Washington Trust Bancorp Inc (WASH) 2017 Q1 法說會逐字稿

Good morning, and welcome to Washington Trust Bancorp, Inc.'s conference call. My name is Michelle, and I'll 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, Michelle. Good morning, and welcome to Washington Trust Bancorp, Inc.'s First Quarter 2017 Conference Call. This morning's call will be hosted by Washington Trust's executive team: 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, please note that today's presentation may contain forward-looking statements and actual results could differ materially from those statements. Our complete safe harbor statement appears in our earnings press release and in other documents filed with the SEC. To review the complete safe harbor statement and other documents, please visit our Investor Relations website at washtrustbancorp.com. 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, and thank you for joining us on today's conference call. Earlier this morning, we released our first quarter results. I'd now like to take a few minutes to review the highlights of the quarter with you, then I'll ask David Devault to discuss our financial performance. After our prepared remarks, Ned, David and I will answer any questions you may have about the quarter or the year ahead.

Washington Trust posted solid first quarter results, with net income totaling $11.8 million or $0.68 per diluted share. While earnings were down from the previous quarter, net income and earnings per diluted share were up from the first quarter a year ago. Our profitability measures and asset quality remain strong and we continue to be well capitalized.

Once again, our diversified business model was key to our quarterly performance as we had good contributions from our core business lines. We also continue to benefit from the solid level of business activity and production throughout the market area.

Now I'd like to take a few minutes to review some of the quarterly highlights. It was a good quarter for deposits as we surpassed the $3.1 billion mark, which is up slightly from year-end but represents an 8% increase in deposits from a year ago. We were also successful in attracting a good mix of low-cost demand deposits, NOW accounts and savings deposits, which helps our continued efforts to manage our balance sheet and cost of funds. We had solid in-market deposit growth, generating new funds from both new and existing customers.

Deposit generation has been an ongoing challenge for all financial institutions. We believe we have great potential to guide our additional deposit share in Rhode Island and have the right strategy to do so. A year ago, we opened a new branch on the East Side of Providence and I'm pleased to report that the office is exceeding our expectations. We recently began renovations on a new branch site in Coventry, Rhode Island and are looking forward to entering that market later this year.

Our continued branch expansion and strong Rhode Island brand reputation has also helped us attract new retail, commercial and municipal relationships in the state and this has provided us a good source of new deposits and loans. We believe our continued efforts to support the local community and economy will do us well for now and in the future.

Total loans were $3.2 billion at March 31, 2017, which is down a bit from year-end but up by 6% from a year ago. Our mortgage banking division had a very respectable first quarter as residential real estate loans amounted to $1.1 billion. Despite the increase in residential loan balances, we couldn't really match the record level of revenues and loans sold in the fourth quarter. Production has been consistent throughout the Rhode Island, Connecticut and Massachusetts market areas. We had a steady volume of applications in recent weeks and the pipeline is healthy. So there are signs that seasonal demand and favorable interest rates will continue to support additional mortgage banking activity through the next quarter or so anyway.

Commercial loans amounted to $1.8 billion at March 31, which is down from year-end but ahead of where we were last year at this time. Commercial loan growth was hampered by lower-than-average C&I line of credit use and a higher volume of commercial real estate payoffs during the quarter. Our commercial pipeline is healthy, however. Because of the current rate environment we predict the trend of commercial real estate payoffs could continue into the next quarter.

We've seen some aggressive pricing and some aggressive terms and conditions in the market, but we remain focused on the fundamentals because building client relationships and maintaining strong credit quality continue to be very important to us.

Our wealth management area had a great start to the year as favorable financial markets helped assets under administration peak to a record of $6.2 billion while generating $9.5 million in revenue. We've been providing comprehensive wealth management and trust services to high net worth clients for more than 100 years. Over time, we've introduced new technology and more comprehensive lines of services to better meet client needs and improve the client experience, and it's paid off as our wealth management division provides a nice stream of revenues for the company and continues to be a key line of business which differentiates us.

I'd now like to turn the discussion over to David Devault who will provide an in-depth review of our financial performance. David?

