UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2007.
or
Commission File Number: 001-31486
WEBSTER FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(203) 465-4364
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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. x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of common stock outstanding as of October 26, 2007 was 53,489,973.
INDEX
PART I – FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II – OTHER INFORMATION
Item 1A.
Item 5.
Item 6.
SIGNATURE
EXHIBIT INDEX
2
ITEM 1. INTERIM FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION (unaudited)
(In thousands, except share data)
Assets:
Cash and due from depository institutions
Short-term investments
Securities:
Trading, at fair value
Available for sale, at fair value
Held-to-maturity (fair value of $2,007,892 and $1,434,543)
Loans held for sale
Loans, net
Goodwill
Cash surrender value of life insurance
Premises and equipment
Accrued interest receivable
Other intangible assets
Deferred tax asset, net
Prepaid expenses and other assets
Total assets
Liabilities and Shareholders’ Equity:
Deposits
Federal Home Loan Bank advances
Securities sold under agreements to repurchase and other short-term debt
Long-term debt
Reserve for unfunded credit commitments
Accrued expenses and other liabilities
Total liabilities
Preferred stock of subsidiary corporation
Shareholders’ equity:
Common stock, $.01 par value;
Authorized - 200,000,000 shares
Issued - 56,584,354 shares and 56,388,707 shares
Paid-in capital
Retained earnings
Less: Treasury stock, at cost; 3,064,181 shares at September 30, 2007
Accumulated other comprehensive loss, net
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying Notes to Consolidated Interim Financial Statements.
3
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(In thousands, except per share data)
Interest Income:
Loans
Securities and short-term investments
Total interest income
Interest Expense:
Federal Home Loan Bank advances and other borrowings
Other long-term debt
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit losses
Noninterest Income:
Deposit service fees
Insurance revenue
Loan related fees
Wealth and investment services
Gain (loss) on sales of loans and loan servicing, net
Increase in cash surrender value of life insurance
Loss on write-down of securities available for sale to fair value
Net gain on securities transactions
Gain on Webster Capital Trust I and II securities
Other income
Total noninterest income
Noninterest Expenses:
Compensation and benefits
Occupancy
Furniture and equipment
Intangible assets amortization
Marketing
Professional services
Acquisition costs
Debt redemption premium
Severance and other costs
Other expenses
Total noninterest expenses
Income before income taxes
Income taxes
Net Income
Basic earnings per share
Diluted earnings per share
Average shares outstanding:
Basic
Diluted
4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)
(In thousands, except share and per share data)
Nine months ended September 30, 2006:
Balance, December 31, 2005
Opening balance adjustment (Note 18)
Balance, December 31, 2005 (as adjusted)
Comprehensive income:
Net income
Other comprehensive income (loss), net of taxes
Decrease in net unrealized loss on securities available for sale due to write-down to fair value
Net unrealized loss on securities available for sale
Amortization of unrealized loss on securities transferred to held to maturity
Amortization of deferred hedging gain
Other comprehensive income
Comprehensive income
Dividends paid: $.79 per common share
Exercise of stock options
Excess tax benefit from stock options exercised
Repurchase of 1,314,760 shares
Stock-based compensation expense
Restricted stock grants and expense
Employee Stock Purchase Plan
Balance at September 30, 2006
Nine months ended September 30, 2007:
Balance, December 31, 2006
Balance, December 31, 2006 (as adjusted)
Deferred gain on derivatives sold
Amortization of net actuarial loss and prior service cost
Other comprehensive loss
Dividends paid: $.87 per common share
Repurchase of 3,130,109 shares
Cumulative effect of change in accounting for uncertainties in income taxes
Contingent consideration in a business combination
Balance at September 30, 2007
5
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
Operating Activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Amortization of intangible assets
Stock-based compensation
Net gain on sale of foreclosed properties
Net gain on sale of securities
Net gain on sale of loans and loan servicing
Net loss (gain) on trading securities
Decrease (increase) in trading securities
Loans originated for sale
Proceeds from sale of loans originated for sale
Decrease (increase) in interest receivable
Decrease in prepaid expenses and other assets
Increase (decrease) in accrued expenses and other liabilities
Proceeds from surrender of life insurance contracts
Company contribution to stock purchased by the Employee Stock Purchase Plan
Net cash provided by operating activities
Investing Activities:
Purchases of securities, available for sale
Proceeds from maturities and principal payments of securities available for sale
Proceeds from sales of securities, available for sale
Purchases of held-to-maturity securities
Proceeds from maturities and principal payments of held-to-maturity securities
Decrease in short-term investments
Net increase in loans
Proceeds from sale of foreclosed properties
Net purchases of premises and equipment
Net cash provided by (used in) investing activities
Financing Activities:
Net increase in deposits
Proceeds from FHLB advances
Repayment of FHLB advances
Net increase (decrease) in federal funds purchased and securities sold under agreement to repurchase
Long-term debt issued
Repayment of long-term debt
Cash dividends to common shareholders
Common stock repurchased
Net cash (used in) provided by financing activities
Decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
Supplemental Disclosures:
Income taxes paid
Interest paid
Supplemental Schedule of Noncash Investing and Financing Activities:
Mortgage loans securitized and transferred to mortgage-backed securities held-to-maturity
Residential construction loans held-for-sale transferred to Residential construction loan portfolio
Transfer of loans to foreclosed properties
7
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
(Unaudited)
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 or nine months ended September 30, 2007 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 credit 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, 2006.
NOTE 2: Sale Transactions
On March 30, 2007, Webster announced the sale of certain branches of its People’s Mortgage Corporation (PMC), a subsidiary of Webster Bank, National Association (“Webster Bank”). The branch offices in Severna Park and Rockville, Maryland, and Hamden, Connecticut were sold. On April 30, 2007, Webster sold an additional PMC branch office located in Andover, Massachusetts. The Company established a liability for exit costs through the recognition of a pre-tax charge of $2.3 million in its first quarter 2007 results. The expenses relate primarily to severance, lease termination and other transaction costs. No additional costs have been incurred as of September 30, 2007. As of September 30, 2007, the remaining liability was $0.6 million. The Company expects activities associated with the exit from PMC’s operations to be substantially complete by December 31, 2007.
8
NOTE 3: Securities
A summary of trading, available for sale and held to maturity securities follows:
Trading:
Municipal bonds and notes
Available for Sale:
U.S Government Agency bonds
Corporate bonds and notes
Equity securities
Mortgage-backed securities
Total available for sale
Held to maturity:
Total held to maturity
As of September 30, 2007, the fair value of equity securities consisted of Federal Home Loan Bank (FHLB) stock of $69.2 million, Federal Reserve Bank (FRB) stock of $41.7 million, common stock of $45.3 million and preferred stock of $19.8 million. The fair value of equity securities at December 31, 2006 consisted of FHLB stock of $96.0 million, FRB stock of $41.7 million, common stock of $40.2 million and preferred stock of $20.0 million. During the nine months ended September 30, 2007, Webster purchased $50.6 million of agency mortgage backed securities as part of its ongoing Community Reinvestment Act program that are classified as available for sale.
The following table identifies temporarily impaired investment securities as of September 30, 2007 segregated by length of time the securities have been in a continuous unrealized loss position.
Total securities
9
The following table identifies temporarily impaired investment securities as of December 31, 2006 segregated by length of time the securities had been in a continuous unrealized loss position.
U.S. Government agency Bonds
Unrealized losses on fixed income securities result from the cost basis of securities being greater than current market value. This will generally occur as a result of an increase in interest rates since the time of purchase, a structural change in an investment or from deterioration in credit quality of the issuer. Management has and will continue to evaluate impairments, whether caused by adverse interest rate or credit movements, to determine if they are other-than-temporary.
In accordance with applicable accounting literature, Webster must demonstrate an ability and intent to hold temporarily impaired securities until full recovery of their cost basis. Management uses both internal and external information sources to arrive at the most informed decision. This quantitative and qualitative assessment begins with a review of general market conditions and changes to market conditions, credit, investment performance and structure since the prior review period. The ability to hold temporarily impaired securities will involve a number of factors, including: forecasted recovery period based on average life; whether its return provides satisfactory carry relative to funding sources; Webster’s capital, earnings and cash flow positions; and compliance with various debt covenants, among other things. As of September 30, 2007, Webster had the ability and intent to hold all temporarily impaired securities to full recovery, which may be until maturity in the case of debt securities.
In estimating the recovery period for equity securities, the Company reviews analyst forecasts, earnings assumptions and other company specific financial performance metrics. In addition, this assessment will incorporate general market data, industry and sector cycles and related trends to determine a reasonable recovery period.
In November 2006, Webster announced its intention to securitize $1.0 billion of residential mortgage loans and hold the resulting securities in its held-to-maturity securities portfolio, primarily for collateral purposes. As of December 31, 2006, $371.1 million of these loans had been securitized and an additional $633.0 million in loans were securitized in January 2007. A separate mortgage servicing asset was not recognized in these transactions. The held-to-maturity securities were recorded at an amortized cost equal to the carrying amount of the securitized loans.
