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Webster Financial Corp
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Good morning, and welcome to Webster Financial Corporation Third Quarter 2021 Earnings Call. Please note this event is being recorded.
I would now like to introduce Webster's Director of Investor Relations, Kristen Manginelli to introduce the call. Ms. Manginelli, please go ahead.
Thank you, Sherry. Good morning, and welcome. Earlier this morning, we issued a press release to announce Western Financial Corporation’s third quarter 2021 earnings. On the call today, we will provide some brief comments regarding the company's third quarter earnings.
Today's presentation slides have been posted on the company's Investor Relations website. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and are subject to the Safe Harbor rule. Please review the forward-looking disclaimer and Safe Harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us.
I'll now introduce Webster's Chairman and CEO, John Ciulla.
Thanks, Kristen. Good morning and thank you for joining Webster's third quarter earnings call. CFO, Glenn MacInnes and I are here in Waterbury, and we will review our performance for the quarter. I'll also provide an update on the status of our merger process with Sterling, and at the end of our presentation, Glenn and I will take your questions.
Despite the continued impact of COVID, expectations for higher inflation in supply chain and labor challenges, we see increased economic activity and strengthening confidence from our business and consumer clients, with respect to demand for products and services. And we've seen improving loan activity, which coupled with anticipated higher interest rates should benefit the banking industry and Webster.
Credit quality has remained remarkably strong for Webster and for the industry as a whole. With respect to our internal transformational project, we continue to make significant progress on the strategic revenue enhancements and operational efficiencies across the organization, in order to achieve our fourth quarter 2021 cost savings target. Glenn will provide more detail in his remarks.
Related to our merger with Sterling, our teams have been working diligently and collaboratively to prepare for our closing and remain on schedule for all integration design, planning and execution activities. We are in a position to close the transaction shortly after we received the final regulatory approvals on our application.
In August, we received approval from our primary regulator, the OCC and shareholders of both banks. While we have no certainty on the timing of the final approvals, we’re hopefully we will receive them during the fourth quarter. Based on our communications with regulators and the fact that there are no outstanding information requests, we remain confident that an approval is forthcoming.
With respect to the strategic rationale for the merger, I can say that through integration planning our team is more excited about the deal and the opportunities that the combination will provide for our clients, colleagues, communities and shareholders than we were during due diligence and at announcement.
The two organizations are very complimentary, with virtually no customer or branch footprint overlap. And the strong commercial banking teams at both banks will benefit from a larger balance sheet and a more diversified combined loan book. We are creating a unique commercially focused midsize bank with differentiated businesses and a diverse and growing funding profile.
Interestingly, last week, both Sterling and Webster were among five banks nationally recognized by Coalition Greenwich, as 2021 Greenwich CX Leaders. Financial services leaders that have excelled in customer satisfaction, customer loyalty, and creating an environment that is easy for the customer to do business. Specifically, each bank was recognized for customer experience in commercial, middle market banking.
I'll begin the financial report on Slide 2, our financial metrics remain strong. We continue to execute on our fundamental banking activities, organically adding new customers and deepening existing relationships across all business lines and geographies. Excluding PPP, linked quarter loan balances grew by 11% annualized. Despite NIM compression, the strong loan growth enabled us to increase net interest income by 4%, when compared to last quarter. Our adjusted earnings per share in Q3 were $1.08. Third quarter performance includes $5.8 million of net pre-tax charges related to the merger and our strategic initiatives.
Tangible common equity grew by 7%, and is $171 million higher than a year ago. Total revenue in Q3 was 6.5% higher than a year ago, while adjusted expenses decreased 2.7%. Our efficiency ratio improved to 55%, a decrease of more than 500 basis points from a year ago.
Our third quarter adjusted return on common equity was 12%, and the adjusted return on tangible common was nearly 15%. Our $8 million provision was driven by strong loan growth and resulted in a reserve build of $7 million in the quarter. Credit quality remained solid with key asset quality metrics continuing to be near cycle lows.
As a percentage of the portfolio, NPLs, net charge-offs and commercial classified loans were all better than a year ago. And our percentage of NPLs to total loans is at its lowest point since before the Great Recession.
I’m now on Slide 3, excluding PPP, total loans grew 3.3% from a year ago, led by commercial loan growth of $700 million, or 5%. This is a very strong quarter for commercial banking with $1.2 billion of loan originations, up solidly from a year ago, driven by growth in sponsoring specialty, commercial real estate, middle market and business banking verticals.
Loan fundings of $967 million were up 62% or $372 million from a year ago. Consumer loans grew 3.8% or $252 million from second quarter, and declined less than 1% compared to prior year. The linked quarter increase reflected stronger purchase mortgage and lower refinance activity during the quarter. Overall residential mortgage activities drove 82% of consumer loan originations, flat to linked quarter and from a year ago.
