Webster Financial Corporation (WBS) Q4 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to Webster Financial Corporation’s Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce Webster’s Director of Investor Relations, Terry Mangan to introduce the call. Please go ahead, sir.

Thank you, Darrel. 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 operation, and business and financial performance. Webster has based these forward-looking statements on current expectations and projections about future events. Actual results might differ materially from those projected in the forward-looking statements. Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial’s public filings with the Securities and Exchange Commission, including our Form 8-K containing our earnings release for the fourth quarter of 2020. I’ll now introduce Webster’s Chairman and CEO, John Ciulla.

Thanks, Terry. Good morning, everyone. Thank you for joining Webster’s fourth quarter earnings call. CFO, Glenn MacInnes and I will review business, financial and credit performance for the quarter, after which HSA Bank President, Chad Wilkins; and Jason Soto, our Chief Credit Officer, will join us for Q&A. As we look back on 2020, a challenging year for all of us in so many different ways, my first thought is how proud I am of Webster bankers, as they found a way to deliver for each other, our customers, our communities, and for our shareholders. While increasing COVID cases continue to present real challenges, we are optimistic that 2021 will bring a level of normalization, as the distribution of vaccines dramatically changes the path of the pandemic, the broader economy, including COVID impacted sectors continue to recover, and the peaceful transition of power that occurred yesterday, hopefully represents the beginning of a less divisive political environment. We remain focused on prudently managing capital, credit, and liquidity as we also position ourselves for growth and outperformance as the macro environment improves in 2021 and beyond. Turning to slide 2. I’m really pleased with our strong business performance in the quarter. We originated $1.9 billion in loans, generated strong loan-related fees, continued to grow deposits and HSA total footings approached $10 billion. Credit trends are favorable, and the net interest margin has stabilized. Our adjusted earnings per share in Q4 were $0.99, up from $0.96 a year ago. Our fourth quarter performance includes $42 million of pretax charges related to the strategic initiatives we announced last quarter. Glenn will provide additional perspective on these charges in his remarks. An improved economic outlook with continued uncertainty, along with a flat quarter-over-quarter loan portfolio, supported a $1 million CECL allowance release in the quarter. Our fourth quarter adjusted return on common equity was 11.5% and the adjusted return on tangible common equity in the quarter was 14.2%. On slide 3. Loans grew 8% from a year ago or 2% when excluding $1.3 billion in PPP loans. Commercial loans grew 6% from a year ago or more than $800 million. Deposits grew 17% year-over-year, driven across all business lines. Loan yield increased 4 basis points linked quarter, while deposit costs continued to decline. Slide 4 through 6 set forth key performance statistics for our three lines of business. I’m on slide 4. This was a very strong quarter for Commercial Banking, with more than $1.2 billion of loan originations, up solidly from Q3 and down only slightly from a strong 4Q 2019. Loan fundings of $825 million were also up solidly from Q3. We continue to benefit from our industry expertise and deep relationships in select sectors, including technology that has not been adversely impacted during the pandemic. Commercial bank deposits are at record levels, up more than 35% from the prior year’s fourth quarter. The Commercial Banking loan portfolio yield increased 9 basis points in the quarter, driven by better spreads and enhanced by a higher level of acceleration of deferred fees as we saw payoff activity return to more normalized levels. Noninterest income in Commercial Banking was up linked quarter due to higher syndication and other fees tied to the strong origination activity. Now, turning to HSA Bank on slide 5. HSA Bank total footings increased 17% from a year ago and now totaled nearly $10 billion. Core deposits were up 15% and 13%, excluding the State Farm acquisition, which closed in 2020. The year-over-year increase in balances was driven by continued contributions as well as reduced accountholder spending due to COVID-19 restrictions. The TPA accounts declined from a year ago, reflecting the expected departures that occurred in Q3. We added 668,000 accounts in 2020, 10% fewer than we added in 2019, consistent with industry trends and due primarily to lower enrollments with existing employers as COVID-19 impacted the overall employment environment. We expect this trend to continue into the first half of the New Year. HSA deposit costs continue to decline as we remain disciplined in this low interest rate environment and totaled 9% in the quarter -- 9 basis points, excuse me, in the quarter. I’m now on slide 6. Community Banking loans grew 5% year-over-year and declined 5%, excluding PPP. As indicated on the slide, PPP loans decreased $63 million as we saw repayment and forgiveness activity begin in the quarter. Community Banking deposits grew 14% year-over-year with consumer and business deposits growing 9% and 31%, respectively. Deposit costs continued to decline and totaled 16 basis points in the quarter. Net interest income grew $8.3 million from a year ago, driven by overall loan and deposit growth. The next two slides address credit metrics and trends, which continue to be surprisingly stable, given all the challenges in the macro environment. On slide 7, we show our commercial loan sectors most directly impacted by COVID. Overall loan outstandings to these sectors have declined 10% from September 30th and payment deferrals have declined $64 million or 31%. On slide 8, we provide more detail across our $20 billion commercial and consumer loan portfolio. The key takeaway here is that payment deferrals declined by 35% to $315 million at December 31st and now represent 1.6% of total loans compared to 2.4% of total loans at September 30th. At year-end, $100 million or 32% of the $315 million in payment deferrals are first-time deferrals. And CARES Act and interagency statement defined payment deferrals, which are included in the $315 million of total payment deferrals at December 31st, decreased 29% from September 30th and now stand at $201 million. While challenges related to the pandemic and the overall economy remain, I am pleased with the considerable support we have been able to provide to our customers as they work through these challenging times. We continue to actively monitor risk, make real-time credit rating decisions and address potential credit issues proactively. We remain confident about the quality of our risk selection and underwriting processes, our portfolio management capabilities, and our capital position. I’ll now turn it over to Glenn for the financial review.

