Webster Financial's (WBS) CEO James Smith on Q2 2016 Results - Earnings Call Transcript

| About: Webster Financial (WBS)

Webster Financial Corporation (NYSE:WBS)

Q2 2016 Earnings Conference Call

July 20, 2016 9:00 AM ET

Executives

James Smith – Chairman and Chief Executive Officer

Glenn MacInnes - EVP and Chief Financial Officer

Joseph Savage - Executive Vice Chairman

John Ciulla - President

Chad Wilkins - HSA Bank Head

Analysts

Jared Shaw - Wells Fargo

Steven Alexopoulos - JP Morgan

Bob Ramsey - FBR Capital Markets

Casey Haire - Jefferies & Company, Inc.

Steve Moss - Evercore ISI

Collyn Gilbert - KBW

Matthew Breese - Piper Jaffray

Presentation

Operator

Good morning, and welcome to Webster Financial Corporation's Second Quarter 2016 Results Conference Call. This conference is being recorded.

Also, this presentation includes forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition, results of operations, and business and financial performance. Webster has based these forward-looking statements on current expectations and projections about future events. Actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning risks, uncertainties, assumptions, and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial’s public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the second quarter of 2016.

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

James Smith

Thank you, Christine, and good morning, everyone. Thanks for joining Webster's second quarter earnings call. CFO, Glenn MacInnes, and I will review business and financial results and then take questions along with President, John Ciulla; Executive Vice Chairman, Joe Savage; and HSA Bank Head, Chad Wilkins.

Beginning on Slide 2, this was a solid quarter overall for Webster with over $1.4 billion of loan originations, continued strong revenue growth of 9% year-over-year and key credit metrics at exceptionally strong levels.

Record net interest income was driven by the fifth consecutive quarter of year-over-year double digit loan growth. Non-interest income also rose to a record and year-over-year revenue grew for the 27th consecutive quarter a signal accomplishment.

While the loan portfolio yield was unchanged from Q1 pressure on the securities portfolio yield from historically low interest rates led to a 3 basis point decline in the net interest margin. Record non-interest income reflected higher commercial activity in particular including higher revenue from assisting our clients in their interest rate hedging needs.

I’ll call your attention to a correction and reduction of prior period’s net income relating to HSA Bank totaling 1.6 million in Q1 2016 and 1.6 million for full year 2015. While the corrections have no effect on Q2 results, they have the effect of reducing non-interest income and increasing non-interest expense over the previous five quarters. Glenn will provide more detail.

As in our second quarter earnings release posted this morning, we’ll be speaking through the remainder of this presentation to the adjusted prior period information. Sustained strong loan originations which have now exceeded $1 billion in eight of the past ten quarters have overcome the effect of historically low interest rates and been a primary driver of revenue and pre-provision net revenue as PPNR and the pipelines remained robust even after Q2 strong performance. Had it not been for the strategically and financially compelling Boston expansion which has expected resulted in net expenses of 5.3 million in the quarter or roughly $0.04 a share, we would have achieved records for PPNR and net income a sub 60% efficiency ratio and return on average tangible common equity exceeded 12%.

On Slide 3, you can see the quarterly trends for loans and deposits over the past year. Loans were 10% and were fully funded by an equal amount of deposit growth. As a result, the loan to deposit ratio remains quite favorable at 86%. On a loan side, commercial led the way with year-over-year growth of 13% and commercial and business loans now comprise 58% of the loan portfolio. On the deposit side, transactional and HSA accounts grew by 12% and now comprise 56% of deposits.

On Slide 4, loan growth is spread across all key loan segments with each segment again posting solid year-over-year growth.

On Slide 5, you can see the diverse sources of our 1.5 billion in deposit growth where transaction accounts accounting for 73% of the growth. This slide provides a clear illustration of how Webster benefits from our multiple low cost deposit funding sources.

Slide 6 shows solid loan growth in both interest income and non-interest income to record levels reflecting strength in both categories in commercial banking and HSA Bank and overall revenue growth in community banking and private banking.

Non-interest expense growth reflects primarily HSA Bank’s growth over the past year and expenses related to the Boston expansion. The net result is 5% year-over-year growth in pre-provision net revenue which ex the Boston initiative would have 11%.

Line of business performance begins on Slide 7. Commercial banking continued its strong performance in highly competitive environment by delivering 4% loan growth in the quarter and 13% year-over-year. Year-over-year revenue grew 12% to a record and PPNR grew 16% demonstrating strong operating leverage. Commercial banking leads the way in delivering economic profit.

Portfolio yield increased linked quarter due to a favorable mix of origination and payoff activity marked by a robust origination activity in the higher yielding middle market. Our team continues to demonstrate success in selected industry verticals including tech, media and telecom and healthcare and through geographic expansion and by providing treasury management solutions for our commercial clients and commercial real estate investors.

Webster commercial bankers remained focused on delivering a totality of our product and service offerings through effective cross sell. As a result, second quarter non-interest income was a record including record swap revenue generated across commercial business units.

Asset quality and commercial banking remains solid as the quarter show a positive net migration in classified assets, non-performing loans and charge-offs.

