Webster Financial Management Discusses Q2 2013 Results - Earnings Call Transcript

| About: Webster Financial (WBS)

Webster Financial (NYSE:WBS)

Q2 2013 Earnings Call

July 12, 2013 9:00 am ET

Executives

James C. Smith - Chairman, Chief Executive Officer, Chairman of Executive Committee, Chairman of Webster Bank and Chief Executive Officer of Webster Bank

Gerald P. Plush - President, Chief Operations Officer of Webster Bank, Chief Operating Officer, President of Webster Bank and Director of Webster Bank

Glenn I. MacInnes - Chief Financial Officer, Executive Vice President, Chief Financial Officer of Webster Bank and Executive Vice President of Webster Bank

Analysts

David Rochester - Deutsche Bank AG, Research Division

Bob Ramsey - FBR Capital Markets & Co., Research Division

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

Casey Haire - Jefferies & Company, Inc., Research Division

Dan Werner - Morningstar Inc., Research Division

Matthew J. Keating - Barclays Capital, Research Division

David Darst - Guggenheim Securities, LLC, Research Division

Matthew T. Clark - Crédit Suisse AG, Research Division

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

John G. Pancari - Evercore Partners Inc., Research Division

Jake Civiello - RBC Capital Markets, LLC, Research Division

Jason A. O’Donnell - Merion Capital Group

Operator

Good morning, and welcome to Webster Financial Corporation's Second 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 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 with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second 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, Jesse. Good morning, everyone. Welcome to Webster's Second Quarter Earnings Call and Webcast. I'm joined by President and COO, Jerry Plush; and CFO, Glenn MacInnes. Based on your feedback, we've shortened our remarks to about 20 minutes with less focus on strategy and more on quarterly performance.

Webster delivered solid second quarter results driven by several factors: a stable net interest margin and strong commercial loan originations contributed to record net interest income; a 16% year-over-year increase in noninterest income reflected gains in deposit fees, loan fees, wealth and investment services and mortgage banking. Overall, revenue grew by over 5% year-over-year to a quarterly record. Improved asset quality was marked by a sharp linked-quarter decline in commercial classified assets, a 6% decline in nonperforming loans and the lowest net charge-offs since 2007. Core expenses declined both linked-quarter and year-over-year. We're really pleased about that.

The result was a 13% year-over-year increase in pretax earnings and a 9% increase in earnings per share. Positive operating leverage of 6.6% drove the efficiency ratio back below 60% from 63.75% a year ago. Return on assets climbed to 92 basis points and return on equity was 8.8%, still short of our overarching financial goal to deliver economic profit, but ever closer to our goal to be a high-performing regional bank.

Net interest margin, flat at 323 basis points, benefited from continuing solid commercial loan originations, and in part from a slowdown in premium amortizations in the securities portfolio. Commercial and commercial real estate loans grew at a 16% annualized rate in the quarter, matching their strong year-over-year growth rate. And loan yields and spreads stabilized as the fundamental shift in the yield curve appears to be taking some pressure off loan pricing.

We're well positioned for the long end up interest rate scenario. In fact, our investment portfolio strategy was built with this outlook as the highest probability. Glenn will discuss the investment portfolio in more detail, but let me note that the value of our available-for-sale portfolio declined less than 2% during the quarter, and tangible book value was unchanged despite a 70 basis point rise in the 10-year treasury rate.

The regional economy across our 4-state footprint continues to grow at a slow but steady pace that has characterized recent quarters. The outlook for businesses in the region is fairly positive, with most expecting the current pace to continue or pick up, according to the most recent Fed Beige Book. Meanwhile, the housing market continues its recovery both in sales volume and pricing, and our core Connecticut market, May home sales were at their highest level in 3 years, and the medium price for single-family homes rose 8%.

Turning to capital. Last week, the Federal Reserve finalized its rule implementing Basel III capital requirements and related Dodd-Frank changes. Those changes were approved by the OCC and FDIC earlier this week and include 3 pieces of relatively good news for Webster. First, regulatory capital ratios were unchanged from the proposed rules in the Basel III NPR. Second, while advanced banks must include unrealized available-for-sale securities gains and losses in capital, midsize banks like Webster can opt out of that treatment. This allows us to avoid regulatory capital volatility in managing our balance sheet and interest rate risks. Third, proposed risk weightings on mortgages and home equity loans will not be implemented, leaving Basel I treatment in place, which results in an estimated forward benefit of about 75 basis points in our Tier 1 common to risk-weighted assets ratio as compared to the original proposal.

Now that we have final capital rules and greater clarity on stress testing, let me encapsulate our capital strategy by saying that we're setting our capital targets to provide sufficient cushion, not simply to meet a point in time standard, but to also confidently pass the annual regulatory, severely adverse stress scenario. At this point, a 10% target for Tier 1 common to risk-weighted assets seems reasonable, leaving us with a comfortable cushion. We estimate that all of our regulatory capital levels remain well in excess of the recently published Basel III regulatory requirements, with tangible capital above 8% and Tier 1 common above 11%.

In a further capital development this week, the FDIC proposed increasing the leverage ratio at large complex banks and holding companies to as high as 6%. For comparison purposes, our leverage ratios are 8.9% at the holding company and 8.2% at the bank. This proposed rule could have multiple positive competitive ramifications for well-capitalized regional banks like Webster, given the challenges it poses for the big banks, most of which will need to build capital. So we're pleased with our capital position and continue to target a dividend payout ratio in the 30s, consistent with the board's decision in April to boost the dividend by $0.05 a share to $0.15, for a 32% payout. Given the newness of the capital rules, we'll be cautious regarding stock buybacks for now.

In closing, I hope to see many of you at Webster's Investor Day in September in New York City. For your convenience, we've scheduled the meeting shortly after the conclusion of the Barclays Financial Services Conference.

With that, I'll turn the call over to Jerry for comments on line of business performance.

