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Edited Transcript of WBS earnings conference call or presentation 18-Jul-19 1:00pm GMT

Q2 2019 Webster Financial Corp Earnings Call

WATERBURY Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Webster Financial Corp earnings conference call or presentation Thursday, July 18, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Charles L. Wilkins

Webster Financial Corporation - EVP and Head of HSA Bank

* Glenn I. MacInnes

Webster Financial Corporation - Executive VP & CFO

* John R. Ciulla

Webster Financial Corporation - President, CEO & Director

* Terrence K. Mangan

Webster Financial Corporation - SVP of IR

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Conference Call Participants

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* Casey Haire

Jefferies LLC, Research Division - VP and Equity Analyst

* Collyn Bement Gilbert

Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst

* David John Chiaverini

Wedbush Securities Inc., Research Division - Senior Analyst

* Jared David Wesley Shaw

Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Laurie Katherine Havener Hunsicker

Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst

* Mark Thomas Fitzgibbon

Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks

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Presentation

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Operator [1]

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

I will now introduce Webster's Director of Investor Relations, Terry Mangan. Please go ahead, sir.

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Terrence K. Mangan, Webster Financial Corporation - SVP of IR [2]

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Thank you, Melissa. Welcome to Webster. This conference is being recorded. Also, this presentation includes forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition, results of operations and business and financial performance. Webster has based these forward-looking statements on current expectation and projections about future events. Actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial's public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second quarter of 2019.

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

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [3]

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Thanks, Terry. Good morning, everyone. Thank you for joining Webster's Second Quarter 2019 Earnings Call. CFO Glenn MacInnes and I will review business and financial performance for the quarter. HSA Bank President Chad Wilkins is here with us in Waterbury and will be available during Q&A.

Let me start by saying we're really pleased with our solid financial performance in Q2. Loan and deposit growth was strong. Net interest income and noninterest income increased. Expenses were efficiently managed. And we created positive operating leverage for the ninth consecutive quarter. Our capital position is strong, and our consistent financial performance enabled us to recently announce a 21% increase in the common dividend. We continue to take a long view on value creation, and we are investing in our differentiated businesses across all markets to drive strong customer relationships and to maximize economic profits over time.

I'll begin on Slide 2. We posted our fourth consecutive quarter of net income at just under $100 million. Net income to common shareholders was $96.2 million after $2.5 million of preferred dividend expense. Earnings per share of $1.05 in Q2 compares to $1.06 in Q1 and $0.92 in Q2 of 2018 when that period is adjusted for $8.6 million of onetime expense items, resulting in a 14% growth rate from prior year's Q2.

Tangible book value per share continues to grow and is 15% higher than last year even as we increased the quarterly common dividend. Loan growth and a higher net interest margin contributed to our 39th consecutive quarter of year-over-year revenue growth and a 13% increase in adjusted pre-provision net revenue.

In Q2, total revenue was 8% higher than last year while adjusted expenses increased 5% resulting in positive operating leverage. The efficiency ratio was 56% for the third quarter in a row. Credit quality remained solid with noteworthy linked quarter reductions in nonperforming commercial classified and past-due loans.

We've now posted 4 consecutive quarters with return on common equity above 13% and return on tangible common equity above 16%. Webster's financial performance is driven by a disciplined commitment to our purposeful execution of long-term strategic priorities mainly to expand Commercial Banking, aggressively grow HSA Bank and optimize and transform Community Banking.

Turning to Slide 3, I'll make a few comments on our first half 2019 line of business performance. Commercial Banking continued to execute at a high level, delivering year-over-year double-digit loan growth. We are growing loans without sacrificing underwriting discipline and benefiting from our differentiated execution in select industry verticals and in commercial real estate.

Commercial Banking revenue in the first half of 2019 grew 4% from prior year with all business units and all geographies contributing to our growth. Deposits were also up nicely as we continue to build franchise value by acquiring new customers and deepening existing relationships across our footprint.

HSA Bank's first half PTNR improved more than 30% as we added in excess of 724,000 new accounts and continued to drive higher levels of customer satisfaction through our operational excellence initiatives. HSA Bank remains the leading bank administrator of health and savings accounts and surpassed $8 billion in HSA footings in the quarter. Also in the quarter, we expanded and extended our important relationship with Cigna, increasing investments in technology, security, marketing and other resources to advance and grow the customer experience.

Community Banking is making progress, optimizing distribution channels, investing in digital capabilities and focusing on high-value consumers and small businesses. We again generated year-over-year PPNR growth, up 9% from the first half of 2018 through modest revenue gains and continued expense discipline and process efficiencies. We continue to grow loans, core deposits and full relationships across our Boston to New York retail footprint.

Slide 4 highlights our solid loan and deposit growth dynamics. On a consolidated basis, loans increased $1.2 billion or 7% from a year ago. Deposits increased $1.3 billion or 6% over the last year with low-cost health savings accounts representing 55% of the increase. Glenn will provide more detail as he reviews the balance sheet and line of business performance.

Our regional economies and the markets we operate in remain solid and growing. Despite macro uncertainty in the pace of global growth, a more challenging interest rate environment and a handful of potential geopolitical risks, our customers, both consumers and businesses, are healthy and generally positive on the forward outlook. We remain confident in our ability to consistently build long-term franchise value and to maximize growth of economic profits over time.

