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WASHINGTON TRUST BANCORP INC - Quarter Report: 2018 March (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 MARCH 31, 2018 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 x
 
Accelerated filer o
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 April 30, 2018 was 17,270,360.



FORM 10-Q
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
For the Quarter Ended March 31, 2018
 
 
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)
 
March 31,
2018
 
December 31,
2017
Assets:
 
 
 
Cash and due from banks

$85,680

 

$79,853

Short-term investments
2,322

 
3,070

Mortgage loans held for sale (including $17,494 at March 31, 2018 and $26,943 at December 31, 2017 measured at fair value)
19,269

 
26,943

Securities:
 
 
 
Available for sale, at fair value
787,842

 
780,954

Held to maturity, at amortized cost (fair value $11,995 at March 31, 2018 and $12,721 at December 31, 2017)
11,973

 
12,541

Total securities
799,815

 
793,495

Federal Home Loan Bank stock, at cost
41,127

 
40,517

Loans:
 
 
 
Total loans
3,387,406

 
3,374,071

Less allowance for loan losses
25,864

 
26,488

Net loans
3,361,542

 
3,347,583

Premises and equipment, net
28,316

 
28,333

Investment in bank-owned life insurance
73,782

 
73,267

Goodwill
63,909

 
63,909

Identifiable intangible assets, net
8,893

 
9,140

Other assets
81,671

 
63,740

Total assets

$4,566,326

 

$4,529,850

Liabilities:
 
 
 
Deposits:
 
 
 
Noninterest-bearing deposits

$601,478

 

$578,410

Interest-bearing deposits
2,654,956

 
2,664,297

Total deposits
3,256,434

 
3,242,707

Federal Home Loan Bank advances
808,677

 
791,356

Junior subordinated debentures
22,681

 
22,681

Other liabilities
65,453

 
59,822

Total liabilities
4,153,245

 
4,116,566

Commitments and contingencies


 


Shareholders’ Equity:
 
 
 
Common stock of $.0625 par value; authorized 60,000,000 shares; issued and outstanding 17,261,730 shares at March 31, 2018 and 17,226,508 shares at December 31, 2017
1,079

 
1,077

Paid-in capital
118,172

 
117,961

Retained earnings
326,505

 
317,756

Accumulated other comprehensive loss
(32,675
)
 
(23,510
)
Total shareholders’ equity
413,081

 
413,284

Total liabilities and shareholders’ equity

$4,566,326

 

$4,529,850


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 ended March 31,
2018

 
2017

Interest income:
 
 
 
Interest and fees on loans

$34,578

 

$30,352

Taxable interest on securities
5,118

 
4,709

Nontaxable interest on securities
23

 
112

Dividends on Federal Home Loan Bank stock
516

 
387

Other interest income
205

 
104

Total interest and dividend income
40,440

 
35,664

Interest expense:
 

 
 

Deposits
4,422

 
3,502

Federal Home Loan Bank advances
3,983

 
3,344

Junior subordinated debentures
183

 
138

Other interest expense

 
1

Total interest expense
8,588

 
6,985

Net interest income
31,852

 
28,679

Provision for loan losses

 
400

Net interest income after provision for loan losses
31,852

 
28,279

Noninterest income:
 
 
 
Wealth management revenues
10,273

 
9,477

Mortgage banking revenues
2,838

 
2,340

Service charges on deposit accounts
863

 
883

Card interchange fees
847

 
802

Income from bank-owned life insurance
515

 
536

Loan related derivative income
141

 
148

Other income
266

 
324

Total noninterest income
15,743

 
14,510

Noninterest expense:
 
 
 
Salaries and employee benefits
17,772

 
16,917

Net occupancy
2,002

 
1,967

Outsourced services
1,873

 
1,457

Equipment
1,180

 
1,467

Legal, audit and professional fees
726

 
616

FDIC deposit insurance costs
404

 
481

Advertising and promotion
177

 
237

Amortization of intangibles
248

 
277

Change in fair value of contingent consideration

 
(310
)
Other expenses
2,748

 
2,177

Total noninterest expense
27,130

 
25,286

Income before income taxes
20,465

 
17,503

Income tax expense
4,254

 
5,721

Net income

$16,211

 

$11,782

 
 
 
 
Weighted average common shares outstanding - basic
17,234

 
17,186

Weighted average common shares outstanding - diluted
17,345

 
17,293

Per share information:
Basic earnings per common share

$0.94

 

$0.68

 
Diluted earnings per common share

$0.93

 

$0.68

 
Cash dividends declared per share

$0.43

 

$0.38


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 ended March 31,
2018

 
2017

Net income

$16,211

 

$11,782

Other comprehensive income (loss), net of tax:
 
 
 
Net change in fair value of securities available for sale
(10,414
)
 
401

Net change in fair value of cash flow hedges
889

 
98

Net change in defined benefit plan obligations
360

 
213

Total other comprehensive (loss) income, net of tax
(9,165
)
 
712

Total comprehensive income

$7,046

 

$12,494




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, 2018
17,227

 

$1,077

 

$117,961

 

$317,756

 

($23,510
)
 

$413,284

Net income

 

 

 
16,211

 

 
16,211

Total other comprehensive income, net of tax

 

 

 

 
(9,165
)
 
(9,165
)
Cash dividends declared

 

 

 
(7,462
)
 

 
(7,462
)
Share-based compensation

 

 
669

 

 

 
669

Exercise of stock options, issuance of other compensation-related equity awards
35

 
2

 
(458
)
 

 

 
(456
)
Balance at March 31, 2018
17,262

 

$1,079

 

$118,172

 

$326,505

 

($32,675
)
 

$413,081



 
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

 

 

 
11,782

 

 
11,782

Total other comprehensive income, net of tax

 

 

 

 
712

 
712

Cash dividends declared

 

 

 
(6,592
)
 

 
(6,592
)
Share-based compensation

 

 
607

 

 

 
607

Exercise of stock options, issuance of other compensation-related equity awards
22

 
2

 
470

 

 

 
472

Balance at March 31, 2017
17,193

 

$1,075

 

$116,200

 

$299,555

 

($19,045
)
 

$397,785



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



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


Three months ended March 31,
2018

 
2017

Cash flows from operating activities:
 
 
 
Net income

$16,211

 

$11,782

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

 
400

Depreciation of premises and equipment
827

 
901

Net amortization of premium and discount
695

 
893

Amortization of intangibles
248

 
277

Share-based compensation
669

 
607

Tax benefit from stock option exercises and other equity awards
207

 
195

Income from bank-owned life insurance
(515
)
 
(536
)
Net gains on loan sales and commissions on loans originated for others, including fair value adjustments
(2,679
)
 
(2,269
)
Proceeds from sales of loans
89,575

 
92,325

Loans originated for sale
(79,212
)
 
(86,133
)
Change in fair value of contingent consideration liability

 
(310
)
Increase in other assets
(10,973
)
 
(724
)
Increase (decrease) in other liabilities
6,483

 
(530
)
Net cash provided by operating activities
21,536

 
16,878

Cash flows from investing activities:
 
 
 
Purchases of:
Mortgage-backed securities available for sale
(40,657
)
 
(20,248
)
 
Other investment securities available for sale
(1,064
)
 
(19,963
)
Maturities and principal payments of:
Mortgage-backed securities available for sale
20,100

 
19,483

 
Other investment securities available for sale
500

 
5,875

 
Mortgage-backed securities held to maturity
540

 
871

Purchases of Federal Home Loan Bank stock
(610
)
 
(585
)
Net (increase) decrease in loans
(15,571
)
 
9,070

Purchases of loans
(1,520
)
 

Purchases of premises and equipment
(811
)
 
(733
)
Net cash used in investing activities
(39,093
)
 
(6,230
)
Cash flows from financing activities:
 
 
 
Net increase in deposits
13,727

 
51,819

Proceeds from Federal Home Loan Bank advances
515,000

 
175,000

Repayment of Federal Home Loan Bank advances
(497,679
)
 
(225,189
)
Payment of contingent consideration liability
(1,217
)
 

Net proceeds from stock option exercises and issuance of other equity awards
(456
)
 
277

Cash dividends paid
(6,739
)
 
(6,372
)
Net cash provided by (used in) financing activities
22,636

 
(4,465
)
Net increase in cash and cash equivalents
5,079

 
6,183

Cash and cash equivalents at beginning of period
82,923

 
107,797

Cash and cash equivalents at end of period

$88,002

 

$113,980

Noncash Investing and Financing Activities:
 
 
 
Loans charged off

$690

 

$79

Loans transferred to property acquired through foreclosure or repossession
3,074

 
410

Supplemental Disclosures:
 
 
 
Interest payments

$8,047

 

$6,985

Income tax payments
908

 
566


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, 2017.

(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 did not change the core principle for revenue recognition in Topic 606; instead, the amendments provided more detailed guidance in a few areas and additional implementation guidance and examples 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 were 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 completed a 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 was explicitly excluded from the scope of this ASU. Revenue streams that were within the scope of Topic 606 include wealth management revenues, service charges on deposit accounts and card interchange fees. Management adopted the provisions of ASU 2014-09 effective January 1, 2018, using the modified retrospective transition method. The adoption did not have a material impact on the Corporation’s consolidated financial statements. See Note 12 for further details.

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 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


- 8-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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 was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Management adopted the provisions of ASU 2016-01 effective January 1, 2018. The adoption did not have a material impact on the Corporation’s consolidated financial statements.

Accounting Standards Update No. 2018-03, “Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2018-03”), was issued in February 2018 to clarify certain aspects of the guidance issued in ASU 2016-01. Companies, such as Washington Trust, were not required to adopt the provisions of ASU 2018-03 until the interim period beginning after June 15, 2018. However, early adoption was permitted, as long as ASU 2016-01 provisions were adopted. Management early adopted the provisions of ASU 2018-03 effective January 1, 2018. The adoption did not have an 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. In January 2018, Accounting Standards Update No. 2018-01, “Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 was issued to address concerns about the costs and complexity of complying with the transition provisions of ASU 2016-02. Both ASU 2016-02 and ASU 2018-01 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Management has assembled a project team that meets regularly to address the changes pursuant to Topic 842. The Corporation rents premises used in business operations under non-cancelable operating leases, which currently are not reflected in its Consolidated Balance Sheets. As disclosed in Note 18, the Corporation was committed to $38.4 million of future minimum lease payments under these non-cancelable operating leases. Upon adoption of ASU 2016-02 on January 1, 2019, the Corporation expects to report increased assets and liabilities as a result of recognizing right-of-use assets and lease liabilities in its Consolidated Balance Sheets. The Corporation does not expect a material change to the timing of expense recognition in the Consolidated Statements of Income.

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, with early adoption permitted in 2019. 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 and to address the additional data requirements necessary and the approach for implementation. The Corporation does not plan to early adopt ASU 2016-13 and it has not yet determined 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 from equity method investees. The adoption of ASU 2016-15 requires a retrospective transition method applied to each period presented. This ASU was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Management adopted the provisions of ASU 2016-15 effective January 1, 2018. The adoption did not


- 9-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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 was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Management adopted the provisions of ASU 2016-18 effective January 1, 2018. The adoption 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 was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 requiring retrospective application for all periods presented. Management adopted the provisions of ASU 2017-07 effective January 1, 2018, utilizing the practical expedient that permitted employers to use the amounts previously disclosed in notes to financial statements as an estimation basis for applying the retrospective application requirements. The adoption of ASU 2017-07 resulted in an increase in salaries and employee benefits, a decrease in other expenses and no change to net income. The adoption did not have a material impact on the Corporation’s consolidated financial statements. See Note 13 for further details.

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 was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 with provisions applied on a prospective basis.  Management adopted the provisions of ASU 2017-09 effective January 1, 2018. The adoption did not 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.

(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 $14.1 million at both March 31, 2018 and December 31, 2017 and were included in cash and due from banks in the Unaudited Consolidated Balance Sheets.

As of March 31, 2018 and December 31, 2017, cash and due from banks included interest-bearing deposits in other banks of $28.9 million and $31.9 million, respectively.



- 10-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(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)
 
March 31, 2018
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$171,491

 

$9

 

($5,886
)
 

$165,614

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
605,430

 
1,936

 
(17,619
)
 
589,747

Obligations of states and political subdivisions
2,355

 
4

 

 
2,359

Individual name issuer trust preferred debt securities
18,112

 

 
(1,016
)
 
17,096

Corporate bonds
13,914

 

 
(888
)
 
13,026

Total securities available for sale

$811,302

 

$1,949

 

($25,409
)
 

$787,842

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

$11,973

 

$38

 

($16
)
 

$11,995

Total securities held to maturity

$11,973

 

$38

 

($16
)
 

$11,995

Total securities

$823,275

 

$1,987

 

($25,425
)
 

$799,837



(Dollars in thousands)
 
December 31, 2017
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$161,479

 

$—

 

($3,875
)
 

$157,604

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
594,944

 
3,671

 
(7,733
)
 
590,882

Obligations of states and political subdivisions
2,355

 
4

 

 
2,359

Individual name issuer trust preferred debt securities
18,106

 

 
(1,122
)
 
16,984

Corporate bonds
13,917

 
13

 
(805
)
 
13,125

Total securities available for sale

$790,801

 

$3,688

 

($13,535
)
 

$780,954

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

$12,541

 

$180

 

$—

 

$12,721

Total securities held to maturity

$12,541

 

$180

 

$—

 

$12,721

Total securities

$803,342

 

$3,868

 

($13,535
)
 

$793,675


As of March 31, 2018 and December 31, 2017, securities with a fair value of $365.1 million and $357.8 million, respectively, were pledged as collateral for Federal Home Loan Bank of Boston (“FHLB”) borrowings, potential borrowings with the FRB, certain public deposits and for other purposes. See Note 7 for additional disclosure on FHLB borrowings.



