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Webster Financial Corp. (NYSE:WBS)

Q1 2010 Earnings Conference Call

April 22, 2010 9:00 AM ET

Executives

James Smith - Chairman and CEO

Jerry Plush - CFO and Chief Risk Officer

Analysts

Ken Zerbe – Morgan Stanley

Dean Choksi – Barclays Capital

Amanda Larson – Raymond James

Damon DelMonte – Keefe, Bruyette, & Woods

Bob Ramsey – FBR Capital Markets Corporation

Matthew Kelley – Sterne, Agee & Leach

Collyn Gilbert – Stifel Nicolaus & Company

Operator

Good morning and welcome to Webster Financial Corporation's first quarter 2010 results conference call. This conference is being recorded. Also this presentation includes forward looking statements within the Safe Harbor Provision 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 defer 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 statement is contained in Webster Financial’s public filings with the Securities and Exchange Commission including our form 8-K containing our earnings releases for the first quarter of 2010.

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

Jim Smith

Good morning and welcome to Webster's first quarter earnings call and webcast. You can find our earnings release that was issued earlier this morning along with the slides and in depth supplemental information that accompany this presentation in the investor relations section of our website websterbank.com.

I'll provide an overview of the quarter and talk about our regional bank strategy and then turn it over to Jerry Plush, our Chief Financial Officer and Chief Risk Officer to walk through the balance of today's earnings presentation. Then we'll open it up for your questions.

I'm pleased to say that the first quarter was marked by many positive developments including Webster's return to profitability from continuing operations. A small profit to be sure but a large step in the right direction. A lower provision for loan losses coupled with an improved margin growth in core deposits and a higher level of earnings assets were the primary drivers. Pre-tax, pre-provision earnings of $57.3 million held steady from the previous quarter and increased $10 million from a year ago.

The lower loan loss provision down by a third from Q4 ‘09 was driven by improving credit quality trends some strongly so, including nonperforming loans down 6.5% from Q4 to their lowest level in a year and charge-offs down 22% from Q4.

Since the provision continued to exceed net charge-offs in the quarter though by less than in previous quarters, loan coverage increased to 3.16% and NPL coverage reached 99%. The reduction in NPLs were driven primarily by continued declines in non-accrual loans and a greater number of cures and exits. Commercial real estate, residential consumer lending and the discontinued liquidating portfolio all saw declines in NPLs while in C&I asset based lending NPLs rose and the other categories in aggregate declined.

Delinquencies remained stable at the Q4 ‘09 level, which was the lowest level since Q4 ‘08; Jerry will provide more detail in his comments.

These improvements in asset quality are largely a reflection of a somewhat stronger economy, which continues to improve in our region. Retailers cite sales increases and manufacturers say demand continues to grow. Home prices are now rising along with sales in most of the region's residential markets. While commercial real estate appears to be stabilizing even as potential defaults remain a concern.

According to the Beige Book, most delinquent employers are no longer shedding workers and many are restoring recession induced cuts and wages and benefits.

Connecticut for example has added jobs the last two months. Should the economy continue to strengthen we expect that our credit metrics will likely improve as well. We’re doing our part to contribute to the economic recovery with an initiative to nearly double business lending to $850 million in 2010 and to add a 150 bankers.

In market business lending increased nearly 60% in Q1 to $115 million from Q4 and our pipeline has grown dramatically. While new business checking accounts rose 18%, full implementation of the initiative including hiring additional business bankers would boost originations and result in growth in the loan portfolio, which has been in controlled decline for some time as we've reduced our out of market loan exposures.

Turning to slide four, you can see that our capital levels are strong across the board. The increasingly important tier 1 common to risk weighted assets ratio crept up 4 basis points to 7.9%. The leverage ratio was 8.73% and our total risk based ratio was 14.37%. These ratios, which declined from Q4 due to partial repayment of CCP, are well above regulatory requirements and well above our internal capital targets as well.

The most notable development regarding capital during the quarter was the repayment of 25% or $100 million of the capital purchase program to the US Treasury, which is noted on slide five that there was no accompanying requirement for raising additional capital is a testament to our capital strength. We're doing our best to repay CPP in an orderly responsible manner that produces the best outcome for shareholders.

We intend to pursue further repayment as our credit metrics and profitability improve always with the objective of producing the best outcome for shareholders. We also downstream capital to the bank to bolster capital levels there.

As credit repayers, I expect we'll have more time to discuss strategy on these calls, a welcome change and we'll report on our progress toward achieving our published 2010 initiatives, which are listed on slide six. These initiatives are the areas where we're investing considerable capital and organizational resources.

It's worth noting that a significant portion of the variable compensation for our senior executive officers is tied to successful execution of these initiatives.

On slide seven, you can see the specific action steps that we tie to each of these initiatives in order to achieve our objectives. The major steps we've taken so far are shown on slide eight and will be updated each quarter.

Since the initiatives are an expression of the strategy, let me spend a minute describing our regional bank strategy and our plans for the future. Our strategy is simple; we'll build wallet share and market share among businesses and consumers in our markets by continually improving on service quality to achieve best in class status and offering products and services that meet their financial needs. We'll do better what we do best.

Our overarching commitment to maximizing the growth of economic profit over time will drive our strategic decisions and our allocation of capital and other resources. For example, giving our customers accelerating preference for the online channel, we recently redesigned our website to improve its look and feel and transitioned the site from primarily transactional to a marketing engine with improved online acquisition capability. We're setting records each month for new customer enrolment online.

Next up is mobile banking and alerts. These are examples of how we're giving priority to investments which can generate a positive return on investment.