We are executing at a high level in the areas we control, growing revenue, loans and core deposits through new customer acquisition and further penetration of our existing customer base, diligently managing credit risk, continually investing in our differentiated businesses with strategic focus while maintaining expense discipline and realizing efficiency gains to drive operating leverage and improve our returns and finally, maintaining a strong values-based culture at the bank, creating a great environment for our bankers while always taking care of our customers and investing in our communities.

I'll now turn the call over to Glenn for the financial review.

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [4]

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Thanks, John. Slide 5 provides more detail on our average balance sheet. The securities portfolio grew by $164 million linked quarter. This follows an increase of $165 million in Q1. Year-over-year, the portfolio was up $330 million consistent with our balance sheet growth.

Loan growth continues to be led by the commercial categories, which were up $321 million linked quarter and $1.1 billion versus prior year. Linked quarter consumer loan growth of $200 million reflects the $242 million mortgage portfolio purchase that closed at the end of Q1. Similar to the industry, we continue to see paydowns of home equity balances over the past year.

Deposit growth was $213 million linked quarter with 3 quarters of the growth in demand and low-cost HSA deposits. Deposits grew $1.3 billion from a year ago with slightly more than half of the growth coming from HSA deposits.

Borrowings increased $468 million linked quarter. This includes $300 million in 10-year senior notes issued late in Q1, which we swapped out to floating. The remainder of the increase was the result of seasonality in public funds. Versus prior year, borrowings were down $61 million as the growth in deposits and equity exceeded growth in loans and securities.

Slide 6 summarizes our Q2 income statement and drivers of quarterly earnings. Net interest income totaled $242 million and increased modestly from Q1. We had solid linked quarter earning asset growth of 2.6%, which was offset by higher than anticipated NIM compression as average second quarter interest rate levels were lower than anticipated at the time of our Q1 earnings call in mid-April. For example, the average 1-month LIBOR rate was 5 basis points lower and the average 10-year swap rate was 20 basis points lower.

Versus prior year, net interest income grew by $17 million or 7.5%. Noninterest income increased in excess of $7 million versus both prior quarter and prior year. This exceeded our expectation due to increased level of commercial activity and gains in our BOLI portfolio.

Reported noninterest expense increased $5 million linked quarter and was flat compared to a year ago. The linked quarter reflects an increase of $3.9 million due to higher legal expense, outside professional fees, and seasonal sales and sponsorships. Expenses were flat to prior year, which included a onetime deposit insurance charge of $7.2 million. This was primarily offset by annual merit and other benefit cost increases.

Pre-provision net revenue of $137 million represents a new quarterly record and was up from $135 million in Q1. Versus prior year, pre-provision net revenue increased $15 million or 13% on an adjusted basis.

Loan loss provision for the quarter was $11.9 million resulting in a coverage ratio of 110 basis points. Our efficiency ratio was 56%, same as in Q1 and improved from 57.8% a year ago. And the effective tax rate was 21.1%.

Slide 7 provides additional detail on year-over-year pre-provision net revenue growth. Net interest income grew by $17 million or 7.5%, $4 million driven by rate and $13 million driven by volume. The rate component is the net result of a 31 basis point improvement in loan yield and a 20 basis point increase in deposit cost. When measured against the 70 basis point increase in average Fed funds rate, this resulted in a loan beta of 44% and a deposit beta of 28%. The combination resulted in a 6 basis point increase in net interest margin to 3.63%.

Starting on Slide 8, I'll review the line of business results. Commercial Banking reported second quarter loan growth of 3.5% linked quarter and 10.8% year-over-year.

C&I loan growth was $257 million linked quarter and $648 million from prior year. Commercial Real Estate loans grew $126 million linked quarter and $427 million from prior year. While the loan portfolio yield declined 2 basis points linked quarter primarily due to lower LIBOR rates, it increased 36 basis points from a year ago. As you see on the bottom right, PPNR was flat compared to a year ago.

Net interest income grew $3.7 million reflecting average loan growth of 11%, while noninterest income was modestly lower. And operating expenses increased from prior year as we continue to invest in the business.

Slide 9 highlights HSA Bank, which delivered another solid quarter led by the production of 129,000 new accounts. Over the past 12 months, HSA Bank has opened 724,000 new accounts.

As John noted, during the quarter, we crossed the $8 billion mark in total footings with just under 3 million accounts. Our footings consist of $6.2 billion in low-cost, long-duration deposits and $1.8 billion in linked investments. We continue with strong account growth in the channels where we have the greatest influence in sales and marketing activities, including direct-to-employer.

Total accounts were 11% higher than a year ago and total footings were up $1 billion or 15%. Net interest income was 21% higher from a year ago. The increase reflects growth of 13% in average deposits and a higher net credit rate. The cost of deposits was 20 basis points, flat to a year ago.

Noninterest income increased 9% from higher account fees and interchange revenue, each driven by growth in accounts. Total revenue for the quarter grew 16% from a year ago. Year-over-year expense growth was 10% as a result of account growth and ongoing expense discipline with targeted investments. Combined, this resulted in positive operating leverage and pretax net revenue growth of 24%.

