Webster Financial Corp Q1 FY2022 Earnings Call

Good morning. Welcome to the Webster Financial Corporation's First Quarter 2022 Earnings Call. Please note this event is being recorded. I would now like to introduce Webster's Director of Investor Relations, Alan Herman, to introduce the call, Mr. Herman, please go ahead.

Good morning. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation, for more information about risks and uncertainties which may affect us. The presentation accompanying management's remarks can be found on the company's Investor Relations site at wbst.com. I will now turn it over to Webster Financial CEO, John Ciulla.

Thanks a lot, everyone. Good morning, everyone. And thank you for joining us for our first quarter earnings call. It was an eventful quarter as we closed our merger of equals with Sterling, executed on our integration plan, and announced and completed the acquisition of Bend Financial, all while continuing to generate solid performance in our underlying businesses. I'll begin with some high-level remarks on the macro environment, our performance for the first quarter of '22, and I'll provide a quick update on the merger. I will turn it over to Glenn after that to review our financials, the financial effects of the merger, and to provide our outlook for full year 2022. Despite uncertainty in the macroeconomic environment driven by the war in Ukraine, supply chain, labor market challenges, the lingering impact of COVID, and some of you may have seen that 1.4% surprising GDP contraction this morning, we feel that the underlying strength in economic activity remained strong. Demand for debt financing and continued confidence among our clients is prevalent, and our base case continues to call for solid economic growth, rising interest rates, and positive trending in loan demand over the next 6 to 8 quarters. We're very pleased with our performance in Q1. Our reported net income was a loss of $20 million, and EPS was a loss of $0.14. These results, however, were impacted by various one-time merger-related charges, including the non-PCD double-count provision for Sterling. Excluding these merger-related expenses, adjusted net income was $184 million and adjusted earnings per share was $1.24. Those adjusted metrics equate to a return on assets of 1.37% and a return on common tangible equity of 17%. Loans and deposits grew smartly year-over-year, driving material revenue growth. We effectively managed expenses and our efficiency ratio was approximately 49% for the quarter. Credit performance continues to be favorable; excluding the non-PCD provision included in the merger accounting, our provision for the quarter was $14 million. All credit metrics remained strong, including our non-performing loans and total loans ratio at 57 basis points period-end, down from 71 basis points for standalone Webster a year ago. We closed our merger on January 31st, we're excited to be operating as a combined organization and believe our combination is as strategically compelling today as it was when we announced it a year ago. We now have $65 billion in assets, $54 billion in deposits, and $44 billion in loans as a combined company. As was our intention at the outset, we have created a commercially focused bank that we believe can outperform as we leverage our significant expertise, industry verticals, and broad asset generation capabilities. Our funding and liquidity profile is a differentiated strength for Webster. Our diversified sources of low-beta deposits, particularly from our HSA Bank franchise, should provide a competitive advantage as interest rates rise and liquidity returns to more normalized levels. Our loan to deposit ratio of 80% provides ample flexibility for us going forward. In combination with a predominantly floating rate loan portfolio, we expect significant income improvement in a rising interest rate environment. Our tangible book value per share and capital levels at close were roughly in line with our expectations at the merger announcement. We expect to achieve $60 million in realized cost savings in '22 and another $60 million of savings for the full year of '23. We've begun the consolidation of our corporate real estate footprint and expect to reduce our combined corporate square footage by over 40% by the end of the year. We've eliminated redundant operating costs that were identified, and at quarter-end, the combined organization was operating at 93% of its headcount relative to the merger announcement a year ago. We expect to complete the core banking systems conversion in the third quarter of 2023. All customer-facing rebranding has been completed. In combination with the financial merits of the deal and strong business execution, we are well on the path to sustainably generating the targeted financial metrics we set forth a year ago at the deal announcement, including high returns on tangible common equity. With respect to our outstanding people, we have seen effectively no attrition among client-facing colleagues due to the merger or the competitive labor market. In fact, we've added additional commercial bankers and have a pipeline of teams and portfolios that we believe will help us sustain our growth momentum. We've great business momentum heading into the second quarter; excluding the effects of PPP and the material contraction in mortgage warehouse balances due to the rate environment, linked quarter loan growth for the two legacy entities combined was 1.5% or 6% annualized. Year-over-year growth on the same basis was 8.5%. Growth was driven primarily by commercial categories as anticipated. As we have discussed with many of you, our increased balance sheet capacity allows us to immediately expand relationships with our existing customer base. As a proof point, at year-end 2021, the combined banks had a total of 109 relationships with exposure greater than $40 million. With a bigger balance sheet shifting legal day one of the merger on January 31st, we pre-screened 61 deals and approved 27 deals with exposures over $40 million. These higher old trends contribute to our confidence in reaching our 8% to 10% 2022 full-year loan growth targets. We feel good about our ability to leverage our bigger balance sheet without sacrificing credit quality and without expanding our existing underwriting guidelines. Of note, the weighted average risk rating of our top 100 exposures is more than half a turn better than that of our overall loan portfolio. Asset quality improves as hold levels increase. Deposits on a combined basis also exhibited solid growth this quarter, up 3.2% on a linked quarter basis, and up almost 4% year-over-year. Our deposit cost declined one basis point despite the start of Fed tightening and higher market rates broadly. Growth this quarter was principally driven by HSA and our government banking business. HSA added 288,000 new accounts and core deposits increased almost $0.5 billion. As mentioned earlier, we closed on our acquisition of Bend this quarter, which we view as another proof point with respect to the merger, providing additional opportunities to accelerate growth in low-cost, long-duration HSA deposits.

