Executive Summary / Key Takeaways

• Waterstone Financial (WSBF) operates as a holding company with a dual nature: a stable, growing community bank in southeastern Wisconsin and a volatile, nationally focused mortgage banking segment currently facing headwinds.
• First quarter 2025 results highlight this divergence, with the Community Banking segment driving consolidated net income despite a net loss in the Mortgage Banking segment, primarily due to lower origination volumes and compressed margins amid intense competition.
• The company is strategically shifting its funding mix towards increased time deposits, successfully reducing reliance on higher-cost borrowings and improving net interest income, a critical factor in offsetting mortgage segment weakness.
• WSBF maintains a strong capital position, with WaterStone Bank exceeding all regulatory requirements and considered well-capitalized, providing a buffer against potential credit quality fluctuations and supporting capital allocation initiatives like the ongoing share repurchase program.
• Key factors for investors to monitor include the performance trajectory of the mortgage banking segment in a challenging market, the continued success of the deposit-gathering strategy, and trends in asset quality, particularly within the loan portfolio.

A Foundation in Community, A Reach for the Nation

Waterstone Financial, Inc. traces its roots back to 1921 with the establishment of WaterStone Bank SSB. For over a century, the bank has served the financial needs of communities in southeastern Wisconsin, building a foundation of local relationships and traditional banking services. This legacy continues today through its Community Banking segment, operating 14 branches focused on consumer and business banking products, including residential mortgages, home equity loans, commercial real estate financing, and a suite of deposit and transactional services.

Over time, the company expanded its reach and diversified its operations. A significant step in this evolution was the name change from Wauwatosa Holdings, Inc. to Waterstone Financial, Inc. in August 2008. Complementing its regional community bank, WSBF established Waterstone Mortgage Corporation, a wholly-owned subsidiary that operates a national mortgage banking segment. This segment focuses primarily on originating single-family residential mortgage loans for sale into the secondary market, licensed in 48 states. This dual structure positions WSBF as a hybrid financial institution, balancing the stability of a traditional community bank with the growth potential and inherent volatility of a national mortgage originator.

In the competitive landscape, WSBF operates within a crowded field. In its core Milwaukee-Waukesha market, it holds a modest 1.4% market share, competing with larger regional players like Associated Banc-Corp (ASB) and national giants such as U.S. Bancorp (USB) and PNC Financial Services Group (PNC), as well as numerous smaller institutions and indirect competitors like fintech firms. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, the intensity of competition is evident across both its segments.

WSBF's competitive positioning is characterized by a blend of localized strength and national reach. In community banking, its established branch network fosters customer loyalty, potentially yielding higher recurring revenue from deposits and loans compared to purely digital competitors. However, against larger, more technologically advanced rivals like USB and PNC, WSBF faces challenges. The company's technology infrastructure, while supporting online banking and data processing, is described in competitive analysis as less advanced than some peers, potentially leading to higher operating costs and slower processing speeds in certain areas compared to competitors who have invested heavily in digital platforms. This technological disparity can impact efficiency and vulnerability to price competition.

Despite this, WSBF's mortgage banking segment, through Waterstone Mortgage Corporation, has developed expertise in originating loans for the secondary market. While specific technological differentiators are not detailed, the segment's focus and scale in this area suggest operational workflows designed for this specific market. However, the segment's performance is highly susceptible to broader market conditions and intense competition from other mortgage originators, which has recently pressured margins.

Recent Performance: A Tale of Two Segments Unfolds

The first quarter of 2025 vividly illustrates the distinct dynamics of WSBF's two core segments. Consolidated net income for the three months ended March 31, 2025, was $3.0 million, essentially flat compared to the $3.0 million reported for the same period in 2024. This apparent stability at the consolidated level masks significant divergence beneath the surface.

The Community Banking segment demonstrated robust performance, with net income increasing substantially to $4.6 million in Q1 2025 from $2.6 million in Q1 2024. This improvement was primarily driven by an $805,000 increase in net interest income, reaching $12.4 million. This growth in net interest income reflects the successful execution of a strategic shift in funding. The bank has increased its reliance on time deposits, allowing it to reduce its average balance of higher-cost FHLB advances. Interest expense on borrowings decreased significantly, contributing positively to the net interest margin. Furthermore, the segment benefited from a negative provision for credit losses of $518,000 in Q1 2025, a favorable swing from a $105,000 provision in Q1 2024. This negative provision was attributed to decreases in historical loss rates and loan portfolio balances, although partially offset by increased qualitative factors for commercial real estate loans reflecting economic and internal asset quality risks.

In stark contrast, the Mortgage Banking segment experienced a challenging quarter, reporting a net loss of $1.6 million in Q1 2025, a significant decline from net income of $298,000 in Q1 2024. This downturn was primarily a function of reduced activity and compressed margins in the national mortgage market. Loan origination volume decreased by $97.4 million, or 20.1%, compared to the prior year period, driven by a decrease in purchase products despite a slight increase in refinance activity. Consequently, mortgage banking noninterest income fell by $4.6 million, or 22.6%, to $15.7 million. Management noted that the contraction in the gross margin on loans originated and sold reflects decreased industry demand and increased competition from mortgage originators. Operating expenses in this segment also saw shifts, with compensation decreasing due to reduced headcount and lower volumes, while professional fees increased significantly due to legal services and the finalization of a settlement related to a previously disclosed matter. Other noninterest expenses also rose, partly due to provisions for branch losses and overhead, reflecting strategic adjustments like closing underperforming branches over the past year.