As we get into the initiatives, it's clear that our focus on business banking has complemented very effectively our geographic expansion. In Boston, we're making meaningful progress and penetrating small and middle market businesses. As of the first quarter, our Boston book of business loans stands at $32 million, $7 million ahead of plan and we continue to add key personnel. In Westchester, we have filled key positions in retail, small business and middle market banking and we intend to open a new regional office there in the fourth quarter. In the interim, deposits are growing briskly and in the Providence MSA, we're enjoying similar success.

Behind the numbers are the stories of why we are winning in these new markets. In January we won the primary banking relationship of Capco Steel, the largest privately owned steel fabricator in the Northeast. This was a competitive situation, so competitive in fact that Joe Savage, our Head of Commercial Banking drove to Providence on Super Bowl Sunday to help his team close the deal. The financing, which involves the state and will allow Capco to hire additional employees, drew praise from Rhode Island Governor Carcieri at a press conference. More recently US Senator Sheldon Whitehouse together with the local SBA Director and Rhode Island officials praised Webster for our support of another customer.

Stories like these too clearly demonstrate that Webster is there for its customers and are the reasons we're having success with our geographic expansion. To it we were recently awarded Rhode Island's Primary Operating Account for tax collections.

Similarly we're focused on winning the hearts and minds of retail customers through optimization of our delivery channels, which in coming months will include mobile banking and email alerts on balances and over drafts I mentioned earlier.

At the end of March we began rolling out extended service hours at key branches across our four state footprints. Effective this week, we have completed the implementation of extended hours at a total of 89 branches including 9 AM to 7 PM on Thursday and Friday and 9 AM to 3 PM on Saturday.

We conducted a thorough analysis to determine which branches should implement extended hours such that we maximize our return on this investment of staff time and support services. The primary factor that we took into consideration was whether extended hours would enable us to capture new business and a greater share of our existing customers business.

We picked branches that exhibited the highest overall customer usage and meet the convenience threshold of our service quality model. The 89 offices we selected, which is about half of our total were used by 84% of our customers over the past year indicating that extended hours in those offices make Webster more convenient for the vast majority of our customers.

So far our pilot offices have demonstrated that we can recoup the cost of extended hours by deepening our level of engagement with existing customers, cross selling products and acquiring new customers. Next will come 7 to 8 extended hours in the customer care center and 24x7 online support.

Our business model emphasizes superior service quality, which in addition to convenient hours combines Webster's highly rated service attitude with continually improving daily delivery for transaction and processing services across all channels with the measured goal being the achievement of near flawless delivery. We've identified the key improvements that are required and so far the metrics for service improvements are tracking close to plan.

Specifically we are reducing error rates, shortening the account opening process, simplifying product offerings, increasing speed of transactions, expediting workflows and improvement and reliability of our remote systems including our ATMs. Eliminating mistakes and speeding service will improve the customer experience, save money and make us more competitive. We're serious about improving these service mechanics and we intend to be best in class. By measuring our success at every turn, we'll learn what works and what we need to do better.

Another prong of our service quality strategy is to proactively identify and meet our customer's needs. We're improving our banker's product knowledge, upgrading our sales skills and engaging our customers at every opportunity in our effort to help them achieve their financial goals. Our significantly improved marketing capabilities including investing in our recently installed market data mart, give us improved prospecting and cross selling tools. Once again we've chosen to invest in initiatives, which we believe will generate economic profit.

Our commitment to measuring service quality permeates Webster. Front office or back office, line or staff, customer facing or support services the only designation that matters is that we're all responsible for the customer experience no matter where we are in the company and we're measuring our results. We have sharpened our competitive edge and vowed to win in every market, every banking office against every competitor everyday.

During the first quarter we also unveiled the next phase in our branding campaign. About a year ago we launched a new branding platform that is designed to evolve as we raise our game and our interaction with customers. The first expression was focused on our promise we take your banking personally. In this next innovation our brand promise raises the stakes so to speak in our customer's minds. The promise is Expect It.

Expect It is a simple yet versatile expression of the Webster Service model. When customer interacts with Webster through any channel they will get the products that fit their needs and excellent service. Customers can expect it because Webster is ready, willing and able to deliver it. Expect It is a customer facing idea that provides the messaging flexibility to all business lines and in all modes of communication.

An example of Expect It is how we're implementing changes under the new Reg E rules. Without yet divulging our strategy to use these changes as a customer acquisition and retention tool, I'll say that our solution gives customers choices that work best for them and clear explanations of what those choices are. It also recognizes that customers use debit cards differently from how they use checks or credit cards.

While our revenue hit could be up to $15 million in the second half if the opt-in rate was zero, we expect to achieve a favorable opt-in rate possibly generate higher usage rates and attract new customers. Our billboards, radio and print ads for the Expect It campaign are already in the market and our TV ads begin airing next week.

In another branding development during the quarter we changed the name of our equipment finance arm, Center Capital to Webster Capital Finance. This name change is designed to signal the integration of equipment finance more closely into Webster's portfolio of financial products for businesses and more formally align the equipment finance team as part of the Webster family. Branding it with the Webster name demonstrates our continued commitment to our equipment finance customers.

By design we shrunk the equipment finance (footings) by about $100 million and see that portfolio settling in around the $750 million mark. By using higher spreads to reduce the asset size of the business we'll drive the economic profitability of the business higher.

I'll leave the other initiatives for discussion at another time except for one which is crucial to our strategic and financial plans. We find our methodology to assign and measure return on risk adjusted capital for each of our lines of business. We'll be implementing this program in the quarters ahead as part of our capital and risk management initiatives. We'll also be setting targets for returns on capital as part of the internal discipline and using our planning process to identify gaps and opportunities for improving returns and to allocate capital most efficiently.

In summary, we are very confident in our ability to implement our regional bank strategy in markets and businesses we know well with the goal of generating improving economic returns. We're committed to earning a return in excess of our cost of capital in each of our business segments and overall. With that I'll turn the call over to Jerry.

