Webster Financial Corp (WBS) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Webster Financial Corporation Second 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, the 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 2017.

I'll now like to introduce your host, Jim Smith, Chairman and CEO of Webster.

Please go ahead, sir.

Thank you, Michelle, and good morning, everyone.

Thanks for joining Webster's Second Quarter 2017 Earnings Call.

President, John Ciulla; CFO, Glenn MacInnes; and I will review the quarter.

And then HSA Bank President, Chad Wilkins will join us to take questions.

I'll start this call by saluting and thanking, Joe Savage, who retired June 30, following 15 years of distinguish service to Webster.

Joe had a distinctly positive impact on Webster overall and on commercial banking, in particular.

His principled leadership, consistently high performance and competitive spirit have left a lasting impact on our company and its culture.

Turning to highlights of the quarter on Slide 2, Webster again reported solid business and financial performance.

Record levels of net interest income, preprovision net revenue, pretax income and net income produced year-over-year earnings per share growth of 20%.

Return on average common shareholders' equity of 9.6%.

I'm proud to report, exceeded its cost.

And a return on average tangible common shareholders' equity reached 12.7%, as our capital position strengthened further.

Among the highlights of the quarter were strong loan originations of over $1.4 billion.

Commercial Banking originations were particularly strong, and once again accounted for more than 60% of the total, marking the 20th consecutive quarter of year-over-year double-digit growth in average commercial loans.

While loan payoffs remained elevated, they were again replaced with higher-yielding loans.

Higher yields on earning assets are one important part of the story.

Low-cost funding is another, as HSA and transaction account deposit growth fully funded loan growth.

And deposit cost barely rose, both linked quarter and year-over-year.

Combination of these positive forces drove the net interest margin higher.

The true value of our funding base, more than half of which is in an HSA and transaction deposits is just starting to come into focus and net value will only increase as rates rise.

Also contributing to the quarter's strong performance are continuing favorable credit trends, which combined with slower loan growth produced the lowest quarterly loan loss provision in almost 5 years.

While nonetheless maintaining stable coverage ratios.

One compelling example of positive asset quality trend can be seen in the residential loan portfolios, where charge-offs on the nearly $11 billion of resi mortgage and home equity loans originated since 2008, which now account for 80% of our current portfolio or just 5 basis points life today.

Validating the sustainability of our improving performance is the fact that revenue grew for the 31st straight quarter year-over-year.

Again outstripping expense growth and generating positive operating leverage and an efficiency ratio with a 60 handle, even as we continue to invest purposefully in differentiated strategies at a high economic profit potential, namely, HSA Bank, the Commercial Banking expansion, which John will discuss and retail expansion in Boston.

According to the federal reserve's July Beige Book, economy activity expanded modestly in recent weeks in the Boston district, which includes Connecticut and the New York district as well consistent with our experience.

Commenters felt that prospects for future growth in our markets are good, which mirrors our view.

Turning briefly to strategy, HSA Bank continues to deliver strong performance, reflecting the significant investments we're making in Webster's #1 strategic priority.

The long-term potential for health savings accounts shines ever more brightly, as more advisers, consultants, employers and individuals recognize the significant role HSAs play in a holistic retirement planning strategy.

In order to maximize the extraordinary opportunity ahead, we continue to invest heavily in key initiatives, including those related to operational excellence, customer service enhancements, product development and sales capabilities.

We recently recruited several seasoned professionals to lead our sales and relationship teams.

And we have undertaken an in-depth initiative to improve our competitive positioning and sales methodology.

The material growth we are experiencing in the number and size of prospective employer-client proposals reflects the measurable results of our strategy to acquire larger employers in order to expand the universe of potential new HSA account holders.

As we said in the last quarter's earnings call, the rate of expenses would be higher for some period of time, given the level of investment in this important initiative.

So while revenue is grown by about 20%-or-so in 2017, expenses are growing at about the same rate, which is boosting net revenue, but keeping a temporary lid on operating leverage, which should begin to improve into next year.

Even though the healthcare bill didn't clear the Senate this week, the one thing everyone seems to agree upon is the importance of HSAs as part of the eventual solution to the healthcare conundrum.

Even without healthcare reform, the focus on consumer-directed healthcare by insurers and employers is intensified.

With eventual reform will come the likelihood that premiums paid from HSAs would be tax deductible and contribution limits could double.

Pushing HSAs to a fundamentally different and imposing position, whereby, they could become a competitive alternative to IRAs and 401(k)s as a primary retirement savings vehicle.

Just think about that for a minute.

A true game changer.

An HSA Bank is in a position to reap the maximum benefit.

Separately, our Boston expansion continues to show promise.

As total attributable deposits and loans reached $340 million and $240 million, respectively, while the negative EPS effect this quarter was about $0.02.

We're still on track for breakeven late next year.

I'll now turn it over to John Ciulla to report further on the quarter.

