Washington Trust Bancorp Inc (WASH) 2015 Q3 法說會逐字稿

Good morning, and welcome to Washington Trust Bancorp Inc's conference call. My name is Melissa. 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 Marketing and Investor Relations. Miss Eckel?

Thank you, Melissa, and good morning, everyone. Washington Trust Bancorp Inc's third-quarter 2015 conference call will be hosted this morning by Joseph MarcAurele, Washington Trust's Chairman and Chief Executive Officer. Ned Handy, President and Chief Operating Officer, and David Devault, Vice Chair, Secretary and Chief Financial Officer.

We'd like to remind you that this morning's presentation may include forward-looking statements, and actual results could differ materially from these statements. Our complete Safe Harbor segment, including a discussion of related factors, appears as part of our earnings press release. As well as within our most recent SEC reports on Forms 10-K and our 10-Q filings. All of these materials are first to the SEC, and are available on our Investor Relations website at washtrustbancorp.com. As a reminder, Wash Trust trades on NASDAQ's OMX market under the symbol WASH.

I'm now pleased to turn the call over to Washington Trust's Chairman and Chief Executive Officer, Joseph MarcAurele.

Thank you, Beth, and good morning. Today, David and I will review Washington Trust's third-quarter results, which were issued in a press release yesterday afternoon. After our prepared remarks, Ned Handy will join us to answer any questions you may have about the third quarter or the remainder of the year.

Washington Trust earned $10.2 million or $0.60 diluted share for the third quarter of 2015. These results were below the levels we reported in the second quarter, primarily resulting from conditions affecting revenues in several business lines that we will discuss in more detail later on. That said, our third-quarter performance ratios remained healthy, with a return on average equity and return on average assets at 11.13% and 1.11%, respectively.

Our results for the most recent quarter reflect our continued efforts to compete and grow in a challenging environment. During the quarter, we completed the acquisition of Halsey Associates, a New Haven Connecticut-based registered investment advisor. We had solid deposit growth in the quarter, and recently released FDIC statistics indicate further Rhode Island market share growth for Washington Trust. While loan growth was affected by strong competition and other factors, asset quality remained very satisfactory. David will discuss our financials in greater detail. First, I'd like to provide some highlights from the quarter.

Our Wealth Management division is a key line of business, and we continue to make strategic investments in this area for future growth. As I mentioned earlier, one of the highlights of the quarter was our acquisition of Halsey Associates on August 1. At the time of closing, Halsey had approximately $840 million in assets under administration, increasing Washington Trust's Wealth Management assets to approximately $6 billion. During August and September, however, the equity markets declined noticeably. While the market has rebounded somewhat, there are still headwinds that we have to face. We remain cautiously optimistic that increased holiday spending will help the market recover.

In the months ahead, we will introduce new Wealth Management technology. Including our websites and client portals, designed to enhance our client-advisor relationships. We also look forward to the opportunities Halsey presents in helping us grow our Wealth Management and lending business in Connecticut. We had modest loan growth during the third quarter, as total loans rose by $21 million to $2.95 billion at September 30.

On the Commercial side, new loan production generated during the quarter was offset by an unusually high amount of commercial real estate payoffs. We didn't lose these clients to bank competitors. In many cases, these payouts resulted from outright sales of properties to new buyers. And many of them were financed by REITs and institutional parties at prices, terms and conditions that frankly we were unwilling to match. Competition remained fierce. Yields continue to come down during the quarter. The good news, however, is that we believe the Commercial pipeline is healthy going into the fourth quarter.

Residential mortgage volume was solid. We had solid production throughout the Rhode Island, Massachusetts and Connecticut markets. Purchase activity picked up during the quarter, while refinancing actually slowed. We had particularly strong mortgage activity in Rhode Island, indicating that the local economy continues to improve. The Federal Reserve obviously did not increase rates as expected. So we continued to take advantage of market opportunities as they presented themselves. We did, however, see a decline in mortgage banking revenues on a linked quarter basis, and David will provide some color on this in his comments. The residential mortgage pipeline also remains healthy going into the fourth quarter.

We had a nice uptick in deposits in the third quarter, as total deposits reached $2.84 billion at September 30. We had good in-market deposit growth, which has helped our funding costs. Recently released FDIC statistics indicate that Washington Trust Rhode Island deposit market share increased to 9.58% at June 30, 2015. We remain in third place behind Bank of America and Citizens.

