Washington Trust Bancorp Inc (WASH) 2018 Q3 法說會逐字稿

Good morning, and welcome to Washington Trust Bancorp, Inc.'s Conference Call. My name is Latonya, 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, Latonya. Good morning, and welcome to Washington Trust Bancorp Inc.'s third 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 Executive Vice President, Chief Financial Officer and Treasurer.

Before we begin, please note today's presentation may contain forward-looking statements and actual results could differ materially from what is discussed on today's call. Our complete safe harbor statement appears in our earnings press release and other documents that are filed with the SEC. We encourage you to visit our Investor Relations site at ir.washtrust.com to view all of our SEC file documents and the complete safe harbor statement. Washington Trust trades on NASDAQ under the symbol WASH. I'm now pleased to introduce Washington Trust's Chairman and CEO, Ned Handy.

Thank you, Beth. Good morning, and thank you all for joining us on today's conference call. Yesterday, we released our third quarter earnings. This morning I'll spend a few minutes reviewing the highlights of the quarter, and then Ron Ohsberg will discuss our financial performance. After our prepared remarks, Mark Gim will join us and we'll be happy to answer questions about the quarter and what lies ahead for the remainder of 2018.

Washington Trust had another solid operating performance as we posted net income of $17.5 million or $1.01 per diluted share for the third quarter. We remain well capitalized in our asset quality, which has been a hallmark for some time, remains strong. We had contributions from all business lines as we had good deposit growth, healthy loan production and increased wealth management asset generation.

Let me take a moment to discuss some of the quarter's highlights. Total deposits reached a record $3.4 billion at September 30, 2018. Promotional CD specials and seasonal inflows from municipal, institutional and governmental clients were key to this growth and helped us compete in the heated battle for deposits.

In-market deposit growth has enabled us to reduce FHLB borrowings over time. As we've mentioned on past calls, organic growth through branch expansion has been a key part of our deposit and market share strategy over time. Last year, we opened a branch in Coventry, Rhode Island and that has performed well. Our new North Providence, Rhode Island branch is currently under construction and is scheduled to open after the first of the year. Recently released FDIC deposit market share statistics indicate that we continue to hold the #3 spot in Rhode Island behind market leaders Bank of America and Citizens. Aside from the North Providence branch opening in early 2019, we do not currently have any branch expansion plans, but we do believe there is additional deposit growth potential for us in Rhode Island.

Total loans reached a record $3.6 billion at quarter's end, led by consistent commercial loan growth. We had good commercial real estate and commercial and industrial production during the quarter. We continued to have loan payoffs although not at the level we've had in the last quarter. The commercial pipeline remains healthy through year-end.

Rising rates led to slower residential real estate activity in the third quarter as total residential loans were up only modestly from the previous quarter. And the portfolio remains healthy but the late September Fed rate hike and typical New England seasonality may serve to dampen mortgage demand through year-end.

Wealth management assets under administration were $6.5 billion at September 30, up from the second quarter. The highlight of the quarter was Halsey Associates reaching $1 billion in assets under administration. As you'll recall, we acquired Halsey, a New Haven-based registered investment advisory firm, in August 2015. They have a great team and have done a terrific job of helping us build relationships and expand the Washington Trust Brand in Connecticut.

I'll now turn the discussion over to Ron for a more in-depth review of our financial performance. Ron?

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

Net income amounted to $17.5 million or $1.01 per diluted share for the third quarter compared to $17.7 million and $1.01 for the second quarter. We also reported return on equity of 16.26% and return on assets of 1.47%.

Net interest income for the third quarter rose by $338,000, or 1%. The net interest margin was 2.99%, down 6 basis points. Included in net interest income was income associated with loan payoffs and prepayment penalties of $173,000, which compared to $483,000 in the second quarter. Excluding these amounts, net interest income was up by $648,000 or 2% and the net interest margin was 2.98%, down 3 basis points.

The average balance of interest-earning assets rose by $86 million on a linked-quarter basis. The yield on these assets increased by 5 basis points to 4.03%. Excluding the core -- the non-core income items, the yield on non -- on interest-earning assets increased by 8 basis points to 4.02%.

