Form 10-Q 2012.06.30 10Q

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

FORM 10-Q

(Mark One)
 x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended JUNE 30, 2012 or
 o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______.

Commission file number:  001-32991

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

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

(401) 348-1200
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes          oNo

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

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

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

The number of shares of common stock of the registrant outstanding as of August 3, 2012 was 16,363,048.



FORM 10-Q
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
For the Quarter Ended June 30, 2012
 
 
 
TABLE OF CONTENTS
 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




2


PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands,
CONSOLIDATED BALANCE SHEETS (unaudited)
except par value)
 
 
June 30,
2012
 
December 31,
2011
Assets:
 
 
 
 
Cash and due from banks
 

$66,702

 

$82,238

Short-term investments
 
3,913

 
4,782

Mortgage loans held for sale, at fair value; amortized cost $22,708 in 2012 and $19,624 in 2011
 
23,530

 
20,340

Securities:
 
 
 
 
Available for sale, at fair value; amortized cost $452,733 in 2012 and $524,036 in 2011
469,167

 
541,253

Held to maturity, at cost; fair value $48,220 in 2012 and $52,499 in 2011
 
47,026

 
52,139

Total securities
 
516,193

 
593,392

Federal Home Loan Bank stock, at cost
 
40,418

 
42,008

Loans:
 
 
 
 
Commercial
 
1,191,995

 
1,124,628

Residential real estate
 
702,019

 
700,414

Consumer
 
319,828

 
322,117

Total loans
 
2,213,842

 
2,147,159

Less allowance for loan losses
 
30,448

 
29,802

Net loans
 
2,183,394

 
2,117,357

Premises and equipment, net
 
27,223

 
26,028

Investment in bank-owned life insurance
 
54,746

 
53,783

Goodwill
 
58,114

 
58,114

Identifiable intangible assets, net
 
6,528

 
6,901

Other assets
 
60,289

 
59,155

Total assets
 

$3,041,050

 

$3,064,098

Liabilities:
 
 
 
 
Deposits:
 
 
 
 
Demand deposits
 

$321,488

 

$339,809

NOW accounts
 
263,124

 
257,031

Money market accounts
 
388,686

 
406,777

Savings accounts
 
264,772

 
243,904

Time deposits
 
892,383

 
878,794

Total deposits
 
2,130,453

 
2,126,315

Federal Home Loan Bank advances
 
523,989

 
540,450

Junior subordinated debentures
 
32,991

 
32,991

Other borrowings
 
481

 
19,758

Other liabilities
 
60,402

 
63,233

Total liabilities
 
2,748,316

 
2,782,747

Commitments and contingencies
 


 


Shareholders’ Equity:
 
 
 
 
Common stock of $.0625 par value; authorized 30,000,000 shares; issued and outstanding 16,359,394 shares in 2012 and 16,292,471 shares in 2011
 
1,022

 
1,018

Paid-in capital
 
90,022

 
88,030

Retained earnings
 
203,726

 
194,198

Accumulated other comprehensive loss
 
(2,036
)
 
(1,895
)
Total shareholders’ equity
 
292,734

 
281,351

Total liabilities and shareholders’ equity
 

$3,041,050

 

$3,064,098



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


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars and shares in thousands,
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
except per share amounts)
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans

$25,344

 

$24,707

 

$50,707

 

$48,966

Interest on securities:
Taxable
4,069

 
4,869

 
8,446

 
9,642

 
Nontaxable
682

 
758

 
1,375

 
1,527

Dividends on corporate stock and Federal Home Loan Bank stock
78

 
66

 
155

 
133

Other interest income
17

 
13

 
37

 
37

Total interest income
30,190

 
30,413

 
60,720

 
60,305

Interest expense:
 

 
 

 
 

 
 

Deposits
3,385

 
4,030

 
6,819

 
8,232

Federal Home Loan Bank advances
3,998

 
4,685

 
8,083

 
9,417

Junior subordinated debentures
391

 
392

 
783

 
782

Other interest expense
5

 
242

 
239

 
483

Total interest expense
7,779

 
9,349

 
15,924

 
18,914

Net interest income
22,411

 
21,064

 
44,796

 
41,391

Provision for loan losses
600

 
1,200

 
1,500

 
2,700

Net interest income after provision for loan losses
21,811

 
19,864

 
43,296

 
38,691

Noninterest income:
 

 
 

 
 

 
 

Wealth management services:
 

 
 

 
 

 
 

Trust and investment advisory fees
5,819

 
5,822

 
11,597

 
11,498

Mutual fund fees
1,002

 
1,135

 
2,027

 
2,258

Financial planning, commissions and other service fees
652

 
553

 
1,034

 
834

Wealth management services
7,473

 
7,510

 
14,658

 
14,590

Service charges on deposit accounts
764

 
909

 
1,523

 
1,841

Merchant processing fees
2,732

 
2,682

 
4,720

 
4,626

Card interchange fees
626

 
581

 
1,169

 
1,068

Income from bank-owned life insurance
477

 
482

 
963

 
958

Net gains on loan sales and commissions on loans originated for others
3,015

 
537

 
6,112

 
1,062

Net realized gains on securities
299

 
226

 
299

 
197

Net (losses) gains on interest rate swap contracts
(4
)
 
(35
)
 
24

 
41

Equity in earnings (losses) of unconsolidated subsidiaries
124

 
(145
)
 
87

 
(289
)
Other income
668

 
538

 
1,060

 
921

Noninterest income, excluding other-than-temporary impairment losses
16,174

 
13,285

 
30,615

 
25,015

Total other-than-temporary impairment losses on securities

 

 
(85
)
 
(54
)
Portion of loss recognized in other comprehensive income (before tax)

 

 
(124
)
 
21

Net impairment losses recognized in earnings

 

 
(209
)
 
(33
)
Total noninterest income
16,174

 
13,285

 
30,406

 
24,982

Noninterest expense:
 

 
 

 
 

 
 

Salaries and employee benefits
14,451

 
12,398

 
28,911

 
24,226

Net occupancy
1,527

 
1,236

 
3,053

 
2,557

Equipment
1,143

 
1,070

 
2,250

 
2,119

Merchant processing costs
2,320

 
2,345

 
3,983

 
4,014

Outsourced services
895

 
875

 
1,815

 
1,747

FDIC deposit insurance costs
426

 
464

 
884

 
1,187

Legal, audit and professional fees
519

 
467

 
1,001

 
959

Advertising and promotion
478

 
427

 
850

 
780

Amortization of intangibles
186

 
237

 
373

 
475

Foreclosed property costs
170

 
338

 
468

 
504

Debt prepayment penalties
961

 
221

 
961

 
221

Other expenses
2,152

 
2,186

 
4,078

 
4,215

Total noninterest expense
25,228

 
22,264

 
48,627

 
43,004

Income before income taxes
12,757

 
10,885

 
25,075

 
20,669

Income tax expense
4,044

 
3,320

 
7,924

 
6,304

Net income

$8,713

 

$7,565

 

$17,151

 

$14,365

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
16,358

 
16,252

 
16,344

 
16,225

Weighted average common shares outstanding - diluted
16,392

 
16,284

 
16,381

 
16,257

Per share information:
Basic earnings per common share

$0.53

 

$0.46

 

$1.04

 

$0.88

 
Diluted earnings per common share

$0.53

 

$0.46

 

$1.04

 

$0.88

 
Cash dividends declared per share

$0.23

 

$0.22

 

$0.46

 

$0.44


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


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
 

 
 
Three Months
 
Six Months
Periods ended June 30,
 
2012
 
2011
 
2012
 
2011
Net income
 

$8,713

 

$7,565

 

$17,151

 

$14,365

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
 
Unrealized (losses) gains on securities arising during the period
 
(601
)
 
3,537

 
(458
)
 
3,626

Less: reclassification adjustment for net gains on securities realized in net income
 
192

 
145

 
138

 
92

Net unrealized (losses) gains on securities available for sale
 
(793
)
 
3,392

 
(596
)
 
3,534

Reclassification adjustment for change in non-credit portion of OTTI realized losses transferred to net income
 

 

 
80

 
(13
)
Cash flow hedges:
 
 
 
 
 
 
 
 
Unrealized losses on cash flow hedges arising during the period
 
(128
)
 
(468
)
 
(204
)
 
(419
)
Less: reclassification adjustment for amount of gains on cash flow hedges realized in net income
 
112

 
122

 
223

 
245

Net unrealized (losses) gains on cash flow hedges
 
(16
)
 
(346
)
 
19

 
(174
)
Defined benefit plan obligation adjustment
 
171

 
60

 
356

 
120

Total other comprehensive (loss) income, net of tax
 
(638
)
 
3,106

 
(141
)
 
3,467

Total comprehensive income
 

$8,075

 

$10,671

 

$17,010

 

$17,832




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


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars and shares in thousands)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)

 
Common
Shares Outstanding
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total
Balance at January 1, 2011
16,172

 

$1,011

 

$84,889

 

$178,939

 

$4,025

 

$268,864

Net income
 
 
 
 
 
 
14,365

 
 
 
14,365

Total other comprehensive income, net of tax
 
 
 
 
 
 
 
 
3,467

 
3,467

Cash dividends declared
 
 
 
 
 
 
(7,226
)
 
 
 
(7,226
)
Share-based compensation
 
 
 
 
680

 
 
 
 
 
680

Exercise of stock options, issuance of other compensation-related equity instruments and related tax benefit
73

 
4

 
787

 
 
 
 
 
791

Shares issued – dividend reinvestment plan
21

 
2

 
482

 
 
 
 
 
484

Balance at June 30, 2011
16,266

 

$1,017

 

$86,838

 

$186,078

 

$7,492

 

$281,425



 
Common
Shares Outstanding
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Balance at January 1, 2012
16,292

 

$1,018

 

$88,030

 

$194,198

 

($1,895
)
 

$281,351

Net income
 
 
 
 
 
 
17,151

 
 
 
17,151

Total other comprehensive loss, net of tax
 
 
 
 
 
 
 
 
(141
)
 
(141
)
Cash dividends declared
 
 
 
 
 
 
(7,623
)
 
 
 
(7,623
)
Share-based compensation
 
 
 
 
876

 
 
 
 
 
876

Deferred compensation plan
10

 
1

 
145

 
 
 
 
 
146

Exercise of stock options, issuance of other compensation-related equity instruments and related tax benefit
57

 
3

 
971

 
 
 
 
 
974

Balance at June 30, 2012
16,359

 

$1,022

 

$90,022

 

$203,726

 

($2,036
)
 

$292,734




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


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Six months ended June 30,
2012

 
2011

Cash flows from operating activities:
 
 
 
Net income

$17,151

 

$14,365

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
1,500

 
2,700

Depreciation of premises and equipment
1,584

 
1,540

Foreclosed and repossessed property valuation adjustments
171

 
392

Net gain on sale of bank property
(348
)
 
(203
)
Net amortization of premium and discount
1,113

 
664

Net amortization of intangibles
373

 
475

Share-based compensation
876

 
680

Income from bank-owned life insurance
(963
)
 
(958
)
Net gains on loan sales and commissions on loans originated for others
(6,112
)
 
(1,062
)
Net realized gains on securities
(299
)
 
(197
)
Net impairment losses recognized in earnings
209

 
33

Net gains on interest rate swap contracts
(24
)
 
(41
)
Equity in (earnings) losses of unconsolidated subsidiaries
(87
)
 
289

Proceeds from sales of loans
213,852

 
52,714

Loans originated for sale
(198,824
)
 
(46,587
)
(Increase) decrease in other assets
(3,108
)
 
2,291

Decrease in other liabilities
(2,932
)
 
(5,888
)
Net cash provided by operating activities
24,132

 
21,207

Cash flows from investing activities:
 

 
 

Purchases of mortgage-backed securities available for sale

 
(90,855
)
Proceeds from sale of:
Mortgage-backed securities available for sale
6,247

 
42,783

 
Other investment securities available for sale
6,338

 
1,000

Maturities and principal payments of:
Mortgage-backed securities available for sale
57,196

 
54,494

 
Other investment securities available for sale
681

 

 
Mortgage-backed securities held to maturity
4,842

 

Remittance of Federal Home Loan Bank stock
1,590

 

Net increase in loans
(76,517
)
 
(60,274
)
Purchases of loans, including purchased interest
(3,047
)
 
(3,116
)
Proceeds from the sale of property acquired through foreclosure or repossession
1,883

 
1,675

Purchases of premises and equipment
(3,453
)
 
(1,239
)
Net proceeds from the sale of bank property
1,571

 
1,279

Equity investments in real estate limited partnerships

 
(294
)
Net cash used in investing activities
(2,669
)
 
(54,547
)
Cash flows from financing activities:
 

 
 

Net increase (decrease) in deposits
4,138

 
(40,287
)
Net decrease in other borrowings
(19,277
)
 
(1,354
)
Proceeds from Federal Home Loan Bank advances
362,930

 
248,078

Repayment of Federal Home Loan Bank advances
(379,391
)
 
(188,360
)
Proceeds from the issuance of common stock under dividend reinvestment plan

 
484

Proceeds from the exercise of stock options and issuance of other compensation-related equity instruments
1,007

 
725

Tax benefit from stock option exercises and issuance of other compensation-related equity instruments
113

 
68

Cash dividends paid
(7,388
)
 
(7,005
)
Net cash (used in) provided by financing activities
(37,868
)
 
12,349

Net decrease in cash and cash equivalents
(16,405
)
 
(20,991
)
Cash and cash equivalents at beginning of period
87,020

 
92,736

Cash and cash equivalents at end of period

$70,615

 

$71,745

 
 
 
 
 
Noncash Investing and Financing Activities:
 
 
 
Loans charged off

$1,377

 

$2,096

Loans transferred to property acquired through foreclosure or repossession
1,810

 
801

Securities proceeds due from broker
760

 

 
 
 
 
 
Supplemental Disclosures:
 
 
 
 
Interest payments

$15,602

 

$18,710

Income tax payments
7,744

 
5,836


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


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



(1)
General Information
Washington Trust Bancorp, Inc. (the “Bancorp”) is a publicly-owned registered bank holding company and financial holding company.  The Bancorp owns all of the outstanding common stock of The Washington Trust Company (the “Bank”), a Rhode Island chartered commercial bank founded in 1800.  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.

The consolidated financial statements include the accounts of the Bancorp and its subsidiaries (collectively, the “Corporation” or “Washington Trust”).  All significant intercompany transactions have been eliminated.  Certain prior year amounts have been reclassified to conform to the current year classification.  Such reclassifications have no effect on previously reported net income or shareholders’ equity.

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.  Material estimates that are particularly susceptible to change are the determination of the allowance for loan losses and the review of goodwill, other intangible assets and investments for impairment.  The current economic environment has increased the degree of uncertainty inherent in such estimates and assumptions.

In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) and disclosures necessary to present fairly the Corporation’s financial position as of June 30, 2012 and December 31, 2011, respectively, and the results of operations and cash flows for the interim periods presented. Interim results are not necessarily reflective of the results of the entire year.  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.  The accompanying 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 year ended December 31, 2011.

(2)
Recently Issued Accounting Pronouncements
Fair Value Measurement – Topic 820
Accounting Standards Update No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“ASU 2011-04”), was issued in May 2011. The amendments in ASU 2011-04 added language to clarify many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements, as well as prescribed additional disclosures for Level 3 fair value measurements and financial instruments not carried at fair value. For many of the requirements, the Financial Accounting Standards Board (“FASB”) did not intend for ASU 2011-04 to result in a change in the application of the requirements in GAAP. The amendments required by ASU 2011-04 were to be applied prospectively and were effective for fiscal years and interim periods within those years, beginning after December 15, 2011. The Corporation adopted ASU 2011-04 in the first quarter of 2012, provided the additional disclosures required and made the election to use the exception permitted with respect to measuring counterparty credit risk on our interest rate derivative contracts. See Note 10 to the Consolidated Financial Statements for additional information. The adoption of ASU 2011-04 did not have a material impact on the Corporation’s consolidated financial position, results of operations or cash flows.

Comprehensive Income – Topic 220
Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), was issued in June 2011.  The FASB issued ASU 2011-05 to improve the comparability and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity.  ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  Accounting Standards Update No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”), was issued in December 2011. ASU 2011-12 deferred the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated



8


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


other comprehensive income into net income. No other requirements in ASU 2011-05 were affected by this amendment. The provisions of ASU 2011-05, exclusive of the provisions pertaining to the reclassification adjustments deferred by ASU 2011-12, were to be applied retrospectively and were effective for fiscal years and interim periods within those years, beginning after December 15, 2011. The Corporation adopted these provisions of ASU 2011-05 in the first quarter of 2012 and elected to present comprehensive income in a separate financial statement, the Consolidated Statements of Comprehensive Income. The adoption of these provisions of ASU 2011-05 did not have a material impact on the Corporation’s consolidated financial position, results of operations or cash flows.

Intangibles-Goodwill and Other – Topic 350
Accounting Standards Update No. 2011-08, “Testing for Goodwill Impairment” (“ASU 2011-08”), was issued in September 2011. The objective of ASU 2011-08 was to simplify the testing of goodwill for impairment by allowing entities to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative test. There will no longer be a requirement to calculate the fair value of a reporting unit unless it is determined, based on a qualitative assessment, that it is more-likely-than-not that its fair value is less than its carrying amount. The more-likely-than-not threshold was defined as having a likelihood of more than 50 percent. The provisions of ASU 2011-08 are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of ASU 2011-08 did not have a material impact on the Corporation’s consolidated financial position, results of operations or cash flows.

Balance Sheet - Topic 210
Accounting Standards Update No. 2011-11, “Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”), was issued in December 2011 and was intended to enhance current disclosure requirements on offsetting financial assets and liabilities. The requirements in ASU 2011-11 enables users to compare balance sheets prepared under U.S. GAAP and International Financial Reporting Standards (“IFRS”), which are subject to different offsetting models. The requirements affect all entities that have financial instruments that are either offset in the balance sheet or subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11 will be effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The required disclosures shall be provided retrospectively for all comparative periods presented. The adoption of ASU 2011-11 is not expected to have a material impact on the Corporation’s consolidated financial position, results of operations or cash flows.

(3)
Cash and Due from Banks
The Bank is required to maintain certain average reserve balances with the Board of Governors of the Federal Reserve System.  Such reserve balances amounted to $4.0 million at both June 30, 2012 and December 31, 2011 and are included in cash and due from banks in the Consolidated Statements of Condition.

As of June 30, 2012 and December 31, 2011, cash and due from banks included interest-bearing deposits in other banks of $22.4 million and $41.6 million, respectively.




9


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(4)
Securities
The following tables present the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value of securities by major security type and class of security at June 30, 2012 and December 31, 2011.

(Dollars in thousands)
 
 
 
 
 
 
 
June 30, 2012
Amortized Cost (1)
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$29,443

 

$2,876

 

$—

 

$32,319

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
305,757

 
18,535

 

 
324,292

States and political subdivisions
68,939

 
4,784

 

 
73,723

Trust preferred securities:
 
 
 
 
 
 
 
Individual name issuers
30,658

 

 
(7,038
)
 
23,620

Collateralized debt obligations
4,047

 

 
(3,280
)
 
767

Corporate bonds
13,889

 
659

 
(102
)
 
14,446

Total securities available for sale

$452,733

 

$26,854

 

($10,420
)
 

$469,167

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

$47,026

 

$1,194

 

$—

 

$48,220

Total securities held to maturity

$47,026

 

$1,194

 

$—

 

$48,220

Total securities

$499,759

 

$28,048

 

($10,420
)
 

$517,387


(Dollars in thousands)
 
 
 
 
 
 
 
December 31, 2011
Amortized Cost (1)
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Securities Available for Sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$29,429

 

$3,404

 

$—

 

$32,833

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
369,946

 
19,712

 

 
389,658

States and political subdivisions
74,040

 
5,453

 

 
79,493

Trust preferred securities:
 
 
 
 
 
 
 
Individual name issuers
30,639

 

 
(8,243
)
 
22,396

Collateralized debt obligations
4,256

 

 
(3,369
)
 
887

Corporate bonds
13,872

 
813

 
(403
)
 
14,282

Perpetual preferred stocks (2)
1,854

 

 
(150
)
 
1,704

Total securities available for sale

$524,036

 

$29,382

 

($12,165
)
 

$541,253

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

$52,139

 

$360

 

$—

 

$52,499

Total securities held to maturity

$52,139

 

$360

 

$—

 

$52,499

Total securities

$576,175

 

$29,742

 

($12,165
)
 

$593,752

(1)    Net of other-than-temporary impairment losses.
(2)    Callable at the discretion of the issuer.



10


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Securities available for sale (“AFS”) and held to maturity (“HTM”) with a fair value of $469.1 million and $558.2 million, respectively, were pledged to secure borrowings with the Federal Home Loan Bank of Boston ("FHLBB"), potential borrowings with the Federal Reserve Bank, certain public deposits and for other purposes at June 30, 2012 and December 31, 2011.

The following table presents a roll forward of the balance of credit-related impairment losses on debt securities, for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:
(Dollars in thousands)
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Balance at beginning of period

$3,313

 

$2,946

 

$3,104

 

$2,913

Credit-related impairment loss on debt securities for which an other-than-temporary impairment was not previously recognized

 

 

 

Additional increases to the amount of credit-related impairment loss on debt securities for which an other-than-temporary impairment was previously recognized

 

 
209

 
33

Balance at end of period

$3,313

 

$2,946

 

$3,313

 

$2,946


There were no credit-related impairment losses recognized in earnings on debt securities in both the three months ended June 30, 2012 and 2011. For the six months ended June 30, 2012 and 2011, credit-related impairment losses recognized in earnings on debt securities totaled $209 thousand and $33 thousand, respectively. The anticipated cash flows expected to be collected from these pooled trust preferred debt securities were discounted at the rate equal to the yield used to accrete the current and prospective beneficial interest for each security.  Significant inputs included estimated cash flows and prospective defaults and recoveries.  Estimated cash flows are generated based on the underlying seniority status and subordination structure of the pooled trust preferred debt tranche at the time of measurement.  Prospective default and recovery estimates affecting projected cash flows were based on analysis of the underlying financial condition of individual issuers, and took into account capital adequacy, credit quality, lending concentrations, and other factors.

All cash flow estimates were based on the underlying security’s tranche structure and contractual rate and maturity terms.  The present value of the expected cash flows was compared to the current outstanding balance of the tranche to determine the ratio of the estimated present value of expected cash flows to the total current balance for the tranche.  This ratio was then multiplied by the principal balance of Washington Trust’s holding to determine the credit-related impairment loss.  The estimates used in the determination of the present value of the expected cash flows are susceptible to changes in future periods, which could result in additional credit-related impairment losses.

