Washington Trust Bancorp, Inc. (WASH) Q3 2012 Earnings Report, Transcript and Summary

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

Thank you, Emily. Good morning. This is the Third Quarter 2012 Earnings Conference Call for Washington Trust Bancorp Inc. NASDAQ Global Market Select under the symbol WASH. Please note this morning's conference call is being recorded and webcast live. A webcast replay of today's conference call will be available shortly after the conclusion of this call through the Corporation's website, washtrust.com in the Investor Relations section under the subhead, Presentations. However, the information we provide during today's call is accurate only as of this date and you should not rely on these statements after the conclusion of the call. Hosting this morning's discussion is Joseph J. MarcAurele, Chairman, President and Chief Executive Officer; and David V. Devault, Senior Executive Vice President, Secretary and Chief Financial Officer. And now I am pleased to introduce Washington Trust's President, Chairman and CEO, Joseph MarcAurele. Joe?

Thank you, Beth. Good morning, and thank you for joining us on today's conference call. Yesterday, we released our third quarter results. This morning, I'll discuss the highlights of the quarter and David will review our financial performance. At the conclusion of today's call, we'll answer your questions and provide an outlook for the months ahead. I'd like to begin by stating that we're extremely pleased with our third quarter results. We had good growth along all business lines, all total deposits and total loans reached all-time highs. We had record mortgage production and wealth management assets reached the $4.2 billion mark. This strong operating performance resulted in another quarter of record earnings. Net income was $8.9 million or $0.54 per fully diluted share, up $0.08 or 17% from the third quarter a year ago. Our profitability ratio has also improved as return on average equity was 12.02% for the quarter. Return on average assets also increased to 1.17%. All profitability measures have increased steadily over the past several quarters and ROE surpassed the 12% mark for the first time since the third quarter of 2008. Our mortgage area continues to contribute significantly to our profitability as loan sales gains were once again a key source of revenues, mortgage origination volume remained strong during the third quarter. Mortgage production was strong in all 3 markets where we have offices: Rhode Island, Massachusetts and Connecticut, as we continued to take advantage of a strong refinance environment. We also had healthy commercial loan growth in the third quarter, attracting new commercial real estate and C&I relationships in the Rhode Island, Greater Boston and Hartford, New Haven, Connecticut markets. The new business continues to come at the expense of larger competitors, our commercial team also brought in new business deposits and cash management relationships, contributing to total deposit growth during the quarter. Our total deposits reached a record $2.2 billion at September 30. We had good growth in both retail and business deposits over the past year, due to increased marketing promotions, business development efforts and new branch openings. The increase in low cost core deposits has enabled us to improve our deposit mix and reduce borrowings. Earlier this month, the FDIC released its latest deposit market share standings of -- based on June 30, 2012 data. We're pleased to report that Washington Trust once again increased our statewide deposit market share and ranks third behind Citizens and Bank of America in the Rhode Island market. Another area that contributes significantly to corporate profitability is our wealth management area and continues to serve as a key source of noninterest income. And as stated, wealth management assets under administration reached $4.2 billion at the end of the quarter. In recent years, we've hired wealth management professionals away from larger competitors. That strategy is obviously paying off as we brought in significant new client relationships. We also added new talents to our Providence trust and estate planning team to support the continued growth in that market. I'd now like to ask David Devault to provide more detail on our third quarter financials. David?

