WASHINGTON FEDERAL INC - FORM 10-Q - July 26, 2018

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EX-32 - EXHIBIT 32 - WASHINGTON FEDERAL INCwafd10-qex326302018.htm
EX-31.2 - EXHIBIT 31.2 - WASHINGTON FEDERAL INCwafd10-qex3126302018.htm
EX-31.1 - EXHIBIT 31.1 - WASHINGTON FEDERAL INCwafd10-qex3116302018.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-34654
WASHINGTON FEDERAL, INC.
(Exact name of registrant as specified in its charter)
 
Washington
 
91-1661606
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
425 Pike Street Seattle, Washington 98101
(Address of principal executive offices and zip code)
(206) 624-7930
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 ("Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
Emerging growth company
o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of class:
July 24, 2018
Common stock, $1.00 par value
83,537,545


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
 
 
 
 
  
The Consolidated Financial Statements of Washington Federal, Inc. and Subsidiaries filed as a part of the report are as follows:
 
 
  
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)





 
June 30, 2018
 
September 30, 2017
 
(In thousands, except share data)
ASSETS
 
 
 
Cash and cash equivalents
$
345,919

 
$
313,070

Available-for-sale securities, at fair value
1,255,401

 
1,266,209

Held-to-maturity securities, at amortized cost
1,670,450

 
1,646,856

Loans receivable, net of allowance for loan losses of $128,666 and $123,073
11,325,971

 
10,882,622

Interest receivable
43,670

 
41,643

Premises and equipment, net
269,674

 
263,694

Real estate owned
11,275

 
20,658

FHLB and FRB stock
128,790

 
122,990

Bank owned life insurance
214,752

 
211,330

Intangible assets, including goodwill of $301,368 and $293,153
311,796

 
298,682

Federal and state income tax assets, net
4,293

 
—

Other assets
184,330

 
185,826

 
$
15,766,321

 
$
15,253,580

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Customer accounts
 
 
 
Transaction deposit accounts
$
6,572,766

 
$
6,361,158

Time deposit accounts
4,714,707

 
4,473,850

 
11,287,473

 
10,835,008

FHLB advances
2,370,000

 
2,225,000

Advance payments by borrowers for taxes and insurance
32,632

 
56,631

Accrued expenses and other liabilities
89,953

 
131,253

 
13,780,058

 
13,247,892

Stockholders’ equity
 
 
 
Common stock, $1.00 par value, 300,000,000 shares authorized; 135,343,437 and 134,957,511 shares issued; 83,534,098 and 87,193,362 shares outstanding
135,344

 
134,958

Additional paid-in capital
1,665,421

 
1,660,885

Accumulated other comprehensive income (loss), net of taxes
8,137

 
5,015

Treasury stock, at cost; 51,809,339 and 47,764,149 shares
(975,001
)
 
(838,060
)
Retained earnings
1,152,362

 
1,042,890

 
1,986,263

 
2,005,688

 
$
15,766,321

 
$
15,253,580




SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
3

WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands, except share data)
 
(In thousands, except share data)
INTEREST INCOME
 
 
 
 
 
 
 
Loans receivable
$
131,541

 
$
117,457

 
$
382,581

 
$
348,326

Mortgage-backed securities
18,022

 
15,992

 
52,588

 
45,007

Investment securities and cash equivalents
5,509

 
4,267

 
14,762

 
13,345

 
155,072

 
137,716

 
449,931

 
406,678

INTEREST EXPENSE
 
 
 
 
 
 
 
Customer accounts
18,887

 
12,764

 
49,939

 
38,173

FHLB advances
16,333

 
16,337

 
47,104

 
49,011

 
35,220

 
29,101

 
97,043

 
87,184

Net interest income
119,852

 
108,615

 
352,888

 
319,494

Provision (release) for loan losses
1,000

 
—

 
50

 
(1,600
)
Net interest income after provision (release) for loan losses
118,852

 
108,615

 
352,838

 
321,094

 
 
 
 
 
 
 
 
OTHER INCOME
 
 
 
 
 
 
 
Gain on sale of investment securities
—

 
—

 
—

 
968

FDIC loss share valuation adjustments
—

 
—

 
(8,550
)
 
—

Loan fee income
1,094

 
889

 
2,909

 
3,310

Deposit fee income
6,411

 
5,714

 
19,500

 
15,803

Other income
4,946

 
7,319

 
17,974

 
15,873

 
12,451

 
13,922

 
31,833

 
35,954

 
 
 
 
 
 
 
 
OTHER EXPENSE
 
 
 
 
 
 
 
Compensation and benefits
31,223

 
28,947

 
92,467

 
84,774

Occupancy
9,095

 
8,829

 
26,779

 
26,370

FDIC insurance premiums
2,950

 
2,842

 
8,622

 
8,591

Product delivery
4,356

 
3,246

 
11,977

 
10,096

Information technology
10,118

 
6,617

 
26,828

 
19,754

Other expense
9,235

 
6,581

 
28,032

 
19,285

 
66,977

 
57,062

 
194,705

 
168,870

Gain (loss) on real estate owned, net
168

 
(124
)
 
(64
)
 
1,069

Income before income taxes
64,494

 
65,351

 
189,902

 
189,247

Income tax expense
13,100

 
21,239

 
37,567

 
61,819

NET INCOME
$
51,394

 
$
44,112

 
$
152,335

 
$
127,428

 

 


 
 
 
 
PER SHARE DATA
 
 
 
 
 
 
 
Basic earnings per share
$
0.61

 
$
0.49

 
$
1.78

 
$
1.43

Diluted earnings per share
0.61

 
0.49

 
1.78

 
1.42

Dividends paid on common stock per share
0.17

 
0.15

 
0.49

 
0.69

Basic weighted average number of shares outstanding
84,168,992

 
89,199,823

 
85,589,588

 
89,297,471

Diluted weighted average number of shares outstanding
84,252,659

 
89,497,264

 
85,698,888

 
89,653,955


SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
4


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
 
(In thousands)
Net income
$
51,394

 
$
44,112

 
$
152,335

 
$
127,428

 
 
 
 
 
 
 
 
Other comprehensive income (loss) net of tax:
 
 
 
 
 
 
 
Net unrealized gain (loss) on available-for-sale investment securities
(4,851
)
 
3,171

 
(18,282
)
 
(8,224
)
Reclassification adjustment of net gain (loss) from sale of available-for-sale securities included in net income
—

 
—

 
—

 
968

Related tax benefit (expense)
1,104

 
(1,165
)
 
5,506

 
2,667

 
(3,747
)
 
2,006

 
(12,776
)
 
(4,589
)
 
 
 
 
 
 
 
 
Net unrealized gain (loss) on cash flow hedges of borrowings
3,865

 
(2,856
)
 
20,887

 
28,810

Related tax benefit (expense)
(879
)
 
1,049

 
(4,989
)
 
(10,587
)
 
2,986

 
(1,807
)
 
15,898

 
18,223

 
 
 
 
 
 
 
 
Other comprehensive income (loss) net of tax
(761
)
 
199

 
3,122

 
13,634

Comprehensive income
$
50,633

 
$
44,311

 
$
155,457

 
$
141,062





SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
5


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED) 
(in thousands)
Common Stock
Additional Paid-in Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Treasury Stock
Total
Balance at October 1, 2017
$
134,958

$
1,660,885

$
1,042,890

$
5,015

$
(838,060
)
$
2,005,688

Adjustment pursuant to adoption of ASU 2018-02
—

—

(1,772
)
1,772

—

—

Net income
—

—

152,335

—

—

152,335

Other comprehensive income (loss)
—

—

—

1,350

—

1,350

Dividends on common stock
—

—

(41,091
)
—

—

(41,091
)
Proceeds from exercise of common stock options
60

1,228

—

—

—

1,288

Restricted stock expense
215

3,419

—

—

—

3,634

Exercise of stock warrants
111

(111
)
 
 
 
—

Treasury stock acquired
—

—

—

—

(136,941
)
(136,941
)
Balance at June 30, 2018
$
135,344

$
1,665,421

$
1,152,362

$
8,137

$
(975,001
)
$
1,986,263

 
 
 
 
 
 
 
(in thousands)
Common Stock
Additional Paid-in Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Treasury Stock
Total
Balance at October 1, 2016
$
134,308

$
1,648,388

$
943,877

$
(11,156
)
$
(739,686
)
$
1,975,731

Net income
—

—

127,428

—

—

127,428

Other comprehensive income (loss)
—

—

—

13,634

—

13,634

Dividends on common stock
—

—

(61,341
)
—

—

(61,341
)
Proceeds from exercise of common stock options
309

6,769

—

—

—

7,078

Restricted stock expense
105

5,021

—

—

—

5,126

Exercise of stock warrants
225

(225
)
—

—

—

—

Treasury stock acquired
—

—

—

—

(46,470
)
(46,470
)
Balance at June 30, 2017
$
134,947

$
1,659,953

$
1,009,964

$
2,478

$
(786,156
)
$
2,021,186




SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
6


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) 
 
Nine Months Ended June 30,
 
2018
 
2017
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
 
Net income
$
152,335

 
$
127,428

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation, amortization, and accretion expense, net
38,980

 
29,602

Cash received from (paid to) FDIC under loss share agreements, net
1,595

 
813

Stock based compensation expense
3,634

 
5,126

Provision (release) for loan losses
50

 
(1,600
)
Loss (gain) on sale of investment securities
—

 
(968
)
Decrease (increase) in accrued interest receivable
(2,027
)
 
(1,257
)
Decrease (increase) in federal and state income tax receivable
(4,293
)
 
16,047

Decrease (increase) in cash surrender value of bank owned life insurance
(4,490
)
 
(4,907
)
Gain on bank owned life insurance
(2,416
)
 
(4,983
)
Net realized (gain) loss on sales of premises, equipment, and real estate owned
(1,333
)
 
(1,691
)
Decrease (increase) in other assets
(878
)
 
6,618

Increase (decrease) in accrued expenses and other liabilities
(40,862
)
 
(47,859
)
Net cash provided by (used in) operating activities
140,295

 
122,369

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Origination of loans and principal repayments, net
(308,167
)
 
(668,413
)
Loans purchased
(143,605
)
 
(72,856
)
FHLB & FRB stock purchased
(408,800
)
 
(93,009
)
FHLB & FRB stock redeemed
403,000

 
85,224

Available-for-sale securities purchased
(166,696
)
 
—

Principal payments and maturities of available-for-sale securities
156,240

 
290,243

Proceeds from sales of available-for-sale securities
—

 
350,890

Held-to-maturity securities purchased
(170,836
)
 
(415,729
)
Principal payments and maturities of held-to-maturity securities
143,837

 
176,333

Proceeds from sales of real estate owned
11,960

 
13,780

Proceeds from settlement of bank owned life insurance
3,484

 
6,913

Cash paid for acquisitions
(2,211
)
 
—

Proceeds from sales of premises and equipment
1

 
3,956

Premises and equipment purchased and REO improvements
(22,604
)
 
(9,541
)
Net cash provided by (used in) investing activities
(504,397
)
 
(332,209
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in customer accounts
452,694

 
33,654

Proceeds from borrowings
10,220,000

 
2,325,000

Repayments of borrowings
(10,075,000
)
 
(2,130,000
)
Proceeds from exercise of common stock options and related tax benefit
1,288

 
7,078

Dividends paid on common stock
(41,091
)
 
(61,341
)
Treasury stock purchased
(136,941
)
 
(46,470
)
Increase (decrease) in borrower advances related to taxes and insurance, net
(23,999
)
 
(9,197
)
Net cash provided by (used in) financing activities
396,951

 
118,724

Increase (decrease) in cash and cash equivalents
32,849

 
(91,116
)
Cash and cash equivalents at beginning of period
313,070

 
450,368

Cash and cash equivalents at end of period
$
345,919

 
$
359,252

(CONTINUED)

SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
7


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Nine Months Ended June 30,
 
2018
 
2017
 
(In thousands)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
Non-cash investing activities
 
 
 
Real estate acquired through foreclosure
$
1,517

 
$
2,323

Non-cash financing activities
 
 
 
Stock issued upon exercise of warrants
3,836

 
7,546

Cash paid during the period for
 
 
 
Interest
95,394

 
82,919

Income taxes
34,160

 
33,228




SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
8


WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE A – Summary of Significant Accounting Policies

Nature of Operations - Washington Federal, Inc. (the "Company") is a Washington corporation headquartered in Seattle, Washington. The Company is a bank holding company that conducts its operations through its national bank subsidiary, Washington Federal, National Association (the "Bank"). The Bank is principally engaged in the business of attracting deposits from businesses and the general public and investing these funds, together with borrowings and other funds, in one-to-four family residential mortgage and construction loans, home equity loans, lines of credit, commercial real estate loans, commercial and industrial loans, multi-family and other forms of real estate loans. As used throughout this document, the terms "Washington Federal" or the "Company" refer to Washington Federal, Inc. and its consolidated subsidiaries and the term "Bank" refers to the operating subsidiary Washington Federal, National Association.

Basis of Presentation - The Company has prepared the consolidated unaudited interim financial statements included in this report. All intercompany transactions and accounts have been eliminated in consolidation. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America (“GAAP”), requires management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from these estimates. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation are reflected in the interim financial statements. Certain amounts in the financial statements from prior periods have been reclassified to conform to the current financial statement presentation.

The information included in this Form 10-Q should be read in conjunction with the financial statements and related notes in the Company's 2017 Annual Report on Form 10-K (“2017 Annual Financial Statements”). Interim results are not necessarily indicative of results for a full year.

During the nine months ended June 30, 2018, an immaterial correction was recorded related to acquisitions of insurance agency businesses in prior years. The balance sheet classification correction resulted in an increase in goodwill of $7,135,000 and finite-lived intangible assets of $5,106,000 and a corresponding decrease in other assets of $12,241,000.

Summary of Significant Accounting Policies - The significant accounting policies used in preparation of the Company's consolidated financial statements are disclosed in its 2017 Annual Financial Statements. There have not been any material changes in the Company's significant accounting policies compared to those contained in its 2017 Annual Financial Statements for the year ended September 30, 2017.

Off-Balance-Sheet Credit Exposures - The only material off-balance-sheet credit exposures are loans in process and unused lines of credit, which had a combined balance of $2,161,343,000 and $1,992,905,000 at June 30, 2018 and September 30, 2017, respectively. The Company estimates losses on off-balance-sheet credit exposures by allocating a loss percentage derived from historical loss factors for each asset class.

NOTE B – New Accounting Pronouncements

In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The ASU expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedge items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition with a cumulative effect adjustment recorded to opening retained earnings as of the initial adoption date. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December

9
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements.