The following table summarizes temporarily impaired securities at June 30, 2012, 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
June 30, 2012
#

 
Fair
Value
 
Unrealized
Losses
 
#

 
Fair
Value
 
Unrealized
Losses
 
#

 
Fair
Value
 
Unrealized
Losses
Trust preferred securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individual name issuers

 

$—

 

$—

 
11

 

$23,620

 

($7,038
)
 
11

 

$23,620

 

($7,038
)
Collateralized debt obligations

 

 

 
2

 
767

 
(3,280
)
 
2

 
767

 
(3,280
)
Corporate bonds
3

 
5,505

 
(102
)
 

 

 

 
3

 
5,505

 
(102
)
Subtotal, debt securities
3

 
5,505

 
(102
)
 
13

 
24,387

 
(10,318
)
 
16

 
29,892

 
(10,420
)
Total temporarily impaired securities
3

 

$5,505

 

($102
)
 
13

 

$24,387

 

($10,318
)
 
16

 

$29,892

 

($10,420
)



11


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table summarizes temporarily impaired securities at December 31, 2011, 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
December 31, 2011
#

 
Fair
Value
 
Unrealized
Losses
 
#

 
Fair
Value
 
Unrealized
Losses
 
#

 
Fair
Value
 
Unrealized
Losses
Trust preferred securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individual name issuers

 

$—

 

$—

 
11

 

$22,396

 

($8,243
)
 
11

 

$22,396

 

($8,243
)
Collateralized debt obligations

 

 

 
2

 
887

 
(3,369
)
 
2

 
887

 
(3,369
)
Corporate bonds
3

 
5,203

 
(403
)
 

 

 

 
3

 
5,203

 
(403
)
Subtotal, debt securities
3

 
5,203

 
(403
)
 
13

 
23,283

 
(11,612
)
 
16

 
28,486

 
(12,015
)
Perpetual preferred stocks
2

 
1,704

 
(150
)
 

 

 

 
2

 
1,704

 
(150
)
Total temporarily impaired securities
5

 

$6,907

 

($553
)
 
13

 

$23,283

 

($11,612
)
 
18

 

$30,190

 

($12,165
)

Unrealized losses on debt securities generally occur as a result of increases in interest rates since the time of purchase, a structural change in an investment or deterioration in credit quality of the issuer.  Management evaluates impairments in value whether caused by adverse interest rates or credit movements to determine if they are other-than-temporary.

Further deterioration in credit quality of the companies backing the securities, further deterioration in the condition of the financial services industry, a continuation or worsening of the current economic downturn, 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 additional write-downs.

Trust Preferred Debt Securities of Individual Name Issuers
Included in debt securities in an unrealized loss position at June 30, 2012 were 11 trust preferred security holdings issued by seven individual companies in the financial services/banking industry.  The aggregate unrealized losses on these debt securities amounted to $7.0 million at June 30, 2012.  Management believes the decline in fair value of these trust preferred securities primarily reflects investor concerns about global economic growth and how it will affect the recent and potential future losses in the financial services industry.  These concerns resulted in increased risk premiums for securities in this sector.  Based on the information available through the filing date of this report, all individual name trust preferred debt securities held in our portfolio continue to accrue and make payments as expected with no payment deferrals or defaults on the part of the issuers.  As of June 30, 2012, trust preferred debt securities with an amortized cost of $11.8 million and unrealized losses of $2.5 million were rated below investment grade by Standard & Poors, Inc. (“S&P”).  Management reviewed the collectibility of these securities taking into consideration such factors as the financial condition of the issuers, reported regulatory capital ratios of the issuers, credit ratings including ratings in effect as of the reporting period date as well as credit rating changes between the reporting period date and the filing date of this report and other information.  We noted no additional downgrades to below investment grade between the reporting period date and the filing date of this report.  Based on these analyses, management concluded that it expects to recover the entire amortized cost basis of these securities.  Furthermore, Washington Trust does not intend to sell these securities and it is not more likely than not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be maturity.  Therefore, management does not consider these investments to be other-than-temporarily impaired at June 30, 2012.

Trust Preferred Debt Securities in the Form of Collateralized Debt Obligations
Washington Trust has two pooled trust preferred holdings in the form of collateralized debt obligations with a total amortized cost of $4.0 million and aggregate unrealized losses of $3.3 million at June 30, 2012.  These pooled trust preferred holdings consist of trust preferred obligations of banking industry companies and, to a lesser extent, insurance industry companies.  For both of these pooled trust preferred securities, Washington Trust’s investment is senior to one or more subordinated tranches which have first loss exposure.  Valuations of the pooled trust preferred holdings are dependent in part on cash flows from underlying issuers.  Unexpected cash flow disruptions could have an adverse impact on the fair value and performance of pooled trust preferred securities.  Management believes the unrealized losses on these pooled trust preferred securities primarily reflect investor concerns about global economic growth and how it will affect the recent and potential future losses in the financial services industry and the possibility of further incremental deferrals of or defaults on interest payments on trust preferred debentures by financial institutions participating in these pools.  These concerns have resulted in a substantial decrease in market



12


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


liquidity and increased risk premiums for securities in this sector.  Credit spreads for issuers in this sector have remained wide during recent months, causing prices for these securities holdings to remain at low levels.

As of June 30, 2012, one of the pooled trust preferred securities had an amortized cost of $2.8 million.  This security was placed on nonaccrual status in March 2009. The tranche instrument held by Washington Trust has been deferring a portion of interest payments since April 2010.  The June 30, 2012 amortized cost was net of $2.1 million of credit-related impairment losses previously recognized in earnings, reflective of payment deferrals and credit deterioration of the underlying collateral. Included in the $2.1 million were credit-related impairment losses of $209 thousand recorded in the first quarter of 2012, reflecting adverse changes in the expected cash flows for this security. As of June 30, 2012, this security has unrealized losses of $2.2 million and a below investment grade rating of “Ca” by Moody’s Investors Service Inc. (“Moody’s”).  Through the filing date of this report, there have been no further rating changes on this security.  This credit rating status has been considered by management in its assessment of the impairment status of this security.

As of June 30, 2012, the second pooled trust preferred security held by Washington Trust had an amortized cost of $1.3 million.  This security was placed on nonaccrual status in December 2008. The tranche instrument held by Washington Trust has been deferring interest payments since December 2008. The June 30, 2012 amortized cost was net of $1.2 million of credit-related impairment losses previously recognized in earnings reflective of payment deferrals and credit deterioration of the underlying collateral.  As of June 30, 2012, this security has unrealized losses of $1.1 million and a below investment grade rating of “C” by Moody’s.  Through the filing date of this report, there have been no rating changes on this security.  This credit rating status has been considered by management in its assessment of the impairment status of this security. The analysis of the expected cash flows for this security as of June 30, 2012 did not negatively affect the amount of credit-related impairment losses previously recognized on this security.

Based on information available through the filing date of this report, there have been no further adverse changes in the deferral or default status of the underlying issuer institutions within either of these trust preferred collateralized debt obligations.  Based on cash flow forecasts for these securities, management expects to recover the remaining amortized cost of these securities.  Furthermore, Washington Trust does not intend to sell these securities and it is not more likely than not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be at maturity.  Therefore, management does not consider the unrealized losses on these investments to be other-than-temporary.

Corporate Bonds:
At June 30, 2012, Washington Trust had three corporate bond holdings with unrealized losses of $102 thousand. These investment grade corporate bonds, maturing in three years, represent large financial corporations with potential exposure to the European markets. The unrealized losses on these securities are attributable to the increased risk premium required in the current economic environment.




13


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


As of June 30, 2012, the amortized cost of debt securities by maturity is presented below.  Mortgage-backed securities are included based on weighted average maturities, adjusted for anticipated prepayments.  All other 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.  Yields on tax exempt obligations are not computed on a tax equivalent basis.  Included in the securities portfolio at June 30, 2012 were debt securities with an amortized cost balance of $91.9 million and a fair value of $85.4 million that are callable at the discretion of the issuers.  Final maturities of the callable securities range from three to twenty-five years, with call features ranging from one month to five years.

(Dollars in thousands)
Within 1 Year
 
1-5 Years
 
5-10 Years
 
After 10 Years
 
Totals
Securities Available for Sale:
 
 
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises:
 
 
 
 
 
 
 
 
 
Amortized cost

$—

 

$29,443

 

$—

 

$—

 

$29,443

Weighted average yield
%
 
5.41
%
 
%
 
%
 
5.41
%
Mortgage-backed securities issued by U.S. government-sponsored enterprises:
 
 
 
 
 
 
 
 
 
Amortized cost
90,411

 
161,311

 
44,625

 
9,410

 
305,757

Weighted average yield
4.29
%
 
3.91
%
 
2.61
%
 
2.34
%
 
3.78
%
State and political subdivisions:
 
 
 
 
 
 
 
 
 
Amortized cost
4,083

 
64,053

 
803

 

 
68,939

Weighted average yield
3.62
%
 
3.90
%
 
3.81
%
 
%
 
3.89
%
Trust preferred securities:
 
 
 
 
 
 
 
 
 
Amortized cost (1)

 

 

 
34,705

 
34,705

Weighted average yield
%
 
%
 
%
 
1.83
%
 
1.83
%
Corporate bonds:
 
 
 
 
 
 
 
 
 
Amortized cost
3,196

 
10,693

 

 

 
13,889

Weighted average yield
6.32
%
 
4.73
%
 
%
 
%
 
5.09
%
Total debt securities available for sale:
 
 
 
 
 
 
 
 
 
Amortized cost

$97,690

 

$265,500

 

$45,428

 

$44,115

 

$452,733

Weighted average yield
4.33
%
 
4.11
%
 
2.63
%
 
1.94
%
 
3.80
%
Fair value

$101,209

 

$275,084

 

$48,189

 

$44,685

 

$469,167

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

$9,714

 

$23,013

 

$10,631

 

$3,668

 

$47,026

Weighted average yield
2.67
%
 
2.56
%
 
2.44
%
 
1.49
%
 
2.47
%
Fair value

$9,961

 

$23,597

 

$10,901

 

$3,761

 

$48,220

(1)
Net of other-than-temporary impairment losses.




14


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(5)
Loans
The following is a summary of loans:
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount

 
%

 
Amount

 
%

Commercial:
 
 
 
 
 
 
 
Mortgages (1)

$664,410

 
30
%
 

$624,813

 
29
%
Construction and development (2)
17,365

 
1

 
10,955

 
1

Other (3)
510,220

 
23

 
488,860

 
22

Total commercial
1,191,995

 
54

 
1,124,628

 
52

Residential real estate:
 
 
 
 
 
 
 
Mortgages (4)
680,772

 
31

 
678,582

 
32

Homeowner construction
21,247

 
1

 
21,832

 
1

Total residential real estate
702,019

 
32

 
700,414

 
33

Consumer:
 
 
 
 
 
 
 
Home equity lines (5)
224,550

 
10

 
223,430

 
10

Home equity loans (5)
40,690

 
2

 
43,121

 
2

Other (6)
54,588

 
2

 
55,566

 
3

Total consumer
319,828

 
14

 
322,117

 
15

Total loans (7)

$2,213,842

 
100
%
 

$2,147,159

 
100
%
(1)
Amortizing mortgages and lines of credit, primarily secured by income producing property. As of June 30, 2012 and December 31, 2011, $99.2 million and $107.1 million, respectively, of these loans were pledged as collateral for FHLBB borrowings (see Note 8).
(2)
Loans for construction of residential and commercial properties and for land development.
(3)
Loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate. As of June 30, 2012, $24.3 million and $36.3 million, respectively, of these loans were pledged as collateral for FHLBB borrowings and were collateralized for the discount window at the Federal Reserve Bank.  Comparable amounts for December 31, 2011 were $27.2 million and $42.1 million, respectively (see Note 8).
(4)
As of June 30, 2012 and December 31, 2011, $598.3 million and $611.8 million, respectively, of these loans were pledged as collateral for FHLBB borrowings (see Note 8).
(5)
As of June 30, 2012 and December 31, 2011, $190.1 million and $165.4 million, respectively, of these loans were pledged as collateral for FHLBB borrowings (see Note 8).
(6)
Fixed-rate consumer installment loans.
(7)
Includes net unamortized loan origination costs of $6 thousand and $31 thousand, respectively, and net unamortized premiums on purchased loans of $58 thousand and $67 thousand, respectively, at June 30, 2012 and December 31, 2011.




15


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Nonaccrual Loans
Loans, with the exception of certain well-secured residential mortgage 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 residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured and the loan is in the process of collection. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued but not collected on such loans is reversed against current period income. Subsequent interest payments received on nonaccrual loans are applied to the outstanding principal balance of the loan or recognized as interest income depending on management's assessment of the ultimate collectability of the loan. Loans are removed from nonaccrual status when they have been current as to principal and interest 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.

The following is a summary of nonaccrual loans, segregated by class of loans, as of the dates indicated:
(Dollars in thousands)
Jun 30,
2012
 
Dec 31,
2011
Commercial:
 
 
 
Mortgages

$2,597

 

$5,709

Construction and development

 

Other
3,405

 
3,708

Residential real estate:
 
 
 
Mortgages
8,659

 
10,614

Homeowner construction

 

Consumer:
 
 
 
Home equity lines
695

 
718

Home equity loans
371

 
335

Other
15

 
153

Total nonaccrual loans

$15,742

 

$21,237

Accruing loans 90 days or more past due

$—

 

$—


As of June 30, 2012 and December 31, 2011, nonaccrual loans of $3.0 million and $3.6 million, respectively, were current as to the payment of principal and interest.




16


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


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, as of the dates indicated:

(Dollars in thousands)
Days Past Due
 
 
 
 
 
 
June 30, 2012
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$411

 

$233

 

$2,339

 

$2,983

 

$661,427

 

$664,410

Construction and development

 

 

 

 
17,365

 
17,365

Other
849

 
434

 
1,714

 
2,997

 
507,223

 
510,220

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
4,969

 
1,600

 
4,039

 
10,608

 
670,164

 
680,772

Homeowner construction

 

 

 

 
21,247

 
21,247

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
1,996

 
548

 
139

 
2,683

 
221,867

 
224,550

Home equity loans
482

 
114

 
223

 
819

 
39,871

 
40,690

Other
182

 
15

 

 
197

 
54,391

 
54,588

Total loans

$8,889

 

$2,944

 

$8,454

 

$20,287

 

$2,193,555

 

$2,213,842


(Dollars in thousands)
Days Past Due
 
 
 
 
 
 
December 31, 2011
30-59
 
60-89
 
Over 90
 
Total Past Due
 
Current
 
Total Loans
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$1,621

 

$315

 

$4,995

 

$6,931

 

$617,882

 

$624,813

Construction and development

 

 

 

 
10,955

 
10,955

Other
3,760

 
982

 
633

 
5,375

 
483,485

 
488,860

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
3,969

 
1,505

 
6,283

 
11,757

 
666,825

 
678,582

Homeowner construction

 

 

 

 
21,832

 
21,832

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
645

 
210

 
525

 
1,380

 
222,050

 
223,430

Home equity loans
362

 
46

 
202

 
610

 
42,511

 
43,121

Other
66

 
7

 
147

 
220

 
55,346

 
55,566

Total loans

$10,423

 

$3,065

 

$12,785

 

$26,273

 

$2,120,886

 

$2,147,159


Included in past due loans as of June 30, 2012 and December 31, 2011, were nonaccrual loans of $12.7 million and $17.6 million, respectively.




17


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Impaired Loans
Impaired loans are loans for which it is probable that the Corporation will not be able to collect all amounts due according to the contractual terms of the loan agreements and loans restructured in a troubled debt restructuring. Impaired loans do not include large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, which consist of most residential mortgage loans and consumer loans. The following is a summary of impaired loans, as of the dates indicated:
(Dollars in thousands)
Recorded
Investment (1)
 
Unpaid
Principal
 
Related
Allowance
 
Jun 30,
2012
 
Dec 31,
2011
 
Jun 30,
2012
 
Dec 31,
2011
 
Jun 30,
2012
 
Dec 31,
2011
No Related Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$1,158

 

$7,093

 

$1,155

 

$7,076

 

$—

 

$—

Construction and development

 

 

 

 

 

Other
2,681

 
1,622

 
2,677

 
1,620

 

 

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
1,224

 
2,383

 
1,605

 
2,471

 

 

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines

 

 

 

 

 

Home equity loans

 

 

 

 

 

Other

 

 

 

 

 

Subtotal

$5,063

 

$11,098

 

$5,437

 

$11,167

 

$—

 

$—

With Related Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$2,696

 

$5,023

 

$3,901

 

$6,760

 

$204

 

$329

Construction and development

 

 

 

 

 

Other
7,651

 
8,739

 
8,250

 
9,740

 
523

 
839

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
3,003

 
3,606

 
3,246

 
4,138

 
582

 
495

Homeowner construction

 

 

 

 

 

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity lines
105

 
278

 
172

 
373

 

 
82

Home equity loans
123

 
130

 
147

 
153

 
1

 
1

Other
139

 
205

 
140

 
227

 
1

 
69

Subtotal

$13,717

 

$17,981

 

$15,856

 

$21,391

 

$1,311

 

$1,815

Total impaired loans

$18,780

 

$29,079

 

$21,293

 

$32,558

 

$1,311

 

$1,815

Total:
 
 
 
 
 
 
 
 
 
 
 
Commercial

$14,186

 

$22,477

 

$15,983

 

$25,196

 

$727

 

$1,168

Residential real estate
4,227

 
5,989

 
4,851

 
6,609

 
582

 
495

Consumer
367

 
613

 
459

 
753

 
2

 
152

Total impaired loans

$18,780

 

$29,079

 

$21,293

 

$32,558

 

$1,311

 

$1,815

(1)
The recorded investment in impaired loans consists of unpaid principal balance, net of charge-offs, interest payments received applied to principal and unamortized deferred loan origination fees and costs. For impaired accruing loans (including those 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. As of June 30, 2012 and December 31, 2011, recorded investment in impaired loans included accrued interest of $17 thousand and $46 thousand, respectively.



18


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following tables present the average recorded investment and interest income recognized on impaired loans segregated by loan class for the periods indicated:
(Dollars in thousands)
Average Recorded Investment
 
Interest Income Recognized
Three months ended June 30,
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
Mortgages

$5,773

 

$15,231

 

$35

 

$149

Construction and development

 

 

 

Other
11,257

 
8,564

 
84

 
117

Residential real estate:
 
 
 
 
 
 
 
Mortgages
4,743

 
6,114

 
18

 
46

Homeowner construction

 

 

 

Consumer:
 
 
 
 
 
 
 
Home equity lines
138

 
96

 

 
2

Home equity loans
125

 
396

 
3

 
5

Other
143

 
260

 
3

 
4

Totals

$22,179

 

$30,661

 

$143

 

$323


(Dollars in thousands)
Average Recorded Investment
 
Interest Income Recognized
Six months ended June 30,
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
Mortgages

$8,382

 

$16,682

 

$105

 

$322

Construction and development

 

 

 

Other
11,049

 
10,014

 
158

 
211

Residential real estate:
 
 
 
 
 
 
 
Mortgages
5,102

 
5,574

 
45

 
90

Homeowner construction

 

 

 

Consumer:
 
 
 
 
 
 
 
Home equity lines
191

 
101

 
1

 
3

Home equity loans
148

 
427

 
4

 
11

Other
154

 
231

 
5

 
8

Totals

$25,026

 

$33,029

 

$318

 

$645


At June 30, 2012, there were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status or had been restructured.

Troubled Debt Restructurings
Loans are considered restructured in a troubled debt restructuring 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 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. 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 collectibility of the loan.



19


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


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.

Troubled debt restructurings are classified as impaired loans. The Corporation identifies loss allocations for impaired loans on an individual loan basis. The recorded investment in troubled debt restructurings was $13.3 million and $19.7 million, respectively, at June 30, 2012 and December 31, 2011. Included in these amounts was accrued interest of $16 thousand and $46 thousand, respectively. The allowance for loan losses included specific reserves for these troubled debt restructurings of $802 thousand and $858 thousand, respectively, at June 30, 2012 and December 31, 2011.

The following table presents loans modified as a troubled debt restructuring during the three months ended June 30, 2012 and 2011.
(Dollars in thousands)
 
 
 
 
Outstanding Recorded Investment (1)
 
# of Loans
 
Pre-Modifications
 
Post-Modifications
Three months ended June 30,
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
1

 

 

$197

 

$—

 

$197

 

$—

Other
2

 
2

 
375

 
561

 
375

 
561

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
2

 
2

 
651

 
427

 
651

 
427

Totals
5

 
4

 

$1,223

 

$988

 

$1,223

 

$988

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

The following table presents loans modified as a troubled debt restructuring during the six months ended June 30, 2012 and 2011.
(Dollars in thousands)
 
 
 
 
Outstanding Recorded Investment (1)
 
# of Loans
 
Pre-Modifications
 
Post-Modifications
Six months ended June 30,
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
3

 
2

 

$861

 

$215

 

$861

 

$215

Other
7

 
7

 
1,625

 
1,292

 
1,625

 
1,292

Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
Mortgages
2

 
5

 
651

 
1,310

 
651

 
1,310

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Other
2

 
1

 
5

 
117

 
5

 
117

Totals
14

 
15

 

$3,142

 

$2,934

 

$3,142

 

$2,934

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




20


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table provides information on how loans were modified as a troubled debt restructuring during the three and six months ended June 30, 2012 and 2011.
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Payment deferral

$240

 

$988

 

$240

 

$1,926

Maturity / amortization concession
24

 

 
917

 
667

Interest only payments

 

 
361

 
15

Below market interest rate concession
761

 

 
1,426

 

Combination (1)
198

 

 
198

 
326

Total

$1,223

 

$988

 

$3,142

 

$2,934

(1)
Loans included in this classification had a combination of any two of the concessions included in this table.

The following tables present loans modified in a troubled debt restructuring within the previous twelve months for which there was a payment default during the three and six months ended June 30, 2012 and 2011.
(Dollars in thousands)
# of Loans
 
Recorded
Investment (1)
Three months ended June 30,
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
Mortgages
1

 
2

 

$197

 

$196

Other
2

 
7

 
52

 
341

Residential real estate:
 
 


 
 
 
 
Mortgages
1

 
3

 
495

 
1,206

Consumer:
 
 
 
 
 
 
 
Other
1

 

 
12

 

Totals
5

 
12

 

$756

 

$1,743

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

(Dollars in thousands)
# of Loans
 
Recorded
Investment (1)
Six months ended June 30,
2012
 
2011
 
2012
 
2011
Commercial:
 
 
 
 
 
 
 
Mortgages
1

 
2

 

$197

 

$196

Other
2

 
8

 
52

 
395

Residential real estate:
 
 
 
 
 
 
 
Mortgages
1

 
5

 
495

 
1,596

Consumer:
 
 
 
 
 
 
 
Other
1

 

 
12

 

Totals
5

 
15

 

$756

 

$2,187

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




21


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Credit Quality Indicators
Commercial
The Corporation utilizes an internal rating system to assign a risk to each of its commercial loans. Loans are rated on a scale of 1 to 10. This scale can be assigned to three broad categories including “pass” for ratings 1 through 6, “special mention” for 7-rated loans, and “classified” for loans rated 8, 9 or 10. The loan rating system takes into consideration parameters including the borrower's financial condition, the borrower's performance with respect to loan terms, and the adequacy of collateral. As of June 30, 2012 and December 31, 2011, the weighted average risk rating of the Corporation's commercial loan portfolio was 4.80 and 4.87, respectively.