- 11-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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
March 31, 2018
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less

$63,132

 

$61,513

 

$1,663

 

$1,666

Due after one year to five years
262,288

 
254,949

 
5,192

 
5,202

Due after five years to ten years
290,876

 
281,962

 
3,840

 
3,847

Due after ten years
195,006

 
189,418

 
1,278

 
1,280

Total securities

$811,302

 

$787,842

 

$11,973

 

$11,995


Included in the above table are debt securities with an amortized cost balance of $205.0 million and a fair value of $197.2 million at March 31, 2018 that are callable at the discretion of the issuers.  Final maturities of the callable securities range from 2 months to 19 years, with call features ranging from 1 month to 3 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
March 31, 2018
#
 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
Obligations of U.S. government-sponsored enterprises
8

 

$68,706


($1,787
)
 
8

 

$86,901


($4,099
)
 
16

 

$155,607


($5,886
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
32

 
249,667

(4,807
)
 
22

 
265,077

(12,828
)
 
54

 
514,744

(17,635
)
Individual name issuer trust preferred debt securities

 


 
7

 
17,096

(1,016
)
 
7

 
17,096

(1,016
)
Corporate bonds
6

 
2,112

(18
)
 
3

 
10,914

(870
)
 
9

 
13,026

(888
)
Total temporarily impaired securities
46

 

$320,485


($6,612
)
 
40

 

$379,988


($18,813
)
 
86

 

$700,473


($25,425
)


(Dollars in thousands)
Less than 12 Months
 
12 Months or Longer
 
Total
December 31, 2017
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
 
#

 
Fair
Value
Unrealized
Losses
Obligations of U.S. government-sponsored enterprises
8

 

$69,681


($798
)
 
8

 

$87,923


($3,077
)
 
16

 

$157,604


($3,875
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
20

 
128,965

(613
)
 
22

 
279,693

(7,120
)
 
42

 
408,658

(7,733
)
Individual name issuer trust preferred debt securities

 


 
7

 
16,984

(1,122
)
 
7

 
16,984

(1,122
)
Corporate bonds
3

 
921

(5
)
 
3

 
10,980

(800
)
 
6

 
11,901

(805
)
Total temporarily impaired securities
31

 

$199,567


($1,416
)
 
40

 

$395,580


($12,119
)
 
71

 

$595,147


($13,535
)


- 12-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)


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 March 31, 2018.

Trust Preferred Debt Securities of Individual Name Issuers
Included in debt securities in an unrealized loss position at March 31, 2018 were seven trust preferred security holdings issued by five 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 March 31, 2018, individual name issuer trust preferred debt securities with an amortized cost of $6.1 million and unrealized losses of $417 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 March 31, 2018 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 March 31, 2018.

Corporate Bonds
At March 31, 2018, Washington Trust had nine corporate bond holdings with unrealized losses totaling $888 thousand. These investment grade corporate bonds were issued by large corporations. Management believes the unrealized losses on these bonds are a function of the changes in the investment spreads and interest rate movements and not changes in the credit quality of the issuers of the debt securities. 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 March 31, 2018.



- 13-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(5) Loans
The following is a summary of loans:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount

 
%

 
Amount

 
%

Commercial:
 
 
 
 
 
 
 
Commercial real estate (1)

$1,217,278

 
36
%
 

$1,210,495

 
36
%
Commercial & industrial (2)
603,830

 
18

 
612,334

 
18

Total commercial
1,821,108

 
54

 
1,822,829

 
54

Residential Real Estate:
 
 
 
 
 
 
 
Residential real estate (3)
1,249,890

 
37

 
1,227,248

 
36

Consumer:
 
 
 
 
 
 
 
Home equity
285,723

 
8

 
292,467

 
9

Other (4)
30,685

 
1

 
31,527

 
1

Total consumer
316,408

 
9

 
323,994

 
10

Total loans (5)

$3,387,406

 
100
%
 

$3,374,071

 
100
%
(1)
Commercial real estate loans consist of commercial mortgages primarily secured by income producing property, as well as construction and development loans. Construction and development loans are made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings.
(2)
Commercial & industrial consist of loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.
(3)
Residential real estate loans consist of mortgage and homeowner construction loans secured by one- to four- family residential properties.
(4)
Other consumer loans consists of loans to individuals secured by general aviation aircraft and other personal installment loans.
(5)
Includes net unamortized loan origination costs of $4.1 million and $3.8 million, respectively, at March 31, 2018 and December 31, 2017 and net unamortized premiums on purchased loans of $855 thousand and $878 thousand, respectively, at March 31, 2018 and December 31, 2017.

As of March 31, 2018 and December 31, 2017, there were $1.9 billion and $1.6 billion, respectively, of loans pledged as collateral to the FHLB under a blanket pledge agreement and to the FRB for the discount window. See Note 7 for additional disclosure regarding borrowings.

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
 
 
 
 
 
 
March 31, 2018
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate

$—

 

$—

 

$—

 

$—

 

$1,217,278

 

$1,217,278

Commercial & industrial
2,898

 

 
397

 
3,295

 
600,535

 
603,830

Total commercial
2,898

 

 
397

 
3,295

 
1,817,813

 
1,821,108

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
6,909

 
789

 
4,108

 
11,806

 
1,238,084

 
1,249,890

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
3,203

 
744

 
288

 
4,235

 
281,488

 
285,723

Other
20

 
2

 

 
22

 
30,663

 
30,685

Total consumer
3,223

 
746

 
288

 
4,257

 
312,151

 
316,408

Total loans

$13,030

 

$1,535

 

$4,793

 

$19,358

 

$3,368,048

 

$3,387,406




- 14-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Days Past Due
 
 
 
 
 
 
December 31, 2017
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate

$6

 

$—

 

$4,954

 

$4,960

 

$1,205,535

 

$1,210,495

Commercial & industrial
3,793

 
2

 
281

 
4,076

 
608,258

 
612,334

Total commercial
3,799

 
2

 
5,235

 
9,036

 
1,813,793

 
1,822,829

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
1,678

 
2,274

 
3,903

 
7,855

 
1,219,393

 
1,227,248

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
2,798

 
75

 
268

 
3,141

 
289,326

 
292,467

Other
29

 

 
14

 
43

 
31,484

 
31,527

Total consumer
2,827

 
75

 
282

 
3,184

 
320,810

 
323,994

Total loans

$8,304

 

$2,351

 

$9,420

 

$20,075

 

$3,353,996

 

$3,374,071


Included in past due loans as of March 31, 2018 and December 31, 2017, were nonaccrual loans of $7.1 million and $11.8 million, respectively.

All loans 90 days or more past due at March 31, 2018 and December 31, 2017 were classified as nonaccrual.



- 15-



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
 
Mar 31,
2018
 
Dec 31,
2017
 
Mar 31,
2018
 
Dec 31,
2017
 
Mar 31,
2018
 
Dec 31,
2017
No Related Allowance Recorded
 
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate

$—

 

$—

 

$—

 

$—

 

$—

 

$—

Commercial & industrial
5,427

 
4,986

 
6,257

 
5,081

 

 

Total commercial
5,427

 
4,986

 
6,257

 
5,081

 

 

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
8,288

 
9,069

 
8,455

 
9,256

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
560

 
557

 
560

 
557

 

 

Other
114

 
14

 
115

 
14

 

 

Total consumer
674

 
571

 
675

 
571

 

 

Subtotal
14,389

 
14,626

 
15,387

 
14,908

 

 

With Related Allowance Recorded
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate

$—

 

$4,954

 

$—

 

$9,910

 

$—

 

$1,018

Commercial & industrial
456

 
191

 
508

 
212

 
53

 
1

Total commercial
456

 
5,145

 
508

 
10,122

 
53

 
1,019

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
1,421

 
715

 
1,467

 
741

 
112

 
104

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
223

 

 
223

 

 
108

 

Other
28

 
133

 
26

 
132

 
5

 
6

Total consumer
251

 
133

 
249

 
132

 
113

 
6

Subtotal
2,128

 
5,993

 
2,224

 
10,995

 
278

 
1,129

Total impaired loans

$16,517

 

$20,619

 

$17,611

 

$25,903

 

$278

 

$1,129

Total:
 
 
 
 
 
 
 
 
 
 
 
Commercial

$5,883

 

$10,131

 

$6,765

 

$15,203

 

$53

 

$1,019

Residential real estate
9,709

 
9,784

 
9,922

 
9,997

 
112

 
104

Consumer
925

 
704

 
924

 
703

 
113

 
6

Total impaired loans

$16,517

 

$20,619

 

$17,611

 

$25,903

 

$278

 

$1,129

(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 accruing impaired 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.



- 16-



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 March 31,
2018
 
2017
 
2018
 
2017
Commercial:
 
 
 
 
 
 
 
Commercial real estate

$4,100

 

$9,780

 

$—

 

$26

Commercial & industrial
5,492

 
6,965

 
66

 
76

Total commercial
9,592

 
16,745

 
66

 
102

Residential Real Estate:


 


 


 


Residential real estate
9,850

 
16,240

 
112

 
122

Consumer:


 


 


 


Home equity
667

 
969

 
9

 
10

Other
144

 
143

 
3

 
4

Total consumer
811

 
1,112

 
12

 
14

Totals

$20,253

 

$34,097

 

$190

 

$238

 
 
 
 
 
 
 
 
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. When loans are placed on nonaccrual status, 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.

The following is a summary of nonaccrual loans, segregated by class of loans:
(Dollars in thousands)
Mar 31,
2018
 
Dec 31,
2017
Commercial:
 
 
 
Commercial real estate

$—

 

$4,954

Commercial & industrial
397

 
283

Total commercial
397

 
5,237

Residential Real Estate:
 
 
 
Residential real estate
9,340

 
9,414

Consumer:
 
 
 
Home equity
771

 
544

Other
13

 
16

Total consumer
784

 
560

Total nonaccrual loans

$10,521

 

$15,211

Accruing loans 90 days or more past due

$—

 

$—


As of March 31, 2018 and December 31, 2017, loans secured by one- to four-family residential property amounting to $4.0 million


- 17-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

and $4.4 million, respectively, were in process of foreclosure.

Nonaccrual loans of $3.5 million and $3.4 million, respectively, were current as to the payment of principal and interest at March 31, 2018 and December 31, 2017.

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at March 31, 2018.

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.

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 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 recorded investment in troubled debt restructurings was $6.8 million and $11.2 million, respectively, at March 31, 2018 and December 31, 2017. These amounts included insignificant balances of accrued interest. The allowance for loan losses included specific reserves for these troubled debt restructurings of $159 thousand and $1.1 million, respectively, at March 31, 2018 and December 31, 2017.

As of March 31, 2018, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.

For the three months ended March 31, 2018, there was one loan modified as a troubled debt restructuring with a pre-modification and post-modification recorded investment of $608 thousand. This troubled debt restructuring included a combination of concessions pertaining to maturity and interest only payment terms. There were no loans modified as a troubled debt restructuring for the three months ended March 31, 2017.

For the three months ended March 31, 2018, there were no payment defaults on troubled debt restructured loans modified within the previous 12 months. For the three months ended March 31, 2017, payment defaults on troubled debt restructured loans modified within the previous 12 months occurred on one loan totaling $779 thousand.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


- 18-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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 4.73 at March 31, 2018 and 4.70 at December 31, 2017. 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. See
Note 6 for additional information.

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 nonaccrual 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.



- 19-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the commercial loan portfolio, segregated by category of credit quality indicator:
(Dollars in thousands)
Pass
 
Special Mention
 
Classified
 
Mar 31,
2018
 
Dec 31,
2017
 
Mar 31,
2018
 
Dec 31,
2017
 
Mar 31,
2018
 
Dec 31,
2017
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$1,044,335

 

$1,067,373

 

$1,077

 

$—

 

$—

 

$5,114

Construction & development
171,866

 
138,008

 

 

 

 

Commercial real estate
1,216,201

 
1,205,381

 
1,077

 

 

 
5,114

Commercial & industrial
559,377

 
592,749

 
37,290

 
9,804

 
7,163

 
9,781

Total commercial

$1,775,578

 

$1,798,130

 

$38,367

 

$9,804

 

$7,163

 

$14,895


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. See Note 6 for additional information.

Various other techniques are utilized to monitor indicators of credit deterioration in the portfolios of residential real estate loans and consumer 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 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. See Note 6 for additional information.

The following table presents the residential and consumer loan portfolios, segregated by category of credit quality indicator:
(Dollars in thousands)
Current
 
Past Due
 
Mar 31,
2018
 
Dec 31,
2017
 
Mar 31,
2018
 
Dec 31,
2017
Residential Real Estate:
 
 
 
 
 
 
 
Self-originated mortgages

$1,112,533

 

$1,091,291

 

$10,347

 

$6,413

Purchased mortgages
125,551

 
128,102

 
1,459

 
1,442

Total residential real estate

$1,238,084

 

$1,219,393

 

$11,806

 

$7,855

Consumer:
 
 
 
 
 
 
 
Home equity

$281,488

 

$289,326

 

$4,235

 

$3,141

Other
30,663

 
31,484

 
22

 
43

Total consumer

$312,151

 

$320,810

 

$4,257

 

$3,184


(6) Allowance for Loan Losses
The allowance for loan losses is management’s best estimate of incurred losses inherent 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.



