Webster Financial Corp (WBS) 2018 Q2 法說會逐字稿

Good morning, and welcome to Webster Financial Corporation's Second Quarter 2018 Earnings Call.

I will now introduce Webster's Director of Investor Relations, Terry Mangan.

Please go ahead, sir.

Thank you, Melissa.

Welcome to Webster.

This conference is being recorded.

Also, this presentation includes forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition, results of operations and business and financial performance.

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

Actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial's public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second quarter of 2018.

I'll now introduce John Ciulla, President and CEO of Webster.

Thanks, Terry.

Good morning, everyone.

Welcome to Webster's Second Quarter 2018 Earnings Call.

CFO Glen Maclnnes and I will review business and financial performance for the quarter, we'll then be joined by HSA Bank President, Chad Wilkins, to take questions.

I'll begin on Slide 2. Webster's second quarter results reflect continued progress in executing on our strategic priorities: to aggressively grow HSA Bank, expand Commercial Banking, and to optimize and transform Community Banking.

Solid execution on these strategic priorities resulted in double-digit, year-over-year preprovision net revenue growth from all 3 lines of business in the quarter.

Our reported diluted earnings per share of $0.86 in Q2 reflect record levels of net interest income, total revenue, preprovision net revenue and net income.

Included in the reported earnings per share are 2 expense items that Glenn will speak to in more detail.

Excluding these expense items, our reported EPS would have been $0.92 per share.

With a continued strong focus on generating economic profit, we've now earned in excess of our 9.5% cost of capital for the fifth consecutive quarter.

Tangible book value per share continues to grow and is 7.3% higher than a year ago, even as we increased the common dividend by 27% in Q2.

Loan growth and the 30 basis point year-over-year increase in the net interest margin led to our 35th consecutive quarter of year-over-year revenue growth.

We continue to derive significant benefit from funding solid growth in primarily LIBOR-based commercial loans with lower-cost, longer-duration HSA and transactional deposits.

Almost 60% of our deposits are in transactional and HSA deposits, which had a blended cost of 11 basis points in Q2.

The same cost those deposits had in the third quarter of 2015, which is just prior to when the Fed began increasing short-term interest rates.

This funding profile continues to be a differentiator for Webster.

In Q2, total revenues increased almost 12% from a year ago, while reported expenses increased less than 10%, resulting in the fifth consecutive quarter of positive operating leverage.

Our efficiency ratio was below 60% for the fourth consecutive quarter.

Asset quality remains stable as nonperforming assets and charge-offs remain in recent cycle low ranges.

Slide 3 provides a tangible depiction of Webster's favorable loan and deposit betas.

Total loan growth compared to last year was 4.4%, with commercial loans growing almost 8%.

The overall portfolio yield on loans in Q2 is 59 basis points higher than a year ago, as loan growth continues to be led largely by floating rate commercial loans.

Deposits also grew 4.3% from a year ago, funding loan growth in most of the year-over-year reduction in borrowings.

The cost of deposits increased only 9 basis points over last year.

Starting on Slide 4, I'll review the line of business performance.

Commercial Banking generated quarterly revenue exceeding $100 million for the first time, as loans grew 8% year-over-year and 2.6% linked quarter.

Growth was led by our middle-market segments, included -- including asset-based lending, which reported strong loan originations during the quarter contributing to the solid C&I loan growth.

Investor CRE loans were essentially flat year-over-year and grew 1.4% linked quarter, while CRE loan fundings were solid in Q2.

We also saw a significant amount of pay downs and payoffs as nonbank lenders continue to be in that market with very competitive structures and pricing.

A $7.1 billion or 71% of Commercial Banking's $9.9 billion loan portfolio resetting in 30 days or less, the portfolio yield increased 40 basis points from Q1 and 91 basis points from a year ago.

Average loan growth of 5.8% year-over-year and higher deposit margins resulted in a 12% increase in net interest income from a year ago.

Noninterest income grew 20% from the prior year, primarily from improved swap revenue.

As we continue to invest in this business, year-over-year expenses grew 15%.

The net result was PPNR growth in Commercial Banking of 12%.

We actively managed the commercial loan portfolio and are encouraged by the fact that asset quality metrics continue to be solid.

Turning to Slide 5. HSA Bank delivered another quarter of strong performance in Q2, underscoring the bidirectional value of HSA Bank in Webster.

Our 2.7 million accounts now have total footings of $7 billion.

This consists of $5.5 billion in low cost, long-duration deposits that helped fund Webster's earnings assets and $1.5 billion in linked investment balances.

