Q3 2023 Washington Trust Bancorp Inc Earnings Call

Thomson Reuters StreetEvents

24 October 2023 at 10:44 pm·26-min read

Participants

Edward Otis Handy; Chairman & CEO; Washington Trust Bancorp, Inc.

Elizabeth Boyle Eckel; Executive VP and Chief Marketing & Corporate Communications Officer; Washington Trust Bancorp, Inc.

Ronald Stephen Ohsberg; Senior EVP, CFO & Treasurer; Washington Trust Bancorp, Inc.

Unidentified Company Representative

William K. Wray; Senior EVP & Chief Risk Officer; The Washington Trust Company of Westerly

Damon Paul DelMonte; MD; Keefe, Bruyette, & Woods, Inc., Research Division

Laura Katherine Havener Hunsicker; Senior Analyst; Seaport Research Partners

Mark Thomas Fitzgibbon; MD & Head of FSG Research; Piper Sandler & Co., Research Division

Presentation

Operator

Good morning, and welcome to the Washington Trust Bancorp Inc.'s 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, Executive Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel?

Elizabeth Boyle Eckel

Thank you, Emily. Good morning, and welcome to Washington Trust Bancorp, Inc.'s third quarter 2023 Conference Call. Joining us this morning are members of Washington Trust's executive team, Ned Handy, Chairman and Chief Executive Officer; Mary Noons, President, Chief Operating Officer; Ron Ohsberg, Senior Executive Vice President, Chief Financial Officer and Treasurer; and Bill Wray, Senior Executive Vice President and Chief Risk Officer.
Please note that today's presentation may contain forward-looking statements and actual results could differ materially from what is discussed on today's call. Our complete safe harbor statement is contained in our earnings release, which was issued yesterday as well as other documents that are filed with the SEC. All of these materials and other public filings are available on our Investor Relations website at ir.washtrust.com. Washington Trust trades on NASDAQ under the symbol WASH.
I'm now pleased to introduce today's host, Washington Trust's Chairman and CEO, Ned Handy.

