WASHINGTON TRUST BANCORP INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Corporation’s Audited Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2020, 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 months ended March 31, 2021 are not necessarily indicative of the results for the full-year ended December 31, 2021 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: the negative impacts and disruptions of the COVID-19 pandemic and measures taken to contain its spread on our employees, customers, business operations, credit quality, financial position, liquidity and results of operations; changes in consumer behavior due to changing political, business and economic conditions, or legislative or regulatory initiatives; the possibility that future credits losses are higher than currently expected due to changes in economic assumptions or adverse economic developments; volatility in national and international financial markets; reductions in net interest income resulting from interest rate changes or volatility as well as changes in the balance and mix of loans and deposits; reductions in the market value or outflows of wealth management assets under administration; decreases in the value of securities and other assets; reductions in loan demand; changes in loan collectability, 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, cybersecurity incidents, fraud, natural disasters and future pandemics; reputational risk relating to our participation in the Paycheck Protection Program and other pandemic-related legislative and regulatory initiatives and programs; 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, 2020, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC, may result in these differences. You should carefully review all of these factors and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and we assume no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. Critical Accounting Policies and Estimates Accounting policies involving significant judgments, estimates and assumptions by management, which have, or could have, a material impact on the Corporation’s consolidated financial statements are considered critical accounting policies. Management considers the following to be its critical accounting policies: the determination of the allowance for credit losses on loans, the valuation of goodwill and identifiable intangible assets, and accounting for defined benefit pension plans. See our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 for a description of the Corporation’s critical accounting policies for the valuation of goodwill and identifiable intangible assets and accounting for defined benefit pension plans. Management updated its critical accounting policy for the allowance for credit losses on loans in the first quarter of 2021 as the result of incorporating additional econometric factors in the determination of the probability of default for each loan portfolio segment. The updated policy is presented below. Allowance for Credit Losses on Loans The allowance for credit losses (“ACL") on loans is management’s estimate of expected credit losses over the expected life of the loans at the reporting date. In accordance with the ACL policy, the methodology is reviewed no less than annually. The ACL on loans is established through a provision for credit losses recognized in the Unaudited Consolidated Statements of Income and by recoveries of amounts previously charged-off. The ACL on loans is reduced by charge-offs on loans. Loan charge-offs are recognized when management believes the collectability of the principal balance outstanding is unlikely. Full -40- Management's Discussion and Analysis or partial charge-offs on collateral dependent individually analyzed loans are generally recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. The level of the ACL on loans is based on management’s ongoing review of all relevant information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the calculation of loss given default and the estimation of expected credit losses. As discussed further below, adjustments to historical information are made for differences in specific risk characteristics, such as differences in underwriting standards, portfolio mix, delinquency level, or term, as well as for changes in environmental conditions, that may not be reflected in historical loss rates. 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. Pooled loan portfolio segments include commercial real estate (including commercial construction loans), commercial and industrial (including Paycheck Protection Program (“PPP”) loans), residential real estate (including homeowner construction), home equity and other consumer loans. The second component involves identifying individually analyzed loans that do not share similar risk characteristics with loans that are pooled into portfolio segments. Individually analyzed loans include nonaccrual commercial loans, reasonably expected troubled debt restructurings (“TDRs”) and executed TDRs, as well as certain other loans based on the underlying risk characteristics and the discretion of management to individually analyze such loans. For loans that are individually analyzed, the ACL is measured using a discounted cash flow (“DCF”) method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan is collateral dependent, at the fair value of the collateral. Factors management considers when measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due. For collateral dependent loans for which repayment is to be provided substantially through the sale of the collateral, management adjusts the fair value for estimated costs to sell. For collateral dependent loans for which repayment is to be provided substantially through the operation of the collateral, such as accruing TDRs, estimated costs to sell are not incorporated into the measurement. Management may also adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of circumstances associated with the collateral. For pooled loans, the Corporation utilizes a DCF methodology to estimate credit losses over the expected life of the loan. The life of the loan excludes expected extensions, renewals and modifications, unless the extension or renewal options are included in the original or modified contract terms and not unconditionally cancellable by the Corporation. The methodology incorporates a probability of default and loss given default framework. Default triggers include the loan has become past due by 90 or more days, a charge-off has occurred, the loan has been placed on nonaccrual status, the loan has been modified in a TDR or the loan is risk-rated as special mention or classified. Loss given default is estimated based on historical credit loss experience. Probability of default is estimated utilizing a regression model that incorporates econometric factors. These factors are selected based on the correlation of the factor to historical credit losses for each portfolio segment. The national unemployment rate (“NUR”) and gross domestic product (“GDP”) econometric factors are utilized for the commercial real estate and other consumer loan portfolio segments; the NUR and national home price index (“HPI”) econometric factors are utilized for the residential real estate and home equity portfolio segments; and the NUR econometric factor is utilized for the commercial & industrial loan portfolio segment. To estimate the probability of default, the model utilizes forecasted econometric factors over a one-year reasonable and supportable forecast period. After the forecast period, the model reverts to the historical mean of the respective econometric factor and the associated probability of default on a straight-line basis over a one-year reversion period. The DCF methodology combines the probability of default, the loss given default, prepayment speeds and the 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 are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates. These qualitative risk factors include: (1) changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses; (2) changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments; (3) changes in the nature and volume of the portfolio and in the terms of loans; (4) changes in the experience, ability, and depth of lending management and other relevant staff; (5) changes in the volume and severity of past due loans, -41- Management's Discussion and Analysis the volume of nonaccrual loans, and the volume and severity of adversely classified or rated loans; (6) changes in the quality of the institution’s credit review system; (7) changes in the value of underlying collateral for collateral dependent loans; (8) the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and (9) the effect of other external factors such as legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio. Qualitative loss factors are applied to each portfolio segment with the amounts determined by historical loan charge-offs of a peer group of similar-sized regional banks. Because the methodology is based upon historical experience and trends, current economic data, reasonable and supportable forecasts, as well as management’s judgment, factors may arise that result in different estimations. Deteriorating conditions or assumptions could lead to future increases in the ACL on loans. In addition, various regulatory agencies periodically review the ACL on loans. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination. The ACL on loans is an estimate, and ultimate losses may vary from management’s estimate. 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. Overview The Corporation offers a comprehensive product line of banking and financial services to individuals and businesses, including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management services through its offices in Rhode Island, eastern Massachusetts and Connecticut; its ATMs; telephone banking; mobile banking and its internet website (www.washtrust.com). 