Webster Financial's (WBS) CEO James Smith on Q4 2016 Results - Earnings Call Transcript

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Webster Financial Corporation (NYSE:WBS) Q4 2016 Earnings Conference Call January 19, 2017 9:00 AM ET

Executives

James Smith - Chairman and Chief Executive Officer

John Ciulla - President of Webster Financial Corporation and Webster Bank

Glenn MacInnes - Executive Vice President and Chief Financial Officer of Webster Financial Corporation and Webster Bank

Chad Wilkins - Head of HSA Bank

Analysts

Steven Alexopoulos - JPMorgan Chase & Co.

Jared Shaw - Wells Fargo Securities

Collyn Gilbert - Keefe, Bruyette & Woods, Inc.

David Rochester - Deutsche Bank

Edward Beachley - FBR Capital Markets & Co.

Casey Haire - Jefferies LLC

Mark Fitzgibbon - Sandler O’Neill and Partners

Matthew Breese - Piper Jaffray

Matthew Keating - Barclays Investment Bank

Operator

Good morning, and welcome to Webster Financial Corporation Fourth 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 statement.

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

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

James Smith

Thank you, Audrey, and good morning, everyone. Thanks for joining Webster’s fourth quarter 2016 earnings call. President, John Ciulla; CFO, Glenn MacInnes; and I will review the quarter. And then Executive Vice Chairman, Joe Savage and HSA Bank Head, Chad Wilkins, will join us to take questions.

Beginning on Slide 2, Q4 was an extraordinary quarter in many respects. Record quarterly loan originations were driven by the 18th consecutive quarter of year-over-year double-digit commercial loan growth, coupled with an uptick in the net interest margin. Year-over-year revenue grew 10%, 29th straight quarter of year-over-year revenue growth.

Credit metrics remain strong, including the lowest level of net charge-offs in nearly a decade. Record revenue of $256 million, resulted in diluted EPS of $0.60. Return on tangible common equity of 12.3% and return on common shareholders’ equity of 9.2%. The quarter benefitted from a one-time gain on sale of $7.3 million, which Glenn will describe in more detail.

I want to spend a minute discussing our strategic management framework. We invest in strategies that maximize value for customers and shareholders. We allocate capital and resources, and prioritize projects accordingly, while managing expenses with vigilance to achieve top quartile efficiency.

I’ve noted in recent quarterly calls and investor presentations that we got a couple of terrific differentiated businesses, with strategies that have high economic profit potential, namely HSA Bank and Commercial Banking. And the Boston expansion qualifies as having high EP potential as well.

We are committed to investing in those businesses when the opportunity is right, and that means now, rather than phasing investments over time simply for the sake of protecting the efficiency ratio in a given quarter. This will create some variability in period expenses, as it did in Q4, but in the intermediate term will drive the efficiency ratio sustainably lower and economic profit sustainably higher.

Even as we invest in our future I can assure you of one thing, we will never lose our expense discipline. It’s embedded in our DNA.

HSA Bank is Exhibit A. Elevated Q4 expenses reflect the fact that HSA Bank is our highest strategic priority and with good reason. It has the potential to generate more economic profit than any other business by far. We continually invest in Evolution1, our industry-leading scalable technology platform.

We’ve accelerated the expansion of the sales force and client services teams, and the introduction of 24/7 service. We rolled out our live online chat to member and employer portals to streamline and enhance the customer experience. We’ve augmented staffing earlier and to a greater degree than usual, to smoothly handle the welcomed tsunami of new member activity during enrollment season. And this is reflected in improving service levels and quality.

We’re also investing in more sophisticated data analytics, boosting marketing investment and fast tracking the priority enhancements on our product roadmap. More investments sooner to maximize the extraordinary opportunity HSA Bank presents to increase shareholder value.

Our obsession with the HSA business, and crucially, our commitment to invest in it, have enabled rapid growth and transformation. One proof-point of the early pay-off can be seen in the 660,000 new accounts opened by HSA Bank in 2016 that almost equaled the 691,000 total accounts that existed at year-end 2014.

It’s helpful to remember that this business is still in the land-grab stage as the market leaders scoop up as many health partners, large employers and members as we can. The true pay-off is down the line as accounts our on-boarded in season. To underscore that point, 55% of our accounts at year-end had vintages of less than two years. That’s over 1 million accounts with average balances of approximately $1,200, whereas accounts with vintages longer than five years have average balances of about $6,500.

We estimate that the newer accounts generate net revenue per account of only 40% of the longer vintage accounts. Further to that point, we expect to open over 400,000 accounts during the Q1 enrollment season.

Think of the seasoning value, and the impact on revenue growth and unit profitability down the line. And there is more, because the full story of consumer directed health-plans and potential explosive growth in HSAs as, yet to be told. The ongoing 20% compounded annual growth rate and puttings [ph] confidently predicted by Devenir and other experts, could increase significantly given the recent national election results and the increasingly likely reform of the Affordable Care Act.

And while no action has been taken, it’s possible that eligibility for HSAs could expand by multiples of previous expectations, perhaps even including Medicare and Medicaid enrollees. And contribution limits could potentially double. Hundreds of millions of Americans may ultimately qualify for HSA plans versus the 18 million who had them as of mid-year 2016, according to Devenir’s mid-year report.

As the leading bank administrator in this space, we have the technology, service platform, scale and expertise to capture a significant share of the market. HSA Bank is poised to fulfill its mission to lower the cost of healthcare, while improving access and quality. And that puts Webster on the launch pad to extraordinarily high performance.

Given the high level of interest in this business, we’re planning another HSA Bank Investor Day later this year. Moving briefly to Commercial Banking, this line of business has performed beautifully and is leading the way in generating economic profit. I commend EVP, Chris Motl, on his recent promotion to lead all of Commercial Banking. Chris has worked closely with John Ciulla and Joe Savage for a dozen years and will oversee the exciting expansion of this business.

