Webster Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 11 Oct 2013

[Operator:]

Good morning, and welcome to Webster Financial Corporation's Third Quarter 2013 Results Conference Call. 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 results -- these forward-looking statements on current expectations 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 within the Securities and Exchange Commission, including our Form 8-K, containing our earnings release for the third quarter of 2013. I'll now introduce your host, Jim Smith, Chairman and CEO of Webster. Please go ahead, sir.

[James C. Smith:]

Thank you, Kevin. Good morning, everyone. Welcome to Webster's Third Quarter Earnings Call and Webcast. I'm joined by CFO, Glenn MacInnes, for about 20 minutes of prepared remarks focused on business and financial performance in the quarter, followed by your questions. Beginning on Slide 2. Webster delivered solid third quarter results, as our bankers continued to excel in service to our customers and communities. Solid performance was driven by several factors. A stable net interest margin, unchanged once again linked-quarter at 3.32%, was aided by strong commercial loan originations and resulted in another quarterly record for net interest income, which grew more than $5 million year-over-year. Commercial and commercial real estate loans grew at a 14% annualized rate from June 30, as well as 14% year-over-year. While core noninterest income declined $1.7 million from 1 year ago on a reduction of $5.8 million in mortgage banking revenue, total revenue, nonetheless, grew by 2%. Core expenses declined both linked-quarter and year-over-year, an essential outcome given the anticipated reduction in mortgage banking revenue. Positive operating leverage of 3.9% kept the efficiency ratio right at 60%, compared to over 62% 1 year ago. Improved asset quality was marked with another linked-quarter decline in commercial classified assets, a 5% decline in nonperforming loans and the lowest gross charge-off since the fourth quarter of 2007. Rising housing prices and lower debt service are having a positive effect on distressed consumer's payment behavior. Given linked-quarter loan growth of 2%, or 7.5% annualized, and improving loan quality, the loan loss provision was flat linked-quarter and up $3.5 million year-over-year. The result was an 8.4% year-over-year increase in core pretax, pre-provision earnings, a 1.5% increase in pretax earnings and a 2.3% increase in earnings per share. Return on assets reached 93 basis points and return on equity was 8.9%, still short of our goal to deliver economic profit, but bringing us ever closer to our goal to be a high-performing regional bank. Our capital position remains rock solid, and each of our key capital ratios saw increases from June 30 on the basis of another solid quarterly earnings performance. These ratios continue to be well above our internal targets and the fully phased-in Basel III well-capitalized targets. Our capital strategy provides us with the ability to support our asset growth, returning capital to shareholders through dividends and selective buybacks and confidently pass the annual regulatory severely adverse stress scenario. As indicated at our recent Investor Day, a target of 10% for the Tier 1 common risk-weighted ratio allows us to meet these objectives. We will exceed that target today. With regard to balance sheet sensitivity, we continue to be well-positioned for the long end up interest rate scenario. Economic activity in the Federal Reserve's first district of Boston, which includes the bulk of our 4-state footprint, continues to expand at a modest pace, according to the most recent Fed Beige Book. The market for single-family homes and condos continues to make a healthy recovery as sales and prices are increasing, the days-to-market ratio is falling and more buyers are entering the market, which is good news for Webster, given our increased penetration of the purchase mortgage market. Other indicators show that the state of Connecticut, which is the heart of our franchise, has added over 14,000 jobs through 8 months this year, and the trend remains positive. Turning now to the line of business performance. Slide 3 summarizes our Commercial Banking results. Overall, loans were up $200 million, or 4%, from June 30 and they're up 15% from 1 year ago, as originations set a record for the third quarter. We also sold down nearly $80 million during the quarter as part of our agent-led business. Our agent-led transactions generated fees of $1.2 million in the quarter, up from $800,000 in Q2. Portfolio yield decreased by 9 basis points from the elevated second quarter level, which had benefited from interest income recapture on a nonperforming loan that paid off and from incremental yield related to the carry period for a sizable agent-led transaction. The yield on new fundings of 3.86% is more representative of the portfolio and the market. Though the commercial bank pipeline is down slightly from Q2 due to strong late-quarter closing activity, loan activity remains strong. Deposits of $3.3 billion grew almost 16% year-over-year, while the cost of funds was 2 basis points lower. Strong linked-quarter deposit growth reflects seasonality in government deposits as well as the acquisition of new clients. Cash management services are gaining traction as we invest in our product suite. During the quarter, we officially launched our eighth regional hub from our asset-based lending headquarters in New York City, having recruited a veteran regional president with a track record and skills to grow our portfolio in this very attractive market. We're confident in our successful, repeatable business model, as evidenced by our success in our Boston regional hub, which is now over $1 billion in loans. Slide 4 reviews our Business Banking unit, which has seen year-over-year loan growth of 10%. Our portfolio yield was down 6 basis points from Q2, reflective of continuing runoff of higher-yielding loans, though the yield on originations rose to 4.66%, up 35 basis points from both linked-quarter and year-ago quarters. Business