Webster Financial Corp Q1 FY2024 Earnings Call

Good morning, and welcome to the Webster Financial First Quarter 2024 Earnings Call. Please note, this event is being recorded. I’d now like to introduce Webster's Director of Investor Relations, Emlen Harmon to introduce the call. Mr. Harmon, 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 investors.websterbank.com. For the Q&A portion of the call, we ask that each participant ask just one question and one follow-up before returning to the queue. I'll now turn it over to Webster Financial CEO and Chairman, John Ciulla.

Thanks, Emlen. Good morning and welcome to Webster Financial Corporation's First Quarter 2024 Earnings Call. We appreciate you joining us this morning. I will provide remarks on our high-level results and operations before turning it over to Glenn to cover our financial results in greater detail. We're off to a solid start this year, having achieved a number of significant accomplishments, both strategically and financially. I first want to provide some color around initiatives that solidify Webster's commitment to our clients, communities, and colleagues, as these have been and continue to be core to our company values. In the fourth quarter, Webster launched the You're Home program, a special purpose credit program offering down payment assistance and flexible credit requirements to help expand homeownership opportunities for low to moderate income first-time homebuyers. The You're Home program is the most recent component of our broad community investment strategy, a multi-year commitment to expanding access to capital, providing loans, investments, technical assistance, and financial services to individuals and small businesses in LMI neighborhoods. We are also launching four new finance labs in the coming weeks, in partnership with local non-profits. The Webster Finance Labs Initiative provides technology and programming to create financial empowerment opportunities for young people. By the end of this year, we will have deployed over $1.7 million into nine labs under this initiative. Our colleagues share this commitment to service. Last year, the Webster volunteers gave nearly 17,000 hours of their time to nearly 500 community organizations across our footprint. These are just a few examples of how Webster and our colleagues demonstrate our commitment to our values and our communities. Turning to our financial performance on Slide 2. On an adjusted basis for the quarter, we generated a return on average assets of 1.26% and a return on tangible common equity of 17.9%. Our adjusted EPS was $1.35. We’re pleased to grow client deposits by $1.8 billion and use those funds to redeem brokered deposits. Amidst a challenging growth environment for the industry, we grew loans at 0.7% or 1.2%, when adjusting for the transfer of $240 million of loans to held-for-sale. Our $1.6 billion in funded loan originations this quarter were driven by high-quality C&I, CRE categories including fund banking and public sector finance, and CRE in property types with solid operating dynamics. Our efficiency ratio was 45% in line with the low to mid-40s range we expect to operate in for the year. Our interest income performance was softer than originally anticipated as a number of factors led to lower than expected loan yields, and we saw our deposits continue to reprice higher, albeit at a moderated rate. Despite these dynamics, we still anticipate that NII for the full year will be in the lower range of the guidance we provided in January, assuming loan demand and credit quality of that loan demand cooperate. Structurally and longer-term, we should continue to generate returns near the top of our peer group, given the strategic advantage provided by our funding profile and business mix and the operating flexibility we have created in terms of our liquidity and capital positions. We anticipate the ability to generate a return on assets in the range of 1.3% and a return on tangible common equity in excess of 18% for the full year 2024 and beyond. Our recently closed acquisition of Ametros augments our competitive position. On the next slide, we've provided the overview of Ametros as a reminder of the business fundamentals now that they are officially a subsidiary of Webster. Ametros is a particularly unique and exciting opportunity as the company provides a valuable service for its members and provides Webster with low-cost, fast-growing deposits that add significant fee income. To describe the business in brief, Ametros administers recipients' funds for medical claims settlements via a proprietary technology platform and service teams. Ametros is already illustrating its growth potential, as it has grown to $870 million in deposit balances relative to $805 million in deposit balances when we announced the acquisition in December. It is our expectation Ametros will grow deposits at 25% CAGR over the next five years before considering potential benefits from expanding existing partnerships, new market penetration, or medical cost inflation. Slide 4, which many of you are familiar with now, highlights our funding diversity and now officially incorporates Ametros. As you will see on subsequent slides, we've combined Ametros with HSA Bank in a segment we've named Healthcare Financial Services, with the segment reporting to our talented President and COO, Luis Massiani for the foreseeable future. We will continue to provide business-specific performance measures for both Ametros and HSA Bank. Before turning it over to Glenn, let me touch on overall credit and more specifically, CRE. Consistent with industry trends, we have seen negative risk rating migration and a return to pre-pandemic credit metrics. We continue to proactively monitor our overall loan portfolio and we complete deep dives on targeted segments frequently. While trend lines point to continued pressure on credit performance, excluding office, we haven't seen any concentrated or correlated problem areas with respect to any particular geography, industry sector, or product type. On Slide 5, we provide incremental information on our commercial real estate portfolio, as it continues to be a focal point of investors in a higher-for-longer interest rate environment. Our commercial real estate portfolio is diversified by geography and product type, is conservatively underwritten, and has continued to perform well from an asset quality perspective. In its entirety, our commercial real estate portfolio has a weighted average origination LTV of 56% and an amortizing debt service coverage ratio of 1.5 times. Classified loans are 1.5% of the portfolio with non-accruals of just 10 basis points. As rent-regulated multifamily lending has been in focus this quarter, we provided some of the attributes of our portfolio on this slide as well. As you can see in the incremental detail provided here, our modestly sized portfolio is granular, was underwritten at conservative LTVs and debt service coverage ratios, and adds limited maturities in the next two years. Additionally, a majority of the book was underwritten following the Housing Stability Act passed in 2019. Therefore, our expectations for the performance of those properties incorporates the unfavorable effects of this legislation on property cash flows. In this category, the average loan size is $3.5 million. We have only seven exposures greater than $15 million, and our largest rent-regulated multifamily loan is now $49 million. Given the underwriting of the loans and client selection, the credit performance of this portfolio has been solid, as illustrated by just 10 basis points in classified loans and non-accrual. We have also refreshed statistics on our office exposure on this page, where I will point out that we continue to reduce the size of our portfolio. We are actively working the portfolio, given sector pressures. I would note that our New York City office exposure is a manageable $217 million. In addition to the information here, there are two additional slides at the front of the supplement to this presentation that provide significant detail on our overall CRE portfolio, highlighting the diversity of the portfolio in terms of property type and geography. Importantly, we have been disciplined in terms of hold levels over time, as there are relatively few tall trees in terms of single-point exposures across our various portfolios. Our larger exposures have a stronger weighted average risk rating, as you would expect, and we currently have no classified exposures in the greater than $50 million CRE category. With that, I'll turn it over to Glenn to cover our financials in more detail.

