Washington Trust Bancorp, Inc.
Q4 2016 Earnings Call Transcript

Published: 26 Jan 2017

[Operator:]

Good morning, and welcome to Washington Trust Bancorp, Inc.’s Conference Call. My name is Michelle and I’ll 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, and good morning. Washington Trust Bancorp Inc.’s fourth quarter and year end 2016 conference call. This morning’s call will be hosted by Washington Trust’s executive team of by Joseph MarcAurele, Chairman and Chief Executive Officer; Ned Handy, President and Chief Operating Officer; and David Devault, Vice Chair, Secretary and Chief Financial Officer. Before we begin today’s presentation, I’d like to note that it may contain forward-looking statements, and actual results could differ materially. Our Safe Harbor statement appears in our earnings press release and in other documents filed with the SEC. Please visit our Investor Relations website at washtrustbancorp.com to review these SEC files documents and our complete Safe Harbor Statement. Washington Trust trades on NASDAQ under the symbol WASH. And now I am pleased to introduce Washington Trust’s Chairman and CEO, Joe MarcAurele.

[Joseph MarcAurele:]

Thank you Beth. Good morning and thank you for joining us on today’s conference call. This morning I’ll review the highlights of our 2016 performance and David will discuss the company’s financial results. At the end of our prepared remarks, David, Ned and I will answer any questions you may have about 2016 or the year ahead. I’m pleased to report that Washington Trust posted solid fourth quarter results which contributed to earnings of $46.5 million or $2.70 per diluted share for 2016. This marked our seventh consecutive year of increased annual earnings. Our key profitability measures remain strong and capital levels continue to exceed regulatory requirements. Our credit quality also remains healthy. Our stock performed well, reaching an all-time high level in the fourth quarter and we declared a $0.37 cash dividend in December. Our record performance is the result of our continued success at growing our core business lines, expanding our local and regional footprint and maintaining disciplined pricing and expense management. In a moment, David will provide a detailed analysis of our financial performance, but first I’d like to highlight and discuss some of our key business lines. Total deposits exceeded $3 billion at year end. We had success during the year in attracting new low cost deposits as both demand deposits in our accounts grew by 7% from the end of 2015. Generating low cost deposits is critical to our funding and to fund continued loan growth, but deposit generation is a continued challenge industrywide. In recent years our deposit growth strategies have focused on opening branches in markets dominated by larger competitors and deepening relationships with our commercial and municipal customers. These strategies have proven successful. We believe local community branches, which are adequately staffed to provide good personal service still have value. We realize the unique convenient technology as well, so in 2017 we’ll do both. We’ll open a branch in Coventry, Rhode Island, a new market for us and we’ll continue to add convenience through technology in all aspects of our business. Total loans stood at $3.2 billion at December 31, 2016, an increase of 7% from the end of 2015, which was in line with our annual projections. This reflected a 7% increase in the commercial portfolio despite heavy payoffs and an 11% increase in the residential portfolio. Our mortgage banking division had a strong fourth quarter as both revenues and loans sold during the quarter were record highs for us. Full year mortgage banking revenues totaled $13.2 million for 2016, up by 33% from 2015. We had good production from throughout our market area, including our new Wellesley, Massachusetts office in the third quarter of 2016. It goes without saying that we’ll be closely watching our mortgage business as we continue during this year, given what will be a somewhat higher rate environment. Wealth management revenues amounted to $37.6 million in 2016, an all-time high for the company. Assets under administration peaked at $6.1 billion at December 31. As with community banking, we’ve invested in technology to improve the client experience. However, we believe the personal service and advice we provide is valued by our clients. We are able to differentiate ourselves and compete against the larger firms by offering a comprehensive suite of products and providing customized solutions to meet our clients’ needs. We are confident that this approach will work in other markets. As you recall, in 2015 we acquired Halsey Associates, an SEC registered investment advisor headquartered in New Haven. Last week we relocated Halsey’s headquarters into one of the city’s more prominent office towers. The expanded office space will allow our mortgage commercial banking and trust and fiduciary professionals to meet with Halsey clients and other industry professionals such as attorneys, accountants, developers and realtors. Establishing and building relationships in new markets is key to our future growth. I’ll now ask David Devault to take a few minutes to review our financial results. David?

