Webster Financial Corp (WBS) 2016 Q2 法說會逐字稿

Good morning, and welcome to Webster Financial Corporation's second-quarter 2016 results conference call. This conference is being recorded.

Also, this presentation includes forward-looking statements within the Safe Harbor provision 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 2016.

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

Thank you, Christine, and good morning, everyone. Thanks for joining Webster's second-quarter earnings call. CFO Glenn MacInnes and I will review business and financial results and then take questions along with President John Ciulla; Executive Vice Chairman Joe Savage; and HSA bank head Chad Wilkins.

Beginning on slide 2, this was a solid quarter overall for Webster, with over $1.4 billion of loan originations, continued strong revenue growth of 9% year-over-year and key credit metrics at exceptionally strong levels. Record net interest income was driven by the fifth consecutive quarter of year-over-year double-digit loan growth. Noninterest income also rose to a record, and year-over-year revenue grew for the 27th consecutive quarter, a signal accomplishment.

While the loan portfolio yield was unchanged from Q1, pressure on the securities portfolio yield from historically low interest rates led to a 3-basis-point decline in the net interest margin. Record noninterest income reflected higher commercial activity in particular, including higher revenue from assisting our clients in their interest rate hedging needs.

I'll call your attention to a correction and reduction of prior period's net income relating to HSA Bank totaling $1.6 million in Q1 2016 and $1.6 million for full-year 2015. While the corrections have no effect on Q2 results, they have the effect of reducing noninterest income and increasing noninterest expense over the previous five quarters. Glenn will provide more detail.

As in our second-quarter earnings release posted this morning, we'll be speaking through the remainder of this presentation to the adjusted prior-period information.

Sustained strong loan originations, which have now exceeded $1 billion in eight of the past 10 quarters, have overcome the effect of historically low interest rates and been a primary driver of revenue and pre-provision net revenue as PPNR. And the pipeline has remained robust even after Q2's strong performance. Had it not been for the strategically and financially compelling Boston expansion, which as expected resulted in net expenses of $5.3 million in the quarter or roughly $0.04 a share, we would've achieved records for PPNR and net income. A sub-60% efficiency ratio, and return on average tangible common equity would've exceeded 12%.

On slide 3, you can see the quarterly trends for loans and deposits over the past year. Loans grew 10% and were fully funded by an equal amount of deposit growth. As a result, the loan-to-deposit ratio remains quite favorable at 86%.

On the loan side, commercial led the way with year-over-year growth of 13%, and commercial and business loans now comprise 58% of the loan portfolio.

On the deposit side, transactional and HSA accounts grew by 12% and now comprise 56% of deposits.

On slide 4, loan growth is spread across all key loan segments, with each segment again posting solid year-over-year growth.

On slide 5, you can see the diverse sources of our $1.5 billion in deposit growth, with transaction accounts accounting for 73% of the growth. This slide provides a clear illustration of how Webster benefits from our multiple low-cost deposit funding sources.

Slide 6 shows solid loan growth in both interest income and noninterest income to record levels, reflecting strength in both categories -- in commercial banking and HSA bank -- and overall revenue growth in community banking and private banking. Noninterest expense growth reflects primarily HSA bank's growth over the past year and expenses related to the Boston expansion. The net result is 5% year-over-year growth in pre-provision net revenue, which, ex the Boston initiative, would've been 11%. Line of business performance begins on slide 7.

Commercial banking continued its strong performance in a highly competitive environment by delivering 4% loan growth in the quarter and 13% year over year. Year-over-year revenue grew 12% to a record, and PPNR grew 16%, demonstrating strong operating leverage. Commercial banking leads the way in delivering economic profit.

Portfolio yield increased linked quarter due to a favorable mix of origination and payoff activity marked by a robust origination activity in the higher-yielding middle market.

Our team continues to demonstrate success in selected industry verticals including tech media and telecom and healthcare, and through geographic expansion, and by providing treasury management solutions for our commercial clients and commercial real estate investors.

Webster commercial bankers remain focused on delivering the totality of our product and service offerings through effective cross-sell. As a result, second-quarter noninterest income was a record, including record swap revenue generated across commercial business units. Asset quality in commercial banking remains solid, as the quarter saw positive net migration in classified assets, nonperforming loans and charge-offs.

Now, moving to community banking on slide 8, our Boston expansion is tracking on plan. Accounts and balances are ahead of plan, and we generated $140 million in new deposit balances. We are delivering all of Webster to the market behind our marketing campaign of surprisingly good service, as evidenced by strong referrals and growing pipelines across all units including consumer deposits, mortgages, businesses and commercial banking, and private banking, which bodes well for revenue in coming quarters.

Our 24 x 7 customer care program, followed in Q2 by the QuickSwitch tool that facilitates easier account transfer from other banks, has strengthened our value proposition as we make a name for ourselves in greater Boston.

