Waterstone Financial, Inc. (WSBF) Earnings Call Transcript & Summary

Welcome to the Annual Meeting of Shareholders of Waterstone Financial, Inc., which I will refer to as the company. Given the unique circumstances presented by COVID-19 virus, the annual meeting is being conducted virtually by webcast and audio conference. The annual meeting will please come to order. My name is Doug Gordon, President and Chief Executive Officer of the company and WaterStone Bank. Participating with me at the meeting are Mark Gerke, Chief Financial Officer and Executive Vice President of the company and WaterStone Bank; and Bill Bruss, Chief Operating Officer and secretary of the company and WaterStone Bank, who will also act as Secretary of the annual meeting. I'd also like to welcome the other directors of the company in attendance at the meeting; Pat Lawton, Chairman; Ellen Bartel; Tom Dalum; Mike Hansen; Kris Rappé; and Steve Schmidt. We have made available electronically the rules of conduct of the meeting. If you would like to discuss a matter not on the agenda, I encourage you to contact an officer or director of the company after the meeting. Although we provided an opportunity to shareholders to submit questions in advance of the annual meeting, there were none submitted. Although we will take a vote on the matters to be considered at the annual meeting in a few moments, any registered shareholder wishing to vote their proxy may do so electronically during the meeting. If you have already voted your proxy or proxies, you need not vote again unless you wish to make a change. The Board of Directors has previously appointed [ Denise Mihajlovic ] to act as the inspector at the annual meeting and any adjournments and to count and examine all voting. The inspector's report will be attached to the minutes of the annual meeting. The Secretary has delivered to the inspector a list of the shareholders of the company entitled to vote at the annual meeting, arranged in alphabetical order, as of the close of business on March 25, 2020, the record date for voting. The Secretary informs me that the records of the company show that there are 26,438,256 outstanding votes entitled to be cast at this annual meeting, of which 13,219,129 represent a majority. We have previously received confirmation that the notice regarding the availability of proxy materials for the shareholder meeting was mailed on or about April 9, 2020, to each shareholder of record as of the close of business on the record date. Copies of the affidavit of distribution with documents attached -- will be attached to the minutes of this annual meeting. The Secretary has previously delivered to the inspector the list of the shareholders and all proxies which have been received. The Secretary informs me that substantially more than a majority of the total outstanding votes entitled to be cast at the annual meeting are present in person or by proxy. The inspector is making an exact count and will submit a formal report on the number of shares present or represented during the course of the annual meeting. A quorum is declared present subject to the confirmation of [ effect ] by the inspector in her report. The business to be acted upon at the meeting -- annual meeting as stated in the notice of the annual meeting is as follows: one, the election of the 2 directors of the company; two, approval of the company's 2020 omnibus incentive plan; three, ratification of the company's selection of RSM US LLP as its independent registered public accounting firm; four, an advisory, non-binding resolution to ratify the approval of the executive compensation described in the company's proxy statement; and five, an advisory nonbinding proposal as to the frequency that shareholders will vote on our executive compensation. In order to save time at this meeting, we propose to arrange the proceedings so that a vote will not be taken until all items have been moved and seconded. Again, registered shareholders who are attending the annual meeting by webcast do have the opportunity to vote their shares during the meeting. If you've already voted by proxy, you need not vote during the meeting. First item of business to be voted upon is the election of 2 directors of the company. The directors to be elected are to serve for a 3-year term and until their respective successors have been elected and qualified. The Board of Directors has nominated to serve as directors, Michael L. Hansen and Steven J. Schmidt, each of whom are currently members of the Board of Directors. The nominees are prepared to serve if elected. The Chair will entertain a motion that the proposal to elect the directors be adopted.

I so move.

Is there a second?

I second the motion.

The second item to be acted upon is the approval of the company's 2020 Omnibus Incentive Plan. The Chair will now entertain a motion to approve our 2020 Omnibus Incentive Plan.

I so move.

I second the motion.

The third item to be acted on is the ratification of the company's selection of RSM US LLP as its independent registered public accounting firm for 2020. The Chair will now entertain a motion to ratify RSM US LLP as the company's registered independent public accounting firm.

I so move.

I second the motion.