Thanks, John. And good morning, everyone. Let me start with our period-end balance sheet on Slide 7. At period-end, our total loans were $43.5 billion, total assets were $65.1 billion, and total deposits were $54.4 billion. On a pro forma basis, linked quarter loan growth was led by $442 million in sponsor and specialty and $255 million in C&I. This was partially offset by declines in mortgage warehouse and PPP. Pro forma deposits increased $1.7 billion or 3% linked quarter with growth across all categories, except higher-cost CDs. Borrowings ended the period at $1.6 billion. Capital ratios continue to be exceptionally strong post-merger with a common equity tier one ratio of 11.4% and a tangible common equity ratio of 8.3%. At merger announcement, we had estimated a pro forma common equity tier one ratio of 11.3% at close. Tangible book value per common share was $28.94, down from $30.22 last quarter. A number of factors contributed to this decline, including merger accounting, merger-related charges, and the impact of AFS securities valuation marks on AOCI. Moving on to Slide 8, we detail the various merger and restructuring adjustments for the quarter, including a reversal of accrued strategic initiative expenses, merger-related expenses, and the non-PCD double-count provisions. In aggregate, these three items subtracted $1.38 from EPS for the quarter. On Slide nine, we provide our reported to adjusted and pro forma income statement, which includes the January adjusted results for Sterling. The January Sterling performance is excluded from our reported results as it occurred prior to the closing of the merger. On an adjusted basis, we reported $184 million of net income available to common or $1.24 in diluted earnings per share in the quarter. Our pre-provision net revenue was $242.9 million. Our return on assets was 1.37%, our return on tangible common equity was 17%, and we had an efficiency ratio of 48.7%. I will point out that our adjusted performance benefited from the deferred tax valuation adjustment of $10 million in the quarter, which is reflected in the effective tax rate of 18%. As John highlighted earlier, we feel very good about the trajectory of our returns, given where we are in the integration process. On the next three slides, we have provided trends on pro forma income statement categories to give you a better sense of the starting point as we head into the second quarter. Slide ten shows our net interest income for the quarter. $464 million in total net interest income includes $394 million reported for Webster and $70 million for Sterling in January. This includes $36 million in purchase accounting accretion. The pro forma net interest margin for the quarter was 3.24%, while the net interest margin excluding the effects of purchase accounting was 2.98%. Non-interest income is presented on Slide 11. Non-interest income is again presented on a pro forma combined basis, including Sterling's January non-interest income. When combining Webster's reported non-interest income of $104 million for Q1 with $11 million for Sterling in January, the total is $115 million. The linked-quarter decline from Q4 reflects lower investment gains of $11 million realized at Webster and $5 million at Sterling. In addition, we recognized lower wealth management and mortgage banking fee income. Non-interest expense is presented on Slide 12. Webster reported $255 million in adjusted expenses and Sterling's January adjusted expenses were $46 million, which total to $301.5 million. On a linked-quarter basis, the general trend in non-interest expense was driven by a decrease in Q4 performance-based expenses, which was partially offset by seasonal benefit expenses and intangible amortization. Total and tangible amortization on a pro forma basis was $4.9 million in each of the prior periods compared to $7.5 million in Q1 2022. Moving onto our allowance on Slide 13, the allowance totaled $569 million for the quarter, largely driven by merger-related accounting. The net PCD allowance for Sterling added $88 million and was marked through the balance sheet. The PCD allowance adjustment is the net of $136 million in gross PCD reserves, less $48 million in charge-offs recognized at acquisition, reflecting balances written off by Sterling in prior periods. The non-PCD provision added $175 million in accordance with purchase accounting, this is recognized as a provision in our income statements commonly referred to as the double-count, as the assets are both marked on the balance sheet and income statement. The balance of our increase was the net effect of $9 million charge-offs and $14 million provision expense. Slide 14 shows our key asset quality metrics. As John indicated earlier, our asset quality remains strong, including an NPL ratio of 57 basis points and commercial classified loans total 213 basis points of the commercial portfolio. This compares to 62 basis points and 226 basis points respectively on a combined basis at year-end. On Slide 15, we are exceptionally well-positioned from a capital perspective. Our regulatory capital ratios exceed well-capitalized levels by substantial amounts. Our common equity tier-one ratio of 11.4% exceeds well-capitalized by $2.4 billion, and our tier-one risk-based capital of 12% exceeds well-capitalized by $1.9 billion. Our tangible book value per share of $28.94 is up $0.53 from the prior year. Slide 16 provides our estimated purchase accounting marks at close relative to expectations at the merger announcement. Loan marks totaled $317 million compared to $381 million anticipated at announcement, including marks related to credit, interest, and liquidity. Our security mark of $60 million is lower than the originally anticipated mark of $102 million driven by the higher rate environment. The core deposit intangible is estimated at $119 million versus $106 million at announcements, again, driven by higher rates. We've also added $91 million of intangibles for customer relationships related to recurring revenue portfolios in our commercial bank segment. The property and equipment mark was $23 million. Goodwill and other intangibles totaled $2.1 billion in line with the announcement. On Slide 17, we have provided the expected income statement impacts of the merger. In accordance with acquisition accounting, Sterling's previously scheduled yield accretion and intangible amortization are eliminated. In the first quarter, we realized $34.7 million of purchase accounting accretion in net interest income. Our scheduled accretion for the calendar year is $73.5 million. In the first quarter, purchase accounting accretion benefited the net interest margin by 29 basis points. With respect to intangible asset amortization, Webster reported $6.4 million in intangible amortization in Q1, which includes $5.2 million related to the merger. Total intangible amortization will be $9 million for Q2, including the full effect of the merger and legacy amortization. On Slide 18, we provide our full-year outlook. Each of these items assumes no material change in the macroeconomic or regulatory environment. We expect net interest income of $1.85 billion on a GAAP basis, excluding accretion. Our projection assumes the Fed funds rate ends the year at 2.5%, implying an addition of 200 basis points of rate increases. Our net interest income projection also anticipates loans to grow at 8% to 10% annually, beginning from our legal day one balances of $43.3 billion. We expect fee income of $430 million to $450 million and expenses, excluding one-time costs, to be $1.1 billion to $1.12 billion. So we continue to monitor inflationary headwinds. We anticipate an effective tax rate in the range of 22% to 23% going forward.