Slide 10 highlights Community Banking. Business Banking had year-over-year loan growth of 6%. Combined with the Q1 mortgage portfolio purchase, growth offset a continued decline in our home equity portfolio. The net result was an increase of 2% in loans.

On the deposit side, consumer and business deposits each grew 6% year-over-year. Net interest income grew modestly year-over-year, while noninterest income grew 5% driven by deposit charges and higher swap-related fee income in Business Banking. Total revenue growth was 1.6% from a year ago, and noninterest expense grew 1% resulting in positive operating leverage and 3.4% growth in PPNR.

Slide 11 highlights our key asset-quality metrics. Nonperforming loans in the upper left had a linked-quarter decline of $11 million and now represents 77 basis points of total loans. Net charge-offs in the upper right were $11.6 million in the quarter. The annualized net charge-off rate is generally consistent with our 20-quarter average of 21 basis points. Commercial classified loans in the lower left improved to 259 basis points to total commercial loans. This compares to a 20-quarter average of 322 basis points.

Our allowance for loan loss was $212 million with a provision of $11.9 million and a coverage ratio of 110 basis points. Our allowance for loan loss continues to reflect stable commercial and consumer asset quality.

Slide 12 provides our outlook for Q3 compared to Q2. We expect average loans to increase around 2% driven primarily by our commercial and residential portfolios. We expect average interest-earning assets to grow over 2%. With regard to net interest margin, given the rate environment, at this point, we anticipate 7 to 10 basis points of NIM compression. As a result, we expect net interest income to be stable from Q2 levels.

Reported noninterest income is likely to be down as a result of BOLI portfolio gains included in Q2. We expect our efficiency ratio to be below 57%, and our provision will be driven by loan growth, asset quality and mix. We expect the tax rate on a non-FTE basis to be approximately 21%. And lastly, we expect our average diluted share count to be similar to Q2's level.

With that, I'll turn things back over to John.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [5]

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Thank you very much, Glenn. Now before we open it up for Q&A, I'd like to provide additional context to Glenn's guidance on NIM and net interest income trends. Our asset sensitivity, which peaked in Q3 of 2017, continues to moderate. And we have and will continue to take steps to manage our overall interest rate sensitivity given the outlook on future rate moves.

In Q2, despite the 11 basis points overall NIM compression, we were able to grow net interest income modestly linked quarter as a result of our ability to safely grow loans at market-leading levels.

Moreover and importantly, much of the 2Q NIM compression was driven by higher premium amortization in the securities portfolio, the mortgage loans purchased at the end of the first quarter and the full quarterly impact of the note issuance we completed in Q1.

Our deposit costs, largely as a result of our differentiated HSA business and a net increase in demand deposits, increased only 2 basis points quarter-over-quarter, which we believe outperforms broader market trends. And our yield on loans contracted only 2 basis points quarter-over-quarter despite a more significant contraction in LIBOR.

While we expect NIM compression in the third quarter, balance sheet actions and asset growth should allow us to keep net interest income relatively flat. Looking out further, we see challenge to the NIM in Q4 as well, and our focus will again be to mitigate the impact on net interest income. As we head into 2020 and beyond, we'll benefit from the Q1 seasonal lift in HSA deposits, and we'll continue to refine our view and further our execution on the structure of our balance sheet. Our goal, always taking a long view, continues to be driving net interest income and delivering growth in economic profits.

I want to again thank our nearly 3,400 bankers for their continued efforts and performance. Together, our bankers are making a positive difference for our customers, our shareholders, the communities we serve and for each other.

With that, Melissa, I'm happy to open it up for questions.

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Questions and Answers

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Operator [1]

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

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [2]

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John, I wanted to follow up first on your comments that you expanded and extended the relationship with Cigna. Just want to confirm are you saying that the contract was renewed?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [3]

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Steve, as we always tell you, we don't specifically comment on contracts with Cigna or otherwise, but let me reiterate that we have enjoyed a mutually beneficial leadership with Cigna for the last 5 years since we began partnering with them. It's a contractual relationship. And in Q2, we expanded and extended that relationship, and we continue to view the relationship as a very strong one.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [4]

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Okay. That's helpful. And then I want to shift to the margin. So Glenn, does the 3Q guidance, does that assume a July rate cut?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [5]

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It does. We have a July -- we have factored in a July rate cut and September rate cut, each 25.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [6]

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Okay. So if we look at the NIM guidance, down 7 to 10 in the third quarter, is that about what you expect from a 25 basis point cut? Or is there some other factor in there, like bond premium amortization or something that's elevating that?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [7]

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Yes. No, there is, and I think it's all related because you're -- we're assuming also, I should say, a 10-year swap rate of around 2%. And so in that 7 to 10 range, I would put the amortization impact somewhere between 2 and 3 basis points.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [8]

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Okay. So a normal response to a cut might be less 2 to 3, somewhere in that range?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [9]

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Yes. Somewhere around there.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [10]

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Okay. Got you. And then what's your appetite? How do you think about offsetting this? Following John's comments where you guys are, obviously, thinking long term, but do you plan on further reining in expense growth? Like what do you think about the offsets as this NIM pressure builds here?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [11]

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Yes. Steve, I mean, I'll take it first. Obviously, like we've talked about, we take a long view in terms of building franchise. We pull levers and I think we've demonstrated to the market in our reduction of our expenses over time and our management of the efficiency ratio, we certainly have opportunity to be careful on expenses, but we're also careful to make sure that we think we've got a couple of really differentiating businesses that we'll continue to invest in.