Thanks, John. I will focus on the key aspects of performance in the quarter, including stable adjusted net interest margin, an increase in noninterest income, ongoing expense control and a favorable credit profile. I’ll begin with our average balance sheet on slide 9. Average securities grew $160 million or 1.8% linked quarter. Securities represented 27% of total assets at December 31st. Average loans declined $142 million or 0.6% linked quarter, primarily driven by $176 million decline in consumer loans, reflecting higher pay-down rates in mortgage and home equity portfolios. Prepayment and forgiveness on PPP loans during the quarter totaled $98 million. In Q4, we recognized $7.3 million of PPP deferred fee accretion, and the remaining deferred fee balance totaled $27 million at December 31st. Deposits increased $276 million linked quarter, primarily driven by growth in Community Banking and HSA. This was partially offset by a reduction in CDs. The strong growth in deposits allowed us to pay down borrowings, which were lower by $289 million from Q3. At $1.9 billion, borrowings represent 5.2% of total assets compared to 7% at September 30th and 11.6% in prior year. The tangible common equity ratio increased to 7.9% and will be 32 basis points higher, excluding the $1.3 billion and 0% risk weighted PPP loans. Tangible book value per share at quarter-end was $28.04, an increase of about 1% from September 30th and 3% from prior year. Slide 10 highlights adjustments to reported net income. Aggregate adjustments totaled $42 million pretax, or $31.2 million after tax, representing $0.35 per share. Of the $42 million in adjustments, $38 million is related to our strategic initiatives, which John will discuss further. The remaining $4.1 million is associated with the debt prepayment. The prepayment expense adversely impacted current quarter net interest income and impacted net interest margin by 5 basis points. However, we will benefit by approximately $1.3 million in net interest income per quarter, and NIM will benefit by 2 basis points. On slide 11, we provide our reported and adjusted income statement. As highlighted on the previous page, the adjustments total $42 million pretax. On an adjusted basis, net interest income increased by $1.3 million from prior quarter. This was a result of a $4.5 million reduction in deposit and borrowing costs, along with $1 million in additional loan income, which was partially offset by a $4 million decline in securities income, primarily as a result of elevated prepayments. Taken together, our adjusted net interest margin of 2.8% was flat to third quarter. As compared to prior year, net interest income declined by $11 million. $47 million of the decline was the net result of lower market rates and was partially offset by interest income of $29 million from earning asset growth and $8 million from a reduction in borrowings. Noninterest income increased $1.7 million linked quarter and $5.9 million from prior year. Loan fees increased $2.5 million from prior quarter as a result of higher syndication, prepayment and line usage fees. Other income increased $4.4 million, reflecting higher direct investment income and swap fees. HSA fee income decreased $3.1 million linked quarter as Q3 included $3.2 million of exit fees on TPA accounts. Mortgage Banking revenues decreased $3 million linked quarter as a result of lower volume on loans originated for sale. The $5.9 million increase in noninterest income from prior year reflects additional loan fees, higher mortgage banking revenue and HSA fee income, partially offset by lower deposit service fees. Noninterest expense of $181 million reflects an increase of $2 million, primarily due to technology and seasonal increases in temporary staffing to support the HSA annual enrollment. Noninterest expense decreased $1.5 million or 1% from prior year, and our efficiency ratio was 60% in the quarter. Pre-provision net revenue was $116 million in Q4. This compares to $115 million in Q3 and $122 million in prior year. Our CECL provision in the quarter reflects a credit of $1 million, which I’ll discuss in more detail on the next slide. And our adjusted tax rate was 22.1%. Turning to slide 12, I will review the results of our fourth quarter allowance for loan losses under CECL. The allowance coverage ratio, excluding PPP loans declined from 1.8% to 1.76% with total reserves of $359 million. The reserve balance reflects our lifetime estimate of credit losses. The small decline from prior quarter is the net effect of an improvement in the macroeconomic forecast partially offset by additional qualitative reserves. The increase in qualitative reserves is driven by uncertainty around the resolution of the pandemic and the pace of the recovery. The total reserves provide a more adverse scenario than shown in the baseline assumptions at the bottom of the page. Slide 13 highlights our key asset quality metrics as of December 31st. Nonperforming loans, in the upper left, increased $3 million from Q3. Commercial, residential mortgage and consumer each saw linked quarter declines, while commercial real estate increased. Net charge-offs, in the upper right, decreased from the third quarter and totaled $9.4 million after $1.9 million in recoveries. The net charge-off rate was 17 basis points in the quarter. Commercial classified loans, in the lower left, increased $30 million from Q3 and represented 352 basis points of total commercial loans. Slide 14 highlights our liquidity metrics. Our diverse deposit gathering sources continue to provide us with considerable flexibility. Deposit growth of $414 million exceeded total asset growth and lowered the loan-to-deposit ratio to 79%. Our sources of secured borrowing capacity increased further and totaled $12 billion at December 31st. Slide 15 highlights our strong capital metrics. Regulatory capital ratios exceed well capitalized levels by substantial amounts. Our common equity Tier 1 ratio of 11.35% exceeds well capitalized by $1.1 billion. Likewise, Tier 1 risk-based capital of 11.99% exceeds well capitalized levels by $895 million. Our guidance will continue to be impacted by the pace and duration of the pandemic over the next few quarters. That being said, we anticipate modest loan growth, excluding the timing of PPP forgiveness and round two originations. NIM will also be influenced by the rate environment and PPP forgiveness. Assuming today’s rates, we would expect net interest income to be around Q4’s level. Noninterest income will be modestly lower linked quarter, driven by lower loan-related and mortgage banking fees. The provision for credit losses will continue to be impacted by credit trends, the macroeconomic environment, government stimulus and the duration of the pandemic. Core operating expenses will be lower as we begin to recognize the benefits of our strategic initiatives. And our tax rate will be approximately 21% to 22%. With that, I’ll turn things back over to John for a review of our strategic initiatives.