Jerry Plush

Thank you Jim and good morning everyone. Turning to slide nine, here we provide a view of core earnings for the first quarter. We're clearly pleased to show a return to positive pretax results for Q1 and to show pretax pre-provision earnings of $57.3 million essentially equal to the fourth quarter of 2009. We also note on the slide that the $57.3 million includes the impact of the Freddie Mac buybacks of about $1.4 million, we’ll provide some more detail on that in a minute.

So again we've outlined certain items to take into account to get from the pretax, pre-provision results. So we adjust for non-core items such as the $4.3 million in gains on the sale of investment securities, the loss of $3.7 million on the write-down of pool trust preference securities and this reflects a change in our credit valuation methodology from insurance companies. We see this adjustment as exclusive to the quarter only given it was a methodology change in how we assess the underlying issuers. We also exclude $10 million in REO and repossessed equipment write downs and $11 million of the previously announced fraud related costs as well as the $43 million provision expense for the quarter.

So overall adjusting for these items you can see that the continued strength of our underlying operating performance is apparent in the quarter and more detail will be provided in our core performances review in the next slide.

So here on slide 10, here's a look at the drivers of core pretax, pre-provision earnings. You can see the strength from a year ago in growth of almost $10 million in earnings through a combination of an increase of 29 basis points in the margin and a $324 million increase in average interest earning assets.

In comparison to Q4 the net interest margin increased by 2 basis points to 3.28%, while earning assets increased by $108 million.

On an average basis, we have combined growth of $327 million in securities and short-term investments and that offset a combined decline of $290 million in loans and loans held for sale. The net result, a million-dollar increase in net interest income quarter-over-quarter.

Our noninterest income declined by $3.5 million most of which is explained by a seasonal decline of about $3 million in deposit service fees. Other income was somewhat higher at 4.3 million compared to $2.6 million in Q4 and that's a result of some banker on life insurance proceeds with some direct investment gains offsetting declines in other categories such as loan related fees and mortgage banking revenue.

Our core expenses declined by $2.6 million from Q4 and that's even with higher than expected marketing expenses that we noted on our last call that would happen in Q1.

Lower comp and benefit expenses, during Q4 we also saw reduced utilization of outside professional services in Q1. It's also worth noting here that the margin would have been 3.31% in Q1 if not for the $1.4 million of Freddie Mac buybacks from mortgage bank securities, the result of a policy change which enables the GSEs to repurchase loans out of MBS apart. These buybacks and they're actually buyouts to be technically correct. In effect create faster amortization and hence proportional write off of any premium on each security must be taken. Fannie Mae is doing a similar program in Q2 and we'll have some more on that when we talk about perspectives in the second quarter in just a few slides.

Turning now to slide 11, you can see the activity in the investment portfolio for the quarter. The increase in the portfolio compensated for soft loan demand in certain lines of business and the sale of confirming mortgage loan production during the quarter. We continue to buy relatively short duration agency CMOs with limited extension risk and we sold some 30-year agency pass throughs and 10/1 hybrid arms with greater extension risk. The portfolio's overall duration remains unchanged to 3.7 years. Note that 55% of our portfolios in held maturity. This portfolio is mainly comprised of $1.1 billion of residential mortgage loans that we've securitized in the past and $675 million in municipal securities. The classification of longer duration securities in the HTM portfolio will provide protection to the TCE ratio should interest rates rise. The $2.4 billion of securities in AFS are shorter duration. They've got excellent liquidity and should provide us with whatever flexibility that maybe needed to manage the balance sheet going forward.

We turn now to the loan mix and yield slide. Here you can see our yields in the overall portfolio increased by one basis point to end the fourth quarter. The improvement was primarily due to a 13 basis point increase in commercial yields and that's mainly from improved spreads and fees on loan renewals. Yields increased by 33 basis points over $228 million of renewals of commercial loans during the quarter on top of $108 million in loans that we modified by 91 basis points in the fourth quarter.

The declines in the three other categories, they largely reflect the effect of fixed rate maturities that are priced at higher levels being replaced by new originations at lower rates.

Average balances declined across all categories. Note, however, that period end imbalances in commercial loan mortgage, which excludes our asset based lining and equipment finance divisions, they grew by $34 million up to $1.54 billion. Again, this represents our core middle market and small business lines. This growth is encouraging, it reflects our initiatives in these areas as Jim previously noted and came despite generally weak loan demand in the market.

Turning now to slide 13, we'll take a look at some key asset quality progressions and here we provided a five quarter trend in total nonperforming loans, REO repossessed property and past due loans.

Individual credit and other performance data for our principle loan segments like we've done in the past here today we've included them in the supplemental information that's posted in the investor relation section of our website. So overall nonperforming loans declined by $24.2 million in the quarter and that's a continued reduction and new non-accruals that continue to increase in cures and exits and we're going to review that in greater detail in the next slide.

It's instructive to note here that about 30% of our NPLs are actually current as we've been actively identifying and addressing problem situations. Our real estate owned and repossessed equipment has been relatively flat over the past year and that reflects our focus on remediation and problem loans and the resolution of repossessed property and equipment. Our past due loans remain in a fairly tight band and are about 1% of total loans over the past year. The March 31 balance of about $115 million is influenced by a $12 million commercial credit that reached principle maturity was current on interest, was in legal documentation at quarter end and that was resolved subsequent to quarter end. So our past due loans were actually flat then compared to year end.

We'll turn now to slide 14 and here we provided a reconciliation of NPLs over the past year. Here you can readily see the continued decline in new non-accruals approvals and a continued increase in cures and exits. We've also had the more recent favorable trend over the declining level of gross charge-offs since the third quarter of 2009. We had one pre-loan of about $15 million that came onto and then off with nonperforming status within the quarter. The amounts indicated in Q1 for new nonaccruals and cures were therefore influenced by this particular loan. If those new nonaccruals otherwise would have been closer to $101 million compared to $125 million in the fourth quarter and the cures and exits would have been closer to $81 million then still well in excess of the Q4 results of $55 million.

