Washington Trust Bancorp, Inc.
Q3 2014 Earnings Call Transcript

Published: 21 Oct 2014

[Operator:]

Good morning and welcome to the Washington Trust Bancorp Incorporated Conference Call. My name is Rob, I will 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?

[Elizabeth Eckel:]

Thanks, Rob, and thank you everyone for joining us for Washington Trust Bancorp Inc.'s third quarter conference call. Washington Trust trades on NASDAQ/OMX market under the symbol WASH. The host of this morning's discussion are Joseph J. MarcAurele, Chairman, Chief Executive Officer; and David V. Devault, Vice Chair, Secretary and Chief Financial Officer. As a reminder, today's call is being recorded webcast live and a replay will be made available shortly after the call through the Corporation's website washtrustbankcorp.com. Please remember that the information discussed on today's call is accurate only as of this date and you should not rely on any statements after the conclusion of the call. I'm now pleased to introduce Washington Trust's Chairman and CEO, Joseph J. MarcAurele.

[Joseph MarcAurele:]

Well, thank you, Beth. Good morning and thank you for joining us today. Yesterday afternoon we released Washington Trust's third quarter earnings. David and I will now review those results and then answer any questions that you may have about the company's performance. I am pleased to report a solid quarter for Washington Trust as we earned $10.5 million or $0.62 per diluted share for the third quarter of 2014. I am proud to note that this now represents the company's highest quarterly earnings to-date. These results are truly a companywide effort, as not only did we have good growth along key business lines, but every employee from the front line to the back office continues to play a role in our success. Let me provide some detail on our efforts during the quarter. Total loans reached a record $2.67 billion at September 30, up 4% from the previous quarter, with solid commercial loan growth and residential mortgage production. In the past 12 months we have had double-digit loan growth, with total loans up almost 14% from a year ago. Our commercial lending activity was steady throughout the third quarter, and our team did a terrific job of bringing in quality commercial real estate and C&I loans from throughout the Rhode Island, Massachusetts, and Connecticut areas. While there is a lot of competition out there, we continue to get quality referrals from numerous sources, including existing clients, attorneys, and accountants. Our business development efforts have provided a healthy pipeline to keep our team busy with really what we'll end up being through the whole year. Our residential mortgage area continues to perform well with total originations approaching $200 million in the third quarter. We have had good production in all three states. In fact, we were recently named one of the fastest growing mortgage lenders in Connecticut according to the Commercial Record's Fast 50. Our sales and service model is a key to our residential mortgage success. Our originators were closely with the processing team to ensure loans close quickly for homeowners. In many cases, we were able to close within 30 days, which is much faster than the majority of our competitors. A few weeks ago we opened a new mortgage production office in Darien, Connecticut. We held a grand opening reception attended by more than 100 attorneys, accountants, and realtors, who were just as interested in our commercial lending and wealth management capabilities as they were about our mortgage lending services. We are excited about these additional growth opportunities that we have in Fairfield County. Our retail banking and business cash management teams have also done an outstanding job, as deposits reached an all-time high of $2.74 billion. At September 30, deposits were up 6% from the previous quarter, including an exceptional 16% increase in demand deposits. Total deposits were up 12% from a year ago, which is attributable to strong business development and promotional efforts, as well as continued successful branch expansion in Rhode Island. Our branch expansion strategy is working as we have gained market share in Rhode Island. According to recently released FDIC statistics, Washington Trust Rhode Island deposit market share increased from 7.81% at June 30, 2013, to 9.34% at June 30, 2014. Our branch network provides funding for future loan growth and we're committed to opening new branch offices in Rhode Island over the next few years. Earlier this year, we opened a branch in Johnston, Rhode Island and it's off to a very solid start. In 2015 we will open a branch in Rumford, Rhode Island, which is in the northern section of East Providence and borders Seekonk, Massachusetts. It's a great location for us as it not only fills in a gap between our branches but also offers retail and business banking opportunities. Wealth management revenue has totaled $8.4 million for the quarter and remains a significant contributor to corporate earnings and future growth. The wealth management business weathered a challenging period in the financial markets and wealth management assets stood at approximately $5 billion at the end of the quarter. David, will now review our third quarter financial results in more detail. David?

