UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
þQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
or
oTransition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-31486
WEBSTER FINANCIAL CORPORATION
(203) 465-4329
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
The number of shares of common stock outstanding as of April 30, 2005 was 53,772,087.
INDEX
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ITEM 1. INTERIM FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
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CONSOLIDATED STATEMENTS OF INCOME (unaudited)
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CONSOLIDATED STATEMENTS OF INCOME (unaudited), continued
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)
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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
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NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 1: Basis of Presentation and Principles of Consolidation
The Consolidated Interim Financial Statements include the accounts of Webster Financial Corporation (“Webster” or the “Company”) and its subsidiaries. The Consolidated Interim Financial Statements and Notes thereto have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant inter-company transactions have been eliminated in consolidation. Amounts in prior period financial statements are reclassified whenever necessary to conform to current period presentations. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results which may be expected for the year as a whole.
The preparation of the Consolidated Interim Financial Statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as of the date of the Consolidated Interim Financial Statements, and the reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates. Material estimates that are susceptible to near-term changes include the determination of the allowance for loan losses and the valuation allowance for the deferred tax asset. These Consolidated Interim Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in Webster’s Annual Report on Form 10-K for the year ended December 31, 2004.
NOTE 2: Stock-Based Compensation
At March 31, 2005 and 2004, Webster had a fixed stock-based compensation plan that covered employee and non-employee directors. During 2002, effective as of January 1, 2002, the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, were adopted on a prospective basis, for all stock options granted January 1, 2002 and thereafter. Prior to this date, the provisions of APB No. 25 and related interpretations were applied for option grant accounting. Therefore, the expense related to stock-based compensation for the quarter ended March 31, 2004 differs from the expense that would have been recognized if the fair value based method had been applied to all option grants since the original effective date of SFAS No. 123. Awards under the plan, in general, vest over periods ranging from 3 to 4 years. As of January 1, 2005, all stock options granted prior to the implementation of SFAS No. 123 are fully vested. Webster also grants restricted stock to senior management and directors.
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The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all stock option awards.
In addition, the cost of restricted stock granted is reflected in compensation and benefits expense and totaled $350,000 and $286,000, net of taxes, for the three months ended March 31, 2005 and 2004.
See Note 18, Recent Accounting Pronouncements, for information regarding a newly released pronouncement concerning stock-based compensation accounting.
NOTE 3: Purchase and Sale Transactions
The following purchase and sale transactions have been completed or announced during 2005. The results of operations of the acquired companies are included in the Consolidated Statements of Income subsequent to the date of the completion of the acquisition.
Eastern Wisconsin Bancshares, Inc.On September 7, 2004, Webster announced its entry into the health savings account business through a definitive agreement to acquire Eastern Wisconsin Bancshares, Inc., (“EWBI”) the holding company for State Bank of Howards Grove (“State Bank”), headquartered in Howards Grove, Wisconsin. This transaction closed on February 28, 2005. The acquisition makes Webster one of the largest custodians and administrators of health savings accounts in the United States. The purchase price was approximately $27 million in cash. The State Bank had $163 million in assets and $144 million in deposits, including $95 million in health savings account deposits at the time of the agreement.
A definitive agreement was announced on February 8, 2005 whereby Webster would divest State Bank’s two retail branches and related loans and deposits and retain the health savings account operation. The health savings account division operates under the name of HSA Bank, a division of Webster Bank. The branch sale closed on April 15, 2005. See Note 17, Subsequent Events, for further information.
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NOTE 4: Securities
A summary of trading, available for sale and held to maturity securities follows:
The following table depicts temporarily impaired investment securities:
Unrealized losses on fixed income and equity securities result from the cost basis of securities being greater than current market value. This can be caused by an increase in interest rates since the time of purchase or from deterioration in credit quality of the issuer. Forty-eight securities had an unrealized loss for twelve consecutive months or longer due to interest rates being higher at March 31, 2005 than at the time of purchase. Approximately 98 percent of the unrealized loss was concentrated in twenty-six mortgage-backed and three corporate securities. These mortgage-backed securities are rated or carry an implied AAA credit rating. The three corporate securities are unrated but have undergone an internal credit review by Webster. As a result of this credit review of the issuers, Webster has determined that there has been no deterioration in credit quality subsequent to purchase. Based on our experience with these types of investments and our financial strength, Webster has the ability to hold these investments to maturity or full recovery of the unrealized loss.
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Management will continue to evaluate impairments, whether caused by adverse interest rate or credit movements, to determine if they are other-than-temporary. The determination will be based on the severity of unrealized loss, length of time of impairment, and the financial condition and near-term prospects of the issuer.
NOTE 5: Loans Held for Sale
Loans held for sale totaled $352.2 million and $147.2 million at March 31, 2005 and December 31, 2004, respectively. Included in the March balance are approximately $97.8 million of loans which were sold on April 15, 2005, to National Exchange Bank and Trust of Wisconsin, as part of the previously announced branch divestiture.
At March 31, 2005 and December 31, 2004, residential mortgage origination commitments totaled $317.8 million and $284.4 million, respectively. Residential commitments outstanding at March 31, 2005 consisted of adjustable rate and fixed rate mortgages of $67.2 million and $250.6 million, respectively, at rates ranging from 1.0% to 11.0%. Residential commitments outstanding at December 31, 2004 consisted of adjustable rate and fixed rate mortgages of $55.1 million and $229.3 million, respectively, at rates ranging from 1.0% to 8.5%. Commitments to originate loans generally expire within 60 days. At March 31, 2005 and December 31, 2004, Webster also had outstanding commitments to sell residential mortgage loans of $415.9 million and $305.3 million, respectively.
