Washington Trust Bancorp Inc (WASH) 2017 Q3 法說會逐字稿

Good morning, and welcome to Washington Trust Bancorp, Inc.'s conference call. My name is Melissa. I will be your operator today. (Operator Instructions) Today's call is being recorded.

And now, I will turn the call over to Elizabeth B. Eckel, Senior Vice President, Marketing and Investor Relations. Ms. Eckel?

Thank you, Melissa. Washington Trust Bancorp, Inc.'s Third Quarter 2017 Conference Call will be hosted by Joseph MarcAurele, Washington Trust's Chairman and Chief Executive Officer; Ned Handy, President and Chief Operating Officer; David Devault, Vice Chair, Secretary and Chief Financial Officer; and Ron Ohsberg, Senior Executive Vice President and Treasurer.

Before we begin, please note that today's presentation may contain forward-looking statements and actual results could differ materially. Our safe harbor statement appears in our earnings press release and in other documents Washington Trust files with the SEC. Please visit our Investor Relations website at washtrustbancorp.com to review these materials and our entire safe harbor statement. Washington Trust trades on NASDAQ under the symbol WASH.

I'm now pleased to introduce Washington Trust's Chairman and Chief Executive Officer, Joseph MarcAurele.

Thank you, Beth. Good morning, and thank you for joining us on today's conference call. Yesterday afternoon, we released our third quarter earnings. This morning, David and I will provide some insight into Washington Trust's performance. After our prepared comments, Ned Handy and Ron Ohsberg will join us to answer any questions you may have about our third quarter results or our thoughts on what lies ahead for the remainder of 2017.

I am pleased to report that Washington Trust had another good quarter, earning $13 million or $0.75 per diluted share. We generated a record of $47.3 million in total quarterly revenues. Our performance reflects our continued success at growing our key business lines. Diversified revenue streams were integral to our solid quarterly results, allowing us to maintain strong profitability metrics.

Let me take a few minutes to discuss some positive highlights for the quarter.

First, total loans were up 4% from the second quarter. Commercial loan activity was fairly robust during the quarter. We had growth in both commercial real estate and commercial and industrial portfolios. There was some payoff activity during the quarter, but it seems to have slowed to a more normal run rate. Our commercial pipeline remains healthy heading into the fourth quarter.

In our residential mortgage business, total portfolio loans were up more than 2% from the prior quarter and almost 11% from a year ago. Purchase activity outpaced refinancings during the quarter, with good production from our Rhode Island, Massachusetts and Connecticut offices. Total mortgage loan originations for the year are ahead of where we were a year ago. As we look into the fourth quarter, mortgage application activity has been steady. So we're optimistic that we'll have a good fourth quarter.

A notable highlight for the third quarter was a record $3.2 billion in total deposits, which is a 4% increase from the previous quarter. This is a nice rebound from the second quarter dip in deposit balances, which, as we reported then, was a result of seasonal outflows from large institutional and governmental entities. Business development and promotional efforts also contributed to healthy increases in both demand deposits and money market accounts.

In October, the FDIC released June 30, 2017, deposit market share statistics. We're pleased to report that Washington Trust once again increased our share of deposits in Rhode Island and maintained our #3 rank behind Citizens and Bank of America within the state. Organic growth through branch expansion has been a key part of our deposit and market share strategy over time. In early November, we'll continue our statewide branch expansion when we open a new branch in Coventry, Rhode Island, located just off the 95 Corridor in the central part of the state. The Coventry location fills in a gap within our existing branch network, offering additional convenience for existing customers as well as opportunities to build new relationships. Deposit generation is a key source of funding for future loan growth. It does remain a challenge in our highly competitive market. We're pleased with our third quarter growth, and hope the trend will continue through year-end.

Our wealth management division had a strong quarter as wealth management revenues and assets under administration both reached record levels. Both our wealth management division and our clients have benefited from appreciation are resulting from the surging stock market. Dows' recent record-high closing may signal that the market -- the financial markets should end the year on a high note.

I'll now turn the discussion over to David for an in-depth review of our financial results. David?