Thanks, John, and good morning, everyone. I will start on Slide 6 with our GAAP and adjusted earnings for the first quarter. We reported GAAP net income to common holders of $212 million with diluted earnings per share of $1.23. On an adjusted basis, we reported net income to common shareholders of $233 million and diluted EPS of $1.35. The largest component of the adjustments was in addition to the estimated FDIC special assessment of $12 million, a one-time tax adjustment of $11 million, and $3 million in Ametros closing costs. In addition, a securities repositioning loss was more than offset by an MSR sale. It is notable that there were no sterling-related merger charges this quarter, and this will continue to be the case. Next, I will review the balance sheet trends, beginning on Slide 7. Total assets were $76 billion at period end, up $1.2 billion from the fourth quarter. Our security balances were up $250 million relative to the fourth quarter. The yield on our portfolio increased 29 basis points linked quarter to 3.64%, via the combination of growth, reinvestment of cash flows, and $388 million in restructuring executed this quarter. Loans were up $373 million, driven by commercial categories and reflective of opportunities to gain market share. While total deposits were flat, we grew core deposits $1.5 billion and retail CDs $350 million, which was offset by a decline in brokered deposits. As John noted, and you can see on this slide, we have aligned Ametros and HSA Bank for segment presentation purposes, while still providing the same data on HSA Bank that we have historically. The loan-to-deposit ratio was 84% in the range of where we expect to operate over the next few quarters. Borrowings increased $1 billion as we use them for liquidity purposes, given the managed decline in brokered deposits. Capital levels remain strong. The common equity Tier 1 ratio was 10.5%, and our tangible common equity ratio was 7.15%, both lower than prior quarter, primarily as a result of the Ametros acquisition. Tangible book value decreased to $30.22 per common share, reflecting the impact of the Ametros acquisition and a small increase in AFS security losses. In a steady interest rate environment, we anticipate $100 million of unrealized security losses would accrete back into the capital annually. Loan trends are highlighted on Slide 8. In total, loans were up roughly $373 million or 0.7% on a linked quarter basis. We reclassified $240 million of payroll finance and factoring loans to held-for-sale. We expect to execute on the sale in the near future. Without the reclassification, loan growth would have been closer to 1.2% linked quarter or approximately 5% annually. Growth was driven by commercial real estate, where we had the opportunities to add new relationships and lower risk asset classes, including $275 million in multi-family and $424 million in general commercial real estate categories. The yield on loans remained flat relative to the prior quarter as a result of a shift in mix offsetting higher loan origination yields. Floating and periodic loans were 59% of total loans at quarter end. We provide additional detail on deposits on Slide 9. We grew our core deposits $1.5 billion and retail CDs $350 million this quarter. Given the strength of our core deposit growth, we reduced brokered deposits. The net effect was effectively flat total deposits on a linked quarter basis. When combined, transactional and low-cost, long-duration health care financial services deposits comprise 46% of our deposit base. Our DDA balances were down $520 million relative to the prior quarter. Two-thirds of the decline was driven by clients moving excess cash balances to higher-yielding money market accounts, with the other third related to specific client transaction activity. Our total cost of deposits was up just 8 basis points to 223 basis points this quarter, as the pace of deposit repricing continues to slow. For the month of March, our deposit cost was 224 basis points. Increases were the results of clients opting for higher-yielding products as well as renewals in the CD portfolio. Our cumulative cycle-to-date total deposit beta is now 41%. On Slide 10, we rolled forward our deposit beta assumptions to incorporate the second quarter, during which we expect our cycle-to-date beta to reach 42%, as a result of lag repricing impact and a continued higher rate environment. Moving to Slide 11, we highlight our reported to adjusted income statement compared to our adjusted earnings for the prior period. Overall adjusted net income was down $18 million relative to the prior quarter. Net interest income was down $3 million from the prior quarter. This was a result of higher funding costs and lower day count, partially offset by higher earning asset yields. Adjusted non-interest income was up $17 million. Adjusted expenses were up $22 million, and the provision increased $9.5 million. Excluding adjustments, our tax rate was 20.7% this quarter up from 19.5% in the fourth quarter. Our efficiency ratio was 45%. On Slide 12, we highlight net interest income, which declined $3 million or 0.6% linked quarter. The decline was related to lower net interest margin and day count. The net interest margin was down 7 basis points to 335 basis points, as a result of increased funding costs, which were partially offset by higher asset yields. Interest rate hedges also contributed modestly to the decline. We recognized $11 million in cost this quarter versus $9 million last quarter. As John highlighted, NIM was below our expectations as the macro environment made it challenging to grow higher spread assets that meet our risk criteria. Our yield on earning assets increased 5 basis points over the prior quarter, with loan yields flat and securities portfolio up 29 basis points. As previously noted, we repositioned $388 million of securities in the first quarter. This will improve our securities yield by 4 basis points in the second quarter. The pace of deposit repricing continues to moderate and was up just 8 basis points. Total liability costs were up 11 basis points. We have provided detail on our hedging program on Slide 27 in the supplement of this presentation, which reviews the bank's asset sensitivity. On Slide 13, we highlight non-interest income, which was up $17 million versus prior quarter on an adjusted basis. $11 million of the increase was driven by our Healthcare Financial Services segment, with $6 million driven by the seasonal increases in growth in HSA Bank and $5 million due to the addition of Ametros. An additional $5 million of the increase was attributed to a non-cash swing in the credit valuation adjustment. The remaining drivers were related to BOLI events, commercial loan, and other deposit fees. Non-interest expense is on Slide 14. We reported adjusted expenses of $321 million, up $22 million from the prior quarter. $10 million of the increase came from healthcare financial services, with $7 million driven by Ametros operating expense and intangibles and $3 million due to seasonality and account growth at HSA Bank. Remaining growth and expenses were related to seasonal increases in payroll tax and benefit costs, annual merit, and performance-based incentives. Slide 15 details components of our allowance for credit losses, which was up relative to the prior quarter. After recording $37 million in net charge-offs, we incurred a $43 million loan provision, of which $38 million was attributable to macro and credit factors and $5 million of which was attributable to loan growth. As a result, our allowance coverage to loans increased to 126 basis points from 125 basis points last quarter. Slide 16 highlights our key asset quality metrics. On the upper left, non-performing assets increased $70 million relative to the prior quarter, with non-performing loans now representing 56 basis points of total loans. Commercial classified loans as a percent of commercial loans increased to 224 basis points from 182 basis points, as classified loans increased by $183 million on an absolute basis. The classified loan increase was concentrated in the C&I portfolio across diverse industries. Our classified loan ratio remained well below Webster's pre-pandemic level. Net charge-offs on the upper right totaled $37 million or 29 basis points of average loans on an annualized basis, consistent with last quarter's level. On Slide 17, we maintained strong capital levels. All capital levels remain at or above our internal targets. Our common equity Tier 1 ratio was 10.5% and our tangible common equity ratio was 7.2%. Our tangible book value was $30.22 a share. I will wrap up my comments on Slide 18 with our outlook for 2024. The outlook includes the impact of Ametros, which closed in January and directly impacts deposits, interest income, fees, and expenses. We expect loans to grow around 5% for the full year towards the lower end of our prior guide. Growth will continue to be driven by our commercial business with more of a tilt to C&I relative to CRE categories. We are reiterating our deposit growth in the 5% to 7% range, with growth in the commercial bank, full relationship deposits, retail deposits, Interlink, Ametros, and corporate deposits. We expect net interest income of roughly $2.4 billion on a non-FTE basis, which is at the low end of our prior guide. For those modeling net interest income on an FTE basis, I’d add roughly $65 million through the outlook. Our net interest income assumes two decreases to the Fed funds rate, with one in September and the other in December. Non-interest income continues to be forecasted in the range of $375 million to $400 million. Adjusted expenses continue to be in the range of $1.3 billion to $1.325 billion. Our efficiency ratio is expected to be in the low to mid 40% range. We expect an effective tax rate of 21%. And of course, we will remain prudent managers of capital. Our long-term Common equity Tier 1 ratio remains at 10.5%. With that, I will turn it over back to John for closing remarks.