Now moving to community banking on Slide 8, our Boston expansion is tracking on plan. Accounts and balances are ahead of plan and we’ve generated 140 million in new deposit balances. We’re delivering all of Webster to the market. We heard our marketing campaign of surprisingly good service as evidenced by strong referrals and growing pipelines across all units including consumer deposits, mortgages, businesses and commercial banking and private banking which boards well for revenue in coming quarters.

Our 24/7 costumer care program followed in Q2 by the quick switch tool that facilitates easier account transfer from other banks has strengthened our value proposition as we make a name for ourselves in greater Boston.

While the super low rate environment is stressing spread income, we remain confident that our Boston strategy will deliver over a $1 billion in deposit balances and more than 500 million in loans in five years and Boston will be a top performing market.

Slide 8 reflects another quarter of strong and positive momentum in business banking. Loan balances were up nearly 10% year-over-year driven by strong loan originations across all markets and channels. Strengthened further by our fast track loan processing program that is booking more than half the loans under a 100,000 within 48 hours of application. Strong deposit growth was driven by 20% year-over-year growth in DDA originations with the balance per DDA up over 10%.

Slide 9 highlights the steady growth in loan and deposit balances for personal banking. Loan originations declined year-over-year and rose sharply linked quarter as did the pipeline reflecting the recent surge in mortgage volume and also reflecting higher home equity originations. Deposit growth again reflected record high average transaction account balances highlighting our success in attracting the mass affluent segment.

New investment production of $100 million was up linked quarter and down year-over-year. We’ve been working to right size these units since last year, managing expenses to improve margins and ensure compliance readiness for the Department of Labor fiduciary rule. As a result while assets under administration grew modestly advisor productivity rose significantly.

Slide 10 reflects trends in mortgage originations with nearly 87% of portfolio loans coming from high value jumbo mortgage relationships that typically have higher than average products and services per household and support our mass affluent strategy.

Focused investment in online and mobile banking continue to improve digital banking penetration with mobile banking customers growing 16% year-over-year and automated transactions via ATMs, online and mobile accounting for 70% of the total. Investments in banker training and salesforce.com are helping improve banking center sales productivity by 20% year-over-year.

Overall, we are pleased that the community banking transformation continues to gain momentum as reflected in the increasing concentration of higher value relationships across consumers and businesses. Progress in executing our mass effluent strategy is benefiting from best in class net promoter scores in that segment.

Slide 11 presents the results of HSA Bank with strong continued year-over-year growth in deposits of 13% and in accounts of 18%. When adjusted for anticipated attrition related to the JPM HSA transaction which included a purchase price adjustment or clawback for accounts at risk of terminating, deposits grew 20% and accounts grew 26%.

During the quarter, we added 538 employers and 103,000 new accounts bringing year-to-date new account production to a record 437,000. This performance demonstrates the successful execution of our growth strategy and validates the aggressive investments we are making in our platform capabilities and service offering with a goal of providing an industry leading customer experience at every client and customer touch point.

Second quarter PPNR was flat year-over-year and down from Q1. We call that last quarter we’ve reported that the deposit duration was reduced to better match long term loan duration which lowered spread income year-over-year.

Also the clawback benefit in Q2 was 1.6 million lower than in Q1. Lower expenses after the termination of the JPM HSA transition services agreement have not materialized as quickly as first thought and post migration volumes remained elevated and activities including client and customer support have resulted in higher than planned operational expenses.

Simultaneously, we’ve aggressively pursued on-boarding and integration of new clients. For example those 538 new employers, while also providing product extensions to multiple existing health plan partners which effected expense levels.

We boosted marketing expenses and further expanded our sales force and the belief that every dollar invested will elevate HSA Bank’s potential and return significant value to shareholders.

For example, our new claims sink feature allows customers to consolidate due and pay claims from multiple carriers in three simple steps without leaving the HSA Bank member website. We’ve enhanced our mobile app enabling customers to verify and pay qualified medical expenses right at the pharmacy.

It’s likely that expenses for the remainder of 2016 will be relatively flat as we invest in operational excellence, product development and new business initiatives and prepare for peak season 2017 beginning late in Q3. Positive operating leverage should significantly ramp up PPNR thereafter as accounts and deposits continue to grow at around 20% or more.

Slide 12 highlights results for Webster Private Bank where our recent model shift is driving growth across all product categories. Loans have grown to the point where total outstandings our double what they were three years ago and deposits were up 25% year-over-year. Growth in fee generating assets drove the strong increase in non-interest income, revenue per new client grew to a new high and PPNR increased as well. Boston looks like a good opportunity for the Private Bank.

Now I’ll turn it over to Glenn for his financial comments.

Glenn MacInnes

Thanks Jim and good morning, everyone. I’ll begin on Slide 13 which summarizes our earnings drivers. Average interest earning assets increased 308 million or 1.3% compared to the first quarter. The loan portfolio was up 280 million or 1.8% primarily in commercial up 143 million and in commercial real estate up 81 million.

Net interest margin decreased to 308 basis points for the quarter. The average ten year swap declined 17 basis points during the quarter and 49 basis points versus the fourth quarter average negatively impacting the yield on our investment portfolio. Commercial loan volume offsetting in contraction resulting a net interest income of 177 million.

Non-interest income increased by 2.7 million linked quarter. The increase reflects strength in loan origination fees and revenue from client hedging activities. The expenses increased modestly considering Q1 included approximately 1 million in branch optimization expense.