The fourth item to be acted upon is the ratification of our executive compensation as described in the proxy statement. The Chair will now entertain a motion to ratify our executive compensation.

So moved.

I second the motion.

Fifth item to be acted on is a proposal of the frequency that shareholders will vote on our executive compensation. The Chair will now entertain a motion to ratify a say-on-pay advisory vote on our executive compensation either annually, every 2 years or every 3 years.

I so move.

I second the motion.

The vote will now be taken on proposals 1, 2, 3, 4 and 5. Will anyone who wishes to vote electronically do so now? If you've already voted your proxy or proxies, you do not need to vote now unless you wish to make a change. I will now pause for 2 minutes to allow an opportunity for electronic voting. [Voting]

2 minutes have passed, and I declare the voting closed on the proposals 1 through 5. I will now discuss the affairs of the company. I will start with our results from 2019. And those results were literally a decade ago considering what we've been going through. So I will discuss them briefly but then I will also give you some flavor on where our portfolio is and how it stands up for the current pandemic and downturn that we're experiencing. The first slide is our consolidated annual income. The blue line is our pretax income over these -- over the 5 years. You can see we get a big jump in 2015 to '16, and this is a common theme on some of these slides is that we refinanced $400 million of Federal Home Loan Banks that were at 4% during 2015 and '16, down to levels of 1% to 2%. So we did have a significant increase in earnings as a result of that but we actually had operating earnings that exceeded that. But from 2016 to 2019, our pretax income has increased by 13%. If you look at the red bars, that our earnings per share from that same time 2016 to 2019, our earnings per share have increased by 47%. The difference between those 2 is a combination of the tax rate reduction that we saw for corporate income taxes in 2018 and also the result of -- by stock buybacks and the impact that they have on the earnings per share. On the next slide, we have our pretax income by operating segment. Community Banking, in blue, again saw a significant growth in 2015 to '17, again a lot due to the Federal Home Loan Bank advanced refinancings. But the increase in '17 to '18 was a lot of loan growth that supported it, and we'll discuss why it's flat in 2019 in future slides. Mortgage banking, and we've had very consistent income in the mortgage banking area considering the industry that isn't very consistent. I'll discuss that later as to why that is and why we're unique. But 2018 was our dip. This typically happens. Interest rates were rising in -- coming the end of 2018, almost throughout 2018. And as a result, we are predominantly a purchase lender. We lend for the purchase of homes predominantly. You have a lot of people that refinance lenders that predominantly do their lending just for refinances. Well, when there is no financing because of rising rates, they tend to try and compete with the purchase acquirers by lowering their rates. That's the only way they really can compete because they don't have realtor relations or builder relations. So that obviously affects our margins. As a result, you have a shrinking volume as well as a shrinking margin, and that's what happens in years like that but they still remain very profitable in 2018, despite many mortgage banking operations losing money in that year. On the next slide shows the dividends that we've declared and how we've given back to shareholders. In the last 3 years, we've paid out $0.98 a share between our quarterly dividends and our special dividend. On a $14 stock price, that's a 7% dividend yield, so that's a significant return to shareholders. And yet, it still only represents the payout of about 86% of our net earnings during that time. On the next slide is our asset quality, and this is another good story. All of these ratios that you see, past dues to loans, nonaccrual to loans, nonaccrual to assets, nonperforming assets to assets, are all at 0.5% or below. I think that shows very favorably industry-wide and shows the asset quality that we had at the end of 2019. To further tell you about that, we have from January of '18 through March of 2020, we had charge-offs of only $158,000. We had recoveries of 40 -- $480,000. So we had net recoveries of that 2.25 years of $322,000. So the portfolio is performing very well and the asset quality is very well at the end of '19. On the next slide, we show our loan and deposit growth. See our loan growth, in the blue, has been very good 2016 to '18. 2019, we had the declining rates. And as the declining rates came, we were continuing to originate a lot of loans but we also had a lot of prepayments. We had a lot of customers that took advantage of long-term fixed rates, either through insurance companies or REITs or private equities, getting 10-year rates at very low rates relative to what we offer. And we can't afford to do that for interest rate sensitivity matters. So we lost a lot of good loans that went to longer-term fixed rates but we did originate a lot of loans. It's just -- we had to run like crazy to stand still. In deposits, in the red, 2017 was our transition year. We changed retail management and wanted to go from more of a service-oriented culture to a sales culture. And the new management has done that as you can see by the results in our 2018 return of deposit growth. 