Business context and reporting period
Waterstone Financial, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2015. It operates community banking, primarily in southeastern Wisconsin, and mortgage banking, originating residential loans for sale in the secondary market. Unless noted otherwise, figures below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $10.1 million | $10.6 million | $19.5 million | $20.3 million |
| Provision for loan losses | $0.8 million | $0.3 million | $1.1 million | $0.5 million |
| Noninterest income | $31.0 million | $23.2 million | $53.1 million | $40.3 million |
| Noninterest expense | $31.9 million | $27.6 million | $58.4 million | $51.2 million |
| Net income | $5.3 million | $3.8 million | $8.3 million | $5.7 million |
| Basic / diluted EPS | $0.17 / $0.17 | $0.11 / $0.11 | $0.26 / $0.26 | $0.17 / $0.16 |
| Net interest margin, reported | 2.46% | 2.53% | 2.38% | 2.42% |
Balance sheet, liquidity and capital at June 30, 2015
- Total assets were $1.74 billion, down 2.6% from December 31, 2014. Loans held for sale were $207.9 million, up from $125.1 million; loans held for investment, net, were approximately $1.08 billion and essentially unchanged.
- Cash and cash equivalents were $48.1 million, versus $172.8 million at year-end. Deposits declined $13.6 million to $850.3 million. Borrowings increased $10.0 million to $444.0 million, comprising $360.0 million of FHLB advances and $84.0 million of repurchase agreements.
- Six-month cash flow was $66.1 million used in operating activities, $1.7 million provided by investing activities, and $60.3 million used in financing activities. The operating outflow reflects the high volume of mortgage loans originated for sale; cash declined $124.7 million overall.
- Shareholders’ equity was $401.4 million, down $48.8 million, chiefly reflecting share repurchases, dividends and lower accumulated other comprehensive income. WaterStone Bank reported a 31.36% total risk-based capital ratio and was considered well capitalized.
Material changes versus comparable periods
- Net income rose 40% in Q2 and 47% for the first half. Mortgage banking income was the main driver: mortgage segment revenue increased 34.5% in Q2 and 31.7% year to date, with originations up 26.3% and 29.7%, respectively.
- Mortgage banking segment net income increased to $2.9 million in Q2 from $1.0 million, and to $4.3 million for the first half from $1.0 million. Higher origination volume also raised compensation expense, reflecting commission-based pay.
- Net interest income declined 5.2% in Q2 and 4.0% year to date. Management cited lower loan yields and higher deposit costs, including a 14-basis-point increase in the average cost of time deposits in Q2.
- Loan-loss provision increased to $0.8 million in Q2 and $1.1 million year to date, largely related to two loans secured by out-of-state single-family properties. Despite this, non-accrual loans fell to $28.7 million from $38.0 million at year-end, and nonperforming assets declined to $43.0 million from $56.7 million.
- Net charge-offs were $1.5 million for the first half, down from $3.6 million a year earlier. The allowance for loan losses was $18.4 million, or 1.68% of loans receivable, versus $18.7 million, or 1.89%, at year-end.
- The company repurchased approximately 4.28 million shares under announced plans during the first half at an average price of $12.90; 1.13 million additional shares remained authorized at June 30. The filing also reports 4.307 million shares repurchased in the equity statement, a figure investors may wish to reconcile.
Outlook, risks and unusual items
- The filing gives no specific earnings or operating guidance. Management’s forward-looking statements are subject to economic, competitive, interest-rate, credit, regulatory, funding and execution risks.
- Management identifies interest-rate exposure as a key market risk. Its model estimates that a gradual 100-basis-point increase would raise annual net interest income by 2.35%, while a 100-basis-point decline would reduce it by 2.06%. The company cautions that actual results may differ, particularly because mortgage prepayment assumptions may not hold.
- Credit risks include geographic concentration in the Milwaukee area, collateral valuations and potential further losses on impaired loans or foreclosed property. Real estate owned, net, was $14.3 million after $1.2 million of write-downs in the first half. Troubled debt restructurings totaled $18.8 million, including $9.1 million on non-accrual status.
- Mortgage banking exposes the company to changing origination volumes and secondary-market conditions. Loan-sale agreements include representations and warranties and limited recourse provisions; management reported historically insignificant repurchases and expects losses to remain insignificant.
- Cash requirements include $412.7 million of time deposits scheduled to mature within one year, as well as $59.7 million of off-balance-sheet lending commitments. Management says a significant portion of maturing deposits has historically remained, but retention is not assured and replacement funding could cost more or be unavailable on attractive terms.
- The company reported no material change to previously disclosed risk factors, no pending legal proceeding expected to materially affect results, and effective disclosure controls. It noted the adoption of a 2015 equity incentive plan, with stock-based compensation contributing to increased employee expense.
Important facts for investors to verify
- Whether elevated mortgage originations and mortgage banking income are sustainable, and how sensitive profitability is to volume, margins and commission expense.
- The reconciliation between the 4.28 million shares reported repurchased under plans and the 4.307 million shown in the equity statement, and the subsequent share count of 30.0 million reported as of July 30, 2015.
- Trends in impaired loans, non-accruals, troubled restructurings, collateral values and the adequacy of the $18.4 million loan-loss allowance.
- Liquidity and funding capacity given the lower cash balance, large near-term time-deposit maturities, borrowings and lending commitments.
- Key assumptions behind the interest-rate sensitivity estimates and the potential effect of actual rate movements and mortgage prepayments.