Waterstone Financial, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing is an annual report; it also presents unaudited quarterly results, including the fourth quarter. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking through Waterstone Mortgage Corporation, which originates residential loans for sale.
Financial performance and condition
| Metric | FY 2016 / year-end | Prior comparable period |
|---|---|---|
| Net income | $25.5 million | $16.6 million in 2015 |
| Basic / diluted EPS | $0.94 / $0.93 | $0.57 / $0.56 in 2015 |
| Net interest income | $43.4 million | $38.8 million in 2015 |
| Net interest margin | 2.64% | 2.36% in 2015 |
| Noninterest income | $126.4 million | $104.5 million in 2015 |
| Noninterest expense | $127.4 million | $115.5 million in 2015 |
| Return on average assets / equity | 1.45% / 6.33% | 0.94% / 3.99% in 2015 |
| Total assets | $1.79 billion | $1.76 billion at year-end 2015 |
| Loans held for investment, net | $1.16 billion | $1.10 billion at year-end 2015 |
| Deposits | $949.4 million | $893.4 million at year-end 2015 |
| Borrowings | $387.2 million | $441.2 million at year-end 2015 |
| Cash and cash equivalents | $47.2 million | $100.5 million at year-end 2015 |
| Shareholders’ equity | $410.7 million | $391.9 million at year-end 2015 |
Net cash used in operating activities was $24.1 million, compared with $13.0 million used in 2015; the filing attributes this chiefly to mortgage-loan origination and sale cash flows. Investing activities used $25.0 million and financing activities used $4.2 million. Cash declined $53.3 million over the year.
Mortgage banking income rose 21.9% to $121.1 million as mortgage originations for sale increased 19.8% to $2.38 billion and margins improved. Community banking net income was $14.0 million, up from $8.3 million; mortgage banking net income was $12.3 million, up from $8.3 million.
Fourth quarter: Net income was $6.4 million, or $0.23 per basic and diluted share. Net interest income was $12.0 million, provision for loan losses $40,000, noninterest income $31.2 million, and noninterest expense $32.4 million.
Material changes versus 2015
- Net income increased 54%; net interest income rose 11.8%, reflecting loan growth and lower borrowing costs.
- Mortgage originations and mortgage banking income expanded, while compensation and other volume-related costs also increased. Total noninterest expense rose 10.3%.
- Provision for loan losses fell to $380,000 from $2.0 million. Net charge-offs declined to $536,000 from $4.5 million.
- Non-accrual loans decreased 44% to $9.9 million; non-performing assets fell to $16.0 million from $26.8 million. The allowance was $16.0 million, 1.36% of loans and 162.62% of non-performing loans.
- Deposits grew 6.3%, including growth in transaction accounts; borrowings declined $54.0 million. Certificates of deposit remained 70.2% of deposits.
- The company’s effective tax rate increased to 39.2% from 35.8%, including a $658,000 expense from writing off a deferred tax asset tied to exercised stock options.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings, revenue, margin or loan-growth guidance. Management describes plans to grow commercial business lending and commercial real estate and multifamily lending, and to seek more lower-cost transaction deposits.
- Interest-rate exposure is significant. The company’s model estimated that an immediate 100-basis-point rate increase would raise next-12-month net interest income 3.41%, while a 100-basis-point decrease would reduce it 4.04%; actual results may differ from model assumptions.
- Mortgage banking depends on origination volumes, interest rates, margins, secondary-market liquidity and investor programs. Loan sales carry representations, warranties and limited recourse that can require repurchases, although management reported historically insignificant losses and repurchases.
- Credit risk includes concentration in real estate and growth in commercial real estate and multifamily loans. Management cautions that weaker local economic conditions or property values could raise delinquencies, losses and required reserves. The expected-credit-loss standard (CECL) was identified as a future implementation and allowance-estimation risk.
- Liquidity and funding considerations include $469.3 million of certificates of deposit scheduled to mature within one year, $130.0 million of FHLB advances due within 12 months, and $81.3 million of disclosed commitments to originate loans and unfunded credit commitments. FHLB advances are callable at the lender’s option as described in the filing.
- A mortgage subsidiary faces an employment-related lawsuit alleging wage and contract violations; the matter was transferred to arbitration. Management believes pending proceedings will not materially adversely affect consolidated results, but the outcome is uncertain.
- The company reported one remaining impaired municipal bond with $116,000 amortized cost and $94,000 cumulative impairment. The filing notes market-value, prepayment and reinvestment risks in securities.
- Management and the auditor reported effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and controls.
Important facts for investors to verify
- Whether mortgage banking production, margins and profitability can persist, and how sales volumes respond to rate and secondary-market changes.
- Credit performance and underwriting concentrations in multifamily and commercial real estate as those portfolios grow; validate the declining nonperforming-asset trend and allowance adequacy.
- Deposit retention and repricing around the sizable near-term certificate maturities, and the availability and cost of wholesale funding and callable FHLB advances.
- The sensitivity of net interest income, securities values and borrower credit quality to interest-rate changes, including the assumptions behind management’s simulation.
- The financial and operational effect, if any, of the arbitration proceeding, loan-sale repurchase obligations, and future CECL adoption.
- Capital distributions: the company declared $0.33 per share in 2016 and had authorization to repurchase up to 989,500 additional shares at year-end; future dividends and repurchases remain subject to financial and regulatory constraints.