Taking together pre-provision net revenue totaled 89.2 million up 3% from Q1 and 5% from prior year. The provision for loan loss totaled 14 million for the quarter. Our loan loss coverage increased from 110 to 111 basis points in Q2.

Pretax GAAP reported income was 75.2 million in the quarter and reported net income of 50.6 million includes an effective tax rate of 32.7%.

As Jim highlighted in his opening comments, during the quarter we determine the prior periods did not accurately reflect revenue and expense for HSA Bank and needed to be corrected. We’d indicated in our updated guidance in mid-June that the correction pertained to end up migration throughout at HSA Bank, at the time we expected a net 2 million adjustment in second quarter’s results. Since then we identified additional corrections to determine that appropriate action is to correct prior periods. Second quarter results were not impacted.

A pretax correction of 2.4 million was made in Q1 2016 and a pretax correction of 2.6 million was made for all of 2015. Both corrections reduced previously reported net income. While the corrections impact the bank’s consolidated financials, they are confined to HSA Bank segment and are detailed on Slide 22 in the appendix and we have also provided a detailed reconciliation in the press table. All financial data in today’s press release as well as this presentation reflect those corrections.

Slide 14 highlights the drivers of net interest margin versus prior quarter. Starting at the top, while the average balance in securities portfolio increased slightly, the yield declined 12 basis points. The lower yield was primarily driven due to increased premium amortization of 1.7 million quarter-over-quarter driven by an increase in CPRs from 12.1% to 14.8%.

Cash flows for the quarter totaled 318 million with the yield of 318 basis points and purchases totaled 280 million at a yield of 299 basis points.

Further down you see average loan balances grew 1.8%, while the total portfolio yield was unchanged. Commercial loans representing 58% of total loans grew 2.8%, while the yield increased by 1 basis point. Consumer loans grew by 0.8% and the yield decline 2 basis points primarily as a result of lower yield on the residential mortgage portfolio which fell by 5 basis points.

As we highlight the combined interest income generated by our loan portfolio increased 2.4 million for the quarter. Average deposits increased 268 million led by increases in core deposit categories. Savings led the way with an increase of 155 million about half what was related to the Boston expansion. HSA deposits increased by 70 million and demand deposits increased by 3 million.

The overall deposit costs were unchanged at 27 basis points. Average borrowings were essentially unchanged while the average cost of borrowings decreased 8 basis points to a 144 basis points. In March, 145 million of long term borrowings costing 276 basis points matured and we replaced with the mix of lower cost short and long term borrowings.

The tax equivalent adjustment to 3.3 million from 3 million in Q1, primarily due to growth in municipal bonds of 68 million.

In summary, continued strong loan growth along with lower cost of borrowings more than offset margin compression, resulting a net interest income of a 177 million.

On Slide 15 we provide additional detail on our non-interest income which increased 2.7 million from the previous quarter. Mortgage banking revenue increased by 316,000, settlements of 83 million were about the same as Q1. The premiums on Q2 settlements came in at 179 basis points compared to 173 basis points in Q1.

Wealth and investment services highlighted in blue were essentially flat quarter-over-quarter. Loan fees in dark green increased 1.4 million on hither commercial activity. Other income increased by 832,000. Strength in client hedging activities helped to offset a 2.3 million positive fair value adjustment in the JPM HSA receivable in Q1.

HSA Bank fee income was essentially flat. And deposit serviced fees increased 566,000 primarily from higher NSF, interchange and ATM fees. This was led by a 9% increase in debit card transactions.

Slide 16 highlights our non-interest expense which was flat to prior quarter. Q1 included approximately 1 million in branch optimization which was offset by targeted investments in HSA.

Turning to Slide 17, our investment in Boston kept our efficiency ratio about 60 at 61.5% in the quarter. Excluding Boston related expenses; our efficiency ratio would have been 59.2%.

Turning now to Slide 18, which highlights our key asset quality metrics. Overall we are pleased with our asset quality performance is seen by the positive trends in all metrics. Non-performing loans in the upper left decreased by 8 million and represent 82 basis points of total loans, primarily from reductions in commercial non-mortgage and commercial real estate.

Past due loans in the upper right decreased by 21 million and represent 21 basis points of total loans. The decrease from Q1 was primarily due to the positive resolution of a commercial real estate loan that is fully secured by a high performing property returning to current status.

Commercial classified loans in the bottom left decreased by 33 million and now represent 3.31% of total loans and remained well below our five year average of 5.6%. The decrease for the quarter was primarily attributable to a commercial real estate.

New non-accruals were 15.7 million. The decrease was primarily due to lower commercial non-mortgage and commercial real estate inflows. Net charge-offs which include gross charge-offs of 9.1 million related to NPLs as seen on the chart on the bottom right totaled 7.8 million in the quarter for an annualized net charge-off rate of 19 basis points in Q2. This compares the net charge-offs to 16.4 million in Q1, charge-offs in that quarter included 8.7 million related to one commercial credit. Loan loss coverage increased to 111 basis points as we provided 6.2 million more the net loan charge-offs.

In summary, our credit metrics remain at historically strong levels and we maintain a positive forward view on performance.

Slide 19 highlights our capital position. Ratio remained an excess of Basel III well capitalized levels. The tangible common equity ratio increased 12 basis points from March 31st and stands as the top end of our stated range of 6.75 to 7.25.