On a consolidated basis, total assets decreased slightly by $34.2 million, or 1.5%, to $2.18 billion at March 31, 2025, primarily reflecting decreases in loans receivable and loans held for sale, aligning with a decrease in borrowings. Cash and cash equivalents increased by $3.5 million, supported by growth in deposits and advance payments by borrowers for taxes. The securities available for sale portfolio increased by $5.1 million, influenced by purchases and an increase in fair value due to lower longer-term interest rates. Loans held for sale decreased by $19.6 million, consistent with the slowdown in purchase activity in the mortgage market. Loans receivable held for investment saw a $17.1 million decrease, with declines in multi-family, construction, and home equity loans partially offset by growth in one-to-four family, commercial real estate, and commercial categories.

Funding dynamics were notable, with total deposits increasing by $21.3 million to $1.38 billion, driven by growth in time deposits and money market/savings accounts. This deposit growth facilitated a significant decrease in total borrowings, which fell by $50.7 million, or 11.3%, to $395.9 million. This shift from borrowings to deposits is a key strategic move aimed at improving funding costs and net interest margin. Advance payments by borrowers for taxes increased seasonally. Other liabilities decreased, partly due to seasonal fluctuations in outstanding checks for tax payments and a decrease in the fair value adjustment for back-to-back loan swaps.

Shareholders' equity increased by $2.2 million, primarily benefiting from an increase in the fair value of the securities portfolio.

Strategic Focus and Outlook

WSBF's strategic direction appears centered on leveraging the stability of its community banking operations while navigating the challenging environment in mortgage banking and optimizing its funding structure. The successful transition towards greater reliance on time deposits is a critical component of this strategy, directly contributing to improved net interest income by lowering funding costs. This strategic pivot is essential in offsetting the volatility and current profitability pressures in the mortgage segment.

The company actively manages its exposure to interest rate risk, which is significant given the longer maturities of its loan and securities portfolios relative to its deposit base. Strategies include emphasizing variable rate loans, managing the expected life of the investment portfolio, and adjusting the term structure of deposits and borrowings. An analysis of net interest income sensitivity at March 31, 2025, indicated that a 100 basis point instantaneous increase in rates could decrease forecast net interest income over the next 12 months by 7.08%, while a 100 basis point decrease could increase it by 7.86%. This highlights the sensitivity of earnings to interest rate movements, despite management's mitigation efforts.

While explicit forward-looking financial guidance figures were not provided in the management discussion, the stability of the "forecast factor" used in the CECL allowance calculation suggests management's internal economic outlook assumption remained consistent quarter-over-quarter. The ongoing stock repurchase program, with approximately 1.4 million shares remaining under the current authorization, signals management's commitment to returning capital to shareholders and confidence in the company's intrinsic value, even amidst segment-specific challenges.

The outlook for WSBF is closely tied to the performance of its two distinct segments and the prevailing macroeconomic environment, particularly interest rates and housing market activity. Continued strength and deposit growth in community banking are expected to provide a stable earnings base. The mortgage banking segment's performance will likely remain sensitive to interest rate volatility and competitive pressures on margins. Strategic adjustments within this segment, such as branch optimization, aim to improve efficiency, but a significant recovery in profitability may depend on a more favorable market environment for mortgage origination.

Risks and Considerations

Investing in WSBF involves considering several key risks. Interest rate risk remains paramount, as significant fluctuations could materially impact net interest income, asset valuations, and loan demand. Credit risk is inherent in lending activities; while the allowance for credit losses is determined based on management's judgment and current conditions, higher-than-anticipated loan defaults could necessitate increased provisions, impacting earnings. The increase in non-accrual loans in Q1 2025 warrants close monitoring, although the overall ratio remains relatively low.

Competition is a persistent challenge across both segments. In community banking, competing for deposits and loans against larger, more technologically advanced institutions requires continuous effort. In mortgage banking, the intense competition noted by management can compress margins and reduce origination volumes, directly impacting profitability. The company's reliance on external short-term borrowings in the mortgage segment also exposes it to funding cost volatility.

Operational risks, including those related to cybersecurity and the reliance on third-party service providers, are also factors. Furthermore, the company is subject to various legal and regulatory risks, as highlighted by the recent legal settlement finalized in Q1 2025. While historical loan repurchase activity related to representations and warranties on sold mortgages has been insignificant, this remains a potential contingent liability.

Conclusion

Waterstone Financial presents a compelling case study of a financial institution balancing a stable, relationship-driven community banking core with a more dynamic, market-sensitive national mortgage operation. The first quarter of 2025 underscores this duality, with the community bank's solid performance and strategic funding gains providing resilience against the headwinds faced by the mortgage segment. While the lack of detailed information on specific technological differentiators makes a direct comparison on this front challenging, the company's strategic focus on optimizing its funding structure and managing interest rate risk are critical operational levers.

The investment thesis for WSBF hinges on the continued strength and growth potential of the Community Banking segment, its ability to effectively manage interest rate risk, and the potential for improvement in the Mortgage Banking segment as market conditions evolve or strategic efficiency gains take hold. The company's strong capital position offers a degree of safety and flexibility. Investors should closely watch trends in net interest margin, asset quality metrics, mortgage origination volumes and margins, and the impact of competitive pressures on both segments. The success of the strategic shift towards deposit funding and the trajectory of the national mortgage market will be key determinants of WSBF's future financial performance and the realization of its investment potential.