Edward Otis Handy

Thank you, Beth. Good morning, and thank you for joining our third quarter conference call. We appreciate your time and interest in Washington Trust. During my remarks this morning, I'll provide comments about our third quarter results in context with the market conditions we're seeing as well as an update on our current focus for value creation. Then Ron Ohsberg will offer more detail regarding our third quarter performance. And after our prepared remarks, Mary Noons and Bill Wray will join us for the Q&A session.
In the third quarter, our team did a solid job of managing through the current challenging market dynamics while executing our long-term strategy which is to build a sustainably relevant, consistently profitable and relationship-driven regional financial services organization. We remain laser-focused on all approaches to achieving in-market deposit growth, including technology investment, product development, branch expansion and sales management. We grew in-market deposits in the third quarter in a very competitive landscape and through our continued efforts and focus should drive additional growth in future periods.
During this suppressed earnings cycle, we are committed to building capital. In the short run, this means shifting our lending activity to primarily supporting existing customers with high-quality credit that contributes to our capital. As such, we expect loan growth to slow measuredly. We remain entirely attentive to quality credit, both new and existing. Our underwriting and portfolio management standards, although always prudent have tightened to reflect the uncertainty of the markets we serve. We will provide more detail in the Q&A session.
We continue to operate in a challenging economic environment with financial markets in flux and geopolitical and stability increasing. While these macro level headwinds have affected earnings and do not appear likely to abate for some time, we remain confident that Washington Trust is positioned to weather this storm and emerge even stronger. We have a proven business model with diverse revenue streams, disciplined credit culture, and we continue to make progress executing our strategy to further strengthen our market opportunities, enhance the value that we deliver to our people, our customers, our communities and our shareholders.
Moving on to the quarter. Ron will soon take you through a detailed review of our financial performance, but here are a few high-level points from the quarter. First, our third quarter results, while they were not up to our historical standards, they were in line with both the prior quarter and expectations. We posted third quarter net income of $11.2 million or $0.65 per diluted share about flat with $11.3 million or $0.66 per diluted share in the second quarter. Our margin remains under pressure from the competitive interest rate environment. On a positive note, our wealth management division delivered steady revenues, and we continue to tightly manage expenses.
Turning to deposit growth, which is core to our strategy. We made good progress in the third quarter. our deposit franchise is strong, intact and growing, albeit more expensive with understandable product shift in the current rate environment. Our branching strategy continues to be successful with average size of $209 million and deposits at our 3 newest branches stand at $70 million after 2 years, $28 million after just 1 year and $11 million after only 5 months. As mentioned on previous calls, we plan to open a new branch in the Olneyville section of Providence in early 2024 and one in Smithfield, Rhode Island also in the first quarter.
Finally, our credit remains strong during the quarter, and we consider managing credit risk and overall balance sheet strength through this challenging point in the cycle and imperative for positioning Washington Trust for long-term performance.
Before I turn the call over to Ron, I'd like to briefly mention some important progress we made in executing several key strategic priorities during the quarter. These achievements advance our mission to deliver what today's banking consumers want, need and value. Digital offerings, high-touch service and competitive products and pricing.
During the quarter, we made advancements in expanding our digital presence. We understand technology is dominating every aspect of our lives and banking is no different. Consumers are demanding convenient digital offerings and Washington Trust is focused on being there with the right offerings to meet that demand whether it involves enhancing online deposit account opening or providing seamless continuous expedited services across delivery channels.
Throughout our history, Washington Trust has had joined a strong brand reputation in our core markets. Recently, we launched a new brand positioning statement. "What We Value is You", supported by a multimedia advertising campaign designed to reach and enhance our presence both digitally and throughout our expanded market area. "What We Value is You", is a powerful phrase that embodies the spirit and purpose of Washington Trust and helps illuminate the importance we place on our employees, customers and communities as drivers of shareholder value.
Our new campaign promotes Washington Trust's comprehensive financial solutions, including checking and savings accounts, digital banking services, home lending and business banking and it highlights our current deposit special offers. These are certainly unusual times, but we believe we have the right strategy and the right team in place to weather the current macro dynamics while capitalizing on market trends and the strengths of our bank.
I'll now turn the call over to Ron for an in-depth review of our financial performance. Ron?

