Webster Financial Corp (WBS) 2020 Q3 法說會逐字稿

Good morning, and welcome to the Webster Financial Corporation's Third Quarter 2020 Earnings Call. I will now introduce Webster's Director of Investor Relations, Terry Mangan. Please go ahead, sir.

Thank you, Maria. Welcome to Webster. 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 with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the third quarter of 2020. I'll now introduce Webster's Chairman and CEO, John Ciulla.

Thanks, Terry. Good morning, everyone. I hope you're all safe and well. Thank you for joining Webster's third quarter earnings call. CFO, Glenn MacInnes and I will review business, financial and credit performance for the quarter after which HSA Bank President, Chad Wilkins; and Jason Soto, our Chief Credit Officer, will join us for Q&A. As a reminder, our presentation deck includes the supplemental section containing additional information and disclosures. We remain focused on managing capital, credit and liquidity as we continue to deliver for our customers, communities and shareholders. We're positioning ourselves for growth and outperformance. Our differentiated businesses and our engaged bankers, who I'm so proud of, help us win in the marketplace every day. In a challenging environment, we generated meaningful business activity in the third quarter. Our bankers are working with our customers and prospects, and we are generating new relationships, loans and deposits.

Loan originations were higher than a year ago and our pipelines are solid. HSA Bank is winning more direct-to-employer relationships than a year ago. Our operational execution remains strong and we continue to manage credit and enterprise risk effectively.

Turning to Slide 2. Pre-provision net revenue of $110.4 million increased 2% from Q2 as revenue grew in excess of expenses. Earnings per share in the quarter were $0.75 compared to $0.57 in Q2 and $1 in the prior year's third quarter.

Our $23 million provision resulted in a reserve build of $11 million. Glenn will walk you through the assumptions underlying the CECL process and resulting provision for the quarter. Our third quarter return on common equity was 9%, and the return on tangible common equity was 11%. As I mentioned last quarter, we remain confident in our ability to again sustainably generate economic profit, even in this more economically challenging and lower interest rate environment. I'll provide further perspective in a few minutes. Loans grew 12% from a year ago on Slide 3 or 5% when excluding $1.4 billion in PPP loans. Commercial loans grew more than 10% from a year ago or by almost $1.2 billion, led by growth of more than $900 million in high-quality commercial real estate loans.

The decline in floating and periodic rate loans to total loans compared to a year ago reflects the $1.3 billion of fixed rate PPP loans added in the second quarter. Deposits grew 16% year-over-year driven across all business lines. Core deposits exceeded $4.3 billion and represent 90% of total deposits compared to 86% a year ago, while CDs declined $685 million from a year ago.

Slides 4 through 6 set forth key performance statistics for our 3 lines of business. Commercial banking is on Slide 4. Loan balances increased almost 10% from a year ago, excluding PPP loans. Both investor CRE and C&I businesses in middle market banking and sponsor and specialty saw double-digit loan growth year-over-year. Deposits up 32% from a year ago are nearly $6 million at September 30 as our commercial clients maintain liquidity on their balance sheets. Commercial deposits were up 11% linked quarter on seasonal strength in our treasury and payments solutions business, which includes government banking.

HSA Bank is on Slide 5. Core deposit growth was 15% year-over-year or 12.6%, excluding the impact of the State Farm transaction, which closed in the third quarter and added 22,000 accounts and $132 million in deposit balances. We continue to see strong increases in new direct-to-employer business opportunities throughout the quarter, winning more new HSA RFPs than we did last year, specifically in the large employer space. COVID-19 has impacted the HSA business, with new account openings 28% lower from prior year when adjusting for the State Farm acquisition. This is consistent with the industry and is due to slower hiring trends across our employer customers.

HSA consumer spending increased in the quarter, a trend we expect to continue as elective medical services continue to open up across the country. This spending rebound had a favorable impact on interchange revenue when compared to Q2. PPA accounts and balances declined 41,000 and $64 million, respectively, linked quarter, continuing the out migration of accounts that we disclosed a year ago. In the quarter, we recognized approximately $3 million of account closure fees related to the out migration.

Performance fundamentals of HSA Bank and the broader HSA market remains strong with ample opportunity for continued growth. And while it's too early to forecast the upcoming January 1 enrollment season, we're pleased with the large direct-to-employer wins we've recorded in this challenging 2020 selling season.

I'm now on Slide 6. Community banking grew almost 10% year-over-year and declined slightly, excluding PPP. Business banking loans grew 5% from a year ago when excluding PPP. Personal banking loans decreased 3% from a year ago as an increase in residential mortgages was offset by declines in home equity and other consumer loans. Community banking deposits grew 12% year-over-year with consumer and business deposits growing 6% and 32%, respectively. The total cost of community banking deposits was 24 basis points in the quarter. That's down 48 basis points from a year ago.

Net interest and noninterest income both improved 3% from prior year, driven by increased loan and deposit balances and by mortgage banking and swap fees, respectively. Self-service transactions declined slightly linked quarter as we expanded and opened banking centers with enhanced safety protocols, but grew year-over-year, reflecting the continued shift in consumer preference to digital channels.

The next 2 slides address credit metrics and trends. Our September 30th reported credit metrics remained favorable and actually improved modestly, which Glenn will review in more detail. While pleased with the reported metrics, we nonetheless remain appropriately cautious on credit as we continue to operate through the considerable uncertainties presented by the pandemic.

On Slide 7, we've updated our disclosure on the commercial loan sectors most directly impacted by COVID, including payment deferral information.

The key points on this slide are that overall loan outstandings to these sectors have declined 5% from June 30, and the payment deferrals have declined $282 million or 57%.