Common equity Tier 1 ratio was 10.5% noticeably above our operating range of 9.25% to 9.75%. We continue with our strategy to grow our balance sheet primarily with a 100% risk weighted loans.

Given Webster strong capital position and solid earnings, board increased regular quarterly cash dividend in April to $0.25 from $0.23 per share.

Before I hand it back to Jim, a few comments on our outlook for Q3 compared to Q2. Overall average interest earning assets will grow approximately 1% to 2%. We expect average loan growth to be approximately 2% to 3%. We expect further modest pressure on NIM and would anticipate being flat to down 2 basis points. Reflecting the loan growth and our NIM expectation, we expect an increase of around 1.5 million to 2.5 million in net interest income in Q3.

NIM and net interest income expectations are subject to overall interest rate environment and not being materially different than it is today. We do not expect any changes in short term or long term interest rates up or down until the first quarter of 2017.

We expect the provision to be in line with Q2’s level depending on loan growth and we expect non-interest income to be relatively flat quarter-over-quarter as Q2 included record level of consumer - commercial hedging activity.

We continue to manage our non-interest expense closely while opportunistically investing in talent acquisition and other initiatives in support of our growth strategies. We expect the efficiency ratio including the Boston expansion to be in the range of 62%. Our expected effective tax rate on a non-FTE basis should to around 33% and we expect our average diluted share count to be about 92 million shares.

With that I’ll turn things back over to Jim.

James Smith

Glenn, thank you very much for that report and now let’s open it up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Jared Shaw with Wells Fargo. Please proceed with your question.

Jared Shaw

Hi, good morning.

James Smith

Good morning, Jared.

Glenn MacInnes

Good morning, Jared.

Jared Shaw

Maybe just starting with the following-up on the Glenn’s comments on the fee income, so you are expecting fee income to stay flat as we go into you know the second half, is that with higher hedging activity on the client hedging activity or would you expect to see that pull back a little bit and be covered by growth in other areas?

Glenn MacInnes

Yeah, that’s exactly right Jared. We did about 4.6 million in hedging activity in the quarter which is a record for us up 1.2 million from prior quarter, so some of that will go away but it will be offset by other fee income.

Jared Shaw

Okay, was that mostly just loan …

Joseph Savage

Hey, Jared. Jared, this is Joe. The one comment I’d make on the hedging activity fee income and I am probably jumping John a little bit on this one, but it’s coming from different sources. So yeah, Glenn is absolutely right, we don’t think we’ll be at a record level, but there is lots of different sources it’s starting to emanate from.

Glenn MacInnes

I think if I look at by line, I would say you know we expect an increase in deposit service fees and loan related fees as well. Those are the two offsets which in and out keep us flat quarter-over-quarter.

Jared Shaw

Okay. And when you look at the hedging activity this quarter, is that mostly just loan swap activity?

Glenn MacInnes

Yes.

Jared Shaw

Okay, great, thanks. And then on the HSA balances, what was the - was there any final impact to Q2 balances from the JP Morgan through up or is that all incorporated into the balances previously to second quarter?

James Smith

So there is about 700,000 in a clawback on other income that’s related to the HSA transaction for the second quarter.

Jared Shaw

So in terms of period end balances, was there an impact, was there a net outflow at all?

James Smith

I think that equates about - it equates to about $30 million. There are some zero based accounts too that we just cleaned up, so some of that’s already out of our run rate, so I would say up to say 20, it’s not a big number up to 20.

Jared Shaw

Okay. And that in going forward we should be done with that at this point?

James Smith

I think there will be some minimal stuff going into Q3.

Jared Shaw

Okay. And then just finally looking at the business banking growth and talking about the fast track closings, where do the - what do you look at as the opportunity for that business and is it based on just rolling it out to all your geographies or is that more of penetration of the existing customer base throughout the geographies?

Glenn MacInnes

I think it’s across our geography base because in business banking Jared we essentially underwrite everything, so it really just pushing more volume through this new more efficient process.

James Smith

Yeah, it’s Jim, I just wanted to say, so right now it’s about 50% of transactions under a 100,000, we’d like that to be 80% or 90% and we want to get it fully automated and then we want to more to 250. And eventually this is how we are going to originate business banking loans and consumer loans.

Jared Shaw

Great, thank you very much.

Joseph Savage

Hey, Jared, just a point of clarification when we talk about the true-up for 700,000, I want to make sure you understand that for the most part those balances have already [left] [ph], and so you won’t expect to see a reduction quarter-over-quarter as a result of that. And if we had a $700,000 true up, you can pretty much apply 4.5% to that to get to 31 million but those balances - my point is those balance have previously left, so they are out of the run rate.

Jared Shaw

Got it, great, thank you.

Operator

Our next question comes from the line of Steven Alexopoulos with JP Morgan. Please proceed with your question.

Steven Alexopoulos

Hey good morning, everybody.

James Smith

Good morning, Steve.

Glenn MacInnes

Good morning.

Steven Alexopoulos

I wanted to start on the margin maybe for Glenn, beyond the flat to down 2 basis point guidance that you just gave us for next quarter, is it your expectation for the margin to continue to decline beyond 3Q ‘16 given what the curve has done recently?