I'm now on Slide 4, deposits grew 11.5% year-over-year driven across all business lines. Core deposits grew by $3.8 billion and represent 94% of total deposits compared to 90% a year ago, while CDs declined $686 million from a year ago. Deposit costs continue to decline and were 6 basis points in total in the quarter.
Commercial banking deposits are up more than 23% from a year ago, primarily driven from municipalities and excess liquidity among clients across all lines of business, and all geographies. Retail banking deposits grew 7.3% year-over-year, with consumer and small business deposits growing 6.5% and 12.7%, respectively. Retail deposit costs have continued to decline as well, and totaled 5 basis points in the quarter. Turning to HSA Bank, total deposits grew 5% year-over-year or 8% on a core basis, excluding the TPA balances. Total footings grew 14% year-over-year.
Slide 5 provides an overview of the transaction and integration timeline. As I discussed earlier, merger integration activities continue to be on track, with the team from both banks working collaboratively and tirelessly to position us for success at close and beyond. We are prepared to successfully combine the two companies and begin operations shortly after we received the necessary approval.
As shared in our merger announcement in April, Jack Kopnisky and I both recognized that a critical element of success in bringing these two companies together is from a cultural perspective. As such, we've established a cultural integration framework that provides a clear and aligned view on the purpose and values of the organization, and what we will expect from our colleagues in terms of guiding behaviors and performance. The new executive management team is working together to ensure that our combined culture reflects the strength that both banks bring to the combination.
With that, I'll now turn it over to Glenn for the financial review.
Thanks, John, and good morning, everyone. We reported another quarter of solid results evidenced by strong loan growth, favorable credit performance and continued execution on our merger strategic initiatives.
I'll begin with our average balance sheet on Slide 6. Average securities increased $76 million linked quarter. Securities represented 27% of total assets at September 30. During the quarter we purchased approximately 1.1 billion in securities, up from 600 million in the prior quarter. Purchases had a weighted yield of 1.44% and a duration of five years. Securities called, matured or paid down totaled around $500 million, with a yield of 2.23%.
Our average cash balance held at the Fed totaled $2.3 billion, an increase of $1.1 billion linked quarter, driven by growth and commercial deposit. Average loans increased $125 million or 0.6% linked quarter, primarily driven by an increase in C&I, commercial real estate and residential mortgages, partially offset by PPP loan forgiveness. During the quarter forgiveness on PPP loans totaled $448 million, and the remaining PPP loans were $398 million. In Q3, we recognize $16 million of PPP deferred fee accretion, and the remaining differed fees totaled $15 million.
Excluding PPP, average loans grew $650 million or 3.2%, average commercial loans grew $427 million or 3.1%, while residential mortgage loans increased $297 million, or 6.3%. Average deposits grew $1.1 billion or 4% linked quarter. The increase was driven by continued growth in commercial transaction deposit products, and was partially offset by a decline in higher costs, retail CDs. Average borrowings were flat to Q2, and down $1 billion from prior year as a result of excess liquidity.
Borrowings represent 3.8% of total assets at September 30, compared to 7% a year ago. The loan to deposit ratio was 72% at September 30. The common equity Tier 1 ratio increased 10 basis points linked quarter to 11.77%. The tangible common equity ratio decreased 20 basis points to 7.71%, as a result of balance sheet growth. And tangible book value grew 2.2% linked quarter and 6.4% from prior year.
Slide 7 highlights our GAAP performance and adjustment to reported income available to common. During the quarter, we recognized a net of $4.3 million after tax charges related to our merger and strategic initiatives. On an adjusted basis, income available to common was $98 million or $1.08 per share, resulting in a 12.2% return on average common equity and a 14.8% return on tangible common equity.
On Slide 8, we provided our reported to adjusted income statement. On an adjusted basis, net interest income increased by $9 million linked quarter, driven by loan growth and PPP fee accretion, which was partially offset by a lower yield on securities. NIM of 2.8% declined 2 basis points from prior quarter, primarily due to an increase in excess deposits held at the Fed, partially offset by higher PPP fee accretion.
Excluding excess liquidity and PPP fees, third quarter NIM was approximately flat linked quarter. As compared to prior year net interest income increased by $10 million. This was a result of higher PPP fee accretion, lower funding cost and long growth, which was partially offset by lower yield in the securities portfolio.
Non-interest income increased $11 million linked quarter, primarily driven by fair value adjustments of $6 million on direct investments, and $3 million on customer derivative, as well as higher loan related fees of $3 million. This was partially offset by a decline of $2 million in HSA fee income due to lower exit fees on TPA account, and a seasonal decline in interchange revenue.