Thank you, Joe. Good morning, everyone, thanks for joining us on our call today. I'll review the first quarter 2017 operating results and financial position as described in our press release issued this morning.

Net income in the first quarter was $11.8 million or $0.68 per diluted share. That compares to net income of $12.2 million or $0.70 per diluted share in the fourth quarter of 2016. Profitability metrics continued to be very respectable, with a return on equity of 11.87% and a return on assets of 1.08%. Net interest income in the first quarter was $28.7 million, up modestly from the fourth quarter. And the margin was 2.87%, down 2 basis points from the fourth quarter. Now I would also note there was a noticeably higher amount of commercial loan prepayment income in the fourth quarter at $816,000, whereas in the latest quarter, it was only $135,000. And excluding the prepayment fee income, the margin was 2.86% in the quarter, up 5 basis points from the fourth quarter.

Net interest income benefited from $112 million increase in average interest-earning assets, and that was the impact of, mainly, securities portfolio additions and other asset growth in the fourth quarter, so we had the full quarter impact of that. And the Federal Reserve rate increase in December was also a contributing factor to the improvement in net interest income in the margin. The impact of the March increase will, for the most part, occur starting in April.

The yield on interest-earning assets was up by 3 basis points from the preceding quarter. And if you exclude the prepayment fee income in both quarters, the yield on interest-earning assets was up 9 basis points.

On the funding side, average wholesale funding balances, which I would define as Federal Home Loan Bank advances and wholesale brokered time deposits was up $114 million from the fourth quarter, and the cost of wholesale funding was up by 5 basis points. Meanwhile, the cost of in-market deposits, which we would define as deposits excluding wholesale brokered deposits, remained relatively stable at 32 basis points, up 1 basis point in the quarter.

As Joe mentioned, loans amounted to $3.2 billion at the end of March. They were down, in total, by $10 million in the quarter. We saw an increase of $8 million in the residential mortgage portfolio and a decline in the total commercial portfolio of $9 million or about 0.5% in the quarter. As Joe mentioned, there was a lower utilization level on lines of credit and we also -- the growth was hampered by payoffs in the commercial real estate portfolio. Consumer balances were down about $9 million due largely to a decline in home equity line and loan balances.

In the investment securities portfolio, we added about $40 million in mortgage-backed securities and agency debt securities in the quarter. Net of calls, maturities and routine pay-downs, the net increase in the total balance was about $14 million in the first quarter.

Total deposits were up 2%. And if you exclude wholesale brokered deposits, which is a managed amount, in-market deposits were up by 3% in the quarter, which is a nice way to start the year.

Noninterest income continues to be a significant portion of our total revenue stream at 34% of total revenues in the first quarter. Noninterest income was $14.5 million, down $2.8 million on a linked quarter basis. I'll get to some of the reasons for that in a moment. The largest component of noninterest income, wealth management revenues, were $9.5 million, a 2% increase on a linked quarter basis as we saw an increase in asset-based revenues. And wealth management assets under administration, the vast majority of which are managed assets, were up by $180 million in the latest quarter and stand at $6.2 billion at the end of the quarter, which is an all-time high for the company. So that business line continues to do very well.

Mortgage banking revenues, meanwhile, were down by $2.2 million from the fourth quarter. And that fourth quarter were very strong results. A lot of good things came together in that quarter in the mortgage banking world. And we've noticed similar changes in a number of other regional community banks that report mortgage banking on a comparable basis, with declines in both dollars and percentage of mortgage banking revenues.

Loans sold into the secondary market were $107 million in the first quarter compared to $200 million in the fourth quarter. Despite that, mortgage banking revenues were up 6% over the first quarter a year ago and we've seen a nice rebuild in the pipeline since January of this year. Also, loan-related derivative income, which is primarily interest rate swap transactions with commercial borrowers, was $148,000 in the latest quarter and that was down $764,000 on a linked quarter basis. And the simple reason is that there were just fewer numbers of swap transactions with borrowers compared to the previous quarter.