Gerald P. Plush

Thanks, Jim. Let's begin on Slide 3 to review our Commercial Banking results. Overall loans were up $211 million or 4% from March 31, and are up 16% from a year ago. Total originations were up $433 million from Q1. Loan and origination growth in the quarter includes a Webster agent transaction for $65 million, where we will sell down $45 million this month. This is part of our agented direct business, which generated $795,000 in fee income during the second quarter. The 2 basis point increase in portfolio yield reflects the benefit from deferred fee income from prepayments and also from past due borrowers paying current in Q2. The yield on new fundings was 4.35% compared to 4.15% in Q1 and 4.30% a year ago. The Commercial Bank pipeline now stands at $378 million compared to $322 million at March 31. Deposits totaled $2.8 billion at June 30, for a growth of 25% from a year ago, even as a 12 basis point cost of funds in Q2 was 4 basis points lower than a year ago.

We can turn now to Slide 4, and we'll review our Personal Banking results. Our overall consumer loan balances have declined 2.5% over the past year from ongoing consumer deleveraging. Our residential mortgages are essentially flat over the past year, largely driven by our strategy of selling conforming fixed rate loans. The personal bank portfolio yield declined by 5 basis points in the second quarter.

Our consumer lending originations remained strong in the second quarter. The yield on new originations rose to 3.83% compared to 3.58% in Q1 and 3.79% a year ago. Purchase loans represented 37% of the total production in the second quarter compared to 23% in the first quarter and 31% a year ago. The pipeline in consumer lending remained strong at $535 million at June 30 compared to $551 million at March 31. Our focus remains on originating a larger percentage of Jumbo mortgages and 44% of the total portfolio is now Jumbo loans, up from 40% a year ago. Transaction account deposits are over 25% of total deposits, and that's up from 23% a year ago. Our emphasis on transaction accounts and overall pricing discipline has resulted in a continued reduction in cost of funds over the past year.

We continue to work to optimize our delivery channels. In June, we introduced mobile deposit capture for iPhones and Android smartphones. MDC is a crucial step in helping transform our banking centers from transaction processors to sales and advice platforms. We also began construction of a new banking center in new Milford, Connecticut, as part of a 2-for-1 consolidation, and we've launched major upgrades at our 4 banking centers in West Hartford, Connecticut. Our new banking center in Storrs, Connecticut will be completed this month. And in Waterbury, work is underway on the relocation of our flagship branch. We're reducing that from 8,000 square feet down to 2,500 square feet.

We'll turn now to Slide 5 to review our Business Banking unit, which has seen loan growth of 12% compared to a year ago. Our portfolio yield was down 6 basis points from Q1, reflective of the flat yields on new originations, offset by the runoff of higher yielding loans. The yield on originations in the quarter was 4.31% compared to 4.29% in Q1 and 4.43% a year ago. Our Business Banking transaction account deposits are approaching 75% of total deposits and [indiscernible] to 9 basis points in the second quarter. The group is seeing transaction deposit growth of 13% compared to a year ago.

We can turn now to Slide 6 and take a look at the results of the Private Banking unit. The group recently added a Chief Investment Strategist and a Director of Fiduciary Services, as it strengthens its platform to capitalize on what we see as a very attractive, high net worth market opportunity for us. Loan growth in the Private Bank was $24 million or 9% for March 31, and $51 million or 21% compared to a year ago. The pipeline remains strong at $59 million at the end of this quarter compared to $54 million at March 31. We did see a slight decline in deposits from March 31, but we did post growth of 45% from a year ago. Also important to note that assets under management grew 9.5% to $1.8 billion.

We'll turn now to Slide 7 for the results of HSA Bank. Deposits grew $35 million following a seasonally strong Q1, where most of our deposit growth occurs each year. Deposits grew overall 22% from a year ago. We continue to tightly manage the tiered rate structure that we pay on our Health Savings Accounts, which resulted in a 6 basis point linked-quarter reduction in the cost of funds. We added over 29,000 new accounts compared to 23,000 new accounts added a year ago.

Turning now to Slide 8. This shows our overall loan balances and originations on a consolidated basis compared to the line of business breakouts we just reviewed. Overall, our loan balances are $12.25 billion. That represents an increase of 2% from March 31, and up 6% from a year ago. Our total originations are 20% higher than a year ago, and they reflect strong commercial performance. Our residential mortgage and consumer originations of 4 portfolio also performed well, with the combined increase of over 20% compared to Q1 and also a year ago.

With that, I'll turn it over to Glenn for comments on financial results and also an outlook for Q3.

Glenn I. MacInnes

Thank you, Jerry. I'll begin on Slide 9, which summarizes our quarterly trend of net income available to common shareholders and key performance ratios. Of note is the $3 million increase in earnings over prior year. The increase is after additional preferred dividend cost of $2 million this quarter related to our $126 million preferred issuance in December 2012. As you see, return on average assets was 92 basis points in Q2, and return on average tangible common shareholders equity was 12.26%. Slight decline in return on tangible common versus prior year was driven by a $78 million increase in tangible common shareholders' equity.

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 earning -- average interest earning assets grew $44 million compared to the first quarter, and our net interest margin remained flat at 323 basis points, resulting in an increase of $1.3 million in net interest income to $147.1 million from Q1. Noninterest income also improved to $51.9 million, resulting in an increase in total revenues of $5 million from Q1. The last driver of our core earnings growth is our continued prudent management of operating expenses, which resulted in a decrease of $1.4 million for Q1. As a result, our core pretax, pre-provision earnings of $76.4 million nearly matched the record established in the fourth quarter of 2012, and is $6.4 million higher than last quarter.

Slide 11 highlights the components of our net interest income for Q2 compared to Q1. As Jerry noted, most of the strong growth occurred late in the quarter, as we generated $244 million in period-end growth compared to the average loan growth -- compared to average loan growth of $37 million that you see here. The benefit in the quarterly growth in average earning assets of $44 million was offset by a 3 basis point decline in the yield on interest earning assets, resulting in interest income relatively flat with Q1. Including in earning asset yields were 2 basis points of interest recognized on a previously nonperforming commercial loan resolved during the quarter.

