Washington Trust Bancorp Inc Q4 FY2020 Earnings Call

Good morning. And welcome to Washington Trust Bancorp Incorporated Conference Call. My name is Chuck. I will be your operator today. Operator provided instructions. Today’s call is being recorded. And now I will turn the call over to Ms. Elizabeth B. Eckel, Senior Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel.

Thank you, Chuck. Good morning, everyone, and welcome to Washington Trust Bancorp Inc.'s conference call on the fourth quarter and full year 2020. Joining us on today’s call are members of Washington Trust's executive team, Ned Handy, Chairman and Chief Executive Officer; Mark Gim, President and 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. As a reminder, 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 Washington Trust's earnings press release that was issued yesterday and in other documents that we filed with the SEC. We encourage you to visit our Investor Relations site at ir.washtrust.com to view our complete Safe Harbor statement and all of these public filings. Washington Trust trades on NASDAQ under the symbol WASH. And now I am pleased to introduce the host for today’s call, Washington Trust’s Chairman and CEO, Ned Handy.

Thank you, Beth, and good morning, and thank you for joining us on today’s call. I’d like to start by wishing you all the very best in this New Year. We’re all thrilled we’re in the New Year. We hope that you and your families have stayed safe throughout this pandemic and we’re all grateful that the vaccination campaign is underway, with hopes that it will bring some normality back to us all soon. So 2020 was a year like no other, marked by unprecedented challenges, disruption and uncertainty. Washington Trust performed strongly and prevailed just as we’ve done so many times before in our 220-year history. I’m really proud of the work our team has done to help our customers and our communities get through these ongoing challenges. By embracing our responsibility and being a proactive part of the solution, we’ve created more value in the Washington Trust franchise. This morning, I’ll provide some 2020 highlights and Ron Ohsberg will review our fourth quarter and year-end financial results. After our prepared remarks, Mark Gim and Bill Wray will join us for a question-and-answer session. I’m pleased to report that Washington Trust ended 2020 with another solid performance, posting fourth quarter earnings of $18.6 million or $1.07 per diluted share. These results contributed to a strong full year 2020 earnings of $69.8 million or $4.00 per diluted share, compared to $69.1 million or $3.96 per diluted share reported for 2019. Our success in 2020 was due to several things: the spirit and resilience of our dedicated team of employees who maintained high service levels and business-as-usual operations during a major pandemic; the strength, stability and improvement in our balance sheet and multiple facets of our business which, during continued low interest rates and an uncertain operating environment, enabled us to achieve these earnings; and the loyalty and perseverance of our customers who have trusted us to help them through these difficult times. Washington Trust's strong corporate governance and enterprise risk management practices, which specifically address and test our business continuity plan, ensured our preparedness for this crisis. Strategic technological investments made in recent years also enabled us to quickly, securely and flawlessly transition business operations to a remote working environment. Over the past year, we’ve learned many lessons, including just how much our customers value our personal service. In 2020 Washington Trust, like the rest of the industry, saw increased customer use of digital banking, online account opening and other technological conveniences. We remain committed to and will keep pace with these technological developments, as we know this trend will continue. However, we also know that when customers need financial advice, they prefer a human connection and want to have a real conversation with a trusted advisor, whether it’s in person, by phone or through video conferencing. We take great pride in the relationships we’ve built with our customers and strive to provide a high level of personal service. In fact, our Net Promoter Scores, which consistently rank us higher than the industry averages for customer satisfaction, actually increased during the pandemic. Looking forward, we will continue to measure customer satisfaction and monitor trends to ensure we’re consistently improving the customer experience across all delivery channels and business lines. Let me take a few moments to share some of the business line highlights from 2020. Loan outstandings grew 8% in 2020, aided by PPP fundings, but challenged by prepayment fees on the retail side and payoffs on the commercial side. Our credit formation was up about 35% over 2019. I’d like to take a moment to acknowledge the efforts of our lending team, branch staff, customer service center and all of the employees throughout the bank who went the extra mile to assist borrowers, both customers and non-customers, with PPP loans. I’ve personally spoken with several local borrowers who are grateful for the advice and