Thanks, Glenn. To follow up on one point in our outlook, while we have maintained our longer-term 10.5% common equity Tier 1 target, I anticipate we will run it closer to 11% in the near to medium-term given the increased uncertainty generated by a higher-for-longer bias. We think we would like to have incremental optionality in our pocket, and that would be prudent. Additionally, given higher capital levels in areas for which we see the greatest opportunities for loan growth for the remainder of the year, we anticipate that commercial real estate relative to our total capital levels should decline. Over the next four quarters to six quarters, our intent is to bring CRE concentration to approximately 250% of Tier 1 capital plus reserves with a longer-term target closer to 200% as we approach the $100 billion asset size threshold. There are many more industry headwinds and tailwinds, as we work our way through 2024. But I continue to be very confident in our ability to navigate the current landscape, both offensively and defensively. We will prioritize strong capital levels and disciplined credit management. We will continue to take care of our clients and deepen those client relationships across business lines. We have a diverse funding profile and a loan-to-deposit ratio in the mid-80s, providing us with significant flexibility and optionality on the funding side. Finally, our efficient operating model and unique businesses should allow us to continue to provide better than peer returns consistently over time. Finally, as you are all aware, Glenn recently informed me and our Board of Directors of his intent to retire. We've kicked off a comprehensive search for his successor in partnership with Spencer Stuart. There's been broad interest in the role, and we are confident that we will find a terrific person to fill some big shoes. Glenn will in all likelihood be with us for at least the next earnings call, so I'll save my farewell remarks for July. As all of you know, Glenn has been an invaluable asset to me and to the bank for more than a decade, and he has shined over the last five years through a pandemic, a transformational merger, and the industry events of last March. Thank you all for joining us today. And Eric, Glenn, and I will open the line for questions.

