Good morning, and welcome to the Washington Trust Bancorp, Inc.'s conference call. My name is Grant, and I will be your operator today. If participants need assistance during the call at any time, please press star zero. Participants interested in asking a question at the end of the call should press star one to get in the queue. Today's call is being recorded. Now I will turn the call over to Elizabeth B. Eckel, Senior Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel, you may begin.
Thank you, and good morning. Welcome to Washington Trust Bancorp, Inc.'s third quarter conference call. Hosting today's call are members of Washington Trust executive team, Ned Handy, Chairman and Chief Executive Officer, Mark Gim, President and Chief Operating Officer, Ron Ohsberg, Senior Executive Vice President and Chief Financial Officer and Treasurer, and Bill Wray, Senior Executive Vice President and Chief Risk Officer. This 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 the earnings press release, which was issued yesterday, and in other documents we file with the SEC. These materials and all public filings are available on our investor relations site at ir.washtrust.com. Washington Trust trades on NASDAQ under the symbol WASH. Now I'm pleased to introduce the host of today's call, Washington Trust Chairman and CEO, Ned Handy.
Thank you, Beth. Good morning, and thank you for joining our third quarter call. We appreciate your continued interest in Washington Trust, and hope all is well with you as we all continue to navigate the best and safest ways forward. I'll provide an overview of our third quarter highlights, and then Ron Ohsberg will review our financial performance. After our prepared remarks, Mark Gim and Bill Wray will join us to answer any questions you may have about the quarter. I'm pleased to report that Washington Trust posted strong third quarter results with net income of $18.8 million or $1.07 per diluted share. We had a strong quarter. We hit record highs in net interest income, wealth management revenues, assets under management, and total end-market deposits in the quarter.
We continue to believe that the Rhode Island market presents us an opportunity to add physical presence in addition to digital advances to leverage our brand and bring our distinctive level of care to more Rhode Islanders conveniently. I'm proud of the team's continued efforts on growth, combined with their high degree of care for our customers as they too work their way through this uncertain stage in the pandemic. We continue to feel optimistic about how we and our customers are managing the pandemic, and we acknowledge that the need for informed care, thoughtful decision-making, and an empathetic approach to finding the optimum work and life balances is still critical to see our way through these trying times. We strive to keep what is safest for everyone and what is best for our customers at the center of our thinking.
The economies in which we operate are faring better than in the midst of the pandemic, with students back in school, restaurants open, gyms open, and municipalities ready to embark on the equitable deployment of subsidies to make meaningful long-term improvements in critical areas like housing, infrastructure, education, workplace training, and mental health assistance. The realities of labor shortages and logistics challenges and the risk of ongoing inflation weigh on us all. We're helping where we can, adjusting where we must, and are prepared to adapt to any necessary changes. We were recently named by Newsweek as the best small bank in Rhode Island. We are humbly proud to serve our customers well.
Whether we're serving our customers in person or in remote channels, our market reputation for outstanding service quality is very strong, as exemplified by our high Net Promoter Score, which has exceeded national averages both before and during the pandemic. Whether it is to simply speed the delivery of a mortgage or to make it even easier for small business customers to manage payments or to ensure that our operating infrastructure is ever more reliable and secure, we recognize that the best solution is often digital. As always, the protection of our customers' data and privacy is of paramount concern. In all of these areas, we partner with our core providers and with fintech companies, and we believe that active engagement with the fintech ecosystem is an important method of understanding both new opportunities as well as competitive challenges.
Once again this quarter, we were well-served by the diversity of our revenue sources and our commitment to strong credit practices, which have helped to minimize potential costs associated with the pandemic. Total loans declined 0.3% in the quarter. This was largely due to PPP loan forgiveness. New loan formation in commercial was strong at $100 million in the quarter, but was offset by commercial payoffs and pay downs. Third quarter mortgage lending activity remained robust and pipelines are relatively strong. Recent increases in longer-term interest rates will likely result in a reduction of mortgage refinancing activity compared to the record levels of late 2020 and early 2021. However, in our markets, supply and demand characteristics suggest that buyer purchase activity and housing values should remain.
