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Webster Financial Corp
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Good morning. And welcome to Webster Financial Corporation’s Second Quarter 2019 Earnings Call.
I will now introduce Webster’s Director of Investor Relations, Terry Mangan. Please go ahead, sir.
Thank you, Melissa. Welcome to Webster. This conference is being recorded. Also, this presentation includes forward-looking statements within the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 with respect to Webster’s financial condition, results of operations and business and financial performance.
Webster has based these forward-looking statements on current expectations and projections about future events. Actual results might differ materially from those projected in the forward-looking statements.
Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial’s public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second quarter of 2019.
I will now introduce Webster’s President and CEO, John Ciulla.
Thanks, Terry. Good morning, everyone. Thank you for joining Webster’s second quarter 2019 earnings call. CFO, Glenn MacInnes and I will review business and financial performance for the quarter; HSA Bank President, Chad Wilkins is here with us in Waterbury and will be available during Q&A.
Let me start by saying we are really pleased with our solid financial performance in Q2, loan and deposit growth was strong, net interest income and non-interest income increased, expenses were efficiently managed and we created positive operating leverage for the ninth consecutive quarter.
Our capital position is strong and our consistent financial performance enabled us to recently announce a 21% increase in the common dividend. We continue to take a long view on value creation and we are investing in our differentiated businesses across all markets to drive strong customer relationships and to maximize economic profits over time.
I will begin on slide two. We posted our fourth consecutive quarter of net income at just under $100 million. Net income to common shareholders was $96.2 million after $2.5 million of preferred dividend expense, earnings per share of $1.5 in Q2, compares to $1.6 in Q1 and $0.92 in Q2 of 2018, when that period is adjusted for $8.6 million of one-time expense items, resulting in a 14% growth rate from prior year’s Q2.
Tangible book value per share continues to grow and is 15% higher than last year, even as we increase the quarterly common dividend. Loan growth and a higher net interest margin contributed to our 39th consecutive quarter of year-over-year revenue growth and a 13% increase in adjusted pre-provision net revenue.
In Q2, total revenue was 8% higher than last year, while adjusted expenses increased 5%, resulting in positive operating leverage. The efficiency ratio was 56% for the third quarter in a row.
Credit quality remained solid with noteworthy linked quarter reductions in nonperforming, commercial classified and past due loans. We have now posted four consecutive quarters with return on common equity above 13% and return on tangible common equity above 16%.
Webster’s financial performance is driven by a disciplined commitment to our purposeful execution of long-term strategic priorities, namely, to expand Commercial Banking, aggressively grow HSA Bank and optimize and transform community banking.
Turning to slide three, I will make a few comments on our first half 2019 line of business performance. Commercial Banking continued to execute at a high level, delivering year-over-year double-digit loan growth.
We are growing loans without sacrificing underwriting discipline and benefiting from our differentiated execution in select industry verticals and in commercial real estate. Commercial Banking revenue in the first half of 2019 grew 4% from prior year, with all business units and all geographies contributing to our growth. Deposits were also up nicely as we continue to build franchise value by acquiring new customers and deepening existing relationships across our footprint.
HSA bank’s first half PPNR improved more than 30%, as we added in excess of 724,000 new accounts and continue to drive higher levels of customer satisfaction through our operational excellence initiatives. HSA Bank remains the leading bank administrator of health and savings accounts, and surpassed $8 billion in HSA footings in the quarter.
Also in the quarter, we expanded and extended our important relationship with Cigna, increasing investments in technology, security, marketing and other resources to advance and grow the customer experience.
Community Banking is making progress optimizing distribution channels, investing in digital capabilities and focusing on high value consumers and small businesses. We again generated year over year PPNR growth, up 9% from the first half of 2018 through modest revenue gains and continued expense discipline and process efficiencies. We continue to grow loans, core deposits and full relationships across our Boston to New York retail footprint.
Slide four highlights our solid loan and deposit growth dynamics. On a consolidated basis loans increased $1.2 billion or 7% from a year ago. Deposits increased $1.3 billion or 6% over the last year, with low cost health savings accounts representing 55% of the increase. Glenn will provide more detail as he reviews the balance sheet and line of business performance.
Our regional economies and the markets we operate in remain solid and growing, despite macro uncertainty in the pace of global growth, a more challenging interest rate environment and a handful of potential geopolitical risks.
Our customers both consumers and businesses are healthy, and generally, positive on the forward outlook. We remain confident in our ability to consistently build long-term franchise value and to maximize growth of economic profits over time.
We are executing at a high level in the areas we control, growing revenue, loans and core deposits through new customer acquisition and further penetration of our existing customer base, diligently managing credit risk, continually investing in our differentiated businesses with strategic focus, while maintaining expense discipline and realizing efficiency gains to drive operating leverage and improve our returns.
And finally, maintaining a strong value based culture at the Bank, creating a great environment for our bankers, while always taking care of our customers and investing in our communities.
I will now turn the call over to Glenn for the financial review.
Thanks, John. Slide five provides more detail on our average balance sheet. The securities portfolio grew by $164 million linked quarter. This follows an increase of $165 million in Q1. Year-over-year the portfolio was up $330 million, consistent with our balance sheet growth.
