Webster Financial Corporation (WBS) Q3 2019 Earnings Report, Transcript and Summary

Good morning and welcome to Webster Financial Corporation’s Third Quarter 2019 Earnings Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note this conference is being recorded. I will now introduce Webster’s Director of Investor Relations, Terry Mangan. Please go ahead, sir.

Thank you, Sherry. Welcome to Webster. This conference is being recorded. Also, this presentation includes forward-looking statements within the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 with respect to Webster’s financial condition, results of operations and business and financial performance. Webster has based these forward-looking statements on current expectations and projections about future events. Actual results 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 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 third quarter of 2019. I will now introduce Webster’s President and CEO, John Ciulla.

Thanks Terry. Good morning, everyone. Thank you for joining Webster’s third quarter 2019 earnings call. CFO, Glenn MacInnes and I will review business and financial performance for the quarter; HSA Bank President, Chad Wilkins is here with us in Waterbury and will be available during Q&A. I'll begin my comments on Slide 2. We are pleased with our financial performance for the quarter. Despite the challenging interest rate environment and a less certain economic outlook, our financial metrics continue to be strong. Webster posted its 40th consecutive quarter of year-over-year revenue growth that is 10 years of sustained top line growth. We continue to execute on our fundamental banking activities, organically adding new customers and deepening existing relationships across all business lines and geographies. Year-over-year average loan balances grew 8% led by commercial loan growth of 11%. Despite NIM compression, the strong loan growth enabled us to maintain our quarterly net interest income relatively flat to last quarter. Loan growth was funded primarily by deposit growth. Total average deposits increased almost 6% year-over-year with HSA deposits growing 12.5%. Earnings per share totaled $1 in Q3 or $1.1 adjusted for onetime expense items, as compared to $1.5 in Q2 and $0.98 in Q3 of 2018, when that period is adjusted for discrete items. The adjusted EPS growth is 3% from prior year's third quarter. Tangible book value per share continues to grow and is 16% higher than last year. Tangible common equity also grew by 16% and is $340 million higher than a year ago. Total revenue in Q3 was 2.6% higher than a year ago, while adjusted expenses increased only 1.3%, resulting in the 10th consecutive quarter of positive operating leverage. Our efficiency ratio remained below 57%, even if we continue to invest in our businesses. We now posted 7 consecutive quarters with return on common equity above 12% and return on tangible common equity above 15%. Our performance continues to be driven by the purposeful execution of long term strategic priorities to aggressively grow HSA Bank, expand Commercial Banking, and optimize Community Banking. Credit quality remained solid, with key asset quality metrics continuing to be near cycle lows. As a percentage of portfolio, non-accruals, delinquency and classified commercial loans were all flat to better than a year ago. Despite being relatively late in the economic cycle, at present, we are not seeing any material negative trends or correlated behaviors across any geography, product or industry sector. Turning to Slide 3, I'll comment briefly on our lines of business. Commercial Banking's loan portfolio has increased $832 million over the past year for year end of period growth of 8%. We continue to adhere to our underwriting discipline while developing strong relationships by outperforming our clients' expectations. This segment also grew deposits by $277 million, or 6.5% over the past year, and our Commercial Banking pipeline was strong heading into Q4. HSA Bank continues to be a market leader and differentiator for Webster, growing its pretax net revenue by 26% so far this year. HSA Bank has added 737,000 new accounts over the past 12 months as we deepen relationships and further penetrate the direct to employer market. We anticipate a strong enrollment period with respect to new account growth in Q1 2020, as our opportunities, proposals, and new accounts pipeline are all up year-over-year, particularly in the large employer segment. We also expect attrition from our third party administrator bucket of accounts which in aggregate, represented less than 9% of our total footings as of third quarter end. As you may recall from our Investor Day in 2017, this wholesale channel contains our least profitable accounts, our HSA Bank acts only as custodian for the assets. We don't receive interchange revenue, account fees are nominal, and balances are approximately 65% of that of the rest of the book. As a result of one of our custodial clients being acquired in Q3 and another becoming a non-bank custodian itself, we anticipate that the accounts and assets related to these clients will attrite over the next two years. Importantly, HSA Bank's PTNR should not be materially impacted over the next six quarters, given the profitability dynamics of the accounts, and the fact that transition and account closing fees help mitigate the lost interest margin. Community Banking continues on its transformational roadmap to optimize distribution channels, invest in digital capabilities and focus on high value consumers and small businesses. This line of business continues to grow loans, core deposits and full relationships across our Boston to New York retail footprint. We were again recognized as the leading SBA lender in Connecticut and in all of New England with respect to 7(a) loans. Community Banking provides $4 billion of net funding to Webster. On Slide 4, we highlight the solid loan and deposit growth dynamics that I mentioned earlier. Despite increased uncertainty in the global economic outlook brought on by trade tensions, slowing growth in Europe and other markets, and a host of geopolitical event risks here and abroad, Webster's customers remained healthy and optimistic. We continue to see solid activity across our geographic footprint and across our lines of business throughout our retail, wealth, small business and commercial client base. I'll now turn it over to Glenn for the financial review.

