Washington Trust Bancorp, Inc.
Q1 2018 Earnings Call Transcript

Published: 23 Apr 2018

[Operator:]

Good morning, and welcome to Washington Trust Bancorp, Inc.'s conference call. My name is Doug, I'll be your operator for today. [Operator Instructions] Today's call is being recorded. And now I'd turn the call over to Elizabeth Eckel, Senior Vice President, Marketing and Investor Relations. Ms. Eckel?

[Elizabeth 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 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. 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 filed with the SEC. Please visit our Investor Relations Web site 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 please to introduce Washington Trust's Chairman and Chief Executive Officer, Ned Handy.

[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 Cut 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 continued 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 had a nice steady increase in local cost demand that now accounts over time and DDAs and NOW accounts are up almost 10% from a year ago. As we have mentioned in the past, we have 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 a 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 have 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 three 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 pay offs 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. Ron?

[Ron Ohsberg:]

Yes. Thank you, Ned. Good morning, everyone and thank you for joining us on our call today. I will review our first quarter 2018 operating results and the financial position as described in our press release issued on Friday. Net income amounted to $6.2 million [ph] 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%, 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 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 3.03% 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 includes 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. Non-interest income continues to be important to our business representing 33% of total revenues in the first quarter. Total non-interest 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 [ph]. 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 $565,000 in fair value adjustments related to the commencement of 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 borrower loan related derivative transactions. Now let me turn to non-interest expenses. Total non-interest 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 two 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, one-time 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, 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 primarily related to the conversion of our wealth management accounting system that was completed in April 2018. Excluding these items non-interest 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 the fourth quarter. Free portfolio which includes construction loans increased by $7 million from the balance, end of the previous quarter and 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 securities and agency debt securities from the quarter, offset by normal amortization, municipal bond maturity and the decline in the fair value of available for sale from securities. Total deposits rose by $14 million in the quarter within market deposits up $6 million and wholesale brokerage up $8 million. In terms of asset quality, non-performing loans stood at 0.31% of total loans down 14 basis points from the end of December as we resolved a couple of longstanding 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 was provisioned with zero in Q1 compared to $200,000 in the prior quarter. Total shareholders equity for the corporation remain constant at $413 million compared to Q4 with net income being offset by dividend in FAS 115 marked on our available for sale securities. The cooperation and the subsidiary bank capital levels continued to exceed the required levels to be considered well capitalized. Total risk based capital, 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 expiration of $0.43 per share was a 10% increase in the preceding quarter it was dated on April 30. At this point, I will turn the call back to Ned.

[Ned Handy:]

Thank you, Ron. 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 will host our annual meeting of shareholders. 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:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Mark Fitzgibbon with Sandler O'Neill. Please proceed with your question.

[Mark Fitzgibbon:]

Hey guys, good morning.

[Ned Handy:]

Hey Mark.

[Mark Fitzgibbon:]

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?

[Ron Ohsberg:]

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're 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.

[Mark Fitzgibbon:]

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?

[Ron Ohsberg:]

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

[Mark Fitzgibbon:]

Okay, great. And then, sort of a 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?

[Ron Ohsberg:]

Yes. I would say our provisioning will be a function of loan growth at this point. And we resolved two problem credits at the end of the quarter here. We don't have any commercial non-performing assets at this time. So it is 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 are good.

[Mark Fitzgibbon:]

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 Gim:]

Mark, this is Mark Gim. I'll take that question. No, those were two -- three 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 run-off that we would anticipate happening was included in Ron’s projection of lost revenues per quarter. Somewhat of an unusual occurrence and that the client facing personnel in question were not under non-solicit, non-compete agreements. We would consider that to be an unusual situation which isn't present elsewhere in the wealth franchise. So, in Weston rather than Halsey.

[Mark Fitzgibbon:]

But generally, your client facing folks are under non-compete, non-solicitation?

[Ron Ohsberg:]

That's correct for the acquired entities.

[Mark Fitzgibbon:]

Okay.

[Ron Ohsberg:]

Within the trust function of the core bank that finance was a non-compete -- unusual and that would not be the case.

[Mark Fitzgibbon:]

Okay. Thank you.

[Ned Handy:]

Thanks Mark.

[Operator:]

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

[Damon DelMonte:]

Hey good morning everyone. How is it going today?

[Ned Handy:]

Good morning, Damon.

[Damon DelMonte:]

Good morning. So, just to kind of follow up on the last question by Mark on the wealth management. I think you guys noted, you are 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, that’smaybe 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?

[Mark Gim:]

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-six 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.

[Damon DelMonte:]

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 revenues. Is that fair?

[Mark Gim:]

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

[Ron Ohsberg:]

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

[Damon DelMonte:]

Got you. Okay. All right. That's helpful. And then, with respect to your outlook for loan growth obviously some I think you 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 at kind of an annualized basis, are you still comfortable in that maybe 6% to 7% range for the full year?

