Washington Trust Bancorp Inc: Form 10-Q for the period ended Jun 30, 2023

The following discussion should be read in conjunction with the Corporation’s Audited Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2022, and in conjunction with the condensed Unaudited Consolidated Financial Statements and notes thereto included in Item 1 of this report. Operating results for the three and six months ended June 30, 2023 are not necessarily indicative of the results for the full-year ended December 31, 2023 or any future period.

Forward-Looking Statements

This report contains statements that are “forward-looking statements.” We may also make forward-looking statements in other documents we file with the SEC, in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “outlook,” “will,” “should,” and other expressions that predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different than the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.

Some of the factors that might cause these differences include the following:

• changes in general business and economic conditions on a national basis and in the local markets in which we operate;
• changes in customer behavior due to political, business and economic conditions, including inflation and concerns about liquidity;
• interest rate changes or volatility, as well as changes in the balance and mix of loans and deposits;
• changes in loan demand and collectability;
• the possibility that future credits losses are higher than currently expected due to changes in economic assumptions or adverse economic developments;
• ongoing volatility in national and international financial markets;
• reductions in the market value or outflows of wealth management AUA;
• decreases in the value of securities and other assets;
• increases in defaults and charge-off rates;
• changes in the size and nature of our competition;
• changes in legislation or regulation and accounting principles, policies and guidelines;
• operational risks including, but not limited to, changes in information technology, cybersecurity incidents, fraud, natural disasters, war, terrorism, civil unrest and future pandemics;
• regulatory, litigation and reputational risks; 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, 2022, 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.

Overview

Washington Trust offers a full range of financial services, including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management and trust services through its offices in Rhode Island, Massachusetts and Connecticut.

Our largest source of operating income is net interest income, which is the difference between interest earned on loans and securities and interest paid on deposits and borrowings. In addition, we generate noninterest income from a number of sources, including wealth management services, mortgage banking activities and deposit services. Our principal noninterest expenses include salaries and employee benefit costs, outsourced services provided by third-party vendors, occupancy and facility-related costs and other administrative expenses.

We continue to leverage our strong regional brand to build market share and remain steadfast in our commitment to provide superior service. We believe the key to future growth is providing customers with convenient in-person service and digital banking solutions. In April 2023, we opened a new full-service branch in Barrington, Rhode Island. In addition, we have plans to open a branch in Smithfield, Rhode Island and another in the Olneyville section of Providence later in 2023 or early in 2024.

Risk Management

The Corporation has a comprehensive ERM program through which the Corporation identifies, measures, monitors and controls current and emerging material risks.

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

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

Credit risk represents the possibility that borrowers or other counterparties may not repay loans or other contractual obligations according to their terms due to changes in the financial capacity, ability and willingness of such borrowers or counterparties to meet their obligations. In some cases, the collateral securing payment of the loans may be sufficient to assure repayment, but in other cases the Corporation may experience significant credit losses which could have an adverse effect on its operating results. The Corporation makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and counterparties and the value of the real estate and other assets serving as collateral for the repayment of loans. Credit risk also exists with respect to investment securities. For further discussion regarding the credit risk and the credit quality of the Corporation’s loan portfolio, see Note 4 and Note 5 to the Unaudited Consolidated Financial Statements. For further discussion regarding credit risk associated with unfunded commitments, see Note 16 to the Unaudited Consolidated Financial Statements. For further discussion regarding the Corporation’s securities portfolio, see Note 3 to the Unaudited Consolidated Financial Statements.

Interest rate risk is the risk of loss to future earnings due to changes in interest rates. It exists because the repricing frequency and magnitude of interest-earning assets and interest-bearing liabilities are not identical. See the “Asset/Liability Management and Interest Rate Risk” section below for additional disclosure.

Liquidity risk is the risk that the Corporation will not have the ability to generate adequate amounts of cash in the most economical way for it to meet its maturing liability obligations and customer loan demand. For detailed disclosure regarding liquidity management, see the “Liquidity and Capital Resources” section below.

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

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

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

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

ERM is an overarching program that includes all areas of the Corporation. A framework approach is utilized to assign responsibility and to ensure that the various business units and activities involved in the risk management life-cycle are effectively integrated. The Corporation has adopted the “three lines of defense” strategy that is an industry best practice for ERM. Business units are the first line of defense in managing risk. They are responsible for identifying, measuring, monitoring, and controlling current and emerging risks. They are responsible for reporting on and escalating their concerns. Corporate functions such as Credit Risk Management, Financial Administration, Information Assurance and Compliance, represent the second line of defense. They are responsible for policy setting and for reviewing and challenging the risk management activities of the business units. They collaborate closely with business units on planning and resource allocation with respect to risk management. Internal Audit is a third line of defense. They provide independent assurance to the Board of Directors of the effectiveness of the first and second lines in fulfilling their risk management responsibilities.

For additional factors that could adversely impact Washington Trust’s future results of operations and financial condition, see Part II, Item 1A below and the section labeled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC.

Results of Operations

Summary

The following table presents a summarized consolidated statement of operations:

(Dollars in thousands)

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

Net income totaled $11.3 million and $24.1 million, respectively, for the three and six months ended June 30, 2023, compared to $20.0 million and $36.4 million, respectively, for the same periods in 2022. Results in 2023 were impacted by steep increases in market interest rates and a decline in wealth management revenues.

In 2023, the decrease in net interest income was driven by increases in funding costs, which offset the benefit of higher yields on, and growth in, average interest-earning asset balances. The decline in noninterest income reflected lower mortgage banking revenues, as higher market interest rates have dampened mortgage activity. The decline in noninterest income also reflected lower wealth management asset-based revenues and AUA balances attributable to a higher level of client asset outflows, which were partially offset by net investment appreciation. The increased provisioning for credit losses reflected a higher level of loan growth in 2023 and continued negative outlook in economic forecasts, partially offset by continued strength in our asset and credit quality. The increase in noninterest expenses largely reflected increases in FDIC deposit insurance costs and salaries and employee benefits, as well as modest increases in a variety of other interest expense categories.

