Washington Trust Bancorp Inc (WASH) 2018 Q1 法說會逐字稿

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

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

Thank you, Doug. Good morning, and welcome to Washington Trust Bancorp, Inc.'s First Quarter 2018 Conference Call. Today's call will be hosted by Washington Trust's executive team: Ned Handy, Chairman and Chief Executive Officer; Mark Gim, President and Chief Operating Officer; and Ron Ohsberg, Senior Vice -- Executive Vice President, Chief Financial Officer and Treasurer.

Please note today's presentation may contain forward-looking statements and actual results could differ materially from the statements made on today's call. Our complete safe harbor statement appears in our earnings press release and in other documents we file with the SEC. Please visit our Investor Relations website at ir.washtrust.com to review the complete safe harbor statement and other documents. Washington Trust trades on NASDAQ under the symbol WASH.

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

Thank you, Beth. Good morning, and thank you for joining us on today's conference call. We released our first quarter 2018 earnings last Friday afternoon. This morning, Mark, Ron and I will review those results with you and answer any questions you may have about the quarter or the year ahead.

Washington Trust started the year on a positive note, with record quarterly earnings and earnings per share.

Net income for the first quarter of 2018 amounted to $16.2 million or $0.93 per diluted share. Our first quarter earnings benefited from a lower corporate tax rate, which was part of the Tax Cuts and Jobs Act enacted in December 2017.

Here are some highlights for the quarter: Company's profitability metrics were strong. We haven't seen levels like this since 2000. Net interest income also reached an all-time high. Asset quality continued its favorable trend, and capital levels were also strong and continue to exceed regulatory requirements.

Let me take a few minutes to discuss our core business line activity. Total deposits reached $3.3 billion at March 31, up slightly from year-end. We've had a nice steady increase in low-cost demand and NOW accounts over time, and DDAs and NOW accounts are up almost 10% from a year ago.

As we've mentioned in the past, we've had success in growing deposit market share by expanding our Rhode Island branch footprint. We opened the Coventry branch in the fourth quarter of 2017, and it is ramping up well. We will continue with our branch expansion strategy and have secured a branch site in North Providence, Rhode Island. We expect that branch to open at the end of this year or in early 2019.

Deposit generation has been an industry-wide challenge, and we believe rising interest rates and increased competition will make it even more difficult going forward. We've seen things heat up here in our local market as banks and credit unions are offering cash incentives for new checking accounts and setting above-market rates for special term certificates of deposit.

Total loans were $3.4 billion at March 31, up marginally from year-end and up 5% from a year ago.

Our mortgage banking area had sound growth in the first quarter of 2018, and total residential loans are up more than 10% year-over-year. Mortgage banking revenues were also down slightly from the preceding quarter, but favorable to Q1 2017. A steady rise in interest rates since year-end affected both loan demand and the volume of residential mortgage loans sold to the secondary market. Our mortgage banking results also reflect financial adjustments associated with the introduction of a portfolio-based hedging program. And Ron will explain the financial impact of the hedging program in his comments in a moment.

In the last year with rising rates, we've seen a shift in the composition of our mortgage pipeline as almost 3 quarters of our activity is now purchase loans versus refinancing.

Our mortgage pipeline is healthy, and we continue to generate strong production from our loan offices, continuing with more than 50% of the production from Massachusetts.

Commercial loans amounted to $1.8 billion at March 31, which is relatively flat from year-end and up slightly from a year ago. As in previous quarters, we had a very high level of commercial payoffs in the first quarter. Our commercial pipeline is healthy, and commercial loan growth has typically been slower in the first quarter. So we are confident that things will ramp up in the next few quarters.

Our asset quality remains excellent, so we have limited concern on that end.

We posted a record $10.3 million in wealth management revenues in the first quarter of 2018. Wealth management assets under administration stood at $6.3 billion, down from year-end levels. The decline in wealth management assets was primarily due to client outflows resulting from the departure of client-facing personnel. Ron will discuss the estimated financial impact of this as well.

At quarter's end, we introduced new wealth management technology, including a new online portal for clients and advisers. Our wealth management and technology teams worked diligently throughout last year and the first quarter, and the system was successfully implemented on April 1.