Management’s evaluation of securities’ impairment losses at September 30, 2007 began with recognition that the Federal Reserve’s Open Market Committee lowered the federal funds rate target by 50 basis points on September 18, 2007 to 4.75%. The Federal Reserve’s action appears to have been due in part to a weakening housing market, subprime mortgage problems, and the lack of liquidity in the banking system hurting investors’ ability to finance their securities positions. Restoring financial market stability and liquidity is positive for both the banking system and Webster.
10
Three available for sale corporate securities totaling $10.8 million at September 30, 2007, had been in an unrealized loss of position for twelve consecutive months or longer due to higher interest rates subsequent to their purchase. At September 30, 2007 the unrealized loss on these securities was $0.3 million. The Company invests in corporate securities that are investment grade, below investment grade and unrated. Securities that are below investment grade or have undergone an internal credit review. As a result of the credit review of the issuers, management has determined that there has been no deterioration in credit quality subsequent to the purchase or last review period. These securities are performing as projected. Management does not consider these investments to be other-than-temporarily impaired based on its credit reviews and Webster’s ability and intent to hold these investments to full recovery of the cost basis which may be to maturity.
Forty-nine held to maturity municipal securities totaling $20.8 million at September 30, 2007, had been in an unrealized loss position for twelve consecutive months or longer due to higher interest rates subsequent to their purchase. At September 30, 2007 the unrealized loss on these securities was $0.3 million. Most of these bonds are insured AAA rated general obligation bonds with stable ratings. There were no significant credit downgrades since the last credit review period. These securities are currently performing as anticipated. Management does not consider these investments to be other-than-temporarily impaired. Webster has the ability and intent to hold these investments to full recovery of the cost basis which may be to maturity.
At September 30, 2007, Webster had $568.2 million in held to maturity securities (including the municipal securities described above) that were in an unrealized loss position for twelve months or longer. At September 30, 2007 the unrealized loss on these securities was $19.9 million. These securities have had varying levels of unrealized loss due to higher interest rates subsequent to their purchase. Approximately 98 percent of that unrealized loss, or $19.6 million, was concentrated in 22 mortgage-backed securities held to maturity totaling $547.4 million in fair value. These securities carry AAA ratings or Agency-implied AAA credit ratings and are currently performing as expected. Management does not consider these investments to be other-than-temporarily impaired and Webster has the ability and intent to hold these investments to full recovery of the cost basis which may be to maturity. Management expects that recovery of these temporarily impaired securities will occur over the weighted-average estimated remaining life of these securities.
There were no other-than-temporary impairment write-downs of securities during the nine months ended September 30, 2007 and 2006, respectively.
NOTE 4: Loans Held for Sale
Loans held for sale had a total carrying value of $211.7 million and $354.8 million at September 30, 2007 and December 31, 2006, respectively. The composition of loans held for sale at September 30, 2007 and December 31, 2006 follows:
(Dollars in thousands)
Residential mortgage loans:
1-4 family units
Construction
Total residential mortgage loans
Consumer loans:
Home equity loans
Home equity lines of credit
Total consumer loans
Total loans held for sale
At September 30, 2007 and December 31, 2006, residential mortgage origination commitments totaled $241.7 million and $305.1 million, respectively. Residential commitments outstanding at September 30, 2007 consisted of fixed rate mortgages at rates ranging from 5.38% to 8.75%. Residential commitments outstanding at December 31, 2006 consisted of adjustable rate and fixed rate mortgages of $17.5 million and $287.6 million, respectively, at rates ranging from 5.50% to 8.25%. Commitments to originate loans generally expire within 60 days. At September 30, 2007 and December 31, 2006, Webster also had outstanding commitments to sell residential mortgage loans of $433.4 million and $652.4 million, respectively. See Note 15 for a further discussion of loan origination and sale commitments.
11
During the second quarter of 2007, a lower of cost or market adjustment of $1.2 million was recorded on the residential construction loans held for sale portfolio. This adjustment was charged to noninterest income (mortgage banking activities). Subsequent to the write-down, $96.3 million of residential construction loans that were not under contract were transferred from the held for sale portfolio to the residential mortgage portfolio. There are no residential construction loans in the held for sale portfolio at September 30, 2007 as the Company discontinued residential construction lending outside of its primary New England market area during the first quarter of 2007. During the third quarter of 2007, the Company changed its mortgage banking focus to the New England and Mid-Atlantic states with a reduced national presence. During the first quarter of 2007, the Company recorded a $700,000 write-down in value on one loan in Florida that had been classified as held for sale. This write-down was charged to noninterest income (mortgage banking activities).
NOTE 5: Loans, Net
A summary of loans, net follows:
Commercial loans:
Commercial non-mortgage
Asset-based lending
Equipment financing
Total commercial loans
Commercial real estate:
Commercial real estate
Commercial construction
Total commercial real estate
Home equity credit loans and lines of credit
Other consumer loans
Total loans
Less: allowance for loan losses
At September 30, 2007, total loans included $18.0 million of net premiums and $47.9 million of net deferred costs, compared with $24.3 million of net premiums and $44.6 million of net deferred costs at December 31, 2006. The unadvanced portions of closed loans totaled $470.2 million and $512.9 million at September 30, 2007 and December 31, 2006, respectively.
Webster’s National Wholesale Construction Lending (“NCLC”) originates loans using bank approved mortgage brokers. As of September 30, 2007, Webster held residential construction loans originated by NCLC totaling $118.1 million ($20.3 million in its primary market area and $97.8 million out of its primary market area), of which loans secured by properties in Florida total $27.9 million. As of December 31, 2006, Webster held residential construction loans originated by NCLC totaling $187.0 million ($42.8 million in its primary market area and $144.2 million out of its primary market area), of which loans secured by properties in Florida total $32.7 million. The Company has discontinued residential construction lending outside of its primary New England market area. In connection with discontinuing this activity the Company allocated $10.0 million of allowance for loan loss during the first quarter of 2007 to this portfolio and since has recorded $2.2 million in charge-offs.
At September 30, 2007 and December 31, 2006, unused portions of home equity credit lines were $2.1 billion and $2.0 billion, respectively. Unused commercial lines of credit, letters of credit, standby letters of credit, equipment financing
12
commitments and outstanding commercial loan commitments totaled $2.7 billion at September 30, 2007 and $3.2 billion at December 31, 2006. Other consumer loan commitments totaled $15.0 million and $65.3 million at September 30, 2007 and December 31, 2006, 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.
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 stand-by letters of credit within the scope of Financial Accounting Standards Board (“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 stand-by 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 September 30, 2007, Webster’s stand-by letters of credit totaled $175.7 million. At September 30, 2007, the fair value of stand-by letters of credit is considered insignificant to the financial statements.
13
NOTE 6: Allowance for Credit Losses
The allowance for credit losses is maintained at a level adequate to absorb probable losses inherent in the loan portfolio and in unfunded credit commitments. This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged-off and reduced by charge-offs on loans.
A summary of the changes in the allowance for credit losses follows:
Balance at beginning of period
Provisions charged to operations
Subtotal
Charge-offs
Recoveries
Net charge-offs
Balance at end of period
Net loan charge-offs as a percentage of average total loans (1)
Components:
Allowance for loan losses
Allowance for credit losses
Allowance for loan losses as a percentage of total loans
Allowance for credit losses as a percentage of total loans
14
NOTE 7: Goodwill and Other Intangible Assets
The following tables set forth the carrying values of goodwill and other intangible assets, net of accumulated amortization:
Balances not subject to amortization:
Balances subject to amortization:
Core deposit intangibles
Other identified intangibles
Total goodwill and other intangible assets
Changes in the carrying amount of goodwill for the nine months ended September 30, 2007 are as follows:
Balance at December 31, 2006
Purchase price adjustments
The addition to goodwill is principally due to a final year earn-out of contingent consideration related to a prior business combination, partially offset by an adjustment due to the resolution of various acquisition related tax liabilities.
Amortization of intangible assets for the nine months ended September 30, 2007, totaled $9.0 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.
For years ending December 31,
2007 (full year)
2008
2009
2010
2011
Thereafter
15
NOTE 8: Income Taxes
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at September 30, 2007 and December 31, 2006 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. Due to uncertainties of realization, a valuation allowance has been established for the full amount of the net state deferred tax asset applicable to Connecticut, and for substantially all Massachusetts and Rhode Island net state deferred tax assets.
Deferred tax assets:
Net operating loss and tax-credit carry forwards
Compensation and employee benefit plans
Intangible assets
Deductible acquisition costs
Accrued liability for unrecognized tax benefits
Net unrealized losses on securities available for sale
Other
Total deferred tax assets
Less: valuation allowance
Deferred tax assets, net of valuation allowance
Deferred tax liabilities:
Deferred loan costs
Equipment financing leases
Purchase accounting and fair-value adjustments
Net unrealized gains on securities available for sale
Mortgage servicing rights
Total deferred tax liabilities
Deferred tax asset
Management believes it is more likely than not that Webster will realize its net deferred tax assets, 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.