Our wealth management division's assets under administration stood at a record $7.4 billion at September 30. Wealth management revenues were $10.5 million, up slightly for the third quarter and at a record level. We're very pleased with our wealth management division's continued strong performance from both a customer and shareholder perspective. Growth through business development and market appreciation helps us enhance this recurring revenue stream, which provides a welcome diversity in the current low interest rate environment. I'll now turn the call over to Ron for a more detailed review of our financial performance.
Thank you, Ned. Good morning, everyone, and thank you for joining us on our call today. As Ned mentioned, net income was $18.8 million or $1.07 per diluted share for the third quarter. This compared to $17.5 million and $1 per share for the second quarter. Net interest income amounted to $36.1 million, up by $1.3 million or 4%. The net interest margin was 2.58%, up by 3 basis points. Net interest income continued to benefit from accelerated fee income recognition due to PPP forgiveness, which totaled $2 million and had a 13 basis point benefit to the margin. This compared to $1 million and 7 basis points in the second quarter.
Additionally, there were no commercial loan prepayments in the third quarter compared to $717,000 of prepayment fees in the second quarter, which was 5 basis points. Excluding the impact of these items, the margin increased from 2.42% to 2.45%. Average earning assets increased by $69 million, with increases of $42 million in average loans and $16 million in average investment securities. The yield on earning assets was 2.85% for the third quarter, unchanged from the previous quarter. On the funding side, average in-market deposits rose by $108 million, while wholesale funding sources decreased by $79 million. The rate on interest-bearing liabilities declined by 3 basis points to 0.35%. Non-interest income comprised 36% of total revenues in the third quarter and amounted to $20.5 million, down by $73,000 from the preceding quarter.
Wealth management revenues were $10.5 million, up by $27,000. This included an increase in asset-based revenues, which were up by $233,000 or 2%, offset by a decrease in transaction revenues of $206,000 due to a decline in seasonal tax reporting and preparation fees. The increase in asset-based revenues correlated with an increase in the average balance of assets under administration, which were up by $249 million or 3%. September 30 end-of-period assets totaled $7.4 billion, up by $2 million from June 30, reflecting net positive client asset inflows, which were partially offset by market depreciation of assets. Our mortgage banking revenues totaled $6.4 million in the third quarter, up by $379,000 or 6%.
This included net realized gains on sales of loans of $5.8 million, which were down by $2.8 million or 33%. Mortgage loans sold totaled $174 million, down by $117 million or 40%. This was partially offset by an increase in sales yield. Mortgage banking revenues were helped by positive fair value changes on mortgage loans held for sale and forward loan commitments of $467,000. This compared to a negative fair value change of $2.5 million in the second quarter. Mortgage loan originations amounted to $396 million, down by $93 million or 19% from the preceding quarter, and were down by $114 million or 22% from the third quarter of 2020. We are seeing a shift in market demand away from saleable loans.
The percentage of originations to be sold in the secondary market declined from 50%-48% on a linked-quarter basis and from 70% in the first quarter. Our mortgage risk pipeline is still robust at September 30. The pipeline was $281 million, down by $17 million or 6% from the end of June. Loan-related derivative income was $728,000, down by $447,000 in the preceding quarter. Regarding non-interest expenses, these were down by $492,000 or 1% from the second quarter. In the second quarter, debt prepayment penalties of $895,000 were incurred to pay off higher cost FHLB advances. Excluding the impact of these penalties, non-interest expense was up by $403,000 or 1% from the second quarter.
Salaries and employee benefits expense increased by $80 thousand or 0.4% in the third quarter. FDIC deposit insurance costs were up by $108 thousand, and the remaining increase reflected modest increases across a variety of expense categories. Income tax expense totaled $5.3 million for the third quarter. The effective tax rate was 22.1% compared to 21.8% in the preceding quarter. We currently expect our full year 2021 effective tax rate to be 22%. Now turning to the balance sheet. Total loans were down by $13 million from June 30 and up by $4 million from a year ago. In the third quarter, commercial loans decreased by $90 million or 4%, which included a net reduction in PPP loans of $70 million.