For non-impaired loans, the Corporation assigns a loss allocation factor to each loan, based on its risk rating for purposes of establishing an appropriate allowance for loan losses. See Note 6 for additional information.

Descriptions of the commercial loan categories are 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, 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 in nonaccrual status when management determines there is uncertainty of collectibility. A “doubtful” loan is placed on non-accrual status and has a high probability of loss, but the extent of the loss is difficult to quantify due to dependency upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. A loan in the “loss” category is considered generally uncollectible or the timing or amount of payments cannot be determined. "Loss" is not intended to imply that the loan has no recovery value but rather it is not practical or desirable to continue to carry the asset.

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

The following table presents the commercial loan portfolio, segregated by category of credit quality indicator:
(Dollars in thousands)
Pass
 
Special Mention
 
Classified
 
Jun 30,
2012
 
Dec 31,
2011
 
Jun 30,
2012
 
Dec 31,
2011
 
Jun 30,
2012
 
Dec 31,
2011
Mortgages

$626,603

 

$583,162

 

$25,182

 

$29,759

 

$12,625

 

$11,892

Construction and development
17,365

 
10,955

 

 

 

 

Other
480,782

 
455,577

 
22,589

 
22,731

 
6,849

 
10,552

Total commercial loans

$1,124,750

 

$1,049,694

 

$47,771

 

$52,490

 

$19,474

 

$22,444




22


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)



Residential and Consumer
The residential and consumer portfolios are monitored on an ongoing basis by the Corporation using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed on an aggregate basis in these relatively homogeneous portfolios.

For non-impaired loans, the Corporation assigns loss allocation factors to each respective loan type and delinquency status. See Note 6 for additional information.

Various other techniques are utilized to monitor indicators of credit deterioration in the portfolios of residential real estate mortgages and home equity lines and loans. Among these techniques is the periodic tracking of loans with an updated FICO score and an estimated loan to value (“LTV”) ratio. LTV is determined via statistical modeling analyses. The indicated LTV levels are estimated based on such factors as the location, the original LTV, and the date of origination of the loan and do not reflect actual appraisal amounts. The results of these analyses are taken into consideration in the determination of loss allocation factors for residential mortgage and home equity consumer credits. See Note 6 for additional information.

The following table presents the residential and consumer loan portfolios, segregated by category of credit quality indicator:
(Dollars in thousands)
Under 90 Days Past Due
 
Over 90 Days Past Due
 
Jun 30,
2012
 
Dec 31,
2011
 
Jun 30,
2012
 
Dec 31,
2011
Residential Real Estate:
 
 
 
 
 
 
 
Accruing mortgages

$672,113

 

$667,968

 

$—

 

$—

Nonaccrual mortgages
4,620

 
4,331

 
4,039

 
6,283

Homeowner construction
21,247

 
21,832

 

 

Total residential real estate loans

$697,980

 

$694,131

 

$4,039

 

$6,283

Consumer:
 
 
 
 
 
 
 
Home equity lines

$224,411

 

$222,905

 

$139

 

$525

Home equity loans
40,467

 
42,919

 
223

 
202

Other
54,588

 
55,419

 

 
147

Total consumer loans

$319,466

 

$321,243

 

$362

 

$874



(6)
Allowance for Loan Losses
The allowance for loan losses is management's best estimate of inherent risk of loss in the loan portfolio as of the balance sheet date. The 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 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 three elements: (1) identification of loss allocations for individual loans deemed to be impaired, (2) loss allocation factors for non-impaired loans based on credit grade, loss experience, delinquency factors and other similar economic indicators, and (3) general loss allocations for other environmental factors, which is classified as “unallocated”.

Periodic assessments and revisions to the loss allocation factors used in the assignment of loss exposure are made to appropriately reflect the analysis of migrational loss experience. The Corporation analyzes historical loss experience in the various portfolios over periods deemed to be relevant to the inherent risk of loss in the respective portfolios as of the balance sheet date. The Corporation adjusts the loss allocations for various factors it believes are not adequately presented in historical loss experience, including trends in real estate values, trends in rental rates on commercial real estate, consideration of general economic conditions and our assessments of credit risk associated with certain industries and an ongoing trend toward larger credit relationships. These factors are also evaluated taking into account the geographic location of the underlying loans. Revisions to loss allocation factors are not retroactively applied.

Loss allocations for loans deemed to be impaired are measured on a discounted cash flow method based upon the loan's contractual



23


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


effective interest rate, or at the loan's observable market price, or, if the loan is collateral dependent, at the fair value of the collateral less costs to sell. For collateral dependent loans, 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 circumstances associated with the property.

Loss allocation factors are used for non-impaired loans based on credit grade, loss experience, delinquency factors and other similar credit quality indicators. Individual commercial loans and commercial mortgage loans not deemed to be impaired are evaluated using the internal rating system described in Note 5 under the caption “Credit Quality Indicators” and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower's financial condition, the borrower's performance with respect to loan terms, and the adequacy of collateral. Portfolios of more homogeneous populations of loans including the various categories of residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other indicators and our historical loss experience for each type of credit product.

An additional unallocated allowance is maintained to allow for measurement imprecision attributable to uncertainty in the economic environment and ever changing conditions and to reflect management's consideration of qualitative and quantitative assessments of other environmental factors, including, but not limited to, conditions that may affect the collateral position such as environmental matters, tax liens, and regulatory changes affecting the foreclosure process, as well as conditions that may affect the ability of borrowers to meet debt service requirements.

Because the methodology is based upon historical experience and trends, current economic data as well as management's judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in our market area, concentration of risk, and declines in local property values. Adversely different conditions or assumptions could lead to increases in the allowance. In addition, various regulatory agencies periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination.

The following is an analysis of activity in the allowance for loan losses for the three months ended June 30, 2012:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
Other
 
Total Commercial
 
Residential
 
Consumer
 
Un-allocated
 
Total
Beginning Balance

$9,352

 

$110

 

$5,906

 

$15,368

 

$4,325

 

$2,133

 

$8,219

 

$30,045

Charge-offs

 

 
(580
)
 
(580
)
 
(16
)
 
(100
)
 

 
(696
)
Recoveries
388

 

 
31

 
419

 
63

 
17

 

 
499

Provision
(795
)
 
54

 
882

 
141

 
341

 
331

 
(213
)
 
600

Ending Balance

$8,945

 

$164

 

$6,239

 

$15,348

 

$4,713

 

$2,381

 

$8,006

 

$30,448


The following is an analysis of activity in the allowance for loan losses for the three months ended June 30, 2011:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
Other
 
Total Commercial
 
Residential
 
Consumer
 
Un-allocated
 
Total
Beginning Balance

$7,600

 

$532

 

$6,256

 

$14,388

 

$4,805

 

$2,046

 

$7,870

 

$29,109

Charge-offs
(124
)
 

 
(617
)
 
(741
)
 
(146
)
 
(157
)
 

 
(1,044
)
Recoveries
2

 

 
76

 
78

 

 
10

 

 
88

Provision
(104
)
 
(315
)
 
1,278

 
859

 
(188
)
 
253

 
276

 
1,200

Ending Balance

$7,374

 

$217

 

$6,993

 

$14,584

 

$4,471

 

$2,152

 

$8,146

 

$29,353





24


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following is an analysis of activity in the allowance for loan losses for the six months ended June 30, 2012:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
Other
 
Total Commercial
 
Residential
 
Consumer
 
Un-allocated
 
Total
Beginning Balance

$8,195

 

$95

 

$6,200

 

$14,490

 

$4,694

 

$2,452

 

$8,166

 

$29,802

Charge-offs
(9
)
 

 
(910
)
 
(919
)
 
(250
)
 
(208
)
 

 
(1,377
)
Recoveries
390

 

 
37

 
427

 
73

 
23

 

 
523

Provision
369

 
69

 
912

 
1,350

 
196

 
114

 
(160
)
 
1,500

Ending Balance

$8,945

 

$164

 

$6,239

 

$15,348

 

$4,713

 

$2,381

 

$8,006

 

$30,448


The following is an analysis of activity in the allowance for loan losses for the six months ended June 30, 2011:
(Dollars in thousands)
Commercial
 
 
 
 
 
 
 
 
 
 
 
Mortgages
 
Construction
 
Other
 
Total Commercial
 
Residential
 
Consumer
 
Un-allocated
 
Total
Beginning Balance

$7,330

 

$723

 

$6,495

 

$14,548

 

$4,129

 

$1,903

 

$8,003

 

$28,583

Charge-offs
(459
)
 

 
(1,195
)
 
(1,654
)
 
(265
)
 
(177
)
 

 
(2,096
)
Recoveries
4

 

 
146

 
150

 
1

 
15

 

 
166

Provision
499

 
(506
)
 
1,547

 
1,540

 
606

 
411

 
143

 
2,700

Ending Balance

$7,374

 

$217

 

$6,993

 

$14,584

 

$4,471

 

$2,152

 

$8,146

 

$29,353


The following table presents the Corporation’s loan portfolio and associated allowance for loan loss by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology.
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Loans
 
Related Allowance
 
Loans
 
Related Allowance
Loans Individually Evaluated for Impairment:
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Mortgages

$3,849

 

$204

 

$12,099

 

$329

Construction & development

 

 

 

Other
10,319

 
523

 
10,334

 
839

Residential real estate mortgages
4,228

 
582

 
5,988

 
495

Consumer
367

 
2

 
612

 
152

Subtotal

$18,763

 

$1,311

 

$29,033

 

$1,815

Loans Collectively Evaluated for Impairment:
 
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
 
Mortgages

$660,561

 

$8,741

 

$612,714

 

$7,866

Construction & development
17,365

 
164

 
10,955

 
95

Other
499,901

 
5,716

 
478,526

 
5,361

Residential real estate mortgages
697,791

 
4,131

 
694,426

 
4,199

Consumer
319,461

 
2,379

 
321,505

 
2,300

Subtotal

$2,195,079

 

$21,131

 

$2,118,126

 

$19,821

Unallocated

 
8,006

 

 
8,166

Total

$2,213,842

 

$30,448

 

$2,147,159

 

$29,802







25


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(7)
Time Certificates of Deposit
Scheduled maturities and weighted average interest rates paid on time certificates of deposit outstanding at June 30, 2012 were as follows:
(Dollars in thousands)
Scheduled Maturity
 
Weighted Average Rate
July 1, 2012 through December 31, 2012

$355,866

 
0.58
%
2013
225,934

 
1.54
%
2014
136,114

 
1.90
%
2015
86,170

 
2.63
%
2016
69,109

 
1.82
%
2017 and after
19,190

 
1.77
%
 

$892,383

 
 

The aggregate amount of time certificates of deposit in denominations of $100 thousand or more was $447.4 million at June 30, 2012. The following table represents the amount of certificates of deposit of $100 thousand or more at June 30, 2012 maturing during the periods indicated:
(Dollars in thousands)
Scheduled Maturity
July 1, 2012 to September 30, 2012

$168,432

October 1, 2012 to December 31, 2012
83,793

January 1, 2013 to June 30, 2013
58,079

July 1, 2013 and beyond
137,069

 

$447,373



(8)
Borrowings
Federal Home Loan Bank Advances
Advances payable to the FHLBB amounted to $524.0 million at June 30, 2012 and $540.5 million at December 31, 2011.

In connection with the Corporation's ongoing interest rate risk management efforts, in January 2012, the Corporation modified the terms of $31.1 million of its FHLBB advances with original maturity dates in 2014 into longer terms maturing in 2016 and 2017. Also, in May 2012, the Corporation conducted another balance sheet management transaction, which consisted of the sale of $6.0 million in mortgage-backed securities and the prepayment of a $5.0 million FHLBB advance with an original maturity date in 2013. The transaction resulted in net realized gains on sales of securities of $217 thousand and debt prepayment penalty expense of $203 thousand. In June 2012, the Corporation prepaid two FHLBB advances totaling $10.0 million with original maturity dates in 2015, resulting in debt prepayment penalty expense of $758 thousand. Also in June 2012, the Corporation modified terms of $36.7 million of its FHLBB advances with original maturity dates in 2014 and 2015 into longer terms maturing in 2017. The following table presents maturities of and weighted average interest rates paid on FHLBB advances outstanding at June 30, 2012.




26


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(Dollars in thousands)
Scheduled Maturity
 
Redeemed at Call Date (1)
 
Weighted Average Rate (2)
July 1, 2012 through December 31, 2012

$137,252

 

$142,252

 
1.09
%
2013
39,229

 
34,229

 
3.37
%
2014
32,129

 
32,129

 
3.19
%
2015
112,682

 
112,682

 
3.49
%
2016
96,587

 
96,587

 
3.61
%
2017 and after
106,110

 
106,110

 
3.80
%
 

$523,989

 

$523,989

 
 
(1)
Callable FHLBB advances are shown in the respective periods assuming that the callable debt is redeemed at the call date while all other advances are shown in the periods corresponding to their scheduled maturity date.
(2)
Weighted average rate based on scheduled maturity dates.

In addition to the outstanding advances, the Bank also has access to an unused line of credit with the FHLBB amounting to $8.0 million at June 30, 2012.  Under agreement with the FHLBB, the Bank is required to maintain qualified collateral, free and clear of liens, pledges, or encumbrances that, based on certain percentages of book and fair values, has a value equal to the aggregate amount of the line of credit and outstanding advances.  The FHLBB maintains a security interest in various assets of the Corporation including, but not limited to, residential mortgage loans, commercial mortgages and other commercial loans, U.S. government agency securities, U.S. government-sponsored enterprise securities, and amounts maintained on deposit at the FHLBB.  Included in the collateral specifically pledged to secure FHLBB borrowings were securities available for sale and held to maturity with a fair value of $305.9 million and $320.8 million, respectively, at June 30, 2012 and December 31, 2011.  Also included in the collateral specifically pledged to secure FHLBB borrowings were loans of $907.2 million and $911.5 million, respectively, at June 30, 2012 and December 31, 2011.  The Corporation maintained qualified collateral substantially in excess of the amount required to collateralize the line of credit and outstanding advances at June 30, 2012 for liquidity management purposes.  Unless there is an event of default under the agreement, the Corporation may use, encumber or dispose any portion of the collateral in excess of the amount required to secure FHLBB borrowings, except for that collateral which has been specifically pledged.

Other Borrowings
Securities sold under repurchase agreements amounted to $19.5 million at December 31, 2011. The securities sold under repurchase agreements were executed in March 2007 and matured in March 2012.  The securities underlying the agreements were held in safekeeping by the counterparty in the name of the Corporation and repurchased at maturity.

(9)
Shareholders’ Equity
Regulatory Capital Requirements
The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios as of June 30, 2012 and December 31, 2011, as well as the corresponding minimum and well capitalized regulatory amounts and ratios:



27


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(Dollars in thousands)
Actual
 
For Capital Adequacy Purposes
 
To Be "Well Capitalized" Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation

$292,179

 
13.15
%
 

$177,736

 
8.00
%
 

$222,171

 
10.00
%
Bank

$287,344

 
12.95
%
 

$177,517

 
8.00
%
 

$221,896

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

$264,372

 
11.90
%
 

$88,868

 
4.00
%
 

$133,302

 
6.00
%
Bank

$259,571

 
11.70
%
 

$88,758

 
4.00
%
 

$133,137

 
6.00
%
Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation

$264,372

 
9.00
%
 

$117,480

 
4.00
%
 

$146,850

 
5.00
%
Bank

$259,571

 
8.85
%
 

$117,284

 
4.00
%
 

$146,605

 
5.00
%
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
Corporation

$279,751

 
12.86
%
 

$174,073

 
8.00
%
 

$217,592

 
10.00
%
Bank

$275,183

 
12.66
%
 

$173,845

 
8.00
%
 

$217,307

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

$252,516

 
11.61
%
 

$87,037

 
4.00
%
 

$130,555

 
6.00
%
Bank

$247,983

 
11.41
%
 

$86,923

 
4.00
%
 

$130,384

 
6.00
%
Tier 1 Capital (to Average Assets): (1)
 
 
 
 
 
 
 
 
 
 
 
Corporation

$252,516

 
8.70
%
 

$116,158

 
4.00
%
 

$145,198

 
5.00
%
Bank

$247,983

 
8.55
%
 

$115,961

 
4.00
%
 

$144,952

 
5.00
%
(1)    Leverage ratio

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

Forward Loan Commitments
Interest rate lock commitments are extended to borrowers that relate to the origination of readily marketable mortgage loans held for sale.  To mitigate the interest rate risk inherent in these rate locks, as well as closed mortgage loans held for sale, best efforts forward commitments are established to sell individual mortgage loans.  Both interest rate lock commitments and commitments to sell fixed-rate residential mortgage loans are derivative financial instruments. Effective July 1, 2011, Washington Trust elected to carry newly originated closed loans held for sale at fair value pursuant to Accounting Standards Codification Topic No. 825, "Financial Instruments" ("ASC 825"). Changes in fair value of the interest rate lock commitments, commitments to sell fixed-rate mortgage loans and loans held for sale are recognized in earnings.

Interest Rate Risk Management Agreements
Interest rate swaps are used from time to time as part of the Corporation’s interest rate risk management strategy.  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.  The credit risk associated with swap 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.

As of June 30, 2012 and December 31, 2011, the Bancorp had three interest rate swap contracts designated as cash flow hedges to hedge the interest rate associated with $33 million of variable rate junior subordinated debentures.  The effective portion of



28


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


the changes in fair value of derivatives designated as cash flow hedges is recorded in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized.  The ineffective portion of changes in fair value of the derivatives is recognized directly in earnings as interest expense.  The Bancorp has pledged collateral to derivative counterparties in the form of cash totaling $1.8 million and $1.9 million, respectively, at June 30, 2012 and December 31, 2011.  The Bancorp may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

The Bank has entered into interest rate swap contracts to help commercial loan borrowers manage their interest rate risk.  The interest rate swap contracts with commercial loan borrowers allow them to convert floating rate loan payments to fixed-rate loan payments.  When we enter into an interest rate swap contract with a commercial loan borrower, we simultaneously enter into a “mirror” swap contract with a third party.  The third party exchanges the client’s fixed-rate loan payments for floating rate loan payments.  We retain the risk that is associated with the potential failure of counterparties and inherent in making loans.  As of June 30, 2012 and December 31, 2011, Washington Trust had interest rate swap contracts with commercial loan borrowers with notional amounts of $61.0 million and $61.6 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.

The following table presents the fair values of derivative instruments in the Corporation’s Consolidated Balance Sheets as of the dates indicated:
(Dollars in thousands)
Asset Derivatives
 
Liability Derivatives
 
 
 
Fair Value
 
 
 
Fair Value
 
Balance Sheet Location
 
Jun 30, 2012
 
Dec 31, 2011
 
Balance Sheet Location
 
Jun 30, 2012
 
Dec 31, 2011
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
 

$—

 

$—

 
Other liabilities
 

$1,775

 

$1,802

Derivatives not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
 
 
 
Forward loan commitments:
 
 
 
 
 
 
 
 
 
 
 
Commitments to originate fixed-rate mortgage loans to be sold
Other assets
 
3,065

 
1,864

 
Other liabilities
 
2

 

Commitments to sell fixed-rate mortgage loans
Other assets
 
4

 

 
Other liabilities
 
3,889

 
2,580

Customer related derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
Other assets
 
4,225

 
4,513

 
 
 

 

Mirror swaps with counterparties
 
 

 

 
Other liabilities
 
4,357

 
4,669

Total
 
 

$7,294

 

$6,377

 
 
 

$10,023

 

$9,051


The following tables present the effect of derivative instruments in the Corporations’ Consolidated Statements of Income and Changes in Shareholders’ Equity for the periods indicated:
(Dollars in thousands)
Gain (Loss) Recognized in Other Comprehensive Income (Effective Portion)
 
Location of Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Gain (Loss) Recognized in Income (Ineffective Portion)
 
Three Months
 
Six Months
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
 
 
2012
 
2011
 
2012
 
2011
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk management contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts

($16
)
 

($346
)
 
$19
 
$(174)
 
Interest Expense
 

$—

 

$—

 
$—
 
$—
Total

($16
)
 

($346
)
 
$19
 
$(174)
 
 
 

$—

 

$—

 
$—
 
$—



29


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)




(Dollars in thousands)
 
 
Gain (Loss) Recognized in Income
 
Location of Gain (Loss) Recognized in Income
 
Three Months
 
Six Months
Periods ended June 30,
 
2012
 
2011
 
2012
 
2011
Derivatives not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
 
Forward loan commitments:
 
 
 
 
 
 
 
 
 
Commitments to originate fixed-rate mortgage loans to be sold
Net gains on loan sales & commissions on loans originated for others
 

$1,248

 

($53
)
 

$1,199

 

$33

Commitments to sell fixed-rate mortgage loans
Net gains on loan sales & commissions on loans originated for others
 
(1,586
)
 
42

 
(1,305
)
 
(506
)
Customer related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
Net gains (losses) on interest rate swaps
 
398

 
1,214

 
609

 
1,118

Mirror swaps with counterparties
Net gains (losses) on interest rate swaps
 
(401
)
 
(1,249
)
 
(585
)
 
(1,077
)
Total
 
 

($341
)
 

($46
)
 

($82
)
 

($432
)

(11)
Fair Value Measurements
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  As of June 30, 2012 and December 31, 2011, securities available for sale, mortgage loans held for sale and derivatives were recorded at fair value on a recurring basis.  Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights.  These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

ASC 825 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 that may otherwise not be required to be measured at fair value under other accounting standards. Washington Trust elected the fair value option for its portfolio of mortgage loans held for sale pursuant to forward sale commitments originated after July 1, 2011 in order to reduce certain timing differences and better match changes in fair values of the loans with changes in the fair value of the derivative forward loan sale contracts used to economically hedge them. The election under ASC 825 related to mortgage loans held for sale does not result in a transition adjustment to retained earnings and instead, changes in fair value have an impact on earnings.

The following table summarizes information related to mortgage loans held for sale, commitments to originate fixed-rate mortgage loans to be sold and commitments to sell fixed-rate mortgage loans.
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Notional or Principal Amount
 
Fair Value
 
Notional or Principal Amount
 
Fair Value
Mortgage loans held for sale (1)

$22,708

 

$23,530

 

$19,624

 

$20,340

Commitments to originate
83,633

 
3,063

 
56,950

 
1,864

Commitments to sell
106,340

 
(3,885
)
 
76,574

 
(2,580
)
(1)
At June 30, 2012, the difference between the aggregate fair value and the aggregate principal amount of mortgage loans held for sale amounted to $822 thousand. There were no mortgage loans held for sale 90 days or more past due as of June 30, 2012.




30


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table presents the changes in fair value related to mortgage loans held for sale, commitments to originate fixed-rate mortgage loans to be sold and commitments to sell fixed-rate mortgage loans for the periods indicated. Changes in fair values are reported as a component of net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Mortgage loans held for sale

$338

 

$—

 

$106

 

$—

Commitments to originate
1,248

 
(53
)
 
1,199

 
33

Commitments to sell
(1,586
)
 
42

 
(1,305
)
 
(506
)
Total changes in fair value

$—

 

($11
)
 

$—

 

($473
)

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.