Thanks, John. Slide 5 provides detail on our average balance sheet. The securities portfolio increased 457 million linked quarter and 825 million year-over-year, largely due to balance sheet repositioning. Growth has been primarily in fixed rate agency residential and agency commercial mortgage bank securities. Loan growth continued to be led by Commercial Banking, which grew over 300 million linked quarter and 1.1 billion versus prior year. Business banking grew 26 million linked quarter and 96 million versus prior year. Linked quarter consumer loan growth of 103 million reflects an increase of 140 million in residential mortgages. Compared to a year ago, residential mortgages increased 368 million. Partially offsetting this and in line with industry trends, we continue to see pay downs in home equity balances. Deposit growth was 407 million linked quarter led by an increase of 234 million in money market deposit accounts, as a result of seasonal strength in public funds. Deposits grew 1.3 billion from a year ago with 56% of the growth coming from health savings accounts. Deposit growth funded loan growth both linked quarter and year-over-year. Borrowings increased 491 million linked quarter and 814 million from prior year, funding growth and securities as part of repositioning. The increase in borrowings from a year ago includes 300 million in 10-year senior notes issued in March, which we swapped the floating. The growth in borrowings is all short term or floating, which helped reduce the bank's asset sensitivity. Our loan deposit ratio remains favorable at 84% and our capital levels remained strong. Slide 6 summarizes our Q3 income statement and drivers of quarterly earnings. Net interest income totaled 240.5 million stable to 2Q. Our solid linked quarter earning asset growth of 3.4% was offset by a 14 basis point reduction in net interest margin to 3.49%. The balance sheet repositioning represented 5 basis points of compression, but had almost no effect on net interest income. The remaining 9 basis points of NIM compression was in line with our expectations. The balance sheet repositioning consisted of increased fixed rate securities, funded by short term or floating rate borrowings and the purchase of 1 billion of one month LIBOR floors hedging floating rate commercial real estate loans. As a result, asset sensitivity was reduced and future net interest income is protected if rates fall. Versus prior year, net interest income grew by 10 million or 4.4%. Non-interest income decreased 5.9 million linked quarter and 2.4 million from prior year. The linked quarter decline reflects a higher level of commercial activity, as well as [indiscernible] proceeds in Q2. The decline from a year ago reflects a lower level of loan syndication fees. Reported non-interest expensive 180 million was flat linked quarter and year-over-year, while the pre provision net revenue of 131 million declined from Q2's level, it increased 5% from prior year. Loan loss provision for the quarter was 11.3 million resulting in coverage ratio of 107 basis points. And our efficiency ratio was 56.6%, up modestly from Q2 and improved from a year ago and the effective tax rate was 21.3%. Slide 7 provides additional detail on year-over-year pre provision net revenue growth. Net interest income grew by 10 million. Strong long growth drove an increase of 14 million from volume, which was partially offset by a decrease of 4 million driven by a lower rate environment. Non-interest expense increased 1.1 million from prior year. This includes 1.7 million of business optimization expense, resulting from a review of technology assets in retail lending. Beginning with Slide 8, I'll highlight the line of business results. Commercial Banking loan growth was led by commercial real estate, which grew 5% linked quarter and 14% versus prior year. C&I balances were flat in linked quarter as a result of higher prepay activity, but grew 6% from prior year. Net interest income grew 5.6 million from last year, primarily reflecting average loan growth of 1.1 billion or 11%. Non-interesting income declined 4.3 million as the prior year's quarter benefited from higher syndication fees and operating expenses increased 1 million from continued investments in the business. Combined, ongoing loan growth was partially offset by lower fee income, which resulted in a modest increase in PPNR. Slide 9 