Excluding PPP loans, commercial loans decreased by $20 million or 1% from June 30, reflecting payoffs and pay downs of $103 million, as well as lower line utilization of $17 million. These decreases were partially offset by new loan originations and advances of $100 million. Residential loans increased by $82 million, reflecting a higher proportion of loans originated for portfolio. In-market deposits were up by $310 million or 8% from June 30th and up by $602 million or 16% from a year ago. The quarterly increase included seasonal inflows from our municipal and higher ed depositors as well as organic growth.
Compared to last year, deposit inflows have allowed us to improve our funding mix by paying down higher cost wholesale advances. Wholesale brokered CDs were up by $23 million in the third quarter, while FHLB advances were down by $186 million. Total shareholders equity amounted to $555 million at September 30, up $7.5 million from the end of Q2. We remain well capitalized. The total risk-based capital ratio was 13.83% at September 30, and the tangible equity to tangible assets ratio was 8.19%. Our third quarter dividend of 15% per share was paid on October 8. Regarding asset quality, non-performing assets increased by $495,000 in the third quarter.
Non-accrual loans were 0.26% of total loans, and loans past due by 30 days or more were 0.22%. The allowance for credit losses on loans totaled $41.7 million or 0.97% of total loans and provided NPL coverage of 380%. Excluding PPP loans, the allowance coverage was 99 basis points. Net charge-offs were $168,000 in the third quarter compared to $258,000 in the second quarter. For both the third quarter and the second quarter of 2021, there was no provision for credit losses. The provision and related ACL reflect our current estimate of forecasted economic conditions and continued stable asset quality metrics. Finally, I'd like to provide an update on our COVID-19 lending impact.
As of September 30, we had loan deferments on 5 CRE loans totaling $38 million or 1% of total loans outstanding, excluding PPP loans. This was down from 22 loans totaling $93 million or 2% as of June 30. Also as of September 30, we are reporting 630 PPP loans with a carrying value of $77 million. In the third quarter, $73 million was forgiven by the SBA, with $2 million of net deferred fees accelerated into income as a result. Net unamortized fees on PPP loans amounted to $2.6 million as of the end of September. At this time, I will turn the call back to Ned.
Thank you, Ron. This was another strong quarter for Washington Trust, and we feel well positioned heading into the final quarter of the year. Now Ron and Mark and Bill and I are happy to take any questions you might have.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. This time, we will pause momentarily to assemble our roster. Our first question today will come from Mark Fitzgibbon with Piper Sandler. Please go ahead.
Good morning.
Hey, Mark.
First question I had for you. I heard, Ned, your comments about the mortgage business perhaps normalizing. Do you feel like in a more traditional environment, this is a, you know, maybe a $25 million or a $27 million revenue kind of business? Or does, you know, when things normalize, you know, do revenues fall more precipitously than that, do you think?
You know, I'm gonna turn that to Mark for comments. Mark, he's closest to it. I think you know we'll probably bottom out at somewhere higher than our you know pre-pandemic levels just based on the volume that we've been generating of late.
Mark, this is Ron. We had $15 million in mortgage revenue in 2019. If you annualize what we just did in the third quarter, that works out to about $25.5 million. You know, that feels like it's probably still higher than where it's going to end up. So it's, you know, it's gonna be somewhere, I think, between that $15 million and the $25 million that we're at currently. You know, is that $20 million? I think it's hard to say. Mark, again, I don't know if you have any color you want to add to that.
I do, and thanks for those preceding comments, Ned and Ron. Mark, I think if we look back to where we entered the pandemic in 2020, we had a mortgage pipeline somewhere just below the $200 million range. From a mix standpoint, I think, certainly the run-up in longer-term interest rates will have an impact first on the conventional saleable refinance business. Depending on whether or not inflation expectations continue to be high, if the pipeline were to decline in relative terms, it would probably be more on the saleable side than on the portfolio side. However, as Ned said in his comments, we think the housing markets in Connecticut, Massachusetts, and Rhode Island remain pretty robust. Mortgage pipeline for retention of portfolio mortgages for reasons of size, for example, jumbo, should still continue to be strong.
