Washington Trust Bancorp Inc (WASH) 2016 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 I will now turn the call over to Elizabeth B. Eckel, Senior Vice President, Marketing and Investor Relations. Ms. Eckel?

Thank you, Melissa. Washington Trust Bancorp Inc.'s third-quarter 2016 conference call will be hosted by Joseph MarcAurele, Washington Trust's Chairman and Chief Executive Officer; Ned Handy, our President and Chief Operating Officer; and David Devault, Vice Chair, Secretary, and Chief Financial Officer.

Before we begin the call, it's important to note that today's presentation may contain forward-looking statements and actual results could differ materially. Our complete Safe Harbor statement appears in our earnings press release and in other documents that Washington Trust files with the SEC.

We encourage you to visit our Investor Relations website at washtrustbancorp.com to review these materials and the Safe Harbor statement. Washington Trust trades on NASDAQ under the symbol WASH.

And now I'm pleased to introduce Washington Trust's Chairman and CEO, Joseph MarcAurele.

Good morning, everyone, and thank you for joining us on today's conference call. Yesterday we released our third-quarter 2016 earnings. This morning I'll review some of the highlights from the quarter, and David will discuss the financial performance. At the conclusion of the call, Ned, David, and I will answer any questions you may have about our results for the remainder of the year.

I'm pleased to report that Washington Trust posted record quarterly earnings, as net income amounted to $12.3 million or $0.72 per diluted share. These results included an adjustment to a contingent consideration liability on our balance sheet that contributed approximately $939,000 or $0.05 per diluted share to our earnings. David will provide more information on this matter in his comments.

The third quarter also marked the first time in our 216-year history that we exceeded $4 billion in total assets. At quarter's end, profitability measures were strong, and capital ratios continue to be very satisfactory. Our solid results once again demonstrate our ability to achieve consistent growth and profitability despite environmental, economic and competitive pressures.

Our performance also reflects the strength and diversity of our business model, as our ability to generate a consistent stream of revenues from both interest and noninterest income sources has been a key to our success over time.

Now let me take a moment to discuss our core business lines. A notable highlight for the quarter was the significant increase in total deposits, which amounted to $3 billion at September 30. This is a nice rebound from second-quarter levels, which were affected by seasonal fluctuations of some of our larger institutional and governmental depositors. We hope this positive trend will continue, but realize we may continue to see quarter-end variations from time to time, and based on the timing of transactions by these larger depositors.

Turning to the lending business, total loans stood at $3.2 billion at September 30, with total growth of over 3% for the quarter. The commercial portfolio, including commercial real estate and C&I, rose by 1.4% in the quarter, as overall growth was masked to some extent by continued payoffs in the commercial real estate portfolio.

The year-to-date increase in the commercial portfolio stands at 6.2%, and we are optimistic that we will finish the year with a respectable level of commercial loan growth. The residential portfolio increased by 7% in the quarter, including some whole loan purchases as well as organic growth.

The Wealth Management division, as all of you know, is a key part of our business model, providing a major source of noninterest income. The division had an outstanding third quarter as Wealth Management revenues reached an all-time quarterly high, and end-of-quarter Assets Under Administration surpassed $6 billion for the first time. We believe our Wealth Management group has additional growth potential, and in recent years, we've made investments in talent and technology to further position ourselves as one of the region's premier providers of Wealth Management and Trust and Estate services.

On the mortgage banking side, we generated strong mortgage banking revenues as a result of record volume of loans sold in the secondary market in the third quarter. We had a healthy mix of both purchase and refinance activity from throughout the region.

In recent years, we've opened up mortgage production offices in nearby Massachusetts and Connecticut with great success. In July, we expanded our Massachusetts presence yet again by opening a mortgage production office in Wesley, an affluent suburb outside of Boston. The office is near our Weston Financial Wealth Management office, providing us with opportunities to build synergies between the groups.

As we look into the fourth quarter, our mortgage pipeline is currently in very good condition and we are on pace to finish out the year with very solid production levels.