I'd now like to turn the discussion over to Ron Ohsberg, who will provide an in-depth review of our financial performance.

Yes. Thank you, Ned. Good morning, everyone, and thank you for joining us on our call today. I'll review our first quarter 2018 operating results and the financial position as described in our press release issued on Friday.

Net income amounted to $16.2 million [client correction] or $0.93 per diluted share for the first quarter compared to $8 million and $0.46 in the fourth quarter of 2017. We also reported return on equity for the quarter of 15.96% and return on assets of 1.45%. These reported results were affected by the enactment of tax reform in December, which, as you know, permanently lowered the corporate tax rate from 35% to 21% effective January 1.

In the fourth quarter, we wrote down the value of our net deferred tax asset by $6.2 million with a corresponding increase to income tax expense. This write-down reduced the EPS in the fourth quarter by $0.36.

Net income for the first quarter of 2018 benefited from a new lower corporate tax rate.

Net interest income for the quarter rose by $963,000 or 3% and net interest margin was 3.08% -- excuse me, 3.03%, up 8 basis points compared to the preceding quarter.

The average balance of interest-earning assets rose by $66 million on a linked quarter basis. The yield on average earning assets increased 14 basis points from the preceding quarter to 3.84%.

On the funding side, average in-market deposits were up $1 million, while the average balance of wholesale funding sources, which include FHLB borrowings and wholesale brokered deposits was up $58 million from the fourth quarter.

The cost of in-market deposits, which includes all deposits less wholesale brokered deposits, was 41 basis points, up 3 basis points in the quarter. Meanwhile, the cost of wholesale funding rose by 9 basis points.

Noninterest income continues to be important to our business, representing 33% of total revenues in the first quarter. Total noninterest income was $15.7 million in the quarter, down $467,000 or 3% in Q1.

Wealth management revenues were $10.3 million, up 4% from the preceding quarter. Wealth management assets under administration amounted to $6.3 billion, down $371 million or 6%. The decline in wealth management assets resulted mainly from client outflows in the latter portion of the first quarter due to the loss of certain client-facing personnel. We are estimating an impact of about $600,000 to $700,000 per quarter starting in Q2, which will be partially offset by some savings in comps.

Our mortgage banking revenues totaled $2.8 million in the first quarter of 2018, down by $259,000 or 8% from the preceding quarter. These results reflect both seasonality and higher retention of originations in the portfolio, partially offset by a $565,000 in fair value adjustments related to the commencement of a portfolio hedging program as well as a higher sales yield.

Mortgage banking revenues were up $498,000 or 21% over the same period a year ago. We consider the mortgage pipeline to be in good shape.

Loan-related derivative income was $141,000 in the first quarter compared to $470,000 last quarter; the decrease is due to lower volume of commercial loan -- commercial borrower loan related to derivative transactions.

Now let me turn to noninterest expenses. Total noninterest expenses for the latest quarter increased $1.4 million, or 5% from the previous quarter. There are several items here that I'd like to call out. In the fourth quarter, we had 2 contra-expense items. The first was a $333,000 reduction in the contingent consideration liability related to the 2015 Halsey acquisition earnout. The second was the receipt of $325,000 in settlement of a claim against another bank related to a previously-disclosed dispute.

In the first quarter and, as previously announced, onetime cash incentive bonuses of approximately $450,000 were expensed and paid as part of Washington Trust's employee compensation enhancements that were made in response to reduction in corporate taxes from the tax act.

And finally, in Q1, system -- software system implementation expenses of $681,000 were recognized, an increase of about $435,000 from the preceding quarter. These were classified as other expenses and primarily relate to the conversion of our wealth management accounting system that was completed in April 2018.

Excluding these items, noninterest expenses were down $167,000 or 1% on a linked quarter basis.

The effective income tax rate was 20.8% in the first quarter of 2018 compared to 62.3% in the preceding quarter. Income tax expense totaled $4.3 million for Q1, down from $13.2 million in Q4 of 2017. Again, the linked quarter reduction in income tax expense and the effective tax rate was due to the enactment of the tax act.