[David Devault:]

Thank you, Joe. Good morning everyone and thanks for joining us on our call today. I’ll review our fourth quarter 2016 operating results and financial position as described in our press release yesterday afternoon. Net income amounted to $12.2 million or $0.70 per diluted share for the fourth quarter. This compared to net income of $12.3 million or $0.72 per diluted share for the third quarter. Profitability results in the latest quarter were solid with a return on equity of 12.26% and return on assets of 1.14%. For the full year 2016 net income was $46.5 million or $2.70 per diluted share and net income was up by 7% over the previous year. And for the full year the return on equity was 11.96% and the return on assets was 1.16%. The full year net income and earnings per share amounts were record highs for the company. Our results were driven by revenue growth, offset in part by increases in core non-interest expenses and a higher loan loss provision. In the latest quarter, total net interest income was $28.6 million, up by $1.2 million or 4% from the third quarter. The net interest margin was 2.89% in the latest quarter, down by five basis points on a linked quarter basis. Included in net interest income in the latest quarter was $816,000 in loan prepayment fee income and that compared to $365,000 of that type of income in the third quarter. The fourth quarter prepayment fee income contributed about eight basis points with a net interest margin in the fourth quarter and prepayment fee income contributed about four basis points to the margin in the third quarter. The reduction in the margin is largely attributable to a change in the mix of interest-earning assets resulting from the addition of debt securities to the balance sheet and increases in wholesale funding balances. This includes additions made during the fourth quarter as well as the full quarter impact of additions of that nature made during the third quarter. In the fourth quarter, agency mortgage backed securities and agency debt securities totaling $235 million were added with a weighted average yield of 2.55%. Net of amortization maturities and calls on existing securities, the net increase in the securities portfolio was $174 million in the fourth quarter. Total average interest-earning assets increased by $224 million over the third quarter and the yield on interest-earning assets declined by about two basis points from the third quarter. Excluding prepayment fee income in both quarters, the yield on interest earning assets was down by about six basis points. On the funding side, average wholesale funding balances which we would define as federal home bank advances, as well as wholesale broker time deposits, increased by $113 million in the quarter. And the average balance of in-market deposits increased by about $70 million. The cost of interest bearing funds was up by three basis points on a linked quarter basis. We added some wholesale broker time deposits and lengthened the federal home bank loan advance position somewhat in response to the securities portfolio additions and a purchase of residential mortgage loans. Total loans stood at $3.2 billion at the end of December, an increase of 2% in the quarter and they were up by 7% in the full year. Residential loans rose by $43 million in the fourth quarter. This included a purchase of $36 million of loans from another bank. These are whole loans individually evaluated to our underwriting standards and they were all secured by properties in Massachusetts. In the last 12 months, total residential loans increased by 11%. The commercial portfolio rose by $14 million or about 1% in the latest quarter, and the growth was concentrated in commercial construction balances. In the last 12 months, the commercial portfolio is up 7%. Total deposits stand at $3.1 billion at the end of December. They were up about 1% in the quarter, and up about 4% in the last 12 months. Included in the deposit growth was $53 million of wholesale broker time deposits added in the latest quarter and $110 million for the full year. Excluding those broker deposits, in market deposits were down 1% in the quarter, but up by about 1% in the last 12 months. And as Joe mentioned, the deposit mix improved as demand deposits in now account balances increased by 4% in the quarter and 7% in the year. Non-interest income continues to represent a significant portion of our total revenues, with an amount of 38% of total revenues in the latest quarter. Non-interest income was $17.3 million in the quarter, up modestly on a linked quarter basis. Wealth management revenues were $9.3 million, down by about 3% from the third quarter largely due to a decline in transaction based revenues. In wealth management, assets under administration were $6.1 billion at the end of December, an increase of $6 million in the latest quarter. Total wealth management revenues for the year and the wealth management asset balances at the December 31, stand at all-time record highs for the company. Our mortgage banking business had an excellent quarter, with record quarterly results. Revenues, including gains and commissions on loan sales and mortgage servicing fee income, was $4.5 million in the latest quarter, an increase of 22% on a linked quarter basis. That increase was attributable to higher sales volume, as well as a higher effective yield on loan sales. Mortgage loans sold and brokered into the secondary market, amounted to $200 million in the latest quarter. Loan related derivative income was $912,000 in the latest quarter. Most of that is related to interest rates, swap transactions and that was down by about $266,000 on a linked quarter basis due to a lower volume of that type of transaction. On the expense side, non-interest expenses in the latest quarter were $25 million, a 1% linked quarter increase, but included in the third quarter was a $939,000 reduction in non-interest expenses. And we had explained at the time that that was due to a downward adjustment in the fair value of the contingent consideration liability recognized in connection with the 2015 acquisition. And excluding that third quarter adjustment, non-interest expenses were down by about $616,000 or 2% on a linked quarter basis. Salaries and benefits, the largest component of non-interest expenses, were down by about $380,000. The effective income tax rate was 32.6%, in the latest quarter and 32.5% for the full year. Our current forecast for the effective tax rate in 2017 is about 34%. The 2016 effective rate was lower than usual, or was affected downward, because there were some non-taxable income items in the year, and in 2017 we see some reduction in the relative amount of municipal and state municipal debt securities contributing to net interest income, and that is tax exempt of course, but that it has been declining. Looking at asset quality, total loans past due by 30 days or more as a percentage of loans outstanding was point 0.76% at the end of December, up 9 basis points in the quarter. Non-performing loans as a percentage of total loans was 0.68%, down by 7 basis points from the end of September. That was largely due to $2.6 million of charge-offs recognized in the quarter. In the latest quarter, a charge-off of $2.5 million was recognized on one commercial real estate relationship. That credit was a previously modified trouble debt relationship was placed on non-accrual status in the third quarter. And following the charge-off, the remaining carrying value for this credit is $3.9 million at the end of December. This was the primary cause also for an increase in the loan loss provision, which was $2.9 million in the quarter compared to $1.8 million in the third quarter. The allowance as percentage of total loans is 0.8% at the end of December compared 0.81% at the end of September. Total shareholders' equity is $391 million at December 31, and that decreased by about $5 million from the end of the previous quarter. That decrease included a charge to equity of $9.5 million related to market depreciation on available for sale securities and a charge of $2.6 million to equity associated with the annual measurement of defined benefit pension liabilities. Both of these amounts are net of tax, and are recognized in the accumulated other comprehensive income component of shareholders' equity. As Joe mentioned, we declared a quarterly dividend of $0.37 per share in December, and that was paid this month. The corporation and the subsidiary banks capital levels continue to be well capitalized. The total risk based capital ratio was 12.26% for the corporation at December 31, down about 5 basis points from the end of December. And the tangible equities tangible assets ratio was 7.35% compared to 7.77% at the end of the third quarter. At this time, I'll turn the call back to our chairman and CEO, Joseph MarcAurele.