Renovations are currently underway at the site of our new branch on the East side of Providence. In addition to our branch, the developer's plan calls for a mixed-use property, including retail shops, restaurants and parking. We expect the branch to open in early 2016.

David will now review our third-quarter results. David?

Thank you, Joe. Good morning, everyone, and thanks for joining us on our call this morning. I'll review our third-quarter 2015 operating results and financial position as described in our press release yesterday afternoon.

Net income amounted to $10.2 million or $0.60 per diluted share for the third quarter. That compares to second-quarter net income of $11.5 million or $0.68 per diluted share. Included in the operating results for the third quarter were acquisition-related expenses, which equated to $0.03 to per diluted share. Excluding that item, the linked quarter decline in earnings reflects some conditions affecting revenues in mortgage banking, Commercial Banking and Wealth Management. And I'll comment on those matters during this call.

On a year-to-date basis, earnings and earnings per share are up 10% over the same period a year ago. Our year-to-date return on equity is 12.17%, and the return on assets is 1.20% for the same period. Comparable returns on equity and assets for the nine months ended in 2014 were 11.6% and 1.21%, respectively.

Joe mentioned the Halsey acquisition. That was completed during the quarter on August 1. The cost to acquire Halsey was $10 million, including $1.7 million in cash, $5.4 million in the form of Washington Trust common stock, and a $2.9 million liability for the estimated present value of future earn-outs to be paid. As of the acquisition date, Halsey's assets under administration were approximately $840 million. And the acquisition resulted in the recognition of intangible assets of about $6.6 million, and goodwill of $6.7 million.

There were acquisition-related expenses in the quarter, $504,000, and there were $433,000 of acquisition-related expenses in the second quarter. Again on after-tax basis, the acquisition costs resulted in a charge to diluted earnings per share of $0.03 in the third quarter, and it was $0.02 in the second quarter. And we expect a small amount of remaining acquisition-related expenses will be recognized in the fourth quarter.

Looking at net interest income, the largest source of revenue, the net interest income was $26 million, down slightly from the second quarter. While there was a modest increase in average interest earning assets, the net interest income results reflect continued pressure on the margin and a lower level of prepayment fee income.

The margin in the third quarter was 3.07%, down 8 basis points from the second quarter. A portion of that decrease relates to prepayment fee income on commercial loans, of which there was $169,000 in the third quarter. And that was a reduction of $350,000 from the second quarter. Excluding that prepayment fee income in both periods, looking at it that way, the margin was down by 4 basis points quarter to quarter. And that decline reflects the pressure being placed on asset yields, as we continued to operate in a sustained low interest rate environment. Meanwhile on the funding side, the cost of interest-bearing liabilities was 0.79%, unchanged from the second quarter.

On the balance sheet, total loans rose by $21 million or 0.7%. The largest increase was in residential, which were up by $23 million or 2.3% in the quarter, and residential loans were up about 8% in the last 12 months. Consumer balances were up $2 million in the quarter, led by an increase in home equity line balances.

Commercial loan balances declined by about $4 million or 0.2% in the quarter. That included a net increase of $8 million in commercial real estate, and a decrease of $12 million in commercial and industrial. We did originate a fair amount of new commercial real estate credits in the quarter. And we saw a net increase of $11 million in construction and development loan balances, which are in this category. However, overall balance growth in commercial real estate was hindered by about $36 million in unscheduled loan payoffs during the quarter that Joe referred to earlier.

Looking at C&I, the most significant reason for the decline was a reduction in line of credit utilization by commercial borrowers. So the relatively low level of loan growth in the latest quarter did not help to overcome the continued pressure on the margin. But we do have reasons to believe that fourth-quarter original portfolio growth should be much better. Also, investment securities stand at $345 million at the end of September, down by $29 million in the quarter. That decrease reflects calls of securities and routine principal paydowns on mortgage-backed securities, partially offset by purchases of US government agency securities for balance sheet liquidity purposes.

Total deposits rose by nearly $100 million or 4% in the third quarter, and stand at $2.8 million. Wholesale brokered time deposits declined by $17 million in the quarter, and excluding those wholesale brokered time deposits, in market deposits rose by 5%. And that increase included a nice go ahead of $56 million or 12% in demand deposit accounts. These strong deposit inflows allowed us to reduce Federal Home Loan Bank borrowings by $90 million during the latest quarter.

Non-interest income represents about 35% of our total revenues, and was $13.9 million in the latest quarter, down 9% on a linked-quarter basis. And there were several contributing factors for this.