I redefault rate on modified residential loans is approximately 9% and that's clearly had a favorable impact on our results and it's reflected in our cures number this quarter. We've seen industry redefault rates in the range of 40% plus, so our performance here has been very solid in comparison.

Continuing with key asset quality progressions on slide 15, here we show net charge-offs in the provision for loan losses decline for the second consecutive quarter. The provision totalled $43 million in Q1, that's slightly above the gross charge-offs we reported and as you can see the excess of the provision over the net charge-offs reached its lowest level over the past year of $2.7 million, a positive sign.

The allowance for loan losses now represents 3.16% of total loans and provides a coverage ratio of approximately 99% of our total NPLs. Most of the $11.5 million decline in that charge-offs from the fourth quarter is explained by reductions of $8 million in equipment finance and $3 million in pre. Again, you can see more details as you review the supplemental slides on our website which also now provide five quarter trends statistics and information for each loan segment.

We'll turn now to slide 16 to take a look at deposit growth and here you can see we grew deposits at a 10% annualized rate versus last quarter and our total deposits are up $1.3 billion or 10% from a year ago. With the deposits first initiative we announced at the beginning of 2009, we consistently demonstrated over the last five quarters an ability to grow deposits across multiple lines of business or maintaining a very effective pricing discipline of reducing our cost overall.

We've also improved the mix of core to total deposits and our total to loan deposit ratio overall. We also acknowledge the environments contributed to the improved core to total ratio as we saw strong consumer preference for liquidity as they moved money toward MMDA now in savings and away from CDs. This mix change has also been beneficial to our cost to funds but it's also increased the risk to rising rates which we've begun addressing and I'll provide some more details on that in a few minutes.

So in summary, good growth again in Q1 and a 12 basis point decline in cost compared to Q4 with reductions in cost in all categories.

So let's turn to the next slide to discuss more of what's happened in deposits by the line of business. And here on this slide you can see our competitive advantage in deposit gathering is very clear. Throughout 2009 our focus on deposits is not happening in one or two lines of business but across the five lines of businesses as detailed here on slide 17. And again a particular note is our focus on growing core accounts, DDAs in every line of business as the key to strong customer relationships and profitability clear starts there. It's important to note that retail grew $97 million over the past year inclusive of a billion dollar decline in CDs. Our small business deposits grew 10%, HSA grew 27% and our commercial deposits grew over 56%.

Our government business continues to grow with new operating relationships in the quarter in all four states that we serve. Advisory services in this line of business are also showing very solid growth trends.

So in summary overall growth of a $1.03 million over the past year, we've significantly reduced cost by 81 basis points and that reflects our competitive differentiation of strong deposit gathering capabilities across five lines of business and a consistent deposit for us to focus and we're a loan deposit ratio at 78%. We've got the funding flexibility to target growth in different areas at different times based on cost and market opportunity.

We'll turn now to slide 18 and we wanted to review some changes that have happened in borrowing and mixing cost. Clearly the strong deposit growth we just reviewed reduced the need for the utilization of borrowings and they're down over $400 million in the last year. They're up slightly quarter over quarter from some on balance sheet interest risk moves that we took in Q1. In Q4 we began to execute a series of liability lengthening strategies to better prepare for the possibility of a rise in short-term interest rates and you can see some of the impact here in the lengthening of duration from 1.5 years in Q3 ‘09 to 2.3 years in Q1. We've managed to do this without materially changing the overall cost of borrowings or the size of the portfolio.

We began in Q4 with the termination of $150 million of pay floating interest rate swaps on long term debt and the restructuring of a $100 million of fixed rate, FHLB advances from an eight-month to a four-year maturity, the gain on the interest rate swaps being advertised over the four year remaining life of the fixed rate debt. We've replicated that derivative strategy again in Q1 and we've added a few twists that you'll see as we go to the next slide.

So here on slide 19 you can see that we've executed in the first quarter a combination of $1.2 billion of on and off balance sheet transactions to lengthen liabilities and let me spend the next few minutes explaining a couple of these transactions in greater detail. So in first transaction, we sold $600 million to fed funds futures contracts for the next year locking in an average fed funds rate of about 48 basis points. We view this as a partial hedge to protect against spread compression and our $1.8 billion portfolio of floating rate loans, which are currently priced at floors.

We should point out this transaction does not qualify for hedge accounting treatment and it's market to market on a daily basis and all the gains and losses flow through other noninterest income and at the end of Q1 there was a loss of $152,000. But we should also point out that the timing of gains may not also coincide with spread compression on fluid loans when rates rise to the forward-looking nature of these contracts and we'll be sure to clearly illustrate any material impacts for you in future releases but the real issue is we protected the economics more so than the NIM for the organization.

The second contract is designed to protect us from rising rates further in the future. Although you can see we have taken steps to protect ourselves from a sudden rise in rates, we feel the more likely scenarios for the fed to raise rates late in 2010 or in 2011; the $100 million forward starting swap locks in a fix rate hedge of 285 for three years starting in April of 2011. This does qualify as a hedge and there'll be no impact to earnings in 2010.

In addition we entered into a $100 million swap and terminated a $175 million of existing swaps again to convert floating rate liabilities to fix, we added about $75 million of new fixed rate term wholesale funding to replace maturing funding. And then the final piece of our multipronged strategy is to book more long-term retail CDs and so far we've been very successful increasing that portfolio with terms greater than two years up to five years by $111 million.