Loan growth continues to be led by the commercial categories, which were up $321 million linked quarter and $1.1 billion versus prior year. Linked quarter consumer loan growth of $200 million reflects the $242 million mortgage portfolio purchase that closed at the end of Q1. Similar to the industry, we continue to see pay downs of home equity balances over the past year.
Deposit growth was $213 million linked quarter with three quarters of the growth in demand and low cost HSA deposits. Deposits grew $1.3 billion from a year ago, was slightly more than half of the growth coming from HSA deposits.
Borrowings increased $468 million linked quarter. This includes $300 million in 10-year senior notes issued late in Q1, which we swapped out to floating. The remainder of the increase was the result of seasonality and public funds, versus prior year, borrowings were down $61 million as the growth in deposits and equity exceeded growth in loans and securities.
Slide six summarizes our Q2 income statement and drivers of quarterly earnings. Net interest income totaled $242 million and increased modestly from Q1. We had solid linked quarter earning asset growth of 2.6%, which was offset by higher than anticipated NIM compression as average second quarter interest rate levels were lower than anticipated at the time of our Q1 earnings call in mid-April. For example, the average one month LIBOR rate was 5 basis points lower and the average 10-year swap rate was 20 basis points lower.
Versus prior year net interest income grew by $17 million or 7.5%. Non-interest income increased in excess of $7 million versus both prior quarter and prior year. This exceeded our expectation due to increased level of commercial activity and gains in our BOLI portfolio.
Reported non-interest expense increased $5 million linked quarter and was flat compared to a year ago. The linked quarter reflects an increase of $3.9 million due to higher legal expense outside professional fees and seasonal sales and sponsorships. Expenses were flat to prior year, which included a one-time deposit insurance charge of $7.2 million. This was primarily offset by annual merit and other benefit costs increases.
Pre-provision net revenue of $137 million represents a new quarterly record and was up from $135 million in Q1. Versus prior year pre-provision net revenue increased $15 million or 13% on an adjusted basis.
Loan loss provision for the quarter was $11.9 million, resulting in a coverage ratio of 110 basis points. Our efficiency ratio was 56%, same as in Q1 and improved from 57.8% a year ago and the effective tax rate was 21.1%.
Slide seven provides additional detail on year-over-year pre-provision net revenue growth. Net interest income grew by $17 million or 7.5%, $4 million driven by rate and $13 million driven by volume. The rate component is the net result of a 31-basis-point improvement in loan yield and a 20-basis-point increase in deposit costs.
When measured against the 70-basis-point increase in average fed funds rate. This resulted in a loan beta of 44% and the deposit beta of 28%. The combination resulted in a 6-basis-point increase in net interest margin to 3.63%.
Starting on slide eight, I will review the line of business results. Commercial Banking reported second quarter loan growth of 3.5% linked quarter and 10.8% year-over-year. C&I loan growth was $257 million linked quarter and $648 million from prior year. Commercial real estate loans grew $126 million linked quarter and $427 million from prior year. While the loan portfolio yield declined 2 basis points linked quarter, primarily due to lower LIBOR rates, it increased 36 basis points from a year ago.
As you see on the bottom right, PPNR was flat compared to a year ago. Net interest income grew $3.7 million reflecting average loan growth of 11%, while non-interest income was modestly lower and operating expenses increased from prior year as we continue to invest in the business.
Slide nine highlights HSA Bank, which delivered another solid quarter led by the reduction of 129,000 new accounts. Over the past 12 months, HSA Bank has opened 724,000 new accounts. As John noted during the quarter, we crossed the $8 billion mark in total footings, with just under 3 million accounts. Our footings consist of $6.2 billion and low cost long duration deposits and $1.8 billion in linked investments.
We continue with strong account growth in the channels where we have the greatest influence in sales and marketing activities, including direct-to-employer. Total accounts were 11% higher than a year ago and total footings were up $1 billion or 15%.
Net interest income was 21% higher from a year ago. The increase reflects growth of 13% and average deposits and a higher net credit rate. The cost of deposits was 20 basis points, flat to a year ago. Non-interest income increased 9% from a high from higher account fees and interchange revenue, each driven by growth in accounts.
Total revenue for the quarter grew 16% from a year ago. Year-over-year expense growth was 10% as a result of account growth and ongoing expense discipline was targeted investments, combined this resulted in positive operating leverage and pretax net revenue growth of 24%.
Slide 10 highlights Community Banking. Business Banking had year-over-year loan growth of 6%, combined with Q1 -- the Q1 mortgage portfolio purchase growth offset a continued decline in our home equity portfolio. The net result was an increase of 2% in loans.
On the deposit side, Consumer business deposits each grew 6% year-over-year. Net interest income grew modestly year-over-year, while non-interest income grew 5%, driven by deposit charges and higher swap-related fee income in Business Banking. Total revenue growth was one 1.6% from a year ago and non-interest expense grew 1%, resulting in positive operating leverage and 3.4% growth in PPNR.