At both March 31, 2005 and December 31, 2004, Webster Bank serviced for others residential and commercial loans totaling approximately $1.6 billion.
NOTE 6: Loans, Net
A summary of loans, net follows:
At March 31, 2005, loans, net included $18.9 million of net premiums and $32.9 million of net deferred costs, compared with $20.5 million of net premiums and $32.1 million of net deferred costs at December 31, 2004. The unadvanced portions of residential and commercial construction loans totaled $411.9 million and $523.3 million at March 31, 2005 and December 31, 2004, respectively.
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At March 31, 2005 and December 31, 2004 unused portions of home equity credit lines extended were $1.2 billion. Unused commercial and commercial real estate lines of credit, letters of credit, standby letters of credit, equipment financing commitments and outstanding commercial loan commitments totaled $ 2.7 billion at March 31, 2005 and $2.9 billion at December 31, 2004. Consumer loan commitments totaled $80.2 million and $53.3 million at March 31, 2005 and December 31, 2004, respectively.
Webster is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and commitments to sell residential first mortgage loans and commercial loans. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the Consolidated Statements of Condition. See Note 15 for further discussion.
The estimated fair value of commitments to extend credit is considered insignificant at March 31, 2005 and December 31, 2004. Future loan commitments represent residential and commercial mortgage loan commitments, commercial loan and equipment financing commitments, letters of credit and commercial and home equity unused credit lines. The interest rates for these loans are generally established shortly before closing. The interest rates on home equity lines of credit adjust with changes in the prime rate.
A majority of the outstanding letters of credit are performance standby letters of credit within the scope of FASB Interpretation No. (“FIN”) 45. These are irrevocable undertakings by Webster, as guarantor, to make payments in the event a specified third party fails to perform under a nonfinancial contractual obligation. Most of the performance standby letters of credit arise in connection with lending relationships and have a term of one year or less.
The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. At March 31, 2005, Webster’s standby letters of credit totaled $200.1 million. At March 31, 2005, the fair value of stand-by letters of credit is not material to the unaudited interim financial statements.
NOTE 7: Allowance for Loan Losses
The following table provides a summary of activity in the allowance for loan losses:
Included in charge-offs are $629,000 of write-downs of loans transferred to held for sale during the first quarter of 2005.
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NOTE 8: Goodwill and Other Intangible Assets
The following tables set forth the carrying values of goodwill and other intangible assets, net of accumulated amortization:
Changes in the carrying amount of goodwill for the three months ended March 31, 2005 is as follows:
During the first quarter of 2005, $9.0 million of core deposit intangibles with an amortization period of 7 years were added as a result of the EWBI purchase described in Note 3. Approximately $4.4 million of this addition relates to deposits held in the two retail branches that were divested on April 15, 2005.
Amortization of intangible assets for the three months ended March 31, 2005, totaled $4.9 million. Estimated annual amortization expense of current intangible assets with finite useful lives, absent any impairment or change in estimated useful lives, is summarized below.
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NOTE 9: Deferred Tax Asset
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at March 31, 2005 and December 31, 2004 are summarized below. Temporary differences result from the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A 100% valuation allowance has been applied to the deferred tax assets applicable to Connecticut, Massachusetts and Rhode Island due to uncertainties of realization.
Management believes it is more likely than not that Webster will realize its net deferred tax asset, based upon its recent historical and anticipated future levels of pre-tax income. There can be no absolute assurance, however, that any specific level of future income will be generated.
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NOTE 10: Deposits
The following table summarizes the composition of deposits:
Interest expense on deposits is summarized as follows:
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NOTE 11: Federal Home Loan Bank Advances
Advances payable to the Federal Home Loan Bank (“FHLB”) are summarized as follows:
Webster Bank had additional borrowing capacity of approximately $478.3 million from the FHLB at March 31, 2005 and $651.6 million at December 31, 2004. Advances are secured by a blanket security agreement against certain qualifying assets, principally residential mortgage loans. At March 31, 2005 and December 31, 2004, Webster Bank had unencumbered investment securities available to secure additional borrowings. If these securities had been used to secure FHLB advances, borrowing capacity at March 31, 2005 and December 31, 2004 would have been increased by an additional $724.8 billion and $913.6 million, respectively. At March 31, 2005 Webster Bank was in compliance with the FHLB collateral requirements.
As of March 31, 2005, $350 million of fixed rate advances had been converted to floating rate through the use of interest rate swaps. See Note 15 for further information on interest rate swaps.
Total callable FHLB advances at March 31, 2005 and December 31, 2004 were $366 million.
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NOTE 12: Securities Sold Under Agreement to Repurchase and Other Short-term Debt
The following table summarizes balances for other borrowings:
The following table sets forth certain information on short-term borrowings:
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NOTE 13: Shareholders’ Equity
Capital guidelines issued by the Federal Reserve Board and the Office of the Comptroller of Currency of the United States (“OCC”) require Webster and its banking subsidiary to maintain certain minimum ratios, as set forth below. At March 31, 2005, Webster and Webster Bank, were deemed to be “well capitalized” under the regulations of the Federal Reserve Board and the OCC, respectively, and in compliance with the applicable capital requirements.
