WASHINGTON TRUST BANCORP INC - Quarter Report: 2019 September (Form 10-Q)

(Dollars in thousands)

September 30,
2019

December 31,
2018

Aggregate fair value

Aggregate principal balance

Difference between fair value and principal balance

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



☒	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended
	September 30, 2019	or



☐	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)		(IRS 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)



Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol(s)	Name of each exchange on which registered
COMMON STOCK, $.0625 PAR VALUE PER SHARE	WASH	The NASDAQ Stock Market LLC

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. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). ☒ Yes ☐ 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.



Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

☐ Yes ☒ No

The number of shares of common stock of the registrant outstanding as of October 31, 2019 was 17,350,703.



FORM 10-Q
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
For the Quarter Ended September 30, 2019

TABLE OF CONTENTS
	Page Number
	Page Number
PART I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018	3
Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018	4
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018	5
Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2019 and 2018	6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018	8
Condensed Notes to Unaudited Consolidated Financial Statements:	10
Note 1 - Basis of Presentation	10
Note 2 - Recently Issued Accounting Pronouncements	10
Note 3 - Cash and Due from Banks	13
Note 4 - Securities	13
Note 5 - Loans	17
Note 6 - Allowance for Loan Losses	23
Note 7 - Federal Home Loan Bank Advances	26
Note 8 - Shareholders’ Equity	27
Note 9 - Derivative Financial Instruments	28
Note 10 - Fair Value Measurements	31
Note 11 - Revenue from Contracts with Customers	37
Note 12 - Defined Benefit Pension Plans	39
Note 13 - Share-Based Compensation Arrangements	40
Note 14 - Business Segments	40
Note 15 - Other Comprehensive Income (Loss)	42
Note 16 - Earnings Per Common Share	44
Note 17 - Leases	45
Note 18 - Commitments and Contingencies	46
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	48
Item 3. Quantitative and Qualitative Disclosures About Market Risk	77
Item 4. Controls and Procedures	77
PART II. Other Information
Item 1. Legal Proceedings	78
Item 1A. Risk Factors	78
Item 6. Exhibits	78
Signatures	79

- 2-

PART I. Financial Information

Item 1. Financial Statements



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets (unaudited)	(Dollars in thousands, except par value)



	September 30, 2019			December 31, 2018
Assets:
Cash and due from banks		$141,768			$89,923
Short-term investments	4,336			3,552
Mortgage loans held for sale, at fair value	44,657			20,996
Securities:
Available for sale debt securities, at fair value	887,020			927,810
Held to maturity debt securities, at amortized cost (fair value $10,316 at December 31, 2018)	—			10,415
Total securities	887,020			938,225
Federal Home Loan Bank stock, at cost	45,030			46,068
Loans:
Total loans	3,778,106			3,680,360
Less allowance for loan losses	26,997			27,072
Net loans	3,751,109			3,653,288
Premises and equipment, net	29,293			29,005
Operating lease right-of-use assets	27,500			—
Investment in bank-owned life insurance	81,920			80,463
Goodwill	63,909			63,909
Identifiable intangible assets, net	7,448			8,162
Other assets	114,888			77,175
Total assets		$5,198,878			$5,010,766
Liabilities:
Deposits:
Noninterest-bearing deposits		$619,839			$603,216
Interest-bearing deposits	2,966,314			2,920,832
Total deposits	3,586,153			3,524,048
Federal Home Loan Bank advances	956,786			950,722
Junior subordinated debentures	22,681			22,681
Operating lease liabilities	29,541			—
Other liabilities	105,892			65,131
Total liabilities	4,701,053			4,562,582
Commitments and contingencies (Note 18)
Shareholders’ Equity:
Common stock of $.0625 par value; authorized 60,000,000 shares; issued and outstanding 17,338,348 shares at September 30, 2019 and 17,302,037 at December 31, 2018	1,084			1,081
Paid-in capital	121,900			119,888
Retained earnings	383,765			355,524
Accumulated other comprehensive loss	(8,924		)	(28,309		)
Total shareholders’ equity	497,825			448,184
Total liabilities and shareholders’ equity		$5,198,878			$5,010,766

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

- 3-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income (unaudited)	(Dollars and shares in thousands, except per share amounts)



		Three Months					Nine Months
Periods ended September 30,		2019			2018		2019			2018
Interest income:
Interest and fees on loans			$41,558			$38,493		$125,440			$109,633
Interest on mortgage loans held for sale		410			384		878			923
Taxable interest on debt securities		6,318			5,383		20,550			15,859
Nontaxable interest on debt securities		1			9		18			52
Dividends on Federal Home Loan Bank stock		747			634		2,162			1,700
Other interest income		493			261		1,232			723
Total interest and dividend income		49,527			45,164		150,280			128,890
Interest expense:
Deposits		9,792			6,546		27,957			16,222
Federal Home Loan Bank advances		6,512			4,937		20,153			13,627
Junior subordinated debentures		245			232		750			629
Total interest expense		16,549			11,715		48,860			30,478
Net interest income		32,978			33,449		101,420			98,412
Provision for loan losses		400			350		1,575			750
Net interest income after provision for loan losses		32,578			33,099		99,845			97,662
Noninterest income:
Wealth management revenues		9,153			9,454		27,954			29,329
Mortgage banking revenues		4,840			2,624		11,126			8,403
Card interchange fees		1,099			983		3,114			2,791
Service charges on deposit accounts		939			885		2,743			2,651
Loan related derivative income		1,407			278		2,877			1,087
Income from bank-owned life insurance		569			572		1,784			1,624
Net realized losses on securities		—			—		(80		)	—
Other income		335			419		944			1,066
Total noninterest income		18,342			15,215		50,462			46,951
Noninterest expense:
Salaries and employee benefits		18,332			17,283		54,387			52,359
Outsourced services		2,722			1,951		7,846			6,174
Net occupancy		1,933			2,013		5,835			5,945
Equipment		1,046			1,080		3,085			3,329
Legal, audit and professional fees		645			559		1,843			1,840
FDIC deposit insurance costs		(460		)	410		509			1,236
Advertising and promotion		368			440		1,132			946
Amortization of intangibles		236			245		714			740
Other expenses		2,048			2,081		6,634			6,911
Total noninterest expense		26,870			26,062		81,985			79,480
Income before income taxes		24,050			22,252		68,322			65,133
Income tax expense		5,236			4,741		14,740			13,737
Net income			$18,814			$17,511		$53,582			$51,396

Net income available to common shareholders			$18,778			$17,475		$53,477			$51,284
Weighted average common shares outstanding - basic		17,338			17,283		17,324			17,263
Weighted average common shares outstanding - diluted		17,414			17,382		17,406			17,392
Per share information:	Basic earnings per common share		$1.08			$1.01		$3.09			$2.97
	Diluted earnings per common share		$1.08			$1.01		$3.07			$2.95
	Cash dividends declared per share		$0.51			$0.43		$1.49			$1.29

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

- 4-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (unaudited)	(Dollars in thousands)



	Three Months						Nine Months
Periods ended September 30,	2019			2018			2019			2018
Net income		$18,814			$17,511			$53,582			$51,396
Other comprehensive income (loss), net of tax:
Net change in fair value of available for sale debt securities	2,886			(4,531		)	19,940			(18,057		)
Net change in fair value of cash flow hedges	(171		)	155			(1,235		)	1,409
Net change in defined benefit plan obligations	227			361			680			1,081
Total other comprehensive income (loss), net of tax	2,942			(4,015		)	19,385			(15,567		)
Total comprehensive income		$21,756			$13,496			$72,967			$35,829

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

- 5-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity (unaudited)	(Dollars and shares in thousands)



For the three months ended September 30, 2019	Common Shares Outstanding	Common Stock		Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total
Balance at July 1, 2019	17,336		$1,083		$121,115			$373,873			($11,866	)		$484,205
Net income	—	—		—			18,814			—			18,814
Total other comprehensive income, net of tax	—	—		—			—			2,942			2,942
Cash dividends declared ($0.51 per share)	—	—		—			(8,922		)	—			(8,922		)
Share-based compensation	—	—		792			—			—			792
Exercise of stock options, issuance of other compensation-related equity awards, net of awards surrendered	2	1		(7		)	—			—			(6		)
Balance at September 30, 2019	17,338		$1,084		$121,900			$383,765			($8,924	)		$497,825



For the nine months ended September 30, 2019	Common Shares Outstanding	Common Stock		Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total
Balance at January 1, 2019	17,302		$1,081		$119,888			$355,524			($28,309	)		$448,184
Net income	—	—		—			53,582			—			53,582
Total other comprehensive income, net of tax	—	—		—			—			19,385			19,385
Cash dividends declared ($1.49 per share)	—	—		—			(26,063		)	—			(26,063		)
Share-based compensation	—	—		2,295			—			—			2,295
Exercise of stock options, issuance of other compensation-related equity awards, net of awards surrendered	36	3		(283		)	—			—			(280		)
Cumulative effect of change in accounting principle	—	—		—			722			—			722
Balance at September 30, 2019	17,338		$1,084		$121,900			$383,765			($8,924	)		$497,825

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

- 6-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity (unaudited)	(Dollars and shares in thousands)



For the three months ended September 30, 2018	Common Shares Outstanding	Common Stock		Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balance at July 1, 2018	17,278		$1,080		$118,883			$336,670			($35,062	)		$421,571
Net income	—	—		—			17,511			—			17,511
Total other comprehensive loss, net of tax	—	—		—			—			(4,015		)	(4,015		)
Cash dividends declared ($0.43 per share)	—	—		—			(7,496		)	—			(7,496		)
Share-based compensation	—	—		658			—			—			658
Exercise of stock options, issuance of other compensation-related equity awards, net of awards surrendered	12	1		(321		)	—			—			(320		)
Balance at September 30, 2018	17,290		$1,081		$119,220			$346,685			($39,077	)		$427,909



For the nine months ended September 30, 2018	Common Shares Outstanding	Common Stock		Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balance at January 1, 2018	17,227		$1,077		$117,961			$317,756			($23,510	)		$413,284
Net income	—	—		—			51,396			—			51,396
Total other comprehensive loss, net of tax	—	—		—			—			(15,567		)	(15,567		)
Cash dividends declared ($1.29 per share)	—	—		—			(22,467		)	—			(22,467		)
Share-based compensation	—	—		1,977			—			—			1,977
Exercise of stock options, issuance of other compensation-related equity awards, net of awards surrendered	63	4		(718		)	—			—			(714		)
Balance at September 30, 2018	17,290		$1,081		$119,220			$346,685			($39,077	)		$427,909

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

- 7-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statement of Cash Flows (unaudited)	(Dollars in thousands)



Nine months ended September 30,		2019			2018
Cash flows from operating activities:
Net income			$53,582			$51,396
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,575			750
Depreciation of premises and equipment		2,478			2,454
Net amortization of premiums and discounts on securities and loans		3,113			2,157
Amortization of intangibles		714			740
Share-based compensation		2,295			1,977
Tax benefit from stock option exercises and other equity awards		202			454
Income from bank-owned life insurance		(1,784		)	(1,624		)
Net gains on loan sales, including fair value adjustments		(10,749		)	(7,950		)
Net realized losses on securities		80			—
Proceeds from sales of loans, net		365,057			306,095
Loans originated for sale		(380,635		)	(296,367		)
Decrease in operating lease right-of-use assets		1,422			—
Decrease in operating lease liabilities		(1,312		)	—
Increase in other assets		(41,239		)	(20,903		)
Increase in other liabilities		42,575			19,256
Net cash provided by operating activities		37,374			58,435
Cash flows from investing activities:
Purchases of:	Available for sale debt securities: Mortgage-backed	(72,262		)	(96,867		)
	Available for sale debt securities: Other	(10,507		)	(30,964		)
Proceeds from sale of:	Other investment securities available for sale	9,920			—
Maturities, calls and principal payments of:	Available for sale debt securities: Mortgage-backed	96,521			63,918
	Available for sale debt securities: Other	51,135			6,795
	Held to maturity debt securities: Mortgage-backed	—			1,603
Remittance (purchases) of Federal Home Loan Bank stock		1,038			(4,008		)
Net increase in loans		(92,135		)	(181,853		)
Purchases of loans		(7,324		)	(1,750		)
Proceeds from the sale of property acquired through foreclosure or repossession		—			49
Purchases of premises and equipment		(2,768		)	(2,320		)
Purchases of bank-owned life insurance		—			(5,000		)
Proceeds from surrender of bank-owned life insurance		326			—
Equity investment in real estate limited partnership		(1,256		)	—
Net cash used in investing activities		(27,312		)	(250,397		)
Cash flows from financing activities:
Net increase in deposits		62,105			171,641
Proceeds from Federal Home Loan Bank advances		1,334,000			1,462,500
Repayment of Federal Home Loan Bank advances		(1,327,936		)	(1,425,464		)
Payment of contingent consideration liability		—			(1,217		)
Net proceeds from stock option exercises and issuance of other equity awards, net of awards surrendered		(280		)	(714		)
Cash dividends paid		(25,322		)	(21,856		)
Net cash provided by financing activities		42,567			184,890
Net increase (decrease) in cash and cash equivalents		52,629			(7,072		)
Cash and cash equivalents at beginning of period		93,475			82,923
Cash and cash equivalents at end of period			$146,104			$75,851

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

- 8-



Washington Trust Bancorp, Inc. and Subsidiaries
Consolidated Statement of Cash Flows – continued (unaudited)	(Dollars in thousands)



Nine months ended September 30,	2019		2018
Noncash Activities:
Loans charged off		$1,888		$889
Loans transferred to property acquired through foreclosure or repossession	2,000		3,074
In conjunction with the adoption of ASU 2016-02 as detailed in Note 2 to the Unaudited Consolidated Financial Statements, the following assets and liabilities were recognized:
Operating lease right-of-use assets	28,923		—
Operating lease liabilities	30,853		—
In conjunction with the adoption of ASU 2017-12 as detailed in Note 2 to the Unaudited Consolidated Financial Statements, the following qualifying debt securities classified as held to maturity were transferred to available for sale:
Fair value of debt securities transferred from held to maturity to available for sale	10,316		—
Supplemental Disclosures:
Interest payments		$47,168		$28,596
Income tax payments	14,531		12,585

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

- 9-

Condensed Notes to Unaudited Consolidated Financial Statements

Note 1 - Basis of Presentation

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 complete product line of 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 balances and transactions have been eliminated. Certain previously reported amounts have been reclassified to conform to current year’s presentation.

The Bancorp also owns the common stock of two capital trusts, which have issued trust preferred securities. These capital trusts are variable interest entities in which the Bancorp is not the primary beneficiary and, therefore, are not consolidated. The capital trust’s only assets are junior subordinated debentures issued by the Bancorp, which were acquired by the capital trusts using the proceeds from the issuance of the trust preferred securities and common stock. The Bancorp’s equity interest in the capital trusts, classified in other assets, and the junior subordinated debentures are included in the Unaudited Consolidated Balance Sheets. Interest expense on the junior subordinated debentures is included in the Unaudited Consolidated Statements of Income.

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 indicative 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, 2018.

Note 2 - Recently Issued Accounting Pronouncements

Accounting Standards Adopted in 2019

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 depends on its classification as a finance or operating lease. ASU 2016-02 requires a modified retrospective transition, with a package 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. In July 2018, Accounting Standards Update No. 2018-10, “Codification Improvements to Topic 842, Leases” was issued to provide more detailed guidance and additional clarification for implementing ASU 2016-02. Also in July 2018, Accounting Standards Update No. 2018-11, “Targeted Improvements” (“ASU 2018-11”) was issued and allows for an optional transition method in which the provisions of Topic 842 would be applied upon the adoption date and would not have to be retroactively applied to the earliest reporting period presented in the consolidated financial statements. The Corporation used this optional transition method for the adoption of Topic 842. In December 2018, Accounting Standards Update No. 2018-20, “Leases (Topic 842) Narrow-Scope Improvement for Lessors” was issued to address lessors’ concerns about sales taxes and other similar taxes collected from lessees, certain lessor costs, and recognition of variable payments for contracts with lease and non-lease components. These ASUs were effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018.

- 10-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Management assembled a project team to address the changes pursuant to Topic 842. The project team identified and reviewed all lease agreements in scope of Topic 842. The Corporation rents premises used in business operations under non-cancelable operating leases, which as of December 31, 2018 were not reflected in its Consolidated Balance Sheets. The Corporation has no finance leases.

The Corporation adopted Topic 842 “Leases” effective January 1, 2019 and has applied the guidance to all operating leases within the scope of Topic 842 at that date. The Corporation elected to adopt the package of practical expedients, which among other things, does not require reassessment of lease classification. The Corporation recognized $28.9 million in operating lease right-of-use-assets, $30.9 million in operating lease liabilities, a reduction in rent-related liabilities of $2.9 million, a reduction of net deferred tax assets of $222 thousand and a cumulative effect adjustment (net of taxes) that increased beginning retained earnings by $722 thousand in the Consolidated Balance Sheets. The cumulative effect adjustment represented the recognition of unamortized deferred gains associated with two leases. There was no change to the timing in recognition of operating lease rent expense on the Corporation’s consolidated financial statements associated with our leases.

In March 2019, Accounting Standards Update No. 2019-01, “Leases (Topic 842) Codification Improvements” (“ASU 2019-01”) was issued to address lessors’ concerns about determining fair value of underlying leased assets and presentation issues in the statement of cash flows for sales-type and direct financing leases. ASU 2019-01 also clarified for both lessees and lessors that transition disclosures related to Topic 250 were not required for annual periods are also not required for interim periods. ASU 2019-01 was effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019, with early adoption permitted. The Corporation early adopted this ASU 2019-01 effective January 1, 2019 and it 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 was effective for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. In addition, ASU 2017-12 also permitted the reclassification of eligible securities from the held to maturity classification to the available for sale classification. The Corporation adopted the provisions of ASU 2017-12 on January 1, 2019 using a modified retrospective transition method. As permitted by ASU 2017-12, qualifying debt securities classified as held to maturity with an amortized cost of $10.4 million and a fair value of $10.3 million were reclassified to available for sale upon the adoption date. An unrealized loss of $75 thousand (net of taxes) was recognized in the accumulated other comprehensive income component of shareholders’ equity at the date of adoption. The adoption of ASU 2017-12 did not have a material impact on the Corporation’s consolidated financial statements.

