Waterstone Financial, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2019. Waterstone operates a community bank concentrated in southeastern Wisconsin and a mortgage banking business originating residential loans primarily for sale in the secondary market.
Financial performance and condition
- Q3 earnings: Net income was $10.9 million, up 25.5% from $8.7 million a year earlier. Diluted EPS was $0.42 versus $0.31. Annualized return on average assets was 2.17% and return on average equity was 11.15%.
- Nine-month earnings: Net income was $27.1 million, up 8.1% from $25.1 million. Diluted EPS was $1.03 versus $0.90; annualized returns on average assets and equity were 1.84% and 9.21%, respectively.
- Revenue and costs: Q3 net interest income fell 5.0% to $13.2 million, while noninterest income rose 10.1% to $37.5 million, primarily from mortgage banking. Noninterest expense declined 0.5% to $36.2 million. For nine months, net interest income declined 4.0% to $39.1 million; noninterest income rose 4.7% to $96.9 million and noninterest expense declined 0.4% to $100.9 million.
- Margins: Net interest margin decreased to 2.80% in Q3 from 3.07% in Q3 2018, and to 2.85% for the nine-month period from 3.13%. Higher deposit and borrowing costs outpaced growth in interest income.
- Mortgage banking: Q3 mortgage banking segment net income was $4.1 million versus $2.1 million. Nine-month segment net income was $8.7 million versus $6.1 million. Mortgage origination volume increased, supported by refinance activity, but gross margins on loans sold contracted amid a greater refinance mix and pricing competition.
- Credit: The company recorded a $0.08 million negative provision in Q3 and a $0.73 million negative provision for nine months, citing recoveries and improved portfolio risk. The allowance for loan losses was $12.5 million, or 0.91% of loans, versus $13.2 million, or 0.97%, at year-end 2018. Non-accrual loans were $6.3 million (0.46% of loans); nonperforming assets were $8.2 million (0.41% of assets). Total past-due loans increased to $8.5 million from $7.0 million.
- Balance sheet and liquidity: Total assets were $2.01 billion, up 4.7% from December 31, 2018. Loans held for sale increased $96.2 million to $237.8 million; portfolio loans were $1.39 billion. Cash and cash equivalents declined $19.9 million to $66.2 million. Deposits were nearly flat at $1.04 billion; borrowings rose $80.7 million to $515.8 million. Shareholders’ equity declined $12.4 million to $387.2 million.
- Cash flow: Cash used in operating activities was $68.3 million for nine months, compared with $23.7 million used in 2018, largely reflecting mortgage-loan origination and sale timing. Investing activities provided $0.6 million and financing activities provided $47.8 million. Cash and cash equivalents decreased $19.9 million to $66.2 million.
- Capital and shareholder returns: WaterStone Bank exceeded regulatory capital requirements and was considered well capitalized. Its total risk-based capital ratio was 22.86%, and common equity Tier 1 ratio was 22.05%. The company repurchased $22.7 million of stock and paid $22.9 million in cash dividends during the nine months. At September 30, 1,350,800 shares remained authorized for repurchase under the current plan.
Material changes, outlook, and risks
- Mortgage production and income increased, particularly from refinancing as mortgage rates declined; management reported margin compression from product mix and intensified price competition.
- Funding costs rose: nine-month interest expense increased to $20.4 million from $13.7 million, as deposit and borrowing rates repriced upward. Management identified rate changes, competition for deposits, economic conditions, credit quality, mortgage-market conditions, and operational and technology risks as factors that could affect results.
- Interest-rate simulation estimated that an immediate +100-basis-point change would increase next-12-month net interest income by 1.03%, while a −100-basis-point change would reduce it by 2.52%. These are model estimates based on stated assumptions.
- The company adopted lease accounting guidance in 2019, recording $9.4 million of lease liabilities and $8.9 million of right-of-use assets. Management reported no impact on income from adoption.
- The company was preparing for the expected January 1, 2020 adoption of the CECL credit-loss standard and was developing and reviewing its calculation; the filing does not provide a clear estimate of the adoption impact.
- Legal contingency: A prior employment-related arbitration award and court judgment against Waterstone Mortgage Corporation were vacated in April 2019, and the case was closed. Herrington and approximately 90 former claimants subsequently filed new arbitration demands. The company denies the allegations, intends to defend them, and said a loss was not probable at the filing date.
- No earnings guidance or quantified forward outlook is provided. Management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether mortgage origination volumes and margins remain sufficient to offset ongoing pricing competition and refinance-cycle variability.
- Whether higher deposit and borrowing costs continue to pressure net interest income and margin.
- Trends in past-due loans, non-accrual loans, troubled debt restructurings, collateral values, and the adequacy of the allowance.
- Liquidity and refinancing capacity, including the $535.4 million of time deposits scheduled to mature within one year and the company’s reliance on FHLB advances and mortgage-related funding.
- Developments in the renewed arbitration claims and any potential financial exposure; management stated that loss was not probable.
- The eventual CECL adoption impact and the assumptions supporting the reported interest-rate sensitivity estimates.