WASHINGTON TRUST BANCORP INC quarterly report, Q3 FY2016

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Business context and reporting period

Washington Trust Bancorp, Inc. is a Rhode Island-based bank holding company providing commercial, residential and consumer banking and wealth management services in Rhode Island, eastern Massachusetts and Connecticut. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016; comparisons are to the same 2015 periods unless noted.

Financial performance and position

  • Profitability: Third-quarter net income was $12.3 million, or $0.72 diluted EPS, versus $10.2 million and $0.60. Nine-month net income was $34.3 million, or $1.99 diluted EPS, versus $32.7 million and $1.92. Third-quarter return on average assets/equity was 1.21%/12.57%; nine-month figures were 1.17%/11.86%.
  • Revenue and margins: Third-quarter net interest income rose 5% to $27.4 million; nine-month NII rose 5% to $81.9 million. Fully taxable equivalent net interest margin declined to 2.94% for the quarter and 3.07% year to date, from 3.07% and 3.13%. Noninterest income rose 24% to $17.3 million in the quarter and 11% to $47.8 million year to date, led by mortgage banking, wealth management and loan-related derivatives. Noninterest expense was $24.7 million for the quarter, nearly flat, and $76.1 million year to date, up 5%.
  • Credit costs: Provision for loan losses was $1.8 million for the quarter and $2.8 million year to date, compared with $0.2 million and $0.3 million. Management attributed the increase mainly to one commercial mortgage relationship. Nine-month net charge-offs were $4.2 million versus $1.2 million.
  • Balance sheet and funding: Total assets were $4.20 billion, up 11% from year-end 2015. Loans were $3.18 billion, up 6%; securities were $581.1 million, up 47%. Deposits increased 4% to $3.04 billion, while Federal Home Loan Bank advances rose 77% to $671.6 million. Shareholders’ equity was $395.3 million; total risk-based capital was 12.31%, and the Bank remained above well-capitalized regulatory thresholds.
  • Cash flow and liquidity: For the first nine months, operating cash flow was $28.3 million, investing cash outflow was $375.0 million, and financing cash inflow was $378.2 million. Cash and cash equivalents ended at $129.2 million, up $31.5 million. Management said liquidity remained within internal targets and funding sources were expected to meet anticipated needs. Available FHLB borrowing capacity was $611.4 million, in addition to a $40 million unused line.
  • Dividends: The company declared $0.37 per share for the quarter and $1.09 year to date, compared with $0.34 and $1.02 in 2015.

Material changes versus prior periods

  • Loan growth, particularly commercial real estate, and a larger securities portfolio supported higher net interest income, but lower asset yields reduced net interest margin. Management cited additions of lower-yielding securities and runoff of higher-yielding assets.
  • Commercial real estate loans increased 12% from year-end 2015; residential real estate loans increased 7%. Commercial and industrial loans declined 5%.
  • Nonperforming assets rose to $25.0 million, or 0.59% of assets, from $21.8 million, or 0.58%. Nonaccrual loans rose to $24.0 million from $21.0 million; past-due loans increased to 0.67% of loans from 0.58%.
  • Wealth management revenue increased 8% year to date, partly reflecting the 2015 Halsey acquisition; assets under administration reached $6.06 billion. Mortgage banking revenue increased 88% in the quarter and 18% year to date, reflecting higher volume and yield on loans sold.
  • The allowance for loan losses declined to $25.6 million, or 0.81% of loans, from $27.1 million, or 0.90%, at year-end. The company cited portfolio charge-offs and changes in estimated loss exposure.

Outlook, commentary, risks and unusual items

  • No specific earnings or revenue guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results. It planned a Coventry, Rhode Island branch opening in 2017; a Providence branch opened in January 2016 and a Wellesley mortgage office in July 2016.
  • Management described interest-rate exposure as within internal tolerance limits. Simulations showed estimated 12-month net interest income changes of -3.49% for a 100-basis-point rate decline and +2.72% for a 100-basis-point rise. The company warned that actual results may differ due to deposit behavior, balance-sheet changes and mortgage prepayments.
  • Credit concentration warrants attention: a troubled commercial mortgage relationship had a $6.4 million carrying value at quarter-end and incurred a $1.9 million third-quarter charge-off. Potential problem loans totaled approximately $6.8 million, primarily one commercial and industrial relationship described as well-secured and current.
  • Available-for-sale securities included $25.7 million fair value of trust preferred debt securities with $4.2 million in unrealized losses. Some holdings were below investment grade. Management expected full recovery and did not consider them other-than-temporarily impaired, but noted that further credit or market deterioration could result in write-downs.
  • 2016 year-to-date items were reported to increase diluted EPS by a net $0.04: a $589,000 tax-exempt life insurance gain (+$0.03 per share), $425,000 of severance expense (-$0.02), $431,000 of debt prepayment penalties (-$0.02), and a $939,000 non-taxable reduction in Halsey contingent consideration expense (+$0.05). The contingent consideration adjustment benefited third-quarter earnings.
  • Other risks identified include economic and financial-market weakness, interest-rate and funding changes, loan demand and credit quality, securities valuation, wealth management asset values, competition, and regulatory or accounting changes. Management said ordinary-course legal matters were not expected to materially affect financial position or results; it reported no material changes to the prior annual report’s risk factors.

Important facts for investors to verify

  1. Whether the elevated loan-loss provision and charge-offs remain concentrated in the disclosed commercial mortgage relationship, and how nonaccrual and past-due balances develop.
  2. Whether loan and securities growth can sustain net interest income as asset yields and net interest margin remain under pressure.
  3. The composition, cost and stability of funding, particularly the increase in FHLB advances and out-of-market brokered time deposits.
  4. The durability of earnings growth after excluding the BOLI gain, contingent consideration benefit, severance costs and debt prepayment penalty.
  5. Credit and valuation developments in below-investment-grade trust preferred securities, and any resulting impairment or capital effects.
  6. Whether liquidity, capital ratios and management’s interest-rate simulations remain resilient under changing market conditions.