Webster Financial Corporation's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Jan.17.14 | About: Webster Financial (WBS)

Webster Financial Corporation (NYSE:WBS)

Q4 2013 Earnings Conference Call

January 17, 2014 9:00 a.m. ET

Executives

James C. Smith – Chairman & Chief Executive Officer

Glenn I. MacInnes – Chief Financial Officer & Executive Vice President

Joseph J. Savage – President of the Company and Webster Bank

Analysts

Dave Rochester – Deutsche Bank

Dave Darst – Guggenheim Securities

Matthew Clark – Credit Suisse

Casey Haire – Jefferies & Company

Bob Ramsey – FBR Capital Markets

Matthew Kelley – Sterne, Agee & Leach, Inc.

Collyn Gilbert – Keefe, Bruyette & Woods

Jake Civiello – RBC Capital Markets

Operator

Good morning, and welcome to Webster Financial Corporation's Fourth 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 may 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 fourth quarter of 2013.

I'll now introduce your host, Jim Smith, Chairman and CEO of Webster. Please go ahead, sir.

James Smith.

Thank you, Rob. Good morning, everyone. Welcome to Webster's Fourth Quarter Earnings Call and Webcast. I'm joined by CFO, Glenn MacInnes, for about 20 minutes of prepared remarks focused on business and financial performance in the quarter followed by your questions.

First things first, I want to congratulate Joe Savage who has also joined us here today on his promotion to President of Webster Financial Corporation and Webster Bank, as well as his election to the Bank’s Board of Directors. Joe earned this promotion through his consistently high performance leading commercial banking over nearly a dozen years and because he models the values that bring Webster’s 3,000 bankers together and set us apart. Our culture defines and differentiates us in our markets and Joe reinforces that winning culture every day. He’ll now bring his special talents to bear for the benefit of the entire organization.

Turning to the fourth quarter and beginning on Slide 2, Webster delivered another solid performance as our bankers continued to excel in service to our customers and communities. Strong overall performance was driven by multiple factors. In a nutshell, record core revenues, positive operating leverage once again, strong commercial loan growth, improving asset quality and a steeper yield curve, produced a record level of quality core pretax pre-provision earnings of over $80 million. Net interest income increased 2.6% linked quarter and over 5% year-over-year to another quarterly record, driven by a four basis point increase in the net interest margin and ongoing strength in commercial lending.

Overall loan balances are $12.7 billion, an increase of just under 2% from September 30 and about 6% from a year ago. Balances in every key category are higher linked quarter, except for asset based lending where most of the linked quarter decline was seasonal and the ABL portfolio has grown 11% from a year ago.

Total originations were just under $1.2 billion in the quarter, which was 21% lower than a year ago. More than half the decline was in residential mortgages, given the still high level of refinancing activity a year ago. Most of the remainder of the decline was in commercial lending as the fourth quarter of 2012 benefited from the substantial tax related closing activity at that time. Our pipeline remains strong, especially for commercial banking and business banking and our emphasis on purchase mortgages should strengthen the personal lending pipeline in the months ahead.

Core non-interest income increased 12% from the third quarter as an expected rebound from the third quarter’s depressed level of mortgage banking revenue was augmented by strong results in wealth and investment services revenue. Total core revenue grew 4.8% linked quarter and exceeded $200 million for the first time. Year-over-year, core revenue grew 3.1% despite a $5.7 million decline in mortgage banking revenue.

Once again, revenue grew faster than expenses, both linked quarter and year-over-year. This positive operating leverage drove the efficiency ratio down to 59.3% compared to 60% in the third quarter and 59.7% a year ago. For the full year, positive operating leverage of 4.3% drove the efficiency ratio down nearly 3 percentage points to 60.4% as selective strategic investments and our successful efforts to operate more efficiently have made us sustainably more competitive. I want to stress that positive operating leverage has been and remains a crucial metric on our path to high performance, including our overarching financial goal to earn a return in excess of our cost of capital.

Asset quality improved further, marked by meaningful declines in commercial classified assets, non-performing loans and non-performing assets. The ratios of NPLs to loans and NPAs to loans plus other real estate owned are at their lowest levels since the first quarter of 2008. Clearly the strengthening economy, rising home prices and lower debt service are having an increasingly positive effect on consumers’ payment behavior. Given improving asset quality and linked quarter loan growth of just under 2%, the loan loss provision increased to $500,000 linked quarter and $1.5 million year-over-year. The reserve release in the quarter was $5 million, its lowest level in 13 quarters.

Net income for the quarter was reduced by two items that Glen will discuss in more detail. The first item involves other than temporary impairment charges on certain investment securities related to the Volcker Rule. The second item is a $1.6 million pretax, noncore expense, primarily for banking center and facilities optimization. Adjusting for these items, core EPS was $0.52 in the fourth quarter. Adjusting only for the OTTI charge, return on assets and common equity were each at their highest levels over the four quarters of 2013 at 94 basis points and 9.0%.

Our improving financial performance, while still short of our goal to deliver economic profit, has driven our market cap close to its all-time high. And Webster’s cumulative total shareholder returns over the past three, four and five year periods ranks number one in our proxy peer group. Our strong capital position supports our asset growth, provides for the return of capital to the shareholders through dividends and selective buybacks and enables to confidently pass the annual regulatory severely adverse stress scenario. A target of 10% for the tier one common to risk weighted assets ratio allows us to meet those objectives and at 11.43%, we will exceed that target. All of our capital ratios are well above internal targets as well as estimated, fully phased-in Basel III well-capitalized targets.