Thank you, Joe. Good morning, everyone. I'll review our third quarter 2017 operating results and financial position as described in our press release issued yesterday.

Net income was $13 million or $0.75 per diluted share for the quarter, that compares to the $13.2 million and $0.76 in the second quarter. The profitability metrics remain strong with a return on equity in the latest quarter of 12.56% and return on assets of 1.18%. Increases across most revenue categories contributed to these results. The results also reflect the impact of a $570,000 third quarter expense item, which we consider to be noncore. Net interest income was up by $155,000. The margin -- net interest margin was 2.93%, a decline of 4 basis points from the second quarter. Included in net interest income was prepayment fee of $131,000 in the latest quarter compared to $549,000 in the second quarter. Excluding those amounts, net interest income was up by about 2% and the margin was 2.9%, down 1 basis point on a linked-quarter basis.

The yield on interest-earning assets declined by 1 basis point. And excluding prepayment fee income in both quarters, the yield on interest-earning assets rose by 4 basis points to 3.66%. The average balance of interest-earning assets increased by $35 million, reflecting growth in the loan portfolio, partially offset by a decline in average investment securities.

On the funding side, the average balance of wholesale funding sources, including Federal Home Loan Bank borrowings and wholesale brokered deposits, increased by $32 million in the second quarter, while the average balance of in-market deposits declined by $24 million, and that reflects the seasonal outflows towards the end of the second quarter. The cost of wholesale funding rose by 7 basis points. And meanwhile, the cost of in-market deposits, which includes all deposits less wholesale brokered deposits, was 35 basis points, up by 2 basis points from the latest quarter.

On the balance sheet, total loans rose by 4%. The commercial real estate portfolio rose by $90 million, an 8% increase, the C&I portfolio was up by 2%. Residential loans also rose by 2%, and there was a modest decline in the consumer portfolio. Investment securities declined by $36 million during the quarter due to amortization on mortgage-backed securities and some calls of municipal securities. Total deposits increased by 4%. In-market deposits were up by 5%, as we saw a rebuilding of institutional and governmental depositor relationships following those seasonal outflows in the second quarter.

Noninterest income continues to be very important, and it represents 37% of our total revenues in the latest quarter. Noninterest income was $17 million, a 3% increase on a linked-quarter basis. Wealth management revenues were $10 million, a 1% increase from the second quarter. That increase includes a $390,000 increase in asset-based revenues, offset by a $319,000 decline in service fees, primarily related to the tax service fees, which are typically concentrated in the second quarter. Wealth management assets under administration rose by just under 3%, benefiting from market appreciation, and stand at a record level of $6.6 billion at the end of the latest quarter. And managed assets represent 92% of total wealth management assets.

The mortgage banking business had a good quarter with a 4% revenue increase over the second quarter. The volume of loans sold into the secondary market was $147 million, up 7% over the second quarter. And we consider the mortgage pipeline to be in good shape. Loan-related derivative income was very strong at $1.5 million in the third quarter, up about $300,000 on a linked-quarter basis.

In noninterest expenses, the total for the latest quarter was up by 2% from the second quarter, included in the latest quarter was a $570,000 charge related to an isolated external fraud matter. Excluding that charge, noninterest expenses were down about 0.5% on a linked-quarter basis. Our effective income tax rate was 32.8%, and our current forecast for the effective rate in the fourth quarter is about 33.5%. That could vary depending on the amount of excess tax benefits associated with the settlement of stock-based incentives.

Looking at asset quality, total delinquencies, loans past due by 30 days or more declined by 17 basis points to 0.49% of total loans at the end of September. And nonperforming loans declined by 7 basis points to 0.56% of total loans at the end of September. Net charge-offs for the quarter were $654,000, including a $400,000 charge-off on one commercial real estate credit. And through September, net charge-offs have amounted to only 0.04% of average loans on an annualized basis. Our allowance for loan losses stands at 0.82% of total loans, down by 1 basis point in the quarter. The provision for loan losses was $1.3 million, and that compares to $700,000 in the second quarter.