So excluding the retain CDs we calculate the incremental cost of these wholesale transactions around 75 basis points compared to today's target of fed funds rate. So we're now in an asset sensitive position to both parallel changes in interest rates until flattening of the yield curve as interest rates rise. We have some liability sensitivity to an increase of just short term rates primarily due to the forward floating rate loans. We'll continue to evaluate additional cost effective mitigation transactions in 2010 and their balance sheet and conditions changes but we believe a change for substantial additional actions are unlikely.

I'm going to conclude my remarks by providing some comments on expectations as we look forward into second quarter. So, if we'd start with credit, there's clearly positive signs that we saw in Q1, which could continue into Q2. We do have to remain cautious due to the economic uncertainty including employment levels and we also note that the first quarter did not have any lumpy commercial charge-offs, which are always difficult to predict so there's always some risk on the commercial side.

On the margin we would say that the margin is going to reflect the Fannie Mae buyouts we referenced earlier. Again, similar to the Freddie Mac buyout program in Q1, we estimate this could have a $2.5 million impact in that interest income. However, an expected increase level of average earning assets will help to keep managed risk income relatively flat and we'll need to look forward to some continued disciple around our deposit pricing and our loans renewals then to try and offset some of the Fannie Mae impact. We will feel the full impact in Q2 of these and then we'll expect to rebounce to be showing up in Q3.

We would expect core noninterest revenue to be consistent with first quarter's level as a rebound of deposit service fees from the otherwise seasonally low first quarter, it’s likely to offset what we think will be a reduced level of other income. Also please note as Jim said before, deposit fees will be under some pressure in future quarters. We'd expect our core noninterest expenses to increase slightly from the $120.5 million in the first quarter due to marketing initiatives that we're undertaking and also from some hired compensation levels from our expanded service initiatives and as we continue to hire additional bankers, then please note that these investments will show benefit then in subsequent quarters.

Also the preferred dividend expense, that should be expected to be around $4.7 million as we see the full quarter benefit on the $100 million dollars of CPP that was repurchased in early March. I'll now turn it back to Jim for some of his concluding remarks.

Jim Smith

Thank you, Jerry. Our first quarter results are a major step forward. Webster bank has returned to profitability. Credit trends have been positive. Webster is emerging from the most challenging period as a better, stronger company endowed with a team of talented motivated bankers. Our regional bank strategy is clear and we're committed to executing it in a manner that delivers improving returns on capital. That concludes our prepared remarks we're pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Ken Zerbe with Morgan Stanley. Please proceed with your question.

Ken Zerbe – Morgan Stanley

First question on TARP repayment; I heard your comments that you wanted to do it in a shareholder friendly manner and it seems that you're off to a good start with $100 million. Going forward, are there any other considerations that we should be aware of that would lead you to try to repay it sooner rather than later, which may have an increased likelihood of an equity issuance or are you comfortable sort of repaying it $100 million every couple of quarters for the next year or so?

Jim Smith

Well, it's a great question Ken. There's a lot of moving parts there and I think it's a question of timing when is the best time to repay that is providing maximum consideration from a shareholder perspective. So, we are willing to stretch this out for a while to make sure that we raised a minimum amount of common equity that maybe required in order to repay it but it's hard to put an explicit timeframe on it right now.

So, as I indicated the first step was to be able to pay back $100 million without a capital raise was an important step forward and it validates the capital strength of course. And now as our credit performance continues to improve and profitability as well, we'll be in a stronger position to repay we think with less need for a capital raise. But we need to see how all the variables play out as to what the timing ought to be and I would say that if we were to pay it back sooner rather than later there is a high probability there would be some kind of capital raise that would be involved. I would do only indicate that we would do our utmost to minimize the amount of common equity that might be involved.

Alternatively, we could wait longer term and balance that against other desires to exit the program in order to pay a substantial portion back out of earnings going forward but I think we just have to evaluate as we go and just reassure that whatever decision we make we'll make it at that time in the best interest of shareholders.

Ken Zerbe – Morgan Stanley

In the past you mentioned that you were worried that you could potentially see some competitive pressure from people who don't have TARP basically using that against you. Now, that you started to repay, do you still feel those pressures?

Jim Smith

We think repaying it was a very big step forward in that regard to show momentum and to show the capital strength of the company in the process but that is out there as a consideration. We don't think that it's a negative for us at this point but it's something you have to continue to watch and so if others don't have the capital and you do that's one of the elements that you have to weigh in your repayment plans.

Operator

Thank you. Our next question is from Dean Choksi of Barclays Capital. Please proceed with your question.

Dean Choksi – Barclays Capital

Good morning, glad to hear that you are back on the offensive on some of your initiatives. I think Jerry you talked about the expense structure being up going forward, kind of given all the internal activities that you're doing how should we think about the expense structure going forward and then kind of when do you expect to see net loan growth or when do you kind of see the benefits of that?

Jerry Plush

Dean, it’s Jerry. First on the expenses, the guidance I wanted to try and provide just in terms of generalities is there's two lines to be thinking of that we believe will definitely increase in Q2 and that'll be again around comp and benefits and around marketing. Marketing is absolutely, to tie into Jim's comments we're rolling out a very strong series of the campaigns right now whether it's on TV, whether it's radio or whether it's direct mail, whether it's on billboards. So you would expect to see that continuation if not even slightly higher marketing expense in the second quarter and then you'll begin to see some – that to tail off in Q3 and Q4. As it relates to compensation expense, I think you would see us – this would be natural in terms of the extended hours initiatives and all the hiring plans that we've listed out, and the update in some of the strategic initiatives. So they're sort of the higher areas that to expect. We are running a series of – you should expect, however, the OneWebster savings that'll continue to come through.

You’d expect us to continue to work away from a procurement perspective, from an efficiency perspective and other line items in Q3 and Q4 and see us trying to adjust and if not, not only completely offset, begin to bring expenses down in those quarter.