Average Balances / Net Interest Margin - Fully Taxable Equivalent Basis

The following table presents average balance and interest rate information. Tax-exempt income is converted to an FTE basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. Unrealized gains (losses) on available for sale securities and changes in fair value on mortgage loans held for sale are excluded from the average balance and yield calculations. Nonaccrual loans, as well as interest recognized on these loans, are included in amounts presented for loans.

(Dollars in thousands)

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

(Dollars in thousands)

(Dollars in thousands)

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

(Dollars in thousands)

Net Interest Income

Net interest income, the primary source of our operating income, totaled $33.5 million and $70.7 million, respectively, for the three and six months ended June 30, 2023, compared to $37.5 million and $72.6 million, respectively, for the same periods in 2022. Net interest income is affected by the level of and changes in interest rates, and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Prepayment penalty income associated with loan payoffs is included in net interest income.

The following discussion presents net interest income on an FTE basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities.

Net interest income includes the periodic recognition of prepayment penalty fee income associated with commercial loan payoffs. Prepayment penalty fee income amounted to $50 thousand (or 1 basis point benefit to NIM) and $174 thousand (or 1 basis point benefit to NIM), respectively, for the three and six months ended June 30, 2023, compared to $62 thousand (or 0 basis point benefit to NIM) and $138 thousand (or 0 basis point benefit to NIM), respectively, for the same periods in 2022.

The analysis of net interest income, NIM and the yield on loans is impacted by changes in the level of net amortization of premiums and discounts on securities and loans, which is included in interest income. Changes in market interest rates affect the level of loan prepayments and the receipt of payments on mortgage-backed securities. Prepayment speeds generally increase as market interest rates decline and decrease as market interest rates rise. Changes in prepayment speeds could increase or decrease the level of net amortization of premiums and discounts, thereby affecting interest income. Additionally, as PPP loans were forgiven by the SBA in the previous year, related unamortized net fee balances were accelerated and amortized, increasing net interest income.

As noted in the Unaudited Consolidated Statements of Cash Flows, net amortization of premiums and discounts on securities and loans (a net reduction to interest income) amounted to $707 thousand for the six months ended June 30, 2023, compared $1.8 million for the same period in 2022. This included no accelerated amortization of net deferred fee balances on PPP loans forgiven by the SBA for the three and six months ended June 30, 2023, compared to $323 thousand (or 2 basis points benefit to NIM) and $1.1 million (or 4 basis points benefit to NIM), respectively, for the same periods in 2022.

FTE net interest income for the three and six months ended June 30, 2023 amounted to $33.7 million and $71.2 million, respectively, down by $4.1 million and $2.0 million, respectively, from the same periods in 2022. For the three and six months ended June 30, 2023, growth in average interest-earning assets net of increased average interest-bearing liability balances, contributed approximately $1.6 million and $4.0 million, respectively, of net interest income. Increases in funding costs outpaced increases in asset yields, reducing net interest income by $5.6 million and $5.9 million, respectively, for the three and six months ended June 30, 2023.

NIM was 2.03% and 2.18%, respectively, for the three and six months ended June 30, 2023, compared to 2.71% and 2.64%, respectively, for the same periods in 2022. While NIM benefited from higher market interest rates on loans, it was adversely impacted by a higher cost of funds.

Total average securities for the three and six months ended June 30, 2023 increased by $105.4 million and $113.7 million, respectively, from the average balances for the same periods a year earlier due to purchases of debt securities. The FTE rate of return on the securities portfolio for the three and six months ended June 30, 2023 was 2.47% and 2.46%, respectively, compared to 1.80% and 1.70%, respectively, for the same periods in 2022, reflecting the impact of higher market interest rates in 2023.

Total average loan balances for the three and six months ended June 30, 2023 increased by $953.1 million and $914.6 million, respectively, from the average loan balances for the comparable 2022 periods, largely reflecting growth in average residential real estate loan and CRE balances. The yield on total loans for the three and six months ended June 30, 2023 was 4.97% and 4.85%, respectively, compared to 3.40% and 3.32%, respectively, in the corresponding periods in 2022.

The yield on total loans was impacted by the accelerated amortization of net deferred fee balances on PPP loans when such loans were forgiven by the SBA in 2022 and to a lesser extent by the periodic recognition of commercial loan prepayment fee income. Excluding the impact of these items, the yield on total loans for the three and six months ended June 30, 2023 was 4.97% and 4.84%, respectively, up from 3.37% and 3.26%, respectively, for the same periods in 2022, reflecting higher market interest rates.

Higher levels of wholesale funding were used in 2023 to fund balance sheet growth. The average balance of FHLB advances for the three and six months ended June 30, 2023 increased by $828.1 million and $860.4 million, respectively, compared to the average balances for the same periods in 2022. Due to increases in market interest rates, the average rate paid on such advances for the three and six months ended June 30, 2023 was 4.77% and 4.64%, respectively, up from 1.09% and 0.88%, respectively, for the same periods in 2022. Included in total average interest-bearing deposits were wholesale brokered deposits, which increased by $277.7 million and $133.4 million, respectively, from the same periods in 2022. Due to increases in market interest rates, the average rate paid on wholesale brokered deposits for the three and six months ended June 30, 2023 was 4.71% and 4.33%, respectively, compared to 0.41% and 0.28%, respectively, for the same periods in 2022.

As market interest rates rose, deposit balances shifted from lower cost deposits to higher cost deposits. Average in-market interest-bearing deposits, which excludes wholesale brokered deposits, for the three and six months ended June 30, 2023 increased by $120.9 million and $132.4 million, respectively, from the average balances for the same periods in 2022, with increases in time deposits and interest-bearing demand deposits. The average rate paid on in-market interest-bearing deposits for the three and six months ended June 30, 2023 was 2.27% and 1.97%, respectively, compared to 0.38% and 0.35%, respectively, from the same periods in 2022. The average balance of noninterest-bearing demand deposits for the three and six months ended June 30, 2023 decreased by $121.8 million and $113.4 million, respectively, from the average balances for the same periods in 2022.

