Washington Trust Bancorp, Inc.
Q2 2018 Earnings Call Transcript

Published: 24 Jul 2018

[Operator:]

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

[Elizabeth Eckel:]

Thank you, Michelle. Good morning and welcome to Washington Trust Bancorp, Inc.'s Second 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. Before we begin, please note that today's presentation may contain forward-looking statements and actual results could differ materially from those statements. Our complete Safe Harbor statement appears in our earnings press release and in other materials that we filed with the SEC. Please visit our Investor Relations website at ir.washtrust.com to review these materials and our complete Safe Harbor statement. Washington Trust trades on NASDAQ under the symbol WASH. And now I'm pleased to introduce Washington Trust's Chairman and Chief Executive Officer, Ned Handy. Ned?

[Ned Handy:]

Thank you, Beth. Good morning and thank you for joining us on today's conference call. Yesterday afternoon we released our second quarter results. This morning I'll review the highlights of the quarter and then I'll ask Ron Ohsberg to discuss our financial performance. After our prepared remarks, Ron, Mark Gim and I will be happy to answer any questions you may have about the quarter and our outlook for the remainder of 2018. Washington Trust reported another strong performance in the second quarter of 2018 with record quarterly earnings of $17.7 million or $1.01 per diluted share. Total revenues reached a record level and our profitability ratios reached a 15-year high. Asset quality remained strong and capital levels continue to exceed regulatory requirements. Our stock value appreciated during the quarter and our market cap exceeded $1 billion at the end of the second quarter, enabling us to reward our shareholders with a $0.43 dividend. Now I'd like to take a moment to share some of the highlights from the quarter. Total deposits were up by 2% from the first quarter and up 10% from a year ago. Deposit growth and mix improvement remain our primary focus. All banks are striving to grow their deposit base so there's a lot of competition in the marketplace. We kicked off a CD promotional offer in early April and by quarter's end we have brought in nearly $100 million with a substantial portion of it in new money. The CD promotion itself has been a funding success, but it also introduced new clients to our branch network giving our branch colleagues time to introduce our service promise and solution approach over the term of the initial CD relationship. In some cases, new customers opened checking accounts simultaneously. The promotion gave a particular boost to our newer branches helping them expand their presence and build new client relationships. Also in June we transitioned approximately $70 million in wealth management client assets which had previously been held outside the bank, on to our balance sheet and placed them into insured interest bearing demand deposit accounts. These strategies helped us achieve deposit growth during the quarter and helped us at the seasonal deposit outflows we experienced due to the underlying business cycles of our larger educational and municipal customers. There is considerable competitive pressure on our market from both banks and credit unions, so we'll need to be creative and strategic in our pricing and promotions. Total loans were up by 3% from the previous quarter and 9% from a year ago. Our residential mortgage area had another good quarter with strong origination volume. Our increased presence in the Greater Boston marketplace and the higher average price point there resulted in a larger than usual number of portfolio loans during the second quarter. We have a solid residential pipeline and believe it should steadily shift towards saleable categories over time. And although we anticipate additional rate increases and tight housing inventories, we believe mortgage banking revenues and activity will remain healthy through year end. On the commercial side we had good commercial loan originations, but as in previous quarters, we had a substantial amount of payoff which ultimately diluted overall portfolio growth. C&I growth in the quarter included the transfer of completed commercial construction loans into C&I. Our commercial pipeline is healthy, supporting our continued expectation from mid-to-single digit growth, but the market is extremely competitive on both pricing and structure. As I mentioned earlier we have excellent asset quality and we intend to keep it that way so we will remain prudent in our credit decisions and not chase deals that don’t meet our criteria. Wealth management assets under administration were $6.2 billion at June 30, which is down from the previous quarter as a result of client outflows associated with the departure of client facing wealth management personnel towards the end of the prior quarter. Wealth management revenues were down by 7% from the previous quarter primarily as a result of lower asset levels. Early in Q2 we rolled out a new wealth management technology platform and client portal. We also expanded our client service teams ensuring our clients of multiple contacts to address their wealth management, trust and estate planning, financial planning, and investment needs. These initiatives have provided immediate efficiencies by streamlining workflows. More importantly, they have allowed us to improve our client experience by offering our clients the best in both online and personal service. I'll now turn the discussion over to Ron Ohsberg, who will review our financial performance. Ron?