Your first question comes from Matthew Breese with Stephens. Please go ahead.

Hi, good morning everybody. I was hoping to start just on the NIM and NII. If I look at where we are this quarter versus the guide suggests that at some point this year, kind of a material snapback in the overall quarterly cadence of NII. I was hoping you could just help me better understand the rest of the year in terms of NII or where you expect that snapback to occur either on an NII basis or a NIM basis? Thank you.

Yes. Let me begin and John can provide additional insights. We see a couple of key drivers here, Matt. First, we're guiding towards 5% loan growth. On average, this translates to approximately $1.4 billion to $1.5 billion in average loans on a year-over-year basis, which will benefit us. Additionally, in our investment portfolio, we will fully benefit from the restructuring conducted in the fourth quarter and the $1.1 billion addition we made, as well as the restructuring from the first quarter. We continue to identify opportunities in the securities portfolio, where we anticipate about $500 million in cash flow will reprice each quarter, likely leading to an increase of around 300 basis points. Furthermore, while the fixed-rate loan portfolio was somewhat weaker in the first quarter, we expect to see about $800 million per quarter from it, with an anticipated increase of around 200 basis points. These factors provide us with positive momentum. Conversely, we are experiencing pressure on deposits. Our deposit costs increased by 8 basis points in the first quarter, which was a more moderate rise compared to previous quarters. However, as we progress through the cycle, we expect deposit costs to peak in the second and third quarters, which may offset some of the gains from loan growth, investment, and the repricing of fixed-rate assets.

Yes, Matt, I would say that we are making an effort to avoid overpromising and underdelivering, which has not been our approach over the past seven years. The first quarter was notable for us as we experienced back-ended loan growth, with minimal loan growth in Sponsor & Specialty, but we're starting to observe increased activity in that area. Consequently, our loan yields were lower, average loans decreased, and the repricing of our portfolio that Glenn mentioned did not occur as we expected due to a significant decline in prepay, refinance, and repricing activities. We also experienced a short-term shift in deposits, which we anticipate will recover, allowing us to benefit fully from HSA and Ametros moving forward. When you combine what Glenn explained about potential higher net interest income from the securities portfolio, the favorable deposit mix changes, and anticipated standard loan growth—particularly from our higher-yielding loans—you can see why we haven't adjusted our guidance beyond moving to the low end of the initial range we provided. Therefore, we believe our outlook of approximately $2.4 billion remains accurate. If circumstances change, particularly with prepayments and other factors, it could affect our guidance, but this is our best assessment at this point.

I appreciate all that. And the next one is just on credit. All-in-all, the credit metrics look pretty solid, still with the quarter-over-quarter change was notable. You had mentioned there was nothing specific that was driving everything. But I appreciate if there is any sort of common threads, particularly in the C&I book. And then, John, you had mentioned kind of getting to a 200% CRE concentration over time. Does something similar hold through for the reserves, which looks a little light versus your $100 billion bank peers as well?

Yes, there’s a lot to discuss here. From a credit standpoint, you’ve accurately pinpointed the situation. When we examine the credit metrics, the annualized charge-offs for this quarter align with industry trends and are similar to last quarter. While the increase in classified and non-accruals appears significant, our absolute numbers remain below what Webster Bank reported before the pandemic in December 2019. Therefore, it's fair to say that our levels are not alarmingly high. We are noticing a downward trend in risk ratings, consistent with reports from others in the industry. As I mentioned earlier, we anticipate ongoing pressure on credit as we navigate through what we believe will be a modest cycle. We have seen a broad contribution to the classified and non-performing loans, leaning slightly more towards commercial and industrial loans than commercial real estate. We believe we have a strong position in the commercial real estate sector, but the only segment showing negative trends is healthcare services, although we view this industry as having promising fundamentals moving forward. The other issues we've observed have been unique cases, such as specific equipment finance deals and middle market transactions, leading to only a few loans contributing to increased classifications. We aren’t raising alarms across the board; Jason is conducting thorough analyses. I view this as a general deterioration that aligns with industry trends. Regarding our commercial real estate concentration, your calculations suggest we are in the 280 to 285 range. If we maintain that portfolio stability and address upcoming payoffs and roll-offs, we still have room to originate quality commercial real estate loans, particularly since we’re producing some of the best loans now in non-office and rent-regulated multifamily segments due to fewer market participants. This results in improved yields and better structure. As we rebuild the capital lost in the Ametros acquisition, achieving our target of $250 million over six quarters while expanding our balance sheet doesn’t seem overly difficult. Looking ahead, as we approach category four in three years, we will need to reduce our commercial real estate concentration further. Over time, we expect our capital levels and reserves to rise, which we can manage smoothly. Considering our balance sheet makeup, which lacks consumer unsecured loans and credit cards, the transition to this new category shouldn't significantly hinder earnings. Nevertheless, we will likely see developments in our capital and reserve strategies based on the balance sheet composition as we progress.