Slide 11 highlights our key asset quality metrics. Nonperforming loans in the upper left had a linked quarter decline of $11 million and now represent 77 basis points of total loans. Net charge-offs in the upper right were $11.6 million in the quarter. The annualized net charge-off rate is generally consistent with our 20-quarter average of 21 basis points. Commercial classified loans in the lower left improved 259 basis points to total commercial loans. This compares to a 20-quarter average of 322 basis points.
Our allowance for loan loss was $212 million, with a provision of $11.9 million and a coverage ratio of 110 basis points. Our allowance for loan loss continues to reflect stable commercial and consumer asset quality.
Slide 12 provides our outlook for Q3 compared to Q2. We expect average loans to increase around 2%, driven primarily by our commercial and residential portfolios. We expect average interest earning assets to grow over 2%.
With regard to net interest margin, given the rate environment, at this point, we anticipate 7 basis points to 10 basis points of NIM compression. As a result, we expect net interest income to be stable from Q2 levels.
Reported non-interest income is likely to be down as a result of BOLI portfolio gains included in Q2. We expect our efficiency ratio to be below 57% and our provision will be driven by loan growth, asset quality and mix. We expect the tax rate on a non-FTE basis to be approximately 21%. And lastly, we expect our average diluted share count to be similar to Q2’s level.
With that, I will turn things back over to John.
Thank you very much, Glenn. Before we open it up for Q&A, I’d like to provide additional context to Glenn’s guidance on NIM and net interest income trends. Our asset sensitivity, which peaked in Q3 of 2017 continues to moderate, and we have and will continue to take steps to manage our overall interest rate sensitivity, given the outlook on future rate moves.
In Q2 despite the 11 basis points overall NIM compression, we were able to grow net interest income modestly linked quarter as a result of our ability to safely grow loans at market-leading levels.
Moreover, and importantly, much of the 2Q NIM compression was driven by higher premium amortization in the securities portfolio, the mortgage loans purchased at the end of the first quarter and the full quarterly impact of the note issuance we completed in Q1.
Our deposit costs largely as a result of our differentiated HSA business and a net increase in demand deposits increased only 2 basis points quarter-over-quarter, which we believe outperforms broader market trends. And our yield on loans contracted only 2 basis points quarter-over-quarter, despite a more significant contraction in LIBOR.
While we expect NIM compression in the third quarter, balance sheet actions and asset growth should allow us to keep net interest income relatively flat. Looking out further, we see challenge to the NIM in Q4 as well and our focus will again be to mitigate the impact on net interest income.
As we head into 2020 and beyond, we will benefit from the Q1 seasonal lift in HSA deposits and we will continue to refine our view and further our execution on the structure of our balance sheet. Our goal always taking a long view continues to be driving net interest income and delivering growth in economic profits.
I want to again thank our nearly 3400 bankers for their continued efforts and performance. Together, our bankers are making a positive difference for our customers, our shareholders, the communities we serve and for each other.
With that, unless I am happy to open it up for questions.
Thank you. [Operator Instructions] Our first question comes from the line of Steven Alexopoulos with J.P. Morgan. Please proceed with your question.
Hey. Good morning, everybody.
Steve, good morning. Hope your summer is going well.
So far so good. John, I wanted to follow-up first on your comments that you expanded and extended the relationship with Cigna. I just wanted to confirm, are you saying that the contract was renewed?
Steve, as we always tell you, we don’t specifically comment on contracts with Cigna or otherwise. But let me reiterate that we have enjoyed a mutually beneficial relationship with Cigna for the last five years since we began partnering with them. It’s a contractual relationship and in Q2 we expanded and extended that relationship and we continue to view the relationship as a very strong one.
Okay. That’s helpful. And then I want to shift to the margin. So, Glenn, does the 3Q guidance, does that assume a July rate cut?
It does. We have a July -- we have factored in July rate cut and September rate cut each 25 basis points.
Okay. So if we look at the NIM guidance down 7 basis points to 10 basis points in the third quarter. Is that about what you expect from a 25 basis point cut or is there some other factor in there like bond premium amortization or something that’s elevating there?
No. Yeah. No. There is and I think it’s all related because we are assuming also, I should say, a 10-year swap rate of around 2%. And so in that 7 basis points to 10 basis points range, I would put the amortization impact somewhere between 2 basis points and 3 basis points.
Okay. So a normal response to a cut might be less 2 basis points to 3 basis points somewhere in that range?
Yes. Somewhere around there.
Great. Okay. Got you. And then what’s your appetite, how you think about offsetting this following John’s comments where you guys are obviously thinking long-term. But do you plan on further rating an expense growth, like, what do you think about the offsets so this NIM pressure builds here?
Yeah. Steve, I mean, I will take it first. Obviously, what we have talked about, we take a long view in terms of building franchise. We pull levers and I think we have demonstrated to the market in our reduction of our expenses over time and our management of the efficiency ratio. We certainly have opportunity to be careful on expenses, but we are also careful to make sure that we think we have got a couple of really differentiating businesses that we will continue to invest in.
