Washington Trust Bancorp Inc (WASH) 2016 Q4 法說會逐字稿

Good morning and welcome to Washington Trust Bancorp Incorporated conference call. My name is Michele 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, Marketing and Investor Relations. Ms. Eckel?

Thank you, and good morning. Welcome to Washington Trust Bancorp Inc's fourth-quarter and year-end 2016 conference call.

This morning's call will be hosted by Washington Trust's Executive team of Joseph MarcAurele, Chairman and Chief Executive Officer; Ned Handy, President and Chief Operating Officer; and David DeVault, Vice Chair Secretary and Chief Financial Officer.

Before we begin today's presentation I would like to note that it may contain forward-looking statements and actual results could differ materially from those statements. Our safe harbor statement appears in our earnings press release and in other documents filed with the SEC.

Please visit our investor relations website at washtrustbankcorp.com to review these SEC-filed documents and our complete 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, Joe MarcAurele.

Thank you, Beth. Good morning, and thank you for joining us on today's conference call. This morning I will review the highlights of our 2016 performance and David will discuss the Company's financial results. At the end of our prepared remarks David, Ned and I will answer any questions you may have about 2016 or the year ahead.

I am pleased to report that Washington Trust posted solid fourth-quarter results which contributed to earnings of $46.5 million or $2.70 per diluted share for 2016. This marks our seventh consecutive year of increased annual earnings. Key profitability measures remain strong and capital levels continue to exceed regulatory requirements. Our credit quality also remains healthy.

Our stock performed well, reaching an all-time high level in the fourth-quarter and we declared a $0.37 cash dividend in December. Our record performance is a result of our continued success at growing our core business lines, expanding our local and regional footprint, and maintaining disciplined pricing and expense management. In a moment David will provide a detailed analysis of our financial performance, but first I would like to highlight and discuss some of our key business lines.

Total deposits exceeded $3 billion at year-end. We had success during the year in attracting new low-cost deposits as both demand deposits and NOW accounts grew by 7% from the end of 2015. Generating low-cost deposits is critical to our funding and to fund continued loan growth. But deposit generation is a continued challenge industrywide.

In recent years our deposit growth strategies have focused on opening branches and markets dominated by our larger competitors and deepening relationships with our commercial and municipal customers. These strategies have proven successful. We believe local community branches which are adequately staffed to provide good personal service still have value.

We realize that you need convenient technology as well. So in 2017 we will do both. We will open a branch in Coventry, Rhode Island, a new market for us, and we will continue to add convenience through technology in all aspects of our business.

Total loans stood at $3.2 billion at December 31, 2016, an increase of 7% from the end of 2015, which was in line with our annual projections. This reflected a 7% increase in the commercial portfolio, despite heavy payoffs and an 11% increase in the residential portfolio.

Our mortgage banking division had a strong fourth quarter, as both revenues and loans sold during the quarter were record highs for us. Full year mortgage banking revenues totaled $13.2 million for 2016, up by 33% from 2015.

We had good production from throughout our market area including our new Wellesley, Massachusetts office in the third quarter of 2016. It goes without saying that we will be closely watching our mortgage business as we continue during this year given what will be a somewhat higher rate environment.

Wealth management revenues amounted to $37.6 million in 2016, an all-time high for the Company. Assets under administration peaked at $6.1 billion at December 31.

As with community banking, we've invested in technology to improve the client experience; however, we believe the personal service and advice we provide is valued by our clients. We've been able to differentiate ourselves and compete against the larger firms by offering a comprehensive suite of products and providing customized solutions to meet our clients' needs. We are confident that this approach will work in other markets.

As you recall in 2015 we acquired Halsey Associates, an SEC registered investment advisor headquartered in New Haven. Last week we relocated Halsey's headquarters into one of the city's more prominent office towers. The expanded office space will allow our mortgage, commercial banking and trust and fiduciary professionals to meet with Halsey clients and other industry professionals such as attorneys, accountants, developers and realtors. Establishing and building relationships in new markets is key to our future growth.

I will now ask David DeVault to take a few minutes to review our financial results. David?