Turning to the balance sheet. Total loans were up $13 million from the end of fourth quarter. The CRE portfolio, which includes construction loans, increased by $7 million from the balance at the end of the previous quarter. C&I portfolio decreased by $9 million. Residential loans rose by $23 million or 2%, while consumer loans were down $8 million.

Investment securities increased by $6 million from the end of December, as we purchased $42 million of agency mortgage-backed maturities and agency debt securities in the quarter, offset by normal amortization, municipal bond maturity and the decline in the fair value of available-for-sale securities.

Total deposits rose by $14 million in the quarter, with in-market deposits up $6 million and wholesale brokered CDs up $8 million.

In terms of asset quality, nonperforming loans stood at 0.13% of total loans, down 14 basis points from the end of December as we resolved a couple of long-standing problem loans. Loans past due by 30 days or more as a percentage of loans outstanding decreased by 2 basis points in the quarter to 0.57%.

Q1 net charge-offs totaled $624,000 compared to $1 million in the previous quarter. And the allowance for loan losses stood at 0.76% of total loans, down 3 basis points. The loan loss provision was 0 in Q1 compared to $200,000 in the prior quarter.

Total shareholders' equity for the corporation remained constant at $413 million compared to Q4 with net income being offset by dividend and the FAS 115 mark on our available-for-sale securities. The corporation and the subsidiary bank capital levels continued to exceed the required levels to be considered well capitalized. Total risk-based capital ratio for the corporation was 12.56% at the end of March compared to 12.45% in December. The tangible equity to tangible assets ratio was 7.57% at the end of March compared to 7.63% in December. And finally, our first quarter dividend declaration of $0.43 per share was a 10% increase on the preceding quarter and was paid on April 13.

At this point, I will turn the call back to Ned.

Thank you, Ron. So Washington Trust posted record earnings in the first quarter of 2018. We increased our dividend for the 25th time in 26 years. Our continued profitability, good asset quality and strong capital position provide a solid foundation for future growth. We have a terrific team and are excited about the opportunities in our markets to grow the bank. We are guided by a strong corporate culture, and our team is dedicated to making our communities better places to live and work. Tomorrow, we'll host our annual meeting of shareholders and we look forward to presenting our 2017 results, sharing our first quarter highlights and discussing our outlook for the year ahead.

Thank you for your time. And now Mark, Ron 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 wondered if you could start by sharing with us here sort of outlook for the net interest margin over the next couple of quarters?

Sure, Mark. This is Ron. I'll take that one. So I guess, I'll start by saying that we take any Fed rate hikes as they come. So we're not really forecasting any of that. So absent any rate hikes, we would expect margin to be stable to slightly up for the balance of the year. Having said that, we are definitely seeing some competitive pressure in deposits, but we remain disciplined with pricing on those. So stable to up slightly would be my guidance at this time.

Okay. And then secondly, Ron, should we assume the effective tax rate will bump up a little bit in the second quarter because you won't have the impact of the share-based awards in there.

Yes. We're sticking with 21.5% for the year at this point.

Okay. Great. And then sort of broader question, over the last couple of years, you guys have been growing loans at a reasonable clip and the reserve has been sort of coming down a little bit. I know credit is squeaky clean and -- but I guess, I'm just curious given how late we are probably in the cycle, your thoughts on provisioning going forward.

Yes, I would say our provisioning will be a function of loan growth at this point. And we resolved 2 problem credits at the end of the quarter here. We don't have any commercial nonperforming assets at this time. So it's pretty clean. And we don't see anything in the immediate future that's going to change that. I understand your point about the lateness in the credit cycle, but for right now, things look -- they look good.

Okay. And then lastly, I wondered if you could just discuss what happened with personnel leaving in the wealth management business and was that at Halsey?

Mark, this is Mark Gim. I'll take that question. No, those were 2 -- well, 3 client-facing personnel from Weston Financial Group in the Boston marketplace, and that happened in the middle of the first quarter. We think that substantially all the asset runoff that we would anticipate happening was included in Ron's projection of loss revenues per quarter. Somewhat of an unusual occurrence in that the client-facing personnel in question were not under nonsolicit, noncompete agreements. Those -- that -- I would consider that to be an unusual situation, which isn't present elsewhere in the wealth franchise. So in Weston rather than Halsey.