Average deposits increased $36 million, while we reduced the rate pay by 3 basis points. CDs represent our highest cost of deposits at 126 basis points. For the remainder of the year, we have approximately $700 million of maturities at a rate of 72 basis points. To the extent they roll over, our cost -- our current cost average is around 30 basis points on our new CDs.

5 basis point reduction in the cost of borrowing from Q1 primarily reflects the April maturity of $100 million FHLB advances yielding 3.35%. There are no significant long-term FHLB maturities until June of 2014. Incremental funding is done primarily at short-term rates from 10 basis points to 20 basis points. At the end of June, we did add $50 million in 5-year FHLB advances at an effective yield of 1.5% to maintain funding duration. We also added $50 million of 8.5 year 3% LIBOR caps in April, as we continue to opportunistically position the balance sheet for higher rates. Interest expense for the quarter declined $1.3 million, which drove the improvement in interest income.

Jim and Jerry have already discussed the activity in loans and deposits and given the recent changes in markets, I wanted to touch on some of the points regarding our investment portfolio, beginning on Slide 12. So as we highlight on Slide 12, we continue to keep the investment portfolio relatively flat, as we reinvest cash flows of over $400 million per quarter. With the 70 basis point rise in the 10-year during the quarter, the unrealized gain in the AFS portfolio fell by 1.8% of the portfolio or $60 million. The duration of the AFS portfolio extended from 2.7 years to 3.2 years. Our longer duration investments in the held-to-maturity portfolio, which extends from 2.9 and 4.1 years. We maintain a roughly 50-50 split between AFS and HTM to balance liquidity needs, with the retention of GAAP capital.

The extension was expected and included in our interest rate risk modeling. We have consistently disclosed that rising long-term rates benefit the bank's earnings. In this case, we expect to recover the reduction of AFS market value in less than 3 years with the P&L. Note the tangible book value per share was unchanged this quarter despite the AFS mark, which was primarily offset during the quarter from an increase in retained earnings.

Earnings will increase due to a combination of higher rates on new fixed-rate loans, slower prepayments, fees on loans and investments and reduced investment premium amortization. Unamortized premium on the entire portfolio was $245 million compared to $236 million at March 31. Premium amortization on the entire portfolio was $15.7 million compared to $16.3 million in Q1. The decrease is a result of a 1.8% decline in agency MBS annualized cash flow from 28.3% to 26.5%. We expect further declines in Q3 and Q4 and for further benefit net interest income.

Prepayments, calls, amortizations and maturities during the quarter amounted to $433 million, with a yield of 319 basis points. During the quarter, we purchased $476 million of securities at an average expected yield of 218 basis points at a duration of 3.8 years. Most of our purchases were fixed-rate agency MBS, although we added $77 million of floating rate CMBS and collateralized loan obligations at a yield of 179 basis points.

Our AFS portfolio now contains $345 million of high-quality floating rate CMBS and CLOs yielding around 185 basis points. 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 with limited duration. In July, our expected yield and fixed-rate MBS purchases has been in the 275 to 300 basis point range, with a duration of about 4 years. Given the current level of the 10-year, we would expect our investment portfolio yield to reach the bottom in Q2.

Slide 13 provides detail on noninterest income. Gain on sale of loans remained strong at $5.9 million, but was nonetheless lower than the first quarter by $1.1 million. Included in the $1.1 million reduction was a loss of $600 million on the sale of our commercial credits. In Q2, we originated and sold $206 million in conventional fixed-rate mortgages at a gain on sale of 273 basis points. This compares to $229 million of originations in Q1 sold at 290 basis -- 297 basis points. Wealth and investment services had a record quarter and grew just over $1 million quarter-to-quarter. Likewise, loan fees each grew by $1 million in Q2, driven by continued production, momentum and strong commercial originations. Lastly, other income improved by $2.1 million, as Q1 included a onetime $1.5 million write-down on a loan previously transferred to held-for-sale. This is reflected in the BOLI and Other category on the chart.

Slide 14 highlights our core noninterest expense, which decreased compared to both Q1 and a year ago. In addition to the anticipated decline in compensation and benefits expense from a seasonally high Q1, we achieved meaningful declines in occupancy, professional services and marketing, as well as loan workout expense.

Our efficiency ratio is highlighted on Slide 15. Our core efficiency ratio of 59.98% was back in the 50% range after the expected seasonal uptick in expenses in Q1. Ongoing achievement of positive operating leverage helped us maintain the efficiency ratio below 60%.

Turning now to Slide 16, which highlights our asset quality metrics. Nonperforming loans declined by $12 million the quarter, led by an exit of a $9 million commercial real estate credit that was included in nonperforming in Q1, and lower new non-accruals of $34 million compared to $48 million in Q1. We had an increase of $10 million in past due loans. This follows a significant reduction of $34 million in Q1, and represents a reduction of 24% from a year ago. For the quarter, the increase was the result of a high level of Business Banking maturities, which will resolve over the next 2 quarters, as well as a single commercial non-mortgage loan that we expect to be resolved in July.

We've made continuing progress in commercial classified loans, which declined another 14% on a linked-quarter basis and are now below $300 million. Going forward, we expect the ratio of commercial classified to commercial loans to be in the range of 4% to 5%. For Q2, the delta between the provision of $8.5 million and the net charge-offs of $12.9 million was less than $5 million. Assuming recent trends remain intact, we think continued improvement in asset quality can be expected in 2013.

Slide 17 highlights our capital position. Our tangible equity and tangible common equity ratios are only slightly lower from March 31 despite the $219 million increase in asset growth and the aforementioned reduction in unrealized gains in the AFS securities. This underscores the strength of our earnings in Q2, and the effective management of our investment portfolio.