highlights HSA Bank, which delivered solid quarter led by the production of 141,000 new accounts. Our 3 million accounts have 8.2 billion in total footings. Footings were 964 million or 13% higher than prior year while accounts were 11% higher. Net interest income was 15% higher from a year ago, reflecting growth of 12% in average deposits and a higher net credit rate. The cost of deposits was 20 basis points has remained flat for 11 quarters. Non-interesting income increased 6% from prior year, driven by a 12% increase in interchange revenue, and a modest increase in account fees. Total revenue for the quarter grew 12% from a year ago, while expenses increased 7%, resulting in positive operating leverage and pretax net revenue growth of 17%. Slide 10 highlights Community Banking. Total loans grew 5% year-over-year with strong contributions from business banking and residential mortgages. Business and consumer deposits grew 9% and 5%, resulting an overall deposit growth of 6% from prior year. Net interest income was adversely impacted by a declining interest rate environment compared to last year. Non-interesting income however increased 5% led by higher mortgage banking revenue. As a result, total revenue was relatively flat. Excluding 1.7 million of onetime business optimization cost, expenses grew 2% from continued investments in technology. Slide 11 highlights our key asset quality metrics. Non-performing loans in the upper left at a linked quarter increased 14 million. NPLs now represent 83 basis points of total loans, flat to a year ago. 9 million of the increase relates to an asset based loan where we are confident that we are fully secured. Net charge offs in the upper right were 13.8 million in the quarter. The linked quarter increase was driven by two loans in our regional portfolio with no correlated risk. We saw partial offset from a decrease on the consumer side. Commercial classifieds in the lower left increased modestly and now represent 274 basis points of total commercial loans. This compares to a 20 quarter average of 320 basis points. Our allowance for loan loss was 209 million with a provision of 11.3 million and a coverage ratio of 107 basis points. Our allowance for loan loss continues to reflect stable commercial and consumer asset quality. As you know, the industry is approaching the adoption of a new accounting standard for credit losses, which will go into effect January 1st, 2020. We have made significant progress on our CECL implementation plan in 2019 and continue to increase and expect an increase of approximately 25% to 35% above our current ALLL allowance. The initial adoption will be recorded as a capital charged and will have minimal impact on capital ratios, which will remain above well capitalized levels. This estimate is based on our expectation of forecasted economic conditions and portfolio balances as of September 30, 2019. Slide 12 provides our outlook for Q4 compared to Q3. We expect average loans to increase around 2% driven primarily by commercial and residential loans. We expect average interest earning assets to grow around 2.5%. With regard to net interest margin, assuming one additional rate cut in October, we anticipate 12 to 15 basis points of NIM compression. This includes approximately 3 basis points as a result the balance sheet repositioning executed in Q3. As a result, we expect net interest income to decline 3 million to 5 million. While the rate environment remains choppy, we would anticipate net interest income to bottom out in Q4 and improve from that point forward. This assumes 2 fed cuts, one in October and one in March, as well as a 10-year swap rate of around 1.6% along with continued loan and deposit growth. For additional perspective, if rates remained where they are today, we would expect NIM to decline 8 to 10 basis points and net interest income to be stable to Q3. Our goal continues to be to maximize net interest income without taking undue risk. Reported non-interest income is likely to be 1 million to 3 million higher, and we expect our efficiency ratio to be below 57%. And our provision will be driven by loan growth, asset quality and mix. We expect the tax rate on a non-FTE basis to be approximately 21%. And lastly, excluding any share buybacks, we would expect our average diluted share counts to be similar to Q3's level. With that I'll turn things back over to John.

