Webster Financial Corporation (NYSE:WBS) Q3 2023 Earnings Call Transcript

Webster Financial Corporation (NYSE:WBS) Q3 2023 Earnings Call Transcript October 19, 2023

Webster Financial Corporation beats earnings expectations. Reported EPS is $1.55, expectations were $1.5.

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

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John Ciulla: Thanks, Emlen. Good morning, and welcome to Webster Financial Corporation’s Third Quarter 2023 Earnings Call. We appreciate you joining us. 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. The results we announced today further illustrate the power of Webster in terms of earnings potential as well as our sound operating and risk profile. We continue to enhance our liquidity position. And in contrast to broader industry trends, we grew deposits by $1.6 billion. We also grew our net interest income and materially expanded net interest margin in the quarter. In the quarter, we also completed our core systems conversion, marking a significant milestone in our integration, and we are pleased with the outcome and did so with limited client disruption.

Our streamlined technology architecture will allow us to further enhance client experience and more efficiently deliver for our clients in the future. Achieving this outcome took an exceptional effort on the part of our colleagues particularly our client-facing colleagues and those dedicated to the conversion. I want to express the gratitude of our executive team, directors and shareholders for their efforts. With the core conversion complete, we expect our company’s financial potential will become even more evident over the near to medium term and we will have significantly more opportunity to build upon our operating capabilities going forward, including services that allow us to enhance noninterest income in our commercial, consumer and HSA businesses.

Furthermore, our colleagues will direct their full attention to continuing to grow the organization as they deepen existing and develop new client relationships, enhance our product capabilities and client service, raise Webster market profile and keep operations running smoothly. With that as an introduction, I’ll get into our financial highlights for the quarter. I’ll start on slide two. On an adjusted basis, we generated EPS of $1.55, with solid results across nearly all of our income statement lines and PPNR grew 2% from the prior quarter. This generated an adjusted return on assets of nearly 1.5% and an adjusted return on tangible common equity of 21%. Our efficiency ratio remained at 42% among the best in the industry. We grew our deposits by almost 3% over prior quarter and we were able to grow net interest income despite a decline in loans.

As we have discussed in our prior calls and at our Investor Day in March, we’ve continued to evaluate our capital allocation and the risk return dynamics across lending businesses since our merger closed nearly two years ago. We’ve discussed with many of you that the time would come to deemphasize some businesses where our resources and capital could be better allocated and we are starting to see some of that today, particularly in an environment where liquidity is at a premium and the credit environment remains uncertain. In the quarter, we focused our loan origination efforts on franchise building, full relationships, C&I and non-office commercial real estate. We purposely deemphasized our mortgage warehouse activities where balances materially declined.

As a result of our deposit growth and more targeted loan origination activities, our loan-to-deposit ratio improved to 83%, providing us a ton of flexibility as we move forward. We have a solid loan pipeline and feel good about our ability to continue to safely grow earning assets, even with the backdrop of sluggish loan demand. Our common equity Tier 1 ratio and TCE ratio are strong at 11.2% and 7.2%, respectively. Our robust capital position and returns provide us a great deal of flexibility and optionality in terms of capital deployment, whether it be organic growth, share repurchases, payment on our common dividend or in selective instances, executing on complementary acquisitions such as the interLINK and Bend transactions that we’ve executed on over the last two years.

On slide three, we again provide a profile of our diverse and unique deposit funding. Many of you have seen this slide a few times now, but we’d like to highlight what we believe to be one of our key competitive advantages, particularly as deposits exit the banking system. The deposit growth we generated this quarter was a team effort with most of these channels contributing and Glenn will provide more details on our deposit growth shortly. This business profile also enables our robust liquidity position, which we review on the following slide, slide four. We again increased our immediately available liquidity to $19.8 billion from $18 billion last quarter. In the most recent quarter, our uninsured deposits fell to 22% of total from 25% last quarter and our liquidity coverage of those uninsured deposits grew to 148% versus 124% last quarter.