So I think it’s a combination of balance sheet actions. It’s a combination of growing our balance sheet and growing loans to offset the NIM compression and expense management and that’s why we are trying to focus everyone to the net interest income line rather than the headline NIM number.
Okay. And then just finally on HSA Bank, how much flexibility do you have to lower the deposit rates you are paying, and maybe for Chad, what does the HealthEquity, Wage deal mean for your business as an opportunity, stronger competitor, how do you think about that? Thanks.
Yeah. Thanks, Steve. I said on the rate side, we haven’t had pressure either way on rate. So I don’t expect them to move. I mean we haven’t moved rates other than to come down slightly over the last couple of years. And then moving to the HealthEquity, WageWorks deal, I think, the -- in general that transaction is pretty much complicated and expensive, and we have been through similar but smaller transitions and conversions over the years, and they have done right, it can be great if not wrong, quite the opposite, right? So the bottomline this doesn’t change our focus outside of putting ourselves in position to take advantage of any disruption that might happen as they work through the transition.
And Steve, if I could make kind of a higher level strategic comment, obviously, there have been a number of transactions announced in the industry, as a leading player as you can imagine, we are in and around all of the activity. We are really pleased with the execution of Chad and his team, and our position at the leading HSA provider from a Bank perspective as the industry consolidates and moves around. And we are going to, obviously, continue to make the investments necessary to keep our competitive advantage and maintain our position as a key player in the marketplace.
Okay. Terrific. Thanks for taking my questions.
Thank you. Our next question comes from the line of Collyn Gilbert with KBW. Please proceed with your question.
Thanks. Good morning, guys.
Hey. Good morning, Collyn.
So this -- great color and certainly on the strategy, John, that you are offering to sort of help to offset some of these NIM challenges. And then, just, Glenn, back to -- you had indicated 2 basis points to 3 basis points maybe could be amortization related of the NIM. Can you just talk about some of the other drivers, how you are seeing loan pricing in the market on origination yields and then where you are seeing deposit pricing trends go kind of near-term and then a little bit longer term on some of those inputs?
Yeah. I will let Glenn put a finer point, but Collyn, if I can just jump in. I think, from a pricing perspective on the loans, the yields are really coming down based on the reference rate and where LIBOR is, I think, we are seeing pretty stable credit spreads, if you will, so LIBOR is impacting the loans.
And as we said, one of the things in our story here is that, I think, you will see a lot of our peers and other folks in the industry have deposit pricing going up higher. Obviously, we think, no matter what the interest rate environment is, having HSA and having steady cost, long duration, growing deposits will be an advantage.
So we have seen a little bit of pressure as we talked about in the last quarter in terms of deposit pricing across the footprint, and in particular, large metro areas. But I think we are seeing that consumer demand on pricing increases subside with what’s going on in the broader interest rate market, which I think is kind of consistent with what we are seeing in the industry.
So when you look at kind of a core NIM contraction. The loans and the deposits we feel pretty bullish on our ability to effectively manage deposit costs, and obviously, we are somewhat, because we have a large floating rate book susceptible to move in LIBOR. So that’s kind of my top of the house view on core NIM contraction.
Yeah. And I will just maybe I can add a little. We talked about the amortization 2 basis points to 3 basis points, and I think, to John’s point, if you look at our lending book that’s one month LIBOR based, because that would be more sensitive to a change in rates. We have about $7.5 billion, $7 billion, a little over $7.5 billion on that book.
And so that would be the biggest headwind for us, the offset would, obviously, be things like public fund, CDs, general deposit costs, and then our borrowings, FHLB advances would come down as well with the rate. So, when you factor all that in Collyn, I would say, you get to the range that we are.
Okay. Okay. That’s helpful. And then just on the loan growth side, obviously, really good growth this quarter. It looks like you are anticipating good growth next quarter and you are certainly speaking optimistically about that, and John, you just said, you are seeing decent credit spreads. But can you just frame it a little bit in terms of appetite and demand for that type of growth. I mean, obviously, we are sitting over the fed that’s ready to cut. So they see something, I am not sure what they see, but different perhaps on what your performance is showing. But can you just talk a little bit about what’s driving that -- those favorable loan growth trends?
Sure. And I probably sound like a broken record Collyn, I have had this conversation so many times. I really think it’s because we have got kind of a variety of levers. So if you look across our sponsor and specialty business, which has some industry verticals, our traditional middle market across the expanded geography, asset based lending, equipment finance, commercial real estate and we have got a kind of a plethora of business lines and geographies and we haven’t been what’s really nice is when I was making a comment yesterday to Chris Motl. I look through and you are not seeing a disproportionate contribution in any one place we go over time.
So if you look at the leverage, its category, if you look at any particular industry segment, if you look at any particular geography. We really haven’t had to supercharge or take additional risk in any of those geographies. So I think the growth has been really nice and spread across our sectors.
I will also tell you that one of the things I have said on the call is that we will sacrifice on price before we will sacrifice on structure. I believe that’s true. I looked at our weighted average risk ratings over the last year and they have trended down, which means lower better risk quality, lower risk ratings and our credit spreads over that same period have come down a little bit as well.