In February 2017, the FASB issued ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. The ASU clarifies that a financial asset is within the scope of Subtopic 610-20 if it meets the definition of an in substance nonfinancial asset. The amendments also define the term in substance nonfinancial asset. The amendments clarify that nonfinancial assets within the scope of Subtopic 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty. A contract that includes the transfer of ownership interests in one or more consolidated subsidiaries is within the scope of Subtopic 610-20 if substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial assets. The amendments clarify that an entity should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counterparty and derecognize each asset when a counterparty obtains control of it. The ASU is effective for public business entities for annual periods beginning after December 15, 2017, and interim periods therein. Entities may use either a full or modified approach to adopt the ASU. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash: a Consensus of the FASB Emerging Issues Task Force. This ASU requires a company’s cash flow statement to explain the changes during a reporting period of the totals for cash, cash equivalents, restricted cash, and restricted cash equivalents. Additionally, amounts for restricted cash and restricted cash equivalents are to be included with cash and cash equivalents if the cash flow statement includes a reconciliation of the total cash balances for a reporting period. This ASU is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, with early application permitted. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU address eight specific cash flow issues with the objective of reducing diversity in practice. The specific issues identified include: debt prepayments or extinguishment costs; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period; however, early adoption is permitted. The Company is currently evaluating the guidance to determine its adoption method and does not expect this guidance to have a material impact on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses. The amendments in this ASU were issued to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investments in leases and other commitments to extend credit held by a reporting entity at each reporting date. The amendments require that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The ASU eliminates the current framework of recognizing probable incurred losses and instead requires an entity to use its current estimate of all expected credit losses over the contractual life. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets.

For purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, an allowance for expected credit losses is recorded as an adjustment to the cost basis of the asset. Subsequent changes in estimated cash flows would be recorded as an adjustment to the allowance and through the statement of income.

Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses rather than as a direct write-down to the security's cost basis.


10
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For most debt securities, the transition approach requires a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period the guidance is effective. For other-than-temporarily impaired debt securities and PCD assets, the guidance will be applied prospectively. While the Company is currently in the process of evaluating the impact of the amended guidance on its consolidated financial statements, it currently expects the ALLL to increase upon adoption given that the allowance will be required to cover the full remaining expected life of the portfolio upon adoption, rather than the incurred loss model under current U.S. GAAP. The extent of this increase is still being evaluated and will depend on economic conditions and the composition of the Company’s loan and lease portfolio at the time of adoption.

In February 2016, the FASB issued ASU 2016-02, Leases. The amendments require lessees to recognize a lease liability, which is a lessee's obligation to make lease payments arising from a lease, and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The guidance also simplifies the accounting for sale and leaseback transactions. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently in the process of accumulating the lease data necessary to apply the amended guidance. The Company is continuing to evaluate the impact of the amended guidance on its consolidated financial statements, but the effects of recognizing most operating leases is not expected to be material. The Company expects to recognize right-of-use assets and lease liabilities for substantially all of its operating lease commitments based on the present value of unpaid lease payments as of the date of adoption.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, to require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this ASU also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect this guidance to have a material impact on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this update supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the industry topics of the codification. For public companies, this update was to be effective for interim and annual periods beginning after December 15, 2016. However, in August 2015, the FASB issued ASU 2015-14, which delayed the effective date of ASU 2014-09 by one year and permits companies to voluntarily adopt the new standard as of the original effective date. The Company does not expect this guidance to have a material impact on its consolidated financial statements.

NOTE C – Dividends and Share Repurchases

On May 25, 2018, the Company paid a regular dividend on common stock of $0.17 per share, which represented the 141st consecutive quarterly cash dividend. Dividends per share were $0.17 and $0.15 for the quarters ended June 30, 2018 and 2017, respectively. On July 23, 2018, the Company declared a regular dividend on common stock of $0.18 per share, which represents its 142nd consecutive quarterly cash dividend. This dividend will be paid on August 24, 2018 to common shareholders of record on August 10, 2018.

For the three months ended June 30, 2018, the Company repurchased 1,224,384 shares at an average price of $32.64. During the three months ended June 30, 2018, 2,329 shares of common stock were issued to investors holding warrants previously issued as part of the 2008 Troubled Asset Relief Program ("TARP"). As of June 30, 2018, 107,617 of these warrants remain outstanding. Net of warrant cash repurchase activity, there are 2,855,765 remaining shares authorized to be repurchased under the current Board approved share repurchase program.

NOTE D – Loans Receivable


11
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following table is a summary of loans receivable.
 
June 30, 2018
 
September 30, 2017
 
(In thousands)
 
(In thousands)
Gross loans by category
 
 
 
 
 
   Single-family residential
$
5,745,598

45.1
%
 
$
5,711,004

46.8
%
   Construction
1,885,034

14.8

 
1,597,996

13.1

   Construction - custom
612,688

4.8

 
602,631

4.9

   Land - acquisition & development
150,936

1.2

 
124,308

1.0

   Land - consumer lot loans
103,118

0.8

 
104,405

0.9

   Multi-family
1,346,534

10.6

 
1,303,148

10.7

   Commercial real estate
1,435,418

11.3

 
1,434,610

11.8

   Commercial & industrial
1,133,075

8.9

 
1,093,360

9.0

   HELOC
136,766

1.1

 
144,850

1.2

   Consumer
188,125

1.5

 
85,075

0.7

Total gross loans
12,737,292

100
%
 
12,201,387

100
%
   Less:
 
 
 
 
 
      Allowance for loan losses
128,666

 
 
123,073

 
      Loans in process
1,230,132

 
 
1,149,934

 
      Net deferred fees, costs and discounts
52,523

 
 
45,758

 
Total loan contra accounts
1,411,321

 
 
1,318,765

 
Net loans
$
11,325,971

 
 
$
10,882,622

 

The following table sets forth information regarding non-accrual loans.
 
 
June 30, 2018
 
September 30, 2017
 
(In thousands, except ratio data)
Non-accrual loans:
 
 
 
 
 
 
 
Single-family residential
$
26,119

 
43.1
%
 
$
27,930

 
56.3
%
Construction
1,841

 
3.0

 
—

 
—

Construction - custom
—

 
—

 
91

 
0.2

Land - acquisition & development
1,757

 
2.9

 
296

 
0.6

Land - consumer lot loans
642

 
1.1

 
605

 
1.2

Multi-family
—

 
—

 
139

 
0.3

Commercial real estate
9,684

 
16.0

 
11,815

 
23.8

Commercial & industrial
19,876

 
32.8

 
8,082

 
16.3

HELOC
637

 
1.1

 
531

 
1.1

Consumer
28

 
—

 
91

 
0.2

Total non-accrual loans
$
60,584

 
100
%
 
$
49,580

 
100
%
% of total net loans
0.53
%
 
 
 
0.46
%
 
 

The Company recognized interest income on non-accrual loans of approximately $3,926,000 in the nine months ended June 30, 2018. Had these loans been on accrual status and performed according to their original contract terms, the Company would have recognized interest income of approximately $1,741,000 for the nine months ended June 30, 2018. Recognized interest income for the nine months ended June 30, 2018 was higher than what otherwise would have been collected in the period due to the collection of past due amounts. Interest cash flows collected on non-accrual loans vary from period to period as those loans are brought current or are paid off.

12
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



The following tables provide details regarding delinquent loans.
 
June 30, 2018
Loans Receivable
 
Days Delinquent Based on $ Amount of Loans
 
% based
on $
Type of Loan
Net of Loans In Process
 
Current
 
30
 
60
 
90
 
Total Delinquent
 
 
(In thousands, except ratio data)
 
 
Single-family residential
$
5,744,620

 
$
5,714,962

 
$
7,201

 
$
4,521

 
$
17,936

 
$
29,658

 
0.52
%
Construction
1,012,239

 
1,009,782

 
—

 
616

 
1,841

 
2,457

 
0.24

Construction - custom
285,858

 
285,687

 
171

 
—

 
—

 
171

 
0.06

Land - acquisition & development
121,508

 
119,593

 
—

 
270

 
1,645

 
1,915

 
1.58

Land - consumer lot loans
103,040

 
102,303

 
128

 
301

 
308

 
737

 
0.72

Multi-family
1,346,512

 
1,346,512

 
—

 
—

 
—

 
—

 
—

Commercial real estate
1,435,417

 
1,433,030

 
684

 
—

 
1,703

 
2,387

 
0.17

Commercial & industrial
1,133,075

 
1,126,480

 
—

 
—

 
6,595

 
6,595

 
0.58

HELOC
136,766

 
135,406

 
863

 
146

 
351

 
1,360

 
0.99

Consumer
188,125

 
187,773

 
125

 
127

 
100

 
352

 
0.19

Total Loans
$
11,507,160

 
$
11,461,528

 
$
9,172

 
$
5,981

 
$
30,479

 
$
45,632

 
0.40
%
Delinquency %
 
 
99.60%
 
0.08%
 
0.05%
 
0.26%
 
0.40%
 
 


September 30, 2017
Loans Receivable
 
Days Delinquent Based on $ Amount of Loans
 
% based
on $
Type of Loan
Net of Loans In Process
 
Current
 
30
 
60
 
90
 
Total Delinquent
 
 
(In thousands, except ratio data)
 
 
Single-family residential
$
5,709,690

 
$
5,671,933

 
$
10,925

 
$
4,810

 
$
22,022

 
$
37,757

 
0.66
%
Construction
793,959

 
793,959

 
—

 
—

 
—

 
—

 
—

Construction - custom
277,599

 
277,508

 
—

 
—

 
91

 
91

 
0.03

Land - acquisition & development
104,856

 
104,526

 
—

 
—

 
330

 
330

 
0.31

Land - consumer lot loans
104,335

 
103,389

 
112

 
680

 
154

 
946

 
0.91

Multi-family
1,303,119

 
1,302,720

 
5

 
255

 
139

 
399

 
0.03

Commercial real estate
1,434,610

 
1,432,052

 
507

 
—

 
2,051

 
2,558

 
0.18

Commercial & industrial
1,093,360

 
1,092,735

 
—

 
51

 
574

 
625

 
0.06

HELOC
144,850

 
143,974

 
221

 
342

 
313

 
876

 
0.60

Consumer
85,075

 
84,644

 
245

 
107

 
79

 
431

 
0.51

Total Loans
$
11,051,453

 
$
11,007,440

 
$
12,015

 
$
6,245

 
$
25,753

 
$
44,013

 
0.40
%
Delinquency %
 
 
99.60%
 
0.11%
 
0.06%
 
0.23%
 
0.40%
 
 

The percentage of total delinquent loans was 0.40% as of June 30, 2018 and 0.40% as of September 30, 2017. There are no loans greater than 90 days delinquent and still accruing interest as of either date.


13
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following table provides information related to loans restructured in a troubled debt restructuring ("TDR") during the periods presented:

 
Three Months Ended June 30,
 
2018
 
2017
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Outstanding
 
Outstanding
 
 
 
Outstanding
 
Outstanding
 
Number of
 
Recorded
 
Recorded
 
Number of
 
Recorded
 
Recorded
 
Contracts
 
Investment
 
Investment
 
Contracts
 
Investment
 
Investment
 
 
 
($ in thousands)
 
 
 
($ in thousands)
Troubled Debt Restructurings:
 
 
 
 
 
 
 
 
 
 
 
   Single-family residential
5

 
$
714

 
$
714

 
11

 
$
1,836

 
$
1,836

   HELOC
1

 
75

 
75

 
—

 
—

 
—

 
6

 
$
789

 
$
789

 
11

 
$
1,836

 
$
1,836



 
Nine Months Ended June 30,
 
2018
 
2017
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Outstanding
 
Outstanding
 
 
 
Outstanding
 
Outstanding
 
Number of
 
Recorded
 
Recorded
 
Number of
 
Recorded
 
Recorded
 
Contracts
 
Investment
 
Investment
 
Contracts
 
Investment
 
Investment
 
 
 
($ in thousands)
 
 
 
($ in thousands)
Troubled Debt Restructurings:
 
 
 
 
 
 
 
 
 
 
 
   Single-family residential
25

 
$
4,909

 
$
4,909

 
31

 
$
5,682

 
$
5,682

   Land - consumer lot loans
—

 
—

 
—

 
1

 
204

 
204

   Commercial & Industrial
3

 
7,256

 
7,256

 
—

 
—

 
—

   HELOC
1

 
75

 
75

 
1

 
228

 
228

 
29

 
$
12,240

 
$
12,240

 
33

 
$
6,114

 
$
6,114


The following table provides information on payment defaults occurring during the periods presented where the loan had been modified in a TDR within 12 months of the payment default.

 
Three Months Ended June 30,
 
2018
 
2017
 
Number of
 
Recorded
 
Number of
 
Recorded
 
Contracts
 
Investment
 
Contracts
 
Investment
 
($ in thousands)
 
($ in thousands)
Trouble Debt Restructurings That Subsequently Defaulted:
 
 
 
 
 
 
 
   Single-family residential
—

 
$
—

 
3

 
$
401

 
—

 
$
—

 
3

 
$
401




14
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
Nine Months Ended June 30,
 
2018
 
2017
 
Number of
 
Recorded
 
Number of
 
Recorded
 
Contracts
 
Investment
 
Contracts
 
Investment
 
($ in thousands)
 
($ in thousands)
Troubled Debt Restructurings That Subsequently Defaulted:
 
 
 
 
 
 
 
   Single-family residential
2

 
$
206

 
16

 
$
3,586

   Commercial real estate
—

 
—

 
2

 
267

 
2

 
$
206

 
18

 
$
3,853


Most loans restructured in TDRs are accruing and performing loans where the borrower has proactively approached the Company about modification due to temporary financial difficulties. As of June 30, 2018, 96.7% of the Company's $171,603,000 in TDRs were classified as performing. Each request for modification is individually evaluated for merit and likelihood of success. The concession granted in a loan modification is typically a payment reduction through a rate reduction of between 100 to 200 basis points for a specific term, usually six to twenty four months. Interest-only payments may also be approved during the modification period. Principal forgiveness is not an available option for restructured loans. As of June 30, 2018, single-family residential loans comprised 89.4% of TDRs.

The Company reserves for restructured loans within its allowance for loan loss methodology by taking into account the following performance indicators: 1) time since modification, 2) current payment status and 3) geographic area.

In May 2018, the Bank entered into an agreement with the FDIC to early terminate its remaining FDIC loss share agreements, which relate to the Horizon Bank and Home Valley Bank acquisitions. The Bank paid $39,906,000 to settle the FDIC clawback liability and this amount is consistent with the liability on the balance sheet as of March 31, 2018 so no additional gain or loss was recorded in the three months ended June 30, 2018. Under the termination agreement, all rights and obligations of the Bank and the FDIC have been resolved and completed. As such, future recoveries, gains, losses and expenses related to the previously covered assets will now be recognized entirely by the Bank and the FDIC will no longer share in such gains or losses.