You know, it's very broad guidance that Ron gave, but somewhere between pre-pandemic levels and an annualized level of sales gains would be likely with interest rates in the housing market where we see them now. Does that help?
It's very helpful. Thank you. Also, I guess I was curious, as you think about the margin, you guys were, you know, performed a little better maybe than you thought you were going to last quarter. How are you thinking about the outlook for the margin today? Do you still have some ability to drive those funding costs lower?
Yeah. There's not much left there, Mark. I would say we'll probably see some pressure on asset yields. Yeah, we did do a little better in the third quarter than we guided. I would say the guidance we gave before is kind of consistent with the guidance we're giving now. I would say we trend closer to 240 in the fourth quarter.
Okay. Last question, I guess I was curious about, it looks like you've got about $1.6 billion in loans in Massachusetts and no branches there. Is that a missed opportunity to maybe sell other products and services to those loan customers? You know, is that in the cards for you all to, you know, open some branches in Massachusetts? Thank you.
Yeah. Mark, do you wanna comment on that?
Yes, I would. Mark, we continue to try to figure out the best way to improve deposit gathering in markets where we have less of a physical presence, like Connecticut, or no physical presence in Massachusetts. We have been successful on a preliminary basis in introducing some programs where if we are able to get deposits from customers, for example, who are jumbo mortgage customers in Massachusetts and service them primarily digitally, we've been successful in gathering some of those amounts. The trick is to, of course, keep and build on them. I think in the remote markets, where we don't have a current branch presence, it's more likely that we would try to broaden our digital offerings to those customers than to open branches de novo.
It's primarily 'cause it's a hard market to get into de novo, and you'd have to either open several at one time or perhaps look for opportunities through M&A and branch divestiture. I'd say at the current time, our plans are more, you know, if there are physical opening presence opportunities, they're probably going to be more profitable faster in Rhode Island than they would be in Mass or Connecticut. We may look to a combination of digital and/or M&A to broaden that. Our customer service center is our outreach part of the digital offering program and has been, as we think, successful in servicing some of those remote customers.
Thank you.
Thanks, Mark.
Our next question will come from Damon DelMonte with KBW. Please go ahead.
Hey, good morning, guys. Hope everybody's doing well today.
Morning, Damon.
First question regarding loan growth and kind of the outlook. You know, Ned, can you just give us a little bit of insight as to how you think, you know, the pay down activity is gonna play out here in the back half of the year? I mean, originations have been strong. You know, you've just been offset by the elevated pay downs. Do you think that's slowing at all and you can start to show some net growth in the coming quarters?
I would say certainly slowing in Q4 versus Q3 is our expectation. Q3 we had a pretty big payoff quarter. You know, the story continues to be somewhat the same. We're lending to high quality borrowers who are able to take advantage of long-term financing opportunities or sales at continuing low cap rates. I think while rates stay low, our type of customer will keep taking advantage of cycling money in and out of deals. We try to put you know, prepayment penalties or success fees in place, but that's a pretty early thing to be negotiated away by competition in the market. That's a little bit difficult.
I think, you know, certainly as rates if rates tick up a little bit, that may put some pressure on cap rates and might make it less enticing. We, in terms of scheduled payoffs, think the number's a little lower in Q4. I'm happy with credit formation. I'd like to see more. We continue to look at the possibilities of adding lenders and growing organically that way. We think there's opportunity, with some of the, you know, the noise in Connecticut and in Massachusetts, we think there may be some opportunities to add lenders. I think for the time being, we don't see it as an opportune time to change, you know, our risk tolerances.
You know, we think we're playing in the right place and you know, we're on the pavement constantly fighting it out on the street corner to win, hopefully more than our fair share of deals. You know, I've said it before, Damon, and I'll say it again. I'd rather be paid off early in real estate than late. I like the quality of the deals we're getting involved in, and I think we'll keep on that path.
Got it. Okay. That's a good color. Thank you. Then, you know, on the C&I side in line utilization, you know, where does that stand in the third quarter, and how does that compare to the second quarter?