Thanks, Glenn. I’m on slide 16. As we discussed on the October earnings call, we’ve been working through a comprehensive strategic and organizational review since before the onset of the pandemic. And while today we’ll provide more detail on our progress and some shorter term financial targets, I want to stress that the work we have done over the last year and the actions we are taking are transforming our Company and the way we do business. We believe that we will continue delivering incremental value to our customers and shareholders for years to come, consistent with our overarching objectives of maximizing economic profits and creating long-term franchise value. Importantly, these actions afford us the capacity to invest in the future and provide better customer experiences through improved products, services and digital offerings, all in the furtherance of our mission to help individuals, families and businesses achieve their financial goals. We are investing in revenue growth drivers that leverage our differentiated businesses. These include accelerating growth in new and existing Commercial Banking segment, improving sales productivity, enhancing noninterest income through treasury and commercial card products and driving deeper relationships across all lines of business. While we anticipate short-term benefits from these initiatives, they will contribute meaningfully to our financial performance in 2022 and beyond. Additionally, we continue to invest in technology to provide better digital experiences for our customers and bankers to further improve customer acquisition and retention rates. As shown on slide 17, we have made significant progress on our efficiency opportunities. We remain on track to deliver an 8% to 10% reduction in core noninterest expense. We expect this to be fully realized on a run rate basis by the end of the fourth quarter of 2021. Our efficiency initiatives fall into three areas of focus that we discussed last quarter, rationalizing retail and commercial real estate; simplifying the structure of the organization; and optimizing our ancillary spend. We’ve taken actions to simplify our organizational structure, including combining like functions, automating manual processes and selectively outsourcing commoditized activities. A portion of the project-related expense adjustments that Glenn discussed relate to these actions and the associated severance costs result from a targeted reduction in the overall workforce. We announced in December the consolidation of 27 banking centers and we have targeted actions aimed at reducing corporate office square footage over time. The real estate optimization plan reflects our response to changes in customer preferences and the shift in workplace dynamics that have only accelerated during the pandemic. The remaining quarterly cost benefits will be driven by a more disciplined approach to ancillary spend, redesigning and automating internal critical processes and leveraging back office synergies. Slide 18 provides an overview of the cost savings and an expense walk to our fourth quarter target run rate. Achieving these efficiencies will allow us to continue to invest in our franchise and improve the customer experience. The last slide for me is an important one. We’ve updated it from prior quarters. It aggregates our activities during 2020 related to helping our employees, our consumer and business customers and the communities we serve navigate an extraordinarily challenging time. This is what the Webster way is all about. I have to thank each of our bankers for their dedication, perseverance and hard work during the pandemic and through a period of transformation. The commitment to our customers, our shareholders and to each other has enabled Webster to continue to differentiate itself. And before we go to Q&A, I’d like to take a moment to share with you all that today is Terry Mangan’s last earnings call as he will be retiring on March 31st. Many of us and many of you have had the pleasure of working with Terry over his 18-year career at Webster. Terry’s efforts have been recognized at the national level by Institutional Investor as a top Investor Relations professional. I want to thank Terry personally for his significant and long-lasting contributions that have helped our organization navigate through exciting, fun and challenging times. With that, Darrel, Glenn, Chad, Jason and I are prepared to take questions.

Thank you. [Operator Instructions] Our first question has come from the line of Steven Alexopoulos of JP Morgan. Please proceed with your questions.

Hey. Good morning, everybody. I wanted to start on the strategic plan. And I appreciate the $18 million of projected cost saves being called out by 4Q. John, can you give us an idea or maybe Glenn, in terms of the timing of that recognition through the year. I’m just trying to get a better sense of when these cost saves will work into the run rate through the year.

Yes. Steve, I’ll take a shot at it and then Glenn can add some more context. As you said, first quarter, expenses should show the beginning of our expense moves. The second quarter, when the banking center consolidations are complete and many of the employee actions will be complete, will be the real time where we’ll see a more dramatic shift in expenses. And then, we see more savings in the third and fourth quarter. So, without giving you kind of a specific scorecard, I’d say first quarter will be modest. You’ll see a bigger drop in the second and third quarters, getting to that final run rate target.

Okay. That’s helpful. And then, maybe for Glenn, I appreciate the NII guidance for the first quarter. But, if we think about the forward curve, how are you thinking about the trajectory of margin through the year? And specifically, I’m hoping you could comment on the additional opportunity maybe to pay down additional borrowings.

Yes. So thanks, Steve, and good morning. So, I think I would look at two things. One is that, as I highlighted in my prepared remarks, we did see a sort of increase in prepayment speeds, particularly on the CMBS portfolio. And you see that reflected when you look at the yield on the treasury portfolio. So, that’s something that’s changed, and I think that’s industry-wide. So, a little bit of pressure on NIM there -- on core NIM there. As far as borrowings, we do have the opportunity, based on year-end to pay down probably another -- up to $500 million in borrowings. Now those are all short-term, low-rate borrowings. I think, the weighted cost is somewhere around 8 basis points. So, that’s sort of what I would say is point A. Point B would be, on the funding side, we still have about $900 million in CDs coming due in the first quarter, and that’s at 81 basis points, and those will typically reprice down to the high 20s, say 25 to 27 basis points. For the full year, we have about $2 billion in CDs that are coming due at 66 basis points. There is probably 30 basis points to be had on that as well. So, if I look at core NIM, I’m looking at core NIM in the range of -- bouncing around from like 2.85% to 2.87%, give or take. Now, the wild card’s of course going to be liquidity and the stimulus as more money flows into the market, depending on the final bill, we could be left with a lot of municipalities and businesses with a lot more liquidity. And to the extent we don’t see the loan growth, you’d have to either park that money at the Fed or invest some of it. So, we’re constantly looking at those alternatives.