Compared to prior year, non-interest income grew $8.7 million. This reflects an increase of $9 million related to fair value adjustments on direct investments, $6.1 million from higher loan and deposit service fees, and $1.7 million increase in investment income. This was partially offset by declines of $5.6 million in mortgage banking revenue, and $2.5 million in HSA fee income. The reduction in mortgage banking revenue was the result of holding more loans on the balance sheet, as we deployed excess liquidity into fixed rate loans. The decline in HSA fee income was driven by $3.2 million in TPA closure fees recorded a year ago.
Adjusted non-interest expense increased $5.6 million from prior quarter, reflective of a $4.3 million increase in performance based compensation, and a $1.4 million increase in technology expense. Versus prior year, non-interest expense declined $4.8 million due to our previously announced efficiency initiatives, resulting in lower occupancy costs, compensation and other expenses.
Pre provision net revenue was $139 million in Q3. This compares to $125 million in Q2, and $115 million in prior year. Our CECL provision in the quarter reflects an expense of $7.8 million. The adjusted tax rate was 23.8%, an increase of 15 basis points linked quarter. The net result is an adjusted net income of $98 million or $1.08 per share, down from $1.21 per share in prior quarter.
As you see on Slide 9, we reported a $5 million linked quarter increase in core non-interest expense. This was primarily the result of performance related compensation, as evidenced by balance sheet and revenue growth and strong credit quality. We expect to complete the execution of our strategic initiatives by the end of the year, and remain on track to deliver core expenses in the range of $164 million in Q4. Any variability would be related to performance based compensation.
The cost savings on this slide are reflective of our standalone initiatives. Over the last six months we've made meaningful progress on our integration plans with Sterling, and remain confident in our ability to deliver 11% of incremental cost synergies on a combined basis.
Turning the Slide 10, I'll review the results of our third quarter allowance for loan losses under CECL. In the quarter, we reported an $8 million provision expense and a $7 million increase in the allowance. The allowance coverage ratio excluding PPP loans remained flat at 1.49% with total reserves of $315 million. As we look at the trend from Q2 to Q3, we established $6 million in reserves related to commercial and residential loan growth, and $2 million due to credit quality and macroeconomic trends.
Slide 11 highlights our key asset quality metrics, reflecting strong credit quality performance. Non-performing loans in the upper left declined $20 million from Q2. Commercial, residential mortgage and consumer each recorded linked quarter declines. NPLs as a percent of total loans are 47 basis points, down from 74 basis points a year ago.
Net charge-offs in the upper right were $900,000 in the quarter, including $1.6 million in net charges for commercial and $700,000 in net recoveries for consumer. Year-to-date, we have recorded $5 million in net charge-off, which is on track for our lowest level since 2005. Commercial classified loans in the lower left increased $2 million from Q2 and represent 251 basis points of total commercial loans.
Slide 12 highlights our strong capital levels. Regulatory capital ratios exceed well capitalized levels by substantial amount. Our common equity Tier 1 ratio of 11.77% exceeds well capitalized by more than $1.2 billion. Likewise, Tier 1 risk based capital is 12.39% exceeds well capitalized levels by $1 billion.
With respect to the fourth quarter, we expect average core loan growth excluding PPP loans to be in the range of 2% to 2.5%. Net interest income will decline $3 million linked quarter, primarily due to lower PPP income. Non-interest income will decline around $4 million linked quarter, as the net result of non-reoccurring fair value marks on direct investment and customer derivatives.
As indicated earlier, core expenses will be in the range of $164 million. Any variability would be related to performance based compensation, and our tax rate will be similar to Q3 level.
With that, I'll turn it back over to John, for closing remarks.
Thanks Glenn. Webster's third quarter results demonstrate our continued focus on building long-term franchise value, and maximizing economic profits through disciplined capital allocation process and strong execution in our differentiated businesses. Our colleagues remain committed to serving their clients, while at the same time preparing for a successful integration. Webster continues and the new Webster will continue to deliver for its clients, communities, shareholders and colleagues.
Lastly, I want to say a big thank you to all of our colleagues for their commitment to our values and dedication to our customers and to each other.
With that Sherry, Glenn and I are prepared to take questions.
Thank you. [Operator Instructions] Our first question is from Chris McGratty with KBW. Please proceed.
Hey, good morning.
Good morning, Chris.
Let me start with you on the deployment in the quarter on the securities book. You've seen a lot of your peers be a little more aggressive in deploying cash. What are your thoughts into the merger in terms of redeploying more cash into the investment portfolio?
Sure. Good morning, Chris. In the quarter, we had an average balance at the Fed of about $2.2 billion and we have begun to deploy some of that. So we're below $2 billion as we speak. And so, I think you would expect with a combination of both loan growth and securities deployment that we would probably end the quarter on average before quarter of about $1 billion.