So, I think, to me that’s a little bit of quantitative evidence that we are necessary we are sacrificing on price and not on quality. All of our loan pipelines are up in Business Banking and in Commercial. So I do feel pretty, pretty bullish about where we are.
Collyn, and one more point I wanted to make that I think is important is if people go from worrying about your loan growth during good times, not being high enough to worrying that a lot of loan growth during late cycle is dangerous is that our, we really have been disciplined. And in this quarter, if you look at the chart the originations weren’t off dramatically, in fact, they were down from a year ago but prepayments were down significantly. And I think that’s an important point to make, because it means, we haven’t been driving outsized originations in the period. We were just fortunate not to see a lot of payoffs in the quarter.
Okay. That’s helpful. And then just one final, just again kind of time to longer term thoughts on all of this, you are giving guidance near-term on the efficiency ratio, and what you just said on the loan growth, I mean, do we -- should we assume that this can be extended that stable efficiency ratio, this high single-digit loan growth rate can be, that’s like a target and objective for you all to maintain throughout 2020 as well?
I mean, it is strategically right and we are being, I think, transparent about the challenges in the interest rate environment of NIM compression. But our goals are to try and make sure we are growing assets. We are getting paid for value and we are not taking too much credit risk that we can through balance sheet actions and growth in our earning assets offset some of the NIM compression.
And you have noticed were 56% efficiency ratio. We guided towards 57%. We generally give ourselves a little bit of wiggle room there, because as you know, in any one quarter, if we see a great Commercial Banking team or if Chad has an opportunity to supercharge sales or make an investment in HAS we want to keep growing our differentiated assets. But our goal is over the long-term and we feel confident that kind of the continued downward migration again over the longer on efficiency ratio is achievable.
Okay. Great. I will leave it there.
[Inaudible]
Thanks very much. Oh! Sorry. Go ahead, Glenn.
No. I just, to John’s point we want to maintain the flexibility to strategically invest in our business. If you look at it and you look at it the way we are set up from a strategic standpoint and you just go through the lines of business, commercial head count as an examples up 20 year-over-year, HSA is up 40 year-over-year, that’s offset by reductions in the community bank of 55 and in the middle and back office of 25. So if you think about the way we are investing in the businesses it sort of plays through on that efficiency ratio too, but we need the flexibility to invest in the businesses.
That’s great. All right. Thanks very much, guys.
Thank you, Collyn.
Thank you. Our next question comes from the line of Mark Fitzgibbon with Sandler O’Neill. Please proceed with your question.
Guys, good morning. I had a question first for, Chad. I guess, Chad, I am curious, the guidance issued recently by the IRS and the Treasury Department related to high-deductible health plans, you should obviously be pretty good for new business generation in the HSA area. I guess, I am curious how long you think before health plans begin to adopt the new guidance?
Yeah. That’s a great question, Mark, and it’s something that we have been lobbying aggressively over the last couple of years. There are three things that we focus on from a lobbying perspective and its eligibility within Medicare and Medicare Advantage for HSAs, allowing HSA eligibility with direct primary care agreements and then this, and so I am happy to see that we were successful on this front.
This does open up our opportunity, our target opportunity for both employers and consumers. And I don’t have a specific answer for you for how long it will take, I mean, I think, it’s going to be next year, it’s difficult, because a lot of plans have already set in motion what they are going to offer as I go through October. I think as they work through next year, we will see some changes. But it eliminates one of the larger obstacles with regard to HSAs and really does open up our opportunity.
Great. And then, Glenn, you referenced a $3.5 million in miscellaneous other income in the press release. What exactly is that?
So, yeah -- so that was BOLI benefits and I think you are probably familiar with the bank on life insurance. You have seen on our balance sheet $546 million, which we get a return per quarter of about $3.6 million. That is when in the event of a debt benefit is accelerated.
Yeah.
So during the quarter we had a little over $3 million in accelerated benefits.
Okay. And then, lastly, I wondered if you could sort of update us on additional plans for branch optimization?
Sure. Mark, it’s John, and by the way congratulations on the Sandler-Piper transaction.
Thank you.
Yeah. I think it’s the same. We do not have anything targeted right now. We constantly are working and we would all starts from the premise that our consumer preferences are changing, fewer transactions are happening in the Bank, our digitally active households continue to increase and our focus really is to shift expenses from the real estate platform, obviously, into technology.
And so for us it’s looking every quarter at our footprint, making sure we are taking care of our customer base, with an ultimate goal of not necessarily reducing the number of branches, but reducing square footage over time. We are down 3% on square footage year-over-year and we will continue that, but right now we don’t have any targeted consolidations.
Thank you.
Thanks, Mark.
Thank you. Our next question comes from the line of David Chiaverini with Wedbush Securities. Please proceed with your question.
Hi. Thanks. Good morning. Got a couple of questions for you. First, in HAS, so looking at slide nine, again this pretax net revenue per average account at $45 roughly, so it was down about $1.50 from the first quarter. I was curious as to what drove that decline, whether it was a lower net credit rate or if there was a change in economics with Cigna?
