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WASHINGTON TRUST BANCORP INC - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
 x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended SEPTEMBER 30, 2017 or
 o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______.

Commission file number:  001-32991

WASHINGTON TRUST BANCORP, INC.
(Exact name of registrant as specified in its charter)

RHODE ISLAND
 
05-0404671
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
23 BROAD STREET
 
 
WESTERLY, RHODE ISLAND
 
02891
(Address of principal executive offices)
 
(Zip Code)

(401) 348-1200
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Mark one)
 
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No

The number of shares of common stock of the registrant outstanding as of October 31, 2017 was 17,220,879.



FORM 10-Q
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
For the Quarter Ended September 30, 2017
 
 
TABLE OF CONTENTS
 
Page Number
 
 
 
 



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PART I.  Financial Information
Item 1.  Financial Statements
Consolidated Balance Sheets (unaudited)
(Dollars in thousands, except par value)
 
September 30,
2017
 
December 31,
2016
Assets:
 
 
 
Cash and due from banks

$128,580

 

$106,185

Short-term investments
2,600

 
1,612

Mortgage loans held for sale, at fair value
28,484

 
29,434

Securities:
 
 
 
Available for sale, at fair value
714,355

 
739,912

Held to maturity, at amortized cost (fair value $13,537 at September 30, 2017 and $15,920 at December 31, 2016)
13,241

 
15,633

Total securities
727,596

 
755,545

Federal Home Loan Bank stock, at cost
42,173

 
43,129

Loans:
 
 
 
Commercial
1,800,116

 
1,771,666

Residential real estate
1,195,537

 
1,122,748

Consumer
327,425

 
339,957

Total loans
3,323,078

 
3,234,371

Less allowance for loan losses
27,308

 
26,004

Net loans
3,295,770

 
3,208,367

Premises and equipment, net
28,591

 
29,020

Investment in bank-owned life insurance
72,729

 
71,105

Goodwill
63,909

 
64,059

Identifiable intangible assets, net
9,388

 
10,175

Other assets
69,410

 
62,484

Total assets

$4,469,230

 

$4,381,115

Liabilities:
 
 
 
Deposits:
 
 
 
Demand deposits

$621,273

 

$585,960

NOW accounts
448,128

 
427,707

Money market accounts
716,827

 
730,075

Savings accounts
367,912

 
358,397

Time deposits
1,002,941

 
961,613

Total deposits
3,157,081

 
3,063,752

Federal Home Loan Bank advances
814,045

 
848,930

Junior subordinated debentures
22,681

 
22,681

Other liabilities
61,195

 
54,948

Total liabilities
4,055,002

 
3,990,311

Commitments and contingencies


 


Shareholders’ Equity:
 
 
 
Common stock of $.0625 par value; authorized 60,000,000 shares; issued and outstanding 17,214,160 shares at September 30, 2017 and 17,170,820 shares at December 31, 2016
1,076

 
1,073

Paid-in capital
117,189

 
115,123

Retained earnings
312,334

 
294,365

Accumulated other comprehensive loss
(16,371
)
 
(19,757
)
Total shareholders’ equity
414,228

 
390,804

Total liabilities and shareholders’ equity

$4,469,230

 

$4,381,115


The accompanying notes are an integral part of these unaudited consolidated financial statements.
3



Consolidated Statements of Income (unaudited)
(Dollars and shares in thousands, except per share amounts)


 
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans

$32,509

 

$29,633

 

$94,503

 

$88,753

Interest on securities:
Taxable
4,655

 
3,024

 
14,208

 
7,881

 
Nontaxable
41

 
218

 
225

 
825

Dividends on Federal Home Loan Bank stock
467

 
288

 
1,293

 
729

Other interest income
197

 
93

 
457

 
227

Total interest and dividend income
37,869

 
33,256

 
110,686

 
98,415

Interest expense:
 

 
 

 
 
 
 
Deposits
3,835

 
3,110

 
10,928

 
9,059

Federal Home Loan Bank advances
3,816

 
2,641

 
10,669

 
7,106

Junior subordinated debentures
159

 
125

 
446

 
356

Other interest expense

 
1

 
1

 
4

Total interest expense
7,810

 
5,877

 
22,044

 
16,525

Net interest income
30,059

 
27,379

 
88,642

 
81,890

Provision for loan losses
1,300

 
1,800

 
2,400

 
2,750

Net interest income after provision for loan losses
28,759

 
25,579

 
86,242

 
79,140

Noninterest income:
 
 
 
 
 
 
 
Wealth management revenues
10,013

 
9,623

 
29,432

 
28,278

Mortgage banking revenues
3,036

 
3,734

 
8,295

 
8,642

Service charges on deposit accounts
942

 
915

 
2,726

 
2,757

Card interchange fees
894

 
870

 
2,598

 
2,527

Income from bank-owned life insurance
546

 
521

 
1,624

 
2,110

Loan related derivative income
1,452

 
1,178

 
2,744

 
2,331

Equity in earnings (losses) of unconsolidated subsidiaries
(89
)
 
(88
)
 
(266
)
 
(265
)
Other income
489

 
508

 
1,446

 
1,429

Total noninterest income
17,283

 
17,261

 
48,599

 
47,809

Noninterest expense:
 
 
 
 
 
 
 
Salaries and employee benefits
17,251

 
16,908

 
51,404

 
50,693

Net occupancy
1,928

 
1,766

 
5,662

 
5,376

Equipment
1,380

 
1,648

 
4,160

 
4,652

Outsourced services
1,793

 
1,254

 
4,960

 
3,911

Legal, audit and professional fees
534

 
691

 
1,732

 
1,982

FDIC deposit insurance costs
308

 
504

 
1,258

 
1,488

Advertising and promotion
416

 
370

 
1,015

 
1,055

Amortization of intangibles
253

 
321

 
787

 
966

Debt prepayment penalties

 

 

 
431

Change in fair value of contingent consideration

 
(939
)
 
(310
)
 
(898
)
Other expenses
2,891

 
2,127

 
7,678

 
6,474

Total noninterest expense
26,754

 
24,650

 
78,346

 
76,130

Income before income taxes
19,288

 
18,190

 
56,495

 
50,819

Income tax expense
6,326

 
5,863

 
18,552

 
16,500

Net income

$12,962

 

$12,327

 

$37,943

 

$34,319

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
17,212

 
17,090

 
17,201

 
17,060

Weighted average common shares outstanding - diluted
17,318

 
17,203

 
17,320

 
17,198

Per share information:
Basic earnings per common share

$0.75

 

$0.72

 

$2.20

 

$2.01

 
Diluted earnings per common share

$0.75

 

$0.72

 

$2.19

 

$1.99

 
Cash dividends declared per share

$0.39

 

$0.37

 

$1.15

 

$1.09


The accompanying notes are an integral part of these unaudited consolidated financial statements.
4



Consolidated Statements of Comprehensive Income (unaudited)
(Dollars in thousands)


 
Three Months
 
Nine Months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Net income

$12,962

 

$12,327

 

$37,943

 

$34,319

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Net change in fair value of securities available for sale
1,094

 
(91
)
 
3,323

 
1,651

Net change in fair value of cash flow hedges
(13
)
 
(4
)
 
(364
)
 
(94
)
Net change in defined benefit plan obligations
217

 
166

 
427

 
497

Total other comprehensive income, net of tax
1,298

 
71

 
3,386

 
2,054

Total comprehensive income

$14,260

 

$12,398

 

$41,329

 

$36,373




The accompanying notes are an integral part of these unaudited consolidated financial statements.
5



Consolidated Statements of Changes in Shareholders' Equity (unaudited)
(Dollars and shares in thousands)


 
Common
Shares Outstanding
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Total
Balance at January 1, 2017
17,171

 

$1,073

 

$115,123

 

$294,365

 

($19,757
)
 

$390,804

Net income

 

 

 
37,943

 

 
37,943

Total other comprehensive income, net of tax

 

 

 
 
 
3,386

 
3,386

Cash dividends declared

 

 

 
(19,974
)
 

 
(19,974
)
Share-based compensation

 

 
1,872

 

 

 
1,872

Exercise of stock options, issuance of other compensation-related equity awards
43

 
3

 
194

 

 

 
197

Balance at September 30, 2017
17,214

 

$1,076

 

$117,189

 

$312,334

 

($16,371
)
 

$414,228



 
Common
Shares Outstanding
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Total
Balance at January 1, 2016
17,020

 

$1,064

 

$110,949

 

$273,074

 

($9,699
)
 

$375,388

Net income

 

 

 
34,319

 

 
34,319

Total other comprehensive income, net of tax

 

 

 

 
2,054

 
2,054

Cash dividends declared

 

 

 
(18,780
)
 

 
(18,780
)
Share-based compensation

 

 
1,634

 

 

 
1,634

Exercise of stock options, issuance of other compensation-related equity awards and related tax benefit
87

 
5

 
707

 

 

 
712

Balance at September 30, 2016
17,107

 

$1,069

 

$113,290

 

$288,613

 

($7,645
)
 

$395,327



The accompanying notes are an integral part of these unaudited consolidated financial statements.
6



Consolidated Statement of Cash Flows (unaudited)
(Dollars in thousands)


Nine months ended September 30,
2017

 
2016

Cash flows from operating activities:
 
 
 
Net income

$37,943

 

$34,319

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
2,400

 
2,750

Depreciation of premises and equipment
2,613

 
2,737

Net amortization of premium and discount
2,560

 
1,802

Amortization of intangibles
787

 
966

Goodwill impairment
150

 

Share-based compensation
1,872

 
1,634

Tax benefit from stock option exercises and other equity awards
414

 
430

Income from bank-owned life insurance
(1,624
)
 
(2,110
)
Net gains on loan sales and commissions on loans originated for others, including fair value adjustments
(8,004
)
 
(8,682
)
Net gain on sale of portfolio loans

 
(135
)
Equity in (earnings) losses of unconsolidated subsidiaries
266

 
265

Proceeds from sales of loans
345,539

 
370,526

Loans originated for sale
(337,772
)
 
(369,746
)
Change in fair value of contingent consideration liability
(310
)
 
(898
)
Increase in other assets
(9,814
)
 
(22,719
)
Increase in other liabilities
6,537

 
17,635

Net cash provided by operating activities
43,557

 
28,774

Cash flows from investing activities:
 
 
 
Purchases of:
Mortgage-backed securities available for sale
(35,213
)
 
(248,221
)
 
Other investment securities available for sale
(19,963
)
 
(70,495
)
Maturities and principal payments of:
Mortgage-backed securities available for sale
62,745

 
41,446

 
Other investment securities available for sale
21,269

 
89,441

 
Mortgage-backed securities held to maturity
2,283

 
3,029

Remittance (purchases) of Federal Home Loan Bank stock
956

 
(12,933
)
Net increase in loans
(88,914
)
 
(95,759
)
Net proceeds from sale of portfolio loans

 
510

Purchases of loans
(737
)
 
(77,180
)
Proceeds from the sale of property acquired through foreclosure or repossession
513

 
731

Purchases of premises and equipment
(2,184
)
 
(2,608
)
Purchases of bank-owned life insurance

 
(5,000
)
Proceeds from bank-owned life insurance

 
2,054

Net cash used in investing activities
(59,245
)
 
(374,985
)
Cash flows from financing activities:
 
 
 
Net increase in deposits
93,329

 
103,119

Proceeds from Federal Home Loan Bank advances
1,000,000

 
981,250

Repayment of Federal Home Loan Bank advances
(1,034,885
)
 
(688,608
)
Net proceeds from stock option exercises and issuance of other equity awards
194

 
282

Cash dividends paid
(19,567
)
 
(18,291
)
Net cash provided by financing activities
39,071

 
377,752

Net increase in cash and cash equivalents
23,383

 
31,541

Cash and cash equivalents at beginning of period
107,797

 
97,631

Cash and cash equivalents at end of period

$131,180

 

$129,172

Noncash Investing and Financing Activities:
 
 
 
Loans charged off

$1,415

 

$4,390

Loans transferred to property acquired through foreclosure or repossession
576

 
1,045

Supplemental Disclosures:
 
 
 
Interest payments

$21,512

 

$16,093

Income tax payments
19,272

 
14,860


The accompanying notes are an integral part of these unaudited consolidated financial statements.
7



Condensed Notes to Unaudited Consolidated Financial Statements


(1) General Information
Washington Trust Bancorp, Inc. (the “Bancorp”) is a publicly-owned registered bank holding company that has elected to be a financial holding company.  The Bancorp’s subsidiaries include The Washington Trust Company, of Westerly (the “Bank”), a Rhode Island chartered commercial bank founded in 1800, and Weston Securities Corporation (“WSC”).  Through its subsidiaries, the Bancorp offers a comprehensive product line of banking and financial services, including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management services through its offices in Rhode Island, eastern Massachusetts and Connecticut; its automated teller machines (“ATMs”); telephone banking; mobile banking and its internet website (www.washtrust.com).

The Unaudited Consolidated Financial Statements include the accounts of the Bancorp and its subsidiaries (collectively the “Corporation” or “Washington Trust”).  All intercompany transactions have been eliminated. Certain previously reported amounts have been reclassified to conform to the current year’s presentation.

The accounting and reporting policies of the Corporation conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices of the banking industry.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period.  Actual results could differ from those estimates.

The Unaudited Consolidated Financial Statements of the Corporation presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and note disclosures required by GAAP. In the opinion of management, all adjustments (consisting of normal recurring adjustments) and disclosures considered necessary for the fair presentation of the accompanying Unaudited Consolidated Financial Statements have been included. Interim results are not necessarily reflective of the results of the entire year. The accompanying Unaudited Consolidated Financial Statements should be read in conjunction with the Audited Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

(2) Recently Issued Accounting Pronouncements
Revenue from Contracts with Customers - Topic 606
Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), was issued in May 2014 and provides a revenue recognition framework for any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets unless those contracts are within the scope of other accounting standards. As issued, ASU 2014-09 was effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period with early adoption not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, Accounting Standards Update No. 2015-14, “Deferral of the Effective Date” (“ASU 2015-14”) was issued and delayed the effective date of ASU 2014-09 to annual and interim periods in fiscal years beginning after December 15, 2017. In 2016, Accounting Standards Update No. 2016-08, “Principal versus Agent Considerations” (“ASU 2016-08”), Accounting Standards Update No. 2016-10, “Identifying Performance Obligations and Licensing” (“ASU 2016-10”) and Accounting Standards Update No. 2016-12, “Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”) were issued. These ASUs do not change the core principle for revenue recognition in Topic 606; instead, the amendments provide more detailed guidance in a few areas and additional implementation guidance and examples, which are expected to reduce the degree of judgment necessary to comply with Topic 606. The effective date and transition requirements for ASU 2016-08, ASU 2016-10 and ASU 2016-12 are the same as those provided by ASU 2015-14. Management assembled a project team to address the changes pursuant to Topic 606. The project team has completed the scope assessment and contract review for in-scope revenue streams. Washington Trust's largest source of revenue is net interest income on financial assets and liabilities, which is explicitly excluded from the scope of this ASU. Revenue streams that are within the scope of Topic 606 include wealth management revenues, service charges on deposit accounts and card interchange fees. Management does not anticipate a material change in the timing or measurement of in-scope revenues and continues to evaluate the effect that this ASU will have on the recognition of certain contract acquisition costs, as well as changes in the required disclosures. The Corporation plans to adopt ASU 2014-09 using the modified retrospective transition method with a cumulative effect adjustment to opening retained earnings as of January 1, 2018.

Financial Instruments - Overall - Topic 825
Accounting Standards Update No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”), was issued in January 2016 and provides revised guidance related to the accounting for and reporting of financial


- 8-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

instruments. Some of the main provisions include: requiring most equity securities to be reported at fair value with unrealized gains and losses reported in the income statement; requiring separate presentation of financial assets and liabilities by measurement category and form (i.e. securities or loans); clarifying that entities must assess valuation allowances on a deferred tax asset related to available for sale debt securities in combination with their other deferred tax assets; and eliminating the requirement to disclose the method and significant assumptions used to estimate fair value for financial instruments measured at amortized cost on the balance sheet. ASU 2016-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of ASU 2016-01 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Leases - Topic 842
Accounting Standards Update No. 2016-02, “Leases” (“ASU 2016-02”), was issued in February 2016 and provides revised guidance related to the accounting and reporting of leases. ASU 2016-02 requires lessees to recognize most leases on the balance sheet. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as a finance or operating lease. ASU 2016-02 requires a modified retrospective transition, with a number of practical expedients that entities may elect to apply. ASU 2016-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. Washington Trust expects to adopt the provisions of ASU 2016-02 effective January 1, 2019. Management has assembled a project team that meets regularly to evaluate the provisions of this ASU, identify additional data requirements necessary and determine an approach for implementation. The Corporation has not yet determined the impact ASU 2016-02 will have on its consolidated financial statements.

Compensation - Stock Compensation - Topic 718
Accounting Standards Update No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), was issued in March 2016. ASU 2016-09 includes multiple provisions intended to simplify several aspects of the accounting for share-based payment transactions, including income tax consequences and the classification of certain tax-related transactions on the statement of cash flows. ASU 2016-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. Management adopted the provisions of this ASU on January 1, 2017 using the appropriate transition method as required by ASU 2016-09. For Washington Trust, the most significant provision of this ASU pertained to the accounting for excess tax benefits or tax deficiencies on share based award exercises and vestings. ASU 2016-09 requires that excess tax benefits or tax deficiencies be recognized as income tax benefit or expense in the Consolidated Statements of Income in the period that they occur. Management adopted this specific provision of the ASU on a prospective basis. The ASU also requires that the excess tax benefits or tax deficiencies be reported as an operating activity in the Consolidated Statement of Cash Flows and, in accordance with the ASU, management elected the retrospective transition method in adopting this specific provision. The adoption of ASU 2016-09 did not have a material impact on the consolidated financial statements.

Financial Instruments - Credit Losses - Topic 326
Accounting Standards Update No. 2016-13, “Financial Instruments - Credit Losses” (“ASU 2016-13”), was issued in June 2016. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 provides for a modified retrospective transition, resulting in a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is effective, except for debt securities for which an other-than-temporary impairment has previously been recognized. For these debt securities, a prospective transition approach will be adopted in order to maintain the same amortized cost prior to and subsequent to the effective date of ASU 2016-13. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted, for annual periods and interim periods within those annual periods, beginning after December 15, 2018. Washington Trust is evaluating the effect that this ASU will have on consolidated financial statements and disclosures. Management has assembled a project team that meets regularly to evaluate the provisions of this ASU, identify additional data requirements necessary and determine an approach for implementation. The Corporation has not yet determined if it will early adopt ASU 2016-13 or the impact it will have on its consolidated financial statements.

Statement of Cash Flows - Topic 230
Accounting Standards Update No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), was issued in August 2016. ASU 2016-15 provides classification guidance on certain cash receipts and cash payments, including, but not limited to, debt prepayment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of bank-owned life insurance policies and distributions received


- 9-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

from equity method investees. The adoption of ASU 2016-15 requires a retrospective transition method applied to each period presented. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The adoption of ASU 2016-15 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Accounting Standards Update No. 2016-18, “Restricted Cash” (“ASU 2016-18”), was issued in November 2016. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash. Restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The adoption of ASU 2016-18 requires a retrospective transition method applied to each period presented. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The adoption of ASU 2016-18 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Intangibles - Goodwill and Other - Topic 350
Accounting Standards Update No. 2017-04, “Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”), was issued in January 2017 and eliminates Step 2 of the annual goodwill impairment test.  Step 2 is a more detailed analysis, which involves measuring the excess of the fair value of the reporting unit, as determined in Step 1, over the aggregate fair value of the individual assets, liabilities, and identifiable intangibles as if the reporting unit was being acquired in a business combination. Under ASU 2017-04, an impairment charge would be recognized for the amount by which the carrying amount exceeded the reporting unit’s fair value under Step 1.  ASU 2017-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019 and the provisions should be applied on a prospective basis.  Effective April 1, 2017, management early adopted the provisions of this ASU, as permitted.  The adoption of ASU 2017-04 did not have a material impact on the Corporation’s consolidated financial statements.

Compensation - Retirement Benefits - Topic 715
Accounting Standards Update No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”), was issued in March 2017. ASU 2017-07 requires that employers include the service cost component of net periodic benefit cost in the same line item as other employee compensation costs and all other components of net periodic benefit cost in a separate line item(s) in the statement of income. In addition, the line item in which the components of net periodic benefit cost other than the service cost are included shall be identified as such on the statement of income or in the notes to the financial statements. ASU 2017-07 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of ASU 2017-07 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Receivables - Nonrefundable Fees and Other Costs - Subtopic 310-20
Accounting Standards Update No. 2017-08, “Premium Amortization on Purchased Callable Debt Securities” (“ASU 2017-08”), was issued in March 2017. ASU 2017-08 shortens the amortization period for certain callable debt securities purchased at a premium by requiring that the premium be amortized to the earliest call date. Effective January 1, 2017, management early adopted the provisions of this ASU, as permitted. The adoption of ASU 2017-08 did not have a material impact on the Corporation’s consolidated financial statements.

Compensation - Stock Compensation - Topic 718
Accounting Standards Update No. 2017-09, “Scope of Modification Accounting” (“ASU 2017-09”), was issued in May 2017 to provide clarity when applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. ASU 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 and the provisions should be applied on a prospective basis.  Early adoption is permitted. The adoption of ASU 2017-09 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Derivatives and Hedging - Topic 815
Accounting Standards Update No. 2017-12, “Targeted Improvements to Accounting for Hedging Activities” (“ASU 2017-12”), was issued in August 2017 to better align financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. The provisions of ASU 2017-12 should be applied on a modified retrospective transition method in which the Corporation will recognize the cumulative effect of the change in the opening balance of retained earnings as of the adoption date. The Corporation has not yet determined the impact ASU 2017-12 will have on its consolidated financial statements.



- 10-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(3) Cash and Due from Banks
The Bank maintains certain average reserve balances to meet the requirements of the Board of Governors of the Federal Reserve System (“FRB”).  Some or all of these reserve requirements may be satisfied with vault cash. Reserve balances amounted to $11.9 million at September 30, 2017 and $11.5 million at December 31, 2016 and were included in cash and due from banks in the Unaudited Consolidated Balance Sheets.

