Washington Trust Bancorp, Inc. (WASH) Q1 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to Washington Trust Bancorp Inc.’s conference call. [Operator Instructions] Today's call is being recorded. And now, I will turn the call over to Elizabeth Eckel, senior Vice President of Marketing and Investor Relations. Ms. Eckel?

Thanks, Maureen. Good morning. This is the first quarter 2014 conference call for Washington Trust Bancorp Inc. NASDAQ OMX, under the symbol WASH. This morning’s conference call is being recorded and webcast live. A replay of today’s call will be available shortly after the conclusion of the call through the corporation’s website, washtrustbancorp.com, under Presentations. However, the information we provide during today’s call is accurate only as of this date, and you should not rely on today’s statements after the conclusion of the call. Washington Trust executives Joseph J. MarcAurele, Chairman and CEO; David V. Devault, Vice Chair, Secretary, and Chief Financial Officer; and Edward O. Handy III, President and Chief Operating Officer, are hosting today’s call and will answer questions at the end of the presentation. And now, I’m pleased to introduce Washington Trust’s Chairman and CEO, Joseph J. MarcAurele. Joe?

Thank you, Beth, and good morning, and thank you all for joining us on this morning’s call. Earlier, we released our first quarter 2014 results of net income totaling $9.3 million or $0.55 per diluted share. David will provide a more detailed analysis of our core earnings and financial results shortly. Overall, Washington Trust had another good quarter. Profitability, capital and asset quality measures all remained strong. During the quarter, we did increase our cash dividend for the third consecutive quarter. The local economy has been -- continued to be slow to recover. The competition has, in fact, heated up. This has made for a challenging environment. We continue to stick to our business model and manage those things that we can control. We had some success along various business lines during the quarter. As the net interest margin rose, core expenses were well managed, and we were able to reduce the loan loss provision. Our mortgage area has been a key source of growth in earnings for us in recent years. Mortgage production did slow in the first quarter, due to several factors, not the least of which was a difficult winter, and obviously higher interest rates. These things certainly contributed. We’ve seen an uptick in the mortgage activity in recent weeks. While we won’t reach the levels that we saw during the refinancing boom, we’re optimistic that production will start to pick up, particularly in the Massachusetts and Connecticut markets, where we have added to staff. Commercial loans were down slightly from the fourth quarter of 2013, primarily as a result of strong year-end closing activity and payoffs of a few larger loans. Commercial pricing has continued to be very competitive. We do, however, have a healthy pipeline and some good prospects. But we remain cautious about this area and growth going forward. On March 1, we sold our merchant processing services business. That line of business we sold to Vantiv, one of the nation’s leading payment processors. Vantiv is very familiar to us. They’ve managed our credit card processing for quite a while, and we’re familiar with their service and technology. We believe this is a good situation for our merchant customers, who will benefit from Vantiv’s 24/7 customer service and many innovative payment solutions. David will discuss the impact of this transaction on earnings going forward. Wealth management assets under administration were relatively flat from year-end. Wealth management revenues were down, however. Fourth quarter revenues did include, and were positively impacted by significant insurance commission, which tends to be a little episodic, and was not repeated in the first quarter. Our retail banking area continues to be a bright spot for us. It’s important to note that demand deposit growth has increased 19% since the first quarter of 2013. Core deposit growth is a key initiative for us, obviously, as it helps our interest margin. We hope to keep the deposit growth momentum going in 2014, with the opening of a new branch in Johnston, Rhode Island. It will be our 19th branch. It’s located just outside of Providence. The Johnston market has a good mix of business and retail households, and we are excited about the opportunity that this offers for all of our lines of business. I’d now like to ask David Devault to provide an analysis of our first quarter financial results. David?