banking deposits exceed loans by 74% and provide low-cost funding across the bank. That cost [ph] of 8 basis points is down 1 basis point from Q2. Transaction accounts now comprise about 75% of these deposits and have grown over 9% year-over-year. Our overall consumer loan balances have declined, certainly now that the personal bank have declined about 2% over the past year, primarily due to ongoing consumer deleveraging. Residential mortgages are essentially flat, largely driven by our strategy of selling conforming fixed-rate loans. The personal bank portfolio yield declined 1 basis point, while the yield on new originations increased 14 basis points. Total consumer lending originations were down 12% in the quarter. First mortgage originations declined 15% to $309 million, and the mortgage pipeline for sale dropped 53%, driven by the sharp slowdown in refinancing activity. This resulted in a 90% decrease in mortgage banking revenue, regarding which, Glenn will provide more detail. On a more positive side, we continue to see increases in purchase mortgage originations, given our emphasis in this area. In the third quarter, purchase mortgage originations represented 53% of total residential mortgage originations, compared to 40% in Q2 and 36% 1 year ago. We expect mortgage banking expenses to be 20% lower in Q4 than they were in Q2. The yield on new originations rose to 3.97%, up 14 basis points from the linked-quarter and 12 basis points from 1 year ago, driven by increases in mortgage and home equity rates. Our credit cards program continued to improve our noninterest income, growing by 23% over the previous quarter. Personal Banking investments, assets under administration, grew 8.1% year-over-year to $2.5 billion, driven by a 9.4% increase in sales production and increased market valuations. Revenue from Personal Banking investments correspondingly grew by 20% year-over-year. Transaction account deposits grew 5% over the prior year and now represents 25% of total deposits, up from 23% 1 year ago. Our emphasis on transaction account growth, combined with lower cost of CD renewals, has caused a reduction of 4 basis points in the cost of funds this quarter and 15 basis points year-over-year. We continue to work on optimizing our delivery channels. Positive self-service channels that includes ATMs and mobile deposits represent 31% of total deposits made, compared to 19% 1 year ago. Banking center transactions are down 12% from the year ago and 25% of our Consumer Deposits households are already active mobile customers. Since launching Mobile Deposit Capture for consumers in June, we've processed over 35,000 deposits. During Q3, we opened a new 1600-square-foot banking center adjacent to the University of Connecticut main campus and relocated our flagship branch in Waterbury. The Waterbury location resulted in a space reduction of 9,000 square feet, while adding the convenience of WiFi and digital displays. These are examples of how we're making banking easier, while creating efficiencies by shrinking the size of our physical footprint where it makes economic sense. Slide 6 presents the results of the Private Banking unit. Dan FitzPatrick and his team are in the process of building a top-notch Private Banking business at Webster, and the early results are favorable for what we view as a primary growth opportunity over the next few years. Loans grew over 3% linked-quarter and 21% year-over-year. The large jump in the pipeline is a leading indicator of what's to come, as we provide clients our full range of banking and investment services. We saw deposit growth of 6% linked-quarter and 19% year-over-year. Assets under management, adjusted to reflect the sale of nonstrategic AUM portfolio during Q3, increased 7.7% year-over-year and should benefit from the ramp-up in loan and deposit growth, as well as the quality of our investment in fiduciary advice and our expanding private banker team. Slide 7% presents the results of HSA Bank, which grossed $2 billion in footings at September 30, including about $1.5 billion in deposits. That's quite a jump from $1 billion in footings reached less than 3 years ago, and is attributed to HSA Bank's singular focus on providing financial products and expert service to consumer-directed healthcare insurers, sponsors and end users. Deposits grew modestly from Q2, as is normally the case, since most of our deposit growth occurs in the first quarter of the year. Year-over-year, deposits and deposit accounts continued their 20% growth rate. We continue to tightly manage a multitude of rate structure on these long-duration, low-cost health savings accounts, which resulted in a 4-basis-point, linked-quarter reduction in the cost of funds. We expect the CDH [ph] market will grow at least 20% annually in the foreseeable future, as the Affordable Care Act changes take hold and consumers assume more responsibility for the cost and quality of the health care services they consume. Slide 8 shows our overall loan balances and originations on a consolidated basis compared to the line of business breakouts we've just reviewed. Overall, our loan balances are $12.5 billion, an increase of almost 2% from June 30 and over 6% from 1 year ago. Note that balances in every commercial category are higher linked-quarter, a sign of continuing solid performance by the Commercial Banking units. Total originations were 24% higher than 1 year ago and reflect, once again, strong commercial bank performance. The overall decline in originations from Q2 reflects the sharp drop in mortgage refinance activity. Before turning it over to Glenn for comments on financial results and the outlook for Q4, I want to acknowledge the service of Jerry Plush, who, as you know, recently left Webster. In his 7 years here, Jerry made many important contributions. He and I enjoyed a close working relationship, and I always admired his remarkable energy and creative leadership. Jerry's colleagues and I appreciate his commendable efforts on Webster's behalf, as we've progressed along the path to high performance. We all wish Jerry success and happiness in the years ahead. Glenn?