Total accounts were 13% higher than a year ago, and footings per account of just over $2,600 are 5% higher.

Combination of account growth and account seasoning results in total footings being $1.1 billion or 19% higher than a year ago.

The 119,000 new accounts opened in Q2 were 19% higher than a year ago, but declined, as expected, from the seasonally strong level in Q1.

Revenue grew 28% from a year ago in HSA.

This was led by a net interest income growth of 38%, which was the result of a 14% increase in average deposit balances and a higher net credit rate.

Coupled with a year-over-year expense growth of 9%, evidence of our continued investment in the business, significant positive operating leverage resulted in pretax net revenue growth of 62.5%.

We continue to be excited about the long-term growth prospects for HSAs.

And we're encouraged to see the House Ways and Means Committee mark up a comprehensive package of bills last week that support the usability and expansion of HSA plans and limits.

Moving to Slide 6. Community Banking's loan balances were essentially flat year-over-year, as 7% growth in Business Banking loans was offset by a 1% decline in Personal Banking loans.

The decline in Personal Banking loans was driven by continued consumer deleveraging, combined with slowness in residential mortgage originations, consistent with industry trends.

We continue to maintain our disciplined approach to loan pricing in this very competitive residential lending market.

Deposits grew 3.3% year-over-year, with growth rates about equal for personal and business deposits.

Total revenue grew 3.5% year-over-year.

Deposit growth and improved spreads drove 6% growth in net interest income, while investments grew by 8% year-over-year.

This was partially offset by lower noninterest income, including a $2.2 million decline in mortgage banking revenue.

Noninterest expense grew only 0.9% year-over-year as we continue to transform and optimize the business.

Community Banking continued to make solid progress along its transformational roadmap, as positive operating leverage delivered PPNR growth of 11.6% year-over-year.

Consistent with our continued focus on network optimization, we completed the consolidation of 4 banking centers in April and announced a strategic sale of 6 additional banking centers that we expect to close in the fourth quarter.

This combination will result in a 6% reduction in banking center total square footage.

With that, I'll turn the call over to Glenn.

Thanks, John.

Slide 7 provides highlights of Webster's average balance sheet.

Average loans grew 0.7% linked quarter and 3.6% year-over-year.

Loan originations of $1.5 billion in Q2 resulted in fundings of $1.1 billion, our second-best quarterly performance.

Loan payoffs were elevated at $905 million, which reduced overall average loan growth.

Growth was led by C&I loans, which increased to $197 million, or 3.2%, from March 31.

Year-over-year, C&I loans increased $613 million or 10.6%.

The flatness in consumer loans, both linked quarter and year-over-year primarily reflect continued pay downs in home equity loans.

Average deposits were essentially flat linked quarter, driven by seasonality in government banking.

Increases in HSA deposits and CDs were offset by declines in nonmaturity accounts.

Versus prior year, average deposits increased over $1 billion or 5%, with HSA Bank representing 66% of the increase.

The $81 million linked quarter increase in borrowings reflects short-term funding.

Year-over-year, borrowings were reduced by $574 million as deposit growth exceeded loan funding needs.

The loan-to-deposit ratio of 84% increased modestly but remains favorable relative to regional peers and the industry.

Common Tier -- common equity Tier 1 and tangible common equity ratios remained strong supported by Webster's earnings growth.

Slide 8 summarizes our Q2 income statement and factors resulting in record quarterly earnings.

On a linked quarter basis, total revenue increased 3.7% to a new quarterly record.

Net interest income grew $10.8 million, as the net interest margin increased 13 basis points.

On a year-over-year basis, total revenue growth of 11.8% was led by an increase of $27 million in net interest income.

We have now posted back-to-back quarters of year-over-year revenue growth above 10%.

Our revenue growth was largely the result of a 30 basis point improvement in net interest margin along with average interest-earning asset growth of $681 million.

Noninterest income declined modestly linked quarter primarily due to lower loan fees and client hedging revenues.

On a year-over-year basis, noninterest income growth of $3.7 million was led by HSA Bank.

Noninterest expense increased $8.8 million linked quarter, reflecting a $7.2 million deposit insurance accrual and $1.4 million of banking center optimization costs.

The deposit insurance accrual of $7.2 million in the quarter is related to FDIC insurance premiums for the periods prior to 2018.

The accrual is our current estimate of the aggregate amount of premiums due for the period of Q1 2015 through Q4 2017 and is the result of a reclassification of loans under existing and modified FDIC loan category definitions.