Okay. That’s helpful. Then maybe one final one, assuming Chad’s there. So, HSA account growth was a bit soft in 2020. Can you talk about the outlook for 2021 and maybe any early reads, given the enrollment season that wrapped? Thanks.

Sure. Chad, I’ll throw that directly over to you, if that’s okay.

Yes. That’s great. Thanks, John. Thanks, Steve. Yes. Steve, if you have been tracking our account growth over the last three quarters, we’ve been down about 15% to 20% over prior periods due to the impact of the pandemic on the economy and the labor markets. We’re seeing similar trends in our 1:1 enrollments as core new accounts for January and trending to Q1 or about 20% behind last year at this point. Most of the -- or all the weakness actually really is in our new accounts from existing employers which we’ve stated before, represents about 80% of our account generation. And so, as of the latest information, new accounts, HSA accounts from existing employees are down about 30%. But, as we’ve talked in prior calls, we’re having a very good new employer sales season. So, we’re up about 25% in our enrollments with new employers coming on board. So, in aggregate, we’re down about 20%, which again is in line with the reductions we’ve seen since the pandemic started in Q2 and seems to be consistent across the industry.

Okay. That’s helpful. And before I sign off, congrats to Terry. I can’t wait to get a copy of your book. Thanks, everybody.

Thanks, Steve.

Our next questions come from the line of Chris O’Connell with KBW. Please proceed with your questions. Chris O’Connell: Congratulations to Terry on your retirement.

Thanks, Chris. It’s good to hear from you. Strange to see a different name than Collyn’s since before the financial crisis, quite a long street, but we’re glad to have you on the call. Chris O’Connell: Absolutely. So, just circling back maybe to Chad, following up on the last question. Was that just referring all -- on those percentages to account growth? And if so, do you have a read through as to what the deposit balances might be doing with the enrollment season in the first quarter?

Yes. I’ll just say, we mentioned that the deposits really haven’t tracked along with accounts because of obviously additional seasoning of the accounts, but also because during 2020, the pandemic really slowed a lot of the spend out of the account. So, they are a little -- I don’t want to say artificially higher, but in essence, they are because there hasn’t been too much spend. But Chad, maybe you can put a finer point on what 1:1 looks like or what the year look like with respect to deposits. Okay. Chad just dropped from the call. So, Chris, what I would say is, we said deposits were up about 13% and 15%, respectively. If you take out the State Farm acquisition, it’s 13%, it’s 15%. And so, while accounts were generally flat, if you add back the TPA accounts, and our new account growth was, as Chad said, about 20% behind the prior year. We still had significant growth in deposits, and we’re seeing pretty significant growth in deposits in the first quarter too, more similar to last year. Glenn can give you the dollar amount, but there is that interesting dynamic that the reason that accounts and deposits are kind of separating a bit is because there is not as much many swipes to the individual accounts because people aren’t getting as many elective medical services as they had before the pandemic.

Yes. And I would just add. I mean, our forecast and it’s still relatively early, our forecast for deposits quarter-over-quarter, so fourth quarter to the end of the first quarter is somewhere between $350 million to $400 million at this point.

I think, we have Chad back. I don’t know, Chad, if you heard us. Anything you else you wanted to say about kind of deposits? I talked about them kind of splitting off from account growth because of certain pandemic related trends. Okay. He’s not on. We’ll move on. Chris, does that answer your question? Chris O’Connell: Yes. No, that’s fine. That’s great. The $350 million to $400 million I think is a good starting point. And then, you guys have mentioned I think kind of modest loan growth outlook, at least near term. As you kind of go through the course of 2021, and obviously the environment is kind of constantly changing at this point, but where are you guys seeing loan growth demand, and where are you most comfortable growing loans at this point?

Yes. Chris, I think, that’s a great question. And I always give this answer that every quarter we seem to have significant rises in payoffs or lower payoffs or big spikes in originations, and lo and behold, even in a pandemic year, you look at commercial loan growth. And it’s approaching that 8% to 10% that we kind of are able to produce year in and year out. And I always talk to you guys about all the different levers we have, both geographically and in different sectors and across asset classes. Fourth quarter was interesting. We didn’t see overall balance sheet loan growth at the bank, but we saw actually outflow of mortgage refi, even though our activity was pretty high. And while we had really high originations for what we thought was going to be a pandemic-muted fourth quarter, we also had significant payoffs. And so, while fourth quarter ‘19 was driven really by great commercial real estate growth, fourth quarter ‘20 was driven by great sponsor and specialty growth, particularly in the technology and health care sectors. So, as we look forward, I think there may be still a little bit of uncertainty in the real estate market. Obviously, some property types, retail, we don’t do a lot of. There is not opportunity right now and on a lot of uncertainty in hotel. And so, you think about mixed use, industrial, office, and I think a lot of our key really great real estate investors are kind of taking a pause. So, I would say the pipelines there are okay but not great. I still think technology and health care will drive a good amount of growth. Our middle market and municipality and institutional business has really been solid during this time in this rate environment and we think that will continue. So, I would say, look to C&I more than commercial real estate would be my guess. And then, as it relates -- I think, one of the reasons Glenn talks about modest is because while we do see some pipeline, we also see some forecasted payoff activity. And so, that will be the wild card on whether we can actually significantly grow the loan book.

Hey John, I’m back on, by the way. I’m sorry. I got kicked off here.

That’s all right, Chad.

Thank you so much. Our next questions come from the line of Brock Vandervliet with UBS. Please proceed with your questions.