- 20-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the activity in the allowance for loan losses for the three months ended March 31, 2018:
(Dollars in thousands)
Commercial
 
 
Consumer
 
 
 
CRE (1)
C&I (2)
Total Commercial
Residential Real Estate
Home Equity
Other
Total Consumer
Total
Beginning Balance

$12,729


$5,580


$18,309


$5,427


$2,412


$340


$2,752


$26,488

Charge-offs
(627
)
(6
)
(633
)

(35
)
(22
)
(57
)
(690
)
Recoveries
25

29

54


7

5

12

66

Provision
(308
)
268

(40
)
67

(192
)
165

(27
)

Ending Balance

$11,819


$5,871


$17,690


$5,494


$2,192


$488


$2,680


$25,864

(1) Commercial real estate loans.
(2) Commercial & industrial loans.
 
 
 
 
 
 
 
 
 
The following table presents the activity in the allowance for loan losses for the three months ended March 31, 2017:
(Dollars in thousands)
Commercial
 
 
Consumer
 
 
 
CRE (1)
C&I (2)
Total Commercial
Residential Real Estate
Home Equity
Other
Total Consumer
Total
Beginning Balance

$11,166


$6,992


$18,158


$5,252


$1,889


$705


$2,594


$26,004

Charge-offs

(2
)
(2
)

(45
)
(32
)
(77
)
(79
)
Recoveries

107

107

4

2

8

10

121

Provision
1,200

(800
)
400

103

(106
)
3

(103
)
400

Ending Balance

$12,366


$6,297


$18,663


$5,359


$1,740


$684


$2,424


$26,446

(1) Commercial real estate loans.
(2) Commercial & industrial loans.
 
 
 
 
 
 
 
 
 


- 21-



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)
March 31, 2018
 
December 31, 2017
 
Loans
 
Related Allowance
 
Loans
 
Related Allowance
Loans Individually Evaluated for Impairment
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Commercial real estate

$—

 

$—

 

$4,954

 

$1,018

Commercial & industrial
5,861

 
53

 
5,157

 
1

Total commercial
5,861

 
53

 
10,111

 
1,019

Residential Real Estate:
 
 
 
 
 
 
 
Residential real estate
9,708

 
112

 
9,783

 
104

Consumer:
 
 
 
 
 
 
 
Home equity
783

 
108

 
557

 

Other
141

 
5

 
147

 
6

Total consumer
924

 
113

 
704

 
6

Subtotal
16,493

 
278

 
20,598

 
1,129

Loans Collectively Evaluated for Impairment
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Commercial real estate
1,217,278

 
11,819

 
1,205,541

 
11,711

Commercial & industrial
597,969

 
5,818

 
607,177

 
5,579

Total commercial
1,815,247

 
17,637

 
1,812,718

 
17,290

Residential Real Estate:
 
 
 
 
 
 
 
Residential real estate
1,240,182

 
5,382

 
1,217,465

 
5,323

Consumer:
 
 
 
 
 
 
 
Home equity
284,940

 
2,084

 
291,910

 
2,412

Other
30,544

 
483

 
31,380

 
334

Total consumer
315,484

 
2,567

 
323,290

 
2,746

Subtotal
3,370,913

 
25,586

 
3,353,473

 
25,359

Total

$3,387,406

 

$25,864

 

$3,374,071

 

$26,488



- 22-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(7) Borrowings
Federal Home Loan Bank Advances
Advances payable to the FHLB amounted to $808.7 million and $791.4 million, respectively, at March 31, 2018 and December 31, 2017.

The following table presents maturities and weighted average interest rates on FHLB advances outstanding as of March 31, 2018:
(Dollars in thousands)
Total Outstanding
 
Weighted
Average Rate
April 1, 2018 to December 31, 2018

$487,955

 
1.83
%
2019
137,258

 
1.62

2020
67,033

 
1.95

2021
46,222

 
2.57

2022
55,446

 
3.58

2023 and thereafter
14,763

 
2.44

Balance at March 31, 2018

$808,677

 
2.04
%

As of March 31, 2018 and December 31, 2017, the Bank had access to a $40.0 million unused line of credit with the FHLB and also had remaining available borrowing capacity of $624.8 million and $449.9 million, respectively. The Bank pledges certain qualified investment securities and loans as collateral to the FHLB.



- 23-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(8) Shareholders’ Equity
Regulatory Capital Requirements
At both March 31, 2018 and December 31, 2017, the Corporation and the Bank were 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
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation

$423,152

 
12.56
%
 

$269,589

 
8.00
%
 
N/A

 
N/A

Bank
420,438

 
12.48

 
269,565

 
8.00

 

$336,956

 
10.00
%
Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
397,042

 
11.78

 
202,192

 
6.00

 
N/A

 
N/A

Bank
394,328

 
11.70

 
202,174

 
6.00

 
269,565

 
8.00

Common Equity Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
375,044

 
11.13

 
151,644

 
4.50

 
N/A

 
N/A

Bank
394,328

 
11.70

 
151,630

 
4.50

 
219,021

 
6.50

Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation
397,042

 
8.84

 
179,741

 
4.00

 
N/A

 
N/A

Bank
394,328

 
8.78

 
179,700

 
4.00

 
224,625

 
5.00

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
416,038

 
12.45

 
267,365

 
8.00

 
N/A

 
N/A

Bank
413,593

 
12.38

 
267,338

 
8.00

 
334,172

 
10.00

Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
389,289

 
11.65

 
200,524

 
6.00

 
N/A

 
N/A

Bank
386,844

 
11.58

 
200,503

 
6.00

 
267,338

 
8.00

Common Equity Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation
367,291

 
10.99

 
150,383

 
4.50

 
N/A

 
N/A

Bank
386,844

 
11.58

 
150,378

 
4.50

 
217,212

 
6.50

Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation
389,289

 
8.79

 
177,089

 
4.00

 
N/A

 
N/A

Bank
386,844

 
8.74

 
177,048

 
4.00

 
221,310

 
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 1.25% on January 1, 2017 and 1.875% on January 1, 2018. The Capital Conservation Buffer will increase another 0.625% on January 1, 2019 to reach the full 2.50%.



- 24-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(9) 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 caps, swaps, 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 March 31, 2018 and December 31, 2017, 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 March 31, 2018 and December 31, 2017, 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.

As of March 31, 2018 and December 31, 2017, the Bank had 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 months ended March 31, 2018 and 2017, 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 variable-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 variable-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 March 31, 2018 and December 31, 2017, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $538.6 million and $545.0 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 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.



- 25-



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.

As of March 31, 2018, the notional amounts of risk participation-out agreements and risk participation-in agreements were $52.1 million and $34.0 million, respectively, compared to $52.4 million and $34.1 million, respectively, as of December 31, 2017.

Foreign Exchange Contracts
Foreign exchange contracts represent a contractual commitment to buy or sell a foreign currency on a future date at a specified price. The Corporation uses these foreign exchange contracts on a limited basis to reduce its exposure to fluctuations in currency exchange rates associated with a commercial loan that is denominated in a foreign currency. These derivatives are not designated as hedges and therefore changes in fair value are recognized in earnings. The changes in fair value on the foreign exchange contracts substantially offset the foreign currency translation gains and losses on the related commercial loan.

As of March 31, 2018 and December 31, 2017, the notional amount of foreign exchange contracts was $3.1 million and $3.0 million, respectively.

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 and pricing risk associated with rate locks and residential real estate mortgage loans held for sale, the Corporation enters into forward sale commitments. Forward sale commitments are contracts for delayed delivery or net settlement of the underlying instrument, such as a residential real estate mortgage loan, where the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. Both interest rate lock commitments and forward sale commitments 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 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
Mar 31, 2018
 
Dec 31, 2017
 
Balance Sheet Location
Mar 31, 2018
 
Dec 31, 2017
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate caps
Other assets

$67

 

$25

 
Other liabilities

$—

 

$—

Interest rate swaps
Other assets
1,313

 
213

 
Other liabilities

 
14

Interest rate floors
Other assets
90

 
110

 
Other liabilities

 

Derivatives not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
 
Loan related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
Other assets
137

 
268

 
Other liabilities
10,978

 
1,295

Mirror swaps with counterparties
Other assets
10,787

 
1,152

 
Other liabilities
137

 
268

Risk participation agreements
Other assets

 

 
Other liabilities

 

Foreign exchange contracts
Other assets
20

 

 
Other liabilities

 
26

Forward loan commitments:
 
 
 
 
 
 
 
 
 
Interest rate lock commitments
Other assets
931

 
965

 
Other liabilities

 
20

Forward sale commitments
Other assets
144

 
26

 
Other liabilities
453

 
1,424

Total
 

$13,489

 

$2,759

 
 

$11,568

 

$3,047




- 26-



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 Changes in Shareholders’ Equity and Unaudited Consolidated Statements of Income:
(Dollars in thousands)
Gain (Loss) Recognized in
Other Comprehensive Income, Net of Tax
(Effective Portion)
Three months ended March 31,
2018
 
2017
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
Interest rate risk management contracts:
 
 
 
Interest rate caps

$38

 

($33
)
Interest rate swaps
839

 
131

Interest rate floors
12

 

Total

$889

 

$98



(Dollars in thousands)
 
Amount of Gain (Loss) Recognized in Income on Derivatives
Three months ended March 31,
Statement of Income Location
2018
 
2017
Derivatives not Designated as Hedging Instruments:
 
 
 
 
Loan related derivative contracts:
 
 
 
 
Interest rate swaps with customers
Loan related derivative income

($9,195
)
 

($255
)
Mirror swaps with counterparties
Loan related derivative income
9,324

 
478

Risk participation agreements
Loan related derivative income

 
(75
)
Foreign exchange contracts
Loan related derivative income
12

 

Forward loan commitments:
 
 
 
 
Interest rate lock commitments
Mortgage banking revenues
(14
)
 
617

Forward sale commitments
Mortgage banking revenues
1,318

 
(1,029
)
Total
 

$1,445

 

($264
)



- 27-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(10) 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
March 31, 2018
 
 
 
 
Derivative Assets:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate caps

$67

 

$—

 

$67

 

$—

 

$67

Interest rate swaps
1,313

 

 
1,313

 

 
1,313

Interest rate floors
90

 

 
90

 

 
90

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
161

 
24

 
137

 

 
137

Mirror swaps with counterparties
11,152

 
365

 
10,787

 

 
10,787

Foreign exchange contracts
20

 

 
20

 

 
20

Total

$12,803

 

$389

 

$12,414

 

$—

 

$12,414

 
 
 
 
 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
 
 
 
 
Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
11,343

 
365

 
10,978

 

 
10,978

Mirror swaps with counterparties
161

 
24

 
137

 

 
137

Total

$11,504

 

$389

 

$11,115

 

$—

 

$11,115




- 28-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
Gross Derivative Positions
 
Offsetting Derivative Positions
 
Net Amounts Presented in Balance Sheet
 
Cash Collateral Pledged
 
Net Amount
December 31, 2017
 
 
 
 
Derivative Assets:
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
Interest rate caps

$25

 

$—

 

$25

 

$—

 

$25

Interest rate swaps
213

 

 
213

 

 
213

Interest rate floors
110

 

 
110

 

 
110

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
2,857

 
2,589

 
268

 

 
268

Mirror swaps with counterparties
3,801

 
2,649

 
1,152

 

 
1,152

Total

$7,006

 

$5,238

 

$1,768

 

$—

 

$1,768

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

$14

 

$—

 

$14

 

$14

 

$—

Loan-related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
3,884

 
2,589

 
1,295

 
1,025

 
270

Mirror swaps with counterparties
2,917

 
2,649

 
268

 

 
268

Foreign exchange contracts
26

 

 
26

 

 
26

Total

$6,841

 

$5,238

 

$1,603

 

$1,039

 

$564


As of March 31, 2018 there was no pledged collateral to derivative counterparties in the form of cash. As of December 31, 2017, Washington Trust pledged collateral to derivative counterparties in the form of cash totaling $1.0 million. Washington Trust may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

(11) Fair Value Measurements
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  As of March 31, 2018 and December 31, 2017, 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


- 29-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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 forward sale commitment contracts used to economically hedge them.

The aggregate principal amount of the residential real estate mortgage loans held for sale recorded at fair value was $17.3 million and $26.4 million, respectively, at March 31, 2018 and December 31, 2017. The aggregate fair value of these loans as of the same dates was $17.5 million and $26.9 million, respectively. As of March 31, 2018 and December 31, 2017, the aggregate fair value of residential real estate mortgage loans held for sale exceeded the aggregate principal amount by $214 thousand and $543 thousand, respectively.

There were no residential real estate mortgage loans held for sale 90 days or more past due as of March 31, 2018 and December 31, 2017.

Changes in fair value of mortgage loans held for sale accounted for under the fair value option election amounted to a decrease of $329 thousand in the three months ended March 31, 2018, compared to an increase of $451 thousand in the three months ended March 31, 2017. These amounts were offset in earnings by the changes in fair value of forward sale commitments used to economically hedge them. The changes in fair value are reported as a component of mortgage banking revenues in the Unaudited Consolidated Statements of Income.