On Slide 8, we provide more detail across our entire $20 billion commercial and consumer loan portfolio. The key takeaway here is that payment deferrals declined by 65% to $482 million at September 30 and now represent 2% of total loans compared to 7% at June 30. Consistent with industry trends, we've had meaningful declines in payment deferrals in every loan category from June 30 to September 30.

Of the $482 million of payment deferrals at September 30, $251 million or 52% are first time deferrals. CARES Act and Interagency Statement payment deferrals, which are included in the $482 million of total payment deferrals at September 30 decreased 62% from June 30 and now totaled just $283 million. While pandemic-related challenges remain, we are pleased to have been able to provide considerable support to our customers and communities under our mission to help individuals, families and businesses achieve their financial goal.

As I stated last quarter, we are actively monitoring risk. We are making real-time credit rating decisions and addressing potential credit issues proactively. We continue to feel good about the quality of our risk selection, our underwriting, our portfolio management capabilities and the strength of our capital and credit allowance positions. I'll now turn it over to Glenn for the financial review.

Thanks, John. I'll begin with our average balance sheet on Slide 9. Average securities grew $184 million or 2.1% linked quarter and represented 27% of total assets at September 30, largely in line with levels over the past year. Average loans grew $262 million or 1.2% linked quarter. PPP loans averaged $1.3 billion in Q3 and grew $403 million from Q2, reflecting the full quarter impact of loans funded last quarter. We had no forgiveness activity on PPP loans during the quarter, and therefore, no acceleration of deferred fees.

During the quarter, we had $5.5 million of PPP fee accretion and the remaining deferred fees totaled $35 million. Apart from PPP loans, commercial real estate loans increased $124 million or 2%, while asset-based and other commercial loans decreased $108 million and $38 million, respectively. The $119 million decline in consumer loans include $62 million in home equity and $32 million in residential mortgages.

Deposits increased $1 billion linked quarter, well in excess of the combined growth of $446 million in loans and securities. We saw increases across all of deposit categories, except CDs, which declined $280 million or nearly 10%. The cost of CDs declined 36 basis points and was a significant driver of our reduction in deposit costs. Public funds increased to $599 million in a seasonally strong third quarter, while the cost of these deposits declined from 35 basis points to 18 basis points. Borrowings declined $744 million from Q2, and now represent 7% of total assets compared to 8.5% at June 30 and 10.5% in prior year.

Regulatory risk-weighted capital ratios increased due to growth in equity. The tangible common equity ratio increased to 7.75% and would be 34 basis points higher, excluding the $1.4 billion and 0% risk-weighted PPP loans. Tangible book value per share at quarter end was $27.86, an increase of 1.7% from June 30 and 4.8% from prior year.

Slide 10 summarizes our income statement and drivers of quarterly earnings. Net interest income declined $5.1 million from prior quarter. Lower rates resulted in a quarter-over-quarter decline of $16.7 million in interest income from earning asset. This was partially offset by $7.9 million due to lower deposit and borrowing costs and $3.7 million as a result of loan and security balance growth. As a result, our net interest margin was 11 basis points lower linked quarter. Core loan yields and balances contributed 14 basis points to the decline, with PPP loans contributing another 2 basis points to the NIM decline.

Lower reinvestment rates on our securities portfolio resulted in 3 basis points of NIM compression, while higher premium amortization resulted in additional 4 basis points of NIM compression. This was partially offset by a 10 basis point reduction in deposit costs, reflective of reduced rates across all categories, which benefited NIM by 10 basis points. And fewer borrowings contributed another 2 basis points of NIM benefit. As compared to prior year, net interest income declined $21 million. $65 million of the decline was the net result of lower market rates, which were partially offset by $44 million in earning asset growth. Noninterest income increased $15 million linked quarter and $5.2 million from prior year.

HSA fee income increased $4.1 million linked quarter. Interchange revenue increased $1 million, driven by a 12% linked quarter increase in debit transaction volume. We also recognized $3.2 million of exit fees on TPA accounts during the quarter. The mortgage banking revenue increase of $2.9 million linked quarter was split between increased origination activity and higher spreads.

Deposit service fees increased $1.5 million quarter-over-quarter driven by overdraft and interchange fees. Consumer and business debit transactions increased 16% linked quarter. Other income increased $5.7 million, primarily due to a discrete fair value adjustment on our customer hedging book recorded last quarter. The increase in noninterest income from prior year reflects higher mortgage banking revenue and HSA fee income, partially offset by lower deposit service and loan-related fees.

Reported noninterest expense of $184 million included $4.8 million of professional fees, driven by our strategic initiatives, which John will review in more detail. We also saw a linked-quarter increase of $4.3 million from higher medical costs due to an increase in utilization. Noninterest expense increased $4.1 million or 2.3% from prior year. The efficiency ratio remained at 60%. Pre-provision net revenue was $110 million in Q3. This compares to $108 million in Q2 and $131 million in prior year. The provision for credit loss for the quarter was $22.8 million, which I will discuss in more detail on the next slide. And our effective tax rate was 20.9% compared to 21.8% in Q2.

Turning to Slide 11. I'll review the results of our third quarter allowance for loan losses under CECL. As highlighted, the allowance for credit losses to loans increased to 1.69% or 1.8%, excluding PPP loans. We have summarized the key aspects of our macroeconomic scenario, which reflect the gradual improvement in employment with real GDP returning to pre-COVID levels in 2022. The forecast improved slightly from prior quarter, but was offset by commercial risk rating migration, resulting in a provision of $23 million.

The $370 million allowance reflects our estimate of life of loan losses as of September 30. We will continue to assess the effects of credit quality, loan modifications and the macroeconomic conditions as we move through the pandemic.

Slide 12 highlights our key asset quality metrics as of September 30. Nonperforming loans in the upper left decreased $10 million from Q2. Commercial real estate, residential mortgage and consumer, each saw linked-quarter declines, while commercial increased $3 million.

