Washington Trust Bancorp, Inc. (WASH) Q2 2015 Earnings Report, Transcript and Summary

Good morning and welcome to Washington Trust Bancorp Inc.'s Conference Call. My name is Jesse. 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?

Thank you, and good morning. Washington Trust Bancorp Inc.’s second quarter 2015 conference call will be hosted this morning by Joseph MarcAurele, Washington Trust Chairman and Chief Executive Officer, Ned Handy, President and Chief Operating Officer and David Devault, Vice Chair, Secretary and Chief Financial Officer. Please note that today's presentation may include forward-looking statements and actual results could differ materially from those statements. We remind to see our earnings release and our most recent SEC reports on Forms 10-K and 10-Q for discussion of any related factors. The materials will be furnished to the SEC and are available on our Investor Relations section of our website washtrustbancorp.com. Let me remind you that Washington Trust trades on NASDAQ/OMX market under the symbol WASH. I'm now pleased to turn the call over to Washington Trust's Chairman and CEO, Joseph MarcAurele.

Thank you, Beth. And good morning, and thank you all for joining us on today’s conference call. This morning, I'll review our second quarter highlights and David will discuss the company’s financial results. At the conclusion of the call, Ned, David and I will answer any questions you may have about the company's performance. Washington Trust posted solid second quarter results as net income amounted to $11.5 million, or $0.68 per diluted share, representing the highest quarterly earnings in Washington Trust 215 year history. Our profitability measures also improved during the second quarter with a very strong return on equity and return on assets. We are well capitalized and asset quality remains solid. We're pleased with all – with our overall performance and the consistency of our earnings over time. Our industry continues to weather the challenges of a slow growth economy and margin compression from continued low interest rates. Washington Trust success is attributable to our diversified business model and expanded regional presence. Let me take a moment to further discuss the strategy and the contributions of our individual business lines. Our wealth management division is a key part of our diversified business model, as it provides us with a major source of non-interest income. In the second quarter, wealth management revenues hit an all time high, as did assets under administration. In June, we are very pleased that we made a major announcement to expand our wealth management division, as we signed an agreement to acquire Halsey Associates, Incorporated, a New Haven, Connecticut-based registered investment adviser. Halsey has an experienced team of professionals who specialize [Technical Difficulty] in providing comprehensive investment counseling services to high-net-worth families, corporations, foundations and endowment clients in Connecticut, metropolitan New York and throughout the United States. We're excited about the many opportunities the Halsey acquisition offers. We expect the transaction to close in the third quarter and assets under administration on a combined pro forma basis will be approximately $6 billion. The Halsey acquisition will help us expand our presence in the Connecticut region. As you know we currently have mortgage banking offices in Glastonbury and Darien, Connecticut and conduct commercial lending activities in the area. Halsey's New Haven location, as well as their referral network and client base will provide cross-sell opportunities for both our residential mortgage and commercial lending teams. We've had good loan growth during the year, total loans reached $2.9 billion at June 30. Our mortgage area benefited from low interest rates earlier in the year and the trend continued into the second quarter. We had good mix of both refinancing and purchase activity and production really from throughout all of southern New England. As a result of strong mortgage banking production, we had healthy loan sale gains during the quarter. The pipeline looks good through the remainder of the summer, but obviously a rate increase this fall could slow production down by year end. Our total commercial loans reached $1.6 billion at June 30. Overall growth was dampened a bit by commercial real estate pay-offs during the quarter. We continue to see good quality commercial credits in southern New England and have a strong pipeline going into the third quarter. We are competitive on pricing, but remain disciplined on structure. Total deposits stood at $2.7 billion at June 30, down from the previous quarter, reflecting seasonal outflows by large municipal depositors. In the last 12 months, we opened two new branches in Rhode Island and total deposits increased almost 6% during that period. We are committed to a de novo branch strategy in Rhode Island as we believe there is additional market share to gain in the state. Current plans are to open a branch on the east side of Providence later this year and a branch in Coventry, Rhode Island sometime in 2016. I’ll now turn the discussion over to David for review of our financial results. David?