On the funding side, average in-market deposits were up $57 million, while the average balance of wholesale funding sources was down $13 million. The cost of in-market deposits was 62 basis points, up 13 basis points in the quarter and the cost of wholesale funding was 2.13%, also rising by 13 basis points.

Noninterest income comprised 31% of total revenues in the third quarter and totaled $15.2 million, down $778,000 from the preceding quarter. Wealth management revenues were $9.5 million, down 2%. The decrease consisted of a seasonal decline in transaction-based revenues of $334,000, partially offset by an increase of $186,000 in asset-based revenues. The decline in transaction-based revenues is attributable to tax preparation fee revenue, which is generally recognized in the second quarter. Wealth management assets under administration amounted to $6.5 billion, up by $242 million or 4%, mainly due to appreciation of assets. We also experienced positive net client asset flows during the quarter.

Our mortgage banking revenues totaled $2.6 million in the third quarter, down by $317,000. These results reflected a higher volume of loans sold to the secondary market as well as higher sales yield compared to Q2. This was, however, offset by a decrease in fair value on mortgage loan commitments and loans held-for-sale due to a decline in the mortgage pipeline and commitment balances as of the end of Q3. Loan-related derivative income was $278,000 in the third quarter compared to $668,000 last quarter due to lower transaction volume.

Now let me turn to noninterest expenses. Total noninterest expenses for the latest quarter decreased by $226,000, or 1% from the previous quarter. There are several items here that I'd like to call out included in other expense in the second quarter were software implementation expenses of $114,000, primarily related to the conversion of our wealth management accounting system, which was implemented in April. In the third quarter, a onetime third-party vendor credit of $300,000 was recognized as a reduction to outsourced services expense. Excluding these items, noninterest expenses were up $188,000 or 1% on a linked-quarter basis, which was mainly due to an increase in foreclosed property costs.

Income tax expense totaled $4.7 million for Q3, essentially unchanged. The effective income tax rate was 21.3% in the quarter compared to 21.2% in the preceding quarter.

Turning to the balance sheet. Total loans were up by $66 million or 2% from the end of the second quarter and 7% from a year ago. The CRE portfolio, which includes all commercial construction loans increased by $22 million, C&I portfolio increased by $25 million and the residential loans rose by $22 million. Investment securities increased by $35 million during the quarter. Total deposits rose by $93 million or 3% in the quarter and were up 8% from a year ago. In-market deposits were up by $95 million, which included an increase in DDA of $34 million, money market of $46 million and time deposits of $18 million.

The growth in deposits reflected the seasonal inflows of various institutional and governmental depositors as well as growth in promotional time deposits from a campaign that was implemented at the beginning of the second quarter. This increase in deposits allowed us to pay down our FHLB borrowings by $73 million.

In terms of asset quality, nonaccrual loans were 0.3% of total loans, down from 0.34% at the end of June. Loans past due by 30 or more days as a percentage of loans outstanding decreased by 10 basis points in the quarter to 0.38%.

Net charge-offs were nominal in both the third and second quarter, totaling $15,000 in Q3 versus $90,000 in Q2. The allowance for loan losses was 0.75% of total loans, which was consistent with last quarter. The loan loss provision was $350,000 in Q3 compared to $400,000 last quarter.

Total shareholders' equity was $428 million, up $6.3 million compared to Q2. We remain well capitalized. The total risk-based capital ratio was 12.77% compared to 12.61% at June 30. Tangible equity to tangible assets was 7.57% compared to 7.48% at the end of June. And finally, our third quarter dividend declaration of $0.43 per share was paid on October 12.

At this time, I'll turn the call back to Ned.

Thank you, Ron. The third quarter is an important transitional period for us as it signals the end of a busy summer and marks the beginning of what soon becomes a race to year-end. We're pleased with our third quarter results as we generated solid earnings and business line growth that will give us momentum right through the year-end. So thank you for your time this morning. And now Mark, Ron and I are happy to answer any questions you might have.

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

First question. Ron, I was curious if you could give us any color on that $300,000 onetime vendor credit. What exactly is that?

Yes. That was just a contract true-up that we had.

Okay. And then secondly, I think, Ned, you referenced a healthy loan pipeline. Could you share with us the size and complexion of it?