Our Tier 1 common to risk-weighted asset ratio increased from March 31. You will also note in our appendix that the 3 key regulatory ratios increased from March 31 as well, once again, highlighting the strength of our overall capital position.

We are also pleased the regulators have settled on capital rules, and particularly the exclusion of AOCI from regulatory capital. If the same exclusion applied to TCE, as we think it should, our ratio would increase 30 basis points to 757 basis points.

So before turning it back over to Jim, I'll provide a few comments on our expectations for Q3. Overall, our average earning assets will likely grow in the range of 1% to 2%; we expect average loan growth in Q3 to be in the 2% to 3% range; net interest margin pressure has diminished with the recent rise in rates, and we think we are at or near the bottom. As a result, should current rates continue, we would expect no to minimal marginal compression. That being said, we expect net interest income to be approximately $2 million higher than Q2 level, primarily due to loan volume.

Regarding asset quality, our leading indicators of credit were encouraging during the quarter and may signal further improvement in asset quality. Given our outlook on Q3 loan growth, we could see a modest increase in the Q3 provision.

Regarding noninterest income, we expect to see continued pressure on mortgage banking gain-on-sale revenue. As a result of the rising rates, we have begun to see pressure in mortgage activity levels. In addition, we expect tighter pricing due to increased competition and higher GSE guarantee fees, which will likely compressed gain-on-sale levels. Partially offsetting this headwind is the continued progress we have made in the areas of wealth and cash management services. In addition, during Q3, we will be implementing pricing changes and looking to launch additional value-added products to mitigate the expected decline in mortgage banking. Taken all together, we see a modest reduction in linked-quarter noninterest income.

We would expect to see core operating expenses close to Q2 levels, as we continue to invest in our business, while focusing on operating leverage to achieve a sustainable 60% efficiency ratio. We expect our effective tax rate on a non-FTE basis to be around 31% in Q3. Based on our current market price and no additional buybacks in the quarter, we expect to see the average diluted share count be approximately 90.3 million shares.

I'll now turn things back over to Jim for concluding remarks.

James C. Smith

Thanks, Glenn. I trust you can see reflected in our second quarter results our commitment to invest in strategies that increase economic profits. We're continuing to reconfigure the Personal Bank to meet changing consumer preferences and improved economic returns, and we're successfully building profitable relationships across our business units. Expenses are tightly controlled, asset quality continues to improve and our capital position is rock solid. Taken together, these are the elements that propel us toward our goal to be a high-performing regional bank.

We're now pleased to take your comments and questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Dave Rochester with Deutsche Bank.

David Rochester - Deutsche Bank AG, Research Division

Glenn, just real quick. You mentioned 2 basis points in the margin came from recaptured interest this quarter. Did I get that right?

Glenn I. MacInnes

That's correct.

David Rochester - Deutsche Bank AG, Research Division

And how much came from prepayment penalty income?

Glenn I. MacInnes

For the quarter, probably about 2 basis points.

David Rochester - Deutsche Bank AG, Research Division

Great. And that's versus what in 1Q?

Glenn I. MacInnes

I think it was about the same in Q1.

David Rochester - Deutsche Bank AG, Research Division

Okay, great.

Glenn I. MacInnes

Or flat.

David Rochester - Deutsche Bank AG, Research Division

And in terms of your margin guidance, how much of an unwind of the securities premium amortization you're assuming for that going forward?

Glenn I. MacInnes

Meaning how much does it drop?

David Rochester - Deutsche Bank AG, Research Division

Yes, how much does that decline? How much are you assuming?

Glenn I. MacInnes

So I think it's probably about $400,000 quarter-over-quarter. You're talking about the total amortization level?

David Rochester - Deutsche Bank AG, Research Division

In terms of the amortization expense, that's right.

Glenn I. MacInnes

Yes. So probably about $400,000, $500,000.

David Rochester - Deutsche Bank AG, Research Division

So you're assuming that the current curve stays where it is through the end of the year?

Glenn I. MacInnes

I'm using a 2 50, 10-year, and assuming that we stay in the 2 50, 2 60 range.

David Rochester - Deutsche Bank AG, Research Division

Perfect. And on loan pricing, you guys had mentioned the environment had improved somewhat. If you just talk about some of the areas you've been able to raise pricing and by how much, that would be great.

James C. Smith

I'd just say pricing has been firm, and Jerry went over with some of the numbers where pricing was higher on, obviously, on the origination of mortgage loans, including those that went in the portfolio. Commercial pricing was firm. You saw it was up about 15 or 20 basis points in the quarter, also higher than last year. And I also made the comment that it feels as if the increase in long rates has had an overall impact on the ability to hold pricing, pretty much across the board.

Operator

The next question is coming from the line of Bob Ramsey with FBR Capital Markets.

Bob Ramsey - FBR Capital Markets & Co., Research Division

I thought the margin guidance was particularly encouraging. Did I hear you correctly that not only should margin be more or less flattish from here, but that the securities portfolio yield, you believe, is at a bottom in the second quarter?

Glenn I. MacInnes

Yes, we believe the securities yield is at a bottom. We did highlight that there were 2 basis points in the 3 23 this quarter that are sort of nonrecurring, Bob. So 3 23 will be in the 3 21, 3 22 range.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And I know you just spoke about the firmer loan pricing, and you had talked about that earlier on. I'm just curious, how much of that do you think is a reflection of the movement that you've seen in rates? How much of it are competitors being a little bit more rational this quarter? Or sort of what do you attribute the better loan pricing in the market to?

James C. Smith

It's hard to say which proportion. I'd say it's probably a little of both, driven by the fact that rates are up. And I think it got people's attention in a big way.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Obviously, your loan yields on the originations are better this quarter than the prior quarter. How much of that was back-end loaded sort of in the month of June, I guess, when, really, rates started to move, and how much was sort of through the quarter?

Glenn I. MacInnes

A fair bit of it, Bob, given that's when a lot of the funding actually took place.