guidance they received from us and, as a result of the personal attention they received, have committed to further building their banking relationships with us. We continue to assist local borrowers with PPP forgiveness and with the second round of PPP loans. Ron will provide a more detailed update of our PPP lending program shortly. We continue to be satisfied with the overall credit quality of our loan portfolios and Ron provides some more details in his comments. We also recognize that we’re not through with this pandemic. We’ve cleared about $500 million in deferments through year end and have another $200 million or so to clear. We are monitoring those assets very closely. Ron will give you some more information and we’ll be happy to answer any questions you may have during the Q&A session. Total deposits at December 31, 2020, were up 25% from a year prior and in-market deposits, which exclude wholesale brokered time deposits, grew by 18% in 2020. The growth in deposits allowed us to reduce Federal Home Loan Bank borrowings, improve our loan-to-deposit ratio and, since interest rates have remained low, decrease our funding costs to help offset continued margin pressure and improve our balance sheet for what comes ahead. A year ago we were discussing the industry-wide need for deposits. Today we’re reporting an all-time high level of deposits including low-cost core checking and savings accounts and increased money market balances. Consumers started curtailing their spending habits and shifted to saving and liquid deposit accounts given the continued economic uncertainty resulting from the pandemic. In 2020, we found new ways to encourage customers to save. We introduced Add-It-Up, a program which automatically rounds up debit card purchases to the next dollar and transfers the difference into another Washington Trust account. The program has not only helped increase savings balances, but also improved debit card and checking account activation. As I’ve mentioned on previous calls, we consider our branch employees frontline heroes, because they have continued to work throughout the pandemic, smiling beneath their masks and assisting customers through plexiglass dividers and drive-through banking windows. And while banks across the nation and locally have announced plans to close branches, Washington Trust remains committed to expanding our network as branch banking remains an important part of our community engagement and our delivery strategy. In 2020, we broke ground for our East Greenwich branch. We believe there’s a great deal of opportunity in this market and look forward to a spring 2021 opening. And while the pandemic and social distancing protocols may still be in place when we open our East Greenwich branch doors, customers will be welcomed into a safe and friendly environment and feel human connection with our team. Our mortgage banking team also deserves recognition for the incredible results they produced in 2020. Not only did mortgage originations and sales volumes reach record levels in 2020, but mortgage banking revenues totaled a record $47.4 million for the full year 2020, up 220% from 2019. Low interest rates drove increased mortgage demand in early 2020, and while the onset of the pandemic was a cause for concern, our residential mortgage team continued to work diligently and didn’t miss a beat when employees were forced to work remotely. Throughout the pandemic rates remained low and a new work-from-home trend resulted in significant new growth in single-family home purchases and mortgage refinancing. Our mortgage team has worked extremely hard and there’s some indication that mortgage banking activities may start to normalize in 2021, but it’s difficult for us to predict what will happen for the full year. Ron will provide some further color in his comments. Our wealth management division's assets under administration reached a record $6.9 billion at December 31, up 7% from the end of 2019, positioning us very well to head into 2021. Throughout the year we provided ongoing advice and guidance to help our clients better understand market volatility and economic uncertainty. Once our wealth management advisors began working remotely, we became even more attentive with our clients and proactive with our communications, conducting video conferences and webinars and providing frequent market updates. We also saw an increase in our clients’ use of our online portals, viewing their portfolio status, accessing statements and communicating with our advisors. Our wealth management division continues to be a key part of our diversified business model, providing a consistent stream of non-interest income to our company. Ron will provide more detail on our expenses, but I’m proud that we continue to operate our business efficiently, while prioritizing expenditures to ensure outstanding and safe customer experiences, as well as the continued well-being and development of our employee team. As a testament to these efforts we were recognized as one of the best places to work in Rhode Island for the 10th straight year and one of the best banks to work for by American Banker, being the only bank in Rhode Island on that list. I’ll now turn the call over to Ron for a review of our financial performance. Ron?

