Washington Trust Bancorp Inc (WASH) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Washington Trust Bancorp, Inc. 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. Good morning, and welcome to Washington Trust Bancorp, Inc.'s Second Quarter 2017 Conference Call. Today'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 the actual results could differ material from those statements. Our complete safe harbor statement appears in our earnings press release and in other documents that are 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.

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

Thank you, Beth. Good morning, and thank you for joining us at on today's conference call. Yesterday afternoon, we released our second quarter results. I'd now like to take a few moments 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 remainder of 2017. I'm pleased to report that Washington Trust momentum continued into the second quarter as we achieved record earnings with net income totaling $13.2 million or $0.76 per diluted share. As a result of this performance, our return on average equity was 13.06%. Our return on average assets was also strong at 1.21%. Our asset quality metrics also remained strong during the quarter, and our capital levels continued to exceed regulatory minimums. The deposits were down by 3% from the first quarter. We typically experience a seasonal outflow of deposits in the second quarter followed by an increase as the year progresses. This is primarily due to the business cycle of some of our larger educational and governmental customers who have regularly scheduled cash flows with tuition, tax and other payments. Despite the seasonal decline in deposits, total deposits were up 8% from a year ago and demand and NOW account deposits increased 12% from the last year's level. This is a good trend, particularly, considering the tremendous competition for deposits in our market. We continue to attract new deposit relationships, however, there is and will be an ongoing challenge between balancing pricing and growth.

Total loans were down slightly from the first quarter. This decline was attributable to a high level of commercial real estate payoffs during the quarter. This is a trend that we've experienced over the last few quarters. We closely manage the portfolio and anticipate that this trend may dissipate somewhat over the next couple of quarters. On a positive note, our commercial and industrial portfolio grew by 3% from the previous quarter.

Our mortgage banking division had a very strong quarter as residential real estate portfolio loans were up 3% from the first quarter. We originated a record amount of residential mortgages in the month of June. Mortgage banking continues to be a good story for us as mortgage banking revenues are up 25% from the previous quarter and residential real estate -- the residential real estate loan portfolio was up more than 16% from a year ago. We had solid productions from, really, throughout our Rhode Island, Massachusetts and Connecticut market areas.

Our wealth management division is another area that contributed to our record quarterly earnings, generating nearly $10 million in revenues. That is an all-time high. We also reached a record $6.4 billion in wealth management assets under administration. This continues to be a significant and meaningful business for the company. I'll now turn the discussion over to David Devault, who will review our financial performance. David?

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

Net income was $13.2 million or $0.76 per diluted share in the quarter and both of those amounts were up 12% over the first quarter of 2017. And as Joe mentioned, the profitability metrics were strong, return on equity was above 13% and return on assets above 1.2%. Noticeable increases in several revenue categories drove these results, including net interest income, which benefited from higher short-term interest rates. Net interest income in the quarter was up by 4% over the first quarter. The net interest margin was 2.97%, up 10 basis points over the first quarter. Net interest income in the latest quarter included about $549,000 in prepayment fee income and that compared to $135,000 in the first quarter. Excluding those amounts, the net interest margin was 2.92% in the latest quarter, up 6 basis points over the first quarter. The yield on interest-earning assets rose by 12 basis points to 3.68%. And excluding prepayment fee income in both quarters, the yield on all interest-earning assets increased by 8 basis points to 3.62%.

The average balance of interest-earning assets in the latest quarter declined by $17 million, reflecting some contraction in total loan balances. On the funding side, the average balance of wholesale funding sources, which includes FHLB borrowings and wholesale brokered deposits was down by about $19 million from the previous quarter, and the cost of wholesale funding was up 6 basis points. The cost of in-market deposits, which includes all deposits plus wholesale brokered deposits, was up -- was 33 basis points, up just 1 basis point in the latest quarter.

As Joe mentioned, total loans declined in the quarter by about $25 million. The primary driver of this was a decline -- it was a relatively large amount of payoffs in the commercial real estate portfolio. That portfolio experienced a net drop of $79 million, despite a very decent amount of new loans and additions to existing credits totaling $62 million in the quarter.