16
On January 1, 2007, Webster adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Tax positions must meet the more-likely-than-not recognition threshold at the effective date in order for the related tax benefits to be recognized or continue to be recognized upon adoption of FIN 48. As a result of the adoption of FIN 48, Webster recognized a $1.4 million decrease in the liability for unrecognized tax benefits, which was accounted for as an addition to the January 1, 2007, balance of retained earnings. After the impact of recognizing the decrease in the liability noted above, Webster’s net unrecognized tax benefits totaled $5.9 million. Of that amount, $3.9 million, if recognized, would affect the effective tax rate, and the remainder would reduce goodwill. Webster recognizes accrued interest and penalties related to unrecognized tax benefits, where applicable, in income tax expense. As of the adoption date, Webster had net accrued interest expense related to unrecognized tax benefits of $639,000. At September 30, 2007, Webster had net accrued interest expense related to unrecognized tax benefits of $745,000.
Currently, the Company is under examination from various taxing authorities. It is reasonably possible that at least some of these examinations will conclude in the next 12 months and result in a change in our unrecognized tax benefits. However, quantification of an estimated range of the change in the Company’s unrecognized tax benefits cannot be made at this time.
Webster and its subsidiaries file Federal and various state and local income tax returns. With few exceptions, Webster is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2002.
NOTE 9: Deposits
The following table summarizes the period end balance and the composition of deposits:
Demand
NOW
Money market
Savings
Health savings accounts ("HSA")
Retail certificates of deposit
Brokered deposit
Total
Interest expense on deposits is summarized as follows:
HSA
17
NOTE 10: Federal Home Loan Bank Advances
Advances payable to the Federal Home Loan Bank (“FHLB”) are summarized as follows:
Fixed Rate:
4.09 % to 5.27 % due in 2007
2.67 % to 5.93 % due in 2008
4.98 % to 5.96 % due in 2009
4.16 % to 8.44 % due in 2010
6.60 % to 6.60 % due in 2011
5.22 % to 5.49 % due in 2013
6.00 % to 6.00 % due in 2015
0.00 % to 5.66 % due in 2017 to 2027
Unamortized premiums
Hedge accounting adjustments
Total advances
Webster Bank had additional borrowing capacity of approximately $1.3 billion from the FHLB at September 30, 2007 and $1.6 billion at December 31, 2006. Advances are secured by a blanket security agreement against certain qualifying assets, principally residential mortgage loans. At September 30, 2007 and December 31, 2006, Webster Bank had unencumbered investment securities available to secure additional borrowings. If these securities had been used to secure FHLB advances, borrowing capacity at September 30, 2007 and December 31, 2006 would have been increased by an additional $276.9 million and $849.0 million, respectively. At September 30, 2007 Webster Bank was in compliance with the FHLB collateral requirements.
18
NOTE 11: Securities Sold Under Agreements to Repurchase and Other Short-term Debt
The following table summarizes securities sold under agreements to repurchase and other short-term borrowings:
Securities sold under agreements to repurchase
Federal funds purchased
Treasury tax and loan
The following table sets forth certain information on short-term repurchase agreements:
Quarter end balance
Quarter average balance
Highest month end balance during quarter
Weighted-average maturity (in months)
Weighted-average interest rate at end of period
19
NOTE 12: Shareholders’ Equity
A total of 1,156,356 and 3,130,109 shares of common stock were repurchased during the three and nine month periods ended September 30, 2007 at an average cost of $42.39 and $43.46 per common share, respectively. The following table summarizes the Company’s share repurchase activity for the nine months ended September 30, 2007.
Shares available to be repurchased as of January 1, 2007
Shares repurchased during the three months ended March 31, 2007
Shares available to be repurchased as of March 31, 2007
Shares granted to be repurchased under the June 2007 program
Shares repurchased during the three months ended June 30, 2007
Shares available to be repurchased as of June 30, 2007
Shares granted to be repurchased under the September 2007 program
Shares repurchased during the three months ended September 30, 2007
Shares available to be repurchased as of September 30, 2007
Management intends to selectively repurchase shares of common stock given the current level of the stock price. The tangible capital ratio at September 30, 2007 was 6.17% compared to 6.46% at December 31, 2006 and 5.66% at September 30, 2006. A total of 1,314,760 shares of common stock were repurchased during the first nine months of 2006 at an average cost of $46.82 per common share. Of the shares repurchased, 1,296,394 shares were repurchased as part of the July 2003 stock buyback program.
Webster does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Webster repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. During the nine months ended September 30, 2007 and 2006, Webster repurchased 8,107 and 18,366 shares, respectively, outside of the publicly announced repurchase programs.
Accumulated other comprehensive loss is comprised of the following components:
Unrealized (loss) gain on available for sale securities, net of tax
Unrealized loss upon transfer of available for sale securities to held-to-maturity, net of tax and amortization
Underfunded pension and other postretirement benefit plans, net of tax:
Net actuarial loss
Prior service cost
Deferred gain on hedge accounting transactions
20
NOTE 13: Regulatory Matters
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 September 30, 2007, 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:
At September 30, 2007
Webster Financial Corporation
Total risk-based capital
Tier 1 capital
Tier 1 leverage capital ratio
Webster Bank, N.A.
At December 31, 2006
21
NOTE 14: Business Segments
Retail Banking and Commercial Banking have been identified as reportable operating segments. The balance of Webster’s activity is reflected in Other. The methodologies and organizational hierarchies that define the business segments are periodically reviewed and revised. The following table presents the operating results and total assets for Webster’s reportable segments.
Three months ended September 30, 2007
Net interest income (loss)
Net interest income (loss) after provision
Noninterest income
Noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Total assets at period end
Three months ended September 30, 2006
22
Nine months ended September 30, 2007
Nine months ended September 30, 2006
Retail Banking includes deposit activities, distribution network costs, business and professional banking, consumer lending, residential mortgage, mortgage banking, wealth management and insurance. For the nine months ended September 30, 2007, the increase in noninterest income is primarily due to deposit services fees reflecting an increased contribution from HSA Bank, a division of Webster Bank, the recent implementation of a new consumer fee structure and growth in NSF and Debit Card fees, as well as investment service fee income due to business growth. The increase in noninterest expense is primarily attributable to increases in retail distribution costs associated with the acquisition of NewMil, HSA Bank expenses, write-off of software development costs due to the cancellation of a technology project, the ongoing build out of the compliance function, costs related to closing the remaining operations of People’s Mortgage Corporation and severance-related charges from ongoing line of business restructuring.
Commercial Banking includes middle market, commercial real estate, asset-based lending, equipment financing, insurance premium financing and cash management. Net income decreased $1.4 million for the nine months ended September 30, 2007 when compared to the comparable period in 2006. The decreases are attributable to increases in noninterest expense, primarily due to higher compensation and benefits costs and increases in overhead costs. Offsetting the decreases in net income are increases in net interest income due to loan growth in commercial and commercial real estate loans.
Other includes indirect expenses allocated to segments. These expenses include administration, finance, technology, processing operations and other support functions. Other also includes the Treasury unit, which is responsible for managing the wholesale investment portfolio and funding needs and expenses not allocated to the business lines, the residual impact of methodology allocations such as the provision for credit losses and funds transfer pricing.
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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’ assets and liabilities. The provision for credit 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 credit losses, which is based on an evaluation of the adequacy of the allowance for credit 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 Other. Taxes are allocated to each segment generally based on the effective rate for the period shown.
NOTE 15: Derivative Financial Instruments
At September 30, 2007, there were outstanding interest rate swaps with a total notional amount of $552.5 million which are used to hedge FHLB advances, repurchase agreements and long-term debt (subordinated notes and senior notes). The swaps are used to transform the debt from fixed rate to floating rate and qualify for fair value hedge accounting under SFAS No. 133. Of the total, $202.5 million of the interest rate swaps mature in 2008, $200.0 million in 2013 and $150.0 million in 2014, with an equal amount of the hedged debt also maturing on these dates. At December 31, 2006, there were outstanding interest rate swaps with a notional amount of $752.5 million.
Webster transacts certain derivative products with its customer base, primarily interest rate swaps and, to a lesser extent, interest rate caps. These customer derivatives are offset with matching derivatives with other counterparties in order to minimize risk. Exposure with respect to these derivatives is largely limited to nonperformance by either the customer or the other counterparty. The notional amount of customer derivatives and the related counterparty derivatives each totaled $310.9 million at September 30, 2007 and $274.5 million at December 31, 2006. The customer derivatives and the related counterparty derivatives are marked to market and any difference is reflected in noninterest income.
The fair values and notional amounts of derivatives at September 30, 2007 and December 31, 2006 are summarized below:
September 30,
2007
December 31,
2006
Asset and liability management positions
Interest rate swaps:
Receive fixed/pay floating
Customer related positions
Receive floating/pay fixed
Total interest rate swaps position
Counterparty offset
Total interest rate swaps position, net
Interest rate caps:
Written options
Purchased options
Total interest rate cap position
Total interest rate cap position, net
Total customer related positions
Total derivative positions
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Certain derivative instruments, primarily forward sales of mortgage backed securities (“MBS”), 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 closing and funding a single-family residential mortgage loan, an interest-rate locked commitment is generally extended to the borrower. During the period from commitment date to closing date, Webster Bank is subject to the 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, under which Webster agrees to deliver whole mortgage loans to various investors or issue MBS, are established. At September 30, 2007, outstanding rate locks totaled approximately $241.7 million and the outstanding commitments to sell residential mortgage loans totaled $433.4 million. Forward sales, which include mandatory forward commitments of approximately $410.2 million and best efforts forward commitments of approximately $23.2 million at September 30, 2007, 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 and forward sales commitments are recorded at fair value, with changes in fair value recorded in current period earnings. Loans held for sale are carried at the lower of aggregate cost or fair value.