But generally, your client-facing folks are under noncompete, nonsolicitation.

That's correct for the acquired entities. Within the trust function of the core bank, that nonsolicit, non-compete is unusual, and that would not be the case.

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

So just to kind of follow-up on that last question by Mark on the wealth management. I think you guys noted you're expecting roughly $600,000 to $700,000 of loss revenues with the outflow of those assets under management. What can we expect -- I mean, I guess, if you annualize that in kind of tax effect that's maybe like $0.10 a share of earnings for the year. So how can we kind of think about the offset on the expense side of that?

Yes, I'll take that. Damon, it's Mark Gim, again. All-in on a salary benefit and incentive basis, the salary expense for those personnel will be roughly $800,000 to $900,000. We will be looking to replace those personnel as time goes on. But you could probably view the marginal impact as being somewhere in the mid 6-figure range for salary and benefit saves. Again, if we did add personnel, it would be with an eye towards acquiring either people with existing books of business or with [synergy] business generation capacity.

Okay. So we may see a bigger hit in the next couple of quarters until you kind of address the personnel loss and get some more AUM back on the books to generate more revenue. Is that fair?

Well, no, I think that the revenue shortfall number we provided was really related to the foregone earnings on the assets under management. So that number that Ron provided, I think is a reasonable estimate of loss revenues. Not shown obviously would be any interim savings on the expense side.

Or normal growth in the business, which we fully expect to recover some of that revenue.

Got you. Okay. All right. That's helpful. And then with respect to your outlook for loan growth, obviously some -- I think you've mentioned some commercial prepayments or pay downs that weren't necessarily planned this quarter and just kind of some seasonal impacts, but as you look out for the duration of 2018 and you look on kind of an annualized basis, are you still comfortable in that maybe 6% to 7% range for the full year?

I would use sort of mid-single digits for growth, which is what we've talked about, and I think that still remains the case. First quarter is generally a little bit slow for us. We did have a continuation of pay downs, payoffs that weren't expected. Credit formation in the first quarter was pretty strong, but outstripped by payouts. So the pipeline is healthy. So I expect that we'll be back to good numbers in the second quarter and beyond. So I think we're still comfortable with sort of mid-single-digit growth.

Okay. Great. And then I guess, last question with relation to the margin, I think the yields on loans was 4.16%, which was up from 4% last quarter. Is that just attributable to more favorable pricing in the market and the impact of the Fed increases? Or was there any benefit from maybe some onetime payments and interest or anything like that?

No, no. It's all rate driven. We have a large [network]. It's all rate.

Our next question comes from the line of Nicole Gulino with American Capital Partners.

I was just wondering if you could let me know where prepayment income was for the quarter and what you calculated the core NIM at?

Yes. So included in net income was prepayment income of $46,000 compared to $174,000 last quarter. So if we take that out, net interest income was up by about $1.1 million or 4%, the margin was 3.03%. So really, it was pretty negligible.

Our next question comes from the line of Laurie Hunsicker with Compass Point.

Just wanted to go back to your AUA. Just wanted to make sure I'm thinking about this the right way. So when we look at your wealth management revenues that were $10.3 million, round numbers, those will be down at a run rate, and I'm just talking about the revenue line, not the expense, so I appreciate the color on the expense. So round numbers, those will be down about $800,000-or-so per quarter. But I know that 2Q, typically contains some tax prep, round numbers of around $200,000. Was any of the outflows related to that? Or should we still think of that seasonally? In other words, that revenue line will still be up and then down another $200,000 in September, all else being equal.

Laurie, this is Mark. Just a couple of things. I don't think $800,000 was the number that we provided...

$600,000 to $700,000.

$600,000 to $700,000 was net -- netting out their salary and benefits, correct?

No, that was not.

Okay. So same question. So $600,000 to $700,000, if we're thinking about them, let me just ask maybe a different way. The $200,000 or so that has typically been in 2Q from tax prep, are you still expecting that for the June quarter?

Yes, tax prep would not be affected by the departure of the assets.

Okay. Great. And then how many client-facing personnel do you guys have?