With regard to balance sheet sensitivity, we continue to be well-positioned for the long end up interest rate scenario.

The economy in the Federal Reserve's first district of Boston, which includes the bulk of our four-state footprint, continues to expand modestly, with a generally positive outlook according to the Fed Beige Book released a couple of days ago. Home prices continue to rise and commercial real estate in the region maintains modest strength. Other indicators show that the state of Connecticut, which is the heart of our franchise, has added about 16,000 jobs or about 1% of the workforce over the last 12 months, with an uptick to 4,000 jobs added in November, the most recent month available.

Turning now to line of business performance; Slide 3 summarizes Commercial Banking results. On a combined basis, loans were up 3% from September 30 and up 12% from a year ago. Full year fundings matched prior year at $1.7 billion, which is strong performance considering the tax driven financing at the end of 2012. Our agency transactions generated fees of $2.5 million for the year, up $1 million from 2012. Aggregate volume in this business was $427 million in 2013 compared to $275 million a year ago.

Portfolio yield decreased by 10 basis points from the third quarter, reflecting market pressure and the benefit of a greater amount of prepay in Q3 that accelerated FAS 91 recognition in that quarter. The yield of 3.32% and 4459 million of new fundings compares to a yield of 3.86% on $516 million of new fundings in Q3, with the yield decline reflecting asset mix, market pressure and a greater proportion of high quality CRE fundings where our borrowers are taking advantage of interest rate swaps. Swap fees were up $1.1 million linked quarter to $2.7 million.

Commercial banking’s forward momentum is reflected in the best yearend pipeline we’ve had in three years. Transaction account deposits grew 6% compared to Q3 and 20% from a year ago. This growth represents intense focus on capturing core operating relationships across our businesses. Revenue from cash management services grew 9.5% year-over-year as we continued to invest in our product suite. We turned the corner on our equipment finance business. You’ll recall we pulled back from a national franchise to focus more closely on our regional markets. Credit quality is now outstanding and we’re building up the sales platform. The $460 million portfolio grew 8% from Q3 and 10% year-over-year.

Our middle market New York franchise, which we launched in Q3 with the hiring of our regional president, is off to a good start with a couple of loans booked, an active and growing pipeline and successful recruitment of talent in the market. We’re excited about the potential of our New York hub to duplicate the success we’ve enjoyed in Boston.

Slide 4 reviews our Business Banking unit, which recorded year-over-year loan growth of 7%. You can see that increasing competition has driven yields lower on new originations relative to Q3. Transaction accounts improved to about 75% of total deposits for the segment and have grown more than 4% from a year ago while reflecting a seasonal decline from Q3. Business banking deposits exceed loans by 68% and provide very low-cost funding across the bank.

Slide 5 presents personal banking results. Overall consumer loan balances have declined about 1% over the past year, primarily due to ongoing consumer deleveraging. Residential mortgage balances are essentially flat, largely driven by our strategy of selling conforming fixed-rate loans. The personal bank portfolio yield was unchanged from Q3 at 3.82% while yield on new originations held in portfolio in Q4 improved to 4.19% from 3.97% in Q3.

Total consumer lending originations were down 31% or $165 million year-over-year, primarily due to a decline in refi mortgages. Given our emphasis on purchase mortgage originations, full year purchase originations grew 13%. In the fourth quarter, purchase mortgage originations represented 71% of total Resi mortgage originations, compared to 53% in Q3 and 32% a year ago. Jumbo originations represented 60% of originations held for portfolio, driving our portfolio concentration to 46% compared to 42% a year ago.

Net operating expenses for personal lending were down 24% in Q4 as compared to the peak in Q2 and are expected to decline further by approximately 10% in Q1 this year.

Our credit cards program continued to boost noninterest income, growing by 70% year-over-year to $1.7 million and flat to Q3.

Personal Banking deposits totaled $8.2 billion at yearend, down 3.6% from a year ago though up 5.6% annualized from Q3. The decline from a year ago reflects the high level of CD maturities in Q3 that contributed to the four basis point linked quarter reduction in the cost of deposits.

Low cost transaction account deposits grew $125 million or 6% over Q3 and now represent 26% of total deposits in the personal bank compared to 25% in the previous quarter. Our emphasis on transaction account growth, combined with lower cost of CD renewals, has caused a reduction of 1 basis point in the cost of funds this quarter and 13 basis points year-over-year.

Personal Banking investments assets under administration in Webster Investment Services grew by 9.5% year-over-year to $2.5 billion, driven by a 14% increase in sales production and increased market valuations. Revenues from Personal Banking investments correspondingly grew by a record 23% year-over-year.

We continue to optimize our distribution network. Banking center building square footage has declined about 4% from a year ago to 744,000 total square feet, even as we added two new, smaller banking centers in high opportunity markets. The momentum continues at the start of 2014 as we recently consolidated two banking centers into a single new facility. All of our banking centers are now staffed with trained, universal bankers which has enabled the staffing decline of 7% year-over-year. Migration to digital channels continues. Deposits at self-service channels, including ATMs and mobile deposits, increased by 33% year-over-year and now represent 32% of total deposits, while banking center transactions decreased 11%. Our active mobile customer base has increased by over 40% and now represents 23% of our consumer deposit households. 21% of our mobile base has made at least one mobile deposit since we launched that service in June.