Thank you, Joe. Good morning everyone. Thanks for joining us on our call today. I’ll review our first quarter 2014 operating results and financial condition, as described in our press release this morning. Net income amounted to $9.3 million, or $0.55 per diluted share for the first quarter of this year. That compares to fourth quarter 2013 net income of $9.8 million or $0.58 and first quarter 2013 net income of $7.4 million, or $0.45. Looking at the first quarter year over year comparison, we would point out that the first quarter last year included an impairment loss on an investment security, which was deemed to be other than temporarily impaired, and that had an impact of about $1.9 million last year, after tax, or $0.11 per diluted share. There were certain transactions in the first quarter of this year that resulted in a net after tax charge of $0.01 per diluted share on March 1, and as previously noted, we sold our merchant processing services business line. That sale resulted in a net gain of $6.3 million, $4 million on an after-tax basis, $0.24 per share. In connection with that sale, we incurred divestiture costs in the first quarter this year of $355,000, or $227,000, $0.01 per share, on an after tax basis. We also prepaid $99.3 million in Federal Home Loan Bank advances, which resulted in a debt prepayment penalty expense of $6.3 million. Again, that translated into $4 million or $0.24 against earnings on an after-tax basis. And I’ll talk about the replacement funding in a moment. The combined impact of the divestiture of this business line and the reduction in interest expense due to the change in borrowing transactions is expected to result in future ongoing pretax income enhancement of approximately $1 million in the remainder of this year, $1.3 million in 2015, continuing benefits in the future years. First quarter 2014 net interest income was $23.8 million, up modestly on a linked quarter basis. The net interest margin for the quarter was 3.34%, up 10 basis points on a linked quarter basis. We prepaid, again, $99.3 million in FHLB advances in March. The replacement funding was largely in the form of wholesale broker time deposits, amounting to $80 million, as well as the use of on balance sheet liquidity. The net impact of these borrowing transactions was a reduction in interest expense of approximately $170,000 in March, which increased the first quarter’s net interest margin by about 2 basis points. In addition, the quarterly dividend on our investment in Federal Home Loan Bank capital stock increased by $107,000 in the first quarter. That also had a positive impact on the net interest margin of about 2 basis points. The remaining increase in the net interest margin on a linked quarter basis reflected somewhat higher yields on residential and consumer loans, as well as a lower average cost on in-market deposits and a modest effect due to the number of days in the quarter. Noninterest income was $19.4 million in the first quarter. Excluding the $6.3 million gain on the sale of the business line and also excluding the $717,000 other than temporary impairment charge recognized in the fourth quarter of last year, noninterest income was down $2.7 million on a linked quarter basis. There were several factors. As Joe mentioned, when we reported the fourth quarter results, we had an above-average level of swap transaction fee income, as well as an above-average level of commissions on insurance transactions. Both of these fee items were lower in the first quarter. We also saw some decline in mortgage banking revenues on a linked quarter basis and finally, we also had the impact of the sale of the merchant processing business. There were only two months of revenue from that business line in the first quarter. In our wealth management business, revenues were $8.1 million in the first quarter. Asset-based revenues were $7.8 million, up slightly from the previous quarter. Transaction-based revenues were down, again reflecting the decline in insurance income. Wealth management assets under administration were up in the quarter and stand at $4.81 billion at the end of March. Mortgage banking revenues, or net gains on loan sales and commissions received on loans originated for others, declined by 20% on a linked quarter basis, $312,000. This reflects a decline in origination and sales activity due to somewhat higher rates compared to what had been in effect going into the fourth quarter, as well as seasonal activity declines, no doubt some level of weather-related effects also. Residential mortgage loans sold into the secondary market were $57 million in the first quarter, down from $66 million in the fourth quarter. We’ve seen some strengthening in the pipeline towards the end of the first quarter that has continued into the first part of April as well. I’ll now comment on noninterest expenses. Noninterest expenses in the first quarter were $29.3 million, compared to $24 million in the fourth quarter. The linked quarter comparison also contains some items that need to be taken into consideration to fully understand the change. We had the prepayment penalty expense in the first quarter of $6.3 million, we had the divestiture cost of $355,000, mostly in salaries and benefits and some in legal and professional expenses as well. In addition, we had a $400,000 contribution expense to our charitable foundation in the fourth quarter of 2013. There was no such expense in the latest quarter. So excluding these items, noninterest expenses were down about $1.3 million on a linked quarter basis. More than 1/2 of this would be the elimination of the merchant processing expenses in March. They were down about $886,000 on a linked quarter basis. So, when you eliminate all of these noncomparable items, we would conclude that operating expenses were down modestly on a linked quarter basis. On the balance sheet, total loans increased by 0.6% in the quarter. Commercial loans were down 2%, largely due to payoffs of several larger commercial loans, as we mentioned. Residential loans were up 5%, and the total loan portfolio stands at $2.48 billion at the end of March. Deposits were up about 3% in the quarter. This included a net increase of about $73 million in out of market wholesale broker time deposits, which were mostly the source for the prepayment of the Federal Home Loan Bank advances. In market deposits, which we define to exclude wholesale brokered, were up about $13 million in the quarter. We had growth in money market borrowings [ph] partially offset by some runoff in market time deposits. Asset quality was a bright spot for the company. We saw some further improvement in important credit quality metrics. Nonperforming assets were down $5.5 million or 28%. Total loans past due were down $3.9 million or 18% in the quarter. These were largely due to the successful progress in the resolution of some larger problem commercial credits. Nonperforming loans stand at $13.6 million or 0.55% of total loans, down from 0.74% at the end of December. Chargeoffs were $1.1 million in the quarter, compared to $522,000 in the previous quarter. And included in the first quarter was an $853,000 chargeoff on one commercial real estate relationship that had been allocated as loss exposure at the end of December. As a result of the continuing trend in asset quality improvement, we’ve reduced our loan loss provision to $300,000 in the most recent quarter, compared to $400,000 on a linked quarter basis. The allowance for loan losses stands at 1.09% of total loans at the end of March. Shareholders’ equity for the corporation increased by $6.2 million. The corporation and the subsidiary bank continued to remain well-capitalized. The total risk based capital ratio for the company -- for the corporation is 13.56% at the end of March, up from 13.29% at the end of the fourth quarter. In March, we declared a quarterly dividend of $0.29 per share, which was paid on April 11. That was a $0.02 increase over the dividend paid in the previous quarter, and represents our third consecutive quarterly dividend increase. And at this time, I’ll turn the call back to our chairman and CEO, Joe MarcAurele.

