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| WASH > SEC Filings for WASH > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
Forward-Looking Statements
This report contains statements that are "forward-looking statements." We may
also make written or oral forward-looking statements in other documents we file
with the SEC, in our annual reports to shareholders, in press releases and other
written materials, and in oral statements made by our officers, directors or
employees. You can identify forward-looking statements by the use of the words
"believe," "expect," "anticipate," "intend," "estimate," "assume," "outlook,"
"will," "should," and other expressions that predict or indicate future events
and trends and which do not relate to historical matters. You should not rely on
forward-looking statements, because they involve known and unknown risks,
uncertainties and other factors, some of which are beyond the control of the
Corporation. These risks, uncertainties and other factors may cause the actual
results, performance or achievements of the Corporation to be materially
different from the anticipated future results, performance or achievements
expressed or implied by the forward-looking statements.
Some of the factors that might cause these differences include the following:
changes in general national, regional or international economic conditions or
conditions affecting the banking or financial services industries or financial
capital markets, volatility and disruption in national and international
financial markets, government intervention in the U.S. financial system,
reductions in net interest income resulting from interest rate volatility as
well as changes in the balance and mix of loans and deposits, reductions in the
market value of wealth management assets under administration, changes in the
value of securities and other assets, reductions in loan demand, changes in loan
collectibility, default and charge-off rates, changes in the size and nature of
the Corporation's competition, changes in legislation or regulation and
accounting principles, policies and guidelines, and changes in the assumptions
used in making such forward-looking statements. In addition, the factors
described under "Risk Factors" in Item 1A of this Annual Report on Form 10-K may
result in these differences. You should carefully review all of these factors,
and you should be aware that there may be other factors that could cause these
differences. These forward-looking statements were based on information, plans
and estimates at the date of this report, and we assume no obligation to update
any forward-looking statements to reflect changes in underlying assumptions or
factors, new information, future events or other changes.
Application of Critical Accounting Policies and Estimates Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on income and the carrying value of certain assets, are considered critical accounting policies. The Corporation considers the following to be its critical accounting policies: allowance for loan losses, accounting for acquisitions and review of goodwill and intangible assets for impairment, and other-than-temporary impairment of investments. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions.
Allowance for Loan Losses
Determining an appropriate level of allowance for loan losses necessarily
involves a high degree of judgment. The Corporation uses a methodology to
systematically measure the amount of estimated loan loss exposure inherent in
the loan portfolio for purposes of establishing a sufficient allowance for loan
losses. The methodology includes three elements: (1) identification of loss
allocations for certain specific loans, (2) loss allocation factors for certain
loan types based on credit grade and loss experience, and (3) general loss
allocations for other environmental factors. The methodology includes an
analysis of individual loans deemed to be impaired in accordance with GAAP
(Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by
Creditors for Impairment of a Loan - an amendment of FASB Statements No. 5 and
15"). Other individual commercial loans and commercial mortgage loans are
evaluated using an internal rating system and the application of loss allocation
factors. The loan rating system and the related loss allocation factors take
into consideration parameters including the borrower's financial condition, the
borrower's performance with respect to loan terms, and the adequacy of
collateral. We periodically reassess and revise the loss allocation factors used
in the assignment of loss exposure to appropriately reflect our analysis of
migrational loss experience. Portfolios of more homogenous populations of loans
including residential mortgages and consumer loans are analyzed as groups taking
into account delinquency ratios and other indicators, the
Corporation's historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional unallocated allowance is maintained based on a judgmental process whereby management considers qualitative and quantitative assessments of other environmental factors. For example, a significant portion of our loan portfolio is concentrated among borrowers in southern New England and a substantial portion of the portfolio is collateralized by real estate in this area. A portion of the commercial loans and commercial mortgage loans are to borrowers in the hospitality, tourism and recreation industries. Further, economic conditions which may affect the ability of borrowers to meet debt service requirements are considered, including interest rates and energy costs. Results of regulatory examinations, historical loss ranges, portfolio composition, including a trend toward somewhat larger credit relationships, and other changes in the portfolio are also considered.
