Webster Financial Corp (WBS) 2019 Q1 法說會逐字稿

Good morning, and welcome to Webster Financial Corporation's First Quarter 2019 Earnings Call.

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

Please go ahead, sir.

Thank you, Michelle.

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 first quarter of 2019.

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

Thanks, Terry.

And good morning, everyone.

Welcome to Webster's First Quarter 2019 Earnings Call.

CFO, Glenn Maclnnes, and I will review business and financial performance for the quarter.

HSA Bank President, Chad Wilkins, is with us here in Waterbury and will join us for Q&A.

I'll begin on Slide 2. We are pleased to report our first quarter 2019 financial results.

This quarter may well have been Webster's strongest on record.

Quarterly net income was slightly below $100 million with net income to common shareholders of $97.5 million after $2.2 million of preferred dividend expense.

Earnings per share of $1.06 in Q1 compares to $1.01 in Q4 when that quarter is adjusted for onetime items, and $0.85 a year ago.

The EPS growth from a year ago is 25%.

Preprovision net revenue in Q1 grew 21% from a year ago.

Loan growth and a higher net interest margin led to our 38th consecutive quarter of year-over-year revenue growth.

In Q1, total revenue was just under 10%, higher than a year ago, while expenses increased approximately 2% demonstrating disciplined expense management.

This resulted in the eighth consecutive quarter of positive operating leverage.

The efficiency ratio dropped below 56%, enabling us to continue to invest confidently in our future.

Credit quality remains strong.

We've now posted 3 consecutive quarters with return on common equity above 14% and return on tangible common equity above 17% consistent with our goal of maximizing economic profits over time.

Turning to Slide 3. I'll touch on a few line of business highlights.

Webster's performance continues to be the outcome of our purposeful execution of our long-term strategic priorities.

Mainly to expand Commercial Banking, aggressively grow HSA Bank and optimize and transform Community Banking.

After reporting double-digit PPNR growth in each of our lines of business for 2018, we've now posted our fifth consecutive quarter with consolidated PPNR growth above 15% when compared to the prior year.

Commercial Banking led Webster's overall loan growth rate with compound growth of almost 12% since the end of 2013, and we expect Commercial Banking to drive Webster's loan growth going forward.

By continuing to invest in people, process and technology, we were able to leverage our deep industry expertise in select Commercial Banking segments.

While investments muted bottom line results in Q1, we continue to drive year-over-year PPNR growth in this business line.

Our focus remains on building long-term franchise value in what we believe is a differentiated Commercial Banking business.

As the leading bank administrator of health savings accounts with almost $8 billion in total footings and 3 million accounts, HSA Bank remains a strategic priority and key differentiator for Webster.

In a corner -- in a quarter where Fed H.8 data shows that U.S. commercial banks increased total deposits by less than 1%, Webster reported 4% deposit growth driven significantly by a $468 million increase in HSA Bank deposits.

The HSA team delivered robust account, deposit and total footings growth and posted strong year-over-year pretax net revenue.

Community Banking continues to make progress, optimizing distribution channels and processes, investing in digital offerings and capabilities and focusing on high-value consumers and small businesses.

We have 10 fewer banking centers than a year ago, a reduction of 6% and banking center square footage has been reduced by 7% overall.

We've made multiyear investments in our self-service channels, our products and our digital offerings.

Our efforts to transform Community Banking are delivering results as seen with Community Banking's PPNR increase this quarter.

Turning to Slide 4. On a consolidated basis, loans increased $1 billion or 6% from a year ago.

Commercial loans grew just under 10% and consumer loans were essentially flat.

Adjusting for a 242 million mortgage portfolio purchase late in the quarter, consumer loans declined 4%.

The adjusted consumer decline was led by a decrease of $177 million and home equity line of credit outstandings consistent with broader industry trends.

With the $1 billion increase in loans over the past year coming from the commercial categories, commercial loans now represent 63% of total loans compared to 61% a year ago and 47% in 2011 coming out of the financial crisis.

Deposits increased $1.4 billion or 6% from year a ago.

Health savings accounts represent 53% of the deposit growth, and at 19 basis points were essentially flat in terms of cost from a year ago.

Our loan portfolio yield was 59 basis points higher than a year ago, while the total cost of deposits increased only 22 basis points over that period.

Looking forward, we are confident about our businesses and the opportunities for continued growth.

Despite mixed signals on broad economic indicators and recognized pockets of slower global growth, we are pleased to see solid economic growth in our key markets, including our home state of Connecticut.

Overall, business activity in the communities we serve remains robust as evidenced by loan and deposit originations and solid asset quality across individual, small enterprise and large commercial customers.

I'll now turn the call over to Glenn for the financial review, including performance in the quarter for our 3 lines of business.