While the super-low rate environment is stressing spread income, we remain confident that our Boston strategy will deliver over $1 billion in deposit balances and more than $500 million in loans in five years, and Boston will be a top-performing market.

Slide 8 reflects another quarter of strong and positive momentum in business banking. Loan balances were up nearly 10% year over year, driven by strong loan originations across all markets and channels, strengthened further by our fast-track loan processing program that is booking more than half the loans under $100,000 within 48 hours of application. Strong deposit growth was driven by 20% year-over-year growth in DDA originations, with the balance per DDA up over 10%.

Slide 9 highlights the steady growth in loan and deposit balances for personal banking. Loan originations declined year over year and rose sharply linked quarter, as did the pipeline, reflecting the recent surge in mortgage volume and also reflecting higher home equity originations. Deposit growth again reflected record high average transaction account balances, highlighting our success in attracting the mass affluent segment.

New investment production of $100 million was up linked quarter and down year over year. We've been working to rightsize this unit since last year, managing expenses to improve margins and ensure compliance readiness for the Department of Labor fiduciary rule. As a result, while assets under administration grew modestly, advisor productivity rose significantly.

Slide 10 reflects trends in mortgage originations, with nearly 87% of portfolio loans coming from high-value jumbo mortgage relationships that typically have higher-than-average products and services per household and support our mass affluent strategy. Focused investments in online and mobile banking continue to improve digital banking penetration, with mobile banking customers growing 16% year over year and automated transactions via ATMs, online and mobile accounting for 70% of the total. Investments in banker training and Salesforce.com are helping improve banking center sales productivity by 20% year over year.

Overall, we are pleased that the community banking transformation continues to gain momentum, as reflected in the increasing concentration of higher-value relationships across consumers and businesses. Progress in executing our mass affluent strategy is benefiting from best-in-class net promoter scores in that segment.

Slide 11 presents the result of HSA Bank, with strong continued year-over-year growth in deposits of 13% and in accounts of 18%. When adjusted for anticipated attrition related to the JPM HSA transaction, which included a purchase price adjustment, or clawback, for accounts at risk of terminating, deposits grew 20% and accounts grew 26%.

During the quarter, we added 538 employees and 103,000 new accounts, bringing year-to-date production to a record $437,000. This performance demonstrates the successful execution of our growth strategy and validates the aggressive investments we're making in our platform capabilities and service offering, with the goal of providing an industry-leading customer experience at every client and customer touch point.

Second-quarter PPNR was flat year over year and down from Q1. Recall that last quarter we reported that the deposit duration was reduced to better match long-term loan duration, which lowered spread income year over year. Also, the clawback benefit in Q2 was $1.6 million lower than in Q1. Lower expenses after the termination of the JPM HSA transition services agreement have not materialized as quickly as first thought, and post-migration volumes remain elevated. And activities including client and customer support have resulted in higher-than-planned operational expenses.

Simultaneously, we have aggressively pursued onboarding and integration of new clients -- for example, those 538 new employers while also providing product extensions to multiple existing health plan partners, which affected expense levels. We boosted marketing expenses and further expanded our sales force in the belief that every dollar invested will elevate HSA Bank's potential and return significant value to shareholders.

For example, our new claims sync feature allows customers to consolidate, view and pay claims from multiple carriers in three simple steps without leaving the HSA Bank member website. We've enhanced our mobile app, enabling customers to verify and pay qualified medical expenses right at the pharmacy.

It's likely that expenses for the remainder of 2016 will be relatively flat as we invest in operational excellence, product development and new business initiatives, and prepare for peak-season 2017 beginning late in Q3. Positive operating leverage should significantly ramp up PPNR thereafter as accounts and deposits continue to grow at around 20% or more.

Slide 12 highlights results for Webster Private Bank where our recent model shift is driving growth across all product categories. Loans have grown to the point where total outstandings are double what they were three years ago and deposits are up 25% year over year. Growth in fee-generating assets drove the strong increase in noninterest income. Revenue per new client grew to a new high, and PPNR increased as well. Boston looks like a good opportunity for the private bank.

I will now turn it over to Glenn for his financial comments.

Thanks, Jim, and good morning, everyone. I'll begin on slide 13, which summarizes our earnings drivers. Average interest-earning assets increased $308 million, or 1.3%, compared to the first quarter. The loan portfolio was up $280 million, or 1.8%, primarily in commercial; up $143 million; and in commercial real estate, up $81 million.

Net interest margin decreased to 308 basis points for the quarter. The average 10-year swap declined 17 basis points during the quarter and 49 basis points versus the fourth-quarter average, negatively impacting the yield on our investment portfolio.

Commercial loan volume offset NIM contraction, resulting in net interest income of $177 million. Noninterest income increased by $2.7 million linked quarter. The increase reflects strength in loan origination fees and revenue from client-hedging activities. Expenses increased modestly, considering Q1 included approximately $1 million in branch optimization expense. Taken together, pre-provision net revenue totaled $89.2 million, up 3% from Q1 and 5% from prior year.

