Webster Financial Corporation Q3 2008 Earnings Call Transcript

Oct.21.08 | About: Webster Financial (WBS)

Webster Financial Corporation (NYSE:WBS)

Q3 2008 Earnings Call

October 21, 2008 9:00 am ET

Executives

James Smith - Chairman and Chief Executive Officer

Jerry Plush - Chief Financial Officer and Chief Risk Officer

John Ciulla - Chief Credit Risk Officer

Terry Mangan - Investor Relations

Analysts

Ken Zerbe - Morgan Stanley

Andrea Zao - Barclays Capital

Damon Delmonte - Keefe, Bruyette & Woods

James Abbott - Friedman, Billings, Ramsey

Collyn Gilbert - Stifel Nicolaus

Matt Kelly - Sterne, Agee & Leach

Operator

Good morning, ladies and gentlemen, and welcome to the Webster Financial Corporations’ Second Quarter 2008 Earnings Results Conference Call. At this time, all participants are on listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. As a reminder ladies and gentlemen, this conference is being recorded.

Also, this presentation includes forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation and 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 expectations and projections about future events. These forward-looking statements are subject to risks, uncertainties, and assumptions as described in Webster Financials public filings with the Securities and Exchange Commission, which could cause future results to differ materially from historical performance or future expectations.

I would now like to introduce your host for today’s conference, Mr. James C. Smith, Chairman and Chief Executive Officer. Please go ahead, sir.

James Smith - Chairman and Chief Executive Officer

Good morning, everyone. Welcome to Webster’s Third Quarter 2008 Investor Call and Webcast. Joining me today are Jerry Plush, our Chief Financial Officer and Chief Risk Officer, John Ciulla, our Chief Credit Risk Officer; and Terry Mangan, Investor Relations. I will provide some overview and context for the third quarter results, and Jerry will provide specifics on our financial performance. Our remarks will last about 30 minutes, and then we will invite your questions.

We’re living on interesting times to be sure and that is reflected in the results for the quarter. While we reported a Q3 loss of $0.42 per fully diluted share after securities impairments of $0.55 and $0.04 of other charges, core operating results were $0.17 per share including loan loss provisions of $0.61 per share as indicated in the EPS reconciliation of the earnings release. The difference to the consensus estimate of $0.22 per share was attributable to the $5 million provision to the liquidating home equity portfolio. In today’s extraordinary operating environment, it’s easy to lose site of progress and operating performance that might be celebrated in a different time.

So, let me call attention to some of our progress in Q3 as compared to Q2. We reported higher net interest margin than last quarter. Higher net interest income, higher fee-base revenues and seriously lower operating expenses as our cost containment and efficiency efforts under the One Webster initiative began to take hold. When the storm subsides and we acknowledge that it has not and it could take awhile, the true quality of our improving operating earnings will shine through and that will be a bright day for Webster.

One of the strong points is that our primary market is in southern New England is holding up reasonably well to this point in the down leg of the economic cycle. In Connecticut and Massachusetts, for example, job loss has been below the national average. Real estate values did not generally escalate to the extent seen elsewhere in the country and new home construction also lagged, a former negative becoming a current positive for real estate values. A recent case showed a valuation update suggest that property value declines in our footprint remain low relative to other geographies. The economic outlook now robust is generally for slow growth. Economists we respectfully that while the regional economy is in are on the verge of recession. Economic growth is likely by the second half of 2009. We say in some of our ads that we’re from here and right now, southern New England is a good place to be from.

The banks in our markets are generally strong so we don’t have quite a degree of heightened anxiety over the safety of local banks that other areas of the country have experienced. Still, we’re seeing very aggressive pricing of deposits as the biggest players look to attract deposit funding even at relative high cost as an alternative to the very high priced wholesale funding in the severely stressed capital market. We are defending our deposit base and will continue to do so. We believe that the higher FDIC deposit insurance to $250,000 on all deposit accounts and unlimited insurance on interest bearing -- non interest bearing deposits should help to broadly allay fears if not inspire confidence as regards banks in general. And then, they positively influence deposit pricing and stability as we move forward. Still, the bigger banks liquidity hunt will continue to pressure the non-interest margin until wholesale rates received.

I’m going to focus my remarks this morning on Webster’s strong capital position, our decision to pay the regular quarterly cash dividend of $0.30 a share and our perspective on the treasury’s TARP program.

Let’s start with capital. You heard us talk incessantly in recent quarters about our strong capital position. For example, our estimated Tier 1 capital ratio of 8.65% at September 30 well exceeds the peer group median ratio from 630 and as well in excess of our high internal standards. Our estimated total capital to risk weighted assets ratio is 13.1% also well above the peer group June 30 median ratio.

Our tangible capital ratio at September 30 is 6.34%, again well above regulatory requirements and above our internal standard of 6% though down from 6.79% at June 30, $96,000 worth or 37 basis points of the 45 basis point decline was attributable to FAS115 or other than temporary impairment marks against the carrying value of our preferred securities and capital notes or to losses on the sale of those securities. Excluding Fannie Mae or Freddie preferreds, which have already market. The carrying value of those securities including preferreds, pooled or single issue or trust preferreds and capital notes is now only 52% of their par value. It then includes over $76 million par value of AAA and AA securities. The $11 million in remaining capital notes have been written down to about 40% of cost.

The point is that we do not expect that these marks will continue at the hyper rate experienced in the last two quarters especially when considering the potentially positive effect of treasuries capital infusion program on the ability of many of the capital notes issuers to meet their payment obligations. Clearly, Webster’s opportunistic capital raise in June has put us in a strong position to weather the current financial and economic storm and we are entirely confident that our capital levels and the strength of our underlying operating results are more than sufficient to see us through to the opportunities for growth which await on the other side of the downturn.

