Washington Trust Bancorp Inc (WASH) 2021 Q2 法說會逐字稿

Good morning, and welcome to Washington Trust Bancorp Inc.'s Conference Call. My name is Vaishnavi, and I will be your operator today. (Operator Instructions) Today's call is being recorded.

And now I will turn the call over to Elizabeth B. Eckel, Senior Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel.

Thank you. Good morning, and welcome to Washington Trust Bancorp, Inc.'s Second Quarter 2021 Conference Call. Joining us on today's call are members of Washington Trust's executive team, Ned Handy, Chairman and Chief Executive Officer; Mark Gim, President and Chief Operating Officer; Ron Ohsberg, Senior Executive Vice President, Chief Financial Officer and Treasurer; and Bill Wray, Senior Executive Vice President and Chief Risk Officer.

As a reminder, today's call may contain forward-looking statements, and actual results could differ materially from what is discussed today. Our complete safe harbor statement appears in our earnings press release as well as in other documents filed with the SEC. You may view these materials as well as our safe harbor statement in its entirety on our Investor Relations site at ir.washtrust.com. Washington Trust trades on NASDAQ under the symbol RUSH.

I'm now pleased to introduce the host of today's call, Washington Trust's Chairman and CEO, Ned Handy.

Thank you, Beth, and good morning, everybody. Thank you for joining our second quarter call. I hope everyone is doing well and has remained healthy since our last call. We appreciate your continued interest in Washington Trust.

Today's agenda is similar to past calls. I'll provide an overview of our second quarter highlights, and then Ron Ohsberg will review our financial performance. After our prepared remarks, Mark Gim and Bill Wray will join us to answer any questions you may have about the quarter.

I'm pleased to report that Washington Trust posted strong second quarter results with net income of $17.5 million or $1 per diluted share. Meaningful quarter-over-quarter increases in net interest income, wealth management revenues and loan-related derivative fees were offset by lower mortgage banking revenues. Noninterest expenses were well managed in the quarter, and our returns and capital levels reflect the successful quarter. Ron will provide more detail in a moment.

We are increasingly optimistic about where we, our customers and the economies in which we operate stand with regards to the pandemic. As we contemplate the new work environment, we think first about what is safest for everybody. And then we turn to what is most effective and efficient for our customers. We will implement all of the best practices we've learned throughout the pandemic. And we'll find the appropriate balance between technology-assisted flexibility, outstanding customer service, culture-enhancing practices and continued dedication to delivering consistent, strong results.

I continue to feel great pride in the way our employees adjusted and adapted without ever losing sight of what matters most to our customers and the communities we serve. We were recently named by Forbes as one of America's best in-state banks for 2021. This award, based on a survey of our customers, recognizes the strength of our franchise based on factors such as trust, products, branch services, digital services and financial advice. Additionally, we were also recognized by Providence Business News as one of the best places to work and one of the healthiest employers in Rhode Island.

We're very proud of these acknowledgments and believe that when we take great care of our customers and our employees, it translates into growth and profit for our shareholders.

We were pleased that Lisa Stanton joined our Board in April. Lisa has deep experience in the payment space and in various aspects of data security. Lisa was most recently General Manager Enterprise Strategy for American Express. We very much look forward to her contributions.

It's a digital world and we recognize that the ever-spreading technology ecosystem poses both opportunities and challenges. So we continue to invest in improving our customers' experience across delivery channels and in our evolving hybrid work environment. At the same time, we are investing to protect our customers' data privacy while educating them about the increasing risk of cyber fraud that accompany the shift to digital commerce.

Our business model has consistently provided a diverse stream of earnings for us through various economic cycles, and that has served us well during the crisis. Our commitment to strong credit practices has helped to minimize potential costs associated with the pandemic.

We opened our new branch location in East Greenwich, Rhode Island, our first in that vibrant market. We're very pleased with the first few months of operations. We continue to believe we have deposit market share opportunity in Rhode Island and believe that physical presence matters in tandem with enhanced digital connection and service points.

