Waterstone Financial, Inc. — Q2 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2016. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking through Waterstone Mortgage Corporation, which originates residential loans mainly for sale. Unless noted, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q2 2016 | Six months 2016 | Comparison |
|---|---|---|---|
| Net interest income | $10.2 | $20.1 | Up 1.0% and 3.3%, respectively, year over year |
| Noninterest income | $36.4 | $57.8 | Up 17.1% and 8.9%; mortgage banking was the principal driver |
| Net income | $7.8 | $11.6 | Versus $5.3 and $8.3 in 2015 |
| Diluted EPS | $0.29 | $0.43 | Versus $0.17 and $0.26 in 2015 |
| Net interest margin | 2.50% | 2.49% | Versus 2.46% and 2.38%; fully tax-equivalent margins were 2.56% and 2.55% |
| Noninterest expenses | $34.2 | $59.5 | Up 7.1% and 1.8%, respectively |
Aggregate net interest income plus noninterest income was $46.5 million in Q2 and $77.9 million for the first half. Annualized return on average assets and equity were 1.78% and 7.86% for Q2, and 1.34% and 5.89% for the first half.
Balance sheet at June 30, 2016: Assets were $1.80 billion, up 2.1% from year-end 2015. Loans receivable, net of allowance, were $1.114 billion; loans held for sale were $208.8 million; and securities available for sale were $253.7 million. Deposits totaled $942.7 million, up $49.3 million. Borrowings were $414.7 million, down $26.5 million. Shareholders’ equity was $400.6 million, up $8.7 million.
Cash flow and liquidity: Cash and cash equivalents ended the half at $82.5 million, down from $100.5 million at year-end. Net cash used in operating activities was $33.0 million, compared with $66.1 million used in the first half of 2015; investing activities used $1.6 million, while financing activities provided $16.6 million. Mortgage-loan originations for sale and subsequent sale proceeds are substantial and affect reported operating cash flow. Time deposits of $479.4 million mature within one year. The company reported $89.1 million of lending commitments and standby letters of credit.
Credit and capital: The allowance for loan losses was $15.7 million, or 1.39% of loans receivable, versus $16.2 million and 1.68% at year-end. Nonaccrual loans were $11.4 million (1.01% of loans), down from $17.6 million; nonperforming assets were $20.0 million (1.11% of assets), down from $26.8 million. Net charge-offs were $0.7 million, annualized at 0.12% of average loans. The Bank reported regulatory capital ratios of 30.91% total capital, 29.66% Tier 1 and common equity Tier 1, and 21.06% Tier 1 capital to average assets; management stated the Bank was well capitalized.
Material changes versus comparable periods
- Q2 net income rose 47% year over year; first-half net income rose 40%. Mortgage banking income increased to $35.0 million for Q2 and $55.6 million for the half, supported by origination volume and margins.
- Mortgage originations for sale reached $675.1 million in Q2, up 13.3%, and $1.046 billion for the half, up 5.1%. Purchase loans represented 88% of Q2 originations and 87% of first-half originations, versus 86% and 82% a year earlier.
- First-half provision for loan losses declined to $0.2 million from $1.1 million; no provision was recorded in Q2 versus $0.8 million in Q2 2015. Nonperforming loans, past-due loans and real-estate-owned balances declined from year-end levels.
- Deposit interest expense rose as time-deposit balances and costs increased, while borrowing costs fell following repayment of $70 million of higher-rate advances and replacement with $50 million of lower-rate FHLB funding. Total deposits grew while borrowings declined.
- Compensation expense increased, mainly with mortgage origination commissions and activity. Lower real-estate-owned expenses and FDIC premiums partly offset the increase.
Outlook, risks and unusual items
- The filing provides no numerical earnings or growth guidance. Management cautions that first-half results are not necessarily indicative of full-year results.
- Management identifies interest-rate changes, competition for deposits, economic conditions, mortgage and securities markets, credit quality, regulation, operational risk and employee retention as factors that could cause results to differ from forward-looking statements. A 100-basis-point rate increase was modeled to raise 12-month net interest income 1.68%; a 100-basis-point decline was modeled to reduce it 2.00%. These are simulations dependent on assumptions, especially loan and securities prepayments.
- Mortgage banking carries exposure from interest-rate lock commitments, forward loan-sale commitments and loan-sale representations and warranties. At quarter-end, lock commitments had a $5.5 million reported fair-value asset and forward commitments a $2.9 million liability. Management reported historically insignificant repurchases, but future claims remain possible.
- A mortgage subsidiary lawsuit alleging Fair Labor Standards Act and contract-related violations was transferred to arbitration. The company said it would defend the matter and does not expect pending proceedings to materially affect its financial statements.
- Other notable items: the company purchased a $10 million bank-owned life insurance policy; repurchased $3.9 million of shares during the first half; and recorded a $150,000 mortgage-servicing-rights impairment allowance. A $857,000 deferred tax asset related to 2007 stock options may result in additional tax expense if the options expire unexercised in January 2017.
- The company was evaluating the impact of new accounting standards for expected credit losses and leases. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether mortgage banking income and elevated purchase-loan activity can be sustained, and how results respond if mortgage originations or margins weaken.
- Deposit retention and repricing: nearly $479.4 million of time deposits mature within one year, with potentially higher renewal costs.
- Credit trends, collateral values, charge-offs and reserve adequacy, including $11.6 million of troubled debt restructurings and the effect of future local economic deterioration.
- Borrowing maturities, callable advances and repurchase agreements, as well as liquidity available to meet commitments and deposit outflows.
- Developments in the employment-related lawsuit, mortgage-loan repurchase exposure, and the stock-option tax asset that could expire in January 2017.