Webster Financial Corp (WBS) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Webster Financial Corporation's Fourth Quarter and Yearend Earnings Conference Call. [Operator Instructions]

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, result of operations and business and financial performance.

Webster has based these forward-looking statements on current expectations and projections about the future events.

These forward-looking statements are subject to risk, uncertainties and assumptions as described in Webster Financial's public filings with the Securities and Exchange Commission which could cause future results to differ materially from historical performance or future expectations.

I would now like to introduce your host for today's conference, Mr. James C. Smith, Chairman and Chief Executive Officer.

Please go ahead sir.

Good morning, everyone, and welcome to Webster's fourth quarter 2005 investor call and webcast.

Joining me today are Bill Bromage our President; our Chief Financial Officer, Bill Healy; and Terry Mangan, Investor Relations.

Others are here as well to respond to your questions after our formal remarks which should take about 30 minutes.

I'll provide the highlights and some strategic context for the quarter.

And then Bill Healy will provide details on our performance, after which we'll discuss the '06 operating environment.

As you've seen in our earnings release, we reported $0.84 a share in diluted earnings compared to $0.90 a share a year ago apart from the $0.60 per share de-leveraging cost taken at that time -- cash EPS of $0.93 a share compared to $0.98 a share a year ago.

The $0.09 difference between cash and GAAP EPS reflects stock-based compensation of $0.03 a share and intangible amortization of $0.06 a share.

Items of special note in the quarter and their effect on EPS compared to the reported amounts that I just mentioned are EPS this quarter included $0.01 per share of securities gains compared to $0.02 a share a year ago, apart from the de-leveraging costs.

More significantly, securities gains represented just $0.04 a share in all of 2005 compared with $0.25 a share in the prior year.

Additionally, our Q4 '04 net interest income benefited from the larger wholesale borrowings and securities portfolio in place during that quarter keeping in mind that our $750 million de-leveraging a year ago was phased in during the course of the fourth quarter.

As a result, the average securities portfolio was $343 million lower in Q4 '05 and the full portfolio was at a wholesale spread that was 90 basis points lower than in Q4 '04.

So we earned about $0.06 a share of EPS from what we call wholesale spread income on the securities portfolio in Q4 '05 compared with $0.18 a share in Q4 '04.

Looking at all of 2005, wholesale spread represented $0.43 a share of EPS compared to $0.82 a share in 2004.

The net expenses related to our de novo branching program were $0.01 a share greater in Q4 '05 than a year ago and about $0.03 a share greater in all of 2005.

The '05 quarter also included about $0.02 a share of onetime costs related to our core systems conversion project, bringing these costs to about $0.10 a share in all of 2005.

In the end, the one-time costs of $8.1 million were higher than our original estimate of about $5 billion for 2005.

Additionally, we incurred about $2 million of unbudgeted temporary staffing costs in Q4 '05 that were associated with ensuring a smooth transition to our new IT systems.

We now have the best commercial banking systems available, including significant scalability, and we expect any remaining temporary staffing costs to zero out by the end of Q1 '06.

The net effect of the items that I've cited is that adjusted EPS before their impact totaled $0.81 in Q4 '05 compared to $0.71 a year ago for an increase of 14%.

Applying the same analysis to the full year, 2005 core earnings would have increased very significantly, which underscores the improved quality of earnings derived from adherence to our core operating principles.

The net interest margin was 3.22 in the quarter compared to 3.25 a year ago.

The decline was centered on a 90 basis point decrease in what we call the wholesale spread, as an increase of 38 basis points in yield on the securities portfolio over the past year was more than offset by an increase of 128 basis points in the cost of borrowings.

As a result, the wholesale spread declined 56 basis points in Q4 '05 compared to 146 basis points a year ago.

A very positive metric is the spread between the yield on loans and the cost of deposits or what we call the retail spread.

The retail spread actually increased by 8 basis points from a year ago and 1 basis point from the third quarter and totaled 4.08% in Q4 '05, Coupled with almost $800 million of growth in average loans year-over-year, we generated $0.12 a share of incremental loan spread, which is 8% higher than a year ago.

For the full year, the net interest margin improved to 3.29% compared to 3.11 in 2004, with the increase largely attributable to the benefit of the well-timed Q4 '04 de-leveraging.

Because of the de-leveraging, we had 525 million less of securities on average in 2005 than in the previous year.

The securities portfolio will likely continue to decline during '06 as a result of our previously announced strategy to pay down borrowings with cash flows in the flatter yield curve environment.

Credit performance remained strong with a 5-basis-point charge-off ratio in the quarter.

The provision of $2 million once again exceeded net charge-offs, which totaled 1.4 million, resulting in a slight increase in the allowance for loan losses from September 30.

For the full year, the provision of 9.5 million exceeded net charge-offs of 4 million by $5.5 million.

