Waterstone Financial, Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017. Waterstone Financial operates a community bank serving southeastern Wisconsin and a mortgage banking subsidiary originating residential mortgages for sale in 24 states. Results include the community banking and mortgage banking segments. Unless stated otherwise, amounts below are in U.S. dollars.
Key financial results
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total assets at year-end | $1.806 billion | $1.791 billion | +0.9% |
| Net interest income | $50.7 million | $43.4 million | +16.8% |
| Net interest margin | 3.00% | 2.64% | +0.36 percentage points |
| Noninterest income | $124.4 million | $126.4 million | -1.5% |
| Noninterest expense | $131.9 million | $127.4 million | +3.5% |
| Income before taxes | $44.4 million | $42.0 million | +5.8% |
| Net income | $26.0 million | $25.5 million | +1.7% |
| Diluted earnings per share | $0.93 | $0.93 | Flat |
| Return on average assets / equity | 1.43% / 6.32% | 1.45% / 6.33% | Both slightly lower |
| Cash and cash equivalents at year-end | $48.6 million | $47.2 million | +$1.4 million |
| Loans held for investment, gross | $1.292 billion | $1.178 billion | +$113.9 million |
| Deposits at year-end | $967.4 million | $949.4 million | +1.9% |
| Borrowings at year-end | $386.3 million | $387.2 million | -$0.9 million |
| Shareholders’ equity at year-end | $412.1 million | $410.7 million | +0.3% |
Cash flow, liquidity, and capital
- Cash flow from operating activities was $107.1 million, investing activities used $94.9 million, and financing activities used $10.8 million. Cash and cash equivalents increased $1.4 million during the year.
- Regulatory liquidity ratios at year-end were 8.06% for primary liquidity and 18.82% for total regulatory liquidity; the Bank reported compliance with its requirements.
- Borrowings included $375.0 million of Federal Home Loan Bank advances and $11.3 million of short-term repurchase agreements. The advances had a weighted average rate of 2.38%; $100 million matured within 12 months and another $100 million was putable within 12 months at the FHLB’s option.
- The Bank was reported as well-capitalized: total risk-based capital was 28.93%, common equity Tier 1 was 27.92%, and Tier 1 leverage was 21.10%.
- Of $688.98 million in certificates of deposit, $587.32 million matured within one year. Outstanding loan commitments and unfunded credit commitments totaled approximately $80.7 million.
Material changes versus the prior year
- Net interest income rose as average loan balances increased and the cost of borrowings fell. Average borrowing cost declined to 2.14% from 3.39%; total interest expense fell by $3.9 million despite higher deposit costs.
- Community banking net income increased to $16.4 million from $14.0 million. Mortgage banking net income declined to $9.6 million from $12.3 million.
- Mortgage originations increased 3.3% to $2.46 billion, but mortgage banking income fell 0.8% to $120.0 million as margins declined approximately 3.3%. Purchase originations grew, while refinance originations fell 31.6%.
- Asset quality improved overall: nonaccrual loans decreased 38.4% to $6.1 million; nonperforming assets fell to $10.6 million from $16.0 million; and troubled debt restructurings decreased to $5.1 million from $10.1 million.
- The allowance for loan losses declined to $14.1 million from $16.0 million, and the Company recorded a negative provision of $1.2 million versus a $0.4 million provision in 2016. Net charge-offs nevertheless increased to $786,000 from $536,000.
- Mortgage loans held for sale fell 33.5% to $149.9 million, while securities available for sale declined $27.1 million to $199.7 million, primarily reflecting paydowns and maturities.
Outlook, risks, contingencies, and unusual items
- The filing provides no numerical earnings or revenue guidance. Management describes plans to grow commercial business, commercial real estate, and multifamily lending, while seeking lower-cost transaction deposits and managing interest-rate exposure.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate from 35% to 21%. Revaluation of deferred tax assets produced a one-time fourth-quarter 2017 tax expense of approximately $2.7 million. The reported effective tax rate was 41.6%, compared with 39.2% in 2016.
- Fourth-quarter net income was $3.1 million, down from $6.4 million a year earlier. Fourth-quarter income tax expense was $6.1 million, including the deferred-tax revaluation; pretax income was $9.2 million versus $10.6 million.
- A class-action wage case against Waterstone Mortgage resulted in a judgment confirmed largely by the district court. The judgment is on appeal, with execution stayed. The Company estimated a possible loss range of $0 to $11 million, judged the loss not probable, and recorded no accrual. A separate wage lawsuit was at an early stage; the Company could not estimate its likelihood or possible loss.
- Key exposures include interest-rate movements, deposit competition and certificate maturities, mortgage origination margins and secondary-market access, real-estate concentration, credit losses, regulatory change, cybersecurity and third-party service-provider risks.
- The Company identified expected-credit-loss accounting (CECL) as a forthcoming change that could increase the allowance and implementation costs; it was evaluating the impact. The audited financial statements received an unqualified opinion, and the auditor reported effective internal control over financial reporting.
Important facts for investors to verify
- Track whether loan growth—particularly in multifamily and commercial real estate—continues without deterioration in delinquencies, nonaccruals, charge-offs, or collateral values.
- Review the size and timing of certificate maturities and FHLB advance maturities or call options, and how funding costs respond to higher rates.
- Assess whether mortgage banking margins and segment profitability stabilize as the purchase/refinance mix and mortgage-market conditions change.
- Follow the appeal and any subsequent accrual or payment in the Herrington case, as well as developments in the Werner matter.
- Separate recurring earnings from the $2.7 million tax revaluation charge and the unusually high 2017 dividend of $0.98 per share, which included a special dividend; the reported dividend payout ratio was 103.16%.
- Monitor implementation of CECL and any resulting change in reserves, earnings, or capital.