15
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE E – Allowance for Losses on Loans
The following tables summarize the activity in the allowance for loan losses. 

Three Months Ended June 30, 2018
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision &
Transfers
 
Ending
Allowance
 
(In thousands)
Single-family residential
$
34,144

 
$
(299
)
 
$
283

 
$
273

 
$
34,401

Construction
27,389

 
—

 
—

 
2,744

 
30,133

Construction - custom
2,081

 
—

 
—

 
(67
)
 
2,014

Land - acquisition & development
7,622

 
(12
)
 
2,699

 
(2,609
)
 
7,700

Land - consumer lot loans
2,853

 
(1
)
 
35

 
20

 
2,907

Multi-family
7,982

 
—

 
—

 
109

 
8,091

Commercial real estate
11,588

 
—

 
91

 
(100
)
 
11,579

Commercial & industrial
29,330

 
(3,317
)
 
433

 
1,069

 
27,515

HELOC
802

 
—

 
—

 
9

 
811

Consumer
3,785

 
(45
)
 
223

 
(448
)
 
3,515

 
$
127,576

 
$
(3,674
)
 
$
3,764

 
$
1,000

 
$
128,666

Three Months Ended June 30, 2017
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision &
Transfers
 
Ending
Allowance
 
(In thousands)
Single-family residential
$
37,164

 
$
(267
)
 
$
81

 
$
1,133

 
$
38,111

Construction
25,061

 
—

 
—

 
(3,195
)
 
21,866

Construction - custom
1,176

 
—

 
—

 
714

 
1,890

Land - acquisition & development
6,669

 
—

 
863

 
(315
)
 
7,217

Land - consumer lot loans
2,513

 
—

 
118

 
(83
)
 
2,548

Multi-family
7,929

 
—

 
—

 
(17
)
 
7,912

Commercial real estate
10,772

 
—

 
164

 
411

 
11,347

Commercial & industrial
28,365

 
—

 
154

 
653

 
29,172

HELOC
826

 
—

 
1

 
50

 
877

Consumer
1,447

 
(144
)
 
282

 
(296
)
 
1,289

 
$
121,922

 
$
(411
)
 
$
1,663

 
$
(945
)
 
$
122,229



16
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Nine Months Ended June 30, 2018
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision &
Transfers
 
Ending
Allowance
 
(In thousands)
Single-family residential
$
36,892

 
$
(1,049
)
 
$
615

 
$
(2,057
)
 
$
34,401

Construction
24,556

 
—

 
—

 
5,577

 
30,133

Construction - custom
1,944

 
(50
)
 
—

 
120

 
2,014

Land - acquisition & development
6,829

 
(12
)
 
7,278

 
(6,395
)
 
7,700

Land - consumer lot loans
2,649

 
(67
)
 
35

 
290

 
2,907

Multi-family
7,862

 
—

 
—

 
229

 
8,091

Commercial real estate
11,818

 
(36
)
 
92

 
(295
)
 
11,579

Commercial & industrial
28,524

 
(3,433
)
 
603

 
1,821

 
27,515

HELOC
855

 
(1
)
 
—

 
(43
)
 
811

Consumer
1,144

 
(217
)
 
785

 
1,803

 
3,515

 
$
123,073

 
$
(4,865
)
 
$
9,408

 
$
1,050

 
$
128,666


Nine Months Ended June 30, 2017
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision &
Transfers
 
Ending
Allowance
 
(In thousands)
Single-family residential
$
37,796

 
$
(763
)
 
$
455

 
$
623

 
$
38,111

Construction
19,838

 
—

 
—

 
2,028

 
21,866

Construction - custom
1,080

 
(3
)
 
—

 
813

 
1,890

Land - acquisition & development
6,023

 
(63
)
 
9,092

 
(7,835
)
 
7,217

Land - consumer lot loans
2,535

 
(17
)
 
368

 
(338
)
 
2,548

Multi-family
6,925

 
—

 
—

 
987

 
7,912

Commercial real estate
8,588

 
(11
)
 
1,684

 
1,086

 
11,347

Commercial & industrial
28,008

 
(163
)
 
1,096

 
231

 
29,172

HELOC
813

 
(90
)
 
2

 
152

 
877

Consumer
1,888

 
(798
)
 
975

 
(776
)
 
1,289

 
$
113,494

 
$
(1,908
)
 
$
13,672

 
$
(3,029
)
 
$
122,229


The Company recorded a provision for loan losses of $1,000,000 for the three months ended June 30, 2018, compared to no provision for loan losses for the three months ended June 30, 2017. A provision for loan losses of $50,000 and a release of allowance for loan losses of $1,600,000 was recorded during the nine months ended June 30, 2018 and June 30, 2017, respectively. Reserving for new loan originations as the loan portfolio grows has been largely offset by recoveries of previously charged-off loans. Recoveries, net of charge-offs, totaled $90,000 for the three months ended June 30, 2018, compared to net recoveries of $1,252,000 during the three months ended June 30, 2017. Recoveries, net of charge-offs, totaled $4,543,000 for the nine months ended June 30, 2018, compared to net recoveries of $11,764,000 during the nine months ended June 30, 2017.

Non-performing assets were $71,859,000, or 0.46%, of total assets at June 30, 2018, compared to $70,238,000, or 0.46%, of total assets at September 30, 2017. Non-accrual loans were $60,584,000 at June 30, 2018, compared to $49,580,000 at September 30, 2017. Delinquencies, as a percent of total loans, were 0.40% at June 30, 2018, compared to 0.40% at September 30, 2017.

The reserve for unfunded commitments was $6,750,000 as of June 30, 2018, which is a decrease from $7,750,000 at September 30, 2017.

Management believes the allowance for loan losses plus the reserve for unfunded commitments, totaling $135,416,000, or 1.06% of gross loans as of June 30, 2018, is sufficient to absorb estimated losses inherent in the portfolio of loans and unfunded commitments.


17
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following tables show loans collectively and individually evaluated for impairment and the related allocation of general and specific reserves.
 
June 30, 2018
Loans Collectively Evaluated for Impairment
 
Loans Individually Evaluated for Impairment
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
(In thousands, except ratio data)
 
(In thousands, except ratio data)
Single-family residential
$
34,401

 
$
5,726,737

 
0.6
%
 
$
—

 
$
24,139

 
—
%
Construction
30,133

 
1,007,676

 
3.0

 
—

 
4,563

 
—

Construction - custom
2,014

 
285,858

 
0.7

 
—

 
—

 
—

Land - acquisition & development
7,700

 
118,323

 
6.5

 
—

 
3,184

 
—

Land - consumer lot loans
2,907

 
97,310

 
3.0

 
—

 
833

 
—

Multi-family
8,086

 
1,343,468

 
0.6

 
5

 
3,045

 
0.2

Commercial real estate
11,502

 
1,388,029

 
0.8

 
77

 
31,805

 
0.2

Commercial & industrial
27,515

 
1,087,664

 
2.5

 
—

 
45,400

 
—

HELOC
811

 
134,522

 
0.6

 
—

 
562

 
—

Consumer
3,515

 
188,004

 
1.9

 
—

 
26

 
—

 
$
128,584

 
$
11,377,591

 
1.1
%
 
$
82

 
$
113,557

 
0.1
%

September 30, 2017
Loans Collectively Evaluated for Impairment
 
Loans Individually Evaluated for Impairment
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
(In thousands, except ratio data)
 
(In thousands, except ratio data)
Single-family residential
$
36,892

 
$
5,713,576

 
0.7
%
 
$
—

 
$
5,552

 
—
%
Construction
24,556

 
793,958

 
3.1

 
—

 
—

 
—

Construction - custom
1,944

 
277,495

 
0.7

 
—

 
105

 
—

Land - acquisition & development
6,828

 
104,767

 
6.5

 
1

 
89

 
1.0

Land - consumer lot loans
2,649

 
96,337

 
2.8

 
—

 
171

 
—

Multi-family
7,857

 
1,302,625

 
0.6

 
5

 
493

 
1.0

Commercial real estate
11,698

 
1,391,668

 
0.8

 
120

 
21,765

 
0.6

Commercial & industrial
28,524

 
1,093,210

 
2.6

 
—

 
81

 
—

HELOC
855

 
141,689

 
0.6

 
—

 
215

 
—

Consumer
1,144

 
84,887

 
1.4

 
—

 
82

 
—

 
$
122,947

 
$
11,000,212

 
1.1
%
 
$
126

 
$
28,553

 
0.4
%

As of June 30, 2018, $128,584,000 of the allowance was calculated under the Company's general allowance methodology and the remaining $82,000 was specific reserves on loans deemed to be individually impaired. As of September 30, 2017, $122,947,000 of the allowance was calculated under the Company's general allowance methodology and the remaining $126,000 was specific reserves on loans deemed to be individually impaired.

The Company has an asset quality review function that analyzes its loan portfolio and reports the results of the review to its Board of Directors on a quarterly basis. The single-family residential, HELOC and consumer portfolios are evaluated based on their performance as a pool of loans, since no single loan is individually significant or judged by its risk rating, size or potential risk of loss. The construction, land, multi-family, commercial real estate and commercial and industrial loans are risk rated on a loan by

18
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


loan basis to determine the relative risk inherent in specific borrowers or loans. Based on that risk rating, the loans are assigned a grade and classified as follows:

•
Pass – the credit does not meet one of the definitions below.

•
Special mention – A special mention credit is considered to be currently protected from loss but is potentially weak. No loss of principal or interest is foreseen; however, proper supervision and management attention is required to deter further deterioration in the credit. Assets in this category constitute some undue and unwarranted credit risk but not to the point of justifying a risk rating of substandard. The credit risk may be relatively minor yet constitutes an unwarranted risk in light of the circumstances surrounding a specific asset.

•
Substandard – A substandard credit is an unacceptable credit. Additionally, repayment in the normal course is in jeopardy due to the existence of one or more well defined weaknesses. In these situations, loss of principal is likely if the weakness is not corrected. A substandard asset is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified will have a well-defined weakness or weaknesses that jeopardize the collection or liquidation of the debt. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets risk rated substandard.

•
Doubtful – A credit classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weakness makes collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The probability of loss is high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.

•
Loss – Credits classified loss are considered uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this asset even though partial recovery may be affected in the future. Losses should be taken in the period in which they are identified as uncollectible. Partial charge-off versus full charge-off may be taken if the collateral offers some identifiable protection.


19
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following tables provide information on loans based on risk rating categories as defined above.
June 30, 2018
Internally Assigned Grade
 
 
 
Pass
 
Special mention
 
Substandard
 
Doubtful
 
Loss
 
Total Gross Loans
 
(In thousands, except ratio data)
Loan type
 
 
 
 
 
 
 
 
 
 
 
  Single-family residential
$
5,713,075

 
$
—

 
$
32,523

 
$
—

 
$
—

 
$
5,745,598

  Construction
1,880,415

 
55

 
4,564

 
—

 
—

 
1,885,034

  Construction - custom
612,688

 
—

 
—

 
—

 
—

 
612,688

  Land - acquisition & development
147,864

 
—

 
3,072

 
—

 
—

 
150,936

  Land - consumer lot loans
102,476

 
—

 
642

 
—

 
—

 
103,118

  Multi-family
1,343,950

 
—

 
2,584

 
—

 
—

 
1,346,534

  Commercial real estate
1,402,581

 
4,900

 
27,937

 
—

 
—

 
1,435,418

  Commercial & industrial
1,084,175

 
9,582

 
39,318

 
—

 
—

 
1,133,075

  HELOC
136,122

 
—

 
644

 
—

 
—

 
136,766

  Consumer
188,093

 
—

 
32

 
—

 
—

 
188,125

Total gross loans
$
12,611,439

 
$
14,537

 
$
111,316

 
$
—

 
$
—

 
$
12,737,292

 
 
 
 
 
 
 
 
 
 
 
 
Total grade as a % of total gross loans
99.0
%
 
0.1
%
 
0.9
%
 
—
%
 
—
%
 
 

September 30, 2017
Internally Assigned Grade
 
 
 
Pass
 
Special mention
 
Substandard
 
Doubtful
 
Loss
 
Total Gross Loans
 
(In thousands, except ratio data)
Loan type
 
 
 
 
 
 
 
 
 
 
 
 Single-family residential
$
5,671,229

 
$
—

 
$
39,775

 
$
—

 
$
—

 
$
5,711,004

 Construction
1,594,926

 
—

 
3,070

 
—

 
—

 
1,597,996

 Construction - custom
602,540

 
—

 
91

 
—

 
—

 
602,631

 Land - acquisition & development
123,028

 
207

 
1,073

 
—

 
—

 
124,308

 Land - consumer lot loans
103,787

 
—

 
618

 
—

 
—

 
104,405

 Multi-family
1,295,261

 
5,795

 
2,092

 
—

 
—

 
1,303,148

 Commercial real estate
1,391,996

 
5,944

 
36,670

 
—

 
—

 
1,434,610

 Commercial & industrial
1,054,972

 
14,814

 
23,574

 
—

 
—

 
1,093,360

 HELOC
144,229

 
—

 
621

 
—

 
—

 
144,850

 Consumer
84,984

 
—

 
91

 
—

 
—

 
85,075

Total gross loans
$
12,066,952

 
$
26,760

 
$
107,675

 
$
—

 
$
—

 
$
12,201,387

 
 
 
 
 
 
 
 
 
 
 
 
Total grade as a % of total gross loans
98.9
%
 
0.2
%
 
0.9
%
 
—
%
 
—
%
 
 




20
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following tables provide information on gross loans based on borrower payment activity.