Dean Choksi – Barclays Capital

Do you have a sense of kind of how much expense can be removed through OneWebster that's remaining?

Jerry Plush

Yes, we have about $5.5 million in remaining ideas and the need to be executed on and as you will start to see the benefits of that and again, that's annualized that you'll see start to flow through. So you’ll only get a part of that obviously in Q3 and Q4 and then in addition it'll be based on the success of how we continue to execute on our continuous improvement idea generations there after. But we do have opportunities that we have identified and you should see several million dollars worth the benefit in each quarter thereafter.

Dean Choksi – Barclays Capital

Great, thank you.

Jerry Plush

Sure, thanks Dean. Oh, Dean, you did ask, wait, I think there was a comment there about loan demand. I would think on the loan side clearly like probably others have reported, we continue to see softness in the market. I do think that the real positive for Webster is the continued buildup on the small business as well as in the middle market areas as we continue to add folks, as the folks we've already added gain traction. We still look forward to some nice growth because we're very, very focused on those specific areas.

I would think that you'd see some moderation if not rebound in the residential area and I would think that we'd probably stabilize more on the consumer side as well so I think generally speaking, you know, the first quarter was really a transition quarter for us as an organization. I think we talked about that a lot in the fourth quarter that really because of the plan declines that we saw in AVL and equipment finance and Jim gave some perspective in terms of where those balances will settle out. We would expect that we'd pretty much be there within the next couple of months and then you'd begin to see sort of the new areas where we're very, very focused particular in small business and middle market begin to take hold and really show consistent growth.

So we tend to think that the additions again, the addition to staff, the existing complement and just the way we're positioning ourselves in the market will be our competitive advantage to gaining some share back there.

Operator

Our next question is from the line of Amanda Larson with Raymond James. Please proceed with your question.

Amanda Larson – Raymond James

You have some very strong trends in the cures and I just wanted to know if there was any specific loan bucket that was driving the strong trend.

Jerry Plush

Amanda, it’s Jerry. The one point and that's why I wanted to bring out the curing that's happening in terms of all the residential modifications, that's probably the single category where we're seeing the best experience in terms of the fruits of all the work that was done over six months ago now coming back in. So I would say that category in particular. But I think there is – obviously we talked a little bit on the commercial side that we've had a couple of credits that came back in as well.

So I think it has to really point toward the modification program that we talked about a lot last year is really showing some of the benefits and we're in a very, very low redefaults rates, that's a huge, huge positive for us. And I think that's the complement to the group and how they've restructured it. I think when the loans were restructured they were done well and if they were right offs it needed to be taken at that point in time, they were taken so. I think that we've set a lot of customers out for success, and so ourselves for success I think with the way that program has been managed.

Amanda Larson – Raymond James

Okay, great. I appreciate your commentary on the projections for growth. I was wondering to what degree do you believe consolidation in New England is necessary for growth in your legacy footprint in Connecticut with so many strong players there.

Jim Smith

Amanda, this is Jim. Our focus is on organic growth and we believe that with the strategy and the initiatives that I outlined, which is one of the reasons I wanted to do that that we would be able to achieve our goals through organic growth. So we are not looking so much at acquisitions at this point but do believe that as our currency recovers that over time there may well be the opportunity for us to make acquisitions or likeminded partners that decide that the market is a little bit too crowded. And as you know, historically we've done very well by combining with other institutions.

So we see that as part of our plan but not the focus at this point. We also think that while there may well be significant consolidation in New England over the next several years that it's not as immediate right now but the focus is more likely to be on the very few assisted transactions that may come up in this region but that there will be consolidation in New England down the line and we would like to be part of it.

Operator

Our next question is from Damon DelMonte with Keefe, Bruyette, & Woods. Please proceed with your question.

Damon DelMonte – Keefe, Bruyette, & Woods

Good morning guys. How are you? Jerry, I was just wondering if you could recap your comments at end of your remarks regarding the NIM and fee income going forward.

Jerry Plush

Yes, I think Damon if you were to look at the NIM for Q1 normalized without the buybacks it probably would have been around 331. If you look at the higher level of buybacks we're expecting from the Fannie Mae buybacks, that probably takes about 6 basis points or so off of that number. And basically in order to achieve that level and then continue to try and work up from there during the quarter, we're going to need to be very, very diligent as it relates to deposit pricing and continue the discipline and also be very disciplined around loan pricing. And again our expectations are you'd see a rebound from that back more normalized in Q3.

So hope that's helpful and it gives you a little more perspective around what to think. So, do we think there is up sight to try and offset some of the buyouts? Yes, we do and I think that the flip side is it does really depend as well though on the loan mix that's booked during the quarter and in terms of some of the pricing decisions we make there.

Damon DelMonte – Keefe, Bruyette, & Woods

Great, thank you very much. And then in regards to your core fee income going forward, could you just recap your comments on those lines of business?

Jerry Plush

Sure. Deposit service fees will tick up because Q1 tends to be lower transaction volume quarters but just seasonality. And so we'd expect a rebound there. Generally speaking, I would expect that to more than offset the drop that we probably see in other income, there was a lot of ins and outs in other income during the quarter. So if you were to be thinking about consistency to Q1, that's probably not a bad way to think about it.

Damon DelMonte – Keefe, Bruyette, & Woods

With respect to your securities portfolio, that has grown to be about 29% of total assets, I think that’s up from 20% a year ago. Kind of where do you see that shaping out in the coming quarters?

Jerry Plush

Damon, in my comments one of the things I wanted to try and highlight was the fact that we've got several billion of that in AFS and we also -- you have to remember there's fairly high prepaid speed happening in this portfolio. It’s probably panned out at a $100 million or so a quarter or excuse me, a month within the quarter. So you've got several hundred million dollars potentially that can come out of that portfolio in any given quarter just given where interest rates are. And then also with all those securities in AFS, it gives us a lot of flexibility to use that for funding loan growth.