While non-accrual assets have risen in the past couple of quarters, our 55-basis-point non-accrual ratio and our miniscule net charge-off ratio compare quite favorably to our peer group.

Our loan portfolio totals $12.3 billion and has grown by 5% over the past year.

Commercial, including commercial real estate, and consumer loans have grown at a combined rate of 7% over the past year, while Resis have increased as planned by only 1%.

As a result, Resis now comprise 39% of total loans compared to 41% a year ago.

Our deposits totaled $11.6 billion at December 31 and grew by 10% from a year ago.

DDA and NOL account balances have grown by 10% and 19%, respectively.

CDs have grown by 26%, as consumer preferences have shifted to this higher-yielding category, proving once again the high correlation between rising Fed Funds rates and higher CD balances.

We opened eight de novo branches during 2005 and now have opened 19 de novo branches over three years.

These branches had total deposits of $572 million at December 31, up 91% from a year ago.

Our de novo program contributed to the net interest margin being 3 basis points higher than it otherwise would have been.

Net de novo expenses were $1.5 million, or $0.02 a share in Q4 '05, compared to 0.8 million, or $0.01 a share, a year ago.

For all of 2005, net de novo expenses represented about $0.08 a share compared to about $0.05 a share a year ago.

HSA Bank represented $210 million in deposits at year-end, or 204 million on average in the fourth quarter, at an average rate paid of 2.38%.

We ended the year with 138,000 accounts.

So deposits and accounts each almost doubled over the past year.

HSA Bank contributed to Webster's net interest margin being 2 basis points higher than it otherwise would have been.

We're currently at $237 million in deposits and 144,000 accounts compared to year-end.

Our total core revenues, consisting of net interest income and non-interest income and excluding securities gains and nonrecurring items, were $184 million in the quarter, up 4% from a year ago.

Net interest income increased by 2% compared to a year ago as strengthened loan growth and loan spread was masked by the lower wholesale margin and the reduced securities portfolio.

The core fee revenue categories of deposit service fees, insurance, loan and loan servicing and wealth management grew by about 10% over the past year, led by growth in the number of accounts and investment products sales.

Core expenses, adjusted for non-comparable items, grew by just under 6% from a year ago.

Included in this growth, are continuing investments in revenue producing personnel and the initial higher run rate of our new technology platform.

I'd like to comment on our 2005 performance in the context of the operating principles that we discussed throughout the year.

These principles have guided us to a stronger balance sheet and higher quality of earnings as we complete our business model transformation.

Our tangible equity ratio improved 33 basis points year-over-year to 5.54%, meeting our year-end '05 goal of 5.5%.

We've increased tangible equity by almost $100 million over the past year or 12%.

Our securities portfolio now represents under 21% of assets compared to almost 30% two years ago.

Borrowings represented 25% of total assets at year-end compared to 34% two years ago and met our yearend '05 goal of 26%.

As a result, we've reduced by half our tangible capital exposure to sharply rising rates.

We favor commercial and consumer loan growth, which is resulting in continued reduction of residential mortgages as a percentage of total loans.

And we favor deposits over borrowings as the primary funding source for new loans.

Deposit growth at twice the level of loan growth during 2005, enabled improvement in our loan to deposit ratio to 106%, meeting our year-end '05 goal of less than 107%.

Strong deposit growth contributed to a reduction of $308 million in borrowings compared to a year ago.

We've made significant progress during 2005, in strengthening the balance sheet and delivering higher quality earnings in a very challenging interest rate environment that we expect to continue through 2006.

I'll now ask Bill Healy to provide financial details.

Thank you, Jim, and good morning to all of you.

This was a quarter of solid performance in our core businesses in a challenging interest rate environment.

It was highlighted by continued strengthening of our balance sheet and high quality of core earnings.

In fact, if you look into our earnings and exclude from all periods, security gains and the onetime core infrastructure expenses, share earnings would have been up $0.10 year-to-date, but down $0.03 for the linked quarter.

All of the decline to the linked quarter can be attributed to the reduction in our wholesale interest rate spread, which is defined as the yield on the investment portfolio, less the cost of borrowings.

For the quarter, this spread declined 27 basis points, which equates to $0.04 per share.

Also for the quarter, we recorded approximately 4.3 million of items in both non-interest income and non-interest expenses.

These were nonrecurring items particular to the quarter and offset one another.

Because these items offset, we feel a fair estimate of core earnings for the quarter was the $0.84 that we reported.

In reviewing our performance, I will focus my comments for the most part on our linked quarter performance.

Starting with the income statement, net interest income was flat with the third quarter at 129.7 million.

Growth in average loans from the third quarter was partially offset by a planned reduction in average securities and a 27 basis point decline in the wholesale spread.

The net interest margin was 3.22% compared to 3.26% in the third quarter.

The 4 basis point decline was less than what we anticipated at the time of our conference call in October, mainly as a result of more favorable deposit mix and pricing.