It's important to note that the additional expense is a result of a reclassification for the purpose of setting FDIC premium levels and does not change our risk rating, classified assets or other reported credit metrics.

On a go-forward basis, our quarterly FDIC premium expense will be in line with Q1 2018, around $6.5 million to $7 million.

Excluding the deposit insurance accrual, year-over-year noninterest expense increased $8.8 million, reflecting annual merit increases in strategic hires.

Taken together, PPNR of $113 million in Q2 increased 1.5% linked quarter and 15.2% from prior year.

Excluding the deposit insurance accrual, PPNR growth is 7.9% quarter-over-quarter and 22.5% year-over-year.

Our loan loss provision was $10.5 million in Q2, reflecting loan growth and stable credit quality.

With an effective tax rate of 20.3%, we reported a record level of net income available to common shareholders.

The efficiency ratio, which excludes the deposit insurance accrual and banking center optimization cost, was 57.8%.

The linked quarter and year-over-year improvement in the efficiency ratio reflects positive operating leverage.

We have now posted 5 consecutive quarters of year-over-year positive operating leverage.

Slide 9 provides additional detail on PPNR performance.

The waterfall chart reflects the drivers of our 15% growth in PPNR versus prior year.

Net interest income grew $27.2 million or 14%, $14.6 million due to volume and $12.6 million due to rate.

The rate benefit includes a 59 basis point improvement in loan yield and a 9 basis point increase in deposit costs.

When measured against the 76 basis point increase in average Fed funds rate, this resulted in a loan beta of 78% and a deposit beta of 12%.

Slide 10 provides additional detail on net interest income, which had a linked quarter increase of $10.8 million.

Our performance benefited by the significant increases in the average 1 and 3-month LIBOR rates, as we have $6.8 billion of loans tied to 1-month LIBOR and $1.2 billion tied to 3-month LIBOR.

The yield on interest-earning assets increased 18 basis points, while the cost of interest-bearing liabilities increased only 5 basis points.

The result was a 13 basis point improvement in NIM to 3.57%.

Slide 11 details noninterest income, which declined modestly linked quarter as some commercial transactions are now expected to close in Q3.

Year-over-year growth of $3.8 million was led by growth of $3.1 million in fee income at HSA Bank.

HSA account fees increased $1.8 million and interchange revenue increased $1.2 million, both reflect growth in a number of HSA accounts.

Other income increased $2.5 million, including $1.2 million from higher client hedging revenue.

Mortgage banking revenue decreased $2.1 million from lower originations compared to a year ago.

Slide 12 highlights our noninterest expense trend.

The linked quarter increase was $8.8 million.

Adjusting for the combined deposit insurance accrual and banking center optimization cost in Q2, expenses were relatively flat to Q1.

The $1.7 million decline in compensation reflects seasonally lower payroll taxes and benefit costs.

Marketing increased $1.3 million due to additional campaigns in the quarter.

The year-over-year expense increase is $16 million, or $8.8 million when adjusted for the deposit insurance accrual.

Compensation and benefits represent $6.7 million of the adjusted increase, reflecting $2.9 million from annual merit increases and $2.4 million from strategic hires.

Slide 13 highlights our key asset quality metrics.

We have a positive near-term view of asset quality.

The net charge-off ratio remained below 20 basis points annualized.

The allowance for loan and lease losses is now $207 million, as the provision again exceeded net charge-offs in support of loan growth.

The allowance continues to represent 115 basis points of total loans.

Slide 14 provides our outlook for Q3 compared to Q2.

We expect average loan growth to be in a range of 1% to 2%.

We expect average interest-earning assets to grow around 1% as total securities stay relatively flat.

We expect NIM to be up 1 to 3 basis points.

The smaller increase is driven by lower expected increases in 1 and 3-month LIBOR, more normal levels of deferred fees and discount accretion and some modest deposit rate changes.

Given our earning assets and NIM expectations, we expect net interest income to increase between $4 million and $6 million.

Noninterest income is likely to be approximately $1 million to $3 million higher, driven by anticipated commercial activity.

We expect our efficiency ratio to continue to be below 60%.

Our provision will be driven by loan growth, portfolio mix, net charge-offs and our portfolio quality.

We expect our tax rate on a non-FTE basis to be approximately 20%.

Lastly, we expect our average diluted share count to be similar to Q2's level.

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

Thanks, Glenn.

I'll conclude by highlighting this week's announcement of Webster Bank receiving an outstanding rating from our primary regulator, the OCC, for its community reinvestment act performance evaluation.