In our Wealth Management business, third-quarter revenues were $8.9 million, down very slightly from the previous quarter. Included in the third-quarter results were $662,000 of revenues generated by Halsey since the August 1 acquisition date, and you need to take that into account in looking at the linked-quarter comparison. But clearly, asset-based Wealth Management revenues were adversely affected by equity market declines during the quarter, particularly in August and September. And the linked-quarter comparison also reflects a decline of $344,000 in tax preparation fees and services, which are typically concentrated in our second quarter.

Wealth Management assets under administration stand at $5.7 billion at the end of September, up $503 million or 10% in the quarter. That increase reflects the addition of assets from the Halsey acquisition. However as with revenues, total Wealth Management assets were adversely affected by the declines in the equity markets again during the quarter.

Mortgage banking revenues, which we define as net gains on loan sales and commissions received on loans originated for others, was $2 million in the third quarter, down 29%, or nearly $800,000 on a linked-quarter basis. The decline is reflective of a lower yield on loan sales, and also reflects a decline in loan sales volume. Residential mortgage loans sold into the secondary market were $143 million in the second quarter, and $132 million in the latest quarter. Another revenue source, loan related derivative income, which is primarily interest rate swaps with borrowers, amounted to $327,000 in the quarter. That was down $390,000 on a linked-quarter basis.

Finally, other income, which was $457,000 in the third quarter, was down about $200,000 on a linked-quarter basis. And we had reported there was a $250,000 recovery or settlement that we had received in the second quarter on a trust preferred debt obligation that we had previously owned. And that had contributed about $0.01 per share to earnings per share in the second quarter.

Looking at non-interest expenses, which amounted to $24.5 million, they were up about 1% on a linked-quarter basis. Included in non-interest expenses in the quarter were $504,000, again, of acquisition expenses. That compares to $433,000 in the second quarter. On a core basis, non-interest expenses rose by about 1%. And the increase includes the addition of $447,000 of expenses associated with the Halsey business. And again, that's for the two-month period at the end of the quarter. So those increases in total non-interest expenses were partially offset by a decrease in advertising and promotional expenses due to the timing of those activities.

Meanwhile, our asset quality metrics remained satisfactory and fairly stable in the latest quarter. Non-performing loans stand at $16.8 million or 0.5% of total loans. That compares to $15.1 million or 0.55% of total loans at the end of the second quarter. Total past-due loans or deliquencies were $21.8 million or 0.74% of total loans at the end of the third-quarter, down from 0.82% or $24 million at the end of the second quarter.

We recognized a loan loss provision charge to earnings in the latest quarter of $200,000, and that compares to $100,000 in the second quarter. That quarterly provision reflects loan loss allocations commensurate with growth and changes in loan portfolio balances, as well as reductions in other loss exposures based on our assessment of continued improvement in credit quality conditions. The allowance for loan losses is 0.92% of total loans, down 2 basis points from the end of the second quarter.

Total shareholders' equity for the Corporation was $370.5 million at the end of the quarter, up $11.4 million during the quarter. That increase includes the common stock issuance of $5.4 million in the quarter in connection with the Halsey acquisition. We declared a $0.34 per share dividend in the third quarter, which was paid last week. And the Corporation and the subsidiary banks' capital continued to exceed the required levels to be considered well-capitalized. Our total risk-based capital ratio for the Corporation is at 12.8% at the end of the third-quarter, up 2 basis points in the quarter. And the intangible equity to tangible assets ratio is 8.19%, down about 9 basis points from the end of the second quarter.

At this time, I'll turn the call back to our Chairman and CEO, Joe MarcAurele.

Thank you, David. The third quarter obviously, is evidence that Washington Trust is not immune to the challenges of this operating environment. To a certain extent, we do believe it is unusual to have simultaneously disappointing revenue results in more than one or two business lines. That has not been our experience over a long period of time. We continue to strongly believe in the soundness and diversity of our business model, which has fairly consistently benefited from this kind of diversity.

Washington Trust remains a strong, well-capitalized institution. We have a strong foundation, and we're committed to growing the Corporation to enhance in the value to our shareholders. We've embarked on significant growth initiatives, including acquisitions and [OVO] branching and investments in technology. We believe we'll benefit from these initiatives going forward.

This concludes our prepared remarks. At this point, David, Ned and I are open to answer any questions you may have. Thank you.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Mark Fitzgibbon, Sandler O'Neill.