Quite similar to the third quarter, our cost of funds increased faster than the yield on earning assets.

Impacting this was the reduction in our wholesale spread and a continuation of the shift in the deposit mix to higher costing retail CDs.

Yields on fixed rate loans continued to be affected by the flatter yield curve as well during the quarter.

Non-interest income included 4.2 million of items particular to the quarter.

These items included $1 million in security gains and 3.2 million of nonrecurring revenue items.

Adjusting for this, non-interest income declined by $800,000.

For the quarter, core fee categories of deposit service fees, insurance revenues, loan and loan servicing fees, and wealth management fees grew by almost 4% or 1.7 million.

Deposit service fees increased by 3% or 727,000, mostly as a result of NSF fees.

This category has fully rebounded from the reduction in NSF fees experienced industry-wide earlier in the year.

In fact, deposit service fees increased 11% from a year ago, assisted by 2.4 million in fees during the year from HSA Bank.

Insurance revenues declined by 3% from the third quarter, as the fourth quarter tends to be the weakest quarter of the year for this business.

Loan and loan servicing fees increased mostly as a result of 873,000 in nonrecurring prepayment penalties recorded in the quarter.

Wealth management fees were up 621,000 based on strong performance in our retail broker dealer.

This category rebounded by 11% from Q3 when we saw a lower level of fixed income annuity and other investment product sales.

Gain on sale of mortgages declined by 1.4 million in the quarter as a result of lower origination volumes and competitive pricing pressures.

Other income of 3.5 million included 2.3 million of nonrecurring gains from our direct investment portfolio.

On the expense side, total expenses for the quarter were 119.4 million.

Excluding 4.3 million of nonrecurring costs, which included 1.3 million of conversion costs, 2 million in temporary help related to pre and post conversion efforts, and 1 million in cash - in a cash earn-out related to our acquisition, expenses were 115 million.

Quarterly run rate of expenses as we head into 2006 is about 116 million when you adjust for the full period impact of four new de novo branches opened in December and additions to staff during the quarter.

Turning to a review of the balance sheet, total assets at December 31st were 17.8 billion, the same as at September 30th.

Loans increased by 1% from September 30th while securities declined by 3%, as we implemented our previously announced plan of not reinvesting cash flows in the portfolio.

As a result, the securities portfolio declined to 20.8% of total assets at December 31st compared to 21.5% at September 30th.

The average duration of the 2.6 billion available for sale portfolio was 1.9 years at December 31st compared to 2.0 years at September 30th.

For the entire portfolio, including 1.1 billion of health maturity securities, the duration was 2.8 years, the same as at the end of the prior quarter.

The portfolio yielded 4.76% during the quarter, up from 4.68% in the third quarter.

Available for sale unrealized losses, pre-tax at December 31st, were 41 million compared to a loss 29 million at September 30th.

Total loans had a point-to-point growth of 1% or 85 million from quarter-to-quarter, while average loans grew at 3% or 353 million from the third quarter.

The lower level of point-to-point growth reflects seasonal pay-downs in our asset based commercial lending business, which declined by 57 million from September 30th.

Commercial real estate loans grew by 74 million or 4% apart from the $68 million of loans that were reclassified from the commercial portfolio in this category.

Consumer loans increased by 1% or 26 million from the third quarter.

We continue to see higher prepayment speeds in the higher yielding floating rate credit lines as consumers appear to be refinancing into lower costing fixed rate first mortgages.

Total deposits of 11.6 billion were flat with September 30th as a result of the decline of 100 million in treasury deposits, which for us represent an alternative source of short-term funding.

We did see a growth of about 70 million in retail deposits as demand deposits increased by 8% or $114 million from a seasonal low point at September 30th.

The higher rate environment continues to drive a shift in favor of CDs by consumers during the quarter.

These deposits grew by 3% from September 30th, mostly the result of a shift from money-market accounts.

The shift to higher costing CDs contributed to the 18 basis point increase in the cost of deposits compared to the third quarter.

Our tangible capital ratio increased by 9 basis points to 5.54% at December 31st, and reflects tangible equity growth of 70 million or 2 % in the quarter, while assets were flat.

The 9 basis point improvement in tangible equity represents 22 basis points from net retained earnings, a decline of 8 basis points from the share repurchase and a decline of 5 basis points from a negative FAS 115 mark in the quarter.

Our exposure of tangible capital to an upward shock in interest rates of 200 basis points is 39 basis points at December 31st.

This has been cut nearly in half compared to exposure prior to the de-leveraging program.

From an overall interest rate sensitivity perspective, we are slightly liability sensitive and relatively neutral to falling rates.

For any parallel change in interest rates of plus 100 or 200 basis points, the impact on EPS would be minimal.

We have indicated in the past our [ALCO] committee regularly reviews the impact of non-parallel shifts in the curve, which describes the current environment.

The most likely scenario is a further flattening with the short end of the curve rising faster than the long end.