It’s remarkable the difference an election can make in the economic outcome. Nearly all of the forecasted policy changes in a Trump administration supported by a Republican Congress appear to be positive for our business and our company. From investment in infrastructure to less regulation, spurring faster economic growth, job growth and loan market in middle market businesses and likely higher interest rates.

If proven true, the overall effect should speed the timeline for us to earn in excess of our cost to capital. I’ll now turn it over to John Ciulla to report further on the quarter.

John Ciulla

Thanks, Jim. Good morning, everyone. I’ll begin on Slide 3. You can see the five-year annual trend for loans and deposits, which underscores Webster’s balance sheet growth and transformation. Loans have grown by $5.8 billion or 9% compounded annually since the end of 2011.

Commercial loans have led the way with a 14% compounded annual growth rate and now comprise 59% of total loans compared to 47% just five years ago. This shift in loan mix has favorably altered our asset liability profile, as floating rate and periodically adjusting loans now represent 69% of total loans compared to 63% five years ago.

Deposits have grown by $5.6 billion or 7% compounded annually in the same period. All of this growth has been in transactional and HSA accounts, which now represent 57% of total assets compared to 37% five years ago. Given the strength of our deposit profile, our loan to deposit ratio remains favorable at 88%, even with strong loan growth over the period.

Turning to Slide 4, loans and deposits each grew $1.3 billion over the past year, demonstrating our clear ability to internally fund our loan growth through transaction and HSA deposit.

Slide 5 shows our revenue, expense and PPNR growth over the past five years, resulting in an 8% compound PPNR growth over the period. In 2016, higher expenses were primarily driven by Boston expansion expenses of approximately $22 million, and continued investment in HSA Bank representing a $16 million increase in 2016 expenses.

Slide 6 shows growth in net interest income and noninterest income, reflecting revenue growth in all lines of business led by double-digit revenue growth in Commercial Banking, overall PPNR grew 5% year-over-year.

I’ll now turn to line of business performance beginning on Slide 7.

Commercial Banking continued to deliver strong results, reporting loan growth of 4% in the quarter and 13% year-over-year. Deposits grew nearly 10% when compared to last year. And overall, Commercial Banking activities resulted in 12% and 16% revenue and PPNR growth respectively when compared to the prior year.

For the full year 2016 in the Commercial Bank, noninterest income grew by 26% over 2015, driven by swap fees, syndication and other loan fees, and a 9% growth in cash management fees. The commercial loan portfolio yield increased to 10 basis points linked quarter and 25 basis points year-over-year. The quarterly increase primarily reflects higher LIBOR rates and higher fee activity, including FASB acceleration due to prepay mix. And asset quality metrics in Commercial Banking remained solid and at cycle lows.

Turning to Slide 8 for HSA Bank, as Jim mentioned earlier, our commitment to accelerate strategic investments in a rapidly grown HSA Bank was reflected by record new account acquisition including 98,000 new accounts acquired in the fourth quarter. Deposits in the fourth quarter grew 15% year-over-year, while the number of accounts grew 19%.

Adjusting for the anticipated attrition related to the JPM HSA transaction in the prior year, year-over-year deposits grew over 20%, and accounts increased 27%, both in line with growth expectation. HSA Bank’s success in 2016 can in part be attributed to an intensified focus on the carrier and larger employer segments.

59% of total new account volume in 2016 came from these segments compared to just 48% in the prior year. As we look ahead to the first quarter of 2017, we remain confident that account growth will accelerate and exceed the 335,000 new accounts produced in Q1 2016 by more than 20%.

January to date, we have opened 295,000 accounts which represents more than 70% of our Q1 2017 target. While HSA Bank revenue was up modestly for the linked quarter and 13% year-over-year. PPNR growth was slower due to expenses and investments related to operational excellence, the customer experience and service delivery, as Jim detailed in his remarks, and in preparation for this year’s enrollment period.

Enhancements related to these investments have been well received by our partners, employers and members, leading to a smooth employer onboarding and member enrollment season to date.

Moving to Community Banking on Slide 9, which reflects another strong quarter in business banking, deposit balances were up 9% year-over-year, driven by an 8% growth in transaction deposits. Loan balances were up 11%, driven by record loan originations. Business Banking continues as an important net funding source for the bank as deposits continue to exceed funded loans in the segment.

Slide 10 highlights growth in the year-over-year loan and deposit balances for Personal Banking. Portfolio loan balances were up $168 million or 3% year-over-year with another $132 million in mortgages originated for sale in the quarter. Total deposits and transaction deposits were up 4% and 5% respectively year-over-year, premier checking accounts have grown by 16% over last year, reflecting the ongoing progress in acquiring high-value customers, as we continue to leverage our best-in-class net promoter scores.

We continue to build momentum in our strategically compelling Boston initiative, as activity grows across all our lines of businesses in that market. While deposit and loan balance growth has been slower than originally anticipated, we recently crossed the $200 million mark in banking centered de novo deposit balances. The number of new consumer DDA accounts opened has met expectations and our loan pipelines are expanding.

As announced earlier this week, we are consolidating eight banking centers during the second quarter. This is part of Webster’s long-term banking center optimization program that began in 2011, including the 17 new banking centers that opened in Greater Boston in early 2016. We are purposefully balancing our physical presence with the fast-growing customer preference for digital banking.

Our investments in mobile and online banking coincide with our customers’ increasing use of these channels, enabling us to reduce our physical footprint. In fact, Webster’s overall banking center teller transactions have declined almost 40% from 2010 to 2016. In addition, 47% of Webster’s checking account households are now served by mobile banking and self-service deposits now represent 40% of all deposits.

Community Banking continues to improve the digital experience as reflected in a 16% year-over-year increase in active mobile banking users and 6% increase in active online subscribers. We’re confidently pursuing the transformational strategic roadmap that we’ve been talking about for the last few years, and it’s what is necessary in order that Community Banking earn its cost of capital.

