Waterstone Financial, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; balance-sheet comparisons are against December 31, 2019. Waterstone operates community banking in Wisconsin and mortgage banking through Waterstone Mortgage Corporation, originating residential loans primarily for sale. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $13.4 | $13.2 | $39.2 | $39.1 |
| Provision (credit) for loan losses | $1.0 | $(0.1) | $6.3 | $(0.7) |
| Noninterest income | $75.8 | $37.5 | $174.1 | $96.9 |
| Noninterest expense | $53.0 | $36.2 | $135.9 | $100.9 |
| Net income | $26.3 | $10.9 | $53.3 | $27.1 |
| Diluted EPS | $1.08 | $0.42 | $2.15 | $1.03 |
| Net interest margin | 2.63% | 2.80% | 2.64% | 2.85% |
Mortgage banking income was $72.1 million in Q3 and $166.3 million year to date, versus $36.1 million and $93.5 million, respectively, in 2019. For Q3, mortgage banking segment net income rose to $20.1 million from $4.1 million; community banking segment net income was $6.2 million versus $6.7 million. Nine-month segment net income was $38.9 million for mortgage banking and $14.4 million for community banking.
Q3 annualized return on average assets was 4.78% and return on average equity was 26.30%; nine-month figures were 3.35% and 18.02%. Effective tax rates were 25.2% for Q3 and 25.0% year to date.
Financial position, funding and cash flow
- Total assets were $2.22 billion, up 11.2% from year-end 2019. Cash and cash equivalents were $86.6 million; available-for-sale securities were $153.2 million.
- Loans held for sale rose to $385.8 million from $220.1 million, reflecting increased refinancing activity. Portfolio loans were $1.43 billion, up $46.1 million; the allowance for loan losses was $18.8 million, or 1.31% of loans, versus $12.4 million, or 0.91%, at year-end.
- Deposits increased $116.9 million to $1.18 billion. Borrowings increased $68.6 million to $552.1 million, including $34.0 million in short-term FHLB advances and $48.1 million outstanding on the mortgage subsidiary’s $55.0 million repurchase facility.
- Shareholders’ equity was $399.4 million. The Bank was reported well-capitalized; its actual total capital, Tier 1 risk-based, common equity Tier 1 and leverage ratios were 22.29%, 21.20%, 21.20% and 16.87%, respectively.
- For the first nine months, operating cash flow was $(116.4) million, investing cash flow $(15.1) million and financing cash flow $143.7 million. Cash increased $12.3 million to $86.6 million. Operating cash flow was negative in the context of the high-volume mortgage origination-and-sale business.
- The company declared $0.86 per share in dividends during the first nine months; Q3’s declared dividend was $0.12 per share. It repurchased $32.7 million of shares year to date.
Material changes and notable items
- Net income rose substantially year over year, principally because of mortgage banking growth: nine-month originations for sale increased 46.7% to $3.15 billion, while mortgage banking income increased 77.8%. Management attributed higher production and margins to low rates and strong refinance demand. Compensation costs also rose with production and commissions.
- Net interest income was nearly flat year to date, while reported net interest margin narrowed 21 basis points to 2.64%. Lower asset yields were substantially offset by lower time-deposit and borrowing costs.
- The company recorded a $6.3 million nine-month loan-loss provision, compared with a $0.7 million provision credit in 2019, citing COVID-19 uncertainty and loan downgrades to Watch. The allowance rose to $18.8 million. Non-accrual loans declined to $6.0 million, or 0.42% of loans, from $7.0 million, or 0.51%, at year-end; total nonperforming assets were $6.8 million, or 0.31% of assets.
- A tentative $4.25 million settlement of the Herrington-related employment claims and related proceedings was reached in September, subject to claimant approval. The company recorded a $4.25 million reserve; approximately $3.2 million affected Q3 earnings because $1.1 million had been accrued earlier in the year.
- Under CARES Act relief, the company deferred CECL adoption and continued using the incurred-loss model. Management expected the initial CECL allowance increase, including unfunded-commitment reserves, not to exceed 130% of the December 31, 2019 allowance; the estimate remained subject to model validation and economic assumptions.
- At September 30, the company reported $30.1 million in 279 PPP loans and approximately $3.2 million in loans subject to COVID-related payment deferrals that were not treated as troubled debt restructurings under the CARES Act.
Outlook, risks and contingencies
The filing provides no quantitative earnings or revenue guidance. Management cautioned that COVID-19, unemployment, borrower payment capacity, fee waivers, interest-rate changes, mortgage-market conditions and funding costs could affect future results. Mortgage banking earnings are exposed to changes in origination volume, refinance demand and sale margins; management noted that current results benefited from unusually strong low-rate demand. The company also cited geographic concentration in the Milwaukee area and reliance on deposits and wholesale funding. A 100-basis-point rate increase was modeled to raise one-year net interest income by 1.71%; a 100-basis-point decrease was modeled to reduce it by 3.48%.
Commitments to extend credit totaled approximately $129.9 million. Mortgage loan-sale representations and limited recourse obligations remain; the reserve for related losses was $3.2 million, compared with $0.9 million at year-end. Related claimant approval remains a condition of the proposed legal settlement. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Key facts for investors to verify
- Whether elevated mortgage originations and margins persist as rates, refinance activity and housing demand change.
- Whether loan downgrades, COVID-related deferrals, troubled restructurings and economic conditions require further provisions or affect the CECL adoption estimate.
- Whether the proposed $4.25 million litigation settlement receives claimant approval and fully resolves the disclosed proceedings.
- Whether deposit retention, certificate maturities, short-term borrowings and available liquidity remain adequate and cost-effective.
- How dividends and share repurchases affect capital, particularly as earnings and credit conditions evolve.