Our continuing strong capital position and our improving underlying operating results give us the flexibility to continue our cash dividend at $0.30 a share this quarter. We indicated last quarter that we would balance the desire to pay dividends against our capital needs and operating performance in the quarters ahead. And, while we need to reassess each quarter going forward, the advisability of paying that rate our board is pleased to announce the full dividend for this quarter. Year-to-date the dividend is more covered by our operating earnings. Our ability to cover the dividend with future operating earnings will be the key determinate of the dividend pay out in the quarters ahead.

Over the next couple of weeks will be considering whether or not to participate in the treasury TARP program under which we are eligible to apply to our primary regulator for preferred capital and an amount equal to between 1% and 3% of our risk weighted assets. That would amount to a range of about $135 to $400 million for us.

Let me be clear, we made no decision to participate with over $1 billion of tangible equity and continued strong regulatory capital ratios and operating in a fairly sound region of the country we do not see a need for additional capital. But, when the rest of the world beginning with the big nine is lining up for that remarkably low cost capital and we imagine ourselves in a hotly competitive world competing without it. We must think both defensively and opportunistically about the benefits of participation. If we do participate we’ll honor the treasury’s objective to try to put the funds into the market in the form of additional credit availability to our customers and communities.

Before I turn it over to Jerry, I want to make a couple of observations. I believe that Webster may well be the most transparent reporter of financial information in its peer group and that is not a coincidence. We’re proud of it and we worked hard to attain that distinction. We have always said that we believe in full timely and transparent disclosure and we proven that to be the case in these tumultuous times. Consider the granularity of our loan portfolio reporting in detail by asset category, C&I, commercial real estate, equipment finance, asset-based lending, mortgage portfolio, consumer loan, de-liquidating portfolio and even the granularity and reporting in the securities portfolio, you simply can’t get more granule information than we provide to you and frankly, I sometimes wonder whether our style of reporting, particularly in times of stress, might actually be hurting our valuation. But, we plan to continue to report in just that way because openness is a core principal with us.

You will hear from Jerry this morning that loans grew in several categories during the quarter even though originations were down in most cases. Originations are down because underwriting standards are tighter, pricing is higher and credit quality generally has deteriorated to some degree. We are more focused on knowing everything about our existing relationships than in courting new ones right now. The fact that balances are up reflects changing customer behaviors in a difficult time including defensive draws by businesses as well as consumers and sharply reduce prepayment activities. You will hear about an increase in non-accrual assets and delinquencies. In the continuing portfolio, resdev was the biggest region accounting for about 85% of net increase in non-accrual assets and for 48% of all commercial non-accrual assets, even though it represents just over 3.5% of the $6 billion portfolio.

Reflecting the (inaudible) demand for new housing, 35% of resdev loans are now non-accrual. Since a small portfolio can skew results for the whole portfolio, which if you look closely may actually be performing quite well, we decided to break out the resdev loans in the tables at the end of the press release. Most of the resdev loans are well secured loans we made to builders we know well, all of whom are working with and helps to completing and marketing their product.

While non-accrual assets outside of resdev held the ground in the quarter, delinquencies rose by 35 million to 102 million or about 28 basis points across the continuing portfolios. About half of the increase came from the resident and consumer portfolios which, overall are performing pretty well. The continuing migration influenced our decision to increase the available reserves in the quarter to absorb potential future loan losses. By reserving $9.5 million more than we charged off, we boosted our loan loss coverage ratio by 6 basis points to 1.36%.

We also stepped up to the liquidating portfolios attacking the national construction lending portfolio with a $10.6 million provision and writing off Florida, Arizona, and every loan less than 75% complete and reserving on a case-by-case basis against the few loans that remain. With regard to the liquidating home equity portfolio, we added $5 million in provision, recognizing that the default rate has exceeded our original projections and pay downs have been at a slower rate than expected. Even though losses given default have been less than we estimated, the overall performance including the likely of the losses would exceed our original expectations for 2008, compel us to add additional reserves. This action brings Q3 reserve levels to 7.5% of loans in that portfolio. We’re not suggesting by our action that we’ll need to provide $5 million every quarter but we will provide reserves in future quarters as needed.

I will now turn it over to Jerry for his comments on Q3 financial results.

Jerry Plush - Chief Financial Officer and Chief Risk Officer

Thank you Jim and good morning everyone. I’m going to cover several items. First, an overview of the loan composition and growth and then we’ll talk through the investment portfolio and the other than temporary impairment charges that have been taken this quarter. My remarks will also cover deposits, borrowings and an asset quality. I will provide commentary on the third quarter and in closing some brief perspective on the fourth quarter.

So, let’s start first with loans and growth. Commercial loans consisting of CSI and CRE loans totaled $6 billion grew by 11% combined from a year ago. Commercial loans now comprise 46% of the total loan portfolio, compared to 44% a year ago. Total loan portfolio growth was 4% compared to a year ago offset somewhat by a planned reduction of 3% residential loans. It’s important to note that we’re in the process of evaluating the securitization of part of our residential loan portfolio in the fourth quarter for approximately $500 million and assuming we complete the process before quarter end it will further reduce our total loans and increase securities by the end of the year.

The C&I portion of the commercial portfolio totaled $3.7 billion at September 30, and that grew $39.7 million from June 30, primarily in asset-based lending. The entire CNI portfolio yielded 5.24% in the quarter compared to 5.52% in the second quarter. Equipment finance outstandings remain flat at a billion dollars in comparison with June 30th. This portfolio continues to stay very granular, no single credit represents 1% of the portfolio and the average deal size is less than $100,000. Asset-based lending outstandings were $868 million September 30 in comparison to the $842 million at June 30. The current asset coverage is as follows: Approximately 92% of the outstandings are secured by receivables and inventory. The remaining 8% consists of equipment at 7%, real estate at 1%.

The commercial real estate portfolio totaled $2.4 billion at September 30 and that grew $51 million from June 30. These loans are primarily institutional quality real estate with five to ten year loan terms that represent stabilized properties with good debt service coverage and LCDS under 75%, generally well under 75% in many cases. The charge-offs in the pre-portfolio were zero for the quarter and 378,000 year-to-date. This portfolio yielded 5.47% in the quarter compared to 5.61% in the second quarter of 2008.