Slide 6 presents the results of the Private Banking unit which we view as a primary growth opportunity. Our investment in the leadership team and our focus on local service, a full suite of deposit lending, always objective investment advice and fiduciary services is resonating in the market as we seek to develop deep, lasting relationships. Loans grew almost 13% linked-quarter and 32% year-over-year and the loan portfolio yield grows 12 basis points linked-quarter.

Deposits grew about 8% linked and 12% year-over-year, with a 3 basis point year-over-year decline in the cost of deposits driven by growth in transaction deposits. Assets under management, adjusted to reflect the sale of a nonstrategic AUM portfolio during Q3, increased 16.5% year-over-year, with new inflows of almost $40 million in Q4 and $146 million over the course of the year.

Slide 7% presents the results of HSA Bank, which now has over $2.1 billion in footings, including over $1.5 billion in deposits. HSA Bank’s steady rise in assets and accounts over the 10 year history of held savings accounts is a reflection of the group’s quality reputation for service and the resulting loyal customer base. The value of HSA’s fast growing, long duration, low cost deposits will become increasingly evident in a higher rate environment as they fund our rapidly growing commercial loan portfolios without need to stress deposit pricing in our primary markets. HSA Bank’s deposits grew modestly from Q3 as is normally the case since most of our deposit growth occurs in the first quarter each year. Year-over-year, deposits and deposit accounts continued their 20% growth rate.

Both carrier distribution and average group size increased more than 30% year-over-year. Accounting for the seasonally robust first quarter enrolments, deposits have increased by $124 million since yearend. It looks as if we’ll surpass the 62,000 new accounts that were added in January last year by at least 50% and might reach 100,000 new accounts by month end. The business continues to scale well as we add significant volume.

In an exciting recent development, Chad Wilkins joined us recently as Head of HSA Bank and as a member of Webster’s Executive Management Committee. Chad’s experience includes several years as General Manager and CEO of a leading national healthcare insurer, following 15 years with U.S banks spent primarily in increasingly responsible positions in commercial payments roles. Chad’s unique background in both health insurance and banking will prove valuable in moving HSA Bank forward at this exciting time for consumer directed healthcare plans.

With that, I’ll turn it over to Glenn.

Glenn MacInnes

Thank you, Jim. I'll begin on Slide 8 which summarizes our quarterly trend of net income available to common shareholders and key performance metrics. Of note, earnings declined $3.6 million from Q3 as a result of $4.7 million after tax OTTI charge related to the Volcker Rule. Apart from this, reported earnings increased $1.1 million, led by an increase of 7.2% in core pretax, pre-provision earnings. Compared to a year ago, earnings declined $6.8 million, again largely as a result of the OTTI charge. Excluding OTTI, earnings were down only $2.1 million from a year ago, absorbing an after tax impact of $3.7 million in lower mortgage banking revenue and $2 million of additional preferred dividend cost related to our issuance in December of 2012.

Let me take a moment to provide more detail on the OTTI charge that we recognized in the quarter. The pretax OTTI charge of $7.3 million was comprised of $4.7 million for CDOs and $2.6 million for CLOs. With respect to the CDOs, the recent guidance on the Volcker Rule permits banks to hold pool trust preferred securities only if the underlying collateral was issued by banks with under $15 billion in assets. The four CDOs we impaired were all collateralized primarily by debt issued by insurance companies. Important to note that earlier this week we sold those same CDOs at a gain of $4.3 million, which will be recorded in the first quarter.

With respect to CLOs, there’s still uncertainty as to whether and for how long we can own these securities. Consequently, the proper accounting required us to record the OTTI charge and we will continue to monitor the situation. Note that both the CDOs and CLOs have been held in AFS portfolio and marked each quarter through OCI. The recognition of OTTI therefore had no impact on shareholders equity in the quarter. Back on the slide, you see our reported return on average assets was 85 basis points in Q4. Adjusting for the OTTI charge, the return on average assets would be 94 basis points and return on average tangible common shareholders equity would have been 12.4%.

Slide 9 highlights our core earnings drivers. Over the next few pages, I’ll discuss in more detail the key drivers of our core earnings growth, but would note our average interest earning assets grew $246 million compared to the third quarter and our net interest margin of 327 basis points increased from 323 basis points in each of the first three quarters of 2013. Combined, this resulted in a new quarterly record in net interest income of $153.9 million in Q4 or an increase of $3.9 million from Q3.

Core noninterest income, which excludes securities gains and the OTTI charge, increased $5.5 million or 12% from Q3. This primarily reflects the expected rebound of mortgage revenue from Q3 and a strong quarter for wealth and investment services. And continued prudent management of core operating expenses contributed to another quarter of positive operating leverage. Taken together, our record core pretax pre-provision earnings of $80.5 million were $5.4 million higher than Q3 and up 5% from prior year.

Slide 10 highlights the components of our net interest income in Q4 compared to Q3. We posted quarterly growth in average earning assets of $246 million and a 4-basis-point increase in the yield on interest-earning assets, which was led by a 20 basis point increase in the yield on securities. This combination resulted in an increase of $3.9 million in interest income compared to Q3. As you see, virtually all the growth in average earning assets was due to growth in our commercial business.

Average deposits decreased $71 million as a net result of broad business growth, offset by seasonality in government balances, while the rate pay remained the same at 29 basis points. So total interest paid on deposits declined modestly from Q3.

CDs represent our highest cost of deposits at 108 basis points, with $1.2 billion maturing over the course of 2014 at a rate of 52 basis points. To the extent they roll over, our current average cost is around 30 basis points.