[Glenn I. MacInnes:]

Thank you, Jim. I'll begin on Slide 9, which summarizes our quarterly trend of net income available to common shareholders and key performance ratios. Of note, earnings are up from both prior year and linked-quarter despite the adverse impact of this quarter's decline in mortgage banking and the $2 million of additional preferred dividend cost related to our issuance in December of 2012. As you see, return on average assets was 93 basis points in Q3, and return on average tangible common shareholders' equity was 12.43%. Slide 10 highlights our core earnings drivers. Over the next few pages, I will discuss in more detail the key drivers of our earnings growth but would note, our average interest earning assets grew $243 million, compared to the second quarter and our net interest margin remained flat for the third straight quarter at 323 basis points. Combined, this resulted in the quarterly record in net interest income of $150 million in Q3 and an increase of $2.9 million from Q2. Noninterest income declined by $5.9 million from Q2, primarily due to a dropoff in mortgage banking results, which were the result of a decline in mortgages originated for sale. This resulted in a reduction of $5.2 million in revenue that I will discuss in more detail on Slide 14. The last primary driver of our earnings growth is our continued prudent management of core operating expenses, which reflect a decrease of $1.7 million from Q2. Taken together, our core pretax pre-provision earnings of $75.1 million were $1.3 million lower than Q2, while up about 9% from prior year. Slide 11 highlights the components of our net interest income in Q3 compared to Q2. The quarterly growth in average earning assets of $243 million more than offset a 5-basis-point decline in the yield on interest-earning assets. This resulted in an increase of $1.6 million in interest income compared to Q2. Average deposits increased $285 million, while we reduced the rate pay by 4 basis points. The reduction on the cost of deposits reflects an increase of $120 million in average demand deposits combined with a decline of $111 million in average CDs, and a 16-basis-point reduction in the rate paid on CDs compared to Q2. CDs represent our highest cost of deposits at 110 basis points, but for the remainder of the year, 15% of our CDs, or approximately $319 million, mature at a rate of 56 basis points. To the extent they roll over, our current average cost is around 30 basis points. Our incremental wholesale funding is done primarily at a short-term -- at short-term rates at around 20 basis points. So as you see, interest expense for the quarter declined $1.2 million, which contributed to the improvement in net interest income. The net result is a $2.9 million, or 2%, increase in net interest income versus prior quarter and a flat net interest margin of 323 basis points. Jim discussed the activity in loans and deposits, so I will discuss our investment portfolio, beginning on Slide 12. As you see, we continue to keep the investment portfolio flat at $6.4 billion as we reinvested our cash flow in the quarter. Cash flows during the quarter amounted to $369 million with a yield of 316 basis points. During the quarter, we purchased $399 million of securities at an average expected yield of 236 basis points and a duration of 2.9 years. Most of our purchases were fixed-rate agency MBS, although we added $82 million of floating-rate CMBS and collateralized loan obligations at a yield of 195 basis points. With the 10-year rate essentially unchanged during the quarter, the unrealized gain in the AFS portfolio increased by $8 million. 7% of the total portfolio, or $428 million, consists of high-quality, floating-rate CMBS and CLOs, yielding around 184 basis points, all of which are in AFS. Our fixed-rate agency MBS purchases have been concentrated in higher-coupon, higher-premium bonds, which we think will perform better than lower coupons and will increase in yield as rates rise. Assuming the 10-year stays flat or increases, we would expect our investment portfolio yield to have reached the bottom in Q3. Slide 13 provides the detail on our interest rate risk profile. With the short end of interest rate curve seemingly anchored for the next year or 2, our attention has been focused on the impact of rising long-term rates. The long end up analysis is part of our normal quarterly disclosure and monthly AOLC [ph] process. We showed data as of June 30 at our recent Investor Day and have refreshed it here as of August 31. You can clearly see the growing benefit to PPNR over time. Note our PPNR analysis reflect scenarios with an immediate increase in long-end rates compared to a scenario with no change in rates. The benefit from higher rates is primarily related to slowdowns in prepayments of higher-yielding assets, the reduction of investment premium amortization and higher new-asset yields. While most use parallel shift scenarios to assess asset sensitivity, that assumes an increase in short-term rates that still seems to be off sometime in the future. We will continue to take gradual steps to prepare for the eventuality of higher short-term rates. But in the meantime, we wanted to highlight our interest rate risk profile for what seems to be a likely scenario. Slide 14 provides detail on noninterest income. As previously highlighted, there was a $5.9 million reduction on a linked-quarter basis, which equaled the decline in mortgage banking revenue. During the quarter, mortgage settlements declined by 8% versus prior quarter. In addition, pricing and supplements comprised 45 basis points. This resulted in a $1.4 million reduction in revenue. The remaining $4.5 million reduction was attributable to a 53% reduction in our originated-for-sale pipeline and 94 basis points of compression. Note that we have approximately $1.2 million of unrealized gains in our loans held for sale that we were unable to record under the lower of cost or market rules. We expect to recognize most of this in the fourth quarter, assuming a stable rate environment. Wealth and investment services revenue declined by $825,000 from Q2. $200,000 of the reduction was due to a sale of a nonstrategic portfolio of assets under management. The remainder primarily reflects the seasonality impact on production levels Loan fees grew by $335,000 in Q3, driven primarily by an increase in loan servicing fee income. So apart from mortgage banking, core noninterest income was essentially flat to Q2 and 10% higher than a year ago. Slide 15 highlights our core noninterest expense, which decreased compared to both Q2 and 1 year ago. A decline of $906,000 in compensation and benefits expense accounted for a little over half of the linked-quarter decline, but we also saw notable reductions in technology and equipment, deposit insurance and loan workout expenses. I would also note that during the quarter we recognized a $1.7 million correction for a tax provision established during 2008, 2009 and 2010. This resulted in an effective tax rate of 27.7% during the quarter. As you know, tax expense is a noncore expense, so the correction had no impact on our efficiency ratio. Our efficiency ratio is highlighted on Slide 16. Our core efficiency ratio remained at the 60% level, even taking into account the linked-quarter revenue decline of $3.1 million. Our ongoing commitment to achieving positive operating leverage should help us maintain the efficiency ratio at or below 60%. Turning now to Slide 17, which highlights our asset quality metrics. Nonperforming loans declined by $9.1 million in the quarter, led by a reduction of $8.1 million in the residential mortgage portfolio as a result of lower inflows and active resolution efforts. We also had a decrease of $1.5 million in past due loans. For the quarter, a $7.9 million decrease in commercial loan mortgage reflects the resolution, as expected, of loans that went past due at June 30 from a high level of Business Banking maturities in a single commercial loan. Past due residential mortgages increased $4.7 million from June 30, primarily as a result of a positive residential loan movement from nonperforming into delinquency. We've made continuing progress on reducing commercial classified loans, which declined over 10% on a linked-quarter basis and remained below $300 million in total. Assuming recent trends remain intact, we think continued improvement in asset quality can be expected in Q4 and beyond. Slide 18 highlights our capital position. All capital levels improved over Q2 while supporting $280 million of balance sheet growth, once again highlighting the strength of our core earnings. So before turning it back over to Jim, I'll provide a few comments on our expectations for Q4. Overall, average earning assets will likely grow in the range of 1% to 2%. We expect average loan growth in Q4 to be in the 2% to 3% range, with continued growth in our Commercial Banking business. Assuming that loan prepayments stay constant with the Q3 level, we expect net interest margin to be about flat. Of course, NIM will vary with loan prepayment activity in loans returning to performing status. That being said, we expect net interest income to be approximately $1 million to $2 million higher than the Q3 level, driven by loan volume. Our leading indicators of credit were encouraging during the quarter, and we continue to signal further improvement in asset quality. Given our outlook of Q4 loan growth, we could see a modest increase in the Q4 provision. Regarding noninterest income, we do not expect to see a return to the high mortgage refinance activity that we saw earlier in the year. We believe mortgage activity levels will stabilize as the market moves more toward purchase activity with a larger-arm component benefiting portfolio loan growth. Lastly, the favorable local mark I mentioned earlier should positively affect mortgage banking revenue in Q4, assuming a stable rate environment. We continue to make progress in the areas of wealth and cash management services and expect additional fee revenue from these activities. So taking it all together, we anticipate an increase of up to 10% in noninterest income in Q4. We would expect to see core operating expenses modestly increase from Q3, as we continue to invest in our business while focusing on operating leverage to maintaining an efficiency ratio at or below 60%. And we expect our effective tax rate on a non-FTE basis to be around 30% in Q4. Based on our current market price and no additional buybacks in the quarter, we expect to see the average diluted share count to be approximately 90.4 million shares. With that, I'll turn things back over to Jim for concluding remarks.