I don't think it's our attention to grow the portfolio further. We thought that it was necessary to deploy the inflows that we were fortunate enough to receive and certainly we want everything. We talked a lot about the deposit side, it’s all about organic, it's all of us and you can hear in a lot of the remarks today that's the way we're thinking about the loan side and there is really tangible evidence of that taking hold.

So the expectations are we want to see that the loan side and get ourselves back to a lot more normalized loan-to-deposit ratio that's back in the probably upper 80s to 90% type of range and that would be the goal as well.

So I think a combination of not really wanting to grow the investment portfolio further, being able to use the cash flows from that to fund loan growth coupled with a desire to get that loan-to-deposit ratio back now as things stabilize more to what we'd refer to as more normalized level for us going forward.

Operator

Our next question is from Bob Ramsey with FBR Capital Markets Corporation. Please proceed with your question.

Bob Ramsey – FBR Capital Markets Corporation

As you're looking at the aging of the modified loans, do you expect that you'll see a similar amount of NPL cures in the second quarter as the first?

Jerry Plush

Good question. We would expect to see a fairly consistent number not necessarily as high a number. So if you think about the program and just in terms of the timing and sort of the six months that we take to make sure that these loans are performing well, we'll take them back into accrual status. We probably had the high peak in terms of timing wise.

Bob Ramsey – FBR Capital Markets Corporation

As you think about the provision here, do you think that the build over charge-offs will continue to narrow? Obviously there's not a lot of cushion there and when do you think you will switch to a position of in less than charge-offs?

Jerry Plush

Bob, good question. I think we want to remain cautious which is why we continue to be actually slightly above. I would expect we want to have more certainty in Q2 probably would say if from the chair today make the observation that we'd probably offset charge-offs and I think that that cautious approach will pay dividend down the road. So I think in terms of being anxious to try and get into – are we going to start to charge off more than we provide, I think that maybe something we’d look at in the second half of the year.

Clearly we think that charge-offs will remain at a pretty good clip like we saw in the first quarter throughout the course of 2010 but that doesn't necessarily mean in Q2 or excuse me in the second half rather of the year that we would necessarily continue to replenish at the same rate. But I would think for Q2 we want to make sure we're absolutely certain in terms of – and I think that's just prudent management. We're trying to be cautious about this, make sure there is no downward trends that we see.

Bob Ramsey – FBR Capital Markets Corporation

As I think about the diluted share count for you guys, once you do swing back to profitability assuming that stocks sort of where it is today, what is a good diluted share count to factor in (inaudible) TARP warrants?

Jerry Plush

I think in terms of what we've got projected for Q2 through Q4 we're probably around 81 million shares, if I've got that number accurate, maybe a slight tick below might be 80.7 rising to 80.9, but gives you a pretty good band within which to work.

Operator

Our next question is from Matthew Kelley with Sterne, Agee & Leach. Please proceed with your question.

Matthew Kelley – Sterne, Agee & Leach

Hi, guys. On the Freddie buyout, what was the actual dollar amount that was bought out because there are two issues; does your premium amortization but then you also have a lower investment yield, so curious with the dollar amount on the Freddie buyout and then similar overview of the Fannie buyout for Q2.

Jim Smith

Hey, it’s about $45 million that came out and then you could probably roughly say twice that amount, so be in that range maybe around $80 million related to Fannie.

Matthew Kelley – Sterne, Agee & Leach

Okay and the reinvestment yields, how much lower would they be on that $125 million?

Jim Smith

Maybe 1% or so.

Matthew Kelley – Sterne, Agee & Leach

Okay. So the $1.4 million this quarter, the 3 basis points, that's just the premium amortization, correct?

Jim Smith

Yes, that's all you can take, yes, Matt, right.

Matthew Kelley – Sterne, Agee & Leach

No, but I mean just going forward you got 120, down 100 dips.

Jim Smith

Right, and you got it.

Matthew Kelley – Sterne, Agee & Leach

OK. Then on the Reg E changes, the $15 million, just to confirm that's a full year number correct?

Jim Smith

Yes, that would be the second half assuming zero opt-in. Yes, that's just a raw number.

Jerry Plush

And what Jim’s comment was very consistent because I made a statement in the fourth quarter, we talked about a range of anywhere between $5 million to $7 million and we wanted to actually give you a broader perspective of which Jim did of no opt-in because what we think our exposure could be. So it gives you a sort of a range of thoughts that we've been having around potential success rate or not, we're not going to know that until we get to the third quarter and actually walk through the experience because again, remember this is consume optionality, it’s up to the consumer on the opt-in process here. And you could -- that's going to depend on everyone’s individual situation what they want to do. But I think the way we've laid out the plan, we’ll talk more about obviously in the second quater.

Matthew Kelley – Sterne, Agee & Leach

But just to be clear the $5 million to $7 million is loss potential income in the second half of the year.

Jerry Plush

No, per quarter.

Matthew Kelley – Sterne, Agee & Leach

Per quarter, okay.

Jerry Plush

So we're saying that gives you a range of potential that we think that know if you were to look at anywhere between $10 million to $15 million, $15 million would be the maximum but that depends on opt-in rates. And we've got very – as Jim said, we're going to be very guarded about this. We know how we're going to roll out the program, we're very active in terms of executing on our strategy around that and we'll certainly be in a position to talk more about that on the second quarter call.

Jim Smith

We've got a good program.

Matthew Kelley – Sterne, Agee & Leach

Fair enough, and then just last question. As you move to the positive side and into the black, what should we be thinking about the tax rate?

Jerry Plush

Twenty percent for the balance of the year.

Matthew Kelley – Sterne, Agee & Leach

Okay, and then for next year?

