Waterstone Financial, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022; balance-sheet comparisons are against December 31, 2021. Waterstone operates a Wisconsin community bank and a residential mortgage banking business that originates loans mainly for sale. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and condition
- Q2 earnings: Net income was $8.0 million, down from $17.9 million a year earlier; diluted EPS was $0.36 versus $0.74. Pretax income was $10.2 million versus $23.8 million.
- First-half earnings: Net income was $13.3 million versus $39.2 million; diluted EPS was $0.58 versus $1.64. Annualized return on average assets was 1.30% versus 3.62%, and return on average equity was 6.42% versus 18.49%.
- Interest income and margin: Q2 net interest income was $14.1 million, down 1.4%; reported net interest margin was 3.02%, up from 2.78%. First-half net interest income was $25.9 million, down 8.1%; margin was 2.69% versus 2.79%. Lower average loan balances and lower loan production weighed on interest income; lower deposit and borrowing costs partly offset the decline.
- Noninterest income and expenses: Q2 noninterest income fell 40.0% to $31.2 million, primarily as mortgage banking income declined 40.8% to $29.4 million. Q2 noninterest expenses fell 19.0% to $35.1 million, mainly from lower mortgage commissions and employee costs. For the first half, noninterest income declined 43.6% to $61.1 million and expenses declined 18.9% to $70.0 million.
- Mortgage banking: First-half mortgage originations for sale were $1.49 billion, down 31.8%; mortgage banking income was $57.7 million, down 44.6%. Management attributed lower production to rising rates, including a 68.7% decline in refinance volume, and lower gross margins amid competition. The company opened five mortgage branches in Q2; direct start-up costs were about $510,000.
- Assets and capital: Total assets were $1.94 billion, down 12.4% from year-end. Loans receivable were $1.28 billion, up $70.8 million; loans held for sale were $206.7 million, down about $106 million. Shareholders’ equity was $386.4 million, down $46.4 million, reflecting repurchases, dividends, securities valuation losses, and CECL adoption, partly offset by earnings.
- Funding and liquidity: Deposits totaled $1.21 billion, down $20.2 million. Borrowings were $281.1 million, down $196.0 million after $195.0 million of long-term debt repayments. Cash and cash equivalents were $122.2 million, down from $376.7 million at year-end. The company reported $57.2 million of parent-company liquid assets on an unconsolidated basis. Certificates of deposit totaling $494.6 million mature within one year; management said it expects a significant portion to remain, but gave no assurance.
- Cash flow and shareholder returns: First-half operating cash flow was $118.2 million; investing activities used $100.8 million and financing activities used $271.9 million. Financing included $195.0 million of long-term debt repayment, $21.8 million in cash dividends, and $37.9 million of share repurchases. The company repurchased 1.417 million shares in Q2 at an average $17.07; 1.351 million shares remained authorized under the plan at June 30.
- Credit quality: The allowance for credit losses on loans was $17.3 million, or 1.35% of loans. Nonaccrual loans were $7.5 million, 0.59% of loans, versus $5.6 million and 0.46% at year-end. Loans past due 90 days or more were $6.2 million. The Bank remained well-capitalized; its total risk-based capital ratio was 23.32%.
Material changes, outlook, and risks
- CECL adoption: Adopted January 1, 2022. The company recorded a $430,000 increase to the loan allowance and a $1.4 million allowance for unfunded commitments; the after-tax cumulative adjustment reduced retained earnings by $1.4 million. The reported first-half provision was a $28,000 credit overall, comprising $340,000 for loans and a $368,000 credit for unfunded commitments.
- Available-for-sale securities: Fair value was $200.5 million versus $179.0 million at year-end, but gross unrealized losses increased to $19.1 million from $3.2 million, which management attributed to interest rates, spreads, and market conditions rather than credit deterioration. No securities credit-loss allowance was recorded; management said it did not intend to sell the securities and believed it would not need to sell before recovery.
- Management outlook: The filing provides no quantitative earnings or revenue guidance. Management said results for the first half are not necessarily indicative of full-year results. It continues to monitor COVID-19 conditions; the businesses were described as fully operational.
- Principal risks: Management identifies interest-rate and inflation changes, mortgage-market conditions and production, credit losses, deposit retention and funding costs, competition, economic conditions, regulatory changes, cybersecurity and third-party performance as risks. The company reported no material change in its previously disclosed risk factors and no significant subsequent events through issuance.
- Contingencies: Mortgage loan-sale representations and warranties can require repurchases, though historical repurchases and losses were described as insignificant; the related reserve was $1.8 million. Management said pending legal proceedings were not expected to materially adversely affect the consolidated financial statements.
- Interest-rate sensitivity disclosure: The filing contains conflicting figures. The sensitivity table shows a 100-basis-point increase reducing projected one-year net interest income by 0.43% ($245,000), while accompanying narrative says a 100-basis-point increase would increase it by 8.08%. The filing text does not reconcile this difference.
Key facts for investors to verify
- Reconcile the conflicting 100-basis-point interest-rate sensitivity disclosures and confirm the applicable modeled result.
- Assess whether mortgage originations and margins continue to contract as rates rise, and how the five new branches affect costs and production.
- Monitor deposit retention and repricing, especially the $494.6 million of certificates of deposit due within one year, alongside available funding sources.
- Track growth in nonaccrual and 90-day-past-due loans, the CECL allowance assumptions, and the concentration of lending in southeastern Wisconsin real estate.
- Evaluate the effect of unrealized securities losses on equity and liquidity, and the pace of buybacks and dividends relative to earnings and capital.