The provision for loan loss totaled $14 million for the quarter. Our loan loss coverage increased from 110 to 111 basis points in Q2.

Pretax GAAP reported income was $75.2 million in the quarter, and reported net income of $50.6 million includes an effective tax rate of 32.7%.

As Jim highlighted in his opening comments, during the quarter we determined that prior periods did not accurately reflect revenue and expense for HSA Bank and needed to be corrected. We had indicated in our updated guidance in mid-June that the correction pertained to end-of-migration true-up at HSA Bank. At the time, we expected a net $2 million adjustment in second quarter's results. Since then, we identified additional corrections and have determined that appropriate action is to correct prior periods. Second-quarter results were not impacted.

A pretax correction of $2.4 million was made in Q1 2016, and a pretax correction of $2.6 million was made for all of 2015. Both corrections reduced previously reported net income. While the corrections impact the bank's consolidated financials, they are confined to HSA Bank segment and are detailed on slide 22 in the appendix. And we have also provided a detailed reconciliation in the press tables.

All financial data in today's press release as well as this presentation reflect those corrections.

Slide 14 highlights the drivers of net interest margin versus prior quarter. Starting at the top, while the average balance and securities portfolio increased slightly, the yield declined 12 basis points. The lower yield was primarily driven due to increased premium amortization of $1.7 million quarter over quarter, driven by an increase in CPRs from 12.1% to 14.8%. Cash flows for the quarter totaled $318 million with a yield of 318 basis points, and purchases totaled $280 million at a yield of 299 basis points.

Further down, you see average loan balances grew 1.8% while the total portfolio yield was unchanged. Commercial loans representing 58% of total loans grew 2.8% while the yield increased by one basis point. Consumer loans grew by 0.8% and the yield declined 2 basis points, primarily as a result of lower yield on the residential mortgage portfolio which fell by 5 basis points.

As we highlight, the combined interest income generated by our loan portfolio increased $2.4 million for the quarter. Average deposits increased $268 million, led by increases in core deposit categories. Savings led the way with an increase of $155 million, about half of which was related to the Boston expansion. HSA deposits increased by $70 million and demand deposits increased by $63 million.

The overall deposit costs were unchanged at 27 basis points. Average borrowings were essentially unchanged, while the average cost of borrowings decreased 8 basis points to 144 basis points. In March, $145 million of long-term borrowings costing 276 basis points matured, and we replaced with a mix of lower-cost shorts and long-term borrowings. The tax-equivalent adjustment increased to $3.3 million from $3 million in Q1, primarily due to growth in municipal bonds of $68 million.

In summary, continued strong loan growth along with lower cost of borrowings more than offset margin compression, resulting in net interest income of $177 million.

On slide 15, we provide additional detail on our noninterest income, which increased $2.7 million from the previous quarter. Mortgage banking revenue increased by $316,000. Settlements of $83 million were about the same as Q1. The premiums on Q2 settlements came in at 179 basis points, compared to 173 basis points in Q1.

Wealth and investment services highlighted in blue were essentially flat quarter over quarter. Loan fees in dark green increased $1.4 million on higher commercial activity. Other income increased by $832,000. Strength in client hedging activities helped to offset a $2.3 million positive fair value adjustment in the JPM HSA receivable in Q1. HSA Bank fee income was essentially flat. The deposit service fees increased $566,000, primarily from higher NSF, interchange and ATM fees. This was led by a 9% increase in debit card transactions.

Slide 16 highlights our noninterest expense, which was flat to prior quarter. Q1 included approximately $1 million of branch optimization, which was offset by targeted investments in HSA.

Turning to slide 17, our investment in Boston kept our efficiency ratio above 60% at 61.5% in the quarter. Excluding Boston-related expenses, our efficiency ratio would've been 59.2%.

Turning now to slide 18, which highlights our key asset quality metrics. Overall, we are pleased with our asset quality performance, as seen by the positive trends in all metrics. Nonperforming loans in the upper left decreased by $8 million and represent 82 basis points of total loans, primarily from reductions in commercial nonmortgage and commercial real estate. Past-due loans in the upper right decreased by $21 million and represent 21 basis points of total loans. The decrease from Q1 was primarily due to the positive resolution of a commercial real estate loan that is fully secured by a high-performing property returning to current status.

Commercial classified loans in the bottom left decreased by $33 million and now represent 3.31% of total loans and remain well below our five-year average of 5.6%. The decrease for the quarter was primarily attributable to commercial real estate.

New nonaccruals were $15.7 million. The decrease was primarily due to lower commercial nonmortgage and commercial real estate inflows.