[James C. Smith:]

Thanks, Glenn. In summary, Webster's third quarter results represented a continuation of our progress, as we implement strategies to produce positive and growing economic profits. We're building profitable relationships across the organization, adapting rapidly in light of changing consumer preferences and controlling expenses, while asset quality continues to improve and our capital position remains rock solid. We've taken another step this quarter toward our goal to be a high-performing regional bank. We're now pleased to take your comments and questions.

[Operator:]

[Operator Instructions] Our first question today is coming from John Pancari from Evercore Partners.

[John G. Pancari:]

Your loan growth came in at the higher end of your guidance that you provided mid-quarter and at your analyst day. Can you give us just a little bit more color on what came in better than you were looking at the time you gave guidance? And what areas are you most positive on in terms of driving the growth in future quarters?

[James C. Smith:]

Yes. Actually, we're pleasantly surprised that the quarter ended strong. And I think those -- that's what actually occurred was strong, particularly on the Commercial Banking side, in virtually every area of Commercial Banking. Commercial real estate in particular and the multifamily group got a bump coming toward the end of the quarter. But generally, it was stronger-than-anticipated closings on the commercial side.

[John G. Pancari:]

Okay. And on that -- along those lines, in terms of the loan growth outlook, is it fair to assume you'll stay in this 2% linked-quarter range here in the coming quarters? Or do you expect a material change from that level?

[Glenn I. MacInnes:]

Yes, John, it's Glenn. At least in the upcoming quarter, we feel pretty good about the pipeline. And Joe and -- Joe Savage's team have built a pretty strong pipeline going into 2014 as well.

[Operator:]

Our next question is coming from Dave Rochester from Deutsche Bank.

[David Rochester:]

Outside of that $1.2 million gain that you're talking about for 4Q in the mortgage banking line, just given your thoughts on mortgage activity going forward, where should we expect that mortgage banking line to normalize?

[Glenn I. MacInnes:]

Yes. So for the fourth quarter, I think, that we'll probably see settlements or volume for sale at around $100 million mark somewhere around there. The gain on sale rate, I would say, $150 million to $160 million. And so all in, I'd say, you'd probably expect to see $2 million to $2.5 million range, including that recapture of $1 million. Going into 2014, I think the more normal trend, given the mix between refi and purchased, you'd expect to see about $150 million to $200 million a quarter. You'd also probably see the gain-on-sale rate come down to more normal $125 million. So for the year, you'll probably see about $10 million on a full-year basis.

[David Rochester:]

Great. So you definitely see upside from here in that line item?

[Glenn I. MacInnes:]

Yes. I think, quarter-over-quarter, and then going into next year, I think year-over-year will be down. But I think a more normal number for us is going to be $200 million a quarter and 125 basis points.

[David Rochester:]

Great. That's good color. And then I was just wondering how much of the expense reduction this quarter potentially came from that mortgage banking operation? Did you realize any expense saves there?

[Glenn I. MacInnes:]

Not -- it's not fully in the quarter. We did take some positions out. I think on the backside it was probably about 15% to 20% reduction in costs. But you don't see the full benefit of that in this quarter.

[David Rochester:]

Can you kind of quantify what that full quarter benefit is?

[Glenn I. MacInnes:]

Yes. I mean, there has been some redirect on the consumer side on HELOCs and stuff like that. But I think, generally, it's about $1 million, $1.5 million that you'd see on an annual basis, as of right now, given the current volume.

[David Rochester:]

Great. And you'd mentioned the stats from the CDs repricing in 4Q. Would you happen to have a schedule for next year? So is that -- the CDs that you're saying are going to roll off at a much lower cost than where we're seeing the cost for the total CD portfolios? Just wondering if you've got some of the higher-cost stuff rolling off next year.

