Webster Financial Corp (WBS) 2017 Q1 法說會逐字稿

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Good morning, everyone, and welcome to the Webster Financial Corporation's First Quarter 2017 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 Financial's 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 may 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 first quarter 2017. I will now introduce your host, Jim Smith, Chairman and CEO of Webster. Please go ahead, sir.

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Thank you, Donna, and good morning, everyone. Thanks for joining Webster's first quarter 2017 earnings call. President, John Ciulla; CFO, Glenn MacInnes; and I will review the quarter. And then Executive Vice Chairman, Joe Savage; and HSA Bank President, Chad Wilkins, will join us to take questions. Beginning with the highlights on Slide 2, Webster reported solid business and financial performance, most notably, record net income. While unseasonably high loan payoffs muted loan growth, loan originations of almost $1.2 billion in the quarter were up over 20% from a year ago, with commercial originations again accounting for more than 2/3 of the total and delivering a 19th consecutive quarter of year-over-year double-digit commercial loan growth.

A 13-basis-point increase in earning asset yields drove an 11-basis-point increase in the net interest margin. Also notable is strong deposit growth, with most of it coming from HSA and transactional deposits, such that the cost of the deposits was flat year-over-year and up only 1 basis point linked-quarter, while borrowings declined over $500 million from year-end. Revenue grew year-over-year for the 30th straight quarter by over 7%. Year-over-year expense growth was a touch higher at 7.4% as we continue to invest purposefully in differentiated strategies that have high economic profit potential. Credit metrics remain favorable, including the lowest level of quarterly net charge-offs in almost 10 years, which combined with the flat-linked quarter loan portfolio, resulted in a lower loan loss provision, even as coverage ratios improved further.

The quarter also benefited from a lower-than-anticipated tax rate, which Glenn will describe. All in, return on average common shareholders' equity reached 9.4%, approximating our cost of equity. And the return on average tangible common shareholders' equity was 12.5%. Our capital position strengthened further in the quarter and will support ongoing balance sheet growth.

According to the Fed's April Beige Book, economic activity continues to expand modestly in the metropolitan markets we serve, with the job market tightening and commercial real estate markets cooling a bit. I hope you've had a chance to read the letter to shareholders in Webster's 2016 annual Report co-authored by John Ciulla and me. In addition to spelling out what a good year 2016 was for Webster, the letter delves into our strategic perspective. The annual report's overall theme is thinking forward, investing in strategic growth. It describes our commitment to our strategic management framework, investing capital and strategies that create value for customers and maximize economic profit and shareholder value over time. We allocate capital and resources to essential investments in infrastructure and regulatory initiatives, and then to the highest economic profit businesses, and we prioritize projects accordingly. Performance objectives are clear, and we have achieved close alignment among strategic, financial and compensation plans.

An intensive strategic review undertaken last year helped us sharpen our strategic choices. The result is we're investing even more aggressively in HSA Bank, accelerating the expansion in Commercial Banking and, in Community Banking, optimizing the physical digital balance while investing in the Boston expansion. In effect, we doubled down on the key strategic priorities we had identified 4 years ago. Along those lines, Webster was featured this month in the American Bankers magazine. The Bankers cited Webster's leading position among banks in the health savings account market and focused on our progress following our strategic choice in late 2013 to invest more heavily in the business, upgrading our technology platform, expanding the product set and pursuing larger client and health partner relationships.

Since that time, HSA Bank has seen its total HSA footings almost triple to now total $5.8 billion in 2.4 million accounts. Deposits alone have grown by well over $3 billion from organic growth and acquisition. That rapid growth explains why 60% of our accounts are less than 2 years old. Those young accounts represent the hidden gem of HSAs, as they will produce a vintage effect over time. Those 1.5 million accounts less than 2 years old have average balances of $1,200, while accounts seasoned more than 5 years carry average balances 5x as high. Imagine how that drives account profitability over time. Also HSA-related, Greg Madar, Webster's exceptional Chief Accounting Officer, has been named Chief Financial Officer for HSA Bank and will report to HSA President, Chad Wilkins. HSA Bank is a specialized business and runs on an industry-leading technology platform separate from Webster's, has its own customer care center and dedicated human resources, with capital and support coming from Webster. This structure positions HSA Bank to be focused and innovative as the leading bank administrator in the rapidly evolving world of health care consumerism and to capitalize on exciting industry growth opportunities.

Commercial Banking, another differentiator for Webster, is our highest economic profit generator today, and we're investing to fuel its continued growth.

Coming out of the strategic review, we accelerated investment in our front-end systems, made meaningful upgrades to the treasury and cash management systems and products and accelerated recruitment of additional high-quality bankers. Our strategic decision to expand commercial banking into adjacent Metropolitan markets is bearing fruit. Our successful expansion to Boston in 2009 was a model for our further expansion into the New York City and Philadelphia Metropolitan markets in recent years. You can see the positive results. Our expansion of the Community Banking footprint last year into Boston proceeds apace, with retail deposits up over 20% linked-quarter, or $40 million, and the umbrella effect is benefiting all of our businesses. Direct contribution continues to improve, resulting in a declining EPS drag of about $0.02 in Q1 and an impact of about 1.5 points on the efficiency ratio.