2019 has muted a little but that's mainly because it was curtailed because of the low loan growth. We didn't need the deposit growth. But at this point in time, we're very comfortable with the machines that operate our loan growth and our deposit growth for the organic growth that we need for profitability and to leverage the excess capital that we have. On the next slide is our net interest margin. Again, as we go from '15 to '17, a lot of that is translated from the Federal Home Loan bank refinances. But we also had more of a yield curve that was ascending as the yield curve started to flatten at the end of 2018 all through 2019. That's a very difficult time for financial institutions. We tend to borrow short and lend long, so we need that spread between the 2-year Treasury and the 10-year Treasury to be of significance. Historically, we see that generally at about a 1.5% to 2%-type spread. Well, during February of this year, it was at 15 basis points. It's expanded now to 50 to 55 basis points but that's still not sufficient when you combine 0 interest rates and no slope to the curve. So we continue to have margin pressure and need to outgrow -- need to grow the portfolio to outgrow that compression. On the next slide, we get into our mortgage subsidiary, the volumes that they've had. As you can see, they've had a consistent growth in volumes. They had record volume in 2019 and just filed an 8-K for our April volume of 360 -- I believe 367 million, which was a record for the company. And that's with 95% of the people working from home. So what's even more impressive in the volume increase in 2019, in 2018, we started to weed out some of the less profitable branches and less producing branches in terms of the metrics of the loans that they do per loan officer. So we had 263 loan officers in 2018. We had only 226 in 2019 and yet did more volume with much less in terms of loan officers. On the next slide, we start to get into what the strategy is and what makes Waterstone Mortgage so unique. When I purchased Waterstone Mortgage when I first started here in 2006, we purchased it for $1 million. And the strategy between the management team at that point in time and myself was to take the bank's capital and our ability to fund their growth and their ability to grow the company. But the direction that we focused on was that we were going to focus strictly on purchase business. Being a public company, it's bad enough the seasonality of this business but we couldn't afford to have the cyclicality based on strictly what interest rates were doing and what we do in terms of refinance business, because then we have earnings that just were -- would be up and down every quarter and not consistent. They still have seasonality, but they are -- there is a consistency of a year-over-year when we compare quarters. So we look for branches and loan officers that have realtor and builder relations. And we consistently have a higher percentage of purchase business than what the industry does as exemplified by this chart. You can see in the blue, Waterstone Mortgage has run between 83% and -- 81% and 91% purchase business, where the industry average is anywhere from 52 to 73. And you can go through the history of the company, and that's been a consistent number. And it makes for a much more consistent volume and consistent income for us. As we go to the next slide, you'll see what we've done to be unique in that purchase business and be able to attain and attract new realtor and builder relations. All of our operations and technology is geared for acceleration to close. The realtors want to close by the end of the month because their commission comes out the next week. People who are first-time homebuyers when they give notice, they have to be out of their apartment at the end of the month. So it's not unusual for us to have 60% of our business closed in the last 7 business days of the month. So we have to be structured to be able to do that. We have excellent technology. We have excellent operations. We're not a low-cost provider by any means but you'll see in later slides why we can afford to do this and continue to outperform the market. In terms of refinances, we do refinancing. It's a good portion of our business right now but it's more of a secondary citizen in terms of our operations. We charge higher rates for the refinances. And in terms of putting them on the calendar for closing, they fit in outside of taking care of the purchase business. So we never want to lose focus of that purchase business. So this chart shows you from application to close, how many days it takes Waterstone Mortgage versus the industry. And you can see we're consistently in the 25- to 28-day range. And the industry average is in the -- anywhere from the low 40s to the high 40s. I think that's a significant competitive advantage, and that's how we do continue to maintain those realtor relations. And again, even through the -- working through the pandemic with 95% of the people at home, we've been able to continue to do these term times. On the next slide is the mortgage banking gross margin. Like I mentioned, we're a high-cost producer but we also get it back in margin. With the relations that we have, our pricing is a little higher than market. They pay for the service that we give them and the number of different products that we offer. I mean historically we've always been 4.5% to 5% in margin. Again, in 2018 when interest rates were rising, the refi business again cut margins. And what is unusual is in 2019 as rates started to drop, we didn't get those margins back. The market continued to be very competitive. They started working off of lower pricing margins relative to the MBS and also Treasuries. But now as we move into 2020, we're starting to see those margins creep up as people get real busy with the refinance activity that they have. To give some flavor, most of our competitors that are bank mortgage companies or bank mortgage operations, they run about 3% in terms of this margin. And this margin is the total income divided by originations. And if you're in -- if you're a bank that buys correspondent business from brokers and other mortgage banks, you probably are in the 2.5%. So we are significantly above our peers and it more than offsets the cost that we have to term -- give those term times that we do. Now we move on to this next century, and that's the COVID-19 model. We were quick as an organization to respond. We closed our branches on March 18, which was very quick. We were able to service our customers