Waterstone Financial, Inc. — Q1 2017 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking through Waterstone Mortgage, which originates residential loans for sale in the secondary market. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and condition
- Revenue and earnings: Interest income was $15.8 million and noninterest income was $25.9 million, for combined interest and noninterest income of $41.7 million, up from $37.0 million in Q1 2016. Net income rose 70% to $6.6 million from $3.9 million; diluted EPS was $0.24 versus $0.14.
- Net interest income and margins: Net interest income increased 19% to $11.9 million. The reported net interest margin was 2.64%, versus 2.06%; on a fully tax-equivalent basis it was 3.02%, versus 2.54%. Lower borrowing costs were the principal driver.
- Mortgage banking: Mortgage banking income increased 19.8% to $24.7 million. Originations for sale were $481.3 million, up 29.7% year over year. Management cited higher volume, partly offset by lower margins, and a $0.3 million gain on a bulk sale of mortgage servicing rights.
- Credit costs and asset quality: The company recorded a $1.2 million provision credit, compared with a $0.2 million provision expense in Q1 2016. The allowance for loan losses fell to $14.7 million, or 1.23% of loans, from $16.0 million and 1.42%. Nonaccrual loans declined to $8.0 million (0.67% of loans) from $9.9 million; nonperforming assets were $13.1 million, down from $16.0 million. Net charge-offs were $88,000.
- Expenses and profitability: Noninterest expense rose 15.2% to $29.1 million, led by compensation and other expenses associated with mortgage origination. Annualized return on average assets was 1.54% versus 0.90%; return on average equity was 6.44% versus 3.95%. The effective tax rate was 34.2%, compared with 35.7%; Q1 2017 included an approximately $350,000 tax benefit related to stock awards.
- Cash flow: Operating activities provided $105.3 million, investing activities used $10.6 million, and financing activities used $67.3 million. Cash and cash equivalents increased $27.4 million to $74.6 million. Mortgage loan sale proceeds were $608.5 million; loan originations for sale were $481.3 million.
- Balance sheet and funding: Total assets declined 3.5% to $1.73 billion, mainly reflecting lower loans held for sale. Portfolio loans rose to $1.19 billion from $1.18 billion; securities available for sale fell to $222.1 million from $226.8 million. Deposits were $946.0 million, down $3.4 million. Borrowings declined $52.4 million to $334.8 million. Shareholders’ equity increased to $415.1 million from $410.7 million.
- Liquidity and capital: The holding company reported $37.6 million of liquid assets on an unconsolidated basis. The Bank was reported as well capitalized; its total risk-based capital ratio was 30.48%, and common equity Tier 1 was 29.33%. Time deposits of $510.7 million were scheduled to mature within one year.
Material changes versus the prior comparable period
- Net income increased by $2.7 million, reflecting stronger net interest income, mortgage banking income and a provision credit.
- Interest expense on borrowings fell by $1.8 million, primarily after $220 million of higher-rate FHLB borrowings matured in 2016. Deposit interest expense increased modestly.
- Mortgage originations for sale increased $110.1 million year over year, while management reported a decrease in mortgage banking margin.
- Noninterest expense increased $3.8 million; compensation rose $2.3 million, largely with mortgage volume and commission-based pay. Real estate owned write-downs increased to $455,000 from $130,000.
- Compared with year-end 2016, total borrowings decreased $52.4 million, cash and cash equivalents increased $27.4 million, and nonperforming assets declined $2.9 million.
Outlook, risks, contingencies and unusual items
- Guidance: The filing provides no specific earnings or operating guidance. Management cautions that first-quarter results are not necessarily indicative of full-year results.
- Interest-rate risk: The company’s simulation estimated that an immediate 100-basis-point rate increase would raise projected one-year net interest income by 1.72%; a 100-basis-point decrease would lower it by 4.17%. Actual results depend on repricing and mortgage prepayment behavior.
- Credit and geographic risk: Lending is concentrated in the Milwaukee metropolitan area, particularly residential and commercial real estate. Management cited improving credit indicators but noted that higher-than-expected defaults or property-value declines could require future provisions or charge-offs.
- Funding risk: Management noted that deposit retention at renewal is not assured and that replacement funding may be more costly or unavailable on attractive terms. Several FHLB advances and repurchase agreements are callable before maturity.
- Legal contingency: On April 13, 2017, after quarter-end, an arbitrator issued a partial liability award against Waterstone Mortgage in a wage-and-expense class action. Damages had not been determined; the company estimated a possible award, including fees and costs, of up to $10.0 million. It intends to challenge the findings and recorded no accrual, stating it did not believe a plaintiff recovery was probable.
- Other items: Mortgage banking derivatives are used to manage interest-rate exposure, not for speculation, and are not designated as accounting hedges. The company also disclosed approximately $80.3 million of lending commitments and standby letters of credit; it reported no probable losses on these commitments.
Important facts for investors to verify
- Track whether mortgage origination volumes and margins sustain the increase in mortgage banking income, and whether related expenses grow proportionately.
- Monitor the resolution and potential damages in the arbitration, including any subsequent accrual, appeal, or settlement developments.
- Assess whether the $1.2 million provision credit and lower allowance remain appropriate as loan growth, delinquencies, and collateral values evolve.
- Review upcoming time-deposit maturities, callable borrowings, and the cost and availability of replacement funding.
- Compare actual net interest income and funding costs with the disclosed interest-rate sensitivity estimates.
- Confirm the status of share repurchases and dividends, and consider the effect of the reported stock-award tax benefit on comparability.