Slide 11 highlights results for Webster private bank, year-over-year revenue increased 9%, primarily driven by strong loan growth and steady AUM performance. Our private bankers are focused on serving the core banking, lending, asset management trust and financial planning needs of Webster customers, namely the owners, executives of our commercial and business banking client as well as high net-worth families and individuals in our community bank.

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

Glenn MacInnes

Thanks, John, and good morning, everyone. Slide 12 provides the backdrop of our ongoing business momentum, including our key highlights of the quarter’s performance with comparative data for the four prior quarters. Starting at the top, continued growth in earning assets combined with an increase in net interest margin with a record net interest income. 1 basis point increase in NIM, reflects an 8% basis point increase in the commercial loan yield and flat deposit costs, partially offset by a lower investment portfolio yield.

Non-interest income increased by $4.2 million, driven by $7.3 million one-time gain on the sale of an asset. The gain was partially offset by lower commercial and consumer fee revenue. The majority of the expense increase quarter-over-quarter is in the deferred compensation due to the impact of the strong performance of Webster share price. Combined, we reported record pre-provision net revenue of $94 million. The lower quarter-over-quarter provision reflects the stable credit environment and lower charge-offs, somewhat offset by continued loan growth.

Our coverage ratio increased to 114 basis points, up from 113 in prior quarter and 112 in prior year. Reported pre-tax income was $81.5 million and our reported net income of $57.7 million benefitted from the favorable tax treatment of the previously mentioned one-time gain, as we were able to recognize a portion of our tax loss carry forward. As a result our effective tax rate was 29.3% in the quarter. Absent the one-time gain, our tax rate would have been around 32%.

Slide 13 highlights our average balance sheet and drivers of net interest margin. Growth in average interest earning assets was driven by higher yield in commercial loans and an increase in the securities portfolio. LIBOR and prime rate increases contributed to a 4 basis point increase in loan yield, the loan yield improvement more than offset a 6 basis point decrease on securities. Average deposits were relatively flat to Q3 with no change in the overall cost.

Growth in HSA and savings balances offset the seasonal decline in government deposits. Average borrowings increased $525 million, funding the majority of our interest earning asset growth in the quarter. Most of the increase in borrowings was in short-term FHLB advances at around 55 basis points.

We expect to pay down borrowings in Q1 from seasonal deposit strength in both HSA and the government banking. Combined, our cost of interest bearing liabilities was flat to Q3. Our Municipal bond portfolio and tax exempt commercial lending contributed to an increase in our tax equivalent adjustment. The net impact on the combination of interest earning assets and liabilities was a 1 basis point improvement in net-interest margin.

To summarize, interest earning asset growth, along with higher commercial loan portfolio yield and no change in the cost of liabilities resulted in a quarter-over-quarter increase in net interest income of $5.1 million.

Slide 14 details our non-interest income, which increased $4.2 million from Q3. The increase was primarily driven by the $7.3 million gain mentioned early, which is reflected in other income highlighted in grey. Other income also benefited from client hedging activity, increasing $1.2 million quarter-over-quarter.

Loan related fees highlighted in dark green declined $3.3 million from Q3’s record level of syndication fees. And mortgage banking revenue, highlighted in brown, declined $1 million due to lower settlement volume’s spreads.

Slide 15 highlights our non-interest expense strength. The increase in compensation benefits is primarily attributable to the $2.8 million linked-quarter increase in variable compensation tied to Webster’s higher share price in Q4 as well as $1.6 million seasonally higher medical cost. The increase in occupancy expense was driven by a one-time $1.2 million charge as a result of corporate facilities optimization. And as John highlighted, we have announced banking center optimization actions, which we expect to be reflected in Q2’s results.

Slide 16 highlights our efficiency ratio trend. The results exclude the one-time gain on the sale of the asset previously mentioned, but do include expenses associated with the Boston expansion and the impact of Webster’s higher share price. Excluding these two items our ratio would be at 60% level.

Slide 17 highlights our key asset quality metrics. Nonperforming loans, in the upper left, increased $6 million, primarily in commercial loans, represents 79 basis points of the total. Past due loans in the upper right increased by $3 million and represent 25 basis points to the total loans.

Commercial classified loans, in the bottom left, increased by $5 million representing 3.3% of total loans and remain well below our five-year average of 4.4%. Net charge-offs totaled $6.1 million in the quarter for an annualized net charge off rate of 15 basis points. Loan loss coverage increased to 114 basis points in support of our loan growth and mix. In summary, our credit metrics remains strong and we maintain a positive core view on asset quality performance.

Slide 18 highlights our capital position. The tangible common equity ratio was 7.19% at year-end, down modestly from September 30. This was due to asset growth and a $24 million increase in unrealized losses in the AOCI driven by higher rates. Excluding the AOCI adjustment, TCE was up 1 basis point to 7.49%. And, our common equity tier 1 ratio was 10.51%, up slightly due to growth in retained earnings.

We continue our strategy to grow primarily with a 100% risk-weighted loans. Risk-weighted assets represented 72% of total tangible assets, compared to 71% a year ago.

Before turning it back to Jim, I have a few comments on our outlook for Q1.

We expect average interest earning assets to grow approximately 2%. We expect average loan growth to be in the range of approximately 1% to 2%. We expect NIM to increase around 6 basis points, driven by higher loan yields and lower securities amortization. As a result, we expect net-interest income to increase by around $5 million linked-quarter, despite having two fewer days than Q4.

Of course, the projected increase is subject to the overall interest rate environment. We expect provision to be in the range of Q3 and Q4’s provision, driven by loan growth and asset quality.

Non-interest income, excluding the one-time asset sale gain, is likely to be up modestly. We continue to manage our non-interest expense closely while opportunistically investing in talent and initiatives, as Jim highlighted. As such, we expect the efficiency ratio to be flat to somewhat lower to Q4’s level.

We expect our effective tax rate on a non-FTE basis should be around 30%. But for the full year we expect it to be in the range of 32% to 33%. And we expect our average diluted share count to be around 92 million shares.