As of September 30, 2017 and December 31, 2016, cash and due from banks included interest-bearing deposits in other banks of $42.0 million and $60.3 million, respectively.

(4) Securities
The following tables present the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value of securities by major security type and class of security:
(Dollars in thousands)
 
September 30, 2017
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$121,499

 

$—

 

($2,374
)
 

$119,125

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
563,240

 
4,915

 
(6,485
)
 
561,670

Obligations of states and political subdivisions
3,156

 
7

 

 
3,163

Individual name issuer trust preferred debt securities
27,897

 

 
(1,509
)
 
26,388

Corporate bonds
4,122

 
24

 
(137
)
 
4,009

Total securities available for sale

$719,914

 

$4,946

 

($10,505
)
 

$714,355

Held to Maturity:
 
 
 
 
 
 
 
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises

$13,241

 

$296

 

$—

 

$13,537

Total securities held to maturity

$13,241

 

$296

 

$—

 

$13,537

Total securities

$733,155

 

$5,242

 

($10,505
)
 

$727,892



(Dollars in thousands)
 
December 31, 2016
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$111,483

 

$7

 

($3,050
)
 

$108,440

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
592,833

 
4,923

 
(9,671
)
 
588,085

Obligations of states and political subdivisions
14,423

 
62

 

 
14,485

Individual name issuer trust preferred debt securities
29,851

 

 
(3,115
)
 
26,736

Corporate bonds
2,155

 
16

 
(5
)
 
2,166

Total securities available for sale

$750,745

 

$5,008

 

($15,841
)
 

$739,912

Held to Maturity:
 
 
 
 
 
 
 
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises

$15,633

 

$287

 

$—

 

$15,920

Total securities held to maturity

$15,633

 

$287

 

$—

 

$15,920

Total securities

$766,378

 

$5,295

 

($15,841
)
 

$755,832




- 11-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

As of September 30, 2017 and December 31, 2016, securities with a fair value of $364.3 million and $736.2 million, respectively, were pledged as collateral for Federal Home Loan Bank of Boston (“FHLBB”) borrowings, potential borrowings with the FRB, certain public deposits and for other purposes. See Note 8 for additional disclosure on FHLBB borrowings.

The schedule of maturities of debt securities available for sale and held to maturity is presented below. Mortgage-backed securities are included based on weighted average maturities, adjusted for anticipated prepayments.  All other debt securities are included based on contractual maturities.  Actual maturities may differ from amounts presented because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties.
(Dollars in thousands)
Available for Sale
 
Held to Maturity
September 30, 2017
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less

$59,796

 

$59,636

 

$1,792

 

$1,832

Due after one year to five years
226,076

 
224,715

 
5,603

 
5,728

Due after five years to ten years
246,549

 
243,740

 
4,239

 
4,334

Due after ten years
187,493

 
186,264

 
1,607

 
1,643

Total securities

$719,914

 

$714,355

 

$13,241

 

$13,537


Included in the above table are debt securities with an amortized cost balance of $155.5 million and a fair value of $151.5 million at September 30, 2017 that are callable at the discretion of the issuers.  Final maturities of the callable securities range from 8 months to 19 years, with call features ranging from 1 month to 4 years.

Other-Than-Temporary Impairment Assessment
Washington Trust assesses whether the decline in fair value of investment securities is other-than-temporary on a regular basis. Unrealized losses on debt securities may occur from current market conditions, increases in interest rates since the time of purchase, a structural change in an investment, volatility of earnings of a specific issuer, or deterioration in credit quality of the issuer.  Management evaluates impairments in value both qualitatively and quantitatively to assess whether they are other-than-temporary.

The following tables summarize temporarily impaired securities, segregated by length of time the securities have been in a continuous unrealized loss position:
(Dollars in thousands)
Less than 12 Months
 
12 Months or Longer
 
Total
September 30, 2017
#
 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
Obligations of U.S. government-sponsored enterprises
9

 

$79,988


($1,511
)
 
2

 

$29,137


($863
)
 
11

 

$109,125


($2,374
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
20

 
153,078

(2,200
)
 
14

 
179,166

(4,285
)
 
34

 
332,244

(6,485
)
Individual name issuer trust preferred debt securities

 


 
9

 
26,388

(1,509
)
 
9

 
26,388

(1,509
)
Corporate bonds
2

 
402

(1
)
 
1

 
1,845

(136
)
 
3

 
2,247

(137
)
Total temporarily impaired securities
31

 

$233,468


($3,712
)
 
26

 

$236,536


($6,793
)
 
57

 

$470,004


($10,505
)




- 12-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Less than 12 Months
 
12 Months or Longer
 
Total
December 31, 2016
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
Obligations of U.S. government-sponsored enterprises
10

 

$98,433


($3,050
)
 

 

$—


$—

 
10

 

$98,433


($3,050
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
35

 
407,073

(9,671
)
 

 


 
35

 
407,073

(9,671
)
Individual name issuer trust preferred debt securities

 


 
10

 
26,736

(3,115
)
 
10

 
26,736

(3,115
)
Corporate bonds
2

 
400

(5
)
 

 


 
2

 
400

(5
)
Total temporarily impaired securities
47

 

$505,906


($12,726
)
 
10

 

$26,736


($3,115
)
 
57

 

$532,642


($15,841
)

Further deterioration in credit quality of the underlying issuers of the securities, further deterioration in the condition of the financial services industry, worsening of the current economic environment, or additional declines in real estate values, among other things, may further affect the fair value of these securities and increase the potential that certain unrealized losses be designated as other-than-temporary in future periods, and the Corporation may incur write-downs.

U.S. Government Agency and U.S. Government-Sponsored Enterprise Securities, including Mortgage-Backed Securities
The gross unrealized losses on U.S. government agency and U.S government-sponsored debt securities, including mortgage-backed securities, were primarily attributable to relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on the assessment of these factors, management believes that the unrealized losses on these debt security holdings are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Washington Trust does not intend to sell these securities and it is not more-likely-than-not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2017.

Trust Preferred Debt Securities of Individual Name Issuers
Included in debt securities in an unrealized loss position at September 30, 2017 were nine trust preferred security holdings issued by six individual companies in the banking sector.  Management believes the unrealized loss position in these holdings was attributable to the general widening of spreads for this category of debt securities issued by financial services companies since the time these securities were purchased.  Based on the information available through the filing date of this report, all individual name issuer trust preferred debt securities held in our portfolio continue to accrue and make payments as expected with no payment deferrals or defaults on the part of the issuers.  As of September 30, 2017, individual name issuer trust preferred debt securities with an amortized cost of $10.9 million and unrealized losses of $621 thousand were rated below investment grade by Standard & Poors, Inc. (“S&P”).  Management reviewed the collectibility of these securities taking into consideration such factors as the financial condition of the issuers, reported regulatory capital ratios of the issuers, credit ratings, including ratings in effect as of the reporting period date as well as credit rating changes between the reporting period date and the filing date of this report, and other information.  We noted no additional downgrades to below investment grade between September 30, 2017 and the filing date of this report.  Based on this review, management concluded that it expects to recover the entire amortized cost basis of these securities.  Furthermore, Washington Trust does not intend to sell these securities and it is not more-likely-than-not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be maturity.  Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2017.



- 13-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(5) Loans
The following is a summary of loans:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount

 
%

 
Amount

 
%

Commercial:
 
 
 
 
 
 
 
Mortgages (1)

$1,085,535

 
33
%
 

$1,074,186

 
33
%
Construction & development (2)
126,257

 
4

 
121,371

 
4

Commercial & industrial (3)
588,324

 
17

 
576,109

 
18

Total commercial
1,800,116

 
54

 
1,771,666

 
55

Residential Real Estate:
 
 
 
 
 
 
 
Mortgages
1,171,161

 
35

 
1,094,824

 
34

Homeowner construction
24,376

 
1

 
27,924

 
1

Total residential real estate
1,195,537

 
36

 
1,122,748

 
35

Consumer:
 
 
 
 
 
 
 
Home equity lines
259,880

 
8

 
264,200

 
8

Home equity loans
34,777

 
1

 
37,272

 
1

Other (4)
32,768

 
1

 
38,485

 
1

Total consumer
327,425

 
10

 
339,957

 
10

Total loans (5)

$3,323,078

 
100
%
 

$3,234,371

 
100
%
(1)
Loans primarily secured by income producing property.
(2)
Loans for construction of commercial properties, loans to developers for construction of residential properties and loans for land development.
(3)
Loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.
(4)
Loans to individuals secured by general aviation aircraft and other personal installment loans.
(5)
Includes net unamortized loan origination costs of $3.9 million and $3.0 million, respectively, at September 30, 2017 and December 31, 2016 and net unamortized premiums on purchased loans of $781 thousand and $783 thousand, respectively, at September 30, 2017 and December 31, 2016.

As of September 30, 2017 and December 31, 2016, there were $1.6 billion and $1.4 billion, respectively, of loans pledged as collateral for FHLBB borrowings and potential borrowings with the FRB. See Note 8 for additional disclosure regarding borrowings.

Nonaccrual Loans
Loans, with the exception of certain well-secured loans that are in the process of collection, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more overdue with respect to principal and/or interest, or sooner if considered appropriate by management. Well-secured loans are permitted to remain on accrual status provided that full collection of principal and interest is assured and the loan is in the process of collection. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued but not collected on such loans is reversed against current period income. Subsequent interest payments received on nonaccrual loans are applied to the outstanding principal balance of the loan or recognized as interest income depending on management’s assessment of the ultimate collectability of the loan. Loans are removed from nonaccrual status when they have been current as to principal and interest generally for a period of six months, the borrower has demonstrated an ability to comply with repayment terms, and when, in management’s opinion, the loans are considered to be fully collectible.



- 14-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following is a summary of nonaccrual loans, segregated by class of loans:
(Dollars in thousands)
Sep 30,
2017
 
Dec 31,
2016
Commercial:
 
 
 
Mortgages

$5,887

 

$7,811

Construction & development

 

Commercial & industrial
429

 
1,337

Residential Real Estate:
 
 
 
Mortgages
11,699

 
11,736

Homeowner construction

 

Consumer:
 
 
 
Home equity lines
27

 

Home equity loans
453

 
1,058

Other
16

 
116

Total nonaccrual loans

$18,511

 

$22,058

Accruing loans 90 days or more past due

$—

 

$—


As of September 30, 2017 and December 31, 2016, loans secured by one- to four-family residential property amounting to $3.9 million and $5.7 million, respectively, were in process of foreclosure.

Nonaccrual loans of $5.3 million and $3.5 million, respectively, were current as to the payment of principal and interest at September 30, 2017 and December 31, 2016.

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at September 30, 2017.

Past Due Loans
Past due status is based on the contractual payment terms of the loan. The following tables present an age analysis of past due loans, segregated by class of loans:
(Dollars in thousands)
Days Past Due
 
 
 
 
 
 
September 30, 2017
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$—

 

$—

 

$5,887

 

$5,887

 

$1,079,648

 

$1,085,535

Construction & development

 

 

 

 
126,257

 
126,257

Commercial & industrial
8

 
21

 
426

 
455

 
587,869

 
588,324

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
1,530

 
1,748

 
4,524

 
7,802

 
1,163,359

 
1,171,161

Homeowner construction

 

 

 

 
24,376

 
24,376

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
761

 
54

 

 
815

 
259,065

 
259,880

Home equity loans
847

 
549

 
57

 
1,453

 
33,324

 
34,777

Other
19

 
1

 
15

 
35

 
32,733

 
32,768

Total loans

$3,165

 

$2,373

 

$10,909

 

$16,447

 

$3,306,631

 

$3,323,078




- 15-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Days Past Due
 
 
 
 
 
 
December 31, 2016
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$901

 

$—

 

$7,807

 

$8,708

 

$1,065,478

 

$1,074,186

Construction & development

 

 

 

 
121,371

 
121,371

Commercial & industrial
409

 

 
745

 
1,154

 
574,955

 
576,109

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
5,381

 
652

 
6,193

 
12,226

 
1,082,598

 
1,094,824

Homeowner construction

 

 

 

 
27,924

 
27,924

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
655

 
26

 

 
681

 
263,519

 
264,200

Home equity loans
776

 
76

 
658

 
1,510

 
35,762

 
37,272

Other
32

 
1

 
110

 
143

 
38,342

 
38,485

Total loans

$8,154

 

$755

 

$15,513

 

$24,422

 

$3,209,949

 

$3,234,371


Included in past due loans as of September 30, 2017 and December 31, 2016, were nonaccrual loans of $13.2 million and $18.6 million, respectively.

All loans 90 days or more past due at September 30, 2017 and December 31, 2016 were classified as nonaccrual.



- 16-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Impaired Loans
Impaired loans are loans for which it is probable that the Corporation will not be able to collect all amounts due according to the contractual terms of the loan agreements and loans restructured in a troubled debt restructuring.

The following is a summary of impaired loans:
(Dollars in thousands)
Recorded Investment (1)
 
Unpaid Principal
 
Related Allowance
 
Sep 30,
2017
 
Dec 31,
2016
 
Sep 30,
2017
 
Dec 31,
2016
 
Sep 30,
2017
 
Dec 31,
2016
No Related Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$776

 

$4,676

 

$773

 

$9,019

 

$—

 

$—

Construction & development

 

 

 

 

 

Commercial & industrial
5,077

 
6,458

 
5,183

 
6,550

 

 

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
9,430

 
14,385

 
9,574

 
14,569

 

 

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
27

 

 
27

 

 

 

Home equity loans
453

 
1,137

 
453

 
1,177

 

 

Other
14

 
116

 
14

 
116

 

 

Subtotal
15,777

 
26,772

 
16,024

 
31,431

 

 

With Related Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$5,886

 

$5,104

 

$9,909

 

$6,087

 

$933

 

$448

Construction & development

 

 

 

 

 

Commercial & industrial
734

 
662

 
775

 
699

 
48

 
3

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
2,640

 
1,285

 
2,667

 
1,310

 
157

 
151

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines

 

 

 

 

 

Home equity loans

 

 

 

 

 

Other
134

 
28

 
135

 
29

 
7

 
4

Subtotal
9,394

 
7,079

 
13,486

 
8,125

 
1,145

 
606

Total impaired loans

$25,171

 

$33,851

 

$29,510

 

$39,556

 

$1,145

 

$606

Total:
 
 
 
 
 
 
 
 
 
 
 
Commercial

$12,473

 

$16,900

 

$16,640

 

$22,355

 

$981

 

$451

Residential real estate
12,070

 
15,670

 
12,241

 
15,879

 
157

 
151

Consumer
628

 
1,281

 
629

 
1,322

 
7

 
4

Total impaired loans

$25,171

 

$33,851

 

$29,510

 

$39,556

 

$1,145

 

$606

(1)
The recorded investment in impaired loans consists of unpaid principal balance, net of charge-offs, interest payments received applied to principal and unamortized deferred loan origination fees and costs. For impaired accruing loans (troubled debt restructurings for which management has concluded that the collectibility of the loan is not in doubt), the recorded investment also includes accrued interest.



- 17-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the average recorded investment balance of impaired loans and interest income recognized on impaired loans segregated by loan class.
 
 
 
 
 
 
 
 
(Dollars in thousands)
Average Recorded Investment
 
Interest Income Recognized
Three months ended September 30,
2017
 
2016
 
2017
 
2016
Commercial:
 
 
 
 
 
 
 
Mortgages

$8,041

 

$13,159

 

$21

 

$40

Construction & development

 

 

 

Commercial & industrial
6,427

 
2,342

 
67

 
21

Residential Real Estate:


 


 


 


Mortgages
15,107

 
13,962

 
102

 
86

Homeowner construction

 

 

 

Consumer:


 


 


 


Home equity lines
73

 
297

 
1

 
2

Home equity loans
470

 
1,328

 
4

 
9

Other
142

 
145

 
2

 
3

Totals

$30,260

 

$31,233

 

$197

 

$161

 
 
 
 
 
 
 
 
(Dollars in thousands)
Average Recorded Investment
 
Interest Income Recognized
Nine months ended September 30,
2017
 
2016
 
2017
 
2016
Commercial:
 
 
 
 
 
 
 
Mortgages

$9,117

 

$13,856

 

$73

 

$220

Construction & development

 

 

 

Commercial & industrial
6,750

 
3,141

 
219

 
42

Residential Real Estate:
 
 
 
 
 
 
 
Mortgages
15,750

 
11,985

 
374

 
253

Homeowner construction

 

 

 

Consumer:
 
 
 
 
 
 
 
Home equity lines
81

 
427

 
5

 
10

Home equity loans
653

 
1,240

 
20

 
33

Other
142

 
147

 
8

 
7

Totals

$32,493

 

$30,796

 

$699

 

$565


Troubled Debt Restructurings
Loans are considered restructured in a troubled debt restructuring when the Corporation has granted concessions,that it otherwise would not have considered, to a borrower experiencing financial difficulties. These concessions may include modifications of the terms of the debt such as deferral of payments, extension of maturity, reduction of principal balance, reduction of the stated interest rate other than normal market rate adjustments, or a combination of these concessions. Debt may be bifurcated with separate terms for each tranche of the restructured debt. Restructuring a loan in lieu of aggressively enforcing the collection of the loan may benefit the Corporation by increasing the ultimate probability of collection.

Restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectibility of the loan. Loans that are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately 6 months before management considers such loans for return to accruing status. Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term.



- 18-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Troubled debt restructurings are reported as such for at least one year from the date of the restructuring. In years after the restructuring, troubled debt restructured loans are removed from this classification if the restructuring did not involve a below-market rate concession and the loan is not deemed to be impaired based on the terms specified in the restructuring agreement.

Troubled debt restructurings are classified as impaired loans. The Corporation identifies loss allocations for impaired loans on an individual loan basis. The recorded investment in troubled debt restructurings was $13.5 million and $22.3 million, respectively, at September 30, 2017 and December 31, 2016. These amounts included insignificant balances of accrued interest. The allowance for loan losses included specific reserves for these troubled debt restructurings of $1.1 million and $567 thousand, respectively, at September 30, 2017 and December 31, 2016.

As of September 30, 2017, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.

The following tables present loans modified as a troubled debt restructuring:
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
Outstanding Recorded Investment (1)
 
# of Loans
 
Pre-Modifications
 
Post-Modifications
Three months ended September 30,
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

 

 

$—

 

$—

 

$—

 

$—

Construction & development

 

 

 

 

 

Commercial & industrial

 
5

 

 
914

 

 
914

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

 

 

 

 

 

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines

 

 

 

 

 

Home equity loans

 

 

 

 

 

Other

 

 

 

 

 

Totals

 
5

 

$—

 

$914

 

$—

 

$914

(1)
The recorded investment in troubled debt restructurings consists of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs, at the time of the restructuring. For accruing troubled debt restructured loans, the recorded investment also includes accrued interest.


- 19-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
Outstanding Recorded Investment (1)
 
# of Loans
 
Pre-Modifications
 
Post-Modifications
Nine months ended September 30,
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

 

 

$—

 

$—

 

$—

 

$—

Construction & development

 

 

 

 

 

Commercial & industrial

 
6

 

 
1,047

 

 
1,047

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

 
1

 

 
3,550

 

 
3,550

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines

 

 

 

 

 

Home equity loans

 

 

 

 

 

Other

 

 

 

 

 

Totals

 
7

 

$—

 

$4,597

 

$—

 

$4,597

(1)
The recorded investment in troubled debt restructurings consists of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs, at the time of the restructuring. For accruing troubled debt restructured loans, the recorded investment also includes accrued interest.

The following table provides information on how loans were modified as a troubled debt restructuring:
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Below-market interest rate concession

$—

 

$—

 

$—

 

$—

Payment deferral

 

 

 

Maturity / amortization concession

 
324

 

 
457

Interest only payments

 

 

 
3,550

Combination (1)

 
590

 

 
590

Total

$—

 

$914

 

$—

 

$4,597

(1)
Loans included in this classification were modified with a combination of any two of the concessions listed in this table.
 
 
 
 
 
 
 
 
For the three months ended September 30, 2017, there were no payment defaults on troubled debt restructured loans modified within the previous 12 months. For the nine months ended September 30, 2017, payment defaults on troubled debt restructured loans modified within the previous 12 months occurred on two loans totaling $1.6 million. For the three and nine months ended September 30, 2016, payment defaults on troubled debt restructured loans modified within the previous 12 months occurred on three loans totaling $6.6 million and seven loans totaling $6.7 million, respectively.

Credit Quality Indicators
Commercial
The Corporation utilizes an internal rating system to assign a risk to each of its commercial loans. Loans are rated on a scale of 1 to 10. This scale can be assigned to three broad categories including “pass” for ratings 1 through 6, “special mention” for 7-rated loans, and “classified” for loans rated 8, 9 or 10. The loan rating system takes into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, the adequacy of collateral, the adequacy of guarantees and other credit quality characteristics. The weighted average risk rating of the Corporation’s commercial loan portfolio was 4.71 at September 30, 2017 and 4.68 at December 31, 2016. For non-impaired loans, the Corporation takes the risk rating into consideration along with other credit attributes in the establishment of an appropriate allowance for loan losses.



- 20-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

A description of the commercial loan categories is as follows:

Pass - Loans with acceptable credit quality, defined as ranging from superior or very strong to a status of lesser stature. Superior or very strong credit quality is characterized by a high degree of cash collateralization or strong balance sheet liquidity. Lesser stature loans have an acceptable level of credit quality but exhibit some weakness in various credit metrics such as collateral adequacy, cash flow, secondary sources of repayment, or performance inconsistency or may be in an industry or of a loan type known to have a higher degree of risk.

Special Mention - Loans with potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s position as creditor at some future date. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Examples of these conditions include but are not limited to outdated or poor quality financial data, strains on liquidity and leverage, losses or negative trends in operating results, marginal cash flow, weaknesses in occupancy rates or trends in the case of commercial real estate and frequent delinquencies.