[David Devault:]

Thank you, Joe. Good morning everyone. Thanks for joining us on our call today. I'll review our third quarter 2014 operating results and financial position as described in our press release yesterday afternoon. Net income and earnings per share both reached all-time highs for us in the third quarter of 2014. Net income was $10.5 million or $0.62 per diluted share for the third quarter. That compared to second quarter 2014 net income of $9.8 million or $0.58 per share. Third quarter 2014 net interest income was $24.9 million, up 2% on a linked quarter basis. The growth in net interest income was achieved primarily by a 4.9% linked quarter increase in average interest earning assets led by residential and commercial loan growth. Meanwhile on the funding side, net interest income was helped by deposit inflows, including average balance increases in money market deposits and demand deposits. The net interest margin in the third quarter was 3.21%, compared to 3.35% in the previous quarter. The yield on interest earning assets declined by 14 basis points on a linked quarter basis. This was caused by a decline in loan yields, with new originations coming on to the balance sheet at current lower rates, and also reflects the mix of commercial loan originations, the majority of which were variable rate loans tied to LIBOR. There was also a maturity of some higher yielding investment securities at the end of the second quarter. Funding costs declined slightly by 1 basis point from the second quarter. We did add $50 million in wholesale funding in the form of longer-term brokerage CDs, which we used to pay down show-term federal home loan bank borrowings. This liability expansion, along with the beneficial impact of the increase in DDA balances, and the increase in floating rate loans, has improved our interest rate risk position with respect to exposure to rising rates. On the balance sheet, total loans increased by $93 million or 4% in the quarter. Commercial loans increased by 1.8% in the quarter, including $14 million dollars in commercial real estate loans, and $10 million increase in the C&I category during the quarter. Residential and consumer loans were up by $69 million or about 8%. The total loan portfolio stood at $2.7 billion at the end of the September. Investment securities rose by $47 million in the third quarter. The net increase reflected additions to support collateralization of public deposits and other liquidity management purposes. The additions included both agency securities and GSE mortgage backed securities. Total deposits grew by $153 million or 6% in the latest quarter, primarily due to linked quarter increases of $65 million in demand deposit accounts, $61 million in money market accounts, and a net increase of $40 million in wholesale broker time deposits. Total end market deposits, which excludes the category of wholesale broker time deposits, are up 8% in the last 12 months. We reduced our federal home loan bank borrowings outstanding by $60 million in the latest quarter, which was explained earlier by the additions to the broker time deposits for the most part. Let me comment now on non-interest income, which continues to represent a significant portion of our total revenues. Total non-interest income was $13.1 million in the latest quarter, up 2.4% on a linked quarter basis. In our wealth management business third quarter revenues were $8.4 million, down by about 1.8% on a linked quarter basis. That decline included $324,000 drop in non-asset based revenues mostly in the category of tax preparation fees, which are typically concentrated in the second quarter. Asset based revenues rose by $168,000 from the second quarter level. Total wealth management revenues for the latest quarter were up nearly 10% compared to the same quarter a year ago. In wealth management, assets under administration were just under $5 billion at the end of September, a decline of about 0.5% on a linked quarter basis. And that decrease was primarily due to financial market volatility in the latest quarter. Our mortgage banking revenues in the form of net gains on loan sales, and commissions received on loans originated for others were $1.7 million in the quarter, an increase of 2% on a linked quarter basis. Residential mortgage loans sold into the secondary market rose from $77 million in the second quarter to $80 million in the latest quarter. We also saw an increase in net gains on interest rate swap contracts, which totaled $376,000 in the third quarter due to an increase in customer related interest rate swap transactions in the quarter. Looking at non-interest expenses, total non-interest expenses in the latest quarter were $22 million, down by $400,000 or 1.8% on a linked quarter basis. The most significant changes included salaries and employee benefit costs, which declined by 1.7%, the largest contributing factor here was a decline in payroll tax expense; and advertising and promotion costs were $172,000 less than the second quarter, as there were seasonal promotional efforts in effect during the second quarter that were not in effect in the third quarter. Looking at asset quality, the results for the quarter showed a continuation of very manageable levels of asset quality indicators. Non-performing loans increased by $4.4 million to 0.63% of total loans, up from 0.49% at June 30. The increase was primarily due to the classification of one commercial real estate loan with a carrying amount of $4.9 million into non-accrual status during the quarter. Total delinquencies declined by $1.1 million and stand at 0.75% of total loans, down from 0.82% at June 30. Loans classified as troubled debt restructurings amounted to $18.3 million at September 30, down from $26.5 million at the end of the second quarter, reflecting a payoff of an $8 million commercial real estate loan. The loan loss provision charge to earnings was $600,000 in the latest quarter, up $150,000 from the second quarter, mostly due to portfolio growth. Net charge-offs were very modest at $101,000 in the latest quarter and net charge-offs for the first three quarters of this year represent a loss rate of only 0.08% of average loans on an annualized basis. The allowance for loan losses stands at 1.04% of total loans at the end of the third quarter, down 2 basis points from the end of the second quarter. Total shareholder's equity for the corporation was $349 million at September 30, an increase of $5.1 million in the latest quarter. In the third quarter we declared a quarterly dividend of $0.32 per share paid on October 15. That dividend rate represented an increase of $0.03 per share over the prior dividend rate and it was also our third dividend increase in the past year. The corporation and our subsidiary bank continued to remain well capitalized. For example, the total risk based capital ratio for the corporation is 13.26% at the end of the third quarter, up 2 basis points from the end of June. The tangible equity to tangible assets ratio was 8.51%, down by 10 basis points in the latest quarter. At this time, I'll turn the call back to our Chairman and CEO, Joe MarcAurele.