So I think it's a combination of balance sheet actions. It's a combination of growing our balance sheet and growing loans to offset the NIM compression and expense management. And that's why we're trying to focus everyone to the net interest income line rather than the headline NIM number.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [12]

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Okay. And then just finally on HSA Bank, how much flexibility do you have to lower the deposit rates you're paying? And maybe for Chad, what does the HealthEquity wage deal mean for your business. It's an opportunity, a stronger competitor? How do you think about that?

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Charles L. Wilkins, Webster Financial Corporation - EVP and Head of HSA Bank [13]

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Yes. Thanks, Steve. I've said on the rate side, we haven't had pressure either way. On rates, I don't expect them to move. I mean we haven't moved rates other than to come down slightly over the last couple years.

And then moving to the HealthEquity/WageWorks deal, I think the -- in general, that transaction, it's big. It's complicated and expensive. And we've been through similar but smaller transitions and conversions over the years. And if done right, they can be great. If done wrong, quite the opposite, right? So the bottom line, this doesn't change our focus outside of putting ourselves in position to take advantage of any disruption that might happen as they work through the transition.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [14]

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And Steve, if I could make kind of a higher-level strategic comment, obviously, there have been a number of transactions announced in the industry. As a leading player, as you can imagine, we're in and around all of the activity. We're really pleased with the execution of Chad and his team and our position as the leading HSA provider from a bank perspective as the industry consolidates and moves around. And we're going to obviously continue to make the investments necessary to keep our competitive advantage and maintain our position as a key player in the marketplace.

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Operator [15]

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

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [16]

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So this -- great color, and certainly, on the strategy, John, that you're offering to sort of help to offset some of these NIM challenges.

And then just, Glenn, back to -- you'd indicated 2 to 3 basis points maybe could be amortization related of the NIM. Can you just talk about some of the other drivers? How you're seeing loan pricing in the market on origination yields? And then where you're seeing deposit pricing trends go kind of near term and then a little bit longer term on some of those inputs?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [17]

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I'll let Glenn put a finer point, but Collyn, if I can just jump in, I think from a pricing perspective on the loans, the yields are really coming down based on the [rest were] trading where LIBOR is. I think we're seeing pretty stable credit spreads, if you will. So LIBOR is impacting the loans.

And as we said, one of the things in our story here is that I think you'll see a lot of our peers and other folks in the industry have deposit pricing going up higher. Obviously, we think no matter what the interest rate environment is, having HSA and having steady cost, long-duration, growing deposits will be an advantage.

So we have seen a little bit of pressure as we talked about in the last quarter in terms of deposit pricing across the footprint and in particular, large metro areas. But I think we're seeing that consumer demand on pricing increases subside with what's going on in the broader interest rate market, which I think is kind of consistent with what we're seeing in the industry.

So when you look at kind of the core NIM contraction, the loans and the deposits, we feel pretty bullish on our ability to effectively manage deposit costs. And obviously, we're somewhat because we have a large floating rate book susceptible to moves in LIBOR. So that's kind of my top-of-the-house view on core NIM contraction.

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [18]

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And I'll just -- maybe I can add a little. You talked about the amortization, 2 to 3 basis points, and I think to John's point, if you look at our lending book, that's 1-month LIBOR-based because that would be most sensitive to a change in rates. We have about 7.5 -- a little over $7.5 billion on that book. And so that would be the biggest headwind for us.

The offset would, obviously, be things like public funds, CDs, general deposit costs and then our borrowings, FHLB advances would come down as well with the rate. So when you factor all that in, Collyn, that's how you get to the range that we are.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [19]

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Okay. That's helpful. And then just on the loan growth side, obviously really good growth this quarter. Looks like you're anticipating good growth next quarter, and you're certainly speaking optimistically about that. And John, you just said you're seeing decent credit spreads. But can you just frame it a little bit in terms of appetite and demand for that type of growth? I mean obviously we're sitting over the Fed that's ready to cut, so they see something. I'm not sure what they see. But different, perhaps, than what your performance is showing. But can you just talk a little bit about what's driving that -- those favorable loan growth trends?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [20]

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Sure. And I probably sound like a broken record, Collyn. You know I've had this conversation so many times. I really think it's because we've got kind of a variety of levers. So if you look across our Sponsor & Specialty business, which has some industry verticals, our traditional Middle Market across the expanded geography, asset-based lending, equipment finance, Commercial Real Estate. We've got a kind of plethora of business lines and geographies.

And we haven't been -- what's really nice is when I was making a comment yesterday to Chris Motl, I look through and you're not seeing a disproportionate contribution in any one place as we go over time. So if you look at the leverage category, if you look at any particular industry segment, if you look at any particular geography, we really haven't had to supercharge or take additional risk in any of those geographies.