Classified - Loans identified as “substandard”, “doubtful” or “loss” based on criteria consistent with guidelines provided by banking regulators. A “substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. The loans are closely watched and are either already on nonaccrual status or may be placed on nonaccrual status when management determines there is uncertainty of collectibility. A “doubtful” loan is placed on non-accrual status and has a high probability of loss, but the extent of the loss is difficult to quantify due to dependency upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. A loan in the “loss” category is considered generally uncollectible or the timing or amount of payments cannot be determined. “Loss” is not intended to imply that the loan has no recovery value but rather it is not practical or desirable to continue to carry the asset.

The Corporation’s procedures call for loan ratings and classifications to be revised whenever information becomes available that indicates a change is warranted. The criticized loan portfolio, which generally consists of commercial loans that are risk-rated special mention or worse, and other selected loans are reviewed by management on a quarterly basis, focusing on the current status and strategies to improve the credit. An annual loan review program is conducted by a third party to provide an independent evaluation of the creditworthiness of the commercial loan portfolio, the quality of the underwriting and credit risk management practices and the appropriateness of the risk rating classifications. This review is supplemented with selected targeted internal reviews of the commercial loan portfolio.

The following table presents the commercial loan portfolio, segregated by category of credit quality indicator:
(Dollars in thousands)
Pass
 
Special Mention
 
Classified
 
Sep 30,
2017
 
Dec 31,
2016
 
Sep 30,
2017
 
Dec 31,
2016
 
Sep 30,
2017
 
Dec 31,
2016
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$1,079,485

 

$1,065,358

 

$—

 

$776

 

$6,050

 

$8,052

Construction & development
126,257

 
121,371

 

 

 

 

Commercial & industrial
567,113

 
559,416

 
10,885

 
8,938

 
10,326

 
7,755

Total commercial loans

$1,772,855

 

$1,746,145

 

$10,885

 

$9,714

 

$16,376

 

$15,807


Residential and Consumer
The residential and consumer portfolios are monitored on an ongoing basis by the Corporation using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed on an aggregate basis in these relatively homogeneous portfolios. For non-impaired loans, the Corporation assigns loss allocation factors to each respective loan type.

Various other techniques are utilized to monitor indicators of credit deterioration in the portfolios of residential real estate mortgages and home equity lines and loans. Among these techniques is the periodic tracking of loans with an updated FICO score and an estimated loan to value (“LTV”) ratio. LTV ratio is determined via statistical modeling analyses. The indicated LTV levels are estimated based on such factors as the location, the original LTV ratio, and the date of origination of the loan


- 21-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

and do not reflect actual appraisal amounts. The results of these analyses and other loan review procedures are taken into consideration in the determination of loss allocation factors for residential mortgage and home equity consumer credits.

The following table presents the residential and consumer loan portfolios, segregated by category of credit quality indicator:
(Dollars in thousands)
Current and Under 90 Days Past Due
 
Over 90 Days
Past Due
 
Sep 30,
2017
 
Dec 31,
2016
 
Sep 30,
2017
 
Dec 31,
2016
Residential Real Estate:
 
 
 
 
 
 
 
Accruing mortgages

$1,159,462

 

$1,083,088

 

$—

 

$—

Nonaccrual mortgages
7,175

 
5,543

 
4,524

 
6,193

Homeowner construction
24,376

 
27,924

 

 

Total residential loans

$1,191,013

 

$1,116,555

 

$4,524

 

$6,193

Consumer:
 
 
 
 
 
 
 
Home equity lines

$259,880

 

$264,200

 

$—

 

$—

Home equity loans
34,720

 
36,614

 
57

 
658

Other
32,753

 
38,375

 
15

 
110

Total consumer loans

$327,353

 

$339,189

 

$72

 

$768


(6) Allowance for Loan Losses
The allowance for loan losses is management’s best estimate of inherent risk of loss in the loan portfolio as of the balance sheet date. 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: (1) the identification of loss allocations for individual loans deemed to be impaired and (2) the application of loss allocation factors for non-impaired loans based on historical loss experience and estimated loss emergence period, with adjustments for various exposures that management believes are not adequately represented by historical loss experience.

The following table presents the activity in the allowance for loan losses for the three months ended September 30, 2017:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
C&I (1)
 
Total Commercial
 
Residential
 
Consumer
 
Total
Beginning Balance

$10,735

 

$1,200

 

$7,067

 

$19,002

 

$5,369

 

$2,291

 

$26,662

Charge-offs
(535
)
 

 
(122
)
 
(657
)
 

 
(37
)
 
(694
)
Recoveries

 

 
8

 
8

 
1

 
31

 
40

Provision
1,482

 
(95
)
 
(301
)
 
1,086

 
70

 
144

 
1,300

Ending Balance

$11,682

 

$1,105

 

$6,652

 

$19,439

 

$5,440

 

$2,429

 

$27,308

(1) Commercial & industrial loans.



- 22-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the activity in the allowance for loan losses for the nine months ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
C&I (1)
 
Total Commercial
 
Residential
 
Consumer
 
Total
Beginning Balance

$9,971

 

$1,195

 

$6,992

 

$18,158

 

$5,252

 

$2,594

 

$26,004

Charge-offs
(935
)
 

 
(286
)
 
(1,221
)
 
(32
)
 
(162
)
 
(1,415
)
Recoveries
82

 

 
162

 
244

 
29

 
46

 
319

Provision
2,564

 
(90
)
 
(216
)
 
2,258

 
191

 
(49
)
 
2,400

Ending Balance

$11,682

 

$1,105

 

$6,652

 

$19,439

 

$5,440

 

$2,429

 

$27,308

(1) Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the three months ended September 30, 2016:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
C&I (1)
 
Total Commercial
 
Residential
 
Consumer
 
Total
Beginning Balance

$10,413

 

$904

 

$6,520

 

$17,837

 

$5,469

 

$2,520

 

$25,826

Charge-offs
(1,940
)
 

 
(3
)
 
(1,943
)
 
(52
)
 
(60
)
 
(2,055
)
Recoveries
4

 

 
46

 
50

 
5

 
23

 
78

Provision
1,981

 
78

 
(59
)
 
2,000

 
(21
)
 
(179
)
 
1,800

Ending Balance

$10,458

 

$982

 

$6,504

 

$17,944

 

$5,401

 

$2,304

 

$25,649

(1) Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the nine months ended September 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
C&I (1)
 
Total Commercial
 
Residential
 
Consumer
 
Total
Beginning Balance

$9,140

 

$1,758

 

$8,202

 

$19,100

 

$5,460

 

$2,509

 

$27,069

Charge-offs
(3,271
)
 

 
(757
)
 
(4,028
)
 
(192
)
 
(170
)
 
(4,390
)
Recoveries
21

 

 
134

 
155

 
9

 
56

 
220

Provision
4,568

 
(776
)
 
(1,075
)
 
2,717

 
124

 
(91
)
 
2,750

Ending Balance

$10,458

 

$982

 

$6,504

 

$17,944

 

$5,401

 

$2,304

 

$25,649

(1) Commercial & industrial loans.



- 23-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the Corporation’s loan portfolio and associated allowance for loan loss by portfolio segment and by impairment methodology:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Loans
 
Related Allowance
 
Loans
 
Related Allowance
Loans Individually Evaluated for Impairment:
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Mortgages

$6,659

 

$933

 

$9,776

 

$448

Construction & development

 

 

 

Commercial & industrial
5,791

 
48

 
7,098

 
3

Residential real estate
12,069

 
157

 
15,661

 
151

Consumer
628

 
7

 
1,280

 
4

Subtotal
25,147

 
1,145

 
33,815

 
606

Loans Collectively Evaluated for Impairment:
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Mortgages

$1,078,876

 

$10,749

 

$1,064,410

 

$9,523

Construction & development
126,257

 
1,105

 
121,371

 
1,195

Commercial & industrial
582,533

 
6,604

 
569,011

 
6,989

Residential real estate
1,183,468

 
5,283

 
1,107,087

 
5,101

Consumer
326,797

 
2,422

 
338,677

 
2,590

Subtotal
3,297,931

 
26,163

 
3,200,556

 
25,398

Total

$3,323,078

 

$27,308

 

$3,234,371

 

$26,004



- 24-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(7) Goodwill
The following table presents the carrying value of goodwill at the reporting unit (or business segment) level:
(Dollars in thousands)
Commercial Banking
 
Wealth Management Services
 
Total
Balance at December 31, 2016

$22,591

 

$41,468

 

$64,059

Impairment

 
(150
)
 
(150
)
Balance at September 30, 2017

$22,591

 

$41,318

 

$63,909


The balance of goodwill in the Commercial Banking segment arose from the acquisition of First Financial Corp. in 2002. The balance of goodwill in the Wealth Management Services segment arose from the 2005 acquisition of Weston Financial Group, Inc. (“Weston Financial”) and its broker-dealer and insurance agency subsidiaries, as well as the 2015 acquisition of Halsey Associates, Inc. (“Halsey”).

As the result of a decision that will reduce the business activities of WSC, Weston Financial’s broker-dealer subsidiary that conducts mutual fund and variable annuity transactions, primarily for Weston Financial clients, the carrying value of WSC’s goodwill was assessed for impairment during the second quarter of 2017. As a result of management’s assessment, an impairment charge of $150 thousand was recognized in the second quarter of 2017 and classified in other expenses in the Unaudited Consolidated Statements of Income.

(8) Borrowings
Federal Home Loan Bank Advances
Advances payable to the FHLBB amounted to $814.0 million and $848.9 million, respectively, at September 30, 2017 and December 31, 2016.

The following table presents maturities and weighted average interest rates on FHLBB advances outstanding as of September 30, 2017:
(Dollars in thousands)
Total Outstanding
 
Weighted
Average Rate
October 1, 2017 to December 31, 2017

$315,189

 
1.37
%
2018
168,134

 
1.32

2019
137,258

 
1.62

2020
72,033

 
1.90

2021
51,222

 
2.43

2022 and thereafter
70,209

 
3.34

Balance at September 30, 2017

$814,045

 
1.75
%

As of September 30, 2017 and December 31, 2016, the Bank had access to a $40.0 million unused line of credit with the FHLBB and also had remaining available borrowing capacity of $420.1 million and $594.5 million, respectively. The Bank pledges certain qualified investment securities and loans as collateral to the FHLBB.



- 25-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(9) Shareholders’ Equity
Regulatory Capital Requirements
Capital levels at both September 30, 2017 and December 31, 2016 exceeded the regulatory minimum levels to be considered “well-capitalized.”

The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios, as well as the corresponding minimum and well capitalized regulatory amounts and ratios that were in effect during the respective periods:
(Dollars in thousands)
Actual
 
For Capital Adequacy Purposes
 
To Be “Well Capitalized” Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation

$411,531

 
12.53
%
 

$262,717

 
8.00
%
 
N/A

 
N/A

Bank
410,366

 
12.50

 
262,680

 
8.00

 

$328,350

 
10.00
%
Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
383,956

 
11.69

 
197,038

 
6.00

 
N/A

 
N/A

Bank
382,791

 
11.66

 
197,010

 
6.00

 
262,680

 
8.00

Common Equity Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
361,958

 
11.02

 
147,778

 
4.50

 
N/A

 
N/A

Bank
382,791

 
11.66

 
147,758

 
4.50

 
213,428

 
6.50

Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation
383,956

 
8.83

 
173,991

 
4.00

 
N/A

 
N/A

Bank
382,791

 
8.80

 
173,948

 
4.00

 
217,434

 
5.00

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
390,867

 
12.26

 
255,093

 
8.00

 
N/A

 
N/A

Bank
389,840

 
12.23

 
255,050

 
8.00

 
318,813

 
10.00

Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
364,655

 
11.44

 
191,320

 
6.00

 
N/A

 
N/A

Bank
363,628

 
11.41

 
191,288

 
6.00

 
255,050

 
8.00

Common Equity Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
342,656

 
10.75

 
143,490

 
4.50

 
N/A

 
N/A

Bank
363,628

 
11.41

 
143,466

 
4.50

 
207,228

 
6.50

Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation
364,655

 
8.67

 
168,271

 
4.00

 
N/A

 
N/A

Bank
363,628

 
8.65

 
168,207

 
4.00

 
210,259

 
5.00

(1)
Leverage ratio.

In addition to the minimum regulatory capital required for capital adequacy purposes included in the table above, the Corporation is required to maintain a minimum Capital Conservation Buffer, in the form of common equity, in order to avoid restrictions on capital distributions and discretionary bonuses. The required amount of the Capital Conservation Buffer was 0.625% on January 1, 2016 and 1.25% on January 1, 2017. The Capital Conservation Buffer will increase by 0.625% each year until it reaches 2.5% on January 1, 2019.



- 26-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(10) Derivative Financial Instruments
The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments principally to manage the Corporation’s interest rate risk. Additionally, the Corporation enters into interest rate derivatives to accommodate the business requirements of its customers. All derivatives are recognized as either assets or liabilities on the balance sheet and are measured at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation.

Interest Rate Risk Management Agreements
Interest rate risk management agreements, such as swaps, caps and floors, are used from time to time as part of the Corporation’s interest rate risk management strategy. Interest rate swaps are agreements in which the Corporation and another party agree to exchange interest payments (e.g., fixed-rate for variable-rate payments) computed on a notional principal amount. Interest rate caps and floors represent options purchased by the Corporation to manage the interest rate paid throughout the term of the option contract. The credit risk associated with these transactions is the risk of default by the counterparty. To minimize this risk, the Corporation enters into interest rate agreements only with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and, thus, are not a measure of the potential loss exposure.

Cash Flow Hedging Instruments
As of September 30, 2017 and December 31, 2016, the Bancorp had two interest rate caps with a total notional amount of $22.7 million that were designated as cash flow hedges to hedge the interest rate risk associated with our variable rate junior subordinated debentures. For both interest rate caps, the Bancorp obtained the right to receive the difference between 3-month LIBOR and a 4.5% strike. The caps mature in 2020.

As of September 30, 2017 and December 31, 2016, the Bank had two interest rate swap contracts with a total notional amount of $60.0 million that were designated as cash flow hedges to hedge the interest rate risk associated with short-term variable rate FHLB advances. The interest rate swaps mature in 2021 and 2023.

During the second quarter of 2017, the Bank executed three interest rate floor contracts with a total notional amount of $300.0 million that were designated as cash flow hedges to hedge the interest rate risk associated with a pool of variable rate commercial loans. The Bank obtained the right to receive the difference between 1-month LIBOR and a 1.0% strike for each of the interest rate floors. The floors mature in 2020.

The effective portion of the changes in fair value of derivatives designated as cash flow hedges is recorded in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized.  The ineffective portion of changes in fair value of the derivatives is recognized directly in earnings. For the three and nine months ended September 30, 2017 and 2016, there was no ineffectiveness recorded in earnings.

Loan Related Derivative Contracts
Interest Rate Swap Contracts with Customers
The Corporation has entered into interest rate swap contracts to help commercial loan borrowers manage their interest rate risk.  The interest rate swap contracts with commercial loan borrowers allow them to convert floating-rate loan payments to fixed-rate loan payments.  When we enter into an interest rate swap contract with a commercial loan borrower, we simultaneously enter into a “mirror” swap contract with a third party.  The third party exchanges the client’s fixed-rate loan payments for floating-rate loan payments.  We retain the risk that is associated with the potential failure of counterparties and the risk inherent in originating loans.  As of September 30, 2017 and December 31, 2016, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $539.1 million and $428.7 million, respectively, and equal amounts of “mirror” swap contracts with third-party financial institutions.  These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.

Risk Participation Agreements
The Corporation has entered into risk participation agreements with other banks participating in commercial loan arrangements. Participating banks guarantee the performance on borrower-related interest rate swap contracts. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings.



- 27-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Under a risk participation-out agreement, a derivative asset, the Corporation participates out a portion of the credit risk associated with the interest rate swap position executed with the commercial borrower for a fee paid to the participating bank. Under a risk participation-in agreement, a derivative liability, the Corporation assumes, or participates in, a portion of the credit risk associated with the interest rate swap position with the commercial borrower for a fee received from the other bank.

At September 30, 2017 and December 31, 2016, the notional amounts of risk participation-out agreements were $52.7 million and $38.3 million, respectively. The notional amounts of risk participation-in agreements were $32.3 million and $28.5 million, respectively, at September 30, 2017 and December 31, 2016.

Loan Commitments
Interest rate lock commitments are extended to borrowers and relate to the origination of residential real estate mortgage loans held for sale.  To mitigate the interest rate risk inherent in these rate locks, as well as closed residential real estate mortgage loans held for sale, forward commitments are established to sell individual residential real estate mortgage loans.  Both interest rate lock commitments and commitments to sell residential real estate mortgage loans are derivative financial instruments, but do not meet criteria for hedge accounting and, as such the changes in fair value of these commitments are reflected in earnings. The Corporation has elected to carry certain closed residential real estate mortgage loans held for sale at fair value, as changes in fair value in these loans held for sale generally offset changes in interest rate lock and forward sale commitments.

The following table presents the fair values of derivative instruments in the Corporation’s Unaudited Consolidated Balance Sheets:
(Dollars in thousands)
Asset Derivatives
 
Liability Derivatives
 
 
Fair Value
 
 
Fair Value
 
Balance Sheet Location
Sep 30, 2017
 
Dec 31, 2016
 
Balance Sheet Location
Sep 30, 2017
 
Dec 31, 2016
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps
Other assets

$—

 

$—

 
Other liabilities

$418

 

$378

Interest rate caps
Other assets
31

 
134

 
Other liabilities

 

Interest rate floors
Other assets
252

 

 
Other liabilities

 

Derivatives not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
 
Forward loan commitments:
 
 
 
 
 
 
 
 
 
Interest rate lock commitments
Other assets
1,712

 
1,133

 
Other liabilities
28

 
88

Commitments to sell mortgage loans
Other assets
28

 
279

 
Other liabilities
2,419

 
1,349

Loan related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
Other assets
3,269

 
2,036

 
Other liabilities

 

Mirror swaps with counterparties
Other assets

 

 
Other liabilities
3,456

 
2,228

Risk participation agreements
Other assets

 

 
Other liabilities

 

Total
 

$5,292

 

$3,582

 
 

$6,321

 

$4,043




- 28-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the effect of derivative instruments in the Corporation’s Unaudited Consolidated Statements of Income and Changes in Shareholders’ Equity:
(Dollars in thousands)
Amount of Gain (Loss) Recognized in
Other Comprehensive Income
(Effective Portion)
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
Interest rate swaps

$74

 

$—

 

($26
)
 

$—

Interest rate caps
(7
)
 
(4
)
 
(64
)
 
(94
)
Interest rate floors
(80
)
 

 
(274
)
 

Total

($13
)
 

($4
)
 

($364
)
 

($94
)


(Dollars in thousands)
 
Amount of Gain (Loss) Recognized in Income on Derivatives
 
Amount of Gain (Loss) Recognized in Income on Derivatives
 
 
Three months
 
Nine months
Periods ended September 30,
Statement of Income Location
2017
 
2016
 
2017
 
2016
Derivatives not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
Forward loan commitments:
 
 
 
 
 
 
 
 
Interest rate lock commitments
Mortgage banking revenues

$32

 

$641

 

$639

 

$2,387

Commitments to sell mortgage loans
Mortgage banking revenues
59

 
(665
)
 
(1,321
)
 
(2,845
)
Customer related derivative contracts:
 
 
 
 
 
 
 
 
Interest rate swaps with customers
Loan related derivative income
1,917

 
32

 
5,583

 
17,064

Mirror swaps with counterparties
Loan related derivative income
(505
)
 
1,250

 
(2,578
)
 
(14,527
)
Risk participation agreements
Loan related derivative income
40

 
(104
)
 
(261
)
 
(206
)
Total
 

$1,543

 

$1,154

 

$2,062

 

$1,873




- 29-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(11) Balance Sheet Offsetting
For interest rate risk management contracts and loan-related derivative contracts, the Corporation records derivative assets and derivative liabilities on a net basis. The interest rate risk management contracts and loan-related derivative contracts with counterparties are subject to master netting agreements. The following tables present the Corporation’s derivative asset and derivative liability positions and the effect of netting arrangements on the Unaudited Consolidated Balance Sheets:
(Dollars in thousands)
Gross Derivative Positions
 
Offsetting Derivative Positions
 
Net Amounts Presented in Balance Sheet
 
Cash Collateral Pledged
 
Net Amount
September 30, 2017
 
 
 
 
Derivative Assets:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate caps

$31

 

$—

 

$31

 

$—

 

$31

Interest rate floors
252

 

 
252

 

 
252

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
5,425

 
2,156

 
3,269

 

 
3,269

Mirror swaps with counterparties
2,061

 
2,061

 

 

 

Total

$7,769

 

$4,217

 

$3,552

 

$—

 

$3,552

 
 
 
 
 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps

$418

 

$—

 

$418

 

$418

 

$—

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
2,156

 
2,156

 

 

 

Mirror swaps with counterparties
5,517

 
2,061

 
3,456

 
3,456

 

Total

$8,091

 

$4,217

 

$3,874

 

$3,874

 

$—


(Dollars in thousands)
Gross Derivative Positions
 
Offsetting Derivative Positions
 
Net Amounts Presented in Balance Sheet
 
Cash Collateral Pledged
 
Net Amount
December 31, 2016
 
 
 
 
Derivative Assets:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate caps

$134

 

$—

 

$134

 

$—

 

$134

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
4,920

 
2,884

 
2,036

 

 
2,036

Mirror swaps with counterparties
2,758

 
2,758

 

 

 

Total

$7,812

 

$5,642

 

$2,170

 

$—

 

$2,170

 
 
 
 
 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps

$378

 

$—

 

$378

 

$133

 

$245

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
2,884

 
2,884

 

 

 

Mirror swaps with counterparties
4,986

 
2,758

 
2,228

 
1,295

 
933

Total

$8,248

 

$5,642

 

$2,606

 

$1,428

 

$1,178




- 30-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

As of September 30, 2017 and December 31, 2016, Washington Trust pledged collateral to derivative counterparties in the form of cash totaling $3.9 million and $1.4 million, respectively. Washington Trust may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

(12) Fair Value Measurements
The Corporation uses fair value measurements to record fair value adjustments on certain assets and liabilities and to determine fair value disclosures.  As of September 30, 2017 and December 31, 2016, securities available for sale, residential real estate mortgage loans held for sale, derivatives and the contingent consideration liability are recorded at fair value on a recurring basis.  Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights.  These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

Fair value is a market-based measurement, not an entity-specific measurement.  Fair value measurements are determined based on the assumptions the market participants would use in pricing the asset or liability.  In addition, GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Corporation’s market assumptions.  These two types of inputs have created the following fair value hierarchy:

Level 1 – Quoted prices for identical assets or liabilities in active markets.
Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable in the markets and which reflect the Corporation’s market assumptions.