Thanks, Jim.

Good morning.

I'll begin on Slide 3. Loan growth of $1 billion over the past year has been led by commercial categories and has been fully funded by growth in transactional and health savings account deposits.

Our strong growth in these core deposit categories, along with growth in non-transactional deposits has enabled us to maintain a loan-to-deposit ratio in the mid-80s over the past year.

Periodic and floating loans represent 70% of total loans, which has supported a 19 basis point increase in the net interest margin over the past year, that Jim mentioned, and continues to position us well in the rising rate environment.

Turning to the line of business performance on Slide 4. As we noted on last quarter's call, Private Banking financial performance is now included in the Commercial Banking financials.

Commercial Banking continues to perform at a high level in a very competitive environment.

Year-over-year revenue was up 9.4% and PPNR is up 8.1%.

Loans grew 9.3% from the prior year second quarter on a spot basis and over 10%, when comparing year-over-year quarterly average balances.

Despite solid origination activity, year-over-year loan growth was muted by a material increase in repayment activity in the quarter, primarily impacting our investor CRE and sponsor and specialty business units.

Notwithstanding an industry-wide softening in loan growth, we remain focused on achieving our 10% annual loan growth target over the long term.

Deposits grew 10% year-over-year and the percentage of transactional deposits to total deposits remained solid at 59%.

We are making progress in our strategic initiatives in Commercial Banking, namely, the successful metro market expansion strategy and Middle Market banking, expanded industry segment activities and sponsor relationships, further developing our sales and syndication capabilities, continued investment in people and product enhancements and positioning our wealth offering for business owners and investors across our core footprint.

Turning to Slide 5. HSA Bank delivered another solid quarter.

When adjusted for the 2Q 2016 impact of the JPM acquisition, revenue grew 21% and PPNR growth 30% over the same period last year.

Much of the improvement was driven by increased interest income related to growth in deposits and improved deposit spreads.

HSA Bank generated a number of key new employer wins in the quarter, as our up market strategy is beginning to pay off.

Total accounts were up 18% year-over-year, as we added 100,000 new accounts in the quarter.

Accounts grew marginally from the linked quarter due to seasonality, normal attrition of approximately 12% and the timing of account closures related to post-enrollment partner cleanup of unfunded accounts.

Total footings grew 20% year-over-year and now exceed $5.9 billion.

Year-over-year, deposits grew 16% and investments grew 39%.

Deposit balances were impacted by a higher level of investment transfer versus the same period last year, as on a net basis, $53 million transferred from deposits to investments this quarter, as compared to $33 million a year ago.

The number of account holders with investment accounts continues to increase and is approaching 3% of total account holders.

Moving to Slide 6, Community Banking had a strong quarter and has delivered PPNR growth of 7% year-over-year.

Deposit balances grew by 6% compared to prior year with transaction deposits as a percentage of total deposits nearing 40%, which help to keep the cost of deposits at 26 basis points.

Overall, loan balances grew by 3% with business loans growing 10% year-over-year.

Yield on new loans improved by 45 basis points, helping portfolio yields improve by 3 basis points, overall.

Year-over-year, revenues were up 4% with noninterest income growth of 2%, driven by growth in mortgage banking and investment services income.

Community Banking is progressing along its transformational strategical -- strategic road map.

Continued focus on improving digital delivery drove year-over-year growth in digitally active households to 46% of total households.

Self-service transactions as a percentage of total transactions reached 70%.

We are investing in our digital banking infrastructure and optimizing the physical footprint.

Eight banking centers were closed in the second quarter, resulting in a total branch footprint of 167 banking centers as of June 30.

I'll now turn it over to Glenn.

Thanks, John, and good morning, everyone.

I'll begin on Slide 7 with a review of Webster's average balance sheet, which totaled $26.2 billion and increased 4.7% over prior year.

This was almost entirely driven by commercial loan growth.

The remainder of my comments will focus primarily on linked quarter comparisons of key average balance sheet items.

Average commercial loans grew $207 million or 2.1% and represented most of the loan growth.

Of this commercial nonmortgage and commercial real estate were the key drivers.

Consumer loans grew modestly at 0.2%.

This reflected growth of 1.4% in residential mortgages, which was offset by a 1.6% decline in other consumer categories.

Period end, total loan balances were up 1% with commercial and consumer loans each up by approximately 1%.

Average deposit growth of $320 million was broad-based including increases of $108 million in savings balances from growth in Boston and seasonality; $86 million in health savings account balances and $67 million in interest-bearing checking.

Excess deposits over loan funding contributed to a $200 million decrease in borrowings.

Over the last 2 quarters, average borrowings have decreased by $750 million at a cost of approximately 90 basis points.

This resulted in a borrowings to asset ratio of 10.9%, its lowest level in 6 years.

And our loan-to-deposit ratio of 84.4% at June 30 is substantially below the March 31, New England bank median of 97%.