I'll now turn the discussion over to David for a review of our financial results. David?

Thank you, Joe. Good morning, everyone. Thanks for joining us on our call today. I will review our third-quarter 2016 operating results and financial position as described in our press release issued yesterday.

Net income amounted to $12.3 million or $0.72 per diluted share for the third quarter. This compared to net income of $11.1 million or $0.64 per diluted share in the second quarter of this year. The profitability results in the latest quarter were solid, with a return on equity of 12.57% and a return on assets of 1.21%.

These net income and earnings per share amounts were record highs for the Company. Included in the results was a reduction in a contingent consideration liability that resulted in additional income of $939,000 or $0.05 per diluted share for the quarter. I'll explain that item further in a few moments. But even excluding that, the profitability of the Company was up nicely over the second quarter.

These results were driven by revenue growth compared to the second quarter, while core noninterest expenses were essentially unchanged, and we saw an increase in the loan loss provision as well. Total net interest income in the latest quarter was $27.4 million compared to $26.8 million in the second quarter. The increase was driven by balance sheet growth, including both loans and investment securities.

Loans were up by $100 million. Included in that loan growth was about $59 million in residential mortgage whole loans purchased in the third quarter. Meanwhile, we increased the investment securities portfolio by a net $161 million, primarily due to the addition of agency mortgage-backed securities. The additions were also consistent with our liquidity management and collateralization needs.

Total average interest-earning assets rose by $178 million in the second quarter. The yield on interest-earning assets declined by about 10 basis points to 3.55%, due to the lower yields on the asset additions. On the funding side, we saw a good increase in the average balance of in-market deposits of $66 million, and we maintained an all-in average cost of deposits of 31 basis points.

We added some wholesale broker time deposits and lengthened the Federal Home Loan Bank advance position somewhat in response to the securities portfolio additions. So while net interest income was positively impacted by the balance sheet growth, the net interest margin declined by 11 basis points to 2.94%.

Total loans stand at $3.2 billion at the end of September, up 3% in the quarter, and they were up 6% in the first three quarters of 2016. Residential loans were up by $75 million in the quarter. And, as I indicated, this included purchases of loans from other banks. These are whole loans, individually evaluated to our underwriting standards, and are nearly all secured by properties in Massachusetts.

The commercial portfolio, including both C&I and CRE, was up by $25 million or 1.4% in the quarter. The growth was concentrated in commercial real estate and construction balances. In total, commercial loans were up by 6.2% on a year-to-date basis.

Deposits stood at $3 billion at the end of September, up 9% in the quarter. We saw very good inflows in money market and demand deposit categories in the quarter. And a lot of that is related to the business cycles of various larger institutional depositors in the quarter. And those results were directionally consistent with the trend that we've seen in recent years.

Also included in the deposit growth was an increase of about $65 million in brokered wholesale time deposits, which was one of the funding sources for the investment portfolio additions that I mentioned. Excluding the wholesale broker deposits, the in-market deposits were up by 7% in the latest quarter.

Noninterest income continues to represent a significant portion of our total revenues amounting to 39% of total revenues in the latest quarter. Noninterest income was $17.3 million, up 8.5% on a linked-quarter basis. In the second quarter, we had a $589,000 gain from the receipt of bank-owned life insurance proceeds. And excluding the impact of that item, noninterest income was up by more than 12% over the second quarter.

The Wealth Management business did very well in the latest quarter. Revenues were $9.6 million, up 1.5% on a linked-quarter basis. We would point out that the second quarter included, as is typical, about $300,000 in tax preparation fees, which are a seasonal item. So, we would consider the improvement in the run rate to be better than the 1.5% increase would otherwise indicate.

Wealth management assets under administration stand at $6.1 billion at the end of September, and were up by $152 million in the latest quarter. And both the revenues for the division and the level of Wealth Management assets stand at all-time record quarterly highs for the Company. The mortgage banking business also achieved very solid results in the latest quarter. Revenues, including gains in commissions on loan sales, and servicing fee income, was $3.7 million in the quarter, up 38% on a linked-quarter basis. The increase reflects higher sales volume as well as a higher effective yield on the loans sold.