[Joseph MarcAurele:]

Thank you David. We're pleased with our 2016 earnings and our ability to once again provide a healthy return to our shareholders. Looking forward, 2017 promises to bring some new opportunities and some challenges. You know the change will be inevitable. There may be some headwinds. However, Washington Trust has witnessed many changes, and we’ve faced many obstacles over our now 216 plus year history, and we've succeeded mostly by focusing on the fundamentals. We have a strong foundation. We’re committed to doing what's best for our customers, our employees and our shareholders. We will continue to do that. We thank you for your time. And now Ned, David and I are happy answer any questions you may have.

[Operator:]

[Operator instructions]. The first question comes from Mark Fitzgibbon with Sandler O’Neill

[Mark Fitzgibbon:]

Good morning. First question I had. Dave, it looked like you put about $175 million of leverage trade earned during the quarter at - it looks to me like a little less than 100 basis points spread. I guess given the prospect for higher rates, what was sort of the thought process on that?

[David Devault:]

Well, a lot of that occurred before the higher rate scenario played out, but the thought process was clearly to enhance income, and we had the ability to do that, the amount of securities as part of the total balance sheet was relatively low. It got down to as low as 11% at some point in the early third quarter and between the third quarter editions and the fourth quarter editions, it's up to about 18% of total assets, which seems like a good amount, a reasonable amount and provides ample liquidity and a lot of that is pledgeable for collateralization purposes at the Federal Home Loan Bank for liquidity. And so it's part of our overall balance sheet strategy.

[Mark Fitzgibbon:]

Okay. And then secondly, on the mortgage side, in the fourth quarter, could you share with us what the split was in the mortgage originations between purchases and refi? And was a lot of that volume coming out of that new office in Wellesley?

[David Devault:]

I don't know if I have a split between purchase and refi. The Wellesley office has been doing well considering it's been open for maybe six to nine months and the production there has been very satisfactory. Overall, all of the offices did well, because it was just a good operating result in that line of business.

[Mark Fitzgibbon:]

Okay. And then I know you aren’t going to ...