In the recent organizational step, we announced that Peter Gabriel will head Webster Private Bank and will now report to Chris Motl, who you may recall was promoted to lead Commercial Banking at the beginning of this year. This move further strengthens our ability to deliver the totality of Webster to the owners and executives of our commercial and high net worth customers. We continue to keep a close watch on the developments in Washington, D.C. It seems we've entered a soft period between rhetoric and action, where the extent to which policy reforms may quicken the pace of economic growth remains to be seen. We remain optimistic that the pro-growth agenda, advancing infrastructure investment and tax and regulatory reform, bodes well for economic growth and job creation and for bank performance in general. We're specifically interested in reforms affecting health savings accounts and consumer directed healthcare. We remain quite bullish on the future of HSAs as a bipartisan solution by partners and solution to healthcare cost, quality and access, whether or not Congress passes significant healthcare reform.

And we're more than pleased with the amount of attention that HSAs are getting in mainstream America. I'll now turn it over to John Ciulla to report further on the quarter.

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Thanks, Jim. Good morning. I'll begin on Slide 3. Loan growth of $1.2 billion over the past year was driven by strong performance across all commercial categories, and has been fully funded by growth in transactional and health savings account deposits. Our strong growth in these core deposit categories has enabled us to maintain a loan to deposit ratio in the 85% to 88% range over the past year. Periodic and floating loans represent 70% of total loans, which continues to position us well in a rising rate environment. Turning to the line of business performance on Slide 4. Commercial Banking continues to deliver strong results, with the segment reporting year-over-year revenue and PPNR growth of 16% and 17%, respectively. The year-over-year revenue and PPNR growth was driven by 13% loan growth and a 40-basis-point improvement in the yield on our largely floating rate loan portfolio.

Loans grew 1% from the prior quarter, as solid originations and funding, notably in the middle market sponsor and specialty businesses, were partially offset by a higher level of payoffs concentrated in commercial real estate. Deposits grew 11% when compared to last year, and the percentage of transactional deposits to total deposits improved. Linked-quarter deposit balance changes were impacted by normal seasonality and government deposits. Loan and fee volume from our strategic initiatives, namely expanding our industry segment activities and sponsor relationships, as well as growth in our metro markets within Middle Market banking, is contributing to the PPNR growth. Sales and syndication activities continue to generate fee growth, which in the first quarter compensated for lower swap revenue, resulting from fewer commercial real estate transactions in the quarter. I'll now turn to Slide 5. HSA Bank delivered another record-breaking quarter, adding over 370,000 new accounts, putting total end-of-period accounts at nearly 2.4 million, up 21% over the same period in 2016. While we did not achieve our new account target for Q1, primarily due to fewer accounts from the carrier channel, we remain optimistic about production for the remainder of the year. Total footings exceeded $5.7 billion, including nearly $4.8 billion in deposits and almost $1 billion in investment assets. This represents 20% growth over the same period a year ago and over 10% when compared to the prior quarter. Year-over-year, deposits and investments grew 17% and 36%, respectively. Deposit balances were impacted by a higher level of investment transfer versus the same period last year as well as the aforementioned new account shortfall. For reference, this year's first quarter of $72 million was transferred from deposits to investments as compared to $35 million in last year's first quarter. Our cost of funds for deposits declined 1 basis point from last quarter and 4 basis points from the first quarter of 2016, as we adjusted some of our rate tiers and partner rates to better align with the market. HSA Bank revenue and PPNR were up 15% and 13%, respectively, year-over-year when adjusted for the Q1 2016 impact of the JPM acquisition. We continue to make significant investments in our business as we expand our sales force, extend our service and capabilities to include 24x7 support and online chat, and invest in our technology and infrastructure as part of our ongoing operational excellence initiative. These investments totaled approximately $1 million in the quarter and will continue throughout 2017, as we will look to advance our data analytics, new product enhancements and sales methodology. By investing in our people, our platform and our servicing capabilities, HSA Bank is well positioned for future success and to capture our share of the rapidly growing health savings marketplace. Moving to Slide 6. Community Banking continues to make steady progress on a strategic roadmap designed to optimize profitability, while investing for future business growth. Deposit balances grew by 5% year-over-year, with consumer and business deposits growing by 4% and 6%, respectively. Overall Community Banking loan balances grew by 3% year-over-year. Business loans grew 12% on strong quarterly new originations, 11% higher than the prior year's first quarter. Mortgage loan volume was lower due to higher interest rates.