Net charge-offs, which include gross charge-offs of $9.1 million related to NPLs, as seen on the chart on the bottom right, totaled $7.8 million in the quarter for an annualized net charge-off rate of 19 basis points in Q2. This compares to net charge-offs of $16.4 million in Q1, as charge-offs in that quarter included $8.7 million related to one commercial credit.

Loan loss coverage increased to 111 basis points as we provided $6.2 million more than net loan charge-offs.

In summary, our credit metrics remain at historically strong levels, and we maintain a positive forward view on performance.

Slide 19 highlights our capital position. Ratios remain in excess of Basel III well-capitalized levels. The tangible common equity ratio increased 12 basis points from March 31 and stands of the top end of our stated range of 6.75 to 7.25. Common equity tier 1 ratio was 10.5%, noticeably above our operating range of 9.25% to 9.75%. We continue with our strategy to grow our balance sheet, primarily with 100% risk-weighted loans.

Given Webster's strong capital position and solid earnings, the Board increased regular quarterly cash dividend in April to $0.25 from $0.23 per share.

Before handing it back to Jim, a few comments on our outlook for Q3 compared to Q2. Overall, average interest-earning assets will grow approximately 1% to 2%, and we expect average loan growth to be approximately 2% to 3%. We expect further modest pressure on NIM and would anticipate being flat to down 2 basis points. Reflecting a loan growth in our NIM -- and our NIM expectation, we expect an increase of around $1.5 million to $2.5 million in net interest income in Q3.

NIM and net interest income expectations are subject to overall interest rate environment and not being materially different than it is today. We do not expect any changes in short-term or long-term interest rates, up or down, until the first quarter of 2017. We expect the provision to be in line with Q2's level depending on loan growth. We expect noninterest income to be relatively flat quarter over quarter, as Q2 included record level of consumer -- commercial hedging activity.

We continue to manage our noninterest expense closely while opportunistically investing in talent acquisition and other initiatives in support of our growth strategies. We expect the efficiency ratio, including the Boston expansion, to be in the range of 62%. Our expected effective tax rate on a non-FTE basis should be around 33%, and we expect our average diluted share count to be about 92 million shares.

With that, I'll turn things back over to Jim.

Glenn, thank you very much for that report. And now let's open it up for questions.

(Operator Instructions) Jared Shaw, Wells Fargo.

Maybe just starting with the -- following up on Glenn's comments on the fee income. You are expecting fee income to stay flat as we go into the second half. Is that with higher hedging activity on the client hedging activity, or would you expect to see that pull back a little bit and be covered by growth in other areas?

Yes, that's exactly right, Jared. We did about $4.6 million in hedging activity in the quarter, which was a record for us, up $1.2 million from prior quarters. So, some of that will go away, but it will be offset by other fee income.

Okay. And was that mostly just loan (multiple speakers) --

Jared, this is Joe. One comment I would make on the hedging activity fee income -- and I'm probably jumping John a little bit on this one. But it's coming from different sources. So, yes, Glenn is absolutely right. We don't think we will be at a record level, but there's lots of different sources it's starting to emanate from.

I think if I would look at it by line, I would say we would expect an increase in deposit service fees and loan-related fees as well. Those are the two offsets which, in and out, keep us flat quarter over quarter.

Okay. And when you look at the hedging activity this quarter, was that mostly just loan swap activity?

Yes.

Okay, great. Thanks. And then on the HSA balances, what was the -- was there any final impact to 2Q balances from the JPMorgan true-up, or was that all incorporated into the balances previously to second quarter?

There is about $700,000 in clawback on other income that's related to the HSA transaction for the second quarter.

But in terms of period-end balances, was there an impact? Was there a net outflow at all in the second quarter?

I think that equates to about -- it equates to about $30 million. There are some zero-based accounts too that were just cleaned up. So some of that is already out of our run rate. So I would say up to 20 -- it's not a big number. Up to 20.

Okay. And going forward, we should be done with that at this point?

I think there will be some minimal stuff going into Q3.

Okay. And then just finally, looking at the business banking growth and talking about the fast-track closings, what are the -- what do you look at as the opportunity for that business? And is it based on just rolling it out to all your geographies, or is it more penetration of the existing customer base throughout the geographies?

I think it's across our geography base. Because in business banking, Jared, we centrally underwrite everything, so it's really just pushing more volume through this new, more efficient process.

Yes. And if I may -- it's Jim. I just want to say right now it's about 50% of transactions under $100,000. We'd like that to be 80% or 90%, and we want to get it fully automated. And then we want to move to $250,000. And eventually this is how we are going to originate business banking loans and consumer loans.

Great. Thank you very much.

Jared, just a point of clarification, when we talk about the true-up for $700,000. I want to make sure you understand that that -- for the most part, those balances have already left. So you wouldn't expect to see a reduction quarter over quarter as a result of that. And if we had a $700,000 true-up, you could pretty much apply 4.5% to that and get to $31 million. But those balances -- my point is that those balances were previously left, so they are out of the run rate.