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. COVID-19 Pandemic Related On March 11, 2021, the American Rescue Plan Act (“ARP”) was signed into law providing an additional $1.9 trillion in COVID-19 economic relief. The ARP included provisions on aid to state and local governments, hard-hit industries and communities, additional direct stimulus payments to qualifying individuals, additional funding for the Small Business Administration’s (“SBA’s”) PPP and other provisions. PPP loans are 100% guaranteed by the SBA. In the first quarter of 2021, we originated 1,058 PPP loans with principal balances totaling approximately $97 million and we processed SBA forgiveness on approximately 700 PPP loans with principal balances totaling $66 million. As of March 31, 2021, the carrying value of PPP loans amounted to $228.6 million and included net unamortized loan origination fee balances of $5.7 million. On May 4, 2021, the SBA announced that PPP funding has been exhausted and that it has stopped accepting applications from most lenders. As of this date, the carrying value of PPP loans held in our commercial and industrial portfolio totaled approximately $208 million, down from the end of first quarter due to additional loans being forgiven by the SBA. A significant portion of this remaining balance is expected to ultimately be forgiven by the SBA in accordance with the terms of the program. See additional disclosure regarding PPP loans under the heading “Commercial & Industrial Loans” in the Financial Condition section. Risk Management The Corporation has a comprehensive enterprise risk management (“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 -42- Management's Discussion and Analysis 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 enterprise risk management 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 5 and Note 6 to the Unaudited Consolidated Financial Statements. For further discussion regarding credit risk associated with unfunded commitments, see Note 18 to the Unaudited Consolidated Financial Statements. For further discussion regarding the Corporation’s securities portfolio, see Note 4 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. Liquidity risk is the risk that the Corporation will not have the ability to generate adequate amounts of cash for it to meet its maturing liability obligations and customer loan demand. For detailed disclosure regarding liquidity management, asset/liability management and interest rate risk, see “Liquidity and Capital Resources” and “Asset/Liability Management and Interest Rate Risk” sections 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 must report on and escalate their concerns. Corporate functions such as Credit Risk Management, Financial Administration, Information Assurance and Compliance, comprise 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 the 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 the section labeled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC. -43- Management's Discussion and Analysis Results of Operations The following table presents a summarized consolidated statement of operations: (Dollars in thousands) Change Three months ended March 31, 2021 2020 $ % Net interest income $32,871 $32,602 $269 1 % Noninterest income 25,974 19,927 6,047 30 Total revenues 58,845 52,529 6,316 12 Provision for credit losses (2,000) 7,036 (9,036) (128) Noninterest expense 34,713 30,453 4,260 14 Income before income taxes 26,132 15,040 11,092 74 Income tax expense 5,661 3,139 2,522 80 Net income $20,471 $11,901 $8,570 72 % The following table presents a summary of performance metrics and ratios: Three months ended March 31, 2021 2020 Diluted earnings per common share $1.17 $0.68 Return on average assets (net income divided by average assets) 1.45 % 0.89 % Return on average equity (net income available for common shareholders divided by average equity) 15.55 % 9.49 % Net interest income as a percentage of total revenues 56 % 62 % Noninterest income as a percentage of total revenues 44 % 38 % Net income totaled $20.5 million for the three months ended March 31, 2021, up by $8.6 million, or 72%, from the same period in 2020. These results reflected higher levels of noninterest income and a reduction in the provision for credit losses, partially offset by an increase in noninterest expenses. Noninterest income increased due primarily to strong mortgage banking results and growth in wealth management revenues. A negative provision for credit losses (or a benefit) was recognized in the first quarter of 2021 as a result of improvement in forecasted economic conditions and continued stable asset quality metrics. Noninterest expenses increased largely due to debt prepayment penalty expense recognized in the first quarter of 2021 on the prepayment of FHLB advances. -44- Management's Discussion and Analysis Average Balances / Net Interest Margin - Fully Taxable Equivalent (FTE) Basis The following table presents average balance and interest rate information. Tax-exempt income is converted to a fully taxable equivalent 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 fair value adjustments 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. Three months ended March 31, 2021 2020 Change (Dollars in thousands) Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Assets: Cash, federal funds sold and short-term investments $154,895 $33 0.09 $113,344 $349 1.24 $41,551 ($316) (1.15) Mortgage loans held for sale 61,408 441 2.91 31,087 285 3.69 30,321 156 (0.78) Taxable debt securities 915,864 3,242 1.44 905,293 5,833 2.59 10,571 (2,591) (1.15) FHLB stock 28,867 133 1.87 51,962 640 4.95 (23,095) (507) (3.08) Commercial real estate 1,625,859 11,359 2.83 1,582,956 16,097 4.09 42,903 (4,738) (1.26) Commercial & industrial 839,740 7,866 3.80 607,499 6,556 4.34 232,241 1,310 (0.54) Total commercial 2,465,599 19,225 3.16 2,190,455 22,653 4.16 275,144 (3,428) (1.00) Residential real estate 1,454,323 12,817 3.57 1,469,282 14,283 3.91 (14,959) (1,466) (0.34) Home equity 257,733 2,122 3.34 285,832 3,101 4.36 (28,099) (979) (1.02) Other 20,106 241 4.86 19,855 249 5.04 251 (8) (0.18) Total consumer 277,839 2,363 3.45 305,687 3,350 4.41 (27,848) (987) (0.96) Total loans 4,197,761 34,405 3.32 3,965,424 40,286 4.09 232,337 (5,881) (0.77) Total interest-earning assets 5,358,795 38,254 2.90 5,067,110 47,393 3.76 291,685 (9,139) (0.86) Noninterest-earning assets 353,136 327,838 25,298 Total assets $5,711,931 $5,394,948 $316,983 Liabilities and Shareholders’ Equity: Interest-bearing demand deposits $183,989 $96 0.21 $155,416 $500 1.29 $28,573 ($404) (1.08) NOW accounts 697,964 102 0.06 505,282 69 0.05 192,682 33 0.01 Money market accounts 909,890 714 0.32 795,268 2,092 1.06 114,622 (1,378) (0.74) Savings accounts 489,851 69 0.06 374,374 62 0.07 115,477 7 (0.01) Time deposits (in-market) 703,580 2,238 1.29 780,355 4,049 2.09 (76,775) (1,811) (0.80) Total interest-bearing in-market deposits 2,985,274 3,219 0.44 2,610,695 6,772 1.04 374,579 (3,553) (0.60) Wholesale brokered time deposits 579,149 444 0.31 391,822 1,764 1.81 187,327 (1,320) (1.50) Total interest-bearing deposits 3,564,423 3,663 0.42 3,002,517 8,536 1.14 561,906 (4,873) (0.72) FHLB advances 542,684 1,380 1.03 1,123,754 5,765 2.06 (581,070) (4,385) (1.03) Junior subordinated debentures 22,681 94 1.68 22,681 213 3.78 — (119) (2.10) Total interest-bearing liabilities 4,129,788 5,137 0.50 4,148,952 14,514 1.41 (19,164) (9,377) (0.91) Noninterest-bearing demand deposits 890,628 610,872 279,756 Other liabilities 159,244 132,000 27,244 Shareholders’ equity 532,271 503,124 29,147 Total liabilities and shareholders’ equity $5,711,931 $5,394,948 $316,983 Net interest income (FTE) $33,117 $32,879 $238 Interest rate spread 2.40 2.35 0.05 Net interest margin 2.51 2.61 (0.10) -45- Management's Discussion and Analysis Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency: (Dollars in thousands) Three months ended March 31, 2021 2020 Change Commercial loans $246 $278 ($32) Net Interest Income Net interest income continues to be the primary source of our operating income. Net interest income for the three months ended March 31, 2021 totaled $32.9 million, compared to $32.6 million for the same period in 2020. 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 a fully taxable equivalent (“FTE”) basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities. The analysis of net interest income, net interest margin and the yield on loans may be impacted by the periodic recognition of prepayment penalty fee income associated with loan payoffs. Prepayment penalty fee income associated with loan payoffs for both the three months ended March 31, 2021 and 2020 was immaterial. The analysis of net interest income, net interest margin and the yield on loans is also impacted by changes in the level of net amortization of premiums and discounts on securities and loans, which is included in interest income. As market interest rates decline, the receipt of payments on mortgage-backed securities and loan prepayments generally increase. This results in accelerated levels of amortization reducing net interest income and may also result in the proceeds having to be reinvested at a lower rate than the mortgage-backed security or loan being prepaid. In addition, as lower yielding PPP loans are forgiven by the SBA, unamortized net fee balances are accelerated and amortized into 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 $882 thousand for the three months ended March 31, 2021. This compares to net amortization or a net reduction of $1.5 million for the same period in 2020. Net interest income in 2021 included approximately $1.2 million of accelerated amortization of net fees associated with $66 million of PPP loans that were forgiven by the SBA in the three months ended March 31, 2021. FTE net interest