June 30, 2018
Performing Loans
 
Non-Performing Loans
 
Amount
 
% of Total
Gross  Loans
 
Amount
 
% of Total
Gross  Loans
 
(In thousands, except ratio data)
Single-family residential
$
5,719,479

 
99.5
%
 
$
26,119

 
0.5
%
Construction
1,883,193

 
99.9

 
1,841

 
0.1

Construction - custom
612,688

 
100.0

 
—

 
—

Land - acquisition & development
149,179

 
98.8

 
1,757

 
1.2

Land - consumer lot loans
102,476

 
99.4

 
642

 
0.6

Multi-family
1,346,534

 
100.0

 
—

 
—

Commercial real estate
1,425,734

 
99.3

 
9,684

 
0.7

Commercial & industrial
1,113,199

 
98.2

 
19,876

 
1.8

HELOC
136,129

 
99.5

 
637

 
0.5

Consumer
188,097

 
100.0

 
28

 
—

 
$
12,676,708

 
99.5
%
 
$
60,584

 
0.5
%
September 30, 2017
Performing Loans
 
Non-Performing Loans
 
Amount
 
% of Total
Gross  Loans
 
Amount
 
% of Total
Gross  Loans
 
(In thousands, except ratio data)
Single-family residential
$
5,683,074

 
99.5
%
 
$
27,930

 
0.5
%
Construction
1,597,996

 
100.0

 
—

 
—

Construction - custom
602,540

 
99.9

 
91

 
0.1

Land - acquisition & development
124,012

 
99.8

 
296

 
0.2

Land - consumer lot loans
103,800

 
99.4

 
605

 
0.6

Multi-family
1,303,009

 
99.9

 
139

 
0.1

Commercial real estate
1,422,795

 
99.2

 
11,815

 
0.8

Commercial & industrial
1,085,278

 
99.3

 
8,082

 
0.7

HELOC
144,319

 
99.6

 
531

 
0.4

Consumer
84,984

 
99.9

 
91

 
0.1

 
$
12,151,807

 
99.6
%
 
$
49,580

 
0.4
%

21
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following tables provide information on impaired loan balances and the related allowances by loan types. 
June 30, 2018
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average Recorded Investment
(Year-To-Date)
 
(In thousands)
Impaired loans with no related allowance recorded:
 
 
 
 
 
 
 
Single-family residential
$
22,114

 
$
23,310

 
$
—

 
$
21,944

Construction
4,843

 
4,933

 
—

 
2,928

Construction - custom
—

 
—

 
—

 
37

Land - acquisition & development
3,073

 
3,120

 
—

 
1,741

Land - consumer lot loans
455

 
490

 
—

 
337

Multi-family
2,606

 
2,606

 
—

 
1,403

Commercial real estate
26,818

 
31,372

 
—

 
22,338

Commercial & industrial
35,427

 
35,736

 
—

 
19,507

HELOC
562

 
655

 
—

 
486

Consumer
26

 
68

 
—

 
56

 
95,924

 
102,290

 
—

 
70,777

Impaired loans with an allowance recorded:
 
 
 
 
 
 
 
Single-family residential
153,356

 
156,644

 
2,792

 
167,211

Land - acquisition & development
—

 
—

 
—

 
23

Land - consumer lot loans
5,136

 
5,502

 
—

 
6,832

Multi-family
461

 
461

 
5

 
477

Commercial real estate
7,162

 
7,975

 
77

 
11,492

Commercial & industrial
3,924

 
6,964

 
—

 
4,547

HELOC
1,491

 
1,575

 
—

 
1,500

Consumer
73

 
73

 
—

 
87

 
171,603

 
179,194

 
2,874

(1)
192,169

Total impaired loans:
 
 
 
 
 
 
 
Single-family residential
175,470

 
179,954

 
2,792

 
189,155

Construction
4,843

 
4,933

 
—

 
2,928

Construction - custom
—

 
—

 
—

 
37

Land - acquisition & development
3,073

 
3,120

 
—

 
1,764

Land - consumer lot loans
5,591

 
5,992

 
—

 
7,169

Multi-family
3,067

 
3,067

 
5

 
1,880

Commercial real estate
33,980

 
39,347

 
77

 
33,830

Commercial & industrial
39,351

 
42,700

 
—

 
24,054

HELOC
2,053

 
2,230

 
—

 
1,986

Consumer
99

 
141

 
—

 
143

 
$
267,527

 
$
281,484

 
$
2,874

(1)
$
262,946


(1)
Includes $82,000 of specific reserves and $2,792,000 included in the general reserves.



22
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


September 30, 2017
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average Recorded Investment
(Year-To-Date)
 
(In thousands)
Impaired loans with no related allowance recorded:
 
 
 
 
 
 
 
Single-family residential
$
21,325

 
$
23,880

 
$
—

 
$
19,371

Construction - custom
148

 
165

 
—

 
231

Land - acquisition & development
330

 
8,208

 
—

 
176

Land - consumer lot loans
208

 
330

 
—

 
431

Multi-family
139

 
3,231

 
—

 
748

Commercial real estate
12,890

 
22,487

 
—

 
11,466

Commercial & industrial
8,279

 
14,321

 
—

 
7,425

HELOC
490

 
1,212

 
—

 
487

Consumer
88

 
1,433

 
—

 
57

 
43,897

 
75,267

 
—

 
40,392

Impaired loans with an allowance recorded:
 
 
 
 
 
 
 
Single-family residential
181,941

 
186,167

 
4,030

 
204,723

Land - acquisition & development
90

 
90

 
1

 
576

Land - consumer lot loans
7,949

 
8,526

 
—

 
8,976

Multi-family
493

 
493

 
5

 
1,024

Commercial real estate
15,079

 
16,707

 
120

 
16,991

Commercial & industrial
—

 
—

 
—

 
297

HELOC
1,728

 
1,806

 
—

 
1,451

Consumer
97

 
284

 
—

 
100

 
207,377

 
214,073

 
4,156

(1)
234,138

Total impaired loans:
 
 
 
 
 
 
 
Single-family residential
203,266

 
210,047

 
4,030

 
224,094

Construction - custom
148

 
165

 
—

 
231

Land - acquisition & development
420

 
8,298

 
1

 
752

Land - consumer lot loans
8,157

 
8,856

 
—

 
9,407

Multi-family
632

 
3,724

 
5

 
1,772

Commercial real estate
27,969

 
39,194

 
120

 
28,457

Commercial & industrial
8,279

 
14,321

 
—

 
7,722

HELOC
2,218

 
3,018

 
—

 
1,938

Consumer
185

 
1,717

 
—

 
157

 
$
251,274

 
$
289,340

 
$
4,156

(1)
$
274,530


(1)
Includes $126,000 of specific reserves and $4,030,000 included in the general reserves.


23
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE F – Fair Value Measurements
FASB ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active exchange markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company has established and documented the process for determining the fair values of its assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, fair value is determined using valuation models or third-party appraisals. The following is a description of the valuation methodologies used to measure and report the fair value of financial assets and liabilities on a recurring or nonrecurring basis.
Measured on a Recurring Basis
Available-for-Sale Securities and Derivative Contracts
Securities available for sale are recorded at fair value on a recurring basis. The fair value of debt securities are priced using model pricing based on the securities' relationship to other benchmark quoted prices as provided by an independent third party, and under GAAP are considered a Level 2 input method. Securities that are traded on active exchanges, including the Company's equity securities, are measured using the closing price in an active market and are considered a Level 1 input method.
The Company offers interest rate swaps to its variable rate borrowers who want to manage their interest rate risk. At the same time, the Company enters into the opposite trade with a counter party to offset its interest rate risk. The Company has also entered into commercial loan hedges as well as borrowings hedges using interest rate swaps. The fair value of these interest rate swaps are estimated by a third party pricing service using a discounted cash flow technique. These are considered a Level 2 input method.
 

24
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following tables present the balance of assets and liabilities measured at fair value on a recurring basis.
 
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Financial Assets
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Equity securities
$
491

 
$
—

 
$
—

 
$
491

U.S. government and agency securities
—

 
216,009

 
—

 
216,009

Municipal bonds
—

 
22,755

 
—

 
22,755

Corporate debt securities
—

 
184,232

 
—

 
184,232

Mortgage-backed securities
 
 
 
 
 
 
 
Agency pass-through certificates
—

 
828,449

 
—

 
828,449

Commercial MBS
—

 
3,465

 
—

 
3,465

Total available-for-sale securities
491

 
1,254,910

 
—

 
1,255,401

Interest rate contracts
—

 
10,141

 
—

 
10,141

Commercial loan hedges
—

 
3,005

 
—

 
3,005

Borrowings hedges
—

 
19,193

 
—

 
19,193

Total financial assets
$
491

 
$
1,287,249

 
$
—

 
$
1,287,740

 
 
 
 
 
 
 
 
Financial Liabilities
 
 
 
 
 
 
 
Interest rate contracts
$
—

 
$
10,141

 
$
—

 
$
10,141

Total financial liabilities
$
—

 
$
10,141

 
$
—

 
$
10,141

There were no transfers between, into and/or out of Levels 1, 2 or 3 during the nine months ended June 30, 2018.

25
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
September 30, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Financial Assets
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Equity securities
$
522

 
$
—

 
$
—

 
$
522

U.S. government and agency securities
—

 
211,077

 
—

 
211,077

Municipal bonds
—

 
26,624

 
—

 
26,624

Corporate debt securities
—

 
185,298

 
—

 
185,298

Mortgage-backed securities
 
 
 
 
 
 
 
Agency pass-through certificates
—

 
834,297

 
—

 
834,297

Commercial MBS
—

 
8,391

 
—

 
8,391

Total available-for-sale securities
522

 
1,265,687

 
—

 
1,266,209

Interest rate contracts
—

 
1,139

 
—

 
1,139

Total financial assets
$
522

 
$
1,266,826

 
$
—

 
$
1,267,348

 
 
 
 
 
 
 
 
Financial Liabilities
 
 
 
 
 
 
 
Interest rate contracts
$
—

 
$
1,139

 
$
—

 
$
1,139

Commercial loan hedges
—

 
174

 
—

 
174

Borrowings hedges
—

 
1,693

 
—

 
1,693

Total financial liabilities
$
—

 
$
3,006

 
$
—

 
$
3,006

There were no transfers between, into and/or out of Levels 1, 2 or 3 during the fiscal year ended September 30, 2017.


26
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Measured on a Nonrecurring Basis

Impaired Loans & Real Estate Owned

Real estate owned ("REO") consists principally of properties acquired through foreclosure. From time to time, and on a nonrecurring basis, adjustments using fair value measurements are recorded to reflect increases or decreases based on the discounted cash flows, the current appraisal or estimated value of the collateral, but only up to the fair value of the real estate owned as of the initial transfer date less selling costs.

When management determines that the fair value of the collateral or the real estate owned requires additional adjustments, either as a result of an updated appraised value or when there is no observable market price, the Company classifies the impaired loan or real estate owned as Level 3. Level 3 assets recorded at fair value on a nonrecurring basis at June 30, 2018 included loans for which a specific reserve allowance was established or a partial charge-off was recorded based on the fair value of collateral, as well as real estate owned where the fair value of the property was less than the cost basis.

The following tables present the aggregated balance of assets that were measured at fair value on a nonrecurring basis at June 30, 2018 and June 30, 2017, and the total gains (losses) resulting from those fair value adjustments for the three and nine months ended June 30, 2018 and June 30, 2017. The estimated fair value measurements are shown gross of estimated selling costs.
 
 
June 30, 2018
 
Three Months Ended June 30, 2018
 
Nine Months Ended June 30, 2018
 
Level 1
 
Level  2
 
Level  3
 
Total
 
Total Gains (Losses)
 
(In thousands)
 
(In thousands)
Impaired loans (1)
$
—

 
$
—

 
$
15,125

 
$
15,125

 
$
(3,120
)
 
$
(4,094
)
Real estate owned (2)
—

 
—

 
6,354

 
6,354

 
(97
)
 
(656
)
Balance at end of period
$
—

 
$
—

 
$
21,479

 
$
21,479

 
$
(3,217
)
 
$
(4,750
)

(1)
The gains (losses) represent remeasurements of collateral-dependent loans.
(2)
The gains (losses) represent aggregate writedowns and charge-offs on REO.

 
June 30, 2017
 
Three Months Ended June 30, 2017
 
Nine Months Ended June 30, 2017
 
Level 1
 
Level  2
 
Level  3
 
Total
 
Total Gains (Losses)
 
(In thousands)
 
(In thousands)
Impaired loans (1)
$
—

 
$
—

 
$
7,807

 
$
7,807

 
$
(305
)
 
$
(1,666
)
Real estate owned (2)
—

 
—

 
9,777

 
9,777

 
(467
)
 
(1,087
)
Balance at end of period
$
—

 
$
—

 
$
17,584

 
$
17,584

 
$
(772
)
 
$
(2,753
)

(1)
The gains (losses) represent remeasurements of collateral-dependent loans.
(2)
The gains (losses) represent aggregate writedowns and charge-offs on REO.
Impaired loans - The Company adjusts the carrying amount of impaired loans when there is evidence of probable loss and the expected fair value of the loan is less than its contractual amount. The amount of the impairment may be determined based on the estimated present value of future cash flows or the fair value of the underlying collateral. Impaired loans with a specific reserve allowance based on cash flow analysis or the value of the underlying collateral are classified as Level 3 assets.
The evaluations for impairment are prepared by the Company's Problem Loan Review Committee, which is chaired by the Chief Credit Officer and includes the Loan Review manager and Special Credits manager, as well as senior credit officers, division managers and group executives, as applicable. These evaluations are performed in conjunction with the quarterly allowance for loan loss process.

27
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Applicable loans included in the previous quarter's review are reevaluated and if their values are materially different from the prior quarter evaluation, the underlying information (loan balance and collateral value) are compared. Material differences are evaluated for reasonableness and discussions are held between the relationship manager and their division manager to understand the difference and determine if any adjustment is necessary.
The inputs are developed and substantiated on a quarterly basis, based on current borrower developments, market conditions and collateral values. The following methods are used to value impaired loans:
•
The fair value of the collateral, which may take the form of real estate or personal property, is based on internal estimates, field observations, assessments provided by third-party appraisers and other valuation models. The Company performs or reaffirms valuations of collateral-dependent impaired loans at least annually. Adjustments are made if management believes that more recent information is available and relevant with respect to the fair value of the collateral.
•
The present value of the expected future cash flows of the loans is used for measurement of non-collateral-dependent loans to test for impairment.
Real estate owned - When a loan is reclassified from loan status to real estate owned due to the Company taking possession of the collateral, a special credits officer, along with the special credits manager, obtains a valuation, which may include appraisals or third-party price opinions, which is used to establish the fair value of the underlying collateral. The determined fair value, less selling costs, becomes the carrying value of the REO asset.
The fair value of REO assets is re-evaluated quarterly and the REO asset is adjusted to reflect the fair value as necessary. After foreclosure, the valuations are updated periodically and current market conditions may require the assets to be written down further or up to the cost basis established on the date of transfer. The carrying balance of REO assets are also written down once a bona fide offer is contractually accepted, through execution of a purchase and sale agreement, where the accepted price is lower than the cost established on the transfer date.
Fair Values of Financial Instruments
FASB ASC 825 requires disclosure of fair value information about financial instruments, whether or not recognized on the statement of financial condition, for which it is practicable to estimate those values. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value estimates presented do not reflect the underlying fair value of the Company. Although management is not aware of any factors that would materially affect the estimated fair value amounts presented below, such amounts have not been comprehensively revalued for purposes of these financial statements since the dates shown, and therefore, estimates of fair value subsequent to those dates may differ significantly from the amounts presented below. 