The consumer loan portfolio totaled $3.2 billion and that consist of $2.9 billion in the continuing portfolio and $296 million in the liquidating home equity portfolio. We had a modest increase in the continuing portfolio from June 30 and this is all direct to consumer, retail based and market growth and lines now comprise 57% of total outstandings. Branching originations were $181 million in Q3, in comparison with $344 million in the second quarter. The total consumer portfolio yielded 5.24% in the quarter compared to 5.23% in the second quarter. We would the decline in yields in the fourth quarter as HELOCS -- on the HELOC portfolio, given the recent prime rate reduction of 50 basis points in October.

Turning now to residential loans, they remain relatively flat at $3.6 billion, the portfolio represented 28% of total loans at September 30, similar to June 30. As you know, we have now for some time deemphasize residential loan growth. The residential portfolio yielded 5.6% in the quarter compared 5.67% in the second quarter.

Let’s turn now to the investment portfolio. Webster recorded OTTI write-downs of investments to fair value for certain investment securities plus what is available for sale of $33.5 million during the quarter. Please note that we have again provided some granule disclosure regarding the composition of our investment portfolio consistent with our SEC filings in our investor presentations again today and the supplemental schedules that are posted on our website. These schedules include significant detail about the corporate bonds and notes and the equity securities holdings. Particularly in light of the other than impairment charges we have taken in Q3 and Q2.

It’s important to note that all the securities where we have taken impairment charges are classified as available for sale. You have also seen these supplemental slides, the unrealized loss position across the specific investments in the portfolio at both September 30 and June 30. The underlying positions are marked down through other comprehensive income adjustment to equity as for any securities classified as AFS were market values of lower than cost the difference is already reflected in tangible capital.

So, similar to the second quarter we have done a significant amount of analysis on the available for sale securities portfolio and we concluded that we should impair a certain BBB rated and underrated pool trust preferred securities. In addition we also recognized OTTI charges of $8 million related to the $9 million we have in Fannie Mae and Freddy Mac preferred stock. We also recognized $2 million in losses on the sales of $5 million in Fannie and Freddy preferred stock during the quarter. We also elected to recognize loss position related to four common stock positions and recognize a million dollars in impairment charges on certain lots within the prescribed 12 month consecutive month at a loss time line that we have been following and that’s consistent with prior quarters.

In our press release today we noted that the OTTI related to Fannie and Freddy preferred was treated as a capital loss and that limited the tax benefit to the company. Subsequently on October 3 of ’08, the Emergency Economic Stabilization Act was enacted, which includes a provision for many banks to recognize OTTI charges related to Fannie and Freddy preferred stock as an ordinary loss which increases the tax benefit to the company. Had the company recognized the OTTIs in ordinary loss for the quarters ended September 30, 2008, the OTTI recorded would have been $3.5 million or $0.07 per diluted share. The company will recognize this additional tax benefit in the fourth quarter of ’08 for a total of about approximately $3.8 million or $0.07 per diluted share.

Next, let’s provide an update on deposits. Our loan to deposit ratio increased to 109% at September 30 in comparison with the 106% from June and 99% a year ago. This ratio has increased throughout 2008 as our intent was to reduce our Alliance on CDs due to higher cost focused on growing core accounts while also minimizing use of brokered CDs as a funding source. We have been diligently to improve this ratio as evidenced in the recent past but as we have reduced our utilization of brokered deposits, a rise in the loan to deposit ratio will be expected as a result.

Brokered CDs totaled 897 million as of September 30th of 2006 and it declined since then, including over $107 million from a year ago and now total $180 million as of September 30. We previously stated our intent was to continue to evaluate further reductions over the next quarter to two quarters as over $100 million in brokered CDs mature. Given the low level that we currently hold and in order to continue to utilize notable sources of liquidity, we intend to at least maintain the current levels in the fourth quarter.

We continue to make considerate efforts to change our deposit mix and lower the cost of deposits with increased emphasis on growing checking relationships across our retail, commercial and municipal lines of business. Our core deposit to total positive ratio dropped slightly to 60% from the 62% we reported at the end of the second quarter but remains above the 59% in the year-ago period. Additionally, our cost to total deposits declined to 1.9% and as compared to 2.01% for the second quarter and 2.96% a year ago.

Let me now take the opportunity to also give you an update on de novo banking and then on HSA bank. We opened a new office in North Kingston, Rhode Island during the month of August of this year. We already have garnered $7.1 million in deposits. We have just finalized negotiations and plan on opening a downtown Boston, Massachusetts branch office in the spring of 2009. This will be located in the Old Boston Stock Exchange building and our intent for this office and for any new office that we would open in the future is simple. It’s no longer primarily a retailer-consumer reliant strategy as it has been in the past but a total bank strategy. We will only open locations where we’re confident we can have broad companywide opportunities for profitable growth. We believe this Boston location is an excellent example of the strategy in a quality market.

HSA bank, which provides us with low cost stable deposits, had $550 million in health savings deposits at September 30 in comparison with 504 million at June 30, and an increase of 131 million or 34% from a year ago.

We also have 61 million in linked brokerage accounts compared to 55 million a year ago. HSA’s average cost of deposits for this fast growing category was 2.09% as comparable to the 2.10% we reported in Q2. This contributes to lowering our overall cost of the interest-bearing deposits. HSA continues to provide us opportunity to attract core deposits nationally and allows us to tap into the deposit markets who has got significant growth potential. As of the end of September, we had 220,000 accounts in comparison with 214,000 accounts at June 30 and 181,000 a year ago. The average deposit balance for account is now over $2,380 in comparison with $2,163 a year ago. This growth continues to show the viability and acceptance of the consumer-directed healthcare model in the US.

Borrowings increased by 353 million from June 30 and that’s primarily an increase in the use of other borrowings. We continue to rely on borrowings to offset declines in retail deposits and brokerage CDs. Our cost to borrowings declined to 3.33% for the third quarter, down from 3.38% for the second quarter and 5.4% a year ago.

