Q4 2020 Webster Financial Corp Earnings Call
Good morning, and welcome to Webster financial corporations fourth quarter, 'twenty and 'twenty earnings call. At this time, all participants are in a listen only mode.
And after section will follow the formal presentation and.
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As a reminder, this conference is being recorded.
I would now like to introduce Webster's director of Investor Relations Terry Mangan.
We introduced the call. Please go ahead Sir.
Thank you Daryl welcome to Webster. This conference is being recorded also this presentation includes forward looking statements within the Safe Harbor provisions of the private Securities Litigation Reform Act of 1995 with respect to Webster financial condition results of operations and business and financial performance Webster.
<unk> has based these forward looking statements on current expectations and projections about future events actual results might differ materially from those projected and the forward looking statements additional information concerning risks uncertainties assumptions and other factors that could cause actual results to materially differ from those in the forward looking.
<unk> is contained in Webster financials public filings with the Securities and Exchange Commission, including our form 8-K containing our earnings release for the fourth quarter of 2020 on.
Now introduce Webster's chairman and CEO John <unk>.
Thanks, Terry Good morning, everyone. Thank you for joining Webster's fourth quarter earnings call CFO, Glenn Macinnes, and I will review business financial and credit performance for the quarter, after which HSA Bank, President Chad Wilkins and Jason Soto, Our Chief Credit Officer will join us for Q&A.
And we look back on 2020, a challenging year for all of us and so many different ways. My first thought is how proud I am of Webster bankers as they found a weighted to liver for each other our customers our communities and for our shareholders will increase and Covid cases continue to present real challenges. We are optimistic for 2021 will bring a level of normalization.
And as the distribution of vaccines dramatically changes the path of the pandemic the broader economy, including Covid impacted sectors continue to recover and the peaceful transition of power that occurred yesterday, hopefully represents the beginning of a less divisive political environment.
We remain focused on prudently managing capital credit and liquidity as we also positioned ourselves for growth and outperformance as the macro environment improves in 2021 and beyond.
Turning to slide two I'm really pleased with our strong business performance and the quarter. We originated $1 9 billion and loans generated strong loan related fees continued to grow deposits and HSA total footings approached $10 billion credit trends are favorable and the net interest margin has stabilized our adjusted earnings per.
Sure and Q4 were 99 cents up from 96 cents a year ago, our fourth quarter performance includes $42 million of pre tax charges related to the strategic initiatives, we announced last quarter Glenn will provide additional perspective on these charges and his remarks and.
And improved economic outlook with continued uncertainty along with a flat quarter over quarter loan portfolio supported a $1 million seasonal allowance release in the quarter, our fourth quarter adjusted return on common equity was 11, 5% and.
Adjusted return on tangible common equity and the quarter was 14, 2%.
On slide three loans grew 8% from a year ago or 2% when excluding $1 3 billion and PPP loans commercial loans grew 6% from a year ago or more than $800 million.
Deposits grew 17% year over year, driven across all business lines loan yield increased four basis points linked quarter, while deposit costs continue to decline.
Four through six set for the key performance statistics for our three lines of business I'm.
I'm on slide for this.
This was a very strong quarter for commercial banking with more than $1 2 billion of loan originations up solidly from Q3 and down only slightly from a strong for Q2 thousand 19.
Hello, and fundings of $825 million were also up solidly from Q3, we continue to benefit from our industry expertise and deep relationships and select sectors, including technology that have not been adversely impacted during the pandemic commercial.
Commercial bank deposits are at record levels up more than 35% from the prior year's fourth quarter.
The commercial banking loan portfolio yield increased nine basis points, and the quarter, driven by better spreads and enhanced by a higher level and acceleration of deferred fees as we saw payoff activity return to more normalized levels.
Noninterest income and commercial banking was up linked quarter due to higher syndication and other fees tied to the strong origination activity now.
Now turning to HSA bank on slide five.
HSA Bank total footings increased 17% from a year ago and now total nearly $10 billion core deposits were up 15% and 13% excluding state farm acquisition, which closed in 2020.
The year over year increase and balances was driven by continued contributions as well as reduced account holder spending due to COVID-19 restrictions. The tpa accounts declined from a year ago, reflecting the expected departures that occurred in Q3.
We added 668000 accounts in 2020, 10% fewer than we added in 2019, consistent with industry trends and due primarily to lower enrollments with existing employers as COVID-19 impacted the overall employment environment. We expect this trend to continue into the first half of the new year.
HSA deposit costs continued to decline as we remain disciplined and the slow interest rate environment and totaled 9% and the quarter nine basis points excuse me and the quarter.
I'm now on slide six.
Community banking loans grew 5% year over year and declined 5%, excluding PPP as indicated on the slide PPP loans decreased $63 million as we saw repayment and forgiveness activity again in the quarter community banking deposits grew 14% year over year with consumer and business deposits growing 9% and 31%.
And <unk>, respectively deposit costs continued to decline and totaled 16 basis points and the quarter net interest income grew $8 3 million from a year ago, driven by overall loan and deposit growth.
The next day next two slides address credit metrics and trends, which continue to be surprisingly stable given all the challenges and the macro environment on slide seven we show our commercial loan sectors. Most directly impacted by Covid overall loan outstandings to these sectors have declined 10% from September 30, and payment deferrals have declined $64 million.
For a 31%.
On slide eight we provide more detail across our $20 billion commercial and consumer loan portfolio. The key takeaway here is the payment deferrals declined by 35% to $315 million at December 31, and now represent one 6% of total loans compared to two 4% of total loans at September 30th.
At year, and $100 million or 32% of the $315 million and payment deferrals are first time deferrals and.
Cares Act and inter agency statement defined payment deferrals, which are included in the $315 million of total payment deferrals at December 31 day.
Decreased 29% from September 30, and now stand at 201 million.
