Webster Financial Corp (WBS) 2014 Q2 法說會逐字稿

Good morning and welcome to Webster Financial Corporation's second-quarter 2014 results conference call. This conference is being recorded.

Also, this presentation includes forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition, results of operations, and business and financial performance. Webster has based these forward-looking statements on current expectations and projections about future events. Actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial's public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second quarter of 2014.

I will now introduce your host, Mr. Jim Smith, Chairman and CEO of Webster. Please go ahead, sir.

Thank you, Manny. Good morning, everyone. Welcome to Webster's second-quarter earnings call and webcast. I'm joined by CFO, Glenn MacInnes, for about 20 minutes of prepared remarks focused on business and financial performance in the quarter, after which President Joe Savage, Glenn and I will take questions.

Results for the second quarter reflect continuing solid performance, particularly given a tougher interest rate environment than we envisioned heading into the quarter. By continuing to live up to our customers' expectations in a market leading way, we are generating continuing loan growth, strong growth in transaction account balances and deepening customer relationships. Results reflect rigorous expense discipline and strengthening credit quality reflective of an improving economy and our effective risk management. We are making progress along the path to high performance and toward achievement of economic profits.

Beginning on slide 2, net income increased 3% year over year to $48 million. After preferred dividends, net income available to common shareholders was $0.50 a share compared to $0.48 a year ago. Return on average assets was 90 basis points, on average common equity was $8.54, and on average tangible common was $11.52. All of my further comments will be based on core operating earnings.

Looking at slides 3 and 4, results were driven by loan growth in all categories, both linked quarter and year over year, especially in commercial banking. Continuing improvement in asset quality and relentless expense management helped produce the 13th consecutive quarter of year over year positive operating leverage. Strong growth in commercial loans boosted loan interest income, even as lower rates and competitive pricing pressures drove yields lower on loan originations across the board. Lower rates also reduced yields and net interest income in the flat securities portfolio as premium amortizations increased and reinvestment yields declined. As a result, the net interest margin declined a more than anticipated 7 basis points of linked quarter to 3.19%, while net interest income was flat to Q1 and 5.5% higher than a year ago. Overall loan balances grew 2% linked quarter and 8% year over year.

Total loan originations were up 22% from Q1, though down 19% from a year ago with the decrease primarily reflecting the change to refi environment as residential mortgage originations were 53% lower year over year. The overall pipeline totaled $865 million at June 30, up just over 20% from Q1. Notably after another strong quarter of originations, the commercial banking pipeline is up about 8% linked quarter, and the total personal lending pipeline is up 34%.

Core noninterest income was $4.2 million lower than a year ago due to a $5.4 million decline in mortgage banking revenue. Excluding mortgage banking revenue produces an increase of 2.5%, driven by a 7% increase in deposit service fees. On a linked quarter basis, core noninterest income was up about 5%, again driven by higher deposit service fees, in this case because consumer volumes were higher than in weather-impacted Q1 and also by higher loan fees. Fee income was not at the level we had anticipated as mortgage banking revenue was weaker than expected and wealth and investment services revenue and loan fees did not rebound quite as expected from Q1. Glenn will provide more detail in his remarks.

Total core revenue exceeded $200 million for the third straight quarter and grew 2% from a year ago as loan growth drove net interest income higher. We've now reported 19 consecutive quarters of year-over-year revenue growth dating back to 2009, which stands out among our peers.

The pressure on revenue from the challenging interest rate environment and the reduction in year-over-year mortgage banking revenue were met with ongoing expense discipline. Expenses were flat from a year ago and 1.4% lower than in Q1, driving the efficiency ratio down to 59.3% and helping deliver positive operating leverage of 2% year over year and 2.3% linked quarter. We achieved 5% year-over-year growth in core pretax pre-provision earnings to over $80 million, only our second ever quarter above that mark.

Favorable asset quality was marked by modest linked quarter declines in nonperforming loans and assets. As a result, the ratio of NPAs to loans, plus other real estate owned, improved slightly and is at its lowest level since the end of 2007. The loan-loss provision increased modestly to $9.25 million as loan growth was offset by continuing improvement in asset quality. Since net charge-offs were unchanged at about $8 million in the quarter or 0.24% of average loans annualized, there was a small reserve build, about the same as in Q1 versus a $4.4 million net release a year ago.

In April the Board increased the quarterly cash common dividend to $0.20 from $0.15 previously. As a result, the dividend payout is now about 40%. Our strong capital position and solid earnings support asset growth, provide for future increases in the dividend and selective buybacks, and enable us to confidently past the annual regulatory and severely adverse stress scenario.

The Federal Reserve Board's July Beige Book for the Boston District, which includes the bulk of our four-state footprint, reports that most contacts are at least cautiously optimistic about their near-term growth prospects. Respondents in the tourism, biotech and healthcare industries all describe the outlook as highly favorable.

I will now turn to line of business performance, beginning on slide 5.

Growth remains strong in commercial banking as we continue to deepen relationships and take market share. Evidencing our success, Webster has received Greenwich Associates Excellence Awards in middle-market banking for the past two years in national overall client satisfaction. Commercial and commercial real estate loans combined now total over $6 billion and grew 3.6% linked quarter and 16.5% year over year. CRE originations were particularly strong this quarter, pushing the portfolio 5.7% higher linked quarter.