Yeah. We have a pretty small universe of corporate lines. They're down by $17 million in the quarter, down a little bit on a percentage basis. That's not gonna have a major impact on the numbers either way. I expect that utilization will come back to, you know, sort of normal levels. That really, most of that I believe was in one large line that paid down at quarter end. It's really. There are so few lines, it's hard to think of that as being a major mover.
Got it. Okay. Just my, I guess my last question on expenses. You know, Ron, anything you know unique that we should consider going forward? Do you think this, you know, mid-$32 million range is a reasonable run rate going forward?
Yeah. I think that's fine for Q4, Damon. I mean, we're just starting our budgeting process for 2022, so I'm not really ready to talk about that yet. You know, you guys are all aware that, you know, we're seem to be entering an inflationary period, so we'll kind of have to think about how that might affect our run rate going forward. Not quite at that point yet to talk about that.
Okay, fair enough. That's all that I had. Thanks a lot.
Thanks, Damon.
Our next question comes from Erik Zwick with Boenning & Scattergood . Please go ahead.
Good morning, guys.
Morning, Erik.
Morning, Erik.
Just to follow up on that last question, I realize you're still in the planning process for 2022 with expenses and I guess the planning process for the whole organization. But as we think about the new branch in Cumberland that's gonna come online next year, what's the expected timing in terms of the quarter that you expect to open that, and any estimates on the annual cost for that branch?
Yeah, Mark, I don't know if you can talk about the timing, and I can, Erik. The typical cost of a branch for us on a full year basis is about $650,000.
Right. From a timing perspective, Erik, we're thinking late second quarter, perhaps the end of the second quarter of 2022.
Great. Thank you. Transitioning back to the discussion on loans, thinking about it maybe a different way. Ned, in your comments, opening comments, you mentioned that the pipeline is relatively strong today. I wonder if any of you are able to provide any, you know, detail in terms of, you know, the construction of that in terms of type of loans as well as what the average yield is in the pipeline and how that might compare to existing loan portfolio yield?
It's in the mid one. It's like 1.50 ish. There's a good portion of that that's in construction loans, like nearly half of it. It's tilted towards CRE at this point in time. I think just based on loans coming on in the quarter versus loans being paid off, the loans coming on were a little favorable from a yield perspective. I think you know some of the high quality you know year ago two year ago vintage stuff was priced a little lower than what's coming on today. We're getting a little bit of incremental yield. I feel good about that from a margin standpoint.
We did have a fair amount of closing in September itself, so the pipeline got a little emptied out. I expect it will build back up. You know, it's kind of hovered in the $175 million-$200 million range. I expect it will get back there. You know, one thing that I think we're experiencing a little bit is construction loans are funding a little slower just based on logistics issues. I think, you know, they'll take a little bit longer to reach full funding. Other than that, you know, I feel pretty good about where we are.
That's a good color. Thank you. Thinking about credit,
Yeah.
You mentioned at the beginning of the call that you feel the level of the reserve is appropriate today given the risk in the portfolio and the economic outlook. As we think about, you know, provisioning going forward, would you expect it now to match net charge-offs and growth, or are there other factors to consider at this point?
Yeah. Erik, it's Ron. You know, we expect credit to remain, you know, stable in the absence of a COVID relapse or some other unforeseen economic shock. That said, you know, provision should generally track to loan growth and the economic outlook. You know, at least for the short term foreseeable future, it seems to be kinda stable.
Okay. Thanks. One last quick one if I can squeeze it in. I noticed in the press release, and you mentioned it several times already, with regard to mortgage loans and what's been sold, your gain on sale margin was up in 3Q, and I think a lot of your competitors are seeing compression there on the margin. Just curious where your advantage might lie, whether it's in the mix that you're selling or maybe a technological and speed advantage. Just curious if you've got any thoughts on that front.
Yeah, Erik, this is Mark. I'll start with that.
Yeah
... just from kind of an operational perspective, and then Ron can go into some of the details. We do think that one of the things that we do very well is speed in process. Time is a huge advantage for everybody in a mortgage transaction, the seller, the buyer, the bank, any referral sources. We have made, we think, good use of additional digital technology to try to speed the turn time from application to close. It's kind of an unsexy thing, but every day that you can shave off the delivery time helps to preserve margin a little bit.