Thanks, John.

Slide 5 provides more detail on our balance sheet.

The securities portfolio grew by $165 million linked quarter and is up by $150 million over prior year.

We used this portfolio to manage interest rate risk, liquidity and risk-weighted assets.

The modest increase in the quarter is in part driven by our efforts to reduce asset sensitivity.

Loan growth continues to be led by the commercial categories, which were up $141 million linked quarter and $1 billion versus prior year.

Deposit growth was $610 million linked quarter and was led by a seasonally strong first quarter in HSA Bank.

As we highlight, deposits increased $1.1 billion from a year ago.

The linked quarter increase in deposits funded all our loan growth and a $420 million reduction in borrowings.

During the quarter, we concluded a successful issuance of $300 million in 10-year senior notes.

The issuance represented a cost-effective way for us to increase capital at the bank in support of ongoing growth.

The notes were priced to yield 4.14%, and the proceeds were initially used to pay down short-term borrowings at 2.65%.

After factoring in the benefits from reduced FDIC premiums due to higher bank level capital, the all-in, after-tax incremental cost of the issuance was less than 1%.

The impact to our net interest margins will be around 2 basis points beginning with Q2.

Slide 6 summarizes our Q1 income statement and drivers of quarterly earnings.

Net interest income totaled $242 million and increased $4 million or 2% from Q4 versus prior year net interest income grew $27 million or 13%.

Noninterest income declined $4.6 million as Q4 included a gain on sale of banking centers.

On a year-over-year basis, noninterest income was flat.

Noninterest expense increased a little under $1 million linked quarter and $4 million versus prior year.

The linked quarter increase reflects seasonal benefit costs, higher technology costs and was partially offset by lower marketing expense.

The increase versus prior year was primarily driven by annual merit and other benefit costs.

Preprovision net revenue of $135 million was just below Q4, which included the gain of sale from the banking centers versus prior year, preprovision net revenue increased $23 million or 21%.

Loan loss provision for the quarter was $8.6 million, reflective of loan growth and stable credit quality.

The effective tax rate was 20.8%, and our efficiency ratio of 55.9% improved modestly from Q4 and 383 basis points from a year ago.

Slide 7 provides additional detail on year-over-year, preprovision net revenue growth.

Net interest income grew by $27 million or 13%, $17 million driven by rate and $10 million by volume.

The rate component is the net result of a 59-basis-point improvement on loan yield, and a 22-basis-point increase in deposit cost.

When measured against the 97-basis-point increase in average Fed funds rate, the result is a loan beta of 61% and a deposit beta of just 23%.

The combination resulted in a 30-basis-point increase in net interest margin to 3.74%.

I will note that Q1's net interest margin is higher than what we view as the run rate going forward.

I will discuss in more detail when I provide the outlook.

Starting on Slide 8, I'll review the line of business results.

Commercial Banking reported first quarter loan growth of 1.8% linked quarter and 10% year-over-year.

C&I loan growth was $604 million year-over-year led by Sponsor & Specialty Finance.

And investor CRE loans grew $339 million from prior year.

We will continue to see loan growth in all commercial business units.

Loan yields are up 15 basis points linked quarter, and 78 basis points from prior year as the majority of the portfolio reprices on a floating basis.

Loan fundings in the quarter were $492 million, down $397 million from Q4.

The decrease reflects lower CRE fundings from a solid Q4.

As you'll see on the bottom right, PPNR growth was 2% year-over-year.

Net interest income grew $5.9 million reflecting average loan growth of nearly 10%.

Noninterest income was lower by $1.3 million from a year ago, primarily due to a lower level of swap revenue.

And noninterest expenses increased $3.4 million versus prior year.

The increase reflects our continued investments in the business.

Slide 9 highlights HSA Bank, which delivered another solid quarter led by a production of 348,000 new counts.

We finished the quarter with 2.9 million accounts, comprised of $6.2 billion in low-cost, long-duration deposits and $1.7 billion in linked investments.

Account growth was strongest in our direct-to-employer channel, which is an area of strategic focus.

This channel experienced greater than 20% year-over-year growth.

Total accounts were 11% higher than a year ago, and total footings were up $1.1 billion or 15%.

Net interest income was 27% higher from a year ago.

The increase reflects growth of 13% on average deposits and a higher net credit rate.

The cost of deposits was 19 basis points compared to 20 basis points a year ago.

Noninterest income increased 13% from higher account fees and interchange revenue, each driven by growth in accounts.

Total revenue for the quarter grew 21% from a year ago.

Year-over-year expense growth was 7% as a result of account growth over the past year and ongoing disciplined expense management.

Combined, this resulted in positive operating leverage and a pretax net revenue growth of 40%.

Slide 10 highlights Community Banking.

