Waterstone Financial, Inc. — 2018 Form 10-K
Business context and period: This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. Waterstone Financial operates a community bank serving southeastern Wisconsin and a mortgage banking business originating residential loans for sale. The bank’s loan portfolio is concentrated in multifamily and one- to four-family residential real estate.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Total assets at year-end | $1.915 billion | $1.806 billion |
| Loans held for investment, gross | $1.379 billion | $1.292 billion |
| Deposits | $1.038 billion | $967.4 million |
| Borrowings | $435.0 million | $386.3 million |
| Net interest income | $54.2 million | $50.7 million |
| Net interest margin | 3.09% | 3.00% |
| Noninterest income | $118.2 million | $124.4 million |
| Noninterest expense | $133.2 million | $131.9 million |
| Net income | $30.8 million | $26.0 million |
| Diluted EPS | $1.11 | $0.93 |
| Return on average assets / equity | 1.64% / 7.60% | 1.43% / 6.32% |
- Net interest income rose 6.8%, primarily from loan growth and higher loan yields; increased certificate-of-deposit costs partly offset the benefit. The reported spread was 2.75%, versus 2.69% in 2017.
- Mortgage banking income was $113.2 million, down from $120.0 million. Mortgage originations increased about 2% to $2.60 billion, but management cited lower margins and a 14% decline in refinance production.
- Provision for loan losses was a $1.06 million credit, compared with a $1.17 million credit in 2017. Net recoveries were $232,000; the allowance ended the year at $13.25 million, or 0.96% of loans.
- Cash and cash equivalents increased to $86.1 million from $48.6 million. Operating cash flow was $42.9 million, investing cash flow was negative $79.9 million, and financing cash flow was positive $74.4 million. Cash increased $37.5 million overall.
- Deposits grew 7.4%; certificates of deposit represented 70.9% of customer deposits and had a 2.01% year-end weighted-average cost. Borrowings were mainly $430 million of FHLB advances, alongside about $5 million of short-term repurchase agreements.
- WaterStone Bank reported regulatory capital ratios well above minimums: 26.05% common equity Tier 1 and 26.95% total risk-based capital. Its year-end regulatory liquidity ratios were 11.1% primary and 23.0% total.
Material changes versus 2017
- Net income increased 18.4%, while diluted EPS rose from $0.93 to $1.11. The effective tax rate fell to 23.6% from 41.6%; 2017 included a one-time $2.7 million tax expense from revaluing deferred tax assets after the federal rate reduction.
- Gross loans grew 6.8%, led by one- to four-family, multifamily, and commercial real estate lending. Multifamily loans were 43.3% of the portfolio and commercial real estate loans 16.4%.
- Mortgage-related noninterest income declined despite slightly higher originations, as margins weakened. Total noninterest income fell 5.0%; noninterest expenses rose 1.0%.
- Nonaccrual loans increased to $6.6 million from $6.1 million, and loans past due rose to $7.0 million from $5.9 million. However, nonperforming assets declined to $8.7 million from $10.6 million, mainly as real estate owned fell to $2.2 million.
- Shareholders’ equity declined 3.0% to $399.7 million, reflecting dividends, share repurchases, and lower fair value of securities, partly offset by earnings. The company repurchased $19.2 million of stock in 2018.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or growth guidance. Management describes ongoing priorities including profitable customer relationships, loan growth, and reducing reliance on higher-cost certificates of deposit.
- Management’s interest-rate simulation estimated that an immediate 100-basis-point rate increase would raise one-year net interest income by 1.31%; a 100-basis-point decrease would lower it by 1.86%. These are model estimates, not forecasts.
- Key exposures include interest-rate changes, competition for deposits, reliance on certificates of deposit and FHLB funding, real-estate and commercial credit concentrations, secondary mortgage market conditions, and cybersecurity and third-party technology risks. The company also noted the coming transition from LIBOR and implementation of expected-credit-loss accounting (CECL).
- A Fair Labor Standards Act class-action matter involving Waterstone Mortgage could result in a loss ranging from $0 to $11 million. The company said a loss was not probable and recorded no accrual. A separate wage lawsuit had reached a settlement in principle, with an amount expected not to materially affect the financial statements.
- The company acquired an Academy Mortgage branch in New Mexico for approximately $600,000 in June 2018; goodwill recorded was described as insignificant. The company adopted ASC 606 in 2018 with no impact on net income or equity. Adoption of the lease standard in January 2019 increased reported assets and liabilities by approximately $10 million, with no material income-statement impact.
- The independent auditor issued unqualified opinions on the financial statements and internal controls over financial reporting.
Important facts for investors to verify
- Track mortgage banking margins and income alongside purchase/refinance mix, origination volume, and costs as interest rates and housing-market conditions change.
- Review deposit pricing and retention—particularly the $472.5 million of certificates of deposit scheduled to mature within one year—and the company’s use and cost of FHLB advances.
- Monitor credit quality: nonaccrual loans, past-due balances, troubled debt restructurings, commercial real estate exposure, and the adequacy of the allowance.
- Check developments in the Herrington litigation, including potential exposure up to $11 million and the absence of an accrual at year-end.
- Assess capital returns against retained capital: 2018 dividends were $0.98 per share, and repurchases totaled $19.2 million.