Washington Trust Bancorp - 10-Q quarterly report FY

(Mark One)

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.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer    o                                                       Accelerated filer     x                                              Non-accelerated filer    o  

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

oYes          x No

The number of shares of common stock of the registrant outstanding as of July 31, 2007 was 13,304,518.

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 to individuals and businesses including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management services through its branch offices in Rhode Island, Massachusetts and southeastern Connecticut, ATMs, and its Internet web site (www.washtrust.com).

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 U.S. generally accepted accounting principles (“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 near-term change are the determination of the allowance for loan losses and tax estimates.

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, 2007 and December 31, 2006, 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 Washington Trust’s Annual Report on Form 10-K for the year ended December 31, 2006.

In the Corporation’s quarterly report on Form 10-Q for the quarter ended March 31, 2007, a $6.7 million deferred acquisition obligation payment was misclassified as a financing activity, in the line item “Net increase in other borrowings,” in the Consolidated Statements of Cash Flows.  The Consolidated Statement of Cash Flows for the six months ended June 30, 2007 has been corrected to properly report this first quarter payment as an investing activity, in the line item “Payment of deferred acquisition obligation.”

The following table presents the impact of the misclassification on the Consolidated Statements of Cash Flows for the three months ended March 31, 2007:

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140,” (“SFAS No. 155”).  This Statement eliminates the exemption from applying SFAS No. 133 to interests in securitized financial assets so that similar instruments are accounted for similarly regardless of the form of the instruments.  This Statement also allows a preparer to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated.  SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.  Provisions of this Statement may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis.  Prior periods should not be restated.  The adoption of SFAS No. 155 did not have a material impact on the Corporation’s financial position or results of operations.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140,” (“SFAS No. 156”).  This Statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value.  SFAS No. 156 permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value.  An entity that used derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value.  SFAS No. 156 is effective as of the beginning of the first fiscal year that begins after September 15, 2006.  The adoption of SFAS No. 156 did not have a material impact on the Corporation’s financial position or results of operations.

Effective January 1, 2007, the Corporation adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN 48").  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes."  FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The adoption of FIN 48 did not have a material impact on the Corporation’s financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).  This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures of fair value measurements.  SFAS No. 157 applies to the accounting principles that currently use fair value measurement, and does not require any new fair value measurements.  The expanded disclosures focus on the inputs used to measure fair value as well as the effect of the fair value measurements on earnings. This Statement is effective as of the beginning of the first fiscal year beginning after November 15, 2007 and interim periods within that fiscal year.  The Corporation believes the adoption of SFAS No. 157 will not have a material impact on the Corporation’s financial position or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans (an amendment of FASB Statements No. 87, 88, 106 and 132R)” (“SFAS No. 158”).  The recognition and disclosure provisions of SFAS No. 158 were adopted by the Corporation for the fiscal year ended December 31, 2006.  Upon adoption, the funded status of an employer’s postretirement benefit plan was recognized in the statement of financial position and the changes in funded status of the defined benefit plan, including actuarial gains and losses and prior service costs and credits were recognized in comprehensive income.  The requirement to measure the plan’ assets and obligations as of the employers fiscal year end is effective for fiscal years ending after December 15, 2008.  The Corporation is currently evaluating the impact the measurement date provisions of SFAS No. 158 will have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities – Including an amendment to FASB No. 115” (“SFAS No. 159”).  This Statement permits entities to choose to measure eligible items at fair value at specified election dates.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date.  The fair value option (i) may be applied instrument-by-instrument with certain exceptions, (ii) is irrevocable (unless a new election date occurs) and

(iii) is applied only to entire instruments and not to portions of instruments.  This Statement is effective as of the beginning of the first fiscal year that begins after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157, “Fair Value Instruments.”  Retrospective application is allowed for early adopters, prohibited for others.  The choice to adopt early must be made within 120 days of the beginning of the fiscal year of adoption, provided the entity has not yet issued financial statements.  This Statement permits application to eligible items existing at the effective date (or early adoption date).  The Corporation is currently evaluating the impact that SFAS No. 159 will have on its consolidated financial statements.  The Corporation believes the adoption of SFAS No. 159 will not have a material impact on the Corporation’s financial position or results of operations.