Meanwhile, the C&I portfolio rose by 3% in the latest quarter. Residential loans were up 3%, and the consumer portfolio was up 1%. In the investment securities portfolio, we saw a decline of about $6 million in the quarter. We added about $15 million in mortgage-backed securities and that was offset by principal amortization and some called municipal bonds.

Total deposits declined by $94 million or 3% in the latest quarter. It was concentrated in in-market deposits, which were down by 4%. And that was largely due to outflows in institutional and governmental deposit relationships, which is not unexpected at this time of the year based on our experience with the business cycles of these customers.

Our experience in recent years has also shown that deposit inflows from this category of customers and others in the third quarter, typically, overcomes the net second quarter outflows. Noninterest income continues to be very important to our business and it represented 36% of total revenues in the latest quarter.

Total noninterest income was nearly $17 million, up 16% from the first quarter. Wealth management revenues were nearly $10 million, up 2% on a linked-quarter basis. That increase included $154,000 increase in asset-based revenues and about $200,000 more in fees for tax services, which are typically concentrated in the second quarter. Wealth management assets rose by $160 million in the quarter benefiting from market appreciation and stand at $6.4 billion at the end of June. Managed assets continue to represent a very large portion of wealth management assets, standing at 93% of those assets at the end of the quarter.

The mortgage banking business had a very good quarter with a revenue increase of 25% over the first quarter, and the volume of loans sold into the secondary market was up by 29%, and our mortgage pipeline remains strong. Loan-related derivative income, which is primarily commercial borrower derivative transactions, was -- that income amounted to $1.1 million in the latest quarter, up nearly $1 million from the first quarter. And that reflects a nice increase in the volume of commercial borrower derivative transactions compared to a very low level in the first quarter.

Noninterest expenses rose by about $1 million or 4% on a linked-quarter basis. Now, included in the previous quarter was a $310,000 reduction in noninterest expenses resulting from a downward adjustment in the fair value of a contingent consideration liability that we had previously recognized in connection with an acquisition. Excluding that adjustment, noninterest expenses were up about 3% or $700,000 on a linked-quarter basis. The largest increase was in salaries and benefit costs, which includes a higher level of commission expense associated with the increase in mortgage banking activity. The linked-quarter change also reflects an increase of about $250,000 in outsourced services. The largest piece of that increase would be a higher level of execution costs associated with the increase in loan-related derivative transactions.

Our effective income tax rate was 33% in the quarter, up from 32.7% in the first quarter. As we have previously mentioned, under a new generally accepted accounting principle effective this year, excess tax benefits on the settlement of share-based awards are recognized as a reduction to income tax expense in the quarter during which they occur. In our case, we recognized the benefit of $155,000 in the second quarter compared to a benefit of $195,000 in the first quarter. Excluding those benefits, the, what I would call, core effective tax rate in the quarter was 33.8%, which was unchanged in the first quarter.

In asset quality, total loans past due by 30 days or more as a percentage of total loans outstanding is 0.66%, up 1 basis point in the quarter. Nonperforming loans stand at 0.63% of total loans, down 6 basis points in the quarter. Net charge-offs were $484,000, which included a $400,000 charge-off on a commercial real estate loan. And at the half way point of 2017, net charge-offs have amounted to only 0.03% of average loan on an annualized basis. Our allowance for loan losses stands at 0.83% of total loans, up 1 basis point in the quarter. And our loan loss provision charge to our earnings was $700,000 compared to $400,000 in the first quarter.

Total shareholders' equity has moved past $400 million for the first time, standing at $406 million at June 30, the corporation and the subsidiary bank. Capital levels continue to exceed the required levels to be considered well-capitalized and the total risk-based capital ratio for the corporation is 12.78% at June 30, up from 12.38% at March 31.

The tangible assets ratio also increased from 7.51% at the end of March to 7.73%. In June, we declared a quarterly dividend of $0.38 per share and that was paid earlier this month.

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

Thank you, David. We're pleased with our second quarter results as our consistent performance, strong capital position and attractive dividend yield continue to place us among the region's high performing financial institutions. Our solid foundation, unique and competitive business model and improving growth strategy continue to be a big part of our success and we hope that, that will continue to advance us as we get into the future. We thank you for your time, and now, Ned, David, and I are happy to answer any questions. Thank you.

(Operator Instructions) The first question comes from Mark Fitzgibbon with Sandler O'Neill.