Net charge-offs in the upper right decreased from second quarter and totaled $11.5 million after $4.3 million in recoveries. C&I gross charge-offs declined slightly and totaled $12 million, primarily reflecting credits that were already experiencing difficulty prior to the onset of the pandemic. Commercial classifieds in the lower left represented 332 basis points of total commercial loans. This compares to a 20 quarter average of 315 basis points, and the allowance for credit losses increased to $370 million, as discussed on the prior slide.

Slide 13 highlights our liquidity metrics. Our diverse deposit gathering sources continue to provide us with considerable flexibility. Deposit growth of $565 million exceeded total asset growth and lowered the loan-to-deposit ratio to 81%. Our sources of secured borrowing capacity increased further and totaled $11.7 billion at September 30.

Slide 14 highlights our strong capital metrics. Regulatory capital ratios exceeded well capitalized levels by substantial amounts. Our common equity Tier 1 ratio of 11.23% exceeds well capitalized by more than $1 billion. Likewise, Tier 1 risk-based capital exceeds well capitalized levels by $870 million.

Looking to the fourth quarter, we expect stable loan balances with modest PPP forgiveness. Assuming a flat rate environment with an average 1-month LIBOR in the range of 15 basis points and an average 10-year treasury swap rate around 70 basis points, we believe we are near the bottom of core NIM compression. Noninterest income will likely be lower linked quarter due to a reduction in mortgage banking income and lower HSA fees on TPA accounts. Core noninterest expense will remain in the range of Q3, and our tax rate will be around 21%.

With that, I'll turn things back over to John for a review of our strategic initiatives.

Thanks, Glenn. I'm now on Slides 15 and 16. As I've mentioned on recent earnings calls, we have been and remain focused on revenue enhancements and operational efficiencies across the organization. Well before the onset of the pandemic, our management team recognized that we would be operating in a low interest rate and more challenging business environment for an extended period of time. In January, we began an enterprise-wide assessment of our organization to identify revenue opportunities and cost savings using a very thorough and systematic process. The onset of the pandemic in March further impacted the operating environment and accelerated changes in customer preferences and shifting workplace dynamics. This not only made our commitment to this process that much stronger, but it also expanded the opportunities we have to rationalize and align our expenses with our business line execution.

We've identified and begun to implement dozens of initiatives across the bank, a handful of which are set forth on Slide 16 that will result in driving incremental revenue, reducing our overall cost structure and enhancing our digital capabilities to meet our customers' needs and to reduce our cost of delivery of products and services. Our focus remains first on key revenue and asset growth drivers, including accelerating growth in commercial bank by building on our proven track record in select specialized industries, driving HSA Bank growth through improved sales productivity and customer retention and continuing to grow in community core markets through product enhancements.

We are also focused on efficiency and organizational alignment, simplifying our org structure, capturing targeted back office synergies and redesigning and automating critical processes. We also are rationalizing and consolidating our retail and corporate real estate footprint. Through this process, we will continue to improve the customer experience by enhancing digital capabilities, modernizing foundational systems and improving analytical capabilities.

We've begun executing on many of these initiatives, and we recently made a series of organizational changes to position us for success over the next year and well beyond. We plan to provide more detailed information on these initiatives, including additional financial details and timing on realization on our fourth quarter earnings call in January, as we are continuing to work through all of the final decisioning.

What I will say is that with respect to efficiency opportunities, we anticipate reducing our current expense base by 8% to 10%, fully realized on a run rate basis by the fourth quarter of next year. We see considerable opportunity above and beyond that as revenue initiatives and further efficiency gains are realized late in 2021 and in 2022. As we stated last quarter, we remain confident that even if the current operating environment persists with low interest rates and economic uncertainty, the execution on our identified revenue enhancements and efficiency opportunities will allow us to sustainably generate returns in excess of our estimated 10% of cost of capital by the end of 2021.

Our vision remains consistent and is to strengthen our position as a major regional bank in the Northeast that lead with a distinctive and expanding commercial business and aggressively growing and winning national HSA Bank business, a strong community bank franchise in our core markets, all supported by an efficient and scalable operating model.

I want to say a big thank you to all of our bankers for their incredible work during these challenging times. With that, Maria, Glenn, Chad, Jason and I are prepared to take questions.

(Operator Instructions) Our first question is from Steven Alexopoulos from JPMorgan.

John, I want to understand the comments around reducing the expense base. So is this 8% to 10% reduction -- is that -- if we look at this quarter's expenses, about $65 million, $66 million would be the midpoint. Are you saying by 4Q of next year, that will be in the run rate, is that the expectation?

Right. I think we can outperform that, Steve, but we're absolutely confident to put that bogey out there. So I think you have the quarterly expense base a little bit lower, Glenn can talk about that. But that's exactly what we mean. So if you look at third quarter kind of core expenses, we expect to achieve a 10% reduction in those expenses by the fourth quarter of next year from run rate perspective.

Yes. Our stated core -- our GAAP expenses for the quarter were $183 million, almost $184 million, and there were some onetime costs in there, but you can use that as approximate.

As a base. Okay. So -- and that will obviously help with 2022. But as you think about next year, I think we're all struggling with what pretax pre-provision income growth could be for everyone, right? And Glenn, it's helpful that NIM is close to a bottom. But could you frame for us, obviously, this is going to set up a better situation 2 years from now. But talk to us about the ability to grow pretax pre-provision next year.