income for the three months ended March 31, 2021 amounted to $33.1 million, up by $238 thousand, or 1%, from the same period in 2020. Growth in average interest-earning assets and a decline in average interest-bearing liability balances, contributed approximately $4.1 million of net interest income for the three months ended March 31, 2021. This was largely offset by lower asset yields out-pacing declines in funding costs, which reduced net interest income by $3.8 million. The net interest margin was 2.51% for the three months ended March 31, 2021, down by 10 basis points from 2.61% for the same period a year ago. Compression in net interest margin reflected the downward repricing of assets, which occurred at a faster pace than the downward repricing of liabilities. Total average securities for the three months ended March 31, 2021 increased by $10.6 million, or 1%, from the average balances for the same period a year earlier. The FTE rate of return on the securities portfolio for the three months ended March 31, 2021 was 1.44% compared to 2.59% for the same period in 2020, reflecting purchases of relatively lower yielding debt securities and lower market interest rates. Total average loan balances for the three months ended March 31, 2021 increased by $232.3 million, or 6%, from the average loan balances for the comparable 2020 period. This reflected growth in average commercial loan balances concentrated in lower yielding PPP loans. The yield on total loans for the three months ended March 31, 2021 was 3.32% compared to 4.09% for the same period in 2020. Yields on LIBOR-based and prime-based loans reflected lower market interest rates. The average balance of FHLB advances for the three months ended March 31, 2021 decreased by $581.1 million, or 52%, compared to the average balances for the same period in 2020. The average rate paid on such advances for the three months ended March 31, 2021 was 1.03%, down from 2.06% for the same period in 2020, due to lower rates on short-term advances. -46- Management's Discussion and Analysis Included in total average interest-bearing deposits were of out-of-market wholesale brokered time deposits, which increased by $187.3 million, or 48%, from the same period in 2020. The average rate paid on wholesale brokered time deposits for the three months ended March 31, 2021 was 0.31%, down by 150 basis points from 1.81% for the same period in 2020, reflecting lower market interest rates. Average in-market interest-bearing deposits, which excludes wholesale brokered time deposits, for the three months ended March 31, 2021 increased by $374.6 million, or 14%, from the average balances for the same period in 2020. The increases largely reflected growth in lower-cost deposit categories, partially offset by maturities of higher-cost promotional time deposits. The average rate paid on in-market interest-bearing deposits for the three months ended March 31, 2021 was 0.44%, down by 60 basis points from 1.04% for the same period in 2020, reflecting downward repricing of interest-bearing in-market deposits due to lower market interest rates. The average balance of noninterest-bearing demand deposits for the three months ended March 31, 2021 increased by $279.8 million, or 46%, from the average balance for the same period in 2020. See additional disclosure under the caption “Sources of Funds.” Volume / Rate Analysis - Interest Income and Expense (FTE Basis) The following table presents certain information on a FTE basis regarding changes in our interest income and interest expense for the period indicated. The net change attributable to both volume and rate has been allocated proportionately. (Dollars in thousands) Change Due to Three Months Ended March 31, 2021 vs. 2020 Volume Rate Net Change Interest on Interest-Earning Assets: Cash, federal funds sold and other short-term investments $94 ($410) ($316) Mortgage loans held for sale 229 (73) 156 Taxable debt securities 67 (2,658) (2,591) FHLB stock (211) (296) (507) Commercial real estate 427 (5,165) (4,738) Commercial & industrial 2,258 (948) 1,310 Total commercial 2,685 (6,113) (3,428) Residential real estate (143) (1,323) (1,466) Home equity (284) (695) (979) Other 3 (11) (8) Total consumer (281) (706) (987) Total loans 2,261 (8,142) (5,881) Total interest income 2,440 (11,579) (9,139) Interest on Interest-Bearing Liabilities: Interest-bearing demand deposits 78 (482) (404) NOW accounts 22 11 33 Money market accounts 266 (1,644) (1,378) Savings accounts 18 (11) 7 Time deposits (in-market) (366) (1,445) (1,811) Total interest-bearing in-market deposits 18 (3,571) (3,553) Wholesale brokered time deposits 587 (1,907) (1,320) Total interest-bearing deposits 605 (5,478) (4,873) FHLB advances (2,220) (2,165) (4,385) Junior subordinated debentures — (119) (119) Total interest expense (1,615) (7,762) (9,377) Net interest income (FTE) $4,055 ($3,817) $238 -47- Management's Discussion and Analysis 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 best estimate of expected lifetime credit losses as of the reporting date and includes consideration of current forecasted economic conditions. Estimating an appropriate level of ACL necessarily involves a high degree of judgment. As a result of improvement in forecasted economic conditions and continued stable asset quality metrics, a negative provision for credit losses (or a benefit) of $2.0 million was recognized in earnings in the three months ended March 31, 2021. This compares to a positive provision for credit losses (or a charge) of $7.0 million for the same period in 2020. The higher credit provisioning in 2020 was attributable to the negative impact of the emergence of the COVID-19 pandemic on economic conditions. Total net charge-offs were $18 thousand for the three months ended March 31, 2021, compared to $623 thousand for the same period in 2020. The ACL on loans was $42.1 million, or 1.00% of total loans, at March 31, 2021, compared to an ACL on loans of $44.1 million, or 1.05% of total loans, at December 31, 2020. 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) Change Three months ended March 31, 2021 2020 $ % Noninterest income: Wealth management revenues $9,895 $8,689 $1,206 14 % Mortgage banking revenues 11,927 6,096 5,831 96 Card interchange fees 1,133 947 186 20 Service charges on deposit accounts 609 860 (251) (29) Loan related derivative income 467 2,455 (1,988) (81) Income from bank-owned life insurance 556 564 (8) (1) Other income 1,387 316 1,071 339 Total noninterest income $25,974 $19,927 $6,047 30 % Noninterest Income Analysis Revenue from wealth management services represented 38% of total noninterest income for the three months ended March 31, 2021, compared to 44% for the same period in 2020. A substantial portion of wealth management revenues is dependent on the value of wealth management assets under administration 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) Change Three months ended March 31, 2021 2020 $ % Wealth management revenues: Asset-based revenues $9,583 $8,355 $1,228 15 % Transaction-based revenues 312 334 (22) (7) Total wealth management revenues $9,895 $8,689 $1,206 14 % -48- Management's Discussion and Analysis Wealth management revenues for the three months ended March 31, 2021 increased by $1.2 million, or 14%, from the comparable period in 2020, reflecting growth in asset-based revenues. The increase in asset-based revenues was directionally consistent with an increase in the average balances of assets under administration (“AUA”). The following table presents the changes in wealth management AUA: (Dollars in thousands) Three months ended March 31, 2021 2020 Wealth management assets under administration: Balance at the beginning of period $6,866,737 $6,235,801 Net investment appreciation (depreciation) & income 208,953 (772,735) Net client asset outflows (26,464) (125,333) Balance at the end of period $7,049,226 $5,337,733 Wealth management AUA amounted to $7.0 billion at March 31, 2021, up by $1.7 billion, or 32%, from the balance at March 31, 2020, primarily due to net investment appreciation. The average balance of AUA for the three months ended March 31, 2021 increased by approximately 17% from the average balance for the same period in 2020. Mortgage banking revenues represented 46% of total noninterest income for the three months ended March 31, 2021, compared to 31% for the same period in 2020. 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: (Dollars in thousands) Change Three months ended March 31, 2021 2020 $ % Mortgage banking revenues: Realized gains on loan sales, net (1) $13,745 $3,688 $10,057 273 % Unrealized (losses) gains, net (2) (1,888) 2,325 (4,213) (181) Loan servicing fee income, net (3) 70 83 (13) (16) Total mortgage banking revenues $11,927 $6,096 $5,831 96 % Loans sold to the secondary market (4) $292,019 $162,191 $129,828 80 % (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 adjustments 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 months ended March 31, 2021, mortgage banking revenues were up by $5.8 million, or 96%, compared to the same period in 2020. The increase was primarily the result of higher mortgage origination, refinancing and sales activity in response to a low interest rate environment. For the three months ended March 31, 2021, mortgage loans sold to the secondary market totaled $292.0 million, compared to $162.2 million for the same period in 2020. Also included in mortgage banking revenues were changes in the fair value of mortgage loans held for sale and mortgage loan commitments. Service charges on deposit accounts for the three months ended March 31, 2021 decreased by $251 thousand, or 29%, from the same period in 2020, primarily due to lower overdraft activity and related fee income. Loan related derivative income for the three months ended March 31, 2021 decreased by $2.0 million, or 81%, from the same period in 2020, reflecting lower volume