Overall Community Banking operating revenues were up by almost 2%, while expenses related primarily to investments in technology and the effect of a full quarter of Boston compensation expense drove total expenses higher by 4%. The result was a 6% decline in year-over-year PPNR. As we continue to focus on improving the digital experience, we saw year-over-year growth in active online and mobile banking customers of 6% and 14%, respectively. Digitally active households as a percentage of total households grew from 44% a year ago to 46% this quarter. I'll now turn it over to Glenn for his financial comments.

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Thanks, John, and good morning, everyone. I'll begin on Slide 7 with a review of Webster's average balance sheet, primarily focusing on the linked-quarter comparisons to the fourth quarter of 2016. Average commercial loans grew $290 million in the quarter, reflecting the full quarter pull-through of Q4's record level of almost $1.3 billion in commercial originations. Period-end loan balances were up 0.4%, with commercial loans up approximately 1%. Average deposits totaled over $20 billion with linked-quarter strength driven by seasonality in HSA and government deposits. Linked-quarter average deposit growth of $729 million funded loan growth, with the excess paying down approximately $550 million in short-term borrowings at 78 basis points. Our loan-to-deposit ratio of 84.5% at March 31 is well below the Northeast regional fourth quarter 2016 median of 98% per SNL data. Key capital ratios continue to remain strong and improve further, supporting our strategy to grow primarily 100% risk-weighted loans. Slide 8 summarizes our Q1 income statement. Key earning drivers for the quarter were higher net interest income from continued loan growth and NIM expansion, relatively flat adjusted non-interest income, seasonally higher noninterest expense and stable credit. I'll provide more color on each of these categories in the subsequent slides. One item I will highlight is the lower-than-anticipated effective tax rate of 27% in the quarter. While we had expected a tax rate of around 30% in January, the lower rate is due to additional tax benefits as a result of a higher share price during the quarter. The tax impact of equity-based compensation has historically been recorded directly to shareholders' equity and is now recorded through the tax line. Slide 9 provides more detail on net interest income, which increased 9.4% from a year ago and 4% from Q4. The increase reflects NIM expansion of 11 basis points compared to each period, an ongoing growth in average interest-earning assets. Compared to Q4, the NIM expanded 10 basis points from loan yields primarily as a result of increases in the average 1-month LIBOR and prime and another 4 basis points from less premium amortization in the securities portfolio as a result of lower prepayment fees. Both increases were partially offset by a 3-basis-point impact of higher borrowing cost. There was no impact on NIM from the slight increase in deposit cost or the number of days in the quarter. Two fewer days, however, did lower net interest income by $1.9 million. Slide 10 details non-interest income, which was down from Q4 as a result of the $7.3 million asset sale gain that you see at the top of the Q4 column. HSA fee income, highlighted in light green, increased $2.5 million, primarily due to seasonally higher interchange revenue, along with a higher number of accounts. Loan-related fees, highlighted in purple, increased $1.2 million, reflecting higher loan syndication fees somewhat offset by lower prepayment revenue. Other income, highlighted in blue, decreased $2.8 million, primarily reflecting a lower level of commercial hedging activity. And mortgage banking revenue, highlighted in beige, declined $1 million due to seasonally lower application and settlement volumes, combined with lower gain on sale spreads. Slide 11 highlights our noninterest expense trend, which had a linked-quarter increase of $1.9 million. This reflects increases in technology and equipment, consulting services and compensation and benefits. Note there were $1.1 million in facilities optimization costs in both Q1 and Q4. The efficiency ratio improved to 62.1% in Q1 from 63.1% in Q4 led by the strong revenue performance. For additional detail, please refer to the efficiency ratio slide at the end of this presentation deck. Slide 12 highlights our key asset quality metrics. Our credit metrics remain stable, and we maintain a positive forward view on asset quality. In the upper-left chart, we highlighted our nonperforming loans. $34 million of the quarterly increase represents 3 credit relationships. The quarterly increase in NPLs is not related to any one lending unit or geographic market. Consistent with our strong risk management practices, the risks have been identified. The accounts are actively being managed. We have appropriate reserves in place. Commercial classified loans remained relatively stable at 3.34% of commercial loans and well below the 5-year average.

And the provision for loan loss, in the top right, was $10.5 million in the quarter. Loan loss coverage increased 2 basis points to 116 basis points as a result of portfolio balances and mix changes. Slide 13 provides our outlook for Q2. We expect average loan growth to be in the range of approximately 1% to 2%, and we expect average interest-earning assets to grow up to 1%, as securities should be flat. We expect NIM to increase 1 to 3 basis points, driven by higher loan yields and no change in securities yields. This also assumes no changes in market rates or deposit rates from today's levels. As a result, we expect net interest income to increase between $3 million and $5 million to another record level. Non-interest income is likely to be $1 million to $3 million higher. We expect the efficiency ratio to be in the range of 60% to 62%. We also expect banking center optimization costs of around $2.5 million in Q2, which are excluded from the efficiency ratio calculation. These costs relate to the consolidation of the banking center in Q2 that we announced earlier this year. We expect the provision to be in the range of Q1 and Q4, driven by loan growth and asset quality, and we expect our tax rate on a non-FTE basis to be around 32%. Lastly, we expect our average diluted share count to be around 92.5 million shares. With that, I'll turn things back over to Jim.