Thanks, Glenn. When Jack Kopnisky and I decided to embark on the merger of our two companies, in addition to the financial merits of the transaction, there were several aspects to this merger that made it particularly compelling, including the ability to elevate the best talents from both organizations, the alignment, and the complementary nature of the lending verticals, a uniquely valuable funding base, and scale that would allow us to accelerate investment in differentiated businesses. Already in the first few months as a combined company, we are executing on the strategic benefits we anticipated this merger would provide. We're elevating the best talent from both organizations. The Executive Management Committee is a balanced group coming from each legacy organization. We're committed to building a contemporary and values-based culture in the new organization. The leadership team has coalesced to run an agreed-upon set of core values and expected behaviors. These have been formalized into a culture shaping program already rolled out across the bank. Our company and our colleagues are committed to outstanding corporate citizenship. I encourage you to read our recently published ESG report available on our website. As previously highlighted, we had solid loan originations and net loan growth in key commercial segments, and we're seeing immediate results from our ability to execute larger transactions, particularly in our differentiated sponsor and specialty and institutional commercial real estate business. We have an exceptional low-cost sticky deposit base led by HSA Bank and the consumer banking network of the combined organization. We were able to reduce our cost of deposits by a basis point this quarter and continue to explore new customer verticals and digital delivery channels that should further enhance our funding position. We're investing in digital capabilities. We saw a couple of examples in the first quarter. As previously mentioned, we purchased Bend Financial, a cloud-based solutions provider in the HSA space. We're excited about the technology Bend brings to our platform and the business benefits its client-facing experience will provide. In addition, through our innovations group, Webster joined the USDF Consortium as a founding member. The consortium will work to support like-minded, forward-thinking banks as they work to integrate blockchain capabilities into their operations. As an active and engaged participant in the consortium's activities, we will benefit from the pooled expertise and network effects of other members. We will continue to invest in our data environment and migrate our digital platforms to the cloud. We expect to generate significant returns and excess capital as a combined organization as we set forth in the merger announcement a year ago. This will provide us with significant capital flexibility going forward. We will continue to be disciplined in our capital management framework, allocating capital to those businesses and activities that generate the highest return on equity. We will deploy capital into differentiated and growing organic activities first, and into commercial loan portfolios and select inorganic business or product acquisitions like we did with Bend. We'll also continue to return capital to our shareholders in the absence of organic opportunities through dividends and share repurchases. In Q1, we repurchased over $120 million in shares and have replenished our repurchase authorization as announced yesterday. Finally, I want to thank all of our Webster colleagues for their engagement, efforts, and execution. We've asked a lot of every colleague over the last year, as we were preparing for the merger close and delivering outstanding performance in a challenging macro-environment. Our colleagues stepped up and delivered for our clients, our communities, and for our shareholders. With that, Glenn and I are prepared to take questions.

Thank you. Our first question is from Chris McGratty with KBW. Please proceed.

Great, thanks for the question. Glenn maybe start on the expense. The guide was pretty much in line with what we're looking for. I'm just interested in the cadence, as you realize the $60 million cost savings this year and $60 million next year. Where do expenses effectively go to over the next 4, 5 quarters? And then we lift from there once the synergies are less?