Ronald Stephen Ohsberg

Thank you, Ned. Good morning, everyone, and thank you for joining our call. As Ned mentioned, net income was $11.2 million or $0.65 per diluted share. Net interest income was $33.8 million, up by $251,000 or 1% in the preceding quarter. The margin was 1.97%, down by 6 basis points. Average earning assets increased by $167 million and the yield on earning assets was 4.69%, up by 16 basis points.
On the funding side, average end market interest-bearing deposits increased by $77 million and average wholesale funding rose by $83 million. The rate on interest-bearing liabilities increased by 24 basis points to 3.26%. Prepayment fee income was $71,000 in the third quarter and 50,000 in the second quarter.
Net interest -- excuse me, noninterest income comprised 31% of total revenues and amounted to $15.2 million, up by $901,000 or 6% from Q2. Wealth management revenues were $8.9 million, down by $100,000 or 1%. This included transaction-based revenues, which were down $221,000 primarily in seasonal tax servicing fee income, which is concentrated in the first half of the year.
Asset-based revenues were up by $121,000 or 1% with a corresponding increase in average AUA balances which were up by $140 million or 2%. And a period AUA totaled $6.1 million, down by $219 million or 3% from June 30 and reflecting market depreciation of $154 million in net client asset outflows of $65 million.
Mortgage banking revenues totaled $2.1 million, up by $355,000 or 20%. Mortgage loans sold totaled $89 million in the third quarter, up by $24 million. Total originations were $240 million, up by $13 million. Our mortgage pipeline at September 30 was $98 million, down by $67 million or 41% from the end of June. Loan-related derivative income totaled $1.1 million, up by $835,000.
Regarding noninterest expenses, these were up by $1.4 million or 4%. Salaries expense increased by $1 million or 5%, in the second quarter, we reduced performance-based compensation accruals by $1.4 million. Advertising and promotion expense also increased by $362,000 primarily due to timing.
Now turning to the balance sheet. Total loans were up by $230 million or 4% from June 30 and by $762 million or 16% from a year ago. In the third quarter, total loans increased by $123 million or 5%, essentially all in commercial real estate. Residential loans increased by $101 million or 4%.
In-market deposits were up by $35 million or 1% from June 30 and up by $121 million or 3% from a year ago. Wholesale brokered deposits were up $67 million and FHLB borrowings were up by $80 million from June 30. As far as deposit and liquidity metrics are concerned, uninsured and uncollateralized deposits are estimated to be 18% of total deposits. Our average deposit size is $37,000 and we have $1.8 billion of contingent liquidity.
Total equity amounted to $431 million at September 30, down by $28 million from the end of Q2. This included a decrease in the AOCI component of shareholders' equity, largely due to a decline in the fair value of available-for-sale securities. It also declined to $9.6 million in quarterly dividend declarations, and these decreases were partially offset by quarterly net income of $11.2 million.
Regarding asset quality, nonaccruing loans were 0.60% and past due loans were 0.17% of total loans. The increase in nonaccruing loans was largely due to two commercial real estate loans that were placed on nonaccrual status in the third quarter. Both of these loans are current. The allowance totaled $40.2 million or 72 basis points on total loans and provided NPL coverage of 119%.
The third quarter provision for credit losses was a charge of $500,000, down by $200,000 from the provision recognized in the second quarter. The provision for credit losses in the third quarter was composed of our provision for credit losses on loans of $900,000 and a negative provision for credit losses on unfunded commitments of $400,000. We had net charge-offs of $30,000 in the third quarter compared to $37,000 in Q2 and year-to-date net charge-offs totaled $114,000.
And at this point, I'll turn the call back to Ned.

Edward Otis Handy

Thank you, Ron. We'll now take questions.

Question and Answer Session

Operator

(Operator Instructions) Our first question today comes from the line Mark Fitzgibbon with Piper Sandler.

Mark Thomas Fitzgibbon

Ron, I wondered if you could help us think about the margin and maybe how much -- I know that the rate of decline in the margin slowed, but where do you think the margin ultimately bottoms out? How much lower it is likely to go?

Ronald Stephen Ohsberg

Yes. Yes, we expect it to trend lower in the fourth quarter towards the 1.9%. So kind of lower from here, call it, 1.9%, plus or minus.

Mark Thomas Fitzgibbon

And you think that's a sort of a bottoming point for the margin...

Ronald Stephen Ohsberg

No, I don't know if it's the bottom. I mean, we continue to see migration of deposits from lower cost options to higher-cost products. So I don't think we're unusual in that regard. But yes, we continue to see some funding pressure.

Mark Thomas Fitzgibbon

Okay. And secondly, on sort of the cost side of things, given the margin pressure and your plans to open some new branches, it strikes me that it will be hard to reduce costs. Can you talk about what your plans are there? Maybe what a trajectory might be, whether you have a sort of a target in mind for your cost going forward?

Ronald Stephen Ohsberg

Yes. So we're not ready really to talk about 2024 yet. Ned mentioned our marketing push, I would expect marketing to go up somewhat in the fourth quarter as we continue to roll that campaign out. The branches will start to -- the branches that we're opening in the first quarter will have an impact on Q4 took about $200,000 worth in the fourth quarter. We also are committed to increasing our charitable foundation contribution. So haven't decided exactly how much that would be, but we're thinking it's at least $500,000 in the fourth quarter.