So I think the growth has been really nice and spread across our sectors. I'll also tell you that one of the things I said on the call is that we will sacrifice on price before we'll sacrifice on structure. I believe that's true. I looked at our weighted average risk ratings over the last year, and they've trended down, which means lower, better risk quality, lower risk ratings. And our credit spreads over that same period have come down a little bit as well.

So I think, to me, that's a little bit of quantitative evidence that we are -- where necessary, we're sacrificing on price and not on quality. All of our loan pipelines are up in Business Banking and in Commercial. So I do feel pretty bullish about where we are.

Oh, and one more point I wanted to make that I think is important, if people go from worrying about your loan growth during good times, not being high enough, to worrying that a lot of loan growth during a late cycle is dangerous, is that our -- we really have been disciplined. And in this quarter, if you look at the chart, the originations weren't up dramatically. In fact, they were down from a year ago, but prepayments were down significantly.

And I think that's an important point to make because it means we haven't been driving outsized originations in the period. We were just fortunate not to see a lot of payoffs in the quarter.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [21]

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Okay. That's helpful. And then just one final, again, kind of tying to longer-term thoughts on all of this. You're giving guidance near term on the efficiency ratio. And what you just said on the loan growth, I mean, do we -- should we assume that this can be extended, that stable efficiency ratio, this high single-digit loan growth rate can be -- that's like a target and an objective for you all to maintain throughout 2020 as well?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [22]

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I mean it is, strategically, right? And we're being I think transparent about the challenges in the interest rate environment of NIM compression. But our goals are to try and make sure we're growing assets, we're getting paid for value and we're not taking too much credit risk that we can through balance sheet actions and growth in our earnings assets offset some of the NIM compression.

And you've noticed, we're at 56% efficiency ratio. We guided towards 57%. We generally give ourselves a little bit of wiggle room there because as you know, in any one quarter, if we see a great Commercial Banking team or if Chad has an opportunity to supercharge sales or make an investment in HSA, we want to keep growing our differentiated assets. But our goal is, over the long term, and we feel confident that kind of the continued downward migration again over the longer term on efficiency ratio is achievable.

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [23]

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I think -- no, I just -- to John's point, we want to maintain the flexibility to strategically invest in our business. If you look at it and you look at it the way we're set up from a strategic standpoint and you just go through the lines of business, commercial headcount, as an example, is up 20 year-over-year. HSA is up 40 year-over-year. That's offset by reductions in the Community Bank of 55 and in the middle and back office of 25. So if you think about the way we're investing in the businesses, it's sort of placed through on the efficiency ratio, too. But we need the flexibility to invest in the businesses.

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Operator [24]

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Our next question comes from the line of Mark Fitzgibbon with Sandler O'Neill.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [25]

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I had a question first for Chad. I guess Chad, I'm curious the guidance issued recently by the IRS and the Treasury Department related to high-deductible health plans. It should obviously be pretty good for new business generation in the HSA area. I guess I'm curious how long you think before health plans begin to adopt the new guidance?

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Charles L. Wilkins, Webster Financial Corporation - EVP and Head of HSA Bank [26]

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Yes. That's a great question, Mark. And it's something that we've been lobbying aggressively over the last couple of years. There's 3 things that we focus on from a lobbying perspective, and it's eligibility within Medicare and Medicare Advantage for HSAs; allowing HSA eligibility with direct primary care agreements; and then this. And so I'm happy to see that we were successful on this front. This does open up our opportunity, our target opportunity for both employers and consumers.

And I don't have a specific answer for you for how long it will take. I mean I think it's going to be next year. It's difficult because a lot of the plans have already set in motion what they're going to offer as they go through October. I think as they work through next year, we'll see some changes. But it eliminates one of the larger obstacles with regard to HSAs and really does open up our opportunity.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [27]

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Great. And then Glenn, you referenced $3.5 million in miscellaneous other income in the press release. What exactly is that?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [28]

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So -- yes. So that was BOLI benefits, and I think you're probably familiar with the bank-owned life insurance you've seen on our balance sheet, $546 million, which we get a return per quarter of about $3.6 million. That is when -- in the event of a death, the benefit is accelerated. So during the quarter, we had a little over $3 million in accelerated benefits.

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Mark Thomas Fitzgibbon, Sandler O'Neill + Partners, L.P., Research Division - Principal & Director of Research [29]

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Okay. And then lastly, I wonder if you could sort of update us on additional plans for branch optimization?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [30]

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Sure, Mark. It's John. And by the way, congratulations on the Sandler, Piper transaction. Yes. I think it's the same. We do not have anything targeted right now. We constantly are working and it all starts from the premise that our consumer preferences are changing. Fewer transactions are happening in the bank. Our digitally active households continue to increase. And our focus really is to shift expenses from the real estate platform obviously into technology.

And so for us, it's looking every quarter at our footprint, making sure we're taking care of our customer base with an ultimate goal of not necessarily reducing the number of branches but reducing square footage over time. We're down 3% on square footage year-over-year, and we'll continue that. But right now, we don't have any targeted consolidations.