We sold $164 million of mortgages into the secondary market, and that was up 18% over the second quarter, and the pipeline continues to be healthy. Loan-related derivative income, which is primarily interest rate swaps with commercial borrowers, was $1.2 million in the latest quarter, up $670,000 on a linked-quarter basis. Part of that increase relates to a positive fair value change on the portfolio of swaps, following a negative change at the end of the second quarter, which was considered to be a market reaction to Brexit developments at that time.

Looking at noninterest expenses, for the latest quarter, they were $24.7 million, down $1.4 million on a linked-quarter basis. That comparison was affected by a decrease in the estimated liability for a contingent consideration amount to be paid in connection with our 2015 acquisition of Halsey Associates, a registered investment advisor in Connecticut.

In that transaction, the selling shareholders received a combination of cash, Washington Trust common stock, and the ability to receive further cash payments based on the revenues of the acquired company for the three- and five-year periods ending in 2017 and 2019. These are commonly referred to as earnouts. And under purchase accounting, a liability for the estimated present value of those future payments was recorded at the time of the acquisition at the end of July in 2015.

However, downturns in the equity markets in the intervening period have caused the aggregate revenue to fall below the assumed levels at the time of our initial estimate. And we have accordingly reduced the estimated earnout liability by $939,000. This item is not subject to income taxes for the Corporation and, accordingly, caused a $0.05 per share beneficial impact on the earnings-per-share in the third quarter.

The final payouts will be determined at the ends of 2017 and 2019. And we would expect to further adjust the payout liability as we get closer to those dates. I should be very clear that this is solely a result of the market conditions that affected Halsey and the Wealth Management business, in general, in the months subsequent to the acquisition at the end of July of last year.

Halsey continues to perform very well, with excellent client retention and we are very satisfied with the acquisition of Halsey. And we continue to deepen existing Halsey relationships with our fiduciary capabilities, and we're finding referral opportunities with commercial and mortgage services in that market area.

The $939,000 liability reduction was recorded as a reduction to noninterest expenses. Excluding that item, noninterest expenses were down from the second quarter by about $440,000. And the most significant item affecting the comparison is that there were approximately $425,000 of employee severance costs recognized in the second quarter. The effective income tax rate was 32.2% in the latest quarter, and we are forecasting a rate of 32.5% in the fourth quarter.

I'll now comment on asset quality. Total loans past due by 30 days or more as a percentage of loans outstanding was 0.67% at the end of September, up 11 basis points in the quarter. Nonperforming loans as a percentage of total loans was 0.75%, up 19 basis points in the quarter.

The increase in both of these metrics is substantially related to the deterioration in one commercial real estate credit relationship in the quarter. This was a previously-modified troubled debt relationship. And, in the latest quarter, the credit became delinquent. And that factor, along with other assessments of the condition of this credit, led us to charge off $1.9 million on that relationship.

That was also the cause for an increase in the loan loss provision, which was $1.8 million in the quarter compared to $450,000 in the second quarter. With all that, the allowance for loan losses stood at 0.81% of total loans at the end of the third quarter, a decrease of 3 basis points from the end of the second quarter.

Total shareholders? equity for the Corporation was $395 million at the end of September, up $7 million in the quarter. During the quarter, we declared a quarterly dividend of $0.37 per share, which represented a $0.01 per share increase over the prior rate, and that was paid on October 14.

The Corporation and the subsidiary bank capital levels continue to exceed the required levels to be considered well-capitalized. The total risk-based capital ratio for the Corporation is 12.31% at the end of the third quarter compared to 12.43% at the end of June. And the tangible equity to tangible assets ratio, a non-GAAP measurement, was 7.77% at the end of September compared to 8.16% at the end of June.