The following table provides information on the capital ratios.
Accumulated other comprehensive loss is comprised of the following components.
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NOTE 14: Business Segments
Webster has three operating segments for purposes of reporting business line results. These segments include Retail Banking, Commercial Banking and Wealth and Investment Services. The balance of the activity is reflected in Corporate. The methodologies and organizational hierarchies that define the business segments are periodically reviewed and revised. The first quarter of 2004 has been restated, to reflect changes in the methodologies adopted and reflected in the results for the first quarter of 2005. The following table presents the statement of income and total assets for Webster’s reportable segments.
Three months ended March 31, 2005
Three months ended March 31, 2004
The Retail Banking segment includes insurance services, business and professional banking, consumer lending and deposit generation, health savings accounts and direct banking activities, which include the operation of automated teller machines and telebanking customer support and sales. The Retail Banking segment also includes the residential real estate lending, loan servicing and secondary marketing activities. The growth in net interest income compared to a year ago can be attributed to the increases in residential and consumer loans and lower cost deposits and the May 2004 acquisition of FIRSTFED AMERICA BANCORP, INC. (“FIRSTFED”). The increase in noninterest income includes deposit services fees from the growth in deposits as a result of the acquisition of FIRSTFED in May 2004 and the continued success of the High Performance Checking product. Noninterest expenses also rose as a result of the FIRSTFED acquisition.
The Commercial Banking segment includes middle market, specialized, equipment financing, asset-based and commercial real estate lending, deposit and cash management activities and financial advisory services. The results for the first three months of 2005 reflect the growth in equipment financing, middle market and commercial real estate loans, which was a primary reason for the 15% increase in net interest income from the 2004 period. Noninterest income and expense declined due to the sale of Duff & Phelps in March 2004.
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Wealth and Investment Services (“WIA”) includes Webster Financial Advisors, Webster Investment Services and Fleming, Perry and Cox, which combine to provide comprehensive wealth management services for individuals and institutions. Its primary sources of revenue are fees from trust management activities and investment product sales.
Corporate includes the Treasury unit, which is responsible for managing the wholesale investment portfolio and funding needs. It also includes expenses not allocated to the business lines, the residual impact of methodology allocations such as the provision for loan losses and funds transfer pricing offsets.
Management uses certain methodologies to allocate income and expenses to the business lines. Funds transfer pricing assigns interest income and interest expense to each line of business on a matched maturity funding concept based on each business’s assets and liabilities. The provision for loan losses is allocated to business lines on an “expected loss” basis. Expected loss is an estimate of the average loss rate that individual credits will experience over an economic cycle, based on historical loss experiences and the grading assigned each loan. This economic cycle methodology differs from that used to determine our consolidated provision for loan losses, which is based on an evaluation of the adequacy of the allowance for loan losses considering the risk characteristics in the portfolio at a point in time. The difference between the sum of the provisions for each line of business determined using the expected loss methodology and the consolidated provision is included in Corporate. Indirect expenses are allocated to segments. These expenses include administration, finance, technology and processing operations and other support functions. Taxes are allocated to each segment based on the effective rate for the period shown.
NOTE 15: Derivative Financial Instruments
At March 31, 2005, Webster had outstanding interest rate swaps with a notional amount of $803 million. These swaps are hedging FHLB advances, repurchase agreements, senior notes and subordinated debt and qualify for fair value hedge accounting using the short cut method under SFAS No. 133. The swaps are used to transform these liabilities from fixed to floating rate. Of the total, $100 million of the interest rate swaps mature in 2005, $50 million in 2006, $200 million in 2007, $103 million in 2008, $200 million in 2013 and $150 million in 2014 and an equivalent amount of the hedged liabilities mature on these dates.
Additionally, Webster Bank had outstanding $200 million of swaptions, which give it the right, but not the obligation, to enter into $200 million of interest rate swaps, paying 6.15% fixed and receiving one month LIBOR. These swaptions are carried at fair value and mature in 2007. Changes in fair value are reflected in noninterest income.
Webster Bank transacts certain derivative products with its customer base. These customer derivatives are offset with matching derivatives with other counterparties. Exposure with respect to these derivatives is largely limited to nonperformance by either of the parties in the transaction – the customer or the other counterparty. The notional amount of customer derivatives and the offsetting counterparty derivatives each totaled $202.6 million at March 31, 2005. The customer derivatives and the offsetting matching derivatives are marked to market and any difference is reflected in noninterest income.
Certain derivative instruments, primarily forward sales of mortgage-backed securities (“MBSs”), are utilized by Webster Bank in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans held for sale. Prior to the closing and funds disbursement on a single-family residential mortgage loan, an interest-rate locked commitment is generally extended to the borrower. During such time, Webster Bank is subject to risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments, which agree to deliver whole mortgage loans to various investors or issue MBSs, are established. At March 31, 2005, outstanding rate locks totaled approximately $203.5 million and the residential mortgage held for sale portfolio totaled $254.4 million. Forward sales, which include mandatory forward commitments of approximately $146.0 million and best efforts forward commitments of approximately $269.9 million at March 31,
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2005, establish the price to be received upon the sale of the related mortgage loan, thereby mitigating certain interest rate risk. Webster Bank will still have certain execution risk, that is, risk related to its ability to close and deliver to its investors the mortgage loans it has committed to sell.
