Webster Financial Corporation (NYSE:WBS) Q4 2023 Earnings Call Transcript

Webster Financial Corporation (NYSE:WBS) Q4 2023 Earnings Call Transcript January 23, 2024

Webster Financial Corporation reports earnings inline with expectations. Reported EPS is $1.46 EPS, expectations were $1.46. Webster Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Welcome to the Webster Financial Corporation Fourth Quarter 2023 Earnings Conference Call. Please note that this conference 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. For the Q&A portion of the call, we ask that each participant ask just one question and one follow-up before returning to the queue. I will now turn the call over to Webster Financial’s CEO, John Ciulla.

John Ciulla: Thanks a lot Emlen. Good morning, everyone, and welcome to Webster Financial Corporation’s fourth 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. The company continues to execute at a high-level and we are excited about the momentum we’re carrying into 2024. With less distraction from our integration activities and hopefully the industry at large, we are well-positioned to continue delivering financial outperformance as we deliver for our clients across business lines. I’m going to start to review today with our full-year results for 2023. As I’ve stated throughout the year, we performed admirably throughout a difficult period for the banking industry.

This performance illustrates the strength of our franchise, including a uniquely diverse and sound funding base, highly efficient operating model, and focus on non-commoditized businesses. We grew our adjusted EPS to $5.99 from $5.62 in the prior year, generating record EPS for Webster. We reached a record tangible book-value per share in the fourth-quarter as well. Our return on assets was 1.43%, our return on tangible common equity was 20.5% and we ended the year with a 42% efficiency ratio. In addition to our strong financial performance, we realized several meaningful strategic accomplishments. We capably executed our core technology conversion and have completed substantially all of the work on our merger integration. We closed the interLINK acquisition and we announced the acquisition of Ametros.

We grew core deposits through a highly competitive environment in the banking industry, illustrating our funding advantage and the strength of our relationship-oriented business model. We also refined our mix of businesses, emphasizing and building those where we have a strategic advantage and the most promising risk-reward characteristics. On the next slide, our fourth quarter financial results remain solid. On an adjusted basis, we produced a return on tangible common equity of 19.8% and a return on assets of nearly 1.4%. Our adjusted EPS was $1.46. We grew our deposits and loans each by roughly 1% with loan growth focused in strategic commercial categories. We continue to exhibit solid expense control with an efficiency ratio of 43%. Our common equity Tier 1 capital and tangible common equity remains strong at 11.12% and 7.73% respectively.

Our strong starting point and internal capital generation capability will provide us with a significant amount of operating flexibility over the long term. The timing of some of our fourth quarter accomplishments, including our solid loan growth were back-loaded, resulting in a period-end loan and securities balance that were more than $1 billion higher than the average balances. Our overall loan growth coupled with a robust pipeline should provide us with a tailwind as we head into 2024. Following slide illustrates our funding diversity, which highlights one of our key strategic advantages. We are confident that we are adding another unique funding vertical with our acquisition of Ametros, which we announced at the end of last year and expect to close shortly.

We provide some detail on the business on the following slide. Ametros is a particularly unique and exciting opportunity for Webster as it provides low-cost, fast-growing deposits which adds significant fee income. To describe the business in brief, Ametros administers recipients’ funds from medical claims settlements via a proprietary technology platform and service teams. A large majority of the claims Ametros administered are structured as annuities, whereby funds are replenished over the life of the recipient. As of today, there are over $2.5 billion of contracted deposit inflows under this construct. Given this replenishment feature, the average deposit duration exceeds 20 years. The collection and retention of these funds is further enhanced by the value-added services Ametros provides, including payment management, access to discounted medical services, and government reporting.

They have an ardent customer base as evidenced by a net promoter score of 96 and are by far the market leader among professional administrators. We expect deposits will grow at a 25% CAGR over the ensuing five years. Our projected growth trajectory assumes the growth of members and no changes to Ametros existing business constitution, including the addition of new relationships, new business verticals, medical inflation or synergies with Webster’s existing businesses. For all of these, we see varying degrees of opportunity. We anticipate the transaction will be modestly accretive to 2024 earnings and 3% accretive to 2025 earnings. We look forward to officially welcoming our new colleagues in the near future. Our overall credit profile and key credit metrics remain [Technical Difficulty] unchanged from prior quarter, as we continue to proactively manage our credit exposures across the bank.