Okay, thanks. I appreciate all the color. I’ll leave it there. Thank you.

Thank you.

Your next question comes from the line of Chris McGratty with Keefe, Bruyette, & Woods. Please go ahead.

Hi good morning. John, a question on normalized charge-offs. You've kind of been in this 25 basis point, 30 basis point range. How do you view this environment in the context of normal?

Yes. I mean, I think in the benign credit environment leading up to the pandemic, I think we were in the 20 basis point range give or take. The last few quarters, to be completely transparent. Obviously, we had a decent portion of the charge-offs were related to proactive balance sheet management loan sales. This quarter, the vast majority of the charge-offs were what I would call kind of liquidated charge-offs; they happened. They weren't related to asset sales. So I do think that there is more pressure on credit. I think anything below 40 basis points in terms of cycle, 40, 50 basis points in commercial is still absolutely absorbable by our cash flows and our earnings power. I think what I would tell you right now is we are seeing across the industry, the beginning of what I believe will be a shallow credit correction, and the way we look at things going forward, Chris, I still think our provision that The Street has for the full year, it's kind of what we're building in, even looking at our risk rating migration and our classified assets and our non-accruals in the outcomes of the loss given defaults on loans that may be troubled. So this 30 basis points, I’d say, is slightly higher. It doesn't portend to have a huge credit correction. Could it go here in any one quarter. I think you've heard a lot of people say in this earnings cycle. When you have a large commercial loan portfolio, that thing can bounce around a little bit because you really can't control what happens. And if you have a couple of larger charge-offs that could bounce around from that 30 basis points. But I kind of feel like we're in a heightened alert. The ultimate overall metrics still are better than pre-pandemic or around pre-pandemic. And it's a question of whether or not this is deeper. So could you see charge-offs go higher in certain quarters? Yes. Would I be surprised if charge-offs were lower next quarter, I wouldn't be. So I hope that gives you just some color of the way we are thinking.

That's good. Thank you for that. And I guess my follow-up would be, you guys have been early on loan sales, didn't do anything really meaningful this quarter. To get to that CRE targets that you are talking about, is there a scenario where you would accelerate that achievement?

Yeah. I think it's just an economic exercise. We've got some great partnerships. We have some interesting agency eligible loans in our portfolio depending on the interest rate environment and what happens, there is opportunity to do that without taking significant hits. We are looking at everything. And obviously, we want to make sure that our clients, the ones where we have full relationships know that they are banking with us, and we can continue to support them. With respect to non-strategic loans that may have good market value and easily salable, we obviously have some levers to pull. We could have in this quarter, done that. We just didn't think the economics made sense because there wasn't poor credit quality, it was just a question of kind of the earnings and the yields on those loans. So I think my short answer would be yes, as we execute that repositioning and we move forward, and we don't want to jolt the income statement either from having lower earning assets. You will see proactive, selective, and opportunistic loan sales as we move forward, particularly if the interest rate environment moderates as we head into 2025.

Great. Thanks John.

Thank you.

Your next question comes from the line of Mark Fitzgibbon with Piper Sandler. Please go ahead.

Hi guys good morning. Glenn, let me echo John's congratulations on your well-deserved retirement. Glenn, in your modeling, I guess I'm curious, how different would your full-year NII estimate be if we have no Fed rate cuts this year?

Not really. So we have one cut in September and December right now. I think the difference Mark, if I just kept it flat is a total of $4 million. So it's not really relevant.

Okay. Great. Regarding the office book, it seems you have about $260 million in office loan maturities this year. I'm wondering if the borrowers have other options or if you feel obligated to refinance for them. Also, I assume you currently have a good understanding of what’s happening with those individual credits. Are there any potential issues on the horizon with that portfolio?