Accounting Standards Update No. 2018-16, “Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU 2018-16”), was issued in October 2018 to permit the use of the Overnight Index Swap rate based on the Secured Overnight Financing Rate as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to existing benchmark interest rates that are currently used for hedge accounting. ASU 2018-16 was effective for fiscal years beginning after December 15, 2018, and interim periods with those fiscal years. The provisions required prospective application for qualifying new or re-designated hedging relationships entered into on or after the date of adoption. The Corporation adopted the provisions of ASU 2018-16 on January 1, 2019 and it did not have a material impact on the Corporation’s consolidated financial statements.

Accounting Standards Pending Adoption

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 measured at amortized cost, as well as off-balance sheet credit exposures at the reporting date. The measurement is 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. The

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Corporation will adopt ASU 2016-13 on January 1, 2020 and continues to evaluate the effect that this ASU will have on the consolidated financial statements and disclosures.

In April 2019, Accounting Standards Update No. 2019-04, “Codification Improvements to Topic 326 Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments” (“ASU 2019-04”) was issued to provide additional clarification on the scope and disclosure requirements of Topic 326. ASU 2019-04 includes provisions related to accounting policy elections that can be made by the entity related to accrued interest receivable and expected prepayments on financial assets, the inclusion of recoveries in estimating the allowance for credit losses (“ACL”) and consideration of contract extension and renewals when determining the contractual term. This ASU also provides clarification on the tabular vintage disclosures related to line-of-credit arrangements that convert term loans. In May 2019, Accounting Standards Update No. 2019-05, “Financial Instruments - Credit Losses (Topic 326); Targeted Transition Relief” (“ASU 2019-05”) was issued to allow an entity to make an irrevocable fair value option election on instruments within the scope of Topic 326 that are measured at amortized cost, except for held to maturity debt securities. This election can be applied on an instrument-by-instrument basis upon the adoption of Topic 326. The effective dates of ASU 2019-04 and ASU 2019-05 are the same as the effective date of ASU 2016-13.

To prepare for the adoption of ASU 2016-13 and related updates, the Corporation assembled a cross-functional project team that meets regularly to address the additional data requirements necessary, to determine the approach for implementation and to identify new internal controls over enhanced accounting processes that will be put into place for estimating the ACL. This has included assessing the adequacy of existing loan and loss data, as well as validating models for default and loss estimates. The Corporation has substantially completed the development of its Topic 326 compliant methodology. The new methodology will include models that contain additional assumptions used to calculate credit losses over the estimated life of financial assets and off-balance sheet credit exposures and will include the impact of forecasted economic conditions. For available for sale debt securities with unrealized losses, credit losses will be recognized as an allowance rather than a reduction in the amortized cost of the securities. As a result, improvements to estimated credit losses will be recognized immediately in earnings rather than as interest income over time. Based on the credit quality of our existing available for sale debt securities portfolio, the Corporation does not expect the adoption of ASU 2016-13, as it relates to debt securities, to be significant.

The project team continues to review the output from “trial” runs and is in the process of assessing qualitative factors. The Corporation is also updating its accounting processes and policies and internal controls associated with the Topic 326 compliant methodology.

The Corporation plans to finalize its Topic 326 compliant methodology, accounting policies and internal controls in the fourth quarter of 2019. Upon adoption, an increase to the ACL will be recorded with a corresponding one-time cumulative-effect adjustment to retained earnings. The FDIC approved a final rule that provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. The Corporation is planning on adopting the capital transition relief over the permissible three-year period.

Fair Value Measurement - Topic 820

Accounting Standards Update No. 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”), was issued in August 2018 to modify the disclosure requirements related to fair value. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted, including adoption in an interim period. Certain provisions under ASU 2018-13 require prospective application, while other provisions require retrospective application to all periods presented in the consolidated financial statements upon adoption. The adoption of ASU 2018-13 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Compensation - Retirement Benefits - Topic 715

Accounting Standards Update No. 2018-14, “Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans” (“ASU 2018-14”), was issued in August 2018 to modify the disclosure requirements associated with defined benefit pension plans and other postretirement plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020, with early adoption permitted. The provisions under ASU 2018-14 are required to be applied retrospectively. The adoption of ASU 2018-14 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Intangibles - Goodwill and Other - Internal-Use Software - Topic 350

Accounting Standards Update No. 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract” (“ASU 2018-15”), was issued in August 2018 to align the requirements for capitalizing

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

implementation costs incurred in a hosting arrangement that is a service contract with those requirements that currently exist in GAAP for capitalizing implementation costs incurred to develop or obtain internal-use software. Implementation costs would either be capitalized or expensed as incurred depending on the project stage. All costs in the preliminary and post-implementation project stages are expensed as incurred, while certain costs within the application development stage are capitalized. The provisions under ASU 2018-15 can either be applied retrospectively or prospectively. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted, including adoption in an interim period. The adoption of ASU 2018-15 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Note 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 (the “FRB”). Some or all of these reserve requirements may be satisfied with vault cash. Reserve balances amounted to $27.6 million at September 30, 2019 and $21.6 million at December 31, 2018 and were included in cash and due from banks in the Unaudited Consolidated Balance Sheets.

As of September 30, 2019 and December 31, 2018, cash and due from banks included interest-bearing deposits in other banks of $81.9 million and $33.7 million, respectively.

Note 4 - Securities

The following tables present the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value of securities by major security type and class of security:



(Dollars in thousands)
September 30, 2019	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Available for Sale Debt Securities:
Obligations of U.S. government-sponsored enterprises		$196,734		$927		($337	)		$197,324
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	659,096		8,614		(2,805		)	664,905
Individual name issuer trust preferred debt securities	13,320		—		(899		)	12,421
Corporate bonds	13,715		32		(1,377		)	12,370
Total available for sale debt securities		$882,865		$9,573		($5,418	)		$887,020
Total securities		$882,865		$9,573		($5,418	)		$887,020

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)



(Dollars in thousands)
December 31, 2018	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Available for Sale Debt Securities:
Obligations of U.S. government-sponsored enterprises		$246,708		$442		($4,467	)		$242,683
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	675,368		1,943		(16,518		)	660,793
Obligations of states and political subdivisions	935		2		—			937
Individual name issuer trust preferred debt securities	13,307		—		(1,535		)	11,772
Corporate bonds	13,402		—		(1,777		)	11,625
Total available for sale debt securities		$949,720		$2,387		($24,297	)		$927,810
Held to Maturity Debt Securities:
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises		$10,415		$—		($99	)		$10,316
Total held to maturity debt securities		$10,415		$—		($99	)		$10,316
Total securities		$960,135		$2,387		($24,396	)		$938,126

As discussed in Note 2, on January 1, 2019, the Corporation adopted ASU 2017-12. As permitted by ASU 2017-12, qualifying debt securities classified as held to maturity with an amortized cost of $10.4 million and a fair value of $10.3 million were reclassified to available for sale upon the adoption date. An unrealized loss of $75 thousand (net of taxes) was recognized in the accumulated other comprehensive income component of shareholders’ equity at the date of adoption.

As of September 30, 2019 and December 31, 2018, debt securities with a fair value of $435.3 million and $439.7 million, respectively, were pledged as collateral for FHLB borrowings, potential borrowings with the FRB, certain public deposits and for other purposes. See Note 7 for additional disclosure on FHLB borrowings.

The schedule of maturities of available for sale debt securities 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
September 30, 2019	Amortized Cost		Fair Value
Due in one year or less		$105,671		$106,401
Due after one year to five years	340,179		342,582
Due after five years to ten years	289,520		290,083
Due after ten years	147,495		147,954
Total debt securities		$882,865		$887,020

Included in the above table are debt securities with an amortized cost balance of $222.5 million and a fair value of $220.8 million at September 30, 2019 that are callable at the discretion of the issuers. Final maturities of the callable securities range from 3 months to 17 years, with call features ranging from 1 month to 3 years.

Other-Than-Temporary Impairment Assessment

Management 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.

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables summarize temporarily impaired securities, segregated by length of time the securities have been in a continuous unrealized loss position:



(Dollars in thousands)	Less than 12 Months						12 Months or Longer						Total
September 30, 2019	#	Fair Value		Unrealized Losses			#	Fair Value		Unrealized Losses			#	Fair Value		Unrealized Losses
Obligations of U.S. government-sponsored enterprises	3		$20,331		($169	)	4		$50,832		($168	)	7		$71,163		($337	)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	2	692		(1		)	25	239,550		(2,804		)	27	240,242		(2,805		)
Individual name issuer trust preferred debt securities	—	—		—			5	12,421		(899		)	5	12,421		(899		)
Corporate bonds	—	—		—			3	10,425		(1,377		)	3	10,425		(1,377		)
Total temporarily impaired securities	5		$21,023		($170	)	37		$313,228		($5,248	)	42		$334,251		($5,418	)



(Dollars in thousands)	Less than 12 Months						12 Months or Longer						Total
December 31, 2018	#	Fair Value		Unrealized Losses			#	Fair Value		Unrealized Losses			#	Fair Value		Unrealized Losses
Obligations of U.S. government-sponsored enterprises	—		$—		$—		16		$157,032		($4,467	)	16		$157,032		($4,467	)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	10	47,060		(439		)	51	438,701		(16,178		)	61	485,761		(16,617		)
Individual name issuer trust preferred debt securities	—	—		—			5	11,772		(1,535		)	5	11,772		(1,535		)
Corporate bonds	3	1,198		(9		)	5	10,427		(1,768		)	8	11,625		(1,777		)
Total temporarily impaired securities	13		$48,258		($448	)	77		$617,932		($23,948	)	90		$666,190		($24,396	)

Further deterioration in credit quality of the underlying issuers of the securities, 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.

Obligations of 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. 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, the Corporation does not intend to sell these securities and it is not more-likely-than-not that the Corporation will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2019.

Individual Name Issuer Trust Preferred Debt Securities

Included in debt securities in an unrealized loss position at September 30, 2019 were five trust preferred securities issued by four individual companies in the banking sector. Management believes the unrealized losses on these debt security holdings are primarily attributable to changes in the investment spreads and interest rates and not changes in the credit quality of the issuers of the debt securities. 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 interest and make payments as expected with no payment deferrals or defaults on the part of the issuers. As of September 30, 2019, individual name issuer trust preferred debt securities with an amortized cost of $6.1 million and unrealized losses of $458 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

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

financial condition of the issuers, reported regulatory capital ratios of the issuers, credit ratings, including ratings in effect as of the reporting period date as well as credit rating changes between the reporting period date and the filing date of this report, and other information. We noted no additional downgrades to below investment grade between September 30, 2019 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, the Corporation does not intend to sell these securities and it is not more-likely-than-not that the Corporation will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2019.

Corporate Bonds

At September 30, 2019, the Corporation had three corporate bond holdings with unrealized losses totaling $1.4 million. These investment grade corporate bonds were issued by large corporations, primarily in the financial services industry. Management believes the unrealized losses on these bonds are primarily attributable to changes in the investment spreads and interest rates 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, the Corporation does not intend to sell these securities and it is not more-likely-than-not that the Corporation will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider these investments to be other-than-temporarily impaired at September 30, 2019.

The following table summarizes amounts relating to sales of securities:



(Dollars in thousands)	Three Months				Nine Months
For the periods ended September 30,	2019		2018		2019			2018
Proceeds from sales		$—		$—		$9,920			$—

Gross realized gains		$—		$—		$—			$—
Gross realized losses	—		—		(80		)	—
Net realized losses on securities		$—		$—		($80	)		$—

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 5 - Loans

The following is a summary of loans:



(Dollars in thousands)	September 30, 2019		December 31, 2018
Commercial:
Commercial real estate (1)		$1,517,320		$1,392,408
Commercial & industrial (2)	566,426		620,704
Total commercial	2,083,746		2,013,112
Residential Real Estate:
Residential real estate (3)	1,378,518		1,360,387
Consumer:
Home equity	294,250		280,626
Other (4)	21,592		26,235
Total consumer	315,842		306,861
Total loans (5)		$3,778,106		$3,680,360


(1)	Consists 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)	Consists of loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.


(3)	Consists of mortgage and homeowner construction loans secured by one- to four-family residential properties.


(4)	Consists of loans to individuals secured by general aviation aircraft and other personal installment loans.


(5)	Includes net unamortized loan origination costs of $5.7 million and $4.7 million, respectively, at September 30, 2019 and December 31, 2018 and net unamortized premiums on purchased loans of $575 thousand and $703 thousand, respectively, at September 30, 2019 and December 31, 2018.

As of both September 30, 2019 and December 31, 2018, loans amounting to $2.0 billion were 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
September 30, 2019	30-59		60-89		Over 90		Total Past Due		Current		Total Loans
Commercial:
Commercial real estate		$—		$—		$684		$684		$1,516,636		$1,517,320
Commercial & industrial	1		—		—		1		566,425		566,426
Total commercial	1		—		684		685		2,083,061		2,083,746
Residential Real Estate:
Residential real estate	4,333		2,506		4,760		11,599		1,366,919		1,378,518
Consumer:
Home equity	744		417		812		1,973		292,277		294,250
Other	11		—		88		99		21,493		21,592
Total consumer	755		417		900		2,072		313,770		315,842
Total loans		$5,089		$2,923		$6,344		$14,356		$3,763,750		$3,778,106

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)



(Dollars in thousands)	Days Past Due
December 31, 2018	30-59		60-89		Over 90		Total Past Due		Current		Total Loans
Commercial:
Commercial real estate		$155		$925		$—		$1,080		$1,391,328		$1,392,408
Commercial & industrial	—		—		—		—		620,704		620,704
Total commercial	155		925		—		1,080		2,012,032		2,013,112
Residential Real Estate:
Residential real estate	6,318		2,693		1,509		10,520		1,349,867		1,360,387
Consumer:
Home equity	1,281		156		552		1,989		278,637		280,626
Other	33		—		—		33		26,202		26,235
Total consumer	1,314		156		552		2,022		304,839		306,861
Total loans		$7,787		$3,774		$2,061		$13,622		$3,666,738		$3,680,360

Included in past due loans as of September 30, 2019 and December 31, 2018, were nonaccrual loans of $9.8 million and $8.6 million, respectively.

All loans 90 days or more past due at September 30, 2019 and December 31, 2018 were classified as nonaccrual.

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans include nonaccrual loans and loans restructured in a troubled debt restructuring. The Corporation identifies loss allocations for impaired loans on an individual loan basis.

The following is a summary of impaired loans:



(Dollars in thousands)	Recorded Investment (1)				Unpaid Principal				Related Allowance
	Sep 30, 2019		Dec 31, 2018		Sep 30, 2019		Dec 31, 2018		Sep 30, 2019		Dec 31, 2018
No Related Allowance Recorded
Commercial:
Commercial real estate		$684		$925		$926		$926		$—		$—
Commercial & industrial	—		4,681		—		4,732		—		—
Total commercial	684		5,606		926		5,658		—		—
Residential Real Estate:
Residential real estate	12,531		9,347		13,368		9,695		—		—
Consumer:
Home equity	1,379		1,360		1,379		1,360		—		—
Other	88		—		88		—		—		—
Total consumer	1,467		1,360		1,467		1,360		—		—
Subtotal	14,682		16,313		15,761		16,713		—		—
With Related Allowance Recorded
Commercial:
Commercial real estate		$—		$—		$—		$—		$—		$—
Commercial & industrial	—		52		—		73		—		—
Total commercial	—		52		—		73		—		—
Residential Real Estate:
Residential real estate	360		364		386		390		96		100
Consumer:
Home equity	220		85		220		85		220		24
Other	19		22		19		22		5		3
Total consumer	239		107		239		107		225		27
Subtotal	599		523		625		570		321		127
Total impaired loans		$15,281		$16,836		$16,386		$17,283		$321		$127
Total:
Commercial		$684		$5,658		$926		$5,731		$—		$—
Residential real estate	12,891		9,711		13,754		10,085		96		100
Consumer	1,706		1,467		1,706		1,467		225		27
Total impaired loans		$15,281		$16,836		$16,386		$17,283		$321		$127

(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.

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following tables present the average recorded investment balance of impaired loans and interest income recognized on impaired loans segregated by loan class.




(Dollars in thousands)	Average Recorded Investment				Interest Income Recognized
Three months ended September 30,	2019		2018		2019		2018
Commercial:
Commercial real estate		$886		$—		$—		$—
Commercial & industrial	—		5,324		—		62
Total commercial	886		5,324		—		62
Residential Real Estate:
Residential real estate	12,017		9,265		109		96
Consumer:
Home equity	1,414		1,424		16		22
Other	108		25		3		—
Total consumer	1,522		1,449		19		22
Totals		$14,425		$16,038		$128		$180




(Dollars in thousands)	Average Recorded Investment				Interest Income Recognized
Nine months ended September 30,	2019		2018		2019		2018
Commercial:
Commercial real estate		$929		$1,352		$1		$—
Commercial & industrial	2,835		5,599		103		201
Total commercial	3,764		6,951		104		201
Residential Real Estate:
Residential real estate	10,972		9,709		331		293
Consumer:
Home equity	1,409		1,045		43		41
Other	55		85		2		5
Total consumer	1,464		1,130		45		46
Totals		$16,200		$17,790		$480		$540

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 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 for a period of time, 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.