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NOTE 16: Pension and Other Benefits
The following table provides information regarding net benefit costs for the periods shown:
Three months ended September 30,
Service cost
Interest cost
Expected return on plan assets
Transition obligation
Amortization of prior service cost
Amortization of the net loss
Net periodic benefit cost
Nine months ended September 30,
In December 2006, Webster announced that both the Webster Pension Plan and the supplemental pension plan will be frozen as of December 31, 2007. Employees will no longer accrue additional qualified or supplemental retirement income after December 31, 2007. Furthermore, employees hired after December 31, 2006 will not be eligible to enter either plan. At the same time, Webster announced enhancements to its 401(k) qualified and supplemental retirement savings plans. The enhancements will take effect April 1, 2007 for employees hired after December 31, 2006 and January 1, 2008 for all other employees.
Contributions will be made as deemed appropriate by management in conjunction with the Plan’s actuaries. The Company currently estimates there will be no contributions to the Webster Bank Pension Plan in 2007.
In conjunction with the acquisition of FIRSTFED AMERICA BANCORP, INC. (“FIRSTFED”) in May 2004, Webster assumed the obligations of the FIRSTFED pension plan. The plan was not merged into the Webster Bank Pension Plan, but instead will continue to be included in the multiple-employer plan administered by Pentegra (the “Fund”). The Fund does not segregate the assets or liabilities of its participating employers in the on-going administration of this plan and accordingly, disclosure of FIRSTFED accumulated vested and nonvested benefits is not possible. Webster has made $1.0 million in contributions in the first nine months and estimates it will make approximately $2.6 million in total contributions during calendar year 2007.
In conjunction with the acquisition of NewMil Bancorp, Inc. (“NewMil”) in October 2006, Webster assumed the obligations of the New Milford Savings Bank Defined Benefit Pension Plan. On July 31, 2007, the New Milford Savings Bank Defined Benefit Pension Plan was merged into the Webster Bank Pension Plan.
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NOTE 17: Other Comprehensive Income
The following table summarizes the components of other comprehensive income:
Other comprehensive (loss) income:
Net unrealized (loss) gain on securities available for sale
Loss on write-down of securities available for sale included in net income
Total other comprehensive (loss) income
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NOTE 18: Accounting Adjustment
During the second quarter of 2007, management identified an error related to an unintentional over-accrual of insurance revenues between 2002 and 2005, caused by the accrual of direct bill revenues at a rate greater than ultimate collections. The effect was not material in any one period and resulted in a cumulative over-accrual of approximately $4.2 million or $2.7 million after-tax. Management evaluated the financial statement impact of this error and recorded a cumulative decrease to opening retained earnings of $2.7 million, as well as a $4.2 million reduction in other assets for the over-accrual and a $1.5 million decrease in deferred tax asset, net for the related tax effect. The adjustment had no effect on the consolidated statements of income for any of the periods presented herein.
NOTE 19: Recent Accounting Pronouncements
On June 14, 2007, the EITF reached a final consensus on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. This consensus was ratified by the FASB on June 27, 2007. This Issue states that tax benefits received on dividends paid to employees associated with their unvested stock compensation awards should be recorded in additional-paid-in-capital (APIC) for awards expected to vest. Currently, such dividends are a permanent tax deduction reducing the annual effective income tax rate. This Issue also requires that such tax benefits be reclassified between APIC and income tax expense in subsequent periods for any changes in forfeiture estimates. Tax benefits for dividends recorded to APIC would be available to absorb future stock compensation tax deficiencies. This Issue is to be applied prospectively to dividends declared in fiscal years beginning after December 15, 2007. Retrospective application of this Issue is prohibited. This EITF is not expected to have a material effect on Webster’s financial statements.
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB No. 115 to permit measurement of recognized financial assets and liabilities at fair value (the “fair value option”). Unrealized gains and losses on items for which the fair value option has been taken are reported in earnings at each subsequent reporting date. Upfront costs and fees related to items reported under the fair value option are recognized in earnings as incurred and not deferred. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Because SFAS 159 permits management to determine which, if any, financial assets and liabilities to measure at fair value, Webster’s management is currently evaluating what, if any, impact the adoption of SFAS 159 will have on Webster’s consolidated financial position, results of operations or cash flows.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), which is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. This statement defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. Webster is currently evaluating the potential impact of adopting SFAS 157.
In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue No. 06-4 (“EITF 06-4”), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion — 1967. The provisions of EITF 06-4 are effective for Webster on January 1, 2008 and are to be applied as a change in accounting principle either through a cumulative-effect adjustment to retained earnings or other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption; or through retrospective application to all prior periods. Webster is currently evaluating the financial statement impact of adoption of EITF 06-4.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS
Forward Looking Statements
This report contains forward looking statements within the meaning of the Securities 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, or any combination thereof, 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 September 30, 2007 had assets of $16.8 billion and shareholders’ equity of $1.8 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 commercial banking, retail banking, health savings accounts (“HSAs”), consumer financing, mortgage banking, trust and investment services through 179 banking offices, 340 ATMs, and its Internet website (www.websteronline.com). Webster is a bank holding company and is registered with the Board of Governors of the Federal Reserve System (“Federal Reserve”) under the Bank Holding Company Act. As such the Federal Reserve is Webster’s primary regulator, and Webster is subject to extensive regulation, supervision and examination by the Federal Reserve. Webster Bank is regulated by the Office of the Comptroller of the Currency (“OCC”). 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 Securities and Exchange Commission (“SEC”).
Critical Accounting Policies
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2006 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 to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for credit losses, valuation of goodwill/other intangible assets and analysis for impairment, deferred income taxes and pension and other post retirement benefits as the Company’s 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 subjective and 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, 2006 Management’s Discussion and Analysis included in the Annual Report on Form 10-K.
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RESULTS OF OPERATIONS
Summary
Webster’s net income was $35.0 million for the three months ended September 30, 2007, compared to $9.0 million for the three months ended September 30, 2006. Net income per diluted share was $0.64 for the three months ended September 30, 2007 compared to $0.17 for the comparable period in 2006. For the nine months ended September 30, 2007, Webster’s net income was $105.5 million compared to $96.0 million for the comparable period in 2006, an increase of 9.9%. Net income per diluted share was $1.89 for the nine months ended September 30, 2007 compared to $1.80 for the comparable period in 2006. Results for the three and nine months ended September 30, 2007 includes an increase in the provision for credit losses of $11.0 million ($7.6 million net of tax or $0.14 per diluted share). $11.0 million of the provision recorded in the third quarter of 2007 was applicable to the Company’s home equity loans and lines of credit portfolio, based on management’s analysis of third quarter data. This analysis indicated a higher level of estimated losses inherent in this portfolio based on recent adverse trends in credit quality, including increases in delinquencies and nonaccrual loans in this portfolio during the month of September 2007 most particularly for loans originated with high combined loan to value ratios or without income verification. The year-over-year increase in net income is also attributable to a prior year loss on the write-down of available for sale mortgage-backed securities (MBS) of $48.9 million ($31.8 million after tax or $0.60 per common share) that was recorded in the third quarter of 2006. Excluding the prior year write-down, net income decreased by $5.8 million and $22.3 million for the three and nine months ended September 30, 2007, respectively, when compared to the same periods in 2006. The year over year decrease, excluding the prior year write-down, is primarily attributable to the $11.0 million increase in the provision for loan losses as described above, $8.9 million ($5.8 million net of taxes) in redemption premiums and unamortized issuance costs related to the redemption of Webster Capital Trust I and II securities, closing costs of $2.3 million ($1.5 million, net of taxes) related to the remaining operations of PMC, severance related charges from ongoing restructuring in insurance and other lines of business of $4.5 million ($2.9 million, net of taxes), the write-off of software development costs of $3.4 million ($2.2 million, net of taxes) and $1.6 million ($1.1 million, net of taxes) related to the write down in value of various residential construction loans classified as held for sale, partially offset by a $2.1 million ($1.4 million net of taxes) gain on positions in Webster Capital Trust I and II securities that were redeemed by Webster.
The Company completed its previously announced strategic and organizational reviews during the second quarter of 2007. The goal of the strategic review was to look at the bank and all lines of business and focus on core competencies, identify operational efficiencies, and position Webster to realize its vision of becoming New England’s bank. This required evaluating the contribution, growth potential, fit and alignment of each segment and line of business with the Company’s goals and mission. In the first quarter of 2007, the Company announced a decision to close People’s Mortgage Company; terminate mezzanine lending operations (Webster Growth Capital); discontinue construction lending outside of its primary New England market area (National Construction Lending); restructure its insurance operations; and outsource the back office operations of Webster Investment Services.
Additional outcomes that the Company announced as part of its second quarter 2007 earnings call included:
A decision to focus on in-market and contiguous franchise growth.
Future lending relationships outside the Northeast will be direct.
Mortgage banking
Focus will be on the New England and Mid-Atlantic states with reduced national presence.
Insurance
The Company is exploring strategic alternatives for Webster Insurance that may result in its sale and ideally would include a partnership to continue to sell insurance products.