The $255 million increase in borrowings in Q4 occurred at an average rate of about 20 basis points. As a result, the total cost of borrowings declined by 9 basis points from Q3. So as you see, we held the line on interest expense for the quarter, which contributed to the improvement in net interest income. The net result is the $3.9 million or 2.6% increase in net interest income versus prior quarter and a 4 basis point increase in net interest margin to 327 basis points.

Jim discussed the activity in loans and deposits so I will discuss our investment portfolio beginning on Slide 11. As you see, the investment portfolio increased modestly as a result of purchases and lower cash flows. The slowdown in cash flow resulted from higher mortgage rates with reduced premium amortization on a linked-quarter basis by $3.8 million to $12.6 million. This explains the 20 basis point increase in portfolio yield in Q4 to 337 basis points. The strong performance was the result of a strategy to purchase higher coupon, higher premium bonds that perform well in a gradually rising, long term rate environment. We do not expect the portfolio yield to increase further in Q1 as we do not anticipate any additional reduction in premium amortization at today’s rates. Cash flows during the quarter amounted to $264 million, with a yield of 323 basis points compared to $369 million in the third quarter.

During the quarter we purchased $367 million of securities at an average expected yield of 258 basis points and a duration of 3.8 years. Most of the purchases were fixed-rate agency MBS and agency CMBS, although we added $27 million of floating-rate collateralized loan obligations at a yield of 190 basis points. Note that the duration of our total portfolio remains around four years and our purchase yield continues to rise.

In mid-December we suspended purchases of CLOs following the issuance of the Volcker Rule. At December 31 the fair value of the portfolio was $358 million with 70% rated AAA and the remaining 30% in AA. The portfolio yield was 180 basis points. Given the upward trend in rates during Q4, the unrealized gain in AFS portfolio decreased by $17 million or less than 1%. We continued to maintain shorter duration in the AFS portfolio and keep over half our investments in the HTM portfolio. This strategy helps to protect our tangible capital ratio which grew 12 basis points in the quarter despite the 10 year swap rate increasing by 32 basis points and growth in the balance sheet of $243 million.

Slide 12 provides detail on our interest rate risk profile. Even with recently improving economic statistics, the short end of the interest rate curve seems anchored for the next year or more. We expect the curve to steepen further before short term rates start to rise and have positioned our balance sheet to benefit from such an environment, as evidenced by our investment portfolio yields and the NIM this quarter. Our interest rate risk modeling suggests further improvement in PPNR in a long end up scenario. This slide reflects data as of November 30 and you can clearly see the growing benefit to PPNR over time. Note our PPNR analysis reflect scenarios with an immediate increase in long-end rates compared to a scenario with no change in rates. The benefit from higher rates is primarily related to slowdowns in prepayments of higher-yielding assets and the reduction of investment premium amortization, along with higher new asset yields. We’ll continue to take gradual steps to prepare for the eventuality of higher short term rates, but in the meantime we want to highlight our interest rate risk profile for what seems to be a likely scenario.

Slide 13 provides detail on core noninterest income. As previously highlighted, the quarter reflects a $5.5 million increase in core noninterest income. Approximately $1.2 million represented unrealized gains in our loans held for sale at September 30 that we were unable to record in Q3 under the lower of cost to market rules. As these loans settled in Q4, we were able to record the gains in the quarter.

Mortgage banking revenue also increased by an additional $0.9 million in Q4, reaching the normal quarterly level of around $2 million to $2.5 million in the post refi era.

Wealth and investment service revenue increased by $1.9 million from Q3 to achieve a record level of just under $10 million. This strength in the quarter relates primarily to our Webster investment services unit as a result of continued growth and development of junior brokers and strong incremental production. The $1.4 million linked-quarter increase in BOLI and other category that you see on the slide reflects the $1.1 million increase versus prior quarter in client swap fees in our commercial banking unit that Jim previously discussed.

Slide 14 highlights our core noninterest expense, which increased compared to Q3 and prior year ago, though at a lower rate than revenue growth. Noteworthy on this slide is the $3.3 million increase in compensation and benefits from Q3. About $1.1 million of the increase relates to additional expense from deferred compensation programs largely in connection with Webster’s 22% share price increase in the quarter. $1.5 million of the increase reflects higher medical costs for more employees reaching out of pocket maximums toward the end of the year. We had $1.6 million in noncore expense in the quarter, which does not affect our efficiency ratio. These costs primarily consist of write downs on assets held for disposition as part of our banking center optimization as well as severance expenses.

Our efficiency ratio is highlighted on Slide 15. The sub 60% efficiency ratio was the result of strong revenue performance in the quarter and our ongoing focus on operating expenses. Continued achievement of positive operating leverage, which we’ve now demonstrated for four consecutive years, has driven the efficiency ratio lower.

Turning now to Slide 16, which highlights our asset quality metrics. Nonperforming loans declined by $14.6 million in the quarter, led by reductions of $9.6 million in commercial and commercial real estate categories, along with $4.7 million in the residential mortgage portfolio. The decline in NPLs reflects lower inflows in commercial and commercial real estate and increased resolutions across all portfolios.

Past due loans increased $4.9 million in the quarter, primarily as a result of business banking line maturities and renewals and process, along with one CRE credit that is in workout with resolution anticipated during the first half of this year. Consumer and residential delinquency was relatively flat, with a decrease in residential offset by an increase in consumer.