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Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following is a summary of nonaccrual loans, segregated by class of loans:



(Dollars in thousands)	Sep 30, 2019		Dec 31, 2018
Commercial:
Commercial real estate		$684		$925
Commercial & industrial	—		—
Total commercial	684		925
Residential Real Estate:
Residential real estate	12,531		9,346
Consumer:
Home equity	1,599		1,436
Other	88		—
Total consumer	1,687		1,436
Total nonaccrual loans		$14,902		$11,707
Accruing loans 90 days or more past due		$—		$—

As of September 30, 2019 and December 31, 2018, loans secured by one- to four-family residential property amounting to $5.9 million and $761 thousand, respectively, were in process of foreclosure.

Nonaccrual loans of $5.1 million and $3.1 million, respectively, were current as to the payment of principal and interest at September 30, 2019 and December 31, 2018.

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at September 30, 2019.

Troubled Debt Restructurings

Loans are considered to be troubled debt restructurings when the Corporation has granted concessions to a borrower due to the borrower’s financial condition that it otherwise would not have considered. 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 of 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 collectability of the loan. Loans which 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.

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 $876 thousand and $5.6 million, respectively, at September 30, 2019 and December 31, 2018. The allowance for loan losses included specific reserves for these troubled debt restructurings of $101 thousand and $103 thousand, respectively, at September 30, 2019 and December 31, 2018.

For the three and nine months ended September 30, 2019, there were no loans modified as a troubled debt restructuring. For the three months ended September 30, 2018, there were no loans modified as a troubled debt restructuring. For the nine months

- 21-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

ended September 30, 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.

For the three and nine months ended September 30, 2019 there were no payment defaults on troubled debt restructured loans modified within the previous 12 months. For the three and nine months ended September 30, 2018, payment defaults on troubled debt restructured loans modified within the previous 12 months occurred on one loan with a carrying value of $608 thousand at the time of default.

As of September 30, 2019, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.

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. 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 collectability. 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. On a quarterly basis, management reviews the criticized loan portfolio, which generally consists of commercial loans that are risk-rated special mention or worse, and other selected loans. Management’s review focuses on the current status of the loans 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

- 22-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

underwriting and credit risk management practices and the appropriateness of the risk rating classifications. This review is supplemented with selected targeted internal reviews of the commercial loan portfolio.

The following table presents the commercial loan portfolio, segregated by category of credit quality indicator:



(Dollars in thousands)	Pass				Special Mention				Classified
	Sep 30, 2019		Dec 31, 2018		Sep 30, 2019		Dec 31, 2018		Sep 30, 2019		Dec 31, 2018
Commercial:
Commercial real estate		$1,498,212		$1,387,666		$18,224		$205		$884		$4,537
Commercial & industrial	529,219		559,019		25,679		50,426		11,528		11,259
Total commercial		$2,027,431		$1,946,685		$43,903		$50,631		$12,412		$15,796

Residential and Consumer

Management monitors the relatively homogeneous residential real estate and consumer loan portfolios on an ongoing basis using delinquency information by loan type. For non-impaired residential real estate and consumer loans, the Corporation assigns loss allocation factors to each respective loan type.

Other techniques are utilized to monitor indicators of credit deterioration in the residential real estate loans and consumer loan portfolios. Among these techniques is the periodic tracking of loans with an updated Fair Isaac Corporation (“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 real estate and home equity consumer credits.

The following table presents the residential and consumer loan portfolios, segregated by loan type and credit quality indicator:



(Dollars in thousands)	Current				Past Due
	Sep 30, 2019		Dec 31, 2018		Sep 30, 2019		Dec 31, 2018
Residential Real Estate:
Self-originated mortgages		$1,261,364		$1,238,402		$10,503		$9,079
Purchased mortgages	105,555		111,465		1,096		1,441
Total residential real estate		$1,366,919		$1,349,867		$11,599		$10,520
Consumer:
Home equity		$292,277		$278,637		$1,973		$1,989
Other	21,493		26,202		99		33
Total consumer		$313,770		$304,839		$2,072		$2,022

Note 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.

- 23-

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 September 30, 2019:



(Dollars in thousands)	Commercial											Consumer
	CRE (1)			C&I (2)			Total Commercial			Residential Real Estate		Home Equity		Other			Total Consumer			Total
Beginning Balance		$16,882			$4,453			$21,335			$4,857		$913		$293			$1,206			$27,398
Charge-offs	(947		)	(1		)	(948		)	—		—		(18		)	(18		)	(966		)
Recoveries	—			123			123			—		36		6			42			165
Provision	866			(1,128		)	(262		)	554		64		44			108			400
Ending Balance		$16,801			$3,447			$20,248			$5,411		$1,013		$325			$1,338			$26,997

(1) Commercial real estate loans.

(2) Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the nine months ended September 30, 2019:




(Dollars in thousands)	Commercial												Consumer
	CRE (1)			C&I (2)			Total Commercial			Residential Real Estate			Home Equity			Other			Total Consumer			Total
Beginning Balance		$15,381			$5,847			$21,228			$3,987			$1,603			$254			$1,857			$27,072
Charge-offs	(947		)	(19		)	(966		)	(486		)	(372		)	(64		)	(436		)	(1,888		)
Recoveries	—			151			151			—			71			16			87			238
Provision	2,367			(2,532		)	(165		)	1,910			(289		)	119			(170		)	1,575
Ending Balance		$16,801			$3,447			$20,248			$5,411			$1,013			$325			$1,338			$26,997

(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 September 30, 2018:



(Dollars in thousands)	Commercial											Consumer
	CRE (1)		C&I (2)			Total Commercial			Residential Real Estate			Home Equity		Other			Total Consumer			Total
Beginning Balance		$12,443		$6,642			$19,085			$5,314			$1,375		$400			$1,775			$26,174
Charge-offs	—		(1		)	(1		)	(68		)	—		(27		)	(27		)	(96		)
Recoveries	—		71			71			—			2		8			10			81
Provision	1,052		535			1,587			(1,131		)	12		(118		)	(106		)	350
Ending Balance		$13,495		$7,247			$20,742			$4,115			$1,389		$263			$1,652			$26,509

(1) Commercial real estate loans.

(2) Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the nine months ended September 30, 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		)	(8		)	(635		)	(73		)	(111		)	(70		)	(181		)	(889		)
Recoveries	25			104			129			—			12			19			31			160
Provision	1,368			1,571			2,939			(1,239		)	(924		)	(26		)	(950		)	750
Ending Balance		$13,495			$7,247			$20,742			$4,115			$1,389			$263			$1,652			$26,509

(1) Commercial real estate loans.

(2) Commercial & industrial loans.

- 24-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the Corporation’s loan portfolio and associated allowance for loan losses by portfolio segment and by impairment methodology:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Loans		Related Allowance		Loans		Related Allowance
Loans Individually Evaluated for Impairment
Commercial:
Commercial real estate		$684		$—		$925		$—
Commercial & industrial	—		—		4,714		—
Total commercial	684		—		5,639		—
Residential Real Estate:
Residential real estate	12,890		96		9,710		100
Consumer:
Home equity	1,599		220		1,445		24
Other	107		5		22		3
Total consumer	1,706		225		1,467		27
Subtotal	15,280		321		16,816		127
Loans Collectively Evaluated for Impairment
Commercial:
Commercial real estate	1,516,636		16,801		1,391,483		15,381
Commercial & industrial	566,426		3,447		615,990		5,847
Total commercial	2,083,062		20,248		2,007,473		21,228
Residential Real Estate:
Residential real estate	1,365,628		5,315		1,350,677		3,887
Consumer:
Home equity	292,651		793		279,182		1,579
Other	21,485		320		26,212		251
Total consumer	314,136		1,113		305,394		1,830
Subtotal	3,762,826		26,676		3,663,544		26,945
Total		$3,778,106		$26,997		$3,680,360		$27,072

- 25-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 7 - Federal Home Loan Bank Advances

Advances payable to the FHLB amounted to $956.8 million and $950.7 million, respectively, at September 30, 2019 and December 31, 2018.

As of September 30, 2019 and December 31, 2018, the Bank had access to a $40.0 million unused line of credit with the FHLB and also had remaining available borrowing capacity of $601.5 million and $628.5 million, respectively. The Bank pledges certain qualified investment securities and loans as collateral to the FHLB.

The following table presents maturities and weighted average interest rates on FHLB advances outstanding as of September 30, 2019:



(Dollars in thousands)	Scheduled Maturity		Weighted Average Rate
October 1, 2019 to December 31, 2019		$355,822	2.56	%
2020	444,533		2.34
2021	86,222		2.73
2022	55,447		3.65
2023	9,428		4.01
2024 and thereafter	5,334		5.06
Balance at September 30, 2019		$956,786	2.56	%

In October 2019, FHLB advances totaling $78.8 million were modified to lower interest rates and the maturities of these advances were extended. Original maturity dates ranging from 2021 to 2023 were modified to 2024 to 2026. The original weighted average interest rate was 3.52% and was revised to 2.76%. The table below presents the original terms as of September 30, 2019, as well as the revised terms associated with these FHLB advances:



(Dollars in thousands)	Original Terms				Revised Terms
	Scheduled Maturity		Weighted Average Rate		Scheduled Maturity		Weighted Average Rate
2021		$20,000	3.07	%		$—	—	%
2022	54,634		3.63		—		—
2023	4,190		4.27		—		—
2024	—		—		40,000		2.45
2025	—		—		—		—
2026	—		—		38,824		3.09
Total		$78,824	3.52	%		$78,824	2.76	%

- 26-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 8 - Shareholders' Equity

Regulatory Capital Requirements

Capital levels at September 30, 2019 exceeded the regulatory minimum levels to be considered “well capitalized.”

The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios, as well as the corresponding minimum and well capitalized regulatory amounts and ratios that were in effect during the respective periods:



(Dollars in thousands)	Actual				For Capital Adequacy Purposes				To Be “Well Capitalized” Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2019
Total Capital (to Risk-Weighted Assets):
Corporation		$486,454	12.94	%		$300,835	8.00	%	N/A		N/A
Bank	483,783		12.87		300,790		8.00			$375,988	10.00	%
Tier 1 Capital (to Risk-Weighted Assets):
Corporation	459,140		12.21		225,627		6.00		N/A		N/A
Bank	456,469		12.14		225,593		6.00		300,790		8.00
Common Equity Tier 1 Capital (to Risk-Weighted Assets):
Corporation	437,142		11.62		169,220		4.50		N/A		N/A
Bank	456,469		12.14		169,195		4.50		244,392		6.50
Tier 1 Capital (to Average Assets): (1)
Corporation	459,140		8.97		204,810		4.00		N/A		N/A
Bank	456,469		8.92		204,722		4.00		255,903		5.00

December 31, 2018
Total Capital (to Risk-Weighted Assets):
Corporation	455,699		12.56		290,146		8.00		N/A		N/A
Bank	453,033		12.49		290,128		8.00		362,660		10.00
Tier 1 Capital (to Risk-Weighted Assets):
Corporation	428,338		11.81		217,609		6.00		N/A		N/A
Bank	425,672		11.74		217,596		6.00		290,128		8.00
Common Equity Tier 1 Capital (to Risk-Weighted Assets):
Corporation	406,340		11.20		163,207		4.50		N/A		N/A
Bank	425,672		11.74		163,197		4.50		235,729		6.50
Tier 1 Capital (to Average Assets): (1)
Corporation	428,338		8.89		192,690		4.00		N/A		N/A
Bank	425,672		8.84		192,652		4.00		240,815		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 1.875% on January 1, 2018. The capital conservation buffer increased another 0.625% on January 1, 2019, reaching the full requirement of 2.50%.

The Bancorp owns the common stock of two capital trusts, which have issued trust preferred securities. In accordance with GAAP, the capital trusts are treated as unconsolidated subsidiaries. At both September 30, 2019 and December 31, 2018, $22.0 million in trust preferred securities were included in the Tier 1 Capital of the Corporation for regulatory capital reporting purposes pursuant to the FRB’s capital adequacy guidelines.

- 27-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 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 September 30, 2019 and December 31, 2018, the Bancorp had two interest rate caps with a total notional amount of $22.7 million that were designated as cash flow hedges to hedge the interest rate risk associated with our variable rate junior subordinated debentures. For both interest rate caps, the Bancorp obtained the right to receive the difference between 3-month LIBOR and a 4.5% strike. The caps mature in 2020.

As of September 30, 2019 and December 31, 2018, 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 September 30, 2019 and December 31, 2018, 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 changes in fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized.

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 September 30, 2019 and December 31, 2018, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $729.9 million and $648.0 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.

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

- 28-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

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 September 30, 2019, the notional amounts of risk participation-out agreements and risk participation-in agreements were $44.5 million and $73.0 million, respectively, compared to $57.3 million and $46.5 million, respectively, as of December 31, 2018.

Foreign Exchange Contracts

Foreign exchange contracts represent contractual commitments 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 September 30, 2019 and December 31, 2018, the notional amount of foreign exchange contracts was $2.6 million and $2.8 million, respectively.

Loan Commitments

Interest rate lock commitments are extended to borrowers and relate to the origination of mortgage loans held for sale. To mitigate the interest rate risk and pricing risk associated with rate locks and 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 therefore, the changes in fair value of these commitments are reflected in earnings.

As of September 30, 2019, the notional amounts of interest rate lock commitments and forward sale commitments were $84.8 million and $156.6 million, respectively, compared to $30.8 million and $62.0 million, respectively, as of December 31, 2018.

- 29-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the fair values of derivative instruments in the Corporation’s Unaudited Consolidated Balance Sheets:



(Dollars in thousands)	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
	Balance Sheet Location	Sep 30, 2019		Dec 31, 2018		Balance Sheet Location	Sep 30, 2019		Dec 31, 2018
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps	Other assets		$—		$20	Other liabilities		$—		$—
Interest rate swaps	Other assets	2		903		Other liabilities	1,000		—
Interest rate floors	Other assets	69		37		Other liabilities	—		—
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Other assets	37,765		5,340		Other liabilities	80		7,719
Mirror swaps with counterparties	Other assets	80		7,592		Other liabilities	37,913		5,392
Risk participation agreements	Other assets	1		—		Other liabilities	3		—
Foreign exchange contracts	Other assets	6		—		Other liabilities	—		7
Forward loan commitments:
Interest rate lock commitments	Other assets	1,762		806		Other liabilities	1		—
Forward sale commitments	Other assets	393		—		Other liabilities	977		816
Gross amounts		40,078		14,698			39,974		13,934
Less amounts offset in Consolidated Balance Sheets (1)		157		10,732			157		10,732
Net amounts presented in Consolidated Balance Sheets		39,921		3,966			39,817		3,202
Less collateral pledged (2)		—		—			37,695		1,460
Net amounts			$39,921		$3,966			$2,122		$1,742


(1)	Interest rate risk management contracts and loan related derivative contracts with counterparties are subject to master netting arrangements.


(2)	Collateral pledged to derivative counterparties is in the form of cash. Washington Trust may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

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
	Three Months						Nine Months
Periods ended September 30,	2019			2018			2019			2018
Derivatives Designated as Cash Flow Hedging Instruments:
Interest rate risk management contracts:
Interest rate caps		$18			$17			$32			$66
Interest rate swaps	(211		)	189			(1,442		)	1,322
Interest rate floors	22			(51		)	175			21
Total		($171	)		$155			($1,235	)		$1,409

For derivatives designated as cash flow hedging instruments, see Note 15 for additional disclosure pertaining to the amounts and location of reclassifications from accumulated other comprehensive income into earnings.

- 30-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)



(Dollars in thousands)		Amount of Gain (Loss) Recognized in Income on Derivatives
		Three Months						Nine Months
Periods ended September 30,	Statement of Income Location	2019			2018			2019			2018
Derivatives not Designated as Hedging Instruments:
Loan related derivative contracts:
Interest rate swaps with customers	Loan related derivative income		$12,284			($3,178	)	39,568			(15,374		)
Mirror swaps with counterparties	Loan related derivative income	(11,108		)	3,415			(36,958		)	16,384
Risk participation agreements	Loan related derivative income	213			25			213			25
Foreign exchange contracts	Loan related derivative income	18			16			54			52
Forward loan commitments:
Interest rate lock commitments	Mortgage banking revenues	(340		)	(504		)		$955			($327	)
Forward sale commitments	Mortgage banking revenues	(101		)	316			(1,969		)	1,552
Total			$966			$90			$1,863			$2,312

Note 10 - Fair Value Measurements

The Corporation uses fair value measurements to record fair value adjustments on certain assets and liabilities and to determine fair value disclosures. Items recorded at fair value on a recurring basis include securities available for sale, mortgage loans held for sale and derivatives. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

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


•	Level 1 – Quoted prices for identical assets or liabilities in active markets.


•	Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.


•	Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable in the markets and which reflect the Corporation’s market assumptions.

Fair Value Option Election

GAAP allows for the irrevocable option to elect fair value accounting for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation has elected the fair value option for 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 following table presents a summary of mortgage loans held for sale accounted for under the fair value option:

Changes in fair value of mortgage loans held for sale accounted for under the fair value option election amounted to a decrease of $82 thousand and an increase of $462 thousand in the three and nine months ended September 30, 2019, respectively, compared

- 31-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

to decreases of $352 thousand and $240 thousand in the three and nine months ended September 30, 2018, respectively. These amounts were partially 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.

There were no mortgage loans held for sale 90 days or more past due as of September 30, 2019 and December 31, 2018.

Valuation Techniques

Debt Securities

Available for sale debt securities are recorded at fair value on a recurring basis. When available, the Corporation uses quoted market prices to determine the fair value of debt securities; such items are classified as Level 1. There were no Level 1 debt securities held at September 30, 2019 and December 31, 2018.

Level 2 debt securities 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.

Debt 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 debt securities held at September 30, 2019 and December 31, 2018.

Mortgage Loans Held for Sale

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

Collateral Dependent Impaired Loans

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

Property Acquired Through Foreclosure or Repossession

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

Derivatives

Interest rate 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, factors such as the likelihood of default by the Corporation and its counterparties, its net exposures and remaining contractual life are considered 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, if any. 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.