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Thanks, Glenn. We're off to a good start in 2017, and our momentum gives us optimism as we look over the remainder of the year. Our balance sheet is well positioned for rising rates, given our diverse loan portfolio and fast-growing, low-cost funding sources. Investments in strategic growth are bearing fruit and point to a promising future. We're planning an Investor Day with special focus on HSA Bank on Thursday, November 9, in New York. Details will come out soon, but mark your calendars. We hope you can join us. I'll now open it up for questions.

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(Operator Instructions)

Our first question is coming from Steven Alexopoulos of JPMorgan.

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I want to start on the HSA business. Looking at the new account growth, the 371,000 accounts, as John indicated, that was a bit below the 400,000 you guys have guided to. Can you give more color on the shortfall there, and they're coming in lower than expected?

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Sure. This is Jim. I'll make a comment, and Chad is with us as well. Just to say that I think that to some extent, we benefited from the integrations that we've made with a lot of our health carrier partners. And so the enrollment period actually proceeded faster and have less of a tailwind than might otherwise have been expected. And as a result of that, we overestimated what the yield would be. Chad, you want to comment?

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Yes, Jim. Thanks, and good morning, Steve. So what Jim says is accurate. First of all, we were expecting 400,000 accounts in the first quarter. And through January, we were right on track with our forecast. But it tailed off a little bit more quickly than we had anticipated or we've seen in the past in February and March. I think that's really attributable to more efficient enrollment season. And then when you think about just the total accounts that we received in the quarter, we are going to see some fluctuations. These are large health plans that have large employers that they -- so there's -- if you have, from a timing standpoint, when they come on and when they enroll, we'll see a little bit of a fluctuation year-over-year. And so we had a little bit lower enrollment than we expected in our health plan channel, but still solid growth coming from those partners year-over-year. Good news is, for the quarter, we were up 20% plus, in line with industry growth rates. And we expect that kind of growth to continue. So we're happy with where we're at from an end-of-period account standpoint.

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Also, Steve, I'll add to that, that the balances in the new accounts ran a touch lower than expectations, and also that we had sweeps into investment accounts totaling over $70 million in the quarter, up from $35 million a year ago.

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Okay, that's helpful. Change gears for a second on the NPA Bill. Glenn, I heard you say there were 3 larger credits there. It doesn't look like you needed to build the reserve. Can you give me more color on those credits? Or any read-throughs for the rest of the book?

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Yes, Steve, I'll take this one. So it's 3 credits, loan, commercial, each of which have about a 10 -- in between a $10 million and $12 million exposure. There's no correlated risk characteristics there in 3 different lending units, 3 different geographies. We do not see any sort of underlying trends, and the issues are unique to each of the credits. I can tell you that we have pretty good line of sight on 2 of those credits to what we believe will be a favorable resolution. And as you know, we need to put up what we believe to be appropriate reserves for those credits, and those are all appropriate reserves. One of the things we've said over time is that when you're operating at these historic lows from a credit metrics perspective, that in any one quarter, particularly in the commercial bank, and when you combine Business Banking, it's about a $10 billion loan portfolio, that it any one quarter you could see some choppiness in any category. And so we're really not concerned. Obviously, we never like to see increases in NPLs, but we're not concerned by these 3. And I would say as related to the provision that our classifieds remain flat, our delinquencies are down, and our charge-offs are down. when So you take the whole asset quality picture into consideration, we characterize it as stable.

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Okay, that's helpful. And maybe just a final one on margin, maybe for Glenn. Looking at the commercial loans, Slide 4, why did the yield on new fundings increase so much quarter-over-quarter? And then with HSAs more in the mix in terms of deposits, Glenn, how are you thinking about deposit betas for the rest of the year?

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Yes. So I think the primary driver of the commercial loan change in yield is mix-driven. And that's been the case. So you'll see that. That's the reason for the increase.

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And LIBOR on the yields.

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But on the new fundings . . .

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Right, yes.

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And then on our outlook for beta, we have about $16.3 billion of our deposit base is what we used to consider managed funds. And that's about 80%, and a big portion of that is HSA. We have not seen, with the exception of government or public funds, any pressure on pricing yet. We have bumped up our CD rates. That's more of a balance sheet strategy. So we're watching that. I think, if anything, if I look at previous cycles, we would expect our total booked beta to be lower based on where the market is right now and based on the portion of HSA balances that we hold.

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Our next question is coming from Jared Shaw of Wells Fargo.

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Just following up on the HSA site for a second. Do you think that any of the conversation -- or rather change in conversation from the election had an impact on people adopting the [ actual ] healthcare plans are going into funding those accounts at the beginning of the year? You talked about the new account opening was a little bit lower. But also, it seemed like there was a little bit of a disconnect between the funding levels of new accounts versus where we were at this time last year.