Got it. Great. Thank you.

Steven Alexopoulos, JPMorgan.

I wanted to start on the margin, maybe for Glenn. Beyond the flat-to-down 2-basis-point guidance that you just give us for next quarter, is it your expectation for the margin to continue to decline beyond 3Q 2016 given what the curve has done recently?

Yes, but at a lower rate. We don't expect, as I indicated, rates to go up until the first quarter of 2017, even on the long end. So I think it will flatten out, but our projection is up to one or 2 basis points a quarter.

Up one to 2 basis points a quarter?

I mean up down (multiple speakers) --

Oh, up 2 in terms of pressure. Okay. Thank you, Glenn. Then I just want to shift gears to the commercial, which is still a very strong driver of loan growth. Can you guys give some color? What is driving the strong originations, and can you talk about the loan pipeline which is up considerably?

Yes, sure, Steve. It's John. It really was a terrific quarter. And I think we are seeing strength, interestingly in this quarter, across all of our business units and all of our geographies. It's not a reliance on commercial real estate. We had very strong middle-market originations, both in our regional middle-market group across geographies and in the sponsoring segment area that you guys have heard me speak to before in our specialty areas. We were up in ABL. We had good momentum in equipment finance.

So I think it's really just our model. It's the people we have and consistent execution. We've talked about some of the key hires we made in our sponsor and specialty areas, and we've hired some folks over from GE. And we are really getting great, great traction across all of our business lines.

Okay. That's helpful. Maybe one final one for Chad. Good growth in HSA in terms of number accounts and deposits. Can you talk about what you're seeing as you compete for business here going into the back half of the year and particularly heading into the peak season? Thanks.

Yes. Thanks, Steve. We are -- as I mentioned in the first quarter, we have been staffing up on the sales side, increasing about 50%. So, we've got -- we've had two or three we added last month, and then we've got two to three additional sales reps we are looking to hire between now and the end of August to get us in position for kind of the midmarket sales season in the fall.

I think there's been a lot of activities that have been focused on marketing and sales throughout the beginning of the year. We hit 10 trade shows, which is a record for us year to date. We also have a 20-city tour where we are going out with a well-known person in the industry who is talking about regulatory affairs and compliance. So we are hitting 20 cities, inviting all of our partners and prospective partners in, and that's going very well. So I think we are seeing a lot more activity.

And if you look at between the end of last year and through the second quarter, we've added about a little over 4,000 employers and 437,000 accounts. So the results have been good year to date.

The other thing I'd mention is that we've had some good success selling our other product capabilities to our existing partners. So, part of the work that we've been focused on in the second quarter and going into the third is deepening our integrations with those partners and also extending them out to these -- to the new product offerings.

So, we are feeling like we are starting to hit on all cylinders, as evidenced by the 25% growth year to date when you take out the impact of the transition agreement attrition.

Great. Thanks for all the color, guys.

Bob Ramsey, FBR Capital Markets.

I was hoping maybe you could touch a little bit more on the fast-track loan program. I know you said you are doing half of all loans under $100,000. What is that volume? I'm just curious how much business there is there, sort of what the typical purpose is. And does underwriting differ at all through the channel than what would be done in a more traditional way?

About $7 million of volume -- and a lot of it is coming through the banking centers. So, as you can imagine, what we are trying to do is shorten the time from application to ultimate funding. We basically take -- working alongside our credit risk partners, we basically take what we believe to be our key credit underwriting metrics, and we try and -- we have not yet automated the process, but we have automated -- we have basically built up the process to quickly decision without having to do full underwriting on all the elements. So, out of about $90 million of total volume in the footprint, $7 million right now is going through that process. And as Jim said, the key for us is to continue to evolve that process but also increase the dollar limits of loans that go through that process, and continue to automate to be even more efficient in the originations.

Great. And it the -- obviously I know you said the goal is to shorten that process in time. Is that sort of to become more efficient? Is it a cost benefit or is it a service benefit that obviously the borrower likes a faster process? Or does this enable you to process more volume? I'm just trying to get a sense of what the ultimate outcome could be.

Yes. It's a combination but primarily from a customer preference perspective. Obviously, you read a lot about the fintechs and what's being offered in the marketplace. We obviously want to stay competitive. We want to make sure we are disciplined from a credit perspective. But if you have non-bank competitors and other banks who have automated processes and they can shorten the turnaround time significantly, we need to be competitive there. So, we are going to have higher yields, shorter turn time and a much more efficient cost structure in delivering the product.

Bob, it's Glenn. I'll just add to that. It does reduce on a static basis compensation expense because you are reducing the touch points and the referrals and kickouts of all the applications. But what we are seeing is the volume is more than offsetting that right now. So it's a win for us. We feel good about it.

Because it also reduces fallout. So, it works in so many ways.