While challenges related to the pandemic and the overall economy remain and I am pleased with the considerable support we've been able to provide to our customers as they work through these challenging times, we continue to actively monitor risk make real time credit rating decisions and address potential credit issues proactively we remain confident about the quality of our risk selection and hunter.
Underwriting processes, our portfolio management capabilities and our capital position on.
I'll now turn it over to Glenn for the financial review.
Thanks, John and I will focus on the key aspects of the performance and the quarter, including stable adjusted net interest margin and increase in noninterest income ongoing expense control and a favorable credit profile.
And begin with our average balance sheet on slide nine average securities grew $160 million or one 8% linked quarter.
<unk> represented 27% of total assets at December 31.
Average loans declined $142 million or 6% linked quarter, primarily driven by $176 million decline and consumer loans, reflecting higher pay down rates and mortgage and home equity portfolios.
Prepayment and forgiveness on PPP loans during the quarter totaled $98 million and.
And Q4, we recognized $7 3 million of PPP deferred fee accretion and the remaining deferred fee balance totaled $27 million at December 31.
Deposits increased $276 million linked quarter, primarily driven by growth and community banking and HSA and this was partially offset by a reduction and Cds.
And the strong growth and deposits allowed us to pay down borrowings, which were lower by 289 million for Q3 at.
At $1 9 billion borrowings represent five two percentage of total assets compared to 7% at September 30, and 11, 6% and prior year.
Tangible common equity ratio increased to seven 9% and it will be 32 basis points higher excluding the $1 3 billion and zero percent risk weighted PPP loans and tangible book value per share at quarter and was $28 for an.
On increase of about 1% from September 30th and 3% for prior year.
Slide 10 highlights adjustments to reported net income.
Aggregate adjustments totaled $42 million pretax or <unk> $31 2 million after tax representing 35 per share.
Of the $42 million and adjustments $38 million is related to our strategic initiatives, which John will discuss further the.
And the remaining for one is associated with the debt prepayment and the prepayment expenses adversely impacted current quarter net interest income and impacted net interest margin by five basis points. However, we will benefit by approximately $1 3 million and net interest income per quarter, and NIM will benefit by two basis points.
On slide 11, we provide our reported and adjusted income statement.
As highlighted on the previous page the adjustments total $42 million pre tax.
On an adjusted basis net interest income increased by $1 3 million from prior quarter. This was the result of a $44 5 million reduction and deposit and borrowing costs, along with $1 million and additional loan income, which was partially offset by a $4 million decline and securities income primarily as a result of elevated prepayments.
Taken together, our adjusted net interest margin of two 8% was flat to third quarter.
As compared to prior year net interest income declined by $11 million $47 million of the decline was the net result of lower market rates and was partially offset by interest income of 29 million from earning asset growth and $8 million from a reduction in borrowings.
Non interest income increased $1 7 million linked quarter and $5 9 million for prior year.
Loans fees increased $2 5 million from prior quarter as a result of higher syndication prepayment and line usage fees.
Other income increased $4 4 million, reflecting higher direct investment income and swap fees.
<unk> HSA fee income decreased $3 1 million linked quarter. As Q3 included $3 2 million of exit fees on Tpa accounts mortgage banking revenues decreased $3 million linked quarter as a result of lower volume on loans originated for sale.
The $5 9 million increase and noninterest income for prior year reflects additional loan fees and higher mortgage banking revenue and HSA fee income, partially offset by lower deposit service fees.
Noninterest expense of $181 million reflects an increase of $2 million, primarily due to technology and seasonal increases and temporary staffing to support the HSA annual enrollment non.
Noninterest expense decreased $1 5 million or 1% for prior year, and our efficiency ratio was 60% and the quarter.
Pre provision net revenue was $116 million and Q4. This compares to a $115 million and Q3 and $122 million and prior year.
Our CSO provision and the quarter reflects a credit of $1 million, which I'll discuss in more detail on the next slide and our adjusted tax rate was 22, 1%.
Turning to slide 12, I will review.
The results of our fourth quarter allowance for loan losses under <unk>.
The allowance coverage ratio, excluding PPP loans declined from one 8% to 176% with total reserves of $359 million. The reserve balance reflects our lifetime estimate of credit losses.
A small decline from prior quarter is the net effect of and improvement in the macroeconomic forecast, partially offset by additional qualitative reserves and the increased increase and qualitative reserves is driven by uncertainty around the resolution of the pandemic and the pace of the recovery.
The total reserves provide a more adverse scenario and then shown and the baseline assumptions at the bottom of the page.
Slide 13 highlights our key asset quality metrics as of December 31 non.
Nonperforming loans and the upper left increased $3 million from Q3 commercial residential mortgage and consumer each saw linked quarter declines, while commercial real estate and increased.
Net charge offs and the upper right decreased from the third quarter and totaled $9 4 million after $1 9 million and recoveries for net charge off rate was 17 basis points for the quarter.
Commercial classified loans and the lower left increased $30 million from Q3 and represented 352 basis points of total commercial loans.
Slide 14 highlights our liquidity metrics are diverse deposit gathering sources continue to provide us with considerable flexibility deposit growth of $414 million exceeded total asset growth and lowered the loan to deposit ratio to 79%.
Our sources of secured borrowing capacity increased further and totaled 12 billion at December 31.
Slide 15 highlights our strong capital metrics regulatory capital ratios exceed well capitalized levels by substantial amounts our common equity tier one ratio of 11, 35% exceeds well capitalized by $1 1 billion Likewise tier one risk based capital of $11, 99% exceeds well capitalized levels.
$895 million.
Our guidance will continue to be impacted by the pace and duration of the pandemic over the next few quarters.
That being said, we anticipate modest loan growth, excluding the timing of PPP for goodness and round to originations.
NIM will also be influenced by the rate environment and PPP forgiveness, assuming today's rates, we would expect net interest income to be around Q4's level non.