First question I had is for you, Dave. Dave, could you help us think about, sort of, the NIM outlook. It looks like the core NIM was about $292 million in the quarter, assuming that prepayment penalty income slows and -- but, presumably, you benefit from high rates and some remixing. Should we assume maybe some modest growth off that core margin of $292 million going forward?

I think the $292 million range is a pretty good indication of what we would expect over the next couple of quarters. We have to rebuild deposit balances and reduce some wholesale funding levels, so that can influence it. And of course, we're talking about no FED rate increase when we are talking about those kind of forecasts.

Okay. And then, secondly, you guys have traditionally had better loan growth in the back half of the year and you've built provisions in sync with that. Should we expect the same kind of trend in the back half of this year?

Well, loan growth is certainly a factor that drives the appropriate level of your allowance for loan losses, and I think it's reasonable to anticipate that if loan balances grow at a more -- a higher level than we saw in the first half of the year, then certainly, it's reasonable to assume that the provision would increase. At this time, we're not seeing loss formation that would increase that above normal levels. So that's the way we're doing it right now.

Mark, it's Ned. The commercial pipeline's very strong. The level of payoffs that we've experienced in the first couple of quarters, we expect to diminish somewhat. But credit formation in the second quarter was very strong compared to history. So we have every reason to believe that we'll be back at sort of normalized loan growth levels.

Okay. And then based on what you see in the pipeline today, how are you thinking about derivative income in the back part of the year? How sustainable do you think that derivative number is?

Well, it is a relatively volatile amount -- component of income. But right now, we're seeing pretty decent customer interest in derivative transactions. Now that pretty much can foresee that maybe a quarter at a time. So it's -- but overall, we're seeing good demand for those transactions.

And lastly, just to preempt Laurie's question, are you planning to make a contribution to the charitable foundation later this year?

We'll make that decision in the fourth quarter.

I could have preempted David's response by saying the exact same thing, Mark.

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

So just to kind of follow up on the loan growth question. The high amount of commercial real estate pay-downs that you guys have been seeing, where have those loans been going? Are they being taken down by competitor banks or other institutions?

No, no. typically sold assets -- typically, equity buyers, so they're going into funds. Some finance through life companies, we see MDS, we see very little going from us to other competitive banks. So -- but cap rates are low, we've had a couple of Rhode Island-based developers, as an example, decide to sell their entire portfolios just because pricing's so strong at an all-time high in this market and, similarly, in the Boston market. We think upward moving rates will have an upward effect of cap rates and will impact value, but -- and that's probably why we're seeing a slowdown in projected payouts, but at this point, we're not being cavalier. We know we have to work extra hard to keep the pipeline up and offset -- continue to pay payouts, but we do expect a slowdown in the payouts.

Okay. And based on what you're seeing in your pipeline's now, you guys are confident that you'll see some net positive growth that we see in the third quarter if not for the entire second half of the year?

Yes. Yes to both.

Yes to both. Okay, great. And with regards to expenses, didn't sound like there was anything out of the ordinary in this quarter's expense base. So is that $26.3 million level, is that a good run rate to build off of?

Absolutely, yes.

Okay, great. And then I guess just my last question. Could you just give us a little bit of an update as to where you're seeing the most opportunity in your footprint? I know you guys, in the last couple of years, have expanded into Connecticut area and kind of in the southeastern Mass area, are you still seeing good opportunities in those markets? Or are you looking even further beyond those areas?

Yes, I would say we're still -- feel very strongly about the greater Boston market both from the resi side and the commercial side, primarily, in the case of Massachusetts on the real estate side. Connecticut, we're seeing a few more C&I opportunities but also a good strength in both Fairfield County and the Greater New Haven market to the extent that we go outside of our 3-state footprint, we do so with in footprint developers. So I wouldn't say we're seeing a higher level of external opportunities but we do see some. So I think, we're still seeing strength in all markets, the Rhode Island residential market has come back somewhat. So we're seeing a little bit more activity right here at home, which is nice. So I think it's pretty well balanced.

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

Just wanted to go back to expenses here, David. I want to make sure I heard you right. There was about $250,000 of outsourced services expense in that $2.5 million number. Is that correct?

The increase in outsource was about $250,000 and that's the biggest piece of that increase is associated with the increase in derivative transaction.