of commercial borrower interest rate swap transactions. Other income for the three months ended March 31, 2021 increased by $1.1 million from the same period in 2020. Included in other income in the first quarter of 2021 was income of $1.0 million associated with a litigation settlement. -49- Management's Discussion and Analysis Noninterest Expense The following table presents noninterest expense comparisons: (Dollars in thousands) Change Three months ended March 31, 2021 2020 $ % Noninterest expense: Salaries and employee benefits $21,527 $19,468 $2,059 11 % Outsourced services 3,200 3,000 200 7 Net occupancy 2,128 2,019 109 5 Equipment 994 977 17 2 Legal, audit and professional fees 597 822 (225) (27) FDIC deposit insurance costs 345 422 (77) (18) Advertising and promotion 222 259 (37) (14) Amortization of intangibles 226 230 (4) (2) Debt prepayment penalties 3,335 — 3,335 100 Other 2,139 3,256 (1,117) (34) Total noninterest expense $34,713 $30,453 $4,260 14 % Noninterest Expense Analysis Salaries and employee benefits expense for the three months ended March 31, 2021 increased by $2.1 million, or 11%, compared to the same period in 2020, largely reflecting volume-related increases in mortgage banking commissions expense and annual merit increases, partially offset by higher deferred labor costs (a contra expense) largely associated with PPP loan originations. Legal, audit and professional fees for the three months ended March 31, 2021 decreased by $225 thousand, or 27%, compared to the same period in 2020, reflecting a decline in legal expenses. Debt prepayment penalty expense for the three months ended March 31, 2021 totaled $3.3 million and resulted from the prepayment of $26.8 million of higher-yielding FHLB advances. There were no debt prepayments in the comparable period in 2020. Other expenses for the three months ended March 31, 2021 decreased by $1.1 million, or 34%, compared to the same period in 2020. Included in other expenses in the first quarter of 2020 was a charge for $800 thousand representing the establishment of contingency loss reserve associated with counterfeit checks drawn on a commercial customer’s account. This contingency matter was resolved in the second quarter of 2020 and resulted in a partial reversal, or a benefit, of $170 thousand being recognized as a reduction to other expenses in the second quarter of 2020. Income Taxes The following table presents the Corporation’s income tax provision and applicable tax rates for the periods indicated: (Dollars in thousands) Three months ended March 31, 2021 2020 Income tax expense $5,661 $3,139 Effective income tax rate 21.7 % 20.9 % The effective income tax rates for the three months ended March 31, 2021 and 2020 differed from the federal rate of 21%, primarily due to state income tax expense, partially offset by the benefits of tax-exempt income and income from BOLI. The increase in the effective tax rate for the three months ended March 31, 2021 compared to the same period in 2020 largely reflected higher state income tax expense and a decrease in the proportion of tax-exempt income to pre-tax income. -50- Management's Discussion and Analysis Segment Reporting The Corporation manages its operations through two business segments, Commercial Banking and Wealth Management Services. Activity not related to the segments, including activity related to the investment securities portfolio, wholesale funding matters and administrative units are considered Corporate. The Corporate unit also includes income from BOLI and the residual impact of methodology allocations such as funds transfer pricing offsets. Methodologies used to allocate income and expenses to business lines are periodically reviewed and revised. See Note 15 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) Change Three months ended March 31, 2021 2020 $ % Net interest income $34,520 $29,009 $5,511 19 % Provision for credit losses (2,000) 7,036 (9,036) (128) Net interest income after provision for credit losses 36,520 21,973 14,547 66 Noninterest income 14,515 10,665 3,850 36 Noninterest expense 20,658 19,461 1,197 6 Income before income taxes 30,377 13,177 17,200 131 Income tax expense 6,592 2,764 3,828 138 Net income $23,785 $10,413 $13,372 128 % Net interest income for the Commercial Banking segment for the three months ended March 31, 2021, increased by $5.5 million, or 19%, from the same period in 2020, reflecting growth in loans partially offset by lower yields on loans due to lower market interest rates. For the three months ended March 31, 2021, a negative provision for credit losses (or a benefit) of $2.0 million was charged to earnings, compared to a positive provision for credit losses (or a charge) of $7.0 million for the same period in 2020. The year-over-year reduction in credit loss provisioning reflected improvement in forecasted economic conditions and continued stable asset quality metrics. Noninterest income derived from the Commercial Banking segment for the three months ended March 31, 2021 was up by $3.9 million, or 36%, from the comparable period in 2020 reflecting higher mortgage banking revenues, partially offset by lower loan related derivative income and lower fee income for service charges on deposit accounts. See additional discussion regarding mortgage banking revenues and loan related derivative income under the caption “Noninterest Income” above. Commercial Banking noninterest expenses for the three months ended March 31, 2021 were up by $1.2 million, or 6%, from the same period in 2020, largely reflecting increases in salaries and employee benefits. 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) Change Three months ended March 31, 2021 2020 $ % Net interest expense ($23) ($67) $44 66 % Noninterest income 10,895 8,689 2,206 25 Noninterest expense 6,737 7,200 (463) (6) Income before income taxes 4,135 1,422 2,713 191 Income tax expense 954 356 598 168 Net income $3,181 $1,066 $2,115 198 % -51- Management's Discussion and Analysis For the three months ended March 31, 2021, noninterest income derived from the Wealth Management Services segment increased by $2.2 million, or 25%, compared to the same period in 2020, reflecting growth in asset-based revenues and income of $1.0 million associated with a litigation settlement. See further discussion under the caption “Noninterest Income” above. For the three months ended March 31, 2021, noninterest expenses for the Wealth Management Services segment decreased by $463 thousand, or 6%, from the same period in 2020. This included decreases in legal and other expenses partially offset by an increase and salaries and employee benefits expense. See further discussion under the caption “Noninterest Expense” above. Corporate The following table presents a summarized statement of operations for the Corporate unit: (Dollars in thousands) Change Three months ended March 31, 2021 2020 $ % Net interest (expense) income ($1,626) $3,660 ($5,286) (144 %) Noninterest income 564 573 (9) (2) Noninterest expense 7,318 3,792 3,526 93 (Loss) income before income taxes (8,380) 441 (8,821) (2,000) Income tax (benefit) expense (1,885) 19 (1,904) (10,021) Net (loss) income ($6,495) $422 ($6,917) (1,639 %) Net interest income for the Corporate unit for the three months ended March 31, 2021 was down by $5.3 million, or 144%, compared to the same period in 2020. Lower interest income on securities resulting from lower yields was partially offset by lower wholesale funding costs. The decline in net interest income for the Corporate unit reflected unfavorable net funds transfer pricing allocations with the Commercial Banking segment as the downward repricing of assets occurred at a faster pace than the repricing of liabilities. For the three months ended March 31, 2021, noninterest expenses for the Corporate unit increased by $3.5 million, or 93%, from the same period in 2020, due to debt prepayment penalty expense of $3.3 million that was recognized in the first quarter of 2021. See further discussion under the caption “Noninterest Expense” above. Financial Condition Summary The following table presents selected financial condition data: (Dollars in thousands) Change March 31, 2021 December 31, 2020 $ % Cash and due from banks $166,960 $194,143 ($27,183) (14 %) Total securities 948,094 894,571 53,523 6 Total loans 4,194,666 4,195,990 (1,324) — Allowance for credit losses on loans 42,137 44,106 (1,969) (4) Total assets 5,719,389 5,713,169 6,220 — Total deposits 4,549,142 4,378,353 170,789 4 FHLB advances 466,912 593,859 (126,947) (21) Total shareholders’ equity 533,599 534,195 (596) — Total assets amounted to $5.7 billion at March 31, 2021, up by $6.2 million, from the end of 2020. -52- Management's Discussion and Analysis The securities portfolio increased by $53.5 million due to purchases of debt securities and the balance of cash and due from banks declined by $27.2 million reflecting lower levels of cash collateral pledged to derivative counterparties. See Note 10 to the Unaudited Consolidated Financial Statements for additional disclosure regarding derivative financial instruments. Total loans declined modestly by $1.3 million, as loan originations were offset by payoffs and pay-downs. The ACL on loans decreased by $2.0 million from the end of 2020, reflecting improvement in forecasted economic conditions and continued stable asset quality metrics. Total deposits increased by $170.8 million, or 4%, with an increase in in-market deposits partially offset by a decrease in wholesale brokered time deposits. FHLB advances decreased by $126.9 million, or 21%, from December 31, 2020. Shareholders’ equity declined modesty by $596 thousand, reflecting a decrease in accumulated other comprehensive income due to a temporary decline in the fair value of available for sale debt securities. Securities I nvestment security activity is monitored by the Investment Committee, the members of which also sit on the Asset/Liability Committee (“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 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 have securities designated as held to maturity and does not maintain a portfolio of trading securities. Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. 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 March 31, 2021 and December 31, 2020, 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 4 and 11 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities. -53- Management's Discussion and Analysis Securities Portfolio The carrying amounts of securities held are as follows: (Dollars in thousands) March 31, 2021 December 31, 2020 Amount % Amount % Available for Sale Debt Securities: Obligations of U.S. government-sponsored enterprises $181,951 19 % $131,669 15 % Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises 742,987 79 740,305 83 Individual name issuer trust preferred debt securities 12,908 1 12,669 1 Corporate bonds 10,248 1 9,928 1 Total available for sale debt securities $948,094 100 % $894,571 100 % The securities portfolio stood at $948.1 million as of March 31, 2021, or 17% of total assets, compared to $894.6 million as of December 31, 2020, or 16% of total assets. 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 $53.5 million, or 6%, from the end of 2020, reflecting purchases of debt securities totaling $208.0 million, with a weighted average yield of 1.44%. These purchases were partially offset by routine pay-downs on mortgage-backed securities and calls of debt securities, as well as a temporary decline in the fair value of available for sale securities. As of March 31, 2021, the carrying amount of available for sale debt securities included net unrealized losses of $4.5 million, compared to a net unrealized gains of $13.0 million as of December 31, 2020. The decline in fair value of available for sale debt securities from the end of 2020 was primarily concentrated in obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, and attributable to relative changes in interest rates since the time of purchase. See Note 4 to the Unaudited Consolidated Financial Statements for additional information. Loans Total loans amounted to $4.2 billion at March 31, 2021, down by $1.3 million, from the end of 2020. This included a net decrease of $9.8 million in the residential real estate portfolio, reflecting continued elevated payoff and refinancing activity, and a net increase of $8.7 million in the commercial loan portfolio. Growth in commercial loans was largely due to first quarter 2021 originations of PPP loans within the commercial and industrial portfolio, which were partially offset by payoffs and pay-downs, including PPP loans that were forgiven by the SBA. -54- Management's Discussion and Analysis The following is a summary of loans: (Dollars in thousands) March 31, 2021 December 31, 2020 Amount % Amount % Commercial: Commercial real estate (1) $1,618,540 39 % $1,633,024 39 % Commercial & industrial (2) 840,585 20 817,408 19 Total commercial 2,459,125 59 2,450,432 58 Residential Real Estate: Residential real estate (3) 1,457,490 35 1,467,312 35 Consumer: Home equity 256,799 6 259,185 6 Other (4) 21,252 — 19,061 1 Total consumer 278,051 6 278,246 7 Total loans $4,194,666 100 % $4,195,990 100 % (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. C&I also includes PPP loans. (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. Since the beginning of the COVID-19 pandemic and through March 31, 2021, Washington Trust has processed loan payment deferral modifications, or "deferments", on 652 loans totaling $727 million. The majority of these deferments qualified as eligible loan modifications under Section 4013 of the CARES Act, as amended and therefore, were not required to be classified as TDRs and were not reported as past due. As of March 31, 2021, we had active deferments on 88 loans totaling $191.4 million, or 5% of total loans excluding PPP loans. As of May 3, 2021, we have active deferments on 44 loans totaling $121.5 million, or 3% of total loans excluding PPP loans at March 31, 2021. Management continues to actively monitor the deferments and loan portfolios in certain industry segments that it considers “at risk” of significant impact. Deferment extensions have been prudently underwritten and have resulted in loan risk rating downgrades when warranted. Management considers deferments when estimating the allowance for credit losses. Loss exposure within these industries is mitigated by a number of factors such as collateral values, LTV ratios, and other key indicators, however, some degree of credit loss has been incorporated into the ACL on loans. Commercial Loans The commercial loan portfolio represented 59% of total loans at March 31, 2021. 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 $409.9 million and $408.8 million, respectively, at March 31, 2021 and December 31, 2020. Our participation in commercial loans originated by other banks also includes shared national credits. Shared national credits are defined as participations in loans or loan commitments of at least $100.0 million that are shared by three or more banks. Commercial loans fall into two major categories, commercial real estate and commercial and industrial loans. Commercial real estate 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. Commercial real estate loans also include construction loans made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings. Commercial and industrial loans primarily provide working capital, equipment financing and financing for other business-related purposes. Commercial and industrial loans are frequently collateralized by equipment, inventory, accounts receivable, and/or general business assets. A portion of the -55- Management's Discussion and Analysis Bank’s commercial and industrial loans is also collateralized by real estate. Commercial and industrial loans also include PPP loans that are fully guaranteed by the U.S. government, 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”) CRE loans totaled $1.6 billion at March 31, 2021, down by $14.5 million, or 1%, from the balance at December 31, 2020. Included in CRE loans were construction and development loans of $123.6 million and $111.2 million, respectively, as of March 31, 2021 and December 31, 2020. For the three months ended March 31, 2021, CRE loan originations and construction advances were offset by payoffs and pay-downs of approximately $60 million. The following table presents a geographic summary of CRE loans by property location: (Dollars in thousands) March 31, 2021 December 31, 2020 Outstanding Balance % of Total Outstanding Balance % of Total Connecticut $641,757 40 % $649,919 40 % Massachusetts 456,379 28 468,947 29 Rhode Island 435,779 27 431,133 26 Subtotal 1,533,915 95 1,549,999 95 All other states 84,625 5 83,025 5 Total $1,618,540 100 % $1,633,024 100 % The following table presents a summary of CRE loans by property type segmentation: (Dollars in thousands) March 31, 2021 December 31, 2020 Count Outstanding Balance % of Total Count Outstanding Balance % of Total CRE Portfolio Segmentation: Multi-family dwelling 135 $506,813 31 % 137 $524,874 32 % Retail 131 345,679 21 136 339,569 21 Office 74 292,087 18 73 290,756 18 Hospitality 39 168,094 10 40 157,720 10 Healthcare 15 116,779 7 15 109,321 7 Industrial and warehouse 23 77,537 5 28 97,055 6 Commercial mixed use 20 41,702 3 22 42,405 3 Other 37 69,849 5 38 71,324 3 Total CRE loans 474 $1,618,540 100 % 489 $1,633,024 100 % Average CRE loan size $3,415 $3,340 Largest individual CRE loan outstanding $32,200 $32,200 -56- Management's Discussion and Analysis The following table presents a summary of CRE loan deferments by industry segmentation: (Dollars in thousands) May 3, 2021 March 31, 2021 December 31, 2020 Count Balance % of Outstanding Balance (1) Count Balance % of Outstanding Balance (1) Count Balance % of Outstanding Balance (2) CRE Deferments by Segment: Hospitality 5 $27,280 16 % 16 $69,406 41 % 20 $83,073 53 % Retail 3 20,600 6 3 20,600 6 5 39,781 12 Healthcare 1 18,425 16 1 18,345 16 2 22,305 20 Office 1 1,833 1 1 1,833 1 2 2,457 1 Commercial mixed use — — — — — — 1 637 2 Multi-family dwelling — — — — — — 1 364 — Other 7 27,750 40 7 27,749 40 7 27,785 39 Total CRE deferments 17 $95,888 6 % 28 $137,933 9 % 38 $176,402 11 % (1) Percent of respective outstanding portfolio segment balance as of March 31, 2021. (2) Percent of respective outstanding portfolio segment balance as of December 31, 2020. As of May 3, 2021, we have active deferrals on 17 CRE loans totaling $95.9 million, which represented 6% of the total CRE portfolio at March 31, 2021. The hospitality segment consisted of 39 loans with balances totaling $168.1 million at March 31, 2021, representing 10% of the total CRE portfolio. We generally underwrite this segment at an LTV of 65% or less. Our hospitality properties are largely limited service properties with no restaurants and limited meeting space. This segment also includes leisure travel properties that are located on the New England coastline. At May 3, 2021, we have active deferrals on 5 hospitality loans totaling $27.3 million, which represented 16% of this segment’s balance at March 31, 2021. The retail segment consisted of 131 loans with balances totaling $345.7 million at March 31, 2021, representing 21% of the total CRE portfolio. Our retail properties generally have single tenant drugstores or strong anchor tenants, often national grocery store chains. At May 3, 2021, we have active deferrals on 3 retail loans totaling $20.6 million, which represented 6% of this segment’s balance at March 31, 2021. The healthcare segment consisted of 15 loans with balances totaling $116.8 million at March 31, 2021, representing 7% of the total CRE portfolio. This segment is composed of assisted living, nursing homes and continuing care retirement communities. At May 3, 2021, we have active deferrals on 1 healthcare loan totaling $18.4 million, which represented 16% of this segment’s balance at March 31, 2021. Commercial and Industrial Loans (“C&I”) C&I loans amounted to $840.6 million at March 31, 2021, up by $23.2 million, or 3%, from the balance at December 31, 2020. For the three months ended March 31, 2021, C&I loan originations were concentrated in PPP loan originations. Originations were partially offset by payoffs and pay-downs of $93 million, which included $66 million of PPP loans that were forgiven by the SBA. C&I line utilization increased modestly in the first quarter of 2021. As of March 31, 2021, there were 2,065 PPP loans with a carrying value of $228.6 million included in the C&I portfolio. The average PPP loan size was $111 thousand. Net unamortized loan origination fees on PPP loans amounted to $5.7 million at March 31, 2021. Shared national credit balances outstanding included in the C&I loan portfolio totaled $44.7 million at March 31, 2021. 