- 32-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

However, as of September 30, 2019 and December 31, 2018, 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 Associates, Inc. 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 was based upon unobservable inputs; therefore, the contingent liability was classified within Level 3 of the fair value hierarchy. The unobservable inputs included probability estimates regarding the likelihood of achieving revenue growth targets and the discount rates utilized the discounted cash flow calculations applied to the estimated earn-outs to be paid. The contingent consideration liability was 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 were included in noninterest expenses in the 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 likelihood of payout on the remaining earn-out period had been deemed remote and as a result the fair value of the contingent consideration liability was reduced to zero in the fourth quarter of 2018. There have been no changes to the fair value of the contingent consideration liability for the three and nine months ended September 30, 2019.

- 33-

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)
September 30, 2019	Total				Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale debt securities:
Obligations of U.S. government-sponsored enterprises		$197,324		$—		$197,324		$—
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	664,905		—		664,905		—
Individual name issuer trust preferred debt securities	12,421		—		12,421		—
Corporate bonds	12,370		—		12,370		—
Mortgage loans held for sale	44,657		—		44,657		—
Derivative assets	39,921		—		39,921		—
Total assets at fair value on a recurring basis		$971,598		$—		$971,598		$—
Liabilities:
Derivative liabilities		$39,817		$—		$39,817		$—
Total liabilities at fair value on a recurring basis		$39,817		$—		$39,817		$—



(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, 2018	Total				Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale debt securities:
Obligations of U.S. government-sponsored enterprises		$242,683		$—		$242,683		$—
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	660,793		—		660,793		—
Obligations of states and political subdivisions	937		—		937		—
Individual name issuer trust preferred debt securities	11,772		—		11,772		—
Corporate bonds	11,625		—		11,625		—
Mortgage loans held for sale	20,996		—		20,996		—
Derivative assets	3,966		—		3,966		—
Total assets at fair value on a recurring basis		$952,772		$—		$952,772		$—
Liabilities:
Derivative liabilities		$3,202		$—		$3,202		$—
Total liabilities at fair value on a recurring basis		$3,202		$—		$3,202		$—

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 nine months ended September 30, 2019 and 2018.

- 34-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Items Recorded at Fair Value on a Nonrecurring Basis

The following table presents the carrying value of assets held at September 30, 2019, which were written down to fair value during the nine months ended September 30, 2019:



(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)
(Dollars in thousands)	Total				Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Collateral dependent impaired loans		$1,451		$—		$—		$1,451
Property acquired through foreclosure or repossession	2,000		—		—		2,000
Total assets at fair value on a nonrecurring basis		$3,451		$—		$—		$3,451

The allowance for loan losses on collateral dependent impaired loans amounted to $221 thousand at September 30, 2019.

The following table presents the carrying value of assets held at December 31, 2018, which were written down to fair value during the year ended December 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)
(Dollars in thousands)	Total				Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Collateral dependent impaired loans		$883		$—		$—		$883
Property acquired through foreclosure or repossession	2,142		—		—		2,142
Total assets at fair value on a nonrecurring basis		$3,025		$—		$—		$3,025

The allowance for loan losses on collateral dependent impaired loans amounted to $24 thousand at December 31, 2018.

The following tables present valuation techniques and unobservable inputs for assets measured at fair value on a nonrecurring basis for which the Corporation has utilized Level 3 inputs to determine fair value:



(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
September 30, 2019	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans		$1,451	Appraisals of collateral	Discount for costs to sell	0% - 18% (13%)
				Appraisal adjustments (1)	0% - 100% (19%)
Property acquired through foreclosure or repossession		$2,000	Appraisals of collateral	Discount for costs to sell	20%
				Appraisal adjustments (1)	13%


(1)	Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

- 35-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)



(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
December 31, 2018	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans		$883	Appraisals of collateral	Discount for costs to sell	0% - 10% (10%)
				Appraisal adjustments (1)	0% - 100% (2%)
Property acquired through foreclosure or repossession		$2,142	Appraisals of collateral	Discount for costs to sell	13%
				Appraisal adjustments (1)	12% - 28% (20%)


(1)	Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

Valuation of Financial Instruments

The estimated fair values and related carrying amounts for financial instruments for which fair value is only disclosed are presented below as of the periods indicated. 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)
September 30, 2019	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:
Loans, net of allowance for loan losses		$3,751,109		$3,749,391		$—		$—		$3,749,391

Financial Liabilities:
Time deposits		$1,223,662		$1,239,646		$—		$1,239,646		$—
FHLB advances	956,786		962,160		—		962,160		—
Junior subordinated debentures	22,681		19,265		—		19,265		—



(Dollars in thousands)
December 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:
Held to maturity debt securities		$10,415		$10,316		$—		$10,316		$—
Loans, net of allowance for loan losses	3,653,288		3,598,025		—		—		3,598,025

Financial Liabilities:
Time deposits		$1,255,108		$1,269,433		$—		$1,269,433		$—
FHLB advances	950,722		950,691		—		950,691		—
Junior subordinated debentures	22,681		19,226		—		19,226		—

- 36-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 11 - Revenue from Contracts with Customers

The following tables summarize 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.



For the three months ended September 30,	2019				2018
(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		$32,978		$—		$33,449		$—
Noninterest income:
Asset-based wealth management revenues	9,013		9,013		9,322		9,322
Transaction-based wealth management revenues	140		140		132		132
Total wealth management revenues	9,153		9,153		9,454		9,454
Mortgage banking revenues	4,840		—		2,624		—
Card interchange fees	1,099		1,099		983		983
Service charges on deposit accounts	939		939		885		885
Loan related derivative income	1,407		—		278		—
Income from bank-owned life insurance	569		—		572		—
Net realized losses on securities	—		—		—		—
Other income	335		323		419		419
Total noninterest income	18,342		11,514		15,215		11,741
Total revenues		$51,320		$11,514		$48,664		$11,741



For the nine months ended September 30,	2019					2018
(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		$101,420			$—		$98,412		$—
Noninterest income:
Asset-based wealth management revenues	27,075			27,075		28,413		28,413
Transaction-based wealth management revenues	879			879		916		916
Total wealth management revenues	27,954			27,954		29,329		29,329
Mortgage banking revenues	11,126			—		8,403		—
Card interchange fees	3,114			3,114		2,791		2,791
Service charges on deposit accounts	2,743			2,743		2,651		2,651
Loan related derivative income	2,877			—		1,087		—
Income from bank-owned life insurance	1,784			—		1,624		—
Net realized losses on securities	(80		)	—		—		—
Other income	944			917		1,066		1,051
Total noninterest income	50,462			34,728		46,951		35,822
Total revenues		$151,882			$34,728		$145,363		$35,822

- 37-

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				Nine Months
Periods ended September 30,	2019		2018		2019		2018
Revenue recognized at a point in time:
Card interchange fees		$1,099		$983		$3,114		$2,791
Service charges on deposit accounts	728		670		2,109		2,045
Other income	268		258		771		732
Revenue recognized over time:
Wealth management revenues	9,153		9,454		27,954		29,329
Service charges on deposit accounts	211		215		634		606
Other income	55		161		146		319
Total revenues from contracts in scope of Topic 606		$11,514		$11,741		$34,728		$35,822

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 $4.8 million at both September 30, 2019 and December 31, 2018 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 September 30, 2019 and December 31, 2018 and were included in other liabilities in the Unaudited Consolidated Balance Sheets.

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 carrying value of contract cost assets amounted to $683 thousand at September 30, 2019, compared to $458 thousand at December 31, 2018 and were included in other assets in the Unaudited Consolidated Balance Sheets.

- 38-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 12 - Defined Benefit Pension Plans

Washington Trust maintains a qualified pension plan for the benefit of certain eligible employees who were hired prior to October 1, 2007. Washington Trust 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 qualified pension plan is funded on a current basis, in compliance with the requirements of ERISA.

The following table presents components of net periodic benefit cost and other amounts recognized in other comprehensive income (loss), on a pre-tax basis:



(Dollars in thousands)	Qualified Pension Plan												Non-Qualified Retirement Plans
	Three Months						Nine Months						Three Months				Nine Months
Periods ended September 30,	2019			2018			2019			2018			2019		2018		2019		2018
Net Periodic Benefit Cost:
Service cost (1)		$510			$561			$1,528			$1,683			$31		$27		$94		$81
Interest cost (2)	741			679			2,225			2,036			140		119		422		356
Expected return on plan assets (2)	(1,124		)	(1,318		)	(3,371		)	(3,954		)	—		—		—		—
Amortization of prior service credit (2)	(4		)	(6		)	(12		)	(17		)	—		—		—		—
Recognized net actuarial loss (2)	198			374			594			1,122			104		103		307		308
Net periodic benefit cost		$321			$290			$964			$870			$275		$249		$823		$745


(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 nine months ended September 30,	2019	2018	2019	2018
Measurement date	Dec 31, 2018	Dec 31, 2017	Dec 31, 2018	Dec 31, 2017
Equivalent single discount rate for benefit obligations	4.38%	3.69%	4.28%	3.58%
Equivalent single discount rate for service cost	4.44	3.76	4.48	3.79
Equivalent single discount rate for interest cost	4.12	3.42	3.98	3.22
Expected long-term return on plan assets	5.75	6.75	N/A	N/A
Rate of compensation increase	3.75	3.75	3.75	3.75

- 39-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 13 - Share-Based Compensation Arrangements

During the nine months ended September 30, 2019, the Corporation granted performance share unit awards and nonvested share unit awards.

Performance share awards were granted to certain executive and non-executive officers to 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 determined by the closing price of the Corporation’s common stock on the award date. The weighted average fair value of the performance share awards was $52.83. The number of shares to be vested will be contingent upon the Corporation’s attainment of certain performance measures as detailed in the performance share award agreements. The performance share awards will earned over a 3-year performance period and the current performance assumption results in 43,360 shares being earned.

The Corporation granted to non-executive officers and directors 10,870 nonvested share units, with 3-year cliff vesting. The weighted average grant date fair value of the nonvested share units was $51.43.

Note 14 - 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 bank-owned life insurance (“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.

- 40-

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 September 30,	2019		2018		2019			2018			2019		2018		2019		2018
Net interest income (expense)		$28,515		$27,036		($114	)		($90	)		$4,577		$6,503		$32,978		$33,449
Provision for loan losses	400		350		—			—			—		—		400		350
Net interest income (expense) after provision for loan losses	28,115		26,686		(114		)	(90		)	4,577		6,503		32,578		33,099
Noninterest income	8,607		5,174		9,153			9,454			582		587		18,342		15,215
Noninterest expenses:
Depreciation and amortization expense	642		654		360			371			40		44		1,042		1,069
Other noninterest expenses	16,255		15,599		6,217			6,194			3,356		3,200		25,828		24,993
Total noninterest expenses	16,897		16,253		6,577			6,565			3,396		3,244		26,870		26,062
Income before income taxes	19,825		15,607		2,462			2,799			1,763		3,846		24,050		22,252
Income tax expense	4,347		3,344		646			710			243		687		5,236		4,741
Net income		$15,478		$12,263		$1,816			$2,089			$1,520		$3,159		$18,814		$17,511

Total assets at period end		$3,994,458		$3,694,991		$78,812			$69,494			$1,125,608		$1,006,187		$5,198,878		$4,770,672
Expenditures for long-lived assets	662		612		87			14			48		19		797		645




(Dollars in thousands)	Commercial Banking				Wealth Management Services						Corporate				Consolidated Total
Nine months ended September 30,	2019		2018		2019			2018			2019		2018		2019		2018
Net interest income (expense)		$83,684		$79,656		($361	)		($225	)		$18,097		$18,981		$101,420		$98,412
Provision for loan losses	1,575		750		—			—			—		—		1,575		750
Net interest income (expense) after provision for loan losses	82,109		78,906		(361		)	(225		)	18,097		18,981		99,845		97,662
Noninterest income	20,753		15,947		27,961			29,329			1,748		1,675		50,462		46,951
Noninterest expenses:
Depreciation and amortization expense	1,985		1,928		1,089			1,137			118		129		3,192		3,194
Other noninterest expenses	48,676		46,574		19,631			19,986			10,486		9,726		78,793		76,286
Total noninterest expenses	50,661		48,502		20,720			21,123			10,604		9,855		81,985		79,480
Income before income taxes	52,201		46,351		6,880			7,981			9,241		10,801		68,322		65,133
Income tax expense	11,371		9,834		1,845			2,008			1,524		1,895		14,740		13,737
Net income		$40,830		$36,517		$5,035			$5,973			$7,717		$8,906		$53,582		$51,396

Total assets at period end		$3,994,458		$3,694,991		$78,812			$69,494			$1,125,608		$1,006,187		$5,198,878		$4,770,672
Expenditures for long-lived assets	2,259		1,864		379			327			130		129		2,768		2,320

- 41-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 15 - Other Comprehensive Income (Loss)

The following tables present the activity in other comprehensive income (loss):




Three months ended September 30,	2019									2018
(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 available for sale debt securities		$3,772			$886			$2,886			($5,924	)		($1,393	)		($4,531	)
Net losses on debt securities reclassified into earnings (1)	—			—			—			—			—			—
Net change in fair value of available for sale debt securities	3,772			886			2,886			(5,924		)	(1,393		)	(4,531		)
Cash flow hedges:
Change in fair value of cash flow hedges	(283		)	(66		)	(217		)	(626		)	(148		)	(478		)
Net cash flow hedge losses reclassified into earnings (2)	60			14			46			830			197			633
Net change in fair value of cash flow hedges	(223		)	(52		)	(171		)	204			49			155
Defined benefit plan obligations:
Amortization of net actuarial losses (3)	300			70			230			477			112			365
Amortization of net prior service credits (3)	(4		)	(1		)	(3		)	(6		)	(2		)	(4		)
Net change in defined benefit plan obligations	296			69			227			471			110			361
Total other comprehensive income (loss)		$3,845			$903			$2,942			($5,249	)		($1,234	)		($4,015	)


(1)	The pre-tax amount is reported as net realized losses on securities in the Unaudited Consolidated Statements of Income.


(2)	The pre-tax amounts are included in interest expense on FHLB advances, interest expense on junior subordinated debentures and interest and fees on loans in the Unaudited Consolidated Statements of Income.


(3)	The pre-tax amounts are included in other expenses in the Unaudited Consolidated Statements of Income.




Nine months ended September 30,	2019									2018
(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 available for sale debt securities		$25,985			$6,106			$19,879			($23,605	)		($5,548	)		($18,057	)
Net losses on debt securities reclassified into earnings (1)	80			19			61			—			—			—
Net change in fair value of available for sale debt securities	26,065			6,125			19,940			(23,605		)	(5,548		)	(18,057		)
Cash flow hedges:
Change in fair value of cash flow hedges	(1,653		)	(388		)	(1,265		)	632			50			582
Net cash flow hedge losses reclassified into earnings (2)	39			9			30			1,082			255			827
Net change in fair value of cash flow hedges	(1,614		)	(379		)	(1,235		)	1,714			305			1,409
Defined benefit plan obligations:
Amortization of net actuarial losses (3)	900			211			689			1,430			337			1,093
Amortization of net prior service credits (3)	(12		)	(3		)	(9		)	(17		)	(5		)	(12		)
Net change in defined benefit plan obligations	888			208			680			1,413			332			1,081
Total other comprehensive (loss) income		$25,339			$5,954			$19,385			($20,478	)		($4,911	)		($15,567	)


(1)	The pre-tax amount is reported as net realized losses on securities in the Unaudited Consolidated Statements of Income.


(2)	The pre-tax amounts are included in interest expense on FHLB advances, interest expense on junior subordinated debentures and interest and fees on loans in the Unaudited Consolidated Statements of Income.


(3)	The pre-tax amounts are included in other expenses in the Unaudited Consolidated Statements of Income.

- 42-

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) Gains on Available For Sale Debt Securities		Net Unrealized (Losses) Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
For the three months ended September 30, 2019			Net Unrealized (Losses) Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
Balance at July 1, 2019		$292		($873	)		($11,285	)		($11,866	)
Other comprehensive income (loss) before reclassifications	2,886		(217		)	—			2,669
Amounts reclassified from accumulated other comprehensive income	—		46			227			273
Net other comprehensive income (loss)	2,886		(171		)	227			2,942
Balance at September 30, 2019		$3,178		($1,044	)		($11,058	)		($8,924	)



(Dollars in thousands)	Net Unrealized (Losses) Gains on Available For Sale Debt Securities			Net Unrealized Gains (Losses) on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
For the nine months ended September 30, 2019				Net Unrealized Gains (Losses) on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
Balance at January 1, 2019		($16,762	)		$191			($11,738	)		($28,309	)
Other comprehensive income (loss) before reclassifications	19,879			(1,265		)	—			18,614
Amounts reclassified from accumulated other comprehensive income	61			30			680			771
Net other comprehensive income (loss)	19,940			(1,235		)	680			19,385
Balance at September 30, 2019		$3,178			($1,044	)		($11,058	)		($8,924	)



(Dollars in thousands)	Net Unrealized Losses on Available For Sale Debt Securities			Net Unrealized Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
For the three months ended September 30, 2018	Net Unrealized Losses on Available For Sale Debt Securities			Net Unrealized Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
Balance at July 1, 2018		($21,060	)		$826			($14,828	)		($35,062	)
Other comprehensive loss before reclassifications	(4,531		)	(478		)	—			(5,009		)
Amounts reclassified from accumulated other comprehensive income	—			633			361			994
Net other comprehensive (loss) income	(4,531		)	155			361			(4,015		)
Balance at September 30, 2018		($25,591	)		$981			($14,467	)		($39,077	)



(Dollars in thousands)	Net Unrealized Losses on Available For Sale Debt Securities			Net Unrealized (Losses) Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
For the nine months ended September 30, 2018	Net Unrealized Losses on Available For Sale Debt Securities			Net Unrealized (Losses) Gains on Cash Flow Hedges			Defined Benefit Pension Plan Adjustment			Total
Balance at January 1, 2018		($7,534	)		($428	)		($15,548	)		($23,510	)
Other comprehensive (loss) income before reclassifications	(18,057		)	582			—			(17,475		)
Amounts reclassified from accumulated other comprehensive income	—			827			1,081			1,908
Net other comprehensive (loss) income	(18,057		)	1,409			1,081			(15,567		)
Balance at September 30, 2018		($25,591	)		$981			($14,467	)		($39,077	)

- 43-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 16 - Earnings per Common Share

The following table presents the calculation of earnings per common share:



(Dollars and shares in thousands, except per share amounts)
	Three Months						Nine Months
Periods ended September 30,	2019			2018			2019			2018
Earnings per common share - basic:
Net income		$18,814			$17,511			$53,582			$51,396
Less dividends and undistributed earnings allocated to participating securities	(36		)	(36		)	(105		)	(112		)
Net income available to common shareholders		$18,778			$17,475			$53,477			$51,284
Weighted average common shares	17,338			17,283			17,324			17,263
Earnings per common share - basic		$1.08			$1.01			$3.09			$2.97
Earnings per common share - diluted:
Net income		$18,814			$17,511			$53,582			$51,396
Less dividends and undistributed earnings allocated to participating securities	(36		)	(36		)	(105		)	(112		)
Net income available to common shareholders		$18,778			$17,475			$53,477			$51,284
Weighted average common shares	17,338			17,283			17,324			17,263
Dilutive effect of common stock equivalents	76			99			82			129
Weighted average diluted common shares	17,414			17,382			17,406			17,392
Earnings per common share - diluted		$1.08			$1.01			$3.07			$2.95

Weighted average common stock equivalents, not included in common stock equivalents above because they were anti-dilutive, totaled 93,075 and 87,775, respectively for the three and nine months ended September 30, 2019, compared to 41,525 and 46,692, respectively, for the same periods in 2018.

