Webster Financial Corporation (NYSE:WBS) Q2 2023 Earnings Call Transcript

Webster Financial Corporation (NYSE:WBS) Q2 2023 Earnings Call Transcript July 20, 2023

Webster Financial Corporation beats earnings expectations. Reported EPS is $1.5, expectations were $1.47.

Operator: Good morning, and welcome to the Webster Financial Corporation Second 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 and accompanying management’s remarks can be found on the company’s Investor Relations website at investors.websterbank.com. I’ll now turn it over to Webster Financial CEO, John Ciulla.

John Ciulla: Thanks, Emlen. Good morning, and welcome to Webster Financial Corporation’s Second Quarter 2023 Earnings Call. We appreciate you joining us this morning. I’ll provide remarks on our high-level results and operations before turning it over to Glenn to cover our financial results in greater detail. Webster’s results in the quarter illustrate the competitive advantages of our funding profile while we experienced some temporary NIM headwinds as we pulled liquidity onto our balance sheet early in the quarter, overall, our diverse and distinctive deposit gathering channels provided steady funding as we grew deposits significantly and increased our off-balance sheet liquidity. Glenn will provide more specific detail on balance sheet trends in his remarks.

In the face of industry challenges, we are proud of our financial performance in the quarter. On an adjusted basis, we generated EPS of $1.50 while we saw a modest 1.9% quarter-over-quarter decline in net interest income, we anticipate a positive trajectory through the remainder of the year. Our other income statement lines exhibited positive trends as we grew noninterest income and maintained flat expenses. Despite maintaining a higher-than-normal liquidity position, we generated an adjusted ROA of just under 1.4% and an adjusted return on tangible common equity of 20.4%, we grew our deposits by over 6% in the quarter. Our robust funding profile positioned us to continue to serve our clients, and we grew our loan book by 1.4%. Our strong deposit growth allowed us to reduce our loan-to-deposit ratio to 88%, which provides us balance sheet flexibility as we move forward.

If you turn to Slide 3, I want to reemphasize the unique funding model that enabled this performance we have a diverse set of deposit-generating businesses, each with distinct client dynamics. This model provides us with a funding advantage as characteristics of the various businesses partially mitigate the effects of general industry deposit outflows. While we are not immune to the higher funding costs the banking industry is experiencing, we like our competitive positioning on that front, and we have the ability to grow core deposits through environments in which others are challenged. Our consumer deposits are largely originated in footprint to long-tenured clients. Our $8 billion plus of HSA deposits are all in individual customer accounts and nearly all are within FDIC insurance limits.

As most of you are aware, this is a particularly unique source of low-cost and long-duration deposits. Within Commercial Banking, we have $2 billion of business banking deposits that share similar characteristics to the consumer book. The remainder of commercial deposits are diverse by industry, customer type and geography and are aligned with our relationship banking model. And finally, interLINK, a platform we acquired earlier this year provides readily available core deposit funding at a low cost of acquisition with nearly all deposits covered by FDIC insurance. On Slide 4, you can see that not only did we grow deposits smartly, but immediately available liquidity also increased to $18 billion, which covers just under 125% of our uninsured and uncollateralized deposits.

Our balance sheet remains in exceptionally sound condition. As Glenn will discuss further on subsequent slides, things remain stable from an overall credit perspective. While we do not see any significant signs of broad credit weakness, we continue to act prudently and proactively with respect to managing our existing loan portfolio and onboarding new credit given the existing macro uncertainties. I want to once again touch briefly on our office portfolio. You can see that on Slide 5, as that has continued, I know to be an area of market focus. We have proactively reduced the size of our nonmedical office portfolio, which is now down by almost $400 million over the last year or roughly 25%. We’ve done so without incurring significant losses as our charge-off rate on this relatively small portion of the office portfolio is under 2% on an annualized basis.

