Good morning, and welcome to the Washington Trust Bancorp Inc.'s Conference Call. My name is Emily, and I will be your operator today. [Operator Instructions] Today's call is being recorded. And now I will turn the call over to Elizabeth B. Eckel, Executive Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel?

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

Thank you, Beth. Good morning, and thank you for joining our third quarter conference call. We appreciate your time and interest in Washington Trust. During my remarks this morning, I'll provide comments about our third quarter results in context with the market conditions we're seeing, as well as an update on our current focus for value creation. Then Ron Ohsberg will offer more detail regarding our third quarter performance. And after our prepared remarks, Mary Noon and Bill Wray will join us for the Q&A sessions. In the third quarter, our team did a solid job of managing through the current challenging market dynamics while executing our long-term strategy which is to build a sustainably relevant, consistently profitable and relationship-driven regional financial services organization. We remain laser-focused on all approaches to achieving in-market deposit growth, including technology investment, product development, branch expansion and sales management. We grew in-market deposits in the third quarter on a very competitive landscape and through our continued efforts and focus should drive additional growth in future periods. During this suppressed earnings cycle, we are committed to building capital. In the short run, this means shifting our lending activity to primarily supporting existing customers with high-quality credit that contributes to our capital. As such, we expect loan growth to slow measuredly. We remain entirely attentive to call quality credit, both new and existing. Our underwriting and portfolio management standards, although always prudent have tightened to reflect the uncertainty of the markets we serve. We will provide more detail in the Q&A session. We continue to operate in a challenging economic environment with financial markets in flux and geopolitical and stability increasing. While these macro level headwinds have affected earnings and do not appear likely to abate for some time, we remain confident that Washington Trust is…

Thank you, Ned. Good morning, everyone, and thank you for joining our call. As Ned mentioned, net income was $11.2 million or $0.65 per diluted share. Net interest income was $33.8 million, up by $251,000 or 1% in the preceding quarter. The margin was 1.97 down by 6 basis points. Average earning assets increased by $167 million and the yield on earning assets was $469 million up by 16 basis points. On the funding side, average end market interest-bearing deposits increased by $77 million and average wholesale funding rose by $83 million. The rate on interest-bearing liabilities increased by 24 basis points to $3.26. Prepayment fee income was $71,000 in the third quarter and 50,000 in the second quarter. Net interest - excuse me, noninterest income comprised 31% of total revenues and amounted to $15.2 million up by $901,000 or 6% from Q2. Wealth management revenues were $8.9 million, down by $100,000 or 1%. This included transaction-based revenues, which were down $221,000 primarily in seasonal tax servicing fee income, which is concentrated in the first half of the year. Asset based revenues were up by $121,000 or 1% with a corresponding increase in average AUA balances which were up by $140 million or 2%, and a period AUA totaled $6.1 million, down by $219 million or 3% from June 30 and reflecting market depreciation of $154 million in net client asset outflows of $65 million. Mortgage banking revenues totaled $2.1 million, up by $355,000 or 20%. Mortgage loans sold totaled $89 million in the third quarter up by $24 million. Total originations were $240 million, up by $13 million. Our mortgage pipeline at September 30 was $98 million down by $67 million or 41% from the end of June. Loan-related derivative income totaled $1.1 million up by $835,000. Regarding noninterest…

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

Thank you. [Operator Instructions] Our first question today comes from the line of Mark Fitzgibbon with Piper Sandler. Mark, please go ahead. Your line is now open.

Hi, guys. Good morning.

Good morning, Mark.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thank you.

Thanks Mark.

Our next question comes from the line of Damon DelMonte with KBW. Please go ahead. Your line is now open.

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

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

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

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

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

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

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

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

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

2024.

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

I know, it's fair.

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

Got it. Okay. That's all that I had. Thank you very much.

Okay.

Thanks Damon.

Our next question comes from the line of Laurie Hunsicker with Seaport Research Partners. Laurie, please go ahead. Your line is now open.

Hi, thanks. Good morning. Just a follow-up on expenses. I know you guys used to do the charitable foundation contribution. Are you thinking about that more as that will be an ongoing fourth quarter event? Or is that going to bleed through into all quarters? Would there just be an ongoing quarterly contribution? Or how should we be thinking about modeling that?