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

James Smith

Thank you, Glenn. In summary, our solid strategic choices implemented efficiently are generating faster growth, higher profitability, and more capital and resources to invest in our promising future.

I’ll now open it up to questions.

Question-and-Answer Session

Operator

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Steven Alexopoulos with JPMorgan. Please proceed with your question.

Steven Alexopoulos

Hey, good morning, everybody.

James Smith

Good morning, Steve.

Glenn MacInnes

Good morning, Steve.

Steven Alexopoulos

Hi, I wanted to start on HSA Bank. How should we think about 2017 from an expense view? Is it another year of investing in that business or should we see stronger operating leverage this year?

James Smith

Steve, this is Jim. So I’m going to ask Chad to add if necessary to the comment that - I think we look at it that we make clear that we are in the investment stage in the business. And we have accelerated a lot of those investments into current periods. And we expect that may continue through the beginning of the year, but that we ought to start seeing a ramp in some unit efficiencies in 2017.

Steven Alexopoulos

Okay. That’s helpful. And maybe for Chad, of all the potential changes to this business onto the Trump administration, what do you see as potentially being the most impactful to Webster at this point?

Chad Wilkins

Yes, I think the - hi, Steve, by the way. Good to hear from you. I think the most impactful would be if some of the suggested changes around increasing the limits on HSA were enacted that would be obviously positive. And it’s also something that I think is, is doable in somewhat near-term. The other is the expansions of HSAs to other accounts, so allowing Medicare participants to be able to contribute to their HSAs and perhaps government program participants as well. So those could have great impacts just from a pure deposit standpoint.

When they talk about decoupling the HSA from high deductible health-plans and make them available more broadly, that obviously could have a huge impact on this industry. But that’s probably a little bit of a longer term, but you never know with all the houses in control. So I think that it’s just generally and the great exposure that we get in the market.

Steven Alexopoulos

Okay. Thank you. And I’m just totally shifting gears. The commercial bank continues to have good momentum. Should we read anything into the sharp drop in the pipeline of the fourth quarter? Do you expect this to have any applications for growth in 1Q?

John Ciulla

Steve, it’s John. Good morning. I don’t at all. If you look we’re about $10 million above last year’s 4Q. 4Q is usually seasonally the biggest origination quarter for us. So the pipeline is always naturally drained, but if you look - we have a pretty strong definition in terms of probability to close and dollar amount to put something into the pipeline. And I also measure and we can talk about the activity that’s going on, and I would tell you that the activity heading into 2017 looks favorable.

Steven Alexopoulos

Okay. That’s great. And maybe if I could sneak one more in, maybe for Glenn, I received quite a few questions this morning on the $3 million increase in stock-based compensation, given that many other banks also saw their stocks are pretty big in the quarter. Glenn, can you just walk through what drove such a big increase and how we should think about that run rate going forward? Thanks.

Glenn MacInnes

And so it is driven by the $16.27 increase in the stock price quarter-over-quarter, and what it is, Steve, is that we have some deferred comp plan that are tied to Webster shares. And so, as the shares appreciate the liabilities is adjusted and reflect the movement in the share price. For the most part, when you see comp plans they are all set in Rabbi Trust.

Given that this is Webster’s stock, we cannot build or hedge against it, and we’re not allowed to do that. So that’s why you see this, the volatility in that number. The number is up - at 2.8 quarter-over-quarter, so incrementally. And so, if you go back there is always an adjustment quarter-over-quarter but you see the steepness in Q3 to Q4.

James Smith

Just basically a couple of 100,000 shares.

Glenn MacInnes

Yes, this 200,000, use about - on average, say, 200,000 shares times the $16 movement in the stock price and that’s how you get it. And then you look at the quarter-over-quarter impact, you net those two out, that’s where they are.

Steven Alexopoulos

Okay. That’s helpful. Thanks for all the color, guys.

Glenn MacInnes

Sure.

James Smith

Steve, I just want to say to you that your knowledge of the HSA business and the depth of your research and analytics is extraordinary.

Steven Alexopoulos

Thanks, Jim.

Operator

Thank you. Our next 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.

John Ciulla

Good morning, Jared.

Jared Shaw

Just staying on the HSA for a minute, when you talk about the 295,000 accounts already opened this quarter, is that a gross number or is that the net of attrition?

John Ciulla

That’s the gross number here.

Jared Shaw

That’s gross. Should we expect attrition to be consistent with what we’ve seen in the past or is there, maybe, a bigger impact from last year that may not be repeated this year?

Chad Wilkins

Jared, this is Chad. Good morning. Yes, we should see it be consistent with past, with one caveat that won’t - last year we had the anomaly with the JPMorgan Chase transition related to clawback and that type of thing. And we don’t expect to see that kind of anomaly this year.

Jared Shaw

Okay. And then, Jim, you had spoken about the land grab in the HSA space and how we’re still on the early stages. When you look out at the group of carriers and TPAs and that the large employers that may not yet be on be on the high-deductible healthcare plan system yet. How far are we through that land grab? Would you say we’re still in the early innings or have we really got a lot of momentum going from the industry so far and that we are down to the end there?

James Smith

We would say we are probably in the middle innings and that a lot of the growth in the future will come from tapping into the potential members from the employers and health plans that will be signed up as the shift to consumer-directed healthcare continues. So there is very significant opportunity to still land new large employers as well as some carriers. And then, on top of that there may be an expansion in the eligibility for consumer-directed healthcare and HSA accounts that we expect will augment the opportunity significantly.

Jared Shaw

Okay, thanks. And then you’re shifting over to the Boston side, with the growth being a little less than you had initially expected, how much time are you giving yourself to evaluate those 17 locations, where maybe if there’s one or two that are not performing as much as you had initially expected or you could see some either relocation or consolidation of those 17 branches? Are you committed to giving it a few years to work out or could we see individual movement earlier?