In the scenario of the short end up 50 basis points from here, with no movement in the longer end EPS could be reduced by about 2% over the next 12 months compared to a scenario with no change in rates.

It should be noted all these scenarios assume no corrective action and our base case scenario already assumes a further 25 basis point of yield curve flattening.

Our ability to execute on our business plans to attract and grow low cost deposits through de novo branching in HSA Bank as well as our planned reduction in the securities portfolio will enable us to partially offset the impact of changes in the curve.

Let me now turn the program back to Jim for his introductory remarks on 2006.

Thanks, Bill.

Webster's performance in 2005 and our outlook for 2006 are consistent with our emphasis on producing a stronger balance sheet, less exposure to interest rate shocks, and a higher quality earnings stream.

We believe that the benefits of our operating discipline far outweigh the cost and bode well for shareholder value creation.

To be sure, given our conservative interest rate assumptions for '06, we expect the year will be quite challenging and may will be remembered more for the high quality of our earnings than for the rate of earnings growth.

As we complete our final steps in Webster's transformation to a commercial bank financial services provider, we're confident that our strategy will yield superior total shareholder return in the years ahead.

To underscore the alignment of management's interest with our shareholders' interest, the board has adopted a long-term incentive plan for President Bill Bromage and me that ties our ability to receive restricted shares to Webster's total shareholder return compared to the KBW 50 and the financial services companies in the S&P 400.

It's a leveraged plan that pays more for outstanding performance and less for below median performance.

Specifically, if we fail to attain a total shareholder return over a three-year period of at least the 35th percentile of the peer group, the payout is zero.

Believe me, our interests are aligned, not just philosophically, as they always have been but quite directly in terms of our compensation relationship to total shareholder return.

Regarding our assumptions for '06, on interest rates we're looking for three 25 basis point increase in the Fed Funds rates beginning next week and spread through the year.

Coupled with what we expect will be a lesser increase in longer rates, there's a possibility that the wholesale spread will go negative later in '06.

The key point, here, is that while these development would pressure the margin and reduce the likelihood of net interest income growth, the earnings quality will be the highest ever, virtually 100% derived from franchise activities.

Meanwhile the continuing reduction in the securities portfolio will pretty much offset strong commercial and consumer loan growth, while we expect to hold the Resi portfolio flat.

So earning assets won't grow much in '06.

Decent deposit growth including strong CD growth will enable further reduction in wholesale borrowings such that the securities portfolio and wholesale borrowings should both comprise less than 20% of assets at year-end and the loan-to-deposit ratio should decline close to 100%.

The brightest spot is the so-called retail spread which we expect to continue at strong stable levels, currently more than 4%.

We also expect decent growth in non-interest income.

We intend to use our buyback program to offset the impact of lost spread income from the wholesale portfolio, while maintaining the tangible capital ratio in the 5.5% range.

We expect to repurchase upwards of 2 million shares in 2006.

Expense control will be paramount in the expected operating environment.

While our efficiency ratio has gradually increased as net interest income from wholesale portfolio has declined, Webster remains in the top quatile of our peer group, when measuring operating expenses to average assets.

We consider expense discipline one of our primary strengths.

That said, given the higher run-rate from the improved IT infrastructure, and other infrastructure building initiatives, we've decided to temporarily scale back certain strategic initiatives including our de novo branching program.

We now intend to open six de novo branches in '06 instead of the nine originally contemplated such that net expenses from this program will rise less than $1 million in '06 as compared to '05.

This action will help us meet stringent expense targets in '06.

Our current expectation is that we will return to the approximate 6% of existing branches annual de novo rate in 2007.

I'll now ask Bill Healy to provide additional detail on the '06 assumptions.

I will now provide some specific comments on our overall expectations for 2006.

We do not give or confirm estimates or ranges but speak to our overall trends and expectations.

There is always uncertainty with any interest-rate forecast.

Our current base rate expectation for 2006 is similar to the forward yield curve where we assume another 75 basis point of Fed tightening over the course of 2006.

We also expect further flattening of the yield curve.

Given our interest rate assumptions, we estimate that the wholesale spread will turn negative in late 2006.

As you evaluate our expectations for the 2006 performance, you should be viewing our outlook in light of our interest rate forecast.

We realize that your perspective on interest rates and the slope of the yield curve could be different.

We expect little or no growth in average earning assets when you compare the full year 2006 average to actual earning assets of 16.3 billion in the fourth quarter of 2005 as planned reductions in securities will offset increases in the loan portfolio.

The securities portfolio is anticipated to decline by about 500 million on average compared to the actual average balance of 3.8 million for the full year 2005.

Non reinvestment of portfolio cash flows during 2006 drives the expected decline in securities.

The decline in securities will be offset by an expected increase in total loans in the mid-to-high single digits compared to the actual loan average balances of 11.9 billion for the full year of 2005.

