Washington Trust Bancorp, Inc. (WASH) Q1 2013 Earnings Report, Transcript and Summary

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

Thank you, Chad. Good morning. This is the Q1 2013 conference call for Washington Trust Bancorp, Inc. NASDAQ Global Select market, symbol WASH. This morning’s conference call is being recorded and webcast live. A replay of today’s conference call will be available shortly after the conclusion of the call through the corporation’s website at www.washtrust.com in our Investor Relations section under 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 MarcAurele, Chairman, President and Chief Executive Officer; and David Devault, Senior Executive Vice President, Secretary and Chief Financial Officer. And now I’m pleased to introduce Washington Trust’s Chairman, President and CEO, Joseph MarcAurele.

Good morning, and thank you for joining us on today’s call. Earlier this morning we released our Q1 2013 results. I’d like to take a few moments to discuss the highlights for the quarter and later David will review our financial performance. At the conclusion of the call we will answer any questions you may have. For Q1 2013, net income totaled $7.4 million or $0.45 per fully diluted share. Included in these results was the recognition of a $2.8 million impairment charge to earnings on a trust preferred collateralized debt obligation investment security. The after-tax impact of this charge was $1.9 million or $0.11 per diluted share. David will discuss this item in more detail a little later on in the presentation. Returns on average equity and average assets for the quarter were 9.91% and 0.98% respectively. We remain well capitalized and recently increased the dividend during the quarter to $0.25 per share. The local economy has shown some signs of improvement. We do though continue to be under some level of competitive pressure. Despite some economic challenges, Washington Trust posted solid loan growth and strong mortgage production in Q1 2013. In recent years we’ve opened new branches and mortgage offices, hired talent from larger competitors and enhanced technology. These investments paid off for us in 2012 and provided momentum going into Q1 2013. Our commercial lending area had a great Q4 and built a pipeline that carried us into Q1 2013. As a result of the solid business development efforts, commercial loans were up by about $25 million or 2%. We’ve been successful in attracting quality commercial credits from larger competitors. In addition to providing commercial financing we’ve been able to obtain their cash management and deposit relationships as well. Mortgage banking activity remained strong during Q1 although it was not as robust as the record high level in Q4. We have seen some pickup in the purchase market and the recent interest rate drop has once again spurred additional refinancing activity. We continue to generate good mortgage origination production in Massachusetts where home values have held up and the economy has rebounded faster than Rhode Island. We have an experienced team of originators covering Rhode Island, Massachusetts and Connecticut and are confident that we’ll get our fair share of the mortgage business in 2013. In the past 12 months we have done a good job attracting new core deposits which once again helped our deposit mix and lowered our cost of funds. Wealth management assets under administration were up from year-end. Wealth management revenues totaled $7.5 million for Q1. A stronger and more consistent financial market will benefit our wealth management returns. I would now like to ask David Devault to provide more detail on our Q1 results. Thank you.