The outstanding CRE rating is the result of the dedicated effort by our bankers and is symbolic of the way we operate our business, deliver for our customers and support the communities where we live and work.

This recognition is a testament to our enduring Webster values and sets us apart compatibly in the marketplace.

I want to congratulate all of the Webster bankers on this achievement and on a solid second quarter.

I will now open it up for questions.

(Operator Instructions) Our first question comes from the line of Steven Alexopoulos with JP Morgan.

I wanted to start maybe for Glenn on the margin.

Given that we had the June hike so late in the quarter and the HSA deposits have been flat at 20 bps, can you walk through why you're expecting much more subdued NIM expansion in 3Q?

Sure.

And I think it's primarily driven by the deceleration, I would characterize it as, of 1-month and 3-month LIBOR.

Whereas in the first quarter and second quarter, we saw LIBOR increased on average 31 basis points, 1-month LIBOR.

We think that's probably going to look more like 12.

And as you know, LIBOR is coming closer to fed fund.

Likewise, on 3-month LIBOR where we saw an acceleration of 41 basis points average quarter-over-quarter, we think that's going to be closer to 3. And so given that, where we saw a 15 basis point increase in our loan yield, we think that's probably going to be about half of that going into Q3.

The other factor, Steve, is deposit rate increases.

And so in Q2, our beta was about 12%.

We might be a little conservative on our estimate, but we think that's going to continue to be pushed up a little bit, so closer to like a 20%, maybe even a little higher.

Again, that might be conservative.

And then the last thing I'd highlight is, during the quarter, as you probably saw in the slide, we had some deferred fees of about 2 basis points.

So those factors altogether are why -- how we end up at like 1 to 3 basis points.

Okay.

And, Glenn, are you seeing any pressure to raise the rates on the HSA deposits or just stay at 20?

Go ahead, Chad.

This is Chad, Steve.

We are not seeing any pressure at this point.

And there really hasn't been any movement in the market.

Okay.

And, Chad, while I have you, so when we look at account growth in HSA Bank, it trended more favorably -- a little bit more favorably this quarter.

Do you expect that trend to continue to improve from here?

And can you talk about how you're feeling as we think about heading into the next enrollment cycle?

Well, that's what we're working on every day, Steve, is trying to improve our growth rates.

As you know, we've talked a lot about the investments in our sales teams, which are -- we have about 20% more feet on the street than we did last year, and the quality of the team is higher in terms of professionals and leaders.

We've also invested in the tools and the materials they need, demos, presentations and things like that, to make them more successful.

So yes, we're doing everything we can to increase our growth rates.

And what we're seeing is pretty positive signs in our pipeline right now for 1/1/19.

The size and the number of deals is up where we expect them to be.

And so we're optimistic about the traction we're getting for all the investments.

Okay.

And then maybe just one final one back to Glenn.

Ex the FDIC charge, expenses were actually pretty flat quarter-over-quarter.

How do you think about expense growth for the rest of the year?

So I think our general guidance is that we think we'll continue to be below 60.

And obviously, we're benefiting from the rate environment there.

But we are continuing to make investments across the board on commercial, whether it's cash management or credit monitoring and the risk side BSA, CECL.

On the CIO side, cybersecurity mobile replacement, we're replacing our mobile platform on HSA, as Chad indicated, sales and an automated workflow and issues that he has going on in HSA.

So I think -- I'm not going to give a specific number, but I think if we're in the 57%, 58% range over the next quarter, that's probably where we would expect to be.

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

Maybe just following up on the HSA side.

Chad, as we go into the next enrollment cycle and going forward, do you see the focus really shifting more towards that employer -- direct employer sales versus the referrals through the carrier networks?

And if so, should we expect to see sort of a continual growth in hiring there?

Yes, Jared, we continue to invest in our direct-to-employer channel.

And that's really our primary focus.

We absolutely are committed to supporting our partners and adding new partners.

But we -- most of our investment and efforts have been on the direct-to-employer channel.

We're seeing the kind of results we want to see in that channel.

That's where we're seeing the most growth.

And I think our investment in salespeople will -- it's slowing down a little bit.

We put a lot -- we've grown about 20% each year over the past 2 or 3 years.

So we'll continue to add salespeople, but probably not at the pace we had, and that depends on market conditions as well.

Okay, great.

And then looking at the economies up in New England, primarily Connecticut and Massachusetts and Metro New York, what are you seeing in terms of the strength and sort of customer demand there?