And at this time, I'll turn the call back to our Chairman and CEO, Joe MarcAurelle.

Thank you, David. We're very pleased with our third-quarter performance. We believe it's a testament to our continued commitment to employees, customers, and shareholders. And for our history, throughout our history, we've helped generations of depositors, borrowers, and investors reach their goals.

We've also provided consistent returns for our shareholders. We hope certainly to continue to do this. I would like to thank you for your time this morning. And now Ned, David and I are happy to answer any questions.

(Operator Instructions) Mark Fitzgibbon, Sandler O'Neill & Partners.

The first question I had is on the balance sheet. You guys obviously had really strong growth this quarter. And you typically have pretty strong loan closings in the fourth quarter. Can you help us think about how much more balance sheet we're likely to see this year?

The commercial growth in the quarter is -- we are expecting it to be pretty good. The pipeline is in good condition. And now there is a number of expected closings in the quarter that we would expect the year will end very nicely.

Ned, if you have other thoughts on that --?

Yes. No, I think the commercial pipeline is about $215 million. About $145 million of that is C&I about $70 million of it in CRE. Of the $70 million, about $43 million is in construction. The resi pipeline stays over $200 million. We expect that to continue to be strong for the fourth quarter.

Big variable on the commercial side is payouts, and we had continued payouts in the third quarter, which we had to cover. And then we grew a little bit, and I think we'll probably see the same. My expectation is that we'll end the year in kind of the mid-single-digit growth levels on the commercial side of the balance sheet.

And then with respect to securities, I suspect that this quarter, the growth in the securities portfolio was a function of the fact that you had to collateralize muni deposits coming in it. Are you likely to see more of that in 4Q? And do you expect growth in the securities portfolio?

Well, the reasons for the growth of the securities portfolio -- collateralization is certainly a factor, but just growth in the balance sheet in general was a target there. And we believe that has worked out very well. We may do some more of that in the fourth quarter and will continue to look at the environment as the quarter continues.

Okay. And then the loan loss provision, obviously a little bit elevated this quarter due to that one credit -- can you help us think about what a good run rate for that might look like, assuming no surprises in 4Q?

We would expect, assuming the growth levels that we are targeting in the loan portfolio and the overall reasonably good credit quality conditions that we are experiencing, that a loan loss provision in the $1 million range on a quarterly basis is probably a reasonable number to assume.

Okay. And then, lastly, I wondered if you could share with us what kind of volume the Wellesley mortgage office produced in the third quarter? How much of the volume came out of there?

I don't think we have that in the room this morning, but it was very good, considering it had just been opened. And, in fact, before the office was even open, the people that we hired were busy putting loans into the pipeline. So, I think we are very satisfied with the progress there.

Thank you.

Thanks, Mark.

Thanks, Mark.

Damon DelMonte, KBW.

Just to kind of follow-up on the balance sheet growth strategy, how do we look at the margin in relation to the continued growth in the balance sheet? It looks like, this quarter, the margin came down a little bit more than what you were guiding for last quarter, but I think the growth in the securities portfolio helped to generate enough net interest income to mitigate any impact from the lower margin. Is that kind of the strategy going forward that we could expect?

Yes.

You'll probably see a little bit more of that, Damon.

Yes, I think you could see a 5-ish basis point reduction in the margin in the quarter, and that would reflect both the full-quarter impact of the additions in the third quarter and possibly some additions in the fourth quarter.

Okay. Right. So, around another 5 basis points from this level? Okay. And then could you talk a little bit about your outlook for expenses? If we back out the -- if we get to, like, a core number this quarter, call it maybe $25.5 million or so, $25.6 million, is that a reasonable starting point for the upcoming quarters?

Yes. We are working very hard to be prudent in spending and focusing it on the items that -- where we need to spend dollars. And there is always investments that are required and things like technology and so forth. So -- but, over time, we're trying to be very prudent with spending.

Okay. And then just one quick final question. You had mentioned that on the swap fee income, there was a fair value adjustment that kind of reversed itself from the second quarter. Could you quantify how much that was this quarter?

