Waterstone Financial, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context
Waterstone operates a community bank concentrated in southeastern Wisconsin and a mortgage-banking subsidiary originating residential mortgages primarily for sale in the secondary market. Community banking supplies most net interest income; mortgage banking generates most noninterest income and a majority of noninterest expense.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $11.3 | $9.9 | $31.5 | $29.4 |
| Provision for loan losses | $0.1 | $0.6 | $0.3 | $1.7 |
| Noninterest income | $37.4 | $28.6 | $95.2 | $81.6 |
| Noninterest expense | $35.5 | $29.8 | $95.0 | $88.2 |
| Income before taxes | $13.1 | $8.1 | $31.3 | $21.1 |
| Net income | $7.5 | $5.2 | $19.1 | $13.5 |
| Diluted EPS | $0.27 | $0.19 | $0.70 | $0.45 |
- Q3 net income rose about 44%; nine-month net income rose about 42%. Annualized return on average assets/equity was 1.66%/7.36% in Q3 and 1.45%/6.38% for the nine months, versus 1.18%/5.21% and 1.03%/4.26%, respectively, in 2015.
- Net interest margin was 2.70% for Q3 and 2.56% year to date, compared with 2.39% and 2.38% in 2015. On a fully tax-equivalent basis, margins were 2.74% and 2.61%, versus 2.45% and 2.44%.
- Mortgage banking income was $35.6 million in Q3 (+33%) and $91.1 million year to date (+18%). Mortgage originations for sale were $710.1 million in Q3 and $1.76 billion year to date. Higher volume and margins, including purchase-loan activity, supported revenue.
- Compensation expense increased to $27.6 million in Q3 and $71.0 million year to date, largely reflecting mortgage commissions and origination activity. Management also cited higher health-insurance costs and, in Q3, increased ESOP expense. A $564,000 tax charge related to 2007 stock-option awards contributed to the higher Q3 effective tax rate of 42.5%; the nine-month rate was 39.0%.
- At September 30, total assets were $1.80 billion; portfolio loans were $1.15 billion gross ($1.14 billion net of allowance), and loans held for sale were $227.8 million. Assets rose 1.8% from year-end. Securities available for sale were $245.4 million.
- Deposits increased $62.3 million to $955.6 million; borrowings declined $63.2 million to $378.0 million. Shareholders’ equity increased $17.6 million to $409.6 million. Cash and cash equivalents fell $46.2 million to $54.3 million.
- For the nine months, operating cash flow was negative $36.3 million, compared with positive $7.8 million in 2015; investing cash flow was negative $13.1 million and financing cash flow positive $3.2 million. The operating cash outflow reflects substantial mortgage-loan originations and sales: $1.76 billion originated for sale and $1.79 billion in sale proceeds.
- The Bank reported regulatory capital well above minimums: total capital ratio 29.59%, Tier 1 risk-based ratio 28.39%, common equity Tier 1 ratio 28.39%, and Tier 1 leverage ratio 20.71%.
Material changes and credit quality
- Net interest income growth reflected loan growth and lower borrowing costs after $220 million of 4.34% FHLB advances matured; these were partly replaced with $100 million of long-term advances at a 0.78% weighted average rate and retail deposits. Deposit costs rose as time deposits repriced and balances grew.
- Asset-quality measures improved: non-accrual loans fell to $10.7 million, or 0.93% of loans, from $17.6 million, or 1.58%, at year-end. Nonperforming assets were $18.1 million, or 1.01% of assets, versus $26.8 million, or 1.52%.
- The allowance for loan losses was $15.6 million, 1.36% of gross loans, versus $16.2 million, 1.54%, at year-end. Nine-month net charge-offs were $0.9 million (annualized 0.11% of average loans), down from $3.5 million (0.43%) in 2015.
- Troubled debt restructurings declined to $10.7 million from $17.5 million; $4.1 million were non-accruing. Management attributes improved credit metrics partly to a stabilizing local real estate market, while noting future provisions depend on portfolio conditions, collateral values, and economic factors.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or revenue guidance. Management says results for the nine months are not necessarily indicative of full-year results. Mortgage-banking performance remains exposed to origination volume, margins, secondary-market conditions, and interest rates.
- Management’s interest-rate simulation estimated that a gradual 100-basis-point rise would increase annual net interest income by 1.45%, while a 100-basis-point decline would reduce it by 1.42%. A 100-basis-point rise was estimated to reduce economic value of equity by 1.54%; assumptions, particularly mortgage prepayments, may differ from actual outcomes.
- Liquidity considerations include $481.1 million of time deposits scheduled to mature within one year, a $50 million short-term FHLB advance maturing October 27, 2016, and $91.7 million in total off-balance-sheet commitments. The company says some maturing deposits may not remain and alternative funding may be more expensive or unavailable on attractive terms.
- Waterstone Mortgage is defending a Fair Labor Standards Act and contract-related loan-officer lawsuit, transferred to arbitration. Management does not expect pending proceedings to have a material adverse effect. The company reports no probable losses on credit commitments or standby letters of credit.
- Mortgage-loan sale agreements include representations, warranties, and limited recourse; management says historical repurchase activity and losses have been insignificant. Mortgage banking derivatives are used to manage interest-rate exposure, not for speculation; their valuations include significant unobservable inputs.
- Unusual or noteworthy items include the $564,000 stock-option-related tax expense; a $100 million bank-owned life insurance policy purchased in March 2016; and no mortgage-servicing-rights sales in 2016, compared with a $807,000 gain on such sales in 2015.
- The company had authorization to repurchase up to 989,500 additional shares at September 30, 2016; no shares were purchased under the plan during Q3. It declared dividends of $0.21 per share during the first nine months.
Most important facts for investors to verify
- Whether mortgage originations and margins remain strong and how much earnings depend on mortgage banking versus community banking.
- Whether credit-quality improvements persist, particularly in non-accrual loans, troubled restructurings, charge-offs, and collateral values.
- How the $481.1 million of near-term time-deposit maturities are retained or refinanced, and the resulting funding costs and liquidity position.
- The sustainability of net interest margin as deposit costs rise and interest rates, loan yields, and mortgage prepayments change.
- The outcome and potential financial exposure of the loan-officer litigation, and the effects of stock-option tax attributes as awards expire or are exercised.