[Glenn I. MacInnes:]

Yes. Not a lot of higher stuff next year. I mean, 58 -- I think the total portfolio is at $110 million. So nothing real big coming off next year.

[Operator:]

Our next question today is coming from Steven Alexopoulos from JPMorgan.

[Steven A. Alexopoulos:]

I wanted to start looking at the -- I guess, it was a 50-basis-point decline or so on the $516 million of Commercial Bank loan fundings. Are you guys needing to get much more competitive on price to put up the growth numbers you've been showing?

[James C. Smith:]

There has been competition on price, but we actually feel that our spreads have held up pretty well. In this case, we were comparing to a quarter that was an outlier on the upside when you look at Q2 for the reasons that I explained in my remarks. So yes, there is pricing pressure. But when we look at our performance -- and we measure this. Actually, we have an outside group take a look at it. We know that our pricing is holding up pretty well. And with spreads at about 308 basis points in the quarter, they're holding pretty well.

[Glenn I. MacInnes:]

The only thing I would add to that is that, Joe would -- we'd say in the commercial, the deals we don't participate in, the ones we walk away and split now about 50/50 between price and structure. And that was if you go back 1 year, it was more structure. The last 2 quarters has been more price, so it's sort of leveling out.

[Steven A. Alexopoulos:]

Okay. Are you guys noticing any disruption to the loan pipeline with a little bit of headlines around the government shutdown?

[James C. Smith:]

Not really at this point. I mean, we know that it's tough to get an SBA loan and working hard with our clients to make that happen. So where the government is directly involved, some concern. I guess the question is whether it's going to have a psychological impact at some point down the line.

[Steven A. Alexopoulos:]

Okay. And just final question. With the efficiency ratio now just above 60% and you guys have spent a lot of time, right, getting that below 60% over the past year where you're saying mortgage is going to shake out, do you need to refocus the bank on new efficiency initiatives to make some traction there?

[James C. Smith:]

I would say we don't need to refocus because we're constantly focused on it all day, every day. And we continue to make good progress on the expense side, and you saw the Q3 relative to Q1 and Q2. And so we're looking at driving positive operating leverage by improving revenue and controlling expenses, including outright reductions in some areas. We've got programs for ECM, which is the Electronic Content Management, that could make a very significant impact on the expense side over the next couple of years. You've heard all the things we've been talking about on reducing square footage in the branch system, moving to the Universal Banker as we downsize the number of personal bankers overall because we're pushing transactions to the automated side. There are tens, maybe hundreds, of initiatives that are taking place in the company to control or drive down expenses even as we try to improve the revenue. So being at 60%, while we continue to look for ways to drive it into the 50s, is consistent with where we thought we'd be about now.

[Glenn I. MacInnes:]

Yes. The only thing I would add is that, also, if you look on the revenue side, obviously, we're up. Net interest income this quarter was a record for the organization. And where we're focused a lot of effort is on the Private Banking and Treasury & Payment services, which are fee-generating businesses. And we recognize that to be a top-performing bank. We need to get our annuity net interest income up as well. So that's another driver, in addition to all the expense rationalization.

[Operator:]

Our next question today is coming from Bob Ramsey from FBR Capital Markets.

[Bob Ramsey:]

Real quick on the margin front. Great to see that margins were stabilizing and sounds like it's going to be there -- stay there. I know you all said in the outlook it sort of assumes prepayments stay where they are. How much of a benefit was there from prepayments this quarter? I can't remember if you all said that in your remarks.

[James C. Smith:]

I didn't, but it was about 2 basis points. So -- and it's been 2 basis points for the last 2 quarters. So our core, if you just strip that out, say, our core of 3 21, was 3 21 again this quarter.

[Bob Ramsey:]

Okay, great. And I'm curious, too. I know you said that on the securities portfolio side, you think that yields probably have bottomed out this quarter there. But it sounds like you're still purchasing new securities below the portfolio yield. How was it that you sort of get to a stable overall portfolio yield?

[Glenn I. MacInnes:]

Yes. I think the premium amortization slows down as the portfolio goes out a little further, so that's a benefit. And that will be a -- it was a benefit in Q2 to Q3 and will be even more of a benefit going into Q4.

[Operator:]

[Operator Instructions] Our next question is coming from Ken Zerbe from Morgan Stanley.

[Ken A. Zerbe:]

Just a quick question on the taxes. Is there an opportunity for taxes to be lower? Because I know you mentioned the 30% as your expectation for fourth quarter. I believe that was your expectation prior to this. But if I read the press release right, you mentioned that, I guess, $0.5 million of the tax scheme that you took in the quarter related to reduction in your expectations for taxes this year. I'm just trying to make sure I get all the pieces right.

[James C. Smith:]

So that's the UTP runs, the state tax provision, which is going to bring us down to the 30%. It's already in that rate, so we think 30% is the right number.

[Ken A. Zerbe:]

Okay, so no change there. And then just a broader question on the economic growth or the loan growth. We've heard from other banks just saying that the improvement that we're seeing in the economy, albeit however modest it is, isn't necessarily translating a ton into loan growth. Obviously, you guys are doing very well on the loan growth side. Is Connecticut, the Northeast just simply a stronger market? Or is there anything else specifically that's driving the loan growth aside from economic factors?