I think we're going to do with kind of a single contribution to the foundation to keep it going for a while. And so we just need to determine how big that contribution will be in the fourth quarter. And I think it will be at least $500,000.

Okay. But I mean, that will be an ongoing fourth quarter event as we look out similar to historically…

I think as of today, that's a fair assumption, yes.

Got it. Got it. Okay. And then just going back to deposits, you had a really nice jump in deposits. Can you talk about sort of two things. Number one is, how should we think about when you're going to start to clip broker deposits? And then also, how should we be thinking about your growth in core deposits? I know that's a real emphasis. But specifically, this is a challenging environment. How should we think about that as we look forward?

So I missed the part about the brokered deposits.

Well, your broker deposits linked quarter, you went from $601 million to $668 million. I mean where is that going? And then obviously, you had a jump in core deposits. Help us think about that a little.

Yes. We're going to manage broker deposits to about 10% of total assets. So we're near the kind of topped out on brokerage. General deposit growth, I mean, I guess I should point out, in the quarter, we had one large institutional deposit withdrawal. It wasn't an inexpensive deposit, but that was $100 million of institutional money that had been placed with us, which we knew was somewhat temporary in nature, but it did leave in the third quarter. So that contributed to our more muted deposit growth in the quarter. We're very focused on deposit growth and have a number of internal things that we're looking at to increase that going forward. So we're not prepared to talk about what the numbers of that might look like. But I can assure you, it's an important priority for us right now. Rhode Island market - deposit market does not grow very much. And our internal analysis shows that we grow considerably faster than the market as a whole. It has not grown fast enough to keep up with the loan growth that we've been posting. That's pretty evident. Loan growth will be coming down. And hopefully, if we do what we intend to do, deposit growth will pick up.

Okay. Great. Thanks. And then just going back to the commercial real estate nonperformers. Ron and Bill, can you help us think about what was the balance on the senior housing facility? And then the balance on you mentioned a couple of post offices. What was the dollar balance? And then what's the debt service coverage ratio looking like? What's the vacancy looking like. Maybe while you're grabbing those Ned, can you just comment - go ahead. Yes, I'm sorry.

Thy are still looking for the longer set. Okay. On the - the senior housing facility was $13.9 million. That was our share. It's a participation. And then the other is - the office property is $8.7 million, and that's secured by two office buildings.

Secured by two. Okay. And what is the vacancy on both of those? And what's the debt service coverage? So I can follow-up with you after, if that's helpful.

Yes. I want to make sure I give you current versus pro forma on each of those, so we can follow up and give you those stats.

Okay. Great. And then just one last question. Obviously, very, very well capitalized here. I realize earnings are bumping up against dividend. But how do you think about the buyback? I mean you've got all your peers seemingly in your geography, are now active in some form in a buyback. Your stock is very, very discounted from the last point you were looking at. Can you just help us think about that a little bit from the standpoint of your capital. Thanks.

Yes. Yes, we have no intention of doing any buybacks.

Okay. Great. Thanks. I'll leave it there.

Thanks Laurie.

[Operator Instructions] We have no further questions. I'll turn the call back over to the management team for any further remarks.

Thank you, Emily, and thank you all for your time today. This is a - certainly, these are uncertain times, and we're confident that Washington Trust is the best alternative for people, business and organization to seek a higher level of personal guidance, competitive products and stability to make the most of their financial well-being. I want to take this moment to thank our employees for the incredible amount of work they've done through these difficult times. We have a long, long history of managing through challenges, so I'm confident we'll farewell here. I also want to thank our customers for knowing us as well as we know you. We learn and get stronger with each experience, and we'll do so here as well. And we appreciate the support and assurances we've received from our shareholders and the investor community global unrest, economic uncertainty and a stubborn inverted yield curve or hardships we all have to endure. But with strong partners, patience, prudent decisions and disciplined hard work, we will gain strength and be positioned well for much better times ahead. So thank you all for your time this morning. Have a great day.

Thank you, everyone for joining us today. This concludes our call, and you may now disconnect your lines.