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

Net income amounted to $12.2 million or $0.70 per diluted share for the fourth quarter. This compared to net income of $12.3 million or $0.72 per diluted share for the third quarter. The profitability results in the latest quarter were solid with a return on equity of 12.26% and a return on assets of 1.1 4%.

For the full-year 2016 net income was $46.5 million or $2.70 per diluted share. And net income was up by 7% over the previous year. And for the full year the return on equity was 11.96% and the return on assets was 1.16%.

The full-year net income and earnings per share amounts were record highs for the Company. Our results were driven by revenue growth, offset in part by increases in core non interest expenses and a higher loan loss provision.

In the latest quarter total net interest income was $28.6 million, up by $1.2 million or 4% from the third quarter. The net interest margin was 2.89% in the latest quarter, down by five basis points on a linked-quarter basis. Included in net interest income in the latest quarter was $816,000 in loan prepayment fee income, and that compare to $365,000 of that type of income in the third quarter.

The fourth-quarter prepayment fee income contributed about eight basis points for the net interest margin in the fourth-quarter and prepayment fee income contributed about four basis points to the margin in the third quarter. The reduction in the margin is largely attributable to a change in the mix of interest-earning assets, resulting from the addition of debt securities to the balance sheet, and increases in wholesale funding balances.

This includes additions made during the fourth quarter as well as the full quarter impact of additions of that nature made during the third quarter. In the fourth quarter agency mortgage-backed securities and agency debt securities totaling $235 million were added with a weighted average yield of 2.55%.

Net of amortization, maturities and calls on existing securities, the net increase in the securities portfolio was $174 million in the fourth quarter. Total average interest earning assets increased by $224 million over the third quarter and the yield on interest-earning assets declined by about two basis points from the third quarter. Excluding prepayment fee income in both quarters the yield on interest-earning assets was down by about six basis points.

On the funding side, average wholesale funding balances, which we would define as federal home loan bank advances, as well as wholesale broker time deposits, increased by $113 million in the quarter. And the average balance of in-market deposits increased by about $70 million.

The cost of interest-bearing funds was up by three basis points, three basis points on a linked quarter basis. We added some wholesale brokered time deposits and lengthened the federal home loan bank advance position somewhat in response to the securities portfolio additions and a purchase of residential mortgage loans. Total loans stood at $3.2 billion at the end of December, an increase of 2% in the quarter and they were up by 7% in the full year.

Residential loans rose by $43 million in the fourth quarter. This included a purchase of $36 million of loans from another bank. These are whole loans individually evaluated to our underwriting standards and they're all secured by properties in Massachusetts. In the last 12 months total residential loans increased by 11%.

The commercial portfolio rose by $14 million or about 1% in the latest quarter and the growth was concentrated in commercial construction balances. In the last 12 months the commercial portfolio is up 7%.

Total deposits stand at $3.1 billion at the end of December. They were up about 1% in the quarter and up about 4% in the last 12 months. Included in the deposit growth was $53 million of wholesale brokered time deposits added in the latest quarter and $110 million for the full-year.

Excluding those brokered deposits, in-market deposits were down 1% in the quarter but up by about 1% in the last 12 months. And as Joe mentioned the deposit mix improved as deposit -- demand deposits and NOW account balances increased by 4% in the quarter and 7% in the year.

Noninterest income continues to represent a significant portion of our total revenues with an amount of 38% of total revenues in the latest quarter. Non-interest income was $17.3 million in the quarter, up modestly on a linked-quarter basis.

Wealth management revenues were $9.3 million, down by about 3% from the third quarter, largely due to a decline in transaction-based revenues. And wealth management assets under administration were $6.1 billion at the end of December, an increase of $6 million in the latest quarter. Total wealth management revenues for the year in the wealth management assets balances at December 31 stand at all-time record highs for the Company.

Our mortgage banking business had an excellent quarter with record quarterly results. Revenues including gains and commissions on loan sales and mortgage servicing fee income was $4.5 million in the latest quarter, an increase of 22% on a linked quarter basis. And that increase was attributable to higher sales volume as well as a higher effective yield on loan sales. Mortgage loans sold and brokered into the secondary market amounted to $200 million in the latest quarter.