The interest rate locked loan commitments are recorded at fair value, with changes in fair value recorded in current period earnings. The changes in the fair value of forward sales commitments are also recorded to current period earnings. Loans held for sale are carried at the lower of aggregate cost or fair value. The changes in the fair value of forward sales commitments will be adjusted monthly based upon market interest rates and the level of locked loan commitments and unallocated forward sales commitments.
NOTE 16: Pension and Other Benefits
The following table provides information regarding net benefit costs for the periods shown:
Webster plans to contribute at least an amount equal to the greater of the contribution required to meet the minimum funding standards under Internal Revenue Code Section 412 or the amount necessary to avoid an additional minimum liability as defined in SFAS No. 87 and No. 132. Additional contributions will be made as deemed appropriate by management in conjunction with the plan’s actuaries. For the year 2005, the preliminary estimated contribution ranges from $4.0 million to $5.0 million. As of March 31, 2005, no contributions have been made.
NOTE 17: Subsequent Events
On April 15, 2005, Webster Bank completed its previously announced divestiture of the two retail branch offices of State Bank. Webster retained the health savings account business only, which now operates as HSA Bank, a division of Webster Bank.
NOTE 18: Recent Accounting Pronouncements
In April 2005, the Securities and Exchange Commission (“SEC”) issued rules that amend the compliance dates for Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. Under SFAS No. 123R, calendar year companies that are not small business issuers were required to adopt this standard in the third quarter of 2005. However, the new SEC rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of next reporting period, that begins after June 15, 2005. For companies with a calendar year end, the new compliance date is January 1, 2006. As Webster has already adopted the provisions of SFAS No. 123, the delayed compliance date and adoption of SFAS No. 123R are not expected to have an impact on its consolidated financial statements.
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Forward Looking Statements
This report contains forward looking statements within the meaning of the Securities and Exchange Act of 1934, as amended. Actual results could differ materially from management expectations, projections and estimates. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of Webster’s loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting Webster’s operations, markets, products, services and prices. Some of these and other factors are discussed in Webster’s annual and quarterly reports previously filed with the Securities and Exchange Commission. Such developments could have an adverse impact on Webster’s financial position and results of operations. Except as required by law, Webster does not undertake to update any such forward looking statements.
Description of Business
Webster Financial Corporation (“Webster” or the “Company”), a bank holding company and financial holding company under the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Delaware in 1986. Webster, on a consolidated basis, at March 31, 2005 had assets of $17.4 billion and shareholders’ equity of $1.6 billion. Webster’s principal assets are all of the outstanding capital stock of Webster Bank, National Association (“Webster Bank”), and Webster Insurance, Inc. (“Webster Insurance”). Webster, through its various non-banking financial services subsidiaries, delivers financial services to individuals, families and businesses throughout southern New England and eastern New York State, and equipment financing, asset-based lending, mortgage origination and insurance premium financing throughout the United States. Webster Bank provides business banking, retail banking, health savings accounts (“HSA”), consumer financing, mortgage banking, trust and investment services through 154 banking offices, 291 ATM’s and its Internet website (www.websteronline.com). In 2004, Webster Bank converted from a federal savings bank to national bank charter, regulated by the Office of the Comptroller of the Currency. Webster’s common stock is traded on the New York Stock Exchange under the symbol of “WBS”. Webster’s financial reports can be accessed through its website within 24 hours of filing with the SEC.
Critical Accounting Policies
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2004 Annual Report on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for loan losses, valuation of goodwill/other intangible assets and analysis for impairment, deferred income taxes and pension and other post retirement benefits as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require management’s most difficult, subjective or complex judgment as a result of the need to make estimates about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management’s Discussion and Analysis and the December 31, 2004 Management’s Discussion and Analysis included in the Annual Report on Form 10-K.
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RESULTS OF OPERATIONS
Summary
Webster reported net income of $47.5 million in the first quarter 2005, compared to $42.3 million in the year-ago period, an increase of 12%. Net income per diluted share was $.88 in the first quarter compared to $.90 in the year-ago period. The year over year comparison is impacted by the amount of securities gains and acquisitions. Net income per share included $756,000, or $0.01, from gains on sale of securities in the current first quarter while the year ago period included $5.5 million, or $0.08, of gains. The first quarter of 2005 results are inclusive of Webster’s acquisitions of FIRSTFED, First City Bank and EWBI, all of which were completed subsequent to the 2004 first quarter. These acquisitions added loans of $1.6 billion and deposits of $1.9 billion. Diluted shares outstanding in the first quarter of 2005 included 6.7 million shares issued in the FIRSTFED acquisition.
The increase in net income for the current quarter was driven by a 13% growth in total revenues partially offset by higher operating expenses. The increase in total revenue, consisting of net interest income and total noninterest income, was primarily due to a $22.4 million or 21% increase in net interest income. Total noninterest expenses for the current quarter reflects the impact of acquisitions and continued investments to support Webster’s strategic growth objectives.
Selected financial highlights are presented in the table below.
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Net Interest Income
Net interest income was $128.2 million in the first quarter of 2005, compared to $105.8 million in the year-ago period an increase of $22.4 million or 21%. The increase over the prior year reflects double-digit growth in the loan portfolio and a higher net interest margin.