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Yes. Interesting question, Jared. It's really hard to know, and we haven't seen a lot of other stats yet to get a bead on that. There's been general comment about a bit of a low, about businesses waiting to make some decisions to figure out what kind of policy reform they're going to see. Could that spill over a little bit into decisions on HSAs and consumer-directed healthcare? Sure, it could. We can't say for sure, but that would be consistent with, I think, what we're seeing generally in terms of economic growth.

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Okay. And then also you had mentioned that the carrier channel's a little bit weaker. And we saw the news out of Anthem that they selected one company to be the preferred partner. Does that mean then that I think in the past, with Anthem, weren't you one of several partners? Does that eliminate that channel delivery for you?

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Chad?

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Yes. Jared, yes, we saw the announcement, too. Obviously, we've known about that for a while, that it was just in there as well. But there -- we still -- I guess, first, I'd say that we don't get a large percentage of new business that we create from Anthem. We -- that said, because when we did the JPM acquisition, we actually started to do new business with them. And we've seen, frankly, double-digit deals over last year. So -- and we're continuing. And then that's all new business for us. So we're seeing good growth. It takes a while for that integration to be built out and to get traction. There's a lot of different platforms that Anthem operates. So I imagine it's not going to have an immediate impact, although it's something that we'll have to keep an eye on over time. We continue to appreciate the Anthem relationship and want to work with them more in the future. So -- and we're optimistic about being able to do that.

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Great. And then just following up also on the NPL, out of those 3 loans. Were those previously classified? Or did those go from nonclassified to nonperforming?

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Previously classified.

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And they're still reflected in there.

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Our next question is coming from Collyn Gilbert of KBW.

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Just to follow up quickly, back on the NPL question, was there -- you had indicated, John, that there's specific reserves attached to those 3 credits. Was that part of the provisioning this quarter? Or you already assigned specific reserves to those before?

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Part of the provisioning this quarter.

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Okay. Roughly how much of the $10 million was out of those 3?

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We wouldn't comment on those, Collyn.

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Collyn, it's Glenn. You can look at our trend, and you can look at the build. And our net charge-offs were $5.7 million in the quarter. And so you look at our build, just to give you a sense of -- or the direction.

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So Collyn, not to get too far in the weeds, right? But when something goes into nonaccrual and it comes out. And you look to do a specific reserve, it comes out of a general reserve. So when you look at the provision for the quarter, it's really not directly attribute to any one credit. It's the totality of what the reserve methodology comes out with in the general reserve of all the credits, and then the specific reserves against those that are in nonaccrual. And it's an aggregate, so it's very difficult to point from one credit to attribute part of the provision to any one credit.

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Collyn, Joe. The other thing I would add to that, John made a pretty good comment right at the outset, which was that of those credits, 2 we see proceed to a very successful resolution. So if embedded or implicit in your question is the concern regarding provision build, we think we're in a decent place there.

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Okay, okay. That's very helpful. And then just another sort of detailed question. So, Glenn, I appreciate the guidance that you always give, obviously, on the fee income or any of the lines. But just specifically within that, mortgage banking's obviously been a big, big, focus this quarter. You guys did better than your peers. Is that just a timing issue, do you think? Or how do you see that business trending as we look out to the rest of the year?

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Well, I would say we were down quarter-over-quarter. And part of that was volume-driven, and part of it was offset by spreads widening. When I look at Q2, we expect to see the volume go up by more than 40%. The early indication is it looks very promising. So the ad volume is up, but we do see some narrowing of the spread. So where we were, 300 basis points is coming down 50 or 60 basis points. So net-net, pretty stable quarter-over-quarter.

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Okay, okay. That's helpful. And then, Glenn, another question for you. Just on the kind of the deposit pricing strategy outside of HSA, as you guys are looking at the core bank business, can you just give us a little bit more color there, how you're thinking about it? I know you had indicated you bumped up CD rates a little bit, but just wanting to understand how you're managing kind of the growth and the rate component within just the core bank business.

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I think we -- when we look at that total book, and I'll start with retail, we do distinguish Boston from the rest of the franchise, and that it's more aggressive in pricing. So as you know, in the past, we've done some promotional pricing there, and then we've pulled back. But quite frankly, we haven't seen, with the exception of CD rates, and mostly from some of the larger banks, pressure on that portfolio. So that we haven't had to respond on anything but CD rates.

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Okay, okay. And then a question for you, Chad. Just on the account openings that we saw this quarter, what was the split among the delivery channels or kind of the origination split among large employers? I know you said majority of it was that, but just wanting to get some more color around that.

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Yes. Collyn, we see, in terms of both their existing portfolio and new account production, a little over -- around 60% new account growth comes from our health plan channel partners.