Comparing to actual averages for the full year 2005, commercial, including commercial real estate loan growth, is expected to be in the low double digits.

Consumer growth is expected to be in the mid single digits and residential loans are expected to decline slightly as planned.

We expect the net interest margin for all of 2006 to be reasonably similar to the actual net interest margin of 3.22% in the fourth quarter of 2005.

We see continued margin compression during the first half of the year with a rebound in the second half.

While the net interest margin benefits from the continued shrinkage in the wholesale portfolio, rising short-term rates in a flatter yield curve constrain any opportunity for further margin expansion in 2006.

We expect net interest income to be relatively flat to the full year 2005 amount of 517 million.

This is a result of higher loan volumes being offset by the decline in securities and the full year net interest margin being similar to the fourth quarter of 2005.

We expect that deposit growth will exceed loan growth in 2006 with overall deposit growth in the high single digits when comparing the 2006 average balance with the actual total average deposits of 11.3 billion for the full year 2005.

We expect excess deposit growth to reduce borrowings.

Non-interest income will total 217.3 million in the full year 2005, not including 3.6 million of security gains.

We expect that non-interest income will grow in the high single-digits in 2006 from the 2005 level of 217.3 million.

We do not expect to realize much in the way of security gains in 2006.

In projecting our expenses for the full year 2006, you should annualize the fourth quarter 2005 run rate of 116 million, which did not include IT conversion costs.

We expect the 416 million annualized base to grow in the low single digits, reflecting expense control and a decline of 4 million in deposit intangible expense.

The increase in expenses also included - also is in conjunction with six new de novo openings in 2006, our increased IT run rate and the build-out of our compliance function.

Our provision expense was 9.5 million in 2005 and the full year loan charge-off ratio was 0.04%.

Overall asset quality measures are expected to remain strong in 2006, although we expect the net charge-off ratio to increase from its very low level in 2005 to somewhere around 0.10% in full year of 2006 of average loans.

We intend the provision at least to equal that level in 2006.

Our effective tax rate is expected to continue to be around the 32% level during the course of 2006.

Average diluted shares for all of 2006 are expected to be about 1.1 million shares less than the full year 2005 average of 54.2 million shares.

We recognize that many analysts currently anticipate a higher level of average earning assets in 2006 than the roughly 16.3 billion that we expect.

Of course, your rate assumptions may be different than ours and we recognize that our rate forecast may be more conservative than most.

But with that said, it appears that many analysts will need to take into account the 500 million reduction that we expect in average securities in 2006 compared to the actual average balance of 3.8 billion for the full year 2005.

In conclusion, we remain focused on achieving for the progress in 2006 towards building a stronger balance sheet and generating a higher quality earnings stream from our core businesses.

Now, I'll turn the program back to Jim for his closing comments.

Thank you Bill.

I know we've provide you with a lot of detail.

But we want you to have the best information possible for your analytical use.

And we continue to believe that the more transparent we can be, and the better information we can provide to you, the better you will get know us and the more confidence you'll have in our ability to achieve our goals.

Webster is a strong, confident, progressive company.

We're making significant progress toward our vision of being the leading regional financial services provider.

Webster has the highest customer satisfaction rating of the top five banks in Connecticut according to our research.

Our concentrated regional franchise puts us number two in Connecticut for deposit market share, middle market and small business banking.

And we have exciting opportunities for growth in Massachusetts, Rhode Island and Westchester County in New York.

I want to mention how proud I am of Webster's employees who contributed so much as we converted our IT infrastructure during 2005 to a modern scalable platform.

This was the largest investment we've ever made and Webster's people have been the ultimate ingredient in the success of this project.

We firmly believe that Webster's people and our standing as the largest independent bank headquartered in New England increasingly provide us with a strong competitive advantage and the opportunity to build strong customer relationships which will increase shareholder value.

Thank you for joining us today.

We will now be please to take your questions and comments.

Thank you. (Operator Instructions).

Our first question comes from Jared Shaw with KBW.

Hey, good morning.

Good morning, Jared.

I had a couple questions.

First just on the IT expense this quarter, you said it was $2 million of temporary cost.

Is that included in the $8.1 million or is that separate from that?

That's separate from that.

That is a run rate expense where the 8 million was a one-time infrastructure related expense.

Okay.

And then that $2 million is likely to be in first quarter, but it will be gone by the end of first quarter?

No, Jared.

The 2 million was in the fourth quarter, and we expect that -- the cost of temporary help in the first quarter will be a minimal compared to that.

Okay.

Great.

Then on the consumer loan - I'm sorry, on the commercial loan growth, can you give us an idea of how you're doing in the Westchester market and the Massachusetts markets?

Jared, this is Bill Bromage.

Yes, in the Westchester market -- in Fairfield, Westchester County, we have a -- as you know, we have a health facility in that marketplace.

We've added half a dozen key resources to call into that market, and they've had an outstanding year in '05 with meaningful growth and far and beyond our expectations.