Just going back to the earlier question on HSA business, it seems like, just stepping back a bit, much of the slower growth is COVID-related in one way or another. What’s your sense of, for example, if we were to get vaccine efficacy midyear, when does the HSA business kind of shake off this hangover?

Yes. I’ll take a shot and then I’ll give it to Chad. I think, again, let me put a high perspective on it. We are still so bullish on the business. Our trends are consistent with what we can read, at least through the periodic Devenir reports and what our pure-play competitors report in conferences. It does seem to be an industry sector experience that we’re seeing. I think, I want to put a finer point on what Chad said before that really the slowdown in account growth was almost entirely related to existing customers we have, not signing up as many new accounts and new employers because of the employment market, right? Many companies aren’t hiring. Some companies are shedding employees. And so, I do think that the good news for us is that during the pandemic, we actually had our best year in terms of driving new large employer wins. And so, while accounts per employer are down, we’re adding customers. And so, as the economy rebounds, as the employment market changes, as confidence gets out there and there is more activity, we feel like we’ll naturally be able to capture new accounts through the new employers we’ve gotten. I think, our best guess, my best guess would be, like everything else, we look to the second half of 2021 when there is a little bit more activity. And then, as we recall, there may be some pent-up demand for medical procedures, which could also mute deposit growth over time. But, we think that’s when we might get more activity in the market. Chad, I don’t know if you disagree or if you have anything further to provide there.

That’s exactly right, John. We think that everything will come back to pre-pandemic levels as the economy opens up and we get beyond the pandemic, so. And you hit all the key points. And just to hit what -- I’m not sure exactly how you answered that, John, but to add to that. Yes, we’re seeing similar deposit growth that we saw last year in the first quarter. So, we expect the first quarter to be about the same. But one of the things we need to keep in mind is the TPA accounts, we expect about 60% of the deposits and accounts to roll off as we go through the rest of the year, not so much in the first quarter, but the rest of the year.

Okay. And a quick accounting kind of follow-up for Glenn. The loss on hedge terminations, $3.7 million, did that flow through NII, or was that...

Yes.

It did.

So, there’s two components. One is a break fee, which is $400,000 that flows through income. The other is -- the remainder is -- flows through net interest income. That was worth about 5 basis points on margin.

Okay, great. I wanted to clarify that. I think that’s important. Okay. Thank you.

Thanks, Brock.

Thank you. Our next questions come from the line of Mark Fitzgibbon with Piper Sandler. Please proceed with your questions.

Hey, guys. Good morning, and congratulations, Terry. First question for you, John, is on the expense initiatives. I’m curious if you think there’s even more room to kind of push costs and efficiency ratios lower, given the increased digitization of the business, once you complete this optimization program. Can you -- do you think you can drive efficiency even lower?

We do, Mark. And we were -- we thought about how to present this. You’ll see on page 18, it really represents the low end of the 8% to 10% range. We do think that we’ll be able to achieve the full 10% in that range, and as we move into 2022, continue to become more efficient and lower the unit cost of delivery. One of the things I want to be clear about is that we are not about generating shareholder value through cost cutting. What we want to do is make sure that we can continue to drive our differentiated Commercial Banking business and our HSA business and our Community Bank business and grow over time. So, hopefully, we become continue to be more and more efficient on a unit cost basis, Mark, over time. Our goal obviously is if we do get a lift in rates and loan growth comes back significantly, we want to be prepared to be able to expand Commercial Banking, hire new commercial bankers, continue to invest in technology. So, our real dollar level of cost may go up, but ultimately, we want to achieve operating leverage, deliver this really significant step in lowering our cost structure, and then over time, continue to drive efficiencies, both on the cost line and by generating operating leverage and higher revenues.

Great. And then, secondly, can you update us on how you’re thinking about geographic expansion and maybe share some thoughts on whether your view with respect to M&A has changed? Obviously, you have a strong currency now. I’m curious how you’re thinking about M&A.

Yes. It’s interesting. I think from a geographic expansion perspective, it’s always on our drawing board. And we have paused obviously in this unique environment over the last few years in kind of a credit frenzy first, a lot of competition and now obviously the pandemic. I could see us expanding in contiguous geographic metro markets to go into middle market. As you know, we have a significant national presence in our key industry sector specialties, which I think we’ve proven over time. We know how to select risks and we have really deep knowledge there. So, we’ve been able to maintain good growth and expansion without planting flags in other cities. But, we do see that as part of the tool of expanding Commercial Banking over time. With respect to M&A, it’s interesting, I got a lot of feedback from the last call that I had pivoted and I certainly didn’t mean to. I mean, I think, the answer for us is always, as you know, we’re very confident in the fact that we believe we’ve got differentiated businesses that we need to exploit over time and we need to continue to invest in. And so, we think we can grow organically over time. We’ve also said that scale matters and that if there were a really, really compelling opportunity in HSA or from a whole bank perspective that had great strategic and financial merits to it, obviously, we would look at it. But I will tell you that this bank right now, particularly, Mark, as you can imagine, undergoing the transformation we’re going through right now is completely focused internally at making sure that we drive value, that we take care of our customers and take care of our own business. And then, we’ll look at opportunities if they arise.

Our next question comes from the line of Jared Shaw of Wells Fargo. Please proceed with your questions.

Hi. Good morning, everyone. This is Timur Braziler filling in for Jared. Maybe starting first on the allowance, just wondering how heavy did you guys lean on the qualitative overlays in keeping the allowance at somewhat of an artificially elevated level. And as we go forward, how should we think about applying these qualitative overlays and what type of pace of reserve release could we see if the economic backdrop and credit picture remains unchanged?