Okay. Great. That's helpful. Thank you.

Casey Haire, Jefferies.

Question on the efficiency ratio guide. If I heard you correctly Glenn, I think you said 62% in the back half of the year. With NII up and fees flat, that presumes -- that implies a decent amount of expense pressure. Where is that coming from and why? Presumably, given that you could have some more leverage coming from the Boston expansion as you did this quarter.

Yes. When you are saying expense pressure, here is the way we look at it. Obviously, it's a challenging rate environment. We put that 60% target out there. We think we will be at 62%, all in, for the second -- for the third quarter. And we continue to work it. So, I think you look at it, there's certainly pressure on the expense line. But some of the positive factors offsetting that, as you indicated, will be Boston coming more online; continued loan growth, as John has highlighted. We feel really good about it. We feel really good about the pipeline.

And then, focus on fees. And you saw that evidenced in the second quarter. So, we are starting to get some real traction on fees. Then the rest is all up to prudent expense management, which we are -- as you know from history, we are always rationalizing our branch network, and we are always rationalizing our costs channels. So, that's about everything we can do.

And I think it's key to note -- which you did, Glenn -- that the 62 which includes Boston, Boston is around 2 points by itself.

So did I -- I hope I answered --?

Yes, well, I mean -- I am just -- because we are at 61.5 this quarter, so we are going higher next quarter despite revenues going up. So, you are basically outlining a negative operating leverage quarter with good growth dynamics. I'm just trying to understand where the expense offsets it.

It's the timing of our investments. And as I indicated in the comments, strategic investments. There's going to be some lumpiness when we choose to be opportunistic about when we have an opportunity to bring people in, whether it's on the commercial side or whether it's on the HSA side or the community side. So, there is some -- there will always be some plus and minuses there. It's not a linear equation getting down to 60%.

Okay. Got you. And just the Boston expansion costing 200 basis points of efficiency ratio, where can that -- how much leverage is there from that, once that sort of -- from today's current run rate?

I think, if you look at the guidance we gave, we expect that Boston will continue to contribute. It's -- the high point was in the first quarter. Expenses will be relatively flat, but you will start to see revenue start to offset it. And we've given guidance about our expectation for breakeven. The rate environment may put a little pressure on that. But we still feel pretty good about where we are in Boston.

Okay. All right. And then just switching to HSA, Glenn, maybe Chad as well. The footings and the account growth seems to be pretty robust. The PPNR does seem a little bit behind your schedule at 1.5% year over year. Is there -- what sort of -- is there anything that you can point to that's sort of muting that progress?

Yes, I can -- there's actually a few items. One is that I think, as Jim indicated in his comments, we made a decision here from a funds transfer pricing standpoint to reduce in the first quarter by about 20 basis points the funds transfer credit that the HSA business was getting. That's worth about $1.9 million. So, if you just take that factor, on an apples-to-apples basis last year versus this year, the PPNR would've increased 17%. That's the first thing. And we did that because we are conservative, because we really want to build a history before we start assigning a longer duration to these deposits.

But when I stand back and I look at the business and I look at the three-year planning horizon -- and Chad and team have done a tremendous amount of work on this -- this is still a business at the top of the house on a consolidated segment that we'll do somewhere around 30% PPNR over the next couple of years.

The other point that Jim brought up is that we are doubling down on the investment in this business. So, the expenses are higher than we had originally anticipated, say, a year ago because we are seeing more opportunity, and more opportunity to bring new clients in. We think that's the right thing to do.

So, you have a multiple -- a few factors that are driving this right now. But I think you will begin to see the operating leverage in this business accelerate as we begin 2017.

Okay, understood. Just last question. The reinvestment yield today in the third quarter was very -- it was 299 last quarter. Where are you guys reinvesting today in the shape of this yield curve?

240.

240? Okay. Thank you.

Steve Moss, Evercore.

Following up on Casey's question, just given the challenging rate environment, when do you believe you can get back below a 60% efficiency ratio?

You know, it is a challenging rate environment. We are still targeting to do what we can by the end of the fourth quarter, and there is pressure on that. That's what I was trying to convey. But we are pulling all the levers we can, whether it's loan growth, whether it's our focus on fees, whether it's bringing Boston up to speed. But as I indicated, we look at all our entire expense base.

So, we saw -- but we're not going to hit the ratio for a quarter only to forego potential revenue opportunities, significant revenue opportunities, in the next couple of quarters. So, it's a matter of managing our opportunistic investment and taking advantage of that today and then for future revenue. So, it's a challenge, but we are still targeting toward the end of the year to come as close as we can to 60%.

Okay. Then changing to commercial banking loan yields, they have generally been heading higher, ignoring the rate hike in the fourth quarter. I'm wondering what is supporting that yield and pushing that yield a bit higher. What loan type?