We've made continuing progress on reducing commercial classified loans which declined another 13% on a linked-quarter basis. Commercial classified loans now total $227 million or 3.3% of commercial loans. Assuming recent trends remain intact, we think continued improvement in key asset quality metrics can be expected in Q1 and beyond.

Slide 17 highlights our capital position. Key capital levels improved over Q3 while supporting $243 million in balance sheet growth, once again highlighting the strength of our core earnings and the effective management of our investment portfolio.

So before turning it back over to Jim, I'll provide a few comments on our expectations for Q1. Overall, average earning assets will likely grow in the range of 1% to 2%. We expect average loan growth in Q1 to be in the 2% to 3% range, with continued growth in our Commercial Banking business.

Assuming that loan prepayments stay consistent with Q4 level, we expect net interest margin to be down 3 to 4 basis points, driven by lower commercial yields and anticipate calls on municipal securities in Q1. Of course NIM will vary with loan prepayment activity and loans returning to performing status. That being said, we expect net interest income to increase up to $1 million over Q4 driven by loan volume with partial offset through the NIM compression.

Our leading indicators of credit were encouraging during the quarter, and we continue to signal further improvement in asset quality. Given our outlook for Q1 loan growth, we can see a modest increase in the Q1 provision.

Regarding noninterest income, we expect higher fee revenue from deposit and investment services, partially offset by lower banking revenue. We do not expect purchase mortgage activity to pick up until Q2. So taken together, we anticipate a modest increase quarter-over-quarter in noninterest income going into Q1.

We would expect core operating expenses in Q1 to remain flat to Q4 as a result of seasonally higher employment expenses, offset by reductions in increased level of deferred compensation and medical costs which we’ve seen in Q4. We continue to target an efficiency ratio of around 60% in Q1. And we expect our effective tax rate on a non-FTE basis to be around 31%, 32% in Q1. Based on our current market price and no additional buybacks in the quarter, we expect to see the average diluted share count to be in the range of 90 to 91 million shares.

So with that, I'll turn things back over to Jim for concluding remarks.

James Smith

Thank you, Glenn. Just briefly, it’s clear that we’re making progress along the path to high performance. Revenue and profits are improving. Lending activities are strong. Efficiency is sustainable. Performance relative to our peers continues to improve.

We’re happy to take your comments and questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from the line of Dave Rochester with Deutsche Bank. Please proceed with your question.

Dave Rochester – Deutsche Bank

That was a really nice jump in Wealth Management fees. I know you talked about that a little bit. Are any of those performance-related? Is this a good run rate going forward as you grow that business?

James Smith

When you say performance related --?

Dave Rochester – Deutsche Bank

More like one time-ish annual 4Q type of thing or will that stick around?

James Smith

No, we expect it probably will stick around most of these are like RA type performance and we’re seeing strength both in Webster investment services and in the private bank. So as I mentioned, this is a key area of focus for us in strategic investment and we’re expecting bigger things from wealth and investment services.

Dave Rochester – Deutsche Bank

Great and just switching to the margin, regarding loan yields, was there any impact from a change in prepayment penalty income? Sorry if I missed that if you gave it.

James Smith

A change in prepayment?

Dave Rochester – Deutsche Bank

Prepayment penalty income. I think it was about $1 million or so last quarter.

James Smith

Yeah. I think it’s about 5 basis points.

Dave Rochester – Deutsche Bank

And you talked about the pipeline still being strong. Was just wondering how it compares to the pipeline going into the quarter at the end of 3Q? Were you stronger than that level? Should we expect stronger originations or will we be stepping down?

James Smith

We’ve got the information, but take us a second to dig it out. Let’s focus on the commercial pipeline is bigger than it was at the end of Q3 and 15% higher than it was and it’s the highest level at yearend in at least the last three years.

Dave Rochester – Deutsche Bank

And just switching to the Commercial Banking origination yield, I know you talked about that being down a little bit and potentially being a driver for margin pressure in 1Q. Are you not expecting that yield to rebound? I know you mentioned a mix shift in the production. Is this the mix we should expect going forward and should we see the low 3% range on originations in that --?

James Smith

I’ll ask Joe Savage to respond.

Joseph Savage

Hey Dave, Joe Savage. Yeah, our expectation would be that it would rebound. And again we’re talking about yields. More specifically as James said in his opening comments, we did more floaters on the CRE side and that was the preponderance share of the book on originations. So assuming that doesn’t stay at that particular level and then we see a step up which we would expect to see in our segment banking side, my guess is you’ll see improvement in the overall yields. I think it would be important however to say that there is market pressure and you can read that in all the statistics. You look at the BB, B universe, down year-over-year some 60 basis points in yields. And so there’s going to be that pressure, but we’re highly dependent upon mix. We’re highly dependent upon fixed versus float and in the case of CRE for example we had a greater proportion of float versus fix and that doesn’t crush the spread so much, although spreads were down. But it will push the yield around.

James Smith

And I would just add that if you look at our payoffs for the quarter, you see coming down with an average rate of about 366. So you can put that in the context of where our NIM is and get some sense of what’s coming back on.

Operator

Our next question is from the line of Dave Darst with Guggenheim Securities. Please proceed with your question.

Dave Darst – Guggenheim Securities

You had an announcement earlier in the week where you've appointed someone as the Director of Continuous Improvement. Could you maybe talk about what's new to this role and what are the things that you may accomplish here that you haven't maybe been able to do in the past 18 months? Because you’ve made a lot of progress on the expense side and I think internally in these types of areas.