I’ll touch on our office CRE portfolio and credit in general as we turn to slide five. Office loan exposure continues to be a focus of our conversations with investors and we continue to actively manage our risk in that asset class. Notably, we’ve proactively reduced our office exposure, which is now under $1.2 billion or 2.3% of loans. Including actions taken this quarter, we’ve reduced the portfolio by $500 million since the second quarter of 2022 or 30% of the original balance. The portfolio is generally well secured with an at-origination weighted average LTV of 54% and a current debt service coverage ratio of 1.9 times. No delinquencies in the portfolio and a low level of non-accruing assets. Note that of the remaining portfolio, almost two-thirds of our exposure has some level of tertiary support in the form of a guarantee or reserve.

Overall, while it’s clear that the credit environment remains uncertain and that the industry trend indicates some level of bumpiness as we move forward. We remain generally pleased with the resilience and credit metrics in our existing loan portfolio. While our commercial classified increased in the quarter, they remain well below pre-pandemic levels. Our nonperforming loans and charge-offs remain stable and is historically favorable levels. We continue to add to our overall allowance for credit losses and our 1.27% coverage of loans and leases compares favorably to peers. We continue to proactively manage credit exposure in our portfolio to ensure early identification of problem credits. I’ll now turn it over to Glenn to provide more details on the quarter.

Glenn MacInnes: Thanks, John, and good morning, everyone. I’ll start on slide six with our GAAP and adjusted earnings. We reported GAAP net income to common shareholders of $222 million with earnings per share of $1.28. On an adjusted basis, we reported net income to common shareholders of $267 million and EPS of $1.55, excluding $62 million in pre-tax merger-related expense. Merger-related charges were associated with our core conversion, which was completed in the third quarter and will decline significantly in the fourth quarter. Next, I will review our balance sheet trends, beginning on slide seven. Total assets were $73 billion at period end, down $900 million from the second quarter. Interest-bearing deposits, primarily cash held at the Fed was $1.8 billion at period end.

We averaged $1.2 billion in cash for the quarter in line with what we anticipate going forward. Our security balances were relatively flat in the quarter as we reinvested proceeds from majorities in sales. Loans were down $1.5 billion, reflective of both lower loan demand and a decline in nonstrategic loan categories. Deposits grew $1.6 billion in the quarter, and we reduced borrowings by $2.6 billion. Deposit growth was across several product types and business lines, including over $250 million in noninterest-bearing deposit growth. Our loan-to-deposit ratio was 83% in the quarter, down from 88% last quarter and we anticipate operating in the mid-80s going forward. Our capital levels are consistently strong. The common equity Tier 1 ratio was 11.2%, and our tangible common equity ratio was 7.2%.

Tangible book value decreased to $29.48 per share reflecting the impact of AOCI, the dividend, a small share repurchase. This was partially offset by retained earnings. Unrealized security losses, included in tangible book value increased to $819 million after tax from $645 million last quarter, driven by higher rates. In a steady interest rate environment, we anticipate roughly $125 million of this would accrete back into capital annually. Loan trends are highlighted on slide eight. In total, loans were down by $1.5 billion or 3% on a linked quarter basis. The Commercial Bank continues to drive loan trends, where declines were reflective of both lower demand and declines in nonstrategic categories. Mortgage warehouse was down $600 million.

Commercial real estate was down $100 million as we continue to reduce our office exposure and C&I was lower by $900 million. The yield on the loan portfolio increased 14 basis points and floating and periodic loans were 59% of total loans at quarter end. We provide additional detail on deposits on slide nine. With total deposits of $1.6 billion from prior quarter or 2.7%. We saw growth in all major deposit categories with the exception of savings. Growth was aided by the seasonal inflow in public funds, along with growth in interLINK, commercial and HSA. In our commercial business, we continue to recapture balances that have left in search of diversity earlier this year as well as new clients. Our total deposit costs were up 24 basis points to 196 basis points for a cumulative cycle-to-date total deposit beta of 37%.

