Good morning and welcome to Webster Financial Corporation’s Fourth Quarter 2014 Results Conference Call. This conference is being recorded. Also, this presentation includes forward-looking statements within the Safe Harbor provisions 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 within the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the fourth quarter of 2014.
I would now introduce your host, Jim Smith, Chairman and CEO of Webster. Please go ahead, sir.
Thank you, Kevin. Good morning, everyone. Welcome to Webster’s fourth quarter earnings call and webcast. CFO, Glenn MacInnes, and I will review business and financial performance, after which President Joe Savage, Glenn and I will take questions.
Webster moved further along the path to high performance in the fourth quarter and for the full year 2014 with our sustained growth and progress driven by a succession of solid strategic choices. We’ve invested our capital and resources and energy and growth strategies that are adding value for customers and shareholders.
Beginning on Slide 2, record quarterly net income of $51 million increased 6% year-over-year excluding Volcker Rule OTTI Q4 2013. Well, earnings per share also increased 6% on this basis.
Full year net income reached the milestone of $200 million. Return on average common equity in the quarter was 8.8% and return on average tangible common equity was 11.8% holding steady due to higher capital levels resulting from earnings growth.
All my further comments will be based on core operating earnings. Looking at Slides 3 and 4, year-over-year results were driven by solid Q4 loan growth. Overall loan balances grew 3% linked quarter and over 9% year-over-year with originations across the bank in near record levels. Once again, strength in commercial and commercial real-estate loans up 5% linked quarter and 15% year-over-year accounted for most of the growth.
Quite notably, the net interest margin was unchanged at 3.17% which speaks to our rigorous pricing discipline predicated on relationship profitability and validated by independent outside sources. The strong loan growth and stable NIM produced record quarterly net interest income.
Non-interest income grew 5% linked quarter and 4% year-over-year with particular strength in loan fees. Apart from the $1.8 million year-over-year decline in mortgage banking revenue, growth was almost 8%.
Core Pre-Provision Net Revenue or PPNR grew nearly 3% linked quarter and over 4% year-over-year to another record, we’ve now reported 21 consecutive quarters of year-over-year revenue growth dating back to 2009.
Expenses again grew at a lower rate than revenues, both linked quarter and year-over-year even as we continually invest in our chosen strategies and in a risk infrastructure. The net result once again is an efficiency ratio below 60% pushing PPNR up 8% linked quarter to another record.
The quarterly loan loss provision remained at $9.5 million as loan growth was accompanied by continuing improvement and asset quality. Key credit quality metrics are at levels not seen since 2007 reflecting the improving economy and vigilant risk management. We’ve now built reserves in four straight quarters totaling about $7 million net ad to reserves for the year 2014 versus the prior year net release from reserves of $24 million.
Turning to Slide 5, to put performance into full-year context, sustained revenue growth and expense discipline have resulted in record PPNR of $327 million in 2014 up over 8% from prior year. We’ve now delivered five consecutive years of positive operating leverage and our full-year efficiency ratio has steadily improved over that time by 700 basis points, this performance distinguishing Webster from most of our peers.
Slide 6, demonstrates the balance sheet drivers behind Webster’s multiyear track record of PPNR growth and positive operating leverage. For instance, commercial loans have grown by more than half in four years and now represent 56% of total loans compared to 45% at the end of 2010. Transaction accounts have grown 73% since that time and represent 48% of deposits versus 32% at yearend 2010.
The duration of our assets is much shorter than it was prior to the last upgrade cycle 10 years ago and the duration of our liabilities is longer. So we’re well positioned for a short rate-up scenario.
I’ll now turn to line of business performance beginning on Slide 7. Commercial banking continues to perform at a high level growing loans revenue and economic profit for earning regional and national recognition from its middle market customers for excellence in client service.
Commercial banking loans grew 5% linked quarter and 16.5% year-over-year propelled by record quarterly originations of over $900 million and record fundings of $660 million, reflecting both strong lending activity and new customer acquisition across all business units and all geographies.
Anticipated Q1 payoffs combined with a smaller pipeline due to exceptionally strong loan conversion in Q4 may affect loan growth near term. The portfolio yield declined one basis points linked quarter while the decline in the yield on new fundings reflects origination mix more than competitive pricing pressure.
Q4 similar to Q2 saw a greater proportion of high-quality lower yielding investor CRE fundings representing 31% of Q4 commercial originations compared to 10% in Q3.
We continue to exhibit strong pricing discipline in the Commercial Bank. Samp;P which each quarter provides objective pricing information on our loan originations and portfolio compared to the market. Recently opined that compared to our peers Webster’s more selective use of price as a key lever to win business has resulted in margins remaining at a premium to the market.