Thank you, Ned. Good morning, everyone, and thank you for joining us on our call today. As Ned mentioned, net income was $18.6 million or $1.07 per diluted share for the fourth quarter. This compared to $18.3 million and $1.06 for the third quarter. Full year 2020 net income was $69.8 million or $4.00 per diluted share, compared to $69.1 million or $3.96 per diluted share reported for the prior year. Net interest income amounted to $32.2 million in the fourth quarter, up by $589,000 or 2%. Net interest margin was 2.39%, up by 8 basis points. In the fourth quarter PPP loan forgiveness commenced. As a result, net interest income benefited from accelerated net deferred fee amortization of $423,000, a 3-basis-point benefit to the margin. Commercial loan prepayment penalty fee income was modest and totaled $123,000 in the fourth quarter, compared to $33,000 in the third quarter. Average earning assets decreased by $82 million, mainly due to a decrease of $71 million in average loans, and the yield on earning assets decreased by 6 basis points to 2.92%, due to higher levels of prepayments on residential mortgages and mortgage-backed securities. On the funding side, market deposits rose by $110 million, while wholesale funding sources decreased by $199 million. The rate on interest-bearing liabilities declined by 18 basis points to 0.67%. Non-interest income comprised 46% of total revenues in the fourth quarter and amounted to $27.7 million, up by $2.3 million or 9%. Included in other non-interest income in the fourth quarter was a gain of $1.4 million associated with the sale of our limited partnership interest in a low income housing tax credit. Excluding this gain, non-interest income was up by $859,000 or 3% from the prior quarter. Also note that we have an offsetting expense item to this gain. Our mortgage banking revenues totaled $14.1 million in the fourth quarter. This included net realized gains on loan sales of $13.4 million. Realized gains declined by $886,000 or 6% from the prior quarter, reflecting lower sales volume, partially offset by a higher sales yield. Mortgage loans sold totaled $318 million, down by $36 million or 10% from the all-time quarterly high reported last quarter. Net unrealized gains included in mortgage banking revenues increased on a linked quarter basis, reflecting an increase in the fair value of mortgage loan commitments as of December 31. Full year 2020 mortgage banking revenues totaled $47.4 million, up $32.6 million or 220% from a year ago. The volume of both mortgage originations and sales reached record highs in 2020. Mortgage loan originations amounted to $1.7 billion in 2020, up from $945 million in the prior year, and mortgage loans sold totaled $1.1 billion in 2020, up from $591 million in 2019. Our mortgage origination pipeline at December 31 was about $323 million, which is 85% higher than it was at this time a year ago. Wealth management revenues were $9.2 million in the fourth quarter, up by $252,000 or 3%. This was due to an increase in asset base revenues, which were up by $280,000 or 3% in the preceding quarter. The increase in asset base revenues correlated with the increase in average balances of assets under administration, which were up by $213 million or 3%. The December 31 end-of-period balance of assets under administration totaled a record $6.9 billion, up by $471 million or 7% from September 30, reflecting financial market appreciation. Loan-related derivative income amounted to $173,000. This was down by $1.1 million on a linked quarter basis reflecting a lower volume of swap transactions. Regarding non-interest expenses, total expenses were up by $1.8 million or 5% from the third quarter. Included in the fourth quarter we recognized $1.4 million of debt prepayment penalty expense associated with the payoff of higher-rate FHLB advances. Excluding this, non-interest expenses were up by $352,000 or 1% from the prior quarter. Salaries and employee benefits expense increased by $183,000 or 1% in the fourth quarter. Income tax expense totaled $5.5 million for the fourth quarter. The effective tax rate was 22.9%, compared to 21.9% in the prior quarter and we expect the full year 2021 effective tax rate to be 22%. Now turning to the balance sheet. Total loans were down by $86 million or 2% from September 30 and up by $303 million or 8% from the end of 2019. In the fourth quarter, commercial loans decreased by $38 million or 2%. Payoffs and pay-downs amounted to approximately $105 million and included $18 million of PPP loans that were forgiven by the SBA. Residential loans decreased by $39 million, reflecting increased payoff activity, and consumer loans decreased by $9 million. Investment securities were down by $19 million or 2%. In-market deposits were up by $85 million or 2% from September 30 and up by $573 million or 18% from the end of 2019. This included increases in DDA balances of 31% and savings accounts of 25%. The deposit inflows have allowed us to improve our funding mix by paying down higher cost wholesale advances. Wholesale brokered CDs were up by $7 million in the fourth quarter and FHLB borrowings were down by $120 million. PPPLF borrowings were paid off in the fourth quarter, and therefore were down by $106 million from September 30. Total shareholders’ equity amounted to $534 million at December 31, up by $6.5 million. Washington Trust remains well capitalized; total risk-based capital ratio was 13.51% at December 31, compared to 13.09% at September 30. The tangible equity to tangible assets ratio was 8.22%, compared to 7.91%. Our fourth quarter dividend declaration of $0.52 per share was paid on January 8. This reflected a $0.01 increase in Q4. Regarding asset quality, non-performing assets declined by $1.5 million in the fourth quarter. Non-accruing loans were 0.31% of total loans, compared to 0.34% at the end of Q3. Loans past due 30 days or more were 0.30% of total loans, compared to 0.24% at the end of Q3. Troubled debt restructurings increased by $7.1 million from September 30, largely due to restructurings of two C&I relationships that did not qualify for TDR accounting. The allowance for credit losses on loans totaled $44.1 million or 105 basis points of total loans and provided NPL coverage of 334%. Excluding PPP loans, the allowance coverage was 110 basis points. The provision for credit losses was $1.8 million, compared to $1.3 million recorded in Q3 and included $1.6 million for loans and $200,000 for unused commitments. Net charge-offs were $118,000, compared to $96,000 in Q3. And finally, I’d like to provide an update on our COVID-19 lending impact. Loan deferments on January 21 totaled $203 million or 5% of total loans outstanding, excluding PPP loans, and down from 10% as of September 30. This includes $143 million of commercial real estate, $33 million of C&I, $26 million of residential and $1 million of consumer loans. The breakdown of commercial deferments by industry category is presented in a table in our earnings release. We’ll be happy to get into the details during Q&A. As of December 31, we are reporting 1,700 PPP loans with a carrying value of $200 million. PPP loans with principal balances totaling approximately $18 million were forgiven by the SBA during the fourth quarter. As I mentioned earlier, approximately $425,000 of net deferred fees were accelerated into income. Net unamortized fees on PPP loans amounted to $3.9 million at December 31. The timing and recognition of these net fees into the margin will depend upon the pace of loan forgiveness as approved by the SBA. And at this time, I will turn the call back over to Ned.