Consistent with our strategy, commercial and business note loans now represent over 55% of total loans compared to 52% a year ago and 46% three years ago. Yields are lower as noted earlier due to lower rates generally and competitive pricing compression, but also due to a shift in originated asset mix, namely an increase in high-quality CRE originations in the quarter.

As competition for high quality loans intensifies, we remain disciplined in our pricing execution. The economics of every credit transaction are measured through our internal RAROC model, and every quarter we subject the commercial portfolio to external review that validates our pricing relative to peers.

Deposits declined modestly linked quarter and year over year as a result of seasonality in commercial and government deposits and the disciplined, targeted, deposit pricing strategy with respect to non-transaction accounts, particularly in government banking. DDA and other transaction accounts grew 16.5% linked quarter and 23.5% year over year. These core accounts now represent 60% of total commercial deposits, up from 47% a year ago. Noninterest income increased 14.6% year over year, though declined 1.5% from a strong Q1.

While acknowledging a challenging environment for fee generation driven by intense competition, we believe there are immediate opportunities for accelerating growth in multiple fee categories, notably in cash management, swaps and loan syndication fees.

In summary, commercial banking posted revenue growth of 8% against expense growth of 4% year over year for positive operating leverage of 4%, and this unit continues to earn well in excess of its cost of capital. Momentum continues to build, evidenced by pipeline growth from March 31.

Slide 6 reviews our business banking unit. Business banking is a case in point regarding our focus on providing value-added products to our customers. About 15% of new originations had swaps attached, helping us deliver fee income gains from 14% linked quarter and 11% year over year. Business banking continued its steady growth, recording loan growth of 3% linked quarter and 9% year over year as higher volume offset lower spreads. Deposits grew about 7% linked quarter and year over year, driven primarily by higher average account balances. Transaction account balances comprise about three quarters of total deposits.

Slide 7 presents personal banking results. Overall consumer loan balances were up a bit both linked quarter and year over year, despite the significant year-over-year slowdown in mortgage originations. Residential mortgage originations were up 43% linked quarter and down 53% year over year with purchased mortgages accounting for 75% of Q2 volume. Given the high concentration of jumbo mortgages consistent with our mass affluent strategy, only $56 million was sold in the secondary market versus $217 million last year and $65 million last quarter, resulting in lower than expected gain on sale income. The pipeline grew 45% from Q1 to $325 million, which should boost mortgage banking revenue in Q3.

All other consumer loans originations were up 49% linked quarter and 7% year over year as all three categories -- home equity loans and lines and unsecured consumer lending -- rebounded from the sluggish first quarter.

Credit card revenue grew 18% linked quarter and 20% year over year due to higher sales volumes and growth in transactions. We've penetrated 16% of the checking account base with credit cards, up from 10% a year ago, and there is great opportunity for further gains. Personal banking deposits were up marginally from Q1 and down about 1% from a year ago, driven by heavy CD maturities in Q3 of 2013. The average consumer DDA account balance continued to rise by 4% year over year to $6300. Total checking relationships increased once again, and the cross-sale of product per household ratio improved 7% year over year. Deposit fee income rose 7% linked quarter as debit card transactions rebounded 11% from weather impaired Q1. These were down 1.4% year over year, though debit card usage grew 4%.

Investment assets under administration in Webster investment services continued their strong growth at about 11% year over year to $2.7 billion, driven by increased market valuation and customers consolidation of their financial assets with Webster. The 33,000 households with Webster investment service relationships are among the most valuable at Webster. They average total footings significantly higher than the rest of the Community Bank, have a cross-sell ratio of about 30% higher and exhibit extraordinary longevity.

Distribution strategy continues to drive and accommodate customer migration from banking centers to self-service channels. Banking center transactions declined by 8.3% year over year, while overall sales service deposits, including mobile, accounted for about a third of overall consumer deposits, up 20% over the last year.

We continued to optimize our physical network during the quarter, reducing banking center square footage by approximately 18,000 square feet or 2.5% year to date. Banking center staff declined 7% year over year, while sales productivity per FTE was up 7%.

The bottom line is that we're generating higher revenue off a lower expense base as we transform the community banking model. Despite the mortgage banking revenue hit, community banking eked out positive operating leverage in the quarter at more than 3% year over year.

Slide 8 presents the results of Webster private bank, serving high net worth individuals, families and charitable organizations. We've now completed the transformation to the new model under the strategic plan we announced early last year. We've assembled a skilled leadership team, meaningfully expanded our suite of investment choices, implemented a competitive increase in our fee schedule and upgraded our fiduciary and planning capabilities. We're seeing the benefits of uniting investment management, trust and estate planning, deposits and lending in a holistic way.

While we've attracted $170 million in new inflows over the past 12 months, that progress is masked by two events -- one being the sale in Q3 last year of announced strategic portfolio and the other being the recent departure of two former private bank execs who had been repurposed to producer roles and two portfolio managers who didn't buy into the new and I'm certain the improved model. The departures triggered voluntary liquidations of about 15% of AUM, worth about $1.7 million in annual fee revenue.

A point worth noting is that the liquidating AUM yields significantly less revenue than our core book and 37% less than AUM booked in the first half of 2014 under the new fee schedule. We've filled the four positions and look forward to resuming net AUM growth, as well as expanding into Providence, Boston and New York.