Common Equity Tier-1 and tangible common equity ratios both improved, supporting our strategy to grow, primarily 100% risk-weighted loans.

And tangible book value per share increased for the ninth conservative quarter, ending at $20.74 per share for growth of 6.9% over prior year, and a CAGR of 6.7% over the past 2 years.

Slide 8 summarizes our Q2 income statement, in fact, is contributing to record reported net income.

The earnings drivers for the quarter included record net interest income from continued loan growth and NIM expansion; increased noninterest income, led by mortgage revenue and higher deposit service fees; and modestly higher noninterest expense.

I'll provide more color on each of these categories in the subsequent slides.

One item I will highlight is the lower-than-anticipated provision expense.

We had originally anticipated Q2's provision to be in the range of $10 million to $12 million, driven by loan growth and asset quality.

The provision of $7.3 million reflects lower-than-anticipated period-end loan balances, a mixed shift in originations this quarter toward consumer and further improvement in consumer credit.

Each of the loan coverage was flat quarter-over-quarter at 116 basis points.

Slide 9 provides more detail on net interest income, which increased 11.8% from a 1 year ago, and 2.7% linked quarter.

NIM expansion was driven by interest earning asset yields benefiting from higher market interest rates and continued deposit pricing discipline.

Higher loan yields accounted for 6 basis points of the NIM increase and the total loan yield above 4% was there for the first time in 4 years.

And another 2 basis points came primarily from lower premium amortization of securities portfolio as a result of lower prepayments fees.

These increases were partially offset by a 2 basis point impact from higher borrowing cost and a 1 basis point impact from higher deposit cost.

Slide 10 details noninterest income, which increased $1.5 million.

The main driver was an increase of $1.1 million in mortgage banking revenue highlighted in beige, which primarily reflects expansion in servicing valuations due to extended duration.

We had modest increases in wealth and investment revenue and HSA fee income, with a partial offset in lower loan-related fees due to Q1 strength and syndication fees.

Slide 11 highlights our noninterest expense trend, which had a linked quarter increase of $635,000.

As anticipated, the quarter had lower payroll-related taxes, which were partially offset by annual merit increases and higher variable share price compensation.

During the quarter, there were $1.6 million in facilities optimization severance-related expenses versus $1.1 million in Q1.

The $1.1 million of expense was below our initial expectations of $2.5 million.

As a result of revenue growth of almost 3% and modest expense growth, our efficiency ratio improved to 60.6%.

For additional detail, please refer to the efficiency ratio slide on Page 15.

Slide 12 highlights our key asset quality metrics.

Nonperforming loans highlighted in the upper left decreased $8 million, a net decline of $5 million in commercial primarily reflected paydowns, charge-offs and returns to accrual.

While $3 million decline in consumer, primarily reflected returns to accrual.

As discussed during our April earnings call, NPLs had increased in Q1, as a result of 3 credit relationships totaling $34 million.

All 3 credits are progressing as anticipated are in the process of being remediate.

Commercial classified loans remain relatively stable at 3.42% of commercial loans and below our 5-year average of 3.85%.

And the $7.3 million provision in the top right exceeded net charge-offs by $6.8 million.

As a result, the allowance increased to $199.6 million.

And as I mentioned, our loan loss coverage remained at a 116 basis points.

Lastly, net charge-offs were 16 basis points annualized and continue to be below our 5-year average of 31 basis points.

Overall, our credit metrics remain stable, and we maintain a positive forward view on asset quality.

Slide 13, provides our outlook for Q3.

We expect average loan growth to be in the range of 1.5% to 2.5%.

And we expect average interest earning assets to grow 1% and securities should be flat to slightly down.

We expect NIM to be flat to up 2 basis points, driven by higher loan yields, partially offset by lower securities yields, as a result of higher premium amortization.

Our projections assume 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 to $5 million.

Noninterest income is likely to be up $1 million to $2 million.

We expect the efficiency ratio to be in the range of 60% to 62%, given asset quality trends and our expectation for loan growth and portfolio mix, we expect the provision to be close to Q1's level.

And we expect our tax rate on a non-FTE basis to be approximately 32%.

Lastly, we expect our average diluted share count to be approximately 92.5 million shares.

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

Glenn, thank you.

I just want to underscore, again, that we produced a return on shareholders' equity that exceeded our cost of capital.

So we actually put an economic profit for the quarter, and we're quite pleased about that.

Our strategic management framework, which I think you're familiar with is a discipline whereby, we invest in businesses that add value for customers and maximize economic profits and shareholder value over time.

We allocate our capital and our resources and prioritize our projects accordingly.

We're excited about our financial performance and our strategic progress and our forward momentum.

As you are probably aware, we're planning an Investor Day with special focus on HSA Bank for Wednesday, November 8 in New York City.

We originally had announced it at the end of 9, we had to switch it for logistical reasons.