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Operator [31]

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

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [32]

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Got a couple questions for you. First, in HSA, so looking at Slide 9, again, this pretax net revenue per average account, $45 roughly. So it was down about $1.50 from the first quarter. I was curious as to what drove that decline, whether it was lower net credit rate or if there was a change in economics with Cigna?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [33]

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I think that -- well, Dave, it's Glenn. First off, interchange revenue was relatively flat. I think our account fees declined. Lower account closure fees were the key drivers of that, and lower paper statement fees, which we charge for it. So it was really volume-driven.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [34]

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That's also higher average accounts in those secondary (inaudible).

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [35]

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I'd say on the lower statement on fees, we actually are saving on expense on that. So it's a net gain to the business.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [36]

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Got it. And congrats on extending the relationship with Cigna. I was curious and I figure I'll try, what's the typical length of an extension? Is it about 5 years?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [37]

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Yes. David, I'm -- we're not going to talk about the typical length of the contract. So I appreciate the question. Just say we have a long-term relationship, and our expectation that it will continue to be a long-term relationship.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [38]

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Yes. Fair enough. And then shifting gears to credit quality. There was a nice decline this quarter. What drove that decline and how's the outlook for credit quality?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [39]

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Yes. It's a great question, and I'd almost want to turn around and ask you the same thing. We're really pleased with where our asset quality statistics are now. We're now at a level on commercial classifieds that is lower than pre-financial crisis. And there really hasn't been a particular driver, except for the fact that we've just seen our customers continue to be healthy, grow top line, watch expenses and so. I think we're choosing -- we're selecting credit pretty well, but we've grown the portfolio in the last 9 or 10 years pretty significantly.

So I think the drivers are good risk selection. We monitor the portfolio very well, but the most important part for us is that we're in industries that have predictable, protectable, recurring cash flows. We've been fortunate not to be in areas like oil and gas and energy and construction, some of the more cyclical areas. So we're just pleased right now with where we are, and we're at cycle lows.

The outlook is interesting. We've had -- in the small charge-offs we've had in any risk rating migration down. We haven't been able to see any correlated risk or any themes in either geography, industry or product. So outlook right now is cautiously optimistic. Every time another quarter goes by, we think about how close we are to the end of this long cycle, now a record expansion cycle in the U.S. But there is nothing on our radar screen, and I think we do a pretty good job of looking forward and monitoring our portfolio that gives us particular concern. We just need to stay vigilant.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [40]

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Great. And then the deposit decline in Commercial Banking, was that related to seasonality perhaps in the municipal business?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [41]

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Yes. Public funds, it's all seasonality, Dave.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [42]

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Got it. And then last one from me. You alluded to in the fourth quarter the NIM compression. Should we assume more mid-single digit as opposed to high single digit given the 2 to 3 basis points of amortization?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [43]

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Dave, I think, we're not going to sort of drill it down into a number. There are so many things going on. It's so volatile right now in either the macro environment or the things that we're doing. I just think we wanted to make a statement to give you more of a sense directionally over the longer period of time that we'll fight continued compression trends. But we're not going to get more specific than that.

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Operator [44]

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Our next question comes from the line of Laurie Hunsicker with Compass Point.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [45]

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I wonder if we could just start the other, other income in noninterest income. And I think Mark was asking about this too. So included in that $13.3 million is a $3.5 million BOLI death benefit. Is that correct? That's where that shows up?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [46]

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Yes. So the increase is $7 million, a little over $7 million quarter-over-quarter and year-over-year. Half of that is BOLI and the other half is...

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [47]

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And then what is...

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [48]

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The other half is commercial activity, primarily swap activity.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [49]

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Okay. And then how -- I mean, how should we be thinking about that activity. I mean that line item absent even some gain on sale of branches in the fourth quarter, that's really been running closer to $7 million to $8 million. Is that a good way to be thinking about that number?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [50]

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Yes. I don't think that you can bring the $3 million, for example, forward. That's why our guidance is that noninterest income will likely be down quarter-over-quarter. All things being considered, it depends on commercial activity. It depends on transaction and volume and things like that.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [51]

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Okay. And then same question here within the expense line. The other, other expense line was up $4 million. I just want to make sure I heard you right. You said that $3.9 million was due to higher legal expenses.

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [52]

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Yes. So during the quarter, we had settlements that totaled just a little over $2 million. And so I would not push those forward either based on what offset the gain that you saw in noninterest income.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [53]

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Perfect. Okay. And then just sort of last question here, a little bit more macro. When you first expanded into Boston, you stated a goal by 2020 of getting to a mark that it looks like you're pretty close to. You said, hey, we'll be $1.5 billion, and it's seeming like you're getting there.

Can you talk a little bit about what's next for Boston, how you're thinking about Boston? And then also within the framework of some of the M&A that we've seen happen in the Boston marketplace, just how you're looking at M&A? You've got a strong stock currency. There've been some deals that have happened in your marketplace, both in Boston and beyond, that have gone off much closer to book, just how you're thinking about that?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [54]

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Sure. I'll try and hit both of those, Laurie. You're correct. Boston is now contribution breakeven -- past contribution breakeven -- positive just from a Community Bank perspective, which was obviously one of our goals. And then we did set out a loan and deposit growth as target for the 5 years, again, just with respect to retail. And we're above with respect to loan, slightly below with respect to deposit as we go through year 4, but we're confident we're going to hit our target numbers.