Noninterest expenses were $25.3 million, up $313,000 or 1% on a linked quarter basis. Included in the first quarter results is negative expense, essentially, of $310,000, resulting from a downward adjustment in the fair value of the contingent consideration liability we've recognized in connection with a 2015 acquisition. Excluding that adjustment, noninterest expenses were up about 2% on a linked quarter basis. About half of that increase was in salaries and benefit costs, which is the largest component, obviously, of noninterest expenses, and that reflects higher employer payroll taxes as we've turned the corner into a new fiscal year; the impact of merit increases, less a decline in commissions expense as a result of a lower level of mortgage origination activity.

Our effective all-in income tax rate was 32.7% in the quarter compared to 32.6% in the fourth quarter. Now pursuant to a new requirement under generally accepted accounting principles effective in 2017, excess tax benefits on the settlement of share-based awards are recognized as a reduction to income tax expense in the quarter in which they occur. Previously, they were simply added to equity without going through earnings. In our case, we recognized the benefit of $195,000 for this in the first quarter. And excluding that benefit, the effective core tax rate for the first quarter was 33.8%.

Looking at asset quality, we saw a decline in past- due loans of 11 basis points to 0.65% in the quarter. Nonperforming loans were essentially up--- unchanged, up 1 basis point from the end of December. And charge-offs were very low at only $79,000. The allowance for loan losses stands at 0.82% of total loans at March 31, up 2 basis points from the end of the fourth quarter. Our loan loss provision was $400,000 in the first quarter, and that compared to a $2.9 million provision in the fourth quarter, a substantial portion of which was due to loss exposure recognized on one nonaccrual commercial real estate relationship at that time.

Total equity for the corporation is $398 million at March 31, up $7 million in the quarter. The corporation and the subsidiary bank continued to be well capitalized. The corporation's total risk-based capital ratio was 12.38% at the end of March, up 12 basis points from the end of the fourth quarter. Tangible equity to tangible assets ratio was 7.51% at the end of March. That's up from 7.35% at the end of December. In March, we declared a quarterly dividend of $0.38 per share, and that was a $0.01 per share increase over the preceding dividend rate. And this represents the seventh consecutive year with a dividend increase.

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

Thank you, David. Our first quarter performance illustrates the importance of our diverse business model, particularly in the current operating environment. Each of our business units contributes to the bottom line, and together they make our company what it is. But tomorrow we'll host our Annual Meeting of Shareholders, and we look forward to presenting our 2016 results and the first quarter highlights and our outlook for this year.

We believe we're in the right markets, have an outstanding team, and have solid potential for future growth. We remain optimistic about what lies ahead.

And thank you for your time. And now Ned, David and I are happy to answer your questions.

(Operator Instructions) Our first question comes from the line of Mark Fitzgibbon with Sandler O'Neill.

I wonder, David, if maybe you could give us a sense for whether the new commercial real estate and C&I loans that you're booking on the balance sheet are sort of at or above the portfolio yield today.

Well, the --- they'd be slightly above, I would say and it depends on the mix. And we've seen a continued demand for LIBOR-based lending. And that -- particularly in the CRE portfolio.

Okay. So I mean, given that and also the rate increases that we've seen, it sounds like the net interest margin trend ought to be up a little bit in the coming quarters. Is that fair?

That would make sense to us, and that is what we think the -- there is a near-term effect where, typically, we have some seasonal outflow of institutional deposits that we backfill with some borrowings. That typically happens throughout the second quarter, and then we see that turn around and a rebuild of in-market deposits in the latter half of the year. But all in all, even without another rate increase, we would expect to see some margin improvement.

Okay. And then in the past year, in terms of provisioning, it looked like in the early part of the year when loan growth was a little lower, you provided a little bit less, and later in the year, when loan growth picked up, provisioning picked up. Should we expect a similar trend, do you think, this year?

Well, one of the key factors in determining the measurement of loss exposure that drives the need for provision is growth. So with modest growth in the first quarter, there was a modest provision. That's not the only reason, but there were really very little new loss formation as well in the first quarter. So we'd love to see growth accelerate in the loan portfolio and we'll make appropriate provisions as that occurs.