[Joseph MarcAurele:]

Mark, it’s Joe. I think it would be fair to say that throughout all of 2016, we were operating at approximately 30% of the volume as refi. That was - that's probably a pretty good number.

[Mark Fitzgibbon:]

Okay, and then I know you regulatory capital ratios are strong, but the tangible common equity ratio is starting to look a little bit thin. I wondered if you could share with us your thoughts on raising additional capital in 2017.

[David Devault:]

Well, that ratio obviously was reduced because of the leveraging that took place. That leveraging is I would say essentially done. At this point, we don't expect to continue to do that kind of growth in the securities portfolio. Between earnings retention net of dividends, we see that tangible equity to the tangible assets ratio continuing to grow from the current level.

[Mark Fitzgibbon:]

Then lastly Dave, I wondered if you could just share with us your outlook for the margin.

[David Devault:]

Sure. I would say on a core basis, and this would exclude prepayment penalty fee income, and also exclude the potential favorable impact of future Federal Reserve rate increases, that we would expect the margin to settle out in the 270 to 275 range throughout 2017. And again that does not include prepayment fee income which can be irregular, and whatever the Fed does.

[Mark Fitzgibbon:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Laurie Hunsicker with Compass Point Research.

[Laurie Hunsicker:]

Good morning. I wonder - and your credit is obviously very pristine, but just wonder if we can go back to the commercial real estate relationship, and you can just remind us what potentially changed. We obviously saw you guys take a $1.9 million charge on that loan in the quarter and now $2.5 million charge. What changed in-between quarters and how do you see resolution on that loan?

[David Devault:]

Well, in the fourth quarter we continued to assess the underlying real estate collateral associated with that credit and the overall condition of the borrower, and that assessment led us to conclude that this recognition of loss and related charge-off was appropriate. I would say that at this point, we feel that we’ve done a very creditable job of recognizing whatever is associated with that credit, and I’m hoping that we're able to work out at the carrying value that we have of about $3.9 million.

[Ned Handy:]

Laurie, it’s Ned. I think we’ve positioned it so that we can now work with the borrower to resolve this in a relatively short time frame. We've recognized where we needed to position the asset to do that.

[Laurie Hunsicker:]

Okay, and you don't have any other exposure with this borrower, do you?

[David Devault:]

No. The $3.9 million is the totally of it.

[Laurie Hunsicker:]

Okay, great. Then just in terms of charitable foundation contribution, I know in the past you’ve done that typically in the fourth quarter. We didn’t see it. How are you thinking about that?

[David Devault:]

At this point the foundation is satisfactorily funding the charitable giving program that we have. It is likely that we will not do that again in 2017 as well. And if we change our approach on that we would certainly talk about that.

[Laurie Hunsicker:]

Okay, and then how do you think about dividend payout targets?

[David Devault:]

Well, the dividend will follow the path of earnings, and as I've said the 50% to 55% payout ratio seems to make sense for us. It's providing sufficient earnings or capital growth to support the growth of the balance sheet. That's what we're assuming at this point, and we will continue to evaluate it each quarter.

[Laurie Hunsicker:]

Okay. And then Joe, last question for you. You had mentioned the opportunities. Obviously we’ve seen your stock take a very healthy jump here, and that could potentially be acquisition currency. How are you thinking about acquisitions and how has your approach changed in the last few months?

[Joseph MarcAurele:]

Well, I guess we would count that with the fact that everyone else's stock has also increased. I think Laurie, our philosophy on this hasn't changed from what it was in the past. I think it’s a function of price, and whether or not we can find something that makes sense to combine with that we also feel will - we would be able to grow. You know, expenses synergies aside, we are interested in things that are in markets that we think present growth opportunities for us. So I think any kind of a payback period is still within the same kind of parameters that we had discussed before.

[Laurie Hunsicker:]

Okay, great, and then just one last question. Again with stock currencies up et cetera, have you all seen any sort of increased M&A discussions because of stock prices?

[Joseph MarcAurele:]

I would say, Laurie, that people are currently taking a little bit of a pause because, I think all of us would like to get comfortable that these kind of evaluations have a chance to hold.

[Laurie Hunsicker:]

Great. Thank you.

[Operator:]

This concludes our question answer session. I'd like to turn the conference back over to Joseph MarcAurele for closing remarks.

[Joseph MarcAurele:]

Well, thank you all for taking the time with us again today. We look forward to the first quarter and to having further discussions, and we're certainly hoping to produce the same kind of results we have historically. So thank you very much.

[Operator:]

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