Noninterest income will be modestly lower linked quarter, driven by lower loan related and mortgage banking fees. The provision for credit losses will continue to be impacted by credit trends the macroeconomic environment Dumber government stimulus and the duration of the pandemic.
Core operating expenses will be lower as we begin to recognize the benefits of our strategic initiatives and our tax rate will be approximately 21% to 22%.
With that I'll turn things back over to John for a review of our strategic initiatives. Thanks Glenn.
I'm on slide 16, as we discussed on the October earnings call, we've been working through a comprehensive strategic and organizational review since before the onset of the pandemic and while today, we will provide more detail on our progress and some shorter term financial targets I want to stress that the work we've done over the last year and the actions. We are taking are transforming our company.
And the way we do business, we believe that we will continue delivering incremental value to our customers and shareholders for years to come and consistent with our overarching objectives of maximizing economic profits and creating long term franchise value.
Accordingly, these actions afford us the capacity to invest and the future and provide better customer experiences through improved products services and digital offerings. All in furtherance of our mission to help individuals families and businesses achieve their financial goals, we are investing and revenue growth drivers that leverage our differentiated businesses. These are.
Include accelerating growth and new and existing commercial banking segments, improving sales productivity enhancing noninterest income through treasury and commercial card products and driving deeper relationships across all lines of business. While we anticipate short term benefits from these initiatives they will contribute meaningfully to our financial performance in two.
<unk> thousand 22, and beyond Additionally, we continue to invest and technology to provide better digital experiences for our customers and bankers to further improve customer acquisition and retention rates.
As shown on slide 17, we have made significant progress on our efficiency opportunities, we remain on track to deliver and 8% to 10% reduction and core noninterest expense.
We expect this to be fully realized on a run rate basis by the end of the fourth quarter of 2021.
Our efficiency initiatives fall into three key areas of focus that we discussed last quarter.
Rationalizing retail and commercial real estate.
Simplifying the structure of the organization and optimizing our ancillary spend.
We've taken actions to simplify our organizational structure, including combining like functions automating manual processes and selectively outsourcing commoditized activities a portion of the project related expense adjustments that Glenn discussed related to these actions and the associated severance costs result from a targeted reduction and the overall workforce.
We announced in December the consolidation of 27 banking centers and we have targeted actions aimed at reducing corporate office square footage over time, the real estate optimization plan reflects our response to changes in customer preferences, and the shift and workplace dynamics that have only accelerated during the pandemic.
The remaining quarterly cost benefits will be driven by a more disciplined approach to ancillary spend redesigning and automating internal critical processes and leveraging back office synergies slide.
Slide 18 provides an overview of the cost savings and and expense walk to our fourth quarter target run rate.
Achieving these efficiencies will allow us to continue to invest and our franchise and improve the customer experience.
The last slide for me is an important one we've updated it from prior quarters.
It aggregates our activities during 2020 related to helping our employees, our consumer and business customers and the communities, we serve navigate and extraordinarily challenging time. This is what the Webster way is all about.
I have to thank each of our bankers for their dedication perseverance and hard work during the pandemic and through a period of transformation and commitment to our customers our shareholders and to each other has enabled webster to continue to differentiate itself.
And before we go to Q&A I'd like to take a moment to share with you all that today as Terry Mangan last earnings call as he will be retiring on March 31.
Many of US and many of you have had the pleasure of working with Terry over his 18 year career at Webster and <unk> efforts have been recognized at the national level by institutional Investor at the top Investor Relations professional I want to thank Terry personally for a significant and long lasting contributions that have helped our organization and navigate through exciting fun.
John and challenging times, and with that Darrell Glenn Chad, Jason and I are prepared to take questions.
Yeah.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.
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Yes.
Our first question will come from the line of Steven Alexopoulos of J P. Morgan. Please proceed with your questions.
Hey, good morning, everybody.
Hey, good morning.
I wanted to start on the strategic plan and I appreciate the $18 million of projected cost saves being called out by for Q. John can you give us an idea on maybe Glenn in terms of the timing of that recognition through the year I'm just trying to get a better sense of when these cost saves on work into the run rate through the year.
Yes, Steve I'll take a shot at it and then Glenn can add some more context.
As he said first quarter expenses should show the beginning of <unk>.
<unk> expense moves the second quarter when the banking center consolidations are complete and many of the employee actions will be complete will be the real time, where we'll see a more dramatic shift and expenses and then.
We see more savings and the third and fourth quarter, so without giving you kind of a specific scorecard I'd say first quarter will be modest youll see on a bigger drop and the second and third quarters getting to that final run rate target.
Okay.
That's helpful and then maybe for Glenn I appreciate the NII guidance for the first quarter, but if we think about the forward curve. How are you thinking about the trajectory of margin through the year and specifically I'm, hoping you could comment on the additional opportunity maybe to pay down additional borrowings.
Yes so.
Thanks, Steve and good morning.
So I think I would look at two things one is that as I highlighted in my prepared remarks, we did see sort of increase and prepayment speeds, particularly on the MBS portfolio and.
And you see that reflected when you look at the yield on the treasury portfolio. So.
That's something that's changed and I think that's industry wide, so a little bit of pressure on NIM there on core NIM there.
As far as borrowings we do have the opportunity based on year and.
The Paydown probably.
Another for up to $500 million and borrowings now those are all short term.
Low rate.
Borrowings I think at a weighted cost and somewhere around eight basis points. So that's that.
Sort of what I would say is eight point they would be on the funding side.
We still have about eight on $900 million and Cds coming due and in the first quarter and Thats at 80, 81 basis points and those would typically reprice down to.
The high Twenty's and they say 25 to 27 basis points for the full year.
We have about $2 billion.
And Cds that are coming due at 66 basis points, there's probably 30 basis points to be had on that as well.