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 March 31, 2021. -57- Management's Discussion and Analysis The following table presents a summary of C&I loan by industry segmentation: (Dollars in thousands) March 31, 2021 December 31, 2020 Count Outstanding Balance % of Total Count Outstanding Balance % of Total C&I Portfolio Segmentation: Healthcare and social assistance 299 $196,555 23 % 253 $200,217 24 % Manufacturing 161 89,118 11 146 88,802 11 Owner occupied and other real estate 277 76,704 9 268 74,309 9 Accommodation and food services 359 69,380 8 271 47,020 6 Educational services 65 67,694 8 53 64,969 8 Retail 201 57,128 7 192 63,895 8 Professional, scientific and technical 277 39,957 5 265 39,295 5 Finance and insurance 90 31,185 4 106 26,244 3 Entertainment and recreation 112 30,241 4 91 29,415 4 Information 36 29,005 3 32 28,394 3 Transportation and warehousing 46 23,727 3 42 24,061 3 Public administration 24 19,700 2 26 23,319 3 Other 919 110,191 13 772 107,468 13 Total C&I loans 2,866 $840,585 100 % 2,517 $817,408 100 % Average C&I loan size $293 $325 Largest individual C&I loan outstanding $19,305 $19,500 PPP loans were included in the C&I portfolio. The following table presents a summary of PPP loans by industry segmentation: March 31, 2021 December 31, 2020 Count Outstanding Balance % of Total Count Outstanding Balance % of Total PPP Loans By Industry: Accommodation and food services 299 $46,873 21 % 209 $23,678 12 % Healthcare and social assistance 224 44,902 20 173 47,354 24 Manufacturing 100 22,564 10 89 23,321 12 Professional, scientific and technical 235 21,444 9 220 20,031 10 Retail 143 12,209 5 134 12,107 6 Educational services 43 11,243 5 32 9,681 5 Owner occupied and other real estate 123 9,658 4 115 9,241 5 Entertainment and recreation 85 4,797 2 61 3,386 2 Information 24 3,325 1 20 2,478 1 Transportation and warehousing 23 2,088 1 21 2,059 1 Finance and insurance 37 1,102 — 55 2,000 1 Public administration 5 421 — 4 483 — Other 724 47,957 22 573 43,961 21 Total PPP loans (included in the C&I loan portfolio) 2,065 $228,583 100 % 1,706 $199,780 100 % -58- Management's Discussion and Analysis The following table presents a summary of C&I loan deferments by industry segmentation: (Dollars in thousands) May 3, 2021 March 31, 2021 December 31, 2020 Count Balance % of Outstanding Balance, excl PPP loans (1) Count Balance % of Outstanding Balance, excl PPP loans (1) Count Balance % of Outstanding Balance, excl PPP loans (2) C&I Deferments by Segment: Healthcare and social assistance 3 $12,990 9 % 5 $19,855 13 % 5 $19,620 13 % Accommodation and food services 1 304 1 1 304 1 2 2,889 12 Transportation and warehousing — — — 3 814 4 4 1,120 5 Entertainment and recreation — — — 2 424 2 3 560 2 Owner occupied and other real estate — — — 1 326 1 1 326 1 Manufacturing — — — — — — 2 947 1 Other — — — 5 7,693 12 4 7,673 12 Total C&I deferments 4 $13,294 2 % 17 $29,416 5 % 21 $33,135 5 % (1) Percent of respective outstanding portfolio segment balance, excluding PPP loans, as of March 31, 2021. (2) Percent of respective outstanding portfolio segment balance, excluding PPP loans, as of December 31, 2020. As of May 3, 2021, we have active deferrals on 4 C&I loans totaling $13.3 million, which represented 2% of the total C&I portfolio (excluding PPP loans) at March 31, 2021. Healthcare and social assistance totaled $196.6 million as of March 31, 2021 and is our largest single C&I industry segment, representing 23% of the total C&I portfolio. This segment includes specialty medical practices, elder services and community and mental health centers. At May 3, 2021, we have active deferrals on 3 healthcare and social assistance loans of $13.0 million, which represented 9% of this industry segment’s balances (excluding PPP loans) as of March 31, 2021. Residential Real Estate Loans The residential real estate loan portfolio represented 35% of total loans at March 31, 2021. 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) Three months ended March 31, 2021 2020 Amount % of Total Amount % of Total Originations for retention in portfolio (1) $131,791 30 % $108,498 37 % Originations for sale to the secondary market (2) 309,325 70 183,222 63 Total $441,116 100 % $291,720 100 % (1) Includes the full commitment amount of homeowner construction loans. (2) Includes brokered loans (loans originated for others). -59- Management's Discussion and Analysis The table below presents residential real estate loan sales activity: (Dollars in thousands) Three months ended March 31, 2021 2020 Amount % of Total Amount % of Total Loans sold with servicing rights retained $226,645 78 % $44,498 27 % Loans sold with servicing rights released (1) 65,374 22 117,693 73 Total $292,019 100 % $162,191 100 % (1) Includes brokered loans (loans originated for others). Residential real estate loan origination, refinancing and sales activity increased year-over-year in response to declines in market interest rates. 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 $8.9 million and $7.4 million, respectively, as of March 31, 2021 and December 31, 2020. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $1.4 billion and $1.2 billion, respectively, as of March 31, 2021 and December 31, 2020. Residential real estate loans held in portfolio amounted to $1.5 billion at March 31, 2021, down by $9.8 million, or 1%, from the balance at December 31, 2020, reflecting continued elevated payoff and refinancing activity. The following is a geographic summary of residential real estate mortgages by property location: (Dollars in thousands) March 31, 2021 December 31, 2020 Amount % of Total Amount % of Total Massachusetts $985,925 68 % $994,800 68 % Rhode Island 332,846 23 331,713 23 Connecticut 117,068 8 122,102 8 Subtotal 1,435,839 99 1,448,615 99 All other states 21,651 1 18,697 1 Total (1) $1,457,490 100 % $1,467,312 100 % (1) Includes residential mortgage loans purchased from and serviced by other financial institutions totaling $114.0 million and $131.8 million, respectively, as of March 31, 2021 and December 31, 2020. As of May 3, 2021, we have active deferrals on 19 residential real estate loans totaling $11.9 million, which represented 1% of the total residential real estate portfolio balance as of March 31, 2021. The average size of residential real estate loans with active deferrals as of May 3, 2021 was approximately $624 thousand and these loans have an estimated LTV ratio of 53%. Consumer Loans Consumer loans include home equity loans and lines of credit and personal installment loans. The consumer loan portfolio totaled $278.1 million at March 31, 2021, down by $195 thousand from December 31, 2020. Home equity lines of credit and home equity loans represented 92% of the total consumer portfolio at March 31, 2021. The Bank estimates that approximately 60% of the combined home equity lines of credit and home equity loan balances are first lien positions or subordinate to other Washington Trust mortgages. Purchased consumer loans, consisting of loans to individuals secured by general aviation aircraft, amounted to $10.6 million and $10.0 million, respectively, at March 31, 2021 and December 31, 2020. As of May 3, 2021, we have active deferrals on 4 consumer loans totaling $486 thousand, which represented 0.2% of the total consumer portfolio balance as of March 31, 2021. -60- Management's Discussion and Analysis Asset Quality Nonperforming Assets Nonperforming assets include nonaccrual loans and property acquired through foreclosure or repossession. The following table presents nonperforming assets and additional asset quality data: (Dollars in thousands) Mar 31, 2021 Dec 31, 2020 Commercial: Commercial real estate $— $— Commercial & industrial — — Total commercial — — Residential Real Estate: Residential real estate 11,748 11,981 Consumer: Home equity 1,147 1,128 Other 88 88 Total consumer 1,235 1,216 Total nonaccrual loans 12,983 13,197 Property acquired through foreclosure or repossession, net — — Total nonperforming assets $12,983 $13,197 Nonperforming assets to total assets 0.23 % 0.23 % Nonperforming loans to total loans 0.31 % 0.31 % Total past due loans to total loans 0.26 % 0.30 % Accruing loans 90 days or more past due $— $— Nonaccrual Loans During the three months ended March 31, 2021, 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) For the periods ended March 31, 2021 2020 Balance at beginning of period $13,197 $17,408 Additions to nonaccrual status 734 1,729 Loans returned to accruing status (3) (393) Loans charged-off (64) (635) Loans transferred to other real estate owned — (28) Payments, payoffs and other changes (881) (163) Balance at end of period $12,983 $17,918 -61- Management's Discussion and Analysis The following table presents additional detail on nonaccrual loans: (Dollars in thousands) March 31, 2021 December 31, 2020 Days Past Due Days Past Due Over 90 Under 90 Total % (1) Over 