The overall credit characteristics of this portfolio have not changed materially, as you can see in the figures we provide on LTVs, debt service coverage and other metrics. While our criticized and classified loans are up modestly from last quarter, they are down relative to fourth quarter and the year ago period given the proactive actions we’ve taken. Consistent with my comments above, while we are pleased with performance to date, we fully appreciate the changing dynamics in commercial real estate, and we continue to manage our portfolios and credit selection accordingly and prudently. I’ll now turn it over to Glenn to provide more details on the quarter.

Photo by John Schnobrich on Unsplash

Glenn MacInnes: Thanks, John, and good morning, everyone. I’ll start on Slide 6 with our GAAP and adjusted earnings. We reported GAAP net income to common shareholders of $231 million earnings per share of $1.32. On an adjusted basis, we reported net income to common shareholders of $261 million and EPS of $1.50, excluding onetime merger-related expense of $30 million. Merger expenses were primarily related to professional fees, severance and technology costs. Next, I’ll review our balance sheet trends, beginning on Slide 7. Total assets were $74 billion at period end, down $800 million from the first quarter largely as a result of shifting from on balance sheet cash to off-balance sheet liquidity sources. At quarter end, we held $1 billion in cash on the balance sheet, which approximates the level of cash we anticipate holding going forward.

Loan growth was $700 million, principally driven by Commercial Banking. Our security balances were relatively flat in the quarter as were reinvested proceeds from maturities and sales. Deposits grew $3.5 billion in the quarter and reduced our borrowings by more than $4 billion. Deposit growth was achieved despite a $700 million seasonal decline in public funds quarter-over-quarter. As a result of the loan and deposit growth, our loan-to-deposit ratio was 88% at quarter end, down from 92% from prior quarter. Our capital levels remain strong. Common equity Tier 1 ratio was 10.66% and our tangible common equity ratio was 7.23%. Tangible book value increased to $29.69 a share with retained earnings exceeding the impact of AOCI and a small share repurchase.

Unrealized security losses included intangible book value increased to $645 million after tax from $560 million last quarter, driven by higher rates. In a steady interest rate environment, we anticipate roughly $100 million of this will accrete back into capital annually. Loan trends are highlighted on Slide 8. Total, we grew loans by $700 million or 1.4% on a linked-quarter basis. Loan growth was concentrated in the Commercial Bank, where we continue to see opportunities in strategic segments. C&I grew $85 million with an additional $125 million in sponsor. Commercial real estate was up $150 million. Mortgage warehouse grew $235 million, consistent with seasonal trends and residential mortgage grew $140 million. The yield on our portfolio increased 26 basis points.

Excluding accretion, the loan yield increased 27 basis points. Floating and periodic loans remained at 60% of total at quarter end. We provide additional detail on deposits on Slide 9. Total deposits of $3.5 million from prior quarter were 6.2%. Growth was primarily driven by interLINK and time deposits. Time deposit growth was driven by $1.9 billion of brokered deposits and $900 million in consumer banking CDs. Roughly half the consumer time deposit growth was from existing clients shifting into higher-yielding products. A quarter was from the balanced increase of existing clients and 1/4 of the growth came from new clients. Commercial deposits grew $700 million when excluding the seasonal decline in public funds. We have started to recapture funds that were diversified across financial institutions earlier this year.

We’re seeing new opportunities for growth in transactional accounts. Our total deposit costs were up 61 basis points to 172 basis points for a cumulative cycle-to-date total deposit beta of 34%. On Slide 10, we have updated the forward progression of our deposit beta assumptions. We anticipate a total cumulative deposit beta of 40% by the first quarter of 2024, which is up modestly from our prior projection due to client preferences for higher-yielding deposit products. As you can see in the chart on the right, we expect the pace of our deposit cost increase to moderate over the next few quarters. Moving to Slide 11. We highlight our reported to adjusted income statement compared to our adjusted earnings for the prior period. Net interest income was down $11.5 million or 1.9% linked quarter, primarily reflecting increased funding costs.