So if I look at core NIM.
And I'm looking at core NIM and a range of two and bouncing around for like 285 to 287 give or give or take.
Now the Wildcards for of course going to be liquidity and stimulus as more money flows into the market depending on the final bill.
Left with a lot and municipalities and and businesses with with a lot more liquidity and.
And to the extent, we don't see the loan growth.
And you'd have to either parked that money and deferred or or invest some of it and so we're constantly looking at those alternatives. Okay. That's helpful. And then maybe one final one.
Chad there so HSA account growth was a bit soft and 2020, you talk about the outlook for 2021, and maybe any early reads given the enrollment.
Season, and that ramped thanks, sure Chad I'll throw that directly over to you if that's okay.
Yeah, that's great. Thanks, John Thanks, Steve.
Yes, Steve.
You've.
And tracking our account growth over the last three quarters, we've been down about 15% to 20% over prior periods.
The impact of the pandemic on the economy and the labor markets.
We're seeing similar trends and our one one enrollments as for new accounts for January and.
Trending into Q1 or about 20% behind last year at this point.
Most of the or all the weakness actually really is and our new accounts from existing employers, which we've stated before represents about 80% of our account generation.
And.
So as of the latest information new accounts HSA accounts from existing employers and down about 30%.
As we've talked on prior calls, we're having a very good new employer sales season, So we're up about 25%.
And our enrollments with new employers coming on board so.
So in aggregate were down about 20%, which again is in line with the reductions we've seen since the pandemic.
And Q2, and and and it seems to be consistent across the industry.
Okay, that's helpful and before I sign off and congrats Terry I can't wait to get a copy of your book.
Thanks for everybody.
Thanks, Steve.
Yeah.
Thank you. Our next question comes from the line of Chris O'connell with <unk>. Please proceed with your questions.
Good morning, General and and congratulations to Terry on your retirement thanks.
Thanks, Chris it's good to hear for you a strange to see a different name and Collins the principal for the financial crisis.
Quite a long streak, but we're glad that we're glad to have you on the call.
Absolutely.
So just circling back maybe to Chad following up on the last question.
Or is that just referring all on those percentages to account growth and if so do you have a read through as to what the deposit balances might be doing with enrollment season, and the first quarter.
Yes.
We mentioned that the deposits really havent tracked along with accounts because of obviously additional seasonality seasoning of the accounts, but also because during 2020, the pandemic really slowed a lot of the spend out of the accounts. So there are little I wont say artificially higher but in essence, they are because there hasnt been and into one.
And.
Chad maybe you can put a finer point on what one one looks like or what the year looks like with respect to deposits.
Oh.
Okay, Chad just dropped from the call so Chris what I would say is.
We said deposits were up about 13% and 15% respectively. If you take out the state farm acquisition.
13% is 15% and so while accounts were generally flat if you add back the tpa accounts and our new account growth was as Chad said about 20%.
On a percent behind the prior year, we still had significant growth in deposits and we're seeing pretty significant growth in deposits and the first quarter two more similar to last year. Glenn can give you. The dollar amount, but there is that interesting dynamics that the reason that accounts and deposits are kind of separating a bit is because.
There's not as many swipes to the individual accounts because people aren't getting.
As many elective medical services as they had before the pandemic and I would just add on and off.
Our cash and it's still relatively early on our forecast for deposits.
Quarter over quarter, so fourth quarter for the end of the first quarter somewhere between.
$3 $50 million to $400 million at this point.
I think we have Chad back that we I don't know Chad if you heard US anything you wanted to also wanted to say about kind of deposits I talked about that and kind of splitting off from account growth because of certain pandemic related trends.
Okay.
Okay. He is not on we'll move on and Chris does that answer your question.
Yes, no that's fine.
That's great and the 350 Department and I think.
<unk> is a good starting point.
On.
And then you guys had mentioned and I think.
And a modest loan growth outlook at least near term.
Kind of go through the course of 2021.
And so obviously the environment and it's kind of a constantly changing at this point, but.
And what are you guys seeing loan growth demand and where are you on most comfortable.
Growing loans at this point.
Yes, Chris I think that's a great question and I.
Please give this answer that every quarter, we seem to have significant rises and pay offs or or lower pay offs or big spikes and originations and lo and behold even in a pandemic year, you look at commercial loan growth and its approaching that 8% to 10% that we kind of are able to produce year in and year out and I always talk to you guys about all the different levers we have both.
Geographically and in different sectors and across asset classes.
Fourth quarter was interesting we didnt see overall balance sheet loan growth at the bank, but we saw actually outflow of mortgage refi, even though our activity was pretty high and while we had really high originations for what we thought was going to be a pandemic muted fourth quarter. We also had significant pay offs and so while fourth quarter.
<unk> 19 was driven really by great commercial real estate growth fourth quarter, 'twenty was driven by great sponsor and specialty growth, particularly in the technology and healthcare sectors. So as we look forward I think there may be still a little bit on of uncertainty and.
And the real estate market, obviously, some property types you know retail we don't do a lot of theres not opportunity right now and on a lot of uncertainty and hotel and so you think about mixed use industrial office and I think a lot of our key really great real estate investors are kind of taking a pause.
So I would say the pipelines there are okay, but not great and I still think technology and health care will drive a good amount of growth, our middle market and municipality and institutional business has really been solid during this time and this rate environment and we think that will continue so I would say look to C&I more than commercial real estate would be.
And my guess and then as it relates I think one of the reasons Glenn talks about modest is because while we do see some pipeline. We also see.
Some forecasted payoff activity and so.
That'll be the wildcard on whether we can actually significantly grow the loan book.
Got it that's helpful. That's all I had thank you.
Thanks, Chris.
Hey, John and back on by the way sorry, I got kicked off here.
John.