The overall deposit decrease linked quarter reflects seasonality and municipal deposits. Transaction deposits increased 12% linked quarter and now represents 64% of total commercial deposits up from 52% a year ago. This accounts for the year-over-year decline in deposit cost and evidences strong momentum in establishing and growing primary bank relationships.
On Slide 8, for the full year of 2014, the commercial banking segment posted positive operating leverage of over 8% and PPNR has grown rapidly and consistently since 2010.
Moving now to community banking, Slide 9, shows the business banking unit continuing its growth trajectory, higher originations up 30% linked quarter and 20% year-over-year drove loan growth. The portfolio yield increased by 11 basis points linked quarter due to an increase in yields on originations and collected interest on non-accrual loans.
Deposits grew year-over-year while a decline from Q3 is entirely attributable to end of period customer activities as average deposits were higher in the quarter. Transaction account balances far exceed loan balances and provide attractive funding for other lending activities.
Turning to the personal banking unit on Slide 10, overall consumer loan balances grew modestly year-over-year and linked quarter. Resi mortgage loan growth reflects an increase in loans originated for portfolio while consumer loans increased about 1%. The linked quarter decline in originations reflects a seasonal drop in mortgage activity which is now picked up a bit in Q1. The linked quarter increase in personal banking deposits reflects seasonal growth and transaction deposits.
Investment assets under administration and Webster investment services grew 9% year-over-year to $2.8 billion driven by a combination of new asset inflows and market gains.
Slide 11, provides more color on residential mortgage origination trends. Overall Resi mortgage production declined 11% linked quarter and rose 27% year-over-year somewhat better than the market due in part to rapid growth in Jumbo originations through new or correspondent channels. Consistent with our mass affluent focus, 82% of mortgages originated per portfolio were Jumbo loans.
Slide 12, the community banking segment continues to make progress along our transformational strategic roadmap designed to improve profitability from a lower expense space. The year-over-year revenues declined 1% against an expense decline of 4% generating positive operating leverage of about 3%. PPNR which totaled $134 million in 2014 has grown consistently since 2010.
Slide 13, presents the results of Webster Private Bank. With the strategic shift to our new business model now virtually complete, loans and deposits increased smartly linked quarter and year-over-year. AUM stabilized following a previously reported personnel changes triggered by the model makeover. And the AUM pipeline has increased significantly over the past two quarters.
Slide 14, presents the results of HSA Bank. Deposits grew about 3% linked quarter and 19% from a year ago. HSA Bank opened about 47,000 new accounts in the quarter, up 50% year-over-year while the cost of deposits declined to 27 basis points.
We expect the new accounts in the peak enrollment period in Q1 of 2015, apart from the January acquisition of JPMorgan Chase’s HSA business, will substantially exceed the 118,000 new accounts that we opened in the first quarter of 2014. Through January 16, the legacy HSA Bank business has added 100,000 accounts and $147 million in deposits.
HSA Bank enjoys a well-earned reputation for outstanding customer service, substantiated by recent recognition from Kiplinger, as the best HSA account for outstanding reputation, service and breadth of investment offering. Our products suite also includes Health Reimbursement Accounts, Flexible Spending Accounts and other capabilities that meet the needs of employers and carriers as well as brokers and individuals.
Turning to Slide 15, and let me take a couple of minutes here. Last week, Webster’s HSA Bank division closed on the acquisition of JPMorgan Chase’s Health Savings Account business. Webster acquired over 750,000 transaction deposit accounts with an estimated $1.3 billion in deposits plus $185 million in linked brokerage account balances.
Pro forma at last yearend, HSA Bank had about $3.2 billion in deposits and about 1.5 million accounts plus about 800 million in linked investment accounts. The acquisition further solidifies HSA Bank’s position as a national leader in Health Savings Accounts and accelerates our strategy to move deeper into the large employer and insurance carrier markets as we added key partnerships with multiple large employer clients and with two of the five largest health insurance providers in the US
The industry has been growing at 20% plus for several years. And experts expect growth to continue at that rate for years to come as employers gravitate to high deductible health plans to control cost and reward their employees for taking responsibility for their healthcare decisions.
HSA Bank has been a fast growing source of deposits for Webster with 10-year compound growth rate of nearly 30%. On a pro forma basis, at December 31, this earnings accretive transaction lowers Webster’s loan-to-deposit ratio about seven points to 82%, while transaction accounts overall increased from 48% of deposits to 53%.