Glenn will provide more detail in his comments. On the next slide, I’ll quickly touch on the standard overview of our office CRE portfolio. We continue to make solid progress on reducing the size of this portfolio, which is down another $120 million this quarter. The majority of the reduction came from either payoffs or properties being repositioned. Overall performance of the portfolio continues to be relatively consistent with solid support underlying the credits. We did see a tick-up in classified loans to 7.7% from 5% last quarter, but delinquencies and non-accruals are non-existent. Given we are getting to a much smaller absolute balance, we will likely move this slide to the appendix in future quarters. With that, I will turn it over to Glenn to cover our financials in more detail.

Glenn MacInnes: Thanks, John, and good morning, everyone. I’ll start on Slide 7 with our GAAP and adjusted earnings for the fourth quarter. We reported GAAP net income to common shareholders of $181 million with earnings per share of $1.05. On an adjusted basis, we reported net income to common shareholders of $250 million and EPS of $1.46. The largest component of the adjustments were $47 million FDIC special assessment, $31 million in merger-related expense, and a securities repositioning loss of $17 million. Next, I’ll review balance sheet trends beginning on Slide 8. Total assets were $75 billion at period-end, up $1.8 billion from the third quarter. Our securities balances were up $1.5 billion from the third quarter, $400 million of the increase was attributed to value appreciation of our AFS portfolio, while the remaining $1.1 billion reflects incremental actions we took to reduce our asset sensitivity.

Much of the securities growth occurred late in the fourth quarter with the associated net interest income benefit to be realized in the first quarter. As I noted a moment ago, we also repositioned roughly $400 million of our securities portfolio, with less than one year earn-back. This should result in a benefit of 3 basis points to our net interest margin in the first quarter. Loans were up $640 million driven by commercial categories. The majority of the growth occurred late in the quarter, resulting in a period-end balance that was higher than average by $375 million. Deposits grew by $450 million in the quarter, the net result of seasonal declines in public sector funds offset by growth in CDs, interLINK, and interest-bearing checking. Our loan-to-deposit ratio was 83%, flat to last quarter.

Our capital levels remained strong. Common equity Tier 1 ratio was 11.12% and our tangible common equity ratio was 7.7%. Tangible book value increased to $32.39 per share or just under 10% quarter-over-quarter reflecting earnings and the improvement in AOCI. In a steady interest-rate environment, we anticipate $75 million of unrealized security losses would accrete back into capital annually. Loan trends are highlighted on Slide 9. In total, loans were up roughly $650 million or 1.3% on a linked-quarter basis. The Commercial Bank continues to drive loan trends where we grew the C&I and commercial real estate portfolios. On net, much of the growth was in low-risk lower-yielding portfolios. Growth in C&I was principally in fund banking and public sector finance as well as business banking.

Commercial real-estate growth was in stronger risk-rated portfolios, including multifamily. Notably, we ran off remaining balances in mortgage warehouse. The yield on the loan portfolio increased 4 basis points and floating and periodic loans were 59% of total loans at quarter end. We provide additional detail on deposits on Slide 10. The total deposits up $450 million from prior quarter or 0.7%. We saw growth in all major deposit product categories with the exception of demand and money market accounts, where seasonality in public funds drove declines. Our total deposit costs were up 19 basis points to 215 basis points for a cumulative cycle-to-date total deposit beta of 40%. On Slide 11, we rolled forward our deposit beta assumptions to incorporate the first quarter during which we anticipate our beta to reach 41%.

Moving to Slide 12, we highlight our reported to adjusted income statement compared to our adjusted earnings for the prior period. Overall, adjusted net income was down $17 million relative to prior quarter. Net interest income was down $16 million as anticipated balance sheet growth was achieved later in the quarter and we continue to run off non-strategic loans. Adjusted non-interest income was down $10 million, largely driven by a non-cash swing in our modeled credit valuation adjustment on customer derivatives. Partially offsetting these trends, expenses were down $1.6 million and the provision was down $0.5 million. We also benefited from a lower tax rate 19.5% this quarter, down from 20.1% in the third quarter as a result of state and local true-ups.

Our efficiency ratio was 43%. On Slide 13, we highlight net interest income, which declined $16 million linked-quarter. This was driven by a later-than-anticipated growth in our earning assets in addition to run-off of non-strategic portfolios. Net interest margin decreased 7 basis points from the prior quarter to 3.42%. As a result of the timing of our fourth quarter earning asset growth and forecasted originations in Q1, we expect to grow both net interest income and NIM into the first quarter. Our yield on earning assets increased 5 basis points over prior quarter. The pace of deposit pricing moderated to 19 basis points, while the cost of total interest-bearing liabilities was up 14 basis points. The increase is driven by a periodic change in deposit mix, primarily due to seasonality — seasonal decline in public funds with offsetting growth coming in higher-yielding deposit categories and wholesale funding.