Steve, I'll give you a little -- obviously, we're not going to provide detailed guidance, but I'll give you a little bit of perspective. In the fourth quarter, we'll talk -- as we work through our final analytics and make final decisions, we'll be able to provide you with kind of our quarterly realization of expense saves and revenue enhancements. So we will see progressive improvement in our operations over the course of 2021. So it doesn't all just magically appear at the end of the year. I think from a top line perspective, the -- we think that we're roughly at the bottom of NIM compression if rates kind of stay where they are. We have confidence that we'll be able to grow assets. Fees are hard to predict in this environment. And obviously, provision from a net income perspective -- I know you asked about PPNR, it's kind of a wild card from a profitability perspective.

So our full plan is to improve incremental profitability and PPNR each of the quarters in 2021. So we're not kicking the can forward, but we wanted to put a stake in the ground of what we expect to do from sort of a structural realignment of the way we operate into 2022. So I would say stay tuned for more details in our January call, but also, we fully expect if the operating environment stayed stable, that we would see incremental improvement in each of the quarters in 2021.

And Steve, the only thing I would add to that is, it's not core, but as I indicated in my prepared remarks, we have about $35 million in deferred fees and PPP that we expect during the course of 2021, most of that would probably be forgiven. So that will impact earnings as well up to, say, $33 million to $35 million.

Okay. That's helpful. And to shift to credit, actually, before I ask my question, if we look at the COVID-19 impacted loan slide, do those balances include any leverage loans? Or are those outside of those buckets? And then I have one question.

Those are all sector based, so they would include any loans we have related to those segments. Jason, I don't know whether you want to put more color on that?

Yes. No, both slides include leverage loans, both on the sector slide. And if you look at the next page, leverage is actually broken out separately, so you can see the detail there.

Yes. Okay. So I think somewhere adding leverage on top of those, but that's already included. Okay. That's helpful.

Yes, correct. Correct.

So now -- I mean, we've been looking at this slide now for 2 quarters. Can you talk to us in terms of the deeper dive you've done in the portfolio? And where you're now most concerned for losses?

Sure, Steve. Jason, I'll go right to you, and then maybe I'll make some comments.

Yes. So when we think about overall losses, look, we do a deep dive. We have weekly meetings with the lines of business to assess modifications, deferrals, trends, a lot of color from our borrowers because we're having conversations regularly. If you think about in terms of total losses, I think about the -- in the near term, I would say it's going to be the troubled sectors that we're all focused on. We had some credits that were pushed over the edge initially that were having trouble before COVID.

Going forward, it's going to be the sectors that we're -- that everybody is focused on, being hotels, travel and leisure, media, restaurants. But going forward, I guess what I would say generally is, I'm a little concerned about the business banking, small business portfolio. But if you look at the DDA deposits for those borrowers overall, at 9/30 versus pre COVID. They're actually very healthy and deferrals overall are sort of going down. So you feel cautiously encouraged at the moment in terms of how that portfolio is going to perform.

So I think there are pockets of risks throughout the portfolio that we're focusing on, but I don't see any area where we have significant concentration that I'm overly concerned about. So we had a good quarter in terms of third quarter, in terms of charges and NPLs. I think those numbers will likely get a bit worse throughout 2021 before they return to normalized levels. But I continue to be cautiously encouraged and I think that the likelihood of some additional stimulus given the rising cases throughout the country will also be helpful and necessary at some level.

Yes, Jason. I'd say, Steve, if you look at our slight pickup in classifieds, the biggest contributors were those sectors that Jason just referenced. We do look at whether or not we need specific reserves on those credits. We don't have a lot of identified embedded loss. So I do think there are some wildcards about path of the virus about the level of stimulus. But I too agree with Jason that it's really sector based. We're not seeing any differences in performance across geographies, business units or those elements or product type. It really relates to whether a sector needs people to gather and be close together and travel. So I think those are the big keys.

And fortunately, relative to our peers, we've got lower exposure in those categories, which we're happy about.

Our next question is from Collyn Gilbert with KBW.

This is great color on the expense plan and certainly a great plan. So appreciate that. John, you had alluded to that maybe in the beginning of next year, we'll get a little bit more color. Just curious, kind of broadly -- I know you put it in the slides, but just broadly where you're going to see kind of some of those savings come? I know you mentioned real estate rationalization or -- is there any more color you can offer just kind of broadly as to where you see those expense reductions coming?

Yes. It's just difficult in terms of where we are in the process to give specifics because some final decisions haven't been made. But I think you're right. If you look at our retail branch network, if you look at our corporate space with the changing work environment, we expect to gain material efficiencies in those categories. We're also automating manual processes, combining like functions across HSA and Webster and creating centers of Excellence that not only we believe will bring us efficiencies, but as importantly, Collyn, will make our ability to deliver for our customers better and take out defects.

And so we're pretty excited about some of the preliminary work we're doing. And we're prepared to put the cost movie out there because we've been working on this for 10 or 11 months. Glenn referenced the additional expense related to the project. We're obviously using professionals and outside help to go through this process and we think it will change the way we do business and transform the organization. So we look forward to sharing more in the first quarter on our call. But we're not really prepared to go any deeper right now.

Okay. Okay. And then just in terms of kind of your outlook for loan growth, with the comment that you made, the intention is to try to continuing to build PPNR next year. Any -- where do you see the opportunities to kind of grow the loan book, either from a geographic perspective or from a loan segmentation perspective?

Yes. No, I think that's a great question, and I'll relate it a little bit to Steve's question on credit performance, that it really ends up being sector based. And we're fortunate, as we said before, to have either been really good or a combination of lucky and good in where we play. So we don't have a lot of -- we're not relying on a lot of oil and gas. We're not relying on leisure, hotels. And so we've been focused, as you know, in health care, technology and technology infrastructure, which is our largest exposure in the sponsor and specialty business and has not only performed brilliantly during the pandemic, but it's actually accelerated. So we had $173 million in new originations in sponsored and specialty in Q3.