through drive-ups, through digital banking platform. And we beefed up our call center. So we haven't missed a beat in terms of our customer service levels but we found -- we know it's extremely important at this point in time, and the highest priority to keep our employees, our customers and our communities safe. And we've done everything that we can to do that. That includes having anybody that was possible to work from home, working from home. And 45% of the bank employees are working from home. And like I mentioned, 95% of the mortgage employees are working from home. And we will cautiously and safely bring those people back to work as the economy begins to open. I will discuss the loan modification program that we have and also the Paycheck Protection Program in new slides. The next slide, want to give some flavor to our loan composition because I think that's what shareholders should be focusing on at this point in time. It seems in valuing bank stocks today, book value is what people are valuing in terms of not only what the current book value is, but what is the potential for deterioration in that book value as a result of the pandemic and potential loan losses. As you can see from this chart, 76% of our portfolio is in residential real estate. It's either multifamily, 2- to 4-family or single family. And as terms of classes in this pandemic, this has been the best class -- classes of any. Rentals continue to be relatively strong with all the stimulus that's there and the addition to the unemployment of $600 a week. Those areas has still continued to perform fairly well. The higher-risk areas are in areas of commercial real estate and some of the business areas, business loan areas, which I will break down further on further charts. But just to discuss our multifamily, not only do we feel this is a good class but we're in a better class of that class. We're predominantly a blue-collar lender in terms of multifamily. The rents typically are $600 to $1,000. We don't deal in the luxury high-rise downtown $2,000 to $3,000 a month rents. We're in secondary and tertiary markets to be able to do that, which I think if anything comes out of this pandemic, you're going to see migrations to more secondary and tertiary markets as people move away from the density population. And our customers have had good rental collections in the 90%-plus range at this point in time. Not what they had prior but certainly not what anybody would expect, considering the unemployment numbers that we're starting to see. As we go to the next slide, our loan modification program, we've modified 7.6% of our total loans. Now we don't have the typical modification that you're seeing in Fannie and Freddie and others where they're actually forbearing payments where people don't have to make payments for 3 or 6 months, and then they'll deal with those payments at the end of that term. Our forbearance program is just a forbearance of principal. So our portfolio of modification is paying interest and taxes. So there is some relief there but they're not falling behind in the accrued interest, and they'll be able to just pick up their payments as we go forward. That's by design for a couple of reasons. I think it's better protection for the bank. And it's also better protection for the consumer because you let the consumer get behind, it's very difficult to play catch-up. And as these forbearance come due and they ask them to pay 3 months up front or to amortize it and increase their payments, it's going to make it that much more difficult for them to catch up. So this program has worked. The people are making their payments. I'm sure we'll have some issues of people that just won't even be able to make the mod payments. But we'd rather deal with that on an individual basis than just have a blanket modification program. I have to point out that out of our single family, about 85 million is serviced by a third party. And that's because we've purchased loans from Waterstone Mortgage that are in states that we don't service. And they do have the Fannie and Freddie modification program, so they've modified a little over $6 million of loans where there's 3 months of forbearance of all payments that we'll deal with. But it's very small relative to our portfolio. And even out of the 12 loans that are there, I think 2 or 3 of them are continuing to pay contractually, even though they have the modification program. But from this chart, you can see commercial real estate and commercial and industrial are 20% of our portfolio but they're 63% of our modifications. As we go to the next slide, I wanted to break down the commercial real estate because not all commercial real estate has been stressed. The industrial and office markets haven't been as stressed as the retail, the hotel, specialty real estate, which may be restaurants, golf courses, day cares. And then, of course churches have had stress. So you can see out of here in this portfolio, 53% of that portfolio are those stressed areas, and they represent 87% of our modifications. But again, each of these is paying interest and taxes, so it's not as big of a give as some of the forbearance programs. And just a little flavor, the interest that we collect on our whole -- I mean the principal that we collect in our whole portfolio on a monthly basis only amounts to about $3.5 million. So when you're talking about having 7% or -- of your portfolio, you're not talking about a large dollar amount. Maybe $350,000 or even less than, 300 -- $300,000 a month in terms of forgiveness. As we go to the next slide, it breaks down the C&I. And the first 5-or-so categories they are very nominal in terms of modified loans. Again, the modifications come in the high-risk areas, which are the specialty businesses and arts and entertainment and recreation. But again, that only amounts to $3.2 million on $1.4 billion portfolio, so it's not -- doesn't have a big impact on the overall profitability of the bank. On the next slide is the Paycheck Protection Program. I think we did a great job here and that our