Hey. Timur, good morning. It’s Glenn. Let me take that and then John can add some color. But, I’d first start by saying the quantitative methods still represent a significant majority of our total allowance. So, that’s the first thing to keep in context. And I think with respect to qualitative adjustments, I think in this environment, heightened level of uncertainty, you probably would expect to see a higher percentage of qualitative versus quantitative to account for the unknown. So, I think, the other thing to keep in perspective is through the 10 months of the pandemic, our customer performance has been very different than prior recessions and the qualitative factors help address the risk outside the model. And so, that -- we don’t specifically disclose the qualitative reserve, but as you probably saw in our K, it’s driven by such factors, it’s like credit concentration, credit quality trends, the quality of internal loan reviews, nature and volume of the portfolio, staffing letters, underwriting exceptions and economic considerations that are not reflected in the base.

I think that’s great. I mean, obviously, Timur, you should be in any one of these banks and seeing the processes that we’ve all built to try and leverage lots of data and models. And so, it’s primarily quantitatively driven. The reality, if I can step back just from an industry perspective, right, is for all of us with a mid-30s exogenous shock in GDP in the second quarter, all the models over predicted, the quantitative models over predicted losses, because you’re plugging in a Moody’s model, you’re plugging in GDP, you’re plugging in unemployment. And obviously, we hadn’t seen that in prior history that it predicted short-term significant losses that just weren’t going to come. And now, what you’re seeing on the other side is a little bit of the opposite, right, where you’ve got forward-looking, improved economic outlook. Not a lot of loan growth. So, most banks have pretty consistent portfolio. They’re not having to provide very much for new loans. And the models probably predict too much of a release given the significant uncertainty around things like new strains of the virus, the distribution and efficacy of the vaccines, what’s -- are we going to get the kind of government stimulus that’s targeting the right areas? And so, there’s still a decent amount of uncertainty in there. But, Glenn’s right. The process remains the key for all the banks is to just have the right repeatable, modeled, quantitative-driven process, and then be able to use some level of quantitative factors to make sure that what you see and what is really happening doesn’t overpredict or underpredict future losses. And I’ve been surprised, quite frankly, just editorially, looking at all of our peers and others. And what you’re seeing in the mid-cap space kind of is a general theme of really small provisions to small releases somewhere in that margin. So, we seem to be consistent with a lot of the peers as well.

Right. And could that accelerate if loan growth doesn’t reengage in, let’s say, the next two quarters? Can we see an acceleration of reserve releases as some of that uncertainty rolls off, or are you going to try and maintain some of those balances and incorporate future loan growth into that amount?

So, loan growth is one variable. And so, I think -- so that’s one thing we look at in addition to the economic conditions, the credit quality, risk migration. And then, you got the other factors like government stimulus and things like that potentially down the road. So, it’s hard to say. But, look, I think the $359 million total allowance that we ended the year is our best estimate, and it is a sum of primarily quantitative methods and then supplemented with qualitative methods to account for uncertainty.

Okay. That’s good color. Thank you. And then, last one for me. Just on the second round of PPP, any kind of guidance you guys can provide for us on what kind of magnitude we should be expecting out of the second round, or is it still too early to tell?

It’s probably a little too early to call. But Jason, I don’t know if you want to provide a little perspective on that. I got some more stats this morning. I mean, we’re active. And there’s a good number of applications we have. Jason, do you have some color on that?

Yes. So, in the first couple of days here, we’ve received over 2,000 applications, about $250 million in total volume. We’ve processed a good portion of those and ready to start submitting to the SBA. So, I think, overall, I would say, we probably don’t expect the same level of activity as we had last time around, but the early start has been pretty good.

Our next questions come from the line of Laurie Hunsicker with Compass Point. Please proceed with your questions.

I just want to say, Terry, it’s been a great, great pleasure working with you over the years. Glenn, first question for you on the deferrals and I love the detail you give. Can you just help us understand a little bit maybe more broadly and any color you can give around the hotel book. It seems like we’ve only seen sort of two categories where we’ve seen the upticks understandably. But just if you can help us with any details on that $123 million book, what the LTV is, where they’re located, what’s flagged, any color you can share with us around that? And just maybe the uptick, going from $28 million to $45 million.

Sure. Jason, I’ll throw that right to you, if that’s okay.

Yes. No, that’s fine. So, looking at the book, right, if you step back, it’s really six or seven deals that make up that population. And there is really only two deals that are in active deferral in that population. And both of those are paying interest, right? They’re not paying principal. We’ve given that deferral. And the recovery, we expect it to be slow. But we’ve seen some support of willingness by the sponsors or the owners to put some money into those just to keep it going. And time will tell. Right? And so, it’s not a huge exposure. We’re not overly concerned about it. But, we are obviously monitoring it closely. And just to answer your question, the LTV going into the cycle, and obviously, we all acknowledge there’s been some impact here, but going into is about 60%.

Okay. And then, of your hotel book, the $123 million, how much of that is CRE versus C&I?

It’s all CRE.

All CRE.

Okay, perfect. Okay, thanks. And then, Jason and Glenn, maybe the same question on the $1.4 billion of leverage. Again, that was the only other uptick that we saw in deferrals, and that’s still very, very, very small, obviously, 4.3% deferral rate. But any color you can give around that.

Yes. I’ll take that one. Sure. It was really driven by one credit that migrated -- that produced an active deferral, I would say, offset by a couple of others that came off. And that one credit, we’re really not overly concerned about. We sit in the capital structure on a first out basis with less than 20% loan-to-value. It’s in the leisure space, just so you know. And there is 5 times the amount of junior equity and debt behind us in that deal. And in exchange for us providing a deferral, the sponsor actually put in some equity.