Okay. Great. And then maybe a question on capital. Once the deal closes, you guys have a lot of capital and you're generating a lot of capital. John, can you just talk about the buyback and the potential magnitude of a buyback?
Sure. I mean, I know when we put out the announcement of the transaction, we showed a $400 million stock repurchase to sort of plug excess capital there. We've talked about a 10.5 target CET1 ratio. And then what I would say is what I always say, which is we'd like to deploy capital in areas where we think we can generate and maximize economic profits first. Clearly, this company will have a lot of excess cash pro forma for the -- capital pro forma for the combination and we also generate a lot of capital each year. So we'll then look at dividends and buybacks.
And, certainly, I think we have the capacity for significant stock repurchase. But again, if we find areas where we can accelerate loan growth, look at acquiring portfolios of commercial loans, or deploying capital into our differentiated businesses, that's first choice. But we'll be appropriate in our allocation of capital deployment.
Okay. And I think you said last quarter, you think the pro forma company can do double digit loan growth. Sterling's results supported that last night. Any change to your view on prior comments?
Chris, it's funny, I still think 8% to 10% growth is absolutely achievable. Could we outperform that? We're going to have a larger balance sheet, we'll have higher holds, but the market is still not back to normal in terms of loan demand. And we've seen fewer payoffs in the last couple quarters, so I think the prudent guidance sticks with approaching that double digit loan growth, which we think as a combined company we can achieve.
Great, thank you.
Thank you.
Our next question is from Matthew Breese with Stephens. Please proceed.
Good morning. Just on expenses, obviously, the delta was driven by performance based comp. And it sounds like that could happen that we set on the table again for the fourth quarter. So could you just outline for us what performance based comp was this quarter? And is that a good range to consider for the fourth quarter?
Yeah, so I think there was a bit of a true up Matt, -- it's Glenn, in the third quarter based on our performance. So it spiked up in the third quarter. At anything, I would expect it to be somewhere between $1 million and $1.5 million in the fourth quarter at most.
Okay.
Sorry, I wouldn't pull it forward, or push it forward.
Okay. And then maybe you could just talk about the health and strength of the pipeline, obviously, you're very optimistic on long-term loan growth. But how do you feel about it over the next three to six months?
Yeah, Matt, I'm getting more bullish. I think we talked last time around the fact that before you saw sort of back to normal loan demand, a lot of these companies and individuals needed to kind of deploy their excess liquidity. And then, obviously, with some uncertainty, and you see supply chain issues and labor issues, maybe people are a little reticent to invest.
But obviously, we saw good third quarter following a pretty good second quarter for us. And our pipeline, going into the fourth quarter is one of the strongest has been in the last several years, and that's across all of our business lines.
Utilization, we still haven't seen a significant tick up there. So that could be a tailwind. If, in fact, we start to see people on the asset conversion cycle and in businesses like ABL start to pick up a little bit. So I'm getting more bullish, and we are seeing a lot of pent up activity.
But again, I still think there's a lot of liquidity out there. And we haven't seen in line utilizations tick up. So, I'm still thinking we're kind of going to be cranking as we get into the second and third quarter next year.
Got it. And then just to follow up on the last question, the near double digit loan growth on a combined basis. In niche market from Boston and New York, these are traditionally slower growth markets, it's going to be a much bigger balance sheet. Could you just walk us through maybe some of the areas that might need to change on a combined basis in order for you to get there? Or maybe it's nothing at all? I mean, are you considering bringing some business lines national or adding new business lines? Could you just give us a sense for it -- historically banks that big, it’s just tough for them to get the kind of loan growth? How you intend to get there?
Sure. I think our current assumptions of 8% to 10% really our BAU. So it doesn't -- we're likely to continue in all specialized national and local businesses out of the gate. And so, we've done a lot of discussions, we've done a lot of diligence. We like all the businesses, it gives us a lot of levers. It gives us diversity across geographies, it gives us some national franchises. And so I don't think that we will make any significant adjustments to the lines of businesses that we're focused on or the geographies we're in over the short-term.
But then -- and you know, Jack, and you know us, I think we will obviously look at each of our businesses as we move forward. And as we get bigger and think, where are the risk return dynamics, can we generate significant economic profits in that business, can we maintain our competitive position, maybe in some of the smaller niche businesses.
But the short answer to your question is, how do we look at 8% to 10% loan growth next year, it's really executing on all the business lines that the combined bank will have currently. And I think, there are opportunities for us to go deeper in some businesses and accelerate that trajectory. But that's not included in our strategic plan right now.
Great. I'll leave it there. Thanks for taking my questions.
Thank you.
Our next question is from Brock Vandervliet with UBS. Please proceed.
Thank you. Good morning.
Hey, Brock.