Securities available for sale are summarized as follows:

Securities held to maturity are summarized as follows:

During the second quarter of 2007, in conjunction with a potential early adoption of an accounting pronouncement, two held to maturity securities with an amortized cost of $12.1 million were sold resulting in a realized loss of $261 thousand.

Securities available for sale and held to maturity with a fair value of $527.8 million and $557.4 million were pledged in compliance with state regulations concerning trust powers and to secure Treasury Tax and Loan deposits, borrowings, and certain public deposits at June 30, 2007 and December 31, 2006, respectively.  In addition, securities available for sale and held to maturity with a fair value of $8.7 million and $9.6 million were collateralized for the discount window at the Federal Reserve Bank at June 30, 2007 and December 31, 2006, respectively.  There were no borrowings with the Federal Reserve Bank at either date.  Securities available for sale with a fair value of $2.0 million and $2.1 million were designated in a rabbi trust for a nonqualified retirement plan at June 30, 2007 and December 31, 2006.  As of June 30, 2007, securities available for sale with a fair value of $20.8 million were pledged as collateral to secure securities sold under agreements to repurchase.

At June 30, 2007 and December 31, 2006, the available for sale and held to maturity securities portfolio included $8.1 million and $1.7 million of net pretax unrealized losses, respectively.  Included in these net amounts were gross unrealized losses amounting to $12.5 million and $9.1 million at June 30, 2007 and December 31, 2006, respectively.

The following tables summarize, for all securities in an unrealized loss position at June 30, 2007 and December 31, 2006, respectively, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.

For those debt securities whose amortized cost exceeds fair value, the primary cause is related to the movement of interest rates.  The Corporation believes that the nature and duration of impairment on its debt security holdings are primarily a function of interest rate movements and changes in investment spreads, and does not consider full repayment of principal on the reported debt obligations to be at risk.  The Corporation has the ability and intent to hold these investments to full recovery of the cost basis.  The debt securities in an unrealized loss position at June 30, 2007 consisted of 223 debt security holdings.  The largest loss percentage of any single holding was 6.28% of its amortized cost.

Causes of conditions whereby the fair value of corporate stock equity securities is less than cost include the timing of purchases and changes in valuation specific to individual industries or issuers.  The relationship between the level of market interest rates and the dividend rates paid on individual equity securities may also be a contributing factor.  The Corporation believes that the nature and duration of impairment on its equity securities holdings are considered to be a function of general financial market movements and industry conditions.  The equity securities in an unrealized loss position at June 30, 2007 consisted of 10 holdings of financial and commercial entities.

The following is a summary of loans:

The following is an analysis of the allowance for loan losses:

The changes in the carrying value of goodwill and other intangible assets for the six months ended June 30, 2007 are as follows:

Amortization of intangible assets for the six months ended June 30, 2007 totaled $716 thousand.  Estimated annual amortization expense of current intangible assets with finite useful lives, absent any impairment or change in estimated useful lives, is summarized below.

The components of intangible assets at June 30, 2007 are as follows:

Effective January 1, 2007, the Corporation adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  The adoption of FIN 48 did not result in any adjustment to retained earnings as of January 1, 2007.

As of the adoption date, the Corporation had gross tax affected unrecognized tax benefits of $1.2 million.  If recognized, this amount would be recorded as a component of income tax expense.  There have been no significant changes to this during the six months ended June 30, 2007.

The Corporation recognizes potential accrued interest related to unrecognized tax benefits in income tax expense in the Consolidated Statements of Income.  As of the adoption date of January 1, 2007, accrued interest amounted to

$70 thousand.  To the extent interest is not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.  Penalties, if incurred, would be recognized as a component of income tax expense.

The Corporation files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  The Corporation is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2003.  With a few exceptions, the Corporation is no longer subject to state income tax examinations by tax authorities for years before 2000.