So we are very pleased with the performance there and the receptivity we're getting in that marketplace.

In the Massachusetts and Rhode Island, we had made a decision to exit a couple of business segments that First Fed had been in.

So when we look at our portfolio in aggregate, it has not grown.

But when we look at the mix of the portfolio and what we are able to accomplish there, we're pleased with that.

Notably, in '05, we've added a stellar team of middle market and small business people to go after that marketplace.

They have been very well received and we are enthusiastic about the prospects as we go forward.

Okay.

And then just looking at the asset quality on the commercial side.

It definitely had a move into the - probably the direction you don't want to go in.

Just in terms of the growth looking year-over-year in NPAs, is there -- is that comprised of a few larger loans or is that just a general -- is that a pretty granular increase?

Jared, it's Bill, again.

If I may take a moment, let me respond to the asset quality because we have had a couple of quarters of increase, and I'd like to comment on that.

As you saw, we're $73 million at the end of the year, which was up about 12.5 million from the end of September.

And in fact, that was up about $16 million from the end of June.

So we're looking at a trend there that clearly is worthy of comment.

And while we believe the $73 million is by itself is not a disturbing number for us, we're not pleased with the two consecutive quarters of $10 to $15 million of net increase in this non-performing book.

The smaller end of our commercial portfolio continues to perform at a pattern of inflow and outflow each quarter that nets out.

Over the past two quarters, we've had four or so larger credits, larger being in the $4 million range, three of those this quarter, that we've not had the normal time period required to get to a resolution.

Since year-end -- since this year-end one credit for $4.5 million that was delinquent 90 days has had a delayed capital infusion made and it is now current and performing.

As you may recall from the last quarter's call, we had a $3 million real-estate credit, which we felt was well secured and would end with a full recovery.

In fact, in the fourth quarter, we completed the foreclosure and we carried in our [OREO] book instead of in our non-performing loan book.

And since year-end, we have sold this property with a full recovery.

On these larger credits in total we expect in excess of $10 million of resolution in the first quarter.

We remain confident in the credit quality of our portfolio and our lending practices.

We are principally a secured lender and have a track record of strong collection efforts, notably the two cases I indicated.

Together those factors result in a high recovery levels on our problem loans and correspondingly the low net charge-offs levels that you noted over the past several quarters.

We expect similar outcomes from the current non-performing asset portfolio and expect that as we transition into the commercial bank we're going to have these inflows and outflows and we'll have some peaks and valleys, but we remain confident in the portfolio.

Just looking at a commercial segment there, the 46.4 million, what type of allowance level do you have allocated against your commercial - against your commercial book, if you look at a total commercial allowance to total commercial loans?

We provided about 3% Jared.

We go through a very sophisticated detailed process with segment-by-segment and in adversely rated loans -- loan-by-loan reviews.

All of that when you add it up and come up with a simple metric, is about 3%.

And all of the loans in our non-performing have been very closely scrutinized and individually marked to the extent to which they need to with specific reserves.

And then you said that the -- even with the commercial -- not looking at the commercial real estate but the actual commercial loans, those are secured positions, a lot of those are?

For the most part, they are secured.

We occasionally wind up with a secured loan, one of our -- we have one of our loans of about that size is unsecured.

And we could end up with a seven figure loss on it, but well within the run rate capacity that we've shown over the past several quarters.

Okay.

And then the $5 million of commercial real estate, around $3 million of that you said that has already been taking care of by the --?

Yes. $3 million of it was the inflow into non-accruals of the third quarter, it went into OREO this quarter and next quarter, it will be -- not will be it is gone.

Okay.

Great.

Thank you very much.

You're welcome.

Our next question is from Kevin Timmons with CL King.

Hey, guys.

Jared got most of my questions in.

By the way, I appreciate the guidance you give.

So many companies have stopped giving any guidance.

It's helpful that you guys do what you do.

The infrastructure program is totally done now, is that correct?

Pretty much, there could be some tag-in expenses related to it.

And as we've indicated the run rate will be higher than it was in the past by about $1 million a quarter beginning in Q4 '05.

Okay.

But that's sort of -- included in the run rate that Bill gave us?

Yes.

Okay.

The three large credits that went non-performing, how much did they total?

The three large credits that went non-performing totaled -- bear with me one second -- about $9.8, just under $10 million.

So the 10 million of resolution is the entirety of that.

Well, keeping in mind we had a similar level of inflow last quarter.

So it may not be these specifically those.

One of the ones I mentioned we resolved in the $10 million, is one that went $3 million -- $3 million plus loan that went not accrual last quarter.

Okay.

But we had a total over the two quarters about eight loans that averaged around the $4 million number.

That was -- the ones that we're working towards resolving and getting out of here.

On the --

--that kind of inflow, that number is going to take a couple quarters to start cleaning those up.

Okay, great.