Hey, just zeroing in on a couple aspects of loan growth. I think you covered the sponsor and specialty and C&I. What are you thinking in terms of residential, especially in the Q4 timeframe, that seasonal slowdown? And also, you noted some strength in CRE, maybe you could talk about those two areas?
Yeah, our commercial real estate actually had one of its biggest origination and funding quarters in quite some time. So there's obviously activity there. But again, we always talk about the dynamic of originations and pay downs, and we had fewer pay downs in commercial real estate in the quarter and that benefited kind of the net growth.
You'll see most of our growth continue to come in the commercial categories, Brock, but we have had a couple of strong quarters in residential mortgage just given the dynamics of interest rates, and kind of activity in the marketplace and where people are moving. Connecticut's been the beneficiary of a lot of influx, which is where we have most of our residential loan exposure, so that's helped.
We do think that'll slow a little bit, just given the seasonality fourth quarter and winter. So, that never really moves the needle ultimately, for our significant loan growth much, so I would say you can anticipate our residential originations and fundings to be slightly lower than the prior quarter. And, we expect the commercial pipelines which are robust to continue to convert into funded loans in the fourth quarter.
Okay. And Glenn, you touched on this in your prepared remarks. But if you could just kind of review and kind of connect the chord for us between the operating expense we saw in Q3 and your goal for Q4, and kind of how we get from here to there?
Yeah, I did kind of hit on it. And I think one of the bigger drivers was this performance based compensation. And so that was the largest driver that will drive that number. There are other things that are sort of more seasonal, whether it's marketing, transit, timing and mailing campaigns and things like that.
But, again, when I pull it all together, we still feel comfortable or feel that we'll hit that around $164 million. And like I said, subject to any variability on performance based comp. That $164 million excludes like amortization and things like that, just its efficiency based.
Got it. Okay, thank you.
Thanks, Brock.
Our next question is from David Chiaverini with Wedbush. Please proceed.
Hey, thanks. A couple questions for you. Starting with on loans, you spoke about the growth, but I wanted to touch on the pricing, loan pricing. And on Slide 3, I see how the yield increased to 3.6% in the third quarter. I'm assuming PPP was a key driver of that. But can you talk about the loan pricing environment?
Sure, David, it's good to hear from you. Yeah, the 14 basis points quarter-over-quarter increase in yield wasn't really on kind of the pricing. It was on acceleration. The biggest drivers were acceleration of deferred fees on PPP and other loans on prepaying.
So I'll give you a sense, in the quarter, from an origination standpoint, our yields actually held up pretty well in terms of prior quarter, which is a good sign. So we're not seeing a lot of degradation in price. And they range from anywhere from kind of the mid 2s yields for high quality commercial real estate, to approaching 5% on a good sponsor and specialty deals, around 4% on business banking, and middle market kind of somewhere in that 2.5% range to 3%. So, depending on the mix those are the coupons on our originations and we didn't see much degradation over the last several quarters, which in a competitive market was a plus for us.
If I can just say a little more, so if you look at the third quarter versus the second quarter, Dave, I mean, the yield is basically flat. If you adjust out for PPP, I think in the second quarter, the yield on the total book was 340. And the third quarter it was like 338. It was basically flat.
Got it. Thanks for that. And then shifting to HAS, can you talk about the pipeline there as we head into the open enrollment period?
Yeah, sure. We've had a good year in selling activity, and as we've talked about, our growth has been around market, particularly in the direct to employer channels. Our healthcare partners have grown a little bit less quickly. Our pipeline this year is good, obviously a lot of what we -- everything that's going to really matter for enrollment period, most of that is kind of in process. And we think it looks fairly encouraging right now. I'd say that obviously, this quarter is kind of slow, as we approach the enrollment period.
The wildcard in the last couple of years and through the pandemic, with the whole industry has been less new customer acquisition and more the amount of account signed up with your larger employers. And with changing employment dynamics, less hiring, more disruption, that slowed a bit. We always talk about 75% to 80% of our new accounts every year actually come from our existing customers. And that kind of waned a little bit last year.
So what I would say is, we're hoping with the changing employment market to the positive that with a good selling season for us and onboarding of new customers, better retention and a more normalized new account opening from existing customers, we should see a pretty robust enrollment period. So we're enthusiastic right now. And obviously, I'm reticent to give you any numbers, because we don't really have a line of sight. And we'll start talking about it in the fourth quarter when we start to see enrollment.
Great to hear. Thanks very much.
Thank you.
Our next question is from Steven Duong with the RBC Capital Markets. Please proceed.
Hey, good morning, guys. Hey, Glenn, we spoke about your deposit beta. Can you share with everyone just overall on Slide 22, your rate sensitivity analysis? What goes into the deposit beta for the first say, 50 basis points and just curious in the subsequent 50 basis points as well?