Thanks Glenn. Webster's third quarter results demonstrate an unwavering focus on building long term franchise value and maximizing economic profits through strong execution on everything we control. We are growing loans and deposits to maximize net interest income and fee income, staying laser focused on maintaining our credit discipline, deepening customer relationships, diligently controlling expenses and at the same time, investing confidently in our future. This is how Webster continues and will continue to deliver for its customers, communities, shareholders and employees. I said often that our people make the difference. I'm pleased to highlight on this call that Webster's Head of Community Affairs and Philanthropy, Kathy Luria was recently named the ABA Foundations 2019 George Bailey Distinguished Service Award winner. In the words of American Banker Associations, President and CEO, Rob Nichols, “Kathy Luria's work at Webster serves as an example for the entire industry for how bankers can and should engage with their communities”. Thanks to her efforts, it's clear that Webster is making a tangible difference in the community it serves. Congratulations to Kathy and to all our Webster bankers. With that, Sherry, I'm happy to open up for questions.

Thank you. [Operator Instructions] Our first question is from Steven Alexopoulos with J.P. Morgan. Please proceed.

Hi. Start on the deposit side, non-HSA deposit costs trended a bit higher again in the quarter and really being pushed by savings deposits. When do you guys expect to see total deposit cost start to trend lower, and maybe help offset some of the NIM pressure?

Steve, that's a great question. And hello, good to talk to you. You know, I think we do have room. As we talked about often, we think we've got some latitude given the strong HSA deposit growth. But we're also very much focused on continuing to grow our relationships in the community bank, and, you know, Boston's been continued to be a very competitive market. We do think in Q4, we will see a material reduction in our overall core deposit rates, you know, given what's going on in the market, and given some of the opportunity we have across our footprint.

Okay, that's helpful. And then maybe for Glenn. In the past, you called out NIM declining, I think was 5 to 7 basis points without premium amortization for every rate cut, given all the additional hedging now, where's that new level?

So I think as you look into Q4, the guidance I gave was 12 to 15. About three of that, as I indicated is the hedging side of it. If you took out the premium memorization, it's probably worth another basis point to a basis point and a half going into Q4. The rest is primarily the impact of lower loan rates. And our outlook for Q4 is that with one fed cut in October, that you'll likely see an average fed funds rate go from 230 in the third quarter down to 183 in the fourth quarter. So that's a 47 basis point drop. And as you know, Steve, about 54% of our loan book is tied in one way to either one month or three month live or which would typically follow fed funds.

Okay. But Glenn, relative to the five to seven range, are we still in that range even with the hedging maybe the lower end, but are we still in that range? Are we now below it? Just looking even beyond into 2020 at this point?

So on the five to seven in NIM compression?

Yeah.

I'm not sure I understand, maybe just repeat that question.

So in the past, you talked about NIM going down 5 to 7 basis points for every cut. My question is, are we still post this for hedging in that range or are we now below that range, essentially?

So the hedging won't – let me back up from it. So as I get into next year, and I look at the NIM compression, and again, assuming a 10 year at 160, assuming one more fed cut in October, one in into the March on the 18th. I would expect to see 2 to 3 basis points of NIM compression a quarter. That being said, as I indicated, we bottom out in net interest income in the fourth quarter, and then we began growing net interest income.

Got it. Okay, that's helpful. And then an HSA Bank. I want to follow-up on John's prepared comments calling out for a healthy 1Q enrollment season. Now that employees are going through their annual health plan selection. Are you seeing higher adoption of high deductible plans at this point?

Yeah, hi Steve. Yeah, we're seeing it depends on what our employers are doing in order to influence, the enrollments if they're using decision support tools and things like that in education, their enrollment we're seeing definitely increasing in enrollments. That said, you know, we're having a great – our pipeline is very strong as we go into the end of the year, and we expect to be well above what we saw last year. And our enrollments again 80% of our calves come from existing employers. So a lot depends on your point, how enrollments go through Q1.

And Steve, as you know, we have been spending a lot of time trying to educate the employees of our employer customers on all of the pros of funding their account and maximizing contributions and opening accounts. So hopefully we'll see some influence there. As Chad said, of that 80% of our new accounts that come from our existing customers, hopefully we can influence the enrollment levels.

And then just a final one for Chad, I need to say. If I look at the income growth, it's slowed over the past year. Is this just continued downward pressure a monthly account fees and do you expect it to remain under pressure? Thanks.

Yeah, thanks Steve. We had one thing that impacted fees in the third quarter was about a $400,000 reduction in paper statement fees. We've had an initiative going on to eliminate paper statements. That being offset by about a $500,000 reduction in the actual cost of delivering paper statements. So that's more of a one-time item, but the savings and the cost will continue. We also are seeing a little bit of pressure on large employer account fees. But that's really isolated more towards existing programs that have larger balances. So we're happy to trade fees for existing balances as we go out and compete in the market on large accounts.

Okay. Terrific. Thanks for taking my questions.

Thanks, Steve.

Our next question is from Collyn Gilbert with KBW. Please proceed.

Thanks, guys. Good morning.

Hi Collyn.

To get to the end of the Q and let you flush out probably 10 times what you're doing on the leverage side and then the hedging side before I had to ask my question. But Glenn, could you just walk through this again? I just want to make sure I understand what you're doing here and trying to understand why, what's going to drive the NII to bottom in 4Q, I guess it just sorry – if you could just walk through exactly what you did this quarter, what you added that the yield of security you added I know you said fix duration. Just kind of walk through some of that math again, if you would please?