Determination of Fair Value
Fair values are based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  When available, the Corporation uses quoted market prices to determine fair value.  If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates.  If observable market-based inputs are not available, the Corporation uses unobservable inputs to determine appropriate valuation adjustments using methodologies applied consistently over time.

The following is a description of valuation methodologies for assets and liabilities recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Items Measured at Fair Value on a Recurring Basis
Securities
Securities available for sale are recorded at fair value on a recurring basis.  When available, the Corporation uses quoted market prices to determine the fair value of securities; such items are classified as Level 1.  This category includes exchange-traded equity securities.

Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value 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 generally includes obligations of U.S. government-sponsored enterprises, mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises, municipal bonds, trust preferred securities and corporate bonds.

In certain cases where there is limited activity or less transparency around inputs to the valuation, securities may be classified as Level 3.  As of June 30, 2012 and December 31, 2011, Level 3 securities were comprised of two pooled trust preferred debt securities, in the form of collateralized debt obligations, which were not actively traded.  As of June 30, 2012 and December 31, 2011, the Corporation concluded that the low level of activity for its Level 3 pooled trust preferred debt securities continued to



31


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


indicate that quoted market prices are not indicative of fair value.  The Corporation obtained valuations including broker quotes and cash flow scenario analyses prepared by a third party valuation consultant.  The fair values were assigned a weighting that was dependent upon the methods used to calculate the prices.  The cash flow scenarios (Level 3) were given substantially more weight than the broker quotes (Level 2) as management believed that the broker quotes reflected highly limited sales evidenced by an inactive market.  The cash flow scenarios were prepared using discounted cash flow methodologies based on detailed cash flow and credit analysis of the pooled securities.  The weighting was then used to determine an overall fair value of the securities.  Management believes that this approach is most representative of fair value for these particular securities in current market conditions.

Our internal review procedures have confirmed that the fair values provided by the aforementioned third party valuation sources utilized by the Corporation are consistent with GAAP.  Our fair values assumed liquidation in an orderly market and not under distressed circumstances.  Due to the continued market illiquidity and credit risk for securities in the financial sector, the fair value of these securities is highly sensitive to assumption changes and market volatility.

Mortgage Loans Held for Sale
Effective July 1, 2011, Washington Trust elected to carry newly originated closed loans held for sale at fair value pursuant to ASC 825, "Financial Instruments." Fair values are estimated based on what secondary markets are currently offering for loans with similar characteristics. Any change in the valuation of mortgage loans held for sale is based upon the change in market interest rates between closing the loan and the measurement date and an immaterial portion attributable to changes in instrument-specific credit risk. Mortgage loans held for sale are categorized as Level 2.

Derivatives
Interest rate swap 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 and, accordingly, are classified as Level 2. Our internal review procedures have confirmed that the fair values determined with independent pricing models and utilized by the Corporation are consistent with GAAP. For purposes of potential valuation adjustments to its interest rate swap contracts, the Corporation evaluates the credit risk of its counterparties as well as that of the Corporation.  Accordingly, Washington Trust considers factors such as the likelihood of default by the Corporation and its counterparties, its net exposures and remaining contractual life, among other factors, in determining if any fair value adjustments related to credit risk are required.  Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of collateral securing the position. Washington Trust met the criteria for and effective January 1, 2012 elected to apply the accounting policy exception with respect to measuring counterparty credit risk for derivative transactions subject to master netting arrangements provided in ASU 2011-04. Electing this policy exception had no impact on financial statement presentation.

Fair value measurements of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages) are estimated using the anticipated market price based on pricing indications provided from syndicate banks. These derivative financial instruments are categorized as Level 2.

Items Measured at Fair Value on a Nonrecurring Basis
Collateral Dependent Impaired Loans
Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell.  Such collateral primarily consists of real estate and, to a lesser extent, other business assets.  Management may 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.

Loan Servicing Rights
Loan servicing rights do not trade in an active market with readily observable prices.  Accordingly, we determine the fair value of loan servicing rights using a valuation model that calculates the present value of the estimated future net servicing income.  The model incorporates assumptions used in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service and contractual servicing fee income.  Loan servicing rights are subject to fair value measurements on a nonrecurring basis.  Fair value measurements of our loan servicing rights use significant unobservable inputs and, accordingly, are classified as Level 3.




32


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Property Acquired Through Foreclosure or Repossession
Property acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans.  Subsequently, it is carried at the lower of carrying value or fair value less costs to sell.  Fair value is generally based upon appraised values of the collateral.  Management adjusts 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.

Items Recorded at Fair Value on a Recurring Basis
The tables below present the balances of assets and liabilities reported at fair value on a recurring basis:

(Dollars in thousands)
 
 
Assets/Liabilities at Fair Value
 
Fair Value Measurements Using
 
June 30, 2012
Level 1
 
Level 2
 
Level 3
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$—

 

$32,319

 

$—

 

$32,319

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

 
324,292

 

 
324,292

States and political subdivisions

 
73,723

 

 
73,723

Trust preferred securities:
 
 
 
 
 
 
 

Individual name issuers

 
23,620

 

 
23,620

Collateralized debt obligations

 

 
767

 
767

Corporate bonds

 
14,446

 

 
14,446

Mortgage loans held for sale

 
23,530

 

 
23,530

Derivative assets (1):
 
 
 
 
 
 
 
Interest rate swap contracts with customers

 
4,225

 

 
4,225

Forward loan commitments

 
3,069

 

 
3,069

Total assets at fair value on a recurring basis

$—

 

$499,224

 

$767

 

$499,991

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (1):
 
 
 
 
 
 
 
Mirror swap contracts with customers

$—

 

$4,357

 

$—

 

$4,357

Interest rate risk management swap contracts

 
1,775

 

 
1,775

Forward loan commitments

 
3,891

 

 
3,891

Total liabilities at fair value on a recurring basis

$—

 

$10,023

 

$—

 

$10,023

(1)
Derivative assets are included in other assets and derivative liabilities are reported in other liabilities in the Consolidated Balance Sheets.




33


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(Dollars in thousands)
 
 
Assets/Liabilities at Fair Value
 
Fair Value Measurements Using
 
December 31, 2011
Level 1
 
Level 2
 
Level 3
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$—

 

$32,833

 

$—

 

$32,833

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

 
389,658

 

 
389,658

States and political subdivisions

 
79,493

 

 
79,493

Trust preferred securities:
 
 
 
 
 
 
 
Individual name issuers

 
22,396

 

 
22,396

Collateralized debt obligations

 

 
887

 
887

Corporate bonds

 
14,282

 

 
14,282

Perpetual preferred stocks
1,704

 

 

 
1,704

Mortgage loans held for sale

 
20,340

 

 
20,340

Derivative assets (1):
 
 
 
 
 
 
 

Interest rate swap contracts with customers

 
4,513

 

 
4,513

Forward loan commitments

 
1,864

 

 
1,864

Total assets at fair value on a recurring basis

$1,704

 

$565,379

 

$887

 

$567,970

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (1):
 
 
 
 
 
 
 
Mirror swap contracts with customers

$—

 

$4,669

 

$—

 

$4,669

Interest rate risk management swap contracts

 
1,802

 

 
1,802

Forward loan commitments

 
2,580

 

 
2,580

Total liabilities at fair value on a recurring basis

$—

 

$9,051

 

$—

 

$9,051

(1)
Derivative assets are included in other assets and derivative liabilities are reported in other liabilities in the Consolidated Balance Sheets.

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, Level 2 or Level 3 during the three and six months ended June 30, 2012 and 2011.

The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis during the periods indicated:
Three months ended June 30,
2012
 
2011
(Dollars in thousands)
Securities Available for Sale (1)
 
Securities Available for Sale (1)
 
Derivative Assets / (Liabilities) (2)
 
Total
Balance at beginning of period

$749

 

$752

 

($27
)
 

$725

Gains and losses (realized and unrealized):
 
 
 
 
 
 
 
Included in earnings (3)

 

 
(11
)
 
(11
)
Included in other comprehensive income
18

 
182

 

 
182

Balance at end of period

$767

 

$934

 

($38
)
 

$896





34


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Six months ended June 30,
2012
 
2011
(Dollars in thousands)
Securities Available for Sale (1)
 
Securities Available for Sale (1)
 
Derivative Assets / (Liabilities) (2)
 
Total
Balance at beginning of period

$887

 

$806

 

$435

 

$1,241

Gains and losses (realized and unrealized):


 


 


 
 
Included in earnings (3)
(209
)
 
(33
)
 
(473
)
 
(506
)
Included in other comprehensive income
89

 
161

 

 
161

Balance at end of period

$767

 

$934

 

($38
)
 

$896

(1)
During the periods indicated, Level 3 securities available for sale were comprised of two pooled trust preferred debt securities, in the form of collateralized debt obligations.
(2)
During the periods indicated, Level 3 derivative assets / liabilities consisted of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages). After evaluating forward loan commitments during the third quarter of 2011, it was determined that significant inputs and significant value drivers were observable in active markets, and the Corporation therefore reclassified these derivatives from out of Level 3 into Level 2.
(3)
Losses included in earnings for Level 3 securities available for sale consisted of credit-related impairment losses on two Level 3 pooled trust preferred debt securities. No credit-related impairment losses were recognized during the three months ended June 30, 2012 and 2011. Credit-related impairment losses of $209 thousand and $33 thousand were recognized during the six months ended June 30, 2012 and 2011, respectively. The losses included in earnings for Level 3 derivative assets and liabilities, which were comprised of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages), were included in net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.

The following table presents additional quantitative information about assets measured at fair value on a recurring basis for which the Corporation has utilized Level 3 inputs to determine fair value.
(Dollars in thousands)
June 30, 2012
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range of Inputs Utilized (Weighted Average)
Trust preferred securities:
 
 
 
 
 
 
 
Collateralized debt obligations

$767

 
Discounted Cash Flow
 
Discount Rate
 
17.50%
 
 
 
 
 
Cumulative Default %
 
5.2% - 100% (27.1%)
 
 
 
 
 
Loss Given Default %
 
85% - 100% (90.9%)

Given the low level of market activity for trust preferred securities in the form of collateralized debt obligations, the discount rate utilized in the fair value measurement was derived by analyzing current market yields for trust preferred securities of individual name issuers in the financial services industry. Adjustments were then made for credit and structural differences between these types of securities. There is an inverse correlation between the discount rate and the fair value measurement. When the discount rate increases, the fair value decreases.

Other significant unobservable inputs to the fair value measurement of collateralized debt obligations included prospective defaults and recoveries. The cumulative default percentage represents the lifetime defaults assumed, excluding currently defaulted collateral and including all performing and currently deferring collateral. As a result, the cumulative default percentage also reflects assumptions of the possibility of currently deferring collateral curing and becoming current. The loss given default percentage represents the percentage of current and projected defaults assumed to be lost. There is an inverse correlation between the cumulative default and loss given default percentages and the fair value measurement. When the default percentages increase, the fair value decreases.

Items Recorded at Fair Value on a Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP.  These adjustments to fair value usually result from the application of lower of cost or market accounting or write-downs of individual assets.  The valuation methodologies used to measure these fair value adjustments are described above.




35


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table presents the carrying value of certain assets measured at fair value on a nonrecurring basis during the six months ended June 30, 2012:
(Dollars in thousands)
Carrying Value at June 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Collateral dependent impaired loans

$—

 

$—

 

$2,792

 

$2,792

Property acquired through foreclosure or repossession

 

 
1,070

 
1,070

Total assets at fair value on a nonrecurring basis

$—

 

$—

 

$3,862

 

$3,862


Collateral dependent impaired loans with a carrying value of $2.8 million at June 30, 2012 were subject to nonrecurring fair value measurement during the six months ended June 30, 2012.  As of June 30, 2012, the allowance for loan losses allocation on these loans amounted to $733 thousand.

During the six months ended June 30, 2012, properties acquired through foreclosures or repossession with a fair value of $1.8 million were transferred from loans.  Prior to the transfer, the assets whose fair value less costs to sell was less than the carrying value were written down to fair value through a charge to the allowance for loan losses. For the three and six months ended June 30, 2012, such valuation adjustments charged to the allowance for loan losses amounted to $268 thousand and $332 thousand, respectively.  Subsequent to foreclosures, valuations are updated periodically and assets may be marked down further, reflecting a new cost basis. Subsequent valuation adjustments charged to earnings totaled $52 thousand and $171 thousand for the three and six months ended June 30, 2012, respectively.

The following table presents the carrying value of certain assets measured at fair value on a nonrecurring basis during the six months ended June 30, 2011:
(Dollars in thousands)
Carrying Value at June 30, 2011
 
Level 1
 
Level 2
 
Level 3
 
Total
Collateral dependent impaired loans

$—

 

$—

 

$3,292

 

$3,292

Property acquired through foreclosure or repossession

 

 
1,449

 
1,449

Total assets at fair value on a nonrecurring basis

$—

 

$—

 

$4,741

 

$4,741


Collateral dependent impaired loans with a carrying value of $3.3 million at June 30, 2011 were subject to nonrecurring fair value measurement during the six months ended June 30, 2011.  As of June 30, 2011, the allowance for loan losses allocation on these loans amounted to $900 thousand.

During the six months ended June 30, 2011, properties acquired through foreclosures or repossession with a fair value of $801 thousand were transferred from loans.  Prior to the transfer, the assets whose fair value less costs to sell was less than the carrying value were written down to fair value through a charge to the allowance for loan losses. For the three and six months ended June 30, 2011, such valuation adjustments charged to the allowance for loan losses amounted to $124 thousand.  Subsequent to foreclosures, valuations are updated periodically and assets may be marked down further, reflecting a new cost basis. Subsequent valuation adjustments charged to earnings totaled $238 thousand for the three and six months ended June 30, 2011.




36


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table presents additional quantitative information about 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)
June 30, 2012
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans

$2,792

 
Appraisals of collateral
 
Discount for costs to sell
 
0% - 50% (18%)
 
 
 
 
 
Appraisal adjustments (1)
 
10% - 15% (15%)
Property acquired through foreclosure or repossession

$1,070

 
Appraisals of collateral
 
Discount for costs to sell
 
0% - 15% (8%)
 
 
 
 
 
Appraisal adjustments (1)
 
6% - 47% (14%)
(1)
Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

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

Loans
Fair values are estimated for categories of loans with similar financial characteristics. Loans are segregated by type and are then further segmented into fixed-rate and adjustable rate interest terms to determine their fair value. The fair value of fixed-rate commercial and consumer loans is calculated by discounting scheduled cash flows through the estimated maturity of the loan using interest rates offered at June 30, 2012 and December 31, 2011 that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation's historical repayment experience. For residential mortgages, fair value is estimated by using quoted market prices for sales of similar loans on the secondary market, adjusted for servicing costs. The fair value of floating rate commercial and consumer loans approximates carrying value. Fair value for impaired loans is estimated using a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or if the loan is collateral dependent, at the fair value of the collateral less costs to sell. Loans are classified within Level 3 of the fair value hierarchy.

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

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

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

The following tables present the carrying amount, estimated fair value and placement in the fair value hierarchy of the Corporation's financial instruments as of June 30, 2012 and December 31, 2011. The tables exclude financial instruments for which the carrying value approximates fair value. Financial assets for which the fair value approximates carrying value include cash and cash equivalents, FHLBB stock, accrued interest receivable and bank-owned life insurance. Financial liabilities for which the fair value approximates carrying value include non-maturity deposits, other borrowings and accrued interest payable.



37


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(Dollars in thousands)
 
 
 
 
Fair Value Measurements
June 30, 2012
Carrying Amount
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$47,026

 

$48,220

 

$—

 

$48,220

 

$—

Loans, net of allowance for loan losses
2,183,394

 
2,279,875

 

 

 
2,279,875

Loan servicing rights (1)
851

 
1,012

 

 

 
1,012

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$892,383

 

$903,000

 

$—

 

$903,000

 

$—

FHLBB advances
523,989

 
560,747

 

 
560,747

 

Junior subordinated debentures
32,991

 
20,785

 

 
20,785

 

(1)
The carrying value of loan servicing rights is net of $161 thousand in reserves as of June 30, 2012. The estimated fair value does not include such adjustment.


(Dollars in thousands)
 
 
 
 
Fair Value Measurements
December 31, 2011
Carrying Amount
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$52,139

 

$52,499

 

$—

 

$52,499

 

$—

Loans, net of allowance for loan losses
2,117,357

 
2,198,940

 

 

 
2,198,940

Loan servicing rights (1)
765

 
937

 

 

 
937

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$878,794

 

$891,378

 

$—

 

$891,378

 

$—

FHLBB advances
540,450

 
577,315

 

 
577,315

 

Junior subordinated debentures
32,991

 
20,391

 

 
20,391

 

(1)
The carrying value of loan servicing rights is net of $172 thousand in reserves as of December 31, 2011. The estimated fair value does not include such adjustment.

(12)
Defined Benefit Pension Plans
The Corporation offers a tax-qualified defined benefit pension plan for the benefit of certain eligible employees. The pension plan was amended effective October 1, 2007 to freeze plan entry to new hires and rehires.  Existing employees hired prior to October 1, 2007 continue to accrue benefits under the plan.  Benefits are based on an employee’s years of service and compensation earned during the years of service.  The plan is funded on a current basis, in compliance with the requirements of ERISA. The Corporation also has non-qualified retirement plans to provide supplemental retirement benefits to certain employees, as defined in the plans.  The supplemental retirement plans provide eligible participants with an additional retirement benefit.




38


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


For the periods indicated, the composition of net periodic benefit cost was as follows:
(Dollars in thousands)
Qualified Pension Plan
 
Non-Qualified Retirement Plans
 
Three Months
 
Six Months
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Service cost

$643

 

$578

 

$1,287

 

$1,157

 

$37

 

$18

 

$75

 

$36

Interest cost
706

 
644

 
1,412

 
1,289

 
126

 
124

 
252

 
248

Expected return on plan assets
(747
)
 
(698
)
 
(1,493
)
 
(1,397
)
 

 

 

 

Amortization of prior service cost
(9
)
 
(9
)
 
(17
)
 
(17
)
 

 

 

 

Recognized net actuarial loss
247

 
99

 
491

 
196

 
30

 
3

 
59

 
6

Net periodic benefit cost

$840

 

$614

 

$1,680

 

$1,228

 

$193

 

$145

 

$386

 

$290


Employer Contributions:
The Corporation previously disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2011 that in 2012 it expected to contribute $3.0 million to its qualified pension plan and make $723 thousand in benefit payments under its non-qualified retirement plans.  In January 2012, the Corporation contributed $3.0 million to the qualified pension plan. In support of its long-term funding strategy for the qualified pension plan, the Corporation currently expects to make an additional contribution of approximately $3.0 million to this plan later in 2012.  During the six months ended June 30, 2012, benefit payments of $360 thousand were made under the non-qualified retirement plans and the Corporation presently anticipates making an additional $360 thousand in benefit payments throughout the remainder of 2012.

(13)
Share-Based Compensation Arrangements
Washington Trust has two share-based compensation plans, Bancorp’s 2003 Stock Incentive Plan, as amended, and Bancorp’s 1997 Equity Incentive Plan, as amended, (collectively “the Plans”).

Amounts recognized in the consolidated financial statements for share options, nonvested share units and nonvested performance shares are as follows:
(Dollars in thousands)
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Share-based compensation expense

$464

 

$352

 

$876

 

$680

Related tax benefit

$166

 

$125

 

$313

 

$242


Compensation expense for share options and nonvested share units is recognized over the service period based on the fair value at the date of grant.  Nonvested performance share compensation expense is based on the most recent performance assumption available and is adjusted as assumptions change.  If the goals are not met, no compensation cost will be recognized and any recognized compensation costs will be reversed.

Share Options
During the six months ended June 30, 2012 and 2011, the Corporation granted 99,775 and 57,450 non-qualified share options, respectively.  The share options awarded were granted to certain key employees with three-year cliff vesting and provide for accelerated vesting upon a change in control, death or retirement (as defined in the plans).

The fair value of the share option awards granted were estimated on the date of grant using the Black-Scholes Option-Pricing Model based on assumptions noted in the following table.  Washington Trust uses historical data to estimate share option exercise and employee departure behavior used in the option-pricing model; groups of employees that have similar historical behavior are considered separately for valuation purposes.  The expected term of options granted was derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding.  Expected volatility was based on historical volatility of Washington Trust shares.  The risk-free rate for periods within the contractual life of the share option was based on the U.S. Treasury yield curve in effect at the date of grant.



39


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Six months ended June 30,
2012

 
2011

Expected term (years)
9.0

 
9.0

Expected dividend yield
3.45
%
 
3.33
%
Weighted average expected volatility
42.97
%
 
41.90
%
Weighted average risk-free interest rate
1.53
%
 
3.05
%

The weighted average grant-date fair value of the share options awarded during the six months ended June 30, 2012 and 2011 was $7.44 and $7.46, respectively.

A summary of the status of Washington Trust's share option activity as of June 30, 2012, and changes during the six months ended June 30, 2012, is presented below:
 
Number of Share Options
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (Years)
 
Aggregate Intrinsic Value (000's)
Outstanding at January 1, 2012
712,061

 

$22.96

 
 
 
 
Granted
99,775

 
23.27

 
 
 
 
Exercised
(99,846
)
 
20.04

 
 
 
 
Forfeited or expired
(15,925
)
 
27.56

 
 
 
 
Outstanding at June 30, 2012
696,065

 

$23.32

 
5.1
 

$1,481

As of June 30, 2012:
 
 
 
 
 
 
 
Options exercisable
443,540

 

$24.77

 
2.9
 

$572

Options expected to vest in future periods
252,525

 

$20.78

 
8.9
 

$910


The total intrinsic value (which is the amount by which the fair value of the underlying stock exceeds the exercise price of an option on the exercise date) of share options exercised during the six months ended June 30, 2012 and 2011 was $528 thousand and $359 thousand, respectively.

Nonvested Share Units
The Corporation granted 27,725 nonvested share units to directors and certain key employees during the six months ended June 30, 2012 with three to five year cliff vesting terms. The Corporation granted 31,950 nonvested share units to directors and certain key employees during the six months ended June 30, 2011 with one to three year cliff vesting terms. The nonvested share units also provide for accelerated vesting if there is a change in control, death or retirement (as defined in the plans).

A summary of the status of Washington Trust’s nonvested shares as of June 30, 2012, and changes during the six months ended June 30, 2012, is presented below:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
Nonvested at January 1, 2012
91,250

 

$19.84

Granted
27,725

 
23.54

Vested
(4,819
)
 
19.60

Forfeited
(4,181
)
 
21.94

Nonvested at June 30, 2012
109,975

 

$20.70





40


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


Nonvested Performance Shares
Performance share awards are granted providing the opportunity to earn shares of common stock of the Corporation, the number of which will be determined pursuant to, and subject to the attainment of, performance goals during a specified measurement period.  The number of shares earned will range from zero to 200% of the target number of shares dependent upon the Corporation’s core return on equity and core earnings per share growth ranking compared to an industry peer group.