In-market deposits were up 12% from a year ago. We also saw continued reduction of cost in both our in-market deposit base and our wholesale funding base. And Ron will comment on the margin impact.

Turning to lending. Total loans amounted to $4.3 billion at June 30, up 3% from the end of the first quarter with residential mortgage and commercial real estate growth outstripping reductions from PPP forgiveness. We processed forgiveness of about $85 million in PPP loans in the second quarter.

Commercial pipelines continue to improve and have returned to pre-pandemic levels. We've seen a resurgence in CRE in warehouse and multifamily, in particular, and are seeing commercial lending activity pick up as the economy begins to recover.

Mortgage sales volume in the quarter remained strong at $291 million, essentially even with Q1. Consistent with that, we've seen in the industry and our market area, market pricing has reduced our sales yields from very elevated levels realized over the past several quarters. Residential mortgage originations at $489 million continued to be very strong in the second quarter with an increasing percentage of these originations heading for portfolio.

Our mortgage team continues to work diligently. The pipeline and application activity remains strong at higher than pre-pandemic levels. It appears, however, that we are beginning to see indications of normalizing in the industry, although it's too soon to forecast the pace and the impact.

Our Wealth Management division's assets under administration reached a record $7.4 billion at June 30, up 6% from March 31. This growth reflects financial market appreciation as well as strong business development and client retention efforts net of routine asset client asset flows.

Wealth management revenues were $10.4 million for the second quarter, up 5% from the preceding quarter, providing a key source of noninterest income. We are very pleased with our Wealth Management division's second quarter performance.

I'll now turn the call over to Ron for a more detailed review of our financial performance. Ron?

Thank you, Ned, and good morning, everyone, and thank you for joining us on our call today. As Ned mentioned, net income was $17.5 million or $1 per diluted share for the second quarter. This compared to $20.5 million and $1.17 in the first quarter. Net interest income amounted to $34.8 million, up by $1.9 million or 6% from the preceding quarter. Net interest margin 2.55%, up 4 basis points.

Net interest income continued to benefit from accelerated fee income recognition due to PPP forgiveness, which totaled $1 million and had a 6 basis point benefit to the margin. This compared to $1.2 million and 9 basis points for the first quarter. Excluding PPP accelerated fees in both periods, the margin increased by 7 basis points from 2.42% to 2.49%.

Also in the second quarter, commercial loan prepayment fees totaled $717,000 compared to $217,000 in the first quarter. Excluding the PPP and prepayment fees, the margin increased from 2.40% to 2.42%. Average earning assets increased by $140 million with increases of $114 million in average investments and $42 million in average loans. The yield on earning assets decreased by 5 basis points to 2.85%.

On the funding side, average in-market deposits rose by $113 million while wholesale funding sources decreased by $3 million. The rate on interest-bearing liabilities declined by 12 basis points to 38 basis points.

Noninterest income comprised 37% of total revenues in the second quarter and amounted to $20.6 million, down $5.4 million or 21% from the preceding quarter. As previously disclosed, included in other noninterest income in the first quarter was income of $1 million associated with the settlement. Excluding the impact of this item, noninterest income was down by $4.4 million or 18%.

Wealth management revenues were a record $10.4 million in the second quarter, up by $533,000 or 5%. This included an increase in asset-based revenues, which were up by $408,000 or 4% and as well as an increase in transaction revenues of $125,000. The increase in transaction revenues was largely due to tax reporting and preparation fees, which are concentrated in the first half of the year.

The increase in asset-based revenues correlated with an increase in the average balance of assets under administration, which were up by $359 million or 5%. The June 30 end-of-period assets totaled an all-time high, $7.4 billion, up by $392 million or 6% from March 31, reflecting market appreciation of assets and net positive new business.

Our mortgage banking revenues totaled $6 million in the second quarter, down by $5.9 million or 50% from the first quarter. This included net realized gains of $8.6 million, which were down by $5.2 million or 38%. Loan sales volume remained strong in the second quarter. However, realized gains were impacted by a reduction in the sales yield compared with the very high levels recorded the past few quarters.