Thank you, Chris, and good morning. I want to elaborate on the $60 million savings, as we have a clear plan to achieve it. It consists of three main areas: eliminating redundancies, consolidating corporate facilities—which John mentioned with a 45% reduction in square footage—and improving operational efficiencies through the consolidation of vendor contracts, operating systems, and automation. We provided guidance indicating that we expect to reach between $1.1 billion and $1.12 billion. I anticipate that by the fourth quarter, we will be nearing around $285 million. However, it's important to note that in the fourth quarter, we typically see an increase in HSA-type expenses, somewhat balanced by decreased healthcare-related employee compensation costs. Therefore, that $285 million is our initial target for the fourth quarter.

Okay. There’s still a bit more to go for 2023, but there are also inflationary pressures.

So look, we're sticking with achieving the additional $60 million in 2023. The big driver of that will be the completion of our core banking conversion, which will generate significant savings. And then we'll, as you would expect, we'll get a full-year run rate of a lot of the initiatives that we executed this year.

And then if I could just one more on the margin. The expansion was a little better than we thought. Can you, given the challenges of two months in the quarter, can you just provide what the March core margin was for liftoff for Q2?

Yeah. 2.98.

That's my estimate month of March.

Ex-accretion, right?

All right. Thank you.

Thanks Chris.

Our next question is from Casey Haire with Jefferies, please proceed.

Yes, thanks. Good morning, everyone.

Morning Casey.

I wanted to discuss the loan growth on slide 5. This quarter has shown a slight slowdown, so could you provide some insight on the mix? There are many factors at play, and the sponsor and specialty areas appear strong. Can we expect a similar mix in the upcoming quarters that will help us reach that 8% to 10% target? Additionally, what exactly do we mean by sponsor and specialty? John, I know you have a strong interest in that vertical. What are the limitations regarding concentration in that area?

It's a great question, Casey. You can probably hear that obviously the contraction in mortgage warehouse and runoff of PPP is what muted the GAAP-reported loan growth. But obviously, for me, the underlying characteristics on page 5 are strong because the proof point on this transaction was in our institutional real estate, C&I, and sponsor and specialty that we had a lot of momentum, and with a bigger balance sheet, we were going to be able to accelerate loan growth, and that's why I'm still pretty confident. Mortgage warehouse is about $500 million in balances right now. We don't see that contracting much more during this kind of purchasing season and kind of our general thought is that that $500 million would be a good average balance for that business for the rest of the year. So neither a big driver of growth nor a drag. But as you noted, our originations were really strong across C&I, sponsor and specialty. And actually, in CRE we just had an inordinate amount of prepayments that spilled over from the fourth quarter in investor CRE. So a lot of momentum there, and I think as we talked about when we announced this deal, our sponsor and specialty business on our $20 billion loan portfolio is a standalone legacy Webster company. We were saying to ourselves, 'hey, are we reaching maybe a threshold of concentration?' And now, on the other side from a legacy Sterling perspective, they had a relative concentration in commercial real estate. You look at this $43 billion loan portfolio and the granular nature of all these categories, we really have significant running room to expand in all these categories. So that 11% growth in a single quarter in sponsor is terrific. Again, some of that was because of lower prepayments, I wouldn't pencil that in. But we expect general C&I across all the middle market businesses, investor CRE, and sponsor and specialty to continue to grow smartly from a good pipeline, stronger loan demand, and the bigger balance sheet. So that's why I think the underlying numbers here from a loan growth perspective are not discouraging because of the geography of what muted the growth.

Okay. Great. And then on the buyback. You guys announced a $600 million renewal last night. Ahead of that your $120 million in the quarter ahead of that $400 million or so expectation at deal announcement. Can you just give us some updated thoughts on your buyback appetite going forward?

Sure. I think we're going to continue to be disciplined and opportunistic. The environment is a bit choppy. Obviously, we had the increased authorization, which makes sense given the size of our company and moving forward. As I articulated, I think our first prize for us is outsized loan growth, portfolio purchases, team lift outs, and opportunistic product enhancements for companies like for our activities in divisions like HSA Bank. But obviously, we look to say a 45% to 65% payout ratio. We prepay a pretty robust dividend and if we don't have line-of-sight to organic investment and we don't feel like there's a recessionary environment right in front of us and we feel pretty confident, we'll certainly use some of that authorization to buy back shares over the course of the next three to four quarters.

Okay. Very good. And just one last question for me, Glenn. On slide 26, regarding asset sensitivity, you noted a 20% beta over the first 12 months of the forecast. Does this apply to 100 basis points of hikes and 200?

So we have increased that, if you recall from the last call, we were in the 11% range. I think that's something that we have to look at and we're using 2021 right now. I think we do have a ramp-up towards the end of the year. The wildcard here, Casey, is if the Fed goes 50 in 50, I think it may spike up, but what we're using in our model right now on a full-year basis, 12-month ramp-up basis, is like 21%.

Okay. Does that apply to both 200 basis points and 100 basis points?