James C. Smith

If you look at our average loan growth, it's less than 0.5% and yet we're up 2%, $244 million. So most of it did come in, in June.

Operator

Our next question is coming from the line of Steven Alexopoulos with JP Morgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Sorry if I missed this, but what's the current balance of the unamortized premium that's left in the securities portfolio?

Glenn I. MacInnes

So as of second quarter, it was $245 million.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Okay. And I'm curious on in terms of the mortgage business, with the 30-year mortgage now in the 4s, can you talk about what you're seeing from the consumer side? Are you seeing more demand for ARMs? Are people trying to lock in quickly? Just curious what you're seeing there.

Glenn I. MacInnes

So I think what we're -- one of the big trends that we're seeing is the reduction, obviously, in refinance volume where as it was 2/3 in the first quarter, it's now shifted to like a 50-50 mix. So that's one of the things we're seeing. As far as products...

James C. Smith

Generally, people still favor the fixed, but we expect that as rates or should rates continue to rise that, that will start to change. But if anything, those that we're thinking about refinancing are moving more quickly to do so. So there really hasn't been a significant shift toward ARMs yet.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

And how did gain on sale margins change in the quarter?

Glenn I. MacInnes

So I think we were, in my comments, I think we're down 10 basis points or so. So we were at 2 7 -- we were at 2 97 in Q1, and we went to 2 73.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Okay. And just a final question, I know you've commented on this a few times, but this thought of less pressure on loan pricing. Is this including -- I could see down the real estate-related given the curve has steepened up, but even on C&I products, are you seeing less competition or not as much competition in terms of loan pricing?

James C. Smith

There's plenty of competition. And it may be -- from quarter-to-quarter, it could be what the makeup is of the originations. But it just feels like that withering pressure we were seeing in Q1 seems to have abated, I guess, is the way I'd say it. And as a result of that, our rates were -- our yields were a little bit higher on originations than they were in Q1 and higher than they were in Q2 last year on the C&I side.

Glenn I. MacInnes

I think, Steve, one of the trends we've seen, when we look at business that we've passed on, is that about 2/3 of that, the business again we passed on is relative to structure and 1/3 pricing. And if you go back a year ago, it was almost the opposite.

Operator

The next question is coming from the line of Ken Zerbe with Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

Just on the securities portfolio, I appreciate the detail you talked about with the extension of the duration there. Are you guys taking actions or do you plan to take actions to sort of proactively keep the duration a little bit shorter just given the move up in rates that we're seeing, whether it's new investments that you're making at shorter durations to keep the average a little bit lower or not going up as much?

Glenn I. MacInnes

Yes. Well, we have purchased CLOs and CLOs in part to that. But the other part of it is, is when we look at future rate shocks, future increases in rates, I think the steepest part of the duration would be from where we were to today's point at the end of Q2. And then it starts to abate as we go anything over 100 basis points in additional on the long end. So it's -- there's not as much as you go further out, it's not linear.

Ken A. Zerbe - Morgan Stanley, Research Division

Okay. So less of a need, got it. Okay.

James C. Smith

Another thing, Ken, is that as rates continue to rise from here, the extension of the duration will slow down, and we anticipate that the duration doesn't get much past 5 years even in a significant upward shock from here.

Ken A. Zerbe - Morgan Stanley, Research Division

All right. That helps. And then just one other question on deposit outflows or industry deposit trends. Obviously, you guys had good deposit growth this quarter. Another mid-cap bank recently talked about deposit outflows, maybe it was a timing issue. Just want to check, when you look at sort of the month-by-month trend in deposits, are you seeing any slowdown, any kind of uptick in outflows in the back half of the quarter versus the first half?

Gerald P. Plush

Ken, it's pretty consistent because most of the outflows that we're experiencing continue to come from maturing CDs. We're actually seeing a fair bit of that actually stay and transfer in the transaction balances or get reinvested. We reported record fee income in our Webster Investment Services division. So you're seeing some depositors seek alternatives. I think the really encouraging news with us is that you're continuing to see nice inflows and build in both a number of new accounts, as well as also in balances in the existing portfolio and the transaction account side. So I think that just emphasize -- that shows the emphasis that the team respectively in each of the lines of business are -- really got a lot of focus on that.

Operator

The next question is coming from the line of Casey Haire with Jefferies & Company.

Casey Haire - Jefferies & Company, Inc., Research Division

Just a follow-up. One more question on the NIM, on the funding side of things. I was wondering, does the guidance -- what does it assume on the funding cost side of things because it doesn't sound like there's much more help with on the FHLB side or CDs? So I was just curious, do you expect it to be flat from here? Or does it bake -- does it assume any increase in funding cost?

Glenn I. MacInnes

Yes. I think that we'll probably be down 2 to 3 basis points on the funding cost. We do have some actions that we're taking on deposits that will further reduce some of the rates 2 to 3.

Casey Haire - Jefferies & Company, Inc., Research Division

Okay. And then on the expense side, the flat -- it sounds like it's flat quarter-to-quarter. I know you guys have a lot of initiatives in place, FIS, JLL, sounds like eBanking initiatives came online in June. I was just curious, how much are you guys now with the NIM kind of stable from here? Is franchise reinvestment kind of the theme going forward, which we shouldn't expect much more leverage from here going forward?

Glenn I. MacInnes

Yes, I think that 2 things. One, there's still -- some of the initiatives that we began were in the first part of the year, Universal Banker, branch rationalization, so -- and JLL outsourcing, FIS, some of those things. So we're just starting to see some of that. I think you'll see more as the year progresses, and the point being is that we continue to drive down expenses. So it's not that we've reached a plateau by any means on expenses.

Casey Haire - Jefferies & Company, Inc., Research Division

Okay. And then just lastly on capital, obviously sounds -- if I understand it correctly, it sounds like you guys are close to 12% under the new rules on Tier 1 common. Obviously, these are all new and it's constantly evolving. But at what point do you guys get a -- I mean, what's the trigger point where you guys are a little bit more aggressive with capital and what is the priority?