28
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
 
 
 
June 30, 2018
 
September 30, 2017
 
 
Level in Fair Value Hierarchy
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
 
 
 
 
($ in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
1
 
$
345,919

 
$
345,919

 
$
313,070

 
$
313,070

Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
Equity securities
 
1
 
491

 
491

 
522

 
522

U.S. government and agency securities
 
2
 
216,009

 
216,009

 
211,077

 
211,077

Municipal bonds
 
2
 
22,755

 
22,755

 
26,624

 
26,624

Corporate debt securities
 
2
 
184,232

 
184,232

 
185,298

 
185,298

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
 
2
 
828,449

 
828,449

 
834,297

 
834,297

Commercial MBS
 
2
 
3,465

 
3,465

 
8,391

 
8,391

Total available-for-sale securities
 
 
 
1,255,401

 
1,255,401

 
1,266,209

 
1,266,209

Held-to-maturity securities
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
 
2
 
1,655,450

 
1,595,034

 
1,646,856

 
1,635,913

                           Commercial MBS
 
2
 
15,000

 
15,000

 
—

 
—

Total held-to-maturity securities
 
 
 
1,670,450

 
1,610,034

 
1,646,856

 
1,635,913

 
 
 
 
 
 
 
 
 
 
 
Loans receivable
 
3
 
11,325,971

 
11,492,022

 
10,882,622

 
11,247,586

FDIC indemnification asset
 
3
 
—

 
—

 
8,968

 
8,564

FHLB and FRB stock
 
2
 
128,790

 
128,790

 
122,990

 
122,990

        Other assets - interest rate contracts
 
2
 
10,141

 
10,141

 
1,139

 
1,139

        Other assets - commercial loan hedges
 
2
 
3,005

 
3,005

 
—

 
—

        Other assets - borrowings hedges
 
2
 
19,193

 
19,193

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
 
 
Customer accounts
 
2
 
11,287,473

 
10,924,562

 
10,835,008

 
10,411,686

FHLB advances
 
2
 
2,370,000

 
2,365,478

 
2,225,000

 
2,266,791

        Other liabilities - interest rate contracts
 
2
 
10,141

 
10,141

 
1,139

 
1,139

Other liabilities - commercial loan hedges
 
2
 
—

 
—

 
174

 
174

        Other liabilities - borrowings hedges
 
2
 
—

 
—

 
1,693

 
1,693

The following methods and assumptions were used to estimate the fair value of financial instruments:
Cash and cash equivalents – The carrying amount of these items is a reasonable estimate of their fair value. 
Available-for-sale securities and held-to-maturity securities – Securities at fair value are primarily priced using model pricing based on the securities' relationship to other benchmark quoted prices as provided by an independent third party, and are considered a Level 2 input method. Equity securities that are exchange traded are considered a Level 1 input method.
Loans receivable – For certain homogeneous categories of loans, such as fixed- and variable-rate residential mortgages, fair value is estimated for securities backed by similar loans, adjusted for differences in loan characteristics, using the same methodology described above for AFS and HTM securities. The fair value of other loan types is estimated by discounting the future cash flows and estimated prepayments using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining term. Some loan types were valued at carrying value because of their floating rate or expected maturity characteristics. Net deferred loan fees are not included in the fair value calculation but are included in the carrying amount.
FHLB and FRB stock – The fair value is based upon the par value of the stock that equates to its carrying value.

29
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Customer accounts – The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the estimated future cash flows using the rates currently offered for deposits with similar remaining maturities.
FHLB advances – The fair value of FHLB advances and other borrowings is estimated by discounting the estimated future cash flows using rates currently available to the Company for debt with similar remaining maturities.
Interest rate contracts – The Company offers interest rate swaps to its variable rate borrowers who want to manage their interest rate risk. At the same time, the Company enters into the opposite trade with a counterparty to offset its interest rate risk. The fair value of these interest rate swaps is estimated by a third party pricing service using a discounted cash flow technique.
Commercial loan hedges – The fair value of the interest rate swaps is estimated by a third party pricing service using a discounted cash flow technique.
Borrowings hedges – The fair value of the interest rate swaps is estimated by a third party pricing service using a discounted cash flow technique.
The following tables provide a reconciliation of amortized cost to fair value of available-for-sale and held-to-maturity securities.
 
June 30, 2018
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Yield
 
Gains
 
Losses
 
 
($ in thousands)
Available-for-sale securities

 
 
 
 
 
 
 
 
U.S. government and agency securities due
 
 
 
 
 
 
 
 
 
5 to 10 years
$
63,986

 
$
—

 
$
(1,678
)
 
$
62,308

 
2.41
%
Over 10 years
153,928

 
122

 
(349
)
 
153,701

 
2.71

Equity securities due
 
 
 
 
 
 
 
 
 
1 to 5 years
500

 
—

 
(9
)
 
491

 
1.80

Corporate debt securities due
 
 
 
 
 
 
 
 
 
1 to 5 years
113,727

 
1,687

 
(273
)
 
115,141

 
3.60

5 to 10 years
69,964

 
—

 
(873
)
 
69,091

 
3.23

Municipal bonds due
 
 
 
 
 
 
 
 
 
1 to 5 years
1,390

 
—

 
(10
)
 
1,380

 
2.05

Over 10 years
20,328

 
1,047

 
—

 
21,375

 
6.45

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
836,777

 
1,563

 
(9,891
)
 
828,449

 
3.34

Commercial MBS
3,460

 
5

 
—

 
3,465

 
4.27

 
1,264,060

 
4,424

 
(13,083
)
 
1,255,401

 
3.28

Held-to-maturity securities
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
1,655,450

 
635

 
(61,051
)
 
1,595,034

 
3.16

Commercial MBS
15,000

 
—

 
—

 
15,000

 
2.94

 
1,670,450

 
635

 
(61,051
)
 
1,610,034

 
3.16

 
$
2,934,510

 
$
5,059

 
$
(74,134
)
 
$
2,865,435

 
3.21
%
 

30
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
September 30, 2017
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Yield
 
Gains
Losses
 
 
($ in thousands)
Available-for-sale securities
 
 
 
 
 
 
 
 
 
U.S. government and agency securities due
 
 
 
 
 
 
 
 
 
Within 1 year
$
9,300

 
$
146

 
$
—

 
$
9,446

 
10.38
%
1 to 5 years
5,688

 
2

 
—

 
5,690

 
1.51

5 to 10 years
69,108

 
—

 
(1,238
)
 
67,870

 
1.93

Over 10 years
127,936

 
353

 
(218
)
 
128,071

 
1.92

Equity securities
 
 
 
 
 
 
 
 
 
1 to 5 years
500

 
22

 
—

 
522

 
1.80

Corporate bonds due
 
 
 
 
 
 
 
 
 
1 to 5 years
63,622

 
2,083

 
—

 
65,705

 
2.96

5 to 10 years
119,960

 
210

 
(577
)
 
119,593

 
2.62

Municipal bonds due
 
 
 
 
 
 
 
 
 
Within 1 year
2,344

 
10

 
—

 
2,354

 
1.23

1 to 5 years
1,367

 
55

 
—

 
1,422

 
2.05

Over 10 years
20,343

 
2,505

 
—

 
22,848

 
6.45

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
828,069

 
8,402

 
(2,174
)
 
834,297

 
2.96

Commercial MBS
8,350

 
41

 
—

 
8,391

 
3.31

 
1,256,587

 
13,829

 
(4,207
)
 
1,266,209

 
2.86

Held-to-maturity securities
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Agency pass-through certificates
1,646,856

 
7,143

 
(18,086
)
 
1,635,913

 
3.14

 
1,646,856

 
7,143

 
(18,086
)
 
1,635,913

 
3.14

 
$
2,903,443

 
$
20,972

 
$
(22,293
)
 
$
2,902,122

 
3.02
%

For available-for-sale investment securities, there were no sales during the nine months ended June 30, 2018 and sales totaling $350,890,000 during the nine months ended June 30, 2017. There were purchases of $166,696,000 of available-for-sale investment securities during the nine months ended June 30, 2018 and no purchases during the nine months ended June 30, 2017. For held-to-maturity investment securities, there were purchases totaling $170,836,000 during the nine months ended June 30, 2018 and purchases of $415,729,000 during the nine months ended June 30, 2017. There were no sales of held-to-maturity investment securities during either period. Substantially all of the agency mortgage-backed securities have contractual due dates that exceed 10 years.
The following tables show the unrealized gross losses and fair value of securities as of June 30, 2018 and September 30, 2017, by length of time that individual securities in each category have been in a continuous loss position. The decline in fair value since purchase is attributable to changes in interest rates. Because the Company does not intend to sell these securities and does not consider it more likely than not that it will be required to sell these securities before the recovery of amortized cost basis, which may be upon maturity, the Company does not consider these investments to be other than temporarily impaired.

31
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
June 30, 2018
Less than 12 months
 
12 months or more
 
Total
 
Unrealized
Gross Losses
 
Fair
Value
 
Unrealized
Gross Losses
 
Fair
Value
 
Unrealized
Gross Losses
 
Fair
Value
 
(In thousands)
 
 
Corporate debt securities
$
—

 
$
—

 
$
(1,146
)
 
$
118,818

 
$
(1,146
)
 
118,818

Municipal bonds
(10
)
 
1,380

 
—

 
—

 
(10
)
 
1,380

U.S. government and agency securities
(64
)
 
43,310

 
(1,963
)
 
120,006

 
(2,027
)
 
163,316

Equity securities
(9
)
 
491

 
—

 
—

 
(9
)
 
491

Agency pass-through certificates
(13,696
)
 
706,627

 
(57,246
)
 
1,401,192

 
(70,942
)
 
2,107,819

 
$
(13,779
)
 
$
751,808

 
$
(60,355
)
 
$
1,640,016

 
$
(74,134
)
 
$
2,391,824


September 30, 2017
Less than 12 months
 
12 months or more
 
Total
 
Unrealized
Gross Losses
 
Fair
Value
 
Unrealized
Gross Losses
 
Fair
Value
 
Unrealized
Gross Losses
 
Fair
Value
 
(In thousands)
 
 
Corporate debt securities
$
—

 
$
—

 
$
(577
)
 
$
49,423

 
$
(577
)
 
$
49,423

U.S. government and agency securities
(759
)
 
24,400

 
(697
)
 
96,195

 
(1,456
)
 
120,595

Agency pass-through certificates
(17,683
)
 
1,163,358

 
(2,577
)
 
249,304

 
(20,260
)
 
1,412,662

 
$
(18,442
)
 
$
1,187,758

 
$
(3,851
)
 
$
394,922

 
$
(22,293
)
 
$
1,582,680



32
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE G – Derivatives and Hedging Activities

The Company periodically enters into certain interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rate payments, while the Company retains a variable rate loan. Under these agreements, the Company enters into a variable rate loan agreement and a swap agreement with the client. The swap agreement effectively converts the client’s variable rate loan into a fixed rate. The Company enters into a corresponding swap agreement with a third party in order to offset its exposure on the variable and fixed components of the client's swap agreement. The Company had $781,626,000 and $1,035,573,000 notional in interest rate swaps to hedge this exposure as of June 30, 2018 and September 30, 2017, respectively. The interest rate swaps are derivatives under FASB ASC 815, Derivatives and Hedging, with changes in fair value recorded in earnings. There was no net impact to the statement of operations for the nine months ended June 30, 2018 and 2017 as the changes in value for the asset and liability side of the swaps offset each other.

The Company has entered into interest rate swaps to convert certain existing and future short-term borrowings to fixed rate payments. The primary purpose of these hedges is to mitigate the risk of rising interest rates, specifically LIBOR rates, which are a benchmark for the short-term borrowings. The hedging program qualifies as a cash flow hedge under ASC 815, which provides for offsetting of the recognition of gains and losses of the interest rate swaps and the hedged items. The hedged item is the LIBOR portion of the series of existing or future short-term fixed rate borrowings over the term of the interest rate swap. The change in the fair value of the interest rate swaps is recorded in other comprehensive income. The Company had $700,000,000 notional in interest rate swaps to hedge existing and anticipated future borrowings as of June 30, 2018 and September 30, 2017.

The Company also enters into interest rate swaps to hedge the interest rate risk of individual fixed rate commercial loans and these relationships qualify as fair value hedges under ASC 815, which provides for offsetting of the recognition of gains and losses of the respective interest rate swap and the hedged item. The interest rate swaps in these hedging relationships had a notional amount of $97,927,000 and $52,936,000 as of June 30, 2018 and September 30, 2017, respectively.

The following table presents the fair value and balance sheet classification of derivatives at June 30, 2018 and September 30, 2017:
 
 
Asset Derivatives
 
Liability Derivatives
 
 
June 30, 2018
 
September 30, 2017
 
June 30, 2018
 
September 30, 2017
 
 
Balance Sheet
 
 
 
Balance Sheet
 
 
 
Balance Sheet
 
 
 
Balance Sheet
 
 
 
 
Location
 
Fair Value
 
Location
 
Fair Value
 
Location
 
Fair Value
 
Location
 
Fair Value
 
 
(In thousands)
Interest rate contracts
 
Other assets
 
$
10,141

 
Other assets
 
$
1,139

 
Other liabilities
 
$
10,141

 
Other liabilities
 
$
1,139

Commercial loan hedges
 
Other assets
 
3,005

 
Other assets
 
—

 
Other liabilities
 
—

 
Other liabilities
 
174

Borrowings hedges
 
Other assets
 
19,193

 
Other assets
 
—

 
Other liabilities
 
—

 
Other liabilities
 
1,693

 
 
 
 
$
32,339

 
 
 
$
1,139

 
 
 
$
10,141

 
 
 
$
3,006



33
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE H – Income Taxes

On December 22, 2017, the U.S. Government enacted significant new tax legislation (the “Tax Act”). For businesses, the Tax Act reduces the corporate federal tax rate from a maximum of 35% to a flat 21% rate. The corporate tax rate reduction was effective January 1, 2018. Because the Company has a fiscal year end of September 30, the reduced corporate tax rate will result in the application of a blended federal statutory tax rate of 24.53% for its fiscal year 2018 and then 21% thereafter.

Under generally accepted accounting principles, the Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

At September 30, 2017, the Company’s deferred tax assets and liabilities were determined based on the then-current enacted federal tax rate of 35%. As a result of the reduction in the corporate income tax rate under the Tax Act, the Company revalued its deferred tax assets and liabilities at December 31, 2017. Deferred tax assets and liabilities expected to be realized in fiscal year 2018 were re-measured using the aforementioned blended rate. All remaining deferred tax assets and liabilities were re-measured using the new statutory federal rate of 21%. These re-measurements resulted in a discrete tax benefit estimate of $5,387,000 that was recognized during the nine months ended June 30, 2018. The Company’s revaluation of its deferred tax assets and liabilities is subject to further clarification of the Tax Act and refinements of its estimates.