The decline in sales yield is consistent with what we are seeing within our markets. Note that the second quarter sales yield is still higher than it was at the pre-pandemic level.

Mortgage loans sold totaled $291 million in the second quarter, down modestly by $1 million from the previous quarter. Realized gains in the second quarter were offset by net unrealized losses of $2.5 million, reflecting a decrease in the fair value of mortgage loan commitments as of June 30. This compared to a net unrealized loss of $1.9 million in the preceding quarter.

Originations amounted to $489 million, up by $48 million or 11% from the preceding quarter and were up by $63 million or 15% from the second quarter in 2020. We are seeing a shift in market demand away from salable loans to portfolio. The percentage of originations to be added -- excuse me, to be sold in the secondary market declined from 70% to 50% on a linked-quarter basis. Our mortgage origination pipeline was smaller but still very robust at June 30. The pipeline was approximately $298 million, down by $98 million or 24% from $396 million at the end of March.

Loan-related derivative income was $1.2 million, up by $708,000 from the preceding quarter.

Regarding noninterest expenses, these were down by $1.7 million or 5% from the first quarter. In both the second and first quarter of 2021, debt prepayment penalties were incurred to pay off higher cost of FHLB advances. This expense was $895,000 in the second quarter compared to $3.3 million in the first. Excluding the impact of these penalties from both periods, noninterest expense was up by $739,000 or 2% from the first quarter of 2021.

Salaries and employee benefits expense increased by $555,000 or 3% in the second quarter largely due to increases in performance-based compensation accruals. Advertising and promotion expense was up by $338,000 on a linked-quarter basis largely due to timing.

Income tax expense totaled $4.9 million for the second quarter. The effective tax rate was 21.8% compared to 21.7% in the previous quarter. We currently expect our full year 2021 effective tax rate to be approximately 22%.

Now turning to the balance sheet. Total loans were up $105 million or 3% from March 31 and by $12 million, essentially flat from a year ago. In the second quarter, commercial loans decreased by $25 million or 1%, which included a net reduction in PPP loans of $82 million. Excluding PPP, commercial loans increased by $57 million or 3% from March 31, reflecting originations and advances totaling $162 million, partially offset by payoffs and pay-downs of $103 million.

Residential loans increased by $133 million, reflecting a higher proportion of loans originated for portfolio as well as $39 million of residential loans with a weighted average rate of 2.74% that were purchased for portfolio.

Investment securities were up by $104 million or 11% from March 31. In the second quarter, we purchased $194 million of investments with a weighted average yield of 1.91%. And securities represented 18% of total assets as of June 30.

In-market deposits were down $20 million or 1% from March 31 and were up by $421 million or 12% from a year ago. The quarterly decline was modest, considering the drawdown of PPP-related deposits and the normal seasonal outflows of our municipal and higher ed deposits. Compared to last year, deposit inflows have allowed us to improve our funding mix by paying down higher-cost wholesale advances.

Wholesale brokered CDs were up by $197 million in the second quarter at an average marginal rate of 8 basis points. FHLB borrowings were down by $58 million from March 31.

Total shareholders' equity amounted to $548 million at June 30, up by $14 million from the end of Q1. Washington Trust remains well capitalized. The total risk-based capital ratio was 13.65% at June 30. And the tangible equity to tangible asset ratio was 8.27%. Our second quarter dividend declaration of $0.52 per share was paid on July 9.

Regarding asset quality, nonperforming assets declined by $2.5 million in the second quarter. Non-accruing loans were 24 basis points on total loans. And loans past due 30 days or more were 20 basis points of total loans, both of which were lower than the first quarter. TDR has decreased by $3.5 million from March 31, reflecting payoffs.

The allowance for credit losses on loans totaled $41.9 million or 97 basis points of total loans and provided NPL coverage of 400%. Excluding PPP loans, the allowance coverage was 100 basis points. There was no provision for credit losses in the second quarter compared to a negative $2 million recognized in the preceding quarter. The provision for credit losses and the related ACL reflected our current estimate of forecasted economic conditions and continued stable asset quality metrics. Net charge-offs were $258,000 in Q2 compared to $18,000 in Q1.