And I'm curious, on the mortgage business, if origination volume doesn't come back as strongly as you hope it will, do you have plans in place to do some cost control kinds of things in the latter part of the year?

Well, there's 2 things that can happen with -- if you're referring to portfolio growth, we can -- we've done some wholesale purchases in the past and we would consider that again. For mortgage banking itself, we are watching cost control -- the cost structure of that line of business very carefully. We've been able to maintain a very solid core nucleus of quality people to support that business. And we're constantly taking steps, either through technology or just reviewing the way we do things to make it as efficient as we possibly can.

Our next question comes from the line of Damon DelMonte with KBW.

So my first question is kind of circling on the loan growth outlook. Are you guys still optimistic that you could, for the full year, get back to that mid- to upper single-digit range?

It's Joe. I think at this point, we would probably guide to mid-single digits. We believe that we will, at least for the next 3 or 4 months and certainly throughout this current quarter, continue to experience some level of commercial real estate payoffs. So I think we're in the mid-single digit range.

Damon, it's Ned. Just to add a little color. Both pipelines are coming back to what we would call within the range of being pretty strong. The resi pipeline is about $171 million. The commercial pipeline is about $190 million, which is pretty good for us, historically. On the commercial side, about half of that is construction, so --- and that was part of the issue in the first quarter, too. We had good loan formation, but we had a fair amount of that in construction, so it's funding over time. And at the same time, we've had some commercial real estate payoffs that are more significant than the fundings almost. So we think that's a challenge going forward in this quarter. But on the pipeline side, things are rebuilding. And applications on the resi side have been stronger as we move forward. But February and March were a little bit lower, so the sales on the resi side, the sales outlook is going to be a bit little lower in the quarter ahead.

Okay. What do you guys think is driving these --- the ongoing accelerated security payoffs? Is it loans that are being refinanced away from you to other competitors? Are they just businesses that have sold and they're just paying down, kind of cashing in on their fortunes? What's leading to this level of payoffs?

So all-time low cap rates, we're funding quality projects that are taking advantage of low cap rates and selling at the height of the market. They are typically being financed, but more institutionally, not by competitor banks. They're going to the REITs or the life companies, with long-term fixed-rate, nonrecourse financing that, frankly, we don't care to compete with. And I think as rates stay low, cap rates will stay low and that will continue a little bit. As rates come up, cap rates should come up. That might slow a little bit, but we're expecting that we'll see a little bit more of it in the quarter ahead.

Got you, okay. That's helpful. I appreciate the color on that. And then I guess, kind of with regards to the outlook for overall noninterest income, obviously, swap gains were down and we talked a little bit about the mortgage banking side of things. David, can you kind of quantify a reasonable run rate on a quarterly basis for your outlook for noninterest income? At this quarter, it was, call it, $14.5 million. Do you see a little bit of a rebound in the mortgage banking income to kind of get you back up over $15 million a quarter? Or do think it kind of trends from this point forward?

I would expect some modest improvement in the near term and we had some very low derivative swap income in the first quarter, we hope to see more of that in the future. Mortgage banking should be okay in the near term. I don't know that it will be dramatically better than the first quarter. Wealth seems to be doing well, so we hope to see modest growth.

One of the issues on the swap site, Damon, is that as we do more construction loans, some of them will take a forward swap but not all of them. Some of them prefer to float during the construction period. And then we would expect to see some of those swap at completion. We're actually talking to some about doing forward swaps now and hope that that will -- with rates -- with the prospect of rates increasing, that that will make sense to some of our customers. But it's not a given in a construction scenario that your customer will take a swap.

Got you. Okay, great. And then, I guess, just my last question, kind on the funding side of things. We've seen a rate increase, obviously, just last month. We had one in December. We had one midyear last year. I think the general sentiment is that banks have been able to lag on increasing their funding costs and not having to really react to increasing their deposit costs. What are you guys seeing in your markets? And what are your expectations if we were to have another rate hike or 2 in 2017? Do you think are going to continue to be able to lag? Or are we going to start to see higher betas for future rate increases?

