Webster Financial Corporation (NYSE:WBS) Q1 2023 Earnings Call Transcript April 20, 2023
Webster Financial Corporation misses on earnings expectations. Reported EPS is $1.49 EPS, expectations were $1.59.
Operator Good morning. Welcome to Webster Financial Corporation’s First Quarter 2023 Earnings Call. Please note this event is being recorded. I would now like to introduce Webster’s Director of Investor Relations, Emlen Harmon to introduce the call. Mr. Harmon, please go ahead.Emlen Harmon Good morning. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the Safe Harbor rules. Please review the forward-looking disclaimer and Safe Harbor language in today’s press release and presentation for more information about risks and uncertainties, which may affect us. The presentation accompanying management’s remarks can be found on the company’s Investor Relations site at investors.websterbank.com.I will now turn it over to Webster Financial CEO, John Ciulla.John Ciulla Thanks a lot, Emlen.
Good morning and welcome to Webster Financial Corporation’s first quarter 2023 earnings call. We appreciate you joining us today. I will provide remarks on our high level results and strategic positioning before turning it over to Glenn to cover our financial results in greater detail.First quarter of 2023 was a memorable one for the banking industry, unfortunately highlighted by high-profile bank failures that caused dislocation across the system. The good news is that the industry remains fundamentally strong and well capitalized and the near-term view is less volatile than a month ago. Webster’s results in the quarter are reflective of our resilient business model and a shifting environment for banking. We continue to deliver for our clients.
And in the quarter, we prudently grew loans and core deposits. We generated solid returns and our asset quality profile remained effectively unchanged from the prior quarter.On an adjusted basis, we generated EPS of $1.49. In light of the market dislocation and out of an abundance of caution, we took actions to augment our balance sheet liquidity including increasing our cash position and utilizing higher cost funding sources. We also saw a decline in fees as a result of reduced direct investment gains and overall client financing activities among other effects.Due to these actions and some seasonal factors, our PPNR was down 6.6% from the prior quarter. Our adjusted ROA of 1.46% was up from 1.37% a year ago and our return on tangible common equity was a strong 21%, up from 17% last year.
Loans grew 2% on a linked-quarter basis with a focus on strategic categories with attractive risk profiles. Our total deposits were up 2%, also on a linked quarter basis with core deposits up 4%.While it seems like ages ago, many of you attended our Investor Day on March 2, just days before the market disruption. During that event, we provided a transparent look at our go-forward strategies and differentiated businesses with a focus on our unique funding profile and credit and risk management practices, all of which are especially beneficial during times of stress and uncertainty. While I will touch again on some of the points we made in early March, I would encourage you to revisit the Investor Day presentation and webcast that are posted on our website, as we believe the attributes we outlined will continue to benefit our company and drive outperformance regardless of the operating environment.Let me spend just a minute on deposit and deposit trends and then provide you with an update on our office portfolio, two topics that I know are of significant interest.
I am on Page 3 of our presentation. The unique qualities of our deposit franchise remain a core strength of Webster. Our deposits consist of $24 billion of consumer deposits largely originated in our retail footprint to long-tenured clients. $8 billion of HSA Bank deposits, the entirety of these deposits are individual customer accounts and nearly all are within FDIC insurance coverage limits, and as you know, HSA deposits are long duration and low cost.$2 billion of business banking deposits within our commercial bank. Generally, these are smaller dollar and behaved similarly to those in the consumer book. $5 billion of public fund deposits within the commercial bank, the majority of which are collateralized with highly predictable behavioral characteristics.
Our remaining commercial deposits of $11 billion are diverse by industry, customer type and geography. There are no sector concentrations and these deposits are relatively small balance in nature with an average balance of less than $200,000 per account. I will refer you again to Chris Motl’s presentation at Investor Day where we broke down the multiple deposit-generating businesses in our commercial bank franchise. And finally, interLINK, the acquisition of which we completed in the first quarter has already proven to be highly valuable, provides readily available core deposit funding to almost all FDIC insured deposits and we have access to these funds at a very low cost of acquisition.In summary, between the Consumer Bank, HSA and interLINK, 63% of our total deposit accounts are consumer-oriented, small balance accounts that are long duration in nature.