[Glenn I. MacInnes:]

What's happening here is we're taking a bigger share of what's out there than we were before. We've added some bankers in the last couple of years. And in addition to the strong core we have, have been able to bring new clients to Webster. We also have been doing very well in Greater Boston. We're seeing traction in New York and Westchester County and now down into the city. We have our commercial real estate operations are on a regional basis, so we've had some success in the Philadelphia area. So when you look at the loan portfolio, it's not just the franchise, but it's the region around us as well. So we've got a little bit of a bigger market there for CRE, for ABL, for equipment finance. And all of those have contributed to our growth. I really -- I want to really be clear that I think that the quality of our bankers and the reputation of the bank and our ability to put out a term sheet and then live by it is key in our ascension in the considered set.

[Operator:]

Our next question today is coming from Jason O'Donnell from Merion Capital Group.

[Jason A. O’Donnell:]

Glenn, I apologize if I missed it, but with respect to the mortgage banking business, what was the dollar volume of mortgages sold in the third quarter versus the second quarter?

[Glenn I. MacInnes:]

So the dollar volume of our pipeline, there's 2 pieces. One is what we settled in the third quarter, and the dollar volume went from -- Q2 to Q3 went from 216 to 198 so an 8% reduction there. On the pipeline, which was the bigger driver of the revenue reduction, the mortgage pipeline went from 210 to 100, or a 53% reduction. And then you -- then we also had the impact of compressing rates going from 154 to 60 basis points on the pipeline.

[Jason A. O’Donnell:]

Okay, 154 to 60. Okay.

[Glenn I. MacInnes:]

Yes.

[Jason A. O’Donnell:]

Perfect. Great, that's helpful. And then on the expense front, given the objective that you all have in place to significantly reduce square footage going forward, how much do you think you can eliminate in the way of occupancy expense between now and, say, the end of next year?

[Glenn I. MacInnes:]

We're still -- I mean, I think, we're at a total of $49 million on an annual basis on occupancy spent. So I would say, take 10% off of that, somewhere around there. But does it all occur next year? No. Probably some into 2015 as well.

[Jason A. O’Donnell:]

Okay. So 10%, but that could be spread out between, let's say, next year and first of the following...

[Glenn I. MacInnes:]

Yes, at least.

[Jason A. O’Donnell:]

Okay. And then Jim, on the executive management front, have you and the board come to a decision yet as to whether you'll be filling the COO role or is that still an open question at this point?

[James C. Smith:]

We have not, it's still an open question. I do want to say though that we've got a very strong group of executives here who have closed ranks and have taken up the responsibilities. And I think I've already said to you separately that we've laid out what our plans are. We intend to complete those plans and meet our timelines. We've got a very good talent development program here. We have succession planning at every level in the company. And so this really has been an opportunity, over the near term, for our team to move up and show what they can do and do extremely well.

[Operator:]

Our next question is coming from Casey Haire of Jefferies.

[Casey Haire:]

Just a quick question on the loan growth guide, it feels, I guess, a little conservative. If we look back to your fourth quarters and years past, you guys have obviously done pretty well in the Commercial front with seasonality. I'm just curious, are you guys just being conservative? Or do you expect an acceleration and a slowdown on the consumer side of the house?

[James C. Smith:]

Yes. There was an acceleration last year in the fourth quarter, if you're comparing it to that, which was based off of a tax play or tax concerns, as well as, I think, it was the sequester going on back then, right? So there was a lot of pull forward last fourth quarter. I don't think -- we're not anticipating that in our forecast. And then I think that we'll probably also have some commercial real estate pay downs in the fourth quarter -- this fourth quarter as well. I think all things considered that that's why we are where we are from a guidance standpoint.

[Glenn I. MacInnes:]

And another thing, you mentioned the question about being conservative. I guess what we'd say is we don't want to overpromise. We're not conservative by design but we're careful.

[Casey Haire:]

Okay. And then on the fee side, wealth management was down quarter-to-quarter. I know that's an area that you guys are optimistic about. Why would that be down in an up quarter for market levels?

[Glenn I. MacInnes:]

So last quarter was a record for the organization on wealth management. This quarter, it was down about $823,000, or that's what it is now. And about $200,000 of that was as a result of the sale of nonstrategic assets under management. So that's about a third of the -- the other 2/3 were, quite frankly, just seasonality, the lower volumes.

[Casey Haire:]

Okay. Got you. And just last one for me. So on the capital management side, I know you guys are not focused on M&A right now. But why not use some of the excess capital? Or what's holding you back from using some of the excess capital towards share buyback, given a pretty attractive stock price?

[James C. Smith:]

Yes. Well, we've said that we would look at share buyback, but opportunistically. And that's just how we look at it. So we're funding our -- capitalizing our loan growth with the horizon looking pretty bright there. And looking at our dividend, what our payout ratio ought to be. And then we've got approved buyback capability that we'd use under opportunistic circumstances.

[Glenn I. MacInnes:]

The other thing I would add is that we've always done it with an eye toward our stress testing as well and the severely adverse scenario. And so that's another component as we look at our capital plan.

[Operator:]

Our next question today is coming from Mark Fitzgibbon from Sandler O'Neill + Partners.

[Mark T. Fitzgibbon:]

Glenn, I wonder if you could clarify for us the -- you'd mentioned there was $1.3 million in revenue recognition that was delayed in the mortgage banking business. Why was that exactly?

[Glenn I. MacInnes:]

It's the mark on the asset -- this is the timing of the lower of cost or market accounting. And what it does is it requires you to mark the asset, either the lower of cost or the market, in this case, the costs. And then as you sell the asset, you get to realize the gain. There's about $1.2 million that we will sell in the fourth quarter. And if rates stay constant, we'll realize the gain at that point.

[Mark T. Fitzgibbon:]

Okay. And then secondly, you guys have previously suggested a target for the reserve-to-loan ratio at sort of in that 1 20 to 1 25 range and you're basically there now. Would -- should we expect reserve releases to stop or slow dramatically? Or have you sort of recalibrated your target for reserve levels?