So that will be November 8. And we are very pleased with the initial response.

And look forward to seeing many of you then.

Contact Terry Mangan, if you have any questions.

I'll now open it for questions and comments.

(Operator Instructions) Our first question comes from the line of Jared Shaw with Wells Fargo Securities.

May be starting with HSA, it sounds like this quarter, the investment discussion sounds a little more aggressive, you're seeing aggressive investment in the space.

Is that higher than where we were last quarter going into the end of the year?

Or is that just a continuation of what we have seen?

This is a continuation, and we did discuss this last quarter as well and had previewed what some of those investments may be.

And the point is that because we're aggressive -- investing aggressively in this business, which is our highest strategic priority, it will have an elevated level of expenses over some period of time, which is why you're not seeing the improvement in operating leverage, though revenue is growing at 20%.

And then, when you talk about the return -- or starting to see operating leverage in 2018, should we expect to see that in the first quarter during the enrollment cycle?

Or is that for the full year, or by the end of the year?

We're not going to pursue that finally, Jared.

But let's just say, you'll be seeing it through 2018.

Jared, it's Glenn.

And I think the broader challenge in Q1 is all the onboarding collateral call center volume, marginal cost associated with account volume.

So to Jim's point, I think you'll see it not necessarily in Q1, but thereafter.

Okay.

And then on the elevated paydowns that you had in the second quarter.

How is it trending so far in the third quarter.

And then on your loan growth outlook for the quarter, is that assuming that the loan mix stays flat from where we were at the end of this quarter?

Jared, it's John.

I would say, it's tough to call right now.

I think we have a decent amount of prepayment activity planned for the quarter but not quite as elevated.

And I would say there is nothing that would change the mix.

I think it will still be sort of dominated a bit by Commercial Banking in terms of what drives our growth.

As you know, we're selling the vast majority of conforming residential mortgages.

But I think the mix -- you shouldn't really look for a mix change.

And I would say prepayments may be slightly lower as a percentage of originations from what we can see now, but it's still way too early to make the call.

Okay.

And then just finally from me.

There has been a lot of negative news around the state of the Connecticut economy and Hartford.

Does that accelerate your desire to add geographic diversity to the loan book through Boston and Philadelphia and D.C. and maybe other areas?

Or are you comfortable with where we are right now with diversity?

We're pretty comfortable with the approach that we're taking and have taken over a decade now.

Actually, we benefited from the fact that we've had contiguous expansion in our Community Bank as well as more regional expansion in the Commercial Bank.

So we think we're in a pretty good position, but -- and your point is well taken that Connecticut over the years has failed to fund it's very generous retirement promises to state workers.

And then over time, that's translated to not investing adequately in the infrastructure and all that's coming to head right now, which we think can be a positive.

And let's remember the Connecticut is one of the top 1 or 2 wealthiest states in the country.

We have the most productive workforce in the country, high quality of life, great educational system.

There are lot of things that are real assets for Connecticut.

So we just have to address this problem.

And I think actually one positive income of the current budget debate is, it's forcing a legislature to make more responsible fiscal choices and could ultimately lead to higher confidence in a sustainable economic future.

And I would say regarding Hartford, there's been a lot talk about would they go bankrupt.

This is over about $50 million in total expenses for the next year or so.

I just want to say, I really admire the mayor for having the courage to be strong for what he believes in.

And in the end, that's the kind of attitude we need throughout the state in order to get to the best result.

I think John may have a comment on this, too.

Jared, I would just say, I chair this year's CBIA, which is the largest business association in the state.

And I think the membership feels like we haven't had this much consensus around something needing to get done.

So I'd echo Jim's comments, but I think people are confident that we're closer to solution than we have been before.

And while the situation has clearly muted growth, our customers from a credit performance perspective, there's no delta between Connecticut and other areas.

And we're still adding customers here.

And I'll give you just a Commercial Bank anecdote.

I think we talked about average loan growth year-over-year and the Commercial Bank being around 10%, and in Connecticut we're up about 5.5%.

So we're not growing as quickly as in Connecticut, but there still is growth.

And if you look back 10 years ago, across all of our loan categories, we were probably 80% to 90% Connecticut and right now, we're hovering just below 50% in Connecticut.

So you think about all the diversification we have done with Boston and Providence and White Plains in New York and Philadelphia.

And we've done it smartly.

And it's in north to everyone's benefit that we have been doing that for the last 10 to 15 years.

Our next question comes from the line of Steven Alexopoulos with JPMorgan.

I wanted to start with HSA Bank.

You guys had very strong PPNR growth in the quarter.

Do you think 30% year-over-year growth is sustainable moving forward, even with the investments you're making back into the business?

So I think that it did stand out as an extraordinarily good quarter.

There is a little seasonality quarter-by-quarter.

So we'd say 30% is on the high side.

I think we are -- we made a point that revenue will probably grow by about 20% in 2017, expenses will grow at about the same rate.