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

The following table presents certain information on an 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)

Provision for Credit Losses

The provision for credit losses results from management’s review of the adequacy of the ACL. The ACL is management’s estimate, at the reporting date, of expected lifetime credit losses and includes consideration of current forecasted economic conditions. Estimating an appropriate level of ACL necessarily involves a high degree of judgment.

The following table presents the provision for credit losses:

(Dollars in thousands)

The provision recognized in 2023 provided for loan growth and reflected continued negative outlook in economic forecasts, partially offset by continued strength in asset and credit quality metrics. The negative provision recorded in 2022, reflected low loss rates and strong asset and credit quality that more than offset negative trends in macroeconomic forecasts and loan growth that was concentrated in residential real estate loans.

Net charge-offs totaled $37 thousand for the three months ended June 30, 2023, compared to net recoveries of $10 thousand for the same period in 2022. For the six months ended June 30, 2023, net charge-offs totaled $84 thousand, compared to net recoveries of $158 thousand for the same period in 2022.

The ACL on loans was $39.3 million, or 0.73% of total loans, at June 30, 2023, compared to $38.0 million, or 0.74% of total loans, at December 31, 2022. See additional discussion under the caption “Asset Quality” for further information on the ACL on loans.

Noninterest Income

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

(Dollars in thousands)

Noninterest Income Analysis

Revenue from wealth management services represented 64% of total noninterest income for the six months ended June 30, 2023, compared to 62% for the same period in 2022. A substantial portion of wealth management revenues is dependent on the value of wealth management AUA and is closely tied to the performance of the financial markets. This portion of wealth management revenues is referred to as “asset-based” and includes trust and investment management fees. Wealth management revenues also include “transaction-based” revenues, such as commissions and other service fees that are not primarily derived from the value of assets.

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

(Dollars in thousands)

Wealth management revenues for the three and six months ended June 30, 2023 decreased by $1.0 million and $2.9 million, respectively, from the same periods in 2022, reflecting a decrease in asset-based revenues. The change in asset-based revenues correlated with the change in average AUA balances. The average balance of AUA for the three and six months ended June 30, 2023 decreased by 12% and 15%, respectively, from the average balance for the same periods in 2022.

The end of period AUA balance amounted to $6.4 billion at June 30, 2023. The following table presents the changes in wealth management AUA balances:

(Dollars in thousands)

AUA and related asset-based revenues were adversely impacted by client withdrawals associated with the departure of four client-facing advisors at the end of the third quarter of 2022. These four advisors were associated with approximately $1.0 billion of AUA as of September 30, 2022. Through June 30, 2023, cumulative client asset withdrawals associated with the departure of the advisors amounted to $660 million, of which $56 million was withdrawn in the six months ended June 30, 2023 and $604 million was withdrawn in the fourth quarter of 2022. The cumulative withdrawals reduced wealth management revenues by approximately $951 thousand and $1.9 million, respectively, in the three and six months ended June 30, 2023. We currently estimate a decline in full-year 2023 revenues of approximately $3.8 million associated with these withdrawals. While there are cost savings in salaries and employee benefits expense associated with the departure of these advisors, they currently are being offset by a higher level of legal expenses also associated with this matter.

Mortgage banking revenues represented 11% of total noninterest income for the six months ended June 30, 2023, compared to 17% for the same period in 2022. These revenues are dependent on mortgage origination volume and are sensitive to interest rates and the condition of housing markets. The composition of mortgage banking revenues and the volume of loans sold to the secondary market are shown in the following table:

Management's Discussion and Analysis

(Dollars in thousands)

(1) Includes gains on loan sales, commission income on loans originated for others, servicing right gains, and gains (losses) on forward loan commitments.

(2) Represents fair value changes on mortgage loans held for sale and forward loan commitments.

(3) Represents loan servicing fee income, net of servicing right amortization and valuation adjustments.

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

For the three and six months ended June 30, 2023, mortgage banking revenues were down by $329 thousand and $2.6 million, respectively, compared to the same periods in 2022. The decline in mortgage banking revenues was mainly attributable to a decline in sales volume and a reduction in the sales yield. The volume of loans sold to the secondary market reflected an overall reduction in mortgage origination, refinancing and sales activity in 2023, which was driven by increase in market interest rates and changes in the housing markets. Mortgage banking revenues are also impacted by changes in the fair value of mortgage loans held for sale and forward loan commitments, which are primarily based on current market prices in the secondary market and correlate to changes in the size of the mortgage pipeline. In addition, the overall decline in mortgage banking revenues in 2023 was partially offset by higher net loan servicing fee income associated with loans sold with servicing retained. The increase in net loan servicing fee income was largely due to lower amortization of servicing rights, reflecting lower prepayment speeds on the serviced mortgage portfolio.

Income from BOLI for the six months ended June 30, 2023, was up by $828 thousand from the same period in 2022, reflecting the recognition of $658 thousand in non-taxable income in 2023 associated with the receipt of life insurance proceeds.

For the three and six months ended June 30, 2023, loan related derivative income decreased by $422 thousand and $774 thousand, respectively, from the same periods in 2022, reflecting a lower volume of commercial borrower interest rate derivative transactions.

Noninterest Expense

The following table presents noninterest expense comparisons:

(Dollars in thousands)

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Noninterest Expense Analysis

Salaries and employee benefits expense, the largest component of noninterest expense, for the three and six months ended June 30, 2023 increased by $207 thousand and $989 thousand, respectively, compared to the same periods in 2022. The increase in 2023 largely reflected annual merit increases and higher staffing levels, partially offset by decreases in performance-based compensation accruals.

Outsourced services expense for the three and six months ended June 30, 2023, increased by $246 thousand and $500 thousand, respectively, compared to the same periods in the prior year, due to changes to and expansion of services provided by third party vendors.

Net occupancy expense for the three and six months ended June 30, 2023 increased by $242 thousand and $379 thousand, respectively, compared to the same periods in 2022, primarily due to branch expansion.

