Waterstone Financial, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unless stated otherwise, dollar amounts below are in millions. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking, originating residential loans largely for sale.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $13.7 | $12.5 | $26.9 | $24.4 |
| Mortgage banking income | $32.1 | $36.2 | $56.3 | $60.9 |
| Total noninterest income | $33.3 | $37.2 | $58.5 | $63.2 |
| Noninterest expenses | $34.7 | $36.2 | $64.9 | $65.2 |
| Net income | $9.4 | $8.9 | $16.4 | $15.5 |
| Diluted EPS | $0.34 | $0.32 | $0.59 | $0.55 |
| Net interest margin, reported | 3.14% | 3.00% | 3.16% | 2.98% |
Q2 net income rose about 6%; six-month net income rose about 6%. Net interest income improved on loan growth and lower borrowing costs, while mortgage banking income fell as production and margins weakened. Mortgage segment net income was $2.9 million in Q2 versus $3.9 million a year earlier; community banking segment net income was $6.6 million versus $5.0 million. The effective tax rate fell to 24.8% in Q2 and 24.1% for the first half, mainly reflecting the federal corporate tax rate reduction.
Financial position, cash flow and credit
- Total assets were $1.877 billion at June 30, up 3.9% from year-end 2017. Gross loans held for investment rose $50.3 million to $1.342 billion; deposits increased $28.1 million to $995.4 million.
- Cash and cash equivalents were $78.1 million, up $29.5 million from year-end. Available-for-sale securities were $185.0 million, down $14.7 million.
- Borrowings increased $46.2 million to $432.5 million, including $430.0 million of long-term FHLB advances. Shareholders’ equity declined $8.4 million to $403.7 million, reflecting dividends, share repurchases and lower securities fair value, partly offset by earnings.
- For the first half, operating cash flow was $14.7 million versus $41.5 million in 2017; investing cash use was $41.2 million versus $37.4 million; financing cash provided was $56.0 million versus $78.3 million. Cash increased $29.5 million, compared with an $82.3 million increase in the prior-year period.
- Allowance for loan losses was $13.1 million, or 0.98% of loans, versus $14.1 million and 1.19% at year-end. The company recorded a $1.1 million negative provision for the first half, citing recoveries and improved portfolio risk. Nonperforming assets declined to $8.5 million from $10.6 million; nonaccrual loans were $6.1 million. Past-due loans increased to $7.2 million from $5.9 million.
- The Bank exceeded regulatory capital requirements and was reported as “well capitalized.” Its June 30 ratios included 27.41% total risk-based capital and 20.11% Tier 1 capital to average assets.
Material changes, outlook and risks
- Mortgage origination volume declined 5.9% in Q2 and 1.9% for the first half year over year, while management reported roughly 10% margin compression, attributing it to heightened price competition amid lower demand. First-half mortgage banking income fell 7.6%.
- Time-deposit costs rose as deposits repriced in a competitive market. Management identified rising rates, competition for deposits, mortgage-market conditions, credit quality, economic conditions, regulatory changes, cyber and technology risks, and integration of acquired operations as factors that could affect results. No quantitative earnings guidance was provided.
- On June 29, the mortgage subsidiary acquired an Academy Mortgage branch for approximately $0.6 million; recorded goodwill was described as insignificant.
- Herrington employment litigation remains on appeal. The company estimated potential loss of $0–$11 million, considered a loss not probable, and recorded no accrual. A separate Werner wage case is in discovery; the company could not estimate its outcome or potential loss.
- Available-for-sale securities had $4.5 million of gross unrealized losses at June 30, versus $1.6 million at year-end. Management attributed long-held losses principally to interest rates, not credit deterioration, but warned that economic deterioration could lead to future impairment losses.
- ASC 606 was adopted January 1, 2018 with no impact on net income or equity. The company was evaluating forthcoming lease and expected-credit-loss accounting standards.
Important facts for investors to verify
- Whether mortgage production and gain margins stabilize, and how continued competition affects mortgage-segment profitability.
- Deposit retention and funding costs, including the $507.8 million of time deposits scheduled to mature within one year and the company’s increased FHLB borrowing.
- Credit trends: past-due balances rose despite lower nonperforming assets and a reduced allowance; monitor collateral values, troubled restructurings and future provisions.
- Developments in the Herrington appeal and Werner litigation, including any change to the potential exposure or accrual assessment.
- Cash generation, dividends and repurchases alongside the decline in equity and increase in borrowings.