Waterstone Financial, Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021; balance-sheet comparisons are against December 31, 2020. Dollar amounts below are in millions unless stated otherwise. Waterstone operates a Wisconsin community bank and a mortgage-banking business that originates residential loans primarily for sale.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net interest income | $14.3 | $13.2 | $28.2 | $25.8 |
| Provision (credit) for loan losses | $(0.8) | $4.5 | $(1.8) | $5.3 |
| Noninterest income | $52.0 | $66.9 | $108.2 | $98.4 |
| Noninterest expense | $43.3 | $47.7 | $86.3 | $82.9 |
| Net income | $17.9 | $20.9 | $39.2 | $27.0 |
| Diluted EPS | $0.74 | $0.85 | $1.64 | $1.08 |
| Net interest margin | 2.78% | 2.62% | 2.79% | 2.65% |
Q2 net income fell about 15% year over year, while first-half net income rose about 45%. Q2 annualized return on average assets was 3.25% (3.87% in Q2 2020), and return on average equity was 16.49% (22.39%). For the first half, those measures were 3.62% and 18.49%, respectively, versus 2.59% and 14.03%.
Mortgage banking income was $49.6 million in Q2, down 22% year over year, as originations and gross margins declined. First-half mortgage banking income rose 10.5% to $104.0 million, supported by higher origination volume despite margin pressure. Community banking benefited from lower funding costs and a loan-loss provision credit. The negative provision reflected improved economic assumptions, a smaller loan balance, and loan recoveries; first-half net recoveries were $0.4 million.
Financial condition, cash flow and capital
- Total assets were $2.20 billion, up 0.8% from year-end. Cash and cash equivalents increased to $228.7 million from $94.8 million.
- Net loans receivable were $1.279 billion, down from $1.356 billion; loans held for sale were $352.6 million, down from $402.0 million. Available-for-sale securities were $172.2 million.
- Deposits were $1.231 billion, up $46.2 million. Borrowings declined $33.1 million to $475.0 million, principally following repayment of short-term funding. Shareholders’ equity rose to $431.7 million from $413.1 million.
- First-half operating cash flow was $76.9 million, investing cash flow was $64.1 million, and financing cash flow was $(7.0) million. Cash increased $134.0 million to $228.7 million. Cash generation included proceeds from $2.32 billion of loan sales and a net decline in portfolio loans.
- The Bank was well capitalized. At June 30, its total risk-based capital ratio was 25.29%, Tier 1 risk-based ratio 24.20%, common equity Tier 1 ratio 24.20%, and Tier 1 leverage ratio 17.49%.
- First-half dividends declared were $0.90 per share; Q2 dividends declared were $0.70 per share. The company repurchased 60,051 shares during Q2 at an average $19.42 per share.
Material changes and management commentary
- Q2 net interest income increased 7.8% year over year as lower deposit costs more than offset lower loan yields. First-half net interest income increased 9.5%; reported net interest margin improved to 2.79% from 2.65%.
- Mortgage production shifted toward purchase loans as refinance activity weakened with rising mortgage rates. Q2 mortgage originations were approximately $1.07 billion, down 6.8%; first-half originations were $2.18 billion, up 17.8%. Management cited increased competition and lower gross margins.
- Nonaccrual loans declined to $4.4 million, or 0.34% of loans, from $5.6 million, or 0.40%, at year-end. Total nonperforming assets were $4.5 million. Troubled debt restructurings fell to $4.4 million from $11.6 million.
- The company continued using the incurred-loss methodology, delaying CECL adoption under pandemic-related legislation. Management was validating its CECL model and estimated that the adoption-related change in the allowance, including unfunded commitments, would not exceed 115% of the June 30 allowance based on a parallel computation; the estimate remained subject to change. Adoption was expected no later than January 1, 2022.
- Management reported no significant subsequent events through issuance and no material change in previously disclosed risk factors. No formal earnings or revenue guidance is provided in the filing.
Outlook, risks and contingencies
Management said business activity had improved as restrictions eased, but had not returned to pre-pandemic levels; it also noted rising Delta-variant infections and the possibility of renewed restrictions. Key risks include economic weakness and borrower credit deterioration, interest-rate and funding-cost changes, mortgage-market competition and production volatility, securities-market movements, and operational, cybersecurity and third-party risks. The loan portfolio is geographically concentrated in the Milwaukee metropolitan area and is primarily real-estate-secured.
Liquidity was described as adequate, with access to deposits, loan and securities cash flows, and FHLB advances. However, $564.2 million of time deposits were scheduled to mature within one year; deposit retention and replacement funding costs are uncertain. Outstanding off-balance-sheet commitments totaled $141.7 million. Mortgage-loan sale agreements carry representation-and-warranty and limited-recourse exposure; the related reserve was $2.7 million. Management did not expect pending legal proceedings to have a material adverse effect. The company also reported a $4.3 million legal-settlement cash outflow during the first half.
Key facts for investors to verify
- Whether mortgage origination volumes and margins can remain resilient as refinance activity slows and competition persists.
- How much of first-half earnings growth came from the loan-loss provision credit and whether credit quality remains stable.
- The eventual CECL allowance impact, including reserves for unfunded commitments, and the assumptions behind management’s estimate.
- Deposit renewal and retention trends, liquidity needs, and the cost and availability of alternative funding.
- Credit exposure in the real-estate-focused portfolio, including impaired loans, TDRs, deferral arrangements and collateral valuations.
- Whether dividends and share repurchases remain consistent with capital needs and regulatory restrictions.