James Smith

Sure. So it’s David Hadd who joined us I guess a couple of weeks back and we are very focused -- continuous improvement to us is to continue to rationalize our distribution channels. That’s a big focus for us as well as and you know that we’re working under e-forms or electronifying all our paper. So that process is finding its way through the whole bank. So there’s a lot going on that David we’re fortunate to have is going to head up and coordinate throughout the bank.

Dave Darst – Guggenheim Securities

Do you have any expense guidance or are there any points in the year when we should see some benefit of these activities?

James Smith

Yeah. I think you’re starting to see some of it already in our number and the fact that we’re sub 60. But the expense itself will most likely come in the second half of the year, particularly with respect to e-forms and that will allow us to keep control on costs and also quite frankly to invest in those businesses where we will get additional revenue.

Dave Darst – Guggenheim Securities

Okay. And then with your capital ratios continuing to lift, could you comment on what you see as the ability to return more capital this year either in further repurchases or raising the dividend?

James Smith

Sure. We did note that our capital levels allow us that flexibility and I think we focus more on the dividend improving. We’re somewhere in the 30% or so of payout range. So as earnings improve there’s an opportunity to increase the dividend. We may look a little harder at what that payout ratio ought to be. We’ve got 50 million of approved unused buyback authority as well. We’d probably use that opportunistically rather than as an ongoing event.

Dave Darst – Guggenheim Securities

Is any of that based on the outcome of the stress test?

James Smith

No. the stress test -- I think we’ve tried to be very clear about that is to say that the way we look at the stress test is we want to make sure that we have ample capital in the event of a severely adverse scenario and that we can look forward a couple of years and say all right, what would our ratios have to be now to make sure that we remained well capitalized with a buffer in the event of a severe adverse scenario. And so we peg that at about 10% for tier one common. We’re right now at close to 11.5%. So we have plenty of capital. And then we look at that and say well, we can capitalize our asset growth because we think we’ve got great opportunity for loan growth, particularly in the commercial area and then we can look at how we’re going to return the capital as well.

Operator

Our next question is from the line of Matthew Clark with Credit Suisse. Please proceed with your question.

Matthew Clark – Credit Suisse

In the -- you may have mentioned it during your prepared comments, but the uptick in Other Income, can you just remind us where that came from there?

James Smith

In Other Income primarily swap, customer swap fees quarter-over-quarter increase about a $1.2 million

Matthew Clark – Credit Suisse

Okay. And then on the expenses, as we look out beyond the upcoming quarter, it sounds like there's some seasonality here in the first. And I think you had mentioned your guidance for the quarter was around a 60% efficiency ratio. I assume we’ll get some relief as we move throughout the year. Is that fair?

James Smith

I think that’s fair. It’s all about operating leveraging for us. So you’ll see some -- just see an improve as the year goes on.

Matthew Clark – Credit Suisse

Okay. All right, that’s it for me. I think you guys covered the rest. Thanks.

Operator

The next question is from the line of Casey Haire with Jefferies. Please go ahead with your question.

Casey Haire – Jefferies & Company

Glenn, just wanted to follow up on your remarks about preparing for short rates. I know that’s a bit of a longer term phenomenon given your expectation for short rates coming up in the second half of 2015. But was wondering what you were planning to do to prepare for that eventuality this year, be it shortening duration or otherwise.

Glenn MacInnes

There’s a couple of things, extending liabilities through cash and derivative markets throughout 2014. Obviously growing, continuing to grow our commercial bank which for the most part is floating rate sensitive type assets and then really focus on increasing our personal deposits. I think if you look along those broad minds, that’s pretty much what we’re focused on in preparation for rising short term rates. And then on top of that you have obviously the clear benefit we get from our partners in our health savings account business as far as volume.

Casey Haire – Jefferies & Company

Okay, but no change in the investment strategy really this year?

Glenn MacInnes

No change, no.

Casey Haire – Jefferies & Company

And then switching to credit, the loan-loss reserve coverage ratio at 1.20%, how much lower can we go from here?

Glenn MacInnes

As I said, asset quality continues to improve and it’s something we monitor. We don’t have a target that we’re drifting toward, but it could go lower, but it’s all going to be driven by obviously loan growth and asset quality. We’d like to see the charge off level which is 47 basis points come down much more. We think the normal for us is probably around 30 bps.

Casey Haire – Jefferies & Company

Okay, great. And just to clarify, the fee guide, that's the modest increases off of that 51.5. So it’s X the OTTI charge, correct?

Glenn MacInnes

Yes. It does not include the gain that we realized this week from the sale of the CDOs. I think that is not -- I would write that out.

James Smith

Both are out.

Glenn MacInnes

Both are out.

Operator

The next question is from the line of Bob Ramsey of FBR. Please proceed with your question.

Bob Ramsey – FBR Capital Markets

I know you highlighted early in the prepared comments that since you launched mobile deposit in June that I think 21% of your mobile users have made at least one mobile deposit. I’m curious how that affects you all from a cost perspective and in terms of what does it cost to process a mobile deposit versus an ATM or teller-handled deposit?

James Smith

I don’t have the stats right in front of me, but it’s cheaper and cheaper is the way I say it and particularly in terms of the load it takes off of the universal banker in the banking center so that they can provide counsel and advice. So it is multiples cheaper obviously than an over the counter transaction and marginally cheaper than an ATM transaction.