James C. Smith

Well, the priority is to make sure we have ample capital regardless of the scenario, and some of these things are still relatively new. We want to make sure that they're adopted as we think they will be and that we're comfortable with them, which is why I made a comment about being on the conservative side for now. But you're right, we do have ample capital, I don't know if it's a 12, but...

Glenn I. MacInnes

11.22%.

James C. Smith

It's somewhere around 11 plus...

Glenn I. MacInnes

11.22%.

James C. Smith

Yes, 11.22. So we're well over our estimate of necessary capital plus buffer to meet the adverse stress scenario. So to your point, we do have capital that we can leverage as we go forward.

Casey Haire - Jefferies & Company, Inc., Research Division

Okay. I mean, is it safe to say that you guys are going to keep conservative until you get through the stress test?

James C. Smith

Well, we've done stress test thing, so we know where we stand. But I'd say, we're going to be cautious over the near term is, I guess, the best way to put it.

Operator

The next question is coming from the line of Dan Werner with Morningstar Inc.

Dan Werner - Morningstar Inc., Research Division

You indicated with regard to the expense levels that you thought they'd be maintained at the $122 million, $123 million level here, and you had declining occupancy expenses on a linked quarter. I'm trying to reconcile how does the establishment of the Metro New York hub impact that?

Glenn I. MacInnes

Yes. So it's Glenn. And first, we didn't -- we're not saying we're staying at $121 million, $122 million. We continue to rationalize our expense base. So we're working it down, and we're reinvesting in the business at the same time, much like we've done over the last couple of quarters where we've launched Private Banking, Treasury and Payment services. We've expanded our commercial loan and our mortgage banking officers, all while reducing expenses. So the model here is positive operating leverage, and we continue to reinvest in the business to the extent our financials allow us to.

Gerald P. Plush

Yes. And I think to the point on the Metro New York office, we're already at 360 Lex with our Webster Business Credit. So our ABL business is already headquartered there. There's capacity to take on some additional personnel in that facility, and that's where we'll have our new regional president sitting.

Dan Werner - Morningstar Inc., Research Division

Okay. And then one last question on the commercial growth, and I apologize if you touched on this. How much of the growth was due to line utilization versus new customers?

Glenn I. MacInnes

All our line utilization increase was in asset-based lending.

Gerald P. Plush

Yes, I think it was virtually all in terms of incremental originations.

Operator

The next question is coming from the line of Matthew Keating with Barclays.

Matthew J. Keating - Barclays Capital, Research Division

As it relates to capital, I guess, your most recent Basel III impact, I guess, before today was about 100 basis points impact. So I guess what you're saying is post the new Fed's final NPR that there won't be any impact essentially from Basel I to Basel III on Tier 1 common. So I guess my question is given some higher capital levels, and you kind of mentioned in your prepared remarks that you think some of the new leverage ratios for largest banks significantly advantaged smaller regional players. Can you talk about what impact do you think these capital trends will have on the bank M&A environment in general?

James C. Smith

Well, haven't spent a lot of time thinking about it, but would say that the larger banks will probably going to be a little bit less interested than they were before. I think it does create really more competitive opportunity than anything else for the mid-sized banks that significantly exceed the leverage capital ratios of today. So whether it drives additional M&A among them, I would doubt, except that they have some assurance that until they hit a certain size now, that they're not going to be subject to the large complex bank rules and that they can -- rest assured that they can be confident in their current leverage capital ratios. So to the extent that gives people more confidence to do things now that we have clarity, perhaps it would have an implication for M&A activity.

Matthew J. Keating - Barclays Capital, Research Division

Okay. And in Webster's case, any change in your stance on M&A, continue to look for opportunistic partners but no real change then, is that safe to presume?

James C. Smith

Yes, that's true and I would deemphasize looking. I would say, we're investing in organic growth and improving what we do, and sure there maybe some opportunities that come along, but it's not an important strategy prong.

Matthew J. Keating - Barclays Capital, Research Division

And my final question would just be with the 2014 CCAR getting a lot closer, can you talk about, I guess, the link between that process and your capital plan? Is there a strong link there in terms of what you can return on the capital front versus the stress test, and just maybe just talk about how you expect that process to proceed?

James C. Smith

Well, you know we're not part of the CCAR, but we do have our stress testing under the Dodd-Frank at rules, and I was mentioning in my comments that we're already well into that process and that in deciding what our capital levels ought to be, we're looking at what our levels would be in a fully stressed out, the maximum stress adverse scenario and saying that our ratios are not simply for what we need to have today, but looking at what do we look like 9 quarters out, what are our capital ratios and are we going to exceed the requirements for a well capitalized plus a buffer. And so we're saying that 10%, we would easily make that target on the Tier 1 Capital side, and we're sitting at 11.22%. So we have an abundance of capital even relative to looking at what the implications of the stress test will be. So in us, it's a validation of the very strong capital position that we have. And again, you get some clarity out of that, that allows you to make some confident decisions going forward. So I think a lot of the capital questions are being resolved. And even though it may mean there's more capital to be carried than people might have desired, the certainty, I think, will be an asset in making strategic decisions going forward.

Operator

The next question is coming from the line of David Darst with Guggenheim Securities.

David Darst - Guggenheim Securities, LLC, Research Division

Can you discuss the sustainability of your origination volumes? And then 2 questions, one, should we see the loan growth -- top line loan growth pick up as your prepayments speed slow, and then also on loan fees, are your loan fees pretty well tied to your commercial origination volumes?

Gerald P. Plush

David, it's Jerry. I'll just make a comment right out of the gate that the one thing we've been pretty consistent in reporting on has been the pipeline, and I got to say that the strength of the pipeline that you can see that even with really, really strong origination numbers, you can see that the pipelines remain pretty robust across the board. So I think that gives you a good view into our sense of the quarter upcoming, so I think that we feel good about the ability. And I think Glenn gave the guidance of our ability to continue at about this 1.5%, 2.5% growth rates that we've been putting out the last couple of quarters.