So yeah. And I'll break it into two pieces. One is the repositioning activity that we did primarily during the third quarter, and we bought about a $1, that does protect us on the downside, if rates continue to drop, and we think that's prudent. The other activity we did was we purchased securities and we purchased about 600 on an actual base, about 640 million of securities. And what that does is, it removes some of the assets sensitivity. The combination of those two is neutral to net interest income. We have a spread that we're earning on the securities because they're funded primarily by one month FHLD of about 50 basis points and the cost of the floors is similar. So those actions are neutral. And what they do is they protect us on the downside of regular rates were 3to drop, the securities that we purchased would have a higher yield. Likewise, if rates were to drop, we'd have a floor on primarily our commercial real estate loans, which we're hedging. So that's one activity. When I talk about bottoming out in the fourth quarter, I think you got to think about the dynamics of the rate environment. And so from the second to third quarter, you saw 20 basis point reduction in average fed funds. And then from the third to the fourth quarter, more severe 47 basis point reduction in fed funds. If you assume that the fed does not cut again until March 18, that would imply that fed funds a quarter-over-quarter, fourth quarter into first quarter would be down an average of 13 basis points. So the rate of decline is significantly less. And then if you take that and you assume a 10-year swap rate of around 160, that's how you get your number. So if I'm thinking of Q3's level, 240.5 million of net interest income, I am guiding to a reduction of three to five. That gets you in a range of 235 to 237 in the fourth quarter. What you have, beginning of the first quarter as you have less pressure from the fed, you have an inflow of HSA deposits, which help reduce some of your borrowing costs. And then you have, as John indicated, further reductions in advance of the fed reduction on your core deposit cost. So we think 4 to 5 basis points a quarter, we could potentially get on our core retail deposits in a reduction. So that's – I said a lot. So that's really the dynamics that how we're looking at it.

Okay.

Hey Collyn, just to put a finer point on our strategy. You know, we're – obviously the NIM compression is the big question in the industry. You know, we're not apologetic for being asset sensitive, obviously, we've got a very great high growth source of low cost funds and we've been growing loans about market rates. And the kind of loans we grow generally are our floating rate. And we've been able to if you look back, you know, I looked last night, three years ago, we trailed our proxy peer group by 10 basis points in NIM, we were around 3.10. And now even with the compression, we're still about 20 basis points above our proxy peer group. And we're significantly higher on an absolute value. So we feel good about where we are. And our repositioning strategies really are to try and make sure that in the downside scenario where rates start to move more aggressively towards zero, we're protected and we're protecting our income level. But we don't want to leverage and mortgage all of the upside of what we do best in terms of deploying our organic deposits against loan growth over time. So that just give the kind of a high level strategy that Glenn talks about in terms of the specific execution.

And the only thing I would add for that is if you go back to our deck on page 19, you can see how our sensitive to both our rising rate environment and declining rate environment. And obviously, as John pointed out, we – our goal is to maximize that interest income without taking undue risk. So prudent to take some actions just in any event rates did continue to drop.

Gotcha. Okay. And then Glenn, if rates go the other way, if we've seen, you know, if the 10-year has bottomed here and then they go up, I mean, how much risk now is to NIM if let's say a 10-year goes back up to two or just?

So again, you can see that on page 19 as far as our disclosure, we have both up a rising rate scenario and a declining rate in scenario. You know, if short end up or long end up 50 basis points, you still you've actually increased your upside. You've taken a little away on the downside because we're hedging floating rate loans for the most part, but your upside has actually improved.

Okay. Okay, great. That's helpful. And then I guess, and I haven't done the math yet, but you know, so maybe perhaps it answers my second question. But with your fourth quarter guide of an efficiency under 57%, which is, you know, kind of consistent. I know, you don't get guidance for 2020, but let's assume you guys are always focused on operating leverage and et cetera, et cetera. If that 57% efficiency holds in 2020, does that imply any material change in the expense structure or how should we think about the kind of expense optimization potentials?

Yeah. No, I think we have opportunity, we've mentioned it on the calls. You know, I think our goal is to drive that 57% efficiency ratio down over time. Obviously, the interest rate environment in the short term impacts that and we've always said to that we're not going to let an artificial boundary impact our ability to invest in the commercial bank, invest in technology for long term efficiencies or investing in HSA. So I do think there are opportunities and I think we had really nice year-over-year expense discipline this year. And with some of the stuff we're doing in the middle in the back office, you know, we have an opportunity, I think, to actually reduce expenses over time, Collyn, but that's really – looking right now what LRP, that's really all I'd like to say.