Glenn MacInnes

Bob, it’s Glenn. We can come back to you with those numbers. I know that we track that. So I can give you a sense of that.

Bob Ramsey – FBR Capital Markets

Great. No, that sounds great. And one other question; I know you guys highlighted at your Analyst Day this year the opportunity over the next several years to bring down the square footage in your branch network. I am curious as you think about 2014, what are plans to consolidate branches or otherwise tweak the distribution channel?

James Smith

It probably is more tweak than anything else and we have some consolidations that are planned, a couple of two into ones, maybe a three into one. Don’t have a lot of closures on the horizon because we’ve taken care of a lot of that along the way. We’re trying to match up some of our activities against the expiration of leases in some of our branches. So I think you really have to look at this as at least a three year process to make that happen. So we’re down around 744 right now. We were at one point at least 800. So we’re making some progress. We’ll continue to make progress through this year and then as the leases come up, that will accelerate later this year and into next year.

Operator

The next question comes from the line of Matthew Kelley of Sterne, Agee. Please go ahead with your question.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Just staying on that topic, the decline in branch-based transaction and the increase in mobile, is that transition happening faster than what you thought it would this time last year? What’s the pace of that transition relative to your expectations?

James Smith

Yeah. I’d say it’s faster than we could have anticipated. I think the world is startled at how quickly that it’s happening, that you have no customers in mobile a little bit over a year ago and now you’ve got 40% of the base in there and then the fact that 21% of them in a period of less than six months actually made a mobile deposit is really astonishing. And for us, it’s reinforcing that we say this is really important. We have go to ahead and make this ahead. Going back to where we said we’ve got to have all of our ATMs be image capture oriented. And so we accelerated that investment because we thought we’d get a good return on it. And that inspired us to move forward more quickly with the mobile and I think we’re seeing a dividend from having made those choices.

But yes, it is happening faster and we expect it will continue to surprise on the upside. And that’s going to help us to rationalize the banking center expenses. One of the things that’s happening is we’re running our community banking operation more efficiently by far than we were before. And one of the benefits of that in reducing the expenses is we’re able to reinvest that. To Glenn’s point, it’s not just about reducing expenses. It’s about investing in the businesses that are going to give us the highest return on capital. And so we’ve been able to shift some of that spend into the commercial group and into the private bank.

Matthew Kelley – Sterne, Agee & Leach, Inc.

And are all your branches now operating on the universal model that you’ve designed and implemented or is there more?

James Smith

Yes, they are and we noted that as a result of that, we need fewer people obviously in the branches because we’re not doing transactions. So we’re down about 7% year-over-year. We expect that number will continue to shrink marginally in 2014 and ’15.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Got you. And on the commercial real estate business, you had mentioned that you had a good slug that was a floating rate. What was that percentage in the quarter and how did that compare to the full year?

Joseph Savage

This is Joe. Is this Matt?

Matthew Kelley – Sterne, Agee & Leach, Inc.

Yes.

Joseph Savage

In the fourth quarter we had 23% of that CRE book was fixed. In the third quarter it was 7% and that really more than anything explains the yield comment. I’d have to take a look at the full year, but it was 23% Q4 fixed and 7% CRE in the prior quarter. And as Jim said right in his opening comments, the beautiful net results of all that was $1 million improvement in our swap income. So it wasn’t a bad outcome.

Matthew Kelley – Sterne, Agee & Leach, Inc.

And then last question, Jim, how would you handicap the likelihood for traditional bank M&A for Webster as we head into -- as we start ‘14 compared to last year, this time last year?

James Smith

I guess I’d give the same response I have for many quarters now which is that we are laser liked focused on improving our performance because we think that’s where we’re going to get the biggest reward. And as we move closer to returning an excess of our cost of capital, we know that there’s more progress that we can make there. So we’re really not focused on M&A. I think the environment is such that there’s likely to be some consolidation, but it isn’t a key element of our strategy at this point because we’re focused on improving ourselves. The more we improve ourselves, the more that will create potential opportunity.

Operator

(Operator Instructions). The next question is from Collyn Gilbert of KBW. Please go ahead with your question.

Collyn Gilbert – Keefe, Bruyette & Woods

Just a question on the commercial pipeline, what is your approval rate or your pass-through rate that you’re seeing on your commercial pipeline and how would you say that is compared to say a year ago?

Joseph Savage

Collyn, this is Joe. How are you?

Collyn Gilbert – Keefe, Bruyette & Woods

Good. Thanks.

Joseph Savage

Good. Our approval rate, we’ve done studies on this. Typically we don’t put something on our pipeline until it meets several tests. The RMS has to say there’s a better than a 50-50 chance that it will go through. It generally is 2 million or greater in terms of revenues, 180 days is the expectation when it would close. When we tested those assumptions we -- because we have some account officers who don't like to put anything on until they’re absolutely certain it’s going to happen, we get to about a 66% realization rate. And so the real story for us this year is that gosh, we drained everything last year and this year surprisingly we built that pipeline and I think we’re sitting at 370 now versus 200 last year. So when Glenn gave you an outlook for Q1 as opposed to nothing occurring first quarter last year, it should be a good first quarter for us this year. So I’m not sure I got all your questions, but I hope that gives you a feel. It’s about a 66% is what we get out of that 367. We would expect that to roll in over a three to six month period of time.