So you could take that as a guide for how PPNR may play out over the balance of the year.

I think as you look into '18, Steve, it would -- it could be between 25% and 30% PPNR growth on a full year basis, year-over-year.

Yes, okay.

Again remember that some of that will come from operating leverage, but most of that will come from revenue growth.

Yes, yes, okay.

And then looking at the slowdown of growth in deposits and accounts that we saw this quarter, again, looking at a year-over-year basis, give a little bit of color on what drove the slowdown and at least the growth rates we should be expecting moving forward?

I'm going to ask Chad, if he'd step into that question.

Yes, good morning, Steve.

On the account side, we had total account growth year-over-year of about 18%, that was impacted slightly by the closure of about 20,000 accounts that should have fallen into 2016, so that was little bit of a drag.

And that was due to -- we were going to partner cleanup of unfunded accounts, as we were heading into the end of the last year and into the first quarter, it just fell into the second quarter.

We shouldn't expect to see that going forward.

We refined that process.

But here, the question on what we should expect to see for the rest of the year, I think that in this range that we saw in second quarter is what we should expect on account growth.

On the deposit side, we had 20% floatings growth year-over-year and about 16% deposit growth, that was impacted by a higher level of transfers from deposits into investments this year.

And we're not too surprised to see that.

We've been promoting our HSAs, obviously, as a great vehicle to plan and save for your healthcare and retirement.

And we have also improved some of the functionality to make it easier for our account holders to transfer funds into their investments.

Both of these, I think are competitive advantages we have in the marketplace.

I would like to add just one thing that when you're look at comparability and you're thinking about cleanups, it's something we're pretty disciplined about.

In fact, we have only 6% of our accounts are unfunded.

And you look at the industry, the average is above 20%.

Okay, that's helpful.

Just one final question on commercial loan growth.

Looking at the commercial pipeline, which you guys pointed out on Slide 4. Why has the pipeline contracted so much here, and you are expecting a slowdown in commercial growth in the third quarter tied to that?

Yes, it's a great -- I mean, it's a great question, Steven.

And I -- we look at the pipeline, the number right now is really not that out of whack when you look at prior year same quarter, you look at other factors.

The problem -- one of the problems with our pipeline, just to put it out there is that we're very disciplined in sales force about it being greater than 50% probability of a close within 90 days.

And so if you look at the pipeline as -- at the beginning of last quarter, our originations were double what our pipeline was in Q2.

So I would just relook at it on a relative basis, I would say there definitely is softness, there definitely is more competition, but we had robust originations first quarter, second quarter in that $500-million-plus range in the commercial bank.

And we're confident I think that we can hit the 10% year-over-year annualized growth target in third and fourth quarter.

The question is from a timing perspective, is it all in the fourth quarter, what happens in the third quarter, but I wouldn't look at the pipeline.

I would say on a relative basis, given the size of our franchise and the pipeline not expanding more, you are seeing what the fed data is showing, which is a slight slowdown.

But we feel like we have got enough arrows in the quiver and enough regional presence to continue to grow at double digit.

Our next question comes from David Chiaverini with Wedbush Securities.

So I wanted to follow-up on the HSA.

So looking at the economics, the preprovision net revenue for average account, last quarter, well in the first quarter, it was $26.99 million and increased to $28 million in the second quarter.

What type of ramp should -- can we expect in that line?

And with the backdrop being that the percent of accounts less than 2 years old still is north of 50%.

Yes, so it's Glenn, and thank you for the question.

I think there is a lot of moving pieces in that, if you look at it on a per account basis.

But I think it's hard to predict PPNR per account because the more successful we are particularly in enrollment periods and the added expense for collateral and onboarding push down the average account PPNR.

So I'd be hesitant to answer or to provide a forecast on PPNR growth now.

Okay, great.

And shifting gears, the borrowing to assets you mentioned how it's been trending down, which I think is a great trend.

And with the securities guidance of that being flat to down, how low do you expect borrowing to assets to go?

In fact, are you guys going to take that down to the low-single digits?

No, I think where we are, given that we're the lowest we've been in 6 years.

It will hover around that level.

We feel comfortable with where we are from a balance sheet structure standpoint.

Okay.

And then on the loan loss provision the guidance that is you're closer to the first quarter than the second quarter, when looking forward.

The first quarter was still much lower than the trend through 2016.

Looking out, do you think that we're going to get back to that '16 -- 2016 quarterly trend, as we get into 2018?

Or do you think the first quarter level is going to be where we're going to be for the next few quarters?

Well, again, it's going to be driven by mix and portfolio growth.

And I think the guidance going into Q3 is driven in part, obviously, by asset quality, but also the source of our growth and it should shift, whereas, the first quarter to second quarter was more residential in growth.

The shift will be more for the third and fourth quarter on the commercial side.

So I think we're good at a coverage ratio of 116 basis points.