Meanwhile, private banking added more new relationships and with higher average revenues in Q2 than in Q1, and internal referrals also increased linked quarter. The pipeline for AUM is up, and the pipelines for residential mortgages and tailored credits each doubled in the quarter.

We expect this momentum to pick up significantly now that the transformation of the private banking model is substantially complete.

Slide 9 presents the results of HSA Bank, which now has over $2.4 billion in footings, including over $1.75 billion in deposits. Deposits grew 2% in the second quarter and 19% from a year ago. HSA Bank opened about 35,000 new accounts in the quarter, up 18% year over year. The cost to deposits declined 2 basis points linked quarter and is down 10 basis points year over year to 31 basis points.

Growth in investment assets were split about evenly between market gains and account holder contributions. These fast-growing, low-cost, long duration, tax advantaged and nationally diverse transaction account deposits will become an even more valuable funding source when interest rates eventually rise. HSA Bank expanded its product suite in the second quarter to include health reimbursement accounts and flexible spending accounts, along with new capabilities including mobile access, stacked card payments and claims integration that support our strategy to move deeper into the large employer and insurance carrier markets.

And now I'll turn it over to Glenn for his comments.

Thanks, Jim. I'll begin on slide 10, which summarizes our core earnings drivers. Our average interest-earning assets grew $278 million compared to Q1, attributable entirely to growth in our loan portfolio. Net interest margin of 319 basis points decreased from 326 basis point in the prior quarter. Combined, this resulted in net interest income of 155.1 -- flat to prior quarter, but up over 5% from prior year. Core noninterest income increased by $2.1 million or 5% on a linked quarter basis. The increase was driven primarily by a rebound in consumer activity, resulting in higher deposit service fees. Core expenses were $1.7 million below Q1, primarily as a result of seasonal reductions in compensation and occupancy expense and a benefit in professional services.

Taken together, our core pretax pre-provision earnings of $80.3 million were up about 5% from prior year and just below our record level of $80.5 million. Pretax GAAP reported income totaled $70.9 million for the quarter, and reported net income of $47.8 million includes an effective tax rate of 32.5% in the quarter. You will recall in Q1 we recognized a $2 million non-reoccurring tax benefit.

Slides 11 and 12 highlight the components of net interest margin. On slide 11, you see net interest margin for Q2 versus Q1, and as you see, we've posted quarterly growth and average interest earning assets of $278 million, virtually all of which was in our loan portfolio. The yield on securities decreased by 14 basis points, while the yield on loan decreased by 5 basis points. As a result, our yield on average interest-earning assets declined 8 basis points from the first quarter.

Interest income on securities dropped by $2.3 million versus prior quarter. $1.3 million of the decline was due to an increase in securities premium amortization associated with a 1.3% increase in annual cash flows on the MBS portfolio to 17.1%. The accelerated cash flow was driven by a surprising 16 basis point decline in the average ten-year swap rate during the quarter from [286] to [270]. The remaining [$1] million decline was due to run-off of higher yielding securities, including $45 million of municipal bonds yielding 7.16%, which were replaced with lower yielding securities, as well as a slightly smaller portfolio. We expect a significant reduction in municipal call activity going forward, but portfolio churn will continue to put pressure on the portfolio's yield. Higher interest rates would slow down premium amortization and help support the yield.

Our loan growth of $277 million offset portfolio spread compression of 5 basis points, resulting in a net increase in interest on loans of $1.8 million.

Taken together, interest on earning assets was about $500,000 lower than Q1.

With regard to liabilities, average deposits decreased $60 million, largely reflecting a managed decline in public deposits. The rate paid on deposits increased 1 basis point to 29 basis points due to a slight mix change in rounding. Our CD portfolio cost increased 3 basis points to 113 basis points. We have about [650] million of retail CDs maturing over the remainder of 2014 at a rate of approximately 52 basis points, which approximately equals our rate paid on new and renewing CDs. After adding an average of about [50] million of five-year brokered CDs in Q2, we expect to add about another [100] million in Q3, which will result in the CD portfolio cost increasing about 4 basis points in the third quarter.

In doing so, we continue to gradually position our balance sheet for an eventual rise in short-term rates, which I will discuss on a subsequent slide.

Further down, you see average borrowings increased by $316 million. The average cost of borrowings decreased by 16 basis points due to the elimination of double carrying costs from issuing 150 million of senior notes on February 11 to replace the maturity on April 15 and a maturity of 100 million borrowing at 316 basis points, as well as an increased amount of lower-cost FHLB short-term advances.

Incremental short-term secured borrowings currently cost about 25 basis points. Combined, the 1 basis point increase in the cost of deposits and the 16 basis point decrease in the cost of borrowings resulted in a 2 basis point decrease in the average cost of interest-bearing liabilities. The net result is a roughly $400,000 or 0.3% decrease in net interest income versus prior quarter and a 7 basis point decline in net interest margin to 319 basis points. After the tax equivalent adjustment, GAAP net interest income was about $200,000 lower than our record level in Q1.

Slide 12 shows the components of net interest margin versus prior year. The year-over-year view of the balance sheet illustrates the strength in commercial loan growth. In total, average loans grew $1.1 billion compared to second-quarter 2013, with the commercial categories representing almost 97% of growth. Average interest-earning assets grew $1.2 billion or 6% compared to a year ago with loans representing over 92% of the growth. The loan growth drove the increase of $6.9 million in interest on earning assets, while interest paid on interest-bearing liabilities declined by about $600,000. As a result, net interest income on an FTE basis was $7.5 million or 5% higher than a year ago.