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The past month of deposit activity highlights the tremendous value of our deposit franchise. Customer activity within the Consumer Bank and HSA was business as usual throughout the entire quarter and both of these categories grew in Q1.In mid-March, within the Commercial Bank, we saw elevated two-way activity for a few days as clients look to diversify their deposit concentrations, but that activity quickly resumed its normal course. I would also note that we have opened approximately 500 accounts, primarily operating accounts that are in the process of being funded with new commercial depositors since the middle of March.In addition to the strength of our overall deposit franchise, we maintained significant alternate sources of liquidity. This is displayed on Slide 4.
As of yesterday, we had $16 billion of immediately available liquidity between cash balances and undrawn borrowing facilities. This represents 118% of our uninsured and uncollateralized deposits. We expect this ratio will continue to grow over the short-term.As it relates to credit, at Investor Day, Jason Soto, our Chief Credit Officer, detailed the quality of our loan portfolio. We are proud of our credit risk framework and our risk selection. For many quarters, our origination efforts have been focused on existing customers and higher rated loans. Our strict underwriting standards include stress testing, economic and interest rate sensitivity and we continue to perform robust reviews of portfolio segments that are sensitive to environmental trends.
We proactively sold loans last year, where we believed it would be our economics and help reduce future credit risk. The net result of all of our actions is that the weighted average risk rating in our loan portfolio has improved over the past year, each quarter and is unchanged on a linked quarter basis. As you will see in our disclosures, the level of classified assets in our portfolio has remained stable as well.On Slide 5, we have refreshed and augmented our disclosures on our office portfolio. As you can see, our non-medical office portfolio represents just 2.8% of total loans, has a low ad origination LTV, a strong current and updated debt service coverage ratio profile has limited lease maturities in each of the next 2 years is diversified across geographies and thus far continues to perform well.
In fact, criticized assets have fallen to 4.7% of loans from 6.6% of loans in the fourth quarter of ‘22. I will also remind you that the $1.4 billion in office exposure is down $260 million or 15% from the close of our MOE as we were proactive in managing this portfolio during ‘22. And we have originated only a nominal amount of office exposure since the two banks came together a year ago.With that, I will turn it over to Glenn to review the financial statements in more detail.Glenn MacInnes Thanks, John. Good morning, everyone. I will start on Slide 6 with our GAAP and adjusted earnings. We reported GAAP net income to common shareholders of $217 million with earnings per share of $1.24. On an adjusted basis, we reported net income to common shareholders of $259 million and EPS of $1.49 after excluding onetime after-tax expenses of $42 million.
Merger expenses were related to professional fees, severance and other compensation-related charges and a provision adjustment for acquired unfunded lending commitments. The strategic initiative expense is related to repositioning of our securities portfolio.Next, I will review balance sheet trends, beginning on Slide 7. Total assets were $74.8 billion at period end, up $3.6 billion from the fourth quarter as we bolstered our balance sheet liquidity and had $1.2 billion in loan growth. Our securities balance increased modestly in the quarter. As discussed at our Investor Day, we sold $400 million in lower yield securities in January, recording a loss on sale. The proceeds were used to purchase higher yielding securities, resulting in an earn-back of less than 1 year.AOCI attributed to unrealized losses against our AFS portfolio improved to $560 million from $631 million last quarter.
In a steady interest rate environment, we anticipate roughly $85 million of this will accrete back into capital annually. Loan growth was $1.2 billion, driven primarily by commercial banking. Deposits were up $1.2 billion from quarter end, reflective of growth in interLINK, HSA and our CD portfolio and match our quarterly loan growth.From quarter end through April 19, deposits have grown another $2.8 billion. Borrowings increased by $2.3 billion as we enhanced our liquidity position in light of recent market events. Our borrowings included $8.6 billion of FHLB advances. While we continue to enhance our liquidity profile as the rate – funding rate environment stabilizes, we anticipate holding more normalized levels of cash while replacing wholesale borrowings with deposit funding.