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Okay. And then the rest of it, was there any other concentration beyond that one?

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Rest of it's really retail and direct to employer.

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Okay, okay. All right. And then just one final question, Jim. For you, and I hear I may ask this a lot just because if the dynamics of which the industries are changing, can you just kind of give us your updated thoughts on HSA, the value of it to Webster, the value of it as a standalone entity, just given the movement that we have seen in the industry and probably will continue to see as we move out over the next few years?

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Sure. Well, you've heard us say before that we think that HSA can be the highest contributor to economic profit and fastest growing as well. There's no telling what its potential value could be. It stands on its own as a specialized business. I was trying to reinforce that point in my comments this morning. It also has bi-directional value to Webster because it provides us with very low-cost funding sources rapidly growing and offsetting the loan growth that we have. So I'm not going to try to put a number on it, but there is extraordinary value in that asset.

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Our next question is coming from Mark Fitzgibbon of Sandler O'Neill.

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John, just a follow-up on that NPL question. I know that you had said that there weren't any sort of macro trends that you could draw away from that, and they came from different lending units and geographies. But Id wondered if you could share with us which lending units they came from, maybe what industries those credits are in?

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Mark, we don't really want to get that specific on those credits. I can tell you, in general, they were not in commercial real estate. They were in our Middle Market and segment businesses across the franchise. But I'd rather not comment on the specific credits.

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As you said -- let me just reinforce that, Marky. I think he gave pretty good color there. They're in different industries. They're in different geographies. They're in different business units. There's no systemic impact there at all. I think it's pretty good response.

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Okay. And then could you share with us the size and complexion of your loan pipelines today?

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Sure, I will. And it's interesting. Steve Alexopoulos asked the question last quarter on it. And from a commercial bank perspective, we had drained the pipeline at a very strong fourth quarter, and we had $220 million in our pipeline going into the first quarter. I had mentioned at the time that while the pipeline is -- it didn't provide guidance, it's not always just positive on where you end up because we have a pretty conservative definition of the pipeline, which is greater than a 50% chance to close within 90 days. And so we had a $220 million pipeline going into the first quarter. We actually funded in the commercial bank $534 million and funded loans in the first quarter. So I've commented that activity was high, but that our sort of matured pipeline hasn't gotten really that much -- that strong at the time. At the end of the first quarter, we're at $270 million, which compares a little bit favorably to year-end, but is unfavorable to the prior year, Mark. I still see pretty good activity across the business units. I would comment that high-quality commercial real estate transactions, for us, and given our underwriting box, seem to be a little bit tougher to come by. So I'd say it's a little bit slower. But in the other business lines, I think we have reasonable activity. You've seen a little slowness across the industry, but I'm pretty confident that we'll continue to build the pipeline and have a pretty robust second quarter.

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Okay. And then lastly on HSA. HSA deposits are now about 24% of funding for the balance sheet. How high would you be comfortable taking that over time?

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Significantly higher than it is today. Basically, these are checking accounts that have some yield attached to them. It's a core competency that we have. We get a lot of diversification by geography clearly because we have customers in all 50 states. So we don't have a concern about the proportion of HSA deposits to the total. We also have, Mark, to the extent if it ever becomes a concern, we have the ability to offload them as broker deposits. We also kind of encourage sweeps into investment accounts. We have lots of leverage to pull there. So we have no concern about the continuing rapid growth in HSA accounts.

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Our next question is coming from Dave Rochester of Deutsche Bank.

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Looking at the expense trends in HSA, it looks like the expenses are continuing to grow kind of in that mid-teens pace year-over-year. Was just wondering how much longer you think you're going to need to run at that pace. And are you still building out the sales force in that business at this point? Or is it more technology you're spending on?

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So let me just comment. If we need to go deeper, we will, but I think we made it clear that we have upped our investment in HSA Bank. We've talked about the 24/7 center, about the online chat, about investing in the technology platform, which is really important. And actually, you saw the payoff in the efficiency of the healthcare carriers enrollment because of the quality of the integration that both they and we have been investing in. We've boosted the sales force. And we've made it clear that, therefore, the rate of expenses would be higher over some period of time. I think the way to look at it would be that we'll probably start to see some operating leverage improvement late in 2017 then accelerating thereafter. I think that would be how we focus on that. Glenn, maybe you'd like to make a comment?

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Yes. The only thing I would add to that is if you're looking linked-quarter, there is a cost associated with the onboarding collateral of new accounts. And of the $2.3 million increase linked-quarter in the HSA business, that's about $1.4 million of that. That's a big driver sort of seasonality of the business.

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Got you. So one year out, this mid-teens pace should be something lower, low-teens or high-singles?

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On the expense side.

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On the expense side? Yes.

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Yes. As Jim highlighted, you'll start to see the leverage improve toward the end of this year.

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And are you guys still building out the sales force? Or is that pretty much done?

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We have made a lot of progress on it, but we're still building.

