Waterstone Financial, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Dollar amounts are in millions unless otherwise noted. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking, originating residential loans for sale in the secondary market.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $13.9 | $13.0 | $40.7 | $37.4 |
| Mortgage banking income | $32.7 | $31.9 | $88.9 | $92.8 |
| Total noninterest income | $34.1 | $33.1 | $92.6 | $96.2 |
| Noninterest expense | $36.4 | $34.3 | $101.3 | $99.6 |
| Income before taxes | $11.4 | $11.8 | $33.0 | $35.2 |
| Net income | $8.7 | $7.4 | $25.1 | $22.8 |
| Diluted EPS | $0.31 | $0.26 | $0.90 | $0.82 |
- Q3 net income rose about 18%; nine-month net income rose about 10%. Lower income tax expense supported the increases: the effective tax rate was 24.0% in Q3 and 24.1% year to date, versus 37.1% and 35.2%, respectively, in 2017. The lower federal rate followed the Tax Cuts and Jobs Act.
- Net interest margin was 3.07% in Q3, up from 2.95%, and 3.13% for the nine months, up from 2.97%. Higher average loan balances and yields helped; higher deposit costs partially offset the benefit.
- Mortgage origination volume increased 11.2% in Q3 and 2.7% year to date, but mortgage margins declined approximately 10%. Nine-month mortgage banking income fell 4.1%, and mortgage segment net income declined to $6.1 million from $8.3 million.
- Annualized return on average assets was 1.80% in Q3 and for the nine-month period (2017: 1.56% and 1.70%). Return on average equity was 8.48% in Q3 and 8.25% year to date (2017: 7.12% and 7.42%).
Financial condition, cash flow and capital
- At September 30, total assets were $1.92 billion, up 6.3% from year-end 2017. Loans held for investment were $1.36 billion, up $65.8 million; loans held for sale were $192.7 million, up $42.8 million. Available-for-sale securities declined $20.6 million to $179.1 million.
- Deposits totaled $1.00 billion, up $37.1 million. Borrowings rose $64.8 million to $451.1 million, including $430.0 million of long-term FHLB advances. Total shareholders’ equity was $404.6 million, down $7.5 million, reflecting dividends, repurchases and securities valuation losses, partly offset by earnings.
- Cash and cash equivalents were $58.9 million, compared with $48.6 million at year-end. Nine-month operating cash flow was negative $23.7 million, versus positive $73.5 million in 2017; investing cash flow was negative $49.2 million, while financing provided $83.2 million. Cash increased $10.2 million over the period. Mortgage loan origination and sale volumes substantially affect reported operating cash flows.
- The allowance for loan losses was $13.2 million, or 0.97% of loans, versus $14.1 million and 1.12% at year-end. The company recorded a $1.1 million negative provision and $209,000 in net recoveries for the nine months, citing improvement in the portfolio’s risk profile.
- Bank nonaccrual loans were $6.5 million, 0.48% of loans, versus $6.1 million and 0.47% at year-end. Total past-due loans rose to $9.1 million from $5.9 million; nonperforming assets fell to $8.7 million from $10.6 million, mainly as real estate owned declined.
- WaterStone Bank reported regulatory capital ratios above applicable thresholds and was classified as well capitalized. At September 30, its total risk-based capital ratio was 27.01% and common equity Tier 1 ratio was 26.10%. The company paid $23.8 million in cash dividends and repurchased $9.4 million of shares during the first nine months.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Management identifies interest-rate movements, competition for deposits, mortgage market conditions and margins, credit quality, economic conditions, regulatory changes, cybersecurity, and integration of acquired operations among material risks. A 100-basis-point rate increase was modeled to raise one-year net interest income by 0.72%; a 100-basis-point decrease was modeled to reduce it by 1.29%.
- Mortgage banking added New Mexico branches in the second quarter and acquired an Academy Mortgage branch on June 29 for approximately $0.6 million. Management attributed higher mortgage expenses partly to the expanded branch network.
- In the Herrington employment-related case, the Seventh Circuit on October 22, 2018 vacated the district court order enforcing an arbitration award. The filing describes possible loss of $0–$11 million, says loss was not considered probable, and records no accrual. Further proceedings could reinstate the award or result in individual arbitration. A separate Werner case remains unresolved; the company says it cannot estimate the likelihood or range of loss.
- Available-for-sale securities had $5.2 million of gross unrealized losses at September 30, compared with $1.6 million at year-end. Management attributed the losses primarily to higher market rates rather than credit deterioration and said it did not expect to sell the securities before recovery; further market deterioration could lead to impairment losses.
- $509.3 million of time deposits were scheduled to mature within one year. Management expects a significant portion to remain, but notes that replacement funding could cost more or may not be available on attractive terms.
Investor verification points
- Track mortgage origination margins and volumes, especially whether margin pressure persists as demand and competition change.
- Monitor deposit retention, repricing and the $509.3 million of near-term time-deposit maturities, alongside increased borrowing costs and reliance on FHLB funding.
- Review loan delinquencies, nonaccrual trends, collateral valuations, allowance adequacy and the effects of any continued real-estate weakness.
- Follow the Herrington case after the appellate ruling and assess potential financial exposure; also monitor developments in Werner.
- Assess the impact of ongoing share repurchases and dividends on equity, liquidity and capital, and whether the new branches contribute adequately to mortgage profitability.