On slide 10, we have updated the forward progression of our deposit beta assumptions. We anticipate our cycle-to-date beta will reach 40% in the fourth quarter of this year. While the macro data has pushed out the interest rate cycle, we would still anticipate a beta in the low to mid-40s by the middle of 2024. Our expectations here align with our outlook for which we assume no further Fed increases at this point with cuts beginning at the back half of 2024. Moving to slide 11, we highlight our reported to adjusted income statement compared to our adjusted earnings for the prior period. Overall, adjusted net income was up $7 million over prior quarter. Net interest income was up $3.3 million as we continue to benefit from our asset-sensitive balance sheet.

Adjusted noninterest income was flat while expenses were down $2.3 million. We also benefited from a lower tax rate, 20.1% this quarter, down from 21.7% in the second quarter. Partially offsetting these trends, the provision was up $5 million. The net interest margin was 3.49%, up 14 basis points from the prior quarter. The NIM benefited from more normalized on-balance sheet liquidity as well as our asset-sensitive position and our efficiency ratio was 42%. On slide 12, we highlight net interest income, which grew $3.3 million linked quarter. Net interest margin increased 14 basis points from the prior quarter. Our yield on earning assets increased 17 basis points from the prior quarter and the pace of deposit pricing moderated to 24 basis points.

It’s important to note that our total cost of funds were up just four basis points as growth in core deposit categories was used to replace wholesale funding and brokered CDs. On slide 13, we highlight our noninterest income, which was flat to prior quarter. An increase in derivative valuation and direct investment gains was offset by declines in deposit service fees. Transaction activity tied to commercial clients remained slow in the third quarter, though the outlook is improving into next year. The year-over-year decrease was primarily driven by $10 million in lower client deposit fees, $7 million lower loan-related fees, $4 million from the outsourcing of the consumer investment service platform and lower client hedging activity. Noninterest expense is on slide 14.

We reported adjusted expenses of $301 million, down $2 million from the prior quarter. Reductions in professional fees, occupancy and marketing were partially offset by higher employee benefits and technology expense. Slide 15 details components of our allowance for credit losses, which were up $6 million over prior quarter. After reporting $29 million in net charge-offs, we incurred a $36 million provision expense for macro owned credit factors, partially offset by the impact of lower loan balances. As a result, our allowance coverage to loans increased to 127 basis points from 122 basis points last quarter. Slide 16 highlights our key asset quality metrics. On the upper left, nonperforming assets are flat to prior quarter and prior year with nonperforming loans representing just 43% of loans, 43 basis points of loans.

Commercial classified loans as a percent of commercial loans increased to 174 basis points from 139 basis points as classified loans increased by $118 million on an absolute basis. The balance was up as we saw a migration of a few larger credits that we expect to cure over time. Net charge-offs in the upper right totaled $29 million or 23 basis points of average loans on an annualized basis. We divested another $78 million in office loans in the quarter. These divestitures generated $13 million of the $29 million in net charge-offs. Worth repeating, our total office exposure declined $110 million, inclusive of other actions this quarter. On slide 17, we maintained strong capital levels. All capital levels remain in excess of regulatory and internal targets.

Our common equity Tier 1 ratio was 11.2%, and our tangible common equity ratio was 7.2%. Our tangible book value was $29.48 a share. Including the AFS mark on our securities portfolio, our common equity Tier 1 ratio would be approximately 9.5% as of September 30th. I’ll wrap up my comments on slide 18 with our fourth quarter outlook. We expect loans to grow in the range of 1% to 2% with growth focused in strategic segments. We expect core deposits to be in the range of third quarter with a year-end loan-to-deposit ratio in the mid-80s. We expect net interest income of $580 million to $590 million on a non-FTE basis and excluding accretion approximately $4 million in accretion would be added to the interest income outlook and for those modeling net interest income on an FTE basis, I would add roughly $17 million to the outlook.