The following table describes the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have impacted interest income and interest expense during the periods indicated. Information is provided in each category with respect to changes attributable to changes in volume (changes in volume multiplied by prior rate), changes attributable to changes in rates (changes in rates multiplied by prior volume) and the total net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
Webster’s net interest margin (annualized tax-equivalent net interest income as a percentage of average earning assets) improved 23 basis points to 3.32% from 3.09% in the year-ago period. The increase reflects the benefit of the balance sheet deleveraging program in the fourth quarter of 2004 and the impact of higher interest rates on earning asset yields. The deleveraging program involved the sale of $750 million of investment securities with the proceeds used to prepay approximately $500 million of FHLB advances and $250 million of overnight borrowing.
Interest Income
Total interest income on a fully tax-equivalent basis for the first quarter of 2005 increased $39.5 million, or 24%, from the prior year. Higher volumes of earning assets accounted for approximately two-thirds of the interest income increase. This increase is primarily due to growth in the loan portfolio, principally a result of the FIRSTFED acquisition. Total loans were $11.7 billion at March 31, 2005, an increase of 23% over the $9.5 billion a year ago. The yield on earning assets also increased, rising 44 basis points from the prior year’s first quarter primarily due to the higher interest rate environment than in the year ago first quarter. The loan portfolio accounted for the majority of the increase, as its yield increased 40 basis points and its contribution to total earning assets increased to 75% from 68% a year earlier.
Interest Expense
Total interest expense for the first quarter of 2005 increased $15.7 million, or 27%, from the prior year. The higher interest rate environment caused the cost of interest bearing liabilities to increase 20 basis points compared to the year ago period, and accounted for two-thirds of the increase in interest expense. The growth of deposits accounted for the remaining third of the increase. Deposit growth in the excess of loans and the deleveraging program reduced the reliance on higher cost borrowings.
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The following table shows the major categories of average assets and liabilities together with their respective interest income or expense and the rates earned or paid by Webster.
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Provision for Loan Losses
Management performs a quarterly review of the loan portfolio and based on this review determines the level of provision necessary to maintain an adequate loan loss allowance. Several factors influence the amount of the provision, primarily growth and mix in the loan portfolio, net charge-offs, the risk of loss on nonperforming and classified loans and the level of economic activity. The provision for loan losses was $3.5 million for the quarter, compared to $5.0 million the same period a year ago. The reduction in the provision was primarily the result of improved asset quality and the reduced level of net charge-offs. Net charge-offs in the first quarter of 2005 were $1.1 million, compared to $3.1 million for the same period a year earlier. The annualized net charge-off ratio for the current quarter was 0.04% of average total loans, down from 0.13% a year earlier, an indication of strong asset quality.
At March 31, 2005 and December 31, 2004, the allowance for loan losses totaled $152.5 million and $150.1 million, or 1.30% and 1.28% of total loans, and represented 334% and 416% of nonperforming loans, respectively.
For further information see the “Loan Portfolio Review and Allowance for Loan Loss Methodology”, included in the “Financial Condition – Asset Quality” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 30 through 32 of this report.
Noninterest Income
Total noninterest income of $53.0 million for the three months ended March 31, 2005 declined $1.7 million, or 3%, from the same period a year ago. This decline is the result of lower security gains in the current first quarter of $4.7 million from a year ago and the loss of Duff & Phelps revenue, which totaled to $3.8 million in the 2004 first quarter. Adjusted for these items, noninterest income increased $6.9 million, or 15%, over the year ago quarter.
Revenues from deposit service fees, insurance, loan and loan servicing and wealth management grew 11% compared to a year ago. Contributing to this increase was higher deposit service fees resulting primarily from the growth in the number of accounts. Loan and loan servicing fees rose as a result of increased origination volumes and higher prepayment fees. Gain on sales of loans and loan servicing increased primarily as a result of increased volumes of mortgage originations through Webster’s People’s Mortgage Corporation subsidiary.
Noninterest Expenses
Total noninterest expenses for the first quarter ended March 31, 2005 were $107.8 million, compared with $92.1 million recorded in the same period a year ago. The increase of $15.7 million resulted from $7.4 million of additional expenses relating to the acquisitions of FIRSTFED, First City and EWBI, $1.7 million from additional investment in de novo branch expansion, $1.1 million of expenses related to the core systems conversion and the continued investment in personnel and technology to meet our strategic plan for growth.
Income Taxes
Income tax expense for the first quarter ended March 31, 2005 is higher than the prior year period primarily due to a higher level of income before taxes, partially offset by a lower effective tax rate. The effective tax rates for the three months ended March 31, 2005 and 2004 were approximately 32.1% and 33.2% respectively. The majority of the decline in the effective tax rate can be attributed to a higher level of tax-exempt income during the current period due to an increase in the municipal securities portfolio.
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Financial Condition
Total assets were $17.4 billion at March 31, 2005 compared with $17.0 million at December 31, 2004. Most of the increase occurred in loans held for sale and investment securities. The increase in loans held for sale is attributable to higher mortgage origination volume awaiting delivery into the secondary markets and $98 million of loans from EWBI that were sold on April 15, 2005. Total deposits increased $461 million, including approximately $169 million in health savings account deposits (“HSA”) and $48.3 million of other deposits from EWBI. The remaining growth in deposits was driven by Webster’s High Performance Checking products and continued growth from its de novo branches in Fairfield County, Connecticut and Westchester County, New York.
On April 15, 2005, Webster Bank completed its previously announced divestiture of the two branch offices of EWBI, with deposits other than health savings accounts totaling $48 million and loans of $98 million sold as part of the divestiture. Webster retained the health savings account business only, which now operates as HSA Bank and is a division of Webster Bank.