Legal, audit and professional fees for the three and six months ended June 30, 2023 increased by $301 thousand and $427 thousand, respectively, compared to the same periods in 2022, reflecting higher legal expenses.

FDIC deposit insurance costs for the three and six months ended June 30, 2023 increased by $969 thousand and $1.5 million, respectively, compared to the same periods in 2022, reflecting an increase in the FDIC’s deposit assessment rate and growth in assets.

Advertising and promotion expense for the three and six months ended June 30, 2023 decreased by $297 thousand and $240 thousand, respectively, due to timing of activities.

Other expense for the three and six months ended June 30, 2023 increased by $163 thousand and $541 thousand, respectively, compared to the same periods in 2022, reflecting modest increases across a variety of other noninterest expense categories.

Income Taxes

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

(Dollars in thousands)

The effective income tax rates for the three and six months ended June 30, 2023 and 2022 differed from the federal rate of 21%, primarily due to the benefits of tax-exempt income, income from BOLI and federal tax credits, partially offset by state income tax expense.

The decrease in the effective tax rate for the three and six months ended June 30, 2023 compared to the same periods in 2022 largely reflected an increase in benefits from BOLI income.

Segment Reporting

The Corporation manages its operations through two reportable business segments, consisting of Commercial Banking and Wealth Management Services. See Note 13 to the Unaudited Consolidated Financial Statements for additional disclosure related to business segments.

Commercial Banking

The following table presents a summarized statement of operations for the Commercial Banking business segment:

(Dollars in thousands)

Net interest income for the Commercial Banking segment for the three and six months ended June 30, 2023, decreased by $4.1 million and $2.0 million, respectively, from the same periods in 2022. Net interest income was adversely impacted increases in funding costs, but this was partially offset by growth in and higher yields on average interest-earning assets.

The provision recognized in 2023 provided for loan growth and reflected continued negative outlook in economic forecasts, partially offset by continued strength in asset and credit quality metrics. See additional discussion under the caption “Provision for Credit Losses.”

Noninterest income derived from the Commercial Banking segment for the three and six months ended June 30, 2023 was down by $477 thousand and $2.6 million, respectively, from the comparable periods in 2022, reflecting lower mortgage banking revenues, lower loan related derivative income and higher BOLI income. See additional discussion under the caption “Noninterest Income” above.

Commercial Banking noninterest expenses for the three and six months ended June 30, 2023 were up by $2.1 million and $4.2 million, respectively, from the same periods in 2022, with the largest increases in FDIC deposit insurance costs, salaries and employee benefits and net occupancy costs. See additional discussion under the caption “Noninterest Expense” above.

Wealth Management Services

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

(Dollars in thousands)

For the three and six months ended June 30, 2023, noninterest income derived from the Wealth Management Services segment decreased by $1.1 million and $2.8 million, respectively, from the same periods in 2022, largely reflecting a decrease in asset-based revenues. See further discussion under the caption “Noninterest Income” above.

For the three and six months ended June 30, 2023, noninterest expenses for the Wealth Management Services segment decreased by $157 thousand and increased modestly by $44 thousand, respectively, from the comparable periods in 2022.

Financial Condition

Summary

The following table presents selected financial condition data:

(Dollars in thousands)

Total assets amounted to $7.0 billion at June 30, 2023, up by $351.7 million, or 5%, from the end of 2022, largely reflecting loan growth.

The securities portfolio increased by $28.5 million, or 3%, from the end of 2022, reflecting purchases of debt securities and an increase in fair value of available for sale securities primarily attributable to changes in interest rates, partially offset by routine pay-downs on mortgage-backed securities.

Total loans increased by $271.0 million, or 5%, from the end of 2022, with growth in both the residential real estate and commercial portfolios.

Total deposits increased by $295.5 million, or 6%, from the end of 2022, with increases in both wholesale brokered deposits and in-market deposits. FHLB advances increased by $60.0 million, or 6%, from December 31, 2022. The increase in both wholesale brokered deposits and FHLB advances reflected higher levels of wholesale funding being utilized to fund balance sheet growth.

Shareholders’ equity increased by $5.5 million, or 1%, reflecting net income and an increase in the AOCL component of shareholders' equity due to increases in the fair value of available for sale debt securities and cash flow hedges that were primarily attributable to relative changes in market interest rates. These increases were partially offset by dividend declarations and an increase in treasury stock balances, largely due to stock repurchases in early 2023.

Securities

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

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

Determination of Fair Value

The Corporation uses an independent pricing service to obtain quoted prices. The prices provided by the independent pricing service are generally based on observable market data in active markets. The determination of whether markets are active or inactive is based upon the level of trading activity for a particular security class. Management reviews the independent pricing service’s documentation to gain an understanding of the appropriateness of the pricing methodologies. Management also reviews the prices provided by the independent pricing service for reasonableness based upon current trading levels for similar securities. If the prices appear unusual, they are re-examined and the value is either confirmed or revised. In addition, management periodically performs independent price tests of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of June 30, 2023 and December 31, 2022, management did not make any adjustments to the prices provided by the pricing service.

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

See Notes 3 and 7 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities.

Securities Portfolio

The carrying amounts of securities held are as follows:

(Dollars in thousands)

The securities portfolio represented 15% of total assets at June 30, 2023, unchanged from December 31, 2022. The largest component of the securities portfolio is mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises.

The securities portfolio increased by $28.5 million, or 3%, from the end of 2022. This included purchases of U.S. government agency and U.S. government-sponsored debt securities, including mortgage-backed securities, totaling $60.2 million, with a weighted average yield of 4.98%, as well as an increase of $4.4 million (pre-tax) in the fair value of available for sale securities. These were partially offset by $35.4 million of routine pay-downs on mortgage-backed securities.

As of June 30, 2023, the carrying amount of available for sale debt securities included net unrealized losses of $168.0 million, compared to net unrealized losses of $172.4 million as of December 31, 2022. The increase in fair value of available for sale debt securities from the end of 2022 was primarily concentrated in obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, and primarily attributable to relative changes in interest rates since the time of purchase. See Note 3 to the Unaudited Consolidated Financial Statements for additional information.