Our view on Boston has always been kind of a macro holistic view on the Boston market that it's one of the economic drivers if not the economic driver in the Northeast outside of New York. So as you know, we've had a lot of loan activity there, even before we established our flagship office in 2009. And if you now look at the totality of that market, we've got a full complement of retail, business banking, wealth, commercial, specialty lending, and it's certainly with New York, Philadelphia, the 3 big metro drivers of profitability and growth for the bank.

So we're very, very, very pleased with the fact that we made that move and it's helped us both from a direct financial contribution perspective, and it will also help the lines of business.

From an M&A perspective, we continue to take a really disciplined approach. And our view is we've got 2 hurdles for M&A: One is financial, but the other one is strategic as well. So if you think about us doing a whole bank acquisition to get more banking-center footprint, it's unlikely for us to do a tuck-in acquisition in those markets because we have a stated strategy of growing HSA, expanding and becoming more commercial and optimizing our community bank, which we have and I think Boston is a great example of that.

So we never say never. Obviously, we look at a lot of stuff from a strategic perspective, but I think we're being really disciplined, and thus far, there hasn't been a really appealing opportunity for us in footprint.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [55]

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Okay. And then just a follow-up. So you're 20 branches now in Boston, is that correct?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [56]

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No. There's 1 or 2 less.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [57]

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16.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [58]

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16. Okay. And the thought of doing any de novo in addition to what's currently there is unlikely. You're also going to stay put at these levels. Is that how you're thinking about that?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [59]

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Yes. So again, I hate to box us, and I think unlikely is probably a good word, but we are thinking about the way our retail distribution looks. So for instance, in Boston, we've got these 16 banking centers that have pretty significant square footage, right? That's what they were when we took over for Citibank. If there was a reasonably efficient way for us to have more and smaller locations, you could see us trade out one big one for 2 small ones if we thought that was better. So it's really about real estate optimization at the end of the day.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [60]

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Okay. Great. And then just last question on Boston. I know that some of the centers were very large in square footage and you all had done some work I think on subleasing. Have you all maximized where you wanted to be on that? Or is that an area that we could continue to see come down in noninterest expense? Or how should we think about that?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [61]

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Yes. No, I think that effort continues. There are still some banking centers that, by our standards, are -- have too much square footage, and we'll shrink those down to what we think the appropriate square footage is. So that effort will continue.

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Operator [62]

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

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [63]

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Just wanted to touch base on the expansion markets and how the success of commercial growth is going in the Philly and D.C. markets. And on the heels of that, would you look at expanding that strategy to any other markets?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [64]

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Great question. And I think we've been very pleased with our expansion so far. In Philadelphia, we're doing well in middle market. We've had an established commercial real estate activity there for more than 10 years. We've actually just added a new terrific lender down there, and he's already got some significant momentum. And so what I would say is -- and you know this from what we've talked about, we've kind of taken a deliberate longer-term patient approach to these geographic expansion moves.

I think about New York and getting questions a few years ago on whether we would ever get to scale. And now we've really got great momentum there with I think something like $0.5 billion in exposure and a lot of great direct customers in our New York Middle Market.

So Philadelphia has really started to ramp up in middle market with the curve. So we've taken the same approach in Providence, Boston, White Plains, New York City, Philadelphia. You know we have real estate and asset-based lending in Washington, D.C. And again, we mute the growth expectations in order to make sure that we're not taking undue risk in those markets, and that's worked.

So there has been a pause for the last couple years in moving to the next kind of contiguous geographic market. And I think for us, it has a lot to do with the macro environment, Jared. So we do feel like we're closer to the end of this cycle than the beginning of this expansion cycle. So I think it get -- while it gets more challenging and there's a lot of liquidity and there's a lot of competition in the market, it's not always the best time to go into a new market.

So while we're constantly evaluating those opportunities that will allow us to get to economic profit quickly, given the macro circumstances and what we've seen so far, we have not moved and we do not have any near-term kind of 12-month plans to open up another middle market office in a contiguous metro market.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [65]

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Okay. And then in light of the changing rate environment and the expectation now for lower rates, should we expect to see any broader balance sheet repositioning going into this?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [66]

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So Jared, we, as you know, peaked in asset sensitivity in the third quarter of '17. And since then -- and I think on Page 19 of the -- of our earnings deck, you can see the progress that we've made against reducing some of our asset sensitivity, which is the goal as we look at the rate environment.

Obviously, things like the purchase of the fixed rate mortgage portfolio, which was funded with short-term borrowings, helped reduce the asset sensitivity. We swapped, as I indicated in my comments, the senior note issuance from Q1 to floating. That shortens up borrowings. During the -- we also purchased approximately $200 million in floors to protect on the downside. But we continue to look at ways to protect net interest income as John indicated. And so there is a host of levers that we continue to reevaluate and evaluate during the course of the quarter.

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Operator [67]

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Our next question comes from the line of Casey Haire with Jefferies.

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Casey Haire, Jefferies LLC, Research Division - VP and Equity Analyst [68]

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Just a couple quick follow-ups on the NIM. Number one, and apologies if I missed this, but the securities reinvestment yield in the current rate environment versus the 3.01% existing, where is that today?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [69]

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So we're reinvesting -- it's rolling off at about 3.10%. It's coming in about 2.65%.