[Joseph MarcAurele:]

Thank you, David. As I mentioned earlier, we achieved record results through the coordinate effort and shared vision of really our entire team. In recent years we've embarked on significant growth initiatives by expanding into new markets, investing in technology, and most pointedly attracting talent from the competition. We remain committed to growing the corporation to generate continued profitability and value for our shareholders. I thank you for participating in this morning's call. David and I are now happy to answer any questions you may have.

[Operator:]

Thank you. We will now begin the question-and-answer session. (Operator Instructions). The first question comes from Mark Fitzgibbon with Sandler O'Neill.

[Mark Fitzgibbon:]

David you had said the liability extension that you have been doing has helped improve the positioning of a balance sheet relative to rates. Could you help us sort of -- could you quantify that for us possibly and also share with us your thoughts on the outlook for the net interest margin over the next quarter or two?

[David Devault:]

Yes the -- I think at the end of June we had put in our Q that the benefit to rising rates and in that 200 rate scenario was about 1.95% of net interest income. That's about a little over 3% now, as a result of the changes in the funding mix and asset mix. With respect to margin, the type of loan growth we saw in the third quarter could very well be repeated in the fourth quarter, and the reality of the type of incremental assets that you can add are probably going to have some continued impact as expressed by a lower net interest margin. So I believe we'll continue to grow net interest income very soundly it may be accomplished however with some erosion of net interest margin.

[Mark Fitzgibbon:]

Okay. And secondly, you guys had very strong residential mortgage growth in the third quarter. Was a lot of that 15 and 30 year paper or was it hybrid ARMs?

[David Devault:]

More than half of it is 71 and 51 ARMs. So it's -- it has relatively favorable interest rate risk management characteristics.

[Mark Fitzgibbon:]

Okay. And then lastly, it strikes me that your performance metrics really dwarf your peers and you guys have a great currency advantage. I guess, I was curious, why not be out there using that currency to do acquisitions of less successful banks?

