Waterstone Financial, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; comparisons are primarily with 2012. The company operates a Wisconsin community bank and a multistate mortgage-banking business. The figures reflect the pre-conversion company; the mutual-to-stock conversion and public offering closed on January 22, 2014.
Financial performance and position
| Metric | 2013 | 2012 |
|---|---|---|
| Total assets at year-end | $1.947 billion | $1.661 billion |
| Net interest income | $39.2 million | $41.9 million |
| Provision for loan losses | $4.5 million | $8.3 million |
| Noninterest income | $87.8 million | $91.2 million |
| Noninterest expense | $99.1 million | $102.1 million |
| Income before taxes | $23.3 million | $22.7 million |
| Net income | $14.7 million | $34.9 million |
| Basic and diluted EPS | $0.43 | $1.02 |
| Net interest margin | 2.56% | 2.62% |
| Return on average assets / equity | 0.90% / 7.01% | 2.07% / 18.89% |
2013 net income was lower despite higher pretax income, chiefly because 2012 included a $12.2 million income tax benefit, largely from reversing deferred-tax valuation allowances. 2013 tax expense was $8.6 million (37.0% effective rate). The filing’s audited statements report 2012 net income of $34.9 million; an inconsistent MD&A passage gives $39.4 million.
- Mortgage banking: Loans originated for sale were approximately $1.75 billion, roughly flat year over year. Mortgage banking segment revenue was $84.9 million, down 3.5%; segment pretax income fell to $9.1 million from $19.2 million as margins declined and operating expenses rose. A $2.6 million gain on sale of mortgage servicing rights partly offset weaker loan-sale economics.
- Loans and credit: Net loans held for investment were $1.068 billion, down 3.1%; the portfolio was concentrated in one- to four-family and multifamily residential real estate. Nonaccrual loans declined to $51.0 million (4.66% of loans) from $74.7 million (6.59%). Nonperforming assets fell to $73.6 million (3.78% of assets) from $110.6 million (6.66%). Net charge-offs increased to $11.3 million from $9.7 million. The allowance was $24.3 million, 2.22% of loans and 47.61% of nonperforming loans.
- Liquidity, deposits and borrowings: Cash and cash equivalents were $429.2 million versus $71.5 million; year-end cash and deposits included $388.7 million of stock-subscription funds awaiting the January 2014 conversion close. Deposits totaled $1.245 billion, up 32.5%, while borrowings were $455.2 million, down 5.1%. Borrowings included $350.0 million of FHLB advances, $84.0 million of securities-backed repurchase agreements and $21.2 million of short-term mortgage-funding repurchase agreements. Of $637.8 million in certificates of deposit, $505.8 million matured within one year.
- Cash flow: Operating activities provided $52.3 million; investing activities provided $24.1 million; financing activities provided $281.3 million. Cash increased $357.7 million, substantially reflecting the offering-related subscription funds held at year-end.
- Capital: WaterStone Bank was categorized as well capitalized. At year-end its Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 12.48%, 20.41% and 21.67%, respectively.
Material changes and management commentary
- Net interest income decreased 6.5%, as lower asset yields and a smaller average earning-asset base more than offset lower funding costs; the net interest margin declined six basis points.
- Management attributed lower loan-loss provisioning and real-estate-owned expense to improving credit measures and stabilization in the local real estate market. Real estate owned fell 37% to $22.7 million; property sales totaled $25.7 million and generated a reported net gain of $2.8 million.
- Mortgage banking experienced weaker margins after mortgage rates rose during 2013, reducing refinance demand. The company reduced support staffing in the fourth quarter after anticipated origination growth did not materialize. The federal government shutdown also delayed some loan closings and sales.
- The public offering sold 25.3 million shares at $10 per share; approximately $248 million of net proceeds were reported. The company stated it planned to use funds for general corporate purposes, including lending and possible branch expansion, but had not allocated most proceeds to specific uses. The offering materially increased liquidity and capital, while management cautioned that higher equity could weigh on return on equity until proceeds are deployed.
Outlook, risks and unusual items
- Management intended, subject to regulatory approval, to open six full-service branches by the end of 2016, two each in 2014, 2015 and 2016. It warned that new branches may take time to become profitable.
- The board declared a $0.05-per-share dividend on March 18, 2014, payable April 11, 2014. Future dividends remain subject to financial, capital, regulatory and other constraints. A liquidation-account requirement can limit dividends from the Bank to the holding company.
- Key risks include interest-rate and mortgage-market volatility, continued credit losses and collateral-value changes, concentration in real estate lending and the Milwaukee-area economy, reliance on certificates of deposit and FHLB funding, mortgage-loan repurchase claims, competition, regulatory costs, and execution of the offering-proceeds deployment plan.
- At year-end, the Bank had $9.6 million of loan commitments and $34.4 million of unfunded construction, credit-line and standby-letter-of-credit commitments. Management reported no probable losses on these commitments. The company reported no material adverse legal proceedings.
- Prior regulatory actions were terminated: the Bank’s memorandum of understanding ended in November 2013. Separate Federal Reserve Board resolutions for the former holding company required prior written approval for specified dividends, debt increases and stock redemptions; management warned noncompliance could prompt further action. New regulatory capital rules were scheduled to take effect for the Bank on January 1, 2015.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective. The filing notes estimates—especially loan-loss allowances and collateral valuations—are judgmental and could change.
Important facts for investors to verify
- Reconcile the $388.7 million of year-end subscription funds and related deposits/cash with the January 2014 offering close and the reported approximately $248 million of net proceeds.
- Track whether credit improvement continues: nonaccrual loans and troubled debt restructurings declined, but net charge-offs rose and real-estate lending remains concentrated.
- Assess the sustainability of mortgage banking earnings after the 2013 margin decline, reduced refinance demand, staffing adjustments and the one-time servicing-rights sale gain.
- Monitor how offering proceeds are deployed, the resulting returns on equity, planned branch openings and the company’s capacity to pay dividends under regulatory and liquidation-account limits.
- Review the maturity and renewal profile of certificates of deposit, callable FHLB advances and repurchase agreements, alongside sensitivity to changing interest rates.