During the six months ended June 30, 2012, performance share awards were granted to certain executive officers for the opportunity to earn shares of common stock of the Corporation ranging from zero to 61,600 shares.  The performance shares awarded were valued at $23.65, the fair market value at the date of grant, and will be earned over a three-year performance period.  The current assumption based on the most recent peer group information results in the shares vesting at 157% of the target, or 48,356 shares.

During the six months ended June 30, 2011, performance share awards were granted to certain executive officers for the opportunity to earn shares of common stock of the Corporation ranging from zero to 65,954 shares.  The performance shares awarded were valued at $21.62, the fair market value at the date of grant, and will be earned over a three-year performance period.  The current assumption based on the most recent peer group information results in the shares vesting at 154% of the target, or 50,784 shares.

A summary of the status of Washington Trust’s performance share awards as of June 30, 2012, and changes during the six months ended June 30, 2012, is presented below:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
Performance shares at January 1, 2012
76,341

 

$19.97

Granted
46,200

 
23.65

Vested
(2,666
)
 
21.62

Forfeited
(2,335
)
 
17.03

Performance shares at June 30, 2012
117,540

 
$21.44

As of June 30, 2012, there was $4.2 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements (including share options, nonvested share awards and performance share awards) granted under the Plans.  That cost is expected to be recognized over a weighted average period of 2.3 years.

(14)
Business Segments
Washington Trust segregates financial information in assessing its results among two operating segments: Commercial Banking and Wealth Management Services.  The amounts in the Corporate column include activity not related to the segments, such as the investment securities portfolio, wholesale funding activities and administrative units.  The Corporate column is not considered to be an operating segment.  The methodologies and organizational hierarchies that define the business segments are periodically reviewed and revised.  Results may be restated, when necessary, to reflect changes in organizational structure or allocation methodology. Any changes in estimates and allocations that may affect the reported results of any business segment will not affect the consolidated financial position or results of operations of Washington Trust as a whole.

Management uses certain methodologies to allocate income and expenses to the business lines.  A funds transfer pricing 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.  Certain indirect expenses are allocated to segments.  These include support unit expenses such as technology and processing operations and other support functions.

Commercial Banking
The Commercial Banking segment includes commercial, commercial real estate, residential and consumer lending activities; equity in losses of unconsolidated investments in real estate limited partnerships, mortgage banking, secondary market and loan servicing activities; deposit generation; merchant credit card services; cash management activities; and direct banking activities, which include the operation of ATMs, telephone and Internet banking services and customer support and sales.



41


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)



Wealth Management Services
Wealth Management Services includes asset management services provided for individuals, institutions and mutual funds; personal trust services, including services as executor, trustee, administrator, custodian and guardian; institutional trust services, including services as trustee for pension and profit sharing plans; and other financial planning and advisory services.

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

The following tables present the statement of operations and total assets for Washington Trust’s reportable segments:
(Dollars in thousands)
Commercial Banking
 
Wealth Management Services
 
Corporate
 
Consolidated Total
Three months ended June 30,
2012

2011

 
2012

2011

 
2012

2011

 
2012

2011

Net interest income (expense)

$19,364


$18,809

 

($2
)

($3
)
 

$3,049


$2,258

 

$22,411


$21,064

Noninterest income
7,580

4,850

 
7,472

7,510

 
1,122

925

 
16,174

13,285

Total income
26,944

23,659

 
7,470

7,507

 
4,171

3,183

 
38,585

34,349

Provision for loan losses
600

1,200

 


 


 
600

1,200

Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization expense
602

599

 
331

341

 
54

70

 
987

1,010

Other noninterest expenses
15,858

13,581

 
4,827

4,917

 
3,556

2,756

 
24,241

21,254

Total noninterest expenses
16,460

14,180

 
5,158

5,258

 
3,610

2,826

 
25,228

22,264

Income before income taxes
9,884

8,279

 
2,312

2,249

 
561

357

 
12,757

10,885

Income tax expense (benefit)
3,397

2,764

 
858

838

 
(211
)
(282
)
 
4,044

3,320

Net income

$6,487


$5,515

 

$1,454


$1,411

 

$772


$639

 

$8,713


$7,565

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at period end

$2,331,097


$2,151,315

 

$49,869


$51,520

 

$660,084


$733,471

 

$3,041,050


$2,936,306

Expenditures for long-lived assets

$1,782


$394

 

$7


$90

 

$12


$42

 

$1,801


$526






42


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(Dollars in thousands)
Commercial Banking
 
Wealth Management Services
 
Corporate
 
Consolidated Total
Six months ended June 30,
2012

2011

 
2012

2011

 
2012

2011

 
2012

2011

Net interest income (expense)

$38,992


$37,213

 

$1


($9
)
 

$5,803


$4,187

 

$44,796


$41,391

Noninterest income
14,287

9,031

 
14,657

14,590

 
1,462

1,361

 
30,406

24,982

Total income
53,279

46,244

 
14,658

14,581

 
7,265

5,548

 
75,202

66,373

Provision for loan losses
1,500

2,700

 


 


 
1,500

2,700

Noninterest expenses:
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization expense
1,204

1,199

 
633

678

 
120

138

 
1,957

2,015

Other noninterest expenses
30,624

26,271

 
9,799

9,587

 
6,247

5,131

 
46,670

40,989

Total noninterest expenses
31,828

27,470

 
10,432

10,265

 
6,367

5,269

 
48,627

43,004

Income before income taxes
19,951

16,074

 
4,226

4,316

 
898

279

 
25,075

20,669

Income tax expense (benefit)
6,848

5,352

 
1,577

1,608

 
(501
)
(656
)
 
7,924

6,304

Net income

$13,103


$10,722

 

$2,649


$2,708

 

$1,399


$935

 

$17,151


$14,365

 
 
 
 
 
 
 
 
 
 
 
 
Total assets at period end

$2,331,097


$2,151,315

 

$49,869


$51,520

 

$660,084


$733,471

 

$3,041,050


$2,936,306

Expenditures for long-lived assets

$2,674


$816

 

$713


$348

 

$66


$75

 

$3,453


$1,239



(15)
Other Comprehensive Income
The following table presents the activity in other comprehensive income (loss) during the three months ended June 30, 2012 and 2011:
 
2012
 
2011
(Dollars in thousands)
Pre-tax Amounts
Income Taxes
Net of Tax
 
Pre-tax Amounts
Income Taxes
Net of Tax
Securities available for sale:
 
 
 
 
 
 
 
Unrealized (losses) gains on securities arising during the period

($934
)

($333
)

($601
)
 

$5,495


$1,958


$3,537

Less: reclassification adjustment for net gains on securities realized in net income
299

107

192

 
226

81

145

Net unrealized (losses) gains on securities available for sale
(1,233
)
(440
)
(793
)
 
5,269

1,877

3,392

Cash flow hedges:
 
 
 
 
 
 
 
Unrealized losses on cash flow hedges arising during the period
(199
)
(71
)
(128
)
 
(727
)
(259
)
(468
)
Less: reclassification adjustment for amount of gains on cash flow hedges realized in net income
174

62

112

 
190

68

122

Net unrealized losses on cash flow hedges
(25
)
(9
)
(16
)
 
(537
)
(191
)
(346
)
Defined benefit plan obligation adjustment
266

95

171

 
93

33

60

Total other comprehensive (loss) income

($992
)

($354
)

($638
)
 

$4,825


$1,719


$3,106





43


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The following table presents the activity in other comprehensive income (loss) during the six months ended June 30, 2012 and 2011:
 
2012
 
2011
(Dollars in thousands)
Pre-tax Amounts
Income Taxes
Net of Tax
 
Pre-tax Amounts
Income Taxes
Net of Tax
Securities available for sale:
 
 
 
 
 
 
 
Unrealized (losses) gains on securities arising during the period

($693
)

($235
)

($458
)
 

$5,636


$2,010


$3,626

Less: reclassification adjustment for net gains on securities realized in net income
214

76

138

 
143

51

92

Net unrealized (losses) gains on securities available for sale
(907
)
(311
)
(596
)
 
5,493

1,959

3,534

Reclassification adjustment for change in non-credit portion of OTTI realized losses transferred to net income
124

44

80

 
(21
)
(8
)
(13
)
Cash flow hedges:
 
 
 
 
 
 
 
Unrealized losses on cash flow hedges arising during the period
(320
)
(116
)
(204
)
 
(651
)
(232
)
(419
)
Less: reclassification adjustment for amount of gains on cash flow hedges realized in net income
347

124

223

 
381

136

245

Net unrealized gains (losses) on cash flow hedges
27

8

19

 
(270
)
(96
)
(174
)
Defined benefit plan obligation adjustment
533

177

356

 
186

66

120

Total other comprehensive (loss) income

($223
)

($82
)

($141
)
 

$5,388


$1,921


$3,467


The following table presents the components of accumulated other comprehensive income as of the dates indicated:
(Dollars in thousands)
Net Unrealized Gains on AFS Securities
 
Noncredit -related Impairment
 
Net Unrealized Losses on Cash Flow Hedges
 
Pension Benefit Adjustment
 
Total
Balance at December 31, 2011

$13,143

 

($2,062
)
 

($1,127
)
 

($11,849
)
 

($1,895
)
Period change, net of tax
(596
)
 
80

 
19

 
356

 
(141
)
Balance at June 30, 2012

$12,547

 

($1,982
)
 

($1,108
)
 

($11,493
)
 

($2,036
)
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2010

$11,936

 

($2,150
)
 

($671
)
 

($5,090
)
 

$4,025

Period change, net of tax
3,534

 
(13
)
 
(174
)
 
120

 
3,467

Balance at June 30, 2011

$15,470

 

($2,163
)
 

($845
)
 

($4,970
)
 

$7,492






44


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


(16)
Earnings Per Common Share
Washington Trust utilizes the two-class method earnings allocation formula to determine earnings per share of each class of stock according to dividends and participation rights in undistributed earnings.  Share-based payments that entitle holders to receive non-forfeitable dividends before vesting are considered participating securities and included in earnings allocation for computing basic earnings per share under this method.  Undistributed income is allocated to common shareholders and participating securities under the two-class method based upon the proportion of each to the total weighted average shares available. The calculation of earnings per common share is presented below.
(Dollars and shares in thousands, except per share amounts)
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Net income

$8,713

 

$7,565

 

$17,151

 

$14,365

Less dividends and undistributed earnings allocated to participating securities
(40
)
 
(30
)
 
(74
)
 
(57
)
Net income applicable to common shareholders

$8,673

 

$7,535

 

$17,077

 

$14,308

 
 
 
 
 
 
 
 
Weighted average basic common shares
16,358

 
16,252

 
16,344

 
16,225

Dilutive effect of common stock equivalents
34

 
32

 
37

 
32

Weighted average diluted common shares
16,392

 
16,284

 
16,381

 
16,257

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic

$0.53

 

$0.46

 

$1.04

 

$0.88

Diluted

$0.53

 

$0.46

 

$1.04

 

$0.88


Weighted average common stock equivalents, not included in common stock equivalents above because they were anti-dilutive, totaled 394 thousand and 349 thousand, respectively, for the three months ended June 30, 2012 and 2011. These amounts totaled 393 thousand and 374 thousand, respectively, for the six months ended June 30, 2012 and 2011.

(17)
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, interest rate swap agreements and commitments to originate and commitments to sell fixed-rate mortgage loans.  These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Corporation’s 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.




45


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


The contractual and notional amounts of financial instruments with off-balance sheet risk are as follows:
(Dollars in thousands)
Jun 30,
2012
 
Dec 31,
2011
Financial instruments whose contract amounts represent credit risk:
 
 
 
Commitments to extend credit:
 
 
 
Commercial loans

$221,163

 

$222,805

Home equity lines
183,895

 
185,124

Other loans
33,395

 
35,035

Standby letters of credit
8,777

 
8,560

Financial instruments whose notional amounts exceed the amount of credit risk:
 
 
 
Forward loan commitments:
 
 
 
Commitments to originate fixed-rate mortgage loans to be sold
83,633

 
56,950

Commitments to sell fixed-rate mortgage loans
106,340

 
76,574

Customer related derivative contracts:


 


Interest rate swaps with customers
60,958

 
61,586

Mirror swaps with counterparties
60,958

 
61,586

Interest rate risk management contract:


 


Interest rate swap
32,991

 
32,991


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, the 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.  The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.  Under a standby letter of credit, the Corporation is required to make payments to the beneficiary of the letter of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary.  Standby letters of credit extend up to five years.  As of June 30, 2012 and December 31, 2011, the maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered, totaled $8.8 million and $8.6 million, respectively. At June 30, 2012 and December 31, 2011, there were no liabilities to beneficiaries resulting from standby letters of credit.  Fee income on standby letters of credit for the three and six months ended June 30, 2012 amounted to $28 thousand and $55 thousand, respectively, compared to $33 thousand and $97 thousand for the three and six months ended June 30, 2011.

As of June 30, 2012 and December 31, 2011, a substantial portion of the standby letters of credit was supported by pledged collateral.  The collateral obtained is determined based on management’s credit evaluation of the customer.  Should the Corporation be required to make payments to the beneficiary, repayment from the customer to the Corporation is required.

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

Leases
As of June 30, 2012 and December 31, 2011, the Corporation was obligated under various non-cancellable operating leases for



46


WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS    (Continued)


properties used as banking offices and other office facilities.  Rental expense under the operating leases amounted to $770 thousand and $1.4 million, respectively, for the three and six months ended June 30, 2012, compared to $429 thousand and $850 thousand, respectively, for the same periods in 2011. Rental expense is recorded as a component of net occupancy expense in the accompanying Consolidated Statements of Income.

At June 30, 2012, the minimum annual lease payments under the terms of these leases, exclusive of renewal provisions, are as follows:
(Dollars in thousands)
 
 
Periods ending:
July 1, 2012 to December 31, 2012

$1,135

 
2013
2,256

 
2014
2,252

 
2015
1,740

 
2016
1,463

 
2017 and thereafter
11,860

Total minimum lease payments
 

$20,706


Lease expiration date ranges have not changed significantly from December 31, 2011.

Other Contingencies
Litigation
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.

Other
When selling a residential real estate mortgage loan or acting as originating agent on behalf of a third party, Washington Trust generally makes various representations and warranties. The specific representations and warranties depend on the nature of the transaction and the requirements of the buyer.  Contractual liability may arise when the representations and warranties are breached.  In the event of a breach of these representations and warranties, Washington Trust may be required to either repurchase the residential real estate mortgage loan (generally at unpaid principal balance plus accrued interest) with the identified defects or indemnify (“make-whole”) the investor for its losses.

In the case of a repurchase, Washington Trust will bear any subsequent credit loss on the residential real estate mortgage loan.  Washington Trust has experienced an insignificant number of repurchase demands over a period of many years.  As of June 30, 2012 and December 31, 2011, the unpaid principal balance of loans repurchased due to representation and warranty claims was $628 thousand and $773 thousand, respectively. Washington Trust has recorded a reserve for its exposure to losses from the obligation to repurchase previously sold residential real estate mortgage loans.  This reserve is not material and is included in other liabilities in the Consolidated Balance Sheets and any change in the estimate is recorded in net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.




47


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 consolidated financial statements, and notes thereto, included in the Annual Report on Form 10-K for the year ended December 31, 2011, and in conjunction with the condensed consolidated financial statements and notes thereto included in Item 1 of this report.  Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results for the full-year ended December 31, 2012 or any future period.

Forward-Looking Statements
This report contains statements that are “forward-looking statements.”  We may also make written or oral 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 the control of the Corporation.  These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Corporation to be materially different from 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: changes in general national, regional or international economic conditions or conditions affecting the banking or financial services industries or financial capital markets, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, reductions in net interest income resulting from interest rate volatility as well as changes in the balance and mix of loans and deposits, reductions in the market value of wealth management assets under administration, changes in the value of securities and other assets, reductions in loan demand, changes in loan collectibility, default and charge-off rates, changes in the size and nature of the Corporation’s competition, changes in legislation or regulation and accounting principles, policies and guidelines such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 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, 2011, 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 carrying value of certain assets and impact income are considered critical accounting policies.  The Corporation considers the following to be its critical accounting policies: allowance for loan losses, review of goodwill and intangible assets for impairment and valuation of investment securities for impairment. 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 year ended December 31, 2011.

Recently Issued Accounting Pronouncements
See Note 2 to the Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on the Corporation’s consolidated financial position, results of operations or cash flows.

Overview
Washington Trust offers a comprehensive product line of 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, ATMs, and its Internet website at www.washtrust.com.

Our largest source of operating income is net interest income, the difference between interest earned on loans and securities and interest paid on deposits and other borrowings.  In addition, we generate noninterest income from a number of sources including wealth management services, deposit services, merchant credit card processing, bank-owned life insurance, loan sales and commissions on loans originated for others.  Our principal noninterest expenses include salaries and employee benefits, occupancy and facility-related costs, merchant processing costs, FDIC deposit insurance costs, technology and other



48


administrative expenses.

Our financial results are affected by interest rate volatility, changes in economic and market conditions, competitive conditions within our market area and changes in legislation, regulation and/or accounting principles.  While the regional economic climate has improved in recent quarters, uncertainty surrounding future economic growth, consumer confidence, credit availability and corporate earnings remains.  Management believes that overall credit quality continues to be somewhat affected by weaknesses in national and regional economic conditions, including high unemployment levels, particularly in Rhode Island.

We believe that the Corporation's financial strength and stability, capital resources and reputation as the largest independent bank headquartered in Rhode Island were key factors in the recent expansion of our retail and mortgage banking businesses and in delivering solid results in 2011 and in the first half of 2012. We opened a mortgage lending office in Warwick, Rhode Island, in February 2012 and our third full-service branch in Cranston, Rhode Island, in July 2012.

Composition of Earnings
Net income for the second quarter of 2012 amounted to $8.7 million, or 53 cents per diluted share, up from the $7.6 million, or 46 cents per diluted share, reported for the second quarter of 2011.  The returns on average equity and average assets for the second quarter of 2012 were 11.98% and 1.16%, respectively, compared to 10.83% and 1.04%, respectively, for the same quarter in 2011.

For the six months ended June 30, 2012, net income amounted to $17.2 million, or $1.04 per diluted share, up from $14.4 million, or 88 cents per diluted share, reported for the same period in 2011. The returns on average equity and average assets for the first six months of 2012 were 11.92% and 1.13%, respectively, compared to 10.44% and 0.99%, respectively, for the same period in 2011.

The increase in profitability over the 2011 periods reflected strong mortgage banking results (net gains on loan sales and commissions on loans originated for others), higher net interest income and a lower provision for loan losses, partially offset by increases in salaries and employee benefit costs and income taxes.

In addition, 2012 and 2011 results also included the following items:
Gains recognized on the sale of bank property, included in other income, amounted to $348 thousand and $203 thousand, respectively, in the three months ended June 30, 2012 and 2011.
A charge of $131 thousand, classified in net occupancy expense, was recognized in the second quarter of 2012 due to the termination of an operating lease associated with the planned closure of a branch in September 2012.
Balance sheet management transactions were executed in the second quarters of 2012 and 2011, consisting of the sale of mortgage-backed securities and the prepayment of Federal Home Loan Bank of Boston (“FHLBB”) advances. As a result, in the three months ended June 30, 2012 and 2011, the Corporation recognized net realized gains of $217 thousand and $226 thousand, respectively, and debt prepayment penalty expense of $961 thousand and $221 thousand, respectively.
Net impairment losses recognized in earnings on investment securities totaled $209 thousand and $33 thousand, respectively, for the first six months of 2012 and 2011. There were no such impairment losses recognized in the quarters ended June 30, 2012 and 2011.

Net interest income for the second quarter and first half of 2012, respectively, increased by $1.3 million, or 6%, and by $3.4 million, or 8%, from the same periods in 2011, reflecting the benefit of lower funding costs, as well as growth in average loan balances. The net interest margin (fully taxable equivalent net interest income as a percentage of average interest-earnings assets) for the quarter ended June 30, 2012 was 3.30%, up by 9 basis points from the second quarter a year earlier. For the first six months of 2012, the net interest margin was 3.28%, up from 3.19% for the same period in 2011.

The loan loss provision charged to earnings for the three and six months ended June 30, 2012 amounted to $600 thousand and $1.5 million, respectively. Comparable amounts for the same periods in 2011 were $1.2 million and $2.7 million, respectively.  Net charge-offs for the second quarter and first half of 2012 totaled $197 thousand and $854 thousand, respectively, compared to $956 thousand and $1.9 million, respectively, in the same periods a year earlier. Management believes that the level of the provision for loan losses has been consistent with the trend in asset quality and credit quality indicators.

Revenue from wealth management services is our largest source of noninterest income. For the three and six months ended



49


June 30, 2012, wealth management revenues totaled $7.5 million and $14.7 million, respectively, essentially level when compared to the same periods in 2011.  Wealth management assets under administration totaled $4.1 billion at June 30, 2012, down by $68.5 million, or 2%, from the balance at June 30, 2011.

Mortgage banking revenues, which are dependent on mortgage origination volume and are sensitive to interest rates and the condition of the housing markets, amounted to $3.0 million and $6.1 million, respectively, for the second quarter and first half of 2012, up by $2.5 million and $5.1 million, respectively, from the same periods in 2011. To a certain extent, the mortgage origination volume in the first six months of 2012 reflected an increase in refinancing activity in response to relatively low market rates of interest. The increase over 2011 also reflected continued origination volume growth in our residential mortgage lending offices.

Noninterest expenses for the three and six months ended June 30, 2012 increased by $3.0 million, or 13%, and $5.6 million, or 13%, respectively, from the comparable 2011 periods, primarily due to increases in salaries and employee benefit costs. Also included in the increase in noninterest expenses were the debt prepayment penalties and lease termination charge described above. The increase in salaries and employee benefit costs from 2011 reflected higher amounts of commissions paid to mortgage originators, higher staffing levels in support of mortgage origination and other business lines and higher defined benefit plan costs primarily due to a lower discount rate in 2012 compared to 2011.

Income tax expense amounted to $4.0 million and $7.9 million, respectively, for the three and six months ended June 30, 2012, up by $724 thousand and $1.6 million, respectively, from the same periods in 2011.  The effective tax rate for the three months ended June 30, 2012 and 2011was 31.7% and 30.5%, respectively. For the first six months of 2012 and 2011, the effective tax rate was 31.6% and 30.5%, respectively. The increase in the effective tax rate from 2011, reflected a higher portion of taxable income to pretax book income in 2012.




50


Results of Operations
Segment Reporting
Washington Trust manages its operations through two business segments, Commercial Banking and Wealth Management Services.  Activity not related to the segments, such as the investment securities portfolio, wholesale funding activities and administrative units are considered Corporate.  The Corporate unit also includes 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.  The Corporate unit’s net interest income increased in 2012, as funding costs declined more than asset yields.  See Note 14 to the Consolidated Financial Statements for additional disclosure related to business segments.