[Glenn I. MacInnes:]

Yes. So I think that when you look at reserve releases as a percent of earnings, it continues to come down, especially when you look at it versus prior year quarters. But really the driver there, Mark, is the portfolio quality, which, as you saw on our slide, continues to improve. So would it come down from the 1 27? Probably yes. I think that we've given guidance before saying that 1 20 was probably right, and we're always reevaluating that whether that's the right number. But that's going to be driven by the portfolio quality. You saw also that our charge-offs -- our gross charge-offs were down to the lowest level, at least in 5 or 6 quarters. So while net charge-offs weren't down, it was because of lower recovery. So there is a lot of favorable indicators that we're seeing both on the asset quality side and charge-offs side that lead us to evaluate our provision levels.

[James C. Smith:]

Right. So there is room for further modest reserve releases over the near term. But longer term, we'd expect that the provision would exceed the charge-offs.

[Mark T. Fitzgibbon:]

Okay. And then lastly, you talked a lot about the strong commercial pipeline. Could you tell us, in dollars, how big that is today?

[Glenn I. MacInnes:]

So I think that -- going into $300 million.

[James C. Smith:]

It's -- yes.

[Glenn I. MacInnes:]

About $330 million. $330 million?

[James C. Smith:]

Around $330 million. It's probably 10% lower what it was at the end of the last quarter, but it's actually growing as we speak.

[Operator:]

Our next question today is coming from Matthew Clark from Credit Suisse.

[Matthew T. Clark:]

Yes, just a couple of quick ones. You mentioned mortgage expense is expected to be down 10% in the upcoming quarter. Can you just quantify what the expenses were embedded in the second and third quarter run rates?

[Glenn I. MacInnes:]

Absolute dollars, I don't have that in front of me. But what I would tell you it's primarily in the compensation line because it's staff related. And it's -- the first tranche is all temporary health, and over time go away in response to volume reductions and then it gets more into the core. You see our $900,000 decline in compensation quarter-over-quarter. A piece of -- a component of that is that, but it's not a full component.

[James C. Smith:]

Actually, we benefit from a very efficient mortgage banking origination processing, closing and the like. We only have about 100 people, or slightly less, that actually support from the back office all the activities we have with our 80-plus mortgage loan originators in the market. Plus, we've got 20 people in the Customer Care Center. We've got our branches, our banking centers that are referring business as well. So very efficient to begin with and very careful to structure it that way, but there will be savings in Q4.

[Matthew T. Clark:]

Okay. And then on the premium amortization front, can you give us what the change was there in the quarter?

[Glenn I. MacInnes:]

Quarter-over-quarter, the amortization change was, let's see, about -- so it was about, let's see, about $600,000. If rates stay constant, you'll see an acceleration of that into the fourth quarter.

[Operator:]

Our next question today is coming from Collyn Gilbert from KBW.

[Collyn Bement Gilbert:]

Glenn, just a question on the loan yield. Could you just tell us what the blended origination yield was in the quarter, and then also what the roll-off yield was of loans in the quarter?

[Glenn I. MacInnes:]

Sure. The blended yield for the quarter, 3 79. Well, the production during the quarter. Roll off, I don't have in front of me, I'll have to come back to you. I just don't have that.

[Collyn Bement Gilbert:]

Okay. Okay. And then on the securities side, with you kind of getting to the bottom end of the yield, are you finding yourself managing that securities portfolio more to yield or duration? Because I know you guys, in the last couple of quarters, have been putting on a lot of shorter-duration paper.

[Glenn I. MacInnes:]

I would say it's more toward duration.

[Collyn Bement Gilbert:]

Okay. So even keeping that duration on the shorter end or trying to keep it where it is, do you still think yields can -- have bottomed here on the Securities side?

[Glenn I. MacInnes:]

Yes, we do.

[Collyn Bement Gilbert:]

Okay. And then just on the reserve comment. So if we're -- if we move, migrate to that sort of 1 20 or so over the next 3 quarters or whatever the timeline might be, are you anticipating then a pretty sizable drop in net charge-offs for next year? Because I'm just trying to reconcile the provision may be only up slightly for next year, you're still putting on some good loan growth. So I guess in order for that formula to work, it would have to assume that net charge-offs drop quite a bit.

[Glenn I. MacInnes:]

Yes. Our target is not to have net charge-offs at 47 basis points. So that will be a steady decline. You're not going to see it drop immediately. But I think a more normal charge-off number would be in the 30 basis point range. But it's just a matter of stepping down to that.

[James C. Smith:]

Right. And then going back to the comment made before, the overall asset quality, as well as the loan growth, will both be considered not only in terms of the provision, but in terms of what the overall coverage ought to be. The 1 20 isn't absolute at the bottom, it could be depending upon loan quality, it could be less than that.

[Operator:]

Our next question is coming from David Darst from Guggenheim Securities.

[David Darst:]

I wonder if you could quantify maybe what you see is the opportunity in the HSA Bank to integrate with the carriers and the exchanges?

[James C. Smith:]

Sure. Actually, our strategy in HSA Bank is to make sure that we have a full consumer-directed health care platform so that we provide the notional reimbursement accounts such as the health reimbursement accounts and flexible savings accounts, as well as HSAs, to give us a better opportunity to win business as we go forward, and to move upmarket to be able to talk directly with carriers and TPAs and benefits administrators, as well as large employers, and we've been moving in that direction for some time. We expect that platform conversion to take place sometime in 2014. It will give us the opportunity to offer that multi-purse product. So by doing that and recognizing that the world is moving more toward the personal responsibility, the consumer managing their healthcare expenses, it bodes well for growth overall in CDH [ph] accounts and, in particular, in HSA accounts. The providers that have the multi-purse find in the last 1.5 years or so that their HSA accounts grew much faster than they would have had they not had the multi-purse. Therefore, we think it's reasonable to expect a growth rate. We're not going to say it's going to keep growing at 20, but it's definitely double-digit growth in the foreseeable future. And it's even possible that adoption of these accounts could accelerate, which would create additional opportunity for us.