Yes. So the pipeline is in the mid-200s, which is great. It's really grown in the last quarter. It's a good balance between CRE and C&I. It's spread as is our portfolio and our business of late spread between Massachusetts, Connecticut and Rhode Island with the C&I portion mostly focused on Rhode Island and the real estate activity balanced actually between the 3 states. So it's at an all-time high for the year. And I think we're going to have -- we should have a good fourth quarter.

Okay. And should we take this quarter's fund flows as a sign that we're down with outflows in the asset management business related to those previous employee departures?

Yes. Mark, this is Mark Gim. I'll take that question. I think there are a couple of dynamics that work there. First, I think we are -- we're comfortable that the vast majority of asset flows associated with the Weston employees leaving in the first quarter of this year are behind us. Secondly, we're seeing some traction as we get back in the marketplace focused on new originations, not just in -- at Weston, but also in Rhode Island and Connecticut. And Ned's comments about Halsey going over the $1 billion mark, we think are indicative of the fact that we're getting more traction as we focus on business development throughout the wealth part of the franchise.

Okay. And then it looked like C&I loan yields declined on a linked-quarter basis by about 11 basis points to 4.77%. Was that a function solely of lower prepayment penalties or something else?

Yes, yes.

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

Yes. So margin was a little lower, I think than we expected. As we talked about previously, we're asset sensitive. We have about $1.3 billion in LIBOR and prime-based loans, and $1.9 billion of earning assets maturing or repricing within 1 year. We calculated the beta on LIBOR for Q3 to be about 86% versus a 114% in Q2. So we didn't get quite as much lift out of the June rate hike as we expected. And as we've talked about, we've been pretty aggressive on some -- on our deposit gathering activities. But as far as Q4 is concerned, I would say we're looking at a stable margin for Q4. And a lot of that will depend upon again what happens in the deposit market, but we'll get some benefit out of the September hike, but we're planning on a stable margin for Q4.

Yes. A couple of additional comments on that, Mark. First of all, the third quarter carried pretty much the full cost of the CD promotion that brought in over $100 million in new money compared to the second quarter. So the cost of funds level was, relatively speaking, elevated Q3 compared to Q2. It's anyone's guess as to what competitive deposit betas will look like as the fourth quarter unfolds, but just as a point of comparison, we wouldn't expect to see the same increase in cost of funds resulting from those inflows in Q4 compared to Q3 as we did Q3 compared to Q2. And lastly, any additional Fed rate hike or LIBOR increase in late fourth quarter might have a beneficial impact, but really that wouldn't be felt until Q1 of 2019.

Our next question comes from Damon DelMonte with KBW.

Just to kind of follow-up on Mark's question there about the margin outlook. Are you guys still running that CD promotion that you started earlier in the year?

We are not running that one, we are running another smaller one that was -- that's similar in rate, shorter in term and the goals for that are more modest than the $100 million that we produced in Q3.

Got it. Okay. And then with regard to the growth this quarter, specifically in C&I. Was that growth driven by line utilization, increases in line utilization? Or more along the lines of new customers and new loans being originated?

Yes. So I think it's a combination of things. There was some line utilization, but there was also some -- completion of some construction projects that transferred. So these are C&I users, owners, we're keeping in the real estate book during construction and then transfer them over. So there were some movement between the portfolios. These are fully owner-occupied buildings. And we just think it's the right thing to manage the construction process and real estate and then move them over. So there was about $60 million of that in the quarter.

Got it. Okay. And do you know what your overall line utilization is on a percentage basis?

We do have that. Give me 1 second to find that. I want to say, it's in the -- it's kind of in the below 50%.

About 54% mid.

Yes. Sorry, 54%.

Okay. Great. All right. And then with regards to expenses, kind of what's the outlook from this point here? I think on an operating basis when we exclude a couple of the moving parts, it looked like it was down quarter-over-quarter. So Ron, any comments on your outlook for expenses here?

Yes. We'd expect Q4 expenses to be in line on a core basis with Q3.

Okay. All right. And then, I guess, just lastly, credit continues to be very strong. The provision was within expectation this quarter. Is there anything on the horizon that's given you guys any concern or any change in your view for provision expense going forward?

There really is not, Damon. We're very pleased with where the credit stats sit. We monitor that closely and there are no individual loans, certainly no group of loans that give us any concern. So we're pleased with where we are.