Loans grew modestly year-over-year with growth in business loans of residential mortgages offset by a continued decline in our home equity portfolio.

Quarter end balances included a $242 million residential mortgage portfolio purchase in Eastern Massachusetts, which closed at the end of the quarter.

Consumer deposits grew 6% year-over-year and business deposits grew 7%.

Net interest income grew 2.5% year-over-year driven by deposit growth and increased deposits spreads.

Noninterest income was essentially flat.

Total revenue growth was 2.1% from a year ago, and noninterest expense declined 1.8% from ongoing optimization of our expense-base.

The net result was positive operating leverage and a 16% growth in PPNR.

Slide 11 highlights our key asset-quality metrics.

Nonperforming loans in the upper left remained flat at 84 basis points of total loans.

Net charge-offs, in the upper right, were $9.6 million in the quarter.

The annualized net charge-off rate was equal to our 20-quarter rolling average of 21 basis points.

Commercial classified loans remained at 2.75% of total commercial loans.

Our allowance for loan loss was $211 million with a provision of $8.6 million and a coverage ratio of 112 basis points.

The provision was slightly less than net charge-offs due to a modest improvement in consumer and commercial portfolio of quality.

Slide 12 provides our outlook for Q2 compared to Q1.

We expect average loans to increase between 2% and 3%, led by commercial loans and our portfolio purchase late in the quarter.

We expect average interest-earning assets to grow around 2%.

Regarding net interest margin, recent volatility in both the short end and long end of the rate curve make it challenging to forecast net interest margin and net interest income.

As I indicated on our January earnings call, if the Fed were to stay on hold and the 10-year swap remained at 275, we'd likely see quarter-to-quarter reduction of 1 to 2 basis points in NIM.

At this point, we expect net interest margin to be 6 to 8 basis point lower in Q2, which includes around 2 basis points for the senior notes issuance in late March.

Another 2 basis points for the mortgage portfolio purchase and around 2 basis points from higher securities premium, amortization as a result of the 10-year swap dropping around 25 basis points from January.

Given our earning asset and NIM expectations, we expect net interest income to be up modestly from Q1.

Noninterest income is likely to increase between $2 million and $3 million as a result of higher deposit fees and investment revenue.

We expect our efficiency ratio to continue to be below 58%, and our provision will be driven by loan growth, mix and quality.

We expect our tax rate on a non-FTE basis to be approximately 21%.

And, lastly, we expect our average diluted share count to be similar to Q1's.

I'll turn things back over to John at this point.

Thanks, Glenn.

I'll conclude our prepared remarks by proudly mentioning how we recently issued Webster's second annual environmental social and governance report, which is available on our website.

Our ESG report highlights Webster's commitment to being a good corporate citizen and our leadership on responsible lending, sustainability, diversity and ethical governance.

I want to recognize and thank our nearly 3,400 bankers for their continued effort and outstanding performance.

Together, you are making a positive difference for our customers, our shareholders, the communities we serve and for each other.

We'll now open it up for questions.

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

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

Michelle, I think something went wrong with Steve's line.

Yes, that was weird.

I'm here.

Okay, Collyn.

We're waiting for Steve to rejoin, why don't you go ahead?

All right.

Okay.

I guess, sorry I wasn't prepared quite so quickly.

To speak specifically about the resi portfolio purchase, if you could just talk about, sort of, the strategy behind that?

How you're, sort of, seeing kind of longer-term loan growth migration?

And if there's more portfolio purchases that you intend to do?

So I'll take that, and maybe John would like to add some color.

But from a financial perspective, the loans were acquired at a discount and the returns will exceed our cost of capital.

We saw it as an opportunistic acquisition.

I would note that the yield on the portfolio exceeds our total residential portfolio, which is at $372 million.

So it will be accretive to net interest income for the year.

And it's -- also fits nicely and it's consistent with our strategy to decrease some of our asset sensitivity.

On a qualitative side, it allows us -- it's 500 high-quality customers in and around the Boston area.

And will allow us the opportunity to develop additional banking relationships with these customers.

So Collyn, I think, Glenn gave you details.

I think from a strategic perspective the word opportunistic is probably the right way to describe it.

It's economically profitable, as Glenn mentioned.

And for us, we've talked about looking to acquire portfolios.

We certainly weren't out looking for a residential-mortgage portfolio.

But when this opportunity came about and in the market it came about, it was an effective way on an economically profitable basis to acquire customers in Boston where we're making a lot of good progress.

And so everything, kind of, came together from an economic and strategic perspective.

Okay.

And what's the duration of the book, Glenn?

It's 4 years.

Okay.

And, I mean, do you see potentially pursuing this more as it offset to growing the security's book?

Or how do you balance those 2?

No.

I mean, we like the asset in that we purchased at a discount.