And what -- and do you see any positive signs on the horizon that we could see some real improvement in the overall economy for commercial lending?

Yes, it's a good question.

I think there are positive signs sort of everywhere.

And as you know, we've spoken to it on prior calls.

Connecticut has had its challenges and it's growing slightly slower than the other New England states and the other states in which we operate.

And Jared, that's been sort of a key to us.

As you think about the commercial bank being funded by HSA as being kind of the driver of the NIM expansion and the growing PPNR, we have strong commercial presence in Boston and New York City and Philadelphia.

HSA is a national business, so a lot of the choices we've made previously to expand geographically in certain segments that represent high growth have enabled us to sort of be immune for the fact that Connecticut is growing a little more slowly.

But I will tell you there are signs in Connecticut.

Our -- we look at asset quality across the footprint.

Our borrowers are doing well.

I just think it's a question of relative strength of growth, but I think most of our footprint is growing and benefiting from an expanding economy.

Okay.

And then just finally for me.

Looking at M&A, we've seen some deal activity pick up in market.

What are your thoughts on M&A here?

It seems like acquirers are able to really get a lot of cost saves out and eliminate a competitor.

Any change in sort of your thoughts of whole bank M&A in market?

We haven't really.

Obviously, with the fact that we feel like we have a differentiated business proposition and we think we're starting to really show that bidirectional value that we keep talking about with HSA in the core bank, we think that our ability to generate shareholder return and create value organically outweighs opportunities we see in the marketplace.

And when -- I've talked about before, it's not only just the financial aspects of a transaction, but it's strategically.

And I think a whole bank acquisition for us right now with a lot of banking centers just to get some contiguous market share in Community Banking is not a top priority for us.

So I would say that our -- even though, obviously, there's a lot more chatter in the market, given the Crapo Bill and everything that's occurred, I think our position remains stable to prior quarters.

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

Let me start, I guess, with -- well, just with the topic of loans -- and this sort of ties in, Glenn, to your comment on the NIM -- and where you sort of see that mix of growth going.

You guys -- your loan yields have been, I think, really strong, certainly much higher than a lot of your peers'.

So maybe if you can just kind of talk about that kind of where you're seeing the best opportunities for growth on the lending side.

And then also to -- I'd be curious to hear, what types of loans structures, geographies, whatever that you might be walking away from as you guys kind of look at the pipeline?

A good question.

Good question, Collyn.

I'll do my best.

I think we had a really strong origination quarter across -- and a record origination quarter across most of our C&I and commercial real estate categories along with Business Banking, a lot of robust origination activity.

So for us, I don't think there's a particular pocket.

Obviously, in certain quarters when we have higher yield, you see a mix change away from sort of commercial real estate to some of the C&I loans.

And that was the -- in terms of growth, that's really where we were this quarter.

I would say if -- when we scour our loan segments and geographies, we ask our business line leaders every quarter to provide us with sort of a typical deal and what's going on with margin or structure.

I'd say we're continuing to see really aggressive pricing and more aggressive structures in commercial real estate.

And one of the reasons I wouldn't say we've selectively exited at all, but I think we've maintained discipline.

So you've seen that asset category being more flat year-over-year than grow.

Otherwise, I think in our sponsor and specialty business, in our regional middle-market activities and our asset-based lending across all geographies we've made really, really good progress.

I think we've been really disciplined in terms of structure and pricing.

So for us it's about -- again, and we've talked about this -- it's about having a lot of levers across a bunch of different product sets and a fairly broad geography that allows us to avoid concentrations and just really good lenders out in the marketplace servicing their customers.

And certain hot-topic loan categories like we've never been, as we've said before, a big participant in the New York City multifamily space.

We're careful on real estate.

But there really aren't any subsegments that we're either kind of jumping into or doubling down on or avoiding as we continue to serve our marketplaces.

Okay.

That's helpful.

And then just on the uptick in marketing and advertising expenses.

Is that just part of -- was there anything specific going on there or what was specifically driving that?

No, just seasonal.

It really is.

When we have marketing spends or campaigns or we're supporting certain geographies, we have lumpy expenses.

Glenn called it out because it was higher this quarter but it's not associated with a specific strategy.

Okay.

Okay, that's helpful.

And then just finally on the efficiency, Glenn.

57% to 58%, is -- that's a nice change.

I mean, you guys have been saying below 60% forever, and I feel like it's kind of hovered in that just below 60%.

But 57% to 58% is a nice drop below 60%.

Do you -- is it something that's kind of you're sort of catching up on some of the initiatives that you kind of have in place that you then sort of flatline at that level?