Glenn MacInnes

Yeah, but at a lower rate, we don’t expect as I indicated rates to go up until the first quarter ‘17 even on the long end. So I think you know it will flatten now but our projection is up to 1 or 2 basis points a quarter.

Steven Alexopoulos

Up 1 to 2 basis points a quarter?

Glenn MacInnes

I mean up - down.

Steven Alexopoulos

Oh, up to in terms of pressure.

Glenn MacInnes

Right, yeah.

Steven Alexopoulos

Okay. And then - thank you Glenn. I just want to shift gears to the commercial which is still very strong driver of loan growth, can you just give some color, what’s driving the strong originations and when you talk about the loan pipeline which is up considerably?

John Ciulla

Yeah sure Steve. It’s John. I mean it really was a terrific quarter and I think you know we are seeing strength interestingly in this quarter across all of our business units and all of our geographies, it’s not a reliance on commercial real estate, we had very strong middle market originations both in our regional middle market group across geographies and in the sponsoring segment area that you guys have heard me speak to before in our specialty areas. We were up in ABL. We had good momentum in equipment finance. So I think it’s really just our model, it’s the people we have and kind of consistent execution. We’ve talked about some of the key hires we made in our sponsor and specialty areas and we’ve hired some folks over from GE and we’re really getting great, great traction across all of our business lines.

Steven Alexopoulos

Okay, that’s helpful. Maybe one final one for Chad. Good growth in HSA in terms of number of accounts and deposits. Can you talk about where you are seeing as you compete for business here going into the back half of the year and then particularly heading into the peak season? Thanks.

Chad Wilkins

Yeah, thanks Steve. We are as I mentioned in the first quarter where we’ve been staffing up on the sales side increasing about 50%, so we’ve got - we’ve had two or three we added last month and we’ve got two to three additional sales reps we’re looking to hire between now and the end of August to get us in position for kind of the mid market sales season and the fall.

I think there has been a lot of activities that have been focused on marketing and sales throughout the beginning of the year. We hit ten trade shows which is a record for us year-to-date. We also have a 20 city tour where we’re going out with a well-known person in the industry who is talking about regulatory affairs and compliance. And so we are hitting 20 cities inviting all of our partners and prospective partners and that’s going very well.

So I think we’re seeing a lot more activity you know and if you look at between the end of last year and through the second quarter, we’ve added about a little over 4,000 employers and 437,000 accounts which is so the results have been good year-to-date.

The other thing I’d mention is that you know we’ve had some good success selling our other product capabilities to our existing partner, so part of the work that we’ve been focused on in the second quarter and going into the third is deepening our integration with those partners and also extending amount to these - to the new product offering.

So we’re feeling we are starting to hit on all cylinders as evidenced by the 25% growth year-to-date when you take out the impact of the transition agreement attrition.

Steven Alexopoulos

Great, thanks for the color guys.

James Smith

Thanks, Steve.

Glenn MacInnes

Thanks, Steve.

Operator

Our next question comes from the line of Bob Ramsey with FBR Capital Markets. Please proceed with your question.

Bob Ramsey

Hey, good morning, guys.

James Smith

Hey Bob.

Bob Ramsey

Maybe you could touch a little bit more on the fast track program, I know you said you are doing half of our loans under 100,000, what is that volume, I am just curious how much business there is there, sort of what the typical purposes and there is underwriting differ at all through this channel then you know what would be done in a more traditional way?

James Smith

That $7 million of volume and a lot of it’s coming through the banking centers. So as you can imagine what we’re trying to do is shorten the time from application to ultimate funding. We basically take you know working alongside our credit risk partners, we basically take what we believe to be our key credit underwriting metrics and we try and we’ve not yet automated the process but we have automated, we have - excuse me, we basically build up the process to quickly decision without having to do full underwriting on all the element.

So out of that $90 million of total volume in the footprint, $7 million right now is going through that process. And as Jim said, the key for us is to continue to evolve that process but also increase the dollar limits of loans that go through that process and continue to automate to be even more efficient in the originations.

Bob Ramsey

Great. And is the obliviously I know you said the goal is to show that process in time, is that sort of to become efficient, is it a cost benefit or is it a service benefit that obviously the borrow relax the faster process or do this enable you to process more volume, I am just trying to get a sense of what the ultimate outcome could be?

James Smith

Yeah, it’s a combination but primarily from a customer, you know obviously you read a lot of the Fintex and what’s being offered in the marketplace. We obviously want to stay competitive, we want to make we disciplined from a credit perspective. But if you have non-bank competitors and other banks who have automated processes and they can shorten the turnaround time significantly, we need to be competitive there.

So we’re going to have you know higher yields, shorter turn time and a much more efficient cost structure in delivering the product.

Glenn MacInnes

Hey Bob, I think I want to explain, I just add to that. It does reduce on a static basis in compensation expense because you are reducing the touch points and the referrals and the kick outs of all the applications. But what we’re seeing is the volume is more than offsetting that right now. So it’s a win.

James Smith

Because it also reduces fall out, so it works in so many ways.

Bob Ramsey

Okay, great, that’s helpful. Thank you.

Operator

Our next question comes from the line of Casey Haire with Jefferies. Please proceed with your question.