The Commercial Banking segment reported net income of $6.5 million and $13.1 million, respectively, for the three and six months ended June 30, 2012. Comparable amounts for the same periods in 2011 were $5.5 million and $10.7 million, respectively. Commercial Banking net interest income for the second quarter and first half of 2012, respectively, increased by $555 thousand, or 3%, and $1.8 million,or 5%, from the same periods in 2011, reflecting the benefit of lower funding costs, as well as growth in average loan balances.  The provision for loan losses for the three and six months ended June 30, 2012 declined by $600 thousand, or 50%, and $1.2 million, or 44%, respectively from the comparable 2011 periods. Noninterest income derived from the Commercial Banking segment totaled $7.6 million and $14.3 million, respectively, for the three and six months ended June 30, 2012, up by $2.7 million, or 56%, and $5.3 million, or 58%, respectively, from the comparable 2011 periods, primarily due to higher mortgage banking revenues. Commercial Banking noninterest expenses for the three and six months ended June 30, 2012, were up by $2.3 million, or 16%, and $4.4 million, or 16%, respectively, from the same periods in 2011, reflecting increases in salaries and employee benefit expenses.

The Wealth Management Services segment reported net income of $1.5 million and $2.6 million, respectively, for the three and six months ended June 30, 2012, essentially level when compared to the same periods in 2011.  Noninterest income derived from the Wealth Management Services segment was $7.5 million and $14.7 million, respectively for the second quarter and first half of 2012, compared to $7.5 million and $14.6 million, respectively, for the same periods 2011.  This noninterest income is largely dependent on the value of wealth management assets under administration and is closely tied to the performance of the financial markets. Wealth management assets under administration totaled $4.1 billion at June 30, 2012, down by $68.5 million, or 2%, from a year ago. Noninterest expenses for the Wealth Management Services segment totaled $5.2 million and $10.4 million, respectively, for the three and six months ended June 30, 2012, down by $100 thousand, or 2%, and up by $167 thousand, or 2%, respectively, from the same periods in 2011.

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

FTE net interest income for the three and six months ended June 30, 2012 increased by $1.3 million, or 6%, and $3.4 million, or 8%, respectively, from the same periods in 2011. The net interest margin was 3.30% and 3.28%, respectively, for the three and six months ended June 30, 2012, compared to 3.21% and 3.19%, respectively, for the same periods in 2011. The increase in net interest income and improvement in the net interest margin were largely due to growth in average loan balances and reductions in funding costs.

Average interest-earning assets amounted to $2.8 billion for both the three and six months ended June 30, 2012, up by 4% and 5%, respectively, from the average balances for the same periods in 2011.  Total average loans for the three and six months ended June 30, 2012, increased by $154.1 million and $151.8 million, respectively, compared to the average balances for the same periods in 2011, with increases in both the commercial and residential real estate loan portfolios.  The yield on total loans for the second quarter and first six months of 2012 decreased by 21 basis points and 19 basis points, respectively, from the comparable 2011 periods, reflecting declines in short-term interest rates.

Total average securities for the three and six months ended June 30, 2012 decreased by $44.4 million and $29.2 million, respectively, from the average balances for the same periods a year earlier, primarily due to maturities of and principal payments received on mortgage-backed securities.  The FTE rate of return on securities for the three and six months ended June 30, 2012



51


decreased by 33 basis points and 32 basis points, respectively, from the same periods last year. The decrease in total yield on securities reflects maturities and pay-downs of higher yielding securities.

Average interest-bearing liabilities for the three and six months ended June 30, 2012, increased by $18.5 million, or 1%, and by $32.0 million, or 1%, respectively, from the comparable periods in 2011, largely due to growth in lower-cost deposit balances, offset, in part, by decreases in time deposits and other borrowings. The weighted average cost of funds declined by 28 basis points, or 17%, for the three and six months ended June 30, 2012, compared to the same periods in 2011, primarily due to declines in the rate paid on time deposits and FHLBB advances.

The average balance of FHLBB advances for the three months ended June 30, 2012 was level when compared to the 2011 period. For the six months ended June 30, 2012, the average balance of FHLBB advances was up by $23.8 million, or 5%, compared to the average balance for the first six months of 2011.  The average rate paid on such advances for the second quarter and first half of 2012 decreased by 55 basis points and 72 basis points, respectively, from the comparable periods in 2011, reflecting lower market interest rates on new advances. The decline in the average rate paid on FHLBB advances also reflected the benefit of the balance sheet management transactions executed in 2011 and 2012. See additional discussion under the caption “Composition of Earnings” above.

Total average interest-bearing deposits for the three and six months ended June 30, 2012 increased by $40.0 million and $20.7 million, respectively, compared to the average balance for the same periods in 2011. This increase reflected growth in lower-cost deposit balances, partially offset by a decrease in time deposits. The average rate paid on interest-bearing deposits for the second quarter and first half of 2012 decreased by 16 basis points and 17 basis points, respectively, compared to the same periods in 2011, primarily due to declines in the rate paid on time deposits. The average balance of noninterest-bearing demand deposits for the three and six months ended June 30, 2012 increased by $69.5 million, or 28%, and $75.6 million, or 30%, respectively, when compared to the average balance for the same periods in 2011.




52


Average Balances / Net Interest Margin - Fully Taxable Equivalent (FTE) Basis
The following tables present average balance and interest rate information.  Tax-exempt income is converted to a FTE basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit.  For dividends on corporate stocks, the 70% federal dividends received deduction is also used in the calculation of tax equivalency.  Average balances and yields for securities available for sale are based on amortized cost.  Nonaccrual and renegotiated loans, as well as interest earned on these loans (to the extent recognized in the Consolidated Statements of Income) are included in amounts presented for loans.
Three months ended June 30,
2012
 
2011
(Dollars in thousands)
Average Balance
 
Interest
 
Yield/ Rate
 
Average Balance
 
Interest
 
Yield/ Rate
Assets:
 
 
 
 
 
 
 
 
 
 
 
Commercial loans

$1,166,545

 

$14,590

 
5.03
%
 

$1,065,619

 

$13,900

 
5.23
%
Residential real estate loans, including mortgage loans held for sale
714,154

 
7,809

 
4.40
%
 
656,570

 
7,732

 
4.72
%
Consumer loans
320,442

 
3,067

 
3.85
%
 
324,890

 
3,166

 
3.91
%
Total loans
2,201,141

 
25,466

 
4.65
%
 
2,047,079

 
24,798

 
4.86
%
Cash, federal funds sold and short-term investments
30,078

 
17

 
0.23
%
 
34,166

 
13

 
0.15
%
FHLBB stock
40,418

 
54

 
0.54
%
 
42,008

 
32

 
0.31
%
 
 
 
 
 
 
 
 
 
 
 
 
Taxable debt securities
451,207

 
4,069

 
3.63
%
 
486,905

 
4,869

 
4.01
%
Nontaxable debt securities
70,462

 
1,039

 
5.93
%
 
78,447

 
1,150

 
5.88
%
Corporate stocks
1,804

 
34

 
7.58
%
 
2,513

 
47

 
7.50
%
Total securities
523,473

 
5,142

 
3.95
%
 
567,865

 
6,066

 
4.28
%
Total interest-earning assets
2,795,110

 
30,679

 
4.41
%
 
2,691,118

 
30,909

 
4.61
%
Noninterest-earning assets
222,057

 
 
 
 
 
212,968

 
 
 
 
Total assets

$3,017,167

 
 
 
 
 

$2,904,086

 
 
 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
 
 
 
 
NOW accounts

$254,528

 

$39

 
0.06
%
 

$229,746

 

$60

 
0.10
%
Money market accounts
405,241

 
232

 
0.23
%
 
393,945

 
249

 
0.25
%
Savings accounts
258,824

 
72

 
0.11
%
 
224,588

 
69

 
0.12
%
Time deposits
905,466

 
3,042

 
1.35
%
 
935,813

 
3,652

 
1.57
%
FHLBB advances
494,257

 
3,998

 
3.25
%
 
494,989

 
4,685

 
3.80
%
Junior subordinated debentures
32,991

 
391

 
4.77
%
 
32,991

 
392

 
4.77
%
Other
973

 
5

 
2.07
%
 
21,663

 
242

 
4.48
%
Total interest-bearing liabilities
2,352,280

 
7,779

 
1.33
%
 
2,333,735

 
9,349

 
1.61
%
Demand deposits
321,094

 
 
 
 
 
251,585

 
 
 
 
Other liabilities
52,939

 
 
 
 
 
39,485

 
 
 
 
Shareholders’ equity
290,854

 
 
 
 
 
279,281

 
 
 
 
Total liabilities and shareholders’ equity

$3,017,167

 
 
 
 
 

$2,904,086

 
 
 
 
Net interest income
 
 

$22,900

 
 
 
 
 

$21,560

 
 
Interest rate spread
 
 
 
 
3.08
%
 
 
 
 
 
3.00
%
Net interest margin
 
 
 
 
3.30
%
 
 
 
 
 
3.21
%




53


Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:
(Dollars in thousands)
 
 
 
Three months ended June 30,
2012
 
2011
Commercial loans

$122

 

$91

Nontaxable debt securities
357

 
392

Corporate stocks
10

 
13

Total

$489

 

$496



Six months ended June 30,
2012
 
2011
(Dollars in thousands)
Average Balance
 
Interest
 
Yield/ Rate
 
Average Balance
 
Interest
 
Yield/ Rate
Assets:
 
 
 
 
 
 
 
 
 
 
 
Commercial loans

$1,144,114

 

$28,888

 
5.08
%
 

$1,051,577

 

$27,406

 
5.26
%
Residential real estate loans, including mortgage loans held for sale
717,430

 
15,884

 
4.45
%
 
653,938

 
15,432

 
4.76
%
Consumer loans
320,195

 
6,164

 
3.87
%
 
324,471

 
6,310

 
3.92
%
Total loans
2,181,739

 
50,936

 
4.69
%
 
2,029,986

 
49,148

 
4.88
%
Cash, federal funds sold and short-term investments
41,196

 
37

 
0.18
%
 
39,029

 
37

 
0.19
%
FHLBB stock
41,012

 
106

 
0.52
%
 
42,008

 
64

 
0.31
%
 
 
 
 
 
 
 
 
 
 
 
 
Taxable debt securities
468,828

 
8,446

 
3.62
%
 
489,544

 
9,642

 
3.97
%
Nontaxable debt securities
71,185

 
2,098

 
5.93
%
 
78,947

 
2,316

 
5.92
%
Corporate stocks
1,828

 
67

 
7.37
%
 
2,512

 
96

 
7.71
%
Total securities
541,841

 
10,611

 
3.94
%
 
571,003

 
12,054

 
4.26
%
Total interest-earning assets
2,805,788

 
61,690

 
4.42
%
 
2,682,026

 
61,303

 
4.61
%
Noninterest-earning assets
221,430

 
 
 
 
 
212,379

 
 
 
 
Total assets

$3,027,218

 
 
 
 
 

$2,894,405

 
 
 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
 
 
 
 
NOW accounts

$250,390

 

$85

 
0.07
%
 

$227,375

 

$118

 
0.10
%
Money market accounts
408,647

 
457

 
0.22
%
 
396,614

 
572

 
0.29
%
Savings accounts
253,837

 
142

 
0.11
%
 
222,481

 
144

 
0.13
%
Time deposits
895,405

 
6,135

 
1.38
%
 
941,093

 
7,398

 
1.59
%
FHLBB advances
509,012

 
8,083

 
3.19
%
 
485,233

 
9,417

 
3.91
%
Junior subordinated debentures
32,991

 
783

 
4.77
%
 
32,991

 
782

 
4.78
%
Other
9,938

 
239

 
4.84
%
 
22,389

 
483

 
4.35
%
Total interest-bearing liabilities
2,360,220

 
15,924

 
1.36
%
 
2,328,176

 
18,914

 
1.64
%
Demand deposits
326,159

 
 
 
 
 
250,550

 
 
 
 
Other liabilities
53,012

 
 
 
 
 
40,520

 
 
 
 
Shareholders’ equity
287,827

 
 
 
 
 
275,159

 
 
 
 
Total liabilities and shareholders’ equity

$3,027,218

 
 
 
 
 

$2,894,405

 
 
 
 
Net interest income
 
 

$45,766

 
 
 
 
 

$42,389

 
 
Interest rate spread
 
 
 
 
3.06
%
 
 
 
 
 
2.97
%
Net interest margin
 
 
 
 
3.28
%
 
 
 
 
 
3.19
%




54


Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency:
(Dollars in thousands)
 
 
 
Six months ended June 30,
2012
 
2011
Commercial loans

$229

 

$182

Nontaxable debt securities
723

 
789

Corporate stocks
18

 
27

Total

$970

 

$998


Volume / Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)
The following table presents certain information on a FTE basis regarding changes in our interest income and interest expense for the period indicated.  The net change attributable to both volume and rate has been allocated proportionately.
(Dollars in thousands)
 
Three months ended
 
Six months ended
 
 
June 30, 2012 vs. 2011
 
June 30, 2012 vs. 2011
 
 
Increase (Decrease) Due to
 
Increase (Decrease) Due to
 
 
Volume
 
Rate
 
Net Change
 
Volume
 
Rate
 
Net Change
Interest on Interest-Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial loans
 

$1,275

 

($585
)
 

$690

 

$2,365

 

($883
)
 

$1,482

Residential real estate loans, including mortgage loans held for sale
 
646

 
(569
)
 
77

 
1,449

 
(997
)
 
452

Consumer loans
 
(43
)
 
(56
)
 
(99
)
 
(83
)
 
(63
)
 
(146
)
Cash, federal funds sold and other short-term investments
 
(2
)
 
6

 
4

 
2

 
(2
)
 

FHLBB stock
 
(1
)
 
23

 
22

 
(2
)
 
44

 
42

Taxable debt securities
 
(344
)
 
(456
)
 
(800
)
 
(396
)
 
(800
)
 
(1,196
)
Nontaxable debt securities
 
(118
)
 
7

 
(111
)
 
(228
)
 
10

 
(218
)
Corporate stocks
 
(13
)
 

 
(13
)
 
(25
)
 
(4
)
 
(29
)
Total interest income
 
1,400

 
(1,630
)
 
(230
)
 
3,082

 
(2,695
)
 
387

Interest on Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
NOW accounts
 
5

 
(26
)
 
(21
)
 
9

 
(42
)
 
(33
)
Money market accounts
 
6

 
(23
)
 
(17
)
 
18

 
(133
)
 
(115
)
Savings accounts
 
9

 
(6
)
 
3

 
20

 
(22
)
 
(2
)
Time deposits
 
(113
)
 
(497
)
 
(610
)
 
(344
)
 
(919
)
 
(1,263
)
FHLBB advances
 
(7
)
 
(680
)
 
(687
)
 
443

 
(1,777
)
 
(1,334
)
Junior subordinated debentures
 

 
(1
)
 
(1
)
 

 
1

 
1

Other
 
(151
)
 
(86
)
 
(237
)
 
(295
)
 
51

 
(244
)
Total interest expense
 
(251
)
 
(1,319
)
 
(1,570
)
 
(149
)
 
(2,841
)
 
(2,990
)
Net interest income
 

$1,651

 

($311
)
 

$1,340

 

$3,231

 

$146

 

$3,377


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

The provision for loan losses charged to earnings for the second quarter and first six months of 2012 amounted to $600 thousand and $1.5 million, respectively. Comparable amounts for the same periods in 2011 were $1.2 million and $2.7 million, respectively.  The decline in the provision for loan losses from 2011 was based on our analysis of the trends in asset quality and



55


credit quality indicators, as well as the absolute level of loan loss allocation. Net charge-offs for the second quarter and first half of 2012 totaled $197 thousand and $854 thousand, respectively, compared to $956 thousand and $1.9 million, respectively, in the same periods a year earlier.

The allowance for loan losses was $30.4 million, or 1.38% of total loans, at June 30, 2012, compared to $29.8 million, or 1.39% of total loans, at December 31, 2011.  Management will continue to assess the adequacy of its allowance for loan losses in accordance with its established policies.  See additional discussion under the caption “Asset Quality” below for further information on the Allowance for Loan Losses.

Noninterest Income
Noninterest income is an important source of revenue for Washington Trust.  For the three and six months ended June 30, 2012, noninterest income represented 42% and 41% of total revenues, respectively.  The principal categories of noninterest income are shown in the following table:
(Dollars in thousands)
Three Months
 
Six Months
 
 
 
 
 
Incr (Decr)
 
 
 
 
 
Incr (Decr)
Periods ended June 30,
2012

 
2011

 
$
 
%
 
2012
 
2011
 
$
 
%
Wealth management services:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trust and investment advisory fees

$5,819

 

$5,822

 

($3
)
 
 %
 

$11,597

 

$11,498

 

$99

 
1
 %
Mutual fund fees
1,002

 
1,135

 
(133
)
 
(12
)%
 
2,027

 
2,258

 
(231
)
 
(10
)%
Financial planning, commissions & other service fees
652

 
553

 
99

 
18
 %
 
1,034

 
834

 
200

 
24
 %
Wealth management services
7,473

 
7,510

 
(37
)
 
 %
 
14,658

 
14,590

 
68

 
 %
Service charges on deposit accounts
764

 
909

 
(145
)
 
(16
)%
 
1,523

 
1,841

 
(318
)
 
(17
)%
Merchant processing fees
2,732

 
2,682

 
50

 
2
 %
 
4,720

 
4,626

 
94

 
2
 %
Card interchange fees
626

 
581

 
45

 
8
 %
 
1,169

 
1,068

 
101

 
9
 %
Income from bank-owned life insurance
477

 
482

 
(5
)
 
(1
)%
 
963

 
958

 
5

 
1
 %
Net gains on loan sales and commissions on loans originated for others
3,015

 
537

 
2,478

 
461
 %
 
6,112

 
1,062

 
5,050

 
476
 %
Net realized gains on securities
299

 
226

 
73

 
32
 %
 
299

 
197

 
102

 
52
 %
Net (losses) gains on interest rate swap contracts
(4
)
 
(35
)
 
31

 
89
 %
 
24

 
41

 
(17
)
 
(41
)%
Equity in earnings (losses) of unconsolidated subsidiaries
124

 
(145
)
 
269

 
186
 %
 
87

 
(289
)
 
376

 
130
 %
Other income
668

 
538

 
130

 
24
 %
 
1,060

 
921

 
139

 
15
 %
Noninterest income, excluding other-than-temporary impairment losses
16,174

 
13,285

 
2,889

 
22
 %
 
30,615

 
25,015

 
5,600

 
22
 %
Total other-than-temporary impairment losses on securities

 

 

 
 %
 
(85
)
 
(54
)
 
(31
)
 
(57
)%
Portion of loss recognized in other comprehensive income (before tax)

 

 

 
 %
 
(124
)
 
21

 
(145
)
 
(690
)%
Net impairment losses recognized in earnings

 

 

 
 %
 
(209
)
 
(33
)
 
(176
)
 
(533
)%
Total noninterest income

$16,174

 

$13,285

 

$2,889

 
22
 %
 

$30,406

 

$24,982

 

$5,424

 
22
 %




56


Revenue from wealth management services is our largest source of noninterest income.  It is largely dependent on the value of wealth management assets under administration and is closely tied to the performance of the financial markets.  The following table presents the changes in wealth management assets under administration for the three and six months ended June 30, 2012 and 2011.
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three Months
 
Six Months
Periods ended June 30,
2012
 
2011
 
2012
 
2011
Wealth Management Assets under Administration:
 
 
 
 
 
 
 
Balance at the beginning of period

$4,196,447

 

$4,119,207

 

$3,900,061

 

$3,967,207

Net investment (depreciation) appreciation & income
(131,896
)
 
1,625

 
166,259

 
147,188

Net client cash flows
15,362

 
27,601

 
13,593

 
34,038

Balance at the end of period

$4,079,913

 

$4,148,433

 

$4,079,913

 

$4,148,433


Noninterest Income Analysis
Wealth management revenues for the three and six months ended June 30, 2012 were $7.5 million and $14.7 million, respectively, comparable to the amounts reported for the same periods in 2011.  Wealth management assets under administration totaled $4.1 billion at June 30, 2012, down by $68.5 million, or 2%, from a year ago.

Service charges on deposit accounts for the three and six months ended June 30, 2012 totaled $764 thousand and $1.5 million, respectively, down by $145 thousand, or 16%, and $318 thousand, or 17%, respectively, from the comparable periods in 2011. These decreases were largely due to a decline in overdraft and non-sufficient funds fees.

Net gains on loan sales and commissions on loans originated for others is dependent on mortgage origination volume and is sensitive to interest rates and the condition of housing markets. For the three and six months ended June 30, 2012, this revenue source totaled $3.0 million and $6.1 million, respectively, up by $2.5 million and $5.1 million, respectively, from the same periods in 2011, reflecting increased refinancing activity in response to relatively low market rates of interest and origination volume growth in our residential mortgage lending offices. See discussion regarding the fair value option election on mortgage loans held for sale in Notes 10 and 11 to the Consolidated Financial Statements.

For the three and six months ended June 30, 2012, equity in earnings of unconsolidated subsidiaries (primarily generated by two real estate limited partnerships) amounted to $124 thousand and $87 thousand, respectively, compared to losses of $145 thousand and $289 thousand, respectively, recognized for the same periods in 2011.

Other noninterest income totaled $668 thousand and $1.1 million, respectively, for the three and six months ended June 30, 2012, up by $130 thousand and $139 thousand, respectively, from the same periods in 2011. Included in these amounts were gains recognized on the sale of bank property of $348 thousand and $203 thousand, respectively, recognized in the three months ended June 30, 2012 and 2011.

Net realized gains on securities for the three months ended June 30, 2012 and 2011 totaled $299 thousand and $226 thousand, respectively. Comparable amounts for the six months ended June 30, 2012 and 2011 were $299 thousand and $197 thousand, respectively. These amounts were primarily recognized on the sale of mortgage-backed securities resulting from the consummation of balance sheet management transactions in both 2012 and 2011. During the second quarter of 2012, gains were also recognized on the sale of perpetual preferred stock.

For the six months ended June 30, 2012 and 2011, net impairment losses recognized in earnings on investment securities totaled $209 thousand and $33 thousand, respectively. There were no such impairment losses recognized in the quarters ended June 30, 2012 and 2011. See additional discussion in the “Financial Condition” section under the caption “Securities” below.