HSA Bank
The Company is evaluating strategic alliances as well as additional investment in HSA Bank to continue capturing a high market share in the fast-growing health savings account deposit segment.
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In addition, the Company announced its intent to open two new branch locations in the fourth quarter of 2007 (East Longmeadow, MA and Woodbridge, CT), and currently anticipates opening approximately six new locations in 2008. Two new branches (New Rochelle, NY and Longmeadow, MA) were opened during the third quarter of 2007. The Company intends to optimize its existing franchise by combining certain offices into stronger locations and using efficiency gained to fund investment in de novo branches. The Company has also detailed a facilities strategy to consolidate back office operations into one location and a regional hub approach to consolidate facilities in certain cities, which is expected to occur over the next 2 years.
The stated goal of the organizational review, which was announced on February 28, 2007, was to implement a structure that will result in a more efficient and effective organization. The organizational review resulted in the creation of: an Office of the Chairman; an Executive Management Committee; a new position – the Chief Administrative Officer, who is responsible for all shared services functions; restructuring and streamlining of governance committees and layers of management; and a restructured approach to risk management that distinctly addresses credit, operating and interest rate risk.
Selected financial highlights are presented in the following table.
Earnings and Per Share Data
Total noninterest expense
Net income per diluted common share
Dividends declared per common share
Book value per common share
Tangible book value per common share
Diluted shares (average)
Selected Ratios
Return on average assets
Return on average shareholders' equity
Net interest margin
Efficiency ratio (a)
Tangible capital ratio
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Net Interest Income
Net interest income, which is the difference between interest earned on loans, investments and other interest earning assets and interest paid on deposits and borrowings, totaled $127.1 million for the three months ended September 30, 2007, compared to $122.4 million for the comparable period in 2006, an increase of $4.7 million or 3.8%. For the nine months ended September 30, 2007 net interest income totaled $385.5 million compared to $379.4 million for the comparable period in 2006, an increase of $6.1 million or 1.6%.
The increase in net interest income is largely due to Webster’s balance sheet repositioning actions as proceeds from the sale of securities were used to pay down high cost borrowings. For the three months ending September 30, 2007, the yield on interest earning assets increased 30 basis points while the cost of interest bearing liabilities decreased by 6 basis points compared to the same period in 2006. The decreased yield on interest bearing liabilities is attributable to decreases on long-term debt and FHLB borrowings. For the nine months ending September 30, 2007, the yield on interest earning assets rose 48 basis points while the cost of interest bearing liabilities rose 22 basis points compared to the same period in 2006. As a result, the net interest margin for the three months ended September 30, 2007 was 3.38%, an increase of 37 basis points from the comparable period in 2006. For the nine months ended September 30, 2007, the net interest margin was 3.42%, an increase of 29 basis points from the comparable period in 2006.
Net interest income can change significantly from period to period based on general levels of interest rates, customer prepayment patterns, the mix of interest earning assets and the mix of interest bearing and non-interest bearing deposits and borrowings. Webster manages the risk of changes in interest rates on its net interest income through an Asset/Liability Management Committee and through related interest rate risk monitoring and management policies. See “Asset/Liability Management and Market Risk” for further discussion of Webster’s interest rate risk position.
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. The table presented below is based upon the fully tax-equivalent basis.
Three months ended September 30,2007 vs. 2006
Increase (decrease) due to
Nine months ended September 30,2007 vs. 2006
Interest on interest-earning assets:
Interest on interest-bearing liabilities:
Borrowings
Net change in net interest income
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Interest Income
Interest income, on a fully tax-equivalent basis, for the three months ended September 30, 2007 decreased $8.2 million, or 3.1%, from the comparable period in 2006, and for the nine months ended September 30, 2007, rose $1.3 million, or 0.2%, from the comparable period in 2006. For the nine months ended September 30, 2007 the increase in short-term interest rates had a favorable impact on interest sensitive loans as well as higher rates on new volumes. Partially offsetting the impact of higher short term rates were lower loan and securities balances. The year to date average balance for loans was $12.4 billion, a decrease of 1.6% from $12.6 billion for the comparable period in 2006 and the year to date average balance for securities was $2.4 billion, a decrease of 31.2% from $3.5 billion for the comparable period in 2006.
The yield on interest-earning assets for the nine months ended September 30, 2007 increased 48 basis points from the comparable period in 2006. The increase reflects the rising interest rate environment in these periods and the reduction in low yielding assets.
The loan portfolio yield for the nine months ended September 30, 2007 increased 27 basis points to 6.78% and comprised 81.2% of average interest-earning assets compared to a loan portfolio yield of 6.51% and comprising 77.0% of average interest- earning assets for the nine months ended September 30, 2006.
Interest Expense
Interest expense for the three months ended September 30, 2007 decreased $13.3 million, or 9.7%, from the comparable period in 2006 primarily due to lower FHLB borrowings. For the nine months ended September 30, 2007, interest expense decreased $5.9 million, or 1.6%, from the comparable period in 2006. The decrease for the nine months was primarily due to lower borrowings, primarily FHLB borrowings, offset by rising short-term interest rates and continued consumer preference for higher yielding certificates of deposit and money market savings accounts.
The cost of interest bearing liabilities was 3.32% for the three months ended September 30, 2007, a decrease of 6 basis points compared to 3.38% for the comparable period in 2006. For the nine months ended September 30, 2007, the cost of interest bearing liabilities was 3.29%, an increase of 22 basis points from 3.07% for the comparable period in 2006. Deposit costs for the nine months ended September 30, 2007 increased to 2.91% from 2.46%, an increase of 45 basis points from the comparable period in 2006. Total borrowing rates for the nine months ended September 30, 2007 increased 50 basis points to 5.36% from 4.86% for the comparable period in 2006.
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The following summarizes the major categories of assets and liabilities together with their respective interest income or expense and the rates earned or paid by Webster.
Assets
Interest-earning assets:
Securities (b)
Total interest-earning assets
Noninterest-earning assets
Liabilities and shareholders’ equity
Interest-bearing liabilities:
Demand deposits
Savings, NOW & money market deposits
Certificates of deposit
Total interest-bearing deposits
Repurchase agreements and other short-term debt
Total borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities
Shareholders’ equity
Fully tax-equivalent net interest income
Less: tax equivalent adjustments
Interest-rate spread
Net interest margin (b)
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Provision for Credit Losses
Management performs a quarterly review of the loan portfolio and unfunded commitments to determine the adequacy of the allowance for credit losses and the amount of provision for credit losses required. Several factors influence the amount of the provision, primarily loan growth and portfolio mix, net charge-offs, the risk of loss on nonperforming and classified loans and the level of economic activity.
The provision for credit losses was $15.3 million for the three months ended September 30, 2007, an increase of $12.3 million compared to $3.0 million from the comparable period in 2006. For the nine months ended September 30, 2007, the provision was $22.5 million, an increase of $14.5 million from $8.0 million in the comparable period in 2006. The provision recorded in the third quarter of 2007 includes $11.0 million applicable to the Company’s home equity loans and lines of credit portfolio, based on management’s analysis of third quarter data. This analysis indicated a higher level of estimated losses inherent in this portfolio based on recent adverse trends in credit quality, including increases in delinquencies and nonaccrual loans in this portfolio during the month of September 2007 most particularly for loans originated with high combined loan to value ratios or without income verification.
Net charge-offs for the three months ended September 30, 2007 were $4.0 million compared to $3.1 million for the comparable period in 2006. For the nine months ended September 30, 2007, net charge-offs were $13.5 million compared to $7.3 million for the comparable period in 2006. Included in the net charge-offs for the nine months ended September 30, 2007 is $2.2 million related to 13 residential construction loans in Florida for which management has determined a high probability of loss based on borrower delinquency and market deterioration. The annualized net charge-off ratio for the three months ended September 30, 2007 was 0.13% of average total loans, compared to 0.10% for the comparable period in 2006. Included in net charge-offs in the third quarter of 2007 were $0.5 million of consumer overdraft losses. Prior to the second quarter of 2007, overdraft losses were shown as a reduction of deposit fee income. Uncollected fees related to overdraft amounts continue to be charged against deposit service fees.
Webster’s National Wholesale Construction Lending (“NCLC”) originates loans using bank approved mortgage brokers. As of September 30, 2007, Webster held residential construction loans originated by NCLC totaling $118.1 million ($20.3 million in its primary market area and $97.8 million out of its primary market area), of which loans secured by properties in Florida total $27.9 million. As of December 31, 2006, Webster held residential construction loans originated by NCLC totaling $187.0 million ($42.8 million in its primary market area and $144.2 million out of its primary market area), of which loans secured by properties in Florida total $32.7 million. The Company has discontinued residential construction lending outside of its primary New England market area. In connection with discontinuing this activity the Company allocated $10.0 million during the first quarter of 2007 in reserves to offset potential exposure in this portfolio and since has recorded $2.2 million in charge-offs.
The allowance for credit losses, which is comprised of the allowance for loan losses and the reserve for unfunded commitments, totaled $164.0 million, or 1.32% of total loans at September 30, 2007, and $155.0 million, or 1.20% of total loans at December 31, 2006. The allowance for loan losses totaled $154.5 million or 1.24% of total loans at September 30, 2007 and $147.7 million or 1.14% of total loans at December 31, 2006 and represented 162.1% and 250.7% of nonperforming loans, respectively.