Yes. It does. That holds for 200 as well.

Okay. Very good. Thank you.

Thanks, Casey.

Our next question is from Steven Alexopoulos with JPMorgan. Please proceed.

Hi, good morning. This is Alex Larong for Steve, thanks for taking my questions.

Hi Alex.

As you guys integrate the two companies together, what are some of your more immediate revenue synergies that you're targeting? And beyond that, what are some of the larger opportunities that will take more time for revenue synergies? Thanks.

That's a great question. The immediate revenue synergies include having a larger balance sheet that enables more profitable and extensive relationships with our current commercial clients. This could lead to increased capital market fees depending on the market conditions. We see opportunities for cross-selling as well, such as leveraging our legacy Webster Private Bank to expand into the commercial portfolio at legacy Sterling, which would enhance our penetration in wealth management with a wider range of products and services for our clients. On the longer-term side, we are excited about initiatives through our innovations group to digitally serve 3 million retail clients at HSA Bank and to digitize other products. We believe there's significant potential in using our larger balance sheet and corporate relationships to boost sales of our standard HSA products to a broader corporate client base at Webster. In the short term, expect to see stronger, deeper, and more profitable core commercial relationships, while in the long term, we aim to enhance cross-selling opportunities across the bank and HSA through innovation and digital solutions.

Thanks John, and one question on the HSA business. So coming out of the pandemic, can you talk about the HSA business and if you're seeing some return to normal for that business, such as for balance growth and fee income. Thanks.

Yeah, another great question Alex, and we have. Not back to pre-pandemic levels, but there was muted activity. You probably heard us over the last several calls talk about one of the dynamics was that most of the deposit growth and account growth came actually from existing clients. So further penetration into existing clients. That sort of waned a little bit as general activity slowed during the pandemic. As you heard me mention in my script, we had 288 thousand new accounts. And obviously, net account growth reported was a little muted by the TPA accounts still running off. But that was an increase over last year's account growth, and so that was healthy. Almost $0.5 billion in new core deposits, which was also a positive trend line. And what we did see underlying that was more of our existing clients were signing up new employees to high deductible health plans and HSA accounts. So I'd say that's trending in the right direction towards pre-pandemic levels. And I think we saw the same thing as well in our card swipes and activity just from discretionary healthcare activities and the like. So definitely encouraging, not yet back to where we'd like it.

Yes, and let me just add a little color. On the debit transactions as an example, I think we did $6.9 million in the quarter that's versus $6.4 million. So that's the transaction volume is up year-over-year 8.2, a little over 8%. So we are seeing some of that on a light quarter basis prior year.

Thanks for taking my questions.

Thanks, Alex.

Our next question is from Brock Vandervliet with UBS. Please proceed.

Hey, good morning, everyone.

Morning, Brock.

Morning. Just to follow up on the HSA questions, I noticed the on-balance sheet deposits, your off-balance sheet funds are growing significantly faster. Is that the mix we should expect going forward and then can you compare the economics of the two?

Sure. I'd be happy to. We talk about this a good amount. So the answer is the trend line, obviously, while overall penetration in the investment category is still relatively low. It's increasing, but relatively low. Obviously, the larger balance accounts are the ones that transition into investments. And obviously, when you look at that number, there's also the benefit or a detriment of market performance that moves that around, and so, obviously, over the course of the last year, there were significant expansion in the value of those investments as well as more people going into those investments. It's no secret and we're very transparent about the fact that for us, and I'd say particularly in a rising interest rate environment, the deposits are more valuable to us because we get the full benefit of the value of those deposits to deploy directly into loan and asset growth. With respect to the investments through both our proprietary offering and our other vendor, we only get really 12b-1 fees from that, so we're talking somewhere between 10 and 30 basis points depending on which avenue that runs, and so it is less profitable on its face. However, what we've always said is the investors in our HSA client base tend to have high average deposit balances as well, and tend to be among our stickiest depositors. We want to provide our clients with as much flexibility as we can there. I think at the end of the day, there's a nice virtuous cycle that has allowed us to keep deposit growth running; albeit dollar for dollar, it's not as profitable.

Got it. Okay. As a follow-up, can you provide an expected range for net charge-offs for the combined company, assuming relative stability and no recession in the near future?

I've been surprised by the way credit has performed, even leading up to the pandemic. Before the pandemic, we were experiencing around 20 basis points in annualized net charge-offs. If we consider commercial categories and there is a return to normal, we could expect that the annualized charge-off rate might normalize to around 20 to 30 basis points. While we haven't seen this yet due to various factors like stimulus, this is likely where we believe it will stabilize on a commercial basis.

Got it. Okay. Thanks for the questions.

Thank you, Brock.

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

Hey. Good morning, everybody.

Good morning.

Maybe starting with the NII guide. Does that assume sort of a stable mix of loans and securities in cash from where we are right now? Or is that loan growth accelerate? Should we assume that a lot of that's funded or some of that's funded out of cash and securities?