Yes. I mean, obviously, it's a book we're looking at significantly. It is the area where you've had the biggest decline in valuation. We give you the stats, Mark that say, we start out from a pretty good loan-to-value perspective, pretty good debt service. You've seen a small migration into classified for us. We have done a really good job of taking the book down from $1.7 billion to $1 billion over the last six quarters or seven quarters. I think, now what we are doing is focusing on kind of how we deal with — we're dealing with maturities there, the way we're dealing with maturities across the entire CRE book and consistent with what you've heard from others during this reporting cycle. We have had opportunities, we've been able to refi some. There is, I think — you probably qualify it pretty well that there is not an immediate source of refinancing away from us, quite frankly for most of these loans unless they have unique circumstances. So we had a couple of payoffs, a couple of sales. In most cases where we are doing on the maturities shorter-term extensions. Obviously, you can't — people will say is the industry kicking the can forward, I guess at some level they are — but we can't kick the full can forward as an OCC-regulated bank. So what we are doing is making sure that there is debt service in place at market or near market rates. We're making sure that we get kind of bootstrap collateral. We get debt service coverage reserves, we get guarantees for periods of time. So that's basically what we have. I think we have 75% of our loans now have some sort of credit enhancement either through a guarantee or a debt service reserve. And so we are just kind of working our way through that portfolio. And I think we are fortunate that our overall portfolio is relatively small, more than half of it is Class A. It's geographically diverse. It's not all Metro. And so, so far — and I'm knocking on wood here, we've been able to kind of work with borrowers through it. And despite the precipitous drop in valuation that you are reading about, and we see some of that the owners of these properties, most of them feel like they still have equity in the building, and so they're willing to work with us to make sure we have a solid performing secured loan moving forward.

Thank you.

Thanks Mark.

Your next question comes from the line of Steven Alexopoulos with JPMorgan. Please go ahead.

Hi good morning everyone.

Hi Steve.

John, I want to start on the loan outlook. So for the banks that reported this quarter, most CEOs are sounding a bit more optimistic, citing approved pipelines, customer sentiment, et cetera, and you guys are taking the range down to the lower end, not a massive change, but you're pushing to the lower end. What really changed versus last quarter? And are you not also seeing an improvement in pipelines?

Good question. So I think if you look at the first quarter, we had 1.2% loan growth, which is kind of in line with that 5%. And you're right, first quarter is usually a seasonally low origination quarter and obviously consistent with everyone else, loan demand was sort of muted at the beginning of the year. And then we moved some loans off which we can talk about later with respect to payroll finance and factoring into held-for-sale. I think as we go forward, our Sponsor & Specialty book, Steve, which, as you know, has been kind of a crown jewel of ours and we've seen the beginnings of green shoots and pipeline build there, but it's been slower activity in that sponsor space. And so I think that was one reason. We talked just a second ago with Matt about commercial real estate and the fact that we're going to be a little bit more selective and careful as we move forward in that segment, both with respect to the kind of inherent risks and the optics of our concentration levels there. And what I would say is definitely things getting better. I think the second half could be good. Could we outperform on the 5%? Yes. But as I mentioned earlier, we don't like to overpromise and underdeliver. We were disappointed this quarter by the NII. And I think, we looked at the makeup of our portfolio, went to our business line leaders and thought 5% was the right guide. I'm hoping that we can outperform that. We are seeing better pipelines, we're not seeing as robust pipeline, but I think there's reason to be optimistic for the second half.

Got it. Okay. And then for my follow-up. So on the margin, I know it came in a little bit weaker this quarter, a lot of moving pieces of all-wholesale funding, et cetera. For you, Glenn do you think this is a bottom for the margin this quarter? And how do you think about NIM trending before we get any rate cuts and then maybe if we do get rate cuts? Thanks.

So Steve, I think margin will be relatively flat quarter-over-quarter. Net interest income will improve quarter-over-quarter. But I think the margin where we are right now, 3.35% will probably be relatively flat. I do in our forecast and the assumptions that I laid out before, whether it's loan growth or the investment portfolio, the repricing stuff. I do think that our margin will get to like the 3.45% ish by the end of the year, somewhere around there. Potential upside, depending on how quick we can reduce deposit costs, but that's how we're thinking of it right now. So you can think about a full-year average margin somewhere around 3.41%, 3.42%.

Got it. And I know you mentioned in response to Mark's question that the impact of cuts is not very significant. However, in a scenario where there are cuts, considering Interlink's higher-cost deposits, would that positively affect the margin incrementally by the end of the year if we see rate cuts? Is that the way we should interpret it?

Yes, it would. Currently, we anticipate that deposit costs are peaking in the second quarter and will decrease after that. A significant factor in this is that from our $60 billion in deposits, around 20% have characteristics similar to Interlink, which means they reprice quickly. This includes public funds and other similar products, amounting to about $12 billion in high-rate products that will adjust downward relatively fast. These will be the first to align with any Fed cuts. We expect that the deposit beta will be over 20% on the way down, reflecting a three-month cycle for core deposits. Therefore, when the Fed begins cutting rates, our deposit costs will also decrease. Additionally, we are observing the industry pulling back, and if we examine our CD rates, we had $2.2 billion mature in the first quarter, which repriced higher by 43 basis points. Looking ahead, we have another $2 billion maturing in the second quarter and another $2 billion in the third quarter, which are expected to be neutral. By the third quarter, it might even work to our advantage because we have lowered our rates and reduced the term. Thus, we believe the impact from the CDs repricing will start to ease from the second quarter onwards.

Okay. Got it. Thanks for taking my questions.

Thanks Steve.

Your next question comes from the line of Casey Haire with Jefferies. Please go ahead.