Loan-related derivative income was $912,000 in the latest quarter. Most of that is related to interest rate swap transactions and that was down by about $266,000 on a linked-quarter basis due to a lower volume of that type of transaction.

On the expense side, noninterest expenses in the latest quarter were $25 million, a 1% linked-quarter increase, but included in the third-quarter was a $939,000 reduction in noninterest expenses, and we had explained at the time that was due to a downward adjustment in the fair value of the contingent consideration liability recognized in connection with our -- with a 2015 acquisition.

And excluding the third-quarter adjustment, noninterest expenses were down by about $616,000 or 2% on a linked quarter basis. And salaries and benefits, the largest component of noninterest expenses, were down by about $380,000.

The effective income tax rate was 32.6% in the latest quarter and 32.5% for the full year. Our current forecast for the effective tax rate in 2017 is about 34%.

The 2016 effective rate was lower than usual or was affected downward because there were some nontaxable income items in the year, and in 2017 we see some reduction in the relative amount of municipal and -- state municipal debt securities contributing to net interest income and that is tax-exempt of course, but that has been declining.

Looking at asset quality, total loans past due by 30 days or more as a percentage of loans outstanding was 0.76% at the end of December, up nine basis points in the quarter. Nonperforming loans as a percentage of total loans was 0.68%, down by 7 basis points from the end of September. That was largely due to $2.6 million of charge-offs recognized in the quarter.

In the latest quarter a charge-off of $2.5 million was recognized on one commercial real estate relationship. That credit was a previously modified troubled debt relationship. It was placed on nonaccrual status in the third quarter. And following the charge-off the remaining carrying value for this credit is $3.9 million at the end of December.

This was the primary cause also for an increase in the loan loss provision which was $2.9 million in the quarter, compared to $1.8 million in the third-quarter. The allowance as a percentage of total loans is 0.8% at the end of December, compared to 0.81% at the end of September.

Total shareholders equity is $391 million at December 31, and that decreased by about $5 million from the end of the previous quarter. That decrease included a charge to equity of $9.5 million related to market depreciation on available for sale securities and a charge of $2.6 million to equity associated with the annual measurements of defined benefit pension liabilities.

Both of these amounts are net of tax and are recognized in the accumulated other comprehensive income component of shareholders equity. As Joe mentioned we declared a quarterly dividend of $0.37 per share in December and that was paid this month.

The Corporation and the subsidiary bank's capital levels continue to be well-capitalized. The total risk-based capital ratio was 12.26% for the Corporation at December 31, down about five basis points from the end of December. And the tangible equity -- tangible assets ratio was 7.35% compared to 7.77% at the end of the third quarter.

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

Thank you, David. We're pleased with our 2016 earnings and our ability to once again provide healthy returns to our shareholders. Looking forward 2017 promises to bring some new opportunities and some challenges.

The change will be inevitable. There may be some headwinds. However, Washington Trust has witnessed many changes and we've faced many obstacles over our now 216+ year history. We've succeeded mostly by focusing on the fundamentals. We have a strong foundation. We're committed to doing what's best for our customers, our employees and our shareholders. We will continue to do that.

We thank you for your time and now Ned, David and I are happy to answer any questions you may have.

(Operator Instructions)

Mark Fitzgibbon, Sandler O'Neill.

Good morning. First question I had, Dave, it looked like you put $175 million of leverage trade on during the quarter at it looks to me a little less than 100 basis points' spread. I guess, given the prospect for higher rates what was the thought process on that?

A lot of that occurred before the higher rate scenario played out. But the thought process was clearly to enhance income and we had the ability to do that. The amount of securities as part of the total balance sheet was relatively low.

It got down to as low as 11% at some point in the early third quarter, and between the third-quarter additions and the fourth quarter additions it's up to about 18% of total assets, which seems like a good amount, a reasonable amount. It provides ample liquidity and a lot of that is pledgeable for collateralization purposes and for the federal home bank for liquidity. It's part of our overall balance sheet strategy.