And finally, I'd like to provide an update on our COVID-19 lending impact. As of June 30, we had loan deferments on 22 loans, totaling $93 million or 2% of total loans outstanding, excluding PPP, which was down from 88 loans totaling $191 million or 5% of total loans as of March 31. The deferments as of June 30 consist of 14 commercial real estate loans totaling $87 million and 8 residential real estate loans totaling $6 million.

As of June 30, we are reporting 1,513 PPP loans with a carrying value totaling $147 million. In the second quarter, we originated $4 million of PPP loans, down from the $97 million that we originated in Q1. Also in the second quarter, approximately $85 million were forgiven by the SBA. As I mentioned earlier, approximately $1 million of net deferred fees were accelerated into income.

Net unamortized fees amounted to $4.9 million as of June 30. The timing and recognition -- the timing of the recognition of these net fees into the margin will depend upon the pace of loan forgiveness as approved by the SBA.

And that concludes my remarks. And at this time, I'll turn the call back over to Ned.

Thank you, Ron. This was another strong quarter for Washington Trust, and we feel well positioned heading into Q3. And at this point, we're happy to take any questions.

(Operator Instructions) The first question comes from Mark Fitzgibbon with Piper Sandler.

I saw that the flows turned positive in the wealth management business. I guess I'm curious, have you hired some new producers there? And have we also seen sort of the last of the runoff from those past employee departures?

So Mark, this is Mark Gim. I'll start with that. We have not added new business developers recently. But as you know, we've both increased our outbound marketing from our inside business development officers and also had launched a Private Clients Group initiative a couple of years ago, which is starting to bear fruit on both sides. And as far as the outflows from Weston Financial, we do believe that the substantial majority of that is really behind us.

So a combination of good business development outreach and slowed asset outflows from Weston Financial really contributed to that. And we're feeling very positive about business development momentum going into the second half of 2021.

Mark, just to add on to that. The Weston outflows really were finished by the first quarter of last year.

Okay. And then on the mortgage front, if gain on sale margins kind of remain under pressure, and it sounds like you're going to be portfolioing a little bit more volume versus selling it. I guess I'm curious how you're thinking about the expense structure at the mortgage company. Is there an opportunity to maybe scale back some of the costs there if volumes are coming down a bit?

Mark, I'll take the first part of that question as far as expense base is concerned and then turn it to Ned and Ron for further comments. We really did not add to the expense base in the mortgage banking business at all during the really strong origination volumes for the last 4 quarters. We think we have a very flexible and process-oriented infrastructure in place.

So there was very limited incremental cost. The majority of the costs in that business when volumes increase is variable based on commissions. And as sales go up, the commission expense goes up as well. As sales come down, the commission expense goes down as well. So we really did not build up our mortgage banking cost infrastructure at all at anything more than the very marginal levels during 2020.

So there is -- we're not concerned about cost reductions. As Ron said, the mortgage banking business -- well, the mortgage business remains strong but more skewed towards purchase in this environment than salable mortgages. As the 10-year trended up early in the second quarter, we saw refi drop off as a percentage. So cost reduction is not really on our radar screen simply because we didn't have nonvariable cost increases running up into that end...

Mark, what is -- I'm sorry.

Go ahead.

I was going to say what's the rough split fixed versus variable cost this quarter in the mortgage business.

Ron, do you have that?

Mark, I'd have to get back to you on that one.

Okay. And then lastly, Ron, I wondered if you could kind of share with us your outlook for the margin and operating expenses.

Sure. So for the margin, I think we'd expect to see a slight decline in kind of the core margin in the third quarter to perhaps 2.4% plus or minus. And mainly, that's because we're still seeing some asset yield pressure as the residential mortgages and investment securities roll over. And you'll note that we had some asset yield compression in those 2 areas in the second quarter.

So that should likely continue. Most of the liability repricing opportunity is behind us. There's a little bit more left to go, but I think we'll be roughly in the 2.40% range. As far as operating expenses, I would say that our Q2 operating expenses represent a good run rate going forward.