Yes, it assumes loan growth between 8% and 10%, so roughly 9%. It also takes into account that part of our securities portfolio will support that growth. Overall, that’s our position. We expect to see some borrowings as well. As you know, we've been reducing our cash levels over the past couple of quarters, and our securities portfolio is around $15 billion. We have now entered a phase where we will start to see that grow longer-term, and you may notice a slight decline in the securities portfolio.

Okay, that's good information. And what was AOCI on a combined basis at the end of the quarter?

So total AOCI?

Yes.

The impact of the valuation of securities after tax is $240 million. This influenced our tangible common equity ratio, which stands at 8.26%, a solid figure. This includes a 40 basis point reduction due to the unrealized loss on the available-for-sale portfolio.

Okay, that's great. Thank you. When we consider the accretion this quarter, could you clarify the accelerated pay down you mentioned regarding Gary? What was the actual amount of paydowns? Was that more than you anticipated?

So it was about $15 million in accretion impact as I think I mentioned in my comments. I'm not sure that we had these balances associated with General office circle back with you on the actual loan balances that prepaid on.

Okay. That's good. Thanks. Lastly, following up on Brock's question about the charge-offs, what do we expect for the ratio of the allowance for credit loss as we move forward? Is there still a larger qualitative reserve associated with that or are we fine with the current situation?

I guess that we are at 131 coverage and I think we're expecting like stable ACL ratio and we'll continue to monitor credit quality, macro loan mix, loan growth as well. I think John hit on it in some of his comments, there is a qualitative portion and we're being somewhat conservative on that until we see how things play out over the next couple of quarters.

Yes. I think that's spot on. I think we review really good about the reserve as Glenn said, in other way to say, we think it's relatively conservative. I think there is enough choppiness going forward that it's the right reserve level now. But if we do see some of the uncertainties going forward, the war, some of the other choppiness kind of settled down, we do think there may be an opportunity to lower that reserve a bit.

Great. Thanks a lot.

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

Hi. Thanks for taking the question. You mentioned at the outset about the economy contracting and a question I always seem to get whenever recession enters the narrative related to Webster is your leverage loan exposure. Could you talk about what the exposure is there and any details you can provide to give investors comfort related to historical loss rates, leverage multiples, and equity contribution by private equity sponsors to provide cushion for you guys. Can you rattle off some stats there?

David, I appreciate your question. I could discuss this for quite some time, but I promise to keep it brief. We've seen a contraction in GDP, and I wanted to address that even if it wasn't part of my prepared remarks, so we aren't overlooking the situation. One of the reasons for pursuing this transaction and expanding our balance sheet is that it allows for more flexibility under a prudent management approach. As of the end of the quarter, our leverage loans represented about 6% of our total loan portfolio, with credit performance consistent with the rest of our loans. This has held true even through the financial crisis and the pandemic, where, despite some volatility in risk ratings, the performance has remained strong. We feel we're not heavily involved in large market-level syndicated deals. Instead, we maintain strong, long-term relationships with private equity sponsors and focus on sectors with reliable and predictable cash flows such as technology, data centers, infrastructure, and healthcare. These sectors typically perform well during standard economic cycles and even during the pandemic. We do not engage much in covenant-light transactions. As you mentioned, a key benefit of these deals is the substantial equity backing our senior debt, which means it would take significant changes for private equity firms to alter their commitments. We often collaborate with these firms for over 20 years, building relationships where senior debt and equity yield favorable outcomes. While it’s enterprise-dependent and not secured by hard collateral, we have taken the time to validate our strategies and underwriting in this segment. Overall, this represents just 6% of a $44 billion loan portfolio, positioning us appropriately.

Very helpful. Thank you. And then, shifting over to you guys spoke about the USDF Consortium. I was curious can you talk to the opportunity there, particularly on the deposit front?

Sure. Let me take a step back. We're excited about the Innovations Group, which is led by the former CFO of Sterling. The group is exploring various aspects of banking as a service, including direct banking activities and the Consortium around distributed ledger and blockchain. From an analyst's standpoint, it's important to note that we are experiencing a significant increase in expenses and do not have any immediate revenue expected. Our ultimate goal is two-fold: to support our existing businesses through digital strategies and to continue digitizing consumer and retail banking while seeking effective ways to tap into new profit opportunities. For instance, the Consortium in distributed ledger can be applied to various use cases, such as end-to-end processes in correspondent mortgages, trading and storing loans on a blockchain, or developing efficient 24-hour payment strategies. However, working collaboratively with other banks, technology providers, and regulators means that progress will be gradual. Therefore, while we believe there will be exciting benefits for us starting in 2023 and beyond, we do not expect to see immediate direct advantages in our financial statements for 2022.

Good morning.

Hi Matt.

I want to go to the NII guide, the $1.85 billion for the year given expectations for higher rates and the asset-sensitive balance sheet. Could you help me with the exit rate of core NII in the fourth quarter? It feels like it should be north of $500 million, but curious your thoughts and maybe you can help me hone that down.

You're looking for the exit rate of net interest income in the fourth quarter?