Okay. All right. I will leave it there. Thanks, guys.

Thanks, Collyn.

Our next question is from David Chiaverini with Wedbush Securities. Please proceed.

Hi, thanks. Good morning.

Good morning.

So starting out with the commentary you said about some custodial relationships that were acquired in the quarter and how it represented 9% of total. I think I heard you say 9% of total HSA accounts. I was curious, what percentage deposits that represents?

Less than that slight less than about 7.5% to 8% in deposits. So and I'll we stay because I don't want there to be confusion on the phone. So those two custodial relationships where the accounts are less profitable 65% of the average balance, no interchange fees and nominal account fees. They're across two custodial customers, one of which was acquired, although we're not going to mention names, you'd probably know, one of them was acquired in the third quarter, and the other one has a non-bank custodial license now to take on the deposits. So we expect based on contractual relationships that over the course of the next eight quarters or so that a large majority or all of those accounts and deposits will – that's right, we're working with both of those customers to make sure our customers to make sure that all the underlying customers are not impacted and it's smooth. And the key point I wanted to make is that between the economics of those accounts, and the transition and account closing fees that we will receive over the course of these next eight quarters, the impact to us financially is offset by, you know, the net interest margin we lose on those assets going away from us as offset by those transaction and closing account fees.

Great, that's helpful. And then shifting gears back to the balance sheet repositioning. Was this a onetime action in the third quarter? Or can we expect, you know, additional balance sheet repositioning going forward?

So, Dave, it's Glenn. Good morning. Those are the actions that we took during the third quarter. It is evolving, it depends on our view, and where we think we're positioned. But let me just say we want to continue to be very conscious of protecting the bank in a down rate environment. But we also don't want to hold back on a rising rate environment. So that's our strategy. We're operating within a band of that. So it's hard to say. I mean, it depends on your view of the rate.

Yep, yep. Well, ideally, I'd like to see them go up. But that doesn't always work out that way. So shifting gears to credit quality, you mentioned that the increase in NPLs was an asset based loan. And that you believe you're fully secured. I was curious as to what industry that was in?

I believe it was a distribution company. And again, fully followed cash dominion. So we think there's not a risk of loss there as we look at it present time. And I did know, you know, it's – we talked about the episodic nature of some of these categories and asset quality. If you look over a year, you know, NPLs are flat as a percentage of total portfolio too. So while we're always concerned when something flows in there, David, it doesn't give us significant cause for concern.

Okay, thanks. And then last one for me is on CECL, you mentioned about how the reserve could go up 25% to 35%. Can you comment on what the ongoing impact of EPS could be given that, you know, home equity lending is penalized under CECL and you get up and running that off, so that could actually be a tailwind for you, but wanted to hear your thoughts there?

Yeah, so, it's too hard to say right now. It's going to be driven by volume. You're correct in that, our longer data assets, obviously have a bigger CECL impact. That being said, when we look at it, we like things like mortgage banking or mortgage customers have higher checking accounts. They also purchase more banking products and services. So it's too soon to say it the implications to any particular product.

I think that's right, Dave, you know, we thought about – I'm one of those that shares the concern that if we get into a significant downturn and credit crisis, that there'll be a procyclical issue with respect to CECL meaning there may be a disincentive for banks to continue to aggressively make mortgage loans and extend longer dated credit to consumers. But I think as we look through our general models right now, we don't anticipate shifting our current mix, which as you know, is about two thirds commercial and a third consumer. We don't think that in the short term, either our EPS will be impacted, or kind of our business rationale and strategy will be impacted by the results of CECL.

Got it. Thanks very much.

Nice to talk to you.

Our next question is from Laurie Hunsicker with Compass Point. Please proceed.

Yeah. Hi. Good morning.

Laurie, good morning. How are you?

Great. Thank you. I'm just saying with credit. I was hoping that you could give us an update in terms of just where you are with respect to your leverage loan book and then also specifically within consumer where you are with lending in terms of balances and what you're seeing there in terms of non-performers and charge off?