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

Can we just go back to the deposits? Can you help remind us what's going on with the interest-bearing demand line so that's gone from March quarter it had a cost of 0.14% to then 0.47% in June and now it's 1.37%. I know it's a smaller number, but the balance there is going up and the cost is going up. So just remind me what's going on there?

Right. So Laurie, in the second quarter, at the -- really in the middle of June, we implemented a program to sweep some of our wealth management -- assets under management into a deposit product on the balance sheet. And that was a total of about $75 million. We're paying our customers what they were getting within their wealth management account. So the rate is about 1.90% for Q3. So on a weighted average basis that's what caused -- it's an interest-bearing DDA product on our balance sheet. And so that's the increase quarter-over-quarter.

And have all of those deposits then come over or does that line continue to increase?

So Laurie, the majority of what we expect in the -- any time in the near term has moved over to that. It's a rough reflection of the percentage of investable assets in cash that we have in the wealth management division that is eligible currently to be swept into this type of account.

Okay. And then other line item here, money markets that was up 11 basis points. Any comments on that one?

Yes. So money market is kind of 2 tier, right. It's -- you've got the retail money markets then what we kind of call our cash management balances and the cash management side of things has been very sensitive to market rates. And where it's -- in many cases, it's a retention play as customers call and say, I can get this somewhere else and so we match that. So we've seen those rates get very competitive and up into the upper 1s, approaching 2%. And so that's the kind of the rate inflation that you're seeing in money market.

And Laurie, it's Ned. We've opted to manage those largely municipal and institutional accounts sort of on a one-off basis. We haven't done anything programmatic or anything sort of wholesale to adjust rates. We're managing those relationships and our cash management team is very close to those customers. So that is a competitive space and they do demand sort of top-tier pricing, and we expect that they'll continue to be under some pressure but we manage that very closely.

Okay. And then of the $632 million, how much of that is municipal? You know what I'll follow-up with you after.

Yes. That would be great.

Yes. On the AUA, so you had amazing growth linked quarter, you were up 16%. The team of the 3 people that left, was there any drop? I mean, I know we had $371 million in the March quarter, $257 million in the June quarter. Was that 0? Or was there any drop in that?

There was nominal drop in that, Laurie. So the majority of the growth was really asset appreciation driven. Net client flows were certainly positive for the quarter, but the majority of that reflected market action.

Okay. And then can you just remind us how you're thinking about approaching maybe doing another AUA acquisition?

Sure. We are always alert for opportunities in the marketplace. They're a function of a combination of factors, including seller book composition. We tend to prefer high net worth individuals as opposed to institutional accounts, which we think are more price sensitive. Age and location of principals. How much time do they have till retirement, for example, and is there a risk of runoff in the near term. And lastly, multiples in pricing, expectations in that space have moved around over the last 4 or 5 years as markets have moved forward and it's largely a function of EBIT multiple. Lastly, former consideration, the sellers in our view would be better served by taking a portion of stock. So these are more idiosyncratically structured transactions Laurie, than bank deals for those reasons. So you're always looking, but it's not always easy to find that set. And lastly in the size range, I would say, in the $0.5 billion to $1.5 billion range would be typically in our sweet spot.

Okay. Great. That's helpful. And then lastly, on expenses. I just want to make sure I'm thinking about this the right way. So as we look heading into the fourth quarter and just remind me, your charitable foundation that you've done historically in the fourth quarter, there are no plans to do that currently. Is that correct?

I'm sorry, Laurie, what?

Charitable.

Charitable -- yes, the charitable contribution that's usually $300,000, $400,000, that's no longer occurring. Is that correct?

Yes. We have no plans to do that.

Okay. And so then we think about the fact that you had obviously this $300,000 vendor credit and then a new branch coming online is theoretically we kind of net all those together a $26.5 million-or-so quarterly run rate seems about right, or is there anything I'm missing?

That sounds, right.

Yes, you really captured the only larger initiative coming on, Laurie, which would be the opening of a new branch, but that really -- the expenses there would be largely toward the tail end of the fourth quarter, and not really fully felt until the first quarter of 2019 for those reasons.

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

Thank you, everyone for participating and for your continued interest and support of Washington Trust. We certainly look forward to speaking with you again in early 2019 and again appreciate your continued support and interest. So thank you very much. Have a great day.

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