[David Darst:]

As you work on the platform conversion, is there a point next year where there's like a -- maybe a one time step-up in the deposit base?

[Glenn I. MacInnes:]

No. The step-up will come from improved results in the enrollment period. Most of the enrollments for these accounts take place toward the end the year. So we see them really show up in the first quarter of the following year, because that's when the enrollments take place. And then as you saw in the second and third quarters, relatively modest growth over the balance of the year. So it's by having the additional capabilities that will be more effective in gaining market share from the carriers and the TPAs and the like. So it's not a step-up. As immediately as a result of the platform, it's what the platform allows you to do in soliciting for new business.

[David Darst:]

Okay. And then maybe discussing the New York City hub, is there any particular focus, maybe commercial, real estate or CNI that, that team is targeting? And then, are you looking at that to increase the capacity or add more teams there? Or do you have the platform you want?

[James C. Smith:]

Yes. It's really -- it's broadly Commercial Banking, products and services, loans, deposits, cash management services. We already have our asset-based lending group headquartered where our regional president will be, which is part that we keep our expenses low as well. We already have begun recruiting additional bankers for that market. We expect, in particular, to see opportunities in commercial real estate, Middle Market, CNI and, as I mentioned, ABL. And of course, there's a big multifamily market there as well that we think that we could tap into.

[Operator:]

Our next question today is coming from Matthew Kelley from Sterne Agee.

[Matthew Brandon Kelley:]

On the $257 million of originations in commercial real estate during the quarter, how much of that came out of the Metro New York multifamily business? And what was the yield on that, would be the second question.

[Glenn I. MacInnes:]

So out of the -- for New York, let's see, for the quarter.

[Matthew Brandon Kelley:]

Yes, the multifamily, out of the $257 million.

[Glenn I. MacInnes:]

I would say, probably $34 million. It's not a real big number.

[Matthew Brandon Kelley:]

Okay, got you. And what were the yields on that compared to the overall commercial real estate origination yield?

[Glenn I. MacInnes:]

Probably mid-3s.

[Matthew Brandon Kelley:]

Mid-3s, got you. And then going back to the HSA Bank, how would you size up profitability for that as a stand-alone business? You take in deposits. You presumably are buying securities with that liquidity. You got a fee income stream. It looks like the fees cover the bulk of the expenses. So how would ROAs and ROEs stack up for that as a stand-alone business line? And how should we be thinking of that as that grows at detached [ph] rates going forward?

[James C. Smith:]

Well, we look at it really as providing low-cost deposits that have long duration and low elasticity; therefore, a very stable long-term funding source. So the way we look at it is to say, right now, the fee revenue covers about 90% of the expenses. Internally, we'd say we would price the deposits against our transfer price here for deposits of that duration. We put up higher capital against this business, as a deposit business, because it is a specialty business. And then we look at the kind of returns we get, and we definitely earn well in excess of the cost of capital. So if you are trying to figure out how to spread them, we'd say the spread, right about now, would be around 200 basis points.

[Matthew Brandon Kelley:]

Okay, got you. And then I just want to make sure we're clear. You're trying to integrate your products with the Aon Hewitts, Towers of the World that are creating the actual private exchanges that we're reading about? Is that correct? Did you defer HSA Bank?

[James C. Smith:]

We're actually -- yes, we're trying to provide a product that would be useful in the exchanges, right, and integrated into the exchange, which we have not yet done, by the way, because the exchanges are just coming on. But we're -- that's part of the ramp up that we're doing, is ensuring that we are able to integrate with the exchanges. But in the meantime, we're talking directly to carriers. We're talking to large employers, TPAs, benefits administrators and the like, in addition to brokers and direct to individuals. But the health exchanges will be an increasingly important part of the business.

[Matthew Brandon Kelley:]

Got it. And then one question on expenses. You haven't really quantified or talked about outsourcing some of your IT operation. You had a separate agreement when you announced the Jones Lang deal on that front. Maybe just talk about that, give us a little update on what that is targeted to save?

[James C. Smith:]

I think we're still -- having just on JLL 2 quarters ago and FIS as well, we're still in the early stages of that. I mean, you're starting to see some of that come though on both the occupancy line and the technology. As I highlighted for the quarter, you saw that come down. But I don't have an absolute number for each of those. I think you'll see it become more pronounced in our trends as we go forward.

[Operator:]

Our next question today is coming from Dan Werner from Morningstar.

[Dan Werner:]

Glenn, in the investment securities portfolio, are you transferring any securities, specifically agency mortgage-backs from available to sell to health to maturity, to kind of protect yourself from capital hits? Or -- and if you are fine, I'm just wondering, is that a policy or a strategy you're considering going forward if certain interest rates rise here significantly?

[Glenn I. MacInnes:]

Yes. I mean, we've been fairly consistent with being 50/50, our split. And new purchases are going more into the AFS portfolio. But I think we have retained -- I'm sorry, new purchases are going more into ACM [ph], but we have retained sort of that 50/50 split.

[Operator:]

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

[James C. Smith:]

I just want to thank you all for being with us today. Have a good day. Thank you, Kevin.

[Operator:]

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.