Slide 13 provides detail on core noninterest income. Our GAAP reported noninterest income reflects a decrease of $2.2 million from the first quarter; however, Q1 included a gain of $4.3 million from the sale of four collateralized debt obligations. Excluding this, the nominal amounts of OTTI in both Q2 and Q1, core noninterest income increased $2.1 million or 5% versus prior quarter.

As Jim discussed, we had expected the linked quarter increase to be higher, and I will now discuss some of the key categories. Deposit service fees performed as expected, increasing $1.6 million, reflecting growth in cash management fees, debit card interchange revenue and ATM fees. Mortgage banking revenue declined $262,000 from Q1 and totaled $513,000 in Q2. While we had not expected this category to improve until the second half of the year, the decline from Q1 reflects a 14% linked quarter decline on settlement volumes from a lower level of originations for sale in Q1. The quarter also excludes approximately $300,000 in unrealized gains we expect to record in Q3.

Wealth and investment service revenue was unexpectedly flat at $8.8 million to prior quarter when we had anticipated being higher. While loan fees increased $408,000 linked quarter, this was not at the level we had anticipated, and we expect this category to be stronger in Q3 as a result of higher anticipated closings on Webster's agent transactions.

Slide 14 highlights our core noninterest expense, which declined $1.7 million from Q1 and is essentially flat to a year ago. During the quarter, we continued to invest in business growth as evidenced by an increase in marketing and technology. We also opened a commercial lending office in Washington DC. Expansion into Washington -- the Washington market has been great, a part of our strategic plan, and we see this as an area of great potential for Webster.

We managed the impact of additional investments through continued expense discipline across all areas of the organization. This quarter a combined increase of $1.8 million in marketing and technology expense was offset by a reduction in professional services.

We also recognized on a linked quarter basis reductions in occupancy, compensation and benefits as a result of expense seasonality.

Management discipline is reflected in our efficiency ratio, as you see on slide 15. Despite revenue challenges in the quarter, we achieved positive operating leverage on a linked quarter and prior year basis, resulting in an efficiency ratio of 59.3%. Our efficiency ratio was 108 basis points lower than linked quarter and 72 basis points lower than a year ago.

Slide 16 provides detail on our interest rate risk profile. Our risk profile to a steepening of the yield curve is acid sensitive, and the results presented here are modestly improved since last quarter. Our Q2 results have highlighted the investment portfolio sensitivity to changes and prepayment speeds. This continues to be one of the driving forces behind the benefit from rising long-term rates. Our view on timing on the eventual rise in short-term rates has not changed from the mid to late 2015 and is consistent with the market. Timing, of course, is uncertain and could change based on economic data in the coming quarters.

As noted earlier, we continue to take gradual steps to protect ourselves and prepare for the eventuality of higher short-term rates. We are limiting duration risk in the investment portfolio through asset selection and have kept new purchases at durations between 2.9 and 4.0 years over the last five quarters. With 54% of the portfolio in HTM and an AFS duration of only 2.8 years, our tangible common equity ratio is well protected from increasing rates.

On the liability side, we have been lengthening duration by opportunistically buying LIBOR caps, entering into forward starting swaps and issuing five-year retail and brokered CDs without adding significant costs. The asset sensitivity of our core bank is growing with over three quarters of our loan bookings in the last three quarters are floating or periodic rather than fixed rate. And our deposit funding composition also continues to improve with 85% now in core accounts.

HSA Bank provides us with a unique funding advantage in the form of deposits with long average lives, low price elasticity and a rapid rate of growth. With HSA now comprising over 11% of total deposits, we feel we are less susceptible to an outflow of search deposits than many of our peers.

Turning now to slide 17, which highlights our asset quality metrics, the benefits of improving asset quality are increasing. The annualized net charge-off rate was at or below 25 basis points for the second quarter in a row as net charge-offs were just under $8 million in both Q2 and Q1. Nonperforming loans declined to $144.5 million and were 1.09% of total loans, our lowest level since Q4 of 2007. A reduction of a little over $1 million in OREO also lead to an improvement in ratio of NPA plus OREO to loans, which totaled 1.14% at June 30.

New nonaccruals were significantly lower at $23.7 million in the quarter compared to $33.9 million in Q1. $23.7 million in new nonaccruals also compares to an average of just under $36 million for the four prior quarters. Past due loans also saw a decrease of a little over $1 million in the quarter and now represent .35% of total loans.

Commercial classified loans now total $269 million or 3.66% of commercial loans compared to 3.35% at March 31 and 4.54% a year ago. The $30 million increase from March is due to a few downgrades, and the ratio of classifieds to loans remains at historically low levels of less than 4%. Assuming recent economic trends remain intact, continued improvement in key asset quality metrics can be expected in Q3 and beyond.

Slide 18 highlights our capital position. Tangible equity ratios improved from prior quarter and prior year, while supporting almost $349 million and $1.2 billion in balance sheet growth, respectively -- once again highlighting the strength of our core earnings.

Tier 1 common to risk weighted assets declined slightly as most of our asset growth was in loan categories with higher risk weightings but also higher yields and better economic profit. We continue with approximately [40] million of approved but underused share buyback capacity.