For further information, see “Loan Portfolio Review and Allowance for Credit Losses Methodology”, included in the “Financial Condition – Asset Quality” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 40 through 43 of this report.
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Noninterest Income
Total noninterest income, was $60.2 million for the three months ended September 30, 2007, an increase of $53.4 million and for the nine months ended September 30, 2007 was $181.6 million, an increase of $62.5 million from the comparable period in the prior year. The quarterly and year to date increase when compared to the same periods in 2006 are primarily due to a prior year loss on the write-down of available for sale mortgage-backed securities of $48.9 million. Excluding the prior year write-down, total noninterest income for the three months ended September 30, 2007 increased $4.5 million, or 8.1%, from the comparable period in 2006. For the nine months ended September 30, 2007, excluding the prior year write-down, noninterest income increased $13.6 million, or 8.1% from the comparable period in 2006. The increase for the three months ended September 30, 2007 is primarily attributable to a $4.7 million increase in deposit service fees reflecting debit card interchange income and the implementation during the year of a new consumer fee structure and a $2.0 million increase in mortgage banking activities offset by a $1.8 million decrease in the gain on the sales of securities. The increase in noninterest income for the nine months ended September 30, 2007 when compared to the same period in 2006, was primarily due to increases in deposit service fees and a gain on the redemption of Webster Capital Trust I and II securities during the second quarter of 2007, in addition to increased fees from mortgage banking activities and the wealth and investment services lines of businesses partially offset by decreases in insurance revenue and the net gain on securities transactions.
Noninterest Expenses
Total noninterest expenses for the three months ended September 30, 2007 were $121.7 million, an increase of $5.8 million, or 5.0%, from the comparable period in 2006 and for the nine months ended September 30, 2007 were $391.0 million, up $38.7 million, or 11.0%, from the comparable period in 2006. Contributing to the increases when comparing the three months ended September 30, 2007 with the comparable period in 2006 were $4.9 million related to compensation costs, $1.2 million in furniture and equipment costs and $0.5 million in severance-related charges offset by $0.9 million in lower intangible amortization costs. Contributing to the higher compensation was HSA Bank, compliance and regulatory areas and a reduction in the deferral of salaries related to loan origination costs and other expenses.
Contributing to the increases when comparing the nine months ended September 30, 2007 with the comparable period in 2006 were $8.9 million of debt prepayment expenses related to redemption premiums and unamortized issuance costs, $10.6 million related to compensation and benefit costs, severance-related charges of $4.6 million primarily related to restructuring in conjunction with the Company’s strategic and organizational review, $3.4 million related to the write-off of software development costs and $2.3 million of closing costs related to PMC. As part of Webster’s previously announced strategic review process, the Company determined in the first quarter of 2007, that PMC’s operations no longer fit Webster’s core business model. This determination led to the decision to close PMC’s remaining operations. The closing costs relate primarily to severance, lease termination and other transaction costs. Other factors include increases in furniture and equipment, occupancy, and broker and referral fees offset by lower intangible amortization costs. The increases in compensation and benefits are primarily due to investments in people as discussed above.
Income Taxes
Income tax expense for the three and nine months ended September 30, 2007 is higher than the comparable prior year period primarily due to a higher level of income before taxes. The effective tax rates for the nine months ended September 30, 2007 and 2006 were 31.3% and 30.5%, respectively. The increase in the effective tax rate reflects the effects of an increase in pre-tax income combined with higher state and local tax expense, offset by higher levels of tax-exempt interest income and non-taxable increase in cash surrender value of life insurance in 2007, as compared to 2006.
Financial Condition
Webster had total assets of $16.8 billion at September 30, 2007, compared with $17.1 billion at December 31, 2006. Total loans declined by $502.9 million, or 3.9%, from December 31, 2006 and $601.2 million, or 4.6%, from September 30, 2006. The decline is principally due to the residential loan securitization that took place in the fourth quarter of 2006 and the first quarter of 2007. At the same time, total deposits increased $95.6 million, or 0.8%, from December 31, 2006 and $249.9 million, or 2.0%, from September 30, 2006. Webster’s loan to deposit ratio declined to 98.9% at September 30, 2007 compared with 103.7% and 105.8% at December 31, 2006 and September 30, 2006, respectively.
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At September 30, 2007, total shareholders’ equity of $1.8 billion represented a net decrease of $69.1 million from December 31, 2006. The change in equity for the nine months ended September 30, 2007 consisted of net income of $105.5 million, $13.9 million related to stock options exercised, stock based compensation and the related tax benefits, $2.6 million related to deferred gains on derivatives sold, $1.4 million resulting from the adoption of FIN 48, $1.6 million relating to business combination contingent consideration payments and $0.6 million of other miscellaneous amounts, more than offset by $48.5 million of dividends to common shareholders, $136.0 million to repurchase shares of common stock and a $10.1 million unfavorable change in unrealized losses on the available for sale securities portfolio (net of tax). At September 30, 2007, the tangible capital ratio was 6.17%, compared to 6.46% at December 31, 2006 and 5.66% at September 30, 2006.
Securities Portfolio
Webster maintains an investment securities 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 September 30, 2007, the investment securities portfolio totaled $2.5 billion, or 14.9% of total assets, an increase from $2.0 billion, or 11.5% of total assets, at December 31, 2006 and a decrease from $3.3 billion, or 18.3% of total assets, at September 30, 2006.
Loan Portfolio
At September 30, 2007, total loans were $12.4 billion, down $502.9 million from December 31, 2006. The decrease is primarily due to the securitization of $633 million of residential mortgage loans, partially offset by growth in commercial and commercial real estate loans.
Commercial loans (including commercial real estate) represented 43.9% of the loan portfolio at September 30, 2007, up from 40.9% at December 31, 2006, while residential mortgage loans declined to 29.6% of the loan portfolio at September 30, 2007 from 34.2% at December 31, 2006. The remaining portion of the loan portfolio consisted of consumer loans.
The following paragraphs highlight, by business segment, the lending activities in the various portfolios during the quarter. Refer to Webster’s 2006 Annual Report on Form 10-K, pages 2 through 7, for a more complete description of Webster’s lending activities and credit administration policies and procedures.
RETAIL BANKING
Business & Professional Banking
Business & Professional Banking, Webster’s small business banking division, had loans outstanding of $905.2 million at September 30, 2007, a 1.4% increase from $892.8 million at December 31, 2006. At September 30, 2006, the portfolio totaled $725.1 million. Included in the portfolio is $541.5 million of loans secured by commercial real estate. New originations for the three months ended September 30, 2007 totaled $85.4 million, compared to $73.8 million for the comparable period in 2006.
Consumer Finance
Residential Mortgage and Mortgage Banking
For the three months ended September 30, 2007, residential mortgage loan originations totaled $700.0 million, compared to $800.0 million for the comparable period in 2006. A majority of this originated loan volume, including servicing, is sold in the secondary market. At September 30, 2007 and December 31, 2006, there were $211.7 million and $353.4 million, respectively, of residential mortgage loans held for sale in the secondary market. See Note 4 of Notes to Consolidated Interim Financial Statements within this report for further information.
The residential mortgage loan portfolio totaled $3.7 billion, $4.4 billion and $4.8 billion as of September 30, 2007, December 31, 2006 and September 30, 2006, respectively. At September 30, 2007, approximately $908 million, or 24.7%, of the portfolio consisted of adjustable and variable rate loans. The adjustable rate mortgage loans are offered at initial interest rates discounted from the fully-indexed rate. At September 30, 2007, approximately $2.8 billion, or 75.3% of the total residential mortgage loan portfolio, consisted of fixed rate loans.
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Consumer Lending
Consumer lending includes home equity loans and lines of credit and other consumer loans. At September 30, 2007, consumer loans totaled $3.3 billion, an increase of $75.9 million ($60.2 million of the increase was in home equity loans and $17.4 million in home equity lines of credit offset by a decrease of $1.7 million in other consumer loans) compared to December 31, 2006 and an increase of $246.2 million ($197.4 million of the increase was in home equity loans, $48.7 million in home equity lines of credit and $0.1 million in other consumer loans) compared to September 30, 2006. At September 30, 2007, 19.5% of the total home equity loans and lines of credit were in a first lien position and 80.5% were in a second lien position. Additionally, approximately 75% of the total home equity loans and lines were geographically located within the New England and Mid-Atlantic market areas and the other approximately 25% were spread throughout the remaining United States of which no individual state has a significant percentage. The Company has discontinued all wholesale home equity lending outside of its New England and Mid-Atlantic market areas. For further information on the results of operations related to Consumer Lending, see “Provision for Credit Losses”, included in the “Results of Operations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 36 of this report.
Webster Insurance
Webster Insurance offers a full range of insurance products to both businesses and individuals. A regional insurance agency, Webster Insurance provides insurance products and services throughout Connecticut, Massachusetts and Rhode Island that include; commercial and personal property and casualty insurance; life, health, disability and long-term care insurance; third party worker’s compensation claims administration and risk management services. It is the largest insurance agency based in Connecticut and is headquartered in Meriden with offices in several other Connecticut communities, including Vernon, Waterford and Westport as well as an office in Harrison, New York. For the three and nine months ended September 30, 2007 and 2006, Webster Insurance recorded revenues of $8.9 million and $28.2 million compared to $9.8 million and $30.5 million, respectively. Webster Insurance incurred expenses of $8.2 million and $27.5 million, including $0.2 million and $1.5 million of severance and other restructuring charges, for the three and nine months ended September 30, 2007 compared with $28.7 million and $9.5 million for the same periods in 2006. As previously disclosed, the Company is currently exploring strategic alternatives for Webster Insurance that may result in its sale and ideally would include a partnership to continue to sell insurance products.