I'm happy to answer those questions. And you know, I like answering a quick credit question. So on leveraged, if you go back to the January call, when we sort of laid out and we're transparent about where we were leveraged, the amount of leverage loans both from a funded perspective and from a total exposure perspective that are leveraged that origination has not moved as a percentage of portfolio, so it's roughly 10% of the commercial portfolio and 6.5% of the overall bank loan portfolio. And the interesting dynamic there, Laurie, but besides the fact that and I'm going to knock on wood here, we've had none of the charges we had in year-to-date 2019 were in that bucket. And as you know, we've had really good success over the last 10 years and even before in that category. We also don't have an increase in classified or watch and worth loans in that category. So really, it's status quo. What I will say interestingly is that in the second to third quarter, our leverage loans didn't grow at all. And interesting that is year-over-year, the origination level in our sponsor and specialty group where most of our leveraged loans are, was actually down 52% from prior year. Whereas in ABL and commercial real estate, we were up mid-teens in both of those categories. And again, we take a different disciplined approach, but that's not a result of a strategic shift. It's a result of I think we're living up to our promise to, you know, stretch on price, not on structure. So if you look at the net result, our originations year-over-year across the commercial bank are actually 14 basis points better from a weighted average risk rating. And our spread is down significantly, almost 70 basis points, our credit spreads. So I'm not going to say that will last. If we have great opportunities in sponsor and specialty and we have great opportunities and leverage loans, we're going to continue to underwrite them, because we have confidence in it. But I think those credit trends and those credit metrics underscore the fact that we've been disciplined in the way we view the marketplace.

Okay, great. And then what is your charge off rate running right now in the sponsor and specialty book?

It's well below our commercial. I don't have that number out but it's well below our 21 basis point 20 quarter rolling average. We were 28 basis points this quarter and none of the sponsor and specialty loans contributed to loss.

Okay, perfect. And then just last question around that. What percentage of your book, do you consider covenant light at this point?

I think back in January, I gave you something like less than 3% of the leverage loans were covenant light. I think it's probably low single digits 1% or 2%. And Laurie, to be quite honest with you, and to be transparent, I think that's some of the reason why our sponsor and special originations have been down because we haven't been chasing the market as aggressively because so many of the transactions even BB transactions, you know, are covenant light and we've been very disciplined I think, in that process.

Okay, thanks, Glenn. And then on lending club, can you just give us an update on how big that balances and what the charge off that's running?

Sure and it's John.

I'm so sorry, John. I am so sorry.

That's okay. Glenn doesn't answer the credit question, but I am only kidding. Lending club is $177 million in its funded exposure at the end of the third quarter versus a $230 million exposure into 2Q of 2016. We've been running that book down slowly. And I will tell you, it's economically profitable. It is less than 1% of our overall loan portfolio. And it is not a critical element of our strategy. But even with, you know, higher interest, coupons and higher charges, it's actually economically profitable for us. So we're not emphasizing it and we're not anxious to exit, but it's a very, very small portion of the whole.

Okay. And then just looking at your charge offs, again, the 2 million or so in consumer charge off. Are most of those coming from that lending club book?

A portion. It's a mix.

Okay, great. I can follow-up with you offline. I just wanted to – I just wanted to go back to where David and Steven were on HSA, I just want to make sure that I understand that. So as we look at your current balances, you finished September with total footings at 8.163 billion, of the two custodial relationships that are gone, was any of that reflected in that number? And then maybe can you also help us specifically think about what fourth quarter is going to look like both in terms of deposits and in terms of HSA investments? I realized obviously that 1Q is your seasonally strongest but in other words if we're just thinking about how those space in and also the one HSA custodial relationship, that was a choir, did that close in third quarter or when is that expected to close?

It closed in third quarter. So the third quarter numbers don't reflect any of this attrition. We have obviously begun the process of working with our customers to come up with the schedule and the process under the existing contracts to move those. That's why we know the process is going to take up to eight the next eight quarters. We don't have the final details in terms of quarter by quarter by quarter. But what we wanted to do is be very transparent about the fact that we know that more than likely, the vast majority or all of these accounts and balances will try it over two years. We wanted to be careful to let you and the market know that the economic impact HSA and to the bank is mitigated over the next six quarters, obviously will have to then replace those deposits in those accounts. Chad may be able to give you some insights as to whether the fourth quarter will be impacted. But again, we don't have the exact schedule run off. And one of the reasons we wanted to talk about it is when we do get to 1Q and start to look at our organic growth rate and all the wonderful work we're doing in the director employer channel, we want to be able to say absent these less profitable accounts are trading, this would be our performance versus market. So, Chad, I don't know if you want to give some insight as to what you think the fourth quarter impact will be.

