Waterstone Financial, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are against December 31, 2017. Unaudited consolidated results cover WaterStone Bank and Waterstone Mortgage Corporation. The company operates community banking, primarily in southeastern Wisconsin, and mortgage banking across 23 states.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net interest income | $13.1 million | $11.9 million |
| Net interest margin | 3.18% (3.20% tax-equivalent) | 2.97% (3.02% tax-equivalent) |
| Noninterest income | $25.2 million | $25.9 million |
| Noninterest expenses | $30.1 million | $29.1 million |
| Income before taxes | $9.1 million | $10.0 million |
| Net income | $7.0 million | $6.6 million |
| Basic and diluted EPS | $0.25 | $0.24 |
| Annualized return on average assets / equity | 1.57% / 6.90% | 1.54% / 6.44% |
Net interest income rose 10.5%, reflecting loan growth and lower borrowing costs; the reported spread increased to 2.88% from 2.64%. The allowance release was $880,000, versus a $1.2 million release in Q1 2017. Net income increased despite lower pretax income, primarily as the effective tax rate fell to 23.2% from 34.2%, mainly following the federal corporate tax rate reduction.
Mortgage banking income was $24.2 million, down 2.0% year over year; management cited a roughly 6.2% decline in mortgage margins. Mortgage originations for sale were $489.2 million in the cash-flow and loan disclosures. Compensation and benefits rose 4.9%, while total noninterest expenses increased 3.7%.
Financial position, liquidity and capital
- Total assets were $1.84 billion, up 1.8% from year-end. Loans held for investment grew $22.9 million to $1.31 billion; loans held for sale declined $22.3 million to $127.6 million.
- Cash and cash equivalents increased $34.8 million to $83.4 million. Operating cash flow was $19.8 million, compared with $105.3 million in Q1 2017; mortgage loan originations and sales make the period-to-period cash-flow comparison sensitive to timing and volume.
- Deposits totaled $974.2 million, up $6.8 million. Borrowings were $434.4 million, up $48.1 million, including $415.0 million of FHLB advances. Time deposits of $522.6 million were scheduled to mature within one year.
- Shareholders’ equity was $397.4 million, down $14.7 million. The company cited dividends, share repurchases and a decline in securities’ fair value as primary factors. Q1 cash dividends were $17.2 million; the equity statement reports a $0.62-per-share dividend.
- The allowance for loan losses was $13.2 million, or 1.00% of loans, down from $14.1 million and 1.09% at year-end. Net charge-offs were $7,000. Non-accrual loans increased to $6.6 million (0.50% of loans) from $6.1 million (0.47%); total past-due loans rose to $6.9 million from $5.9 million.
- WaterStone Bank was described as well capitalized. At March 31, its total capital ratio was 27.85%, Tier 1 risk-based capital was 26.89%, and Tier 1 leverage was 20.67%.
Material changes, outlook and risks
- Loan growth, higher average loan yields and a lower average cost of borrowings supported improved net interest income. Time-deposit costs rose 26 basis points year over year, and management noted competitive pressure on deposit pricing.
- Mortgage production increased, but lower margins weighed on mortgage banking income and segment net income. The filing gives no formal earnings or revenue guidance; management cautions that quarterly results are not necessarily indicative of full-year results.
- Interest-rate sensitivity analysis estimated that an instantaneous 100-basis-point rate increase would raise forecast 12-month net interest income by 0.90%, while a 100-basis-point decrease would reduce it by 2.72%. Actual results may differ, including due to mortgage prepayment behavior.
- Available-for-sale securities had $3.8 million of gross unrealized losses at quarter-end, versus $1.6 million at year-end. Management attributed declines in securities held at a loss for 12 months or longer primarily to higher market rates, not credit deterioration, and said it did not expect to be forced to sell before recovery. Further economic deterioration could cause impairment losses.
- Herrington litigation: A court judgment against the mortgage subsidiary was being appealed, with execution stayed. The possible loss was estimated at $0 to $11.0 million; management did not consider a loss probable and recorded no accrual.
- Werner litigation: The FLSA case remained at an early stage. The court denied conditional certification and notice; the company could not estimate a possible loss.
- Other stated risks include economic and competitive conditions, interest rates, credit quality, secondary mortgage-market conditions, regulation, cybersecurity and technology. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Progress and potential financial impact of the Herrington appeal, and developments in the Werner case.
- Whether mortgage origination volume and margins stabilize, and how the mortgage segment’s profitability responds.
- Credit trends: past-due and non-accrual loan increases, troubled debt restructurings, and the adequacy of the allowance after its reduction.
- Deposit retention and repricing, particularly the $522.6 million in time deposits maturing within one year, and the cost and availability of replacement funding.
- Interest-rate exposure and changes in securities’ unrealized losses or impairment assessments.
- The filing reports mortgage originations for sale of $489.2 million in some disclosures but $516.0 million in the mortgage-segment discussion; verify the difference in scope or presentation. Also confirm the treatment and sustainability of the reported $0.62-per-share dividend.