It came to us.

It's a -- we're not out there eagerly trying to buy additional portfolios, but we're opportunistic, as John said.

And if we have the economics work for us, we will take advantage of it.

Okay.

That's helpful.

And then, Glenn, just on the NIM, so obviously guidance for the second quarter, you've laid that out pretty clearly.

Can you just talk about, sort of, the outlook a little bit longer term if we stay in this shaped curve and just in this rate environment for a long period of time?

Yes.

Sure.

So if I assume Fed funds are going to be at the 2.50% for the rest of the year and I assume the 10-year is going to be at 2.60%, I think what you'd see and the short answer is, 1 to 2 basis points from the second to third to the third to the fourth quarter in NIM compression.

But that being said, I would also expect net interest income to go up from the second to third quarter, and the third to fourth quarter anywhere from $3 million to $4 million, which is a result of continued growth.

So while we'll have NIM compression 1 or 2 basis points, you'll still have net interest income up $3 million to $4 million.

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

Can you guys hear me?

We can, Steven, and we want to let you know that we did not hit the dump button here.

You might want to after I ask my questions, John.

So the 2 issues that I want to address is, first, the Cigna contract, with one of your competitors in the space making quite a bit of noise that they planned to go after the contract, which they say is up this year.

Can you help us think about how much risk is there to Webster that you could lose the contract?

How aggressively will you compete for it?

That's my first question.

Steve, I'll take it and then let Chad provide some color.

Obviously, everybody's competing with everybody in this space aggressively.

We think we've been doing a terrific job.

We don't comment specifically on the Cigna contract or any other material contract with our partners with respect to terms and conditions and renewal dates.

I will tell you that we've got a strong technologically integrated, contractual relationship with Cigna.

We've worked together and continued to grow together.

And, in fact, Chad and the team are working on a number of initiatives to enhance that relationship for the benefit of both Cigna and HSA Bank.

And so we don't see anything that would change that outlook for that relationship going forward.

I don't know, Chad, if you provide any other...

I think that hit it really well, John.

We both invested heavily in this relationship and we continue to invest in the relationship.

We've added resources as well and, I think, we can actually influence the growth rates by using some of the tools and resources that we have at our disposal.

And Cigna has been a lot more open to us participating and helping them with the sales process and growth process.

So we like where we are with the relationship.

So not sure where that competitor is getting their information from.

Got you.

Could you guys give a sense how much of the business is coming from Cigna?

We haven't really commented to the extent -- it's not something we've commented on.

Well, it isn't, and our concentration is lower as we've grown since the acquisition.

Particularly, with the (inaudible)

So it has that declined since the deal?

Yes, our direct-to-employer business is growing faster than any other channel, so that's increasing as a percentage of the portfolio and our partner channels are decreasing.

And you're seeing the same thing in the industry as well.

Got you.

Okay.

And then, to shift direction, so healthcare stocks have been feeling the burn over the past week on fears of better care for all (sic)[Medicare For All] , which could potentially eliminate private health care insurance and HSAs.

You guys are, obviously, connected in Washington.

What are your views on the risk that HSAs could go away?

And is there a Plan B here?

Yes, Steve, I'll take that one first, again, and let Chad fill in any of the gaps.

I'm not going to comment, obviously, on the market performance over the last couple of days.

I think we have, obviously, thought about this in the context of legislative and policy changes over time.

And we feel pretty strongly that the probability remains remote that the system would be changed enough with a single payer or Medicare For All program, to really disrupt what we're doing.

I mean you think about a cost of a full replacement on a program like that, you think about where the political will and the support really is in aggregate for it.

And the fact that the current employer paid and insurance paid health care system works for most of America.

We think that the probability is pretty remote that you're going to get something that -- some of the -- Senator, Sanders and others have talked about in townhall forums.

I'd also say, specifically, to HSAs is that, there's $25 million-plus HSA accounts now.

We're reaching critical mass and it's embedded in, kind of, the process, and you think about it like akin to a 401(k) that the more it's embedded, the less likely it is to be legislatively eliminated or driven away.

And I think, lastly, if you think about bipartisan support that we've talked about when you guys had asked this questions on specific legislation, it is a product that has bipartisan support, I think, largely because it provides more transparency into the system.

It lets people manage their own health care, and ultimately, drive down health care costs.

So our view, from where we sit here at Waterbury is that, any modification or enhancements or changes to the overall health care system should and will likely include HSAs as part of the solution.

So that's, kind of, where we feel from a high level.

Okay.

And I don't know, Chad, if you have anything to add to that.

But I did have one specific for Chad.

So Devenir, interestingly enough, came out with a recent forecast and they kept the outlook for asset growth at 19% this year.

And you guys so far grew a little over 15%.

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

And do you think industry could be 19% this year?

