Waterstone Financial, Inc. annual report, FY2021

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Waterstone Financial, Inc. — 2021 Form 10-K

Reporting period: Year ended December 31, 2021; filed February 28, 2022. Waterstone Financial operates community banking through WaterStone Bank in southeastern Wisconsin and mortgage banking through Waterstone Mortgage Corporation, which operates in multiple states.

Financial performance and condition

  • Earnings: Net income was $70.8 million, down from $81.1 million in 2020; diluted EPS was $2.96 versus $3.30. Fourth-quarter net income was $12.6 million versus $27.8 million in fourth-quarter 2020.
  • Income and margins: Net interest income rose 3.8% to $55.5 million. Net interest margin was 2.68%, compared with 2.67%. Noninterest income fell 16.7% to $203.2 million, chiefly reflecting lower mortgage banking income. Noninterest expense declined 6.8% to $170.6 million. The efficiency ratio worsened to 65.94% from 61.53%.
  • Mortgage banking: Mortgage banking income reported on the consolidated income statement was $191.0 million, down 18.1%. Mortgage loan originations were about $4.2 billion, down year over year; lower refinance activity and an 11.6% decline in gross margin weighed on results.
  • Profitability: Return on average assets was 3.20% versus 3.77%; return on average equity was 16.38% versus 20.18%.
  • Cash flow: Net cash from operating activities was $154.5 million, compared with $93.6 million used in 2020. Cash and cash equivalents increased to $376.7 million from $94.8 million. Cash flow reflects the mortgage business’s large loan-originations and loan-sale activity.
  • Balance sheet and lending: Total assets increased 1.4% to $2.22 billion. Loans held for investment declined 12.3% to $1.21 billion; loans held for sale fell 22.2% to $312.7 million. The loan portfolio was concentrated in multifamily real estate (44.6%), one- to four-family residential (24.9%), and commercial real estate (20.8%).
  • Funding and liquidity: Deposits rose 4.1% to $1.23 billion, while borrowings declined to $477.1 million, primarily FHLB advances. Cash and cash equivalents were $376.7 million. The Bank’s primary and total regulatory liquidity ratios were 33.1% and 46.5%, respectively, above stated minimums of 4.0% and 8.0%. Certificates of deposit represented about 50.8% of customer deposits; $533.0 million were scheduled to mature within one year.
  • Credit quality: The allowance for loan losses declined to $15.8 million, or 1.31% of loans, from $18.8 million, or 1.37%. The 2021 provision was a $4.0 million credit, versus a $6.3 million provision in 2020. Non-accrual loans were $5.6 million (0.46% of loans), compared with $5.6 million (0.40%) a year earlier; net recoveries were $945,000.
  • Capital and shareholder returns: Shareholders’ equity was $432.8 million, up 4.8%. The Bank reported a 24.50% common equity Tier 1 risk-based capital ratio and was classified as well-capitalized. Dividends declared were $1.80 per share. The Company repurchased $10.2 million of stock in 2021 and authorized a new 3.5 million-share repurchase plan in December.

Material changes versus 2020

  • Net income declined 12.8%, as weaker mortgage banking income more than offset higher net interest income and lower expenses.
  • Mortgage originations decreased 4.6%; refinance production fell 25.2%, while purchase production increased 8.6%. Management cited higher mortgage rates and increased purchase demand.
  • Deposit growth shifted toward transaction accounts: transaction deposits increased while time deposits declined $74.7 million. Borrowings decreased $30.9 million.
  • Cash and cash equivalents rose substantially, while loans held for investment and loans held for sale decreased.
  • The allowance for loan losses declined by $3.0 million, reflecting management’s assessment of improving economic factors and lower loan balances; net recoveries also increased.

Outlook, risks, contingencies, and unusual items

  • The filing provides no formal earnings or revenue guidance. Management notes that mortgage banking results are sensitive to interest rates, refinance demand, secondary-market conditions, and competitive pricing.
  • In a modeled, instantaneous parallel-rate scenario, a 100-basis-point increase was estimated to raise one-year net interest income by 12.17%; a 100-basis-point decrease was estimated to reduce it by 6.41%. These are sensitivity estimates, not forecasts.
  • The Company deferred CECL adoption under pandemic-related legislation and adopted the standard on January 1, 2022. Its preliminary estimate put the impact on the December 31, 2021 allowance within a range of no change to a 10% increase; management expected greater earnings volatility under CECL.
  • COVID-19 remains a risk to borrowers, collateral values, operations, funding, and demand. Other identified risks include interest-rate changes, credit concentration in real estate and the Milwaukee area, reliance on certificates of deposit and mortgage banking revenue, cybersecurity and third-party disruptions, and the transition away from LIBOR.
  • At year-end, $3.3 million of loans had pandemic-related modifications; $405,000 qualified for CARES Act treatment. Troubled debt restructurings totaled $4.0 million, down from $11.6 million, and were reported as performing under modified terms.
  • The filing describes ongoing litigation involving Waterstone Mortgage Corporation, including multiple lawsuits alleging Fair Labor Standards Act violations. Separately, the previously described Herrington-related matters were settled for $4.25 million, paid in February 2021. The Company recorded a $4.0 million gain on the 2021 sale of mortgage servicing rights related to $1.24 billion of loans.
  • The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The allowance for loan losses was identified as a critical audit matter because its qualitative reserve estimates require significant judgment.

Important facts for investors to verify

  • Whether mortgage banking margins and production stabilize as refinance activity declines and competition affects loan-sale pricing.
  • How CECL adoption affected the opening 2022 allowance and subsequent credit-loss provisions.
  • Deposit retention and repricing needs, particularly the $533.0 million of certificates of deposit maturing within one year, and the cost and duration of FHLB funding.
  • Credit trends in multifamily and commercial real estate, including non-accrual loans, delinquencies, and the adequacy of the allowance.
  • The status and potential financial exposure of the remaining mortgage-company litigation, along with the sustainability of dividends and share repurchases.