David Darst - Guggenheim Securities, LLC, Research Division

Okay. And would you also say that your loan fees are directly tied to the level originations? Or is it something with the agent direct business that you're doing that might increase that?

Gerald P. Plush

I think it's a good point, and I think it's a combination of the 2. I think in terms of when we made specific comments of what our expectations or what happened in the second quarter and that we continue to see that there's some real opportunities for us to continue in the agent business in the third and the fourth quarters. So I think you continue to see some good fees continuing in those periods. In addition that I think you also see the fees associated with the origination volumes also continuing.

Operator

Our next question is coming from the line of Matthew Clark with Crédit Suisse.

Matthew T. Clark - Crédit Suisse AG, Research Division

A lot of my questions have been answered, but on the loan front with the strong originations, and can you give us a better sense of where you're seeing the new business, whether it'd be the types of businesses, the types of competitors and where from a geographic standpoint?

Gerald P. Plush

Yes. I think on the Business Banking side, we're seeing really good results across the core footprint. We certainly are continuing to see equally strong demand in the New York side of our footprint as well. So good news there in the pipeline rebuilt in the quarter, so I think you can get a fair sense of it's really core footprint on that side of the fence. In terms of -- on the commercial side, I think you can see that it's also pretty much across all the geographies, and I also think it's pretty safe to say you're seeing across all the lines of business. So we're seeing a nice pickup evenly distributed across those as well.

Matthew T. Clark - Crédit Suisse AG, Research Division

Okay. And again, it's largely market share gains?

Gerald P. Plush

Yes, I think so. I think in terms of -- we're taking business, we're certainly head-to-head. There's a lot of competition out there certainly in the segments that I just reported on, and I think you would say that we're continuing to take some share.

Matthew T. Clark - Crédit Suisse AG, Research Division

Okay. And then on the reserve front, in the reserve release, there's a little bit less, obviously, to support growth. But I assume you want to still keep reserves above last cycle at the -- at least, relative to the trough. I mean, can you give us a better sense of how much more we might see on the release front?

Glenn I. MacInnes

Well, it's all driven by loan growth, obviously, so that's one of the key factors, and actually, one of the things we looked at this quarter. But you're right, that our -- the net release was only 6 point -- a little over 6% of our core earnings, where last year, it was close to 20%. And so this is -- it's encouraging to us that our earnings are real quality earnings as well. But the 1 33 that we are as coverage right now, as we said in the past, I mean it's subject to loan growth and with an eye toward the improving asset quality, we think could likely drift down to 1 25, in that range, 1 20, 1 25.

Operator

Our next question is coming from the line of Matthew Kelley with Sterne Agee.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

There's an uptick in the deposit service fees, I'm wondering if you can just talk about the outlook for that line item and just the implications of some of the changing of transaction ordering, a little update on that conversation.

Gerald P. Plush

Yes, I think on the deposit service fee side, you're seeing some of the seasonality that you would naturally see take place. We're also and I think Glenn alluded to this in his comments, we're looking at some pricing changes that we would expect to take place by the end of the third quarter that would also continue to bolster that as we go into Q4 and also, obviously, into 2014. Also looking to launch some additional value-added products and services that should continue to also help support on the Personal Bank because, particularly the consumer deposit side, some ancillary products that will help keep that going.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

And did those offset the change in the transaction ordering?

Glenn I. MacInnes

Yes, that's what I was going to highlight -- we had previously, I think, highlighted that. We thought it would as much as $2.5 million of a net negative impact. And in fact, what we've seen is a reduction in the NSF fees quarter-over-quarter. And I think that's somewhat self-inflicted and that -- the mobile products out there and the online product, consumers are more in touch with their balances. We've also moved upstream as far as average account balance. So we don't think that the impact is going to be as high as $2.5 million anymore. We're actually running through that data now, but it's going to be significantly less than that.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

How much were NSF fees down? What was that trending towards?

Glenn I. MacInnes

Well, going -- actually the biggest dropoff we saw from Q4 to Q1 was about, on our base, about $1 million in Q1 and then sort of stabilized in Q2, but definitely downward pressure on NSF fees.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

And then on the mortgage banking business, what type of offsets will you have in kind of reducing headcount or operational-type expenses in that business's volumes and on sale margin decline?

Glenn I. MacInnes

Yes. So the guys in mortgage do a really good job at looking at the sensitivity to changes and shifts in volume. And I can tell you, if we get a 10% to 15% reduction in volume, that could reduce expenses on an annualized basis somewhere around $2.5 million. So you can sort of use that number. We're very efficient in the mortgage business. We have an efficiency ratio somewhere just north of 50%, so they're pretty efficiently run.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Got you. Then just last question, Jim. I wonder if you could just talk about, again, M&A. Obviously, you have a much stronger multiple now. There's been a pretty healthy stream of transactions, smaller banks throughout New England. It seems like the math could be a little more compelling with some of the changes in valuation, particularly your currency. And just give us an update on your appetite for deals now versus 3, 6 months ago.

James C. Smith

Pretty much the same. I don't know if you heard my previous response, but we're really 100% focused on doing better what we do well. And there may be some opportunities that come along, and it's great that if our currency has a higher relative value that would make us a more compelling potential partner to somebody that sees us as a like-minded partner. But it's not occupying a lot of our time.

Operator

The next question is coming from the line of Collyn Gilbert with KBW.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Just a question sort of tying two things together. Number one is the structure that you guys are seeing on your new loans. I mean, are these sort of prime LIBOR-based loans? Are they fixed-rate? More on the commercial side is my question, obviously.

Gerald P. Plush

Yes, they're LIBOR-based. And I think one of the things the team are really -- they're sticking to the guns and not conceding on structure.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And did you -- Glenn, you may have said it, and if you did I apologize. The yield on the ABLs -- the new ABL origination that you're seeing is what?

