan growth as the highest and best use of capital, thus the focus on primarily growing loans receivable.
During 2023, average interest-bearing customer deposit accounts increased $167,664,000 or 1.3% and the average balance of borrowings increased by $1,530,807,000, or 88.4%, from 2022.
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The following table sets forth the information explaining the changes in the net interest income and net interest margin.
Net Interest Income Summary
Year Ended September 30,
($ in thousands)
Assets
Liabilities and Shareholders’ Equity
___________________
(1)Interest income includes net amortization-accretion of deferred loan fees, costs, discounts and premiums of $20,130,000, $29,156,000 and $48,079,000 for year ended 2023, 2022 and 2021, respectively.
(2)Includes cash equivalents and non-mortgage backed security investments, such as U.S. agency obligations, mutual funds, corporate bonds, and municipal bonds.
(3)Net interest income divided by average interest-earning assets.
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The following table shows the potential impact of changing interest rates on net income for one year. The Company's focus is primarily on the impact of abrupt upward or downward changes in short term rates. It is important to note that this is not a forecast or prediction of future events, but is used as a tool for measuring potential risk. This analysis assumes zero balance sheet growth and a constant percentage composition of assets and liabilities.
Potential Increase (Decrease) in Net Interest Income
(In thousands, except percentages)
Actual results will differ from the assumptions used in this model, as management monitors and adjusts both the size and the composition of the balance sheet in order to respond to changing interest rates. In a rising interest rate environment, it is likely that the Company will grow its balance sheet to offset margin compression that may occur. Improvement in the net interest income sensitivity during the year is primarily the result of interest rate swap activity and extension of the maturity of certain borrowings.
Another method used to quantify interest rate risk is the NPV analysis. This analysis calculates the difference between the present value of interest-bearing liabilities and the present value of expected cash flows from interest-earning assets and off-balance-sheet contracts. The following tables set forth an analysis of the Company’s interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (measured in 100-basis-point increments).
The tables below express the NPV under varying interest scenarios.
(Basis Points) (In thousands) (In thousands)
(Basis Points) (In thousands) (In thousands)
As of September 30, 2023, the Company was in compliance with all of its interest rate risk policy limits.
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Item 8. Financial Statements and Supplementary Data
Index to financial statements and financial statement schedules:
Report of Independent Registered Public Accounting Firm (PCAOB ID: 34) 61
Financial statements and supplementary data:
Consolidated Statements of Financial Condition 65
Consolidated Statements of Operations 66
Consolidated Statements of Comprehensive Income 67
Consolidated Statements of Shareholders' Equity 68
Consolidated Statements of Cash Flows 69
Notes to Consolidated Financial Statements 71
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of WaFd, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of WaFd, Inc. and subsidiaries (the “Company”) as of September 30, 2023 and 2022, the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended September 30, 2023, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2023, and 2022, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2023, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of September 30, 2023, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 17, 2023, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for Loan Losses - Refer to Notes A and E to the financial statements
Critical Audit Matter Description
The estimates of the Company's expected credit losses under the CECL methodology is based on relevant information about current conditions, past events, and reasonable and supportable forecasts regarding collectability of the reported amounts. In order to estimate the allowance for loan losses ("ALL"), the Company used either a cohort or weighted average remaining maturities methodology to determine the historical loss rate, by loan portfolio class, then considered whether qualitative adjustments to those historical loss rates were warranted.
Significant management judgments are required in determining whether, and to what extent, qualitative adjustments for each portfolio loan class are required. These adjustments are made after considering the conditions over the period from which historical loss experience was based and are split into two components: 1) asset or class specific risk characteristics or current
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conditions at the reporting date related to portfolio credit quality, remaining payments, volume and nature, credit culture and management, business environment or other management factors, not captured in the historical loss rates and 2) reasonable and supportable forecasts of future economic conditions and collateral values.
Given the significance of the ALL, and management judgment required for quantitative and qualitative evaluation of past events, current conditions, and reasonable and supportable forecasts, performing audit procedures to evaluate the ALL requires a high degree of auditor judgment and increased extent of effort.
We have identified the ALL estimate for certain loan portfolio classes as a critical audit matter based upon the above factors.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the ALL estimate for loan portfolio classes for which we concluded the ALL was significant included the following, among others:
•We tested the effectiveness of management’s controls over model applicability, qualitative adjustments, the reasonable and supportable forecast adjustments, and management's review and approval process over the final determination of the ALL.
•We tested the underlying data and mathematical accuracy of the cohort methodology used to determine most loan portfolio class historical loss rates. We also evaluated the reasonableness and conceptual soundness of the methodology.
•To test the qualitative adjustments, we performed analysis to evaluate management’s determination of the qualitative adjustments made to account for specific risk characteristics or current conditions that differ from the period over which the historical loss rate was determined. Our procedures included evaluating management’s inputs and assumptions used in determining the qualitative and forecast adjustments by comparing the information to internal and external source data including, among others, the economic forecasts utilized by the Company and third-party economic forecasts for selected assumptions. In addition, we performed procedures on the overall ALL amount, inclusive of the qualitative adjustments, by evaluating the Company’s analysis of peers’ estimated current expected credit losses for loans to the Company’s recorded ALL.
Goodwill - Refer to Note A to the financial statements
Critical Audit Matter Description
The Company’s goodwill balance as of September 30, 2023, included within Intangible Assets, is related to the Company’s single reporting unit. Goodwill is evaluated for potential impairment on an annual basis and between tests if circumstances such as material adverse changes in legal, business, regulatory and economic factors exist. The Company performed its annual impairment test as of August 31, 2023, using a quantitative impairment approach, and concluded the fair value of the single reporting unit exceeded its respective carrying value and did not result in an impairment for the reporting unit. When performing the quantitative assessment of goodwill impairment, the Company estimated fair value of its reporting unit using the market capitalization approach, based on its stock price, adjusted for the effect of a control premium.