I think you could count on us being around there.

Obviously, charge-offs are also going to impact that.

And we're at a 5-year historical low on that as well.

So...

Okay.

And then last one from me is a clarification on the loan growth.

That is the double-digit guidance, that's just for commercial rather than overall loan growth.

Is it that the overall loan growth guidance over the long term is high single-digit?

Or I just want some clarification there.

Yes, it's what we're talking about double-digit clarification is commercial loan growth only.

And so when you heard, Glenn talk about his guidance on loan growth that's the aggregate of all of our category.

Our next question comes from the line of Collyn Gilbert with KBW.

Just starting with HSA and then just back to the point that you guys saw greater sort of shift or transition from investments -- I'm sorry, from deposits to investments this quarter and maybe an ongoing trend going forward.

Do you have expectations to how you see that relationship evolving over the next year or 2?

In terms of the...

Just the rate of deposits that might be going into investments.

Sure.

So we saw in the last several months, the amount of -- the number of our customers, who are -- who have investment accounts is closing in our 3%.

So it's still a relatively small portion of the overall population, but they have relatively high balance.

As you know, they still keep around $5000-or-so in their accounts.

So they are savings customers as well as investing customers.

And we have a industry-leading offering of investment account.

So we do expect that we'll be able to accommodate the desire for people to build those balances over time.

So we expect more existing customers to look at that as an option, some of the newer customers may as well.

But remember that the total right now is less than 3%.

We expect that over time that number probably move up closer to 5%.

So you noted that we had $53 million shifted versus $33 million, which is a higher proportion than the growth in deposits, overall.

So it's clear that the investment portion is going to grow faster than the deposit portion going forward, which is why we're focused on total footings.

Okay, okay, that's helpful.

And then just in terms of the outlook for 2018, again, sticking on the HSA theme.

I understand that you're not in a position to necessarily quantify specifics, but maybe could you just talk broad -- a little bit more broadly, big picture kind of what you see as variables to drive performance in 2018?

Well, sure.

Performance will, of course, be driven by our success in onboarding new larger employers, which will stimulate account growth as well as broaden the universe for future account growth as well.

We will continue to make these investments that we've been describing to you, which are a significant portion of the overall expense base through 2018 that will be overcome by revenue growth we think increasingly, which is why we think there could be some improvement in the operating leverage.

So I think the best guidance we can give right now is to say that we're running an efficiency ratio that's probably in the low-60s, that ratio will probably improve, as we start to generate some operating leverage in 2018.

Okay, okay.

So as we -- again, a lot of moving parts of the business.

I know and Glenn to your point on PPNR is a tough metric, I think, for us to sort of track given the seasonality.

Should we be -- and the shift that we're seeing from investments to deposits is should we be honing in maybe on kind of account growth.

Is maybe the baseline measure for sort of success in trajectory here do you think?

I would say, you can step back and look at it from a total full year PPNR standpoint.

And you could look at 2017 as having a PPNR closer to 20%-plus -- a little over 20% and then it ramping up in 2018, to Steven Alexopoulos' question, somewhere between 25% and 30%.

I think that's when you start hitting your stride as far as both on -- leverage on expense as well as account growth and balance growth.

Okay, okay.

Okay, that's helpful.

And then just John, question for you on that.

You had indicated that yield on new loans was up 45 basis points.

I'm sorry, I missed the time frame that you were referring to.

I presume that...

That was specific to business banking.

So our $1-plus billion small business lending portfolio year-over-year and that yield improvement occurred because of a change in mix to more longer term C&I away from some smaller owner-occupied and investment CRE loans as well as increases in the LIBOR and more LIBOR-based rate.

So that was specific to that one portfolio.

Got it, okay.

That's helpful.

Okay.

And then just finally on Boston.

Jim you had indicated that you guys expected breakeven to occur late next year.

I -- do I misunderstand.

I thought that, that was going to be happening at the end of this year.

Maybe just talk a little bit about some of the dynamics going on with Boston, if you could?

Sure, I will, Collyn.

Back, I think it was either a quarter or 2 ago, we indicated that our initial view had been that we could wear out the get EPS drag at about $0.01 a quarter.

And we said in the October call that as we look ahead, particularly given sensitivity on deposit pricing at all, that probably would be about $0.005 a quarter.

And if you play that out, that puts you in about the fourth quarter of 2018 for a breakeven.

So we don't want to go crazy on the deposit gathering side, but we do want to pick our spots and decide where we want to be aggressive.

And we are seeing that our loan originations are benefiting from the fact that we have the retail presence in that market as well.

So we've said, we'll be at a $1 billion in deposits and a $0.5 billion in new loans by the end of the fifth year.

We're still highly confident that will occur.

And we're moving along the path of getting to breakeven by at about a $0.005 a quarter.

So we're late 2018.