- 44-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

Note 17 - Leases

The Corporation has committed to rent premises used in business operations under non-cancelable operating leases and determines if an arrangement meets the definition of a lease upon inception.

The Corporation adopted the provisions of ASU 2016-02 (Topic 842) on January 1, 2019. Operating lease right-of-use (“ROU”) assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease. Upon adoption, operating lease ROU assets totaling $28.9 million and operating lease liabilities totaling $30.9 million were recognized in our Unaudited Consolidated Balance Sheets for leases that existed at the adoption date, based on the present value of lease payments over the remaining lease term. Operating leases entered into after the adoption date will be recognized as an operating lease ROU asset and operating lease liability at the commencement date of the new lease.

The Corporation’s leases do not provide an implicit interest rate, therefore the Corporation used its incremental collateralized borrowing rates commensurate with the underlying lease terms to determine the present value of operating lease liabilities. The weighted average discount rate used to discount operating lease liabilities at September 30, 2019 was 3.66%.

The Corporation’s operating lease agreements contain both lease and non-lease components, which are generally accounted for separately. The Corporation’s lease agreements do not contain any residual value guarantees.

Operating leases with terms of 12 months or less are included in ROU assets and operating lease liabilities recorded in the Corporation’s Unaudited Consolidated Balance Sheets. Operating lease terms include options to extend when it is reasonably certain that the Corporation will exercise such options, determined on a lease-by-lease basis. As of September 30, 2019, the Corporation has one lease that has not yet commenced. At September 30, 2019, lease expiration dates ranged from 2 months to 21 years, with additional renewal options on certain leases ranging from 1 to 5 years. At September 30, 2019, the weighted average remaining lease term for the Corporation’s operating leases was 14.1 years.

Rental expense for operating leases is recognized on a straight-line basis over the lease term and amounted to $944 thousand and $2.8 million, respectively, for the three and nine months ended September 30, 2019, compared to $942 thousand and $2.8 million, respectively, for the same periods in 2018. Variable lease components, such as consumer price index adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities.

The following table presents the undiscounted annual lease payments under the terms of the Corporation’s operating leases at September 30, 2019, including a reconciliation to the present value of operating lease liabilities recognized in the Corporation’s Unaudited Consolidated Balance Sheets:




(Dollars in thousands)
October 1, 2019 to December 31, 2019		$930
2020	3,515
2021	3,312
2022	3,165
2023	3,090
2024 and thereafter	24,716
Total operating lease payments (1)	38,728
Less interest	9,187
Present value of operating lease liabilities (2)		$29,541

(1) Includes $4.2 million related to options to extend lease terms that are reasonably certain of being exercised.

(2) Includes short-term operating lease liabilities of $2.3 million.

- 45-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)

The following table presents the components of total lease expense and operating cash flows:



(Dollars in thousands)
Periods ended September 30, 2019	Three Months		Nine Months
Lease Expense:
Operating lease expense		$931		$2,787
Variable lease expense	13		36
Total lease expense (1)		$944		$2,823
Cash Paid:
Cash paid reducing operating lease liabilities		$926		$2,677

(1) Included in net occupancy expenses in the Unaudited Consolidated Income Statement.

The following table presents the minimum annual lease payments under the terms of these leases, exclusive of renewal provisions at December 31, 2018:




(Dollars in thousands)
Years ending December 31:	2019		$3,544
	2020	2,980
	2021	2,677
	2022	2,293
	2023	2,059
	2024 and thereafter	22,648
Total minimum lease payments			$36,201

At December 31, 2018, lease expiration dates ranged from 5 months to 22 years, with additional renewal options on certain leases ranging from 1 to 5 years.

Note 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:

- 46-

Condensed Notes to Unaudited Consolidated Financial Statements – (continued)



(Dollars in thousands)	Sep 30, 2019		Dec 31, 2018
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit:
Commercial loans		$481,350		$533,884
Home equity lines	290,442		270,462
Other loans	74,931		46,698
Standby letters of credit	9,343		7,706
Financial instruments whose notional amounts exceed the amount of credit risk:
Forward loan commitments:
Interest rate lock commitments	84,820		30,766
Forward sale commitments	156,594		61,993
Loan related derivative contracts:
Interest rate swaps with customers	729,913		648,050
Mirror swaps with counterparties	729,913		648,050
Risk participation-in agreements	73,040		46,510
Foreign exchange contracts	2,648		2,784
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 $9.3 million and $7.7 million, respectively, as of September 30, 2019 and December 31, 2018. At September 30, 2019 and December 31, 2018, there were no liabilities to beneficiaries resulting from standby letters of credit. Fee income on standby letters of credit was insignificant for the three and nine months ended September 30, 2019 and 2018.

Forward Loan Commitments

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Management's Discussion and Analysis

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, 2018, and in conjunction with the condensed Unaudited Consolidated Financial Statements and notes thereto included in Item 1 of this report. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the full-year ended December 31, 2019 or any future period. Certain previously reported amounts have been reclassified to conform to 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 collectability, 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; operational risks, including, but not limited to cybersecurity breaches, fraud and 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, 2018, 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, 2018.

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

The Corporation 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, which is 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 benefit costs, outsourced services provided by third-party vendors, occupancy and facility-related costs and other administrative expenses.

- 48-

Management's Discussion and Analysis

We continue to leverage our strong statewide brand to build market share and remain steadfast in our commitment to provide superior service.

Risk Management

The Corporation has a comprehensive enterprise risk management (“ERM”) program through which the Corporation identifies, measures, monitors and controls current and emerging material risks.

The Board of Directors is responsible for oversight of the ERM program. The ERM program enables the aggregation of risk across the Corporation and ensures the Corporation has the tools, programs and processes in place to support informed decision making, to anticipate risks before they materialize and to ensure the Corporation’s risk profile is consistent with its risk strategy.

The Board of Directors has approved an ERM Policy that addresses each category of risk. The risk categories include: credit risk, interest rate risk, liquidity risk, price and market risk, compliance risk, strategic and reputation risk, and operational risk. A description of each risk category is provided below.

Credit risk represents the possibility that borrowers or other counterparties may not repay loans or other contractual obligations according to their terms due to changes in the financial capacity, ability and willingness of such borrowers or counterparties to meet their obligations. In some cases, the collateral securing payment of the loans may be sufficient to assure repayment, but in other cases the Corporation may experience significant credit losses which could have an adverse effect on its operating results. The Corporation makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and counterparties and the value of the real estate and other assets serving as collateral for the repayment of loans. Credit risk also exists with respect to investment securities. For further discussion regarding the credit risk and the credit quality of the Corporation’s loan portfolio, see Note 5 and Note 6 to the Unaudited Consolidated Financial Statements. For further discussion regarding the Corporation’s securities portfolio, see Note 4 to the Unaudited Consolidated Financial Statements.

Interest rate risk is the risk of loss to future earnings due to changes in interest rates. It exists because the repricing frequency and magnitude of interest earning assets and interest bearing liabilities are not identical. Liquidity risk is the risk that the Corporation will not have the ability to generate adequate amounts of cash in the most economical way for it to meet its maturing liability obligations and customer loan demand. For detailed disclosure regarding liquidity management, asset/liability management and interest rate risk, see “Liquidity and Capital Resources” and Asset/Liability Management and Interest Rate Risk sections below.

Price and market risk refers to the risk of loss arising from adverse changes in interest rates and other relevant market rates and prices, such as equity prices. Interest rate risk, discussed above, is the most significant market risk to which the Corporation is exposed. The Corporation is also exposed to financial market risk and housing market risk.

Compliance risk represents the risk of regulatory sanctions or financial loss resulting from the failure to comply with laws, rules and regulations and standards of good banking practice. Activities that may expose the Corporation to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, adherence to all applicable laws and regulations, and employment and tax matters.

Strategic and reputation risk represent the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, and failure to assess existing and new opportunities and threats in business, markets, and products.

Operational risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, natural disasters and security risks.

ERM is an overarching program that includes all areas of the Corporation. A framework approach is utilized to assign responsibility and to ensure that the various business units and activities involved in the risk management life-cycle are effectively integrated. The Corporation has adopted the “three lines of defense” concept that is an industry best practice for ERM. Business units are the first line of defense in managing risk. They are responsible for identifying, measuring, monitoring, and controlling current and emerging risks. They must report on and escalate their concerns. Corporate functions such as Credit Risk Management, Financial Administration, Information Assurance and Compliance comprise the second line of defense. They are

- 49-

Management's Discussion and Analysis

responsible for policy setting and for reviewing and challenging the risk management activities of the business units. They collaborate closely with business units on planning and resource allocation with respect to risk management. Internal Audit is a third line of defense. They provide independent assurance to the Board of Directors of the effectiveness of the first and second lines in fulfilling their risk management responsibilities.

For additional factors that could adversely impact Washington Trust’s future results of operations and financial condition, see the section labeled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Results of Operations

The following table presents a summarized consolidated statement of operations:



(Dollars in thousands)	Three Months									Nine Months
					Change									Change
For the periods ended September 30,	2019		2018		$			%		2019		2018		$		%
Net interest income		$32,978		$33,449		($471	)	(1	%)		$101,420		$98,412		$3,008	3	%
Noninterest income	18,342		15,215		3,127			21		50,462		46,951		3,511		7
Total revenues	51,320		48,664		2,656			5		151,882		145,363		6,519		4
Provision for loan losses	400		350		50			14		1,575		750		825		110
Noninterest expense	26,870		26,062		808			3		81,985		79,480		2,505		3
Income before income taxes	24,050		22,252		1,798			8		68,322		65,133		3,189		5
Income tax expense	5,236		4,741		495			10		14,740		13,737		1,003		7
Net income		$18,814		$17,511		$1,303		7	%		$53,582		$51,396		$2,186	4	%

The following table presents a summary of performance metrics and ratios:



	Three Months						Nine Months
For the periods ended September 30,	2019			2018			2019			2018
Diluted earnings per common share		$1.08			$1.01			$3.07			$2.95
Return on average assets (net income divided by average assets)	1.44		%	1.47		%	1.39		%	1.48		%
Return on average equity (net income available for common shareholders divided by average equity)	15.20		%	16.26		%	15.09		%	16.41		%
Net interest income as a percentage of total revenues	64		%	69		%	67		%	68		%
Noninterest income as a percentage of total revenues	36		%	31		%	33		%	32		%

Net income totaled $18.8 million, for the three months ended September 30, 2019, up by $1.3 million, or 7%, over the same period in 2018. This increase was mainly driven by increased mortgage banking activities and loan related derivative transactions.

Net income totaled $53.6 million for the nine months ended September 30, 2019, up by $2.2 million, or 4%, over the same period in 2018. This largely reflected growth in net interest income, increased mortgage banking activities and loan related derivative transactions, partially offset by lower wealth management revenues and increased salaries and employee benefits expense.

- 50-

Management's Discussion and Analysis

Average Balances / Net Interest Margin - Fully Taxable Equivalent (FTE) Basis

The following table presents 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 loans, as well as interest recognized on these loans, are included in amounts presented for loans.



Three months ended September 30,	2019					2018					Change
(Dollars in thousands)	Average Balance		Interest		Yield/ Rate	Average Balance		Interest		Yield/ Rate	Average Balance			Interest			Yield/ Rate
Assets:
Cash, federal funds sold and short-term investments		$96,231		$493	2.03		$52,218		$261	1.98		$44,013			$232		0.05
Mortgage loans held for sale	39,771		410		4.09	34,571		384		4.41	5,200			26			(0.32	)
Taxable debt securities	920,910		6,318		2.72	825,302		5,383		2.59	95,608			935			0.13
Nontaxable debt securities	75		3		15.87	935		11		4.67	(860		)	(8		)	11.20
Total securities	920,985		6,321		2.72	826,237		5,394		2.59	94,748			927			0.13
FHLB stock	47,982		747		6.18	45,181		634		5.57	2,801			113			0.61
Commercial real estate	1,490,878		17,314		4.61	1,233,230		13,931		4.48	257,648			3,383			0.13
Commercial & industrial	584,601		6,946		4.71	642,005		7,720		4.77	(57,404		)	(774		)	(0.06	)
Total commercial	2,075,479		24,260		4.64	1,875,235		21,651		4.58	200,244			2,609			0.06
Residential real estate	1,367,017		13,728		3.98	1,331,304		13,362		3.98	35,713			366			—
Home equity	291,058		3,615		4.93	284,080		3,469		4.84	6,978			146			0.09
Other	22,270		278		4.95	27,635		344		4.94	(5,365		)	(66		)	0.01
Total consumer	313,328		3,893		4.93	311,715		3,813		4.85	1,613			80			0.08
Total loans	3,755,824		41,881		4.42	3,518,254		38,826		4.38	237,570			3,055			0.04
Total interest-earning assets	4,860,793		49,852		4.07	4,476,461		45,499		4.03	384,332			4,353			0.04
Noninterest-earning assets	320,223					248,437					71,786
Total assets		$5,181,016					$4,724,898					$456,118
Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits		$137,980		$649	1.87		$134,632		$465	1.37		$3,348			$184		0.50
NOW accounts	471,302		69		0.06	458,143		104		0.09	13,159			(35		)	(0.03	)
Money market accounts	699,138		2,094		1.19	631,570		1,104		0.69	67,568			990			0.50
Savings accounts	362,142		72		0.08	375,528		60		0.06	(13,386		)	12			0.02
Time deposits (in-market)	800,571		4,181		2.07	706,726		2,806		1.58	93,845			1,375			0.49
Total interest-bearing in-market deposits	2,471,133		7,065		1.13	2,306,599		4,539		0.78	164,534			2,526			0.35
Wholesale brokered time deposits	475,026		2,727		2.28	438,604		2,007		1.82	36,422			720			0.46
Total interest-bearing deposits	2,946,159		9,792		1.32	2,745,203		6,546		0.95	200,956			3,246			0.37
FHLB advances	980,091		6,512		2.64	852,904		4,937		2.30	127,187			1,575			0.34
Junior subordinated debentures	22,681		245		4.29	22,681		232		4.06	—			13			0.23
Total interest-bearing liabilities	3,948,931		16,549		1.66	3,620,788		11,715		1.28	328,143			4,834			0.38
Noninterest-bearing demand deposits	626,408					612,597					13,811
Other liabilities	115,480					65,207					50,273
Shareholders’ equity	490,197					426,306					63,891
Total liabilities and shareholders’ equity		$5,181,016					$4,724,898					$456,118
Net interest income (FTE)				$33,303					$33,784						($481	)
Interest rate spread					2.41					2.75							(0.34	)
Net interest margin					2.72					2.99							(0.27	)

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Management's Discussion and Analysis

Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:



(Dollars in thousands)
Three months ended September 30,	2019		2018		Change
Commercial loans		$323		$333		($10	)
Nontaxable debt securities	2		2		—
Total		$325		$335		($10	)