Total shareholders' equity stands at $414 million, up by $8 million in the quarter. Both the corporation and the subsidiary bank capital levels continued to exceed the required levels to be considered well capitalized, and total risk-based capital ratio for the corporation was 12.53% at the end of September.

The consolidated tangible equity to tangible assets ratio was 7.76% at the end of September, up 3 basis points during the quarter. With our third quarter dividend declaration in September, we increased the quarterly dividend rate by $0.01 to $0.39 per share, and that was paid on October 13.

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

Thank you, David. I would like to take a moment to comment on some leadership changes that will take place in early 2018. A few weeks ago, David Devault and I announced our intention to retire from the corporation. Ron Ohsberg, who has joined us on today's conference call, will take over as Chief Financial Officer and Treasurer when David retires on January 31, 2018.

Ned Handy, who has served as President and Chief Operating Officer for the past several years, will succeed me as Chairman and Chief Executive Officer when I retire on March 2, 2018. Mark Gim, who is currently traveling and was unable to join us today, will take over Ned's role as President and Chief Operating Officer.

David and I have both been contemplating retirement for some time. But leaving Washington Trust was, obviously, not an easy decision. This company has a special place, which is why it's been around for 217 years, and is recognized as one of the top financial institutions in the country. I've been honored to serve as Chairman and CEO and to work alongside some outstanding professionals, particularly, David Devault, who has served faithfully for over 31 years at the company. And I would just like to personally thank David for all of the help he has given me over the last several years. I could not have done my job without David.

As I head off and David packs his bags to travel, we're confident, very confident that Ned, Mark, Ron and the entire leadership team will successfully guide Washington Trust in the years ahead. And again, I thank all of the management team for all the help they -- and support they've given me in particular. Thank you for your time this morning.

And now Ned, David, Ron and I are happy to answer any of your questions. Thank you.

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

Joe and Dave, congratulations on your retirement. And Ned, Mark and Ron, best of luck in your new roles.

Thanks, Mark.

Thank you.

I wonder if I could start by asking a quick question about the external fraud that you mentioned in the press release. If you could, maybe, give us a little more detail on that, and whether there might be any additional charges coming down the pike on that?

It's kind of an unusual item. We're continuing to work through the matter. I don't believe -- we don't consider there to be any additional exposure. It's -- I can say it's not a cyber-related matter, nor is it an internal control problem. And it's just an unusual item for us.

Was it a loan-related event?

No. It has something to do with a fraud perpetrated through the banking system.

Were there other institutions affected by it?

No. Well -- no. The answer is no.

Okay. You just can't give more detail on it.

We're continuing to work through it. And we're hoping that there will be some recovery at some point in the future.

Yes, Mark, we -- this is Joe. We don't want to be too cryptic about this. This was an isolated incident that happened with just one event that we're working through now. And we feel like the charge that we took this quarter is the extend of it, and we are working through a potential recovery of that. But we really wouldn't want to predict that at this point.

Okay. And then secondly, Dave, I wonder if you could help us think about the net interest margin over the next couple of quarters, where that's likely to trend?

Sure. Not -- without assuming a future fed rate increase, I would say that the trends that you saw in the third quarter are fairly representative of what we're going to expect to happen in the next few quarters. Some pressure both on deposit rates, which as we look at other regional community banks in the Northeast, we see a fair number of them reporting higher deposit costs, and that affected us as well. And the loan growth was helpful. And so overall, I would say, margin on that basis would be about flat over the next couple of quarters. A fed rate increase could potentially improve that. But again that depends on what the rate of deposit funding costs would be during that period of time.

Okay. And then on the mortgage banking line, you guys had much better results than some of your peers up there. I'm curious is that because you just have more purchase volume, you think, than the peers? Or is there something else there?

The purchase portion of the secondary market originations has been fairly good. We have what we believe is a good -- a well-run business with a diversified base of investors who know our product and are willing to buy our product, and we've over time refined our origination system to be able to meet the needs of individual investors. We also operate in a good market in the Boston area and other southern New England markets. So it just works well for us.