Casey Haire

Hey, good morning, guys, thanks. Question on the efficiency ratio guide, if I heard you correctly Glenn, I think you said 62% in the back half of the year, within NII up and fees flat, so that presumes, that implies a decent amount of expense pressure, where is that coming from and why, I presumably given that you could have some more leverage coming from the Boston expansion as you did this quarter?

Glenn MacInnes

Yeah, when you are saying expense pressure, here is a way we look at it. Obviously it’s a challenging rate environment. You know we put that 60% target out there. We think we’ll be at 52 all in for the third quarter and we continue to work it. So I think if you look at it, there is certainly pressure on the expense line but some of the positive factors offsetting that as you indicated will be Boston coming more online, continued loan growth as John has highlighted, we feel really good about, we feel good about the pipeline and then focus on fees and you saw that evident in the second quarter. So we’re starting to get some real attraction on fees.

And then the rest is all up to prudent expense management which were as you know from history, we’re always rationalizing our branch network and we’re always rationalizing our cost channels. So that’s about everything we can do.

James Smith

And I think it’s key to know which you did Glenn that the 62 which includes Boston, Boston is around 2 points it is.

Glenn MacInnes

So I hope I answered you.

Casey Haire

Yeah, well I mean I am just - I mean because we’re at 61.5 this quarter, so we’re going higher next quarter despite revenues going up, so you are basically outlining a negative operating leverage quarter with good growth dynamics. I am just trying to understand where the expenses are?

Glenn MacInnes

It’s the timing of our investments and as I indicated in the comment, strategic investments. I mean there is going to be some lumpiness which used to be opportunistic about when we have an opportunity to bring people in whether it’s on the commercial side or whether it’s on the HSA side or the community side. So there’s some - there will always be some plus and minuses there, it’s not a linear equation get down to 60.

Casey Haire

Okay, got you. And just the Boston expansion causing 200 basis points of efficiency ratio, where can that, I mean how much of leverage is there from that once that sort of from today’s current run rate?

Glenn MacInnes

I think you know if you look at the guidance we gave, you kwon we expect that Boston will continue to contribute, it’s - that the high point was in the first quarter, expenses will be relatively flat but you’ll start to see revenue, start to offset it. And we’ve give guidance about our expectation for breakeven the rate environment, they put a little pressure on that, but we still feel pretty good about where we are in Boston.

Casey Haire

Okay, alright. And then just switching to HSA, Glenn maybe Chad as well, you know the footings and the account growth is seems to be pretty robust, the PPNR does seem a little bit behind your schedule at 1.5% year-over-year, is there, what sort of - is there anything that you can point to that sort of you know muting that progress?

Glenn MacInnes

Yeah, I can - there is actually a few items, one is that I think as Jim indicated in his comments, we made a decision here from a funds transfer pricing standpoint to be reduced in the first quarter about by about 20 basis points, the funds transfer credit that the HSA business is getting, that’s worth about a 1.9 million. And so if you just take that factor on an apples-to-apples basis last year versus this year, the PPNR would have increased 17%, that’s the first thing.

And we did that because we are conservative and because we really want to build a history before we start assigning a longer duration to these deposits. But when I stand back and I look at the business, I am looking at the three year planning horizon and Chad and team have done a tremendous amount of work on this. This is still a business at the top of the house on a consolidate segment that will do you know somewhere around 30% PPNR over the next couple of years.

The other point that Jim bought up is that we were doubling down on the investment in this business. So the expenses are higher than we had originally anticipated say a year ago because we are seeing more opportunity and more opportunity bring new clients. We think that’s the right thing to do. So you have a multiple few factors that are driving this right now, but I think you’ll begin to see the operating leverage in this business accelerate as we begin 2017.

Casey Haire

Okay, understood. Just last question, the reinvestment yield today in the third quarter was raised; it was 299 last quarter. Where are you guys reinvesting today in the shape of this yield curve?

Glenn MacInnes

240.

Casey Haire

240. Okay, thank you.

Glenn MacInnes

Thank you.

Operator

Our next question comes from the line of Steve Moss with Evercore ISI. Please proceed with your question.

Steve Moss

Good morning.

James Smith

Good morning, Steve.

Steve Moss

Following-up on Casey’s question, just given the challenging rate environment, when do you believe you can get back below 60% efficiency ratio?

James Smith

You know it is a challenging rate environment. We’re still targeting to do what we can by the end of the fourth quarter and there is pressure on it that’s what I was trying to convey. But we’re pulling all the levers we can whether it’s loan growth, whether it’s you know our focus on fees, whether it’s bring the Boston up to speed. But as I indicate you know we look at all our entire expense base. So we saw but we’re not going to hit the ratio for quarter only to forgo potential revenue opportunities so given revenue opportunities in the next couple of quarters. So it’s a matter of managing our opportunistic investment and taking advantage of today and then for future revenue.

So it’s a challenge but we’re still targeting toward the end of the year to come as close as we can to 60.

Steve Moss

Okay. And then changing to commercial banking loan yields, you know there’ve generally been heading higher ignoring the rate hike in the fourth quarter. I am wondering you know what is supporting that yield and pushing that yield a bit higher, what loan type?

James Smith

For us it’s a combination of stabilization of yields in the marketplace from a competitive perspective on credit spreads, but also mix of what we’re originating. So as we mentioned this quarter we had a significant originations and loan volume in our middle market segment and sponsor business which tends to have a higher yield. So I would say mix is a first driver and secondarily some stabilization in terms of overall pricing in the marketplace.