Nine months ended September 30,	2019					2018					Change
(Dollars in thousands)	Average Balance		Interest		Yield/ Rate	Average Balance		Interest		Yield/ Rate	Average Balance			Interest			Yield/ Rate
Assets:
Cash, federal funds sold and short-term investments		$75,333		$1,232	2.19		$53,828		$723	1.80		$21,505			$509		0.39
Mortgage loans held for sale	28,379		878		4.14	29,770		923		4.15	(1,391		)	(45		)	(0.01	)
Taxable debt securities	972,511		20,550		2.83	817,274		15,859		2.59	155,237			4,691			0.24
Nontaxable debt securities	602		24		5.33	1,743		65		4.99	(1,141		)	(41		)	0.34
Total debt securities	973,113		20,574		2.83	819,017		15,924		2.60	154,096			4,650			0.23
FHLB stock	48,185		2,162		6.00	43,149		1,700		5.27	5,036			462			0.73
Commercial real estate	1,461,736		51,702		4.73	1,225,875		39,740		4.33	235,861			11,962			0.40
Commercial & industrial	603,143		21,972		4.87	624,563		22,113		4.73	(21,420		)	(141		)	0.14
Total commercial	2,064,879		73,674		4.77	1,850,438		61,853		4.47	214,441			11,821			0.30
Residential real estate	1,358,606		41,099		4.04	1,278,662		37,717		3.94	79,944			3,382			0.10
Home equity	284,657		10,757		5.05	285,143		9,908		4.65	(486		)	849			0.40
Other	24,017		887		4.94	29,328		1,073		4.89	(5,311		)	(186		)	0.05
Total consumer	308,674		11,644		5.04	314,471		10,981		4.67	(5,797		)	663			0.37
Total loans	3,732,159		126,417		4.53	3,443,571		110,551		4.29	288,588			15,866			0.24
Total interest-earning assets	4,857,169		151,263		4.16	4,389,335		129,821		3.95	467,834			21,442			0.21
Noninterest-earning assets	292,702					239,187					53,515
Total assets		$5,149,871					$4,628,522					$521,349
Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits		$144,306		$1,959	1.82		$100,644		$595	0.79		$43,662			$1,364		1.03
NOW accounts	462,856		228		0.07	456,083		215		0.06	6,773			13			0.01
Money market accounts	668,330		5,534		1.11	671,135		2,944		0.59	(2,805		)	2,590			0.52
Savings accounts	365,911		204		0.07	373,105		173		0.06	(7,194		)	31			0.01
Time deposits (in-market)	795,559		11,900		2.00	662,850		6,890		1.39	132,709			5,010			0.61
Total interest-bearing in-market deposits	2,436,962		19,825		1.09	2,263,817		10,817		0.64	173,145			9,008			0.45
Wholesale brokered time deposits	485,405		8,132		2.24	426,096		5,405		1.70	59,309			2,727			0.54
Total interest-bearing deposits	2,922,367		27,957		1.28	2,689,913		16,222		0.81	232,454			11,735			0.47
FHLB advances	1,019,172		20,153		2.64	846,359		13,627		2.15	172,813			6,526			0.49
Junior subordinated debentures	22,681		750		4.42	22,681		629		3.71	—			121			0.71
Total interest-bearing liabilities	3,964,220		48,860		1.65	3,558,953		30,478		1.14	405,267			18,382			0.51
Noninterest-bearing demand deposits	613,917					590,573					23,344
Other liabilities	98,012					61,042					36,970
Shareholders’ equity	473,722					417,954					55,768
Total liabilities and shareholders’ equity		$5,149,871					$4,628,522					$521,349
Net interest income (FTE)			$102,403						$99,343						$3,060
Interest rate spread					2.51					2.81							(0.30	)
Net interest margin					2.82					3.03							(0.21	)

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Management's Discussion and Analysis




(Dollars in thousands)
Nine months ended September 30,	2019		2018		Change
Commercial loans		$977		$918		$59
Nontaxable debt securities	6		13		(7		)
Total		$983		$931		$52

Net Interest Income

Net interest income continues to be the primary source of our operating income. Net interest income for the three and nine months ended September 30, 2019 totaled $33.0 million and $101.4 million, respectively, compared to $33.4 million and $98.4 million, respectively, for the same periods in 2018. 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. Prepayment penalty income associated with loan payoffs is included in net interest income.

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 may be impacted by the amount of prepayment penalty income associated with loan payoffs recognized in each period. For the three and nine months ended September 30, 2019, prepayment penalty income associated with loan payoffs amounted to $130 thousand and $215 thousand, respectively, compared to $173 thousand and $703 thousand, respectively, for the same periods in 2018.

FTE net interest income for the three and nine months ended September 30, 2019 amounted to $33.3 million and $102.4 million, respectively, down by $481 thousand and up by $3.1 million, respectively, from the same periods in 2018. Excluding the impact of prepayment penalty income associated with loan payoffs from each period, net interest income for the three and nine months ended September 30, 2019 decreased by $438 thousand and increased by $3.5 million, respectively, from the same periods in 2018. The decline in third quarter net interest income reflected an increase in cost of funds, partially offset by growth in average loan balances. On a year-to-date basis, the increase in net interest income reflected growth in average loans and securities and relatively higher market interest rates on variable rate loans, partially offset by higher cost of funds and growth in higher cost time deposits.

The net interest margin was 2.72% and 2.82%, respectively, for the three and nine months ended September 30, 2019, compared to 2.99% and 3.03%, respectively, for the same periods a year ago. Excluding the impact of prepayment penalty income associated with loan payoffs from each period, the net interest margin was 2.71% and 2.81%, respectively, for the three and nine months ended September 30, 2019, compared to 2.98% and 3.00%, respectively, for the same periods in 2018. The decrease in the net interest margin was driven by higher cost of funds, partially offset by relatively higher market interest rates on variable rate loans.

Total average securities for the three and nine months ended September 30, 2019 increased by $94.7 million and $154.1 million, respectively, from the average balances for the same periods a year earlier. The FTE rate of return on the securities portfolio for the three and nine months ended September 30, 2019 was 2.72% and 2.83%, respectively, compared to 2.59% and 2.60%, respectively, for the same periods in 2018, reflecting purchases of relatively higher yielding debt securities in the fourth quarter of 2018 and first half of 2019.

Total average loan balances for the three and nine months ended September 30, 2019 increased by $237.6 million and $288.6 million, respectively, from the average loan balances for the comparable 2018 periods, primarily due to growth in average commercial real estate and residential real estate loan balances. The yield on total loans for the three and nine months ended September 30, 2019 was 4.42% and 4.53%, compared to 4.38% and 4.29%, respectively, for the same periods in 2018. Yields on LIBOR-based and prime-based loans reflected relatively higher market interest rates.

The average balance of FHLB advances for the three and nine months ended September 30, 2019 increased by $127.2 million and $172.8 million, respectively, compared to the average balances for the same periods in 2018 to fund loan growth and purchases of securities. The average rate paid on such advances for both the three and nine months ended September 30, 2019 was 2.64%, compared to 2.30% and 2.15%, respectively, for the same periods in 2018, due to relatively higher rates on short-term advances.

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Management's Discussion and Analysis

Included in total average interest-bearing deposits were of out-of-market wholesale brokered time deposits, which increased by $36.4 million and $59.3 million, respectively, from the same periods in 2018. The average rate paid on wholesale brokered time deposits for the three and nine months ended September 30, 2019 was 2.28% and 2.24%, respectively, compared to 1.82% and 1.70%, respectively, for the same periods in 2018, as maturities were replaced with wholesale brokered time deposits with higher rates.

Average in-market interest-bearing deposits, which excludes wholesale brokered time deposits, for the three and nine months ended September 30, 2019 increased by $164.5 million and $173.1 million, respectively, from the average balances for the same periods in 2018. The year-over-year increase in average in-market interest bearing deposits was largely due to growth in time deposits. The average rate paid on in-market interest-bearing deposits for the three and nine months ended September 30, 2019 increased by 35 basis points and 45 basis points, respectively, compared to the same periods in 2018, largely due to higher rates paid on promotional time deposits, as well as competitive pricing on money market accounts and interest-bearing demand deposits.

The average balance of noninterest-bearing demand deposits for the three and nine months ended September 30, 2019 increased by $13.8 million and $23.3 million, respectively, from the average balances for the same periods in 2018.

- 54-

Management's Discussion and Analysis

Volume / Rate Analysis - Interest Income and Expense (FTE Basis)

The following table presents certain information on a FTE basis regarding changes in our interest income and interest expense for the period indicated. The net change attributable to both volume and rate has been allocated proportionately.



(Dollars in thousands)	Three Months Ended September 30, 2019 vs. 2018									Nine Months Ended September 30, 2019 vs. 2018
	Change Due to									Change Due to
	Volume			Rate			Net Change			Volume			Rate			Net Change
Interest on Interest-Earning Assets:
Cash, federal funds sold and other short-term investments		$225			$7			$232			$330			$179			$509
Mortgage loans held for sale	55			(29		)	26			(43		)	(2		)	(45		)
Taxable debt securities	652			283			935			3,153			1,538			4,691
Nontaxable debt securities	(17		)	9			(8		)	(45		)	4			(41		)
Total securities	635			292			927			3,108			1,542			4,650
FHLB stock	41			72			113			211			251			462
Commercial real estate	2,970			413			3,383			8,082			3,880			11,962
Commercial & industrial	(679		)	(95		)	(774		)	(778		)	637			(141		)
Total commercial	2,291			318			2,609			7,304			4,517			11,821
Residential real estate	366			—			366			2,405			977			3,382
Home equity	83			63			146			(17		)	866			849
Other	(67		)	1			(66		)	(197		)	11			(186		)
Total consumer	16			64			80			(214		)	877			663
Total loans	2,673			382			3,055			9,495			6,371			15,866
Total interest income	3,629			724			4,353			13,101			8,341			21,442
Interest on Interest-Bearing Liabilities:
Interest-bearing demand deposits	12			172			184			341			1,023			1,364
NOW accounts	3			(38		)	(35		)	1			12			13
Money market accounts	127			863			990			(12		)	2,602			2,590
Savings accounts	(2		)	14			12			(3		)	34			31
Time deposits (in-market)	412			963			1,375			1,570			3,440			5,010
Total interest-bearing in-market deposits	552			1,974			2,526			1,897			7,111			9,008
Wholesale brokered time deposits	178			542			720			831			1,896			2,727
Total interest-bearing deposits	730			2,516			3,246			2,728			9,007			11,735
FHLB advances	791			784			1,575			3,084			3,442			6,526
Junior subordinated debentures	—			13			13			—			121			121
Total interest expense	1,521			3,313			4,834			5,812			12,570			18,382
Net interest income (FTE)		$2,108			($2,589	)		($481	)		$7,289			($4,229	)		$3,060

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 levels of nonperforming loans, past due loans and net charge-offs, both current and historic; local economic and credit conditions; the direction of real estate values; and regulatory guidelines. The provision for loan losses is charged against earnings in order to maintain an allowance for loan losses that reflects management’s best estimate of probable losses inherent in the loan portfolio at the balance sheet date.

Loan loss provisions of $400 thousand and $1.6 million, respectively, were charged to earnings for the three and nine months ended September 30, 2019, compared to $350 thousand and $750 thousand, respectively for the three and nine months ended September 30, 2018. These provisions were based on management’s assessment of loss exposure, as well as loss allocations commensurate with growth and changes in the loan portfolio, including changes in asset quality and credit quality metrics.

- 55-

Management's Discussion and Analysis

The allowance for loan losses was $27.0 million, or 0.71% of total loans, at September 30, 2019, compared to $27.1 million, or 0.74% of total loans, at December 31, 2018. See additional discussion under the caption “Asset Quality” for further information on the allowance for loan losses.

Noninterest Income

Noninterest income is an important source of revenue for Washington Trust. The principal categories of noninterest income are shown in the following table:



(Dollars in thousands)	Three Months									Nine Months
					Change										Change
Periods ended September 30,	2019		2018		$			%		2019			2018		$			%
Noninterest income:
Wealth management revenues		$9,153		$9,454		($301	)	(3	%)		$27,954			$29,329		($1,375	)	(5	)%
Mortgage banking revenues	4,840		2,624		2,216			84		11,126			8,403		2,723			32
Card interchange fees	1,099		983		116			12		3,114			2,791		323			12
Service charges on deposit accounts	939		885		54			6		2,743			2,651		92			3
Loan related derivative income	1,407		278		1,129			406		2,877			1,087		1,790			165
Income from bank-owned life insurance	569		572		(3		)	(1	)	1,784			1,624		160			10
Net realized gains on securities	—		—		—			100		(80		)	—		(80		)	100
Other income	335		419		(84		)	(20	)	944			1,066		(122		)	(11	)
Total noninterest income		$18,342		$15,215		$3,127		21	%		$50,462			$46,951		$3,511		7	%

Noninterest Income Analysis

Revenue from wealth management services is our largest source of noninterest income, representing 55% of total noninterest income for the nine months ended September 30, 2019, compared to 62% for the same period in 2018. A substantial portion of wealth management revenues is dependent on the value of wealth management assets under administration and is closely tied to the performance of the financial markets. This portion of wealth management revenues is referred to as “asset-based” and includes trust and investment management fees. Wealth management revenues also include “transaction-based” revenues, such as financial planning, commissions and other service fees that are not primarily derived from the value of assets.

The categories of wealth management revenues are shown in the following table:



(Dollars in thousands)	Three Months									Nine Months
					Change									Change
Periods ended September 30,	2019		2018		$			%		2019		2018		$			%
Wealth management revenues:
Asset-based revenues		$9,013		$9,322		($309	)	(3	)%	27,075		28,413		(1,338		)	(5	)
Transaction-based revenues	140		132		8			6		879		916		(37		)	(4	)
Total wealth management revenues		$9,153		$9,454		($301	)	(3	)%		$27,954		$29,329		($1,375	)	(5	)%

Wealth management revenues for the three and nine months ended September 30, 2019 decreased by $301 thousand and $1.4 million, respectively, from the comparable periods in 2018, due to a decline in asset-based revenues.

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Management's Discussion and Analysis

The following table presents the changes in wealth management assets under administration:



(Dollars in thousands)	Three Months					Nine Months
Periods ended September 30,	2019			2018		2019			2018
Wealth management assets under administration:
Balance at the beginning of period		$6,478,890			$6,220,155		$5,910,814			$6,714,637
Net investment appreciation & income	66,514			232,245		809,060			333,671
Net client asset flows	(419,077		)	9,940		(593,547		)	(585,968		)
Balance at the end of period		$6,126,327			$6,462,340		$6,126,327			$6,462,340

Wealth management assets under administration were $6.1 billion at September 30, 2019, down by $336.0 million, or 5%, from a year ago. Wealth management assets and related asset-based revenues were adversely impacted by net client outflows largely associated with the departures of certain client-facing personnel in the first quarter of 2018 and two senior counselors at the end of the second quarter of 2019.

Mortgage banking revenues represented 22% of total noninterest income for the nine months ended September 30, 2019, compared to 18% for the same period in 2018. These revenues are dependent on mortgage origination volume and are sensitive to interest rates and the condition of housing markets.

The composition of mortgage banking revenues and the volume of loans sold to the secondary market are shown in the following table:



(Dollars in thousands)	Three Months									Nine Months
					Change									Change
Periods ended September 30,	2019		2018		$			%		2019		2018		$			%
Mortgage banking revenues:
Gains on loan sales, net (1)		$4,752		$2,485		$2,267		91	%		$10,749		$7,950		$2,799		35	%
Loan servicing fee income, net (2)	88		139		(51		)	(37	)	377		453		(76		)	(17	)
Total mortgage banking revenues		$4,840		$2,624		$2,216		84	%		$11,126		$8,403		$2,723		32	%

Loans sold to the secondary market (3)		$184,976		$132,116		$52,860		40	%		$414,469		$334,677		$79,792		24	%


(1)	Includes gains on loan sales, commission income on loans originated for others, servicing right gains, fair value adjustments on mortgage 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.


(3)	Includes brokered loans (loans originated for others).

For the three and nine months ended September 30, 2019, mortgage banking revenues were up by $2.2 million and $2.7 million, respectively, compared to the same periods in 2018. The increase in mortgage banking revenues reflected higher sales volume and an increase in the sales yield on loans sold in the secondary market. Also included was an increase in fair value adjustments on mortgage loan commitments and loans held for sale, reflecting growth in the mortgage pipeline and corresponding loan commitment balances.

Loan related derivative income for the three and nine months ended September 30, 2019 increased by $1.1 million and $1.8 million, respectively, from the comparable periods in 2018, due to a higher volume of commercial borrower interest rate swap transactions.

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Management's Discussion and Analysis

Noninterest Expense

The following table presents noninterest expense comparisons:



(Dollars in thousands)	Three Months										Nine Months
						Change									Change
Periods ended September 30,	2019			2018		$			%		2019		2018		$			%
Noninterest expense:
Salaries and employee benefits		$18,332			$17,283		$1,049		6	%		$54,387		$52,359		$2,028		4	%
Outsourced services	2,722			1,951		771			40		7,846		6,174		1,672			27
Net occupancy	1,933			2,013		(80		)	(4	)	5,835		5,945		(110		)	(2	)
Equipment	1,046			1,080		(34		)	(3	)	3,085		3,329		(244		)	(7	)
Legal, audit and professional fees	645			559		86			15		1,843		1,840		3			—
FDIC deposit insurance costs	(460		)	410		(870		)	(212	)	509		1,236		(727		)	(59	)
Advertising and promotion	368			440		(72		)	(16	)	1,132		946		186			20
Amortization of intangibles	236			245		(9		)	(4	)	714		740		(26		)	(4	)
Other	2,048			2,081		(33		)	(2	)	6,634		6,911		(277		)	(4	)
Total noninterest expense		$26,870			$26,062		$808		3	%		$81,985		$79,480		$2,505		3	%

Noninterest Expense Analysis

Salaries and employee benefits expense for the three and nine months ended September 30, 2019 increased by $1.0 million and $2.0 million, respectively, compared to the same periods in 2018, largely reflecting annual merit increases and volume-related increases in mortgage banking commission expense, partially offset by lower wealth management compensation costs associated with the departure of personnel. Year-to-date salaries and employee benefits expense was also impacted by one-time incentive bonuses of approximately $450 thousand that were recognized in the first quarter of 2018. There were no such one-time bonuses recognized in 2019.

Outsourced services expense for the three and nine months ended September 30, 2019 increased by $771 thousand and $1.7 million, respectively, compared to the same periods in 2018. Equipment expense for the three and nine months ended September 30, 2019 decreased by $34 thousand and $244 thousand, respectively, from the same periods a year ago. Both the increase in outsourced services and decline in equipment expense reflected changes to and expansion of services provided by third party vendors, including software application processing and operational services, as well as volume-related increases in third party processing costs.

FDIC deposit insurance costs for the three and nine months ended September 30, 2019 decreased by $870 thousand and $727 thousand, respectively, compared to the same periods in 2018, largely due to approximately $900 thousand of FDIC assessment credits recognized in the third quarter of 2019.