Thank you, Joe. Good morning, everyone. Thanks for joining us on our call today. I’ll review our Q1 2013 operating results and financial position as described in our press release this morning. Net income amounted to $7.4 million with diluted earnings per share of $0.45 for Q1 this year. This compares to Q4 2012 net income of $9 million or $0.55 per diluted share, and Q1 2012 net income of $8.4 million or $0.51 per diluted share. While the operating results of our major lines of business were very sound in the latest quarter, the overall results did not meet our expectations. The sole reason for this was an other-than-temporary impairment charge to earnings of $2.8 million on a trust preferred collateralized debt obligation or CDO. The net after-tax impact of this was $1.9 million or $0.11 per diluted share. By way of background on this, on March 22 the trustee for the CDO entity issued a notice that a liquidation of the CDO entity will take place at the direction of holders of the 2 most senior CDO tranches. We estimate that the proceeds from the liquidation event will be insufficient to satisfy the amount owed to note holders of the subordinated CDO tranches of which Washington Trust is a note holder. We had recognized other-than-temporary impairment charges of $2.1 million on this security in years prior to this year; however, prior to the March announcement of the liquidation event, the expected future cash flows of the CDO through its maturity in the year 2033 were considered to be sufficient to recover our remaining $2.8 million amortized cost. The Q1 impairment loss reduces our carrying value in the holding to 0. As far as the effect on ongoing core earnings this year, we believe that’s negligible as the security had been in non-accruing status with no interest recognition since 2009, and we did not expect to recognize any interest income on the holding this year. The recognition of the impairment charge and the related reduction of the fair value to 0 resulted in a modest reduction to equity capital of approximately $400,000 and that translates to a charge of about $0.024 in booked value and tangible booked value per share. Q1 2013 net interest income was $22.5 million, down by about $700,000 from Q4 last year. Included in Q4 last year was a large prepayment penalty fee income item of about $357,000. Excluding the impact of that item, net interest income was down about 1% on a linked quarter basis. The net interest margin held fairly steady at 3.32% compared to 3.33% in Q4 last year. Excluding the impact of the prepayment penalty income in Q4 last year, the net interest margin for that quarter was 3.28%. And on this basis, the linked quarter increase reflects a reduction in the cost of funds offset to a lesser extent by a decline on the yield on loans. Average interest earning assets declined by $20.5 million on a linked quarter basis, reflecting payments received on mortgage backed securities partially offset by loan growth. In February, we also restructured $72.5 million of Federal Home Loan Bank advances with maturities in 2015 into new terms in the 2017 to 2019 period at a lower cost. The benefit of this in Q1 was approximately $70,000 with an expected benefit of $326,000 in the remaining quarters of this year. Our noninterest income business lines continued to play an important role in our profitability. In the wealth management division, assets under administration rose by 5% and reached an all-time quarterly high level of $4.42 billion at March 31. Asset based revenues of $7.1 million in the quarter was also our highest amount ever. Total wealth management revenues, including transaction-based fees amounted to about $7.5 million in the latest quarter. That was down slightly on a linked quarter basis because in Q4 last year there were 2 significant insurance commissions received of about $462,000. Total wealth management revenues were 5% higher than Q1 last year. Mortgage banking also continued to contribute significantly to our profitability as mortgage originations and secondary market delivery volume remained strong. While down 7% from the record high level reported in Q4 last year, net gains on loan sales and commissions received on loans originated for others totaled $4.2 million in Q1. This was 35% higher than Q1 a year ago. We believe the linked quarter decline was to a certain extent seasonal and we’ve seen strengthening in the mortgage pipeline in the past several weeks. Meanwhile merchant processing fee revenue was down by about 11% on a linked quarter basis which is the typical seasonal trend and correlates with the corresponding linked quarter decline in merchant processing expenses. With respect to noninterest expenses, for Q1 they amounted to $24.2 million, down 12% on a linked quarter basis, and 3% higher than Q1 a year ago. The linked quarter comparison is affected by debt prepayment penalties and charitable contribution expense both recognized in Q4 last year. Excluding those items, noninterest expense on a linked quarter basis declined by 4% from Q4 including declines in commissions and incentives as well as the seasonal decline in merchant processing costs. The year-over-year increase in noninterest expenses included higher salary and employee benefit costs reflecting higher staffing levels to support growth and higher levels of business development-based compensation in mortgage banking and other areas. Our effective income tax rate in Q1 was 31.6% and that compares to an overall effective rate for the year 2012 of 31.1%. On the balance sheet, total loans rose by $31 million in the quarter with increases in commercial loans of $25 million or 2% and a 1% increase in residential loans. The growth in commercial loans includes a $25.5 million or 3% increase in commercial real estate loans. Our total loan portfolio stands at $2.3 billion, up 8% in the last 12 months, including a 12% increase in commercial loans. Total deposits were up modestly in Q1, increasing by $7 million. In the last 12 months we’ve seen total deposit growth of 8%. We continue to have success in growing the lower-cost, non-time categories of deposits. Total deposits were at an all-time high level of $2.3 billion at March 31. With respect to asset quality, nonperforming assets amounted to 0.94% of total assets at March 31, up 11 basis points from the end of last year. The increase in nonperforming assets was due to a $3.1 million increase in nonaccrual loans. That change was driven by the classification into nonaccrual status of one commercial real estate loan with a carrying value of $5.1 million. At the present time this loan remains current with respect to contractual payment terms. Meanwhile, in the quarter, total loan delinquencies 30 days or more past due declined by $1.9 million to end the quarter at $26.2 million or 1.13% of total loans. Our asset quality levels have compared favorably with both regional and national asset quality indicators over a long period of time, and we believe that relative comparison will remain true when the Q1 comparisons are available. Net charge-offs continued at a low pace, amounting to $334,000 in the quarter, down from $479,000 on a linked quarter basis and $657,000 a year ago. Q1 net charge offs this year amounted to only 0.06% of average loans on an annualized basis and that is half of the rate that we experienced in 2012. We maintained our loan loss provision at $600,000 in the latest quarter, unchanged from Q4 last year. The allowance for loan losses stands at a very adequate level of 1.34% of total loans, down one basis point in the quarter. Total shareholders’ equity for the corporation was $301.0 million at the end of March, up by $5.6 million in the quarter. Key capital ratios also rose in the quarter as well. The tangible equity to tangible asset ratio at March 31 was 7.94%, an increase of 25 basis points from the end of 2012. The corporation and its subsidiary bank continued to remain well-capitalized. The corporation’s estimated total risk-based capital was 13.5% at the end of Q1, also up by 24 basis points in the quarter. In March, we declared a quarterly dividend of $0.25 per share which was paid earlier this month. That represented a $0.01 increase over the dividend paid in the previous quarter. It was our third dividend increase going back to March, 2012. At this time I’ll turn the call back to our President and CEO, Joe MarcAurele.