Thank you, David. Washington Trust posted solid results for the first quarter. However, we recognize that growth will be both a priority and a challenge going forward. Our team is focused on these priorities, with a directed effort, and we’re all working together toward the desired result. We thank you for your time this morning, and now Ned, David, and I will be happy to answer any questions. Thank you.

[Operator Instructions] And our first question comes from Mark Fitzgibbon from Sandler O’Neill & Partners.

The first question I had was for Dave. I wonder if you could help us think through the merchant processing fees and expenses. Should we assume that merchant processing costs will go to zero and, excluding some small referral fees, the merchant processing fee line will essentially go to slightly above zero as well?

That’s correct.

Okay. Secondly, as it relates to the capital ratio, capital’s been building. You’re up around an 870 TCE ratio. And I know you increased the dividend, but do you feel like you’re carrying excess capital today? And if so, where are you sort of targeting for a capital ratio, and when might we see the company get there?

Well, earnings retention have been strong. That’s why we’ve pushed up the dividend. There was a pause in balance sheet growth, I would say, in the quarter, which may have also upped the capital ratios a little bit. So we’re hoping that with growth, and with continued strong dividends, that we’ll be able to keep that within a very manageable range.

Okay. And then the other thing I was surprised by, the average yield on your residential real estate loans went up from, I think, 409 to 415. Why was that? And are you extending duration or something to improve the yield?

I think there’s been some bottoming out in terms of yields of loans coming on compared to the book that had been in place at the beginning of the quarter. It’s not a significant extension of duration. It’s what we’re originating today.

What is -- what are you -- what types of loans are driving the production today?

Mark, I think we could let Ned talk a little bit about that. The commercial group reports to him. So he can give you some color on the real estate market.

Yes, so the competitive stresses are for longer duration, but we’re trying to stick within our -- 10 years is really the longest we will go, and we haven’t done a lot of those. We’ve done a few more construction loans, which are starting to fund now, as we get into the second quarter. Those are priced a little bit better, but there haven’t been huge fundings on those. We’ve done a couple of larger ticket apartment deals, which are bringing a little bit better pricing. But we've been -- what David is referring to is, as loans pay off, and we had a few large loans from prior periods pay off in the first quarter, and they generally have higher pricing than the loans we’re putting on, that’s been a problem in the last couple of quarters. That, I think, is sort of diminishing in effect, and the loans we’re putting on are slightly better priced than had been in the prior two quarters. So I think it’s a notch up in pricing, and frankly, sticking to our guns and not giving into competitive pressure on the duration and structure, and in some cases pricing. So we're trying to -- obviously, it causes more pressure on us from a growth perspective, but we’re going to stay consistent in our approach, at least for a while here.

No, I was sort of talking about the residential side. The average yield had gone up quite a bit from the fourth quarter to the first quarter, and it didn’t seem like you put on enough production that it could really budge the numbers that much. So I guess I was just curious if there was something else.

I think prepayments, or payoffs and amortization of deferred costs, were probably higher in the fourth quarter than the first quarter. That would have had some negative impact on yield in the fourth quarter. Origination volume was down slightly, so payoffs of existing loans were no doubt down slightly. Less than 1/2 of that production is fixed rate. We do add jumbo loans to portfolio where we have strong relationships with mortgage clients, and those are a little bit harder to sell in the secondary market as well. They’re great quality loans, and they’re above-average in terms of quality and the strength of the relationship. So I wouldn’t expect us to continue that kind of pace of growth over a long period of time, but it is something that we are able to take advantage of right now.

And the last question I had, Dave, is, if you sort of net out the nonrecurring items in the margin that you had this quarter, and assume a full quarter benefit from the liability restructuring, it looks like the margin is probably relatively stable here in the near term. Is that your understanding as well?