Loans

Total loans amounted to $5.4 billion at June 30, 2023, up by $271.0 million, or 5%, from the end of 2022.

The following is a summary of loans:

(Dollars in thousands)

(1) CRE consists of commercial mortgages primarily secured by income-producing property, as well as construction and development loans. Construction and development loans are made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings.

(2) C&I consists of loans to businesses and individuals, a portion of which are fully or partially collateralized by real estate.

(3) Residential real estate consists of mortgage and homeowner construction loans secured by one- to four-family residential properties.

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

Commercial Loans

The commercial loan portfolio represented 47% of total loans at June 30, 2023.

In making commercial loans, we may occasionally solicit the participation of other banks. The Bank also participates in commercial loans originated by other banks. In such cases, these loans are individually underwritten by us using standards similar to those employed for our self-originated loans. Our participation in commercial loans originated by other banks amounted to $545.3 million and $510.6 million, respectively, at June 30, 2023 and December 31, 2022. Our participation in commercial loans originated by other banks also includes shared national credits. Shared national credits are defined as participation in loans or loan commitments of at least $100.0 million that are shared by three or more banks.

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

Commercial Real Estate Loans

CRE loans totaled $1.9 billion at June 30, 2023, up by $110.7 million, or 6%, from the balance at December 31, 2022. In 2023, CRE loan originations and advances of approximately $151 million were partially offset by payments of approximately $53 million. Included in the net increase in CRE were reclassifications of $13 million from C&I.

Included in the CRE loan portfolio were construction and development loans of $156.3 million and $164.1 million, respectively, as of June 30, 2023 and December 31, 2022.

Shared national credit balances outstanding included in the CRE loan portfolio totaled $16.4 million and $10.5 million, respectively, at June 30, 2023 and December 31, 2022. The balances were included in the pass-rated category of commercial loan credit quality and were current with respect to contractual payment terms at both June 30, 2023 and December 31, 2022.

The following table presents a geographic summary of CRE loans by property location:

(Dollars in thousands)

The following table presents a summary of CRE loans by property type segmentation:

(Dollars in thousands)

Commercial and Industrial Loans

C&I loans amounted to $611.5 million at June 30, 2023, down by $44.9 million, or 7%, from the balance at December 31, 2022. The net reduction in C&I reflected payments of approximately $60 million and reclassifications of $13 million to CRE, partially offset by originations and advances of $28 million.

Shared national credit balances outstanding included in the C&I loan portfolio totaled $38.4 million and $40.9 million, respectively, at June 30, 2023 and December 31, 2022. All of these loans were included in the pass-rated category of commercial loan credit quality and were current with respect to contractual payment terms at both June 30, 2023 and December 31, 2022.

The following table presents a summary of C&I loan by industry segmentation:

(Dollars in thousands)

Residential Real Estate Loans

The residential real estate loan portfolio represented 47% of total loans at June 30, 2023.

Residential real estate loans held in portfolio amounted to $2.5 billion at June 30, 2023, up by $187.1 million, or 8%, from the balance at December 31, 2022. While total residential real estate loan origination activity has declined from the prior year, we originated a high proportion of loans for portfolio.

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

(Dollars in thousands)

(1) Includes residential mortgage loans purchased from and serviced by other financial institutions totaling $56.6 million and $59.9 million, respectively, as of June 30, 2023 and December 31, 2022.

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

The table below presents residential real estate loan origination activity:

(Dollars in thousands)

(1) Includes the full commitment amount of homeowner construction loans.

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

The table below presents residential real estate loan sales activity:

(Dollars in thousands)

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

Residential real estate loan origination, refinancing and sales activity decreased in response to increases in market interest rates and changes in the housing markets.

We have active relationships with various secondary market investors that purchase residential real estate loans we originate. In addition to managing our interest rate risk position and earnings through the sale of these loans, we are also able to manage our liquidity position through timely sales of residential real estate loans to the secondary market.

Loans are sold with servicing retained or released. Loans sold with servicing rights retained result in the capitalization of servicing rights. Loan servicing rights are included in other assets and are subsequently amortized as an offset to mortgage banking revenues over the estimated period of servicing. The net balance of capitalized servicing rights amounted to $8.7 million and $9.0 million, respectively, as of June 30, 2023 and December 31, 2022. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $1.5 billion as of both June 30, 2023 and December 31, 2022.

Consumer Loans

Consumer loans include home equity loans and lines of credit and personal installment loans. Home equity lines of credit and home equity loans represented 94% of the total consumer portfolio at June 30, 2023. Our home equity line and home equity loan origination activities are conducted primarily in southern New England. The Bank estimates that approximately 55% of the combined home equity lines of credit and home equity loan balances are first lien positions or subordinate to other Washington Trust mortgages.

The consumer loan portfolio totaled $319.5 million at June 30, 2023, up by $18.1 million, or 6%, from December 31, 2022, largely reflecting increases in home equity lines and loans. Purchased consumer loans, consisting of loans to individuals secured by general aviation aircraft, amounted to $12.6 million and $9.6 million, respectively, at June 30, 2023 and December 31, 2022.

Asset Quality

The Corporation continually monitors the asset quality of the loan portfolio using all available information.

In the course of resolving problem loans, the Corporation may choose to modify the contractual terms of certain loans. As disclosed in Note 2, the Corporation adopted ASU 2022-02, which eliminated the accounting guidance for TDRs and added enhanced disclosures with respect to certain modifications for borrowers experiencing financial difficulty. Effective January 1, 2023, a loan that has been modified is considered a TLM when the following conditions are met: (1) the modification is considered a continuation of an existing loan and not a new loan in accordance with GAAP, (2) the modification is made to a borrower experiencing financial difficulty and (3) the modification has a direct impact to the contractual cash flows. During the three and six months ended June 30, 2023, there were no TLMs.

