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Thursday, November 2, 2023

Washington Trust's added costs for racism

Washington Trust reports 40% drop in profits after DOJ settlement

By Nancy Lavin, Rhode Island Current

A month after The Washington Trust Co. agreed to a $9 million settlement with the U.S. Department of Justice over alleged discrimination against would-be borrowers in Black and Hispanic neighborhoods, its holding company saw profit margins plummet.

The $11.2 million third-quarter earnings mark a 40% decline compared with the third quarter of 2022, according to the quarterly report published on Oct. 23. Quarterly earnings per diluted share also plunged from $1.08 to 65 cents per share, year-over-year.

But correlation does not equal causation, observers warn. The Westerly-based community bank is certainly hurting, but not because of the fallout from alleged redlining.

“They’ve got bigger problems than a DOJ settlement,” said Michael Ice, a finance professor at the University of Rhode Island.

Namely, high interest rates, which are forcing banks to pay more on deposits and Federal Home Loan Bank advances. Case in point: Washington Trust’s net interest margin – the difference between interest income generated versus the amount of interest paid – dropped 85 basis points from a year ago, to 1.97%.

“Banks live on the net interest margin,” Ice said. “And for community banks, the net interest margin is horrible right now.”

Challenging environment

Meanwhile, market forces rendering borrowers unable to pay back their loans on time are also hitting the bank’s balance sheet. Washington Trust’s overdue leases and loans – a.k.a. nonperforming assets – nearly tripled compared with a year ago. The bank in its earnings statement chalked up the increase to two commercial real estate loans that became 90 days overdue this quarter.

Then there’s the ongoing battle for deposits, competing not only against established finance giants like Bank of America, but also the “shadow banks” outside of financial regulation and nimble fintech firms appealing to customers with better rates or more flexible products.

“That’s a big worry, because banks are now competing with players that don’t have the brick and mortar branches,” said Peter Nigro, Sarkisian chair of financial services for Bryant University.

All this is to say Washington Trust is facing an uphill battle to survive and grow that has little to do with the investments required by or public perception from the settlement. 

Company executives failed to mention the settlement at all in a post-earnings call with investors on Oct. 24, although they alluded to the community investments, marketing and costs for new branches that are required under the federal agreement.

Washington Trust executives were not available to be interviewed for this story, with a company spokesperson referring to prior statements made about the settlement and in the earnings report. Emailed questions were not returned. 

On the hook to open two new branches

Plans to open a new branch in Providence’s Olneyville neighborhood next year – fulfilling part of the DOJ decree to add two branches in communities of color – is expected to come with a $200,000 cost evident in the upcoming, fourth-quarter earnings report, Ron Ohsberg, senior executive vice president, chief financial officer and treasurer told investors. Ohsberg also estimated the bank will commit $500,000 in community investments in the upcoming quarter.

Analysts on the call questioned the approach of spending more on brick-and-mortar at a time when banks nationwide have scaled back their branches as a way to cut costs and in recognition of changing customer behavior. 

Washington Trust doesn’t have much of a choice, at least when it comes to the two branches mandated by the settlement, but even before that, the bank had carved a path focused on physical expansion as a means to grow deposits.

“They believe you need to be visible, that you need that nice, colonial-looking building for people to put deposits in,” Ice said. 

But Ice didn’t think the alleged redlining would dissuade new customers from banking with Washington Trust, or cause a mass exodus of existing customers. 

“Redlining is not a good look, but I don’t think it kills them,” he said. “It just doesn’t jump out to me like a big deal.”

While Rhode Island Treasurer James Diossa initially threatened to pull the state’s $187 million in deposits from the bank following the settlement announcement, it appears the state won’t make any big investment moves yet after reaching a separate agreement with the bank that includes additional requirements around diversity and oversight.

Ice took a more blasé tone.

“I come from a world where banks are getting sued every day,” he said, referring to his prior, three-decade career on Wall Street.

Washington Trust is hardly the first financial institution accused of discriminatory lending practices, either. Especially since Attorney General Merrick Garland doubled down on DOJ efforts to combat redlining under a coordinated, “aggressive” campaign launched in Oct. 2021. 

Two years in, the Department of Justice has reached settlement agreements with 10 banks and lending institutions, including Washington Trust, totaling $107 million, according to a statement on Oct. 19.  

Bryant University’s Nigro also downgraded the severity of the allegations against Washington Trust compared with discrimination cases against other banks. The DOJ settlement accuses Washington Trust of discrimination primarily by failing to locate branches in Black and Hispanic neighborhoods, a kind of indirect, rather than overt denial of services.

“In the scheme of things, it’s not as bad as some of the cases I’ve worked on,” said Nigro, who previously worked in the U.S. Office of the Comptroller of the Currency.

Cases like a 1990s federal discrimination lawsuit against Mississippi-based Deposit Guaranty National Bank, which was found to have run credit scores on Black borrowers and then rejected their loan applications three times as often as white borrowers. The bank was sold in a merger deal shortly after the case was settled in 1999.

While the redlining allegations are unlikely to lead to Washington Trust’s demise, intensifying interest margin pressures might, according to Nigro. Mergers and acquisitions are a growing strategy for community banks to survive, and the nation’s oldest community bank is not necessarily an exemption, despite leaders’ insistence that they are not looking at deals now.

“It’s becoming so hard for a bank of that size to compete, so all bets are off,” Nigro said. 



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