Yes, for us, it is a combination of stabilization of yields in the marketplace from a competitive perspective on credit spreads, but also mix of what we are originating. So, as we mentioned, this quarter we had significant originations and loan volume in our middle-market segment and sponsor business, which tends to have higher yield. So, I would say mix is a first driver, and secondarily some stabilization in terms of overall pricing in the marketplace.

Okay. Then the midmarket clients that you are capturing, are those clients coming from large banks or regional competitors?

It's a great question. I think it's a combination. As I said, we do a good deep dive every quarter on where our originations are coming from geographically from a competitive perspective, whether or not it's stealing market share or whether or not it's just expansion and new transactions in the market. And I really couldn't characterize it as coming from any one place. I think in commercial real estate and in our middle-market sponsoring segment group, it tends to be transactions that are competitive in the marketplace, not direct steals from competitors. In the areas like business banking and in the regional middle market where we may be competing with a bank for their business, I think I would say it's coming from a combination of larger banks and our regional peers.

Steve, this is Joe Savage. Perhaps implicit sometimes in the question with respect to stealing share, is you are either giving up on pricing and structure. And the answer with respect to both of those is an unequivocal no. We have an S&P come in annually and they look at us. They compare us to peer institutions. And I've got John to my right; he's probably more studied on it than I am. But every time I've looked at the analytics, we are at or above our peers when it comes to pricing for risk and pricing in these markets.

So, if we are going to take a deal, we are going to take a deal because we did it smartly or they want to work with our people or because we've attracted talented people to our franchise. It's not because we are buying any business. So, we just really want to make that clear. There is real discipline in shop.

Yes, Steve, to put a finer point on that, the information we get in terms of as we are pricing every loan against our RAROC model, that RAROC model is informed by what S&P tells us by asset class, by geography, by size of loan on what we should be doing with respect to spread, non-usage fees, upfront fees, amendment fees. And we continue to make sure we are managing that at or above the market.

Great. Thank you very much.

Collyn Gilbert, KBW.

Just maybe Chad, going back or starting off on the HSA side, the growth is a little bit slower this quarter. Are you still -- do you still feel good about kind of being able to track at industry growth rates in that 20% to 25% in terms of deposits?

Yes, I do, Collyn. I think when we look at the impact of the clawback agreement and the balances that left as part of that, we are at that -- right around that 20% growth rate. And I anticipate that to continue to improve as we work on our sales and distribution efforts going into 2017 and 2018. So, yes, we feel good about that.

And plus, if you look at the account growth rate, again, netting for the attrition of the purchased accounts, we are at a 25%. Those are newer accounts. We have a larger -- last two years, we've added a lot of more new accounts than we ever have. Those take a little while to get the traction going.

Okay. That's helpful. Then Glenn, just going back to your comment on changing the -- sort of your transfer pricing credit within HSA, that was all on the funding side? Because I know, yes, like linked quarter if we back into it, it looks like the net interest income from HSA dropped about $3 million. So, it wasn't -- this isn't a change in the investment yield assumption. This is all on the funding side?

Yes. It's on our funds transfer pricing, which is really the credit we give to the HSA business for providing the funds to fund those businesses that are generating assets.

But it wasn't a material linked quarter matter.

Yes, it wasn't material linked quarter. It was more material year over year. What was material linked quarter was the net reduction in the HSA clawback provision. In the first quarter, we had a clawback of $2.3 million and second quarter $700,000. That's $1.6 million and that's reflected in noninterest income.

Okay. And I was looking at the net interest income. It had like a $3 million drop.

Quarter over quarter?

Yes. If we back it -- if I'm backing into it correctly.

No. I'm showing net interest income being flat.

Okay. All right. I'll double check that.

So I can circle back with you on that.

Okay. Then just in terms of -- it sounds like the outlook here for HSA, at least in the back half of the year, is going to be kind of accelerated expense growth or flat expense growth. And I think that's -- differs from the thought that once you guys kind of onboarded all the platforms that we'd start to see some expense reduction. And I hear what you're saying; you are seeing opportunity.

Is there -- is this industry -- and I guess this question really is for you, Chad -- I mean, are you finding -- or collectively, that the HSA business is just moving at a much faster pace than perhaps what you anticipated it to be? And I know you are saying you are seeing opportunities, but I'm just trying to -- it's a pretty quick -- as you said, like within a year, sort of the outlook is changing. So, I'm just trying to understand sort of the speed at which this business is moving and how you need to respond or how quickly you feel like you need to sort of keep up if there is a part of that to this.

Yes, I think -- well, there is a combination, Collyn. I think there is it the speed of the industry and then there is the speed of us. The pace of change here is probably a lot more accelerated than the industry. Because if you look at the -- there's three things I'd call out. One is, the TSA contract -- that covered processing and servicing for all of the accounts. So, really managing everything. So we've had to staff up and train and get all the process in place to handle essentially 4,800 employers and 850,000 accounts that came over between the end of the third quarter and the first quarter last year.