Nonperforming Assets

Nonperforming assets include nonaccrual loans and OREO.

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

(Dollars in thousands)

Nonaccrual Loans

During the six months ended June 30, 2023, the Corporation made no changes in its practices or policies concerning the placement of loans into nonaccrual status.

The following table presents the activity in nonaccrual loans:

(Dollars in thousands)

The following table presents additional detail on nonaccrual loans:

(Dollars in thousands)

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

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at June 30, 2023.

As of June 30, 2023, the composition of nonaccrual loans was 91% residential and consumer and 9% commercial, compared to 100% residential and consumer as of December 31, 2022. Total nonaccrual loans decreased by $2.4 million from the end of 2022.

Nonaccrual residential real estate mortgage loans amounted to $8.5 million at June 30, 2023, down by $3.4 million from the end of 2022. As of June 30, 2023, the balance of nonaccrual residential mortgage loans was predominately secured by properties in Connecticut, Massachusetts and Rhode Island. Included in total nonaccrual residential real estate loans at June 30, 2023 were five loans purchased for portfolio and serviced by others amounting to $1.5 million. Management monitors the collection efforts of its third-party servicers as part of its assessment of the collectability of nonperforming loans.

Past Due Loans

The following table presents past due loans by category:

(Dollars in thousands)

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

As of June 30, 2023 and December 31, 2022, the composition of past due loans (loans past due 30 days or more) was 96% residential and consumer and 4% commercial, compared to 87% residential and consumer and 13% commercial at December 31, 2022. Total past due loans decreased by $5.2 million from the end of 2022.

Total past due loans included $3.7 million of nonaccrual loans as of June 30, 2023, compared to $7.2 million as of December 31, 2022.

All loans 90 days or more past due at June 30, 2023 and December 31, 2022 were classified as nonaccrual.

Potential Problem Loans

The Corporation classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines provided by banking regulators. Potential problem loans include classified accruing commercial loans that were less than 90 days past due at June 30, 2023 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.

Potential problem loans are not included in the amounts of nonaccrual loans presented above. They are assessed for loss exposure using the methods described in Note 4 to the Unaudited Consolidated Financial Statements under the caption “Credit Quality Indicators.” 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 modified, or require an increased allowance coverage and provision for credit losses on loans.

As of June 30, 2023, there were no loans deemed to be potential problem loans.

Allowance for Credit Losses on Loans

The ACL on loans is management’s estimate of expected lifetime credit losses on loans carried at amortized cost. The ACL on loans is established through a provision for credit losses recognized in earnings. The ACL on loans is reduced by charge-offs on loans and is increased by recoveries of amounts previously charged off.

The Corporation’s general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that the collection of loan principal is unlikely. Full or partial charge-offs on collateral dependent individually analyzed loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. The Corporation does not recognize a recovery when new appraisals indicate a subsequent increase in value.

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

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

The following table presents additional detail on the Corporation’s loan portfolio and associated allowance:

(Dollars in thousands)

Management employs a process and methodology to estimate the ACL on loans that evaluates both quantitative and qualitative factors. The methodology for evaluating quantitative factors consists of two basic components. The first component involves pooling loans into portfolio segments for loans that share similar risk characteristics. The second component involves individually analyzed loans that do not share similar risk characteristics with loans that are pooled into portfolio segments.

The ACL for individually analyzed loans is measured using a DCF method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan was collateral dependent, at the fair value of the collateral.

The ACL for pooled loans is measured utilizing a DCF methodology to estimate credit losses for each pooled portfolio segment. The methodology incorporates a probability of default and loss given default framework. Loss given default is estimated based on historical credit loss experience. Probability of default is estimated using a regression model that incorporates econometric factors. Management utilizes forecasted econometric factors with a one-year reasonable and supportable forecast period and one-year straight-line reversion period in order to estimate the probability of default for each loan portfolio segment. The DCF methodology combines the probability of default, the loss given default, prepayment speeds and remaining life of the loan to estimate a reserve for each loan. The sum of all the loan level reserves are aggregated for each portfolio segment and a loss rate factor is derived. Quantitative loss factors for pooled loans are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates.

The ACL on loans amounted to $39.3 million at June 30, 2023, up by $1.3 million, or 3%, from the balance at December 31, 2022. The ACL on loans as a percentage of total loans, also known as the reserve coverage ratio, was 0.73% at June 30, 2023, compared to 0.74% at December 31, 2022.

The Corporation recorded a provision for credit losses of $700 thousand and $1.5 million, respectively, for the three and six months ended June 30, 2023. The provision provided for loan growth and reflected continued negative outlook in economic forecasts, partially offset by continued strength in asset and credit quality metrics.

Net charge-offs totaled $37 thousand for the three months ended June 30, 2023, compared to net recoveries of $10 thousand for the same period in 2022. For the six months ended June 30, 2023, net charge-offs totaled $84 thousand, compared to net recoveries of $158 thousand for the same period in 2022.

The ACL on loans is an estimate and ultimate losses may vary from management’s estimate. Deteriorating conditions or assumptions could lead to further increases in the ACL on loans; conversely, improving conditions or assumptions could lead to further reductions in the ACL on loans.

The following table presents the allocation of the ACL on loans by portfolio segment. The total ACL on loans is available to absorb losses from any segment of the loan portfolio.

(Dollars in thousands)

(1) Percentage of loans outstanding in respective category to total loans outstanding.

Sources of Funds

Our sources of funds include in-market deposits, wholesale brokered deposits, FHLB advances, other borrowings and proceeds from the sales, maturities and payments of loans and investment securities. The Corporation uses funds to originate and purchase loans, purchase investment securities, conduct operations, expand the branch network and pay dividends to shareholders.

Deposits

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

The Bank is a participant in the DDM program, ICS program and the CDARS program. The Bank uses these deposit sweep services to place customer and client funds into interest-bearing demand accounts, money market accounts, and/or time deposits issued by other participating banks. Customer and client funds are placed at one or more participating banks to ensure that each deposit customer is eligible for the full amount of FDIC insurance. As a program participant, we receive reciprocal amounts of deposits from other participating banks. We consider these reciprocal deposit balances to be in-market deposits as distinguished from traditional wholesale brokered deposits.

