Webster Financial Corp (WBS) 2021 Q3 法說會逐字稿

Good morning, and welcome to Webster Financial Corporation's 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 Webster 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 rules. 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 and 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 receive 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, but 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 that announcement. The 2 organizations are very complementary 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 midsized bank with differentiated businesses and a diverse and growing funding profile.

Interestingly, last week, both Sterling and Webster were among 5 banks nationally to be 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 pretax 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 sponsor and 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 continued 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 time line. 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 2 companies and begin operations shortly after we receive the necessary approvals.

As shared in our merger announcement in April, Jack Kopnisky and I both recognize that a critical element of success in bringing these 2 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 and 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 5 years. Securities called, matured or paid down total 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 in commercial deposits. 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 recognized $16 million of PPP deferred fee accretion and the remaining deferred 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 cost 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 11.7%. 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 adjustments 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 provide 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 costs and loan growth, which was partially offset by lower yields in the securities portfolio. Noninterest income increased $11 million linked quarter, primarily driven by fair value adjustments of $6 million on direct investments and $3 million on customer derivatives 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 accounts and a seasonal decline in interchange revenue.

Compared to prior year, noninterest 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 PPA closure fees recorded a year ago.

Adjusted noninterest 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, noninterest 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 noninterest 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 stand-alone initiatives. Over the last 6 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 to 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 trend. Nonperforming 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-offs, 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 of 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. Noninterest income will decline around $4 million linked quarter as the net result of nonrecurring 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 levels.

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.

(Operator Instructions) Our first question is from Chris McGratty with KBW.

Glenn, maybe to 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. 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 you probably -- we'd probably end the quarter on average for fourth 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. Can you just -- 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 dividend 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, the -- 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?

No, Chris, it's funny. No, 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 of 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.

Our next question is from Matthew Breese with Stephens.

Just on expenses. Obviously, the delta was driven by performance-based comp, and it sounds like that that could happen, at least that's 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?

Yes. 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. Sorry, I wouldn't pull it forward or push it forward.

Okay. And then maybe you could just talk about the health and the strength of the pipeline. Obviously, you're very optimistic on long-term loan growth, but how do you feel about it over the next 3 to 6 months?

Yes, Matt, I'm getting more bullish. I think we talked last time around the fact that before you saw a 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 a little reticent to invest. But obviously, we saw a good third quarter following a pretty good second quarter for us, and our pipeline going into the fourth quarter is one of the strongest it's 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 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 line utilizations pick 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 a follow-up on the last question, the near double-digit loan growth on a combined basis. In this market from Boston to 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 historically, banks that big, it's just tough for them to get the kind of loan growth. How do you intend to get there?

Sure. I think our current assumptions of 8% to 10% really are 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'll 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.

Our next question is from Brock Vandervliet with UBS.

Just zeroing in on a couple of 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 time frame, the seasonal slowdown? And also you noted some strength in CRE. Maybe you could talk about those 2 areas.

Yes. 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 paydowns, and we had fewer paydowns 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 has 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 will 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 cord for us between the operating expense, we saw at Q3 and your goal for Q4 and kind of how we get from here to there.

Yes. So 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, timing of mailing campaigns and things like that. But again, when I pull it all together, we still feel comfortable or feel that will 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 it's efficiency based.

Our next question is from David Chiaverini with Wedbush.

A couple of 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. Sure, David. It's good to hear from you. Yes, the 14 basis point 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 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 the 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.

Just if I can just say a little short. 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 3.40%. And the third quarter, it was like 3.38%. That was basically flat.

Got it. And then shifting to HSA. Can you talk about the pipeline there as we head into the open enrollment period?

Yes, sure. We've got 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 partners -- health care 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 accounts signed up with your large 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 a 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.

Our next question is from Steven Duong with RBC Capital Markets.

Glenn, we've spoken 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.

Yes. Thanks, Steven. Good question. And I'll refer to back to Page 22, where you see our short end up of 50 basis points indicates sensitivity 6.2% on PPNR. It 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 point 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 see that. At least from a modeling standpoint, the beta has come back in. And at that point, we'd say 20%. And then by the first 100 basis points will probably be closer to our -- 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 wildcard. I mean there is a school of thought that says it's going to be closer to 0 for the first 2 moves, so anything like that would be additive to our asset sensitivity.

Yes, yes. 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 deposits. 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 time lines 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.

Our next question is from Laurie Hunsicker with Compass Point.

I just wondered if you could comment on the jump in your leverage S&S and just how we should think about that, so up almost $200 million linked quarter. Where are your plans to grow that? Is that in terms of where the loan growth is going to come in terms of your projection?