Our capital levels remain strong as evidenced by our common equity Tier 1 ratio of 10.4% and a tangible common equity ratio of 7.15%. Lastly, we continue to grow tangible book value which ended the quarter at $29.47 per share.Loan trends are highlighted on Slide 8. In total, we grew loans by $1.2 billion or 2.3% on a linked quarter basis. Loan growth was diverse by category. Commercial grew by $540 million, commercial real estate grew by $900 million and residential mortgage balances were up modestly. The yield on the portfolio increased 55 basis points as loan yields outpaced increases in deposit costs. Excluding accretion, loan yields increased by 56 basis points. Floating and periodic rate loans remained approximately 60% at quarter end.We provide additional detail on deposits on Slide 9 with total deposits up $1.2 billion from prior quarter or 2.3%.
In addition to growth in interLINK and HSA, we added $370 million in CDs. Our total deposit costs were up 51 basis points to 111 basis points for a cumulative cycle-to-date beta of 24%. It’s worth repeating that between consumer, HAS, and interLINK, 63% of our deposits are in consumer-oriented loan duration categories, and to a large extent, fully FDIC insured. In our HSA business, the average account balance is under $3,000. In Consumer Banking, our average account balance is under $25,000 and in Commercial Bank, our average account balance is under $200,000.On Slide 10, you see the forward progression of our deposit beta assumptions. We anticipate our total cycle-to-date deposit beta will increase to 38% by the first quarter of 2024 with a more significant ramp in the second quarter, followed by fairly steady progression throughout the remainder of the year.Moving to Slide 11, you can see our reported to adjusted income statement compared to the adjusted earnings for the fourth quarter of 2022.
Net interest income was down $7.1 million or 1.2% linked quarter reflecting a shorter day count and a funding mix shift inclusive of the actions to augment our liquidity. Adjusted fees were down $19 million while expenses remained effectively flat. I will provide additional line item detail on subsequent slides. The net interest margin was 3.66%, down 8 basis points from the prior quarter and our efficiency ratio was 42%.On Slide 12, net interest income was down $7.1 million linked quarter or 1.2%. Day count was roughly 2%, a 2% headwind to net interest income growth quarter-over-quarter. Excluding accretion income, net interest income would have been down $4.4 million or just 0.7%. Net interest margin, excluding accretion, decreased 6 basis points from the prior quarter.
While our yield on earning assets, excluding accretion, increased 50 basis points over the prior quarter, the decline in NIM was driven by higher funding costs as we enhanced our liquidity position. Total cost of funds was up 60 basis points quarter-over-quarter.Slide 13, which highlight our fee income for the quarter. On an adjusted basis, fees were down $19 million linked quarter. The primary drivers of the decline were lower direct investment income, lower client hedging activity and valuation marks and lower client contract fees. I will detail our outlook for the year later in my remarks, but we expect to recapture a portion of the hedging and valuation mark as well as the direct investment income as we move through 2023.Non-interest expenses are highlighted on Slide 14.
We reported an adjusted expense of $303 million, in line with prior quarter. The results reflect lower compensation and marketing expenses, which were offset by an increase in the FDIC assessment rate, intangible amortization on interLINK, and operating cost associated with strategic investments, including the Bend and interLINK acquisitions.Slide 15 details our components of our allowance for credit losses, which was up $19 million over prior quarter. After recording $25 million in net charge-offs, we incurred $38 million in provision expense with loan growth, representing $12 million and the macro and credit factors, $26 million. Additionally, we completed the adoption of the TDR accounting rules effective January 1 of this year. This resulted in a $6 million increase in reserve, which was recorded as a charge to retained earnings.
As a result, you will see our coverage ratio increased modestly to 1.21%.Slide 16 highlights our key asset quality metrics. On the upper left, non-performing assets declined $19 million from prior quarter and represent 36 basis points of loans. Commercial classified loans as a percent of commercial loans declined to 1.47% from 1.5% despite a modest increase of $6 million on an absolute basis. Net charge-offs on the upper right totaled $25 million or 20 basis points of average loans on an annualized basis.On Slide 17, we continue to exhibit strong capital levels. All capital levels remain in excess of regulatory and internal targets. Our common equity Tier 1 ratio was 10.4% and our tangible common equity ratio was 7.15%. Our tangible book value per share increased to $29.47 a share from $29.07 in the last quarter.