Thank you, David. While we continue to be faced with challenging operating environments in general, we continue to be confident that Washington Trust can turn these challenges into opportunities by balancing our strategic growth initiatives with disciplined expense management. Washington Trust continues to have a strong foundation and has provided solid returns for our shareholders. We will continue to focus on enhancing the value of our company. We thank you for your time this morning and now David and I would be happy to answer any questions.

[Operator instructions] Our first question comes from Damon DelMonte with KBW.

Just wondering if we could start off with the mortgage banking. Can you just give us a little perspective on the volume and the gain on sales that you saw this past quarter versus Q4?

Well, Q4 was an all-time high. A lot of events occurred that really led to that in Q4. We saw some reduction this quarter in the pipeline, particularly earlier in the quarter with some increase in rates that had occurred around that time and probably some seasonality as well. So we’ve seen some strengthening in the pipeline over the last several weeks that keeps our optimism high and solid for mortgage banking as we head into the near term.

Can you quantify actual dollar amounts for volume or even what the gain on sale in margin was for Q1 versus Q4?

I don’t have a margin number per se. The originations in the quarter were $184 million. We sold about $153 million into the secondary market. In Q4 we had originated about $220 million and sold about $157 million into the secondary market. The margins have held pretty well, but they’re not necessarily as high as they had been at certain points last year.

Okay, that’s helpful. And then can you just repeat, David, what you said about the benefit expected from the FHLB restructurings? I think you said that in this last quarter you had about $70,000 of additional interest income and what was it -- what’s the total amount that can be expected in Q2?

Well, $326,000 for the remaining quarters of this year.

Okay, for the remaining quarters, okay.

Yes. I mean there would be a continuing benefit in 2014, but you can extrapolate that over time.

Yes, okay, that’s good. And then I guess just as you look at loan growth opportunities for the remainder of the year, do you think that something in the high single-digit ranges is achievable for this year?

David, it’s Joe. I would say that mid- to higher-single digit commercial loan growth in general is probably something that’s realistic for us. We feel decent about the pipeline as it stands today and actually feel a little bit better about the mix of C&I versus commercial real estate with a little bit stronger C&I pipeline than we had seen during the previous several months.

Our next question comes from Frank Schiraldi with Sandler O’Neill.