Total equity was $1.6 billion at March 31, 2005, up $20 million from December 31, 2004. This net increase was primarily due to net income of $47 million that was partially offset by $12 million of dividend payments to common shareholders and a $19 million unfavorable change in unrealized gains (losses) on the available for sale securities portfolio.
Securities Portfolio
Webster maintains an investment portfolio that is primarily structured to provide a source of liquidity for its operating needs, to generate interest income and provide a means to balance interest rate sensitivity. At March 31, 2005 the investment portfolio totaled $3.8 billion, or 21.9% of total assets, compared with $3.7 billion, or 21.9%, at December 31, 2004 and $4.4 billion, or 29.4%, at March 31 a year ago. The increase is a result of purchases of $247.9 million during the quarter consisting mostly of available for sale securities, offset by sales and payments of $124.7 million and $28.1 million of unrealized losses on the available for sale portfolio. At both March 31, 2005 and December 31, 2004, the portfolio consisted primarily of mortgage-backed securities.
Loan Portfolio
At March 31, 2005, total loans were $11.7 billion relatively unchanged from the total at December 31, 2004. Growth in commercial loans of $90.0 million during the quarter was offset by declines in the residential, commercial real estate and consumer portfolios.
Most of the commercial loan growth occurred in Middle Market where loans were up $47.8 million, asset-based loans grew by $20.6 million, equipment finance by $18.9 million and small business by $17.9 million. Commercial Real Estate loans were flat at $1.7 billion as strong fourth quarter activity was partially offset by pay-offs and the sell-down of positions in the first quarter. Residential mortgages declined by 1% or $52.4 million as we allowed the portfolio to decline in this period of rising rates. Consumer loans totaled $2.6 billion and were down $29.3 million as the rising rate environment appeared to cause accelerated prepayments in the home equity line portfolio.
Commercial loans (including commercial real estate) represented 37.3% of the loan portfolio up from 36.7% at year end, while residential mortgage loans declined to 40.4% from 40.8%. The remaining portion of the loan portfolio consisted of home equity and other consumer loans.
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The following paragraphs highlight, by business segment, the lending activities in the various portfolios during the quarter. Refer to Webster’s 2004 Annual Report on Form 10-K, pages 4 and 5 for a more complete description of Webster’s lending activities and credit administration policies and procedures.
Commercial Lending
Middle Market
At March 31, 2005, Middle Market loans, including commercial and owner-occupied commercial real estate, totaled $998.0 million compared to $1.0 billion at December 31, 2004 and $748.6 million at March 31, 2004. Originations for the first quarter of 2005 totaled $101.3 million as compared to $47.2 million for the same period in 2004.
Asset-Based Lending
At March 31, 2005, Webster Business Credit Corporation (“WBCC”), an asset-based lending subsidiary, had total asset-based loans of $568.6 million compared to $547.9 million at year end and $539.3 million at March 31, 2004. In its direct originations, it generally establishes depository relationships with the borrower through cash management accounts. At March 31, 2005 and December 31, 2004, the total of these deposits was $41.7 million and $39.6 million, respectively. During the first quarter of 2005, WBCC funded loans of $71.4 million, with new commitments of $118.9 million compared to funding of $37.0 million with new commitments of $121.1 million for the same period in 2004.
Business and Professional Banking
The Business and Professional Banking Division administered a portfolio of approximately $467.7 million at March 31, 2005, a 5.7% increase from $438.8 million at December 31, 2004. At March 31, 2004, the portfolio totaled $449.8 million. Included in the portfolio is $255.6 million of loans secured by commercial real estate. Originations totaled $74.7 million for the first quarter of 2005 compared to $54.2 million in the same period in 2004. Webster Bank is a leader among Connecticut-based banks for providing loans of $1 million and under to small businesses in the state. At March 31, 2005, small business deposit balances totaled $1.1 billion, compared to $1.2 billion at December 31, 2004.
Equipment Financing
Center Capital Corporation (“Center Capital”), a nationwide equipment financing company, had a portfolio which totaled $646.6 million at March 31, 2005, compared to $627.7 million at December 31, 2004 and $527.0 million a March 31, 2004. Center Capital originated $78.3 million in loans during the first quarter, compared to $66.4 million during the same period a year ago.
Insurance Premium Financing
Budget Installment Corp. (“BIC”) finances commercial property and casualty insurance premiums for businesses throughout the United States. BIC had total loans outstanding of $78.1 million at March 31, 2005 compared to $79.7 million at December 31, 2004, and $63.5 million a year ago. Loans originated in the first quarter of 2005 totaled $15.9 million, compared to $43.9 million for the same period in 2004.
Commercial Real Estate Lending
At March 31, 2005 and December 31, 2004, commercial real estate loans totaled $1.7 billion. Included in these loans are owner-occupied loans originated by the Middle Market and Business and Professional Banking divisions at March 31, 2005 of $577.8 million, $581.7 million at December 31, 2004 and $411.5 million at March 31, 2004. During the first quarter of 2005, originations totaled $24.9 million, a decrease of $65.5 million, or 72.5%, from the same period a year earlier.