Edward Otis Handy

But Mark, this is Ned. Yes, Mark, I just wanted to add. I mean, we're looking at everything we can on the expense side attrition, whether we fill positions. We're looking at all of the real estate that we still own and whether there's strategies around that, that makes sense. So we are focused on everything we can be focused on to control expenses.

Mark Thomas Fitzgibbon

Okay. But it feels like, Ned, there's not as much wiggle room on the cost side maybe as you'd like and the margin continues to be pressured. The wealth business continues to be pressured and mortgage is rate dependent. So I guess the question I have is, if earnings fall below the dividend, would you cut the dividend?

Ronald Stephen Ohsberg

Yes. So Mark, the dividend is really capital related. So as long as we have sufficient capital to pay the dividend, we're committed to paying the dividend.

Mark Thomas Fitzgibbon

Okay. And you talked a little bit about slowing the growth. Does that mean stopping the growth? I mean, because your capital ratios are optically pretty light already and have come down a lot by some of the growth that you've put on. What should we assume for sort of balance sheet or loan growth going forward?

Edward Otis Handy

Yes. Mark, this is Ned. We have construction loans in process. So stopping the growth is probably not realistic, but low -- very low single-digit growth. I expect here forward, we're -- but for taking care of existing customers and booking accretive assets that help earnings, we are just kind of pencils down. So we had a big pipeline coming into this quarter that mostly existing customers that we took care of. But we recognize the levels of growth that we showed in the quarter, we will not be showing that going forward. We need to rebuild earnings and capital, and we need to make sure that the loan books help on that front.

Mark Thomas Fitzgibbon

Ned, I guess I'm curious, I'm sort of scratching my head. You guys have grown your office loan portfolio this year by 12%. It just seems like an inopportune time to be doing that. Can you help us sort of understand better. Why you would want to do that given the capital ratios are tight and you're trying to conserve capital there.

Ronald Stephen Ohsberg

That's a fair question. We have no expectations of growing the office book. And I'm going to ask Bill to just talk about the details on the office project that we did in the quarter.

William K. Wray

It was really one deal with an extremely strong sponsor and amazing deal metrics. So in the never say never category, this is one we felt it was the right thing to do. It had a 16% going in debt yield about a 50% LTV, 2.0 coverage, no tenant concentrations. So it was a deal that made sense. And so it's certainly -- we never want to be a bank that just puts up the Heisman and says, stay away, that's just not the right way to treat our market. So this was one of those deals that was a real cherry to pick. And we also got really good structure in terms of a guarantee on this. So we certainly -- I haven't seen any office deals in a while. This was -- has gotten the pipeline quite a while ago.

Edward Otis Handy

And just to give you a sense, Mark, we came into the quarter with a pipeline that was north of $300 million. Our pipeline right now is below $100 million. On total...

Mark Thomas Fitzgibbon

Okay. Last question is, I wonder if you could give us a little more detail on those two nonperforming loans in the commercial real estate bucket. Maybe some color around what's going on there? Because I think Ron mentioned that they're performing, but you put them on nonaccrual, what's going on with those?

William K. Wray

Right, this is Bill again. So one of them is a senior housing facility. LTV of 59%, been challenged on vacancy, been challenge also with staffing costs. A lot of these places it had a real difficulty hiring people, it had huge agency staffing, which has put a lot of pressure on their bottom line. It's had millions and millions of sponsor support over the last couple of years, but was it matured and so the nonaccrual was based on that. It is current. We're now discussing forbearance possibly going to IO for a while until that fill recover.
Again, a solid deal with a strong sponsor, but the nonaccrual was tripped by the maturity and then the fact that we had to get the forbearance in place. The other one is a couple of Class B office properties occupancy around 60%, still getting sponsor support. But still current, we believe that they'll get through this okay, and we're talking right now about a potential modification to interest only for a while. But again, we felt it was prudent on those to go nonaccrual as well. So -- but as I said, both of them, as you noted, are fully performing and haven't missed a payment.

Operator

Our next question comes from the line of Damon DelMonte with KBW.