HSAs are strategically important to Webster because they attract low cost, long duration, nationally diverse, purpose driven transaction deposits which provide a stable source of retail funding for Webster’s strong loan growth and liquidity and for managing interest rate risk. HSAs now represent nearly 20% of our deposits and differentiate Webster from our peers in a most positive way. Their enormous value will be seen even more clearly when short rates ultimately rise.
Now I’ll turn it over to Glenn for financial comments.
Thanks, Jim. I’ll begin on Slide 16 which summarizes our core earnings drivers. Our average interest-earning assets grew $445 million compared to third quarter, almost 75% of what was attributable to our loan portfolio. Net interest margin of 317 basis points was unchanged from Q3. Taken together this resulted in record quarterly net interest income of $160.6 million up over 2% from prior quarter and almost 4% from prior year.
Core non-interest income increased by $2.6 million or 5% on a linked quarter basis with the primary drivers being, loan fees and BOLI proceeds. Core expenses were $2.7 million higher than Q3 with the majority of the increase related to compensation and benefits. Taken together, our record core pre-provision net revenue totaled $86.6 million and was up 4% linked quarter and 8% from prior year.
Our pretax GAAP reported income totaled $74.6 million for the quarter and our reported record net income of $51 million includes an effective tax rate of 31.6%.
Slide 17 highlights the drivers of net interest margin versus prior quarter. As highlighted, we achieved quarterly growth and average interest earning assets of $445 million. The securities portfolio had average linked quarter growth of $92 million as we began to purchase securities related to the HSA acquisition. The yield on securities decreased by 2 basis points and interest income was about $400,000 higher.
Cash flow from securities totaled $242 million during the quarter with a yield of 330 basis points. In addition, we sold $62 million of securities that generated gains of $1.1 million while there was $899,000 of OTTI related to spread widening in our non-Volcker compliant CLL portfolio.
Securities purchased during the quarter totaled $464 million with an average yield of 280 basis points and duration of 4.5 years. Average loan balances grew $324 million and the portfolio yield of 383 basis points for the third straight quarter resulting in an increase in interest income of $3.3 million. The quarter included $1 million — an increase of $1 million quarter-over-quarter in income collected on non-accrual loans, which equates to approximately 3 basis points in loan yield for the quarter.
In summary, the lower securities yield and unchanged loan yield resulted in a net reduction of one basis point in the earning asset yield. The reduction was more than offset by an increase in average earning assets resulting in a $3.7 million increase in interest income.
Average deposits increased $19 million, demand deposits increased by $63 million or 2% offset by seasonal outflows and public deposits. The rate paid on deposits was 29 basis points for the third straight quarter with a one basis point decline in the cost of core deposits offsetting a three basis point-increase in CDs.
Average borrowings increased by $415 million while the average cost declined by 7 basis points. The incremental funding was primarily short-term FHLB advances at a cost of around 22 basis points. The net result in Q4 was an increase of about $600,000 in interest expense on borrowings. We expect short-term borrowings to fall by about $1 billion on average in Q1 due to the HSA acquisition and seasonal growth in public deposits.
In summary, earning asset growth and the stable NIM resulted in $3.2 million increase in net interest income.
Slide 18 provides detail on core non-interest income which increased $2.6 million or 5% versus prior quarter. Loan fees increased $2.9 million linked quarter as a result of prepayment revenue. Other income increased $1.4 million primarily from BOLI proceeds. And this was offset by lower mortgage banking revenue as a result of a 9% linked quarter decrease in settlement volume along with modest declines in deposit fees.
Slide 19 highlights our core non-interest expense, which was up $2.7 million from both Q3 and prior year. The linked quarter increase reflects approximately $2 million from a seasonal increase in medical expense, $1 million in expense as a result of an increase in our stock price and $1 million from higher incentive payments.
Our expense discipline and continued focus on operating leverage are reflected in our efficiency ratio on a next slide. As you see on Slide 20, solid revenue growth and continued expense control led to an efficiency ratio below 59%, 33 basis points lower linked quarter and 65 basis points lower than prior year.
The next three slides focuses on the transformation of our interest rate risk profile to a more asset sensitive position in anticipation of rising short-term rates.
Slide 31 summarizes changes to our earning asset mix since 2004, the last time we saw short-term rates increase. As you will see, we are a much different bank today on both sides of the balance sheet from what we were 10 years ago. As a result, we feel we are much better positioned for a rising rate environment than ever before.
The numbers shaded in blue show floating rate earning assets have increased from 19% to 35% of total earning assets since 2004. Also note, 85% of our commercial real-estate portfolio is floating or periodic. Periodic securities, Camp;I and commercial real-estate loans typically have 90-day rate resets. The periodic Resi mortgages are primarily five and seven-year arms.