Well, on the wealth management side of the business, there are roughly 100 employees. Of those, I would say probably 30% would have client-facing responsibilities. It varies -- of course, the customers vary based on business model and location. I would say, in this particular case, it was an unusual situation, as I said earlier, where the counselors in question were at the time of acquisition relatively junior and did not enter into nonsolicit, noncompete as time went on. So I would not look at this and say this is something that is we would expect to occur elsewhere in the franchise.

Okay. But so then just to clarify, of your 30 senior client-facing individuals, do they all have nonsolicitation?

So again, in the acquired entities of Weston and Halsey, there are nonsolicit, noncompetes in place for certain client-facing personnel. That would not be the case in the trust company structure that has been in place since 1902 within Washington Trust.

Okay. And so again, just to clarify, so these were more junior people that left under Weston, but somehow they took the $400 million with them.

Well, they were more junior at the time of acquisition in 2005, Laurie.

Yes, they came with the acquisition and were young at the time, so didn't have agreements in place and just were not asked to sign agreements along the way, unfortunately.

Well, economically.

Yes.

Okay. And just again, last question on this. So does this make you think a refresh of going back and looking at your nonsolicitation? I mean, presumably, obviously markets go up, markets go down, but your AUA is absolutely unbelievable compared to a lot of community banks, but it's such a big piece of your RTC. And so as we think about this, does it make you all rethink how you're approaching these people if you're going to go back and potentially think about putting in some additional contracts for them? Or how do you think about that?

Well, contracts are already in place for the majority of employees. And as we advance people to positions of client contact authority, we also -- we do, do that. That's why I would say this is kind of an unusual situation. One of the employees who departed was subject to a nonsolicit, noncompete agreement and has not, we believe, participated in any outreach. I think it affects the question, Laurie, more going forward with any future activity. And we have planned for that. Again, recall that this transaction was consummated in 2005.

Got it. Okay. That's helpful. Okay. And then just as we think about your approach going forward to adding RIAs, how are you thinking about that?

I would say we continue to remain alert and enthusiastic for opportunities that make financial and cultural sense. As you are probably aware, there has been a significant amount of focus in this business not just in the bank space, but in the nonbank financial M&A acquisition space as well. So we try to be prudent about price paid, what you can do with the franchise when it's acquired and when you can be additive from the standpoint of adding trust; for example, fiduciary services or financial planning services to an RIA that might not have those. Geography, price, value to shareholder and compatibility with the existing franchise tend to pass through the screen. So this doesn't -- our stance really has not changed very much on that. I would say that the competitive environment for M&A, again primarily nonbanks, has become more pronounced during the equity market run-up over the last couple of years. So we want to be, as I said, careful about price paid and value.

Okay. Great. And then just shifting gears, your Coventry branch, how much did that finish the quarter with, in deposits? Or where does it stand currently?

A little over $3 million. So it's ramping up nicely. It's on pace for what we would expect, but it's been pretty busy. We're pretty bullish on it.

Okay. Great. And then the cost of those deposits is in line with what you're currently running?

Yes.

Okay. And then de novo plans, you mentioned one more coming on end of '18, early '19. Should we be thinking about kind of one de novo a year give or take? Is that how you're thinking about things now?

I think that's the safe way to think. We don't have another location even in our sights at this moment, but we have still a $30 billion market for us to try and be successful here in Rhode Island. So that's one of the ways we intend to go about it.

Okay. All right. And then just last question, kind of going back to your loan loss provisioning, which was there, and I know Mark touched on this briefly, but in other words, if we're thinking, okay, as we roll forward, you said loan growth would be mid-single digits. If we assume something in the neighborhood of charge-offs running to where you've been, excluding some things that cleaned up this quarter, that would kind of put our loan loss provisioning somewhere in that $1 million to $1.3 million per quarter run rate. Am I thinking about that the right way?

That could be in the ballpark. I mean, it's really hard to say. We had $600,000-some of charge-offs. That was related to the 2 loans that I mentioned that are gone. So for perspective, we're not expecting a lot of charge-offs for the balance of the year.

This does conclude our Q&A session. I'd like to now hand it back to Ned Handy for closing comments.

Well, thank you all for your time and for your interest in our company. We appreciate you joining the call, and wish you all well in the days and months ahead. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.