January e-News

Perspectives on the Economy and Business
An interview with John Warren and Joseph MarcAurele

John C. Warren is Chairman and CEO of Washington Trust.
Joseph J. MarcAurele is President and COO.

As 2009 comes to an end, where are we now versus a year ago in terms of the economy and financial markets?
JW: A year ago today, the world was in crisis. A number of major institutions had failed and the government had put into place the TARP program, even though no one was sure how the money would be distributed. There really was a sense of crisis around the financial system. A year later, it's hard to say we're in a more normalized period, but I would. We're not in the crisis mode that we were experiencing.

JM: We ended last year with a huge shock and I think it was not only a shock in the stock market, but it was particularly a shock in the financial markets. There was this sense that things were incredibly unstable and potentially could collapse. And then what ended up happening over time is, I think a combination of some government programs and just the fact that the economy in the United States in particular is just so big, it was able to be stabilized again. So I think as the stock market has come back, there is at least a sense of stability now.

How about real estate and housing values?
JW: People are kind of looking around. When they get a sense that the economy is coming back, some of those people who have been holding off on real estate purchases are going to take advantage of the opportunities that are out there.

JM: I think residential property values have stabilized to some extent. I think there is a looming concern over potential devaluation in commercial real estate.

What do you see as the biggest challenges going forward?
JW: One of the biggest challenges - and this is national - is that we've got massive government stimulus that's out in places all around the country and we're going to have to deal with those debt issues at some point. Locally, the real challenge is, how do we get the jobs back to Rhode Island? How do we grow jobs in Rhode Island?

JM: The challenge is how do we restart the economic engine? I think that's probably more challenging in Rhode Island, given the dramatic levels of unemployment right now, but I do think it's dramatically better than it was a year or 15 months ago.

What positives do you see?
JW: Brown University and Johnson & Wales have some great things going on in the Jewelry District in downtown Providence. Both are expanding their campuses, and Brown is moving its medical school down there. All of that is going to pump money into the economy and those are major programs that will be going on for the next five or six years.

JM: I think difficult times in anything in life present you with an opportunity because sometimes it's very hard to get people to the table unless it's around a crisis. Although we feel that there are structural issues in state government that have not been addressed, there has definitely been more dialogue between business leaders and legislators over the last year or two. I think a lot of it has been productive and to some extent people have begun to listen. Quite frankly, if you can get that dialogue started, you have a better chance of passing legislation that will be business-friendly and better for everyone. To the extent that we can get the business engine restarted and make some systemic changes that will stick, this will entice more businesses to locate here and that will be better for everyone.

Where is Washington Trust in all this? Why should people and businesses turn to you?
JW: Same reasons they always have: for the strength and the stability. After 209 years, we're still here. We've got money to lend and we're reaching out, trying to help people, help the region, and help the economy. The economy is the worst we've seen since the Great Depression. The unemployment rate is as high as we've seen in decades. In this environment, you need an organization that has the capital and the people and the leadership going forward to help you make it through.

JM: People trust Washington Trust because of our stability and our track record over time, both in the community and from a financial performance perspective. I think that, combined with a very customer-focused value proposition, gives us an opportunity to separate ourselves from the rest of our competitors. There is no other banking company in this state that has that combination of history and customer focus, and I think it positions us very well for the future.

What makes the culture at Washington Trust different?
JW: It comes down to our people. People really enjoy coming to work here and embrace the idea that they can make a difference every day - for their customers, for their peers, and for the community. And that connects them to a corporate culture that has been in place for more than 200 years.

JM: One of the things that jumps out at you here is that there is enormous pride in this company and there is enormous ownership here. People feel like everything that goes on here is part of them and that's very unusual.

ECONOMIC OUTLOOK

By Mary M. McGoldrick, Senior Vice President and Chief Investment Officer

As we look out to 2010, there are a number of encouraging signs for the U.S. economy. In the latest quarter, the nation's output of goods and services grew at a 2.8% annual rate, suggesting that a recovery has begun. Particular strength was noted in exports, residential investment, federal government spending and inventory investment, with all of these segments posting double-digit growth. Other indicators that suggest better times lie ahead include:

• The index of leading economic indicators has risen for the past seven months (see chart)
• The latest University of Michigan Consumer Sentiment Survey showed a stronger-than-forecasted six point gain
• Retail sales rose 1.3% in November and were 0.2% higher than a year ago¹
• Existing home sales have rebounded to the highest level since February 2007²
• Exports have risen for six consecutive months¹
• More than $100 billion in TARP funds have been repaid to the U.S. Treasury, evidence that the financial system has stabilized after the 2008 crisis³

Based on this evidence, the consensus forecast for 2010 calls for economic growth of 2.7%, compared with the -2.4% contraction of 2009. However, it is important to note that this is a forecast and that there are risks to the achievement of these positive results.