Note again, our focus on is on organic deposit growth, our primary focus is on operating and checking account growth and this will help reduce usage of borrowings in future period. Our intent is also to grow only in the lines of business to continue to contribute to deposit growth in the future.

Turning now to asset quality, the provision for credit losses was $45.5 million for the third quarter in comparison with $25 million for the second quarter and $15.25 million from a year ago. The increased provision for credit losses in the third quarter is the result of increased levels in non-performing assets, higher delinquent loan levels and management’s decision to expedite the resolution of the liquidating NCLC portfolio. We also recognized the need to augment the reserve for the liquidating home equity portfolio and have looked this portfolio using both internally and externally generated low rate analytics to determine a forward review on projected charge-offs over the next several quarters. Our total allowance for credit loss to total loans was 1.54% at September 30 in comparison with 1.52% at June and 1.32% a year ago. The allowance for the continuing portfolio only was 1.36% and that’s up from 1.03% in the second quarter.

Net charge-offs in the third quarter low rate totaled $20.5 million for the continuing portfolio and $20.8 million for the liquidating portfolio, of which $14 million is related NCLC and $6.8 million is related to home equity and that compares to second quarter net charge-offs of $11.2 million for the continuing portfolio and $9.2 million for the liquidating portfolio.

Our total non-performing assets increased to $250 million at September 30 in comparison with $224 million at June 30. The MPAs and the continuing portfolio were $219 million at September 30 in comparison to $182 million at June 30. Six input for resdev credit relationships aggregating approximately 27 million represented the majority of the increase. Significant credits included in the $27 million of new resdev non-accruals were $9.3 million project located in Western Connecticut and 9.3 million exposure related to three developments located across Massachusetts and a $3.7 million project also in Connecticut. The MPAs were 1.94% of loans plus other real estate loans and the net charge-off right was 1.29% annualized in Q3. Credit metrics and the $2.9 million continuing home equity portfolio show an uptick as the 30 plus delinquency rate is at 1.58% at September 30, up from the 1.35% at June 30 while non-accruals were at 0.8% in comparison to 0.72% at June 30.

I will now provide some additional detail on the liquidating portfolios consisting of the outer market in direct home equity and national construction loans. We had $337 million in outstandings in these portfolios at September 30 compared to $373 million at June 30 and $424 million when the liquidating portfolios were established at year-end of 2007. The total of the 337 consist of $25 million in remaining construction loans, $60 million in permanent loans and $296 million in home equities. The reduction in liquidity reflects the expedited resolution approach management took regarding the NCLC portfolio during the quarter. Charge-offs in the continuing portfolios continue to be taken against the reserves established which were increased by $15.5 million in the quarter to offset charge-offs. Remaining reserves of $5.8 million and $22 million against the respective September 30 portfolio amounts which are $25 million in construction and process and $296 million in home equity respectively.

Let’s turn now to third quarter results. As Jim indicated, net interest income totaled $129.2 million in the quarter and that’s an increase of $3.5 million from the second quarter as average earning assets grew by $98.7 million from the second quarter and the net interest margin grew 6 basis points to 3.32% and that’s up from 3.26% at the end of the second quarter. Our securities portfolio totaled $3 million at September 30 comparable to the second quarter and above the $2.5 million a year ago. The yield on the securities portfolio for the quarter was 5.54% in comparison to 5.43% in the second quarter and 5.79% for the third quarter of last year.

Our non-interest income was $15.7 million in the quarter compared to a loss of $5.7 million in the second quarter. The third quarter includes $33.5 million in OTTI charges and $2 million of losses on sales of Fannie and Freddy preferred stock. While the second quarter included $54.9 million in previously discussed write-downs on certain investment securities, while non-interest income for the third quarter last year did not reflect any such charges.

Deposit service fees totaled $31.7 million and that’s up from $29.9 million in the second quarter and $29.9 million in the year ago period. Our loan related fees were $7.2 million in comparison with $7.9 million in the second quarter and $7.7 million a year ago, while wealth management was $7.1 million and that’s a comparison with $7.6 million in the second quarter and $7.1 million a year ago.

Our other non-interest income was 2.7 for the quarter and that compares with 854,000 in the second quarter and $1.7 million a year ago. Other income in the third quarter benefited from an increase in direct investment income.

Our revenues from mortgage banking activities were only 50,000 for the quarter compared to a 100,000 for the second quarter and 1.8 million for the third quarter of last year. The reduced income in mortgage banking over the last year continues to reflect the closure of the national wholesale mortgage lending activities in the fourth quarter of 2007.

Net losses from the sale of securities in the quarter were 2.1 million and that’s inclusive of the 2 million losses on the sale of 5 million in Fannie and Freddy preferred stock and compared to 104,000 in net gains for the second quarter and 482,000 reported a year ago.

Our total non-interest expenses were 117.5 million in the quarter compared to a 137.7 million in the second quarter and a 113.5 million in the third quarter of ’07. Our core expenses exclusive of 2.5 million in charges were down to 115 million for the quarter compared to a 120 million for the second quarter and 113 million a year ago.

Total non-interest expense for the third quarter included 2.5 million in charges related to One Webster optimization and additional subsidiary goodwill impairment in the quarter and over 21 million of severance and other charges were recorded in Q2. And marketing expense was down to 2.5 million in the third quarter in comparison with 4.9 in the second and 4.1 million in the third quarter of ’07.

Our foreclosure expenses were 3.5 million in the quarter and that’s up from the 1.6 million we recorded in the second quarter and only 231,000 from a year ago. Other expense amounted to $14.8 million in comparison with 16.6 in the second and 15.1 a year ago period.

At this point, let me provide a little perspective on the fourth quarter. The NIM has seen positive benefits. So far this quarter from LIBOR based loan pricing. However, this is showing signs of normalizing and is way off from lower overnight borrowing costs; however, we believe there will be even more pressure this quarter from competitive deposit pricing in addition some to lower yields on assets tied to prime and higher average non-performing asset levels.