Yeah. Thanks, Steven. Good question. And I'll refer to back to Page 22, where you see our short end up 50 basis points indicates as sensitivity 6.2% on PPP and OR. That is the factor that we have lowered our deposit beta, it was as high as 32, we did lower it to say between 25 and 30.
But the fact of the matter is, even in a rising rate environment, we're assuming a lag. So the first 25 basis points that we think the beta will be closer to 11, and in fact, the second 25 basis points 11, as well. It's not until like that third lift that we start to at least from a modeling standpoint, the beta has come back. And at that point, we'd say 20%.
And then by the first 100 basis point, we'd probably be closer to what we now say, is our full beta of say, 29%. So there is a lag in there. That is built into this what you see back on Page 22. And it's a wild card. I mean, there is a school of thought that says it's going to be closer to zero for the first two moves. So anything like that would be additive to our asset sensitivity.
Yeah. No, I think that's something we're all trying to wrestle with that we've never been here before. And given the amount of liquidity in the system, it just doesn't seem that everyone's going to be chasing after deposit. I appreciate that.
And then, I guess, John, just on the merger, do you get a sense that the Fed is just backed up? Or is it something more overall, where the regulators kind of want to slow the process down a little bit?
We think it's backed up. And as I said earlier, we don't have clear line of sight to timing. We've had really good discussions and dialogue with all the various regulators. So, what we can say, we announced the deal in April, if you look at historic timelines on mergers, we're still kind of well in a comfortable zone. So we don't think that there's anything sort of behind the scenes that could derail this transaction.
And so, the only thing I want to say is, we've answered all the questions. We really like our application, the merits of the transaction itself, and so we think it's just timing.
I appreciate it. Thank you.
Our next question is from Laurie Hunsicker with Compass Point. Please proceed.
Good morning. I'm just wondering if you could comment on the dumps in your leverage S&S and just how we could think about that. So, it's almost $200 million linked quarter, where are your plans to grow that? Is that a sense of where the loan growth is going to come in terms of your projection?
Yeah, Laurie, I think we've demonstrated over time a really disciplined approach in terms of making sure that our enterprise reliant lending, whether it's regulatorily leveraged or not, the activities in that book remain within the appropriate level, given the entire loan book. That's one of the reasons why we think that this transaction will be so terrific is because it does give us some more running room from a risk management framework and a concentration framework to continue to grow sponsor and specialty.
What's interesting is that that business has high originations, it's very profitable, as you know, and we think we're kind of the best in the business at it. But it also has a relatively low and short average life. So a lot of times you see good originations and a lot of payoffs. So again, I don't think you will see disproportionate outsized growth over the long-term. And I think, once we close the merger, our concentration there is about half of what it was, we'll be able to accelerate growth there to the point we can. We are certainly not in a position right now where us, the regulators, our risk infrastructure, our risk committee is concerned with respect overall exposure.
Okay. So sorry, just to follow up. So your $1.4 billion, your $3.6 billion, so maybe asked a different way, shat percentage would you like the leverage piece of that to be when you think about growth going forward? Is that going to stay around the same 60-40? Or, how do you think about that?
Yeah, I think I'm not sure we look at it that way. I think we look at our overall risk rating. There are some leverage deals that are actually very highly risk graded, and they fit regulatory definition. So I think as a percentage of Tier 1 capital and reserves, we kind of look at our sponsor and specialty overall enterprise book. And, we're kind of comfortable with whatever it is right now, $3.6 billion on $20 billion loan portfolio. We still think we have some running rooms. So if you'd look forward to a $40 billion loan portfolio, we've got significant running room. And I think, we've been prudent risk managers throughout and will continue to be.
Okay, great, helpful. Thanks. Can you just clarify the gain that you booked on the strategic initiatives of $4 million, what exactly was that?
Yeah, Laurie, it’s Glenn. That was a reversal of an estimate we made on severance liabilities. And it was sort of driven by two things. One is that we had a higher retention rate on some of our employees. And then, the second was that there are initiatives that are tied to things like the core banking platform and loan system. So given the MOE, we sort of paused on some of those, until we make those final decisions, so that's really what's driving the $4 million.
Got it. And then, how should we think about that line going forward? Obviously, you've got the merger broken down separately. How should we think about that line going forward?
That line being…
Just the strategic initiative line? So last quarter it was $1.1 million. Are we – you’ve got your branch is already closed as of last quarter.
I don't think you should -- I'm sorry, after the fourth quarter, once we achieve our -- as we indicated, we’ll achieve the $164 million for an efficiency based comp expenses. You shouldn't expect to see anything. I mean, that’s real trade off.