Our net interest income outlook assumes no further Fed increases. We currently expect NIM to be flat to the third quarter. Non-interest income should be approximately $90 million. Core expenses are expected to be around $305 million with an efficiency ratio in the range of 42%. Our expense outlook excludes the FDIC special assessment. We expect an effective tax rate of 21%. We’ll continue to be prudent managers of capital and target a common equity Tier 1 ratio of 10.5%. With that, I’ll turn it back to John for closing remarks.

John Ciulla: Thanks a lot, Glenn. As I wrap up my remarks, I want to hit on the implications of the proposed regulatory changes for banks in excess of $100 billion in assets as it’s among the topics we’re most frequently asked about. We anticipate it will be several years before we reach the asset threshold at which the proposed regulations would impact Webster during that time, both the application of the regulations and the operating environment may significantly change. As you would expect, we’ve already begun to build the necessary capabilities, talent and investment to tackle the enhanced risk framework requirements that may apply to us as we approach $100 billion, just as we have tackled the OCC’s heightened standard requirements that came with crossing the $50 billion threshold.

While there will likely be increased financial burdens such as required debt issuance and compliance costs, there could be several paths to absorbing and overcoming these challenges, including our increased scale and earnings power. In the near term, we believe our size brings a unique mix of scale and agility relative to many of our regional bank peers. We’ll utilize our strong operating position to grow in our key markets and business lines, allocating our resources to the highest return opportunities, all within a disciplined risk management framework. With that, I want to wrap up my comments by saying thank you to all our colleagues for their strong efforts, both in moving our strategy forward, completing the conversion and getting us to where we are today.

Operator, with that, Glenn and I will open up the line to questions.

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Chris McGratty of Keefe, Bruyette, & Woods. Your line is open.

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Q&A Session

Christopher McGratty: Great. Good morning.

John Ciulla: Hey, Chris.

Christopher McGratty: John, maybe a high-level question. This ongoing derisking that you’ve been doing, I guess where are you in terms of like how much more do you think you need to do I mean the loss rates on the office, the implied loss rates on the office from this quarter looks a bit higher than what you’ve been doing for the last several quarters. Could you just kind of big picture, where are you in terms of derisking the book?

John Ciulla: Yes, it’s interesting. I don’t think, Chris, there’s kind of a dedicated time line. I think we’re — as you heard me say, the $1.2 billion in office we have right now, we sort of feel good about with respect on a relative basis to having — getting credit enhancements, continuing to work on the portfolio. So for us, it’s looking at loans, looking at the strategic nature of them, whether they’re with investors and clients that we know very well that we’re going to continue doing business with, whether they’re stand-alone transactional, what the kind of metrics and dynamics are. And then each quarter, Jason and the team sit down and say, hey, we — even though this may not be a problem now, this is something that’s not strategic for us or we have an opportunity at a reasonable economic cost to move down.

So we’re not really looking at a serial reduction in the exposure. We’re being opportunistic and we’re making, I think, the right economic decisions because many of these loans are going to refinance fine, they’re going to pay off fine, some of which we think in the future may have some problems just given the paradigm shift. But I think you’ll see us continue at this level looking at a $25 million, $75 million portfolio or book of business in the quarter. And if there’s a good economic strategic way to exit those credits, we will. But we’re not kind of urgently in a serial fashion trying to get rid of the exposure.

Christopher McGratty: Okay. That’s helpful. Maybe, Glenn, you gave the loan to deposit and expectations to the balance sheet. How should we be thinking about just the level of borrowings and securities growth from here or decline?

Glenn MacInnes: So I think I’ll take securities first. So we’re like $14 million, $14.5 million. I think you would expect it over the course of, say, the next couple of quarters to stay within that range, depending on loan growth. The question on borrowings is I think we’re at a level right now where we probably expect to be pretty flat to the — say $2 plus billion mark.

Christopher McGratty: Okay. And maybe last one. One of your peers turned the buyback back this quarter. I’m interested in your updated thoughts on whether buybacks at this point of the cycle makes sense?