90 Under 90 Total % (1) Commercial: Commercial real estate $— $— $— — % $— $— $— — % Commercial & industrial — — — — — — — — Total commercial — — — — — — — — Residential Real Estate: Residential real estate 5,686 6,062 11,748 0.81 5,172 6,809 11,981 0.82 Consumer: Home equity 486 661 1,147 0.45 644 484 1,128 0.44 Other 88 — 88 0.41 88 — 88 0.46 Total consumer 574 661 1,235 0.44 732 484 1,216 0.44 Total nonaccrual loans $6,260 $6,723 $12,983 0.31 % $5,904 $7,293 $13,197 0.31 % (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 March 31, 2021. As of March 31, 2021, the composition of nonaccrual loans was 100% residential and consumer and 0% commercial, unchanged from the composition at December 31, 2020. Nonaccrual residential real estate mortgage loans amounted to $11.7 million at March 31, 2021, down by $233 thousand from the end of 2020. As of March 31, 2021, the balance of nonaccrual residential mortgage loans was predominately secured by properties in Massachusetts, Connecticut and Rhode Island. Troubled Debt Restructurings A loan that has been modified or renewed is considered to be a TDR when two conditions are met: (1) the borrower is experiencing financial difficulty and (2) concessions are made for the borrower’s benefit that would not otherwise be considered for a borrower or a transaction with similar credit risk characteristics. These concessions include modifications of the terms of the debt such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit the Corporation by increasing the ultimate probability of collection. TDRs are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans that are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term and full collection of principal and interest is in doubt. TDRs are reported as such for at least one year from the date of the restructuring. In years after the restructuring, a TDR is removed from this classification if the restructuring did not involve a below-market rate concession and the loan is performing in accordance with its modified contractual terms for a reasonable period of time. As of March 31, 2021, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured in a TDR. See Note 5 for disclosure regarding the Corporation’s election to account for eligible loan modifications under Section 4013 of the CARES Act, as amended. Loan modifications that did not qualify for the TDR accounting relief provided under the CARES Act were classified as TDRs. -62- Management's Discussion and Analysis The following table sets forth information on TDRs as of the dates indicated. The amounts below consist of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs. Accrued interest is not included in the carrying amounts set forth below. (Dollars in thousands) Mar 31, 2021 Dec 31, 2020 Accruing TDRs Commercial: Commercial real estate $958 $1,792 Commercial & industrial 6,761 6,814 Total commercial 7,719 8,606 Residential Real Estate: Residential real estate 3,844 3,932 Consumer: Home equity 781 788 Other 14 14 Total consumer 795 802 Accruing TDRs 12,358 13,340 Nonaccrual TDRs Residential Real Estate: Residential real estate 1,864 2,273 Consumer: Home equity 71 72 Other — — Total consumer 71 72 Nonaccrual TDRs 1,935 2,345 Total TDRs $14,293 $15,685 TDRs amounted to $14.3 million at March 31, 2021, down by $1.4 million from the end of 2020, reflecting payoffs. As of March 31, 2021, the composition of TDRs was 54% commercial and 46% residential and consumer, compared to 55% and 45%, respectively, as of December 31, 2020. The ACL included specific reserves for TDRs of $161 thousand at March 31, 2021, compared to $159 thousand at December 31, 2020. -63- Management's Discussion and Analysis Past Due Loans The following table presents past due loans by category: (Dollars in thousands) March 31, 2021 December 31, 2020 Amount % (1) Amount % (1) Commercial: Commercial real estate $— — % $265 0.02 % Commercial & industrial 1 — 3 — Total commercial 1 — 268 0.01 Residential Real Estate: Residential real estate 9,661 0.66 10,339 0.70 Consumer: Home equity 1,131 0.44 1,667 0.64 Other 119 0.56 118 0.62 Total consumer 1,250 0.45 1,785 0.64 Total past due loans $10,912 0.26 % $12,392 0.30 % (1) Percentage of past due loans to the total loans outstanding within the respective category. As of March 31, 2021, the composition of past due loans (loans past due 30 days or more) was 100% residential and consumer and 0% commercial, compared to 98% and 2%, respectively, at December 31, 2020. Total past due loans decreased by $1.5 million from the end of 2020. Total past due loans included $8.4 million of nonaccrual loans as of March 31, 2021, compared to $8.5 million as of December 31, 2020. All loans 90 days or more past due at March 31, 2021 and December 31, 2020 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 March 31, 2021 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 or TDRs presented above. They are assessed for loss exposure using the methods described in Note 5 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 restructured, or require increased allowance coverage and provision for loan losses. As of both March 31, 2021 and December 31, 2020, there were no potential problem loans. In addition and as a result of the COVID-19 pandemic, management continues to actively monitor loan deferments and loan portfolios in certain industry segments that it considers “at-risk” of significant impact. See additional disclosure under the caption “ Commercial Loans” within the Financial Condition section. Allowance for Credit Losses on Loans The ACL on loans is management’s estimate of expected credit losses over the expected life of the loans at the reporting date in accordance with GAAP. The ACL on loans is established through a provision charged to 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 -64- Management's Discussion and Analysis 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 TDRs or nonaccrual loans or when management believes it is warranted. The Corporation has continued to maintain appropriate professional standards regarding the professional qualifications of appraisers and has an internal review process to monitor the quality of appraisals. For residential 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) March 31, 2021 December 31, 2020 Loans Related Allowance Allowance / Loans Loans Related Allowance Allowance / Loans Individually analyzed loans $16,838 $343 2.04 % $18,252 $379 2.08 % Pooled (collectively evaluated) loans 4,177,828 41,794 1.00 4,177,738 43,727 1.05 Total $4,194,666 $42,137 1.00 % $4,195,990 $44,106 1.05 % 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 $42.1 million at March 31, 2021, down by $2.0 million from the balance at December 31, 2020. As a result of improvement in forecasted economic conditions and continued stable asset quality metrics, a negative provision for credit losses (or a benefit) of $2.0 million was recognized in earnings in the three months ended March 31, 2021. Net charge-offs amounted to $18 thousand for the three months ended March 31, 2021. The ACL on loans as a percentage of total loans, also known as the reserve coverage ratio, was 1.00% at March 31, 2021, compared to 1.05% at December 31, 2020. The ACL on loans is an estimate, and ultimate losses may vary from management’s estimate. 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. -65- Management's Discussion and Analysis (Dollars in thousands) March 31, 2021 December 31, 2020 Allocated ACL ACL to Loans Loans to Total Portfolio (1) Allocated ACL ACL to Loans Loans to Total Portfolio (1) Commercial: Commercial real estate $21,297 1.32 % 39 % $22,065 1.35 % 39 % Commercial & industrial 12,389 1.47 20 12,228 1.50 19 Total commercial 33,686 1.37 59 34,293 1.40 58 Residential Real Estate: Residential real estate 6,469 0.44 35 8,042 0.55 35 Consumer: Home equity 1,431 0.56 6 1,300 0.50 6 Other 551 2.59 — 471 2.47 1 Total consumer 1,982 0.71 6 1,771 0.64 7 Total allowance for credit losses on loans at end of period $42,137 1.00 % 100 % $44,106 1.05 % 100 % (1) Percentage of loans outstanding in respective category to total loans outstanding. Sources of Funds Our sources of funds include deposits, brokered time 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 Demand Deposit Marketplace program, Insured Cash Sweep program and the Certificate of Deposit Account Registry Service 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 out-of-market wholesale brokered deposits. The following table presents a summary of deposits: (Dollars in thousands) Change March 31, 2021 December 31, 2020 $ % Noninterest-bearing demand deposits $932,999 $832,287 $100,712 12 % Interest-bearing demand deposits 171,571 174,290 (2,719) (2) NOW accounts 745,376 698,706 46,670 7 Money market accounts 950,413 910,167 40,246 4 Savings accounts 511,759 466,507 45,252 10 Time deposits (in-market) 701,524 704,855 (3,331) — Total in-market deposits 4,013,642 3,786,812 226,830 6 Wholesale brokered time deposits 535,500 591,541 (56,041) (9) Total deposits $4,549,142 $4,378,353 $170,789 4 % Total deposits amounted to $4.5 billion at March 31, 2021, up by $170.8 million, or 4%, from December 31, 2020. This included a decrease of $56.0 million, or 9%, in out-of-market brokered time deposits. Excluding out-of-market brokered time -66- Management's Discussion and Analysis deposits, in-market deposits were up by $226.8 million, or 6%, from the balance at December 31, 2020. In-market deposit growth reflected a continuation of consumer behavior fostering excess liquidity across the banking industry, as well as temporary increases associated with PPP loan origination funds deposited to customer accounts at Washington Trust. 