The employment situation represents a major concern. With one of ten Americans currently unemployed, it will be a challenge to see sustained improvement in consumer spending. In addition, many employed consumers are choosing to forego current spending and instead are focused on rebuilding their savings. Our outlook does incorporate moderate gains in spending, fueled in part by stabilization in the job market. The monthly data show a moderation in job losses compared to a year ago. Coupled with a decline in the number of initial claims for unemployment insurance, we believe the employment situation is poised to improve.

The other major risk to the forecast centers on monetary policy. The stabilization in the financial markets that began in the spring of 2009 was fueled by historically low short-term interest rates and a number of federal programs designed to provide support to the housing agencies and the mortgage market. As these programs wind down and the talk turns to when the Federal Reserve will raise interest rates to maintain price stability, there is concern that premature tightening of monetary policy could result in another downturn, a “double dip.” We believe that the members of the FOMC are sensitive to this risk, and in fact, the post meeting statements suggest that short-term interest rates will remain low for “an extended period of time.”

If we are successful in meeting these challenges, the U.S. economy should show moderate growth in 2010. Locally, the health of the Rhode Island economy will be dependent on national conditions. Historically, the state's economy has fared worse during times of economic weakness due to its reliance on manufacturing jobs. Currently, 73,000 Rhode Islanders are out of work,4 and most forecasters do not anticipate an employment recovery until 2012. However, the state will benefit from federal stimulus spending, and there is a renewed emphasis on economic development efforts. The issues have been identified, and we now hope that innovative collaboration between business and government will help to provide long-term solutions.

¹ U.S. Department of Commerce
² National Association of Realtors
³ Pender, Kathleen. “Net Worth.” San Francisco Chronicle December 20, 2009: F-1.
⁴ Rhode Island Department of Labor and Training

MARKETS OUTLOOK
by Kent W. Gladding, Vice President & Investment Officer, Washington Trust Investors

Crisis creates opportunities, and nowhere was that more apparent than in global equity markets during the spring of 2009. Since this year's market low was recorded in March, the S&P 500 has rebounded 64%. The stock market rally, and indeed the rally in risky assets in general, represented a profound optimism in capitalism, and investor confidence in the ability of central banks and finance officials to restore order to capital markets around the world.

The rally was driven in part by absurdly low valuations, which only made sense if earnings growth rates remained near zero. The valuation argument, combined with confidence that monetary policy would ultimately result in positive growth rates, fueled a dramatic rally in the riskiest asset classes, such as junk bonds, commercial real estate, and stocks of highly levered companies.

Additionally, stocks of real growth companies, meaning actual growth rates that were either in the teens or high single digits, performed splendidly. Apple, Cognizant Technology, and Intuitive Surgical, Inc. were excellent examples of growth companies with soaring stock prices. Their ability to grow in a challenging economic environment was indicative of their ability to create unique products and deliver responsive service that was viewed as a value proposition by their customers.

To a large extent, the professional investor's goal is to identify investments that are likely to provide positive earnings. Naturally, for this exercise to be meaningful, it must be done in the context of what's going on in the world. Factors that loom large in the current landscape are interest rate levels, exchange rates, commodity prices, unemployment levels, budget deficits, and expected GDP growth rates.

Since unemployment remains high and total credit is not expanding, we remain skeptical of companies that are highly dependent on discretionary consumer spending unless they are rapidly growing market share. Medical technology companies, banks with improving credit portfolios, global outsourcers, and multinationals with burgeoning businesses in developing markets represent segments that continue to offer compelling opportunities for equity investors. Industrial cyclical companies tend to lag the rest of the stock market coming out of a recession and at this point continue to remain depressed. For that reason, it makes sense to analyze these companies to identify candidates for a rebound.

As active investors, we believe that a focus on companies with superior fundamentals, offering the best products and services, will serve investors well in the long run. Additionally, a global focus can provide a road map around our relatively weaker domestic economy.

The opinions expressed in this document are those of the authors and may not reflect those of Washington Trust. The information in this report has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Any opinions expressed herein are subject to change at any time without notice. Any person relying upon this information shall be solely responsible for the consequences of such reliance.

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