On Slide 14, we highlight non-interest income, which was down $10 million to prior quarter on an adjusted basis, $8 million of the decline was attributable to a non-cash swing and model credit valuation adjustment on customer derivatives. This resulted in a $4 million charge this quarter relative to a $4 million benefit last quarter. We also experienced a seasonal decline in HSA interchange fees and transaction activity tied to commercial clients remained slow in the fourth quarter. Non-interest expense is on Slide 15. We reported adjusted expenses of $299 million, down $2 million from the prior quarter. Reductions in reoccurring, FDIC insurance, technology costs were partially offset by increased marketing and employee benefit costs. Slide 16 details components of our allowance for credit losses, which was effectively flat relative to prior quarter.

After recording $34 million in net charge-offs, we incurred a $34 million provision, $26 million of which was attributable to macro and credit factors and $8 million of which was attributable to loan growth. As a result, our allowance coverage to loans decreased modestly to 125 basis points from 127 basis points last quarter, in part reflecting the mix shift to loans with lower loss content. Slide 17 highlights our key asset quality metrics. On the upper left, non-performing assets are flat to prior quarter and up slightly to prior year, with non-performing loans representing just 41 basis points of total loans. Commercial classified as a percent of commercial loans increased to a 182 basis points from 174 basis points as classified loans increased by $44 million on an absolute basis.

Net charge-offs on the upper-right totaled $34 million or 27 basis points of average loans on an annualized basis. We divested another $51 million of commercial loans in the quarter and $21 million of residential loans. These divestitures resulted in $14 million of the $34 million in net charge-offs. On Slide 18, we maintain strong capital levels. All capital levels remain in excess of regulatory and internal targets. Our common equity Tier 1 ratio was 11.12% and our tangible common equity ratio was 7.7%, our tangible book value was $32.39 a share. I’ll wrap up my comments on Slide 19 with our outlook for 2024. The outlook includes the pro-forma impact of Ametros, which directly impacts deposits, net interest income, fees, and expenses. We expect to grow — we expect loans to grow in the range of 5% to 7%.

Growth will continue to be driven by our commercial businesses. Likewise, we expect deposits to grow 5% to 7%. We expect net interest income of $2.4 billion to $2.45 billion on a non-FTE basis. For those modeling net interest income on an FTE basis, I would add roughly $75 million to the outlook. Our net interest income outlook assumes four decreases in the Fed funds rate beginning in May. Non-interest income is forecasted to be in the range of $375 million to $400 million. This includes approximately $25 million in fees generated by Ametros. Expenses are expected to be in $1.3 billion to $1.325 billion. This includes approximately $50 million due to the addition of Ametros, representing both operating costs and the estimated intangible amortization.

Our efficiency ratio is expected to be in the low-to-mid 40% range. We expect an effective tax rate of 21%. We will continue to be prudent managers of capital and target a common equity Tier 1 ratio of approximately 10.5%. With Ametros expected to close shortly, we anticipate rebuilding capital in the near term, after which we are committed to utilizing roughly 40% of our earnings per share repurchases and tuck-in acquisitions, similar to those that we have announced in the past couple of years. With that, I’ll turn it back to John for closing remarks.

John Ciulla: Thanks, Glenn. Despite continued industry headwinds, we remain optimistic about our prospects for 2024. Webster is in an advantageous position as we enter the year with good momentum. In a challenging year for the banking industry last year, we were able to add to our capabilities and grow the bank. Streamlining our technology will allow us to more efficiently improve our product and service offerings. We’ve also taken steps to reduce our earnings volatility. Our funding position and capital generation provide us with a great opportunity to grow the company in strategically compelling areas. We will continue to invest in our people and technology, further enabling that opportunity. Given these dynamics and the starting point for our efficiency ratio, we will make these investments while maintaining peer leading profitability and returns.

I’m going to conclude my remarks with a few acknowledgments of thanks. As we near the two-year anniversary of the merger with Sterling, Jack Kopnisky will move out of his role as Executive Chairman of the company, and I will become Chair. Jack’s counsel and partnership in building our company has been invaluable over the past two years, and the company would not be where it is today without his vision and significant contributions. As this is the last earnings call prior to the February 1 transition, I want to take this opportunity to publicly offer our collective thanks to Jack. Thank you to our colleagues for their efforts and on behalf of our shareholders and clients. While 2023 was a challenging year in terms of industry turmoil and the work that went into completing our core conversion.

Our colleagues put in a ton of work building our franchise and achieving our 2023 financial results. Thank you all for joining us on the call today. Operator, Glenn and I will open the line for questions.

Operator: Certainly. [Operator Instructions] Your first question comes from the line of Mark Fitzgibbon from Piper Sandler. Please go ahead, your line is open.