Glenn I. MacInnes

Yes, I think you didn't miss it. So the coupon rate is about 3.5 for the quarter.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then do you guys look at the duration? I know you've talked obviously about the change in duration in the securities book. How about the loan book, how that's changed?

James C. Smith

Yes, absolutely we do. In fact, if you look at duration on loans because of the loan mix and the repricing of our loans that we actually are quite asset sensitive when you look at the loan book versus the deposits. So the duration of our deposits on the bank, forgetting the borrowings or securities portfolio, the duration of the liabilities is significantly longer than the assets. It's part of why we have our investment portfolio strategy as we do.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. So the loan book that -- do you have those numbers specifically?

James C. Smith

The loan book is more sensitive than it was a few years ago.

Gerald P. Plush

But 65% of our portfolio is floating, so it's...

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, okay. All right. And then, Glenn, you had mentioned -- I think when you're talking about the early -- the change in the early stage delinquencies in the quarter, something about big Business Banking maturities? Did I -- I was just trying to...

Glenn I. MacInnes

Yes, these were credits that were written 5 to 7 years ago, and they're all maturing now. And so, it's really -- if you look at the $10 million increase, about $4.2 million is Business Banking unsecured lines maturing now. The biggest pop came in during the second quarter. It went down for the rest of the year. And by the way, they're still paying the most part. So we think this will all be resolved by year end. It's not an ongoing trend. The program ended in 2007. It's not...

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. So it's a timing issue, it sounds like more than anything on this tranche of loans.

Glenn I. MacInnes

That's right.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then just finally on the provision, it seemed like it came in a little bit higher than what you guys had sort of indicated maybe at some of the conferences. Was that just a function of the late quarter loan growth or was that a function of these early stage delinquencies?

Glenn I. MacInnes

No, More of the first, the late stage loan growth came in pretty high.

James C. Smith

And I just want to say on the delinquencies, remember, that slight uptick but down by almost 1/3 from 2 quarters ago, and there was reduction on the consumer side. So that was not a factor in the bump-up in the provision.

Operator

The next question is coming from the line of John Pancari with Evercore Capital Partners.

John G. Pancari - Evercore Partners Inc., Research Division

I want to see if you can comment on the NIM outlook beyond the third quarter if you can. I know that your comments around pricing as well as what you're seeing how the curve is influencing that could bode well for the longer-term view. So I want to see if you can give us a little bit of color there.

Glenn I. MacInnes

Sure. I think that we'll flatten out going into Q3, actually 2 basis points that we talked about, and then we'll see a gradual rise. I mean, I think, we're at sort of the bottom, but it will be sort of protracted before it really starts to increase.

John G. Pancari - Evercore Partners Inc., Research Division

So 3Q could really mark that inflection, in other words 4Q can actually be up?

Glenn I. MacInnes

4Q could be slightly up. Again, it's driven off the 10-year. We use 2 50, 2 60, 10-year swap, 10-year or 10-year treasury, and you see the volatility is still there. So we're certainly hopeful. But if we were to stay in the range of 2 50, 2 60 or 2 75, I think we start to see an increase in probably beginning in the late fourth quarter.

John G. Pancari - Evercore Partners Inc., Research Division

Okay. And then on your pricing comments, are you seeing any differentiation between the pricing on C&I versus CRE? I would expect you may see a little bit more relief on the CRE side since it's particularly anchored to the 5-year to an extent. But are you seeing any differentiation there?

Gerald P. Plush

I think there are some signs, but right now, I would say that it's pretty similar.

Operator

The next question is coming from the line of Jake Civiello with RBC Capital Markets.

Jake Civiello - RBC Capital Markets, LLC, Research Division

Just as a follow-up to John's question. If we were to see a continued steepening in the yield curve in the second half of the year with the 10 year approaching 3% or potentially even higher and Fed funds remaining flat, what would that do to the margin?

James C. Smith

It would be a positive.

Glenn I. MacInnes

Yes, no question, yes.

James C. Smith

And I don't know whether you heard the comment we made before, but the long end-up scenario with short rates staying down for some period of time is very favorable for us and it's the one when we're building our investment portfolio strategy to which we gave the highest probability weighting. So long end up is good for us.

Jake Civiello - RBC Capital Markets, LLC, Research Division

So that's positive regardless of how quickly the long end moves higher?

James C. Smith

Pretty much.

Glenn I. MacInnes

Yes, I mean, I think I would just say, if you look at the analysis, the interest rate risk analysis we do in our Q, long end up 50 basis points gets us 2.5% in additional pretax preprovision net revenue. And so that's sort of helped. So you can look at it that way. As it goes 15 and another 50, that it's more of a marginal benefit, but it does obviously help us.

Operator

The next question is coming from the line of Jason O'Donnell with Marion Capital Group.

Jason A. O’Donnell - Merion Capital Group

Can you provide an update on the rollout of the Universal Banker strategy and whether you still expect that to be completed by year end?

Gerald P. Plush

Yes Jason, it's Jerry. We're about 60% of the way through, so roughly 102 of the 168 banking centers that we've got it rolled out. We've got a really nice phased approach between now and the balance of the year, and our expectation is that we're going to be on track to achieve the results that we expected. We're also seeing a really nice increase in sales per FTE from those who've been through the education sessions and where it's been implemented. So we think that also bodes well for the future.

Jason A. O’Donnell - Merion Capital Group

Okay, great. And then just one housekeeping item. It looks like other noninterest income was a little higher than we were expecting. Were there any nonrecurring or noncore items in there that drove the linked-quarter improvement?

Glenn I. MacInnes

Yes, there was a $1.5 million in the commercial credit that we wrote off that was held for sale, we wrote off in Q1. That change quarter-over-quarter is what you're seeing.

Operator

It appears there are no further questions at this time. I would like to turn the floor back over to Mr. Smith for any concluding comments.

James C. Smith

Thanks, Jesse. Thank you all for being with us today. Have a good day.

Operator

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

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