The following table presents a summary of deposits:

(Dollars in thousands)

Total deposits amounted to $5.3 billion at June 30, 2023, up by $295.5 million, or 6%, from December 31, 2022, with increases in wholesale brokered deposits and in-market deposits.

Wholesale brokered deposits increased by $243.3 million, or 68%, from December 31, 2022, as higher levels were utilized to fund balance sheet growth.

In-market deposits, which exclude wholesale brokered deposits, were up by $52.2 million, or 1%, from the balance at December 31, 2022. As expected, due to higher market interest rates and increased competition, in-market deposits shifted from relatively lower cost products to higher cost products in 2023. As of June 30, 2023, in-market deposits were approximately 59% retail and 41% commercial. Our in-market deposits are well-diversified by industry and customer type. The average size of our in-market deposit accounts was approximately $37 thousand at June 30, 2023.

The following table presents a summary of the Bank’s uninsured deposits:

(Dollars in thousands)

(1) Determined in accordance with regulatory reporting requirements, which includes affiliate deposits and fully-collateralized preferred deposits.

(2) Uninsured deposit balances of Washington Trust Bancorp, Inc. and its subsidiaries that are eliminated in consolidation.

(3) Uninsured deposits of states and political subdivisions, which are secured or collateralized as required by state law.

Borrowings

Borrowings primarily consist of FHLB advances, which are used as a source of funding for liquidity and interest rate risk management purposes. FHLB advances totaled $1.0 billion at June 30, 2023, up by $60.0 million, or 6%, from the balance at the end of 2022.

For additional information regarding FHLB advances see Note 9 to the Unaudited Consolidated Financial Statements.

Liquidity and Capital Resources

Liquidity Management

Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Corporation’s primary source of liquidity is in-market deposits, which funded approximately 68% of total average assets in the six months ended June 30, 2023. While the generally preferred funding strategy is to attract and retain low-cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and brokered deposits), cash flows from the investment securities portfolio and loan repayments. Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs, although management has no intention to do so at this time.

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

The table below presents a summary of contingent liquidity balances by source:

(Dollars in thousands)

(1) As of June 30, 2023 and December 31, 2022, loans with a carrying value of $2.9 billion and $2.4 billion, respectively, and securities available for sale with carrying values of $97.4 million and $102.1 million, respectively, were pledged to the FHLB resulting in this additional borrowing capacity.

(2) As of June 30, 2023 and December 31, 2022, loans with a carrying value of $18.5 million and $20.9 million, respectively, and securities available for sale with a carrying value of $12.9 million and $12.7 million, respectively, were pledged to the FRBB for the discount window resulting in this additional unused borrowing capacity.

In addition to the amounts presented above, the Bank also had access to a $40.0 million unused line of credit with the FHLB. Additionally, $215.0 million of availability was utilized in the year to collateralize an institutional deposit through a standby letter of credit with the FHLB.

The ALCO establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained within target ranges established by the ALCO during the six months ended June 30, 2023. Based on its assessment of the liquidity considerations described above, management believes the Corporation’s sources of funding meet anticipated funding needs.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

In the ordinary course of business, the Corporation enters into contractual obligations that require future cash payments. These include payments related to lease obligations, time deposits with stated maturity dates, and borrowings. Also, in the ordinary course of business, the Corporation engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These financial transactions include commitments to extend credit, standby letters of credit, forward loan commitments, loan related derivative contracts and interest rate risk management contracts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. The Corporation’s credit policies with respect to interest rate contracts with commercial borrowers, commitments to extend credit, and standby letters of credit are similar to those used for loans. Some commitments to extend credit and standby letters of credit are expected to expire without being drawn upon, and thus, total amounts do not necessarily represent future cash requirements. Interest rate risk management contracts with other counterparties are generally subject to bilateral collateralization terms. These contracts with various counterparties may subject the Corporation to various cash flow requirements, which may include posting of cash as collateral for arrangements that are in a liability position. For additional information on derivative financial instruments and financial instruments with off-balance sheet risk see Notes 6 and 16 to the Consolidated Financial Statements.

Capital Resources

Total shareholders’ equity amounted to $459.2 million at June 30, 2023, up by $5.5 million from December 31, 2022. The increase included net income of $24.1 million. In addition, the AOCL component of shareholders' equity increased by $9.0 million, reflecting increases in the fair value of cash flow hedges and available for sale debt securities primarily attributable to changes in market interest rates. These increases to shareholders’ equity were partially offset by $19.1 million in dividend declarations and a net increase in treasury stock balances of $7.1 million. The net increase in treasury stock included the repurchase of 200,000 shares in January and February at an average price of $43.70 and a total cost of $8.7 million, under the 2023 Repurchase Program.

The Corporation declared a quarterly dividend of 56 cents per share for the three months ended June 30, 2023, compared to 54 cents per share declared for the same period in 2022. On a year-to-date basis, dividend declarations totaled $1.12 per share in 2023, compared to $1.08 in 2022.

The ratio of total equity to total assets was 6.55% at June 30, 2023, compared to a ratio of 6.81% at December 31, 2022. Book value per share was $26.98 at June 30, 2023, compared to $26.40 at December 31, 2022.

The Bancorp and the Bank are subject to various regulatory capital requirements and are considered “well capitalized” with the Bancorp having a total risk-based capital ratio of 11.81% at June 30, 2023, compared to 12.37% at December 31, 2022.

See Note 10 to the Unaudited Consolidated Financial Statements for additional discussion regarding shareholders’ equity, including the stock repurchase program and regulatory capital requirements.

Asset/Liability Management and Interest Rate Risk

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

The Corporation utilizes the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, interest rate contracts and the pricing and structure of loans and deposits, to manage interest rate risk. The interest rate contracts may include interest rate swaps, caps and floors. These interest rate contracts involve, to varying degrees, credit risk and interest rate risk. Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract. The notional amount of the interest rate contracts is the amount upon which interest and other payments are based. The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk. See Notes 6 and 16 to the Unaudited Consolidated Financial Statements for additional information.