James Smith

Jared, we still look at this as a broad marvelous opportunity. We’re not so much thinking of culling the 17. We actually think of being able to serve all of Greater Boston with only 17 offices, where you really wouldn’t have been able to do that few years ago. So there are some of the banking centers that aren’t strong as some others, and we’re taking a look at them. We’re going to have opportunities if we choose as leases mature to move to smaller locations or maybe even to move into locations in Boston where we’re not located now, where we might trade to smaller locations in a couple cases that would allow us to open a new location in an unreserved part of that market.

But basically we like the position that we have. We like the offices that we have. We don’t expect there is going to be significant impact there. To the extent actually that we have - and we’ve said in the past that some of the offices are pretty large. We’ve actually had some success in talking about subletting some of those offices, so that we can defray some of that expense and that should help us along the lines to earning economic profit.

I think most importantly that we have complete confidence that we will achieve our longer-range goals as stated as $1 billion in deposits over five years or so and $0.5 billion dollars in loans. This is a great opportunity for us to create value in that market.

Even though we came in a little light on the deposit side, as John indicated, we opened the same number of accounts that we thought. We got relationship development opportunities. This is a terrific market for us to be in.

Jared Shaw

Okay, thanks.

Operator

Thank you. Our next question comes from the line of Collyn Gilbert with KBW. Please proceed with your question.

Collyn Gilbert

Thanks. Good morning, gentlemen.

James Smith

Good morning, Collyn.

Collyn Gilbert

Just a follow-up on Jared’s question on Boston, John, is there anything you could point to, as to why you think kind of the growth has been slower than what you guys have originally projected coming out of that market? And are you repositioning the strategy at all or is there anything you guys are doing differently to try to accelerate sort of the production out of that part of the franchise?

John Ciulla

It’s a good question. I mean we - I think a couple things, externally very competitive market. When we entered the market a lot of our competitors were offering high interest rates on deposits and a lot of the offers were very competitive. So I think the economics out front were impacted by competition.

I would say, when you think about - we were able to take position of the former Citibank banking offices and open them up right away. But it took some time to make sure we had the right folks in the right places. I think about business banking as being a key part of the strategy. And we were really a couple of quarters behind in getting our full complement of business bankers in the market, and then obviously it takes some time to build momentum.

So I would say a combination of competition right out of the box and the impact that has in the economics, and then a little bit more time than we originally anticipated to make sure that we had the right people in the banking centers, and that we had our full complement of mortgage bankers and business bankers all set and ready to go. So we are starting to see the momentum now, Collyn.

Collyn Gilbert

Okay, okay.

James Smith

Collyn, Let me just add a little guidance there, if I could, that in the last call we said that discretion was the better part of valor. And that to John’s point that we’ve started with promos, but the market was on fire with promos. We decided that we would pull back. So to some degree we didn’t pull in the amount of deposits we would have from those promotional programs early on, because we decided to back off a little bit. More recently, we’ve gone in and selectively run lower level of promos, which we are finding we’re having some success with. So there are some levers for us to pull without negatively impacting the results there.

We also said that the only difference in looking at Boston now is instead of it breaking even sometime in late 2017 that we figured it will go to economic profitability by about $0.005 a quarter. So that means you get there sometime in late 2018 at this point. So if we had net expenses for all of Boston at $3.8 million in the fourth quarter, you should expect that to be dropped by about $0.5 million a quarter going forward.

Collyn Gilbert

Okay.

John Ciulla

Collyn, the last thing anecdotally, right, and I - in terms of activity, private banking activity and pipeline is growing. We have a whole bunch of looks at Bank at Work now, where we’re trying to leverage our existing commercial customers in Boston that we’ve obviously been up there since 2009. We are now able to offer things like Bank at Work to the employees, because we’ve got a local banking center presence. So we definitely still see increased activity in the market too, which is very encouraging for us.

Collyn Gilbert

Okay, okay. That’s helpful. And then just on the HSA front maybe, Chad, you could sort of respond to this. How are you guys thinking about acquisitions or list-outs or anything like that, as you kind of look to build the business going forward?

Chad Wilkins

Yes, good morning, Collyn. We are still always open to looking at acquisitions. We’re obviously going out in the market proactively, talking with other players to see if that’s an option. And we are just going to do. The only deal we’ll do is one that works for us, where we’ve got potential growth tied to the acquisition. And it makes economic sense for us as well. We also are thinking about other ancillary businesses that might be beneficial to or complement the HSA business, and the other health account business.

Collyn Gilbert

Okay, okay. That’s helpful. And then just finally, Glenn, a question for you, just on the efficiency, so it looks like kind of given your guidance the efficiency is going to track higher than what you all had previously kind of targeted. Can you just talk a little bit more, maybe I don’t know - if you give us color as to how the efficiency is tracking within the HSA Bank versus the core bank.

But just trying to understand what’s kind of driving some of these expense investments, and then how quickly you think you maybe recapture the returns and we can see that efficiency drop back to below the 60% that you all had been targeting?

Glenn MacInnes

Yeah, sure. So, I think generally the HSA business because of the investment, Jim laid it out there, was very articulate about that we continue to invest in the business. We think the time is now. That’s what is driving the efficiency ratio. Obviously, our Boston investment is a big driver of that. And then for the quarter obviously the increase in the stock price had something to play on that.

But I think, generally, the HSA business has been running pretty close to about 62%, 63% as the investment of business. And you’d expect that to come down as Jim highlighted during 2017, as we start getting operating leverage. And I think in some respect, the bank will sort of mirror that. We continue to invest not only in HAS though but into commercial bank. We’re optimizing retail bank. We’re optimizing part and investing in the private bank as well. So these things are going on.

So I think we are at 63% going into the first quarter, but you got to keep in mind there is a lot going on as far as medical costs are up and things like that. There are some seasonality to that expense as well as we go into the first quarter. And some of that will wear down as we go through the year. I’m not going to give you guidance for the full year. But I would expect that we start at 63% and you’d expect that to temper down over the next of couple quarters.