Steve Moss

Okay. And then the mid-market clients that you are capturing are those clients coming from large banks or regional competitors?

James Smith

It’s a great question. I think it’s a combination, so you know as I said we do a good deep dive every quarter on where our originations are coming from geographically from a competitive perspective whether or not it’s stealing market share or whether not it’s just expansion in new transactions in the market. And I really couldn’t characterize it is coming from any one place I think in commercial real estate and in our middle market sponsor and segment group, it tends to be transactions that are competitive in the marketplace not direct steals from competitors, in the areas like business banking and in the regional middle market where we may be competing with the bank for their business. I think I would say it’s coming from a combination of larger banks and our regional peers.

Joseph Savage

Hey Steve, this is Joe Savage. Perhaps and push it sometimes in the question with respecting steering share is you are either giving up on pricing and structure. And the answer with respect to both of those is in unequivocal no, we have S&P come in annually and they look at us, they compare us to peer institutions and I’ve got John to my right, he is probably more studied on as am IM but every time I’d looked at the analytics, we are at or above our peers when it comes to pricing for risk and pricing in these market.

So if we are going to take a deal, we are going to take a deal, because we did it smartly or they want to work with our people or because we’ve attracted talented people to our franchise, it’s not because we’re buying any business. So we just really want to make that, there is real discipline in shop.

James Smith

Yes, Steve to put a final point on that, the information we get in terms of as we are pricing every loan against ROA rock model, that ROA rock model is informed by what S&P tell us by asset class, by geography, by size of loan and what we should be doing with respect to spread a non-usage fees, upfront fees, amendment fees. So - and we continue to make sure we are managing that at or above the market.

Steve Moss

Great, thank you very much.

Operator

Our next question comes from of Collyn Gilbert with KBW. Please proceed with your question.

Collyn Gilbert

Thanks. Good morning, guys.

James Smith

Good morning, Collyn.

Collyn Gilbert

Just maybe Chad going back or starting off on the HSA side, so the growth was little bit slower this quarter, are you still - do you still feel good about kind of being able to track it industry growth rates in that 20% to 25% in terms of deposits?

James Smith

Yeah, I do Collyn. I think when we look at the impact of the clawback agreement the balance is that left is part of that, you know we are at that right around that 20% growth rate and I anticipate that that to continue to improve as we work on our sales and distribution efforts going into ‘17 and ‘18. So yeah we feel good about that. And plus if you look at the account growth rate, again netting for the attrition of the purchased accounts, we are at 25%. So those are newer accounts, so we have a larger - you know the last two years we’ve add about lot of more new accounts than we ever have. So those take a little while to get the traction going.

Collyn Gilbert

Okay that’s helpful. And then Glenn just going back to your comment on changing the sort of your transfer pricing credit within HSA, so that was all on the funding side, because I know yeah like linked quarter if we back into it, it looks like the net interesting come from HSA dropped about 3 million, so was it - this is a change in the investment yield assumption, this is all on the funding side?

Glenn MacInnes

Yeah, it’s on our funds transfer pricing which is really the credit we give to the HSA business for providing the funds to fund those businesses that are generating assets.

James Smith

But it wasn’t a material linked quarter.

Glenn MacInnes

Yeah, it wasn’t material linked quarter, it was more material year-over-year.

Collyn Gilbert

Okay.

Glenn MacInnes

But was material linked quarter was the net reduction in the HSA clawback provision. So in the first quarter we had a clawback of 2.3 million and second quarter 700,000, so it’s 1.6 million and that’s reflected in non-interest income.

Collyn Gilbert

Okay, and I was looking at the net interest income had like $3 million drop.

Glenn MacInnes

Quarter-over-quarter?

Collyn Gilbert

Yeah. If I am backing into it correctly.

Glenn MacInnes

No. I am showing net interest income being flat.

Collyn Gilbert

Okay, right, I’ll double check that.

Glenn MacInnes

So I can circle that with you on afterwards.

Collyn Gilbert

Okay. Okay. Okay and then just in terms of - you know so it sounds like that the outlook here for HSA at least in the back half of the year is going to be kind of you know accelerated expense growth or flat expense growth and I think that’s differs from you know the thought that once you guys kind of on-boarded on the platforms that we start to see some expense reduction. And I hear what you are saying you know you are seeing opportunities, is there - is this industry and I guess this question really is for you Chad, I mean are you finding or collectively that the HSA business it just moving at a much faster phase then perhaps what you anticipated it to be and I know you are saying you are seeing opportunities but I am just trying to you know as a pretty quick you know as you said like you know it was in a year sort of the outlook is changing. So I am just trying to understand sort of the speed at which this business is moving and how you need to respond or how quickly you feel like you need to sort of keep up if there is a part add to this?

Chad Wilkins

Yeah, I think well there is a combination Collyn, I think there is the speed of the industry and then there is a speed of us right. There the pace of here is probably a lot, more accelerate than the industry, because if you look at the - there is three things that I would call out, one is the TSA contract that covered processing and servicing for all of the account, so really managing everything. So we’ve had to staff up and train and get all the process in place to handle essentially 4,800 employers and 850.000 accounts that came over between the end of the third quarter and the first quarter of last year. In addition we’ve added about 4,000 employers and 437,000 accounts of our own between the end of fourth quarter and the end of the second quarter. So tremendous amount of growth all coming on to a relatively new platform.