[Joseph MarcAurele:]

Well, we certainly look at things. We don't preclude really anything from us other than things outside significantly outside of our geography. I would tell you that we -- as we think of this, we like to think of it either as a logical expansion geographically that we feel we can grow or something that might be slightly away from us that we feel as though we can be additive to particularly in the lines of business that we consider ourselves good at, which would most pointedly be commercial, wealth management, and the mortgage business. So I would say that these things are not out of the question.

[Mark Fitzgibbon:]

And just one follow-up. In the past I had actually focused if you had interesting opening branches down in sort of Central and Southern Connecticut. Obviously with the press releases that you all put out, you've been doing a fair amount of lending down in those markets. Has your view evolved at all?

[Joseph MarcAurele:]

I would say no, Mark. My feeling is that we have a statewide brand in Rhode Island without having statewide convenience. The branches that we've opened in Rhode Island have all been very successful. They've exceeded or certainly met our pro forma's. One of the issue is obviously with opening standalone branches in markets like Connecticut particularly Fairfield County, is the combination of cost and brand recognition. So I think that's more difficult, I wouldn't put it totally out of the picture in the future but right now we feel as though we can be very successful in expanding in Rhode Island where our brand is so strong.

[Mark Fitzgibbon:]

Thank you.

[Joseph MarcAurele:]

There is significant expense to building a branch -- a brand recognition in markets outside of Rhode Island.

[Operator:]

(Operator Instructions). Our second question comes from the line of Travis Lan with Keefe, Bruyette & Woods. Please go ahead with your question.

[Travis Lan:]

You guys had previously talked about kind of a mid-to-high-single-digit loan growth rate and obviously this quarter was well above that. So just wondered, is there any change in your thinking about how active you wanted to be or whether the growth opportunity is just kind of stronger than you had expected?

[Joseph MarcAurele:]

I think I would hold to that prediction right now, Travis, and the reason for that is because particularly in our real estate book, given the type of business we've done over the last four or five years, we are subject to payoffs at times. So I think mid-to-high-single-digit loan growth is probably going to be what we see. We always hope to be pleasantly surprised by that. We feel good about the current commercial pipeline, which stands at about a $175-ish million. But all that being said, the payoff situation is something that's not always controllable.

[Travis Lan:]

Okay. All right. Then, on the residential side, could you breakout may be in general terms, just a split between production in Rhode Island, Connecticut, and Massachusetts? And then, also David, if you could just elaborate on the difference between origination yields may be on the fixed and the ARM production?

[David Devault:]

Yes. More than half of our origination volume comes from outside Rhode Island. The greater Boston area is the by far largest source of mortgage originations. So that has been true for a couple of years now and it really speaks to the good decision that was made to expand our mortgage business into their market. The yields on loans are working on getting some information for that right now. What we saw in the quarter was that the 51 and 71 ARMs were in the range of 3.57%. Weighted average yield of third quarter originations for 51 3.81%; for 71s that amounted to, as I said about 70% -- 70% to 75% of total originations in the quarter. Most of the increase of what, the net increase on the balance sheet, were at loans in those categories.

[Travis Lan:]

Okay. That's helpful. And then could you just give a little bit more color on the single CRE credit that you guys had mentioned, I guess specifically which geography that loan was in when it was originated kind of LTV and if you have any specific reserve there at this point?

[Joseph MarcAurele:]

Yes, that's a very immediate geographic area loan for us is local. It arose from a commercial, commercial real estate relationship. It has been troubled for some time. We've been monitoring it closely and based on the performance of the borrow we put that into non-accrual status during the quarter. We have about an $850,000 loss allocation on that credit, which we believe is appropriate.

[David Devault:]

It was originated about five years ago, Travis.

[Travis Lan:]

Okay. All right. That's helpful. And then Joe, just the last one, I know you talked about whole bank M&A but just how you guys think about potential branch deals in Rhode Island or neighboring states or wealth management deals as well? Thank you.