Consumer Finance
Mortgage Banking and Residential Mortgage Loans
For the three months ended March 31, 2005, originated residential mortgage loans totaled $548.6 million compared to $419.0 million for the same period in 2004. During the first quarter of 2005, long-term interest rates fell and application activity increased, which will also positively impact the second quarter volume. A majority of this originated loan volume, including servicing, is sold in the secondary market. At March 31, 2005 and December 31, 2004, there were
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$254.4 million and $147.2 million, respectively, of residential mortgage loans held for sale in the secondary market. See Notes 5 and 6 of Notes to Consolidated Interim Financial Statements within this report for further information.
The residential mortgage loan portfolio totaled $4.7 billion and $4.8 billion at March 31, 2005 and December 31, 2004, respectively. At March 31, 2005, approximately $1.1 billion, or 24%, of the total residential mortgage loan portfolio were adjustable rate loans. Adjustable rate mortgage loans are offered at initial interest rates discounted from the fully-indexed rate. Adjustable rate loans originated during 2005 when fully-indexed, will be 2.75% above the constant maturity one-year U.S. Treasury yield index. At March 31, 2005, approximately $3.6 billion, or 76% of the total residential mortgage loan portfolio, was fixed rate.
Consumer Loans
At March 31, 2005, consumer loans totaled $2.6 billion, a decrease of $29.3 million, or 1%, compared to the prior year end. At March 31, 2004, consumer loans were $2.2 billion. Originations during the first quarter of 2005 totaled $183.9 million compared to $188.8 million for the same period a year earlier. The decline occurred primarily in floating rate home equity loans and is attributable to the higher interest rate environment.
Asset Quality
Loan Portfolio Review and Allowance for Loan Loss Methodology
Webster devotes significant attention to maintaining asset quality through conservative underwriting standards, active servicing of loans and aggressive management of nonperforming and classified assets. The allowance for loan losses is maintained at a level estimated by management to provide adequately for probable losses inherent in the current loan portfolio. Probable losses are estimated based upon a quarterly review of the loan portfolio, loss experience, specific problem loans, economic conditions and other pertinent factors which, in management’s judgment, deserve current recognition in estimating loan losses. In assessing the specific risks inherent in the portfolio, management takes into consideration the risk of loss on nonperforming loans and classified loans, including an analysis of the collateral for these loans.
The adequacy of the allowance is subject to judgment in its determination. Actual loan losses could differ materially from management’s estimate if actual loss factors and conditions differ significantly from the assumptions utilized. These factors and conditions include the general economic conditions within Webster’s marketplace and nationally, trends within industries where the loan portfolio is concentrated, real estate values, interest rates and the financial condition of individual borrowers. While management believes the allowance for loan losses is adequate at March 31, 2005, actual results in future periods may prove different and these differences could be significant. Management considers the adequacy of the allowance for loan losses to be a critical accounting policy.
See the Allowance for Loan Losses Methodology section within Management’s Discussion and Analysis on pages 28 through 30 of Webster’s 2004 Annual Report on Form 10-K for additional information.
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Nonperforming Assets
The amount of nonperforming assets increased to $49.1 million, or 0.28% of total assets, at March 31, 2005 from $39.2 million, or 0.23% of total assets, at December 31, 2004 and up from $41.3 million, or 0.27% of total assets, at March 31, 2004.
The following table details nonperforming assets:
Total nonperforming loans increased $9.5 million during the first quarter, primarily due to three credits, two of which are commercial real estate loans and the third a commercial loan. Management considers each of these loans well secured and does not expect to realize losses from their resolution.
The allowance for loan losses at March 31, 2005 was $152.5 million and represented 334% of nonperforming loans and 1.30% of total loans. This compares with an allowance of $150.1 million that represented 416% of nonperforming loans and 1.28% of total loans at December 31, 2004. The allowance was $123.6 million, or 338% of nonperforming loans and 1.30% of total loans, at March 31, 2004. For additional information on the allowance, see Note 7 of Notes to Consolidated Interim Financial Statements elsewhere in this report.
Not included in the totals above are performing troubled debt restructurings of $441,000, $20,000 and $609,000 at March 31, 2005, December 31, 2004 and March 31, 2004, respectively.
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Other Past Due Loans
The following table sets forth information as to loans past due 30–89 days.
The overall decrease in loans past due 30-89 days of $7.9 million at March 31, 2005 from December 31, 2004 is primarily due to decreases of $8.6 million in commercial loans and $3.1 million in residential mortgage loans, partially offset by an increase of $3.7 million in commercial real estate loans.
Deposits
Total deposits increased $460.5 million, or 4%, to $11.0 billion at March 31, 2005 from December 31, 2004 and $2.4 billion, or 28%, from March 31, 2004. The increases occurred in most categories of deposits. The growth since year end was a result of HSA Bank, de novo branches and a funding diversification strategy, which raised deposits through the issuance of institutional certificates of deposit and Eurodollar deposits. The percentage of total deposits representing core deposits decreased to 64.8% at March 31, 2005, from 66.5% at December 31, 2004 and 67.7% at March 31 a year ago. This decline is due to the movement of core deposits into higher yielding certificates of deposit.
Borrowing and Other Debt Obligations
Total borrowed funds, including other long-term debt, decreased $33.9 million, or 1%, to $4.7 billion at March 31, 2005 from December 31, 2004. The decrease is primarily a result of the fourth quarter deleveraging program and deposit growth that was utilized to reduce our reliance on wholesale funding. See Notes 11 and 12 of Notes to Consolidated Interim Financial Statements for additional information.
