Waterstone Financial, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. Figures below are in millions of dollars unless noted. The interim financial statements are unaudited.
Business context
Waterstone operates a community bank focused primarily on southeastern Wisconsin, alongside a mortgage banking subsidiary that originates residential mortgages for sale in the secondary market. The bank is the principal source of net interest income; mortgage banking generates most noninterest income and a majority of noninterest expense.
Key financial results
| Metric | Q1 2019 | Q1 2018 / prior date |
|---|---|---|
| Interest income | $19.2 | $17.0 |
| Net interest income | $12.9 | $13.1 |
| Net interest margin | 2.93% | 3.18% |
| Noninterest income | $24.3 | $25.2 |
| Noninterest expense | $29.3 | $30.1 |
| Net income | $6.5 | $7.0 |
| Diluted earnings per share | $0.24 | $0.25 |
| Operating cash flow | $17.8 | $19.8 |
Net income fell about 5.9%; basic EPS remained $0.25. The provision for loan losses was a credit of $0.7 million, compared with a $0.9 million credit a year earlier, reflecting management’s assessment of improving portfolio risk. Net charge-offs were $8,000.
At March 31, total assets were $1.93 billion, up $13.3 million from year-end. Loans held for investment were $1.38 billion, nearly unchanged; loans held for sale were $123.0 million, down $18.6 million. Cash and cash equivalents were $104.8 million, up $18.7 million. Deposits totaled $1.04 billion, down $1.2 million. Borrowings were $448.5 million, up $13.4 million, primarily from mortgage banking short-term financing. Shareholders’ equity was $384.5 million, down $15.2 million.
The allowance for loan losses was $12.6 million, or 0.91% of loans. Non-accrual loans were $6.8 million (0.49% of loans), versus $6.6 million at year-end; total nonperforming assets were $8.4 million (0.44% of assets), down from $8.7 million. No loans 90 days or more past due were still accruing.
The Bank’s regulatory capital ratios remained well above applicable requirements. At March 31, its total risk-based capital ratio was 27.39%, common equity Tier 1 ratio 26.53%, and Tier 1 leverage ratio 20.36%.
Changes and management commentary
- Net interest income decreased $205,000 as funding costs rose faster than asset yields. Average loan yield increased 21 basis points, but average deposit cost rose to 1.71% from 1.06%, and borrowing cost rose to 2.08% from 1.61%.
- Mortgage banking income decreased 3.4% to $23.4 million. The mortgage segment’s net income declined to $719,000 from $1.1 million. Management cited lower mortgage production, a 1.3% decline in gross margin on loans sold, and intensified price competition. Purchase loans represented 89.9% of originations, compared with 85.1% a year earlier.
- Total noninterest expense declined 2.6%, partly reflecting lower compensation, real-estate-owned costs, and loan-processing expense. Branch closures reduced mortgage-segment salaries and occupancy costs; advertising and data-processing costs increased.
- Shareholders’ equity was reduced by declared regular and special dividends and share repurchases. The equity statement reports a $0.62-per-share dividend. The company repurchased about 482,000 shares for approximately $8.0 million during the quarter; 230,300 shares remained authorized under its current program at quarter-end.
Liquidity, risks, and unusual items
- Cash from operating activities was $17.8 million; cash increased $18.7 million to $104.8 million during the quarter. The company cited loan-sale proceeds and additional short-term borrowing among the principal cash sources. Deposit maturities are a funding consideration: $564.4 million of time deposits were scheduled to mature within one year.
- FHLB advances totaled $430.0 million, with contractual maturities in 2027 and 2028, although several advances have earlier call dates. Mortgage banking also had an $18.5 million repurchase-agreement balance against a $35.0 million commitment.
- Off-balance-sheet credit commitments totaled $112.6 million, principally unused construction-loan commitments of $71.3 million. Management reported no probable losses on commitments or standby letters of credit.
- Interest-rate simulation estimated that an immediate 100-basis-point increase would reduce projected one-year net interest income by 0.65%; a 100-basis-point decrease would increase it by 2.18%. Management cautioned that actual sensitivity depends in part on mortgage prepayment behavior.
- The company adopted lease accounting guidance on January 1, 2019. It recorded $9.8 million in lease liabilities and $9.3 million in right-of-use assets; approximately $0.4 million of additional lease assets and liabilities were expected when leases commenced in Q2.
- In the Herrington employment case, a prior arbitration award and related judgment totaling more than $10 million were vacated by the district court on April 25, 2019, after the quarter ended. The company recorded no accrual, but said claimants could reassert claims in individual arbitration and that any potential loss could not then be estimated. A separate Werner matter was settled; the filing says its amount would not materially affect the financial statements.
- No specific earnings or financial guidance is provided. Risks identified include interest-rate and margin changes, deposit competition and retention, mortgage-market conditions and pricing, credit quality, economic conditions, regulatory changes, and operational and technology risks. Management stated that risk factors were not materially changed from its 2018 Form 10-K.
Investor verification points
- Track whether higher deposit and borrowing costs continue to pressure net interest margin and earnings.
- Verify mortgage origination volume, gain-on-sale margins, and mortgage-segment profitability amid pricing competition.
- Monitor non-accrual loans, impaired credits, collateral values, and the adequacy of the allowance, especially given the geographic concentration in the Milwaukee area.
- Assess the retention and repricing of the $564.4 million of time deposits due within one year, and the company’s reliance on FHLB and short-term mortgage funding.
- Follow developments in the Herrington claims and confirm whether any new arbitration or loss accrual arises.
- Review the effects of dividends and ongoing repurchases on holding-company liquidity and capital, alongside the company’s stated strong regulatory capital ratios.