Having said that, I think that we do believe that compared to the high margins of late 2020, margins are returning to a more normal level, perhaps higher than when we entered the pandemic. It's hard to defend against market trends with internal process improvements alone. We do think that is an advantage and an edge for us in execution. Ron, I don't know if you have anything to add on components of margin.
Yeah
in Q3.
Yeah, Mark. The only other thing I would add to that is it becomes a little bit of a supply and demand thing. As you know, as volumes are ramping up high, you tend to see the yields go up because there's you know, less capacity to process the loans and the pricing pressure, the pricing opportunity gets better. You know, we kind of dipped down a little bit in Q2. We rebounded a bit in Q3. I would say we're probably still at a fairly high historical yield. We'll see how long we're able to maintain that.
That's helpful. Thanks for taking my questions today.
Thanks, Erik.
Thanks, Erik.
Our next question comes from Laurie Hunsicker with Compass Point. Please go ahead.
Yeah. Hi, thanks. Good morning. Wondering, Ron, if we could circle back to your comments on fourth quarter margin guide of around 2.40, you know, stripping out PPP, and obviously there were no prepay fees. So we are at 2.44, essentially for third quarter. So four basis points of contraction. Can you just help us think a little bit more about that? I guess, you know, looking into 2022, you know, what potentially you can do to mitigate it, especially given that your cost of funds is so low and there's nothing left in terms of borrowing prepays. At least I think that was what was in my notes. But if you could just help us think about that, and then just one last piece of that.
Can you share with us what is remaining in terms of PPP fees that are unamortized? Thanks.
Yes. I'll answer that second part first. It's $2.6 million of unamortized PPP.
Great.
As far as just the margin itself, I mean, we're gonna continue to see some asset yield pressure on our resi book and on our mortgage-backed securities. You know, as those pay down, you know, the legacy yields are higher and they're being replaced by lower yielding assets. That's really the main story there. I think we've done a nice job of bringing down our funding costs, you know, through both deposit growth and just kind of repricing our wholesale funding book down. Not a lot of opportunity left there with that. That's kind of where we are.
I wouldn't expect to see lots of big moves within the margin, but I would say the overall trend over the next few quarters would probably be, you know, a little lower than where we are right now.
Okay. That's helpful. Obviously your credit is looking pristine here, but just wondered if you could help us think. It looks like on the hotel side, your hotel loan balances have gone up from what's been, you know, previously $150 million to $160 million, you're now $199 million. Are you adding to your hotel book? Just any color you can give us on the $38 million in deferrals. How much of that is hotel? Thanks.
We did make one new hotel loan in Newport on a very favorable loan to value a property that had just been renovated and with a customer we know. I will tell you, Laurie, that we're not out canvassing for new hotel loans otherwise. That was a rare opportunity. Bill, I don't know if you've got specifics on Ron on the five remaining deferrals in terms of whether there are hotels in there.
Yeah. There's one hotel.
Yeah.
One healthcare, one retail.
Okay.
Basically three relationships.
Hotel is just under $10 million.
Okay, great. Thanks. Do you have an average LTV on your hotel book? Or if not, I can follow up with you offline.
Bill, I don't know if you have.
Yeah, we'll have to do that offline to give you what the latest numbers are. The numbers we looked at last time across the portfolio, if I remember right, were in the mid-50s. We tend to underwrite these very carefully, but we should do an offline follow-up.
Okay, great. Just one last question. I appreciate the 22% tax rate guide for fourth quarter. How should we be thinking about the tax rate in 2022?
Yeah. Yeah. It's gonna be approximately what we're seeing this year at like 622.
Great. Thanks. I'll leave it there.
Sure.
Thanks, Laurie.
Ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to Ned Handy for any closing remarks.
Well, thank you all for joining us this morning. We do appreciate your continued interest, and hope all is well with you and continues that way. We will talk to you all soon. Laurie, we'll come back to you. Have a great day, everybody.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.