That is my feeling. Stable in the near term. The second half of the year, we start to see some impact of the continuing paydowns scheduled paydowns in the investment portfolio that we’re clearly not able to replace at today’s rates. We hope to overcome that, certainly, with good, solid loan growth and prudent management of deposit pricing.

Our next question comes from Travis Lan of KBW.

I was wondering if you could disclose your commercial pipeline or at least provide some color or comparison between where it stood at the end of the first quarter versus the end of the fourth quarter.

Ned, obviously, we had a great fourth quarter, especially the second half of the fourth quarter in terms of closings. And we did somewhat deplete the pipeline. And so part of the issue in the fourth quarter has been rebuilding the pipeline, right now. What I call sort of 50% and better, or proposals accepted by customers or better, is about $140 million, and some of that is on the verge of closing now. We’ve closed some construction loans in the first quarter that are beginning to fund now, so I feel better about the second quarter. And our outreach into Connecticut and Massachusetts through -- largely, at this point, through participating banks. We’ve had five or six banks that we’ve had meaningful conversations with. That’s starting to help us in those marketplaces. And so I’m encouraged by where we are. It’s a relatively high point in the pipeline, but certainly first quarter was largely about rebuilding all that we closed in the fourth quarter.

That's helpful. And I know you had mentioned some large commercial paydowns in the quarter. I was wondering if there was any notable prepayment income embedded in the margin at all.

Some of the prepayment was risk management oriented, so those are by choice. And some of it was just maturing larger-ticket real estate deals that happened to mature in the first quarter. So I don’t believe we had any unusual prepayment penalty income in the first quarter.

And it was pretty consistent from the fourth to the first quarter.

And then David, if you could just -- do you have a sense for the impact that the Johnston branch is going to have on expenses over the next few quarters?

The Johnston branch will have a modest at most effect over the remainder of the year. In large part, that staffing is really being reallocated from the existing retail staff. There will be some modest level of noninterest expenses associated with the facility, but I would say it would be low to mid six figures at most.

And then just last one for me is, with NPAs down about 50% year over year, do you think there’s more room to bleed the reserve going forward? Or how do you think about that, with the massive credit improvement that you’ve seen?

Well, the coverage ratio is probably a better indicator. I would say that we would -- we believe there’s room for the allowance as a percentage of total loans to drift somewhat lower for the reasons that you just mentioned.

[Operator Instructions] And our next call comes from Taylor Brodarick of Guggenheim Securities.

I guess, first question: I heard a little commentary about the weather, maybe -- sounds like impacting resi mortgage production. I heard from a similar bank in the region, greater expenses, I guess overhead expenses, related to snow removal. Did you experience any of that? And I guess also, any sort of Q2 lift that you see in resi mortgage that maybe got pushed back from Q1?

Well, first, on the expense side, whatever that impact was, was modest, and it’s not something we felt needed to be mentioned in the numbers. I think we always plan on higher snow removal costs at that time of the year, and manage other expenses so that -- from a timing standpoint, so that it doesn’t stand out. Again, the residential pipeline has risen within the past four to six weeks, so whether that’s the lift of the weather impact or just strengthening conditions in general, I don’t know. But it is a positive sign.

And looking at the loan to deposit ratio, drifting down a little bit from year-end, is there sort of a quantitative target that you all look at as far as what you want to get when you’re looking at loan and deposit pricing?

That impact is a little bit, probably large -- the change in the loan to deposit ratio on a quarterly basis is probably unusually large, because loans did not grow very much. But we did add the broker deposits, so that it was really a change in the funding mix of the total balance sheet that impacted that. Over time, we recognize we need to grow both loans and deposits to continue to generate good returns.

And I guess the last question would be, on that one commercial mortgage relationship, just remind me if there’s anything interesting or of note with that relationship, and if there are any other similar situations that we need to be aware of.

No, that was really a successful resolution and property was sold that allowed a significant paydown on the loan and the recognition of the chargeoff that had been previously reserved for. So there’s a modest amount of relationship remaining -- balance remaining with that commercial real estate relationship, but we don’t see any significant or really any loss exposure remaining that hasn’t already been allocated there. Our largest nonaccrual relationship now is just over $1 million, which is that one. And I think that’s the lowest amount we’ve had with the largest nonperforming relationship in a long time. So again, it just points to the continuing trend in asset quality improvement.

[Operator Instructions] And at this time, this concludes our question and answer session. I would like to turn the conference back over to Mr. Joe MarcAurele for any closing remarks.

Thank you very much. We really appreciate everyone’s time today, and certainly continue to appreciate your interest in our company. We’re about to kind of move forward for the second quarter, and we will see you on the next earnings call. So thank you very much.

At this time, the conference has now concluded. Thank you [indiscernible].