Good morning everyone. I wanted to discuss expenses. You maintained your guidance, which suggests a notable increase from the current run rate. I understand you still need to fully integrate Ametros. I'm curious if that outlook is conservative or if you could provide some insight into the expense pressures at the midpoint of your guidance.

Thank you, Casey. You are correct. We have a complete year and a full quarter of Ametros anticipated going forward, so the expectation is annualized. To address your question directly, I would say the number we are presenting is conservative. This conservatism stems from our focus on expanding our program and operational streams as we aim for $100 billion. We are committed to investing in critical areas, ensuring we enhance our control functions, compliance, and more. Additionally, we are focused on improving our treasury payment systems and digital channels to provide our clients with the quality experiences they deserve. As we have mentioned, we're starting with an efficiency ratio in the mid-40s, which is 10% lower than many of our competitors. Many businesses, particularly those in the $50 billion to $100 billion range, will need to continue investing. Our low starting efficiency gives us some leeway. We do have chances to adjust the timing of expenses and to reassess our business structure. We have discussed extensively over the last two years that while we appreciate our diverse business lines, some are too small to be significantly beneficial, and we've repositioned capital accordingly. You saw this with the mortgage warehouse adjustment and the decision to move payroll finance and factoring balances to held-for-sale as we exited that business. We also have further chances to refine our operations and reallocate capital, which could help alleviate cost pressures. Therefore, I believe this number is realistic considering our forward strategy. It remains conservative because we do have options to leverage if revenue does not materialize as we anticipate.

Got it. Thanks. And then just wanted to circle back on the loan growth. So if I'm understanding you correctly, CRE is kind of run in place. The loan pipeline sounds okay. But CRE drove a ton of growth this quarter, it's 42% of the loans. So that means to hit 5% for the rest of the year, the rest of the portfolio is going to have to average high single-digit pace of growth. It just doesn't seem like that the pipeline supports that. And just some color there on what buckets you're looking to grow to pick up the slack for CRE.

Yes, that’s a valid question, Casey. As you know, our business operates like an aircraft carrier. We can expect strong commercial real estate originations in the second quarter as we work through our pipeline and continue to position ourselves. Over the next six quarters, you will see changes in our balance sheet, and I don’t think we’ll experience a significant decline from a commercial real estate perspective. We are witnessing increased activity in our Sponsor & Specialty business, which has historically seen about 10% compounded annual growth. There’s more private equity activity, and we’re starting to see firms gearing up. We have fund banking available as a strategic lever that is performing well for us, helping us grow high-quality, yielding assets, as well as deposits. In addition to our robust middle market pipeline, we have our asset-based lending and equipment finance businesses, giving us several options to support our profile. Even if commercial real estate slows in the latter half of the year, we have many strategies to navigate that. I have repeatedly mentioned that in a normalized environment, we achieve 10% commercial growth, which we have consistently maintained over eight years. This current environment is rather unique, with fluctuating loan demand, and there’s a desire to moderate CRE growth compared to other sectors. However, as you pointed out, the high single-digit loan growth in other categories does not overly concern us, provided the market remains favorable. We prioritize risk management, and we are confident in our bank’s performance. Despite the pressure on net interest margin, we are sustaining it at 3.35%. Our efficiency ratio stands at 45%, with a return on assets at 1.25% and a return on equity at 18%. We will focus on making prudent short-term decisions, even if it results in a quarter where we don’t meet our goals. I believe our long-term growth targets are entirely achievable. We are not approaching this blindly, Casey; we understand that commercial real estate growth will likely slow, but we are confident in our ability to grow in other asset classes.

Great. Thank you.

Thank you.

Your next question comes from the line of Jared Shaw with Barclays. Please go ahead.

Hi, good morning. Maybe just switching over to deposits with DDA balances declining this quarter. Do you think that we're near the bottom here? Or is there still some more diminishment you expect out of the base? And where do you think deposit growth comes from to hit those targets going forward?

Yes. So let me start by saying we observed an increase in the first quarter with customers moving excess cash into money market deposit accounts. However, looking at my forecast, it appears to have leveled off. In the second quarter, I anticipate a $10.5 billion on demand deposit account balance that will remain stable for the year. Regarding growth, the projections indicate a range of $3 billion to $4 billion in deposit growth. Key factors contributing to this include Ametros, with expectations of around $100 million on the low end and $150 million on the high end, HSA growth between $200 million and $500 million over the year, and Interlink, which I estimate will grow by about $1.4 billion by year-end. We have also continued to see growth in certificates of deposit, with $300 million in the last quarter, and we estimate around $500 million for the full year. The remaining growth will likely come from wholesale funding or channels.

Okay, that’s helpful. Could you provide more details on the credit valuation changes we observed this quarter and the factors that influenced them? Additionally, how do you plan to manage that going forward?

Yes. That's primarily driven by the reduction in rates that you observed last quarter, as rates decreased from the third to the fourth quarter, and then there was a rebound from the fourth quarter to the first quarter. It's mostly due to rates. This pertains to the valuation aspect of our customer derivative book. There has been some fluctuations over the last couple of quarters, making it challenging to forecast, but it can be linked to rates. If rates remain stable now, you'd likely expect stability as well. If rates decline, there could be a slight negative impact, but it wouldn't be as significant as what we experienced from the third to the fourth quarter, which was approximately $4.3 million, if I recall correctly.