Thank you, Joe. Good morning, everyone. Thanks for joining us on our call today. I’ll review our second quarter 2015 operating results and financial position, as described in our press release yesterday afternoon. Net income amounted to $11.5 million or $0.68 per diluted share for the second quarter, that compare to first quarter of 2015 net income of $11 million or $0.65 per diluted share. The second quarter earnings and earnings per share results were both record highs for the company. These results were helped by growth in net interest income, strong mortgage banking results, a modest loan loss provision and continued success in managing our core operating expenses. We also recognized some acquisition expenses in connection with the upcoming acquisition of Halsey Associates. I'll have more about that in a few moments. There were some very solid financial metrics associated with our operating results in the latest quarter, return on equity was 12.88% and the return on assets was 1.27% for the quarter, both of those are very high performing results among our peer group. Total non-interest, excuse me, net interest income in the latest quarter was $26 million, up 1.3% on a linked quarter basis. That increase was helped by a $34 million increase in average interest earning assets, largely due to commercial loan growth. The net interest margin for the second quarter was 3.15%, down 3 basis points from the first quarter. Included in the latest quarter was about $519,000 of commercial loan prepayment fee income compared to $266,000 of that type of income in the first quarter. Excluding the prepayment fee income, the margin was down about 5 basis points on a linked quarter basis and that decline would be largely due to run-off and replacement of higher yielding loan balances. On the funding side, the cost of average interest bearing liabilities declined by about 3 basis points in the quarter. On our balance sheet, total loans rose by $48 million or 1.7% in the quarter. Commercial balances were up 1.5%, including a $33 million increase in our CRE portfolio. There was some modest decline in the C&I portfolio. In the last 12 months, total commercial loan balances are up 16%. Our residential loan portfolio increased by 1.4% in the latest quarter and are up 14% in the last 12 months. We saw a good growth in our consumer portfolio with a 3% increase in the second quarter, led by increases in home equity lines. And the total loan portfolio stands at about $2.9 billion at the end of June. Our investment securities portfolio increased by about $9 million in the second quarter. That reflects purchases of US government agency securities for balance sheet liquidity purposes. Total deposits declined by 1.6% in the second quarter. The largest outflow was in money market deposits. And we consider that to be largely seasonal flow related to governmental and other institutional depositors. Non-interest income continues to represent a significant portion of our total revenues. Total non-interest income was $15.3 million in the latest quarter, an increase of 9% on a linked quarter basis. Mortgage banking revenues in the form of net gains on loan sales and commissions received on loans originated for others was $2.7 million in the latest quarter, a 6% increase over the first quarter. That is largely driven by volume, residential mortgage loans sold into the secondary market rose from a $128 million in the first quarter to $143 million in the latest quarter. And our success in continuing to shift a higher portion of loan originations into saleable product has helped us to maintain that healthy level of mortgage banking revenues. In the latest quarter, we also saw a continuation of commercial borrower demand for interest rate swap contracts. Net gains on interest rate swap contracts were $717,000, up about 11% on a linked quarter basis, and that’s probably an above average level of what we would expect over time. In our wealth management business, second quarter revenues were $8.9 million, a 6% linked quarter increase. The increase included $346,000 more in tax preparation service fees and that is generally something that’s concentrated in our second quarter. Wealth management assets under administration rose to $5.2 billion. They were up 1% on a linked quarter basis and 4% in the last 12 months. Looking at non-interest expenses, total expenses for the second quarter were $24.3 million, up about 3% in total from the first quarter. Included in that was $433,000 of acquisition related costs. Excluding those non-interest expenses were up about 1.4% compared to the first quarter, largely due to an increase in advertising and promotional expenses which is something that we would typically put more dollars in, in the second quarter. Meanwhile, our asset quality metrics remained stable and manageable in the latest quarter. Non-performing loans declined by $734,000 and stand at 0.52% of total loans, a 3 basis point decline in the quarter. Total loan delinquencies meanwhile rose by just under $5 million, stand at 0.82% of total loans, up from 0.66% at the end of March. And the dollar amount of the increase was largely due to one well secured commercial relationship. We recognized a loan loss provision charge to earnings of $100,000 in the second quarter, following no provision in the first quarter. In the second quarter, our provision reflects loan loss allocations commensurate with growth in loan portfolio balances, but they were offset by reductions in other loan loss exposure allocations in response to continued improvement in credit quality conditions. And the allowance remains at 0.94% at June 30, a 3 basis point decline from the end of the first quarter. Total shareholder’s equity for the corporation was just over $359 million at the end of June, a $5.3 million increase in the quarter. We continue to pay a quarterly dividend of $0.34 per share, which was declared in June and paid earlier this month. The corporation and our subsidiary banks capital levels continue to well exceed the well capitalized minimums. Total risk based capital for the corporation was 12.78%, down 2 basis points in the latest quarter and the tangible equity to tangible assets ratio was 8.28% at the end of June, a 6 basis point increase in the quarter. As Joe mentioned, we have announced that we will be acquiring Halsey Associates Incorporated, a registered investment adviser firm in New Haven. That transaction is expected to close in the third quarter. We expect the – at this time we estimate that there will be a decline in our tangible equity to tangible assets ratio modest of about 21 basis points. And we expect that following the recognition of some additional acquisition costs this quarter that we'll see a modest accretion to earnings per share in the latter part of 2015. At this time, I’ll turn the call back to Joe MarcAurele.