And Mark, it's Ned. I think, David's right. The Boston Market has been very supportive. Connecticut has been strong for us. The pipeline remains fairly robust. And so we expect the next few quarters to be -- to continue to be strong. And we are -- as David said, we do well in the purchase market. Our LOs are sort of independent contracts, if you will, and they have great networks of their own and not branch-dependent, which tends to sort of end itself to refi business. So they're taking advantage of the full market.

Okay. And then lastly, are you seeing much of the way of M&A opportunities on the wealth management side?

Well, Mark, this is Joe. I would comment on that. I would say that wealth management is something that we remain interested in. We are, quite frankly, shown things fairly consistently. We probably have a little bit of a geographic prejudice to that. We like these things to be within striking distance of us. We like the business. And for us it really is a -- it has a lot to do with the age of the principles, the actual price and how -- if we can structure these things in a way that keeps the principles of those companies with us, a lot like we structured the Halsey deal. So yes, we would certainly consider that as we go forward.

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

So my first question is just dealing with loan growth. Could you guys talk a little bit about what drove the commercial real estate growth during the quarter? Like what kind of asset classes and types of credits you're putting on?

Damon, it's Ned. A good mix from a commercial real estate side, the property side, probably weighted a little bit towards multi-family and construction. We had during the quarter new originations and commercial across the board of about $161 million. So we did still have some payoffs, about $42 million in the quarter, unexpected payoffs. So I think the highlight was the new credit formation was very strong. Those payoffs have continued to be mostly in real estate, where borrowers are still taking advantage of very low cap rates and selling at kind of the top of the market. But construction, multi-family, some retail, some office are all Rhode Island, Massachusetts and Connecticut, so all within our sort of short striking distance. Some participations, but I would say more direct to borrowers than both participation certainly. So I think a good mix, we had about -- let's see, we had about 21 -- $16 million in new C&I loans, and about $21 million in construction advances during the quarter on C&I credits. So it's still a pretty good balance between CRE and C&I for us.

Okay. That's great. It's helpful. And then as you kind of look into the fourth quarter and as you go into '18, obviously, the first half of this year, you were struggling for loan growth, but it was probably more a function of the payoff, not on the origination side. So what are you seeing as you go into the fourth quarter and into 2018?

And you're correct. It was more about payoffs and about loan than actually new credit formation. But the pipeline is at about $200 million, which is pretty good for us. We think we'll hit the sort of the mid-single-digit growth rate that we projected for this year. And we don't see any reason why we won't get our fair share of activity going into 2018. The team's busy. Did the payoffs have slowed somewhat? To Joe's earlier point, they still continue to be there. So we have to keep an eye on that. And those are generally deals that are either selling or refinancing long-term nonrecourse with sort of insurance companies or CMBS. So they are not deals that we could keep if we wanted to, or should keep if we wanted to. So that's going to be the ongoing challenge to spend to which the portfolio churns. And as I said in the past, rather have real estate loans payoff too early than too late. So I'm okay with that and run hard to replace high-quality deals.

That make sense. Okay. And then my other question just as it relates to expenses, if we take out that $570,000 fraud-related charge, is this a good core base to build off as going forward?

I would say so. It's really nothing unusual in those numbers other than that one item that I mentioned. We would expect nominal growth over the next few quarters.

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

I just want to say Joe and David, it has been a real pleasure working with you guys, and best of luck. And Ned and Mark and Ron, congratulations. Just wanted to echo that, makes it special. So just going back to the loan growth for a moment, obviously, CRE was really strong, 30% annualized this quarter. How much of that was participations?

The exact dollar amount, I don't have in front of me. But Maria may have it?

Okay. I can follow back with you offline. And then same question. I know you have -- you have purchased RESI loans, primarily in Massachusetts. Any of your growth in the residential book this quarter purchased?

No. We haven't done any purchases this past quarter, Laurie.

Okay. Okay. And I guess, as we think about your overall loan growth, I mean linked-quarter 15% annualized, you're just hitting it out of the park. How should we think about that overall for next year?