loan officers, our credit area, our community presidents were on it from day 1. So we are taking applications, processing applications. There were a lot of banks that were still waiting for additional guidance as it continued to change. We just -- we're fluid and changed as the guidance changed. So we got on top of it. We got in early. Even before the first portion of it, the Phase 1 got done, we got a lot of our customers not only approved but funded. We've done a little less than $30 million in taking care of a lot of customers who are very satisfied. We also attracted new customers that were turned away from large banks because either they were too busy or they were not going to even get around to funding them. So we were able to attract some new businesses as a result. But I think we did a really good job here, and it will pay for itself. So we move on to the next slide. If you go through the 10-Q, we've added some risks in our 10-Q recently in the 2020 March 31. As they relate to mortgage banking, as there were a lot of things, a lot of noise in the mortgage banking area in March, we started to get concerned about early payment defaults. When we sell to an investor, generally the borrower has to make the first 3 or 4 payments, otherwise that investor can put the loan back to us. So with the amount of forbearance that's going on, we are concerned, how is that going to be handled? Is that a payment default? Is that not a payment default? And we have not had any loans put back to us for any forbearance reasons. The loans that become unsaleable for us are the ones that we closed the loan and the borrower becomes unemployed before the investor buys the loan. At that point in time, they will not purchase the loan and becomes an unsaleable loan for us. And we either have to wait till they get employed again, refinance some or sell it in a scratch-and-dent market. We have not had a lot of that, and the reason we haven't is based on the next paragraph that mortgage servicing market has virtually gone away. With all of the forbearance, the value of mortgage servicing has really traveled to 0. In fact, I've heard of people selling, servicing retained to Fannie at a higher price than servicing release. So basically they're putting a negative value in for the servicing. Fortunately, again because the mortgage company is part of the bank, we have that ability to retain the servicing. And it's helping us in 2 ways. First of all, we're getting the servicing for virtually 0 or nominal amounts. And that servicing will have value at some point in time. Historically, when we've pooled it and sold it, like we -- like we'll intend to at some point in time here, we've exceeded 1% in terms of the value of that servicing. So not only does it -- we think there's a hidden value there in the future but also by retaining our own servicing, it gives us the ability to sell to Fannie Mae in their cash window, and closings then happen. They'll buy it within 10 days or around 10 days after we close. Whereas our other investors, if we're selling, servicing release, may take 20 to 30 days. Well, that's so important because of the time frames of the unemployment of our borrower that's much less likely obviously to go unemployed in 10 days than they are in 30. So it will help us with our saleability of our loans. On the next slide, we just continue to get back to the communities that we serve. We find it important to be a good corporate citizen. We've donated $800,000 to over 240 local nonprofits and schools in 2019. And our employees have given back with volunteer hours of over 700 hours. And the next slide gives you a flavor of who we have partnered with in terms of local nonprofits and schools. Next slide, we have our Moola account, which is our kids account. And in 2019, we partnered with Children's Hospital of Wisconsin and donated $10 for every new Moola account that was opened. Next slide is our HERO program. We started this in early 2019. It's probably more apropos today, but it's our Honoring Emergency Responding Officials and we give discounted products and services, including the checking account that is a free checking account with free checks, an opening gift, an annual gift, access to a large ATM market. And it's for our currently employed and retired service members for the fire departments, police sheriff's department and EMTs, similar to our MVP program that we offered in 2018. On the next slide, in 2018, we bought 3 branches from Associated Bank that came about through their merger with Bank Mutual. They had a 1-year moratorium for us to be able to open. So late in 2019, we opened branches in West Allis and Oak Creek. We intend to open the Milwaukee branch in late 2020. As you can see by the chart, these red figures of the new branches continue to fill in our footprint. We think that's extremely important for convenience of our customers, especially as we try to attract more in terms of core deposits. There is more and more digital banking going on. There is -- you do need that technology. However, in 2019 nationally, 85% of all new accounts were opened in branches. So you need all platforms, including digital banking, your call center, your drive-ups and your branches. On the next slide, we also now offer foreign currency exchange. That was at the request of many of our customers in some select branches. On the next slide is an exciting new digital banking that we have that will go live on June 16. Our current core provider, FIS, has an antiquated digital platform. In fact, they don't even have a business mobile platform, which has really hindered us in trying to attract new business customers. But the Q2 is a state-of-the-art digital experience and it has virtually all of the technology that you'd want in the digital platform. We're excited to be able to offer that for our existing customers and also to offer it to attract new customers. And that is the end of my presentation. So the inspector's completed her count, and the secretary will now read the certificate and report of the inspector of election.