John Ciulla: Yes, Chris, I think it’s a great question. We bought back $50 million in the quarter in Q3. We clearly have capital levels and capacity to generate capital to continue the program. I would tell you that we’re looking at this from a position of having good flexibility, but also recognizing that we want to make sure that we have capital if we do a tuck-in acquisition, if we do grow loans significantly, if we see cracks in the market from a credit perspective. So I guess the way I would characterize it is I wouldn’t rule it out, but I think we’re being a little bit more cautious as we look in the fourth quarter to our activities in that area.

Christopher McGratty: Okay. Thanks. Thanks, John.

John Ciulla: Thank you.

Operator: Your next question comes from the line of Casey Haire of Jefferies. Your line is open.

Casey Haire: Yeah, thanks. Good morning, everyone. Just following up, I guess, Glenn, on the NIM. So NIM is going to be flat in the fourth quarter and borrowings, which obviously helped in the third quarter, the decline there. Sounds like they’re going to be flat. So what is the offset to the beta creep that you expect to keep NIM flat? Is it loan growth? Just looking for a little color on what holds NIM stable in the fourth quarter?

Glenn MacInnes: Sure. So some of it is loan growth. Some of it is the rate on loans where we get the full benefit of the periodic loans re-pricing. And then you do have — we do pick up one day, at least on a NIM basis from an earnings standpoint. And then it’s pretty much some of that’s neutralized by what we think deposit growth will be or deposit cost will be going into the fourth quarter. Like I said in my comments, we still think that there’s — there’ll be deposit pressure going into the fourth quarter, albeit very more moderate than it’s been certainly in the last couple of quarters.

Casey Haire: Okay. Great. And then just question on the funding strategy. I mean your deposit growth was pretty broad-based. InterLINK still is doing a lot of the heavy lifting on that slide, what is it, slide five. It’s 9% of your deposit franchise. What long-term, is there — is that — is there a ceiling that you have for interLINK or is that is 9% the right level? Just trying to figure out how big that can become?

Glenn MacInnes: So we’re in the process of doing our outlook over the next couple of quarters and actually years. So I think if we’re at 9% now depending on our sources of funds and other sources of funds that could go plus or minus. It could go as high as 15%, but that’s something that we’re still in the process of planning right now, Casey.

Casey Haire: Got it. Okay. And just last one for me. On the efficiency, I know it’s early for ’24, but you guys obviously at 42% are more efficient than most of my coverage universe. John, you mentioned you are — there are going to be some financial burdens about in getting the bank ready to be $100 billion. What — can you pass that along? Or is that something that you might let the efficiency ratio drip up?

John Ciulla: Yes. That’s a good question. And again, as Glenn said, we’re working through our plan now, and we’re not going to sort of — we’re not ready to provide guidance for ’24. But I will tell you, our sense is look, we still have some opportunity coming out of the conversion as we consolidate sub-ledgers and look at back office processes and consolidate call centers, which we still haven’t completed. So, Casey, we do still have some merger-related cost opportunities, cost save opportunities. And I kind of like where we are. Our feeling is we also have opportunities to invest and grow, particularly if the market green lights with respect to loan growth and people feel comfortable about a soft landing, I think we can identify additional teams in commercial banking to bring on.

We’re definitely investing in products and capital markets and FX and card and other commercial treasury products that will enhance our balance of noninterest income. So our kind of view is we think we can operate steadily in the low 40s efficiency ratio. And to the extent we can gain more cost savings that will — it will provide us an opportunity to invest in key products and services and people. So if we can continue to post the numbers that we promised when we did the merger, the 20% ROATC, the 1.5 ROA and an efficiency ratio in the low 40s, I think size, scale and momentum will allow us to keep that efficiency ratio in the low 40s without starving the bank with respect to future investment. And then if you fast forward, right, three years, you look at the size of our balance sheet as we approach $100 billion, I think we’ll have some optionality, and we’ll be in a better place than others who are similarly situated given how kind of efficient our operating model is.