Yes.

I think historically, the Devenir results are the estimates of how the participants are going to grow, is always higher than what the actual results end up being.

So I think that there will be a little less than what folks are predicting.

Our growth rates, as you mentioned, are a little bit behind what Devenir results came out at the end of '18.

We have, as you look across our different channels, obviously, the growth rates fluctuate.

And we're having the best results.

And our direct, as Glenn mentioned earlier, at -- of over 20% both accounts and deposits.

And that's where we're actually investing the most and we have the most influence over sales and marketing efforts.

Now, I do think that we can influence growth rates across the rest of our portfolio because of the results that we're seeing in direct and the conversations we have with our health plan partners and the interest they have in leveraging some of the tools and processes that we have in those channels.

So I think we'll see -- we'll be able to influence that growth rate.

And then, Steve, I would just add, I'm not sure what their market assumption is either.

I mean we saw some of our increases result of -- the increases in the market.

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

I have a couple of follow-up questions on HSA.

So looking at Slide 9 of your deck, the pretax net revenue per account has increased very nicely by about $10 per account over the past year to $47 per account.

Could an insurance carrier customer of yours point to that increase and say, "We want a piece of those increased economics as part of a revenue-share agreement?" Does that happen at all?

I'd say that the -- it depends on our partner, it depends on the volume, the dynamics of the account.

We price based on fees and the average balance of the accounts and things like that.

So it just depends on the relationship with the carrier and the amount of integration, the investment and so on.

And so our pricing fluctuates depending on all of those factors.

Hopefully that reflects the rate environment, too, that we're seeing the benefit of.

Right, when you look at that, obviously, included in that is a higher net credit rate that's gone to the business year-over-year-over-year in a rising-interest-rate environment, too.

So if you look at the PPNR year-over-year as an example, 40% improvement, about half of that is driven by rate, Dave.

And to Chad's point, if I -- if you look at the financials and you break it down, so we have net interest income of about $42 million.

And for the quarter, noninterest income of about $26 million.

And then, you peel that back and we highlight the interchanged piece, but the remaining fees, the account fees so $14 million.

I think the part that's most sensitive and Chad can jump in here, of the account fees, say, $14 million, is the 40% or so that's paid by the employers, right, the companies.

And so when there's negotiation, that's, sort of, the first area that's negotiated.

So it's 40% of the $14 million that's really subject to negotiations, so say, $5 million or $6 million.

Yes, that's right, Glenn.

That's where we're seeing the pricing pressures on the fees.

So there are some revenue -- you already have in place some revenue-share agreements that incorporate some of the fee rate or credit rate from rising interest rates already kind of (inaudible)?

No.

No, I think, it's more of the fee side, less of the credit side.

And on the fee side, what I was trying to highlight is, it's that portion that's paid by the employer for the most part.

And we're going to base our pricing, our fee pricing on the maturity, size and performance of the overall portfolio.

And a lot of that is driven by scale of the new business, the size of the new business coming in, obviously.

Okay.

And sticking with the HSAs, is it fair to say that there are better economics in the direct-to-employer channel versus the insurance carrier channel?

Well, that depends.

It depends on how deep the integration is, what the pricing is with the carrier.

And how involved they are in driving the performance.

For instance, the penetration within the employer, the average balance on the accounts, encouraging folks to save.

So I think, the -- we have some health-plan partners that perform really well and some don't.

But I'd say in general, the -- we do -- normally, we'll experience dynamics in the direct channel.

Great.

And then, shifting gears, the loan growth that you've highlighted looking out to the second quarter, I know it's being driven by the portfolio purchase.

But in general, how are you guys seeing demand for loans?

Do you see any sort of change in the environment either better or worse for demand for loans on the commercial side?

So I'd say -- on the commercial side, I'd say sort of steady.

First quarter was seasonally low.

If you look back over the last couple of years, first quarter has been a little bit lower.

But we still saw solid growth and solid originations in the first quarter and our pipeline remains robust.

So I would say, kind of, steady as she goes.

On the consumer side, we've obviously seen, just given general trends and ticks up in interest rate recently and our disciplined view on pricing, we've seen mortgage, home equity and other consumer categories not grow as much and be relatively flat.

I will tell you that given the recent decline in long interest rates, that we have seen our pipeline increase materially as we head into the second quarter on mortgages.

So what I'd say is BAU in the commercial bank, kind of, thinking about that 10% annualized growth rate, which drives most of our growth.

And we will likely see a higher mortgage origination volume in the second quarter based on the pipeline.

Our next question comes from of Casey Haire with Jefferies.

Glenn, I wanted to touch on the efficiency guide for the second quarter.

I understand that NIM is going against you this quarter.

But you did pretty -- you handedly beat your efficiency ratio guide this quarter.