Including both AFS and HTM marks on our securities portfolio, our TCE ratio would be approximately 6.4% and our common equity Tier 1 ratio would be approximately 8.4%, both as of March 31.I will wrap up my comments on Slide 18 with our full year outlook for 2023. We expect loans to grow in the range of 4% to 6% with growth focused in strategic segments. We expect full year core deposit growth of 8% to 10% with a year end loan-to-deposit ratio in the range of 85% to 90%. We expect net interest income of $2.375 billion to $2.425 billion on a non-FTE basis, excluding accretion. We expect $25 million in accretion would be added to that interest income outlook.For those modeling on net interest income on an FTE basis, I would add roughly $65 million to the outlook.
Our net interest income outlook includes the growth expectations above along with a 25 basis point rate hike in May. We assume the Fed fund rate remains flat for the remainder of 2023 at 5.25%. Fee income should be in the range of $375 million to $400 million. Core expenses are expected to be $1.2 billion to $1.225 billion with an efficiency ratio of roughly 40%. We expect our effective tax rate to be in the range of 22% to 23%. We continue to be prudent managers of capital. Capital actions will be dependent on the market environment. We continue to target a common equity Tier 1 ratio of 10.5% over time.With that, I’ll turn it back over to John for closing remarks.John Ciulla Thanks, Glenn. On Page 19, I’ll briefly hit on the next steps of our merger integration, as we have or soon to complete the largest aspects of bringing our company together.
Most notably, our core conversion is approaching in a few months’ time. We successfully ran our first mock conversion last weekend and have several others planned through our go-live date. The list of additional integration activities outstanding is short as we approach our core conversion, though we will continue to use the scale of our platform to invest in our technology, people and continuing to improve the client experience.We’re fortunate to operate from a position of strength, our interest rate risk management, diversity of funding and growing deposit base, efficient operations and ability to invest in our platform position us well for the future. We maintain high levels of capital, both on a stated and marked basis and exhibit robust internal capital generation and the ability to consistently grow tangible book value per share going forward.
While the shift in operating environment will weigh on our NIM to a degree, our loan yields to continue to reprice higher and we will continue to lock in the benefits of a higher interest rate environment.The full year guidance we provided today is based on our best thinking around our base case for the impact of macro factors and it’s too early to anticipate all of the effects of the recent events, including future regulatory costs or the depth of a potential recession later in the year. With that said, it’s our strategic aim to ensure we continue to position our bank to support our key clients and business segments through any operating environment. We will continue to prudently grow loans and add franchise enhancing full relationships all within the confines of the credit economic and funding environment.
This will likely mean closer scrutiny of new and existing businesses and continued focus on funding loans with growing core deposits. We will continue to be good stewards of capital and we manage our balance sheet in an efficient and prudent manner depending on the environmental opportunities and/or challenges.In summary, we expect we will continue to generate return to the top of our peer group, thanks to the strength I have highlighted today. I want to make this important point, we believe that based on our guidance we have provided, our year end performance metrics will continue to meet or exceed the targets we set forth, not only at merger announcement but at Investor Day last month, that’s an ROATCE of approximately 20% and ROA in the 1.5% range, and efficiency ratio around 40%.
We believe those metrics will still be kind of best-in-class in our peer group.Thank you to our colleagues for their exceptional work in this quarter. They made special efforts to engage and stay in front of our clients and have kept our organization operating at a high level through an unusual period. And before I conclude, I just want to express our support for our colleagues Gold National Bank after the event that took place earlier this month in Louisville, we know a number of individuals there. They run an organization a very strong character, and we want Jim Ryan and their entire team to know that Webster and the rest of the industry has them in our thoughts.Operator, and I will open it up to questions.