That makes sense. Okay. Just last question, if you can help a little bit on margin, so I'm looking at margin ex-PPP looks like it was 265 in June, now 260 in September. If we fast forward maybe two quarters, so the PPP for the most part is gone, and then Sterling is rolled in. How should we be thinking about your pro forma margin? Any help that you can give us there?
Yeah, let me give you some color on what we see from Q3 to Q4 first, and then -- because you're right, the PPP does run off, but it's sort of offset by the deployment of some of our excess cash as well. So if you think about it, going into the Q4, you'll have say 7 basis points left as a result of PPP coming down. And then you'll have some compression on the securities portfolio and that'll be offset by the deployment of -- primarily offset by the deployment of cash.
And as well as, I think we have a little bit more room on deposits, you would expect to see our deposit closer to 5 basis points in the fourth quarter. So, that you would expect all things considered and I sort of gave the guidance on net interest income, down $3 million that sort of backs into like a 3 basis point compression into the fourth quarter on NIM.
And then as you get into the first quarter, you obviously don't have the benefit of PPP. So you lose that, but you more than offset that on the deployment of excess cash, which should bode well for core, meaning core ex-PPP net interest margin.
Okay. I’m sorry, just one last question. As we think about margin, do you have an accretion number yet in terms of what you're thinking about for net interest with Sterling?
No.
Okay.
Yeah. No, we haven't made the marks yet. And it sort of went back and forth. I mean, I think we're closer to where we were, when we announced the transaction in April today, given where the tenure is at 163. And so, there was a bit of a dip in rates during the second quarter, but I think we're sort of back very close to where we were, when we made the announcement, though all that has to be trued up.
Right. Thank you.
Thanks, Laurie.
Our next question is from Jared Shaw with Wells Fargo Securities. Please proceed.
Hey, everybody, good morning.
Hey, Jared.
I guess, sticking with or going back to the loan growth side, great trends there in a market, I guess that really isn't seeing overall growth yet. I mean, are you taking market share? And if so, where are you seeing the most success in terms of bringing new customers on, especially with utilization rates being flat?
Yeah, it’s interesting, and I've said this a number of times, Jared that particularly in this market, there hasn't been as much trading of traditional like middle market, we're taking from peoples or citizens or they're taking from us. Because a lot of banks, including Webster, and I'm sure Sterling as well have done a really good job of hugging their customers. We're seeing a lot of taking advantage. And I think this is -- and I've described this to the market before, one of the advantages of our commercial real estate and our sponsor and specialty business is taking advantage of economic growth and activity with sponsors. And I use that word sponsors to capture commercial real estate investors, private equity sponsors, family offices, who are engaged in capital markets, activities, acquisitions, mergers, trading of property.
So, when I look at this quarter, for example, we're doing a good job in business banking, of winning more than our fair share. And I think we've got a strong business banking franchise from Boston to Westchester County. So I think that's where our folks are fighting really well on the ground with good products, turning credits around quickly. And so I think that's kind of where we might be gaining share through growth.
I think on sponsor and specialty and commercial real estate, it's the depth and duration of the relationships that we have with our sponsors, and our commercial real estate investors, where we've demonstrated surety of execution over a long period of time, and those transactions are less competitive. Not saying we're the only one, but we're the first call or we're the second call, and then we can kind of win that business. And oftentimes, it's a new acquisition or a repositioning acquisition of a piece of property, rather than saying we're going up against an incumbent bank, we're going up against other banks and non-banks to provide financing based on go forward economic activity.
So, I don't think we're gaining significant middle market, market share in traditional multi-generational middle market companies. I think we're gaining more disproportionate share in the economic activity that's coming back after the pandemic through transactions.
Okay. Thanks, that's a great color. I guess, shifting a little bit to the credit side, credits very strong. I guess I was surprised to see the allowance ratio stayed flat. Can you give us some color over how you're looking at the progression back to a day one more of a day one level? And how we should be thinking about that, I guess, in light of also, when the deal closes, you'll have additional supplemental credit coverage from the provision in the credit market?
Yeah, as Glenn noted, almost the entire provision was related to robust growth on the balance sheet in terms of loans and mix. And so, we're obviously very disciplined in the CECL process. We rely on our models. While still positive going forward, not significant change in the forward outlook, you've got labor challenges and supply chain disruption as well. So, we're sort of status quo, but adding for significant balance sheet growth.
And I think what you'll see over time is, as the economy continues to grow and as we continue to maintain strong asset quality, there's an opportunity for us. And that model will show us that the 149 may be able to come down a bit. So, I know a lot of people think strategically about their CECL model, but we kind of stick to the regimen of the process. And, as we said, there's nothing in the portfolio that's giving us concern. But we'll continue to make sure that we're providing for life of loan projected losses over our loan growth.