Or do you think that there's continued opportunities to tick that down lower and lower?

I mean, I know you guys have been very clear and vocal on saying most of the way you manage the expense side is kind of a reallocation of resources.

But just trying to understand how you're thinking about that longer term.

I think a lot of it, Collyn, will depend on our -- your outlook on rates.

And we've certainly benefited from that.

And so if you look at the guidance, if net interest income is up $4 million to $6 million and noninterest income is up $1 million to $3 million, some of that will be reinvested and some -- along the lines of some of the things I highlight, whether it's cash management or credit monitoring or things like that CECL.

But generally, there's a downward bias to our efficiency ratio, meaning a little bit push down provided things continue to improve quarter-over-quarter.

And Collyn, just to put a strategic focus on that.

Obviously, we benefited significantly from the revenue side of that equation, which has helped us drive it down.

And that's really important to us because we have said we think we have some differentiated businesses.

We need to keep opportunistically investing in those businesses, whether it's people or systems in Commercial Banking or providing Chad with the ability to continue to expand or knitting in the community bank, continuing to invest so that we can really build out our digital capabilities, both internally and externally, to compete in 2020 and beyond.

So we are very much focused on expense management, but we talk about 60% as a guide because we're not going to be afraid in a particular quarter to make a key investment that will ultimately drive long-term value.

But as Glenn said, I think, if you look at our expectations over the balance of the year, I think we're in the range we are now.

And we could go lower depending on investment opportunities.

Okay.

That's very helpful.

And then just one final question for Chad.

Chad, are you -- do you see any sort of diverging trends among geographies as to where you're seeing success in building out your HSA relationships?

Yes, I'd say we see some of that when we add a new partner.

Obviously, we've had some new health plans that we signed up over the last couple of years and aggregators as well.

So we'll see a little bit of regional activity there.

But otherwise, it's -- primarily we're seeing the same kind of activity in the regions where we focus as we have historically.

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

John, what would -- would you contemplate additional branch sales in coming quarters?

Is that something that's possible?

Mark, I think we are constantly reviewing our network to make sure, first and foremost, we're taking care of all of our customers.

And so what we have said is, we'll continue to evaluate.

We know, with changing customer preferences, that we need to try and free up capital to invest in digital technologies and the other nonbanking center channels but that, we have always said, the banking centers are going to be core and important to our delivery of Community Banking services.

So that may be an amorphous answer, but I think what you'll see is we could add some smaller-sized banking centers in key areas to take advantage of opportunity.

We could continue to consolidate if we had opportunities.

And certainly, if there were an opportunity that maximized value to us in a market where we were consolidating, we would look at a sale.

But it really is -- the strategy is around making sure we have the optimal-sized network with lower square footage across the footprint.

Okay.

And then for Chad, just to follow up on Steve's question earlier.

What do you think sort of the catalyst is that causes employers to begin to pressure you to nudge up deposit rates in the HSA business?

I think as employers look at the HSA plan, their first priority is the functionality, the technology, consumer experience, investment options and things like that.

So interest rates seem to fall through a little bit lower level.

So we really haven't seen much pressure from our employers.

I think as we see other competitors start to raise their rates, that'll probably have us look at that a little more closely or if it's -- I think where we'll see some of the fluctuation is in fees as well as rates continues to rise.

Yes.

And if I can, Mark, I'll add a little color to that.

As you looked at noninterest income for the quarter and HSA, $22.8 million, if you break that out, about $12.6 million of that is account fees and 40% of that is paid by the company.

60% -- the remaining 60% is paid by the employees.

And I think from conversations with Chad, if there's a battle, it's probably on that 40% that the company is paying as a subset of that $12.6 million.

And we have seen a little more pressure on fees of late.

Our next question comes from the line of David Chiaverini with Wedbush Securities.

I had a question on deposit.

So HSA deposit growth is very good, 14%, but overall deposits were flat in the quarter.

And you mentioned about seasonality in government deposits.

But I was curious, are there any initiatives to increase Commercial Banking deposits?

So you're speaking specifically to commercial deposits?

Right, because HSA deposit growth has been very strong in Community Banking deposits, there was a small uptick in the quarter.

But I know it's Commercial Banking deposits were down in the quarter.

So I was curious as to kind of the outlook there and if there are any initiatives in the works to kind of improve the deposit growth there.

Yes, actually it's a good question.

In this quarter, we really saw a -- the reduction in deposits in government banking.