57


Noninterest Expense
The following table presents a noninterest expense comparison for the three and six months ended June 30, 2012 and 2011.
(Dollars in thousands)
Three Months
 
Six Months
 
 
 
 
 
Incr (Decr)
 
 
 
 
 
Incr (Decr)
Periods ended June 30,
2012

 
2011

 
$
 
%
 
2012
 
2011
 
$
 
%
Salaries and employee benefits

$14,451

 

$12,398

 

$2,053

 
17
 %
 

$28,911

 

$24,226

 

$4,685

 
19
 %
Net occupancy
1,527

 
1,236

 
291

 
24
 %
 
3,053

 
2,557

 
496

 
19
 %
Equipment
1,143

 
1,070

 
73

 
7
 %
 
2,250

 
2,119

 
131

 
6
 %
Merchant processing costs
2,320

 
2,345

 
(25
)
 
(1
)%
 
3,983

 
4,014

 
(31
)
 
(1
)%
Outsourced services
895

 
875

 
20

 
2
 %
 
1,815

 
1,747

 
68

 
4
 %
FDIC deposit insurance costs
426

 
464

 
(38
)
 
(8
)%
 
884

 
1,187

 
(303
)
 
(26
)%
Legal, audit and professional fees
519

 
467

 
52

 
11
 %
 
1,001

 
959

 
42

 
4
 %
Advertising and promotion
478

 
427

 
51

 
12
 %
 
850

 
780

 
70

 
9
 %
Amortization of intangibles
186

 
237

 
(51
)
 
(22
)%
 
373

 
475

 
(102
)
 
(21
)%
Foreclosed property costs
170

 
338

 
(168
)
 
(50
)%
 
468

 
504

 
(36
)
 
(7
)%
Debt prepayment penalties
961

 
221

 
740

 
335
 %
 
961

 
221

 
740

 
335
 %
Other
2,152

 
2,186

 
(34
)
 
(2
)%
 
4,078

 
4,215

 
(137
)
 
(3
)%
Total noninterest expense

$25,228

 

$22,264

 

$2,964

 
13
 %
 

$48,627

 

$43,004

 

$5,623

 
13
 %

Noninterest Expense Analysis
For the three and six months ended June 30, 2012, salaries and employee benefit expense, the largest component of noninterest expense, totaled $14.5 million and $28.9 million, respectively, up by $2.1 million, or 17%, and $4.7 million, or 19%, from the same periods in 2011.  This increase reflected higher amounts of commissions paid to mortgage originators, higher staffing levels in support of mortgage origination and other business lines and higher defined benefit pension costs primarily due to a lower discount rate in 2012 compared to 2011.

Net occupancy expense for the three and six months ended June 30, 2012 increased by $291 thousand, or 24%, and $496 thousand, or 19%, compared to the same periods in 2011, reflecting increased rental expense for premises leased by Washington Trust and included costs associated with a de novo branch that opened in September 2011 and two residential mortgage lending offices that opened in December 2011 and March 2012. Also included in net occupancy expense in the second quarter of 2012 was a charge of $131 thousand for the termination of an operating lease associated with the planned closure of a branch in September of 2012.

Debt prepayment penalties totaled $961 thousand for the three and six months ended June 30, 2012 compared to $221 thousand for the same periods a year ago, reflecting prepayments of higher cost FHLBB advances. See additional discussion under the caption “Composition of Earnings” above.

FDIC deposit insurance costs for the three and six months ended June 30, 2012 amounted to $426 thousand and $884 thousand, respectively, down by $38 thousand, or 8%, and $303 thousand, or 26%, from the same periods in 2011, reflecting lower assessment rates and a statutory change in the calculation method that became effective for the second quarter of 2011.

Income Taxes
Income tax expense amounted to $4.0 million and $7.9 million, respectively, for the three and six months ended June 30, 2012, compared to $3.3 million and $6.3 million, respectively, for the same periods in 2011.  The Corporation’s effective tax rate for the three and six months ended June 30, 2012 was 31.7% and 31.6%, respectively, up from 30.5% for both comparative periods in 2011. The increase in the effective tax rate reflected a higher portion of taxable income to pretax book income in 2012.  The effective tax rates differed from the federal rate of 35%, due largely to the benefits of tax-exempt income, the dividends received deduction, income from bank-owned life insurance and federal tax credits.




58


Financial Condition
Summary
Total assets amounted to $3.0 billion at June 30, 2012, down by $23.0 million from the end of 2011, reflecting a decline in the investment securities portfolio primarily due to principal payments received on mortgage-backed securities not being reinvested, offset, in part, by loan growth.

The balances of nonperforming assets (nonaccrual loans, nonaccrual investment securities and property acquired through foreclosure or repossession), total past due loans and loans classified as troubled debt restructurings all declined from December 31, 2011 to June 30, 2012.  While these asset quality indicators showed noticeable improvement in the first half of 2012, overall credit quality continues to be affected by weaknesses in national and regional economic conditions, including high unemployment levels.

Total liabilities decreased by $34.4 million from the balance at December 31, 2011, reflecting the balance sheet management transactions described previously and securities sold under repurchase agreements.

Shareholders’ equity totaled $292.7 million at June 30, 2012, up by $11.4 million from the balance at December 31, 2011.  Capital levels continue to exceed the the regulatory minimum levels to be considered well-capitalized, with a total risk-based capital ratio of 13.15% at June 30, 2012, compared to 12.86% at December 31, 2011.

Securities
Washington Trust’s securities portfolio is managed to generate interest income, to implement interest rate risk management strategies, and to provide a readily available source of liquidity for balance sheet management. Securities are designated as either available for sale, held to maturity or trading at the time of purchase.  The Corporation does not currently maintain a portfolio of trading securities.  Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements.  Securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized.  Securities held to maturity are reported at amortized cost. See Notes 4 and 11 to the Consolidated Financial Statements for additional information.

As noted in Note 11 to the Consolidated Financial Statements, a majority of our fair value measurements utilize Level 2 inputs, which utilize 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.  Our Level 2 financial instruments consist primarily of available for sale debt securities.  Level 3 financial instruments utilize valuation techniques in which one or more significant input assumptions are unobservable in the markets and which reflect the Corporation’s market assumptions.  As of June 30, 2012 and December 31, 2011, our Level 3 financial instruments consisted of two available for sale pooled trust preferred securities, which were not actively traded.

As of June 30, 2012 and December 31, 2011, the Corporation concluded that the low level of trading activity for our Level 3 pooled trust preferred securities continued to indicate that quoted market prices were not indicative of fair value.  The Corporation obtained valuations including broker quotes and cash flow scenario analyses prepared by a third party valuation consultant.  The fair values were assigned a weighting that was dependent upon the methods used to calculate the prices.  The cash flow scenarios (Level 3) were given substantially more weight than the broker quotes (Level 2) as management believed that the broker quotes reflected limited sales evidenced by a relatively inactive market.  The cash flow scenarios were prepared using discounted cash flow methodologies based on detailed cash flow and credit analysis of the pooled securities.  The weighting was then used to determine an overall fair value of the securities.  Management believes that this approach is most representative of fair value for these particular securities in current market conditions.  Our internal review procedures have confirmed that the fair values provided by the referenced sources and utilized by the Corporation are consistent with GAAP.  If Washington Trust was required to sell these securities in an un-orderly fashion, actual proceeds received could potentially be significantly less than their fair values.




59


The carrying amounts of securities as of the dates indicated are presented in the following tables:
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount

 
%

 
Amount

 
%

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

$32,319

 
7
%
 

$32,833

 
6
%
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
324,292

 
69

 
389,658

 
72

States and political subdivisions
73,723

 
16

 
79,493

 
15

Trust preferred securities:
 
 
 
 
 
 
 
Individual name issuers
23,620

 
5

 
22,396

 
4

Collateralized debt obligations
767

 

 
887

 

Corporate bonds
14,446

 
3

 
14,282

 
3

Perpetual preferred stocks

 

 
1,704

 

Total securities available for sale

$469,167

 
100
%
 

$541,253

 
100
%

(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount

 
%

 
Amount

 
%

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

$47,026

 
100
%
 

$52,139

 
100
%
Total securities held to maturity

$47,026

 
100
%
 

$52,139

 
100
%

As of June 30, 2012, the investment portfolio totaled $516.2 million, down by $77.2 million from the balance at December 31, 2011, reflecting maturities and principal payments received on mortgage-backed securities and, to a lesser extent, sales of mortgage-backed securities and perpetual preferred stocks. See additional discussion regarding balance sheet management transactions under the caption “Composition of Earnings” in the Overview section.

At both June 30, 2012 and December 31, 2011, the net unrealized gain position on securities available for sale and held to maturity amounted to $17.6 million and included gross unrealized losses of $10.4 million and $12.2 million, respectively, as of June 30, 2012 and December 31, 2011.  Nearly all of these gross unrealized losses were concentrated in variable rate trust preferred securities issued by financial services companies.

The carrying amount of state and political subdivision holdings included in our securities portfolio at June 30, 2012 totaled $73.7 million. The following table presents state and political subdivision holdings by geographic location.
(Dollars in thousands)
 
 
 
 
 
 
 
June 30, 2012
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
New Jersey

$31,380

 

$2,652

 

$—

 

$34,032

New York
11,442

 
768

 

 
12,210

Pennsylvania
10,117

 
452

 

 
10,569

Illinois
9,452

 
488

 

 
9,940

Other
6,548

 
424

 

 
6,972

Total

$68,939

 

$4,784

 

$—

 

$73,723





60


The following table presents state and political subdivision holdings by category.
(Dollars in thousands)
 
 
 
 
 
 
 
June 30, 2012
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
School districts

$25,853

 

$1,588

 

$—

 

$27,441

General obligation
35,998

 
2,786

 

 
38,784

Revenue obligations (a)
7,088

 
410

 

 
7,498

Total

$68,939

 

$4,784

 

$—

 

$73,723

(a)
Includes water and sewer districts, tax revenue obligations and other.

The Bank owns trust preferred security holdings of seven individual name issuers in the financial industry and two pooled trust preferred securities in the form of collateralized debt obligations.  The following tables present information concerning the named issuers and pooled trust preferred obligations, including credit ratings.  The Corporation’s Investment Policy contains rating standards that specifically reference ratings issued by Moody’s and S&P.

Individual Issuer Trust Preferred Securities
(Dollars in thousands)
June 30, 2012
 
Credit Ratings
 
 
 
 
 
 
 
 
 
June 30, 2012
 
Form 10-Q Filing Date
Named Issuer
(parent holding company)
(a)
 
Amortized Cost (b)
 
Fair Value
 
Unrealized Loss
 
Moody's
 
S&P
 
 
Moody's
 
S&P
 
JPMorgan Chase & Co.
2
 

$9,741

 

$6,900

 

($2,841
)
 
 Baa2
 
 BBB
 
 
 Baa2
 
 BBB
 
Bank of America Corporation
3
 
5,748

 
4,736

 
(1,012
)
 
 Ba2
 
 BB+
(c)
 
 Ba2
 
 BB+
(c)
Wells Fargo & Company
2
 
5,121

 
4,115

 
(1,006
)
 
 A3/Baa1
 
 A-/BBB+
 
 
 A3/Baa1
 
 A-/BBB+
 
SunTrust Banks, Inc.
1
 
4,169

 
3,108

 
(1,061
)
 
 Baa3
 
 BB+
(c)
 
 Baa3
 
 BB+
(c)
Northern Trust Corporation
1
 
1,982

 
1,675

 
(307
)
 
 A3
 
 A-
 
 
 A3
 
 A-
 
State Street Corporation
1
 
1,972

 
1,563

 
(409
)
 
 A3
 
 BBB+
 
 
 A3
 
 BBB+
 
Huntington Bancshares Incorporated
1
 
1,925

 
1,523

 
(402
)
 
 Baa3
 
 BB+
(c)
 
 Baa3
 
 BB+
(c)
Totals
11
 

$30,658

 

$23,620

 

($7,038
)
 
 
 
 
 
 
 
 
 
 
(a)
Number of separate issuances, including issuances of acquired institutions.
(b)
Net of other-than-temporary impairment losses recognized in earnings.
(c)
Rating is below investment grade.

The Corporation’s evaluation of the impairment status of individual name trust preferred securities includes various considerations in addition to the degree of impairment and the duration of impairment.  We review the reported regulatory capital ratios of the issuer and, in all cases, the regulatory capital ratios were deemed to be in excess of the regulatory minimums.  Credit ratings were also taken into consideration, including ratings in effect as of the reporting period date as well as credit rating changes between the reporting period date and the filing date of this report.  We noted no additional downgrades to below investment grade between the reporting period date and the filing date of this report.  Where available, credit ratings from multiple rating agencies are obtained and rating downgrades are specifically analyzed.  Our review process for these credit-sensitive holdings also includes a periodic review of relevant financial information for each issuer, such as quarterly financial reports, press releases and analyst reports.  This information is used to evaluate the current and prospective financial condition of the issuer in order to assess the issuer’s ability to meet its debt obligations.  Through the filing date of this report, each of the individual name issuer securities was current with respect to interest payments.  Based on our evaluation of the facts and circumstances relating to each issuer, management concluded that all principal and interest payments for these individual issuer trust preferred securities would be collected according to their contractual terms and it expects to recover the entire amortized cost basis of these securities.  Furthermore, Washington Trust does not intend to sell these securities and it is not more likely than not that Washington Trust will be required to sell these securities before recovery of their cost basis, which may be at maturity.  Therefore, management does not consider these investments to be other-than-temporarily impaired at June 30, 2012.




61


Pooled Trust Preferred Obligations
(Dollars in thousands)
June 30, 2012
 
Credit Ratings
 
 
 
 
 
 
 
No. of Cos. in Issuance
 
Deferrals & Defaults (a)
 
June 30, 2012
 
Form 10-Q Filing Date
 
Amortized Cost
 
Fair Value
 
Unrealized Loss
 
 
 
 
Deal Name
 
 
 
 
 
Moody's
 
S&P
 
Moody's
 
S&P
Tropic CDO 1, tranche A4L (d)

$2,784

 

$565

 

($2,219
)
 
38
 
42%
 
Ca
(c)
 
(b)
 
Ca
(c)
 
(b)
Preferred Term Securities [PreTSL] XXV, tranche C1 (e)
1,263

 
202

 
(1,061
)
 
73
 
34%
 
C
(c)
 
(b)
 
C
(c)
 
(b)
Totals

$4,047

 

$767

 

($3,280
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(a)
Percentage of pool collateral in deferral or default status.
(b)
Not rated by S&P.
(c)
Rating is below investment grade.
(d)
This security was placed on nonaccrual status in March 2009. The tranche instrument held by Washington Trust has been deferring a portion of interest payments since April 2010. The June 30, 2012 amortized cost was net of $2.1 million of credit-related impairment losses previously recognized in earnings reflective of payment deferrals and credit deterioration of the underlying collateral. Included in the $2.1 million, were credit-related impairment losses of $209 thousand recorded in the first quarter of 2012, reflecting adverse changes in the expected cash flows for this security. As of June 30, 2012, this security has unrealized losses of $2.2 million and a below investment grade rating of “Ca” by Moody's Investors Service Inc. (“Moody's”). Through the filing date of this report, there have been no rating changes on this security. This credit rating status has been considered by management in its assessment of the impairment status of this security.
(e)
This security was placed on nonaccrual status in December 2008. The tranche instrument held by Washington Trust has been deferring interest payments since December 2008. The June 30, 2012 amortized cost was net of $1.2 million of credit-related impairment losses previously recognized in earnings reflective of payment deferrals and credit deterioration of the underlying collateral. The analysis of the expected cash flows for this security as of June 30, 2012 did not negatively affect the amount of credit-related impairment losses previously recognized on this security. As of June 30, 2012, the security has unrealized losses of $1.1 million and a below investment grade rating of “C” by Moody's. Through the filing date of this report, there have been no rating changes on this security. This credit rating status has been considered by management in its assessment of the impairment status of this security.

These pooled trust preferred holdings consist of trust preferred obligations of banking industry companies and, to a lesser extent, insurance companies. For both of these pooled trust preferred securities, Washington Trust's investment is senior to one or more subordinated tranches which have first loss exposure. Valuations of the pooled trust preferred holdings are dependent in part on cash flows from underlying issuers. Unexpected cash flow disruptions could have an adverse impact on the fair value and performance of pooled trust preferred securities. Management believes the unrealized losses on these pooled trust preferred securities primarily reflect investor concerns about global economic growth and how it will affect the recent and potential future losses in the financial services industry and the possibility of further incremental deferrals of or defaults on interest payments on trust preferred debentures by financial institutions participating in these pools. These concerns have resulted in a substantial decrease in market liquidity and increased risk premiums for securities in this sector. Credit spreads for issuers in this sector have remained wide during recent months, causing prices for these securities holdings to remain at low levels.

Further deterioration in credit quality of the companies backing the securities, further deterioration in the condition of the financial services industry, a continuation or worsening of the current economic downturn, or additional declines in real estate values 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 additional write-downs.

See Note 4 to the Consolidated Financial Statements for additional discussion on securities.

Loans
Total loans amounted to $2.2 billion at June 30, 2012, up by $66.7 million, or 3%, in the first six months of 2012, due to growth in the commercial loan portfolio.

Commercial Loans
Commercial loans fall into two major categories, commercial real estate and other commercial loans (commercial and industrial).  A significant portion of the Bank’s commercial and industrial loans are also collateralized by real estate, but are not classified as commercial real restate loans because such loans are not made for the purpose of acquiring, developing, constructing, improving or refinancing the real estate securing the loan, nor is the repayment source income generated directly from such real property.



62



Commercial Real Estate Loans
Commercial real estate loans amounted to $681.8 million at June 30, 2012, up by $46.0 million, or 7%, from the $635.8 million balance at December 31, 2011.  Included in these amounts were commercial construction loans of $17.4 million and $11.0 million, respectively.  Commercial real estate loans are secured by a variety of property types, with approximately 83% of the total composed of retail facilities, office buildings, lodging, commercial mixed use, multi-family dwellings and industrial & warehouse properties.

The following table presents a geographic summary of commercial real estate loans, including commercial construction, by property location.
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount
 
% of Total
 
Amount
 
% of Total
Rhode Island, Connecticut, Massachusetts

$629,891

 
92
%
 

$589,083

 
93
%
New York, New Jersey, Pennsylvania
37,428

 
6
%
 
33,317

 
5
%
New Hampshire
12,271

 
2
%
 
11,668

 
2
%
Other
2,185

 
%
 
1,700

 
%
Total

$681,775

 
100
%
 

$635,768

 
100
%

Other Commercial Loans
Other commercial loans amounted to $510.2 million at June 30, 2012, up by $21.4 million from the balance at December 31, 2011.  This portfolio includes loans to a variety of business types.  Approximately 66% of the total is composed of retail trade, owner occupied & other real estate, health care/social assistance, manufacturing, construction businesses, accommodation & food services and wholesale trade businesses.

Residential Real Estate Loans
The residential real estate loan portfolio amounted to $702.0 million at June 30, 2012, up by $1.6 million from the balance at December 31, 2011.  Washington Trust originates residential real estate mortgages within our general market area of Southern New England for portfolio and for sale in the secondary market.  The majority of loans originated for sale are sold with servicing released.  Washington Trust also originates residential real estate mortgages for various investors in a broker capacity, including conventional mortgages and reverse mortgages.  Total residential real estate mortgage loan originations, including brokered loans as agent, totaled $348.7 million for the six months ended June 30, 2012, compared to $135.8 million for the same period in 2011.  Of these amounts, $247.5 million and $57.1 million, respectively, were originated for sale in the secondary market, including brokered loans as agent. Washington Trust has continued to experience strong residential real estate mortgage refinancing and sales activity, due in part to the low mortgage interest rate environment.

From time to time Washington Trust purchases one- to four-family residential mortgages originated in other states as well as southern New England from other financial institutions.  All residential mortgage loans purchased from other financial institutions have been individually underwritten using standards similar to those employed for Washington Trust’s self-originated loans.  Purchased residential mortgage balances totaled $61.7 million and $71.4 million, respectively, as of June 30, 2012 and December 31, 2011.




63


The following is a geographic summary of residential mortgages by property location. There are no loans in either California or Colorado as of June 30, 2012.
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount
 
% of Total
 
Amount
 
% of Total
Rhode Island, Connecticut, Massachusetts

$679,847

 
96.7
%
 

$675,935

 
96.5
%
New York, Virginia, New Jersey, Maryland, Pennsylvania,
  District of Columbia
9,749

 
1.4
%
 
11,499

 
1.6
%
Ohio
4,935

 
0.7
%
 
5,665

 
0.8
%
New Hampshire
4,021

 
0.6
%
 
2,767

 
0.4
%
Washington, Oregon, California
1,390

 
0.2
%
 
1,881

 
0.3
%
Georgia
1,110

 
0.2
%
 
1,118

 
0.2
%
New Mexico, Colorado
497

 
0.1
%
 
1,079

 
0.2
%
Other
470

 
0.1
%
 
470

 
%
Total

$702,019

 
100.0
%
 

$700,414

 
100.0
%

Consumer Loans
Consumer loans amounted to $319.8 million at June 30, 2012, down by $2.3 million from the balance at December 31, 2011.  Our consumer portfolio is predominantly home equity lines and home equity loans, representing 83% of the total consumer portfolio at June 30, 2012.  Consumer loans also include personal installment loans and loans to individuals secured by general aviation aircraft and automobiles.

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

The following table presents nonperforming assets and additional asset quality data for the dates indicated:
(Dollars in thousands)
Jun 30,
2012
 
Dec 31,
2011
Nonaccrual loans:
 
 
 
Commercial mortgages

$2,597

 

$5,709

Commercial construction and development

 

Other commercial
3,405

 
3,708

Residential real estate mortgages
8,659

 
10,614

Consumer
1,081

 
1,206

Total nonaccrual loans
15,742

 
21,237

Nonaccrual investment securities
767

 
887

Property acquired through foreclosure or repossession, net
2,332

 
2,647

Total nonperforming assets

$18,841

 

$24,771

 
 
 
 
Nonperforming assets to total assets
0.62
%
 
0.81
%
Nonperforming loans to total loans
0.71
%
 
0.99
%
Total past due loans to total loans
0.92
%
 
1.22
%
Accruing loans 90 days or more past due

$—

 

$—


Nonperforming assets decreased to $18.8 million, or 0.62% of total assets, at June 30, 2012, from $24.8 million, or 0.81% of



64


total assets, at December 31, 2011.

Nonaccrual loans totaled $15.7 million at June 30, 2012, down by $5.5 million in the first six months of 2012, reflecting net decreases in all categories, particularly commercial mortgages and residential real estate mortgages. Property acquired through foreclosure or repossession amounted to $2.3 million at June 30, 2012, compared to $2.6 million at December 31, 2011. The balance at June 30, 2012 consisted of ten commercial properties and five residential properties.

Nonaccrual investment securities at June 30, 2012 were comprised of two pooled trust preferred securities.  See additional information herein under the caption “Securities” above.

Nonaccrual Loans
During the three and six months ended June 30, 2012, the Corporation has made no changes in its practices or policies concerning the placement of loans or investment securities into nonaccrual status.  There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at June 30, 2012.

The following table presents additional detail on nonaccrual loans as of the dates indicated:
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Days Past Due
 
 
 
Days Past Due
 
 
 
Over 90
 
Under 90
 
Total
 
Over 90
 
Under 90
 
Total
Commercial:
 
 
 
 
 
 
 
 
 
 
 
Mortgages

$2,339

 

$258

 

$2,597

 

$4,995

 

$714

 

$5,709

Construction and development

 

 

 

 

 

Other
1,714

 
1,691

 
3,405

 
633

 
3,075

 
3,708

Residential real estate mortgages
4,039

 
4,620

 
8,659

 
6,283

 
4,331

 
10,614

Consumer
362

 
719

 
1,081

 
874

 
332

 
1,206

Total nonaccrual loans

$8,454

 

$7,288

 

$15,742

 

$12,785

 

$8,452

 

$21,237


Nonaccrual commercial mortgage loans decreased by $3.1 million from the balance at the end of 2011, largely reflecting payoffs and loans returned to accruing status in accordance with policy. As of June 30, 2012, the $2.6 million balance of nonaccrual commercial mortgage loans consisted of five relationships. The loss allocation on total nonaccrual commercial mortgage loans was $133 thousand at June 30, 2012.  All of the nonaccrual commercial mortgage loans were located in Rhode Island and Connecticut.  As of June 30, 2012, the largest nonaccrual relationship in the commercial mortgage category totaled $2.3 million and is secured by several properties, including office, light industrial and retail space.  This relationship was collateral dependent and based on the fair value of the underlying collateral, a $126 thousand loss allocation on this relationship was deemed necessary at June 30, 2012.  The Bank has additional accruing commercial real estate and residential mortgage loans totaling $4.6 million to this borrower.  These additional loans have performed in accordance with terms of the loans and were not past due as of June 30, 2012.