Since the methodology is based upon historical experience and trends as well as management's judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in our market area, concentration of risk, and declines in local property values. While management's evaluation of the allowance for loan losses as of December 31, 2008, considers the allowance to be adequate, under adversely different conditions or assumptions, the Corporation would need to increase the allowance.
The Corporation's Audit Committee of the Board of Directors is responsible for oversight of the loan review process. This process includes review of the Bank's procedures for determining the adequacy of the allowance for loan losses, administration of its internal credit rating systems and the reporting and monitoring of credit granting standards.
Accounting for Acquisitions and Review of Goodwill and Identifiable Intangible
Assets for Impairment
Goodwill is recorded as part of the Corporation's acquisitions of businesses
where the purchase price exceeds the fair market value of the net tangible and
identifiable intangible assets. Goodwill is not amortized, but rather is subject
to ongoing periodic impairment tests at least annually or more frequently upon
the occurrence of significant adverse events in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets." Goodwill was reviewed in 2008 by
reviewing estimates of selected market information for the respective segments
of the Corporation.
For acquisitions accounted for using the purchase method of accounting, assets acquired and liabilities assumed are required to be recorded at their fair value. Intangible assets acquired are primarily comprised of wealth management advisory contracts and core deposit intangibles. The values of these intangible assets were estimated using valuation techniques, based on discounted cash flow analysis. These intangible assets are being amortized over the period the assets are expected to contribute to the cash flows of the Corporation, which reflect the expected pattern of benefit. These intangible assets are amortized based upon the projected cash flows the Corporation will receive from the customer relationships during the estimated useful lives. These intangible assets are subject to impairment tests in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". The carrying value of the wealth management advisory contracts and other identifiable intangibles are reviewed for impairment on an annual basis, or sooner, whenever events or changes in circumstances indicate that their carrying amount may not be fully recoverable. Wealth management assets under administration are analyzed to determine if there has been a reduction since acquisition that could indicate possible impairment of the advisory contracts. Impairment would be recognized if the carrying value exceeded the sum of the undiscounted expected future cash flows from the intangible assets. Impairment would result in a write-down to the estimated fair value based on the anticipated discounted future cash flows. The remaining useful life of an intangible asset that is being amortized is also evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.
The Corporation makes certain estimates and assumptions that affect the determination of the expected future cash flows from the advisory contracts and other identifiable intangibles. These estimates and assumptions include account attrition, market appreciation for wealth management assets under administration and anticipated fee rates, projected costs and other factors. Significant changes in these estimates and assumptions could cause a different valuation for the intangible assets. Changes in the original assumptions could change the amount of the intangible recognized and the resulting amortization. Subsequent changes in assumptions could result in recognition of impairment of the intangible assets.
These assumptions used in the impairment tests of goodwill and intangible assets
are susceptible to change based on changes in economic conditions and other
factors. Any change in the estimates which the Corporation uses to determine the
carrying value of the Corporation's goodwill and identifiable intangible assets,
or which otherwise
adversely affects their value or estimated lives could adversely affect the Corporation's results of operations. See Note 8 to the Consolidated Financial Statements for additional information.
Other-Than-Temporary Impairment of Investments The Corporation records an investment impairment charge at the point it believes an investment security has experienced a decline in value that is other-than-temporary. In determining whether an other-than-temporary impairment has occurred, the Corporation considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for impairment, the severity and duration of the impairment, changes in the value subsequent to the reporting date, forecasted performance of the issuer, changes in the dividend or interest payment practices of the issuer, changes in the credit rating of the issuer or the specific security, and the general market condition in the geographic area or industry the issuer operates in. With respect to holdings of collateralized debt obligations representing pooled trust preferred debt securities, estimates of cash flows are evaluated upon consideration of information including, but not limited to, past events, current conditions, and reasonable and supporting forecasts for the respective holding. Such information generally includes the remaining payment terms of the security, prepayments speeds, the financial condition of the issuer(s), expected defaults, and the value of any underlying collateral.