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 March 31, 2018 and December 31, 2017.

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-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 March 31, 2018 and December 31, 2017.

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.



- 30-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Derivatives
Interest rate cap, swap 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 March 31, 2018 and December 31, 2017, 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 forward sale commitments) are primarily based on current market prices for similar assets in the secondary market for mortgage loans and therefore are classified as Level 2 assets. The fair value of interest rate lock commitments is also dependent on the ultimate closing of the loans. Pull-through rates are based on the Corporation’s historical data and reflect the Corporation’s best estimate of the likelihood that a commitment will result in a closed loan. Although the pull-through rates are Level 3 inputs, the Corporation has assessed the significance of the impact of pull-through rates on the overall valuation of its interest rate lock commitments and has determined that they are not significant to the overall valuation. As a result, the Corporation has classified its interest rate lock commitments as Level 2.

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

One of the two earn-out periods associated with this contingent consideration liability ended December 31, 2017 and a payment of $1.2 million was made by the Corporation in the first quarter of 2018.

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.



- 31-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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)
March 31, 2018
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$165,614

 

$—

 

$165,614

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
589,747

 

 
589,747

 

Obligations of states and political subdivisions
2,359

 

 
2,359

 

Individual name issuer trust preferred debt securities
17,096

 

 
17,096

 

Corporate bonds
13,026

 

 
13,026

 

Mortgage loans held for sale
17,494

 

 
17,494

 

Derivative assets
13,489

 

 
13,489

 

Total assets at fair value on a recurring basis

$818,825

 

$—

 

$818,825

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities

$11,568

 

$—

 

$11,568

 

$—

Contingent consideration liability
187

 

 

 
187

Total liabilities at fair value on a recurring basis

$11,755

 

$—

 

$11,568

 

$187



(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, 2017
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$157,604

 

$—

 

$157,604

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
590,882

 

 
590,882

 

Obligations of states and political subdivisions
2,359

 

 
2,359

 

Individual name issuer trust preferred debt securities
16,984

 

 
16,984

 

Corporate bonds
13,125

 

 
13,125

 

Mortgage loans held for sale
26,943

 

 
26,943

 

Derivative assets
2,759

 

 
2,759

 

Total assets at fair value on a recurring basis

$810,656

 

$—

 

$810,656

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities

$3,047

 

$—

 

$3,047

 

$—

Contingent consideration liability
1,404

 

 

 
1,404

Total liabilities at fair value on a recurring basis

$4,451

 

$—

 

$3,047

 

$1,404



- 32-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)


It is the Corporation’s policy to review and reflect transfers between Levels as of the financial statement reporting date. There were no transfers in and/or out of Level 1, 2 or 3 during the three months ended March 31, 2018 and 2017.

The contingent consideration liability is a Level 3 liability remeasured at fair value on a recurring basis. The following table presents the change in the contingent consideration liability, which is included in other liabilities in the Unaudited Consolidated Balance Sheets.
(Dollars in thousands)
 
 
 
Three months ended March 31,
2018

 
2017

Balance at beginning of period

$1,404

 

$2,047

Change in fair value

 
(310
)
Payments
(1,217
)
 

Balance at end of period

$187

 

$1,737


Items Recorded at Fair Value on a Nonrecurring Basis
The following table presents the carrying value of assets held at March 31, 2018, which were written down to fair value during the three months ended March 31, 2018:
(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

$1,086

 

$—

 

$—

 

$1,086

Property acquired through foreclosure or repossession
3,074

 

 

 
3,074

Total assets at fair value on a nonrecurring basis

$4,160

 

$—

 

$—

 

$4,160


The allowance for loan losses on collateral dependent impaired loans amounted to $169 thousand at March 31, 2018.

The following table presents the carrying value of assets held at December 31, 2017, which were written down to fair value during the year ended December 31, 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

$1,425

 

$—

 

$—

 

$1,425

Property acquired through foreclosure or repossession
131

 

 

 
131

Total assets at fair value on a nonrecurring basis

$1,556

 

$—

 

$—

 

$1,556


The allowance for loan losses on collateral dependent impaired loans amounted to $690 thousand at December 31, 2017.



- 33-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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)
March 31, 2018
Collateral dependent impaired loans

$1,086

Appraisals of collateral
Discount for costs to sell
6% - 15% (10%)
 
 
 
 
 
Property acquired through foreclosure or repossession

$3,074

Appraisals of collateral
Discount for costs to sell
13%
 
 
 
Appraisal adjustments (1)
12%
(1)
Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range of Inputs Utilized
(Weighted Average)
December 31, 2017
Collateral dependent impaired loans

$1,425

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

$131

Appraisals of collateral
Discount for costs to sell
10%
 
 
 
Appraisal adjustments (1)
12% - 17% (15%)
(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 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 such as cash and cash equivalents, FHLB stock, accrued interest receivable, bank-owned life insurance, non-maturity deposits and accrued interest payable.
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
March 31, 2018
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

$11,973

 

$11,995

 

$—

 

$11,995

 

$—

Loans, net of allowance for loan losses
3,361,542

 
3,355,384

 

 

 
3,355,384

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$1,031,239

 

$1,033,989

 

$—

 

$1,033,989

 

$—

FHLB advances
808,677

 
807,294

 

 
807,294

 

Junior subordinated debentures
22,681

 
19,340

 

 
19,340

 




- 34-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

(Dollars in thousands)
 
 
 
 
 
 
 
 
 
December 31, 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

$12,541

 

$12,721

 

$—

 

$12,721

 

$—

Loans, net of allowance for loan losses
3,347,583

 
3,369,932

 

 

 
3,369,932

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$1,015,095

 

$1,018,396

 

$—

 

$1,018,396

 

$—

FHLB advances
791,356

 
792,887

 

 
792,887

 

Junior subordinated debentures
22,681

 
18,559

 

 
18,559

 


(12) Revenue from Contracts with Customers
Overview
Revenue from contracts with customers in the scope of Accounting Standards Codification (“ASC”) Topic 606 is measured based on the consideration specified in the contract with a customer and excludes amounts collected on behalf of third parties. The Corporation recognizes revenue from contracts with customers when it satisfies its performance obligations.

The Corporation’s performance obligations are generally satisfied as services are rendered and can either be satisfied at a point in time or over time. Unsatisfied performance obligations at the report date are not material to our consolidated financial statements.

In certain cases, other parties are involved with providing services to our customers. If the Corporation is a principal in the transaction (providing services itself or through a third party on its behalf), revenues are reported based on the gross consideration received from the customer and any related expenses are reported gross in noninterest expense. If the Corporation is an agent in the transaction (referring to another party to provide services), the Corporation reports its net fee or commission retained as revenue.

Accounting Policy Updates
The Corporation adopted Topic 606 “Revenue from Contracts with Customers” effective January 1, 2018 and has applied the guidance to all contracts within the scope of Topic 606 as of that date. As a result, the Corporation has modified its accounting policy for revenue recognition as detailed in this footnote.

As discussed in Note 2, the Corporation applied Topic 606 using the modified retrospective method, therefore, the prior period comparative information has not been adjusted and continues to be reported under Topic 605. There was no cumulative effect adjustment as of January 1, 2018, and there were no material changes to our consolidated financial statements at or for the three months ended March 31, 2018, as a result of adopting Topic 606.

The Corporation applied the practical expedient pertaining to contracts with original expected duration of one year or less and does not disclose information about remaining performance obligations on such contracts.

The Corporation also applied the practical expedient pertaining to contracts for which, at contract inception, the period between when the entity transfers the services and when the customer pays for those services will be one year or less. As such, the Corporation does not adjust the consideration from customers for the effects of a significant financing component.

A substantial portion of the Corporation’s revenue is specifically excluded from the scope of Topic 606. For the revenue that is within scope of Topic 606, the following is a description of principal activities from which the Corporation generates its revenue from contracts with customers, separated by the timing of revenue recognition.



- 35-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Revenue Recognized at a Point in Time
The Corporation recognizes revenue that is transactional in nature and such revenue is earned at a point in time. Revenue that is recognized at a point in time includes card interchange fees (fee income related to debit card transactions), ATM fees, wire transfer fees, overdraft charge fees, and stop-payment and returned check fees. Such revenue is derived from transactional information and is recognized as revenue immediately as the transactions occur or upon providing the service to complete the customer’s transaction.

Revenue Recognized Over Time
The Corporation recognizes revenue over a period of time, generally monthly, as services are performed and performance obligations are satisfied. Such revenue includes wealth management revenues and service charges on deposit accounts. Wealth management revenues are categorized as either asset-based revenues or transaction-based revenues. Asset-based revenues include trust and investment management fees that are earned based upon a percentage of asset values under administration. Transaction-based revenues include financial planning fees, tax preparation fees, commissions and other service fees. Fee revenue from service charges on deposit accounts represent the service charges assessed to customer who hold deposit accounts at the Bank.

Costs of Obtaining Revenue from Contracts with Customers
The Corporation pays commissions and incentives to its employees in accordance with certain employment arrangements and incentive plans. For commissions and incentives that are excluded from the scope of Topic 606, such as those paid to mortgage originator employees, the Corporation expenses these costs when incurred or applies the guidance in ASC Topic 310. For commissions and incentives that are in-scope of Topic 606, such as those paid to employees in our wealth management services and commercial banking segments in order to obtain customer contracts, contract cost assets are established. The contract cost assets are capitalized and amortized over the estimated useful life that the asset is expected to generate benefits. The amortization of the contract cost asset is recorded within salaries and employee benefits expense.

Disaggregation of Revenue
The following table summarizes total revenues as presented in the Unaudited Consolidated Statements of Income and the related amounts which are from contracts with customers within the scope of Topic 606. As shown below, a substantial portion of our revenues are specifically excluded from the scope of Topic 606.
Three months ended March 31,
2018
 
2017
(Dollars in thousands)
As reported in Consolidated Statements of Income
Revenue from contracts in scope of Topic 606
 
As reported in Consolidated Statements of Income
Revenue from contracts in scope of Topic 606
Net interest income

$31,852


$—

 

$28,679


$—

Noninterest income:
 
 
 
 
 
Asset-based wealth management revenues
9,955

9,955

 
9,247

9,247

Transaction-based wealth management revenues
318

318

 
230

230

Total wealth management revenues
10,273

10,273

 
9,477

9,477

Mortgage banking revenues
2,838


 
2,340


Service charges on deposit accounts
863

863

 
883

883

Card interchange fees
847

847

 
802

802

Income from bank-owned life insurance
515


 
536


Loan related derivative income
141


 
148


Other income
266

266

 
324

297

Total noninterest income
15,743

12,249

 
14,510

11,459

Total revenues

$47,595


$12,249

 

$43,189


$11,459




- 36-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents revenue from contracts with customers based on the timing of revenue recognition:
(Dollars in thousands)
 
 
Three months ended March 31,
2018

2017

Revenue recognized at a point in time:
 
 
Card interchange fees

$847


$802

Service charges on deposit accounts
672

692

Other income
226

222

Revenue recognized over time:
 
 
Wealth management revenues
10,273

9,477

Service charges on deposit accounts
191

191

Other income
40

75

Total revenues from contracts in scope of Topic 606

$12,249


$11,459


Receivables primarily consist of amounts due from customers for wealth management services performed for which the Corporation’s performance obligations have been fully satisfied. Receivables amounted to $5.3 million at March 31, 2018, compared to $5.7 million at December 31, 2017 and were included in other assets in the Unaudited Consolidated Balance Sheets.

Deferred revenues, which are considered contract liabilities under Topic 606, represent advance consideration received from customers for which the Corporation has a remaining performance obligation to fulfill. Contract liabilities are recognized as revenue over the life of the contract as the performance obligations are satisfied. The balances of contract liabilities were insignificant at both March 31, 2018 and December 31, 2017 and were included in other liabilities in the Unaudited Consolidated Balance Sheets.

Contract cost assets (capitalized commission and incentive costs, net of amortization) at March 31, 2018 were insignificant and were included in other assets in the Unaudited Consolidated Balance Sheets.

(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.

During the first quarter of 2018, the Corporation made a $3.0 million contribution to the qualified pension plan.

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 $13.0 million and $13.3 million are included in the Consolidated Balance Sheets at March 31, 2018 and December 31, 2017, 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 ended March 31,
2018
2017
 
2018
2017
Net Periodic Benefit Cost:
 
 
 
 
 
Service cost (1)

$561


$537

 

$27


$32

Interest cost (2)
679

669

 
119

107

Expected return on plan assets (2)
(1,318
)
(1,236
)
 


Amortization of prior service (credit) cost (2)
(6
)
(6
)
 


Recognized net actuarial loss (2)
374

279

 
102

65

Net periodic benefit cost

$290


$243

 

$248


$204

(1)
Included in salaries and employee benefits expense in the Unaudited Consolidated Statements of Income.
(2)
Included in other expenses in the Unaudited Consolidated Statements of Income.

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 three months ended March 31,
2018
 
2017
 
2018
 
2017
Measurement date
Dec 31, 2017
 
Dec 31, 2016
 
Dec 31, 2017
 
Dec 31, 2016
Equivalent single discount rate for benefit obligations
3.69%
 
4.18%
 
3.58%
 
3.96%
Equivalent single discount rate for service cost
3.76
 
4.29
 
3.79
 
4.25
Equivalent single discount rate for interest cost
3.42
 
3.73
 
3.22
 
3.36
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 three months ended March 31, 2018, the Corporation granted equity awards, which included performance share awards and nonvested share unit awards.