Thank you so much. Our next question is coming from the line of Brock Vandervliet with UBS. Please proceed with your questions.
Yeah. Thanks, good morning.
Good morning, Brock and maybe.
Good morning, just going back to the earlier question on on the HSA business. It seems like just stepping back a bit much of the.
Slower growth as Covid related and one way or another whats your sense of you know for example, if we were to get no.
Vaccine efficacy.
Mid year.
When does the.
The HSA business kind of shake off this.
This hangover.
Yes, I'll take a shot and then I'll give it to Chad I think again, let me let me put a high perspective on it we are still so bullish on the business.
Our trends are consistent with what we can read at least through the periodic Devin and reports and what are our pure play <unk>.
<unk> report and conferences, it does seem to be and industry.
Sector experience that we're seeing.
I think I want to put a finer point on what Chad said before it really the slowdown and account growth was almost entirely related to existing customers we have.
Not signing up as many new accounts and new employers because of the employment market and many companies arent hiring.
Some companies are shedding employees and so I do think that.
And the good news for US is that during the pandemic, we actually had our best year in terms of <unk>.
And driving new large employer wins and so while accounts per employer are down, we're adding customers and so as the economy rebounds, as the employment market changes as confidence gets out there and there is more activity. We feel like we will naturally be able to capture new accounts through the new.
New employers, we've gotten I think our best guess might get by best guess would be like everything else, but we look for the second half of 2021.
When there is a little bit more activity and then as we recall there may be some pent up demand for medical procedures, which could also.
Deposit growth over time, but we think that's when we might get more activity and the market Chad I don't know if you disagree or if you have any and even further to provide there.
And that's exactly right John.
I think that that everything will come back to pre pandemic levels as.
The economy opens up and we get beyond the pandemic so and.
And you hit all the key points and and just to hit.
And what those.
I'm not sure exactly where and how you answered that jamba to add to that.
We're seeing similar deposit growth that we saw it last year and the first quarter. So we expect first quarter to be about the same and but one of the things we need to keep in mind as the Tpa accounts, we expect about 60% of the deposits and and accounts to roll off as we go through the rest of the year not so much on the first quarter.
But the rest of the year.
Thanks, John.
Okay and.
Quick accounting kind of follow up for Glenn.
The loss on hedge terminations $3 $7 million that flow through NII or was that.
And it did so there's two there's two components one is it break.
A break fee, which is 400000 net flow through income.
And the remainder is the flow through net interest net interest income.
It's worth about five basis points on our margin.
Okay, Great I wanted to clarify that I think that's important okay. Thank you. Thanks, Brian.
Okay.
Thank you. Our next question comes from the line of Mark Fitzgibbon with Piper Sandler. Please proceed with your questions.
Hey, guys good morning, and congratulations Terry.
Good morning, Mark.
Thank you Sean.
And for you John is on the expense initiatives I'm curious if you think there's even more room to kind of push cost and efficiency ratio is lower given the increased digitization of the business. Once you complete this optimization program can you do you think you can drive efficiency even lower.
We do Mark and.
And we were.
We thought about how to present this youll see on page 18, it really represents the low end of the 8% to 10% range. We do think that we'll be able to achieve the full 10% and that range and as we move into 2020 to continue.
To become more efficient and lower the unit cost of delivery one of the things I want to be clear about is that we're not about generating.
Shareholder value through cost cutting.
We want to do is make sure that we can continue to drive our differentiated commercial banking business and our HSA business and our community bank business and grow over time. So hopefully we become continue to be more and more efficient on a unit cost basis Mark overtime. Our goal obviously is if we do.
Get a lift and rates and loan growth comes back significantly we want to be prepared to be able to expand commercial banking higher new commercial bankers continue to invest and technology. So a real dollar level of cost may go up but ultimately we want to.
<unk> operating leverage deliver this day.
Okay.
This really significant step and lowering our cost structure and then over time continue to drive efficiencies both on the cost line and by generating operating leverage and higher revenues.
Great and then secondly can you update us on how you're thinking about geographic expansion and maybe share some thoughts on whether your view with respect to M&A has changed obviously you have a strong currency now I'm curious, how you're thinking about M&A.
Yes, it's interesting I think from a geographic expansion perspective, it's always on our drawing board and we have paused, obviously and this unique environment over the last few years and.
Kind of a credit frenzy first a lot of competition and now obviously the pandemic.
I could see us expanding and in contiguous geographic Metro markets.
To go into middle market as you know, we have a significant national presence and our key industry sector specialties, which I think we've proven over time, we know how to select risk and and we have really deep knowledge. There. So we've been able to maintain good growth and expansion without planting flags and others and other cities.
But we do see that as part of the tool of expanding our commercial banking over time with respect to M&A. Its interesting I got a lot of feedback from our last call that I had pivoted and and I certainly didn't mean to I mean, I think the answer for US is always as you know, we're very confident and the fact that we believe we've got differentiated business.
Is that we need to exploit over time, and we need to continue to invest and and so we think we can grow organically over time. We've also said that scale matters and that if there were a really really compelling opportunity and HSA or from and a whole bank perspective.
<unk> had great strategic and financial Merit.
<unk> two and obviously, we would look at it but I will tell you that this bank right now, particularly mark as you can imagine undergoing the transformation, we're going through right now.
And is completely focused internally and making sure that we drive value that we take care of our customers and.
And take care of our own business and.
And we'll we'll look at opportunities if they arise.
Thank you.
Thanks Mark.
Okay.
Thank you. Our next question comes from the line of Gerard Shaw of Wells Fargo. Please proceed with your questions.
Hi, Good morning, everyone. This is chemo and Brazil are filling in for Jared and Kay good morning.
Good morning.
And maybe starting first on the allowance just wondering how heavy did you guys lean on the qualitative overlays and keeping the allowance at somewhat of an artificially elevated level and as we go forward how should we think about applying these qualitative overlays and what type.