[Ron Ohsberg:]

Thank you, Ned. Good morning everyone and thank you for joining us on our call today. I'll review our second quarter 2018 operating results and then financial position as described in our press release issued on Monday. Net income amounted to $17.7 million or $1.01 per diluted share for the second quarter compared to $16.2 million and $0.93 in the first quarter. We also reported return on equity for the quarter of 16.99% and return on assets of 1.53%. Net interest income for the second quarter was $1.3 million or 4%. The net interest margin was 305 up 2 basis points from the preceding quarter. Included in net interest income was prepayment fee income of $483,000 compared to $46,000 in the first quarter. Excluding these amounts net interest income was up by $822,000 or 3% and net interest margin was 301 in a way this quarter down 2 basis points compared to the first quarter. The average balance of interest earning assets rose by $91 million on a linked quarter basis. The yield on average earnings assets increased by 14 basis points to 398. Excluding prepayment fee income in both quarters the yield on interest earnings assets increased by 10 basis points to 394. On the finding side average in-market deposits were up $15 million while average balance of wholesale funding sources was up $85 million from the first quarter. The cost of in-market deposits was 49 basis points up 8 basis points in the quarter. Meanwhile the cost of wholesale funding was 2% rising by 15 basis points. Noninterest income continues to be very important to our business representing 33% of total revenues in the second quarter. Total noninterest income was $16 million in the quarter up $250,000 or 2% in Q2. Wealth management revenues were $9.6 million down 7% from the preceding quarter. Wealth management assets under administration declined to $6.2 billion down by $124 million or 2%. As Ned mentioned, the decline caused by client asset outflows of approximately $507 million during the first and second quarters, resulting from the loss of several investment accounts in the latter portion of the first quarter. Our mortgage banking revenues totaled $2.9 million in the second quarter up $103,000 or 4% from the preceding quarter. These results reflected a higher volume of loans sold to the secondary market as compared to Q1. We consider the mortgage pipeline to be in good shape. Loan related derivative income was $668,000 in the second quarter compared to $141,000 in the first quarter due to higher transaction volume. Now turning to total noninterest expense for the latest quarter has decreased by $842,000 or 3% from the previous quarter. There are several items here that I'd like to call out. 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 the reduction in corporate taxes from the Tax Act. Also in Q2 software implementation costs of $114,000 were recognized which compared to $681,000 in the preceding quarter. These were classified as other expenses and primarily relate to the conversion to our new wealth management trust accounting system that was completed in April. Excluding these items, noninterest expenses were up $175,000 or 1% on a linked quarter basis. The effective income tax rate was 21.2% in the second quarter compared to 20.8% in the preceding quarter. Income tax expense totaled $4.7 million in Q2 compared to $4.3 million in Q1. Turning to the balance sheet, total loans were up $103 million from the end of the first quarter. The Cree [ph] portfolio which includes all commercial construction loans increased by $1 million while the C&I portfolio increased by $28 million. Both of these changes reflect the transfer from Cree to C&I of a $22 million construction loan into permanent C&I financing. Excluding the transfer, Cree was up a net $23 million and C&I was up net $6 million. Residential loans rose by $78 million or 6% as we placed a higher than traditional percentage of loans into the portfolio. Consumer loans were down $4 million. Investment securities decreased by $12 million reflecting normal amortization, several bond calls and fair value adjustments. Total deposits rose by $65 million in the quarter. In-market deposits were up by $24 million and wholesale brokerage CDs were up $41 million. Within in-market deposits, our second quarter CD promotion has brought in about $100 million of which we estimate over 90% is new money into the bank. We also have implemented a program to transition certain wealth management client assets into insured interest bearing, demand deposit accounts on our balance sheet. Finally, FHLB borrowings increased by $92 million in the quarter. In terms of asset quality non-accrual loans were 0.34% of total loans compared to 0.31% at the end of March. Loans past due 30 days or more as a percentage of loans outstanding, decreased by 9 basis points in the quarter to 0.48%. Q2 net charge offs totaled $90,000 compared to $624,000 in the preceding quarter. The allowance for loan losses was 0.75% of total loans down 1 basis point in the quarter. The loan loss provision was $400,000 in Q2 compared to zero in the prior quarter. Total shareholders' equity was $422 million up $8.5 million compared to Q1, both the corporation and the subsidiary bank continued to be well capitalized. Tangible equity to tangible assets ratio was 7.48% at the end of June compared to 7.57% at the end of March and finally our second quarter dividend declaration of $0.43 per share was paid on July 13. At this point I'll turn the call back to Ned.