So before turning it back to Jim, I will provide a few comments on our expectation for the third quarter.

Overall, average interest earning assets will grow in a range of 1% to 2%. We expect average total loan growth to be in the 2% range with growth expected to be led by CNI and commercial real estate once again. We expect to see continued pressure on net interest margin. Assuming the 10-year swap rate stays close to its current level, we would expect to see 3 to 4 basis points compression in Q3, driven by lower securities and commercial loan yields.

Of course, NIM will vary with loan and security prepayment activity, and that is also dependent on the future course of interest rates. That being said, we expect net interest income to increase about $1 million over Q2, driven by loan volume with some offset in NIM compression.

Our leading indicators of credit continue to be encouraging and signal further improvement in asset quality. The outlook for loan growth in Q3, we see a modest increase in Q3 provision.

Regarding noninterest income, we expect mortgage banking revenue to improve from the less than million -- $1 million level seen in Q2 and Q1.

In addition, we anticipate seeing stronger Q3 growth wealth management loan fees, client and client swap activity. As a result, we anticipate core noninterest income to increase about 6% linked quarter.

We continue to demonstrate a disciplined approach to investing in the business, and as a result, we expect our core operating expenses to be at or below our targeted level to achieve a 60% efficiency ratio, and we expect the effective tax rate on a non-FTE basis to be around 32.25%. Based on our current market price and no additional buybacks in the quarter, we expect to see the average diluted share count to be in the range of 90.5 million shares.

So with that, I will turn things back over to Jim for concluding remarks.

Thanks, Glenn. Our results demonstrate our sustained success in growing our businesses and generating positive operating leverage in pursuit of our economic profits. We are making good progress in our quest to be a high-performing regional bank. We are now happy to take your comments and questions.

(Operator Instructions). Dave Rochester, Deutsche Bank.

Hi, good morning, guys. Jim, you were saying the personal banking pipeline was up -- did I catch this right -- 34% quarter over quarter?

I was talking about the mortgage banking pipeline at $325 million was up about 40%.

Okay. And then the commercial pipeline, that's up 8%?

That's correct.

So would you guys say you are more positive perhaps on loan growth in 3Q versus 2Q?

Certainly on the personal bank side, yes. I would say the commercial bank has continually demonstrated that momentum.

Dave, this is Joe Savage. It is pretty interesting if you take a look at the originations that we did in the first half of the year. It was really stunning because we had that strong first quarter, and we absolutely, as you recall, drained that pipeline. We've been racing to rebuild it, and I would say that -- and we have had great close activity. We've done some meetings with our folks. We feel reasonably good that we are going to have a solid third quarter. How that pipeline ends up, it may be a situation where our close activity is moving at a rate almost greater than we can replace it. But we feel pretty good, long answer to your short question, but we are not in any way intimidated by that number. We think that number might actually climb a little bit as we head into Q4.

Great. I appreciate that extra color there. And switching to expenses and guidance, it sounded like you are still thinking that you can come below that 60% efficiency level. I was just wondering, in terms of the actual dollar amount trends in 3Q versus 2Q, do you expect to see that flat to down, or should that actually grow a little bit as we go into the back half of the year?

Dave, it's Glenn. I think that you might see a little growth, modest I would call it, as we continue to invest in the business, but we have, as we indicated, every intent to be [60] or below.

Perfect. And just one last one on the loan growth side, can you talk about what drove the stronger growth in CRE this quarter? As in where you guys are seeing the opportunities and if you expect to see -- it sounds like you expect to see that momentum continue in 3Q?

Sure. Again, this is Joe. It was a great quarter -- we put on 13 loans. I think what this group wants to hear, we really stay true to our debt service coverage ratio and LTBs, sitting at about [160] and 57% LTB. So we're putting out good quality stuff. Probably the one thing I would want to say for everybody to hear is that in our CRE book, we've got a seasoned group of folk. It's been fairly broad-based where that activity has been occurring. But interestingly we are a tad worried about general overall pricing and structural deterioration when talking to [Bill Rang], who heads our CRE book, he basically said he's putting out more term sheets, but he's not winning them because he's not getting the hit rate he wants. But fortunately we were able to still get the momentum.

So I would say in the markets that you would expect us to be good in -- the Pennsylvania/Philadelphia area, Jersey, Boston, New York -- it's going to be pretty good. One additional bit of color that I would want to add, though, the multifamily represented about 50% of that activity, although we're right within our ranges on that activity.

So we think it's going to be pretty good. We think it's going to be broad-based. We've got a highly engaged group. So no reason not to think it won't go well.

Great. All right. Thanks, guys.

Collyn Gilbert, Keefe, Bruyette & Woods.

Thanks. Good morning, gentlemen. Just to follow up a little bit on that question, can you guys talk a little bit more about the DC initiatives and what you intend to do down there and how you intend to do it?

Yes. Collyn, this is Joe. I'll take a shot at that again. As you know, we were tickled several years back with what we did in the Boston area, and that went well, and we gradually started expanding that group. And, as you recall, really the pioneers, if you will, going into territories would be areas like commercial real estate and asset-based lending. We replicated that model, and we're replicating that model in the New York area and in the Philly area. We're the front runners, generally, having been in that group. And then we fill back in with the middle market group.