I think that -- well, Dave, it’s Glenn, first off, interchange revenue was relatively flat. I think our account fees declined, lower account closure fees were the key drivers of that and lower paper statement fees which we charge for, so it was really volume driven.
So from higher average accounts in those sectors…
I’d say on the lower statement fees. We actually are saving on expense on that. So it’s a net gain to the business.
Got it. Thanks for that and congrats on extending the relationship with Cigna. I was curious and I figure out, I will try, what’s the typical length of an extension. Is it about five years?
Yeah. David, we are not going to talk about the typical length of the contract. So I appreciate the question, just say we have a long-term relationship and our expectation that it will continue to be a long-term relationship.
Yeah. Fair enough. And then shifting gears to credit quality, there is a nice decline this quarter, what drove that decline and how is the outlook for credit quality?
Yeah. It’s a great question and I’d almost want to turn around and ask you the same thing. We are really pleased with where our asset quality statistics are now. We are now at a level on commercial classifieds that is lower than pre-financial crisis.
And there really hasn’t been a particular driver, except for the fact that we have just seen our customers continue to be healthy, grow topline, watch expenses and so. I think we are choosing so -- we are selecting credit pretty well, but we have grown the portfolio in the last nine years or 10 years pretty significantly.
So I think the drivers are good risk selection. We monitor the portfolio very well, but the most important part for us is that, we are in industries that have predictable, protectable, recurring cash flows. We have been fortunate not to be in areas like oil and gas and energy and construction, some of the more cyclical areas. So we are just pleased right now with where we are and we are at cycle lows.
The outlook is interesting. We have had in the small charge-offs we have had in any risk rating migration down. We haven’t been able to see any correlated risk or any themes in either geography industry or product. So our outlook right now is cautiously optimistic.
Every time another quarter goes by, we think about how close we are to the end of this long cycle, now a record expansion cycle in the U.S., but there is nothing on our radar screen and I think we do a pretty good job of looking forward and monitoring our portfolio that gives us a particular concern. We just need to stay vigilant Great.
Great. And then the deposit decline in Commercial Banking, was that related to seasonality, perhaps, in the municipal business?
Yeah. Public funds, it’s all seasonality, Dave.
Got it. Got it. And then last one from me, you alluded to in the fourth quarter, the NIM compression, should we assume more mid single-digit as opposed to high single-digit given the 2 basis points to 3 basis points of amortization?
Dave, I think, we are not going to sort of drill it down into a number. There are so many things going on, it so volatile right now and either the macro environment or the things that we are doing. I just think we wanted to make a statement to give you more of a sense directionally over the longer period of time that we will fight continued compression trends, but we are not going to get more specific than that.
Understood. Thanks very much.
Thank you. Our next question comes from the line of Laurie Hunsicker with Compass Point. Please proceed with your question.
Yeah. Hi. Thanks. Good morning.
Laurie, good morning.
I wonder if we could just start the other income and non-interest income and I think, Mark, was asking about this too. So included in that $13.3 million is a $3.5 million BOLI debt benefit, is that correct? That’s why that show?
So the -- yeah. So the increase of $7 million, a little over $7 million quarter-over-quarter and year-over-year, half of that is BOLI and the other half is…
And what -- yeah.
The other half is commercial activity primarily swap activity.
Okay. And then how -- I mean how should we be thinking about that actually, not line item absent even some gains -- gain on sale of branches in the fourth quarter. That’s really been running closer to $7 million to $8 million, is that a good way to be thinking about that number?
Yeah. I don’t think that you can bring the $3 million for example forward.
Right.
That’s why our guidance says that, non-interest income are likely down quarter-over-quarter, all things being considered -- it depends on commercial activity, it depends on transaction and volume and things like that.
Okay. And then, same question here within the expense line.
Yeah.
The other expense line was up $4 million. I just want to make sure I heard you right. You said that…
Yeah.
…$3.9 million was due to higher legal expenses.
Yeah. So during the quarter we had settlements, the total just a little over $2 million. And so I would not push those forward either.
All right.
They somewhat offset the gain that you saw in non-interest income.
Perfect. Okay. Thanks. And then just sort of last question here, a little bit more macro, when you first expanded into Boston, you stated a goal by 2020 of getting to a mark that it looks like you are pretty close to, you said, hey, we will be 1.5 billion and it seems like you are getting there. Can you talk a little bit about what’s next for Boston, how you are thinking about Boston? And then also within the framework of some of the M&A that we have seen happen in the Boston marketplace, just how you are looking at M&A. You have got a strong stock currency there have been some deals that have happened in your marketplace both in Boston and beyond that have gone off much closer [inaudible] just how you are thinking about that? Thanks.
Sure. I will try and hit both of those Laurie. You are correct, Boston is now contribution breakeven, past contribution breakeven positive just from a Community Bank perspective, which was obviously one of our goals and then we did set out a loan and deposit growth as target for the five years. Again, just with respect to retail and we are above with respect to loan slightly below with respect to deposits as we go through year four, but we are confident we are going to hit our target numbers.