Thank you, Joe. Good morning, everyone and thanks for joining us on our call today. I'll review our third quarter 2012 operating results financial position as described in our press release yesterday afternoon. Net income for the corporation was $8.9 million, with diluted earnings per share of $0.54. These were both record levels for Washington Trust. These results are up $0.01 per diluted share from the previous quarter and are $0.08 per diluted share higher than the third quarter of 2011. Key performance ratios in the third quarter were solid with return on average equity climbing to over 12% and return on average assets of 1.17%. These were higher in both cases than the linked quarter results. There were certain transactions in the quarter that resulted in a $0.01 reduction in diluted earnings per share on an after-tax basis. These included a nontaxable gain of $528,000 and the receipt of proceeds on a bank owned life insurance policy and $1.2 million in debt prepayment penalty expense resulting from the prepayment of $32.4 million in Federal Home Loan Bank advances. The net interest margin in the third quarter was 3.28%, down a modest 2 basis points on a linked quarter basis. This reflects the impact of the sustained low interest rate environment on earning asset yields, which declined at a slightly higher rate than funding costs during the latest quarter. Linked quarter interest earning asset yields declined 7 basis points, partially offset by a 6 basis point decline in the cost of funds. The net interest margin is 6 basis points higher than the third quarter of 2011, again reflecting a reduction in the cost of funds. Average interest-earning assets rose by $25.8 million or 1% from the second quarter and are 4% higher than the third quarter a year ago. As a result, third quarter 2012 net interest income $22.7 million was up 1% on a linked quarter basis and is 6% higher than the third quarter a year ago. In addition to the prepayment of $32.4 million in Federal Home Loan Bank advances I mentioned earlier, we also modified $13 million in FHLB advances, with original maturities in 2014 and 2015, extending these into longer terms maturing in 2017 with a lower average rate. The advance prepayments and modifications are expected to result in net interest income enhancements of approximately $319,000 this year, with continuing benefits in future years. Noninterest income was $16.9 million, up 5% on a linked quarter basis and up $4 million, or 31%, compared to the same quarter 1 year ago. As I mentioned earlier, this includes $528,000 in a nontaxable gain related to bank owned life insurance proceeds. There were no sales of securities or other-than-temporary impairment charges in the third quarter of this year. In the second quarter, we did recognize $299,000 in securities gains and a $348,000 gain on the sale of bank property. And in the third quarter last year, we recorded $158,000 of other-than-temporary impairment charges. Excluding these items, noninterest income for the third quarter of this year was up 6% on a linked quarter basis and up 25% from the same quarter a year ago. A major reason for this is the continued strong mortgage origination volume and the resulting mortgage banking revenues, which includes net gains on loan sales and commissions received on loans originated for others. These totaled $3.5 million in the third quarter of this year. That's an increase of 16% on a linked quarter basis and that $3.5 million is up $2.4 million from the same quarter 1 year ago and the mortgage pipeline remains healthy as we head into the fourth quarter. Third quarter wealth management revenues were $7.2 million, down $280,000 on a linked quarter basis and up $400,000 compared to last year. The linked quarter decrease reflects a seasonal decrease in tax preparation fees which are typically concentrated in the second quarter. Wealth management assets were up $163 million or 4% in the quarter and stand at $4.2 billion at the end of September. As we measure average wealth management assets, they were up about 1% compared to the second quarter due to the path of the markets declining during the second quarter and rising during the third quarter. Regarding noninterest expenses, noninterest expenses in the latest quarter were $26.3 million, up 4% on a linked quarter basis and up 16% from the same quarter a year ago. Included in the second quarter of 2012 were debt prepayment penalties of $961,000 and again, at $1.2 million in debt prepayment penalties in the latest quarter. We also had $131,000 of a charge in the second quarter related to the termination of an operating lease. Excluding those unusual items, third quarter noninterest expenses were up about 4% on a linked quarter basis. The linked quarter increase is largely in 2 areas: Salaries and benefits. Salaries and benefits were up due to higher amounts of commissions paid to mortgage originators, higher staffing levels to support the mortgage origination business and other business lines and higher profit based incentive accruals. Merchant processing expense was also up by $387,000 compared to the second quarter, which is a typical seasonal increase that we experience. The effective income tax rate in the latest quarter was reduced to 30.3% compared to 31.7% in the second quarter and that's the impact of the nontaxable gain related to the receipt of the BOLI proceeds. At this time, our forecasted rate for the full year 2012 was approximately 31.6%, including the impact of the nontaxable gain in the latest quarter. On the balance sheet, we were very pleased to report a $43 million or 1.9% increase in loans led by growth of 2.3% in commercial loans. Residential loans were also up by $13.4 million or 2%. The total loan portfolio stands at $2.3 billion, up by 5.1% from the end of last year and includes a very respectable 8.1% increase in total commercial loans for the first 9 months of this year. Total deposits were also up solidly in the latest quarter with an increase of $104 million or 4.9% and the largest increases were in the core categories of money market and demand deposits. Total deposits stand at $2.2 billion at the end of September. Turning to asset quality, which has been a comparative strength for Washington Trust throughout this economic cycle. Nonperforming assets, which we measure to include nonaccrual loans, nonaccrual investment securities and properties acquired through foreclosure or repossession amounted to 0.69% of total assets at September 30th, up 7 basis points from the end of the second quarter. The increase in nonperforming assets was centered in nonaccrual loans, which rose by $2 million to $17.7 million at the end of the quarter. The increase is primarily due to 1 commercial credit, with a carrying value of $3.3 million, net of a $252,000 charge off. Meanwhile, progress was made in the administration of nonaccrual residential mortgages, which declined by $1.5 million in the latest quarter. We're also reporting a $7.3 million increase in troubled debt restructurings. This is essentially attributable to one $8.2 million commercial real estate credit in the hotel industry. A restructuring converted a portion of the credit to interest-only payments at a reduced rate for a temporary period, while a very strong guarantor is injecting over $1 million of his own cash into the property for improvements and providing additional collateral to the bank. This is a good example of where it is appropriate and prudent to work with a cooperative borrower in a restructuring mode and this credit has remained in accruing status. So overall, we believe Washington Trust asset quality levels remain very manageable and continue to compare favorably with both regional and national asset quality indicators. Net charge-offs amounted to $296,000 in the latest quarter. And for the first 9 months of this year, net charge-offs have amounted to only 0.07% of average loans on an annualized basis. We maintained our loan loss provision at $600,000 for the quarter unchanged from the second quarter. The allowance for loan losses remained at a very adequate level of 1.3% of total loans with a coverage level equal to 173% of nonaccrual loans. Total shareholders equity is $298 million at the end of September, up 6% on a year-to-date basis. The corporation and the subsidiary bank continue to remain well capitalized. The corporations estimated total risk-based capital ratio is 13.18% at the end of the third quarter, up 3 basis points on a linked quarter basis. Tangible equity, or the tangible assets, rose by 18 basis points in the quarter and stands at 7.84%. In September, we announced an increase in our quarterly dividend by $0.01, up to $0.24 per share, and that was paid on October 12. At this time, I'll turn the call back to our President and Chief Executive Officer, Joe MarcAurele.