So precisely to Glenn's comment, the leaders that will take charge in seeing what it is that we think we can accomplish in Washington, we'll start with the CRE lender that we brought on board. And we also have presence with ABL. And then ultimately I think John Ciulla and team are going to have to make the determination of whether or not it's robust enough to consider bringing in middle-market banking and filling out that franchise.

But it has been a wonderful growth story for us. But out of the gate, precisely to Glenn's point, we brought a seasoned, end market commercial real estate lender, and our Bill Rang is down there fairly regularly with him looking at what opportunities may be available.

Okay. So you still would categorize it is in the early stages in --

Precisely.

Okay. Okay. And just talking on the lending side, is there anything in particular that would be driving just the commercial classified credits now looked like they have upticked for two quarters in a row? Is it one-offs there? Are there any trends? I mean, obviously, Joe, you are talking about competitive pressures -- the environment is intensifying. I'm just trying to gauge, what's the timing before this trickles into credit cracks?

Bingo. That's a great point, and you're right. They did tick up. And maybe the way I characterize it -- I was looking at the number in the commercial bank that classified number six about as low as I have ever seen it at 2.5% of the total book. So Dan Bley and the credit team, we feel pretty good about that number. And, of course, there is another side to that -- what do we see with respect to NPLs and the charge-offs and those kind of things? Those continue to be pretty good.

I don't want to paint a rosy picture here. We do do big tickets. And we're now at that point where the numerator, if you will, is so small that you can add a $15 million transaction and really move the needle. So not a lot of names came in -- I think one or two. In fact, I got a flash of four came in. So it's not big that's going on there.

So we're watching it carefully, and that's kind of why I made my comments when I tried to get some additional color for what Bill Rang was bringing on in the CRE book. Because those guys are doing a real good job with the LTDs and DSC disciplines and not winning deals, winning the deals I guess that meet their standards.

Okay. That's very helpful. And then just one final question, Glenn, for you on the NIM. I think we were all sort of hoping that maybe the NIM was bottoming and -- the NIM was bottoming. Obviously it didn't this quarter. What was the surprise, or what occurred that you didn't anticipate that caused the NIM to fall more than what you were projecting?

I think it was -- on the investment security side, it was the impact from the 10 year and how that affected CPRs, particularly in, say, the last month -- last month and a half where they accelerated. CPRs are relative to particular bonds. We saw higher premium bonds paying off more than typical. So usually when we see a CPR increase of, say, [1], we would expect to see a $600,000 hit on net interest income. In fact, we saw almost a [1.2], so almost double the impact. And that is a function of what bonds chose to pay off.

So that I think is the bigger surprise as far as with respect to NIM. So when I look at the decline in basis points -- the 7 basis points -- about 5 is attributable to the securities portfolio.

Okay.

Also, just to add to that, and then the reinvestment rate --

There's two things in the investment portfolio. So the reinvestment rate -- and that we had [250] million come out off at, say [380] and it was reinvested at, say, [264], so it was 116 basis points that you could characterize as churn, right?

Okay.

So that 28, 30 basis points in the 10 year really does make a difference.

Got it. That's all I had. Thanks, guys.

John Pancari, Evercore Partners.

Good morning, guys. Along the lines of the margin question, it looks like your new money yields on loans -- looking at the [531] there -- pulled back notably in the second quarter. So can you give us a little bit of color there? I know you referenced the competitive pressure you are seeing on pricing and structure on CRE. Can you talk a little bit about the competition you are seeing, and do you expect that the new money yields can continue to trend lower?

This is Joe speaking, again. I would say I would expect -- I guess the one bit of good news is it's about 100% loading is what we're putting on in the book. The other side of that is that, yes, we are seeing the new money yields going in. Interestingly, some of the payoffs have been about that same number. So that's good news for us. We typically ask our team as we prep for this call to give us the dynamics on how the markets are changing, and one of the comments that -- they've been fairly consistent that pricing is selling out a little bit right now. There is still competition out there, but it's settling out.

So I would say it's there, and it's going to push us. But when you have the return on capital discipline that we put forward, basically what it means is we are going to have to work harder to get transactions to meet our pricing hurdles.

But to the question about more intensity, it's really intense out there right now, and if the 10 year stays in the level of [250] or higher swap rates of around [260], [270], we don't think there's going to be significant additional compression on new money.

Okay. All right. And then secondly, on the -- real quick, just on the wealth management revenue again, the main reason for the flat rev is the departures, correct, for that total wealth management line?

That had a meaningful impact, yes.

Okay. And is there -- I know you replaced the people and it sounds like you are a little bit more positive now -- but any potential for incremental departures? I mean could this cause anything? Because I know with wealth management businesses, once you get a string of departures and AUM declines, it can really get moving.

Yes. I think that most of that action happened in a concentrated period and that we're solid and strong, and the team is committed.

You know, what happens is you want everything to go smoothly and everybody to be happy with very significant fundamental change that you're making. But it doesn't always play out that way. So I think that's what happened here, and I know that the team led by Dan Fitzpatrick is very solicitous of the people in the group. They seem to be quite cohesive. They are quite optimistic. We've got a really good model. I mentioned that the pipelines have doubled in the deposit and the lending side. AUMs are up. Referrals are up. Everything is a go there. So we're not expecting to have any serious additional fallout.