Wealth and Investment Services
There are two business units within wealth and investment services providing investment and advisory services to affluent and high-net worth individuals and institutions. Webster Financial Advisors (“WFA”) targets high-net worth clients, not-for-profit organizations and business clients with investment management, trust, credit and deposit products and financial planning services. WFA takes a comprehensive view when dealing with clients in order to fully serve their short and long-term financial objectives. Proprietary and non-proprietary investment products are offered through WFA and the J. Bush & Co. division. WFA provides several different levels of financial planning expertise including specialized services through another wholly-owned subsidiary, Fleming, Perry & Cox. At both September 30, 2007 and December 31, 2006, there were approximately $2.3 billion of client assets under management and administration, of which $1.5 billion were under management. These assets are not included in the Consolidated Financial Statements.
Webster Investment Services, Inc. (“WIS”) offers customers an expansive array of investment products including stocks and bonds, mutual funds, managed accounts and annuities. Brokerage and online investing services are available for customers who prefer to access and manage their own investments. At September 30, 2007 and December 31, 2006, there were $1.8 billion and $1.6 billion of assets under administration, respectively. These assets are not included in the Consolidated Financial Statements.
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COMMERCIAL BANKING
Middle-Market Banking
At September 30, 2007, December 31, 2006 and September 30, 2006, middle market loans, including commercial and owner-occupied commercial real estate, totaled $1.5 billion. Originations for the three months ended September 30, 2007 totaled $30.1 million as compared to $146.0 million for the comparable period in 2006.
Commercial Real Estate Lending
Commercial real estate loans totaled $1.9 billion at both September 30, 2007 and December 31, 2006 and $1.8 billion at September 30, 2006. Growth in the portfolio continued to be offset by prepayments as borrowers find more attractive rates and structures primarily in the secondary markets. Included in these loans are owner-occupied and non-owner occupied loans originated by the Middle Market division and the Business & Professional Banking divisions of $711 million at September 30, 2007, $764 million at December 31, 2006 and $609 million at September 30, 2006. The balance of the portfolio is administered by the Commercial Real Estate Division. During the three months ended September 30, 2007, originations totaled $50.9 million compared to $41.6 million for the comparable period in 2006.
Asset-Based Lending
At September 30, 2007, asset-based loans totaled $806.6 million, compared to $765.9 million at December 31, 2006 and $821.7 million at September 30, 2006. The majority of these loans are managed by Webster Business Credit Corporation (“WBCC”), an asset-based lending subsidiary, which is headquartered in New York, NY. In addition to direct originations, WBCC generally establishes depository relationships with the borrower through cash management accounts. At September 30, 2007, December 31, 2006 and September 30, 2006, the total of these deposits was $23.0 million, $48.6 million and $46.7 million, respectively. During the three months ended September 30, 2007, WBCC funded loans of $17.7 million, with new commitments of $61.0 million, compared to funding loans of $60.4 million with new commitments of $120.1 million for the comparable period in 2006.
Equipment Financing
Center Capital Corporation (“Center Capital”), a nationwide equipment financing subsidiary of Webster Bank, headquartered in Farmington, CT, had a portfolio which totaled $980.7 million at September 30, 2007, compared to $889.8 million at December 31, 2006 and $864.5 million at September 30, 2006. Center Capital originated $109.9 million in loans during the three months ended September 30, 2007, compared to $99.8 million during the comparable period in 2006.
Insurance Premium Financing
Budget Installment Corporation (“BIC”), an insurance premium financing subsidiary, headquartered in Garden City, NY, provides products covering commercial property and casualty policies for businesses throughout the United States. BIC had total loans outstanding of $92.0 million at September 30, 2007, compared to $90.0 million at December 31, 2006 and $93.3 million at September 30, 2006. Loans originated in the three months ended September 30, 2007 totaled $55.9 million, compared to $59.7 million for comparable period in 2006.
Asset Quality
Loan Portfolio Review and Allowance for Credit Losses 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 credit losses is maintained at a level estimated by management to provide adequately for probable losses inherent in the current loan portfolio and unfunded commitments. Probable losses are estimated based upon a quarterly review of the loan portfolio, past loss experience, specific problem loans, economic conditions and other pertinent factors which, in management’s judgment, deserve current recognition in estimating credit losses. In assessing the specific risks inherent in the portfolio, management takes into consideration the risk of loss on nonaccrual loans, classified loans and watch list loans including an analysis of the collateral for such loans.
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The allowance for credit losses analysis includes consideration of the risks associated with unfunded loan commitments and letters of credit. These commitments are converted to estimates of potential loss using loan equivalency factors, and include internal and external historic loss experience. At September 30, 2007, the reserve for unfunded credit commitments was $9.5 million, which represents 5.8% of the total allowance for credit losses.
Management considers the adequacy of the allowance for credit losses to be a critical accounting policy. 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 market 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 credit losses is adequate as of September 30, 2007, actual results may prove different and these differences could be significant.
See the Allowance for Credit Losses Methodology section within Management’s Discussion and Analysis on pages 40 through 43 of Webster’s 2006 Annual Report on Form 10-K for additional information.
Nonperforming Assets
Nonperforming assets consist of nonaccrual loans and foreclosed properties. Nonperforming assets are summarized in the following table:
Loans accounted for on a nonaccrual basis:
Commercial:
Commercial banking
Total commercial
Residential:
Originated by NCLC
All other originations
Total residential
Consumer (2)
Total nonaccruing loans
Foreclosed properties
Total nonperforming assets
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Nonperforming assets were $104.2 million at September 30, 2007, an increase of $42.3 million from December 31, 2006. The increase is comprised of a $36.4 million increase in nonaccrual loans and a $5.9 million increase in foreclosed properties. The $36.4 million increase in nonaccrual loans from December 31, 2006, was primarily the result of an increase of $22.0 million in nonaccrual residential loans, $10.6 million in nonaccrual consumer loans and $7.2 million in nonaccrual commercial loans, partially offset by a $3.4 million reduction in nonaccrual commercial real estate loans as a result of principal pay downs.
The increase in nonaccrual commercial loans is primarily related to several loans to one middle market customer that were classified as nonaccrual during the quarter. The increase in consumer nonaccrual loans relates in part to home equity loans and lines that were originated as no income verification loans and that have high combined loan-to-value ratios.
The increase in residential nonaccrual loans relates primarily to $18.5 million of residential construction loans originated by the Company’s NCLC operations. The Company has previously announced that it has discontinued residential construction lending outside of its primary New England market area. In connection with discontinuing this activity the Company allocated $10.0 million of allowance for loan losses during the first quarter of 2007 to this portfolio, and since has recorded $2.2 million in charge-offs. In accordance with FFIEC regulations, the Company is obtaining independent valuations on nonaccrual residential construction loans and any adjustment in value would result in a charge to the allowance designated for such loans. While management believes the remaining $7.8 million allowance is adequate as of September 30, 2007, actual results may prove different and these differences could be significant.
The allowance for loan losses at September 30, 2007 was $154.5 million and represented 1.24% of total loans in comparison with an allowance of $147.7 million that represented 1.13% of total loans at December 31, 2006. For additional information on the allowance, see Note 6 of Notes to Consolidated Interim Financial Statements elsewhere in this report.
Included in the table above are $7.4 million of commercial loans, related to one customer, which went on nonaccrual during the second quarter of 2007 and were restructured during the third quarter of 2007. Not included in the totals above are residential and consumer performing troubled debt restructurings of $144,000 at September 30, 2007, December 31, 2006 and September 30, 2006.
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Other Past Due Loans
The following table sets forth information regarding Webster’s over 30-day delinquent loans, excluding loans held for sale and nonaccrual loans.
Past due 30-89 days:
Commercial
Past due 90 days or more:
The increase in over 30 day delinquent loans of $25.6 million from December 31, 2006, is primarily the result of a $19.4 million increase in residential loans past due and an $11.6 million increase in consumer loans past due offset by a decrease in commercial real estate past due loans of $5.5 million. The increase in residential past due loans is primarily related to residential construction loans that were originated by the Company’s NCLC operations. The increase in consumer past due loans is in part attributable to loans that were originated with no income verification and that have a high combined loan-to-value ratio.
Total deposits increased $95.6 million, or 0.8%, to $12.6 billion at September 30, 2007 from December 31, 2006 and $250.0 million, or 2.0%, from September 30, 2006. The deposit growth occurred primarily in Savings and HSA categories and has been driven by new deposits to the bank.
Borrowings and Other Debt Obligations
Total borrowed funds, including long-term debt, decreased $300.8 million, or 11.6%, to $2.3 billion at September 30, 2007 from $2.6 billion at December 31, 2006. Borrowings represented 13.6% of assets at September 30, 2007 compared to 15.1% at December 31, 2006 and 21.9% at September 30, 2006. See Notes 10 and 11 of Notes to Consolidated Interim Financial Statements for additional information.