Nonaccrual other commercial loans amounted to $3.4 million at June 30, 2012, down by $303 thousand from the December 31, 2011 balance of $3.7 million.  The loss allocation on these loans was $391 thousand at June 30, 2012. The largest nonaccrual relationship in the other commercial category was $1.2 million at June 30, 2012. This relationship was collateral dependent and secured by retail properties. Based on the fair value of the underlying collateral, a loss allocation of $115 thousand was deemed necessary as of June 30, 2012.

Nonaccrual residential mortgage loans decreased by $1.9 million from the balance at the end of 2011.  As of June 30, 2012, the $8.7 million balance of nonaccrual residential mortgage loans consisted of 31 loans, with $6.9 million located in Rhode Island and Massachusetts.  The loss allocation on total nonaccrual residential mortgages was $1.6 million at June 30, 2012.  Included in total nonaccrual residential mortgages at June 30, 2012 were 16 loans purchased for portfolio and serviced by others amounting to $4.8 million.  Management monitors the collection efforts of its third party servicers as part of its assessment of the collectibility of nonperforming loans.




65


Nonaccrual consumer loans decreased by $125 thousand from the balance at the end of 2011, reflecting decreases in nonaccrual home equity lines and loans.

Past Due Loans
The following table presents past due loans by category as of the dates indicated:
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount
 
% (1)

 
Amount
 
% (1)

Commercial real estate loans

$2,983

 
0.44
%
 

$6,931

 
1.09
%
Other commercial loans
2,997

 
0.59
%
 
5,375

 
1.10
%
Residential real estate mortgages
10,608

 
1.51
%
 
11,757

 
1.68
%
Consumer loans
3,699

 
1.16
%
 
2,210

 
0.69
%
Total past due loans

$20,287

 
0.92
%
 

$26,273

 
1.22
%
(1)Percentage of past due loans to the total loans outstanding within the respective category.

As of June 30, 2012, total past due loans amounted to $20.3 million, or 0.92% of total loans, down by $6.0 million from December 31, 2011.

Included in past due loans as of June 30, 2012 were nonaccrual loans of $12.7 million.  All loans 90 days or more past due at June 30, 2012 and December 31, 2011 were classified as nonaccrual.

Troubled Debt Restructurings
Loans are considered restructured in a troubled debt restructuring 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 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 collectibility 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. As of June 30, 2012, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured.




66


The following table sets forth information on troubled debt restructured loans as of the dates indicated. The carrying 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.
(Dollars in thousands)
Jun 30,
2012
 
Dec 31,
2011
Accruing troubled debt restructured loans:
 
 
 
Commercial mortgages

$1,251

 

$6,389

Other commercial
6,916

 
6,625

Residential real estate mortgages
570

 
1,481

Consumer
159

 
171

Accruing troubled debt restructured loans
8,896

 
14,666

Nonaccrual troubled debt restructured loans:
 
 
 
Commercial mortgages

 
91

Other commercial
2,317

 
2,154

Residential real estate mortgages
2,028

 
2,615

Consumer
47

 
106

Nonaccrual troubled debt restructured loans
4,392

 
4,966

Total troubled debt restructured loans

$13,288

 

$19,632


As of June 30, 2012, loans classified as troubled debt restructurings totaled $13.3 million, down by $6.3 million from the balance at December 31, 2011. The net decrease in troubled debt restructured loans reflected declassifications from troubled debt restructuring status and paydowns, offset, in part, by loans restructured during the first half of 2012.

At June 30, 2012, the largest troubled debt restructured relationship consisted of three accruing other commercial loans with a carrying value of $4.7 million, secured by real estate and marketable securities. This restructuring took place in the fourth quarter of 2011 and included a below market rate concession and modification of certain payment terms. In connection with this restructuring, a principal payment of $4.9 million was also received during the fourth quarter of 2011.

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 June 30, 2012 and other loans for which known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future.  These loans are not included in the amounts of nonaccrual or restructured loans presented above.  Management cannot predict the extent to which economic conditions or other factors may impact borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses.  The Corporation has identified approximately $12.6 million in potential problem loans at June 30, 2012, compared to $7.4 million at December 31, 2011.  The increase from the end of 2011 primarily reflects one commercial mortgage relationship totaling $5.4 million that was downgraded in the first quarter of 2012 to a risk rating of “classified” from “special mention” based on management's assessment of potential weakness in future year cash flow to be generated by the underlying property. Approximately 88% of the potential problem loans at June 30, 2012 consisted of three commercial lending relationships, which have been classified based on our evaluation of the financial condition of the borrowers.  Potential problem loans are assessed for loss exposure using the methods described in Note 5 to the 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.  For a more detailed discussion on the allowance for loan losses,



67


see additional information 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, 2011.

The allowance for loan losses is management’s best estimate of the probable loan losses inherent in the loan portfolio as of the balance sheet date.  The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans.

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

As of June 30, 2012, the allowance for loan losses was $30.4 million, or 1.38% of total loans, compared to $29.8 million, or 1.39% of total loans at December 31, 2011.  The status of nonaccrual loans, delinquent loans and performing loans were all taken into consideration in the assessment of the adequacy of the allowance for loans losses.   In addition, the balance and trends of credit quality indicators, including the commercial loan categories of Pass, Special Mention and Classified, are integrated into the process used to determine the allocation of loss exposure.  See Note 5 to the Consolidated Financial Statements for additional information under the caption “Credit Quality Indicators.”  Management believes that the allowance for loan losses is adequate and consistent with asset quality and delinquency indicators.

The estimation of loan loss exposure inherent in the loan portfolio includes, among other procedures, (1) identification of loss allocations for individual loans deemed to be impaired in accordance with GAAP, (2) loss allocation factors for non-impaired loans based on credit grade, loss experience, delinquency factors and other similar economic indicators, and (3) general loss allocations, classified as an "unallocated" portion of the total allowance, for measurement imprecision attributable to uncertainty in the economic environment and ever changing conditions, as well as qualitative and quantitative assessments of other environmental factors.  We periodically reassess and revise the loss allocation factors used in the assignment of loss exposure to appropriately reflect our analysis of migrational loss experience.  We analyze historical loss experience in the various portfolios over periods deemed to be relevant to the inherent risk of loss in the respective portfolios as of the balance sheet date.  Revisions to loss allocation factors are not retroactively applied.

The methodology to measure the amount of estimated loan loss exposure includes an analysis of individual loans deemed to be impaired.  Impaired loans are loans for which it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreements and all loans restructured in a troubled debt restructuring.  Impaired loans do not include large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, which consist of most residential mortgage loans and consumer loans.  Impairment is measured on a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or if the loan is collateral dependent, at the fair value of the collateral less costs to sell.  For collateral dependent loans, 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 circumstances associated with the property.

The following is a summary of impaired loans by measurement type:
(Dollars in thousands)
Jun 30,
2012
 
Dec 31,
2011
Collateral dependent impaired loans (1)

$14,550

 

$22,316

Impaired loans measured on discounted cash flow method (2)
4,213

 
6,717

Total impaired loans

$18,763

 

$29,033

(1)
Net of partial charge-offs of $1.8 million and $2.3 million, respectively, at June 30, 2012 and December 31, 2011.
(2)
Net of partial charge-offs of $209 thousand and $328 thousand, respectively, at June 30, 2012 and December 31, 2011.

Impaired loans consist of nonaccrual commercial loans, troubled debt restructured loans and other loans classified as impaired.  The loss allocation on impaired loans amounted to $1.3 million and $1.8 million, respectively, at June 30, 2012 and December 31, 2011.  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



68


the identified loss exposure, therefore the remaining allocation of loss is minimal.

Other individual commercial loans and commercial mortgage loans not deemed to be impaired are evaluated using the internal rating system and the application of loss allocation factors.  The loan rating system is described under the caption “Credit Quality Indicators” in Note 5 to the Consolidated Financial Statements.  The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, and the adequacy of collateral.  Portfolios of more homogenous populations of loans including residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other indicators and our historical loss experience for each type of credit product. We continue to periodically reassess and revise the loss allocation factors and estimates used in the assignment of loss exposure to appropriately reflect our analysis of migrational loss experience.

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

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

For the three and six months ended June 30, 2012, the loan loss provision totaled $600 thousand and $1.5 million, respectively, compared to $1.2 million and $2.7 million, respectively, for the same periods in 2011.  The provision for loan losses was based on management’s assessment of trends in asset quality and credit quality indicators, as well as the absolute level of loan loss allocation.  For the three and six months ended June 30, 2012, net charge-offs totaled $197 thousand and $854 thousand, respectively, compared to $956 thousand and $1.9 million, respectively, for the same periods in 2011.  Commercial and commercial real estate loan net charge-offs amounted to 58% of total net charge-offs in the six months ended June 30, 2012, compared to 78% for the same period in 2011.

Management believes that overall credit quality continues to be affected by weaknesses in national and regional economic conditions, including high unemployment levels.  While management believes that the level of allowance for loan losses at June 30, 2012 is appropriate, management will continue to assess the adequacy of the allowance for loan losses in accordance with its established policies.

The following table presents the allocation of the allowance for loan losses as of the dates indicated:
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
 
Amount

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

$8,945

 
30
%
 

$8,195

 
29
%
Construction and development
164

 
1

 
95

 
1

Other
6,239

 
23

 
6,200

 
22

Residential real estate:
 
 
 
 
 
 
 
Mortgage
4,595

 
31

 
4,575

 
32

Homeowner construction
118

 
1

 
119

 
1

Consumer
2,381

 
14

 
2,452

 
15

Unallocated
8,006

 

 
8,166

 

Balance at end of period

$30,448

 
100
%
 

$29,802

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

Sources of Funds
Our sources of funds include deposits, brokered certificates of deposit, FHLBB borrowings, other borrowings and proceeds from the sales, maturities and payments of loans and investment securities.  Washington Trust uses funds to originate and purchase



69


loans, purchase investment securities, conduct operations, expand the branch network and pay dividends to shareholders.

Management’s preferred strategy for funding asset growth is to grow low cost deposits (demand deposit, NOW and savings accounts).  Asset growth in excess of low cost deposits is typically funded through higher cost deposits (certificates of deposit and money market accounts), brokered certificates of deposit, FHLBB borrowings, and securities portfolio cash flow.

Deposits
Washington Trust offers a wide variety of deposit products to consumer and business customers.  Deposits provide an important source of funding for the Bank as well as an ongoing stream of fee revenue. Total deposits amounted to $2.1 billion at June 30, 2012, up by $4.1 million from the balance at December 31, 2011.

Demand deposits totaled $321.5 million at June 30, 2012, down by $18.3 million, or 5%, from the balance at December 31, 2011.  NOW account balances increased by $6.1 million, or 2%, and totaled $263.1 million at June 30, 2012.  Money market accounts totaled $388.7 million at June 30, 2012, down by $18.1 million, or 4%, from the balance at December 31, 2011, reflecting a seasonal decrease in government deposits.  During the first six months of 2012, savings deposits increased by $20.9 million, or 9%, and amounted to $264.8 million at June 30, 2012.

Time deposits (including brokered certificates of deposit) amounted to $892.4 million at June 30, 2012, up by $13.6 million, or 2%, from the balance at December 31, 2011.  The Corporation utilizes out-of-market brokered time deposits as part of its overall funding program along with other sources.  Excluding out-of-market brokered certificates of deposits, in-market time deposits totaled $789.7 million and $788.7, respectively, at June 30, 2012 and December 31, 2011.  Washington Trust is a member of the Certificate of Deposit Account Registry Service (“CDARS”) network.  Included in in-market time deposits at June 30, 2012 were CDARS reciprocal time deposits of $189.9 million, which were up by $6.0 million from December 31, 2011.

Borrowings
The Corporation utilizes advances from the FHLBB as well as other borrowings as part of its overall funding strategy.  FHLBB advances are used to meet short-term liquidity needs, to purchase securities and to purchase loans from other institutions.  FHLBB advances amounted to $524.0 million at June 30, 2012, down by $16.5 million from the balance at the end of 2011.

The decline in FHLBB advances from the balance at December 31, 2011 included certain balance sheet management transactions described in Note 8 to the Consolidated Financial Statements.

Other borrowings of the Corporation decreased by $19.3 million from the balance at the end of 2011, reflecting the maturity of securities sold under repurchase agreements totaling $19.5 million.

Liquidity and Capital Resources
Liquidity Management
Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. Washington Trust’s primary source of liquidity is deposits, which funded approximately 70% of total average assets in the six months ended June 30, 2012.  While the generally preferred funding strategy is to attract and retain low cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace.  Other sources of funding include discretionary use of purchased liabilities (e.g., FHLBB term advances and other borrowings), cash flows from the Corporation’s securities portfolios and loan repayments.  Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs although management has no intention to do so at this time.  For a more detailed discussion on Washington Trust’s detailed liquidity funding policy and contingency funding plan, see additional information in Item 7 under the caption “Liquidity and Capital Resources” of Washington Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Liquidity remained well within target ranges established by the Corporation’s Asset/Liability Committee (“ALCO”) during the six months ended June 30, 2012.  Based on its assessment of the liquidity considerations described above, management believes the Corporation’s sources of funding will meet anticipated funding needs.

For the six months ended June 30, 2012, net cash used in financing activities amounted to $37.9 million.  FHLBB advances and other borrowings decreased by $16.5 million and $19.3 million, respectively, while total deposits increased by $4.1 million in the first six months of 2012.  Net cash used in investing activities totaled $2.7 million for the six months ended June 30, 2012.  Proceeds from the sale of securities as well as maturities and principal payments received were offset primarily by loan



70


growth.  Net cash provided by operating activities amounted to $24.1 million for the six months ended June 30, 2012, most of which was generated by net income.  See the Corporation’s Consolidated Statements of Cash Flows for further information about sources and uses of cash.

Capital Resources
Total shareholders’ equity amounted to $292.7 million at June 30, 2012, compared to $281.4 million at December 31, 2011.

The ratio of total equity to total assets amounted to 9.63% at June 30, 2012.  This compares to a ratio of 9.18% at December 31, 2011.  Book value per share at June 30, 2012 and December 31, 2011 amounted to $17.89 and $17.27, respectively.

The Bancorp and the Bank are subject to various regulatory capital requirements.  As of June 30, 2012, the Bancorp and the Bank is categorized as “well-capitalized” under the regulatory framework for prompt corrective action.  See Note 9 to the Consolidated Financial Statements for additional discussion of capital requirements.

Contractual Obligations and Commitments
The Corporation has entered into numerous contractual obligations and commitments.  The following tables summarize our contractual cash obligations and other commitments at June 30, 2012:
(Dollars in thousands)
Payments Due by Period
 
Total
 
Less Than 1 Year (1)
 
1-3 Years
 
4-5 Years
 
After 5 Years
Contractual Obligations:
 
 
 
 
 
 
 
 
 
FHLBB advances (2)

$523,989

 

$155,441

 

$86,745

 

$219,262

 

$62,541

Junior subordinated debentures
32,991

 

 

 

 
32,991

Operating lease obligations
20,706

 
2,261

 
4,320

 
2,920

 
11,205

Software licensing arrangements
4,621

 
2,027

 
2,027

 
567

 

Other borrowings
481

 
282

 
89

 
105

 
5

Total contractual obligations

$582,788

 

$160,011

 

$93,181

 

$222,854

 

$106,742

(1)
Maturities or contractual obligations are considered by management in the administration of liquidity and are routinely refinanced in the ordinary course of business.
(2)
All FHLBB advances are shown in the period corresponding to their scheduled maturity.  Some FHLBB advances are callable at earlier dates.  See Note 8 to the Consolidated Financial Statements for additional information.




71


(Dollars in thousands)
Amount of Commitment Expiration – Per Period
 
Total
 
Less Than 1 Year
 
1-3 Years
 
4-5 Years
 
After 5 Years
Other Commitments:
 
 
 
 
 
 
 
 
 
Commercial loans

$221,163

 

$134,790

 

$37,559

 

$2,042

 

$46,772

Home equity lines
183,895

 
885

 

 

 
183,010

Other loans
33,395

 
26,216

 
1,493

 
5,686

 

Standby letters of credit
8,777

 
8,677

 
100

 

 

Forward loan commitments to:
 
 
 
 
 
 
 
 
 
Originate loans
83,633

 
83,633

 

 

 

Sell loans
106,340

 
106,340

 

 

 

Customer related derivative contracts:
 
 
 
 
 
 
 
 
 
Interest rate swaps with customers
60,958

 
9,457

 
39,006

 
5,832

 
6,663

Mirror swaps with counterparties
60,958

 
9,457

 
39,006

 
5,832

 
6,663

Interest rate risk management contract:
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
32,991

 
10,310

 

 
22,681

 

Total commitments

$792,110

 

$389,765

 

$117,164

 

$42,073

 

$243,108




72


Off-Balance Sheet Arrangements
For information on financial instruments with off-balance sheet risk and derivative financial instruments see Notes 10 and 17 to the Consolidated Financial Statements.

Asset/Liability Management and Interest Rate Risk
Interest rate risk is the primary market risk category associated with the Corporation’s operations.  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.  Interest rate risk is the risk of loss to future earnings due to changes in interest rates.  The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with Washington Trust’s liquidity, capital adequacy, growth, risk and profitability goals.

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

The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure.  As of June 30, 2012 and December 31, 2011, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation.  The Corporation defines maximum unfavorable net interest income exposure to be a change of no more than 5% in net interest income over the first 12 months, no more than 10% over the second 12 months, and no more than 10% over the full 60-month simulation horizon.  All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Corporation’s balance sheet remain stable for a 60-month period.  In addition to measuring the change in net interest income as compared to an unchanged interest rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.

The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve of up to 500 basis points as well as parallel changes in interest rates of up to 400 basis points.  Because income simulations assume that the Corporation’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on- and off-balance sheet financial instruments as of June 30, 2012 and December 31, 2011.  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 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.
 
June 30, 2012
 
December 31, 2011
 
Months 1 - 12
 
Months 13 - 24
 
Months 1 - 12
 
Months 13 - 24
100 basis point rate decrease
(2.34)%
 
(7.30)%
 
(2.29)%
 
(6.70)%
100 basis point rate increase
2.10%
 
3.68%
 
2.06%
 
3.25%
200 basis point rate increase
4.46%
 
7.04%
 
4.13%
 
5.88%
300 basis point rate increase
5.70%
 
7.37%
 
5.45%
 
6.40%




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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 in deposits.  If market interest rates were to fall from their already low levels and remain lower for a sustained period, certain core savings and time deposit rates could decline more slowly and by a lesser amount than other market rates.  Asset yields would likely decline more rapidly than deposit costs as current asset holdings mature or reprice, since cash flow from mortgage-related prepayments and redemption of callable securities would increase as market rates fall.

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

While the ALCO reviews simulation assumptions and periodically back-tests the simulation results to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin.  Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of the Corporation’s balance sheet may change to a different degree than estimated.  Simulation modeling assumes a static balance sheet, with the exception of certain modeled deposit mix shifts from low-cost core savings deposits to higher-cost time deposits in rising rate scenarios as noted above.  Due to the low current level of market interest rates, the banking industry has experienced relatively strong growth in low-cost FDIC-insured core savings deposits over the past several quarters.  The ALCO recognizes that a portion of these increased levels of low-cost balances could shift into higher yielding alternatives in the future, particularly if interest rates rise and as confidence in financial markets strengthens, and has modeled increased amounts of deposit shifts out of these low-cost categories into higher-cost alternatives in the rising rate simulation scenarios presented above.  It should 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.  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 assumed relationship between short-term interest rate changes and core deposit rate and balance changes used in income simulation may differ from the ALCO’s estimates.  Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments.  Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value.  Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.

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




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The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of June 30, 2012 and December 31, 2011 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 (noncallable)

$616

 

($1,188
)
States and political subdivisions
2,222

 
(4,188
)
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
2,159

 
(14,313
)
Trust preferred debt and other corporate debt securities
316

 
770

Total change in market value as of June 30, 2012

$5,313

 

($18,919
)
 
 
 
 
Total change in market value as of December 31, 2011

$8,138

 

($21,724
)

See Notes 10 and 17 to the Consolidated Financial Statements for more information regarding the nature and business purpose of financial instruments with off-balance sheet risk and derivative financial instruments.

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 Securities Exchange Act of 1934, 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 effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of the end of the quarter ended June 30, 2012.  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 recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  The Corporation will continue to review and document its disclosure controls and procedures and consider such changes in future evaluations of the effectiveness of such controls and procedures, as it deems appropriate.

Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the period ended June 30, 2012 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 1A to Part I of Washington Trust’s Annual Report on Form 10-K for the year ended December 31, 2011.

Item 6.  Exhibits
(a) Exhibits.  The following exhibits are included as part of this Form 10-Q:
Exhibit Number
 
10.1
2012 Annual Performance Plan - Filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 001-32991), as filed with the Securities and Exchange Commission on June 20, 2012. (1) (2)
10.2
Compensatory agreement with James M. Hagerty, dated June 20, 2012 - Filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 001-32991), as filed with the Securities and Exchange Commission on June 28, 2012. (1) (2)
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. (3)
101
The following materials from Washington Trust Bancorp, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes to these financial statements - Furnished herewith. (4)
____________________
(1)
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the Securities and Exchange Commission, which are incorporated by reference herein.
(2)
Management contract or compensatory plan or arrangement.
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Securities Exchange Act.
(4)
Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.





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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:
August 7, 2012
 
By:
/s/ Joseph J. MarcAurele
 
 
 
 
Joseph J. MarcAurele
 
 
 
 
Chairman, President and Chief Executive Officer
 
 
 
 
(principal executive officer)
 
 
 
 
 
Date:
August 7, 2012
 
By:
/s/ David V. Devault
 
 
 
 
David V. Devault
 
 
 
 
Senior Executive Vice President, Secretary and Chief Financial Officer
 
 
 
 
(principal financial and accounting officer)



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Exhibit Index

Exhibit Number
 
10.1
2012 Annual Performance Plan - Filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 001-32991), as filed with the Securities and Exchange Commission on June 20, 2012. (1) (2)
10.2
Compensatory agreement with James M. Hagerty, dated June 20, 2012 - Filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 001-32991), as filed with the Securities and Exchange Commission on June 28, 2012. (1) (2)
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. (3)
101
The following materials from Washington Trust Bancorp, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes to these financial statements - Furnished herewith. (4)
____________________
(1)
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the Securities and Exchange Commission, which are incorporated by reference herein.
(2)
Management contract or compensatory plan or arrangement.
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Securities Exchange Act.
(4)
Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.




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