The pace of reserve release could we see if the economic backdrop and credit picture remains unchanged.
So a TMR and good morning, it's Glenn let me take that and and John can add some color, but I'd first start by saying.
The quantitative method still represent a significant majority of our total allowance.
And so that's the first thing to keep in context, and I think with respect to qualitative adjustments I think in this environment heightened level of uncertainty.
You, probably would expect to see a higher percentage of <unk>.
Qualitative versus quantitative.
To account for the unknown and.
So I think the other thing and keep in perspective as to the 10 months of the pandemic our customer performance has been very different than prior recessions and the qualitative factors helped address the risk outside the model and so.
Net debt, we don't specifically disclose the qualitative reserve, but as you probably saw on our K its driven by such factors as like credit concentration and credit quality trends.
On the quality of internal loan reviews nature and volume of the portfolio of staffing letters underwriting exceptions and economic considerations that are not reflected in the base.
So thats.
Net.
I think thats, great and mix.
You, obviously keep margin should be and any one of these banks and seen the processes that we've all built to.
And to try and leverage lots of data and models and so it's primarily quantitatively driven the reality if I can step back just from an industry perspective, right is for all of us.
Mid thirties, exigent shock and GDP in the second quarter all of the models over predicted the quantitative models over predicted losses, because you're plugging in a Moody's model Youre plugging and GDP are plugging and unemployment and obviously.
We haven't seen that and prior history that it predicted short term significant losses.
Just werent going to come and now what you're seeing on the other side is a little bit of the opposite right, where you've got forward looking improved economic outlook not a lot of loan growth. So most banks have pretty consistent portfolio theyre not have and it provides very much for new loans.
And the models, probably predict too much of a release given the significant uncertainty around things.
Things like new strains of the virus, the distribution and efficacy and the vaccines.
Are we going to get the kind of government stimulus that's targeting the right areas and so there is still a decent amount of uncertainty and there, but but Glenn is right the process remains.
Key for all the bank just to just have the right repeatable modeled quantitative driven process and then be able to use some level of quantitative factors to make sure that what you see and what is really happening doesn't.
Over predict or under predict future losses, and I've been surprised quite frankly, just editorially looking at all of our peers and others and what Youre seeing and the mid cap space kind of as a general theme of really small provisions to small releases somewhere in that and that margin. So we seem to be consistent with a lot on appears as well.
Alright and.
Could that accelerate if loan growth doesn't and Reengage and let's say the next two quarters can we see an acceleration of reserve releases of some of that uncertainty rolls off or are you going to try and maintain some of those balances and incorporate future loan growth and to that amount and so so.
Loan growth is one variable.
And so I think so that's that's one thing we look at and addition to the economic conditions, the credit quality and risk migration.
And then you've got the other factors that government stimulus and things like that that potentially again down the road. So it's hard to say.
But.
Look I think the 359 total allowance.
We ended the year is our best estimate and it is the sum of primarily quantitative methods.
And then supplemented with qualitative methods to account for uncertainty.
Okay. That's good color. Thank you and then last one for me just on the second round of PPP and he kind of guidance you guys can provide for us on what kind of magnitude we should be expecting out of the second round or is it still too early to tell.
It's probably a little too early to call, but Jason and I don't know if you want to provide a little perspective on that I can I got some more stats. This morning, I mean, we're active and there is a good number of of applications we have.
Jason you have some color on yes, yes, yes, so and the first couple of days here and we received over 2000 and applications about $250 million and total volume we process a good portion of those and ready to start submitting to the SBA. So I think overall I would say, we probably don't expect the same level of activity.
<unk> as we had last time around but the early start has been pretty pretty good.
Okay. Thank you and <unk>.
Thank you.
Thank you our next questions come from the line of Laurie Hunsicker with Compass point. Please proceed with your questions.
Yeah, Hi, Thanks, Good morning, Hey, Laura and I, just want to thank Jerry it's been a great great pleasure working with you over the years.
And Glenn first question for you on.
The deferral and I loved the detail you can can you just help us understand a little bit maybe more broadly and any color you can give a random halbach.
Bank, we've only seen one or two categories, where we've seen the upticks understandably, but just if you can help us with any details on that $123 million pop what the LTV is located and what flag.
Any color you can share with us around that and Joe.
And and maybe the uptick going from 28 million to $45 million.
Sure, Jason and I'll throw that right to you if that's okay, yes, and yes, no that's fine so looking at the book right.
If you step back, it's really six or seven deals that make up that.
And that population and there's really only two deals that are in active deferral in their population and both of those are paying interest right theyre not theyre not paying principal and given that deferral and the recovery expected to be slow, but we've seen some support of willingness by the sponsors of the owners to put some money into those just to keep it.
Boeing and time will tell right and so it's not a huge exposure we're not overly concerned about it but we are obviously monitoring it closely.
And going and just to answer your question the LTV going into the cycle and obviously, we would all acknowledge there's been some impact here, but going into it's about 60%.
Okay, and then of your hotel box for 100 on 23 million and how much of that is clean.
And I.
It's all all.
Great.
Perfect Okay.
And then Jason and Glenn maybe same question on the $1 4 billion of leverage and that was the only other uptick what we saw on general and that sounds very very very small obviously corp points for our center for all right and.
Any color you can give around that yes, I'll take that one sure. It was really driven by one credit that migrated.
And that produce and active deferral I would say offset by a couple of others that came off and.
And that one credit we're really not overly concerned about we sit in the capital structure on a first out basis with less than 20% loan to value it and.
On the leisure space just just so you know and there is five times the amount of junior equity and.
And debt behind Us and net deal and in exchange for us provided and deferral the sponsor actually put on some equity.
Okay, Great Super helpful and.
I just wondered if.
And maybe more broadly.
John just going back to <unk>.