Fair Value Option Election
GAAP allows for the irrevocable option to elect fair value accounting for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation has elected the fair value option for residential real estate mortgage loans held for sale to better match changes in fair value of the loans with changes in the fair value of the derivative loan sale contracts used to economically hedge them.

The aggregate principal amount of the residential real estate mortgage loans held for sale that were recorded at fair value was $27.8 million and $29.4 million, respectively, at September 30, 2017 and December 31, 2016. The aggregate fair value of these loans as of the same dates was $28.5 million and $29.4 million, respectively. As of September 30, 2017 and December 31, 2016, the aggregate fair value of residential real estate mortgage loans held for sale exceeded the aggregate principal amount by $733 thousand and $40 thousand, respectively.

There were no residential real estate mortgage loans held for sale 90 days or more past due as of September 30, 2017 and December 31, 2016.

The following table presents the changes in fair value related to mortgage loans held for sale, interest rate lock commitments and commitments to sell residential real estate mortgage loans, for which the fair value option was elected. Changes in fair values are reported as a component of mortgage banking revenues in the Unaudited Consolidated Statements of Income.
(Dollars in thousands)
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Mortgage loans held for sale

($81
)
 

$117

 

$693

 

$612

Interest rate lock commitments
32

 
641

 
639

 
2,387

Commitments to sell mortgage loans
59

 
(665
)
 
(1,321
)
 
(2,845
)
Total changes in fair value

$10

 

$93

 

$11

 

$154




- 31-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Valuation Techniques
Securities
Securities available for sale are recorded at fair value on a recurring basis.  When available, the Corporation uses quoted market prices to determine the fair value of securities; such items are classified as Level 1. There were no Level 1 securities held at September 30, 2017 and December 31, 2016.

Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments. The fair value of these securities is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.  This category includes obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, obligations of states and political subdivisions, individual name issuer trust preferred debt securities and corporate bonds.

Securities not actively traded whose fair value is determined through the use of cash flows utilizing inputs that are unobservable are classified as Level 3. There were no Level 3 securities held at September 30, 2017 and December 31, 2016.

Mortgage Loans Held for Sale
The fair value of mortgage loans held for sale is estimated based on current market prices for similar loans in the secondary market and therefore are classified as Level 2 assets.

Collateral Dependent Impaired Loans
The fair value of collateral dependent loans that are deemed to be impaired is determined based upon the fair value of the underlying collateral. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. For collateral dependent loans for which repayment is dependent on the sale of the collateral, management adjusts the fair value for estimated costs to sell. For collateral dependent loans for which repayment is dependent on the operation of the collateral, such as accruing troubled debt restructured loans, estimated costs to sell are not incorporated into the measurement. Management may also adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3.

Property Acquired Through Foreclosure or Repossession
Property acquired through foreclosure or repossession included in other assets in the Unaudited Consolidated Balance Sheets is adjusted to fair value less costs to sell upon transfer out of loans through a charge to allowance for loan losses. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Such subsequent valuation charges are charged through earnings. Fair value is generally based upon appraised values of the collateral. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3.

Derivatives
Interest rate swap, cap and floor contracts are traded in over-the-counter markets where quoted market prices are not readily available.  Fair value measurements are determined using independent pricing models that utilize primarily market observable inputs, such as swap rates of different maturities and LIBOR rates. The Corporation also evaluates the credit risk of its counterparties as well as that of the Corporation.  Accordingly, Washington Trust considers factors such as the likelihood of default by the Corporation and its counterparties, its net exposures and remaining contractual life, among other factors, in determining if any fair value adjustments related to credit risk are required.  Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of collateral securing the position. Although the Corporation has determined that the majority of the inputs used to value its interest rate swap, cap and floor contracts fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with interest rate contracts and risk participation agreements utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Corporation and its counterparties. However, as of September 30, 2017 and December 31, 2016, the Corporation has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Corporation has classified its derivative valuations in their entirety as Level 2.

Fair value measurements of forward loan commitments (interest rate lock commitments and commitments to sell residential real estate mortgages) are estimated based on current market prices for similar assets in the secondary market and therefore are classified as Level 2 assets.


- 32-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)


Contingent Consideration Liability
A contingent consideration liability was recognized upon the completion of the Halsey acquisition on August 1, 2015 and represents the estimated present value of future earn-outs to be paid based on the future revenue growth of the acquired business during the 5-year period following the acquisition.

The fair value measurement is based upon unobservable inputs, therefore, the contingent liability is classified within Level 3 of the fair value hierarchy. The unobservable inputs include probability estimates regarding the likelihood of achieving revenue growth targets and the discount rates utilized the discounted cash flow calculations applied to the estimates earn-outs to be paid. The discount rates used ranged from 3% to 4%. The contingent consideration liability is remeasured to fair value at each reporting period taking into consideration changes in those unobservable inputs. Changes in the fair value of the contingent consideration liability are included in noninterest expenses in the Unaudited Consolidated Statements of Income.

The fair value of the contingency represents the estimated price to transfer the liability between market participants at the measurement date under current market conditions.

Items Recorded at Fair Value on a Recurring Basis
The following tables present the balances of assets and liabilities reported at fair value on a recurring basis:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
September 30, 2017
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$119,125

 

$—

 

$119,125

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
561,670

 

 
561,670

 

Obligations of states and political subdivisions
3,163

 

 
3,163

 

Individual name issuer trust preferred debt securities
26,388

 

 
26,388

 

Corporate bonds
4,009

 

 
4,009

 

Mortgage loans held for sale
28,484

 

 
28,484

 

Derivative assets
5,292

 

 
5,292

 

Total assets at fair value on a recurring basis

$748,131

 

$—

 

$748,131

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities

$6,321

 

$—

 

$6,321

 

$—

Contingent consideration liability (1)
1,737

 

 

 
1,737

Total liabilities at fair value on a recurring basis

$8,058

 

$—

 

$6,321

 

$1,737

(1)
The contingent consideration liability is included in other liabilities in the Unaudited Consolidated Balance Sheets.



- 33-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
December 31, 2016
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$108,440

 

$—

 

$108,440

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
588,085

 

 
588,085

 

Obligations of states and political subdivisions
14,485

 

 
14,485

 

Individual name issuer trust preferred debt securities
26,736

 

 
26,736

 

Corporate bonds
2,166

 

 
2,166

 

Mortgage loans held for sale
29,434

 

 
29,434

 

Derivative assets
3,582

 

 
3,582

 

Total assets at fair value on a recurring basis

$772,928

 

$—

 

$772,928

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities

$4,043

 

$—

 

$4,043

 

$—

Contingent consideration liability (1)
2,047

 

 

 
2,047

Total liabilities at fair value on a recurring basis

$6,090

 

$—

 

$4,043

 

$2,047

(1)
The contingent consideration liability is included in other liabilities in the Unaudited Consolidated Balance Sheets.

It is the Corporation’s policy to review and reflect transfers between Levels as of the financial statement reporting date.  During the nine months ended September 30, 2017 and 2016, there were no transfers in and/or out of Level 1, 2 or 3.

The following table presents the change in the contingent consideration liability, a Level 3 liability measured at fair value on a recurring basis, during the periods indicated:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Balance at beginning of period

$1,737

 

$2,986

 

$2,047

 

$2,945

Change in fair value

 
(939
)
 
(310
)
 
(898
)
Payments

 

 

 

Balance at end of period

$1,737

 

$2,047

 

$1,737

 

$2,047




- 34-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Items Recorded at Fair Value on a Nonrecurring Basis
The following table presents the carrying value of assets held at September 30, 2017, which were written down to fair value during the nine months ended September 30, 2017:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
Assets:
 
 
 
 
 
 
 
Collateral dependent impaired loans

$3,406

 

$—

 

$—

 

$3,406

Property acquired through foreclosure or repossession
1,038

 

 

 
1,038

Total assets at fair value on a nonrecurring basis

$4,444

 

$—

 

$—

 

$4,444


The allowance for loan losses on collateral dependent impaired loans amounted to $710 thousand at September 30, 2017.

The following table presents the carrying value of assets held at December 31, 2016, which were written down to fair value during the year ended December 31, 2016:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
Assets:
 
 
 
 
 
 
 
Collateral dependent impaired loans

$3,828

 

$—

 

$—

 

$3,828

Property acquired through foreclosure or repossession
605

 

 

 
605

Total assets at fair value on a nonrecurring basis

$4,433

 

$—

 

$—

 

$4,433


The allowance for loan losses on collateral dependent impaired loans amounted to $469 thousand at December 31, 2016.

The following tables present valuation techniques and unobservable inputs for assets measured at fair value on a nonrecurring basis for which the Corporation has utilized Level 3 inputs to determine fair value:
(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range of Inputs Utilized
(Weighted Average)
September 30, 2017
Collateral dependent impaired loans

$3,406

Appraisals of collateral
Discount for costs to sell
0% - 25% (15%)
 
 
 
Appraisal adjustments (1)
0% - 15% (1%)
 
 
 
 
 
Property acquired through foreclosure or repossession

$1,038

Appraisals of collateral
Discount for costs to sell
10% - 12% (11%)
 
 
 
Appraisal adjustments (1)
8% - 53% (15%)
(1)
Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.



- 35-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range of Inputs Utilized
(Weighted Average)
December 31, 2016
Collateral dependent impaired loans

$3,828

Appraisals of collateral
Discount for costs to sell
10% - 20% (15%)
 
 
 
Appraisal adjustments (1)
0% - 10% (9%)
 
 
 
 
 
Property acquired through foreclosure or repossession

$605

Appraisals of collateral
Discount for costs to sell
10% - 12% (11%)
 
 
 
Appraisal adjustments (1)
6% - 50% (24%)
(1)
Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

Valuation of Other Financial Instruments
The methodologies for estimating the fair value of financial instruments that are measured at fair value on a recurring or nonrecurring basis are discussed above. The methodologies for other financial instruments are discussed below.

Loans
Fair values are estimated for categories of loans with similar financial characteristics. Loans are segregated by type and are then further segmented into fixed-rate and adjustable-rate interest terms to determine their fair value. The fair value of fixed-rate commercial and consumer loans is calculated by discounting scheduled cash flows through the estimated maturity of the loan using interest rates offered at the measurement date that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation’s historical repayment experience. For residential mortgages, fair value is estimated by using market prices for sales of similar loans on the secondary market. The fair value of floating rate commercial and consumer loans approximates carrying value. Fair value for impaired loans is estimated using a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or if the loan is collateral dependent, at the fair value of the collateral. Loans are classified within Level 3 of the fair value hierarchy.

Time Deposits
The discounted values of cash flows using the rates currently offered for deposits of similar remaining maturities were used to estimate the fair value of time deposits. Time deposits are classified within Level 2 of the fair value hierarchy.

Federal Home Loan Bank Advances
Rates currently available to the Corporation for advances with similar terms and remaining maturities are used to estimate fair value of existing advances. FHLBB advances are categorized as Level 2.

Junior Subordinated Debentures
The fair value of the junior subordinated debentures is estimated using rates currently available to the Corporation for debentures with similar terms and maturities. Junior subordinated debentures are categorized as Level 2.



- 36-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the carrying amount, estimated fair value and placement in the fair value hierarchy of the Corporation’s financial instruments. The tables exclude financial instruments for which the carrying value approximates fair value. Financial assets for which the fair value approximates carrying value include cash and cash equivalents, FHLBB stock, accrued interest receivable and bank-owned life insurance. Financial liabilities for which the fair value approximates carrying value include non-maturity deposits and accrued interest payable.
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
September 30, 2017
Carrying Amount
 
Total
Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$13,241

 

$13,537

 

$—

 

$13,537

 

$—

Loans, net of allowance for loan losses
3,295,770

 
3,328,953

 

 

 
3,328,953

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$1,002,941

 

$1,006,263

 

$—

 

$1,006,263

 

$—

FHLBB advances
814,045

 
819,827

 

 
819,827

 

Junior subordinated debentures
22,681

 
17,952

 

 
17,952

 


(Dollars in thousands)
 
 
 
 
 
 
 
 
 
December 31, 2016
Carrying Amount
 
Total
Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$15,633

 

$15,920

 

$—

 

$15,920

 

$—

Loans, net of allowance for loan losses
3,208,367

 
3,218,651

 

 

 
3,218,651

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$961,613

 

$962,374

 

$—

 

$962,374

 

$—

FHLBB advances
848,930

 
852,888

 

 
852,888

 

Junior subordinated debentures
22,681

 
16,970

 

 
16,970

 


(13) Defined Benefit Pension Plans
The Corporation maintains a tax-qualified defined benefit pension plan for the benefit of certain eligible employees who were hired prior to October 1, 2007. The Corporation also has non-qualified retirement plans to provide supplemental retirement benefits to certain employees, as defined in the plans. The defined benefit pension plans were previously amended to freeze benefit accruals after a 10-year transition period ending in December 2023.

The defined benefit pension plan is funded on a current basis, in compliance with the requirements of ERISA.

The non-qualified retirement plans provide for the designation of assets in rabbi trusts. Securities available for sale and other short-term investments designated for this purpose, with the carrying value of $11.3 million and $11.7 million are included in the Consolidated Balance Sheets at September 30, 2017 and December 31, 2016, respectively.



- 37-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The composition of net periodic benefit cost was as follows:
(Dollars in thousands)
Qualified Pension Plan
 
Non-Qualified Retirement Plans
 
Three months
 
Nine months
 
Three months
 
Nine months
Periods ended September 30,
2017
2016
 
2017
2016
 
2017
2016
 
2017
2016
Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
 
 
 
Service cost

$537


$537

 

$1,611


$1,611

 

$32


$30

 

$97


$91

Interest cost
669

644

 
2,005

1,932

 
107

108

 
321

324

Expected return on plan assets
(1,236
)
(1,158
)
 
(3,707
)
(3,475
)
 


 


Amortization of prior service (credit) cost
(6
)
(6
)
 
(17
)
(17
)
 


 


Recognized net actuarial loss
279

207

 
836

621

 
76

62

 
269

185

Net periodic benefit cost

$243


$224

 

$728


$672

 

$215


$200

 

$687


$600


The following table presents the measurement date and weighted-average assumptions used to determine net periodic benefit cost:
 
Qualified Pension Plan
 
Non-Qualified Retirement Plans
For the nine months ended September 30,
2017
 
2016
 
2017
 
2016
Measurement date
Dec 31, 2016
 
Dec 31, 2015
 
Dec 31, 2016
 
Dec 31, 2015
Equivalent single discount rate for benefit obligations
4.18%
 
4.48%
 
3.96%
 
4.19%
Equivalent single discount rate for service cost
4.29
 
4.63
 
4.25
 
4.59
Equivalent single discount rate for interest cost
3.73
 
3.88
 
3.36
 
3.44
Expected long-term return on plan assets
6.75
 
6.75
 
N/A
 
N/A
Rate of compensation increase
3.75
 
3.75
 
3.75
 
3.75



- 38-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(14) Share-Based Compensation Arrangements
During the nine months ended September 30, 2017, the Corporation granted equity awards, which included performance share awards and nonvested share unit awards.

The performance share awards granted to certain executive officers provides them with the opportunity to earn shares of common stock of the Corporation. The performance share awards were valued at fair market value as of January 19, 2017 (the award date), or $51.85, and will be earned over a 3-year performance period. The number of shares earned will range from zero to 200% of the target number of shares dependent upon the Corporation’s core return on equity and core earnings per share growth ranking compared to an industry peer group. The current assumption based on the most recent peer group information available results in shares earned at 144% of the target, or 37,564 shares.

The Corporation granted to non-employee directors and a certain executive officer 7,900 nonvested share units, with 3- to 5-year cliff vesting. The weighted average grant date fair value of the nonvested share units was $50.83.

(15) Business Segments
Washington Trust segregates financial information in assessing its results among its Commercial Banking and Wealth Management Services operating segments.  The amounts in the Corporate unit include activity not related to the segments.

Management uses certain methodologies to allocate income and expenses to the business lines.  A funds transfer pricing (“FTP”) methodology is used to assign interest income and interest expense to each interest-earning asset and interest-bearing liability on a matched maturity funding basis.  The matched maturity funding concept considers the origination date and the earlier of the maturity date or the repricing date of a financial instrument to assign an FTP rate for loans and deposits originated. Loans are assigned a FTP rate for funds used and deposits are assigned a FTP rate for funds provided. Certain indirect expenses are allocated to segments.  These include support unit expenses such as technology, operations and other support functions.

Commercial Banking
The Commercial Banking segment includes commercial, residential and consumer lending activities; equity in earnings (losses) of unconsolidated investments in real estate limited partnerships; mortgage banking activities; deposit generation; 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
Wealth Management Services includes investment management; financial planning; personal trust and estate services, including services as trustee, personal representative, custodian and guardian; and settlement of decedents’ estates. Institutional trust services are also provided, including fiduciary services.

Corporate
Corporate includes the Treasury Unit, which is responsible for managing the wholesale investment portfolio and wholesale funding needs.  It also includes income from bank-owned life insurance, as well as administrative and executive expenses not allocated to the operating segments and the residual impact of methodology allocations such as funds transfer pricing offsets.



- 39-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the statement of operations and total assets for Washington Trust’s reportable segments:
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Commercial Banking
 
Wealth Management Services
 
Corporate
 
Consolidated Total
Three months ended September 30,
2017

2016

 
2017

2016

 
2017

2016

 
2017

2016

Net interest income (expense)

$24,795


$22,860

 

($48
)

($11
)
 

$5,312


$4,530

 

$30,059


$27,379

Provision for loan losses
1,300

1,800

 


 


 
1,300

1,800

Net interest income (expense) after provision for loan losses
23,495

21,060

 
(48
)
(11
)
 
5,312

4,530

 
28,759

25,579

Noninterest income
6,711

7,101

 
10,013

9,623

 
559

537

 
17,283

17,261

Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization expense
646

709

 
411

501

 
50

58

 
1,107

1,268

Other noninterest expenses (1)
15,834

14,759

 
6,810

5,584

 
3,003

3,039

 
25,647

23,382

Total noninterest expenses
16,480

15,468

 
7,221

6,085

 
3,053

3,097

 
26,754

24,650

Income before income taxes
13,726

12,693

 
2,744

3,527

 
2,818

1,970

 
19,288

18,190

Income tax expense
4,463

4,392

 
1,092

1,261

 
771

210

 
6,326

5,863

Net income

$9,263


$8,301

 

$1,652


$2,266

 

$2,047


$1,760

 

$12,962


$12,327

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at period end

$3,486,783


$3,617,967

 

$63,600


$53,236

 

$918,847


$532,831

 

$4,469,230


$4,204,034

Expenditures for long-lived assets
890

424

 
25

280

 
22

58

 
937

762

(1)
Other noninterest expenses for the Wealth Management Services segment includes a $939 thousand benefit resulting from the reduction of a contingent consideration liability in the three months ended September 30, 2016.

 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Commercial Banking
 
Wealth Management Services
 
Corporate
 
Consolidated Total
Nine months ended September 30,
2017

2016

 
2017

2016

 
2017

2016

 
2017

2016

Net interest income (expense)

$72,985


$67,414

 

($120
)

($46
)
 

$15,777


$14,522

 

$88,642


$81,890

Provision for loan losses
2,400

2,750

 


 


 
2,400

2,750

Net interest income (expense) after provision for loan losses
70,585

64,664

 
(120
)
(46
)
 
15,777

14,522

 
86,242

79,140

Noninterest income
17,500

17,331

 
29,432

28,278

 
1,667

2,200

 
48,599

47,809

Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization expense
1,960

2,093

 
1,288

1,440

 
152

170

 
3,400

3,703

Other noninterest expenses (1)
45,764

43,788

 
20,106

19,084

 
9,076

9,555

 
74,946

72,427

Total noninterest expenses
47,724

45,881

 
21,394

20,524

 
9,228

9,725

 
78,346

76,130

Income before income taxes
40,361

36,114

 
7,918

7,708

 
8,216

6,997

 
56,495

50,819

Income tax expense
13,142

12,336

 
3,172

2,788

 
2,238

1,376

 
18,552

16,500

Net income

$27,219


$23,778

 

$4,746


$4,920

 

$5,978


$5,621

 

$37,943


$34,319

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at period end

$3,486,783


$3,617,967

 

$63,600


$53,236

 

$918,847


$532,831

 

$4,469,230


$4,204,034

Expenditures for long-lived assets
1,640

1,779

 
368

468

 
176

361

 
2,184

2,608

(1)
For the nine months ended September 30, 2017, other noninterest expenses for the Wealth Management Services segment includes a $310 thousand benefit resulting from the reduction of a contingent consideration liability and a $150 thousand goodwill impairment charge. For the nine months ended September 30, 2016, other noninterest expenses for the Wealth Management Services segment includes a benefit of $898 thousand resulting from the reduction of a contingent consideration liability.