I'm just wondering at 58%, what -- is there anything that would drive that meaningfully higher other than the NIM compression?

No.

I think -- look we continue to be disciplined on our expense.

But we also are opportunistically making investments.

And, I think, if you look full year, you probably expect for the efficiency ratio to bounce in the range of 56% and 58%.

Right, Casey, I'll put a finer point on that because it's something we've been, I think, consistent with over time.

We used to talk about 60%, as that guidepost.

And when we were asked why we weren't going to go lower than that, we talked about the fact that given our focus disciplined, strategic process is that we want to continue to invest in those areas that maximize our ability to generate economic profit.

And so I'll give you an example in this quarter in Commercial Banking, investments in treasury and payment solutions in our end-to-end technology around portfolio management and hiring new people, you saw a muted year-over-year PPNR growth in the commercial bank.

That's a perfect example of where we're going to opportunistically invest where we think we can continue to drive long-term shareholder value and franchise value.

So, I think, Glenn's point is in our forecast, we've got a certain level of expenses, but we give ourselves a little bit of cushion to make sure we can continue to operation -- opportunistically invest in our key business lines.

Got you.

Okay.

And then, Glenn, just a bigger picture question on the securities portfolio.

Obviously, a pretty big asset for you guys at 30% of earning assets and a very nice yield, if we were to keep the -- if the curve were to remain flat, at what point would those yields start to roll over?

And what is the strategy in terms of balances?

Is it to keep it at this 30% concentration?

Or would you think to shrink it?

No.

I think as we look at our positioning from an asset-sensitivity standpoint and wanting to move more toward neutral, you might see a slight increase in the investment portfolio.

And you saw some of that in -- going into the first quarter.

That's one of the strategies because the duration is longer on that, that we can add securities and reduce the asset sensitivity of the organization.

Obviously, we can do -- we can also lengthen it through hedge floating, floating rate loans or things, swaps like we see fixed-pay floating type of things.

But securities is something we can also do.

Okay.

And from a yield perspective, like if the curve would to hold this shape, at what point would those yields rollover?

They'd stay relatively flat.

I'm going to give you some perspective.

In the first quarter, our purchases were [355] at 5.4 years duration.

That will come down in the -- as we go into the second quarter, probably about that 20, 25 basis points.

But as I think, for this year, we're okay as far as the reinvestment rate versus the portfolio, right?

Got you.

Okay.

Great.

And then, just last one for me.

On the loan growth, obviously, a pretty strong result here in the fourth quarter.

How much of that is coming from outside your core footprint markets?

It's pretty consistent with what the overall portfolio is.

We've always talked about, kind of, that, particularly when you attribute the sponsors, that the business that we do to where the sponsors are located, we're still in that like 80% to 85% within our footprint.

So it's coming across our middle-markets offices and coming in Sponsor & Specialty with respect to our kind of end-market sponsors.

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

Just wanted to follow-up on the loan-growth question to get a sense for how prepayment activity has been.

And how is that changed year-over-year?

Is that driving some of the increase in loan growth?

Matt, this is the toughest question every quarter because it's really tough to predict.

I think originations were slightly down, as we talked about seasonally.

Prepayments were down as well, so we did get a little bit of loan growth in the commercial side.

I don't really see any elements or items that are driving prepayments right now.

And it seems to be, generally episodic.

Fourth quarter was a big origination and a big prepayment.

And I think there's a natural cadence to that at year-end, as people are trying to get deals done and get a refinancings done.

We don't really have a line of sight into 2Q with respect to prepayment activity.

So it's a tough one.

I don't think there are certain market elements or drivers or interest-rate impacts or competition that give us a good idea of trending on the prepayment line.

Understood.

Okay.

And then, maybe you could talk about the deposit market outside of HSA.

We've heard a few of your peers note that competition has leveled off or perhaps is subsiding just a bit.

Has this been your experience as well since the Fed has gone on a pause?

Or how would you characterize it?

We -- you want me to -- so we have seen it sort level off.

That being said, in my outlook, I'm thinking 1 or 2 basis points on a total basis.

But some of it's regional, too.

For instance, in our Boston market our deposit costs are higher than our core market.

And so that's a phenomenon as well.

We've seen promotional pricing, sort of, stabilize in the last couple of weeks with the Fed on hold.

But we haven't seen anything going down yet.

So I think there is a lag between the Fed fund's increase and the natural increase in deposits, and we factor some of that in, but it is sort of stabilizing at this time.

Agreed.

Okay.

And then, as we think about your community bank centers, John, you noted 10 less this year than last.

Is that a good cadence for the next year and the year after that?

About 10 a year?

It's not.

What we say every quarter, which is true is, we constantly reevaluate the network.