Our commercial real estate has been really good. We've been focusing a lot on albeit lower earning, but really high-quality institutional government transactions in our middle market group. So we had $531 million in commercial bank originations in the quarter, which sort of is similar to what we had in Q1 before the pandemic really set in. So I think for us, there's no question that loan demand is going to be muted. That's just the way it's going to be because I think there's going to be uncertainty, not as much corporate confidence and investment. And I think even individuals, as you know, are keeping very liquid right now. So I think demand will be down, but I think there will be pockets and sectors where we play very well, where we'll continue to make new loans. So -- and I do think what we said in our 1Q call that even though before we had seen any behaviors, our guess was that loan origination would be lower, but the prepayments would be lower. That's all coming true.

So this quarter, we saw loan growth on lower originations in commercial, and we obviously had kind of really high mortgage originations. So I think we'll still see mortgage, we'll see some growth in personal loans and in commercial, in the sectors where we perform best and where we have great relationships and are not being negatively impacted by the pandemic, I still think we have confidence that we can grow assets.

Okay. That's great. And then just one final question on M&A, and you're welcome to answer it relative to HSA or the bank. But just curious as to how you guys are thinking about potential acquisitions as you look out. Need for scale, obviously, you're addressing it within your own organization, but what kind of the opportunities are a little bit longer-term or more broadly for you guys to really increase scale through acquisitions, again, through either the core bank or the HSA bank?

Sure. It's a great question. And our comments have evolved over the last couple of years on the calls from a complete focus internally to a recognition that we do think scale is really important. And so I would say that we're always looking. You saw the State Farm transaction. There are other transactions like that in the marketplace that we look at all the time.

With respect to HSA, portfolio acquisitions, teams of commercial bankers, those are things we would act on, regardless of what the environment is. And we do think that there is a higher likelihood that we would be engaged in some sort of bank M&A on the other side of this. And so what you see right now is our laser focus on making sure that we are recognizing our potential from PPNR perspective and a valuation perspective by focusing on being the best we can be, scalable and nimble, which I think will put us in a really good position because we believe that there will be more M&A in the mid-cap bank space coming out the other side of this, and we want to make sure we're controlling our destiny. And as I said, we'd never say never. We're focused internally now, but we do want to gain scale when there's clear visibility on the other side of credit through this pandemic.

Our next question is from Mark Fitzgibbon with Piper Sandler.

Just a follow-up on one, maybe for Jason. I know it's hard to sort of estimate and there's lots of variables at this point. But based on what you see today, how are you thinking about provisioning levels in, say, the fourth quarter and beyond?

Yes, sure. I can start and maybe, Glenn, you want to jump in as well. So when you think about some of the bigger drivers, ratings migration, right? You saw we had some migration to classify this quarter. I would say, as we got a view into revenue recovery in the third quarter from a lot of our borrowers, right, many of them recovered very quickly. Some of them, we realized it's going to take a little bit longer. Those are the ones that we downgraded to classified.

I feel like, at this point, we've got the book well-rated and we'll probably be calling balls and strikes over the next few quarters. So I don't see a major level of migration at this point. Some of the situations, in special mention, they may deteriorate, but you'll probably have just as many, if not more, that will improve. So I don't see a huge pressure barring an increase in cases or something falls apart in terms of additional stimulus. I don't see a huge pressure on reserves in the short term. But obviously, that could change based on the environment. I don't know if Glenn have add anything to that.

Yes, Mark, I will. This is John, and then I'll let Glenn provide the technical thing. Just from top of that, I think this quarter, Mark, is a really nice demonstration of kind of the way the processes supposed to work. We had very little aggregate loan growth. So you think about the portfolio not growing that much, which means you didn't need to increase your provision for life of loan losses for a lot of incremental exposure, you saw the Moody's outlook that us and many of our peers use sort of get marginally to more favorable. So that didn't require to kind of look at it to flat to slightly better. Some of the qualitative factors around the level of modifications and everything came down, so that would require lower.

And then you saw a little bit of drift into classified, some internal risk rating migration lower, which kind of offsets those other positives. And low and behold, we had $11 million in net charge-offs. We built our reserve a little bit. So it really depends on how fast we can grow loans going into next year. What happens in our risk migration, and what the path of the virus does to Moody's forward look to really give you an indication of kind of where we might be from a provisioning perspective. Glenn?

No, I think between you and Jason, you covered. The only thing I would add is that most of us are using -- in the mid-cap space, we're using the Moody's baseline forecast. And just keep in mind, that has about $1.5 trillion in stimulus built into it. And so -- plus or minus, depending on what happens there. But as John and Jason both pointed out, I mean, I see it more as a -- we look at the thing from a duration standpoint. And right now, liquidity seems good, customers seem strong, but it's all going to be a matter of the course in pandemic and liquidity. And so we're keeping a very close eye on it.

Okay. And then secondly, it looked like -- I mean the deferral trends look terrific. I guess I'm curious, is there dramatic differences across the various geographies that you all traffic in as New York -- New York City being much harder hit, the deferral rate is much higher than they are, say, in Connecticut or elsewhere?

Yes. It's interesting, and I'll ask Jason, obviously, for his comment. But Mark it's funny, and I just mentioned that when Steve asked the question. We haven't seen real differences in geographies. It's been much more sector based, right? It's not whether you're in New York and Boston, it's whether you're a hotel or multi-use facility in real estate. So it's definitely more sector-driven. And I will remind folks, it's interesting, and I have to mention Bill Wrang's name on every earnings call. I think that's a trend. But he was never one to dive into New York City. We've got significant real estate exposure in New Jersey and down into Philadelphia and then up into Boston and Connecticut.