Advances payable to the Federal Home Loan Bank (“FHLB”) are summarized as follows:

During the first quarter of 2007, the Corporation prepaid $26.5 million in advances payable to the FHLB resulting in a debt prepayment penalty charge, recorded in noninterest expense, of $1.1 million.  See additional discussion in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Noninterest Expense.”

In addition to outstanding advances, the Corporation also has access to an unused line of credit amounting to $8.0 million at June 30, 2007.  Under an agreement with the FHLB, the Corporation is required to maintain qualified collateral, free and clear of liens, pledges, or encumbrances that, based on certain percentages of book and market values, has a value equal to the aggregate amount of the line of credit and outstanding advances (“FHLB borrowings”).  The FHLB maintains a security interest in various assets of the Corporation including, but not limited to, residential mortgages loans, U.S. government or agency securities, U.S. government-sponsored agency securities, and amounts maintained on deposit at the FHLB.  The Corporation maintained qualified collateral in excess of the amount required to collateralize the line of credit and outstanding advances at June 30, 2007.  Included in the collateral were securities available for sale and held to maturity with a fair value of $403.0 million and $451.5 million that were specifically pledged to secure FHLB borrowings at June 30, 2007 and December 31, 2006, respectively.  Unless there is an event of default under the agreement with the FHLB, the Corporation may use, encumber or dispose of any portion of the collateral in excess of the amount required to secure FHLB borrowings, except for that collateral that has been specifically pledged.

The following is a summary of other borrowings:

In the first quarter of 2007, securities sold under repurchase agreements of $19.5 million were executed.  The securities sold under agreements to repurchase are callable at the issuer’s option, at one time only, in one year and mature in five years.  The securities underlying the agreements are held in safekeeping by the counterparty in the name of the Corporation and are repurchased when the agreement matures.  Accordingly, these underlying securities are included in securities available for sale and the obligations to repurchase such securities are reflected as a liability.

The Stock Purchase Agreement for the August 2005 acquisition of Weston Financial Group, Inc. (“Weston Financial”) provides for the payment of contingent purchase price amounts based on operating results in each of the years in the three-year earn-out period ending December 31, 2008.  Contingent payments are added to goodwill and recorded as deferred acquisition liabilities at the time the payments are determinable beyond a reasonable doubt.  Deferred acquisition obligations amounted to $3.8 million at June 30, 2007 compared to $10.4 million at December 31, 2006.  In the first quarter of 2007 the Corporation paid approximately $6.7 million in earn-out payments.

Under the Corporation’s 2006 Stock Repurchase Plan, 149,700 shares of stock were repurchased at a total cost of $3.9 million during the six months ended June 30, 2007.  In addition, 13,717 shares were acquired in the same period pursuant to the Nonqualified Deferred Compensation Plan.

The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios at June 30, 2007 and December 31, 2006, as well as the corresponding minimum regulatory amounts and ratios:

The Corporation’s capital ratios at June 30, 2007 place the Corporation in the “well-capitalized” category according to regulatory standards.

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, financial guarantees, 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 uses the same credit policies in making commitments and

conditional obligations as it does for on-balance sheet instruments.  The contractual and notional amounts of financial instruments with off-balance sheet risk are as follows:

Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any conditions 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 are conditional commitments issued to guarantee the performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  Under the standby letters of credit, the Corporation is required to make payments to the beneficiary of the letters 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.  At June 30, 2007 and December 31, 2006, the maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered, totaled $9.2 million and $9.4 million, respectively.  At June 30, 2007 and December 31, 2006, there was no liability to beneficiaries resulting from standby letters of credit.  Fee income on standby letters of credit for the six months ended June 30, 2007 and 2006 totaled $51 thousand and $58 thousand, respectively.

At June 30, 2007, a substantial portion of the standby letters of credit were 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.

Commitments to originate and commitments to sell fixed rate mortgage loans are derivative financial instruments.  Accordingly, the fair value of these commitments is recognized in other assets on the balance sheet and changes in fair value of such commitments are recorded in current earnings in the income statement.  The carrying value of such commitments as of June 30, 2007 and December 31, 2006 and the respective changes in fair values for the six months ended June 30, 2007 and 2006 were insignificant.