Waterstone Financial, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; balance-sheet comparisons are to December 31, 2014. Amounts below are in millions unless stated otherwise. The company operates community banking, primarily in southeastern Wisconsin, and mortgage banking, originating residential loans mainly for sale in the secondary market.
Key financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net interest income | $9.9 | $10.9 | $29.4 | $31.2 |
| Noninterest income | $28.6 | $23.9 | $81.6 | $64.2 |
| Net income | $5.2 | $4.8 | $13.5 | $10.4 |
| Diluted EPS | $0.19 | $0.14 | $0.45 | $0.31 |
| Net interest margin, reported | 2.39% | 2.55% | 2.38% | 2.45% |
- Revenue and profit: Mortgage banking income was $26.7 million in Q3, up 21.1%, and $77.3 million for the nine months, up 31.6%. Mortgage originations rose 12.3% to $550.0 million in Q3 and 22.9% to approximately $1.5 billion year to date. Nine-month net income increased 29.6%; Q3 net income increased 9.1%.
- Margins and expenses: Q3 net interest income declined 9.2%, reflecting lower loan yields and higher deposit costs. Nine-month net interest margin was 2.38%, or 2.44% on a fully tax-equivalent basis. Noninterest expense increased 10.2% in Q3 and 12.6% year to date, led by compensation tied to mortgage production and 2015 equity awards.
- Cash flow: Nine-month operating cash flow was $7.8 million, versus cash used of $22.9 million a year earlier; investing cash flow was $8.2 million versus cash used of $103.3 million. Financing used $58.3 million, including $72.2 million for repurchases and $4.5 million in dividends. Cash and cash equivalents declined $42.4 million to $130.4 million.
- Balance sheet and funding: Total assets were $1.745 billion, down 2.2% from year-end. Net loans were $1.084 billion; loans held for sale were $141.8 million. Deposits were $873.2 million, up $9.2 million. Borrowings remained $434.0 million: $350.0 million of FHLB advances and $84.0 million of repurchase agreements, with a 3.89% weighted-average rate.
- Capital and liquidity: Shareholders’ equity was $390.6 million, down $59.6 million, primarily from share repurchases and dividends. The Bank exceeded regulatory capital requirements and was classified as well capitalized; reported capital ratios were substantially above minimums. Cash and available-for-sale securities totaled approximately $387.9 million.
Material changes and asset quality
- Net interest income fell while mortgage-related noninterest income rose; this shifted earnings contribution further toward mortgage banking. Mortgage banking segment net income was $2.8 million in Q3 versus $1.2 million, and $7.1 million year to date versus $2.3 million.
- At September 30, nonaccrual loans were $21.9 million, down from $38.0 million at year-end; nonperforming assets were $34.0 million versus $56.7 million. Past-due loans were $15.7 million versus $34.1 million.
- The allowance for loan losses declined to $16.9 million from $18.7 million, or 1.54% of loans. Nine-month provision rose to $1.7 million from $0.9 million, while net charge-offs fell to $3.5 million from $4.7 million. Management attributed the lower allowance and nonperforming balances to improved loan-quality measures and a stabilizing local real estate market.
- Real estate owned, net, declined to $12.2 million from $18.7 million. The company sold $17.3 million of properties and recorded $1.5 million of write-downs during the first nine months.
- The company repurchased approximately 5.55 million shares for an average $12.93 per share under its plans; $72.2 million was recorded as repurchases. A fourth plan was authorized in September, with 1,285,600 additional shares authorized for purchase at quarter-end.
Outlook, risks and unusual items
- No specific earnings or operating guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- Key stated risks include economic and competitive conditions, interest-rate changes, mortgage origination and secondary-market conditions, credit losses, regulatory changes, and the company’s ability to manage market, credit and operational risks. The loan portfolio is geographically concentrated in the Milwaukee area.
- Interest-rate simulation estimated that a gradual 100-basis-point increase would raise projected 12-month net interest income by 2.07%, while a 100-basis-point decline would reduce it by 1.31%. Management noted that actual prepayments may differ from assumptions.
- Time deposits of $443.2 million mature within one year. Management expects a significant portion to remain, but states retention is not assured and replacement funding could cost more or be unavailable on attractive terms.
- Off-balance-sheet commitments totaled $85.8 million, primarily loan and line-of-credit commitments. The filing reports no material expected losses on these commitments. Mortgage loan sale agreements include representations, warranties and limited recourse; historical repurchases and losses were described as insignificant.
- Other notable items: stock-based compensation expense was $2.3 million for the nine months, versus $0.1 million in 2014; the 2015 equity plan authorized up to 2.53 million options and 1.012 million restricted shares. Securities had $0.9 million of gross unrealized losses; management did not consider the identified declines other-than-temporary. No pending legal proceedings were expected to materially affect results, and disclosure controls were deemed effective.
Important facts for investors to verify
- Whether mortgage origination volumes and margins remain strong, and how commission-related expenses affect mortgage banking profitability.
- Whether net interest margin stabilizes as loan yields, deposit costs and interest rates change.
- Whether improvements in nonaccrual loans and past dues persist, and whether the reduced allowance remains adequate given charge-offs and collateral valuations.
- How the company funds the $443.2 million of time deposits due within a year and manages callable borrowings and other liquidity needs.
- The pace and price of further repurchases, and the effect of buybacks and dividends on capital, liquidity and per-share results.