Mark was going in terms on the M&A question, because I've gone to that point Youre stocking.
And you know exponentially outperform sir.
And certainly even recently and so that is very very strong currency can you help us think more generally if you were to Ken Posner for bank M&A, what's the smallest deal that makes sense and that's the largest deal that makes sense.
What's your sweet spot.
We're approaching that and I realize you've got a lot going on here and the next couple of quarters, but just sort of thinking a little bit further out.
I think Laurie it's hard for me to provide a detailed perspective, there I think it's consistent with what I've said before and what we've said is that.
It's a pretty high bar for us from a financial perspective, because we think we've got a lot of organic running room, and we certainly don't want to kind of dilute that as we move forward.
And would say if a transaction was really financial compelling obviously that would be one of the gating elements, but more importantly for us it's around strategy and you've seen the makeup of our of our earnings streams shift to more commercial overtime.
And more wholesale over time, and you've seen us try and aggressively grow HSA bank. So kind of tuck in acquisitions that are basically branch based are not particularly interesting to us. So.
If something came along that enabled us to gain scale with financially compelling and was.
Consistent with our strategic.
Our view of of of expanding our commercial banking capabilities and enhancing the value of our HSA franchise that would be something we would look at so I would say larger rather than smaller.
And not really focused on contiguous branch acquisition.
Great. Thanks, Okay, and then just had one last question for you on HSA.
Just looking at the on it.
Just in terms of that bill.
Non interest income.
The sharp drop linked quarter, and then also just more broadly and looking at for HSA efficiency ratio going from 52% to 54% and you can you help us talk about that and I'll, let Ed.
Yes.
And he is.
And so Laurie and my prepared comments I highlighted the HSA change quarter over quarter, there were $3 1 million and tpa fees exit fees last quarter. So thats, primarily what youre seeing on the drop on noninterest income.
And obviously that impacts and that impacts efficiency ratio as well.
Got it okay. So I'm, sorry, $3 1 million last quarter.
And within that 2000 and perfect.
Perfect. Okay, great. Thank you so much alright, Laurie. Thank you. Thank you.
Thank you. Our next question is coming from the line and Steven Duong with RBC capital markets. Please proceed with your questions.
Hey, good morning, guys.
I apologize I jumped on a little late so I'm not sure it and you guys covered this but.
On your margin.
Just looking at your sensitivity if the.
And if the yield curve steepened and say that the tenure gets to 2% by the end of the year how does that.
And look for your NII going into 'twenty and 'twenty two.
Look I think if you look at our book half of it is tied to the short end of the curve. So I think we have about $8 6 billion and one month LIBOR and another $3 5 billion at three month LIBOR. So thats. The primary driver obviously, our resi book and our investment portfolio are tied to the longer and then the curve, but that will take on.
While the cycle for us.
Got it Glenn and just.
The front end.
And as.
Yes, and busted through the floors is that correct.
And about.
So we have about $3 5 billion of floors right.
Right now and they're in the money about 50 basis points 50 to 55 basis points.
Got it alright spread thats primarily in commercial.
Little Mountain home equity and smaller mountain business banking.
Got it.
And then just.
<unk>.
And the growth environment.
Little slow this year on Maui.
And you guys are accumulating a decent amount of capital.
How are you guys thinking about buybacks and.
And valuation levels that are attractive to you guys and and considering that.
Yeah.
And I think for more full capital management perspective, we've talked about obviously, we feel like we'll maintain the dividend as we go forward just in terms of growing our earnings back into the 40% to 50% payout ratio. We had started as you know in the first quarter.
2020 to start buying back shares and the pandemic hit and obviously like most of our peers decided it wasn't prudent until we have full clarity.
And to continue that we feel like we're approaching that point sometime in the first quarter early second quarter and so we do have.
Proved authority and we expect to look more aggressively at stock repurchase depending on where the stock price is and what the market looks like.
Beginning over the next several months.
Great. Thank you.
And then just a last one for me.
Yes.
The corporate tax rate gets to 28% what would that do to your effective tax rate.
So that is something that we've been talking about and obviously tax strategy is something that we're continually focused on but.
I don't I don't have a number for you on this call that day.
And it is something that for.
Looking at.
Alright, I appreciate it thanks Glenn.
And Terry.
And why.
Chad.
Okay.
Thanks, David.
Thank you our next.
Question comes from the line of William Wallace.
Raymond James Please proceed with your questions.
Thanks for taking on.
Go ahead.
I'm just curious if you look at your commercial loan pipelines starting to build on what you're seeing any variations in demand geographically that stands out to you.
Yes, that's actually a great question and we've been trying to look through all of that I think.
In some ways and it's really there are some geographic.
On issues with respect to.
Who is it.
Areas and opened and where they haven't been there is some difference.
And in particular, obviously go and consumers.
Kind of rolling and non metro suburban areas and Metro is a little bit more challenged.
And but I think at the end of the day more than geography Bill.
And Bill is is sector and.
So we continue to see the biggest disparity and in loan demand across sectors, and that's obviously seems pretty obvious.
That had been significantly impacted either don't have the credit worthiness for the ability to take on more capital.
Those.
Who will be slightly impacted are being more conservative in terms of doing things forward that would create the need for more loans capital and then of course as I mentioned earlier, we have some some sectors that are growing quite nicely.
Technology and Aldi.
Infrastructure health care.
And some of those sub sectors, we play and we have.
For Ts.
And we're literally seeing on.
On surpassed demand so I would say.
Got it.
Sector driven more than geographic.
Okay fair enough I appreciate that color.
And then a follow up on the expense reduction target that 8% to 10% target.
From I believe and so the third quarter.
Run rate operating run rate are you anticipate and does that include inflate.
Inflationary pressures colas et cetera that we see and the beginning of every year.
Does it is a net it's a net net number.
Great. It's a net number so youll see even and that work.