In the -- right, okay. And so that's my second question. What is the actual dollar expense related to the derivative income?

I'm not sure we have that with us today. It's a percentage of the derivative income.

Okay. All right. And just to go over to loans, again, did you all have any purchased residential loans in the quarter?

No.

No.

Okay. And I know at one point, I guess, if we roll back to December, you all had been purchasing loans in Massachusetts. Is that going to potentially be part of your strategy? Or how are you thinking about loan growth with respect to the residential...

I would say, compared to last year, we are comfortable with self-originated portfolio growth. And right now our outlook is that, that would be adequate for our needs.

Okay. And then same question on commercial real estate. So your commercial real estate was down linked-quarter 6%. How are you thinking about that?

So the pipeline is very strong. Again, we think the payoffs, which are a big part of it, we had very large payoffs in the second quarter. But the new credit formation is strong. Our pipeline is strong as it's ever been and there's a fair amount of construction in that. So the actual funding levels will follow a little bit, but we have a lot of confidence that we'll grow in the second -- in the third quarter and the fourth quarter, and we'll kind of stick with our growth objectives.

So Laurie, excuse me -- just to put a little bit of color on, when we say, large amount of payoffs. It was $118 million and that compared to $27 million of payoffs in the first quarter. So to Ned's point, this, I think, validates that we've been doing business with good developers and strong borrowers who have built great properties and they're able to market them. So we lose the loan, but that's been a good business for us. And total originations in CRE or additions were about $62 million, which was also higher than the previous quarter by quite a bit.

That's actually funded dollars. The originations were more like $120 million.

Right, funded. Yes.

But a little bit of construction in that new volume in the second quarter, but...

Okay. And if you were to think about what your overall CRE would do this year in just percentage growth terms, what are you thinking?

I'm sorry.

Loan growth, Laurie?

Overall loan but specifically within CRE? If you were thinking about, overall, how your CRE book would look in terms of growth for full year '17, what are you thinking? Factoring in, obviously, we had the dip here.

We're looking at all commercial loans being up, probably, around the 5% for the full year. That's combined C&I and CRE to be our best estimate at this time.

Okay. And then -- I mean, your C&I just this quarter is tracking at 11%, that's very strong. Was this an anomaly? Or that 11% run rate would hold?

But no, very strong quarter. And the good news is, it was new credit formation, new originations, not just line utilizations, which we've seen in the prior quarters. The pipeline remains strong. The pipeline is definitely weighted towards CRE. But there is a fair amount of C&I for the balance of the year. So I don't -- we will not sustain that kind of growth rate for the year, certainly, but we have good opportunities in the pipeline still.

Okay, great. And then just one last question for you, Joe and Ned. Just generally more macro. How you're thinking about M&A? I think, last quarter, you said maybe think you would think about something but it would be a billion-ish or under. Are you still thinking that? Has anything changed in the last quarter?

Laurie, I think we'd be consistent with what we said last quarter in regard to what we would look at. One of the things that would be nice is something that had really good deposit growth opportunities. That would be helpful. I think, that would be helpful to a lot of banks in the Northeast. We would also be very interested in looking at the right wealth management acquisition. We're very happy with the results of the Halsey acquisition that we did in 2015. Things like that within a reasonable distance. So where we're located today, I'd say that's probably a 100-mile circus -- circle. I think either one of those things would make a lot of sense for us if it worked.

Okay. And then just one last question to follow up. Your loan to deposits did uptick this quarter, you're 106%, which is kind of top of where you've been in a while. How do you think about where you cap that out?

Well, because of the seasonal or business cycle decline in deposits that we experienced in the latest quarter, that's going to drive that up, typically, at this time of the year. And as I said earlier in my comments, our experience over the last several years has been that the inflows in the third and fourth quarter more than exceed the outflows in the second quarter or even year-to-date outflows for the first half of the year. So that's something we're watching very closely. We have ample liquidity both on balance sheet and off balance sheet sources. High loan to deposit ratios are characteristic of many New England and Northeast banks. Not all of them, but that's something that we're managing through.

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

Well, I just like to thank everyone in the call. We appreciate your interest in the company. We feel good about the quarter and we enter the third quarter with a relative level of confidence. And we look forward to speaking to you at the end of the third quarter. Thank you.

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