But we don't have -- we're not kind of overweighed in the metro areas, if you will. So we haven't seen the kind of risk in New York multifamily or other areas. So geographies haven't really impacted us. I will tell you anecdotally, and I know, Mark, you live in New Canaan, I think. We have seen precipitous increase in home values in Northern Westchester and Fairfield County, as evidenced by some of REO properties and other things. It's been pretty spectacular the growth outside of the metro market, which has stabilized and taken any risk we had had in terms of home prices in our core market kind of out.

But that's really the only geographic thing that I've seen is a little bit of flight from metro and an impact on home prices and rents. Jason?

Yes. No. I think you mostly hit it. I guess what I would say is, initially, right, if you look at the deferrals that we got in our consumer book, there was certainly a disproportionate amount in New York, right? Early on, New York wasn't doing so well. But at this point, you saw consumer deferrals decline to under $100 million. And overall, we're feeling better about the portfolio. I actually think there's been some benefit within our footprint because of the stronger relative numbers to this point. So the portfolios like business banking, mid-market, right, and a good portion of commercial real estate, I think, will also benefit from that throughout this period.

And then the last question I had. I know, John, you said it's a little early to talk about renewal season. But I'm not sure if Chad is on the line, if you could give any color on sort of what you're seeing, how the pipeline is shaping up. And also, maybe help us think through any potential ramifications on the HSA business in the event that we do see a blue wave?

Great questions, Mark. I'll take the blue wave question and then Chad can give the rest. We've been studying a lot, spending a lot of time with the lobbyists in Washington, and we really do feel good. And we can say with confidence that even in the CARES Act, there were discussions about how we could leverage the HSA account product to help.

And so I think there's kind of bipartisan support for HSA going forward as a really good tool to allow people to kind of deal with health care costs and even have an HSA as part of the Medicare program at some point. So our view right now is that, with respect to the still low probability of a complete replacement of our private insurance system with a single-payer program and a lot of the talk that's going on that could benefit HSAs, we feel like politically, we're in pretty good shape regardless of what the outcomes of the November election are. Chad, maybe you can provide some guidance and details on what you're seeing as you head into the January 1 period.

Yes. Thanks, John. Thanks, Mark. I agree with John, your comments on the political environment. I think under Obamacare, HSAs were largely -- there was very limited impact, and we grew quite a bit during that administration. So I think it's more likely we're going to have positive impact than negative.

With regard to sales results, we're really happy with what we're seeing at this point in the year for 1/1 particularly in the large employer direct space. We've had 12 large employer wins, and our pipeline in the closed contracting section of the pipeline is more than 2x what it was at this point last year. So we're really happy with the results, but we're seeing -- in the area where I think everybody on this call know, we've been investing in sales, marketing and product capabilities to drive these kind of results in the channels that we can influence directly. And so we're happy to see those results.

That said, I want people to keep in mind that 80% of our accounts come from existing employers. And you heard John mention that due to the pandemic and a weaker labor market, we've seen about a 28% decrease in enrollments. They've come back somewhat here at the end of the third quarter, but we're still not seeing as strong enrollments yet from our large employers or our existing employees. We expect that to come back as the economy rebounds. But while we're under -- while it's under stress, that will be subdued. Also, a couple of our large health plan providers are under a bit of pressure. And we -- so -- and we don't have as much visibility into that segment. So it's hard to call the ball for 1:1, but in the areas where we have visibility, and we can impact it directly, we like what we're seeing.

Our next question is from David Chiaverini with Wedbush Securities.

I had a follow-up first on credit. Looking on Slide 8, how the percent of the portfolio that is in deferral for leveraged loans and middle market at 4% for each are the 2 highest. I was curious, when push comes to shove, will sponsors step-up in the leverage portfolio to support their investments and the equity they have in these deals?

David, I'll provide some overview, and then I'll turn it over to Jason. It's always hard, right, to make really strong statements with conviction. That's one of the reasons we're in this business. And we've just recently had a situation where a 20-year sponsor relationship, they went above and beyond to make sure that the bank was taken care of. And we were in this business, as you know, through the Great Recession.

So my comment is that we believe that we are careful to select the sponsors who we do business with. We go deep with sponsors with expertise and build relationships and so we have a track record of when the going gets tough, both parties come together and figure out a solution. So my answer is, yes, there are times where a sponsor can't put good money after bad, if there's something fundamentally flawed with the business. But if your risk selection is good upfront and you partner with the right sponsors, that is a wonderful secondary, tertiary support function.

So the other thing I will add, and I've said it before, is that the way to look at it is pretty simple. If a sponsor has purchased a business in a sector where they feel like there's real value, real growth opportunity and the ability to create growth, the pandemic, which is a temporary delay, right? There's really not that many paradigm shifts, maybe there'll be a paradigm shift in commercial real estate and other areas down the road. You really have to figure if we're lending money appropriately at reasonable leverage levels, meaning that there's significant cash equity usually and generally much more than the actual debt on the company, that the borrower is not going to hand you the keys when they're trying to protect a significant amount of investment, and they know that the issues are only temporary.

So unless the business has some sort of fatal flaw, they're going to ride through this with us. We're going to provide them some sort of deferrals of payments or covenant relief, but they're going to put in additional cash equity and support the company to make sure at the other side of this temporary issue that we have, not a permanent one, that they can reach their potential with their company and get a return on their investment.

So long winded way, but you know that I thought about this a lot, and we've seen it be a benefit to our credit performance through The Great Recession and early on in the pandemic. Jason, is there anything you want to add to that?

Yes. No, I'll give a little bit more specifics, right? So I'll talk about sponsor and leverage together. The majority of the modifications have been, in fact, nonpayment related, payments down to about 3% on a combined basis. And sponsors, in a lot of cases, have been supportive in about 1/3 of what I'll call the more major modifications that we've done in the portfolio. There's been some level of support provided by the sponsor, either cash equity sub debt or guarantee a portion of the debt. And that includes, in the restaurant space where we've modified a handful loans, about 45%, 50% of those, there's been double-digit equity that's coming to these deals or sub debt. So I've been very pleased overall with the performance of the portfolio during this time period and the support from the sponsors.