Slide 22, shows even more dramatic changes on the liability side. Transaction accounts have more than doubled and with the addition of the JPM business, we’ll compromise 42% of liabilities versus 16% 10 years ago.
We’ve also taken actions to lengthen our time deposits and borrowings. In fact, after we pay down short-term borrowings in Q1, the remaining portfolio will have duration of around two years.
Turning to Slide 23, as we have discussed on past calls, we have been making a conscious shift to become more asset sensitive and this slide shows the progress we have made. Here you see our asset sensitivity profile as we get closer to a tightening of monetary policy which we expect to occur later in the year. We have made this shift at minimal cost to our NIM and net interest income. In fact, our NIM has only declined 10 basis points over this time period despite a very challenging rate environment.
The HSA acquisition is included in the 2014 yearend numbers, and it has added 2% for asset sensitivity. We expect to invest about $500 million of deposits and securities and use the remaining proceeds to pay-down short-term borrowings. In Q4, we have already purchased about half of that and expect to complete the investment program by April.
Our asset sensitivity assumes deposit rates react immediately to changes in market rates. A lag in timing of deposit rate increases or a bold twister scenario would improve our results significantly.
Turning now to Slide 24, which highlights our asset quality metrics. Non-performing loans in the upper left declined to $132 million and were 0.95% of total loans, our lowest level since Q4 of 2007. New non-accruals were up about $1.5 million to $25 million though noticeably below the prior year level of $40 million. Past due loans in the upper right also saw another quarterly decrease and now represent 0.29% of total loans.
Commercial classified loans in the bottom left increased $13 million and remain in line with the recent trend while continuing to represent a little over 3% of commercial loans. Our annualized net charge-off rate of 20 basis points on $6.7 million of net charge-offs in the quarter represents the fourth consecutive quarter at or below 25 basis points. The full year charge-off rate was 23 basis points compared to 48 basis points in 2013.
Assuming recent economic trends remain intact, continuing improvement in key asset quality metrics is expected as we head into 2015.
Slide 25 highlights our capital position. The ratios that you see here declined slightly from the levels at September 30, but remain well in excess of the fully phased in Basel III well-capitalized level in our internal targets. Strong asset growth impacted capital ratios this quarter
Tangible common equity was impacted due to a yearend pension liability valuation adjustment of $21 million which lowered the ratio by 10 basis points. The decline in Tier 1 common was driven by strong asset growth, the HSA acquisition will impact this ratio by about another 30 basis points in Q1 and bring us closer to our long-term target of 10%.
Our strong capital position and solid earnings continue to support asset growth, provide for future increases in the dividend and selective buybacks and enable us to confidently pass the annual regulatory severely adverse stress scenario.
Before turning it back over to Jim, I’ll provide a few comments on our expectation for the first quarter. Overall, average interest-earning assets will grow approximately 3%, which include security purchases in connection with the HSA acquisition. And we expect average loan growth to be approximately 2% with growth expected to be led by Camp;I.
We expect to see continued pressure on net interest margin and assuming the level of the 10-year swap and its spread to mortgage rates remain in today’s range, we would expect two to four basis-point compressions in Q1 driven by lower securities and commercial yields.
That being said, we expect to increase — we expect an increase of up to $1 million in net interest income over Q4, driven by loan and investment volume with some offset in NIM compression.
Leading indicators of credit continue to see no further improvement in asset quality. Given the outlook for loan growth in Q1, we expect to see a modest increase in the Q1 provision.
Regarding non-interest income, we expect an increase of 10% to 11% over Q4 core level. And this is driven primarily by an increase in deposit service fees as a result of our HSA acquisition in addition to higher wealth and investment fees, with some offset from lower loan prepayment revenue.
While our expense base will increase by approximately $5 million from the HSA acquisition, we will continue to demonstrate a disciplined approach to investing in the business and expect to operate with core operating expenses at a targeted level to keep our efficiency ratio below 60%.
Our expected effective tax-rate on a non-FTE basis to be around 33% due to increased earnings and lower tax exempt income, and we expect the average diluted share-count to be in the range of 90.7 million shares.
So with that, I’ll turn things back over to Jim.
Thanks, Glenn. Before we begin Qamp;A, I just want to take a moment to acknowledge the recent high-recognition of Glenn, Terry and Webster’s overall investor relations program is nominated by sell-side analysts who cover us in Institutional Investor magazine’s 2015 company rankings. Congratulations, John.
We’ll now take your comments and questions