WASHINGTON TRUST BANCORP INC annual report, FY2011

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Washington Trust Bancorp, Inc. — 2011 Form 10-K

Business context and period: Annual report for the fiscal year ended December 31, 2011, with fourth-quarter comparisons. Washington Trust is a Rhode Island-based bank holding company operating primarily in southern New England through Commercial Banking and Wealth Management Services. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.

Financial performance and condition

  • Full-year earnings: Net income was $29.7 million, up 24% from $24.1 million in 2010. Diluted EPS rose to $1.82 from $1.49. Return on average assets was 1.02% (0.82% in 2010); return on average equity was 10.61% (9.09%).
  • Fourth quarter: Net income was $7.8 million versus $7.2 million in Q4 2010; diluted EPS was $0.47 versus $0.44. Net interest income was $22.0 million versus $20.3 million, and the loan-loss provision was $1.0 million in both quarters.
  • Revenue and margins: Full-year net interest income increased 10% to $85.0 million. Net interest margin improved to 3.20% from 2.93%, primarily as funding costs fell; the cost of interest-bearing liabilities declined 37 basis points. Noninterest income increased 9% to $52.8 million, including $28.3 million in wealth-management revenue, up 7%, and $5.1 million in mortgage banking revenue, up 25%.
  • Expenses and credit costs: Noninterest expense rose 6% to $90.4 million, including higher compensation and expansion-related costs, partly offset by lower FDIC insurance expense. The loan-loss provision declined to $4.7 million from $6.0 million; net charge-offs fell to $3.5 million, or 0.17% of average loans, from $4.8 million, or 0.24%.
  • Cash flow: Operating activities provided $37.2 million; investing activities used $158.6 million, principally reflecting loan growth and securities activity; financing activities provided $115.7 million. Cash and cash equivalents declined $5.7 million to $87.0 million.
  • Balance sheet and funding: Total assets were $3.06 billion, up 5%; loans were $2.15 billion, up 8%. Deposits rose 4% to $2.13 billion, including a 49% increase in demand deposits. FHLBB advances were $540.5 million, up from $498.7 million; junior subordinated debentures were $33.0 million and other borrowings were $19.8 million. Shareholders’ equity was $281.4 million.
  • Capital and liquidity: The Corporation reported Tier 1 risk-based, total risk-based, and leverage capital ratios of 11.61%, 12.86%, and 8.70%, respectively, and was categorized as well capitalized; the Bank was also well capitalized. Management said liquidity remained within internal target ranges and funding sources were expected to meet anticipated needs. An unused FHLBB line of credit was $8.0 million.
  • Asset quality: Nonperforming assets were $24.8 million, or 0.81% of assets, versus $23.0 million, or 0.79%, a year earlier. Nonaccrual loans increased to $21.2 million from $18.5 million, principally due to residential mortgages; past-due loans were $26.3 million, or 1.22% of loans. The allowance was $29.8 million, or 1.39% of loans. Troubled debt restructurings declined to $19.6 million; identified potential problem loans increased to $7.4 million from $6.7 million.

Material changes versus 2010

  • Net income increased 24%, supported by higher net interest income, lower loan-loss provision, and growth in wealth management and mortgage banking revenues.
  • Loans grew $151.5 million, led by commercial lending; commercial loans represented 52% of total loans, versus 51% in 2010. Residential mortgages grew 9%, while consumer loans declined slightly.
  • Deposit growth was concentrated in demand, NOW, and savings accounts. Time deposits declined 7%; out-of-market brokered time deposits increased to $90.1 million from $52.3 million.
  • Nonperforming assets edged higher, and nonaccrual loans rose, with residential mortgage deterioration partly offset by lower nonaccrual commercial loans.
  • Unrealized losses on securities were concentrated in financial-sector trust preferred securities. Net impairment losses recognized in earnings declined to $191,000 from $417,000.

Outlook, commentary, risks, and unusual items

  • Outlook: No quantified earnings or financial guidance is provided. Management described continued plans to grow market share in Rhode Island and selectively expand into attractive markets. A mortgage office opened in Warwick in February 2012; a full-service Cranston branch was planned for later in 2012.
  • Management commentary: Management cited persistent economic uncertainty and high unemployment, while stating that 2011 results reflected financial strength, lower funding costs, commercial loan growth, and strong mortgage activity. It considered the allowance for loan losses adequate, while noting continued economic and credit uncertainty.
  • Interest-rate exposure: Simulations estimated net interest income would decline 2.29% over 12 months under a 100-basis-point rate decrease and rise 2.06% under a 100-basis-point increase. These are model estimates, not forecasts; results depend on deposit behavior, prepayments, and other assumptions.
  • Securities and subsequent event: Two pooled trust preferred securities were on nonaccrual and had a combined fair value of $0.9 million. After year-end, an underlying issuer announced further interest deferrals; management expected an approximately $180,000 impairment charge in Q1 2012 and deemed it immaterial to 2011 results.
  • Unusual items: 2011 included a $203,000 gain on sale of bank property and a charitable contribution of appreciated securities costing $990,000, with a $331,000 realized gain. Securities sales and FHLBB advance prepayments generated gains and $694,000 in debt prepayment penalties. A $7.0 million after-tax pension remeasurement charge reduced accumulated other comprehensive income.
  • Risks and contingencies: Principal risks include commercial-credit and real-estate concentrations, regional economic weakness, interest-rate and liquidity sensitivity, wealth-management market exposure, competition, evolving banking regulation, and operational or cyber risks. Mortgage-sale representations and warranties can require loan repurchases or indemnification; the related reserve was described as immaterial. Ordinary-course litigation was not expected by management to materially affect financial position or results.
  • Reporting quality: The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded internal control over financial reporting was effective. The filing reports no unresolved SEC staff comments.

Important facts for investors to verify

  • Whether rising residential mortgage delinquencies, nonaccrual loans, and potential problem credits lead to higher charge-offs, provisions, or allowance needs.
  • The collectability, valuation assumptions, and subsequent impairment developments for pooled and individual-issuer trust preferred securities.
  • Deposit mix and funding costs, including brokered deposits and FHLBB advance maturities, calls, collateral requirements, and refinancing terms.
  • Whether net interest margin and earnings remain resilient as interest rates, deposit pricing, and mortgage prepayments change.
  • The sustainability of mortgage banking and wealth-management revenues, which are sensitive to refinancing volume, market performance, client flows, and assets under administration.
  • Capital, dividend capacity, pension funding, and regulatory changes; the common dividend was $0.22 per share each quarter in 2011, and future dividends remain subject to board and regulatory discretion.