Investments and businesses it accounts merit increases and we.
And we expect to lower that on a on a real dollar basis right.
Okay. Okay.
And then also as you look at the forgiveness of the PPP loans, what's your kind of expectation of timing of that and and ultimate level based on what you know now so we have 1 billion and three at year and maybe just a little under that and we probably I would probably say about 40% and the first quarter of 40% and the second quarter and and 10 and 10.
If you just think of it coming out that way and and I can change.
And that's what I would that's that's how we're forecasting right now.
Okay. Thank you.
Alright, and I will just echo everyone else's sentiments and say thank you for all the help over the years Terry it's been great working with you and good luck on your retirement thanks.
Thanks, guys. Thank you very much Bali.
Thank you. Our next question is come from the line of Bernard Horn with Polaris Capital Management. Please proceed with your questions.
Good morning.
And I also joined a little bit late so if my questions are.
Redundant please move on and I can follow up offline.
Terry Thanks for your really highly professional stewardship of the Investor relations functions from the very early days of <unk>.
Perhaps as a public company. So we've enjoyed it and thank you for all your work two questions. The first is on capital and I don't think this is a big deal, but some of the big banks have been concerned that the overwhelming amount of stimulus money showing up and bank balance sheets is.
Pushing.
Assets to a level, where they may have capital problems.
And I know you've managed the balance sheet and down a little bit but are there any issues that you can see that moving forward. If you do get a lot more money.
And the deposit strategies capital strategies that might affect your.
Management of the bank and the second well I probably should.
And so that for let me get necessarily push out loans. So I think we have the opportunity to pay down on a short term basis, probably about a half a billion and short term borrowings, but we are getting near the bottom of that and.
I think what you're highlighting is depending on stimulus and the eventual impact through municipalities and things like that we could be.
The industry's very seem to have a lot more excess capital our loan to deposit ratio of 79% as of quarter and it is something we're looking at as far as the deployment, if we don't get the loan growth.
And we do we buy a floating rate securities or do we parked and money and as Ed. So those are conversations for any of that we're having pretty much on a daily basis and just monitoring it.
Thanks, and the second question is just really about.
We're all trying to guess, which way the post Covid World World goes.
Certainly you've been a beneficiary I think of the move to suburban and recipe, but on the commercial side are you seeing any early warning signs that you might be.
Cautious about with respect to the.
Deployment of commercial real estate office buildings, and so forth and weather.
You see any potential problems there.
And I'm sure you get them just just for the question.
And it's actually a great question Bernie and it's nice to hear from you and I'll, let Jason and put a finer point on it I think we've got really good strong relationships and our Investor Cree group and I think everybody seems to be a little bit more thoughtful and careful particularly in metro market buildings, we're seeing even on the outside of office on on <unk>.
<unk> family were not Big and New York, Metro, which which obviously benefits US here, we are seeing I think a little bit of stabilization and Boston and given where we underwrite and the quality of the sponsors were not seeing any any cracks and multifamily I think and office, we've been sort of spending I always I always getting them on one bill Wrang mentioned and on average.
Earnings call, but bill on a while back really pivoted, we had I think maybe 35% of our 40% of our <unk>.
Property types were and office going back 10 years ago and.
And I think Bill took a decided to you and some of the paradigm shifts to.
To move away from that so we don't have tons of Metro office.
Which is which is good and I think that a lot.
Most people on the industry. Our sense now is we're not really going to know.
For several more quarters, what happens because you've got obviously, if you look at the real.
And they can see rates, meaning people in the seats and those buildings and those offices in Boston, and New York, and Philadelphia, where we have real estate exposure.
And 10% to 15% 20% of the people in their seats.
There's a lot of talk and I have seen in Connecticut, and a lot of the big companies and the Ceos I talked to trying to drive and immediate 25% reduction and there and Theyre occupied office space coming out of the pandemic.
But we also feel and you also read a lot about people.
Starting to really struggle working remotely and.
And that particularly if you have de densify to office space. You May have you may need the same square footage going forward. So that's a long way for me is saying I think it's too soon and we're not seeing real problems.
Yet I think it is too soon to see problems because you don't have lease renewals and I think it's too soon to call what the future of work will mean, two office occupancy, but it's something that we're really focused on and we are taking your last question was I think we're taking that into consideration as we look at new potential opportunities, which would mean, we're going to be much more selective.
Jason I, probably stole all of your Thunder, but is there and I'll add three quick sort of data points. If you will to support everything you said, which I think was spot on.
So we've got one active deferral and our office portfolio, which is fairly large.
It's about $4 million. So the portfolio has been performing very well we have not received a lot of deferrals and to your point about sort of.
Maturity of leases, we've got less and 10% of the square footage and our lease portfolio on our office portfolio coming due over the next couple of a couple of years, so less than 10% and 21 less than 10% and 22. So I don't think Theres a lot on near term pressure and then the last point I'll make is that going into this and because.
We haven't seen Jayson and I think we lost you we're having technical problems today for the first time and you can you hear me now.
I can hear him fine Oh, you can't Okay, alright, so the last point I would add is just going into this and we still view this as a reasonably good until we get more information or loan to value on the entire portfolio is 54% and debt service coverage over two times. So theres a fair amount of cushion, even if you see pressure on rental rates.
Or occupancy.
Covid.
Thanks James.
And that's really.
It was very good color and thanks for the.
The great Conservative way that you've addressed that market for this point. Thanks. Thanks Barry.
Stay healthy and safe.
Okay.
Thank you there are no further questions at this time I would like to hand, the call back over to John Steele for closing comments.
Thanks, Daryl I appreciate everybody's interest and the company and I wish everybody, a happier and healthier in 2021, thanks for joining us this morning.
That does conclude this morning's conference you may disconnect. Your lines at this time. Thank you for your participation and have a great day.