[Joseph MarcAurele:]

Well I would -- branch deals I think are -- they probably aren't really any in Rhode Island that are that interesting. One of the issues associated with branch deals that you would buy from larger banks is they do a pretty good job of figuring out who wants to sell to you and that they are may be not that good. I think we would again continue to expand in Rhode Island. I don't see us buying a series of branches in Connecticut and Massachusetts unless it was very interesting and the price was right and we thought we could grow them. I would tell you that we are very interested in expanding our wealth management business and to the extent that we would have an opportunity to do something particularly in markets like Connecticut and Massachusetts that were interesting to us, we would definitely take those seriously. We have looked at a lot of them in the last few years. I think the gaining factor so far has been our discipline around price and seller's expectation of what they were.

[Operator:]

Our next question comes from Taylor Brodarick of Guggenheim Securities. Please go ahead with your question.

[Taylor Brodarick:]

Right. Thank you. I guess the question, so the LPO count in Connecticut is it two right; there is Stamford one and one at Darien. Any sort of numbers that you could kind of report how they're tracking, particularly the older ones so far, they exceeding expectations?

[Joseph MarcAurele:]

Taylor, we essentially were in a temporary space in Stamford and we really moved out of that temporary space into Darien so it's really the same people.

[Taylor Brodarick:]

One.

[Joseph MarcAurele:]

It's been in place for about a year or so. And David -- do you know the actual production, its tracked very well while it was in temporary space. So --

[David Devault:]

Yes, it's growing and given that it's been open for really less than a year it's -- we're very satisfied with the volume of originations coming from that area. We also have another one in Glastonbury, Connecticut that's been there about three-and-a-half years.

[Taylor Brodarick:]

And then, I think I asked this on the last call but just look at your loan deposit ratio, it seems to give you sort of optionality to boost the income periodically. Again could you just kind of remind us how you think of that ratio and how you saw off production is it, and we had 100% again we need to start accelerating sales or to kind of depend on the product and the relationship involved?

[Joseph MarcAurele:]

Well it does depend on the mix and one of the things we're encouraged by is the success we've had in garnering commercial deposits along with particularly C&I relationships and to a lesser extent CRE relationships. We've also continued to place a lot of effort in growing institutional deposits to our cash management team. We've had some very good success stories over the last couple of years and that has been continuing. So we're trying very hard to continue to grow deposits. We will manage the balance sheet appropriately. We are high on the loan to asset, loan to deposit ratio side but it's something that we think is manageable and with that we will continue to manage it.

[Taylor Brodarick:]

Really last question, just if you look at the equity market volatility over the last few weeks, what do you hear from your wealth management people as far as, I guess concerns from their clients I know you have a pretty sticky high network client base. But I just was kind of curious for your thoughts on that and sort of what you hear from that side of the business in regards to client retention to may be client acquisition from other wealth managers?

[Joseph MarcAurele:]

Well, I would tell you that communication is probably more important during the time of volatility than any other time. And this is not a time for our investment management staff to hide from clients given the volatility. Now all that being said I think your statement is correct. We do have a very significant number of high net worth individuals who have been with us for a long time, and a certain segment of our business is not totally based on performances, really a lot about providing the right type of service and liquidity to our wealth management customers. So far I would say that the retention part of that business has been terrific. It does though challenge the new business development part of it because it does create a certain amount of paralysis among customers in regard to their existing relationship so. This kind of an atmosphere does probably make it a little bit more challenging to get people to move. All that being said again we've had success with that but it probably could be better in a more robust market.

[Operator:]

This concludes the question-and-answer session. I would like to turn this conference back over to Joseph MarcAurele for any closing remarks.

[Joseph MarcAurele:]

Well again we appreciate all of your time and we look forward to a reasonable fourth quarter. We think the momentum is good. And we will get back to you at that point and I hope all of you have a nice day.

[Operator:]

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