Okay. And if I can just hop back to margin real quick, I appreciate the color you gave us for the third-quarter margin. Can you give us a little bit of color about the margin beyond the third quarter, particularly given the securities yield pressure -- the loan yield pressure and CD costs moving higher?

Sure. So I think in the fourth quarter we expect the investment portfolio to bottom out, and then you heard the comments with respect to the commercial portfolio where we think that we are sort of at the bottom there, too. So I think flattish to you said start to begin to see an increase.

Now, of course, this all depends on rates, and we're thinking that the 10 year is going to continue to go up. I think our average for the third quarter or what we are thinking based on the forward curve is that the fourth quarter will have a 10 year of about 288 basis points, right? So we're sitting here today at 265. We're thinking the third quarter we go up 9 basis points on average to 275 and then another 15 to 288, and that's in line with the forward curve. But all our assumptions are obviously driven by that.

Okay. And if I could just ask one last question around rate sensitivity. Have you guys talked about the amount of deposits that could potentially move off your balance sheet at all once short rates move higher?

Sure. We do surge analysis. It's probably about 5% of total deposits.

That could move off your balance sheet, correct?

That could move off.

(technical difficulty)

Secondly, last quarter you had mentioned, Glenn, on a call that you expected mortgage banking to rebound in the second half of the year and sort of in that range of $1.5 million to $2 million a quarter. Is that still a good estimate?

Yes. I think that is a good estimate, and you have to keep in mind that there is about $300,000 lower cost of market of unrealized gains that we'll recognize in the third quarter and that we couldn't recognize in the second quarter. So that's part of it. But really the market was driven -- you look at the first-quarter activity, which was down to our all-time low on a purchase -- at least for the last couple of quarters -- that translated into a 14% decline in settlement volumes. So we expect it to come back over the $1 million level. So I think $1.2 million, $1.3 million is the appropriate level.

And the last question I have follows up on Collyn's earlier question about the DC expansion. Can you help us think about how large this portfolio is likely to become and also give us a sense of whether this lending initiative expansion is likely to include some opening of branches in that market or acquisition of branches in that market?

Sure. I'll take a shot at that, and then Jim may want to add to it with respect to the branch notion. But typically what we've been doing, Mark, in these large markets -- at least at this juncture, it has been effectively branchless. We've got the one major branch bank in the Boston area, and we have our New York offices really piggybacking on our asset-based vending franchise.

So really the notion is to lead first with the commercial bank and in those units where our competencies are easily exportable given the people we have. And so if you think about it and you go down to Washington and you think about that business, that would essentially largely be coming out of the gate as a commercial real estate book.

So, if we saw over the next couple of years -- I will say with respect to commercial real estate -- $150 million, that would be a good day. Assuming it met our RAROC hurdles. So we like to give these things some amount of gestation, and then we can accelerate.

I think Philly initiative we started many years ago -- that's in a $500 million-ish category today. So that gives you a feel for how we would go at it.

Thank you.

Mark, I will just add to that that the way that we are managing the program we don't need the retail exposure to be successful on the commercial side. We've demonstrated in Boston. It's happening in New York and in Philadelphia, and I'm sure we'll have the same experience in Washington.

If you are talking 10 years out, though, you would have to think we probably would have some kind of additional physical presence there just for the convenience of the people in the market, but not a full-fledged retail franchise. It would not be necessary to make this strategy work.

Thank you.

David Darst, Guggenheim Securities.

Good morning. Jim, you were giving us statistics on your sales for FTE, year to date. Is any of that beginning to show the benefit of changes that you've made to your incentive compensation system?

Very definitely. And, in fact, we expect that productivity number to increase as a result of what we call the WIN program, the Webster Incentive program. And we are seeing those people that have been through that program are producing at an increasingly higher rate. So I mentioned that we are up 7% year to date. In terms of overall sales productivity, we expect that number to go higher. This principle agent arrangement on incentives is working beautifully because the interests of the seller are aligned with that of the client and for the benefit of the company as well.

So 7% year to date -- let's say that the all-in rate should be closer to 12% to 15% productivity improvement. So you can actually sell the same amount or more by identifying and meeting your clients' needs with a staff that is significantly smaller in size. Very, very efficient.

So where would you say you are in rolling it out across the entire franchise? Are you through the pilot and it's fully launched?

It's through the pilot. It's fully launched. It's taking hold. So it takes a quarter or two to really see what it can do. But it is delivering as we had expected.

I think the only thing I would add is not only is productivity up, but we are selling the right products. Meaning that the profitability is aligned with what we are selling both in the center and in the distribution network. And that's significant for us.

Actually along those lines, one of the things we have talked about over the last couple of years is our product and customer profitability model is a significant part of making sure that we have the alignment correct. I had mentioned in a shareholders letter a couple of years ago that it would help us make better choices over the near-term and could become a competitive advantage over the longer term, and we're getting closer to the latter.

Okay. Got it. Thank you.

Matthew Kelley, Sterne Agee.

Hi, guys. Getting back to that question on deposit sensitivity, just so I'm clear. You would expect an outflow of 5% of your deposit base. Under what interest rate scenario did that match up to?

I think that would be under a short-term increase of, say, 200 basis points.

Okay. Got you.

We call it the surge, Matt.

And then on your $304 million of commercial real estate origination, you suggested that the yield on those originations was pretty close to the [373] portfolio yield, is that correct?