Exactly.

Yes. So I'm not going to be real prescriptive, but it is in the range slightly above the range of $500 million.

Great. Okay. And then what are the blended new loan yields you're putting on the books today, commercial real estate, traditional C&I? And then oppositely, have you started to feel any pressure, even exception-based pricing, on the deposit front at all?

Regarding deposits, there aren't significant changes, except in a few specific government scenarios. I'll answer the second question first. For the first question about rates and spreads, we maintain a disciplined approach across both legacy organizations, although there's some variability across different asset classes. For instance, I'm observing high-quality institutional commercial real estate yielding between L plus 175 to L plus 300. When it comes to sponsors and specialty loans, we have noted that some of those leveraged loans are yielding much higher. Typically, our quarterly origination volumes depend on the mix of loans we have during that period. While the competitive landscape remains tough, we have not experienced any drastic rate compression. We had some rate adjustments before the pandemic, which leveled out, and even with today’s competitiveness, we continue to meet our capital return targets on these loans. The loans with lower yields tend to have better risk ratings, resulting in lower capital allocation for those categories.

Got it. Okay. And then the last one for me is just more out of curiosity. You said you were going to reduce corporate square footage by 40% to 45%. Is that predominantly the double headquarters or Sterling's legacy headquarters, or could you just frame for us what the corporate square footage is? And how much in the way of cost savings is from that?

I believe the annualized figure is about $5 million, and it's not linked to leaving markets or relocating our headquarters. In fact, we have more employees at our Waterbury headquarters than we did prior to the official headquarters move. We are reorganizing our workforce. We have several locations in New York that we will consolidate, particularly concerning the overlap between the two banks. The savings primarily stem from reducing square footage and taking less space in existing buildings or moving to more efficient ones due to the future of work and our hybrid model. Since we're using a campus approach with staff working from various offices, many of our call center operations are transitioning. From an efficiency perspective, we are integrating the HSA Bank, legacy Sterling, and legacy Webster call centers. Even before the merger, these call centers were shifting significantly towards remote work, which is a growing trend in the industry. This shift will also help us reduce our office footprint and related housing costs over time.

Great. Well, I appreciate it. Thank you. That’s all I had.

(Operator Instructions) Our next question is from Laurie Hunsicker with Compass Point, please proceed.

Hey, good morning. I wanted to go back to Jared 's question on AOCI. Can you see what is the actual dollar AOCI loss if you're 8.177 billion of equity?

Though it’s to after-tax loss of $245 million, unrealized loss, unrealized loss. I would look at it, Laurie as I will just reiterate, I mean, there's a lot of talk about this. I'm not sure that we're concerned as maybe some of you are. We're coming from tangible common equity spot of 8.26%. For every 100 basis points immediate shock to the curve, you'd expect it to probably impact the tangible common equity ratio by 40 basis points. So we put that in perspective. You got a 300 basis points rate shock, 300 basis points shock, you'd still be above 7% on your tangible common equity ratio. I understand the concerns and I understand the talk about it, but we're not as concerned about it to be honest with you.

From an economic perspective, the rate increase would significantly benefit our revenue.

No. I hear you, your deposits obviously just became more valuable. It's only marking one tiny piece, but obviously we follow it because we look at tangible bucks. I just wanted to get clarity on that. On net interest margin, net interest income, and appreciate all the slides in the clarity you've given, I just want to make sure that I've got this right. So your guide on accretion income for the full year is $73.5 million, of which $36 million was in the first quarter, dropping to $18.3 million in the second quarter. Did I hear that right?

You did.

Okay.

This is spread out based on the schedule set by contracts. Our loan situation, including prepayments and similar factors, will result in some variability. You can definitely expect that.

Yeah, absolutely. I appreciate the guide. Just putting that together again, it was 29 basis points on your headline margin this quarter, next quarter it drops to 11 basis points on your headline margin.

Exactly.

Extrapolating your $9 million to $10 million, you're looking at falling to around $9 million to $10 million per quarter in the third and fourth quarters, which would translate to about 6 basis points.

Yeah.

That's very helpful. Can you tell me the dollar amount of net interest income from PPP fees this quarter?

It was $5.1 million.

And do you know how much you've got remaining of?

$84 million left in balances, which will run off probably just even in the second quarter. So we should be through it all by then.

Okay. So you probably have just about a million or two left of PPP fees spend on that?

Yes. It's very small. Very small.

Great. Okay. And then on fee income, can you talk to us a little bit about two questions. First, specifically on overdraft fees, I was looking at that. I know Sterling has a higher proportion than you. Was there some sort of drop pro forma or is there some sort of mark or something like that?

No. There's no mark there. I don't if you're looking, there should not be a change. There is no adjustment there.

Can you provide some insight on overdraft NSF fees for the quarter, how you plan to implement more customer-friendly changes, and when we might see those changes impact the non-interest income line?