Okay, great. Super helpful. Okay. And then, I just wondered if maybe more broadly, John, just going back to where Mark was going in terms of the M&A question, because again, to his point, your stock is exponentially outperformed here, certainly even recently. And so, that’s very, very strong currency. Can you help us think more generally if you were to consider full bank M&A, what’s the smallest deal that makes sense? What’s the largest deal that makes sense? What’s your sweet spot? Just how you’re approaching that? And I realize you’ve got a lot going on here in the next couple of quarters, but just sort of thinking a little bit further out. Thanks.

Yes. I think, Laurie, it’s hard for me to provide a detailed perspective there. I think, it’s consistent with what I’ve said before. And what we’ve said is that it’s a pretty high bar for us from a financial perspective because we think we’ve got a lot of organic running room and we certainly don’t want to kind of dilute that as we move forward. I would say, if a transaction was really financially compelling, obviously, that would be one of the gating elements. But more importantly for us, it’s around strategy. And you’ve seen the makeup of our earnings streams shift more commercial over time and more wholesale over time and you’ve seen us try and aggressively grow HSA Bank. So, kind of tuck-in acquisitions that are basically branch-based are not particularly interesting to us. So, if something came along that enabled us to gain scale, was financially compelling and was consistent with our strategic view of expanding our Commercial Banking capabilities and enhancing the value of our HSA franchise, that would be something we would look at. So, I would say larger rather than smaller and not really focused on contiguous branch acquisition.

Great, thanks. Okay. And then, Chad, one last question for you on HSA. Just looking at the -- just in terms of both, your noninterest income, just the sharp drop linked quarter and then also just more broadly looking at your HSA efficiency ratio going from 52% to 54%, can you help us think about that a little bit, especially for your NII…

So, Laurie, in my prepared comments, I highlighted the HSA change quarter-over-quarter. There were $3.1 million in TPA fees, exit fees last quarter. So, that’s primarily what you’re seeing on the drop on noninterest income. And obviously, that impacts efficiency ratio as well.

Got it. So, I’m sorry, $3.1 million last quarter staying within that 27.2 -- okay, great. Thank you so much.

All right, Laurie. Thank you.

Our next questions come from the line of Steven Duong with RBC Capital Markets. Please proceed with your questions.

I apologize. I jumped on a little late. So, I’m not sure if you guys covered this. But, on your margin, just looking at your sensitivity, if the yield curves steepen, say that the 10-year gets to 2% by the end of the year, how does that look for your NII going into 2022?

Look, I think if you look at our book, half of it is tied to the short end of the curve. So I think we have about $8.6 billion in one-month LIBOR and other $3.5 billion at three-month LIBOR. So, that’s the primary driver. Obviously, our resi book and our investment portfolio are tied to longer end of the curve, but that will take a while to cycle through.

Got it, Glenn. And just the front end, there is -- you bought this through the floors, is that correct…?

So, we have about $3.5 billion of floors right now and they’re in the money about 50 basis points, 50 to 55 basis points. That’s primarily in commercial, it’s little amount in equity and smaller amount in business banking.

Got it. And then, just if the growth environment, if it’s a little slow this year on loans, you guys are accumulating a decent amount of capital. How are you guys thinking about buybacks and valuation levels that are attractive to you guys and considering that?

Yes. I think, from a full capital management perspective, we’ve talked about, obviously we feel like we’ll maintain the dividend as we go forward just in terms of growing our earnings back into the 40% to 50% payout ratio. We had started, as you know, in the first quarter of 2020 to start buying back shares and the pandemic hit. And obviously, like most of our peers, decided it wasn’t prudent until we had full clarity to continue that. We feel like we’re approaching that point sometime in the first quarter or early second quarter. And so, we do have approved authority, and we expect to look more aggressively at stock repurchase, depending on where the stock price is and what the market looks like beginning over the next several months.

Great. Thank you. And then, just a last one for me. If the corporate tax rate gets to 28%, what would that do to your effective tax rate?

So, that is something that we have been talking about. And obviously, tax strategy is something that we’re continually focused on. But I don’t have a number for you on this call. But, it is something that we’re looking at.

All right. I appreciate it. Thanks, Glenn. And Terry, good luck on the new chapter. It’s a pleasure working with you.

Thanks, Steve.

Our next questions come from the line of William Wallace with Raymond James. Please proceed with your questions.

Thanks for taking my call, guys. I’m just curious, if you look at your commercial loan pipelines starting to build, are you seeing any variations in demand geographically that stands out to you?

Yes. It’s actually a great question. And we’ve been trying to look through all of that. I think it’s -- in some ways, it’s really obvious. There are some geographic issues with respect to whose -- where areas have been opened and where they haven’t been. There is some different -- commercial, in particular obviously consumers kind of rolling in the non-metro suburban areas. Metro is a little bit more challenged. But, I think, at the end of the day, more than geography, Bill, is sector. And so, we continue to see the biggest disparity in loan demand across sectors. And that obviously seems pretty obvious. Those that have been significantly impacted either don’t have the creditworthiness or the ability to take on more capital. Those in the middle who have been slightly impacted are being more conservative in terms of doing things forward that would create the need for more loan capital. And then, of course, as I mentioned earlier, we have some sectors that are growing quite nicely. Technology, technology infrastructure, healthcare, in some of those subsectors we play in and we have expertise. We’re literally seeing unsurpassed demand. So, I would say, it’s really sector-driven more than geographic.

Okay. Fair enough. I appreciate that color. And then, a follow-up on the expense reduction target, that 8% to 10% target from, I believe, it was the third quarter run rate -- operating run rate, are you anticipating -- does that include inflationary pressures, COLAs, [ph] et cetera, that we see in the beginning of every year?

It does. It’s a net number. So, you’ll see even in that walk, we -- investments in businesses, it counts merit increases. We expect to lower that on a real dollar basis.