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Question-and-Answer Session [Operator Instructions]
Our first question comes from Chris McGratty from Keefe, Bruyette & Woods. Please go ahead. Your line is open.Chris McGratty Good morning.John Ciulla Good morning, Chris.Chris McGratty Just want to make sure the 20 ROATCE, the 150 and the 40. What was the time period again, just want to make sure I got it?John Ciulla It’s a 2-year merger. So I think fourth quarter ‘23.Chris McGratty Okay. Great. In terms of the balance sheet, could you help us with just your expectations for interLINK from here? How much you’re going to continue to pull on that and maybe the implications for borrowings and ultimately, just where you wanted the loan to deposit to settle?Glenn MacInnes Yes. Thanks. So Chris, let me take that. It’s Glenn.
Good morning. So we think that the interLINK will probably close the year closer to $5 billion right now. And so November, as of – I mean as of now, we’re at almost $3.5 billion as of yesterday. So we’re well on the path there.John Ciulla And Chris, we have talked about the beauty of that is it’s a lever we can pull just and down from an accordion perspective. So – if we continue to see momentum out of the business lines with respect to deposit growth, we can throttle that down. But it’s a wonderful tool to have, particularly in this environment.Chris McGratty And then just lastly, on the buyback, obviously, a lot of your period is going back because of the macro uncertainty. I guess where do you shake out in terms of thinking about this in terms of timing?John Ciulla Yes, I think that’s great.
Obviously, with the uncertainty in the market, we – in the first quarter, we weren’t active. And in the second quarter, we likely won’t be. But we do believe in our model now and our base case of what’s going to happen in the macro environment as things settle that there’ll be several hundred million dollars in buybacks in the third and fourth quarter. But again, I always want to caveat that with the fact that we will be prudent given the environment that we will be in. But certainly, at this valuation, it’s an attractive investment for us to return capital that way.Chris McGratty Alright. Thanks a lot.Operator Our next question comes from Casey Haire from Jefferies. Please go ahead. Your line is open.Casey Haire Yes. Thanks. Good morning, guys.John Ciulla Hey, Casey.Casey Haire Couple of questions on the expense front, so the strategic expenses up in the quarter.
Was any of that relating to the control issues around – that caused the 10-K delay?John Ciulla Yes. The answer is no. It has to do with what we’re doing with respect to our conversion and other merger-related charges. So, we have not had material expense increases related to resolution of the MW and we are well on the path of remediation of all that, too. So it’s not going to pop anywhere.Casey Haire So consistent with what you guys talked about at Investor Day, this is not going to have – it’s not going to lead to a meaningful impact on expenses.John Ciulla No.Casey Haire Okay. And just following up, so the efficiency ratio, 42% in the first quarter, you guys are still shooting for that 40% level, which implies a sub-40% efficiency ratio in the remaining quarters despite you’re keeping your expense guide the same, but you’ve taken down your revenues.
So I’m just trying to square what appears to be a tougher outlook and you’re still holding that efficiency ratio?Glenn MacInnes Yes. So you saw our expenses for the first quarter at $303 million basically flat quarter-over-quarter. So we think we have some opportunity there. But I think as you push it forward, we still feel good about operating in the 40% range. So we were a little elevated this quarter, and I think it will play out fine.John Ciulla Yes, Casey, if you again, look at the middle range of our guidance, I think that comes out to about 41%, so kind of flat and I said around 40% with our targets. I think we do have opportunities and levers to pull once we get through conversion on expenses. And so I think that’s where we will be right in that 40%, low 40s, 40% range.Casey Haire Very good.
Thank you. And just last one. Any commentary on HSA up 6% year-over-year, I think that’s a little bit lighter than what you guys talked about at Investor Day, to John, I agree with you, that seems like a long time ago now, but just color on a mid-single-digit growth rate in HSA year-over-year.John Ciulla No, I think what we’re – where we are is kind of the industry growth slowed a little bit. We’re pretty happy with where we are with respect to year-over-year in the first quarter growth. So I would say I don’t think it’s anything unusual. Casey, we’re still bullish that it’s very difficult to find deposit growth in the high single digits on low-cost deposits, so nothing unusual. And actually, I think we had a pretty good quarter relative to what Devenir and year-over-year relative to what Devenir showed in terms of industry growth.Casey Haire Great.