Okay. And then secondly on the mortgage side in the fourth quarter, could you share with us what the split was in the mortgage originations between purchase and refi? And was a lot of that volume coming out of that new office in Wellesley?

I don't know if I have a split between purchase and refi. The Wellesley office has been doing well, considering it's been open for maybe six to nine months.

The production there has been very satisfactory. Overall all of the offices did well because it was a good operating result in that line of business.

Okay.

Mark, it's Joe. I think it would be fair to say that throughout all of 2016 we were operating at approximately 30% of the volume as refi. That was -- that's probably a pretty good number.

Okay. And then, I know your regulatory capital ratios are strong but the tangible common equity ratio is starting to look a little bit thin. I wondered if he can share with us your thoughts on raising additional capital in 2017.

That ratio obviously was reduced because of the leveraging that took place. That leveraging is, I would say, essentially done at this point.

We don't expect to continue to do that kind of growth in the securities portfolio. And between earnings retention, net of dividends, we see that tangible equity, that tangible assets ratio continuing to grow from the current level.

And then lastly, Dave, I wondered if you could share with us your outlook for the margin?

Sure. I would say on a core basis, and this would exclude prepayment penalty fee income and also exclude the potential favorable impact of future Federal Reserve rate increases, that we would expect to margin to settle out in the to $270 million to $275 million range throughout 2017. Again, that does not include prepayment fee income, which can be a irregular. And whatever the Fed does.

Thank you.

You're welcome.

Thanks Mark.

(Operator Instructions)

Laurie Hunsicker, Compass Point Research.

Good morning.

Good morning, Lori.

Your credit is obviously very pristine, but just wonder if we can go back to the commercial real estate relationship and you can just remind us what potentially changed. You obviously saw you guys take a $1.9 million charge on that loan in the third quarter, and now $2.5 million charge. What changed between quarters and how do you see resolution on that loan?

Well in the fourth quarter we continued to assess the underlying real estate collateral associated with that credit and the overall condition of the borrower. And that assessment led us to conclude that this recognition of loss and related charge-off was appropriate.

I would say that at this point we feel that with -- we've done a very creditable job of recognizing whatever is associated with that credit. I'm hoping that we are able to work out at the carrying value that we have of about $3.9 million.

Laurie, it's Ned. I think we positioned it so that we can now work with the borrower to resolve this in a relatively short timeframe. We've recognized where we've needed to position the asset to do that.

You don't have any other exposure with this borrower, do you?

No. This is the -- the $3.9 million is the totality of it.

Okay, great. Just in terms of charitable foundation contributions, I know in the past you've done that typically the fourth quarter, we didn't see it. How are you thinking about that?

At this point the foundation is satisfactorily funding the charitable giving program that we have. It is likely that we will not do that again in 2017 as well. And if we change our approach on that we would certainly talk about that.

Okay. And then how do you think about dividend payout targets?

The dividend will follow the path of earnings and as I've said, the 50% to 55% payout ratio seems to make sense for us. It's providing sufficient earnings or capital growth to support the growth of the balance sheet. That's what we are assuming at this point and we will continue to evaluate it each quarter.

Joe, last question for you. You had mentioned new opportunities. Obviously we've seen your stock take a very healthy jump year. And that could potentially be acquisition currency. How are you thinking about acquisitions and how has your approach changed in the last few months?

Well I guess we would couch that with the fact that everyone else's stock has also increased. I think Laurie, our philosophy on this hasn't changed from what it was in the past. I think it's a function of price and whether or not we can find something that makes sense to combine with that we also feel will -- we would be able to grow.

Expense synergies aside, we are interested in things that are in markets that we think present growth opportunities for us. I think any kind of a payback period is still within the same kind of parameters that we have discussed before.

Great. One last question, again with stock currencies up et cetera, have you all seen any sort of increased M&A discussions because of stock prices?

I would say, Laurie, that people are currently taking a little bit of a pause, because I think all of us would like to get comfortable that these kind of valuations have a chance to hold.

Right. Thank you.

You're welcome.

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

Well thank you all for taking the time with us again today. We look forward to the first-quarter and to having further discussions, and we are certainly hoping to produce the same kind of results we have historically. So thank you very much.

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