Deposit pricing pressures have increased as many competitors have and continue to aggressively price CDs for liquidity purposes. In addition, Q4 will see the impact of higher average non performing asset levels and that’s assuming we don’t expedite the resolution of a significant number of credits. My comment here references the indications we gave in our presentation at the Lehman Conference that we will continue to explore alternatives regarding our liquidating home portfolio, our resdev portfolio and certain investment securities in the coming months.

Overall, we would expect the NIM would be flat. Provision, we continue to believe it is prudent to maintain reserves and to cover the charge-offs given economic uncertainty and its effect on the MPA and delinquency levels. We would expect a core provision, now exclude what we did for NCLC in Q3 in the term of core provision. We would think our core provision would be comparable if not slightly higher to levels we posted in Q3. And on the expense side, we will continue to implement One Webster initiatives and see corresponding benefits that will occur in the fourth quarter and future quarters. We could see marketing expense up slightly in Q4 because of our marketing and deposits right now. We also believe that we'll continue to see some rising foreclosure and workout costs that we have previously discussed.

As we indicated in today's release, we're very very, focused on cost containment and we will actually need to do so to offset expected rising costs and FDIC insurance premiums and other expenses in the future periods.

At this point I’m now going to turn it back over to Jim and he'll have some concluding remarks

James Smith - Chairman and Chief Executive Officer

Thanks Jerry. Webster’s third quarter operating results reflect the positive results from our narrowed focus on direct to customer core franchise activities. The One Webster initiative will have the meaningful positive impact on our future operating results and we believe can drive the efficiency ratio well below 60%. We know that today’s challenging economic environment will one day give way to calmer times. Webster is a sound capable regional commercial bank with a strong diversified balance sheet and a capital structure that gives us maximum flexibility to address any issues which may arise as we go forward.

By helping our customers achieve their financial goals, we have every confidence that we will achieve our vision to be New England’s bank while increasing shareholder value. Thanks for being with us today. We would now be pleased to try to respond to your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question is coming from Ken Zerbe with Morgan Stanley. Please state your question.

Ken Zerbe

Thanks, good morning.

Jerry Plush

Hello Ken.

Ken Zerbe

When you guys recently setup a liquidating portfolio, I was under the impression that you setup the reserve groups or losses so then we could all just push this over to the side and focus on the continuing portfolio. It just doesn’t seem like that’s worked out to be the case given that the additional provision that we saw this quarter. Is there any reason to believe that we won’t just sort of see several more quarters of small or ongoing reserve build or additional provision expense in liquidating portfolio from here?

Jerry Plush

Ken, its Jerry. I would say if you go back and take -- listen again through the comments that I made we really looked at using low rate model and this will be specific to the liquidating home equity portfolio that put in a range to get an external view and internal view of modeling where the reserve sits at this point in time is a good forecast we think of the difference between those two as we can see what we refer to as over the next several quarters and those several quarters would be over the next 12 months. I think that just given where the portfolio has performed and I think this echoes with Jim's comment is that, yes, we could certainly see that we would add to that over quarters and we would take that into account as we do our provisioning.

Ken Zerbe

Understood. Okay. And then the second question I had was have the recent treasury actions had any noticeable impact on the value of your portfolio during October?

Jerry Plush

Ken, again it's Jerry. I think it's a great question. I think it's too early to tell just given the - once we see the folks that get the capital injections, I absolutely would have believed that we would see improvement or stability certain in this decline. But I think we have got to take a wait and see through November 14, understand specifically who is actually receive the capital and then evaluate those particular issuers within these pools.

Ken Zerbe

All right, great. Thank you very much

Jerry Plush

Ken, I would like to just make a comment on the first question which is you know that we said that liquidating portfolio about a year it go. And we did, at the time, make the assessment as to what we thought that the losses might be and did our best to reserve against them based on what we knew at the time. And I think we all realized that the markets got deteriorated very significantly since then and as a result it's appropriate to take a look. And in the construction portfolio, you could see that we have tried to resolve the issues there. And in the home equity portfolio, with the best information that we have to put up incremental reserve in this quarter, I was clear in my remarks to say that we're not suggesting by our action that we'll need to provide $5 million every quarter, so we will provide reserves in future quarters as needed against that portfolio.

Ken Zerbe

Okay, great. Thanks

John Ciulla

And Ken, this is John Ciulla just to pile on. The original assessment with respect to the provision in the portfolio that was done obviously coming in a benign credit environment on the beginning of what is obviously worse credit environment was done based on certain just assumptions of default frequency, loss given default and attrition in the portfolio, assuming certain pay downs. Now we now have the benefit of 9 to 12 months of actual performance in the portfolio and relative performance to the core hasn't changed as much as the fact the economic environment has accelerated loss and also blocked the acceleration of the attrition in the portfolio. So as Jerry said, we have the benefit of being able to look at 12 months of actual activity in the various segments in the liquidating portfolio and try and use that low rate analysis to have a more accurate forward looking loss forecast.

Operator

Thank you. Our next question is coming from Andrea Jao with Barclays Capital. Please state your question.

Andrea Jao

Good morning.

Jerry Plush

Good morning, Andrea.

Andrea Jao

I appreciate your detail disclosure, so thank you. One area that I do need help thinking about is given your outlook on the economy, weakness until the first half of phone line and you already talked about increasing amount performance in the fourth quarter, how should we think about the different asset classes and the continuing portfolios given your specific outlook? Should we expect this to hang in, should we expect modest deteriorations? What would it take to see a more substantial ramp up in the credit metrics in the continuing portfolio?