34
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

PART I – Financial Information
Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING STATEMENTS

Washington Federal, Inc. (the "Company" or "Washington Federal") makes statements in this Quarterly Report on Form 10-Q that constitute forward-looking statements. Words such as “expects,” “anticipates,” “believes,” “estimates,” “intends,” “forecasts,” “projects” and other similar expressions or future or conditional verbs such as “will,” “should,” “would” and “could” are intended to help identify such forward-looking statements. These statements are not historical facts, but instead represent current expectations, plans or forecasts of the Company and are based on the beliefs and assumptions of the management of the Company and the information available to management at the time that these disclosures were prepared. The Company intends for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are not guarantees of future results or performance and involve certain risks, uncertainties and assumptions that are difficult to predict and often are beyond the Company's control. Actual outcomes and results may differ materially from those expressed in, or implied by, the Company's forward-looking statements.
You should not place undue reliance on any forward-looking statement and should consider the following uncertainties and risks, as well as the risks and uncertainties discussed elsewhere in this report, including under Item 1A. “Risk Factors,” and in any of the Company's other subsequent Securities and Exchange Commission ("SEC") filings, which could cause the Company's future results to differ materially from the plans, objectives, goals, estimates, intentions and expectations expressed in forward-looking statements:
•
a deterioration in economic conditions, including declines in the real estate market and home sale volumes and financial stress on borrowers (consumers and businesses) as a result of the uncertain economic environment;
•
the effects of a severe economic downturn, including high unemployment rates and declines in housing prices and property values, in the Company's primary market areas;
•
the effects of and changes in monetary and fiscal policies of the Board of Governors of the Federal Reserve System and the U.S. Government;
•
fluctuations in interest rate risk and changes in market interest rates;
•
the Company's ability to make accurate assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and the value of the assets securing these loans;
•
the Company's ability to successfully complete merger and acquisition activities and realize expected strategic and operating efficiencies associated with such activities;
•
legislative and regulatory limitations, including those arising under the Dodd-Frank Act and potential limitations
in the manner in which the Company conducts its business and undertake new investments and activities;
•
the ability of the Company to obtain external financing to fund its operations or obtain this financing on favorable terms;
•
changes in other economic, competitive, governmental, regulatory and technological factors affecting the Company's markets, operations, pricing, products, services and fees;
•
the success of the Company at managing the risks involved in the remediation efforts associated with its Bank Secrecy Act program, costs of enhancements to the Bank’s BSA program are greater than anticipated; and governmental authorities undertake enforcement actions or legal proceedings with respect to the Bank’s BSA program beyond those contemplated by the Consent Order, and the potential impact of such matters on the success, timing and ability to pursue the Company’s growth or other business initiatives;
•
the success of the Company at managing the risks involved in the foregoing and managing its business; and
•
the timing and occurrence or non-occurrence of events that may be subject to circumstances beyond the Company's control.

All forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, changes to future operating results over time, or the impact of circumstances arising after the date the forward-looking statement was made.
GENERAL & BUSINESS DESCRIPTION
Washington Federal, Inc. is a bank holding company headquartered in Seattle, Washington that conducts its operations through Washington Federal, National Association (“Bank”), a federally chartered national bank subsidiary. Washington Federal, Inc. and

35
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

its consolidated subsidiaries are 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.

The Company's fiscal year end is September 30th. All references to 2017 represent balances as of September 30, 2017 or activity for the fiscal year then ended.

INTEREST RATE RISK
Based on management's assessment of the current interest rate environment, the Company has taken steps, including growing shorter-term loans and transaction deposit accounts, to reduce its interest rate risk profile. The mix of transaction and savings accounts is 58% of total deposits as of June 30, 2018 while the composition of the investment securities portfolio is 26% variable and 74% fixed rate. When interest rates rise, the fair value of the investment securities with fixed rates will decrease and vice versa when interest rates decline. The Company has $1,670,450,000 of mortgage-backed securities that it has designated as held-to-maturity and are carried at amortized cost. As of June 30, 2018, the net unrealized loss on these securities was $60,416,000. The Company has $1,255,401,000 of available-for-sale securities that are carried at fair value. As of June 30, 2018, the net unrealized loss on these securities was $8,659,000. The Company has executed interest rate swaps to hedge interest rate risk on certain FHLB borrowings. The unrealized gain on these interest rate swaps as of June 30, 2018 was $19,193,000. All of the above are pre-tax net unrealized gains or losses.

The Company relies on various measures of interest rate risk, including an asset/liability maturity gap analysis, modeling of changes in forecasted net interest income under various rate change scenarios, and the impact of interest rate changes on the net portfolio value (“NPV”) of the Company.
Net Interest Income Sensitivity. The Company estimates the sensitivity of its 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 the Company's interest-earnings 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 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 1.2% in the next year. This compares to an estimated increase of 3.0% as of the September 30, 2017 analysis. The change is primarily due to higher interest rates, lower expected prepayment speeds and shifts in the mix of fixed versus adjustable rate assets, partially offset by a decrease in the estimated deposit betas used for transaction deposits in the Company's asset liability management model. 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 net interest income decrease of 0.4% in the first year and decrease of 4.0% in the second year assuming a constant balance sheet and no management intervention.

NPV Sensitivity. NPV is an estimate of the market value of shareholders' equity. NPV is calculated as the difference between the present value of expected cash flows from interest-earning assets and the present value of expected cash flows from interest-paying liabilities and off-balance-sheet contracts. The sensitivity of NPV to changes in interest rates provides a view of interest rate risk as it incorporates all future expected cash flows. As of June 30, 2018, in the event of an immediate and parallel increase of 200 basis points in interest rates, the NPV is estimated to decline by $413,496,000 or 19.3% and the NPV to total assets ratio to decline to 11.9% from a base of 13.8%. As of September 30, 2017, the NPV in the event of a 200 basis point increase in rates was estimated to decline by $462,604,000 or 18.2% and the NPV to total assets ratio to decline to 14.6% from a base of 16.6%. The change in NPV sensitivity and lower base NPV ratio is due primarily to higher interest rates that have resulted in lower asset prices as well as greater asset price sensitivity due to lower expected prepayment speeds on fixed rate loans and mortgage-backed securities as of June 30, 2018.

Repricing Gap Analysis. At June 30, 2018, the Company had approximately $1,832,133,000 more in liabilities subject to maturity or repricing in the next year than assets, which resulted in a one-year repricing gap of (11.6)% of total assets. This was a decrease from the (15.7)% gap as of September 30, 2017. A negative repricing gap implies that funding costs on paying liabilities will change more rapidly than interest income on earning assets with movements in interest rates. A negative repricing gap typically results in lower margins when interest rates rise and higher margins when interest rates decline. This interest rate gap analysis provides management with a high-level indication of interest rate risk, but it is considered less reliable than more detailed modeling.

36
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

Interest Rate Spread. The interest rate spread is measured as the difference between the rate on total loans and investments and the rate on costing liabilities at the end of each period. The interest rate spread increased to 2.93% at June 30, 2018 from 2.90% at September 30, 2017. The spread increase of 3 basis points is primarily due to the rise in short-term interest rates, which resulted in a higher rate being earned on cash and adjustable rate loans and investment securities partially offset by a higher rate being paid on interest-bearing deposits and FHLB borrowings. As of June 30, 2018, the weighted average rate on earning assets increased by 19 basis points to 4.01% compared to September 30, 2017, while the weighted average cost of funds increased by 16 basis points to 1.08%. The interest rate spread increased to 2.93% at June 30, 2018 from 2.85% at June 30, 2017.
Net Interest Margin. Net interest margin is measured as net interest income divided by average earning assets for the period. Net interest margin increased to 3.29% for the quarter ended June 30, 2018 from 3.13% for the quarter ended June 30, 2017. The yield on earning assets increased 28 basis points to 4.26% and the cost of interest bearing liabilities increased 13 basis point to 1.04%. The higher yield on earning assets is the result of the rise in short-term interest rates, which resulted in a higher rate being earned on cash and adjustable rate loans and investment securities, as well as the shift in mix from investment securities into a higher proportion of loans receivable that carry higher yields on average. The higher rate in interest bearing liabilities was primarily due to the increase in rates on interest-bearing deposit accounts partially offset by the maturity of certain long-term FHLB advances with higher rates.
The following table sets forth the information explaining the changes in the net interest margin for the period indicated compared to the same period one year ago.
 
Three Months Ended June 30, 2018
 
Three Months Ended June 30, 2017
 
Average Balance
 
Interest
 
Average Rate
 
Average Balance
 
Interest
 
Average Rate
 
($ in thousands)
 
($ in thousands)
Assets
 
 
 
 
 
 
 
 
 
 
 
Loans receivable
$
11,322,932

 
$
131,541

 
4.66
%
 
$
10,579,593

 
$
117,457

 
4.45
%
Mortgaged-backed securities
2,550,004

 
18,022

 
2.83

 
2,551,598

 
15,992

 
2.51

Cash & Investments
584,918

 
4,077

 
2.80

 
627,197

 
3,373

 
2.16

FHLB & FRB stock
135,313

 
1,432

 
4.24

 
124,968

 
894

 
2.87

 
 
 
 
 
 
 
 
 
 
 
 
 Total interest-earning assets
14,593,167

 
155,072

 
4.26
%
 
13,883,356

 
137,716

 
3.98
%
Other assets
1,154,328

 
 
 
 
 
1,142,899

 
 
 
 
Total assets
$
15,747,495

 
 
 
 
 
$
15,026,255

 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity
 
 
 
 
 
 
 
 
 
 
 
Customer accounts
$
11,075,998

 
$
18,887

 
0.68
%
 
$
10,567,710

 
$
12,764

 
0.48
%
FHLB advances
2,533,077

 
16,333

 
2.59

 
2,274,451

 
16,337

 
2.88

 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
13,609,075

 
35,220

 
1.04
%
 
12,842,161

 
29,101

 
0.91
%
Other liabilities
142,557

 
 
 
 
 
155,460

 
 
 
 
               Total liabilities
13,751,632

 
 
 
 
 
12,997,621

 
 
 
 
Stockholders' equity
1,995,863

 
 
 
 
 
2,028,634

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and equity
$
15,747,495

 
 
 
 
 
$
15,026,255

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
119,852

 
 
 
 
 
$
108,615

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin
 
 
 
 
3.29
%
 
 
 
 
 
3.13
%
As of June 30, 2018, total assets had increased by $512,741,000 to $15,766,321,000 from $15,253,580,000 at September 30, 2017. During the nine months ended June 30, 2018, cash and cash equivalents increased by $32,849,000, loans receivable increased $443,349,000, and investment securities increased by $12,786,000.

37
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

Cash and cash equivalents of $345,919,000 and stockholders’ equity of $1,986,263,000 as of June 30, 2018 provide management with flexibility in managing interest rate risk going forward.

LIQUIDITY AND CAPITAL RESOURCES
The principal sources of funds for the Company's activities are loan repayments (including prepayments), net deposit inflows, repayments and sales of investments and borrowings and retained earnings, if applicable. The Company's principal sources of revenue are interest on loans and interest and dividends on investments.
The Bank has a credit line with the Federal Home Loan Bank of Des Moines ("FHLB") up to 45% of total assets depending on specific collateral eligibility. This line provides a substantial source of additional liquidity if needed.
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 loan 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. The Bank is also eligible to borrow under the Federal Reserve Bank's primary credit program.
The Company's cash and cash equivalents totaled $345,919,000 at June 30, 2018, an increase from $313,070,000 at September 30, 2017. These amounts include the Bank's operating cash.
The Company’s net worth at June 30, 2018 was $1,986,263,000, or 12.60% of total assets. This is a decrease of $19,425,000 from September 30, 2017 when net worth was $2,005,688,000, or 13.15% of total assets. The Company’s net worth was impacted in the nine months ended June 30, 2018 by net income of $152,335,000, the payment of $41,091,000 in cash dividends, treasury stock purchases of $136,941,000, as well as other comprehensive income of $3,122,000. The ratio of tangible capital to tangible assets at June 30, 2018 was 10.83%. 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.
Washington Federal, Inc. and its banking subsidiary are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements.
Federal banking agencies establish regulatory capital rules that require minimum capital ratios and establish criteria for calculating regulatory capital. Minimum capital ratios for four measures are used for assessing capital adequacy. The standards are indicated in the table below. The common equity tier 1 capital ratio recognizes common equity as the highest form of capital. The denominator for all except the leverage ratio is risk weighted assets. The rules set forth a “capital conservation buffer” of up to 2.5%. In the event that a bank’s capital levels fall below the minimum ratios plus these buffers, the bank's regulators may place restrictions on it. These restrictions include reducing dividend payments, share buy-backs, and staff bonus payments. The purpose of these buffers is to require banks to build up capital outside of periods of stress that can be drawn down during periods of stress. As a result, even during periods where losses are incurred, the minimum capital ratios can still be met. The capital rules that became effective in January 2015 include a phase-in period for certain minimum ratios and the capital buffers, before the full minimum ratios take effect in 2019. Management continues to monitor the financial position of the Company and its capital ratios as the rules phase in.

38
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

There are also standards for Adequate and Well Capitalized criteria that are used for “Prompt Corrective Action” purposes. To remain categorized as well capitalized, the Bank and the Company must maintain minimum common equity risk-based, tier 1 risk-based, total risk-based and tier 1 leverage ratios as set forth in the following table.
 
Actual
 
Minimum Capital
Adequacy Guidelines
 
Minimum Well-Capitalized Guidelines
 
Capital
 
Ratio
 
Ratio
 
Ratio
 
($ in thousands)
June 30, 2018
 
 
 
 
 
 
 
Common Equity Tier I risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
$
1,667,375

 
14.81
%
 
4.50
%
 
NA

      The Bank
1,660,952

 
14.74
%
 
4.50
%
 
6.50
%
Tier I risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
1,667,375

 
14.81
%
 
6.00
%
 
NA

      The Bank
1,660,952

 
14.74
%
 
6.00
%
 
8.00
%
Total risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
1,802,791

 
16.01
%
 
8.00
%
 
NA

      The Bank
1,796,368

 
15.94
%
 
8.00
%
 
10.00
%
Tier 1 Leverage ratio:
 
 
 
 
 
 
 
      The Company
1,667,375

 
10.80
%
 
4.00
%
 
NA

      The Bank
1,660,952

 
10.75
%
 
4.00
%
 
5.00
%
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
Common Equity Tier 1 risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
$
1,701,327

 
15.99
%
(1)
4.50
%
 
NA

      The Bank
1,668,314

 
15.68
%
(1)
4.50
%
 
6.50
%
Tier I risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
1,701,327

 
15.99
%
(1)
6.00
%
 
NA

      The Bank
1,668,314

 
15.68
%
(1)
6.00
%
 
8.00
%
Total risk-based capital ratio:
 
 
 
 
 
 
 
      The Company
1,828,935

 
17.22
%
(1)
8.00
%
 
NA

      The Bank
1,795,929

 
16.91
%
(1)
8.00
%
 
10.00
%
Tier 1 Leverage ratio:
 
 
 
 
 
 
 
      The Company
1,701,327

 
11.49
%
 
4.00
%
 
NA

      The Bank
1,668,314

 
11.27
%
 
4.00
%
 
5.00
%

(1) Ratio has been updated from previously reported % to correct immaterial error in the calculation of risk-weighted assets, which is the denominator used in calculating the ratio.