If necessary, the investment is written down to its current fair value through a charge to earnings at the time the impairment is deemed to have occurred. Future adverse changes in market conditions, continued poor operating results of the issuer or other factors could result in further losses that may not be reflected in an investment's current carrying value, possibly requiring an additional impairment charge in the future.
Overview
Washington Trust offers a comprehensive product line of financial services to
individuals and businesses including commercial, residential and consumer
lending, retail and commercial deposit products, and wealth management services
through its offices in Rhode Island, Massachusetts and southeastern Connecticut,
ATMs, and its Internet website (www.washtrust.com).
Our largest source of operating income is net interest income, the difference between interest earned on loans and securities and interest paid on deposits and other borrowings. In addition, we generate noninterest income from a number of sources including wealth management services, deposit services, merchant credit card processing, bank-owned life insurance, loan sales, commissions on loans originated for others and sales of investment securities. Our principal noninterest expenses include salaries and employee benefits, occupancy and facility-related costs, merchant processing costs, technology and other administrative expenses.
Our financial results are affected by interest rate volatility, changes in economic and market conditions, competitive conditions within our market area and changes in legislation, regulation and/or accounting principles. During the latter part of 2008, market and economic conditions were severely impacted when credit conditions rapidly deteriorated and financial markets experienced widespread illiquidity and elevated levels of volatility. Concerns about future economic growth, lower consumer confidence, rapid contraction of credit availability and lower corporate earnings continued to challenge the economy. The rate of unemployment continued to increase, reaching its highest level in several years. Corporate and related counterparty credit spreads widened and heightened concerns about numerous financial services companies adversely impacted the financial markets. As a result of these unparalleled market conditions, federal government agencies including the U.S. Treasury Department and the FRB initiated several intervention actions in the U.S. financial services industry.
The deteriorating economy somewhat negatively impacted the credit quality of our loans, particularly in our commercial portfolio. During 2008, we increased the allowance for loan losses in response to this condition as well as growth in the portfolio. The condition of the financial markets described above also contributed to declines in the values of holdings in our investment securities portfolio. During 2008 we recognized impairment charges on securities amounting to $5.9 million.
Composition of Earnings
Net income for the year ended December 31, 2008 amounted to $22.2 million, or
$1.57 per diluted share, compared to $23.8 million, or $1.75 per diluted share,
for 2007. The rates of return on average equity and average assets for
2008 were 11.12% and 0.82%, respectively. Comparable amounts for 2007 were 13.48% and 0.99%, respectively. The $1.6 million, or 6.8%, decrease in net income in 2008 was attributable to several factors as described below.
Net interest income increased by $5.6 million, or 9.3%, in 2008, reflecting higher interest-earning asset levels and lower deposit costs. The net interest margin (fully taxable equivalent net interest income as a percentage of average interest-earning assets) declined 12 basis points in 2008 primarily due to compression of asset yields and funding costs resulting from the 450 basis point aggregate impact of Federal Reserve rate cutting actions from October 2007 through December 2008.
The loan loss provision charged to earnings in 2008 was $4.8 million, an increase of $2.9 million from 2007. The higher loan loss provision was largely due to growth in the loan portfolio as well as our ongoing evaluation of credit quality and general economic conditions. Asset quality remained manageable during the year with net charge-offs of only 0.08% of average total loans in 2008, compared to a ratio of 0.03% in 2007. The ratio of the allowance for loan losses to total loans amounted to 1.29% at December 31, 2008 and 2007.
Noninterest income amounted to $40.5 million in 2008, down $5.0 million, or 11.0%, from 2007. This decline in noninterest income was largely due to the recognition of losses on write-downs of investments securities to fair value of $5.9 million ($3.8 million after tax, or 27 cents per diluted share). Wealth management revenues, the largest source of noninterest income, declined by $743 thousand, or 2.6%, in 2008. Wealth management revenues are largely dependent on the value of the assets under administration and are closely tied to the performance of the financial markets. Assets under administration were down $866.7 million, or 21.6%, from December 31, 2007. Wealth management assets under administration and related revenues were adversely affected by declining values in the financial markets.