Given the significant judgments made by management to estimate the fair value of its reporting unit, including the selection of a control premium, performing audit procedures to evaluate goodwill for impairment required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the fair value of the reporting unit and selected control premium included the following procedures, among others:
•We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the determination of fair value of the reporting unit and selection of the control premium.
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•With the assistance of our fair value specialists we:
◦Evaluated the appropriateness of using the market capitalization approach to estimate the fair value of the reporting unit.
◦Evaluated certain inputs and assumptions, within management’s impairment analysis, including assessing including peer company transaction data, to determine applicability.
◦Performed procedures to assess the reasonableness of the control premium assumption used in the Company’s market capitalization approach.
◦Assessed the mathematical accuracy of the valuation used in the impairment test.
/s/ Deloitte & Touche LLP
Seattle, Washington
November 17, 2023
We have served as the Company’s auditor since 1982.
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WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
ASSETS
Held-to-maturity securities, at amortized cost 423,586 463,299
Federal and state income tax assets, net 8,479 —
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Customer accounts
Advance payments by borrowers for taxes and insurance 52,550 50,051
Federal and state income tax liabilities, net — 3,306
Commitments and contingencies (see Note M)
Shareholders’ equity
Accumulated other comprehensive income (loss), net of taxes 46,921 52,481
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
65
WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
INTEREST INCOME
INTEREST EXPENSE
OTHER INCOME
Gain (loss) on sale of investment securities 33 99 14
Gain (loss) on termination of hedging derivatives (867) — 14,110
Prepayment penalty on long-term debt — — (13,788)
OTHER EXPENSE
PER SHARE DATA
Basic earnings per common share $ 3.72 $ 3.40 $ 2.39
Diluted earnings per common share 3.72 3.39 2.39
Dividends paid on common stock per share 0.99 0.95 0.91
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
66
WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income (loss), net of tax:
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
67
WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Other comprehensive income (loss) — — — — 52,832 — 52,832
Dividends on common stock ($0.91 per share) — — — (65,876) — — (65,876)
Dividends on preferred stock ($33.45 per share) — — — (10,034) — — (10,034)
Proceeds from stock issuances — 20 319 — — — 339
Stock-based compensation expense — 246 6,135 — — — 6,381
Other comprehensive income (loss) — — — (17,304) — (17,304)
Dividends on common stock ($0.95 per share) — — — (61,576) — — (61,576)
Dividends on preferred stock ($48.75 per share) — — — (14,625) — — (14,625)
Proceeds from stock issuances — 65 1,758 — — — 1,823
Stock-based compensation expense — 213 6,595 — — — 6,808
Treasury stock purchased — — — — — (3,260) (3,260)
Other comprehensive income (loss) — — — — (5,560) — (5,560)
Dividends on common stock ($0.99 per share) — — — (63,792) — — (63,792)
Dividends on preferred stock ($48.75 per share) — — — (14,625) — — (14,625)
Proceeds from stock issuances — 42 1,224 — — — 1,266
Treasury stock purchased — — — — — (30,463) (30,463)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Loss (gain) on sale of investment securities (33) (99) (14)
Prepayment penalty on early extinguishment of debt — — 13,788
Gain on early termination of long term borrowing hedge — — (14,110)
Gain on settlements of bank owned life insurance (821) (1,385) —
Impairment loss on premises and equipment 6 — 944
Decrease (increase) in accrued interest receivable (23,131) (13,236) 3,163
CASH FLOWS FROM INVESTING ACTIVITIES
Held-to-maturity securities purchased — (195,357) —
Proceeds from settlements of bank owned life insurance 1,809 2,266 —
Purchase of strategic investments (12,500) — —
Net cash received (paid) in business combinations (2,590) — (1,500)
Proceeds from sales of premises and equipment 1,090 41 3,376
Premises and equipment purchased and REO improvements (15,063) (11,790) (29,472)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the early termination of long term borrowing hedge — — 14,110
Proceeds from issuance of preferred stock, net — — 293,325
Proceeds from employee stock purchase 177 — —
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
69
WAFD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Non-cash investing activities
Real estate acquired through foreclosure $ 121 $ 73 $ 221
Other personal property acquired through foreclosure — 577 —
Non-cash financing activities
Cash paid during the year for
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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WAFD, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2023, 2022, AND 2021
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company and nature of operations. Washington Federal Bank, a federally-insured Washington state chartered commercial bank dba WaFd Bank (the "Bank" or "WaFd Bank"), was founded on April 24, 1917 in Ballard, Washington and is engaged primarily in providing lending, depository, insurance and other banking services to consumers, mid-sized to large businesses, and owners and developers of commercial real estate. WaFd, Inc., a Washington corporation was formed as the Bank’s holding company in November, 1994 under the name Washington Federal, Inc. Washington Federal, Inc. changed its name effective September 29, 2023 to Wafd, Inc. As used throughout this document, the terms “WaFd,” the “Company” or "we" or "us" and "our" refer to the WaFd, Inc. and its consolidated subsidiaries, and the term “Bank” refers to the operating subsidiary, Washington Federal Bank. The Company is headquartered in Seattle, Washington. The Bank conducts its activities through a network of 198 bank branches located in Washington, Oregon, Idaho, Utah, Arizona, Nevada, New Mexico and Texas.