Waterstone Financial, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; balance-sheet comparisons are to December 31, 2013. Figures are in U.S. dollars; financial amounts below are in millions unless stated otherwise. Waterstone operates community banking and mortgage banking businesses, with the bank primarily serving southeastern Wisconsin and mortgage lending across multiple states.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $10.9 | $9.6 | $31.2 | $29.6 |
| Provision for loan losses | $0.3 | $1.0 | $0.9 | $4.0 |
| Noninterest income | $23.9 | $21.0 | $64.2 | $70.8 |
| Noninterest expense | $27.0 | $24.4 | $78.3 | $75.7 |
| Income before taxes | $7.5 | $5.2 | $16.3 | $20.7 |
| Net income | $4.8 | $3.2 | $10.4 | $12.8 |
| Diluted EPS | $0.14 | $0.09 | $0.31 | $0.37 |
- Revenue and margins: Q3 mortgage banking income rose 21% to $22.1 million, as originations for sale increased 10.9% to $489.8 million and sales margins improved. For the nine-month period, mortgage banking income fell 10.5% to $58.7 million as originations declined 11.5% to $1.26 billion and margins weakened. Net interest margin was 2.55% in Q3 versus 2.51%; nine-month margin was 2.45% versus 2.59% (fully tax-equivalent: 2.50% versus 2.64%).
- Profitability: Q3 net income increased 48% year over year, while nine-month net income declined 18%. Nine-month pretax income fell $4.4 million, primarily reflecting a $6.1 million decline in mortgage banking segment pretax income, partly offset by improved community banking results. Nine-month annualized return on assets was 0.78% versus 1.05%; return on equity was 3.18% versus 8.20%, with both measures affected by the 2014 equity offering.
- Assets, funding and liquidity: Total assets were $1.80 billion, down 7.6% from year-end; loans held for investment were $1.11 billion, up 1.7%, and loans held for sale were $144.2 million, up 48.6%. Deposits were $875.2 million, down 29.7%, while total borrowings were $434.0 million, down from $455.2 million. Cash and equivalents ended at $141.3 million, versus $429.2 million at year-end. Management reported an average liquidity ratio of 11.3% for the nine months, compared with 4.3% a year earlier.
- Debt and capital: Borrowings comprise $350 million of Federal Home Loan Bank advances and $84 million of repurchase agreements; the advances and repurchase agreements are callable quarterly before maturity. Shareholders’ equity rose to $448.5 million from $214.5 million, principally due to $248.4 million in net stock-offering proceeds. WaterStone Bank was categorized as well capitalized; at September 30 its total risk-based capital ratio was 31.16% and Tier 1 leverage ratio was 19.05%.
- Cash flow: For the nine months, operating cash flow was negative $22.9 million, investing cash flow negative $103.3 million and financing cash flow negative $161.7 million; cash and equivalents fell $287.9 million. The filing attributes major cash movements to the stock offering and subscriber refunds, securities and loan investment, ESOP funding and the mortgage lending business.
Material changes and credit quality
- The second-step conversion and public offering closed January 22, 2014: 25.3 million shares were sold at $10 per share, generating $253 million gross proceeds; reported net proceeds were approximately $248.4 million. Oversubscription funds were returned. This transaction substantially increased equity and affected cash, deposits, returns and year-over-year comparisons.
- Q3 provision for loan losses fell to $0.3 million from $1.0 million; the nine-month provision fell to $0.9 million from $4.0 million. Management cited improving portfolio indicators and stabilization in the local real estate market. Nine-month net charge-offs were $4.7 million, versus $10.3 million.
- Nonaccrual loans declined to $43.1 million from $51.0 million at year-end; the nonaccrual-to-loans ratio fell to 3.88% from 4.66%. Total nonperforming assets were $69.0 million, or 3.83% of assets, slightly above 3.78% at year-end, as real estate owned rose to $25.8 million from $22.7 million. Troubled debt restructurings totaled $26.8 million, including $16.8 million nonaccrual.
- The allowance for loan losses was $20.4 million, or 1.84% of loans, compared with $24.3 million and 2.22% at year-end; coverage of nonaccrual loans was approximately 47.4%. Nine-month charge-offs were concentrated in multifamily loans. Management cautions that further property-value deterioration could require additional provisions or charge-offs.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management expects offering proceeds to be deployed over time for general corporate purposes, including loan funding; it says higher net interest-earning assets may support net interest income, while the larger equity base may continue to weigh on returns on assets and equity.
- Mortgage banking results remain sensitive to origination volume, product mix and secondary-market sales margins. Management attributed weaker nine-month production mainly to lower refinance demand, while Q3 benefited from purchase demand and stronger margins.
- Key stated risks include interest-rate changes, credit losses and collateral values, economic conditions, competition, mortgage and securities markets, regulation, operational risk, and the ability to retain deposits and obtain alternative funding on acceptable terms. $395.2 million of time deposits were scheduled to mature within one year; management said retention was expected based on experience but was not assured.
- Interest-rate simulation estimated that a gradual 100-basis-point rise would increase annual net interest income 2.57%, while a 100-basis-point decline would reduce it 2.20%. A 100-basis-point rise or decline was estimated to reduce economic value of equity by 1.02% or 1.23%, respectively; actual outcomes may differ, particularly due to prepayment assumptions.
- Two municipal securities had additional credit impairment charges of $17,000 in the nine months; their combined estimated fair value was $181,000. Management warned broader economic deterioration could lead to future securities impairment. No material pending legal proceeding liability was anticipated, and management reported disclosure controls as effective.
Investor verification priorities
- Confirm how offering proceeds, subscription refunds and balances temporarily held in deposit accounts affect reported cash, deposits and period-to-period comparisons.
- Track mortgage origination volumes, refinance-versus-purchase mix, sales margins and servicing-rights sales, which materially influenced earnings.
- Monitor multifamily and other real-estate credit exposure, nonaccrual and restructured loans, collateral values, real estate owned and allowance adequacy.
- Review deposit retention and upcoming maturities alongside callable FHLB advances, repurchase agreements and available liquidity.
- Assess whether interest-rate sensitivity assumptions and the expected deployment of excess capital translate into sustained net interest income without undue pressure on margins or returns.