Okay. Thanks. And then just finally for me, maybe Glenn, you can just comment on the LIBOR transition, how that's going? And then, we've seen some data that shows that potentially the SOFR spreads are a little bit better. Are you seeing that at all? Or is it still asset under LIBOR?
So first of all, we're well positioned from a LIBOR standpoint. I think we actually have a transaction coming up that will be SOFR based. This spread between SOFR and LIBOR, for the most part, I would think that the market is probably going to price based on that. So, I think that remains to be seen, but I would be surprised if everyone prices down to SOFR without some kind of spread on top of it.
So, we haven't seen enough in the market yet to determine that, but that's kind of what we're thinking right now.
Great. Thanks a lot.
Thank you.
And our final question is from Ken Zerbe with Morgan Stanley. Please proceed.
Alright. Great. Thanks. So if we can go back to expenses, I just want to make sure that we're thinking about the 164 right. And I do recognize that the merger closes, we may not actually see the 164. But it feels like there just might be a little misunderstanding here. So the 164 doesn't include amortization, so that would make it higher. And then, are you excluding all performance based comp from the 164 such that we should add -- all right, go ahead, please.
Ken, if you look on Slide 9, the reason we call an efficiency based ratio based is that we've excluded amortization, even from the time we set the target. So it's always been -- that million has always been moved out.
My comments were that we feel confident in hitting the 164. But with the understanding that if we were up, say $1 million or $1.5 million, it would all be performance based compensation. That's how we feel right now. And that's not to say that we see that right now. But if we continue to have the trends that we've had, whether 3.2% loan growth, favorable credit quality, and things like that, you might expect to see some of that. But generally, I think, we'll be in that range of 164.
Ken, when we set the targets and the goals, we're setting performance at plan, in terms of revenue performance. And then in the last couple of months and quarters, we've actually significantly outperformed. So obviously, Glenn trues up the accrual. And you've actually seen that across a lot of banks this quarter. And to the extent we significantly outperformed plan in the fourth quarter, and there needs to be more accruals, which we're not saying there is right now, but that there could be based on some of the pipeline and trajectory, that could be the delta.
Got it. It would be on top of the 164, if fees and other things were part of.
Exactly, see the excess revenue.
Yeah, understood. Okay. And then just the other question, just going back to the reserve. Obviously, you're one of the only banks that sort of build or capture reserve relatively flat this quarter. I mean, do you feel that you're at sort of a good place where your reserve sort of on a Webster standalone basis, like at least for the near-term? But I guess, more importantly, also, like post the Sterling deal, what is the right ACL target, if you want to call it a day one level that we should be thinking about?
I think what -- look at 149, I think obviously we feel comfortable with that's why we've posted it. It's our outlook on loan growth. And I think Sterling is very similar to us, as a matter of fact, as far as the coverage ratio anyway. So, it's going to be driven by a portfolio mix and economic outlook. So, our growth our provision for the quarter was primarily driven by loan growth and so that's really what drove it.
I think if you look on the slide we had, we took a little on for lower GDP forecast in 2021 and 2022, but the bulk of our provision for the quarter was driven by loan growth.
And Ken, I've always been careful, right, being a former credit officer. The reserve is -- what the reserve is, as you look through your risk rating, your probability defaults and your loss given default, and then obviously, you've got your macroeconomic factors. And so we're at the right level right now.
From a management perspective, when I look qualitatively at the portfolio, is there room for that to come down on a combined basis as well, when concentrations across a larger portfolio will go down. Sure, there is. And I think if you continue to see economic growth and the macro factors continue to improve, and you continue to see good credit quality and good credit management for us and for Webster 2.0. That number can certainly come down.
And I'd also remind people, we feel very good about our credit performance. If you look back now, particularly in commercial banking going back 15-years, I think we've been able to out deliver and outperform. But, our sponsor and specialty business does carry with it by definition, because it's enterprise reliant, higher loss given default.
Now, they haven't emerged in our execution over time, so when the mix is more sponsor and specialty, you also see us have a more robust provision. So that's kind of the way to describe it. But we're at the right level right now, continued execution and macro environment improvement that number can come down.
Yeah, I guess that's why I was asking what is that future number? What could that future number be in a better environment? Other banks would refer to it as sort of their CECL day one number. But if you don't want to comment, I understand. I just thought it building up.
I don't think I can intelligently except to say, I think you're right. There is some credence to looking at that legal day one, if you believe that that's the right macro environment and the size of the portfolio, and then up or down depending on the mix of originations, and what the combined bank at a $40 billion balance sheet, which will probably lower correlated risks and concentrations could provide some relief. I just don't want to speculate on it right now.
All right. Thank you very much.
Thank you.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing remarks.
Terrific. I want to thank everyone for your continued interest in Webster. Have a great day.
Thank you. This does conclude today's conference. You may disconnect your lines and thank you for your participation.