Thank you, David. We had another good quarter and are pleased to provide solid returns to our shareholders. In the months ahead, we have several significant events that will keep the momentum going. In August, we celebrate our 215th year of service. We are really very proud that Washington Trust is recognized as the oldest community bank in the nation and one of the top performing banks in our region. In the third quarter we will welcome the Halsey Associates team and their clients to Washington Trust. We're very excited about the opportunities that lie ahead for our combined company's. And finally, construction will continue on our new branch on the east side of Providence for a fourth quarter opening. But I really like to thank our shareholders and members of the investment community for your continued support and interest in our company. Thank you for your time this morning and now Ned, David and I are happy to answer any questions.

Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from the line of Mark Fitzgibbon with Sandler O'Neill. Please proceed with your question.

Good morning and thanks for taking my call.

Hello, Mark.

Hi, Mark.

Hey, guys. You had said previously that there will be about $4 million of revenues from the Halsey deal per year? Could you help us think about what the annual expense base looks like and what potential cost synergies there might be?

Mark, this is Dave. The cost synergies will kick in over time, but Halsey's operating contribution to our earnings is – its based on size, will not be significant to earnings per share. We expect it to be positive and it’s a well run company with a very efficient operating model.

So is it sort of $800,000, $900,000 per quarter of operating expense, would that be a good guesstimate? I am sorry of quarterly operating expenses?

That’s – let's see, probably a little bit high, but it’s in that range, I would say.

Okay. And then so if we look at the combined expense base, next quarter we sort of – and I heard your comments earlier about some of the items in 2Q, it sounds like operating expenses are to be in that sort of $24.5 million range in 3Q, is that – am I in the ballpark?

I am reluctant to give guidance to that degree of precision. Mark, we expect that we'll see some additional acquisition expenses in the second – in the third quarter, probably between $4 and $500,000 and once that settles, then I think we'll see really an operating result that would make sense in the fourth quarter.

Okay. And then in terms of the margin, the trends that are probably similar going forward to what we saw this quarter, some modest additional compression in the NIM?

We certainly see that if the yield curve remains where it is today that, that’s simply going to be a fact of life. We are doing whatever we can to offset that. I think we said that we've – in a couple of previous quarters that we would anticipate some modest margin compression and that’s in fact what we saw in the latest quarter.

Okay. I wondered if you could also share with us the commercial loan pipelines, and give us a sense for what is happening with commercial line utilization rates?

Yes. It’s Ned, Mark. The commercial pipeline is actually at an all time high. It’s well over $200 million and that’s spread between Connecticut and Rhode Island and Massachusetts. It is fairly evenly split between C&I and CRE. We've got a few pre-construction deals in the pipeline, but not a lot. So the pipeline is very healthy. We're finding opportunities. Of course the market is extremely competitive and we're being careful on structure as Joe said and tend to be willing – more willing to compete on price than on structure. So we're not winning everything, but the opportunities are as robust as they've been.

And the line utilization rates, how are those looking?

Down a little bit. We don’t have a ton of revolvers. But – I think they were in the 30% to 40%.

Yes. Utilization is probably at a seasonal low at this time of the year and – but it’s not that volatile.

Okay. And then last question, I know there is some seasonality in the second quarter related to deposits, which we saw this quarter. But the loan to deposit ratio is been creeping up for a while. I guess, I am curious how high you'd be willing to let that go?

Well, that is certainly something that we spend a lot of time thinking about. We remain competitive on deposits and we will continue to be. The trade-off between in-market deposits and wholesale funding is something that we look very closely at. We have a lot of ability to use wholesale funding sources, if those are more effective than deposits. But between the market capacity that we have to grow market share in Rhode Island combined with the de novo branching strategy, we think there is continued upside to grow the deposit base.

Thank you.

Thanks, Mark.

Thank you. The next question is coming from the line of Travis Lan with KBW. Please proceed with your question.

Thanks. Good morning, everyone.

Good morning, Travis.

Morning.

And now that you – and just kind of taking back, Mark's last question. Now that you have residential and commercial lending, and will have wealth in Connecticut. At what point do you consider kind of building up the branch network there to kind of juice deposit growth a little bit?