Jerry Plush

I think you're going to look at something higher than that. I think you'll see some gradual increase. We'll give you some guidance on that when Terry makes the rounds.

Operator

Our next question is from Collyn Gilbert with Stifel Nicolaus & Company. Please proceed with your question.

Collyn Gilbert – Stifel Nicolaus & Company

Jerry, just a question on the credit front. You were kind of cautious at the beginning of the year, committing a little reluctant to commit too much to a positive outlook on credit because of the CRE and kind of equipment finance. Just the performance that you saw this quarter and I know you had indicated that if you see stability in the second quarter you'll feel better. Have you seen trends change in CRE and equipment finance that has given you more confidence or is it kind of the overall market or maybe just talk a little bit about that?

Jerry Plush

Yes, Collyn, I think and John's here today too and he'll probably have an observation or two, but I think I'll take maybe one after I'm done. In terms of -- I think it's overall -- what we talked about and when you look at the detail slides, there's really good trends pretty much throughout the portfolio. Clearly on the charge-off side, you saw better trends from equipment finance as well as from pre. But I think we still continue to feel very good about the way the portfolio has been managed on the pre side, very good about the way we're working out the problem credits. Sponsors continue to step up, we continue to see some good signs in that portfolio. And the cautious comment is we're not out of the woods yet but it turns out the industry what we think in particular for us, it’s better at this point in time to remain a little more cautious given another quarter before we say we've definitely seen -- we've got more than a quarter or two's worth of data to say that we have absolutely got rock solid positive trends but the data, sure points to it across the board when you look at the declines in delinquencies, the declines in NPLs, the declines in charge-offs, the drop off as it relates to the provision expense that we've had a book related to each portfolio.

Regarding equipment finance, clearly I think what you saw us do towards the latter part of 2009 was be very, very proactive to try and address and charge off a lot of the problem credits that we had within that portfolio and clearly you're starting to see some better experience from that portfolio, that was pretty evident in the first quarter.

So I think net net we are seeing and feeling good about the portfolio and you always do a touch wood and you just again, given all the uncertainty of the economy among, just in terms of particular around employment, but in equipment finance, it's a lot of small business owners and if you see that their demands starts to pick up, you've got a lot of people then that obviously will be getting stronger cash flows than from the increased orders of business that they get and we should see more stabilization as you think about the balance of 2010.

Collyn Gilbert – Stifel Nicolaus & Company

Okay, that's helpful. And then just, Jim, I know you have in the past mentioned a targeted kind of efficiency goal of 60%. Are you still on track you think to be able to achieve that?

Jerry Plush

Hey, Collyn, it's Jerry, Yes. And I think the efficiency goal has to come from a combination of two things. Clearly we've got to continue to be after the expense side, we're going to continue to look at things like consolidation, opportunity, centralization opportunities of facilities but we've not been reticent to spend money here in the midst of all the things that we've been doing to really invest in the franchise and to build the earnings engine of the franchise. And I think you can clearly see with all the business development officers that we're adding and the fact that we're pretty bullish about Westchester and putting a regional headquarters there.

There’s definitely some increased commitment that will drive expenses and the end result of that is we believe that they pay off with a lot more revenue opportunities in a lot deeper stronger customer relationships. So it's got to come as well from the revenue side, it's got to come from greater asset size, greater earning asset size predominantly.

So I hope that's helpful because I don't think it's – people tend to spend a lot of time focused on that. I know we've had some conversations in the past and it's not to say that we don't think that continuing to be very hawkish around expenses looking for renegotiations of contracts, looking for our department structured appropriately, should we look to centralized very decentralized, should we look to consolidate; a lot of those ideas are continuing to be in play and that's with the whole OneWebster initiative aside, put that to the side as it relates to the asset side of the company, we’ve got to grow our earning assets and that's another, another, another big lever that we've got to pull in that.

Jim Smith

Collyn, I just wanted to add something if I could that in the context of getting a return on our capital we see that the efficiency ratio would have to be 60 or less than that over time in order to achieve that. But to Jerry's point some of that maybe driven by revenue rather than simply by reducing cost. So we wouldn't say look for 60 in the second quarter or the third quarter of 2010 in part because we think now is the time to be investing our future, to create the opportunity for more revenue whether it’s that extended hours program we're taking about or the business bank because there are other things that were mentioned here today.

So as much as we're doing our best to be as efficient as we can on the cost side, we're also making investments that cause expenses that could put the ratio even a little bit higher over the near term even though we think longer term we would have to be in that range to be competitive and to generate the kinds of returns we think we're capable of.

Collyn Gilbert – Stifel Nicolaus & Company

Okay, that is very helpful. And then one final question on the -- I just want to make sure I got your comment right, Jerry. On the securities front you said you're not interested in really growing that, so we probably won't see the kind of growth rate in the securities book going forward that we have seen in the last few quarters.

Jerry Plush

Yes, and if anything we may keep it at a stable level depending on how we see loan demand in the second quarter but there really is -- there maybe some increases that relates to the average, Collyn, I think that's one of the things. So in terms of maybe point to point, you won't see it but in terms of the average for the quarter there could be a popup there probably around the $100 million or so. But the one other thing to take into account again we really want to see -- we're out there and we're being proactive, we really want to lend and I think it's not just lend, we really want to develop customer relationships and we've been very successful on the deposit side and we've really got to – as we see some economic recovery starting to kick through the year and our ability to take away market share from competitors, that's really the key thing. So this quarter is a lot about execution for us as an organization and I think in terms of signalling we certainly don't want to signal that our intent in terms of getting to earnings just to grow the investment portfolio.

Operator

Thank you. Mr. Smith, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments.

Jim Smith

Well, thank you very much. Thanks everybody for being with us today. We look forward to seeing you soon.

Operator

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

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THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Webster Financial Corp. Q1 2010 Earnings Call Transcript
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