[Ned Handy:]

Thank you, Ron. So Washington Trust had another good quarter. Our continued profitability and solid financial metrics reflect the strength and stability of the corporation as evidenced by our recent recognition by American Banker as one of the nation's top performing mid-tier banks. The key to our corporation's continued success is the hard work and discipline of our employees. We have an extremely dedicated and experienced team of employees who truly care about our company, our customers, and the communities we serve. Their commitment to Washington Trust is evident in our selection as one of Rhode Island's best places to work for the eighth consecutive year. This award is given based upon feedback provided by our employees and a confidential and anonymous workplace survey. It's a great honor to receive this recognition. In closing I'd like to thank our shareholders for their continued support of our corporation. We appreciate the confidence you placed in us to manage and guide Washington Trust. We remain committed to doing what's best for the corporation and enhancing shareholder value. And that concludes my prepared remarks, and now Mark, Ron and I will be happy to answer any questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O'Neill. Please proceed with your question.

[Mark Fitzgibbon:]

Good morning.

[Ned Handy:]

Good morning, Mark.

[Mark Fitzgibbon:]

Ned, I wonder if you guys could help us think about how large your loan pipelines are today, commercial pipelines?

[Ned Handy:]

Yes, so we had a good quarter in the second quarter and closed a fair amount of loans at the end of the quarter, so our commercial pipeline is a little over a $100 million in that 50% and 90% bucket, so term sheets out and accepted, it's about $177 million in what we call our 30% bucket which deals in discussions. So it's - I would classify the commercial pipeline as sort of in the rebuild mode having closed a few in the third month of the quarter. On the residential side that report is on to Mark, I'll let Mark talk about that.

[Mark Gim:]

Yes, hi good morning Mark. The residential portfolio pipeline dropped from about a $167 million approximately three months ago to rough $135 million. So we had a strong origination month, quarter rather in Q2 and as Ron mentioned a lot of that was driven by purchase activity particularly in the metro Boston area, much of which was non-conforming primarily by reason of size. So that pipeline has slowed somewhat, but we would expect it to remain healthy through the end of the year.

[Mark Fitzgibbon:]

And would, do you think we'll see the loan loss provision sort of move back up a bit in the back half of the year given that you are seeing such strong loan growth?

[Ron Ohsberg:]

Yes, this is Ron, Mark. Our credit looks quite good at this point in time and I would expect our provisioning going forward to be a function of asset growth.

[Mark Fitzgibbon:]

Okay and then Ron, could you help us think about the margin for the next couple quarters?

[Ron Ohsberg:]

Yes, so in the absence of any additional rate hikes our guidance would be that the margin would remain relatively stable going forward.

[Mark Fitzgibbon:]

Okay and then I know your regulatory capital ratios are strong, but the tangible common equity ratio is getting a little bit low compared to peers. How are you thinking about that? Do you feel as though you might need to raise some additional capital if growth remains this strong?

[Ron Ohsberg:]

No, we don't have any plans to raise capital at this time.

[Mark Gim:]

Okay, Mark I think that really is a function of our business mix. We recognize that we look somewhat low compared to peers, but given the risk profile, the balance sheet, and the fairly high concentration of revenues coming from less capital intensive sources like wealth and mortgage banking, it feels like a comfortable level for us ex. Really explosive growth or acquisition.

[Mark Fitzgibbon:]

Okay, and then lastly you guys have done an obviously a great job running your own bank, why not use your stronger relative currency to roll up maybe some of the less efficient banks around you?

[Mark Gim:]

Yes Mark, that's a great question and certainly it's something that we think about. As we've said before it's a function of what we'd have to pay as we've said in the past and what we think we could do with it once we own it. So certainly we've said before our loan gathering footprint is bigger than our deposit gathering footprint and so, with the pressure on deposit growth it's got to be at least part of our thought process, so it is. And we appreciate the comment about our currency. We want to keep it that way. So we're going to be careful and prudent as we have been over time, but certainly it's in the mix.

[Mark Fitzgibbon:]

Thank you.

[Mark Gim:]

You’re welcome.

[Operator:]

Thank you. Our next question comes from Laurie Hunsicker with Compass Point. Please proceed with your question.

[Laurie Hunsicker:]

Yes, hi good morning.

[Ned Handy:]

Good morning, Laurie.

[Laurie Hunsicker:]

I wondered if you could help us think about some of the line items in your deposit costs, so maybe starting with the interest bearing demand, it looks like that had a big jump like quarter, it went from costing 14 basis points to costing 47 basis points?

[Ron Ohsberg:]

Right, so Laurie it's Ron. So that is a direct function of the program that we implemented to bring in our wealth management assets on balance sheet. So we're paying a comparable rate under that program as we were paying when it was in the wealth area.

[Laurie Hunsicker:]

Okay and then the wealth management deposits that came over the $70 million that was split into many different line items?