Travis, this is Joe. Our feeling on establishing a branch network outside of Rhode Island has really been pretty consistent. Our sense is, is that if we were to venture off into those markets it would probably be more effective to do something like that through acquisition. We don’t – it would be very expensive to transfer our brand into those markets through de novo branching. And we also believe that we have a lot of opportunity in Rhode Island to continue to capitalize on what is a very strong statewide brand here, but a brand that does not have today statewide convenience. The de novo branches that we have are opened so far have performed very well. They are above our pro formas. So for the time being, absent some significant opportunity, we would continue to do that with a level of caution, given some of the industry and certainly our concerns about the effectiveness of new branches. So we really try to do them in a very cost effective way, and watch them very closely for any signs of faltering in regard to the type of growth we would expect to get.

Okay. That’s helpful. Just in terms of your deposit growth in Rhode Island and I guess, if you look at the environment today and then think about the environment, you know, should rates begin to rise later in the year? How much do you – how much growth do you think is just going to dependent solely on paying up for deposits? And do you think about kind of betas [ph] and how do you kind of measure that for yourselves?

That is something we do think about quite a bit. And we are seeing, I would say healthy competition for deposits in selected products. Right now I think that is a function of the entire region having a relatively high loan to deposit ratio and that’s something that’s just going to have to be factored into our planning and cost structure on a go forward basis.

All right. And just shifting to the loan side. Ned, commercial construction I know is only 4% of the portfolio, but its accounted for almost a quarter of total loan growth in the last year/ So what's changed in that market that made – that’s made you above the more positive and is there a certain size that you want that portfolio to be at the end of the day?

Yes. So we're - I think exceedingly careful on where we put construction dollars to use, most of that is either in multi-family markets in Rhode Island and around the greater Boston area in measured sizes and or with existing customers in the Rhode Island marketplace. It’s about an even mix between multi-family office and then some of that is some medical office and medical related properties that we've – that we're building now, that would convert to C&I exposure upon completion. We keep those deals in the real estate book as while they are being built and then transfer them over. They are really C&I risk at the end of the day. We don’t have a specific target for construction as a component of the overall book, but it will not be the fastest growing over time. And in fact we – just using the Boston multi-family market as an example we've already decided that that’s a market that has heated up to a point where we're going to take a pause and we'll look at all the markets that were active and where that kind of – through that kind of a lens. So it’s not intended to be the driver of growth. It’s happened to be a place where we've found some opportunities with customers that we know who have in fact themselves gotten more active in the construction front over the last 18 to 24 months. But it’s a different type of real estate risk and one that we were very careful about. And I don’t see growth in that segment of our real estate book out stripping the balance of the book.

Okay. Great. That’s good color. And last one from me Joe, is just kind of getting back to the idea, that you know, if you entered Connecticut it would through M&A. And I guess, just think about M&A more broadly, you guys have premium currency obviously that enables you to be kind of a choice buyer of banks? What are seeing in your M&A conversations, did they accelerated at all, and what are you hearing from, maybe some of the smaller banks in your markets in terms of what they want in a deal, and kind of what's holding some of the smaller guys back?

Well, I really think Travis that we have – it’s fair to say that we've had more conservations than we've had in the past. I do believe that some of the particularly smaller banks that are extremely margin dependent are getting to a point where they probably feel as thought they need to do something. I really believe that what holds some of these deals back is more – in fact that there is probably a little bit of an absence of activist investors who are pushing boards and banks to do things. And I guess there is also this ongoing, somewhat more issue of people getting a little bit of reality check around price. So it’s like anything else. These deals swing from an accretion and profitability perspective by the acquirer having everything to do with price first and then asset quality second, probably third, your ability to grow depending upon the market where these acquisition possibilities are available. So those are the gating factors us. But also there are – there will come a point where some of these things will absolutely happen more than they are happening today.

Great. Thank you all very much.

Thanks.

Thank you. [Operator Instructions] Our next question is coming from the line of Laurie Hunsicke with Compass Point. Please proceed with your question.

Yes. Hi. Good morning, gentlemen.

Good morning, Laurie.

I wonder if you could just follow up on the commercial construction just sort of frame it? And again, I realize it’s so small, but because it’s so small it’s been percentage growth. If we think about it, I mean, roughly is your target to put on, give or take, $10 million a quarter?

We are…

Do you think about it in terms of how much you would cap it? I guess that's another way to ask. In other words, when that portfolio gets to 5% or 10%, is it capped or is there no cap?