Collyn Gilbert

Okay. And if we just think about it, so it sounds like from what you’re saying that the reduction in the efficiency may more likely come on the expense side than a ramp in…?

Glenn MacInnes

There is some. I mean, there is investment in the business that is nonrecurring and whether that’s a build-out or whether that’s operational efficiency type of things that we’re doing right today, those won’t be repetitive and will start back to get some of the leverage associated with doing those activities.

Collyn Gilbert

Okay. And then just one final question, not necessarily asking for guidance, but just targets in terms of EPS growth or ROA, I mean, do you guys have kind of a range of where you think you can be once these investments are completed? It sounds like maybe by the end of this year or where you think you should be running from a profitability standpoint?

Glenn MacInnes

Well, we think we should be earning in excess of our cost to capital and we’re not. And one of the comments I made is that the environment seems to be improving and actually give us propulsion to our earning our cost of capital. That’s what we focus on, ROE number one, and return on a tangible number two, ROA. Basically, I mean, it gets back to investing in strategies that maximize value over time and, that’s why we’re investing in cash management systems in commercial bank and accelerating those and accelerating investments in HSA.

So there could be a little bit of lumpiness as we go, but we’re highly confident that we’re going to generate sustainably better efficiency ratio and higher economic returns. We’d rather not be predicting anything other than that we think we can earn in excess of our cost to capital. I can’t say it will happen in 2017, but that’s the road we’re on. Every management decision that we make is oriented on our goal.

Collyn Gilbert

Okay. Okay, that’s helpful. Thank you very much.

Operator

Thank you. Our next question comes from the line of David Rochester with Deutsche Bank. Please proceed with your question.

David Rochester

Hey, good morning, guys.

James Smith

Hi, David.

John Ciulla

Good morning, Dave.

David Rochester

Hey, Glenn, back on the expense side you mentioned some one-time expenses and the numbers for build-outs and what not. Can you just may be frame how much we’re talking about there that could eventually come out through the year? I know you may end up allocating that to something else, but just any sense for how much expense that is now?

Glenn MacInnes

I’m not going to go into the detail on that. I mean, I think the efficiency ratio guidance that we gave should give you some - should give you our thought process [indiscernible].

David Rochester

Okay. And switching to HAS, you guys have mentioned contribution limits could double in that industry. Have you guys done any work around that as to what percentage of your existing customer base actually maxes out their contribution this year and then what might that actually do to profitability?

James Smith

Yes. We don’t have any information for you on that right now, but it is something we look at. It is a smaller percentage of our portfolio in the - under the 5% range that max out their contributions year-over-year. And then extrapolating that to have many of those would actually max out and, say the limits double, is the work we’re analyzing right now.

And many of the ones that are maxing out now are also what we call the sweepers, where they move into investment accounts. But the potential for the base overall, where we’re looking at those accounts that have a vintage of more than two years have an average balance of $6,500. Think of the impact that could have, very, very significant.

David Rochester

Got you. Got you. So, I guess, from a contribution limit boost perspective, may be you don’t see that much of a needle-moving event there, but there are other potentials that could drive the needle more meaningfully. Is that…?

James Smith

No, we think there is a big needle mover there. We haven’t…

David Rochester

Okay.

James Smith

…completely quantified it at this point, but that is a significant potential rocket boost to HSA deposits.

David Rochester

Got you. But right now I guess there’s less than 5% of your customers that are maxing out, is that right?

James Smith

That’s about right.

David Rochester

Okay. And just switching to NIM, appreciate the color there for 1Q. I’m just wondering how you’re thinking about the rest of the year and what kind of rate assumptions you’re looking at this point.

Glenn MacInnes

Well, I think we based our assumptions on a forward curve. So we’re thinking 25 basis point increase in June and another 25 in November. Right now, we’re thinking the 10-year swap goes from say, 2.25% today up to 2.65% by the end of the year. All that combined, I think we get the benefit going into Q1 of the lower amortization, the big driver of the 7 basis point increase, about 3 basis points to that. And then I think NIM, we think will stay relatively flat for a few quarter anyway.

David Rochester

So you got the big bump in 1Q, and then NIM stays flat for at least a couple of quarters, is that…

Glenn MacInnes

Yeah, relatively flat. I think what we’re starting to see is, we more than - what we are putting on in the commercial book is exceeding the portfolio balance. We are not yet there on the investment book. We think by the end of the quarter or during Q1, the investments that we book will have a yield higher than the portfolio. So things are starting to turn. But I think it’s going to take a couple of quarters to find its way through.

David Rochester

And where are reinvestment rates today for securities book?

Glenn MacInnes

I think we are still at like 2.65% on the investment book, and the portfolio - yeah, I would say, 2.90%, and the portfolio is about 3%. So we are starting to close the GAAP there. And like I like said, during the quarter we should be good. We expect the raise to be somewhere between 2.90% and 3%. If you look at what have during the quarter, Dave, we purchased at about 2.61%, what came off is 2.93%. So that GAAP is tightening.

David Rochester

Got you, so 2.61% for the quarter, but then you’re expecting 2.90% to 3%.

Glenn MacInnes

2.90% to 3% in Q1. That’s correct.

David Rochester

Got you. Well, all right. Thanks, guys. I appreciate it.

James Smith

Thank you.

Operator

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

Edward Beachley

Hi, Ted Beachley here for Bob Ramsey.

James Smith

Hi, Ted.

Edward Beachley

Hey, how is it going?

James Smith

Good.

Edward Beachley

So my first question is, was the expected impact of the HSA specifically to any repeal of ObamaCare?

Chad Wilkins

I’ll just say, the HAS, a lot of people have been talking on, actually on both sides of the aisle, that if there is any change that, it will emphasize consumer directed health care, which directly would impact HSA. So HSA is seen as part of the solution and any kind of repeal or modification of ObamaCare. And that’s one of the reasons that we think there is so much potential here. I don’t know if you heard our comments before where we are talking about possibly expanding enrollment, possibly even including Medicare and Medicaid. But there are so many things that could happen that are positive as a result of the focus on the Affordable Care Act, that it’s a real positive for HSA Bank.