That's great color. And then a follow-up on the loan growth outlook. So I wanted to reconcile a couple of comments that you made. On the one hand, you mentioned about the fourth quarter, expect stable loan balances. And you mentioned about how loan demand is muted. Earlier in the call, you mentioned about how pipelines are solid. And one of the initiatives as we look out to next year is to accelerate commercial loan growth. So I was curious, is it more of a timing thing that the solid pipeline should lead to an acceleration in loan growth next year and that the near-term clearly sounds like it's flat? Or just curious as to what your thoughts are there.

David, another really smart question, and it's tough. When we ever answer questions even pre-pandemic about this, kind of what I've said is we really have confidence that the personal loan side in terms of mortgage and others are very -- there's some seasonality to it, obviously. And then there's also interest rates impact demand, refinance activity. When we talk about commercial banking and business banking, we've demonstrated over a 7- or 8-year period of time this ability to grow loans double digit. But we've had quarters that are -- show less growth, maybe seasonality, maybe disproportionate amount of paydowns. Obviously, right now, we're not confident in the double-digit growth environment. There's just not the economic backdrop and the loan demand there. But again, quarterly, it's going to be interesting. We do have a lot of -- a big mortgage pipeline. Our commercial pipeline is solid. It's not what it was the last year at this time, but it's better than the last 2 quarters. I'll give you a couple of dynamics if you're thinking short term.

We do think that there could be some more higher originations in the fourth quarter and additional payoffs, particularly if sponsors in real estate or C&I are looking to do transactions before the end of the year, if they're concerned about retroactive tax moves by a new government in terms of what might impact 2021. So we do think the fourth quarter has the potential of being a little bit better from a loan growth perspective. But again, it may be just better originations and higher payoffs, which lead to the same level of modest loan growth. We are in the early stages of rolling out some new sponsor and specialty industry verticals and middle market industry verticals. And again, we'll talk more about that in January in earnest. But that will take a while to ramp up. So I wouldn't think -- and you know us as risk managers, this isn't the time to be going all-in in a new sector. So you'll see us start to grow those sectors smartly over the course of 2021 and into 2022.

So I think you have to think about originations. You have to think about whether or not there'll be higher prepayments and whether there are seasonal reasons or political reasons why you might see increased activity. And then what I would say is, we think we can outperform the market with respect to loan growth, which will be somewhat muted. So I hope that -- it may sound inconsistent, but I'm trying to sort of be thoughtful about the short-term and the long term. And I think the best thing to say is we know we've got a track record of being able to grow commercial loans at the top -- on the top decile or top quartile of the market.

Our next question is from Jared Shaw with Wells Fargo.

Maybe just circling back on the credit question. Should we think that -- as some of those potential NPL formations or charges, Jason, that you talked about coming later in the next few quarters come through, should we see the allowance as a ratio then start to come down? Are we fully provided for future charge-offs? Or would we likely see charge-offs being covered somewhat by provision? Or can we expect to see that ratio, the ALLL ratio start to trickle down?

Hey, Jared, I'll take a quick shot and then give it to Jason. Just from a high level, obviously, we feel really good that we've got all of our identified lost content captured in what is an above-market level provision. So I think if you -- if we end up performing at our base case of credit outcome, which as Jason mentioned, we do think we'll see some weakness, and I think the industry generally feels on a lag basis, we could see some cracks in credit in first Q and 2Q. We feel like we are covered for our base case. And obviously, if the dynamics change, or as Glenn said, the path of the virus indicates a longer duration of economic uncertainty, then that could impact the provisioning going forward. Jason?

Yes. I think you guys hit all the right points. And I guess, if I look at the situation right now, right, there are some accounts that I do expect will -- could worsen, right, depending on the length of recovery and overall liquidity of the borrower. But I'm also really cautiously optimistic that there are a lot of borrowers that will improve. So when I look at it on a net-net basis, putting some of the other factors aside, I don't feel like there will be as much pressure from a reserving standpoint. And I do feel that we're well covered. I know we're sort of near the top of our peers. And so I feel good about where that lies. So of course, as everybody said, it's going to depend on the path of the virus, what the new stimulus, assuming it's approved, looks like and where it's targeted.

And the big thing that I know we've also mentioned is consumer behavior, right? Some of these things like movie theaters, entertainment venues, other things like that, it just could be a much longer return over time. But at the moment, I feel really good about where we reserved. I think there's likely to be less pressure and I'm cautiously optimistic.

Okay. That's great color. And then talking about the potential for higher originations offset by the payoffs in the fourth quarter. When you're looking at new loan originations right now, can you comment on what you're seeing in terms of pricing or spreads or structure? Are you able to put on -- is that incremental loan that's coming on in a better position for the bank overall, whether you look at pricing or structure?

Yes, another great question, Jared. I think the short answer is yes, right now. I don't know how long that duration will go. I get write-ups from the business line leaders and the line of businesses within commercial and community and they all talk about the marketplace, and I did see sort of saying that in this quarter, and if we look at the numbers, we have had better credit spreads for same risk rating. But they've talked about competition coming a little bit back into the market and people getting a little more aggressive again.

So I don't know how long it will last, but I will tell you that from a pure statistical perspective, it looks like we got paid more for taking the same risk or lower risk and structure in the third quarter. And again, our spread and our yield is dependent not only on that variable, what we're able to do in terms of pricing risk, but also on the mix. And so we had pretty solid in our sponsor and specialty, particularly in technology, pretty terrific yield with good structures. We've got such a fantastic team there. And there's not as much competition from the nonbanks right now. So I think that helped us from a pricing and structure perspective.