Thanks, Ron. 2020 was certainly a whirlwind but it turned out to be a strong year for Washington Trust. We were profitable. We remained well capitalized. We maintained credit quality and announced an increased dividend for our shareholders, which was recently paid in early January. We faced numerous challenges in 2020 and met them head on. I’m grateful to our team for their work and their support. 2021 promises to be another challenging year; we will continue to deal with the pandemic and its ongoing after effects. Interest rates remain low and continue to pressure margins. And we must anticipate changes the new Biden administration may make that could affect our industry. We learned a lot of lessons in 2020 and we’ll use that knowledge to help our company move forward in 2021. Again, thanks for your interest in the company and we’re happy to turn to questions and answers now.

Operator provided instructions. And our first question will come from Mr. Mark Fitzgibbon with Piper Sandler. Please go ahead.

Hey, guys. Good morning.

Good morning, Mark.

Hi.

Good morning, Mark.

First question, I just want to follow up Ron, one of the things you mentioned on loan deferrals. So the $203 million in deferrals you have outstanding, when did those expire? And I guess I’m curious, are most of those paying interest at this point?

Bill is on the call and he can provide more detail on the components of the deferrals. We believe our deferrals may be extending a little longer than others in the industry; we’re well aware of that. We’re looking at about $76 million that would roll off basically in the first quarter and then the balance would roll off by the end of the year.

Mark, I’ll just add some color. We’ve got a fair number of—about nine hotels in that mix. Those are just going to take a while longer to come back. We know them well. Bill can give some more specific color if needed, but those we extended some right to the end of the year. We started a little higher than some in our peer group and I think we’ve cleared $500 million; we’ve got another $200 million left. We are watching them very closely and in touch with the borrowers regularly. It’ll take a while, but we’ve got a chunk that are going to come off in the first quarter and then the balance of them are scheduled out through the remainder of the year.

Do you have a sense for what percentage of those are paying interest-only?

On the commercial side, about half of them are paying interest-only; about half are both P&I deferments. On the residential side, they’re generally full P&I deferments.

And then changing gears a little bit, on the mortgage business, obviously, you had a banner year in 2020. Revenues about tripled versus 2019. As we move into 2021, at some point volumes should start to come down. How do you model mortgage revenues in an environment like this?

I can take a shot at that.

Mark, go ahead.

Mark, if you want to take it, go ahead.

This is Mark Gim. I will try to provide a big picture outlook for what we think 2021 will shape up like and then Ron can add perspective. Obviously, as you say, at some point the mortgage banking activity should slow to more normal levels. That said, as we finished the fourth quarter, we found that pipeline volumes going into January and February have been very strong, more characteristic of what we saw at the beginning of the fourth quarter. This is a combination of purchase activity and still a lot of refinancing activity, more of which is saleable. So although we share your view that at some point this will slow down, it looks like the first quarter is shaping up to be another fairly strong one. The residential housing markets in New England and in our specific markets have been very robust. Normally, January would be a slower time for purchase and home-buying activity, but it has not yet slowed. Limited housing stock in our markets and very strong demand for housing suggest this may continue at least through the first quarter or perhaps into the first half of the year.

