Western New England Bancorp, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter filing; quarterly figures are included below where relevant. The company is a community banking holding company operating Westfield Bank, with 22 banking offices in western Massachusetts and northern Connecticut.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Net interest and dividend income | $60.0 million | $59.4 million |
| Non-interest income | $9.2 million | $8.5 million |
| Non-interest expense | $46.2 million | $44.8 million |
| Provision for loan losses | $1.9 million | $1.4 million |
| Income before taxes | $21.1 million | $21.7 million |
| Net income | $16.4 million | $12.3 million |
| Diluted earnings per share | $0.57 | $0.41 |
| Tax-equivalent net interest margin | 3.08% | 3.12% |
Net income rose 33%, while pretax income declined about 3%; the lower effective tax rate (22.3% versus 43.4%) was a major contributor to the earnings increase. The 2017 rate included a $4.0 million noncash deferred-tax-asset write-down related to the Tax Act. Non-interest income in 2018 included $715,000 of BOLI death benefits; excluding that item, non-interest income was nearly flat year over year. Management’s adjusted net income, excluding favorable acquisition-related purchase accounting amortization, was $15.1 million in 2018 versus $12.5 million in 2017.
Fourth quarter: Net income was $3.8 million, or $0.14 per diluted share, versus a $353,000 loss, or $(0.01) per share, in fourth-quarter 2017. Fourth-quarter net interest income was $14.8 million, compared with $15.4 million a year earlier.
Balance sheet, funding and capital
- Total assets were $2.119 billion, up 1.7% from $2.083 billion. Net loans were $1.685 billion, up about 4%; gross loans were $1.692 billion. Commercial real estate represented 45.4% of gross loans and residential real estate 34.1%.
- Deposits were $1.596 billion, up 6.0%. Time deposits grew 18.6% to $660.0 million, while core deposits declined to 58.6% of deposits from 63.0%. Deposits with maturities within one year totaled $443.2 million.
- FHLB borrowings were $267.3 million, down from $297.8 million. Cash and cash equivalents were $26.8 million. Available FHLB borrowing capacity was $218.3 million, with another $65.0 million in unused correspondent-bank lines.
- Shareholders’ equity was $237.0 million, or 11.2% of assets, compared with $247.3 million, or 11.9%, a year earlier. Tangible book value per share increased 2.8% to $7.78.
- The Bank was categorized as well-capitalized. At year-end, its total risk-based capital ratio was 14.18%, CET1 ratio 13.46%, and leverage ratio 10.59%.
Cash flow and asset quality
Operating activities provided $24.6 million of cash; investing activities used $45.7 million and financing activities provided $20.8 million. Cash and cash equivalents declined $343,000 to $26.8 million. These cash-flow figures reflect bank balance-sheet activity and should not be interpreted like cash flow at a nonfinancial company.
The allowance for loan losses increased to $12.1 million, or 0.71% of loans, from $10.8 million, or 0.67%. Net charge-offs were $678,000. Non-performing loans were $13.5 million, or 0.79% of loans, versus $12.8 million, or 0.78%. Criticized loans increased to $79.9 million (4.7% of loans) from $63.6 million (3.9%); adversely classified loans rose to $49.7 million from $23.9 million. The company reported no foreclosed real estate at year-end.
Material changes and unusual items
- Loan originations increased to $357.7 million from $213.0 million; the loan portfolio grew 4.0%.
- Interest expense rose 29.6% to $19.0 million, as deposit and borrowing costs increased. Average cost of funds rose to 1.26% from 0.97%; the average asset yield increased to 4.05% from 3.88%.
- Non-interest expense increased 3.2%. Higher salaries, data processing, professional fees and other costs reflected business growth and infrastructure. Legal fees included $309,000 relating to a previously charged-off loan; the company recovered $300,000 and said further recovery efforts may not be successful.
- Share repurchases reduced equity by $22.8 million during 2018; cash dividends were $4.6 million. From January 1 through March 13, 2019, the company repurchased a further 1.493 million shares for $14.8 million. A new 2019 authorization allows repurchases of up to 2.814 million shares after completion of the prior plan.
- Adoption of accounting guidance for equity securities moved unrealized marketable-equity losses into earnings; 2018 included $142,000 of such losses. Securities also recorded $281,000 of realized losses. Unrealized losses on available-for-sale debt securities increased, but management attributed them mainly to higher market yields and reported no other-than-temporary impairment.
Outlook, risks and contingencies
Management’s stated strategy emphasizes commercial and residential lending, growth in core deposits, investment in technology and customer service, and capital returns through dividends and repurchases. The filing provides no numerical earnings or growth guidance. Management said liquidity was adequate for expected funding needs and anticipated no material 2019 capital expenditures apart from strategic initiatives.
- Interest-rate risk is significant. Modeling estimated net interest income would change by -3.5% in months 1–12 and -7.7% in months 13–24 under a parallel +200 basis-point shock; modeled results are not forecasts. The company had $35.0 million notional of interest-rate swaps.
- Credit quality bears monitoring, particularly the increase in criticized and adversely classified loans and the portfolio’s commercial real estate exposure. Management considers the allowance adequate, but estimates are judgmental and may need revision.
- Core deposits made up a smaller share of funding, time-deposit costs rose, and substantial time deposits were scheduled to mature within a year. Competition or outflows could increase reliance on more expensive wholesale funding.
- The company was implementing the expected-credit-loss standard (CECL), effective for it in 2020; it had not quantified the impact and expected the methodology for estimating the allowance to change significantly.
- Other disclosed risks include economic weakness in the company’s regional markets, regulatory changes, cybersecurity and third-party service-provider disruptions, and the transition away from LIBOR. Bank dividends to the holding company are subject to regulatory limits; the filing states the Bank had no retained earnings available for dividends without prior regulatory approval.
- The company disclosed $368.9 million of outstanding credit commitments and letters of credit; many commitments may expire undrawn. It reported no material pending litigation and said it did not anticipate significant losses from commitments and contingencies.
Most important facts for investors to verify
- Whether the sharp increase in criticized and adversely classified loans leads to higher non-performing loans, charge-offs or provision expense.
- Whether deposit mix and pricing stabilize as $443.2 million of time deposits mature within one year, and how this affects funding costs and margin.
- The actual effect of CECL adoption on the allowance, earnings and capital when the standard is implemented.
- How much of reported earnings growth is sustainable apart from tax-rate changes, BOLI death benefits and acquisition-related purchase accounting.
- The pace and price of post-year-end repurchases, and their effects on capital, tangible book value and share count.
- Regulatory approval and capacity for upstream Bank dividends, given the disclosed restrictions and the holding company’s reliance on subsidiary dividends.
The independent auditor issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2018.