There is a guidelines that we live by. We have no cap. We don’t as I said, I’ don’t – it will not be the largest part of our real estate growth in any given quarter. We fund about $5.5 million – between $5 million and $5.5 million a month right now on existing constructions deals. That’s a nice number for us, that’s helpful. We are seeing, I mean, the markets are competitive right now that we are seeing, we've had one construction deal actually sell prior to construction completion. So - and we've seen a fair amount of runoff in the real estate book, unexpected pre maturity runoff which is fine. And I having a real estate background, I like to real estate deals pay off. I am okay with that. So we have some interest in replacing those. But I would tell you that we take a very close look at the – not just the construction risk, but the risk of – the market risk upon completion of construction which is typically 18 to 24 months down the road. So we're very careful about what we get involved in today, where we won't know the – obviously if it’s pre-leased that’s another story and then you are looking at credit risk of the tenant. So we look at construction deals very carefully. We don’t have a natural limit. But I think or a stated limit, but I think we have a natural limit just based on our risk parameters and again, we have very robust discussion around that type of risk.

Okay. And do you know what your average sized loan is in that portfolio?

I don’t know that right off the top of my head. But some of those construction loans are done with two or three other banks, some of them we do directly. I would be guessing to tell you the average size. But I would – I'd be surprised if our average exposure in that per deal was over $10 million.

Okay. And then you mentioned some of the…

It wouldn’t be many larger than that. Yes, I agree.

Okay. And then you mentioned some of that was multi-family in Boston. Any idea how much of the $111 million is multi-family Boston?

That’s a great question. We looked at that specifically. I can tell you that we have no more than four or five exposures names in that marketplace and in that list that’s really greater Boston. That includes the suburb ring sort of 25 to 30 miles around downtown Boston. So…

Yes. Laurie, the multi-family is about a third of the $110 million. So its pretty well diversified. That’s the largest concentration. In fact – and then retail would be about $80 million and commercial mix use about $34 million. So its pretty well diversified within that portfolio. This is a balance that has ebbed and flowed over time. It’s probably at a high for us at this point, but it’s not an order of magnitude change by any means.

Got it. Okay. Perfect. Very helpful. Okay. And then just jumping over to occupancy in the quarter, linked-quarter there was drop. Was that snow removal that's there in first quarter and missing from second? Or was there some other expense reduction that you undertook?

Snow removal, low utility costs and things of that nature.

Okay. Then lastly, just to jump back to assets under management here in the Halsey acquisition. So pro forma you mentioned you'd be at $6 billion. They're adding, round numbers, $850 million. Just to sort of tag team onto I guess where Mark was going with expenses, when I was initially looking at this in terms of what could be pre-tax if we used your same run rate assumption, netting out your tax prep fees. I was coming out with a pre-tax annual revenue of $1.4 million, I guess using the sort of guidelines as far as per Mark, $800,000 or so of operating expenses. That's taking me out to a lower number. Can you just help us think about, if we stayed completely constant right now, where we are today at this point in time with Halsey, what would they drop to on a pre-tax basis?

If you're – I am sorry, are you saying that 1.4 million would be the pre-tax contribution from the acquisition, is that the number that…

Yes. In other words, that's how I backed into it. Again, this is really rough. I mean, I guess the better question is, you gave us the $4 million of revenue number. What is the pre-tax number? You mentioned, there wouldn't be that many cost saves associated with it. So as we think about it, just in terms of where it stands today, assuming no asset runoff or anything like that. What is good pre-tax number…

Well, I can't give you a number. I think that numbers were little bit high. I am not saying they were cost saves, I am saying that over time we would be able to achieve efficiencies as we you know, can integrate back room functions. But this is not a cost savings driven transaction…

Right.

It’s a market expansion and geographic expansion and adding a business that is something that we've done before that we do very well. So I mean, it’s strategic in that sense.

Right. No, I understand that. So if we're thinking about the pre-tax contribution, I mean, can you help us understand where that is, just approximately? $1.4 million is too high. Is $1 million a relevant number?

At this point, we haven’t even had the closing yet. So…

Okay.

So, we will I think address this in future releases, either in our 10-Q or things that will have post closing.

Perfect. Okay. And then just one more question related to that. The intangibles that add on; round numbers, I'm backing in to about $620,000? Is that a good number?

Again, I think that we will have more…

Okay.

Color on that in future things that we will issue.

That’s perfect. Okay. Thanks so much.

Yes.

Okay.

Thanks, Laurie.

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Joseph MarcAurele for any concluding remarks.

Well, I'd like to just close by thanking everyone for your interest today and as we go forward we certainly feel good about some of the progress that we've made, particularly in our wealth management areas and in some of our market expansion, certainly into Connecticut and Massachusetts and really its helped us a lot to be a little bit more regional in our focus. So we thank you and look forward to speaking to you as we go forward.

Ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.