Noninterest expenses totaled $71.7 million for 2008, up by $2.8 million, or 4.1%, from 2007. Noninterest expenses for 2007 included $1.1 million in debt prepayment charges recorded as a result of prepayments of higher cost Federal Home Loan Bank of Boston ("FHLB") advances in the first quarter of 2007. There were no debt prepayment penalty charges recognized in 2008. Excluding the 2007 debt prepayment charge, noninterest expenses rose by $3.9 million, or 5.8%. Approximately 40% of the 2008 increase, on this basis, represents costs attributable to our wealth management business, an increase in FDIC deposit insurance costs and operating expenses related to a de novo branch opened in June 2007.
Income tax expense amounted to $7.3 million in 2008, a decrease of $3.5 million from 2007. Income tax benefits of $1.4 million, or 10 cents per diluted share were recognized in 2008 resulting from a change in state corporate income tax legislation and the resolution of certain state tax positions. Excluding these income tax benefits, the Corporation's effective income tax rate for 2008 was 29.3%, as compared to 31.3% in 2007.
Sources and Uses of Funds
Our sources of funds include deposits, brokered certificates of deposit, FHLB
borrowings, other borrowings and proceeds from the sales, maturities and
payments of loans and investment securities. Washington Trust uses funds to
originate and purchase loans, purchase investment securities, conduct
operations, expand the branch network and pay dividends to shareholders.
In April 2008, the Bancorp sponsored the creation of Washington Preferred Capital Trust ("Washington Preferred"). Washington Preferred is a Delaware statutory trust created for the sole purpose of issuing trust preferred securities and investing the proceeds in junior subordinated debentures of the Bancorp. The Bancorp issued $10.3 million in junior subordinated deferrable interest notes, which bear a rate equal to the three-month LIBOR rate plus 3.50%, to Washington Preferred. See Note 11 to the Consolidated Financial Statements for additional information on junior subordinated debentures.
In October 2008, Washington Trust issued $50.0 million of its Common Stock in a
private placement with select institutional investors. Net proceeds were
$46.9 million after deducting offering-related fees and expenses. On October 20,
2008, the Corporation filed a registration statement with the SEC to register
these shares for resale. Washington Trust will use the net proceeds for general
corporate purposes and to support strategic growth initiatives in its commercial
and wealth management business.
Total assets amounted to $3.0 billion at December 31, 2008, up by $425.5 million, or 16.8%, from the end of 2007. Led by growth in commercial loans, total loans increased $265.5 million, or 16.9%, in 2008 and amounted to $1.8 billion, or 62% of total assets, at December 31, 2008. Commercial loans increased by $200.0 million, or 29.4%, over the prior year and amounted to $880.3 million, or 48% of total loans, at the end of 2008.
The securities available for sale portfolio is managed to generate interest income, to implement interest rate risk management strategies and to provide a readily available source of liquidity for balance sheet management. The fair value of securities available for sale totaled $866.2 million at December 31, 2008, or 29% of total assets. The carrying value of the securities portfolio increased by 15.2% in 2008, largely due to purchases of mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises.
Management's preferred strategy for funding asset growth is to grow low cost deposits (demand deposit, NOW savings accounts). Asset growth in excess of low cost deposits is typically funded through higher cost deposits (certificates of deposit and money market accounts), brokered certificates of deposit, FHLB borrowings, and securities portfolio cash flow.
Deposit gathering continues to be very competitive and the current environment has impacted the Corporation's ability to generate growth in lower costing deposits. Total deposits, which included brokered certificates of deposit, amounted to $1.8 billion at December 31, 2008, up by $144.7 million, or 8.8%, from the balance at December 31, 2007. Deposit growth in 2008 was concentrated in time deposits. At December 31, 2008, Washington Trust had $188.0 million in out-of-market brokered certificates of deposit and $829.6 million in FHLB advances compared to $129.8 million and $616.4 million, respectively, at December 31, 2007.