And as I indicated the net drag in Q2 was about $0.02, with an impact on the efficiency ratio of about 1.5%.

Our next question comes from the line of Mark Fitzgibbon with Sandler O'Neill.

The first question I had is sort of follow-up to Collyn's question, could you -- I know your goal is a $1 billion in 5 years of loans and deposits in Boston, but where do you stand today?

Can you update us on those balances?

Sure.

I indicated in my comments that we're at $340 million in attributable deposits and $240 million in loans.

Okay, great.

And then secondly, on the HSA business, it looks like the number of accounts in the HSA business went down by about 13,000 during the quarter.

Chad, could you sort of clarify what was driving that?

Good morning, Mark.

As we were preparing our Q2 results, we recognized a error that was made in our number or account number count in first quarter.

We included about 17,000 notional accounts in that number.

We're really just reporting out on HSA growth.

So we backed that out of the first quarter number, that's really the cause of that -- to correct that error.

And the other thing I'd say is, it really was a material to the period account growth.

We're still at over 20% year-over-year growth for the period.

And Mark, I hope you heard earlier that we were talking about those, we do an account clean up with our partners that also had an impact.

Our next question comes from the line of Matthew Breese with Piper Jaffray.

I just wanted to talk a little bit about the margin trajectory longer term, given the shape of the yield curve and perhaps the fed not raising rates as quickly as we once thought.

So I just wanted to get a sense for, I know the margin next quarter is positive, but should we continue to see 1 to 2 basis points or flat to 2 basis points of expansion thereafter and for how long, if things remain the same?

So if I look at the rates, and I have to say nothing happens for rest of the year, I mean, fed funds stay at 1.25% and the tenure stays at 2.25%.

And I work it all the way through, the next increase we're factoring one is a potential December 14 increase, but there is only like a 40% chance for that now.

But if I strip that out, you would still see NIM go up slightly in the third quarter and then slightly down a basis point or 2 over the next -- into the fourth quarter.

And really, what's driving that is, we continue to benefit from the loan balances.

While the loan -- the yield on the loans continue to increase in part because of the June increase.

So you would expect, if our loan -- total loan balance yield was 4.04% you would expect that to go up going into the third and fourth quarter on a commercial consumer and resi side.

On the -- the offset for that would be on the securities side.

And really driven by where the tenure is right now.

And the fact that our securities yield will go down from 3.04% to 2.83%.

And so that would be partly offset.

And now of course, the wild card is always going to be deposit cost.

And we haven't seen anything move in beta besides government deposit and that we wouldn't expect that to happen, if rates stay exactly where they are today.

Understood, okay.

That's great detail.

And then loan growth this quarter compared to the outlook, obviously an upward trend.

I just wanted to get a sense for where the confidence is in terms of segment analysis or geography.

Are you expecting better growth in some of your markets and what those are?

Matthew, it's John.

I don't think we really have a sense, as we said you heard the discussion around Connecticut being a little bit weaker than some of our other markets.

So that trend could continue depending on what happens in the state.

But I don't think there is any other specific geographies, Boston and New York have been really strong for us.

Philadelphia on commercial real estate, we continue to be really deliberate and cautious in new markets to make sure we're not sort of being the lowest common denominator in any market.

But I think, as we've talked about with asset-based lending and equipment finance and commercial real estate and business banking and our sponsoring and specialty with all of our industry segments and our sponsor relationships, we've got sort of this portfolio of levers.

And in any one quarter with episodic capital markets activities and underwritings and transactions that we are winning or losing, we feel pretty confident that across the portfolio of activities, we'll be able to get that annualized double-digit loan growth.

And that's our target.

And if things continue to soften and soften that could change.

But given where we are now and the prepayments that we're looking at, we -- that's still in our target strategy.

Understood.

And then maybe along those lines just looking at the pace of commercial real estate growth, which has slowed down a bit the last 2 quarters.

Should we expect that to reaccelerate.

And as a second part to that question, how do you view the overall health of commercial real estate in various segments, but particularly retail?

How is that holding up on -- for you?

Yes, so, Matt, this is a multipart question, but I think commercial real estate has been more challenging.

It has been more competitive for the first time, where we've seen nonbank, shadow bank lenders in the C&I space.

We're starting to see debt funds go into commercial real estate because their investors are requiring lower returns.

We're seeing more competitive new entrants into the competition.

We're seeing life companies be more aggressive again.

So the number of high-quality looks that we get are down slightly.

And the prepayments are also up a bit, because we're seeing some of our investors decided to move into trade properties.

And we don't know really whether that's a signal that they feel like values are full or what's happening there.

Credit quality remains extremely strong in the sector.

We remain -- and our Head of Commercial Loans will always mention, I recall Bill Wrang, who has been doing this for a long time here, is remaining disciplined with respect to risk returns.

So we're not chasing bad quality deals or giving away the store from a price perspective.

So I think that one area, as we go into the third and fourth quarter may not have the 10% annualized loan growth.