Good morning. The inspector of election has reported as follows. "I hereby certify the following: One, Michael L. Hansen; and Steven J. Schmidt, the nominees to serve on the Board of Directors of Waterstone Financial Inc., have each received a plurality of the votes cast at the annual meeting and are hereby elected as directors to Waterstone Financial, Inc. Two, the proposal to approve the company's 2020 Omnibus Incentive Plan received a majority of votes in favor of approval. Three, the appointment of RSM US LLP as Waterstone Financial Inc.'s independent registered accounting firm has been ratified by a majority of the votes cast at the annual meeting. Four, the nonbinding advisory vote regarding ratification of the company's executive compensation as set forth in the April 9, 2020 proxy statement received a majority of votes in favor of ratification. Five, the nonbinding advisory vote regarding the frequency in which stockholders will vote on the company's executive compensation received a majority of votes in favor of holding such vote on an annual basis. And six, at all times during the annual meeting, more than a majority of the shares outstanding and entitled to vote at the annual meeting were represented in person or by proxy. And consequently a quorum has been in attendance for the entirety of the annual meeting. Signed, [ Denise Mihajlovic, ] Inspector of Election."

The report confirms that a quorum is and has been in attendance at the annual meeting for all purposes. The report also shows that with respect to the first item of business, a plurality of the votes have been cast in favor of the election of Michael L. Hansen and Steven J. Schmidt as directors. With respect to the second item of business, the more than a majority of votes cast have been voted in favor of the approval of the company's 2020 Omnibus Incentive Plan. With respect to the third item of business, in favor of the company's selection of RSM US LLP as the company's registered independent public accounting firm. With respect to the fourth item of business, in favor of the ratification of our executive compensation. And with respect to the fifth item of business, in favor of an annual nonbinding stockholder vote on the company's executive compensation. The certificate and report of inspector of election has been accepted and approved and will be attached to the minutes of the annual meeting. I would like to take a moment just to thank our shareholders for their trust and their support. More importantly, I'd like to thank our Board and our employees for the results that they continue to provide and for how they've responded during this pandemic to virtually exceed all of our customers' expectations and continue to provide the service that's necessary for us to grow. There being no further business to come before the annual meeting, a motion to adjourn is in order.

I move that the annual meeting be adjourned.

I second the motion.

Those in favor signify by saying aye. [Voting]

Those opposed, say no. The motion is carried, and the annual meeting is adjourned. Thank you.