Adjusted noninterest income was up $2 million while expenses remained effectively flat. The net interest margin was 3.35%, down 31 basis points from prior quarter were 12 basis points from temporary actions to increase our liquidity position. And the efficiency ratio was 42%. I’ll discuss each major on — line item on subsequent slides. On Slide 12, we highlight net interest income, which declined $11.5 million in the linked quarter or 1.9%. Net interest margin, excluding accretion, decreased 30 basis points from the prior quarter. Our yield on earning assets, excluding accretion, increased 24 basis points over prior quarter and the total cost of funds was up 58 basis points. The change in the cost of funds was driven by mix change in deposits as well as additional liquidity we added early in the quarter.

A significant driver for the linked quarter decline in NIM with an increase in the average balance sheet liquidity of $2.6 billion. While this did not impact net interest income it has a 12 basis point impact on our NIM relative to prior quarter. Higher funding costs drove the remainder of the decline in deposit competition increased. On Slide 13, we highlight our noninterest income for the quarter. On an adjusted basis, noninterest income was up $2 million linked quarter the primary driver was an increased valuation marks on the client hedging activity. Transaction activity tied to commercial clients remained slow in the second quarter, but we’re seeing some signs of modest improvement in the coming quarters. The year-over-year decrease was primarily driven by $12 million in lower client hedging activity, $7 million lower loan-related fees, $6 million of lower client deposit fees, $4 million due to the outsourcing of our consumer investment services platform.

Noninterest expense is on Slide 14. We reported adjusted expense of $303 million, in line with the prior quarter. A reduction in professional fees and technology expense was offset by higher employee benefit expense and deposit insurance. Slide 15 details components of our allowance for credit losses, which was up $15 million over prior quarter. After recording $20 million in net charge-offs, we incurred $35 million in provision expense to loan growth, representing $8 million and the remainder due to changes in the macroeconomic forecast. You see our allowance coverage to loans increased slightly to 122 basis points. Slide 16 highlights our key asset quality metrics. On the upper left, nonperforming assets increased $35 million from prior quarter and nonperforming loans represent 42 basis points of loans.

Nonperforming assets remain within the range of the past year and are down $28 million from a year ago. Commercial classified loans as a percent of commercial loans declined to 1.39% or 1.47% as classified loans declined $25 million on an absolute basis. Net charge-offs in the upper right totaled $20 million or 16 basis points of average loans on an annualized basis. Notably, we divested $80 million in commercial real estate loans in the quarter. Vast majority of which were secured by office properties. These divestitures generated $13 million charge-offs. On Slide 17, we continue to maintain strong capital levels. All capital levels remain in excess of regulatory and internal targets. Our Common Equity Tier 1 ratio was 10.66%, and our tangible common equity ratio was 7.23%.

Tangible book value increased to $29.69 a share. Including the AFS mark, on our securities portfolio, Common equity Tier 1 ratio would be approximately 9.4% as of June 30. We don’t anticipate it will be subject to explicit changes to the regulatory capital requirements, but are well prepared for any potential changes as evidenced by our capital ratios inclusive of AOCI and our strong liquidity position. I’ll wrap up my comments on Slide 18 with our full year outlook. We expect to grow loans in the range of 4% to 6% with growth focused in strategic segments. We expect to grow core deposits 8% to 10% and the year-end loan-to-deposit ratio in the mid-80s. We expect net interest income of $2.350 billion, $2.375 billion on a non-FTE basis, excluding accretion.

Approximately $25 million in accretion would be added to that net interest income outlook. For those modeling 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 the 25 basis point Fed hike next week. We assume the Fed funds rate will remain flat for the remainder of 2023 at 5.5%. We currently expect NIM to improve by 10 to 15 basis points from the second quarter level to the remainder of the year. Noninterest income should be in the range of $355 million to $365 million. Core expenses are expected to be in the $1.2 billion, $1.225 billion range with an efficiency ratio in the 40% to 42% range. We expect our effective tax rate in the range of 22%.

We’ll continue to be prudent managers of capital. Capital actions will be dependent on the market environment. We continue to target common equity Tier 1 ratio, 10.5%. With that, I’ll turn it back over to John for closing remarks.