The next question comes from Damon DelMonte with KBW.

So my first question just regarding the loan growth. Nice to see commercial loans ex PPP come back this quarter. Can you just talk a little bit about your outlook here in the back half of the year and how the pipelines look and some of the sectors or areas of the economy that are driving this growth?

Yes. So David, I'll take that. It's Ned. The pipeline is healthy. It's back towards pre-pandemic levels. It has been sort of at pre-pandemic levels. We've had a lot of fundings in the last few weeks. So it's kind of a -- the pipeline today is at $158 million, which is decent for us.

And we're seeing renewed activity in mostly industrial and multifamily on the CRE side. Most of the activity has increased. We haven't seen a lot of renewed investment on the C&I side. We've got some senior housing and memory care unit developments that we're getting involved in. We've always been in that space, but that slowed down a little bit during the pandemic. But with vaccinations occurring, that's picked up a little bit. So we're seeing opportunities there.

So we feel good about the second half. I think sort of mid-single digits is still a good place to peg growth for the year.

Okay. Great. And then just kind of tie in loan growth with the mortgage banking discussion. So we should expect to see a continued growth in the residential real estate portfolio as you look to retain more of the originations. Is that fair?

Yes, it is. And we saw some of that in Q2. And that's just kind of market-driven. It's not a conscious decision on our part. It's just the nature of the applications that we're getting more oriented towards jumbo for instance. So I think that's a fair statement, Damon.

Yes. Damon, this is Mark. I'll just reinforce that the purchase activity in the Boston suburban areas where many loans are not salable by -- into the conforming agency market by reason of size remains really strong. So although refi -- conventional refi activity may have dropped off a little bit. The New England housing markets where, we're present, remain very robust, and purchase demand is extremely high and market values are strong.

So as Ron said, it's not that we're redirecting loans from salable into portfolio. It's just that the jumbo mortgage activity is still very, very robust.

Got it. That makes a lot of sense. And then I guess my last question on credit. I mean, obviously, credit trends are phenomenal and very consistent for you guys. How do we think about the provision going forward? Took a credit in the first quarter, nothing this quarter. As you continue to book loans, do we ask about -- do we think about maybe no provision again in the back half of the year?

Yes. I mean we're pretty comfortable with where we are on reserves. I think, generally speaking, the level of provisioning would somewhat correlate to loan growth. But we're also factoring in economic outlook, Damon. So I guess I'd just leave it at saying we feel pretty comfortably reserved at the moment.

Okay. All right. Fair enough. And then if I could just sneak in one more. Just any quick updated thoughts on the dividend and just given the strength of the earnings and capital generation kind of what you would view for the next potential assessment of the dividend?

Yes. So we constantly look at our capital levels, obviously, from a safety and soundness standpoint but also from a shareholder return. We review the dividend every quarter. We're comfortable with it right now. It's -- we consider it to be very sustainable. So I can't give you any guidance as to when the next dividend increase would be, but that's something that we look at every quarter.

The next question comes from Erik Zwick with Boenning and Scattergood.

First question, I know the loan-related derivative income can be lumpy from quarter-to-quarter, and it's interesting just to look across a couple of different banks that reported this morning. You had a strong quarter, and I had another bank that was weaker and pointed to just the shape of the yield curve, making it not as attractive. But just curious from your perspective, what led to some stronger income this quarter and how you think about that line item going forward?

Yes. I mean Erik, it's based on new volume, and we talk about it with every new customer. And if the rate environment is right. We generally fix rates through swaps rather than doing fixed rate lending. And we're -- I think we're dealing with a relatively sophisticated base of customers, especially in our larger ticket loans. And they're accustomed to using swaps to manage interest rate risk. So we happen to have a good quarter in new originations and swaps followed.

So yes -- and you're absolutely correct in your first comment, it's lumpy and it's hard to predict quarter-to-quarter. And I can't tell you today what the next quarter is going to look like. But we feel pretty good about kind of staying in line with prior years in terms of the total year.