I don't think we have solid numbers for the next year Laurie, but I do think that we feel confident that we will, year-over-year, this year, get into the mid-single digits. Next year, if we could do a little bit better than that, that would be our goal. But I don't see us hitting that kind of annualized 15-ish percent growth the next year. I think that would be an outsized number.

Okay.

Hey, Laurie, back to the participation question. Actual participations are down in the quarter by $9 million.

So what was the total participations?

Total number is -- in the portfolio it is $391 million for the quarter. We don't have the number.

We [have continued that] in the quarter.

Okay. And I'm sorry, and how much of that was put on in this quarter?

Well again, the net change in Washington Trust's participation in loans led by other banks declined by $9 million during the quarter. So the increase is from our self-originated products.

Okay, right, of that -- of the $77 million in quarter. Okay. And so going over to loan loss provision, obviously, you had a lot of loan growth, so understandably you had a jump in provision here. Was there anything in the provision line that related to the fraud. I mean, I get that the fraud charge was down in the noninterest expense side, but was there anything about the fraud -- and I appreciate you don't want to disclose it, but was there anything -- so there was nothing fraud related in the loan loss provision line?

Absolutely, not.

Okay, okay. That's helpful. And then as we look at -- where we talked about, can you just comment a little bit, your wealth management is just off the charts, but you have larger outflows. This quarter you had net client outflows of around $86 million. Any color around that?

Laurie, I would say that one of the things that we faced from an outflow perspective is that on balance, our -- particularly, our customers in the southern part of Rhode Island are somewhat older, and are in a mode of kind of depleting their accounts to some extent. So it's one of the things that we kind of constantly have to battle. It's not a lost account issue. It's really more about that part of our business. So to the extent that we continue to -- can continue to grow through developing new relationships, that's a very important part of what we do as we go forward.

Okay, great. And then just last question. I know Mark asked about the RIA and how you're looking at that, potentially on the acquisition part. Can you share with us -- I mean, you have one of the strongest currencies in New England, now you're almost 3x, but can you share with us how you're thinking about an acquisition? And obviously, we're asking this almost every quarter, but you know you now have the file shelf. Just how are you approaching that, that bank acquisition, potentially?

Well, I'll let Joe talk about the appetite and our -- the way we look at potential acquisitions. The shelf was really to position the company to have the ability to either issue debt or raise capital. It's something that most regional community banks have in place, and we decided that was something that we needed to have in as part of our overall capital management strategy.

Yes, I would say from an acquisition perspective, on the whole bank side, Laurie, what we would look to is something that is -- would be in a market that we felt we could grow and, obviously, get some level of cost efficiencies from. One of the things, obviously, that would be very attractive to us would be something that had a very favorable loan-to-deposit ratio. There's not a lot of that in New England. So I would say, as we've said before, it's a function of price and, to an extent, the type of franchise that we thought we could do something with and add value to. And I think we also are very mindful of how -- even though our stock is certainly a good currency, we are very conscious of having reasonable dilution to anything that we would do.

Okay. And just last question around that, will you remind us the parameters in terms of how smaller deal you would look at on the asset side? And how large you would think about?

Well, the Halsey deal was approximately an $800 million deal. I would say that we would do things if they were close enough to us that would be somewhat smaller than that. At some level, to do things that are tiny it's not necessarily worth it.

I don't think you would see us do kind of a debt to bank combination on the whole bank side. But clearly, we would -- we're not addressed to doing things that are $1 billion, $1.5 billion if it made sense.

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

Great, thank you. Thank you to everyone for participating today. We feel as though we had a solid quarter, and we think we have very good momentum as we're going through year-end. Looking ahead, obviously, there are variables. We know that the appointment of a potential new Fed Chairman may have some effect on interest rates and tax reform, obviously, could affect our whole industry. We have a lot of confidence in our diversified business model. It has helped whether economic swings in the past, and we're confident that we'll continue to navigate through those changes. I'd also be remiss if I didn't say that I personally have a lot of confidence in our new management team. And I think the company is well positioned to continue its success. So thank you very much.

Thank you. This concludes today's conference. Thank you for attending today's presentation. You may now disconnect, and have a wonderful day.