We also, as I mentioned, onboarded a lot of kind of government and institutional loans, which have significantly lower yields, but really high kind of investment-grade like credit metrics. So the short answer is mix matters for us, but the short answer to your question is, I think for a period of time, we've been able to get better structures at better pricing. But I don't know how long that will last, depending again on the variability of the economy.

Okay. And then just finally for me, switching to capital, you're seeing good growth in ratios, TCE this quarter. And then with the expected runoff in PPP, that should most likely just still get better. How are you thinking about capital management as you head into -- maybe say head into '21? Is -- are buybacks attractive as part of that strategy? Should we be thinking about the dividend? Or is it still too early to say, given the broader uncertainty?

Yes. I think it's -- you kind of characterized at the end. It's too early to say in terms of making the call, but I think you've hit it. We -- obviously, because of the economic headwinds, all of a sudden, our payout ratio went higher than our range, but we're really confident about our ability to maintain our dividend at its current level. And so we think we're going to grow back into that from an earnings perspective and be right in that 40% to 45% range, which has been our long-term target. And we have grown our capital levels. We think it's prudent right now. And we do think, where we sit, that it's a little bit premature for a number of reasons to engage in repurchasing our stock. We started too, in January. We kept talking about supporting loan growth and looking at strategic inorganic opportunities in HSA, and that's why we were sort of delaying. We began, we thought the prudent thing to do, obviously, when the pandemic hit was to not repurchase shares. I think when we feel like the coast is clear, given our capital levels, that will be back on the table.

Our next question is from Matthew Breese with Stephens Inc.

Matt?

Hey, Matt, did we lose you?

(technical difficulty)

Can you hear me now?

We can Matt. And we promise, we did not hit the dump button.

I believe you. Just thinking about the 8% to 10% expense saved number. That's a net number. I'm just curious, what's the gross number should we get a good idea of the dollars being reinvested into the other programs?

That -- the 8% to 10% is off our base. And so that is the number, right? It's not -- it is -- if you looked at our run rate, and looked at our core expenses, you would expect it go down to 8% to 10%. That includes reinvestment and all those other things.

Correct. So it is the net number. And what you're saying is, at some level above that, not materially, right now, we've got the ability. We've invested heavily in a lot of digital automation, business process tools and so we're leveraging a lot of prior investments to continue to get efficiencies. So we're not announcing simultaneously a significant investment in go-forward technology that gross number is not twice the net number, Matt. It's -- that includes, as Glenn said, the money that we have to reinvest to get everything out of the program.

Got it. Okay. And then just framing the loan growth initiatives a little bit more. Does it include any material mix shift in the composition of the loan book right now? I think you mentioned some of the specialty areas you're in, the sponsor and specialty books. Should we expect some outsized growth in those areas relative to others? And does it also include any sort of geographic expansion? Should we expect you to break out of your core Northeast footprint?

Yes, that's great. Thank you. We've been pretty deliberate over time. And I always tell the story of coming here in Stanford was the -- Stanford, Connecticut was the Great Western Frontier. And we've since moved to Providence in Boston and White Plains in New York and Philadelphia and Washington, D.C. You have noticed that we have not made a big geographic move over the last handful of years, largely because of the competitive dynamics, and most recently, obviously, just kind of the economic landscape.

When we think about commercial, we think about doing things we do well, which we've been able to sort of replicate geographic expansion. So in our current plans, I don't think you'd see us move into a market at the tail end of a pandemic because you end up being the lender of last resort, and there may be some risk choices there. I wouldn't take geographic expansion off the table. If you look forward 3 or 5 years, I think it's something we have a core competency in.

But we also think in terms of what we've been able to slowly and smartly and deliberately add new industry verticals by hiring really talented bankers. And so we're looking to kind of expand our health care practice. We're looking to do more in spaces where we can gather deposits as well as use our balance sheet and make loans. So I think we'll talk to you a little bit about it more in January, but the reality is we're thinking like you are thinking, which is we're not going to bet the bank on going into new geographies or new areas where we don't have deep expertise. And even if we do, and we're kind of instituting a different risk profile, it's certainly not going to outgrow the stuff we're doing that we know well. So I think that's what you're wanting to hear. I think that's the answer to your question is that you're not going to see us make big risk choices or go into new industries that are going to meaningfully impact either our credit performance or our growth in the short term.

We'll dabble. We'll move forward in areas where we think there's protectable, predictable recurring cash flows, and we'll grow those businesses slowly or we'll move into new geographies, and we'll grow them slowly to make sure that we don't make bad risk choices.

Understood. And then maybe just tying this discussion into M&A. There's a bit more willingness here, at least it sounds like to do or think about whole bank M&A. As you think about potential geographic expansion over the next 3 to 5 years, could you acquire into those markets? What would those markets look like? What markets do you like? And then maybe financially speaking, could you give us some parameters on deals that would make sense to you?

Way too premature, Matt. And I was careful to say that, as we said, we've been evolving our view, and we think that there'll be more M&A in the mid-cap space. Right now, we're focused on making sure that we're maximizing our potential. And putting us in a position where, if that's on the top 5 of our priority list, as you look forward a year from now, we'll be able to make those choices and make those decisions that you're referring to right now, but way too premature.

Understood. Okay. Just last one for me.

We need to end the call. Go ahead, Matt. Last question.

Yes, really quick. What was the all-in PPP income this quarter?

I think we're at $9 million, all-in.

$9 million. Okay.

We have reached the end of our question-and-answer session. I would like to turn the floor back over to John Ciulla for concluding comments.

Thank you very much. Thank you for joining us this morning, and I hope all of you remain safe and well. Thanks, and have a great day.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.