So you know there were a lot of efficiency gains that we thought we’d get when we moved over to our operations. However the volume and the change have made the volumes the staffing needs what higher as we went to the first quarter and well into the second. That’s pushed off some other work that we had teed up to a focus on operational efficiency and customer experience, so initiatives are in flight and they are really geared towards making sure that we are set for 1:1:17 and are much more efficient as we go into 1:1:17 which obviously impacts our resource needs as we go into ‘17 and ‘18 and we think it’s going to be much lower than what we’ve seen kind of last year. And additionally we’re not going to be migrating accounts as we go through that 1:1 hurdle next year, so that’s going to have an impact too.

And last point I make is that we are seeing a lot of opportunity out there. You know the reason we went to this platform and we have additional products as a cross sell to our existing customers and capture new and we are having success there and that’s requiring as the build out integrations and work on that. So the good news is that the two things we are focused on our efficiency and growth then we are having good success on both on those fronts, the bad news is it’s requiring as you a higher expense structure as we go through the end of year. But those two combine as we start to get more and more attraction as we go throughout the year, that turns into positive PPNR growth going forward. So I think it’s a good story at the end of the day.

Collyn Gilbert

Okay. Okay, that’s very helpful. Thank you. And then Glenn just a question on the securities book, I know you’d indicated 240, it’s kind of where you are buying you know the new purchases are coming on, any changes on how you are going to manage up going forward or the size of it or just sort of wanting to understating how you are thinking about that in this perhaps prolonged lower rate environment?

Glenn MacInnes

No, no significant changes, the size will be on an absolute dollar basis, will be about the same but it’s relative percent on earning assets will obviously come down as we grow to lumber but pretty much the same on that.

Collyn Gilbert

Okay. Okay, I’ll leave it there, thanks guys.

James Smith

Thanks Collyn.

Glenn MacInnes

Thank you.

Operator

Our next question comes from the line of Matthew Breese with Piper Jaffray. Please proceed with your question.

Matthew Breese

Good morning, guys.

James Smith

Good morning, Matt.

Glenn MacInnes

Good morning, Matt.

Matthew Breese

I was just hoping, I mean maybe we could just talk about the expense outlook for the back half of 2016, what is the overall absolute amount of expenses you are looking for that drives the 62% efficiency ratio?

Glenn MacInnes

We’re only going to give guidance on our target for efficiency ratio. Again I pursue my point that will invest, we’re managing this business from an operating leverage standpoint and looking at investment opportunities as they come along. So I don’t want to be locked into an absolute dollar amount.

Matthew Breese

Okay. And then in terms of the Boston efforts, where are we in terms of breakeven and what are the key metrics which we looking for that they get you to breakeven in terms of loans and deposit balances?

Glenn MacInnes

Yeah, so I think from a breakeven standpoint, we have targeted mid-2017. Obviously the rate environment has an adverse impact on that. We continue to monitor that but there was pressure might push it out a little bit. So that’s one factor. From a breakeven standpoint, I think our - you know we’re really looking at deposits and loans.

John Ciulla

This is John. I mean I think right now Glenn said it right, with a change in the interest rate outlook, we may be looking at slightly further out in our mid-’17 target but in terms of what we are measuring right now in Boston as with referenced earlier, I think we’re pretty pleased, we’re ahead on accounts, we’re ahead on deposits. The amount of activity across all the business lines which would include business banking, private banking and commercial banking has accelerated significantly in terms of opportunities for bank it work for private banking referrals.

So I think we are seeing everything we thought would see from a halo effect and from an activity perspective and we’re getting more looks across every business line. And so the question is now just converting the economics and with the interest rate headwinds how quickly we’ll be able to get to that breakeven point.

James Smith

Yeah, this is Jim. I just wanted to say that over than the spread pressure, we are good. And we had given a census to what we might achieve and by when and we’re good on that expect that the interest rate environment has changed materially since then. Deposits are much higher than original plan in terms of number of accounts. We are very pleased with the progress we made in terms of brand awareness in the market, we really like being there and if anything we think it’s even more compelling in opportunity then we did six months ago.

Matthew Breese

Okay. And then given obviously the more challenging industry environment, does that change any other corporate strategies including M&A or other avenues you might go down to increase fee income, anything like that?

James Smith

I think you have to choose even more carefully when the margins get thinner. And I think that’s something we done well as that we have invested in strategies that can create value for customers as well as for shareholder. So I think all that we’ve done over the last several years puts in very good shape to be able to continue to improve our organic growth in the businesses that we know best. So we’re pleased with that. You know frankly M&A just as not that attractive to us on the bank side, because we got an opportunity to improve ourselves and win competitively in the market rather than take on a similar set of problems that we are trying to solve ourselves. So we see possible - you know if there M&A opportunity within a segment let’s say that would help to advance the strategies that we believe in, that would be one thing but not likely we’re going to be actively involved in M&A on the bank side.

Matthew Breese

Got it, that’s all I had, thank you.

Operator

Thank you. Mr. Smith, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

James Smith

Thank you, Christine, and thank you all for joining us today. Have a good day.

Operator

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