The performance share awards granted to certain executive officers provide 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 18, 2018 (the award date), or $54.25, and will be earned over 3- to 5-year performance periods. 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 140% of the target, or 41,454 shares.

The Corporation granted to a certain non-executive officer 1,000 nonvested share units, with 5-year cliff vesting. The weighted average grant date fair value of the nonvested share units was $56.35.

(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; 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 BOLI, as well as administrative and executive expenses not allocated to the operating segments and the residual impact of methodology allocations such as FTP offsets.



- 39-



Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents 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 March 31,
2018

2017

 
2018

2017

 
2018

2017

 
2018
2017
Net interest income (expense)

$25,976


$23,557

 

($58
)

($32
)
 

$5,934


$5,154

 

$31,852


$28,679

Provision for loan losses

400

 


 


 

400

Net interest income (expense) after provision for loan losses
25,976

23,157

 
(58
)
(32
)
 
5,934

5,154

 
31,852

28,279

Noninterest income
4,936

4,442

 
10,273

9,477

 
534

591

 
15,743

14,510

Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization expense
637

663

 
396

463

 
42

52

 
1,075

1,178

Other noninterest expenses
15,466

14,607

 
7,199

6,448

 
3,390

3,053

 
26,055

24,108

Total noninterest expenses
16,103

15,270

 
7,595

6,911

 
3,432

3,105

 
27,130

25,286

Income before income taxes
14,809

12,329

 
2,620

2,534

 
3,036

2,640

 
20,465

17,503

Income tax expense
3,103

4,029

 
643

978

 
508

714

 
4,254

5,721

Net income

$11,706


$8,300

 

$1,977


$1,556

 

$2,528


$1,926

 

$16,211


$11,782

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at period end

$3,521,309


$3,344,773

 

$66,567


$64,984

 

$978,450


$979,006

 

$4,566,326


$4,388,763

Expenditures for long-lived assets
598

373

 
154

302

 
59

58

 
811

733

 
 
 
 
 
 
 
 
 
 
 
 

(16) Other Comprehensive Income (Loss)
The following tables present the activity in other comprehensive income (loss):
 
 
 
 
 
 
 
 
Three months ended March 31,
2018
 
2017
(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

($13,613
)

($3,199
)

($10,414
)
 

$636


$235


$401

Net gains on securities reclassified into earnings



 



Net change in fair value of securities available for sale

($13,613
)

($3,199
)

($10,414
)
 

$636


$235


$401

Cash flow hedges:
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
803

91

712

 
26

14

12

Net cash flow hedge losses reclassified into earnings (1)
231

54

177

 
136

50

86

Net change in fair value of cash flow hedges
1,034

145

889

 
162

64

98

Defined benefit plan obligations:
 
 
 
 
 
 
 
Defined benefit plan obligation adjustment



 



Amortization of net actuarial losses (2)
476

112

364

 
344

127

217

Amortization of net prior service credits (2)
(6
)
(2
)
(4
)
 
(6
)
(2
)
(4
)
Net change in defined benefit plan obligations
470

110

360

 
338

125

213

Total other comprehensive (loss) income

($12,109
)

($2,944
)

($9,165
)
 

$1,136


$424


$712

(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 other expenses in the Unaudited Consolidated Statements of Income.
 
 
 
 
 
 
 
 



- 40-



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 Losses on Available For Sale Securities
 
Net Unrealized (Losses) Gains on Cash Flow Hedges
 
Pension Benefit Adjustment
 
Total
Balance at December 31, 2017

($7,534
)
 

($428
)
 

($15,548
)
 

($23,510
)
Other comprehensive (loss) income before reclassifications
(10,414
)
 
712

 

 
(9,702
)
Amounts reclassified from accumulated other comprehensive income

 
177

 
360

 
537

Net other comprehensive (loss) income
(10,414
)
 
889

 
360

 
(9,165
)
Balance at March 31, 2018

($17,948
)
 

$461

 

($15,188
)
 

($32,675
)

(Dollars in thousands)
Net Unrealized 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 before reclassifications
401

 
12

 

 
413

Amounts reclassified from accumulated other comprehensive income

 
86

 
213

 
299

Net other comprehensive income
401

 
98

 
213

 
712

Balance at March 31, 2017

($6,424
)
 

($202
)
 

($12,419
)
 

($19,045
)


- 41-



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 ended March 31,
2018

 
2017

Earnings per common share - basic:
 
 
 
Net income

$16,211

 

$11,782

Less dividends and undistributed earnings allocated to participating securities
(38
)
 
(27
)
Net income applicable to common shareholders

$16,173

 

$11,755

Weighted average common shares
17,234

 
17,186

Earnings per common share - basic

$0.94

 

$0.68

Earnings per common share - diluted:
 
 
 
Net income

$16,211

 

$11,782

Less dividends and undistributed earnings allocated to participating securities
(38
)
 
(27
)
Net income applicable to common shareholders

$16,173

 

$11,755

Weighted average common shares
17,234

 
17,186

Dilutive effect of common stock equivalents
111

 
107

Weighted average diluted common shares
17,345

 
17,293

Earnings per common share - diluted

$0.93

 

$0.68


Weighted average common stock equivalents, not included in common stock equivalents above because they were anti-dilutive, totaled 45,832 for the three months ended March 31, 2018. There were no anti-dilutive weighted average common stock equivalents for the three months ended March 31, 2017.


- 42-



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)
Mar 31,
2018
 
Dec 31,
2017
Financial instruments whose contract amounts represent credit risk:
 
 
 
Commitments to extend credit:
 
 
 
Commercial loans

$525,275

 

$537,310

Home equity lines
258,690

 
254,855

Other loans
47,396

 
48,819

Standby letters of credit
6,656

 
6,666

Financial instruments whose notional amounts exceed the amount of credit risk:
 
 
 
Forward loan commitments:
 
 
 
Interest rate lock commitments
46,158

 
45,139

Forward sale commitments
72,008

 
71,539

Loan related derivative contracts:
 
 
 
Interest rate swaps with customers
538,608

 
545,049

Mirror swaps with counterparties
538,608

 
545,049

Risk participation-in agreements
34,010

 
34,052

Foreign exchange contracts
3,079

 
3,005

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

 
60,000


See Note 9 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. Most standby letters of credit extend for one year. The maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered totaled $6.7 million as of both March 31, 2018 and December 31, 2017. At March 31, 2018 and December 31, 2017, there were no liabilities to beneficiaries resulting from standby letters of credit.  Fee income on standby letters of credit was insignificant for the three months ended March 31, 2018 and 2017.


- 43-



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 and pricing risk associated with these rate locks and residential real estate mortgage loans held for sale, the Corporation enters into forward sale commitments.  Both interest rate lock commitments and forward sale commitments are derivative financial instruments.

Leases
At March 31, 2018, the Corporation was committed to rent premises used in business operations under non-cancelable operating leases. Rental expense under the operating leases amounted to $1.0 million for the three months ended March 31, 2018, compared to $1.1 million for the same period in 2017. The following table presents the minimum annual lease payments under the terms of these leases, exclusive of renewal provisions:
 
 
(Dollars in thousands)
 
April 1, 2018 to December 31, 2018

$2,609

2019
3,545

2020
2,866

2021
2,532

2022
2,158

2023 and thereafter
24,651

Total minimum lease payments

$38,361


Lease expiration dates range from 4 months to 23 years, with additional renewal options on certain leases ranging from 1 to 5 years.


- 44-


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, 2017, 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 months ended March 31, 2018 are not necessarily indicative of the results for the full-year ended December 31, 2018 or any future period. Certain previously reported amounts have been reclassified to conform to the current year’s presentation.

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 or outflows 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 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, 2017, 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 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, 2017.

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.



- 45-


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.

Results of Operations
The following table presents a summarized consolidated statement of operations:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Change
For the three months ended March 31,
2018

2017

 
$
%
Net interest income

$31,852


$28,679

 

$3,173

11
%
Noninterest income
15,743

14,510

 
1,233

8

Total revenues
47,595

43,189

 
4,406

10

Provision for loan losses

400

 
(400
)
(100
)
Noninterest expense
27,130

25,286

 
1,844

7

Income before income taxes
20,465

17,503

 
2,962

17

Income tax expense
4,254

5,721

 
(1,467
)
(26
)
Net income

$16,211


$11,782

 

$4,429

38
%

The following table presents a summary of performance metrics and ratios:
For the three months ended March 31,
2018

2017

Diluted earnings per common share

$0.93


$0.68

Return on average assets (net income divided by average assets)
1.45
%
1.09
%
Return on average equity (net income available for common shareholders divided by average equity)
15.96
%
12.00
%
Net interest income as a % of total revenues
67
%
66
%
Noninterest income as a % of total revenues
33
%
34
%

Net income totaled $16.2 million for the three months ended March 31, 2018, compared to $11.8 million for the same period in 2017. Income before income taxes for the three months ended March 31, 2018 increased by $3.0 million, or 17%, compared to the same period a year ago, reflecting higher revenues and a reduction in the loan loss provision, partially offset by an increase in noninterest expense. Despite a higher level of income before income taxes, income tax expense for the three months ended March 31, 2018 decreased by $1.5 million, or 26%, compared to the same period in 2017, due to the December 2017 enactment of the Tax Cuts and Jobs Act (“the Tax Act”), which included the reduction of the federal corporate income tax rate from 35% to 21%, effective January 1, 2018.



- 46-


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.
Three months ended March 31,
2018
 
2017
(Dollars in thousands)
Average Balance
Interest
Yield/ Rate
 
Average Balance
Interest
Yield/ Rate
Assets:
 
 
 
 
 
 
 
Cash, federal funds sold and short-term investments

$53,138


$205

1.56
%
 

$56,195


$104

0.75
%
Mortgage loans held for sale
24,424

226

3.75

 
24,424

222

3.69

Taxable debt securities
804,518

5,118

2.58

 
755,955

4,709

2.53

Nontaxable debt securities
2,355

29

4.99

 
11,521

173

6.09

Total securities
806,873

5,147

2.59

 
767,476

4,882

2.58

FHLB stock
40,888

516

5.12

 
43,622

387

3.60

Commercial real estate
1,218,702

12,346

4.11

 
1,207,032

10,557

3.55

Commercial & industrial
608,784

6,823

4.55

 
573,801

6,157

4.35

Total commercial
1,827,486

19,169

4.25

 
1,780,833

16,714

3.81

Residential real estate
1,228,379

11,929

3.94

 
1,128,044

10,646

3.83

Home equity
287,176

3,160

4.46

 
297,965

2,877

3.92

Other
30,706

370

4.89

 
37,089

446

4.88

Total consumer
317,882

3,530

4.50

 
335,054

3,323

4.02

Total loans
3,373,747

34,628

4.16

 
3,243,931

30,683

3.84

Total interest-earning assets
4,299,070

40,722

3.84

 
4,135,648

36,278

3.56

Noninterest-earning assets
230,638

 
 
 
229,823

 
 
Total assets

$4,529,708

 
 
 

$4,365,471

 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
Interest-bearing demand deposits

$80,502


$28

0.14
%
 

$56,782


$15

0.11
%
NOW accounts
449,298

54

0.05

 
420,622

50

0.05

Money market accounts
718,664

880

0.50

 
754,501

599

0.32

Savings accounts
368,012

57

0.06

 
357,894

51

0.06

Time deposits (in-market)
617,878

1,820

1.19

 
554,855

1,418

1.04

Wholesale brokered time deposits
409,243

1,583

1.57

 
397,274

1,369

1.40

Total interest-bearing deposits
2,643,597

4,422

0.68

 
2,541,928

3,502

0.56

FHLB advances
810,967

3,983

1.99

 
831,614

3,344

1.63

Junior subordinated debentures
22,681

183

3.27

 
22,681

138

2.47

Other



 
27

1

15.02

Total interest-bearing liabilities
3,477,245

8,588

1.00

 
3,396,250

6,985

0.83

Non-interest bearing demand deposits
584,557

 
 
 
527,215

 
 
Other liabilities
56,951

 
 
 
44,889

 
 
Shareholders’ equity
410,955

 
 
 
397,117

 
 
Total liabilities and shareholders’ equity

$4,529,708

 
 
 

$4,365,471

 
 
Net interest income (FTE)
 

$32,134

 
 
 

$29,293

 
Interest rate spread
 
 
2.84
%
 
 
 
2.73
%
Net interest margin
 
 
3.03
%
 
 
 
2.87
%



- 47-


Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:
(Dollars in thousands)
 
 
Three months ended March 31,
2018

2017

Commercial loans

$276


$553

Nontaxable debt securities
6

61

Total

$282


$614

 
 
 
 
 
 
 
 
 
 
 
Net Interest Income
Net interest income continues to be the primary source of our operating income.  Net interest income for the three months ended March 31, 2018 totaled $31.9 million, compared to $28.7 million for the same period in 2017. Net interest income is affected by the level of and 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.

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 months ended March 31, 2018, loan prepayment and other fee income amounted to $129 thousand, compared to $207 thousand from the same period in 2017.