[Ned Handy:]

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 continuation of pay downs, pay offs 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.

[Damon DelMonte:]

Okay, great. And then, I guess last question with relation to the margin. I think the yield on loans was 4.16% which was up from 4% last quarter. Is that 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 in interest or anything like that?

[Ned Handy:]

No. It's all rate driven. We have large network.

[Damon DelMonte:]

Okay, perfect. That's all that I have. Thank you very much.

[Ned Handy:]

Thanks Damon.

[Operator:]

Our next question comes from the line of Nicole Gulino with American Capital Partners. Please proceed with your question. Nicole, your line is live.

[Nicole Gulino:]

Hi, good morning.

[Ned Handy:]

Good morning, Nicole.

[Nicole Gulino:]

How are you?

[Ned Handy:]

Great.

[Nicole Gulino:]

I was just wondering if you could let me know that on a prepayment income was in the quarter, and what you calculated the core NIM at ?

[Ron Ohsberg:]

Yes. 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 a $1.1 million or 4%. The margin was 3.03%. So really -- it was pretty negligible.

[Nicole Gulino:]

Okay, perfect. Okay, great. That's all I had. Thank you so much.

[Ron Ohsberg:]

You're welcome.

[Ned Handy:]

Thanks Nicole.

[Operator:]

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

[Laurie Hunsicker:]

Yes. Hi, Ned, Mark, Ron and Beth, good morning.

[Ned Handy:]

Good morning, Laurie.

[Laurie Hunsicker:]

Just wanted to go back to your AUA, just want to make sure I'm thinking about this the right way. So when we look at share, your wealth management revenues that were 10.3 in round numbers those will be down at a run rate. And I'm just talking about the revenue line not the expense so appreciate the color in the expense. So round numbers those will be down about 800 or so per quarter. But I know that 2Q typically contain some tax prep around numbers of around 200. 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 in September all else being equal.

[Mark Gim:]

Laurie, this is Mark. Just a couple of things. I don't think the 800 was the number that Ron…

[Ned Handy:]

6 to 7.

[Laurie Hunsicker:]

Six to seven was netting out, they were salary and benefits, correct?

[Ned Handy:]

No. That was not netting out.

[Laurie Hunsicker:]

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

[Ned Handy:]

Yes. Tax prep was not affected by the departure of the assets.

[Laurie Hunsicker:]

Okay, great. And then, how many client facing personnel do you guys have?

[Ned Handy:]

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

[Laurie Hunsicker:]

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

[Ned Handy:]

So again in the acquired entities of Western and Halsey there are non-solicit client facing personnel that would not be the case in the first company structure that's been in place since 1902 within Washington Trust.

[Laurie Hunsicker:]

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

[Ned Handy:]

Well, they weren't juniors at that of acquisition in 2005.

[Ron Ohsberg:]

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

[Ned Handy:]

Well, economically.

[Laurie Hunsicker:]

Okay. And just again last question, does this make you think a refresh of going back and looking at your non solicitation. I mean presumably obviously markets go up, markets go down, but your AUA is absolutely unbelievable compared to other community banks. But it's such a big piece of your ROTC 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?

[Ned Handy:]

Well, contracts are always already in place for the majority of employees. And as we advance people to positions to find contact authority, we also -- we do that. That's why would say this is kind of an unusual situation. One of the employees who departed was subject to an non-solicit, non-compete agreement and has not we believe participated in outrage. I think it affects the question, we are going forward with any future activity and we have plan for that again recall that this transaction was consummated in 2005.

[Laurie Hunsicker:]

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

[Ned Handy:]

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 non-bank financial M&A acquisition space as well. So we got to be prudent about price paid, what you can do with the franchise when its acquired, 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 a 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 non-banks 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.

[Laurie Hunsicker:]

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

[Ron Ohsberg:]

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

[Laurie Hunsicker:]

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

[Ned Handy:]

Yes.

[Laurie Hunsicker:]

Okay. Okay. And then, de novo plans you mentioned one more coming on end of '18 early '19, should we be thinking about kind of 1 de novo a year, give or take is that how you're thinking about things now?

[Ned Handy:]

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

[Laurie Hunsicker:]

Okay. All right. And then just last question kind of going back to your loan loss provisioning, which was zero 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-off running to where you've been excluding some things that cleaned up this quarter that would kind of put our loan loss provision somewhere in that $1 million to $1.3 million per quarter run rate. Am I thinking about that the right way?

[Ned Handy:]

That could be in the ballpark. I mean it's really hard to say. Well, we had 600 some of charge offs that was related to the two homes that I mentioned that are gone. So prospectively we're not expecting a lot of charge offs for the balance of the year.

[Laurie Hunsicker:]

Okay. That's helpful. Thank you.

[Ned Handy:]

Thanks Laurie.

[Operator:]

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

[Ned Handy:]

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 a day. Thank you.

[Operator:]

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.