Damon Paul DelMonte

Just to kind of follow-up on the credit discussion there. If you look at the loan loss reserve, it's around 72 basis points. Are there any other credits, I guess, first, that are starting to pop up on the screen as maybe being concerning. And then as you look at the kind of broader credit picture and economic picture, do you still feel comfortable with the reserve that's well below 1%.

Ronald Stephen Ohsberg

Yes, Damon, I'll start with that, and I'll hand it off to Bill. Yes. I mean we do a very, very detailed review of our portfolio each quarter. And yes, we know 72 is probably on the lower end of the peer group range. But given the quality of our portfolio and our understanding of it, we're comfortable with that level. Bill?

William K. Wray

Sure. Again, very comfortable with the level. It's under CECL. It's a forward-looking estimate of lifetime losses in the portfolio. If you look at our losses, and we tend to be aggressive about recognizing losses when they occur. We're almost literally none for the year, almost -- we haven't lost the $40 million we have on our reserve over the last 20 years. And so we're no way complacent about credit. But our quantitative models are built to have conservative estimates in them. We've got good qualitative reserves as well. So we are extremely comfortable where we are. And we have outperformed the industry on credit issues through ups and downs for quite a while. If you look at our delinquencies, they are essentially nonexistent on the commercial side, they are light on the others. We do stress test consistently, both top down and bottom up using a third party and the numbers tell us that we are in good shape on the reserve side. So yes, we do feel comfortable.

Damon Paul DelMonte

Okay. That's helpful. I appreciate that color. And then I guess on the margin front, to go back to that, I guess, Ron, you guys have added a lot of wholesale borrowings. And if loan growth is slowing, is there an opportunity to maybe take cash flows from the securities portfolio and reduce some of the higher cost borrowings? Or have you even considered maybe selling a portion of the securities to kind of accelerate the ability to repay borrowings and get some relief on the margin.

Ronald Stephen Ohsberg

Yes. We've been not reinvesting our investment security cash flows since the first quarter. So the securities portfolio is in runoff mode. At the moment to do just exactly what you said to use that to pay down those wholesale borrowings. And as Ned mentioned, we're slowing the loan growth down right now. So the growth in reliance on wholesale should be coming down.

Damon Paul DelMonte

Okay. And then if the Fed does end up cutting rates in the back half of '24, how do you feel the balance sheet is positioned for something like that? Do you think your margins -- I mean could that be like a built-in inflection point for you if nothing else changes, if the margins keep stripping lower like at that point, you're poised to benefit.

Ronald Stephen Ohsberg

Yes. So an abrupt change in rates is felt immediately in our SOFR book, our prime and SOFR loans are about $1.8 billion. So those tend to reprice immediately. We would have to ratchet down our deposit and wholesale borrowing costs, it doesn't happen quite as quickly as it does with the loan book. Overall, I think that would be a net positive for us. It wouldn't happen immediately, though, it would bleed in over a period of quarters.

Damon Paul DelMonte

Got it. Okay. And then just lastly on the expense front. Yes, I appreciate the commentary before on that. So you kind of feel like this mid-$34-ish million range to $35 million a quarter is a reasonable level, given what you guys have going on with the branch openings and other strategic efforts.

Ronald Stephen Ohsberg

Yes. Like I said, the fourth quarter should look like the third quarter except for the few items that I mentioned. And then things will reset with merit raises and so forth back, in the first quarter and branch costs will be higher in the first quarter than they were in the fourth quarter but not really prepared to go into 2014 on this call...

Unidentified Company Representative

2024.

Ronald Stephen Ohsberg

How could I say 2014. All right 2024...

Damon Paul DelMonte

I know. It's fair.

Ronald Stephen Ohsberg

Thank you. So yes, yes. We're just kind of looking at the Q4 right now and dispositioning ourselves for next year.

Operator

Our next question comes from the line of Laurie Hunsicker with Seaport Research Partners.