Well, the item that I mentioned, which was the volatility at the end of the second quarter, it probably was a turnaround of a few-hundred-thousand-dollars in the quarter.

Okay. Okay, that's helpful. That's all that I had. Thank you very much.

Thanks, Damon.

Laurie Hunsicker, Compass Point Research.

Just if we could go back to expenses, I know that you all have, in the past, done a charitable foundation contribution, typically in the fourth quarter of $300,000 or $400,000. Is that on the table for this year? Or how are you thinking about that?

We haven't made that call yet, Laurie. It's -- we just haven't made that call yet.

Okay. And then on to commercial real estate. Can you give us a little detail behind the $6.3 million loan, what type of accretive LTV, et cetera?

That loan has been on the books for a number of years. It is secured by a couple of office and mixed-use space properties in Eastern Connecticut. Really it's the borrower as much as the properties that -- I think they were both contributing factors to the loss recognition on that credit.

We've looked very carefully at the CRE portfolio. We don't see other things like that in the portfolio. So it's just the unfortunate outcome of a long series of events affecting this borrower.

And that had started originally at $8.2 million? Or had there been other charges on this?

The relationship was around $9 million, and all charge-offs to date have brought it down to the $6.3 million, I believe, and which had taken about $1.9 million of charge-offs. And we have another close to $1 million allocated of loss exposure on that credit.

Of specific reserves?

Yes.

Okay, okay. And then can you update us on the CRE loan from the first quarter that had a hiccup? Is there any movement there? Just if you can remind us any details on that?

Yes, I -- that --

I can follow-up with you off-line if that's easier.

Yes, I want to check my notes to see which one we are referring to there.

Okay. Yes, you had taken an outsized charge in the first quarter. You know what, I will follow-up with you guys off-line.

You gave tax rate guidance for the fourth quarter of 32.5%, which is great. Can you help us think about -- and I realize obviously some of it is directional, depending on how much you make, but can you help us think about what 2017 is going to look like on tax rate?

Well, the driver there is that tax-exempt or municipal bonds, which have been a larger percentage of total assets, are just not an attractive investment in the current environment. And, as a result, the composition of tax-exempt income as a percentage of total income has been going down. We would think the tax rate would drift up towards 34% on an effective all-in basis as a result of that phenomenon.

Okay. That's helpful. Okay, great. And then on your purchase resi book, you've been purchasing -- you've been increasing your purchasing, obviously. Can you tell us a little bit about how you think that portfolio will continue to grow on the purchase side? And then can you just remind us -- average loan size? You said it was Massachusetts average LTV. Just some flavor around that. Thanks.

Sure. The incentive to buy mortgages has been that the ability to generate portfolio loans has been limited. And a lot of our production goes into sales in the secondary market. The loans that we have bought that are primarily ARMS in the [5-1] to [7-1] flavor. And I would say in size, they are probably in a mid-six-figure range in average balance.

We've underwritten them individually. They are in markets that, by and large, we are pretty familiar with. And we may continue to do that to supplement balance sheet growth in the future. We had not bought any for a long time, but this was a decision made in the last several months to really supplement asset growth.

Sure. And then did you have average balance -- I'm sorry, average LTV there?

I don't have that handy.

Okay. Great. Thank you.

(Operator Instructions) Nicole Gulino, American Capital Partners.

Not sure if I missed it. How much was prepayment income during the quarter?

Prepayment income was about $300,000. And the impact of that from quarter to quarter has been fairly minimal in the past couple of quarters.

Okay. Okay, so the core NIM was about [2.85%]?

That sounds about right, yes.

Okay. Okay, great. All my questions have been answered. Thank you.

Thank you, Nicole.

Thanks, Nicole.

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

We'd again like to thank everyone for your time. We hope and we consider the fourth quarter to be an opportunity for us. So, with that, I will close. And, again, thank you for paying attention to our Company.

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