Jerry Plush

Andrea, it's Jerry. You will hear again from all three of us on this one, but let me take a crack at the first reaction. I think as you think about the non-performing portfolio, it's clear that the majority or the increase is around the resdev credits and I think as many would expect that the housing market's been hit the hardest and we're seeing the impact of that flow through to that very specific piece. And again, it's a $217 million portfolio that we're seeing a significant amount of stress particularly in that portfolio. I would say so that kind of tells you what we see in line of sight we think and John can talk a little bit about the proactive matter in which and he and all of the lines of business leaders are on the phones and constantly talking through on a weekly basis to get the most update information in each of these projects. So I think we're assessing those appropriately as we go and also forecasting ahead. As it relates to the past dues, I guess my comment would be that there is a little bit of an anomaly here that from a reporting standpoint, you see a rather dramatic increase of $40 million. $13.7 million of that in the commercial real estate side actually cured subsequent to quarter-end and it was really just a documentation issue in terms of just not being able to get that completed by quarter end. So I can tell you as we said here today, you could take it at $13.7 million reduction off of those past due numbers that you see there. I am going to turn it over to John because he could probably give you some perspective on the balance of the past dues and the continuing portfolio.

John Ciulla

Yeah, Andrea. I mean we are at interesting inflection point because we have seen the residential development portfolio, obviously evidenced the non-performers. I will tell you as you know when those loans go substandard non-accrual and I think we take pretty aggressive approach in our risk rating. We either have or are in the update on the process of updating valuations and you will note that we only had a $160,000 in charges related to that portfolio. So thus far, with respect to our updated valuations, the $75 million in nonaccrual residential development loans had retained value from an updated appraisal standpoint. With respect to the other asset categories, it’s interesting, we see shines of negative risk rating migration trend but we have yet to see significant delinquency or nonaccruals in traditional C&I, in investment commercial real estate, material change in business and professional banking. So as Jerry said, our laser focus right now is working with the business line leaders to have early identification of problems and try and avoid obviously migration to nonaccrual or resolve this issue before they manifest into nonaccrual or loss. But obviously we look very carefully at what the impact of a sustained recession could have on the other asset classes that have not yet evidenced of significant stress into the portfolio, into the credit metrics.

Jerry Plush

Yeah. And Andrea, I just want to add that I think when you look at the continuing portfolio and the past dues, again taking into account that 13.7 increase in KRE, really what you see in the jump in the quarter is clearly in the residential book. And I would ask John to make an observation on that as well.

John Ciulla

Yeah, I mean I think with respect to delinquencies and nonaccrual increases in the continuing residential and consumer portfolio, there is not a magic bullet story there. It is I think stress generally in our portfolio and in the economy that’s driving those increases albeit even after the quarter-over-quarter increases are loss and nonaccrual level and our continuing resi and consumer portfolios remain very very low relative to other national players and peers in the mortgage and home equity business. So we feel pretty good about where we are given the point in the cycle which we are operating.

Jerry Plush

Just a quick comment from me that when people look at how well some of our asset categories are performing and I will cite the investment commercial real estate and asset-based lending and equipment finance for example. There is two ways they can react to it. One is to say well, gee, not much has happened so that means it’s going to get a lot worse. And the other way is to say they must really know what they are doing. And I think in the end it boils down to a large degree to the people who are managing those categories and we take a Mitch Weiss from Center Capital who has done such a great job over the years that’s the equipment finance group, and Warren Mino in our asset-based lending group and Bill Wrang in our commercial real estate group. And we have no doubt that they will perform extremely well in this environment.

Andrea Jao

Very helpful. Thank you.

Operator

Our next question is coming from Damon Delmonte with Keefe, Bruyette & Woods. Please state your question.

Damon Delmonte

Hi. Good morning.

Jerry Plush

Good morning.

Damon Delmonte

Could you just go over again what the growth in home equity loans were this quarter?

Jerry Plush

Yeah, on the continuing home equity in the loans, we were up $50 million on a base of 2.9 billion.

Damon Delmonte

Okay. And with respect to the outer market, are those lines open or have you limited capital lines?

Jerry Plush

Damon, the lines were appropriate the lines have been limited. When John was referring to the – I apologize whether it was Jim or John, but the prepay speeds in that portfolio are naturally going to be down given the fact that half of that portfolios are line portfolio. And accordingly as every time you see these prime drops, you are seeing that the payment pressure on each of those borrowers is reducing as a result. So in terms of prepay speeds slowing up and plus all the economic pressure, you would expect that. So we are not seeing large declines in utilization from where they were but we certainly have gone through and proactively taken steps to cap where appropriate.

John Ciulla

I will give you some more granularity on the line management program. We were sort of I think an early adopter and that was validated by outside counsel and discussions with regulators. We have got a pretty robust line management program that we apply not only to the liquidating portfolio but to in-market home equity portfolio, open to buy home equity exposure. So it’s been fully valid and it’s typical, it’s based on payment deferrals, based on material change in financial performance which is a combination of a reduction in FICO score to below a certain threshold level and also a collateral valuation where we identify on a risk-based approach those lines that either have large availability or we identify as being significantly higher risk and we move to freeze those lines through a systemic line management program. And to-date, we have frozen over $150 million in unused home equity lines across liquidating and continuing.

Damon Delmonte

Okay, thank you. And then Jerry, with respect to your – you were telling about the provision for next quarter. You said the core provision similar to this quarter. Still that would be basically 35 million?

Jerry Plush

I think you got to look at 30 to 35 as a range.

Damon Delmonte

Okay. And then just lastly, just to clarify your position on TARP. You don’t feel that you need to tap it for capital purposes, but if you see others doing it and you think you may put at a competitive disadvantage then you would enter the program?

James Smith

Correct. And I think it’s not just what other people do. We have to look at it on its merits and the fact is that it’s extremely low cost capital. When you take that, combined with the fact that there is a competitive consideration as well, we will take a good hard look at it.

Damon Delmonte

Okay, thank you very much.

Jerry Plush

Yeah. Hey Damon, if I could, I just want to add. Just in terms of all the perspective on TARP, everyday brings new information. And I think that the application process was just announced yesterday as an example. So I mean, we are learning a lot more as the days go on and we certainly will see in conversations with the regulators, how that whole process works through. So we will keep everyone posted in terms of what decisions we make there.