Okay. And then, also as you look at the forgiveness of the PPP loans, what’s your kind of expectation of timing of that and ultimate level based on what you know now?

So, we have about $1.3 billion at year-end, maybe just a little under that. And we probably -- I would probably say about 40% in the first quarter, 40% in the second quarter and then 10% and 10%, if you just think of it coming out that way. And that can change. But, that’s what I would -- that’s how we’re forecasting right now.

Okay. Thank you. And I will just echo everyone else’s sentiment and say thank you for all the help over the years, Terry. It’s been great working with you, and good luck in your retirement.

Our next questions come from the line of Bernard Horn with Polaris Capital Management. Please proceed with your questions.

Good morning. I also joined a little bit late. So, if my questions are redundant, please move on and I can follow up offline. But first, Terry, thanks for your really highly professional stewardship of Investor Relation functions from the very early days of Webster as a public company. So, we’ve enjoyed it. And thank you for all your work. Two questions. The first is on capital. And I don’t think this is a big deal, but some of the big banks have been concerned that the overwhelming amount of stimulus money showing up in bank balance sheets is pushing assets to a level where they may have capital problems. I know you’ve managed the balance sheet down a little bit, but are there any issues that you can see that moving forward, if you do get a lot more money, any deposit strategies, capital strategies that might affect your management of the bank? And the second, well, I probably should answer that…

Yes. Let me take that one. So, I think we have the opportunity to pay down on a short-term basis probably about $0.5 billion more in short-term borrowings. But, we are getting near the bottom of that. And I think what you’re highlighting is, depending on stimulus and the eventual impact through municipalities and things like that, we could be -- I think the industry is -- seem to have a lot more excess capital. Our loan-to-deposit ratio is 79% as of quarter end. It is something we’re looking at as far as the deployment. If we don’t get the loan growth, do we buy floating rate securities or do we park the money in the Fed? So, those are conversations, Bernie, that we’re having pretty much on a daily basis and just monitoring it.

Thanks. And the second question is just really about we’re all trying to guess which way the post-COVID world goes. Certainly, you’ve been a beneficiary, I think, of the move to suburban and resi. But, on the commercial side, are you seeing any early warning signs that you might be cautious about with respect to the deployment of commercial real estate, office buildings and so forth, and whether do you see any potential problems there? Just -- I’m sure you get the gist of the question.

Yes. It’s actually a great question, Bernie. And it’s nice to hear from you. And I’ll let Jason put a finer point on it. I think, we’ve got really good, strong relationships in our investor CRE group, and I think everybody seems to be a little bit more thoughtful and careful, particularly in metro market buildings. We’re seeing, even on the outside of office, on our multifamily, we’re not big in New York Metro, which obviously benefits us here. We are seeing I think a little bit of stabilization in Boston. And given where we underwrite and the quality of the sponsors, we’re not seeing any cracks in multifamily. I think, in office, we’ve been sort of spending -- I always get my one Bill Wrang mentioned on every earnings call. But Bill, a while back really pivoted. We had I think maybe 35% of our -- 40% of our property types were in office going back 10 years ago. And I think Bill took a decided view at some of the paradigm shifts to move away from that. So, we don’t have tons of metro office, which is good. And I think that, like most people in the industry, our sense now is we’re not really going to know for several more quarters what happens because you’ve got -- obviously, if you look at the real vacancy rates, meaning people in the seats in those buildings and those offices in Boston and New York and Philadelphia where we have real estate exposure, you’re talking 10% to 15%, 20% of the people in their seats. There’s a lot of talk, and I’ve seen in Connecticut, a lot of the big companies and the CEOs I talked to trying to drive an immediate 25% reduction in their occupied office space coming out of the pandemic. But, we also feel, and you also read a lot about people starting to really struggle working remotely, particularly and if you have dedensified office space, you may have -- you may need the same square footage going forward. So, that’s a long way for me of saying, I think it’s too soon. We are not seeing real problems yet. I think, it is too soon to see problems because you don’t have lease renewals. And I think it’s too soon to call what the future of work will mean to office occupancy, but it’s something that we’re really focused on. And we are taking -- your last question was -- I think, we’re taking that into consideration as we look at new potential opportunities, which would mean we’re going to be much more selective. Jason, I probably stole all of your thunder, but is there anything...

No. Okay. I’ll add three quick sort of data points, if you will, to support everything you said, which I think was spot on. So, we’ve got one active deferral in our office portfolio, which is fairly large. It’s about $4 million. So, the portfolio has been performing very well. We’ve not received a lot of deferrals. And to your point about sort of maturity of leases, we’ve got less than 10% of the square footage in our lease portfolio -- our office portfolio coming due over the next couple of years. So, less than 10% in ‘21, less than 10% in ‘22. So, I don’t think there’s a lot of near-term pressure. And the last point I’ll make is that going into this and because we haven’t seen...

Jason, I think we lost you. We’re having technical problems today for the first time.

Can you hear me now?

I can hear him fine.

Oh! You can. Okay.

All right. So, the last point I would add is just going into this, and we still view this as reasonably good until we get more information, our loan-to-value on the entire portfolio is 54% and debt service coverage over 2 times. So, there’s a fair amount of cushion, even if you see pressure on rental rates or occupancy, post COVID.

Great. That’s really -- as always, very good color and thanks for the great conservative way that you’ve addressed that market up to this point. Thanks.

Thanks, Bernie. Stay healthy and safe.

Thank you. There are no further questions at this time. I would like to hand the call back over to John Ciulla for closing comments.

Thanks, Darrel. I appreciate everybody’s interest in the Company, and I wish everybody a happier and healthier 2021. Thanks for joining us this morning.

That does conclude this morning’s conference. You may disconnect your lines at this time. Thank you for your participation. And have a great day.