Waterstone Financial, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023; balance-sheet comparisons are to December 31, 2022. Amounts below are in millions unless stated otherwise. Waterstone operates community banking in southeastern Wisconsin and mortgage banking, originating residential loans primarily for sale.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Interest income | $24.2 | $16.4 | $46.1 | $31.4 |
| Net interest income | $12.7 | $14.1 | $26.5 | $25.9 |
| Mortgage banking income | $21.9 | $29.4 | $38.7 | $57.7 |
| Total noninterest income | $23.5 | $31.2 | $42.1 | $61.1 |
| Noninterest expenses | $30.9 | $35.1 | $60.0 | $70.0 |
| Net income | $4.0 | $8.0 | $6.2 | $13.3 |
| Diluted EPS | $0.20 | $0.36 | $0.30 | $0.58 |
| Net interest margin | 2.47% | 3.02% | 2.67% | 2.69% |
Q2 return on average assets was 0.74% versus 1.61%; return on average equity was 4.41% versus 7.93%. The six-month figures were 0.59% and 3.37%, respectively, compared with 1.30% and 6.42%.
Balance sheet, liquidity and capital
- Total assets were $2.23 billion, up 9.8% from year-end. Loans held for investment increased $104.5 million to $1.61 billion; loans held for sale rose $72.1 million to $203.3 million.
- Deposits declined $12.0 million to $1.19 billion (1.0%); money market, savings and demand balances fell, partly offset by a $66.8 million rise in time deposits. Management reported minimal deposit outflows in the first half.
- Borrowings increased $228.1 million to $614.9 million. Cash and cash equivalents were $61.2 million, up from $46.6 million at year-end. FHLB unused borrowing capacity was approximately $184.7 million; unused Bank Term Funding Program capacity was $164.8 million, with no advances outstanding under that program.
- Shareholders’ equity fell $14.7 million to $355.8 million, reflecting dividends, repurchases and lower securities fair value, partly offset by earnings. The Bank reported a 20.18% total risk-based capital ratio and was well-capitalized.
- Available-for-sale securities were $195.0 million, with $27.2 million of gross unrealized losses. Management attributed these losses to noncredit factors, principally rates and market conditions, and said it did not intend, and was not likely required, to sell before recovery. No securities credit-loss allowance was recorded.
- For the six months, operating cash flow was negative $71.5 million versus positive $118.2 million a year earlier; investing cash flow was negative $112.7 million and financing cash flow positive $198.8 million. The cash-flow statement reflects the timing and scale of mortgage loan originations and sales, loan growth and increased borrowings.
Material changes and management commentary
- Q2 net income fell about 50% year over year; first-half net income fell about 54%. Mortgage banking was the main pressure: segment net loss was $1.2 million in Q2 and $4.0 million for the first half, versus profits of $1.7 million and $2.8 million in the comparative periods.
- Mortgage originations and mortgage banking income declined with higher rates, reduced refinancing, affordability and housing inventory constraints, and tighter industry competition. First-half mortgage originations fell 28.3% at the segment level; gross margin on loans originated and sold declined 4.3%.
- Higher asset yields did not offset sharply higher funding costs. Q2 interest expense rose to $11.6 million from $2.3 million, as deposit and borrowing costs increased; the reported quarterly net interest margin contracted year over year.
- First-half noninterest expense declined 14.2%, mainly from lower mortgage commissions, salaries and headcount, partly offset by higher professional fees and other costs.
- The company sold servicing rights on $318.4 million of loans in the first half, receiving $3.5 million and recognizing a $0.6 million gain. Serviced loans for others declined to $156.3 million from $409.6 million at year-end.
- The company repurchased 511,357 shares in Q2 for $7.3 million at an average $14.32 per share. A new 2 million-share program was authorized in May; approximately 1.88 million shares remained at June 30. Dividends declared were $0.20 per share for Q2.
- Management said no significant items affected earnings and reported no significant subsequent events through issuance. It provided no formal earnings or operating guidance.
Risks, contingencies and unusual items
- Management identifies interest-rate, liquidity, credit, competition, mortgage-market, operational, cybersecurity and third-party risks, among others. The loan portfolio is geographically concentrated in the Milwaukee metropolitan area and primarily real-estate-secured.
- Estimated uninsured deposits were $262.5 million across approximately 1,125 customers. Time deposits of $250,000 or more totaled $122.8 million; $603.9 million of time deposits were scheduled to mature within one year. Management cautioned that retention is not assured and replacement funding could cost more or be unavailable on attractive terms.
- Nonperforming assets were $4.3 million, or 0.19% of assets. Nonaccrual loans were $4.1 million (0.26% of loans); total past-due loans rose to $8.0 million from $6.3 million at year-end. Net charge-offs were $6,000 in the first half; the allowance for loan losses was $18.4 million, or 1.14% of loans.
- Interest-rate simulation disclosed a potential decline in forecast net interest income under rising rates. The filing’s sensitivity table and accompanying narrative appear inconsistent: the table shows a 7.96% decrease for a 100-basis-point increase, while the narrative states a 2.37% decrease. The narrative says a 100-basis-point decrease would increase net interest income by 0.52%.
- A lawsuit filed by Mutual of Omaha Mortgage in July 2022 concerning employees hired by Waterstone Mortgage remains pending. The company said it cannot yet assess the likelihood of an unfavorable outcome or estimate a possible loss. Management does not expect other pending legal proceedings to have a material adverse effect.
- Off-balance-sheet commitments included $44.7 million to extend credit under amortizing loans, $61.3 million of unused construction commitments, and other credit lines and letters of credit. The company reported no probable losses on commitments or standby letters of credit. Mortgage-loan sale agreements include limited representations, warranties and recourse provisions; the related reserve was $2.0 million.
Important facts for investors to verify
- Reconcile the conflicting interest-rate sensitivity disclosures and assess exposure to further rate increases.
- Track deposit stability, uninsured deposit levels, near-term certificate maturities, borrowing costs and remaining contingent liquidity capacity.
- Monitor mortgage production, gain-on-sale margins, segment profitability, headcount and the effect of servicing-rights sales on recurring fee income.
- Review loan delinquency and risk-rating migration, especially one- to four-family and commercial real-estate exposures, and changes in the allowance relative to loan growth.
- Confirm the status and potential financial exposure of the Mutual of Omaha litigation and any mortgage-loan repurchase or recourse claims.
- Assess ongoing share repurchases and dividends against capital, liquidity and the Bank’s regulatory restrictions on distributions.