Collyn Gilbert – Keefe, Bruyette & Woods

Okay, that is helpful. And how does that 66% compared to say either a year ago or three years ago? I’m sure it’s way different than three years ago, but just trying to get a --

Joseph Savage

The 66% is the cumulative run over an extended period of time. I’d be a liar to tell you that I knew exactly what that take rate was last year versus two or three years ago as a cumulative run.

Collyn Gilbert – Keefe, Bruyette & Woods

Okay. That's helpful, thanks. And then, I don't know if this is for Glenn or Joe, but what’s the effective duration right now on your loan portfolio?

Glenn MacInnes

Total?

Collyn Gilbert – Keefe, Bruyette & Woods

Yes.

Glenn MacInnes

I would say about one year. If you look at it -- I’m sorry Joe, but I guess that’s the weighted duration of the total.

Joseph Savage

Yeah. Collyn, the commercial book is -- the one thing I think that perhaps is relevant is it’s about 80% float. And we generally see those assets roll off, even they might have, they might have contractual maturities in the five to seven year period of time. Don’t last about a year and a half, two years and that’s what accelerates oftentimes that deferred income that we speak about.

Glenn MacInnes

If you look at it about of the total loan book and this includes residential, commercial, everything, about 35% fixed and the rest is either periodic or floating, meaning periodic being within 30 days, floating being less than 30 days. And as Joe indicated I think on the whole book I think it’s about one and a half years.

Collyn Gilbert – Keefe, Bruyette & Woods

Okay. That's great. And then just one I guess final question, big picture question, maybe for you, Jim. How do you think about like what the appropriate growth is for the Company as you’re looking out over the next, say, year to three years' cycle? Are you really looking at it from a top-down approach? Are you taking a bottoms-up approach based on the people on the ground? Just trying to get a sense of how you’re thinking about where your growth can go and really what’s driving that.

James Smith

I would say really it’s both ways. It’s bottom up and top down and we look at it with the businesses that are able to give us the highest return or the ones that we’re going to be investing in, building those deeper relationships that add value for the client as well as add value for us. We try to balance the investment in that growth, including people and all against our desire to have sustainable efficiency. But there is no limit in terms of -- we’ll grow as fast as we can in the businesses that are going to give us the best return.

Operator

Our final question is from the line of Jake Civiello of RBC Capital Markets. Please go ahead with your question.

Jake Civiello – RBC Capital Markets

I know you said the reserve ratio could have room to move lower, but would you say there’s a particular level where the rate -- where keeping the ratio below it would make you uncomfortable, especially given what transpired over the course three or four years ago?

James Smith

No. I don’t have a specific number. I can just tell you we’re very cautious as we’ve been for the last couple of years at 120. We feel very good about it. We do a lot -- we talk a lot about it. Like I said, I think charge offs and asset quality they continue to improve and we’ll feel better about the portfolio. No specific number though.

Glenn MacInnes

Yeah, completely agree. It’s about asset quality, loan growth and the overall outlook and we’re very comfortable where we are and we could be comfortable at a lower level.

Jake Civiello – RBC Capital Markets

Was there any unusual negative impact in the professional service expense associated with Volcker interpretation that won't be repeated in the first quarter?

James Smith

Nothing significant. Anything that you see in other expense, whether it was professional fees or not would have been relative to investment in the business quarter-over-quarter. Nothing on Volcker

Jake Civiello – RBC Capital Markets

And then I know you’ve talked about this in the past, but can you give a little more thoughts about your decision to extend duration in the investment securities portfolio? In a flattening yield curve environment where the short end increases, but the long end does not move higher as you’re currently expecting, could your strategy lead to a meaningful change in OCI? Or what are some of the issues that could pop up as a result of -- I hesitate to call it a bet that you’re making, but as a result of the decision that you’ve -- say for the path that you have chosen?

James Smith

I don't think that we’ve extended the duration in our investment portfolio. I’m just looking for the chart that we show because I think we’re still in the 3.9. We’ve been about 3.9 to 4. We do look at it and we look at the impact rates could have on the extension. But even 100 basis point shock, rate shock wouldn’t extend the portfolio out anything over five years. So we feel good about that. So there’s no -- we’ve made no conscious decision to extend our portfolio.

Jake Civiello – RBC Capital Markets

Okay. I guess I wasn't referring to specifically in the fourth quarter, but more or less over the course of the year as the total duration went from closer to 3 at the end of last year to 4 at the end of this year.

James Smith

Right. I think that’s all and we used to have a chart and I guess we’ll have to put it back there, but the rise in the rates really is what drove the extension in the investment portfolio. We used to show and we can come back to you Jake with that and show you, we plotted out against the tenure and you can see the impact the tenure has on the effect on -- the effect that tenure has on -- and rising tenure on the duration of the investment portfolio.

Glenn MacInnes

So the purchase duration stayed at about 3.8 and we manage the overall book as well.

James Smith

Yeah, and the tenure was up 100 basis points in 2013. So I think that’s really what’s accounting for most of the extension on the investor portfolio. Again when we look at it and I have right in front of me when we look at even a 200 basis point rate shock based on the way we’re structured right now would only bring the investment portfolio to five years. And it would never, even at a 300 or 400 basis point rate shock, it would never go over five years. And it’s the combination of both AFS and HTM. So I think we’re good from that standpoint or protected from that standpoint.

Operator

There are no further questions at this time. I'll turn the floor back to management for closing comments.

James Smith

Okay Rob. Thank you very much. Thank you all for being with us today. Have a good day.

Operator

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

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