- 40-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(16) Other Comprehensive Income (Loss)
The following tables present the activity in other comprehensive income (loss):
 
 
 
 
 
 
 
 
Three months ended September 30,
2017
 
2016
(Dollars in thousands)
Pre-tax Amounts
Income Taxes
Net of Tax
 
Pre-tax Amounts
Income Taxes
Net of Tax
Securities available for sale:
 
 
 
 
 
 
 
Changes in fair value of securities available for sale

$1,736


$642


$1,094

 

($144
)

($53
)

($91
)
Net gains on securities reclassified into earnings



 



Net change in fair value of securities available for sale

$1,736


$642


$1,094

 

($144
)

($53
)

($91
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
(237
)
(83
)
(154
)
 
(15
)
(11
)
(4
)
Net cash flow hedge losses reclassified into earnings (1)
224

83

141

 



Net change in fair value of cash flow hedges
(13
)

(13
)
 
(15
)
(11
)
(4
)
Defined benefit plan obligations:
 
 
 
 
 
 
 
Defined benefit plan obligation adjustment



 
263

97

166

Amortization of net actuarial losses (2)
355

134

221

 



Amortization of net prior service credits (2)
(6
)
(2
)
(4
)
 



Net change in defined benefit plan obligations
349

132

217

 
263

97

166

Total other comprehensive income

$2,072


$774


$1,298

 

$104


$33


$71

(1)
The pre-tax amounts are included in interest expense on Federal Home Loan Bank advances, interest expense on junior subordinated debentures and interest and fees on loans in the Unaudited Consolidated Statements of Income.
(2)
The pre-tax amounts are included in salaries and employee benefits expense in the Unaudited Consolidated Statements of Income.
 
 
 
 
 
 
 
 
Nine months ended September 30,
2017
 
2016
(Dollars in thousands)
Pre-tax Amounts
Income Taxes
Net of Tax
 
Pre-tax Amounts
Income Taxes
Net of Tax
Securities available for sale:
 
 
 
 
 
 
 
Changes in fair value of securities available for sale

$5,274


$1,951


$3,323

 

$2,621


$970


$1,651

Net gains on securities reclassified into earnings



 



Net change in fair value of securities available for sale

$5,274


$1,951


$3,323

 

$2,621


$970


$1,651

Cash flow hedges:
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
(1,064
)
(361
)
(703
)
 
(129
)
(35
)
(94
)
Net cash flow hedge losses reclassified into earnings (1)
539

200

339

 



Net change in fair value of cash flow hedges
(525
)
(161
)
(364
)
 
(129
)
(35
)
(94
)
Defined benefit plan obligations:
 
 
 
 
 
 
 
Defined benefit plan obligation adjustment
(407
)
(150
)
(257
)
 
789

292

497

Amortization of net actuarial losses (2)
1,105

411

694

 



Amortization of net prior service credits (2)
(17
)
(7
)
(10
)
 



Net change in defined benefit plan obligations
681

254

427

 
789

292

497

Total other comprehensive income (loss)

$5,430


$2,044


$3,386

 

$3,281


$1,227


$2,054

(1)
The pre-tax amount is included in interest expense on Federal Home Loan Bank advances, interest expense on junior subordinated debentures and interest and fees on loans in the Unaudited Consolidated Statements of Income.
(2)
The pre-tax amounts are included in salaries and employee benefits expense in the Unaudited Consolidated Statements of Income.



- 41-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the changes in accumulated other comprehensive income (loss) by component, net of tax:
(Dollars in thousands)
Net Unrealized Gains (Losses) on Available For Sale Securities
 
Net Unrealized Losses on Cash Flow Hedges
 
Pension Benefit Adjustment
 
Total
Balance at December 31, 2016

($6,825
)
 

($300
)
 

($12,632
)
 

($19,757
)
Other comprehensive income (loss) before reclassifications
3,323

 
(703
)
 

 
2,620

Amounts reclassified from accumulated other comprehensive income

 
339

 
427

 
766

Net other comprehensive income (loss)
3,323

 
(364
)
 
427

 
3,386

Balance at September 30, 2017

($3,502
)
 

($664
)
 

($12,205
)
 

($16,371
)

(Dollars in thousands)
Net Unrealized Gains on Available For Sale Securities
 
Net Unrealized Losses on Cash Flow Hedges
 
Pension Benefit Adjustment
 
Total
Balance at December 31, 2015

$1,051

 

($43
)
 

($10,707
)
 

($9,699
)
Other comprehensive income (loss) before reclassifications
1,651

 
(94
)
 

 
1,557

Amounts reclassified from accumulated other comprehensive income

 

 
497

 
497

Net other comprehensive income (loss)
1,651

 
(94
)
 
497

 
2,054

Balance at September 30, 2016

$2,702

 

($137
)
 

($10,210
)
 

($7,645
)


- 42-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(17) Earnings Per Common Share
The following table presents the calculation of earnings per common share:
(Dollars and shares in thousands, except per share amounts)
 
 
 
 
 
 
 

Three Months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Earnings per common share - basic:
 
 
 
 
 
 
 
Net income

$12,962

 

$12,327

 

$37,943

 

$34,319

Less dividends and undistributed earnings allocated to participating securities
(28
)
 
(25
)
 
(84
)
 
(72
)
Net income applicable to common shareholders

$12,934

 

$12,302

 

$37,859

 

$34,247

Weighted average common shares
17,212

 
17,090

 
17,201

 
17,060

Earnings per common share - basic

$0.75

 

$0.72

 

$2.20

 

$2.01

Earnings per common share - diluted:
 
 
 
 
 
 
 
Net income

$12,962

 

$12,327

 

$37,943

 

$34,319

Less dividends and undistributed earnings allocated to participating securities
(28
)
 
(25
)
 
(84
)
 
(72
)
Net income applicable to common shareholders

$12,934

 

$12,302

 

$37,859

 

$34,247

Weighted average common shares
17,212

 
17,090

 
17,201

 
17,060

Dilutive effect of common stock equivalents
106

 
113

 
119

 
138

Weighted average diluted common shares
17,318

 
17,203

 
17,320

 
17,198

Earnings per common share - diluted

$0.75

 

$0.72

 

$2.19

 

$1.99


Weighted average common stock equivalents, not included in common stock equivalents above because they were anti-dilutive, totaled 46,800 and 48,718, respectively, for the three and nine months ended September 30, 2016. There were no anti-dilutive weighted average common stock equivalents for the three and nine months ended September 30, 2017.



- 43-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(18) Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage the Corporation’s exposure to fluctuations in interest rates.  These financial instruments include commitments to extend credit, standby letters of credit, forward loan commitments, loan-related derivative contracts and interest rate risk management contracts.  These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Corporation’s Unaudited Consolidated Balance Sheets.  The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments.  The Corporation’s credit policies with respect to interest rate swap agreements with commercial borrowers, commitments to extend credit and financial guarantees are similar to those used for loans.  The interest rate swaps with other counterparties are generally subject to bilateral collateralization terms.

The following table presents the contractual and notional amounts of financial instruments with off-balance sheet risk:
(Dollars in thousands)
Sep 30,
2017
 
Dec 31,
2016
Financial instruments whose contract amounts represent credit risk:
 
 
 
Commitments to extend credit:
 
 
 
Commercial loans

$516,020

 

$430,710

Home equity lines
256,519

 
232,375

Other loans
49,857

 
49,708

Standby letters of credit
6,657

 
6,250

Financial instruments whose notional amounts exceed the amount of credit risk:
 
 
 
Forward loan commitments:
 
 
 
Interest rate lock commitments
65,332

 
49,502

Commitments to sell mortgage loans
93,083

 
78,896

Loan related derivative contracts:
 
 
 
Interest rate swaps with customers
539,088

 
428,723

Mirror swaps with counterparties
539,088

 
428,723

Risk participation-in agreements
32,333

 
28,460

Interest rate risk management contracts:
 
 
 
Interest rate swaps
60,000

 
60,000


See Note 10 for additional disclosure pertaining to derivative financial instruments.

Commitments to Extend Credit
Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected to expire without being drawn upon, total commitment amounts do not necessarily represent future cash requirements.  Each borrower’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained is based on management’s credit evaluation of the borrower.

Standby Letters of Credit
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support the financing needs of the Bank’s commercial customers. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The collateral supporting those commitments is essentially the same as for other commitments. Generally, standby letters of credit have a term of up to 1 year. As of September 30, 2017 and December 31, 2016, the maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered, totaled $6.7 million and $6.3 million, respectively. At September 30, 2017 and December 31, 2016, there were no liabilities to beneficiaries resulting from standby letters of credit.  Fee income on standby letters of credit was insignificant for the three and nine months ended September 30, 2017 and 2016.


- 44-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)


Forward Loan Commitments
Interest rate lock commitments are extended to borrowers and relate to the origination of residential real estate mortgage loans held for sale. To mitigate the interest rate risk inherent in these rate locks, as well as closed residential real estate mortgage loans held for sale, forward commitments are established to sell individual residential real estate mortgage loans.  Both interest rate lock commitments and commitments to sell residential real estate mortgage loans are derivative financial instruments.

Leases
At September 30, 2017, the Corporation was committed to rent premises used in banking operations under non-cancellable operating leases. Rental expense under the operating leases amounted to $1.1 million and $3.3 million for the three and nine months ended September 30, 2017, compared to $1.0 million and $3.0 million for the same periods in 2016. The following table presents the minimum annual lease payments under the terms of these leases, exclusive of renewal provisions:
 
 
(Dollars in thousands)
 
October 1, 2017 to December 31, 2017

$908

2018
3,372

2019
3,040

2020
2,352

2021
2,011

2022 and thereafter
24,958

Total minimum lease payments

$36,641


Lease expiration dates range from 3 months to 23 years, with additional renewal options on certain leases ranging from 1 to 5 years.


- 45-


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Corporation’s Audited Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2016, and in conjunction with the condensed Unaudited Consolidated Financial Statements and notes thereto included in Item 1 of this report.  Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results for the full-year ended December 31, 2017 or any future period.

Forward-Looking Statements
This report contains statements that are “forward-looking statements.”  We may also make 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 our control.  These risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different than 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: weakness in national, regional or international economic conditions or conditions affecting the banking or financial services industries or financial capital markets; volatility in national and international financial markets; 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 our competition; changes in legislation or regulation and accounting principles, policies and guidelines; occurrences of cyberattacks, hacking and identity theft; natural disasters; and changes in the assumptions used in making such forward-looking statements.  In addition, the factors described under “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC, 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.

Critical Accounting Policies and Estimates
Accounting policies involving significant judgments, estimates and assumptions by management, which have, or could have, a material impact on the Corporation’s consolidated financial statements are considered critical accounting policies. Management considers the following to be its critical accounting policies: the determination of allowance for loan losses, the valuation of goodwill and identifiable intangible assets, the assessment of investment securities for other-than-temporary impairment and accounting for defined benefit pension plans. There have been no significant changes in the Corporation’s critical accounting policies and estimates from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

Recently Issued Accounting Pronouncements
See Note 2 to the Unaudited Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on the Corporation’s financial statements.

Overview
Washington Trust offers a comprehensive product line of banking and 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, eastern Massachusetts and Connecticut; its ATM networks; and its internet website at 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 borrowings.  In addition, we generate noninterest income from a number of sources, including wealth management services, mortgage banking activities and deposit services.  Our principal noninterest expenses include salaries and employee benefits, occupancy and facility-related costs, technology and other administrative expenses.



- 46-


Our financial results are affected by interest rate fluctuations, changes in economic and market conditions, competitive conditions within our market area and changes in legislation, regulation and/or accounting principles.  Adverse changes in economic growth, consumer confidence, credit availability and corporate earnings could negatively impact our financial results.

We continue to leverage our strong statewide brand to build market share and remain steadfast in our commitment to provide superior service. A full-service branch in Coventry, Rhode Island, will open in the fourth quarter of 2017.

Composition of Earnings
The following table presents a summarized consolidated statement of operations:
(Dollars in thousands)
Three Months
 
Nine Months
 
 
 
 
Change
 
 
 
 
Change
Periods ended September 30,
2017
2016
 
$
%
 
2017
2016
 
$
%
Net interest income

$30,059


$27,379

 

$2,680

10
%
 

$88,642


$81,890

 

$6,752

8
%
Noninterest income
17,283

17,261

 
22


 
48,599

47,809

 
790

2

Total revenues
47,342

44,640

 
2,702

6

 
137,241

129,699

 
7,542

6

Provision for loan losses
1,300

1,800

 
(500
)
(28
)
 
2,400

2,750

 
(350
)
(13
)
Noninterest expense
26,754

24,650

 
2,104

9

 
78,346

76,130

 
2,216

3

Income before income taxes
19,288

18,190

 
1,098

6

 
56,495

50,819

 
5,676

11

Income tax expense
6,326

5,863

 
463

8

 
18,552

16,500

 
2,052

12

Net income

$12,962


$12,327

 

$635

5
%
 

$37,943


$34,319

 

$3,624

11
%

The following table presents a summary of performance metrics and ratios:
 
Three Months
 
Nine Months
Periods ended September 30,
2017
2016
 
2017
2016
Diluted earnings per common share

$0.75


$0.72

 

$2.19


$1.99

Return on average assets
1.18
%
1.21
%
 
1.16
%
1.17
%
Return on average equity
12.56
%
12.57
%
 
12.50
%
11.86
%
Net interest income as a % of total revenues
63
%
61
%
 
65
%
63
%
Noninterest income as a % of total revenues
37
%
39
%
 
35
%
37
%

Income before income taxes for the three and nine months ended September 30, 2017, increased by $1.1 million and $5.7 million, respectively, compared to the same periods in 2016, largely due to growth in net interest income, partially offset by an increase in noninterest expenses. Income tax expense for the three and nine months ended September 30, 2017, increased by $463 thousand and $2.1 million, respectively, over the prior year, largely due to higher levels of pre-tax income.

Results of Operations
Segment Reporting
Washington Trust manages its operations through two business segments, Commercial Banking and Wealth Management Services.  Activity not related to the segments, including activity related to the investment securities portfolio, wholesale funding matters and administrative units are considered Corporate.  The Corporate unit also includes income from BOLI and the residual impact of methodology allocations such as funds transfer pricing.  Methodologies used to allocate income and expenses to business lines are periodically reviewed and revised. See Note 15 to the Unaudited Consolidated Financial Statements for additional disclosure related to business segments.



- 47-


Commercial Banking
The following table presents a summarized statement of operations for the Commercial Banking business segment:
(Dollars in thousands)
Three Months
 
Nine Months

 
 
 
Change
 
 
 
 
Change
Periods ended September 30,
2017
2016
 
$
%
 
2017
2016
 
$
%
Net interest income

$24,795


$22,860

 

$1,935

8
%
 

$72,985


$67,414

 

$5,571

8
%
Provision for loan losses
1,300

1,800

 
(500
)
(28
)
 
2,400

2,750

 
(350
)
(13
)
Net interest income after provision for loan losses
23,495

21,060

 
2,435

12

 
70,585

64,664

 
5,921

9

Noninterest income
6,711

7,101

 
(390
)
(5
)
 
17,500

17,331

 
169

1

Noninterest expense
16,480

15,468

 
1,012

7

 
47,724

45,881

 
1,843

4

Income before income taxes
13,726

12,693

 
1,033

8

 
40,361

36,114

 
4,247

12

Income tax expense
4,463

4,392

 
71

2

 
13,142

12,336

 
806

7

Net income

$9,263


$8,301

 

$962

12
%
 

$27,219


$23,778

 

$3,441

14
%

Net interest income for this operating segment for the three and nine months ended September 30, 2017, increased by $1.9 million and $5.6 million, respectively, from the same periods in 2016, largely reflecting growth in loans and a favorable shift in the mix of deposits to lower cost categories as well as favorable net funds transfer pricing allocations with the Corporate unit.

Loan loss provisions charged to earnings totaled $1.3 million and $2.4 million, respectively, for the three and nine months ended September 30, 2017, compared to $1.8 million and $2.8 million, respectively, for the same periods in 2016, based on management’s assessment of loss exposure, as well as loan loss allocations commensurate with changes in the loan portfolio.

Noninterest income derived from the Commercial Banking segment for the three and nine months ended September 30, 2017 was down by $390 thousand and up by $169 thousand, respectively, from the comparable periods in 2016. The year-over-year changes were largely due to changes in mortgage banking revenues and loan related derivative income. See further discussion of the changes in these revenues under the caption “Noninterest Expense.”

Commercial Banking noninterest expenses for the three and nine months ended September 30, 2017 were up by $1.0 million and $1.8 million, respectively, from the same periods in 2016. These increases included a charge of approximately $570 thousand associated with an isolated external fraud matter that was recognized in the third quarter of 2017. See additional discussion under the caption “Noninterest Expense” below for further information on this charge. Excluding this charge, total noninterest expenses for the Commercial Banking segment for the three and nine months ended September 30, 2017 increased by $444 thousand and $1.3 million, from the same periods in 2016, largely reflecting increases in outsourced services and software system implementation expenses.

Wealth Management Services
The following table presents a summarized statement of operations for the Wealth Management Services business segment:
(Dollars in thousands)
Three Months
 
Nine Months
 
 
 
 
Change
 
 
 
 
Change
Periods ended September 30,
2017
2016
 
$
%
 
2017
2016
 
$
%
Net interest expense

($48
)

($11
)
 

($37
)
336
%
 

($120
)

($46
)
 

($74
)
161
%
Noninterest income
10,013

9,623

 
390

4

 
29,432

28,278

 
1,154

4

Noninterest expense
7,221

6,085

 
1,136

19

 
21,394

20,524

 
870

4

Income before income taxes
2,744

3,527

 
(783
)
(22
)
 
7,918

7,708

 
210

3

Income tax expense
1,092

1,261

 
(169
)
(13
)
 
3,172

2,788

 
384

14

Net income

$1,652


$2,266

 

($614
)
(27
%)
 

$4,746


$4,920

 

($174
)
(4
%)



- 48-


For the three and nine months ended September 30, 2017, noninterest income derived from the Wealth Management Services segment increased by $390 thousand and $1.2 million, respectively, compared to the same periods in 2016, reflecting an increase in asset-based revenues resulting from growth in wealth management assets under administration.

For the three and nine months ended September 30, 2017, noninterest expenses for the Wealth Management Services segment increased by $1.1 million and $870 thousand, respectively, from the same periods in 2016. Included in these increases were the year-over-year change in fair value of the contingent consideration liability and a goodwill impairment charge of $150 thousand recognized in the second quarter of 2017. See additional discussion under the caption “Noninterest Expense” below for further information on these items. Excluding the impact of these items, total noninterest expenses for the Wealth Management Services segment increased by $238 thousand and $132 thousand, respectively, for the three and nine months ended September 30, 2017, compared to the same periods in 2016, reflecting costs associated with a software application system implementation.

Corporate
The following table presents a summarized statement of operations for the Corporate unit:
(Dollars in thousands)
Three Months
 
Nine Months
 
 
 
 
Change
 
 
 
 
Change
Periods ended September 30,
2017
2016
 
$
%
 
2017
2016
 
$
%
Net interest income

$5,312


$4,530

 

$782

17
%
 

$15,777


$14,522

 

$1,255

9
%
Noninterest income
559

537

 
22

4

 
1,667

2,200

 
(533
)
(24
)
Noninterest expense
3,053

3,097

 
(44
)
(1
)
 
9,228

9,725

 
(497
)
(5
)
Income before income taxes
2,818

1,970

 
848

43

 
8,216

6,997

 
1,219

17

Income tax expense
771

210

 
561

267

 
2,238

1,376

 
862

63

Net income

$2,047


$1,760

 

$287

16
%
 

$5,978


$5,621

 

$357

6
%

Net interest income for the Corporate unit for the three and nine months ended September 30, 2017 was up by $782 thousand and $1.3 million, respectively, compared to the same periods in 2016, reflecting the impact of additions to the investment securities portfolio in the latter half of 2016, partially offset by increased FHLBB borrowing costs and unfavorable net funds transfer pricing allocations with the Commercial Banking segment.

Noninterest income for the Corporate unit for the three and nine months ended September 30, 2017 was up modestly and down by $533 thousand, respectively, from the corresponding 2016 periods. The decrease in the nine-month period comparison was primarily due to non-taxable income of $589 thousand associated with the receipt of BOLI proceeds in the second quarter of 2016.

Noninterest expenses for the Corporate unit for the three and nine months ended September 30, 2017 were down modestly and down by $497 thousand, respectively, from the same periods in 2016. The decrease in the nine-month period comparison was largely due to debt prepayment penalty expense recognized in the first quarter of 2016.

Net Interest Income
Net interest income continues to be the primary source of our operating income.  Net interest income is affected by the level of interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities.  Included in interest income are loan prepayment fees and certain other fees, such as late charges. The following discussion presents net interest income on a fully taxable equivalent (“FTE”) basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities.  For more information, see the section entitled “Average Balances / Net Interest Margin - Fully Taxable Equivalent (FTE) Basis” below.

The analysis of net interest income, net interest margin and the yield on loans is impacted by the level of loan prepayment and other fee income recognized in each period. For the three and nine months ended September 30, 2017, loan prepayment and other fee income amounted to $195 thousand and $1.0 million, respectively, down by $246 thousand and $639 thousand, respectively, from the same periods in 2016.



- 49-


FTE net interest income for the three and nine months ended September 30, 2017 was up by $2.6 million and $6.4 million, respectively, from the same periods in 2016. The net interest margin was 2.93% and 2.92%, respectively, for the three and nine months ended September 30, 2017, down from 2.94% and 3.07%, respectively, for the same periods a year ago. Excluding the impact of loan prepayment and other fee income from each period, net interest income for the three and nine months ended September 30, 2017 increased by $2.8 million and $7.1 million, respectively. The growth in net interest income largely reflected the impact of purchases of investment securities and residential real estate loans for portfolio that were made in the second half of 2016. For the three and nine months ended September 30, 2017, the net interest margin excluding the impact of loan prepayment and other fee income from each period was 2.91% and 2.89%, respectively, up by 2 basis points and down by 12 basis points, respectively, for the same periods in 2016. While the net interest margin benefited from the rise in short-term interest-rates on floating rate loans, the net interest margin was also impacted by the purchases of investment securities and residential real estate loans for portfolio that were made in 2016 with relatively lower yields than the average yields of the existing portfolios, as well as a higher associated cost of funds.

Total average loans for the three and nine months ended September 30, 2017 increased by $138.2 million and $167.0 million, respectively, from the average balances for the comparable 2016 periods, primarily due to purchases of $111.0 million of residential real estate loans added to portfolio in the second half of 2016. The yield on total loans for the three and nine months ended September 30, 2017 was 3.98% and 3.94%, respectively, up by 17 basis points and 4 basis points, respectively, compared to the same periods in 2016. Excluding the impact of loan prepayment fee income and other fee income from each period, the yield on total loans for the three and nine months ended September 30, 2017 was 3.96% and 3.90%, up by 21 basis points and 7 basis points, respectively, from the same periods in 2016. While yields on short-term LIBOR-based and prime-based loans benefited from the increases in short-term market rates of interest, the comparison to the prior year was also impacted by the purchases of residential real estate loans for portfolio that were made in the second half of 2016 with relatively lower yields.