Edward Beachley

All right, thank you. And yeah, it looks like all my other questions have been answered. Thanks, guys.

James Smith

Thank you.

Chad Wilkins

Thank you.

Operator

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

Casey Haire

Thanks. Good morning, guys, just wanted to follow-up on the NIM. Any deposit pricing pressures that you guys are seeing post the rate hike last month?

Glenn MacInnes

We didn’t see - besides the government, which is public funds are always have a high beta. So you always see that. I think that’s the whole market. We haven’t seen it on the rest of the portfolio.

Casey Haire

Okay, great. And just, Jim, a question for you, I know you guys have been pretty consistent with an internally focus message, but your currency is obviously a very strong one versus the group, which could create some interesting opportunities for you on the M&A prospects. Just curious if that is of any increasing interest to the strategy, given the strength of your currency today.

James Smith

Actually, I think we are being rewarded for focusing internally and focusing on organic growth and the strategies that we have in place. So on the hand we’re going to be outperforming. But when we look at what our potential is for valuation based on the economic profits we’re going to generate from the investments that we are making, there could be very significant upside. So we haven’t changed our view. We are focused internally on our organic growth. I think we have some great opportunities and not really paying much attention to bank M&A.

Casey Haire

Okay, understood. And another big picture question for you, Jim. On the HSA front, at what point - I mean, the growth is now starting to track some of the targets that you laid out at your Investor Day a couple of years ago ex the transition of course. But at what point, if we do get some continued acceleration in HSA, at what point do you guys look to sort of monetize the excess liquidity generated by HSA, be it in broker deposits or something else?

James Smith

Sure, it’s a great question. Right now, there is a nice symmetry between the growth in the HSA deposits on the one hand and the commercial loan growth on the other, where we got almost a perfect match there. And our other businesses will be generating assets as well. So we could easily handle additional rate of deposit flows. But we do have the safety valves, where on the one hand more investors may decide to sweep out, so that would become off balance sheet items. And we could encourage that if appropriate.

And we also have the opportunity as you know to be able to bundle. We think we’re ways away from having to consider that that we easily can handle several billion dollars more of HSA deposits. So that would be a decision we would be looking at down the line. But a welcomed one at that, because it would be indicative of the rate of growth.

Casey Haire

Okay.

James Smith

But I think you helped me make a very important point, which is that we’re not constrained in any way in terms of our ability to invest in this business and to harvest the deposits that will come from.

Casey Haire

Okay, understood. And just last one, Glenn, just to clarify on the tax rate guide, I think you said 32.5% for the year, which implies with a 30% tax rate in the first quarter we’re looking at 33% in the remaining quarters for the year. Am I calculating that correctly?

Glenn MacInnes

Yes. Somewhere and I said between 32% and 33%. So you’re right.

Casey Haire

Okay, great. Thank you.

Operator

Thank you. Our next question comes from the line of Mark Fitzgibbon with Sandler O’Neill and Partners. Please proceed with your question.

Mark Fitzgibbon

Good morning.

James Smith

Hey, Mark.

Glenn MacInnes

Hey, Mark.

Mark Fitzgibbon

Hey, guys. Since your commercial real estate to risk-based capital levels are so low, and so many other banks in the northeast are starting to ease up on their growth in commercial real estate, I’m curious if you perceive there to be a big opportunity for you all to kind of ramp up the CRE growth in coming quarters.

John Ciulla

Mark, it’s a good question. It’s John. I think, we think that opportunity may come, but truthfully we look at each quarter. And so far in 2016 and in the pipeline in 2017 we’re not seeing it. If you talk to Bill Wrang what he would say is, on the high quality strong sponsor transactions that we like to play in there’re still plenty of capital from a number of sources chasing those transactions.

So in terms of having a better probability to win or having more pricing leverage, because of our relatively low level of CRE exposure versus capital, we’ve not really seen that come to fruition. But obviously, we feel going forward, it’s going to provide us additional flexibility.

Mark Fitzgibbon

Okay. And then I know your regulatory capital ratios are well above well capitalized levels. But given what sounds like the prospect of continued strong growth and the 45% rise in your stock price level last year, do you think it might make sense to raise some additional capital in 2017?

John Ciulla

I think we’re still good about our capital levels. And I think if you look at - and I guess, what we have in the deck is tangible common equity and the common equity tier 1. We have excess. I mean, so we have the ability to grow, continue to grow our book at 100% risk weighted assets. So right now, Mark, we feel pretty good about where we are. We look at our capital stack too. And so, we as Jim mentions often, we’re EP driven. And so, we look at our cost to capital and if we look at the capital stack your common equity has an implied cost of 9.5%.

So you have to measure that against other alternatives whether it’s sub debt or preferred. We have those conversations, but we’re in no need to do something right now.

Mark Fitzgibbon

Okay. And then lastly, I was curious what was the asset that you sold that generated the $7.3 million gain in the…?

John Ciulla

So that was a SBLI or Savings Bank Life Insurance company that we had received shares in the early 1990s on. And there were two components to it. One was about 25% of the proceeds were in form of a dividend and 75% were in the form of capital loss. In both cases we were able to offset the tax - the dividend piece from the DRD, DRD reduction, and a capital loss from a carry-forward that we had. So we were able to utilize those and book the whole gain almost entirely tax-free. I think that you’d find out some other banks have the same item.

Mark Fitzgibbon

Thank you.

Operator

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

Matthew Breese

Good morning, everybody.

James Smith

Good morning, Matthew.

Glenn MacInnes

Good morning, Matthew.

Matthew Breese

Just quickly on new commercial loan yields, both CRE and C&I. How have those yields changed today versus pre-election and the rise of the yield curve?