Income Taxes

The following table presents the Corporation’s income tax provision and applicable tax rates for the periods indicated:



(Dollars in thousands)
	Three Months						Nine Months
Periods ended September 30,	2019			2018			2019			2018
Income tax expense		$5,236			$4,741			$14,740			$13,737
Effective income tax rate	21.8		%	21.3		%	21.6		%	21.1		%

The effective income tax rates for the three and nine months ended September 30, 2019 and 2018 differed from the federal rate of 21%, primarily due to state income tax expense, offset by the benefits of tax-exempt income, income from BOLI, federal tax credits and the recognition of excess tax benefits associated with the settlement of share-based awards.

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Management's Discussion and Analysis

The increase in the effective tax rate for the three and nine months ended September 30, 2019 compared to the same periods in 2018 largely reflected a decrease in excess tax benefits recognized upon the settlement of share-based compensation awards, as well as an increase in state tax expense.

Segment Reporting

The Corporation 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 14 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)	Three Months								Nine Months
					Change								Change
Periods ended September 30,	2019		2018		$		%		2019		2018		$		%
Net interest income		$28,515		$27,036		$1,479	5	%		$83,684		$79,656		$4,028	5	%
Provision for loan losses	400		350		50		14		1,575		750		825		110
Net interest income after provision for loan losses	28,115		26,686		1,429		5		82,109		78,906		3,203		4
Noninterest income	8,607		5,174		3,433		66		20,753		15,947		4,806		30
Noninterest expense	16,897		16,253		644		4		50,661		48,502		2,159		4
Income before income taxes	19,825		15,607		4,218		27		52,201		46,351		5,850		13
Income tax expense	4,347		3,344		1,003		30		11,371		9,834		1,537		16
Net income		$15,478		$12,263		$3,215	26	%		$40,830		$36,517		$4,313	12	%

Net interest income for the Commercial Banking segment for the three and nine months ended September 30, 2019, increased by $1.5 million and $4.0 million, respectively, from the same periods in 2018, largely reflecting growth in loans, which was partially offset by a shift in the mix of deposits to higher cost categories and increases in rates paid on in-market deposits.

Loan loss provisions of $400 thousand and $1.6 million, respectively, were charged to earnings for the three and nine months ended September 30, 2019, compared to $350 thousand and $750 thousand, respectively, for the three and nine months ended September 30, 2018. These provisions were based on management’s assessment of loss exposure, as well as loss allocations commensurate with growth and changes in the loan portfolio, including changes in asset quality and credit quality metrics.

Noninterest income derived from the Commercial Banking segment for the three and nine months ended September 30, 2019 was up by $3.4 million and $4.8 million, respectively, from the comparable periods in 2018. The increase largely reflected higher mortgage banking revenues and loan related derivative income. See additional discussion under the caption “Noninterest Income” above.

Commercial Banking noninterest expenses for the three and nine months ended September 30, 2019 were up by $644 thousand and $2.2 million, respectively, from the same periods in 2018, reflecting increases in salaries and employee benefits and outsourced services expenses, partially offset by lower FDIC deposit insurance costs. See further discussion under the caption “Noninterest Expense” above.

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Management's Discussion and Analysis

Wealth Management Services

The following table presents a summarized statement of operations for the Wealth Management Services business segment:



(Dollars in thousands)	Three Months											Nine Months
							Change											Change
Periods ended September 30,	2019			2018			$			%		2019			2018			$			%
Net interest expense		($114	)		($90	)		($24	)	27	%		($361	)		($225	)		($136	)	60	%
Noninterest income	9,153			9,454			(301		)	(3	)	27,961			29,329			(1,368		)	(5	)
Noninterest expense	6,577			6,565			12			—		20,720			21,123			(403		)	(2	)
Income before income taxes	2,462			2,799			(337		)	(12	)	6,880			7,981			(1,101		)	(14	)
Income tax expense	646			710			(64		)	(9	)	1,845			2,008			(163		)	(8	)
Net income		$1,816			$2,089			($273	)	(13	%)		$5,035			$5,973			($938	)	(16	%)

For the three and nine months ended September 30, 2019, noninterest income derived from the Wealth Management Services segment decreased by $301 thousand and $1.4 million, respectively, compared to the same periods in 2018. See further discussion of wealth management revenues under the caption “Noninterest Income” above.

For the three and nine months ended September 30, 2019, noninterest expenses for the Wealth Management Services segment increased by $12 thousand and decreased by $403 thousand, respectively. The modest increase in third quarter noninterest expenses reflected higher outsourced services and legal expenses, offset by lower compensation costs. See further discussion under the caption “Noninterest Expense” above. The decrease in year-to-date noninterest expenses was attributable to software system implementation costs incurred in 2018 associated with an April 2018 system implementation.

Corporate

The following table presents a summarized statement of operations for the Corporate unit:



(Dollars in thousands)	Three Months									Nine Months
					Change									Change
Periods ended September 30,	2019		2018		$			%		2019		2018		$			%
Net interest income		$4,577		$6,503		($1,926	)	(30	%)		$18,097		$18,981		($884	)	(5	%)
Noninterest income	582		587		(5		)	(1	)	1,748		1,675		73			4
Noninterest expense	3,396		3,244		152			5		10,604		9,855		749			8
Income before income taxes	1,763		3,846		(2,083		)	(54	)	9,241		10,801		(1,560		)	(14	)
Income tax expense	243		687		(444		)	(65	)	1,524		1,895		(371		)	(20	)
Net income		$1,520		$3,159		($1,639	)	(52	%)		$7,717		$8,906		($1,189	)	(13	%)

Net interest income for the Corporate unit for the three and nine months ended September 30, 2019 was down by $1.9 million and $884 thousand, respectively, compared to the same periods in 2018. Higher wholesale funding costs were partially offset by increased investment income on debt securities resulting from growth in the investment securities portfolio and higher dividend income on FHLB stock.

Noninterest expense for the Corporate unit for the three and nine months ended September 30, 2019 was up by $152 thousand and $749 thousand, respectively, from the same periods in 2018, reflecting increases in staffing levels.

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Management's Discussion and Analysis

Financial Condition

Summary

The following table presents selected financial condition data:



(Dollars in thousands)					Change
	September 30, 2019		December 31, 2018		$			%
Cash and due from banks		$141,768		$89,923		$51,845		58	%
Total securities	887,020		938,225		(51,205		)	(5	)
Total loans	3,778,106		3,680,360		97,746			3
Allowance for loan losses	26,997		27,072		(75		)	—
Total assets	5,198,878		5,010,766		188,112			4
Total deposits	3,586,153		3,524,048		62,105			2
FHLB advances	956,786		950,722		6,064			1
Total shareholders’ equity	497,825		448,184		49,641			11

Total assets amounted to $5.2 billion at September 30, 2019, up by $188.1 million, or 4%, from the end of 2018. Included in the increase in total assets was the recognition of operating lease right-of-use assets totaling $28.9 million due to the adoption of ASU 2016-02 on January 1, 2019 as disclosed in Note 2 to the Unaudited Consolidated Financial Statements. The remaining increase in total assets reflected increases in total loans and the balance of cash and due from banks, partially offset by a decrease in total securities. The increase in cash and due from banks was largely due to increased levels of cash collateral pledged to derivative counterparties. See Note 9 to the Unaudited Consolidated Financial Statements for additional disclosure regarding derivative financial instruments. Total deposits increased by $62.1 million, or 2%, and FHLB advances increased by $6.1 million, or 1%, from September 30, 2018. Shareholders’ equity amounted to $497.8 million at September 30, 2019, up by $49.6 million from the balance at December 31, 2018. As of September 30, 2019, 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

Investment security activity is monitored by the Investment Committee, the members of which also sit on the Asset/Liability Committee (“ALCO”). Asset and liability management objectives are the primary influence on the Corporation’s investment activities. However, the Corporation also recognizes that there are certain specific risks inherent in investment portfolio activity. The securities portfolio is managed in accordance with regulatory guidelines and established internal corporate investment policies that provide limitations on specific risk factors such as market risk, credit risk and concentration, liquidity risk and operational risk to help monitor risks associated with investing in securities. Reports on the activities conducted by Investment Committee and the ALCO are presented to the Board of Directors on a regular basis.

The Corporation’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 has not maintained 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 September 30, 2019 and December 31, 2018, the Corporation did not make any adjustments to the prices provided by the pricing service.

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Management's Discussion and Analysis

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 10 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities.

Securities Portfolio

The carrying amounts of securities held are as follows:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		%		Amount		%
Available for Sale Debt Securities:
Obligations of U.S. government-sponsored enterprises		$197,324	22	%		$242,683	26	%
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	664,905		76		660,793		72
Obligations of states and political subdivisions	—		—		937		—
Individual name issuer trust preferred debt securities	12,421		1		11,772		1
Corporate bonds	12,370		1		11,625		1
Total available for sale debt securities		$887,020	100	%		$927,810	100	%



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		%		Amount		%
Held to Maturity Debt Securities:
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises		$—	—	%		$10,415	100	%
Total held to maturity debt securities		$—	—	%		$10,415	100	%

As noted above, the securities portfolio is managed to generate interest income, for interest rate risk management purposes, and to provide an available source of liquidity for balance sheet management. Debt securities totaling $82.8 million and $127.8 million, respectively, were purchased during the nine months ended September 30, 2019 and 2018. The 2019 purchases had a weighted average yield of 3.61%, while the 2018 purchases had a weighted average yield of 3.34%. In 2019, the purchases were partially offset by routine principal pay-downs on mortgage-backed securities, calls, maturities and the sale of one debt security.

As disclosed in Note 2 to the Unaudited Consolidated Financial Statements, on January 1, 2019, the Corporation adopted the provisions of ASU 2017-12. As permitted by ASU 2017-12, debt securities classified as held to maturity with an amortized cost of $10.4 million and a fair value of $10.3 million were reclassified to available for sale upon the adoption date.

The securities portfolio stood at $887.0 million as of September 30, 2019, or 17% of total assets, compared to $938.2 million as of December 31, 2018, or 19% of total assets. The largest component of the securities portfolio is mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises.

As of September 30, 2019, the net unrealized gain position on securities available for sale amounted to $4.2 million compared to a net unrealized loss position of $22.0 million on securities available for sale and held to maturity as of December 31, 2018. These net positions included gross unrealized losses of $5.4 million and $24.4 million, respectively, of as September 30, 2019 and December 31, 2018. The decrease in gross unrealized losses in 2019 was primarily concentrated in obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, and largely attributable to relative changes in interest rates since the time of purchase. See Note 4 to the Unaudited Consolidated Financial Statements for additional information.

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Management's Discussion and Analysis

Loans

Total loans amounted to $3.8 billion at September 30, 2019, up by $97.7 million, or 3%, from the end of 2018, largely due to growth in commercial real estate loans.

The following is a summary of loans:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		%		Amount		%
Commercial:
Commercial real estate (1)		$1,517,320	40	%		$1,392,408	38	%
Commercial & industrial (2)	566,426		15		620,704		17
Total commercial	2,083,746		55		2,013,112		55
Residential Real Estate:
Residential real estate (3)	1,378,518		36		1,360,387		37
Consumer:
Home equity	294,250		8		280,626		8
Other (4)	21,592		1		26,235		—
Total consumer	315,842		9		306,861		8
Total loans		$3,778,106	100	%		$3,680,360	100	%


(1)	Consists 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)	Consists of loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.


(3)	Consists of mortgage and homeowner construction loans secured by one- to four-family residential properties.


(4)	Consists of loans to individuals secured by general aviation aircraft and other personal installment loans.

Commercial Loans

The commercial loan portfolio represented 55% of total loans at September 30, 2019.

In making commercial loans, we may occasionally solicit the participation of other banks. The Bank 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 $394.4 million and $406.4 million, respectively, at September 30, 2019 and December 31, 2018. Our participation in commercial loans originated by other banks also includes shared national credits. Shared national credits are defined as participations in loans or loan commitments of at least $100.0 million that are shared by three or more banks.

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

Commercial Real Estate Loans

Commercial real estate loans totaled $1.5 billion at September 30, 2019, up by $124.9 million, or 9%, from the balance at December 31, 2018. Included in commercial real estate loans were construction and development loans of $192.1 million and

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Management's Discussion and Analysis

$190.9 million, respectively, as of September 30, 2019 and December 31, 2018. For the nine months ended September 30, 2019, commercial real estate loan originations and advances were approximately $265 million, which were partially offset by payoffs.

Commercial real estate loans are secured by a variety of property types, with approximately 90% of the total at September 30, 2019 composed of multi-family dwellings, retail facilities, office buildings, lodging, healthcare facilities, industrial and warehouse properties and commercial mixed use properties. The average commercial real estate loan size was $3.0 million and the largest individual commercial real estate loan outstanding was $26.0 million as of September 30, 2019.

The following table presents a geographic summary of commercial real estate loans, including commercial construction, by property location:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		% of Total		Amount		% of Total
Rhode Island		$378,337	25	%		$377,249	27	%
Connecticut	618,262		41		570,116		41
Massachusetts	432,424		28		356,615		26
Subtotal	1,429,023		94		1,303,980		94
All other states	88,297		6		88,428		6
Total		$1,517,320	100	%		$1,392,408	100	%

Commercial and Industrial Loans

Commercial and industrial loans amounted to $566.4 million at September 30, 2019, down by $54.3 million, or 9%, from the balance at December 31, 2018. For the nine months ended September 30, 2019, originations were approximately $43 million and were offset by lower line utilization, payoffs and paydowns.

Shared national credit balances outstanding included in the commercial and industrial loan portfolio totaled $65.6 million at September 30, 2019. All of these loans were included in the pass-rated category of commercial loan credit quality and were current with respect to contractual payment terms at September 30, 2019.

The commercial and industrial loan portfolio includes loans to a variety of business types, with 90% of the total at September 30, 2019 composed of health care/social assistance, educational services, manufacturing, owner occupied and other real estate, professional, scientific and technical, retail trade, transportation and warehousing, entertainment and recreation, other services, finance and insurance services, public administration and construction businesses. The average commercial and industrial loan size was $618 thousand and the largest individual commercial and industrial loan outstanding was $19.1 million as of September 30, 2019.

Residential Real Estate Loans

The residential real estate loan portfolio represented 36% of total loans at September 30, 2019.

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.

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Management's Discussion and Analysis

The table below presents residential real estate loan origination activity:



(Dollars in thousands)	Three Months								Nine Months
Periods ended September 30,	2019				2018				2019				2018
	Amount		% of Total		Amount		% of Total		Amount		% of Total		Amount		% of Total
Originations for retention in portfolio		$105,075	36	%		$80,751	40	%		$226,508	34	%		$277,070	46	%
Originations for sale to the secondary market (1)	189,979		64		119,832		60		437,928		66		330,245		54
Total		$295,054	100	%		$200,583	100	%		$664,436	100	%		$607,315	100	%


(1)	Includes brokered loans (loans originated for others).

The table below presents residential real estate loan sales activity:



(Dollars in thousands)	Three Months								Nine Months
Periods ended September 30,	2019				2018				2019				2018
	Amount		% of Total		Amount		% of Total		Amount		% of Total		Amount		% of Total
Loans sold with servicing rights retained		$25,766	14	%		$24,422	18	%		$53,548	13	%		$82,634	25	%
Loans sold with servicing rights released (1)	159,210		86		107,694		82		360,921		87		252,043		75
Total		$184,976	100	%		$132,116	100	%		$414,469	100	%		$334,677	100	%


(1)	Includes brokered loans (loans originated for others).

Loans are sold with servicing retained or released. Loans sold with servicing rights retained 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 $3.4 million and $3.7 million, respectively, as of September 30, 2019 and December 31, 2018. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $573.6 million and $588.5 million, respectively, as of September 30, 2019 and December 31, 2018.

Residential real estate loans held in portfolio amounted to $1.4 billion at September 30, 2019, up by $18.1 million from the balance at December 31, 2018. While year-over-year residential real estate mortgage loan origination volumes were higher, a lower percentage of residential real estate mortgage loans were originated for retention in portfolio during the three and nine months ended September 30, 2019, compared to the same periods in 2018.

The following is a geographic summary of residential real estate mortgages by property location:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		% of Total		Amount		% of Total
Rhode Island		$347,847	25	%		$352,141	26	%
Connecticut	142,744		11		141,775		10
Massachusetts	871,309		63		849,435		63
Subtotal	1,361,900		99		1,343,351		99
All other states	16,618		1		17,036		1
Total (1)		$1,378,518	100	%		$1,360,387	100	%


(1)	Includes residential real estate loans purchased from other financial institutions totaling $106.7 million and $112.9 million, respectively, as of September 30, 2019 and December 31, 2018.

Consumer Loans

Consumer loans include home equity loans and lines of credit and personal installment loans.

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Management's Discussion and Analysis

The consumer loan portfolio totaled $315.8 million at September 30, 2019, up by $9.0 million, or 3%, from December 31, 2018. Home equity lines of credit and home equity loans represented 93% of the total consumer portfolio at September 30, 2019. The Bank estimates that approximately 65% of the combined home equity lines of credit and home equity loan balances are first lien positions or subordinate to other Washington Trust mortgages. Purchased consumer loans, consisting of loans to individuals secured by general aviation aircraft, amounted to $14.1 million and $17.6 million, respectively, at September 30, 2019 and December 31, 2018.

Asset Quality

Nonperforming Assets

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

The following table presents nonperforming assets and additional asset quality data:



(Dollars in thousands)	Sep 30, 2019			Dec 31, 2018
Commercial:
Commercial real estate		$684			$925
Commercial & industrial	—			—
Total commercial	684			925
Residential Real Estate:
Residential real estate	12,531			9,346
Consumer:
Home equity	1,599			1,436
Other	88			—
Total consumer	1,687			1,436
Total nonaccrual loans	14,902			11,707
Property acquired through foreclosure or repossession, net	4,142			2,142
Total nonperforming assets		$19,044			$13,849

Nonperforming assets to total assets	0.37		%	0.28		%
Nonperforming loans to total loans	0.39		%	0.32		%
Total past due loans to total loans	0.38		%	0.37		%
Accruing loans 90 days or more past due		$—			$—

Total nonperforming assets increased by $5.2 million from December 31, 2018. This included a net increase of $3.2 million in nonaccrual residential real estate loans and an increase of $2.0 million in property acquired through foreclosure. At September 30, 2019, property acquired through foreclosure consisted of two commercial properties.