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 $466.9 million at March 31, 2021, down by $126.9 million, or 21%, from the balance at the end of 2020. See additional disclosure regarding the prepayment of certain FHLB advances and the recognition of debt prepayment penalties under the caption “Noninterest Expense” within the Results of Operations section. For additional information regarding FHLB advances see Note 8 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 three months ended March 31, 2021. 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 time deposits), cash flows from the Corporation’s securities portfolios and loan repayments. Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs, although management has no intention to do so at this time. 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 FRB 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 unused funding capacity by source as of the dates indicated: (Dollars in thousands) March 31, 2021 December 31, 2020 Additional Funding Capacity: Federal Home Loan Bank of Boston (1) $1,044,427 $969,735 Federal Reserve Bank of Boston (2) 20,746 20,678 Unencumbered investment securities 659,579 594,998 Total $1,724,752 $1,585,411 (1) As of March 31, 2021 and December 31, 2020, loans with a carrying value of $2.1 billion and $2.1 billion, respectively, and securities available for sale with carrying values of $94.4 million and $128.6 million, respectively, were pledged to the FHLB resulting in this additional borrowing capacity. (2) As of March 31, 2021 and December 31, 2020, loans with a carrying value of $11.8 million and $12.6 million, respectively, and securities available for sale with a carrying value of $15.3 million and $14.9 million, respectively, were pledged to the FRB 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. The ALCO establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained within target ranges established by the ALCO during the three months ended March 31, 2021. Based on its assessment of the -67- Management's Discussion and Analysis liquidity considerations described above, management believes the Corporation’s sources of funding meet anticipated funding needs. Net cash used in operating activities amounted to $3.4 million for the three months ended March 31, 2021. Net income of $20.5 million was largely offset by mortgage banking related adjustments to reconcile net income to net cash used in operating activities. Net cash used in investing activities totaled $62.7 million for the three months ended March 31, 2021, reflecting outflows to fund purchases of debt securities. These outflows were partially offset by net inflows from maturities, calls and principal payments of securities. For the three months ended March 31, 2021, net cash provided by financing activities amounted to $34.6 million, with increases in deposits, partially offset by a net decrease in FHLB advances and the payment of dividends to shareholders. See the Unaudited Consolidated Statements of Cash Flows for further information about sources and uses of cash. Capital Resources Total shareholders’ equity amounted to $533.6 million at March 31, 2021, down by $596 thousand from December 31, 2020. The decline reflected a decrease of $12.6 million in the accumulated other comprehensive income component of shareholders' equity largely due to a temporary decline in the fair value of available for sale debt securities, as well as $9.1 million in dividend declarations. These decreases were partially offset by net income of $20.5 million. The Corporation declared a quarterly dividend of 52 cents per share for the three months ended March 31, 2021, compared to 51 cents per share declared for the same period in 2020. The ratio of total equity to total assets amounted to 9.33% at March 31, 2021 compared to a ratio of 9.35% at December 31, 2020. Book value per share at March 31, 2021 and December 31, 2020 amounted to $30.83 and $30.94, respectively. The Bancorp and the Bank are subject to various regulatory capital requirements and are considered “well capitalized” with a total risk-based capital ratio of 13.85% at March 31, 2021, compared to 13.51% at December 31, 2020. See Note 9 to the Unaudited Consolidated Financial Statements for additional discussion of regulatory capital requirements and the election of the ASC 326 phase-in option provided by regulatory guidance, which delays the estimated impact of ASC 326 on regulatory capital and phases it in over a three-year period beginning in 2022. Off-Balance Sheet Arrangements In the normal 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. Such transactions are used to meet the financing needs of its customers and to manage the exposure to fluctuations in interest rates. 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 swap agreements with commercial borrowers, commitments to extend credit, and standby letters of credit are similar to those used for loans. Interest rate risk management contracts with other counterparties are generally subject to bilateral collateralization terms. For additional information on derivative financial instruments and financial instruments with off-balance sheet risk see Notes 10 and 18 to the Unaudited Consolidated Financial Statements. 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, off-balance sheet interest rate contracts and the pricing and structure of loans and deposits, to manage interest rate risk. The off-balance sheet 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 -68- Management's Discussion and Analysis 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 10 and 18 to the Unaudited Consolidated Financial Statements for additional information. The ALCO uses income simulation to measure interest rate risk inherent in the Corporation’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, 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 core savings to higher-cost time deposits in selected interest rate scenarios. Additionally, the simulations take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed periodically by the ALCO to ensure their accuracy and consistency. The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of March 31, 2021 and December 31, 2020, 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 net interest margin over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios. The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest 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 March 31, 2021 and December 31, 2020. Interest rates are assumed to shift by a parallel 100, 200 or 300 basis points upward or 100 basis points downward over a 12-month period, except for core savings deposits, which are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the periods indicated. March 31, 2021 December 31, 2020 Months 1 - 12 Months 13 - 24 Months 1 - 12 Months 13 - 24 100 basis point rate decrease (2.23) % (6.46) % (2.05) % (4.73) % 100 basis point rate increase 5.47 8.54 5.56 7.89 200 basis point rate increase 11.01 16.45 11.00 15.05 300 basis point rate increase 16.48 23.47 16.47 21.15 The ALCO estimates that the negative exposure of net interest income to falling rates as compared to an unchanged rate scenario results from a more rapid decline in earning asset yields compared to rates paid on deposits. If market interest rates were to fall and remain lower for a sustained period, certain core savings and time deposit rates could decline more slowly and by a lesser amount than other market interest rates. Asset yields would likely decline more rapidly than deposit costs as current asset holdings mature or reprice, since cash flow from mortgage-related prepayments and redemption of callable securities would increase as market interest rates fall. The overall positive exposure of net interest income to rising rates as compared to an unchanged rate scenario results from a more rapid projected relative rate of increase in asset yields than funding costs over the near term. For simulation purposes, deposit rate changes are anticipated to lag behind other market interest rates in both timing and magnitude. The ALCO’s estimate of interest rate risk exposure to rising rate environments, including those involving changes to the shape of the yield -69- Management's Discussion and Analysis curve, incorporates certain assumptions regarding the shift in deposit balances from low-cost core savings categories to higher-cost deposit categories, which has characterized a shift in funding mix during the past rising interest rate cycles. While the ALCO reviews 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 net interest margin. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of the Corporation’s balance sheet may change to a different degree than estimated. Simulation modeling assumes a static balance sheet, with the exception of certain modeled deposit mix shifts from low-cost core savings deposits to higher-cost time deposits in rising rate scenarios as noted above. As market interest rates have declined, the banking industry has attracted low-cost core savings deposits. The ALCO recognizes that a portion of these increased levels of low-cost balances could shift into higher yielding alternatives in the future, particularly if interest rates rise and as confidence in financial markets strengthens, and has modeled 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, which may cause interest rate sensitivity to differ from the results as presented. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The relationship between short-term interest rate changes and core 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 March 31, 2021 and December 31, 2020 resulting from immediate parallel rate shifts: (Dollars in thousands) Security Type Down 100 Basis Points Up 200 Basis Points U.S. government-sponsored enterprise securities (callable) $4,285 ($18,292) Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises 22,499 (76,595) Trust preferred debt and other corporate debt securities (115) 141 Total change in market value as of March 31, 2021 $26,669 ($94,746) Total change in market value as of December 31, 2020 $13,481 ($69,538) -70-