Okay. Great. And congratulations on the retirement, looking forward to still talking to you over the next quarter or so.

Thanks Jared.

Your next question comes from the line of Manan Gosalia with Morgan Stanley. Please go ahead.

Hi, good morning. Given the comments on capital and eventually moving that CRE to Tier 1 plus reserve numbers lower than even 250%. Does that mean that buybacks are off the table for the foreseeable future? Or do you think you could restart once you get to that 11% CET1 level? And as we think about that 11% level as well, should we think about that as a more permanent target now given that you want to eventually get to that 200% number? Or is it just a function of moving up reserves, slowing the CRE loan growth, and then you can bring that CET1 number back down to $10.5 million?

Yes, for the foreseeable future, our target is 11%, considering the overall dynamics of our situation and the marketplace, along with some credit uncertainty. I think it's unlikely we will buy back shares in 2024 unless specific circumstances change. We generate significant capital annually due to our profitability. As we did after the MOE closing over two years ago at the 11% level, we will continue to generate capital. If we don't have a suitable internal use for that capital, we will return it to shareholders through dividends or, more likely, buybacks since we are comfortable with our current dividend level. You might see that restarting as we approach 2025 and reach the 11% capital level. From an M&A standpoint, we're not focused on inorganic growth right now. We would like to pursue more transactions similar to the Ametros deal, which offers low-cost deposits and fees. However, our current priority is on achieving our guidance, serving our customers, and rebuilding capital to the 11% level before returning to our typical capital management strategy in 2025.

Very helpful. And then thanks for the detail on the rent-regulated multi-family exposure. I see that most balances were originated post-2019. But can you talk about your comfort level with the credits and the level of reserving for the 35% or so that was originated pre-2019? And are there any details that you can share on that portfolio?

Yes. Those accounts are generally small, averaging $3.5 million in exposure. We conducted a thorough analysis of the credit metrics, performance, debt service, and loan-to-value ratios, comparing those underwritten before and after. We are not observing any differences in performance. Overall, the portfolio is performing well with very minimal classified and criticized assets. A key point about our rent-regulated multifamily and multifamily book overall is that we base our underwriting on current market rents, not relying on anticipated rent increases to service the debt, which has proven effective for us. While higher operating costs can affect net operating income, we have not detected any decline in the portfolio. Currently, we are viewing a similar portfolio structure and performance between the underwrites from before and after 2019.

Got it. And no major degradation in LTVs there either?

No, we haven’t seen it.

Okay, thank you.

Your next question comes from the line of Daniel Tamayo with Raymond James. Please go ahead.

Thank you. Good morning guys. Maybe first just changing gears here, looking at the fee income guide. Just curious if there is something in the $97.5 million core number that you did in the first quarter that you expect to moderate? Or do you think that's a decent number to grow off of in 2024?

Yes, we feel optimistic about our guidance of $375 million to $400 million. We had a strong quarter, and the guidance suggests a range of $92 million to $100 million. To break it down, we'll benefit from Ametros throughout the year, contributing an additional $1.5 million to $2 million starting in the second quarter. We also anticipate increases in loan-related and deposit servicing fees over the year. On the downside, we might experience lower HSA interchange, which typically peaks in the first quarter. Overall, we remain confident in our projections and expect the results to be around $98 million to $99 million.

Okay, great, Glenn. Understood. I have a follow-up regarding deposits. You mentioned that you expect non-interest bearing deposits to remain fairly stable for the remainder of the year. If that prediction were to change and we saw a decline in those balances as the year goes on, how would you address that? Would you seek additional funding through wholesale channels, or how would you approach that situation? Additionally, is there any leverage in the market you would consider?

Yes, regarding the funding gap, the answer is yes. The approach might depend on your loan growth, potentially resulting in an additional mix. You might also observe a shift similar to past trends with money market deposits, which would increase your costs. Additionally, I'd like to highlight that with Ametros and HSA, Ametros is performing at around 7 to 8 basis points, and they have started off quite strong. We closed at $800 million, but we are already at $871 million in just two months. We anticipate good growth from both Ametros and HSA. As John mentioned in his opening comments, looking at our diverse funding profile, we have several options available. To keep it brief, if we encounter more pressure on DDA, we would likely turn to wholesale funding. Lastly, regarding Ametros, it’s noted that we have approximately $3.5 billion of committed future funds related to contractual settlements. This business has a pipeline of $3.5 billion that spans over many years, which presents a significant opportunity for us.

Yes, I think I'm reiterating what Glenn mentioned. In the first quarter, we observed fewer DDAs creating funding gaps, but there were DDAs directed towards higher-yielding accounts within the company. Therefore, it didn't lead to a funding gap; it simply resulted in higher cost deposits.

Okay, great. Thanks for all the color. Appreciate again.

At this time, there are no further questions. I would like to turn the call back over to John Ciulla for closing remarks. Please go ahead.

Thank you very much, Eric. I appreciate everyone joining us this morning. Have a great day.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect your lines.