Good morning. David, it sounded like you were pretty upbeat on the net interest margin outlook, given what sounds like a strong commercial pipeline. Do you think you can hold the margin somewhat close to its current level, or are we likely to see a little more slippage?

That optimism was geared more towards net interest income dollars than the margin itself. Structurally, we would continue to expect some continued slippage in the margin if rates stay where they are right now.

Okay. And then secondly, I wondered if you could -- I know you've said the pipelines both commercial and mortgage were healthy. Could you share with us the size of those pipelines, and maybe what the average rate looks like on the commercial pipe?

Mark, it's Ned, good morning. Yes, the pipelines are strong in both areas, the gross pipeline in the Commercial Bank is over $200 million. We expect that to have another strong quarter, as we did last year on the commercial side, both in CRE and C&I.

Obviously, the third quarter was affected by a higher than normal level of payouts in the CRE book. Which we should expect will continue somewhat, rates are down, cap rates are low, prices being paid are very high and our more sophisticated customers are taking advantage of that. So we expect that to continue.

But the growth in the fourth quarter should be -- should get us well back on track. The resi pipeline is still in the $140 million range, strong enough to suggest that we'll have a strong fourth quarter, applications continue to be on track in the higher end of normal. And so we have reason to believe that the fourth quarter will be strong.

And, Ned, I noticed a lot of the press releases you guys put out about deals that you have done have been on loans in Connecticut. What would you guesstimate are your commercial loans booked this past quarter came from Connecticut?

I would have to take a guess at that. It's probably -- it's below 20% of the book. It's a new market to us.

We're active there. Mostly on the C&I -- excuse me, on the CRE side. But it would be fewer deals in Connecticut than in our obviously the whole market of Rhode Island, and we've been particularly active in the general greater Boston market.

You've heard us talk about the downtown Boston market, and we're not doing a whole lot there. But the surrounding markets are very strong, and so we're active there.

And then the last question that I had is on Halsey. I wondered if you could just share with us your thoughts on what percentage of the assets you expect to retain there? And I know it's early, but how the integration is going?

Mark, I would say that we -- this is Joe. We would feel as though that book of business is very sticky. We don't anticipate any significant loss of clients.

The downdraft in the assets under administration at both Halsey and our Rhode Island and even Western Wealth Management businesses were really almost totally attributable to market conditions. Particularly in August and September. But loss clients has been pretty limited.

Thank you.

Thanks, Mark.

(Operator Instructions)

Travis Lan, KBW.

Thanks, good morning, everyone. Ned, I just wondered, so it looks like year to date you're on pace for mid single-digit loan growth.

But, as you've mentioned, each of the last two years, you've seen fourth quarter growth of 5% and 7%. And do you expect this fourth quarter to get back to those levels, or is it a little bit tempered based on the level of competition?

I think we'll get back on track in the high single digits. And we've got a very robust current pipeline, and the next 90 days should be adventuresome and full of activity. So I think we'll get back on track.

Got it. And, Joe, you mentioned, obviously, the competition across the lending environment. But how does that vary within your own markets? Is there a specific geography maybe that is more challenging than others right now?

I would say that it's across every market, particularly the greater Boston market where there are more players. And on the commercial real estate side, the pricing competition in particular is vicious.

And one of the things that we have seen is that as these premier properties at incredibly low cap rates have changed hands. That the long-term financing available either through REITs or institutions has really changed the landscape there.

From our perspective, we believe that the better developers, we like to think a lot of them were our customers, see the value that can be derived from a sale. And quite frankly, are probably intelligently pulling the trigger on those sales.

Unfortunately, as we were paid out on some of the things this quarter, these things were beyond the prepayment penalty phase. So it affected us from the perspective of the types of prepayment penalties that we at times had enjoyed in previous quarters.

Got it. That's helpful. Dave, just last one on the balance sheet. Securities portfolio has come down to 10% of assets. Is that a reasonable level going forward, or would you expect some reinvestment there?

It really can't drift below that to any measurable extent, Travis. So we are reluctantly reloading in the securities portfolio where necessary for liquidity and deposit collateralization management purposes. I say reluctantly, because obviously yields are just not very attractive without taking on any significant amount of interest rate risk or mismatch, and we're not doing that.

Got it. Okay, that's helpful. And then just on the fee side, obviously, David, you gave some good color there. But just maybe I wanted to verify the outlook or the potential for a rebound in mortgage banking and on the swap side. So I know obviously the residential pipeline, it's sounds like it's fairly strong, but just how that may impact the mortgage banking line going forward.