Total average securities for the three and nine months ended September 30, 2017 increased by $236.2 million and $321.9 million, respectively, from the average balances for the same periods a year earlier. The FTE rate of return on the securities portfolio for the three and nine months ended September 30, 2017 was 2.48% and 2.53%, respectively, down by 9 basis points and 21 basis points, respectively, from the comparable periods in 2016, primarily due to purchases of relatively lower yielding securities and runoff of higher yielding securities.

The average balance of FHLBB advances for the three and nine months ended September 30, 2017 increased by $146.5 million and $251.3 million, respectively, compared to the average balances for the same periods in 2016. The average rate paid on such advances for the three and nine months ended September 30, 2017 was 1.81% and 1.72%, respectively, up by 29 basis points and 8 basis points, respectively, from the same periods in 2016, reflecting higher rates on short-term advances.

Total average interest-bearing deposits for the three and nine months ended September 30, 2017 increased by $138.7 million and $156.9 million, respectively, from the average balances for the same periods in 2016. Included in total average interest-bearing deposits were of out-of-market wholesale brokered time deposits, which increased by $94.2 million and $94.9 million, respectively, from the same periods in 2016. Excluding wholesale brokered time deposits, average in-market interest-bearing deposits for the three and nine months ended September 30, 2017 increased by $44.5 million and $62.0 million, respectively, from the average balances for the same periods in 2016. The average rate paid on in-market interest-bearing deposits for the three and nine months ended September 30, 2017 increased by 6 basis points and 4 basis points, respectively, compared to the same periods in 2016, which was largely attributable to an increase in the rate paid on money market accounts and promotional time deposits.

The average balance of noninterest-bearing demand deposits for the three and nine months ended September 30, 2017 increased by $47.3 million and $57.6 million, respectively, from the average balances for the same periods in 2016.

Average Balances / Net Interest Margin - Fully Taxable Equivalent (FTE) Basis
The following tables present average balance and interest rate information.  Tax-exempt income is converted to a fully taxable equivalent basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. Unrealized gains (losses) on available for sale securities and fair value adjustments on mortgage loans held for sale are excluded from the average balance and yield calculations. Nonaccrual and renegotiated loans, as well as interest recognized on these loans are included in amounts presented for loans.


- 50-


Three months ended September 30,
2017
 
2016
(Dollars in thousands)
Average Balance
Interest
Yield/ Rate
 
Average Balance
Interest
Yield/ Rate
Assets:
 
 
 
 
 
 
 
Commercial mortgages

$1,027,517


$9,909

3.83
 

$1,079,917


$9,362

3.45
Construction & development
133,190

1,326

3.95
 
86,623

712

3.27
Commercial & industrial
590,915

6,684

4.49
 
565,170

6,382

4.49
Total commercial loans
1,751,622

17,919

4.06
 
1,731,710

16,456

3.78
Residential real estate loans, including mortgage loans held for sale
1,210,686

11,541

3.78
 
1,080,302

10,386

3.82
Consumer loans
329,689

3,604

4.34
 
341,829

3,340

3.89
Total loans
3,291,997

33,064

3.98
 
3,153,841

30,182

3.81
Cash, federal funds sold and short-term investments
61,390

197

1.27
 
88,414

93

0.42
FHLBB stock
44,057

467

4.21
 
37,933

288

3.02
Taxable debt securities
751,735

4,655

2.46
 
497,738

3,024

2.42
Nontaxable debt securities
4,287

65

6.02
 
22,038

336

6.07
Total debt securities
756,022

4,720

2.48
 
519,776

3,360

2.57
Total interest-earning assets
4,153,466

38,448

3.67
 
3,799,964

33,923

3.55
Noninterest-earning assets
248,070

 
 
 
262,724

 
 
Total assets

$4,401,536

 
 
 

$4,062,688

 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
Interest-bearing demand deposits

$46,352


$30

0.26
 

$39,865


$13

0.13
NOW accounts
442,166

68

0.06
 
402,307

51

0.05
Money market accounts
680,755

642

0.37
 
709,549

487

0.27
Savings accounts
366,177

56

0.06
 
352,032

52

0.06
Time deposits (in-market)
565,402

1,566

1.10
 
552,576

1,408

1.01
Wholesale brokered time deposits
404,953

1,473

1.44
 
310,740

1,099

1.41
FHLBB advances
837,300

3,816

1.81
 
690,843

2,641

1.52
Junior subordinated debentures
22,681

159

2.78
 
22,681

125

2.19
Other
1


 
53

1

7.51
Total interest-bearing liabilities
3,365,787

7,810

0.92
 
3,080,646

5,877

0.76
Non-interest bearing demand deposits
567,737

 
 
 
520,439

 
 
Other liabilities
55,150

 
 
 
69,370

 
 
Shareholders’ equity
412,862

 
 
 
392,233

 
 
Total liabilities and shareholders’ equity

$4,401,536

 
 
 

$4,062,688

 
 
Net interest income
 

$30,638

 
 
 

$28,046

 
Interest rate spread
 
 
2.75
 
 
 
2.79
Net interest margin
 
 
2.93
 
 
 
2.94

Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:
(Dollars in thousands)
 
 
Three months ended September 30,
2017

2016

Commercial loans

$555


$549

Nontaxable debt securities
24

118

Total

$579


$667



- 51-


 
 
 
 
 
 
 
 
Nine months ended September 30,
2017
 
2016
(Dollars in thousands)
Average Balance
Interest
Yield/ Rate
 
Average Balance
Interest
Yield/ Rate
Assets:
 
 
 
 
 
 
 
Commercial mortgages

$1,047,831


$29,174

3.72
 

$1,011,327


$26,569

3.51
Construction & development
129,104

3,650

3.78
 
110,914

2,806

3.38
Commercial & industrial
579,881

19,448

4.48
 
587,098

20,470

4.66
Commercial loans
1,756,816

52,272

3.98
 
1,709,339

49,845

3.90
Residential real estate loans, including mortgage loans held for sale
1,175,563

33,497

3.81
 
1,045,532

30,521

3.90
Consumer loans
332,245

10,391

4.18
 
342,735

10,044

3.91
Total loans
3,264,624

96,160

3.94
 
3,097,606

90,410

3.90
Cash, federal funds sold and short-term investments
59,357

457

1.03
 
75,627

227

0.40
FHLBB stock
44,015

1,293

3.93
 
31,774

729

3.06
Taxable debt securities
760,308

14,208

2.50
 
418,034

7,881

2.52
Nontaxable debt securities
7,602

347

6.10
 
27,939

1,276

6.10
Total debt securities
767,910

14,555

2.53
 
445,973

9,157

2.74
Total interest-earning assets
4,135,906

112,465

3.64
 
3,650,980

100,523

3.68
Noninterest-earning assets
238,050

 
 
 
250,019

 
 
Total assets

$4,373,956

 
 
 

$3,900,999

 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
Interest-bearing demand deposits

$52,564


$37

0.09
 

$44,490


$34

0.10
NOW accounts
433,435

176

0.05
 
397,329

161

0.05
Money market accounts
715,386

1,881

0.35
 
735,324

1,461

0.27
Savings accounts
361,904

158

0.06
 
339,616

148

0.06
Time deposits (in-market)
559,938

4,443

1.06
 
544,441

4,067

1.00
Wholesale brokered time deposits
398,349

4,233

1.42
 
303,442

3,188

1.40
FHLBB advances
828,775

10,669

1.72
 
577,501

7,106

1.64
Junior subordinated debentures
22,681

446

2.63
 
22,681

356

2.10
Other
13

1

10.28
 
66

4

8.10
Total interest-bearing liabilities
3,373,045

22,044

0.87
 
2,964,890

16,525

0.74
Demand deposits
546,393

 
 
 
488,767

 
 
Other liabilities
49,721

 
 
 
61,555

 
 
Shareholders’ equity
404,797

 
 
 
385,787

 
 
Total liabilities and shareholders’ equity

$4,373,956

 
 
 

$3,900,999

 
 
Net interest income
 

$90,421

 
 
 

$83,998

 
Interest rate spread
 
 
2.77
 
 
 
2.94
Net interest margin
 
 
2.92
 
 
 
3.07

Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:
 
 
 
(Dollars in thousands)
 
 
Nine months ended September 30,
2017

2016

Commercial loans

$1,657


$1,657

Nontaxable debt securities
122

451

Total

$1,779


$2,108




- 52-


Volume / Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)
The following table presents certain information on a FTE basis regarding changes in our interest income and interest expense for the period indicated.  The net change attributable to both volume and rate has been allocated proportionately.
(Dollars in thousands)
Three months ended
 
Nine months
 
September 30, 2017 vs. 2016
 
September 30, 2017 vs. 2016
 
Increase (Decrease) Due to
 
Increase (Decrease) Due to
 
Volume
Rate
Net Change
 
Volume
Rate
Net Change
Interest on Interest-Earning Assets:
 
 
 
 
 
 
 
Commercial mortgages

($472
)

$1,019


$547

 

$990


$1,615


$2,605

Construction & development
441

173

614

 
492

352

844

Commercial & industrial
285

17

302

 
(243
)
(779
)
(1,022
)
Total commercial loans
254

1,209

1,463

 
1,239

1,188

2,427

Residential real estate loans, including mortgage loans held for sale
1,236

(81
)
1,155

 
3,722

(746
)
2,976

Consumer loans
(122
)
386

264

 
(316
)
663

347

Cash, federal funds sold and other short-term investments
(36
)
140

104

 
(58
)
288

230

FHLBB stock
52

127

179

 
325

239

564

Taxable debt securities
1,572

59

1,631

 
6,397

(70
)
6,327

Nontaxable debt securities
(269
)
(2
)
(271
)
 
(928
)
(1
)
(929
)
Total interest income
2,687

1,838

4,525

 
10,381

1,561

11,942

Interest on Interest-Bearing Liabilities:
 
 
 
 
 
 
 
Interest-bearing demand deposits
2

15

17

 
6

(3
)
3

NOW accounts
6

11

17

 
15


15

Money market accounts
(20
)
175

155

 
(38
)
458

420

Savings accounts
4


4

 
10


10

Time deposits (in-market)
32

126

158

 
122

254

376

Wholesale brokered time deposits
346

28

374

 
1,002

43

1,045

FHLBB advances
613

562

1,175

 
3,210

353

3,563

Junior subordinated debentures

34

34

 

90

90

Other

(1
)
(1
)
 
(4
)
1

(3
)
Total interest expense
983

950

1,933

 
4,323

1,196

5,519

Net interest income

$1,704


$888


$2,592

 

$6,058


$365


$6,423


Provision and Allowance for Loan Losses
The provision for loan losses is based on management’s periodic assessment of the adequacy of the allowance for loan losses which, in turn, is based on such interrelated factors as the composition of the loan portfolio and its inherent risk characteristics; the level of nonperforming loans and net charge-offs, both current and historic; local economic and credit conditions; the direction of real estate values; and regulatory guidelines.  The provision for loan losses is charged against earnings in order to maintain an allowance for loan losses that reflects management’s best estimate of probable losses inherent in the loan portfolio at the balance sheet date.

Loan loss provisions charged to earnings totaled $1.3 million and $2.4 million, respectively, for the three and nine months ended September 30, 2017, compared to $1.8 million and $2.8 million, respectively, for the same periods in 2016. These provisions were based on management’s assessment of loss exposure, as well as loan loss allocations commensurate with changes in the loan portfolio.

For the three and nine months ended September 30, 2017, net charge-offs amounted to $654 thousand and $1.1 million, respectively, compared to net charge-offs of $2.0 million and $4.2 million, respectively, for the three and nine months ended September 30, 2016.



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The allowance for loan losses was $27.3 million, or 0.82% of total loans, at September 30, 2017, compared to $26.0 million, or 0.80% of total loans, at December 31, 2016, largely reflecting an increase in specific reserves on impaired loans.

See additional discussion under the caption “Asset Quality” below for further information on the allowance for loan losses.

Noninterest Income
Noninterest income is an important source of revenue for Washington Trust.  The principal categories of noninterest income are shown in the following table:
(Dollars in thousands)
Three months
 
Nine months
 
 
 
 
 
Change
 
 
 
 
 
Change
Periods ended September 30,
2017
 
2016
 
$
 
%
 
2017
 
2016
 
$
 
%
Noninterest income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Wealth management revenues

$10,013

 

$9,623

 

$390

 
4
 %
 

$29,432

 

$28,278

 

$1,154

 
4
 %
Mortgage banking revenues
3,036

 
3,734

 
(698
)
 
(19
)
 
8,295

 
8,642

 
(347
)
 
(4
)
Service charges on deposit accounts
942

 
915

 
27

 
3

 
2,726

 
2,757

 
(31
)
 
(1
)
Card interchange fees
894

 
870

 
24

 
3

 
2,598

 
2,527

 
71

 
3

Income from bank-owned life insurance
546

 
521

 
25

 
5

 
1,624

 
2,110

 
(486
)
 
(23
)
Loan related derivative income
1,452

 
1,178

 
274

 
23

 
2,744

 
2,331

 
413

 
18

Equity in earnings (losses) of unconsolidated subsidiaries
(89
)
 
(88
)
 
(1
)
 
(1
)
 
(266
)
 
(265
)
 
(1
)
 

Other income
489

 
508

 
(19
)
 
(4
)
 
1,446

 
1,429

 
17

 
1

Total noninterest income

$17,283

 

$17,261

 

$22

 
 %
 

$48,599

 

$47,809

 

$790

 
2
 %

Noninterest Income Analysis
Revenue from wealth management services is our largest source of noninterest income. A substantial portion of wealth management revenues is largely dependent on the value of wealth management assets under administration and is closely tied to the performance of the financial markets. This portion of wealth management revenues is referred to as “asset-based” and includes trust and investment management fees and mutual fund fees. Wealth management revenues also include “transaction-based” revenues, such as financial planning, commissions and other service fees that are not primarily derived from the value of assets.

The categories of wealth management revenues are shown in the following table:
(Dollars in thousands)
Three months
 
Nine months
 
 
 
 
 
Change
 
 
 
 
 
Change
Periods ended September 30,
2017
 
2016
 
$
 
%
 
2017
 
2016
 
$
 
%
Wealth management revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trust and investment management fees

$9,101

 

$8,358

 

$743

 
9
 %
 

$26,400

 

$24,618

 

$1,782

 
7
 %
Mutual fund fees
690

 
812

 
(122
)
 
(15
)
 
2,039

 
2,467

 
(428
)
 
(17
)
Asset-based revenues
9,791

 
9,170

 
621

 
7

 
28,439

 
27,085

 
1,354

 
5

Transaction-based revenues
222

 
453

 
(231
)
 
(51
)
 
993

 
1,193

 
(200
)
 
(17
)
Total wealth management revenues

$10,013

 

$9,623

 

$390

 
4
 %
 

$29,432

 

$28,278

 

$1,154

 
4
 %



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The following table presents the changes in wealth management assets under administration:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Wealth management assets under administration:
 
 
 
 
 
 
 
Balance at the beginning of period

$6,403,501

 

$5,905,019

 

$6,063,293

 

$5,844,636

Net investment appreciation & income
270,549

 
192,518

 
653,896

 
286,354

Net client asset flows
(86,151
)
 
(40,678
)
 
(129,290
)
 
(74,131
)
Balance at the end of period

$6,587,899

 

$6,056,859

 

$6,587,899



$6,056,859


Wealth management revenues for the three and nine months ended September 30, 2017 increased by $390 thousand and $1.2 million, respectively, from the comparable periods in 2016, primarily due to increases in asset-based revenues. Assets under administration stood at $6.6 billion at September 30, 2017, up by $531 million, or 9%, from a year ago, reflecting financial market appreciation.

Mortgage banking revenues are dependent on mortgage origination volume and are sensitive to interest rates and the condition of housing markets.

The composition of mortgage banking revenues and the volume of loans sold to the secondary market are shown in the following table:
(Dollars in thousands)
Three months
 
Nine months
 
 
 
 
Change
 
 
 
 
Change
Periods ended September 30,
2017
2016
 
$
%
 
2017
2016
 
$
%
Mortgage banking revenues:
 
 
 
 
 
 
 
 
 
 
 
Gains and commissions on loan sales (1)

$2,952


$3,744

 

($792
)
(21
)%
 

$8,004


$8,682

 

($678
)
(8
)%
Loan servicing fee income, net (2)
84

(10
)
 
94

940

 
291

(40
)
 
331

828

Total mortgage banking revenues

$3,036


$3,734

 

($698
)
(19
)%
 

$8,295


$8,642

 

($347
)
(4
)%
 
 
 
 
 
 
 
 
 
 
 
 
Loans sold to the secondary market

$147,331


$164,183

 

($16,852
)
(10
)%
 

$391,687


$409,187

 

($17,500
)
(4
)%
(1)
Includes gains on loan sales and commissions on loans originated for others, servicing right gains and fair value adjustments on loans held for sale and forward loan commitments.
(2)
Represents loan servicing fee income, net of servicing right amortization and valuation adjustments.

For the three and nine months ended September 30, 2017, mortgage banking revenues decreased by $698 thousand and $347 thousand, respectively, from the comparable periods in 2016, reflecting a lower volume of mortgage loans sold to the secondary market and a general decline in sales prices in the secondary market. The declines were partially offset by higher levels of loan servicing fee income, which reflected growth in the balances of residential mortgage loans serviced for others.

Income from BOLI for the three and nine months ended September 30, 2017 increased modestly and decreased by$486 thousand, respectively, compared to the same periods in 2016. The nine-month period comparison decrease was primarily due to a $589 thousand gain that was recognized in the second quarter of 2016 resulting from the receipt of tax-exempt life insurance proceeds.

Loan related derivative income for the three and nine months ended September 30, 2017 increased by $274 thousand and $413 thousand, respectively, from the comparable periods in 2016. This income source includes market value portfolio adjustments and volume related derivative execution fee income.



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Noninterest Expense
The following table presents noninterest expense comparisons:
(Dollars in thousands)
Three months
 
Nine months
 
 
 
 
 
Change
 
 
 
 
 
Change
Periods ended September 30,
2017
 
2016
 
$
 
%
 
2017
 
2016
 
$
 
%
Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries and employee benefits

$17,251

 

$16,908

 

$343

 
2
 %
 

$51,404

 

$50,693

 

$711

 
1
 %
Net occupancy
1,928

 
1,766

 
162

 
9

 
5,662

 
5,376

 
286

 
5

Equipment
1,380

 
1,648

 
(268
)
 
(16
)
 
4,160

 
4,652

 
(492
)
 
(11
)
Outsourced services
1,793

 
1,254

 
539

 
43

 
4,960

 
3,911

 
1,049

 
27

Legal, audit and professional fees
534

 
691

 
(157
)
 
(23
)
 
1,732

 
1,982

 
(250
)
 
(13
)
FDIC deposit insurance costs
308

 
504

 
(196
)
 
(39
)
 
1,258

 
1,488

 
(230
)
 
(15
)
Advertising and promotion
416

 
370

 
46

 
12

 
1,015

 
1,055

 
(40
)
 
(4
)
Amortization of intangibles
253

 
321

 
(68
)
 
(21
)
 
787

 
966

 
(179
)
 
(19
)
Debt prepayment penalties

 

 

 

 

 
431

 
(431
)
 
(100
)
Change in fair value of contingent consideration

 
(939
)
 
939

 
100

 
(310
)
 
(898
)
 
588

 
65

Other
2,891

 
2,127

 
764

 
36

 
7,678

 
6,474

 
1,204

 
19

Total noninterest expense

$26,754

 

$24,650

 

$2,104

 
9
 %
 

$78,346

 

$76,130

 

$2,216

 
3
 %

Noninterest Expense Analysis
Equipment expense for the three and nine months ended September 30, 2017 decreased by $268 thousand and $492 thousand, respectively, from the same periods in 2016. Outsourced services for the three and nine months ended September 30, 2017 increased by $539 thousand and $1.0 million, respectively, from the same periods in 2016. Both the decline in equipment expense and the increase in outsourced services reflects the expansion of services provided by third party vendors.

Prepayment of $10.0 million of FHLBB advances in March 2016 resulted in the recognition of $431 thousand of debt prepayment penalty expense in the first quarter of 2016. There were no prepayments of advances in 2017.

The Corporation recognized reductions to noninterest expenses of $310 thousand in the first quarter of 2017 and $939 thousand in the third quarter of 2016, resulting from the downward adjustment in the fair value of a contingent consideration liability. As part of the consideration to acquire Halsey, a contingent consideration liability was initially recorded at fair value in August 2015 representing the estimated present value of future earn-outs to be paid based on the future revenue growth of Halsey during the 5-year period following the acquisition. This contingent consideration liability is remeasured at each reporting period taking into consideration changes in probability estimates regarding the likelihood of Halsey achieving revenue growth targets during the earn-out period. Actual revenue growth was below the assumed levels at the time of the initial estimate, largely due to downturns in the equity markets during a portion of the earn-out period. As a result, the Corporation reduced the estimated liability with a corresponding reduction in noninterest expenses.

Other expenses for the three and nine months ended September 30, 2017 increased by $764 thousand and $1.2 million, respectively, from the same periods in 2016. Included in other expenses for the three months ended September 30, 2017 was a charge of approximately $570 thousand associated with an isolated external fraud matter. Earlier in 2017, a customer of the Bank reported that two checks that were mailed by the customer to a vendor were altered to change the payee on the checks and increase the amount of one of the checks. The checks were diverted and deposited by an unknown party at another bank. The altered checks then passed through the banking system in a routine manner and were charged against the customer’s account at the Bank. The Bank has reimbursed its customer for the amount inappropriately charged against the customer’s account. Despite demand by Washington Trust, the other bank has refused to return funds since Washington Trust notified them of the event several months ago. The Bank is currently pursuing legal action against the other bank to recover the lost funds, which represents the charge of approximately $570 thousand recognized in the third quarter of 2017. At this time, the Bank is unable to determine the eventual outcome of this action. No employee or customer of the Bank was involved in the fraudulent activity. Excluding this charge, other expenses for the three and nine months ended September 30, 2017, increased by $194 thousand and $636 thousand, respectively. The nine-month period comparison increase was primarily due to the recognition of $455 thousand


- 56-


in costs associated with software application system implementations and a goodwill impairment charge of $150 thousand recognized on a small broker-dealer subsidiary. See Note 7 to the Unaudited Consolidated Financial Statements for additional disclosure related to the goodwill impairment.

