Waterstone Financial, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking, originating residential loans for sale. Unless stated otherwise, dollar amounts below are in millions.
Financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net income | $9.64 | $9.42 | $16.19 | $16.37 |
| Diluted EPS | $0.37 | $0.34 | $0.61 | $0.59 |
| Net interest income | $12.98 | $13.72 | $25.92 | $26.86 |
| Mortgage banking income | $34.11 | $32.09 | $57.46 | $56.28 |
| Noninterest expenses | $35.36 | $34.74 | $64.70 | $64.88 |
- Q2 net income rose about 2.4%; six-month net income fell about 1.1%. Higher EPS reflected fewer weighted-average shares as well as earnings.
- Net interest margin was 2.82% in Q2 versus 3.14% a year earlier, and 2.88% for the first half versus 3.16%. Higher deposit and borrowing costs outpaced growth in interest income.
- Mortgage banking originations increased: $793.3 million in Q2, up 10.0%, and approximately $1.29 billion in the first half, up 4.6%. Increased volume supported income, while gross margin on loans sold contracted amid price competition.
- The company recorded a $30,000 provision in Q2; for the first half it recorded a $650,000 credit to provision, citing improvement in the loan portfolio’s risk profile.
Financial position, cash flow and capital
- At June 30, assets were $2.02 billion, up 5.2% from year-end 2018. Loans held for sale rose $102.4 million to $244.1 million; loans held for investment declined $8.4 million to $1.37 billion.
- Deposits totaled $1.05 billion, up $16.5 million. Borrowings rose $83.6 million to $518.7 million, including $495.0 million of FHLB advances and $23.7 million under a mortgage-banking repurchase agreement.
- Cash and cash equivalents were $70.1 million, down $16.0 million from year-end. First-half operating cash flow was negative $97.9 million, compared with positive $14.7 million in the prior-year period; the filing attributes cash use substantially to funding loans held for sale. Financing activities provided $69.8 million.
- Shareholders’ equity was $386.8 million, down $12.9 million. Dividends and share repurchases were principal reductions; net income and improved unrealized securities values partly offset them. The company paid $19.8 million in cash dividends and repurchased $14.4 million of stock during the first half.
- WaterStone Bank exceeded regulatory capital requirements and was classified as well capitalized. Its June 30 ratios included 21.75% Tier 1 and common equity Tier 1 capital to risk-weighted assets, and 22.58% total capital.
Material changes, outlook and risks
- Management attributed narrower net interest income to deposit and borrowing repricing at higher rates; average loan yields and balances increased but did not fully offset funding costs.
- Mortgage activity benefited from lower mortgage rates and increased refinancing, particularly in Q2. Management also cited margin pressure from price competition and a changing mix of purchase and refinance loans.
- The board authorized a new program to repurchase up to 2.0 million shares on May 30, 2019; 1,845,800 shares remained authorized at June 30. Repurchases may depend on market conditions, available funds and alternative uses of capital.
- No earnings or financial guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- Key risks include interest-rate and funding-cost changes, mortgage volumes and secondary-market conditions, credit deterioration, economic conditions, competition, regulatory changes, cybersecurity and reliance on third-party providers. A 100-basis-point rate increase was modeled to raise next-12-month net interest income 0.29%; a 100-basis-point decrease was modeled to reduce it 2.70%.
- Waterstone Mortgage’s prior class-action arbitration award was vacated by the district court in April 2019. Approximately 90 former claimants filed new arbitration demands in May; the company is responding and said it does not believe a loss is probable.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. The company was preparing for CECL, effective after January 1, 2020, and planned parallel calculations in the second half of 2019.
Important facts for investors to verify
- Whether deposit and borrowing costs continue to pressure net interest margin, and the company’s dependence on FHLB advances and other funding.
- Mortgage origination volumes, gain-on-sale margins, and the sensitivity of earnings to rate-driven changes in refinance activity.
- Loan delinquency and reserve trends: nonperforming assets were $7.4 million, while past-due loans increased to $8.3 million from $7.0 million at year-end.
- Developments and potential exposure from the renewed employment-related arbitration demands.
- How dividends and the new repurchase program affect capital, liquidity and shares outstanding; also review the CECL implementation and its eventual reported impact.