So I think those clients where they are not the operating accounts in the transactional accounts with a lot of municipalities and government entities that we have relationships with, but in terms of their excess cash, I think they are being a little more selective in terms of making sure they're getting the best rate.

And that's what our view is of why we saw government deposits year-over-year down.

And so that seasonality and some behavior in our institutional clients is driving that.

I think we've been looking for a long time, at whether or not as rates rise, tradition Commercial Banking customers would either look for other investments.

And we obviously work very hard at making sure that every time we make a loan, that we are getting the operating account and the cash management business of our customers.

So I would say we are always focused on our incentive plans, our strategies around driving core transactional deposit growth in the commercial bank, and we haven't had or felt the need to come up with a specific strategy to stem any departure of deposits.

But in terms of our core Commercial Banking relationships and our transactional accounts, we haven't seen deposit attrition that concerns us yet.

Let me just add to that, John, if I can.

I mean, the big swing, I think, as you're highlighting, was on the treasury payment solutions group and is primarily government funds and it's seasonality.

So we were down $354 million quarter-over-quarter, and we totally anticipated that because it's -- if you look at over the last couple of years, that's what you would expect, is tax receipts coming in and then there's expenditures.

So you can see some of that back on our appendix on Page 25 by line of business, if that's helpful.

Yes, and I would just add, they're very top of the house and we've said it often that we obviously enjoy a terrific deposit advantage with HSA.

But we manage the retail bank, and we manage the commercial bank very much to make sure that we continue to grow transactional deposits and relationships.

And that's critical to us.

So we don't take our eye off the ball there.

And I was curious about the Boston progress and the deposit growth there.

I know it's been a couple of years now that you've acquired those branches.

Just curious as to what the update on the progress is.

Yes, we continue to make good progress in Boston across all lines of business.

So referrals across business lines, now that we have all of our business lines represented there in that important market in New England, we're really pleased with the results.

I would say the market remains very, very competitive, among the most competitive markets from a deposit-pricing perspective that we're in.

And so we have been sort of really looking at balancing customer acquisition through high-rate deposits offers and the profitability of what we're trying to drive in Boston.

So if you look at our -- we're 2.5 years through our 5-year plan where we talked about $1 billion in deposits and $500 million in loans.

I will tell you we are ahead of plan in loans.

We recently, in this quarter, fell slightly behind in deposit growth.

But again, I think that's, for us, strategies around customer acquisition and not chasing the highest price.

So we also have looked at making sure that our banking center network there is rationalized.

And we just moved one of our banking centers to what we think is a better location with smaller square footage.

So as we manage the rest of the network, we're managing Boston.

And I still think we're really happy with the move we made in that key market.

Okay.

And then lastly on HSA Bank, the pretax net revenue growth, it's been north of 60% a couple of quarters now.

Any change to kind of the guidance of 30%-plus pretax net revenue?

No, I think -- I'll jump in and Chad can add to it.

But I think a big driver of the PPNR growth was the increase in rate.

And that's, again, driven off the curve.

And so I think it was 44 basis points year-over-year, close to $6 million.

And if you normalize it for as if rates didn't move, you'd be closer to our target which is about 30%.

So I would not take 62% and then extrapolate it out, I would temper it down.

I think still in the 30% to 35% PPNR year-over-year growth is where we expect to be.

Anything to add, Chad?

I'd say that we still have a lot of opportunity to improve our efficiency in the business given all the other activity we've around continuous improvement in operational expense.

So we hope to continue to drive that expense as well.

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

John, you touched on it a little bit earlier, just saying how competitive the environment is.

You noted the nonbank lenders.

Can you just provide some anecdotes of what those folks are providing in terms of term, structure, yield?

What are they providing that you aren't?

How far is the delta between yourselves and them?

Yes, that's a good question.

I would say I was speaking in my prepared remarks specifically to the commercial real estate environment.

And I think you're seeing longer tenures on transactions.

So people are going -- willing to go out longer with fixed rates, particularly the permanent finance providers, government entities, insurance companies, others, which just doesn't make sense for us economically.

And on some of the LIBOR-based loans, we're seeing pricing on shorter-term loans that is just below our RAROC model hurdle.

And as we've said all along, we remain very disciplined to generating economic profit and making sure that our relationships hurdle our cost of capital.

We do -- I think as rates go up, some of the fund lenders in both commercial real estate and commercial finance companies will be a little bit squeezed by their cost of funds being higher, and our cost of funds advantage will help us.

But given this overall low rate environment, we have seen a lot of nonbank lenders in.