Mortgage banking we would expect would be continued to be a significant contributor to our profitability. A larger portion of the mortgage pipeline is sale directed rather than portfolio directed than in our previous history, so that is helpful to that line item. And there were some reductions in yield in the quarter that we think we can rebound from on the sales.

So overall, I'm relatively optimistic about mortgage banking. The same thing would be true with derivative income. Certainly, if we have an increase in commercial loan activity, that's generates, all things being equal, swap transaction income. And we'll just have to see where that goes.

Got it, okay. And then last two, just on the expense side. So if you annualize the Halsey expenses, it looks like it's about $2.7 million on an annualized basis. Is that appropriate, or are there any delayed expenses or timing issues that brings that higher?

That is a pretty good way to look at it. We might do some things with spending or maybe office space or something like that, that would have a modest change. But it is a -- that is a good way to look at it.

Okay. Good. And then just Joe had mentioned some Wealth Management technology investments. Are those in the existing run rate or are those additional investments to be made?

Those are, for the most part, prospective. But I would point out that we continuously reinvest in technology in a lot of different business lines over time, and there's things that reach the end of their useful life and the depreciation drops off. So I think we're being very thoughtful about how we manage investment spending.

Great. Thank you, guys, very much.

Laurie Hunsicker, Compass Point.

Hello, good morning, gentlemen. Can you help us think about your construction book?

Obviously, that was huge growth linked quarter. It's a low denominator, but at this point, your $122 million book is 4% of loans. How are you thinking about where that goes?

Again, it is a fairly small balance as part of the total portfolio. And a lot of things came together in the quarter, and there were quite bit of additional advances on things that had been booked or closed in previous quarters. Which largely explains that increase.

Laurie, it is Ned. We're certainly not overweight in construction. We fund about $4 million-ish a month in existing construction loans. And some of those are early stage, and I'd say, as many are later stage and coming to fruition.

What we're finding is those deals as they get towards completion are finding buyers upon completion. Some even -- one prior to completion. So we're not holding on to them for very long once they are completed.

But it is not -- our strategy includes doing some more construction. But it is certainly not an intent to be overweight on it, and we've got diversity across property type. We've got diversity across markets. Some of it is in the greater New Haven area, some of it is in Boston, some of it is here in Rhode Island.

So I don't think it's a concern in terms of being overweight at all, and I think our diversity is -- and I think we're being prudent about it. We get a little bit better pricing in construction, but interestingly, not a whole lot better. So it's not like it's a rate play or yield play for us, it's just part of our business.

Got it. And then can you just remind us, what is your average size construction loan? If you know.

That is a hard question to answer.

I'd say, Laurie, it is probably in the teens. Probably $15 million, $20 million. It depends on the individual deal.

That would be the high-end of the range.

And I would say, importantly, it is probably no different than the average size of our other new originations in the CRE space. It's not like we're doing extra large construction loans, we are pretty careful about individual deal size and total hold levels.

Okay. And then just one last question. Geographically, if we look at -- you started the year with about an $80 million book, and so now you're $122 million. Do know roughly what percentage of that growth has been in Boston? Or maybe asking another way, just more generally, what percentage of your total book is in Boston -- or the Boston market?

I don't think I have that. Total CRE including construction is nearly all Rhode Island, Connecticut and Massachusetts. There is a fair amount in Boston, but it is spread over the three states.

Okay.

I would say, I don't think the we have a concentration the Boston marketplace. We've been pretty careful about particular parts of that for a while now.

And I would say we're focusing more on the outer suburbs. To the extent that we're doing deals in Massachusetts, and we have got a pretty good focus in the greater New Haven market, and obviously we're active in Rhode Island.

Right. And certainly your credit there has been pristine. You have zero non-accruals in that book. (Multiple speakers).

Just one last quick question just from a timing perspective as I'm modeling expenses. The branch, the Eastern Providence branch in Rhode Island, approximately when is that going to open? What month? Just approximate?

Probably, Laurie, January or February.

January or February, okay. And that again should run with an initial drag of about $500,000 or so per year?

That is a good estimate.

Okay, perfect. Thank you, gentlemen.

Thanks, Laurie.

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Joseph MarcAurele for any closing remarks.

Thank you very much. We appreciate everyone's participation today, and obviously we look forward to talking to you again on our next earning calls to close out the year. So thank you very much.

Thank you. This concludes today's teleconference. You may disconnect your lines. Thank you for your participation.