WASH

Business Context and Reporting Period

Company: Washington Trust Bancorp, Inc. (and subsidiary, The Washington Trust Company of Westerly)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2001
Business Overview: A Rhode Island-based financial institution engaged in commercial and consumer banking, trust and investment management, and mortgage banking activities.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability: Net income for the six months ended June 30, 2001, decreased to $4.0 million from $5.8 million in the prior year. This decline was primarily driven by a $4.8 million litigation settlement recorded in the first quarter of 2001. On an "operating earnings" basis (excluding the settlement), earnings increased 12.1% year-over-year.
• Net Interest Margin: The net interest margin (FTE) declined to 3.28% for the six months ended June 30, 2001, from 3.58% in the prior year. This was caused by a 14 basis point decline in earning asset yields and a 15 basis point increase in the cost of interest-bearing liabilities.
• Expense Growth: Total noninterest expenses rose to $23.5 million for the six-month period, compared to $19.3 million in 2000. Excluding the litigation settlement and prior-year acquisition costs, operating expenses increased modestly, driven largely by a 3.5% rise in salaries and employee benefits.
• Balance Sheet: Total assets grew 8.5% to $1.321 billion. Securities available for sale increased significantly to $475.9 million, aided by a reclassification of $42.6 million from "held to maturity" under new accounting standards (SFAS 133). FHLB borrowings increased by $81.5 million to fund asset growth.

Guidance, Outlook, and Risks

• Outlook: Management does not expect the elevated level of mortgage banking revenues seen in the first half of 2001 to continue in the second half, as refinancing activity is tied to falling interest rates. Trust and investment management revenue growth has slowed due to declines in the market value of assets under administration.
• Litigation Contingency: A $4.8 million settlement regarding a 1997 embezzlement suit was finalized in May 2001. The Bank expects to receive an insurance recovery of $775,000 (approx. $553,000 net of tax) in the third quarter of 2001.
• Market Risk: Interest rate sensitivity analysis indicates that a 200 basis point increase in rates would result in a 0.90% decrease in net interest income over the next 12 months. A 200 basis point rise in rates would also decrease the market value of available-for-sale debt securities by 4.9%.
• Capital: The Corporation remains "well-capitalized" with a Tier 1 risk-based capital ratio of 12.05% and a total risk-adjusted capital ratio of 13.67%.

Investor Verification Checklist

• Operating Earnings: Verify the $3.3 million net-of-tax litigation settlement impact to understand core profitability trends versus reported GAAP net income.
• Insurance Recovery: Monitor the third quarter 2001 financials for the expected $553,000 net insurance recovery related to the Maxson litigation.
• Mortgage Banking Revenue: Assess second-half performance given management's explicit caution that first-half mortgage banking revenue levels are not sustainable.
• Interest Rate Sensitivity: Review the impact of the 3.28% net interest margin compression and the cost of funds increase on future profitability in a rising rate environment.
• Asset Quality: Note that nonperforming assets remain low at 0.27% of total assets, but verify the $2.5 million in impaired commercial loans and the adequacy of the $13.6 million allowance for loan losses.