Yes. I think, 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 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 to overall exposure.

Okay. And so sorry, just to follow up. So right. So you're $1.4 billion of your $3.6 billion book, maybe ask a different way. What percentage would you like the leverage piece of that to be when you think about growth going forward? Is it going to stay around the same 60-40? Or how do you think about that?

Yes. 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 rated 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 a $20 billion loan portfolio. We still think we have some running room. So if you 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. Can you just clarify the gain that you booked on the strategic initiatives of $4 million, what exactly was that?

Yes. So Laurie, it's Glenn. That was a reversal of an estimate we made on severance liabilities, and it was sort of driven by 2 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 systems. 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 mergers broken down separately. How should we think about that line going forward?

That line being?

Just a strategic initiative line. So last quarter was $1.1 million. Are we -- you've got your -- your branches already closed as of...

I don't think you shouldn't -- I'm sorry, after the fourth quarter, once we achieve our -- as we indicated, we'll achieve the $164 million in efficiency-based comp expenses, you shouldn't expect to see anything. I mean that's really to answer it all. We...

Everything else was related.

Right.

Right.

That makes sense. Okay. Just last question. If you can help a little bit on margins. I'm looking at margins ex PPP, looks like it was 2.65% in June, now 2.60% in September. If we fast forward maybe 2 quarters so the PPP for the most part has gone and then Sterling has rolled in. How should we be thinking about your pro forma margin? Any help that you can give us there?

Yes, 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 less as a result of PPP coming down. And then you'll have some compression on the securities portfolio, and that will be offset by the deployment -- 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 costs down 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, it 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. So it should bode well for core, meaning core ex PPP, net interest margin.

Okay. And sorry, just one last question as we think about margins. Do you have an accretion number yet in terms of what you're thinking about for net interest income with the Sterling? Okay, okay.

Yes. No, we haven't made the work 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. But all that has to be trued up.

Our next question is from Jared Shaw with Wells Fargo Securities.

I guess sticking with the -- 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 staying flat?

Yes, 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 & 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 & 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 and 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 nonbanks to provide financing based on go-forward economic activity.

So I don't think we're gaining significant middle market, market share in traditional multigenerational 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. That's great color. I guess shifting a little bit to the credit side. Credit is very strong. I guess I was surprised to see the allowance ratio stay flat. Can you give us some color over how you're looking at the progression back to a day 1 -- more of a day 1 level and how we should be thinking about that, I guess, in light of also when the deal closes, you'll have an additional supplemental credit coverage from the provision in the credit market?

Yes. 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. The -- 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 our -- 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 a life of loan projected losses over our loan growth.

Okay. 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 under LIBOR?

No, there's -- 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. The spread between SOFR and LIBOR, as you know, for the most part, I would think that the market is probably going to price based on that, right? 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.

And our final question is from Ken Zerbe with Morgan Stanley.

Just if we can go back to expenses. I just want to make sure that we're thinking about the $164 million 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 million doesn't include amortization, so that would make it higher. And then are you excluding all performance-based comp from the $164 million that we should add? All right. Go ahead, please.

Ken, the -- if you look on Slide 9, we -- that's the reason we call it efficiency-based -- ratio-based that we've excluded amortization even from the time we set the target. So it's always been -- that $1 million has always been moved out. My comments were that we feel confident in hitting the $164 million. 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 it's 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 million.

Yes, Ken, when we set the targets and the goals, we're setting performance at plan in terms of revenue performance. And then 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 million if fees and other things were positive.

Exactly, offset in revenue.

Yes, understood. Okay. And then just the other question, just going back to the reserve. Obviously, you are one of the only banks that sort of built or kept your reserve relatively flat this quarter. I mean do you feel that you're at a good -- sort of a good place for your reserve sort of on a Webster stand-alone basis, at least for the near term? And -- 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 1 level that we should be thinking about?

I think look, at 149, I think we feel -- obviously, we feel comfortable with. That's why we 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 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 the former credit officer. The reserve is what the reserve is as you look through your risk rating, your probability defaults and your loss given defaults, and then obviously, you've got your macroeconomic factors. And so we're at the right level right now. Do -- 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 outdeliver and outperform. But our Sponsor & Specialty business does carry with it by definition because it's enterprise-reliant, higher loss-given defaults. Now they haven't emerged in our execution over time. But -- so when the mix is more Sponsor & 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.

I guess that's what 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 1 number. But if you don't want to comment, I understand. I just thought I tried up there.

Yes. Yes, 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 1 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.

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.