CHANGES IN FINANCIAL CONDITION
Cash and cash equivalents: Cash and cash equivalents are $345,919,000 at June 30, 2018, an increase of $32,849,000, or 10.5%, since September 30, 2017.

Available-for-sale and held-to-maturity securities: Available-for-sale securities decreased $10,808,000, or 0.9%, during the nine months ended June 30, 2018, mostly due to principal repayments and maturities of $156,240,000 and an increase in the net unrealized loss of $18,282,000, partially offset by purchases of $166,696,000. During the same period, the balance of held-to-maturity securities increased by $23,594,000 due to purchases of $170,836,000 partially offset by principal pay-downs and

39
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

maturities of $143,837,000. As of June 30, 2018, the Company had a net unrealized loss on available-for-sale securities of $8,659,000, which is included on a net of tax basis in accumulated other comprehensive income (loss).

Loans receivable: Loans receivable, net of related contra accounts, increased by $443,349,000 to $11,325,971,000 at June 30, 2018 compared to $10,882,622,000 at September 30, 2017. The increase resulted primarily from originations of $2,868,476,000 and purchases of $143,605,000, partially offset by loan principal repayments of $2,493,714,000. Commercial loan originations accounted for 68% of total originations and consumer loan originations were 32% during the period. Purchased loans during the period were pools of consumer loans. The increase in the loan portfolio is consistent with management's strategy during low rate environments to produce more multifamily, commercial real estate, and commercial and industrial loans that generally have adjustable interest rates or a shorter duration.
The following table shows the loan portfolio by category and the change.

 
June 30, 2018
 
September 30, 2017
 
Change
 
($ in thousands)
 
($ in thousands)
 
$
%
Gross loans by category
 
 
 
 
 
 
 
 
   Single-family residential
$
5,745,598

45.1
%
 
$
5,711,004

46.8
%
 
$
34,594

0.6
 %
   Construction
1,885,034

14.8

 
1,597,996

13.1

 
287,038

18.0

   Construction - custom
612,688

4.8

 
602,631

4.9

 
10,057

1.7

   Land - acquisition & development
150,936

1.2

 
124,308

1.0

 
26,628

21.4

   Land - consumer lot loans
103,118

0.8

 
104,405

0.9

 
(1,287
)
(1.2
)
   Multi-family
1,346,534

10.6

 
1,303,148

10.7

 
43,386

3.3

   Commercial real estate
1,435,418

11.3

 
1,434,610

11.8

 
808

0.1

   Commercial & industrial
1,133,075

8.9

 
1,093,360

9.0

 
39,715

3.6

   HELOC
136,766

1.1

 
144,850

1.2

 
(8,084
)
(5.6
)
   Consumer
188,125

1.5

 
85,075

0.7

 
103,050

121.1

Total gross loans
12,737,292

100
%
 
12,201,387

100
%
 
535,905

4.4
 %
   Less:
 
 
 
 
 
 
 
 
      Allowance for loan losses
128,666

 
 
123,073

 
 
5,593

4.5
 %
      Loans in process
1,230,132

 
 
1,149,934

 
 
80,198

7.0

      Net deferred fees, costs and discounts
52,523

 
 
45,758

 
 
6,765

14.8

Total loan contra accounts
1,411,321

 
 
1,318,765

 
 
92,556

7.0

Net Loans
$
11,325,971

 
 
$
10,882,622

 
 
$
443,349

4.1
 %
 
Non-performing assets: Non-performing assets increased $1,621,000 during the nine months ended June 30, 2018 to $71,859,000 from $70,238,000 at September 30, 2017. The change is due to the $11,004,000 increase in non-accrual loans and $9,383,000 decline in REO. Non-performing assets as a percentage of total assets was 0.46% at June 30, 2018 compared to 0.46% at September 30, 2017.




40
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

The following table sets forth information regarding restructured loans and non-performing assets.
 
June 30,
2018
 
September 30,
2017
 
($ in thousands)
Restructured loans:
 
 
 
 
 
 
 
Single-family residential
$
153,356

 
89.4
%
 
$
181,941

 
87.8
%
Land - acquisition & development
—

 
—

 
90

 
—

Land - consumer lot loans
5,136

 
3.0

 
7,949

 
3.8

Multi - family
461

 
0.3

 
493

 
0.2

Commercial real estate
7,162

 
4.2

 
15,079

 
7.3

Commercial & industrial
3,924

 
2.3

 
—

 
—

HELOC
1,491

 
0.9

 
1,728

 
0.8

Consumer
73

 
—

 
97

 
—

Total restructured loans (1)
$
171,603

 
100
%
 
$
207,377

 
100
%
Non-accrual loans:
 
 
 
 
 
 
 
Single-family residential
$
26,119

 
43.1
%
 
$
27,930

 
56.3
%
Construction
1,841

 
3.0

 
—

 
—

Construction - custom
—

 
—

 
91

 
0.2

Land - acquisition & development
1,757

 
2.9

 
296

 
0.6

Land - consumer lot loans
642

 
1.1

 
605

 
1.2

Multi-family
—

 
—

 
139

 
0.3

Commercial real estate
9,684

 
16.0

 
11,815

 
23.8

Commercial & industrial
19,876

 
32.8

 
8,082

 
16.3

HELOC
637

 
1.1

 
531

 
1.1

Consumer
28

 
—

 
91

 
0.2

Total non-accrual loans
60,584

 
100
%
 
49,580

 
100
%
Real estate owned
11,275

 
 
 
20,658

 
 
Total non-performing assets
$
71,859

 
 
 
$
70,238

 
 
Total non-performing assets and performing restructured loans as a percentage of total assets
1.51
%
 
 
 
1.79
%
 
 
Total Assets
 
 
 
 
 
 
 
(1)    Restructured loans were as follows:
 
 
 
 
 
 
 
Performing
$
165,857

 
96.7
%
 
$
202,272

 
97.5
%
Non-performing (included in non-accrual loans above)
5,746

 
3.3

 
5,105

 
2.5

 
$
171,603

 
100
%
 
$
207,377

 
100
%

For the nine months ended June 30, 2018, the Company recognized $3,926,000 in interest income on cash payments received from borrowers on non-accrual loans. The Company would have recognized interest income of $1,741,000 for the same period had these loans performed according to their original contract terms. Recognized interest income for the nine months ended June 30, 2018 was higher than what otherwise would have been collected in the period due to the collection of past due amounts. In addition to the non-accrual loans reflected in the above table, the Company had $50,684,000 of loans that were less than 90 days delinquent at June 30, 2018 but were classified as substandard for one or more reasons. If these loans were deemed non-performing, the Company's ratio of total NPAs and performing restructured loans as a percent of total assets would have increased to 0.78% at June 30, 2018.
Restructured single-family residential loans are reserved for under the Company’s general reserve methodology. If any individual loan is significant in balance, the Company may establish a specific reserve as warranted.
 
Most restructured loans are accruing and performing loans where the borrower has proactively approached the Bank about modifications due to temporary financial difficulties. Each request is individually evaluated for merit and likelihood of success. Single-family residential loans comprised 89.4% of restructured loans as of June 30, 2018. The concession for these loans is

41
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

typically a payment reduction through a rate reduction of 100 to 200 bps for a specific term, usually six to twenty-four months. Interest-only payments may also be approved during the modification period.
For commercial loans, six consecutive payments on newly restructured loan terms are generally required prior to returning the loan to accrual status. In some instances after the required six consecutive payments are made, a management assessment will conclude that collection of the entire principal balance is still in doubt. In those instances, the loan will remain on non-accrual. Homogeneous loans may or may not be on accrual status at the time of restructuring, but all are placed on accrual status upon the restructuring of the loan. Homogeneous loans are restructured only if the borrower can demonstrate the ability to meet the restructured payment terms; otherwise, collection is pursued and the loan remains on non-accrual status until liquidated. If the homogeneous restructured loan does not perform, it will be placed in non-accrual status when it is 90 days delinquent.
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 general reserve calculation. Any modified loan that re-defaults and is charged-off would impact the historical loss factors component of the Company's general reserve calculation.
Allowance for loan losses: The following table shows the Company’s allowance for loan losses by loan category.
June 30, 2018
Loans Collectively Evaluated for Impairment
 
Loans Individually Evaluated for Impairment
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
($ in thousands)
 
($ in thousands)
Single-family residential
$
34,401

 
$
5,726,737

 
0.6
%
 
$
—

 
$
24,139

 
—
%
Construction
30,133

 
1,007,676

 
3.0

 
—

 
4,563

 
—

Construction - custom
2,014

 
285,858

 
0.7

 
—

 
—

 
—

Land - acquisition & development
7,700

 
118,323

 
6.5

 
—

 
3,184

 
—

Land - consumer lot loans
2,907

 
97,310

 
3.0

 
—

 
833

 
—

Multi-family
8,086

 
1,343,468

 
0.6

 
5

 
3,045

 
0.2

Commercial real estate
11,502

 
1,388,029

 
0.8

 
77

 
31,805

 
0.2

Commercial & industrial
27,515

 
1,087,664

 
2.5

 
—

 
45,400

 
—

HELOC
811

 
134,522

 
0.6

 
—

 
562

 
—

Consumer
3,515

 
188,004

 
1.9

 
—

 
26

 
—

 
$
128,584

 
$
11,377,591

 
1.1
%
 
$
82

 
$
113,557

 
0.1
%



42
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

September 30, 2017
Loans Collectively Evaluated for Impairment
 
Loans Individually Evaluated for Impairment
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
Allowance Allocation
 
Recorded Investment of Loans
 
Ratio
 
($ in thousands)
 
($ in thousands)
Single-family residential
$
36,892

 
$
5,713,576

 
0.7
%
 
$
—

 
$
5,552

 
—
%
Construction
24,556

 
793,958

 
3.1

 
—

 
—

 
—

Construction - custom
1,944

 
277,495

 
0.7

 
—

 
105

 
—

Land - acquisition & development
6,828

 
104,767

 
6.5

 
1

 
89

 
1.0

Land - consumer lot loans
2,649

 
96,337

 
2.8

 
—

 
171

 
—

Multi-family
7,857

 
1,302,625

 
0.6

 
5

 
493

 
1.0

Commercial real estate
11,698

 
1,391,668

 
0.8

 
120

 
21,765

 
0.6

Commercial & industrial
28,524

 
1,093,210

 
2.6

 
—

 
81

 
—

HELOC
855

 
141,689

 
0.6

 
—

 
215

 
—

Consumer
1,144

 
84,887

 
1.4

 
—

 
82

 
—

 
$
122,947

 
$
11,000,212

 
1.1
%
 
$
126

 
$
28,553

 
0.4
%

Reserve for losses on unfunded commitments: Unfunded commitments tend to vary depending on the Company's loan mix and the proportionate share of commercial loans. The reserve for unfunded commitments was $6,750,000 as of June 30, 2018, which is a decrease from $7,750,000 at September 30, 2017. Management believes the allowance for loan losses plus the reserve for unfunded commitments, totaling $135,416,000, or 1.06% of gross loans, is sufficient to absorb estimated losses inherent in the portfolio of loans and unfunded commitments. See Note E for further discussion and analysis of the allowance for loan losses as of and for the period ended June 30, 2018.

Real estate owned: Real estate owned ("REO") decreased during the nine months ended June 30, 2018 by $9,383,000 to $11,275,000, primarily due to sales of REO properties during the period.

Intangible assets: Intangible assets increased to $311,796,000 as of June 30, 2018 from $298,682,000 as of September 30, 2017. The increase was primarily due to an immaterial correction recorded during the three months ended December 31, 2017 related to acquisitions of insurance agency businesses in prior years that resulted in an increase in goodwill of $7,135,000 and finite-lived intangible assets of $5,106,000 and a corresponding decrease in other assets of $12,241,000.



43
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

Customer accounts: Customer accounts increased $452,465,000, or 4.2%, to $11,287,473,000 at June 30, 2018 compared with $10,835,008,000 at September 30, 2017.

The following table shows the composition of the Bank’s customer accounts by deposit type.
  
June 30, 2018
 
September 30, 2017
 
Deposit Account Balance
 
As a % of Total Deposits
 
Wtd. Avg.
Rate
 
Deposit Account Balance
 
As a % of Total Deposits
 
Wtd. Avg.
Rate
($ in thousands)
 
 
 
 
 
 
 
 
 
 
 
Non-interest checking
$
1,460,096

 
12.9
%
 
—
%
 
$
1,258,274

 
11.6
%
 
—
%
Interest checking
1,787,035

 
15.8

 
0.45

 
1,760,821

 
16.3

 
0.23

Savings (passbook/statement)
865,102

 
7.7

 
0.12

 
888,881

 
8.2

 
0.11

Money market
2,460,533

 
21.8

 
0.43

 
2,453,182

 
22.6

 
0.19

Time deposits
4,714,707

 
41.8

 
1.39

 
4,473,850

 
41.3

 
1.09

Total
$
11,287,473

 
100
%
 
0.75
%
 
$
10,835,008

 
100
%
 
0.54
%

FHLB advances and other borrowings: Total borrowings increased to $2,370,000,000 as of June 30, 2018 from $2,225,000,000 as of September 30, 2017. The weighted average rate for FHLB borrowings was 2.64% as of June 30, 2018 and 2.80% at September 30, 2017. The decrease in the rate was primarily due to the maturity of certain long-term FHLB advances.

Stockholders' equity: The Company’s total stockholders' equity at June 30, 2018 was $1,986,263,000, or 12.60% of total assets. This was a decrease of $19,425,000 from the September 30, 2017 total of $2,005,688,000, or 13.15% of total assets. The Company’s equity was impacted in the nine months ended June 30, 2018 by net income of $152,335,000, the payment of $41,091,000 in cash dividends, treasury stock purchases of $136,941,000, as well as other comprehensive income of $3,122,000.

RESULTS OF OPERATIONS
Net Income: The Company recorded net income of $51,394,000 for the three months ended June 30, 2018 compared to $44,112,000 for the prior year quarter. The Company recorded net income of $152,335,000 for the nine months ended June 30, 2018 compared to $127,428,000 for the same period one year ago.