[Ron Ohsberg:]

No, it's all in interest bearing DDA.

[Laurie Hunsicker:]

Okay, because again I'm just looking and that went from round numbers $81 million to $86 million or maybe there was a – you know what, I can probably catch up with you offline. Can you help me think about the money markets too, it looked like that jumped up 8 basis points linked quarter, are you going to be running specials or how we should be thinking about that line?

[Ron Ohsberg:]

Yes, I mean we're considering what to do with wealth management. My money how do you wealth management on the frame, but money market, the concern there is cannibalization. So we've been much more targeted on the CD side to make that a requirement of that being new money. That said, we're still analyzing ways that we might be able to do some targeted wealth management fundraising, but we really haven't implemented much in that area yet.

[Mark Gim:]

And Laurie, I think we would say that, the most sensitivity in that category comes not from retail accounts, but from reciprocal deposits with larger municipal or higher education depositors, that category of depositor with well over FDIC insured levels tends to be much more rate sensitive and we have been in a respond to competitive pressure mode as far as that's concerned, so as yet not a major move on the retail side, but mainly with larger depositors.

[Laurie Hunsicker:]

Okay and then your loan to deposit ratios ended up a little bit you're at 105% how do you think about that?

[Ron Ohsberg:]

We think about it all the time. So yes that's why we're doing the CD promotions and that's why we did this wealth management transfer, and that's why we're opening new branches. So we're looking at lots of different ways to bring in more deposits.

[Laurie Hunsicker:]

Okay and then just sort of along the line of Mark's question and I appreciate your comments in terms of margin flat without rate hikes, can you help us quantify with every rate hike how we should be thinking about your margin, especially given how you're repricing on the deposit side?

[Mark Gim:]

Yes, so 72% approximately of our loans are variable rate, mostly LIBOR but also Prime. We didn't see quite as much benefit on the LIBOR side from the most recent hike as we saw earlier in the year. And we're also seeing some funding cost pressure. We've added these promotional CD's they're not inexpensive. And we've added some wholesale funding particularly in light of the seasonality, seasonal outflows of our deposits in Q2. But all that being said, I think we're going to stick with our kind of our stable outlook on margin not expecting to see as much expansion as we had in the first part of the year.

[Laurie Hunsicker:]

Okay, then would it be out of whack, in other words we get another 25 basis points potentially your margin could be up in the neighborhood of 2 to 3 basis points? I'm just saying that core adjusting for prepay penalties, on other words that 301 could be a 303, 304 is that possible?

[Ron Ohsberg:]

With additional rate hikes?

[Laurie Hunsicker:]

Yes.

[Ned Handy:]

It's possible Laurie. I think that to follow up on Ron's comment. This last rate hike by the Fed was fairly well priced into LIBOR and the majority of our loan book that reprices monthly will be priced short term LIBOR. So the rate lift was anticipated in Q2 by LIBOR. There's a smaller portion of the book that's prime tied, so it could be margin positive to see another Fed rate increase. I guess the unknown of course is deposit betas and I think across the board in the industry we're seeing more sensitivity in 2018 today than we did in 2017, so that's the unknown.

[Laurie Hunsicker:]

Okay and then just on AUA, obviously first quarter we had a $371 million drop this quarter $257 million, do you feel like most of the bleed from the three departing people is done or is that still a question?

[Ned Handy:]

Yes, we do. We do feel that the vast majority of that is done and Ron I think that when we had given our estimate of the impact on revenues and the Q1 earnings call, we're comfortable with the range that we gave a little.

[Ron Ohsberg:]

So Laurie just to remind everyone, I think we said $600,000 to $700,000 on the prior earnings call and it's probably more like 710 to 725, so we're on the high end of that original estimate, but that's where we think we are at this point. And I would say that the $9.1 million in asset base revenue that we booked this quarter is probably a good run rate going forward.

[Ned Handy:]

And again asset based revenues are the vast majority of wealth revenues, but not the only one. So as we get fee income from other sources, financial planning, fiduciary fees, and so on.

[Laurie Hunsicker:]

Thanks, that’s helpful. I'll leave it there. Thanks.

[Ned Handy:]

Thanks Laurie.

[Operator:]

Thank you. [Operator Instructions] This concludes our question and answer session. I will turn the conference back over to Net Handy for any closing remarks.

[Ned Handy:]

Thank you all for joining the call. We had a good quarter and as you can tell from the Q&A we're focused on next quarter, so that's behind us and we've got plenty of work to keep us busy. We certainly appreciate your interest and your time and we look forward to talking with you again next quarter, so have a great day and thanks.

[Operator:]

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