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Asset/Liability Management and Market Risk
Interest rate risk is the sensitivity of earnings to changes in interest rates and the sensitivity of the economic value of interest-sensitive assets and liabilities over short-term and long-term time horizons. The Asset/Liability Management Committee manages interest rate risk to maximize net income and net economic value over time in changing interest rate environments, within limits set by the Board of Directors. Management measures interest rate risk using simulation analyses to measure earnings and equity at risk. Earnings at risk is defined as the change in earnings from a base scenario due to changes in interest rates. Equity at risk is defined as the change in the net economic value of assets and liabilities due to changes in interest rates compared to a base net economic value. Economic value is measured as the net present value of future cash flows. Simulation analysis incorporates assumptions about balance sheet changes such as asset and liability growth, loan and deposit pricing and changes to the mix of assets and liabilities. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk is quantified and appropriate strategies are formulated and implemented.
Interest rate risk simulation analyses cannot precisely measure the impact that higher or lower rate environments will have on net income or net economic value. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in cash flow patterns and market conditions, as well as changes in management’s strategies. Results may also vary based upon actual customer loan and deposit behaviors as compared with those simulated. These simulations assume that management does not take any action to mitigate any negative effects from changing interest rates.
The following table summarizes the estimated impact that gradual 100 and 200 basis point changes in interest rates over a twelve month period starting March 31, 2005 and December 31, 2004 might have on Webster’s net income for the subsequent twelve month period.
Interest rates are assumed to change up or down in a parallel fashion and net income results are compared to a flat rate scenario as a base. The flat rate scenario holds the end of the period yield curve constant over the twelve month forecast horizon. Webster is well within policy limits for all scenarios. The policy limit for the -200 basis point scenario was suspended until the first quarter of 2005 due to the low level of interest rates. The reduction in risk to falling rates since the end of 2004 is due primarily to higher interest rates which have reduced mortgage prepayment risk in the securities and loan portfolios. The current interest rate scenario anticipates rates will rise gradually throughout 2005.
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The following table summarizes the estimated economic value of assets, liabilities and off-balance sheet contracts at March 31, 2005 and December 31, 2004 and the projected change to economic values if interest rates instantaneously increase or decrease by 100 basis points.
The book value of assets exceeded the estimated economic value at March 31, 2005 and December 31, 2004 because the equity at risk model assigns no value to goodwill and other intangible assets, which totaled $714.5 million and $694.2 million, respectively.
Changes in net economic value are primarily driven by changing durations of assets and liabilities and by changes in long term rates. Short-term rates have risen about 50 basis points since year end while long term rates have risen by about 30 basis points. As noted in the table above, the estimated volatility in economic value of equity has not changed significantly from year end for a 100 basis point rise in interest rates. The increase in long term rates has had a greater effect in the -100 basis point scenario as the economic incentive to prepay mortgage assets has diminished.
Liquidity and Capital Resources
Liquidity management allows Webster to meet its cash needs at a reasonable cost under various operating environments. Liquidity is actively managed and reviewed in order to maintain stable, cost-effective funding to support the balance sheet. Liquidity comes from a variety of sources such as the cash flow from operating activities, including principal and interest payments on loans and investments, unpledged securities, which can be sold or utilized as collateral to secure funding and by the ability to attract new deposits. Webster’s goal is to maintain a strong increasing base of core deposits to support its growing balance sheet.
Management monitors current and projected cash needs and adjusts liquidity, as necessary. Webster has a detailed liquidity contingency plan, which is designed to respond to liquidity concerns in a prompt and comprehensive manner. It is designed to provide early detection of potential problems and details specific actions required to address liquidity risks.
At March 31, 2005 and December 31, 2004, FHLB advances outstanding totaled $2.3 billion and $2.6 billion, respectively. Webster Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $478.3 million and $651.6 million at March 31, 2005 and December 31, 2004 respectively. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $724.8 million at March 31, 2005 or used to collateralize other borrowings, such as repurchase agreements.
The main sources of liquidity at the holding company are dividends from Webster Bank, investment income and net proceeds from capital offerings and borrowings. The main uses of liquidity are the payment of dividends to common stockholders, repurchases of common stock, purchases of investment securities and the payment of interest on borrowings and capital securities. There are certain regulatory restrictions on the payment of dividends by Webster Bank to the holding company. At March 31, 2005, $169.1 million of retained earnings were available for the payment of
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dividends to the holding company. Webster also maintains $75.0 million in available revolving lines of credit with correspondent banks.
On July 23, 2002, Webster announced a stock buyback program of 2.4 million shares, or approximately 5 percent of its 48.0 million shares of outstanding common stock as of the announcement date. Through March 31, 2005, Webster has repurchased 1,871,803 shares of its common stock under the buyback program, with 528,197 remaining shares to be repurchased. On July 22, 2003, a stock buyback program was announced consisting of 2.3 million shares. To date, no shares have been repurchased under this program.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market risk appears under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, on pages 33 and 34 under the caption “Asset/Liability Management and Market Risk”.
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2005, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, of the design and operation of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective for gathering, analyzing and disclosing the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
As part of its ongoing integration activities, Webster is continuing to incorporate its controls and procedures into EWBI, acquired in the first quarter of 2005.
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PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine litigation incidental to its business, to which Webster or any of its subsidiaries is a party or of which any of their property is the subject.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information with respect to any purchase made by or on behalf of Webster or any “affiliated purchaser”, as defined by Section 240.10b-18(a)(3) of the Securities and Exchange Act of 1934, of shares of Webster common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
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ITEM 6. EXHIBITS
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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