Income Taxes
The following table presents the Corporation’s income tax provision and applicable tax rates for the periods indicated:
(Dollars in thousands)
 
 
 
 
 
 
Three Months
 
Nine Months
Periods ended September 30,
2017
2016
 
2017
2016
Income tax expense

$6,326


$5,863

 

$18,552


$16,500

Effective income tax rate
32.8
%
32.2
%
 
32.8
%
32.5
%

The effective income tax rates differed from the federal rate of 35.0% due largely to the benefits of tax-exempt income, income from BOLI and federal tax credits.

Effective January 1, 2017, Washington Trust adopted Accounting Standards Update No. 2016-09, "Improvements to Employee Share-Based Payment Accounting" ("ASU"). Under this ASU, excess tax benefits on the settlement of share-based awards are recognized as a reduction to income tax expense in the period that they occur. For the three and nine months ended September 30, 2017, the Corporation recognized excess tax benefits on the settlement of share-based awards totaling $64 thousand and $414 thousand, respectively. Prior to 2017, excess tax benefits on the settlement of share-based awards were recognized as additional paid in capital in shareholders' equity and did not impact income tax expense or the effective tax rate.

Financial Condition
Summary
The following table presents selected financial condition data:
(Dollars in thousands)
 
 
 
 
Change
 
September 30, 2017
 
December 31,
2016
 
$
%
Total securities

$727,596

 

$755,545

 

($27,949
)
(4
%)
Total loans
3,323,078

 
3,234,371

 
88,707

3

Allowance for loan losses
27,308

 
26,004

 
1,304

5

Total assets
4,469,230

 
4,381,115

 
88,115

2

Total deposits
3,157,081

 
3,063,752

 
93,329

3

FHLBB advances
814,045

 
848,930

 
(34,885
)
(4
)
Total shareholders’ equity
414,228

 
390,804

 
23,424

6


Total assets stood at $4.5 billion at September 30, 2017, up by $88.1 million from the end of 2016, reflecting increases in total loans and cash and due from banks balances, partially offset by a decline in the investment securities portfolio.

In the nine months ended September 30, 2017, total deposits increased by $93.3 million, or 3%, primarily due to increases in time deposits, demand deposits and NOW account balances. FHLBB advances totaled $814.0 million, down by $34.9 million, or 4%, from December 31, 2016, due to growth in deposits.

Shareholders’ equity amounted to $414.2 million at September 30, 2017, up by $23.4 million from the balance at the end of 2016.  Capital levels continue to exceed the regulatory minimum levels to be considered well-capitalized, with a total risk-based capital ratio of 12.53% at September 30, 2017, compared to 12.26% at December 31, 2016. See Note 9 to the Unaudited Consolidated Financial Statements for additional discussion on regulatory capital requirements.

Securities
Washington Trust’s securities 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. Securities are designated as


- 57-


either available for sale, held to maturity or trading at the time of purchase. The Corporation does not currently maintain a portfolio of trading securities. Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. Securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized. Securities held to maturity are reported at amortized cost.

Determination of Fair Value
The Corporation uses an independent pricing service to obtain quoted prices. The prices provided by the independent pricing service are generally based on observable market data in active markets. The determination of whether markets are active or inactive is based upon the level of trading activity for a particular security class. The Corporation reviews the independent pricing service’s documentation to gain an understanding of the appropriateness of the pricing methodologies. The Corporation also reviews the prices provided by the independent pricing service for reasonableness based upon current trading levels for similar securities. If the prices appear unusual, they are re-examined and the value is either confirmed or revised. In addition, the Corporation periodically performs independent price tests of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of September 30, 2017 and December 31, 2016, the Corporation did not make any adjustments to the prices provided by the pricing service.

Our fair value measurements generally utilize Level 2 inputs, representing quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and model-derived valuations in which all significant input assumptions are observable in active markets.

See Notes 4 and 12 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities.

Securities Portfolio
The carrying amounts of securities held are as follows:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount

 
%

 
Amount

 
%

Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$119,125

 
17
%
 

$108,440

 
15
%
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
561,670

 
78

 
588,085

 
79

Obligations of states and political subdivisions
3,163

 

 
14,485

 
2

Individual name issuer trust preferred debt securities
26,388

 
4

 
26,736

 
4

Corporate bonds
4,009

 
1

 
2,166

 

Total securities available for sale

$714,355

 
100
%
 

$739,912

 
100
%

(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount

 
%

 
Amount

 
%

Securities Held to Maturity:
 
 
 
 
 
 
 
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises

$13,241

 
100
%
 

$15,633

 
100
%
Total securities held to maturity

$13,241

 
100
%
 

$15,633

 
100
%

The securities portfolio stood at $727.6 million as of September 30, 2017, or 16% of total assets, compared to $755.5 million as of December 31, 2016, or 17% of total assets. The largest component of the securities portfolio is mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises.

As of September 30, 2017 and December 31, 2016, the net unrealized loss position on securities available for sale and held to maturity amounted to $5.3 million and $10.5 million, respectively, and included gross unrealized losses of $10.5 million and


- 58-


$15.8 million, respectively.  As of September 30, 2017, the gross unrealized losses were concentrated in obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, and were primarily attributable to relative changes in interest rates since the time of purchase. Management evaluated the impairment status of these debt securities and concluded that the gross unrealized losses were temporary in nature.

As of September 30, 2017, Washington Trust owns trust preferred security holdings of six individual name issuers in the financial services industry. The following table presents information concerning these holdings, including credit ratings.  The Corporation’s Investment Policy contains rating standards that specifically reference ratings issued by Moody’s and S&P.

Individual Name Issuer Trust Preferred Debt Securities
(Dollars in thousands)
September 30, 2017
 
Credit Ratings
 
 
 
 
 
 
 
 
 
September 30, 2017
 
Form 10-Q Filing Date
Named Issuer
(parent holding company)
(i)
 
Amortized Cost
 
Fair Value
 
Unrealized Losses
 
Moody’s
 
S&P
 
Moody’s
 
S&P
JPMorgan Chase & Co.
2
 

$9,796

 

$9,236

 

($560
)
 
 Baa2
 
 BBB-
 
 Baa2
 
 BBB-
Bank of America Corporation
2
 
4,814

 
4,609

 
(205
)
 
 Ba1 (ii)
 
 BB+ (ii)
 
 Ba1 (ii)
 
 BB+ (ii)
Wells Fargo & Company
2
 
5,168

 
4,959

 
(209
)
 
 A1/Baa1
 
 BBB+/BBB
 
 A1/Baa1
 
 BBB+/BBB
SunTrust Banks, Inc.
1
 
4,180

 
3,929

 
(251
)
 
 Baa2
 
 BB+ (ii)
 
 Baa2
 
 BB+ (ii)
Northern Trust Corporation
1
 
1,989

 
1,870

 
(119
)
 
 A3
 
 BBB+
 
 A3
 
 BBB+
Huntington Bancshares Incorporated
1
 
1,950

 
1,785

 
(165
)
 
 Baa2
 
 BB (ii)
 
 Baa2
 
 BB (ii)
Totals
9
 

$27,897

 

$26,388

 

($1,509
)
 
 
 
 
 
 
 
 
(i)
Number of separate issuances, including issuances of acquired institutions.
(ii)
Rating is below investment grade.

The Corporation’s evaluation of the impairment status of individual name trust preferred securities includes various considerations in addition to the degree of impairment and the duration of impairment.  We review the reported regulatory capital ratios of the issuer and, in all cases, the regulatory capital ratios were deemed to be in excess of the regulatory minimums.  Credit ratings were also taken into consideration, including ratings in effect as of the reporting period date as well as credit rating changes between the reporting period date and the filing date of this report.  We noted no additional downgrades to below investment grade between September 30, 2017 and the filing date of this report.  Where available, credit ratings from multiple rating agencies are obtained and rating downgrades are specifically analyzed.  Our review process for these credit-sensitive holdings also includes a periodic review of relevant financial information for each issuer, such as quarterly financial reports, press releases and analyst reports.  This information is used to evaluate the current and prospective financial condition of the issuer in order to assess the issuer’s ability to meet its debt obligations.  Through the filing date of this report, each of the individual name issuer securities was current with respect to interest payments.  Based on our evaluation of the facts and circumstances relating to each issuer, management concluded that all principal and interest payments for these individual name issuer trust preferred debt securities would be collected according to their contractual terms and it expects to recover the entire amortized cost basis of these securities.  Furthermore, Washington Trust does not intend to sell these securities and it is not more-likely-than-not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be at maturity.  Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2017.

Further deterioration in credit quality of the underlying issuers of the securities, further deterioration in the condition of the financial services industry, worsening of the current economic environment, or additional declines in real estate values, among other things, may further affect the fair value of these securities and increase the potential that certain unrealized losses may be designated as other-than-temporary in future periods, and the Corporation may incur write-downs.

Loans
Total loans amounted to $3.3 billion at September 30, 2017, up by $88.7 million, or 3%, from the end of 2016, reflecting increases in the commercial loan portfolio and the residential real estate loan portfolio.

Commercial Loans
The commercial loan portfolio represented 54% of total loans at September 30, 2017.


- 59-



In making commercial loans, we may occasionally solicit the participation of other banks. Washington Trust also participates in commercial loans originated by other banks. In such cases, these loans are individually underwritten by us using standards similar to those employed for our self-originated loans. Our participation in commercial loans originated by other banks amounted to $381.4 million and $391.0 million, respectively, at September 30, 2017 and December 31, 2016. Our participation in commercial loans originated by other banks also includes shared national credits, which are participations in loans or loan commitments of at least $20.0 million that are shared by three or more banks.

Commercial loans fall into two major categories, commercial real estate and commercial and industrial loans. Commercial real estate loans consist of commercial mortgages secured by real property where the primary source of repayment is derived from rental income associated with the property or the proceeds of the sale, refinancing or permanent financing of the property. Commercial real estate loans also include construction loans made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings. Commercial and industrial loans primarily provide working capital, equipment financing and financing for other business-related purposes. Commercial and industrial loans are frequently collateralized by equipment, inventory, accounts receivable, and/or general business assets.  A significant portion of the Bank’s commercial and industrial loans is also collateralized by real estate.  Commercial and industrial loans also include tax exempt loans made to states and political subdivisions, as well as industrial development or revenue bonds issued through quasi-public corporations for the benefit of a private or non-profit entity where that entity rather than the governmental entity is obligated to pay the debt service.

Commercial Real Estate Loans
Commercial real estate loans totaled $1.2 billion at September 30, 2017, up by $16.2 million, or 1%, from the balance at December 31, 2016. The growth in commercial real estate loans was largely due to business cultivation efforts with new and existing borrowers, with an emphasis on larger loan balances to borrowers or groups of related borrowers. Included in commercial real estate loans were construction and development loans of $126.3 million and $121.4 million, respectively, as of September 30, 2017 and December 31, 2016.

As of September 30, 2017, shared national credit balances outstanding included in the commercial real estate loan portfolio totaled $33.6 million. All of these loans were included in the pass-rated category of commercial loan credit quality, all payments were current and the loans were performing in accordance with their contractual terms.

Commercial real estate loans are secured by a variety of property types, with 89% of the total at September 30, 2017 composed of office buildings, retail facilities, multi-family dwellings, lodging, commercial mixed use properties and healthcare facilities. The average loan balance outstanding in the portfolio was $2.3 million and the largest individual commercial real estate loan outstanding was $26.5 million as of September 30, 2017.

The following table presents a geographic summary of commercial real estate loans, including commercial construction, by property location:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount
 
% of Total
 
Amount
 
% of Total
Rhode Island, Connecticut, Massachusetts

$1,136,168

 
94
%
 

$1,105,539

 
93
%
New York, New Jersey, Pennsylvania
62,956

 
5

 
77,038

 
6

New Hampshire
12,668

 
1

 
12,980

 
1

Total

$1,211,792

 
100
%
 

$1,195,557

 
100
%

Commercial and Industrial Loans
Commercial and industrial loans amounted to $588.3 million at September 30, 2017, up by $12.2 million, or 2%, from the balance at December 31, 2016.

As of September 30, 2017, shared national credit balances outstanding included in the commercial and industrial loan portfolio totaled $65.3 million. All of these loans were included in the pass-rated category of commercial loan credit quality, all payments were current and the loans were performing in accordance with their contractual terms.



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The commercial and industrial loan portfolio includes loans to a variety of business types.  Approximately 82% of the total is composed of health care/social assistance, owner occupied and other real estate, manufacturing, retail trade, educational services, professional, scientific and technical, transportation and warehousing, entertainment and finance and insurance services. The average loan balance outstanding in the portfolio was $516 thousand and the largest individual commercial and industrial loan outstanding was $20.8 million as of September 30, 2017.

Residential Real Estate Loans
The residential real estate loan portfolio represented 36% of total loans at September 30, 2017.

Residential real estate loans are originated both for sale to the secondary market as well as for retention in the Bank’s loan portfolio. We also originate residential real estate loans for various investors in a broker capacity, including conventional mortgages and reverse mortgages.

The table below presents residential real estate loan origination activity:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three Months
 
Nine Months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Originations for retention in portfolio

$90,378

 

$90,308

 

$243,079

 

$191,934

Originations for sale to the secondary market (1)
143,112

 
170,673

 
390,044

 
415,174

Total

$233,490

 

$260,981

 

$633,123

 

$607,108

(1)
Also includes loans originated in a broker capacity.

Loans are sold with servicing retained or released.  The table below presents residential real estate loan sales activity:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three Months
 
Nine Months
Periods ended September 30,
2017
 
2016
 
2017
 
2016
Loans sold with servicing rights retained

$37,823

 

$44,611

 

$89,589

 

$116,869

Loans sold with servicing rights released (1)
109,508

 
119,572

 
302,098

 
292,318

Total

$147,331

 

$164,183

 

$391,687

 

$409,187

(1)
Also includes loans originated in a broker capacity.

Loans sold with the retention of servicing result in the capitalization of servicing rights. Loan servicing rights are included in other assets and are subsequently amortized as an offset to mortgage banking revenues over the estimated period of servicing. The net balance of capitalized servicing rights amounted to $3.5 million as of September 30, 2017, essentially unchanged from the balance as of December 31, 2016. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $549.6 million and $522.8 million, respectively, as of September 30, 2017 and December 31, 2016.

Residential real estate loans held in portfolio amounted to $1.2 billion at September 30, 2017, up by $72.8 million, or 6%, from the balance at December 31, 2016. Included in the residential real estate loan portfolio were purchased residential mortgage balances totaling $113.3 million and $128.9 million, respectively, as of September 30, 2017 and December 31, 2016.



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The following is a geographic summary of residential real estate mortgages by property location:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount
 
% of Total
 
Amount
 
% of Total
Rhode Island, Connecticut, Massachusetts

$1,179,112

 
98.6
%
 

$1,106,366

 
98.6
%
New Hampshire, Vermont, Maine
12,085

 
1.0

 
11,445

 
1.0

New York, Virginia, New Jersey, Maryland, Pennsylvania
2,187

 
0.2

 
2,648

 
0.2

Ohio
884

 
0.1

 
997

 
0.1

Other
1,269

 
0.1

 
1,292

 
0.1

Total

$1,195,537

 
100.0
%
 

$1,122,748

 
100.0
%

Consumer Loans
The consumer loan portfolio represented 10% of total loans at September 30, 2017.

Consumer loans include home equity loans and lines of credit and personal installment loans. Washington Trust also purchases loans to individuals secured by general aviation aircraft. The consumer loan portfolio totaled $327.4 million at September 30, 2017, down by $12.5 million, or 4%, from December 31, 2016.

Home equity lines and home equity loans represented 90% of the total consumer portfolio at September 30, 2017. The Bank estimates that approximately 65% of the combined home equity line and home equity loan balances are first lien positions or subordinate to other Washington Trust mortgages. Purchased consumer loans amounted to $23.1 million and $27.7 million, respectively, at September 30, 2017 and December 31, 2016.

Asset Quality
Nonperforming Assets
Nonperforming assets include nonaccrual loans and property acquired through foreclosure or repossession.

The following table presents nonperforming assets and additional asset quality data:
(Dollars in thousands)
Sep 30,
2017
 
Dec 31,
2016
Nonaccrual loans:
 
 
 
Commercial mortgages

$5,887

 

$7,811

Commercial construction & development

 

Commercial & industrial
429

 
1,337

Residential real estate mortgages
11,699

 
11,736

Consumer
496

 
1,174

Total nonaccrual loans
18,511

 
22,058

Property acquired through foreclosure or repossession, net
1,038

 
1,075

Total nonperforming assets

$19,549

 

$23,133

 
 
 
 
Nonperforming assets to total assets
0.44
%
 
0.53
%
Nonperforming loans to total loans
0.56
%
 
0.68
%
Total past due loans to total loans
0.49
%
 
0.76
%
Accruing loans 90 days or more past due

$—

 

$—


Nonaccrual Loans
During the nine months ended September 30, 2017, the Corporation made no changes in its practices or policies concerning the placement of loans into nonaccrual status. In addition, there were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at September 30, 2017.


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The following table presents additional detail on nonaccrual loans:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Days Past Due
 
 
 
 
Days Past Due
 
 
 
 
Over 90
 
Under 90
 
Total
% (1)
 
Over 90
 
Under 90
 
Total
% (1)
Commercial mortgages

$5,887

 

$—

 

$5,887

0.54
%
 

$7,807

 

$4

 

$7,811

0.73
%
Commercial construction & development

 

 


 

 

 


Commercial & industrial
426

 
3

 
429

0.07

 
745

 
592

 
1,337

0.23

Residential real estate mortgages
4,524

 
7,175

 
11,699

0.98

 
6,193

 
5,543

 
11,736

1.05

Consumer
72

 
424

 
496

0.15

 
768

 
406

 
1,174

0.35

Total nonaccrual loans

$10,909

 

$7,602

 

$18,511

0.56
%
 

$15,513

 

$6,545

 

$22,058

0.68
%
(1)
Percentage of nonaccrual loans to the total loans outstanding within the respective category.

As of September 30, 2017, the composition of nonaccrual loans was 34% commercial and 66% residential and consumer, compared to 41% and 59%, respectively, at December 31, 2016.

As of September 30, 2017, nonaccrual commercial mortgage loans were composed of two borrower relationships totaling $5.9 million, down by $1.9 million, from the balance at December 31, 2016.

The largest nonaccrual commercial mortgage relationship as of September 30, 2017 consisted of one loan with a carrying value of $3.1 million, net of charge-offs. Prior to 2017, charge-offs totaling $984 thousand were recognized on this loan. As a result of the continued deterioration in the financial condition of the borrower and changes in the value of the underlying collateral, the Corporation recognized charge-offs on this loan totaling $773 thousand in the nine months ended September 30, 2017. This loan was previously modified in a troubled debt restructuring and has been on nonaccrual status since the third quarter of 2014. This loan is secured by commercial mixed use property in Connecticut and is collateral dependent. Based on the estimated fair value of the underlying collateral, a $300 thousand loss allocation was deemed necessary at September 30, 2017.

The second largest nonaccrual commercial mortgage relationship as of September 30, 2017 consisted of two loans with a carrying value of $2.8 million, net of charge-offs. Prior to 2017, charge-offs totaling $5.5 million were recognized on this relationship. During the second quarter of 2017, one of the loans in this relationship with a carrying value of $986 thousand was sold at a nominal gain. In the third quarter of 2017, a charge-off of $162 thousand was recognized on this relationship. This relationship was previously modified in a troubled debt restructuring and has been on nonaccrual status since the third quarter of 2016. This relationship is secured by mixed use properties in Connecticut and is collateral dependent. Based on the estimated fair value of the underlying collateral, a loss allocation of $633 thousand was deemed necessary at September 30, 2017.

Nonaccrual residential real estate mortgage loans amounted to $11.7 million at September 30, 2017, essentially unchanged from the end of 2016. As of September 30, 2017, the balance of nonaccrual residential mortgage loans was predominately secured by properties in Rhode Island, Connecticut and Massachusetts.  Included in total nonaccrual residential real estate loans at September 30, 2017 were five loans purchased for portfolio and serviced by others amounting to $1.5 million.  Management monitors the collection efforts of its third party servicers as part of its assessment of the collectibility of nonperforming loans.



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Past Due Loans
The following table presents past due loans by category:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount
 
% (1)

 
Amount
 
% (1)

Commercial mortgages

$5,887

 
0.54
%
 

$8,708

 
0.81
%
Commercial construction & development

 

 

 

Commercial & industrial
455

 
0.08

 
1,154

 
0.20

Residential real estate mortgages
7,802

 
0.65

 
12,226

 
1.09

Consumer loans
2,303

 
0.70

 
2,334

 
0.69

Total past due loans

$16,447

 
0.49
%
 

$24,422

 
0.76
%
(1)
Percentage of past due loans to the total loans outstanding within the respective category.

As of September 30, 2017, the composition of past due loans, loans past due 30 days or more, was 39% commercial and 61% residential and consumer, compared to 40% and 60%, respectively at December 31, 2016.

Total past due loans as of September 30, 2017 and December 31, 2016 included nonaccrual loans of $13.2 million and $18.6 million, respectively. All loans 90 days or more past due at September 30, 2017 and December 31, 2016 were classified as nonaccrual.

Troubled Debt Restructurings
Loans are considered restructured in a troubled debt restructuring when the Corporation has granted concessions, that it otherwise would not have considered, to a borrower experiencing financial difficulties.  These concessions include modifications of the terms of the debt such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest.  The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit the Corporation by increasing the ultimate probability of collection.

Restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan.  Loans that are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status.  Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term.