James Smith

As I mentioned in the comments our yields have gone up marginally or modestly due to the interest-rate environment raising the LIBOR, which is interesting the underlying credit spreads, we have seen stabilization over the last year, and as Glenn mentioned in the commercial bank we’re finally getting to that inflection point where the older vintage loans that are paying off and the new stuff that’s coming on is sort of more in line.

We haven’t seen any real change in credit spreads, and if you look at all of our asset categories, they’ve been pretty stable over the course of the last say, five quarters. And any of the yield enhancement have really come from changes in LIBOR and obviously we think there is more opportunity there, and as I mentioned specifically for us in the quarter, when we have payoffs, and we are able to accelerate FASB fees, any certain quarters can be enhanced and we saw in the fourth quarter a significant uptick in our pre-pay mix which enhanced our yield.

Matthew Breese

Right. Okay. And then on the eight-branch consolidation plan, what is the expected cost base on that?

James Smith

Yes. I mean, absent the one-time charge in 2017, we think we save about $2.4 million in expenses, we lose about $1 million or $1.2 million in revenue, is our expectation in terms of deposit loss. And so the net gain is about $1.2 million in 2017, and then that increases overtime.

Matthew Breese

Got it. Okay. And then the last one for me is really around PPNR and the HSA business, looking year-over-year growth has been 2.8% driving $56 million. When do we see a ramp in that PPNR growth, and what are your expectations for what it could be 2017 to 2018?

James Smith

So let me just comment that we did cover this in the general comments in the call. We indicated the level of investment that we’re making, in fact we accelerated investment. So the expense was running higher than you might have thought. We expect that to level out sometime in 2017, and just start to ramp and see the unit cost benefits by the end of the year that will be augmented by the seasoning of the account including the $1.4 million accounts we have right now that have balances of less than $2000. So you get a combination of the revenue growth.

And then the unit benefits on the expense side that should start to push that up in late 2017. And we will continue and increasingly benefit through the balance of the planning period through 2019, and I don’t see why it wouldn’t just continue beyond that.

Glenn MacInnes

The other thing I would add is that bear in mind that we did change the duration of the deposits from 2015 to 2016. So that in and of itself - and the rate curve was lower. So that in and of itself on a quarterly basis were about $2 million. So if you look annually let’s say round numbers $8 million duration, that would change that year-to-date PPNR from 2.5% up to 18% alone. And that was something that we arrived at internally; that was an internal mechanism that we adjusted.

Matthew Breese

Okay, that’s all I had. Thank you.

Operator

Thank you. Our last question comes from the line of Matthew Keating with Barclays. Please proceed with your question.

Matthew Keating

Thank you. Just sticking on the HSA Bank PPNR trends, I appreciate all the detail you provide around that business in the slide deck, but was hoping that you could disaggregate the $12.5 million in pre-provision net revenue between net-interest income, fee income and noninterest expenses similarly as you do in your quarterly 10-Qs and 10-Ks for the fourth quarter? Thanks.

James Smith

I can come back to you on that and give you the details.

Matthew Keating

But it will be in the Q.

James Smith

It will be in the Q, absolutely.

Matthew Keating

Okay. That’s fine. And then maybe for Glenn, the NIM expansion of 6 basis points for the first quarter. It’s a bit higher than some of the banks have guided to at this point. So what’s the principle drivers there? Is that going to be coming more from the securities portfolio, or do you think loan yields will be rising. Just a little bit more color on the principle drivers would be helpful.

Glenn MacInnes

So here is the way. I mean, here’s the way we look at it. The securities portfolio, you are right CPRs go from 16 to 11 that’s our forecast right now, that’s worth about 3 basis points. I think the combination of CRE and C&I, and home equity loans probably at about $5 million - 5 basis points. So CRE and C&I are primarily LIBOR driven. So this would mean that we don’t see any increase there. Then in home equity we see the prime increase as well.

And then partially offsetting that would be higher borrowing costs that would probably take away around 2 basis points. So and then potentially we talk about the government deposits going up. So I think those are the ins and outs. I think you’re right. It’s, say, about 3 basis points in the securities portfolio and the rest on the commercial and resi portfolio, home equity.

Matthew Keating

Thanks. That’s helpful. And maybe a final one for Chad, I know it’s hard to speculate on potential changes to the Affordable Care Act and how that impacts the HSA Bank’s business unit. But, I guess, if there were wholesale or large-scale changes as part of that reform, how do you feel the business is positioned to adjust to that, right? Like essentially would there be capacity constraints, right, if there is a large-scale change, in terms of whether it’s contribution limits rising or including different individuals that are included into HSAs?

How do you think the business might respond? And what do you think the competitive dynamic, mainly the industry response might be as well if you think some of the bigger banks will get back into that business if there were wholesale changes to the current legislation? Thanks.

James Smith

Yes. I think we’re very well positioned and probably as well positioned as anybody in the industry to take advantage of that type of expansion. And as we’ve been talking for most of the morning, the investments that we’re making in the business today are about being in a position to scale and grow effectively going into the future, and to be able to compete more effectively against all of our competitors in the industry. So not only are we in good positioned today, but that’s where all of our energy and investment is going, is to make sure we can take advantage of that kind of opportunity as we go forward.

And I think as this is not the kind of investments we’re making. This is not an easy business to enter, right? It takes a lot of investment and not just the investment in technology tools resources and so on, but you also need to be able to enter the market and sell into it, right? You need to position yourself with consultants and health plans, employers and build a reputation. So it’s very difficult for anyone to just kind of jump in without acquiring an entity as part of that entry.

Matthew Keating

Understood. Thanks very much.

James Smith

Thank you, Matthew.

Operator

Thank you. Ladies and gentlemen, that does conclude our question-and-answer session. At this time, I would like to turn it back to Mr. Jim Smith for closing remarks.

James Smith

Thank you, Audrey. And thank you all for being with us today. Have a good day.

Operator

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

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