Opportunities and Risks
A significant portion of the Corporation's commercial banking and wealth
management business is conducted in the Rhode Island and greater southern New
England area. Management recognizes that substantial competition exists in this
marketplace and views this as a key business risk. A substantial portion of the
banking industry market share in this region is held by much larger financial
institutions with greater resources and larger delivery systems than the
Bank. Market competition also includes the expanded commercial banking presence
of credit unions and savings banks. While these competitive forces will continue
to present risk, we have been successful in growing our commercial banking base
and wealth management business, and management believes that the breadth of our
product line and our size provide opportunities to compete effectively in our
marketplace.
Significant challenges also exist with respect to credit risk, interest rate risk, the condition of the financial markets and related impact on wealth management assets, and operational risk.
Credit risk is the risk of loss due to the inability of borrower customers to repay loans or lines of credit. Credit risk on loans is reviewed below under the heading "Asset Quality". Credit risk also exists with respect to debt instrument investment securities. This risk is reviewed below under the heading "Investment Securities."
Interest rate risk exists because the repricing frequency and magnitude of interest earning assets and interest bearing liabilities are not identical. This risk is reviewed in more detail below under the heading "Asset/Liability Management and Interest Rate Risk."
Wealth management service revenues, which represented approximately 27% of total revenues in 2008, are substantially dependent on the market value of wealth management assets under administration. These values may be negatively affected by changes in economic conditions and volatility in the financial markets.
Operational risk is the risk of loss resulting from data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. Operational risk is discussed above under Item 1A., "Risk Factors."
For additional factors that could adversely impact Washington Trust's future
results of operations and financial condition, see the section labeled "Risk
Factors" in Item 1A of this Annual Report on Form 10-K.
Results of Operations
Comparison of 2008 with 2007
Segment Reporting
Washington Trust manages its operations through two business segments,
Commercial Banking and Wealth Management Services. The Commercial Banking
segment includes commercial, commercial real estate, residential and consumer
lending activities; mortgage banking, secondary market and loan servicing
activities; deposit generation; merchant credit card services; cash management
activities; and direct banking activities, which include the operation of ATMs,
telephone and internet banking services and customer support and sales. Wealth
Management Services includes asset management services provided for individuals
and institutions; personal trust services, including services as executor,
trustee, administrator, custodian and guardian; corporate trust services,
including services as trustee for pension and profit sharing plans; and other
financial planning and advisory services. All other activity, such as the
investment securities portfolio, wholesale funding activities and administrative
units, are not related to the segments and are considered Corporate. See Note 17
to the Consolidated Financial Statements for additional disclosure related to
business segments.
The Commercial Banking segment reported net income of $19.2 million in 2008, up by $2.1 million, or 12.2%, from 2007, primarily due to higher net interest income. Net interest income was up by $8.7 million, or 16.2%, driven by growth in average loan balances and lower deposit costs. This increase in net interest income was partially offset by a $2.9 million increase in the loan loss provision and $2.9 million increase in Commercial Banking noninterest expenses in 2008. Higher noninterest expenses reflected increases in FDIC deposit insurance costs and operating expenses related to a de novo branch opened in June 2007.
The Wealth Management Services segment reported net income of $4.9 million in 2008, a decrease of $796 thousand, or 13.9%, from net income in 2007. Noninterest income derived from the Wealth Management Services segment was $28.3 million in 2008, down by $743 thousand, or 2.6%, from 2007. Lower noninterest income resulted from declines in wealth management assets under administration due to lower valuations in the financial markets. In 2008, noninterest expenses for the Wealth Management Services segment amounted to $20.1 million, up by $451 thousand, or 2.3%, from 2007. This increase was attributable to higher outsourced services expenses for wealth management platform and product support costs.
Net Interest Income . . .
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