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Okay. And then just switching to the NIM real quick. Was just wondering what the loan prepayment penalty income trends were in the quarter versus last quarter, and if you could talk about what you're assuming for securities premium-end this quarter. I know there was a little bit of a lift in asset.

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So I'll take the first one -- the second question first, and that the amortization, we think CPRs will likely flatten down -- or not. We will get the level of decline that we saw in Q4 and Q1. Where our CPRs were 16, we're down to 12.6. They'll probably be at the high-end of 11. And as a result, our amortization will probably only pick up $400,000 or $500,000 quarter-over-quarter. On the loan income, I think Q4 was about $2 million. And in Q1, we had about $0.9 million.

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What was it in Q1, sorry?

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In Q1, $2.9 million; prior quarter, $2 million.

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Got you. And then, sorry, you were saying, on the security [ stream-end ], you expect it to tick down a little bit more this quarter?

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Yes. I think the amortization expense will go down $300,000 to $400,000 quarter-over-quarter.

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Got you. Okay, great. And just on credit...

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That, again, is based on today's curve, right?

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Today's rates, right? No change in rates? Got it.

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A wildcard.

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And just a last one on the credit side. We've seen the reserve ratio a tick up a little bit over the last few quarters. So I was just thinking, is that trend going to continue? Or I know it's highly dependent on migration, but any thoughts there on how we should expect that to trend?

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Yes, it's all going to be driven by loan growth and mix. That's the only migration I can say. So migration.

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Our next question is coming from Bob Ramsey of FBR Capital Markets.

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You gave some good color around the loan pipeline headed into the second quarter. I'm curious if you have any sort of longer-term thoughts. I know several banks have talked about the sort of expectation for loan growth to be stronger in the second half of the year than the first half of the year. Do you have any thoughts or visibility? Or is it too early to say?

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I think it's too early to say definitively. We generally see sort of a seasonal uptick in the third and fourth quarter. Bob, I have heard anecdotally from our folks in the field that there is an expectation of a stronger third and fourth quarter. Obviously, with all the -- I don't use the word, enthusiasm, loosely around the new administration, but there was a lot of business optimism. I think people thought we hit the ground running. Obviously, the first quarter across the industry loan growth was a little slow. And I think the pipelines are pretty modest in the second quarter. But I think it's fair to say we're confident given all the levers we can pull in our different geographies and our business lines that we'll be able to capture good market share. And I think we do believe that the third and fourth quarter will be stronger.

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Okay, great. And then a question around the margin guidance. Obviously, you guys had a really strong quarter for margin expansion this quarter. We did get another, and most of it was loan yields. We didn't get another rate increase in March. Maybe just kind of curious why you don't expect something a little more than 1 to 3 bps in the second quarter?

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Yes. I think the other side of it is with the long end coming down, that impacts our resi, our investment and our home equity loan portfolio. So that's sort of the offset. You're right, in that we get the full benefit. And the guidance I gave is completely -- almost completely driven by loan yield. If you look at it, what we're thinking on the securities yield will be relatively flat quarter-over-quarter. The purchases that we're making on securities, at least what we see right now, is pretty much at the current loan yield, where in the first quarter it was above the loan yield -- or the portfolio yield at that time. So the other factor, Bob, would non-core income. Loan income is likely to be down. And that's based on activity.

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Okay, okay, fair enough. And then, I guess, last question now for you guys, after some of the lending clubs' problems, I know you guys have sort of stepped away from buying lending club loans. Can you -- last year. Can you provide an update on sort of how you view that asset class today?

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Sure. I mean, it's a non-core asset for us. We have about $200 million in total exposure now, and our activities there result in a slow burn of the portfolio.

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Okay. But are you all still not purchasing loans? Or have you stepped back in?

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We are purchasing a modest amount, but not enough to offset the runoff and natural amortization in the portfolio. And that's intentional.

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Also, we're in the top tranches.

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Our next question is coming from Casey Haire of Jefferies.

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Just on, I guess, digging a little bit on the NIM. The -- with the liquidity profile at 84% loan-to-deposit ratio, is there any appetite to maybe -- to pay down some more borrowings at 140 with a 20-bp HSA deposit to provide some near-term NIM support?

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Yes. I mean, some of that you saw we did in the first quarter, paying down like $500 million of 78 basis points, and we're always looking at opportunities to do that. The nuance in the quarter is that we got an inflow of government deposits, which was about half of our deposit inflow. So that's more volatile. So we take advantage of the short-term borrowings when those come in. But the HSA side allows us to take a longer perspective. And of course, we do that.

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Okay. And on the -- I guess, on the fee side, up 1 to 3, can you just walk us through what's driving that growth? I know there's some seasonality, but...

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So, yes. So part of it's going to be driven by loan volume and loan related-type fees. That's a piece of it. The deposit service fees also are projected to increase. And that's pretty much across the board of community HSA and commercial bank. Those are the 2 key drivers. I talked about mortgage banking. That's up slightly. So that's not a big factor going into Q2.