And I would say it's on rate, structure, tenure, covenant package.

It's across the board.

And I think we're trying to remain pretty disciplined.

And I think we're doing a pretty good job.

If you look at it quarter-over-quarter, where we're annualized 10% loan growth in the commercial bank this year, so I think we're doing it safely despite the competitive environment.

That was helpful.

And then, Glenn, just thinking about the margin guidance for next quarter, plus 1 to 3 basis points, but there was a June hike.

As we think about our own -- we make our own assumptions on Fed hikes going forward, is that 1 to 3 basis points, is that a better proxy for margin expansion pro-hike from here?

Or how would you characterize that?

So if I look at over the next 4 quarters, and I -- let me try it this way, if I assume and look at the forward curve, and our forecast is very close to the forward curve over the next 4 quarters, you have Fed funds going up to -- from like 2.00 to 2.50 into the second quarter of 2019, you have the 10-year swap, say, going to like the 3.25, within that scenario, you would expect to see 3 to 5 basis points a quarter in NIM expansion.

Got it.

And then my last one is just around CECL.

You mentioned that a couple of times investing there.

Any thoughts or color you can provide and give us some insight as to how we should think about the provision in 2019, 2020?

No, I mean, it's early stages.

Obviously, we feel like we're along the curve of preparedness.

Obviously, our disclosures will be consistent with market over time.

We're happy with our preparation.

We're currently developing our expected loss model.

And I think we feel like we're too far away to be able to give any indication of what the ultimate impact is going to be.

But I think we agree with the industry that the reserve is likely to go up at some increment under the new standard.

And stay tuned as we report on it in further quarters.

Our next question comes from the line of Erik Zwick with Boenning and Scattergood.

Erik, how are you?

Erik, I understand -- welcome to coverage of Webster.

We're glad you're on the call with us this morning and give our best to Matt.

I will, definitely.

It's good to be on.

I just had a quick question for credit with me.

Looking at the net charge-offs in the quarter, up a little bit, but still obviously low on an absolute basis.

Looks like the commercial -- looking at [5 13] commercial charge-offs drove the increase.

Curious if you can provide me any color on those losses this quarter?

And whether there were just some borrower-specific issues or if higher rates on variable loans maybe starting to pressure any of your borrowers?

Yes, 3 -- basically 3 small charges that are not sort of correlated by industry or geography or risk.

They are unique to the borrowers.

They are not new originations.

So at the end of the day, we look at that number this quarter and we're really pleased with the level.

And there's nothing in those charge-offs that sort of we see a trend in with respect to correlated risk.

Okay.

And just with regard to that higher rates, I'm sure when you underwrite these loans, you stress for an increase in rates.

Are you starting to see higher rates' impact any borrowers that might be operating at similar margins or not at this point?

We have not.

And you are right to say that we do stress interest rate and as we do scenario analyses during our underwriting.

But the rates aren't at a level yet where we've seen a pressure on borrowers due to higher interest rates.

Our next question comes from the line of Brock Vandervliet with UBS.

I thing you've covered all the fundamentals.

I did hear you mention this congressional bill in your intro remarks.

I wondered if you could just speak in terms of the potential implications of that.

And if we see a more favorable public policy outlook toward the HSA business.

Yes, absolutely.

I'm going to, obviously, let Chad answer this question.

He's been very much involved in a lot of this process.

So Chad.

Yes.

Brock, we're pretty excited about the fact that the House Ways and Means Committee marked up 12 bills that are very favorable to HSA.

It's probably the most movement we've seen with regard to HSA legislation maybe even since the introduction of HSAs.

The bills focus on a number of areas expanded coverage, so looking at things like expanding HSA eligibility to bronze-qualified plans; allowing working seniors to contribute to their HSAs; eliminating some of the restrictions that disqualify HSA plans, like onsite clinics; solving some of the logistical issues, like over-the-counter medications and first dollar coverage; and probably most importantly, increasing limits to match the out-of-pocket maximum, which would virtually double the available contributions to HSAs.

So it's a long way to go.

You have to get through the House and the Senate and be signed by the president to get into law.

So a lot of things can happen between now and then.

But we're really excited about the positive momentum.

And the fact that it's -- most of the bills that are being proposed are -- have partisans.

Okay.

And you mentioned it was several bills that have been proposed?

12, to be exact.

Mr. Ciulla, there are no further questions.

I'd like to turn the floor back to you for any final comments.

Thank you very much.

I appreciate everyone's continued interest in Webster, and have a wonderful day.

Thank you.

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