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Q&A Session

Mark Fitzgibbon: Hey, guys. Good morning.

John Ciulla: Good morning, Mark.

Mark Fitzgibbon: First question I had, Glenn, based on where yields are today, do you plan to continue to grow and extend the securities book in the first quarter to sort of further reduce asset sensitivity?

Glenn MacInnes: Yeah. Mark, thanks. We did — as you probably saw, we did add about $1.1 billion in securities at the end of the fourth quarter. So I think that bodes well going into the next couple of quarters. And actually, we did it opportunistically at a high rate environment. So we feel good about that. But the real intent was to further minimize our asset sensitivity.

Mark Fitzgibbon: But, Glenn, do you plan to continue to do that in the first quarter?

Glenn MacInnes: Yeah, I mean, it’ll be not to the extent that it’s $1 billion but it will be at a smaller level, and we’ll reinvest. We have approximately $300 million coming off a quarter in our investment securities portfolio, which will be reinvested.

Mark Fitzgibbon: Okay. And then just real quick, secondly, did you sell any office loans or loan notes in the quarter? And if so, where did you sell them relative to par?

John Ciulla: We did, Mark. I would say, and we’ve been talking about this, the kind of progressive decline in the market values. I think mid 80s, but the loan sales were smaller this quarter, and they weren’t all office. So we did do some balance sheet repositioning, but not as robustly and not in bulk like we had in the last few quarters. As I noted, the $120 million decline in the quarter in office this quarter, interestingly, was primarily from payoffs and refinances at market and par. So we didn’t do a lot of office sales this quarter.

Mark Fitzgibbon: Thank you.

John Ciulla: Thank you.

Operator: Your next question comes from the line of Matt Breese from Stephens. Please go ahead, your line is open.

Matt Breese: Hey, good morning.

John Ciulla: Good morning.

Matt Breese: I was hoping we could touch on loan yields. Expansion was a bit less than I was expecting this quarter, up 4 bps to 6.24%. And I was curious, one, what are incremental loan yields today? Have they changed quarter to quarter? And then is the fact that we saw a slowdown in loan yield expansion tied to just the lack of Fed hikes, or could you provide more color on that?

Glenn MacInnes: Yes, I’ll just hit the numbers at the beginning. So, in the fourth quarter, our commercial loan yields were 7.60% for what was originated in the fourth quarter. And total loans was pretty much same range, I think 7.58% somewhere around there. And — go ahead.

John Ciulla: Matt, so it’s interesting, right? And obviously, we hit on it in the beginning. We had back-ended loan originations in the quarter, which hurt NII growth. And we also, if you look year over year, right, we have $650 million less in mortgage warehouse because we’ve exited that business. The other dynamic there is that the mix of business was high quality non-office commercial real estate fund banking, which has almost a full point of lower weighted average risk rating. But on the other side, also lower yielding. So we didn’t see as much origination, I would say, given market conditions and given credit appetite in sponsor and specialty. And so a little bit of the mutation, if you will, in the expansion of yield had to do with the loan mix in the fourth quarter as much as anything.

Matt Breese: Got it. Okay. And then my second one, you had mentioned intangibles tied to Ametros. And I was curious, what is the breakdown or the types of intangibles? And if it’s CDI, what is the amortization methodology and time frame to recapture that?

Glenn MacInnes: Yeah, it’s a great question, and we’re still working through the intangibles on that. We haven’t closed on it yet. But it’s a little different than the typical banking type of transaction in that these have a life somewhere in excess of 20 years. So you would expect the intangible amortization to be using the bank in the bank space, it’s the maximum 10 years, but in this case, I think it would probably be further out than that.

Matt Breese: But it’s safe to assume it’s a CDI versus goodwill.

Glenn MacInnes: Yeah. Primarily, yes.

Matt Breese: All right. I’ll leave it there. Thank you.

Glenn MacInnes: Great.

Operator: Your next question comes from the line of Chris McGratty from KBW. Please go ahead, your line is open.

Chris McGratty: Hey, good morning.

John Ciulla: Hey, Chris.

Chris McGratty: Hey, John. Hey, Glenn. Maybe a question on capital. I think you basically said that you’re going to pause on the buybacks for a bit until you build a little bit more post Ametros. I guess two-part question. What’s your best estimate for pro forma CET1 for the deal? And then anything precluding you from resuming buybacks maybe Q2, Q3?

Glenn MacInnes: Yeah, so thanks, Chris. And what I said was that in the near term, and so I think that you can think about common equity Tier 1 coming right about down to our target level of 10.5% in the first quarter, and then we begin to build capital from that.