FTE net interest income for the three months ended March 31, 2018 amounted to $32.1 million, up by $2.8 million, or 10%, from the same period in 2017. The net interest margin was 3.03% for the three months ended March 31, 2018, compared to 2.87% for the same period a year ago. Excluding the impact of loan prepayment and other fee income from each period, net interest income for the three months ended March 31, 2018 increased by $2.9 million, or 10%, from 2017. Excluding the impact of loan prepayment and other fee income from each period, the net interest margin was 3.02% for the three months ended March 31, 2018, compared to 2.85% for the same period in 2017, up by 17 basis points. While the net interest margin benefited from the rise in market interest rates on variable rate loans and growth in lower-cost in-market deposit balances, it was also impacted by a higher cost of funds.

In future periods, yields on loans and securities will be affected by the amount and composition of loan growth and additions to the securities portfolio, the runoff of existing portfolio balances and the level of market interest rates.

Total average loans for the three months ended March 31, 2018 increased by $129.8 million, or 4%, from the average balance for the comparable 2017 period, reflecting increases in average residential real estate and commercial loan balances. The yield on total loans for the three months ended March 31, 2018 was 4.16%, compared to 3.84% for the same period in 2017, up by 32 basis points. Excluding the impact of loan prepayment fee income and other fee income from each period, the yield on total loans for the three months ended March 31, 2018 was 4.15%, compared to 3.81% for the same period in 2017, up by 34 basis points. Yields on LIBOR-based and prime-based loans reflected the increases in market rates of interest.

Total average securities for the three months ended March 31, 2018 increased by $39.4 million, or 5%, from the average balance for the same period a year earlier. The FTE rate of return on the securities portfolio for the three months ended March 31, 2018 was 2.59%, up by 1 basis points from the comparable period in 2017.

The average balance of FHLB advances for the three months ended March 31, 2018 decreased by $20.6 million, or 2% compared to the average balance for the same period in 2017. The average rate paid on such advances for the three months ended March 31, 2018 was 1.99%, up by 36 basis points from the same period in 2017, due to higher rates on short-term advances.

Total average interest-bearing deposits for the three months ended March 31, 2018 increased by $101.7 million, or 4%, from the average balance for the same period in 2017. Included in total average interest-bearing deposits were of out-of-market wholesale brokered time deposits, which increased by $12.0 million from the same period in 2017. Excluding wholesale brokered time deposits, average in-market interest-bearing deposits for the three months ended March 31, 2018 increased by $89.7 million from the average balances for the same period in 2017. The average rate paid on in-market interest-bearing deposits for the


- 48-


three months ended March 31, 2018 increased by 12 basis points compared to the same period in 2017, 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 months ended March 31, 2018 increased by $57.3 million, or 11%, from the average balance for the same period in 2017.

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)
Change Due to
Three months ended March 31, 2018 vs. 2017
Volume
Rate
Net Change
Interest on Interest-Earning Assets:
 
 
 
Cash, federal funds sold and other short-term investments

($6
)

$107


$101

Mortgage loans held for sale

4

4

Taxable debt securities
313

96

409

Nontaxable debt securities
(117
)
(27
)
(144
)
Total securities
196

69

265

FHLB stock
(26
)
155

129

Commercial real estate
103

1,686

1,789

Commercial & industrial
380

286

666

Total commercial
483

1,972

2,455

Residential real estate
970

313

1,283

Home equity
(106
)
389

283

Other
(77
)
1

(76
)
Total consumer
(183
)
390

207

Total interest income
1,434

3,010

4,444

Interest on Interest-Bearing Liabilities:
 
 
 
Interest-bearing demand deposits
8

5

13

NOW accounts
4


4

Money market accounts
(30
)
311

281

Savings accounts
6


6

Time deposits (in-market)
177

225

402

Wholesale brokered time deposits
43

171

214

Total interest-bearing deposits
208

712

920

FHLB advances
(85
)
724

639

Junior subordinated debentures

45

45

Other
(1
)

(1
)
Total interest expense
122

1,481

1,603

Net interest income (FTE)

$1,312


$1,529


$2,841




- 49-


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)
 
 
 
 
Change
Three months ended March 31,
2018

 
2017

 
$
 
%
Noninterest income:
 
 
 
 
 
 
 
Wealth management revenues

$10,273

 

$9,477

 

$796

 
8
 %
Mortgage banking revenues
2,838

 
2,340

 
498

 
21

Service charges on deposit accounts
863

 
883

 
(20
)
 
(2
)
Card interchange fees
847

 
802

 
45

 
6

Income from bank-owned life insurance
515

 
536

 
(21
)
 
(4
)
Loan related derivative income
141

 
148

 
(7
)
 
(5
)
Other income
266

 
324

 
(58
)
 
(18
)
Total noninterest income

$15,743

 

$14,510

 

$1,233

 
8
 %

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 primarily includes trust and investment management 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)
 
 
 
 
Change
Three months ended March 31,
2018

 
2017

 
$
 
%
Wealth management revenues:
 
 
 
 
 
 
 
Trust and investment management fees

$9,955

 

$8,518

 

$1,437

 
17
 %
Mutual fund fees

 
729

 
(729
)
 
(100
)
Asset-based revenues
9,955

 
9,247

 
708

 
8

Transaction-based revenues
318

 
230

 
88

 
38

Total wealth management revenues

$10,273

 

$9,477

 

$796

 
8
 %

Wealth management revenues for the three months ended March 31, 2018 increased by $796 thousand from the comparable period in 2017, reflecting a higher level of trust and investment management fees, partially offset by a decline in mutual fund fees. Trust and investment management fee income benefited from financial market appreciation in 2017, as the average balance of assets under administration for the three months ended March 31, 2018 amounted to $6.7 billion, up by 8% from the comparable 2017 period. This revenue source was also positively impacted by a fee increase on a portion of our wealth management business that was effective in January 2018.

The decline in mutual fund fees noted in the above table was attributable to a change in 2017 in the business activities of our Weston Financial Group, Inc. (“Weston Financial”) and WSC subsidiaries. Prior to September 30, 2017, Weston Financial, a registered investment adviser subsidiary of the Bank, served as the investment adviser to a group of mutual funds. WSC, a broker-dealer subsidiary of the Bancorp, acted as the underwriter and principal distributor to these mutual funds. In 2017, Weston Financial concluded that the continued operation of the mutual funds was not in the best interest of its shareholders and recommended the dissolution of the mutual funds to its board of trustees. In the third quarter of 2017, the mutual funds were dissolved and liquidated pursuant to an Agreement and Plan of Dissolution and Liquidation approved by the shareholders of the mutual funds in August 2017. The dissolution of the mutual funds did not significantly impact the amount of Weston Financial’s assets under management.



- 50-


The following table presents the changes in wealth management assets under administration:
(Dollars in thousands)
 
 
 
Three months ended March 31,
2018

 
2017

Wealth management assets under administration:
 
 
 
Balance at the beginning of period

$6,714,637

 

$6,063,293

Net investment (depreciation) appreciation & income
(32,024
)
 
220,423

Net client asset flows
(338,893
)
 
(40,415
)
Balance at the end of period

$6,343,720

 

$6,243,301


Assets under administration stood at $6.3 billion at March 31, 2018, up by $100 million, or 2%, from a year ago, and down by $371 million, or 6%, from December 31, 2017. The decline in the end of period balance of wealth management assets from December 31, 2017 primarily resulted from client outflows in the latter portion of the first quarter of 2018 associated with the loss of certain client-facing personnel.

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)
 
 
 
Change
Three months ended March 31,
2018

2017

 
$
%
Mortgage banking revenues:
 
 
 
 
 
Gains and commissions on loan sales (1)

$2,679


$2,268

 

$411

18
 %
Loan servicing fee income, net (2)
159

72

 
87

121

Total mortgage banking revenues

$2,838


$2,340

 

$498

21
 %
 
 
 
 
 
 
Loans sold to the secondary market

$96,840


$106,912

 

($10,072
)
(9
)%
(1)
Includes gains on loan sales and commissions on loans originated for others, servicing right gains, fair value adjustments on loans held for sale and fair value adjustments and gains on forward loan commitments.
(2)
Represents loan servicing fee income, net of servicing right amortization and valuation adjustments.

For the three months ended March 31, 2018, mortgage banking revenues increased by $498 thousand from the comparable period in 2017. These results reflected a decrease in the volume of loans sold, offset by a $590 thousand increase in fair value adjustments on mortgage loan commitments and loans held for sale and a higher sales yield on loans sold to the secondary market. The increase in fair value adjustments was associated with the commencement of a portfolio-based economic hedging program in the first quarter of 2018. Prior to 2018, Washington Trust economically hedged mortgage loan commitments only on a loan by loan basis.

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.

Based on the assessment of asset quality and credit quality metrics, modest loan growth and other favorable changes in loss exposure allocations, management concluded that no loan loss provision was necessary for the first quarter of 2018. A loan loss provision of $400 thousand was recognized in the first quarter of 2017. Net charge-offs totaled $624 thousand for the three months ended March 31, 2018, compared to a net recovery of $42 thousand for the three months ended March 31, 2017.


- 51-



The allowance for loan losses was $25.9 million, or 0.76% of total loans, at March 31, 2018, compared to $26.5 million, or 0.79% of total loans, at December 31, 2017. See additional discussion under the caption “Asset Quality” for further information on the allowance for loan losses.

Noninterest Expense
The following table presents noninterest expense comparisons:
(Dollars in thousands)
 
 
 
 
Change
Three months ended March 31,
2018

 
2017

 
$
 
%
Noninterest expenses:
 
 
 
 
 
 
 
Salaries and employee benefits

$17,772

 

$16,917

 

$855

 
5
 %
Net occupancy
2,002

 
1,967

 
35

 
2

Outsourced services
1,873

 
1,457

 
416

 
29

Equipment
1,180

 
1,467

 
(287
)
 
(20
)
Legal, audit and professional fees
726

 
616

 
110

 
18

FDIC deposit insurance costs
404

 
481

 
(77
)
 
(16
)
Advertising and promotion
177

 
237

 
(60
)
 
(25
)
Amortization of intangibles
248

 
277

 
(29
)
 
(10
)
Change in fair value of contingent consideration

 
(310
)
 
310

 
100

Other
2,748

 
2,177

 
571

 
26

Total noninterest expense

$27,130

 

$25,286

 

$1,844

 
7
 %

Noninterest Expense Analysis
Salaries and employee benefits expense for the three months ended March 31, 2018 increased by $855 thousand, or 5%. In the first quarter of 2018, one-time cash incentive bonuses of approximately $450 thousand were expensed and paid to employees below a certain compensation threshold. There were no such one-time bonuses in the comparable 2017 period. The remaining increase in salaries and employee benefits expense reflected annual merit increases and an employee compensation enhancement of a $1.00 per hour salary increase for employees below a certain compensation level. Both the one-time cash incentive bonuses and the $1.00 per hour salary increase were employee compensation enhancements that were made in response to the reduction in corporate taxes due to the Tax Act.

Outsourced services for the three months ended March 31, 2018 increased by $416 thousand, or 29%, from the same period in 2017. Equipment expense for the three months ended March 31, 2018 decreased by $287 thousand, or 20% from the same period a year ago. Both the increase in outsourced services and the decline in equipment expense reflects the expansion of services provided by third party vendors.

During the three months ended March 31, 2017, the Corporation recorded a net reduction to noninterest expenses of $310 thousand reflecting the change in fair value of a contingent consideration liability. As part of the consideration to acquire Halsey Associates, Inc. (“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. One of the two earn-out periods associated with this contingent consideration liability ended December 31, 2017.

Other expenses for the three months ended March 31, 2018 increased by $571 thousand from the same period in 2017, primarily due to the recognition of wealth management and trust accounting system implementation expenses in the first quarter of 2018. This system implementation was completed in April 2018.



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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 ended March 31,
2018

2017

Income tax expense

$4,254


$5,721

Effective income tax rate
20.8
%
32.7
%

The decline in income tax expense and in the effective tax rate was due to the December 2017 enactment of the Tax Act, which included the reduction of the federal corporate tax rate from 35% to 21% effective January 1, 2018.

The effective income tax rates for the three months ended March 31, 2018 and 2017 differed from the federal rates of 21.0% in 2018 and 35.0% in 2017 primarily due to the benefits of tax-exempt loan and investment security income, income from BOLI, state income taxes, federal tax credits and the recognition of excess tax benefits associated with the settlement of share-based awards.

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 offsets.  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.

Commercial Banking
The following table presents a summarized statement of operations for the Commercial Banking business segment:
(Dollars in thousands)
 
 
 
Change
Three months ended March 31,
2018

2017

 
$
%
Net interest income

$25,976


$23,557

 

$2,419

10
%
Provision for loan losses

400

 
(400
)
(100
)
Net interest income after provision for loan losses
25,976

23,157

 
2,819

12

Noninterest income
4,936

4,442

 
494

11

Noninterest expense
16,103

15,270

 
833

5

Income before income taxes
14,809

12,329

 
2,480

20

Income tax expense
3,103

4,029

 
(926
)
(23
)
Net income

$11,706


$8,300

 

$3,406

41
%

Net interest income for this operating segment for the three months ended March 31, 2018, increased by $2.4 million from the same period in 2017, largely reflecting growth in loans and lower cost in-market deposits.

Based on management’s assessment of loss exposure, no loss loss provision was necessary for the first quarter of 2018. A loan loss provision of $400 thousand was recognized in the first quarter of 2017.