Damon Delmonte

Okay. Thank you very much.

Operator

Our next question is coming from James Abbott with Friedman, Billings, Ramsey. Please state your question.

James Abbott

Hi, good morning.

Jerry Plush

Good morning.

John Ciulla

Good morning.

James Abbott

I wonder if you could touch base on the commercial net charge-offs, obviously it was higher this quarter than what it had in the prior quarters as far as the run rate goes. Large credits within that portfolio remains charged-off and then if you can give some detail on the industry type?

John Ciulla

Yeah, with respect to the continuing bank commercial charge-offs in the quarter, really driven by two larger credits. One, $6.8 million on a 15 to $20 million asset-based relationship, Pennsylvania manufacturer. And I would say sort of a niche manufacturer where we saw a precipitous decline in inventory value, some problems with receivables, some poor management judgment and so that was the first large one. The second one was a newspaper publisher, where we took a partial charge of roughly $4 million, a regional newspaper publisher and you are well aware of the struggles in that industry and the paradigm shift in the advertising environment.

Jerry Plush

Yeah, and I think James you’ve got to look at those as write-offs specifically that we can’t say that when you look at those two credits in particular that there is similar credits within our portfolio.

John Ciulla

Absolutely. I think they are – we continue to watch the newspaper publishing space or the advertising space. But certainly those two charges are not in a systemic problems in the portfolio.

James Abbott

And on the niche manufacturer, what were they manufacturing, retail goods or what?

John Ciulla

I am not – I would rather not comment more specifically.

James Abbott

Okay. And of your pool, your watch list on the C&I credits, has that – how has that trended over the last quarter? And then if you can give us a sense as to what industry types might be deteriorating within the watch list or that you are more concerned about today than more three months ago?

Jerry Plush

It’s interesting. We certainly are seeing negatives migration through the watch special mentioned categories. I would say that we are not seeing specific industry stress. As you can imagine, all facets – there are some good performers throughout all industries and others based on market presence and market share and management and capitalization and leverage are struggling in this environment, obviously fuel costs coming down could be a benefit to us but across transportation, retail, business services, manufacturing, we have seen an impact of the economic slowdown on all industries. So I don't think there is a specific industry right now that we're hyper concerned about. We're concerned about all of them.

James Abbott

And on the migration, can you give us a sense of the magnitude. Was it because you had some pretty stable 30 to 89 day past due and non performing asset levels in the CNI portfolio levels and in fact the non-prudential financial non accrual. Non prudential financial non accrual loans were down. Could you give us a sense as far as those criticizing classified, how they moved and the magnitude there.

Jerry Plush

Let me get back to you offline on that, we have good data.

James Abbott

Okay.

James Smith

Okay. Sounds good and then (inaudible) really. Broadly there is an increase in the categories. It's, it's material, it's not a spike of over quarterly migrations in the past in this cycle but we can talk about specific asset classes and I don't have that information my fingertips.

James Abbott

Okay, the last, a housekeeping question, between non interest expense going forward, if we take the $117 million back out the severance and goodwill charts and stuff like that, getting $115million run rate and then you talked about higher marketing expenses and so forth. Maybe $115 to$116 million range is a run rate?

Jerry Plush

I would expect James to have other assets. I just wanted to make sure there everyone looks at the details and obviously, we had a significantly lower marketing number this quarter in comparison to the other periods. We talked about that this was a little more of an anomaly and you will see some uptake in that specific category. There is certainly some efforts underway to do additional containment in other line items. We do believe that marketing spent in that three plus million dollar range is very, very important. Remember for us it’s an institution. We have turned off, you know, when you think about the structural changes away from brokers, away from wholesale. Everything’s direct, you know, it's all organic. That requires marketing expense. For us as an organization, I just don’t want anyone coming off the call or not to be thinking that marketing will stay that low going forward. That was a very specific to just that line item. Generally speaking, I think our thoughts are to be trying to look at a quarter that would be a comparable number and that is the target for us.

James Abbott

Okay Thank you.

James Smith

I would like to add one thing which is as much as you're trying to find a run rate on the expenses, there is some seasonality there, particularly when you get into the first quarter and you have some higher compensation and benefits expenses. So, while we want to be reassuring as to what the run rate is, there is a little lumpiness in there. I am sure you realize that.

James Abbott

Understood. Thank you

Operator

Our next question is coming from Collyn Gilbert with Stifel Nicolaus. Please state your question.

Collyn Gilbert

Thank you. Good morning gentlemen.

Jerry Plush

Hi, Collyn.

Collyn Gilbert

Just a question on the commercial update side and where that exposure lies, could you just give us a little bit color off to what exposure you may have in the retail arena, whether it would mortgages on shopping centers or that type of thing?

Jerry Plush

We have $1.47 billion investment commercial real estate traditional investment, commercial real estate portfolio. I may need to get back to you on the specific percentages but that split across office multi use industrial and retail. Retail is a relative small category we obviously have sub limits and we are tracking all of our property types in that portfolio very closely as Jim mentioned we have a very strong team there. We have yet to see any migration to non accrual and have actually not had any office during this fiscal year in that book although we are obviously well aware that we need to keep an eye on vacancy rates on lease rates and on rental rates and the impact on future valuations. I would say retail related investment [creep] portfolio has not shown signs of weakness over and above any of the other property types to-date.

Collyn Gilbert

Okay. And then, could you (inaudible) within that portfolio?

Jerry Plush

Yeah, we obviously and we mentioned in some prior calls take rate pride and keeping a very granular loan portfolio in investment commercial real estate and asset based lending are two various where we have the majority of our higher loan exposures, those over $15 million. So, I would estimate that our investment commercial real estate portfolio has an average exposure rate in the $10 million to $12.5 million range.

James Abbott

Okay, great that was it. Thank you.