Net Interest Income: For the three months ended June 30, 2018, net interest income was $119,852,000, which is $11,237,000 higher than the same quarter of the prior year. Net interest margin was 3.29% for the quarter ended June 30, 2018 compared to 3.13% for the quarter ended June 30, 2017. The increase in net interest income was primarily due to average earning assets increasing by $709,811,000 and the yield on earning assets increasing to 4.26% from 3.98%, partially offset by a higher average rate paid on interest-bearing liabilities, which was 1.04% for the three months ended June 30, 2018 compared to 0.91% for the same quarter one year ago. The higher yield on earning assets is the result of the rise in short-term interest rates, which resulted in a higher rate being earned on cash and adjustable rate loans and investment securities, as well as the shift in mix from investment securities into a higher proportion of loans receivable that carry higher yields on average. The higher rate in interest bearing liabilities was primarily due to the increase in rates on interest-bearing deposit accounts partially offset by the maturity of certain long-term FHLB advances with higher rates. For the nine months ended June 30, 2018, net interest income was $352,888,000, which is $33,394,000 higher than the same period for the prior year. Net interest margin was 3.27% for the nine months ended June 30, 2018 compared to 3.10% for the same period for the prior year. The improvements in net interest income and net interest margin for the nine months ended June 30, 2018 were also due to growth in earning assets, the rise in short-term interest rates and changes in mix.

The following table sets forth certain information explaining changes in interest income and interest expense for the period indicated compared to the same period one year ago. 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 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.

44
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

Rate / Volume Analysis:
 
Comparison of Three Months Ended
06/30/18 and 06/30/17
 
Comparison of Nine Months Ended
06/30/18 and 06/30/17
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
 
(In thousands)
 
(In thousands)
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable
$
8,423

 
$
5,661

 
$
14,084

 
$
29,641

 
$
4,614

 
$
34,255

Mortgaged-backed securities
(10
)
 
2,040

 
2,030

 
(199
)
 
7,780

 
7,581

Investments (1)
(189
)
 
1,431

 
1,242

 
(1,816
)
 
3,233

 
1,417

All interest-earning assets
8,224

 
9,132

 
17,356

 
27,626

 
15,627

 
43,253

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Customer accounts
633

 
5,490

 
6,123

 
1,400

 
10,366

 
11,766

FHLB advances and other borrowings
1,747

 
(1,751
)
 
(4
)
 
3,511

 
(5,418
)
 
(1,907
)
All interest-bearing liabilities
2,380

 
3,739

 
6,119

 
4,911

 
4,948

 
9,859

Change in net interest income
$
5,844

 
$
5,393

 
$
11,237

 
$
22,715

 
$
10,679

 
$
33,394

___________________ 
(1)
Includes interest on cash equivalents and dividends on FHLB & FRB stock
Provision (Release) for Loan Losses: The Company recorded a provision for loan losses of $1,000,000 for the three months ended June 30, 2018, compared with no provision for loan losses for the three months ended June 30, 2017. A provision for loan losses of $50,000 and a release of allowance for loan losses of $1,600,000 was recorded during the nine months ended June 30, 2018 and June 30, 2017, respectively. Reserving for new loan originations as the loan portfolio grows has been largely offset by recoveries of previously charged-off loans. Recoveries, net of charge-offs, totaled $90,000 for the three months ended June 30, 2018, compared to net recoveries of $1,252,000 during the three months ended June 30, 2017. Recoveries, net of charge-offs, totaled $4,543,000 for the nine months ended June 30, 2018, compared to net recoveries of $11,764,000 during the nine months ended June 30, 2017.

Other Income: The three months ended June 30, 2018 results include total other income of $12,451,000 compared to $13,922,000 for the same period one year ago. The decrease is primarily due to gains recognized on bank-owned life insurance during the three months ended June 30, 2017. Results for the nine months ended June 30, 2018 include total other income of $31,833,000 compared to $35,954,000 for the same period one year ago. The decrease during the nine months ended June 30, 2018 is primarily due to a $8,550,000 charge recorded during the quarter ended December 31, 2017 for asset and liability valuation adjustments associated with FDIC loss share agreements. The Bank initiated discussions with the FDIC in December 2017 regarding early termination of its remaining FDIC loss share agreements, which relate to the Horizon Bank and Home Valley Bank acquisitions. In May 2018, the Bank finalized the early termination agreement and paid $39,906,000 to settle the FDIC clawback liability. This amount is consistent with the liability on the balance sheet as of March 31, 2018 so no additional gain or loss was recorded in the three months ended June 30, 2018. Under the termination agreement, all rights and obligations of the Bank and the FDIC have been resolved and completed. As such, future recoveries, gains, losses and expenses related to the previously covered assets will now be recognized entirely by the Bank and the FDIC will no longer share in such gains or losses. The impact of these FDIC loss share valuation adjustments was partially offset by a $3,697,000 increase in deposit fee income, which was driven mostly by the 2017 launch of the Company's new "Green Checking" product.

Other Expense: The three months ended June 30, 2018 results include total other expense of $66,977,000 compared to $57,062,000 for the same period one year ago, a $9,915,000 or 17.4% increase. The Company recognized $4.9 million of expense during the three months ended June 30, 2018 related to enhancements of its Bank Secrecy Act ("BSA") program and projects that it will incur an additional $10,000,000 of non-recurring BSA related costs spread over the next four quarters. Once the program is steadied, BSA costs are expected to be approximately $2,000,000 per quarter. Compensation and benefits costs increased $2,276,000 primarily due to headcount increases and cost of living adjustments since last year. The number of staff, including part-time employees on a full-time equivalent basis, was 1,869 and 1,815 at June 30, 2018 and 2017, respectively. Information technology costs increased by $3,501,000 and other expenses increased by $2,654,000 for the three months ended June 30, 2018 as both were elevated primarily due to the aforementioned Bank Secrecy Act program enhancements and other technology platform initiatives. The nine months ended June 30, 2018 results include total other expense of $194,705,000 compared to $168,870,000 for the same period one year ago, a $25,835,000 or 15.3% increase. Compensation and benefits costs increased $7,693,000 primarily due to

45
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

headcount increases and cost of living adjustments since last year. Information technology costs increased by $7,074,000 and other expenses increased by $8,747,000 for the nine months ended June 30, 2018 due to ongoing initiatives to enhance the Company's overall technology platform and its Bank Secrecy Act program. Additionally, charitable contributions increased by $1,000,000 from the prior year as the Company fulfilled the first year of its previously announced commitment to fund its foundation by $1,000,000 annually for the next five years. Product delivery costs increased by $1,881,000 primarily due to enhanced features provided with the "Green Checking" product. Total other expense for the nine months ended June 30, 2018 and June 30, 2017 equaled 1.67% and 1.51%, respectively, of average assets.

Gain (Loss) on Real Estate Owned: Results for the three months ended June 30, 2018 include a net gain on real estate owned of $168,000, compared to a loss of $124,000 for the same period one year ago. Results for the nine months ended June 30, 2018 include a net loss on real estate owned of $64,000, compared to a gain of $1,069,000 for the same period one year ago.

Income Tax Expense: Income tax expense totaled $13,100,000 for the three months ended June 30, 2018, as compared to $21,239,000 for the same period one year ago. Income tax expense totaled $37,567,000 for the nine months ended June 30, 2018, as compared to $61,819,000 for the same period one year ago. The effective tax rate for the nine months ended June 30, 2018 was 19.78% compared to 32.67% for the nine months ended June 30, 2017 and 32.27% for the full fiscal year ended September 30, 2017. Due to the reduction in the statutory federal corporate tax rate from 35% to 21% effective from January 1, 2018 forward, the Company has a blended federal statutory tax rate of 24.53% for its fiscal year 2018. The Company's effective tax rate for the nine months ended June 30, 2018 differs from the new 2018 statutory rate due to the impact of state tax, bank-owned life insurance, low-income housing investments and tax-exempt loans, as well as discrete tax items. The income tax expense for the nine months ended June 30, 2018 includes a discrete tax benefit of $5,387,000 from the revaluation of the Company's deferred tax assets and liabilities on account of the rate change, as well as tax benefits of $2,472,000 related to stock-based compensation and other adjustments. The Company estimates that its annual effective tax rate for fiscal 2018 (blended rate year) will be approximately 21%, taking into account discrete tax benefits.

Item 3.        Quantitative and Qualitative Disclosures About Market Risk
Management believes that there have been no material changes in the Company’s quantitative and qualitative information about market risk since September 30, 2017. For a complete discussion of the Company’s quantitative and qualitative market risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2017 Form 10-K.

Item 4.        Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. The Company maintains a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the Company's management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report (the "Evaluation Date"). Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective.

(b) Changes in Internal Control over Financial Reporting. During the period to which this report relates, there have not been any changes in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or that are reasonably likely to materially affect, such controls.

46
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES


 
PART II – Other Information
Item 1. Legal Proceedings
From time to time, the Company and its subsidiaries are engaged in legal proceedings in the ordinary course of business, none of which are considered to have a material impact on the Company’s consolidated financial statements.

Item 1A. Risk Factors

In addition to the other information set forth below and in this report, you should carefully consider the factors discussed under "Part I--Item 1A--Risk Factors" in the 2017 Form 10-K for the year ended September 30, 2017. These factors could materially and adversely affect the Company's business, financial condition, liquidity, results of operations and capital position, and could cause its actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this report.

The Office of the Comptroller of the Currency has issued a Consent Order with respect to the Company's Bank Secrecy Act compliance. Failure to comply with the Consent Order could result in additional regulatory enforcement action.

The Bank Secrecy Act ("BSA"), the USA PATRIOT Act of 2001 (the “Patriot Act”), and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. On February 28, 2018, pursuant to a Stipulation and Consent to the Issuance of a Consent Order (the “Stipulation”), the Office of the Comptroller of the Currency issued a Consent Order relating to the Bank, the terms of which are intended to further enhance its BSA program.  Copies of the Stipulation and the Consent Order were filed with the SEC on March 1, 2018 as exhibits to the Company’s Current Report on Form 8-K. The Bank expects to continue to incur significant expenses as it strengthens its BSA program and implements additional policies and procedures associated with complying with the Consent Order. The Bank does not expect to pursue acquisitions or branch expansion until its BSA program has improved. Issuance of the Consent Order does not preclude further government action with respect to the Bank’s BSA program, including the imposition of fines, sanctions, additional expenses and compliance costs, and/or restrictions on the activities of the Bank. In addition, failure to comply with the Consent Order could subject us to additional expense and further regulatory enforcement action, including the imposition of material restrictions on the activities of the Bank or the assessment of fines or penalties, which could prevent the Bank from executing its business strategy and negatively impact its business and the price of the Company's common stock. Any further deficiency in the Bank's BSA/AML policies, procedures and systems could cause us to incur additional significant compliance costs and could subject it to fines and further regulatory actions. Moreover, failure to maintain and implement an effective BSA program could also have serious reputational consequences for the Company. Any of these results could have a material adverse effect on the Company's business, financial condition and results of operations.

The Company has risk of systems failures and cyber-security risk, including "hacking" and "identity theft."
The Company relies extensively on the successful and uninterrupted functioning of its information technology and telecommunications systems to conduct its business. This includes internally developed systems, the systems of third-party service providers, and digital and mobile technologies. Any failure, interruption or breach in security of these systems could result in failures or disruptions in its customer relationship management, general ledger, deposit, loan and other systems, and could damage its reputation, result in loss of customer business, subject it to regulatory scrutiny, or expose it to civil litigation and possible financial liability.
While the Company believes it has robust information systems and security procedures, controls and policies designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur, or, if they do occur, that the Company will be able to address or remediate the damage. Because the techniques used to obtain unauthorized access, disable or degrade systems change frequently and often are not recognized until launched against a target, the Company may be unable to anticipate these techniques or to implement adequate protective measures.
Cybersecurity and the continued development and enhancement of the Company's controls, processes and practices designed to protect customer information, its systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for the Company. As cybersecurity threats continue to evolve, the Company may be required to expend additional resources to continue to enhance, modify and refine its protective measures against these evolving threats.
To date, the Company has not experienced any material losses related to cyber-attacks or other information security breaches, but there can be no assurance that it will not suffer such attacks and losses in the future. The Company’s risk and exposure to these

47
WASHINGTON FEDERAL, INC. AND SUBSIDIARIES

matters remains heightened because of, among other things, the evolving nature of these threats and its plans to continue to implement internet banking and mobile banking channels, expand operations and use third-party information systems. Recent instances of attacks specifically targeting financial services businesses indicate that the risk to the Company’s systems remains significant. If the Company were to experience a cyber-attack or information security breach, it could incur substantial additional expenses, which could include remediation expenses, costs associated with customer notification and credit monitoring services, increased insurance premiums, regulatory penalties and fines and costs associated civil litigation, any of which could have a material adverse effect on the Company’s business, financial conditions or results of operations.

Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information with respect to purchases made by or on behalf of the Company of the Company’s common stock during the three months ended June 30, 2018. 
Period
Total Number of
Shares Purchased
 
Average Price
Paid Per Share
 
Total Number of
Shares Purchased
as Part of  Publicly
Announced Plan (1)
 
Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plan at the
End of the Period (2)
April 1, 2018 to April 30, 2018
275,589

 
$
32.44

 
275,589

 
3,804,560

May 1, 2018 to May 31, 2018
549,100

 
32.17

 
549,100

 
3,255,460

June 1, 2018 to June 30, 2018
399,695

 
33.42

 
399,695

 
2,855,765

Total
1,224,384

  
$
32.64

  
1,224,384

 
2,855,765

 ___________________
(1)
The Company's stock repurchase program was publicly announced by its Board of Directors on February 3, 1995 and has no expiration date. Under this ongoing program, a total of 56,956,264 shares were authorized for repurchase.
(2)
Shares remaining available reflects the impact of TARP warrants that have been repurchased for cash as management also counts these against the maximum number of shares that may be repurchased under the Plan.

Item 3.        Defaults Upon Senior Securities
Not applicable

Item 4.        Mine Safety Disclosures
Not applicable

Item 5.        Other Information
Not applicable

Item 6.        Exhibits
(a)
 
Exhibits
 
 
 
31.1
 
 
 
31.2
 
 
 
32
 
 
 
101
 
Financial Statements from the Company’s Form 10-Q for the three months ended June 30, 2018 formatted in XBRL

48

WASHINGTON FEDERAL, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
July 26, 2018
/S/    BRENT J. BEARDALL        
 
BRENT J. BEARDALL
President & Chief Executive Officer
 
 
July 26, 2018
/S/    VINCENT L. BEATTY       
 
VINCENT L. BEATTY
Executive Vice President and Chief Financial Officer
 
 
July 26, 2018
/S/    CORY D. STEWART      
 
CORY D. STEWART
Senior Vice President and Principal Accounting Officer

49

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