John Ciulla: Thanks a lot, Glenn. I’ll wrap up my remarks today with a short update on our integration and strategic path forward. We’re approaching an important integration milestone this weekend with the conversion of our core operating systems. As many of you are aware, we took a deliberate and thoughtful approach to the conversion of our core. A tremendous amount of work has gone into this event as our team has been working diligently to accomplish the smoothest experience possible for our clients, while at the same time, maintaining the level of service they have come to expect. We completed 3 mock conversions over the first half of 2023 and have been proactively communicating with clients in recent weeks. We’ve already enabled our entire ATM network to access a consolidated core and our frontline colleagues have been trained on new systems and the procedures.

Several of our back-office systems have already been consolidated, and we’re excited to complete this meaningful step from an operational perspective. Post conversion, we’ll be able to accelerate our strategic technology plans, and we’ll be in a position to further realize additional synergies. I want to thank all of our colleagues who are focused on the conversion, whether in a dedicated role or through our continued focus on taking care of our clients across our footprint. We’ll continue to invest in and grow products and capabilities as we deliver a superior experience to our clients and we simplify business processes for colleagues and other business partners. As investors and business partners, you’ll continue to see the full capability of this company.

Webster’s earning power, a strong capital and funding profile, differentiated commercial businesses, colleague, talent and engagement are all attributes that enable Webster to generate peer-leading returns through a variety of operating environments. We’ll utilize our strong operating profile and flexible capital position to continue growing share in our key markets and business segments. Allocating our resources to the highest recurring opportunities to maximize economic profit, all within a disciplined risk management framework. I want to thank you all for joining us today. Operator, with that, Glenn and I will be happy to take questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question comes from Christopher McGratty with Keefe, Bruyette & Woods.

Christopher McGratty: Glenn, on the NII, maybe you could talk through the ranges of NII, the range of outcomes. Is it more about the Fed? Is it more about competition? And I guess, what would it take at this point for you to take a different view of NII?

Glenn MacInnes: Yes, thanks. So Chris, I think it is primarily driven by increased deposit costs, increased funding costs as a whole. So that’s why we adjusted that range down a little bit. The second part of your question was…

John Ciulla: I’m sorry, Chris, John. It’s a combination of our assumption of Feds with one more rate hike and just general deposit competition. As you see, we see NIM expansion coming off this quarter because of the dynamics in our balance sheet, but also because of our floating rate loan book and the pace at which we think deposit costs will grow, plus we have some good guys coming in the third and fourth quarter with respect to kind of core commercial growth seasonal growth in lower-cost government deposits. So that’s kind of what factors into where we are with obviously the governor being just overall higher deposit and funding costs industry-wide.

Christopher McGratty: Got it. In terms of just regulation, you’re comfortably below 100, but obviously, I think the market will expect at some point you’ll be there. Can you just talk through the expense angle potentially that you’re thinking about? And also how you’re capital targets may evolve and capital return strategies may evolve?

John Ciulla: Yes. Chris, it’s a great question. And obviously, we’re spending a lot of time thinking about it. I think it’s too early to even throw out kind of a wild guess on cost. I think the reality is even if you’re at $85 billion, the trickle-down effect of the way you’re regulated, you certainly need to begin being prepared. I actually think our infrastructure with respect to stress testing and the way we measure liquidity we’ve held ourselves to LCR for a long time, even when we didn’t have to even premerger. So I think we have the infrastructure to deal with whatever regulations come down. So I think more than internal costs, right? I think the impact would be — is exactly as you intimated at the end there would be higher capital levels, higher liquidity requirements that would have an economic kind of impact on the bank if we have to hold more liquidity and different types of liquidity and have more capital.

But it would be too early to give you kind of our expectations. We’re just following it closely. And as I said, I think internally, we have the capabilities, the systems and the people to be able to deal with whatever comes at us as it’s phased in over time.

Glenn MacInnes: Yes. And the only thing I would add to that, Chris, as you saw in my comments on our Common Equity Tier 1, even if we were to add in the AFS losses, we’d be at like 9.4% from a 10-plus percent, 10.6%. So that would probably be phased in over time.

Christopher McGratty: Okay. And is there any contemplation of a share repurchase given the strength of the balance sheet? Or is it too uncertain on the economy?