We believe fully that banking centers will be an important channel for us over the medium and long term.

Obviously, we've talked about square footage in aggregate coming down over time.

But there actually is nothing on our radar right now in terms of branch consolidation that we've identified.

So I certainly wouldn't say that 10 and the square footage that we've closed in the last 12 months would be indicative of what we'll do going forward.

We can only tell you that we constantly reevaluate the efficacy of the network.

Understood.

Okay.

And then, as you look at your past dues, there was a -- an increase in C&I past dues, it was up about $16 million quarter-over-quarter.

What was that?

And could you give us some color on the underlying credit trends?

NPAs were up slightly again.

Yes.

I'm happy to.

And it's funny, I am always careful because I always want to be conservative.

But actually our reported results on asset quality didn't reflect how good the quarter was really on an overall asset quality perspective.

And what I mean by that is, that one delinquency that you referenced was actually an administrative delinquency where a $14.4 million commercial credit was actually current with respect to principle, but there was confusion around a 2- and 3-month LIBOR contract.

And so a stub piece of interest was not paid at that quarter end.

And in the first 3 days of this quarter, that administrative delinquency was resolved.

So if you look at that pro forma, that credit is a pass-rated credit that's performing as agreed.

It's unfortunate that from a reporting perspective it had to be characterized in that category.

But it is what it is.

Absent that, we would have been flat on a percentage basis, at about 19 basis points in delinquency, or up about $1.8 million.

So delinquency is really not a story.

Classifieds and nonperformers on a percentage of portfolio basis remained flat, and so we think they're still at pre-great recession levels.

And so we're really comfortable with where that is.

And, in fact, the one commercial credit that drove the absolute number up slightly, a $15 million credit, again, subsequent to quarter end, is no longer classified a nonperformer.

So we're happy with the trends there.

And then, charge-offs were flat with the prior quarters and equal to our trailing 20-month rolling average -- a 20-quarter rolling average of annualized net charge-offs.

So -- and you saw that our provision levels and our coverage went down.

Obviously, that reflects that after all of the stuff that I just talked about, that the actual quality of the portfolio based on our modeling showed some improvement quarter-to-quarter.

Got it.

Okay.

And just for clarification, you mentioned the administrative nonperformer, that paid off.

Was there was an additional credit that paid off subsequent to quarter end or are you referring to the same one?

No.

I'm sorry, the delinquency was a single credit that was administrative, that the payment was made shortly after and cured.

When I talked about the impact on the nonperformers and the classifieds, which were flat on a percentage basis but slightly up on an absolute basis, that in those categories there was a separate credit that has since been resolved and is no longer nonperforming and no longer classified.

Our next question is a follow-up from Collyn Gilbert with KBW.

Just a follow-up to the credit discussion.

So, John, just, kind of, tying to your conservatisms on how you approach the business and credit and all that.

Just seeing the reserve ratio drop, and I know you just kind of outlined what the quality of the portfolio looks like.

But I still just am curios, kind of, in the broader macro trends or whatever, and, Glenn, this is perhaps for you as well.

But just getting a little bit deeper into how you're thinking about the reserve given where we are in the cycle and where that could trend going forward?

Collyn, I could spend an hour on this with you.

As you know well, that the provision is really driven by models.

And over time, the conventions and the rules have allowed there to be, kind of, less qualitative input into that.

And, I think we -- if you look at our reserve versus our peer group, it's a very healthy reserve.

And we think that that's a good thing.

When you have resolutions of credits or impairments or charges, obviously then you need to run the model proforma for all of those and it's based on risk ratings and trending in the portfolio that's very, very much model-driven.

And so we're not releasing reserve or lowering our reserve because strategically we think it's time to do that.

It's -- we want to have the healthiest reserve that we can have within the confines of the process.

And so here, again, once you've dealt with all of your charge-offs and your impairments and things have remediated in a good fashion, your risk ratings kind of dictate where you are on the reserve.

And so it ended up coming down a couple of basis points.

And, Collyn, and just to add a little color, if I do a walk and I'd say, $115 million, it's been sort of like the last couple of quarters, growth would add about 1.5 basis points and then better asset quality, some of it driven by the impaired loan risk coming down, and some of it driven by our outlook on both the commercial and the consumer portfolio, would probably take away the remaining 4. So that's how you -- if you were to do a simple walk, very simple from $115 million to $112 million, that's how I would think about it.

Up 1, a little over 1 for growth, and then down 4 for generally a more continued favorable outlook and lower or less impaired-loans risk.

Okay.

Okay, that's helpful.

And then, just going back to HSA.

Chad, do you have the split between -- of your HSA accounts, the split of direct-to-employer accounts versus insurance carriers or health plan accounts?

Yes, Collyn, I think, the -- I'll pull that out right now.