Just a couple questions: on credit, you continue to have very, very modest levels of charge offs here, so even with the $600,000 provision in the quarter you had a pretty strong continual reserve to loan ratio north of 1.3%. I wondered if you just maybe had any update there, Dave, on your thoughts on provisioning going forward.

Well, at this time we’re not seeing a lot of pressure to increase the provision and our goal would be to certainly cover charge offs and provide enough to keep up with growth in the portfolio. When we took all things into consideration at the end of March, we concluded a $600,000 provision would achieve that. We’re not seeing any significant pressure that would change that in the near term and that’s our outlook at this time.

Okay. And then just wanted to ask about securities balances. Obviously they continue to run off here, and I just wonder is there a point that we’re reaching soon in your mind where you have to at least reinvest and then sort of hold those securities balances at least constant.

If things continued at the current pace, that day will arrive. That is several quarters away by our estimation.

Great. Okay, all right. I just wondered if you could remind us, I know you get a little bit of a boost or I believe you do in investment management revenues during tax season. I don’t know how that hits and how much that is.

It’s typically in the $300,000 to $400,000 range and it typically would be a Q2 matter.

[Operator instructions] Our next question comes from Matthew Breese with Sterne Agee.

Just on the loan growth, I was wondering if you could characterize it a bit more. Would you say that the loan growth you’re experiencing is taking market share or would you say that there’s some organic loan growth in the client base you already have?

I would say that the majority of our loan growth comes from taking market share. Given the state of the economy, and this has been true over the last few years, the growth that you would normally expect in your commercial portfolio coming from existing customers has been less dramatic. We’ve believed, and I think it’s proven out in regards to the deals that we do, that our opportunity continues to be to take share from larger competitors.

And what markets are you seeing the greatest strengths?

Well first of all, on the commercial real estate side we do operate in what I would call primarily a 3-state area: Rhode Island of course, Connecticut to a lesser extent, and Massachusetts to a greater extent than Connecticut. We see very strong metrics coming out of the Massachusetts market, solid metrics in Connecticut and Rhode Island is a kind of pick-and-choose deal market, but we feel as though we get our share coming out of our native market here in Rhode Island.

Okay. And then my last question is really around your thoughts and strategy with M&A. Recently there was a deal done where Newport Bancorp was acquired and I was just curious on your thoughts overall on M&A and your thoughts on that deal, particularly considering it was in your backyard.

We are always interested in deals that make sense, and obviously we look at virtually everything that we think would be of interest to us. Decisions around M&A have everything to do for us with good strategic fit and a price that we believe we can pay and make accretive in a reasonable amount of time.

Our next question is a follow-up from Damon DelMonte with KBW.

Just a quick follow-up: can you remind us what if any additional CDO exposure you guys have?

We have one remaining pool trust preferred CDO holding. I’ll have the carrying value on that in a moment. The risk profile for that security while it is in nonaccrual status is not anywhere near the kind of event that led to what’s happening with the one that we took the impairment charge on. The carrying value of the one that remains is about $1.3 million.

Our next question comes from Julie Casarino [ph] with Prospector Partners.

You just said the carrying value of the remaining CDO is $1.3 million, but haven’t you marked that down to fair value to like less than $0.25 million?

Yes, that’s a good point. The fair value of that at March 31 is $404,000. So if there were a loss, the charge to capital would be that number tax affected, so roughly $300,000. But again, our outlook on the cash flow generating capacity of that entity would indicate that it appears to be in decent shape.

On the 10(k) it looks like $230,000 fair value. So the amortized cost of $1.26 million, it just…

It apparently went up during the quarter.

Oh, okay. Okay. And the other one was being carried at like $600,000, which is why the mark to tangible book was minimal.

Yes. That number tax affected was the approximate $400,000 number I mentioned earlier in the call and in the press release.

There appears to be no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Joseph MarcAurele for any closing remarks.

Well, thank you very much, and thank you, everyone, for joining us on the call today. Again, we all understand the kind of situation that we’re operating in and the industry that we’re in, but we do continue to feel well-positioned to take advantage of opportunities within this market. So we thank you and we look forward to our next call for Q2.

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