Mark has given a good overview. As I think about this, Q1 is likely to look similar to Q4. The Mortgage Bankers Association is forecasting a reduction in mortgage volume across the industry of 20% to 25% compared to last year, and we consider that in our planning. It’s premature to give a full-year forecast on mortgage revenues; there is sentiment that activity will start to cool off by the end of the year, but we don’t know exactly when that will occur.

I was curious, Ron, if you could give us some perspective on the core margin going forward, maybe excluding the impact of PPP—what you’re thinking and what the trend of the margin might be?

Excluding PPP, we would expect some modest expansion in the margin in the first half of the year. We still have opportunity to lower funding costs and we will pursue that. We are seeing pressure on asset yields due to prepayments on residential mortgages and mortgage-backed securities and that will likely continue throughout the year. I would expect a modest uptick, perhaps to the 2.40% range for the first half of the year, and then perhaps trending back toward 2.35% in the second half of the year.

Lastly, could you share your thoughts on the branch network in light of digitization and competitors closing branches? How are you thinking about your branch network?

Mark, do you want to—

We’re well aware of industry trends toward branch closures, particularly among banks with larger numbers of smaller branches. Customers are increasingly using digital channels for transactions. That said, over the last couple of years we haven’t seen much change in in-branch activity for people coming in to open loans or open deposits. Transactional activities have shifted online, but relationship and account-opening activity remains important in branch. We have 23 total branches, and 12 of them have over $100 million of deposits, six have over $200 million. We think in the markets we serve there is room for a deliberate and careful pace of expansion. Some competitors are downsizing smaller branches, and we believe a blend of technology and human service will help us expand in our footprint. Given our average branch size and the growth trajectory of existing locations, we do not view selective expansion in Rhode Island as imprudent, particularly where larger competitors have more branches and there is market share to pursue.

You covered it well. We will be very deliberate as always. Branch expansion is not a huge part of our strategy, but our customer base values human connection. There are still several suburban markets around Providence where we don’t have a presence and where we can compete effectively. It’s a large market and even small market share gains are meaningful for us.

Thank you.

No problem. Thanks, Mark.

Operator provided instructions. The next question will come from Laurie Hunsicker with Compass Point. Please go ahead.

Hi. Thanks. Good morning.

Good morning, Laurie.

Good morning, Laurie.

If we could go back to PPP for a moment—of your $200 million of PPP loans that remain, how much in fees are still associated with that, unamortized fees?

The net unamortized fees were $3.9 million as of December 31.

You mentioned a $423,000 benefit this quarter from accelerated amortization, a 3-basis-point impact. How much was the corresponding impact in the third quarter?

We didn’t have any accelerated amortization in the third quarter.

Nothing in 3Q. Okay. Great. Can you remind us in terms of the CDs and other funding that re-price this quarter and next quarter?

We have about $750 million of funding that we think we can re-price down, including CDs and FHLB borrowings. As I mentioned earlier, we paid down some higher-cost FHLB advances and we would consider additional paydowns if appropriate. That represents our primary opportunity to bring funding costs down in the first and second quarters.

What would be the expected net impact—what cost savings are you expecting from that?

I don’t have that broken out specifically, Laurie. But we think our core margin will trend up to the 2.40% range as a result of these funding actions.

On the expense side, you referenced a gain on the sale of the limited partnership and mentioned an offsetting expense. Can you explain that expense and how much it was?

I was referring to the breakage penalty related to the payoff of higher-rate FHLB advances. We recognized about $1.4 million of one-time income from the sale and had an offsetting one-time expense tied to the breakage, so they essentially offset.

Got it. Last question—regarding the announced 5% buyback, it looks like none was executed in the current quarter. Is that correct, and how are you thinking about share repurchases?

That is correct; we have not repurchased shares under the authorization. We view buybacks as an important option to have. Our stock price has recovered somewhat since we announced the program, so at current price levels we do not have intentions to repurchase shares at the moment.

Great. Thanks. I’ll leave it there.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Ned Handy for any closing remarks. Please go ahead.

Thank you all very much. We do appreciate your time and your interest, and we wish you a more normalized 2021. We hope for all the best and we will talk again soon. So thank you and have a great day.

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