Thank you, David. Washington Trust had a good third quarter and posted record earnings, increased our dividend for the second time and so our stock price reached a 52-week high. We're pleased of our consistent performance in earnings trend, but we remain cautious. The continued low interest rate environment, slow economic growth and increased competitive pressures, as always, present a challenge. Really, the key to our success has been our ability to steer a consistent course as we grow the company. Going forward, we continue to -- we plan to continue to adhere to the business model and the core values that have guided us over the years. Thank you for your time this morning and now David and I would be happy to answer any questions.

[Operator Instructions] And our first question will come from Frank Schiraldi of Sandler O'Neill.

Just a few quick questions. The first on the margin. Dave, you mentioned enhancement of net interest income of $319,000 from those balance sheet restructurings. That's through the end of the year. So that -- is that all 4Q? Or is a percentage of that in 3Q numbers?

About $275,000 of that is going to be in the fourth quarter.

Okay. Given then that that's probably 4 basis points or so in NIM expansion, are you comfortable given the other moving parts here to expect some overall NIM expansion in 4Q?

That's possible. It will depend on the yield upon the new loans come on to the balance sheet add. We've been certainly satisfied with maintaining the NIM. If we can get a little bit of extra NIM out of that transaction and the overall balance sheet management, that would be wonderful, but I think NIM maintenance is really the overarching goal for the company at this time. And the longer this low interest rate environment continues, that's just going to be challenging.

Got you. Okay, and then on credit. Dave, if you could just -- you mentioned the $8.2 million CREE loan that went into accruing TDR status in the quarter. Could you give us a LTV on that and then the market it's in?

It's in the Rhode Island market. I'm not sure I have LTV. We have maintained it in accruing status, which means it would have a nominal loss allocation based on a formula that we would use for that type of accruing loan and we're comfortable with this credit based on all of those factors that I indicated.

Okay. And then finally, on the -- on mortgage production. The pipeline, you said it's still robust. Can you just give it to us in comparison to what the pipeline was this time last quarter?

The pipeline has -- it goes up and down from week to week, but certainly applications have remained strong as we head into the third quarter. It might even be modestly higher than it was 3 months ago, but it depends on the week that you measure it. So it's been pretty steady over the last several months.

Got you. So is the growth in the quarter more on loan sales margins growing rather than originations growing, sequentially?

Well, the growth in the third quarter compared to the second quarter is clearly due to origination increases. We originated about $178 million in the second quarter and that was over $200 million in the third quarter.

[Operator Instructions] And our next question comes from Damon DelMonte of KBW.

I guess first one is probably for David here. I was wondering if you could just talk a little bit about the additional opportunities for balance sheet restructuring? Are you pretty much done? I know this is probably the second or third quarter that you've had some opportunity. I didn't know what the fourth quarter looked like or going beyond that.

There are modest opportunities to do things like that. They're diminishing in benefit as we move forward.

Okay. Along the lines of prepayment of debt or maybe just restructuring and doing a blend and extend?

Either of those things, we continue to look at that all the time to see what makes sense.

Okay. And then as far as your cost of deposits go, it looks like there could be some additional opportunity to lower those costs. Is there anything notable coming up in the fourth quarter?

We see modest opportunity to -- for repricing the weighted average cost of what's maturing and this quarter is not a lot higher than what we've been originating in recent months. So again, we see a modest opportunity for some deposit repricing downward in the fourth quarter, probably to a lesser extent than we've seen in prior quarters.

Okay, that's helpful. And then I guess lastly, with regard to mortgage banking operations, are you guys still comfortable with the size of your group of bankers right now? Or do you see greater opportunities to continue to hire people and start taking advantage of the continued strong volume activity?

Well -- this is Joe. I would tell you that we continue to recruit particularly in markets outside of Rhode Island. I really believe that as we go forward, there will be opportunity to recruit originators. The key to the business going forward is making sure that we don't overly expand the expense base so that at whatever point this business, which we all know to be cyclical, changes, that we can directly change our expense base in a way that makes sense.

[Operator Instructions] Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Joe MarcAurele for any closing remarks.

First of all, I just like to thank everyone for their time. This is obviously a challenging economy and continues to be that way. We feel as though we are well positioned to continue to take advantage of what the market presents us and our goal is to continue to show a consistent performance. So again, thank you very much and I will be back with you at the end of the year.

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