Jerry Plush

Yeah. I think one other comment that very important to make, Collyn, with that portfolio is geographic dispersion. There is not a concentration in one geography and, again, a compliment to Joe savage, Bill Rang and their team that they really sought to have a broader diversification in just our New England footprint and as we disclosed previously, we have grown a nice book that is in the Philadelphia-South jersey market that we consider to have a very high quality team there as well and that is also some additional protection in that we just don't have the concentration within just the footprint. There is a bit also in the mid Atlantic market.

James Abbott

Okay actually then let me go to that what is the extents of that geographic concentration? How far south and how far west and how far north do you go?

Jerry Plush

Yeah I think again the primary concentrations are just that geographic area. You probably look within a 50 mile radius of the showed of your area and the vast majority of the balance is in footprint. So you’re looking New York through Massachusetts.

James Abbott

Okay. great. Thank you

James Smith

And just to follow up, I have more detailed information. The average loan size in investment KRE is slightly below $10 million, I would say 10 to $12 million. So just Below $10 million.

Operator

Our next question is coming from Matt Kelly with Sterne, Agee & Leach. Please provide your question

Matt Kelly

Yes I was wondering if you could provide the par value of the other three pools single evidence downgraded to triple BS. We can do apples to apples comparison on fair value versus par

Jerry Plush

You can see that, Matt n our investment portfolio foreclosure.

James Smith

On the website.

Jerry Plush

On the website.

James Smith

Well see what it is as of September 30. What I'm trying to figure out is what was the par value that we would have seen on June 30. The par values weren't provided for June 30.

John Ciulla

Okay, Jerry same.

Jerry Plush

Same as September30.

Matt Kelly

So during the second quarter, you guys wrote down your amortized costs and triple Bs from, call it $87 million to$49 million at the end of June, you were carrying those at 67% of the amortized cost, and now the triple Bs are carried at 74% of your current amortized cost. You know, isn't it susceptible to additional OTTIs, is that is that value continuing to drift lower on the triple Bs in particular?

Jerry Plush

Yeah Matt It's Jerry, I think echoing an earlier comment. there is no question that as you look at the pressure that has been placed on these institutions, particularly a lot of them that have elected to defer, you know, the underlying issuers, we think that the T.A.R.P. , I think as I had commented to Ken Zerbe's question earlier, I think there was positive that can come from a number of these institutions received in the capital injections. So I think As we see this quarter, we'll do the same cash flow modeling updates that we have done. We'll stay on top of rating agency changes and we'll continue to mostly monitor who is getting the capital injections and take that all into account as we go towards the end of the fourth quarter.

Matt Kelly

Let me make this comment. I know you're looking at amortized costs. I would think you would look at it relative to the par value? That is what I wanted to kind of figure out in terms of using that, the 2Q par value versus the 3Q.and figure about those Canadian guys are just looks like the fair value, which is produced from the cash flow analysis, results in a higher fair value relative to the amortized cost compared to the second quarter. That was my only concern.

Jerry Plush

That may have to do with relative evaluation securities that got down graded. If I’m single (inaudible) I would encourage you. It's one thing to look at it relative to amortized cost. What matters I think for the broader analysis s what is it relative to the par value. It’s not 75% but over 50%.

Matt Kelly

Understood but I mean there is still a pretty big disconnect between, those patches evaluations and where we're seeing observable events and time will tell, you know which, is correct, but those things are trading at $0.10, $0.15 on the dollar versus carrying values from a cash flow analysis that are significantly higher.

Jerry Plush

Okay, believe me everyone why you be able to track it and we'll try to make sure you have the information you need.

Matt Kelly

Okay. Thank you

Operator

[Operator Instructions]. Our next question is coming from Andrea Jao. [Operator Instructions]. We do have a question coming from Andrea Jao with Barclays Capital. Please state your question.

Andrea Jao

Hello again. The process service charges posted a nice increase over last quarter, could you talk about the drivers and the sustainability of that going forward?

Jerry Plush

You said deposit based charges?

Andrea Jao

Yeah. I think it was $31 million, 31.7 million this quarter.

Jerry Plush

Right. Andrea, part of that is the deposit mix change as you see more away from CDs and into transaction based accounts, you will naturally see some uptick in that line. Also I think that the and that’s again why we are so focused on building out the transaction accounts to core operating accounts. I also think that just in terms of dollars we are also looking at spot balances. When you compare 9/30 versus June 30, what would probably be very vey helpful and I think seasonality plays a little bit of a role as it relates to what happens and transaction accounts as a point in time at September 30. If you go back and look at average balances, you will see that those are much higher. We would expect to see some of that build back in the fourth quarter. So, I would say that our current forecasting would tell you that deposit fees would continue to stay in and around the range you that saw here in the third quarter.

Andrea Jao

Okay. And then a hypothetical question about if ever you do participate in TARP and you do receive a government capital infusion, given the weaker environment, do you think it would be relatively easy or possible to lever up on the capital, i.e. raise both deposits and loans to put that capital to work? And if not, at least in the near-term, what happens, do you leave the capital in cash?

Jerry Plush

Andrea, as I said in my remarks, I know that the purpose of the availability of this capital is to encourage institutions to make more credit available in their communities so to unlock this freeze and also provide some stability in the capital account. When we look at over, our view is that we would like to deploy the capital to our customers and into the community, but we also recognize that in the down leg of the cycle that there is not going be as much origination volume as you might otherwise see. So we look at it as over a period of the life of the capital, which might be say three to five years before it would be replaced by other capital or just retired, that we think there will be the opportunity to deploy it. And in the meantime, it has, even if it were just invested short term, the cost of the capital is so inexpensive that the drag will be minimum. So when you look at what is the potential dilution on the one hand versus the value of having the capital on the other and being in a competitive position against the biggest players in the market players in the market, net net we think it’s worth taking a good hard look at it. So even if it’s out there, it wouldn't have a very significant cost and it might be well worth the effort.

Andrea Jao

Okay. Thank you so much.

Operator

This concludes our Q&A session. I would like to turn the floor back to the management for any closing comments.

James Smith

Thank you very much for being with us today.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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