Sure Laurie, I mean, like the rest of the industry, obviously, we're working as we combine the two banks in integration on harmonizing product set. So we're actually working on creating a product that's obviously consumer-friendly, meets consumer needs, and is consistent with everyone else in the industry. I would say it will not have an impact in 2022. The other important thing to recognize is that our total aggregate overdraft fees are less than 1% of revenue. So less than $20 million across the two organizations. I think you'll see that go down over time as we roll out new products, but it won't have a material impact on our financial performance, and it won't really have any impact on our financial performance in 2022.

And Laurie, let me clarify something because I might have misunderstood your question about volumes. Were you referring to the income statement from our press release? That would only reflect two months with Sterling included.

Right.

So that's probably how it will go down over time as we roll out new products, but it won't have a material impact on our financial performance, and it won't really have any impact on our financial performance in 2022.

No. I might have misinterpreted the Sterling number. I will check that again if there’s no change.

Okay.

And then on the ODNFS fees, I just wanted to make sure I heard that right. So that's running on a combined basis for both of you at about $20 million annually, is that right?

In aggregate.

In aggregate, your credit is looking great. Your commercial charge-offs growth, not net, of $11.2 million showed a significant increase from last quarter, where it was $800,000. Was most of that due to Sterling, or did some of it come from vintage Webster? Could you provide any specific details around that?

Yeah Laurie. I can't provide specific details on that. It was one credit, specifically from Legacy Webster, and it was one commercial credit that accounted for the majority of that charge.

There are no other notable aspects or connections related to it. Okay. Great. And then, just, sorry, one last question here. With respect to Sterling's multi-family book, can you just give us a little bit of color around that? A little refresh, it gets around $4 billion. Does anything you've got on LTVs if you could remind us what's rank control, what your plans are, just any color around that would be helpful. Thank you.

Thank you, Laurie. It's about $3.9 billion. It has a weighted-average LTV at origination of 54% and a debt service coverage ratio on average of about 1.56%, performing very well and generating economic profit. I don't think there are any strategic changes. We actually have a nice business there, and we'll continue to originate where opportunistic. Thank you.

Do you know how much is rent control there?

I don't have any additional information.

Perfect. Thank you so much.

And our final question is from Jon Arfstrom with RBC Capital Markets. Please proceed.

Great. Thanks for squeezing me in. I only have a couple of questions. The growth rate you're talking about, John, the 8 to 10%, how much of that do you think is environmental versus the long-term potential of the company over the next couple of years? I guess my question is, can we see this kind of growth rate for a couple of years from the company?

That's a great question. I believe we have enough leverage, geographic opportunities, and interesting business niches that have historically allowed us to grow commercial loans, which now make up the majority of our balance sheet at around a 10% compound annual growth rate over the past six or seven years. In any given quarter, our mortgage warehouse may influence the annualized growth rate, but particularly this quarter, with a larger base, we feel that all these factors still hold true. We can leverage our strengths without increasing risk, and we have the advantage of a larger balance sheet to accelerate some growth from specific exposures in the short term. As the balance sheet expands, market conditions may present challenges, but I believe we can target close to high single digits or even 10% in annualized loan growth. For mortgages and other consumer categories, this might not be realistic because of market constraints, which could dampen overall loan growth. However, I think aiming for 8% to 10% should be our goal in a typical economic environment as we move forward.

Okay. Good. And then last one. It's a real question, kind of a soft question, but maybe a good way to end the call. But you talked about the culture shaping off-site. And I'm just curious what you've learned from that. What do you guys need to work on? And that's serious, what do you need to work on and then what's gone well so far from those activities? Thanks.

Yes, it's a great question. I think it's the hardest thing and I couldn't be more pleased. If I say that I would be more guarded if I wasn't. I mentioned on a couple of non-deal roadshows, you're in a situation where it sucked, I know that technical term, it sucked, you'd have to wait for four months from our originally anticipated close date. But I think if you asked any of the executives or level 2 or level 3 folks across the organization what the silver lining was, it was the fact that we had four more months to work together in terms of planning and meeting and figuring out each other and building trust. I think that actually helped. We've hit the ground running. I've been really pleased. There's no question about the fact that it will take time to make sure that you get rid of the us versus them, or people are still referring to things like legacy Webster and legacy Sterling. But I have to tell you that we've really coalesced around what it means to be a Webster banker about the behaviors we expect when we went in. I don't want to get too grandiose, when we went into the culture practice as a leadership team, we realized that while we believe that all of these values were what we wanted to do, we had different definitions of what those behaviors were, different expectations. We spent a lot of time saying, we really need to be careful about making sure we're on the same page. We all understand what we're trying to accomplish. We all understand the bank's mission and purpose, and we've come together really, really solidly. Half my direct reports are from each of the legacy banks, and I think we're operating as well as either bank was operating before from a trust and collaborative perspective. We'll keep working it, reinforcing it, but I couldn't be more pleased with where we are 90 days into this project.

Thanks a lot, guys.

Thank you.

This does conclude our question-and-answer session. I would like to turn the conference back over to management for closing comments.

Yeah. I just want to thank everybody for their participation and continued interest in support of the company. Hope everybody has 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.