Our view on Boston has always been kind of a macro holistic view on the Boston market, that it’s one of the economic drivers, if not the economic driver in the Northeast outside of New York. So, as you know, we have had a lot of loan activity there even before we established our flagship office in 2009 and if you now look at the totality of that market, we have got a full complement of retail business banking, wealth, commercial, specialty lending and it’s, certainly, with New York, Philadelphia, the three big metro drivers of profitability and growth for the bank. So we are very, very -- very pleased with the fact that we made that move and it’s helped us both from a direct financial contribution perspective and it’s also helped the other lines of business.
From a -- M&A perspective, we continue to take a really disciplined approach and our view is we have got two hurdles for M&A. One is financial, but the other one is strategic as well. So if you think about us doing a whole bank acquisition to get more banking center footprint. It’s unlikely for us to do a tuck-in acquisition in those markets, because we have a stated strategy of growing HAS, expanding and becoming more commercial and optimizing our Community Bank, which we have, and I think, Boston is a great example of that.
So we never say never, obviously, we look at a lot of stuff from a strategic perspective. But I think we are being really disciplined and thus far there hasn’t been a really appealing opportunity for us in footprint.
Okay. And then just a follow-up, so you are 20 branches now in Boston, is that correct?
No. One or two less.
16.
Yeah.
16. Okay. And -- 16. Okay. I am sorry. And the thought of doing any de novo in addition to what’s currently there is unlikely you are also going to stay put at these levels, is that how you…
Yeah. So, again, I hate to boxes, and I think, unlikely is probably a good word.
Okay.
But we are thinking about the way our retail distribution look. So for instance in Boston, we have got the 16 banking centers that have pretty significant square footage, right? That’s what they were when we took over for Citibank. If there was a reasonably efficient way for us to have more and smaller locations, you could see us trade out one big one for two small ones if we thought that was better. So it’s really about real estate optimization at the end of the day.
Okay. Great. And then just last question on Boston, I know that some of the centers were very large in square footage and you all had done some marketing on subleasing, have you all maximized where you wanted to be on that or is that an area that we could continue to see come down in non-interest expense or how should we think about that?
Yeah. No. I think that effort continues. There are still some banking centers that by our standards are have too much square footage and we will shrink those down to what we think these appropriate square footages. So that effort will continue.
Great. Thanks so much.
Thanks, Laurie. Appreciate it.
Thank you. Our next question comes from the line of Jared Shaw with Wells Fargo Securities. Please proceed with your question.
Hi. Good morning, guys.
Jared, good morning.
Hi.
Hope all is well.
Yeah. Good. Thanks. Hope all as well with you. Just wanted to touch base on the expansion markets and how the success of commercial growth is going in the Philly and DC markets? And on the heels of that would you look at expanding that strategy to any other markets?
Great question. And I think, we have been very pleased with our expansion so far in Philadelphia. We are doing well in middle market. We have had an established commercial real estate activity there for more than 10 years. We have actually just added a new terrific lender down there and he’s already got some significant momentum.
And so what I would say is, and you know this from what we have talked about, we have kind of taken a deliberate longer term patience approach to these geographic expansion moves. I think about New York and getting questions a few years ago on whether we would ever get to scale and now we have really got great momentum there with, I think, something like a $0.5 billion in exposure and a lot of great direct-to-customers in our New York middle market.
So Philadelphia has really started to ramp up in middle market with the curve. So we have taken the same approach in Providence, Boston, White Plains, New York City, Philadelphia, we have real estate and asset-based lending in Washington DC, and again, we mute the growth expectations in order to make sure that we are not taking undue risk in those markets and that’s worked.
So there has been a pause for the last couple of years and moving to the next kind of contiguous geographic market. And I think for us it has a lot to do with the macro environment, Jared. So we do feel like we are closer to the end of this cycle than the beginning of this expansion cycle. So I think it get, well, it gets more challenging and there is a lot of liquidity and there is a lot of competition in the market, it’s not always the best time to go into a new market.
So while we are constantly evaluating those opportunities that will allow us to get to economic profit quickly, given the macro circumstances and what we have seen so far, we have not moved and we do not have any near-term kind of 12-month plans to open up another middle market office in a contiguous metro market.
Okay. Great. Thanks. And then in light of the changing rate environment and the expectation now for lower rates, should we expect to see any broader balance sheet repositioning going into this?
So, yeah, Jared, hi. Good morning. We -- as you know peaked in asset sensitivity in the third quarter of ‘17 and since then and I think on page 19 of our earnings deck, you can see the progress that we have made against reducing some of our asset sensitivity, which is a goal, as we look at the rate environment.
Obviously things like the purchase of the fixed rate mortgage portfolio, which was funded with short-term borrowings help reduce asset sensitivity. We swapped, as I indicated in my comments, the senior note issuance from Q1 to floating that shortens borrowings.
During -- we also purchased approximately $200 million in floors to protect on the downside. But we continue to look at ways to protect net interest income as John indicated and so there is a host of levers that we continue to re-evaluate and evaluate during the course of the quarter.
Great. Thanks very much.
Thank you.
Thank you. Our next question comes from the line of Casey Haire with Jefferies. Please proceed with your question.
Thanks. Good morning, guys.