The ALCO uses income simulation to measure interest rate risk inherent in the Corporation’s financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, a 13- to 24-month horizon and a 60-month horizon. The simulations assume that the size and general composition of the Corporation’s balance sheet remain static over the simulation horizons, with the exception of certain deposit mix shifts from low-cost 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, 2023 and December 31, 2022, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Corporation’s balance sheet remain stable for a 60-month period. In addition to measuring the change in net interest income as compared to an unchanged rate scenario, the ALCO also measures the trend of both net interest income and NIM over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.

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

The following table sets forth the estimated change in net interest income from an unchanged rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on- and off-balance sheet financial instruments as of June 30, 2023 and December 31, 2022. Interest rates are assumed to shift by a parallel 100, 200 or 300 basis points upward, as well as 100 or 200 basis points downward over a 12-month period, except for savings deposits, which are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Since market interest rates have risen sharply, management has incorporated the down 200 basis point scenario into the tabular presentation below. 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.

The relative change in interest rate sensitivity from December 31, 2022, as shown in the above table, was attributable to changes in balance sheet composition and market rates, as well as the March 31, 2023 termination of an interest rate swap contract that was designated as a cash flow hedge to hedge the risk associated with a pool of variable rate commercial loans. This receive-fixed, pay-floating interest rate swap previously mitigated exposure to declining rates and reduced positive exposure to rising rates. See Note 6 to the Unaudited Consolidated Financial Statements for additional information on the termination.

As of June 30, 2023, the ALCO estimates that negative exposure of net interest income to falling rates as compared to an unchanged rate scenario results from a more rapid decline in earning asset yields compared to rates paid on deposits. If market interest rates were to fall and remain lower for a sustained period, certain savings and time deposit rates could decline more slowly and by a lesser amount than other market interest rates. For simulation purposes, deposit rate changes are anticipated to lag behind other market interest rates in both timing and magnitude. Asset yields would likely decline more rapidly than deposit costs as current asset holdings mature or reprice, since cash flow from mortgage-related prepayments and redemption of callable securities would increase as market interest rates fall. The negative exposure in down rate scenarios reflects the insensitivity of certain deposit rates to market interest rate declines as they approach their floors.

As of June 30, 2023, the positive exposure of net interest income in Year 1 to rising rates as compared to an unchanged rate scenario results from a more rapid projected relative rate of increase in asset yields than funding costs over the near term. For simulation purposes, deposit rate changes are anticipated to lag behind other market interest rates in both timing and magnitude. The negative exposure to rising rates in Year 2 is due to a higher level of longer-term fixed rate assets, as well as larger proportion of wholesale funds to total sources of funds. Fixed rate assets would not reprice upward in a rising rate environment. Wholesale funds generally would reprice more quickly and by a greater amount than the repricing of in-market deposits in response to changes in market interest rates. As market rates increase, ALCO modeling assumes that deposits shift from low cost to higher cost deposits. This assumption reflects historical operating conditions in rising rate cycles. Although asset yields would increase in a rising interest rate environment, the cumulative impact of relative growth in rate-sensitive higher cost deposit categories and wholesale funds suggests that the increase in the Corporation’s cost of funds could result in a relative decline in net interest income in Year 2 compared to an unchanged rate scenario.

While the ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future NIM. 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 savings deposits to higher-cost time deposits in rising rate scenarios as noted above.

As part of its policy response to the COVID-19 pandemic in 2020, the Federal Reserve reduced its target range for the Fed Funds rate to 0% - 0.25%. This, and various Federal stimulus programs, had the effect of attracting low cost deposits across the banking industry. During 2022 and into 2023, the Federal Reserve reversed policy and increased the target range to 5.00% - 5.25% as of June 30, 2023. This policy change has resulted in higher rates on existing deposit products and a shift of low cost balances into higher cost alternatives, which could continue into the future, particularly if interest rates continue to rise. As such, the ALCO has modeled deposit shifts out of these low cost categories into higher cost alternatives in the rising rate simulation scenarios presented above. Deposit balances may also be subject to possible outflow to non-bank alternatives in a rising rate environment, as well as due to heightened uncertainty in the banking industry. This may cause interest rate sensitivity to differ from the results as presented. Another significant simulation assumption is the sensitivity of savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both savings deposit rates and balances are related to changes in short-term interest rates. The relationship between short-term interest rate changes and deposit rate and balance changes may differ from the ALCO’s estimates used in income simulation.

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

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

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

The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of June 30, 2023 and December 31, 2022 resulting from immediate parallel rate shifts:

(Dollars in thousands)

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Critical Accounting Policies and Estimates

Estimates and assumptions are necessary in the application of certain accounting policies and procedures and can be susceptible to significant change. Critical accounting policies are defined as those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the Corporation’s financial condition or results of operations.

Management considers its accounting policy relating to the ACL on loans to be a critical accounting policy. There have been no material changes in the Corporation’s critical accounting policies and estimates from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Recently Issued Accounting Pronouncements

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

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.”

For factors that could adversely impact Washington Trust’s future results of operations and financial condition, see Part II, Item 1A below and the section labeled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC.

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, the Corporation carried out an evaluation under the supervision and with the participation of the Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, of the Corporation’s disclosure controls and procedures as of the period ended June 30, 2023. Based upon that evaluation, the principal executive officer and principal financial officer concluded that the Corporation’s disclosure controls and procedures are effective and designed to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to the Corporation’s management including its Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosures. The Corporation will continue to review and document its disclosure controls and procedures and consider such changes in future evaluations of the effectiveness of such controls and procedures, as it deems appropriate.

Internal Control Over Financial Reporting

There has been no change in the Corporation’s internal controls over financial reporting during the quarter ended June 30, 2023 that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in the risk factors described in Part I, Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on February 23, 2023 and Part II. Item 1A “Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023 filed with the SEC on May 4, 2023.