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Okay. And then, Glenn, just last one, the NIM guide. If we did get a June hike, I know we wouldn't provide much of an impact on a quarter, but would there be upside due to the 1 to 3?

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I think we're using a forward curve, and that gives the June probability about 60% right now. So it's not going to move that much. If it's so late in the quarter, it's not going to move that much.

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Our next question is coming from Ken Zerby of Morgan Stanley.

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Just a question on the guidance for the earning -- average earning asset growth is 0 to 1%. It seems a little bit lower than what it has been in the last several quarters. I think you mentioned it was due to lower securities. But presumably, that's also due to lower deposit growth. Can you just explain what the main driver is of the 0 to 1%?

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It's pretty much, Ken, the securities portfolio flattening out and continuing to grow loans. And so we're comfortable with where we are in the securities portfolio, so within the range of plus or minus $50 million, $60 million. I think that's where we'll be.

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Got you. I guess, my question's more around like if you had the stronger deposit growth that was coming in, then you put the excess deposits in the securities? So maybe more of a question on the deposit side. Would you a anticipate deposit slowdown or relatively slow deposit growth in second quarter?

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We'd probably look at more in our borrowing structure at that point.

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Yes. It's optionality, Ken.

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Got it. Makes sense. Okay. And then just another question is, on the efficiency ratio, like several years ago, you had the whole P260 goal. Obviously, I get you're making investments in Boston, you're making investments in HSA. Is the sub-60% efficiency ratio even sort of within the cards in the next, I mean, pick your time frame, near-term?

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I think you'll see us continue to make progress. And if you see, I guess, sort of a wide range on the efficiency ratio going into Q2, but we've made progress even quarter-over-quarter. And we're doing that while we balance the investments. So I think the answer is, I think, quarter-over-quarter, you'll continue to see us make progress. There may be episodic instances where we decide to take advantage of something. Certainly, in the first quarter, you have seasonality, whether it's tax and benefits for employees or whether it's open enrollment season for the HSA. But I think, generally, I would expect that you would see that decline over the quarter-over-quarter.

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And let me say, too, Ken, that the core discipline is still there, and we focus on it at all times. Even in this quarter, if you took out 1.5 for Boston, and then you rationalize some of the other investments that we've been clearly discussing in terms of making both an HSA Bank or Commercial Banking, you could see that core discipline is very much intact. It's part of the DNA.

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Okay. And then just a clarification. The banking center optimization, the 60% to 62% efficiency ratio, we would put that in, and then add an addition of $2.5 million?

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You would not include that in the efficiency ratio. That's a nonrecurring item. That's excluded from the efficiency ratio.

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Got it. But from a reported expense base, it would be a little bit higher there?

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Yes, it will be included absolutely in reported expenses.

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Got it, okay. But just not core? Understood, okay.

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You'll see that. You'll also see some further optimization in Boston more with respect to our footprint in existing banking centers. Not that we're eliminating banking centers, but we're shrinking our footprint within banking centers. So there's more to do there.

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Got it. And sorry, how long does -- I mean, obviously, that happens in the second quarter, but does it continue -- is there plans for additional optimization in third and fourth quarter?

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Yes. I mean, I think we're always rationalizing our distribution channels and looking at the trends and how customers want to interact with us. So of course, it's something that's ongoing to Jim's point.

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We're showing time for one final question today. Our last question is coming from Matthew Breese of Piper Jaffray.

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Just on other non-interest income. I noticed that was down a little bit quarter-over-quarter. Was there anything other than lower swap fee income in there or anything one time?

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I think swap fee income is the largest driver. So I would say that's the big driver. There's ins and outs in there, small security sales or direct investment sales back and forth. The biggest driver by far is swap increase.

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Understood, okay. And then on the tax rate guidance compared to this quarter, given the new adoption of accounting rules, should we just, broadly speaking, expect some volatility in the tax line going forward, depending on how the stock price moves?

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Yes. I think you'll see more than you've seen. But I think primarily, you'll see it in the first quarter of every year as stock [ best ] for most of us. And then the other driver that could impact it between the first quarter and other quarters is any exercise of options.

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Understood, okay. And then last one, just a modeling one, could you just update us on the updated balance for loans and deposits in the Boston markets?

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The balance of?

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Yes, and how that compares to last quarter?

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Yes, hold on just a minute. I think our loans, our total loans are about $375 million. And our deposits in the Boston market are, from the new acquisitions, about $289 million, $290 million.

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Okay. And do you have those balances from last quarter?

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No, I know we've improved. I don't have it in front of me, Matt, so we'll have to come back to you on that. Terry -- I'll ask Terry to follow up with you on that.

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Thank you. At this time, I'd like to turn the floor back over to Mr. Smith for any closing comments.

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Thank you, Donna. Thank you all for being with us today. Have a good day.

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Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time, and have a wonderful day.