On April 2, 2007 Webster prepaid $105.0 million of its Capital Trust I and II securities that paid 9.57% pre-tax, at call prices of 104.68% and 105.0%, respectively, plus accrued and unpaid interest. As previously disclosed, Webster recorded a net pretax charge to income in the second quarter of 2007 of $6.8 million ($8.9 million related to the redemption premiums and unamortized issuance costs, partially offset by a $2.1 million gain on Webster Capital Trust I and II securities held by Webster).
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On June 20, 2007, Webster and Webster Capital Trust IV, a statutory trust organized under Delaware law pursuant to a trust agreement dated as of February 6, 2004 (“Trust IV”), completed the sale of $200 million of the Trust IV’s 7.65% Fixed to Floating Rate Trust Preferred Securities (the “Trust Securities”). The Trust Securities were issued at a discount of approximately $656,000, which will be amortized into interest expense over the life of the Trust Securities. The proceeds from the sale of the Trust Securities were used to purchase $200,010,000 aggregate principal amount of Webster’s 7.65% Fixed to Floating Rate Junior Subordinated Notes (the “Junior Subordinated Notes”). The Trust Securities are guaranteed on a subordinated basis by Webster pursuant to a Guarantee Agreement (the “Guarantee”), between Webster and The Bank of New York, as Guarantee Trustee.
The Junior Subordinated Notes will bear interest from the date of issuance to but excluding June 15, 2017 at the annual rate of 7.65% of their principal amount. From and including June 15, 2017 to but excluding June 15, 2037, the initial scheduled maturity date, the Junior Subordinated Notes will bear interest at a floating annual rate equal to three-month LIBOR plus 1.89%. If any Junior Subordinated Notes remain outstanding after June 15, 2037, they will bear interest at a floating annual rate equal to one-month LIBOR plus 2.89%, provided that if Webster elects to extend the scheduled maturity date for the Junior Subordinated Notes, they will bear interest from June 15, 2037 to but excluding the scheduled maturity date at a floating annual rate equal to three-month LIBOR plus 2.89% and thereafter at a floating annual rate equal to one-month LIBOR plus 2.89%. The scheduled maturity date of the Junior Subordinated Notes may be extended at Webster’s option up to two times, in each case for an additional 10-year period if certain criteria are satisfied. Webster may, at its option from time to time, defer interest payments on the Junior Subordinated Notes as provided for in the Indenture.
On June 15, 2007, Webster sold an interest rate swap hedging the forecasted Trust Securities’ transaction which qualified for hedge accounting in accordance with FAS 133 for a gain of $2.7 million. The $2.7 million gain was deferred and added to the carrying value of the Junior Subordinated Notes and is being amortized and recorded to interest expense over ten years, which represents the fixed rate term of the Junior Subordinated Notes. The effect of this transaction reduces the net cost of the Trust Securities to 7.5% through June 15, 2017.
On June 20, 2007, in connection with the closing of the Trust Securities offering, the Company entered into a Replacement Capital Covenant (the “RCC”), whereby the Company agreed for the benefit of certain of its debt holders’ named therein that it would not cause the redemption or repurchase of the Trust Securities or the Junior Subordinated Notes during the time period specified in the RCC unless such repurchases or redemptions are made from the proceeds of the issuance of certain qualified securities and pursuant to the other terms and conditions set forth in the RCC.
The proceeds from the issuance of the Junior Subordinated Notes were used for general corporate purposes.
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. Earnings 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. 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. Key assumptions in both Earnings and Equity at risk include the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From these interest rate risk measures, 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.
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The following table summarizes the estimated impact that gradual parallel changes in interest rates of 100 and 200 basis points over a twelve month period starting September 30, 2007 and December 31, 2006 might have on Webster’s net income for the subsequent twelve month period.
September 30, 2007
December 31, 2006
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 period yield curve constant over a twelve month forecast horizon. Webster is well within policy limits for all scenarios. The flat rate scenario at the end of 2006 assumed a fed funds rate of 5.25%. The flat rate scenario as of September 30, 2007 has a fed funds rate of 4.75%. The reduction in earnings volatility to higher rates since year end is mainly due to customer movement into more rate sensitive deposits, a reduction in equity from share buybacks. Another reason is the passage of time and its impact on the additional income recognition of unamortized premium on certain callable FHLB advances if rates rise and the advances are called. The change in the lower rate scenarios was also impacted by deposit movement and the reduction in equity as well as to higher mortgage rates at the end of September which reduced asset prepayment risk.
The following table summarizes the estimated impact that immediate non-parallel changes in interest rates might have on Webster’s net income for the subsequent twelve month period starting September 30, 2007.
The non-parallel scenarios are modeled with the short end of the yield curve moving up or down 50 and 100 basis points while the long end of the yield curve remains unchanged and vice versa. The short end of the yield curve is defined as terms less than 18 months and the long end as terms of greater than 18 months. Webster’s net income generally benefits from a fall in short term interest rates since more new and existing liabilities than assets are tied to short term rates. The ultimate benefit Webster derives from this mismatch is dependent on the pricing elasticity of its large managed rate core deposit base. An increase in short term interest rates has the opposite effect on net income. Webster’s net income generally benefits from a rise in long term interest rates since more new and existing assets than liabilities are tied to long term rates. A decline in long term interest rates has the opposite effect. These results reflect the annualized impact to earnings of immediate rate changes. The actual impact can be uneven during the year especially in the Short End scenarios where asset yields tied to Prime or LIBOR change immediately while certain deposit rate changes take more time. Webster introduced policy limits for these yield curve twist scenarios in 2007 and is within policy for all scenarios.
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The following table summarizes the estimated economic value of assets, liabilities and off-balance sheet contracts at September 30, 2007 and December 31, 2006 and the projected change to economic values if interest rates instantaneously increase or decrease by 100 basis points.
Book
Value
EstimatedEconomic
Liabilities
Net change as % of base net economic value
The book value of assets exceeded the estimated economic value at September 30, 2007 and December 31, 2006 principally because the equity at risk model assigns no value to goodwill and other intangible assets, which totaled $816.5 million and $825.0 million, respectively.
Changes in net economic value are primarily driven by changing durations of assets and liabilities which are influenced by changes in the level of interest rates, interest rate volatilities and spreads. Although long term rates and rate volatilites are similar to last year, Mortgage spreads, especially jumbo, have widened considerably. The changes in mortgage spreads have had a modest impact on equity at risk at September 30, 2007 versus December 31, 2006 in both the +100 and -100 basis point scenarios, as seen in the table above.
These net income and economic value estimates assume that management does not take any action to mitigate any positive or negative effects from changing interest rates. The estimates are subject to factors that could cause actual results to differ. Management believes that Webster’s interest rate risk position at September 30, 2007 represents a reasonable level of risk given the current interest rate outlook. Management, as always, is prepared to act in the event that interest rates do change rapidly.
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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 September 30, 2007 and December 31, 2006, FHLB advances outstanding totaled $0.6 billion and $1.1 billion, respectively. Webster Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $1.3 billion and $1.6 billion at September 30, 2007 and December 31, 2006, respectively. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $0.3 billion at September 30, 2007 or used to collateralize other borrowings, such as repurchase agreements.
The primary sources of liquidity for the Company are dividends from Webster Bank, investment income and net proceeds from borrowings and capital offerings. The main uses of liquidity are purchases of available for sale securities, the payment of dividends to common stockholders, repurchases of Webster’s common stock and the payment of principal and interest to holders of senior notes and capital securities. There are certain restrictions on the payment of dividends by Webster Bank to the Company. At September 30, 2007, $56.1 million of retained earnings were available for the payment of dividends to the Company. Webster also maintains $75.0 million in available revolving lines of credit with correspondent banks.
For the three months ended September 30, 2007, a total of 1,156,356 shares of common stock were repurchased at an average cost of $42.39 per common share. 1,152,800 shares were repurchased as part of the June 5, 2007, 2.8 million share stock buyback program with 678,900 shares remaining available to be repurchased under this program. On September 26, 2007 the Company’s Board of Directors authorized the repurchase of up to 5 percent of the Company’s common stock or approximately 2.7 million of its 53.6 million shares then outstanding. The remaining 3,556 shares were repurchased outside of the publicly announced repurchase program in the open market to fund equity compensation plans. See Note 12 of Notes to Consolidated Interim Financial Statements within this report for further information.
As previously announced, on April 2, 2007 Webster redeemed all of the securities of Webster Capital Trust I and II.
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 44-46 under the caption “Asset/Liability Management and Market Risk.”
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2007 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 (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). 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.
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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 1A. RISK FACTORS
During the three months ended September 30, 2007, there were no material changes to the risk factors relevant to Webster’s operations, which are described in the Annual Report on Form 10-K for the year ended December 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS
Period
Total Number of
Shares
Purchased
Average Price
Paid Per Share
Shares Purchased
as Part of PubliclyAnnounced Plans
or Programs
Maximum Number ofShares that May Yet BePurchased under the
Plans or Programs (1)
July 1-31, 2007
August 1-31, 2007
September 1-30, 2007
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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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.
/s/ Gerald P. Plush
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