Nonaccrual Loans

During the nine months ended September 30, 2019, the Corporation made no changes in its practices or policies concerning the placement of loans into nonaccrual status.

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Management's Discussion and Analysis

The following table presents the activity in nonaccrual loans:



(Dollars in thousands)	Three Months						Nine Months
For the periods ended September 30,	2019			2018			2019			2018
Balance at beginning of period		$12,867			$11,745			$11,707			$15,211
Additions to nonaccrual status	5,672			2,179			9,216			5,846
Loans returned to accruing status	(597		)	(361		)	(1,570		)	(1,180		)
Loans charged-off	(966		)	(96		)	(1,888		)	(889		)
Loans transferred to other real estate owned	(2,000		)	—			(2,000		)	(3,074		)
Payments, payoffs and other changes	(74		)	(2,658		)	(563		)	(5,105		)
Balance at end of period		$14,902			$10,809			$14,902			$10,809

The following table presents additional detail on nonaccrual loans:



(Dollars in thousands)	September 30, 2019								December 31, 2018
	Days Past Due								Days Past Due
	Over 90		Under 90		Total		% (1)		Over 90		Under 90		Total		% (1)
Commercial:
Commercial real estate		$684		$—		$684	0.05	%		$—		$925		$925	0.07	%
Commercial & industrial	—		—		—		—		—		—		—		—
Total commercial	684		—		684		0.03		—		925		925		0.05
Residential Real Estate:
Residential real estate	4,760		7,771		12,531		0.91		1,509		7,837		9,346		0.69
Consumer:
Home equity	812		787		1,599		0.54		552		884		1,436		0.51
Other	88		—		88		0.41		—		—		—		—
Total consumer	900		787		1,687		0.53		552		884		1,436		0.47
Total nonaccrual loans		$6,344		$8,558		$14,902	0.39	%		$2,061		$9,646		$11,707	0.32	%


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

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at September 30, 2019.

As of September 30, 2019, the composition of nonaccrual loans was 95% residential and consumer and 5% commercial, compared to 92% and 8%, respectively, at December 31, 2018.

Nonaccrual residential real estate mortgage loans amounted to $12.5 million at September 30, 2019, up by $3.2 million from the end of 2018. As of September 30, 2019, the balance of nonaccrual residential mortgage loans was predominately secured by properties in Massachusetts, Rhode Island and Connecticut. Included in total nonaccrual residential real estate loans at September 30, 2019 were five loans purchased for portfolio and serviced by others amounting to $1.5 million. Management monitors the collection efforts of its third party servicers as part of its assessment of the collectibility of nonperforming loans.

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Management's Discussion and Analysis

The following table sets forth information on troubled debt restructured loans as of the dates indicated. The amounts below consist of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs. Accrued interest is not included in the carrying amounts set forth below. See Note 5 to the Unaudited Consolidated Financial Statements for additional information.



(Dollars in thousands)	Sep 30, 2019		Dec 31, 2018
Accruing troubled debt restructured loans
Commercial:
Commercial & industrial		$—		$4,714
Residential Real Estate:
Residential real estate	359		363
Consumer:
Home equity	—		10
Other	19		21
Total consumer	19		31
Total accruing troubled debt restructured loans	378		5,108

Nonaccrual troubled debt restructured loans
Residential Real Estate:
Residential real estate		$497		$510
Total nonaccrual troubled debt restructured loans	497		510
Total troubled debt restructured loans		$875		$5,618

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.

As of September 30, 2019, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.

Troubled debt restructured loans decreased by $4.7 million from the end of December 31, 2018 due to the payoff of one accruing commercial and industrial loan that occurred in the second quarter of 2019.

The allowance for loans losses included specific reserves for troubled debt restructurings of $101 thousand and $103 thousand, respectively, at September 30, 2019 and December 31, 2018.

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Management's Discussion and Analysis

Past Due Loans

The following table presents past due loans by category:



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		% (1)		Amount		% (1)
Commercial:
Commercial real estate		$684	0.05	%		$1,080	0.08	%
Commercial & industrial	1		—		—		—
Total commercial	685		0.03		1,080		0.05
Residential Real Estate:
Residential real estate	11,599		0.84		10,520		0.77
Consumer:
Home equity	1,973		0.67		1,989		0.71
Other	99		0.46		33		0.13
Total consumer	2,072		0.66		2,022		0.66
Total past due loans		$14,356	0.38	%		$13,622	0.37	%


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

As of September 30, 2019, the composition of past due loans (loans past due 30 days or more) was 95% residential and consumer and 5% commercial, compared to 92% and 8%, respectively, at December 31, 2018. Total past due loans increased by $734 thousand from the end of 2018, as an increase in past due residential real estate loans was partially offset by a decline in past due commercial real estate loans.

Total past due loans included $9.8 million of nonaccrual loans as of September 30, 2019, compared to $8.6 million as of December 31, 2018. All loans 90 days or more past due at September 30, 2019 and December 31, 2018 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 September 30, 2019 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.

Management has identified approximately $11.7 million in potential problem loans at September 30, 2019, compared to $14.9 million at December 31, 2018. The decrease in potential problem loan from December 31, 2018 was largely due to one commercial real estate loan that was placed on nonaccrual status, partially charged-off and transferred to other real estate owned in 2019. As of September 30, 2019, 98% of the balance of potential problem loans consisted of three commercial relationships and all of these commercial relationships were current with respect to payment terms. 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, 2018 and in Note 6 to the Unaudited Consolidated Financial Statements.

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Management's Discussion and Analysis

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, and is reduced by charge-offs on loans. The status of nonaccrual loans, past due loans and performing loans were all taken into consideration in the assessment of the adequacy of the allowance for loans losses. In addition, the balance and trends of credit quality indicators, including the commercial loan categories of Pass, Special Mention and Classified, are integrated into the process used to determine the allocation of loss exposure. See Note 5 to the Unaudited Consolidated Financial Statements under the caption “Credit Quality Indicators” for additional information. Management believes that the level of allowance for loan losses at September 30, 2019 is adequate and consistent with asset quality and credit quality indicators. Management will continue to assess the adequacy of the allowance for loan losses in accordance with its established policies.

The Corporation’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. Full or partial charge-offs on collateral dependent impaired loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. The Corporation 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 real estate loans 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.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans include nonaccrual loans and loans restructured in a troubled debt restructuring. The following is a summary of impaired loans by measurement type:



(Dollars in thousands)	Sep 30, 2019		Dec 31, 2018
Collateral dependent impaired loans (1)		$13,264		$10,466
Impaired loans measured on discounted cash flow method (2)	2,016		6,350
Total impaired loans		$15,280		$16,816


(1)	Net of partial charge-offs of $840 thousand and $289 thousand, respectively, at September 30, 2019 and December 31, 2018.


(2)	Net of partial charge-offs of $262 thousand and $85 thousand, respectively, at September 30, 2019 and December 31, 2018.

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)	September 30, 2019						December 31, 2018
	Loans		Related Allowance		Allowance / Loans		Loans		Related Allowance		Allowance / Loans
Impaired loans individually evaluated for impairment		$15,280		$321	2.10	%		$16,816		$127	0.76	%
Loans collectively evaluated for impairment	3,762,826		26,676		0.71		3,663,544		26,945		0.74
Total		$3,778,106		$26,997	0.71	%		$3,680,360		$27,072	0.74	%

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Management's Discussion and Analysis

Loan loss provisions of $400 thousand and $1.6 million, respectively, were charged to earnings for the three and nine months ended September 30, 2019, compared to $350 thousand and $750 thousand, respectively, for the three and nine months ended September 30, 2018. These provisions were based on management’s assessment of loss exposure, as well as loss allocations commensurate with growth and changes in the loan portfolio, including changes in asset quality and credit quality metrics.

Net charge-offs totaled $801 thousand and $1.7 million, respectively, for the three and nine months ended September 30, 2019. This compared to net charge-offs of $15 thousand and $729 thousand, respectively, for the same periods in 2018. The increase in year-to-date net charge-offs was concentrated in residential real estate and consumer home equity.

As of September 30, 2019, the allowance for loan losses was $27.0 million, or 0.71% of total loans, compared to $27.1 million, or 0.74% of total loans, at December 31, 2018.

The following table presents the allocation of the allowance for loan losses. The allocation below is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of any future loss trends. The total allowance is available to absorb losses from any segment of the loan portfolio.



(Dollars in thousands)	September 30, 2019				December 31, 2018
	Amount		% (1)		Amount		% (1)
Allocation of Allowance for Loan Losses
Commercial:
Commercial real estate		$16,801	40	%		$15,381	38	%
Commercial & industrial	3,447		15		5,847		17
Total commercial	20,248		55		21,228		55
Residential Real Estate:
Residential real estate	5,411		36		3,987		37
Consumer:
Home equity	1,013		8		1,603		8
Other	325		1		254		—
Total consumer	1,338		9		1,857		8
Total allowance for loan losses at end of period		$26,997	100	%		$27,072	100	%


(1)	Percentage of loans outstanding in 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. The Corporation uses funds to originate and purchase loans, purchase investment securities, conduct operations, expand the branch network and pay dividends to shareholders.

Deposits

The Corporation 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.

The Bank 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. The Bank uses these deposit sweep services to place customer and client funds into interest-bearing demand accounts, money market accounts, and/or time deposits issued by other participating banks. Customer and client 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. 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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Management's Discussion and Analysis

The following table presents a summary of deposits:



(Dollars in thousands)					Change
	September 30, 2019		December 31, 2018		$			%
Noninterest-bearing demand deposits		$619,839		$603,216		$16,623		3	%
Interest-bearing demand deposits	152,200		178,733		(26,533		)	(15	)
NOW accounts	478,462		466,568		11,894			3
Money market accounts	749,122		646,878		102,244			16
Savings accounts	362,868		373,545		(10,677		)	(3	)
Time deposits (in-market)	792,941		778,105		14,836			2
Total in-market deposits	3,155,432		3,047,045		108,387			4
Wholesale brokered time deposits	430,721		477,003		(46,282		)	(10	)
Total deposits		$3,586,153		$3,524,048		$62,105		2	%

Total deposits amounted to $3.6 billion at September 30, 2019, up by $62.1 million, or 2%, from December 31, 2018. This included a decrease of $46.3 million of out-of-market brokered time deposits. Excluding out-of-market brokered time deposits, in-market deposits were up by $108.4 million, or 4%, from the balance at December 31, 2018, largely due to an increase of $102.2 million in money market accounts.

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 $956.8 million at September 30, 2019, up by $6.1 million, or 1%, from the balance at the end of 2018.

See Note 7 to the Unaudited Consolidated Financial Statements for additional information regarding the October 2019 modification of certain FHLB advances.

Liquidity and Capital Resources

Liquidity Management

Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Corporation’s primary source of liquidity is in-market deposits, which funded approximately 59% of total average assets in the nine months ended September 30, 2019. 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.

The Corporation has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. Management employs stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of “business as usual” cash flows. In management’s estimation, risks are concentrated in two major categories: (1) runoff of in-market deposit balances; and (2) unexpected drawdown of loan commitments. Of the two categories, potential runoff of deposit balances would have the most significant impact on contingent liquidity. Our stress test scenarios, therefore, emphasize attempts to quantify deposits at risk over selected time horizons. In addition to these unexpected outflow risks, several other “business as usual” factors enter into the calculation of the adequacy of contingent liquidity including: (1) payment proceeds from loans and investment securities; (2) maturing debt obligations; and (3) maturing time deposits. The Corporation has established collateralized borrowing capacity with the FRB and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business. Borrowing capacity is impacted by the amount and type of assets available to be pledged.

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Management's Discussion and Analysis

The table below presents unused funding capacity by source as of the dates indicated:



(Dollars in thousands)
	September 30, 2019		December 31, 2018
Additional Funding Capacity:
Federal Home Loan Bank of Boston (1)		$601,520		$628,468
Federal Reserve Bank of Boston (2)	25,070		27,608
Unencumbered investment securities	445,994		493,623
Total		$1,072,584		$1,149,699


(1)	As of September 30, 2019 and December 31, 2018, loans with a carrying value of $2.0 billion and $2.0 billion, respectively, and securities available for sale with carrying values of $262.6 million and $236.7 million, respectively, were pledged to the FHLB resulting in this additional borrowing capacity.


(2)	As of September 30, 2019 and December 31, 2018, loans with a carrying value of $17.4 million and $22.9 million, respectively, and securities available for sale with a carrying value of $17.2 million and $16.4 million, respectively, were pledged to the FRB resulting in this additional unused borrowing capacity.

In addition to the amounts presented above, the Bank also had access to a $40.0 million unused line of credit with the FHLB.

The ALCO establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained within target ranges established by the ALCO during the nine months ended September 30, 2019. Based on its assessment of the liquidity considerations described above, management believes the Corporation’s sources of funding meet anticipated funding needs.

Net cash provided by operating activities amounted to $37.4 million for the nine months ended September 30, 2019, which was generated by net income of $53.6 million and adjustments to reconcile net income to net cash provided by operating activities. Net cash used in investing activities totaled $27.3 million for the nine months ended September 30, 2019, reflecting outflows to fund growth and purchases of loans and purchases of debt securities. These outflows were partially offset by net inflows from maturities, calls, sales and principal payments of securities. For the nine months ended September 30, 2019, net cash provided by financing activities amounted to $42.6 million, with net increases in deposits and FHLB advances, 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 $497.8 million at September 30, 2019, up by $49.6 million from December 31, 2018, including net income of $53.6 million and an increase of $19.4 million in the accumulated comprehensive income component of shareholders’ equity, reflecting an increase in the fair value of available for sale debt securities. These increases were partially offset by $26.1 million for dividend declarations.

The Corporation declared a quarterly dividend of 51 cents per share for the three months ended September 30, 2019, compared to 43 cents per share for the same period in 2018.

The ratio of total equity to total assets amounted to 9.58% at September 30, 2019 compared to a ratio of 8.94% at December 31, 2018. Book value per share at September 30, 2019 and December 31, 2018 amounted to $28.71 and $25.90, respectively.

The Bancorp and the Bank are subject to various regulatory capital requirements. Total risk-based capital ratio amounted to 12.94% at September 30, 2019, compared to 12.56% at December 31, 2018. Capital levels exceeded the regulatory minimum levels to be considered “well capitalized.” See Note 8 to the Unaudited Consolidated Financial Statements for additional discussion of regulatory capital requirements.

Off-Balance Sheet Arrangements

In the normal course of business, the Corporation engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. Such transactions are used to meet the financing needs of its customers and to manage the exposure to fluctuations in interest rates. These financial

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Management's Discussion and Analysis

transactions include commitments to extend credit, standby letters of credit, forward loan commitments, loan related derivative contracts and interest rate risk management contracts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. The Corporation’s credit policies with respect to interest rate swap agreements with commercial borrowers, commitments to extend credit, and standby letters of credit are similar to those used for loans. Interest rate risk management contracts with other counterparties are generally subject to bilateral collateralization terms.

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 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 the Corporation’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, to manage 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 September 30, 2019 and December 31, 2018, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation. 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 rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.

The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest rate 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 rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on- and off-balance sheet financial instruments as of September 30, 2019 and December 31, 2018. Interest 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

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Management's Discussion and Analysis

have certain minimum rate levels below which they will not fall. It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the periods indicated.



	September 30, 2019		December 31, 2018
	Months 1 - 12	Months 13 - 24	Months 1 - 12	Months 13 - 24
100 basis point rate decrease	(3.67)%	(5.57)%	(3.60)%	(5.30)%
100 basis point rate increase	2.72	0.77	1.94	(0.46)
200 basis point rate increase	6.53	3.52	5.85	2.62
300 basis point rate increase	10.35	5.99	9.75	5.49

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 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 interest 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 interest rates fall.

The overall 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 interest 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.

The banking industry attracted and retained low-cost core savings deposits during the low interest rate cycle that lasted several years. The ALCO recognizes that a portion of these increased levels of low-cost balances could continue to shift into higher yielding alternatives in the future, particularly if interest rates rise and as confidence in financial markets strengthens, and has modeled 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.

Mortgage-backed securities and residential real estate 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.

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Management's Discussion and Analysis

The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of September 30, 2019 and December 31, 2018 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)		$1,222			($8,472	)
Obligations of states and political subdivisions	—			—
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	14,108			(63,966		)
Trust preferred debt and other corporate debt securities	(107		)	173
Total change in market value as of September 30, 2019		$15,223			($72,265	)
Total change in market value as of December 31, 2018		$31,617			($85,191	)

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, as amended (the “Exchange Act”), the Corporation carried out an evaluation under the supervision and with the participation of the Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, of the Corporation’s disclosure controls and procedures as of the period ended September 30, 2019. 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 controls over financial reporting during the quarter ended September 30, 2019 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, 2018.

Item 6. Exhibits

(a) Exhibits. The following exhibits are included as part of this Form 10-Q:



Exhibit Number
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – Filed herewith.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – Filed herewith.
32.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Furnished herewith. (1)
101	The following materials from Washington Trust Bancorp, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 2019 formatted in Inline XBRL: (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 consolidated financial statements.
104	The cover page from the Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2019 has been formatted in Inline XBRL and contained in Exhibit 101.

____________________


(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:	November 4, 2019	By:	/s/ Edward O. Handy III
			Edward O. Handy III
			Chairman and Chief Executive Officer
			(principal executive officer)

Date:	November 4, 2019	By:	/s/ Ronald S. Ohsberg
			Ronald S. Ohsberg
			Senior Executive Vice President, Chief Financial Officer and Treasurer
			(principal financial officer)

Date:	November 4, 2019	By:	/s/ Maria N. Janes
			Maria N. Janes
			Executive Vice President and Controller
			(principal accounting officer)

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