Damon, it's Joe. I think 2 things. We see even now a little bit more pressure on the municipal and institutional side of our deposit base. I feel as though the consumer is probably a little bit slower to react. I think the answer, though, is if we get one more increase, we'll probably be able to deal with that kind of on a one-by-one basis. But if we get 2, I wouldn't be surprised if the market reacts a little bit more strongly to that.

(Operator Instructions) Our next question comes from the line of Laurie Hunsicker with Compass Point.

Just to go back here to noninterest income. I know that 2Q typically has a tax benefit. How should we be thinking about that for the June quarter?

That's typically in the range of, I don't know, to the nearest $100,000, probably a $300,000 number in the quarter.

$300k benefit. Okay, perfect. And then the charitable foundation that you guys have typically done in the fourth quarter in terms of expenses, has that been planned for 2017? And that's run like $400,000 or $500,000. How should we think about that line?

Right. At this point, we're not planning to do that. We have plenty of lift in the assets of the foundation to support our giving plans, so I wouldn't count that in. Although it is a decision that we'll revisit as we get towards the end of the year.

Okay. Okay, great. And then with respect to margin, obviously, just linked quarter, 2 basis points of reported. But if we strip out that prepay penalty income, you actually had 5 basis points of core expansion in the quarter, which was a little bit better than I was expecting. Can you help me think about just as we look from March to June, could we potentially see another 5 basis points of core expansion, excluding the prepay penalty income?

Well, again, the -- you have a very similar fact pattern with a 25-basis point fed increase right at the end of the most recent quarter, so there'll be a benefit from that, certainly on prime-based loans. And we all -- but as I mentioned, the second quarter is typically a period where we might have to increase borrowings a little bit because of some typically business cycle outflows associated with larger institutional depositors. So it could be a few basis points. It's pretty hard to be precise to actual specific number.

Okay. Great. And then -- that's helpful. And then with respect to your branching plans, your East Side Boston branch, what were the deposits in that?

It's the East Side of Providence, it's about $6 million.

$6 million, okay. And what, in your mind, is breakeven on that?

I think, Laurie, that's a -- the footprint of that branch is quite small, as is the staffing. We probably think that it starts to breakeven in the high 20s, maybe 30-ish.

20s to 30s, okay. And then the new branch that you're opening, the one in Rhode Island, you started construction. When is the actual planned opening of that approximately?

It's October. It's around the end of the third quarter, early fourth quarter.

Okay, great. And what are your de novo branch plans for the rest of the year. Is it just the one, or is there anything else on the drawing board?

No, that's it for this year. And Laurie, I think we've gone on record as saying in the past, we're pretty cautious with this going forward. We think there may be 1 or 2 more opportunities, but we all -- we're very cognizant of the fact that retail branch banking is a changing world, so we're certainly trying to be judicious. But there are some locations that we're interested in. And so far, these have worked for us.

Great. And then just last question on M&A. One of your community bank peers who has very strong currency and obviously, your currency is very strong, sitting here at 3x booked, indicated that they are really looking to grow substantially. Can you just give us a refresh on your take on M&A, given that you have such strong currency, how you're think about whole bank M&A, and then also, how you're thinking about maybe acquisitions in the RIA front?

I think we're always interested on the wealth management side, Laurie. We've obviously done one in the last year or so, 1.5 years. We think that, that's something we can do well. It's -- those are a function of kind of culture and price to some extent and we obviously look for things that are more high net worth, individual-based, not institutional- based. From a whole bank perspective, our feeling is that we are always interested in things that will get us either synergy to what we do today, or get us into markets that we think we can grow in. It is true that our currency is strong, but quite frankly, a lot of other people's currency has gotten stronger. So we will match that with what we think makes sense from a credit risk perspective, and whether or not we can grow what we buy.

Okay. And then just one last question on that. What would be the largest asset size acquisition that you all would entertain if you were doing a whole bank M&A deal?

I don't think you would see us do something that would be of bet the bank size. So something that was $1 billion-ish or under might make sense.

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

Thank you. I'd just like to thank everyone for your interest and attention today, and we look forward to speaking to you again when next quarter earnings are released. Thank you.

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