Waterstone Financial, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone fourth-quarter filing. The company operates community banking and mortgage banking businesses; its bank is concentrated in southeastern Wisconsin, while its mortgage subsidiary operates across multiple states.
Financial performance and condition
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total assets at year-end | $2.00 billion | $1.92 billion | +4.2% |
| Net interest income | $52.2 million | $54.2 million | −3.7% |
| Net interest margin | 2.83% | 3.09% | −26 basis points |
| Noninterest income | $130.8 million | $118.2 million | +10.6% |
| Noninterest expense | $136.3 million | $133.2 million | +2.3% |
| Net income | $35.9 million | $30.8 million | +16.7% |
| Diluted EPS | $1.37 | $1.11 | +23.4% |
| Return on average assets / equity | 1.82% / 9.14% | 1.64% / 7.60% | Both improved |
- Revenue drivers and margins: Mortgage banking income rose to $125.7 million as mortgage originations increased about 12.5% to approximately $2.9 billion. Refinance volume rose sharply as rates fell, but mortgage gross margin declined about 1.9%, reflecting the higher refinance mix and stronger price competition. Community banking net income was $24.6 million, slightly below 2018; mortgage banking net income increased to $11.2 million from $5.8 million.
- Interest costs: Interest expense increased $8.0 million, outpacing the $6.0 million increase in interest income. Higher deposit and borrowing costs reduced net interest income and margin.
- Loans and credit: Loans held for investment were $1.39 billion, up 0.6%; construction and land loans rose to $37.0 million and commercial real estate loans to $236.7 million. The allowance for loan losses fell to $12.4 million, or 0.89% of loans, following a $0.9 million negative provision. Nonaccrual loans rose to $7.0 million (0.51% of loans) from $6.6 million; nonperforming assets declined to $7.8 million from $8.7 million.
- Liquidity, deposits, and debt: Cash and equivalents were $74.3 million, down from $86.1 million. Deposits were $1.07 billion, up 2.8%; certificates of deposit made up 69.3% of customer deposits, and $665.7 million matured within one year. Borrowings totaled $483.6 million, including $470.0 million of FHLB advances and $13.6 million under repurchase agreements. Regulatory primary and total liquidity ratios were 10.9% and 21.7%, respectively.
- Capital and shareholder returns: Shareholders’ equity was $393.7 million, down 1.5%, primarily from dividends and share repurchases. The bank reported a 22.85% total risk-based capital ratio and was classified as well-capitalized. The company declared $0.98 per share in dividends and repurchased $22.8 million of stock during the year.
- Cash flow: Operating activities used $40.2 million, versus providing $42.9 million in 2018; investing activities used $1.2 million, and financing activities provided $29.6 million. The filing’s cash-flow presentation is substantially affected by the high-volume mortgage-loan origination and sale business. Cash and equivalents declined $11.8 million over the year.
Material changes versus 2018
- Net income increased $5.1 million, supported mainly by higher mortgage banking income and lower loan-loss provision; this outweighed lower net interest income and higher expenses.
- Mortgage loans held for sale increased 55.4% to $220.1 million, while loans held for investment grew only 0.6%.
- Deposits rose $29.3 million and borrowings rose $48.5 million. The average cost of interest-bearing liabilities increased, adding pressure to the spread and margin.
- Nonperforming assets improved as real estate owned, net, fell to $0.7 million from $2.2 million. Nonaccrual loans nevertheless increased modestly.
- Adoption of the new lease accounting standard added $8.9 million in lease liabilities and $8.4 million in right-of-use assets at year-end; it did not affect 2019 operating results.
Outlook, risks, and unusual items
- Outlook: The filing provides no specific earnings or revenue guidance. Management identified CECL implementation, effective in 2020, as a significant upcoming accounting change. It expected the initial allowance for credit losses, including unfunded-commitment reserves, to be no more than 130% of the December 31, 2019 allowance; the estimate remained subject to model validation and change.
- Interest-rate and funding risks: Management’s model estimated that an immediate 100-basis-point rate increase would raise forecast one-year net interest income by 2.03%, while a 100-basis-point decrease would reduce it by 2.80%. Outcomes depend on assumptions, including prepayments. High CD reliance, substantial CD maturities within one year, and dependence on FHLB funding are important sensitivities.
- Credit and concentration risks: Most lending is real-estate-secured, with meaningful multifamily and commercial real estate exposure and geographic concentration in the Milwaukee area. Construction lending, property values, borrower cash flows, and economic conditions could affect losses and provisions.
- Mortgage business and legal contingencies: Mortgage income depends on origination volumes, secondary-market conditions, investor programs, and loan-sale representations and warranties. Waterstone Mortgage faced FLSA-related proceedings. In one individual arbitration, an award found liability, but damages and attorneys’ fees had not been determined; the company considered a loss reasonably possible but not probable and recorded no accrual. Approximately 89 former claimants also filed arbitration demands; the company could not estimate a loss range.
- Other items: There were no significant items identified for 2019 or 2018. A 2017 tax-law-related deferred-tax revaluation had produced a one-time $2.7 million tax expense. Auditors issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor verification priorities
- Review the audited statements and notes for the drivers of the lower net interest margin and for segment-level mortgage profitability, especially margin compression and refinance dependence.
- Assess the quality and concentration of the loan portfolio, the increase in nonaccrual loans, allowance assumptions, and the expected CECL transition impact.
- Check liquidity and refinancing exposure, including the $665.7 million of CDs maturing within one year, FHLB advance terms and call options, and unused credit commitments.
- Follow the FLSA arbitrations, particularly potential attorneys’ fees and whether the company later records an accrual or discloses an estimable loss range.
- Reconcile shareholder distributions and capital deployment, including the declared dividend, special dividend referenced in the filing, and $22.8 million of repurchases.