Noninterest income derived from the Commercial Banking segment for the three months ended March 31, 2018 was up by $494 thousand, or 11%, from the comparable period in 2017. The increase was concentrated in mortgage banking revenues.

Commercial Banking noninterest expenses for the three months ended March 31, 2018 were up by $833 thousand, or 5%, from the same period in 2017, largely reflecting increases in salaries and employee benefits costs and outsourced services, partially offset by declines in equipment expense.



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Wealth Management Services
The following table presents a summarized statement of operations for the Wealth Management Services business segment:
(Dollars in thousands)
 
 
 
Change
Three months ended March 31,
2018

2017

 
$
%
Net interest expense

($58
)

($32
)
 

($26
)
81
%
Noninterest income
10,273

9,477

 
796

8

Noninterest expense
7,595

6,911

 
684

10

Income before income taxes
2,620

2,534

 
86

3

Income tax expense
643

978

 
(335
)
(34
)
Net income

$1,977


$1,556

 

$421

27
%

For the three months ended March 31, 2018, noninterest income derived from the Wealth Management Services segment increased by $796 thousand, or 8%, compared to the same period in 2017, reflecting an increase in asset-based revenues.

For the three months ended March 31, 2018, noninterest expenses for the Wealth Management Services segment increased by $684 thousand, or 10%, from the same period in 2017. The noninterest expense comparison for this segment was impacted by the fair value adjustment on a contingent consideration liability, which decreased noninterest expenses by $310 thousand in the three months ended March 31, 2017. Excluding the impact of this item, total noninterest expenses for the Wealth Management Services segment for the three months ended March 31, 2018 increased by $374 thousand, or 5%, from the same period in 2017. This increase was due to the recognition of software system implementation expenses and was partially offset by lower salaries and employee benefits costs.

Corporate
The following table presents a summarized statement of operations for the Corporate unit:
(Dollars in thousands)
 
 
 
Change
Three months ended March 31,
2018

2017

 
$
%
Net interest income

$5,934


$5,154

 

$780

15
%
Noninterest income
534

591

 
(57
)
(10
)
Noninterest expense
3,432

3,105

 
327

11

Income before income taxes
3,036

2,640

 
396

15

Income tax expense
508

714

 
(206
)
(29
)
Net income

$2,528


$1,926

 

$602

31
%

Net interest income for the Corporate unit for the three months ended March 31, 2018 was up by $780 thousand, or 15%, compared to the same period in 2017, reflecting increased investment income due to growth in the investment securities portfolio and higher dividend income on FHLB stock, partially offset by increased FHLB borrowing costs.

Noninterest expenses for the Corporate unit for the three months ended March 31, 2018 were up by $327 thousand, or 11%, from the same period in 2017, reflecting increased staffing.



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Financial Condition
Summary
The following table presents selected financial condition data:
(Dollars in thousands)
 
 
 
 
Change
 
March 31, 2018
 
December 31,
2017
 
$
%
Cash and due from banks

$85,680

 

$79,853

 

$5,827

7
%
Total securities
799,815

 
793,495

 
6,320

1
%
Total loans
3,387,406

 
3,374,071

 
13,335


Allowance for loan losses
25,864

 
26,488

 
(624
)
(2
)
Total assets
4,566,326

 
4,529,850

 
36,476

1

Total deposits
3,256,434

 
3,242,707

 
13,727


FHLB advances
808,677

 
791,356

 
17,321

2

Total shareholders’ equity
413,081

 
413,284

 
(203
)


Total assets stood at $4.6 billion at March 31, 2018, up by $36.5 million from the end of 2017, largely reflecting loan growth, additions to the securities portfolio and an increase in cash and due from banks balances.

In the three months ended March 31, 2018, total deposits increased by $13.7 million and FHLB advances increased by $17.3 million.

Shareholders’ equity amounted to $413.1 million at March 31, 2018, down by $203 thousand from the balance at the end of 2017, reflecting net income of $16.2 million, offset by $7.5 million in dividends declared and a $10.4 million reduction in the accumulated comprehensive income component of shareholders’ equity resulting from a decline in the fair value of available for sale securities. As of March 31, 2018, the Bancorp and the Bank were “well-capitalized.” See Note 8 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 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. Debt 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. Debt 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 March 31, 2018 and December 31, 2017, 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 11 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities.


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Securities Portfolio
The carrying amounts of securities held are as follows:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount

 
%

 
Amount

 
%

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

$165,614

 
21
%
 

$157,604

 
20
%
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
589,747

 
75

 
590,882

 
76

Obligations of states and political subdivisions
2,359

 

 
2,359

 

Individual name issuer trust preferred debt securities
17,096

 
2

 
16,984

 
2

Corporate bonds
13,026

 
2

 
13,125

 
2

Total securities available for sale

$787,842

 
100
%
 

$780,954

 
100
%

(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount

 
%

 
Amount

 
%

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

$11,973

 
100
%
 

$12,541

 
100
%
Total securities held to maturity

$11,973

 
100
%
 

$12,541

 
100
%

Debt securities primarily consisting of obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, totaling $41.7 million, with a weighted average yield of 3.03%, were purchased in the three months ended March 31, 2018. These purchases were partially offset by a decline in the fair value of available for sale securities, routine principal pay-downs on mortgage-backed securities and a call of a corporate bond.

The securities portfolio stood at $799.8 million as of March 31, 2018, or 18% of total assets, compared to $793.5 million as of December 31, 2017, or 18% 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 March 31, 2018 and December 31, 2017, the net unrealized loss position on securities available for sale and held to maturity amounted to $23.4 million and $9.7 million, respectively, and included gross unrealized losses of $25.4 million and $13.5 million, respectively.  As of March 31, 2018, 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 does not consider these investments to be other-than-temporarily impaired at March 31, 2018. See Note 4 to the Unaudited Consolidated Financial Statements for additional information.

As of March 31, 2018, Washington Trust owns trust preferred securities of five 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.



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Individual Name Issuer Trust Preferred Debt Securities
(Dollars in thousands)
March 31, 2018
 
Credit Ratings
 
 
 
 
 
 
 
 
 
March 31, 2018
 
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
Bank of America Corporation
2
 
4,818

 
4,583

 
(235
)
 
 Baa3
 
 BBB-
 
 Baa3
 
 BBB-
Wells Fargo & Company
2
 
5,172

 
4,927

 
(245
)
 
 A1/Baa1
 
 BBB/BBB-
 
 A1/Baa1
 
 BBB/BBB-
SunTrust Banks, Inc.
1
 
4,181

 
3,906

 
(275
)
 
 Baa2
 
 BB+ (ii)
 
 Baa2
 
 BB+ (ii)
Northern Trust Corporation
1
 
1,989

 
1,870

 
(119
)
 
 A3
 
 BBB+
 
 A3
 
 BBB+
Huntington Bancshares Incorporated
1
 
1,952

 
1,810

 
(142
)
 
 Baa2
 
 BB (ii)
 
 Baa2
 
 BB+ (ii)
Totals
7
 

$18,112

 

$17,096

 

($1,016
)
 
 
 
 
 
 
 
 
(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 March 31, 2018 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 March 31, 2018.

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 $3.4 billion at March 31, 2018, up by $13.3 million from the end of 2017, reflecting an increase in the residential real estate portfolio, partially offset by decreases in the consumer and commercial loan portfolios.

Commercial Loans
The commercial loan portfolio represented 54% of total loans at March 31, 2018.

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 $374.2 million and $364.0 million, respectively, at March 31, 2018 and December 31, 2017. Our participation in commercial loans originated by other banks also includes shared national credits. Effective January 1, 2018, shared national credits are defined as participations in loans or loan commitments of at least $100 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


- 57-


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 March 31, 2018, up by $6.8 million, or 1%, from the balance at December 31, 2017. Included in commercial real estate loans were construction and development loans of $171.9 million and $138.0 million, respectively, as of March 31, 2018 and December 31, 2017.

Commercial real estate loans are secured by a variety of property types, with 91% of the total at March 31, 2018 composed of office buildings, retail facilities, multi-family dwellings, lodging, commercial mixed use properties, industrial and warehouse, and healthcare facilities. The average loan balance outstanding in the portfolio was $2.5 million and the largest individual commercial real estate loan outstanding was $26.3 million as of March 31, 2018.

The following table presents a geographic summary of commercial real estate loans, including commercial construction, by property location:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount
% of Total
 
Amount
% of Total
Rhode Island

$367,643

30
%
 

$360,834

30
%
Connecticut
460,338

38

 
309,013

26

Massachusetts
306,590

25

 
461,230

38

Subtotal
1,134,571

93

 
1,131,077

94

All other states
82,707

7

 
79,418

6

Total

$1,217,278

100
%
 

$1,210,495

100
%

Commercial and Industrial Loans
Commercial and industrial loans amounted to $603.8 million at March 31, 2018, down by $8.5 million, or 1%, from the balance at December 31, 2017.

Shared national credit balances outstanding included in the commercial and industrial loan portfolio totaled $69.0 million at March 31, 2018. Of this balance, $49.3 million was included in the pass-rated category of commercial loan credit quality and $19.7 million was included in the special mention category. All of these loans were current with respect to contractual payment terms at March 31, 2018.

The commercial and industrial loan portfolio includes loans to a variety of business types.  Approximately 90% of the total is composed of health care/social assistance, manufacturing, owner occupied and other real estate, educational services, professional, scientific and technical, retail trade, transportation and warehousing, entertainment and recreation, finance and insurance services, other services, public administration and construction businesses. The average loan balance outstanding in the portfolio was $548 thousand and the largest individual commercial and industrial loan outstanding was $20.1 million as of March 31, 2018.

Residential Real Estate Loans
The residential real estate loan portfolio represented 37% of total loans at March 31, 2018.

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.


- 58-



The table below presents residential real estate loan origination activity:
(Dollars in thousands)
 
 
 
 
 
Three months ended March 31,
2018
 
2017
 
Amount
% of Total
 
Amount
% of Total
Originations for retention in portfolio

$67,840

44
%
 

$57,907

36
%
Originations for sale to the secondary market (1)
87,720

56

 
102,441

64

Total

$155,560

100
%
 

$160,348

100
%
(1)
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 ended March 31,
2018
 
2017
 
Amount
% of Total
 
Amount
% of Total
Loans sold with servicing rights retained

$33,575

35
%
 

$22,567

21
%
Loans sold with servicing rights released (1)
63,265

65

 
84,345

79

Total

$96,840

100
%
 

$106,912

100
%
(1)
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 $3.7 million and $3.6 million, respectively, as of March 31, 2018 and December 31, 2017. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $585.2 million and $568.3 million, respectively, as of March 31, 2018 and December 31, 2017.

Residential real estate loans held in portfolio amounted to $1.2 billion at March 31, 2018, up by $22.6 million, or 2%, from the balance at December 31, 2017. A higher proportion of residential real estate mortgage loans were originated for retention in portfolio in the first quarter of 2018 than in the first quarter of 2017.

The following is a geographic summary of residential real estate mortgages by property location:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount
% of Total
 
Amount
% of Total
Rhode Island

$340,727

28
%
 

$343,340

28
%
Connecticut
141,511

11

 
140,843

12

Massachusetts
751,175

60

 
726,712

59

Subtotal
1,233,413

99

 
1,210,895

99

All other states
16,477

1

 
16,353

1

Total (1)

$1,249,890

100
%
 

$1,227,248

100
%
(1)
Includes residential real estate loans purchased from other financial institutions totaling $127.0 million and $129.5 million, respectively, as of March 31, 2018 and December 31, 2017.

Consumer Loans
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.



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The consumer loan portfolio totaled $316.4 million at March 31, 2018, down by $7.6 million, or 2%, from December 31, 2017, largely due to lower home equity line utilization. Home equity lines and home equity loans represented 90% of the total consumer portfolio at March 31, 2018. 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 $21.3 million and $21.7 million, respectively, at March 31, 2018 and December 31, 2017.

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)
Mar 31,
2018
 
Dec 31,
2017
Commercial:
 
 
 
Commercial real estate

$—

 

$4,954

Commercial & industrial
397

 
283

Total commercial
397

 
5,237

Residential Real Estate:
 
 
 
Residential real estate
9,340

 
9,414

Consumer:
 
 
 
Home equity
771

 
544

Other
13

 
16

Total consumer
784

 
560

Total nonaccrual loans
10,521

 
15,211

Property acquired through foreclosure or repossession, net
3,206

 
131

Total nonperforming assets

$13,727

 

$15,342

 
 
 
 
Nonperforming assets to total assets
0.30
%
 
0.34
%
Nonperforming loans to total loans
0.31
%
 
0.45
%
Total past due loans to total loans
0.57
%
 
0.59
%
Accruing loans 90 days or more past due

$—

 

$—


Total nonperforming assets declined by $1.6 million in the first quarter of 2018, with a $4.7 million decline in nonaccrual loans and a $3.1 million increase in property acquired through foreclosure.

Nonaccrual Loans
During the three months ended March 31, 2018, 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 March 31, 2018.