You mentioned in the press release and on the call about the - as you termed them particular revenues, revenues and expenses that were particular to the quarter.

And you described a little bit what the expenses but on the revenue side, what were the items that were included -- what was the nature of them that were one-time?

Okay.

They were 4.2 million of items, Kevin. 1 million was security gains, 873,000 were prepayment fees that we collected during the quarter on our -- from our loan portfolio, and $2.3 million of gains in our direct investment portfolio.

Okay.

I think that's it for now.

Thank you.

Okay.

Thank you, Kevin.

[Operator Instructions].

Our next question is from Tom Doheny with Sandler O'Neill.

Hi.

Good morning, guys.

Hi, Tom.

I wanted to follow-up on the de novo program.

I guess on the third quarter conference call, Jim, you mentioned the potential to expand that program, now we're talking about you're dialing it back, opening six branches versus nine in 2006.

Is that more of a function of -- obviously, you're in a challenging revenue environment, is that the primary driver?

Or have you -- is the program not succeeding as well as you had thought at this point?

Just the overall thoughts on what's driving the slow down there?

Yes.

I'm glad you asked.

We are very bullish on our de novo program.

But we recognize the environment in which we're operating requires us, we believe, to manage the expenses more tightly for expense management's sake then we might like.

And so in our view we're making a bit of a sacrifice here by cutting back from nine to six.

And I also pointed out that we would ramp back up to the expected rate in '07.

Ideally, we would like to expand the program.

I think we all recognize that if you expand the program you deepen the trough of the program as well and the negative impact it has over the near term on earnings.

And we are trying to balance the need to control expenses against our desire to expand this program.

Great.

And like you said, you got the -- you actually had all four branches you're looking for in the fourth quarter opening -- open in that period?

Yes, we did.

You know, Tom, what's happening here is that we put everything on the table.

I mentioned the de novo initiative as being trimmed back in '06.

There are many other initiatives that we have scaled back in order to put a clamp on expenses.

And so everybody all around the company put something on the table, basically, including the de novo plan.

And the fact that we were willing to scale that back, even temporarily, I think, sent a very strong message to everyone at Webster, and everybody pitched in, which is why we think we'll have a good expense program in '06.

Great.

And then on then -- the growth in the commercial real estate portfolio this quarter looks like it picked up quite a bit.

I think last quarter you talked about some prepayment in that portfolio kind of hindering the growth there but at the same time, you had some comments about your not being willing to match some terms that were out there in the marketplace.

Maybe you can comment on the growth net portfolio and what kind of change this quarter, whether it was less prepayments et cetera?

Yes, it's Bill Bromage.

I think Tom that we have been going through a period of time of a relatively flat portfolio in the CRE book.

And by that, I'm talking about the investor development side and we ended up with a good backlog of credits that we were able to close and not have the prepayments at levels we'd had in the past.

So we had some net growth.

I don't think from my perspective as we look forward into '06, it's not the harbinger of more growth in that book -- or a different perspective on it.

We still see that as a marketplace that is challenged from a finding transactions that are quality transactions, well structured at good yields.

That doesn't mean we can't do that but that is difficult to do in this environment.

It remains very, very competitive and with these rates we may be experiencing a little bit of what can prepay has, but that still remains a risk on our portfolio in terms of run-off of the portfolio.

I would point out that we have a residential development portfolio that's probably 15% or maybe 20% of our book that has performed extraordinary well over a number of years, grown nicely has an outstanding quality record.

We work with builders who have been in the trade for some period of time -- not the investor type builder, but the hammer -- so called "Hammer Swingers" who know how to build homes and do it in a disciplined manner, and don't get ahead of themselves in terms of spec houses.

We've got an outstanding track record in that, it's been an underlying basis for growth and we would expect that to continue.

Great.

And then to follow-up on the Kevin's question, I guess, on the $2.3 million gain, you said that was from the direct investment portfolio, is that essentially a equity gain that you account for via the equity method or is it essentially a security gain?

About I think, $1.6 million of that was realized, Tom.

And it was realized in a fund that we had about a 20% interest in and it was realized by the nature of three investments in that portfolio going to IPO.

The rest of it, of about 600,000 came from just a fair market value adjustment during the quarter.

Okay great.

Thanks a lot.

Okay.

Our next question is a follow-up from Kevin Timmons with CL King.

Hey, guys.

I guess a follow-up to that.

The $3.2 million, the gain on the private security bank, what line item is that in?

Is that in the other line?

The direct investment, Kevin?

Right.

Yes.

It's in the other category, other non-interest income.

Okay.

And then the other thing is, given your outlook for the shape of the curve and the wholesale portfolio probably -- the potential going to a negative spread, would you give serious consideration to blowing out, at least some of that remaining portfolio?

Would you get to that point?

Is there any reason not to consider that?