But again across the portfolio, I think we can offset that.

With respect to retail, we've never been a strong retail ICRE lender.

It's about in our Commercial Banking ICRE portfolio represents less than 50% -- 15% of the total portfolio that's 1-5.

And within that, it's mostly grocery anchored or necessity retail.

We don't have a lot of discretionary retail or big-box exposure.

So in our portfolio, we don't think that the retail is going to hurt the industry -- hurt us very much.

But certainly, across the industry with respect to malls and some other retails, there's going to be softness going forward.

Our next question comes from the line of Casey Haire with Jefferies.

Nice improvement in the efficiency ratio this quarter.

Glenn, the guide for 3Q is pretty wide, especially with NIM expectation up and more balance sheet growth.

I'm just curious, why the wide range and what stopped the momentum from continuing?

Are you guys just giving yourselves room for investment into HSA or Boston, just a little color will be helpful?

Yes, primarily -- good morning.

Primarily, it is in the HSA side, where we continue to invest in the business.

So that will continue to keep the efficiency ratio little high.

And then we may see some softness on the fees.

We guide it to $1 million to $2 million, but a lot of that is contingent on commercial activity and so we're monitoring that.

And that's hard -- sort of hard to predict.

Whether that volume comes in, whether some syndicator or just swap fee income and things like that, that we've seen slowdown along with the commercial loan growth.

So sort of hard to predict some of that.

We feel the net interest income, as I've given guidance, $3 million to $5 million looks pretty good right now.

So that's really -- those are really the drivers.

Okay, great.

And Glenn, you mentioned premium amortization as a headwind to the margin.

What kind of forward curve do we need to see that premium headwind to be?

So I think from an amortization standpoint, further slowdown in our speeds came down to like 12.2%.

But if we had a plus 25 basis point movement in the curve that would flatten that out.

Okay, great.

And then just housekeeping question, I apologize if I missed this.

What was the premium am in the second quarter.

And then the -- was there any loan prepayment penalties inflating the yields in the second quarter?

So we had about -- the premium amortization in Q2 was a little over $10 million, which is down from Q1, $11.2 million.

But as you know, the guidance going into Q3 is that it takes 60 to 90 days for rates to find their into the premium amortization.

Second part of your question was on prepayments.

And I think core Q1 or Q2 they were basically flat at about $800,000.

And our next question comes from the line of Jared Shaw with Wells Fargo Securities.

Just had a quick question on the HSA PPNR.

Did you change the FTP credit at all, given the moving rate and if you did or didn't, would you anticipate seeing that change over the next 12 months at all?

So I'll give you some color.

So it does widening as we look at the forward curve, but by a couple of basis points.

And going into Q2, I think the FTP rate was up -- probably, it's up 5 basis points.

And then that will fluctuate with LIBOR.

So obviously, as we saw the increase in LIBOR and the average LIBOR being up 22 basis points, but some of that gets passed through the HSA.

I guess, so that 5 basis point increase was that from first quarter or was that year-over-year?

Q1 to Q2.

So the way we look at funds transfer pricing is, we had the transactional fees, which is primarily floating and tied to LIBOR.

And then, we have a longer-term fees that's tied closer to the longer end of curve or the FHLB curve.

So there's 2 pieces to that, 2 components to that.

So when you have the LIBOR curve go out, you get some portion.

So if, for instance, the average 1-month LIBOR was up 22 basis points, some portion of that finds its way into the HSA funds transfer pricing rate.

And then movement in the FHLB curve would also impact the rate.

Okay.

And then I'm assuming that...

And I'm sorry, that it actually does widen going into 2018.

Okay.

So I guess, one, as that widens that, you are incorporating that into your expectation for that 25% to 30% growth in PPNR in '18?

Yes.

Okay.

And then does that also impact the commercial lending and the community banking side as much or not as much?

Yes, I think if you were to look at our total book, and you were to say how much -- how is it split out and I look at -- if you look at loans, we have about $6.2 billion that's tied to 1-month LIBOR and other $1.2 billion and this is on the lending side that's tied to 3-month LIBOR and $2.6 billion that's tied to prime.

So those are all moving with short-term rates.

And then if you go out from that, the remaining piece, the biggest part 3 to 5 years, we have about $5.3 billion in loans.

So if I look at the total balance sheet on the asset side, there is about $6.6 billion is tied to 1-month LIBOR meanings that's floating and about $1.7 billion to 3-month LIBOR and $2.6 billion to prime.

And -- so if you think of our earnings assets, it's $24.5 billion.

So you can get a sense of how much is floating versus how much is tied to the longer end of the curve, with the biggest portion, obviously, being on the security side, which is closely tied to the tenure.

There are no further questions at this time.

I would like to turn the call back over to Mr. Jim Smith for closing remarks.

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

Hope to see you in November.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation, and have a wonderful day.