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The following table presents additional detail on nonaccrual loans:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Days Past Due
 
 
 
 
Days Past Due
 
 
 
 
Over 90
 
Under 90
 
Total
% (1)
 
Over 90
 
Under 90
 
Total
% (1)
Commercial:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate

$—

 

$—

 

$—

%
 

$4,954

 

$—

 

$4,954

0.41
%
Commercial & industrial
397

 

 
397

0.07

 
281

 
2

 
283

0.05

Total commercial
397

 

 
397

0.02

 
5,235

 
2

 
5,237

0.29

Residential Real Estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
4,108

 
5,232

 
9,340

0.75

 
3,903

 
5,511

 
9,414

0.77

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
288

 
483

 
771

0.27

 
268

 
276

 
544

0.19

Other

 
13

 
13

0.04

 
14

 
2

 
16

0.05

Total consumer
288

 
496

 
784

0.25

 
282

 
278

 
560

0.17

Total nonaccrual loans

$4,793

 

$5,728

 

$10,521

0.31
%
 

$9,420

 

$5,791

 

$15,211

0.45
%
(1)
Percentage of nonaccrual loans to the total loans outstanding within the respective category.

As of March 31, 2018, the composition of nonaccrual loans was 4% commercial and 96% residential and consumer, compared to 34% and 66%, respectively, at December 31, 2017.

Total nonaccrual loans declined by $4.7 million in the first quarter of 2018 due to the resolution of two commercial real estate relationships. In March 2018, a nonaccrual commercial real estate loan with a carrying value of $3.1 million was transferred to property acquired through foreclosure. Also in March 2018, a second nonaccrual commercial real estate loan with a carrying value of $1.8 million was reclassified to loans held for sale as the loan was sold in April at carrying value.

Nonaccrual residential real estate mortgage loans amounted to $9.3 million at March 31, 2018, down slightly from the end of 2017. As of March 31, 2018, 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 March 31, 2018 were five loans purchased for portfolio and serviced by others amounting to $1.4 million.  Management monitors the collection efforts of its third party servicers as part of its assessment of the collectibility of nonperforming loans.

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 March 31, 2018, 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)
Mar 31,
2018
 
Dec 31,
2017
Accruing troubled debt restructured loans
 
 
 
Commercial:
 
 
 
Commercial real estate

$—

 

$—

Commercial & industrial
5,464

 
4,875

Total commercial
5,464

 
4,875

Residential Real Estate:
 
 
 
Residential real estate
368

 
369

Consumer:
 
 
 
Home equity
12

 
13

Other
128

 
130

Total consumer
140

 
143

Total accruing troubled debt restructured loans
5,972

 
5,387

 
 
 
 
Nonaccrual troubled debt restructured loans
 
 
 
Commercial:
 
 
 
Commercial real estate

 
4,954

Commercial & industrial
281

 
281

Total commercial
281

 
5,235

Residential Real Estate:
 
 
 
Residential real estate
525

 
529

Consumer:
 
 
 
Home equity

 

Other

 

Total consumer

 

Total nonaccrual troubled debt restructured loans
806

 
5,764

Total troubled debt restructured loans

$6,778

 

$11,151


The allowance for loans losses included specific reserves for troubled debt restructurings of $159 thousand and $1.1 million, respectively, at March 31, 2018 and December 31, 2017.

Troubled debt restructured loans declined by $4.4 million in the first quarter of 2018, reflecting the resolution of two nonaccrual commercial real estate relationships discussed under the caption “Nonaccrual Loans.”



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Past Due Loans
The following table presents past due loans by category:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Amount
 
% (1)

 
Amount
 
% (1)

Commercial:
 
 
 
 
 
 
 
Commercial real estate

$—

 
%
 

$4,960

 
0.41
%
Commercial & industrial
3,295

 
0.55

 
4,076

 
0.67

Total commercial
3,295

 
0.18

 
9,036

 
0.50

Residential Real Estate:
 
 
 
 
 
 
 
Residential real estate
11,806

 
0.94

 
7,855

 
0.64

Consumer:
 
 
 
 
 
 
 
Home equity
4,235

 
1.48

 
3,141

 
1.07

Other
22

 
0.07

 
43

 
0.14

Consumer loans
4,257

 
1.35

 
3,184

 
0.98

Total past due loans

$19,358

 
0.57
%
 

$20,075

 
0.59
%
(1)
Percentage of past due loans to the total loans outstanding within the respective category.

As of March 31, 2018, the composition of past due loans, loans past due 30 days or more, was 17% commercial and 83% residential and consumer, compared to 45% and 55%, respectively, at December 31, 2017.

Total past due loans declined by $717 thousand in the first quarter of 2018, reflecting a $5.7 million decrease in commercial loans essentially offset by a $4.0 million increase in residential real estate loans and a $1.1 million increase in consumer loans. The decline in past due commercial loans reflected the resolution of two nonaccrual commercial real estate relationships discussed under the caption “Nonaccrual Loans.”

Total past due loans as of March 31, 2018 and December 31, 2017 included nonaccrual loans of $7.1 million and $11.8 million, respectively. All loans 90 days or more past due at March 31, 2018 and December 31, 2017 were classified as nonaccrual.

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 March 31, 2018 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 $6.3 million in potential problem loans at March 31, 2018, compared to $9.7 million at December 31, 2017. The decrease in potential problem loans from December 31, 2017 was primarily due to payoffs of commercial and industrial loans totaling $2.6 million in the first quarter of 2018. 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 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, 2017 and in Note 6 to the Unaudited Consolidated Financial Statements.

The allowance for loan losses is management’s best estimate of incurred 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,


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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 March 31, 2018 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)
Mar 31,
2018
 
Dec 31,
2017
Collateral dependent impaired loans (1)

$9,638

 

$13,880

Impaired loans measured on discounted cash flow method (2)
6,855

 
6,718

Total impaired loans

$16,493

 

$20,598

(1)
Net of partial charge-offs of $894 thousand and $5.1 million, respectively, at March 31, 2018 and December 31, 2017.
(2)
Net of partial charge-offs of $85 thousand and $84 thousand, respectively, at March 31, 2018 and December 31, 2017.

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.

The following table presents additional detail on the Corporation’s loan portfolio and associated allowance for loan losses:
(Dollars in thousands)
March 31, 2018
 
December 31, 2017
 
Loans
Related Allowance
Allowance / Loans
 
Loans
Related Allowance
Allowance / Loans
Impaired loans individually evaluated for impairment

$16,493


$278

1.69
%
 

$20,598


$1,129

5.48
%
Loans collectively evaluated for impairment
3,370,913

25,586

0.76

 
3,353,473

25,359

0.76

Total

$3,387,406


$25,864

0.76
%
 

$3,374,071


$26,488

0.79
%

The first quarter 2018 decline in collateral dependent impaired loans individually evaluated for impairment reflected the resolution of two nonaccrual commercial real estate relationships disclosed under the caption “Nonaccrual Loans.”



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Based on the assessment of asset quality and credit quality metrics, modest loan growth and other favorable changes in loss exposure allocations, management concluded that no loss loss provision was necessary for the first quarter of 2018. A loan loss provision of $400 thousand was recognized in the first quarter of 2017.

Net charge-offs totaled $624 thousand for the three months ended March 31, 2018, compared to a net recovery of $42 thousand for the three months ended March 31, 2017. Net charge-offs in the first quarter of 2018 were largely attributable to the two commercial real estate relationships discussed under the caption “Nonaccrual Loans.”

As of March 31, 2018, the allowance for loan losses was $25.9 million, or 0.76% of total loans, compared to $26.5 million, or 0.79% of total loans, at December 31, 2017.

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)
March 31, 2018
 
December 31, 2017
 
Amount

 
% (1)
 
Amount
 
% (1)
Commercial:
 
 
 
 
 
 
 
Commercial real estate

$11,819

 
36
%
 

$12,729

 
36
%
Commercial & industrial
5,871

 
18

 
5,580

 
18

Total commercial
17,690

 
54

 
18,309

 
54

Residential Real Estate:
 
 
 
 
 
 
 
Residential real estate
5,494

 
37

 
5,427

 
36

Consumer:
 
 
 
 
 
 
 
Home equity
2,192

 
8

 
2,412

 
9

Other
488

 
1

 
340

 
1

Total consumer
2,680

 
9

 
2,752

 
10

Balance at end of period

$25,864

 
100
%
 

$26,488

 
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, FHLB 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 Demand Deposit Marketplace (“DDM”) program, Insured Cash Sweep (“ICS”) 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 is eligible for the full amount of FDIC insurance. As a program participant, we receive reciprocal amounts of deposits from other participating banks. DDM, ICS 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.



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The following table presents a summary of deposits:
(Dollars in thousands)
 
 
 
 
Change
 
March 31, 2018
 
December 31, 2017
 
$
%
Noninterest-bearing demand deposits

$601,478

 

$578,410

 

$23,068

4
%
Interest-bearing demand deposits
83,249

 
82,728

 
521

1

NOW accounts
470,112

 
466,605

 
3,507

1

Money market accounts
693,748

 
731,345

 
(37,597
)
(5
)
Savings accounts
376,608

 
368,524

 
8,084

2

Time deposits (in-market)
625,965

 
617,368

 
8,597

1

Wholesale brokered time deposits
405,274

 
397,727

 
7,547

2

Total deposits

$3,256,434

 

$3,242,707

 

$13,727

 %
 
 
 
 
 
 
 
Total in-market deposits

$2,851,160

 

$2,844,980

 

$6,180

 %

Total deposits amounted to $3.3 billion at March 31, 2018, up by $13.7 million from December 31, 2017. This included an increase of $7.5 million of out-of-market brokered time deposits. Excluding out-of-market brokered time deposits, in-market deposits were up by $6.2 million from the balance at December 31, 2017.

FHLB Advances
FHLB advances are used to meet short-term liquidity needs and also to fund loan growth and additions to the securities portfolio. FHLB advances totaled $808.7 million at March 31, 2018, up by $17.3 million from the balance at the end of 2017.

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 in-market deposits, which funded approximately 62% of total average assets in the three months ended March 31, 2018.  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., FHLB 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, 2017.

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 three months ended March 31, 2018.  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 $21.5 million for the three months ended March 31, 2018, which was generated by net income of $16.2 million and adjustments to reconcile net income to net cash provided by operating activities. These adjustments included mortgage banking activities and increases in other assets and other liabilities. Net cash used in investing activities totaled $39.1 million for the three months ended March 31, 2018, reflecting outflows to purchase investment securities and fund loan growth, net of inflows from principal paydowns and a call of a debt security. For the three months ended March 31, 2018, net cash provided by financing activities amounted to $22.6 million, largely due to net increases in FHLB advances and deposits, partially offset by 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.

Capital Resources
Total shareholders’ equity amounted to $413.1 million at March 31, 2018, down by $203 thousand from December 31, 2017, including net income of $16.2 million, offset by $7.5 million for dividend declarations and a $10.4 million reduction in the


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accumulated comprehensive income component of shareholders’ equity resulting from a decline in the fair value of available for sale securities.

The Corporation declared a quarterly dividend of 43 cents per share for the three months ended March 31, 2018, compared to 38 cents per share for the same period in 2017, representing a 13% increase from a year ago.

The ratio of total equity to total assets amounted to 9.05% at March 31, 2018 compared to a ratio of 9.12% at December 31, 2017.  Book value per share at March 31, 2018 and December 31, 2017 amounted to $23.93 and $23.99, respectively.

The Bancorp and the Bank are subject to various regulatory capital requirements and are considered “well capitalized,” with a total risk-based capital ratio of 12.56% at March 31, 2018, compared to 12.45% at December 31, 2017. See Note 8 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 9 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 9 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, a 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 March 31, 2018 and December 31, 2017, 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.



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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 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 March 31, 2018 and December 31, 2017Interest 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.
 
March 31, 2018
 
December 31, 2017
 
Months 1 - 12
 
Months 13 - 24
 
Months 1 - 12
 
Months 13 - 24
100 basis point rate decrease
(3.70)%
 
(7.13)%
 
(3.88)%
 
(7.94)%
100 basis point rate increase
2.78
 
2.29
 
3.02
 
2.52
200 basis point rate increase
6.79
 
6.89
 
7.31
 
7.64
300 basis point rate increase
10.81
 
11.29
 
11.65
 
12.77

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.

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 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.


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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 March 31, 2018 and December 31, 2017 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)

$5,209

 

($13,797
)
Obligations of states and political subdivisions
1

 
(6
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
23,890

 
(58,837
)
Trust preferred debt and other corporate debt securities
(66
)
 
109

Total change in market value as of March 31, 2018

$29,034

 

($72,531
)
Total change in market value as of December 31, 2017

$17,308

 

($69,453
)

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 March 31, 2018.  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 March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II.  Other Information

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, 2017.

Item 6.  Exhibits
(a) Exhibits.  The following exhibits are included as part of this Form 10-Q:
Exhibit Number
 
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 March 31, 2018 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)
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:
May 3, 2018
 
By:
/s/ Edward O. Handy III
 
 
 
 
Edward O. Handy III
 
 
 
 
Chairman and Chief Executive Officer
 
 
 
 
(principal executive officer)
 
 
 
 
 
Date:
May 3, 2018
 
By:
/s/ Ronald S. Ohsberg
 
 
 
 
Ronald S. Ohsberg
 
 
 
 
Senior Executive Vice President, Chief Financial Officer and Treasurer
 
 
 
 
(principal financial officer)
 
 
 
 
 
Date:
May 3, 2018
 
By:
/s/ Maria N. Janes
 
 
 
 
Maria N. Janes
 
 
 
 
Executive Vice President and Controller
 
 
 
 
(principal accounting officer)


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Exhibit Index

Exhibit Number
 
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 March 31, 2018 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)
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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