That makes sense. And just on switching gears to M&A. Certainly, activity in the industry and in kind of your region has picked up this year, and Washington Trust certainly has a very strong currency. Could you just remind us how you think about the possibility of an acquisition today and what might be attractive from an asset size or geographies or business mix?

Yes. I don't think it's changed a lot, Erik. This is Ned. I mean our gating factors are what they've always been priced. I was convincing ourselves we can do something once we own it. And it's got to solve for something that we don't think we can solve for as easily organically.

I don't think our geo outlook on a whole bank deal has changed. It's in footprint. It's got to be relatively proximate. There aren't a whole lot of opportunities. We'd be very careful on the credit front. We're not going to inherit credit issues.

So I don't think any of that's different than it has been. We still consider M&A one of the avenues for growth. So we're looking. We're talking. We're not certainly unwilling to consider that as an important part of our growth strategy.

And then, Mark, you can talk about it on the wealth side, if you want?

Yes. Thanks, Ned. We're always looking, Erik, for wealth M&A. And in addition to being on the other end of the line for any outgoing -- incoming calls from sellers looking for a partner, we are doing our best to start to proactively try to identify opportunities in our area.

Probably in that size range, we'd be talking about $800 million to $1.5 billion in AUM with, as Ned said, business mix and capabilities that help complement what we have or address areas that we might like to build up in. So the geography there could extend a little bit further than in footprint as it might for a bank, really New England in general and maybe a little bit further south of Connecticut.

(Operator Instructions) The next question comes from Laurie Hunsicker with Compass Point.

I'm hoping that we can just go back to expenses. Maybe just starting with your debt prepays. You've done that for the last 3 quarters. Is that something that we likely see continue? Or -- I mean how are you thinking about that? You've got another $5 million of PPP on amortized fees come in. Do you not let that drop to the bottom line? Or how do we think about that?

Yes. So we're pretty close to the end of the barrel on those prepayments. So I wouldn't really expect us to be doing any more.

Okay. Okay, fair. And then just looking at your overall expenses, stripping out the prepays, your $32 million a quarter. The last time, your mortgage banking revenues were running at $6 million. You were closer to the $30 million a quarter on noninterest expenses. But are there other tightening measures that you're looking at? Or are we kind of looking at a $32 million run rate for the back half of '21?

I think that's right, Laurie. We don't have any -- we run things pretty lean to begin with. So there isn't a lot of expense that we could take out necessarily. So no, I think that's a pretty fair run rate.

Okay. Okay. And then just any comments on future branch openings? How are you thinking about that?

Yes. Laurie, it's Ned. I'll start with that. And Mark, you can chime in. I think we still have some market opportunity on the deposit front. We think there are a couple of markets, handful of markets in the Rhode Island footprint that -- where we're not physically present, where it would be helpful to be physically present. We don't have anything planned for this year that would be put in place this year. So East Greenwich is it. East Greenwich is doing well already. It's beating our expectations, which is nice to see.

But I think, Laurie, over the next couple of years, there might be a handful of branches. And at the same time, we think it's really important for us to be thinking about sort of the digital approach and what we need to do to simplify things for our customers and find growth through non-brick-and-mortar approaches.

So we've got both on the radar. But I think our branch -- our average branch size is still in that $150 million kind of range. So we've got some -- we can leverage that a little bit. But we're not -- every new branch is a little daunting, right, in this day and age. So we're very careful about it.

Okay. Perfect. That's helpful. And then just last question, going back to what Damon was asking on capital management. Can you discuss buybacks? You all haven't been active in many banks out there. Can you talk a little bit about your thoughts on that?

Yes. So Laurie, it's Ron. Again, we monitor our capital position all the time. We refresh our buyback program, which we will continue to do on an annual basis. No plans at this point in time to be doing any share buybacks at our current stock price level. But it is something that is definitely something that we're thinking about on a quarter-by-quarter basis.

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Ned Handy for any closing remarks.

Well, thank you all very much. We appreciate your time and interest and certainly look forward to speaking with all of you again soon. So that concludes it. Have a great day. We'll speak soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.