Troubled debt restructurings are reported as such for at least one year from the date of the restructuring.  In years after the restructuring, troubled debt restructured loans are removed from this classification if the restructuring did not involve a below-market rate concession and the loan is not deemed to be impaired based on the terms specified in the restructuring agreement.

As of September 30, 2017, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.



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The following table sets forth information on troubled debt restructured loans as of the dates indicated. The amounts below consist of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs. Accrued interest is not included in the carrying amounts set forth below. See Note 5 to the Unaudited Consolidated Financial Statements for additional information.
(Dollars in thousands)
Sep 30,
2017
 
Dec 31,
2016
Accruing troubled debt restructured loans:
 
 
 
Commercial mortgages

$772

 

$1,965

Commercial & industrial
5,362

 
5,761

Residential real estate mortgages
371

 
3,925

Consumer
131

 
106

Accruing troubled debt restructured loans
6,636

 
11,757

Nonaccrual troubled debt restructured loans:
 
 
 
Commercial mortgages
5,886

 
7,807

Commercial & industrial
427

 
1,177

Residential real estate mortgages
533

 
1,384

Consumer
14

 
110

Nonaccrual troubled debt restructured loans
6,860

 
10,478

Total troubled debt restructured loans

$13,496

 

$22,235


The allowance for loans losses included specific reserves for troubled debt restructurings of $1.1 million and $567 thousand, respectively, at September 30, 2017 and December 31, 2016.

Approximately 70% of the balance of accruing troubled debt restructured loans at September 30, 2017 was concentrated in one commercial and industrial loan with a carrying value of $4.7 million. This loan was restructured in 2016 and included a below-market rate concession and interest only payments for a temporary period. This loan is current with respect to payment terms at September 30, 2017.

Approximately 85% of the balance of nonaccrual troubled debt restructured loans at September 30, 2017 consisted of two commercial mortgage borrower relationships. Both of these relationships were restructured in 2013 and included modifications of certain payment terms and a below-market rate concession for a temporary period. See additional disclosure regarding these two nonaccrual commercial mortgage relationships above under the caption “Nonaccrual Loans.”

Potential Problem Loans
The Corporation classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines provided by banking regulators.  Potential problem loans consist of classified accruing commercial loans that were less than 90 days past due at September 30, 2017 and other loans for which known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future.  These loans are not included in the amounts of nonaccrual or restructured loans presented above.  Management cannot predict the extent to which economic conditions or other factors may impact borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses.  The Corporation has identified approximately $10.1 million in potential problem loans at September 30, 2017, compared to $6.8 million at December 31, 2016. The balance of potential problem loans at September 30, 2017 was primarily composed of two commercial and industrial relationships totaling $9.2 million. Management considers both of these relationships to be well-secured. In addition, both relationships were current with respect to payment terms at September 30, 2017. Potential problem loans are assessed for loss exposure using the methods described in Note 5 to the Unaudited Consolidated Financial Statements under the caption “Credit Quality Indicators.”

Allowance for Loan Losses
Establishing 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


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purposes of establishing a sufficient allowance for loan losses.  See additional discussion regarding the allowance for loan losses, in Item 7 under the caption “Critical Accounting Policies and Estimates” of Washington Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and in Note 6 to the Unaudited Consolidated Financial Statements.

The allowance for loan losses is management’s best estimate of probable loan losses inherent in the loan portfolio as of the balance sheet date.  The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans. The status of nonaccrual loans, delinquent loans and performing loans were all taken into consideration in the assessment of the adequacy of the allowance for loans losses. In addition, the balance and trends of credit quality indicators, including the commercial loan categories of Pass, Special Mention and Classified, are integrated into the process used to determine the allocation of loss exposure. See Note 5 to the Unaudited Consolidated Financial Statements under the caption “Credit Quality Indicators” for additional information. Management believes that the level of allowance for loan losses at September 30, 2017 is adequate and consistent with asset quality and delinquency indicators. Management will continue to assess the adequacy of the allowance for loan losses in accordance with its established policies.

The Bank’s general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that the collection of loan principal is unlikely. The Bank recognizes full or partial charge-offs on collateral dependent impaired loans when the collateral is deemed to be insufficient to support the carrying value of the loan. The Bank does not recognize a recovery when an updated appraisal indicates a subsequent increase in value.

Appraisals are generally obtained with values determined on an “as is” basis from independent appraisal firms for real estate collateral dependent commercial loans in the process of collection or when warranted by other deterioration in the borrower’s credit status.  Updates to appraisals are generally obtained for troubled or nonaccrual loans or when management believes it is warranted.  The Corporation has continued to maintain appropriate professional standards regarding the professional qualifications of appraisers and has an internal review process to monitor the quality of appraisals.

For residential mortgages and real estate collateral dependent consumer loans that are in the process of collection, valuations are obtained from independent appraisal firms with values determined on an “as is” basis.

The estimation of loan loss exposure inherent in the loan portfolio includes, among other procedures, the identification of loss allocations for individual loans deemed to be impaired; and the application of loss allocation factors for non-impaired loans based on historical loss experience and estimated loss emergence period, with adjustments for various exposures that management believes are not adequately represented by historical loss experience.

The following is a summary of impaired loans by measurement type:
(Dollars in thousands)
Sep 30,
2017
 
Dec 31,
2016
Collateral dependent impaired loans (1)

$16,077

 

$24,238

Impaired loans measured on discounted cash flow method (2)
9,070

 
9,577

Total impaired loans

$25,147

 

$33,815

(1)
Net of partial charge-offs of $4.1 million and $5.6 million, respectively, at September 30, 2017 and December 31, 2016.
(2)
Net of partial charge-offs of $84 thousand and $21 thousand, respectively, at September 30, 2017 and December 31, 2016.

Various loan loss allowance coverage ratios are affected by the timing and extent of charge-offs, particularly with respect to impaired collateral dependent loans.  For such loans, the Bank generally recognizes a partial charge-off equal to the identified loss exposure; therefore, the remaining allocation of loss is minimal.



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The following table presents additional detail on the Corporation’s loan portfolio and associated allowance for loan losses:
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Loans
Related Allowance
Allowance / Loans
 
Loans
Related Allowance
Allowance / Loans
Impaired loans individually evaluated for impairment

$25,147


$1,145

4.55
%
 

$33,815


$606

1.79
%
Loans collectively evaluated for impairment
3,297,931

26,163

0.79

 
3,200,556

25,398

0.79

Total

$3,323,078


$27,308

0.82
%
 

$3,234,371


$26,004

0.80
%

Loan loss provisions totaling $1.3 million and $2.4 million, respectively, were charged to earnings for the three and nine months ended September 30, 2017, compared to $1.8 million and $2.8 million, respectively, for the same periods in 2016. These provisions were based on management’s assessment of loss exposure, as well as loan loss allocations commensurate with changes in the loan portfolio.

For the three and nine months ended September 30, 2017, net charge-offs were $654 thousand and $1.1 million, respectively. Net charge-offs for the three and nine months ended September 30, 2016 amounted to $2.0 million and $4.2 million, respectively. A significant portion of the charge-offs recognized in 2016 and 2017 were recognized on the two nonaccrual commercial mortgage relationships discussed above under the caption “Nonaccrual Loans.”

As of September 30, 2017, the allowance for loan losses was $27.3 million, or 0.82% of total loans, compared to $26.0 million, or 0.80% of total loans, at December 31, 2016, largely reflecting an increase in specific reserves on impaired loans.

The following table presents the allocation of the allowance for loan losses. The allocation below is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of any future loss trends. The total allowance is available to absorb losses from any segment of the loan portfolio.
(Dollars in thousands)
September 30, 2017
 
December 31, 2016
 
Amount

 
% (1)
 
Amount
 
% (1)
Commercial:
 
 
 
 
 
 
 
Mortgages

$11,682

 
33
%
 

$9,971

 
33
%
Construction & development
1,105

 
4

 
1,195

 
4

Commercial & industrial
6,652

 
17

 
6,992

 
18

Residential real estate:
 
 
 
 
 
 
 
Mortgage
5,360

 
35

 
5,077

 
34

Homeowner construction
80

 
1

 
175

 
1

Consumer
2,429

 
10

 
2,594

 
10

Balance at end of period

$27,308

 
100
%
 

$26,004

 
100
%
(1)
Percentage of loans within the respective category to total loans outstanding.

Sources of Funds
Our sources of funds include deposits, brokered time deposits, FHLBB advances, 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.

Deposits
Washington Trust offers a wide variety of deposit products to consumer and business customers.  Deposits provide an important source of funding for the Bank as well as an ongoing stream of fee revenue.

Washington Trust is a participant in the Insured Cash Sweep (“ICS”) program, Demand Deposit Marketplace (“DDM”) program, and the Certificate of Deposit Account Registry Service (“CDARS”) program. Washington Trust uses these deposit sweep services to place customer funds into interest-bearing demand accounts, money market accounts, and/or time deposits issued by other participating banks. Customer funds are placed at one or more participating banks to ensure that each deposit customer


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is eligible for the full amount of FDIC insurance. As a program participant, we receive reciprocal amounts of deposits from other participating banks. ICS, DDM and CDARS deposits are considered to be brokered deposits for bank regulatory purposes. We consider these reciprocal deposit balances to be in-market deposits as distinguished from traditional out-of-market wholesale brokered deposits.

Total deposits amounted to $3.2 billion at September 30, 2017, up by $93.3 million, or 3%, from December 31, 2016. This included an increase of $3.5 million of out-of-market brokered time deposits. Excluding out-of-market brokered time deposits, in-market deposits were up by $89.8 million, or 3%, from the balance at December 31, 2016.

Demand deposits amounted to $621.3 million at September 30, 2017, up by $35.3 million, or 6%, from the balance at December 31, 2016. NOW account balances increased by $20.4 million, or 5%, from December 31, 2016 and amounted to $448.1 million at September 30, 2017. The increases in demand deposits and NOW account balances reflected growth in both new and existing depositor relationships.

Savings accounts increased by $9.5 million, or 3%, from December 31, 2016 and totaled $367.9 million at September 30, 2017.

Money market accounts amounted to $716.8 million at September 30, 2017, down by $13.2 million, or 2%, from December 31, 2016.

Time deposits were $1.0 billion at September 30, 2017, up by $41.3 million, or 4%, from December 31, 2016.  Included in time deposits at September 30, 2017 were out-of-market wholesale brokered time deposits of $415.8 million, which were up by $3.5 million from the balance at December 31, 2016. Excluding out-of-market brokered time deposits, in-market time deposits totaled $587.2 million at September 30, 2017, up by $37.8 million, or 7%, from December 31, 2016, reflecting growth in promotional time deposits.

FHLBB Advances
FHLBB advances are used to meet short-term liquidity needs and also to fund additions to the securities portfolio and loan growth. FHLBB advances totaled $814.0 million at September 30, 2017, down by $34.9 million from the balance at the end of 2016, due to growth in deposits.

Liquidity and Capital Resources
Liquidity Management
Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand.  Washington Trust’s primary source of liquidity is deposits, which funded approximately 61% of total average assets in the nine months ended September 30, 2017.  While the generally preferred funding strategy is to attract and retain low-cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace.  Other sources of funding include discretionary use of purchased liabilities (e.g., FHLBB term advances and brokered time deposits), cash flows from the Corporation’s securities portfolios and loan repayments.  Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs although management has no intention to do so at this time.  For a more detailed discussion on Washington Trust’s detailed liquidity funding policy and contingency funding plan, see additional information in Item 7 under the caption “Liquidity and Capital Resources” of Washington Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

The Asset/Liability Committee (“ALCO”) establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained within target ranges established by the ALCO during the nine months ended September 30, 2017.  Based on its assessment of the liquidity considerations described above, management believes the Corporation’s sources of funding meets anticipated funding needs.

Net cash provided by operating activities amounted to $43.6 million for the nine months ended September 30, 2017, which was generated by net income of $37.9 million and adjustments to reconcile net income to net cash provided by operating activities. Net cash used in investing activities totaled $59.2 million for the nine months ended September 30, 2017, reflecting outflows to fund growth in loans and purchase investment securities, net of inflows from principal paydowns, maturities and calls of debt securities. For the nine months ended September 30, 2017, net cash provided by financing activities amounted to $39.1 million, due to deposit inflows, partially offset by net outflows associated with FHLBB advances and the payment of dividends to shareholders. See the Corporation’s Unaudited Consolidated Statements of Cash Flows for further information about sources and uses of cash.


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Capital Resources
Total shareholders’ equity amounted to $414.2 million at September 30, 2017, up by $23.4 million from December 31, 2016, including net income of $37.9 million, partially offset by $20.0 million for dividend declarations.

The ratio of total equity to total assets amounted to 9.27% at September 30, 2017 compared to a ratio of 8.92% at December 31, 2016.  Book value per share at September 30, 2017 and December 31, 2016 amounted to $24.06 and $22.76, respectively.

The Bancorp and the Bank are subject to various regulatory capital requirements.  As of September 30, 2017, the Bancorp and the Bank exceeded the regulatory minimum levels to be considered “well-capitalized.” See Note 9 to the Unaudited Consolidated Financial Statements for additional discussion of regulatory capital requirements.

Off-Balance Sheet Arrangements
For additional information on derivative financial instruments and financial instruments with off-balance sheet risk see Notes 10 and 18 to the Unaudited Consolidated Financial Statements.

Asset/Liability Management and Interest Rate Risk
Interest rate risk is the primary market risk category associated with the Corporation’s operations.  Interest rate risk is the risk of loss to future earnings due to changes in interest rates.  The ALCO is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk.  Periodically, the ALCO reports on the status of liquidity and interest rate risk matters to the Bank’s Board of Directors. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with Washington Trust’s liquidity, capital adequacy, growth, risk and profitability goals.

The Corporation utilizes the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, off-balance sheet interest rate contracts and the pricing and structure of loans and deposits for managing interest rate risk. The off-balance sheet interest rate contracts may include interest rate swaps, caps and floors.  These interest rate contracts involve, to varying degrees, credit risk and interest rate risk.  Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract.  The notional amount of the interest rate contracts is the amount upon which interest and other payments are based.  The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk.  See Notes 10 and 18 to the Unaudited Consolidated Financial Statements for additional information.

The ALCO uses income simulation to measure interest rate risk inherent in the Corporation’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, the 13- to 24-month horizon and a 60-month horizon.  The simulations assume that the size and general composition of the Corporation’s balance sheet remain static over the simulation horizons, with the exception of certain deposit mix shifts from low-cost core savings to higher-cost time deposits in selected interest rate scenarios.  Additionally, the simulations take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios.  The characteristics of financial instrument classes are reviewed periodically by the ALCO to ensure their accuracy and consistency.

The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure.  As of September 30, 2017 and December 31, 2016, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation.  The Corporation defines maximum unfavorable net interest income exposure to be a change of no more than 5% in net interest income over the first 12 months, no more than 10% over the second 12 months, and no more than 10% over the full 60-month simulation horizon.  All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Corporation’s balance sheet remain stable for a 60-month period.  In addition to measuring the change in net interest income as compared to an unchanged interest rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.

The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve of up to 500 basis points as well as parallel


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changes in interest rates of up to 400 basis points.  Because income simulations assume that the Corporation’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on- and off-balance sheet financial instruments as of September 30, 2017 and December 31, 2016Interest rates are assumed to shift by a parallel 100, 200 or 300 basis points upward or 100 basis points downward over a 12-month period, except for core savings deposits, which are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements.  Further, deposits are assumed to have certain minimum rate levels below which they will not fall.  It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the periods indicated.
 
September 30, 2017
 
December 31, 2016
 
Months 1 - 12
 
Months 13 - 24
 
Months 1 - 12
 
Months 13 - 24
100 basis point rate decrease
(3.42)%
 
(7.61)%
 
(2.93)%
 
(6.54)%
100 basis point rate increase
3.04
 
2.76
 
2.21
 
1.74
200 basis point rate increase
7.38
 
8.07
 
5.13
 
4.99
300 basis point rate increase
11.76
 
13.52
 
8.08
 
8.35

The ALCO estimates that the negative exposure of net interest income to falling rates as compared to an unchanged rate scenario results from a more rapid decline in earning asset yields compared to rates paid on deposits.  If market interest rates were to fall from their already low levels and remain lower for a sustained period, certain core savings and time deposit rates could decline more slowly and by a lesser amount than other market rates.  Asset yields would likely decline more rapidly than deposit costs as current asset holdings mature or reprice, since cash flow from mortgage-related prepayments and redemption of callable securities would increase as market rates fall.

The positive exposure of net interest income to rising rates as compared to an unchanged rate scenario results from a more rapid projected relative rate of increase in asset yields than funding costs over the near term.  For simulation purposes, deposit rate changes are anticipated to lag behind other market rates in both timing and magnitude.  The ALCO’s estimate of interest rate risk exposure to rising rate environments, including those involving changes to the shape of the yield curve, incorporates certain assumptions regarding the shift in deposit balances from low-cost core savings categories to higher-cost deposit categories, which has characterized a shift in funding mix during the past rising interest rate cycles.

The relative changes in interest rate sensitivity from December 31, 2016 to September 30, 2017 as shown in the above table were attributable to several factors, including a higher absolute level of market interest rates and an increase in rate sensitivity primarily attributable to an increase in the proportion of variable rate commercial loans within the portfolio. Variable rate assets reprice more quickly and by a greater amount than repricing of deposit costs, particularly in a falling rate environment where many deposit rates are at or near their floors.

While the ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin.  Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of the Corporation’s balance sheet may change to a different degree than estimated.  Simulation modeling assumes a static balance sheet, with the exception of certain modeled deposit mix shifts from low-cost core savings deposits to higher-cost time deposits in rising rate scenarios as noted above.

Due to the low level of market interest rates, the banking industry has attracted and retained low-cost core savings deposits over the past several years.  The ALCO recognizes that a portion of these increased levels of low-cost balances could shift into higher yielding alternatives in the future, particularly if interest rates rise and as confidence in financial markets strengthens, and has modeled increased amounts of deposit shifts out of these low-cost categories into higher-cost alternatives in the rising rate simulation scenarios presented above.  Deposit balances may also be subject to possible outflow to non-bank alternatives in a rising rate environment, which may cause interest rate sensitivity to differ from the results as presented. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The


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relationship between short-term interest rate changes and core deposit rate and balance changes may differ from the ALCO’s estimates used in income simulation.

It should also be noted that the static balance sheet assumption does not necessarily reflect the Corporation’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior.

Mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments.  Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value.  Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.

The Corporation also monitors the potential change in market value of its available for sale debt securities in changing interest rate environments.  The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to the Corporation’s capital position.  Results are calculated using industry-standard analytical techniques and securities data.  

The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of September 30, 2017 and December 31, 2016 resulting from immediate parallel rate shifts:
(Dollars in thousands)
 
 
 
Security Type
Down 100 Basis Points
 
Up 200 Basis Points
U.S. government-sponsored enterprise securities (callable)

$2,152

 

($9,771
)
Obligations of states and political subdivisions
2

 
(3
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
15,302

 
(54,823
)
Trust preferred debt and other corporate debt securities
(55
)
 
83

Total change in market value as of September 30, 2017

$17,401

 

($64,514
)
Total change in market value as of December 31, 2016

$14,906

 

($79,508
)

Item 3.  Quantitative and Qualitative Disclosures About Market Risk
Information regarding quantitative and qualitative disclosures about market risk appears under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Asset/Liability Management and Interest Rate Risk.”

Item 4.  Controls and Procedures
Disclosure Controls and Procedures
As required by Rule 13a-15 under the Exchange Act, as amended (the “Exchange Act”), the Corporation carried out an evaluation under the supervision and with the participation of the Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, of the Corporation’s disclosure controls and procedures as of the period ended September 30, 2017.  Based upon that evaluation, the principal executive officer and principal financial officer concluded that the Corporation’s disclosure controls and procedures are effective and designed to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to the Corporation’s management including its Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosures.  The Corporation will continue to review and document its disclosure controls and procedures and consider such changes in future evaluations of the effectiveness of such controls and procedures, as it deems appropriate.

Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the period ended September 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.  Other Information


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Item 1.  Legal Proceedings
The Corporation is involved in various claims and legal proceedings arising out of the ordinary course of business.  Management is of the opinion, based on its review with counsel of the development of such matters to date, that the ultimate disposition of such matters will not materially affect the consolidated financial position or results of operations of the Corporation.

Item 1A.  Risk Factors
There have been no material changes in the risk factors described in Item IA to Part I of Washington Trust’s Annual Report on Form 10-K for the year ended December 31, 2016.

Item 6.  Exhibits
(a) Exhibits.  The following exhibits are included as part of this Form 10-Q:
Exhibit Number
 
3.4
10.1
10.2
10.3
10.4
10.5
31.1
31.2
32.1
101
The following materials from Washington Trust Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes to these financial statements - Filed herewith.
____________________
(1)
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the SEC, which are incorporated by reference herein.
(2)
Management contract or compensatory plan or arrangement.
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Securities Exchange Act.



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Signatures


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 
 
 
 
WASHINGTON TRUST BANCORP, INC.
 
 
 
 
(Registrant)
 
 
 
 
 
Date:
November 6, 2017
 
By:
/s/ Joseph J. MarcAurele
 
 
 
 
Joseph J. MarcAurele
 
 
 
 
Chairman and Chief Executive Officer
 
 
 
 
(principal executive officer)
 
 
 
 
 
Date:
November 6, 2017
 
By:
/s/ David V. Devault
 
 
 
 
David V. Devault
 
 
 
 
Vice Chair, Secretary and Chief Financial Officer
 
 
 
 
(principal financial officer)
 
 
 
 
 
Date:
November 6, 2017
 
By:
/s/ Maria N. Janes
 
 
 
 
Maria N. Janes
 
 
 
 
Executive Vice President and Controller
 
 
 
 
(principal accounting officer)


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Exhibit Index

Exhibit Number
 
3.4
10.1
10.2
10.3
10.4
10.5
31.1
31.2
32.1
101
The following materials from Washington Trust Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes to these financial statements - Filed herewith.
____________________
(1)
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the SEC, which are incorporated by reference herein.
(2)
Management contract or compensatory plan or arrangement.
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Securities Exchange Act.



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