Well, I think, our approach has been to manage it, we thought we took the appropriate action a year or so ago in Q4 '04 and we've gradually been wearing the portfolio out.

We don't - if it goes to negative, it won't be material.

Kevin?

Right.

It would be marginally negative.

We also, I guess, I'd reserve an answer to that question until it actually occurred.

But I would say at this point we don't have a plan to do that.

And the other thing to be clear on is we're not saying that we're not going to borrow money from wholesale sources.

We're saying we're going to get that ratio down under 20%.

Same on the security side, which would get us actually below, in large part, our median peer group level.

And we expect we probably would retain it in that level over the longer term.

So, just by continuing the process through '06, we get to the desired levels and therefore I don't think there really is a need for any special action.

All these, yes -- you've done a good job getting the borrowings down from a level that was, relatively high to a reasonable level.

I'm just saying that the, I think, during the course of the call you mentioned that the decline in the net interest margin on the wholesale business took about $0.04 per share out of earnings and that would be from -- I'm not sure if that was from a year ago or that was from the - I haven't done the calculations.

Kevin, that was on a linked quarter basis.

That was when you compare the third quarter of this year to the fourth quarter of this year.

Okay.

So a less than 30 basis point decline took $0.04 out, and you've got another 56 basis points to go before you get to zero, before you go negative.

I'm just wondering do you see that coming as a high probability [then] coming?

I think the caveat Kevin is that -- and we mentioned this -- our assumptions could be a little on the conservative side.

Right.

It's possible that it won't go negative.

And if doesn't go negative, and we're at the level that we desire to be -- sustainable levels, then I wouldn't want to take any abrupt action.

Okay.

Thank you.

Our next question is a follow-up from Jared Shaw with KBW.

Hi again.

Let's see here.

Jim can you hear me?

Yes, I can hear you.

Okay.

Sorry about that.

Can you give an update on HAS, you did give an update on the growth in the deposits, which is great just in terms of how it was received, I guess is the plan administrators you are working with?

And did you see a lot of growth in terms of people electing the high deductible health brands?

Sure.

I'll be happy to in fact I'm going to ask, Nat Brinn who is the executive with responsibility for HSA Bank to comment.

Hi, Jared can you hear me?

Yes absolutely.

Thanks Jim.

Yes, we -- it was a good year as you know in terms of the account growth and deposit growth and our market share as a leading bank provider.

We were pleased to retain that.

What we're seeing anecdotally out there is that the smaller companies continue to embrace this, but what changed in '05 was that the mid-size and large companies, started to enter the world of high deductible health plans.

For example, two Fortune 500 companies became our clients.

So that was all good news.

What we're seeing, though, is that particularly for those employers, the larger employers they are taking a fairly go-slow approach, not pushing or forcing their employees into these high deductible plans for this '06 enrollment season we just had, but rather putting it out there as an option and letting the early adopters in their employee group select it, so that then next year those employees can tell all of their associates what their experience was.

And so that it will gradually be adopted by the employee group, but the employees won't perceive that the employer is kind of forcing it.

Now we're still seeing, by and large fairly low penetrations amongst the employee groups, under 10% on average.

You've got all extremes.

You might have some smaller employers who would go to a full replacement of only offering high deductible, but by and large, you get a couple of percent penetration in the employee base in the first year.

So what we hope for the '07 enrollment season is not only to have more employees come in, but to have that employee penetration pick up into the double digits and thereby giving the entire HSA market a good lift.

Great, thank you.

And then Jim, you did talk about cutting back your de novo expansion plans.

Could you comment on your outlook for potential acquisitions or your outlook on the acquisition market right now?

I didn't, but I'd be happy to say that we're always interested in making partnerships with like-minded institutions that share our vision of being the leading financial services provider.

We think that there may be some activity in that regard.

The challenge is being able to meet the asking price.

We think there could be a chance for us to have a negotiated opportunity here and there over the year, but we don't see it having a major impact on our results for '06 at this point.

Okay.

Thanks.

And then finally, Bill Healy, we're sorry to see you leave.

I'm sure you'll have fun in retirement.

Could you just give us an update on how the search is going for a new CFO?

Yes.

I'd be happy too.

We are actively engaged in research.

We've identified a number of candidates.

We have begun the interview process.

Meanwhile, of course, we're asking Bill to stay as long as he possibly will.

So when we talk about into second quarter, we really mean it.

Because he has done such a fine job for us.

And we're very appreciative of his efforts on our behalf.

Just witness his grasp of all of these numbers that he's presented in today's program.

Well, if he's going to stay through January and February, I'm sure that June and July won't be a problem at all.

Exactly.

Thank you.

Thank you.

Ladies and gentlemen, there are no further questions at this time.

I'd like to turn the floor back over to management for closing comments.

Yes.

Thank you all for your participation today.

We look forward talking to you soon.

Ladies and gentlemen, this does conclude today's conference.

You may disconnect your lines at this time.

Thank you for your participation.