Waterstone Financial, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are with December 31, 2019. Waterstone operates community banking, primarily in southeastern Wisconsin, and mortgage banking through Waterstone Mortgage Corporation, which originates residential loans mainly for sale.
Financial performance and position
| Metric | Q1 2020 | Comparison |
|---|---|---|
| Interest income | $19.5 million | $19.2 million in Q1 2019 |
| Net interest income | $12.5 million | Down 3.2% from $12.9 million |
| Net interest margin | 2.68% | 2.93% in Q1 2019 |
| Noninterest income | $31.5 million | Up 29.7%, principally mortgage banking |
| Noninterest expense | $35.2 million | Up 20.0% |
| Provision for loan losses | $785,000 | Compared with a $680,000 provision credit in Q1 2019 |
| Net income / diluted EPS | $6.1 million / $0.24 | $6.5 million / $0.24 in Q1 2019 |
| Annualized return on average assets / equity | 1.21% / 6.24% | 1.39% / 6.65% in Q1 2019 |
Mortgage banking income was $30.4 million, up 30.2%. Consolidated originations for sale were $687.7 million, up 40.0%; management attributed the volume increase largely to refinancing following lower mortgage rates. The mortgage segment reported $2.0 million net income, versus $719,000 a year earlier. Community banking net income was $4.1 million, versus $5.8 million.
Balance sheet and liquidity: Total assets were $2.06 billion, up 3.0% from year-end. Loans held for sale rose to $262.7 million and loans receivable to $1.41 billion. Deposits were $1.09 billion, up $18.3 million; borrowings were $522.2 million, up $38.6 million. Cash and cash equivalents declined to $59.1 million from $74.3 million. Operating cash flow was negative $37.7 million, primarily reflecting mortgage loans originated for sale and timing of loan-sale proceeds; investing cash flow was negative $15.2 million and financing cash flow was positive $37.7 million.
The allowance for loan losses was $13.2 million, or 0.94% of loans, versus $12.4 million and 0.91% at year-end. Non-accrual loans were $6.8 million (0.48% of loans), while total past-due loans increased to $11.0 million from $6.5 million. The Bank was classified as well-capitalized; its total risk-based capital ratio was 22.48% and Tier 1 leverage ratio was 17.26%.
Material changes and notable items
- Net interest income declined despite higher average loan balances: funding costs rose, while yields on interest-earning assets fell. Total interest-bearing liability costs increased to 1.87% from 1.82%.
- Mortgage volume grew substantially, but management reported lower mortgage gross margin amid high industry volume and concerns about secondary-market conditions. Compensation costs rose with production; professional fees included a $1.1 million legal award reserve and ongoing litigation costs.
- Shareholders’ equity fell $21.9 million to $371.8 million, principally reflecting declared dividends and share repurchases. The company repurchased 911,968 shares in Q1 for $14.2 million; it declared a $0.62-per-share dividend during the quarter.
- Available-for-sale securities were $171.5 million, down from $178.5 million at year-end. One corporate debt security had a $3.0 million unrealized loss; management attributed the decline primarily to market interest rates and said it did not intend, and was not more likely than not required, to sell before recovery.
Outlook, risks, and contingencies
- COVID-19: Management said the pandemic could adversely affect borrower repayment, collateral values, loan and fee income, funding costs, and operations; the ultimate impact was unknown. The filing notes Federal Reserve rate reductions to a 0%–0.25% target range in March.
- Borrower support and PPP: As of April 30, the company reported 177 modified loans totaling $106.9 million, with principal-only or principal-and-interest deferrals. It had SBA approval for 245 PPP loans totaling $29.4 million and had funded 172 totaling $24.9 million. The company elected CARES Act relief for qualifying COVID-related modifications from TDR accounting.
- CECL: The company delayed adoption under the CARES Act and continued using the incurred-loss model for Q1. Management estimated the initial CECL increase to the allowance, including unfunded-commitment reserves, would not exceed 130% of the December 31, 2019 allowance; the estimate remained subject to model validation and economic developments.
- Legal matters: An arbitrator awarded a former mortgage-company loan officer $14,952 in damages. The filing reports a May 6 award allowing $1.1 million in attorney fees and costs, while also stating a $1.1 million reserve was recorded in Q1. The company retained rights to challenge the award. Approximately 100 other claimants had similar arbitrations; no accrual was recorded, and the company said a loss was reasonably possible but could not estimate a range.
- Funding and commitments: $704.3 million of time deposits were scheduled to mature within one year. Management said wholesale funding remained available but rates were volatile, and deposit outflows or sustained higher funding costs could pressure liquidity or net interest margin. Off-balance-sheet commitments totaled $131.1 million.
- Management gave no quantitative earnings guidance and cautioned that Q1 results are not necessarily indicative of full-year results. Risks also include interest-rate volatility, credit losses, mortgage-market conditions, operational and cybersecurity exposures, and reliance on third-party providers.
Important facts for investors to verify
- Whether pandemic-related deferrals, PPP lending, delinquencies, and credit conditions lead to higher provisions or pressure collateral values.
- How mortgage originations, secondary-market execution, gross margins, and derivative valuations develop after the unusually strong refinancing quarter.
- The timing and final amount of CECL adoption adjustments, including reserves for unfunded commitments.
- The status and accounting treatment of the Herrington fee award and the potential exposure from other claimant arbitrations.
- Deposit retention and funding needs, particularly given near-term certificate maturities, borrowings, dividends, and continued repurchases.