We are at about close to 25% depending on whether you're looking at deposits or accounts in the direct.

And then, about a little over 50% -- or actually 45% in health plan channels, so the rest is retail.

Okay.

And your, kind of, longer-term projections, obviously, I know direct employer has been where your efforts have been in terms of growth, but just, kind of, more broadly, how do you see that mix changing over, I don't know, next 3 years or whatever, some sort of longer-term path?

Yes.

It's not going to be a dramatic change.

I think we're growing our direct channel more quickly.

And, I think, we can continue to do that because we've invested a lot, we've added resources and tools to that, to grow that channel.

So I expect that to continue to grow faster.

So over time, we'll continue to -- that will continue to make up a larger portion of our portfolio.

But I don't see that -- that's over 5-year type of a time frame.

So I don't have an exact number for you, but it will be a couple of percentage points per year increase in the direct channel.

Okay.

And then, just one final question broadly, John and Chad, on the HSA business, right?

So, obviously, there's the volatility in the health care stocks and concern about the health care industry right now and I hear what you're saying in terms of you feel pretty good about the structure of where you sit today.

Is there -- would there be any catalyst or what would be the catalyst that would maybe make you rethink, sort of, your growth investment plans within the HSA business, kind of, more broadly, right?

Is anything that would occur that would cause you to maybe put the brakes on growth and, kind of, reinvest some of that capital into just the core bank business?

I think we're in a good situation right now because we haven't had to make an either/or decision with respect to investment, given some of our earnings momentum.

I can't think of an inflection point, Collyn, or a particular event that would change our view, what I can say, because we've been saying it for a long time and Jim's been saying it before me, we're constantly evaluating HSA in terms of structure opportunity, changing competitive landscape, partnerships, technology, all the things that you would expect us to be looking at in order to make strategic decisions as we go forward.

So as you can imagine, we spent a good deal of time on strategic analysis of HSA over time and what happens with it and how it can operate most effectively within its industry and the competitive landscape.

And right now, we're really pleased with how we are executing and what we are thinking but we're not resting on that and we continue to look for ways to make it even strengthen the business and have the growth even accelerate.

So I can't think of anything that would nearly change our fundamental philosophy about the strength of this business right now.

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

One follow-up, I guess.

At the dinner you hosted a little earlier, you had said that you'd be okay with HSA comprising up to 50% of deposits.

Is that still -- I guess, it seems like you still would be comfortable with that.

Is that still the case?

Yes.

Jared, and obviously it's not a hard and fast rule.

We tried to give you some indication, but I think that's exactly right.

I mean given the optionality we have over time with respect to deploying those funds or even brokering them out, we have to, I think, from a concentration risk perspective, that's probably a good indicator.

Okay.

And then, Glenn, with the drive to becoming more interest-rate neutral, how long do think that will take?

Is that something you are looking at over the next quarter or 2 with the securities purchases and the mortgage purchases?

Or is that more a longer-term transition?

Yes.

It's over a year, maybe even over -- beyond a year.

But it's over quarters, not the next 2 quarters.

Okay.

Great.

And then, just finally for me.

The capital levels continue to grow here.

You've had some success with your loan production offices outside of New England.

Any thoughts to engaging in M&A?

Or having a more robust sort of organic growth focus in these other markets?

Yes.

First, I have to do it, because I paint the loan production office a context because, I think, we really believe that kind of we've established community engagement with local people there.

I think that, that plan, Jared, has worked very well.

We would never say never, but given our strategy about expanding Commercial Banking, leveraging our low cost of funds, it's less likely that we do hold bank acquisitions in some of those markets that we would just organically continue to develop our most profitable businesses in those expanded markets.

So our story on M&A is the same.

While you never say never, we think we still have runway for organic growth and given where our strategic focus is, it has to be incredibly compelling to look at a whole bank partnership or acquisition and present time.

Okay.

So I guess, how would -- how should we think about, sort of, long-term capital ratios, over the last few years you've been steadily growing capital.

Where would you like to see that sort of fall out?

And then, I guess, how can -- how should we expect to see that controlled, whether that's through increased dividends or buybacks?

Right.

Yes, and so a couple of things.

So I think, we feel good about our capital levels.

I would expect them to stay relatively flat given our outlook, our growth outlook on loans.

I think also you probably -- we look at our payout, we look at our dividend payout, it's something that we spent time with in April and you probably would expect given our parameters that we've talked about in the past that dividend would increase at the end of this -- during this quarter.

So that would be another source of --- or use of capital.

But generally, we feel good about where our capital levels are.

We have reached the end of our question-and-answer session.

I would like to turn the call back to Mr. Ciulla for any closing remarks.

Thank you, Michelle.

And thank you, all, for joining us this morning and for your continued support of Webstar.

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.