There's a chance that a small percentage of the overall deposits could move off before the end of the year, in the fourth quarter, but we're still working that out. And again, it would be a very small immaterial percentage.

Okay. And Chad, maybe can you just help us think about, you know, if we fast forward a year, year from now the end of 2020, what those balances might look like just incorporating all of the changes that you're making within HSA your marketing, push, et cetera, as we think about footings, book deposits and investments. How should we be at thinking a growth for 2020? Thanks.

Well, as John was saying, it's hard to for us to estimate exactly how much of that books going to roll off in 2020, as we're working through the transition with our partners right now. The growth rates of that portfolio are consistent with our overall growth rates across the rest of the book. And we continue to focus on increasing those growth rates, particularly in the channels that we have the most influence. And I can tell you in our new account production and direct for instance is up about 15% year-over-year where we're seeing actually a decline in new account growth rates in the custodial channel. So, you know, we expect to be able to, you know – our game plan is to replace those deposits and accounts over that time frame.

Laurie, I think the guidance I gave was that and Glenn and Chad talk about the fact that our pipeline and so forth shows that we're hoping that one and this enrollment cycle where as you know, is the greatest portion of new account acquisition we hope to exceed and our pipeline shows that we will exceed last year's new account openings. And then as these underlying custodial accounts that's right and we get closer to you know the January call and the April call obviously when after the quarter will be able to sort of reconcile all that for you.

Okay, thanks. I'll leave it there.

Our next question is from Jared Shaw with Wells Fargo Securities. Please proceed.

Hi. Good morning. This is actually [indiscernible] filling in for Jared.

Hi. How are you today?

Good. Thanks. Not to beat a dead horse, but just getting back to the HSA, the two custodian accounts, is that the 9% of third party accounts and 7.5% of total deposits or is that whole third party?

Those two accounts make up the lion share of that. So if the question is, there are some other customers in there, but it's, you know, below $50 million in total footings and deposits and around 20,000 accounts not related. So, if the question is, is there more to come, there really isn't a material amount left in that activity. You know, that activity made money for us, it was less profitable and it's not something that we wouldn't do for another client. But it's not been, as you know, where our focus has been. And, you know, the lion share of our account growth over time has come from our growth in direct to employer.

Hi. It's John. There's a chance we may maintain a relationship with one of those custodial partners longer term, it will be much would be much smaller than what we have right now.

Okay, that's helpful. Thank you. And then John, may be looking at the commercial pipeline to get said that it was strong heading into the fourth quarter. What's the composition to that, is that primarily CRE or are you going to see balance in traditional commercial growth?

You know, it's been across the board, at least in the pipeline. And so far, you know, what we can say is commercial real estate continue to be strong not only from an origination perspective and a pipeline perspective, but there's been a slowdown in prepays there. And you know, as we explore that may be just an interesting point in time where, you know, buyers and sellers, the buyers want a higher and higher price, and the buyers wants to pay a lower price given where cap rates and everything on and the sellers are, you know, holding out for higher price. But we don't see really any deterioration in the underlying metrics, particularly where we are. And if I look at the data points, you know, our debt service coverage ratios were actually higher period-over-period and our LTVs were slightly lower period over period. So I just think the dynamics in our query with our existing sponsors and some of the great work we're doing throughout the footprint, is generating some outperformance there. So It looks like we're getting growth throughout the commercial bank, but commercial real estate in particular seems to be really, really active.

Okay, great. And then just one last one for me. Looking at the linked quarter increase in commercial classifieds, anything to note that or any asset class that's primarily driving that or is that pretty granular?

We actually had a couple of asset based transactions there, but it really nothing. And as I say, I don't want to dismiss it because we look at all risk migration, but we know that the watch and worth levels which are the credit sized assets below are actually down. So we're not seeing a real flow. These were episodic. And as Glenn mentioned, if you look at our rolling average of, you know, several quarters in that 3% range, we're still you know, well below our general operating level of commercial classified and still at cycle low. So, I – after we did our review this quarter, I didn't see anything in there that concern me.

Okay, so the ABL that popped up in non-performing and then the increasing classifieds, there's no like geographic concentration.

No.

Okay. Okay. Thank you very much.

Thank you.

That concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you so much, Sherry. I appreciate everybody getting on the phone and your continued interest in Webster. Have a great day.

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.