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Casey Haire, Jefferies LLC, Research Division - VP and Equity Analyst [70]

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And then just on the borrowings, can you give us a sense if we do get a Fed cut, how -- what kind of beta we could expect on the borrowings?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [71]

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Sure. We're primarily FHLB, and so it's about a 90% beta. Those write down at the market.

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Casey Haire, Jefferies LLC, Research Division - VP and Equity Analyst [72]

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All right. And then just last one on the -- just on the expense front, the -- I know you guys are trying to expand Commercial Banking, and there was a decent uptick on the expense run on tech and I guess hires. Was that -- I mean, were you guys just taking advantage of some overearning on the swap side? Or is that -- or are we looking at a ramp-up in Commercial Bank spend within reinvestment?

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [73]

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No. That shouldn't be a sustained increase. Look, we're always very careful to say if you look back at our PPNR year-over-year CAGR in Commercial Banking, we've, for a sustained period of time, been able to grow around 10%, right? Both the loans and the PPNR. But in any one given quarter or even any one given year, where obviously if we have the opportunity to attract talent or the opportunity to invest in our cash management platform, which some of that technology expense is for so that we can get lower-cost funding directly from our Commercial Banking customers, we're going to do that.

And we mentioned on the last couple of calls, we also implemented a kind of an end-to-end commercial loan portfolio digital system that allows us not only to be more efficient in the way we underwrite and book and approve loans, it also allows us to more effectively monitor risk in the portfolio, which I think obviously all of you would be happy about.

So what you do see right now in the cycle is a couple million dollars in extra investment that should not single -- signal, at all, a sustained increase in the expense base or reduction in the overall efficiency ratio of the Commercial Bank. It's really just investments that we can continue to lever to grow revenue over time.

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Operator [74]

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Our next question comes from the line of Ken Zerbe with Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [75]

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With the HSA deposit costs, so 20 basis points. It's been pretty stable for the last year obviously. Could you just remind us like do you guys have any fiduciary duties to offer competitive rates in HSA? And if not, then the other flip side is, why even offer 20 basis points at all? Why not just go to 0 or something very, very low?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [76]

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So Ken, it's Glenn. And within that 20 basis points are a series of tiers. So the lower tier being $1.01, it's like at 5 basis points. It goes all the way up to like 45 basis points. So that's the blended average of those rates.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [77]

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Okay. So the 45 basis points is for like the highest account balance someone could possibly have?

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [78]

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Yes. Correct.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [79]

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Okay. Then I guess it goes back to same question, which is, like I could go out and buy a money market fund and get like 230 or so currently. I guess do you have any obligation to pay current rates on -- due to the most higher amount?

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Charles L. Wilkins, Webster Financial Corporation - EVP and Head of HSA Bank [80]

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There's no specific obligation. But what we do is we keep our rates within kind of the middle of the pack with current competition. And as we've talked about before, it's not a -- it's really not a point of competition that it really tends to be more on capabilities, things like investment capabilities and so on. And we have not seen -- we're not getting pressure run rates either up or down. So I don't expect them to move materially over the near term.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [81]

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Ken, one of the things we've seen over time because this has been kind of an age-old question is that because there is an investment option as you get big dollars, the average balances are still -- across the full $8 billion, the average balances across the 3 million accounts are pretty low.

So people don't seem to be particularly rate sensitive. If they have $700 in their account, they're thinking of it more like a 401(k) or an HRA. And then once they get to a threshold where they're starting to say, hey, wait a minute, I've got real dollars in here and I'm losing, they can immediately, very efficiently and at low costs, sweep into an investment account and control their own destiny with respect to the financial result. And we think that's sort of been the valve that has kept there from being kind of market pressure on rates from the consumer.

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Glenn I. MacInnes, Webster Financial Corporation - Executive VP & CFO [82]

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Yes, I'd also add that for those 70% that are transaction account holders, it acts more like a checking account than it does a savings account, right? So that has an impact on rates as well.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [83]

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Got you. Okay. That helps. And then my second -- actually, I have a comment more than a question, but you're certainly welcome to respond.

With the Cigna contract that we're all talking about, I know you've been asked a couple times on this, it feels like you guys are just sort of dancing around the issue a little bit. Like I know you said, you expanded and extended the relationship, but you refuse to comment on whether you actually re-signed Cigna. I just worry that if we all kind of later find out that the contract was not re-signed but the expanded and extended related to something else, I just worry that there could be some risk involved with that.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [84]

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John, I appreciate -- Ken, I appreciate the comment. And obviously, where we respect the relationship we have with Cigna in terms of both sides not disclosing terms of the agreement. And I think it may seem like I'm being a little cute, but the reality is, we have a contractual relationship with Cigna, one that started 5 years ago when we began a partnership with them. We've extended and expanded that relationship. And I think that that's a clear answer.

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Operator [85]

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Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Ciulla for any final comments.

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John R. Ciulla, Webster Financial Corporation - President, CEO & Director [86]

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No, thank you very much. Thank you for your continued interest in Webster. And I hope everyone has a terrific day.

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Operator [87]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.