Yes. The yield on -- let's see -- on that book came in at -- no, I would say that would have been in all float book yields -- I'm going to guess would have been -- this is just going to be a guess, we would have to give you the right number -- I'm looking at the spreads as I'm talking to you -- [213]. But I want to guess, it's probably in the [270]-ish area, but that would be ballpark.

For real estate originations? I'm looking at slide 29, just the $304 million of originations.

You know what? Just to make sure I give that to you correctly, why don't I get that to you so I confirm it. I don't want to read you anything --

Okay.

Matt, you can see on slide 32 where we have the commercial banking yields -- yield on the fundings, and so it's [333] for commercial banking in total. That consists of the commercial real estate components.

(multiple speakers)

What's your view on the Boston real estate market? Is there a lot of development there on the residential condo front? What's your exposure there? What is your view of that market in terms of supply/demand absorption and your activity in the Boston market?

The Boston market has been a very strong market for us, and it's intensely competitive market. We have seen decent absorption in that market, so we are not seeing any [8-Q] potential issues. It continues to be strong multifamily. Probably the big story there from our vantage point is that it's another one of those intensely competitive markets, and when I was talking about earlier the fact that we are not getting as many hits on the term sheets we are putting forward, I think that's especially true in that market. And we are, quite frankly, surprised at some tickets that are being written by the smaller banks specifically there.

But it's a big market for us, $0.5 billion. I will bet you I'm pretty close on that number, off the top of my head.

Got you. And then what was the commercial line utilization rate? Any change there and any change in kind of the overall health of the small and midsized C&I borrowing customer?

Yes. There's really two -- it's interesting. There are really two areas that -- where utilization is a dynamic process in the commercial bank. Really the others are more term funding related items. So -- and those areas are asset-based lending. That's been very solid. Think about it in terms of if you ex out your letters of credit out of that stack, you are talking about 54% to 56% -- it's been pretty solid over two years. And then the other interesting one -- second best and second most important would be our middle-market regional. And that's lifted from about 37%, 38% up to 42%. So pretty good.

Whether that means anything -- we've seen the same articles in the newspapers. We don't want to get too far out in front in determining whether or not that's a trend, but it's not bad.

Got you. And then last question, on your agreement with Jones Lang, you give us an update on the branch consolidation, total facilities costs, management, how that's going, where we are in that progression, and how much cost savings is left on that side of the business?

Yes. I'll just say I mentioned in my remarks that we have taken out 18,000 square feet out of the banking centers in the first half. That's about 2.5% of the total that's consistent with the program we've had in effect for quite a while. We expect there will be additional opportunities to do some 3 for 2, 2 for 1 consolidations. The branch -- number of banking centers is about the right size. They may -- over time we will have them be a little bit small. They may be better located. They will all be electronically outfitted. That's part of (technical difficulty) which is value added beyond the lower cost of delivering the facilities management and other services that they provide to us.

The effect of their impact really is probably you are seeing it in the numbers at this point.

I would add that I think the last -- you see more of this. But it's really bigger than JLL in that's about rationalizing our distribution network. And so you will see additional closures this year or consolidations. Like, 3 for 1, I think is a potential for the fourth quarter, at least that's what we're working on. But really the retail banking team keeps rationalizing the network. So it's JLL helping us rationalize the network. But you'll see that cost continue to come down.

And what is the report card on deposit and customer retention? How does that compare to your expectations? As you close these branches, are you maintaining in line or less or more than what you anticipated as you start to close locations?

I think we are generally in line with what we anticipated on the closures. So there is an attrition factor that's probably close to maybe a little over 20% when you do this. But that's generally in line I think with the industry and what we anticipated seeing.

And we do a pretty thorough analysis office by office to make sure we know not just where the customers live and what other offices they bank in but how they bank today and where they use the ATMs and how much online banking they do and whether they use mobile. So the ones that we've targeted for consolidation have been the ones that will give us the biggest yield, and our analytics have been very strong.

Thank you.

Jake Civiello, RBC Capital Markets.

Hi, good morning, guys. Glenn, you provided us with your expectations for the 10 year for the rest of the year, highlighting that they are in line with the forward swap curve, if I heard you correctly. Can you give us any perspective as to what would happen to the NIM if the 10 year actually stays flat for the rest of the year?

I don't have those in front of me, but obviously there would be continued pressure. You know, I think we would probably go down to [3] to [4] and then maybe another [3] to [4] in the fourth quarter.

So [3] to [4] each quarter, you're saying.

Yes.

Okay.

We are not predicting that. We're not predicting it.

I know. None of us can predict what's going to happen with interest rates. So I'm just trying to get some perspective on if things stay static with what they are today.

I think you've got to be careful about drawing any conclusion then about the securities portfolio because, again, it depends on the bond selection and the individual security selection that you can't extrapolate and draw a linear forecast from that. And so we've been successful up to this quarter in outpacing NIM compression through portfolio increases, particularly on the commercial side. So this is one quarter where we've seen an impact from the securities portfolio and, again, somewhat unexpected in that the 10 year didn't go up, and we saw CPRs, which typically have a 60- or 90-day lag sort of hit on the securities portfolio.

Sure. That's fair. I understand. Thank you.

Thank you. We have no further questions in queue at this time. I would like to turn the floor back over to management for any closing remarks.

Thank you, Manny, and thank you all for being with us today.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.