In addition, we've added about 4,000 employers and 437,000 accounts of our own between the end of the fourth quarter and the end of the second quarter. So, tremendous amount of growth all coming on to a relatively new platform. So, there were a lot of efficiency gains that we thought we'd get when we moved over to our operations. However, the volume and the change have made the volumes -- the staffing needs a lot higher as we went through the first quarter and well into the second. That's pushed off some of the work that we had teed up to focus on operational efficiency and customer experience. So, those initiatives are in flight, and they are really geared towards making sure that we are set for January 1, 2017 and are much more efficient as we go into January 1, 2017, which obviously impacts our resource needs as we go into 2017 and 2018. And we think it's going to be much lower than what we've seen kind of last year. And additionally, we are not going to be migrating accounts as we go through that January 1 hurdle next year. So, that's going to have an impact, too.

And the last point I would make is that we are seeing a lot of opportunity out there. The reason we went to this platform and we have additional products is cross-selling to our existing customers and capture new. And we're having success there. And that's requiring us to build out integrations and work on that.

So, the good news is that the two things we are focused on are efficiency and growth, and we're having good success on both of those fronts. The bad news is, it's requiring us to keep a higher expense structure as we go through the end of the year. But those two combined as we start to get more and more traction as we go throughout the year, that turns into positive PPNR growth going forward. So, I think it's a good story at the end of the day.

Okay. That's very helpful. Thank you. And then Glenn, just a question on the securities book. I know you had indicated 240 is kind of where you are buying -- you know the new purchases are coming on. Any changes on how you are going to manage that book going forward or the size of it? Or just sort of wanting to understand how you're thinking about that in this perhaps prolonged lower rate environment.

No significant changes. The size will be on an absolute dollar basis, will be about the same. But its relative percent on earning assets will obviously come down as we grow the loan book, but pretty much the same on that.

Okay. I'll leave it there. Thanks, guys.

Matthew Breese, Piper Jaffray.

I was just hoping maybe we could just talk about the expense outlook for the back half of 2016. What is the overall absolute amount of expenses you are looking for that drives the 62% efficiency ratio?

We are only going to give guidance on our target for efficiency ratio. And, again, to my point, that we will invest -- we are managing this business from an operating leverage standpoint and looking at investment opportunities as they come along. So I don't want to be locked into an absolute dollar amount.

Okay. And then in terms of the Boston efforts, where are we in terms of breakeven, and what are the key metrics we should be looking for that gets you to breakeven in terms of loans and deposit balances?

Got you. I think from a breakeven standpoint we had targeted mid-2017. Obviously the rate environment has had an adverse impact on that. We continue to monitor that but there is pressure. It might push it out a little bit. So, that's one factor. From a breakeven standpoint, I think our -- we are really looking at deposits and loans.

This is John. I think right now -- Glenn says it right. With a change in the interest rate outlook, we may be looking at slightly farther out than our mid-2017 target. But in terms of what we are measuring right now in Boston, as was referenced earlier, I think we're pretty pleased. We're ahead on accounts. We're ahead on deposits. The amount of activity across all the business lines which would include business banking, private banking and commercial banking has accelerated significantly in terms of opportunities for bank at work, for private banking referrals.

So, I think we are seeing everything we thought we'd see from a halo effect and from an activity perspective. And we are getting more looks across every business line. So the question is now just converting the economics and, with the interest rate headwinds, how quickly we'll be up to get to that breakeven point.

This is Jim. I just want to say that other than the spread pressure, we are good. And we have given a sense as to what we might achieve and by when, and we are good on that except that the interest rate environment has changed materially since then. Deposits and -- are much higher than original plan in terms of number of accounts. We are very pleased with the progress we've made in terms of brand awareness in the market. We really like being there. And, if anything, we are -- we think it's even more compelling an opportunity than we did six months ago.

Okay. Then given obviously the more challenging industry environment, did that change any other corporate strategies including M&A or other avenues you might go down to increase fee income? Anything like that?

I think you have to choose even more carefully when the margins get thinner. And I think that's something we've done well as we have invested in strategy that can create value for customers as well as for shareholders. So I think that all that we've done over the last several years puts us in very good shape to be able to continue to improve our organic growth in the businesses that we know best. So, we are pleased with that.

Frankly, M&A just is not that attractive to us on the bank side because we've got an opportunity to improve ourselves and win competitively in the market rather than take on a similar set of problems that we are trying to solve ourselves. So, we see possible -- if there is M&A opportunity within a segment, let's say, that would help to advance the strategies that we believe in, that would be one thing. But not likely we are going to be actively involved in M&A on the bank side.

Got it. That's all I had. Thank you.

Thank you. Mr. Smith, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thank you, Christine, and thank you all for joining us today. Have a good day.

Ladies and gentlemen, this does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.