Good morning, Casey.
Just a couple of quick follow-ups on the NIM, number one and apologies if I missed this, but the securities reinvestment yields in the current rate environment versus the 301 existing, where is that today?
So we are reinvesting, its rolling off at about 310 is coming in about 265.
Okay. Great. And then…
So -- yeah.
Sorry. Go ahead.
No. Go ahead.
And then just on the borrowings, can you give us a sense if we do get a fed cut, how -- what kind of beta we could expect on the borrowings?
Yeah. Sure. We are primarily FHLB and so it’s about a 90% beta.
Okay.
Thos write-down of the market.
All right. And just last one, on the -- just on the expense front, the -- I know you guys are trying to expand Commercial Banking and there was a decent uptick on the expense front and tech, and I guess, hires. Was that, I mean, will you guys just taking advantage of some over earning on the swaps side or is that -- are we looking at a ramp-up in Commercial Bank spend…
No.
…reinvestment?
No. That shouldn’t be a sustained increase, look, we are always very careful to say, if you look back at our PPNR year-over-year CAGR in Commercial Banking, we for a sustained period of time been able to grow around 10%, right, both the loans in the PPNR. But in any one given quarter or even any one given year, we are obviously if we have the opportunity to attract talent or the opportunity to invest in our cash management platform, which some of that technology expenses for, so that we can get lower cost funding directly from our Commercial Banking customers, we are going to do that.
And we mentioned on the last couple of calls, we also implemented a kind of an end-to-end commercial loan portfolio digital system that allows us not only to be more efficient to the way we underwrite and book and approved loans. It also allows us to more effectively monitor risk in the portfolio, which, I think, obviously, all of it would be happy about.
So, what you do see right now in the cycle is a couple of million dollars in extra investment that that should not single -- signal at all a sustained increase in the expense base or reduction in the overall efficiency ratio of the Commercial Bank. It’s really just investments that we can continue to lever to grow revenue over time.
Understood. Thanks.
Thank you.
Thanks, Casey.
Thank you. Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed with your question.
Hey. Thanks. Just with…
Good morning.
Just -- good morning. With HSA deposit costs, so 20 basis points has been pretty stable for the last year, obviously. Can you just remind us like do you guys have any fiduciary duties to offer competitive rates in HSA and if not, then the other flip side is, is why even offer 20 basis points at all, why not just go to zero or something very, very low? Thanks.
So, Ken, good morning. It’s Glenn. And within that 20 basis points are series of tiers. So the lower tier being $1 is like a 5 basis points. It goes all the way up to like a 45 basis points. So that’s the blended average of those rates.
Yeah. Okay. So I think 45 basis points just for like the highest account balance someone could possibly have.
Yeah. Correct.
Yeah. Okay.
Well.
And I guess it goes back to the same question, which is, like, I could go out and buy a money market fund and get like 230 or so currently.
Yeah.
Like, do you have any obligation to pay current rates on, let’s say, even those higher amount?
There’s no specific obligation. But what we do is we keep our rates within kind of the middle of the pack with credit competition. And as we have talked about before, it’s not -- it’s really not a point of competition that it really tends to be more on capabilities, things like investment capabilities and so on. And we have not seen -- we are not getting pressure on rates either up or down, so I don’t expect it to move materially over the near-term.
Ken, one of the things we have seen over time, because this has been kind of an age old question is that, because there is an investment option as you get big dollars, the average balances are still across the full $8 billion, the average balances across the 3 million accounts are pretty low. So people don’t seem to be particularly rate sensitive if they have $700 in their account, they are thinking of it more like a 401-k or and HRA.
And then once they get to a threshold where they are starting to say, hey, wait a minute, I have got real dollars in here and I am losing, they can immediately very efficiently and at low cost sweep into an investment account and control their own destiny with respect to the financial result. And we think that sort of been the valve that has kept their from being kind of market pressure on rates from the consumer.
Yeah. I’d also add that for those 70% that are transaction account holders, it acts more like a checking account than it does a savings account, right? So that has an impact on rates as well.
Yeah. Okay. That helps. And then my second, actually, have a comment more than a question, but you can certainly welcome to respond. With the Cigna contract that we are all talking about. I know you have been asked a couple of times on this. It feels like you guys just dancing around the issue a little bit, like, I know you said, you expanded and extended the relationship, but you refused to comment on whether you actually resigned Cigna. I just worry that if we all kind of later find out that the contract was not resigned, but the expanded and extended related to something else. I just worried that there could be some risk involved with that?
Ken, I appreciate.
Am I right with that?
Ken I appreciate the comment. And obviously, we are -- we respect the relationship we have with Cigna in terms of both sides not disclosing terms of the agreement. And I think, it may seem like I am being a little acute, but the reality is we have a contractual relationship with Cigna, one, it started five years ago when we began a partnership with them. We have extended and expanded that relationship and I think that’s a clear answer.
Okay. Thank you.
Thank you very much.
Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I will turn the floor back to Mr. Ciulla for any final comments.
No. Thank you very much. Thank you for your continued interest in Webster and I hope everyone has a terrific day.
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.